Rivera v. Allstate Ins. Co.

• Decision Date: 31 October 2018
• Docket Number: Nos. 17-1310 & 17-1649,s. 17-1310 & 17-1649
• Citation: 913 F.3d 603
• Parties: Daniel RIVERA, et al., Plaintiffs-Appellees. v. ALLSTATE INSURANCE COMPANY, Defendant-Appellant.
• Court: U.S. Court of Appeals — Seventh Circuit

913 F.3d 603

Daniel RIVERA, et al., Plaintiffs-Appellees.

v.ALLSTATE INSURANCE COMPANY, Defendant-Appellant.

Nos. 17-1310 & 17-1649

United States Court of Appeals, Seventh Circuit.

Argued October 25, 2017

Decided October 31, 2018

As Amended on Petition for Rehearing January 14, 2019

Rehearing and Rehearing En Banc Denied February 27, 2019^*

Michael T. Brody, Elizabeth A. Coleman, James Texas Dawson, Attorneys, JENNER & BLOCK LLP, Robert D. Sweeney, John Joseph Scharkey, III, Attorneys, SWEENEY & SCHARKEY LLC, Chicago, IL, for Plaintiffs-Appellees.

Paul R. Garry, Anneliese Wermuth, Attorneys, COZEN O'CONNOR, Gerald L. Pauling, II, Uma Chandrasekaran, John W. Drury, Attorneys, SEYFARTH SHAW LLP, Chicago, IL, Rex S. Heinke, Jessica Weisel, Attorneys, AKIN GUMP STRAUSS HAUER & FELD, Los Angeles, CA, for Defendant-Appellant.

Before Kanne and Sykes, Circuit Judges, and Darrow, District Judge.^*

Sykes, Circuit Judge.

In 2009 Allstate Insurance Company launched an internal investigation into suspicious trading on its equity desk. The initial inquiry unearthed email evidence suggesting that several portfolio managers might be timing trades to inflate their bonuses at the expense of their portfolios, which included two pension funds to which Allstate owed fiduciary duties. Allstate retained attorneys from Steptoe & Johnson to investigate further, and they in turn hired an economic consulting firm to calculate potential losses. Based on the email evidence, the consulting firm found reason to believe that timed trading had potentially cost the portfolios $8 million and possibly much more. Because actual losses could not be established, the consultants used an algorithm to estimate a potential adverse impact of $91 million on the pension funds. Everyone understood that this estimate was wildly unrealistic, but in an abundance of caution, Allstate poured $91 million into the pension portfolios.

When the investigation wrapped up, Steptoe lawyers delivered oral findings to Allstate. The company thereafter determined that four portfolio managers—Daniel Rivera, Stephen Kensinger, Deborah Meacock, and Rebecca Scheuneman—had violated the company's conflict-of-interest policy by timing trades to improve their bonuses. On December 3, 2009, Allstate fired them for cause.

On February 25, 2010, Allstate filed its annual Form 10-K for 2009. The report explained that: (1) in 2009 the company had received information about possible timed trading and retained counsel to investigate; (2) counsel hired an economic consulting firm to estimate the potential impact on the portfolios; and (3) based on this outside investigation, Allstate paid $91 million into the two pension funds to cover the potential adverse impact. That same day Allstate sent a memo to employees in its Investment Department describing the information disclosed in the 10-K. Neither document mentioned the four fired portfolio managers.

Three weeks later the four former employees sued Allstate in federal court for defamation based on the 10-K and the internal memo. They also alleged that Allstate violated 15 U.S.C. § 1681a(y)(2), a provision in the Fair Credit Reporting Act ("FCRA or the Act"), by failing to give them a summary of Steptoe's findings after they were fired. The defamation claim was the main event in the litigation; the FCRA claim received comparatively little attention. A jury returned a verdict in the plaintiffs' favor, awarding more than $27 million in compensatory and punitive damages, and statutory damages on the FCRA claim (there are no actual damages on that claim). The district judge tacked on additional punitive damages and attorney's fees under the FCRA.

Allstate attacks the defamation awards on multiple grounds and also argues that the FCRA awards must be vacated for lack of standing under Spokeo, Inc. v. Robins , ––– U.S. ––––, 136 S.Ct. 1540, 194 L.Ed.2d 635 (2016). We agree that the plaintiffs lack a concrete injury to support Article III standing on the FCRA claim. So that claim must be dismissed on jurisdictional grounds. And that ends our review. Because the FCRA claim provided the sole basis for federal jurisdiction—and thus the only basis for the district court to exercise supplemental jurisdiction over the state-law claim under 28 U.S.C. § 1367(a) —the district court was without power to adjudicate the defamation claim, and it too must be dismissed for lack of jurisdiction. The parties did not identify the § 1367(a) jurisdictional problem in their initial briefing, but that does not matter; defects in subject-matter jurisdiction must always be addressed. Accordingly, we vacate the judgment and remand with instructions to dismiss the action in its entirety for lack of subject-matter jurisdiction. See FED. R. CIV. P. 12(h)(3).

