Former Fifth Third employees, who are participants in the company’s employee stock ownership plan (ESOP), filed a class action lawsuit in the wake of the subprime lending crisis alleging that ESOP fiduciaries breached their duties of loyalty and prudence by remaining invested in Fifth Third stock despite it being overvalued and excessively risky.
At issue in the case was whether ESOP fiduciaries are entitled to a “presumption of prudence” when their decision to invest in employer stock is challenged under ERISA’s duty of prudence. Before the case reached the Supreme Court, each of the seven Courts of Appeals to have considered the question held that the presumption applies to such decisions.
But the Supreme Court unanimously held that ESOP fiduciaries are not entitled to a presumption of prudence. ESOP fiduciaries are instead subject to the same duty of prudence as all other ERISA fiduciaries, except that they are exempt from the duty to diversify plan assets, and the duty of prudence to the extent that it requires diversification.
After holding that ERISA does not create a presumption of prudence for ESOP fiduciaries, the Court went on to provide a road map for lower courts to utilize in “weeding out meritless claims” at the motion to dismiss stage under the plausibility pleading standard set forth in Twombly and Iqbal. The Court provided direction with respect to breach of fiduciary duty claims based on publicly available information, as well as those based on inside information.
Publicly Available Information: ERISA fiduciaries are entitled to prudently rely on market prices of publicly traded stocks. As long as the stock is publicly traded, it is implausible to claim that the fiduciary should have known the stock was over- or undervalued based solely on publicly available information, absent special circumstances. Failing to outsmart the market is not a plausible basis for imposing fiduciary liability.
Inside Information: To state a plausible claim for breach of the duty of prudence based on a failure to act on inside information, the plaintiff must allege a legal alternative action the fiduciary could have taken, consistent with securities laws, that a prudent fiduciary in the same circumstances would not have thought was more likely to do harm than good. The Court provided three points to assist with this analysis:
- ERISA fiduciaries are not required to break the law. The duty of prudence does not allow a fiduciary to sell off the plan’s holdings of employer stock based on inside information, which would violate securities laws.
- When a claim is based on a failure to use inside information to halt further purchases of employer stock, or a failure to disclose that information to the public, courts should consider whether obligating fiduciaries to engage in such actions would conflict with securities laws.
- Courts should also consider whether the complaint has plausibly alleged that a prudent fiduciary could not have concluded that halting further purchases of employer stock or disclosing negative information to the public would do more harm than good.
The Court ultimately vacated the decision of the Sixth Circuit and remanded the case with directions to analyze the complaint in light of its new standard.
Although the Court rejected the presumption of prudence, the remainder of its opinion illustrates the difficult course plaintiffs will have to navigate to survive a motion to dismiss. It called upon the lower courts to “readily divide the plausible sheep from the meritless goats . . . through careful, context-sensitive scrutiny of a complaint’s allegations.”
The Court all but rejected the theory that imprudent investment claims based on over- or undervaluation of stock can be based solely on publicly available information, such as a housing market crisis that causes stock prices of banks to drop nationwide. Its standard for claims based on inside information is filled with negatives (and sometimes double negatives), as well as various avenues for courts to reject claims based on conflicts with securities laws.
To this end, as it did during oral argument, the Court made clear that it is concerned with potential conflicts between obligations imposed on ERISA fiduciaries and “the complex insider trading and corporate disclosure requirements imposed by the federal securities laws or with the objectives of those laws.” The Court took special note that the U.S. Securities and Exchange Commission has not yet weighed in on these matters, and the Court believes those views could be relevant.
In the short term, ESOPs and stock-drop claims are likely to live another day. The long-term impact of Fifth Third remains to be seen. While plaintiffs no longer need to overcome the presumption of prudence, whether their claims are based on publicly available information or inside information, they appear to have an uphill battle going forward.