ERISA-Supreme Court Provides Guidance As To How ERISA Prudence Requirement Applies To ESOP Fiduciaries

In Fifth Third Bancorp v. Dudenhoeffer, No. 12-751, (S.Ct. 2014) the United States Supreme Court (the “Court”) ruled that ESOP fiduciaries are NOT entitled to a presumption of prudence when they purchase and hold employer stock (see my blog of yesterday). In so ruling. The Court expressed its view on how the ERISA prudence requirement applies to ESOP fiduciaries. Here is what the Court said:

In our view, the law does not create a special presumption favoring ESOP fiduciaries. Rather, the same standard of prudence applies to all ERISA fiduciaries, including ESOP fiduciaries, except that an ESOP fiduciary is under no duty to diversify the ESOP’s holdings.

Reviewing ERISA Section 1104, Section 1104(a)(1)(B) “imposes a `prudent person’ standard by which to measure fiduciaries’ investment decisions and disposition of assets.” Massachusetts Mut. Life Ins. Co. v. Russell, 473 U. S. 134, 143, n. 10 (1985). ERISA Section 1104(a)(1)(C) requires ERISA fiduciaries to diversify plan assets. And §1104(a)(2) establishes the extent to which those duties are loosened in the ESOP context to ensure that employers are permitted and encouraged to offer ESOPs. Section 1104(a)(2) makes no reference to a special “presumption” in favor of ESOP fiduciaries. It does not require plaintiffs to allege that the employer was on the “brink of collapse,” under “extraordinary circumstances,” or the like. Instead, §1104(a)(2) simply modifies the duties imposed by §1104(a)(1) in a precisely delineated way: It provides that an ESOP fiduciary is exempt from §1104(a)(1)(C)’s diversification requirement and also from §1104(a)(1)(B)’s duty of prudence, but “only to the extent that it requires diversification.” §1104(a)(2) (emphasis added).

In our view, where 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.

Respondents also claim that petitioners behaved imprudently by failing to act on the basis of nonpublic information that was available to them because they were FifthThird insiders. 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 in the same circumstances would not have viewed as more likely to harm the fund than to help it. The following three points inform the requisite analysis:

1. In deciding whether the complaint states a claim upon which relief can be granted, courts must bear in mind that the duty of prudence, under ERISA as under the common law of trusts, does not require a fiduciary to break the law. As every Court of Appeals to address the question has held, ERISA’s duty of prudence cannot require an ESOP fiduciary to perform an action–such as divesting the fund’s holdings of the employer’s stock on the basis of inside information–that would violate the securities laws.

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

3. Lower courts faced with such claims should also consider whether the complaint has plausibly alleged that a prudent fiduciary in the defendant’s position 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 and a concomitant drop in the value of the stock already held by the fund.

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