Third Circuit: ESOP Plaintiffs Failed to Meet High Pleading Standard for ERISA Breach of Prudence Claim Based on Inside Information

Since the Supreme Court decided Fifth Third Bancorp v. Dudenhoeffer, 573 U.S. 409 (2014), it has been difficult for participants in employee stock ownership plans (ESOPs) to adequately allege a breach of ERISA’s fiduciary duties against ESOP plan fiduciaries for continuing to buy or hold employer stock when they knew or should have known that stock was overvalued and excessively risky. Dudenhoeffer held that ESOP fiduciaries are not entitled to a presumption of prudence, and they could prudently rely on the market price of stock as the assessment of its value in light of all public information. It further held that any claim for the breach of the duty of prudence based on inside information must include allegations of an alternative action that a fiduciary could have taken consistent with securities laws, which a prudent fiduciary in the same circumstances would not have viewed as more likely to harm the plan than to help it.

In this recent case, Perrone v. Johnson & Johnson, No. 21-1885, 2022 WL 4090301 (3d Cir. Sept. 7, 2022), the Third Circuit was tasked in deciding whether fiduciaries of the Johnson & Johnson ESOP, which is an investment option within J&J’s retirement savings plan, violated their fiduciary duties by failing to protect the ESOP’s beneficiaries from a stock price drop which followed from growing allegations and lawsuits related to asbestos in Johnson’s Baby Powder and a 2018 investigative report published by Reuters, J&J Knew For Decades That Asbestos Lurked In Its Baby Powder. These allegations led to significant lawsuits against J&J, including a multi-district products liability action and a securities fraud action. In this lawsuit, Plaintiffs allege two alternative actions that the ERISA fiduciaries should have taken: (1) they should have issued corrective disclosures to correct the stock’s artificial inflation, and (2) they should have directed new ESOP contributions into the ESOP’s cash buffer rather than to purchase J&J stock at artificially inflated prices. The Third Circuit determined that neither of these actions satisfies Dudenhoeffer because a prudent fiduciary in the Defendants’ position could have concluded that either action would harm more than help the ESOP.

With respect to the corrective disclosures, assuming such disclosures would have been consistent with securities laws, the court found that Plaintiffs only allege a general economic theory for why earlier disclosure would have been preferable, which does not satisfy the required showing of an alternative action that would not have done more harm than good. Here, Plaintiffs had to plausibly allege that the circumstances do not justify a prudent fiduciary’s preference to await the results of a thorough investigation into the matter before making a public disclosure. The court noted that the products liability actions are ongoing, and it is still uncertain whether J&J will be liable in tort for dangers related to its talc products. Further, J&J has not admitted that its talc products contain asbestos. As J&J has already prevailed in some products liability trials, there is no consensus that J&J ever had any talc-related issues to cover up. Early disclosures to the press could have caused the stock market to overreact. Thus, a reasonably prudent fiduciary in Defendants’ circumstances could conclude that corrective disclosures would do more harm than good to the ESOP.

With respect to redirection of ESOP contributions to the cash buffer, the court determined that this option would leave a fiduciary between a rock and a hard place, likely to be sued for imprudence either way if he guesses incorrectly about where the stock is headed. Plaintiffs have not adequately alleged that a reasonable fiduciary in Defendants’ position should have anticipated J&J’s stock price was bound to tumble. Defendants could have reasonably anticipated that the stock price would not have dropped or that any price drop would be outweighed by gains accrued prior to the drop or by a rapid rebound. The court found it “too much of a stretch” to state that a prudent fiduciary in Defendants’ position could not have concluded that redirecting contributions would do more harm than good. Because Plaintiffs did not meet the high standard for pleading an ERISA breach of fiduciary duty claim based on inside information, the Third Circuit affirmed the dismissal of Plaintiffs’ complaint.