Differences between ERISA and the federal securities laws dominated a Supreme Court oral argument that often drifted from the specific question presented about inevitable disclosures and an ESOP fiduciary’s conclusion about doing more harm than good under the current pleading standard.
The Supreme Court heard oral argument in a case that once again asks the justices to weigh the potentially conflicted interests of corporate ERISA plan fiduciaries and the duties they owe to company employees. IBM employees claimed that IBM’s employee stock ownership plan (ESOP) fiduciary violated ERISA’s duty of prudence because the ESOP fiduciary should have disclosed inside information about an IBM unit’s valuation earlier than the company did and that the delayed disclosure hurt employee investors. More specifically, the case asks whether the Second Circuit’s understanding of securities fraud pleading requirements regarding an ERISA fiduciary’s duty of prudence is consistent with the Supreme Court’s Fifth Third opinion from a few years ago, which established a complex set of pleading-stage hurdles for plaintiffs in cases at the intersection of ERISA and securities law (Retirement Plans Committee of IBM v. Jander, November 6. 2019).
IBM, government push beyond question granted. Both IBM and the government (amicus without supporting either side) sought to push the discussion beyond the specific question on which the justices granted certiorari and instead talk about corporate officer status and the goals of the federal securities laws. (After several justices asked why the briefing in the case seemed so expansive, the government eventually would, in reply to a question from Justice Ginsburg, concede that the Solicitor General’s office took a fresh look at the case and felt the government’s brief could aid the Court’s understanding of how securities laws may provide at least part of the answer).
Former Solicitor General Paul Clement, arguing for IBM, said plaintiff Larry Jander’s theory was that the IBM ESOP fiduciary should have made a market-wide disclosure because it was inevitable that news of problems with an IBM business unit would become public and that the harm from concealment of such information becomes greater over time. But Clement said this theory is flawed because there is no duty under Pegram (see below regarding Clement’s rebuttal) to make any disclosure and, in any event, federal securities laws would apply to any public company disclosure. Clement also said Jander’s theory was too general and could be made in almost any case.
Justice Sotomayor asked if it matters where an ESOP fiduciary gets inside information. Clement replied that the Court should view the roles of ESOP fiduciary and corporate officer as distinct, even though the same people may perform both roles. Clement would later clarify that the disclosure aspect of the case makes it a securities case regarding the actions of corporate officers, not a case about the ESOP fiduciary. As a result, Jander’s complaint should have alleged securities violations such that the ESOP fiduciary would have the advantage of the procedural protections of the Private Securities Litigation Reform Act (PSLRA).
In a follow-up question, Justice Sotomayor asked what was deficient about Jander’s complaint. Clement said what was different was how after five years of Fifth Third, the cases had "migrated" from ones focused on fiduciary actions to ones seeking disclosures via regular corporate channels to avoid market surprises.
According to a line of questions from Justice Gorsuch, the briefs were devoid of information about why Congress drafted ERISA duties in a manner that allows corporate officers also to be ESOP fiduciaries. Clement initially replied that an outsider would be in no better position because they would be unable to get inside information about a company. Then Justice Gorsuch pressed Clement on why there were special rules for insider trustees. Clement said one reason is reduced costs for employees (the transcript indicates that Clement described Justice Gorsuch as "shaking" his head; Justice Gorsuch responded "I'm not shaking my head. I'm just like ‘ehh,’ you know, maybe, okay."). Clement then added that special rules also incentivize companies to have pension plans in the first place.
Does the government want Fifth Third overturned? Jonathan Ellis, arguing for the government as amicus, conceded that Fifth Third held that an ESOP fiduciary can sometimes have an ERISA duty to act based on inside information. However, he said this case was focused on the possibility that an ESOP fiduciary would need to make a market-wide disclosure, something he said ERISA generally should not require.
Justice Sotomayor asked why ERISA should not require these disclosures, to which Ellis responded that such disclosures would undermine the federal securities laws. Moreover, also addressing his reply to Justice Breyer, Ellis said such disclosure could do more harm than good.
Justice Alito then asked if an insider fiduciary should be the one to decide if disclosure will do more harm than good. Ellis said ERISA law is "workable if a prudent fiduciary does not ‘close its eyes’" to the bodies of law designed to balance such interests. But Ellis said existing law is not workable to the extent it requires an ad hoc disclosure regime; he also noted that a prudent fiduciary could conclude that disclosure is neither good for the fund nor required by the securities laws.
