In the past, fiduciaries of employee stock ownership plans (ESOPs) and other defined contribution plans that invest in employer stock generally have been able to rely on a special “presumption of prudence” in court when defending their decisions to continue to offer employer stock as an investment option, even when the investment has substantially declined in value. This special presumption of prudence ceased to exist on June 25, 2014, when the United States Supreme Court released its unanimous opinion in Fifth Third Bancorp v. Dudenhoeffer [1] holding that there is no special presumption of prudence applicable to fiduciaries with respect to employer stock held in a retirement plan. However, the Supreme Court’s opinion provides some helpful guidance to fiduciaries of plans which continue to permit investments in employer stock.

Background

The special presumption of prudence is also known as the “Moench Presumption” in reference to the Third Circuit Court of Appeals’ decision in Moench v. Robertson [2]. Under ERISA, ESOP trustees are excused from the fiduciary requirement to diversify the plan’s investments, as well as the obligation to act prudently as it relates to the diversification obligation. Previously, courts following the Moench decision presumed that ESOP fiduciaries making decisions to buy or sell employer stock had acted prudently, because ESOPs are intended to invest primarily in employer securities and, in fact, ESOP documents generally require such investments. Under this presumption, fiduciaries could be held liable for losses resulting from employer stock investments only if there was a specific showing that the investment was significantly imprudent. Over the years, some courts also extended the Moench Presumption to cases involving other types of defined contribution plans which required or permitted investments in employer stock.

In the Fifth Third case, former employees brought suit against Fifth Third Bancorp, a bank that did substantial business in subprime lending. The plaintiffs alleged, in a “stock drop” case, that the fiduciaries of the ESOP sponsored by Fifth Third breached their ERISA duty of prudence by continuing to invest in employer stock that the fiduciaries either knew or should have known was inflated in value, and which subsequently lost almost three-quarters of its value. The plaintiffs argued that the plan’s fiduciaries had access to sufficient public and nonpublic information about the bank (e.g., newspaper articles indicating the imminent collapse of the subprime lending market; material misstatements by bank officers about the bank’s financial prospects; etc.) to be aware that the stock was overvalued in the market. The plaintiffs argued that the continued investment in employer securities was a violation of fiduciary duties, and that the fiduciaries should have refrained from further purchases of employer stock, sold employer stock held by the ESOP, and/or disclosed insider information about the employer so that the stock market would adjust the price downward.

The Supreme Court took the Fifth Third case in order to consider whether the Moench Presumption applies to ESOP fiduciaries. Ultimately, the Supreme Court eliminated the presumption of prudence entirely, holding that ESOP fiduciaries are subject to ERISA’s prudent expert standard and that the statutory exception relating to ESOPs only relieves fiduciaries from the fiduciary duty to diversify plan investments. The Supreme Court reasoned that the statutory exemption from the duty of prudence explicitly states that it only applies “to the extent that it requires diversification,” and it makes no reference to any special presumption of prudence.

Some Guidance for Courts and for Plan Fiduciaries

The Supreme Court’s decision in Fifth Third provides a roadmap of the elements of judicial consideration to be applied in determining whether plaintiffs have stated a “plausible claim” against the fiduciaries. Under that decision, courts should consider the following elements in determining whether a claim alleging a breach of the duty of prudence in the context of a stock drop scenario is a plausible claim (and plan fiduciaries should consider these elements when determining whether employer stock is a prudent investment for a plan):

• Publicly available information: Allegations that a fiduciary should have recognized, from public information alone, that the marketplace was either over- or under-valuing publicly traded employer stock are “implausible as a general rule,” absent special circumstances. As a result, generally, a fiduciary will be not considered imprudent in assuming that the market value of employer stock on a major stock exchange provides the best estimate of the stock’s value. The Supreme Court did not elaborate on what circumstances might give rise to a situation where reliance on the stock price as set on a public exchange is not considered prudent. The Court also did not provide guidance to fiduciaries of plans that are invested in employer stock that is not publicly traded.
   
• Insider information: A claim for the breach of the duty of prudence on the basis of insider information will not survive in court unless the plaintiff can plausibly allege another legal course of action that the fiduciary could have taken. The Supreme Court cautioned that the fiduciary duties imposed under ERISA could never require a fiduciary to violate securities laws (i.e., require the fiduciary to remove the stock based on insider information), and that a decision not to stop additional purchases of employer stock or publicly disclose insider information should be considered in light of securities laws and objectives. Also, the alternative course of action must be one that a prudent fiduciary in the same situation would not have viewed as more likely to harm the employer stock fund than to help it (e.g., could a prudent fiduciary have concluded that ceasing investment in employer stock, or selling stock, would have caused or worsened a decline in the value of the stock).

Although this discussion in the decision may be helpful in the context of the investment in stock of a publicly traded company, this discussion provides only limited assistance to fiduciaries of plans that are invested in the stock of a privately-held company. Still, it is clear from the decision that fiduciaries are subject to the same prudence requirements for the investment in employer stock as are applied to any other investment of plan assets.

What Should Fiduciaries Do Now?

Fiduciaries should be aware that plan document provisions that expressly require investment in employer stock, or requiring the offering of employer stock as an investment option, do not eliminate the duty of fiduciary prudence with respect to continued investment in employer stock. Sponsors of plans that require that fiduciaries invest in employer stock may wish to revisit the wording of those plan provisions.

However, the elimination of the Moench Presumption should not discourage employers from including or retaining employer stock in their plans. Although plan document language mandating investment in employer stock is not sufficient to avoid claims of breach of fiduciary duty, the guidance provided by the Fifth Third decision should be able to help plan fiduciaries in avoiding such claims. In addition, future court challenges likely will provide some guidance as to what special circumstances are relevant with respect to reliance on publicly available information in making decisions with respect to the investment in employer stock.

Finally, because fiduciaries may no longer rely on the Moench Presumption with respect to the investment in employer stock, fiduciaries should review their procedures to regularly monitor and review the decision to acquire or retain employer stock. Furthermore, fiduciaries will need to ensure those procedures are being followed and the monitoring and decision-making process documented. Fiduciaries also will need to determine how best to evaluate the value of employer stock while still satisfying their duty of prudence. Also, plan sponsors may want to consider whether retaining an independent fiduciary to monitor the employer stock investments in the retirement plan is advisable.

^[1] Fifth Third Bancorp v. Dudenhoeffer, 573 U.S. _____ (2014).
^[2] Moench v. Robertson, 62 F.3d 553 (3d Cir. 1995).