Pension & Benefits Daily ™
Reproduced with permission from Pension & Benefits Daily, 147 PBD , 07/31/2014. Copyright 姝 2014 by The Bureau of National Affairs, Inc. (800-372-1033) http://www.bna.com
Dude, Where’s My ERISA Presumption of Prudence?
ERISA’s Presumption of Prudence
BY JAMES P. BAKER
ometimes when the U.S. Supreme Court issues a
groundbreaking ruling, ERISA lawyers feel as confused as Chester and Jesse in that teenage cult
classic ‘‘Dude, Where’s My Car?’’:
Chester: Is that a barn?
Jesse: Is it red?
Chester: No.
Jesse: Then it’s not a barn!
On June 25, 2014, in a unanimous decision, the U.S.
Supreme Court rejected the special ‘‘presumption of
prudence’’ courts had granted to ERISA Employee
Stock Ownership Plan (ESOP) fiduciaries.1 With no
need to worry about a ‘‘presumption of prudence,’’
ERISA plaintiffs now need only allege that an ESOP’s
fiduciaries acted imprudently. The court then explained
that plaintiffs may find it difficult to plead imprudence,
‘‘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. . . . would not have viewed as more likely
to harm the fund than help it.’’ ERISA plaintiffs’ lawyers face a new challenge—framing ERISA fiduciary
breach claims that comport with the insider trading restrictions contained in federal securities laws.
S
1
Fifth Third Bancorp v. Dudenhoeffer, 573 U.S. ____, 2014
BL 175777, 58 EBC 1405 (2014) (123 PBD, 6/26/14; 41 BPR
1360, 7/1/14) (‘‘Dudenhoeffer’’).
James P. Baker (james.baker@
bakermckenzie.com) is a partner in Baker &
McKenzie’s San Francisco office. His practice focuses on ERISA litigation.
COPYRIGHT 姝 2014 BY THE BUREAU OF NATIONAL AFFAIRS, INC.
Following the collapse of Enron and later, WorldCom, a tidal wave of ERISA class action claims were
filed against pension plan fiduciaries. In the case of Enron, the bad conduct by Ken Lay and other insiders
doomed the $1.3 billion Enron stock held by employees
in Enron’s 401(k) Plan. The average Enron 401(k) plan
participant held 62% of his or her account balance in
Enron stock. Ken Lay and the other defendants filed an
unsuccessful motion to dismiss arguing that their retention of Enron stock as it tumbled into bankruptcy was
entitled to a ‘‘presumption of prudence.’’2 The parade of
horribles at Enron ultimately allowed plaintiffs to recover $442 million in settlement on behalf of Enron’s
401(k) plan participants.
The first Court to consider the prudence of an ERISA
pension plan fiduciary who primarily held company
stock was the Third Circuit in Moench v. Robertson, 62
F.3d 553, 571, 19 EBC 1713 (3d Cir. 1995). The Court in
Moench considered whether the precipitous decline in
the market value of Statewide Bancorp common stock
held in an ESOP from $18.25 per share to $0.25 per
share over a two-year period constituted a breach of fiduciary duty under ERISA.3 The District Court granted
defendant Statewide ESOP Committee’s motion for
summary judgment. It found that the pension plan’s
language did not give Statewide’s fiduciaries any discretion in retaining employer stock.4 On appeal, the
Third Circuit reversed. It remanded the case and instructed the District Court to determine whether ‘‘an
ESOP fiduciary who invests the [ESOP’s] assets in employer stock is entitled to a presumption that it acted
consistently with ERISA’’ in doing so.5 In so ruling,
ERISA’s ‘‘presumption of prudence’’ was born. After
the Third Circuit’s decision in Moench, every Circuit
Court of Appeals that considered this same issue adopted the Moench presumption. For example, the Ninth
2
In re Corp. Sec., Derivatives & ERISA Litigation, 284 F.
Supp. 2d 511, 534 n.3 (S.D. Tex. 2003).
3
An ESOP is a type of pension plan categorized under
ERISA as an ‘‘Eligible Individual Account Plan.’’ (‘‘EIAP’’). 29
U.S.C. § 1107(d)(3)(A). EIAPs include 401(k) plans and stock
bonus plans that invest in company stock. Edgar v. Avaya,
Inc., 503 F.3d 340, 347, 2007 BL 107798, 41 EBC 2249 (3d Cir.
