When a company maintains an employee stock ownership plan, do plan managers have discretion to decide whether to remain invested in employer stock based on long-term, rather than short-term, goals, or do the managers have to change investment tactics to minimize losses and maximize present value for the investors?
John Dudenhoeffer and Alireza Partovipanah are former employees of Fifth Third Bancorp. As part of their benefits plan, they contributed to an employer stock ownership plan (“ESOP”). By participating in the plan, employees have an option to invest in Fifth Third stock as well as several other funds. In a two-year span, stock value for Fifth Third dropped dramatically. Dudenhoeffer and his fellow class members argue that Fifth Third made misleading disclosures regarding the health of the stock and that the trust managers failed to represent the best interests of the trustees by allowing employees to continue to invest in the company. Fifth Third argues that there is a strong presumption in favor of ESOP managers and their decisions to invest stocks based on long-term company goals. The decision in this case will affect the duties that employers owe to employees who invest in ESOPs and the protection afforded to employee-investors.
Questions as Framed for the Court by the Parties
- Whether the Sixth Circuit erred by holding that Respondents 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 the Employee Retirement Income Security Act of 1974, 29 U.S.C. §§ 1101, et seq. (“ERISA”), and every other circuit to address the issue.
- The complaint in this case alleges a breach of the fiduciary duties of loyalty and prudence, in violation of ERISA § 404(a)(1), 29 U.S.C. §1104(a)(1), by the trustees of an employee pension benefit plan that invests in the stock of the employer. The question before the Court is whether those allegations are inadequate on their face unless they establish that the employer’s financial status is dire.
John Dudenhoeffer and Alireza Partovipanah are former employees of Fifth Third Bank. See Dudenhoeffer v. Fifth Third Bancorp, 692 F.3d 410, 414 (6th Cir. 2012). They, as well as the others in the class, are plan participants in the Fifth Third Bancorp Master Profit Sharing Plan (“the Plan”) and held common stock in Fifth Third. See id. Under the Plan, Fifth Third acts as trustee and participants voluntarily contribute money from their salaries as part of the retirement plan for employees. See id. at 414–15. The Plan uses these contributions to invest in options Fifth Third management preselects. See id. at 415.
The Plan does not mandate that Fifth Third Stock Fund invest only in Fifth Third Stock. See id.Fiduciaries are free to move funds or divest assets invested in the Fifth Third Stock Fund as they see fit. See id.The Plan fiduciaries incorporated Fifth Third’s SEC filings into the Summary Plan Description, which ERISA requires to be sent to Plan participants. See id.
During the period at issue, significant funds were invested in Fifth Third Stock. See id.Plaintiffs allege that during this time, Fifth Third changed from a conservative lender to a subprime lender. See id.Further, Dudenhoeffer and the class argue that the portfolio was increasingly at risk because of defaults and the company failed to disclose the damage to company and stockholders or issued misleading disclosures. See id.Specifically, the Plan lost tens of millions of dollars when the price of Fifth Third Stock declined 74% from July 2007 to September 2009. See id.
The class contends that Fifth Third leadership was aware of the risks presented when investing in a subprime lending market. See id.Finally, they argue that because of mismanagement and inaccurate statements by Fifth Third executives, Fifth Third Stock was artificially inflated before plummeting. See id.The class argues that a reasonably prudent fiduciary would not have stood by and watched the Plan’s assets drain. See id.
Dudenhoeffer and the class filed four counts against Fifth Third, the President and CEO of the company, and several members of the Fifth Third Pension, Profit Sharing, and Medical Plan Committee. See id.The complaint alleged (1) that the defendants violated ERISA by breaching their fiduciary duties to maintain significant investments and not offer imprudent investment options, and breaching their duties by failing to provide accurate and complete information about Fifth Third Stock; (2) that Fifth Third and the President/CEO breached their fiduciary duties by not monitoring the performance of their employees; (3) that all the defendants failed to avoid conflicts of interest relating to managing the Plan; and (4) that all defendants are legally responsible for breaches of their co-fiduciaries. See id. at 415–16.
The District Court for the Southern District of Ohio dismissed the complaint for failing to state a plausible claim for relief. See id. at 416. The court found that the Plan was an employee stock ownership fund (“ESOP”) under ERISA, so there is a presumption in favor of Fifth Third and its leadership that their decisions are reasonable. See id.The court therefore ruled that the class could not make a case for the first count of the complaint, and because the other counts relied on the first, the court dismissed the entire complaint. See id.
