The U.S. Supreme Court recently eviscerated a key protection against stock drop lawsuits filed by participants in defined contribution plans that hold employer stock as an investment. In Fifth Third Bancorp et al. v. Dudenhoeffer, the Court unanimously held that fiduciaries of employee stock ownership plans (ESOPs) are not entitled to any presumption of prudence when facing lawsuits alleging a breach of fiduciary duty.
This is not a total victory for plaintiffs, however. Though the Court eliminated the so-called Moench presumption that had been widely adopted by the circuit courts, it also provided a new framework for pleading stock drop claims that sets a high bar for what is required to establish a breach of fiduciary duty under the Employee Retirement Income Security Act of 1974, as amended (ERISA).
The Supreme Court’s decision concerned the defined contribution retirement savings plan of Fifth Third Bancorp, a large, publicly traded financial services firm. Fifth Third employees were able to defer compensation to the plan, and those compensation deferrals were invested in, among other investment funds, an ESOP that primarily held shares of Fifth Third’s common stock. After Fifth Third’s share price fell by 74 percent over a two-year period, plan participants who had lost money as a result of the decline filed a putative class action contending that the fiduciaries of the plan breached their fiduciary duty by continuing to invest ESOP funds in Fifth Third stock.
According to the plaintiffs, the fiduciaries should have known that Fifth Third’s stock was overvalued and excessively risky due to public information concerning the company’s subprime lending exposure as well as nonpublic information the fiduciaries possessed as company officers. A prudent fiduciary in that situation, according to the plaintiffs, would have sold the ESOP’s holdings of Fifth Third stock, refrained from purchasing more of that stock, or disclosed the nonpublic information to prevent the stock from being overvalued.
ERISA imposes a duty on plan fiduciaries to invest plan assets “prudently.” Ordinarily, a prudent investor must research available investment options and make an informed investment decision based on that research. However, the Moench presumption, first articulated by the Third Circuit in 1995 in Moench v. Robertson, presumed compliance with ERISA’s prudence standard when ESOP fiduciaries invested plan assets in employer stock.
In some circuits, to rebut the presumption of prudent investment, a plaintiff would need to go so far as to make allegations implicating the company’s viability as an ongoing concern or suggesting serious mismanagement of the company. As a result, the Moench presumption made it more difficult for a plaintiff to prevail against a plan fiduciary based upon claims that the fiduciary acted imprudently in continuing to offer employer stock as an investment option.
Nevertheless, in Fifth Third, the Supreme Court, in a unanimous opinion authored by Justice Stephen G. Breyer, overturned the Moench presumption of prudence. The Court held that ESOP fiduciaries are subject to the same duty of prudence that applies to ERISA fiduciaries in general, except that they need not diversify the fund’s assets. Central to the Court’s holding was the fact that the “proposed presumption makes it impossible for a plaintiff to state a duty of prudence claim, no matter how meritorious, unless the employer is in very bad economic circumstances.”
Though it declined to sustain the presumption of prudence, the Court nevertheless was sympathetic to Fifth Third’s argument that companies are often subject to “meritless, economically burdensome lawsuits” resulting from the mere decrease in price of company stock. According to the Court, however, this presumption was not the appropriate mechanism for weeding out meritless claims. Rather, the Court believed that such concerns are more properly dealt with through a “careful, context-sensitive scrutiny of a complaint’s allegations.”
Justice Breyer set forth several considerations to assist lower courts in determining whether a plaintiff asserting ERISA breach of fiduciary duty claims has adequately pleaded a cause of action under the pleading standard established by Ashcroft v. Iqbal and Bell Atlantic Corp. v. Twombly:
First, the Court cited its recent opinion in Halliburton Co. v. Erica P. John Fund, Inc., noting that a security’s market price is often an “unbiased assessment of the security’s value in light of all public information.” Consequently, in the Court’s view, where “a stock is publicly traded, allegations that a fiduciary should have recognized on the basis of publicly available information that the market was overvaluing or undervaluing the stock are generally implausible and thus insufficient to state a claim.”
Second, the Court emphasized that ERISA’s duty of prudence cannot require a fiduciary to violate the law by performing an action that would run afoul of the federal securities laws. As a result, a plaintiff cannot state a claim for breach of the duty of prudence on the basis that the fiduciary should have utilized inside information to prevent losses to the fund by divesting company stock.
Finally, the Court cautioned lower courts that a prudent fiduciary could reasonably conclude that a halt in purchases of company stock by the fund—which the market might interpret as a sign that company insiders viewed the company stock as a bad investment—or a public disclosure of negative information would do more harm than good to the fund. Accordingly, to survive a motion to dismiss, a plaintiff must plausibly allege that the plan fiduciary could not reasonably have reached such a conclusion.
The Fifth Third decision is not likely to dramatically alter the landscape of ESOP stock drop suits, particularly for companies with publicly traded stock. Companies may no longer defeat such actions by relying upon the presumption of prudence, but plaintiffs nevertheless still face an uphill battle in surviving a motion to dismiss, particularly in light of the Court’s categorical rejection of allegations regarding improperly valued market price and failure to capitalize on inside information.
In the private company ESOP context, the Moench presumption similarly no longer applies, but ESOP fiduciaries might take some solace in the Court's consideration that a prudent fiduciary could conclude that certain actions might do more harm than good. In an illiquid market, for example, it would seem that an ESOP fiduciary who concludes that forcing a sale at a discount is not prudent may still have some protection under the Fifth Third decision.