Company stock option at risk in ruling

WINSTON-SALEM, N.C. — A federal appellate court decision could force R.J. Reynolds Tobacco Holdings Inc. to pay out tens of millions of dollars to its 401(k) plan participants for selling their holdings in two Nabisco stock funds at a steep loss six months after the tobacco giant split from its food business.

And if participants ultimately win the lawsuit, plan sponsors might think twice about offering company stock as a retirement fund option at all, lawyers say.

The 4th U.S. Circuit Court of Appeals in Richmond, Va., earlier this month reversed a lower court ruling to dismiss a lawsuit alleging violation of fiduciary duties for eliminating the two investment options. The depressed Nabisco stock rebounded sharply after the food business was spun off in June 1999.

The U.S. District Court for the Middle District of North Carolina had granted R.J. Reynolds' motion to dismiss the case on the grounds that company officials were simply carrying out the directive of the plan amendment to eliminate the two Nabisco funds after the breakup of the conglomerate — a "settlor" function, not subject to the fiduciary provisions of the Employee Retirement Income Security Act.

The appellate court's narrowly crafted decision in the lawsuit, Tatum vs. R.J. Reynolds Tobacco Co., could send the case back to the lower court, if the company does not ask the appellate court to rehear the case by Dec. 28.

"Reynolds believes the district court correctly analyzed the plan documents, but understands the decision of the 4th Circuit," said Seth Moskowitz, a company spokesman. "Reynolds remains confident that the plaintiffs will be unable to prove that the elimination of the two Nabisco stock funds as investment options and the sale of stock of those plan participants who did not previously reallocate their plan assets invested in those Nabisco stock funds violated ERISA in any way."

If sent back, the lower court would also decide whether to grant class-action status on behalf of all the participants in the tobacco company's retirement plan at the time of the spinoff.

The appellate court's decision to reinstate the lawsuit suggests employers might have a tough time convincing higher courts to dismiss lawsuits over employer stock in retirement plans, said a pension lawyer advising corporations who did not wish to be identified. R.J. Reynolds had a strong argument in its favor — that carrying out plan amendments are not fiduciary duties — and if that did not survive appellate review, "you've got to be pretty pessimistic about the chances for dismissal," the source said.

Other lawyers representing corporations said that if the case is decided in favor of participants, plan sponsors might reconsider offering employer stock in retirement plans at all.

Plan sponsors in the past typically offered employer stock in retirement plans to give participants a tax-sheltered way of participating in the growth of the corporation.

Employers "are thinking about it. It begins to not be worth it," said Richard "Brick" Susko, partner in the New York law firm of Cleary, Gottleib, Steen & Hamilton, who advises plan sponsors.

In its decision, the appellate court noted that two amendments to the plan, made on June 14, 1999, and Nov. 19, 1999, required the trustees to freeze the two Nabisco stock funds and prohibit new contributions to them, but did not require the trustees to eliminate the two investment options and liquidate participants' holdings.

According to the appellate court, the amendments required the trustees to freeze the two Nabisco stock funds through Jan. 31, 2000, six months after the breakup of the company. But, because the investment committee could add investment options to the plan on or after Feb. 1, 2000, the trustees could have chosen to re-offer the Nabisco funds as investment options in the plan on that date, even though they were no longer employer stock.

"In other words, the amendments did not require the elimination of the Nabisco funds from the plan, nor did they require the sale of the Nabisco stocks," the appellate court's Dec. 14 ruling stated.

On Dec. 31, 1999, the tobacco company's $1.2 billion retirement plan holdings of Nabisco were valued at $15.6 million, or 1.3% of total assets. But participants might have held even more Nabisco stock at the time of the breakup in June 1999, when the tobacco company prohibited participants from any new investments in the Nabisco common stock fund, and the Nabisco Group Holdings Common Stock Fund (Pensions & Investments, June 10, 2002).

The appellate court's ruling could put employers between the proverbial rock and a hard place.

"If you offer the employer stock fund and it goes down, you get sued. If you take it away and it goes up, you get sued. It's the worst form of second-guessing," Mr. Susko said. "There should be a … rule allowing an employer to eliminate an employer stock fund when the employee no longer works for that employer."

But, in the absence of such a rule, employers wishing for legal exemption from ERISA's fiduciary duty provisions should ensure that their plan amendments unequivocally state they can dispose of stock of divested business affiliates, some sources said.

"One lesson that comes out of this case is that if a company wants to assert the defense that a plan amendment requires a certain investment decision, the company should be extremely clear in its amendment so that there is no uncertainty about whether or not the desired action is required by the plan," said Andrew L. Oringer, partner in the New York law firm Clifford Chance US LLP.

Although ERISA clearly exempts from its diversification rules employer stock offered through retirement plans, that exemption does not apply to stock of former business affiliates. And although decisions by employers to set up, shut down or amend a plan are typically considered to be "settlor" functions outside the scope of ERISA's fiduciary provisions — an argument made by R.J. Reynolds, and upheld by the district court in Durham, N.C. — amendments pertaining to investments of the plan might fall within the scope of the law.

"If you're a fiduciary of the plan and the plan documents neither require you to have employer stock, nor require you to sell employer stock, then you are subject to ERISA's fiduciary standards on whether to keep it or not," noted Jeffrey G. Lewis, a partner in the Oakland, Calif., law firm of Lewis, Feinberg, Renaker & Jackson PC, who represents the plaintiff, Richard Tatum.

Although the court did not discuss the broader question of whether trustees should override explicit plan amendments requiring the sale of stock of disposed business affiliates, a Department of Labor amicus brief supporting the plaintiffs' case before the appellate court had argued that trustees would be bound to ignore the amendment if selling the stock would be imprudent.