Opinion ID: 4707273
Heading Depth: 3
Heading Rank: 3

Heading: Exception for Dual-Hat Directors and Oﬃcers

Text: Despite the exclusive beneﬁt rule, ERISA § 408(c)(3) explicitly allows corporate insiders—who already have ﬁduciary duties under corporation law—to serve as ERISA ﬁduciaries. Section 408(c)(3) states that ERISA’s “prohibited transactions” rules shall not “be construed to prohibit any ﬁduciary from … serving as a ﬁduciary in addition to being an ofﬁcer, employee, agent, or other representative of a party in interest.” 29 U.S.C. § 1108(c)(3). ERISA deﬁnes “party in interest” to include corporate employers and other plan sponsors. 29 U.S.C. § 1002(14). Moreover, ERISA invites conﬂicts of interest within ESOPs like the plan in this case. ERISA’s prohibited transaction rules ordinarily forbid deals between plans and other interested parties such as large stockholders, see 29 U.S.C. § 1106(a)(1)(E) & (a)(2), but ERISA speciﬁcally allows such deals for ESOPs, see 29 U.S.C. § 1107(b)(1) & (d)(3)(A)(ii). By “expressly contemplat[ing] ﬁduciaries with dual loyalties,” § 408(c)(3) takes “an unorthodox departure from the common law” that is in obvious tension with ERISA’s exclusive beneﬁt rule. Donovan v. Bierwirth, 538 F. Supp. 463, 468 (E.D.N.Y. 1981), aﬀ’d as modiﬁed, 680 F.2d 263 (2d Cir. 1982). 18 No. 20-2793 As noted, scholars have defended this “fundamental contradiction” as necessary to encourage employers to establish beneﬁt plans. Without dual-hat ﬁduciaries, employers that establish ERISA plans would be “assuming ﬁnancial liabilities without eﬀective controls.” Langbein & Fischel, 55 U. Chi. L. Rev. at 1127. The eﬀect of adhering strictly to the commonlaw rule would likely be a lower rate of plan formation. Id. ERISA’s necessary accommodation for dual-hat directors and oﬃcers has produced messy conﬂicts of interest that courts and commentators have long recognized and struggled to resolve. See generally Laurence B. Wohl, Fiduciary Duties Under ERISA: A Tale of Multiple Loyalties, 20 U. Dayton L. Rev. 43 (1994). Courts “are faced with the problem of reconciling the overwhelming requirements of common-law trustee singlemindedness with the ERISA permission for dual loyalties.” Id. at 58. Courts “must develop a tolerance for the resulting conﬂicts such dual roles undoubtedly will cause.” Id. The Supreme Court itself has noted this problem, writing that “the analogy between ERISA ﬁduciary and common law trustee becomes problematic … because the trustee at common law characteristically wears only his ﬁduciary hat when he takes action to aﬀect a beneﬁciary, whereas the trustee under ERISA may wear diﬀerent hats.” Pegram v. Herdrich, 530 U.S. 211, 225 (2000). Accordingly, since the 1980s, courts have recognized and tried to harmonize directors and oﬃcers’ dual loyalties under ERISA. In Donovan v. Bierwirth, for example, the Secretary of Labor sued dual-hat trustees of an ERISA plan for breaching their duty of loyalty to beneﬁciaries by using plan assets to purchase company stock at an inﬂated price to fend oﬀ an outside takeover bid. 538 F. Supp. at 465–68. The district court No. 20-2793 19 ﬁrst noted that, because ERISA “abrogated the traditional common law rule” and “clearly contemplates … ﬁduciaries with dual loyalties,” the trustees “did not commit per se violations of ERISA either by their failure to abstain from the investment decision … or by the mere acquisition of [company] stock.” Id. at 469–70. Nevertheless, the court held that “when a ﬁduciary has dual loyalties, his independent investigation into the basis for an investment decision which presents a potential conﬂict of interests must be both intensive and scrupulous” to ensure that the conﬂict is not inﬂuencing the decision. Id. at 470, discussing 29 U.S.C. § 1104(a)(1)(B) (ERISA duty of prudence). Applying that standard, the court found that the trustees failed to exercise such care by not recognizing and taking steps to neutralize their inherent conﬂict—such as, at the very least, consulting independent counsel. Id. at 473. The Second Circuit aﬃrmed, clarifying that dual-hat directors and oﬃcers must do everything possible to “avoid placing themselves” in a decision presenting an actual conﬂict, and if faced with such a conﬂict must inform themselves and act to neutralize it, perhaps by temporarily resigning as trustees. Donovan v. Bierwirth, 680 F.2d at 271–72. But unlike at common law, the court acknowledged, “oﬃcers of a corporation … do not violate their duties as trustees by taking action