(Article from Securities Law Alert, July/August 2020)
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Earlier this year, the Supreme Court vacated a Second Circuit decision holding that plaintiffs satisfied Fifth Third’s “more harm than good” pleading standard for an inside information-based ERISA claim against the fiduciaries of an employee stock ownership plan (“ESOP”)[1] by alleging that delaying an inevitable disclosure of an alleged fraud results in greater stock price harm. Ret. Plans Comm. of IBM v. Jander, 140 S.Ct. 592 (2020).[2] On June 22, 2020, the Second Circuit reinstated its earlier decision and remanded for proceedings consistent with its initial opinion. Jander v. Ret. Plans Comm. of IBM, 962 F.3d 85 (2d Cir. 2020) (per curiam).
Several weeks later, on July 28, 2020, the Eighth Circuit rejected the theory of ERISA liability endorsed by the Second Circuit. Dormani v. Target Corp., 2020 WL 4289987 (8th Cir. 2020) (Kobes, J.). Plaintiffs claimed that the ESOP fiduciaries should have disclosed the company’s supply-chain management problems. Plaintiffs argued that “no prudent fiduciary could conclude disclosure would harm the Plan because an efficient stock market provided with full information would not overreact to disclosure and profit seeking arbitrageurs would have acted quickly to bring the price back to fair value.” In essence, plaintiffs “assume[d] some drop in stock price was inevitable and the earlier the fiduciaries disclosed [the company’s] problems and the earlier the drop took place, the less time the Plan would spend purchasing artificially inflated [company] stock.” The Eighth Circuit found “this chain of reasoning . . . uncertain” and determined that “a reasonably prudent fiduciary lacking the Plan participants’ faith in arbitrageurs could still believe disclosure was the more dangerous of the two routes.”
The Eighth Circuit also rejected plaintiffs’ contention that “the fiduciaries violated the duty of loyalty in administering the Plan” by simultaneously serving as officers or directors of the company. The court explained that “ERISA authorizes fiduciaries to wear different hats.” The Eighth Circuit held that “[m]ere officer or director status does not create an imputed breach of the duty of loyalty simply because an officer or director has an understandable interest in positive performance of company stock.”
The Eighth Circuit further held that plaintiffs could not state a duty of loyalty claim by alleging that the fiduciaries made misleading statements to Plan participants. The court stated that “[l]itigants cannot use the duty of loyalty to circumvent the demanding [Fifth Third] standard for duty of prudence claims.”
[1] 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.” Please click here to read our discussion of the Supreme Court’s decision in Fifth Third.
[2] The Court explained that “[t]he question presented” was whether Fifth Third’s “‘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.” 140 S.Ct. 592. The Court noted that “[i]n their briefing on the merits, however, the petitioners . . . and the Government . . . focused their arguments primarily upon other matters[,]” which the Second Circuit did not address. The Court determined that the Second Circuit should have an opportunity to consider, in the first instance, questions raised concerning whether ERISA imposes any duty on ESOP fiduciaries to act on inside information, and whether claims for failure to disclose inside information are compatible with the federal securities laws. Please click here to read our discussion of the Supreme Court’s decision in Jander.