Courts will no longer afford trustees of Employee Stock Ownership Plans (“ESOPs”) a presumption of prudence, due to a recent decision from the United States Supreme Court. In Fifth Third Bancorp v. Dudenhoeffer, the Court struck down what was known as the Moench presumption of prudence. While the United States Court of Appeals for the Eighth Circuit had avoided adoption or rejection of this presumption several times, several Courts of Appeals have found this presumption to exist under the Employee Retirement Income Security Act (“ERISA”).
In Fifth Third Bancorp, former employees of Fifth Third filed a class action in the Federal District Court of Ohio alleging that Fifth Third and its officers violated the duties of loyalty and prudence imposed by ERISA. Specifically, the complaint, filed in July 2007, alleged that the fiduciaries should have known Fifth Third’s stock was overvalued and excessively risky because of insider knowledge of the company and the increasing public knowledge of risk of subprime mortgage lending, which formed a large part of Fifth Third’s business.
The District Court dismissed the complaint for failure to state a claim on the premise that fiduciaries of ESOPs “start with the presumption that their decision was to remain invested in employer securities was reasonable.” Fifth Third Bancorp v. Dudenhoeffer, 134 S. Ct. 2459, 2464 (2014) (quoting Kuper v. Iovenko, 66 F. 3d 1447, 1459 (CA6 1995)). The Sixth Circuit reversed the District Court’s ruling, determining the presumption is an evidentiary burden and does not apply to pleading. The Supreme Court then granted petitioners certiorari.
In the opinion, the Supreme Court made clear that ESOP fiduciaries are held to no different standardthan other fiduciaries under ERISA, with the exception of the diversification requirement. Fifth Third Bancorp, 134 S. Ct. at 2466. In keeping with Congressional intent, the Court stated that an ESOP is not obligated under § 1104 to diversify the investments of the plan so as to minimize the risk of large losses. Id.
The Court did acknowledge a need to weed out frivolous lawsuits against fiduciaries of ESOPs, but stated that relying on a presumption of prudence was not the appropriate mechanism to do so. Id. at 2470. Rather, the Court suggested lower courts make careful consideration of whether the complaint states a claim that the defendant has behaved imprudently. Id. at 2471.
In order to state a claim for breach of the duty of prudence on the basis of insider information, the claimant most show there was a plausible, legal alternative the defendant could have taken that a prudent fiduciary in the same circumstance would not have believed was more likely to cause harm to the fund. Id. at 2472. The Court outlined three points of requisite analysis:
- ERISA’s duty of prudence does not require an ESOP fiduciary to take action that would violate securities laws;
- To keep in mind additional considerations are relevant where the basis of the complaint is the failure to decide, refraining from additional purchases or failure to disclose information to cause the stock to no longer be overvalued; and
- That a prudent fiduciary in the defendant’s position could not have concluded that actions such as disclosing negative information to the public or stopping sales would not have created more harm than good. Id.
Although trustees and other fiduciaries of ESOPs can no longer rely on a presumption of prudence while managing a plan, the Supreme Court’s clarity and three-step analysis at least provide trustees and other fiduciaries with the tools to make and defend prudent decisions.
Fraser Stryker is a nationally recognized leader in employee benefits and tax law. Attorneys in the Firm’s Employee Benefits & ERISA Practice Group advise businesses, governments, and nonprofit/tax-exempt organizations on a wide variety of tax and employee benefits matters, transactions, and litigation. Fraser Stryker helps employers implement and maintain innovative and cost-effective employee benefit plans that attract and retain top talent. For information regarding qualified plans, such as defined benefit plans, 401(k) plans, and cash balance plans, please contact Nicole R. Konen, Kevin Tracy, or Emily Wischnowski.
Formed in 1898, Fraser Stryker has grown to become a nationally recognized law firm that represents local, national, and multinational clients in complex business transactions and litigation matters. Fraser Stryker attorneys participate actively in a wide array of community organizations. Visit our home page for more information about the Firm.
This article is provided by Fraser Stryker for general informational purposes and is not intended to be and should not be construed as legal advice on any specific facts or circumstances.
Circular 230 Disclosure: We inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing or recommending to another party any matters addressed herein.