In a unanimous opinion in Fifth Third Bank v. Dudenhoeffer, the court ruled that fiduciaries responsible for employer stock funds “are subject to the same duty of prudence that applies to ERISA fiduciaries in general, except that they need not diversify the fund’s assets.” In doing so, the court held that company stock fiduciaries are not entitled to a “presumption of prudence.” Lower federal courts around the country had ruled that fiduciaries are protected from liability by that presumption (known as the Moench presumption based on the name of the 1995 case that first articulated it), unless the fiduciaries let the plan continue to hold or purchase employer stock when they knew or should have known of “dire circumstances” such as the company’s impending collapse.
After finding that ERISA does not provide for a presumption of prudence, the court went on to offer observations about how ERISA’s ordinary prudence standard should be applied to employer stock funds when the stock is publicly traded. The court’s views reveal recognition that fiduciaries should not ordinarily be expected to outguess how the markets will react to public information about a company, and that the securities laws limit what fiduciaries can do to protect plan participants when the fiduciaries learn of non-public information. But, the court left some unanswered questions about employer stock funds of public companies’ plans, and apart from its broadly applicable holding that ordinary prudence standards apply to employer stock funds, said little that expressly pertains to employer stock funds in plans sponsored by private companies.
The death of the Moench presumption means that fiduciaries responsible for employer stock funds should revisit their plan documents, plan governance structures and fiduciary procedures in light of the Supreme Court’s articulation of the prudence standard that applies to employer stock. In addition, fiduciaries and their advisers should be alert to future decisions of lower courts interpreting and applying the Supreme Court’s ruling to claims of fiduciary breach when employer stock funds plummet in value.
What the court did in the Dudenhoeffer case
The question before the Supreme Court in the Dudenhoeffer case was how, if at all, ERISA’s fiduciary duties of loyalty, prudence and plan document conformity are different when a company stock fund is involved, as compared to the plan’s other investments. In rulings dating back to the Moench case, every federal appeals court that has considered the issue had ruled that when it comes to employer stock, as opposed to other investments, fiduciaries are entitled to a presumption of prudence based on the special features of employer stock funds as single-security investments exempt from the diversification element of fiduciary responsibility that ERISA imposes on other plan investments. Agreeing that a decline in the stock’s price was not by itself enough to require fiduciary action, courts used phrases like “extreme risk,” “dire situation,” “[doubts as to] viability as a going concern,” “serious mismanagement” and “impending collapse” to characterize the additional circumstances that must be present to overcome the presumption of prudence and render a fiduciary duty-bound to stop purchasing the employer’s stock and perhaps even to sell all the holdings.The court decided that ERISA provides no basis for the presumption those lower courts had created. The court observed that the ERISA provision giving employer stock funds an exemption from the diversification requirement is the only special rule for such funds that Congress approved when it passed the statute. “But aside from that distinction,” the court ruled, “because [employer stock fund] fiduciaries are ERISA fiduciaries and because [ERISA’s] duty of prudence applies to all ERISA fiduciaries, [such] fiduciaries are subject to the duty of prudence just as other ERISA fiduciaries are.”
What should plan fiduciaries and sponsors do now?
While the lower courts weigh the merits of the Dudenhoeffer and other pending and future stock drop cases in the post-Moench era, plan sponsors and fiduciaries have employer stock funds to manage. It has long been recognized that ERISA’s standard of prudence places a heavy emphasis on the objectivity and thoroughness of the process by which fiduciaries make decisions.
The decision in Dudenhoeffer suggests a few steps that should be considered in consultation with qualified legal counsel:
- Review the provisions of the plan’s governing documents relating to the employer stock fund;
- Weigh the pros and cons of introducing a limit on participant investments in the undiversified company stock fund to limit participant exposure to loss;
- Develop a regular procedure for the plan fiduciary responsible for the company stock fund to review the company stock from an investment perspective;
- Weigh steps to minimize the likelihood that plan fiduciaries could obtain material non-public information, such as leaving decisions about the employer stock fund to company officials who do not have access to that information, or to independent fiduciaries with no ties to the company; and
- Consider whether it is advisable to create, and if appropriate, to implement a plan of action if the fiduciaries become aware of material non-public information, taking care to consider whether specific steps might do the participants more harm than good.
Fiduciaries of private company Employee Stock Owner Plans (ESOPs) must recognize that they, too, lost the protection of the Moench presumption.
The inherently undiversified nature of employer stock funds has always created a significant level of risk for plan participants. ERISA’s fiduciary standards were enacted to mitigate participants’ investment risk by imposing rigorous standards on the plan fiduciaries responsible for administering the plans that offered such funds. Those standards have created significant litigation risks for the fiduciaries. A non-party “friend of the court” brief filed with the Supreme Court by Delta Airlines listed 235 so-called “stock drop” litigation cases under ERISA filed between July 1997, and August 2013, the heyday of the Moench presumption.
With the presumption of prudence gone, some think the risk of litigation over employer stock funds will inevitably increase. However the court’s remarks about fiduciaries’ ability to rely on public stock pricing, and the impact of the securities laws on what fiduciaries can do when they have non-public information may result in rulings by lower courts that are just as protective as the now-defunct Moench presumption.
Andrew Irving, area senior vice president and area counsel of the Institutional Investment & Fiduciary Services group of Arthur J. Gallagher & Co., leads the fiduciary decision-making practice, which focuses on providing independent, conflict-free, discretionary decisions regarding particular transactions or plan assets. As area counsel, he also provides guidance on legal issues that arise in the course of client engagements and manages the services of outside legal counsel when particular assignments require their assistance.NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice. Any opinions of the author(s) do not necessarily reflect the stance of Asset International or its affiliates.