ERISA Litigation Newsletter June 26, 2014
In This Issue

Supreme Court Rules No “Presumption of Prudence” for Employer Stock Plan Fiduciaries


In a decision that could have significant implications for certain companies and their 401(k) and other plans that invest in employer stock, the Supreme Court ruled yesterday, in Fifth Third Bancorp v. Dudenhoeffer, that there is no “presumption of prudence” for fiduciaries of plans that invest in employer stock. The Court, however, made clear that plaintiffs face a significant pleading burden in ERISA “stock-drop” cases.

The U.S. Supreme Court yesterday handed down its first decision addressing ERISA claims involving the holding of employer stock in a defined contribution retirement plan. Plaintiffs regularly allege that fiduciaries breached their duty of prudence by continuing to invest the assets of such a plan in employer stock during the period when the stock price drops in value. Until yesterday, every court of appeals that addressed the question had applied a presumption that investing in employer stock as the plan documents mandate is not imprudent.

The Supreme Court’s decision in Fifth Third Bancorp v. Dudenhoeffer overturned that “presumption of prudence.” But the Court also made clear that the lower courts must still critically review complaints challenging the continued holding of company stock pursuant to a plan mandate:  not only do the generally applicable pleading standards apply to such ERISA claims, but courts should also (i) dismiss – absent special circumstances – claims that it is imprudent to purchase stock at the public market price based on publicly available information and (ii) require plaintiffs alleging that nonpublic information caused the investment to be imprudent to plead how the fiduciary could have acted consistent with the securities laws and the risk that a halt to trading would depress the stock price and harm participants.

The lower federal courts will now need to determine how this guidance applies to future cases challenging the continued holding of employer stock when plan documents require such holding.

The Evolution of the “Presumption of Prudence”

In the last 20 years – since the passage of the Private Securities Litigation Reform Act (“PSLRA”) – the plaintiffs’ bar has filed hundreds of ERISA “stock-drop” cases in lieu of, or in addition to, securities class actions when employer stock held in employee stock ownership plans (“ESOPs”) or other defined contribution retirement plans, like 401(k) plans, experienced a loss in value. Some in the plaintiffs’ bar viewed these claims as a means of circumventing the PSLRA’s heightened pleading requirements. But over the past 20 years, every circuit court to address the question adopted a “presumption of prudence” for such cases – meaning that a fiduciary’s decision to allow continued investment in employer stock when required by plan documents has been presumed prudent. The circuits varied on what showing would be required to overcome that presumption, with many holding that in order to survive dismissal a complaint needed to plead that a company was on the brink of collapse or that there were other “dire circumstances” not foreseen by the employer sponsoring the plan.

Dudenhoeffer Background

Dudenhoeffer was one of these “stock-drop” suits. It was brought as a putative class action by participants in a financial services company’s ERISA-governed retirement plan. Plaintiffs had invested in one of the 20 options available under the plan, the ESOP investment option that was designed to invest primarily in the employer’s publicly traded stock. The plan document required that the ESOP would be one of the available investment alternatives. When the stock price dropped by 74% between July 19, 2007 and September 18, 2009, participants sued the company and certain company officers and employees alleging breach of ERISA fiduciary duty for allowing the continued investment of the plan in the ESOP investment option. The trial court dismissed the complaint on the pleadings, holding that participants failed to overcome the presumption of prudence applicable to such cases. The U.S. Court of Appeals for the Sixth Circuit reversed, holding, among other things, that while a presumption of prudence exists, it should not be applied at the pleading stage.

