More Harm Than Good? Considering Pleading Standards in ERISA Duty-of-Prudence Litigation

BACKGROUND

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.

ISSUE

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 SPLIT

            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.

Looking Forward

            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.

 

Further Reading

For further reading, see: https://columbialawreview.org/content/the-duty-to-inform-in-the-post-dudenhoeffer-world-of-erisa/.

Blocking the Work-Around: SLUSA’s Preemption of State Law Securities Class Actions

BACKGROUND

Due to an increasing volume of private securities fraud litigation being filed in the 1980’s and early 1990’s, Congress feared that plaintiffs were bringing abusive securities claims. Despite little chance of winning on the merits, these plaintiffs would often force defendants to settle due to the expensive nature of discovery in securities litigation. In 1995, Congress passed the Private Securities Litigation Reform Act (“PSLRA”). The Act raised the barrier for private federal securities fraud litigation, putting in place stringent new pleading standards for these lawsuits. Under the PSLRA, plaintiffs would need to provide evidence of fraud before any pretrial discovery took place.  In an effort to circumvent the new federal PSLRA standards, plaintiffs began bringing more securities fraud claims under state law.

To prevent these plaintiffs from avoiding the new pleading standards, Congress then passed the Securities Litigation Uniform Standards Act (“SLUSA”) in 1998. SLUSA precludes claimants from filing class actions that (1) consist of more than fifty prospective members; (2) assert state law claims; (3) involve a nationally listed security; and (4) allege a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security. The result is that private federal securities fraud claims can be pursued as a state law individual action or a federal securities fraud class action, but a plaintiff cannot pursue such claims as a state law class action.

However, Congress did not explicitly define which claims include misrepresentation or omission of material fact. In particular, it is unclear whether claims for breach of contract and breach of fiduciary duties, which are typically brought as state law claims, are treated as alleging misrepresentation or omission of material fact.

THE ISSUE

Does SLUSA preempt class action claims alleging a state law breach of contract and/or fiduciary duty in connection with the purchase or sale of a covered security?

THE SPLIT

The stances taken by the circuits do not fit into a simple binary. Each circuit with precedent on the issue has taken the approach that there are times that SLUSA does preempt these claims, but other times it does not. However, the circuits can be divided into three categories as to where the line has been drawn on preemption.

Sixth Circuit

            The Sixth Circuit has taken a literalist approach to this issue, where the court asks whether the complaint includes allegations of misrepresentation or omission. However, the Sixth Circuit has also instructed district courts to dismiss claims where the plaintiff has omitted allegations of misrepresentation or omission through artful pleading. So under Sixth Circuit precedent, any explicit or implicit allegation of misrepresentation or omission of material fact in a state law class action claim in connection with the purchase or sale of a covered security is sufficient to be preempted by SLUSA.

            In Segal v. Fifth Third Bank, N.A., the plaintiff brought state law class action claims for breach of fiduciary and breach of contract. The plaintiffs accused Fifth Third Bank of investing fiduciary assets in proprietary Fifth Third mutual funds rather than superior funds operated by the Bank’s competitors and providing standardized, largely automated management of the assets after promising individualized management. In the Amended Complaint, the plaintiff stated: “None of the causes of action stated herein are based upon any misrepresentation or failure to disclose material facts of plaintiff.” However, the Sixth Circuit upheld dismissal of the complaint, stating that SLUSA’s preemption does not depend on whether the complaint makes material or dependent allegations of misrepresentation, but “whether the complaint includes these types of allegations, pure and simple.” Additionally, the court made it clear that the question of preemption is dependent on “whether the complaint covers the prohibited theories, no matter what words are used (or disclaimed) in explaining them.”

Second, Third, and Ninth Circuits

            Under the precedent of the Second, Third, and Ninth Circuits, a class action claim for breach of contract and/or fiduciary duty is barred by SLUSA only if the claim requires proof of a misrepresentation or omission of material fact. These courts look to whether any misrepresentation or omission serves as the factual predicate of the state law claim.

            In Freeman Investments, L.P. v. Pacific Line Ins. Co., the plaintiffs alleged the defendant had breached their contracts and its duty of good faith and fair dealing by charging policyholders an excessive “cost of insurance.” The district court dismissed the complaint since it included allegations of systematic concealment and deceit involving hidden fees. However, the Ninth Circuit reversed the dismissal, holding that SLUSA preemption should depend on what the plaintiffs would be required to show to prove their claim. For the claims brought forth by the plaintiffs here, they need not show that the defendant misrepresented the cost of insurance or omitted critical details—they only need to persuade the court that their reading of the contract terms is the proper interpretation. A similar approach was taken by the Second Circuit in In re Kingate Management Ltd. Litigation and the Third Circuit in LaSala v. Bordier et Cie.

Seventh Circuit

            Lastly, the Seventh Circuit decided two cases in 2017, Goldberg v. Bank of America, N.A. and Holtz v. JPMorgan Chase Bank, N.A., where the court took a different approach than any other circuit. The court held that if a claim could be pursued under federal securities law, then it is preempted by SLUSA even if it also could be pursued under state contract or fiduciary law. The court elaborated that allowing plaintiffs to work around securities law by bringing state law contract or fiduciary duty claims would render SLUSA ineffectual. This approach has been the subject of significant criticism from commentators, as well as Judge Hamilton’s dissent in Goldberg, for taking SLUSA’s statutory purpose too far.

LOOKING FORWARD

            In his dissent in Goldberg, Judge Hamilton articulates his belief that only the Supreme Court can settle the circuit split on SLUSA preemption. While the Court may certainly choose to take a case to interpret SLUSA in a way that would resolve the differences between the circuits, the split may more effectively be resolved where it began—Congress. While relying on Congress to act may not be the most reliable option, a section defining the scope of SLUSA preemption could work its way into a much larger bill. After all, securities litigation is on the rise again, and Congress may be interested in helping to clarify an ambiguity that may affect many of these lawsuits.