Yet another stock drop suit has failed to clear the “more harm than good” pleading standard outlined by the United States Supreme Court in 2014.
Johnson & Johnson (“J&J”) offers an Employee Stock Ownership Plan (ESOP) that, as ESOPs generally do, invests solely in J&J stock—which declined in price following a news report accusing J&J of concealing that its baby powder was contaminated with asbestos. J&J denied both that its product was contaminated and that it had concealed anything about the product.
The Plaintiffs—J&J employees who participated in the ESOP—charged that the ESOP’s administrators—who turn out to be senior officers of J&J—violated their fiduciary duties by failing to protect the ESOP’s beneficiaries.
The Case
More specifically, according to the Plaintiffs, those 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, yet they continued holding and purchasing J&J stock. The Plaintiffs asserted that the Defendants should have instead protected the ESOP participants from the inevitable stock price decline[i] by issuing corrective public disclosures.
Case History
The Defendants moved to dismiss, and the District Court granted their motion—applying the Dudenhoeffer standard. The Court held that the Plaintiffs had not adequately pleaded a viable alternative action that the individual Defendants, as ERISA fiduciaries, could have taken, because they could only have issued corrective disclosures in their corporate capacities and not in their ERISA-fiduciary capacities. That court also concluded that the Plaintiffs failed to allege particularized facts to support their argument that earlier disclosure of the potential asbestos liabilities would have been less harmful to the ESOP and its participants than the later disclosure that occurred. That said, and while the district court dismissed the ERISA claims, it did so without prejudice, “allowing the Plaintiffs an opportunity to allege other actions that the individual Defendants could have taken.”
So, in June 2020, the Plaintiffs filed an amended class action complaint—but one, according to the appellate court—that “largely duplicated the prior one,” reiterating the notion that the ERISA fiduciaries should have issued corrective disclosures, but adding reasons why the Defendants COULD have issued disclosures in their capacities as ERISA fiduciaries. Oh, and they also presented another alternative: they said that the fiduciaries should have protected the ESOP participants from the J&J stock price decline by directing new contributions to the ESOP’s cash buffer, rather than buying more J&J stock. However, the fiduciary defendants once again moved to dismiss—and the court (again)—remaining unpersuaded by the alternative approach argument—granted that motion.
Which led to the appeal here.
The Appeal
In considering the appeal, the U.S. Court of Appeals for the Third Circuit turned back to the standards outlined in Dudenhoefer—that “to state a claim for breach of the duty of prudence on the basis of inside information, 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.”
Judge Kent A. Jordan, who wrote the court’s opinion[ii] (Perrone v. Johnson & Johnson, 3d Cir., No. 21-1885, 9/7/22) noted that that same Dudenhoeffer Court presented a few “additional considerations”—specifically, when a complaint alleges that the fiduciaries should have used their inside information to refrain from making additional stock purchases, the court should consider whether that action would conflict with the requirements and objectives of insider trading laws—and with the substance and objectives of corporate disclosure requirements imposed by the federal securities laws. But ultimately it comes back to a determination as to whether a prudent fiduciary could have concluded that disclosing the negative information—either expressly by public disclosure or implicitly by stopping purchases—“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 holding that Judge Jordan pointed out has been affirmed twice by the U.S. Supreme Court.
The Ruling
Judge Jordan commented that the Plaintiffs here propose two alternative actions that they say the Defendants should have taken before the stock price dropped. “First, they say that the Defendants could have used their corporate powers to make public disclosures that would have corrected J&J’s artificially high stock price earlier rather than later. Second, they say that the fiduciaries could have stopped investing in J&J stock and simply held onto all ESOP contributions as cash.”
“It was a guess that J&J’s stock price would drop significantly, and there was even less certainty about the timing and degree of such a drop,” Jordan commented. “It is simply too much of a stretch to say that a prudent fiduciary in the Defendants’ position ‘could not have concluded’ that redirecting contributions to the ESOP’s cash buffer ‘would do more harm than good.’”
That said, Judge Jordan noted that “the District Court rejected those alternative actions as failing the Dudenhoeffer test, and we agree. A reasonable fiduciary in the Defendants’ circumstances could readily view corrective disclosures or cash holdings as being likely to do more harm than good to the ESOP, particularly given the uncertainty about J&J’s future liabilities and the future movement of its stock price. We will therefore affirm the dismissal of the Plaintiffs’ complaint.”
What This Means
This case—as are all of today’s so-called “stock drop” cases—turns on the standard established by the Supreme Court in 2014 referenced here, the Dudenhoefer v. Fifth Third case. At that time the 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. 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”).
Ultimately, the consistency of these decisions may be of some small comfort to plan fiduciaries who also have corporate responsibilities. On the other hand, the persistency of these suits should provide at least some pause to those who have those overlapping responsibilities.
[i] The court expressed some skepticism that J&J’s issues with regard to the talc product suits necessarily meant the stock priced was doomed. “Over the years, thousands of plaintiffs have filed products liability lawsuits alleging that J&J’s talc products caused cancer. Those plaintiffs have had mixed success. J&J has always denied liability and publicly affirmed that its products are asbestos-free and safe for everyday use,” the court noted.
[ii] Judges L. Felipe Restrepo and D. Brooks Smith joined in the court’s ruling.
