On June 25, 2014, the U.S. Supreme Court decided Fifth Third Bancorp et al. v. Dudenhoeffer et al., No. 12-751, holding that a fiduciary of an employee stock ownership plan (ESOP) is subject to the same duty of prudence that applies to ERISA fiduciaries, except that ESOP fiduciaries are not required to diversify fund assets. This decision rejects Moench v. Robertson, 62 F.3d 553 (3d Cir. 1995), and other lower court cases that adopted a presumption of prudence for ESOP investments in employer stock.
Fifth Third Bancorp maintains a 401(k) defined-contribution plan for its employees. Employees may contribute a portion of their compensation to the plan, and may direct those assets to be invested in a variety of different options, including an employer-stock fund that had been designated as an ESOP. The plan requires funds invested in the ESOP portion of the plan to be "invested primarily in shares of common stock of Fifth Third."
Several ESOP participants filed a putative class action against Fifth Third and various corporate officers, alleging that they were fiduciaries of the plan and that they had violated their ERISA duty of prudence. Specifically, the plaintiffs alleged that the fiduciaries should have known that Fifth Third's stock was overvalued and excessively risky based on public and non-public information. According to the plaintiffs, a prudent fiduciary would have taken some or all of the following actions: selling the ESOP's holdings of Fifth Third stock, refraining from purchasing additional Fifth Third stock, canceling the plan's ESOP option, and disclosing the inside information that they possessed so that the market would adjust its valuation of Fifth Third stock downward so that the ESOP would no longer be overpaying for the stock. The plaintiffs alleged that the fiduciaries instead continued to hold and buy Fifth Third stock, the price of which fell dramatically between 2007 and 2009, harming those participants who were invested in the stock.
The District Court dismissed the plaintiffs' complaint for failure to state a claim, concluding that fiduciaries of an ESOP plan are entitled to a presumption of prudence (i.e., a presumption that their decision to remain invested in the employer's securities was reasonable), and that the plaintiffs' complaint had failed to overcome that presumption. The Sixth Circuit reversed. While the court agreed that ESOP fiduciaries are entitled to a presumption of prudence, it concluded that the presumption is only an evidentiary presumption that does not apply at the pleading stage. The Sixth Circuit concluded that the allegations in the plaintiffs' complaint were sufficient to state a claim for breach of fiduciary duty.
The Supreme Court vacated the Sixth Circuit's judgment and remanded the case, holding that ESOP fiduciaries are not entitled to a presumption of prudence in their decision to buy or hold the employer's stock, or to continue to offer employer stock as an investment alternative under the plan. The Court began with Section 404(a)(1)(B) of ERISA (29 U.S.C. § 1104(a)(1)(B)), which imposes a "prudent-person" standard on plan fiduciaries when they make decisions about the investment and disposition of plan assets. ERISA Section 404(a)(1)(C) goes on to require ERISA fiduciaries to diversify plan assets. But Section 407(d)(6)(A) recognizes that ESOPs are designed to invest primarily in the employer's stock, meaning that an ESOP by definition will not be prudently diversified. Thus, Section 404(a)(2) exempts ESOP fiduciaries from the diversification requirement and also from Section 404(a)(1)(B)'s duty of prudence, but "only to the extent that it requires diversification."
The Court concluded from these statutory provisions that ERISA does not create a special presumption of prudence that favors ESOP fiduciaries. Instead, the Court held, "the same standard of prudence applies to all ERISA fiduciaries, including ESOP fiduciaries, except that an ESOP fiduciary is under no duty to diversify the ESOP's holdings." Thus, ESOP fiduciaries are not liable for losses that result from a failure to diversify, but they are subject to the duty of prudence just as other ERISA fiduciaries are. The Court rejected the argument that an ESOP's special purpose of promoting employee ownership of the employer's stock entitles ESOP fiduciaries to a presumption of prudence. The Court observed that neither ERISA's plain language nor Congress's purpose of promoting ESOPs justified "relaxing the duty of prudence as applied to ESOPs" with a presumption of prudence. The Court was also unpersuaded that plan documents could waive the fiduciaries' duty of prudence, or that a presumption of prudence was the only way to encourage employers to offer ESOPs to employees. And while the Court found "legitimate" the concern that if ESOP fiduciaries do not have a presumption of prudence they may face conflicts with the legal prohibition on insider trading, the Court believed that "alternative means" exist for dealing with any potential conflict.
The Court remanded the case to the Sixth Circuit to determine whether the plaintiffs stated an adequate claim under Rule 12 and the Iqbal/Twombly standard. The Court stated that allegations in a complaint that a fiduciary should have recognized from publicly available information alone that the market was over- or undervaluing the stock are implausible, "at least in the absence of special circumstances." And where a complaint alleges breach of the duty of prudence based on nonpublic information, the plaintiffs 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."
Justice Breyer delivered the opinion for a unanimous Court.
The Faegre Baker Daniels ERISA, Benefits & Executive Compensation practice will be issuing a legal update with more information regarding this case.
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