The Supreme Court of the United States on Wednesday rejected the so-called “Moench presumption” that investment by an ESOP in company stock is prudent unless the company is on the brink of collapse. Fifth Third Bancorp v. Dudenhoeffer, No. 12-751 (June 25, 2014). The court determined that ESOP fiduciaries are not entitled to any special presumption of prudence, but are subject to the same duties as other ERSIA fiduciaries, except that they need not diversify the fund’s assets. Because the Moench presumption has been a powerful tool in defeating stock drop cases at the motion to dismiss stage, this ruling undoubtedly alters the litigation risks and costs facing fiduciaries and their insurers. Yet, as the Court closed one door, it opened another.
The Court emphasized that the Iqbal/Twombly standard still poses a significant bar to these claims for plaintiffs, delineating guidelines for lower courts’ “careful consideration” of whether the fiduciaries acted prudently. Where plaintiffs allege that fiduciaries failed to act in the face of publicly available information alone, the Court posited that these claims “are implausible as a general rule,” which does not sound dramatically different than a presumption of prudence. The court did find, however, that such a claim may survive a pleadings challenge if there are “special circumstances affecting the reliability of the market price.” The court did not attempt to define all of the “special circumstances” it contemplates, but suggests that plaintiffs may attempt to show that the market for a particular stock was not efficient and failed to factor in some publicly-available information. As such, the decision inched closer to enshrining in law the efficient capital market hypothesis—at least in its weak form—as discussed in this week’s Halliburton Co. v. Erica P. John Fund, No. 13-317 (Jun. 23, 2014).
Where ESOP fiduciaries are alleged to have acted or failed to act based on non-public, inside information, the Court’s opinion provides less of a roadmap for the lower courts. The decision sets a rule that a plaintiff alleging a breach of the duty of prudence based on inside information must “plausibly allege an alternative action that the defendant could have taken and that a prudent fiduciary in the same circumstances would not have viewed as more likely to harm the fund than to help it.” So, while insiders are not required to—and legally may not—engage in insider trading, fiduciaries must also consider whether refraining from making additional purchases or disclosing inside information would violate securities laws or do more harm to the ESOP than good by signaling to the market that company stock is a bad investment.
There are a number of open questions are raised by Dudenhoeffer, including:
- For cases relying on public information, the motion to dismiss stage in stock drop cases may end up looking more like the class certification stage in securities litigation, as the parties grapple with whether the market for the company’s stock was efficient and reliable factored in publicly available information.
- Where plaintiffs rely on non-public information, the courts will need to determine whether there really is any plausible way for fiduciaries to respond to non-public information without violating the securities laws and harming the plan participants. The moment a plan halts trading in company stock, an efficient market will react and the plan participants will likely suffer the very loses that the fiduciaries are attempting to avoid. Courts, however, are likely to take differing views of the necessary showing required for plaintiffs to meet the plausibility standard.
- Dudenhoeffer’s pronouncement that “the duty of prudence trumps the instructions of a plan” may have repercussions beyond stock drop cases in circumstances where defendants commonly argue that they had no discretion with respect to the challenged action and therefore cannot be held liable for a fiduciary breach.
As the parties and lower courts address these questions and others, the motion to dismiss stage will continue to be a critical signal event in ERISA stock drop cases that will likely become more expensive for fiduciaries and their carriers, particularly if experts are involved, even in “meritless goat” cases. Companies are certain to review their current ERISA plan structures in light of the Dudenhoeffer decision. Predictions that companies will stop offering company stock to employees seem overstated given the tax incentives promoting ESOPs. Plans may consider, however, relying more heavily on independent trustees that are unburdened by inside information to manage their plans.