By MARTIN SIMON
Contributing Editor, Best Practices in Compensation & Benefits

The U.S. Court of Appeals for the 5th Circuit has ruled that an employer had no affirmative duty to communicate the status of its internal deliberations regarding a possible plan change and, in responding to employees’ inquiries by stating that they hadn’t heard about any planned change, did not materially misrepresent the possibility of a change (Martinez v. Schlumberger, Ltd., No. 02-20173 (9-7-2003)).

Facts. William Martinez, Frank Ditta, and Lafayette Kirsey, long-term employees of Schlumberger, Ltd., took early retirement effective July 1, 1998. Before July 1, each had asked personnel representatives at Schlumberger whether the company planed to implement a new retirement incentive program known as a "VERP." The representatives told them that they knew nothing about a new VERP. However, on July 27, 1998, Schlumberger announced a new VERP that provided an additional year of salary not included in the VERP in effect when Martinez, Ditta, and Kirsey retired. The three former employees then sued, claiming that Schlumberger breached its fiduciary duty by falsely telling them that a new VERP was under consideration when they selected their retirement date.

The district court threw the case out of court on the grounds that a truthful response that a new VERP was in the works was not required until the new plan was under "serious consideration." The court determined that serious consideration had not yet begun when the employees had inquired about a possible change.

Legal analysis. The appeals court upheld the lower court, but on different grounds, rejecting the view that the duty to speak truthfully arises only once the employer begins seriously considering a plan, and that a misrepresentation is material only if a company has begun to seriously consider the plan change. The court based its conclusion on the U.S. Supreme Court’s analysis in the related context of securities law. That case involved the question of when misrepresentations about the existence of merger negotiations become material and grounds for a lawsuit by shareholders who sold their stock before the negotiations became public and inflated the stock’s price.

In Basic, Inc. v. Levinson (485 U.S. 224 (1984)), the high court rejected a bright-line approach to materiality similar to the "serious consideration" test. Under the securities laws, a misrepresentation is material "if there is a substantial likelihood that a reasonable shareholder would consider it important" to his or her decisions. The court shunned the idea that materiality could be reduced to a simple formula and explicitly rejected the standard for materiality created by the 3rd Circuit that was similar to the serious consideration test. In contrast, the court endorsed an approach to materiality as a fact-based inquiry.

The 5th Circuit concluded from the Supreme Court’s analysis that when analyzing whether plan changes must be disclosed, courts are not to rely on a bright-line test to determine whether a company’s alleged misrepresentations are material, are to reject the serious consideration approach to materiality, and should adopt a fact-specific approach.

The key question in such an analysis is whether there is a substantial likelihood that a reasonable person would have considered the information that an employer-administrator allegedly misrepresented to be important in making a decision to retire. This entails consideration of a variety of factors, such as "how significantly the statement misrepresents the present status of internal deliberations regarding future plan changes," whether the employee knew or should have been aware of "other information or statements from the company tending to minimize the importance of the misrepresentation," and "the specificity of the assurance." Despite rejecting the serious consideration test, the court recognized that the more seriously a plan is being considered, the more likely a representation about the plan is material.

Ruling. The court concluded that Schlumberger was under no obligation to disclose whether it was considering a new early retirement offering. In addition, the court said that when the employees, in effect asked if Schlumberger planned to rollout an enhanced benefits plan in the near future, responding that no decision had been made was not material or misleading until Schlumberger actually decided to implement the new plan.