In Fifth Third, a unanimous Court held that fiduciaries of employee stock ownership plans (ESOPs) are not entitled to a defense-friendly presumption that continuing to invest in employer stock is prudent; instead, ESOP fiduciaries must comply with the same stringent requirement of prudence (except to the extent that it would require diversification of plan assets) that ERISA imposes on all plan fiduciaries. In so ruling, the Supreme Court disagreed with every Court of Appeals that had addressed the issue.
Score one for the ERISA plaintiffs' bar, right? Not so fast.
In a stunning move, the Supreme Court, under the guise of providing guidance to lower courts, then proceeded to eviscerate an entire category of active ERISA cases with almost no legal analysis and with little, if any, acknowledgement of the broad-ranging effects of its ruling. More troublingly, the Court's extemporaneous foray into the plausibility of ERISA employer stock allegations (1) improperly focused on stock price while ignoring issues of investment risk, (2) employed grossly flawed logic -- for instance, suggesting that an ERISA fiduciary with material non-public information may lawfully continue purchasing artificially-inflated stock to prop up the stock price (securities fraud, anyone?), and (3) ventured well beyond the scope of the only question properly before it, addressing complicated legal and economic issues without the benefit of substantive briefing or critical input from stakeholders. The extent of errors the Court made in the second half of its opinion is breathtaking.
Before we jump to the details, one important disclosure: While at my prior firm, I argued this case on behalf of plaintiff Dudenhoeffer in the United States Court of Appeals for the Sixth Circuit immediately below (i.e., the decision on appeal). At my prior firm, I also acted as lead counsel in numerous ERISA company stock cases filed against some of the largest corporations in the world. Although I left that firm well in advance of the Fifth Third briefing before the Supreme Court, I likely carry a predisposition towards the legal validity of such claims. With that said, I also bring significant experience and knowledge of the subject matter area at issue. The numerous infirmities of the opinion lead me to question whether those involved in drafting Fifth Third can make the same claim.
Now to the details: Prior to Fifth Third, federal courts around the country had held that ESOP fiduciaries were entitled to a "presumption of prudence" when their decision to buy or hold company stock was challenged by a plan participant as imprudent. Those courts reasoned that a presumption was appropriate given the unique nature of an ESOP, which is a plan designed to invest primarily or exclusively in employer stock. In light of an ESOP's singular purpose, the courts found that its fiduciaries should be presumed to have acted prudently when continuing to purchase and hold employer stock but that a plaintiff could rebut the presumption by showing that the fiduciary had "abused its discretion" -- or, put another way, by showing that the fiduciary could not have reasonably believed that continuing to purchase or hold the stock was in keeping with the settlor's expectation of how a prudent fiduciary would act. See, e.g., Moench v. Robertson, 62 F.3d 553, 571 (3d Cir. 1995). This defense-friendly presumption had the effect of cloaking ESOP fiduciaries with a level of protection from liability under most circumstances.
Although the lower courts generally agreed that a "presumption of prudence" was available to ESOP fiduciaries, they differed substantially on when in the litigation fiduciaries could invoke the protection. In Moench, the first federal appellate decision to adopt the theory, the court applied the presumption to a developed factual record on summary judgment. Over time, however, other courts had ruled that the doctrine applied from the start of a case and that, in order to plausibly state a cognizable claim, ERISA plaintiffs must plead facts in their complaint sufficient to overcome the presumption. See, e.g., In re Citigroup ERISA Litig., 662 F.3d 128, 139-40 (2d Cir. 2011) (presumption of prudence applies at pleadings stage and requires plaintiff to allege that company was in "dire [financial] situation" unforeseen by settlor). Such rulings were troublesome to ERISA plaintiffs because their cases were subject to dismissal unless they were capable of proving their case before discovery even began.
Enter Fifth Third: At the district court level, the trial judge dismissed the complaint, concluding that the "presumption of prudence" applied on the pleadings and that plaintiffs had failed to sufficiently plead around the presumption. Dudenhoeffer v. Fifth Third Bancorp, 757 F. Supp. 2d 753 (S.D. Ohio 2010). On appeal, the Sixth Circuit reversed, holding that the "presumption of prudence" is an evidentiary presumption that does not apply until plaintiffs have had the ability to develop a full evidentiary record -- usually on summary judgment or at trial. Dudenhoeffer v. Fifth Third Bancorp, 692 F.3d 410 (2012).
