The U.S. Supreme Court has already taken up a case this term that potentially could alter the way private securities cases are litigated. The Court has now granted cert in a different case that could have a significant impact on ERISA stock-drop litigation. On December 13, 2013, the Court granted the petition of defendant Fifth Third Bank for a writ of certiorari in order to consider the “presumption of prudence” that the lower courts have developed with respect to ESOP fiduciaries’ decision to invest in or to maintain investments in employer stock.
Many ERISA stock drop lawsuit defendants have been able to rely on the presumption – often called the Moensch presumption – to obtain dismissal of the cases against them. However, a split has developed in the circuit courts over the procedural stage at which the presumption applies and how the presumption may be rebutted. The way the Court decides this case could significantly affect the ability of many ERISA lawsuit defendants to rely on the presumption at the motion to dismiss stage to try to get the cases against them dismissed. Background regarding the presumption and the details of the circuit split can be found in a recent memo from the McDermott, Will & Emery law firm (here).
Congress has recognized that Employee Stock Ownership Plans (ESOPs) and Eligible Individual Account Plans (EIAPs), which invest in employer stock, further an important public policy goal by encouraging employee ownership. The courts in turn have held that fiduciaries of these types of plans should not be subject to liability for investing in employer stock, as that was the reason the plans were created, consistent with the Congressional objective of fostering employee ownership. In a 1995 decision, Moensch v. Robertson (here), the Third Circuit concluded that fiduciaries of plans that required or encouraged investment in employer stock were entitled to a presumption that they acted prudently under ERISA by investing in the employer stock. This presumption could only be overcome by a showing that the plan fiduciaries abused their discretion by continuing to invest in the employer stock.
Several circuit courts have adopted the Moench presumption of prudence; however, the courts continue to disagree on whether the presumption can be raised at the motion to dismiss stage and how the presumption can be rebutted. The Supreme Court has now agreed to take up a case that will address these questions – and could even address the question of whether there should be a presumption at all.
The case now before the Supreme Court involves Cincinnati-based Fifth Third Bank and arises out the events surrounding the global financial crisis. The plaintiffs in the case are employees of the bank and participants in the company’s profit sharing plan. Participants in the plan had the option of investing the funds in their plan accounts in several different investments, including the stock of Fifth Third Bank. The bank matched a portion of an employee’s investment in their plan account with stock of the bank, although after a period the employee was free to transfer the stock match investment to other authorized investments.
In their complaint, the plaintiffs allege that the bank, its CEO and the plan fiduciaries breached their fiduciary duties under ERISA by maintaining significant plan investments in company stock and maintaining company stock as an investment option at a time they knew that it was imprudent to do so. The company’s share price declined as the global financial crisis unfolded.
The district court granted the defendants’ motion to dismiss their complaint, holding that as ESOP plan fiduciaries the defendants were entitled to a presumption that their decision to remain invested in employer stock was reasonable. The district court also found that the plaintiffs had failed to allege facts sufficient to overcome the presumption.
The plaintiffs appealed to the Sixth Circuit, which reversed the district court. In a September 7, 2012 opinion written by Judge Jane Stranch for a three-judge panel (a copy of which can be found here), the Court held that the district court had erred in concluding that the presumption of reasonableness applied at the motion to dismiss stage. The Sixth Circuit considered the presumption to be evidentiary, subject to factual rebuttal, and therefor not appropriate to consider and apply at the motion to dismiss stage. The Sixth Circuit court also declined to adopt the more demanding standard for rebuttal of the presumption that certain other circuit courts have adopted – that is, that the presumption may be rebutted only by a showing that fiduciaries continued to invest in the employer stock though it faced a “dire situation” – preferring a test providing that in order to overcome the presumption the plaintiffs must show that the “a prudent man acting in a like capacity” would not have undertaken or continued the investment.
