Dudenhoeffer Strikes Again (and Again): Eighth Circuit Dismisses Two Stock Drop Cases Based on Nonpublic Information

The Eighth Circuit has affirmed the dismissal of two cases in which participants claimed that their plan’s fiduciaries breached their duties of prudence and loyalty by failing to act on nonpublic information about events that later caused a substantial drop in the value of their employer’s stock. In each case, the participants argued that they met the pleading standard established in the Supreme Court’s Dudenhoeffer decision (see our Checkpoint article). Under Dudenhoeffer, if a claim for breach of the duty of prudence is based on a fiduciary’s knowledge of nonpublic information, the complaint must plausibly allege an alternative action the fiduciary could have taken that would have been consistent with the securities laws and that a prudent fiduciary could not have concluded would be more likely to do more harm than good. In both cases, the Eighth Circuit concluded that the participants’ proposed alternatives—which required public disclosure of the nonpublic information—did not meet the Dudenhoeffer standard for imprudence claims. They also rejected the disloyalty claims because they involved essentially the same actions and would, if allowed, “circumvent” the Dudenhoeffer pleading standard.

• Duty of Prudence. In Allen, the participants argued that a government investigation made disclosure of the employer’s misconduct inevitable, and that what the court characterized as “general economic principles” dictated that the longer the fraud was concealed, the greater the harm. But like other courts (see our Checkpoint article), this court decided the argument was “too generic” to meet the pleading standard. A prudent fiduciary could readily conclude that disclosure of a government investigation before its completion would do more harm than good. In Dormani, the participants argued that no prudent fiduciary could conclude that disclosure of problems with the employer’s business expansion would result in greater harm because the efficient public market would quickly correct any overreaction. But the court disagreed, stating that this reasoning was “uncertain,” and a reasonably prudent fiduciary might still believe disclosure was more dangerous.
• Duty of Loyalty. The Allen court acknowledged that Dudenhoeffer’s pleading standard is limited to imprudence claims but cited other circuit court decisions holding that the duty of loyalty does not require disclosure of nonpublic information about the employer (as opposed to the plan). Both courts noted that imposing such a duty would circumvent the demanding Dudenhoeffer standard. Both also concluded that the tension inherent in the fiduciaries’ dual roles as corporate insiders and fiduciaries was not enough to claim disloyalty. And the Allen court noted that, because corporate officers and directors sell their stock periodically, the fiduciaries did not breach their duty of loyalty merely because they sold their own stock at potentially inflated prices.

EBIA Comment: The barrier to breach of fiduciary duty claims created by Dudenhoeffer has left potential stock drop claimants scrambling to frame their claims in ways that will avoid dismissal. These Eighth Circuit cases affirm what most others have suggested: The task won’t be easy. With only one exception (see our Checkpoint article), the appellate courts have been unwilling to second-guess a fiduciary’s fear that acting on nonpublic information will do more harm than good. And recasting imprudence claims as disloyalty claims apparently won’t avoid that judicial reluctance. While it may seem inappropriate for fiduciaries to withhold bad news, for now at least the courts seem inclined to defer to fiduciaries’ judgment. For more information, see EBIA’s 401(k) Plans manual at Sections XXIV.F.3.b (“No Harmful Silence”) and XXV.H.6 (“Potential Fiduciary Liability for Investments in Employer Stock”).

Contributing Editors: EBIA Staff.