The Supreme Court Held that There Is No Presumption of Prudence for ESOP Fiduciaries

In yesterday’s unanimous decision in Fifth Third, the Supreme Court unwound 20 years of lower-court precedent and held that ERISA does not afford a “presumption of prudence” to ESOP fiduciaries at any stage of litigation. Writing for the Court, Justice Breyer explained that “the same standard of prudence applies to all ERISA fiduciaries, including ESOP fiduciaries.” The decision looked closely at ERISA’s language:  the statute expressly exempts ESOP fiduciaries from the requirement to diversify investments, so the Court reasoned that in all other respects ESOP fiduciaries are subject to the same obligations under ERISA as other retirement plan fiduciaries – including the obligation to act prudently with respect “to the sort of financial benefits (such as retirement income) that trustees who manage investments typically seek to secure for the trust’s beneficiaries.” According to the Court, nothing in the text of ERISA allows courts to presume that continuing to invest in employer stock is prudent, even if the plan document requires such investment. Instead, the Court explained that “the duty of prudence trumps the instructions of a plan document, such as an instruction to invest exclusively in employer stock even if financial goals demand the contrary.”

The Court Nonetheless Established Significant Hurdles for Future ESOP Stock-Drop Claims

Although the Court held that there is no presumption of prudence for ESOP fiduciaries, it also recognized that petitioners raised legitimate concerns that the threat of ERISA liability should not force them into an impossible position, such as acting on inside information. Because the Sixth Circuit had incorrectly held that the plaintiffs had stated a claim, without rigorously applying the relevant pleading standards, the Court vacated the lower court’s decision and remanded the case.

The Court acknowledged that ERISA represents a “careful balancing” of interests that courts should consider so that they do not “create a system that is so complex that administrative costs, or litigation expenses, unduly discourage employers from offering welfare benefit plans in the first place.” According to the Court, the ordinary pleading standards – those set forth in Ashcroft v. Iqbal, 556 U.S. 662 (2009) and Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007) – will provide the requisite balancing in this context to “weed out meritless lawsuits.” The Court cautioned that such balancing should be “accomplished through careful, context-sensitive scrutiny of a complaint’s allegations.”

For example, the Court explained that claims based on publicly available information – i.e., claims that public information should have induced an ESOP fiduciary to divest the plan of employer stock – will almost never survive a motion to dismiss on the pleadings. Relying on its decision earlier this week in Halliburton Co. v. Erica P. John Fund, Inc. (June 23, 2014), the Court reasoned that, typically, it is not imprudent for a fiduciary to assume that the market reacts to such information efficiently. As a result, “allegations that a fiduciary should have recognized from publicly available information alone that the market was over- or undervaluing the stock are implausible as a general rule, at least in the absence of special circumstances” that would render the market price unreliable. The Court did not provide a specific example of when such “special circumstances” might exist – it simply noted that no special circumstances were alleged in this case.

With respect to claims that a fiduciary had material, non-public information that should have induced such fiduciary to divest the plan of employer stock or discontinue additional purchases, the Court set forth a general pleading requirement: “To state a claim for breach of the duty of prudence on the basis of inside information, a plaintiff must plausibly allege an alternative action that the defendant could have taken that would have been consistent with the securities laws and that a prudent fiduciary in the same circumstances would not have viewed as more likely to harm the fund than to help it.” Although the Court noted that “the duty of prudence . . . does not require a fiduciary to break the law” – and it recognizes that ERISA expressly provides that it should not be construed “to alter, amend, modify, invalidate, impair, or supersede” any federal law or regulation, such as the federal securities laws – the Court otherwise provided little guidance as to how this new pleading standard should be applied by the lower courts. Instead, the Court raised several issues for lower courts to “consider” when ruling on motions to dismiss ESOP stock-drop claims. For example, the Court advised that:

  • “courts should consider the extent to which [a claim] could conflict with the complex insider trading and corporate disclosure requirements imposed by the federal securities laws or with the objectives of those laws,” and
  • “courts . . . should also consider whether the complaint has plausibly alleged that a prudent fiduciary in the defendant’s position could not have concluded that stopping purchases – which the market might take as a sign that insider fiduciaries viewed the employer’s stock as a bad investment – or publicly disclosing negative information would do more harm than good to the fund by causing a drop in the stock price and a concomitant drop in the value of the stock already held by the fund.”

The Sixth Circuit had considered none of these matters. Thus, the Court vacated the Sixth Circuit’s decision and remanded to have the lower courts apply the pleading standards as explained by the Court in its decision.

