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“Stock drop” cases involve company stock held in a defined contribution plan that has lost significant value (hence, “drop”), in which the plaintiff argues that the plan’s fiduciaries had an obligation to sell plan stock, or at least discontinue buying it, before or during the “drop.”
The Supreme Court, in its 2014 decision in Fifth Third Bancorp et al. v. Dudenhoeffer, fundamentally changed the legal analysis of these cases. It rejected the “presumption of prudence” standard that had been applied by lower courts and replaced it with, for public companies, what might be called a “presumption that the market price is fair” standard.
As we discussed in our article Company stock and inside information: DOL’s view, since Dudenhoeffer, the stock drop lawsuits that have been getting the most traction with courts generally involve claims that plan fiduciaries were aware of inside information on the basis of which they could have reasonably concluded that the company stock’s market price was “artificially inflated.” In these cases, plaintiffs are asserting that plan fiduciaries should (at a minimum) have stopped buying company stock and/or disclosed the inside information.
Two of the leading inside information-based stock drop cases are Harris v. Amgen and Whitley v. BP. The Supreme Court’s decision earlier this year in Harris and the Fifth Circuit Court of Appeals’ recent decision in Whitley are bringing some clarity to the legal analysis of this issue. In both cases, the higher court sided with the plan fiduciaries, reversing decisions by lower courts in favor of participants.
In what follows we review where the courts are coming out on this issue.
In considering whether a participant can bring a stock drop claim based on an allegation that the plan fiduciary knew, based on inside information, that the market-based stock price was “inflated,” the Supreme Court in Dudenhoeffer first made it clear that the fiduciary could not be required to do anything illegal. Thus, a plaintiff could not claim that the fiduciary should have sold stock already purchased by the plan – that would, in effect, be illegal insider trading.
The Court did, however, say that a participant could claim that the fiduciary should stop further purchases of stock and/or disclose the inside information (in some appropriate way). In considering such a claim, however, a court should consider whether taking such action would do more harm than good:
[W]here a complaint faults fiduciaries for failing to decide, based on negative inside information, to refrain from making additional stock purchases or for failing to publicly disclose that information so that the stock would no longer be overvalued, courts … should consider whether the complaint has plausibly alleged that a prudent fiduciary in the defendant’s position could not have concluded that stopping purchases or 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.
A couple of observations about the language just quoted.
First, the Supreme Court seems to be saying here that there may be cases in which, because of the (greater) amount of stock already in the plan relative to the (lesser) amount of ongoing purchases, disclosure of inside information might “do more harm than good” because (as a result of the disclosure of negative nonpublic information) more money will be lost on the stock already in the plan than will be “saved” by not buying more stock. But it also seems to be implying that there may be cases where ceasing purchases/disclosing negative nonpublic information would not “do more harm than good,” presumably because of the (lesser) amount of stock already in the fund relative to (greater) amount of ongoing purchases.
Second, as the Supreme Court seems to imply, and both the Harris and Whitley courts found as a matter of fact, a cessation of stock purchases typically will have to be explained (e.g., to participants) and will thus necessarily result in disclosure of the negative nonpublic information. Thus, while there may be more litigation on that issue, we are going to assume for purposes of this article that cessation of purchases equates to public disclosure.
The application of this language to actual inside information-based stock drop lawsuits is currently being argued-out in the courts.
Whitley v. BP involved losses on BP American Depository Shares (ADSs) held in BP DC plans resulting from the Deepwater Horizon explosion. After re-configuring their complaint to reflect the Supreme Court’s decision in Dudenhoeffer, plaintiff-participants claimed that defendant plan fiduciaries “knew, or should have known, that the market price of BP ADSs was distorted due to non-public company information” and should therefore have taken some action, e.g., stopped buying BP ADSs in the BP plan’s company stock fund.
In January 2015, the United States District Court for the Southern District of Texas issued an opinion finding for the plaintiffs on a motion to dismiss in Whitely. In explaining its holding, the district court complained that it had “struggled with the relevant language in Dudenhoeffer” with respect to the “more harm than good” standard, finding that in some critical respects “Dudenhoeffer itself is inconsistent.”
