February 26, 2020

Retirement Plans Comm. of IBM v. Jander

ERISA

Can a Plaintiff Satisfy Dudenhoeffer’s “More Harm than Good” Pleading Standard with Generalized Allegations that Harm from Inevitable Disclosure of Stock Fraud Increases Over Time?

CASE AT A GLANCE

Plan participants sued the fiduciaries of IBM’s employee stock ownership plan (ESOP) for breach of fiduciary duty, alleging that, as corporate insiders, the fiduciaries failed to disclose nonpublic information that one of IBM’s corporate divisions was overvalued. Plaintiffs alleged that, had the fiduciaries issued a disclosure statement before the inevitable disclosure of such fraud, the stock market would have efficiently and gently corrected the artificially inflated stock price. Instead, IBM’s stock dropped when the fraud was inevitably disclosed during the sale of the corporate division. Plaintiffs contend that they plausibly alleged that a hypothetical fiduciary could not have concluded that a controlled disclosure would have done “more harm than good” to the ESOP than the inevitable disclosure, and therefore, the district court improperly dismissed the complaint.

Docket No. 18-1165
Argument Date: November 6, 2019
From: The Eleventh Circuit
by Jayne Zanglein
Western Carolina University, Cullowhee, NC

ISSUES

Have plan participants plausibly pled that, if an ESOP fiduciary who is a corporate insider had disclosed the overvaluation of a corporate division, rather than waiting for the inevitable disclosure during negotiations for the sale of the corporate division, such controlled disclosure would not have caused “more harm than good” to the plan since the harm of disclosure generally increases over time?

FACTS

Larry Jander, and other IBM employees, who participated in an employee stock ownership plan (ESOP) sponsored by IBM, sued the ESOP fiduciaries, who were corporate insiders, for breach of fiduciary duty. They alleged that the fiduciaries’ failure to disclose that the company’s microelectronics division was overvalued artificially inflated IBM’s stock price. When IBM sold the division, it took a loss and IBM’s stock price plummeted by $12 per share. Despite the fiduciaries’ knowledge that the microelectronics division was losing money, they continued to invest in IBM stock. Jander contends that this continued investment violated the prudence rule of the Employee Retirement Income Security Act (ERISA), which requires fiduciaries to use the care, skill, prudence, and diligence of a similarly situated fiduciary in making investment decisions.

The district court dismissed the case because the plaintiffs had failed to sufficiently allege alternative actions that the fiduciaries could have taken, which would not have caused more harm than good to the participants under the standard announced by the Supreme Court in Fifth Third Bancorp v. Dudenhoeffer, 134 S. Ct. 2459 (2014). Specifically, it held that Jander’s allegations that early corrective disclosure of the overvalued stock would have minimized losses when the market corrected the stock price were too generic and general to satisfy the Dudenhoeffer pleading requirement. Furthermore, the court noted that courts have rejected the hypothesis that the longer a fraud continues, the harsher the market correction will be once the fraud is disclosed. During the period in question, the ESOP sold $391 million of IBM stock and bought $111 million. Based on these facts, the district court concluded that a hypothetical “fiduciary could have concluded that issuing a corrective disclosure would do more harm than good.” The district court held that Jander was required to allege specific evidence of a loss by “possibly retaining an expert to perform a quantitative analysis to show more precisely how Plan participants are harmed in the short and long term by purchasing Fund shares at artificially high prices.” Jander v. IBM, 205 F. Supp. 3d 538 (S.D.N.Y. 2016).

