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(Article from Securities Law Alert, October/November 2019) 

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On November 6, 2019, the Supreme Court heard oral arguments in Retirement Plans Committee of IBM v. Jander, No. 18-1165. At issue is whether plaintiffs can satisfy Fifth Third’s “more harm than good” pleading standard for inside information-based ERISA claims against the fiduciaries of an employee stock ownership plan (“ESOP”) by alleging that delaying an inevitable disclosure of an alleged fraud results in greater stock price harm.

Background

In Fifth Third Bancorp v. Dudenhoeffer, 573 U.S. 409 (2014), the Supreme Court held that in order “[t]o state a claim for breach of the duty of prudence” against ESOP fiduciaries “on the basis of inside 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.”[1]

In Jander v. Retirement Plans Committee of IBM, 910 F.3d 620 (2d Cir. 2018), the Second Circuit held that Fifth Third’s “more harm than good” pleading standard was met where plaintiffs alleged that the disclosure of the overvaluation of one of the company’s business divisions was “inevitable, because [the company] was likely to sell the business and would be unable to hide its overvaluation from the public at that point.” The court found plaintiffs adequately alleged that “the eventual disclosure of a prolonged fraud causes ‘reputational damage’ that ‘increases the longer the fraud goes on.’” The court determined that “when ‘a drop in the value of the stock already held by the fund is inevitable’ . . . it is far more plausible that a prudent fiduciary would prefer to limit the effects of the stock’s artificial inflation on the ESOP’s beneficiaries through prompt disclosure.” Defendants petitioned the Supreme Court for a writ of certiorari to review the Second Circuit’s decision. The Court granted defendants’ petition on June 3, 2019.

Justices Grapple with the Question of Whether Claims Against ESOP Fiduciaries for Failure to Disclose Inside Information Should Be Brought Under the Securities Laws

During oral argument, petitioners’ counsel argued that “ESOP fiduciaries do not have a fiduciary obligation to use information gained in a corporate capacity or to use the regular corporate channels of disclosure for the benefit of plan participants.” Petitioners’ counsel further contended that in every case, plaintiffs could plead “generic allegations” that “it is prudent to disclose early” because “no fraud lasts forever, disclosure’s inevitable, and the harms of concealment only grow over time.” He asserted that permitting such allegations to satisfy Fifth Third is “fundamentally inconsistent” with the “objective reality that if you disclose negative inside information to the market, it’s going to have a negative impact on the value of the stock, which is all an ESOP holds.” Petitioners’ counsel argued that Fifth Third therefore requires something “very specific” and “very different” that would cause a prudent fiduciary to determine that “committing this immediate harm is nonetheless prudent.”

Justice Sotomayor stated that “[t]he economic principle” that the harm of an inevitable disclosure increases over time “is both logical and supported by the literature.” She questioned what was “missing from the specifics” of the complaint, other than the theory that this “economic principle shouldn’t exist at all.” Justice Sotomayor asked whether petitioners’ counsel could “really be saying that it’s a fiduciary duty to help sellers promote fraudulent conduct by avoiding losses for people.” Petitioners’ counsel responded that such disclosure-based claims against ESOP fiduciaries who are also company insiders should be brought under the securities laws, rather than ERISA. Justice Sotomayor stated that this was “not what you asked for cert on.” Justice Breyer raised the same concern, and suggested that the Court should “just stick to the question on which we granted cert.” He stated that plaintiffs’ allegations concerning the increased stock price harm resulting from a delayed disclosure were “fairly specific” and “seem[] adequate.” Justice Breyer questioned, “What’s wrong with [the complaint]?”

Counsel for the United States, as amicus curiae supporting neither party, posited that the securities laws should exclusively govern a company’s disclosure obligations. He asserted that “it would undermine the objectives of the securities laws to impose an additional disclosure regime based on the ad hoc balancing of a single ERISA fiduciary.” Justice Ginsburg observed that this “theory” was “nowhere aired below.” Counsel for the United States explained that he was trying to “be useful to the Court by discussing the objectives of the securities laws” and highlighting the quandary faced by ESOP fiduciaries, who are prohibited under the securities laws from making a selective disclosure only to plan participants. Justice Alito seemed persuaded, and noted that the “more harm than good” standard asks the ”fiduciary . . . to make a very complicated calculation” about whether and when to disclose adverse inside information, by trying to anticipate what the situation would be “at some point in the future when the information will inevitably come out.” Justice Kagan noted that “it does sound like you want us to scrap [Fifth Third] and start all over again.” Counsel for the United States responded that Fifth Third requires courts to consider “whether a[n] ERISA-based obligation to disclose . . . would be inconsistent with the objectives of . . . the securities laws.” He asserted that “in almost every case it would be.”

Justice Gorsuch questioned respondents’ counsel why the securities laws would not “be a really good place to start and maybe finish in assessing what [the] long-term overall health of the corporate interests might be?” He stated, “I mean, isn’t that what the securities laws are all about? It’s . . . ensuring the markets function on a net basis with as much transparency and efficiency as we can muster, subject to . . . imposing reasonable costs and duties on people?” Justice Gorsuch observed that if the fiduciary is supposed to consider “the general interests . . . of the plan as a whole,” he “would have thought the securities laws would have been a really good proxy for the duties we’d expect a fiduciary to abide.”

Respondents’ counsel argued that the case before the Court was among the “rare exception[s]” in which ESOP fiduciaries were required to make a disclosure because of the unique circumstances at issue. He explained that the case involved “fiduciaries who happen to be insiders . . . who happen to be involved in the thing that is alleged to have inflated the stock price, who happen to have direct knowledge of that, and who happen to have responsibility for the accounting of that, and, therefore, are in a position to know about it.” Justice Kavanaugh observed, “That doesn’t seem rare at all. That seems fairly commonplace.” During rebuttal, petitioners’ counsel reiterated that “[t]he allegations here are generic allegations that could be made in every stock drop case.”

The Court will issue a decision in Retirement Plans Committee of IBM v. Jander later this Term.