Ultimately, the argument in these inside information-based stock drop cases is over what standard should be applied to plan fiduciaries at the motion-to-dismiss stage (before costly discovery and an even-more-costly trial on the facts). The lower court in Whitley described the two available alternatives:
Standard (1) – require the plaintiff to allege facts supporting a claim that no fiduciary could have reasonably concluded that ceasing purchases/disclosing nonpublic information would have done more harm than good. The lower court in Whitley found this standard to be “virtually insurmountable for all future plaintiffs.”
Standard (2) – simply require that plaintiffs allege facts supporting a claim that some 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.”
This is all a little dense, and the courts have a tendency to formulate the issues and their conclusions in double negatives. Here’s our best attempt at an English version:
Standard (1): plaintiff must allege facts proving that no prudent fiduciary would have acted as defendant fiduciaries acted (in failing to stop purchases/disclose nonpublic information).
Standard (2): plaintiff only has to allege facts proving that some prudent fiduciary could have acted differently (stopped purchases/disclosed nonpublic information).
The lower court in Whitley went with the latter standard (2), siding, in effect, with plaintiffs, although it admitted that this would have the effect of “turning the filter of Dudenhoeffer into a tap, forcing [plan] fiduciaries to wait until summary judgment for relief from meritless lawsuits.”
The complaint in Harris v. Amgen involves an allegation that Amgen DC plan fiduciaries had inside information about safety concerns with respect to two key Amgen drugs and that, given that knowledge, plan fiduciaries “acted imprudently, and thereby violated [ERISA], by continuing to provide Amgen common stock as an investment alternative when they knew or should have known that the stock was being sold at an artificially inflated price.”
In October 2014, on a motion to dismiss, the Ninth Circuit held for plaintiffs, finding that plaintiffs’ complaint satisfied the Dudenhoeffer standards for an inside information stock drop case because:
[I]t is at least plausible that defendants could have removed the Amgen Stock Fund from the list of investment options available to the plans without causing undue harm to plan participants.
Again, we realize that the language in these cases is hard to parse. But that – the standard applied by the Ninth Circuit – is Standard (2): that some fiduciary could have concluded that stopping purchases/disclosing inside information would do more good than harm.
On January 25, 2016, the Supreme Court (in a brief, unsigned opinion) reversed and remanded, stating that:
The Ninth Circuit … failed to assess whether the complaint in its current form “has plausibly alleged” that a prudent fiduciary in the same position “could not have concluded” that the alternative action “would do more harm than good.”
That – the standard that the Supreme Court is saying the Ninth Circuit should have applied – is Standard (1): that no prudent fiduciary could have concluded that disclosure would do more harm than good.
On September 26, 2016, the Fifth Circuit reversed the lower court in Whitley. In doing so, it stated that: “Under the Supreme Court’s formulation [in Dudenhoeffer], the plaintiff bears the significant burden of proposing an alternative course of action so clearly beneficial that a prudent fiduciary could not conclude that it would be more likely to harm the fund than to help it.”
That is about as clear a statement (and application) of Standard (1) as we are likely to see.
We now have two decisions in inside information-based stock drop cases that come down squarely on the side of plan fiduciaries.
It appears that the emerging standard for such a complaint is a credible allegation that no prudent fiduciary could have concluded that the cessation of stock purchases based on negative inside information (and necessary disclosure of negative nonpublic information) would do more harm than good. Or as we have styled it, Standard (1).
These decisions may not put an end to inside information-based stock drop lawsuits. One can imagine facts – to give an extreme example, where the plan currently holds no company stock but is about to purchase some – where it could plausibly be argued that the cessation of purchases/disclosure of nonpublic information could not possibly harm the plan.
But on a typical set of facts, involving ongoing purchases and a plan that currently holds a substantial amount of company stock that will be negatively affected by disclosure of inside information, the standard the courts seem to be adopting may, as the lower court in Whitley observed, be “virtually insurmountable” for plaintiffs.
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