Sixth Circuit Addresses Plan Assets and Limitations Issues in Holding Service Provider’s Fee Assessments Constituted Self-Dealing


The Sixth Circuit held in Hi-Lex Controls, Inc. v. Blue Cross and Blue Shield of Michigan that a service provider was liable as a fiduciary under ERISA for unauthorized fees it assessed against a self-funded health plan. In reaching that conclusion, the court found that the “fraud or concealment” exception to ERISA’s three-year statute of limitations applied where the service provider knowingly omitted references to the fees in the relevant contracts and subsequently denied assessing the fees. In addition, the court relied on “ordinary notions of property rights” in determining that the account from which the fees were assessed held ERISA plan assets.

In Hi-Lex Controls, Inc. v. Blue Cross and Blue Shield of Michigan, No. 13-1773/13-1859 (May 14, 2014), the U.S. Court of Appeals for the Sixth Circuit held that a service provider violated ERISA’s prohibition on fiduciary self-dealing when it assessed undisclosed fees against a self-funded health plan. In reaching this conclusion, the court addressed issues regarding the identification of ERISA plan assets and the application of the “fraud or concealment” exception to ERISA’s statute of limitations.


In Hi-Lex, beginning in 1991, an employer that maintained a self-funded health plan entered into contracts with a third party administrator (“TPA”). Under the contracts, the plan obtained administrative services from the TPA and access to the TPA’s network of medical providers. The contracts provided that the TPA was to receive a monthly administrative fee equal to a dollar amount multiplied by the number of covered plan participants. In 1993, the TPA began to retain revenue, in addition to the administrative fee, by “adding certain mark-ups” to the amounts hospitals within its network charged the plan for medical services, and retaining the amount of the mark-ups for its own benefit.  (The Sixth Circuit referred to this retained revenue as the “Disputed Fees.”)

In 2011, the employer and the plan sued the TPA in federal district court alleging that the TPA had violated ERISA in assessing the Disputed Fees. On summary judgment, the district court ruled that the TPA functioned as an ERISA fiduciary in assessing the Disputed Fees and, after a bench trial, held that (i) the plaintiffs’ claims were not time-barred and (ii) the TPA’s assessment of the fees violated its fiduciary duties.

Court of Appeals Decision

On appeal, the Sixth Circuit affirmed. The court rejected the TPA’s argument that the plaintiffs’ claims were precluded by ERISA Section 413(2), which bars claims made more than three years after actual knowledge of the violation. In making this statute of limitations argument, the TPA emphasized that the employer obtained actual knowledge of the Disputed Fees in 2007, but did not bring suit until 2011. The Sixth Circuit, however, held that the case fell within Section 413’s exception, that provides that “in the case of fraud or concealment [an] action may be commenced not later than six years after discovery of [the] violation.”

The Court of Appeals noted that the circuit courts are split regarding whether this “fraud or concealment” exception applies (i) where the underlying ERISA violation sounds in fraud, see Caputo v. Pfizer, Inc., 267 F.3d 181, 192-93 (2d Cir. 2001), or instead (ii) where the defendant has actively concealed its  wrongdoing, see Larson v. Northrop Corp., 21 F.3d 1164, 1174 (D.C. Cir. 1994). It concluded, however, that it did not need to “take sides” on this circuit split, because it found (i) that the TPA had committed fraud in connection with the underlying violation by knowingly omitting information about the Disputed Fees in the contracts, and also (ii) that the TPA had actively concealed the violation by subsequently denying it had retained revenue beyond its contractual administrative fee. In addition, the Sixth Circuit upheld the district court’s finding that the employer had exercised due diligence in reviewing the administrative costs of the plan prior to 2007, when it discovered the existence of the Disputed Fees.

