Supreme Court ESOP Decision

Supreme Court ESOP Decision

In the Court’s decision in Fifth Third Bancorp v. Dudenhoeffer, the court says that ESOP fiduciaries are not entitled to any special presumption of prudence. Rather, ESOP fiduciaries are subject to the same duty of prudence that applies to ERISA fiduciaries in general per Section 1104(a)(1)(B), except that they need not diversify the fund’s assets, per Section 1104(a)(2). Section 1104(a)(2) makes no reference to a special “presumption” in favor of ESOP fiduciaries and does not require plaintiffs to allege that the employer was on the “brink of collapse.” 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.

That decision indicated that 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:

• 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.
• 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.
• Courts confronted with such claims should consider whether the complaint has plausibly alleged that a prudent fiduciary 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 stock price and a concomitant drop in the value of the stock already held by the fund.

This Supreme Court decision does not protect fiduciaries of ESOPs from lawsuits triggered by company stock price declines. While this decision is relevant primarily to publicly-traded companies, it sets forth standards for future lawsuits to be used by lower courts and it is something that fiduciaries of private companies with ESOPs should pay close attention to. Companies that sponsor an ESOP plan should put safeguards in place whenever the company is a trustee or fiduciary to an ESOP that is engaging in transactions involving the purchase or sale of employer securities that are not publicly traded. The safeguards include requirements for the selection of an independent valuation advisor and the oversight of the advisor, the analysis required as part of the fiduciary review process and the required documentation of the valuation analysis. ESOP fiduciaries should pay close attention to unrealistic and aggressively optimistic projections and the credibility of the assumptions that go into the appraisal. Remember that ESOP’s are an important way to promote employee ownership; however, they should not be a way to create big cash-outs for owners and top executives.

The rules for implementing and maintaining an ESOP are complex. Plan sponsors interested in instituting an ESOP for their company would be well advised to contact qualified legal counsel and other qualified professionals as needed for this initiative.

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