For the second time in Amgen Inc. v. Harris, the Supreme Court reversed the Ninth Circuit because of its failure to apply the proper pleading standard for claims alleging breach of the duty of prudence against fiduciaries who manage employee stock ownership plans (ESOPs). The Supreme Court’s opinion sets forth a specific, stringent pleading standard for such claims – though questions remain as to how strictly lower courts will interpret that standard. The opinion also shows that it will be strategically advantageous for defendants to attack claims against ESOP fiduciaries at the pleading stage.
The plaintiffs were former Amgen employees who participated in an ESOP holding Amgen’s common stock. After the value of Amgen’s stock dropped, the employee-stockholders filed a class action alleging that the plan’s fiduciaries had breached their duty of prudence under the Employee Retirement Income Security Act (ERISA). Specifically, they alleged that the plan’s fiduciaries had inside information that investing in Amgen’s stock was imprudent but nevertheless (1) allowed the plan’s participants to continue investing, and (2) failed to disclose the inside information to the public. The district court dismissed the complaint for failure to state a claim, but the Ninth Circuit reversed. The plan fiduciaries petitioned to the Supreme Court.
While that petition was pending, the Supreme Court issued its decision in Fifth Third Bancorp v. Dudenhoeffer, which addressed the duty of prudence owed by ERISA fiduciaries who manage ESOPs. In Dudenhoeffer, the Supreme Court held that ESOP fiduciaries are not entitled to a presumption of prudence. The elimination of this presumption was widely viewed as a negative development by those who manage and represent ESOPs. However, in Dudenhoeffer, the Supreme Court did include fiduciary-friendly language recognizing the unique challenges of ESOP fiduciaries who are blamed for failing to act on inside information about the employer’s stock. Specifically, the Supreme Court stated:
To state a claim for breach of the duty of prudence on the basis of inside information, a plaintiff must plausibly allege an alternative action that the defendant could have taken that would have been consistent with the securities laws and that a prudent fiduciary in the same circumstances would not have viewed as more likely to harm the fund than to help it.
[L]ower courts faced with such claims should also consider whether the complaint has plausibly alleged that a prudent fiduciary in the defendant’s position could not have concluded that stopping purchases—which the market might take as a sign that insider fiduciaries viewed the employer’s stock as a bad investment—or publicly disclosing negative information would do more harm than good to the fund by causing a drop in the stock price and a concomitant drop in the value of the stock already held by the fund.
This pleading standard acknowledges that freezing investments into an ESOP and disclosing negative information about company stock to the public will usually do more harm than good. The Supreme Court intended the standard to separate plausible from meritless claims.
Following the issuance of Dudenhoeffer, in 2014 the Supreme Court granted the fiduciaries’ petition for review in Amgen I, vacated the judgment, and remanded for further proceedings consistent with Dudenhoeffer. On remand, the Ninth Circuit again reversed dismissal of the complaint against Amgen and denied rehearing en banc over a strong dissent by Judge Kozinski. The fiduciaries again petitioned for Supreme Court review.
In a short, per curiam decision (Amgen II), the Supreme Court on January 25, 2016, held that the Amgen complaint did not contain sufficient factual allegations to state a claim for breach of the duty of prudence against the ESOP fiduciaries. The Supreme Court emphasized that the Ninth Circuit did not correctly apply the Dudenhoeffer standard. The Ninth Circuit assumed it was plausible that freezing investments into Amgen’s ESOP would not harm plan participants. However, the complaint did not allege that a prudent fiduciary “could not have concluded” that freezing the investments into the ESOP would have done more harm than good. Accordingly, the Court reversed and remanded (again). The Supreme Court noted that the district court could decide whether to allow the plaintiffs to amend the complaint to attempt to meet this standard.
The plaintiffs on remand following Amgen II, as well as plaintiffs in other actions, might simply allege that a prudent fiduciary “could not have concluded” that alternative actions, such as freezing investments into the ESOP and public disclosure of negative inside information, would have done more harm than good. It remains to be seen whether such a conclusory allegation, devoid of a factual basis, will meet muster under Amgen II. There exists a strong argument that the Supreme Court intended to require the allegation of specific facts demonstrating how a prudent fiduciary could not have reached such a conclusion. Given that public disclosure of negative insider information (even if permitted by securities laws) and freezing ESOP investments will typically do harm by causing the value of the employer’s stock to drop, the lower courts will also have to decide what types of factual allegations and special circumstances will suffice under this stringent standard.
While decided in the context of an ESOP, Amgen I and II are also important decisions for 401(k) plans that offer employer stock as an investment option, particularly those plans with ESOP features. Although we will need to await future litigation for complete certainty, we expect that Amgen pleading standards will likely apply in 401(k) plan stock drop litigation. 401(k) plan fiduciaries should continue to carefully monitor company stock as a prudent investment option for their participants and be prepared to substantiate — through appropriate documentation and otherwise — compliance with the fiduciary duty to periodically review and update investment offerings and possible consideration of inside information in accordance with the securities laws.