Do general allegations that disclosure of fraud is always inevitable and that disclosure sooner rather than later is always more prudent satisfy the pleading standard articulated in Fifth Third Bancorp v. Dudenhoeffer?
This case asks the Supreme Court to decide whether general allegations that disclosure of fraud is always inevitable and that disclosure sooner rather than later is always more prudent satisfy the “more harm than good” pleading standard of Fifth Third Bancorp v. Dudenhoeffer. The Retirement Plans Committee of IBM argues that a rule that disclosure sooner rather than later is always prudent is too broad and will result in liability in cases in which fiduciaries did not disclose information as soon as possible, but nonetheless acted prudently. In contrast, Jander asserts that Employee Stock Ownership Plan (ESOP) fiduciaries should not be held to a different standard of prudence than all other ERISA fiduciaries, and that raising the pleading standard would make the standard impossible to meet. The outcome of this case will affect companies’ ability to provide ESOPs to their employees and employees’ access to ESOPs. This case will also have important implications for the stability and protection of employees’ retirement benefits.
Questions as Framed for the Court by the Parties
Whether Fifth Third Bancorp v. Dudenhoeffer’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.
IBM, a global information technology company, provides its employees with the opportunity to invest in the company through an Employee Stock Ownership Plan (ESOP)—a retirement plan that invests in the stock of the company providing the plan. Respondent Larry W. Jander and other retirement plan participants (“Jander”) took part in IBM’s retirement plan and invested in IBM’s stock through an ESOP. ESOPs are governed by the Employee Retirement Income Security Act of 1974 (ERISA), which imposes a duty of prudence on retirement plan fiduciaries, requiring them to act in a manner consistent with an average, prudent man. Petitioner, comprised of the members of the Retirement Plans Committee of IBM (“Committee”), controlled the plan’s management and were the plan’s fiduciaries.
In 2013, IBM’s microelectronics business was projected to incur annual losses of $700 million. Later that year, IBM searched for buyers to purchase its microelectronics business, but did not publicly disclose these losses and instead valued its microelectronics business at approximately $2 billion. On October 20, 2014, IBM agreed to sell its microelectronics business to GlobalFoundries Inc. According to the agreement, IBM would pay GlobalFoundries $1.5 billion to take over the business and supply IBM with semiconductors. However, the agreement also disclosed that IBM would take a $4.7 billion pre-tax charge, which indicated an impairment in the stated value of the microelectronic business. Instead of $2 billion, the value of the microelectronics business was significantly lower. The impairment in the business’s value consequently reduced IBM’s stock price by more than $12.00 per share. Before IBM’s stock price declined, Jander and other retirement plan participants purchased over $100 million of ESOP shares.
In 2016, Jander brought an action in the United States District Court for the Southern District of New York (“District Court”) alleging that the members of the Committee knew that the microelectronics business was projected to incur losses, and therefore violated their fiduciary duty of prudence owed to the plan participants. Specifically, Jander argued that the Committee should have disclosed the true value of the microelectronics business or at least temporarily suspended IBM stock investments.The District Court dismissed the case because Jander failed to show that the Committee could not have concluded that either a public disclosure or a freezing of further stock investments was “more likely to harm than help the fund.”
Jander appealed to the Second Circuit Court of Appeals (“Second Circuit”), which reversed the District Court’s decision, finding that Jander’s allegations sufficiently established that the alternatives available to the Committee would not have caused more harm than good. Specifically, the Second Circuit found that the disclosure of the true value of the microelectronics business was inevitable. Relying on Jander’s generic allegation that earlier disclosure would have caused less reputational damage than later disclosure, the Second Circuit reasoned that a prudent fiduciary would have preferred to minimize the effects of the stock’s artificial inflation through prompt disclosure.
IDENTIFYING THE DUTY OF PRUDENCE
The Retirement Plans Committee (“Committee”) asserts that Jander failed to allege that the Committee engaged in conduct constituting a breach of the duty of prudence. . Because the “could not have concluded” standard requires specific allegations of wrongdoing, the Committee asserts that Jander cannot simply allege that “disclosure is inevitable and thus disclosure sooner rather than later is always prudent.” The Committee argues that if general allegations were sufficient, any claim would satisfy the “could not have concluded” pleading standard and avoid a motion to dismiss. The Committee argues that fraud plaintiffs in general can claim that disclosing information sooner rather than later is always prudent in virtually any fraud case; therefore, an allegation that the defendants failed to disclose such information makes it difficult for courts to distinguish meritless claims from cases in which actual harm occurred.
