News & Knowledge
The Fall of the Moench Presumption: The Supreme Court’s Unfavorable (yet Favorable) Ruling for Fiduciaries in Fifth Third Bancorp v. Dudenhoeffer
J. Timothy Mast
Evelyn Small Traub
Mary Martin Weeks
On June 25, 2014, the Supreme Court of the United States (the “Court”) issued a decision that will impact fiduciaries of retirement plans that hold employer stock. The Court held that such fiduciaries are not subject to the so-called Moench presumption of prudence and are subject to the same duty of prudence that applies to all ERISA fiduciaries, except to the extent that the duty of prudence requires diversification. Although the rejection of the Moench presumption initially sent shockwaves through the ESOP fiduciary universe, the Court’s ruling has some redeeming aspects that could be helpful in defending against stock-drop litigation at the motion to dismiss stage of the litigation.
Background on the Moench Presumption
The Employee Retirement Income Security Act of 1974 (ERISA) requires fiduciaries to act prudently when handling plan assets, including investment of such assets. The prudence requirement generally calls for diversification of investments to minimize the chance of loss. Plans such as Employee Stock Ownership Plans and certain other eligible individual account plans, however, are designed to invest primarily in employer stock. Congress reconciled this inconsistency by generally relieving ESOP fiduciaries, and other fiduciaries of eligible individual account plans that hold employer stock and qualify under ERISA,1 from the duty to diversify and the duty of prudence, but only to the extent that prudence would require diversification.
In Moench v. Robertson, the Third Circuit recognized that ESOPs further congressional objectives of employee stock ownership by holding that fiduciaries of plans that require or encourage investment in employer stock are entitled to a presumption that they acted prudently. This presumption can only be overcome by a showing that ESOP fiduciaries abused their discretion when they chose to continue to invest in or hold employer stock. Since the Moench presumption was first articulated by the Third Circuit, numerous other circuit courts have adopted the Moench presumption in some form or another and have applied it claims involving other eligible individual account plans, such as 401(k) or profit-sharing plans that dictate or encourage investment in employer stock.
Factual Background of Fifth Third Bancorp v. Dudenhoeffer
Fifth Third Bancorp sponsored a defined contribution retirement plan for its employees which authorized participants to direct investments under the plan and also featured a company match of 4% of participant’s compensation. A Fifth Third Bancorp stock fund and nineteen other mutual funds were among the investments options in the plan. Participants were able to allocate their contributions to whichever investment option they chose. The company’s matching contribution was initially invested in the company stock fund and participants could move the funds to other investments thereafter.
Following a decline in Fifth Third Bancorp stock, participants filed suit claiming that the fiduciaries should have known that the drop would occur because (i) public information suggested that the price would drop, and (ii) there was “insider information” known to the fiduciaries which indicated that material misstatements had been made, thus inflating the stock price. The district court, applying the Moench presumption, dismissed the participant’s claim that the fiduciaries breached their duty of prudence by continuing to offer the Fifth Third Bancorp stock as an investment option. The Sixth Circuit reversed, holding that the Moench presumption did not apply at the pleading stage. Fifth Third Bancorp appealed the Sixth Circuit’s decision.
The Court’s Decision
Despite most appellate courts’ consistent recognition of Moench, the Court unanimously rejected the presumption and set forth its own guidance to be decided on remand to the Sixth Circuit. As indicated by the title of this article, the Court’s decision in Dudenhoeffer may be viewed as partially unfavorable (the “bad”) and partially favorable (the “good”) for ESOP fiduciaries and employers.
The Bad – The Rejection of the Moench Presumption
The Court took a narrow approach to ERISA’s fiduciary rules by holding that ESOP fiduciaries are relieved from the prudence requirement only “to the extent that it requires diversification.” The Court was not convinced that a congressional goal of encouraging employee stock ownership otherwise altered ERISA’s mandate of prudence. Therefore, the Court held that no special presumption of prudence applies to ESOP fiduciaries. Further, all fiduciaries – including ESOP fiduciaries – are subject to the prudent person standard under ERISA (except that ESOP fiduciaries are excused from the duty to diversify).
