The Supreme Court ruled this morning, June 25, 2014, that there is NO presumption of prudence for fiduciaries of ESOPs or Employee Stock Ownership Plans. In other words, the “Moench Presumption” which has been adopted nearly unanimously by every Circuit Court in the country has been unequivocally rejected. The decision was unanimous.
But it was not a total victory for these plaintiffs (or others). The Supreme Court disagreed with the two lower courts that any presumption of prudence applied, but also disagreed with the Sixth Circuit that the plaintiffs here stated a plausible claim for a violation of the duty of prudence. The Supreme Court vacated the Sixth Circuit decision and remanded to decide the claim’s plausibility in light of new factors provided by the Court.
[Scroll to the bottom for our analysis]
Here is the summary from the opinion:
1. ESOP fiduciaries are not entitled to any special presumption of prudence. Rather, they are subject to the same duty of prudence thatapplies to ERISA fiduciaries in general, §1104(a)(1)(B), except that they need not diversify the fund’s assets, §1104(a)(2). This conclusion follows from the relevant provisions of ERISA. Section 1104(a)(1)(B) “imposes a ‘prudent person’ standard by which to measure fiduciaries’ investment decisions and disposition of assets.” Massachusetts Mut. Life Ins. Co. v. Russell, 473 U. S. 134, 143, n. 10. Section 1104(a)(1)(C) requires ERISA fiduciaries to diversify plan assets. And §1104(a)(2) establishes the extent to which those duties are loosened in the ESOP context by providing that “the diversification requirement of [§1104(a)(1)(C)] and the prudence requirement (only to the extent that it requires diversification) of [§1104(a)(1)(B)] [are] notviolated by acquisition or holding of [employer stock].” Section 1104(a)(2) makes no reference to a special “presumption” in favor of ESOP fiduciaries and does not require plaintiffs to allege that theemployer was, e.g., on the “brink of collapse.” It simply modifies theduties imposed by §1104(a)(1) in a precisely delineated way. Thus, aside from the fact that ESOP fiduciaries are not liable for losses that result from a failure to diversify, they are subject to the duty of prudence like other ERISA fiduciaries. Pp. 4–15.
2. On remand, the Sixth Circuit should reconsider whether the complaint states a claim by applying the pleading standard as discussed in Ashcroft v. Iqbal, 556 U. S. 662, 677–680, and Bell Atlantic Corp. v. Twombly, 550 U. S. 544, 554–563, in light of the following considerations. Pp. 15–20.
(a) Where a stock is publicly traded, allegations that a fiduciary should have recognized on the basis of publicly available information that the market was overvaluing or undervaluing the stock are generally implausible and thus insufficient to state a claim under Twombly and Iqbal. Pp. 16–18.
(b) To state a claim for breach of the duty of prudence, a complaint must plausibly allege an alternative action that the defendant could have taken, that would have been legal, and that a prudent fiduciary in the same circumstances would not have viewed as more likely to harm the fund than to help it. Where the complaint alleges that a fiduciary was imprudent in failing to act on the basis of inside information, the analysis is informed by the following points.
First, ERISA’s duty of prudence never requires a fiduciary to break the law, and so a fiduciary cannot be imprudent for failing to buy or sell stock in violation of the insider trading laws.
Second, where a complaint faults fiduciaries for failing to decide, based on negative inside information, to refrain from making additional stock purchases or for failing to publicly disclose that information so that the stock would no longer be overvalued, courts should consider the extent to which imposing an ERISA-based obligation either to refrain from making a planned trade or to disclose inside information to the public could conflict with the complex insider trading and corporate disclosure requirements set forth by the federal securities laws or with the objectives of those laws.
Third, courts confronted with such claims should consider whether the complaint has plausibly alleged that a prudentfiduciary in the defendant’s position could not have concluded that stopping purchases or publicly disclosing negative information would do more harm than good to the fund by causing a drop in the stockprice and a concomitant drop in the value of the stock already held by the fund. Pp. 18–20.
