Coming on the heels of its Halliburton decision, in which the Supreme Court held that defendants are entitled to rebut the applicability of the fraud-on-the-market presumption at the class certification stage, is another significant decision for class action defendants, this time in the ERISA context. Fifth Third Bancorp v. Dudenhoeffer, No. 12-751 (Jun 25, 2014). In Dudenhoeffer, the Court would not allow a presumption to continue — the so-called “presumption of prudence” that many courts have allowed for employee stock ownership pan (“ESOP”) fiduciaries. However, as in Halliburton, the Court performed a balancing act of sorts, here, creating a roadmap for the lower courts to follow in weeding out meritless ESOP suits. On the whole, while the Court would not allow a presumption that it could not find in the text of the ERISA statute, it went to great lengths to explain how courts should evaluate allegations of imprudence against ESOP fiduciaries. Its analysis and guidance should help defendants in defeating ESOP class actions.
ERISA class actions are a specialized form of securities class actions, brought by employees generally when the price of a stock in their pension plans drops. ESOPs are pension plans that invest primarily in the stock of the company employing the plan participants. Dudenhoeffer was a putative class action brought against Fifth Third bank when the price of its stock — held in the ESOP — dropped nearly 75 percent between 2007 and 2009. The complaint alleged breach of fiduciary duty in various ways. The trial court dismissed the complaint for failure to state a claim, relying on the presumption that the plan fiduciaries’ investment decisions were prudent. The Sixth Circuit reversed, confining the presumption of prudence to the evidentiary phase of the case. The Supreme Court heard the case in light of a Circuit split.
In holding that the presumption of prudence does not apply to ESOP fiduciaries, the Court was cognizant that Congress intended to exempt ESOP fiduciaries from certain ERISA requirements, such as the obligation to diversify. Yet, the Court observed, there is no express provision entitling an ESOP fiduciary to a presumption of prudence when their decision to buy or sell a stock is challenged as imprudent. As the Court stated: “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.”
Petitioners contended that the presumption was necessary, among other reasons, because ESOP fiduciaries generally are company insiders and the sorts of suits brought in ESOP class actions tend to allege that the fiduciaries were imprudent in failing to act on inside information. While the Court recognized this concern as a “legitimate one,” it did not view the presumption of prudence as the means to address it. Petitioners further argued that the presumption allows courts to weed out meritless lawsuits and that “without some sort of special presumption, the threat of costly duty-of-prudence lawsuits will deter companies from offering ESOPs to their employees, contrary to the stated intent of Congress.” Again, the Court understood the concern, but rejected the presumption as the appropriate way to weed out meritless lawsuits.
Instead, the Court held that plaintiffs in ESOP actions must plead imprudence to the Twombly/Iqbal standard. That standard, it held, should weed out meritless actions. Importantly, relying on its just-issued Halliburton decision, the Court went on to hold that a fiduciary’s reliance on the market price of a stock is generally not imprudent: “where a stock is publicly traded, allegations that a fiduciary should have recognized from publicly available information alone that the market was over- or undervaluing the stock are implausible as a general rule….” The Court would not consider “whether a plaintiff could nonetheless allege imprudence on the basis of publicly available information by pointing to a special circumstance affecting the reliability of the market price as ‘an unbiased assessment of the security’s value in light of all public information’…that would make reliance on the market’s valuation imprudent.”
And what about allegations that the fiduciaries acted on inside information? To that, the Court held that “[t]o 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 that a prudent fiduciary in the same circumstances would not have viewed as more likely to harm the fund than to help it.” Significantly, a fiduciary cannot act in violation of insider trading laws.
With these considerations, the Court vacated and remanded the case to the Sixth Circuit.
Thus, while the Supreme Court declined to allow a presumption of prudence based on a reading of the ERISA statute, it gave very explicit guidance to the lower courts on how to evaluate the question of prudence in the ESOP context — guidance which should help defendants in defeating meritless actions.