Argument preview: Court to address “presumption of prudence” for ERISA fiduciaries
On April 2, the Court will hear argument in Fifth Third Bancorp v. Dudenhoeffer. This case involves a claim by participants in Fifth Third’s 401(k) plan that its fiduciaries violated their fiduciary duties by continuing to offer the company’s stock through the plan after Fifth Third – according to the complaint – “switched from being a conservative lender to a subprime lender.”
In recent years, a number of courts of appeals have held that fiduciaries are entitled to a strong presumption that their investment decisions with respect to company stock are prudent. In addition, other courts of appeals that had previously addressed the issue applied the presumption at the motion-to-dismiss stage. But the Sixth Circuit here disagreed, holding that: (1) there is no special presumption of prudence for fiduciaries of employer stock ownership plans (“ESOPs”), but rather the usual ERISA “prudent man” standard applies; and (2) any “presumption” would, in any event, be evidentiary and require a fully developed evidentiary record not available at the pleading stage.
These are the issues now before the Court.
Fifth Third’s individual account plan (often called a “defined contribution plan”) had a 401(k) feature. Fifth Third employees were permitted to make voluntary contributions to the 401(k) plan and direct them to any of the plan’s twenty investment options. The plan required that one of those options be the Fifth Third Stock Fund, which invests primarily in Fifth Third shares.
For all Fifth Third employees participating in its 401(k) plan, the company matched up to the first four percent of employee contributions. The company placed those matching funds in the Fifth Third Stock Fund. Employees could direct that those funds be moved to other investments.
The plaintiffs’ complaint alleged that the company and plan fiduciaries violated their fiduciary duties under ERISA by continuing to offer the Fifth Third Stock Fund after it had become imprudent to do so because the company had “switched from being a conservative lender to a subprime lender,” and had “either failed to disclose the resulting damage to the company and its stock or provided misleading disclosures.” The district court dismissed, finding that the fiduciaries were entitled to a presumption of prudence with respect to their decision to invest in employer stock. To overcome that presumption, the plaintiffs were required to plead facts sufficient to justify a finding of abuse of discretion, which they had failed to do.
The Sixth Circuit reversed. It first found that the presumption of prudence does not apply at the motion-to-dismiss stage. The court reasoned that presumptions are evidentiary, not standards of review, and as such require a fully developed evidentiary record that does not exist at the pleading stage. The court also found that there should not be a different, more protective standard for ESOP fiduciaries than for other ERISA fiduciaries, but rather “all fiduciaries, including ESOP fiduciaries,” are subject to “identical standards of prudence and loyalty.”
Fifth Third’s brief on the merits argues that ESOPs are unique, and should not be treated like conventional retirement plans. The company argues that the statutory text, established principles of trust law, and Congress’s purpose of promoting employee ownership through ESOPs all underscore that uniqueness and support a robust presumption of prudence. Fifth Third points out that the text of ERISA defines the duty of prudence based on how a prudent person would act “in the conduct of an enterprise of a like character and with like aims.” Because an important ESOP “aim” is to encourage long-term employee ownership stakes in their employer, a prudent person responsible for an ESOP would not divest the company’s securities as readily as other investments. Trust law, the company maintains, reinforces this distinction: trustees must take account of a trust’s purposes, and their performance should be judged in relation to what is prudent under the particular provisions and circumstances of the trust. Fifth Third also argues that the plaintiffs’ case is in tension with federal securities law, because it amounts to the claim that the fiduciaries should have traded (divested Fifth Third’s stock) based on inside information about the company’s lending practices.
Fifth Third also disagrees with the Sixth Circuit’s view that the presumption of prudence is an evidentiary rule rather than standard of review. While some presumptions merely assign the burden of producing evidence at trial, the company argues, others impose a substantive hurdle that the plaintiff must surmount – here, to properly plead a breach of the duty of prudence, the plaintiffs must allege facts showing an abuse of discretion. Measured against that standard, the plaintiffs here alleged no facts (such as impending collapse of the company) that could plausibly show that continued investment in Fifth Third stock would undermine the ESOP’s purpose of encouraging long-term employee ownership of the company.
