Argument analysis: No “coach class” fiduciary duties?
During Wednesday’s argument in Fifth Third Bancorp v. Dudenhoeffer, the Court was skeptical from the outset that there ought to be a special presumption of prudence for fiduciaries of employer stock ownership plans (“ESOPs”). But as the argument unfolded, most members of the Court appeared also to appreciate the difficulties of applying the usual ERISA “prudent person” standard to cases (like this) involving ESOP fiduciaries with inside information. In the end, while the Court likely will not apply a presumption of prudence, it may offer observations on the application of the prudent person standard that will make it difficult for plaintiffs to show that an ESOP fiduciary who failed to stop offering company stock in light of inside information that the stock was overvalued violated the duty of loyalty or prudence.
Attorney Robert Long, appearing for the bank, opened with the company’s position that it is “presumptively prudent” for an ESOP fiduciary to continue offering employer stock as an investment option. But Justice Kennedy quickly interposed what sounded like an accusation: “[Y]ou want us to say that we have sort of a coach class trustee,” such that “[w]e’re all traveling in coach class when we have an ESOP.” And Justice Ginsburg stated that “there is no presumption written into the statute” and the “statutory requirement on loyalty and prudence is undiluted.” Justice Scalia made a similar point, noting that “Section 1104 of ERISA . . . says that the fiduciaries must manage a plan” for the “exclusive purpose of providing benefits to the participants,” which is quite different from “running a plan to . . . own stock in the company.” From the start, then, the “presumption” of prudence did not get a warm reception.
After that opening flurry about the presumption, the argument moved to the topic that occupied most of the remaining time: What does ERISA require of an ESOP fiduciary who has inside information suggesting that company’s stock is dramatically overvalued by the market? The Justices referred to this as the “rock and a hard place” problem. On one hand, if the fiduciary sells, he violates securities law restrictions on insider trading; and if he sells or even only stops buying, he may hurt beneficiaries. On the other hand, if he doesn’t sell or stop buying, he may violate the ERISA duties of loyalty and prudence.
Justice Kagan broached this subject by asking whether a “prudent person” would retain an investment in company stock that he knew to be “wildly overvalued.” Long pointed out that “you have to then bring in securities law” and recognize that the fiduciary cannot “trade on that inside information.” But a fiduciary could stop buying, and Justice Kagan suggested that might hurt participants less – notwithstanding any resulting stock price drop – than it would “to keep putting more and more of their retirement investments into something that is really overvalued.” Justice Sotomayor suggested that the ESOP fiduciary should simply “followthe law and disclos[e] [the] material information” known to him to the public. But Long responded that a general duty to release information does not make sense under ERISA in light of the statute’s “many specific requirements for disclosure.” Moreover, we should not have “two sources of information about the company, the ESOP fiduciary” and the company itself.
This problem of what to require of ESOP fiduciaries with inside information of course led the Justices back to the question of what standard to apply to their behavior. Justice Kennedy asked the questions at the heart of this case: Is the duty of an ERISA fiduciary “somehow different when it’s an ESOP?” And “if so, what is the duty?” Justice Alito wondered whether the Court should consider the interests of ESOP participants as both participants and employees. Long suggested that the ESOP fiduciary’s duty is different; it is to “maximize returns for this special kind of vehicle” that only owns stock in one company. But Justice Kennedy was not satisfied, telling Long that, “If I’m the trustee, I don’t know what to do based on your answer.” That, Long rejoined, is the reason for the lower courts’ longstanding presumption of prudence – because of the special nature of ESOPs,” at least when the plan requires that funds be invested in the ESOP, “that is presumptively prudent.”
The first half of the argument thus amounted to a bit of a round trip, as the Justices appeared at the outset to reject a presumption of prudence. But by the time Long sat down, some members of the Court appeared uncomfortable with applying the usual “prudent person” standard to ESOP fiduciaries with inside information because of the “rock and a hard place” problem.
That discomfort characterized the Justices’ questions for Ronald Mann, representing the plan participants. Mann began by stating that if companies “are going to provide these kinds of benefits, [they] have to accept fiduciary duties.” The rock-and-a-hard place problem is of their own making.