The TPA also argued that its retention of the Disputed Fees was not an ERISA fiduciary violation because those fees were not paid from ERISA plan assets. In this regard, the Disputed Fees were paid from a bank account that was used to pay benefit claims under the plan and that was funded by periodic transfers from the employer. Beginning in 2003, those transfers included participant contributions – which the TPA acknowledged constituted plan assets under Department of Labor (“DOL”) regulations. See 29 C.F.R. Section 2510.3-102(a)(1). But the substantial majority of (and, before 2003, the entirety of) the funds in the account came from employer contributions, which the TPA argued were not plan assets.

The Sixth Circuit disagreed. Relying on DOL authority and the relevant case law, the court reasoned that the employer contributions in the account would be considered to be ERISA plan assets if, under “ordinary notions of property rights,” the plan had a beneficial interest in the funds held in the account. It held that plan participants “had a reasonable expectation” of such a beneficial interest based on several actions and representations of the parties, including statements in the plan’s summary plan description, the TPA’s exclusive check writing authority over the account to pay benefit claims under the plan, and quarterly statements and other data provided by the TPA to the employer with regard to the account. The court also indicated that, in its view, the account was analogous to a trust under common law because (even though no formal trust had been created) the employer had transferred funds to the account for the purpose of paying benefit claims and authorized administrative fees.

Seventh Circuit Reverses Summary Judgment in Case Applying ERISA’s Statute of Limitations


A Seventh Circuit panel declined to apply ERISA’s three-year statute of limitations to bar fiduciary claims in a case arising out of a buy-out transaction involving an employee stock ownership plan. The court held that the claims could have been time-barred if the plaintiffs had actual knowledge of the fiduciary process that their claims challenged more than three years prior to suit.

In Fish v. GreatBanc Trust Co., No. 12-3330 (7th Cir. May 14, 2014), the U.S. Court of Appeals for the Seventh Circuit reversed summary judgment for the defendants on the issue of whether the plaintiffs’ claims were time-barred under ERISA’s statute of limitations.

The litigation was brought by employees of a company (the “Company”) who participated in an employee stock ownership plan (“ESOP”).  Their claims arose from a buy-out transaction in which the Company borrowed money to buy Company stock from its shareholders, who consisted primarily of members of the family that founded and controlled the Company. The stock owned by the ESOP would be exempt from the transaction, and after the transaction the ESOP would be left as the sole Company shareholder. After the transaction, the Company went bankrupt, leaving the stock held by the ESOP worthless. The plaintiffs asserted claims for breach of fiduciary duties against the individual plan fiduciaries and the independent trustee who was retained to negotiate the transaction for the plan, contending that the defendants failed to use a sound process to evaluate the fairness of the proposed buy-out. They also asserted that the defendants caused the ESOP to engage in prohibited transactions without adequate consideration.

The U.S. District Court for the Northern District of Illinois granted summary judgment to the defendants on the grounds that ERISA’s three-year statute of limitations barred the claims. The court held that proxy documents given to the plaintiffs at the time of the buy-out transaction and their knowledge of the Company’s financial affairs after the transaction gave them actual knowledge of the alleged ERISA violations more than three years before suit was filed.

On appeal, the Seventh Circuit reversed. The court stated that, in the circumstances of this case, whether the defendants met fiduciary standards and whether the transaction was exempted from ERISA’s prohibited transaction rules depended in part on whether the defendants performed sufficient due diligence before entering the buy-out transaction. The court held that “a plaintiff asserting a process-based claim under [ERISA] does not have actual knowledge of the procedural breach of fiduciary duties unless and until she has actual knowledge of the procedures used or not used by the fiduciary.” In this regard, the court stated that the district court had “overlooked the procedural dimension of a fiduciary’s duties under ERISA and the ability of a plaintiff to show she was harmed by a fiduciary’s substantive decision precisely because the fiduciary violated ERISA by failing to comply with its procedural obligations.”

