A judge has once again dismissed a lawsuit brought by an employee in Edison International’s 401(k) plan who alleges plan fiduciaries continued to offer company stock as an investment option in the plan when it was no longer prudent to do so.
The lawsuit was filed against the chief executive officer (CEO) of Edison and the vice president and treasurer of Edison who was also a member of the Trust Investment Committee. It 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. A settlement of the action apparently raised investors’ confidence in Edison, thus raising its stock price. However, a finding after the settlement that Edison failed to deliver certain communications, which was revealed in pieces over time, caused Edison’s stock price to fall.
As in her first complaint, the plaintiff alleged in a second amended complaint (SAC) that 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.
U.S. District Judge John A. Kronstadt of the U.S. District Court for the Central District of California previously 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 plaintiff alleged two alternative actions defendants could have taken: made corrective disclosures to the public, thereby allowing the market to cause the price of Edison stock to return to its true value; or 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 allowed the plaintiff to file an amended complaint with more context-specific proof.
More arguments in the SAC
In the SAC, the plaintiff says the vice president and treasurer of Edison should have understood the significance of the steady increase in implied volatility for the company stock—the greater the increase, the more volatile and risky Edison common stock was, and thus the more likely a stock-price correction would be harsher. She also argues that, “Had the overall trend in Edison’s implied volatility during the Class Period been in the opposite direction, [the vice president and treasurer of Edison] might have been able to make a reasonable argument that holding off corrective disclosure was the better option—the one likely to cause less harm to Plan participants—because the harshness of the stock-price correction was likely softening.”
However, the plaintiff contends the trend of increasing implied volatility was a clear signal that acting sooner to correct Edison’s fraud was likely to cause less harm than acting later would. According to the plaintiff, Edison’s declining bond price was another indicator of growing underlying corporate risk at Edison. She says this trend, combined with the trend of increasing implied volatility, was a clear indication to any prudent fiduciary that any stock-price correction that Edison experienced was going to be more severe as the bond price dropped and the implied volatility rose.
The plaintiff applied these arguments to the secondary option of closing the stock fund to new investments until the artificial inflation ended. “Given the increasing implied volatility and decreasing bond prices, as well as the reputational damage that a longer fraud would cause, a cessation of trading at an earlier time, even if it necessitated some public disclosure about the fact of the cessation, could not reasonably be believed to be likely to cause ‘more harm than good’ to Plan participants… Any stock-price drop that might have resulted from the temporary closing of the Stock Fund would be less than the stock-price drop that ultimately occurred after an unnecessarily prolonged and reputation-damaging fraud,” the complaint says.
However, Kronstadt found prudent fiduciaries in the same position as the defendants could have viewed both of the alternative actions as more likely to harm the plan than to help it. He found it insufficient that the SAC offers some “insight into how far the stock price would have dropped if disclosure was made earlier.” The plaintiff alleged that “[w]hereas on March 31, 2014, corrective disclosure would have resulted in, at worst, a $3 price correction, on January 30, 2015, the same corrective disclosure would have resulted in a potential $15 price correction because Edison’s stock was trading at $64.00.” But, Kronstadt said even if Edison’s stock price would have “dropped marginally as a result of a corrective disclosure, the net effect of that drop could have been substantial, causing substantial harm to plan members.”
Kronstadt also found the allegations in the SAC regarding inevitable harm do not withstand the “context-sensitive scrutiny” under Fifth Third, saying they are framed in a manner that could apply to any similar Employee Retirement Income Security Act (ERISA) claim. The allegations in the SAC regarding reputational damage are also generic, he said.
In addition, Kronstadt said the SAC doesn’t present any context-specific allegations that could plausibly support the allegation that a reasonably prudent fiduciary would not decide that, if the stock fund were closed to new investments until the artificial inflation ended, it would more likely cause harm than good to the fund. Citing the Supreme Court’s decision in Amgen v. Harris, the complaint says, closing the fund without explanation might be even worse: “It signals that something may be deeply wrong inside a company but doesn’t provide the market with information to gauge the stock’s true value.”
Kronstadt admitted that the Fifth Third standard is difficult to meet, noting that the vast majority of ERISA duty of prudence claims brought against employee stock ownership plans (ESOPs) since then have foundered on the pleading requirements. The plaintiff conceded that if her claim against the vice president and treasurer of Edison is dismissed then her claim against the CEO should be also, so Kronstadt dismissed the suit. However, he allowed the plaintiff one final chance to amend the complaint, no later than June 19.
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