Supreme Court Hears Arguments in Stock-Drop Case

Allen Smith, J.D. By Allen Smith, J.D. November 8, 2019
Supreme Court Hears Arguments in Stock-Drop Case

​The U.S. Supreme Court heard oral arguments Nov. 6 in a case that could open the floodgates of litigation against plan fiduciaries when the prices of company stocks in employee stock ownership plans (ESOPs) drop. But if the high court applies securities law rather than the Employee Retirement Income Security Act (ERISA), litigation could be reduced.

The plaintiffs in the case, Retirement Plans Committee of IBM v. Jander, No. 18-1165, alleged that fiduciaries of IBM's retirement plan breached their duty of prudence—a type of fiduciary duty—under ERISA by investing in IBM's stock, even though they knew that the company's microelectronics division was overvalued, which artificially inflated the company's stock price. The plaintiffs argued that the fiduciaries eventually had to disclose this information, but by delaying in doing so, they cost the plan more over time.

The 2nd U.S. Circuit Court of Appeals let the plaintiffs proceed with their case, deciding that they had sufficiently alleged that "no prudent fiduciary in the plan defendants' position could have concluded that earlier disclosure would do more harm than good" to the plan.

"It took everyone by surprise" when the 2nd Circuit let the claim proceed, said Kimberly Jones, an attorney with Drinker Biddle & Reath in Chicago. Jones said that in previous litigation, the Supreme Court "did not want, every time there is a drop in stock price, for fiduciaries to be embroiled in litigation as to whether their decisions were appropriate."

In Jander, IBM appealed the 2nd Circuit's decision, asserting that the appeals court incorrectly applied the "do more harm than good" standard for bringing such claims and opened the floodgates for "meritless, economically burdensome lawsuits."

Andrew Oringer, an attorney with Dechert in New York City, said in an interview, "There has been a proliferation of stock-drop cases. Anything the Supreme Court does that affects the viability of stock-drop cases undoubtedly is significant."

IBM's Securities Law Argument

Under securities law, "ESOP fiduciaries do not have a fiduciary obligation to use information gained in a corporate capacity or to use the regular corporate channels of disclosure for the benefit of plan participants," argued Paul Clement, an attorney with Kirkland & Ellis in Washington, D.C., on behalf of IBM before the Supreme Court.

"It's particularly true with respect to the use of regular corporate disclosure channels," he said. "The use of those channels is something that is inherently done wearing a corporate hat, and, indeed, the insiders only have access to the regular corporate disclosure channels because of their corporate roles."

Clement emphasized that "the use of those corporate disclosure channels is a corporate act, and that corporate act is already pervasively regulated by the securities law."  

Federal securities laws govern when and how an insider should disclose material nonpublic information and outlaw disclosures that lead to securities trading, noted DRI in a friend-of-the-court brief. An insider fiduciary cannot be compelled to disclose material nonpublic information to an ESOP participant for purposes of directing employer stock trades in an individual ESOP account, it asserted. The insider fiduciary wears two hats—the corporate officer hat and ERISA fiduciary hat—but may wear only one at a time, it added. 

Clement criticized the plaintiffs, asserting they argue that "the reason we want these insiders to serve as fiduciaries is so they can be sort of canaries in the coal mine; they can take early action based on their unique access to inside information."

But Clement said, "That is absolutely wrong. … All these funds are set up to make sure that doesn't happen. Because if that did happen, these would all be latent security violations."

Justice Sonia Sotomayor criticized the securities law argument, saying that it was not a question that the Supreme Court had agreed to review.


Clement added that even if there were a fiduciary obligation under ERISA to use insider information gained in a corporate capacity or to use corporate disclosure channels, the plaintiffs' allegations would fail. "The allegations that no fraud lasts forever, disclosure's inevitable and the harms of concealment only grow over time so it is prudent to disclose early could be made in every case."

Moreover, he said, "If you disclose negative inside information to the market, it's going to have a negative impact on the value of the stock, which is all an ESOP holds."

Plaintiffs' ERISA Argument

Samuel Bonderoff, an attorney with Zamansky in New York City, argued before the Supreme Court on behalf of the plaintiffs. ESOP fiduciaries must fulfill the same duty of prudence that every other ERISA fiduciary must satisfy, except they don't have to diversify the fund's assets, he said.

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The central question is whether the fiduciaries are doing more harm than good to plan participants, he stated. That determination can be difficult, as some participants are long-term investors, and others are short-term investors. Most simply hold stocks in the plans, he noted.

Disclosing sooner rather than later will not always be better, but it would have been in this case, Bonderoff said.

Justice Brett Kavanaugh was skeptical. "Isn't the problem, as the 5th and 6th Circuit said in similar circumstances, that you have different classes of beneficiaries, some of whom would be harmed, some of whom would [have] benefited? And when that's the circumstance, it's a little hard to hold the fiduciary liable for violating the duty of prudence, given the different interests of the different classes of beneficiaries?"

Bonderoff replied that different facts were involved in the cases before the 5th and 6th Circuits.

Justice Elena Kagan asked how Bonderoff would respond to the argument that the plaintiffs are trying to use ERISA to water down securities law standards.

Bonderoff said that wasn't the case, and that if the court ruled under securities law, lower courts will struggle to determine when securities law pleading standards and ERISA pleading standards apply.

He added, "Disclosure here would have not been inconsistent with the securities laws."

In rebuttal, Clement urged the court to rely on securities law to rule in IBM's favor.



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