Alert December 18, 2014

Ninth Circuit Applies Fifth Third v. Dudenhoeffer to Reverse Dismissal of Stock Drop Case


The Ninth Circuit becomes the first appellate court to interpret the Supreme Court’s Fifth Third v. Dudenhoeffer holding. In its ruling, the Ninth Circuit held that participants can maintain a claim alleging breach of ERISA fiduciary duty when fiduciaries allowed a retirement plan to continue purchasing and holding employer stock when the price of such stock was alleged to be artificially inflated. The Ninth Circuit panel found no tension between the obligations imposed under ERISA and the federal securities laws.

Participants in two 401(k) plans that allowed investment in the employer’s publicly traded stock brought suit against the employer sponsoring the plan and a number of its related individuals and entities that allegedly served in a fiduciary capacity with respect to the plans’ investments. Each plan allowed participants to invest in a fund holding only shares of the publicly traded stock of the employer, or to choose from other investment options. Participants who invested in the employer stock fund sued when the value of the stock held in the plans declined by roughly one-third following revelations of safety concerns surrounding key drugs sold by their employer.

Plaintiffs’ Claims Addressed in the District Court

Participants alleged that defendants breached their fiduciary duties by allowing the plans to remain invested in the employer stock at a time when the value of the stock was artificially inflated as a result of material misstatements made by the company or its officers and directors regarding the efficacy of its products. A parallel securities suit was also filed by shareholders under Sections 10(b) and 20(a) of the Exchange Act of 1934 based on the same facts. Although the district court found that the securities case could survive a motion to dismiss, it nonetheless dismissed the ERISA action, holding that defendants in the ERISA suit were either protected by a presumption of prudence then applicable to the holding of employer stock in certain plans, or that, alternatively, plaintiffs did not state a claim for imprudence where discontinuing the plans’ holdings of employer stock would either cause losses to the plan or require defendants to violate the securities laws.

The Appellate Decision

The Ninth Circuit initially reversed the dismissal order, but the Supreme Court vacated that decision and remanded for further proceedings after it decided Fifth Third Bancorp v. Dudenhoeffer which, among other things, eliminated the presumption of prudence that had previously been relied upon by the district court. Dudenhoeffer is discussed at more length in the June 26, 2014 edition of the ERISA Litigation Update.

On remand after Dudenhoeffer, the Ninth Circuit again reversed the district court’s order dismissing the complaint. The court rejected the district court’s holding that a gradual decline in the price of a stock could not establish an ERISA breach of duty claim where the price of the stock was alleged to be artificially inflated. The survival of the parallel securities claims was relevant to the Ninth Circuit panel: “If the alleged misrepresentations and omissions, scienter, and resulting decline in share price in [the related securities case] 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 Ninth Circuit further rejected the defense that the complaint failed to allege that plaintiffs actually relied on any of the allegedly misleading statements or omissions, holding that the fraud-on-the-market theory applicable to securities claims should also apply under ERISA.

The Ninth Circuit Finds No Contrary Rationale in Dudenhoeffer

The Ninth Circuit also held that allowing the case to proceed would not run afoul of the Supreme Court’s guidance in Dudenhoeffer. It asserted that defendants could have removed the stock fund without causing harm to participants because defendants could have frozen the fund to new investments when the stock was artificially inflated; doing so would not likely “have had an appreciable negative impact on the stock price.” To the extent that such an action would have sent a negative signal to the market, the Ninth Circuit was unconcerned because, among other rationales, it believed that a decline in price would have been “no more than the amount by which the price was artificially inflated” and, furthermore, the removal of the fund itself “may well have caused” those individuals who made allegedly material misstatements or omissions to the market to comply with their securities law obligations. The Ninth Circuit also held that disclosing the allegedly concealed information to the market would have allowed defendants to simultaneously comply with their obligations under the securities laws and ERISA.

Defendants have sought en banc review of the panel’s decision, arguing that, if it stands, it “will have far reaching deleterious effects.”