In the wake of the Enron scandal, the vulnerabilities created by heavy investment in company stock received widespread criticism when employees lost both their jobs and their retirement savings as companies collapsed.
After the most recent financial downturn, precipitated by the subprime mortgage crisis, American workers experienced similar losses.
In response to both downturns, employees invested in company stock brought claims alleging that their employers—who also served as administrators of their savings and investment plans—breached their fiduciary duties
under the Employee Retirement Income Security Act (ERISA)
by failing to disclose material nonpublic information to plan participants and declining to divest plans of company stock.
As Professor Susan Stabile noted in reference to the Enron-era suits, “In whatever formulation, the allegations sound very much like things that would be alleged as violations of the federal securities laws but for the fact that the plaintiffs are participants in a plan covered by ERISA.”
Employees invest in company stock through participant-directed eligible individual account plans (EIAPs), including employee stock ownership plans (ESOPs) and 401(k) plans.
Claims by employees invested in such plans pose the following questions: How do ERISA-based duties differ from disclosure requirements under securities laws?
What action must a prudent ERISA fiduciary take to protect plan participants against loss? How much can, and must, ERISA fiduciaries do without breaking securities laws?
These questions are further complicated by the nature and purpose of ESOPs. Unlike other plans governed by ERISA, Congress intended ESOPs not only to encourage and protect employee savings but also to promote employee ownership and to act as tools of corporate finance, both goals in their own right.
Courts considering ESOP participants’ breach-of-fiduciary-duty claims have been wary of defeating Congress’s purpose of encouraging such plans by creating liability for fiduciaries facing a volatile market and conflicting goals.
For many years, the prevailing standard in the U.S. circuits was to provide a presumption of prudence that assumed ESOP fiduciaries acted prudently unless a plaintiff could prove an abuse of discretion.
In Fifth Third Bancorp v. Dudenhoeffer, the Supreme Court rejected the presumption in a 9-0 decision.
The Court held that “the law does not create a special presumption favoring ESOP fiduciaries. Rather, the same standard of prudence applies to all ERISA fiduciaries . . . .”
Justice Breyer, who authored the opinion, then provided several factors for lower courts to consider when evaluating claims that ESOP fiduciaries had breached their duties by failing to act on nonpublic information.
First, he reminded courts that ERISA-based duties cannot require fiduciaries to break securities laws.
Second, he asked courts to consider duties under ERISA in the context of securities laws.
And third, he instructed courts to evaluate whether a prudent fiduciary in the same circumstances could have thought more harm than good would have been done by refraining from purchasing more stock or disclosing material information that would have caused a stock drop.
While the Court’s guidelines in Dudenhoeffer highlight many of the important issues that typically arise in ESOP suits, they also leave some questions unanswered and open for lower court and SEC development.
These unanswered questions expose fiduciaries to uncertain liability from plaintiffs testing the new standard.
This Note focuses on one of the most common strategies adopted by corporate insiders seeking to avoid liability under ERISA: the appointment of independent third-party fiduciaries to manage and invest plan assets.
By giving control to independent fiduciaries, corporate insiders seek to absolve themselves of responsibility to plan participants. According to one federal district judge, this strategy is “the driving force behind the structure of ERISA plans.”
The success of this strategy depends on whether courts find that the duty to monitor, which is part of ERISA’s duty of prudence, has an attendant duty to inform.
If so, corporations that appoint fiduciaries will not be able to escape liability by delegating their authority because they will still have a duty to inform the appointed fiduciaries of material nonpublic information that could harm plan participants. This Note considers whether this duty exists and concludes that courts should uphold duty-to-inform claims only if defendants have been unable to dismiss securities law actions against them.
Part I provides a brief overview of ERISA and ERISA fiduciary duties, focusing on the duty of prudence and disclosure duties, which are most relevant to this Note. Part II takes a closer look at ESOPs and the presumption of prudence courts applied in evaluating claims before Dudenhoeffer. It then turns to Dudenhoeffer and lower court interpretations of that case. Also in Part II, this Note examines the strategy of appointing independent fiduciaries to avoid liability, as well as plaintiffs’ attempts to overcome this strategy by alleging duty-to-inform claims. Part III discusses whether courts should find that ERISA requires appointing fiduciaries to inform appointed fiduciaries of nonpublic information, looking to principles from trust law, Department of Labor guidelines, and language from Dudenhoeffer itself for guidance. This Note proposes that courts should apply Dudenhoeffer to determine the viability of duty-to-inform claims and suggests that courts should uphold such claims only when appointing fiduciaries break securities laws.
I. ERISA and ERISA Fiduciary Duties
Section I.A of this Part begins by examining the history and purpose of ERISA, paying close attention to Congress’s intent in enacting this comprehensive regulatory framework. It then offers an overview of who qualifies as a fiduciary under ERISA, whether fiduciaries may delegate their responsibilities, and what fiduciary duties the statute imposes. This section focuses on whether ERISA fiduciary duties entail disclosure duties distinct from the requirements made explicit elsewhere in ERISA.
Congress enacted ERISA in 1974, recognizing the expansion of private pension funds in the United States. ERISA was the culmination of a decade-long study finding that the “growth in size, scope, and numbers of employee benefit plans in recent years has been rapid and substantial” and that “the continued well-being and security of millions of employees and their dependents are directly affected by these plans.”
A primary motivation for enacting ERISA was the inadequacy of pre-ERISA standards in ensuring the payment of promised benefits.
Through this new legislation, Congress sought to “correct this condition by making sure that if a worker has been promised a defined pension benefit . . . he actually will receive it.”
