Supreme Court Debates When Employee-Stock Plans Should Dump Stock

Apr 3 2014, 3:22pm CDT | by

Justices wrestled with a difficult question at the U.S. Supreme Court today: If the executives in charge of a retirement plan that invests in company stock learn something bad about the company, should they sell?

That would fit the classic definition of insider trading, of course. And it could hardly be good public policy to encourage executives to help their own employees front-run the rest of the market by selling stock at an inflated price to saps who don’t know as much as they do.

Yet the Obama administration came perilously close to that position in arguments today in Fifth Third Bancorp v. Dudenhoeffer. When pressed by the justices on what a trustee of an employee stock plan should do when in possession of material, non-public information suggesting the stock is overvalued, Deputy Solicitor General Edwin S. Kneedler said “it would ordinarily be the right thing to do to sell.”

Seriously?

Justice Samuel Alito asked if Kneedler could possibly mean what he just said.

“No, he can’t — he can’t sell on the basis of inside information,” Kneedler backpedaled. “He could — I’m sorry, he could stop purchasing, which is –”

“But the market will see through that in about two seconds,” Justice Stephen Breyer snapped.

At issue in this case is whether plaintiff lawyers who pounce whenever a company’s stock price falls can make it past the initial motion for summary judgment, with claims that trustees of employee stock ownership plans should have dumped those shares because they knew they were overvalued. Congress carved out an exception for ESOPs from rules requiring retirement plans to diversify their holdings, under the theory that company stock ownership is a good thing and employees are free to put their retirement savings in other investments if they wish. (Despite silly articles like we’ve seen lately that confuse pension plans with self-directed 401(ks).)


Flash Player 9 or higher is required to view the chart
Click here to download Flash Player now

The justices struggled with how to apply centuries-old standards of fiduciary duties to the peculiar situation of trusts that invest in only one stock, overseen by company executives who may possess inside information.ESOPs hold over $1 trillion in assets and how the Supreme Court rules in this case could have broad implications for how they are run and whether companies take the risk of offering them at all.

For plaintiff lawyers, it’s simple: They should sell when the stock is “overvalued.” Or at the very least, put the fund in the hands of independent directors who don’t have inside information — and charge lots of money to oversee an investment which every employee knows is his or her own company’s stock.

Chief Justice John Roberts put the dilemma facing ESOP trustees in stark terms. Say a company executive possesses information suggesting the stock is overvalued, he asked.

Do you sell? In which case the beneficiaries’ holdings go way down and they sue you, or do you not sell? In which casse when the information comes out, the beneficiaries sue you because their value goes down. What are you supposed to do?

Alito added a wrinkle to that. What if the inside information is an unproven allegation that a company executive had engaged in illegal behavior? That would definitely make the stock go down if news got out. Should the ESOP release the news to the public, serving as a second conduit for company information even when that information is unconfirmed?

Kneedler didn’t have an answer for that. “Stop buying might be the right approach,” he said.

Robert A. Long of Covington & Burling, arguing for Fifth Third, urged the court to follow every appeals court that has considered the question so far and give the “ESOP fiduciary some leeway.” Because, as he noted, plaintiff lawyers could have sued Fifth Third’s ESOP if they had dumped all the bank’s stock after it plunged to $2 on concerns about its subprime lending practices. The price has since surged past $23.

“In this case, if the fiduciaries had shut down the ESOP, they would certainly have been sued because they would have violated the plan terms, and the — the plan has done very well,” he said. Ah, well, logic has never been the hallmark of securities class-action litigation.

 
 

Don't miss ...

 

<a href="/latest_stories/all/all/30" rel="author">Forbes</a>
Forbes is among the most trusted resources for the world's business and investment leaders, providing them the uncompromising commentary, concise analysis, relevant tools and real-time reporting they need to succeed at work, profit from investing and have fun with the rewards of winning.

