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Increased liability for fiduciaries of account-based plans with an employer stock option
On June 25, 2014, the U.S. Supreme Court issued a decision that will impact fiduciaries of retirement plans that hold employer stock. The court held that such fiduciaries are not subject to the so-called Moench presumption of prudence and are subject to the same duty of prudence that applies to all ERISA fiduciaries, except to the extent that the duty of prudence requires diversification.
The principles set forth in Fifth Third Bancorp vs. Dudenhoeffergenerally apply to all “eligible individual account plans” that explicitly provide for the acquisition and holding of employer stock, which include employee stock ownership plans (ESOPs) and certain profit-sharing, 401(k), stock bonus, thrift or savings plans.
The Employee Retirement Income Security Act (ERISA) requires fiduciaries to act prudently when handling plan assets, including investment of such assets. The prudence requirement generally calls for diversification of investments to minimize the chance of loss. Plans such as ESOPs and certain other eligible individual account plans, however, are designed to invest primarily in employer stock. Congress reconciled this inconsistency by generally relieving ESOP fiduciaries, and other fiduciaries of eligible individual account plans that hold employer stock and qualify under ERISA, from the duty to diversify and the duty of prudence, but only to the extent that prudence would require diversification.
In Moench v. Robertson, the Third Circuit recognized that ESOPs further congressional objectives of employee stock ownership by holding that fiduciaries of plans that require or encourage investment in employer stock are entitled to a presumption that they acted prudently.
Fifth Third Bancorp sponsored a defined contribution retirement plan for its employees that authorized participants to direct investments under the plan and also featured a company match of 4 percent of participant’s compensation. A Fifth Third Bancorp stock fund and 19 other mutual funds were among the investments options in the plan. Participants were able to allocate their contributions to whichever investment option they chose. The company’s matching contribution was initially invested in the company stock fund and participants could move the funds to other investments thereafter.
Following a decline in Fifth Third Bancorp stock, participants filed suit claiming that the fiduciaries should have known that the drop would occur because (i) public information suggested that the price would drop, and (ii) there was “insider information” known to the fiduciaries which indicated that material misstatements had been made, thus inflating the stock price.
The district court, applying the Moench presumption, dismissed the participant’s claim that the fiduciaries breached their duty of prudence by continuing to offer the Fifth Third Bancorp stock as an investment option. The Sixth Circuit reversed, holding that the Moench presumption did not apply at the pleading stage. Fifth Third Bancorp appealed the Sixth Circuit’s decision.
The Supreme Court took a narrow approach to ERISA’s fiduciary rules by holding that ESOP fiduciaries are relieved from the prudence requirement only “to the extent that it requires diversification.” The Court was not convinced that a congressional goal of encouraging employee stock ownership otherwise altered ERISA’s mandate of prudence. Therefore, the Court held that no special presumption of prudence applies to ESOP fiduciaries. Further, all fiduciaries—including ESOP fiduciaries—are subject to the prudent person standard under ERISA (except that ESOP fiduciaries are excused from the duty to diversify).
Accordingly, ESOP fiduciaries must prepare to face plaintiffs in litigation without the “defense-friendly” Moench presumption in their arsenal. This could result in the filing of significantly more stock-drop complaints and in plaintiffs’ claims having a better rate of success in overcoming dismissal at early stages, thereby leading to higher litigation costs and potentially increasing the likelihood that companies will resolve the claims via settlement.
Fortunately, the Court also made clear that motions to dismiss remain an “important mechanism for weeding out meritless claims” and provided some helpful guidance to ESOP fiduciaries who seek to dismiss complaints challenging their decisions to invest in or hold employer stock.
Employers and plan fiduciaries should stay tuned as there should be more clarity and guidance forthcoming. In the meantime, they should:
•Review plans to ensure that employer stock is an authorized investment and that the proper fiduciaries are tasked with monitoring the prudence of the investment (and, perhaps, such fiduciaries are being appropriately monitored and evaluated).
•Seek to limit liability by capping the amount that participants can invest in employer stock or by eliminating trading restrictions on participants that may wish to move their investments out of employer stock.
•Conduct risk assessmentsof the continued maintenance of employer stock funds in the aftermath of Dudenhoeffer. If continued inclusion is imprudent, the fund should be frozen or removed.
The article above is excerpted from a longer version posted on the website of law firm Troutman Sanders LLP, here. © 2014 Troutman Sanders LLP. All rights reserved. Republished with permission.
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