The U.S. Supreme Court ruling in Fifth Third Bancorp. et al. vs. Dudenhoeffer et al. has injected uncertainty into defined contribution plans' use of employer stock in investment menus.
The court ruled that employee stock ownership plans have no special presumption of prudence in offering employer stock, erasing a 19-year legal principle — called the Moench presumption — that many plans had used as a defense in participant lawsuits that claimed a breach of fiduciary duty when company stock prices fell.
However, the court also provided guidelines for lower courts to assess whether such stock-drop complaints were sufficient to merit a trial. These guidelines discuss plan fiduciaries' responsibilities relating to public information about stocks, insider information, securities laws and plausible alternative actions in the face of a falling stock price.
The ruling's impact goes beyond ESOPs.
“The decision governs qualified retirement plans that are governed by ERISA that offer company stock of the employer, whether publicly traded or closely held, regardless of the plan design,” said Thomas E. Clark Jr., a partner with The Lowenbaum Partnership LLC, St. Louis, and outside ERISA counsel to FRA PlanTools LLC, a fiduciary consulting firm.
DC consultants, attorneys and trade group representatives say the ruling will encourage more plan executives to review how they administer and monitor company stock within DC plans — or question if they want to add company stock to their investment menu. They said it is too early to determine if the decision will lead to more lawsuits or settlements.
“There's a lot of sorting out to do,” said Lori Lucas, the Chicago-based executive vice president and defined contribution practice leader at Callan Associates Inc.
Fifth Third Bancorp, a publicly traded company that offers participants a 401(k) plan with many investment options, one of which is company stock via an ESOP. The participants sued, saying fiduciaries breached their duties by failing to act when the company stock price fell 74% between July 2007 and September 2009.
In the 9-0 decision, Justice Stephen Breyer wrote that “ESOP fiduciaries are subject to the same duty of prudence that applies to ERISA fiduciaries in general, except that they need not diversify the (ESOP) fund's assets.”
Instead of relying on the “defense-friendly” presumption of prudence, courts should evaluate stock-drop cases “through careful, context-sensitive scrutiny of a complaint's allegations,” Mr. Breyer wrote.
The Department of Labor hailed the ruling that overturned the presumption of prudence standard established in 1995 by the 3rd Circuit Court of Appeals, Philadelphia, in Moench vs. Robertson. “The Supreme Court's decision will restore the ability of ESOP participants to have their day in court when plan trustees overpay for company stock,” Deborah Greenfield, deputy solicitor of labor, wrote in the DOL's blog June 27.
Although the presumption of prudence “was a reasonable tool” for courts to assess the validity of stock-drop lawsuits early, the new guidelines appear to offer protection against meritless lawsuits, said Scott Macey, president and CEO of the ERISA Industry Committee, Washington. If he were a DC plan executive, Mr. Macey said, “I wouldn't take any precipitous action.”
If DC plans don't have company-stock in their investment lineups now, he added, “I doubt they'll consider adding it” given the uncertainty of how courts will interpret the Supreme Court's decision.
“It's very challenging” to eliminate company stock from an investment menu under any circumstances because sponsors fear participants might think there's something wrong with the company, said Callan's Ms. Lucas.