The United States Supreme Court has held that the presumption of prudence in favor of an ESOP fiduciary investing employer stock in an ERISA plan, which Circuit Courts of Appeal have applied in stock drop cases, should not apply as it is inconsistent with ERISA fiduciary duties. The June 25, 2014 opinion in Fifth Third Bancorp v. Dudenhoeffer was unanimous.
Participants in the Fifth Third Bancorp defined contribution plan, which offered employer stock as one of numerous investment options that could be chosen by participants, sued the plan fiduciaries as a result of a 74% drop in Fifth Third Bancorp stock between June 2007 and September 2009. Participants alleged that the fiduciaries, who were officers of Fifth Third Bancorp, knew or should have known from publicly available information that the value of the stock was less than its market value. Participants alleged that the fiduciaries should have (i) sold the holdings of Fifth Third Bancorp stock, (ii) refrained from purchasing more Fifth Third Bancorp stock, (iii) cancelled the employer stock fund, and (iv) disclosed the inside information that the fiduciaries had as a result of being officers so that the market could convert downward the price of the stock. The defendants did none of these, and the value of the Fifth Third Bancorp stock fund deteriorated, resulting in significant loss of retirement savings for the participants. Although the facts of the case technically involved an ESOP, the same reasoning would apply to other individual account plans investing in employer stock.
District Court and Sixth Circuit Decisions
The District Court dismissed the action holding that a presumption of prudence applies in favor of an ESOP fiduciary that is required by the terms of the plan to invest in employer securities. The Sixth Circuit Court of Appeals agreed that there is a presumption of prudence, but held that it applies only at the evidentiary stage and not at the pleadings stage, and the Sixth Circuit reversed the District Court’s summary dismissal. The presumption of prudence was originally set forth in the Third Circuit case of Moench v. Robertson and has been referred to as the Moench presumption. The Moench presumption has been applied in various forms by many Federal Courts of Appeal.
Supreme Court Decision
The Supreme Court held that ESOP fiduciaries are not entitled to a special presumption of prudence. Rather, they are subject to the same duty of prudence that applies to ERISA fiduciaries generally, except that they do not need to diversify the ESOP’s assets. The Supreme Court remanded the case back to the Sixth Circuit to reconsider whether the complaint stated a valid claim based on further guidance set forth in the Supreme Court’s opinion.
The Supreme Court addressed the participants’ argument that the fiduciaries knew or should have known in light of publicly available information, such as newspaper articles, that continuing to hold and purchase Fifth Third Bancorp stock was imprudent. Justice Breyer, writing on behalf of the Supreme Court, stated:
“In our view, where a stock is publicly traded, allegations that a fiduciary should have recognized from publicly available information alone that the market was over- or undervaluing the stock are implausible as a general rule, at least in the absence of special circumstances.”
The opinion went on to state that a fiduciary usually is not imprudent to assume that a major stock market provides the best estimate of the value of the stock traded on it.
The Supreme Court next discussed the participants’ argument that the fiduciaries should have traded on the basis of inside information. The Supreme Court stated:
“To state a claim for breach of the duty of prudence on the basis of inside information, 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.”
In analyzing this argument, the Supreme Court stated that the ERISA duty of prudence does not require a fiduciary to break the law. The Supreme Court stated:
“As every Court of Appeals to address the question has held, ERISA’s duty of prudence cannot require an ESOP fiduciary to perform an action—such as divesting the fund’s holdings of the employer’s stock on the basis of inside information—that would violate the securities laws.”
The Supreme Court advised lower courts in evaluating a complaint that a fiduciary failed to decide, on the basis of inside information, to cease making purchases of employer stock or disclose the inside information so the stock would no longer be overvalued, to consider “the extent to which an ERISA-based obligation either to refrain on the basis of inside information from making a planned trade or to disclose inside information to the public could conflict with the complex insider trading and corporate disclosure requirements imposed by the federal securities laws or with the objectives of those laws.”
The Supreme Court concluded that:
“…lower courts faced with such claims should also consider whether the complaint has plausibly alleged that a prudent fiduciary in the defendant’s position could not have concluded that stopping purchases—which the market might take as a sign that insider fiduciaries viewed the employer’s stock as a bad investment—or publicly disclosing negative information 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 Supreme Court’s rejection of the Moench presumption is disappointing for plan fiduciaries. However, the opinion also rejects basic theories advanced by plaintiffs in stock drop cases. The Dudenhoeffer opinion has provided lower courts with guidance to dispose of these cases on a motion to dismiss.