Ever since the Supreme Court’s decision in Fifth Third Bancorp v. Dudenhoeffer, 573 U.S. 409 (2014), plaintiffs’ attorneys have been trying to crack the code for pleading an ERISA duty-of-prudence claim against fiduciaries of employee stock ownership plans (ESOPs) following a drop in the company’s stock price. Those attempts have been largely unsuccessful, with the notable exception of Jander v. Retirement Plans Committee of IBM, 910 F.3d 620 (2d Cir. 2018), vacated and remanded, 140 S. Ct. 592, reinstated, 962 F.3d 85 (2d Cir. 2020). When the Supreme Court granted certiorari in Jander, many ERISA lawyers expected the Court to clarify how a plaintiff could satisfy the Dudenhoeffer standard while still preventing meritless stock-drop claims. But as it often does, the Supreme Court ducked the issue and remanded the case without addressing the merits.
Although the Supreme Court did not provide clarity, the lower federal courts have continued the trend of dismissing nearly all ERISA stock-drop cases at the pleadings stage. In four recent decisions involving ESOPs sponsored by Target, Wells Fargo, Johnson & Johnson, and General Electric Co. (GE), federal courts rejected arguments based on Jander and held that the plaintiffs failed to meet the Dudenhoeffer pleading standard. These decisions may be a harbinger of what is to come if and when plaintiffs bring more ERISA stock-drop claims.
From Dudenhoeffer to Jander
Under Dudenhoeffer, a plaintiff asserting a duty-of-prudence claim in the ESOP context, based on the fiduciary’s failure to act on non-public information, “must plausibly allege an alternative action that the defendant could have taken that would have been consistent with the securities laws and that a prudent fiduciary in the same circumstances would not have viewed as more likely to harm the fund than to help it.” 573 U.S. at 428. Although on its face the Dudenhoeffer standard marked a significant change from the “presumption of prudence” that some lower courts previously applied to such claims, in practice few cases met the new standard.
Since 2016, the Second Circuit has been the only appellate court to find plaintiffs’ allegations sufficient to satisfy the Dudenhoeffer standard. In Jander, the plaintiffs alleged that the defendants breached the duty of prudence by continuing to invest ESOP funds in IBM stock despite knowledge of “undisclosed troubles” in one of IBM’s businesses. As one potential alternative action, the plaintiffs alleged that the defendants should have made an “early corrective disclosure” “alongside the regular SEC reporting process.” 910 F.3d at 628. The Second Circuit held that this alternative action satisfied Dudenhoeffer, reasoning that a prudent fiduciary could not have concluded that an early corrective disclosure would do more harm than good because disclosure was inevitable and the fallout would only increase with time. Id. at 628-30.
Because other circuits had concluded that similar allegations failed to satisfy Dudenhoeffer, the Supreme Court granted certiorari in Jander. But after the parties raised new arguments in their merits briefs and at oral argument, the Court remanded the case to the Second Circuit to determine whether to consider these newly raised arguments. The Second Circuit declined and remanded the case to the district court to proceed with litigation.
Four decisions that have come out since the Supreme Court’s remand suggest that Jander is an outlier, and not the template that plaintiffs’ lawyers have been searching for since Dudenhoeffer. In each case, the court found that allegations of inevitable disclosure and increasing harm over time — the centerpieces of Jander’s reasoning — failed to satisfy Dudenhoeffer’s “no more harm than good” test.
In Dormani v. Target Corporation, No. 18-2543, 2020 WL 4289987 (8th Cir. July 28, 2020), a team from Faegre Drinker defeated claims that Target ESOP fiduciaries breached the duty of prudence based on their response to Target’s expansion into Canada. The plaintiffs alleged that Target’s ESOP fiduciaries knew Target Canada faced significant supply chain challenges and should have taken action to protect the plan against the resulting fall in Target’s stock price. Specifically, they alleged that the defendants should have made an earlier public disclosure of Target Canada’s challenges or frozen the plan’s purchases of Target stock (which the court noted would lead to disclosure). The Eighth Circuit rejected these alleged alternative actions, reasoning that it was “uncertain” whether earlier disclosure would have mitigated the harm and “allegation[s] based on generic economic principles . . . [are] too generic to meet the requisite pleading standard.” Accordingly, the Eighth Circuit held that a reasonably prudent fiduciary could have concluded that early disclosure or a purchase freeze was “more dangerous” than continuing to invest in Target stock. Id. at *3.
The same Eighth Circuit panel reached the same conclusion in Allen v. Wells Fargo & Co., No. 18-2781, 2020 WL 4279751 (8th Cir. July 27, 2020), which arose out of the “unauthorized accounts scandal” at Wells Fargo. According to the plaintiffs, the Wells Fargo ESOP fiduciaries knew as early as 2013 that government regulators were investigating Wells Fargo’s sales practices, knew that public disclosure was inevitable, and should have taken corrective measures to protect plan participants from the stock drop that followed the September 2016 announcement of the regulators’ investigation. Noting again that “general economic principles” do not satisfy the pleading standard, and that a disclosure made before the conclusion of an investigation could “spook the market” and cause an outsized stock drop, the Eighth Circuit held that the plaintiffs failed to plausibly allege an alternative action that meets the Dudenhoeffer standard. Id. at *4.
Similarly, in Perrone v. Johnson & Johnson, No. CV 19-00923 (FLW), 2020 WL 2060324 (D.N.J. Apr. 29, 2020), a federal district court in New Jersey held that the plaintiffs failed to satisfy the Dudenhoeffer standard. The Perrone plaintiffs claimed that the fiduciaries of the Johnson & Johnson ESOP knew for years, and particularly in the lead-up to a December 2018 Reuters article, that the company’s talc powder may contain asbestos. The plaintiffs further alleged that this information inevitably would come to light, and therefore the defendants should have made “corrective public disclosures” prior to publication of the Reuters article, which triggered a 10% drop in the company’s stock price. The district court held that such disclosures were not a viable alternative because the defendants, in their fiduciary capacity, lacked the authority to order them. Id. at 14-17. But even if the fiduciaries could have made such disclosures, the court held that the plaintiffs failed the “more harm than good” test because they did not allege “particularized facts” to support their claim that an earlier disclosure would have lessened the impact on the stock price. Id. at *19. The plaintiffs have since filed an amended complaint, and Johnson & Johnson’s motion to dismiss the amended complaint is currently pending.
Even within the Second Circuit, a district court has distinguished Jander and dismissed an ESOP duty-of-prudence claim. In Varga v. General Electric Co., No. 118CV1449GLSDJS, 2020 WL 1064809, at *3 (N.D.N.Y. Mar. 5, 2020), the plaintiffs alleged that the fiduciaries of GE’s ESOP knew or should have known that GE had under-reserved for the insurance liabilities of its subsidiaries, and that the fiduciaries should have disclosed the issue or closed the plan to additional investments. Distinguishing Jander as involving a “major triggering event” — IBM’s plan to sell the affected business unit — that made the inevitable disclosure theory plausible, the court in Varga held that the plaintiffs had failed to plausibly allege that earlier disclosure was viable under securities laws or would pass the “more harm than good” test. Id. at *4 & n.3.
These four decisions signal that Jander remains an outlier. Other federal courts continue to distinguish — if not outright reject — Jander’s reasoning as applied to other ERISA stock-drop claims. This will be welcome news to ESOP fiduciaries who may fear an uptick in stock drop cases due to the recent market volatility caused by the COVID-19 pandemic. The reasoning of the Target, Wells Fargo, Johnson & Johnson and GE cases confirm that the Dudenhoeffer standard remains a difficult, and oftentimes impossible, bar to clear.