In Bacon v. Stiefel Laboratories, No. 09-cv-21871, 2011 WL 2973677 (S.D. Fla. July 21, 2011), a federal district court denied plaintiffs' motion for class certification in a lawsuit alleging that plan fiduciaries and the corporate plan sponsor breached their fiduciary duties under ERISA and federal securities laws by, among other things, allegedly engaging in a fraudulent scheme to convince plaintiffs to sell their shares in the company to defendants in advance of a merger that would yield large profits for shareholders. In a thoroughly reasoned opinion, the court analyzed why certification of the putative class was not warranted, holding that "for a case largely predicated on alleged fraud, class treatment is inappropriate in the context of investment decisions [made] in reliance upon that fraud."
This case is a useful tool for ERISA defense practitioners because it provides a roadmap for defending against class certification motions in cases where the participant claims are deemed to require a showing of individual reliance. The case also illustrates the essential relationship between the adjudication of class certification motions in ERISA cases and the underlying determination of the substantive elements of the claims for which certification is sought.
The Court's Decision
Defendant Stiefel Laboratories (Stiefel Labs), the largest privately-held dermatological products manufacturer in the world, was a closely held corporation owned by the Stiefel family. In 1975, Stiefel Labs established an Employee Stock Ownership Plan (ESOP), under which Stiefel Labs made annual contributions of common stock. Effective January 1, 2009, in an effort to become "current with industry practices," the ESOP was combined with the company's 401(k) plan. Under the newly-created plan (the "Plan"), an "optional diversification program" was created pursuant to which employees of Stiefel Labs were able to diversify their holdings and vested participants of the plan were permitted to obtain distributions of their shares of Stiefel Labs' stock. At the time of the Plan restructuring, the value of each share of Stiefel Labs' stock was determined to be $16,469, based on a valuation performed on March 31, 2008, by an external consulting firm.
After recapturing many of the Stiefel Labs' shares that were previously held in the Plan, Stiefel Labs notified its shareholders of a merger with GlaxoSmithKline in April of 2009. GlaxoSmithKline purchased Stiefel Labs at a price of $65,515.29 for each share of common or preferred stock, significantly more than the price that participants received for the shares of stock that they had earlier liquidated.
The Alleged Breach of Fiduciary Duty
Plaintiffs, a putative class of former Plan participants, claimed that defendants Stiefel Labs, Plan fiduciaries, and others breached their fiduciary duties under ERISA and violated federal securities laws by making several misstatements and omissions as part of "a pervasive and fraudulent pattern of behavior by Defendants, which was allegedly designed to prevent Plan participants from realizing the value of their shares in the privately-held company." Specifically, plaintiffs contended that the Plan fiduciaries failed to provide an accurate appraisal of Stiefel Labs' value and stock price because they did not retain an independent appraiser as required by ERISA. Plaintiffs alleged that the appraisal procured by the Plan fiduciaries "grossly undervalued" the participants' accounts. In support of this allegation, plaintiffs cited other valuations of Stiefel Labs performed by reputable investment firms in connection with a potential sale of the company, in which the company was valued at a significantly higher amount. The Plan Trustees, including Charles Stiefel (a Stiefel family member and officer of the company), allegedly never notified the Plan participants of these valuations.
Plaintiffs also alleged that the defendants attempted to recapture shares from the Plan at a discounted price by: (i) offering participants the "optional diversification" program, thus enabling participants to sell their shares in Stiefel Labs back to the company; (ii) enacting a reduction in force, which resulted in many terminated employees putting their shares to Stiefel Labs; and (iii) compensating the participants who diversified or took distributions of company stock at the per-share-value calculated by Stiefel Labs' so-called "independent appraiser," rather than at fair market value. Plaintiffs alleged that, once defendants controlled an increased number of shares of the company, they merged Stiefel Labs into GlaxoSmithKline in exchange for a stock price that was significantly higher than the price defendants paid for the shares that were sold back to the company by Plan participants. According to plaintiffs' complaint, these actions by defendants constituted a "fraudulent cover-up by Defendants that was created to mask the individual motives of the Board and certain individuals in maximizing the value of their own holdings in the company."
