Employee 401(k) Lawsuit Claims GE Inflated Stock Value

Albany, NYOn December 14, 2018, Adele Vargas filed a class action ERISA lawsuit against General Electric Company (“GE”) and Jeffrey Immelt, its former CEO. She alleges that GE improperly manipulated its earnings and inflated its stock price.

As a retirement plan sponsor, it failed in its fiduciary duty to GE employees who invested in the company through the General Electric Common Stock Fund (“Stock Fund”), an investment option offered under the GE Retirement Savings Plan (“the Plan”). This is not just the dizzying stock market volatility that has many 401(k) savers on edge lately. The allegations describe outright deception.

When the truth came out, the value of GE stock dropped, falling from $32.93 per share in July 2016 to $6.70 on Dec. 12, 2018. Jeffrey Immelt had already left the company, retirement package intact. Employees were left holding the bag; their savings are gone now. The remedies for employees who invest in employer stock are still far from perfect under the law.

A complicated scheme and several rounds of lawsuits

The complex scheme requires a somewhat simplified explanation. Among its subsidiaries, GE owned and controlled two insurance companies, Employers Reassurance Corporation and Union Fidelity Life Insurance Company. Because insurance is an inherently risky business, state regulators require insurers and their corporate parents to hold substantial capital reserves against potential liabilities. GE maintained that it had adequate reserves. This reassurance supported the market value of its stock. The Stock Fund invested at least 98 percent of its assets in GE common stock.

GE’s financial statements indicating adequate reserves were apparently misleading. This was uncovered during the course of previous litigation. In 2006 plan participants brought ERISA class action lawsuits alleging that company and plan fiduciaries breached their fiduciary duties under ERISA by continuing to offer the GE Stock Fund even though they knew it was an imprudent investment. GE inflated its earnings and stock price by under-reserving for its insurance liabilities by at least $5 billion to $10 billion.

The 2009 settlement and more bad news

GE settled with plan participants in 2009, while forcefully denying all the allegations about stock price manipulation. Apparently, they lied – again.

By mid-2017, after Immelt’s resignation, GE began to disclose pre-existing problems at its insurance subsidiaries. As the new misstatements unspooled, the stock price began to drop. By 2018, GE had to make billions in additional capital contributions to prop up both insurance subsidiaries. The price of GE stock dropped to roughly $6 per share.

This lawsuit seeks additional relief for plan participants based on the further stock declines and the misrepresentations on which the previous settlement was based.

Are 401(k) plan participants protected from investment loss?

Under ERISA, the answer is “no,” or at best, “sort of.” ERISA requires plan fiduciaries to discharge their duties with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent [person] acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims. The standard speaks to conduct, not investment results. Practically speaking, reasonably decent results often follow from careful behavior, but that’s no guarantee.

With respect to 401(k) plans, where participants direct their investments among a variety of choices offered by the plan, fiduciaries must offer the chance for diversification across a range of choices that can be arguably expected to produce reasonable returns in the long run. It is a pretty forgiving standard.

More protections for fiduciaries dealing with employer stock funds

Courts have tried to address the conflicting duties plan fiduciaries may face when dealing with plans or investment funds within plans that are designed to invest in employer securities. At the outset though, it is important to understand that this is a zero-sum game. If fiduciaries have greater protection, then plan participants/investors have less.

Courts considered this question: should a fiduciary be required to or prevented from acting on non-public, insider information about the shaky financial health of a company in order to prevent the plan from investing in employer stock?

This might have been the situation with GE. In the future, it could affect any number of companies with slow-rolling corporate problems. One choice would seem to conflict with the legal duty to protect plan participants imposed by ERISA. The other might violate securities secrecy laws.

In Moench v. Robertson , a company's stock declined from over $18 in 1989 to twenty-five cents in 1991 before the company went bankrupt. The court ruled that there was a special presumption of prudence for holding employer stock in an ESOP, but that this might be overcome in certain circumstances.

Moench was then seriously limited by Fifth Third Bancorp v. Dudenhoeffer , in which the Supreme Court rejected the idea of any special protections for plan fiduciaries dealing with employer stock. It stopped short of requiring them to act on insider information about the company, however. Instead it prescribed a complicated cocktail of reasonable alternative actions that might be taken based on publicly known information. Fiduciaries were explicitly permitted to consider whether stopping purchases or disclosing information would do more harm than good by driving down the stock price and thus the value of existing employee holdings.

Until recently, no plan participants had succeeded in a “stock-drop” lawsuit brought against plan fiduciaries under the Dudenhoeffer rules. However, the Second Circuit in Jander v. Retirement Plans Committee of IBM recently handed the plaintiffs a small win. Noting that the way court applied the Dudenhoeffer standard “makes it functionally impossible to plead a duty-of-prudence violation,” the court reversed a lower court’s dismissal of the case, allowing it to proceed further.

What this may mean for the GE plaintiffs is not clear yet. But plan participants who are expected to make investment decisions on the basis of incomplete or false information hardly seem to have gotten to have their say, yet.

What is clear is that ERISA does not make plan fiduciaries guarantors of investment performance with self-directed 401(k) accounts. The fact that plan participants may not yet have effective recourse under ERISA when plan fiduciaries participate in stock manipulation schemes should give anyone cause for caution when it comes to investing in employer stock.