Sunday, April 6, 2014

Fifth Third Bancorp v. Dudenhoeffer

The Supreme Court heard arguments Wednesday in the case Fifth Third Bancorp v. Dudenheffer.  The case concerns the obligations of the managers (fiduciaries) of a employee stock ownership plan (ESOP) when they have some evidence that the company stock is a bad investment.  The defendants (Fifth Third Bancorp) want a rule that it is presumptively prudent for a ESOP to buy and hold company stock.  This seems sensible to me.  Some (by which I mean one or more) of the Supreme Court Justices seemed concerned about establishing a special rule for ESOPs but I see this as an application of a more general rule that it is presumptively prudent for fiduciaries to obey instructions.  It is common for defined contribution retirement plans to allow participants to direct how their contributions are invested.  Naturally some participants will make better decisions than others but I don't think it is practical (or sensible) to require a fiduciary of such a plan to routinely independently evaluate (and possibly overrule) the participant's instructions.   

There is a complication in the current case in that the negative information was "inside information" which it can be illegal to act on.  The plaintiff's lawyer appeared to be arguing that even if the defendants could not legally act on the information they could nevertheless be liable for failure to act.  The government lawyer appeared to concede that the defendants could not be held liable for obeying the law but were obligated to do everything they could without breaking the law.  Considering the rather unclear state of insider trading law this would put fiduciaries in possession of inside information in a very difficult position.  In particular the government claimed that although you could not legally sell on the basis of inside information you could legally stop buying.  Perhaps this is actually the law (although some Justices noted no lawyer from the SEC had signed off on the government brief) but it makes no logical sense.  As I understand it employees are allowed to participate in stock purchase plans in which a fixed percentage of their pay is regularly used to buy company stock even if this means they are sometimes buying when in possession of favorable inside information.  The idea is they are not buying because of the favorable inside information.  But if you allow them to suspend purchases when in possession of negative inside information this rational disappears.  Now all of their purchases are based in part on inside information, namely that there is no pending undisclosed bad news.  Thus giving them the sort of insider advantage that the prohibition against inside trading is supposed to prevent.

No comments:

Post a Comment