Calculating damages in 401(k) litigation over company stock.

Publication: Benefits Law Journal

Publication Date: 22-MAR-06

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COPYRIGHT 2006 Aspen Publishers, Inc.

In this article, we will identify the important legal and factual damages issues encountered in typical company stock drop cases. We review background legal precedent for determining and measuring loss in Employee Retirement Income Security Act (ERISA) breach of fiduciary duly cases where the basis of liability is alleged, as in company stock drop cases, to be imprudence in investing plan assets. This relatively well-established case law, while applicable to company stock drop cases, provides an incomplete framework for assessing compensable loss in these cases. We will identify and discuss some additional and unique damages questions confronting the parties and the courts in company stock drop cases. Our assessment leads to the conclusion that, in many if not most stock drop cases, the ultimate measure of damages will not be appreciably different than if liability was alleged to be based on a violation of federal securities laws rather than ERISA.

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The prosecution of class action lawsuits seeking recovery under ERISA (1) for retirement savings plan losses on investments in employer stock is now commonplace. An experienced and well-funded plaintiffs' bar has emerged to investigate and commence such litigation promptly when adverse corporate events lead to a decline in the market price of the employer stock. Plaintiffs generally allege that the events were or should have been known to be foreseen by senior management holding positions as plan fiduciaries; that the defendants acted imprudently by allowing the plan and its participants to continue to hold, and to increase, their positions in company stock; and that the defendants acted disloyally in failing to inform plan participants of the adverse information sooner. Often, the same stock drop also generates a securities class action where the plan and its participants may be class members with issues and damage theories that overlap the tandem ERISA case.

Although there are cogent arguments as to why such claims should not be permitted as a matter of law, (2) for the most part efforts by defense counsel to obtain early dismissal of these lawsuits have been unsuccessful. (3) More and more cases are being certified as class actions and are proceeding to in-depth discovery and trial preparation or are settling. Attention in the defense of these cases is therefore turning, quite naturally, to careful evaluation of causation and damages theories.

DAMAGES AND CAUSATION IN ERISA CLAIMS BASED ON IMPRUDENT INVESTMENT

ERISA's basic remedial provision is ERISA Section 409(a), providing as follows: [a]ny person who is a fiduciary with respect to a plan who breaches any of the responsibilities, obligations[,] or duties imposed upon fiduciaries by this subchapter shall be personally

liable to make good to such plan any losses to the plan resulting

from each such breach, and to restore to such plan any profits

of such fiduciary which have been made through use of assets of the plan by the fiduciary, and shall be subject to such other equitable or remedial relief as the court may deem appropriate, including removal of the fiduciary. (4) There is general agreement that the primary purpose of assessing damages is "to undo harm that may have been caused a pension plan by virtue of the fiduciaries' acts." (5) Accordingly, recovery is limited to losses having a meaningful causal connection to the particular breach of fiduciary duty that is alleged in a given case. (6) Because of the requirement of proximate cause, identifying the nature of an alleged fiduciary breach the particular ERISA provision or duty that has been violated--is an essential starting point for measuring the existence and extent of compensable loss under ERISA Section 409(a). (7)

The leading case regarding the identification and measure of compensable "loss to the plan" for imprudent fiduciary investment decisions is Donovan v. Bierwirth. (8) Donovan involved a corporate control contest in which senior managers of Grumman Corporation, also serving as trustees of the Grumman Corporation Pension Plan, caused the Pension Plan to purchase large quantities of Grumman stock in an effort to thwart a hostile tender offer for a controlling interest in the company. Because the tender offer was for $45 per share, the stock price rose from approximately $26 per share just prior to the tender offer to $38.34, the price at which the Pension Plan purchased 1,158,000 shares. The tender offer failed, and the share price fell--as the fiduciaries knew it would if they were successful in defeating the takeover back to $23 per share. The trustees sold those shares for an average price of $49.75 (including $2.20 per share in dividends) 17 months later. Thus, even though the Grumman stock purchase may have been self-interested and imprudent at an artificially inflated price, it resulted in a gain of $11.41 per share.

Notwithstanding the gain, the Secretary of Labor filed suit against the trustees alleging that they misused plan assets and acted imprudently in causing the plan to acquire Grumman stock at a price in excess of $38 per share, which they knew to be inflated by the tender offer they sought to defeat. The district court bifurcated the trial to focus first on evidence regarding loss to the plan, and only later on the question of whether a breach of fiduciary duty had occurred. After the first phase, the court dismissed the case, finding that even if a breach occurred, the plan had suffered no "loss" because it profited on the challenged purchase of Grumman stock.

In reversing, the Second Circuit established the basic framework for considering questions about the existence and extent of compensable "loss to the plan" in an ERISA breach of fiduciary duty case based on allegations of imprudent investment. The court rejected the Secretary of Labor's argument that the plan's loss should be measured as the difference between the "tender-offer-inflated" $38 per share paid by the plan in acquiring the stock, and the $23 per share that, in the Secretary of Labor's view, reflected the actual value of the stock unaffected by the $40 per share tender offer. The court held that such a measure of damages may be proper in a case alleging that the plan paid higher than market price for stock or higher than fair value for stock not publicly traded (e.g., where a plan purchases stock in a leveraged buy-out by management). The court declined to permit an "overpayment"...

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