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In February, the United States District Court For The Middle District Of North Carolina handed down its decision in Tatum v. R.J. Reynolds Tobacco Company, holding that even though the plan fiduciaries violated “procedural prudence” in eliminating Nabisco stock from the R. J. Reynolds defined contribution plan, their decision to do so was “substantively prudent” and therefore did not violate ERISA.
Oversimplifying somewhat, in June 1999 RJR Nabisco, Inc. (“RJR Nabisco”) “spun-off” 100% of the shares of R.J. Reynolds Tobacco Holdings (“RJRTH”). The remaining company (which now held only Nabisco stock) was renamed Nabisco Group Holdings (“NGH”). NGH held 80.5% of Nabisco’s shares; the remaining 19.5% was held by the public.
When the dust settled, the tobacco company (RJRTH) continued to sponsor the ‘old’ RJR Nabisco plan, and a new plan was created for Nabisco employees. This litigation involves the tobacco company plan (the ‘Plan’).
After the spinoff, the Plan had an RJRTH stock fund, an NGH stock fund and (apparently) an NA stock fund (holding shares of the 19.5% of Nabisco that had been held by the public). RJRTH stock was ‘employer securities’ within the meaning of ERISA section 404(a)(2) and therefore not subject to ERISA’s diversification requirement. NGH and NA stock were not ‘employer securities’ and therefore were subject to that requirement. (In the rest of this article we will refer to the NGH and NA stock funds as the “Nabisco Funds.”)
In November 1999, the Secretary of the Plan’s Employee Benefits Committee (EBC) drafted and signed a document that included language which would have eliminated the Nabisco Funds, but in a 2011 decision the court found that that ‘amendment’ was not validly executed or voted upon by the EBC.
On January 31, 2000, all the stock held by the Plan in the Nabisco Funds was sold.
Between June 15, 1999 and January 31, 2000, the market price of NGH had fallen 60% and NA had fallen 28%. Thus, participants investing in the Nabisco Funds sustained significant losses when the NGH and NA stock was sold.
On March 30, 2000, Carl Icahn made an unsolicited offer for NGH. A ‘takeover battle’ ensued, and NGH was ultimately sold, on December 11, 2000, to Philip Morris. On that day, NGH was priced at $29.9375 per share, and NA was priced at $55 per share, representing an increase of 247% and 82%, respectively, from the January 31, 2000 share prices.
We go into this level of detail to make clear these are classic ‘bad facts.’ Plan holdings of NGH and NA stock were sold right before an extraordinary appreciation in their value — a chain of events that attracts litigation.
The court considered three main issues: whether the elimination of the Nabisco Funds was the exercise of a “settlor function” and therefore not subject to ERISA’s fiduciary rules; whether the elimination of the Nabisco Funds met ERISA’s procedural prudence standard; and whether it was “objectively” or “substantively” prudent.
The defendants initially argued that the sale of NGH and NA stock was not a fiduciary act but was instead a “settlor function” — that, in effect, the sponsor had the right to eliminate the Nabisco Funds as matter of plan design.
It is conceivable that, on different facts, the court might have upheld this defense. But the court found that in the relevant documents the decision to eliminate a fund was consistently described as a fiduciary act. Quoting from the decision:
Several documents reference the fiduciary obligations of the PIC [the Pension Investment Committee]. The outline provided at the July 29, 1999 orientation meeting for the new Tobacco Plan PIC included, as one of the PIC’s functions, to “[a]pprove the selection and elimination of each investment option within the [Plan].” … Likewise, the topics listed for Mr. Kass’s presentation to the PIC on fiduciary duties in October 1999 included topics such as prudence requirements, procedural prudence, and diversification of the Plan’s assets, all of which suggest that Mr. Kass had been given information that the PIC had duties of prudence related to fund selection.
And, for instance, in letters to Mr. Tatum company fiduciaries stated that “we … believe that the fiduciaries of the [Plan] did act prudently and in the interests of Plan participants and beneficiaries when the frozen NGH and NA stock funds were eliminated from the [Plan] on January 31, 2000.”
Based on this evidence the court found that “the act of eliminating the Nabisco Funds was a fiduciary act, subject to the fiduciary duty of prudence ….”
The court then held that “ERISA’s prudence standard requires that a plan investment decision, including the decision to keep or eliminate a plan investment option, be made only after a thorough and impartial investigation and analysis.”
In this regard, the defendants’ expert suggested that “little investigation is required by a fiduciary when the fund at issue is a single stock, non-employer fund” because of the “inherent high risk of a single stock fund.”
The court rejected that approach and instead adopted that view of plaintiff’s expert. He (plaintiff’s expert) “focused more on the risk of divesting a fund already in the Plan,” which required a “more significant investigation into a company’s prospects ….” He testified that:
[O]nce an investment option is part of a plan’s investment portfolio, the fiduciaries must evaluate whether an investment option remains prudent, and must conduct an investigation of the option before deciding to dispose of it. … In performing such an investigation, fiduciaries should “take account of information which is available about that option,” which would include, in this case, “reports from professional analysts who follow the particular company, company filings required by the SEC, news reports, and general commentary on the state of the company and the industry.”
