On June 25, 2014, the Supreme Court of the United States announced its unanimous decision in Fifth Third Bancorp v. Dudenhoeffer. The ruling will likely lead to an increase in the number “stock drop” lawsuits brought under the Employee Retirement Income Security Act by 401(k) plan participants against the fiduciaries – or officers – of those plans due to a drop in the value of employer stock. The decision, however, does not necessarily mean there is a greater likelihood of success for the plaintiffs of such lawsuits.
The facts of Fifth Third are relatively typical of most stock drop cases. The plaintiffs were former Fifth Third employees and 401(k) plan participants. Like many such plans, Fifth Third’s 401(k) plan required that employer stock be available as an investment option. Participants freely chose to invest or remain invested in the stock.
After the stock declined sharply during the financial crisis, the plaintiffs brought a lawsuit claiming that the fiduciaries should have known that Fifth Third’s subprime lending practices would cause the stock to drop. They further argued that the fiduciaries should have taken some action to protect the participants, such as divesting the plan or preventing new purchases of employer stock.
Prior to this ruling, most federal courts agreed that plan fiduciaries were entitled to a “presumption of prudence” regarding investments in employer stock. This meant the participant had to claim egregious facts – the company was on the brink of collapse or bankruptcy, for example – in order to have the case survive a motion to dismiss and become entitled to expensive discovery. Because most cases were dismissed at the beginning stages, plaintiffs’ lawyers were filing fewer of them in recent years.
The court justices rejected the presumption of prudence in Fifth Third, finding it had no basis in the law. Standing alone, this is an unfortunate development for fiduciaries and employers, because the presumption was the legal basis for the dismissal of most stock drop cases. The demise of the presumption will likely cause renewed interest in stock drop cases among plaintiffs’ attorneys, leading to more lawsuits.
The Supreme Court did not end its analysis there, though. The court also provided helpful guidance to the lower courts on what they should consider when deciding whether a stock drop case should be dismissed. The guidance explains the types of claims participants usually make in these cases, and what types of cases should survive dismissal.
The claims raised in these cases usually fall into two categories. First, participants often claim that fiduciaries should have taken some action with respect to employer stock because of publicly-available information, such as media reports or a severely falling stock price, suggesting that employer stock was overvalued. Second, participants frequently claim that fiduciaries possessed insider information which indicated the employer stock was overvalued.
The guidance indicates that neither of these types of claims should survive a motion to dismiss in most circumstances. As a general matter, public information is insufficient to support such a case because the market takes this information into account in setting the stock price each day. And use or disclosure of non-public information is subject to comprehensive regulation under the securities laws, which govern fiduciaries the same as everyone else.
The guidance also requires consideration of what disclosure of such information might do to the stock price. Now, despite the rejection of the presumption, participants may still find it difficult – perhaps even more difficult than under the presumption – to avoid having their cases dismissed. Indeed, there are few circumstances where a fiduciary had a legal course of action that could or would have avoided the drop in the price of the stock.
The Fifth Third decision has significantly changed the legal landscape for these cases. Although it will take the lower courts a while to interpret and apply the ruling, most of these cases will likely be dismissed. In the meantime, though, employers and fiduciaries should reconsider how to structure, govern and monitor employer stock in their retirement plans.