It’s often said that “if at first you don’t succeed, try, try again.” Of course, it’s also said that doing the same thing and expecting a different result is the definition of insanity. So, how might that apply in a fiduciary suit?
As it turns out, in a recent case three participant-plaintiffs allege that the fiduciary defendants breached their fiduciary duties to participants in the Johnson & Johnson Savings Plan, the Johnson & Johnson Savings Plan for Union Represented Employees, and the Johnson & Johnson Retirement Savings Plan because J&J’s senior leadership were aware for decades that J&J’s talc-based products, including J&J’s Baby Powder, contained asbestos and concealed that information from investors, resulting in an artificial inflation of the value of the Company’s stock. An inflation that all came crashing down when that situation came to light—which had a decidedly negative impact on the value of participant holdings in the ESOP—which led to this “stock drop” litigation.
The standard in these cases—established by the U.S. Supreme Court in 2014 in the case of Fifth Third Bancorp v. Dudenhoeffer—has been that in order to successfully assert a breach of the duty of prudence in these cases “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.” And, as we have noted previously, that has turned out to be a difficult standard to meet.
That Was Then
In this case, the plaintiffs ave already been rebuffed once—in April 2020, when U.S. District Judge Freda L. Wolfson (who also ruled on the case at hand) granted the J&J defendants’ motion to dismiss the original complaint for failure to meet that standard—but then gave the plaintiffs leave to amend their claims. Which they subsequently did—but not sufficiently to satisfy Judge Wolfson—for the reasons that follow.
Judge Wolfson noted that this time around (Michael Perrone v. Johnson & Johnson et al., case number 3:19-cv-00923, in the U.S. District Court for the District of New Jersey) the plaintiffs alleged that the J&J defendants (including, by the way Chief Human Resources Officer Peter Fasolo and retired Chief Financial Officer Dominic Caruso) had the “opportunity to correct the record and make the truth about asbestos in Johnson & Johnson’s talc products known to the public” and if they had done so, “the Plans’ participants could have avoided millions of dollars in purchases of artificially inflated J&J shares, and subsequent losses in the value of the Johnson & Johnson stock in their Plan accounts when the truth was revealed to the market.”
The plaintiffs also argued that the J&J fiduciaries “could have used the unitized nature of the Plans’ stock funds to increase the cash buffer of the funds rather than invest in new stock purchases until such time as the stock was no longer artificially inflated.” Finally, the plaintiffs claim that “disclosure would not be necessary under the federal securities laws, so any concern Defendants might have about ‘spooking’ Plan participants or the market generally would be unfounded.” To finish that thought, they claim that “[o]nce the truth came out about Johnson & Johnson’s talc products—as it inevitably would—Plan participants would have been spared significant harm.”
Having laid out those arguments, Judge Wolfson returned to the previous decision where, as she explains here, she concluded that the plaintiffs had “adequately alleged” that the Individual Defendants were plan fiduciaries, and that J&J could be held vicariously liable for actions committed by the Individual Defendants within the scope of their employment. However, then she had questioned whether the corrective disclosure theory satisfied the standard set forth by the Supreme Court in Fifth Third Bancorp v. Dudenhoeffer—which stated that 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.
At that time, even though procedurally she was required to accept the plaintiffs’ presumptions as true, she concluded their arguments fell short of that standard for two reasons; that the plaintiffs’ alleged alternative would have required the Individual Defendants to take an action which could not have been completed in their fiduciary capacity, but only in their corporate one, and that the plaintiffs “…had not adequately alleged, as required by Dudenhoeffer, that their prescribed course of conduct would not do more harm than good.” Judge Wolfson noted that there was a significant drop in J&J stock price following the publication of a Reuters article about the asbestos and it was “not readily apparent that an earlier disclosure of the alleged asbestos in J&J’s [had] products would have caused less damage than a later disclosure.” And—having made that determination, dismissed the claim, with an option to amend it—which they did, and which—following the defendants’ move to (again) dismiss those claims—brings us to the current case.
This Is Now
This time around, the plaintiffs argue that the defendants could have incorporated J&J’s securities filings “into plan-related documents,” i.e., the Summary Plan Description (SPD) and Prospectus, issuing a corrective securities disclosure, or failing to issue such a disclosure, is no longer “a purely corporate” act.
However, Judge Wolfson was unpersuaded, noting that, despite the repositioning, “Plaintiffs have not identified a new alternative action; rather, they now seek to reconstrue what I previously held was a corporate act, i.e., issuing a corrective SEC disclosure, as a fiduciary action. The crux of the alternative action asserted by Plaintiffs has not changed.” Judge Wolfson went on to note that “the SPD, itself, expressly provides that the SEC filings are not part of the SPD and are only incorporated by reference into the Prospectus,” and that “the Prospectus, unlike the SPD, is not a document which ERISA requires the fiduciaries to furnish to the plan participants.”
