Life After Dudenhoeffer--Will It Really Be That Different?

Nearly every year, those of us who practice in the employee benefits arena look forward to a Supreme Court decision that, for better or for worse, will continue to shape our practice. In recent years the Court has opined on ERISA preemption, standing issues, remedies, standard of review in the denial of benefits context, settlor versus fiduciary functions, prohibited transaction claims against non-fiduciaries, subrogation, attorney's fees, plan-based statutes of limitations, etc. This year the Court addressed the ERISA fiduciary duty of prudence for the first time, in Fifth Third Bancorp v. Dudenhoeffer.¹

Dudenhoeffer: The Opinion

By now we all know the Dudenhoeffer Court held that fiduciaries of employee stock ownership plans ("ESOPs") are not entitled to a presumption of prudence (aka the "Moench presumption") when their decisions to buy or hold employer stock are challenged under ERISA.² Defendants in the more than 200 "stock-drop" cases that have been filed in the post-Enron/WorldCom era relied heavily on the presumption in seeking dismissal of stock-drop complaints, especially in the past several years as most Circuits not only adopted the prudence presumption but applied it at the pleadings stage (thank you, Twombly and Iqbal).

The presumption was born out of the lower courts' desire to reconcile competing Congressional directives that both impose a prudent standard of care on all ERISA plan fiduciaries³ and strongly encourage employee ownership through the investment in employer securities, which by nature are not diversified.⁴ Some courts applying the presumption had also recognized that, where a plan was "hard-wired" to mandate the offering of employer stock as an investment, ERISA fiduciaries were obligated to follow that mandate⁵--and it is no small thing to override a plan's terms.⁶ So the prudence presumption gave fiduciaries some level of protection for declining to override the stock hard-wire provisions during periods when the stock was alleged to be an imprudent investment.

The Supreme Court didn't buy it (unanimously). Instead, the Dudenhoeffer 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."⁷ The Court also jettisoned the hard-wire argument, ruling that "the duty of prudence trumps the instruction of a plan document, such as an instruction to invest exclusively in employer stock even if financial goals demand the contrary."⁸

On the other hand, the Court agreed with the Fifth Third fiduciaries that the nature of the plaintiffs' claims posed a "legitimate" concern that, without the presumption, ESOP fiduciaries with alleged access to non-public information concerning the employer would face "conflicts with the legal prohibition on insider trading."⁹ Indeed, many stock-drop complaints have been premised on the notion that plan fiduciaries breached their duties to plan participants by failing to act on inside information they had about the value of the company's stock or the company's business circumstances. The Court reasoned, however, that the presumption ultimately "is an ill-fitting means of addressing" this issue because the potential for conflicts with securities laws is not unique to ESOP fiduciaries--in other words, all ERISA fiduciaries are constrained by the limits of securities laws. And in the ESOP context, "the potential for conflict is the same for an ESOP fiduciary whose company is on the brink of collapse as for a fiduciary who invested in a healthier company."¹⁰ The Court noted parenthetically that "[s]urely a fiduciary is not obligated to break the insider trading laws even if his company is about to fail."¹¹

Finally, while recognizing the risk that the proliferation of meritless claims could undermine Congress's desire to encourage employee ownership, the Court reasoned that the best way to address these concerns is not through a "special presumption" but "through careful, context-sensitive scrutiny of a complaint's allegations" under the rigorous pleading standards established in Twombly and Iqbal.¹² With that, the Court set forth several considerations for lower courts to apply in determining whether a stock-drop complaint states a viable claim for breach of ERISA's duty of prudence.

The Court held that, where employer stock is publicly traded, any claim that a fiduciary should have concluded that the stock was over- or under-valued based on publicly available information is "implausible as a general rule, at least in the absence of special circumstances."¹³ In this respect the Court embraced the efficiency of the market and confirmed that a fiduciary usually "'is not imprudent to assume that a major stock market . . . provides the best estimate of value of the stocks traded on it that is available to him.'"¹⁴

The Court expressly did not consider whether a plaintiff could avoid this general rule by alleging a "special circumstance" undermining the reliability of a stock's market price as an "unbiased assessment of the security's value in light of all public information." But the Court did find that the Sixth Circuit erred in ruling the plaintiffs had stated a viable claim based on allegations "that Fifth Third engaged in lending practices that were equivalent to participation in the subprime lending market, that Defendants were aware of the risks of such investments by the start of the class period, and that such risks made Fifth Third stock an imprudent investment."¹⁵ These allegations were coupled with a stock price decline of 74% between the beginning of the alleged class period and the date the complaint was filed.¹⁶

