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Supreme Court Eliminates Presumption of Prudence for Employer Securities

August 11, 2014
HSE LEGALcurrents

Fiduciaries of retirement plans governed by the Employee Retirement Income Security Act (“ERISA”) must select prudent investments for plan assets. In Fifth Third Bancorp v. Dudenhoeffer, the Supreme Court overturned almost 20 years of lower court caselaw to reject the use of a special presumption that a retirement plan’s investment in employer stock is prudent in most circumstances, and stressed that “the same standard of prudence applies to all ERISA fiduciaries.”

Background

ERISA requires retirement plan fiduciaries to manage plan assets with the care, skill, diligence and prudence under the circumstances then prevailing that a prudent person familiar with such matters would use in conducting a similar enterprise with similar purposes. In addition, plan assets must generally be diversified so as to minimize large losses unless, under the circumstances, it is clearly prudent not to do so. Although the statute does not contain a general exemption from the prudent management requirement for plan investments in employer securities, ERISA does expressly exempt defined contribution plan investments in employer securities from the requirement that a plan’s investments be diversified. Beginning in 1995, many courts interpreted this diversification exemption combined with statutory provisions facilitating employer stock investments, such as special privileges granted to employee stock ownership plans (“ESOPs”) (which by their nature must primarily invest in the stock of the plan sponsor), to give plan fiduciaries a “presumption of prudence” regarding their decisions to invest in employer stock. This presumption provided significant protection to fiduciaries and generally meant that, absent extraordinary circumstances, fiduciaries were required to maintain plan investments in employer securities when so directed by the plan documents.

The Fifth Third case involves Fifth Third Bank’s retirement plan. The plan included an ESOP component that made the Bank’s stock available as an investment option, and into which the company’s matching contributions were initially deposited. The plaintiffs in the case alleged that the plan’s trustees acted imprudently by continuing to hold and invest in the Bank’s stock despite allegedly knowing, based on both public and non-public information, that the Bank’s business model had become excessively risky and its stock overpriced. Between July 2007 and September 2009, the Bank’s share price declined by 74 percent.

The Decision

Focusing on the statutory language, the Supreme Court held that plan fiduciaries are not entitled to any special presumption of prudence for investments in employer securities, noting that the only statutory distinction between investments in employer securities and other investments is the exemption from the duty of diversification. The Court also stated that plan document language mandating employer stock investments could not excuse fiduciaries from their duty to act prudently, since plan fiduciaries must disregard plan terms that contradict ERISA and thus must disregard any mandate to invest the plan imprudently.

However, by way of providing some comfort to public companies, the Court indicated its skepticism, absent special circumstances, toward claims that fiduciaries should have known from publicly available information that the market was over- or undervaluing publicly traded employer securities. The Court also indicated that in order to state a claim based on nonpublic information, a plaintiff must “plausibly allege an alternative action” that fiduciaries could have taken that: (i) would have been consistent with securities laws, and (ii) a prudent fiduciary would not have viewed as more likely to harm the plan than help it.

Implications

It remains to be seen how lower federal courts will apply the Fifth Third decision, and several potentially important cases have been remanded for further consideration following the decision. Although plan fiduciaries lost a helpful defense when the Court rejected the presumption of prudence, the Court’s comments regarding market pricing may offer some comfort to public company fiduciaries with respect to certain claims. Furthermore, the Court helpfully confirmed that an ERISA fiduciary is not required to take action that would violate securities laws. However, the decision may still leave a variety of claims open for potential plaintiffs. In addition, closely-held companies are adversely affected by the decision, since the Court’s more protective comments focus on public company issues.

While waiting to see how federal courts handle future employer stock fiduciary cases, companies and plan fiduciaries should consider how best to align themselves with the guidance provided by Fifth Third. Below are a few suggestions:

  • Given the Court’s ruling that fiduciaries must comply with the general ERISA prudence standard with respect to employer securities, fiduciaries should create a process or enhance the processes currently in place for evaluation of the prudence of employer securities. At a minimum, this should include reviewing (and updating, as appropriate) investment policies, investment committee charters, and other relevant documents.
  • Ongoing participant communications should take the ruling into account when discussing fiduciary oversight of employer securities, and standing communications should be reviewed. However, if a plan offers employer securities as only one investment option, communications should continue to reflect that participants are responsible for their investment allocation decisions. Furthermore, the Supreme Court’s decision does not change the fact that plan fiduciaries are not the guarantors of plan investments, and are not liable for losses which occur despite their prudent conduct rather than as a result of their imprudence.
  • For public companies, fiduciaries without access to material nonpublic information should consider evaluating periodically whether any special circumstances appear to exist that would call into question current market prices.
  • Public companies should consider modifying their fiduciary governance structure to place fiduciary responsibilities with individuals whose job functions are not likely to involve regular access to material nonpublic information. To the extent that having such individuals in a fiduciary role cannot be avoided (for example, if a plan uses an IRS-pre-approved document and must allow the company’s board of directors to oversee the appointment of fiduciaries under the pre-approved terms), those individuals should be trained to understand their legal obligations under both ERISA and securities laws.
  • Private companies should be sensitive to the potential role that access to confidential information about the company’s intentions, pending business transactions, special risks, strategic changes and so forth may play in the decisions of their plan fiduciaries as well, and may likewise want to consider the extent to which the fiduciary governance structure can be altered to minimize or prevent conflicting obligations for plan fiduciaries.
  • While some companies may wish to reevaluate whether to continue holding employer securities in their plans post-Fifth Third, any decisions to eliminate or otherwise change a plan’s investments in employer securities should be undertaken with care and in consultation with plan counsel.

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