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<em>Dudenhoeffer </em>and Stock Drop Cases: Between the Devil and the Deep Blue  Sea

Dudenhoeffer and Stock Drop Cases: Between the Devil and the Deep Blue Sea

Fifth Third Bancorp v. Dudenhoeffer, 134 S. Ct. 2450 (June 25, 2014).

ERISA and Life Insurance News
(January 16, 2015)

The Supreme Court this year upended nearly 20 years of lower court jurisprudence by unanimously rejecting the so-called Moench Presumption, a judicial creation which provided some protection to fiduciaries of employee stock ownership plans in stock drop cases. Fifth Third Bancorp v. Dudenhoeffer, 134 S. Ct. 2450 (June 25, 2014).

In the course of its decision, the Court made clear that plan language cannot trump fiduciary obligations imposed by ERISA.   At the same time, the Court equally made clear that drafting allegations in stock drop cases sufficient to avoid dismissal under Iqbal and Twombly standards would be no simple task.

The Moench Presumption

Employee stock ownership plans, or ESOPs, are intended to encourage employee ownership through investment in employer securities.  In furtherance of that goal, Congress created a qualified exemption from the prudence requirement imposed on fiduciaries of ESOPs, which provides that the diversification requirement and the prudence requirement (only to the extent that it requires diversification) are not violated by acquiring or holding qualified employer securities.   29 U.S.C. § 1104(a)(2).

Still, fiduciaries of such plans have been frequent targets of "stock drop" lawsuits, in which plan participants allege – in the wake of a decline in the stock value – that the fiduciaries violated the prudence requirement by continuing to invest in employer stock, or by failing to divest the plan of such stock altogether.  The quandary for fiduciaries of such plans – which may require investment in employer stock – is complicated by ERISA's requirement that fiduciaries act "in accordance with the documents … governing the plan insofar as such documents … are consistent with the provisions [of ERISA]."  29 U.S.C. § 1104(a)(1)(D).

In the face of (or even just the risk of) declining stock values, which ERISA mandate does the fiduciary follow?

Recognizing the problem, the Third Circuit in Moench v. Robertson, 62 F.3d 553 (3d Cir. 1995), developed the following presumption of compliance with ERISA:  "[A]n ESOP fiduciary who invests the assets in employer stock is entitled to a presumption that it acted consistently with ERISA by virtue of that decision.  However, the plaintiff may overcome that presumption by establishing that the fiduciary abused its discretion by investing in employer securities."  62 F.3d at 571.

The Moench Presumption thereafter was adopted by every circuit court that considered the question.  See, e.g.,  Lanfear v. Home Depot, Inc., 679 F.3d 1267, 1279 (11th Cir. 2012). ("[c]loser judicial scrutiny would force ESOP fiduciaries to choose between the devil and the deep blue sea").

A mini-split was created by Pfeil v. State Street Bank and Trust Co., 671 F.3d 585 (6th Cir. 2012), which held that the presumption was not to be applied at the pleadings stage.  Rather, the Moench Presumption was an evidentiary presumption to be applied at a later stage of the case.  The Sixth Circuit also developed a different standard for rebutting the presumption, requiring "a plaintiff to prove that 'a prudent fiduciary acting under similar circumstances would have made a different investment decision.'"  Id. at 595.

The Origin of Dudenhoeffer

The Dudenhoeffer saga arose in the Sixth Circuit before the decision in Pfeil. A defined contribution plan sponsored by Fifth Third Bancorp included the "Fifth Third Stock Fund," an ESOP in which all employer matching contributions were initially invested.

The complaint alleged Fifth Third changed from a conservative lender to a subprime lender, so that investment in its stock became too risky for a retirement plan.  The plaintiffs alleged that the plan's fiduciaries should have stopped investing in the stock and should have divested the plan of the stock.  According to the complaint, Fifth Third stock dropped 74% in value between July 2007 and September 2009.

The defendants moved to dismiss the complaint and, applying the Moench Presumption, the district court concluded that plaintiffs' complaint failed to state a claim.  "While the Court must accept that Fifth Third embarked on an improvident and even perhaps disastrous foray into subprime lending, which in turn caused a substantial decline in the price of its common stock, the complaint fails to establish that Fifth Third was in the type of dire financial predicament sufficient to establish a breach of fiduciary duty under Kuper and Moench," the district court concluded.  757 F. Supp. 2d 753, 761.

On appeal, the Sixth Circuit quickly dispensed with the Moench Presumption analysis based on its decision in Pfeil.  The court reasoned that "the proper question at the Rule 12(b)(6) stage ... is whether the ... 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.'"  692 F.3d 410, 419.

The complaint satisfied those requirements, the Sixth Circuit concluded.  "Plaintiffs allege that Fifth Third engaged in lending practices that were equivalent to participation in the subprime lending market, that Defendants were aware of the risks of such investments ... and that such risks made Fifth Third Stock an imprudent investment." Id. at 419-20.  Further, plaintiffs alleged that "[a] prudent fiduciary acting under similar circumstances would have acted to protect participants against unnecessary losses, and would have made different investment decisions."  Id. 

The Supreme Court's Decision

The Supreme Court granted the resulting petition for certiorari "[i]n light of differences among the Courts of Appeals as to the nature of the presumption of prudence applicable to ESOP fiduciaries ...."  134 S. Ct. at 2465.  The Court, however, resolved those differences by jettisoning the presumption altogether.

