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In a unanimous decision, in Fifth Third Bancorp, et al. v. Dudenhoeffer, et al., No. 12-751 (June 25, 2014) the United States Supreme Court eliminated the so-called Moench Presumption which protected fiduciaries of Employee Stock Ownership Plans (“ESOPs”). The Moench Presumption was a legal concept created by federal courts over a nearly 20-year period for handling fiduciary duty lawsuits. Under it, the fiduciaries of a retirement plan like an ESOP governed by the Employee Retirement Income Security Act of 1974, as amended (“ERISA”) were presumed to have acted prudently with respect to their ERISA fiduciary duties when the ESOP invested in employer stock.

A plaintiff who alleged the ESOP fiduciaries breached their duty would need to overcome that presumption by providing evidence that buying and/or holding employer stock in the plan was not prudent. Simplistically, the Moench Presumption had the effect of limiting the exposure ESOP fiduciaries had from what might be described as meritless lawsuits. The application of the Moench Presumption in many situations could result in lawsuits being dismissed before much time and expenses were incurred.

The Supreme Court specifically ruled that no such presumption of prudence exists for ESOP fiduciaries. Instead, ESOP fiduciaries investing in employer stock are to be held to the same fiduciary duty of prudence applicable to ERISA fiduciaries investing in other investments such as mutual funds.

Ruling could encourage lawsuits, increase costs and discourage independent fiduciaries

Fiduciaries, particularly ESOP fiduciaries, when deciding to invest in employer stock or deciding to continue to hold employer stock have had and continue to have a fiduciary duty with respect to those decisions. The Supreme Court ruling does not change that. What the ruling does is make it easier for plaintiffs to bring litigation and to have that litigation survive motions to dismiss.

While it is far too early to predict what the effect of the ruling will be, many ERISA and ESOP professionals believe it will foster a climate favorable to plaintiffs who may seek to bring breach of fiduciary claims against plan fiduciaries in general and ESOP fiduciaries in particular.

The elimination of the presumption will probably increase the number of lawsuits alleging a breach of fiduciary duty for buying and/or holding employer stock. Further, without the presumption, such lawsuits will likely progress into the discovery stage or beyond. In effect, the lawsuits will drag on and become more expensive to defend. The result will be more perhaps meritless lawsuits being settled to avoid the expense of litigation. This in turn may result in more meritless suits being filed in the anticipation of receiving a nuisance settlement.

The elimination of the presumption may lead to increased costs in setting up and maintaining ESOPs and other similar retirement plans holding employer stock. As the potential for additional lawsuits increase, fiduciaries and other professionals serving ESOPs by necessity will factor the heightened risk of potentially expensive litigation into their fee structure. The cost of fiduciary liability insurance is also likely to increase as the carriers adjust rates in response to the increased litigation risk. In short, initial and ongoing costs for ESOPs and similar plans will likely increase.

As these costs increase and as litigation exposure increases, independent fiduciaries may exit the market. Even before this decision, many commercial trust companies decided not to serve as ESOP trustees because of that exposure. That trend will only continue. The smaller independent fiduciaries who stepped in to fill that void may decide now that the cost of fiduciary insurance coupled with the risk of costly and time-consuming litigation is too much and will decide to stop providing those fiduciary services. This will make it more difficult for companies to set up and maintain ESOPs and similar plans while attempting to utilize professional fiduciaries.

Action steps

The Supreme Court ruling, while not favorable for ESOP fiduciaries, does not mean companies should not consider ESOPs or permitting employer stock to be an investment option in their retirement plans.

What fiduciaries need to continue to do is to carefully document all their decisions to buy and/or hold employer stock. This would include keeping detailed written records of the meetings where decisions were made as well as potentially engaging outside professionals to assist and advise the fiduciaries when there may be issues regarding the employer’s value or the advisability of holding employer stock or purchasing additional stock.

Because the lawsuits typically only arise when the employer stock value has dropped or is dropping, it will be critical for the ESOP fiduciaries to be able to demonstrate the information they reviewed and the analytical processes they performed to support their decision to buy and/or hold employer stock.

In short, the ruling makes it more important than ever that all fiduciaries, particularly ESOP fiduciaries, engage in a practice of procedural prudence, documenting their decision-making process and bringing in outside experts when the fiduciaries own expertise needs assistance.

For more information, please contact:

Carl J. Grassi

Dale R. Vlasek

Dan Makee

ESOP Transactions

Why should a closely-held business consider an Employee Stock Ownership Plan (ESOP)? The flexibility and tax advantages of an ESOP make it an ideal business strategy for a corporation. Whether your company is looking to offer a valuable employee benefit, to implement an effective corporate debt-financing plan, or to establish a business succession plan, an ESOP may be the solution. Our ESOP attorneys are skilled in a variety of legal disciplines necessary in ESOP transactions, including corporate and commercial matters, employee benefits and federal taxation. We advise selling shareholders, trustees, lenders, and investment bankers concerning all aspects of the ESOP, including the use of ESOPs as a tax-advantaged business-planning tool and the specific business and legal issues surrounding ESOPs. We counsel clients on how to use ESOPs to finance the restructuring of a business, fund an acquisition, or ward off a hostile takeover.

Benefit programs should be a win-win for employers and employees. We strive to accomplish that goal in the design, implementation and operation of sophisticated benefit and executive compensation programs -- qualified and non-qualified retirement programs and health and welfare plans. Our employee benefits team has a long track record of working to maximize the efficiency and economic feasibility of each program. We are able to accomplish this by taking advantage of the complex tax rules and by understanding and rationalizing objectives of the company and its employees. Our employee benefit attorneys routinely work with employees and their internal human resources personnel to assist them in operating and administering their plans.