The court found that no part of the proxy materials provided to the ESOP participants disclosed the processes that the fiduciaries had used to exercise due diligence and to conduct a fairness analysis of the transaction. Further, the court stated that the plaintiffs’ knowledge that a large number of other participants left the Company and cashed out of the ESOP shortly after the buy-out transaction did not give them actual knowledge of the defendants’ processes. Without undisputed proof of such knowledge of alleged inadequate processes, the defendants had failed to show that the plaintiffs had actual knowledge of their claims more than three years prior to suit. 

The court also rejected the defendants’ other arguments, including an argument that, under the particular facts of the case, the plaintiffs received sufficient information to have actual knowledge of the alleged violation more than three years before filing suit but were “willfully blind” to it, and their argument that defendants’ processes are not an element of the plaintiffs’ causes of action and could not form the basis for a statute of limitations defense. The case was remanded to the district court for further proceedings.

Second Circuit Affirms Dismissal of Stock Drop Challenge on Grounds Unrelated to Moench


Prior to the Supreme Court’s decision in Fifth Third Bancorp v. Dudenhoeffer,  the central issue in nearly every case alleging the imprudent investment of plan assets in employer stock has revolved around whether plan fiduciaries are entitled to a presumption of prudence for such investments if they are mandated by the governing plan documents. However, the Second Circuit last month affirmed dismissal of identical claims on alternative grounds, holding that a company’s decision to make contributions to a plan in its stock, as opposed to cash, is not subject to ERISA fiduciary requirements.

In Coulter v. Morgan Stanley & Co., Nos. 13-2504 and 13-2509 (2d Cir. May 29, 2014), the United States Court of Appeals for the Second Circuit affirmed dismissal of claims involving the investment of a financial services company’s 401(k) plan and employee stock ownership plan (collectively, the “Plans”) in the company’s stock during the market downturn of 2008. Typically, before the Supreme Court’s decision in Fifth Third Bancorp (discussed in this ELU), courts had addressed these types of claims by applying the Moench presumption. However, the Coulter court instead held that the employer’s decision to make employer contributions to the Plans in company stock rather than cash was not subject to ERISA’s fiduciary rules, and therefore could not support a claim of breach of duty.

Plaintiffs were participants of the Plans. They brought suit alleging breaches of ERISA fiduciary duty for the Plans’ continued investment in the stock of the employer sponsoring the Plans, during a time when the stock “plunged in conjunction with the broader economic downturn.” The Plans’ investments in the stock declined nearly 70% in 2008. Defendants included the company, the investment committee for the company’s Plans, and the company’s board of directors, and numerous individual executives and employees.

The district court initially denied dismissal motions by the defendants. However, after the Second Circuit later held that the Moench presumption of prudence applied at the motion to dismiss stage in the Citigroup decision, reported in our December 14, 2011 edition, the district court granted renewed motions to dismiss. It held that the defendants, though ERISA fiduciaries, could not be held to have breached any duties because the plaintiffs had not alleged the dire circumstances sufficient to establish a claim under the standard established in Citigroup.

On appeal, plaintiffs argued “primarily” that defendants should have been held liable for electing to satisfy the employer’s contribution obligations to the Plans by contributing company stock rather than cash. The Second Circuit held that the company’s decision as to whether to contribute stock or cash to the Plans was not an ERISA fiduciary decision “because, at the time of the decision, the Company Stock was not a Plan asset.” The court held that even if the conduct complained of was allegedly detrimental to the Plans, since it was not undertaken in an ERISA fiduciary capacity, it was not actionable as a breach of ERISA fiduciary duties or impermissible conflict of interest. Although the Court did not rule on whether the Moench presumption would preclude plaintiffs’ claims, as it had in its earlier Citigroup decision, it followed Citigroup in holding that the company’s Chairman of the Board and CEO did not have an impermissible conflict solely because his compensation was linked to the value of the company’s stock.

