Seeking to resolve a rather lopsided circuit split, the justices of the U.S. Supreme Court seem poised to support a requirement that employees alleging breach of fiduciary duty overcome a pleading-stage presumption that employee stock plan fiduciaries acted with prudence.
The case of Fifth Third Bancorp v. Dudenhoeffer, No. 12-751, comes from the 6th U.S. Circuit of Appeals, which has one of the highest reversal rates before the high court. The circuit is the only federal appeals court to have held that fiduciaries of employee stock ownership plans, or ESOPs, fall outside the presumption, and that any presumption applies only at the merits stage, not when a motion to dismiss on the pleadings has been filed.
If that doesn’t create long enough odds for the respondents in the case — employees alleging breach of fiduciary duty after their employer stock-invested retirement plans deflated — during oral arguments on Wednesday the justices frequently expressed frustration with the employees’ attorney as they pressed him for examples of how a prudent fiduciary should have behaved.
The case involves a bank’s ESOP, which was required to be invested primarily in company stock. The company’s employee benefits plan allowed employees to make voluntary contributions to the 401(k) retirement fund, and employees had the ability to direct their funds to a number of investment options. The company ESOP was one of 20 options from which employees could choose to invest.
The company also provided 401(k) matching funds of up to 4 percent of employees’ contributions. Those matching funds, however, were placed only in the company ESOP.
After the company’s stock plummeted from more than $25 to $2.85 per share, a group of employees filed suit, alleging breach of fiduciary duty under the Employee Retirement Income Security Act. They claimed that company officials knew and failed to disclose the company had shifted from conventional lending to risky subprime lending.
A U.S. District Court dismissed the case on the pleadings, holding that the plaintiffs failed to overcome the “presumption of prudence” — a strong presumption that the decisions fiduciaries make regarding company stock are prudent, as established in the 3rd Circuit case Moench v. Robertson.
But the 6th Circuit took a different view, reversing the district court and holding that the presumption of prudence does not apply to ESOP fiduciaries. Further, it held that the presumption could not be applied at the pleading stage but only after the evidentiary record in the case was complete.
The Supreme Court granted the bank’s petition for certiorari.
‘Coach class trustee?’
Robert Long Jr., a partner in the Washington office of Covington & Burling LLP, argued on the bank’s behalf that “a fiduciary’s decision to do exactly what an employee stock ownership plan is designed to do [by] continuing to offer employer stock as an investment option is presumptively prudent.”
Justice Anthony Kennedy asked if that placed ESOP investors at a disadvantage.
“You want us to say that we have sort of a coach class trustee?” Kennedy asked. “We’re all traveling in coach class when we have an ESOP?”
Long said there was no “coach class” of trustee, but that the limits imposed on an ESOP trustee must be taken into account. For example, a trustee cannot act on inside information about the valuation of company stock, lest he or she be open to securities law liability.
Ronald Mann, a professor at Columbia Law School in New York and also of counsel at the Philadelphia boutique firm Mitts Law, argued on the employees’ behalf.
“If the trustee does not undertake the investigation that a prudent fiduciary would take because of their concern about acquiring insider information of the employer, then they would violate the ordinary standard of prudence,” Mann said.
The justices pressed Mann to give examples of what a prudent company ESOP trustee must do to meet his or her fiduciary obligations — and openly expressed frustration when they didn’t get the answers they were looking for.
“Can we talk concretely instead of just saying, ‘Well, they’ve got to do what a prudent fiduciary can do?’” asked Chief Justice John Roberts Jr. “What does he do? Does he say, ‘I shouldn’t buy any more [stock] because I think it’s going to go down some more?’”
“I think the obligation of the fiduciary at all times is to behave prudently in managing investment prudently,” Mann replied, causing several justices to sigh audibly or lean back in their seats in exasperation.
“I asked for an answer to the question, and it’s not going to help me [if you repeat] this mantra,” Roberts said.
Justice Stephen Breyer posed a direct hypothetical: if a trustee learns inside information that a company’s product is worthless before the market is aware and stock values drop, “what, in your opinion is he supposed to do?”
“The trustee violates the duty of loyalty and the duty of prudence if the trustee … does not take action to protect the beneficiaries,” Mann said.
“So your answer is he sells, right?” Breyer asked.
“I didn’t say that,” Mann said. Breyer threw his hands up in the air.
A decision is expected later this term.