Fifth Third Bancorp v John Dudenhoeffer

For those unable to attend the April 2, 2014 U.S. Supreme Court hearing, a review of the transcript of Fifth Third Bancorp et al v. John Dudenhoeffer et al (No. 12-751) may be of interest. Appearances were made by Robert A. Long, Esquire and partner with Covington & Burling LLP (on behalf of Petitioners), Ronald Mann, Esquire and Albert E. Cinelli Enterprise Professor of Law with the Columbia Law School (on behalf of Respondents) and Edwin S. Kneedler, Esquire, Deputy Solicitor General, Department of Justice (on behalf of the United States, as amicus curiae, supporting Respondents.)

I will leave the legal interpretation to attorneys. The bullet points shown below are excerpted from the transcript and by no means reflect the totality of today's discussion. No doubt we will soon get insights from practicing attorneys who can properly parse the legal issues, ahead of a formal opinion from the U.S. Supreme Court bench.

From my perspective as an economist, I think it is always good whenever further guidance is provided about the important role of the ERISA fiduciary. Notwithstanding this notion of "more is better" in terms of shedding light on fiduciary duties, I envision a kerfuffle as it relates to the discussion about stock valuation. Encouraging the use of an independent appraiser makes sense. However, the valuation community has already been vocal about its fears that an expanded fiduciary standard could increase its liability and thereby cause some firms to exit the market and push up the price of an appraisal as a result. As an aside, during her April 1, 2014 presentation before Practising Law Institute pension plan investment workshop attendees, Counsel for Appellate and Special Litigation, Elizabeth Hopkins mentioned that ESOP enforcement continues to be an active area for the U.S. Department of Labor, with a particular emphasis on the valuation of company stock.

  • There were several questions about what constitutes "prudence," along with comments about the value of a stock that is issued by the plan sponsor and related disclosure requirements if the price of said stock is deemed to be "overvalued".
  • Throughout the proceeding, there were questions and comments about ERISA versus SEC Rule 10b-5 with respect to the use of information known by company executives.
  • Justice Kennedy asked about the landscape relating to the use of an independent fiduciary. Attorney Long commented that not all problems would be solved that way since "you'd have to have a monitoring trustee who would have to give the independent trustee any inside information that they had."
  • Justice Alito asked if an ERISA fiduciary can "take into account the interests of the participants as employees as opposed to their interests as investors" and offered that "It doesn't seem to me that those will necessarily be the same. And there may be situations in which something that would be potentially good for the participants as investors would be quite bad for them as employees." For example, individuals could lose their jobs if decision-makers for an Employee Stock Ownership Plan ("ESOP") stop buying company stock and this signal possibly leads to "bankruptcy and liquidation for the company."
  • Attorney Mann started to address what he called a "rock and a hard place" issue. Various justices commented thereafter, asking what a fiduciary is supposed to do when they have information about a stock. His reply was that, similar to a "corporate context where directors ordinarily are protected by the business judgment rule, if a situation arises in which their interests patently diverge from the interests of the shareholders, they don't simply decide to represent both interests but pick one over the over. They instead step aside and appoint...allow independent people to represent the shareholders."
  • Justice Kennedy asked Attorney Mann how he would write a statute to promote employee ownership of company stock.
  • Attorney Kneedler began his comments with a reference to Section 1104 and the focus of "operating the plan for the exclusive purpose of providing benefits to participants and their beneficiaries, which means the interests of employees are taken into account only insofar as they are participants in the plan, not more generally." He agreed with Justice Sotomayor that a "stock drop in and of itself" is not necessarily proof of poor procedural prudence. He added that "fiduciaries have an obligation to actually exercise their discretion and actually investigate...monitoring of the ... investment."
  • Justice Breyer inquired about the materiality issue, i.e. how much "in assets is accounted for by the ownership" of company stock by an ERISA plan.
  • Subsequent questions and comments focused on the notion of selling existing positions of company stock versus not buying anymore when material information suggests that the stock is expensive relative to its intrinsic worth.
  • When the podium returned to Attorney Long, he stated that "There is no circuit split on the issue that we've spent all our time discussing this morning. The only circuit split is on whether this presumption applies at the motion to dismiss stage." He cited the intent of Congress to encourage company ownership and suggested that rendering ESOPs "unworkable" would "basically cause many companies to say we can't put fiduciaries in that situation, so we're not going to have ESOPs at all."

The case was submitted at 11:30 a.m. Click here to download the Fifth Third Bancorp v. John Dudenhoeffer hearing transcript.

Dr. Susan Mangiero Will Speak at ACI ERISA Litigation Conference

I am delighted to join the roster of multi-disciplinary speakers for this exciting October 24-25, 2013 New York City event. Designed for and by attorneys, the American Conference Institute's 6th National Forum on ERISA Litigation will include comments from renowned judges, in-house counsel, insurance experts, economic consultants and practicing litigators in the ERISA arena. According to the conference flyer, attendees will learn about the following:

  • Emerging trends in multiple facets of ERISA litigation;
  • Understanding new theories of liability arising from investment decisions, including alternative investments and the trend towards de-risking;
  • 401(k) fee case considerations and a discussion about evolving defense strategies, the issue of service providers and the viability of float claims;
  • ESOP litigation to include an overview of DOL investigations and settlements;
  • Benefits claims litigation
  • ERISA fiduciary litigation and ways to minimize liability exposure:
  • Class action update; and
  • Ethical issues that arise in ERISA litigation.