Justice Breyer pointed out, however, that there is “no rule of trust or ERISA law that you can breach a duty to a beneficiary by failing to use inside information.” So what is wrong with just saying that an ESOP fiduciary “cannot have an obligation to use inside information?” The Chief Justice suggested that the duties of prudence and loyalty are especially easy to satisfy for a fiduciary whose entire job is to “get up in the morning and . . . buy some of [his] company’s stock.” How can you “say that he has breached a duty of prudence when the people investing in this ought to know that what they’re going to get is the company’s stock?”
Mann responded that “the most important thing is what you might call procedural prudence.” The ESOP fiduciary at least has an obligation to “investigate the situation,” and that did not happen here. But the Justices expressed uncertainty about what “procedural prudence” requires with respect to inside information. Justice Alito asked whether the “trustee has a duty to acquire inside information” in an investigation. More concretely, Justice Breyer wondered what happens if an insider already knows that an oil strike the public believes to be lucrative is not, because “it’s impossible to get the oil out?” “What is he supposed to do?”
Mann’s responses to these lines of inquiry caused the Court some frustration. The Chief Justice stated that what he perceived as a “mantra” that a “fiduciary at all times is to behave prudently in managing investment prudently” is “not going to help me.” And Justice Alito said that saying “the trustee is to behave as a prudent trustee would behave” is not an “answer to my question.” When pressed sufficiently, Mann did opine that a trustee “believing the stock is overvalued” based on inside information must “take action” to protect the beneficiaries. But he remained cagey about what action, and primarily reemphasized his position that “[t]he only reason petitioners are between a rock and a hard place is that they” chose to have these funds “managed by insiders.” “[I]f an employer is going to provide an employee benefits, the people that manage those benefits have to accept fiduciary duties.”
On behalf of the government, Deputy Solicitor General Ed Kneedler argued that fiduciaries should not, under the statute, take the interests of employees into account other than as participants in the plan. Beyond that, the government agreed with Mann that “fiduciaries have an obligation to actually exercise their discretion and . . . investigate.” Here, the allegation is that they did not even do that. But, asked the Chief Justice, in concrete terms, “what do you do as the trustee” with inside information? “Do you sell?” Kneedler suggested that it would “ordinarily be the right thing to do to sell” – or, rather, he corrected “stop purchasing,” since selling is unlawful – because “the truth will out eventually.”
Justice Kennedy asked whether the Court should “decide what the fiduciary standard” is “without regard to inside information,” or whether it is the “key issue in the case.” Kneedler responded that it is the key issue, and the Court should decide that an ESOP fiduciary, like any other, “has a duty of prudence not to remain invested in or to purchase materially overvalued stock.”
On rebuttal, Justice Sotomayor pressed Long about why ESOP fiduciaries, like all others, shouldn’t just “obey the law.” That might mean recovery under both securities law and ERISA, but the company “created the conflicts” and there are lots of areas of law that “create double remedies.” Long suggested that confusion would result, because it is unclear what the fiduciary is supposed to do under the standard “prudent person” approach. He urged the Court to “recognize this presumption that every court of appeals has recognized to give the ESOP fiduciary some leeway.”
As is often the case, the oral argument here cast more light on what the Court won’t do than on what it will. From the argument, it does not appear that there are five votes to adopt the lower courts’ presumption of prudence. Some version of the “prudent person” standard will likely apply. But it is more difficult to say how it will apply — and the likely outcome is a divided opinion.
Justice Sotomayor probably tipped her hand most clearly; she seems likely to support applying the usual “prudent person” standard in such a way that ESOP fiduciaries could be liable for continuing to offer company stock in the face of inside information that the stock is overvalued. Justice Kagan may be in that camp as well. Other Justices, like the Chief Justice and Justice Breyer, appear loath to require fiduciaries to act on inside information. And a number of Justices appeared to be searching for a middle ground, where a broad range of action (or inaction) might be “prudent” in the face of inside information. Notably, however, as a practical matter, suggesting that a wide range of fiduciary decisions may be prudent is not so different from a presumption of prudence – so the Court may end up pretty close to the rule of the courts of appeals after all.