High Court Makes It Harder to Bring Stock-Drop Cases

By Allen Smith Jan 28, 2016

Following a Supreme Court ruling on Jan. 25, participants in employee stock ownership plans will have a harder time bringing so-called stock-drop cases. The ruling is also expected to affect litigation brought against 401(k) plans with employer stock as an investment option.

In stock-drop cases, plan participants sue plan fiduciaries when company stock prices drop, often alleging that the company should have sold the stocks based on information it had about the value of the stock.

These cases have proliferated since the Supreme Court ruled in 2014 that there is no presumption of prudence for fiduciaries who administer employee stock ownership plans. However, the court’s recent ruling in Amgen v. Harris may halt that trend.

Former employees of Amgen Inc., a pharmaceutical company based in Thousand Oaks, Calif., filed a class action against the business after the stock value fell. The plaintiffs claimed the fiduciaries had breached their fiduciary duties, including the duty of prudence under the Employee Retirement Income Security Act (ERISA), because they knew the stock price was inflated. The district court granted the fiduciaries’ motion to dismiss, but the 9th U.S. Circuit Court of Appeals reversed.

Doing ‘More Harm than Good’

The Supreme Court had ruled in Fifth Third Bancorp v. Dudenhoeffer in 2014 that there is no presumption of prudence for fiduciaries. But the court also stated at that time that lower courts facing stock-drop claims 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.”

The high court vacated the 9th Circuit’s Amgen ruling and sent the case back to the lower courts for proceedings consistent with Fifth Third. The 9th Circuit again reversed the dismissal of the complaint, and the Supreme Court again granted review.

“The Supreme Court essentially scolded the 9th Circuit,” said Andrew Oringer, an attorney with Dechert in New York City. The 9th Circuit failed to assess whether the complaint plausibly alleged that stopping stock purchases would not do more harm than good, according to the high court. For example, stopping the purchase of stock might spark a sell-off.

The Supreme Court also noted that fiduciaries confront unique challenges, given the potential for conflict that arises when fiduciaries are alleged to have imprudently failed to act on inside information they had about the value of the stock. Insider trading generally is a violation of securities law.

“A plaintiff cannot get into the costly discovery phase of litigation without making factual allegations suggesting that all aspects of their case are ‘plausible,’ ” wrote Andrew Holly and Steve Lucke, attorneys with Dorsey in Minneapolis, in an e-mail. “This principle is actually a broader principle that applies to all cases—it is not ERISA-specific. But it is particularly important in ERISA breach-of-fiduciary-duty claims simply because of the size of the cases and the risk that a meritless case can be used to extort settlements.”

The court sent the Amgen case back to the district court, which may let the stockholders amend the complaint to adequately plead a claim for breach of the duty of prudence. However, Holly and Lucke predicted, “It will be a challenge for them to allege that the fiduciaries could have taken steps that would have been both beneficial to the plan and in compliance with the securities law.”

‘Substantial Hurdle’

Despite the loss of the presumption of prudence, Fifth Third “is not necessarily bad for fiduciaries and may even be good for plan sponsors and fiduciaries” in light of Amgen, Oringer said. Plaintiffs must plausibly allege that selling the stock would not do more harm than good, and Oringer said that may not be easy to do. The standard may be a “substantial hurdle” to plaintiffs bringing claims forward, he noted.

He noted that when facing a corporate difficulty, a plan fiduciary may want to specifically consider whether alternatives would do more harm than good to the plan. This could make it even harder for plaintiffs to prevail, he said.

“We continue to see stock-drop cases being brought,” noted James Fleckner, an attorney with Goodwin Procter in Boston. “There are always pockets of the economy, or individual companies, that for one reason or another struggle.” He said that since the abolition of the presumption of prudence, there have been more stock-drop lawsuits than before Fifth Third.

Fleckner said that the court’s ruling in Amgen hopefully “will help bring more balance back.”

This decision is Amgen v. Harris, No. 15-278 (2016).

Allen Smith, J.D., is the manager of workplace law content for SHRM. Follow him @SHRMlegaleditor.


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