Supreme Court Finds No Presumption of Prudence for ESOP Fiduciaries, But Plaintiffs Must Allege Reasons for Lack of Prudence
- July 04, 2014
On June 25, in Fifth Third Bancorp v. Dudenhoeffer, the U.S. Supreme Court unanimously decided that the same standard of prudence generally applies to all ERISA fiduciaries, including ESOP fiduciaries. The only difference, given that ESOPs are meant to be primarily invested in employer stock, is that ESOP fiduciaries are not subject to a duty to diversify plan assets. Contrary to what some appellate courts previously held, ESOP fiduciaries are not protected by any presumption of prudence simply because a plan is designed to be invested in employer stock. This applies even if the formal plan document is drafted to explicitly invest in employer stock.
In this typical stock-drop case, this decision should remind ESOP fiduciaries (including, for example, 401(k) plans that structure employer matching contributions as an ESOP) that adhering to the basic principles of procedural prudence under ERISA is critically important. However, the Supreme Court’s decision goes beyond the elimination of the presumption of prudence previously created by the courts of appeals. It also describes pleadings requirements that will be difficult for plaintiffs to meet.
First, it is not enough for plaintiffs to generally allege that fiduciaries should have known that the market was over- or undervalued based on publicly available information alone. Just like any other investors, fiduciaries may, as a rule, prudently rely on market prices. Special circumstances affecting the reliability of the market prices are needed in that case. The Supreme Court did not elaborate on what these special circumstances might be, but the plaintiff must plausibly allege that fiduciaries should have taken a different course of action on the basis of such circumstances.
Second, if a claim states a lack of prudence based on inside information, the plaintiff must plausibly allege that the fiduciaries should have taken an alternative action that does not violate applicable securities laws, such as any prohibitions against insider trading. The fiduciaries should demonstrate that such action would not do more harm than good, such as telling the market that insider fiduciaries view employer stock as a bad investment, thus causing an abrupt decrease in stock prices.
These are likely to be significant hurdles for plaintiffs. The elimination of the presumption of prudence for ESOP fiduciaries will not necessarily result in more decisions holding fiduciaries liable for breach of their duties. It will not be easy for plaintiffs to survive a motion to dismiss for failure to state a claim. However, because ESOP fiduciaries can no longer rely on a presumption of prudence when investing (or continuing to invest) in employer stock, it is important for them, like any other plan fiduciaries, to be able show that they acted as prudent experts when monitoring employer stock as an investment for plan participants.