The Supreme Court on Wednesday unanimously rejected a frequently used, successful defense by companies against stock-drop lawsuits filed by defined contribution plan participants.
In a 9-0 decision, the justices said a “presumption of prudence” invoked by employee stock option plans — based on nearly 20 years of federal court decisions — shouldn't be considered a special defense against lawsuits alleging breaches of fiduciary duty.
“We hold that no such presumption applies,” wrote Justice Stephen Breyer in the opinion for Fifth Third Bancorp et al. vs. Dudenhoeffer et al. “Instead, 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.”
Rather than rely on the “defense-friendly” legal principle known as the Moench presumption, Mr. Breyer wrote that courts should evaluate stock-drop cases “through careful, context-sensitive scrutiny of a complaint's allegations.”
The Supreme Court heard oral arguments in the Fifth Third case in April after the 6th U.S. Circuit Court of Appeals in Cincinnati had issued a different interpretation of the “presumption of prudence” principle than several other federal appeals courts.
These courts disagreed on the Moench presumption, articulated in 1995 by the 3rd U.S. Circuit Court of Appeals in Philadelphia, in Moench vs. Robertson. This principle gives a presumption of prudence to fiduciaries that offer company stock as an investment option in defined contribution plans.
Several federal appeals courts and federal district courts have issued rulings, citing the Moench presumption as applying to the motion-to-dismiss stage. The 6th Circuit said the Moench presumption should apply at the trial stage — a more relaxed standard for plaintiffs in stock-drop cases.
In Wednesday's ruling, the Supreme Court vacated the 6th Circuit decision and remanded the case to the appeals court “for further proceedings consistent with this opinion.” Mr. Breyer cited several guidelines for the 6th Circuit to determine whether the Fifth Third case meets the standards to proceed to trial, including:
• “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 Supreme Court rulings in two previous cases.
• “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.”
• “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 insider trading laws.”
Mr. Breyer rejected the argument by Fifth Third Bancorp that a weakening of the Moench presumption would make ESOPs and DC plans more vulnerable to lawsuits.
“We do not believe that the presumption here is an appropriate way to weed out meritless lawsuits,” he wrote. “The proposed presumption makes it impossible for a plaintiff to state a duty-of-prudence claim … unless the employer is in very bad economic circumstances. Such a rule does not readily divide the plausible sheep from the meritless goats.”
Robert Steyer is a reporter with Pensions & Investments, a sister publication.