On February 25, 2013, the U.S. District Court for the Middle District of North Carolina issued an opinion and final judgment ruling in favor of defendant R.J. Reynolds Tobacco Company (“RJR”) in a nationwide class action asserting breach of fiduciary duty pursuant to ERISA § 502(a)(2), 29 U.S.C. § 1132(a)(2), based on RJR’s removal of two non-employer, single-stock investment funds from the company’s 401(k) plan. See Tatum v. R.J. Reynolds Tobacco Co., __ F. Supp. 2d __, 2013 WL 692832 (M.D.N.C. Feb. 25, 2013). The decision by the Honorable Judge N. Carlton Tilley, Jr. significantly impacts ERISA’s “hypothetical prudent fiduciary prong,” which is applied under either the “substantive prudence” or causation analyses for breaches of fiduciary duty. In “stock-drop” cases, courts typically approach the burden of persuasion and standard for substantive/prudence in one of two ways—placing the burden on the plaintiff to prove that a hypothetical prudent fiduciary “would have” eliminated the suspect funds from the plan at a particular time; or placing the burden on the defendant to prove that a hypothetical prudent fiduciary “would not have” eliminated the suspect funds at that time. The court in Tatum, however, applied a “could have” standard for substantive prudence/causation because it found credible evidence at trial that a hypothetical prudent fiduciary could have either eliminated or retained the investment funds at issue. Ultimately, the court held that RJR’s decision was objectively prudent: “RJR has satisfied its burden of establishing at trial that its actions were not imprudent and a hypothetical prudent fiduciary could have decided to eliminate the [investment funds] on January 31, 2000.”
This case has application whenever a company with employer stock in a 401(k) spins off a subsidiary and must determine what to do with the formerly-employer stock in the subsidiary plan. It also has implications for claims for fiduciary breach under ERISA where fiduciaries choose between two or more prudent investment options, such as where fiduciaries make a discretionary decision to add one of a number of prudent investment funds, substitute one prudent investment fund for another prudent fund, or remove what may be a violatile, yet prudent, investment option to protect participants from the risk of large losses to their retirement savings.
Background and Opinion
The suit stemmed from a decision made in 1999 by RJR Nabisco Holdings Corp., subsequently renamed Nabisco Group Holdings Corp. (NGH), to spin off RJR, thereby separating NGH’s tobacco business and food business. As part of the spin-off, the 401(k) plan for the previously related entities had to be divided into two separate plans for the now-separate tobacco and food businesses. The plaintiff contended that RJR, its holding company, and two administrative committees (later dismissed) breached their fiduciary duty of prudence to participants of the RJR 401(k) plan when the defendants removed the stock funds of the companies involved in the food business, NGH and Nabisco Holdings Corp. (NA), as investment options from the RJR 401(k) plan approximately six months after the spin-off. Within a year after the divestment, both the NGH and NA stocks appreciated significantly. Plaintiff sought class-wide damages of well over $50 million, claiming as damages the lost appreciation denied them by the divestment of the NGH and NA stock funds (together, “the Nabisco Funds”).
Although it was RJR’s belief at the time that the elimination of the Nabisco Funds through Plan amendment was a settlor act to which no fiduciary duties applied—thereby requiring no minimum investigation, analysis, or procedure—the court found that the elimination was fiduciary in nature. It then held that RJR breached its fiduciary duties of procedural prudence when it decided to remove the Nabisco Funds from the RJR 401(k) plan without undertaking a proper investigation into the prudence of its decision.
Despite this finding, the court correctly noted that the plaintiff could only prevail if “the breach actually caused a loss to the plan.” This required a showing that the decision was not reasonable under the circumstances, which is often referred to as “substantive prudence.” Other courts consider this an issue of causation—if the decision was substantively prudent then any breach of procedural prudence cause no injury. The court first held that RJR had the burden to prove that its decision to divest the Nabisco Funds was objectively prudent. It then found that RJR readily satisfied that burden. The court based this holding on RJR’s evidence that: a single stock fund carries significantly more risk than a diversified fund; the Nabisco Funds themselves were inherently risky investments due to potential tobacco-related liability, which therefore increased risk for the Plan participants; analyst reports during 1999-2000 regarding the Nabisco Funds would not compel a decision to maintain those funds in the Plan; the stock appreciation after divestment was neither expected nor foreseeable; and plaintiff’s evidence of what other plans were doing was “highly questionable” and not persuasive as to what RJR should have done. In light of all these considerations, the court found that “RJR has satisfied its burden of establishing at trial that its actions were not imprudent and a hypothetical prudent fiduciary could have decided to eliminate the Nabisco Funds on January 31, 2000.”
This case is unique in a number of ways. It is not a “stock-drop” case where plan participants are suing for fiduciary breach for failure to eliminate employer funds from an ERISA plan when the employer company is on the brink of financial disaster. By contrast, Tatum contended that the Nabisco Funds—non-employer, single stock funds—should have been retained in RJR’s 401(k), even though the stocks were dropping significantly in value prior to their elimination from the Plan and were inherently risky. Thus, where plan participants typically seek to recover actual “losses” to their plan investments, Tatum’s “losses” were the Nabisco Fund’s unforeseen post-divestment appreciation in value.
With regard to procedural prudence, this case also varies from others in that here the court found “fiduciaries” employees who believed they were acting as settlors. Rarely is this seen, even though courts tend to blur the lines between settlor and fiduciary acts. Here, because the Nabisco Funds were believed and intended to be eliminated by plan amendment, which requires no minimum investigation, analysis, or procedure, the acting employees naturally checked off fewer of the procedural requirements. Few cases of fiduciary breach address this type of inadvertent imprudence, free of claims of self-interest or true disregard for a fiduciary’s duties.
Despite the distinctiveness in the case, Tatum has real implications for ERISA’s “hypothetical prudent fiduciary” standard in certain scenarios. The case addresses for the first time the standard for substantive prudence or causation when those held to be fiduciaries are faced with an investment decision between two or more prudent choices. In most cases of fiduciary breach, such as in the stock-drop context, there is a bright line between prudent and imprudent actions, thus the “would have” standard makes sense. But the “could have” standard adopted by the court in this case is the appropriate standard where fiduciaries make a discretionary decision to add one of a number of prudent investment funds, substitute one prudent investment fund with another prudent fund, or, like in Tatum, remove what may be a violatile, yet prudent investment option from a plan to protect participants from the risk of large losses to their retirement savings. In cases such as these, the application of the “could have” standard is necessary to prevent expanded liability against fiduciaries who make the right substantive decision.Overview