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The jury’s still out on whether ESOP fiduciaries will face more stock-drop lawsuits.
"Unfavorable yet Favorable.” “Supreme Court Giveth and Taketh Away.” “Disappointing Mishmash.”
The U.S. Supreme Court’s June 25, 2014, decision regarding employee
stock ownership plans (ESOPs) inspired a wave of headlines and legal
briefs that attempted to crystallize the contradictory nature of the
The most important aspect of the decision in Fifth Third Bancorp v. Dudenhoeffer relates
to the overturning of the so-called Moench presumption, which protected
employers that sponsor employee stock ownership plans, a type of
defined contribution plan. The Moench presumption basically held that a
plan fiduciary’s decision to acquire and hold employer stock in an
employee stock ownership plan was prudent—in other words, companies were
given the benefit of the doubt that they were fulfilling their
fiduciary duty in a prudent and responsible manner.
Many lower courts relied on the Moench presumption to determine whether
ESOP-related stock-drop lawsuits should proceed. Current and former
employees typically file the claims in response to steep drops in the
value of company shares that the employees accumulated through the ESOP.
The standard, also referred to as a “presumption of prudence,” was
largely seen as a buffer that protected companies with ESOPs against
suits filed by employee plaintiffs, who in many cases lost retirement
About 13.5 million U.S. employees currently have ESOPs, according to the National Center for Employee Ownership. The Dudenhoeffer decision and the legal analysis it sparked raises questions for sponsors of those plans:
The answer to most of these post-Dudenhoeffer questions,
according to many legal experts, will become clear during the next three
to five years as case law expands with new ESOP decisions from the
“Some law firms that specialize in bringing class-action suits tend to
talk about the decision as a game changer,” says J. Michael Keeling,
president of The ESOP Association in
Washington, D.C., an employer-sponsored ESOP advocacy organization.
“I’m a little skeptical of that message … and I call [the decision]
something of a mishmash.”
The legal consensus seems to be wait and see. “Time will tell as to how
high a bar the lower courts will set” for plaintiffs to bring stock-drop
cases, says James Masella, a partner in the litigation department of
New York City-based law firm Patterson Belknap Webb & Tyler LLP.
Until then, HR professionals should keep in mind that, although the
presumption of prudence is gone, it pays to be as prudent as ever when
administering an ESOP.
The Million-Dollar Question
Will the Dudenhoeffer decision give rise to more stock-drop cases? Maybe, maybe not.
The Moench presumption made it very difficult for plaintiffs to rebut
the presumption of prudence, Masella explains. The Supreme Court
indicated that companies with ESOPs are no longer entitled to that
special presumption of prudence but instead are subject to essentially
the same duty of prudence as other plan fiduciaries, such as 401(k) plan
fiduciaries, under the Employee Retirement Income Security Act (ERISA).
Some legal experts, including those who represent plaintiffs in
stock-drop cases, expect the decision to generate many more stock-drop
However, the Supreme Court also imposed several “significant hurdles for
plaintiffs to jump over before they will succeed with a stock-drop
claim,” according to Masella. For example, ESOP plaintiffs now need to
show the existence of “special circumstances” that make a publicly
listed ESOP company’s reliance on publicly quoted stock prices
Anatomy of a Stock-Drop Claim
Stock-drop cases generally boil down to two substantive claims, says Deborah Davidson, a partner in the law firm of Morgan, Lewis & Bockius LLP.
The first, a prudence claim, alleges that employer stock became an imprudent investment because of circumstances adversely affecting the company.
The second, a misrepresentation claim, alleges 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
So, while the decision can be said to have stripped a key protection against stock-drop claims, it also added new safeguards.
Deborah Davidson believes the decision may lead to an increase in
stock-drop complaints, at least in the short term. Davidson is an ERISA
litigation partner in the Chicago office of Morgan, Lewis & Bockius
LLP and a member of the law firm’s ESOP group. However, she—like Masella
and Keeling—is quick to point to the new framework for determining what
is required to establish a breach of an ESOP sponsor’s fiduciary duty.
This framework poses hurdles that may not be as formidable as the Moench
presumption but that seem likely to prevent a flood of new cases.
The Moench presumption forced plaintiffs to demonstrate early in the
lawsuit that the ESOP fiduciary faced an employer in a “dire situation”
or “on the brink of collapse.” As a result, most of these claims “were
destined to fail from the start,” Masella says of the pre-Dudenhoeffer
cases. “It is possible that plaintiffs will now feel re-energized in
pursuing prudence claims in employer stock-drop cases, and will test out
the new boundaries established by the Supreme Court.”
However, despite “the significant sea change caused by the elimination
of the Moench presumption,” Masella says, the new conditions plaintiffs
must meet to proceed with stock-drop claims may prove to be as effective
as the Moench presumption was in enabling plan fiduciaries to defeat
Legal Duties Unchanged
What are the duties of ESOP sponsors? While the Supreme Court changed
the way stock-drop claims are evaluated by courts, it did not alter the
ERISA fiduciary duties of ESOP sponsors. These duties apply only to the
individuals or entities that perform fiduciary functions, such as
managing plan assets or administering the plan, Davidson notes. They
ERISA also identifies diversification of plan assets as a fiduciary
duty, but only for non-ESOPs; ESOPs exclusively include company stock.
Dudenhoeffer doesn’t change the duties that apply to ESOP plan
fiduciaries, Davidson explains. “It just changes the legal framework
courts use to evaluate those duties,” she says.
It may sound contradictory, but the most common legal advice for plan
sponsors following the Supreme Court’s elimination of the presumption of
prudence is to “prudently” fund and manage ESOPs. That means HR
professionals and their colleagues should “prudently consider the value
of company stock when forming and funding the plan,” Masella says.
“Fiduciaries should also ensure that plan documents have clear terms
that are consistent with ERISA and that seek to maximize and protect
plan participant retirement income—by including financially healthy
stock and buying, holding or selling where necessary.”
Masella, Keeling and Davidson identify several actions ESOP sponsors should now consider, including the following:
For ESOP sponsors, prudence is no longer assumed, but it remains required.
Eric Krell is a business writer based in Austin, Texas, who covers human resource, finance and social marketing issues.
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