Another stock drop case got another hearing after the dismissal of the so-called presumption of prudence rule. Guess what happened?
It was supposed to be a game-changer – Supreme Court’s 2014 ruling in Fifth Third Bancorp v. Dudenhoeffer that ESOP fiduciaries are not entitled to any special presumption of prudence. That said, the results seem to be largely the same, including a recent ruling by the U.S. Court of Appeals for the Second Circuit.
In an unsigned opinion, a three-judge panel for the 2nd U.S. Circuit Court of Appeals has upheld the lower court’s ruling in Rinehart et al. vs. Lehman Brothers Holdings Inc. et al. that participants “failed to allege sufficiently” that plan fiduciaries violated their duties under the Employee Retirement Income Security Act.
The Lehman case was brought by participants in a Lehman Brothers retirement plan who argued that directors breached their fiduciary duties by keeping the plan invested in proprietary stock during the run-up to the firm's historic bankruptcy in September 2008, even though they knew the true nature of the investment bank's financial condition.
In its original dismissal of the case originally, the district court relied on what was then the legal standard — a “presumption of prudence” in favor of corporate defendants who allow retirement plans to invest in company stock, noting that in order to overcome that presumption, plaintiffs had to establish that the plan fiduciaries had to know the firm was in a “dire situation.”
This same appeals court had previously affirmed that decision, but in view of the Fifth Third case, the Second Circuit directed the lower court to reconsider the case in light of the Fifth Third case, which it did, and once again rejected the claim.
Current Case
In its most recent review of the case, the Second Circuit noted that in the Fifth Third case, the Supreme Court “made clear that "where a stock is publicly traded, allegations that a fiduciary should have recognized from publicly available information alone that the market was over- or undervaluing the stock are implausible as a general rule, at least in the absence of special circumstances,” and that it was prudent to, as a general matter, rely on the market price. Moreover, they noted that for claims alleging breach of the duty of prudence on the basis of nonpublic information, Fifth Third held 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,” noting that the nation’s highest court cited three considerations pertinent to this analysis, that courts:
- must bear in mind that the duty of prudence, under ERISA as under the common law of trusts, does not require a fiduciary to break the law;
- should consider the extent to which an ERISA-based obligation either to refrain on the basis of inside information from making a planned trade or to disclose inside information to the public could conflict with “the complex insider trading and corporate disclosure requirements imposed by the federal securities laws or with the objectives of those laws;” and
- should consider whether the complaint has plausibly alleged that a prudent fiduciary in the defendant’s position could not have concluded that stopping purchases — which the market might take as a sign that insider fiduciaries viewed the employer’s stock as a bad investment — 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 appellate court noted that while plaintiffs alleged that the defendants “knew or should have known, based on publicly available information, that investment in Lehman had become increasingly risky throughout 2008,” and that failing to consider the wisdom of continuing to invest in Lehman during this period constituted a breach of fiduciary duty. However the court agreed with the lower court that the findings in Fifth Third did not change the reality that, in its opinion, plaintiffs had still failed to plausibly state a breach of duty claim.
The appellate court noted that plaintiffs tried to “plead around” Fifth Third by saying that their claims concern "excessive risk" and therefore are not covered by Fifth Third, but the Second Circuit again concurred with the judgement of the lower court that “the purported distinction between claims involving "excessive risk" and claims involving "market value" is illusory. The Second Circuit rejected the idea presented by the plaintiffs that orders issued by the Securities and Exchange Commission banning the short-selling of Lehman securities contemplated the type of “special circumstances” required to make a valid ERISA claim based on publicly available information.
The Second Circuit also disagreed with the argument by the plaintiffs that, if Lehman plan fiduciaries had conducted an independent investigation, they would have uncovered the fact that the investment in Lehman stock was imprudent. They also cited the recent Supreme Court holding in Amgen that a prudent fiduciary might well have concluded that divesting Lehman stock, or simply holding it without purchasing more, “would do more harm than good,” noting that “such an alternative action in the summer of 2008 could have had dire consequences.”
The bottom line: The Second Circuit held that the plaintiffs “simply have not met the Fifth Third standard for making out “sufficient facts and allegations to state a claim for breach of the duty of prudence.”
The results have been the same in a number of the recent “stock drop” cases, including those brought against Delta Airlines, JP Morgan and BP.
