Two different federal appeals courts recently upheld the dismissal of lawsuits challenging the prudence of employee stock ownership plan (ESOP) offerings in defined contribution (DC) plans. Both of these stock-drop cases involved allegations that plan fiduciaries — who were corporate insiders privy to nonpublic information about the sponsor — breached their ERISA duties by failing to take appropriate action based on that information. In each case, the court ruled that plaintiffs hadn’t meet the pleading standard set by the Supreme Court in Fifth Third Bancorp v. Dudenhoeffer (573 U.S. 409 (2014)).
Demanding pleading standard for stock-drop cases
In Dudenhoeffer, the high court said ERISA stock-drop lawsuits alleging plan fiduciaries failed to act on nonpublic information must propose an alternative action that fiduciaries could have taken without violating federal securities laws. Participants also must plausibly allege that no prudent fiduciary in the same circumstances could have concluded such action would have done more harm than good.
3rd Circuit rejects plaintiffs’ proposed alternative actions
The 3rd US Circuit Court of Appeals determined participants failed to propose an alternative fiduciary action that would meet the high court’s exacting pleading standard (Perrone v. Johnson & Johnson, No. 21-1885 (3rd Cir. Sept. 7, 2022)). Plaintiffs in this case — employees participating in several of their company’s DC plans — alleged that plan fiduciaries were aware of products liability concerns that, when ultimately made public, resulted in a 10% drop in the company’s stock price.
Directing new contributions to ESOP’s cash portion isn’t a viable alternative. The plaintiffs contended that plan fiduciaries should have directed new participant contributions to the cash portion of the unitized ESOP fund instead of purchasing additional shares of company stock. The court disagreed, noting that fiduciaries could just as easily have been sued for imprudence if the stock price rose after increasing the cash portion of the ESOP. The court acknowledged “there may be circumstances in which a reasonably prudent fiduciary would find it advantageous to increase the cash buffer rather than buy the company’s stock.” However, the uncertainty of the products liability allegations in this case meant no prudent fiduciary could have concluded doing so wouldn’t have done more harm than good.
Earlier public disclosure would do more harm than good. Plaintiffs also proposed that plan fiduciaries should have publicly disclosed the products liability concerns to correct the stock price. Assuming securities laws would permit such a disclosure, the 3rd Circuit determined that due to the risk of the stock market overreacting, a reasonably prudent fiduciary could conclude the disclosure would do more harm than good. (All but one of the federal appeals courts that have considered similar public disclosure allegations have reached the same conclusion.) The court also disagreed with the plaintiffs’ assertion that such a disclosure was inevitable, noting that the plan sponsor had already prevailed in some of the relevant products liability lawsuits.
7th Circuit: Independent fiduciary delegation shields corporate insiders
The 7th Circuit affirmed the dismissal of a stock-drop lawsuit involving corporate insiders who had retained an independent fiduciary to oversee the plan’s ESOP fund (Burke v. The Boeing Co., No. 20-3389 (7th Cir. Aug. 1, 2022)). Plaintiffs alleged that the appointing fiduciaries had nonpublic information about safety concerns after one of the plan sponsor’s best-selling passenger airplanes crashed. Notably, the independent fiduciary wasn’t a defendant in the lawsuit.
Corporate insiders weren’t ESOP fiduciaries. Emphasizing the delegation of exclusive responsibility for the ESOP fund, the court found the plan sponsor and corporate insiders weren’t acting as fiduciaries for the fund. Even if they had been, the court said ERISA doesn’t obligate fiduciaries who are also corporate insiders to disclose nonpublic information sooner than securities laws require.
No duty to disclose nonpublic information to independent fiduciary. The plaintiffs also argued that the plan’s investment committee had a duty to disclose the nonpublic information to the independent fiduciary. While acknowledging that appointing fiduciaries have an ongoing duty to monitor their appointees, the court ruled that this duty didn’t require the investment committee — as the appointing fiduciary — to disclose nonpublic information to the independent fiduciary. The court recognized that the appointing fiduciary “anticipated exactly this sort of case, in which Boeing insiders would be accused of facing conflicting fiduciary loyalties.” Citing the long history of ERISA stock-drop lawsuits, the 7th Circuit said the court “could easily imagine a different case in which plaintiffs alleged that defendants breached the duty of prudence by failing to appoint an independent fiduciary.”
Continuing the broader trend of stock-drop dismissals
These rulings show the challenges of bringing viable stock-drop claims alleging plan fiduciaries failed to act on nonpublic information. The high court’s pleading standard has proved very difficult to meet, and most similar stock-drop lawsuits since Dudenhoeffer have been dismissed. However, plan sponsors and fiduciaries may want to discuss potential risk-mitigation strategies with their ERISA counsel, as these rulings have yet to deter the filing of new stock-drop lawsuits.