On December 10, 2018, the U.S. Second Circuit Court of Appeals overturned a lower court’s dismissal of a “stock drop” case in a way that could add to the list of allegations participants might use to overcome employers’ motions to dismiss these types of cases. Although this case involved an employee stock ownership plan (“ESOP”), the holding could equally apply to a 401(k) plan that has company stock as a participant-directed investment option. A copy of the decision may be found here.
Facts and Disposition of Case. In their complaint, Larry Jander and similarly situated participants in an IBM ESOP alleged that the plan’s fiduciaries should have disclosed accounting errors that essentially hid losses incurred by the company’s microelectronics business. These losses artificially inflated the value of company stock, which, in turn, diminished the ESOP’s returns. Alternatively, plaintiffs argued that, in lieu of disclosure of the accounting errors, the fiduciaries should have stopped or limited investments in company stock in order to diminish the effect of the accounting errors on plan participants’ retirement savings.
The district court’s reasoning for dismissing the complaint was based on a highly technical pleading distinction. Very generally stated, the legal issue turned on whether an intervention by the plan fiduciaries (including disclosure of the accounting errors and/or limiting investments in company stock) would be more harmful than helpful, in terms of its result on investment returns.
The Second Circuit sidestepped a thorny pleading distinction by holding that this case satisfied the more stringent pleading requirement, set forth by the U.S. Supreme Court in its 2014 Duddenhoffer decision, that “any prudent fiduciary” (emphasis added) would have known that delayed disclosure of the errors would be more harmful than helpful to investment returns. Accordingly, the appellate court reversed and remanded the case to the lower court for further proceedings. By overturning the district court’s reversal, the appellate court effectively widened the range of arguments plaintiffs might use to argue that fiduciary intervention should have been undertaken in cases involving similar facts and circumstances.
Implications for Fiduciaries. ERISA plan fiduciaries in stock drop cases – which would include fiduciaries of 401(k) plans that have company stock as a participant-directed investment option — have, in the past, often been able to successfully argue that disclosure of errors can do more harm than good, making nondisclosure a credible option. But after this case, the scope of potential arguments plaintiffs may use in order to defeat an assumption that nondisclosure was the more prudent action has effectively been expanded – ERISA fiduciaries, be advised accordingly!
As always, specific questions as to the scope and nature of your ERISA fiduciary duties and potential liability in stock loss and similar situations should be directed to your ERISA counsel or other professional advisors.