(Article from Securities Law Alert, March 2016)
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On March 18, 2016, the Second Circuit affirmed the dismissal of an action brought under the Employee Retirement Income Security Act of 1974 (“ERISA”) by former participants in an employee stock ownership plan (“ESOP”) that invested exclusively in shares of Lehman Brothers Holdings (the “Plan”). Rinehart v. Lehman Bros. Holdings, 2016 WL 1077009 (2d Cir. Mar. 18, 2016) (per curiam) (Rinehart II).[1] The Second Circuit held that the pleading standard set forth in Fifth Third Bancorp v. Dudenhoeffer, 134 S. Ct. 2459 (2014)[2] applies to ERISA claims based upon public information suggesting “excessive risk” as well as to claims based on “market value.” The Second Circuit further held that a plaintiff alleging ERISA claims based on a fiduciary’s failure to investigate inside information must allege (1) facts showing how that investigation would have uncovered relevant nonpublic information, and (2) an alternative action that the fiduciary could have taken that “a prudent fiduciary in the same circumstances would not have viewed as more likely to harm the fund than to help it” (quoting Fifth Third, 134 S. Ct. 2459).
Background
After Lehman Brothers filed for bankruptcy in September 2008, plaintiffs brought suit against the Plan’s fiduciaries (the “Plan Committee Defendants”) alleging that they had “breached their duty of prudence under [ERISA] . . . by continuing to permit investment in Lehman stock in the face of circumstances arguably foreshadowing its demise.” Plaintiffs also asserted ERISA claims against Lehman’s former directors, including the company’s former chairman and CEO, Richard S. Fuld, for allegedly “failing to keep the Plan Committee Defendants apprised of material, nonpublic information that could have affected their evaluation of the prudence of investing in Lehman stock.”
The Southern District of New York dismissed plaintiffs’ first and second amended complaints in their entirety. In re Lehman Bros. Sec. & ERISA Litig., 683 F. Supp. 2d 294 (S.D.N.Y. 2010); In re Lehman Bros. In re Lehman Bros. Sec. & ERISA Litig., 2011 WL 4632885 (S.D.N.Y. Oct. 5, 2011). Among other grounds, the court found that plaintiffs had failed to allege facts sufficient to overcome the presumption of prudence set forth in Moench v. Robertson, 62 F.3d 553 (3d Cir. 1995), adopted by the Second Circuit. On July 15, 2013, the Second Circuit applied the Moench presumption of prudence and affirmed the dismissal of plaintiffs’ second amended complaint. Rinehart v. Akers, 722 F.3d 137 (2d Cir. 2013) (Rinehart I).
Almost a year later, on June 25, 2014, the Supreme Court unanimously held that “the law does not create a special presumption” of prudence for ESOP fiduciaries. Fifth Third, 134 S. Ct. 2459. The Supreme Court subsequently vacated the Second Circuit’s decision in Rinehart I and remanded the action for further consideration in light of Fifth Third. The Second Circuit in turn remanded the action to the district court, which permitted plaintiffs to amend their complaint to narrow their claims and shorten the class period.
On July 10, 2015, the Southern District of New York dismissed plaintiffs’ amended complaint. In re Lehman Bros. Sec. & ERISA Litig., 113 F. Supp. 3d 745 (S.D.N.Y. 2015) (Lehman) (Kaplan, J.).[3] As the Second Circuit explained, the district court “recogniz[ed] that Fifth Third abrogated the Moench presumption of prudence formerly governing ESOP-based ERISA claims in this Circuit, [but] nonetheless concluded that [p]laintiffs failed to allege sufficiently that the Plan Committee Defendants violated their ERISA fiduciary duties.” The district court also held that plaintiffs [had] failed to state ERISA claims against Richard Fuld, the only remaining director-defendant in the action. Plaintiffs appealed.
Second Circuit Holds Plaintiffs Failed to Allege ERISA Claims Against the Plan Committee Defendants Based on Publicly Available Information
The Second Circuit explained that in Fifth Third, the Supreme Court “made clear that ‘where a stock is publicly traded, allegations that a fiduciary should have recognized from publicly available information alone that the market was over- or undervaluing the stock are implausible as a general rule, at least in the absence of special circumstances’” (quoting Fifth Third, 134 S. Ct. 2459).
Applying the standard set forth in Fifth Third, the Second Circuit held that plaintiffs had failed to allege that the Plan Committee Defendants had breached their duty of prudence by continuing to invest in Lehman stock despite the existence of “publicly available information [allegedly indicating] that investment in Lehman had become increasingly risky throughout 2008.” The Second Circuit concurred with the district court’s determination that plaintiffs’ amended allegations did “no more than add marginally to the cacophony of mixed signals described in” plaintiffs’ earlier complaint and did not “nudge the allegations . . . across the plausibility threshold” (quoting Lehman, 113 F. Supp. 3d 745).