Dudenhoeffer and the class appealed the judgment. See id.The Sixth Circuit Court of Appeals held that the first count of the complaint did state a claim upon which relief can be granted and ordered remand of the complaint to consider the allegations. See id. at 423–24.
Fifth Third Bancorp argues that courts should give a robust presumption of prudence in favor of the employer with regard to ESOP schemes. See Brief for Petitioner, Fifth Third Bancorp at 35. Fifth Third asserts that Congress intended ESOPs to play a role in retirement funds, but that the greater purpose of these programs is to allow employees to invest in the business and share in its long-term success. See id. at 27. Additionally, Fifth Third argues that the character of an ESOP is such that if courts do not give a presumption of prudence, employers and employees will both be harmed. See id. at 28, 41. Alternatively, Dudenhoeffer and the class argue that through ERISA, Congress intended for employers to uphold their loyalty and fiduciary duties in managing trusts for its employees. See Brief for Respondent, Dudenhoeffer at 32. They assert that upholding these duties benefits the business and the beneficiaries. See id. at 38, 42. The Supreme Court’s resolution of this case will impact employers managing ESOP investment plans and the duties they owe to the employees who invest in the plans.
Congressional Intent of ESOP Programs
Fifth Third and supporting amici argue that Congress intended ESOP programs to fulfill multiple purposes. See Brief for Petitioner, Fifth Third Bancorp at 27;see Brief of Amicus CuriaeESOP Association in Support of Petitioners at 23. For example, Fifth Third argues that the express purpose of ESOPs is for employees to invest in employer securities. See Brief for Petitioner at 21. In its view, Congress expects ESOPs to give employees a stake in their employer and a share in its long-term success. See Brief for Petitioner at 51; see Brief of Amici Curiae Chamber of Commerce of the United States of America, the ERISA Industry Committee, the American Benefits Council, the Plan Sponsor Council of America, and the National Association of Manufacturers in Support of Petitioners at 8. Fifth Third also asserts that a fiduciary’s duty in managing an ESOP scheme is to act as a reasonably prudent person would in furthering the long-term strategy of the company. See Brief for Petitioner at 27–28. To fulfill Congress’s intent of giving employees a stake in their employer, Fifth Third claims there must be a strong presumption in favor of management to make decisions with long-term goals in mind. See Brief for Petitioner at 27, 35; see Brief of Amicus Curiae Delta Air Lines, Inc. in Support of Petitioners at 9.
Dudenhoeffer and the class argue that Congress intended fiduciaries of ERISA plans to maintain strict standards of trustee conduct, particularly with regard to the standards of loyalty and standard of care. See Brief for Respondent, Dudenhoeffer at 13. Accordingly, Dudenhoeffer argues that trustees have a duty to manage the trust in the interest of the beneficiaries. See id. at 17. While Dudenhoeffer recognizes that Congress intends to encourage employee investment into the company, he argues that this should not come at the expense of the duties owed to the beneficiaries. See id. at 27. The United States, on behalf of Dudenhoeffer, contends that where a company’s financial health is not accurately reflected in its public disclosures, plan managers potentially irreparably damage retirement funds and thwart congressional objectives of promoting investment security through ERISA. See Brief of Amicus Curiae United States in Support of Respondent at 27. Arguing for Dudenhoeffer as well, AARP asserts that diversification requirements in pension legislation have not proven effective; therefore, holding fiduciaries to their duties promotes Congress’s aim of protecting employees investing in these plans. See Brief of Amicus Curiae AARP in Support of Respondent at 11.
GOALS of ESOP Programs
Fifth Third explains that the Plan offers employer stock as one of many investment options. See Brief for Petitioner, Fifth Third Bancorp at 28. Accordingly, employees are free to opt in or out of an ESOP that would allow the employee to build an equity stake in their employer. See id.; see Brief of Amicus Curiae Securities Industry and Financial Markets Association (“SIFMA”) in Support of Petitioners at 25. The character of the scheme allows employees to make their own investment decisions so that the presumption in favor of management decisions can remain robust while giving employees a choice in how they invest their money. See Brief for Petitioner at 30; see Brief of Amicus Curiae SIFMA in Support of Petitioners at 10. Furthermore, Fifth Third argues that if courts do not respect the presumption in favor of management decisions, there will be more litigation from disappointed employees and subsequently employers will stop providing ESOP plans to avoid litigation costs. See Brief for Petitioner at 41.