To accomplish this task, Congress designed ERISA to establish “minimum standards” of fiduciary conduct for those administering retirement plans and to require “adequate public disclosure of the plan’s administrative and financial affairs.”
1. Who Are ERISA Fiduciaries? — Before turning to consider what is required of an ERISA fiduciary, one must determine who qualifies as a fiduciary under the statute. Accordingly, in any claim alleging breach of ERISA fiduciary duties, the “threshold question” is always whether the defendant was in fact “acting as a fiduciary . . . when taking the action subject to complaint.”
Two types of fiduciaries exist under ERISA: “named fiduciaries” and “functional fiduciaries.”
Named fiduciaries refer to persons or entities who are “named in the plan instrument, or who, pursuant to a procedure specified in the plan” are given express “authority to control and manage the operation . . . of the plan.”
Functional fiduciaries “need not be named as fiduciaries in the governing plan document.”
Under 29 U.S.C. § 1002(21)(A), a fiduciary is defined as:
[A] person . . . with respect to a plan to the extent (i) he exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets, (ii) he renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, or has any authority or responsibility to do so, or (iii) he has any discretionary authority or discretionary responsibility in the administration of such plan.
This statutory framework has been “construed liberally” by the Supreme Court, which has not required a person to have exclusive decisionmaking authority over a plan, so long as that person has some discretionary control.
However, courts have interpreted the statute’s “to the extent” language to mean that one is a fiduciary only with respect to the particular actions over which one actually has control.
2. Who Else Can Be an ERISA Fiduciary: How Do ERISA Fiduciaries Delegate Duties? — In addition to named and functional fiduciaries, fiduciary status may be created by appointment under ERISA. Corporate employers who are named fiduciaries under the plan may designate an individual, committee, or professional plan administrator to administer their sponsored plans.
The allocation of nontrustee fiduciary responsibilities is articulated at 29 U.S.C. § 1105.
It explains that plan documents “may expressly provide for procedures (A) for allocating fiduciary responsibilities (other than trustee responsibilities) among named fiduciaries, and (B) for named fiduciaries to designate persons other than named fiduciaries to carry out fiduciary responsibilities (other than trustee responsibilities) under the plan.”
Still, “the delegating fiduciary has a duty to monitor the performance of the fiduciary to whom fiduciary responsibilities are delegated.”
Under 29 U.S.C. § 1103, fiduciaries may delegate trustee responsibilities.
A plan’s assets are to be held in trust by one or more trustees, who “shall be either named in the trust instrument or in the plan instrument . . . or appointed by a person who is a named fiduciary.”
Once a trustee accepts appointment, she has
exclusive authority and discretion to manage and control the assets of the plan, except to the extent that (1) the plan expressly provides that [she] [is] subject to the direction of a named fiduciary who is not a trustee . . . or (2) authority to manage, acquire, or dispose of assets of the plan is delegated to one or more investment managers.
Though fiduciaries may delegate different degrees of responsibility,
one type of appointment, outsourcing, permits fiduciaries to allocate near complete responsibility to professional, independent third-party firms. In a 2014 report, the ERISA Advisory Council (the Council) noted that this practice has grown in “prevalence and scope.”
The Council attributed the popularity of outsourcing to its ability to permit “plan sponsors [to] gain access to expertise and technology, achieve economies of scale, and reduce costs,” as well as “focus on [their] core business rather than managing [their] employee benefit plans.”
3. What Are the Duties of an ERISA Fiduciary? — ERISA fiduciary duties arise out of 29 U.S.C. § 1104, which prescribes four duties owed by fiduciaries,
including (1) the duty of loyalty,
(2) the duty of prudence,
(3) the duty to diversify plan assets,
and (4) the duty to follow the plan’s terms.
To define the general scope of ERISA fiduciaries’ authority and responsibility, Congress intended courts to turn to the common law of trusts.
Additionally, because these duties serve the purpose of protecting the administration of retirement plans, courts have recognized ERISA fiduciary duties as “the highest known to the law.”
When fiduciaries breach these duties, the statute imposes personal liability for resulting losses and/or illicit profits.
The duty of prudence, under which duties to monitor and investigate—the focus of this Note—are found,
requires fiduciaries to act “with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.”
Courts consider the test for prudence to be procedural, or one of conduct, rather than one of results.
As mentioned above, monitoring and investigating duties are subsumed under the duty of prudence.
For fiduciaries investing in company stock, a duty to investigate only arises when there is a “‘red flag’ of misconduct” that would alert a fiduciary to the imprudence of investing in company stock.
Reasonable fiduciaries—those who “appropriately investigate the merits of an investment decision prior to acting”—clearly fulfill their duties.
A more controversial question is whether the duty to monitor includes an attendant duty to disclose to plan participants adverse, material nonpublic information.
Courts have not provided a uniform answer to this question.
Despite the resistance of some circuits to find such a duty,
plaintiffs who have participated in plans governed by appointed, independent fiduciaries have attempted to extend this duty: They claim that fiduciaries have a duty not only to inform plan participants but also to inform appointed fiduciaries.
Whether this duty exists is the focus of this Note.
4. What Disclosure Requirements Does ERISA Impose? — Because ERISA includes express disclosure requirements,
some courts have been reluctant to find that disclosure duties arise under the statute’s fiduciary requirements.
Courts are particularly wary of intervening because they fear interfering in judgments made by businesses in their capacity as such, rather than in their fiduciary capacities.
Whether ERISA’s fiduciary duties encompass a duty to disclose has been called an “area of developing and controversial law.”