Further, the Committee alleges that the fiduciaries in this case did not breach the duty of prudence because they had no obligation to use corporate information, obtained in their role as corporate officers, to make decisions in their separate, unrelated role as fiduciaries. The Committee asserts that corporate officers who are also plan fiduciaries must wear two separate corporate and fiduciary “hats.” The Committee contends that in their corporate capacity, officers have a duty to their corporation to keep company information confidential. However, the Committee argues that in their fiduciary capacity, fiduciaries have a duty to use the information to benefit plan participants under ERISA. Corporate and fiduciary capacities should be kept separate because otherwise, fiduciaries would be forced to choose between breaching a duty to the corporation by using the information, or breaching a duty to plan participants by not using the information.
In contrast, Jander asserts that the Second Circuit’s ruling was narrowly tailored to the case’s specific duty-of-prudence claim. Jander contends that the Second Circuit based its determination that disclosure was inevitable on the case’s specific facts, not simply a finding that all disclosures are inevitable. Specifically, Jander asserts that the Second Circuit ruled correctly in relying on the facts of the case to find in Jander’s favor. Jander argues that the facts of the case indicate that disclosure of the true value of Microelectronics would not have done more harm than good because, if participants continued to buy IBM stock at increased prices, they faced an increased risk of damage due to slow price recovery. Jander argues that even if disclosure of the information is inevitable, courts must also consider the circumstances of the case and whether disclosure may have been particularly dangerous to the person with the information in question. Further, Jander asserts that their own allegations in this case were not generic, and that they applied the standard to the facts of the case, which indicated that the fiduciaries caused harm by delaying the disclosure. Specifically, Jander alleges that delaying the disclosure caused harm because the delay increased the chance of a “harsher correction and a protracted recovery” for the IBM stock, which caused harm to all plan participants.
In addition, Jander claims that the law does not support the Committee’s assertion that corporate and fiduciary decisions must be kept separate. Jander argues that ERISA itself states that “its provisions should not be read to contravene any other law or regulation.” For example, Jander states that a fiduciary who was privy to inside information regarding an overvaluation of stock could not disclose that information exclusively to plan participants, because such action would violate securities laws. Further, Jander maintains that ERISA cannot require fiduciaries to disclose inside information if they are under a duty to keep the information confidential. Therefore, Jander asserts that the Committee’s proposed rule of separate corporate and fiduciary duties is “superfluous” because if a fiduciary is taking action to comply with the duty of prudence, such as disclosing protected corporate information, the fiduciary already is prohibited from violating corporate practice laws.
“MORE HARM THAN GOOD” STANDARD
The Committee asserts that the “could not have concluded” pleading standard of Dudenhoeffer’s “more harm than good” articulation must control ERISA claims. The Committee argues that according to Dudenhoeffer, in order to state an ERISA duty-of-prudence claim, a plaintiff must allege facts demonstrating that “the defendant has acted imprudently” by “failing to act on inside information.” Specifically, the Committee alleges that the plaintiff must identify an alternative course of action that the defendant could have taken, and demonstrate that “a prudent fiduciary in the defendant’s position could not have concluded that [the alternative] would have done more harm than good to the fund.” However, the Committee contends that the Second Circuit has stated that it was unclear whether a plaintiff must simply identify an alternative course of action, or whether the plaintiff must conduct the balancing test mandated by the “could not have concluded” standard. The Committee explains that the “could not have concluded” standard requires plaintiffs to balance the certain harm of an early disclosure—such as financial losses to plan participants—against the “uncertain effects of later disclosure” on newer employees who have not yet established a position in IBM stock.
The Committee contends that applying the “could not have concluded” standard recognizes the reality that a fiduciary may choose from any number of prudent options. The Committee argues that a fiduciary has a duty only to choose one prudent option from several options that may be available. According to the Committee, the “could not have concluded” standard attaches liability to a fiduciary only if the fiduciary has chosen an “outlier” option—an imprudent option that no prudent fiduciary would have selected. Further, the Committee asserts that courts should not apply a “would have concluded” standard because such a standard allows liability to attach if the fiduciary has not done what an average prudent fiduciary would do under the same circumstances. The Committee argues that courts have not specified a definition of the “average” fiduciary, and establishing such a standard would effectively render the average course of action the only course of action.
In contrast, Jander asserts that ESOP fiduciaries must be held to the same “duty of prudence” as all other ERISA fiduciaries, and that applying the Committee’s pleading standard will lessen this duty. Jander argues that ERISA fiduciaries are required to “discharge [their] duties with respect to a plan solely in the interest of the participants and beneficiaries and . . . for the exclusive purpose of . . . providing benefits to participants and their beneficiaries.”Jander contends that applying a strict pleading standard will mean that only a tiny fraction of claims could be pleaded successfully. Jander argues that because all ERISA fiduciaries owe the same types of duties, duty-of-prudence claims against ESOP fiduciaries should not be more difficult to plead than claims against other ERISA fiduciaries.
