U.S. Supreme Court Holds that ESOP Fiduciaries Are Not Entitled to the "Presumption of Prudence" in Fiduciary Litigation
This Hot Topic was prepared by the ABA Section of Labor and Employment Law, Employee Benefits Committee (EBC) members, with the assistance of Amanda Sonneborn of Seyfarth Shaw LLP in Chicago, IL, representing employers in employment matters, Robert Alexander of Bredhoff & Kaiser P.L.L.C. in Washington, D.C., representing Unions and employees and Teresa Renaker of Lewis, Feinberg, Lee, Renaker & Jackson, P.C., in Oakland, CA, representing employees in employee benefits matters.
On June 25, 2014, the United States Supreme Court held in a 9-0 decision written by Justice Breyer that when a decision by a fiduciary of an "employee stock ownership plan" (ESOP) to buy or hold the employer's stock is challenged in court, the fiduciary is not entitled to a "presumption of prudence." Instead, ESOP fiduciaries are subject to the same duty of prudence that applies to Employee Retirement Income Security Act (ERISA) fiduciaries in general, except that they need not diversify the fund's assets. Fifth Third Bank Corp. v. Dudenhoeffer, 12-751, ___U.S. __ (2014).
After suffering major losses in their ESOP, Respondents, ESOP participants, filed suit alleging the Petitioners breached their fiduciary duties of loyalty and prudence required by ERISA. The District Court dismissed for failure to state a claim and the Court of Appeals for the Sixth Circuit reversed, agreeing that the "presumption of prudence" applies but not at the pleading stage. The Supreme Court granted certiorari, abrogated the "presumption of prudence" and remanded the case to the Court of Appeals with instructions to apply the pleading standard in Twombly and Iqbal.
Justice Breyer's analysis for the Court begins with the language of the ERISA statute, and specifically with the "prudent man standard of care," to which ERISA subjects all plan fiduciaries. Ordinarily, Section 1104(a)(1)(C) would require ERISA fiduciaries to diversify assets as part of that standard of care. But "Congress has given ESOP fiduciaries a statutory exemption" from the diversification requirement.
The opinion notes that several courts of appeals have "gone beyond ERISA's express" statutory exemption to give ESOP fiduciaries a "presumption of prudence" with respect to decisions to hold or buy employer stock. The Court concludes, "[i]n our view, the law does not create a special presumption favoring ESOP fiduciaries" --"ESOP fiduciaries are subject to the duty of prudence just as other ERISA fiduciaries are."
The primary statutory argument advanced by the petitioners in support of the presumption was that ERISA defines the duty of prudence in terms of the "character" and "aims" of the plan, and ESOPs operate differently than a typical retirement plan because they seek to promote employee ownership of company stock. The Court rejects the petitioners' arguments that: 1) ERISA's requirement that fiduciaries exclusively pursue the provision of "benefits" to plan participants and their beneficiaries can refer to "nonpecuniary benefits like those supposed to arise from employee ownership of employer stock"; and 2) the plan's mandate that fiduciaries invest in Fifth Third stock "waive[s]" the usual ERISA duty of prudence. The opinion interprets the exclusive benefits rule to refer only to financial benefits and also concludes that "by contrast to the rule at common law, trust documents cannot excuse trustees from their duties under ERISA."
The opinion holds that plain statutory language defeated petitioners' practical arguments that costly duty-of-prudence lawsuits could prevent companies from offering ESOPs. The Court acknowledges the need for a "mechanism" to "weed out" meritless, economically burdensome lawsuits, but holds that the petitioners' proposed presumption "does not readily divide the plausible sheep from the meritless goats." "That important task can be better accomplished through careful, context-sensitive scrutiny of a complaint's allegations."
The opinion similarly responds to the petitioners' argument that "subjecting ESOP fiduciaries to a duty of prudence without the protection of a special presumption will lead to conflicts with the legal prohibition on insider trading" because ESOP fiduciaries are often insiders with non-public information about the value of the employer's stock. The Court observes that this concern is real but that the "presumption of prudence is not the proper response." The Court stresses a case-by-case analysis of the allegations contained in a complaint and comparison to the relevant securities laws and regulations.
Union and Employee Perspective
While ESOPs are not generally collectively bargained plans, and the Supreme Court's ruling will likely have limited impact on those ERISA plans unions sponsor or bargain on behalf of their members, the Dudenhoeffer decision is relevant in at least a couple of respects to all ERISA participant and beneficiary litigation. First, the Court, in rejecting a prudence presumption for ESOP fiduciaries' employer stock investment decisions, reaffirmed that the financial protection of participants' retirement income is at the center of the ERISA fiduciary duty. In that vein, the Court's unanimous decision emphasized that the duty of prudence in financial decisions trumps any competing or conflicting non-pecuniary goal, except to the extent that the statute expressly overrides the prudence duty--such as with the absence of a duty to diversify investments prudently in the ESOP context. Indeed, in reaching its decision the Court refused to consider the common law of trusts, an interpretive aid often relied on by the Court to construe ERISA provisions, as a basis to modify the general duty of prudence in protecting the financial interests of participants and beneficiaries. The opinion clearly holds that the fiduciary duties to protect participants' pecuniary interests under ERISA cannot be modified by plan documents reflecting a settlor's interest in advancing other goals. Accordingly, the Court's strong ruling that the ERISA duty of prudence provides an undiluted obligation to protect the financial security of participants and beneficiaries may be relevant to parties litigating over fiduciaries' investment decisions in a variety of contexts.
