Retirement Planning with Company Stock Just Got Riskier

Do you have a client that sponsors a retirement plan that holds company stock? According to a June 26, 2014 article published by the National Center for Employee Ownership there are 6941 Employee Stock Ownership Plans (ESOP) covering 13.5 million participants and holding $214.4 billion in company stock as of 2011. In addition, there are another 1985 ESOP-like retirement plans that hold 20% or more of their assets in company stock covering 1.2 million participants. These plans hold $18.6 billion in company stock.

If you have a client that holds company stock, the Supreme Court’s recent decision in Fifth Third Bancorp v. Dudenhoeffer should be a topic of discussion at your next meeting especially if you are the fiduciary advisor to a plan that holds company stock.

Unwinding Moench v. Robertson

In Dudenhoeffer, the Supreme Court ruled unanimously that “the law does not create a special presumption favoring ESOP fiduciaries. Rather, the same standard of prudence applies to all ERISA fiduciaries, including ESOP fiduciaries, except that an ESOP fiduciary is under no duty to diversify the ESOP’s holdings.” As a result, every fiduciary is operating from the same page of fiduciary conduct and must determine whether an investment including company stock is a prudent investment even if the governing plan document includes a provision to acquire or contribute company stock to the plan.

This decision essentially unwinds the Moench presumption, which gave deference to a fiduciary that allowed the plan to invest in employer stock when it was required by the governing plan document. Under the 1995 Moench v. Robertson, 62 F.3d 553 case, the 3rd Circuit court of appeals established the presumption of prudence for Statewide Bank, a publicly held bank holding company. This presumption has been used by numerous other courts over the past 18 years in 24 ESOP and in more than 100 401k plan stock-drop cases according to NCEO, yet, not one of the cases involved a closely held company, which makes up 97% of the ESOP industry. However, what NCEO has not and cannot report on is the number of stock-drop cases that have settled. I was personally involved in one such case as an expert wherein the participants were left holding worthless company stock after the executives, 1. borrowed the cash to keep the company going by issuing more worthless stock, and 2. paid the rest of the cash out to retiring executives. So the statistics reported by the NCEO should not be interpreted that closely held companies are bullet proof. Instead, they are just as vulnerable to costly, time consuming litigation as any other company whose stock drops precipitously.

What This Means to You

As a result of this Supreme Court decision both you and the plan sponsor that has hired you are more likely to experience a claim if the stock drops. Granted, the plaintiff will have to prove the price does not reflect the value of the stock but the point is this decision just increased litigation risk. So, if you are risk conscience and desire to maximize risk mitigation strategies to protect yourself, your client, and the participants you should:

1. Discuss outsourcing fiduciary responsibility for company stock to an independent fiduciary; make sure the person you hire has ample experience in this area and document the decision-making process
2. Retain independent ERISA Council for their opinion on the continued prudence of offering company stock, the process to determine prudence, the selection of the independent fiduciary, and the appraiser for a closely held company or a company whose stock is thinly traded
3. Make sure the appraiser’s core competency is establishing stock value for closely held companies
4. Document in your minutes that you reviewed the results of this case, discussed the implication it has on the plan, the decision to continue, freeze, or remove company stock, and the reasons for that decision

Remember, as an advisor, you are the plan’s quarterback. So do what you do best: provide value-added financial advice, but leave the legal advice to the attorneys. Furthermore, if you don’t want to be liable for company stock don’t offer an opinion on its merits, leave that to the attorney, independent fiduciary, and appraiser. To do anything more puts you at risk for something you are not compensated on and most likely don’t have insurance to cover.

No one can afford to make a costly fiduciary mistake especially an advisor that does not have fiduciary E&O coverage. To avoid personal liability as the advisor, make sure your counsel encourages the fiduciaries to consider, evaluate, and document their decisions.

For more information on legal issues pertaining to retirement plans, sign up for the Fiduciary Matters Blog. For additional information on how FRA PlanTools supports an advisor’s compliance obligations and provides fiduciary training contact me via phone at 704-564-0482 or by e-mail.