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Supreme Court Sends IBM Stock Drop ERISA Lawsuit Back to Second Circuit

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Can Stock Drop Lawsuits Succeed by Arguing that Disclosure of Financial Misdeeds is Inevitable?

Washington, DCOn January 14, the Supreme Court sent Retirement Plans Committee of IBM v. Jander, a much-watched ERISA lawsuit, back to the Second Circuit for further consideration of defensive arguments raised by the plan administrators. The decision is a setback, although perhaps not a fatal one, for participants in employee stock ownership plans (ESOPs) who claim that they have been injured because of corporate financial fraud. These “stock drop” lawsuits are one of several different kinds of 401k fiduciary mismanagement lawsuits.

The Supreme Court’s decision is disappointing. The Second Circuit’s decision may determine whether stock drop lawsuits remain viable for the future. In the meantime, ESOP participants who have been harmed through the misdeeds of their employer continue to look for an effective remedy.

A TELLING FINANCIAL SILENCE  


IBM offered employees the opportunity to invest in company stock through its IBM’s 401(k)-plus plan. The “plus” was an ESOP feature. Larry Jander and other employees participated in this company stock option.

The participants claim that IBM artificially inflated the value of IBM stock by misrepresenting the value of its microelectronics business, in likely violation of securities laws. In 2013 IBM was projected to lose $700 million and, as this became public knowledge, the value of the stock plunged by more than $12 per share.

Jander and other retirement participants had purchased over $100 million in ESOP shares before the price dropped. When the bottom fell out, they lost a significant portion of their retirement savings. Although securities laws may protect the soundness of financial markets in general, they do nothing to make retirement plan savers, like Larry Jander, whole in a situation like this. They do little to prevent future breaches of fiduciary duty. It is an open question whether these are tasks ERISA can do.

CONFLICTING DUTIES


The problem is that IBM Retirement Plan fiduciaries were also officers and directors of the corporation -- corporate insiders. As corporate insiders, they had a legal duty under securities laws not to disclose or act on nonpublic information. This is the essence of rules prohibiting insider trading. As plan fiduciaries, however, they also had a duty to preserve plan assets for the benefit of participants and beneficiaries. That would presumably involve acting on the knowledge of the financial fraud in order to minimize the participants’ risk of loss.

In 2014, the Supreme Court made an attempt to resolve this conflict in Fifth Third Bancorp v. Dudenhoeffer. The rule that emerged from Dudenhoeffer was that in an insider information situation, a plan participant might succeed only if two things were true:
  • the fiduciaries had a choice that they could have made that would have been consistent with the securities laws; and
  • that action, in their best view, would not cause more harm than good to the plan.
That is a difficult test to meet, and it is not clear what circumstances would qualify.

The plan participants in Jander argued that the disclosure of problems at IBM’s microeconomics business was inevitable, and therefore fiduciaries could not have concluded that a corrective disclosure would do more harm than good to the plan. Further, they argue, early disclosure was a better choice than later disclosure.

In its argument before the Supreme Court, the IBM fiduciaries raised two counterarguments. The first was that ERISA could not impose a duty on an ESOP fiduciary to disclose inside information. The second was that an ERISA-based duty to disclose would conflict with the objectives of the federal securities law.

The Supreme Court punted. It offered no opinion of this argument either way, but noted that neither objection had been raised in the litigation before the lower courts. It therefore sent the lawsuit back to the Second Circuit specifically so that these objections could be fully briefed and argued.


WHAT’S NEXT FOR STOCK DROP LAWSUITS?  

   
The situation in which Larry Jander and other participants in the IBM ESOP found themselves is far from rare. Over a little more than a year:
  • Employees of Johnson & Johnson who participated in an employee stock purchase program through Johnson and Johnson Saving Plan sued J&J when news of the possible asbestos contamination of Baby Powder caused the value of the stock to drop.
  • Participants in the Boeing Voluntary Investment Plan brought a similar lawsuit when the woes of the 737 Max pushed the value of stock into a sickening dive.
  • Participants in the GE Stock Fund brought a lawsuit against plan fiduciaries based on allegations that the value of GE stock, in which employees were encouraged to invest, was artificially inflated.
More stock drop can be expected in the future. How they are ultimately resolved may hang, at least in part, on the Second Circuit’s next move.
 

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