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U.S. Supreme Court Issues Important Decision Affecting Fiduciaries of ESOPs

By Emily A. Hayes, of Wilson Elser Moskowitz Edelman & Dicker LLP 

In a recent decision, Fifth Third Bankcorp v. Dudenhoeffer, 189 L.Ed. 2d 457 (2014), the U.S. Supreme Court vacated the “presumption of prudence” previously given to fiduciaries of employee-owned stock ownership plans (ESOPs) by many circuits, including the Second Circuit in In re Citigroup ERISA Litig., 662 F.3d 128 (2d Cir. 2011). In so doing, the Court held that ESOP fiduciaries are subject to the same presumption of prudence that applies to ERISA fiduciaries in general. However, the Court also set forth special considerations that apply to ESOP fiduciaries and that should be used by courts in determining whether a complaint states a claim when evaluating a motion to dismiss. As a result, the impact of the decision may not be as dramatic as it first appears.
Federal courts across the country have seen an increasing number of so-called “stock drop” cases, in which employees seek to hold their employers and the administrators of their 401(k) plans liable for continuing to allow the employee to invest in company stock when the employer and/or administrator allegedly knew and failed to disclose that the value of such stock was inflated or the investment was otherwise too risky. In dealing with these cases, a number of circuits adopted the “presumption of prudence,” or Moench presumption, for employee benefit plans that offer company stock as an investment option to plan participants. As noted above, this included the Second Circuit. The Moench presumption heightened the standard to be applied by federal courts at the pleading stage of these cases, making it easier for defendants to obtain early dismissals.
However, Fifth Third changes the landscape. Plaintiffs in that matter, former employees and participants in an ESOP, alleged that the defendants, Fifth Third and several officers as fiduciaries of its ESOP, breached ERISA’s fiduciary duty of prudence. They alleged that the defendants should have known, both through publicly available and inside information, that the Fifth Third stock price was overvalued and risky, and therefore should have taken action, including purchasing less company stock, selling company stock or disclosing negative inside information, which would allow the market to adjust the stock price. The complaint was initially dismissed in the U.S. District Court for the Southern District of Ohio for failure to state a claim, but that decision was reversed by the U.S. Court of Appeals for the Sixth Circuit, which held that while ESOP fiduciaries were entitled to a presumption of prudence, this was an evidentiary inquiry not applicable at the pleading stage. The Supreme Court granted certiorari to clarify the validity of the presumption of prudence.
The Supreme Court held that ESOP fiduciaries are not entitled to a presumption of prudence, but are subject to the same duty of prudence as other ERISA fiduciaries. However, unlike other ERISA fiduciaries, ESOP fiduciaries are not subject to the duty to diversify. This decision was based on the language of the ERISA statute itself:
The Court remanded the matter to the district court with instructions to apply the pleading standards set forth in Ashcroft v. Iqbal and Bell Atlantic v. Twombly, and to apply several special considerations: 

This is an important decision. Previously, under the presumption of prudence, ESOP fiduciaries were granted additional protections so long as the governing plan documents gave them the right to invest in employer stock and they invested consistent with the plan documents. Now their job is harder, in that they need to make sure that the decisions are actually prudent. The plan documents cannot waive this obligation. The value of this decision, especially for national companies that might be subject to such lawsuits in multiple jurisdictions, is that it provides clarity by resolving a previous circuit split. Further, it clarifies the use of diversification and inside information and other considerations that should be used by ESOP fiduciaries when making investment decisions, and still provides a measure of protection not available to general ERISA fiduciaries

 For additional information, contact Emily at emily.hayes@wilsonelser.com [1] or 914.872.7165