The employees’ brief criticizes Fifth Third for demanding “free-floating judicial balancing of unanchored statutory objectives,” rather than simply applying the language of the statute. According to the employees, “this case begins and ends with the language Congress has chosen in the relevant provisions of ERISA.” The critical portion of ERISA is Section 404(a), setting forth the “prudent man standard of care” and establishing a duty of loyalty solely to the participants and beneficiaries. The employees argue that Section 404(a) does not require a showing of abuse of discretion, but instead may be satisfied by merely alleging “disloyal and imprudent” conduct, which they say the complaint does. The Court should not, the employees maintain, use the interest in fostering stock ownership emphasized by Fifth Third to fashion heightened pleading standards when Congress has never adopted such standards.
Two amicus briefs also bear mention – the United States in support of the employees and the U.S. Chamber of Commerce and other industry groups in support of Fifth Third. Like the employees, the United States argues that neither the text nor the purposes of ERISA support a special, “nearly insurmountable” presumption for ESOP fiduciaries – rather, all ERISA fiduciaries should be subject to the “prudent person” standard. According to the United States, ESOP fiduciaries may not manage with any other goal than providing retirement savings for employees – the statute thus does not permit elevating an objective like “fostering employee ownership” over the fundamental ERISA purpose of safeguarding retirement benefits.
The Chamber of Commerce brief demonstrates the strong support of the business community for Fifth Third’s position, but advances little additional legal argument. Like Fifth Third, the Chamber emphasizes that the unique nature of ESOPs and Congress’s desire to favor such plans support the presumption of prudence, as well as its application at the motion-to-dismiss stage.
This argument should be lively because legal and practical considerations arguably point in different directions. On the legal side, it is hard to deny that the presumption of prudence has little statutory basis. The closest that Fifth Third comes to a textual justification for the presumption is the need to consider the “aims” of ESOPs – but, as the United States points out, the overriding “aim” of any ERISA pension plan is to provide employee retirement benefits. Moreover, it would be somewhat odd for the Court to find that congressional policies derived primarily from outside of ERISA – from tax provisions and the like – require the imposition of a different standard of care for some ERISA fiduciaries than for others.
As a practical matter, though, a myopic focus on the best construction of ERISA may miss the forest for the trees here. Every other court of appeals to consider this issue – no fewer than seven, according to the Chamber of Commerce – has held that ESOP fiduciaries are entitled to a presumption of prudence. From that fact and the amicus filings here, it is fair to deduce that this kind of “stock-drop” case against ESOP fiduciaries is unpopular in many circles. Certainly such cases are unpopular with both the broader business community and the securities industry – and, again, they have not fared well with court of appeals judges in recent years. Accordingly, it may be tough to find five votes for eliminating the presumption of prudence among the current Justices.
But neither will it be easy for five Justices to find a convincing textual basis for the presumption. Perhaps, then, the Court will look for some middle ground. For example, the Court could accept the presumption but find it applicable only after the evidentiary record is developed – although that doesn’t really solve the problem of where to find the presumption in the statute. More likely, the Court could shift the focus from the statute to the plan documents, holding, for example, that when the governing documents mandate a company stock purchase option as part of the plan and do not allow fiduciaries to eliminate it, a fiduciary decision to keep the employer’s stock in the plan receives a presumption of prudence. That might be appealing as a way to avoid the question of how to find the presumption in the statute, while effectively preserving it in many cases.
In the end, though, the Justices may be more likely to split votes between the parties’ positions than to craft a new middle ground. Some members of the Court will likely want to preserve the presumption for practical reasons, while others will want to eliminate it for textual ones – although in this case, that split may not find the usual textualists on the side of the text. In short, I look for a divided Court at argument, and ultimately a divided opinion.