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Employer Stock in 401(k) Plans: A New Landscape after Fifth Third Bancorp v. Dudenhoeffer

July 7, 2014

On June 25th, the Supreme Court unanimously invalidated the Moench presumption, a principle long recognized in every Circuit Court that a plan sponsor’s decision to offer its stock as a permissive investment option in its 401(k) plan is presumptively reasonable.  Such a presumption effectively thwarted “stock drop” lawsuits either at the motion to dismiss or summary judgment stages of litigation, depending on when the given Circuit applied it.  Instead, in Fifth Third Bancorp v. Dudenhoeffer, the Supreme Court held that a fiduciary of a plan that holds employer stock must adhere to the same prudent person standard that ERISA imposes on all plan investment decisions, other than the duty to diversify.  Recognizing that a plan sponsor faces unique issues when it offers its stock as a plan investment, the Court instead focused on an “important mechanism for weeding out meritless claims, the motion to dismiss for failure to state a claim”, one that is “context specific.”

The Court’s consideration of this weeding-out mechanism focuses on the two types of information that the fiduciary is likely to be accused of ignoring in exercising its duties: (1) public information that the stock is overvalued, and (2) non-public information that once made public, would cause the stock to lose value.  As to public information, the Court said that it is generally reasonable for a fiduciary to rely on the stock market to determine the value of a stock, and allegations asserting that the fiduciary should have recognized something that the market did not was “implausible as a general rule.”  The Court said it was not considering “whether a plaintiff could nonetheless plausibly allege imprudence on the basis of publicly available information by pointing to a special circumstance affecting the reliability of the market price . . . that would make reliance on the market’s valuation imprudent.”  The Court did not elaborate on what might be such a special circumstance.

Regarding inside information, the Court indicated that a plaintiff must 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.” In evaluating that, the Court first noted that ERISA does not require a fiduciary to break the securities laws.  The Court observed that a lower court should consider whether an obligation under ERISA, like refraining from purchasing more shares of a stock, could conflict with “the insider trading and corporate disclosure requirements imposed by the federal securities laws or with the objectives of those laws.”  Finally, the Court observed that lower courts should also consider whether a prudent fiduciary could have concluded that stopping such a purchase or publicly disclosing negative information, even if not illegal, would do more harm than good to the plan by causing a drop in the stock price.

It is unclear how this Supreme Court decision will impact an employer’s decision regarding whether to continue to maintain an employer stock investment option in its 401(k) plans.  While eliminating the presumption of reasonableness, the Court articulated a complicated standard for lower courts to apply in determining whether a complaint should survive a motion to dismiss.  How will plaintiff’s counsel draft pleadings in light of this decision and how will district courts react to such drafting?  Is the Supreme Court’s new standard a suggested approach, or a mandate?  We think the future is hard to predict.

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