Compliance January 4, 2017

D.C. Appellate Court Affirms Employer Win in Stock Drop Suit

So called “stock drop” litigation remains a concern for many in 2017, but recently some employers have posted key court victories and successfully defended their ESOP investment decisions. 

Reported by

When the Supreme Court’s decision first came down in Fifth Third v. Dudenhoeffer, many thought participants would have an easier time winning damages for “stock-drop” claims filed against Employee Stock Ownership Plans (ESOPs).

The idea is that employers, post-Dudenhoeffer, can no longer rely on a blanket presumption of prudence that previously said it was always the right move to continue to offer employer stock within an ESOP—rather than say, freeze or entirely drop the company stock as a potential investment for employees when the attractiveness of the investment waned. It was believed, as a result, that plaintiffs could more easily challenge the decisions of ESOP fiduciaries to continue offering employer stock that had lost value or was likely to lose further value in the future, for example. This would especially be the case when ESOP fiduciaries decided to continue offering the stock while also being in possession of insider knowledge that could eventually be disclosed and harm the market valuation of the company.

For more stories like this, sign up for the PLANSPONSOR NEWSDash daily newsletter.

While the argument has some logic to it, this hasn’t exactly played out, due the difficult nature of successfully pleading an alternative course of action that defendants should have known to take were they acting as prudent fiduciaries under the Employee Retirement Income Security Act (ERISA).

Take the latest ESOP-focused decision out of the U.S. Court of Appeals for the D.C. Circuit, Coburn v. Evercore. The appellate decision affirms a lower court’s ruling that determined the plaintiffs “failed to plead a plausible alternative course of action their ESOP trustees could have taken rather than continuing offering company stock that would not have ended up hurting more than helping.”

Plaintiffs in the case include former J.C. Penney employees and investors in a J.C. Penney employee stock ownership plan now managed by Evercore. The lead plaintiff claimed that Evercore breached its fiduciary duties of prudence and loyalty when it failed to take preventative action as the value of J.C. Penney common stock tumbled between 2012 and 2013, thereby causing significant losses.

As the appellate decision explains, despite clear factual similarities, plaintiffs argued that the tough pleading requirements in place even after Fifth Third v. Dudenhoeffer should not apply in this circumstance because the “challenge is centered on Evercore’s failure to appreciate the riskiness of J.C. Penney stock rather than Evercore’s valuation of its price.”

In short, the appellate court rejected the argument, because to appreciate the riskiness of a stock intimately involves its market valuation, and to argue that the ESOP fiduciaries should have been able to outguess the market’s valuation is inherently unfair absent special circumstance, such as fraud: “We disagree and therefore affirm the district court’s judgment.” Previously in the case, the district court  also specifically rejected the argument that the plan’s fiduciaries should have known from publicly available information alone that the stock’s price was over or underpriced such that it was imprudently risky to hold.

NEXT: Details from the text of the complaint

While their arguments did not garner sympathy from the district or appellate courts, it cannot be denied that the plaintiffs have had a difficult ride up to this point in the ESOP. 

Background covered in case documents shows that in 2011, J.C. Penney attempted to re-conceptualize its brand and hired former Apple, Inc. executive Ron Johnson as its chief executive officer. Distancing himself from J.C. Penney’s historic reliance on sales, coupons and rebates to boost sales, Johnson implemented a more straightforward pricing scheme, reasoning that a “fair and square” pricing policy would attract shoppers.

“Johnson also reworked both the Company logo and the traditional layout of its stores in an effort to modernize,” according to the appellate court decision. “Taken as a whole, Johnson sought to bring J.C. Penney up to speed with the fads and fashions of 2012, simplifying the business model in order to lower expenses and increase gross profit margins. This strategy proved to be less than successful. J.C. Penney’s 2012 first quarter earnings report showed a $163 million loss, or a $0.75 loss per share. Johnson’s poor start was only the beginning, as the next twenty-one months—from the end of 2012’s first quarter to the end of 2013’s fourth quarter—saw J.C. Penney’s stock price fall from $36.72 to $5.92 per share.”

According to court documents, throughout the entire period that the value of J.C. Penney common stock dipped ever lower, Evercore stood resolute. Despite its authority to eliminate the J.C. Penney Stock Fund as an investment option in the plan and its ability to sell shares currently in the fund, Evercore exercised neither option.

“The shares in the J.C. Penney Stock Fund that [the plaintiff] and other investors owned took the full force of the hit. In 2015, [the lead plaintiff] sued on behalf of herself and all others similarly situated, alleging that Evercore was liable for $300 million in losses to the plan for having breached its fiduciary duty under ERISA §§ 409, 502(a)(2)-(3), 29 U.S.C. §§ 1109(a), 1132(a)(2)-(3).”

On February 17, 2016, the district court granted Evercore’s motion to dismiss the complaint for failure to state a claim. Primarily relying on the United States Supreme Court’s opinion in Dudenhoeffer, the district court held that plaintiffs’ allegations that Evercore should have recognized from publicly available information alone that continued investment in J.C. Penney common stock was “imprudent” were generally implausible absent “special circumstances” affecting the market.

“Because [plaintiff] failed to plead special circumstances—indeed, [she] expressly disclaimed any need to plead them—the district court held that [her] complaint could not survive Evercore’s Rule 12(b)(6) challenge,” the appellate court explains. “The district court also rejected the alternative argument that, pursuant to Tibble v. Edison International, Evercore violated its fiduciary “duty to monitor” investments and remove imprudent ones. The court reasoned that Tibble did not affect the Dudenhoeffer holding and thus could not save the complaint.”

NEXT: Appellate review warrants same result 

Consider its own set of precedents and reviewing the case de novo, the appellate court observes that the Supreme Court has clearly held 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 under-valuing the stock are implausible as a general rule, at least in the absence of special circumstances.”

This is the heart of the Dudenhoeffer opinion—the recognition that “investors have little hope of outperforming the market in the long run based solely on their analysis of publicly available information, and accordingly they rely on the security’s market price as an unbiased assessment of the security’s value in light of all public information.”

As the appellate court further observes, “Where efficient markets exist, traders cannot profit by using existing information available in the market, since this news should already be reflected in securities prices … Echoing this theory, Dudenhoeffer agreed that a fiduciary’s failure to outsmart a presumptively efficient market is not a sound basis for imposing liability.”

Thus, because a stock price on an efficient market reflects all publicly available information, Dudenhoeffer requires additional allegations of “special circumstances” when a plaintiff brings a breach of the duty of prudence claim against a fiduciary based on that information. Special circumstances, the Supreme Court instructed, includes evidence questioning “the reliability of the market price as an unbiased assessment of the security’s value in light of all public information … that would make reliance on the market’s valuation imprudent.”

Such evidence may demonstrate that illicit forces (such as fraud, improper accounting, illegal conduct, etc.) were influencing the market, or it may otherwise suggest that the market was not efficient and therefore the market price of a security in that market was not necessarily indicative of its underlying, fundamental value.

According to the appellate decision, ultimately, “Dudenhoeffer suggested that the special circumstances might include something like available public information tending to suggest that the public market price did not reflect the true value of the shares … Applying Dudenhoeffer here, we believe the claim falls far short. Despite the Supreme Court’s instruction that claims of imprudence based on publicly available information must be accompanied by allegations of special circumstances, the plaintiff acknowledges that she did not allege the market on which J.C. Penney stock traded was inefficient.”

The full text of the appellate court’s opinion is available here

Compliance January 4, 2017

Court Denies Injunction of EEOC Wellness Program Rules

A federal judge found AARP did not prove irreparable harm to its members and is unlikely to succeed on the merits of its case.
Reported by

A federal court has denied AARP’s move for a preliminary injunction of Equal Employment Opportunity Commission (EEOC) wellness programs to enjoin the applicability of these regulations pending the court’s resolution of the merits.

The AARP filed a lawsuit alleging that the EEOC’s final wellness program rules under the Americans with Disabilities Act (ADA) and the Genetic Information Nondiscrimination Act (GINA) are arbitrary, capricious, an abuse of discretion, and not in accordance with law. The AARP asked that the rules be invalidated.

For more stories like this, sign up for the PLANSPONSOR NEWSDash daily newsletter.

The AARP started its complaint by saying that the EEOC rightly argued in 2014 in a lawsuit against Honeywell International that because an employer imposed heavy penalties on employees through a coercive wellness program, employees stood to “lose the fundamental privilege under the ADA and GINA to keep private information private.” Yet, the complaint says, in 2016, the EEOC issued regulations under the ADA and GINA that allow employers to impose heavy financial penalties on employees who do not participate in employee wellness programs. On average, these penalties would double or even triple those employees’ individual health insurance costs, the AARP claims.

The EEOC argues that AARP has failed to establish that it has associational standing to bring this challenge on behalf of its members. It also argues that AARP has failed to satisfy the requirements for a preliminary injunction.

NEXT: AARP has standing, but doesn’t show irreparable harm

U.S. District judge John D. Bates of the U.S. District Court for the District of Columbia first concluded that AARP has sufficiently demonstrated its status as a membership organization. Bates notes that associational standing cases are unspecific about what it means to “play a role in” the  leadership  of  an  organization,  the  financing  of  an  organization,  and  in “guiding”  the  organization’s activities. However, he found that AARP’s members play a role in all of these activities, and although they could play a stronger role, the government points to no cases, and the court can find none, that suggest that what AARP’s members do is insufficient to qualify AARP as a “membership” organization for associational standing purposes.

Regarding the second argument, Bates noted that a plaintiff seeking a preliminary injunction must establish: (1) that he or she is likely to suffer irreparable harm in the absence of injunctive relief; (2) a likelihood of success on the merits; (3) that the balance of equities tips in his or her favor; and (4) that an injunction is in the public interest.

AARP claims that its members will suffer irreparable harm because many of them will be unable to afford the premium increase permitted under both the ADA and GINA rules, and so will be forced to disclose confidential medical information they would not otherwise choose to disclose. But, Bates noted that the goal of each rule is to prevent employers from being able to use information disclosed as part of wellness programs to discriminate against employees, which, of course, would violate the ADA and/or GINA. Thus, the regulations, as well as HIPAA, are designed to guard against the discrimination that plaintiff fears.

Bates also said none of the three member declarations that AARP has submitted in support of its claim indicates that irreparable harm from this disclosure is in fact likely to occur, as a result of either the ADA rule or the GINA rule. “That failing is indicative of the ultimate weakness of AARP’s irreparable harm argument,” he wrote in his opinion. In addition, Bates found AARP’s unexplained delay in bringing the suit weighs against a finding of irreparable harm. Citing other cases, he wrote in his opinion, “An unexcused delay in seeking extraordinary injunctive relief may be grounds for denial because such delay implies a lack of urgency and irreparable harm.” 

NEXT: AARP unlikely to succeed on merits of case

Bates also said, “Lacking the full administrative record, and given the deference the Court owes EEOC, the Court cannot conclude at this time that AARP is likely to succeed on the merits.”

AARP only objects to the specific incentives EEOC has adopted: 30% of the cost of self-only coverage under both the ADA and GINA rules, or 60% of the cost of self-only coverage if the incentives/penalties are stacked.  AARP’s position is that by permitting this level of incentives, EEOC is allowing coercion. Based on the record before it, Bates said he cannot conclude that AARP is likely to succeed in this argument. “The determination as to what level of incentives is permissible is exactly the kind of agency determination to which the Court owes some deference,” he wrote in his opinion. 

Bates says there is nothing in either the ADA or GINA to indicate that the particular incentive level EEOC selected is not permitted by the statute. “The new regulations may permit employers to offer a strong incentive to their employees to disclose health information, but as other courts, including the Supreme Court, have recognized, ‘[a] hard choice is not the same as no choice,’” he wrote.  

Bates also found that the public interest weighs against granting injunctive relief. Enjoining the rules at this late date will likely cause considerable disruption for employers and insurers who designed their 2017 health plans around the fact that these rules would be implemented. Enjoining the rules now will cause uncertainty for employers as to the lawfulness of their wellness programs—and uncertainty for employees as to the terms and cost of their health insurance.  

“Such a disruption across the entire national employment arena is not warranted based on the showing AARP has made here to date. And it would be particularly inappropriate to cause such widespread disruption given AARP’s unexplained delay in bringing this challenge,” Bates concluded.

«