Supreme Court Opinion Sheds No Light on Elusive Stock-Drop Pleading Standard

The Court had granted certiorari to address the following question: whether the “more harm than good” pleading standard first articulated in FifthThird Bancorp v. Dudenhoeffer, 573 US 409 (2014), “can be satisfied by generalized allegations that the harm of an inevitable disclosure of an alleged fraud generally increases over time.” This was undoubtedly an interesting question and one of great import to the viability of future complaints. The facts of most stock drop cases entail a declining stock value, naturally. Theoretically, in virtually any stock drop case, one could allege that an earlier disclosure (before stock prices fell or before they fell further) would have been less harmful than a later one. Is that sufficient to get a newly filed case past the pleadings stage? The Second Circuit held that it was.

By way of background, the Court in 2016 struck down a “presumption of prudence” previously afforded ERISA fiduciaries by most courts with respect to employer stock investments in employee stock ownership plans (ESOPs) and defined contribution plans. It replaced this already-defense-friendly presumption with an even stricter pleading standard that has proven to be virtually impossible for plaintiffs to meet. Under the standard announced in Fifth Third Bancorp v. Dudenhoeffer, to survive a motion to dismiss, plaintiffs must allege that fiduciaries were in possession of non-public (i.e., insider) information that, if known, would damage the company’s stock price. In addition, they 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 circumstance would not have viewed as more likely to harm the fund than to help it.”

Prior to the Second Circuit’s Jander opinion, plaintiffs had been unable to sufficiently plead alternative actions that insider-fiduciaries could have taken, without running afoul of the securities laws, that a prudent fiduciary “would not have viewed” as more likely to cause more harm than good to the fund. The Second Circuit held that the Jander plaintiffs had finally cracked the code by alleging that inside fiduciaries could have minimized harm to the fund by making an “early corrective disclosure” that IBM’s Microelectronics unit was overvalued due to an accounting error. 910 F.3d 620 (2d. Cir. 2018). This was particularly true, the Second Circuit opined, because IBM was selling its Microelectronics unit; any potential purchaser would “surely conduct its own due diligence of the business prior to purchasing it,” and the accounting error would eventually be revealed. Id. at 630.

The Plan petitioned for certiorari asking the Court to address whether generalized allegations that an early disclosure of inside information was sufficient to meet Dudenhoeffer’s strict requirements. But both the Petitioners and the Government focused their arguments on other matters. The Petitioners “argued that ERISA imposes no duty on an ESOP fiduciary to act on inside information.” Slip. Op. at 3. And the Government, expressing the views of the Securities and Exchange Commission and the Department of Labor, argued that any ERISA-based duty to disclose inside information, not otherwise required by the securities laws, would “conflict” with at least the “objectives of” the complex insider trading and corporate disclosure requirements in the securities laws. Id. Because these arguments were not raised below, the Court issued a per curiam opinion vacating the Second Circuit’s judgment and remanding the case. The Court left it to the Second Circuit to decide whether it was appropriate to address these arguments in the first instance. But in so doing, it also vacated the Second Circuit’s decision allowing the plaintiff’s allegation to meet the Dudenhoeffer standard. In this way, the Supreme Court seems only to have muddied the waters.

And those waters were muddied further by the issuance of two opposing, concurring opinions:

• Justice Kagan picked up on Dudenhoeffer’s instruction that ESOP fiduciaries, at times, do have a duty to disclose inside information, so long as that disclosure does not run afoul of the securities laws. In this “conflict-free zone,” Kagan opines, the question is “whether a prudent fiduciary would think the action more likely to help than to harm the fund.”
• Justice Gorsuch, by contrast, notes that insider fiduciaries wear two hats: that of a corporate officer, and that of a fiduciary. Disclosure is an act performed in a corporate capacity. ERISA does not impose “an even higher duty of fiduciaries who have the authority to make or order SEC-regulated disclosures on behalf of the corporation.”

Jander thus does little to help clarify Dudenhoeffer’s elusive pleading standard and indeed may be described as resulting in a legal standard that is now even less clear. Plan fiduciaries and participants (and their lawyers) are therefore left waiting to see whether and how the Second Circuit addresses the impact of the securities laws on ERISA’s duty of prudence in the first instance.