Employer Stock Fund Litigation:
Evaluating Fifth Third Bancorp v.
Dudenhoeffer One Year Later
*Russell L Hirschhorn
Proskauer Rose LLP
212.969.3286
rhirschhorn@proskauer.com
*David S Preminger
Keller Rohrback L.L.P.
646.380.6690
dpreminger@kellerrohrback.com
Matthew Rutchik,
U.S. Department of Labor, EBSA
Thomas Tso,
U.S. Department of Labor, SOL
*slides prepared by
Agenda
• Plans with Publicly Traded Employer Stock
- Background of the Presumption of Prudence
- The Supreme Court decision in Fifth Third v. Dudenhoeffer
- Post-Fifth Third Cases
- Tatum v. RJ Reynolds
2
Types of Claims Asserted in Publicly Traded
Employer Stock Litigation
• Prudence & Loyalty Claims
• Disclosure Claims
• Prohibited Transaction Claims
• Breach of Duty to Monitor
• Knowing Participation in Fiduciary Breaches or
Prohibited Transactions
• Failure Correct Fiduciary Breaches
3
Categories of Publicly Traded Employer Stock
Litigation
• Cases alleging inflation of stock price (usually related to
material misrepresentations in securities lawsuit)
• Cases alleging that the stock had become too risky (but no
allegations that the stock itself was inflated or mispriced)
4
The Rise of the Moench Presumption
• Moench v. Robertson, 62 F.3d 553 (3d Cir. 1995)
- Used the exemption from diversification to create a
presumption that fiduciaries acted prudently in offering
participants the option to invest in employer stock
• Most circuits adopted variations of the presumption, usually
requiring the company to be in “dire circumstances” to
sustain a claim of imprudence.
• Seven circuits applied the presumption on motions to
dismiss.
5
The Sixth Circuit’s Pre-Dudenhoeffer View
• Kuper v. Iovenko, 66 F.3d 1447 (6th Cir. 1995) adopted a
modified version of the presumption -- plaintiffs need only
prove that “a prudent fiduciary acting under similar
circumstances would have made a different investment
decision.”
• Pfeil v. SSBT, 671 F.3d 585 (6th Cir. 2012) declined to
apply the presumption at pleadings stage because it was
an evidentiary presumption (not a pleading requirement).
6
Fifth Third Bancorp v. Dudenhoeffer
Plan Design
• Participants could direct their 401(k) plan contributions to
any one of 20 investment funds including a stock fund.
• Plan mandated “in all events, the Fifth Third Stock Fund . . .
shall be an investment option.”
• Fifth Third matched up to 4% of participants’ pre-tax
contributions; the match was initially invested in the ESOP,
but employees could then move these contributions to other
funds.
7
Fifth Third Bancorp v. Dudenhoeffer
Claims
• Alleged Fifth Third engaged in lending practices that were
equivalent to participation in the subprime market.
• Fifth Third stock declined 74% in value.
• Prudence claim alleged Defendants were aware: (i) of risks of
such investments and (ii) that mismanagement along with
inaccurate and misleading statements by executives caused stock
price to be artificially inflated.
• Disclosure claim alleged Defendants failed to provide complete
and accurate information about stock: (i) change away from
traditional conservative lending philosophy, (ii) deteriorating Tier 1
capital quality, and (iii) failure to set aside adequate reserves for
nonperforming loans.
8
Fifth Third Bancorp v. Dudenhoeffer
Procedural History
• District court dismissed (i) prudence claim for failure to
rebut Moench presumption because “Fifth Third is and was
a viable, ongoing concern” even though the complaint
alleged the shift to the subprime market was “perhaps
disastrous” and (ii) the disclosure claim because the
statements and omissions incorporated in the SPD from the
SEC filings were not made in a fiduciary capacity.
• Sixth Circuit reversed: (i) the presumption did not apply at
pleading phase and could be rebutted by “showing that a
prudent fiduciary acting under similar circumstances would
have made a different investment decision;” (ii)
incorporating SEC filings into a SPD was a fiduciary act.
9
Fifth Third Bancorp v. Dudenhoeffer – Sup. Ct.
THE ISSUE
“Whether the Sixth Circuit erred by holding that [Plaintiffs] were not
required to plausibly allege in their complaint that the fiduciaries of
an employee stock ownership plan (“ESOP”) abused their discretion
by remaining invested in employer stock, in order to overcome the
presumption that their decision to invest in employer stock was
reasonable, as required by [ERISA] and every other circuit to
address the issue?”
