Skip to main content
A Better Partnership


Jul 2014
July 24, 2014

ESOP Advisor - Summer 2014

The Supreme Court has an Opinion on ESOPs: Does It Impact Your ESOP?

Each year the Supreme Court is asked to take approximately 10,000 cases but only accepts around 75-80, according to court records. It is rare for the Court to hear a case involving retirement plans, but on June 25, 2014, the Supreme Court issued a decision involving ESOPs in Fifth Third Bancorp v. Dudenhoeffer. In Dudenhoeffer the Supreme Court rejected a nearly 20-year old rule that had developed in the courts - known as the presumption of prudence - and established a new standard of review for investments in employer stock. Dudenhoeffer is principally a case about ESOPs in publicly traded companies. But an estimated 95% of ESOP assets are in closely held companies that are not traded on any market. How that vast majority of ESOP companies will be impacted by Dudenhoeffer is unclear. 
Rejection of the Presumption of Prudence
Under the presumption of prudence rule, fiduciaries were presumed to be prudent in holding or offering employer stock investments unless the employer’s very survival was in doubt. The presumption provided a significant defense against a claim that a retirement plan investment in employer stock was not prudent. Plaintiffs had to show the fiduciaries knew or should have known the employer was in financial distress and likely to fail. The presumption developed to address the very practical difficulty that a fiduciary faces when a business is in decline. A sale at a low price could result in a lawsuit if the price recovers. However, failing to sell if the business fails or the stock price continues to fall also could result in a lawsuit. The presumption of prudence recognized that Catch-22 and provided a significant defense for fiduciaries when making investment decisions with respect to employer stock.
A New Standard
Although the Supreme Court rejected the presumption of prudence, it did provide new standards for evaluating the prudence of an investment in employer stock. The Court concluded that a plaintiff must be able to demonstrate that another action would have been more prudent. In considering whether a plaintiff’s complaint is potentially justified, the Supreme Court identified three factors to consider:
  • ERISA does not require fiduciaries to violate securities laws by selling employer stock based on insider information;
  • Securities laws serve a significant purpose and may require a fiduciary to refrain from disclosing information or purchasing additional stock, and those actions may conflict with ERISA; and
  •  Would refraining from disclosing information or purchasing additional stock do more harm than good by harming the value of the stock already held by the plan? 
Impact on Closely Held Company ESOPs
At first glance the elimination of the presumption of prudence would appear to be a negative change for all ESOPs, but a review of litigation from 1995-2013 found no decisions involving closely held companies and the presumption of prudence. And although the new standard articulated by the Supreme Court is undoubtedly helpful for fiduciaries of publicly traded companies who invest in employer stock in their retirement plans, it provides little helpful guidance for ESOP fiduciaries in closely held companies. The National Center for Employee Ownership produced an excellent article on this issue, which you can read here.
It is reasonable to assume that most future litigation involving ESOP acquisitions of employer stock in closely held companies will continue to be based on claims that the ESOP paid too much for the employer stock. The elimination of the presumption of prudence may not have significant legal impact on how a court would view that type of claim. Unfortunately, until that is confirmed by a lower court, Dudenhoeffer’s greatest impact may be in encouraging plaintiffs’ lawyers to sue ESOP fiduciaries in hopes of achieving a settlement.

NOTICE. Although we would like to hear from you, we cannot represent you until we know that doing so will not create a conflict of interest. Also, we cannot treat unsolicited information as confidential. Accordingly, please do not send us any information about any matter that may involve you until you receive a written statement from us that we represent you.

By clicking the ‘ACCEPT’ button, you agree that we may review any information you transmit to us. You recognize that our review of your information, even if you submitted it in a good faith effort to retain us, and even if you consider it confidential, does not preclude us from representing another client directly adverse to you, even in a matter where that information could and will be used against you.

Please click the ‘ACCEPT’ button if you understand and accept the foregoing statement and wish to proceed.



+ -