Release Date: 
04/24/19

By Pension and Benefits Editorial Staff

ESOP fiduciaries did not breach their duty to prudently manage plan assets by failing to attempt to persuade officers of the plan sponsor from making affirmative misrepresentations that they knew, based on inside information, artificially inflated the value of the company stock, according to a federal trial court in Texas. The corrective course of action suggested by the plan participants, the court determined was not so clearly beneficial that a prudent fiduciary could not conclude that it would be more likely to harm the fund than to help it. The court affirmed the strict pleading standard followed in the Fifth Circuit, while distinguishing a contrary ruling from the Second Circuit.

Drop in allegedly artificially inflated stock. Exxon maintained an ESOP, to which employees were allowed to contribute up to 25 percent of their compensation. The plan was administered and managed by senior corporate officers of Exxon.

Exxon stock, worth nearly $10 billion, represented the largest single holding of the plan. The plan also continued to purchase $800 million of Exxon stock during a class period when the stock price was allegedly artificially inflated because of fraudulent misrepresentations by Exxon officers regarding the impaired status of its oil reserves. Public statements from the company suggested that it was in a uniquely strong position, avoiding the impaired reserves being reported by its competitors.

In large measure because of the alleged misrepresentations, Exxon's stock price rose to $95 per share in July 2016. However, in Autumn of 2016, the New York Attorney General and the SEC began investigations into whether the company was defrauding investors by overstating the value of its reserves. Subsequently, in October 2016, Exxon revealed that it would need to write down the value of its assets and reserves, precipitating a decline in its stock price of more than $3 a share.

Plan participants brought suit, charging that the plan fiduciaries knew (or should have known), on the basis on non-public inside information, that the Exxon stock price was artificially inflated, yet continued to purchase the stock, in violation of their duties under ERISA. According to the participants, the fiduciaries should, alternatively, have issued disclosures correcting the misrepresentations. A federal trial court in Texas dismissed the participants' claim, ruling, in accord with Fifth Circuit precedent, that the proposed alternative action of corrective disclosure was not so "clearly beneficial that a prudent fiduciary could not conclude that it would be more likely to harm the fund than to help it."

In an amended complaint, the participants stressed the fiduciaries' knowledge of the company's fraudulent misrepresentations and maintained that the fiduciaries should have persuaded the parties responsible for making Exxon's required disclosures under securities law to refrain from making the affirmative misrepresentations. The fiduciaries filed a 12(b)(6) motion to dismiss, arguing that the amended complaint did not meet the applicable standard for pleading a breach of fiduciary duty. The court, strictly adhering to Fifth Circuit precedent and dismissing contrary reasoning from the Second Circuit, granted the motion to dismiss.

Action that prudent fiduciary would not view as more likely to harm the fund. Initially, the court explained that, under the governing standard articulated by the United States Supreme Court, plan participants alleging a breach of the duty of prudence on the basis of non-public information must plausibly allege an alternate action that could have been taken that a prudent fiduciary in the same circumstances would not view as more likely to harm the fund that to help it (Fifth Third Bancorp v. Dudenhoeffer, US Sup Ct (2014), 134 S. Ct 2459). As further explained by the Fifth Circuit, the alternative course of action must be so clearly beneficial that a prudent fiduciary "could not" conclude that it would be more likely to harm the fund than to help (Whitley v. BP, P.L.C., CA-5 (2016), 838 F. 3d 523).

Applying the strict pleading standard to the amended complaint, the court refused to conclude that an attempt to prevent Exxon's alleged misrepresentations would have been so clearly beneficial that a prudent fiduciary would not determine that it would be more likely to harm the fund than to help it. According to the court, as other comparable companies made corrective disclosures, "remaining silent may have communicated to market investors that Exxon was facing the same trouble, which would have had the same outcome as corrective disclosure."

Jander distinguished. Despite affirming the Fifth Circuit precedent regarding the sufficiency of corrective disclosures to plead fiduciary breach, the court did acknowledge a contrary holding in which the Second Circuit ruled that plan fiduciaries could not conclude that a corrective disclosure would do more harm than good (Jander v. Retirement Plans Comm. of IBM, CA-2 (2018), 910 F.3d 620). The Second Circuit premised its ruling on its understanding that the reputational damage to the company would increase the longer the fraud continued and that the disclosure of the inside information was inevitable.

The Texas trial court, however, distinguished Jander, first rejecting the Second Circuit's belief that fraud becomes more damaging to a company's reputation the longer it persists. The argument embraced by the Second Circuit, the court noted, has been expressly rejected by the Fifth Circuit (Martone v. Robb, CA-5 (2018), 902 F. 3d 519).

The court also distinguished Jander by noting the absence of any major triggering event that made Exxon's eventual disclosure inevitable. The participants argued that the investigations by the New York Attorney General and the SEC made disclosure of the non-public information inevitable. The court, however, highlighting the difference between an investigation and a "public charge," reasoned that while eventual disclosure was "foreseeable," it was not inevitable. Accordingly, the participants could not establish that a "prudent fiduciary could not conclude that remaining silent could have resulted in a drop in stock prices that would have done more harm than good to the plan."

SOURCE Fentress v. Exxon Mobil Corporation (DC TX).