Thinking ESOPs: Why Aren’t Courts Conducting the 'Context-Specific' Inquiry Into Complaints That the Supreme Court Requires?

Recently, several appellate-level court decisions have affirmed dismissals of ERISA fiduciary-breach claims involving 401(k) plans. These decisions followed the Supreme Court’s decision earlier this year in a 403(b) case, in which the Supreme Court explained that ERISA’s duty of prudence requires courts to conduct a “context specific” inquiry into a complaint’s allegations. The Supreme Court in that case also said that, at times, “the circumstances facing an ERISA fiduciary will implicate difficult tradeoffs, and courts must give due regard to the range of reasonable judgements a fiduciary may make based on her experience and expertise.”

This was not the first time the Supreme Court proclaimed that ERISA demands a context-specific inquiry into a complaint’s allegations. In 2014, the Supreme Court decided an ERISA “stock-drop” case involving a publicly traded ESOP, and the Supreme Court in that case also mandated a “careful, context-sensitive scrutiny of a complaint’s allegations.” Like the case earlier this year, the 2014 case derived this requirement from ERISA’s express standard of fiduciary prudence, which, among other things, requires fiduciaries to act appropriately in view of the particular circumstances prevailing at the time of the fiduciaries’ decision. Because ERISA itself ties the standard of prudence to the specific facts and circumstances, the Supreme Court explained, courts must review the entire context in order to determine whether a complaint states a plausible claim of fiduciary imprudence.

In the ESOP space, many plaintiffs’ firms have argued that the Supreme Court’s 2014 decision was limited to cases involving publicly traded ESOPs offered as part of a company’s 401(k) plan. In fact, many plaintiffs’ firms argued that the 2014 decision did not even apply to anything other than a publicly traded ESOP — like a 401(k) without a company-stock fund. And many courts agreed, particularly in the ESOP space. The ESOP cases just have not seen courts conduct the type of context-specific inquiry that the Supreme Court announced in 2014, and reaffirmed earlier this year, as required by ERISA’s express standard of fiduciary prudence.

Notably, there is only one standard of fiduciary prudence in ERISA, found in ERISA § 404(a)(1)(B). 29 U.S.C. § 1104(a)(1)(B). Nearly all ERISA fiduciary-breach cases implicate this standard, including claims for violations of ERISA’s fiduciary prohibited-transactions provisions (courts have held that several of the prohibited-transaction exemptions should be interpreted in view of ERISA’s standard of fiduciary prudence). Whether claims involve a health plan, 401(k), ESOP, long-term disability plan, or some other ERISA-governed plan, the same standard of fiduciary prudence applies.

This was by Congress’ design. Congress purposely drafted ERISA largely to regulate the conduct of those who act as fiduciaries, and Congress intended for the standard of fiduciary prudence to be “flexible” and interpreted according to the particular “character and aims” of the particular type of plan involved. See, e.g., Donovan v. Cunningham, 716 F.2d 1455, 1467 (5th Cir. 1983). In other words, ERISA’s standard of fiduciary prudence is always context-specific, because it was designed to be. ERISA’s legislative history explains that courts should interpret the standard of fiduciary prudence bearing in mind the special nature and purposes of the employee benefit plan. See H.R.Rep. No. 93–1280, 93rd Cong., 2nd Sess., reprinted in 1974 U.S.Code Cong. & Ad.News at 5083. A fiduciary of an ESOP has to act appropriately in view of the characteristics of an ESOP; a fiduciary of a health plan has to act appropriately in view of the characteristics of a health plan; and so forth.

In ESOP cases, at the pleading stage, courts should be forcefully petitioned to conduct the context-specific inquiry into a complaint’s allegations that Congress intended, ERISA demands, and the Supreme Court has required. To assist with this context-specific inquiry, courts should be provided education materials to help them understand precisely what ESOPs are, and what they are not, because the character and aims of an ESOP are vital to understanding the scope of an ESOP fiduciary’s fiduciary obligations. 

For example, ESOP claims often allege, or strongly suggest, that ESOP trustees have a fiduciary obligation to ensure that an ESOP pays the lowest possible price for employer stock, in order to maximize the participants’ retirement savings. Courts tasked with determining whether ERISA actually requires this of ESOP trustees will find no help in the text of ERISA; instead, they will be guided by ERISA’s standard of fiduciary prudence, which ties that standard to the character and aims of the particular type of plan involved and the particular decision involved.

There are voluminous materials that can help explain the character and aims of an ESOP and the purpose of the initial ESOP stock purchase. Among these is the Senate Finance Committee’s 1980 publication entitled “Employee Stock Ownership Plans: An Employer Handbook,” which explains that ESOPs are exempt from the requirement that the trustee seek a “fair return” on the investment. See https://www.finance.senate.gov/imo/media/doc/prt96-25.pdf. The Handbook also explains that an ESOP trustee’s principal obligation should be to encourage and facilitate employee ownership of stock, after which the employees will be incentivized to work hard to grow the company.

Materials like these are important to providing courts with context necessary for them to interpret ERISA’s standard of fiduciary prudence. By providing these contextual materials, and persuading courts to conduct the context-specific inquiry the Supreme Court has required, defendants in ESOP cases might begin to see more cases dismissed at the pleading stage.