The Eleventh Circuit reversed and held that Jander had plausibly alleged that a hypothetical prudent fiduciary would not have found that the early disclosure would have caused more harm than good by alleging that (1) the fiduciaries knew the stock was artificially inflated because the microelectronics division was overvalued; (2) the fiduciaries had the power to correct this artificial inflation in quarterly securities filings; (3) in an efficient market, disclosure of the overvaluation would only reduce the value of stock by the amount of overinflation; (4) the fiduciaries knew that the disclosure was inevitable because IBM was planning to sell the division; and (5) the failure to promptly disclose the overvaluation of the electronics division impaired the value of IBM stock as an investment because “eventual disclosure of a prolonged fraud causes ‘reputational damage,’ that ‘increases the longer the fraud goes on.’” The Eleventh Circuit held the district court erred in dismissing the fifth allegation at the motion to dismiss stage simply because it was theoretical or untested. Although an allegation based on economic analyses of general market experience may not be enough to satisfy Dudenhoeffer’s pleading requirement, when combined with other specific allegations such as the overvaluation of a corporate division that is subject to sale, they may suffice. IBM v. Jander, 910 F.3d 620 (2d Cir. 2018).

IBM appealed to the Supreme Court.

CASE ANALYSIS

In Fifth Third Bancorp v. Dudenhoeffer, the Supreme Court rejected a presumption of prudence for ESOP fiduciaries because it made “it almost impossible for a plaintiff to state a duty-of-prudence claim…, unless the employer is in very bad economic circumstances.” The Supreme Court held that an ESOP participant has a cause of action against ESOP fiduciaries for breach of fiduciary duty when the fiduciaries have nonpublic, inside information that would require them to act, and they fail to act. The participant must allege a viable alternative action that the fiduciaries could have lawfully taken, which a prudent fiduciary facing the same circumstances “would not have viewed as more likely to harm the fund than to help it.”

ERISA does not permit a court to evaluate the prudence of a transaction based on hindsight. Instead, the court must examine the fiduciary’s conduct based on the circumstances prevailing at the time the fiduciary acts. ERISA 404(a)(1)(B). The Dudenhoeffer standard places a burden on the plaintiff to plausibly allege that the alternative action it proposes was so “clearly beneficial” that a hypothetical prudent fiduciary could not conclude that the action would cause more harm than good. In other words, the plaintiff must plausibly allege “that a prudent fiduciary in the defendant’s position could not have concluded that stopping purchases—which the market might take as a sign that insider fiduciaries viewed the employer’s stock as a bad investment—or 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.” This standard is difficult to meet.

The IBM ESOP fiduciaries argue that if the Supreme Court holds that generic allegations are sufficient to meet the Dudenhoeffer standard, then “plaintiffs will routinely satisfy a pleading standard designed to be rigorous.” Petition for Writ of Certiorari, 10. This is completely contrary to the Court’s attempt in Dudenhoeffer to “weed out meritless lawsuits.”

The Fifth and Sixth Circuits have held that generalized allegations do not meet Dudenhoeffer’s exacting standards because the allegation is based on hindsight. Martone v. Robb, 902 F.3d 519 (5th Cir. 2018); Graham v. Fearon, 721 F. App’x 429 (6th Cir. 2018). The Eleventh Circuit reached the opposite conclusion in Jander, holding that because disclosure is always 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.”

Plaintiffs argue that if the overinflated price of the division had been disclosed sooner in Securities and Exchange Commission (SEC) filings, then the ESOP-held IBM stock would have been exposed to a “milder price correction and a brisker price recovery.” They argue that if the Supreme Court does not sanction generalized allegations that market corrections become harsher the more the inevitable disclosure is delayed, then ESOP fiduciaries would breach their fiduciary duties only under extraordinary circumstances, such as when the ESOP is on the verge of bankruptcy. This would eviscerate Dudenhoeffer’s holding that ESOP fiduciaries are not entitled to a presumption of prudence and that ESOPs must be treated the same as other pension plans. Plaintiffs also challenge the ESOP fiduciaries’ contention that their allegations were generalized, especially since they detailed the fact that the sale of the overvalued microelectronics division was inevitable because the value of its assets had been significantly impaired.

