Supreme Court Axes 'Presumption Of Prudence' In ESOP Stock-Drop Cases

On June 25, 2014, the U.S. Supreme Court issued a decision that gives comfort to "stock-drop" plaintiffs and may cause shockwaves among employee stock ownership plan (ESOP) fiduciary committees. In Fifth Third Bancorp v. Dudenhoeffer,1 the Court held that ESOP fiduciaries are not entitled to any "presumption of prudence" in lawsuits challenging their decision to invest plan assets in company stock. Instead, ESOP fiduciaries "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 Dudenhoeffer, the plaintiffs were Fifth Third (hereinafter "Company") employees and participants in a defined contribution individual account plan that offered, among its 20 investment options, a company stock fund designated as an ESOP. The plaintiffs alleged that the defendants violated ERISA's duty of prudence by continuing to hold substantial investments in Company stock, and continuing to offer Company stock as an investment option, even though they knew that it was overvalued and excessively risky.

The plaintiffs claimed the defendant fiduciaries were aware of this for two reasons: First, publicly available information, such as newspaper articles, allegedly provided early warning signs that the stock was inflated due to the Company's significant lending to subprime lenders; and second, the defendants were allegedly aware of nonpublic (i.e., insider) information, that the Company had, allegedly, deceived the market by making material misstatements about its financial prospects.

The plaintiffs claimed that a prudent fiduciary in the defendants' shoes would have done one or more of the following: (1) sold the ESOP's holdings of company stock before its value declined; (2) refrained from purchasing any more company stock; (3) canceled the pension plan's ESOP option; or (4) disclosed the insider information so that the market would adjust its valuation of the company's stock downward, and the ESOP would no longer be overpaying for it.

Instead of doing these things, the defendants continued to hold and buy company stock. When the market crashed, its value fell by 74% between July 2007 and September 2009, when the plaintiffs filed their lawsuit.

Consistent with every federal appellate court that had previously decided the issue, the U.S. Court of Appeals for the Sixth Circuit held that ESOP fiduciaries are entitled to a "presumption of prudence." There were, however...