Tuesday, March 12, 2019

SCOTUS asked to revisit ESOP duty under Fifth Third

By Anne Sherry, J.D.

In Fifth Third Bancorp v. Dudenhoeffer (U.S. 2014), the Supreme Court established pleading requirements for an investor to state a claim for breach of the duty of prudence against a fiduciary of an employee stock ownership plan. IBM ESOP defendants have petitioned the Court for a writ of certiorari to examine, in light of a circuit split, whether a plaintiff can satisfy this pleading standard by alleging generally that the harm from a fraud increases the longer it goes on (Retirement Plans Committee of IBM v. Jander, March 4, 2019).

Comparing early disclosure to later disclosure. Under a restrictive reading of Fifth Third, a plaintiff must plausibly allege an alternative action that a prudent fiduciary in the same circumstances could not have viewed as more likely to harm than to help the fund. The Second Circuit determined that the plaintiffs met this threshold. The ESOP defendants allegedly knew that IBM stock was artificially inflated due to an undisclosed fraud and were empowered to disclose the truth. The plaintiffs also alleged that the failure to make prompt disclosure hurt the long-term prospects of IBM as an investment because reputational damage increases the longer a fraud occurs. The complaint also alleged that IBM stock traded in an efficient market, so that a prudent fiduciary need not fear an overcorrection—the market would devalue the stock only by the amount its price was artificially inflated.

The court gave particular weight to the allegation that the defendants knew that disclosure was inevitable because IBM was likely to sell its business. In this scenario, the fiduciary is not comparing disclosure to the status quo of nondisclosure, but comparing “the benefits and costs of earlier disclosure to those of later disclosure—non-disclosure is no longer a realistic point of comparison.”

Petition. The ESOP petitioners argue that the Second Circuit’s reliance on “generalized allegations” subverts Fifth Third and creates a circuit split that, considering New York’s significance to the financial markets and ERISA’s liberal venue provision, will make the Second Circuit the forum of choice for duty-of-prudence claims.

The ESOP petitioners note that the decision directly conflicts with decisions of the Fifth and Sixth Circuits. In a case involving a Whole Foods retirement plan, the Fifth Circuit rejected allegations derived from “general economic principles” that longer frauds mean harsher corrections. The Sixth Circuit also rejected the argument in a case involving Eaton Corporation’s plan. All three cases—IBM, Whole Foods, and Eaton—were filed by the same counsel and advanced very similar arguments, the petitioners observe, noting that the Fifth Circuit opinion remarked on the ease with which the generic allegation could be made in multiple cases. The fact that the courts ruled differently on essentially the same arguments reveals the starkness of the circuit split, according to the petition.

As to the generic nature of the allegation that disclosure is inevitable, this allegation is always available and the respondents concede as much in their complaint, the petitioners argue, with such statements as “no corporate fraud lasts forever; there is always a day of reckoning” and “the federal securities laws, if nothing else, would eventually have forced IBM to come clean.” By placing so much weight on allegations that are present in any Fifth Third claim, the Second Circuit upended the pleading requirement of that decision, which was carefully struck to “weed out meritless lawsuits.”

The circuit court dismissed this concern, reasoning that the fact that similar allegations can be made in other ERISA cases did not make them less plausible in the instant case. Referencing the Court’s statement in Fifth Third that it is important to “divide the plausible sheep from the meritless goats,” the petitioners argue that under the Second Circuit’s approach “every goat becomes a sheep” as long as the allegations of worsening fraud and inevitable disclosure are included.

Finally, the petitioners maintain that the Second Circuit’s decision will permit an end-run around the federal securities laws, allowing plaintiffs who cannot meet the pleading requirements of a fraud claim under the PSLRA to package the same allegations as Fifth Third claims. They observe that separate IBM plaintiffs brought a companion case under the federal securities laws resting on the same allegations underlying the ERISA claim.

The case is No. 18-1165.