While “ERISA and the securities laws ultimately have differing objectives pursued under entirely separate statutory schemes designed to protect different constituencies[,]” recent cases have explored the possibility of liability outside of the traditional “marketplace harm” for corporate practices which manipulated securities prices.  Jander v. Retirement Plans Committee of IBM, 910 F.3d 620, 632 (2d Cir. 2018).

 

Fentress v. Exxon Mobil Corporation

The recent case of Fentress v. Exxon Mobil Corporation, No. 4:16-CV-3484, 2019 WL 426147 (S.D. Tex., Feb. 4, 2019) assessed a company’s potential liability arising from its contribution to global warming.

Plaintiffs, who were participants in the Exxon Mobil Savings Plan and invested in Exxon company stock, brought a class action against Exxon senior corporate officers for failure to prudently manage the plan’s assets pursuant to 29 U.S.C. § 1104(a)(1)(D), alleging that they knew or should have known that Exxon’s stock had become artificially inflated in value owing to fraud and misrepresentation, mainly stemming from corporate failure to report impaired oil and gas reserves.  Exxon stock was the single largest holding of the plan, around $10 billion.

Materially false and misleading statements were primarily attributed to Exxon’s failure to disclose the impairment of reserves owing to, among other causes, “the proxy cost of carbon, which incorporated the future effects of global climate change….”

The plaintiffs alleged that, among other alternative actions, the defendants “should have sought out those responsible for Exxon’s disclosures under the federal securities laws and tried to persuade them to refrain from making affirmative misrepresentations regarding the value of Exxon’s reserves.”

The district court dismissed the non-public information claim because “the alternative actions proposed by plaintiffs were not ‘so clearly beneficial that a prudent fiduciary could not conclude that it would be more likely to harm the fund than to help it,” as required in the Fifth Circuit.  “[C]ourts have repeatedly found that early, corrective disclosures do not meet the alternative action standard of a duty of prudence claim.”

In their amended complaint, the plaintiffs uniquely pled that “based on general economic principles… corrective disclosures do not materially affect stock prices, and that Exxon’s stock drop was instead the result of the market punishing Exxon for its fraud.”

The court acknowledged that under a stock drop theory, plaintiffs may “allege imprudence (1) on the basis of publicly available information or (2) on the basis of non-public information” however reiterated the principle that “where a stock is publicly traded, allegations that [a] fiduciary should have recognized from publicly available information alone that the market was over or undervaluing the stock are implausible as a general rule, at least in the absence of special circumstances.” (quoting Fifth Third Bancorp v. Dudenhoeffer, 134 S. Ct. 2459, 2471 (2014)).  Apparently, global warming and reserve overvaluation do not qualify as “special circumstances.”

The court noted that, generally, ERISA fiduciaries can prudently rely on the market price, that the plaintiff’s burden is ‘significant’ and the alternative course of action must be “so clearly beneficial that a prudent fiduciary could not conclude that it would be more likely to harm the fund than to help it.”  (citing Whitley v. B.P., P.L.C., 838 F.3d 523, 529 (5th Cir. 2016)) (emphasis in the original).

The court refused to acknowledge that “attempting to prevent Exxon’s alleged misrepresentations would have been ‘so clearly beneficial that a prudent fiduciary could not conclude that it would be more likely to harm the fund than to help it.’ … As other comparable companies made corrective disclosures, remaining silent may have communicated to market investors that Exxon was facing the same troubles, which would have had much the same outcome as a corrective disclosure.”

During the pendency of briefing concluding and the court issuing a decision, Jander v. Retirement Plans Comm. of IBM, 910 F.3d 620 (2d Cir. 2018) was decided. The Fentress court identified a circuit split between the Second and Fifth that deprived the Jander opinion of any precedential value, centering on “the argument that reputational damage to the company would increase the longer the fraud went on.”

