Wycoff, Michael v. Hodowal, John R. ( 2008 )

In the
United States Court of Appeals
For the Seventh Circuit
____________
No. 07-1895
JOSEPH J. NELSON and MICHAEL WYCOFF,
on behalf of a class,
Plaintiffs-Appellants,
v.
JOHN R. HODOWAL, et al.,
Defendants-Appellees.
____________
Appeal from the United States District Court for the
Southern District of Indiana, Indianapolis Division.
No. 1:02-cv-0477-DFH-TAB—David F. Hamilton, Judge.
____________
ARGUED NOVEMBER 30, 2007—DECIDED JANUARY 2, 2008
____________
Before EASTERBROOK, Chief Judge, and FLAUM and
WILLIAMS, Circuit Judges.
EASTERBROOK, Chief Judge. Indianapolis Power & Light
Company maintains not only a defined-benefit pension
plan but also a defined-contribution supplemental plan
called the “Thrift Plan.” The defined-benefit plan holds
a diversified portfolio of investments; the defined-con-
tribution plan initially limited employees to holding stock
of IPALCO Enterprises, Inc., the employer’s parent corpora-
tion, or bonds issued by the United States. Employees
may contribute to the Thrift Plan an amount that depends
on §401(k) of the Internal Revenue Code. The employer
2 No. 07-1895
matches these contributions up to 4% of an employee’s
annual salary.
In 1995 the Thrift Plan was amended to allow partici-
pants to diversify their investments. By 2000 the Plan was
offering nine options, from very conservative (a money-
market fund) to risky (IPALCO stock and nothing else),
with several bond funds and mutual funds in between.
The Plan hired Merrill Lynch, Pierce, Fenner & Smith,
Inc., to advise the participants about appropriate invest-
ments; Merrill Lynch stressed the benefits of diversifica-
tion. The Plan allows participants to change invest-
ments among the nine options daily, with no need for
advance notice. But as of 2000 all of the employer’s
matching contributions were allocated to IPALCO stock;
the Plan’s terms made this mandatory.
IPALCO merged with AES Corporation on March 27,
2001. The merger had been approved by IPALCO’s board
of directors in July 2000 and by the shareholders that
October. AES offered a premium of 16% relative to the
price at which IPALCO’s stock had traded the day before the
announcement. Between July 2000 and March 2001 Merrill
Lynch distributed literature to the Thrift Plan’s partici-
pants and held meetings at which all options, including
moving investments from IPALCO’s stock to one of the
mutual funds, were discussed. By the time of these
meetings investors no longer needed to hold IPALCO’s
stock to obtain the merger premium; the price of IPALCO’s
stock had climbed in the market to reflect the value of
the AES stock that it would soon become (less a small
discount to reflect the chance that the merger would be
called off). Nonetheless, when the merger closed about
64% of investments in the Thrift Plan were held as IPALCO
stock ($145.4 million of the Plan’s total assets of $228.1
million).
AES was, and is, a much larger firm than IPALCO. It
operates energy businesses around the globe, and the value
No. 07-1895 3
of its stock in the market reflects not only the acumen of
its managers but also the energy policies of many foreign
nations, plus the exchange rate between the dollar and the
currencies in which AES does business. How Indianapolis
Power & Light performs has but modest influence on the
market price of AES stock. When the merger closed, AES
was trading for $49.60 a share. Three months later it was
at $42.28. On September 25, 2001, AES was trading for
$24.25, and the bottom dropped out the next day: AES fell
to $12.25. It reached a low of $4.11 on February 21, 2002.
The record does not reveal the reasons for the collapse in
price.† We do know that, although the firm suffered red
ink in 2001 and 2002, it continues to be a substantial
enterprise. Its revenues in 2000 were $6.7 billion, with a
profit of roughly $1.40 a share. In 2006 its revenues were
$12.3 billion and its earnings per share 43¢. The stock
closed on December 18, 2007, at $21.58. That is still a
substantial loss compared with the price in March
2001—not only in absolute terms, but also relative to the
stock market, which is higher today than in March 2001.
Two of the Thrift Plan’s participants filed this class-
action suit under the Employee Retirement and Income
†
Though an article in the New York Times gives the general
idea: “There are problems in Venezuela, Brazil and Argentina,
which used to be its biggest profit centers. A subsidiary in
Britain is in default on loans, and AES faces several lawsuits
in California, where it is one of the companies blamed for soar-
ing electricity prices in 2000.” Floyd Norris, “They Had Fun,
Fun, Fun Till the Stock Fell,” New York Times Mar. 29, 2002
(available at http://query.nytimes.com/gst/fullpage.html?res=
9C00E5DE1F3BF93AA15750C0A9649C8B63&n=Top/News/
Business/Companies/AES%20Corporation). The article adds that
some of the loans that AES carried on its books as nonrecourse
allowed the creditors to convert the debt to stock, which created
the possibility that other investors could be diluted when AES
had to issue extra shares at the lower market price.