The court found that the process used by the Plan’s fiduciaries “fell far below what ERISA would require of a fiduciary.” That “process” consisted of a brief consideration of the issue at a couple of meetings, and the decision seemed to be in part based on an erroneous belief that the elimination of the Nabisco Funds was required by law. The court found, “[t]here is no evidence — in the form of documentation or testimony — of any process by which fiduciaries investigated, analyzed, or considered the circumstances regarding the Nabisco stocks and whether it was appropriate to divest.”
Thus, the defendants failed to comply with the procedural prudence required by ERISA.
Finally, the court held that, even where a fiduciary does not meet ERISA’s procedural prudence standards, there was nevertheless no ERISA violation because the decision to eliminate the Nabisco Funds was “substantively” prudent. The court quoted the 4th Circuit in Plasterers’ Local Union No. 96 Pension Plan, et al. v. Pepper: “[e]ven if a trustee failed to conduct an investigation before making a decision, he is insulated from liability … if a hypothetical prudent fiduciary would have made the same decision anyway.”
Critically, in this regard, the standard is not: would it have been prudent to retain Nabisco stock? Rather, it is: was it imprudent to eliminate it? The latter is, obviously, a much easier standard for the fiduciary to meet.
In holding for the defendant and determining that it was not “objectively” imprudent to eliminate the Nabisco Funds, the court found:
Single stock funds, even employer funds, are risky funds to include in a retirement plan. In this regard the court quoted defendants’ expert: “A single stock is approximately four times as risky as a diversified portfolio of mutual funds.” The court also found that the tobacco litigation, in which Nabisco was, despite the spinoff, still involved, increased this ‘riskiness.’
The high risk of the Nabisco Funds added to the risk levels of the Plan. That is, the Plan already had one highly risky stock fund — the RJRTH stock fund (which held employer securities) — making the retention of two other risky funds (the Nabisco Funds) problematic.
Even if public information favored the Nabisco Funds, considering and trading on that information would not have created above-market returns. In its analysis of this point, the court came close to adopting an ‘efficient market’ analysis. It concluded: “The point is that a prudent fiduciary who conducted an adequate investigation, which included reviewing the analyst reports, would not have been obligated to maintain the Nabisco Funds based upon their ratings alone or on the assumption that such ratings meant that the stock was undervalued and may realize above-market returns.”
Carl Icahn’s bidding war was neither expected nor foreseeable.
Tatum’s evidence of other plans where non-employer funds were maintained is not probative on the issue of prudence. Mr. Tatum presented evidence of seven other companies who opted to freeze rather than eliminate non-employer stocks in their own retirement plans. The court found, however, that each decision is fact-based. “[T]he probity of what other plans were doing, even if such evidence were more robust than Tatum’s, is highly questionable. The circumstances of each decision may be different, and the fact that another plan made one decision under unknown circumstances would not inform anyone as to the imprudence of a different action.”
The court’s conclusion, in finding for the defendants on the issue of “substantive” prudence: “A hypothetical prudent fiduciary could have decided not to add or maintain the Nabisco Funds as either frozen or active funds on January 31, 2000.”
One way to read this case is: if defendant fiduciaries had engaged in an adequate process up-front or (conceivably) structured the elimination of the Nabisco Funds as the action of a settlor (e.g., by an appropriate plan amendment), this more-than-a-decade long litigation could have been avoided. As it is, the defendants won a decision on bad facts that included significant criticism of their process. Moreover, the court’s holding for defendants was based on an analysis that, while supported by some case law, seems to conflict with, e.g., the recent decision in Tussey v. ABB (see below). Appeal is certainly a possibility.
In many respects, the case raises more questions than it answers:
1. How do you reconcile this court’s “substantive prudence” standard with the holding of the United States District Court for the Western District of Missouri in Tussey v. ABB? In the latter case, the court seemed to hold that a procedural failure with respect to an identical decision — the failure to follow plan procedures in eliminating a fund from the fund menu — resulted in fiduciary liability, even where the ultimate decision, the selection of a widely held family of target date funds, would seem to have been substantively prudent.
2. What is the standard for holding a single stock fund that is not an employer security? These funds are, unlike funds holding only employer securities, generally subject to ERISA’s diversification requirement. Given their inherently risky nature, many have believed that such funds present a high ‘imprudence risk.’ Nevertheless, the Tatum court seems to be saying that — with appropriate evaluation and monitoring — such a fund could be maintained in some circumstances.
3. How does the standard for the prudent evaluation of retaining a risky investment differ from the standard for the acquisition of such an investment? The facts in Tatum, while a little unusual, are not unheard of — when big companies spin off businesses or split up, the surviving companies may wind up with stock in companies they were formerly related to. Even though it might be imprudent to acquire that stock, the court adopted the position of plaintiff’s expert that the disposition of that stock presents a different set of issues.
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If nothing else, Tatum confirms once again that fiduciary decisions with respect to company stock, or, in this case, ‘ex-company stock,’ are likely to remain a focus of litigation. We will continue to follow this issue.