Supreme Court Allows Suit for 401(k) Misconduct
The Supreme Court ruled on February 20 that individuals may sue their employers for mismanaging their 401(k) accounts. LaRue v. DeWolff, Boberg & Assocs., Inc., No. 06-856 (Feb. 20, 2008). Plaintiff James LaRue alleged that he suffered more than $150,000 in losses after his former employer ignored his instructions to make certain changes in his retirement investments in 2001 and 2002. He asserted a claim for breach of fiduciary duty under the Employee Retirement Income Security Act (ERISA). The district court and the U.S. Court of Appeals for the Fourth Circuit denied LaRue’s claim, construing it as an individual action for damages rather than a claim for injury to the “entire” retirement plan itself. The Fourth Circuit relied upon the Supreme Court’s earlier decision in Massachusetts Mutual Life Insurance Company v. Russell, 473 U.S. 134 (1985), which held that ERISA §502(a)(2) did not allow an individual who participated in a disability plan that paid benefits at a fixed level to recover consequential damages from delays in processing her claim. The Russell opinion stated that the applicable provisions of ERISA “protect the entire plan, rather than the rights of an individual beneficiary.” Id. at 142.

The Supreme Court held that “although §502(a)(2) does not provide a remedy for individual injuries distinct from plan injuries, that provision does authorize recovery for fiduciary breaches that impair the value of plan assets in a participant’s individual account.” Writing for the court, Justice John Paul Stevens noted that “Russell’s emphasis on protecting the ‘entire plan’ from fiduciary misconduct reflects the former landscape of employee benefit plans,” -- a landscape that has changed significantly with the growth in popularity of 401(k) plans and the decline of defined benefits plans where employees receive fixed benefits based on a percentage of their salary. The court further observed that “[f]or defined contribution plans [such as a 401(k)] . . ., fiduciary misconduct need not threaten the solvency of the entire plan to reduce benefits below that participants would otherwise receive.” Accordingly, the reference to the “entire plan” in Russell is “beside the point” in the context of a defined contribution plan. In a concurring opinion, Chief Justice John Roberts agreed that the Fourth Circuit’s analysis was flawed but questioned whether the plaintiff could bring a claim under §502(a)(2), since another section, §502(a)(1)(B), more accurately described his claim. Justice Clarence Thomas, by contrast, authored another concurring opinion that supported the plaintiff’s right to sue but emphasized that losses in the plaintiff’s account were “losses to the plan,” “because a defined contribution plan is essentially the sum of its parts.”

Some commentators have warned that the case could open the floodgates to litigation and may lead some employers to abandon 401(k) plans entirely or raise administration fees to cover the risk of litigation.

Subprime Complaint Dismissed
The United States District Court for the Central District of California recently dismissed without prejudice a shareholder class action filed against New Century Corporation, which is one of the first-filed securities class action lawsuits relating to the subprime lending crisis. Gold v. Morrice, No. CV 07-00931 (C.D. Cal. Jan. 31, 2008). The complaint alleged that New Century provided false or misleading statements in connection with two stock offerings in June 2005 and August 2006. The plaintiffs further alleged that New Century’s stock price declined significantly after the company announced in February 2007 that its financial statements for the first three quarters of 2006 would need to be restated due to errors regarding the company’s allowance for loan repurchase losses. The company ultimately filed for bankruptcy protection in April 2007. The complaint asserted claims under Sections 11 and 12(a) of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934.

On January 31, 2008, the district court granted the defendants’ motion to dismiss, but allowed the plaintiffs to amend the complaint. The court held that the complaint “did not clearly identify the allegedly false statements or which of the factual allegations support an inference that particular statements are false or misleading.” The court encouraged the plaintiffs “to clearly articulate the grounds for an inference that the statements were in fact false or misleading” in their amended complaint. Plaintiffs have been given until February 25, 2008 to file their amended pleading.

Amended Complaint Dismissed in Openwave Backdating Litigation
On the options backdating front, the United States District Court for the Northern District of California has again dismissed with leave to amend a shareholder derivative lawsuit alleging that certain stock option grants at Openwave Systems Inc. had been improperly backdated. See In re Openwave Sys., Inc. S’holder Deriv. Litig., No. C 06-03468 SI (N.D. Cal. Feb. 12, 2008). The court previously dismissed the case in May 2007, but allowed the plaintiffs an opportunity to amend. In its prior dismissal opinion, the court held that the plaintiffs failed to allege sufficient facts supporting an inference that stock option grants were intentionally backdated, holding the fact that 10 out of 39 grant dates were on low trading days was “as consistent with a random selection of stock option grant dates, as with a pattern of backdating.” In their amended complaint, the plaintiffs focused on six grants that were allegedly backdated. Of these grants, “one fell at a monthly low, . . . one fell at a quarterly low, . . . one fell at the second lowest date of the quarter, . . . two fell at the fifth lowest dates of the month, . . . and one fell at the seventh lowest date of the month.”

After the amended complaint was filed, the defendants again moved to dismiss the action on the basis that plaintiffs failed to make the required pre-suit demand under Federal Rule of Civil Procedure 23.1, as well as other grounds. The plaintiffs responded by arguing that demand would have been futile because the board was not disinterested. The court found that plaintiffs’ claims of lack of disinterestedness depended upon plaintiffs’ ability to allege the possibility that backdating occurred with sufficient particularity in the complaint.

