5th Circuit Sides with Whole Foods in Stock Drop Litigation

The case ascended on appeal from the U.S. District Court for the Western District of Texas, where it also flatly failed to meet the high hurdles for proving standing established in Fifth-Third Bank vs. Dudenhoeffer.

The 5th U.S. Circuit Court of Appeals has firmly sided with Whole Foods by rejecting a stock drop lawsuit filed by participants in the company’s defined contribution (DC) retirement plan.

The case ascended on appeal from the U.S. District Court for the Western District of Texas, where it also flatly failed to meet the high hurdles for proving standing established in the influential 2014 Supreme Court decision, Fifth-Third Bank vs. Dudenhoeffer.

Siding with the district court’s interpretation of SCOTUS precedent, the appeals court ruled that the plaintiff failed to plausibly allege an alternative action that the fiduciaries could have taken that would have been consistent with 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.

The underlying case was filed by Thomas Martone, a former Whole Foods employee. He brought the proposed class action against certain Whole Foods executives who are named fiduciaries for the company’s 401(k) plan. In the mold of a classic stock drop suit, Martone alleged that these executives breached their fiduciary duties by allowing employees to continue to invest in Whole Foods stock “while its value was artificially inflated due to a widespread overpricing scheme.”

The district court dismissed the claims based on the rubric set out by Fifth-Third Bank vs Dudenhoeffer. While that high court case ultimately determined that plan sponsors offering employer stock are not entitled to a “presumption of prudence” in the offering of such stock, SCOTUS also quite clearly determined that allegations that a fiduciary should have recognized from publicly available information alone that the market was over- or under-valuing stock “are implausible as a general rule, at least in the absence of special circumstances.” In addition, for claims alleging a fiduciary breach based on non-public information, the Supreme Court held that plaintiffs must “plausibly allege an alternative action fiduciaries could have taken and would not have viewed as more harmful to the plan than helpful.”

As in other recent stock drop litigation decisions, the plaintiff here ultimately failed to jump this hurdle, first in district court and now on appeal. However, the text of the appellate decision includes some important points where defendants’ arguments also failed. For example, the appellate court states that “defendants’ arguments over-read Dura Pharmaceuticals v. Broudo, where the Supreme Court held that a ‘private plaintiff who claims securities fraud must prove that the defendant’s fraud caused an economic loss.’”

“Contrary to defendants’ suggestion, the Supreme Court did not establish a further requirement that the purchaser sell the stock to prove loss causation,” the appellate court points out.

Still, despite this concession going against the defense, the appellate court rejected all the alternative actions that the plaintiff suggested the fiduciary defendants should have taken. These included that, first, the defendants could have temporarily closed or frozen the company stock fund until Whole Foods stock again became a prudent investment. Second, plaintiff claimed that defendants could have “effectuated corrective, public disclosures to cure the underlying fraud,” thereby making Whole Foods stock an accurately priced, prudent investment again. Third, he suggested that defendants could have “diverted some of the company stock fund’s holdings into a low-cost hedging product that would behave in a counter-cyclical fashion vis-à-vis Whole Foods stock.”

The last point in particular is referred to as somewhat novel by the appellate court, but it still falls short, on the following grounds: “Because the amended complaint offers no explanation for why the hedging product would not need to be disclosed [thereby alerting the marketplace of the fraud], Martone has at best alleged the existence of a hedging product which may or may not need disclosure. A prudent fiduciary could conclude that such a product would at least risk a disclosure, thus rendering it more likely to harm the fund than to help it. Accordingly, the hedging product—as alleged—is not a plausible alternative action sufficient to overcome the requirements of Dudenhoeffer and Whitley.”