Trial News

On Nov. 6, the U.S. Supreme Court heard oral arguments in a case involving a class of IBM employees who allege that the company’s employee stock ownership plan (ESOP) fiduciaries failed to publicly disclose that a division of IBM had been overvalued, which artificially inflated the company’s stock price. The plaintiffs argue that by not revealing this information and continuing to invest in company stock, the fiduciaries prevented the market from gradually correcting, ultimately leading to a sharp drop in stock and ESOP value when the overvaluation became public. Although the question before the Court concerned what pleading standard should govern, much of the oral arguments focused on what duties should be imposed on ESOP fiduciaries and whether federal securities laws or ERISA should govern such cases. Attorneys familiar with the case say the outcome is unclear after arguments. (Retirement Plans Comm. of IBM v. Jander, No. 18-1165 (U.S. oral arg. Nov. 6, 2019).)

The complaint claims that IBM’s microelectronics division began incurring annual losses of approximately $700 million in 2013. These losses were not publicly disclosed until 2014, when IBM announced that it had sold the division after a lengthy search for a buyer. After this announcement and the exposure of the division losses, IBM’s stock price fell by more than $12 per share.

The plaintiffs, who participated in IBM’s ESOP, sued several plan fiduciaries, alleging that they acted unlawfully when—despite knowing the microelectronic division’s overvaluation—they continued to invest plan funds in IBM stock and failed to disclose that the company’s stock price was artificially inflated. Although immediate disclosure was not required under federal securities laws, the complaint argued that the fiduciaries breached their duty of prudence under ERISA to act for the benefit of the employees invested in the ESOP. Reviewing the complaint, the district court applied Fifth Third Bancorp v. Dudenhoeffer (134 S. Ct. 2459 (2014)), which set the standard for pleading duty of prudence claims against ESOP fiduciaries.

In Dudenhoeffer, the Court found that ESOP fiduciaries are not entitled to a “presumption of prudence” and instructed courts to apply a “careful, context-sensitive scrutiny” to the allegations. Plaintiffs must allege that fiduciaries “behaved imprudently by failing to act on the basis of nonpublic information that was available to them” and also must offer an alternative action that the defendants could have taken and that a “prudent fiduciary in the same circumstances would not have viewed as more likely to harm the fund than to help it.” The alternative action must also comply with federal securities laws. Dudenhoeffer provided three considerations to guide this analysis, the third of which is at issue in Jander—whether a complaint has “plausibly alleged that a prudent fiduciary in the defendant’s position could not have concluded” that following the alternative action “would do more harm than good to the fund.”

Applying this standard, the district court dismissed the suit, concluding that the complaint’s allegations—early disclosure of the overvalued stock would have minimized the later losses—were insufficient and too general. The Second Circuit reversed, ruling that the plaintiffs had met their burden by alleging that the defendants knew the stock was artificially inflated and chose not to disclose the truth and correct the inflation, an earlier disclosure would have minimized the eventual stock price drop, and the defendants knew that the division sale—and the disclosure of the losses—was inevitable.

The defendants filed a petition for certiorari, and the Supreme Court agreed to review the question: “Can a plaintiff satisfy Dudenhoeffer’s ‘more harm than good’ pleading standard with generalized allegations that harm from inevitable disclosure of stock fraud increases over time?”

At oral arguments, however, the defendants’ attorneys and the U.S. solicitor general’s office instead addressed a new topic not presented to the lower courts or part of the certified question presented: whether and how federal securities laws should apply to ESOP fiduciaries’ duties. Washington, D.C., attorney Jonathan Ellis, on behalf of the federal government in support of neither party, argued that fiduciaries’ duty to disclose under ERISA should be consistent with their duty to disclose under federal securities laws—so only when circumstances supported a securities action against a company for a failure to disclose should an ERISA breach of fiduciary duty claim be brought. Washington, D.C., attorney Paul Clement on behalf of the defendants went further: He argued that the Court should extend its holding from Pegram v. Herdrich (530 U.S. 211 (2000)) so that fiduciaries would have “no obligation to use the inside information gained in a corporate capacity in a fiduciary capacity.”

“The petitioner defendants essentially argued that certain ERISA duty of prudence claims in ESOP stock drop cases should be eliminated,” said Washington, D.C., attorney Matt Wessler, who authored the amicus brief AAJ and Public Justice filed in support of the employees. “This is quite different from the narrow question about the Dudenhoeffer analysis that they asked the Court to decide, and a number of the justices seemed uncomfortable with the prospect of deciding a new, much broader issue.”

Justices Stephen Breyer and Sonia Sotomayor expressed reservations about answering a question different from the one the Court accepted. Justice Ruth Bader Ginsburg asked Ellis to explain “this theory of yours I saw nowhere aired below.”

New York City attorney Samuel Bonderoff, arguing for the employees, discussed the complaint’s allegations about the shareholders’ interests, the harm suffered, and the general importance of ERISA protections. He engaged with Justices Breyer, Sotomayor, and Brett Kavanaugh on how to apply Dudenhoeffer to the facts at issue but also spent a significant portion of his time answering questions from Justice Samuel Alito, Justice Neil Gorsuch, and others on the overlap between securities laws and ERISA, and which should govern the fiduciaries.

Wessler said he sees three options before the Court: “It could address the petitioners’ bigger question about whether ERISA duty of prudence claims should be available to employees in these circumstances, but I didn’t see the justices express much interest in going that far. The Court could decide the limited, certified question about how to apply Dudenhoeffer. And, of course, we’ve seen this happen before, the Court could dismiss the writ as having been improvidently granted, possibly noting the disparity between the question presented and the arguments.”

AAJ and Public Justice’s amicus brief urged the Court to affirm the Second Circuit and to offer guidance to lower courts explicitly limiting Dudenhoeffer to cases involving ESOP stock drops—not all ERISA cases. “If the Court chooses to respond to the narrow question presented, I’m hopeful it also will clarify the narrow contexts in which Dudenhoeffer applies,” Wessler said. “But after the arguments, it’s difficult to predict whether the Court will reach this issue.”