Certain retirement plans, such as employee stock ownership plans (“ESOPs”), are specifically designed to invest all or a portion of their assets in stock of the sponsoring employer. For nearly twenty years, the federal courts have recognized the so-called “Moench presumption” under the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), in favor of decisions by ESOP fiduciaries to acquire and hold company stock. The Moench presumption, which first appeared in the case of Moench v. Robertson,1 has been invoked to achieve the dismissal of numerous “stock-drop” cases asserting that fiduciaries are liable under ERISA for declines in the value of company stock held under ESOPs and similar plans. Under Moench, lower courts generally have held that a fiduciary’s decision to invest in such stock may in certain cases be presumed to be prudent absent evidence to the contrary.
In Dudenhoeffer v. Fifth Third Bank,2 decided last week, the Supreme Court unanimously declined to recognize the existence of the Moench presumption. In a prior DechertOnPoint regarding the then-pending case, we noted that Dudenhoeffer, when ultimately decided, could have broad implications, possibly going well beyond the specifics of when and how the Moench presumption is applied.
As it turns out, the Supreme Court’s decision in Dudenhoeffer is indeed a broad rebuke to the six appellate court decisions that established and have continued to recognize the Moench presumption. However, as discussed below, the precise impact of Dudenhoeffer on ESOP sponsors, ESOP fiduciaries and litigation relating to the acquisition and holding of company stock under ESOPs and similar plans is yet to be determined. Indeed, while the Supreme Court’s repudiation of the Moench presumption may be welcome news to ERISA stock-drop plaintiffs, defendants may well be heartened by certain pronouncements in the Dudenhoeffer decision that potentially could make it more difficult for plaintiffs to prevail.
Dudenhoeffer Drops the Moench Presumption
Generally, under ERISA, a plan fiduciary must act prudently with respect to the fiduciary’s investment decisions for the plan. Prior to Dudenhoeffer, six federal circuit courts had held, in one form or another, that an ERISA plan’s investment in employer stock is presumed prudent if the plan documents expressly provide for such investment. The so-called Moench presumption derives from the various statutory provisions in ERISA and the facilitating and even encouraging investment in stock of the employer by ESOPs and other covered retirement plans. While the specifics of the presumption varied somewhat by circuit, generally the Courts of Appeals had held that an ESOP fiduciary’s decision to buy or hold company stock would be presumptively prudent absent special circumstances, such as a showing that the company was on the verge of collapse.
In Dudenhoeffer, the Supreme Court rejected the framework that plans designed to invest in employer stock are subject to a standard different from that which applies to ordinary ERISA plans. The Court held that the statutory duty of prudence applies regardless of any provision in a plan document, including any provision regarding the purchase or holding of employer stock. The Court acknowledged Congress’s intention of encouraging employee ownership of employer stock by retirement plans, and recognized that ERISA’s generally applicable diversification requirements do not apply to eligible individual account plans, like certain ESOPs. Nevertheless, the Court stated that there was a lack of authority indicating that Congress “sought to promote ESOPs by further relaxing the duty of prudence as applied to ESOPs” with the Moench presumption.
Pro-Fiduciary Aspects of Dudenhoeffer
Although Dudenhoeffer strikes down the defendant-friendly Moench presumption, there are aspects of the case that are likely helpful for plan sponsors and fiduciaries. In this regard, the Supreme Court specifically directed lower courts considering ERISA stock-drop cases to “to weed out meritless lawsuits” through “careful, context-sensitive scrutiny of a complaint’s allegations.”3
First, the Supreme Court stated that generally a fiduciary will not be imprudent for relying upon the market price of a publicly traded stock as indicating a fair value for such stock, because “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.” In effect, the Court endorsed public market prices as the best estimate of value, and confirmed that a fiduciary has no obligation to try to “outsmart a presumptively efficient market” or to “to predict the future of the company stock’s performance.” While Dudenhoeffer does hold open the possibility that there could be “special circumstances affecting the reliability of the market price,” the Court arguably indicated that information available to the public would not ordinarily be expected to rise to the level of a “special” circumstance.
Second, the Supreme Court also appears to have made it difficult for plaintiffs to assert stock-drop cases against fiduciaries who failed to act on the basis of non-public information. In order to base a fiduciary-breach claim on a fiduciary’s improper knowledge of inside information, the Supreme Court stated that a plaintiff cannot merely claim that the defendant should have disclosed or acted upon the inside information. Rather, the plaintiff “must plausibly allege an alternative action that the defendant could have taken that would have been consistent with the securities laws that a prudent fiduciary…would not have viewed as more likely to harm the fund than to help it.” Harkening back to issues that became the centerpiece of the oral argument in the case, the Supreme Court also held that plan fiduciaries cannot be required to sell company stock based on inside information. The Court stated that the “duty of prudence cannot require an ESOP fiduciary to perform an action . . . that would violate the securities laws.” The Supreme Court expressly stated that lower courts addressing whether a fiduciary should stop buying stock or disclose the non-public information should consider whether such actions “could conflict with the complex insider trading and corporate disclosure requirements imposed by the federal securities laws or with the objectives of those laws.”4
The Supreme Court also directed lower courts facing such claims to consider whether stopping plan purchases would do more harm than good by causing a drop in the stock price and, therefore, the value of the ESOP’s stock. This “more harm than good” standard had not previously been crystallized by the Court.
There is little doubt that the Supreme Court’s declining to adopt a presumption of prudence in Dudenhoeffer is a major and significant break with lower-court precedent. One of the issues that would be expected to unfold is the extent to which the Court’s decision not to recognize a presumption may cause plaintiffs’ cases to withstand dismissal at early stages of litigation, thereby adding to litigation costs and possibly increasing the likelihood of settlement.
However, the pro-fiduciary aspects of Dudenhoeffer are also significant, and there may be any number of arguments that plan sponsors and fiduciaries may still have, when faced with claims made in the context of stock-drop litigation.5 Thus, the precise manner in which Dudenhoeffer will affect litigation relating to retirement plans invested in company stock, and the willingness of companies to sponsor such plans, remains to be seen.6
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If you would like to discuss the Dudenhoeffer case and its possible implications, please contact one of the Dechert attorneys listed below or any Dechert attorney with whom you regularly work.