In its cert petition, the bank argued that the Sixth Circuit’s rulings created a split in the circuits requiring the Supreme Court to step in. The bank also argued that the appellate court had interpreted the presumption in a way that unjustifiably puts ESOP fiduciaries at risk of liability and that is inconsistent with the Congressional policy of encouraging stock ownership. In their opposition, the plaintiffs argued that there is no circuit split and that in fact the seeming differences between the Sixth Circuit and the other circuit courts was simply a reflection of the underlying facts in the respective cases and the important differences between the various plans involved.
The U.S. Department of Labor filed an amicus brief in which the agency urged the Court to grant cert in the case on the grounds that a split exists between the circuits. However, rather than arguing for or against the position adopted by the Sixth Circuit, the DoL argued that there should be no presumption of prudence at all, saying that “ERISA’s text and purposes do not call for the application of a presumption at any stage of the proceedings.” The DoL argued further that the judge-created presumption of prudence is based “largely on policy considerations that extend beyond ERISA’s text and are unconvincing in their own right.”
The Supreme Court’s decision to take up the Fifth Third Bank ERISA case potentially could prove significant for other ERISA stock-drop case defendants. As the Morrison Foerster firm said in its December 16, 2013 memo about the Supreme Court’s decision to take up the Fifth Third Bank case, the presumption of prudence is "an important first line of defense in ERISA stock drop litigation." If the Court concludes that the presumption cannot be raised at the motion to dismiss stage or may be rebutted at the pleading stage based on the lower rebuttal standard defined and applied by the Sixth Circuit, it could prove to be more difficult for ESOP fiduciaries to obtain dismissal of the ERISA stock-drop lawsuit filed against them.
As Cleveland-based Keycorp (which itself has been the target of the same kind of ERISA stock-drop lawsuits) argued in its amicus brief in support of Fifth Third Bank’s cert petition, the standards the Sixth Circuit adopted have make it “far too easy for plaintiffs to get a meritless claim under ERISA past the pleading stage.”
The problem for companies subject to these kinds of cases is that even if the cases are entirely lacking in merit, the underlying allegations often go to the heart of the employer’s business operations. Discovery in these cases can be wide-ranging and expensive. The cost of discovery alone can compel corporate defendants to try to settle the case.
In addition, there is a tension at the core of these cases. Imbedded in the underlying allegations is a suggestion that when a company suffers reverses or its stock price drops, the ESOP fiduciaries have fiduciary obligation to liquidate plan holdings in the company stock, the ownership of which was the very reason the ESOP was formed in the first place.
As the Employee Benefits Law Report blog noted in a recent post about the Fifth Third Bank case, “a Supreme Court ruling that the presumption of prudence does not apply at the initial stage, or a ruling that the presumption does not apply at all, would seemingly eviscerate the statutory boundaries that favor ESOPs and likely have a significant chilling effect. Employers would have to consider whether the ESOP model remains viable and is worth the risk.”
The risk that the Supreme Court might jettison the presumption cannot be disregarded. The presumption is a creation of the circuit courts; while lower courts have felt compelled to grapple with it, the Supreme Court will not be so constrained. The Supreme Court certainly is not constrained to the narrower question of when the presumption applies or how it may be rebutted.
The situation here may be analogous to the circumstances in which the Supreme Court took up the “cause and effect” test in the Morrison v. National Australia Bank case. There may have been decades of circuit court case law interpreting the “cause and effect” test for the determination of the jurisdiction of the U.S. securities laws, but the test itself was an invention of the lower courts — like the presumption of prudence here. The Supreme Court could, as it did in the Morrison case, simply disregard the work of the lower courts and examine the question afresh based on the relevant statutory language; the fact that the DoL has urged the court to take that approach could encourage the Court to do so.
In any event, those of us in the professional liability insurance world now have yet another U.S. Supreme Court case to watch out for this term. As the Morrison Foerster firm said in its memo about the case, "regardless of its outcome, the case bears watching by officers, directors, and employees whose responibilities may expose them to ERISA claims for breach of fiduciary duty in connection with employee investments in company stock." The case will likely be argued around March 2014 and will be decided be the end of the current term in June.