Judge Declares Stock Drop Wrongdoing Unproven

July 16, 2009 (PLANSPONSOR.com) - Defined contribution plan employees failed to prove a California technology company imprudently kept a company stock fund as an investment option despite a share price decrease while caught up in a stock options backdating controversy, a federal judge ruled.

U.S. District Judge S. James Otero of the U.S. District Court for the Central District of California issued the decision in a stock drop case against Computer Sciences Corp. (CSC), a Falls Church, Virginia-based technology services firm.

Among other allegations, participants in the Matched Asset Plan, a 401(k) program, alleged the employer violated the Employee Retirement Income Security Act (ERISA) by keeping the company stock option despite a 12%-decline in share price.

The share price drop followed CSC’s announcement that the Securities and Exchange Commission (SEC) had demanded documents about CSC’s stock option practices as part of a wide-ranging probe of allegations companies were improperly backdating the options. Plaintiffs alleged the share price drop from $55.88 to $48.56 was caused by the June 2006 announcement.

However, among the issues Otero raised in ruling for CSC was that the share price of CSC stock on December 31, 1998, the first day of the period covered by the suit, was $64.25, and the stock reached prices of over $95.00 during the time period.

"Had Defendants stopped offering CSC stock as an investment option in December 1998, as Plaintiffs propose, they may have faced lawsuits for doing so when the stock price later rose," Otero wrote in the opinion. "Moreover, not only is a decline in stock price insufficient to make continued investment imprudent, but holding fiduciaries liable for continuing to invest in declining stock would place them in an untenable position, as they could also be liable if they ceased investment in the declining stock and it later rebounded."

Otero cited Department of Labor Bulletin 2004-03, which asserted that "because stock prices fluctuate as a matter of course, even a steep drop in a stock's price would not, in and of itself, indicate that a named fiduciary's direction to purchase or hold such stock is imprudent (see  EBSA Issues Directed Trustee Responsibility Guidance )."

Even a stock selloff would have negative consequences, Otero pointed out: "Alternatively, compelling fiduciaries to sell off a plan's holdings of company stock may bring about precisely the result plaintiffs seek to avoid: a drop in the stock price. Eliminating CSC stock as an investment option for its employees is a clarion call to the investment world that the Committee lacked confidence in the value of its stock, and could have a catastrophic effect on CSC stock price, severely harming all CSC stock holders, including plan members."

Plaintiffs also did not show the plan would have been financially better off if it had rid itself of the company stock fund and invested the assets elsewhere, Otero contended.

The ruling is available here .