North Carolina Lawyers Weekly
Like the noxious vapors left behind by a passing smoker, the litigation between R.J. Reynolds Tobacco and 3,500 of its current and former employees has lingered longer than anyone would have liked. But the protracted dispute might finally be close to being stubbed out after a divided 4th U.S. Circuit Court of Appeals affirmed a district judge’s ruling that RJR did not breach its fiduciary duty to its employees in its handling of their employee pension fund.
In 1999, RJR Nabisco, split into two companies, severing the tobacco maker from its stake in Nabisco, a snack-maker. Several lawsuits were pending against cigarette makers, and well-founded fear of massive verdicts was dragging down the value of the combined company. Before the split, many RJR Nabisco employees held stock in the company as part of their 401(k) plans. RJR decided that, under federal law, the new investment plan for its employees would have to divest itself of Nabisco stock—though this proved to be a misreading of the law.
Traders continued taking big bites out of the Nabisco holding company’s share price, and when it came time to sell off the employees’ stake, shares were trading for crumbs. But an unexpected bidding war soon kicked off, and shareholders were bought out for more than three times the price RJR had gotten for the stock.
Richard Tatum sued RJR in 2002 on behalf of himself and other employees under the Employee Retirement Income Security Act (ERISA). Tatum claimed that RJR had violated its responsibilities to its employees and that they should be compensated for their Nabisco stock at the price it fetched during the buyout.
The way the cookie crumbles
U.S. District Court Judge Carlton Tilley dismissed the suit in 2013, finding that although RJR failed to adequately investigate before eliminating the stock, a prudent fiduciary might have done the same thing anyway. A divided 4th Circuit panel remanded the case, saying Tilley had applied the wrong standard, and the proper question was not whether a prudent fiduciary might have made the same call, but whether he or she in fact would have.
Last year Tilley again dismissed the suit, finding that RJR could satisfy even this more exacting standard because Nabisco’s ongoing exposure to tobacco litigation made it unacceptably risky for RJR to put so many of its employees’ eggs in Nabisco’s basket. On April 28, a divided appeals court agreed, rejecting Tatum’s argument that RJR needed a more compelling reason to justify divesting from a company (sell stock) than to invest (buy it), and finding no good reason for a prudent fiduciary to assume Nabisco’s price would inevitably rebound.
Much of the dispute hinges on the two sides’ differing interpretations of the efficient market hypothesis, which posits that all publicly known information is already priced into the share of any given stock, and therefore there is no way for an investor to know with any confidence whether a particular stock is likely to go up or down in value in the future. For this reason, the U.S. Supreme Court has ruled that fiduciaries are justified in relying on a stock’s current price as the best measure of its long-term worth.
Tatum sought to turn the logic of that theory on its ear, arguing that since all publicly known information about a company is constantly being baked into its price, a prudent fiduciary wouldn’t have divested from Nabisco based on its well-known litigation risk. Tatum argued that the district court should have considered the positive attributes of Nabisco but not the litigation risk, since the latter was already built into the stock’s price.
Judge Diana Gribbon Motz, writing for the court’s majority, disagreed.
“But of course, Nabisco’s positive attributes had also already been reflected in the price of the Nabisco stock,” Motz wrote. “No case suggests that a fiduciary or a court assessing fiduciary duties should give the positive information extra consideration when the market did not do so. Such an artificial advantage for some public information at the expense of other public information flies in the face of the efficient market hypothesis.”
Something to chew on
Motz wrote that while the Supreme Court has said that a fiduciary is not required to divest a stock based on public information that shows a risk of price decrease, no court has ever held that a fiduciary is not justified in divesting a stock for that reason, nor held that a fiduciary carries a burden to prove that it had a “compelling reason,” to sell.
Motz noted that ERISA explicitly requires that a fiduciary diversify plan assets to minimize risk of loss, and ruled that Tatum’s arguments would create an impossible standard for fiduciaries to anticipate unforeseeable events like the bidding war that broke out for Nabisco’s stock. She imagined a scenario where RJR had held onto the stock, only the watch the price continue to plummet.
“As the hypothetical illustrates, much of Tatum’s timing evidence depends on facts not known (and not foreseeable) when the divestment occurred. Yet he argues that a prudent fiduciary would have anticipated these facts,” Motz wrote. “The ‘would have’ standard does not demand such an impossible feat. Having a standard in which the fiduciary is held liable regardless of whether an outcome is foreseeable is akin to having no standard at all.”
Judge Albert Diaz dissented, arguing that in considering the timing of the sell-off, Tilley had ignored the circuit court’s mandate and once again made a conclusion about what a prudent fiduciary could have done, rather than what a prudent fiduciary would have done.
Adam Charnes of Kilpatrick Townsend & Stockton in Winston-Salem argued the case on appeal on behalf of R.J. Reynolds. He was unavailable for comment.
Jeffrey Lewis of Keller Rohrback in Oakland, California, serves as lead counsel for the plaintiffs. Lewis could not be reached for comment.
The 37-page decision is Tatum v. RJR Pension Investment Committee (Lawyers Weekly No. 001-101-17.) The full text of the opinion is available online at nclawyersweekly.com.
Follow David Donovan on Twitter @NCLWDonovan
