Alert September 29, 2014

Fourth Circuit Places Burden on Defendants to Disprove Loss Causation in Fiduciary Breach Cases

Summary

In Tatum v. RJR Pension Investment Committee, No. 13-1360 (August 4, 2014), a divided panel of the U.S. Court of Appeals for the Fourth Circuit held that, if the plaintiff in an ERISA fiduciary breach case proves that the defendant has breached its fiduciary duty and that a related loss has occurred, the defendant is liable for the loss unless it demonstrates that the loss was not caused by the breach – i.e., that the loss would have occurred in the absence of the breach.

Background

Tatum arose from the following facts. In 1999, RJR Nabisco, Inc. engaged in a corporate spinoff to separate its tobacco business (“Reynolds”) from its food business (“Nabisco”). In connection with this spinoff, a new 401(k) plan was established for employees of Reynolds and assets representing the accounts of those employees were transferred from the 401(k) plan of RJR Nabisco to the new Reynolds 401(k) plan. Prior to the spinoff, employer stock was an available investment option under the RJR Nabisco plan, and as a result the Reynolds 401(k) plan ended up holding substantial amounts of Nabisco stock in two funds (the “Nabisco Funds”). The Nabisco Funds were frozen to new investment, but the Reynolds plan permitted participants to continue to hold the Nabisco stock they had previously purchased under the RJR Nabisco plan.

Reynolds decided to eliminate the Nabisco Funds under its 401(k) plan, effective six months after the corporate spinoff. Several months later, a bidding war developed for Nabisco, which ultimately resulted in a significant increase in the price of Nabisco stock. Nonetheless, the plan was divested of the Nabisco Funds after six months’ time. In 2002, a participant in the Reynolds 401(k) plan brought a class action in federal district court against Reynolds (and other plan fiduciaries), alleging that the decision to eliminate the Nabisco Funds under the Reynolds plan was a breach of ERISA’s duty of prudence. The suit sought to hold Reynolds (and other defendants) liable for the profits he (and other class members) would have realized if the Nabisco Funds had not been eliminated.

District Court Decision

In 2003, the district court dismissed the case, finding that the elimination of the Nabisco Funds as investment options was a “settlor” decision that had been incorporated into the plan’s governing documents, and was therefore not subject to ERISA fiduciary duties. The Fourth Circuit reversed that decision, holding that the plan documents did not require divestment of the Nabisco Funds.
Following remand, the district court held a bench trial, and concluded that Reynolds had breached the duty of prudence by deciding to eliminate the Nabisco Funds, and to do so on a six-month time frame, without proper investigation. The court determined that, as a breaching fiduciary, Reynolds bore the burden of proving that its breach did not cause the alleged harm. The court found, however, that Reynolds was not liable for the claimed damages because it had satisfied its burden by proving that elimination of the Nabisco Funds was “one which a reasonable and prudent fiduciary could have made” after performing a proper investigation.

Fourth Circuit Majority Opinion

In a majority opinion written by Judge Motz (joined by Judge Diaz), the Fourth Circuit reversed and remanded the district court decision.
The majority agreed with the district court that Reynolds had breached its duty of prudence by failing to undertake a proper investigation before eliminating the Nabisco Funds. The court noted that the Reynolds working group that made the decision engaged in virtually no discussion or analysis, and never considered alternatives to eliminating the Nabisco Funds six months after the spinoff. Among other things, the court faulted the working group for focusing exclusively on the risks of maintaining an undiversified, single-stock fund and for failing to consult legal counsel or investment experts in making its decision.

The majority also agreed with the district court’s decision that Reynolds, as a breaching fiduciary, bore the burden of proof regarding loss causation – i.e., whether the breach had caused the harm alleged by the plaintiffs. In the court’s view, this burden-shifting approach is supported by traditional trust law and ERISA case law.

However, the majority disagreed with the district court’s holding that Reynolds could satisfy its burden by proving that a hypothetical fiduciary using a prudent process “could have” reached the same decision as Reynolds, i.e., to eliminate the Nabisco Funds six months after the spinoff. Instead, the appellate court ruled, Reynolds could meet its burden, and avoid liability, only if it demonstrated that a prudent fiduciary “would have” come to the same decision.

According to the appeals court, the trial court erred in finding that Reynolds met its burden by showing that the evidence did not compel a decision to maintain the Nabisco Funds, and that a prudent investor “could have inferred” from the facts and circumstances that it was prudent to sell the plan’s Nabisco stock. The majority held that the trial court should have instead determined “whether the evidence established that a prudent fiduciary, more likely than not, would have divested the Nabisco Funds at the time and in the manner in which [Reynolds] did.” It remanded the case to the district court for application of this standard.

Judge Wilkinson’s Dissent

Judge Wilkinson filed a lengthy dissent, criticizing the majority opinion for putting ERISA plan fiduciaries at risk for personal monetary liability for investment decisions that are objectively prudent. The dissent argued that, because ERISA Section 409(a) makes a fiduciary responsible only for losses that “result from” the fiduciary’s breach, plaintiffs should bear the burden of proving loss causation.

Judge Wilkinson expressed particular concern that the court’s decision exposed Reynolds (and future fiduciaries) to liability for a determination that, in his view, protected plan participants from the dangers of undiversified single-stock funds. He also warned that the majority’s decision would lead to more ERISA fiduciary litigation, thereby effectively increasing plan administrative costs to the harm of both participants and fiduciaries. His admonition to “those who might contemplate future service as plan fiduciaries,” is, simply: “Good luck.”

Subsequent Proceedings

On September 2, 2014, the Fourth Circuit denied the petition for rehearing en banc filed by the Reynolds defendants. In advancing a motion to stay the mandate of the Fourth Circuit (which was denied on September 23, 2014), the Reynolds defendants announced their intention to file a petition for writ of certiorari with the Supreme Court, presenting two questions: (i) “whether the defendant bears the burden of proof for the element of causation on a claim under [ERISA Section 409(a)],” and (ii) “what standard to apply to evaluate whether a fiduciary is liable for damages under [ERISA Section 409(a)].”