United States: Fifth Third Bancorp V. Dudenhoeffer: Supreme Court Rejects "Presumption Of Prudence" For Stock Drop Cases

Last Updated: July 2 2014
Article by Sara Pikofsky, Daniel C. Hagen, Evan Miller and Travis DeHaven

On June 25, the United States Supreme Court issued its decision in Fifth Third Bancorp v. Dudenhoeffer, a decision that had been highly anticipated by the ERISA bar. The question before the Court was whether the so-called Moench presumption of prudence applied to a motion to dismiss. Rather than deciding whether the presumption was an evidentiary presumption to be applied at summary judgment or trial or a presumption to be applied at the motion to dismiss stage, the Court turned to the more fundamental question of the validity of the Moench presumption of prudence and rejected the presumption of prudence in its entirety. Although the Court rejected the presumption of prudence (on which many employers had relied in defeating breach of fiduciary duty claims in "stock drop" cases at the motion to dismiss stage), the Court also included a discussion of how to determine whether a complaint meets the Twombly "plausibility" standard. The Court's decision created a new battleground for litigants and new uncertainties for plan sponsors who provide the opportunity for employees and other plan participants to invest in employer stock through their 401(k) plans or employee stock ownership plans ("ESOPs").

Background

Congress chose to encourage employee ownership of employer stock in the structure of ERISA. ERISA contains special provisions for individual account plans (including ESOPs and 401(k) plans) that invest in employer stock. Among other things, ERISA's general requirement that investments be diversified to avoid the risk of large loss does not apply to the acquisition or holding of employer stock by an eligible individual account plan such as a 401(k) plan or ESOP. In addition, employer stock is exempt from ERISA's prudence requirement but "only to the extent that it requires diversification."

Attempting to find an appropriate balance between the Congressional policy in favor of employee ownership and ERISA's duty of prudence, every court of appeals to consider the issue over nearly two decades held that a fiduciary is entitled to a presumption that holding employer stock is prudent. The presumption of prudence was first set forth by the Third Circuit in Moench v. Robertson, 62 F.3d 553 (3d Cir. 1995). The Moench presumption provides that an investment in employer stock is entitled to a presumption that the investment is consistent with ERISA unless it is established that the fiduciary abused its discretion by investing in employer stock (or allowing participants the option of investing in employer stock).

The Moench presumption has served as a powerful defense in a multitude of so-called "stock drop" cases. Plaintiffs began filing stock drop cases in earnest after the Enron scandal, and dozens of companies that allowed investment in employer stock through their 401(k) plans were sued over the past decade. The suits generally alleged that the fiduciaries of the 401(k) plan violated ERISA's fiduciary obligations by allowing participants to continue investing in employer stock when they knew that doing so was imprudent. Defendants frequently responded to such suits with a motion to dismiss alleging that unless the company was on the brink of collapse, the Moench presumption permitted the fiduciary to continue to allow investment in employer stock. Although every court of appeals to consider the issue adopted the Moench presumption, there was less uniformity in describing the circumstances under which the presumption could be overcome (e.g., "brink of collapse," "dire circumstances," or something less drastic), and in considering the degree to which the question could be affected by plan drafting. The Sixth Circuit, which often appeared to be the shakiest of the adopters of the Moench presumption, broke from other courts of appeals that allowed application of the Moench presumption on a motion to dismiss, and it held in Dudenhoeffer that while the Moench presumption was valid, it was an evidentiary presumption that could apply only at summary judgment, not on a motion to dismiss.

Supreme Court Decision

Not only did the Supreme Court reject application of the Moench presumption on a motion to dismiss, it rejected it altogether. The Court, looking to the plain language of ERISA, held that ESOPs were not subject to any special standard of prudence, and that the statute says nothing about "brink of collapse" or similar concepts. Instead the Court held that "the same standard of prudence applies to all ERISA fiduciaries, including ESOP fiduciaries...." The Court also held that the duty of prudence trumps the terms of plan documents, such as a requirement that a plan invest in employer stock.

The Court, however, did not stop with its holding that eviscerated the presumption of prudence. In an effort to provide a mechanism to weed out meritless claims, and to provide a proper balancing of employer and employee interests reflected in the structure of ERISA, the Court looked to the pleading standard espoused in Ashcroft v. Iqbal, 556 U.S. 662 (2009) and Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007). As a preliminary point, the Court noted that evaluating a complaint for failure to act prudently would be context specific, as the duty of prudence is dependent on the circumstances prevailing at the time of the fiduciary act.