which, after careful and impartial investigation, they reasonably conclude best to promote the interests of participants and beneﬁciaries simply because it incidentally beneﬁts the corporation or, indeed, themselves.” Id at 271. In this circuit, we used a similar approach to reconcile ERISA’s exclusive beneﬁt rule with its allowance for dual-hat directors and oﬃcers in Leigh v. Engle, 727 F.2d 113 (7th Cir. 20 No. 20-2793 1984). Dual-hat directors and oﬃcers invested ERISA trust assets in companies that were targets of directors and oﬃcers’ hostile takeover attempts. We said that “plan trustees who are also oﬃcers of either the ‘target’ or the ‘raider’ could be seen as having a signiﬁcant ‘interest’ of their own in the outcome of the contest.” Id. at 127. We invoked the Donovan v. Bierwirth method of addressing directors and oﬃcers’ dual loyalties and held that the directors and oﬃcers violated ERISA’s ﬁduciary requirements: Where the potential for conﬂicts is substantial, it may be virtually impossible for ﬁduciaries to discharge their duties with an “eye single” to the interests of the beneﬁciaries, and the ﬁduci- aries may need to step aside, at least temporar- ily, from the management of assets where they face potentially conﬂicting interests. … Where it might be possible to question the ﬁduciaries’ loyalty, they are obliged at a minimum to en- gage in an intensive and scrupulous independ- ent investigation of their options to insure that they act in the best interests of the plan beneﬁ- ciaries. In the case before us, we believe there is an additional factor which weighs heavily in evaluating the loyalty of the ﬁduciaries. Here the control eﬀorts lasted for several months, and in the case of Hickory, for over a year. The Reli- able Trust held its shares involved in the control contests throughout these periods, and, as we discuss below, the trust’s use of its assets at all relevant times tracked the best interests of the Engle [corporate insiders’] group in the control contest. We believe that the extent and duration No. 20-2793 21 of these actions congruent with the interests of another party are also relevant for courts in de- ciding whether plan ﬁduciaries were acting solely in the interests of plan beneﬁciaries. Id. at 125–26, citing Donovan v. Bierwirth, 680 F.2d at 272; see also Newton v. Van Otterloo, 756 F. Supp. 1121, 1127–30 (N.D. Ind. 1991) (applying Leigh’s “three-pronged approach”); Danaher Corp. v. Chicago Pneumatic Tool Co., 635 F. Supp. 246, 250 (S.D.N.Y. 1986) (doubting “the appropriateness of [a] chief executive oﬃcer continuing in his position of ESOP trustee during [a] takeover attempt” that was favored by current beneﬁciaries at the expense of potential future beneﬁciaries). These cases illustrate how courts have adapted ERISA’s ﬁ- duciary rules to account for the exception allowing for dualhat director and oﬃcer ﬁduciaries. Courts have even applied these adapted ﬁduciary rules in cases involving ESOP valuations much like the one at issue in this case. In Donovan v. Cunningham, for example, the Fifth Circuit applied Donovan v. Bierwirth’s approach in a case where an ESOP trustee who was also a corporate oﬃcer participated in the valuation of corporate stock for an ESOP purchase. 716 F.2d 1455 (5th Cir. 1983). The court recognized that “the stringent prophylactic rules of the common law cannot be incorporated reﬂexively under” ERISA, id. at 1466–67, but that ERISA’s exception allowing ESOPs to purchase employer stock for “adequate consideration” must still be interpreted to imply an exacting duty of prudence for dual-hat ﬁduciaries with potential conﬂicts of interest. Id. at 1467 & n.27. The Fifth Circuit reaﬃrmed this principle in a case where dual-hat directors and oﬃcers were involved in an ESOP’s purchase of company stock at an inﬂated price. Perez v. 22 No. 20-2793 Bruister, 823 F.3d 250, 262–63 (5th Cir. 2016) (“The trustees did not separate Bruister’s personal interests from Donnelly’s valuation process so as to avoid a conﬂict of interest. Their breach of the duty of loyalty turns on their failure to place the interests of participants and beneﬁciaries ﬁrst”; to prove ESOP purchase was “prudent”, “care must be taken to avoid any identiﬁed conﬂicts of interest”); see also Howard v. Shay, 100 F.3d 1484, 1488–89 (9th Cir. 1996) (citing Donovan v. Bierwirth and Leigh v. Engle and holding that dual-hat ﬁduciaries violated their ERISA duties of care and loyalty when ESOP sold undervalued shares back to the dual-hat company president).