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.