It’s not unusual to find a plan fiduciary sued for keeping stock in a plan after it has dropped in value. What’s less common is the situation where a plan fiduciary is sued for too quickly discarding a stock investment by the plan.
In June 2015 the U.S. Supreme Court 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.
Current Case
Now for the third time, the U.S. Court of Appeals for the 4th Circuit has taken up the issue.
On appeal the plaintiff argued (unsuccessfully) that in holding that a prudent fiduciary would have made the same decision as RJR made here, the court focused too much on risk, ignored the plain language of the plan documents, failed to consider the testimony of Prof. Thomas Lys, and did not explain why a prudent fiduciary would have divested the Nabisco Funds at the time that RJR did.
In her majority opinion (2-1), Judge Diana Gribbon Motz noted that, “while the presence of risk is a relevant consideration in determining whether to divest a fund held by an ERISA plan, it is not controlling,” and that “even a cursory review of its opinion reveals that the court also considered value and expected returns, the diversity of the Plan’s investments, the requirements of the Plan documents, and the timing of the divestment,” as well as the nature of the plan as a long-term savings vehicle. In short, the appellate court determined that the lower court “acted entirely within our mandate in addressing risk as a ‘relevant consideration’ along with other factors.”
As for reliance on the terms of the plan documents, the court noted its previous determination that the terms of the plan documents cannot “trump the duty of prudence,” the “Plan terms, and the fiduciary’s lack of compliance with those terms, inform a court’s inquiry as to how a prudent fiduciary would act under the circumstances,” and found that the district court complied with that instruction in its review. As for the claim that it disregarded expert testimony, the appellate court noted that, pursuant to its instruction, the lower court dedicated “…an entire paragraph” to Prof. Lys’ testimony as to how a prudent fiduciary would research an investment decision and cited his “testimony on additional issues over a dozen times,” but found his testimony “less persuasive than that of RJR’s experts.”
Finally, it noted that the district court’s “…straightforward opinion belies any argument that it refused to consider the timing of the divestment,” but rather than simply relying on expert testimony, the court determined that a prudent fiduciary would have made the decision to divest the non-employer funds and would have completed the divestment when RJR did.
As for whether the parties’ dispute was affected by the Supreme Court's Fifth Third Bancorp v. Dudenhoeffer decision, Judge Motz wrote that that precedent holds that “a prudent fiduciary would have relied on the low market price of the Nabisco stock as the current value of the stock,” a factor that provided no basis for second-guessing the divestiture decision.
In ruling for RJR, Judge Motz wrote that one could “easily hypothesize” a situation in which the rebound in Nabisco stock price (following an unexpected takeover bid in 2000) never happened – in which case she noted that RJR likely would have been sued had it kept the Nabisco stock in the plan.
“Having a standard in which the fiduciary is held liable regardless of whether an outcome is foreseeable is akin to having no standard at all, eliminating the purpose of the loss causation analysis,” Judge Motz wrote. “Neither ERISA nor the efficient market theory requires that fiduciaries shoulder such burden or absorb such risk.”
There was a dissent by Judge Albert Diaz, who argued that the district judge failed to properly apply the “would have” standard for evaluating fiduciary conduct. Judge Diaz felt that the timing of the divestment and the plan fiduciaries’ disregard for the plan document qualified as “extraordinary circumstances,” and took issue with the district court’s deference to R.J. Reynolds, noting that the judge's language “smacks of ‘could have’ rather than ‘would have.’”
