Employee Retirement Income Security Act (ERISA) does not Impose Legal Duty on Fiduciaries to Disclose to Participants that they are Selling Most of Their Own Stock in Company Seventh Circuit Holds
Plaintiffs, participants in the defined-contribution supplemental pension plan of their employer Indianapolis Power & Light Company (the Thrift Plan), filed a class action against the Plan’s fiduciaries alleging breach of duties under ERISA (Employee Retirement Income Security Act) based on defendants’ failure to disclose to Plan participants that they had sold most of their own stock in the company. Nelson v. Hodowal, ___ F.3d ___, 2008 WL 90057, *1 (7th Cir. January 2, 2008). The district court certified the litigation as a class action and the class action proceeded to trial. Id., at *2. The district court found in favor of defendants and plaintiffs appealed, id. The Seventh Circuit affirmed.
The Seventh Circuit summarized the factual underpinnings of the class action as follows. The Thrift Plan “initially limited employees to holding stock of IPALCO Enterprises, Inc., the employer’s parent corporation, or bonds issued by the United States,” but was subsequently amended to permit participants “to diversity their investments” and, ultimately, nine (9) options ranging “from very conservative (a money-market fund) to risky (IPALCO stock and nothing else).” Nelson, at *1. “The Plan hired Merrill Lynch, Pierce, Fenner & Smith, Inc., to advise the participants about appropriate investments; Merrill Lynch stressed the benefits of diversification. The Plan allows participants to change investments among the nine options daily, with no need for advance notice.” Id. However, “all of the employer’s matching contributions were allocated to IPALCO stock; the Plan’s terms made this mandatory.” Id. IPALCO merged with global energy company AES Corporation in 2001, and “AES offered a premium of 16% relative to the price at which IPALCO’s stock had traded the day before the announcement.” IPALCO stock climbed following the announcement, and by the time the merger closed “about 64% of investments in the Thrift Plan were held as IPALCO stock ($145.4 million of the Plan’s total assets of $228.1 million).” Id. Because AES is significantly larger than IPALCO, IPALCO’s performance does not significantly impact the market value of AES stock. Nelson, at *1. “When the merger closed, AES was trading for $49.60 a share,” but it began a rapid descent and on February 21, 2002 it “reached a low of $4.11.” Id. The record does not reflect the reasons for the stock’s decline but does confirm that “it continues to be a substantial enterprise” with $6.7 billion in revenues in 2000 and “a profit of roughly $1.40 a share” and $12.3 billion in revenues in 2006. Id. “The stock closed on December 18, 2007, at $21.58.” Id.
Plaintiffs filed a class action against the Plan’s fiduciaries alleging ERISA violations. Nelson, at *2. “The principal contention was that the fiduciaries (all of whom were executives at Indianapolis Power & Light) should have seen the decline coming, or at least should have understood that AES is too volatile to be a suitable investment for pension holdings, and therefore had to compel all of the participants to exchange their IPALCO stock for the Plan’s other investment options before the merger closed.” Id. The class action proceeded to a bench trial, and the district court “found essentially every disputed fact in defendants’ favor.” Id. (citing 480 F.Supp.2d 1061 (S.D. Ind. 2007)). Specifically, the district court “concluded that the defendants had no reason to foresee any decline in the price of AES’s stock (had, indeed, no inside information about AES) and that reasonable fiduciaries would have deemed AES a suitable stock.” Id. Further, the judge “concluded that an ERISA fiduciary is not obliged to strip participants of the ability to make their own decisions, for good or ill” and that “the fiduciaries [were not] obliged (or even allowed) to disregard the Plan’s provision requiring all of the employer’s contributions to be held as IPALCO (and then AES) stock.” Id.
The sole issue on appeal was “whether the defendants had to tell the participants that the defendants were selling most of their own stock in IPALCO-not only stock held through the Thrift Plan, but also stock that the defendants were able to acquire by exercising vested options that they had received in their roles as managers or directors of Indianapolis Power & Light.” Nelson, at *2. In essence, plaintiffs argued that defendants implicitly promoted AES as a good investment “while by divesting their own holdings they demonstrated that their true beliefs were otherwise,” a form of implied deceit referred to by the securities law as “scalping.” Id. The district court had rejected this argument and expressly found that “the defendants actually (and reasonably) believed everything they told the participants, and that they sold IPALCO stock, and cashed out their options, only because AES had announced that it would replace the management team at Indianapolis Power & Light.” Id. In other words, “[t]he defendants were on their way out the door and had no more reason to hold IPALCO (or AES) stock than to hold any other utility stock, and substantial reasons to diversify.” Id. Plaintiffs did not challenge these findings on appeal, id., at *3.
The Seventh Circuit explained that “the case boils down to an argument that an ERISA fiduciary has a duty to disclose, directly to a pension plan’s participants, even non-material information that may affect the participants for reasons unrelated to the value of the investment.” Nelson, at *3. The Circuit Court paid short shrift to this argument, noting at page *3: “plaintiffs maintain that, even though the defendants’ sales did not imply any belief that AES was overpriced in the market or an unsuitable investment for the Thrift Plan’s ongoing participants, defendants should have told each of the participants point blank that the fiduciaries were getting out while the going was good.” To the extent such a warning was required, defendants properly had disclosed their stock sales under § 16(a) of the Securities Exchange Act of 1934, so that information was known “in the fall of 2000 – long before the closing,” but the market did not react negatively to those disclosures. Id.
At bottom, plaintiffs’ theory was that many of the Plan participants would have copied the investment moves of the managers and so “would have sold IPALCO as soon as they learned of the managers’ decisions.” Nelson, at *3. The Circuit Court was disagreed, holding at page *3 that “no regulation or decision requires ERISA fiduciaries to disclose facts that may lead to idiosyncratic reactions.”
Any tidbit might cause such a reaction; the materiality requirement entitles fiduciaries to limit their disclosures and advice to those facts that concern real economic values. In the language of securities law, a non-disclosure that may affect a person’s choice about which securities to hold, but does not relate to the value of those securities, yields transaction causation but not loss causation. And without loss causation there is no liability. [Citation.]
Finally, the Circuit Court explained that fiduciaries may discharge their duty to furnish information “directly or through an intermediary such as Merrill Lynch,” and that “[o]ften delegating the function to a specialist is best for a novice investor.” Here, Merrill Lynch actively advised Plan participants to diversify. Nelson, at *4. “ERISA does not hold a fiduciary responsible for the decline in an investment’s value, when an informed and independent investment adviser has been furnished without charge to all beneficiaries, who exercise full control over which investments their accounts will hold.” Id. Accordingly, the Seventh Circuit affirmed the judgment in favor of the defendants on the class action complaint. Id.
NOTE: Both the Supreme Court and the Seventh Circuit are considering appeals concerning “the extent to which [29 U.S.C.] § 1132(a) authorizes suits seeking recoveries by defined-contribution plans, whose participants may have made different choices and thus were affected differently by the fiduciaries’ conduct.” Nelson, at *2 (citing LaRue v. DeWolff, Boberg & Assoc., U.S. Supreme Court Case No. 06-856 (argued Nov. 26, 2007), and Rogers v. Baxter Int’l, Inc., Seventh Circuit Case No. 06-3241 (argued Nov. 2, 2007)).