On June 25, the Supreme Court issued a unanimous decision in Fifth Third Bancorp v. Dudenhoeffer, which is likely to change the future of the Employee Retirement Income Security Act (ERISA) stock drop litigation.
The plaintiffs in the case were participants in Fifth Third Bancorp’s defined contribution plan (the Plan). The Plan had a number of different investment options, including an employer stock fund that was designated as an employee stock ownership plan (ESOP). The ESOP portion of the Plan was required to be invested primarily in Fifth Third common stock.
The plaintiffs alleged that the Plan fiduciaries breached their fiduciary duties and should have known, on the basis of both publicly available information and inside information, that the Fifth Third stock was overpriced and excessively risky.
The plaintiffs alleged that that the Plan fiduciaries should have (1) sold the ESOP’s holdings of Fifth Third stock before its value declined, (2) refrained from purchasing any more of Fifth Third’s stock, (3) cancelled the ESOP option in the Plan and (4) disclosed the inside information so that the market would adjust its valuation of Fifth Third’s stock downward and the ESOP would no longer be overpaying for the stock.
The Plan fiduciaries, however, continued to hold and purchase Fifth Third stock and the price of Fifth Third’s stock declined by 74 percent between July 2007 and September 2009.
The District Court dismissed the case for failure to state a claim. In dismissing the case, the District Court held that where a lawsuit challenges ESOP fiduciaries’ investment decisions, “the plan fiduciaries start with a presumption that their ‘decision to remain invested in employer securities was reasonable.’” The District Court held that this presumption applied at the pleading stage of litigation and that the plaintiffs’ allegations were insufficient to overcome the presumption.
The Sixth Circuit Court of Appeals reversed the District Court. The Sixth Circuit agreed that the fiduciaries are entitled to a presumption of prudence, but determined that the presumption only applied at the evidentiary stage and not at the pleading stage. The Sixth Circuit held that the plaintiffs’ allegations were sufficient to state a claim for breach of fiduciary duty.
Supreme Court Decision
Fifth Third appealed the Sixth Circuit’s decision. The Supreme Court held that ESOP fiduciaries are not entitled to a presumption of prudence. Rather, ESOP fiduciaries are subject to the same standard of prudence that applies to all ERISA fiduciaries, except that an ESOP fiduciary is under no duty to diversify the ESOP’s investments.
The Supreme Court remanded the case to the Court of Appeals with guidance on how to apply the pleading standard. In its decision, the Court provided that when a stock is publicly traded, an allegation that a fiduciary should have recognized from publicly available information alone that the stock was overvalued or undervalued is generally implausible, absent special circumstances.
The Supreme Court also provided that to state a claim for breach of fiduciary duty on the basis of insider information, a plaintiff must allege an alternative action that the defendant could have taken that would be consistent with the securities laws and that a prudent fiduciary would not have viewed as more likely to harm the stock fund than help it. According to the Court, three points should be considered in this analysis:
ERISA does not require a fiduciary to break the law (e.g., federal securities laws).
Courts should consider whether the decision to purchase stock or failing to disclose information to the public could conflict with the insider trading laws and corporate disclosure requirements and the objectives of those laws.
Courts should consider whether a prudent fiduciary could have concluded that stopping purchases or publicly disclosing negative information would do more harm than good to the stock.
Future Stock Drop Litigation
After this case, plan fiduciaries no longer may rely on or benefit from a presumption of prudence with respect to investments in employer stock. Plan fiduciaries may also find that plan language authorizing continued investment in employer stock in the absence of certain dire circumstances will be of little value. At the same time, in the case of a publicly traded employer/plan sponsor and in the absence of non-public information, it appears that a claim for breach of fiduciary duty for purchasing employer stock or divesting of employer stock will remain limited. Absent special circumstances, plan fiduciaries may continue to assume that the market value of publicly traded employer stock is the best estimate of the stock’s value.
It remains to be seen how courts will apply the standards that the Supreme Court articulated for claims based on nonpublic information and for claims against the fiduciaries who purchase stock or retain the stock of a non-publicly traded employer. Nevertheless, it remains clear from the Supreme Court’s decision that plan fiduciaries must actively monitor an employer stock fund in accordance with ERISA’s prudence requirement and that fiduciaries remain personally liable if their failure to do so leads to financial harm to plan participants.