INTERPLAY BETWEEN ERISA DISCLOSURE AND SECURITIES LAWS:

A SURVEY

Prepared by: Debra L. Mackey, Esq.

Burr & Forman LLP

Birmingham, AL

This article discusses the current status of case law on the relationship between a fiduciary=s obligation under ERISA to disclose information to participants and the restrictions securities laws places on disclosing nonpublic information in the context of employee benefit plans which invest in employer stock. The post-corporate scandal era (e.g. WorldCom, Enron) has flooded the courts with ERISA lawsuits alleging breaches of fiduciary duty involving employer stock. Typical issues in these cases include: who is a fiduciary; what is a fiduciary act; continuing to offer the stock as an investment option and continuing to hold stock as an ESOP investment when fiduciaries knew, or should have known, it was imprudent; failure to monitor other fiduciaries and failure to provide them with information regarding the value of the stock; failure to provide complete and accurate information, and providing misleading information, to participants concerning the stock. The focus of this article is on one narrow issue: how the courts view the interplay between the ERISA disclosure obligations and restrictions on insider information under securities laws.

The survey covers nineteen cases, thirteen of which were decided in 2004, four in 2003, one in 2002, and one in 2001. All are district court cases. In fact, at least one district court within the First through Eleventh Circuits have decided cases involving this issue. We have yet to hear from the circuit courts. Therefore, the state of the law remains very much in flux. Eighteen of the cases surveyed were at the motion to dismiss stage, and the other was a post-dismissal motion. The disclosure claims survived, at least with respect to some defendants, in fifteen of the nineteen cases. Of those fifteen, however, at least three express doubt as to the plaintiffs= position requiring disclosure.

A brief discussion of the Court’s position in each of these cases follows, in chronological order from the earliest decided case.

1. Hull v. Policy Mgmt. Sys. Corp., 2001 U.S. Dist. LEXIS 22343 (D. S.C., Feb. 9, 2001). Claims dismissed. With respect to the corporate defendants, the Court said:

If the allegations of wrongdoing . . . ultimately prove true, the Plan=s remedy will be the same as for the plaintiff class in the related securities action. This result is not at all unreasonable as the duties of disclosure owed to the Plan by the corporate defendants are not based on the duties owed by an ERISA fiduciary to a Plan and its participants, but the general duties of disclosure owed by a corporation and its officers to the corporation=s shareholders.

With respect to the committee defendants, the Court viewed plaintiff=s position as calling for a different standard of care with respect to the purchase of company stock than would be applied to other stock. The Court said:

. . . this standard would put the Committee in the untenable position of choosing one of three unacceptable (and in some instances illegal) courses of action: (1) obtain Ainside@ information and then make stock purchase and retention decisions based on this Ainside@ information; (2) make the disclosures of Ainside@ information itself before acting on the discovered information, overstepping its role and, in any case, likely causing the stock price to drop; or (3) breach its fiduciary duty by not obtaining and acting on Ainside@ information.

2. In re McKesson HBOC, Inc. ERISA Litig., 2002 U.S. Dist. LEXIS 19473 (N.D. Cal., Sept. 30, 2002). Claims dismissed. The Court said:

The court agrees that the fiduciaries were not obligated to violate the securities laws or other laws merely to protect the interests of Plan participants. . . . There was no lawful action that could have been taken by the fiduciary that would have avoided the subsequent loss occurring after public disclosure of the accounting problems.

3. In re WorldCom, Inc. ERISA Litig., 263 F. Supp.2d 745 (S.D. N.Y. 2003) (decided June 17, 2003). Claims survive. The Court said the securities laws cannot shield a fiduciary from failure to perform ERISA obligations.

When a corporate insider puts on his ERISA hat, he is not assumed to have forgotten adverse information he may have acquired while acting in his corporate capacity. Plaintiffs= allegation that Ebbers failed to disclose to the Investment Fiduciary and the other investing fiduciaries material information he had regarding the prudence of investing in WorldCom stock is sufficient to state a claim.

Furthermore, . . . ERISA fiduciaries cannot transmit false information to plan participants when a prudent fiduciary would understand that the information was false.@ Plaintiffs= claim does not require

ERISA fiduciaries to convey non-public material information to Plan participants. What is required, is that any information that is conveyed to participants be conveyed in compliance with the standard of care that applies to ERISA fiduciaries. . . . While there may be some case in which there will be a conflict between the two statutory schemes, it is not so evident that a conflict exists here. The Complaint alleges that WorldCom=s SEC filings contained material misrepresentation regarding WorldCom=s financial condition. Having spoken . . . WorldCom had a duty under the federal securities laws to correct any material misrepresentation when it became aware of the falsity. . . . [T]he existence of duties under one federal statute does not, absent express congressional intent to the contrary, preclude the imposition of overlapping duties under another federal regulatory regime.