ERISA’s express disclosure requirements are articulated at 29 U.S.C. §§ 1021–1025. Affirmative disclosure obligations have been recognized regarding “plan terms and requirements, matters of plan administration, or tax or other legal issues affecting participant plan elections.”
To obtain information about their plans, employees may also consult investment communications, disclosed in summary plan descriptions (SPDs) required by ERISA.
As noted, fiduciary-imposed disclosure requirements are less settled.
In Varity Corp. v. Howe, the Supreme Court clarified that when a fiduciary speaks in that capacity, there is a duty to speak truthfully and completely even if ERISA did not require those communications.
However, the Court did not “reach the question whether ERISA fiduciaries have any fiduciary duty to disclose truthful information on their own initiative, or in response to employee inquiries.”
The Second, Fifth, and Eleventh Circuits have refused to impose affirmative duties to disclose material nonpublic information to plan participants when plaintiffs allege that fiduciaries failed to properly report the risks associated with company stock.
The Second Circuit has drawn a clear line between disclosure requirements relating to administrative matters and those relating to investment matters, refusing to find disclosure duties for the latter.
The Eleventh Circuit has also declined to “create a rule that converts fiduciaries into investment advisors.”
The circuit feared that such a duty would require fiduciaries to disclose adverse nonpublic information to plan participants upon a “guess” that the information would negatively affect the fund.
In Kujanek v. Houston Poly Bag I, Ltd., the Fifth Circuit noted that “trust principles impose a duty of disclosure upon an ERISA fiduciary when there are material facts affecting the interest of the beneficiary which the fiduciary knows the beneficiary does not know but needs to know for his protection.”
However, Kujanek “involved the withholding of Plan-related documents likely covered by ERISA’s detailed disclosure and reporting scheme.”
In interpreting Kujanek, a district court has thus concluded that a specific violation of the disclosure requirements is required to allege a disclosure claim.
In contrast, the Third Circuit has been willing to find affirmative disclosure duties related to discussions of plan benefits. In one case, the circuit held it is “a breach of fiduciary duty for an employer to knowingly make materially misleading statements about the stability of a benefits plan.”
In another case, the circuit noted that the “duty to inform is a constant thread in the relationship between beneficiary and trustee; it entails not only a negative duty not to misinform, but also an affirmative duty to inform when the trustee knows that silence might be harmful.”
Similarly, the Fourth Circuit has acknowledged that ERISA administrators have a fiduciary duty “not to misinform employees through material misrepresentations and incomplete, inconsistent or contradictory disclosures.”
At times, the circuit held, a fiduciary is “obligated to affirmatively provide information to the beneficiary . . . [including] ‘facts affecting the interest of the beneficiary which he knows the beneficiary does not know and which the beneficiary needs to know for his protection.’”
In the context of ESOPs, the Supreme Court’s decision in Fifth Third Bancorp v. Dudenhoeffer suggests that ERISA fiduciary duties require disclosure to plan participants under certain circumstances.
By acknowledging that ESOP fiduciaries may be liable for failing to disclose material nonpublic information when doing so would have been consistent with securities laws and would not have done more harm than good,
the Court implicitly recognized that ERISA’s duty of prudence imposes disclosure duties when those conditions are met.
II. ESOPs and the Current State of the Law
With this background on ERISA and the statute’s disclosure duties established, Part II takes a closer look at ESOPs and the holding and consequences of Dudenhoeffer. Section II.A first explains what ESOPs are and how they function and then considers some of the conflicting goals Congress sought to achieve when establishing this form of investment vehicle. Section II.B discusses the presumption of prudence, which was once the predominant standard of review for breach-of-fiduciary-duty claims by ESOP participants, and examines the current state of the law, focusing on Dudenhoeffer. Following this, section II.C considers how corporate-insider fiduciaries have tried to avoid liability after Dudenhoeffer by seeking to rid themselves of their fiduciary status and responsibilities through the appointment of independent third-party fiduciaries. Because the success of this strategy depends on whether courts find that ERISA imposes a duty to inform appointed fiduciaries of material nonpublic information, this section ends by examining courts’ disagreement over the existence of such a duty and considering the different rationales put forth by courts deciding duty-to-inform cases.
ESOPs are currently the most common mechanism through which employees own company stock.
Statistics made available by the National Center for Employee Ownership (NCEO) suggest that there are currently 9,323 ESOP and ESOP-like plans in the United States with total assets worth $1.3 trillion.
The NCEO estimates that 32 million Americans own employer stock through ESOPs, options, stock purchase plans, and 401(k) plans.
Thus the rules regulating ESOPs have massive consequences, affecting the many Americans invested in employer stock.
To establish an ESOP, a company contributes shares of its stock into a trust fund or uses cash to buy existing shares of its stock.
ESOPs are defined contribution plans, one of two types of pension plans governed by ERISA.
Defined contribution plans, which are more popular today,
place the investment risk on participants.
Amounts are based on contributions, income, expenses, and investment gains or losses.
Defined benefit plans place the investment risk on employers, who must fund the promised benefits.
Contributions are determined by a formula that contemplates compensation, age, and the fund’s investment performance.
Participation in ESOPs is voluntary, but Congress has created tax benefits and other incentives for participating employers and employees.
ESOPs were originally introduced in 1974 and have been continuously endorsed and expanded by Congress. ESOPs were designed to promote employee ownership and to enable companies to use their stock as a “technique of corporate finance.”
Congress believed employee stock ownership would inspire “motivation, commitment, and dedication of our work force,” which would “improve productivity.”
In the Tax Reform Act of 1976,
Congress created tax benefits and other financial incentives for employers to offer company stock for retirement plans and for employees to accept that offer.
