Supreme Court Abolishes Presumption Of Prudence In ERISA Stock-Drop Cases But Sets High Bar For Plaintiffs

In an opinion that reversed nearly two decades of lower-court ERISA class action jurisprudence, the Supreme Court axed the well-established "presumption of prudence" in ERISA "stock-drop" cases. On June 25, the Court issued its decision in Dudenhoeffer v. Fifth Third Bank, No. 12-751, 573 U.S. ____ (2014), rejecting the unanimous view among circuit courts that fiduciaries of employee stock ownership plans (ESOPs) are entitled to a presumption that their decision to continue to hold employer stock as an investment—even in the face of plummeting stock prices—is prudent. Ultimately, however, the Court's opinion is a mixed bag for ESOP providers. While the Court struck down the "presumption of prudence"—a key defense for ESOP fiduciaries in ERISA "stock-drop" class actions—the high Court set a high bar for plaintiffs looking to bring prudence-based claims and encouraged trial courts to scrutinize such claims at the pleading stage to eliminate meritless claims early on. The Court's decision is consistent with heightened pleading standards ushered in by Iqbal and Twombly and reiterates the importance of motions to dismiss as a means of curbing meritless litigation.

Stock-Drops and ESOPs

Dudenhoeffer involved a particular type of ERISA class action commonly known as a "stock-drop" case, in which investors allege that those charged with managing their employer-sponsored retirement plans breached certain statutory duties, causing the investors to lose retirement savings. Over the past two decades, such suits have become common complements to securities class actions.

Under ERISA, those who oversee employer-sponsored retirement plans are subject to certain fiduciary duties, including a duty to manage plan investments prudently. Dudenhoeffer focused on the duties owed by fiduciaries who oversee ESOPs—a special type of retirement plan designed to encourage employees to invest in their employer's stock. Congress has encouraged ESOPs as a way to motivate and reward employees by giving them an ownership stake in the companies they work for. Importantly, while a retirement plan fiduciary's duty of prudence under ERISA generally includes a duty to diversify investments to minimize the risk of large losses,1 ERISA expressly—and logically—exempts ESOP fiduciaries from any duty to diversify2 because the purpose of an ESOP is to hold a single investment: employer stock.

Dudenhoeffer's Trip to the Supreme Court

The plaintiffs in Dudenhoeffer were former Fifth Third employees who invested in the company's stock through its ESOP. Between July 2007 and September 2009, Fifth Third's stock price dropped by 74 percent, wiping out much of the value of these retirement savings. According to the plaintiffs, Fifth Third was heavily invested in the subprime lending market. As is typical in ERISA stock-drop cases, the plaintiffs alleged that the fiduciaries overseeing the plan...