Second, the Court's opinion is persuasive in refusing to allow ESOP policy interests to expand clear and narrow ERISA language that provided a specific and limited exception to the core fiduciary duty of prudence. In relying on the express and limited exception language, the decision may decrease uncertainty in ERISA statutory interpretation claims based on policy readings of the Act, and may also provide participants with a basis to argue against employer/sponsor-favoring presumptions in other contexts. If a presumption of prudence and reading a limitation on fiduciary obligations from "the special purpose of an ESOP," could not survive in Dudenhoeffer in the face of specific ERISA language that expressly spelled out a more limited exception to the fiduciary duty rule, other attempts to create policy-based presumptions in other contexts might be found similarly dubious. If nothing else, the bar in establishing such a presumption has likely been raised by the decision.
It might be that as a practical matter the Court's decision, while rejecting a presumption of prudence that had been the basis for dismissing ESOP stock drop claims in the lower courts, will still substantially limit the viability of ESOP investment fiduciary breach cases in publicly-traded stock. This may be likely particularly with respect to fiduciary breach claims involving a duty to liquidate publicly traded ESOP stock investments. Indeed, the importance of the duty to diversify investments prudently outside the ESOP context is highlighted by the losses suffered by ESOP participants whose remedies may remain limited even after this decision. Nonetheless, by reaffirming the broad sweep of the duty of prudence, and refusing to adopt ERISA presumptions that undermine participants' benefit rights and investment security based on ancillary policy goals or concerns, the Court reaffirmed that imposing strict fiduciary duties "with respect to a plan solely in the interest of the participants and beneficiaries" remains a core purpose of the Act.
Following in the wake of Dudenhoeffer, employers and plan fiduciaries are reasonably fearful of the implications of this seemingly negative decision. Indeed, for years employers and plan fiduciaries took comfort in the predictable application of the so-called Moench presumption of prudence in many jurisdictions (see Moench v. Robertson, 62 F. 3d 553 (3rd Cir. 1995). This presumption allowed plan fiduciaries to limit their potential exposure in the event of a drop in the value of their stock price. Now that the Court has struck down application of such a presumption, many questions remain for employers and plan fiduciaries about how such claims will be handled moving forward. How significant of a drop in stock price does a plaintiff need to show to pass the motion to dismiss stage or is the amount of loss relevant at all? What does a plan fiduciary do if a plan mandates the inclusion of employer stock in a plan and the stock price begins to decline? If a plan fiduciary removes employer stock as an investment option, does the fiduciary run the risk of a claim that it imprudently removed the stock at a low price? These looming questions give employers and plan fiduciaries much to question following the Court's decision.
Despite the potential negatives from the decision, employers and plan fiduciaries may find some comfort in the Court's decision as well. Indeed, here are a few positive elements to consider:
- The Court stated that plaintiffs must offer specific allegations of insider information that would have altered fiduciaries' actions, because "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." This may prove to be a high hurdle for plaintiffs.
- Moreover, to survive a motion to dismiss, plaintiffs must do more than merely allege that the stock price declined. Rather, in a complaint, plaintiffs must specifically identify steps that the fiduciaries could have taken instead to address the issue. The Court warned that "lower courts faced with such claims should also consider whether the complaint has plausibly alleged that a prudent fiduciary in the defendant's position 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."
- The Court acknowledged that Congress intended to encourage ESOPs and went on to note that the Court "is deeply concerned that the objectives sought by this series of laws will be made unattainable by regulations and rulings which treat [ESOPs] as conventional retirement plans, which reduce the freedom of the employee trusts and employers to take the necessary steps to implement the plans, and which otherwise block the establishment and success of these plans." This language certainly will prove useful in future litigation regarding ESOPs.
The vanquishment of the judicially-created presumption of prudence is an obvious victory for employees seeking to enforce their statutory right to prudent investment of their retirement assets. Plaintiffs' lawyers should additionally attend to Part IV of the Court's opinion, which discusses application of the Twombly/Iqbal plausibility standard to complaints charging breaches of the duty of prudence in investing plan assets in publicly-traded employer stock--and leaves some important questions unanswered.
First, the Court appears to endorse the efficient market hypothesis, citing with approval the Seventh Circuit's statements to the effect that the market ordinarily accounts for all publicly available information in pricing a stock. Thus, the Court concludes 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." However, the Court qualifies this general rule by noting that it applies only in the absence of special circumstances that make reliance on the market price imprudent. What might constitute such special circumstances remains to be explored.
Second, the Court addresses claims of imprudence based on a fiduciary's failure to act on nonpublic information, and the potential conflict with the securities laws where prudence might require a fiduciary to trade on inside information if doing so would transgress insider trading rules. The Court holds that the duty of prudence does not require a fiduciary to violate securities laws, so a participant cannot state a claim based on a fiduciary's failure to buy or sell a stock based on information he or she is privy to as a corporate insider. Furthermore, to the extent a plaintiff challenges a fiduciary's failure to "disclose or abstain"--to either disclose the inside information or refrain from trading in the stock--the Court cautions that the plaintiff must plausibly allege that a prudent fiduciary in the same circumstances would not have viewed the course of action as "more likely to harm the fund than to help it." Finally, the Court suggests that SEC guidance might be needed on the question whether a decision to disclose inside information or stop stock purchases might conflict with "insider trading and corporate disclosure requirements imposed by the federal securities laws or with the objectives of those laws"--a surprising statement given that the "disclose or abstain" rule, which permits possessors of inside information to avoid liability for insider trading by either disclosing the information or abstaining from trading, has its origins in the SEC's own 1961 decision in In re Cady, Roberts & Co. Nonetheless, in the wake of Dudenhoeffer, plaintiffs' lawyers will need to evaluate potential cases in light of the Court's comments and draft pleadings accordingly.
This message was sent to &EMAIL_ADDRESS;.
321 N Clark | Chicago, IL 60654 | (312) 988-5813