The Act makes available to employers tax breaks on profit sharing, matching contributions, and compensation made in the form of company stock.
The tax exemptions also encourage employees to invest in company stock because employers often use company stock to match contributions or do so at a higher rate than for other retirement investments.
Because ESOPs are, and are meant to be, beneficial to employers in addition to employees, conflicts can arise from these competing goals. Employers, who often also act as fiduciaries, may be placed in a position where they must choose between their interests and those of their employees.
Moreover, the line between the employer’s roles as fiduciary and businessperson blurs when the employer wears both “hats,” leaving courts torn when considering employer conduct.
As the Fifth Circuit explained in Donovan v. Cunningham:
Congress has repeatedly expressed its intent to encourage the formation of ESOPs by passing legislation granting such plans favorable treatment, and has warned against judicial and administrative action that would thwart that goal. Competing with Congress’ expressed policy to foster the formation of ESOPs is the policy expressed in equally forceful terms in ERISA: that of safeguarding the interests of participants in employee benefit plans by vigorously enforcing standards of fiduciary responsibility.
Courts considering these competing goals often hear two types of claims: the prudent-investment claim and the failure-to-disclose claim.
These suits are typically brought as companion cases to securities class actions alleging the same failures to disclose material nonpublic information to stockholders.
The prudent-investment claim argues that the “fiduciaries knew or should have known that the employer stock was not a prudent investment option for the plan”; the failure-to-disclose claim alleges that the “fiduciar[y] made misrepresentations about or failed to disclose material adverse information affecting the value of the employer stock.”
In such cases, company personnel, including board members, company officers, plan administrators, members of the plan’s administrative and investment committee, and members of the finance committee, are routinely named as defendants based on their alleged status as ERISA fiduciaries.
B. Judicial Review of Claims Alleging Breach of Fiduciary Duties
Beginning in 1995, courts considering these ESOP breach-of-fiduciary-duty claims applied a “presumption of prudence,” a standard articulated by the Third Circuit in Moench v. Robertson.
In Moench, the Third Circuit offered several reasons for adopting such a deferential standard and favoring the goals of ESOPs over the “stringent fiduciary duties” of ERISA.
The Moench court feared that subjecting fiduciaries to stricter judicial scrutiny would “risk transforming ESOPs into ordinary pension benefit plans,” thus frustrating Congress’s purpose.
The court, noting that the very existence of ESOPs demonstrates the per se value in employee ownership despite the risks to participants’ financial gains, concluded that “the policies behind ERISA’s rules governing pension benefit plans cannot simply override the goals of ESOPs, and courts must find a way for the competing concerns to coexist.”
Ultimately, the Third Circuit decided that ESOP fiduciaries should be entitled to an abuse of discretion standard through the presumption of prudence.
After the Third Circuit established the Moench presumption, the Second, Fifth, Sixth, Seventh, Ninth, and Eleventh Circuits adopted this standard.
The Moench presumption was “very difficult to overcome . . . .”
Though courts did not require “‘[p]roof of the employer’s impending collapse,’ . . . mere stock fluctuations [were] insufficient to show that fiduciaries acted imprudently by adhering to the terms of an ESOP.”
One court found that a seventy-five percent decrease in stock price was not in itself a fact that could overcome the Moench presumption.
1. Fifth Third Bancorp v. Dudenhoeffer. — In 2014, the Supreme Court decided Fifth Third Bancorp v. Dudenhoeffer, abrogating the Moench presumption and articulating a new test for lower courts.
The case arose out of the financial crisis that led to the Great Recession.
The plaintiffs were employees and participants in the ESOP of Fifth Third Bancorp, the defendant bank.
They alleged that the bank’s investment in employer stock had become “overvalued and excessively risky.”
According to the plaintiffs, the ESOP fiduciaries, who were officers for the bank, made material misstatements about the company’s financial prospects and breached their fiduciary duties by failing to act on nonpublic information.
Rather than continuing to invest in Fifth Third stock, they asserted, the fiduciaries should have (1) sold off the ESOP’s holdings of company stock, (2) refrained from purchasing more stock, (3) cancelled the plan’s ESOP option, or (4) disclosed the negative inside information to engender market correction.
Instead, the fiduciaries continued to hold and buy Fifth Third securities; after the market crashed, the stock price fell by seventy-four percent between July 2007 and September 2009.
In considering the plaintiffs’ claim, the Supreme Court decided that ERISA “does not create a special presumption favoring ESOP fiduciaries. Rather, the same standard of prudence applies to all ERISA fiduciaries, including ESOP fiduciaries, except that an ESOP fiduciary is under no duty to diversify the ESOP’s holdings.”
The Court explained that “[t]he proposed presumption makes it impossible for a plaintiff to state a duty-of-prudence claim, no matter how meritorious, unless the employer is in very bad economic circumstances.”
According to Justice Breyer, “Such a rule does not readily divide the plausible sheep from the meritless goats.”
Instead, the Court proposed accomplishing “[t]hat important task . . . through careful, context-sensitive scrutiny of a complaint’s allegations”
and replaced the presumption of prudence with a new test:
To state a claim for breach of the duty of prudence on the basis of inside information, a plaintiff must plausibly allege an alternative action that the defendant could have taken that would have been consistent with the securities laws and that a prudent fiduciary in the same circumstances would not have viewed as more likely to harm the fund than to help it.
The Court then provided guidelines for lower courts to follow when evaluating such claims. First, courts should recognize that “the duty of prudence . . . does not require a fiduciary to break the law.”
