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Supreme Court Examines Company-Stock Retirement Plans

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All eyes in the retirement plan industry are focused on the U.S. Supreme Court, awaiting a decision that might have wide ramifications for companies that offer their own stock as an investment choice in 401(k) accounts. Arguments will begin in March.

At issue in Fifth Third Bancorp v. Dudenhoeffer is whether the presumption that employers act prudently when offering their own stock will remain a guiding principle. The 6th Circuit Court of Appeals ruled, contrary to other courts, that there is no such presumption.

“The presumption lifts the burden of proof,” said Nancy G. Ross, a partner with the Chicago law firm McDermott Will & Emery. “The participant has to prove [an employer’s action] wasn’t prudent.”

If that presumption that a company acted prudently is removed, such cases could move to the discovery stage without a plaintiff having shown any hard evidence of a breach of fiduciary duty. The costs could run into the hundreds of thousands of dollars.

“Changing the rule would be antithetical to Congress making it palatable for companies to offer retirement plans,” Ross said.

There’s more than one view on the issue, of course. Attorneys who bring the suits see the need to examine company records to find out just how decisions were made. And they aren’t having any of the talk that tinkering with the case law would be an unfair burden to companies.

“The bottom line is it will be an important case,” said Jerome J. Schlichter, senior partner at Schlichter Bogard & Denton in St. Louis. If the rule is changed “it will just mean that employers have to do [regarding company stock] what they have to do with any investment they want to include” in a retirement plan. That means ensuring they fulfill their fiduciary duty.

The battle lines have been drawn with those on each side of the case filing briefs with the court.

The Department of Labor, for instance, urged the court to uphold the decision. On the other hand a group of trade associations including the U.S. Chamber of Commerce and the Plan Sponsor Council of America have taken up the banks’ cause.

“Obviously, we believe that the 6th Circuit erred when it diverged from other circuits,” said Ed Ferrigno, vice president of Washington affairs for the council.

Since Congress passed the Employment Retirement Income Security Act of 1974, that presumption has gained traction. It balanced the desire of Congress to offer protection to employees while offering employers an incentive to encourage stock ownership in their company.

So-called stock drop cases, filed by participants when the company stock price falls significantly, have been around for two decades, but the stock market’s problems during the Great Recession were a catalyst for more of them.

Nearly all the cases were decided on the basis of a 1991 decision by the U.S. 3rd Circuit Court of Appeals in Philadelphia. In Moench v. Robertson, the court ruled in a case brought by Charles Moench, an employee of Statewide Bancorp, an Employee Stock Ownership case.

Moench claimed Statewide breached its fiduciary duty by continuing to invest in the stock even as its price dropped from more than $18 per share in 1989 to 25 cents in 1991.

The court ruled that a “fiduciary who invests the assets in employer stock is entitled to a presumption that it acted consistently with ERISA by virtue of that decision.”

That decision held sway until the 6th Circuit in Cincinnati decided in the Dudenhoeffer case the plaintiffs were entitled to evidentiary discovery.

“Everyone says the courts are split,” Ross said. “The only split is the 6th Circuit,” which she said often comes down on the side of labor and plan participants.

In the Fifth Third case, the bank’s stock dropped 74% after the mortgage market imploded. The stock drop caused the retirement plan’s assets to fall by millions of dollars. The suit claims Fifth Third should have known the bank was at risk because of its mortgage activities.

The stock, which traded at about $40 per share before plunging to $10, is at about $20 today.

The bounce-back of a stock can create a dilemma for a company.

“You’re damned if you do and damned if you don’t,” Ross said, referring to lawsuitsthat have been filed against companies that were said to have sold off company stock too soon.

One such case involved W.R. Grace, which along with State Street Bank, was accused of breaching its fiduciary duty by selling stock at an imprudently low price while it went through bankruptcy.

Although the company won in court, such suits might give companies pause when they consider ESOPs. If the high court makes it easier for participants to move their lawsuits into the discovery stage, some expect it to have a real effect.

“Should the 6th Circuit prevail,” said Ferrigno, “a lot of companies are going to reconsider offering company stock.”

Check out Scrutinizing Target-Date Funds in 401(k)s on ThinkAdvisor.


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