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Supreme Court Rejects Presumption of Prudence in ERISA Lawsuits

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Washington, DCIn ERISA stock drop lawsuits, a common allegation is that the ERISA plan fiduciary has failed to act prudently by investing plan assets in company stock. Plaintiffs argue that their employee stock plan or savings plan assets would have been more prudently invested in other stock. One of the defenses to that claim is that unless the company is in particularly bad times - such as bankruptcy - the fiduciary is believed to have acted prudently by investing in company stock.

Employee Retirement Income Security Act (ERISA) plans carry a duty of prudence on the part of the plan’s fiduciary. Specifically, ERISA Section 404(a)(1)(B) states fiduciaries must act “with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.”

In other words, the fiduciary is expected to do what a reasonable person in his or her situation would do.

Where this can cause problems is with stock drop cases, when ERISA plan assets are invested in company stock, and that investment results in significant losses to the plan. Plaintiffs allege their plans lose value because they were not prudently invested in company stock. In situations where the company was clearly in trouble, this claim was not complicated. A prudent person investing ESOP assets in the employer’s stock could recognize certain warning signs that a company’s stock was grossly overvalued or about to drop in value dramatically.

But for companies that are not in dire straights, this claim is less straightforward. Fiduciaries are not expected to have special abilities to see the future, and bumps in a company’s stock happen all the time. To that end, the courts have tended to give the benefit of the doubt to fiduciaries that invested ERISA plans in company stock, except in cases where it was obvious the stock was a bad investment.

On June 25, however, the Supreme Court unanimously rejected the presumption of prudence when fiduciaries decide to buy or hold company stock. The lawsuit was Fifth Third Bancorp v. Dudenhoeffer (No. 12-751). In the lawsuit, former Fifth Third employees and ESOP participants, alleged that fiduciaries “should have known - on the basis of both publicly available information and inside information available to petitioners because they were Fifth Third officers - that Fifth Third stock was overpriced and excessively risky.”

They further alleged that a prudent fiduciary would have sold off the employee stock ownership plan’s (ESOP’s) holdings of Fifth Third Stock, or would have disclosed negative inside information so that the stock price would have been corrected downward. According to the lawsuit, the fiduciaries did not take those actions and the price of the stock fell, negatively affecting employees’ retirement savings.

In rejecting the presumption of prudence, the Supreme Court wrote, “We hold that no such presumption applies. Instead, ESOP fiduciaries are subject to the same duty of prudence that applies to ERISA fiduciaries in general, except that they need not diversify the fund’s assets.” The court did, however, point out that fiduciaries are expected to act within the law and therefore cannot take action on insider information if that action would violate securities laws.


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