Essentially, this articulates the commonsense notion that fiduciaries cannot be required, and are in fact prohibited, from engaging in insider trading to fulfill their fiduciary duties. Second, courts should bear in mind the extent to which ERISA-based obligations “could conflict with the complex insider trading and corporate disclosure requirements imposed by the federal securities laws or with the objectives of those laws.”
With this factor, the Court questioned whether ERISA can impose additional requirements on fiduciaries that exceed those that the SEC enforces through securities laws.
As brought to light in later lower court opinions, this is ultimately a question of whether ERISA fiduciaries privy to inside information must disclose such information to fulfill their fiduciary duties, even though such disclosure would not be mandated by federal securities laws.
And third, courts must determine whether the complaint, as held to Iqbal and Twombly standards,
plausibly alleges that “a prudent fiduciary in the defendant’s position could not have concluded that stopping purchases—which the market might take as a sign that insider fiduciaries viewed the employer’s stock as a bad investment—or publicly disclosing negative information would do more harm than good to the fund” due to a resulting stock drop, which would cause a “concomitant drop in the value of . . . the fund.”
2. Interpreting Dudenhoeffer: Harris v. Amgen Inc. — In Harris v. Amgen Inc.,
the Ninth Circuit applied the Dudenhoeffer test to a claim that fiduciaries of a global biotechnology company had breached their duties by continuing to purchase Amgen stock even though they knew or should have known “about material omissions and misrepresentations . . . that artificially inflated the price of the stock.”
In applying the first factor of Dudenhoeffer, the Ninth Circuit panel rejected Amgen’s argument that removal or disclosure could have violated securities laws.
The court posited that “if defendants had revealed material information in a timely fashion to the general public . . . , they would have simultaneously satisfied their duties under both the securities laws and ERISA.”
Alternatively, if Amgen had removed the fund as an investment option, Amgen would not have broken securities laws because “there is no violation absent purchase or sale of stock.”
When considering the second factor of Dudenhoeffer—the extent to which ERISA-based obligations conflict with securities laws—the Ninth Circuit made clear that it predicated its holding on the companion case, Connecticut Retirement Plans,
in which the court denied Amgen’s motion to dismiss the claim alleging the company violated federal securities laws:
If the alleged misrepresentations and omissions, scienter, and resulting decline in share price in Connecticut Retirement Plans were sufficient to state a claim that defendants violated their duties under Section 10(b), the alleged misrepresentations and omissions, scienter, and resulting decline in share price in this case are sufficient to state a claim that defendants violated their duty of care under ERISA.
Notably, the panel’s decision did not explicitly decide whether ERISA could require fiduciaries to freeze a stock plan or disclose nonpublic information in the absence of a securities law violation.
However, subsequent cases have pointed to the Amgen court’s recognition of the existence of a viable securities companion case and found that the existence of such a case may be grounds for satisfying Dudenhoeffer’s second factor.
Finally, the Ninth Circuit applied the Supreme Court’s third directive in Dudenhoeffer—to consider whether a prudent fiduciary may have concluded that removal or disclosure would do more harm than good—and found that the complaint satisfied the standard because it was “quite plausible” that removing the fund would not have caused “undue harm to plan participants.”
When the Supreme Court granted certiorari to the Amgen defendants in January 2016 to decide whether the third factor was properly applied, the Court made clear that the Ninth Circuit had misapplied this factor of the Dudenhoeffer test and reversed the panel’s decision.
The Supreme Court clarified that complaints may only survive a motion to dismiss when they plausibly allege that “a prudent fiduciary in the same position ‘could not have concluded’ that the alternative action ‘would do more harm than good.’”
The Court then remanded the case to the district court to determine whether the stockholders should be granted leave to amend their complaint to comply with the newly clarified standard.
C. How Defendants Have Avoided Liability After Dudenhoeffer
In light of Dudenhoeffer and subsequent case law,
it has become clear that, under certain circumstances, ERISA may impose a duty to disclose material nonpublic information to plan participants, thus exposing fiduciaries to liability when they fail to do so.
This potential for liability puts fiduciaries at risk when their companies face downturns.
1. Appointing Third-Party Fiduciaries. — To avoid situations that would expose themselves to ERISA liability, corporate directors have widely adopted the practice of appointing independent third-party fiduciaries to manage company ESOPs.
These independent fiduciaries are not affiliated with the plan sponsor and make autonomous investment decisions.
This strategy—in which plan documents are written to transfer authority and control from employers to independent fiduciaries—is widespread in ERISA plan management.
By delegating control over plans to independent third-party fiduciaries, insiders may renounce their status as ERISA fiduciaries, and their accompanying duties.
As the Supreme Court has made clear:
In every case charging breach of ERISA fiduciary duty . . . the threshold question is not whether the actions of some person employed to provide services under a plan adversely affected a plan beneficiary’s interest, but whether that person was acting as a fiduciary (that is, was performing a fiduciary function) when taking the action subject to complaint.
Accordingly, before a court contemplates any ERISA breach-of-fiduciary-duty claim, it must find that the alleged fiduciaries were in fact fiduciaries under ERISA.
To make this determination, courts must consider whether an entity or individual “exercises any discretionary authority or discretionary control” over plan asset management or administration.
If a court finds a person’s “authority to appoint plan fiduciaries . . . does not mean that he has a fiduciary obligation to prudently manage and invest the plan’s assets,”
companies may successfully rid themselves of their fiduciary status, effectively exculpating themselves from liability.
Because courts may grant a motion to dismiss before reaching the merits of the underlying claim, such an approach can be highly effective.
