Coming on the heels of the U.S. Supreme Court’s Dudenhoeffer decision, which eliminated a pro-fiduciary presumption with respect to company stock holdings in qualified retirement plans, the 4th Circuit issued a decision last week that could cause even more unrest for plan fiduciaries. The case, Tatum v. RJR Pension Investment Committee, et al., represents a potential elevation of the standard “prudent fiduciary” rule as it had been widely understood it to govern ERISA retirement plans.

In short, the 4th Circuit in this case purports to require a fiduciary to determine whether a prudent fiduciary more likely than not would make the same decision, rather than simply asking whether a prudent fiduciary could make the questioned decision, which had been a generally accepted interpretation of ERISA’s fiduciary prudence rules, at least in some circuits. While this may seem like a merely semantic difference on first read, the impact is that the 4th Circuit requires not just an objective determination of whether a prudent fiduciary might have also made this decision, but a determination that in light of all circumstances known to the plan fiduciaries, the decision is one that more prudent fiduciaries than not would also make. Stated another way, the decision potentially requires a deeper analysis of a spectrum of prudent fiduciary actions, and could require a fiduciary to prove that it acted as a majority of prudent fiduciaries or the most prudent fiduciary would have acted – a standard that demands greater analysis, and certainly some speculation, from plan fiduciaries.

The decision is also notable because it is a “reverse stock drop” case in which the decision to remove a stock fund from a plan was alleged to be imprudent when the stock price subsequently surged. At its worst, the decision in Tatum, particularly as framed in the amicus brief submitted in support of the plan fiduciary, is significant because it has the potential to push plan sponsors and fiduciaries toward a Catch-22 position when it comes to taking action on retaining or eliminating company stock funds.

The Case:

The Tatum case stemmed from the spin-off of the R.J. Reynolds Tobacco Company (RJR) from Nabisco in 1999. As a part of the transaction, a new RJR 401(k) plan was spun off from the existing RJR-Nabisco 401(k) plan. The new RJR plan maintained not only an RJR common stock fund, but also a Nabisco stock fund from the predecessor plan.  Per the terms of the RJR plan document, the Nabisco stock fund was to remain as a frozen fund in the RJR plan after the plan spin-off. Approximately six months after the corporate transaction, the RJR plan fiduciaries liquidated the Nabisco stock fund at a point when its shares had declined significantly in value from the time of the corporate spin-off. Within a year of the liquidation, a takeover bid for Nabisco sparked a bidding war that drove the price of Nabisco stock up dramatically from the time of the liquidation. A class action suit followed and has been in process ever since.

The district court had held that the RJR plan fiduciaries had breached their fiduciary duty in deciding to liquidate the plan’s holding of Nabisco stock without undertaking a proper investigation into the prudence of doing so, but that the breach did not cause losses because the decision was one that a reasonable and prudent fiduciary could have made after performing a proper investigation (essentially, there was a breach, but no harm caused by it). On appeal, the 4th Circuit panel agreed that there was a breach, but reversed the district court’s holding with respect to the harm caused by the decision because it found that the correct standard was not whether a reasonable and prudent fiduciary could have made the same decision, but rather whether a reasonable and prudent fiduciary would have made the decision.

What the Case Might Mean:

The 4th Circuit found a distinct difference between the “could” standard and the “would” standard. Under the “could” standard, the court surmised that a fiduciary is protected if its decision is merely any decision that was possible for a prudent fiduciary, encompassing several possibilities, some of which may be remote. Under the more difficult “would” standard, a fiduciary instead must determine what would be the probable decision by a prudent fiduciary. The dissent and amicus on behalf of RJR (by the Amercian Benefits Council) argue that this standard is unreasonable and unworkable for plan fiduciaries because it would require fiduciaries to make the best possible decision rather than simply a prudent decision, a “with the benefit of hindsight” standard that ERISA has never required. The Court responds to the dissent by saying that its decision is a modest one in interpreting the standard for the district court to review the issue. It states that nothing in the holding requires fiduciaries to make decisions that hindsight will prove was the best decision, but that it rather simply applies ERISA’s strict fiduciary requirements to a situation where procedural prudence was lacking at the time of the decision.

This last point highlights how this case could be interpreted as an example of bad facts making bad law. The ultimate reason the case moved forward is that the decision in 1999 to eliminate the Nabisco stock fund from the spun-off RJR plan wasn’t formally investigated and approved by the entity with the responsibility for doing so under the plan – its benefits committee – and the record demonstrated that the process used by the company left much to be desired in terms of procedural prudence. In addition, the plan was never properly amended to remove the relevant stock fund and testimony of company executives and benefits committee members indicated that more thought was given to the effect of the decision on the company than on the plan participants – a fiduciary no-no. All of these points were problematic for RJR, and the result is that their failure of procedural prudence was the fiduciary breach that allowed plaintiffs to move the analysis to the causation stage and lead to the discussion of the correct fiduciary standard to apply. Because RJR failed to establish and adhere to a reasoned basis for the decision, the district court and now the 4th Circuit panel were invited to opine on what decisions should have been made had procedural prudence been in place.

The end result for now is that this decision represents a potential tightening of the prudent fiduciary standards that govern ERISA plan sponsors. While the decision is somewhat troubling in that it places more stringent standards on plan fiduciaries, it also highlights the importance of maintaining and documenting substantive and thorough fiduciary procedures. The 4th Circuit’s holding here is relevant for not only company stock funds in qualified retirement plans (certainly after Dudenhoeffer’s levelling of company stock funds with any other plan investment offering), but potentially for all other investment holdings.  In addition, in the context of plans or entities that undergo a merger, the holding here will be very relevant for any plans that retain prior company stock after a transaction.

It is worth noting that this remand decision was by a 4th Circuit panel of three judges and it is very likely that RJR will appeal for an en banc rehearing before the full 4th Circuit Court of Appeals, so we have not heard the final say of the 4th Circuit on this matter. Until then, it remains to be seen how or if this decision might be interpreted by other Circuit Courts. Nonetheless, the current posture adopted here could be seen as pushing the fiduciary standard higher for retirement plan fiduciaries – requiring not just the evaluation of whether any prudent fiduciary could have taken an action, but rather an evaluation of whether a prudent fiduciary would more likely than not have taken the action.  Particularly for plan sponsors and fiduciaries of plans with employer stock attempting to cope with the aftermath of the Supreme Court’s Dudenhoeffer decision, this adds another layer of complexity when trying to decide how to evaluate or change company stock fund holdings.