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Benefits

Stock Drop Claims Based on Public Information Fail to Overcome Deference to Market Prices

EBIA  

EBIA  

Kopp v. Klein, 2018 WL 3149151 (5th Cir. 2018); In re SunEdison, Inc. ERISA 401(k) Litigation, 2018 WL 3733946 (S.D.N.Y. 2018)

Two more courts have disallowed claims of imprudence against 401(k) plan fiduciaries that permitted investments in employer stock as those companies headed toward bankruptcy. In Kopp v. Klein, a newly spun-off business established a 401(k) plan with company stock as an investment. When the company experienced serious financial trouble and entered bankruptcy, participants sued claiming, among other things, that the plan’s fiduciaries had breached their duty of prudence by allowing continued investments in company stock despite public information about the company’s financial instability. A Fifth Circuit panel disagreed, however, citing the U.S. Supreme Court’s Dudenhoeffer decision (see our Checkpoint article), which held that fiduciary breach claims based on public information are generally implausible, absent special circumstances, because fiduciaries are entitled to rely upon the price set by the public market as a fair assessment of a stock’s value. The participants argued that Dudenhoeffer was inapplicable because their claim was based on the stock’s “riskiness” rather than the accuracy of the stock’s price. The panel rejected that argument, however, stating that the distinction between risk and price was “illusory.” Market pricing considers risk, so Dudenhoeffer applies equally to claims based on excessive risk. Furthermore, the fiduciaries’ alleged fraud was not the type of special circumstance contemplated in Dudenhoeffer.

In the SunEdison case, the plan sponsor’s aggressive expansion strategy resulted in bankruptcy. As in Kopp, participants sued, claiming that the 401(k) plan’s fiduciaries failed to stop investments in the company’s stock after they knew or should have known that the company was in peril and too risky to be an appropriate retirement investment. The court rejected that claim, however, stating that the Dudenhoeffer analysis applies to all allegations of imprudence based on publicly available information “regardless of whether the allegations are framed in terms of market value or excessive risk.” The participants alleged that eight specified items of public information should be treated as special circumstances allowing their claim to proceed, but the court rejected all eight, noting that the correlation between those negative developments and changes in the company’s stock price suggested that the shares were not riskier than the market’s assessment. Lacking allegations of special circumstances, the participants’ claim was dismissed for failure to satisfy the pleading threshold in Dudenhoeffer.

EBIA Comment: Dudenhoeffer eliminated the presumption of prudence for employer stock investments in part because the presumption made it impossible to state a duty-of-prudence claim, “no matter how meritorious, unless the employer is in very bad economic circumstances.” Ironically, courts are now applying Dudenhoeffer to bar prudence claims in the worst of economic circumstances, creating uncertainty as to what claims can be made if all relevant public information is deemed incorporated into market prices, and risk-based claims can be dismissed as claims of inaccurate pricing (subject to an unclear special circumstances exception). Does this approach to public information cases have a blind spot? Market prices may, in an efficient market, perfectly incorporate all public information, but they do not, by themselves, reveal the amount, type, likelihood, or timing of any relevant risks or gains. Thus, they don’t distinguish between stocks of the same price, or help determine whether a specific stock’s risk of loss and opportunity for gain are suitable for a particular retirement plan. Another court acknowledged some of these limitations in a case involving stock funds liquidated at a substantial loss, expressing the view that market price does not capture all of the factors that must be considered by a prudent fiduciary (see our Checkpoint article). Until the fiduciary duties applicable to publicly traded investments have been more clearly articulated and the special circumstances exception clarified, fiduciaries should not assume that stock traded on a public market requires less attention to factors other than price than it did before Dudenhoeffer. For more information, see EBIA’s 401(k) Plans manual at Sections XXIV.G.1 (“Prudence in Selecting and Monitoring Investments”) and XXV.H.6 (“Potential Fiduciary Liability for Investments in Employer Stock”).

Contributing Editors: EBIA Staff.

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