Supreme Court Unanimously Rejects Special "Presumption of Prudence" For Investment in Employer Stock

by Sherman & Howard L.L.C.
Contact

In the past, fiduciaries of employee stock ownership plans (ESOPs) and other defined contribution plans that invest in employer stock generally have been able to rely on a special “presumption of prudence” in court when defending their decisions to continue to offer employer stock as an investment option, even when the investment has substantially declined in value. This special presumption of prudence ceased to exist on June 25, 2014, when the United States Supreme Court released its unanimous opinion in Fifth Third Bancorp v. Dudenhoeffer [1] holding that there is no special presumption of prudence applicable to fiduciaries with respect to employer stock held in a retirement plan. However, the Supreme Court’s opinion provides some helpful guidance to fiduciaries of plans which continue to permit investments in employer stock.

Background

The special presumption of prudence is also known as the “Moench Presumption” in reference to the Third Circuit Court of Appeals’ decision in Moench v. Robertson [2]. Under ERISA, ESOP trustees are excused from the fiduciary requirement to diversify the plan’s investments, as well as the obligation to act prudently as it relates to the diversification obligation. Previously, courts following the Moench decision presumed that ESOP fiduciaries making decisions to buy or sell employer stock had acted prudently, because ESOPs are intended to invest primarily in employer securities and, in fact, ESOP documents generally require such investments. Under this presumption, fiduciaries could be held liable for losses resulting from employer stock investments only if there was a specific showing that the investment was significantly imprudent. Over the years, some courts also extended the Moench Presumption to cases involving other types of defined contribution plans which required or permitted investments in employer stock.

In the Fifth Third case, former employees brought suit against Fifth Third Bancorp, a bank that did substantial business in subprime lending. The plaintiffs alleged, in a “stock drop” case, that the fiduciaries of the ESOP sponsored by Fifth Third breached their ERISA duty of prudence by continuing to invest in employer stock that the fiduciaries either knew or should have known was inflated in value, and which subsequently lost almost three-quarters of its value. The plaintiffs argued that the plan’s fiduciaries had access to sufficient public and nonpublic information about the bank (e.g., newspaper articles indicating the imminent collapse of the subprime lending market; material misstatements by bank officers about the bank’s financial prospects; etc.) to be aware that the stock was overvalued in the market. The plaintiffs argued that the continued investment in employer securities was a violation of fiduciary duties, and that the fiduciaries should have refrained from further purchases of employer stock, sold employer stock held by the ESOP, and/or disclosed insider information about the employer so that the stock market would adjust the price downward.

The Supreme Court took the Fifth Third case in order to consider whether the Moench Presumption applies to ESOP fiduciaries. Ultimately, the Supreme Court eliminated the presumption of prudence entirely, holding that ESOP fiduciaries are subject to ERISA’s prudent expert standard and that the statutory exception relating to ESOPs only relieves fiduciaries from the fiduciary duty to diversify plan investments. The Supreme Court reasoned that the statutory exemption from the duty of prudence explicitly states that it only applies “to the extent that it requires diversification,” and it makes no reference to any special presumption of prudence.

Some Guidance for Courts and for Plan Fiduciaries

The Supreme Court’s decision in Fifth Third provides a roadmap of the elements of judicial consideration to be applied in determining whether plaintiffs have stated a “plausible claim” against the fiduciaries. Under that decision, courts should consider the following elements in determining whether a claim alleging a breach of the duty of prudence in the context of a stock drop scenario is a plausible claim (and plan fiduciaries should consider these elements when determining whether employer stock is a prudent investment for a plan):

  • Publicly available information: Allegations that a fiduciary should have recognized, from public information alone, that the marketplace was either over- or under-valuing publicly traded employer stock are “implausible as a general rule,” absent special circumstances. As a result, generally, a fiduciary will be not considered imprudent in assuming that the market value of employer stock on a major stock exchange provides the best estimate of the stock’s value. The Supreme Court did not elaborate on what circumstances might give rise to a situation where reliance on the stock price as set on a public exchange is not considered prudent. The Court also did not provide guidance to fiduciaries of plans that are invested in employer stock that is not publicly traded.
     
  • Insider information: A claim for the breach of the duty of prudence on the basis of insider information will not survive in court unless the plaintiff can plausibly allege another legal course of action that the fiduciary could have taken. The Supreme Court cautioned that the fiduciary duties imposed under ERISA could never require a fiduciary to violate securities laws (i.e., require the fiduciary to remove the stock based on insider information), and that a decision not to stop additional purchases of employer stock or publicly disclose insider information should be considered in light of securities laws and objectives. Also, the alternative course of action must be one that a prudent fiduciary in the same situation would not have viewed as more likely to harm the employer stock fund than to help it (e.g., could a prudent fiduciary have concluded that ceasing investment in employer stock, or selling stock, would have caused or worsened a decline in the value of the stock).

Although this discussion in the decision may be helpful in the context of the investment in stock of a publicly traded company, this discussion provides only limited assistance to fiduciaries of plans that are invested in the stock of a privately-held company. Still, it is clear from the decision that fiduciaries are subject to the same prudence requirements for the investment in employer stock as are applied to any other investment of plan assets.

What Should Fiduciaries Do Now?

Fiduciaries should be aware that plan document provisions that expressly require investment in employer stock, or requiring the offering of employer stock as an investment option, do not eliminate the duty of fiduciary prudence with respect to continued investment in employer stock. Sponsors of plans that require that fiduciaries invest in employer stock may wish to revisit the wording of those plan provisions.

However, the elimination of the Moench Presumption should not discourage employers from including or retaining employer stock in their plans. Although plan document language mandating investment in employer stock is not sufficient to avoid claims of breach of fiduciary duty, the guidance provided by the Fifth Third decision should be able to help plan fiduciaries in avoiding such claims. In addition, future court challenges likely will provide some guidance as to what special circumstances are relevant with respect to reliance on publicly available information in making decisions with respect to the investment in employer stock.

Finally, because fiduciaries may no longer rely on the Moench Presumption with respect to the investment in employer stock, fiduciaries should review their procedures to regularly monitor and review the decision to acquire or retain employer stock. Furthermore, fiduciaries will need to ensure those procedures are being followed and the monitoring and decision-making process documented. Fiduciaries also will need to determine how best to evaluate the value of employer stock while still satisfying their duty of prudence. Also, plan sponsors may want to consider whether retaining an independent fiduciary to monitor the employer stock investments in the retirement plan is advisable.


[1] Fifth Third Bancorp v. Dudenhoeffer, 573 U.S. _____ (2014).
[2] Moench v. Robertson, 62 F.3d 553 (3d Cir. 1995).

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Sherman & Howard L.L.C. | Attorney Advertising

Written by:

Sherman & Howard L.L.C.
Contact
more
less

Sherman & Howard L.L.C. on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.
Feedback? Tell us what you think of the new jdsupra.com!