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It's been nearly two years since the U.S. Supreme Court issued its game-changing decision on employer stock plans, and the standard for litigating employer “stock-drop” cases is just as unclear as it has ever been.
Class actions over investment losses in employer stock plans are among the most litigated issues under the Employee Retirement Income Security Act, although the odds of winning one of the cases aren't that high. But that hasn't stopped the influx of stock-drop cases, even after Fifth Third Bancorp v. Dudenhoeffer, 134 S. Ct. 2459, 58 EBC 1405 (U.S. 2014), made it tougher for litigants to bring them .
Stock-drop cases often deal with two scenarios. The first is when a company's stock price plummets and investors—including employees who invest their retirement savings in the stock—claim that public information about the company's struggles demonstrated that the stock was a bad investment. The second is when investors learn that the company's stock was artificially inflated and corporate executives had inside knowledge of corporate fraud that caused the inflation.
The Supreme Court examined these two scenarios and created different pleading standards for each. For the lower courts, this decision has created as many questions as it answered.
Questions only increased in January, when the justices issued a short decision making clear that the hurdles facing workers are high, even in instances of corporate fraud and artificial inflation of stock price (Amgen Inc. v. Harris, 136 S. Ct. 758 (U.S. 2016) (per curiam) ).
Given the rapidly evolving nature of this area of law, here are four questions for attorneys to consider as courts continue to make sense of stock-drop claims brought under ERISA.
Although most recent developments in the employer stock world have favored defendants, plaintiffs' attorneys should keep their eyes on how courts respond to a pair of pro-plaintiff agency briefs filed in a lawsuit challenging losses connected to BP Plc.'s Deepwater Horizon oil spill. If courts find these briefs persuasive, workers bringing lawsuits based on inside knowledge of corporate fraud can expect more victories in the future.
The briefs, filed in support of BP workers by the Department of Labor and the Securities and Exchange Commission, offer a roadmap for pleading that plan fiduciaries should have known based on inside information that a company's stock was artificially inflated .
The coordinated briefs explain how to satisfy Dudenhoeffer's requirement that plaintiffs allege an alternative action that fiduciaries could have taken instead of retaining the declining employer stock. Under Dudenhoeffer, the alternative action must be consistent with securities laws and not, in the view of a prudent fiduciary, likely to do more harm than good to the value of company stock.
Read together, the DOL and SEC briefs contend that making corrective disclosures—that is, telling the general public about the corporate fraud causing the stock price to be artificially inflated—is an alternative action that wouldn't violate securities law or be likely to do more harm than good.
Samuel Bonderoff, an attorney with Zamansky LLC who has represented employees in stock-drop lawsuits, said he is “gratified and heartened” to see the agencies take this position.
“If you know that the price is artificially inflated, and you know that no fraud in history has ever gone on indefinitely, eventually it's going to come to an end and the day of reckoning will come,” Bonderoff told Bloomberg BNA. “The more you let the fraud go on, the more people are buying at an inflated price and the worse people will be going down the line. You'll never be better off continuing to conceal the fraud.”
In particular, Bonderoff praised the briefs for undercutting the defendant-friendly argument that disclosing fraud will always do more harm than good by “spooking” the market and driving stock price down.
A fiduciary who's unsure of whether fraud has occurred might reasonably conclude that making a disclosure could do more harm than good, Bonderoff said. The same can't be said in situations where the evidence of fraud is clear, he said.
“The DOL position is that in these cases—and the BP case is a great example—you're not dealing with a situation where you don't know if there's a fraud,” Bonderoff said. “The fraud has been confirmed. You can't still be thinking that disclosure may spook the market because spooking the market isn't your concern anymore. Your concern is protecting the plan participants.”
While the DOL and SEC briefs are sure to be important in future stock-drop lawsuits based on inside information, another category of post-Dudenhoeffer lawsuits involve attempts to vindicate stock losses based solely on public reports of a company's struggles.
Although many of these lawsuits—including ones involving J.C. Penney Corp., RadioShack Corp. and Delta Air Lines Inc.—have been dismissed for failure to articulate the “special circumstances” required by Dudenhoeffer, one notable outlier has allowed claims to move forward against Eastman Kodak Co.'s company stock plan (Gedek v. Perez, 66 F. Supp.3d 368, 59 EBC 1854 (W.D.N.Y. 2014)).
In that case, a federal judge in New York found that allegations of Kodak's “inexorable slide toward bankruptcy” and “bleak future”—including its alleged practice of initiating patent infringement lawsuits to maintain cash flow—were sufficient to withstand a motion to dismiss following Dudenhoeffer.