Fifth Third filed a petition for writ of certiorari and the Supreme Court granted the petition limited to a single question: "Whether the Sixth Circuit erred by holding that Respondents were not required to plausibly allege in their complaint that the fiduciaries of an employee stock ownership plan ("ESOP") abused their discretion by remaining invested in employer stock, in order to overcome the presumption that their decision to invest in employer stock was reasonable, as required by the Employee Retirement Income Security Act of 1974, 29 U.S.C. ss 1101, et seq. ("ERISA"), and every circuit to address the issue." See Fifth Third Bancorp v. Dudenhoeffer, 2013 U.S. Lexis 9024 (Dec. 13, 2013) (granting petition for writ of certiorari limited to question 1 presented by petition); Fifth Third's Petition for Writ of Certiorari at i (Question 1).
Writing for a unanimous Court, Justice Breyer quickly disposed of the only issue before it. Notwithstanding the lower courts' near-universal recognition of the "presumption of prudence," the Supreme Court held that "the law does not create a special presumption favoring ESOP fiduciaries[;] [r]ather, 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." Slip op., at 8. The Court reasoned that nothing in ERISA supported the existence of a special presumption for ESOP fiduciaries and that none of the arguments Fifth Third advanced -- concerning the special purpose of ESOPs, the avoidance of insider trading prohibitions, or the purported need to weed out meritless suits -- could trump the plain language of the statute. Id. at 8-15. ERISA imposes stringent obligations, including the duty of prudence, on all fiduciaries, the Court reasoned, and nothing about the special nature of ESOPs modified or reduced the extent of those legal obligations. Id.
Had the Court stopped there, I would have nothing but praise for the decision. The first part of the opinion is straight-forward, logical and well-supported by appropriate legal authority. ERISA defendants may not like elimination of the presumption but it's hard to argue with the Court's reasoning: The plain language of the statute imposes certain duties on ERISA fiduciaries, nothing in the statute authorizes a reduced set of duties for ESOP fiduciaries (other than elimination of the duty to diversify), and the policy arguments advanced by Fifth Third, even if accepted, do not authorize courts to graft a reduced standard of care for ESOP fiduciaries onto unambiguous statutory language.
The Court, however, lost its way when it failed to remand the case for further consideration in light of the ruling. Both the district court and the Sixth Circuit had ruled on the sufficiency of the complaint assuming the existence of the presumption (albeit differing on when that presumption should apply). Having rejected the presumption in its entirety, the Supreme Court should have remanded the case for reconsideration of the sufficiency of the complaint under the traditional pleading standards of Twombly and Iqbal and ended the opinion there. The only question before the Court was whether ESOP fiduciaries were entitled to a "presumption of prudence" on the pleadings; the general sufficiency of ERISA breach of fiduciary duty allegations involving employer stock was not at issue -- and, at a minimum, it had not been adequately briefed by the parties or the subject of expert consideration. Unfortunately, the Court paid no mind to this limitation and, rather than merely remanding the case, strayed far afield by offering ill-considered and unsupported guidance to lower courts about the sufficiency of allegations in ERISA employer stock cases. Slip op. at 16-20.
With respect to allegations that employer stock was imprudent based upon publicly available information, the Court stated 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 are implausible as a general rule, at least in the absence of special circumstances." Id. at 16. The Court reasoned that a fiduciary, like any other investor, should not be liable for failing to "out guess" the general market. Id. at 16-17. Regarding allegations that employer stock was imprudent based upon non-public material (or inside) information, the Court suggested that "[t]o state a claim for breach of the duty of prudence on the basis of inside information, 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 in the same circumstances would not have viewed as more likely to harm the fund than to help it." Id. at 18. In that vein, the Court made three additional points: (1) fiduciaries cannot be compelled to violate the law (including the securities laws), (2) these issues implicate complex insider trading prohibitions and corporate disclosure requirements and (3) some actions that plaintiffs allege the fiduciaries should have taken, such as refraining from purchasing additional employer stock, may "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." Id. at 19-20.