4 No. 07-1895
Security Act (ERISA) against the Plan’s fiduciaries. The
principal contention was that the fiduciaries (all of whom
were executives at Indianapolis Power & Light) should
have seen the decline coming, or at least should have
understood that AES is too volatile to be a suitable invest-
ment for pension holdings, and therefore had to compel all
of the participants to exchange their IPALCO stock for the
Plan’s other investment options before the merger closed.
See 29 U.S.C. §1104 (obligations of fiduciaries), §1132(a)(2)
(authorizing suit to recoup losses to a plan). Both the
Supreme Court, in LaRue v. DeWolff, Boberg & Associates,
No. 06-856 (argued Nov. 26, 2007), and this court, in
Rogers v. Baxter International, Inc., No. 06-3241 (argued
Nov. 2, 2007), have under advisement cases posing ques-
tions about the extent to which §1132(a) authorizes suits
seeking recoveries by defined-contribution plans, whose
participants may have made different choices and thus
were affected differently by the fiduciaries’ conduct. But
the precise scope of §1132(a) does not affect subject-matter
jurisdiction, and as defendants have not argued that this
suit falls outside §1132 we need not hold this appeal for
LaRue or Rogers.
The district court held a bench trial and found essen-
tially every disputed fact in defendants’ favor. 480 F. Supp.
2d 1061 (S.D. Ind. 2007). The judge concluded that the
defendants had no reason to foresee any decline in the
price of AES’s stock (had, indeed, no inside information
about AES) and that reasonable fiduciaries would have
deemed AES a suitable stock. (For long-term investors, a
stock’s volatility may be a benefit, as higher risk usually is
associated with higher return unless the risk is fully
diversifiable. See Turan G. Bali, The intertemporal relation
between expected returns and risk, 87 J. Fin. Econ. 101
(2008). A pension fund can ride out the ups and downs
and reap the rewards of risk-taking.) Although partici-
pants’ concentration in AES left them underdiversified—
No. 07-1895 5
and without the offsetting incentive that IPALCO stock
offered by linking the employees’ fates with that of their
employer—the fiduciaries adequately warned partici-
pants, directly and through Merrill Lynch, of that risk. The
district court concluded that an ERISA fiduciary is not
obliged to strip participants of the ability to make their
own decisions, for good or ill. Nor, the judge concluded,
were the fiduciaries obliged (or even allowed) to disre-
gard the Plan’s provision requiring all of the employer’s
contributions to be held as IPALCO (and then AES) stock.
Plaintiffs have abandoned on appeal all but one of
the arguments they presented to the district court. The
last issue remaining in dispute between the parties is
whether the defendants had to tell the participants that
the defendants were selling most of their own stock in
IPALCO—not only stock held through the Thrift Plan, but
also stock that the defendants were able to acquire by
exercising vested options that they had received in their
roles as managers or directors of Indianapolis Power &
Light. Plaintiffs accuse the defendants of promoting
AES as a good prospective employer (and implicitly as a
good investment), while by divesting their own holdings
they demonstrated that their true beliefs were otherwise.
This is the sort of implied deceit that is called scalping
in securities law. Compare SEC v. Capital Gains Research
Bureau, Inc., 375 U.S. 180 (1963), with Lowe v. SEC, 472
U.S. 181 (1985). The district judge found, however, that
the defendants actually (and reasonably) believed every-
thing they told the participants, and that they sold
IPALCO stock, and cashed out their options, only because
AES had announced that it would replace the manage-
ment team at Indianapolis Power & Light. The defend-
ants were on their way out the door and had no more
reason to hold IPALCO (or AES) stock than to hold any
other utility stock, and substantial reasons to diversify.
The plaintiffs and their class, however, were remaining
6 No. 07-1895
as AES’s employees and so, the defendants believed, had
less reason to sell.
None of these findings is challenged as clearly erroneous.
Instead plaintiffs maintain that, even though the defen-
dants’ sales did not imply any belief that AES was over-
priced in the market or an unsuitable investment for
the Thrift Plan’s ongoing participants, defendants should
have told each of the participants point blank that the
fiduciaries were getting out while the going was good. The
district court observed that the defendants had disclosed
their sales by filing the appropriate forms under §16(a)
of the Securities Exchange Act of 1934. See 15 U.S.C.
