Argument analysis: Justices debate liability of insiders for mismanagement of pension plans that invest in employer stock
on Nov 7, 2019 at 6:34 am
The argument yesterday morning in Retirement Plans Committee of IBM v. Jander suggests that the justices are not yet settled on a consensus resolution to this case. Like Fifth Third Bancorp v. Dudenhoeffer in 2014, the case asks the justices to reconcile the competing obligations that the securities laws and the Employee Retirement Income Security Act of 1974 impose on the fiduciaries of pension plans that invest in employer stock, known as ESOPs. Imagine (and you don’t have to think too hard, because it happens all the time) that a corporate officer who is a fiduciary of an ESOP, like the officers of IBM who were fiduciaries of the IBM pension plan involved in this litigation, learns of inside information suggesting that the value of the corporation’s stock is likely to decline. The question in this case, at bottom, is what that fiduciary should do.
If the information is material, then at some point in time the securities laws inevitably will force the disclosure of that information. In many cases, though, the securities laws will not compel immediate disclosure. On the other hand, the insider’s position as a fiduciary of the pension plan gives the insider an obligation to act for the benefit of the employees whose pensions are being invested in the company’s stock. If the insider fiduciaries stop buying the stock (or start selling it), the market well might infer that they have information adverse to the company. It also might violate the securities laws to trade on that information without first disclosing it to the market. Conversely, if the fiduciaries disclose the information to the market, we know that the price of the stock will fall, which will harm the employees already invested in it.
Ordinarily, fiduciaries in these cases have responded by taking no action at all until other circumstances lead to disclosure of the information. In response, the employees sue those fiduciaries, arguing that their inaction violated the fiduciary duty that ERISA imposes on them; the employees typically argue that the fiduciaries should have disclosed the information and then stopped buying employer stock. Dudenhoeffer suggested that the fiduciaries in those cases could have liability only if the employees could establish that a prudent fiduciary would have been forced to conclude that disclosure was better than continued inaction. The lower court in this case decided that the plaintiffs had met that standard based on allegations that earlier disclosure is almost always better for existing investors than later disclosure. The Supreme Court granted review to decide whether those allegations – which could be made routinely in this kind of case – satisfy the Dudenhoeffer test.
A few of the justices, at least, seem predisposed to think that the allegations are adequate. Justice Sonia Sotomayor, for example, pressed Paul Clement, representing the fiduciaries at IBM, to explain “what you think is missing from the specifics.” She could see that a trial might “be a battle of competing experts,” but thought that assessing the validity of a “well-founded economic theory” should be “a matter of fact for the jury.” Justice Stephen Breyer’s comments throughout the argument suggested that he would take the same approach if the case came down to that question.
Other justices, however, were more skeptical. Justice Samuel Alito, for example, asked at one point whether “it is workable, practical, to require an insider fiduciary to determine whether the disclosure of inside information to the public at a particular point in time will do more harm than good? … It seems to me, in that situation, the fiduciary has to make a very complicated calculation.” He seemed quite disinclined to impose liability on fiduciaries for their assessment of that problem.
In a parallel vein, Justice Brett Kavanaugh raised the problem of how fiduciaries should respond if disclosure might help one class of beneficiaries but harm another. As he put it in a question to Samuel Bonderoff, representing the employees:
Isn’t the problem … that you have different classes of beneficiaries, some of whom would be harmed, some of whom would be benefitted? And when that’s the circumstance, it’s a little hard to hold the fiduciary liable for violating the duty of prudence, given the different interests of the different classes of beneficiaries?
A major thread in the discussion was how to respond to the argument of the fiduciaries that the justices should adopt a bright-line rule under which insider fiduciaries would have no separate responsibility under ERISA – they would be immune from liability so long as they made any disclosures required by the securities laws. Sotomayor, Breyer and Justice Ruth Bader Ginsburg seemed strongly disinclined to address that argument, which was not included in the papers seeking review before the court. Because the fiduciaries first raised that argument in their brief on the merits, the justices well might refuse to consider it as a basis for overturning the lower court’s ruling. Gorsuch, in particular, seemed to find the argument meritorious, asking at one point why “wouldn’t the securities law be a really good place to start and maybe finish in assessing what those long-term overall health of the corporation interests might be?”
One final point warrants mention, a comment by Gorsuch early in the argument about the role of insider fiduciaries. As the discussion above suggests, these cases arise primarily because of the routine practice of using insiders as fiduciaries of these plans, a practice that seems problematic whenever the interests of the company (in its existing operations) diverge from the interests of their employees (in protecting their pensions). Gorsuch acknowledged the commonplace decision to use insider fiduciaries but stated:
I’m less clear why this Court should be in the business of accommodating that decision. … And I guess I’m not clear exactly what employees gain from having insiders as trustees if, at the end of the day, they wind up being know-nothings, because they can’t do anything. … An outsider might in these circumstances be able to make a reasoned judgment of some kind about whether to sell or buy or act differently in a way that an insider is, as you point out, disabled from doing.
None of the other justices followed up on that comment, but it well might provide a way to avoid the dilemma that Clement portrayed as confining the responses of the fiduciaries.
Editor’s Note: Analysis based on oral argument transcript.