No presumption of prudence for ESOP fiduciaries, Supreme Court rules

ESOP fiduciaries are not entitled to any special presumption of prudence, the U.S. Supreme Court has ruled in a unanimous decision. Rather, such 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. The Supreme Court’s ruling vacates the holding by the Sixth Circuit Court of Appeals and remands the case to CA-6 for further proceedings.

Note: The “presumption of prudence,” which was viewed as necessary to protect fiduciaries who are required or encouraged by plan terms to invest plan assets primarily in the stock of the sponsoring employer, was adopted by the Sixth Circuit in Kuper v. Iovenko and by the Third Circuit in Moench v. Robertson. The “Moench presumption,” as it has become known, has been rejected by the High Court.

Fiduciary breach claim

A bank maintained a defined contribution plan for its employees. Participants could choose to direct the plan to purchase investments for their individual account from nearly 20 options, including an employee stock ownership plan (ESOP), which invests its funds primarily in employer stock. In addition, a 4% employer match was initially invested in the stock fund (though it could be moved subsequently to other investment options). During the class period, from July 2007 to September 2009, the price of the employer’s stock declined 74%, causing the plan to lose tens of millions of dollars. The plan continued to maintain the stock fund as an investment option during that period.

Plan participants filed a class action lawsuit, claiming that the plan and the employer CEO breached their ERISA fiduciary duties by continuing to offer the stock fund as an investment alternative. Participants also claimed the defendants breached their fiduciary duty by failing to provide participants with accurate information about the risks of investment in the employer’s stock. The district court dismissed the participants’ suit for failure to state a claim, concluding the defendants were protected by the Moench presumption.

On appeal, the Sixth Circuit reversed, holding that the presumption of prudence generally applicable to investments in employer stock could not be applied at the pleadings stage to dismiss a claim for fiduciary breach. Accordingly, the court ruled that the plan participants could continue to litigate their claim.

Moench presumption rejected

The Supreme Court rejected the Moench presumption, holding that ESOP fiduciaries are not entitled to any special presumption of prudence. Rather, they are subject to the same duty of prudence that applies to ERISA fiduciaries in general under ERISA Sec. 404(a)(1)(B), except that they need not diversify the fund’s assets, as required under ERISA Sec. 404(a)(2). The Court vacated and remanded the case.

On remand, the Court said, the Sixth Circuit should reconsider whether the participants’ complaint states a claim in light of certain specified considerations.

Where a stock is publicly traded, the Court stated, 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.

To state a claim for breach of the duty of prudence, a complaint 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 stated.

Where the complaint alleges that a fiduciary was imprudent in failing to act on the basis of inside information, the analysis is informed by the following three points, the Court held. First, ERISA’s duty of prudence never requires a fiduciary to break the law, and so a fiduciary cannot be imprudent for failing to buy or sell stock in violation of the insider trading laws. Second, where a complaint faults fiduciaries for failing to decide, based on negative inside information, to refrain from making additional stock purchases or for failing to publicly disclose that information so that the stock would no longer be overvalued, courts should consider the extent to which imposing an ERISA-based obligation either to refrain from making a planned trade or to disclose inside information to the public could conflict with the complex insider trading and corporate disclosure requirements set forth by the federal securities laws or with the objectives of those laws. Third, lower courts faced with such claims should “consider whether the complaint has plausibly alleged that a prudent fiduciary in the defendant’s position could not have concluded that stopping purchases … 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.”

Source: Fifth Third Bancorp v. Dudenhoeffer (US Sup Ct).

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