Accordingly, ESOP fiduciaries must prepare to face plaintiffs in litigation without the “defense-friendly” Moench presumption in their arsenal. This could result in the filing of significantly more stock-drop complaints and in plaintiffs’ claims having a better rate of success in overcoming dismissal at early stages, thereby leading to higher litigation costs and potentially increasing the likelihood that companies will resolve the claims via settlement.
The Good – Potential Elimination of Plaintiff’s Claims
Fortunately, the Court also made clear that motions to dismiss remain an “important mechanism for weeding out meritless claims” and provided some helpful guidance to ESOP fiduciaries who seek to dismiss complaints challenging their decisions to invest in or hold employer stock. First, the Court made clear that, 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 would generally be considered an implausible claim. The Court further instructed that a plaintiff is required to allege “special circumstances” that would make reliance on the market’s valuation imprudent. In other words, ESOP fiduciaries are not obligated to determine whether stock that is publicly traded is properly valued and generally are entitled to rely on the public market as the best estimate of value.
Second, in order for a plaintiff to state a claim for breach of the duty of prudence on the basis of insider information, the plaintiff must plausibly allege an alternative action that is (i) consistent with securities laws; and (ii) that a prudent fiduciary would not have viewed as more likely to harm the plan than to help it. Here, the Court helped to answer a question that ESOP fiduciaries have been struggling with for years: how to act when the fiduciary is privy to insider information? The dilemma that many ESOP fiduciaries face is that trading stock based on insider information violates securities laws, but plaintiffs (including the Dudenhoeffer plaintiffs) allege imprudence if the ESOP fiduciaries do not act on such information within their possession (e.g., remove the investment from the lineup). The Court explained that the duty of prudence cannot be read to require a fiduciary to act in violation of securities laws.
The above guidance potentially undercuts two key allegations that are generally a part of plaintiffs’ claims in stock-drop litigation: (i) that a fiduciary should not solely rely on market pricing, and (ii) that the fiduciary should have sold the stock based on insider information that he or she possessed.
What Employers Should Be Doing In the Wake of Dudenhoeffer
Employers and ESOP fiduciaries should stay tuned as there should be more clarity and guidance forthcoming. Indeed, in Dudenhoeffer, the Court remanded to the Sixth Circuit to consider the viability of the plaintiffs’ complaint in light of the new guidance from the Court, so that may be the first glimpse into how an appellate court handles a stock-drop claim following the Court’s decision. The Dudenhoeffer opinion seemingly opened the door for guidance from the Securities and Exchange Commission on the topic of insider information in the ESOP context by indicating that its opinion “may well be relevant.” Further, the “more harm than good” standard espoused by the Court will be subject to interpretation by lower courts and could be a large part of the discourse for years to come. Finally, there should be further refinement of the pleading standards required to assert a viable claim in the ESOP context, given the Court’s requirement that plaintiffs must plead “special circumstances” that render a fiduciaries’ reliance on the market price of stock imprudent. It is likely that courts will also struggle with how best to interpret this requirement in future cases.
In the meantime, employers should be reviewing their plans to ensure that employer stock is an authorized investment and that the proper fiduciaries are tasked with monitoring the prudence of the investment (and, perhaps, such fiduciaries are being appropriately monitored and evaluated). Employers may also seek to limit liability by capping the amount that participants can invest in employer stock or by eliminating trading restrictions on participants that may wish to move their investments out of employer stock. Employers can also conduct risk assessments of the continued maintenance of employer stock funds in the aftermath of Dudenhoeffer. If continued inclusion is imprudent, the fund should be frozen or removed.
Troutman Sanders employee benefits and litigation attorneys will continue to monitor all of the above aspects and keep you informed as further guidance becomes available.
1 For purposes of this article, we generally refer to plans holding employer stock as “ESOPs” and fiduciaries of such plans as “ESOP fiduciaries.” However, the Moench presumption and the principles set forth in the Dudenhoeffer case generally apply to all “eligible individual account plans” that explicitly provide for the acquisition and holding of employer stock, which include ESOPs and certain profit-sharing, 401(k), stock bonus, thrift or savings plans.
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