Further disassociating itself from Jander, the court identified that “there was no major triggering event that made Exxon’s eventual disclosure inevitable.” Despite investigations by state attorney generals and the SEC, the court held that, while “put[ting] pressure on the company [they] resulted in no charges within the class period… Exxon’s eventual disclosure was probably foreseeable, but the Court cannot say it was inevitable.”

 

In re Wells Fargo 401(K) Litigation

In re Wells Fargo 401(K) Litigation, 331 F. Supp. 3d 868 (D. Minn. 2018), is another recent case to address these concepts. The plaintiffs alleged that plan fiduciaries had inside information on the basis of which “they knew or should have known that the market price for the sponsor’s stock was ‘inflated’ and that therefore the plan fiduciaries, under ERISA, were required to take some sort of action, e.g., disclosure of the inside information.”

Wells Fargo established three primary hurdles for a plaintiff bringing an ESOP claim.  First, ERISA’s duty of prudence never requires a fiduciary to break the law, thus “a fiduciary cannot be imprudent for failing to buy or sell stock in violation of the insider trading laws.”  Second, when the action at issue is failure to act on negative inside information (be it via sale or disclosure), a court must carefully adjudge whether the proposed action would have ran afoul of corporate disclosure requirements or insider trading laws.  Third, and most often the heavily contested factor, a court must consider whether the complaint has plausibly alleged that a prudent fiduciary in the defendant’s position could not have concluded that stopping purchases or publicly disclosing negative information would do more harm than good to the fund by causing a drop in the stock price and concomitant drop in the value of the stock already held by the fund.”

Wells Fargo conceded the Supreme Court’s decision in Fifth Third Bancorp et al. v. Dudenhoeffer, 573 U.S. 409 (2016), was limited to stock drop claims based on a breach of the ERISA duty of prudence – yet securities law still complicates breach of loyalty claims under ERISA: a court “would have as much concern about these loyalty claims as it had about the prudence claims in Dudenhoeffer.”  While stock drop claims may originate under ERISA, concern of the policy implemented by the Private Securities Litigation Reform Act of 1995 which “sought to reduce the volume of abusive federal securities litigation by erecting procedural barriers… such as heightened pleading standards” is still paramount. Plaintiff’s counsel must be wary of a complaint appearing to be nothing more than an attempt to get around those heightened pleading standards under the securities laws, involving “taking what is essentially a securities-fraud action and pleading it as an ERISA action.” (quoting Wright v. Medtronic, Inc., No. 09-cv-0443, 2010 WL 1027808 (D. Minn., Mar. 17, 2010)).

Pleading a breach of the duty of prudence requires an elevated showing – that a prudent person would not have delayed disclosure of the defect.  By comparison, pleading a breach of the duty of loyalty requires a showing that a fiduciary delayed disclosure of the defect to further his own interests, rather than the interests of the fund participants.  Tussey v. ABB, Inc., 850 F.3d 951, 958 (8th Cir. 2017) (“A fiduciary can abuse its discretion and breach its duties by acting on improper motives, even if one acting for the right reasons might have ended up in the same place.”).

Ultimately, the Wells Fargo court found that, as employees of Wells Fargo, the defendants were “incentivized to avoid doing or saying anything that would harm the image or reputation of Wells Fargo.”  The court stated, “the mere fact that a fiduciary had an adverse interest does not by itself state a claim for relief.”

 

Jander v. Retirement Plans Committee of IBM

In Jander v. Retirement Plans Committee of IBM, 910 F.3d 620 (2018), IBM employees claimed that the plan’s fiduciaries knew that a division of the company was overvalued but failed to disclose that fact – a failure which artificially inflated IBM’s stock price, harming the ESOP’s members.[1]  The court held that even under a more restrictive interpretation of the Supreme Court’s ruling – which was at contention between the parties – the plaintiffs plausibly alleged an ERISA violation.[2]

The plaintiffs took issue with the defendants’ continual investment of the ESOP’s funds in IBM common stock despite the plan defendants’ knowledge of undisclosed troubles relating to IBM’s microelectronics business, in violation of the duty of prudence. The plaintiffs argued the defendants should have either disclosed the truth about Microelectronics’ value or issued new investment guidelines that would temporarily freeze further investments in IBM stock.