Ninth Circuit Holds that Monetary “Make-Whole” Relief Is Not Available Absent Loss to Plan or Unjust Enrichment for Defendant under ERISA Section 502(a)(3)


A Ninth Circuit panel recognized that reformation, equitable estoppel and surcharge were among the “appropriate equitable relief” potentially available under Section 502(a)(3) of ERISA (following dictum in CIGNA Corp. v. Amara), although the majority held that none was available to the plaintiff under the facts. Judge Berzon dissented as to the scope of a surcharge (“make-whole”) remedy and stated that the majority has misinterpreted Amara and created a conflict with post-Amara decisions in other circuits by limiting monetary relief under Section 502(a)(3) to situations where the plan suffered a loss or the defendant was unjustly enriched.

In Gabriel v. Alaska Elec. Pension Fund, No. 12-35458 (9th Cir. June 6, 2014), the U.S. Court of Appeals for the Ninth Circuit followed the Supreme Court’s dictum in CIGNA Corp. v. Amara, 131 S.Ct. 1866 (2011) regarding the types of equitable remedies available under ERISA Section 502(a)(3) in cases brought against breaching plan fiduciaries. (For more information on these cases, please see “Supreme Court Expounds on ERISA's Remedial Provisions,” from Goodwin Procter’s June 2011 ELU, as well as “Fourth Circuit Follows Cigna v. Amara Dictum Expanding the Scope of Relief Under ERISA’s Catch-All Provision,” from the October 2012 ELU.)

The litigation arose from a pension plan’s mistaken determination that the plaintiff was entitled to benefits. When the mistake was discovered and benefit payments terminated, the plaintiff sued under ERISA to have his benefits restored, among other relief. The district court granted summary judgment for the defendants for a number of reasons, including that part of the relief sought (compensatory damages in the form of benefits) was not appropriate equitable relief allowed under ERISA Section 502(a)(3).

On appeal, the Ninth Circuit affirmed, with one panel member dissenting. The court began its analysis with the premise that the equitable relief available under ERISA Section 502(a)(3) includes remedies “traditionally” or “typically” available in equity, as informed by trust law. Citing dictum in Amara, which espoused a more expansive reading of the types of equitable relief available under Section 502(a)(3) than some lower courts had previously allowed, the court stated that reformation, equitable estoppel, and surcharge may be appropriate equitable remedies for breach of fiduciary duty claims.

The court ruled that reformation was not available to the plaintiff because he did not show that the plan’s mistaken determination that he was eligible for benefits was the result of fraud or a mistake in the plan document. The court held that, for equitable estoppel to apply, an ERISA plaintiff must demonstrate that the defendant’s representation related to an ambiguous term in the plan susceptible to multiple interpretations. The court agreed with the defendants that the plaintiff could not meet that standard because the plan was unambiguous that he was not entitled to any benefits.

The panel was divided, however, over the scope of surcharge and the implication of Amara. The majority viewed this type of monetary relief as available in equity only when there is a loss to the trust estate or the defendant was unjustly enriched. The majority affirmed summary judgment for the defendants because the plaintiff was not seeking to recoup for the plan losses it incurred from the defendants’ alleged breaches, and the plaintiff was not arguing that any of the defendants were unjustly enriched by those claimed violations of duty.

In her dissent, Judge Berzon contended that equity courts had broad powers to grant appropriate remedies, including make-whole monetary relief for breach of fiduciary duty, regardless of any loss to the trust estate or unjust enrichment. The dissent argued that the panel created a conflict with the post-Amara decisions by the Fourth, Fifth and Seventh Circuits which, according to Judge Berzon, recognized broad make-whole relief for fiduciary breaches under Section 502(a)(3) even absent loss to the plan or unjust enrichment.

Upcoming Conferences

Goodwin Procter partner Alison Douglass will speak at the following conference:

Insured Retirement Institute’s 2014 Government, Legal & Regulatory Conference
June 29 - July 1, 2014
Washington, D.C.

Goodwin Procter partner Carl Metzger will speak at the following conference:

ACI 18th Forum on D&O Liability Insurance
September 30 - October 1, 2014
New York, NY

Goodwin Procter partner Jamie Fleckner will speak at the following conference:

8th National Forum on Defending and Managing ERISA Litigation
October 27-28, 2014
New York, NY