So what really happened here? Remember that every circuit court that has looked at the issue has found some presumption of prudence, even the Sixth Circuit that had decided against Fifth Third Bank and was the subject of this appeal to the Supreme Court. However, where the Sixth Circuit differed from all other circuits was that they made the presumption an evidentiary presumption to be done at the summary judgment and/or trial stage, rather than at the motion to dismiss stage. The practical effect was that in most courts, plaintiffs had the the court doors shut in their face because the presumption was just too high to clear, where in courts in the Sixth Circuit, plaintiffs would be given the opportunity to engage in [expensive] discovery.
The Supreme Court rejected any presumption, effectively disagreeing with every circuit court to decide the issue:
In our view, the law does not create a special presumption favoring ESOP fiduciaries….§1104(a)(2) establishes the extent to which those duties are loosened in the ESOP context to ensure that employers are permitted and encouraged to offer ESOPs. Section 1104(a)(2) makes no reference to a special “presumption” in favor of ESOP fiduciaries. It does not require plaintiffs to allege that the employer was on the “brink of collapse,” under “extraordinary circumstances,”or the like.
Further, the Supreme Court rejected a very popular argument in ERISA litigation that if the plan document requires something, then that should govern fiduciary behavior even if a prudent fiduciary might otherwise disagree:
Consider the statute’s requirement that fiduciaries act “in accordance with the documents and instruments governing the plan insofar as such documents and instruments are consistent with the provisions of this subchapter.” §1104(a)(1)(D) (emphasis added). This provision makes clear that the duty of prudence trumps the instructions of a plan document, such as an instruction to invest exclusively in employer stock even if financial goals demand the contrary.
The Supreme Court also addressed Fifth Third’s concerns about being between a rock and a hard place in that they can be sued if the price goes down and they keep the stock in the plan or can be sued if the stock price then goes up and they haven’t put it back in. The Supreme Court seemed to sympathize but still held that the presumption of prudence was not the solution:
Petitioners are basically seeking relief from what theybelieve are meritless, economically burdensome lawsuits. We agree that Congress sought to encourage the creationof ESOPs. And we have recognized that “ERISA represents a ‘“careful balancing” between ensuring fair and prompt enforcement of rights under a plan and the encouragement of the creation of such plans.’” Conkright v. Frommert, 559 U. S. 506, 517 (2010) (quoting Aetna Health Inc. v. Davila, 542 U. S. 200, 215 (2004)); see also Varity Corp. v. Howe, 516 U. S. 489, 497 (1996) (In “interpret[ing] ERISA’s fiduciary duties,” “courts may have to take account of competing congressional purposes, such as Congress’ desire to offer employees enhanced protection for their benefits, on the one hand, and, on the other, its desire not to create a system that is so complex that administrative costs, or litigation expenses, unduly discourage employers from offering welfare benefit plans in the first place”).
At the same time, we do not believe that the presumption at issue here is an appropriate way to weed out meritless lawsuits or to provide the requisite “balancing.” The proposed presumption makes it impossible for a plaintiff to state a duty-of-prudence claim, no matter how meritorious, unless the employer is in very bad economic circumstances. Such a rule does not readily divide the plausible sheep from the meritless goats. That important task can be better accomplished through careful, context-sensitive scrutiny of a complaint’s allegations. We consequently stand by our conclusion that the law does not create a special presumption of prudence for ESOP fiduciaries.
The Supreme Court also rejected Fifth Third’s argument that plaintiffs’ claims required them to violate securities laws and thus they needed the presumption of prudence. Instead, the Supreme Court held explicitly that no fiduciary is ever expected to violate securities laws in order to meet their fiduciary duties, which was required even by all of the circuit court if dire circumstances required it but was advocated by plaintiffs to be required whenever they came in possession of the information.