The court granted the defendants’ motions to dismiss on the demand futility issue, finding that the plaintiffs’ allegations “are simply insufficient to allow a reasonable inference of backdating.” The court reasoned that “[al]though the grants that fell on the lowest and second lowest dates of their respective quarters give the Court some pause, these two dates alone, in the context of the remaining 39 grant dates, are not enough to sustain plaintiffs’ burden.” The court further observed that these two grants were publicly disclosed within two days pursuant to the Sarbanes-Oxley Act, which made it unlikely the company could have intentionally chosen the lowest date in the quarter. The court also held that a purported 20-day trading analysis that plaintiffs included with their amended complaint was similarly unpersuasive, given that many of the grants were publicly disclosed within two days, and given that plaintiffs only provided an average 20-day return for nine of the 39 grants. Finally, the court held that the mere fact the directors conducted an investigation and took a $182 million charge for additional stock-based compensation did not support a reasonable inference that backdating occurred. The court thus dismissed the amended complaint pursuant to Federal Rule of Civil Procedure 23.1. The plaintiffs have until February 29, 2008 to file another amended complaint with more particularized allegations.

Shareholders Seek Greater Board Accountability in the Wake of SubPrime-Mortgage Crisis
Investor groups, furious over sharp declines in shareholder value due to subprime-mortgage related losses, are mounting campaigns to demand greater board accountability with respect to management oversight. With losses in the hundreds of billions and more upheaval expected as bankruptcies, litigation, and investigations unfold, shareholder unrest has likely surpassed levels experienced during the Enron collapse. In response to the destabilized market, activist groups such as CtW Investment Group have demanded that major financial institutions provide detailed disclosure about measures taken by boards to monitor management’s assessment and handling of the subprime-mortgage crisis.

Additionally, the Laborers’ International Union of North America and AFL-CIO are among the groups that have submitted shareholder proposals targeting issues such as expanded disclosure of company risks and executive succession plans and policies, term limits for executive employment agreements, and enhanced director involvement in managing conflicts of interest with clients. Some companies have responded to the proposals and are meeting with shareholders, while others are seeking to prevent shareholder votes claiming that their boards acted appropriately. The Securities and Exchange Commission has granted approval for certain targeted companies to exclude certain of the proposals, but denied other exclusion requests. Click here for further discussion by the Wall Street Journal.

California and Delaware Supreme Courts Affirm Stock Ownership Requirements for Derivative Plaintiffs
The California and Delaware Supreme Courts recently clarified the “share ownership” requirements for plaintiffs in shareholder derivative actions. In a derivative lawsuit, a shareholder steps into the corporation’s shoes and asserts claims on behalf of the corporation. Courts in most states have typically held that a plaintiff must own stock in the corporation to have standing to bring a derivative action.

In Grosset v. Wenaas, Case No. S139285 (Cal. Feb. 14, 2008), the California Supreme Court held that a shareholder derivative plaintiff must own stock in the company throughout the entire pendency of the litigation to have standing. The plaintiff, who owned shares of a California software company called JNI Corporation, filed a derivative action alleging that various officers and directors of JNI breached their fiduciary duties, mismanaged the company, and engaged in insider trading and corporate waste. While the case was on appeal, JNI merged with Applied Micro Circuits Corporation, and the plaintiff lost his shares in JNI as a result of the merger. On the defendants’ motion, the Court of Appeals dismissed the appeal on the grounds that the plaintiff was no longer a shareholder and lacked standing to pursue the claims.

The California Supreme Court affirmed the Court of Appeals’ dismissal. The court observed that Delaware law imposed a “continuous ownership” requirement. While California law was less developed than Delaware law on this issue, the court held that California law “is properly construed as containing a continuous ownership requirement.” The court reasoned that “when the stockholder relationship is terminated, either voluntarily or involuntarily, a derivative plaintiff loses standing because he or she no longer has even an indirect interest in any recovery pursued for the corporation’s benefit.”

Meanwhile, in Schoon v. Smith, Case No. 554 (Del. 2008), the Delaware Supreme Court held that a director who does not own stock in the company may not pursue a derivative lawsuit on the company’s behalf. The plaintiff, who was a director of a Delaware corporation called Troy Corporation, alleged that the other directors had aligned themselves with the company’s CEO and were acting to maximize their personal benefit at the company’s expense. The Court of Chancery granted the defendants’ motion to dismiss on the ground that the plaintiff was not a stockholder.

On appeal, the plaintiff asserted that he should be granted “equitable standing” to pursue the claims on behalf of Troy, arguing that “equipping directors with standing to sue derivatively is consistent with the fiduciary duties of directors” and would protect against director misconduct. The Delaware Supreme Court rejected this argument, noting that the shareholder who elected the plaintiff to the board of directors was actively litigating other matters involving Troy. Accordingly, there was no need to extend equitable standing to the plaintiff director, and there would not be a “complete failure of justice” if the non-shareholder director were denied standing to sue. The Delaware Supreme Court thus affirmed the Court of Chancery’s dismissal.