Class Certification Denied
The proposed class representatives were all employed by Stiefel Labs at one time and were participants in the Plan. Each of the proposed class representatives put their shares back to Stiefel Labs as a result of the Plan's restructuring prior to the merger. They purported to bring their suit on behalf of "[a]ll vested participants in the Stiefel Laboratories, Inc. Employee Stock Ownership Plan who sold their shares or directed that the shares in their account in the Employee Plan be sold to Stiefel Laboratories, Inc." during the applicable time period.
In adjudicating plaintiffs' motion for class certification, the Court thoroughly examined whether the putative class satisfied the four criteria of Fed. R. Civ. P. 23(a), namely: numerosity, commonality, typicality, and adequacy of representation. With respect to those criteria, the court ruled as follows:
- The Court determined that the class satisfied the numerosity prerequisite of Rule 23(a)(1), requiring that "the class is so numerous that joinder of all members is impracticable," because plaintiffs' proposed number of class members "easily exceed[ed] the minimum threshold recognized by the Eleventh Circuit. . . . [and] joinder of the proposed class members would be impractical, given the number of class members and their geographic distribution."
- The Court held that the commonality prerequisite, requiring that there be at least one issue common to all members of the class and that any class certification be predicated on "questions of law or fact common to the class," was also met because plaintiffs satisfied the "minimal threshold" of having at least a "single common question" upon which class certification could be granted, i.e., whether defendants breached their fiduciary duty to Plan participants by failing to hire an independent appraiser to properly value the company's stock price and failing to disclose to participants that other valuations performed had estimated the company's value as much greater than what was communicated to participants.
- The third factor under Rule 23(a)(3), mandating that "the claims or defenses of the representative parties [be] typical of the claims or defenses of the class," was also deemed satisfied. The Court accepted plaintiffs' broad statement that class representatives suffered from the same harms as did the proposed class members because "Defendants' scheme to undervalue the shares of Plaintiffs … makes the representatives' claims identical to those of the proposed class members … [and] claims do not vary across classes because, regardless of when the shares were sold, a fractional value of their worth was obtained."
- The fourth factor under Rule 23(a)(4), requiring that the "the representative parties will fairly and adequately protect the interests of the class," was not ruled on by the Court. The Court decided that defendants' argument that class counsel was conflicted because his firm represented others in individual suits against similar defendants on substantially the same grounds was not yet fully developed. Accordingly, the Court declined to rule on the issue in light of the Court's holding with respect to Rule 23(b) (discussed below).
In addition to satisfying the requirements of Rule 23(a), plaintiffs needed to prove that there are one or more grounds for maintaining the lawsuit as a class action under Rule 23(b). Plaintiffs in this case sought class certification under Rule 23(b)(3), under which there must be a showing made by plaintiffs of: (i) predominance of the questions of law or fact common to the members of the class over any questions affecting only individual members; and (ii) superiority of the class action device for the fair and efficient adjudication of the controversy. The rule also delineates four specific areas of inquiry relevant to both predominance and superiority: i) class members' interest in individually controlling the prosecution or defense of separate actions; ii) the extent and nature of any litigation concerning the controversy already begun by or against class members; iii) the desirability or undesirability of concentrating the litigation of the claims in a particular forum; and iv) the likely difficulties in managing a class action.
As the Court acknowledged, the inquiry into predominance "tests whether proposed classes are sufficiently cohesive to warrant adjudication by representation … and [w]hen common questions present a significant aspect of the case and they can be resolved for all members of the class in a single adjudication, there is clear justification for handling the dispute on a representative rather than on an individual basis." Defendants dedicated much of their opposition brief to the predominance issue, claiming that the plaintiffs sought "to lump together incongruous claims and issues in the same classes." Plaintiffs argued that there were several common questions of law and fact that predominated over any individual questions of law or fact, including, among others, whether defendants "caused, or took advantage of, the merger or amendment of the Employee Plan for the purpose of obtaining for their benefit the value of the Company Stock held by the Employee Plan participants upon the sale of the Company."
