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  Chicago, Illinois 60602
  (312) 696-1373

  aswilliams@GCT.law 

 

 

 

ESOP Stock Drop Leaves Inside Trustees No Way Out

Participants in an employee stock ownership plan (ESOP) sponsored by Fifth Third Bancorp filed suit after the Bank’s stock experienced a 74 percent drop in market price between 2007 and 2009 – and plan fiduciaries failed to take action to avoid losses to the plan. The allegations that the plan fiduciaries did not act “prudently” in accordance with ERISA was rejected by the trial court on the basis of a presumption of prudence in dealing with employer stock that is recognized by a number of U.S. Circuit Courts of Appeal. This dismissal was reversed on appeal to the Sixth Circuit Court of Appeals, which held that the presumption of prudence applied only to a “fully developed evidentiary record,” not at the beginning of the case on the basis of the parties’ initial pleadings. The Bank appealed to the Supreme Court, which heard oral arguments earlier this month in the case titled Fifth Third Bancorp v. Dudenhoeffer.

Although the ostensible issue on appeal is the application of the presumption of prudence to investment decisions involving employer stock, the Court’s questioning focused on the practical issues presented: what is a conflicted trustee, alleged to have unfavorable “inside information” about the value of the employer’s stock, supposed to do? Is it “prudent” to sell the employer stock (or stop buying it), which conduct could by itself directly cause the stock value to decline? Or, is it prudent to do nothing and wait until the unfavorable inside information comes out - and the stock price then goes down? In either case, the trustee could be sued by participants because their holdings of employer stock have decreased in value. On the other side of the coin, if the inside trustees are entitled to a presumption of prudence in dealing with employer stock, isn’t having trustees with that reduced level of responsibility like having “coach class” trustees looking out for the ESOP participants?

The situation in the Fifth Third Bancorp case is further complicated by prohibitions under the securities laws on trustees (and others) buying or selling publicly traded employer stock on the basis of non-public “inside” information. If such trustees are not permitted to make trading decisions on the basis of inside information, what are they supposed to do with such information that will not potentially hurt the value of the employer stock?

Regardless of how the Supreme Court deals with the “presumption of prudence,” the oral argument in the Fifth Third Bancorp case suggests very difficult practical issues for the inside trustees not only of ESOPs but also any 401(k) plan that offers an employer stock fund as an investment option. Among the various litigants, the only concrete suggestion as to what conflicted inside trustees could do is resign and turn their responsibilities over to an independent trustee. As observed by Danielle Montesano, Vice President of the First Bankers Trust Services Employee Benefit Group, “Inside trustees may ultimately gain some protection from the Supreme Court’s ruling in the Fifth Third Bank case, but there still will be a risk of litigation any time plans lose money because of a significant drop in the price of the employer’s stock.

But there is a way out. Any remaining issues for company employees who are plan trustees is minimized if the sponsoring employer hires an outside, independent trustee. Institutional fiduciaries will have the ability to take appropriate action free from conflicts.”

 

Recommendations: Whatever the Supreme Court decides in the Fifth Third Bancorp case, it is clear that “inside” ESOP and 401(k) trustees are in an impossible situation if their employer’s stock experiences a significant drop in value. As the oral arguments emphasize, there’s nothing an inside trustee can do in those circumstances which will not be subject to second guessing by aggrieved participants. Consider engaging an outside commercial fiduciary with full investment discretion before the next “stock drop.”


Andrew S. Williams
Golan Christie Taglia LLP
70 West Madison St.
Suite 1500
Chicago, Illinois 60602
(312) 696-1373
aswilliams@GCT.law

 

   
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