Fiduciaries of retirement plans received a nasty pre-Halloween surprise last week when the Court of Appeals for the Ninth Circuit, in Harris v. Amgen, Inc., No. 10-56014, 2014 U.S. App. LEXIS 20816 (9th Cir. October 30, 2014) (Harris II), reaffirmed its earlier decision refusing to dismiss ERISA “stock-drop” claims of breach of fiduciary duty.
Harris II is the first court of appeals ruling on an ERISA stock-drop motion to dismiss since the Supreme Court’s ruling in Dudenhoeffer v. Fifth Third Bancorp, 134 S.Ct. 2459 (2014). We discussed Dudenhoeffer in an article earlier this year. In Dudenhoeffer, the Supreme Court vacated the Sixth Circuit’s decision for the plaintiffs and directed the court of appeals to reconsider whether their suit stated plausible claims for breach of ERISA fiduciary duty based on allegations that 401(k) plan fiduciaries imprudently remained invested in company stock as the stock dropped in value following news of safety concerns over one of its best-selling drugs.
The Harris Stock-Drop Decisions
In an earlier opinion, Harris v. Amgen, Inc., 738 F.3d 1026 (9th Cir. 2013) (Harris I), the Ninth Circuit reversed the district court’s dismissal of the complaint, holding that (1) no “presumption of prudence” applied to the fiduciaries’ decision to continue to offer Amgen stock as an investment option for participants in two 401(k) plans at an allegedly “inflated” price and (2) plaintiffs had sufficiently alleged violation of the fiduciaries’ ERISA duties. Specifically, the Ninth Circuit reasoned:
- Any negative price impact from removing a company stock fund would be mitigated by several factors such that the fiduciary action would be extremely unlikely to negatively impact the stock price.
- “If defendants had revealed material information in a timely fashion to the general public (including plan participants), thereby allowing informed plan participants to decide whether to invest in the Amgen Common Stock Fund, they would have simultaneously satisfied their duties under both the securities laws and ERISA.”
The defendants in Harris I petitioned for a writ of certiorari. After deciding Dudenhoeffer, the Supreme Court granted certiorari in Harris I, vacated the Ninth Circuit’s decision and remanded for reconsideration in light of Dudenhoeffer. Amgen, Inc. v. Harris, 134 S. Ct. 2870 (2014).
On remand, the Ninth Circuit in Harris II again reversed the district court’s dismissal of the plaintiffs’ complaint and remanded to the district court, holding as follows:
- The plaintiffs stated a claim that the defendants acted imprudently by continuing to maintain Amgen common stock as an investment option when they allegedly knew or should have known that the stock was trading at an artificially inflated price.
- The plaintiffs sufficiently alleged that the fiduciaries violated their duty of loyalty and care by failing to provide material information to plan participants about investment of the Amgen Common Stock Fund.
- The fiduciaries’ preparation and distribution of a summary plan description (SPD) that incorporated Amgen’s Securities and Exchange Commission filings by reference were actions taken in their fiduciary capacity and thus statements made in those filings can be used to show (1) that the plans’ ERISA fiduciaries knew or should have known the stock price was artificially inflated and (2) plan participants detrimentally relied on those statements.
The Supreme Court’s Dudenhoeffer Decision
In Dudenhoeffer, the Supreme Court rejected the “presumption of prudence” for employee stock ownership plan (ESOP) fiduciaries that several courts of appeals had used to dismiss ERISA stock-drop claims on motions to dismiss. The Supreme Court held that ESOP fiduciaries have the same duty of prudence applicable to all ERISA fiduciaries, except that, as provided in Section 404(a)(2) of ERISA, ESOP fiduciaries have no duty to diversify plan investments.
Despite its rejection of the presumption of prudence, the Supreme Court’s unanimous decision emphasizes the importance of discouraging “meritless lawsuits” under ERISA and recognizes that such claims are subject to dismissal at the pleading stage in the absence of plausible factual allegations of breach of fiduciary duty. Rather than use a “presumption of prudence” to weed out meritless lawsuits as had a number of the federal circuit courts before Dudenhoeffer was decided, the Supreme Court decided “[t]hat important task can be better accomplished through careful, context-sensitive scrutiny of a complaint’s allegations.”
The Supreme Court stated that the following principles should be applied by the lower courts to determine whether fiduciaries have breached their ERISA duties as to company stock:
- ERISA’s duty of prudence never requires a fiduciary to break the law; therefore, a fiduciary cannot act imprudently by failing to buy or sell stock in violation of federal securities laws regarding insider trading.
- Where a complaint alleges that the fiduciary breached ERISA duties by making additional stock purchases or failing to publicly disclose negative inside information, courts should consider whether imposing ERISA-based fiduciary duties could conflict with existing insider trading and corporate disclosure requirements under federal securities laws.
- Courts should consider whether the complaint has plausibly alleged that a prudent fiduciary could not have reasonably concluded that stopping purchases or publicly disclosing negative information would do more harm than good to the fund.
Did the Court in Harris II Properly Apply Dudenhoeffer?