Dudenhoeffer and the class counter that the purpose of the trust relationship in pension funds is for the trustee to maintain a strict duty of loyalty to the beneficiaries in order to prevent self-interested looting from these funds. See Brief for Respondent, Dudenhoeffer at 19. Dudenhoeffer notes that under this particular plan, there should not be a situation where Fifth Third management is torn between following the language of the plan and performing the duties to their beneficiaries; here, the Plan allowed management to change the investment practices of the trust for the benefit of the company and the beneficiaries. See id. at 33. Accordingly, Dudenhoeffer asserts that if Fifth Third management focused on adequately informing employees and changing investment strategies, the interests of both the company and the beneficiaries would be promoted. See id. at 38, 42. AARP, on behalf of Dudenhoeffer, contends that due to substantial investments in employer stock vehicles, and the lengthy road to recovery by employees when companies go under, plan managers must strictly adhere to fiduciary duties. See Brief of Amicus Curiae AARP in Support of Respondent at 16.
In this case the Court is asked to decide what sorts of allegations are required to state a claim for breach of the fiduciary duties owed to beneficiaries of Employee Stock Ownership Plans ("ESOPs"). Fifth Third Bancorp argues that to state such a claim, plaintiffs must allege facts sufficient to overcome the presumption that a fiduciary’s decision to invest in an ESOP is reasonable. Dudenhoeffer, on the other hand, asserts that ESOP fiduciaries are held to the same duties of loyalty and prudence as any other trustee and, therefore, heightened pleading standards do not apply.
THE TEXT AND PURPOSE OF ERISA
Fifth Third argues that under ERISA, a deferential standard of review is required for decisions made by ESOP fiduciaries. See Brief for Petitioner, Fifth Third Bancorp at 22. This deferential standard of review, Fifth Third contends, is derived from the legislative purpose of ESOPs as well as a long line of ERISA case law by appellate courts. See id.at 22, 26–27. Fifth Third thus asserts that ESOPs are special retirement investment vehicles which were intended by Congress to be treated differently from other conventional plans by encouraging stock ownership by all corporate employees. See Brief for Petitioner at 6, 21, 26–27. Consistent with this purpose, appellate courts have held that a fiduciary’s decision to invest in an ESOP is presumed to be reasonable unless a plaintiff can demonstrate extraordinary circumstances that make continued investment in the plan imprudent. See id.at 22–24. Moreover, according to Fifth Third, the prudence of an ESOP fiduciary’s investment decision is judged according to how a “prudent man” would have acted in the conduct of “an enterprise of a like character and with like aims.” See id. at 25–26. This is a context-specific evaluation. See id.Fifth Third argues that because an ESOP is intended not primarily as a retirement plan, but rather to bolster employee ownership of corporate stock, it may very well be prudent for the fiduciary of an ESOP to invest in a particular company, whereas it would be judged imprudent for the fiduciary of a conventional retirement plan to invest in that same company. See id.at 27–28.
Fifth Third further contends that its position is consistent with general principles of trust law. See Brief for Petitioner, Fifth Third Bancorp at 30–34. Fifth Third argues that the fiduciary’s performance must be judged not by an abstract standard of reasonableness, but by bearing in mind the circumstances of the particular trust in question. See id.at 30–31. Under this standard, a fiduciary should only deviate from a plan’s instructions when changed circumstances threaten to either defeat or substantially impair the trust’s purpose. See id.at 33–34. Fifth Third asserts that because the fundamental purpose of an ESOP is to encourage employees to acquire an equity interest in their employer by purchasing its securities, a drop in the price of those securities, even if sustained over a significant period of time, does not threaten to substantially impair or defeat the purpose of the ESOP. See id.at 34. Accordingly, a fiduciary’s decision to remain invested in an employer’s securities would not be deemed imprudent. See id.
According to Dudenhoeffer, this case can be resolved solely by looking to the text of the statute in question. See Brief for Respondent, Dudenhoeffer at 13. Dudenhoeffer argues that the text of ERISA clearly sets forth that a fiduciary must exercise his duties “solely” in the interests of those invested in a retirement plan for the “exclusive” purpose of providing benefits to participants. See id.at 16. According to Dudenhoeffer, this language unambiguously demonstrates that the interests of employees are always superior to those of their employer and imposes a mandatory federal duty of loyalty on ESOP fiduciaries. See id.at 16–17. This duty of loyalty, Dudenhoeffer maintains, is applicable to all trusts and is emphasized throughout the common law of trusts. See id. at 17–20. Implicitly, Dudenhoefferargues that the fact that this case concerns an ESOP is irrelevant, even if Congress intended them to be special retirement vehicles. See id. In every case in which a trustee is administering a trust, that trustee cannot put the interests of third parties above those of the trust’s beneficiaries. See id.According to Dudenhoeffer, then, a fiduciary breaches their duty of loyalty when, as in the case here, that person places the interests of the employer above the employees for whose “sole” benefit they are operating on behalf of. See id.The same conclusion follows with respect to the duty of prudence. See id.at 20–21.
