Most companies are prepared for the Pavlovian securities fraud suit that follows a precipitous stock price drop. However, with the continuing depression of stock prices across many sectors, companies should also be prepared for the possibility of lawsuits attacking the management of company retirement plans. In these cases, participants in retirement plans funded with employer securities sue plan fiduciaries when company stock prices drop, typically arguing that the fiduciary should have either eliminated plan investments in company stock based on information the fiduciary had about the stock’s value, or disclosed information to ensure the stock was properly valued in an efficient market.
But this puts employers in a tenuous position with respect to their obligations under securities laws and their duties as fiduciaries to retirement plan participants. Disclosing negative nonpublic information may cause the stock’s value (and retirement plan participant accounts) to decrease even more, causing more harm to plan participants. And company insiders are barred from trading on insider information.
Fiduciaries of retirement plans funded with employer stock may believe that properly disclosing the risks of investing in company stock and complying with certain notification obligations provides them with immunity in these lawsuits, but as explained in further detail below, recent caselaw in this area is anything but clear. In volatile markets, fiduciaries of these plans can benefit from retaining counsel to assist in preparing the proper documentation and implementing the appropriate protocols at the board and fiduciary level.
And if plaintiffs’ attorneys do target these plan fiduciaries, having a legal team that understands the intricacies of securities laws will be crucial to successfully defending a fiduciary’s actions in court.
The Employee Retirement Income Security Act of 1974 (ERISA) requires that retirement plan fiduciaries “discharge [their] duties with respect to a plan solely in the interest of the participants and beneficiaries… with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use….” 29 U.S.C. § 1104(a)(1)(B). Until recently, retirement plan fiduciaries enjoyed a presumption of prudence articulated by Moench v. Robertson, 62 F. 3d 553 (3rd Cir. 1995), which made it extremely difficult for participants to state a claim for a breach of fiduciary duty in this context. That changed in 2014, when the U.S. Supreme Court rejected the Moench presumption in Fifth Third Bancorp v. Dudenhoeffer, noting that the “law does not create a special presumption favoring” plan fiduciaries.” 573 U.S. 409 (2014). Dudenhoeffer replaced the prudence presumption with a three factor test used to determine whether plaintiffs have plausibly alleged an alternative action fiduciaries could have taken that would have been legal and that a prudent fiduciary would not have viewed as more likely to harm the fund than to help it:
- First, the duty of prudence under ERISA “cannot require an ESOP [or other retirement plan] fiduciary to perform an action . . . that would violate the securities laws.” at 428.
- Second, where a fiduciary fails to take any action, such as “failing to disclose . . . information to the public so that the stock would no longer be overvalued” or not barring the plan from offering employer stock investments, courts should consider whether such actions “could conflict with the complex insider trading and corporate disclosure requirements imposed by the federal securities laws or with the objectives of those laws.” at 429.
- Third and finally, courts evaluating any of the plaintiffs’ alleged alternative actions “should also consider whether the complaint has plausibly alleged that a prudent fiduciary in the defendant’s position could not have concluded” that those alternatives “would do more harm than good to the fund by causing a drop in the stock price and a concomitant drop in the value of the stock already held by the fund.” Id. In other words, if by taking the alternative action the fiduciaries could have done more harm than good to the stock fund value, it is possible for a plaintiffs’ claims to be thrown out of court.
The Second Circuit recently dove into the muddy waters of Dudenhoeffer after a federal district court dismissed a plaintiff’s claims that IBM retirement plan fiduciaries breached their duties of prudence when they failed to disclose overvaluation of the company’s stock before a sale of its microelectronics business. In so doing, the trial court focused on the third factor, holding that the defendant-fiduciaries’ potential alternative actions alleged in the complaint might have caused more harm than good to IBM’s retirement plan assets. See Jander v. Ret. Plans Comm. of IBM, 272 F. Supp. 3d 444 (S.D.N.Y. 2017).
The Second Circuit Court of Appeals reversed, finding “particularly important” to its holding plaintiff’s allegation that an earlier disclosure of the truth would have mitigated devaluation of fund stock and, thus, harm to the plaintiff, since a sale of the IBM business in question (and, thus, concurrent revelation of the “truth”) was ultimately “inevitable.” Jander v. Retirement Plans Committee of IBM. 910 F.3d 620, 630 (2nd Cir. 2018). Put differently, since overvaluation of the company stock would have been revealed regardless, defendants should have forestalled a drastic correction through prompt disclosure. However, in the appeal and remand that followed, both the Supreme Court and the Second Circuit Court of Appeals declined to provide additional clarification of the Dudenhoeffer factors. See Ret. Plans Comm. of IBM v. Jander, 140 S. Ct. 592 (2020); Jander v. Ret. Plans Comm. of IBM, No. 17-3518, 2020 WL 3412115 (2d Cir. June 22, 2020).
Despite the fact that no definitive standards for determining a breach of a plan fiduciary’s duty emerged from the Jander case, the opinion offers some indications of how courts might evaluate this predicament in the future. First, the survival of the plaintiff’s complaint suggests that the “more harm than good” pleading standard “can be satisfied by generalized allegations that the harm of an inevitable disclosure of an alleged fraud generally increases over time.” Jander, 140 S. Ct. at 594. Plan fiduciaries and executives should evaluate inside information carefully to determine whether it is ripe for disclosure.
Second, knowledge of securities laws remains more crucial than ever in this context. The Supreme Court once again noted, as it had in Dudenhoeffer, that the “U.S. Securities and Exchange Commission had not advised us of its views on these matters, and we believe those views may well be relevant.” Id. (quoting Dudenhoeffer, 573 U.S. at 429). Indeed, the SEC and the Department of Labor joined in submitting amicus briefs to the Supreme Court and the Second Circuit Court of Appeals, which contended that judgment as to whether a fiduciary’s actions would do more harm than good should be determined by the securities laws and “prudent fiduciaries should generally not second-guess that judgment.”
Finally, as Justice Gorsuch noted in his concurrence, the interplay between ERISA and the securities laws is due to be addressed by courts in the near future—and even in later stages of the ongoing Jander litigation. Jander, 140 S. Ct. at 596-97.
In sum, the only thing clear in stock drop litigation is that fiduciaries’ ERISA and securities obligations are deeply entangled, with the Supreme Court signaling it will take cues from the SEC as factors in deciding whether a plan fiduciary has breached its duties.
In unpredictable markets like we are currently experiencing, fiduciaries of retirement plans funded with employer stock should retain counsel to implement the proper documentation and protocols before a lawsuit happens and to track case law developments in real time. The board of directors and high-ranking corporate officers should anticipate and prepare for ERISA stock drop litigation when the stock price is poised for sharp decline or has already sharply declined. This preparation should be undertaken well in advance of any corporate crisis and may include designating specific board members or executives to be responsible for coordinating the corporation’s response to stock drop litigation. And in a lawsuit, hiring attorneys who understand not only ERISA but also the complexities of securities law is more important now than ever, as courts continue to build out the standard articulated in Dudenhoeffer.