The United States Supreme Court clarified the duty of prudence that employee stock ownership plan fiduciaries owe to plan participants in its June 25, 2014 decision Fifth Third Bancorp v. Dudenhoeffer 134 S.Ct. 2459 (U.S. 2014). The “presumption of prudence” no longer exists and employee stock ownership plan fiduciaries are subject to the same standard of prudence and liability as any ERISA fiduciary, aside from the duty to diversify.
The United States Supreme Court addressed the “presumption of prudence” for employee stock ownership plan (“ESOP”) fiduciaries. ESOPs are a type of pension plan that invest primarily in the stock of the company that employs the plan participants. Fifth Third Bancorp (“Fifth Third”) maintained a defined-contribution retirement savings plan for its employees and allowed the employees to direct their contributions to various plans, including its ESOP. The Fifth Third ESOP required its contributions to be primarily invested in shares of Fifth Third common stock.
The Fifth Third ESOP fiduciaries continued to purchase and hold Fifth Third stock until the subprime lending crisis caused the market to crash. Between July 2007 and September 2009, Fifth Third’s stock price dropped 74%. After suffering massive losses in their ESOP, the employees filed a class action against Fifth Third and several of its officers serving as fiduciaries to the ESOP. The employees alleged that Fifth Third and the officers violated their duties of loyalty and prudence imposed by the Employee Retirement Income Security Act of 1974 (“ERISA”). The employees claimed that the fiduciaries knew or should have known that the company’s stock was overvalued and excessively risky because (1) publicly available information such as newspaper articles provided warning, and (2) nonpublic information indicated that Fifth Third officers had deceived the market by making material misstatements about the company’s financial prospects.
Both the Federal District Court for the Southern District of Ohio and the Sixth Circuit Court of Appeals held that ESOP fiduciaries, though governed by ERISA and subject to the duty of prudence, are entitled to a “presumption of prudence.” These holdings were not supported by any statutory language mentioning a presumption of prudence. The Supreme Court disagreed with the lower courts in its Dudenhoeffer decision, ruling that there is no “presumption of prudence” and recognizing that ESOP fiduciaries are subject to the same duty of prudence as any other ERISA fiduciary. However, the Supreme Court acknowledged Congress’s statutory exemption for ESOPs. By its nature, an ESOP is not diversified because it consists almost entirely of an investment in the employer’s stock. Congress, therefore, reduced the ESOP fiduciaries’ duty of prudence only in regard to their duty to diversify. Otherwise, ESOP fiduciaries are held to the exact same standard as all other ERISA fiduciaries. Thus, the duty of prudence liability exists for ESOP fiduciaries to the same extent as all other ERISA fiduciaries, except for the failure to diversify.
For ESOP fiduciaries, this presents an issue because insider trading laws prohibit one from acting on inside information. Generally, ESOP fiduciaries are officers of the company and are privy to inside information, as was the case in Dudenhoeffer. However, the Supreme Court eased personal liability concerns, stating that the duty of prudence would not require one to break a law. Therefore, the duty of prudence could not require one to violate insider trading laws.
The Dudenhoeffer opinion also addressed the heightened pleading standards set forth in Twombly and Iqbal. The Supreme Court made two determinations. First, simply alleging that ESOP fiduciaries should have known of the overvaluation because of public information, such as newspapers, is implausible and fails to state a claim. Next, the employees had to identify a legal alternative course of action. As many of the potential alternative actions would have subjected the ESOP fiduciaries to insider trading liability they are not legal alternative actions. In addition to requiring a legal action, the ESOP fiduciaries had to view the action as more likely to help the fund than to harm it.
This article was co-written by Cot Eversole, 2014 Summer Associate.