- The Supreme Court rules for employees in an ERISA class action.
- Fiduciaries are not entitled to a "Presumption Of Prudence."
- Fiduciaries can be held liable for employees' stock losses.
Sometimes lightning does strike twice.
For the second time in less than a week, the U.S. Supreme Court dealt a blow to big business by issuing a ruling in favor of plaintiffs suing in "stock-drop" cases - this time for employees invested in company stock plans bringing class actions under ERISA.
The decision is another win for Mom and Pop investors, many of whom buy shares of the companies for which they work and hold those shares in a retirement plan known as an ESOP, or Employee Stock Ownership Plan.
Before we get into the importance of the ruling, let's cover some background on the terminology.
ERISA stands for the Employee Retirement Income Security Act, a federal law passed in 1974 to protect workers and their pension plans. ERISA was enacted to protect the interests of employee benefit plan participants and their beneficiaries by requiring the disclosure of financial and other information concerning the plan to beneficiaries.
ERISA also established standards of conduct for plan fiduciaries and provided for access to the federal courts.
Every once in a while a company will announce bad news and its stock price will go down. When this happens, lawyers will sue the company, making what is known as a "stock-drop" claim, saying that the company should have announced the bad news earlier; innocent shareholders, essentially, were tricked into buying stock because they didn't know about the bad news.
In Fifth Third, the Supreme Court unanimously ruled that fiduciaries of ERISA plans do not benefit from a "presumption of prudence" - a key term here - when they fail to take action to prevent stock losses in the employees' plan where there is fraud or other misconduct at the company that leads to a significant drop in the stock.
Previously, fiduciaries of employee stock plans had been entitled to a presumption that keeping employees invested in company stock was fine so long as the company wasn't on the verge of total collapse. That presumption has now been thrown out.
The Supreme Court's decision was a clear win for investors, removing a decades-old defense corporations have had in such stock-drop cases.
"The Supreme Court last Wednesday unanimously rejected a frequently used, successful defense by companies against stock-drop lawsuits filed by defined contribution plan participants," wrote Robert Steyer for industry newspaper InvestmentNews. "In a 9-0 decision, the justices said a 'presumption of prudence' invoked by employee stock option plans -- based on nearly 20 years of federal court decisions -- shouldn't be considered a special defense against lawsuits alleging breaches of fiduciary duty."
"We hold that no such presumption applies," wrote Justice Stephen Breyer. "Instead, ESOP (Employee Stock Ownership Plan) fiduciaries are subject to the same duty of prudence that applies to ERISA fiduciaries in general, except that they need not diversify the (ESOP) fund's assets."
In the case of Fifth Third Bank, the Court held that the company's retirement plan fiduciaries, including the bank's CEO, may have breached their duty to protect participants from needless losses amid the company's 74% stock drop in 2007-2009. A similar case involving Lehman Brothers saw the stock drop 99% and the company fall into bankruptcy and may allow employees to resurrect that case, which had previously been dismissed.
Justice Breyer rejected the argument by Fifth Third Bancorp that a weakening of a prior presumption would make ESOPs and DC plans more vulnerable to lawsuits, according to InvestmentNews.
"We do not believe that the presumption here is an appropriate way to weed out meritless lawsuits," he wrote. "The proposed presumption makes it impossible for a plaintiff to state a duty-of-prudence claim… unless the employer is in very bad economic circumstances. Such a rule does not readily divide the plausible sheep from the meritless goats."
The Court also ruled that if stock plan fiduciaries are also senior executives or other corporate insiders, they have to make sure that any action they take on behalf of stock plan participants doesn't violate the securities laws. So, for example, if a stock plan fiduciary learns of inside information that suggests the company's stock is overvalued, he cannot sell the stock plan's holdings because to do so would be insider trading. He may, however, be able to stop further purchases by the stock plan - or he can simply disclose the relevant information to employees and the market at the same time.
But the Court also suggested that a fiduciary could justify not acting in such a case if he thought that halting purchases of stock or disclosing information to the public would hurt the stock price even more. You can be sure that big business defendants will cling tenaciously to this part of the Fifth Third decision.
Still, investment fraud lawyers representing employees around the country have to be pleased. Gone are the days when a stock plan fiduciary can simply act, as Justice Kennedy put it during the Fifth Third oral argument, like a "coach class trustee." Indeed, all investors in company stock plans should get first-class treatment.
Could it be that the Supreme Court is no longer tilting the playing field in favor of big business over Mom and Pop investors, like those in the Fifth Third retirement plan? Maybe, but remember that the presumption the Court threw out here was a judge-made rule that was nowhere to be found in the original ERISA statute. If there's one thing this Court hates more than anything, it's "judicial activism." In any case, these decisions are certainly encouraging to investors and employees in employee stock cases.
Zamansky LLC are securities and investment fraud attorneys representing investors in federal and state litigation against financial institutions.