Background. When a company’s retirement plan includes employer stock as an investment option and stock value declines significantly, plan participants may seek to recover losses. In the past decade, there have been many “stock drop” lawsuits and most have involved public companies that sponsor KSOPs or other plans holding employer stock. Claimants have alleged that plan fiduciaries failed to liquidate employer stock or failed to restrict further purchases when such investments became imprudent. Defendants have responded by citing The Moench Presumption as part of their defense.
In the 1995 ESOP case Moench v. Robertson, public company stock declined sharply before the company went bankrupt. ESOP fiduciaries continued to invest in company stock while the share price dropped from $18.25 to $.25 over a two-year period. The Third Circuit court ruled that ESOPs are designed to be invested in employer stock and there is a “presumption of prudence” for holding employer stock in an ESOP. A plaintiff can overcome the presumption by establishing that a fiduciary abused its discretion by investing in employer stock.
After Moench, other circuit courts adopted some form of the Moench presumption. The Ninth Circuit, for example, required that evidence show company stock had declined precipitously and was on the brink of collapse. Otherwise, continued investment in employer stock was presumed to be prudent.
In Fifth Third Bancorpv v.Dudenhoeffer, ESOP participants argued that plan fiduciaries had access to public and nonpublic information that demonstrated company stock was overvalued on the market. Plaintiffs alleged that the plan fiduciaries should have sold bank stock, refrained from further purchases or disclosed inside information about the bank so that the stock market would adjust the price accordingly. Defendants cited the “Moench Presumption” as part of their defense. The case then made its way to the Supreme Court.
Ruling. On June 25, the Supreme Court unanimously rejected the Moench Presumption. The Court indicated that ESOP fiduciary responsibilities are the same as for other plan fiduciaries, except that they do not need to diversify an ESOP’s assets. While the ruling negates the “presumption” of prudence, it added a requirement that plaintiffs demonstrate that fiduciaries acted imprudently. Generally, plaintiffs need to show that:
- there were special circumstances requiring fiduciaries to recognize on the basis of public information that stock was over or under-valued or,
- based on nonpublic information, an alternative action could have been taken that would not violate securities laws and do more harm than good.
Implications. Future case law will provide us with more insight into the implications of the Supreme Court’s ruling, a ruling which caught many ESOP professionals by surprise. Implications are likely to be different for public and private companies. As indicated in a recent article issued by The National Center for Employee Ownership (NCEO), 97% of ESOPs are in closely-held companies. The article suggests that the ruling’s impact on private company ESOPs will be minimal. The vast majority of private company plans are funded solely through employer contributions. There are limits on a trustee’s ability to sell the shares if the fair value of the shares drops. In the event of a temporary drop in value, selling the shares could cause more harm than good. Additionally, most private companies sponsoring an ESOP also sponsor a 401(k) plan for their employees. This arrangement clearly offers employees an opportunity to grow and diversify retirement funds while reaping the benefits when their own ideas, initiatives and hard work help grow share value in an ESOP.
Many public ESOPs are also funded solely by company contributions, though some permit participant investment. The ruling may result in some public companies revisiting their investment oversight responsibilities. Some may revisit their decision to offer employer stock as an investment option in plans with self-direction of investment. Some may restructure investment or plan committees. Some may hire external trustees to manage investments and take on a portion of fiduciary responsibilities.
Private companies may revisit the idea of hiring an outside trustee on a permanent basis or to represent the ESOP with respect to a proposed stock transaction. Those without a 401(k) plan may want to add such a plan to demonstrate their balanced approach to participant retirement needs. All ESOP companies should ensure that plan oversight responsibilities are well-documented.