Another employer has dodged liability for keeping employer stock in its 401(k) plan.
The most recent case (Martone v. Robb, 5th Cir., No. 17-50702, 9/4/18) involved Whole Foods, whose plan fiduciaries were alleged to have breached their duty to the plan by allowing employees to continue to invest in Whole Foods stock in the “Growing Your Future 401(k) Plan” while the stock’s value was artificially inflated due to a widespread overpricing scheme.
Specifically, plaintiff and former plan participant Thomas Martone (joined by plaintiffs Walter Robb, III, Roberta Lang and Glenda Jane Flanagan) claimed that from Jan. 1, 2010 through July 30, 2015, Whole Foods engaged in “systemic, illegal overcharging of its customers” by “regularly misstat[ing] the weight of pre-packaged food on which prices were based” – that the company had “insufficient and flawed quality control systems in place to prevent this fraud” – and that three members of Whole Foods’ Board and Investment Committee (plan fiduciaries) "breached their fiduciary duties to the Plan and its participants when they knew (or should have known) ... that Whole Foods’ stock price had become artificially inflated due to undisclosed misrepresentation and fraud, yet they took no action whatsoever to protect the Plan or Plan participants from foreseeable resulting harm.”
The appellate court (the 5th Circuit Court of Appeals) – as had the district court (the U.S. District Court for the Western District of Texas) previously – dismissed the defendants’ argument that since Martone hadn’t sold his stock at a loss, he had suffered no injury. “… Martone alleged exactly that: he purchased and held shares of Whole Food’s stock ... during the Class Period,” and “[w]hen the truth came out” about the alleged overcharging scheme, “the stock price fell.” In doing so, he alleged “an injury-in-fact sufficient to establish his standing to sue.”
‘Inevitable Tension’
However, the real issue here – as is the case in these so-called “stock drop” cases – is what the court described as the “inevitable tension between an employer-fiduciary’s duty of prudence and the use of a fund primarily to invest in the employer’s stock.” Turning, as courts in these cases inevitably do, to the Supreme Court’s holding in Fifth Third Bancorp v. Dudenhoeffer, the court noted that “a plaintiff must plausibly allege an alternative action that the defendant could have taken that would have been consistent with the securities laws and that a prudent fiduciary in the same circumstances would not have viewed as more likely to harm the fund than to help it.” Another Supreme Court ruling – this one from Amgen, Inc. v. Harris – concluded that a complaint must allege “that a prudent fiduciary in the same position ‘could not have concluded’ that the alternative action ‘would do more harm than good.’” Finally, the court here invoked its own holding in Whitley v. BP, PLC that “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.”
Plaintiff Martone here – as others have in other courts – argued that there were alternative courses of action, specifically:
- Defendants could have “temporarily clos[ed] or fr[ozen] the Company Stock Fund ... until ... Whole Foods stock again became a prudent investment.”
- Defendants could have “effectuated corrective, public disclosures to cure the fraud ... thereby making Whole Foods stock ... an accurately priced, prudent investment again.”
- Defendants could have “divert[ed] some of [the] Company Stock Fund’s holdings into a low-cost hedging product that would behave in a countercyclical fashion vis-à-vis Whole Foods stock.”
‘Harm’ Full?
However, the appellate court noted that the district court had previously rebuffed the first two alternatives, noting that neither proposed action sufficed because “where both alternatives proposed would make the stock price drop[,] a prudent fiduciary could very easily conclude that such actions would do more harm than good.”
Here plaintiff Martone sought to solidify his argument, alleging that: (1) defendants knew or should have known that “the longer a fraud goes on, the more damage it does to investors;” and (2) during the Class Period, the Plan was a net purchaser of Whole Foods stock. Unfortunately for Martone, the appellate court agreed with the district court’s assessment (relying on similar conclusions in the Whitley case) that the arguments were “an alleged economic reality” rather than a specific factual allegation.
While the court saw the charge that the plan was a net purchaser of stock as a factual allegation, it said that the plaintiff’s argument benefitted from hindsight “because no one could have known, at the beginning of the Class Period, whether the Plan would be a net purchaser or net seller of Whole Foods stock.” On appeal, the plaintiff argued that fiduciaries “are, in fact, in the business of trying to predict the future” and that "Defendants should have predicted that the Plan would be a net purchaser and should have factored that into their analysis about when to disclose.” The court disagreed, noting that even if a prudent fiduciary could have predicted that the Plan would be a net purchaser over time, "that fact alone does not show that an earlier disclosure would be 'so clearly beneficial' that no prudent fiduciary would consider it more likely to harm than help.”
Hedge ‘Finds’
The appellate court also agreed with the district court’s determination that shifting holdings into a hedging product would have constituted a “qualified change in investment options” that would have necessitated a participant communication, and that a prudent fiduciary “could conclude” that the proposed course of action would “require some sort of disclosure to Plan participants and risk causing a stock drop.”
“Because Martone has failed to plausibly allege an alternative action that the defendant could have taken that would have been consistent with the securities laws and that a prudent fiduciary in the same circumstances would not have viewed as more likely to harm the fund than to help it,” the appellate court stated, affirming the district court’s dismissal of his claims.