Wow, where to begin.
Okay, let's start with this: In providing this purported guidance to lower courts, the Court engaged in almost no legal analysis of any relevant issues -- it simply announced its views of plausibility without any tether to supporting authority. Unlike the first half of the opinion, which is rife with citations to statutory and legal precedents supporting its holding, the "guidance" portion of the opinion reads more like extemporaneous musings that are bereft of cogent reasoning or precedential authority. There is no true analysis. There is little development or explanation of the rationale behind the guidelines. And the few decisions the Court references are cited for unassailable legal principles, such as ERISA fiduciaries are not compelled to violate federal securities laws, rather than as direct (or even indirect) support for its views on the plausibility of allegations in ERISA employer stock cases. See, e.g., slip op. at 18-19. In essence, the Court's guidance consists of "it's this way because we say so."
Third, some of the "logic" the Court employs in describing its "guidance" is patently wrong. At one point, the Court appears to suggest that ERISA fiduciaries may engage in securities fraud in order to prop up the price of employer stock. How? The Court states that where plaintiffs allege an ERISA fiduciary should have stopped making additional purchases of employer stock, courts should "consider whether the complaint has plausibly alleged that a prudent fiduciary in the defendant’s position could not have concluded that stopping purchases — which the market might take as a sign that insider fiduciaries viewed the employer’s stock as a bad investment — or publicly disclosing negative information would 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." Id. at 20. A necessary implication of that statement is that, in at least some circumstances, an ERISA fiduciary in possession of non-public material information may continue to make purchases of employer stock that it knows is artificially inflated for purposes of propping up the stock price. Isn't that securities fraud? See, e.g., FindWhat Investor Group v. FindWhat.com, 658 F.3d 1282, 1317 (11th Cir. 2011) ("Defendants whose fraud prevents preexisting inflation in a stock price from dissipating are just as liable as defendants whose fraud introduces inflation into the stock price in the first instance."). And didn't the Court just get through saying that ERISA fiduciaries must comply with federal securities laws? Don't waste time trying to understand the Court's "logic;" it's intellectual nonsense.
The final problem with the Court's attempt at providing guidance in ERISA employer stock cases perhaps best explains the fundamental flaws in its unsupported dicta: the Court ventured into a subject matter area that was not properly before it, that had not been adequately briefed by the parties and amici, and for which it was not adequately prepared. As the Court expressly recognized (slip op. at 19), determining the sufficiency of allegations in an ERISA company stock case involves the intersection of ERISA's fiduciary obligations, insider trading prohibitions and corporate disclosure requirements -- areas of law that are incredibly complex on their own and in combination push intellectual limits to the brink. The parties and amici in Fifth Third understandably focused their briefing on differing applications of the "presumption of prudence" -- not on the general sufficiency of allegations in ERISA employer stock cases with no such presumption. The Court also lacked the informed views of interested federal agencies that should be considered in reaching any decision on these complicated issues. See, e.g., slip op. at 20 ("The U.S. Securities and Exchange Commission has not advised us of its views on these matters, and we believe those views may well be relevant.") Why, then, jump ill-prepared and head-first into this thicket under the guise of providing guidance? No good answer. As Justice Frankfurter once stated: "Deliberate dicta, I had supposed, should be deliberately avoided. Especially should we avoid passing gratuitously on an important issue of public law where due consideration of it has been crowded out by complicated and elaborate issues that have to be decided." United States v. United States Gypsum Co., 333 U.S. 364, 402 (1948) (Frankfurter, J., concurring). The current Justices should have heeded that warning.
In the end, the Court "leaves it to the courts below to apply" its reasoning to the complaint. Slip op. at 20. Good luck. If applied uncritically, the flawed logic and unsupported dicta of the opinion will be hard for most ERISA plaintiffs to overcome. It will take many years, if ever, before the unfortunate impact of Fifth Third can be fully undone. In the meantime, ERISA employer stock cases will be that much more difficult to sustain, all because the Court ventured into a complicated subject matter area that was not properly before it without the benefit of well-supported briefs or input from appropriate stakeholders.
Better the devil you know. Can we bring back the "presumption of prudence" now?