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On September 21, 2017, the United States District Court for the District Of Minnesota dismissed plaintiffs’ complaint in In Re: Wells Fargo ERISA 401(K) Litigation. Wells Fargo is a stock drop case in which plaintiffs alleged that fiduciaries of the Wells Fargo 401(k) plan had inside information that Wells Fargo stock was overpriced and breached their ERISA fiduciary duty of prudence when they did not take any action to stop ongoing stock purchases.
This sort of ‘inside information’ allegation has been a common feature of stock drop claims since the Supreme Court’s decision in Fifth Third Bancorp. v. Dudenhoeffer. In this article, we discuss the court’s decision, which reviews a number of the key elements of this sort of litigation.
Around 34% of participant assets in the Wells Fargo plan were invested in company stock. The price of that stock ‘dropped sharply,’ resulting in significant losses to participants, after the 2016 announcement that Wells Fargo employees had engaged in certain improper sales practices.
What sort of ERISA case may a plaintiff bring in these circumstances? The court summarized stock drop litigation rules under Dudenhoeffer as follows:
As a general matter, plan fiduciaries may “prudently rely on the market price” of a publicly-traded stock as “the best estimate of” its value. … In other words, the duty of prudence does not require plan fiduciaries to “outsmart a presumptively efficient market.”
Therefore, “allegations that a fiduciary should have recognized from publicly available information alone that the market was over- or undervaluing the stock are implausible as a general rule, at least in the absence of special circumstances.”
One such “special circumstance” occurs when a fiduciary has inside information that a publicly-traded stock is overpriced.
To withstand a motion to dismiss such [an inside information-based] claim, “a plaintiff must plausibly allege [1] an alternative action that the defendant could have taken [2] that would have been consistent with the securities laws and [3] that a prudent fiduciary in the same circumstances would not have viewed as more likely to harm the fund than to help it.”
In their complaint plaintiffs alleged that plan fiduciaries, possessed of inside information indicating that company stock was over-priced, could have taken a number of actions, including, e.g., freezing further stock purchases and stopping matching contributions in company stock. The court found that, while some of these actions may have been ‘“consistent with the securities laws,” they all would necessarily have required or resulted in disclosure of the alleged sales infractions, triggering losses on the stock already held by the plan.
Thus, as the court explained:
The problem for plaintiffs is … the requirement that they plausibly allege that “a prudent fiduciary in the defendant’s position could not have concluded that . . . 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.” (Quoting Dudenhoeffer, emphasis added.)
Beginning with the observation that the “more harm than good” analysis is a “fact-sensitive inquiry” and should not be “evaluated from the ‘vantage point of hindsight,’” the court discussed some of the factors that a fiduciary should consider with respect to it. These include:
Substantive factors: The seriousness of the alleged fraud. How much disclosure would affect stock price both in the short run and the long run. How much stock the plan currently owns and how much additional stock participants will purchase if disclosure is delayed (and for what period of delay).
The timing and form of disclosure: Does the fiduciary have all relevant information, “so that a single complete and accurate disclosure can be made?” Should disclosure “wait until the company’s fraud can be disclosed simultaneously with some remedial action?” Might it be better “to disclose the fraud through normal channels rather than through the fiduciaries of a 401(k) plan?”
The existence of an ongoing fraud.Some (including the Department of Labor) have argued that this is a factor arguing in favor of disclosure. As the court observed, “after all, disclosing the fraud will usually end the fraud, and less fraud will usually mean less damage to the company.” But the court observed that “other factors may weigh in favor of later disclosure,” e.g., the relatively large number of shares already held by the plan and the utility of allowing the company, through regular corporate channels, to make the disclosure, paired with an announcement of remedial measures, all of which might mitigate the impact on stock price.
The point of this list of factors that a fiduciary might consider in making a “more harm than good” analysis is not just to provide a roadmap for fiduciaries but also to make the point that the fiduciary’s job here is nearly impossibly complex. As the court observed, “[a] dozen fiduciaries in the same position could weigh the same factors and reach a dozen different (but equally prudent) conclusions about whether, when, how, and by whom negative inside information should be disclosed.” Thus, “[i]n light of the inherently uncertain nature of this task, plaintiffs will only rarely be able to plausibly allege that a prudent fiduciary “could not” have concluded that a later disclosure of negative inside information would have less of an impact on the stock’s price than an earlier disclosure.” (Emphasis added.)
This court is obviously very skeptical of stock drop cases founded on inside information claims. Indeed, the court begins the decision by characterizing these sorts of cases as taking “what is essentially a securities-fraud action and plead[ing] it as an ERISA action in order to avoid the demanding pleading requirements of the [relevant securities laws].” But as the court observes, in the three years since it was decided, “most post-Dudenhoeffer cases have come down on the side of the defendants.” Thus this skepticism seems to have been widely shared.
Given these considerations, what should a plan fiduciary do when she is concerned that – in view of inside information she possesses – publicly traded stock being purchased for the plan may be over-priced? Before anything else, she will want to raise the issue with counsel. These are obviously, as we said, complex issues to which there will often be no obvious answer, and certainly no easy one.
And, in considering the “more harm than good” issue, the analysis provided by the Wells Fargo court is as a good place as any to start: reviewing the substantive issues, e.g., the amount of stock held by the plan relative to ongoing purchases, the process issues, e.g., the timing and form of any possible disclosure, and the consequences of any ongoing fraud.
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We will continue to follow this issue.