Fifth Third Applies to Claims Alleging “Excessive Risk”
The Second Circuit rejected plaintiffs’ contention that Fifth Third only applies to claims based on publicly available information concerning “market value” and not claims concerning “excessive risk.” The Second Circuit agreed with the district court’s finding that plaintiffs’ purported distinction was “illusory” (quoting Lehman, 113 F. Supp. 3d 745). The Second Circuit explained that “[a]lthough the language of Fifth Third refers primarily to ‘over- or undervaluing’ stock, the Fifth Third Court applied this rule to the plaintiffs’ risk-based claims in that case.” The Second Circuit further reasoned that applying Fifth Third’s holding “to all allegations of imprudence based upon public information—regardless of whether the allegations are framed in terms of market value or excessive risk—is consistent with the efficient market hypothesis that risk is accounted for in the market price of a security.”
Plaintiffs Failed to Allege “Special Circumstances” Within the Meaning of Fifth Third
The Second Circuit regarded as meritless plaintiffs’ contention that the SEC’s July 2008 orders prohibiting short-sales of certain financial firms’ securities, including Lehman stock, “describe[d] market conditions constituting ‘special circumstances.’” The court explained that the SEC’s orders spoke “only conditionally about potential market effects resulting from so-called naked short sales” and did not “purport to describe then-existing market conditions.” The Second Circuit also agreed with the district court’s observation that the “the only plausible inference supported by [the complaint] is that the market processed any risks identified in the SEC’s orders as it would have processed any other public information about Lehman.”
The Second Circuit also rejected plaintiffs’ argument that the SEC orders “created special circumstances by excluding naked short sales of [Lehman] securities.” Although plaintiffs “parrot[ed] language from Fifth Third,” the court held plaintiffs’ “conclusory assertions” did not give rise to a plausible inference of “special circumstances.”
Second Circuit Holds Plaintiffs Did Not Adequately Allege a Breach of Fiduciary Duty Claim Based on the Plan Committee Defendants’ Failure to Investigate Nonpublic Information
Turning from claims based upon public information to claims based upon inside information, the Second Circuit held that plaintiffs had not adequately alleged an ERISA breach of fiduciary duty claim against the Plan Committee Defendants for failing to “investigate nonpublic information regarding the risks” of investing in Lehman stock.
The Second Circuit determined that even after Fifth Third, plaintiffs alleging “a breach of the duty of prudence for failure to investigate . . . ‘must allege facts that, if proved, would show that an adequate investigation would have revealed to a reasonable fiduciary that the investment at issue was imprudent’” (quoting In re Citigroup ERISA Litig., 662 F.3d 128 (2d Cir. 2011)). The Second Circuit agreed with the district court that plaintiffs did not explain “how [their] hypothetical investigation would have uncovered the alleged inside information” (quoting Lehman, 113 F. Supp. 3d 745).
The Second Circuit further reasoned that even if the Plan Committee Defendants had uncovered adverse nonpublic information, plaintiffs had not alleged that “a prudent fiduciary” could not have concluded that taking an alternative action based on that information, such as “divesting Lehman stock, or simply holding it without purchasing more,” would have done more harm than good, as plaintiffs were required to show pursuant to the standard set forth in Fifth Third and reiterated by the Supreme Court in Amgen v. Harris, 136 S. Ct 758 (2016) (per curiam).[4]
Applying this standard, the Second Circuit found that a prudent fiduciary could indeed have concluded that plaintiffs’ proposed alternative actions would have done more harm than good. The court therefore held that plaintiffs had failed to allege ERISA claims based on the Plan Committee Defendants’ alleged failure to investigate nonpublic information.
Second Circuit Holds Lehman’s Former CEO Had No Duty to Inform the Plan Committee Defendants of Nonpublic Information
Finally, the Second Circuit held the district court had correctly dismissed plaintiffs’ duty to monitor and duty to inform claims as to Lehman’s former chairman and CEO, Richard Fuld, in his capacity as an appointing fiduciary of the Plan. The Second Circuit concurred with the district court’s determination that “ERISA does not impose a duty on appointing fiduciaries to keep their appointees apprised of nonpublic information” (quoting Lehman I, 113 F. Supp. 3d 745). The Second Circuit also noted that “plaintiffs [could not] maintain a claim for breach of the duty to monitor . . . absent an underlying breach of the duties imposed under ERISA.”
The Second Circuit therefore affirmed the district court’s dismissal of plaintiffs’ claims in their entirety.
[1] Simpson Thacher represents the former members of the Lehman Brothers Employee Benefit Plans Committee (the “Plan Committee Defendants”) in this action.
[2] Please click here to read our prior discussion of the court’s decision in Fifth Third.
[3] Please click here to read our prior discussion of the court’s decision in Lehman.
[4] Please click here to read our prior discussion of the Amgen decision.