July 17, 2014
A recent U.S.
Supreme Court decision affects fiduciaries of retirement plans that have investments in employer stock.1 In the decision, the Supreme Court held that a retirement plan fiduciary is not entitled to a presumption of prudence merely because the retirement plan requires or
encourages having employer stock as an investment.
Instead, fiduciaries of plans with employer stock investments will be held to the same duty of care and prudence that applies to all fiduciaries of retirement plans governed by ERISA2 except to the extent that the duty of care and prudence would otherwise require
diversification.3 This case, Fifth Third Bancorp v.
Dudenhoeffer, represents a marked departure from what many thought was settled law.
Circuit Courts of Appeals previously held that a fiduciary of an employee stock ownership plan (ESOP) was entitled to a special presumption (often referred to as the "Moench presumption") that the fiduciary acted consistently with ERISA in a decision to purchase, hold, or sell employer stock when
the retirement plan by its written terms required or encouraged investments in employer stock.
With regard to 401(k) plans, this presumption made it more difficult for plaintiffs to prevail against a plan fiduciary based on a claim that the fiduciary acted imprudently by having employer stock as an investment alternative in the 401(k) plan.
Fifth Third Bancorp (Fifth Third) maintained a defined-contribution retirement plan that included an ESOP fund that invested primarily in Fifth Third stock.
As a result of the subprime lending crisis in 2007, Fifth Third's stock lost approximately 74 percent of its value over a two-year period.
The plaintiffs claimed that the plan's fiduciaries breached their fiduciary duty of care and prudence under ERISA by failing to: (1) sell the ESOP's holdings of Fifth Third stock; (2) stop purchasing more Fifth Third stock; (3) remove Fifth Third stock as a permitted investment under the plan;
and (4) use or disclose non-public information (because the plaintiffs alleged that Fifth Third officers had made material misstatements that overstated Fifth Third's financial prospects).
The Supreme Court held that, except with regard to diversification, ESOP plan fiduciaries are subject to the same duty of care and prudence that applies to all other ERISA fiduciaries.
The Supreme Court ruled that: (1) non-pecuniary interests (such as the promotion of employee stock ownership) do not alter the duty of care and prudence under ERISA; (2) plan sponsors cannot reduce the duty of care and prudence imposed on plan fiduciaries by requiring investment in employer stock
through the plan documents; (3) the Moench presumption is an ill-fitting means to protect plan fiduciaries from conflicts with insider trading laws; and (4) the Moench presumption is not an appropriate way to weed out meritless lawsuits.
The Court held that meritless claims should be weeded out through careful scrutiny of the relevant allegations put forth by a claimant.
In evaluating the sufficiency of the allegations in the complaint, the Court stated that claims that a fiduciary should have recognized from publicly available information alone that the market incorrectly valued the stock are generally implausible absent special circumstances.
To state a claim on the basis of inside information, the Court held that a plaintiff must plausibly allege an alternative action 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 do harm than
For example, a fiduciary's decision would cause more harm than good if disclosing negative information would cause a drop in the employer's stock price and an associated drop in the value of the stock already held by the plan.
The Moench presumption, which is no longer considered good law, may have provided retirement plan fiduciaries more robust protection by making it more difficult for plaintiffs to successfully pursue an
action in court.
Nevertheless, the foregoing reasoning used by the Supreme Court in its holding is favorable to plan sponsors because it presents a new standard that may be difficult for plaintiffs to meet (in order to avoid a motion to dismiss) when alleging imprudence by retirement plan fiduciaries for having
employer stock as an investment.
In light of the Supreme Court's Dudenhoeffer decision, plan sponsors should consider taking the following actions:
- Confirm that the proper plan fiduciaries are tasked with monitoring the prudence of plan investment alternatives (including any employer stock fund), and that such plan fiduciaries also are being
appropriately monitored and evaluated.
- Ensure that plan fiduciaries are acclimated or re-acclimated to (and seek training or counsel, as necessary) ERISA fiduciary rules, including duty-of-care and prudence requirements.
- Implement and regularly follow appropriate risk assessment procedures for evaluating the prudence of offering and maintaining employer stock as an investment alternative, and appropriately document such
- Consult with counsel or become familiar with guidance from the U.S.
Securities and Exchange Commission (and other relevant agencies) on the topic of handling non-public information of the plan sponsor.
- Consider appointing independent fiduciaries (such as investment managers) to mitigate potential conflict of interest concerns or limit liability by capping the amount that retirement plan participants can
invest in employer stock or by eliminating trading restrictions on participants that may wish to move their investments out of employer stock.
- Decide whether the Supreme Court's holding in Dudenhoeffer changes the balance in favor of or against having employer stock as an investment alternative in the company's retirement plan.
For practical and cost-effective assistance navigating ERISA and the rules and regulations that impact offering employer stock in tax-qualified retirement plans, please contact any member of the employee
benefits and compensation practice of Wilson Sonsini Goodrich & Rosati.