2007)(187 PBD, 9/27/07; 34 BPR 2365, 10/2/07).
4
Id. at 560.
5
Id. at 571.
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Circuit has said that to ‘‘overcome the presumption of
prudent investment, plaintiffs must . . . make allegations that ‘clearly implicate[] the company’s viability as
an ongoing concern’ or show ‘a precipitous decline in
the employer’s stock . . . combined with evidence that
the company is on the brink of collapse or is undergoing serious mismanagement.’ ’’6
The ERISA Statute Contains No ‘Presumption
of Prudence’
Pension plan ‘‘stock drop’’ claims usually arise when
bad things have occurred at the company such as financial irregularities, product failures, business reversals
or reporting bad results. Bad news at a public company
usually translates into a significant stock price decline.
Typically, when securities fraud class action claims are
filed in connection with these business mishaps, a tag
along ERISA ‘‘stock drop’’ class action is filed. The
ERISA stock drop class action alleges that pension plan
fiduciaries, who are usually company insiders, violated
their fiduciary duties by failing to disclose the bad news
to the public, failing to use the bad news to sell employer stock held by the pension plan or failed to appoint an independent fiduciary at the time the business
mishap occurred. In Fifth Third Bancorp v. Dudenhoeffer, the Supreme Court ruled that ERISA ‘‘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.’’7
The Supreme Court acknowledged that eliminating
the ‘‘presumption of prudence’’ places an ESOP fiduciary:
between a rock and a hard place: If he keeps investing and
the stock goes down he may be sued for acting imprudently
in violation of § 1104(a)(1)(B), but if he stops investing and
the stock goes up he may be sued for disobeying the plan
documents in violation of § 1104(a)(1)(D).
At the same time, we do not believe that the presumption at
issue here is an appropriate way to weed out meritless lawsuits or to provide the requisite ‘‘balancing.’’ The proposed
presumption makes it impossible for a plaintiff to state a
duty-of-prudence claim, no matter how meritorious, unless
the employer is in very bad economic circumstances. Such
a rule does not readily divide the plausible sheep from the
meritless goats. That important task can be better accomplished through careful, context-sensitive scrutiny of a
complaint’s allegations.8
Fifth Third’s primary argument that ESOPs have a
special purpose—to advance employee ownership of
companies—was rejected out of hand. Those words
cannot be found in the ERISA statute. The Supreme
Court could not find that:
[T]he content of ERISA’s duty of prudence varies depending upon the specific nonpecuniary goal set out in an
ERISA plan.9
6
Quan v. Computer Sciences Corp., 623 F.3d 870, 882, 2010
BL 229192, 49 EBC 2642 (9th Cir. 2010)(189 PBD, 10/1/10; 37
BPR 2187, 10/5/10).
7
Slip Opinion at p. 8.
8
Id. at pp. 14-15.
9
Id. at p. 10.
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Second, the Supreme Court rejected Fifth Third’s argument that the words of the pension plan document
overrode the statutory duty of prudence, explaining
‘‘trust documents cannot excuse trustees from their duties under ERISA.’’10
Claims Based on Publicly Available
Information
Fifth Third’s final argument that plaintiffs’ complaint
would cause ERISA fiduciaries to violate federal securities laws by trading company stock based on insider information was much better received. The Supreme
Court observed that Fifth Third’s concern was ‘‘a legitimate one.’’11 It stated, ‘‘Surely a fiduciary is not obligated to break the insider trading laws even if his company is about to fail.’’12 Although the Supreme Court rejected applying the presumption of prudence based
upon this potential ‘‘insider trading’’ problem, the Supreme Court explained that plaintiff’s theory of liability
foundered in the face of the fact that ERISA fiduciaries
cannot break securities laws and trade on the basis of
insider information. In doing so, the Supreme Court expressly embraced the ‘‘efficient market’’ theory of liability:
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 under a general rule, at
least in the absence of special circumstances. Many investors take the view that ‘‘they have little hope of out performing the market in the long run based solely on their analysis of publicly available information,’’ and accordingly they
‘‘‘rely on the security’s market price as an unbiased assessment of the security’s value in light of all public information.’ ’’ Halliburton v. Erica P. John Fund, Inc., ____ U.S.
