The Absurdity of Fifth Third

By James Kwak

No, I’m not talking about the fact that a major bank is named Fifth Third Bank. (As a friend said, why would you trust your money to a bank that seems not to understand fractions?) I’m talking about Fifth Third Bancorp. v. Dudenhoeffer, which was heard by the Supreme Court last week.

The plaintiffs in Fifth Third were former employees who were participants in the company’s defined contribution retirement plan. One of the plan’s investment options was company stock, and the employees put some of their money in company stock. (Most important lesson here: don’t invest a significant portion of your retirement assets in your company’s stock. Remember Enron? Anyway, back to our story.) As you probably guessed, Fifth Third’s stock price fell by 74% from 2007 to 2009—this is a bank, you know—so the plaintiffs lost money in their retirement accounts.

The claim (I’m looking at the 6th Circuit opinion)  is that the people running the retirement plan knew or should have known that Fifth Third stock was overvalued in 2007, and they breached their fiduciary duty to plan participants by continuing to offer company stock as an investment option and by failing to sell the company stock that was owned by the plan. The suit was dismissed in the district court for failure to state a claim, so on review the courts are supposed to accept all the plaintiffs’ allegations as correct.


The serious legal issue in this case has to do with the duty of retirement plan fiduciaries to manage the plan’s assets prudently and for the exclusive benefit of plan participants and beneficiaries (ERISA § 404(a)(1)) and how that applies to an individual account plan that is invested in employer stock, to which the usual diversification requirement does not apply (ERISA § 404(a)(2)). More specifically, it has to do with a “presumption of prudence” that some courts apply in this situation—that is, a presumption that it is prudent for an employer stock ownership plan (ESOP) to continuing investing in company stock.

When you are down in the legal minutiae, this is not a crazy idea; after all, the participant chose the company stock option. But at a higher level, this borders on absurd. If you work at a company, you are already heavily invested in that company. Besides having skills that are particularly useful to that company, there’s the little problem that if the company does badly, you could lose your job. Doubling down by putting your retirement assets in the company is just increasing your risk. (This applies less to retirees, unless you’re drawing other retirement benefits from the company, but then the usual rules about investment diversification still apply.) How could the word “prudent” have anything to do with this practice?

At a higher level, you also have to wonder whether simply having a company stock option counts as prudent management of a retirement plan. ERISA exempts the company stock option itself from the diversification rules, but it doesn’t exempt you from the general duty to manage the plan prudently and for the benefit of participants. Given that diversification is the first rule of investing, it seems to me that the existence of an ESOP within a retirement plan is imprudent to begin with. There is a debate (which I’ve written about here) about whether having a stupid investment menu is exempt from the usual fiduciary duties under ERISA § 404(c), but it certainly shouldn’t be.

In short, if retirement plan fiduciaries actually behaved like fiduciaries, we wouldn’t have ESOPs within retirement plans to begin with. That’s what’s absurd about Fifth Third.

15 responses to “The Absurdity of Fifth Third

  1. The Fed, always wrong, but never in doubt.

  2. All politics is local, and corrupt.

  3. Moses Herzog

    I think ESOPs are generally awesome, and I am pro-ESOP. However, if you are using them as any more than like 1% of your retirement funds (outside of some VERY unusual circumstances) that is incredibly dumb. Which I think is what Kwak is saying.

    Just be be very argumentative, one could argue if you owned stock in a company such as Berkshire Hathaway (not referring to Buffett’s “acumen” here, but to the diversity of the businesses run) it might not be that crazy. Leucadia National might be another one that is quite diversified. I’m not recommending either one of these, I’m just saying if you had an ESOP within similar companies’ such as these, with very diversified operations, it might NOT be sooooo dumb as a retirement plan.

    But businesses such as that are quite the anomaly, not the norm.

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  6. What seems “obvious” here never seems to enter into the “how do we solve inequality?” discussions. I’ve seen a couple of different suggestions for expanding ownership to employees that don’t seem to consider the flaw raised here.

  7. ‘Given that diversification is the first rule of investing, it seems to me that the existence of an ESOP within a retirement plan is imprudent to begin with.’

    Not when you consider that the employees of the company have the best information possible about its efficiency–both of its labor and management–and often of its prospects for the future, it isn’t imprudent at all.

    Essentially, the employees are engaging in insider trading. Legally.