2. Duty-to-Monitor Claims that Allege an Attendant Duty to Inform. — While the successful delegation of authority to independent third-party fiduciaries may prevent courts from finding that employers were fiduciaries with respect to managing plan investments, plaintiffs have tried to get around this by alleging novel duty-to-monitor claims.
The theory, which courts have dubbed “duty-to-inform” claims,
proposes that defendants with nonpublic information may be liable for breaching their fiduciary duties if they fail to inform appointed third parties of material information they possess.
Because this could extinguish the utility of appointing third-party fiduciaries for purposes of avoiding ERISA-based liability,
the courts’ acceptance of this theory is of consequence.
Given the confusion and inconsistency regarding the extent of the disclosure duties that ERISA fiduciaries owe plan participants,
it is not surprising that courts disagree over whether appointing fiduciaries have a duty to inform appointed fiduciaries.
One court has noted: “[T]he duty to keep appointees informed has gained reasonably wide acceptance as an inherent facet of the more general ‘duty to monitor.’”
According to the court, even those courts that “seemed less inclined to unequivocally endorse the duty to inform have found it inappropriate to dismiss such a claim on a Rule 12(b)(6) motion.”
“[A]s a matter of law,” the court refused to hold “that the duty encompasses no obligation to keep appointees reasonably informed of non-public, material information within the appointing fiduciary’s knowledge.”
In Ramirez v. J.C. Penney Corp., the Eastern District of Texas recognized the possibility of a “duty to provide truthful and accurate information.”
Acknowledging that ERISA does not itself create a duty to disclose “all adverse inside information to the public,” the court also noted that ERISA cannot eliminate disclosure duties imposed by other laws.
Because the plaintiffs pointed to the defendants’ material misrepresentations or omissions that caused the stock price to be artificially inflated, the appointed fiduciary could not “effectively discharge its obligations while being kept in the dark.”
Thus, the plaintiffs were found to have alleged facts sufficient to support a duty-of-prudence claim.
However, other courts have decided that “ERISA does not impose a duty on appointing fiduciaries to keep their appointees apprised of nonpublic information.”
In Rinehart v. Lehman Bros. Holdings Inc., the Second Circuit affirmed the Southern District of New York’s grant of defendants’ motion to dismiss on plaintiffs’ duty-to-inform claim.
The Southern District noted that “nothing in ERISA itself or in traditional principles of trust law creates such a duty.”
The court relied on the language of the ERISA statute that defines persons as fiduciaries only to the extent that person “exercises any discretionary authority or discretionary control respecting management” of an ERISA plan or “has any discretionary authority or discretionary responsibility in the administration” of such plan.
Having deemed the defendant a fiduciary only in his appointment of the third party, the court declined to find a continuing duty.
To do otherwise, the court explained, would interfere with the defendant’s business conduct, which “would stretch the concept of fiduciary duty far beyond what ERISA contemplates” and “create endless conflicts of interest between duties of corporate employees to act in the best interests of their employers, often by keeping information confidential, and newly imposed duties to disclose confidential employer information to plan fiduciaries.”
Noting that the Third Restatement of Trusts gives appointing fiduciaries a “duty to act with prudence in supervising or monitoring the agent’s performance and compliance with the terms of the delegation” and to “provid[e] the agent with substantive direction and guidance consistent with the terms and purposes of the trust,”
the court explained that an “initial obligation to provide direction is hardly the same thing as an ongoing obligation to share inside information.”
The court also considered a treatise stating: “‘[I]f a trustee is negligent in selecting, instructing or supervising an agent or employee, he will be held liable to the beneficiary for any resulting loss.’”
Admitting that “instructing” may sound like it gives rise to a duty to inform, the court went on to explain that the term is “congruent with the requirements of the Uniform Trust Code § 807(a)(2), which states only that a trustee ‘shall exercise reasonable care, skill, and caution in . . . establishing the scope and terms of the delegation . . . .’”
This duty, the court concluded, is “very different” than a duty to provide appointees with information.
When the Southern District of Texas rejected the In re BP plaintiffs’ duty-to-inform claim, the court relied on the holding of In re Lehman Bros.,
as well as on guidance from the Department of Labor in the Code of Federal Regulations.
The court found that “a ‘duty to inform’ appointed fiduciaries is nowhere to be found” in the Code of Federal Regulations.
In jurisdictions that reject a duty-to-inform requirement under ERISA, plaintiffs will not be able to successfully bring ERISA breach-of-fiduciary-duty claims if the defendant appointed and delegated authority to a third-party fiduciary. Because the appointment of third parties is a common practice company insiders use to avoid liability,
the existence of a duty-to-inform claim is essential for plaintiffs seeking to get past motions to dismiss.
III. Finding a Duty to Inform and Applying Dudenhoeffer to Such Claims
The conflicting precedent regarding the duty of appointing fiduciaries to disclose material nonpublic information to their appointed third parties needs to be resolved. Despite the important considerations highlighted by courts rejecting such claims, it is inappropriate to assert a per se rule against duty-to-inform claims. Instead, courts should apply Dudenhoeffer to determine whether such claims may withstand a motion to dismiss.
Section III.A explains why creating a per se rule against duty-to-inform claims should be abandoned. Section III.B suggests that courts should consider the factors laid out in Dudenhoeffer when deciding whether an appointing fiduciary violated a duty to inform third parties of material nonpublic information. The section concludes that courts should uphold such claims when they are alleged against defendants who have been unable to dismiss companion securities law claims.
A. Considering a Per Se Rule Against Duty-to-Inform Claims
A strict rule prohibiting duty-to-inform claims is in conflict with principles of trust law, guidance provided by the Department of Labor, and the holding of Dudenhoeffer. This section considers each of these sources to support the conclusion that duty-to-inform claims should withstand a motion to dismiss if they meet the Dudenhoeffer conditions.