§78p(a); 17 C.F.R. §240.16a–2. This information not
only was known to the stock market in the fall of 2000—
long before the closing—but also did not affect the price
of AES stock. Securities law assumes that markets for
widely-traded stock such as AES are efficient and im-
pound all publicly available information. See, e.g., Basic
Inc. v. Levinson, 485 U.S. 224 (1988). This implies that
information that, when revealed, has no effect on a
stock’s price is not “material” to investors’ decisions. See
Eckstein v. Balcor Film Investors, 8 F.3d 1121, 1130 (7th
Cir. 1993). Plaintiffs do not contest any of these conclu-
sions.
Thus the case boils down to an argument that an
ERISA fiduciary has a duty to disclose, directly to a
pension plan’s participants, even non-material informa-
tion that may affect the participants for reasons unre-
lated to the value of the investment. Plaintiffs insist
that many of the participants would have sold IPALCO
as soon as they learned of the managers’ decisions, not
because the information actually affected the stock’s
value (or suitability) but just because they wanted to
copy the managers’ investment strategies as an informa-
tion-conservation device.
No. 07-1895 7
Plaintiffs observe that ERISA requires fiduciaries to act
“with the care, skill, prudence, and diligence under the
circumstances then prevailing that a prudent man
acting in a like capacity and familiar with such matters
would use in the conduct of an enterprise of a like charac-
ter and with like aims” (29 U.S.C. §1104(a)(1)(B))—and
the defendants’ sales of their own IPALCO stock tell us
(plaintiffs insist) that defendants recognized that prudent
men would have sold the IPALCO stock before the merger.
This does not sidestep the district judge’s conclusion that
the defendants sold for reasons that did not apply to
persons who would remain employees of Indianapolis
Power & Light after the merger. The market’s non-reaction
to news of defendants’ sales shows that their decisions
did not reflect anything about the value of IPALCO or AES
stock.
There remains a possibility that participants in the
Thrift Plan would have misunderstood the reasons for, and
the significance of, defendants’ sales, and changed their
own investment allocations for that reason, but no reg-
ulation or decision requires ERISA fiduciaries to disclose
facts that may lead to idiosyncratic reactions. Any tidbit
might cause such a reaction; the materiality require-
ment entitles fiduciaries to limit their disclosures and
advice to those facts that concern real economic values.
In the language of securities law, a non-disclosure that
may affect a person’s choice about which securities to
hold, but does not relate to the value of those securities,
yields transaction causation but not loss causation. And
without loss causation there is no liability. See Dura
Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (2005).
A better line of argument would rely on 29 U.S.C.
§1104(a)(1)(C), which requires fiduciaries to diversify “the
investments of the plan so as to minimize the risk of
large losses, unless under the circumstances it is clearly
prudent not to do so”. Defendants diversified their own
8 No. 07-1895
portfolios and might have done more to promote diversifi-
cation by other participants. Diversification is valuable
even when each security is accurately priced by the stock
market. See Bevis Longstreth, Modern Investment Manage-
ment and the Prudent Man Rule (1986). Although the
defined-benefit plan was already diversified (and worth
more to most employees than their supplemental invest-
ments in the Thrift Plan), additional benefits were avail-
able from diversifying investments in the Thrift Plan.
But here is where it matters that defendants did dis-
close their own sales—not, to be sure, directly to each
participant, but in public filings with the SEC and the
stock markets. Rank-and-file workers at Indianapolis
Power & Light don’t read such filings, but investment
analysts do—and defendants caused the Thrift Plan to
hire Merrill Lynch to provide advice to each participant
personally. Nothing was hidden from Merrill Lynch.
A trustee’s duty to furnish information to beneficiaries,
on which see Restatement (Third) of Trusts §82 (T.D. 4,
2005), may be discharged directly or through an inter-
mediary such as Merrill Lynch. Often delegating the
function to a specialist is best for a novice investor.
Employees who participated in the Thrift Plan may have
had little idea what to make of raw information such as
the steps defendants took to cash out their stock options.
But counselors from Merrill Lynch could put the defen-
dants’ sales in context with other information. As we
have already mentioned, Merrill Lynch was engaged in
part to promote intelligent diversification once extra
investment options were offered in 1995. Plaintiffs have
not referred us to any regulation or judicial decision
obliging fiduciaries to disclose directly to participants
rather than through professional investment counselors.
Sometimes trust law requires delegation to a professional
such as Merrill Lynch. See Restatement (Third) of Trusts
§80(2) & comment d(1) (T.D. 4, 2005). ERISA does not
No. 07-1895 9
hold a fiduciary responsible for the decline in an invest-
ment’s value, when an informed and independent in-
vestment adviser has been furnished without charge to
all beneficiaries, who exercise full control over which
investments their accounts will hold.
AFFIRMED
A true Copy:
Teste:
________________________________
Clerk of the United States Court of
Appeals for the Seventh Circuit
USCA-02-C-0072—1-2-08