In ERISA stock-drop class actions, plaintiffs routinely allege that their employers breached a duty of prudence by permitting employees to invest their retirement assets in their company’s stock. Until today, defendants typically defended against such claims by invoking a judicially crafted presumption that offering company stock was prudent. Today, in Fifth Third Bancorp v. Dudenhoeffer, No. 12-751 (pdf), the Supreme Court rejected that presumption.
But all hope is not lost for stock-drop defendants. Much of the work previously done by the presumption of prudence will now be done by the substantive requirements of the duty of prudence. The Court offered guidance as to what plaintiffs must demonstrate to survive a motion to dismiss—and the standards suggested by the Court will not be easy to satisfy.
As a starting point, fiduciaries who administer retirement plans governed by the Employee Retirement Income Security Act (ERISA) owe a duty of prudence to plan participants. See 29 U.S.C. § 1104(a). To comport with that duty, fiduciaries are generally required to “diversify the investments of the plan so as to minimize large losses, unless under the circumstances it is clearly prudent not to do so.” Id.§ 1104(a)(1)(C). But because Congress wanted to encourage employees to invest in their own companies, it waived the duty of prudence “to the extent it requires diversification” for fiduciaries of an “employee stock ownership plan” (ESOP). Id. § 1104(a)(2).
Several federal courts of appeals had inferred from this exemption that an ESOP fiduciary’s decision to hold or buy employer stock should be presumed prudent, and that the fiduciary could not be held liable unless the company was in such dire financial straits that its viability as a going concern was in doubt. In today’s unanimous opinion by Justice Breyer, the Court held that ERISA’s text provides no presumption—in particular, although Section 1104(a)(2) expressly exempts ESOP fiduciaries from the duty of prudence, to the extent that duty requires diversification, it makes no reference to any special presumption.
Having resolved the question presented, the Court proceeded to “consider more fully one important mechanism for weeding out meritless claims, the motion to dismiss for failure to state a claim,” and explained how, in light of the substance of the duty of prudence, motions to dismiss should be assessed.
The Court effectively ruled out stock-drop claims based on publicly available information, invoking its two-day-old decision in Halliburton Co. v. Erica P. John Fund, Inc. (pdf) (previously discussed on the blog), in which the Court opined that investors may reasonably rely on the market to incorporate public information into a stock’s price. For circumstances in which fiduciaries are alleged to possess nonpublic information that suggests it was imprudent to hold company stock, the Court held that “a plaintiff must plausibly allege an alternative action that the defendant could have taken that would have been consistent with the securities laws and that a prudent fiduciary in the same circumstances would not have viewed as more likely to harm the fund than to help it.” The Court emphasized that ERISA fiduciaries cannot be required to trade on insider information in violation of the securities laws. And the Court cast doubt on other theories sometimes offered by ERISA stock-drop plaintiffs—that fiduciaries should have ceased making new investments in company stock or disclosed the previously nonpublic information. The Court noted that ERISA’s requirements must be in harmony with “the complex insider trading and corporate disclosure requirements imposed by the federal securities laws” and the objectives of those laws, and indicated that ERISA’s fiduciary breach requirements do not require plan fiduciaries to take actions that “would do more harm than good to the fund by causing a drop in the stock price and a concomitant drop in the value of the stock already held by the fund.”
The Court’s decision fundamentally reconfigures the landscape for ERISA stock-drop class actions. Although the rejection of the presumption of prudence is likely to result in more suits against retirement plan fiduciaries, the Court’s substantive guidance arms class-action defendants with potent defenses that can be invoked at the motion-to-dismiss stage. The main issue left open by the Court—when, if at all, fiduciaries must act on nonpublic information—will be litigated extensively in the lower courts, and may ultimately percolate back up to the Supreme Court again.