Supreme Court: Presume Nothing, Fiduciaries

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The U.S. Supreme Court recently held that fiduciary committees of employee stock ownership plans (ESOPs) are not entitled to a “presumption of prudence” in lawsuits challenging their decision to invest plan assets in company stock.

This decision appears to eliminate a key defense for ESOP fiduciaries. It also impacts parties beyond typical ESOP fiduciaries (closely-held private companies) to include:

  • The fiduciaries of defined-contribution plans that include ESOPs
  • The fiduciaries of plans that include employer stock (particularly publicly traded companies)

While the Court maintained that plaintiffs still bear a heavy pleading burden when bringing any prudence-based claims, this case sends a message to retirement plan fiduciaries to be extra vigilant when investing employees’ funds in an employer’s own stock.

In the insurance world, we already know that fiduciary liability insurers are watching and reacting.

Alleged: Poor Management of Employee Stock Ownership Plan

The plaintiffs in Fifth Third Bancorp v. Dudenhoeffer (Dudenhoffer) sued their former employer, Fifth Third Bank, for poorly managing the company’s ESOP.

Fifth Third’s ESOP contributed a company-stock match to employees’ retirement contributions. In the early days of the credit crisis, Fifth Third was heavily exposed to the subprime lending market, and when that market crashed, so did shares of Fifth Third, and with it the plaintiffs’ retirement savings.

The plaintiffs argued that Fifth Third’s plan fiduciaries were imprudent by failing to act on publicly available information that warned of the hazards of subprime lending. Moreover, plaintiffs alleged that Fifth Third should have disclosed insider information to adjust the valuation of the company stock to its actual market value. The complaint contended that the plan fiduciaries breached their duty of care to the plan’s investors, and therefore were liable for the plaintiffs’ losses.

Presumption of Prudence

Prior to Dudenhoeffer, fiduciaries of ESOPs enjoyed a “presumption of prudence” when their management decisions came under scrutiny. Plaintiffs could only overcome the presumption by showing that the fiduciaries continued to invest in employers’ securities even though the company faced “impending collapse” or “dire circumstances.”

In a unanimous decision, the Supreme Court abandoned the “presumption of prudence” and held that fiduciaries are to be held to the “prudent person” standard set forth by the Employee Retirement Income Security Act (ERISA).

The Court makes clear, however, that plaintiffs still bear a heavy burden when bringing stock claims, maintaining a high bar for plaintiffs to get past the pleading stage.

The Court clarifies that plan fiduciaries will not be deemed imprudent solely because they relied on public information to determine the company’s stock value. Moreover, the “prudent person” standard does not require plan fiduciaries to disclose insider information if doing so would violate complex insider trading laws.

Ramifications for Fiduciary Liability Insurance

So what does Dudenhoeffer potentially mean for fiduciary liability insurance?

  • This ruling likely impacts the decisions of public-company fiduciaries with employer stock concentrations more than traditional private-company ESOPs.
  • It is an acknowledgment that although the “presumption of prudence” has been eliminated, plaintiffs still bear a heavy burden when bringing stock-drop claims. In other words, no anticipated dramatic change in the fiduciary liability marketplace.
  • Notwithstanding the prior point, there is definite potential for greater plaintiff success if claims against plan fiduciaries do get past the pleading stages, which may mean larger covered losses – defense costs and damages/settlements.

Insurer reaction: One carrier recently introduced a new fiduciary liability product that amends the definition of covered “wrongful acts” to clearly include obligations under ERISA, Sec. 404(a)(1)(B) – to make “prudent” investments.   That said, it is unclear whether this definitive language offers any distinctive coverage improvement relative to other fiduciary liability policies in the market today.

As always, companies need to be aware of this Court decision, the potential impact of the ruling on their particular risk profile, and the likely reaction of their fiduciary liability insurers.

Tip of the hat to prior coverage of this ruling by

About Andrew Doherty

Andrew J. Doherty is Willis Towers Watson’s Head of Thought & Product Leadership (TPL) / Middle Market Segmen…
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