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April 2 --The issue of inside information dominated the back-and-forth between U.S. Supreme Court justices and attorneys debating the pro-fiduciary presumption of prudence during oral argument April 2 in the first Employee Retirement Income Security Act stock-drop case to reach the high court.
The justices' questions to counsel suggest that they see the central issue as how a prudent fiduciary of an employer stock plan should respond to inside information affecting the value of the stock price.
Counsel for both sides also debated the fundamental nature of employer stock plans, with attorneys for Fifth Third Bancorp emphasizing the goal of employee ownership over the goal of providing retirement savings.
The issue of whether to apply the presumption of prudence--at the motion-to-dismiss stage of litigation or later--received virtually no attention from the justices or the attorneys.
Richard Siegel, a senior associate with Alston & Bird LLP in Washington, in an April 2 interview with Bloomberg BNA called this surprising, saying “there was little discussion of the issue that has given rise to the circuit split--namely, whether the presumption should apply on a motion to dismiss.”
Scott Macey, president and chief executive of the ERISA Industry Committee in Washington, said he thought the justices correctly focused on the “irreconcilable quandary” faced by fiduciaries with inside information.
Macey spoke favorably of the presumption itself, calling it “an appropriate balance of the various interests.”
“I think the Moench presumption has always been a reasonable, appropriate and practical solution to this issue,” Macey told Bloomberg BNA on April 2.
He also said the government and the plaintiffs “weren't offering any practical solution or resolution to these issues” in lieu of the presumption they argued against.
ERIC filed an amicus brief in support of Fifth Third.
Siegel said the justices' questions “left the impression that they did not view the presumption as settled law.”
However, Siegel said, “several of the justices also clearly recognized the practical problems that would arise if [employee stock ownership plan] fiduciaries were not afforded a presumption of prudence.”
“The court focused on how a fiduciary could follow a plan settlor's intention that company stock be offered if following those very instructions was not presumed to be prudent,” Siegel said. “There was substantial discussion of the fact that these cases typically arise in circumstances in which fiduciaries are in possession of nonpublic information, and the court appeared to struggle with how a fiduciary could have a duty to act on nonpublic information when doing so would violate insider trading laws,” he said.
Dean J. Schaner, a partner with Haynes and Boone LLP in Houston, said a Supreme Court decision rejecting the presumption would discourage employers from establishing employer stock plans.
In that case, Schaner said, “employers may not set up ESOP programs, because fiduciaries would be subjected to the time and expense of litigation without the ability to file a quick motion to dismiss.”
Schaner also said a decision invalidating the presumption would cause “an enormous amount of litigation moving forward anytime there's a stock drop.”
The presumption of prudence, first articulated by the U.S. Court of Appeals for the Third Circuit in Moench v. Robertson, 62 F.3d 553, 19 EBC 1713 (3d Cir. 1995), is frequently cited as a grounds for dismissal of employer stock-drop cases.
The Moench presumption requires plaintiffs to point to a plan sponsor's impending collapse or other dire circumstances to show that a reasonable plan fiduciary would've divested the plan of employer stock.
Several circuits--including the Second, Fifth, Sixth, Seventh, Ninth and Eleventh--have adopted some form of the Moench presumption in cases involving employer stock.
In its 2012 Dudenhoeffer decision, the U.S. Court of Appeals from the Sixth Circuit broke from a number of other circuits to hold that the pro-fiduciary presumption doesn't apply at the motion-to-dismiss stage of litigation .
The Sixth Circuit also used Dudenhoeffer to articulate a weaker presumption than had been used in other circuits. While some courts require a showing of impending collapse or other dire circumstances to overcome the presumption, the Sixth Circuit found that plan participants could overcome the presumption by showing that “a prudent fiduciary acting under similar circumstances would have made a different investment decision.”
Throughout the arguments, the justices circled back to the idea of inside information--specifically, how a prudent fiduciary of an employer stock plan should respond when he or she discovers inside information that may affect the value of the stock, but that can't be acted upon without potentially running afoul of federal securities laws.
Justice Stephen G. Breyer pressed Ronald J. Mann of Columbia Law School in New York, the attorney for John Dudenhoeffer, the plan participant representing the class, for an example of a case in which a trustee was found to have breached its duties by failing to act on inside information.
Mann responded that he didn't think such a case existed.
“If there is not such a case, what's the problem?” Breyer asked. “Because what's the rock and the hard place?”
In an exchange with Robert A. Long Jr. of Covington & Burling LLP who argued on behalf of Fifth Third, Justice Elena Kagan questioned the prudence of a hypothetical fiduciary who purchased stock it knew to be overvalued.
“It just sort of defies language to say that some--a prudent person would retain the investment in that kind of wildly overvalued stock, doesn't it?” she asked.
Long said a fiduciary who acted on inside information about a stock's true value would be at risk of violating federal securities laws.
Both Long and several of the justices focused on the unintended consequences that could arise if an employer stock plan fiduciary decided it would be prudent to sell or stop buying employer stock.
After fielding questions from Kagan about the prudence of investing in overvalued stock, Long argued that a fiduciary's decision to sell or stop buying employer stock could cause the stock's value to drop, because it would signal to the market that the fiduciary believed the stock to be overvalued. This drop would in turn hurt plan participants, Long argued.
Chief Justice John G. Roberts Jr. returned to this idea in an exchange with Mann.
