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On February 4, 2019, the United States District Court for the Southern District of Texas found for defendant fiduciaries in Fentress v. Exxon, an insider information-based stock drop case. In this article we briefly review the decision, considering it in the context of stock drop litigation generally and the recent decision (for plaintiffs) by the Second Circuit in Jander v. IBM (December 2018).
As we have discussed (most recently in our article Second Circuit allows IBM stock drop case to proceed), since the Supreme Court’s 2014 decision in Fifth Third Bancorp v. Dudenhoeffer, stock drop litigation has focused on plan fiduciaries’ knowledge of inside information that the company stock being bought by the plan is overvalued by the market. The issue in these cases has– following the analysis provided by the Supreme Court’s opinion in Dudenhoeffer– turned on whether a prudent fiduciary could have concluded that the alternative action proposed by the plaintiff, e.g., making the inside information public, could have done “more harm than good.”
The court in Fentress v. Exxon summarizes this standard as follows:
Where the plaintiffs allege that defendants violated the duty of prudence on the basis of non-public information, the plaintiffs must plausibly allege an alternative action that the defendant could have taken “that a prudent fiduciary in the same circumstances would not have viewed as more likely to harm the fund than to help it.” [Citing Dudenhoeffer].
The court in Fentress noted that “[t]he Fifth Circuit [which includes the Southern District of Texas] has clarified that the plaintiffs’ burden in these cases is ‘significant’” and that “the alternative course of action must be ‘so clearly beneficial that a prudent fiduciary could not conclude that it would be more likely to harm the fund than to help it.’”
In recent litigation per In re: Wells Fargo ERISA 401(k) Litigation (2017), the United States District Court for the District of Minnesota took a similar view, characterizing this test as “very tough” and stating that “[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.”
In its recent decision in Jander, the Second Circuit questioned whether this standard was in fact as “tough” as these courts have described it, arguing that it was not clear from the Dudenhoeffer opinion (and the Supreme Court’s subsequent decision in Harris v. Amgen (2016)) whether the question was whether a prudent fiduciary “could have” come to the same conclusion that defendant fiduciaries had or whether it “would have” come to that conclusion.
The Jander court explained the distinction as between “what an average prudent fiduciary might have thought” (the “would have” version of the test) and “whether any prudent fiduciary could have considered the action to be more harmful than helpful” (the “could have” version of the test).
The Jander court did not answer the “could have” vs. “would have” question. Instead, it concluded that the “very tough” “could have” standard was met where disclosure of the inside information was inevitable:
In the normal case, when the prudent fiduciary asks whether disclosure would do more harm than good, the fiduciary is making a comparison only to the status quo of non-disclosure. In this case [i.e., where the company was for sale and “any potential purchaser would surely conduct its own due diligence”], however, the prudent fiduciary would have to compare the benefits and costs of earlier disclosure to those of later disclosure – non-disclosure is no longer a realistic point of comparison.
In Fentress v. Exxon, plaintiffs argued that defendant fiduciaries should have “sought out those responsible for Exxon’s disclosures under the federal securities laws and tried to persuade them to refrain from making affirmative misrepresentations regarding the value of Exxon’s reserves.”
The court found that this proposed alternative action did not pass the “more harm than good test”: “The Court cannot say that attempting to prevent Exxon’s alleged misrepresentations would have been so clearly beneficial that a prudent fiduciary could not conclude that it would be more likely to harm the fund than to help it.” [Citing Whitley v. BP.]
The court also rejected plaintiffs’ (Jander-based) “disclosure was inevitable” argument, finding that “investigations into [as distinguished from the filing of charges against] Exxon by state attorneys general and the SEC” did not make it inevitable that the non-public information “would come to light.”
Finally, the court rejected another element of Jander– the Second Circuit’s argument that “reputational damage to the company would increase the longer the fraud went on” – making earlier disclosure (in effect) less harmful than (inevitable) delayed disclosure. The Fentress court noted that this view “directly contradicts” Fifth Circuit precedent.
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The Fentress court noted that it had recently written with respect to the “more harm than good” test that:
[T]he Court “is not aware of any post-Amgen case in which a plaintiff has met this significant burden.” The standard is “virtually insurmountable.”
Clearly, the Second Circuit takes a different view. How the “more harm than good” standard is to be applied is likely to be an ongoing issue in stock drop litigation.
For sponsors, we repeat what we said in considering the Jander decision: As a general matter, sponsor fiduciaries who believe they are in possession of inside information that company stock is undervalued should consult with counsel. Given the contested nature of the issue, sponsor fiduciaries may have litigation exposure under ERISA that differs from the company’s exposure under securities laws.