Moreover, Dudenhoeffer asserts that the duties of loyalty and prudence owed by fiduciaries to ESOP beneficiaries are present at all times, not merely in situations where extraordinary circumstances exist. See Brief for Respondent, Dudenhoefferat 47. Dudenhoeffer argues that if Fifth Third’s position is adopted, this will result in a new rule which holds that unless a beneficiary can establish that an employer is experiencing extraordinary circumstances – i.e., is in dire financial straits – then any complaint alleging a breach of the duties of loyalty or prudence must be dismissed. See id. at 47. Dudenhoeffer thus asserts that the fiduciaries in this case, as in all cases, ought to be held to their “traditional” duties of loyalty and prudence, regardless of whether the retirement plans contain employer stock. See id.at 48.
THE ADEQUACY OF THE ALLEGATIONS CONTAINED IN THE COMPLAINT
Fifth Third argues that the plaintiff’s burden to overcome the presumption of reasonableness afforded to fiduciary decisions attaches at the pleading stage. See Brief for Petitioner, Fifth Third Bancorp at 45. According to Fifth Third, the lower court erred when it held that the “presumption of prudence” afforded to a fiduciary’s decision to invest in an ESOP is irrelevant at the pleading stage. See id. at 48. Fifth Third contends that this presumption of prudence in the ERISA context is a substantive standard imposed on the plaintiff. If the plaintiff cannot allege facts that would entitle him or her to relief at the pleading stage, then there is no rationale for allowing the case to proceed to discovery and trial. See id. at 48–49. According to Fifth Third, Dudenhoeffer’s claim is essentially that the fiduciary knew or should have known that the price of Fifth Third stock would decline and, armed with this knowledge, should have sold the stock. See id.at 50–52. To overcome the presumption owed to ESOP trustees, Fifth Third contends that Dudenhoeffer would have to allege something much graver, such as that the purpose of the ESOP in encouraging employee ownership of their employer’s stock would be defeated by an impending collapse of the company. See id.Absent such allegations, the complaint fails. See id.
Although Dudenhoeffer does not directly address or challenge Fifth Third’s interpretation of the plaintiff’s burden at the pleading stage, he rather asserts that the complaint in this case sets forth detailed and specific allegations. See Brief for Respondent, Dudenhoeffer at 21–24. With respect to the duty of loyalty, for example, Dudenhoeffer asserts that the complaint establishes a viable cause of action by demonstrating that the fiduciaries acted in a manner that elevated their interests over those of the plan beneficiaries despite having knowledge which put them in a position to protect the beneficiaries. See id. at 22–23. These detailed and specific allegations put the fiduciaries on “fair notice” of the claims against them and therefore meet the pleading requirements placed on Dudenhoeffer. See id.at 23–24. According to Dudenhoeffer, these allegations show that the fiduciaries in this case did not respond to the market information available to them in the same manner as a non-conflicted and prudent fiduciary would have. See id.at 25.
This case asks the Court to determine the scope of the fiduciary duties that trustees of ESOPs owe to beneficiaries. Fifth Third contends that the principal purpose of ESOPS – i.e., Congress’ intent to foster employee investment in the stock of their employer – is controlling in this case and affords a presumption of reasonableness to a fiduciary’s decision to invest in an ESOP. That presumption can only be overcome by allegations that extraordinary circumstances threatened to defeat the very purpose of the ESOP and therefore made continued investment unwise. Dudenhoeffer maintains that the fiduciary duties that ESOP trustees owe their beneficiaries are the same as the duties any trustee owes any beneficiary. Accordingly, the fact that this case happens to concern an ESOP is irrelevant and the complaint on its face states a viable claim of breach of fiduciary duty. The Court’s decision will affect the type of cases that beneficiaries of ESOPs can bring under ERISA as well as potentially the investment decisions that ESOP fiduciaries make.
- National Center for Employee Ownership, ESOP (Employee Stock Ownership Plan) Facts.
- Workplace Prof, U.S. Supreme Court Accepts Cert in Dudenhoeffer ERISA Moench Presumption of Prudence Case (Dec. 13, 2013).