1. Trust Law Principles. — Principles of trust law do not support a rule against duty-to-inform claims. In Tibble v. Edison International,
a recent Supreme Court case considering the statute of limitations under ERISA in the context of duty-to-monitor claims, Justice Breyer reminded lower courts that an “ERISA fiduciary’s duty is ‘derived from the common law of trusts’” and that in “determining the contours of an ERISA fiduciary’s duty, courts often must look to the law of trusts.”
Because the lower court had applied a statutory bar to the breach-of-fiduciary-duty claim and had not considered the changing circumstances in light of trust law principles, the Court remanded the case.
Thus, strict rules that absolve defendants from their ERISA fiduciary duties seem at odds with the type of construction the Supreme Court has recently advanced.
In Tibble, the Supreme Court relied on Law of Trusts and Trustees and Scott and Ascher on Trusts when considering applicable trust law.
These sources also shed light on why ERISA duty-to-inform claims should be permitted. At common law, a trustee was prohibited from delegating any duty unless permitted by a clause in the governing instrument.
This rule was first relaxed to allow delegation of ministerial tasks, but delegation for discretionary decisions was still forbidden.
Early decisions reflected courts’ reluctance to construe delegations in trust instruments broadly, fearing that providing broad immunity to trustees was “undesirable as a matter of policy.”
Today, there is “nearly universal consensus . . . permit[ting] a trustee to delegate investment and management functions so long as a prudent trustee, comparably skilled in like circumstances, would find such a delegation to be reasonable.”
While a “duty to inform” is not made explicit in Bogert’s treatise nor in Scott and Ascher on Trusts, the prudence requirements and policy concerns suggest that appointing fiduciaries are not permitted complete dereliction of duty post appointment. The trustee must still exercise “reasonable care, skill and caution . . . in the establishment of the agency’s scope, and in the periodic review of the agent’s work.”
And only when a “prudent person” would delegate investment duties is it “clearly permissible for a trustee” to do so.
Further, the development of the delegation doctrine in trust law makes clear that delegation has been permitted to best serve the interests of the trust beneficiaries
because the focus is on protecting the beneficiary, not the trustee.
A per se rule against duty-to-inform claims, even when appointing fiduciaries have violated securities laws, does not protect the interests of ESOP participants. Additionally, the protections put in place for the trustee who has delegated authority ensure that she is not held responsible for unforeseeable bad acts or poor decisions of the delegee; they do not protect the trustee from bad acts for which she herself is responsible in a fiduciary capacity.
Though the In re Lehman Bros. court did touch on the law of trusts, the court’s analysis does not so much draw on the law of trusts as it does distinguish the opinion’s holding from seemingly contradictory trust law principles.
The opinion does not point to a single trust law principle that prohibits or explicitly exempts appointing fiduciaries from keeping appointed fiduciaries reasonably informed.
Although the absence of language affirmatively creating a duty to inform may caution against adopting a liberal construction of such a duty, it also does not require the implementation of a per se ban.
2. Guidance from the Department of Labor. — A per se rule prohibiting duty-to-inform claims also conflicts with guidance from the Department of Labor in the Code of Federal Regulations. In response to the question, “What are the ongoing responsibilities of a fiduciary who has appointed trustees or other fiduciaries with respect to these appointments?,” the Department of Labor provides the following answer:
At reasonable intervals the performance of trustees and other fiduciaries should be reviewed by the appointing fiduciary in such manner as may be reasonably expected to ensure that their performance has been in compliance with the terms of the plan and statutory standards, and satisfies the needs of the plan. No single procedure will be appropriate in all cases; the procedure adopted may vary in accordance with the nature of the plan and other facts and circumstances relevant to the choice of the procedure.
While, as the In re BP court points out, this directive does not explicitly establish a duty to inform, the directive does explain that “[n]o single procedure will be appropriate in all cases” and that appointing fiduciaries should act to ensure compliance and to account for relevant circumstances.
Rather than promoting a strict rule that prohibits courts from finding a duty to inform, the Department of Labor supports consideration of the relevant facts and circumstances. It does not seem a stretch to suggest that appointing fiduciaries who have material nonpublic information would, under certain circumstances, consider disclosure to the appointed fiduciary “reasonably expected to ensure that their performance . . . satisfies the needs of the plan.”
3. Dudenhoeffer. — Dudenhoeffer acknowledges that ERISA fiduciary duties may include a duty to disclose material nonpublic information to plan participants.
This affirmative answer to the longstanding question of whether ERISA fiduciary duties include a duty to disclose
suggests that fiduciaries who have delegated their control may also be subject to the disclosure duties the Dudenhoeffer Court finds present in the statute. Participants in plans run by fiduciaries who have appointed third parties are no less deserving of protection than their peers who are invested in plans in which control has not been delegated. It is therefore consistent with Dudenhoeffer to recognize a duty to inform when plaintiffs allege their third-party fiduciaries should have been informed of material nonpublic information.
B. The Dudenhoeffer Factors in Reviewing Duty-to-Inform Claims
Assuming a court has made the preliminary determination that an appointing fiduciary has fully delegated control to an appointed, independent fiduciary,
courts would turn to the factors proposed in Dudenhoeffer—the standard test now used for claims by ESOP participants alleging fiduciaries failed to act on nonpublic information
—to decide whether to entertain duty-to-inform claims from ESOP participants. Or, put more simply, courts should affirm the existence of a duty to inform and apply Dudenhoeffer to test whether plaintiffs have stated a claim that the duty has been violated sufficient to withstand a motion to dismiss. The following sections walk through considerations courts should undertake when applying Dudenhoeffer to duty-to-inform claims.