Having spoken and attended prior ERISA litigation conferences sponsored by the American Conference Institute, I always learned a lot. In particular, the discussions among jurists, the plaintiffs' bar and defense counsel makes for a collection of timely and lively debates. I hope you will be similarly satisfied if you decide to attend.

As a courtesy to readers of this blog, the American Conference Institute has activated a discount code of $200 for anyone who registers for the conference. Simply type "PRM200" when prompted. Click here to register. Click to download the agenda.

Pension Plan Economics and Corporate Finance

Just published is an article I wrote about the urgent need for appraisers and deal-makers to make sure that they have adequately assessed the economics associated with defined benefit plan funding. Entitled "Pension Plans: The $20 Trillion Elephant in the (Valuation) Room" by Susan Mangiero (Business Valuation Update, July 2013), the objectives of this article are threefold: (1) shed light on the magnitude of the pension underfunding problem and the possible dire impact on enterprise value; (2) remind appraisers of the need to thoroughly understand and evaluate pension plan economics or engage someone to assist them; and (3) explain the adverse consequences on deal-making and corporate strategy when pension plan funding gaps are given short shrift. CEOs, Chief Financial Officers, private equity, venture capital, merger and acquisition and bank lending professionals will want to read this article as it showcases this timely and urgent topic.

Click to read my article about pension plan valuation.

In a related post, ERISA attorney Stephen D. Rosenberg wrote a commentary on his "Boston ERISA & Insurance Litigation Blog" (June 17, 2013) about why he believes that appraisers should not be designed as ERISA fiduciaries. He expresses doubt about whether imposing a fiduciary standard on appraisers will "improve the analysis provided to plan fiduciaries." He suggests that such a move by regulators could create a reluctance for valuation professionals to assume the liability associating with appraising a company with an ERISA plan.

For those who missed our program about appraiser liability, visit the Business Valuation Resources website to obtain a copy of "Valuation and ERISA Fiduciary Liability: Traps for the Unwary Appraiser." The program took place on May 14, 2013. Speakers included myself (Dr. Susan Mangiero), ERISA attorney James Cole with Groom Law Group and Mr. Robert Schlegel with the Houlihan Valuation Advisors.

Fiduciary Shortcuts To Valuation Can Be Dangerous

Despite a plethora of information about how to implement shortcuts to enhance workplace productivity, fiduciaries need to ask themselves whether a "jack in the box" approach that equates speed with care and diligence is worth pursuing.

This topic of shortcuts came up recently in a discussion with appraisal colleagues about the dangers of using a "plug and play" model to estimate value. Although New York Times journalist Mark Cohen rightly cites the merits of having a business valuation done, he lists all sorts of new tools such as iPhone valuation apps that some might conclude are valid substitutes for the real thing. Rest assured that punching in a few numbers versus hiring an independent and knowledgeable third party specialist to undertake a thorough assessment of value is a big mistake, especially if the underlying assumptions and algorithms of a "quick fix" solution are unknown to the user. See "Do You Know What Your Business is Worth? You Should," January 30, 2013.

It's bad enough that a small company owner opts for a drive-in appraisal. It's arguably worse when institutional investors do so, especially as their portfolios are increasingly chock a block with "hard to value" holdings. In the event that a valuation incorrectly reflects the extent to which an investment portfolio can decline, all sorts of nasty things can occur. A pension, endowment or foundation could end up overpaying fees to its asset managers. Any attempts to hedge could be thwarted by having too much or too little protection in place due to incorrect valuation numbers. Asset allocation decisions could be distorted which in turn could mean that certain asset management relationships are redundant or insufficient.

Poor valuations also invite litigation or enforcement or both. As I wrote in "Financial Model Mistakes Can Cost Millions of Dollars," Expert Witnesses, American Bar Association, Section of Litigation, May 31, 2011:

"Care must be taken to construct a model and to test it. Underlying assumptions must be revisited on an ongoing basis, preferably by an independent expert who will not receive a raise or bonus tied to flawed results from a bad model. Someone has to kick the proverbial tires to make sure that answers make sense and to minimize the adverse consequences associated with mistakes in a formula, bad assumptions, incorrect use, wild results that bear no resemblance to expected outcomes, difficulty in predicting outputs, and/or undue complexity that makes it hard for others to understand and replicate outputs. Absent fraud or sloppiness, precise model results may be expensive to produce and therefore unrealistic in practice. As a consequence, a “court or other user may find a model acceptable if relaxing some of the assumptions does not dramatically affect the outcome.” Susan Mangiero, “The Risks of Ignoring Model Risk” in Litigation Services Handbook: The Role of the Financial Expert (Roman L. Weil et al, eds., John Wiley & Sons, 3d ed. 2005).

In recent months, it is noteworthy that regulators have pushed valuation process and policies further up the list of enforcement priorities. Indeed, in reading various complaints that allege bad valuation policies and procedures, I have been surprised at the increased level of specificity cited by regulators about what they think should have been done by individuals with fiduciary oversight responsibilities. Besides the focus of the U.S. Department of Labor, the U.S. Securities and Exchange Commission has brought actions against multiple fund managers in the last quarter alone. Consider the valuation requirements of new Dodd-Frank rules (and overseas equivalent regulatory focus) and it is clear that questions about how numbers and models are derived will continue to be asked.

For further reference, interested readers can check out the following items: