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Employee 401(k) and other pension plans that include company stock can be a financial minefield. What’s a responsible fiduciary to do to lessen the risk of a plummeting share price—and the risk of a subsequent “stock-drop” lawsuit from aggrieved workers?

Navigating Employee 401(k) and Pension Plans
Mary Jo Larson

Mary Jo Larson

September 8, 2021 03:00 PM

Many businesses offer, or even mandate, company stock as an investment option for employees in their 401(k) or other retirement plans. The reason for doing so is clear: Those same staffers are working for the betterment of the business and therefore have skin in the game. The better the company does, the better they do. When company stock funds suffer a significant loss, though, these same plans can beripe for lawsuits.

In these cases, commonly referred to as “stock-drop” litigation, retirement-plan participants sue plan fiduciaries, including their plans’ investment committees, typically arguing that the fiduciaries had sufficient information to avoid, or at least dampen, the negative impact from the stock’s decline. This creates a high-risk environment for fiduciaries, even when employer stock is a required option under the company plan.

Many cases in this area are being filed and litigated, although recent court decisions have made it more difficult for plaintiffs’ stock-drop claims to succeed. The key decision was a 2014 U.S. Supreme Court ruling in Fifth Third Bancorp v. Dudenhoeffer. Before this case, if the plan document required employer stock to be offered, lower courts applied a presumption that the fiduciaries acted prudently in continuing to follow plan terms and maintain employer stock in the plan, even in the face of significant drops in value. In Dudenhoeffer, though, the Supreme Court found that the ERISA fiduciary “duty of prudence trumps the instructions of a plan document”— meaning fiduciaries are no longer entitled to the presumption of prudence.

At the same time, however, the Supreme Court created a new pleading standard for employer stock cases, stating: “Where a stock is publicly traded, allegations that a fiduciary should have recognized on the basis of publicly available information that the market was overvaluing or undervaluing the stock are generally implausible and thus insufficient to state a claim.”

Under Dudenhoeffer, to avoid dismissal, the plaintiff must plausibly allege either (or both):

  • that public information revealed “special circumstances” that made the market price of a publicly traded stock unreliable;
  • that nonpublic information known by the fiduciary should have caused them to take alternative action “that a prudent fiduciary in the same circumstances would not have viewed as more likely to harm the fund than help it.” In other words, if a prudent fiduciary could have concluded that the proposed action would harm the fund more than help it, the claim will not stand. (This is known as the “Not More Harm Than Good Standard.”) Many cases have since interpreted this cornerstone case.

PUBLIC INFORMATION AND SPECIAL CIRCUMSTANCES: None of the more than 100 stock-drop decisions that have come after Dudenhoeffer has found publicly known circumstances that made the stock’s market price unreliable. At this time, it’s difficult to imagine what “special circumstances” would support a stock-drop claim.

NONPUBLIC INFORMATION: Fiduciaries or other company employees may learn of nonpublic information that, if known, would likely reduce the stock’s price. Dudenhoeffer’s fair-market-price presumption does not protect fiduciaries if they have information the public lacks. When material facts become public information, plan participants can experience significant drops in the value of the stock in their accounts. Participant lawsuits then allege the fiduciaries should have done something to prevent those losses, such as:

  • stop making contributions in employer stock;
  • remove employer stock as an investment option for future contributions or investment exchanges, or further limit how much any single participant can invest in employer stock;
  • sell the stock held by the plan;
  • disclose to the participants the relevant facts so they can intelligently decide whether to continue to invest in company stock;
  • publicly disclose the relevant facts or ask the appropriate corporate officers to do so;
  • hire an independent fiduciary to make a decision about the stock; or
  • disclose any negative facts to the Department of Labor and request guidance.

The problem is that any of these actions could damage the stock price and leave the participants even worse off. As one court noted, “[P]ublicizing all of the negative insider information alleged by Plaintiffs would guarantee the collapse of company stock.” The court found it was “simply implausible to say that a reasonable fiduciary could not have concluded that accelerating a stock collapse would cause more harm than good.” Court after court has found that a prudent fiduciary could—and likely would—determine that any action he or she could take in these cases would harm participants more than do them good.

Furthermore, what if the price later rebounds and the participants miss the gains? The fiduciary would again be blamed. As the Supreme Court noted in Dudenhoeffer, this puts a fiduciary “between a rock and a hard place.” It’s always easier to see after the fact what would have been the best course of action. For these reasons, courts have been loath to find that the only reasonable fiduciary action would be to take one of the steps the participants claim was required.

Note that a company’s decision to make contributions in employer stock is not a fiduciary action, according to the few courts that have considered this issue. Employers can make contributions in cash or stock as they see fit, as long as the plan provides for it. The question for fiduciaries is what to do with that stock once it’s contributed.

In addition, the Supreme Court in Dudenhoeffer held that a fiduciary’s ERISA duties cannot compel him or her to take action that would be inconsistent with federal securities laws. A fiduciary therefore cannot be required to make decisions based on inside information.What is still being litigated, however, is whether ERISA may require a fiduciary to take an action that is not required by securities laws but not otherwise inconsistent with them, either.

Dudenhoeffer has made it difficult for plaintiffs to plead fiduciary breach in cases for plans with publicly traded company stock. At the same time, investing in any single stock is inherently risky; participants overweighted in company stock could sustain crushing losses if the price plummets, and possibly lose their jobs as well. Enron and Lehman Brothers are both cautionary examples. Fiduciaries can take steps to enhance participant success and reduce fiduciary risk by implementing a sound program design and a prudent monitoring process, complying with the special ERISA Section 404(c) rules applicable to employer stock, maintaining careful, thorough records, and communicating well.

TO THAT LAST POINT: Clearly communicating the risks of overinvesting in the company stock fund is critical. Even if the responsibility for communication generally falls to administrators, the investment fiduciary should ensure that communication about company stock is frequent and clear—for the protection of employee and fiduciary alike.

Mary Jo Larson is a partner at Warner Norcross + Judd LLP, where she puts her 35 years of benefits experience to work on her clients’ 401(k)s, pension plans, nonqualified deferred compensation plans, and executive compensation. She also advises fiduciaries responsible for the investment of plan assets. Larson is a fellow of the American College of Employee Benefits Counsel (ACEBC) and has been a member of the organization since 2005.

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