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.

Institutional Asset Allocation

My comments about institutional asset allocation, along with those made by Mr. Ron Ryan (CEO, Ryan ALM) and Lynn Connolly (Principal, Harbor Peak, LLC), were well received on January 8, 2014. Part of a joint program that was sponsored by the Quantitative Work Alliance for Applied Finance, Education and Wisdom ("QWAFAFEW") and the Professional Risk Managers' International Association ("PRMIA"), our audience of investment professionals added to the lively debate about topics such as strategic versus tactical asset allocation, fees, role of the pension consultant and the likely capital market impact due to the implementation of strategies such as liability-driven investing ("LDI") and/or pension risk transfers ("PRT"). 

With the size of the U.S. retirement market at $20 trillion and counting, big money is at stake. Bad asset allocation decisions can lead to a cascade of economic woes. It is no surprise that fiduciary breach allegations in the form of ERISA lawsuits are increasingly focused on questions about the appropriateness of a given asset allocation mix and whether an investment consultant or financial advisor has helped or hindered the way that pension monies are allocated. Noteworthy is that scrutiny about the efficacy of the asset allocation process and resulting money mix can, and has been, applied to both defined benefit and defined contribution plans. Keep in mind that asset allocation decisions are likewise central to assessing popular financially engineered products such as target date funds. Accounting issues and how changing rules influence asset allocation decisions are yet another topic that we will tackle in coming months.

Click to access Susan Mangiero's asset allocation slides, distributed to members of the January 8 audience, and meant to peturb a discussion about this always essential topic. Interested readers can check out "Frequently Asked Questions About Target Date or Lifecycle Funds" (Investment Company Institute) and "Annual Survey of Large Pension Funds and Public Pension Reserve Funds: Report on pension funds' long-term investments" (OECD, October 2013).

If you have a specific question about asset allocation and/or the procedural process associated with asset-liability management, send an email to me.

Fiduciary Duty is More Than Numbers

As a published author, I am constantly assessing what has appeal to readers. I try to write about topics that are relevant and timely and welcome feedback. Click here to send an email with your suggestions. As a financial expert, I continuously seek to stay on top of what is being adjudicated. As a risk manager, I regularly evaluate what might have been done differently when things go seriously awry.

What I have noticed is that enumeration seems to offer comfort. Lists of this or that are common to many best-selling books and widely read articles. A trip to the Inc. Magazine website today illustrates the point. Consider this excerpted list of lists:

The popularity of laying out "to do" items extends to the retirement industry as well. For example, Attorney Mark E. Bokert provides insights in his article entitled "Top 10 ERISA Fiduciary Duty Exposures - And What to Do About Them" (Human Resources - Winter Edition, Thomson Publishing Group, 2007). His list of vulnerabilities - and prescriptive steps to try to avoid liability - includes the following:

  • Identify who is a fiduciary and making sure that they are properly trained;
  • Create a proper process by which investments are selected and monitored;
  • Monitor company stock in a 401(k) plan and consider whether to appoint an independent fiduciary;
  • Assess the reasonableness of "like" mutual funds versus existing plan choices;
  • Ensure that communications with plan participants are adequate;
  • Undertake a thorough assessment of vendors and review their performance thereafter;
  • Assess whether 401(k) deferrals and loan repayments are being made in a timely fashion;
  • Identify the extent to which service providers enjoy a float and whether they are entitled;
  • Understand what is allowed in terms of providing investment advice to participants and abide by the rules accordingly; and
  • Critically evaluate whether auto enrollment makes sense and the nature of any default investment selection.

One could easily break out each of the aforementioned items into sub-tasks and create appropriate benchmarks to ascertain whether fiduciaries are doing a good job. Indeed, ERISA attorneys are the first to invoke the mantra of "procedural process" as a cornerstone of this U.S. federal pension law. Importantly however, relying only on numbers is not sufficient. Increasingly legal professionals and regulators are asking that process be demonstrated and discussed. Expect more of the same in 2013. Analyses and expert reports may be deemed incomplete if they do not include a deep dive of the fiduciary decision-making process that took place (or not as the case may be).