ERISA fiduciaries of employee stock ownership plans (ESOPs) and plans with employer stock funds increasingly find themselves in a Catch-22. If they continue to invest in employer stock and the stock price falls, the fiduciaries could be sued for violating their duty of prudence. If they stop investing in employer stock and the price rises, the fiduciaries could be sued for failing to follow plan terms. Many circuit courts previously addressed this situation by applying the Moench presumption of prudence to fiduciaries of ESOPs and other plans that required an employer-stock fund. That is, fiduciaries of plans that required investment in employer stock were presumed to have acted prudently, and that presumption generally was overcome only if plaintiffs could demonstrate that the fiduciaries abused their discretion by continuing to invest plan assets in employer stock. The Supreme Court in Fifth Third Bancorp v. Dudenhoeffer, however, held last year that no special presumption of prudence applied in these circumstances. Instead, fiduciaries of these types of plans were subject to the same ERISA prudence standards that applied to fiduciaries of any other plan. The Court did acknowledge that the separate standard of asset diversification did not apply top ESOPs (although it would apply to other plans with employer stock funds).
After Dudenhoeffer, many commentators expressed concern about what the loss of the presumption of prudence would mean for ESOP fiduciaries. The Sixth Circuit, however, may have restored a sense of calm in a recent decision. In Pfeil, et al. v. State Street Bank & Trust Co., the Sixth Circuit held that an ESOP fiduciary’s investment decisions satisfy the ERISA duty of prudence so long as the fiduciary uses a prudent process when the decisions are made. Further, a public company stock’s current market price is deemed to be a reliable indicator of the stock’s value, absent a showing of special circumstances by the plaintiffs as to why that price is not reliable. This is true even if in hindsight stock losses occur.
This case represents good news for fiduciaries of plans that require investment in employer stock—even though the days of a presumption of prudence are gone. This case demonstrates that if fiduciaries use a prudent process then attacks from plaintiffs will be much tougher to sustain even if hindsight shows the outcome of the decision to be a bad one. This blog will explore the decision and its implications.
Pfeil involves General Motors’ (GM’s) retirement plan for employees, which included an ESOP component that invested in a GM stock fund. The participants in the GM stock fund could change investments on any business day. State Street Bank (“State Street”) served as fiduciary of the plan. To evaluate the GM stock fund, State Street used a system of three separate committees to monitor GM’s stock performance and evaluate whether it was a prudent investment. Together these committees met to discuss GM’s stock 58 times between January 2008 and March 31, 2009. On July 15, 2008, GM announced a restructuring plan. Between November 10, 2008, and March 31, 2009, GM experienced severe financial problems. State Street ultimately decided to divest the plan of the company stock fund on March 31, 2009. Plaintiffs had chosen to remain invested in the fund throughout 2008.
After State Street sold GM’s stock in the fund, the plaintiffs filed a one count lawsuit under ERISA Section 502 claiming that State Street breached its fiduciary duty for the failure to manage plan assets prudently under ERISA Section 404. Specifically, the plaintiffs alleged that State Street should have sold the stock on July 15, 2008, after the announcement of GM’s restructuring.
The district court originally dismissed the plaintiff’s suit under the presumption of prudence standard. The plaintiffs appealed and the Sixth Circuit reversed and remanded, holding that the presumption of prudence did not apply earlier than the summary judgment stage. That was a significant development because litigation costs can start to become significant after the motion to dismiss stage. On remand, the district court granted State Street’s motion for summary judgment. Afterward, the Supreme Court issued the Dudenhoeffer decision. The participants again appealed, and the Sixth Circuit affirmed the grant of summary motion.
The Post-Dudenhoeffer Prudent Process Analysis
Although the Dudenhoeffer decision prevented the Sixth Circuit from affirming the district court’s grant of summary judgment under a pre-Dudenhoeffer presumption-of prudence framework, the circuit court panel noted that it was empowered to review the district court’s decision de novo and affirm the decision on other grounds. The Sixth Circuit then applied its test for a prudent process under ERISA to affirm the grant of summary judgment.
ERISA Section 404 requires plan fiduciaries to act prudently in managing the plan’s assets and imposes a prudent expert standard by which to measure their actions. In general, the duty of prudence requires a fiduciary to take the actions that a financial expert would have made under similar facts and circumstances. The Sixth Circuit explained that under Dudenhoeffer, in determining whether the fiduciary satisfied the duty of prudence, the test is whether the fiduciary has engaged in a reasoned decision-making process, consistent with that of a prudent person acting in a similar capacity. Whether the fiduciary engaged in a reasoned decision-making process depends on whether the fiduciaries, at the time they engaged in the challenged transactions, employed the appropriate methods to investigate the merits of the investment and to structure the investment.
Further, although a presumption of prudence may no longer exist, the court concluded that under modern portfolio theory the current market price of a company’s stock is a reliable estimate of the value of the stock. That is because the market price presumably incorporates all of the information known or knowable about the future prospects of the stock. In order to survive a motion to dismiss against a breach of fiduciary action against an ESOP fiduciary, plaintiffs must show a special plausible circumstance as to why the current market price was not reliable. Citing Dudenhoeffer, the Sixth Circuit held that, absent such a showing, it is prudent for an ESOP fiduciary to rely on the company stock’s market price in its decision-making process. Further, even if hindsight showed that the fiduciary’s decision resulted in a loss to participants, the fiduciary’s conduct had to be evaluated at the time it occurred.
Applying this analysis, the Sixth Circuit held that State Street demonstrated a prudent process in its fiduciary decisions regarding GM’s stock fund because:
- State Street discussed GM’s stock “scores of times” during the class period of less than 9 months and repeatedly discussed at length whether to continue the investments;
- the record indicated that State Street analyzed GM’s stock and business performance and factors that could affect that performance, often culminating in decisive votes;
- State Street was advised by outside legal and financial advisors;
- fiduciaries of other pension plans and investment funds decided both to invest and not to divest on or near the dates that State Street made its decisions; and
- the plaintiffs did not show special circumstances why State Street’s process was imprudent.
Implications for Fiduciaries
The list of factors from above that ultimately led the Sixth Circuit to rule in favor of the fiduciaries is consistent with advice practitioners have recommended to fiduciaries of plans that do not invest in employer stock. No longer having a presumption of prudence means that fiduciaries of ESOPs and other plans with an employer stock fund must employ a prudent process for evaluating continued investment in employer stock. In other words, absent special diversification implications for ESOPs, it appears that the same standards will apply to employer stock as to other investments. While that might not be as ideal as having a presumption of prudence apply to continued investment in employer stock, it is manageable and should reflect a standard that can be embraced by plan fiduciaries.