 

blog comments powered by Disqus

Latest stories

NASA's flying saucer among 'Best of What's New'
Washington, Nov 22 (IANS) NASA's Low-Density Supersonic Decelerator (LDSD), a spacecraft that aims to facilitate the safe landing of future Mars missions, has earned a place in the the Popular Science magazine's "Best Of What's New" list.
 
 
Indian helping to light up Gambia (Diaspora Feature)
Banjul (Gambia), Nov 22 (IANS) Like many Indians who are proving to be philanthropists around Africa, Ram Mohan has set up a social business called Comafrique Intelizon Initiative and has embarked on the replacement of candles in villages in the Gambia with solar lights from India.
 
 
Leopards in human areas not conflict animals: Study
New Delhi, Nov 22 (IANS) Leopards in human areas are not always "stray" or "conflict" animals but residents with strategies to thrive in human dominated areas, says the first GPS-based study of leopards in India.
 
 
Golf courses are hotspots for ticks
Washington, Nov 22 (IANS) Golf courses are prime habitats for ticks, the tiny bloodsucking creatures, says a new study.
 
 
 

Latest from the Network

Pune FC aim for semi-spot in King's Cup
Thimpu, Nov 22 (IANS) Pune FC will be up against fellow Indian side Assam State Electricity Board (ASEB) in a crucial third round group stage encounter of the King's Cup at the Changlimithang Stadium here Sunday. The...
Read more on Sport Balla
 
We're doing okay: Zak after Robin Williams' death
Los Angeles, Nov 22 (IANS) Late actor-comedian Robin Williams' son Zak says that the family is still coming to terms with life after the actor's death. Zak, 31, opened up about how his family is coping since his...
Read more on Celebrity Balla
 
Indian golfers Shiv, Chiragh tied 13th, 14th at Manila
Manila, Nov 22 (IANS) Indian golfers Shiv Kapur and Chiragh Kumar fired five-under 67 each to finish tied 13th and joint 14th, respectively, after the third round of the $1 million Manila Masters at the par-72 Manila...
Read more on Sport Balla
 
Saarc panel decides to close regional centres
Kathmandu, Nov 22 (IANS) The Saarc Programming Committee, meeting here Saturday for its 49th session ahead of the 18th Saarc Summit, has decided to close down three regional centres and merge four others, bringing down...
Read more on Politics Balla
 
Nepal-India border to be sealed during Modi visit
Kathmandu, Nov 22 (IANS) Some parts of the Nepal-India border will be sealed during Indian Prime Minister Narendra Modi's visit to Lumbini, the birthplace of Lord Buddha, an official said here Saturday. Three...
Read more on Politics Balla
 
Australia rest pace trio ahead of India series
Melbourne, Nov 22 (IANS) Cricket Australia (CA) Saturday opted to rest pace trio Mitchell Johnson, Peter Siddle and Josh Hazlewood for the upcoming Sheffield Shield round matches, keeping in mind the upcoming Test...
Read more on Sport Balla
 
Kanye West 'obsessed' with Kim's photoshoot
Kanye West is ''obsessed'' with Kim Kardashian West's nude photoshoot. The 37-year-old rapper, who has 17-month-old daughter North with the reality TV star, is so proud of his wife for baring all and is planning to put...
Read more on Celebrity Balla
 
Lady Gaga: Sir Elton John 'saved' me
Lady Gaga was ''saved'' by Sir Elton John. The 'Pokerface' hitmaker - who battled a drug addiction for two years - has revealed how the 'Candle In The Wind' star helped her through the hard times. She said: ''It's...
Read more on Celebrity Balla
 
Sir Paul McCartney earns £60k a day
Sir Paul McCartney made £60,000 a day last year. Figures obtained by the Sun newspaper show that The Beatles star raked in £22 million over the 12 months as a director of his music firm. Paul was paid £15 million in...
Read more on Celebrity Balla
 
Kelly Brook's new man
Kelly Brook has reportedly found a new man. The 34-year-old model - who spectacularly split from David McIntosh in September this year - is believed to be dating model, James Crabtree, after the pair were seen out and...
Read more on Celebrity Balla