Fiduciaries of qualified retirement plans, including Employee Stock Ownership Plans (ESOPs), have generally been entitled to a presumption that they have acted prudently in offering employer stock as an investment alternative when the terms of the plan require or encourage the fiduciary to invest primarily in employer stock (commonly referred to as the Moench presumption). In Fifth Third Bancorp v. Dudenhoeffer, 2014 WL 2864481 (June 25, 2014), the Supreme Court unanimously rejected the Moench presumption and held that ESOP fiduciaries are subject to the same fiduciary duty of prudence under ERISA that applies to all retirement plan fiduciaries (other than the duty to diversify). The Court, however, arguably narrowed the circumstances under which participants can successfully allege a breach of that standard.
In Dudenhoeffer, participants in an ESOP claimed that the ESOP fiduciaries breached their fiduciary duty by failing to sell company stock, and instead continued to purchase company stock in the run up to the housing market collapse of 2008. The participants asserted that the ESOP fiduciaries knew the company’s stock was overvalued because of market indicators and the fiduciaries’ insider knowledge, and that the fiduciaries should have acted on this information to reduce the ESOP’s holdings in company stock. The district court dismissed the participants’ claim because, according to the court, the fiduciaries were entitled to a presumption that their decision to purchase company stock was prudent. On appeal, the Sixth Circuit reversed, finding that although the presumption of prudence was a valid presumption, it was an evidentiary standard that did not apply at the pleading stage and that the participants had adequately alleged a claim for breach of fiduciary duty.
No Presumption of Prudence
The Supreme Court disagreed with the lower courts and held that ESOP fiduciaries are not entitled to a special presumption of prudence. Instead, the Court determined that ESOP fiduciaries are subject to the same standard of prudence that applies to ERISA fiduciaries, except that an ESOP fiduciary has no duty to diversify investments. Accordingly, while ESOP fiduciaries are not obligated to diversify the investments of an ESOP so as to minimize the risk of large losses, an ESOP fiduciary’s decision to buy or hold company stock is subject to the prudent man standard of care.
Guidance for Lower Courts and Plan Fiduciaries
The Court addressed how the fiduciary duty standard should be applied to ESOP fiduciaries in the context of a motion to dismiss and provided guidance that lower courts should consider in their analysis. First, the Court noted that a fiduciary would not be acting imprudently, absent special circumstances, to assume that a major stock market provides the best estimate of the value of the stock. To this end, the Court stated 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, at least in the absence of special circumstances….”
Second, the Court noted that ERISA’s duty of prudence cannot require an ESOP fiduciary to perform an act that would violate the securities law. The Court explained that “[t]o state a claim for breach of the duty of prudence on the basis of inside information, a plaintiff 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 explained that where ESOP trustees are charged with a breach of fiduciary duty because the trustees did not buy or sell company stock based on inside information or did not inform the public of inside information, “the court should consider the extent to which an ERISA-based obligation either to refrain on the basis of inside information from making a planned trade or to disclose inside information to the public could conflict with the complex insider trading and corporate disclosure requirements imposed by the federal securities laws….”
Third, the Court stated that, when ruling on such claims, lower courts should “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 view the employer’s stock as a bad investment – or publically 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.”
Although the Supreme Court’s decision eliminates the ability of ESOP and ERISA plan fiduciaries to rely on the Moench presumption, it does not substantially change the legal landscape and the duties owed by plan fiduciaries. ESOP trustees are still subject to the prudent man standard of care (as they were previously), and while they cannot rely on a presumption of prudence, the Court placed additional burdens on plaintiffs when alleging facts intended to establish a breach of that standard.
As we monitor future lower court decisions in light of the additional guidance the Court set forth in Dudenhoeffer, plan sponsors and fiduciaries should consider the following action items:
- If a plan expressly requires the investment in employer stock (or that employer stock must be offered as an investment), the plan sponsor should review the current language to determine whether any changes are necessary or advisable. Plan provisions of this nature will not override the duty of plan fiduciaries to determine whether it remains prudent to offer and/or hold employer stock.
- Plan fiduciaries must establish or modify existing procedures to periodically evaluate whether offering and/or holding investments in employer stock remains prudent. For example, plan fiduciaries should review existing investment policy statements to ensure that they remain adequate, including establishing procedures to address precipitous drops in the value of employer stock.
- Re-evaluate the appointment of existing plan fiduciaries. After Dudenhoeffer, it appears even clearer that the CEO, CFO and possibly other senior corporate executives should not serve as a plan fiduciary (e.g., on a plan committee).
- Re-evaluate the training of plan fiduciaries and use of third party advisors. At a minimum, plan fiduciaries should be trained on the fiduciary obligations arising under ERISA, including the duty to monitor employer stock and other investments offered under the plan.