In Harris II, the Ninth Circuit panel emphasized that Amgen stock was “artificially inflated” because of alleged material misrepresentations made by Amgen officers. Those same allegations had been found in another lawsuit to state a cause of action for violation of the federal securities laws, which the Harris II court suggested was dispositive of the ERISA fiduciary breach issue. According to the Ninth Circuit panel:
If the alleged misrepresentations and omissions, scienter, and resulting decline in share price in [the securities class-action suit] were sufficient to state a claim that defendants violated their duties under Section 10(b), the alleged misrepresentations and omissions, scienter, and resulting decline in share price in this case are sufficient to state a claim that defendants violated their more stringent duty of care under ERISA.
The securities class-action suit was Conn. Ret. Plans & Trust Funds v. Amgen, Inc., 660 F.3d 1170 (9th Cir. 2011), aff’d, Amgen, Inc. v. Conn. Ret. Plans & Trust Funds, 133 S.Ct. 1184 (2013).
The Ninth Circuit in Harris II found nothing new in the standards for ERISA liability articulated by the Supreme Court in Dudenhoeffer. The court stated that “we had already assumed those standards when we wrote our earlier opinion” finding that the plaintiffs had stated an ERISA cause of action. The Harris II court readily concluded that plaintiffs had alleged a plausible ERISA cause of action that was not inconsistent with federal securities laws. Specifically, the court made the following findings:
- “Based on the allegations in the complaint, it is at least plausible that defendants could have removed the Amgen [Common] Stock Fund from the list of investment options available to the plans without causing undue harm to plan participants.” The panel based this conclusion on assumptions (1) that it was “extremely unlikely” that an overall decrease in trading volume in Amgen stock caused by the plan’s cessation of purchases would impact the stock price and (2) that even if the cessation of purchases was disclosed to the market, such action would have had the effect only of reducing the stock price to a level at which it would no longer be inflated. Consequently, in the panel’s view, the plans’ fiduciaries would have avoided a breach of their duties if they had removed the stock as an investment option under the plans when Amgen and other defendants began violating federal securities laws.
- “[T]here is no contradiction between defendants’ duty under the federal securities laws and ERISA. Indeed, properly understood, these laws are complementary and reinforcing.” The panel reached this conclusion in response to defendants’ arguments that removing the Amgen stock as an investment option based on undisclosed adverse material information potentially violated federal securities laws. In the panel’s view, the defendants merely had to reveal “material information in a timely fashion to the general public (including plan participants), thereby allowing informed plan participants to decide whether to invest” in their plan’s company stock fund. The panel similarly concluded that the cessation of purchases by the plans would not violate federal securities law prohibitions against insider trading because “there is no violation absent purchase or sale of stock.”
- “[D]efendants’ preparation and distribution of the SPDs, including their incorporation of Amgen’s SEC filings by reference, were acts performed in their fiduciary capacities.” This is similar to a position adopted by the Sixth Circuit in its original decision in Dudenhoeffer, but which has been rejected by the Second Circuit. See In re GlaxoSmithKline ERISA Litig., 494 Fed. Appx. 172 (2nd Cir. 2012). By adopting this view, the Ninth Circuit panel allowed the plaintiffs to proceed with claims that the plans’ fiduciaries knew (or should have known) that the stock was artificially inflated and provides the plaintiffs with a presumption that they relied on those securities laws statements in making investments in Amgen stock through their plan accounts.
The complaint in Harris II also stated an ERISA “prohibited transaction” cause of action based on allegations that Amgen concealed material information in order to inflate the price of Amgen stock sold to the 401(k) plans in violation of ERISA Section 406(a). The defendants argued that this claim should be dismissed because ERISA provides a specific exemption from the prohibited transaction rules as to sales of stock to ERISA-covered retirement plans, if certain conditions are met. The panel refused to dismiss the claim on the basis that the availability of the exemption is an affirmative defense that the defendants have a duty to prove, thereby making dismissal of the claim inappropriate at the pleading stage.
The Harris II decision gives little consideration to the Supreme Court’s warning in Dudenhoeffer against judge-made ERISA obligations that potentially conflict with complex federal securities regulations. Harris II’s conclusions as to the plausibility of the plaintiffs’ claims likewise seemed to give little weight to the cautious approach that Dudenhoeffer requires for such claims, and instead speculates as to the likely anticipated effect of certain actions that the fiduciaries could have taken with respect to the Amgen Common Stock Fund.
Harris II is the first instance of a court of appeals applying Dudenhoeffer, and it’s a surprising and unsettling decision for fiduciaries of 401(k) plans that permit participants to invest in company stock. It is likely that the fiduciaries in Harris II will seek en banc review and/or Supreme Court review of this decision. In addition, it is unclear what impact this decision may have on other courts currently reconsidering this issue in light of Dudenhoeffer.
Other courts may decide to more closely read the Supreme Court’s direction in Dudenhoeffer to apply a “careful, context-sensitive scrutiny of a complaint’s allegations” and reach a different conclusion regarding the plausibility of stock-drop claims than the Ninth Circuit panel has reached.