As for claims of imprudence based on non-public information, the Court rejected as "implausible" any claim that fiduciaries violate their duty of prudence by failing to sell company stock based on non-public information. The Court confirmed that "ERISA's duty of prudence cannot require an ESOP fiduciary to perform an action--such as divesting the fund's holdings of the employer's stock on the basis of inside information--that would violate insider trading laws."¹⁷

With respect to claims that fiduciaries were required to refrain from buying additional shares of employer stock based on non-public information or to disclosethat information publicly, the Court ruled that district courts "should consider the extent to which an ERISA-based obligation" to "refrain" or "disclose" may "conflict with the complex insider trading and corporate disclosure requirements imposed by the federal securities laws or with the objectives of those laws."¹⁸ In addition, lower courts evaluating such claims must "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."¹⁹ SCOTUS left it to the lower courts to sort out the details of these new standards.²⁰

So Now What?--Stock-Drop Claims Post-Dudenhoeffer

Perhaps we will see an uptick in new stock-drop complaints, at least in the short term (though it hasn't happened yet). But stock-drop plaintiffs will face significant hurdles in framing their claims post-Dudenhoeffer. To the extent plaintiffs allege that plan fiduciaries should have sold off the stock (or closed the stock fund to new investments) based on public information, they will need to identify "special circumstances" to demonstrate that the market was inaccurate in valuing the stock.²¹ While the Dudenhoeffer Court did not identify what circumstances would be "special" enough to clear this hurdle, we can infer from the Court's ruling that a stock price decline in the neighborhood of 75% combined with allegations of risky business practices won't do the trick. And allegations of corporate fraud or undisclosed malfeasance seem unlikely to fare any better, since they will necessarily be based on non-public information.

Speaking of which, Dudenhoeffer confirms that plaintiffs will no longer be able to plausibly allege that fiduciaries imprudently failed to sell off employer stock based on non-public information. As for claims that fiduciaries should have refrained from purchasing additional employer stock based on non-public information, insider trading laws still present a hurdle, because what if an analyst or reporter asks the fiduciaries why they closed the fund to new investments? The fiduciaries can't rely on insider information to answer that question, and a response that dodges the issue or appears incomplete is unlikely to be viewed favorably by the market. Indeed, regardless of the explanation, the market may view the decision to close the fund to the company's own employees as a red flag that the stock is a bad investment--which may tank the stock price and lock in participant losses. So plaintiffs may have a hard time demonstrating that a prudent fiduciary could not have concluded that closing the stock fund would do the plan more harm than good. The same is true with respect to allegations that fiduciaries should have disclosed the "bad" information to the market, since the stock price would likely tumble in that scenario as well.

Further, while the prudence presumption is now a thing of the past, many of the principles that courts recognized in dismissing pre-Dudenhoeffer stock-drop complaints are true regardless of the presumption, and they should inform the Twombly/Iqbal plausibility analysis of stock-drop complaints going forward. For example:

• Stock-drop complaints tend to be textbook examples of Monday-morning quarterbacking, but ERISA dictates that the prudence of a fiduciary's actions are to be assessed under "the circumstances then prevailing,"²² not the circumstances that later unfolded.
• Retirement investors have a long-term horizon, and fiduciaries should not have an obligation to yank an investment from the plan's line-up due to short-term price declines and fluctuations.
• In a similar vein, courts should be mindful not to put fiduciaries in the untenable position of facing claims by participants for both failing to sell the stock in the event of a decline and selling the stock in the event of a subsequent rebound.²³
• Single-stock investments are inherently riskier than mutual funds and other commingled investment vehicles, and it's not imprudent to offer a higher-risk investment as part of a well-diversified line-up of investment options. Indeed, the DOL prudence regulations²⁴ embrace modern portfolio theory, which provides that an investment's suitability is judged in the context of other investments offered in the portfolio.

With respect to stock-drop cases that progress to summary judgment or trial, evidence of procedural prudence will necessarily become more important, but this was true before Dudenhoeffer.  In the post-Enron stock-drop cases that have gone to trial, the courts ruled in favor of plan fiduciaries based largely on the fiduciaries' processes, and without applying the prudence presumption.²⁵ And given the proliferation of stock-drop and other plan investment-related lawsuits over the last decade, the processes implemented by plan fiduciaries with respect to plan investments (including employer stock) had, by and large, already become better-documented before the Supreme Court issued its decision.