Turning to Justice Kagan’s concurrence in the Dudenhoeffer case, she noted that she had acknowledged that a fiduciary can have no obligation to take actions “violat[ing] the securities laws” or “conflict[ing]” with their “requirements” or “objectives.” Judge Wolfson then concluded: “as I did on the prior motion to dismiss, that issuing a corrective SEC disclosure revealing the alleged truth about the over inflation of J&J stock and/or the asbestos in the company’s talc products, is not a viable alternative action because it is not one which could be taken in a fiduciary capacity, but only in a corporate one.”
Buffer Rebuffed
As for the so-called “cash buffer” argument—well, Judge Wolfson noted that the defendants responded that they would have been required to issue a public disclosure explaining why the fund was no longer investing in J&J stock, and that disclosure would have caused the Company’s stock prices to drop, negatively impacting the Plans’ funds. Alternatively, even if they were not expressly required to disclose the precise reason for increasing the cash buffer (the alleged asbestos in J&J’s talc-products), increasing the Plans’ cash buffers would have caused market speculation and a resulting decline in stock price. And finally, they counter that even absent a decrease in the Company’s stock price, increasing the cash buffer could have harmed the fund by creating an “investment drag”—something that they note “other courts have rejected similar arguments based on the possibility that increasing an ESOP plan’s cash reserves reduces the return of the stock portion of the fund and hurts current investors.”
All of which, in Judge Wolfson’s assessment, meant that “increasing the fund’s cash buffer would have triggered a disclosure under both ERISA and the federal securities laws,” and that since “…under the securities regulations ... [w]henever an issuer, or any person acting on its behalf, discloses any material nonpublic information regarding that issuer or its securities, the issuer is also required to simultaneously make a disclosure to the public at large,” if the defendants had opted to increase the cash buffers, they “would have been required to reveal to the public-at-large that they were doing so, and to explain that they were doing so because the Company’s stock was artificially inflated and/or that J&J’s talc based products contain asbestos. In essence, increasing the cash buffer—like issuing a corrective disclosure—would have required the Company to reveal the alleged truth about the talc in its products.”
Now, while the plaintiffs argue that Dudenhoeffer’s “more harm than good” standard is satisfied because, by the outset of the class period the disclosure of the truth about J&J’s talc products was “inevitable in light of the increasing number of lawsuits filed against J&J, and the discovery process attendant to such proceedings.” Moreover, they allege that the defendants “should have recognized that earlier disclosure was by far the less harmful option than the one that they did choose—namely, waiting for the truth to come out on its own.”
Harm ‘Full’?
However, Judge Wolfson noted that, “because disclosure would have been required, I find that a prudent fiduciary could have concluded that the disclosure would have resulted in a drop of the Company’s stock price and thus would have done more harm than good.” Additionally, she wrote that “…public admission of alleged decades long asbestos contamination, in the face of J&J’s prior statements to the contrary, would certainly have led to significant reputational harm and a corresponding decrease in the Company’s value, regardless of the timing of such a disclosure.
“As such I found Plaintiffs’ arguments pertaining to the ‘more harm than good’ analysis unavailing,” she wrote, concluding that “Plaintiffs rely on those same arguments now, and I, once again, find them unpersuasive.”
In fact, Judge Wolfson commented that “the Supreme Court noted in Dudenhoeffer, itself, that freezing purchases of an ESOP fund’s stock could signal to the market that insider fiduciaries viewed the employer’s stock as a bad investment.” Wolfson went on to explain that “…nearly every Circuit Court of Appeals to have considered this issue, has found, that an alternative action does not satisfy Dudenhoeffer, when it requires disclosure, either inadvertently or deliberately, of negative information that would cause the company’s stock to drop.”
And yet, despite having come up short twice, and noting that in crafting the Dudenhoeffer standard, the Supreme Court aimed to provide a framework which allows for “careful, context-sensitive scrutiny of a complaint’s allegations,” Judge Wolfson granted the plaintiffs one last opportunity to “amend their complaint and incorporate context-specific allegations regarding J&J, which could demonstrate that increasing the Plans’ cash buffer would not have done more harm than good”—and gave them the opportunity to do so “within 30 days from the date of the accompanying Order.”
What This Means
The case above—as are all of these “stock drop” cases—turns on the standard established by the Supreme Court in 2014. At that time the Court seemed truly concerned that the “presumption of prudence” standard basically established a standard that was effectively unassailable by plaintiffs—and in fact, until that point the vast majority of these cases (including BP and Delta Air Lines, Lehman and GM) failed to get past the summary judgment phase. However, the “more harm than good” standard that emerged with Fifth Third, while a new “standard,” hasn’t had much impact on the ultimate result, though more cases did get past the summary judgment stage (we’ll set aside the question of whether that has created “more harm than good”).
Ultimately, the consistency of these decisions may be of some small comfort to plan fiduciaries who also have corporate responsibilities. On the other hand, the persistency of these suits should provide at least some pause to those who have those overlapping responsibilities.
- Log in to post comments