10
Fifth Third Bancorp v. Dudenhoeffer – Sup. Ct.
THE ANSWER
“In our view, the law does not create a special presumption favoring
ESOP fiduciaries. Rather, the same standard of prudence applies to
all ERISA fiduciaries, including ESOP fiduciaries, except that an
ESOP fiduciary is under no duty to diversify the ESOP’s holdings.”
11
Fifth Third Bancorp v. Dudenhoeffer – Sup. Ct.
(cont’d)
• While courts may have to take account of competing
congressional purposes, such as employees’ rights, with
encouragement of the creation of employee benefit plans,
the Court did “not believe that the presumption at issue
here [was] an appropriate way to weed out meritless
lawsuits or to provide the requisite ‘balancing.’”
- The presumption “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.”
12
Fifth Third Bancorp v. Dudenhoeffer – Sup. Ct.
• Reasons for Rejecting the Presumption
- Presumption is beyond ERISA’s express provisions
- Section 404(a)(1)(B) imposes a “prudent person” standard
- Section 404(a)(1)(C) requires ERISA fiduciaries to diversify
- Section 404(a)(2) establishes the extent to which those duties are
loosened for ESOPs
- ERISA makes no reference to a special presumption
- ERISA only modifies the duties imposed by Section
404(a)(1)(B) in a precisely delineated way: An ESOP fiduciary
is exempt from the diversification requirement and also from
the duty of prudence, but “only to the extent that it requires
diversification.”
13
Fifth Third Bancorp v. Dudenhoeffer – Sup. Ct.
- Rejected arguments for creating a presumption:
- Duty of prudence rooted in providing financial benefits, not nonpecuniary ones like employee ownership
- Unlike common law, ERISA plan documents cannot excuse
trustee from fiduciary duties
- The presumption does not fit the goal of eliminating conflicts with
the securities laws
- The presumption “does not readily divide the plausible sheep from
meritless goats” in weeding out meritless suits.
14
Fifth Third Bancorp v. Dudenhoeffer – Sup. Ct.
• Mechanisms to Sort the Sheep & Goats
- Because the content of the duty of prudence turns on the
circumstances prevailing at the time the fiduciary acts, the
appropriate inquiry will necessarily be context specific.
- Apply the pleading standard as discussed in Twombly and
Iqbal and provided guidance as to considerations.
- Guidance divided between two categories of allegations:
- Breaches based solely on publicly available information
- Breaches based on non-public information
15
Fifth Third Bancorp v. Dudenhoeffer – Sup. Ct.
• Allegations that a fiduciary should have recognized from
publicly available information alone that the market was
overvaluing or undervaluing the stock are implausible as a
general rule, at least in the absence of special
circumstances.
• ERISA fiduciaries, like many investors, see little hope of
outperforming the market based solely on publicly available
information and thus may generally prudently rely on the
market price.
16
Fifth Third Bancorp v. Dudenhoeffer – Sup. Ct.
• 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
- A prudent fiduciary in the same circumstances would not have viewed as
more likely to harm the fund than to help it.
• The lower courts should consider the following:
- Duty of prudence does not require a fiduciary to break the law.
- The extent to which a fiduciary’s decision not to purchase stock or to
publicly disclose inside information conflicts with federal securities laws
or with the objectives of those laws.
- Whether a prudent fiduciary could not have concluded that stopping
purchases or publicly disclosing negative information would do more
harm than good to the stock fund.
17
Discussion Points
• What are “special circumstances?”
• What, if any, types of claims are viable based on publicly
available information?
• Does it matter whether the plan terms require an employer
stock fund to be an investment option?
• What considerations are plan fiduciaries supposed to use in
evaluating the prudence of the employer stock fund as an
investment option?
• What is a plan fiduciary to do with inside information?
18
Post-Dudenhoeffer Decisions
• Harris v. Amgen (9th Cir. 2015)
- Prudence claim for continuing to offer stock as investment
- On appeal from a motion to dismiss
- Removing the stock fund is a plausible option that would not
cause undue harm to the plan
- Removing the stock fund as an option would not violate the
securities laws
- No special pleading standard for ERISA cases
19
Post-Dudenhoeffer Decisions
- Prudence & loyalty claim for failure to disclose
- Incorporation of statements made in SEC filings is performed in a
fiduciary capacity
- Prohibited transaction claim
- Exceptions to PT claims are affirmative defense
- Unless the face of complaint shows affirmative defense applies, claim
cannot be dismissed
- Amgen’s fiduciary status
- Plan contains no exclusive delegation of authority to Committee
(instead, acted on Company’s behalf)
- Nothing indicates Amgen appointed an investment manager
- Blistering dissent
20
Post-Dudenhoeffer Decisions
• Gedek v. Perez (Kodak) (W.D.N.Y.)
