Pension & Benefits News ESOP fiduciaries’ failure to disclose company’s financial condition and divest plan of stock did not state claim for fiduciary breach
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Wednesday, August 28, 2019

ESOP fiduciaries’ failure to disclose company’s financial condition and divest plan of stock did not state claim for fiduciary breach

By Pension and Benefits Editorial Staff

ESOP participants failed to allege special circumstances that would have rendered the plan fiduciaries’ retention of a failing employer stock imprudent, according to the U.S. Court of Appeals in New York (CA-2). Distinguishing the case from Jander v Retirement Plans Committee of IBM, the Second Circuit panel rejected the claim that the fiduciaries should have responded to non-public information of the company’s financial troubles by making proper disclosures and halting purchases or divesting the plan of the stock.

Continued plan investment in stock of company on verge of bankruptcy. SunEdison maintained a defined-contribution plan that allowed company employees to invest in an ESOP primarily comprised of publicly traded SunEdison stock. Plan participants alleged that SunEdison executives breached their duties under the ERISA by allowing for continued investment in the company stock even though the executives knew or should have known that SunEdison was close to bankruptcy. Specifically, the participants charged that the fiduciaries breached the duty of prudence by continuing to offer SunEdison shares as an investment option despite their access to public and non-public information regarding SunEdison’s dire financial condition. According to the participants, the fiduciaries should have responded to non-public information of SunEdison’s financial troubles by making proper disclosures and halting purchases or divesting the plan of SunEdison stock.

A federal trial court dismissed the complaint, reasoning that the participants had failed to plead any special circumstances affecting the reliability of the market price as a reflection of the value of SunEdison shares. The court applied the governing standard expressed by the Supreme Court in Fifth Third Bancorp v. Dudenhoeffer (577 U.S. 409 (2014), pursuant to which, allegations that a fiduciary should have recognized that a publicly traded stock was overvalued or risky from publicly available information alone are generally implausible, absent special circumstances.

Jander distinguished. In arguing that the fiduciaries should have responded to non-public information of SunEdison’s financial troubles by making proper disclosures and halting purchases or divesting the plan of SunEdison stock, the participants relied on a 2018 case from the Second Circuit, Jander v Retirement Plans Committee of IBM. (910 F. 3d 620). In Jander, the Second Circuit held that a prudent fiduciary could have concluded that disclosing the overvaluation of IBM’s microelectronics business would not have done more harm than good because it was inevitable that the overvaluation would be disclosed (as the business was about to be sold) and studies showed early disclosure of fraud would soften the reputational damage. Thus, ESOP participants plausibly pled that plan fiduciaries breached their duty of prudence under ERISA by failing to disclose the financial condition of a company subdivision, thereby, allowing for the overvaluation of the company stock prior to a decline in value. No prudent fiduciary in the position of the plan officials, the court stressed, could have concluded that early corrective disclosure would do more harm than good.

In distinguishing Jander, the court noted that the SunEdison employees failed to allege that an earlier disclosure of SunEdison’s financial problems might have caused less damage than a later disclosure. Nor had they alleged that disclosure of SunEdison’s problems alone, without also halting purchases of SunEdison stock or divesting SunEdison stock altogether, would have sufficed. Accordingly, the case was different from Jander and much more closely tracked Rinehart v. Lehman Bros. Holding Inc., (817 F. 3d 56 (2016)), in which in which the Second Circuit determined that a prudent fiduciary could have concluded that divesting or discontinuing the purchase of company stock would have done more harm than good.

Note: The Supreme Court recently agreed to review Jander in order to resolve a split in the federal circuit courts of appeal regarding the proper application of the Dudenhoeffer pleading requirements. The issue before the Court, as framed by the Jander petitioners, is whether Dudenhoeffer’s“more harm than good” pleading standard can be satisfied by generalized allegations that the harm of an inevitable disclosure of an alleged fraud generally increases over time.

SOURCE: O’Day v. Chatila (CA-2).

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