No One Totally Wins in Presumption of Prudence Decision

The U.S. Supreme Court this week ruled employee stock ownership plan (ESOP) fiduciaries are not entitled to a presumption of prudence for keeping company stock in the plans, but it didn’t just leave it at that.

“There’s no presumption, but plaintiffs have to specifically articulate whether it’s public or inside information they think fiduciaries should have used and what the fiduciaries could have done in the alternative that would have helped the plan and not been a detriment,” Dean Schaner, founder of Haynes and Boone LLP’s Houston Labor and Employment Practice group, tells PLANSPONSOR. “They really heightened the pleadings requirement.”

Schaner notes that the 6th U.S. Circuit Court of Appeals had determined the plaintiffs in the case of Fifth Third Bancorp v. Dudenhoeffer—former employees of Fifth Third Bancorp who contend the bank became a riskier lender and retirement plan fiduciaries should have known this and divested the plan from company stock—could proceed with their lawsuit because a presumption of prudence could not be applied at the pleading stage. However, the Supreme Court vacated that decision, giving the 6th Circuit—and other courts—a new standard for evaluating the pleadings.

Schaner says, although he was one who offered policy arguments in favor of a presumption of prudence, he was not surprised that the court rejected the presumption based on the plain language of ERISA, but did find it interesting that the court required lower courts to carefully scrutinize the language of a complaint in a certain context to see if a 12(b)(6) Motion to Dismiss for “failure to state a claim for which relief can be granted” can be applied.

“Regarding publicly available information, the Supreme Court made it very clear that if you have an effective market, just because there’s a stock price drop, that alone does not mean fiduciaries have to outsmart the market. That alone is not a breach of fiduciary duties,” Schaner explains. The court also said plaintiffs did not have to prove impending doom for the company. “So what’s in between?” he queried. “It’s a malleable area, but fact intensive.”

At the same time, the high court was stringent about insider information. “Fiduciaries cannot violate securities laws, and the court recognized the difficulty for fiduciaries to balance what they know and what is legal to disclose. ERISA doesn’t trump securities laws; fiduciaries are subject to both,” Schaner adds.

In the end, the court did not answer the prevailing question posed during oral argument— What is the trustee of a retirement plan that offers employer stock as an investment option supposed to do with inside information that the stock price may be overvalued?—but left it up to the plaintiffs to argue and the courts to decide. In its opinion, the court invited the Securities and Exchange Commission (SEC) to weigh in on whether plan fiduciaries have a duty to disclose any inside information.

Although retirement plan participants who bring such lawsuits against plan sponsors didn’t get a total win from the Supreme Court’s decision, it was not a win at all for plan sponsors. “The problem is, a company getting sued is at increased risk that will not be able to defeat a case at the pleading stage, so it will have to spend money and time to go to trial,” Schaner says. “It’s unfortunate that without the presumption, fiduciaries are in a more precarious position to determine when there’s a drop in stock price, what other facts are there that they should look at to decide what to do about holding the stock.”

Plan sponsors must carefully evaluate whether they want to continue having an ESOP or switch to another plan type to avoid risk now that the presumption is gone, according to Schaner. He says the high court’s decision, since it leaves so much ambiguity, may lead to more lawsuits if companies experience bad economic positions.

However, in a statement released following the Supreme Court ruling, Paul Ondrasik, head of Steptoe & Johnson’s ERISA, Labor, and Employment Group, contends “while the decision initially may result in a new wave of these cases, it is unlikely to change their outcome. As the court recognized, the lower courts can and should continue to ‘divide the plausible sheep from the meritless goats’ on a motion to dismiss.  And the opinion gives them the tools to do so by rejecting as ‘implausible’ claims based on little more than the fact of a stock drop and allegations of insider information.”

Ondrasik notes while the court rejected the presumption standard set forth in the 3rd U.S. Circuit Court of Appeals decision in Moench v. Robertson, “its decision clearly is not the ‘game changer’ the plaintiffs’ bar had hoped for.” He says the court’s pronouncements that fiduciaries cannot trade on the basis of insider information and that they are entitled to rely on prices set by the market largely sound the death knell for divestment claims. “Claims that fiduciaries should halt trading or make public pronouncements that are not required by the federal securities law should fare no better given the court’s recognition that such ‘alternatives’ generally would cause more harm than good.”

Ondrasik adds that the rejection of the presumption may be somewhat disappointing. “The lower courts had come up with a workable rule that provided guidance to plan sponsors and fiduciaries and protected them from meritless claims.”

ERISA Industry Committee (ERIC) President Scott Macey also issued a statement following the Supreme Court’s decision saying, “Although we are disappointed that the U.S. Supreme Court rejected the ‘presumption of prudence’, we are pleased that the Court clarified the manner in which fiduciaries can defend themselves from meritless lawsuits.”

ERIC had jointly filed an amicus brief with the Supreme Court in the case.