- Court denied Defendants’ motion to dismiss.
- “The complaint recites a history not just of Kodak’s inexorable
slide toward bankruptcy, but of publicly available information
contemporaneously documenting that slide, step by painful
step, and accurately forecasting Kodak’s bleak future.”
- “A reasonable factfinder could conclude that at some point . . .
the ESOP fiduciary should have stepped in and, rather than
blindly following the plan directive to invest primarily in Kodak
stock, shifted the plan’s assets into more stable investments,
as permitted by the plan document, and as consistent with the
plan’s and ERISA’s purposes.”
21
Post-Dudenhoeffer Decisions
• In re BP p.l.c. ERISA Litig., (S.D. Tex.)
- Court denied Plaintiffs leave to amend their complaint to add a
prudence claim based on public information.
- Plaintiffs did not allege a theory as to why the market’s
valuation of BP based on public information was unreliable.
- Plaintiffs’ claim that BP stock was excessively risky failed
because the stock was widely traded in a public market place
and the market is not inefficient.
- Even if Kodak could be reconciled with Dudenhoeffer, the
alleged riskiness of BP’s stock “simply does not conjure the
inevitability of ‘default, bankruptcy, or worse’ present in
[Kodak].”
22
Post-Dudenhoeffer Decisions
• In re BP p.l.c. ERISA Litig., (S.D. Tex.)
- Plaintiffs moved to amend their prudence claim based on
nonpublic information, based on the following allegations:
- Certain individual Defendants, including members of
investment committee, had knowledge that BP had failed to
implement a new safety system at sites such as Deepwater
Horizon despite public assurances to the contrary.
- One individual Defendant was accused of violating the
securities laws; thus, there were adequate allegations that he
possessed the type of inside information that could implicate
the ERISA duty of prudence.
23
Post-Dudenhoeffer Decisions
• In re BP p.l.c. ERISA Litig., (S.D. Tex.) (cont’d)
- Plaintiffs identified alternatives to inaction that were consistent
with securities laws and ERISA—freezing, limiting or restricting
stock purchases, and disclosure.
- Defendants’ position: Dudenhoeffer created a presumption
that alternatives to inaction “would cause more harm than
good,” and plaintiffs must “plausibly allege otherwise to avoid
dismissal.”
- Plaintiffs’ position: Need only plausibly allege that a prudent
fiduciary in the same circumstances would have viewed the
alternative as more likely to help the fund than hurt it.
24
Post-Dudenhoeffer Decisions
• In re BP p.l.c. ERISA Litig., (S.D. Tex.) (cont’d)
- Court found both positions untenable:
- Defendants’ construction would result in a virtually insurmountable
standard for all future plaintiffs;
- Plaintiffs’ construction equally problematic, because freezing the
stock fund or disclosing inside information would be available in
almost any case.
- Court resorted to general pleading guidance of Twombly and
Iqbal.
- Granted leave to amend.
- 1292(b) petition granted
25
Post-Dudenhoeffer Decisions
• In Re UBS ERISA Litig., 2014 WL 4812387 (S.D.N.Y. Sept. 29, 2014)
- District court dismissed the case (again) finding that plaintiffs lacked
Article III standing for failure to allege individual harm.
- Observed in dicta that arguably “the Supreme Court's decision in
Dudenhoeffer has, if anything, raised the bar for plaintiffs seeking to
bring a claim based on a breach of the duty of prudence.”
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Additional Post-Dudenhoeffer Discussion Topics
• Developing split on disclosure claims based on incorporation by
reference of SEC filings into plan documents
• Whether to “hard-wire” employer stock fund into plan document
• Potential increased role of independent fiduciaries in monitoring
employer stock funds
• Whether to discontinue the stock fund entirely:
27
Other Cases to Watch: Previously filed cases
• In re American International Group, SDNY
• Geroulo v. Citigroup Inc., SDNY
• Rinehart v. Akers (Lehman Brothers), SDNY
• Lipman v. Terex, D. Conn.
• Borboa v. Chandler (Land America), E.D. Va.
• Kopp v. Klein (Idearc), N.D. Texas
• Laffen v. Hewlett-Packard Co., N.D. Cal.
• Ramirez v. J.C. Penney Corp., E.D. Texas
• In re RadioShack, N.D. Texas
28