The Court concluded that "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."  Id. at 2467.  This conclusion followed from the fiduciary provisions in 29 U.S.C. § 1104.

That statute – which dispenses with the diversification requirement for ESOP fiduciaries – "makes no reference to a special 'presumption'" nor does it require plaintiffs "to allege that the employer was on the 'brink of collapse,' under 'extraordinary circumstances,' or the like."  Id.  The Court rejected the defendants' argument that because the purpose of an ESOP is to encourage employee ownership, rather than merely to maximize retirement savings, the claim that an ESOP fiduciary was imprudent should be viewed "unfavorably."

The Court noted the requirement that fiduciaries act "in accordance with the documents and instruments governing the plan insofar as such documents and instruments are consistent with the provisions of this subchapter.Id., quoting § 1104(a)(1)(D) (emphasis in original).  "This provision makes clear that the duty of prudence trumps the instructions of a plan document, such as an instruction to invest exclusively in employer stock even if financial goals demand the contrary."   Id.

The Court agreed that an ESOP fiduciary might "find [ ] himself between a rock and a hard place: if he keeps investing and the stock goes down he may be sued for acting imprudently in violation of § 1104(a)(1)(B), but if he stops investing and the stock goes up he may be sued for disobeying the plan documents in violation of § 1104(a)(1)(D)."  Id. at 2470.  Still, the presumption was not "an appropriate way to weed out meritless lawsuits ...." Id.  "Such a rule," the Court wrote, "does not readily divide the plausible sheep from the meritless goats."  Id.

Iqbal and Twombly Redux

Finding the presumption inappropriate, the Court nonetheless denominated the motion to dismiss as an "important mechanism for weeding out meritless claims," and vacated the Sixth Circuit's conclusion that the plaintiffs' complaint stated a claim.  Id. at 2471.    The Court reiterated that the lower courts were to apply "the pleading standard as discussed in Iqbal and Twombly," and made specific observations concerning the contents of the plaintiffs' complaint.

First, the plaintiffs had alleged that Fifth Third's fiduciaries knew or should have known that holding the stock was imprudent "in light of publicly available information."  The Court stated that "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, at least in the absence of special circumstances."  Id.  To the contrary, "a fiduciary usually 'is not imprudent to assume that a major stock market ... provides the best estimate of the value of the stocks traded on it that is available to him.'"  Id.

Next, the plaintiffs had alleged that Fifth Third's fiduciaries were imprudent "by failing to act on the basis of nonpublic information that was available to them because they were Fifth Third insiders."  Id. "To state a claim for breach of the duty of prudence on the basis of inside information," the Court wrote, "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."  Id.  The duty of prudence, the Court emphasized, "under ERISA as under the common law of trusts, does not require a fiduciary to break the law."  Id.

To the extent that a complaint blames fiduciaries for not refraining from additional stock purchases  on the basis of inside information, or for failing to disclose  information to the public, courts should "consider the extent to which an ERISA-based obligation" in either respect could conflict with insider trading laws.  Id.  Finally, the courts should consider "whether the complaint has plausibly alleged that a prudent fiduciary in the defendant's position could not have concluded that stopping purchases – which the market might take as a sign that insider fiduciaries viewed the employer's stock as a bad investment – or publicly disclosing negative information would do more harm than good to the fund by causing a drop in the stock price...."  Id.

Ultimately, the Court left it to the lower courts to apply the Court's guidance to the plaintiffs' complaint.

Broader Application

Does Dudenhoeffer have application beyond stock drop cases and to ERISA cases generally, or to welfare benefits cases specifically?

The rejection of the Moench Presumption is rather text specific, relying heavily on the language of § 1104.  The Court did, however, make the point that plan terms cannot trump duties imposed by ERISA.  While the Court has not suggested otherwise in the past, previous decisions have emphasized fidelity to the language of the plan.  See, e.g., Kennedy v. Plan Administrator for DuPont Savings and Inv. Plan, 555 U.S. 285 (2009).  The decision in Dudenhoeffer is perhaps something of a mild counterweight to that principle. Whether that distinction has any practical application going forward remains to be seen.

More significantly, while rejecting the Moench Presumption, the Court nonetheless arguably set up a row of mini-hurdles which will pose difficulties for plaintiffs in stock drop cases.  The Court accomplished this through its emphasis on the plausibility standard for pleadings set forth in Iqbal and Twombly and its endorsement of the motion to dismiss as an "important mechanism for weeding out meritless claims ...."  134 S. Ct. at 2471.

The Court's forceful invocation of the plausibility standard, and its affirmation of the role of motions to dismiss, may be helpful in the welfare plan context in addressing claims that stray beyond a straightforward claim for benefits under § (a)(1)(B), such as breach of fiduciary duty claims and claims for administrative penalties premised on de facto administrator theories.

Does the complaint plausibly set forth a claim of breach of fiduciary duty which is distinct from the underlying claim for benefits?  Does the complaint set out facts plausibly demonstrating that the insurer acted as a de facto administrator when the plan document identifies the employer as the plan administrator? 

Any occasion that the Supreme Court speaks on ERISA cases is significant.  While the unanimous decision in Dudenhoeffer is directly applicable to stock drop cases, there may be opportunities to utilize some of its language in a broader context for motion practice in welfare plan cases.

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H. Sanders Carter
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Andrea K. Cataland
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Kenton J. Coppage
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