July 12, 2021

Thinking ESOPs: What the Supreme Court’s Decision in a 401(k) Fee Case Could Mean for ESOPs

The U.S. Supreme Court recently agreed to hear a challenge to the dismissal of an Employee Retirement Income Security Act (ERISA) 401(k) excessive fee case. The case involves a question about whether jury trials are appropriate in ERISA cases, but also a question about what an ERISA lawsuit must plead in order to survive a motion to dismiss, particularly when the lawsuit brings a claim for breach of fiduciary duty in managing a 401(k) plan’s fees and investment options. The 401(k) community is watching this case closely, and the employee stock ownership plan (ESOP) community also should pay close attention.

As background, the Supreme Court essentially ended the 401(k) “stock drop” lawsuits when it decided two cases that set a pleading standard that plaintiffs have been unable to meet (with one exception, not relevant here). The Supreme Court’s decisions addressed what a plaintiff has to allege on the face of a complaint to state an ERISA claim for breach of fiduciary duty in managing a publicly traded, company stock fund offered as part of a 401(k) plan. After those Supreme Court decisions, ERISA lawsuits alleging imprudent management of publicly traded company stock funds in a 401(k) generally have been unable to survive a motion to dismiss.

Curiously, those Supreme Court cases have not had any effect on the pleading standard in an ERISA case involving a private company ESOP stock transaction. Most lower courts have determined that the Supreme Court cases addressing publicly traded stock funds offered in a 401(k) have no bearing on ESOP disputes, but these lower courts failed to address, or adequately address, the Supreme Court’s analysis in the “stock drop” lawsuits.

The Supreme Court’s analysis of the standard for pleading a fiduciary breach claim was grounded in fundamental ERISA provisions and concepts about the nature of the fiduciary obligation and the tough choices ERISA fiduciaries face. The Supreme Court also considered the fact that reasonable fiduciaries can disagree, and that ERISA requires courts to consider all of the circumstances and the entire context of the fiduciary action being challenged in the complaint. The Supreme Court’s decision also relied on legislative materials and expressions of congressional intent, which the Supreme Court regularly consults in cases involving the interpretation of ERISA’s provisions.

Yet in ESOP cases, lower courts have not engaged in similar analyses. The pleading standard in ESOP cases is so low that some courts have permitted ESOP lawsuits to proceed simply on the basis that the complaint alleges an ESOP stock purchase, which is a “per se” “prohibited transaction” under ERISA. Such courts have determined that because the defendant has the burden of proving an exemption, the plaintiff has no burden to plead anything more than the happening of a prohibited transaction (this analysis is wrong, because, among other reasons, it ignores the burdens ERISA 502(a) imposes on a plaintiff). It is difficult, if not impossible, to reconcile the Supreme Court’s analysis in the two “stock drop” cases with the analysis conducted by courts in ESOP cases.

When the Supreme Court decides the 401(k) case, it likely will provide hints, or perhaps express directives, about what plaintiffs must plead in order to state a claim for breach of fiduciary duty with respect to plan management decisions. The Supreme Court’s analysis, including how it interprets ERISA provisions, what consideration it gives to ERISA’s legislative history and what consideration it gives to the context of the fiduciaries’ decision, may provide further support for dismissal arguments in ESOP cases.


Thinking ESOPs is an e-newsletter that seeks to encourage thoughtful discussion of key issues in ESOP transactions and ESOP litigation.

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