Legacy stock after Fifth Third Bancorp v. Dudenhoeffer

The United States District Court for the Southern District of Texas, in Schweitzer v. The Investment Committee Of The Phillips 66 Savings Plan (May 9, 2018), recently considered several ERISA fiduciary issues with respect to “legacy stock” (stock of a former employer) held in a defined contribution plan.

In dismissing plaintiffs’ complaint, the court found that:

  1. Shares of legacy stock held by the plan were not “employer securities” and thus were not exempt from ERISA’s diversification requirement.

  2. That diversification requirement was, however, met by the availability of alternative diversified investment options in the plan’s fund menu.

  3. Applying a <Fifth Third Bancorp et al. v. Dudenhoeffer “marker price = prudence” analysis, ERISA’s prudence requirements had been met with respect to the plan’s retention of the legacy stock as an investment option.

In this article we discuss the decision in detail.


In Fifth Third Bancorp et al. v. Dudenhoeffer, the Supreme Court rejected the “presumption of prudence” rule for plan investments in company stock, replacing it with, in effect, a presumption that acquisition of, or failure to dispose of, a company’s publicly traded stock at a market price is prudent.

The extent to which the analysis in Fifth Third applies to “legacy stock” remains unclear. “Legacy stock” is stock in a company that formerly was part of the same controlled group as the current employer/plan sponsor, but is no longer. This typically happens in connection with a spinoff of a controlled group member.

For instance, in Tatum v. R.J. Reynolds Tobacco Company, the corporate parent (RJR) spun off (dividended out) Nabisco stock to shareholders, and as part of that transaction, the RJR plan’s company stock fund received stock in Nabisco. The Tatum litigation involved a challenge to the prudence of RJR plan fiduciaries in disinvesting (selling off) the Nabisco stock shortly before a tender offer for it dramatically increased its market price. (This is called a “reverse stock drop” suit.)

Schweitzer, in contrast, involved a suit by participants in the plan of a spun off subsidiary (Phillips 66), challenging the prudence of Phillips 66 plan fiduciaries in failing to liquidate stock in the former corporate parent (ConocoPhillips Corporation) received by the Phillips 66 plan when (as part of the corporate spin off) assets from the ConocoPhillips plan were transferred to the Phillips 66 plan.

The details here may be a little confusing, but the main points are relatively straightforward: In a spinoff, the parent plan may wind up with stock in the former subsidiary and/or the subsidiary plan may wind up with stock in the former parent (in either case, “legacy stock”). And, in either case, plan fiduciaries may be sued if the legacy stock is sold and it subsequently goes up in value or is not sold and subsequently goes down in value.

All of which puts plan fiduciaries in a challenging position.

Are shares of legacy stock “employer securities?”

ERISA section 404(a)(2) generally provides that “employer securities” are not subject to the requirement that ERISA fiduciaries diversify plan investments. A threshold question for these legacy stock cases is, is legacy stock an “employer security” for purposes of this rule?

Tatum does not seem to have considered the issue. Indeed, the Schweitzer court found that “[n]o court has addressed whether, after a spinoff resulting in two independent companies, shares of stock that were ‘employer securities’ before the spinoff retain that character after the spinoff.”

The Schweitzer court concluded that, at least in the case of the Phillips 66 plan, the legacy ConocoPhillips shares were not employer securities and therefore were subject to ERISA’s diversification requirements. It gave three reasons for this conclusion:

ConocoPhillips was not an employer under (and, by implication, not a sponsor of) the Phillips 66 plan.

In a Private Letter Ruling, the IRS found that “[ConocoPhillips] shares are not employer securities with respect to [the] Plan.” While the court acknowledged that this PLR “is not binding precedent, it is persuasive because it addresses the precise issue in question – whether an employer security retains that character after a spinoff.”

Retaining legacy stock “does not promote the purpose of ERISA’s ‘employer securities’ exemption to ‘bring about stock ownership by all corporate employees.’”

Availability of alternative investment options satisfies diversification requirement

But even though the exemption did not apply, the court found that the plan’s legacy stock investment nevertheless satisfied ERISA’s diversification requirement. The court’s analysis in this regard is interesting.

According to the court, “Plaintiffs allege that Defendants breached their duty to diversify ‘by failing to diversify Plan investments’ because the Plan had more than 25% of its assets invested in the ConocoPhillips Funds at the beginning of the Class Period and ‘continued to hold an excessive amount of assets in the ConocoPhillips Funds.’” Participants could, however, “elect to exchange their assets out of the ConocoPhillips Funds, … [and] may reinvest in the remaining investment options of the Plan, which Plaintiffs do not allege are not diversified.”

Thus: a single stock fund holding shares that are not “employer securities” satisfies ERISA’s diversification requirement where (1) participants may sell fund shares and (2) reinvest in funds chosen from a diversified menu of investment options.

Application of a Fifth Third market analysis to the issue of divestiture

In this situation, the court stated that “[t]he real issue is not diversification but the prudence of the fiduciaries’ decision not to force divestiture.” (Emphasis added.)

The court analyzed this issue of whether prudence required divestiture of the legacy ConocoPhillips stock by applying the “presumption that the market price is prudent” analysis of Fifth Third. Thus it held that an imprudence claim based on “publicly available information [that] showed the riskiness of ConocoPhillips stock” was, in the absence of special circumstances, “implausible.”

On these grounds, the court dismissed plaintiffs’ complaint.

Takeaways for plan sponsors

We note that, while sponsor fiduciaries “won this one,” this is just one decision by a district court. Other courts may reach different conclusions on similar facts. In that context, we would note the following:

Tatum), participants may miss out on significant post-disinvestment gains.

Given these risks, employer officials will want to consider making the issue of “what to do about legacy stock” an element of planning for the spinoff itself. And, in that regard, they will want to begin by consulting with counsel.

While the Schweitzer decision – in the context of a DC plan in which participants may choose from a diversified menu of different investments – generally provides fiduciaries with some comfort, the best defense with respect to any fiduciary decision is process.

Both pre- and post-spinoff, plan fiduciaries should review options, consider all relevant factors, and document their deliberations and decisions.

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We will continue to follow this issue.