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Third Circuit sides with plan fiduciaries in Johnson & Johnson stock drop case on “more harm than good” standard for early disclosure

On September 7, 2022, the Third Circuit handed down its decision in Perrone v. Johnson & Johnson, a stock drop case in which plaintiffs claim (among other things) that sponsor fiduciaries should have disclosed (alleged) “inside information” about risks with respect to J&J’s Baby Powder.

The court, applying the test described by the Supreme Court in Fifth Third Bancorp et al. v. Dudenhoeffer, affirmed the dismissal of this claim, finding that “a reasonably prudent fiduciary in the Defendants’ circumstances could conclude that corrective disclosures would do more harm than good to the ESOP [i.e., the company stock funds in the defined contribution plans sponsored by J&J].”

In what follows we review the case, focusing on the further articulation of when the “more harm than good” standard does and does not apply.

Background

In many respects, Perrone v. Johnson & Johnson is a typical stock drop case.

Johnson & Johnson maintains (at least) three defined contribution plans that allow participant investment in company stock.

For some time (“decades”) there have been news reports and lawsuits claiming J&J’s baby powder (which is primarily talc) contains asbestos. (The court noted that “The problem with mining talc … is that talc deposits can be located dangerously close to … asbestos.”) A 2018 Reuters report (J&J Knew For Decades That Asbestos Lurked In Its Baby Powder), however, triggered a 10% price decline in the value of Johnson & Johnson stock.

That stock drop resulted in (at least) three separate actions – one for products liability and one for securities fraud (both of which are still ongoing) and this action for breach of ERISA’s fiduciary prudence standard.

As in other inside information-based stock drop cases, plaintiffs claim that plan fiduciaries “knew or should have known that J&J was concealing the truth about its dangerous talc products and that J&J’s stock price was therefore overvalued.” In this context, the continued purchase of “overvalued” J&J stock by the plans was imprudent.

Defendants moved to dismiss.

Dudenhoeffer and stock drop claims based on alleged inside information

The framework for considering these sorts of claims was laid out by the Supreme Court in its 2014 decision in Fifth Third Bancorp et al. V. Dudenhoeffer.

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.

The application of this language to actual inside information-based stock drop lawsuits is currently being argued-out in the courts.

Applying the “more harm than good” standard

The Third Circuit, in Perrone, adopted a fairly tight reading of the “more harm than good” standard:

A plaintiff must plausibly allege that “a prudent fiduciary in the same position ‘could not have concluded’ that the alternative action ‘would do more harm than good.’” [Quoting the Ninth Circuit’s decision in Harris v. Amgen.] As the Fifth Circuit has summarized, that standard places on the plaintiff “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.” [Quoting the Ninth Circuit’s decision in Whitley v. BP]That is a high bar to clear, even at the pleadings stage, especially when guesswork is involved, as it is when estimating the effect of earlier versus later public disclosure of information which is itself fluid.

The one case in which plaintiffs cleared this “high bar” was Second Circuit’s (2018) decision in Jander v. IBM. Jander involved the sale of an IBM subsidiary and IBM’s failure to (earlier) disclose information about losses at that subsidiary. In that case, as the court in Perrone noted, plaintiffs credibly alleged that disclosure of the losses was – because of the impending sale of the subsidiary – “inevitable” and therefor earlier disclosure would not do “more harm than good.”

Decision in Perrone

The Third Circuit emphasizes throughout its opinion that to pass the “more harm than good” test “the plaintiff must do more than allege a general economic theory for why earlier disclosure would have been preferable.” And it notes that there may be many legitimate reasons for delay, particularly for waiting for the conclusion of any pending investigation.

Plaintiffs in Perrone argued that in this case (as in Jander), disclosure was inevitable – because of the related products liability and securities law litigation:

Their [plaintiffs’] theory of inevitability is as follows: “[A]s the lawsuits against J&J over illness caused by its talc products proliferated, and the possibility of those lawsuits surviving motions to dismiss and reaching discovery increased, [it became] more and more likely that fact discovery in one or more of those cases would lead to the disclosure of J&J’s internal memos about its longstanding knowledge of asbestos in its talc.”

Note that this argument has a bootstrap quality – that is, it is the J&J litigation itself (specifically, the related products liability lawsuit) that is making disclosure “inevitable” and providing the basis for this (ERISA) stock drop litigation to proceed.

The court rejected plaintiffs’ theory, finding that there was (in effect) nothing inevitable about this sort of disclosure by Johnson & Johnson:

Even if disclosure of some unfavorable documents was likely once discovery commenced in products liability litigation, it is to this day uncertain whether J&J should be liable in tort for dangers relating to its talc products. …

Nor has J&J admitted that its talc products contain asbestos. By contrast, in the events leading up to Jander, IBM allegedly did take steps suggesting that the prior public valuations of its microelectronics businesses were overinflated, although it took those steps somewhat later than the allegedly prudent time to disclose. … Here, because J&J has not and likely will not make the disclosure proposed by the Plaintiffs, it can hardly be said that all prudent fiduciaries would have concluded in 2017 that such disclosure was “inevitable.” … [E]arly disclosures to the press, necessarily shorn of context, could cause the stock market to overreact, misunderstanding the legal significance of the information and believing that J&J would be subject to more legal liability than it really would be. Thus, a reasonably prudent fiduciary in the Defendants’ circumstances could conclude that corrective disclosures would do more harm than good to the ESOP.

Bottom line

The Third Circuit, like the Fifth and the Ninth Circuits, seems to be holding a fairly tight line on stock drop cases – requiring that plaintiffs clear the “high bar” of the “more harm than good” test before proceeding. And the “Jander exception” to this rule – requiring disclosure by fiduciaries where ultimate disclosure is “inevitable” – is, in the Third Circuit at least, being limited to a very narrow circumstance: where disclosure is imminent, and it has (at the time the motion to dismiss is being considered) already been admitted by the sponsor that disclosure is or was necessary.

Company stock – because of the potential for volatility/participant risk of large losses – will always present a target for plaintiffs’ lawyers. If there is concern about securities litigation with respect to a sponsor’s stock, and the sponsor maintains a defined contribution plan that includes a company stock fund, plan fiduciaries should consult with counsel about the proper course of action.

We will continue to follow this issue.