In 1995, the Third Circuit adopted the presumption that an employee stock ownership plan (“ESOP”) fiduciary’s decision to remain invested in the employer’s securities was prudent. Over the following years, a number of other circuits adopted this presumption of prudence.
However, in June 2014, the Supreme Court issued a unanimous decision in Fifth Third Bancorp v. Dudenhoeffer, holding that fiduciaries of ESOPs are not entitled to a presumption of prudence. Despite this rejection of the presumption of prudence, the Supreme Court provided clear guidance to the lower courts, instructing them to carefully consider the plausibility of claims alleging breach of the fiduciary duty of prudence under ERISA based upon publicly traded employer stock drop allegations. (To read more on Alston and Bird’s analysis on the Supreme Court’s decision in Dudenhoeffer, please clickhere.)
Recently, a divided panel of the Sixth Circuit revisited Pfeil v. State Street Bank, following the decision in Dudenhoeffer, and the majority found that, even without the presumption of prudence, State Street was not liable for its role as a fiduciary of General Motor’s (“GM”) ESOP, during the period of time that led to GM filing for bankruptcy in 2009. Pfeil v. State Street Bank & Trust Co., No. 14–1491, 2015 WL 6874769 (6th Cir. Nov. 10, 2015) (“Pfeil II”). In doing so, the majority found that State Street adhered to a prudent process in evaluating whether to keep GM’s stock in the plan. For more on this decision and its potential impact on post-Dudenhoeffer fiduciary litigation, please read below.
Background of Pfeil v. State Street
State Street served as a fiduciary of certain pension plans for employees of GM, including the Common Stock Plan. In 2008, the Common Stock Plan lost money, as GM faced severe business problems that culminated in the company filing for bankruptcy. State Street continued to buy GM stock until November 8, 2008 and did not divest the Common Stock Plan of the GM stock until March 31, 2009. This lawsuit was filed shortly after the divesture.
The plaintiff alleged that State Street’s decision to continue to buy stock and to hold on to GM common stock was imprudent under ERISA. In 2010, the United States District Court for the Eastern District of Michigan granted State Street’s motion to dismiss, holding that State Street was entitled to a presumption of prudence regarding its decisions related to buying and keeping GM’s stock in the Plan. In February 2012, the Sixth Circuit reversed the District Court’s decision and held that the presumption of prudence could not be applied before the summary judgment stage of the litigation.
The case was remanded to the District Court, and after class certification, State Street moved for summary judgment. The District Court granted summary judgment in State Street’s favor, again applying the presumption of prudence. The plaintiff filed a timely appeal to take the case back to the Sixth Circuit (Pfeil II). The Supreme Court then abolished the presumption of prudence in the 2014 decision in Dudenhoeffer.
Majority Opinion in Pfeil II
Circuit Court Judge Boggs authored the majority opinion on the second appeal, which was joined by Judge Suhrheinrich. The majority affirmed summary judgment in favor of State Street, finding that during the class period, State Street’s managers “repeatedly discussed at length whether to continue the investments in GM.” In light of “the prudent process in which State Street engaged,” the majority held that the plaintiff could not demonstrate a genuine issue regarding whether State Street satisfied its duty of prudence under ERISA.
The majority acknowledged that, even though courts could no longer presume that ESOP fiduciaries were prudent, the Supreme Court in Dudenhoeffer suggested that a correct “understanding of the prudence of relying on market prices” would lead a court to a similar result. Pfeil II, 2015 WL 6874769, at *5. Judge Boggs quoted from the Dudenhoeffer decision, noting that:
. . . where a stock is publicly traded, allegations that a fiduciary should have recognized from publicly available information alone that the market was over- or undervaluing the stock are implausible as a general rule, at least in the absence of special circumstances. . . . In other words, a fiduciary usually is not imprudent to assume that a major stock market … provides the best estimate of the value of the stocks traded on it that is available to him . . . .
