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Fiduciary Decision to Dump Employer Stock Upheld

A number of recent stock-drop lawsuits filed against retirement plans have challenged the prudence of continuing to hold company stock – but a federal district court has found that continuing to do so was a prudent fiduciary decision.

Last June the Supreme Court of the United States declined to weigh in on a decision by the 4th U.S. Circuit Court of Appeals in the case of Tatum v. RJR Pension Investment Committee, et al., which had determined that the applicable standard in this stock drop case was whether a prudent fiduciary would have made the same decision. The 4th Circuit court had ruled 2-1 that a defendant has the burden of proof if there is a breach of duty, and that a fiduciary can be held liable for damages even for a prudent decision.

However, the 4th Circuit also found that the lower court did not apply the correct legal standard in determining RJR’s liability, reversed the judgment, and remanded with instructions “to review the evidence to determine whether RJR has met its burden of proving by a preponderance of the evidence that a prudent fiduciary would have made the same decision,” directing the lower court to include in its review of all of the relevant evidence the previously-excluded testimony of one of Tatum’s experts and the timing of the divestment “as part of a totality-of-the-circumstances inquiry.”

The Case

The case was a “reverse” stock drop case in which the employer (RJR) was sued for dropping two company stock funds from the plan. The 1999 spin-off of the R.J. Reynolds Tobacco Company from Nabisco resulted in the creation of a new RJR 401(k) plan (which was spun off from the existing RJR-Nabisco 401(k) plan). The plan document said that the Nabisco stock fund was to remain as a frozen fund in the RJR plan after the plan spin-off, but approximately six months after the corporate transaction, the RJR plan fiduciaries liquidated the Nabisco stock fund at a point when its shares had declined significantly in value from the time of the corporate spin-off. Within a year of that decision, a takeover bid for Nabisco sparked a bidding war that drove the price of the now-liquidated Nabisco stock up dramatically. So, in this case, participants were suing not because the stock had been held as an imprudent investment, but because of the decision to remove the stock as an investment option.

The decision to eliminate the Nabisco stock fund from the spun-off RJR plan wasn’t formally investigated and approved by the benefits committee as required by the plan document, nor was the plan was properly amended to remove the relevant stock fund. According to the record, testimony of company executives and benefits committee members indicated that more thought was given to the effect of the decision on the company than on the plan participants.

Most Recent Decision

In arriving at the most recent decision, Senior U.S. District Judge N. Carlton Tilley, Jr. noted that employees from RJR and Nabisco testified at trial that it was widely believed the shareholder value of Nabisco would be enhanced after the split because the value of Nabisco’s stocks was being unnecessarily depressed by investors’ fears regarding ongoing tobacco-related litigation.

Tilley ruled that RJR expert witness Howard Crane was correct in noting that investment considerations for fiduciaries of an employer-sponsored retirement plan are different than considerations for individual investors. That expert disagreed with the arguments of an expert for the plaintiffs that a prudent fiduciary would use analyst ratings during its decision-making for a participant-directed defined contribution plan. The ruling, which outlines a detailed chronology and analysis of the employer securities in question, determined that the Nabisco Group Holdings common stock funds and Nabisco common stock funds were “generally efficient,” and that in an efficient market, there is no ability for investors to predictably make extraordinary returns based on publicly available information.” Even if analyst ratings or recommendations were meaningful, they would have been essentially irrelevant to a reasonable investment decision because of the efficient market hypothesis,” the analysis concluded. Ultimately, following a detailed discussion, Tilley found that while Tatum’s expert “…is qualified to offer his opinion on this topic, his opinions as to the opportunity for exceptional returns” for the Nabisco stocks “…are not as persuasive as the opinions of others.”

Ultimately, the court held that it is “more likely true than not that had a prudent fiduciary reviewed the information available to it at the time, including Plan documents, public disclosures, analysts’ reports and associated research as to their significance, and newspaper articles, it would have decided to divest the Nabisco Funds at the time and in the manner as did RJR.”

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