When corporate executives also serve as ERISA fiduciaries for employee stock ownership plans (“ESOPs”), their business decisions may become subject to heightened legal scrutiny. That was the holding of the Ninth U.S. Court of Appeals in a recent case in which ESOP participants raised ERISA challenges to a CEO’s compensation package. The decision also upheld a California federal trial court’s ruling that barred the executives from using corporate assets to pay their defense costs. (Johnson v. Couturier, 7/27/09). Although this decision is at odds with holdings from the Eighth U.S. Circuit Court of Appeals (whose jurisdiction includes Missouri), it may nonetheless give ESOP fiduciaries pause when making certain business decisions.
The Couturier case arose out of complaints by ESOP participants that three executives of Noll Manufacturing, who also served as fiduciaries for the ESOP, breached their obligation under ERISA to act solely in the interest of participants when they approved an allegedly excessive compensation package for one of the executives. The executives contested that allegation, claiming that this was a business decision, not an act that was subject to ERISA’s fiduciary duties. They also sought to have their defense costs reimbursed from corporate assets, pursuant to indemnification agreements they had with the company.
The participants filed a motion asking the court to bar the company from paying the executive’s litigation expenses, arguing that to do so would further dilute the value of the company – and thus their interests in the ESOP – and that it would violate Section 410(a) of ERISA.
That provision of ERISA makes it illegal for a plan to indemnify its fiduciaries for their wrongful conduct. The lower court granted the participants’ request, and the Ninth Circuit affirmed that decision.
On appeal, the fiduciaries argued that decisions they made when acting as corporate executives – such as approving executive compensation packages – should not be subject to review under ERISA. The Ninth Circuit acknowledged that in most cases business decisions are not governed by ERISA’s fiduciary standards, but said that in this case those standards were implicated because the decisions affected the ESOP’s value. The court also focused on the fact that the business decisions at issue involved the compensation of one of the fiduciary decision-makers. “Where, as here, an ESOP fiduciary also serves as a corporate director or officer, imposing ERISA duties on business decisions from which that individual could directly profit does not to us seem an unworkable rule.”
Does this ruling mean that corporate executives cannot also serve as ESOP fiduciaries without subjecting their business decisions to fiduciary scrutiny under ERISA? Most likely, the decision should not be read that broadly.
The Ninth Circuit emphasized that the defendants’ business decisions, and their request to have their legal fees reimbursed, affected the company’s equity, and thus the value of the participants’ stake in the ESOP. That analysis admittedly is troubling, because nearly all business decisions affect corporate value. Nevertheless, three distinguishing factors about this case may help other ESOP fiduciaries sleep better at night:
- First, the ESOP in the Couturier case was sponsored by a relatively small, closely held company, and the compensation package at issue constituted nearly 65% of the company’s total assets. The effect of the challenged business decision on the ESOP’s value was therefore much more significant than would ordinarily be the case.
- Second, the business decisions at issue here also involved possible self-dealing on the part of one of the fiduciaries, as it was his compensation that was allegedly excessive.
- Third, the court’s analysis will not necessarily be embraced by courts in other parts of the country. The Ninth Circuit acknowledged that its reasoning had essentially been rejected by the Eighth Circuit, which has held in the past that corporate officers and directors do not act as ERISA fiduciaries when making decisions such as these.
ESOPs often present special challenges for corporate officers and directors who also have responsibilities under the plan. The Ninth Circuit’s Couturier decision gives those individuals one more thing to think about when balancing their roles.