While it is a question on which the U.S. Supreme Court declined to rule in its review of Fifth Third Bancorp v. Dudenhoeffer (Docket No. 12-751), it was prevalent in the discussion about 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 “SCOTUS Takes Up Presumption of Prudence Issue”).
In oral arguments before the court April 2, Robert A. Long Jr., counsel representing Fifth Third Bancorp, said, “A fiduciary’s decision to do exactly what an employee stock ownership plan is designed to do and what the plan requires by continuing to offer employer stock as an investment option is presumptively prudent. Statutory language, trust law, congressional policy and practical considerations all support this result.”
But justices questioned the existence of such a presumption. Justice Anthony M. Kennedy immediately replied: “You … want us to say that we have sort of a coach-class trustee. We’re all traveling in coach class when we have an ESOP. Once … we go down that road, how … do we define what the duties of the trustee are?”
Justice Ruth Bader Ginsburg said: “Mr. Long, there is no presumption written into this statute … [T]he statutory requirement on loyalty and prudence is undiluted. And so I don’t know where this presumption comes from. It’s not in the statute itself.” She pointed out there is only an exception from the diversification requirements for ESOPs—the whole object is to buy the company’s stock, so fiduciaries do not need to diversify.
Justice Sonia Sotomayor questioned whether the plan required investments totally in employer stock, as the Employee Retirement Income Security Act (ERISA) requires that an ESOP invest “primarily” in the employer’s stock. “You use the word ‘primarily.’ There’s an allegation here that you should have stopped buying stock once you understood that there was a serious condition in the company. That you’ve breached your duty of loyalty, not of prudence. What do you do with that allegation?” she asked Long.
Long pointed to U.S. Code Section 1104(a)(1)(b), which says the duty of prudence must take into account the character and aims of the enterprise. “So when we talk about ESOPs, we’re talking about a pension plan of a very specific kind,” he said.
During the discussion, the justices said Long seemed to be contending that the purpose of an ESOP is to own company stock—to give employees an ownership interest in the company. Justice Antonin Scalia pointed to Section 1104 of ERISA, which says the fiduciaries must manage a plan “for the exclusive purpose of providing benefits to participants and their beneficiaries.” He asked Long, “Do you acknowledge … that’s quite different from running a plan to … own stock in the company? That’s … not the basic purpose of it.”
“The pension plans themselves can provide death benefits, hardship benefits, disability benefits,” Long replied. “So if the benefit is stock in the company, a piece of the rock, you know, the duty of the fiduciary is to manage that as best as it can be managed to produce the largest benefit for the participants.”
Long said he agrees there does come a time when the purpose of the ESOP—allowing the employees to build an ownership stake in the company—can no longer be realized because the company is in serious peril, serious jeopardy. But, Justice Elena Kagan argued, there are occasions outside of that “very narrow” category for which it seems to defy statutory language that a prudent person would retain company stock as an investment. (See “'Impending Collapse’ Not Necessary to Rebut Presumption of Prudence”).
The discussion then turned to securities law and what a trustee should do if it had information that company stock was overvalued. “[Y]ou have to then bring in securities law, and you have to recognize [that] to trade on that inside information would violate securities laws. So prudence or loyalty cannot require a violation of securities law,” Long said. He pointed out another option would be to halt trading, but contended that could do great damage to the participants.
“I suppose it could, but a prudent manager might say that it would do greater damage to the … participants in the plan to enable this misinformation to exist and to keep … buying stock, to keep putting more and more of their retirement investments into something that is really overvalued,” Kagan rebutted.
Sotomayor asked, “So what’s wrong with following the law and disclosing that material information to the public and stopping the … employees from losing more money in worthless stock?”
Long expressed concern that requiring trustees to do that would create a new general ERISA duty to provide information, one that is not spelled out in ERISA. But, Sotomayor pointed out, it is not an ERISA responsibility; it is an SEC responsibility. “So what’s … wrong with a rule that simply says a fiduciary has to do whatever [is] possible to protect beneficiaries within the bounds of the law?” she said.
