DOL Argues Dudenhoeffer Rule Applies Only to Public Companies

The Supreme Court's decision in Fifth Third Bancorp v. Dudenhoeffer eliminated the presumption of prudence for ESOP fiduciaries and replaced it with a new set of standards requiring that plaintiffs show plausible alternatives for fiduciaries to offering, holding, buying, or selling company stock. That has proven a very difficult standard in public company cases because courts have assumed that market prices incorporate all current information, including risks. Alternatively, plaintiffs could charge that fiduciaries had inside information that should have led them to act, but that often runs afoul of securities laws. The ruling talked entirely about public companies, and it was unclear that it applied to private companies. Recently, in two cases, district courts have said it could apply and used that to rule for defendants, saying plaintiffs did not assert a plausible course of action under the Dudenhoeffer doctrine.

On appeal in one of these, in Allen v. GreatBanc Trust Co. No. 15-3569 (7th Cir. Aug. 25, 2016) (text of decision), the Department of Labor argued successfully that the rule should apply only to public companies. The court ruled that plaintiffs could continue their case on the basis on issues other than plausible alternatives, specifically that the valuation was improper. The position and decision are notable for their implications for private companies. The presumption of prudence arguably never was an issue for private company litigation, and the doctrine only came up twice in the 26 years that the NCEO has been tracking litigation. If the Dudenhoeffer rule does not apply to private companies, then the legal landscape for private companies may, in effect, look much like it did before Dudenhoeffer.

The DOL position is worth quoting at length (see the full text of the DOL's brief):

"The Supreme Court in Dudenhoeffer required plaintiffs to plead the existence of "special circumstances" in a very specific class of cases: those involving allegations that a fiduciary should have known from "publicly available information alone" that a "publicly traded stock" was overvalued. Dudenhoeffer, 134 S. Ct. at 2471. And it imposed this requirement for a very specific reason: because fiduciaries may, as a general matter, assume that the market price of publicly-traded stock is an "unbiased assessment of the security's value," meaning that only in "special circumstances" would it be plausible to expect a fiduciary to realize that the presumptively efficient market, in fact, was wrong. Id. at 2472. In contrast, plaintiffs here allege that GreatBanc imprudently purchased stock in a privately-held company that does not trade on any stock market, and whose value can be ascertained only through the good-faith and painstaking due diligence of its purchaser. Plaintiffs do not need to plead additional "special circumstances" under Dudenhoeffer in order to state a claim that GreatBanc failed in this regard."