H. Douglas Hinson, an ERISA lawyer with Alston & Bird LLP who has defended companies from similar claims, told Bloomberg BNA that courts have correctly declined to follow the Kodak ruling, which he called “wrong.”
According to Hinson, the Kodak decision rejected the efficient market hypothesis adopted by the Supreme Court in Dudenhoeffer. This hypothesis assumes that, absent inside information affecting stock price, plan fiduciaries can't beat the market because the market always incorporates and reflects all publicly known information relevant to stock price.
The Kodak decision was one of the first post-Dudenhoeffer rulings in this arena, and Hinson said he is “pleased to see that other district courts really didn't follow it.”
Hinson added, “If and when Kodak ever sees an appellate court, I think we might get a different answer.”
Bonderoff has a different take on the Kodak case, although he agreed that it is “somewhat of an outlier.”
In Bonderoff's view, the Kodak court got it right “on the merits and on the law” because the Dudenhoeffer ruling—which involved inside-information allegations—“doesn't necessarily have anything to say” about a situation in which public information makes clear that a company's circumstances had become “so abysmal that any prudent fiduciary could recognize that it's not a prudent investment.”
According to court filings, the Kodak litigants are in the midst of settlement negotiations.
With the exception of the Kodak case, courts have made clear that stock-drop lawsuits based solely on public information face a significant roadblock: the requirement to plead “special circumstances” that would render unreliable the market price for a security.
Given this difficulty, court filings in cases against IBM Corp. and Peabody Energy indicate that litigants may be attempting some strategic maneuvers. While plaintiffs appear to be steering their cases toward the more plaintiff-friendly framework of an inside information case, at least one defendant is trying to do the opposite.
In the case against Peabody, the coal workers who challenged company stock losses in June 2015 originally based their lawsuit solely on public information about the company's financial struggles and the “collapse” of coal prices.
Nine months later, they filed an amended complaint that also accused plan fiduciaries of having inside information about the viability of Peabody stock. In particular, they alleged that a recent investigation by New York's attorney general revealed that Peabody publicly minimized the effects of climate change regulations on its business while privately projecting significant negative consequences from the regulations.
The idea that plaintiffs are better positioned when they can accuse fiduciaries of misusing inside information is similarly reflected in a lawsuit against computer manufacturer IBM.
The IBM workers filed their lawsuit as an inside information case, arguing that company executives artificially inflated stock price by issuing misleading financial statements about the health of its microelectronics business.
In moving to dismiss, IBM rebuffed the idea that the workers' claims were based on inside information. According to the company, “all of their allegations about what should have been disclosed earlier by Defendants were already part of the mix of information available to the market.”
Alston & Bird's Hinson expressed doubt that plaintiffs could find success by “blurring the lines” between public information cases and inside information cases by referring to types of inside information that “falls short of active securities fraud.”
According to Hinson, plaintiffs bringing ERISA lawsuits are in the best position when they can tie stock plan losses to active securities fraud. Absent such a showing, most plaintiffs will be unable to survive a motion to dismiss, Hinson said.
“Those circumstances are extremely rare, where there's securities fraud,” Hinson said. “Absent those facts—which is 99 percent of the cases out there—I still think most fiduciaries are protected even at the motion to dismiss stage.”
Because many ERISA lawsuits run parallel to securities class actions involving the same company stock, one way to predict future ERISA lawsuits is by looking at recent securities class actions. For example, companies like BP and IBM have simultaneously defended ERISA and securities class actions challenging declining stock prices.
Indeed, several companies—including SunEdison Inc., Sanofi-Aventis U.S. LLC, IBM and Whole Foods Market Inc.—have been targeted recently by both ERISA lawsuits and complaints alleging securities fraud.
Even so, Zamansky's Bonderoff called this tactic an “imprecise way of trying to predict where the next case will come.”
“Sometimes we sync up with a securities case, and sometimes we don't,” Bonderoff said. “There are just as many times where we have an ERISA case and there is no parallel securities action.”
Bonderoff said he could have an “ironclad” securities case against a company but no viable ERISA claim, such as when the fiduciary of a company stock plan is a “midlevel HR person” with no reason to know about artificial inflation of the company's stock.
For his part, Hinson predicted that cases involving securities fraud would continue to provide more “fertile ground” for ERISA lawsuits than situations involving only public information of a company's struggles.
In Hinson's view, cases based on public information will keep hitting roadblocks when it comes time to plead special circumstances that rendered the market inefficient. For an actively traded stock, that will be a difficult or impossible standard to meet, Hinson said.
“I think there are circumstances where the market isn't efficient, but I have yet to see a post-Dudenhoeffer one of these complaints that really pleads that plausibly,” Hinson said.
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