In his testimony before the justices, Ronald Mann, counsel speaking on behalf of the plan participants, pointed to Section 1002 of the code, which describes employee benefit plans, and says there are two types of employee benefit plans—those that provide welfare benefits and those that provide pension benefits. So, he contended, the issue is the conflict of trustees who are employed by the plan sponsor. “[W]hat the petitioners are saying is, if I decide to put myself in a position where I owe duties to two different people, my employer on the one hand and the beneficiaries of the plan, because I’ve put myself in a conflicted situation, it’s perfectly right for me to just do nothing,” he said.
Justice Samuel Anthony Alito Jr. asked, “[I]s it your argument that they just never should have insiders serving as trustees? You always have to have an outsider running these ESOPs?”
Mann said he thinks the situation is parallel to the situation that corporate directors face when they come into a conflicted situation. “If a situation arises in which their interests patently diverge from the interests of the shareholders, they don’t simply decide to represent both interests but pick one over the other. They instead step aside and appoint and, you know, allow independent people to represent the shareholders,” he said.
He pointed out that the participants’ complaint alleged, in part, that they were given false information, “the falsity of which perhaps could have been … discovered by considerable investigation.”
“Our position is that the duty of the trustee is to behave as a prudent fiduciary would behave, and if the trustee is unable to do that because the trustee has conflicting interests to serve, then the trustee is violating the duty of loyalty and should arrange the situation differently. I think it’s plain in the case that if the trustee does not undertake the investigation that a prudent fiduciary would take, because of their concern about acquiring insider information of the employer, then they would violate the ordinary standard of prudence,” Mann said.
During the testimony of Edwin S. Kneedler, solicitor general speaking on behalf of the United States as amicus curiae in support of the participants, Justice Stephen G. Breyer said he would like to know directly what the Securities and Exchange Commission (SEC) thinks. He said he does not know what to write to tell trustees what they should do when they learn some inside information that affects the company’s stock. He noted that a brief filed by the AFL-CIO said that in such a situation trustees should turn the plan over to someone else. Breyer stated he is going to ask for the SEC’s input.
Kneedler reiterated Mann’s argument to investigate. He said ESOP trustees still have the duty of prudence, which includes investigation and monitoring of the investment. “The trustee can’t sell on the basis of inside information. He could … stop purchasing,” he added.
In his rebuttal, Long tried to impress on the justices that court circuits have set a precedent for the presumption of prudence. “There is no circuit split on the issue that we’ve spent all our time discussing this morning. The only circuit split is on whether this presumption applies at the motion to dismiss stage,” he said.
He argued that if the company is going through temporary hard times, even if there is a situation where there is some material misinformation that is out in the market, it may all be corrected in the long term. “You know, in this case, if the fiduciaries had shut down the ESOP, they would certainly have been sued because they would have violated the plan terms, and the … plan has done very well,” he said. “[T]hey might have had a very hard time winning that case because they would have been challenged that prudence didn’t really require you to shut it down. Yes, we were going through some severe problems, but we came through them.”
Long submitted to the justices that they should be very cautious about interpreting these duties in ways that will make ESOPs unworkable, and that he thinks that would basically cause many companies to say they cannot put fiduciaries in that situation, so they are not going to have ESOPs at all.
Long told the justices, “They’re going to be sued unless you recognize this presumption that every court of appeals has recognized to give the ESOP fiduciary some leeway.” (See “High Court Lets Stand Presumption of Prudence Decisions”).
He argued that trustees of ESOPS are different from any other fiduciary in any other plan because the plan holds primarily company stock. If there is no presumption of prudence and the stock goes down, they will be sued for not having anticipated that and done something, he said, but if they do something and the stock goes up, they will be sued for that. Long contended that if the justices go with the other side’s approach, this will create a whole new class of cases, in which plaintiffs’ lawyers will be able to argue that a trustee should have anticipated that the stock would improve but let participants who decided to move to another fund sell too cheaply.
“So it’s—it’s unworkable,” he concluded.
An opinion on the case is expected in June. The transcript of the oral arguments before the court is here.