Recently, the U.S. Court of Appeals for the Sixth Circuit held that a 401(k) plan participant who sued under the Employee Retirement Income Security Act (ERISA) for losses in connection with a company stock fund that suffered a drop must show losses on a “net basis” during the class period to have constitutional standing. This decision has great significance in addressing plaintiffs’ standing and class certification in so-called ERISA “stock-drop” cases, often filed after a company’s stock price falls.

Introduction

On May 25, 2012, the U.S. Court of Appeals for the Sixth Circuit held that a 401(k) plan participant who sued under the Employee Retirement Income Security Act (ERISA) for losses in connection with a company stock fund that suffered a drop must show losses on a net basis during the class period to have constitutional standing. This decision has great significance in addressing plaintiffs’ standing and class certification in so-called ERISA “stock-drop” cases, often filed after a company’s stock price falls.

Case Background

Plaintiff Ann Taylor was a participant in the KeyCorp 401(k) Savings Plan (the Plan). The Plan included KeyCorp company stock as one of the investment options. After the company’s stock price fell, Taylor filed suit against the company and certain alleged named fiduciaries in 2008.

Taylor alleged the company had failed to disclose and misrepresented its inappropriate lending and tax practices, which, after being revealed, led to the stock price decline. Taylor alleged that the defendants breached their fiduciary duties by failing to prudently manage the Plan’s investment in KeyCorp stock; that the defendants failed to adequately inform participants about the true risk of investing in KeyCorp stock; that the defendants breached their fiduciary duties by failing to adequately monitor the management and administration of Plan assets; and that they failed to avoid impermissible conflicts of interest. 

The complaint defined the proposed class as “[a]ll persons who were participants in or beneficiaries of the Plan whose Plan accounts included investments in KeyCorp common stock … at any time between December 31, 2006 and the present.”

Defendants filed a motion to dismiss, arguing that on a net basis, Taylor had profited from trades made during the class period, and therefore lacked standing to bring the lawsuit. Specifically, Taylor sold more than 80 percent of her KeyCorp holdings during the time she claimed the stock was artificially inflated, resulting in a net profit to her of $6,317 during the class period.

The district court dismissed the lawsuit, holding that Taylor did not suffer actual injury because she had benefitted from the alleged breaches of fiduciary duty, which allowed her to sell the majority of her KeyCorp holdings at an inflated price.

The Sixth Circuit Decision

On appeal, the Sixth Circuit affirmed. The court concluded it is “common sense” that “plaintiffs suffer no ‘actual injury’ when they benefit from alleged artificial [price] inflation.” In so finding, the court rejected the damages arguments proffered by the plaintiff and the U.S. Department of Labor as amicus curiae.

First, the court rejected Taylor’s “alternative-investment theory” argument that she would have made more money on her investments if her holdings had been transferred away from KeyCorp stock and placed in the best performing alternative investment, in this case the S&P 500 index. The Sixth Circuit held that “such a measure of damages is not appropriate in this case” because “damages based upon an entirely different investment vehicle, such as the S&P 500, are not ‘fairly traceable’ to the defendants’ [alleged] breach.” Rather, the court held that out-of-pocket loss is the correct measure in cases like Taylor’s, which primarily involve information alleged to have been improperly withheld.

The Sixth Circuit also rejected Taylor’s and the Department of Labor’s argument that Taylor had standing because she sold some company stock for a loss during the class period. The court observed the fiduciary duties outlined in ERISA draw upon the common law of trusts, which requires “the netting of gains and losses stemming from a single breach of fiduciary duty.” Because the plaintiff did “not allege separate breaches causing separate damages” during the class period, “all gains and losses during the class period, attributable to one course of conduct, should be netted.” Based on that netting, the Sixth Circuit found it was “clear that Taylor has suffered no actual injury,” and therefore lacked constitutional standing.

Significance of the Sixth Circuit Decision

The impact of the KeyCorp decision may be limited to ERISA stock-drop cases involving allegations that fiduciaries failed to disclose and/or misrepresented corporate practices that caused the stock to be “artificially inflated.” However, in such cases, the decision renders a significant blow to plaintiffs seeking to bring such claims. In rejecting the “alternative-investment theory” for claims of artificial inflation due to failing to disclose the “true financial and operating condition” of the company and, instead, examining losses on a net basis, the Sixth Circuit decision will likely significantly reduce the amount of recovery, if any, that plaintiffs may obtain.
Not only may such cases now be easier for a defendant to defeat by challenging the standing of a plaintiff who did not suffer a loss on a “net basis,” the ramifications for class certification may be significant. The KeyCorp decision provides strong support for opposing class certification on the grounds that each member of the putative class must show he or she suffered a loss on a net basis resulting in individual harm. Even in cases where a class is certified, the class size may be significantly reduced after accounting for those ERISA plan participants who did not suffer a loss on a net basis during the class period.