The U.S. District Court for the Central District of California has dismissed a lawsuit brought by an employee in Edison International’s 401(k) plan, alleging plan fiduciaries continued to offer company stock as an investment option in the plan when it was no longer prudent to do so.
U.S. District Judge John A. Kronstadt found the plaintiff failed to propose alternative actions that a prudent fiduciary would not have viewed as more likely to harm the fund than help it, as required by the standard in the Supreme Court’s ruling in Fifth Third v. Dudenhoeffer.
The lawsuit was filed after Southern California Edison Company (SCE), a subsidiary of Edison International, was charged with “fraud by concealment” in a dealing with the California Public Utilities Commission.
According to the complaint, as a result of SCE’s “materially false and misleading statements and omissions,” Edison’s stock price rose to more than $66 per share, and was trading at “artificially inflated prices during the Class Period.” The compliant says the stock price continued to correct as the truth emerged over the next few months.
In addition to plausibly alleging alternative actions Edison could have taken, Fifth Third said “the duty of prudence . . . does not require a fiduciary to break the law” by “divesting [a] fund’s holdings of the employer’s stock on the basis of inside information,” Kronstadt noted. It also said courts should consider “whether the complaint has plausibly alleged that a prudent fiduciary in the defendant’s position could not have concluded that stopping purchases—which the market might take as a sign that insider fiduciaries viewed the employer’s stock as a bad investment—or publicly disclosing negative information would do more harm than good to the fund by causing a drop in the stock price and a concomitant drop in the value of the stock already held by the fund.”
The plaintiff alleges two alternative actions defendants could have taken. First, defendants could have made corrective disclosures to the public, thereby allowing the market to cause the price of Edison stock to return to its true value. Second, the defendants could have amended the plan to suspend new investments in the stock fund—or remove the stock fund as an investment option altogether—until such time as it was no longer an imprudent investment.
Kronstadt concluded that the alleged actions do not satisfy the standard set in Fifth Third. “Instead, the Complaint makes conclusory allegations that the alternatives would not have caused more harm than good. The Complaint fails to account for the risk that the market might overreact to the proposed public disclosures, causing harm to Plan participants that was greater than the potential decline in share price upon disclosure of the claimed improper conduct,” he wrote in his order granting Edison’s motion to dismiss.
The order gave the plaintiff 21 days to file an amended complaint. It can be viewed here.
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