Finally, the Supreme Court addressed Fifth Third’s concerns, which they found legitimate, as to how ESOP fiduciaries are to defend themselves against expensive litigation that may have no merit. First, the Supreme Court held that an allegation, like the one put forth by plaintiffs here that a stock is over or under valued based on public information, is not enough to state a claim:
In our view, where a stock is publicly traded, allegations that a fiduciary should have recognized from publicly available information alone that the market was over- or undervaluing the stock are implausible as a general rule, at least in the absence of special circumstances. Many investors take the view that “‘they have little hope of outperforming the market in the long run based solely on their analysis of publicly available information,’” and accordingly they “‘rely on the security’s market price as an unbiased assessment of the security’s value in light of all public information.’” Halliburton Co. v. Erica P. John Fund, Inc. ___ U. S. ___, ___ (2014) (slip op., at 11–12)(quoting Amgen Inc. v. Connecticut Retirement Plans and Trust Funds, 568 U. S. ___, ___ (2013) (slip op., at 5)). ERISA fiduciaries, who likewise could reasonably see “little hope of outperforming the market . . . based solely on their analysis of publicly available information,” ibid., may, as a general matter, likewise prudently rely on the market price.
Second, however, the Supreme Court recognized that it may still be possible for a plaintiff to state a plausible claim based on public information but only under special circumstances (which they do not define):
We do not here consider whether a plaintiff could nonetheless plausibly allege imprudence on the basis of publicly available information by pointing to a special circumstance affecting the reliability of the market price as “ ‘an unbiased assessment of the security’s value in light of all public information,’” Halliburton Co., supra, at ___ (slip op., at 12) (quoting Amgen Inc., supra, at ___ (slip op., at5)), that would make reliance on the market’s valuation imprudent. In this case, the Court of Appeals held that the complaint stated a claim because respondents “allege that Fifth Third engaged in lending practices that were equivalent to participation in the subprime lending market, that Defendants were aware of the risks of such investments by the start of the class period, and that such risks made Fifth Third stock an imprudent investment.” 692 F. 3d, at 419–420. The Court of Appeals did not point to any special circumstance rendering reliance on the market price imprudent. The court’s decision to deny dismissal therefore appears to have been based on an erroneous understanding of the prudence of relying on market prices.
So the practical effect is that the Supreme Court is sending this case back to the Sixth Circuit for them to decide whether they can find a plausible claim based on special circumstances, under this claim by the plaintiffs. This may be tough for the plaintiffs as they will not get a chance to re-write their complaint before the Sixth Circuit.
Third, the Supreme Court re-addressed the issue of defending against a claim that an ESOP fiduciary should use insider information. The Supreme Court provided this standard for such a claim:
To state a claim for breach of the duty of prudence on the basis of inside information, a plaintiff must plausibly allege an alternative action that the defendant could have taken that would have been consistent with the securities laws and that a prudent fiduciary in the same circumstances would not have viewed as more likely to harm the fund than to help it.
They then provided the following three points to inform the analysis of such a claim:
First, in deciding whether the complaint states a claim upon which relief can be granted, courts must bear inmind that the duty of prudence, under ERISA as underthe common law of trusts, does not require a fiduciary tobreak the law. Cf. Restatement (Second) of Trusts §166,Comment a (“The trustee is not under a duty to the beneficiary to do an act which is criminal or tortious”). Federal securities laws “are violated when a corporate insidertrades in the securities of his corporation on the basis of material, nonpublic information.” United States v. O’Hagan, 521 U. S. 642, 651–652 (1997). As every Court of Appeals to address the question has held, ERISA’s duty of prudence cannot require an ESOP fiduciary to perform an action—such as divesting the fund’s holdings of theemployer’s stock on the basis of inside information—that would violate the securities laws. See, e.g., Rinehart v. Akers, 722 F. 3d 137, 146–147 (CA2 2013); Kirschbaum v. Reliant Energy, Inc., 526 F. 3d 243, 256 (CA5 2008); White, supra, at 992; Quan, supra, at 881–882, and n. 8; Lanfear v. Home Depot, Inc., 679 F. 3d 1267, 1282 (CA11 2012). To the extent that the Sixth Circuit denied dismissal based on the theory that the duty of prudence required petitioners to sell the ESOP’s holdings of Fifth Third stock, its denial of dismissal was erroneous.