Justice Breyer, who wrote for a unanimous Court in Fifth Third, asked if the Court was to decide only the question on which certiorari was granted, why should Jander not win. Ellis reiterated that securities laws cannot be ignored.
Perhaps getting to the essence of the government’s argument, Justice Kagan asked directly if the government was asking the Court to "scrap" Fifth Third. Ellis replied that the government’s position was consistent with Fifth Third. Ellis later explained that the first two Fifth Third factors (dealing with securities law compliance and insider trading and corporate disclosure requirements) "do a lot of the work" in the case, but that even the third factor suggests that a prudent fiduciary could conclude that making a disclosure not required by the securities laws would do more harm than good.
Shareholder interests; ERISA v.s. securities law. Justice Breyer began the questioning of Jander’s lawyer, Samuel Bonderoff, by asking if the complaint should have been more specific than merely paraphrasing text from Fifth Third. Specifically, Breyer inquired if the complaint should have said something about shareholder interests. Bonderoff said the paragraph cited by Justice Breyer was just one of several places where the complaint discussed shareholder interests and added that the general theory of disclosing earlier rather than later was not truly they crux of the case because there will be times when later disclosure could be better.
Justice Kavanaugh asked why the court should not consider decisions by the Fifth and Sixth Circuits (i.e., the supposed circuit split with the Second Circuit) regarding whether action by the fiduciary would hurt some classes of beneficiaries and help others. Bonderoff said the cases outside the Second Circuit had different facts (he later emphasized to several other justices how unique the facts were in Jander’s case); Bonderoff also said a fiduciary may not know if an ESOP is net buyers or net sellers. Justice Gorsuch asked how a fiduciary could not know that. According to Bonderoff, it depends on plan structure. Justice Kavanaugh reiterated that lack of such knowledge hurts Jander’s case. Then Justice Kagan asked what a reasonable fiduciary should do if they don’t know. Bonderoff conceded that disclosure would result in a stock drop while also explaining that most ESOP participants are holders, not buyers or sellers. So, the fiduciary looks out for the holders, asked Justice Kagan. Bonderoff agreed that the long-term view of a fund would tend to focus on holders.
Justice Gorsuch moved the discussion back to the differences between ERISA and securities laws, but Justice Kagan would later ask Bonderoff to state the precise ways in which these bodies of law diverge. Over the course of several replies to questions, Bonderoff would note that securities laws require allegations about motive or intent, while ERISA does not; he also noted that securities fraud cases are subject to the PSLRA’s heightened pleading requirements, while ERISA cases are not. Justice Kagan observed that Clement was likely argue in rebuttal that Bonderoff had not suggested a difference in the preventative aspects of securities laws and ERISA and that he had merely tried to "water down the securities standard."
Justice Breyer wanted to know what the Court should say if it emphasizes the question for which certiorari was granted. Bonderoff said the case would have to go back to the Second Circuit with instructions about what the pleadings must say about the failure to make a disclosure.
"Securities law, full stop." On rebuttal, Clement denied that IBM was "running away" from the question IBM itself had asked the court to address: "Whether Dudenhoeffer’s [i.e., Fifth Third] ‘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." The basis for asserting the Supreme Court’s Pegram opinion, Clement said, was to show that that opinion’s language (i.e., "that the fiduciary with two hats wear only one at a time") underscored IBM’s view that an ESOP fiduciary has no duty to use insider information or to seek corporate disclosures.
Clement then said IBM disagrees with two other points, one each made by Jander and the government. First, Clement said IBM disputes that ERISA allows corporate officers to be fiduciaries because they can, like the proverbial canary in the coal mine, detect corporate information upon which they could take early action. He added that this is wrong because if fiduciaries use inside information, they could be engaging in latent securities law violations. Second, Clement said IBM disagrees with the government’s proposed "hybrid" action based on both securities law and ERISA because, among other things, it would require courts to figure out if elements like scienter apply. "We said the solution is the securities law, full stop," explained Clement.