“Are [fiduciaries] allowed to take into account the impact of a decision to stop buying on the beneficiaries?” Roberts asked.
“The stock is going down, if the trustee stops buying, that's going to cause a drop in the value of the shares and that's going to hurt the beneficiaries. So what does he do? Does he say, I shouldn't buy any more because I think it's going to go down some more? Or should he say, I should keep buying because otherwise all of the holdings--and this is all they are invested in--their holdings are going to go down?” Roberts asked.
Mann responded by emphasizing that fiduciaries have a duty to “behave prudently,” but Roberts cut him off, saying Mann's “mantra” of prudence was “not going to help me.”
Justice Samuel A. Alito Jr. questioned whether the issue could be resolved by prohibiting corporate insiders--such as corporate officers, executives and board members--from serving as fiduciaries of employer stock plans.
Alito characterized Mann's argument as virtually foreclosing the possibility that corporate insiders could prudently serve as plan fiduciaries.
“You're basically saying that if it's not flatly prohibited, it is very unwise,” Alito said to Mann, going on to say that it was “an impossible position if you are an insider and you're going to serve as a trustee of an ESOP.”
Later in the arguments, Alito questioned whether an insider fiduciary could abstain from acquiring such inside information.
Assuming that it's permissible for an insider to be a fiduciary, “can the insider behave like an outsider?” he asked.
Opposing counsel also offered the justices two different views on the purpose and goals of employer stock plans.
Long emphasized that employer stock plans are a “special kind of plan with special purposes,” because, unlike retirement plans that don't invest in employer stock, their sole purpose isn't providing participants with retirement benefits. Rather, Long argued, a primary goal of employer stock plans is to give employees “a piece of the rock”--meaning, ownership of their company.
Mann took the opposite view, pointing out that ERISA establishes two types of plans--welfare plans and retirement plans. Employer stock plans are intended to be retirement plans, Mann argued, and therefore the responsibilities applicable to retirement plan fiduciaries also apply to employer stock plan fiduciaries, absent enumerated exceptions.
Justice Antonin Scalia jumped on this distinction, asking Long whether the ERISA-mandated “exclusive purpose” of employer stock plans was providing participants with retirement benefits.
“You're saying the benefits to participants is their ownership of company stock, including worthless company stock,” Scalia said to Long.
Roberts questioned whether the instant debate was a reflection of the fact that employer stock plans were “really bad investments.”
In a similar vein, Justice Anthony M. Kennedy queried whether employer stock plans were excused from the duty to maximize investments.
“Let's assume that trustees in a non-ESOPs plan have a duty to maximize returns and provide stable investments. Is it somehow different when it's an ESOP?” he asked Long.
Long answered yes, once again emphasizing that employee ownership--rather than retirement savings--was a major purpose of employer stock plans.
At several points, Alito questioned whether employer stock plan fiduciaries could consider both the participants' interests as investors and their interests as employees when making decisions about employer stock.
On that point, Alito posited that those interests could diverge in certain circumstances.
Specifically, Alito questioned whether the decision to sell declining stock could benefit the participants as investors while simultaneously hurting them as employees--for example, if it increased the likelihood of the employer going bankrupt or laying off workers.
Kennedy questioned the scope of the fiduciary duty of prudence in the context of ESOPs, which are statutorily exempt from the duty to diversify plan assets.
“Once you say the trustee doesn't have the duty to diversify, it seems to me you are living in something of a different world,” Kennedy said.
Roberts appeared to agree, saying the trustee of a plan that must buy employer stock “has the easiest job in the world. He gets up in the morning and says, 'I think I will buy some of this company's stock.' ”
Roberts added that “every Court of Appeals has recognized” that this action is “by definition prudent, because that is the settlor's objective with one exception. If everything is going, you know, south and the company's collapsing, well, then he does have the obligation to do something.”
In this case, Mann took the position that the most important thing was “procedural prudence.”
“These people are managing a fund of $1 billion. The relevant question is what would a reasonable trustee of a billion-dollar fund have done to investigate the situation?” Mann asked.
Arguing on behalf of the government, Edwin S. Kneedler of the Department of Justice echoed this idea.
“The fiduciaries of a plan like this do have an ongoing obligation to investigate and to keep themselves apprised of how the company is doing,” Kneedler said.
The lawsuit was brought by participants in Fifth Third Bancorp's ESOP who challenged the decision by plan fiduciaries to continue offering company stock as an investment option, despite a 74 percent drop in the share price between 2007 and 2009. The participants partially blamed the drop on the company's involvement in subprime mortgage lending.
The U.S. District Court for the Southern District of Ohio dismissed the imprudent investment claim in 2010, finding that the complaint didn't allege the type of dire financial circumstances needed to establish a fiduciary breach under the pro-fiduciary presumption of prudence ; 50 EBC 1353).
On appeal, the Sixth Circuit reversed. It clarified that the presumption of prudence isn't a pleading requirement and that it didn't apply at the motion-to-dismiss stage of litigation.
In the ruling, the Sixth Circuit clarified that the presumption of prudence can be overcome, when “applied to a fully developed evidentiary record,” if the participants show that “a prudent fiduciary acting under similar circumstances would have made a different investment decision.”
The Supreme Court decided to hear the case after asking the U.S. solicitor general to weigh in.
The case garnered a number of amicus briefs that were largely split on the issues.
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Text of the oral argument is available at http://op.bna.com/dlrcases.nsf/r?Open=mcan-9hsvqq.
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