High Court Kills Presumption of Prudence, Gives Some Hope to ESOP Fiduciaries

In a partial win for employees who invest in company stock, a unanimous U.S. Supreme Court ruled that fiduciaries of employee stock ownership plans aren't entitled to a presumption of prudence protecting them from liability for declining share price.

Calling the judge-made presumption a “defense-friendly standard,” Justice Stephen G. Breyer wrote in the court's June 25 opinion that ESOP fiduciaries are subject to the same prudent-person standard that applies to fiduciaries of all plans governed by the Employee Retirement Income Security Act, except for the requirement to diversify plan assets.         

Although the court invalidated what has come to be known as the Moench presumption, ERISA practitioners agreed that the ruling didn't leave ESOP fiduciaries unable to defend themselves from stock-drop lawsuits.         

The court emphasized that, in the absence of “special circumstances,” fiduciaries of publicly traded companies can't be liable for failing to act on publicly available information, as that would require them to outsmart the market.         

The court also said that fiduciaries can't be found imprudent for failing to act in a way that would violate insider trading laws. ESOP participants bringing claims based on inside information must plausibly allege an alternative action that the fiduciaries could have taken that wouldn't violate securities or other laws and that wouldn't have been likely to harm the plan, the court concluded.         

The court's decision left open a number of questions for lower courts to consider, including:

• In the context of publicly traded employer stock, what “special circumstances” are needed to show that an ESOP fiduciary acted imprudently in weighing publicly available information?

• In the context of allegations that an ESOP fiduciary should have taken action based on inside information or disclosed that information to the public, to what extent does the potential imposition of ERISA liability conflict with the requirements or objectives of insider trading and federal securities laws?

• Could a prudent fiduciary in possession of inside information negatively affecting stock price reasonably determine that disclosing such information would “do more harm than good?”        

Fiduciaries Still Have Options          

Scott Macey, president and chief executive of the ERISA Industry Committee in Washington, said that while the opinion looked at first glance like a win for plan participants, the court actually provided many tools for fiduciaries to use in defending meritless stock-drop lawsuits.         

“I don't think there are big winners and losers at this point,” Macey told Bloomberg BNA on June 25. “If the case gets interpreted by the lower courts in the way I understand it, I think that it's initially a little easier for plaintiffs, because they don't have to deal with the Moench presumption at all.”         

“On the other hand, I don't think the fiduciary defendants should take it on the chin that much, because I think the Supreme Court is saying that there are other ways for them to defend these nonmeritorious cases,” Macey said.         

He added that plaintiffs will need to show that there is a substantial reason that a fiduciary shouldn't have relied on the market price of the stock, which is considered to be based on publicly available information, or that the fiduciary could have taken some action neither violative of the law—including insider trading laws—nor harmful to participants if the fiduciary had non-public information.         

Macey also said that the case gives lower courts a lot to consider in determining whether to dismiss these types of cases in the early stages of litigation.        

“The roadmap for defendants and courts becomes somewhat more complex, but I don't think this decision should rule out dismissing a lot of these nonmeritorious cases early on, before they cause years of litigation and costs,” Macey said.

Excerpted from a story that ran in Pension & Benefits Daily (06/25/2014).