4. In re Williams Cos. ERISA Litig., 271 F. Supp.2d 1328 (N.D. Ok. 2003) (decided July 14, 2003). Claims dismissed as to some defendants, survive as to others. The Court rejected the argument that the defendants Ahad no duty to disclose material non-public financial information and, in any event, any such disclosure would have constituted a violation of federal securities laws.

5. Rankin v. Rots, 278 F. Supp.2d 853 (E.D. Mi. 2003) (decided Aug. 20, 2003). Claims survive. This is the AK-Mart@ case. The Court said:

. . . ERISA does not impose a higher standard than securities laws; the duties under ERISA and duties under securities law can exist concomitantly. . . . Defendants had a duty under securities laws not to make any material misrepresentations; they also had a duty to disseminate truthful information to plan participants, including the information contained in SEC filings. . . . [T]heir duties under ERISA and securities law coexist.

6. Tittle v. Enron Corp., 284 F. Supp.2d 511 (S.D. Tx. 2003) (decided Sept. 30, 2003). Claims survive. The Court said:

The fiduciary’s duty to disclose is an area of developing and controversial law. . . . As a matter of public policy, the statutes [ERISA and securities laws] should be interpreted to require that persons follow the laws, not undermine them. They should be construed not to cancel out the disclosure obligations under both statutes or to mandate concealment . . . ; the statutes should be construed to require, as they do, disclosure by Enron officials and plan fiduciaries of Enron=s concealed, material financial status to the investing public generally, including plan participants . . .

7. Crowley v. Corning, Inc., 2004 U.S. Dist. LEXIS 758 (W.D. N.Y., Jan. 14, 2004). Post-dismissal motion denied. Claims dismissed. The Court distinguished this case from WorldCom because the situation in this case was a result of free market forces and not Athe result of bad acts by corporate employees charged with fiduciary responsibilities under the Plan.@ Furthermore, the Court was persuaded by the McKesson case.

8. In re Reliant Energy ERISA Litig., 2004 U.S. Dist. LEXIS 1450 (S.D. Tx., Jan. 27, 2004). Claims survive.

WorldCom holds that once a person is properly alleged to have discretionary control over an ERISA plan’s management or assets, not merely a duty to appoint and monitor the benefits committee=s performance, that person has a duty to disclose material adverse information.

Allegations that defendants’ SEC disclosure statements were materially false and misleading, and that they knew or should have known they were false and misleading, along with allegations that members of the benefits committee were simultaneously officers and directors of the company, is a sufficient basis for a claim that the benefits committee members should have known the material nonpublic information, and is sufficient to survive dismissal Aat this early stage.

9. In re Electronic Data Sys. Corp. ERISA Litig., 305 F. Supp.2d 658 (E.D. Tx. 2004) (decided Feb. 2, 2004). Claims survive.

Although the Court agrees that ERISA does not require Defendants to violate federal insider trading laws by imposing a so-called Aduty to tip,@ Defendants cannot use the securities laws to shield themselves from their fiduciary duty to protect Plan beneficiaries.

10. Pa. Fed=n. v. Norfolk S. Corp. Thoroughbred Ret. Inv. Plan, 2004 U.S. Dist. LEXIS 1987 (E.D. Pa., Feb. 4, 2004). Claims survive. The Court acknowledged that

Officers and Directors are not required to engage in what would essentially amount to insider trading by disclosing non-public information solely to [plan] participants and beneficiaries, nor are they required to advise Plan managers of non-public information outside any fiduciary obligations they may have.

At the motion to dismiss stage, however, the Court allowed the claims to survive because plaintiffs may be able to prove that there was Asome material information the fiduciaries should have provided.

11. In re Sears, Roebuck & Co. ERISA Litig., 2004 U.S. Dist. LEXIS 3241 (N.D. Il., Mar. 2, 2004). Claims survive. The Court emphasized that plaintiffs must show a causal connection between the alleged breach and the alleged losses, noting that had the fiduciaries legally disclosed the information and then attempted to sell the company stock, the price would have dropped and plaintiffs would have suffered losses anyway (the Aefficient capital market=s hypothesis@). Because issues of loss causation are factual, the claim survived the motion to dismiss. The Court did acknowledge that the non-public information must be disclosed to participants.

