Dateline – On June 25, 2014 the U.S. Supreme Court ruled in the Fifth Third Bancorp v. Dudenhoeffer in a much anticipated case impacting fiduciaries of retirement plans that hold employer stock.
Fifth Third sponsored a 401k defined contribution retirement savings plan with twenty different investment options. One option was an Employee Stock Ownership Plan (ESOP) where participants could invest in Fifth Third stock. Under the plan, participants had the ability to direct their own contributions to any of the various investment options. However, the company’s matching contribution of 4% was initially and automatically invested in the ESOP, although the participants could move the funds to other investments thereafter.
Plan participants filed suit against the plan fiduciary and Fifth Third alleging that they violated Employee Retirement Income Security Act of 1974 (ERISA) by imprudently continuing to offer Fifth Third stock as an option even after the risks as a “subprime lender” became known. There were also additional allegations relating to disclosure failures by the plan fiduciaries.
The Southern District of Ohio dismissed the case, finding that the fiduciaries were entitled to a presumption of prudence (Moench presumption) with respect to their decision to invest in Employer stock in accordance with the terms of the plan. To overcome that presumption, the Plaintiffs were required to plead facts sufficient to justify a finding of abuse of discretion, which the Court ruled they failed to do.
On appeal, the Sixth Circuit reversed, holding that an ESOP’s fiduciaries enjoy a presumption of prudence, but presumptions are evidentiary and require a fully developed evidentiary record thus ruling that the Southern District of Ohio did not have proper grounds for a motion to dismiss.
The United States Supreme Court agreed to take the case to decide whether the Sixth Circuit erred in not applying the Moench presumption in the same manner as the other Circuit courts.
U.S. Supreme Court Ruling
The unanimous U.S. Supreme Court ruling found that ESOP fiduciaries are not entitled to a “defense-friendly” special presumption of prudence and are subject to “identical standards of prudence and loyalty” according to ERISA law except they are not required to diversify the fund’s assets. The Court did however provide additional guidance to District Courts for evaluating the plausibility of stock-drop claims at the pleadings stage and ordered the case back to the Sixth Circuit on remand.
The Court further held that plaintiffs seeking to show that a fiduciary should have sold employer stock (or refrained from purchasing), will need to plausibly allege “special circumstances”. This application at the motion-to-dismiss stage will make it more challenging for plaintiffs to satisfy pleading requirements. This is beyond a simple claim that the price of a stock declined in value or that it was imprudent to purchase or hold stock.
The Court also rejected as implausible any claim that fiduciaries violate their duty of prudence by failing to sell company stock based on nonpublic information. In order for the breach of duty on inside information, the plaintiffs “must plausibly allege an alternative action that the defendant could have taken that would have been consistent with the securities law and that a prudent fiduciary in the same circumstances would not have viewed as more likely to harm the fund than to help it.” 573 U.S. 18 (2014).
There is speculation that the Court’s decision, at least in the short term, will lead to an increase in the number of stock-drop cases filed, but those plaintiffs will be forced to narrow and otherwise refine stock-drop claims in a manner that may diminish the potential liability they engender. In the meantime, fiduciaries and employers should be reviewing their current plans to ensure all investments into company stock, profit sharing, 401(k), stock bonuses and savings plans are specifically authorized, tailored to the plan provisions, and incorporate all applicable participant disclosures.
Please contact one of Hylant’s Executive Risk professionals for any further information or questions.
Sara Skirvin, MBA, CRM, CIC, CPIW