This is not to suggest that Dudenhoeffer will have no impact on how plan sponsors and fiduciaries approach employer stock investments. To be sure, plan sponsors are reviewing their current structures and strategies in light of Dudenhoeffer to consider whether they should revisit their plan design with respect to employer stock, their plan governance structure, their fiduciary processes, etc. And on the litigation side of the fence, it may take a while for the lower courts to develop consistency in deciding post-Dudenhoeffer stock-drop cases.²⁶ But having defended about a dozen of these cases, my two cents is that the prudence presumption was certainly nice while it lasted, but the Dudenhoeffer Court ultimately gave fiduciaries more than it took away.

¹134 S. Ct. 2459 (2014).

²This holding presumably applies equally to fiduciaries of other eligible individual account plans ("EIAPs") that invest in employer stock.

³See 29 U.S.C. § 1104(a)(1)(B).

⁴See 29 U.S.C. §§ 1104(a)(2) (exempting EIAPs from ERISA's duty of diversification and duty of prudence to the extent it requires diversification); 1107(b)(1) (exempting EIAPs from ERISA's 10% limitation on investments in employer securities).

⁵See 29 U.S.C. § 1104(a)(1)(D) (a fiduciary must discharge his or her duties with respect to a plan "in accordance with the documents and instruments governing the plan insofar as such documents and instruments are consistent with the provisions of this subchapter and subchapter III of this chapter").

⁶See, e.g., White v. Marshall & Ilsley Corp., 714 F.3d 980, 987 (7th Cir. 2013) ("If the fiduciaries had chosen to violate the terms of the Plan and had forced a sale of employees' M&I stock at the lowest point, the employees would have lost out on the later increase in value and would have had viable claims under ERISA and would seem to have had viable claims under ERISA for the fiduciaries' failure to comply with the terms of the Plan document").

⁷134 S. Ct. at 2467.

⁸Id.

⁹Id. at 2469.

¹⁰Id.

¹¹Id.

¹²Id. at 2470-71.

¹³Id. at 2471.

¹⁴Id. at 2471-72 (quoting Summers v. State Street Bank & Trust Co., 453 F. 3d 404, 408 (7th Cir. 2006)).

¹⁵Id. at 2472 (citation omitted).

¹⁶Id. at 2464.

¹⁷Id. at 2472.

¹⁸Id. at 2473 (citations omitted).

¹⁹Id.

²⁰Id.

²¹As a practical matter, such an allegation could well prove to be self-defeating because the plaintiffs might then need to prove reliance without resorting to a "fraud on the market" theory. Cf. Halliburton Co. v. Erica P. John Fund, Inc., 134 S. Ct. 2398, 2411 (2014) ("'[a]ny showing that severs the link between the alleged misrepresentation and . . . the price received (or paid) by the plaintiff . . . will be sufficient to rebut the presumption of reliance' because 'the basis for finding that the fraud had been transmitted through the market price would be gone.'").

²²29 U.S.C. § 1104(a)(1)(B).

²³Case in point: Tatum v. RJR Pension Investment Committee,--F.3d --, 2014 WL 3805677 (4th Cir. Aug. 4, 2014) (partially vacating trial ruling that plan fiduciaries were not liable for selling off stock before stock price rose dramatically).

²⁴See 29 C.F.R. § 2550.404a-1.

²⁵See, e.g., DiFelice v. US Airways, Inc., 436 F. Supp. 2d 756 (E.D. Va. 2006) (rejecting plaintiff's argument that US Airways failed to properly monitor performance of company stock fund and thereby failed to "adequately consider its retention"; fiduciaries "continued to believe that the Company's efforts to restructure outside of bankruptcy proceedings would prove successful."), aff'd, 497 F.3d 410 (4th Cir. 2007); Brieger v. Tellabs, Inc., 629 F. Supp. 2d 848 (N.D. Ill. 2009) (ruling that plan fiduciaries did not breach their duty of prudence with respect to the plan's investment in Tellabs stock, despite a 90% decline in the company's stock price and multiple restatements of the company's financial statements, and finding that plan fiduciaries had exercised procedural prudence with respect to the plan's continued investment in Tellabs stock).

²⁶It remains to be seen how Dudenhoeffer may affect private company ESOP litigation. Fiduciaries of private company ESOPs are dealing with stock for which there is no readily-available market, so they have fewer options when faced with a declining stock price. In those cases the stock cannot be sold on the whim, so if the fiduciary is challenged for retaining the stock, the focus may be on whether the fiduciary explored alternatives.