On June 23, the U.S. Supreme Court in Fifth Third Bancorp v. Dudenhoeffer1 unanimously rejected the “presumption of prudence” that several courts of appeals had recognized to deal with “stock drop” cases under the Employee Retirement Income Security Act of 1974 (ERISA), as amended.2 What should trustees of employee stock ownership plans (ESOPs) and §401(k) plans that invest in employer stock do when the price of the company begins to fall sharply? Plan fiduciaries are put on the horns of a dilemma: If they hold onto the stock, they may be accused of not acting in accordance with their duty of prudence, but if they sell the stock, they may face charges of insider trading in violation of the federal securities law.

Some of the lower courts attempted to mitigate this dilemma by recognizing a strong presumption of prudence favoring ESOP fiduciaries. For example, the U.S. Court of Appeals for the Second Circuit required the plaintiff to show that the employer was “in a ‘dire situation’ that was objectively unforeseeable by the settlor” of the fund.3 Justice Stephen Breyer’s opinion for the court in Dudenhoeffer closes off this route: “In our view the law does not create a special presumption favoring ESOP fiduciaries. Rather, the same standard of prudence applies to all ERISA fiduciaries…except that an ESOP fiduciary is under no duty to diversify the ESOP’s holdings.”4 The court did, however, offer some concrete suggestions that may facilitate early dismissal of costly “stock drop” litigation.

Background

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