The U.S. Supreme Court heard argument this week in Fifth Third Bancorp v. Dudenhoeffer, the case that will decide whether fiduciaries of employee stock option plans (ESOPs) are presumed to comply with their ERISA duties by continuing to invest in the employer's stock despite allegations that they know or should know that the stock is overvalued. Although such a presumption has enjoyed wide acceptance in the federal Courts of Appeals, its days may be numbered.
Fifth Third's lawyer argued that without the presumption, an ESOP fiduciary would be put in a position either of having to "outsmart the market" by guessing correctly that the stock is overvalued, or, even worse, violating the federal securities laws by divesting the stock on the basis of inside information about the employer.
Several of the Justices responded skeptically. Justice Scalia argued, "You have the same problems" with other types of retirement plans, so "we don't have to adopt a special law for this." Justice Sotomayor asked, "What's wrong with following the law and disclosing that material information to the public and stopping the employees from losing more money in worthless stock?" Justice Kagan argued, "It just sort of defies language to say that a prudent person would retain" an investment in "overvalued stock." Justice Kennedy suggested that a presumption of prudence would create "sort of a coach class trustee." Justice Ginsberg was even more direct, stating, "I don't know where this presumption comes from," because "there is no presumption written into this statute."
A few of the Justices seemed more receptive to the presumption of prudence. Chief Justice Roberts noted that "every Court of Appeals has recognized" that "by definition" an ESOP fiduciary acts prudently by investing in the employer's stock unless "everything is going south and the company's collapsing." Then, even more emphatically, he stated, "I don't understand how you . . . can say that [an ESOP fiduciary] has breached a fiduciary duty of prudence when the people investing in this ought to know what they're going to get is the company's stock." Justice Alito observed that if "stopping purchases in company stock would be a signal that would potentially trigger bankruptcy and liquidation of the company," that might be in the best interests of ESOP participants "if these participants were simply investors," but "it might be very much not in their best interests as employees." In addition, Justice Breyer suggested, "there is no rule of trust or ERISA law that you can breach a duty to a beneficiary by failing to use inside information, period."
Notwithstanding these sympathetic statements from a minority of Justices, a majority of the Supreme Court (Justices Kennedy, Scalia, Ginsberg, Sotomayor and Kagan) seem prepared to hold that an ESOP fiduciary is not entitled to any presumption of prudence and may even be obligated to depart from the plan's terms and cease purchasing employer stock, or divest the plan's holdings in employer stock, if the fiduciary knows or should know, based on insider information, that the stock is overvalued. The Court should issue its decision before the end of the current term in June. We will continue to monitor the case closely.
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