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Stock-Drop Decision Helpful to Employee Stock Ownership Plans (ESOP) Fiduciaries

Yesterday, the Supreme Court issued its much anticipated decision in the stock-drop caseFifth Third Bancorp v. Dudenhoeffer.  The Court vacated the lower court decision that was adverse to the employer, Fifth Third Bancorp, and remanded the case to the lower courts for further proceedings.

Fiduciaries of employee stock ownership plans (ESOPs) had hoped that this decision would clarify their responsibilities for administering an employer stock fund.  Although the decision leaves many questions unanswered, it does provide useful guidance for fiduciaries administering an employer stock fund in an ESOP:

  1. When administering an employer stock fund, a fiduciary is subject to the same standard of prudence that applies to all ERISA fiduciaries, except that there is no duty to diversify.  As a result, there is no “presumption of prudence” with respect to an employer stock fund, as had been widely recognized by lower courts, and a fiduciary should generally continue to apply the same standard of prudence to an employer stock fund as it does to a plan’s other investment options.

  2. A fiduciary can rely on the fact that the market price of shares of the company’s stock accurately reflects the value of the stock, absent special circumstances.  As a practical matter, this means that an allegation that a fiduciary should have recognized, from publicly available information alone, that the market was over- or undervaluing the stock generally will not survive a motion to dismiss.

  3. The duty of prudence does not require a fiduciary to break the law.  Thus, a fiduciary is prohibited from using nonpublic information to take any action — such as selling a plan’s holdings of company stock on the basis of inside information — if doing so would violate the securities laws.

  4. The issues are more complicated when considering whether a fiduciary can use nonpublic information to refrain from making additional purchases of company stock or whether a fiduciary can disclose any nonpublic information to the public.  These issues need to be evaluated in light of the complex insider trading and corporate disclosure requirements under the federal securities laws, and the U.S. Securities and Exchange Commission has not provided guidance on these matters.

  5. In evaluating whether to buy or sell shares of company stock or to disclose nonpublic information, a fiduciary may take into account whether the action will cause more harm than good to the plan.  For example, ceasing purchases might cause the market to believe that the stock is a bad investment, and disclosing negative information to the public might cause the stock price to drop hurting all shareholders, including the plan.

  6. Fiduciaries should be protected from meritless stock-drop claims by the pleading standards that lower courts must apply in these cases.  The Supreme Court made clear that a plausible duty-of-prudence claim must be based on specific allegations, and not just the fact that the price of the employer’s stock dropped and there were fiduciaries who had nonpublic information.

Many of these issues will continue to be argued in the lower courts, as they try to interpret the Supreme Court’s ruling.  However, it seems clear from the Supreme Court’s opinion that it will be difficult for plaintiffs to bring stock-drop suits that can survive a motion to dismiss.

© 2022 Covington & Burling LLPNational Law Review, Volume IV, Number 177
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About this Author

Michael Francese, Covington, employee benefits attorney
Partner

As a partner in Covington’s employee benefits practice group, Mike Francese focuses on counseling clients in matters arising under their employee benefit plans and executive compensation arrangements with respect to ERISA, the Internal Revenue Code, and related federal and state laws.  He also represents clients before agencies and courts on both the federal and state level, and consults with them in connection with mergers, acquisitions, and other corporate transactions.

202.662.5413
Robert Newman, Covington, Employment Attorney
Partner

Robert Newman is a partner in the firm’s employee benefits and executive compensation practice group.  He represents clients ranging from small employers to some of the nation's largest employers, including for-profit and tax-exempt entities.  His practice includes:

  • designing, drafting, and amending a wide range of retirement plans (including 401(k) plans, ESOPs, and traditional and hybrid defined benefit plans) and welfare plans (including health, severance, and cafeteria plans);
  • creating executive compensation arrangements including nonqualified deferred compensation...
202.662.5125
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