Supreme Court Hears Oral Arguments on ERISA Presumption of Prudence

Supreme Court Hears Oral Arguments on ERISA Presumption of Prudence

 WASHINGTON, D.C. — (Mealey’s) Fifth Third Bank and its employee stock ownership plan (ESOP) trustees in oral arguments this morning urged the U.S. Supreme Court to find that the Sixth Circuit U.S. Court of Appeals erred by holding that participants in the ESOP were not required to allege that the ESOP fiduciaries abused their discretion by remaining invested in employer stock to overcome the presumption that the trustees’ decision to invest in employer stock was reasonable under the Employee Retirement Income Security Act (Fifth Third Bancorp, et al. v. John Dudenhoeffer, et al., No. 12-751, U.S. Sup.) [ subscribers may access Supreme Court briefs for this case].

Arguing for Fifth Third and the plan trustees (collectively, Fifth Third), Robert A. Long Jr. of Covington & Burling in Washington told the justices that an ESOP fiduciary’s decision to continue to offer employer securities as an investment option is presumptively prudent.

Justice Ruth Bader Ginsburg noted that there is no presumption of prudence written into ERISA and that, although there is an exception from the diversification requirements for ESOPs, “the statutory requirement on loyalty and prudence is undiluted.”

Inside Information

Long said that the statutory definition of the duty of prudence in ERISA Section 404(a)(1)(b) “says that the duty of prudence must take into account the character and aims of the enterprise” and that ERISA Section 407(d)(6) defines an ESOP “to be a plan that’s designed to invest primarily in the employer’s own stock.”  Long continued that the benefit provided by the ESOP is stock in the company and “the duty of the fiduciary is to manage that as best as it can be managed to produce the largest benefit for the participants.”

Justice Antonin Scalia questioned whether Long was saying that “the benefits to participants is their ownership of company stock, including worthless company stock.”  Long commented that, as every court of appeals that has considered the issue has agreed, “there does come a time when the purpose of the ESOP, of allowing the employees to build an ownership stake in the company, can no longer be realized because the company is in serious peril, serious jeopardy.”  However, he said that if a fiduciary has inside information that enables him to know that the stock price is overvalued, the fiduciary cannot trade on that information because it would violate securities law.

Justice Scalia said that “[w]e don’t have to adopt a special law” for ESOPs because we don’t expect ESOP trustees to “outsmart the market” or “use . . . inside knowledge.”

Justice Anthony M. Kennedy asked Long how to define the duty of a trustee of an ESOP.  Long said that “if the special aims of this plan, employee ownership, can no longer reasonably be achieved, the prudence requires the plan to be shut down.  That is not a bright-line standard, but that is the standard the courts have adopted.”

Conflicting Interests

Representing the participants, Ronald Mann of Columbia Law School in New York said “the trustees in this case undertook to represent conflicting interests.” 

Mann noted that “[t]he complaint in this case alleges that the trustees knew or would have known, if they had undertaken a reasonable investigation of the type that is required by ordinary principles of prudence, that the stock was materially overvalued, and the stock was a much more risky investment than it was at the time the plan was designed.”  In addition, the participants alleged that much of the information available was public and that the petitioners provided false information.

Chief Justice John G. Roberts Jr. commented that, in this case, “the trustee’s job is to buy the company’s stock” and, therefore, investing in company stock “is by definition prudent.”  Mann commented that “the trustee violates the duty of loyalty and the duty of prudence if the trustee, believing that the stock is overvalued, in fact, does not take action to protect the beneficiaries.”

Deputy Solicitor General Edwin S. Kneedler of the U.S. Department of Justice, representing the United States as amicus curiae in support of the participants, emphasized that the plan must be operated for the exclusive purpose of providing “benefits” to participants.

Kneedler said that fiduciaries “have an ongoing obligation to investigate and to keep themselves apprised of how the company is doing.”  “We are focused here on inside information that materially enhances the value of the stock, overvalues it, and in that situation, we think that a fiduciary of an ESOP, just like the fiduciary of any other plan, has a — duty of prudence not to remain invested in or to purchase materially overvalued stock.”

Subprime Lending

John Dudenhoeffer and Alireza Partovipanah, former employees of Fifth Third Bank, are participants in the Fifth Third Bancorp Master Profit Sharing Plan, a defined contribution plan, and invested in Fifth Third common stock through the plan.  The investment options included the company stock, two collective funds and 17 mutual funds.

The participants sued Fifth Third and the plan trustees, alleging that the defendants breached their fiduciary duties by continuing to invest in and hold company stock despite the defendants’ knowledge of the risks presented by its switch from being a conservative lender to a subprime lender.  The participants also alleged that the defendants breached their fiduciary duties by failing to provide the participants with accurate and complete information about the company’s investments and by failing to monitor the performance of their fiduciary appointees.

The U.S. District Court for the Southern District of Ohio granted the defendants’ motion to dismiss.  On Sept. 5, 2012, the Sixth Circuit held that the presumption that ESOP fiduciaries acted reasonably by continuing to invest in and hold company stock does not apply at the motion-to-dismiss stage.