I. Background

Plaintiffs Rivera, Kensinger, Meacock, and Scheuneman were employed as securities analysts in the Equity Division of Allstate's Investment Department. Rivera was the Division director, and Kensinger, Meacock, and Scheuneman were analysts on the growth team. During their time with the company, the Equity Division managed and invested $10 billion in assets on behalf of various funds, including two defined-benefit pension plans. Because the plaintiffs helped manage two pension portfolios, they occupied positions of trust and owed a duty of loyalty to plan beneficiaries under the Employee Retirement Income Security Act. See 29 U.S.C. § 1104(a)(1). They were also bound by Allstate's code of ethics, which required them to avoid conflicts of interest.

In addition to their salaries, the plaintiffs were eligible to receive bonus compensation under Allstate's "pay-for-performance" plan. The plan relied on a formula called the "Dietz method" to estimate portfolio returns and evaluate performance accordingly. The Dietz method assumes that all cash flows in a portfolio occur at the same time of day; high transaction volume makes it impractical to use actual trade times. The particular formula in use at Allstate assumed all cash flows occurred at midday.

While practical, Allstate's formula had two drawbacks. First, it distorted a portfolio's actual performance, both positive and negative. The midday Dietz method inflated measured performance for sales on up days and buys on down days; conversely, it understated measured performance when sales were made on down days and buys on up days. Allstate's traders referred to this discrepancy as the "Dietz effect."

Second, the formula could be manipulated. Because it assumed that all cash flows occurred midday, portfolio managers could wait until the end of day to calculate the Dietz effect before deciding to execute a trade. The system consequently rewarded portfolio managers who waited to make trades even if the portfolio suffered as a result. Moreover, Allstate's bonus structure measured performance relative to a daily benchmark; it didn't consider market movement in the preceding days. This feature also pitted the interests of the manager against those of the portfolio. A manager could improve his performance by delaying a sale over several down days before selling on an up day even if the portfolio would have been better off if he sold earlier. In sum, under Allstate's pay-for-performance plan, portfolio managers could boost their bonus pay by timing trades—potentially at the expense of their portfolios.

In mid-2009 Allstate received troubling information that its portfolio managers were doing just that. Peter Hecht, a member of Allstate's Performance Management Group, reported to Chief Compliance Officer Trond Odegaard that members of the Equity Division were delaying trades to maximize their bonuses at the expense of their portfolios. Odegaard passed these concerns along to Chief Investment Officer Judy Greffin, who ordered him to investigate.

Odegaard and a team of Allstate employees soon discovered signs of timed trading. The team noted several trading patterns that suggested portfolio managers had delayed trades to take advantage of the Dietz effect. The investigation also uncovered emails suggesting that the managers were aware of the Dietz effect and actively considered it when trading. Though not conclusive, the investigation raised concerns that personnel in the Equity Division had timed trades to increase bonuses at the expense of their portfolios; as a result, Allstate may have reported inaccurate financial information to the public.

Allstate accordingly retained the law firm Steptoe & Johnson to investigate further. Steptoe attorneys interviewed Rivera and Scheuneman regarding their trading practices and hired NERA Economic Consulting, Inc., an independent economic consulting firm, to determine if timed trading had harmed the portfolios, especially the pension funds. Beginning with the trades mentioned in the suspicious emails and eventually reviewing six years of trading data, NERA preliminarily estimated a potential adverse portfolio impact of $8.2 million.

But NERA had reason to believe that the actual impact may be much higher. Several suspicious emails could not be tied to particular trades, and other evidence suggested that portfolio managers routinely considered Dietz in the course of trading. Based on Allstate's records, however, it was not possible to calculate actual losses with any precision. So NERA devised an algorithm that would capture every Dietz-favorable trade from June 2003 to May 2009 that was executed after a series of days where the Dietz effect would have harmed the trader's performance. Based on these parameters, NERA estimated that over the six years surveyed, the potential adverse impact on the pension plans was $91 million and the potential adverse impact on the company's other portfolios was $116 million. It was clear to everyone that these estimates vastly overstated the potential effect of timed trading. Erring on the side of caution, however, in mid-December Allstate paid $91 million into the two pension plans to compensate for any potential losses.

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