Fiduciary with insider information

[Guest allisonperry]

Suppose an officer of a company that maintains a defined benefit plan is a member of a fiduciary committee responsible for investing plan assets in company stock. What happens if/when the officer has material nonpublic information? Is the officer prohibited by securities laws from acting on the insider information when making investments on behalf of the plan? If so, is the fiduciary committee violating its fiduciary duty owed to the plan under ERISA if it does not act on material nonpublic information possessed by its members?

[mbozek]

There are ct cases involving Enron and McKesson-HBO where the issue of a 401k lan fids reponsibility to act upon material non public information under ERISA is discussed. I dont know if the Fed cts have ruled that a fid cannot act because of the securities law prohibition against using material non public information to make investment decisions without disclosing the information to all investors. The liability of a fid in a DB plan is more limited than in a 401k plan since co stock cant comprise more than 10% of plan assets and secondly the plan sponsor must make up investment losses by increasing contributions to the plan. Other than bankruptcy of the plan sponsor which results in a loss of accrued benfits I don't know what the claim of a participant would be if the plan has sufficient assets to pay benefits.

[david rigby]

Read, re-read, and ponder well mbozek's response.

But more generically, what part of "insider information" is unclear? If you asked this question of the SEC, what answer would you expect?

[Kirk Maldonado]

Mbozek:

You said

I dont know if the Fed cts have ruled that a fid cannot act because of the securities law prohibition against using material non public information to make investment decisions without disclosing the information to all investors.

Are you implying that it is possible for the fiduciary to violate federal securities laws pursuant to the argument that they need to do so to avoid violating ERISA?

[mbozek]

I thought that the DOL's position was that the fids must take acton because of the exclusive benefit rule even if such acton violated the insider trading rule. My understanding is that the above court cases were considering the question of whether the securites law prevent the fids from acting on insider information.

[KJohnson]

At least in Enron I think DOL's argument was that there were things that could have been done with the insider information consistent with securities law and ERISA such as disclosing the information to other shareholders and the public at large or eliminating Enron stock as an investment option. See pages 24-29 in DOL's brief that can be found here:

http://www.dol.gov/sol/images/EnronBrief1.fnl.PDF

I am not sure if DOL has gone so far as to say that a plan fiduciary must actually violate the insider trading rule beccause of exclusive benefit notions, but it may have.

[mbozek]

The problem is not whether the fid can trade after disclosing but whether the fid should disclose, because disclosing material non public information affecting a company's financial solvency will tank the stock immediately before the plan can off load it. Sale of shares by the plan would be a block trade subject to a suspension of trading by the exchange because of the imbalance between buy and sell orders and while the markets digested the news no shares could be sold. When trading resumes the stock would open at a considerable discount (with an even bigger discount for a block trade by the Plan) from what it was before disclosure exposing the fid to liability from plan participants for disclosing the news. For a publicly held corp it is likely that the sale of all stock from the plan would have to be completed over a period of weeks or months unless a private sale could be arranged. Eliminating co stock as an investment option would cause a sell off similar to disclosing the information since the plan would have to disclose the reason for eliminating the stock without violating the securities laws. In addition, if the stock rebounds, the fids would be open to a law suit by participants for denying them the opportunity to buy the stock at a discounted price under the recognized investment theory of dollar cost averaging. The idea of disclosing and then trading only works if there are enough investors willing to buy all of the shares of the company at its last trade before disclosure.

[Kirk Maldonado]

Mbozek:

If the plan fiduciaries disclose the information, then where is the violation of federal securities laws? By definition, that information is then public, so that there can be no impermissible trading based on material nonpublic information.