1. Factor One of Dudenhoeffer. — Courts should not find a duty to inform when appointing fiduciaries would have violated securities laws by providing appointed fiduciaries with material nonpublic information.
In other words, corporate insiders should not be liable for withholding material information from their appointed fiduciaries in order to comply with insider-trading and selective-disclosure laws.
As long as plaintiffs allege that securities laws require appointing fiduciaries to disclose to the market as a whole, plaintiffs would not be asserting that fiduciaries had to disclose in violation of Rule 10b-5, which prohibits trading on inside information,
or Regulation FD, which bans selective disclosure.
2. Factor Two of Dudenhoeffer. — Prior to Dudenhoeffer, courts were wary of finding disclosure duties under ERISA that would mandate disclosure beyond that which the securities laws either required or permitted.
Since Dudenhoeffer, courts have clarified that ERISA does not impose liability for failure to disclose to plan participants unless securities laws would require disclosure to the market.
When courts apply Dudenhoeffer to duty-to-inform claims, they should only uphold such claims when the appointing fiduciary has been unable to dismiss a claim alleging violation of securities laws for omitting or misrepresenting material nonpublic information.
This qualification would prevent ERISA from expanding disclosure duties that other laws do not not already require.
For legal purposes, interpreting ERISA to be coextensive with, but not broader than, securities laws follows 29 U.S.C § 1144(d), which states that “nothing in [ERISA] shall be construed to alter, amend, modify, invalidate, impair, or supersede any law of the United States . . . or any rule or regulation issued under any such law.”
And turning to practical concerns, this limitation would save ERISA from disrupting the complex statutory framework established by the SEC and subsequent jurisprudence.
Additionally, it is important to reiterate that the argument here is only to uphold duty-to-inform claims against a motion to dismiss and does not suggest that such claims should lead to automatic recovery. The law forbids double recovery for the same injury, even when different legal theories support the same claim.
This limitation ensures that plaintiffs who have already recovered under a settlement or damages award in connection with their securities law claim would not be entitled to recover under a breach-of-fiduciary-duty claim
unless the ERISA-based claim provided for damages in excess of those provided by the securities action.
Damages under ERISA may exceed those under securities claims when plans have other sources of recovery, like fiduciary liability insurance, a fidelity bond, and personal assets of defendants, including their own employee-benefit-plan accounts.
In other words, the ERISA claim would only function as a backstop in case the securities claim did not settle or lead to (adequate) damages.
3. Factor Three of Dudenhoeffer. — The final factor courts should consider when deciding whether appointing fiduciaries had a duty to inform independent third-party fiduciaries of material nonpublic information is whether a “prudent fiduciary” could “not have concluded that” disclosure to the appointed fiduciary “would do more harm than good.”
This language lends itself to fact-specific inquiries in which courts consider “the facts and allegations supporting [the] proposition” that more harm than good would have been the result of disclosure.
These facts and allegations “should appear in the shareholders’ complaint.”
Notably, this factor may only sound like it would precipitate case-by-case analysis. In practice, when coupled with the requirement that securities laws must be breached, this final factor may do little work. Looking at the decisions applying Dudenhoeffer, courts have decided that a prudent fiduciary could not have concluded more harm than good would be done by disclosure if the defendant had also been unable to defeat securities claims against it.
As one district court explained, assuming the defendants had withheld material information from appointed fiduciaries that they were also required to disclose by securities laws, “Defendants cannot claim that complying with the law would have caused the company harm and thus compliance is not necessary under Dudenhoeffer.”
While the Supreme Court made clear in Amgen that it is not enough for a court to assume that it is “quite plausible” that more harm than good would have resulted from disclosure, the Court also suggested that plaintiffs similarly situated to the Amgen shareholders are “masters of their complaint,” able to plead a claim that satisfies the requirements of Dudenhoeffer.
This observation suggests that ERISA duty-to-inform claims should always be permitted when there is a viable securities claim and the complaint is properly pleaded and may never be permitted when such a companion case is absent or has been dismissed. If this is true, then ERISA disclosure duties are parallel to those established by securities laws.
The Supreme Court’s decision in Dudenhoeffer has left ESOP fiduciaries more vulnerable to ERISA-based suits than they were during the era of the Moench presumption. As a result, companies are more likely than ever to appoint independent fiduciaries to reduce the likelihood of suit from employees invested in company stock. One way plaintiffs, who may have suffered serious losses from downturns in their employer’s stock, can still successfully assert breach-of-fiduciary-duty claims is by alleging that appointing fiduciaries have a duty to inform appointed fiduciaries of material nonpublic information that would adversely affect stock price.
Courts should be willing to consider such claims and refrain from creating a per se rule against the duty to inform. Principles of trust law support this proposal. Delegation of trustee responsibilities was originally designed to protect and better serve beneficiaries, and trust law requires appointing trustees to act as reasonable and prudent trustees would when appointing and monitoring delegees. Additionally, the guidance from the Department of Labor and the Supreme Court’s holding in Dudenhoeffer affirm the existence of this duty.
Lower courts should look to the concerns the Supreme Court highlighted in Dudenhoeffer and uphold duty-to-inform claims when securities laws would independently require disclosure. If ERISA-based duties match and backstop those mandated by securities laws, duty-to-inform claims will not upset the complex disclosure regime established by the SEC but will instead complement and reinforce it. Further, this solution appeals to simple logic: ERISA’s duty of prudence requires fiduciaries to comply with law.