In its unanimous opinion in Fifth Third Bancorp v. Dudenhoeffer (docket number 12-751), the high court says they are subject to the same duty of prudence that applies to ERISA fiduciaries in general per Section 1104(a)(1)(B), except that they need not diversify the fund’s assets, per Section 1104(a)(2). The court notes that Section 1104(a)(1)(B) imposes a ‘prudent person’ standard by which to measure fiduciaries’ investment decisions and disposition of assets, and Section 1104(a)(1)(C) requires ERISA fiduciaries to diversify plan assets. But, Section 1104(a)(2) establishes the extent to which those duties are loosened in the ESOP context by providing that “the diversification requirement of [§1104(a)(1)(C)] and the prudence requirement (only to the extent that it requires diversification) of [§1104(a)(1)(B)] [are] not violated by acquisition or holding of [employer stock].”

The justices agreed that Section 1104(a)(2) makes no reference to a special “presumption” in favor of ESOP fiduciaries and does not require plaintiffs to allege that the employer was on the “brink of collapse,” as some circuit courts have established.

“Thus, aside from the fact that ESOP fiduciaries are not liable for losses that result from a failure to diversify, they are subject to the duty of prudence like other ERISA fiduciaries,” Justice Stephen G. Breyer wrote in the opinion.

Instructing the 6th U.S. Circuit Court of Appeals, the Supreme Court said that on remand, the appellate court should reconsider whether the complaint states a claim by applying the pleading standard as discussed in Ashcroft v. Iqbal and Bell Atlantic Corp. v. Twombly, considering that where a stock is publicly traded, allegations that a fiduciary should have recognized on the basis of publicly available information that the market was overvaluing or undervaluing the stock are generally implausible and thus insufficient to state a claim. The pleading standard requires that to state a claim for breach of the duty of prudence, a complaint must plausibly allege an alternative action that the defendant could have taken, that would have been legal, and that a prudent fiduciary in the same circumstances would not have viewed as more likely to harm the fund than to help it.

The question of what the trustee of a retirement plan that offers employer stock as an investment option is supposed to do with inside information that the stock price may be overvalued was prevalent in the high court’s discussion of the case and whether fiduciaries of employee stock ownership plans (ESOPs) have a presumption of prudence that plan participants cannot overcome in a lawsuit unless they plausibly allege plan fiduciaries abused their discretion by remaining invested in employer stock (see “High Court Ponders ‘Conflicts’ for ESOP Fiduciaries”). The high court decided that where the complaint alleges a fiduciary was imprudent in failing to act on the basis of inside information, the analysis is informed by the following points:

• ERISA’s duty of prudence never requires a fiduciary to break the law, and so a fiduciary cannot be imprudent for failing to buy or sell stock in violation of the insider trading laws.

• Where a complaint faults fiduciaries for failing to decide, based on negative inside information, to refrain from making additional stock purchases or for failing to publicly disclose that information so that the stock would no longer be overvalued, courts should consider the extent to which imposing an ERISA-based obligation either to refrain from making a planned trade or to disclose inside information to the public could conflict with the complex insider trading and corporate disclosure requirements set forth by the federal securities laws or with the objectives of those laws.

• Courts confronted with such claims should consider whether the complaint has plausibly alleged that a prudent fiduciary in the defendant’s position could not have concluded that stopping purchases or publicly disclosing negative information would do more harm than good to the fund by causing a drop in the stock price and a concomitant drop in the value of the stock already held by the fund.

Two former employees of Fifth Third Bancorp filed suit in September 2008 over investment option decisions made by various officials at the bank and its holding company during the period before July 10, 2007. The lawsuit contended that the company switched from being a conservative bank lender to a lender in the subprime mortgage market. The lawsuit also contended that the president and other top officials within the bank knew the new investment strategy was far riskier, because of a high potential for defaults, and yet failed to do anything about the continued investment in company stock.

Between July 2007 and September 2009, the company’ stock price dropped significantly, causing the employee plan to lose tens of millions of dollars on its investments. The investments, the workers’ lawsuit argued, continued long after it was prudent to maintain them.

A federal district judge dismissed the lawsuit, finding that the company was entitled to a presumption that its continued investment in company stock was reasonable. However, the 6th Circuit revived the lawsuit, finding it could proceed on the claim that the officers had violated their fiduciary duty and caused the losses to the plan by failing to divest the plan of stock in the company and failing to remove company stock as an investment option for the employees (see "Court Revives Fifth Third Stock Drop Suit"). The 6th Circuit ruled the presumption is not to be applied at the pleading stage of such a lawsuit.

The Supreme Court's opinion is here.