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Whitley v. BP (aka In Re: BP p.l.c. Securities Litigation), a stock drop case, is on appeal before the Fifth Circuit Court of Appeals. The case provides a useful review of post-Fifth Third stock drop litigation theories and counter-theories.
In this article we begin with a review of the Fifth Third stock drop standard and then consider the arguments being made by plaintiffs in post-Fifth Third stock drop cases and possible counterarguments. We conclude with a brief review of the current posture of company stock litigation.
Let’s begin with a summary of the Supreme Court’s 2014 decision in Fifth Third Bancorp et al. v. Dudenhoeffer. In Fifth Third, the Supreme Court rejected the “presumption of prudence” standard that had been applied by lower courts to company stock cases. It replaced it with, for public companies, what might be called a “presumption that the market price is fair” standard. Under Fifth Third, generally:
A plaintiff cannot sue a fiduciary on the premise that the fiduciary should have known, based on public information, that a publicly traded stock is overvalued, absent special circumstances.
A plaintiff cannot state a claim that a fiduciary should have sold stock in a fund based on non-public (aka “inside”) information that the stock was overvalued, because to do so would violate insider trading laws.
With respect to a decision to continue to buy stock or not publicly disclose insider information in such circumstances, it’s probably better to consider the conduct of company officials under the securities laws.
In any case, in considering a motion to dismiss (“whether the complaint has plausibly alleged” a breach of ERISA’s prudence rule), a court should consider whether the proposed action (stopping buying stock and/or disclosing non-public information) would do more harm than good.
Whitley v. BP is a ‘classic’ stock drop claim: after the April 20, 2010 Deepwater Horizon explosion, BP’s stock lost significant value. Plaintiff-participants in the BP DC plans sued, alleging that the sponsor fiduciaries breached their ERISA duties of prudence and loyalty in not selling and in continuing to buy stock in the plan’s company stock fund.
There have been several pre-Fifth Third and post-Fifth Third decisions in Whitley v. BP. We’re going to focus on the claim that the district court, in January 2015 (post-Fifth Third), found to be viable under the Fifth Third standard: plaintiffs’ claim that “that Defendants knew, or should have known, that the market price of BP ADSs [American Depository Shares] was distorted due to non-public company information” and should have taken some action, e.g., stopped buying BP ADSs in the BP plan’s company stock fund, based on that knowledge.
The lower court found that, with respect to this claim, plaintiffs “must plausibly allege” that defendants (1) had inside information and (2) “had a viable, prudent alternative course of action available to them.”
With respect to issue (1) – whether any defendants had inside information – the court found that four defendants, all of them members of the plan’s investment committee, did have such information.
This brings us to a critical issue that will be considered by the Fifth Circuit in the appeal of Whitley v. BP: assuming defendant plan fiduciaries had inside information that would lead them to believe the stock was over-valued, were there viable alternative actions that the BP fiduciaries could have taken? Alternatives, that is, to what they actually did do: continue to purchase stock in the BP plan’s company stock fund.
Let’s pause here and consider the issue the courts are wrestling with. Fifth Third re-framed company stock litigation in terms of the market and the validity of – and therefore the prudence of – the market price. Fifth Third articulates a general rule that buying at a market price is, in effect, “presumptively fair:”
In our view, where a stock is publicly traded, 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. [Emphasis added.]
Under Fifth Third, where a fiduciary has inside (non-public) information that the market is over-valuing company stock:
The defendant fiduciary cannot be required to break the law (e.g., the securities laws prohibiting insider trading).
Courts “should consider the extent to which an ERISA-based obligation either to refrain on the basis of inside information from making a planned trade or to disclose inside information to the public could conflict with the complex insider trading and corporate disclosure requirements imposed by the federal securities laws or with the objectives of those laws.”
Courts “should also consider whether … 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.” [Emphasis added.]
The lower court in Whitley v. BP found that certain alternative courses of action proposed by plaintiffs, e.g., hedging (based on the inside information), violated Fifth Third principle (1) – they were illegal.
It found, however, that two alternatives – freezing, limiting, or restricting company stock purchases and disclosing the non-public information – did not violate either principle (1) or (2). That is, those actions were not illegal and did not conflict with the securities laws. In reaching the latter conclusion, the court found that “disclosing insider information is not an extraordinary or unorthodox measure; it is … a point of harmony between ERISA and the securities laws ….”
But, the lower court found, stopping purchases would necessarily involve making public inside information that would affect the value of company stock held by the fund. Its logic was that plan officials would necessarily have to provide participants with some explanation for why ongoing purchases were being discontinued.
