Reverse stock-drop case raises issues for DC execs

The U.S. Supreme Court might hear a case in which a defined contribution plan sponsor is being sued for selling a stock fund too soon — the opposite of what a typical fiduciary lawsuit alleges.

This reverse stock-drop case — RJR Pension Investment Committee et al. vs. Tatum et al. — will include some knotty legal questions if the court does review it. Key issues include DC plan executives' responsibility to follow and document investment decisions to meet the guidelines for fiduciary prudence contained in the Employee Retirement Investment Security Act.

The case could hinge on whether the Supreme Court decides to rule on a standard of fiduciary prudence distinguishing between the words “could” and “would.”

In the RJR case, a federal District Court issued a pro-RJR ruling, saying the plan needed to show that a hypothetical prudent fiduciary “could have” acted in a similar manner as RJR plan executives. This is a more flexible standard.

But an appeals court reversed the District Court, saying RJR had to show that a hypothetical prudent fiduciary “would have” acted in the same manner - a stricter standard.

ERISA attorneys say there's a big difference between the two standards. In December 2014, the RJR plan petitioned the Supreme Court. Last month, the Supreme Court asked the solicitor general to submit views on the case, a strong indication to ERISA attorneys that the court is interested in ruling on the case.

The RJR case is based on a 1999 decision by RJR Nabisco Holdings to split into a tobacco company (R.J. Reynolds) and a food company (Nabisco).

When the tobacco company was spun off in June, it had a separate 401(k) plan whose investment options included publicly traded shares of the tobacco company, the food company and the old parent company (whose primary asset was its stake in the food company).

The tobacco company 401(k) plan froze the latter two stock investments. Court documents show plan executives sold the two stocks at a substantial loss on Jan. 31, 2000. The food-company stock was down 40% from the spinoff and the parent company stock was off 60%.

However, the food-company stock rose, thanks to a bidding war in which Philip Morris Cos. Inc. was the victor in December 2000. Court documents show the parent company stock rose 247% and the food-company stock rose 82% from the day the tobacco 401(k) plan sold them.

In May 2002, participants in the tobacco company 401(k) plan filed a class-action suit against the plan, alleging a breach of fiduciary duty for imprudently selling its holdings in the food company and the old parent company.

A federal District Court judge in Greensboro, N.C., ruled in favor of the RJR plan in February 2013. Participants appealed. In August 2014, the 4th U.S. Circuit Court of Appeals, Richmond, Va., voted 2-1 to reverse the District Court ruling.

In their petition to the Supreme Court, RJR plan attorneys said the plan held “large amounts of Nabisco stock solely because of a historical accident.”

“Those holdings were not the result of ERISA's pro-diversification policies,” the attorneys wrote. RJR officials acted prudently to avoid being saddled with multiple single-stock investment options, the petition said.

The plan participants' petition to the Supreme Court said the actions by the RJR plan were punctuated with multiple failures to “investigate or monitor the reasonableness” of its decision, representing a breach of fiduciary duties. They said the court shouldn't overturn the appeals court's ruling.

Attorneys unaffiliated with the case don't expect the solicitor general's opinion for several months, meaning the Supreme Court is likely to wait until at least the fall to decide if it wants to take the case. The current court session ends June 30.

ERISA attorneys agree the RJR 401(k) plan executives did a poor job of planning and documenting their decision to divest the plan's food-company investments. “This is a classic case of what not to do when you are changing investment options,” said Mary Ellen Signorille, senior attorney for AARP Foundation Litigation, a unit of the AARP, Washington. “This process was just awful. The takeaway for other employers is "do the process right.'“

AARP supports the RJR plan participants, having written an amicus brief when the appeals court reviewed the federal District Court's decision.

“The biggest takeaway for the benefits community is something we have been preaching forever - procedural prudence,” said Russell Hirschhorn, a New York-based senior counsel for Proskauer Rose LLP, whose firm defends employers in fiduciary breach cases.

“Other fiduciaries should do a better job of documenting their decisions,” said Jeremy Blumenfeld, a Philadelphia-based partner at Morgan Lewis Bockius LLP, whose firm represents employers in fiduciary breach cases. “RJR didn't document.“

However, the District Court judge ruled in favor of RJR, saying that “a hypothetical prudent fiduciary could have decided to eliminate” the food stock investments from the plan. “The court concludes that the fiduciaries' failure to properly investigate their decision ... was not the cause of any of Tatum's or the class' alleged injuries.”

The appeals court noted the many procedural problems presented during the District Court trial, including the fact that an RJR working group spent “only 30 to 60 minutes” considering whether the tobacco company 401(k) plan should sell the food-stock investments.

The appeals court said RJR should be held to a higher standard — that a hypothetical prudent fiduciary “would” have made the same decision as the RJR 401(k) plan executives. The appeals court remanded the case to the District Court, where it remains pending.

Attorneys not involved in the case said the “could” standard is a fair approach to prudence that gives fiduciaries greater leeway to make decisions. The “would” standard, they added, is tougher on plan sponsors.

The appeals court ruling “set a very difficult burden for plan fiduciaries,” said Mr. Hirschhorn of Proskauer Rose.

The appeals court ruling“ is a bad decision; it is a pro-litigation decision,” said James P. McElligott Jr., a Richmond, Va.-based partner at McGuireWoods LLP, whose firm represents DC plans in fiduciary breach cases. “When you make an investment decision, there is no way to guarantee success.”

Mr. McElligott acknowledged that the RJR executives made procedural errors. But he supports the District Court's “could” standard because the court said, in effect, that the RJR plan executives' ultimate decision was “one of a number of reasonable alternatives.”

By contrast, Ms. Signorille of the AARP Foundation Litigation endorses the appeals court's use of the stricter “would” standard for determining prudence. “It troubles me that fiduciaries would go through such a terrible process and get away with it,” she said.