The Court ultimately determined that "one of the greatest barriers to satisfying the predominance standard, and thus for class certification, is the issue of reliance. Reliance is a required element of Plaintiffs' claims …. Therefore, a central question for this Court to address is whether class certification is appropriate where, as here, proof of individual reliance may be necessary."
Plaintiffs argued that the determination of reliance need not require individual inquiry. Based on theories advanced in securities law claims, plaintiffs contended that the court could presume reliance in the instances of omission and the existence of a "common scheme or plan." The Court explored the merits of plaintiffs' arguments and ultimately found them unconvincing. The Court ruled that Rule 23(b)(3) "is unequivocal: any class action certified thereunder must be capable of resolution on a class-wide basis…[and] [n]otwithstanding Plaintiffs' allegations of a 'common scheme' here, the Court finds that individual issues predominate over those of the class." The Court opined:
Plaintiffs argue that Defendants' misrepresentations and omissions have been uniform. However, Plaintiffs' subsequent actions in reliance upon those misrepresentations cannot be similarly uniform across the proposed classes. At the heart of their claims, Plaintiffs seek recovery for damages suffered after individual decisions to put shares to Stiefel Laboratories, even though individual determinations made in reliance upon Defendants' omissions and misrepresentations likely varied with each individual's needs. Plaintiffs ignore this hurdle, asking the Court to presume reliance on Defendants' omissions and misrepresentations as the basis for each of the Plaintiffs' individual determinations to retain or to put shares to Stiefel Laboratories. "This, in effect, places on the defendants the burden of proving plaintiff's nonreliance, that is, proving that the plaintiffs' decision would not have been affected even if defendants had disclosed the omitted facts" (citations omitted).
The Court also found that questions of reliance, investment strategy, and damages necessitate individual inquiry and "[s]imply put, for a case largely predicated on alleged fraud, class treatment is inappropriate in the context of investment decisions [made] in reliance upon that fraud." Accordingly, the Court ruled that the putative class claims did not predominate over the areas of individual inquiry.
With respect to superiority, the Court held that plaintiffs would be better served by controlling their own personal litigation, as opposed to participating in a class, because in cases where there are allegations of fraud, individual showings of proof are appropriate. The court stated: "[r]equiring each individual Plaintiff to detail any relevant omissions and misrepresentations pertinent to them alone—as well as the resulting decision as to whether to put the Stiefel Laboratories' shares to the company—will result in more desirable individualized treatment." Additionally, the Court observed that individualized treatment will not prevent plaintiffs from pursuing their claims for substantial monetary damages.
One of the most effective ways to minimize the exposure in complex ERISA litigation is by defeating class certification. This Court's decision illustrates one means for mounting an effective attack on the class: demonstrating that recovery depends on an individualized showing of reliance that causes the claim not to satisfy one or more of the Rule 23 requirements. The Court in this case accommodated this strategy by holding that, even though the alleged material omissions or misstatements took place on a plan-wide basis, reliance upon those omissions or misstatements by individuals will not be presumed, and thus that individualized showings of reliance would be required.
The Court's ruling appears to be consistent with the principles recently enunciated by the Supreme Court in Wal-mart Stores, Inc. v. Dukes, 131 S. Ct. 2541 (2011), wherein the Supreme Court emphasized the need for class claims to be cohesive, and, therefore, that the need for individualized evaluations of claims can defeat class certification.
Whether rulings like this one will have widespread applicability will depend largely on whether the Court's views on the substantive requirements for misrepresentation claims are endorsed in other jurisdictions and in other contexts. For many claims brought under ERISA, there is still a lack of clarity as to the participant's burden of proof with respect to causation and harm. Under those circumstances where participants are required to make individualized showings of reliance – or at least some showing of individualized harm – as a condition for prevailing, the chances of defeating class certification will be substantially enhanced.