A hidden difficulty many American employees face is that a huge amount of their retirement income – an estimated $4 trillion – is in 401(k) plans, too many of which are managed by individuals indifferent to (or not competent to advance) the interests of future retirees. In this Fourth Circuit case, the district court found the fiduciaries of the retirement plan in breach of their duty of prudence by their arguably poor timing in liquidating a company-stock fund when its shares were in a trough, without performing a reasonable investigation, but excused them from paying any relief to the participants. The court holds (2-1) that the judge erred in insulating the fiduciaries from remedying that breach, concluding that the fiduciaries had the burden of proving that a prudent fiduciary would have made the same decision.
Tatum v. RJR Investment Committee, No. 13-1360 (4th Cir. Aug. 4, 2014): “Richard Tatum brought this suit on behalf of himself and other participants in RJR’s 401(k) retirement savings plan (collectively ‘the participants’). He alleges that RJR breached its fiduciary duties under the Employee Retirement Income Security Act (‘ERISA’), 29 U.S.C. § 1001 et seq., when it liquidated two funds held by the plan on an arbitrary timeline without conducting a thorough investigation, thereby causing a substantial loss to the plan.” Although the district court agreed that the defendants took too cursory a look at timing, it held that they proved that “a reasonable and prudent fiduciary could have made [the same decision] after performing [a proper] investigation” (emphasis in original), thus holding that the breach of duty did not cause a loss.
The decision in this case, dividing the panel (and driving an 85-page opinion), focuses on whether that “could” should have been a “would” – in other words, whether the fiduciaries’ burden was not only to prove that the timing of the sale was one possible prudent outcome, but specifically was the one that a prudent fiduciary presented with the same set of facts most likely might have selected.
The backdrop of the case was the fated 1985 merger of Reynolds Tobacco and Nabisco. When the company decided to split up in 1999, due to the “tobacco taint” on share value (the late-1990s were the height of the tobacco-litigation era), the company faced an issue about what to do with the company’s two common stock fund plans offered in its 401(k): “the Nabisco Common Stock Fund, which held common stock of Nabisco Holdings Corporation, and the RJR Nabisco Common Stock Fund, which held stock in both the food and tobacco businesses.” It decided to split the RJR fund into two common stock funds, Nabisco Holdings (food) and RJR (tobacco). Thus the 401(k) plan wound up with two funds holding exclusively Nabisco stock (collectively “Nabisco Funds”)
The Plan fiduciaries decided first to freeze both Nabisco Funds (which maintained the current shares, but allowed no new investments), then ultimately to close them. The decision to close the plans had several serious shortcomings: it was in breach of the plan documents (which only provided for freezing the plans), the working group in charge of making the decision “spent only thirty to sixty minutes considering what to do with the Nabisco Funds in RJR’s 401(k) plan,” it did not seriously study alternatives to this proposal, and there was “no testimony as to why six months was determined to be an appropriate timeframe” for closing the fund. It was these facts that led the district court to find that the fiduciaries breached their duty of prudence.
The timing of the decision to close the Nabisco Funds and sell the funds came at a time that the shares had “declined precipitously in value.” This prompted the fiduciaries to reconsider the closure decision, but they ultimately forged ahead anyway, fearing that participants who already sold shares might sue RJR. The company sent the participants two letters that “erroneously informed participants that the law did not permit the Plan to maintain the Nabisco Funds,” despite knowing (and being advised by counsel) that this statement was incorrect. Then, shortly before the sale was set in January 2000, participant Tatum emailed the VP of Human Resources asking that the sale be postponed so that the share price had a chance to recover: “the forced sale of the Plan’s Nabisco shares … would result in a 60% loss to his 401(k) account.” The sale was completed, nonetheless. And by the end of the calendar year 2000, Nabisco common stock rose 82% (in a bidding war for Nabisco won by Philip Morris).
Tatum sued the plan fiduciaries (including RJR) in 2002. In 2010, the district court held a four-week bench trial, and in 2013 held that the decision to sell the stock without a proper investigation was not prudent, but that RJR met its burden of disproving loss-causation because its decision to eliminate the Nabisco Funds was “one which a reasonable and prudent fiduciary could have made after performing such an investigation.”
The panel majority reverses. It issues various rulings about whom the proper defendants should be (affirming that RJR was correctly held liable for its role in plan administration, reversing dismissal of the Benefits Committee and Investment Committee, and holding that the judge did not err in denying leave to add individual committee members). On the merits, the panel majority agrees with the district court that the burden of loss causation fell on the imprudent fiduciaries, but holds that the judge erred in only requiring the defendants to prove that the sale and timing was one strategy that a prudent fiduciary could have taken.
Under the common law of trusts, the panel majority observes, trustees bear the burden of untangling the financial consequences of their breaches of duty. The panel majority holds that the same rule attends to ERISA fiduciary violations (a position vociferously denied by the dissent, which would have left the burden of proving loss-causation on plaintiffs). Thus, “[t]o carry its burden, RJR had to prove that despite its imprudent decision-making process, its ultimate investment decision was ‘objectively prudent.'”
The district court erred, though, in holding that defendants met their burden by showing that a prudent fiduciary “could” have chosen the same course action, rather than (more assertively) that it “would” have done so. “We would 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. As the Secretary of Labor notes, this approach would ‘create too low a bar, allowing breaching fiduciaries to avoid financial liability based on even remote possibilities.'”
The panel majority also holds that the record did not establish that prudent fiduciaries would necessarily have made the same decision, rendering the choice of the wrong standard harmless. “Particularly given the extraordinary circumstances surrounding RJR’s decision to divest the Nabisco Funds, including the timing of the decision and the requirements of the governing Plan document, we must conclude that application of the incorrect legal standard may have influenced the court’s decision.”
The panel majority further denies RJR’s alternative argument that it should reverse the findings of fiduciary imprudence. It rejects arguments that the standards of prudence were different (and lower) for single-stock funds. It also upholds the district court findings: “The court found that, without undertaking any investigation, RJR forced the sale, within an arbitrary timeframe, of funds in which Plan participants had already invested …. The district court further found that RJR sold the Nabisco funds when it did because of its fear of liability, not out of concern for its employees’ best interests.”
In dissent, Judge Wilkerson would hold that the burden of loss-causation should remain on the participants, and that shifting the burden means that there may be instances when fiduciaries could be held personally financially liable for making a prudent, but not the most likely prudent, decision. It would have also held that even on this record, the decision to liquidate the fund was prudent and indeed necessary to fend off the risk of greater losses to the plan. “[I]n a larger sense, the interests of plan participants and plan fiduciaries often align. It does neither any good to run up plan overhead with litigation over investment decisions taken, as this one was, to diversify plan assets and protect employees down life’s road. All will be losers — perhaps fiduciaries most immediately but plan participants, sadly, in the end.”