(Article from Securities Law Alert, February 2018)
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On February 6, 2018, the Fifth Circuit followed the Second Circuit in holding that the Supreme Court’s decision in Fifth Third Bancorp v. Dudenhoeffer, 134 S. Ct. 2459 (2014)[1] applies to ERISA claims alleging that company stock was excessively risky in addition to claims that the stock was overvalued. Singh v. RadioShack Corp., 2018 WL 732913 (5th Cir. 2018) (per curiam). The Fifth Circuit further held that plaintiffs could not satisfy Fifth Third’s “special circumstances” exception for claims based on publicly available information by alleging that defendants failed to disclose inside information, or failed to monitor the continued prudence of investing in company stock. The court also ruled that plaintiffs did not satisfy Fifth Third’s “more harm than good” standard for claims based on inside information. Fifth Third’s Standard Governs Public Information-Based Claims Alleging Excessive Risk
The Fifth Circuit rejected plaintiffs’ contention that Fifth Third “addresses only allegations that public information showed that a stock was overvalued, not claims that the stock was excessively risky.” The court found “‘illusory’” the “distinction between claims that stock is overvalued and claims that stock is excessively risky.” Singh, 2018 WL 732913 (quoting Rinehart v. Lehman Bros. Holdings, 817 F.3d 56 (2d Cir. 2016)).[2] The Fifth Circuit reasoned that “[i]n an efficient market, market price accounts for risk.” The court held that “although [Fifth Third] was primarily framed in terms of overvalued-stock allegations, it applies equally to [p]laintiffs’ public-information claims premised on excessive risk.” The Second, Sixth and D.C. Circuits have reached the same conclusion.[3]
Failure to Disclose Inside Information Does Not Constitute a “Special Circumstance”
In Fifth Third, the Court held that “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.” 134 S. Ct. 2459. The Fifth Circuit noted that “[t]he Supreme Court has not defined ‘special circumstances,’ but has said that such circumstances ‘affect[ ] the reliability of the market price as an unbiased assessment of the security’s value in light of all public information.’” Singh, 2018 WL 732913 (quoting Fifth Third, 134 S. Ct. 2459).
Plaintiffs contended that Fifth Third’s “special circumstances” requirement was met because defendants had “withheld material information from the market, skewing the stock price.” The Fifth Circuit held that the failure to disclose inside information does not constitute a “special circumstance” because Fifth Third established a separate standard for analyzing insider-information claims.
Failure to Investigate the Prudence of Continuing to Invest in Company Stock Is Not a “Special Circumstance”
The Fifth Circuit also rejected plaintiffs’ contention that the “special circumstances” requirement was satisfied because the Plan fiduciaries allegedly “failed to investigate the continued prudence of investing Plan assets in [company] stock.”
Because plaintiffs “did not plausibly allege that the purported lack of investigation had any effect on the reliability of the market price,” the Fifth Circuit held that this failure to investigate “cannot be a special circumstance” within the meaning of Fifth Third.
Plaintiffs Did Not Satisfy Fifth Third’s “More Harm Than Good” Standard for Claims Based on Inside Information
“To state a duty of prudence claim based on nonpublic information, ‘a plaintiff 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.’” Id. (quoting Fifth Third, 134 S. Ct. 2459).
In the case before it, the Fifth Circuit found that a prudent fiduciary could conclude that freezing investments in company stock “would signal to the market ‘that insider fiduciaries viewed the employer’s stock as a bad investment,’ causing the Fund’s existing holdings of [company] stock to decline in value.” Id. (quoting Fifth Third, 134 S. Ct. 2459).
The Fifth Circuit also found that “a prudent fiduciary could readily conclude that ‘publicly disclosing negative information 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. (quoting Fifth Third, 134 S. Ct. 2459).
[1] In Fifth Third, the Court outlined the standards for pleading an ERISA breach of the duty of prudence claim against the fiduciary of an employee stock ownership plan. Please click here to read our prior discussion of the Fifth Third decision.
[2] Please click here to read our prior discussion of the Second Circuit’s decision in Rinehart.
[3] See Rinehart, 817 F.3d 56 (“Fifth Third foreclose[s] breach of prudence claims based on public information irrespective of whether such claims are characterized as based on alleged overvaluation or alleged riskiness of a stock.”); Pfeil v. State Street Bank and Trust Co., 806 F.3d 377 (6th Cir. 2015) (“the excessively risky character of investing ESOP funds in stock of a company experiencing serious threats to its business … is accounted for in the market price”); and Coburn v. Evercore Trust Co., 844 F.3d 965 (D.C. Cir. 2016) (“arguing that a stock is too risky to hold at current market prices is part and parcel of the claim that that stock is overvalued” for Fifth Third purposes).