On June 25, 2014, in an unexpected development at the end of its current term, the U.S. Supreme Court held in Fifth Third Bank v. Dudenhoeffer that ESOP fiduciaries are not entitled to a “presumption of prudence” in connection with their decision to invest in or maintain investments in employer stock. In a unanimous opinion written by Justice Stephen Breyer, the Court held that ESOP fiduciaries are subject to the same duty of prudence that applies to ERISA fiduciaries in general, other than the duty to diversify plan assets. A copy of the court’s opinion can be found here.
In recent years, several of the Circuit courts had recognized the existence of a presumption of prudence for ESOP plan fiduciaries. Many ESOP plan fiduciaries had successfully relied on the presumption as the basis for a motion to dismiss claims filed against them under ERISA. The Supreme Court’s opinion could make it more difficult for ESOP fiduciaries to obtain dismissal in ERISA stock drop cases. However, the Court did recognize the importance of motions to dismiss in helping to weed out meritless suits. The Court laid out several guidelines for the lower courts to use in considering motions to dismiss in ERISA stock drop suits. The net effect of the Court’s opinion is that the environment for ERISA stock drop litigation has been substantially changed.
Background
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 lower courts in turn had 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 adopted the Moench presumption of prudence; however, the courts disagreed about whether the presumption could be raised at the motion to dismiss stage and how the presumption could be rebutted.
This case involves Cincinnati-based Fifth Third Bank and arises out of 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 the 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.
In a September 7, 2012 opinion (here), the Sixth Circuit 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 therefore not appropriate to consider and apply at the motion to dismiss stage. The Sixth Circuit also found that the plaintiffs’ allegations were sufficient to state a claim. The defendants filed a petition for a writ of certiorari, which the Supreme Court granted.
In support of the bank’s cert petition, 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 Court’s Opinion
In a unanimous opinion written by Justice Breyer, the court held that ESOP fiduciaries are not entitled to a presumption of prudence. The Court said:
In our view, the law does not create a special presumption favoring ESOP fiduciaries. Rather the same standard of prudence applies to all ERISA fiduciaries, including ESOP fiduciaries, except that an ESOP fiduciary is under no duty to diversify the ESOP’s holdings.
The Court expressly rejected the defendants’ argument that that the Congressional policy expressed in ERISA in favor of employee ownership meant that ESOP plan fiduciaries were entitled to a more “relaxed” duty of prudence.
The Court also rejected the defendants’ argument that the existence of a presumption of prudence was necessary to discourage meritless, burdensome lawsuits. The Court said that “we do not believe that the presumption at issue here is an appropriate way to weed out meritless lawsuits,” adding that “the proposed presumption makes it impossible for a plaintiff to state a duty-of-prudence claim, no matter how meritorious, unless the employer is in very bad economic circumstances.” The presumption “does not readily divide the plausible sheep from the meritless goats.” The task of weeding out the meritless suits “can better be accomplished through careful context-sensitive scrutiny of a complaint’s allegations.”
The Court did recognize motions to dismiss as “one important mechanism for weeding out meritless claims.” The Court identified several factors for the lower courts to keep in mind when considering motions to dismiss in ERISA liability suits. First, “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 a stock are implausible as a general rule.” Second, where the claim is based on a failure to act on nonpublic information, the courts must recognize that fiduciaries cannot be required to break the law, such as by insider trading. Similarly, where the claim is based on a decision not to trade, the court evaluating a motion to dismiss should consider whether not trading would give rise to disclosure issues or would the stock price and thereby harm the fund.
Discussion
In recent years, the presumption of prudence has been an important first line of defense in ERISA stock drop litigation. The Supreme Court’s conclusion that ESOP fiduciaries are not entitled to the presumption will make it more difficult for ESOP fiduciaries to obtain dismissal of an ERISA stock-drop lawsuit filed against them.
Just the same, the Court did also emphasize the importance of motions to dismiss in helping to weed out meritless lawsuits. The motion to dismiss mechanism, the Court said, “requires careful consideration of whether the complaint states a claim that the defendants acted imprudently.” The guidelines the Court laid down for lower courts to consider while reviewing motions to dismiss in ERISA liability lawsuits address many of the kinds of allegations that plaintiffs often allege in ERISA stock drop suits. In particular the Court’s suggestion that plan fiduciaries can rely on the share price and that the duties of plan fiduciaries do not require them to trade on inside information could help defendants seeking to have an ERISA stock drop suit dismissed.
In other words, the Supreme Court’s decision introduces a host of factors that will affect how the trial courts address and rule upon the motions to dismiss in ERISA stock drop suits involving ESOP fiduciaries. These new factors mean that the way that motions to dismiss are framed will change. What that ultimately will mean in terms of outcomes definitely remains to be seen. The lower courts will have to sort out these issues.
There is no doubt that the Court’s holding that the ESOP plan fiduciaries are not entitled to a special presumption of prudence represents a setback for fiduciaries named as defendants in ERISA stock drop suits. The consequences from this ruling may not only be that fewer of these cases are dismissed, it may also mean that more of them are filed. Indeed, some have suggested that the ruling may even act as a deterrent for employers from offering company stock. A June 25, 2014 Forbes article about the ruling (here) quotes two commentators as saying that companies may just stop offering their own stock to employees until lower courts decide more cases.
The one thing I know for sure is that this decision represents a significant change in the environment for ERISA stock drop litigation involving ESOP fiduciaries.