The Employment Retirement Income and Security Act (ERISA) was passed in 1974 to regulate private pension plans. Among other things, ERISA establishes standards of conduct for retirement plan fiduciaries (those who hold a legal relationship of trust with the plan participants), including a duty of prudence.
Wells Fargo’s fraudulent scheme to open fake customer accounts has been well documented and robustly litigated. In addition to consumers and regulators, Wells Fargo has faced legal pressure from many of its own employees. Specifically, Wells Fargo employees brought action against the company for alleged breach of the duty of prudence under ERISA in the management of the company’s 401k retirement plan. Plaintiffs argue that, in failing to disclose the ongoing fraud, Wells Fargo had artificially inflated the value of its own stock and thus the value of the employee retirement accounts which were invested in the company stock.
Could a reasonably prudent fiduciary, who is required under ERISA to manage their plans with “care, skill, prudence, and diligence” under 29 U.S.C. § 1104(a)(1)(B) have concluded that earlier disclosure of fraud would have been more beneficial than harmful to the employees’ stock plan?
The relevant standard for duty of prudence in this case comes from the Supreme Court decision in Fifth Third Bancorp v. Dudenhoefer (2014). In that case, the Supreme Court created a high pleading standard for plaintiffs alleging a breach of duty of prudence under ERISA when such duty comes into conflict with securities law.
The Fifth, Sixth, and Ninth Circuits
In Martone v. Robb (5th Cir. 2018), a former employee of Whole Foods sued the company over a breach of duty of prudence when the company plan fiduciaries continued to invest in the company stock, which was alleged to be “artificially inflated due to a widespread overpricing scheme.” In dismissing the plaintiff’s claim, the Fifth Circuit held that the plaintiff could not successfully argue that disclosing the overpricing scheme would not have resulted in more harm than good to the company’s retirement plan.
The Sixth and Ninth Circuits came to similar conclusions in, respectively, Graham v. Fearon (6th Cir. 2018) and Laffen v. Hewlett-Packard Company (9th Cir. 2018). In Graham, participants in the Eaton Corporation’s retirement plan alleged a breach of duty of prudence when the plan fiduciary bought and held Eaton stock while the company was engaging in fraud. The Sixth Circuit applied Dudenhoefer and affirmed the district court’s grant of defendant’s motion to dismiss. The court wrote
Applying [Dudenhoefer’s] pleading standard to the facts alleged in Plaintiff’s Complaint, we conclude that the district court properly determined the Complaint does not propose an alternative course of action so clearly beneficial that a prudent fiduciary could not conclude that it would be more likely to harm the fund than to help it.
The Ninth Circuit Court also applied Dudenhoefer’s pleading standard in Laffen, stating that “[A] prudent fiduciary in the same circumstances as Defendants-Appellees could view Laffen’s proposed alternative course of action as likely to cause more harm than good without first conducting a proper investigation.”
The Second Circuit
The Second Circuit Court of Appeals has held otherwise. In Jander v. Retirement Plans Committee of IBM (2nd Cir. 2018), plaintiffs sued plan fiduciaries at IBM for breach of duty of prudence when the fiduciaries bought and held IBM stock when a particular division of the company was overvalued. The U.S. District Court for the Southern District of New York dismissed the plaintiff’s claim, but the Second Circuit reversed. The plaintiff in Jander argued that the defendant plan fiduciary could have disclosed the overvaluation earlier along with regular SEC reporting, and the Second Circuit accepted that argument. Applying Dudenhoefer, the Second Circuit determined that a fiduciary could plausibly find that early disclosure of the division overvaluation would be more beneficial than harmful to the plan:
[K]eeping in mind that the standard is plausibility – not likelihood or certainty – we conclude that Jander has sufficiently pleaded that no prudent fiduciary in the Plan defendants’ position could have concluded that earlier disclosure would do more harm than good. We therefore hold that Jander has stated a claim for violation for ERISA’s duty of prudence.
The Eighth Circuit
The Eighth Circuit’s holding in Allen v. Wells Fargo & Co. is consistent with past holdings of the Fifth, Sixth, and Ninth Circuits. In Allen, and in Dudenhoefer, the plaintiff’s complaint states that the plan fiduciary did not act prudently in light of critical inside information. At the court noted in Dudenhoefer,
To state a claim for breach of the duty of prudence on the basis of inside information, a plaintiff must plausibly allege an alternative action that the defendant could have taken that would have been consistent with the 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.
In Allen, Francesca Allen, among other plaintiffs, brought a suit against Wells Fargo that was ultimately dismissed by the United States District Court for the District of Minnesota for failure to state a claim. Allen appealed, and the Eighth Circuit Court of Appeals affirmed that Allen did not meet the pleading standards set forth in Dudenhoefer. In other words, the Eighth Circuit determined that Allen could not plausibly argue that disclosing the fraudulent activity would be more beneficial than harmful to the company retirement plan (or at least not more likely to harm than help). If Wells Fargo had disclosed such information, the company stock would almost certainly have plummeted and wiped out the wealth of plan participants.
Allen has not yet filed a petition for writ of certiorari, and it is not clear that she will. The Supreme Court did issue a per curiam opinion in Jander in January 2020, but the case was vacated and remanded on other grounds than those argued in the Second Circuit. When remanded, the Second Circuit decided the case the same as they had before. On November 9, 2020, the Supreme Court denied certiorari on the question of whether allegations that the harm of an inevitable disclosure of alleged fraud increases over time satisfies the “more harm than good” standard in Dudenhoefer. Thus, the Court declined the opportunity to lower the bar slightly for plaintiffs to bring imprudence claims.
For further reading, see: https://columbialawreview.org/content/the-duty-to-inform-in-the-post-dudenhoeffer-world-of-erisa/.