On June 25, 2014, the U.S. Supreme Court released its much anticipated decision in Fifth Third Bancorp v. Dudenhoeffer, No. 12-751, 2014 U.S. LEXIS 4495. The decision was unanimous and overturned an important “presumption of prudence” that lower courts had for many years afforded ERISA fiduciaries in connection with a decision to buy, hold or offer employer stock as a part of a stand-alone employee stock ownership plan (“ESOP”), ESOP component of a defined contribution plan or an employer stock fund offered under a 401(k) or profit sharing plan. As the name implies, such investment decisions previously had been viewed as prudent in all but the most exceptional circumstances, and the application of the presumption had been a powerful tool for defendants in seeking an early dismissal in ERISA stock-drop lawsuits.
The Supreme Court held that Section 404(a)(2) of ERISA does not create any special presumption favoring ESOP fiduciaries whether at the pleading stage or later in the proceedings as an evidentiary rule. Importantly, the Court explained that the instructions of a plan document – such as a provision requiring employer stock as an investment option – do not excuse fiduciaries from the duty of prudence with respect to the decision to include employer stock. ESOP fiduciaries are now subject to the same standard of prudence that applies to all fiduciaries under ERISA with respect to decisions regarding plan investments, with the caveat that they are not bound by the same diversification requirements that ERISA imposes on fiduciaries who oversee investments of non-ESOP benefit plans. The loss of this defendant-friendly presumption could have significant ramifications for ESOP fiduciaries.
In addition to resolving a split of authority that had developed in the federal circuit courts of appeal over the correct application of the presumption, the Dudenhoeffer decision also provides important guidance regarding how claims against ESOP fiduciaries should be resolved in the future. ESOP fiduciaries often are company insiders and, thus, are constrained by the federal securities laws in their ability to trade employer stock on the basis of nonpublic information. To address the concern that an ESOP fiduciary might find “himself between a rock and a hard place” when faced with competing obligations under ERISA and the federal securities laws, the Supreme Court directed lower courts to use motions to dismiss to weed out meritless lawsuits.
Specifically, the Court said that, if a complaint alleges that the fiduciary should have divested employer stock or removed employer stock from the plan’s investment options, as applicable, based on publicly available information that the “market was over- or undervaluing the stock,” such allegations “are implausible as a general rule, at least in the absence of special circumstances.” (Emphasis added). If, however, a complaint alleges that a fiduciary imprudently failed to act based on nonpublic information, “a plaintiff 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.” The Court made clear that ERISA fiduciaries are not required “to break the law” by divesting the plan’s employer stock based on nonpublic material information. Whether an ERISA fiduciary has an obligation “to disclose truthful information on their own initiative, or in response to employee inquiries” is an open question, however, and implicates “complex insider trading and corporate disclosure requirements imposed by the federal securities laws.” Finally, the Supreme Court directed lower courts to consider whether a complaint plausibly alleges that the ESOP fiduciary “could not have concluded that stopping purchases — which the market might take as a sign that insider fiduciaries viewed the employer’s stock as a bad investment — or publicly disclosing negative information would do more harm than good to the fund by causing a drop in the stock price and a concomitant drop in the value of the stock already held by the fund.”
Lower courts now will have to reconsider how to handle ERISA stock drop lawsuits at the pleadings stage. Although the Supreme Court gave defendants several ways to dismiss meritless cases, plaintiffs may be more likely to file lawsuits now that the biggest hurdle to such litigation – the presumption of prudence – is gone. Until lower courts work out the exact details of how to apply the guidance provided by Dudenhoeffer, fiduciaries of retirement plans that invest in employer stock will be required to shoulder added risk and responsibility in carrying out their important duties. Employers may not want to undertake increased litigation risks in the interim and could be less likely to include employer stock as an investment option in their retirement plans.
Employers with retirement plans that invest in employer stock should review their plan documents, fiduciary committee charters, and investment policy statements to consider whether changes are necessary in light of the Dudenhoeffer decision. Provisions requiring employer stock as an investment option should no longer be relied upon to avoid fiduciary responsibility with respect to employer stock offered under the plan.