Plaintiffs ask the Court to recognize that ERISA’s fiduciary duties are more stringent than securities laws because they were “born of the law of trusts.” For this reason, Congress exempted ESOPs from only one fiduciary standard—the duty to diversify, which, because of the nature of ESOPs, is not relevant. Plaintiffs contend that the Court cannot impose a fiduciary standard on ESOPs that is different from, or higher than, other plans. Plaintiffs urge the Court to rule that the Iqbal/Twombly standard applies, not a heightened standard manufactured out of Dudenhoeffer, which weeds out virtually all prudence claims against ESOP fiduciaries that are based on a duty to disclose a fraud.

In its amicus brief, the United States urges the Court to hold that “[a]bsent extraordinary circumstances, ERISA’s duty of prudence requires an ESOP fiduciary to publicly disclose inside information only when the securities laws require such a disclosure.” The United States contends that, absent extraordinary circumstances, prudent ESOP fiduciaries “generally should be able to rely on the judgment of Congress and the SEC about when such disclosures are required.” Therefore, the preliminary analysis should be whether an ESOP fiduciary, who is also a corporate insider, has a duty to disclose material, nonpublic information under securities law. The government also contends that when it would cause more harm than good for an ESOP fiduciary to disclose inside information, the fiduciary has other options. “[P]rudence may require the ESOP fiduciary to urge a cofiduciary or other responsible corporate officers to make a required disclosure, to utilize internal company reporting mechanisms, or to report possible violations to the SEC, or Department of Labor.”

SIGNIFICANCE

The ESOP fiduciaries claim that if the Supreme Court allows generalized allegations to support a breach of fiduciary duty against ESOP fiduciaries, then the carefully articulated causes  of action under securities law will be circumvented, opening the floodgates to “lawyer-driven securities fraud cases disguised as ERISA fiduciary claims.” This would expose corporations to extortionate settlements of meritless claims. It could also encourage corporations to name noninsiders as ESOP fiduciaries to avoid the chance that they will be exposed to nonpublic information, thus increasing the costs of offering ESOPs and deterring companies from sponsoring such plans. This would conflict with Congress’s desire to promote ESOPs.

Plaintiffs argue that if the Court adopts the approach urged by the fiduciaries, then plans would return to a “pre-Dudenhoeffer world in which duty-of-prudence claims against ESOP fiduciaries are virtually impossible to plead.” Plaintiffs state: “If the outcome of Dudenhoeffer is that only one duty-of-prudence claim in a thousand can be successfully pleaded against ESOP fiduciaries, then this Court’s holding that ESOP fiduciaries deserve no special deference, and Congress’s determination that ESOP fiduciaries owe duties equal to those of other ERISA fiduciaries, is nullified.” The goal of ERISA’s fiduciary rules, which is to protect plan participants, rather than the investing public and the national economy, will be compromised.

Jayne Zanglein, a professor emeritus at Western Carolina University, specializes in pension and medical benefits, and authors ERISA Litigation, now in its seventh edition. She can be reached at 828.331.0866 and at jzanglein@wcu.edu.

PREVIEW of United States Supreme Court Cases 47, no. 2 (November 4, 2019): 24–26. © 2019 American Bar Association

ATTORNEYS FOR THE PARTIES

  • For Petitioner Retirement Plans Committee of IBM (Paul D. Clement, 202.389.5000)
  • For Respondent Larry W. Jander (Samuel Ethan Bonderoff, 212.742.1414)

AMICUS BRIEFS

In Support of Petitioner Retirement Plans Committee of IBM

  • American Benefits Council and ERISA Industry Committee (Russell L. Hirschhorn, 212.969.3000)
  • DRI—The Voice of the Defense Bar (Scott Burnett Smith, 256.517.5100)
  • Securities Industry and Financial Markets Association, the Chamber of Commerce of the United States of America, and the Business Roundtable (Brian David Netter, 202.263.3339)

In Support of Respondent Larry W. Jander

  • American Association for Justice and Public Justice (Matthew W.H. Wessler, 202.888.1741)
  • Law Professors (Todd M. Schneider, 415.421.7100)

In Support of Neither Party

  • United States (Noel J. Francisco, Solicitor General, 202.514.2217)