The United States Supreme Court issued a unanimous opinion on June 25, 2014 in the case of Fifth Third Bancorp v. Dudenhoeffer. While the Supreme Court’s holding substantially affects the fiduciaries of all employee stock ownership plans (ESOPs), as well as fiduciaries of other individual account plans (such as 401(k) plans) that invest in employer stock, it does not signal the end of employer stock investments in qualified plans. In fact, the Court provided a brief outline of defenses for fiduciaries of certain plans investing in employer stock.
Under the Employee Retirement Income Security Act of 1974 (ERISA), each fiduciary of a retirement plan is required to discharge his or her duties in a prudent manner and solely in the interests of the participants and beneficiaries. Generally, plan fiduciaries are also required to diversify the plan’s asset to prevent large losses; however, a specific exception is provided from the diversification requirement for certain plans that are invested in employer stock.
Many courts of appeals, however, have given ESOP fiduciaries a “presumption of prudence” for their decisions to hold or buy employer stock. This presumption, often referred to as the “Moench presumption” (named after the infamous Third Circuit case in which it was initially created) was deemed necessary to further the corporate financing and investment goals of ESOPs.
The Supreme Court agreed to hear this case as a result of a conflict between the circuit courts on whether the Moench presumption should be applied at the pleading stage (in support of a motion to dismiss) or as a defense in the substantive case. Noteably, the circuit courts were not in disagreement as to whether the Moench presumption existed, only as to which stage of litigation it applied.
In a surprising twist, the Supreme Court concluded that the Moench presumption did not exist at all because it was not supported by the statutory language under ERISA. As a result, fiduciaries of plans that permit or require the investment in employer stock will have to defend their actions to invest or continue to invest in the stock of a company whose value has decreased. The Supreme Court did provide some comfort, however, that the fiduciary’s responsibilities under ERISA do not require it to violate securities laws (such as insider trading laws). Of course, this defense is of little assistance to fiduciaries of plans sponsored by privately held companies, as is the case for many ESOPs. It remains to be to seen as to whether Congress will step in and provide explicit relief in these situations. Until then, all plan fiduciaries should be diligent in periodicially reviewing plan investments in employer stock and adequately documenting their decisions to make or retain such investments – regardless of whether the plan document requires such investment.