On Sept. 5, 2012, the Sixth Circuit said “the proper question at the [Federal Rule of Civil Procedure 12(b)(6)] stage in this case is whether the Amended Complaint pleads ‘facts to plausibly allege that a fiduciary has breached its duty to the Plan’ and a causal connection between that breach and the harm suffered by the plan—‘that an adequate investigation would have revealed to a reasonable fiduciary that the investment [in Fifth Third Stock] was improvident.’”

The Sixth Circuit also held that the express incorporation of Securities and Exchange Commission filings into an ERISA-mandated summary plan description (SPD) is a fiduciary communication that can be the basis for a breach of fiduciary duty claim.

Review Sought

Fifth Third filed a petition for a writ of certiorari, contending that the Sixth Circuit’s fiduciary duty ruling conflicts with the Second, Third and 11th Circuits and that its incorporation-by-reference ruling conflicts with the Second, Fifth and 11th Circuits.

On Nov. 12, Solicitor General Donald B. Verrilli Jr., in response to the Supreme Court’s invitation to file a brief expressing the view of the United States, urged the Supreme Court to review the presumption-of-prudence issue but to reformulate the question as “1.  Whether, in a suit claiming that an ESOP fiduciary violated the statutory duty of prudence, 29 U.S.C. 1104(a)(1)(B), the fiduciary should be accorded a presumption that he acted prudently” and “2.  If so, whether the presumption applies at the pleading stage and what a plaintiff must allege to rebut it.”  The solicitor general had also recommended that the court not grant review of the incorporation-by-reference question.

The Supreme Court agreed to hear the presumption-of-prudence issue as worded by the petitioner but declined to review the Sixth’s Circuit incorporation-by-reference ruling.

Amicus briefs in support of Fifth Third were filed by KeyCorp; Delta Air Lines Inc.; Chamber of Commerce of the United States of America, ERISA Industry Committee, American Benefits Council, Plan Sponsor Council of America and National Association of Manufacturers (collectively, Chamber of Commerce); Securities Industry and Financial Markets Association (SIFMA); and ESOP Association.

In addition to the United States, amicus briefs in support of the participants were filed by AARP, American Federation of Labor and Congress of Industrial Organizations (AFL-CIO) and seven law professors who write and teach about pension and employee benefits law.


Fifth Third is also represented by James E. Burke, Joseph M. Callow Jr., Danielle M. D’Addesa and David T. Bules of Keating Muething & Klekamp in Cincinnati and David M. Zionts and John M. Vine of Covington & Burling in Washington.

The participants are also represented by Joseph H. Meltzer, Edward W. Ciolko and Shannon O. Braden of Kessler Topaz Meltzer & Check in Radnor, Pa., Thomas J. McKenna and Gregory M. Egleston of Gainey & McKenna in New York and Maurice R. Mitts of Mitts Law in Philadelphia.

Amicus United States is also represented by Verrilli and Assistant to the Solicitor General John F. Bash of the Department of Justice and Solicitor of Labor M. Patricia Smith, Acting Associate Solicitor G. William Scott, Counsel for Appellate and Special Litigation Elizabeth Hopkins and Attorney Thomas Tso of the U.S. Department of Labor.  All are in Washington.

Amicus KeyCorp is represented by Daniel R. Warren, Scott C. Holbrook, James A. Slater Jr. and David A. Carney of Baker & Hostetler in Cleveland.  Amicus Delta is represented by Paul D. Clement, Jeffrey M. Harris and Barbara A. Smith of Bancroft in Washington.  Amici Chamber of Commerce of the United States of America, et al., are represented by Myron D. Rumeld, Mark D. Harris, John E. Roberts and Russell L. Hirschhorn of Proskauer Rose in New York; Kate Comerford Todd and Steven Lehotsky of National Chamber Litigation Center in Washington; Scott Macey and Debra A. Davis of The ERISA Industry Committee in Washington; Janet M. Jacobson of American Benefits Council in Washington; and Christina Crooks and Patrick Forrest of National Association of Manufacturers in Washington.  Amicus SIFMA is represented by Mark A. Perry, Paul Blankenstein and Ashley S. Boizelle of Gibson, Dunn & Crutcher and Kevin Carroll of SIFMA in Washington.  Amicus ESOP Association is represented by Charles M. Dyke and Sean T. Strauss of Trucker Huss and Laurence A. Goldberg and Lynn H. Dubois of ESOP Law Group.  All are in San Francisco.

Amicus AARP is represented by Jay E. Sushelsky of AARP Foundation Litigation and Melvin Radowitz of AARP in Washington.  Amicus AFL-CIO is represented by James B. Coppess, Lynn K. Rhinehart, Amanda M. Jaret and Harold C. Becker of AFL-CIO in Washington and Laurence Gold in Washington.  Amici law professors are represented by Lynn L. Sarko and Erin M. Riley of Keller Rohrback in Seattle and David Pratt of Albany Law School in Albany, N.Y.

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