In a case alleging that RJR breached its fiduciary duties under the Employee Retirement Income Security Act (ERISA) when it removed and sold Nabisco stock from its plan without a proper investigation into the prudence of doing so, the 4th U.S. Circuit Court of Appeals agreed with a district court finding that RJR did breach its fiduciary duty of procedural prudence and so bore the burden of proving that this breach did not cause loss to the plan participants. But, the appellate court found the lower court failed to apply the correct legal standard in assessing RJR’s argument that its breach did not cause losses to participants.
Assessing Procedural Prudence
In assessing whether RJR acted with procedural prudence when it decided to liquidate Nabisco stock funds following the spinoff of the company, the 4th Circuit noted that a prudent fiduciary need not follow a uniform checklist, but courts have found that a variety of actions can support a finding that a fiduciary acted with procedural prudence, including:
- appointing an independent fiduciary,
- seeking outside legal and financial expertise,
- holding meetings to ensure fiduciary oversight of the investment decision, and
- continuing to monitor and receive regular updates on the investment’s performance.
According to the 4th Circuit’s opinion, the lower court found that RJR fiduciaries’ discussion of the Nabisco stocks lasted no longer than an hour and focused exclusively on removing the funds from the plan. The court further found no evidence that the group considered an alternative to divestment from the stock within six months, such as maintaining the stock in a frozen fund indefinitely, making the timeline for divestment longer, or any other strategy to minimize a potential immediate loss to participants or any potential opportunity for gain.
Instead, the lower court found the “driving consideration” was the “general risk of a single stock fund,” as well as “the emphasis on the unconfirmed assumption that RJR would no longer be exempt from the ERISA diversification requirement because the funds would no longer be employer stocks.” No one researched the accuracy of that assumption, and it was later determined that nothing in the law or regulations required that the Nabisco Funds be removed from the plan.
The six-month timeline for the divestment was chosen arbitrarily and with no research, the lower court found. The purpose of the spinoff of Nabisco from RJR was, in part, to remove the “tobacco taint” on the company from its association with RJR. The lower court found there was no consideration for the idea that it may take some time for the “tobacco taint” to dissipate and Nabisco stocks would recover, or the fact that determining when to remove the stock could result in large losses to retirement plan participant accounts.
At one time following the spinoff, RJR’s fiduciaries did consider the merits of the decision when it was mentioned that RJR’s CEO was concerned that participants were questioning the timing of the elimination given the Nabisco stocks’ continued decline in value, but the fiduciaries did not investigate their decision at the time, and the lower court found that the discussion “focused around the liability of RJR, rather than what might be in the best interest of the participants.”
The 4th Circuit ruled the lower court’s finding that RJR failed to use procedural prudence in deciding to divest its 401(k) plan from Nabisco stock was well-supported.
Proving Loss Causation
In determining whether RJR met its burden of proving its breach did not cause a loss to plan participants, the lower court concluded that RJR met this burden by establishing that “a reasonable and prudent fiduciary could have made [the same decision] after performing [a proper] investigation.” [italics added] On appeal, Richard Tatum, the lead plaintiff in the case, contends that the court should have required RJR to establish whether a reasonable fiduciary would have done so.
The appellate court said it “could diminish ERISA’s enforcement provision to an empty shell if we permitted a breaching fiduciary to escape liability by showing nothing more than the mere possibility that a prudent fiduciary ‘could have’ made the same decision.” The appellate court noted that in an amicus brief, then Acting Secretary of Labor Seth Harris noted this approach would “create... too low a bar, allowing breaching fiduciaries to avoid financial liability based on even remote possibilities.”
RJR argued that, even if the district court erred in applying the “could have” rather than “would have” standard, the error was harmless. In RJR’s view, because the facts found by the district court as to the high-risk nature of the Nabisco stock funds unquestionably establish that a prudent fiduciary would have eliminated them from the plan.
But, the appellate court said this argument fails. “Although risk is a relevant consideration in evaluating a divestment decision, risk cannot in and of itself establish that a fiduciary’s decision was objectively prudent.”
The court noted that, in promulgating the regulations governing ERISA fiduciary duties, the Department of Labor expressly rejected such an approach. In its Preamble to Rules and Regulations for Fiduciary Responsibility, the Department explained, “the risk level of an investment does not alone make the investment per se prudent or per se imprudent.” In addition, the Department said an investment selected as part of a portfolio to further purposes of the plan and with appropriate consideration of surrounding facts and circumstances should not be deemed imprudent merely because the investment, standing alone, would have a high degree of risk.
The 4th Circuit also cited court decisions, such as the recent Dudenhoeffer decision, which say the duty of prudence turns on the circumstances prevailing at the time of fiduciary acts, and appropriate inquiry will necessarily be context-specific. The court rejected RJR’s contention that it would necessarily be imprudent for a fiduciary to maintain an existing single-stock investment in a plan that offers participants a diversified portfolio of investment options.
The appellate court also found the governing plan document required the Nabisco funds to remain as frozen funds in the plan. It noted that ERISA mandates that fiduciaries act “in accordance with the documents and instruments governing the plan insofar as such documents and instruments are consistent with [ERISA],” and that courts have found a breaching fiduciary’s failure to follow plan documents is highly relevant in assessing loss causation. So, the district court erred by failing to factor into its causation analysis RJR’s lack of compliance with the governing plan document.
For all of these reasons, the 4th Circuit said it cannot hold that the lower court’s application of the incorrect “could have” standard was harmless.
The appellate court remanded the case back to the lower court 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. “In doing so, the court must consider all relevant evidence, including the timing of the divestment, as part of a totality-of-the-circumstances inquiry.”
The 4th Circuit’s opinion in Tatum v. RJR Pension Investment Committee, et.al. is here.