Another Liability Risk for Officers and Directors

As you may have read, last week the U.S. Supreme Court issued its most important decision affecting qualified retirement and 401(k) plans in more than a year, Fifth Third Bank Corp. v. Dudenhoeffer. “But Mike,” you say, “this is an executive compensation blog.” That is true. However, we also want to make sure that executives get to keep the compensation they earn, and Dudenhoeffer may pose a liability threat to some of that hard-earned compensation. Many officers (and some directors) are retirement plan fiduciaries, and lawsuits of the type the Supreme Court allows under Dudenhoeffer nearly always name the company’s directors and officers (whether or not they are fiduciaries). Readers will recall that I have blogged on this fiduciary trap several times.

In Fifth Third Bank Corp. v. Dudenhoeffer, the Supreme Court rejected a widely adopted “presumption of prudence” in favor of the fiduciaries of a retirement/401(k) plan that includes a company stock fund investment option (some in the media have been describing Dudenhoeffer as applicable to “employee stock ownership plans” or “ESOPs,” but it's applied more broadly). Benefits and compensation professionals will recognize Dudenhoeffer as a “stock drop lawsuit” of the type routinely filed by plaintiffs’ lawyers looking for a quick buck in the aftermath of a drop in the stock price of a public company that makes available a company stock fund. Dudenhoeffer and other stock drop lawsuits allege that the fiduciaries of the company’s ESOP, retirement, or 401(k) plan, which often includes senior officers of the company, breached their fiduciary duties to the plan participants by continuing to allow investments in the company stock fund when they knew or should have known that the company’s stock was overvalued and excessively risky. Nevermind that federal securities laws would seem to prohibit actions based on this “knowledge.”

Some federal courts have accepted these claims and allowed them to proceed to trial. However, a majority of federal courts had rejected claims of this type under the rationale that the fiduciaries’ decision to allow investments in the company stock fund are presumed to be prudent where the plan document expressly requires investments of company stock.

Regrettably, the Supreme Court overturned the “presumption of prudence” and held that where a stock is publicly traded, plan fiduciaries are subject to the same duty of prudence as other ERISA fiduciaries. The Supreme Court rejected defendants’ contention that subjecting ESOP fiduciaries to a duty of prudence without the protection of a special presumption would lead to conflicts with insider training laws. The Court also dismissed defendants’ argument that a special presumption is necessary to stave off costly duty-of-prudence lawsuits and incentivize companies to offer ESOPs to their employees. The Court found that a special presumption is an inappropriate way to deal with meritless lawsuits.

The Court did outline certain limitations that we will need to design and draft into ESOP, retirement, and 401(k) plans that allow investments in a company stock fund as soon as possible. Additionally, Dudenhoeffer makes it even more important that plan sponsors and fiduciaries follow the list of administration and participant communication best practices and plan design strategies we have described in the past.