Retirement ESOPs and the Presumption of Prudence

The Employee Retirement Income Security Act of 1974 (ERISA) requires that retirement plan administrators manage plan assets as a "fiduciary." A fiduciary duty is the highest standard of care known to American law.

Some retirement plans invest in their own company's stock. These retirement plans are called "ESOPs": employee stock ownership plans.

Why would a plan participant challenge his or her company's decision to invest in it own stock? Or that the ESOP has a duty to diversify? Or that it should limit its investment in company stock or even not invest at all? Isn't self-interest a breach of fiduciary duty?

Nonetheless, the seven federal courts of appeal that considered the issue ruled that the ESOP fiduciary enjoys a legal presumption that investing company stock is prudent. Who would want to work for a company that was not confident enough in its future that its retirement plan would not invest in it?

If company stock declines, and the ESOP fiduciary stays the course, the presumption of prudence would allow the fiduciary to fend off challenges to that decision. These are called "stock drop" lawsuits and the presumption is intended to limit the proliferation of these suits and encourage the use of ESOPs.

Remember When?
How far does the "presumption of prudence" go? Consider this:

"Four class action lawsuits had been filed against the company alleging that it violated its fiduciary duty to its employees by encouraging them to invest in company stock at artificially-inflated prices. Employees have lost about a billion dollars on the energy company's stock held in their 401(k) retirement accounts. Overall, the 20,795 participants in Enron's 401(k) plan had about 63 percent of their assets invested in company stock."

(Quoted from the Feb. 18, 2002, issue of Elder Law FAX, titled "Retirement Plan Fiduciaries Under Scrutiny,"

Enron's stock price fell from a high of $90 a share in August 2000 to close at 61 cents on November 28, 2001 (a week before it filed bankruptcy). The bankruptcy of WorldCom (which at one time was the second largest long distance carrier in the United States) occurred in July 2002. ESOP participants likewise filed lawsuits over WorldCom's decision to invest in its own company stock. (See Elder Law FAX, Feb. 7, 2005,

Presumption: GONE
In Fifth Third Bancorp v. Dudenhoeffer, the plaintiffs were former participants in Fifth Third Bank's 401(k) plan, which offered investments in the bank's common stock. When the share price dropped during the Great Recession, the ESOP remained invested in bank stock despite, the plaintiffs alleged, readily available information that holding the stock would be "imprudent." The bank raised the presumption as a bar to the lawsuit.

The U.S. Supreme Court upheld the presumption of prudence as it applies to the ESOP itself: in enacting ERISA, Congress explicitly permits a company's retirement plan to invest in itself. That form of self-dealing is NOT prima facie a breach of fiduciary duty.


However, the Supreme Court abolished the presumption that buying and holding company stock is prudent.

Instead, said the Court, all ERISA does is to allow ESOP fiduciaries to invest in company stock without the duty to diversify. Stretching the presumption beyond that is not supported by ERISA.

Instead, courts were instructed to carry out "careful, context-sensitive scrutiny of a complaint's allegations" before dismissing the case on the pleadings.

The shield of the presumption now history, the decision may lead to more "stock drop" lawsuits. But it may also encourage ESOP fiduciaries to be a bit more vigilant in overseeing their investment in company stock.

Or maybe the better word to use is "prudent."

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