Jander argues that the “would have concluded” and “could have concluded” standard amount to the same formulation of a prudence claim: the standard defines “what a hypothetical prudent fiduciary could imagine.” Jander contends that, in contrast to the Committee’s claims, Dudenhoeffer did not announce an elevated pleading standard for ESOP fiduciaries. Jander asserts that applying the Committee’s reading of the “more harm than good” standard would make the standard impossible to meet.
THE PURPOSE OF ESOPs: COMPANIES’ INTERESTS VERSUS EMPLOYEES’ INTERESTS
DRI—the Voice of the Defense Bar (“DRI”), in support of the Committee, asserts that ESOPs were not intended to serve as traditional sources of retirement income, but rather were intended to serve a unique purpose: providing employees with an ownership interest in the company that employed them while also giving the company a new source of capital. The Securities Industry and Financial Markets Association and other financial organizations (“SIFMA”) argue that this distinct purpose is evidenced by Congress exempting ESOP fiduciaries from ERISA’s diversification requirement, which normally governs all retirement plans. Despite the risks of ESOPs, the American Benefits Council and the ERISA Industry Committee (“Council”) claim that Congress encouraged ESOPs because they offer mutual benefits to employers and employees. Additionally, the Council contends that since Congress encouraged ESOPs, it did not intend to make it difficult for companies to maintain them. Therefore, the Council asserts that Jander’s allegation must be dismissed or else all ESOP participants will bring claims whenever a company’s stock price declines, which will force companies to incur increased litigation costs or eliminate ESOPs entirely.
A group of law professors (collectively the “Law Professors”), in support of Jander, counter that while one goal of an ESOP is to promote employee stock ownership, its primary purpose is to protect employees’ retirement savings. Specifically, due to the risky nature of ESOPs, the Law Professors assert that ESOP fiduciaries have a significant responsibility to act in employees’ best interests and ensure that employees’ retirement benefits are safeguarded and not destroyed. Unlike other retirement plans, the Law Professors contend that a fiduciary breach of duty under an ESOP can directly endanger an employee’s retirement benefits.Therefore, Law Professors argue that ESOP participants cannot be hindered from bringing fiduciary breach actions because these actions are their only avenue for recovery of lost retirement benefits resulting from a breach.
FIDUCIARIES’ DUAL ROLES: THE FEASIBILITY OF DISCLOSURE
SIFMA, in support of the Committee, argues that an ESOP fiduciary is not required to disclose information acquired as a corporate officer because ERISA allows fiduciaries to serve in multiple capacities. Although a corporate officer can serve as an ESOP fiduciary, the Council asserts that the corporate officer’s interests may not be aligned with the employees’ interests. Therefore, the Council contends that an ESOP fiduciary who is also a corporate officer must only wear “one hat at a time”—ESOP fiduciaries must not consider their corporate duties when making fiduciary decisions. The Council warns that requiring a fiduciary to disclose information obtained in a non-fiduciary context would force companies to hire independent fiduciaries, which would create administrative inefficiencies and increase costs for plan participants. Additionally, if companies did not hire independent fiduciaries, the Council argues that they would be forced to eliminate ESOPs entirely in order to avoid litigation costs from increased ESOP fiduciary breach claims.
The Law Professors, in support of Jander, argue that a fiduciary is required to disclose information even if it was obtained when the fiduciary was acting as a corporate officer. Relying on the common law of trusts, the Law Professors claim that a fiduciary is obligated to use his or her knowledge and skills to benefit the plan beneficiaries, including knowledge of information acquired in a non-fiduciary context. Specifically, the Law Professors assert that a fiduciary who is also a corporate officer must prioritize the interests of the plan beneficiaries and protect their retirement savings, even if that means disclosing information acquired as a corporate officer. Additionally, the United States argues that it is a legal fiction to believe that a corporate officer can completely ignore all of his or her corporate knowledge when acting as a fiduciary. Furthermore, the American Association for Justice and Public Justice (“Association for Justice”) argues that allowing fiduciaries to ignore information obtained in their corporate role incentivizes fiduciaries to engage in disloyal self-dealing and allows them to escape liability altogether.
- Michael Bennett and Adam Cohen: Supreme Court will again review the pleading standard for retirement "stock drop" claims, JD Supra (June 11, 2019).
- Greg Iacurci: Supreme Court to hear 401(k) stock-drop case, Investment News (June 3, 2019).
- J. Christian Nemeth and Allison Crowe: US Supreme Court to Review Unusual Second Circuit Decision in Stock Drop Case Against IBM, National Law Review (June 11, 2019).