Use of Prudent Process by ESOP Fiduciaries Satisfies Duty of Prudence: Sixth Circuit | Practical Law

Use of Prudent Process by ESOP Fiduciaries Satisfies Duty of Prudence: Sixth Circuit | Practical Law

In Pfeil, et al. v. State Street Bank & Trust Co., the US Court of Appeals for the Sixth Circuit held that a fiduciary of an employee stock ownership plan's (ESOP) investment decisions are prudent under the Employee Retirement Income Security Act of 1974 (ERISA) where the fiduciary employed a prudent process for determining not to sell GM stock.

Use of Prudent Process by ESOP Fiduciaries Satisfies Duty of Prudence: Sixth Circuit

Practical Law Legal Update w-000-7530 (Approx. 5 pages)

Use of Prudent Process by ESOP Fiduciaries Satisfies Duty of Prudence: Sixth Circuit

by Practical Law Employee Benefits & Executive Compensation
Published on 12 Nov 2015 • USA (National/Federal)
In Pfeil, et al. v. State Street Bank & Trust Co., the US Court of Appeals for the Sixth Circuit held that a fiduciary of an employee stock ownership plan's (ESOP) investment decisions are prudent under the Employee Retirement Income Security Act of 1974 (ERISA) where the fiduciary employed a prudent process for determining not to sell GM stock.
On November 10, 2015, in Pfeil, et al. v. State Street Bank & Trust Co., the US Court of Appeals for the Sixth Circuit held that a fiduciary of an employee stock ownership plan's (ESOP) investment decisions are prudent under the Employee Retirement Income Security Act of 1974 (ERISA) where the fiduciary employed a prudent process for determining not to sell GM stock (No. 14-1491, (6th Cir. Nov. 10, 2015)). This decision comes after the Supreme Court's decision in Fifth Third Bancorp v. Dudenhoeffer, which rejected the Moench presumption of prudence (No. 12-751, (June 25, 2014)).

Background

General Motors (GM) maintained an ESOP which, during the time at issue, State Street Bank (State Street) served as the fiduciary. (For information on ESOPs, see Practice Note, Employee Stock Ownership Plans (ESOPs).) To monitor and evaluate the ESOP, State Street used a three-tiered system of monitoring containing three separate committees consisting of:
  • A company stock group, which conducted daily monitoring and ongoing research and analysis to maintain awareness of the financial environment impacting company stock. The company stock group also had a comprehensive process to determine if the company stock required additional monitoring.
  • A stock review committee, which provided the additional monitoring, including monthly meetings during which a company stock group officer provided a detailed company-specific report including at least nine specific pieces of information.
  • An independent fiduciary committee, to which the stock review committee could elevate a company stock for further review and action, based on a review of the facts and circumstances.
Together these committees discussed GM stock 58 times between January 2008 and March 31, 2009. Between November 10, 2008 and March 31, 2009, as GM began to experience severe business problems, the independent fiduciary committee met 41 times and the stock review committee also met. On March 31, 2009, State Street decided to divest the GM stock, which was completed by April 24, 2009.
After State Street sold GM's stock in the fund, the participants filed a lawsuit under Section 502 of ERISA (29 U.S.C. § 1132) claiming that State Street breached its fiduciary duty for the failure to manage the ESOP's assets prudently in violation of ERISA Section 404 (29 U.S.C. § 1104). Specifically, the participants claimed that State Street's investment decisions to continue to buy and also to decline to sell GM common stock during certain dates in 2008 were imprudent under ERISA.
Applying the presumption of prudence standard, the district court granted State Street's motion to dismiss the suit. The participants appealed and the Sixth Circuit reversed, holding that the presumption of prudence did not apply earlier than the summary judgment stage. State Street then moved for summary judgment and the district court, applying the presumption of prudence standard, granted the motion. The participants again appealed.

Outcome

The Sixth Circuit affirmed the district court's grant of summary judgment, reviewing the case de novo.
ERISA Section 404 requires plan fiduciaries to act prudently in managing the plan's assets and imposes a prudent person standard by which to measure their actions (29 U.S.C. § 1104(a)). The prudent person standard considers the relevant facts and circumstances and looks to what a hypothetical comparable fiduciary would do under comparable circumstances (see Practice Note, ERISA Fiduciary Duties: Overview: Duty of Prudence).
After the Sixth Circuit's first review of the case, the Supreme Court granted review of Fifth Third Bancorp v. Dudenhoeffer under a similar set of facts (No. 12-751, , at *2461 (June 25, 2014)). In Dudenhoeffer, the Supreme Court rejected the so-called Moench presumption of prudence that had regularly been applied to ESOP fiduciaries and held that the prudent person standard applies to all ERISA fiduciaries, including ESOP fiduciaries, except that ESOP fiduciaries are under no duty to diversify investments (29 U.S.C. § 1104(a)(1)(C)). For more information on the Dudenhoeffer decision, see Legal Update, Supreme Court Rejects Moench Presumption of Prudence and Article, Fifth Third v. Dudenhoeffer: Advisory Board Roundtable Discussion.

Prudent Process Analysis

The Sixth Circuit reasoned that, according to the Dudenhoeffer decision, State Street's actions as an ESOP fiduciary should be evaluated under the prudent process standard. The court explained that when considering whether a fiduciary meets the prudent process standard, a court focuses on whether the fiduciaries employed a reasoned decision-making process consistent with a prudent fiduciary acting in a like capacity.
The court held that a plaintiff claiming that an ESOP’s investment in a publicly traded security was imprudent must show special circumstances to survive a motion to dismiss. In its analysis, the court noted the Modern Portfolio Theory (MPT), which assumes that securities markets incorporate all information that is known or knowable about the future prospects of a security and that the current market price is a reliable estimate of the value of the stock. Citing Dudenhoeffer, the Sixth Circuit went on to hold that, without a showing of some special circumstances, it is prudent for an ESOP fiduciary to rely on a security's market price in its decision-making process and that a fiduciary's process is not imprudent simply for failing to recognize that the market was over or undervaluing the stock.
Applying this analysis, the Sixth Circuit held that State Street demonstrated a prudent process in its fiduciary decisions regarding GM's ESOP because:
  • State Street monitored and researched GM's stock on an ongoing basis and repeatedly discussed whether to continue investments in GM stock and increased the frequency of discussions during GM's financial problems, which demonstrated prudence.
  • The participants did not show special circumstances why State Street's process was imprudent.
Additionally, the court noted that the decision of other fiduciaries to continue to buy and not divest the GM stock on or near the dates that State Street made their decisions was evidence of the reasonableness of State Street's decisions.

Practical Implications

Post Dudenhoeffer, the Sixth Circuit's holding shows that if the fiduciary's process for making decisions about the investment in company stock is prudent, then the investment is also prudent. Interestingly, the court mentioned other fiduciaries, including fiduciaries of other pension plans and non-pension-plan investment funds, as further demonstration of the reasonableness of State Street's decisions. In the Sixth Circuit and other circuits that take a similar approach, the actions of other fiduciaries may help to demonstrate the reasonable nature of a fiduciary's decision.