____, ____ 2014 BL 172975 (2014) (slip op., at 11–12).13
In remanding the case, the Supreme Court signaled
that plaintiff’s insider trading claim may well yet be
doomed at the Motion to Dismiss stage:
The Court of Appeals did not point to any special circumstance rendering reliance on the market price imprudent.
The court’s decision to deny dismissal therefore appears to
have been based on an erroneous understanding of the prudence of relying on market prices.14
Claims Based on Nonpublic Information
The alternate theories of liability advanced by the
Fifth Third plaintiffs also appear to be in jeopardy.
First, plaintiff’s allegation that the Fifth Third ERISA fiduciary should have used insider information to sell the
ESOP’s holdings of Fifth Third stock appears to be a
nonstarter. The Supreme Court pointedly observed that
ERISA ‘‘does not require a fiduciary to break the
law.’’15
10
Citing Central States, Southeast & Southwest Areas Pension Fund, 472 U.S. at 568; see also 29 U.S.C. §§ 1104(a)(1)(D)
and 1110(a). Id. at p. 12.
11
Id. at p. 13.
12
Id.
13
Id. at p. 16.
14
Id. at pp. 17-18.
15
Id. at p. 18.
COPYRIGHT 姝 2014 BY THE BUREAU OF NATIONAL AFFAIRS, INC.
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Plaintiff’s other theory that Fifth Third’s insider
should have stopped buying Fifth Third stock when the
stock price was falling also appears to be on thin ice:
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.16
The Supreme Court also noted that stopping purchases by the ESOP’s fiduciaries could also ‘‘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.’’17
Federal Securities Law and Other Fact
Specific ‘Plausibility’ Problems
While plaintiffs may have won the battle of the ‘‘presumption of prudence,’’ they may yet lose the war due
to the looming challenges of stating a claim that passes
muster under federal securities law and that still meets
Twombly’s plausibility standard, which, as established
in another ruling by the U.S. Supreme Court, requires
that factual allegations in a complaint must be definite
enough to ‘‘raise a right to relief above the speculative
level’’ and that a plaintiff must plead ‘‘enough facts to
state a claim to relief that is plausible on its face.’’18 The
Dudenhoeffer decision effectively eliminates plaintiffs’
ability to rely upon publicly available information in
framing a viable breach of fiduciary duty claim. According to the Court, ‘‘Where a stock is publicly traded, allegations that a fiduciary should have recognized from
publicly available information alone that the market
was over-or under valuing the stock are implausible as
16
Id. at p. 19.
Id. at p. 20.
18
Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 555, 570
(2007).
a general rule, at least in the absence of special circumstances.’’19 The door was left open to plaintiffs, however, ‘‘A plaintiff could nonetheless plausibly allege imprudence on the basis of publicly available information
by pointing to a special circumstance effecting the reliability of the market price as ‘an unbiased assessment
of the security’s value in light of all public information.’ ’’ 20But ‘‘special circumstances’’ may be as hard to
find as Jesse’s car:
Jesse: Hey, have you seen my car?
Christie: Well, I saw it last night . . . I saw the back
seat.
Jesse: No, I’m talking about the whole thing.
The Supreme Court observed that ‘‘special circumstances’’ cannot be found from public information. It
explained that ‘‘allegations that a fiduciary should have
recognized from publicly available information alone
that the market was over-or-under valuing the stock are
implausible as a general rule.’’
To make ERISA plans safe from ‘‘special circumstance’’ claims, employers should consider removing insiders from any positions that administer, operate or
control a pension plan holding company stock. A second alternative would be to appoint an independent fiduciary, who is not an insider, to be solely responsible
for determining whether to retain employer stock in the
pension plan. A third variation to lessen ‘‘special circumstance’’ exposure would be to simply eliminate
company stock as an employer matching or profit sharing contribution in the pension plan.
One final note: The public information defenses suggested by the Supreme Court have a limited range-they
only apply to EIAP’s holding stock of publicly traded
companies. For the thousands of ESOP’s funded by
stock of companies that are not publicly traded, those
fiduciaries must continue to attend to the particulars of
their own procedural prudence so as to avoid being the
subject of future judicial guidance.
17
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20
Slip Opinion at p. 11.
Slip Opinion at p. 10.
BNA
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