Thus, either of the alternatives plaintiffs were proposing would necessarily involve making public inside information that would affect the value of company stock held by the fund. The question then becomes, under Fifth Third, would such disclosure do more harm than good? To state the obvious: if you make negative non-public information public, the value of the stock already in the company stock fund will go down – that’s the harm the courts are concerned about.
The lower court found the resolution of this issue inherently problematic: defendants argued, in effect, that the “more harm than good” standard is “virtually insurmountable for all future plaintiffs” – in effect that disclosure of negative non-public information will always do more harm than good to participants with company stock fund investments. Plaintiffs argued that the issue is “inherently fact-specific” and therefore there should (always) be a trial on the facts. The lower court characterized plaintiffs’ approach as “turning the filter of [Fifth Third] into a tap, forcing [plan] fiduciaries to wait until summary judgment for relief from meritless lawsuits.”
In the end, the lower court came down on the side of the plaintiffs, holding that it “cannot determine, on the basis of the pleadings alone, that no prudent fiduciary would have concluded that removing the BP Stock Fund as an investment option, or fully disclosing the state and scope of BP’s safety reforms, would do more good than harm.”
It’s not clear that the Supreme Court would agree with the lower court that “disclosing insider information is … a point of harmony between ERISA and the securities laws.” In Fifth Third, the Supreme Court stated:
[W]here a complaint faults fiduciaries for failing to decide, on the basis of the inside information, to refrain from making additional stock purchases or for failing to disclose that information to the public so that the stock would no longer be overvalued, additional considerations arise. The courts should consider the extent to which an ERISA-based obligation either to refrain on the basis of inside information from making a planned trade or to disclose inside information to the public could conflict with the complex insider trading and corporate disclosure requirements imposed by the federal securities laws or with the objectives of those laws.
Is there a situation in which disclosure is required under ERISA but not under the securities laws? And if the disclosure obligation is identical (“harmonious” as the BP court put it), shouldn’t the issue be litigated under the securities laws (and not ERISA), inasmuch as those laws are intended to address when an issuer must make information public?
In concluding that plaintiffs’ claim met the Fifth Third standard the lower court cited another post-Fifth Third case, Harris v. Amgen (see our article Harris v. Amgen decided by Ninth Circuit). In Harris v. Amgen, on similar facts, the Ninth Circuit came to a nearly identical conclusion as the lower court in Fifth Third. That decision has been appealed; the Supreme Court has not yet decided whether to hear that appeal.
Recapping (and oversimplifying) company stock litigation post-Fifth Third:
Courts have generally dismissed claims that a fiduciary should have known investment in company stock was imprudent based on public information. (The lower court in Whitley v. BP did just that; so did the Eleventh Circuit in the recently decided Smith v. Delta.)
Courts have rejected (as requiring unlawful action) claims alleging that, e.g., a fiduciary should have sold company stock based on non-public information.
Plaintiffs thus are left with lawsuits claiming that fiduciaries with negative inside information (i) should have stopped buying more stock or (ii) disclosed the negative inside information. Two courts – the District Court Southern District of Texas (in Whitley v. BP) and the Ninth Circuit (in Harris v. Amgen) – have found such a claim to be “viable enough,” under the Fifth Third standard, to survive a motion to dismiss and proceed to the discovery phase.
As a practical matter, there seems to be at this point little that a fiduciary can do to avoid stock litigation where there is a ‘stock drop.’ Litigation is now focusing on a “duty to disclose” to participants that seems to be effectively the same as the sponsor/issuer’s duty to disclose to shareholders under the securities laws. Repeating what the lower court in BP said, “disclosing insider information is … a point of harmony between ERISA and the securities laws.” If, however, the sponsor/issuer has determined that it is not appropriate to make information public under the securities laws, it is unrealistic to expect plan fiduciaries to make a separate determination of the same issue.
In this context, allowing a lawsuit to go forward under ERISA more or less on the same basis as the securities lawsuit seems only to function as a way to bring in more defendants (and to increase the judgment fund by the amount of any ERISA fiduciary liability insurance). And, it seems, at this point and unless and until the Supreme Court further clarifies its Fifth Third decision, whenever there is an unanticipated significant drop in the value of an issuers’ stock, in addition to the (seemingly) inevitable securities lawsuit, there will also be, if the company has a plan with a company stock fund, an ERISA lawsuit.
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We will continue to follow these issues.