The justices agreed June 3 to review a surprise decision from the U.S. Court of Appeals for the Second Circuit that allowed employees participating in the company’s 401(k) retirement plan to move forward with a proposed class action lawsuit they filed in 2015 after IBM’s stock dropped by 7 percent.
The lawsuit, led by Larry Jander, alleges the Retirement Plan Committee of IBM—run by company executives—continued to invest retirement plan funds in IBM stock even though it knew the company’s reported value was artificially inflated, causing plan participants to lose out on retirement savings when the value of IBM shares fell.
The plan fiduciaries had non-public information about IBM’s struggling microelectronics business and should have either made corrective disclosures about the microelectronic unit’s true value or frozen further investments in IBM stock, the employees said. Because the plan fiduciaries did neither, the employees said the fiduciaries violated their duty of prudence under the Employee Retirement Income Security Act.
The Second Circuit’s decision marked a rare win for employees in a series of ERISA cases that, in the aftermath of the Supreme Court’s 2014 decision in Fifth Third Bancorp v. Dudenhoeffer, have been almost universally dismissed.
The court’s 2014 ruling set a high bar for stock drop claims, and since then courts have rejected lawsuits involving the retirement plans of RadioShack, Target, Lehman Brothers, Citigroup, Whole Foods, JPMorgan, L-3 Communications, and BP Plc, among others.
In Dudenhoeffer, the court said in order to claim a plan fiduciary breached his or her duty of prudence, the complaint has to plausibly allege two things: an alternative action the defendant could have taken that would have been legal, and that a prudent fiduciary in the same circumstances wouldn’t have thought that stopping purchases or publicly disclosing the negative information would do more harm than good.
The Second Circuit, however, said the plan participants had sufficiently pleaded that no prudent fiduciary in IBM’s position could have concluded that earlier disclosure would do more harm than good.
The court relied on generic allegations that delayed “disclosure of a prolonged fraud causes ‘reputational damage’ that ‘increases the longer the fraud goes on’” and that disclosure of the truth was inevitable, IBM said in its petition to the court.
“There is simply no denying that allegations deemed sufficient here would not suffice in the Fifth and Sixth Circuits,” IBM wrote.
But the employees dispute the existence of a circuit split. They said IBM “misstated the Second Circuit’s holding to manufacture a phony conflict with the Fifth and Sixth Circuits.”
“The Second Circuit’s decision did not turn on their generalized allegations that the harm of an inevitable disclosure of an alleged fraud generally increases over time,” they said in their opposition brief.
“Rather, the ‘particularly important’ factual allegations for the Second Circuit were those concerning IBM’s efforts to sell Microelectronics; those efforts made disclosure of the value of Microelectronics inevitable in a way unique to the facts of this case that could not simply be replicated in another duty-of-prudence action,” the employees said.
In an email after the Supreme Court announced it would hear the case, Sam Bonderoff, a partner at Zamansky LLC in New York City representing the employees, said they “look forward to a robust review of the issues by the Supreme Court.”
Some ERISA attorneys fear the case could open a floodgate of litigation and put employers at risk of being sued every time their stocks drop if the Supreme Court affirms the appeals court ruling.
By taking the case, the justices have signaled they want to revisit their decision in Dudenhoeffer and how it has been interpreted by the lower courts.
“The question is why do those justices want to revisit it,” said Stephen Rosenberg, head of the ERISA litigation practice at the Wagner Law Group in Boston. “The reason could be as benign as the circuit split indicates to them that they need to return to the issue and clarify the standard.”
It takes four justices to agree to review a case. There were no notable dissents from the court’s decision. The Supreme Court’s ultimate decision is likely to affect a similar case against Wells Fargo that’s before the Eighth Circuit.
An attorney for Davis Polk Wardwell, which represented IBM’s retirement plan committee, did not respond to a request for comment.
The case is Ret. Plans Comm. of IBM v. Jander, U.S., No. 18-1165, certiorari granted 6/3/19.
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(Updated with additional information throughout.)