Another Stock Drop Suit Comes Up Short

Plaintiffs in a stock drop suit were (once again) unable to clear the “more harm than good” threshold with “fuzzy” allegations to make their case. 

In the most recent case, plaintiffs John Osborne, Brian Coleman, Eve Coleman, Helen Millhouse and Matthew D. Brown filed suit against the fiduciaries of various defined contribution plans of the Kraft Heinz Food Company on behalf of themselves and other participants who invested their retirement savings in Kraft Heinz stock through the Plan (and its employee stock ownership plan component) during the period of May 4, 2017, through Feb. 21, 2019. 

The Case

As is often the case in these so-called “stock drop” suits, it is alleged here (Osborne et al. v. Employee Benefits Administration Board of Kraft Heinz et al., case number 1:20-cv-02256) that the fiduciary defendants “knew or should have known” that Kraft Heinz was recording inaccurate amounts of goodwill and intangible assets and that, as a result, the Company’s stock price was artificially inflated.[i] Judge Robert M. Dow Jr. of the U.S. District Court for the Northern District of Illinois, who was ruling on the motion to dismiss these claims, explained that the plaintiffs faulted the defendants “for not disclosing, or trying to cause the Company to disclose, information that would have corrected the allegedly misleading statements that drove up the Company’s stock price.”

More specifically, the plaintiffs have alleged that, as corporate insiders, the defendants “knew or should have known negative information regarding the value of Kraft Heinz’s goodwill and intangibles that ultimately led to the February 2019 impairment,” and that, having that knowledge, they “should have caused or tried to cause the Company to disclose that negative information earlier in order to correct the stock’s artificially inflated price, and that failing to do so was a breach of their ERISA duties of prudence and loyalty.”

Dudenhoeffer Demand

In his ruling, Judge Dow commented that the plaintiffs here “… (somewhat baldly) assert that the disclosure of the true value of Kraft Heinz’s goodwill and intangibles was inevitable and that both the hit to the Company’s stock price and length of its recovery would have been less damaging had the disclosure come earlier.” That said—and his “somewhat baldly” characterization previews his conclusion—he noted that despite the allegation that defendants could not reasonably believe that earlier disclosure would do more harm than good to the Plan or its participants, “the amended complaint’s allegations fail to meet the Dudenhoeffer[ii] standard, specifically the requirement that a plaintiff plead that a prudent fiduciary could not conclude that public disclosure would do more harm than good to the Plan.”

Commenting that “Though Seventh Circuit has yet to reach the issue,” Judge Dow went on to note that “the overwhelming majority of circuit courts to consider an imprudence claim based on inside information post-Dudenhoeffer rejected the argument that public disclosure of negative information is a plausible alternative.”

Judge Dow also commented that the amended complaint is “fuzzy” on exactly what Plaintiffs believe Defendants should have disclosed and when. “While Plaintiffs need not be overly specific, the vagueness of their position—at some point during the Class Period, Defendants should have disclosed something, which would have corrected either some or all of the alleged misstatements—makes it difficult for the Court to determine whether there was an alternative action that the defendant could have taken that a prudent fiduciary would not have viewed as more likely to harm the fund than to help it.” 

Spooked the Market?

Judge Dow went on to explain that “…even granting that Kraft Heinz stock is traded in an efficient market, it is possible that public disclosure would have entailed releasing incomplete or inaccurate information which could have spooked the market and resulted in an outsized drop in the value of [the Company’s] stock.” He noted that, “That would have harmed the Plan, Plan participants holding the stock through that period, and Plan participants planning to sell their stock during that period.”

Judge Dow also commented that the amended complaint’s “allegations of harm rely heavily on general economic principles that, when fraud goes on longer, the inflation [of the price of the asset] will be overstated for a much larger group of purchasers” and that “reputational damage from a longer period of inflated stock prices increases the longer the stock price is artificially inflated.” In Judge Dow’s assessment, those “generic assertions do not satisfy the applicable pleading standard.”

Commenting that “maybe earlier disclosure would have ‘corrected’ the stock price and mitigated harm to the Plan, or maybe not,” but he noted that “the crucial point is that the amended complaint does not adequately allege that some earlier disclosure was so clearly beneficial that a prudent fiduciary could not conclude it would be more likely to harm the Plan than to help it.”

Inevitable Result?

He noted that the plaintiffs rely “heavily” on Jander v. Retirement Plans Committee of IBM, which Judge Dow observed allowed a complaint for breach of prudential duty based on failure to disclose to proceed. “But Jander offers little support here,” he wrote. Judge Dow explained that “In addition to running against the great weight of authority on this issue, the Jander decision largely hangs on facts not adequately pled in the amended complaint now before the Court.” In that case, he said that the Second Circuit took the disclosure in Jander to be “inevitable” because the company “was likely to sell the business and would be unable to hide its overvaluation from the public at that point”—but noted that the case at hand “contains no such allegations, and no facts to support its bare assertion that the impairment of Kraft Heinz’s goodwill and intangibles was inevitable”—and dismissed the first count, but left it open for the plaintiffs to amend.

The second count—that Defendants Bernardo Hees, Paulo Basilio, and David Knopf had fiduciary responsibility for appointing, monitoring and removing members of the Employee Benefits Administration Board (EBAB) breached their fiduciary duty by failing to monitor the EBAB and other individual defendants—well, having failed to make their case that a fiduciary breach occurred—there wasn’t a case to be made that those fiduciaries hadn’t been monitored—and that was dismissed (albeit without prejudice as well)—giving the plaintiffs until Sept. 13 to file a second amended complaint.

What This Means

We’ve noted before that back in 2014, the Supreme Court seemed truly concerned that the “presumption of prudence” standard basically established a standard that was effectively unassailable by plaintiffs—and in fact, until that point the vast majority of these cases (including BP and Delta Air Lines, Lehman and GM) failed to get past the summary judgment phase. Indeed, the plaintiff in the IBM case cited above had argued that no duty-of-prudence claim against an ESOP fiduciary has passed the motion-to-dismiss stage since the 2010 decision in Harris v. Amgen. They had also noted that “imposing such a heavy burden at the motion-to-dismiss stage runs contrary to the Supreme Court’s stated desire in Fifth Third to lower the barrier set by the presumption of prudence.”

However, the “more harm than good” standard that emerged with Fifth Third, while a new “standard,” hasn’t had much impact on the ultimate result, though more cases did get past the summary judgment stage (we’ll set aside the question of whether that has created “more harm than good”).

Not in this case of course—at least not yet.