Recent Court Decision Regarding Divestment of Company Stock Has Important Implications for the Drafting of Plan Documents

A recent federal district court decision highlights the potential protection that can be provided against liability for breach of fiduciary duty under ERISA by the “settlor function” doctrine when plan investment decisions are incorporated into the terms of the plan document by amendment.

Tatum v. R.J. Reynolds Tobacco Company

On December 10, 2003, the U.S. District Court for the Middle District of North Carolina held that the R.J.

Reynolds Tobacco Company and other defendants were not in breach of fiduciary duty under ERISA when, after a spin-off of the tobacco company from RJR Nabisco, two frozen stock funds holding Nabisco stock were liquidated. Tatum v. R.J. Reynolds Tobacco Company, 294 F. Supp. 2d 776 (M.D.N.C. 2003). RJR Nabisco Holdings, Inc. was, prior to June 15, 1999, the parent company of R.J. Reynolds Tobacco Co., R.J. Rey-nolds Tobacco Holdings, and RJR Nabisco. In conjunction with the spin-off of the tobacco companies from the food companies, the newly-created 401(k) plan for the tobacco companies (the “Tobacco Plan”) was amended to provide that the two Nabisco stock funds held by the Plan would be “frozen” from the time of the spin-off and then eliminated from the Tobacco Plan approximately six months after the spin-off. While the Nabisco stocks were “frozen” from June 15, 1999 (the date of the spin-off) to January 31, 2000 (the date they were eliminated from the Tobacco Plan), participants in the Tobacco Plan could not direct investment of new contributions into Nabisco stock or transfer existing plan assets to Nabisco stock. From the time that the two issues of Nabisco stock were frozen to the date they were liquidated, their value had plummeted some 60% and 40% of their pre-“freeze” value. After January 31, 2000, Nabisco stock prices rebounded as stock analysts had predicted.

A participant in the Tobacco Plan filed a class action lawsuit against the plan fiduciaries, including the employers/sponsors of the plan, the plan administrative committee, and the investment committee that controlled and managed plan assets. The complaint alleged that the plan fiduciaries had breached their fiduciary duties under ERISA by liquidating the Nabisco stock funds at a time when the value was low and analysts were advising that the stock be held or bought. A key aspect of the complaint was the allegation that the defendants had the discretion to prevent the January 31, 2000 liquidation of the Nabisco stock funds held by the Tobacco Plan.

The court dismissed the plaintiff’s complaint, holding that the plaintiff could not prove his breach of fiduciary duty claim because the plan fiduciaries did not have any discretion to prevent the liquidation of the Nabisco stock funds. The Court found that two amendments to the plan document that required that the Nabisco stock funds be frozen and eventually liquidated were exercises of settlor functions and, as such, were not subject to the fiduciary requirements of ERISA.

“Settlor Functions” Lie Outside of the Fiduciary Requirements of ERISA

The Department of Labor and the courts have long recognized that when an employer creates, amends, or terminates an employee benefit program, it is acting as a plan settlor and not as a plan fiduciary under ERISA and is, thereby, not subject to ERISA’s fiduciary duty provisions. The Supreme Court has stated that “only when fulfilling certain defined functions, including the exercise of discretionary authority or control over plan management or administration,” does a person be-come a fiduciary under ERISA §3(21)(A). See Lockheed v. Spink, 517 U.S. 882, 890 (1996). Plan design, including the creation, modification, or termination of a plan, is not a fiduciary function, as the functions specified in the definition of fiduciary under ERISA do not include plan design. Instead, when creating, amending, or terminating a plan, employers are acting in a capacity that is analogous to the settlors of a trust, and thus those functions have been termed “settlor functions.” When plan sponsors are engaged in settlor functions, they are not subject to liability for breach of fiduciary duty under ERISA because they are not acting in their capacity as plan fiduciaries. See, e.g., Hughes Aircraft Co. v. Jacobson, 525 U.S. 432 (1999).

The Rationale for the R.J. Reynolds Decision

Two plan amendments were significant to the R.J. Reynolds court’s holding that the defendants were engaged solely in settlor functions and were not subject to the fiduciary requirements of ERISA. One amendment to the combined companies’ 401(k) plan created the Tobacco Plan, stated that the Nabisco stock funds would be frozen, and required the January 31, 2000 liquidation of the frozen Nabisco stock funds. A later amendment to the Tobacco Plan provided specified plan investment options that would become effective on February 1, 2000 and further stated that the plan trustee would maintain any other investment funds designated by the plan investment committee. The court found that the two amendments were created pursuant to settlor authority and effectuated the freezing and ultimate elimination of the Nabisco stock funds in the Tobacco Plan.

Based on what it found to be a “plain reading” of the two relevant amendments, the court rejected the plaintiff’s argument that the defendants had discretion as Tobacco Plan fiduciaries to prevent the January 31, 2000 liquidation of Nabisco stock. The court held that:

  • Defendants had no discretion to prevent the January 31, 2000 liquidation of the Nabisco stock funds;
  • The decision to freeze and eventually liquidate the Nabisco stock funds was made and effectuated pursuant to settlor authority; and
  • The plaintiff could not state a claim against the defendants for breach of fiduciary duty in connection with the freezing and liquidation of the Nabisco stock funds.

The Significance of the Settlor Function Doctrine

The R.J. Reynolds decision points out the importance of the technique of drafting plan documents to mandate that certain activities be performed by the employer sponsoring the plan so as to be able to argue that the employer is engaging in those activities in its capacity as a settlor rather than as a plan fiduciary. An employer might thereby avoid potential liability under ERISA for breach of fiduciary duty.

Thus, when an employer anticipates providing certain plan features, it may be advantageous to amend the plan terms to mandate such plan features and to avoid any discretion on the part of plan fiduciaries in implementing the amendment or administering the plan features.