Opinion analysis: Court rejects “presumption of prudence” for ESOP fiduciaries
Today’s opinion in Fifth Third Bancorp v. Dudenhoeffer rejects the rule – embraced by most of the courts of appeals – that fiduciaries of employer stock ownership plans (“ESOPs”) are entitled to a “presumption of prudence” in connection with their decisions to buy or hold the employer’s stock. Rather, ESOP fiduciaries are subject to the same duty of prudence that applies to ERISA fiduciaries in general, except that they are not required to diversify the ESOP’s assets. After rejecting the presumption of prudence, however, the Court’s opinion sets forth guidelines for the lower courts to apply at the motion-to-dismiss stage that will make it more challenging for plaintiffs to satisfy pleading requirements in cases against ESOP fiduciaries.
I. No presumption of prudence
Justice Breyer’s analysis for the Court begins with the language of the statute, and specifically with the “prudent man standard of care,” to which ERISA subjects all plan fiduciaries. Ordinarily, Section 1104(a)(1)(C) would require ERISA fiduciaries to diversify assets as part of that standard of care. But “Congress has given ESOP fiduciaries a statutory exemption” from the diversification requirement.
The opinion then notes that a number of courts of appeals have “gone beyond ERISA’s express” statutory exemption to give ESOP fiduciaries a “presumption of prudence” with respect to decisions to hold or buy employer stock. But, the Court writes, “[i]n our view, the law does not create a special presumption favoring ESOP fiduciaries” —“ESOP fiduciaries are subject to the duty of prudence just as other ERISA fiduciaries are.”
The primary statutory argument advanced by the petitioners in support of the presumption was that ERISA defines the duty of prudence in terms of the “character” and “aims” of the plan, and ESOPs differ in those regards from a typical retirement plan because they seek to promote employee ownership of stock. The Court rejects “the claim that underlies this argument, namely, that the content of ERISA’s duty of prudence varies depending upon the specific nonpecuniary goal set out in an ERISA plan.” According to the Court, ERISA’s requirement that fiduciaries exclusively pursue the provision of “benefits” to plan participants and their beneficiaries refers only to financial benefits, not “nonpecuniary benefits like those supposed to arise from employee ownership of employer stock.” The Court likewise rejects the petitioners’ related argument that the plan’s mandate that fiduciaries invest in Fifth Third stock “waive[s]” the usual ERISA duty of prudence. The opinion concludes that “by contrast to the rule at common law, trust documents cannot excuse trustees from their duties under ERISA.”
The opinion finds the petitioners’ non-statutory, practical arguments more difficult to dismiss. They argued that “without some sort of special presumption, the threat of costly duty-of-prudence lawsuits” could keep companies from offering ESOPs at all, contrary to congressional intent. This is particularly true because a fiduciary might be sued for violating the duty of prudence if he keeps investing and the stock goes down, but sued for violating the plan mandate to invest if the stock goes up. The Court acknowledges the need for a “mechanism” to “weed out” meritless, economically burdensome lawsuits, but finds that the petitioners’ proposed presumption “does not readily divide the plausible sheep from the meritless goats.” “That important task can be better accomplished through careful, context-sensitive scrutiny of a complaint’s allegations.”
The opinion gives a similar response to the petitioners’ argument that “subjecting ESOP fiduciaries to a duty of prudence without the protection of a special presumption will lead to conflicts with the legal prohibition on insider trading” because ESOP fiduciaries are often insiders with non-public information about the value of the employer’s stock. The Court observes that this concern “is a legitimate one,” but an ESOP-specific presumption of prudence “is an ill-fitting means of addressing it.” Instead, the Court again requires case-by-case scrutiny of the complaint’s allegations against the backdrop of insider trading and corporate disclosure laws.
II. Claims based on publicly available information
According to the Court, “one important mechanism for weeding out meritless claims” is the motion to dismiss, which “requires careful judicial consideration of whether the complaint states a claim that the defendant has acted imprudently.” The opinion sets forth “considerations” that the “Court of Appeals should apply to the pleading standard” set forth in Ashcroft v. Iqbal, and Bell Atlantic Corp. v. Twombly, on remand.
With respect to claims based on publicly available information, the analysis is straightforward: “[W]here a stock is publicly traded, allegations that a fiduciary should have recognized from publicly available information alone that the market was over- or undervaluing the stock are implausible as a general rule, at least in the absence of special circumstances.” The opinion notes that the court of appeals here did not point to any special circumstance rendering reliance on the market price imprudent. Accordingly, with respect to the complaint’s reliance on publicly available information, the lower court’s “decision to deny dismissal appears to have been based on an erroneous understanding of the prudence of relying on market prices.”
III. Claims based on nonpublic information
In this case, however, the complaint also claims “that petitioners behaved imprudently by failing to act on the basis of nonpublic information that was available to them because they were Fifth Third insiders.” According to the Court: “To state a claim for breach of the duty of prudence on the basis of inside information, a plaintiff must plausibly allege an alternative action that the defendant could have taken that would have been consistent with the securities laws and that a prudent fiduciary would not have viewed as more likely to harm the fund than to help it.” The opinion then sets forth “three points [that] inform the requisite analysis.”
First, the duty of prudence cannot require ERISA fiduciaries to violate federal securities laws. Divesting a fund’s holdings based on inside information would be unlawful. So, “[t]o the extent that the Sixth Circuit denied dismissal based on the theory that the duty of prudence required petitioners to sell the ESOP’s holdings of Fifth Third stock, its denial of dismissal was erroneous.”
Second, where a complaint claims that fiduciaries should, on the basis of inside information, either refrain from purchasing additional stock or disclose that information to the public, the courts must consider both “complex insider trading and corporate disclosure requirements” under federal law and the objectives of those laws. The Court pointed out that the “U.S. Securities and Exchange Commission has not advised us of its views on these matters, and we believe those views may well be relevant.”
Third, courts should “consider whether the complaint has plausibly alleged that a prudent fiduciary could not have concluded that stopping purchases—which the market might take as a sign that insider fiduciaries viewed the employer’s stock as a bad investment—or publicly disclosing negative information would do more harm than good to the fund by causing a drop in the stock price.”
In sum, today’s opinion in Dudenhoeffer finds no statutory basis for a “presumption of prudence” in connection with ESOP fiduciaries decisions regarding company stock. But, as oral argument suggested, the Court was clearly troubled by the practical implications of allowing claims against ESOP fiduciaries to go forward as a general matter. The Court addressed that concern by articulating guidelines for the lower courts to apply at the motion-to-dismiss stage to make that a more difficult hurdle to clear.
[Disclosure: Ronald Mann, a frequent contributor to this blog, was among the counsel to the respondents in the case. However, the author of this post was not involved in the case in any way.]