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Rare Win for Stock Drop Participants – NAPA
The participant-plaintiffs in a stock drop case have won a rare victory in federal court.
The plaintiffs alleged that the IBM defendants (IBM itself, along with the Retirement Plans Committee of IBM; Richard Carroll, IBM’s Chief Accounting Officer; Martin Schroeter, IBM’s CFO; and Richard Weber, IBM’s general counsel) failed to prudently and loyally manage the plan’s assets and adequately monitor the plan’s fiduciaries. Specifically, they argued that once the defendants learned that IBM’s stock price was artificially inflated, they should have either disclosed the truth about Microelectronics’ value or issued new investment guidelines temporarily freezing further investments in IBM stock by the plan.
Judge William H. Pauley III of the U.S. District Court for the Southern District of New York held that the plaintiffs failed to establish that the defendants were de facto fiduciaries, then went to apply the standards for such cases established in Fifth Third Bancorp v. Dudenhoeffer, 573 U.S. ___, 134 S.Ct. 2459 (2014).
‘Second’ Citing
In ruling on behalf of the plaintiffs, Chief Judge Robert A. Katzmann (joined in the opinion by Judges Robert D. Sack and Reena Raggi) of the U.S. Court of Appeals for the Second Circuit (Jander v. Retirement Plans Committee of IBM, 2d Cir., No. 17-3518, 12/10/18) noted that the district court determined that plaintiffs‐appellants did not plausibly plead a violation of ERISA’s duty of prudence, because a prudent fiduciary could have concluded that earlier corrective disclosure would have done more harm than good. Moreover, that on appeal, the plaintiff-appellants had asserted that this standard was stricter than the one set out in Fifth Third Bancorp v. Dudenhoeffer, 134 S. Ct. 2459 (2014), and that the district court and others have applied this stricter standard in a manner that “makes it functionally impossible to plead a duty-of-prudence violation.” Setting aside that argument, the Second Circuit found it “unnecessary to determine whether the plaintiff‐appellants are correct, because they plausibly plead a duty-of-prudence claim even under the stricter standard used by the district court – reversing and remanding the case for further proceedings.”
Echoing the comments in the district court, the Second Circuit decision noted that prior to 2014, a consensus had formed that ESOP fiduciaries were entitled to a presumption that their fund management was prudent under a “presumption of prudence” standard. However, in 2014 the Supreme Court “definitively rejected” that standard in Fifth Third Bancorp v. Dudenhoeffer, which held that “the law does not create a special presumption favoring ESOP fiduciaries,” as it recognized a “legitimate” concern that “subjecting ESOP fiduciaries to a duty of prudence without the protection of a special presumption will lead to conflicts with the legal prohibition on insider trading,” given that “ESOP fiduciaries often are company insiders” subject to allegations that they “were imprudent in failing to act on inside information they had about the value of the employer’s stock.” Instead, the new standard required that plaintiffs must “plausibly allege an alternative action that the defendant could have taken that would have been consistent with the securities laws and that a prudent fiduciary in the same circumstances would not have viewed as more likely to harm the fund than to help it.”
The Second Circuit then outlined three considerations to “inform the requisite analysis”: the “duty of prudence cannot require an ESOP fiduciary to perform an action—such as divesting the fund’s holdings of the employer’s stock on the basis of inside information—that would violate the securities laws”; “where a complaint faults fiduciaries for failing to decide, on the basis of the inside information, to refrain from making additional stock purchases or for failing to disclose that information to the public so that the stock would no longer be overvalued … 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”; and finally – and this was the point of contention here – the court is also directed to “…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.”
‘Test’ Cases
Here the court took a different position than other courts had, noting that it “…appears to ask, not whether the average prudent fiduciary would have thought the alternative action would do more harm than good, but rather whether any prudent fiduciary could have considered the action to be more harmful than helpful.” Additionally, Judge Katzmann write that it was “not clear which of these tests determine whether a plaintiff has plausibly alleged that the actions a defendant took were imprudent in light of available alternatives.”
Here plaintiff Jander argued that no duty-of-prudence claim against an ESOP fiduciary has passed the motion-to-dismiss stage since the 2010 decision in Harris v. Amgen, and further argued that “imposing such a heavy burden at the motion-to-dismiss stage runs contrary to the Supreme Court’s stated desire in Fifth Third to lower the barrier set by the presumption of prudence.”
Indeed, since Fifth Third replaced the previous “presumption of prudence” standard, a number of these so-called “stock drop” cases have been relitigated, but most have resulted in judgments for the defendants, including BP and Delta Air Lines, Lehman and GM. In Dennis Smith v. Delta Airlines Inc., et al., the 11th Circuit noted that, “while Fifth Third may have changed the legal analysis of our prior decision, it does not alter the outcome.”
However, in the case at hand, Judge Katzmann noted that “we need not here decide which of the two standards the parties champion is correct, however, because we find that Jander plausibly pleads a duty-of-prudence claim even under the more restrictive ‘could not have concluded’ test.”