When the Supreme Court’s decision first came down in Fifth Third v. Dudenhoeffer, many thought participants would have an easier time winning damages for “stock-drop” claims filed against Employee Stock Ownership Plans (ESOPs).
The idea is that employers, post-Dudenhoeffer, can no longer rely on a blanket presumption of prudence that previously said it was always the right move to continue to offer employer stock within an ESOP—rather than say, freeze or entirely drop the company stock as a potential investment for employees when the attractiveness of the investment waned. It was believed, as a result, that plaintiffs could more easily challenge the decisions of ESOP fiduciaries to continue offering employer stock that had lost value or was likely to lose further value in the future, for example. This would especially be the case when ESOP fiduciaries decided to continue offering the stock while also being in possession of insider knowledge that could eventually be disclosed and harm the market valuation of the company.
While the argument has some logic to it, this hasn’t exactly played out, due the difficult nature of successfully pleading an alternative course of action that defendants should have known to take were they acting as prudent fiduciaries under the Employee Retirement Income Security Act (ERISA).
Take the latest ESOP-focused decision out of the U.S. Court of Appeals for the D.C. Circuit, Coburn v. Evercore. The appellate decision affirms a lower court’s ruling that determined the plaintiffs “failed to plead a plausible alternative course of action their ESOP trustees could have taken rather than continuing offering company stock that would not have ended up hurting more than helping.”
Plaintiffs in the case include former J.C. Penney employees and investors in a J.C. Penney employee stock ownership plan now managed by Evercore. The lead plaintiff claimed that Evercore breached its fiduciary duties of prudence and loyalty when it failed to take preventative action as the value of J.C. Penney common stock tumbled between 2012 and 2013, thereby causing significant losses.
As the appellate decision explains, despite clear factual similarities, plaintiffs argued that the tough pleading requirements in place even after Fifth Third v. Dudenhoeffer should not apply in this circumstance because the “challenge is centered on Evercore’s failure to appreciate the riskiness of J.C. Penney stock rather than Evercore’s valuation of its price.”
In short, the appellate court rejected the argument, because to appreciate the riskiness of a stock intimately involves its market valuation, and to argue that the ESOP fiduciaries should have been able to outguess the market’s valuation is inherently unfair absent special circumstance, such as fraud: “We disagree and therefore affirm the district court’s judgment.” Previously in the case, the district court also specifically rejected the argument that the plan’s fiduciaries should have known from publicly available information alone that the stock’s price was over or underpriced such that it was imprudently risky to hold.
NEXT: Details from the text of the complaint
While their arguments did not garner sympathy from the district or appellate courts, it cannot be denied that the plaintiffs have had a difficult ride up to this point in the ESOP.
Background covered in case documents shows that in 2011, J.C. Penney attempted to re-conceptualize its brand and hired former Apple, Inc. executive Ron Johnson as its chief executive officer. Distancing himself from J.C. Penney’s historic reliance on sales, coupons and rebates to boost sales, Johnson implemented a more straightforward pricing scheme, reasoning that a “fair and square” pricing policy would attract shoppers.
“Johnson also reworked both the Company logo and the traditional layout of its stores in an effort to modernize,” according to the appellate court decision. “Taken as a whole, Johnson sought to bring J.C. Penney up to speed with the fads and fashions of 2012, simplifying the business model in order to lower expenses and increase gross profit margins. This strategy proved to be less than successful. J.C. Penney’s 2012 first quarter earnings report showed a $163 million loss, or a $0.75 loss per share. Johnson’s poor start was only the beginning, as the next twenty-one months—from the end of 2012’s first quarter to the end of 2013’s fourth quarter—saw J.C. Penney’s stock price fall from $36.72 to $5.92 per share.”
According to court documents, throughout the entire period that the value of J.C. Penney common stock dipped ever lower, Evercore stood resolute. Despite its authority to eliminate the J.C. Penney Stock Fund as an investment option in the plan and its ability to sell shares currently in the fund, Evercore exercised neither option.
“The shares in the J.C. Penney Stock Fund that [the plaintiff] and other investors owned took the full force of the hit. In 2015, [the lead plaintiff] sued on behalf of herself and all others similarly situated, alleging that Evercore was liable for $300 million in losses to the plan for having breached its fiduciary duty under ERISA §§ 409, 502(a)(2)-(3), 29 U.S.C. §§ 1109(a), 1132(a)(2)-(3).”
On February 17, 2016, the district court granted Evercore’s motion to dismiss the complaint for failure to state a claim. Primarily relying on the United States Supreme Court’s opinion in Dudenhoeffer, the district court held that plaintiffs’ allegations that Evercore should have recognized from publicly available information alone that continued investment in J.C. Penney common stock was “imprudent” were generally implausible absent “special circumstances” affecting the market.
“Because [plaintiff] failed to plead special circumstances—indeed, [she] expressly disclaimed any need to plead them—the district court held that [her] complaint could not survive Evercore’s Rule 12(b)(6) challenge,” the appellate court explains. “The district court also rejected the alternative argument that, pursuant to Tibble v. Edison International, Evercore violated its fiduciary “duty to monitor” investments and remove imprudent ones. The court reasoned that Tibble did not affect the Dudenhoeffer holding and thus could not save the complaint.”
NEXT: Appellate review warrants same result
Consider its own set of precedents and reviewing the case de novo, the appellate court observes that the Supreme Court has clearly held that “where a stock is publicly traded, allegations that a fiduciary should have recognized from publicly available information alone that the market was over- or under-valuing the stock are implausible as a general rule, at least in the absence of special circumstances.”
This is the heart of the Dudenhoeffer opinion—the recognition that “investors have little hope of outperforming the market in the long run based solely on their analysis of publicly available information, and accordingly they rely on the security’s market price as an unbiased assessment of the security’s value in light of all public information.”
As the appellate court further observes, “Where efficient markets exist, traders cannot profit by using existing information available in the market, since this news should already be reflected in securities prices … Echoing this theory, Dudenhoeffer agreed that a fiduciary’s failure to outsmart a presumptively efficient market is not a sound basis for imposing liability.”
Thus, because a stock price on an efficient market reflects all publicly available information, Dudenhoeffer requires additional allegations of “special circumstances” when a plaintiff brings a breach of the duty of prudence claim against a fiduciary based on that information. Special circumstances, the Supreme Court instructed, includes evidence questioning “the reliability of the market price as an unbiased assessment of the security’s value in light of all public information … that would make reliance on the market’s valuation imprudent.”
Such evidence may demonstrate that illicit forces (such as fraud, improper accounting, illegal conduct, etc.) were influencing the market, or it may otherwise suggest that the market was not efficient and therefore the market price of a security in that market was not necessarily indicative of its underlying, fundamental value.
According to the appellate decision, ultimately, “Dudenhoeffer suggested that the special circumstances might include something like available public information tending to suggest that the public market price did not reflect the true value of the shares … Applying Dudenhoeffer here, we believe the claim falls far short. Despite the Supreme Court’s instruction that claims of imprudence based on publicly available information must be accompanied by allegations of special circumstances, the plaintiff acknowledges that she did not allege the market on which J.C. Penney stock traded was inefficient.”
The full text of the appellate court’s opinion is available here