ESOP Sponsor May Have Had Heightened Duty to Disclose

A federal court has found questions exist as to whether a privately-held company anticipating a sale or merger should have disclosed business information to a retirement plan participant who sold his shares of company stock he held in the plan after resigning.

After determining that only one plaintiff in the case had standing to sue because, among other things, the release of claims he signed did not include claims regarding the retirement plan, the U.S. District Court for the Northern District of Georgia determined that John Wagner was at a disadvantage when he sold shares of his account in Stiefel Laboratories, Inc.’s (SLI) employee stock ownership plan (ESOP).

U.S. District Judge Mark H. Cohen noted in his opinion that the Employee Retirement Income Security Act (ERISA) generally does not require retirement plan fiduciaries to disclose non-public business information to plan participants. The 11th U.S. Circuit Court of Appeals held in Lanfear v. Home Depot that there is no duty to disclose business information to plan participants, even if that information could be relevant to a plan participant in deciding what to do with his or her stock. However, Cohen cited a decision in Hill v. BellSouth Corp., which said some sort of ”special circumstance'” will be required to trigger heightened obligations to disclose.

Cohen noted two major differences between the case against Stiefel and the Lanfear case. First, SLI was a closely held company, while Lanfear involved a publicly traded stock with a value set in the open market. Second, the plan participants in Lanfear were warned about the dangers of investing in higher risk stock, and the 11th Circuit held that those warnings adequately informed the participants about the risks of investing in Home Depot stock. Wagner did not benefit from a warning that investment in a non-diversified single stock fund was risky.

“Wagner did not receive the slightest hint that his shares would not be purchased at a fair market value. Nor did he have the benefit of the open market determining the value of his SLI's stock; instead, Wagner was in a vulnerable position left to trust Defendants that the price at which they were repurchasing his SLI stock was fair and reasonable,” Cohen wrote in his opinion, adding that evidence shows the defendants knew that at the time they repurchased Wagner's stock that the price was inadequate.

Finally, Cohen said an issue of material fact exists whether Wagner detrimentally relied on Stiefel executives’ representations that the company would remain privately held. For all these reasons, Cohen said, the question whether "special circumstances" existed triggering the duty to affirmatively disclose confidential nonpublic information was for the jury to decide. He denied defendants' motion for summary judgement as to Wagner's non-disclosure claims.

Wagner argued that the fiduciaries were obligated to act in the best interests of the plan participants and should have conducted an interim stock valuation considering the bids for the company. He asserts that no later than December 8, 2008, defendants had actual knowledge that the company would sell for no less than $3 billion, and the $60,000 price per one share of stock that the retirement plan custodian paid at the time would serve as a floor for any acquisition. Wagner received $16,469 per share for his stock prior to the acquisition of SLI by GlaxoSmithKline being executed. Cohen again said a genuine issue of material fact existed as to whether SLI’s reliance on its hired appraisers’ valuations was reasonably justified under the circumstances.

According to the court opinion, this is at least the fifth lawsuit brought by former employees of SLI alleging a scheme by certain of SLI's board members to manipulate employees' ownership of shares of the privately-held company in order to profit improperly from the company's eventual sale.

In the years leading up to the lawsuit, SLI executives had considered several acquisition and merger offers that would have paid company stock holders $60,000 to $70,000 per share.

Upon the close of the merger agreement with GlaxoSmithKline, SLI's shareholders, including the ESOP plan participants, received approximately $70,000 per share for their stock. Prior to announcement of the merger, SLI opened a “put window” allowing participants to sell some or all of their shares of SLI stock to the company. Wagner had resigned in 2008 and requested a distribution of his shares in December of that year. All plaintiffs in the lawsuit learned no later than July-August 2009 that the SLI stock held by the plan was allegedly undervalued and they were paid too little for the stock they put to SLI.

In the lawsuit, they claim that defendants breached their fiduciary duties by:

• developing "the concept of the purported one-time 'opportunity' to diversify in which Stiefel Labs repurchased company stock from" the plan participants;
• controlling "the flow of information to the valuator appraising Stiefel Labs' Company stock;"
• setting up "the structure of the eventual sale to GSK for prices well in excess of the amount paid to the employees for their company stock;" and
• communicating "false and misleading information" to plan participants concerning the value and repurchase of SLI stock shares.

The case will now go to trial.