Evolution of inevitable disclosure theory. By way of background, Larry Jander and his fellow employees who invested in the IBM Company Stock Fund (an ESOP) alleged that IBM’s committee overseeing the fund knew that IBM’s valuation of its microelectronics unit was inflated ($2 billion) and that employees who invested in the fund were harmed by losses incurred when IBM divested the microelectronics unit by paying another company $1.5 billion to acquire the unit from IBM. Meanwhile, IBM took a $4.7 billion pre-tax charge related to the unit’s impaired value and the price of IBM stock fell $12 following the announced divestiture.
The Supreme Court’s recent history in such cases following its opinion in Fifth Third has been to eliminate the old presumption of prudence accorded to ERISA fiduciaries and replace that presumption with an elaborate set of pleading requirements that acknowledge the potential for corporate ERISA fiduciaries to possess information which, if acted upon, could expose them to charges of insider trading.
Said the justices in Fifth Third: "To state a claim for breach of the duty of prudence on the basis of inside information, a plaintiff 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." Fifth Third posited three considerations for courts in these cases: (1) did the fiduciary take an action that would violate securities laws; (2) whether the fiduciary’s stopping purchases or publicly disclosing insider information would conflict with insider trading or corporate disclosure laws; and (3) whether the fiduciary’s acting on a plausible alternative would result in more harm than good to the fund.
The district court dismissed Jander’s case because, even after amending the complaint to assert that the fund could have hedged against an IBM stock decline, Jander failed to plead any alternative the fund could have taken to avoid losses to employee investors. The Second Circuit, however, reversed and noted that inconsistencies within Fifth Third suggested two possible tests: (1) what an "average prudent fiduciary" would think about a fund’s alternatives (looser test); and (2) what a prudent fiduciary "could not have concluded" (emphasis in original) regarding harm to the fund, which the Second Circuit understood to potentially mean what "any prudent fiduciary" would think under the circumstances (stricter test). The Second Circuit avoided picking a test and instead concluded that Jander’s complaint was sufficient even if the stricter test applied.
In the Supreme Court, petitioner IBM argued that the strict test implied by Fifth Third plus an intervening Supreme Court per curiam opinion in Amgen v. Harris, favor a strict test regarding the no more harm than good standard. "The complaint’s contrary allegations depend on generic allegations that no fraud lasts forever and disclosure sooner-rather-than-later is always prudent," IBM said in its merits brief. The underlying theory, IBM said, was that the Second Circuit misconstrued Fifth Third by allowing a complaint to proceed on the ground that earlier disclosure of inside information would be better even if public disclosure is inevitable.
By contrast, Jander had argued in the Second Circuit that, at least at the motion to dismiss stage, it would be inconsistent with Fifth Third to apply a too-strict test of the employees’ complaint. Jander explained in his Supreme Court merits response that crediting IBM’s argument based on corporate officer status could result in near immunity from suit for some ERISA fiduciaries and would not put ESOPS out of business: "Not only is this argument procedurally improper, it is without basis in ERISA or this Court’s jurisprudence. Dudenhoeffer’s [i.e., Fifth Third] articulation of the ‘more harm than good’ standard was premised on the idea that an ESOP fiduciary could be liable for failing to act on inside information" (emphasis in original).
Lastly, neither Jander nor IBM was entirely persuaded by the government’s view. Jander disputed the government’s suggested middle ground moderated by federal securities law disclosure requirements as putting standards for ERISA fiduciaries generally at odds with those of ESOP fiduciaries when the court in Fifth Third had intended to treat all ERISA fiduciaries alike. The government, arguing as amicus curiae and for neither party, said that an ESOP fiduciary need disclose inside information only when required by the federal securities laws. IBM agreed in its merits reply with the government’s conclusion that the Second Circuit was wrong but, like Jander, disagreed with the government’s securities disclosure theory, albeit on a somewhat different ground, because the government’s view could put ESOP fiduciaries at risk of liability without the procedural protections applicable to securities fraud cases under the PSLRA.
The case is No. 18-1165.
Attorneys: Paul D. Clement (Kirkland & Ellis LLP) for Retirement Plans Committee of IBM. Samuel Ethan Bonderoff (Zamansky, LLC) for Larry W. Jander. Jonathan Y. Ellis, Assistant to the Solicitor General, Department of Justice, for the U.S. government as amicus curiae supporting neither party.
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