Supreme Court Rejects 'Presumption Of Prudence' In ERISA Employer Stock Cases

The Court's Dudenhoeffer decision also provides some guidance for scrutinizing such claims at the pleadings stage.

On June 25, the U.S. Supreme Court issued its unanimous decision in Fifth Third Bancorp v. Dudenhoeffer,1 holding that fiduciaries of employee stock ownership plans (ESOPs)2 are not entitled to a "presumption of prudence" when their decisions to buy or hold employer stock are challenged as violations of the fiduciary duty of prudence imposed under the Employee Retirement Income Security Act of 1974 (ERISA).3

In rejecting the presumption, the Court disagreed not only with the defendants, but also with all seven U.S. Courts of Appeals that had previously adopted the presumption. The Court reasoned that, while the presumption was created to "reconcile congressional directives that are in some tension with each other,"4 it is ultimately unsupported by ERISA's provisions and is an inappropriate tool for weeding out meritless claims. Thus, the Court held that, while ESOP fiduciaries are exempted from the duty of prudence insofar as that duty would require diversification of ESOP assets, they are otherwise "subject to the duty of prudence just as other ERISA fiduciaries are."5

Nevertheless, the Court recognized the "legitimate" concern that, without the protection of the presumption, ESOP fiduciaries with alleged access to nonpublic information (concerning publicly traded employer stock) will face conflicts between protecting the value of plan assets and the prohibition on insider trading. The Court also recognized the risk that the proliferation of meritless "stock drop" claims will undermine Congress's desire to encourage the use of ESOPs. The Court reasoned that the best way to address these concerns is "through careful, context-sensitive scrutiny of a complaint's allegations"6 under the rigorous pleading standards established in Twombly7 and Iqbal.8 To that end, the Court provided guidance for evaluating the plausibility of stock-drop claims at the pleadings stage.

Background on ERISA Stock-Drop Claims

To date, more than 200 employer "stock drop" class actions have been filed, alleging that plan fiduciaries breached their ERISA duties of prudence and loyalty by allowing participants to invest their plan accounts in employer stock.9 Following the Enron and WorldCom scandals and the recent global financial crisis, there was a significant uptick in the filing of these complaints—often as tagalongs to federal securities fraud complaints.

Stock-drop cases generally boil down to two substantive claims: (1) a "prudence" claim, alleging that employer stock became an imprudent investment because of circumstances adversely affecting the company and that the plan fiduciaries breached their fiduciary duties by failing to liquidate the plan's employer-stock holdings or refrain from purchasing more employer stock and (2) a misrepresentation claim, alleging that the plan fiduciaries knew or should have known about the circumstances adversely affecting the company and that they breached their fiduciary duties by affirmatively misleading or failing to warn participants about the risks.

While these lawsuits typically target publicly held companies, similar claims against fiduciaries of privately held ESOPs have proliferated as well.

"Presumption of Prudence"

Recognizing that federal policy encourages employee ownership of employer stock, as of 2013, all seven federal Courts of Appeals that considered the issue had adopted the "presumption of prudence." Under this standard, courts generally held that ESOP or other eligible individual account plan (EIAP) fiduciaries are entitled a strong "presumption" that their decisions to permit continued investment in employer stock were prudent under ERISA. Indeed, absent allegations that the employer was on the brink of collapse or facing other "dire" circumstances, many courts held that plaintiffs' stock-drop claims could not withstand a motion to dismiss.

While the U.S Courts of Appeals for the Second, Third, Fifth, Sixth, Seventh, Ninth, and Eleventh Circuits all adopted the presumption, in recent years, courts began to diverge on the following issues:

The type of plan language (mandatory, permissive, or something in between) regarding the plan's investment in employer stock that was needed to trigger the presumption The type...