  8. Dr. Strangelove

    BREAKING BAD, NEWS…… “Kathleen Sebelius is resigning as secretary of the Department of Health and Human Services, Bloomberg News and the New York Times reported Thursday.”

    Those withering attacks on the policy, the president, and on her professionally and personally beame too much for Kathy…..you can only be the “fall guy” for only so long, and then it’s—f/u…p… (waahhbulance with all sirens blazing)

  9. Moses Herzog

    I did think Sebelius was a very capable woman. And if you look at the way the very similar health care plan was “rolled out” in Massachusetts, the results weren’t all that different (the Massachusetts “roll out” was also very messy). One could look at that two ways: A) It would be hell getting ANY very complex system right the first time it runs B) Sebelius had a blueprint of Errors from the Massachusetts health care system she could have learned from to make the national “roll out” run much more smoothly.

    She was kind of stuck between a rock and a hard place as to leading people to the water well, and telling them that the pulley system to get the water out of the well was kind of a pain in the ass. She couldn’t have won no matter what she did, other than maybe to have had better quality control (my idea would have been to get a Linus Torvalds type in an unofficial capacity to volunteer and have access to the system as a Quality Control liaison for Sebelius/Obama before the damn thing rolled out).

    I think in the end she and Obama each have to take about 33% responsibility for what happened along with the private contractors who FAILED them.

    I think Sebelius did better than many would have done and she saw it through through the most difficult stage, when she could have very easily told Pres Obama to shove it.

  10. She wasn’t stuck Moses, I think Obama would have done things better than Romney at this difficult stage, it still wouldn’t have much difference, this health care issue was doomed from the start. The sooner you realize it, the more desperate you get, the more desperate you get, the more chiefs start falling.
    If you are NOT born with a silver SPOON in your mouth, you are not welcome to the higher echelons of political Washington D.C. It a numbers racket with a timer attached, an accident waiting to happen. Lies, upon Liesa.

  11. big differences in roll out – the MA insurance plan was NOT a way for the IRS to collect new fines – yeah, the programming was “complex” with ACA because it was all about handing over PERSONAL health records to the apparatchiks at the IRS…and the argument that making the same mistakes a second time makes it okay, well, no wonder the “intellectuals” leading the USA from their dark pools of derivatives keep KILLING “progress” – the neoDickens economy – “No progress (soup) for you”

    With the revelation of “heartbleed” internet security hole, so much more can now be proven about the predatory persecution against anyone on the list (name the list, so many “anti” labels to make up, so little time)…

    Meanwhile, back on the ranch:

    http://rt.com/usa/bundy-ranch-nevada-tensions-940/

    Like all the nuclear testing in Nevada in the 20th century did not hurt the tortoise…??!! Betcha cows and tortoises have no trouble hanging out side by side….both are slow movers and eat different things :-). We’ll see what the plan in the dark is going to do to the water….

    The BIG PLAN in the 1920s that built the Hoover Dam and so many others around the country was to link the whole continent through aqueducts – there will always be more rain/snow in one area than in another, like duh. All about flood control from sea to shining sea…THAT Plan never happened because of the “war effort” need for the “wealth” of others….

    WORSE than McCarthyism, “Moses”….

    JUST WAR.

  12. Smaht Donkey

    Fifth Third preferred to corral it’s employees for itself, for it’s own benefit: maximize their investment-maximize their commitment. Now a business that engages in a fraudulent economy, would it be persuaded to place it’s own employees at risk for it’s own benefit too?

    Hell, I betcha dere’s a few of dem around, cowboy. Watcha tink the risk on dat is?

    What would be the consequence of finding fiduciary negligence?

    Oh, massive risk, pardner. But we’s pertected.

  13. Daniel Barkalow

    Moses: I think ESOPs are a good concept, in that they let you benefit from being capital in a company that does well because you’re good as labor (since we know labor doesn’t benefit when the company does well these days…). On the other hand, they don’t make any sense as retirement options, because you’re almost certain to stop affecting the company’s performance before you use your retirement savings, so your savings depend on the performance of those fools who replace you.

  14. Fiduciary negligence is more “complicated”, thanks to derivative dark pools, than Fiduciary NON-negligence.

    Entering the 21st century with COMPLICATED fiduciary negligence on top? Not good.

    It’s all about how you choose to get yours….okay, but seriously, cannibalism at nanosecond speed?

    Man to land ratio and stick to it….NON-negligence….

    Heartbleed – we have a name for the crab in the pubis….

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