Second, where a complaint faults fiduciaries for failing to decide, on the basis of the inside information, to refrain from making additional stock purchases or for failing todisclose that information to the public so that the stock would no longer be overvalued, additional considerations arise. The courts should consider the extent to which an ERISA-based obligation either to refrain on the basis of inside information from making a planned trade or todisclose inside information to the public could conflict withthe complex insider trading and corporate disclosurerequirements imposed by the federal securities laws orwith the objectives of those laws. Cf. 29 U. S. C. §1144(d) (“Nothing in this subchapter [which includes §1104] shall be construed to alter, amend, modify, invalidate, impair,or supersede any law of the United States . . . or any ruleor regulation issued under any such law”); Black & Decker Disability Plan v. Nord, 538 U. S. 822, 831 (2003) (“Although Congress ‘expect[ed]’ courts would develop ‘a federal common law of rights and obligations under ERISA regulated plans,’ the scope of permissible judicial innovation is narrower in areas where other federal actors are engaged” (quoting Pilot Life Ins. Co. v. Dedeaux, 481 U. S. 41, 56 (1987); citation omitted)); Varity Corp., 516 U. S., at 506 (reserving the question “whether ERISA fiduciarieshave any fiduciary duty to disclose truthful information ontheir own initiative, or in response to employee inquiries”).The U. S. Securities and Exchange Commission has not advised us of its views on these matters, and we believe those views may well be relevant.
Third, lower courts faced with such claims should also consider whether the complaint has plausibly alleged that a prudent fiduciary in the defendant’s position could not have concluded that stopping purchases—which the market might take as a sign that insider fiduciaries viewed the employer’s stock as a bad investment—or publicly disclosing negative information would do more harm than good to the fund by causing a drop in the stock price and a concomitant drop in the value of the stock already held by the fund.
To be clear, this is not a total victory for the plaintiffs and is not a total defeat for ESOP fiduciaries. Instead, the opinion appears to be a carefully crafted balancing act by the Supreme Court that recognizes the concerns of ESOP fiduciaries but won’t allow those concerns to be protected by a presumption of prudence that is unsupported by the statutory language of ERISA and instead was an entirely judicially created doctrine. The Supreme Court instead went to great lengths to prop up the integrity of the duty of prudence, not allowing it to be undermined.
Despite the rejection of the presumption of prudence, the Supreme Court appears to have created a very high bar for plaintiffs to bring a case against ESOP fiduciaries for a drop in the price stock. Instead, the Supreme Court doubles down on the Iqbal and Twombly cases which have regularly been used as a hammer in narrowing what can be considered “plausible” claims.
When claim is alleged that the ESOP fiduciary was supposed to change course based on public information, the claim now needs to show “special circumstances” which the Supreme Court left undefined. How high the bar is will depend on how the lower courts interpret that phrase.
As for the issue of using insider trading and having conflicted fiduciaries, the Supreme Court clearly did not agree with the plaintiffs’ implicit, if not explicit argument at oral arguments, that insider corporate fiduciaries are always conflicted. Instead, the Supreme Court made clear that the securities laws trump ERISA law. Quite explicitly, the Court states that an ERISA fiduciary cannot sell the stock based on insider information. But the Court seems to have provided a narrow opportunity for claims by plaintiffs that an ESOP fiduciary can violate ERISA if they fail to stop purchasing the stock or if they tell the public what they know, but only if they don’t violate the securities laws. It remains to be seen how narrow or broad that opportunity is. However, it may make no difference at all, because the Court has now required the lower courts to consider whether a claim to stop purchasing or a claim to inform the public would hurt the participants more than doing nothing.
So what is the ultimate decision? It appears the Supreme Court has torn up the Moench Presumption’s invitation to the party but instead invited its not so distant cousins Iqbal and Twombly.
So what will be the ultimate outcome? Will employers line up to terminate their ESOPs? My initial reaction is no. The Supreme Court has provided enough cover for a large percentage of ESOP fiduciaries to defend themselves amply at the motion to dismiss stage and avoid the expensive discovery phase of a case. At the same time, the Supreme Court did leave open the possibility that insider fiduciaries may need to use their insider positions to stop purchasing stock or disclose the information they know. This would seem to me to strongly suggest that the use of independent fiduciaries who would not be subject to those circumstances may be increasingly utilized.