Despite this broad statement, the Court offered some guidance regarding what types of allegations a plaintiff would need to include in a complaint asserting a breach of fiduciary duty in order to survive a motion to dismiss. Perhaps the most clear pronouncement the Court made was 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." In other words, a claim based only on publicly available information would be subject to dismissal. In addition, because the Court held that a fiduciary can reasonably conclude that it has little hope of outperforming the market based solely on the fiduciary's analysis of publicly available information, any claim that a fiduciary should have anticipated that the employer stock fund would underperform the market, or underperform other investment options or performance benchmarks, should also fail to state a plausible claim in the absence of special circumstances. The Court, however, did not provide any explanation or examples of what might constitute the "special circumstances" sufficient to get around this rule, other than to state that the special circumstances would have to render reliance on efficient markets unreasonable.

The Court also held that when stating a claim for breach of fiduciary duty based on nonpublic 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 help it." The Court elaborated somewhat, offering three things that lower courts should consider in applying this standard. First, a fiduciary cannot be required to break the law, particularly the securities laws, in order to fulfill fiduciary duties. Second, the courts should consider the interplay between ERISA's fiduciary obligations and the complex securities laws and their objectives when assessing a complaint involving an ESOP or employer stock fund. Third, the complaint must plausibly allege 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 viewed the employer's stock as a bad investment—or publicly disclosing negative information would do more harm than good to the fund by causing a drop in the stock price." The Court, however, did not provide any further details on how to apply these three "considerations."

Significance of Opinion

The Court's opinion offers some certainty to plan sponsors with respect to potential litigation, while leaving many other questions unanswered. Clearly, the presumption of prudence is dead, but any claim that is based solely on public information is similarly buried. The Court has seemingly replaced the presumption of prudence with a new pleading standard that remains to be unpacked and explored, particularly with respect to claims based on fiduciary knowledge of nonpublic information. The three "considerations" the Court mandated are all subject to interpretation and will almost certainly be litigated extensively. What specifically a plaintiff must allege with respect to the prudence of offering employer stock as an investment option (or offering an ESOP) in order to survive a motion to dismiss remains to be hashed out.

In the Court's phrase, the new pleading standard should be used to "divide the plausible sheep from the meritless goats." While the Court (thankfully) identified several meritless claims, it never really stated what a meritorious claim against an employer stock fiduciary would look like. So at this point, we cannot determine what a "plausible sheep" looks like, or how many of them may be in the flock.

What to Do Now?

Even if the Fifth Third v. Dudenhoeffer decision eventually proves neutral or even positive for fiduciaries and plan sponsors—which may be the case—it undoubtedly increases the near-term risk of maintaining an ESOP or employer stock fund in a 401(k) plan. By changing the legal framework that had developed over more than 15 years, and by rejecting an approach that had been adopted by every court of appeals that had considered the issue, the Supreme Court created a level of uncertainty that is likely to generate a new wave of litigation.

Plan sponsors and fiduciaries should begin the process of reviewing plan design, plan documents, fiduciary procedures, and participant communications in light of the Supreme Court's holding and reasoning. Among other things:

  • Plan documents or fiduciary procedures that require an employer stock investment to be maintained unless the company is on the brink of collapse or facing some other dire circumstance will likely need to be revised. In the meantime, a fiduciary cannot rely on such plan terms if prudence would require otherwise.
  • Fiduciaries must implement procedures for carefully evaluating employer stock investments in the absence of a presumption of prudence. Procedures that focus solely or primarily on whether the company faces serious financial difficulties will no longer be sufficient.
  • As part of the context-specific inquiry demanded by the Court, a plan design that allows participants to freely choose whether or not to invest in employer stock may be more defensible as a prudent alternative despite the inevitable fluctuations in the stock's performance over time.
  • Participant communications will likely be even more important. An evaluation of a fiduciary's prudence in maintaining an employer stock investment may be influenced by whether the fiduciary has made significant efforts to educate plan participants about the risks of a single stock investment and the benefits of diversification.
  • Plans that have not engaged the services of an independent fiduciary should take this opportunity to consider the question again in light of the Supreme Court's new landscape. On the one hand, the Court's decision provides additional defenses to fiduciaries that may possess inside information. On the other hand, there are many questions about how lower courts will respond to the Court's direction to consider potential conflicts between ERISA and securities laws in the context of inside fiduciaries. For independent fiduciaries, the Court's endorsement of efficient market principles may provide an effective line of defense less cluttered by those issues.
  • Finally, some plan sponsors will want to consider whether to continue to maintain an ESOP or other employer stock investment option in the current environment. For example, some plan sponsors may want to consider whether the goal of encouraging employee ownership can be served through a Section 423 stock purchase plan or other alternative not subject to ERISA. Others may choose to make employer stock available in their 401(k) plan, if at all, only through individual choice in a brokerage window rather than through a company-designated investment alternative. 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions