IBM Petitions Supreme Court to Consider Dudenhoeffer Pleading Standard

IBM has asked the U.S. Supreme Court to weigh in on a 2nd U.S. Circuit Court of Appeals decision which reversed the company’s District Court win in a lawsuit alleging imprudence in managing company stock investments in one of its retirement plans.

Specifically, the Retirement Plans Committee of IBM and other defendants ask the court to answer “Whether Fifth Third’s ‘more harm than good’ pleading standard can be satisfied by generalized allegations that the harm of an inevitable disclosure of an alleged fraud generally increases over time.”

The Employee Retirement Income Security Act (ERISA) lawsuit argues defendants continued to invest retirement plan assets in IBM common stock despite the defendants’ knowledge of undisclosed troubles relating to IBM’s microelectronics business. In doing so, plaintiffs allege, the plan defendants violated their fiduciary duty of prudence to the plaintiffs under ERISA. Offering alternative actions IBM could have taken—per new pleading standards set forth in the Supreme Court’s decision in Fifth Third v. Dudenhoeffer—the plaintiffs suggested that “once defendants learned that IBM’s stock price was artificially inflated, defendants should have either disclosed the truth about microelectronics’ value or issued new investment guidelines that would temporarily freeze further investments in IBM stock.”

The U.S. District Court for the Southern District of New York determined that the plaintiffs did not plausibly plead a violation of ERISA’s duty of prudence, because a prudent fiduciary could have concluded that earlier corrective disclosure would have done more harm than good—a similar finding to many stock drop decisions handed down after Dudenhoeffer.

Considering the plaintiffs’ assertion that the standard expressed by the District Court is actually stricter than the one set out in Dudenhoeffer and that the District Court and others have applied this stricter standard in a manner that makes it functionally impossible to plead a duty‐of‐prudence violation, the 2nd Circuit noted that the Supreme Court first set out a test that asked whether “a prudent fiduciary in the same circumstances would not have viewed an alternative action as more likely to harm the fund than to help it.” This formulation, the appellate court says, suggests that lower courts must ask “what an average prudent fiduciary might have thought.”

The appellate court pointed out that “only a short while later in the same decision, the [Supreme Court] required judges to assess whether a prudent fiduciary ‘could not have concluded’ that the action would do more harm than good by dropping the stock price.” According to the 2nd Circuit, “This latter formulation appears to ask, not whether the average prudent fiduciary would have thought the alternative action would do more harm than good, but rather whether any prudent fiduciary could have considered the action to be more harmful than helpful.”

The appellate court said it is “not clear which of these tests determine whether a plaintiff has plausibly alleged that the actions a defendant took were imprudent in light of available alternatives.”