Id. at *6 (quoting Dudenhoeffer, 134 S. Ct. at 2471-72 (internal quotation marks and citations omitted)). Judge Boggs also cited to a recent decision from the Southern District of New York, which observed that the “excessively risky” character of investing ESOP funds in stock of a company experiencing serious threats to its business “is accounted for in the market price, and the Supreme Court held that fiduciaries may rely on the market price, absent any special circumstances affecting the reliability of the market price.” Pfeil II, 2015 WL 6874769, at *6 (quoting In re Citigroup ERISA Litig., No. 11 CV 7672 JGK, 2015 WL 2226291, at *14 (S.D.N.Y. May 13, 2015)).
The majority in Pfeil II also found “that a plaintiff claiming that an ESOP’s investment in a publicly traded security was imprudent must show special circumstances to survive a motion to dismiss.” Pfeil II, 2015 WL 6874769, at *6. Per the majority, this holding is in keeping with Modern Portfolio Theory (“MPT”), which “rests on the understanding that organized securities markets are so efficient at discounting securities prices that the current market price of a security is highly likely already to impound the information that is known or knowable about the future prospects of that security.” Id. (citation omitted). The majority concluded that Pfeil failed to show special circumstances that would support the argument that State Street should not have relied on market pricing. Id.
Going further, the majority criticized Pfeil’s argument for relying “on a sleight of hand: on each of these dates, it would have been prudent, in hindsight, for State Street to decide to sell, and that decision would have resulted in less loss; State Street did not make such a prudent decision; therefore, what State Street did was imprudent. But State Street’s decisions were not imprudent or unreasonable simply because it could have made a different decision in response to GM’s financial difficulties.” Pfeil II, 2015 WL 6874769, at *7. Thus, the prudence or imprudence of State Street’s conduct must be evaluated at the time it occurred. Id.
Looking to the record from the District Court, the majority found that State Street “discussed GM stock scores of times during the class period. State Street’s managers repeatedly discussed at length whether to continue the investments in GM that are at issue in this case.” Pfeil II, 2015 WL 6874769, at *8. State Street had an Independent Fiduciary Committee which held more than forty meetings during the less than nine months at issue, to discuss whether to retain GM stock. Id. State Street’s experts presented evidence at the District Court to support the finding that State Street’s process for monitoring GM’s stock was prudent. Id. Moreover, other experts (i.e. fiduciaries of other pension plans and of non-pension plan investment funds) also decided to hold onto GM stock during the same time that Pfeil said it was imprudent for State Street to do so. Id.
Dissent in Pfeil II
Circuit Court Judge White dissented from the majority, finding that the majority’s reliance on the MPT was inapplicable. She opined that “the fact that a stock’s price accurately reflects the company’s risk of failing does not mean that it is prudent to retain the stock as that possibility becomes more and more certain and buyers are willing to pay less and less for a stake in the upside potential.”
Judge White went on to state that she might have agreed with the majority’s conclusion that the process employed by State Street was prudent as a matter of law, were it not for the fact that Pfeil presented evidence that the decision makers at State Street were operating under an incorrect standard. She noted that the Independent Fiduciary Committee with State Street was, per the terms of its engagement agreement, holding on to GM stock until the GM bankruptcy was “imminent” or State Street reached a “clear conclusion” that GM would file for bankruptcy.
Judge White also found that “State Street’s reliance on the plan documents, rather than the fiduciary duty of prudence under the circumstances, was misplaced, regardless whether its interpretation of the documents was correct.” She also rejected the majority’s reliance on the actions of other pension-fund fiduciaries who also continued to buy or hold GM stock as evidence that the stock remained a prudent investment. Because there was at least a question of fact regarding whether State Street satisfied its duty of prudence under the circumstances, Judge White would have reversed and remanded for further proceedings before the District Court.
Conclusion
As the lower courts continue to grapple with the aftermath of Dudenhoeffer, the majority opinion in Pfeil II reflects the strength of having (and adhering to) a prudent process for evaluating investments in company stock. The dissenting opinion by Judge White does raise an important question though regarding the “yardstick” that plan fiduciaries should use when making this evaluation. The Supreme Court stated in Dudenhoeffer that “the duty of prudence trumps the instructions of a plan document, such as an instruction to invest exclusively in employer stock even if financial goals demand the contrary.” Dudenhoeffer, 134 S. Ct. at 2468. As such, adhering to a prudent process and considering whether the duty of prudence requires disregarding the plan documents, will still be a crucial balancing act for plan fiduciaries.