12. In re Dynegy, Inc. ERISA Litig., 309 F. Supp.2d 861 (S.D. Tx. 2004) (decided Mar. 5, 2004). Claims survive as to some defendants but dismissed as to others. The Court noted that the Fifth Circuit has recognized an affirmative duty to disclose under ERISA where disclosure is needed to correct or clarify Arepresentations made to plan participants by plan fiduciaries acting in their fiduciary capacity.@ In order for the fiduciary to have a duty to disclose, he must have Aactual knowledge of material information, which he knows or should know the plan participants do not know, but need to know, to protect their interests.@ ERISA does not impose a fiduciary duty Ato initiate disclosures needed to correct the misstatements of others absent knowledge of material information that they know the plan participants do not know, but need to know, to protect their interests.

13. Herrington v. Household Int’l., Inc., 2004 U.S. Dist. LEXIS 5461 (N.D. Il., Mar. 30, 2004). Claims dismissed. The Court said:

The disclosure standard urged . . . is too broad as it would require defendants to continuously gather and disclose nonpublic information bearing some relation to the plan sponsor=s financial condition. Such a burdensome and unprecedented level of disclosure has not been approved by the Seventh Circuit and for this court to permit such would be extending the statutory language beyond their plain meaning. . . . [A] public disclosure of the wrongdoing or a notification of others that might leak the information to the public would have caused the stock price to fall and the losses would result to the Plan regardless.

14. Hill v. BellSouth Corp., 313 F. Supp.2d 1361 (N.D. Ga., Mar. 30, 2004). Claims survive. The Court noted, however, that Adisclosure duties under ERISA extend only to information about the ERISA plan and not to any information in the possession of the ERISA fiduciary in his capacity as employer.@ The Court acknowledged that the courts generally are more willing to find an affirmative duty to disclose as this is an Aarea of developing and controversial law.@ Even so:

the court must emphasize that the mere fact that an ERISA plan consists, at least in part, in employer stock does not mean that the ERISA fiduciary duty to disclose plan-related information to beneficiaries is transformed into a general duty to disclose the financial details of the business: some sort of >special circumstance= will be required to trigger these heightened obligations.

15. In re CMS Energy ERISA Litig., 312 F. Supp.2d 898 (E.D. Mi. 2004) (decided Mar. 31, 2004). Claims survive. A[C]oncerning the insider trading argument . . . the court agrees . . . that duties owed under ERISA can exist in harmony with those owed under securities laws.@ Quoting WorldCom, the Court said:

Those who prepare and sign SEC filings do not become ERISA fiduciaries through those acts, and consequently do not violate ERISA if the filings contain misrepresentations. Those who are ERISA fiduciaries, however, cannot in violation of their fiduciary obligations disseminate false information to plan participants, including false information contained in SEC filings.

16. In re Sprint Corp. ERISA Litig., 2004 U.S. Dist. LEXIS 9622 (D. Ks., May 27, 2004). Claims survive. A[F]alse statements in SEC filings cannot create fiduciary status, but they can form the basis for liability against a fiduciary.@

17. Kling v. Fid. Mgmt. Trust Co., 323 F. Supp.2d 132 (D. Mass. 2004) (decided June 23, 2004). Claims survive. The Court noted that defendant=s argument that disclosure of information would violate insider trading laws had been sharply criticized.

18. In re ADC Telecomm., Inc. ERISA Litig., 2004 U.S. Dist. LEXIS 14383 (D. Mn., July 26, 2004). Claims survive. The Court said:

Company officers who act as plan fiduciaries may be required to draw upon their corporate knowledge to properly fulfill their obligations to protect and prioritize the interests of plan beneficiaries. Additionally, courts have held that fiduciary liability may attach based upon public disclosures, such as Securities and Exchange Commission filings.

19. In re AEP ERISA Litig., 327 F. Supp.2d 812 (S.D. Oh. 2004) (decided Aug. 10, 2004). The Court rejected the argument that, in order to comply with ERISA, defendants would have to violate securities laws. The information to be disclosed would have been required by both laws. A[T]he theoretical arguments about conflicting bodies of law will not prevent Plaintiffs from having the opportunity to [pursue their claims].@

Conclusion:

While the majority of the cases have allowed fiduciary breach claims based on nondisclosure of nonpublic information to survive, many note doing so Aat this stage@ as it is really too early to know whether such claims are viable. On the other hand, many of the courts flatly reject the federal laws conflict argument. Therefore, as these cases are fleshed out within the circuit courts, we will hope to glean a better understanding of the disclosure obligations of fiduciaries and corporate officers.

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