Scott Macey believes fear of litigation could lead many companies to eliminate the stock option.

Supreme Court asked to clarify company stock issue in 401(k) plans

DOL challenges presumption of prudence in stock-drop cases

The appeal of company stock as an investment option in defined contribution plans could dim considerably if the Department of Labor succeeds in having the U.S. Supreme Court revisit the issue of fiduciary prudence in managing that option.

The department's petition to the Supreme Court, filed Nov. 12 by the U.S. solicitor general's office to hear a Fifth Third Bancorp case, seeks to take advantage of a recent split in judicial circuits that could make it easier for participants to challenge employers when company stock loses value.

If the high court accepts the case this session, as is widely expected, it could have a chilling effect on plan sponsors, but it might also resolve inconsistencies from lower court rulings, said Fifth Third Bancorp spokesman Larry Magnesen, based in Cincinnati. “We were glad to hear that the solicitor general has recommended that the U.S. Supreme Court hear this case.”

Scott Macey, president and CEO of the ERISA Industry Committee in Washington, which represents corporations on benefit issues, said: “Many, many plans across the country have employer-shares funds. If they have to worry about the constant threat of litigation because of variations in stock prices, I can see them getting scared away.

“Then you're just inviting the plaintiffs' bar to file lawsuits anytime there is a drop in the stock. And in a lot of cases (scaring companies away) will be to the detriment of the employees” who like owning part of their company, he said.

DOL officials recognize employers' concerns of increased litigation, but counter that such lawsuits will still require strong evidence, while weak cases risk sanctions and court costs. “If all you've got is a market drop, that's absolutely not a case,” said a DOL official who declined to be identified. “ERISA gives (participants) ready access to the courts. People need to be permitted to make their case.”

In many stock-drop cases, district and appellate court judges have supported the companies, ruling a fiduciary overseeing the company stock option is entitled to a “presumption of prudence” unless a breach of fiduciary duties can be shown or the company is in a dire economic situation.

“Generally the court cases have been favorable” to plan sponsors, said Ed Ferrigno, vice president of Washington affairs for the Plan Sponsor Council of America. “Congress has always recognized the need to balance the interests” of employee ownership and participant protection, he said.

That began to change after a September 2012 ruling from the U.S. Court of Appeals for the 6th Circuit in Cincinnati. That ruling revived a proposed class action by participants in Fifth Third's 401(k) plan against Cincinnati-based Fifth Third Bancorp.

Ruling in Dudenhoeffer vs. Fifth Third Bancorp et al., the appeals court acknowledged rulings by other circuits that an employee stock plan fiduciary's decision to remain invested in company stock “is presumed to be reasonable,” but said that presumption does not apply at the initial stage of a case, despite opposite conclusions reached by other circuits.

Plaintiffs in the case against Fifth Third alleged the bank's 401(k) plan fiduciaries breached their duties by allowing participants to continue to invest in the company's stock when its value plummeted by 74%, in part because of the bank's subprime mortgage lending practices.

While stock-drop class actions often lead to settlements to avoid expensive litigation, even when the presumption of prudence is not applied, they have produced few legal victories for plan participants. If the Supreme Court accepts the petition, the case “has real potential to upset the apple cart in a big way,” said Jeremy Blumenfeld, an attorney in the Philadelphia office of Morgan, Lewis & Bockius LLP, which handles similar cases for plan sponsors but isn't involved in this one.

The judicial split created by the 6th Circuit ruling led Fifth Third Bancorp to appeal the decision to the Supreme Court, which in March asked the government to weigh in on the case. While the court has declined to review numerous other stock-drop cases, the difference this time is that the solicitor general is doing the asking, on behalf of the Department of Labor, and at the behest of the Supreme Court.

DOL officials declined to comment on the recent petition. But in friend-of-the-court briefs filed in similar cases — involving Citigroup Inc. and The McGraw-Hill Cos. — DOL officials warned that the other lower court rulings were “a windfall for fiduciaries” who would no longer have the expense of complying with ERISA-mandated prudence obligations, and could “put hundreds of billions of dollars in pension plan assets at undue risk.”

“It appears the 6th Circuit has taken what DOL has said to heart,” said Thomas E. Clark Jr., chief compliance officer at FRA/PlanTools LLC, a fiduciary consulting firm in Charlotte, N.C.

In their petition to the Supreme Court, Solicitor of Labor M. Patricia Smith, Solicitor General Donald Verrilli, Jr. and staff attorneys argue the presumption of prudence does not apply in stock-drop cases.

“ERISA's text and purposes do not call for application of a presumption at any stage of the proceedings,” the petition states. While the Fifth Third participants will have to substantiate their allegations at subsequent stages of the case, “their well-pleaded, plausible allegations suffice to state a claim,” the government lawyers wrote.

“We don't think any special presumption should apply to investors in company stock,” said the DOL official. He noted the justices are not influenced by lower court rulings.

For Mr. Clark, a former ERISA litigator, the case is part of “a significant shift in thinking by industry experts that company stock investment funds are no longer worth the risk. Compared to other investment options in a plan, a company stock fund requires a higher level of due diligence, given the higher potential for inherent conflict of interest,” said Mr. Clark.

“You're doing a disservice to yourself as a fiduciary and your plan's participants if the fund is kept blindly. Its continued inclusion should meet a well-documented and well-considered goal.”

A Supreme Court resolution would provide some much-needed guidance.

“If they take this case,” said Mr. Clark, “we will get a resolution to an issue that has been outstanding for the last 20 years.”

This article originally appeared in the November 25, 2013 print issue as, "Court asked to clarify company stock issue".