The Jander court recognized Dudenhoeffer’s 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 that they had about the value of the employer’s stock.”  That being said, the Jander court still emphasized that “an ESOP-specific rule that a fiduciary does not act imprudently in buying or holding company stock unless the company is on the brink of collapse (or the like) is an ill-fitting means of addressing” that issue, concluding that the presumption of prudence was not “an appropriate way to weed out meritless lawsuits or to provide the requisite ‘balancing.’”

The court identified the correct standard as one which must “readily divide the plausible sheep from the meritless goats,” a task that is “better accomplished through careful, context-sensitive scrutiny of a complaint’s allegations.”  The court also attacked the “presumption of prudence as ‘making it impossible for a plaintiff to state a duty-of-prudence claim, no matter how meritorious, unless the employer is in very bad economic circumstances.’”

Critically then, under the IBM court’s holding, plaintiffs must 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 IBM court identified three considerations to “inform the requisite analysis.”  The first is that the duty of prudence does not, and cannot, require an ESOP to perform an action which would violate the securities laws.  The second is that if the complaint faults fiduciaries for failing to make additional purchases or disclose information to the public, thereby avoiding overvalued stock, courts must consider whether the action advocated by the plaintiffs could conflict with insider trading and/or corporate disclosure requirements.  Finally, courts must consider whether the complaint plausibly alleged that a prudent fiduciary could not have concluded that any alternative action would have done 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.”  Citing Fifth Third.

Noting that the plan defendants “allegedly knew that IBM stock was artificially inflated through accounting violations” and that the plaintiffs had “plausibly alleged a GAAP violation,” under ERISA’s “lower pleading standards” the plaintiffs had “plausibly pled that IBM’s Microelectronics unit was impaired and that the Plan fiduciaries were aware of its impairment.”

The court also noted that two of the plan defendants had the primary responsibility for the public disclosures that had artificially inflated the stock price to begin with and disclosure could have been done within a regular SEC reporting regime so as not to “spook the market.”

Perhaps most notably, the appellate court endorsed the allegation that the defendants’ failure to promptly disclose “hurt management’s credibility and the long-term prospects of IBM as an investment” as the eventual disclosure of prolonged fraud caused exponentially increasing “reputational damage.”  The court refused to classify this argument as retrospective – the district court’s issue with this claim – as a “reasonable business executive could plausibly foresee that the inevitable disclosure of longstanding corporate fraud would reflect badly on the company and undermine faith in its future pronouncements.”  The plaintiff also supported this argument with economic analyses.

Potentially unique to the IBM case, the court noted that the defendants “allegedly knew that disclosure of the truth… was inevitable, because IBM was likely to sell the business and would be unable to hide its overvaluation from the public at that point… In the normal case, when the prudent fiduciary asks whether disclosure would do more harm than good, the fiduciary is making a comparison only to the status quo of non-disclosure.  In this case, however, the prudent fiduciary would have to compare the benefits and costs of earlier disclosure to those of later disclosure…”  When a loss is inevitable, a fiduciary should endeavor to limit the effects of the artificial inflation, generally leaning toward earlier disclosure.

[1] In a subsequent motion to stay the Second Circuit’s mandate, the defendants’ alleged this ruling was the first to “hold that a plaintiff can state a claim for breach of the fiduciary duty of prudence under Section 502… based on the failure of a corporate officer to disclose that the company’s stock was overvalued.”  Jander v. Retirement Plans Committee of IBM, No. 17-3518, ECF No. 84.

[2] On February 4, 2019, the Second Circuit denied the defendants’ motion to stay the mandate pending the filing and disposition of their writ of certiorari.