applying trust law which requires the fiduciary to “bear the risk of uncertainty as a consequence of his breach of fiduciary duty” and therefore requiring defendants to prove the loss was not caused by their breachSummary of this case from Tatum v. R.J. Reynolds Tobacco Co.
Civil Action No. 02-559 (GK)
January 20, 2004
This amended opinion does not alter the Court's previous decisions regarding the parties1 request to resolve identified legal issues prior to commencement of the bench trial — it merely clarifies those decisions in preparation for issuing Findings of Facts and Conclusions of Law in this matter.
Plaintiff Elaine L. Chao, Secretary of the U.S. Department of Labor ("Secretary"), brings this action against Defendants, Trust Fund Advisors and Union Labor Life Insurance Company. The Secretary alleges that Defendants violated the Employee Retirement Income Security Act of 1974 ("ERISA"), 29 U.S.C. § 1001, et seq., when they failed to adequately investigate and manage Somerset Ridge, a real estate investment they made on behalf of the Local Union and District Council Pension Fund and National Industrial Pension Fund of the Laborers International Union of North America (collectively, "Union Funds"),
In 1995, Defendants used $5.9 million dollars in Union Funds1 assets to purchase 120 acres of property in the City of North Las Vegas, Nevada. Defendants used additional assets from the Union Funds to develop Somerset Ridge into lots that could then be sold to homebuilders. However, Defendants failed to sell any lots and sold Somerset Ridge for a loss in 1999. See Pl.'s Memo, at 3-4.
This matter is now before the Court on the parties' Memoranda of Law regarding legal issues for resolution before commencement of the four-day bench trial, scheduled to begin December 8, 2003. The parties generally disagree as to the scope of review of Defendants1 activities regarding Somerset Ridge and the method to be used to determine the extent of Defendants1 liability for their alleged imprudence.
In analyzing cases brought under ERISA, several fundamental principles must be kept in mind. First, it must be emphasized that ERISA was enacted to address "the crucible congressional concern [of] misuse and mismanagement of [retirement plan] assets by plan administrators." Chao v. Moore, 2001 WL 743204, *7 (D. Md. 2001) (quoting Massachusetts Mut. Life Ins. Co. v. Russell, 473 U.S. 134, 40 n. 8 (1985)); see also Donovan v. Mazzola, 716 F.2d 1226, 1231 (9th Cir. 1983), cert. denied, 464 U.S. 1040 (1984) (stating that ERISA1s "legislative history also instructs courts to interpret [the statutory requirements] `bearing in mind the special nature and purpose of employee benefit plans'") (quoting H.R. Rep. No. 93-1280, 93d Cong., 2d Sess., reprinted in 1974 U.S. Code Cong. Ad. News at 5083). Second, "the common law of trusts [serves as] a starting point for analysis" of cases brought under ERISA. Harris Trust and Sav. Bank v. Saloman Smith Barney, Inc., 530 U.S. 238, 250 (2000) (internal quotations and citation omitted).
While ERISA was developed from the common law of trusts, the courts have also recognized that in some areas the statutory requirements are even more exacting than the common law standards, so as to provide the greatest security for the employees who are the beneficiaries of these trust plans. Donovan v. Mazzola, 716 F.2d at 1231. Accordingly, in order to achieve this goal, "ERISA grants the court wide discretion in fashioning equitable relief to protect the rights of pension fund beneficiaries." Katsaros v. Cody, 744 F.2d 270, 281 (2d Cir.), cert. denied sub nom, 469 U.S. 1072 (1984) (emphasis added).
Upon consideration of the Memoranda, Replies, and the entire record herein, for the reasons discussed below, the Court concludes that ERISA requires that employee benefit plans, and their beneficiaries, are entitled to maximum protection. Consequently, the Court will broadly apply ERISA's prudent person standard when determining Defendants' liability and will apply the burden-shifting, "make whole" standard to determine the extent of that liability.
II. The Court Will Broadly Apply ERISA's Prudent Person Standard to Determine Defendants' Liability.
Under ERISA, a fiduciary is held to the prudent person standard of care, which requires "a fiduciary [to] discharge his duties . . . with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent [person] acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of like character and aims." 29 U.S.C. § 1104 (a)(1)(b). In assessing the fiduciary duties articulated under this standard, courts have concluded that the prudent person standard is an "objective standard, requiring the fiduciary (1) to employ proper methods to investigate, evaluate and structure the investment; (2) to act in a manner as would others who have a capacity and familiarity with such matters; and (3) to exercise independent judgment when making investment decisions." Lanka v. O'Higgins, 810 F. Supp. 379, 387 (N.D.N.Y. 1992) (citing Katsaros, 744 F.2d at 279). In sum, the test of ERISA prudence "focuses on the [defendant]'s conduct in investigating, evaluating and making the [challenged] investment." United States v. Mason Tenders District Council of Greater New York, 909 F. Supp. 882, 886 (S.D.N.Y. 1995).
Although ERISA does refer to a "prudent man" standard of care, the Court will assume that Congress did not intend to exclude 51% of the population from inclusion in this statutory phrase, and will thus use the term "prudent person."
While courts have acknowledged that the prudential duties of an ERISA fiduciary are "the highest known to the law," Donovan v. Bierwirth, 680 F.2d 263, 272 n. 8 (2d Cir.), cert. denied, 459 U.S. 1069 (1982), the parties in this case disagree as to the exact scope of the Court's inquiry into the Defendants' activities under ERISA's prudent person standard. Defendants argue that ERISA's standard should be narrowly applied to their fiduciary duties in this case — requiring review only of their investigation of and decision to purchase Somerset Ridge as part of the Union Funds' overall investment portfolio, holding them to a non-real estate investment expert standard of care. Plaintiff argues that Defendants' fiduciary duties under ERISA are broader — requiring review of the individual investment in Somerset Ridge with regard to Defendants' investigation, analysis, purchase, and management of the Somerset Ridge project according to those standards employed by real estate investment experts.
A. The Prudent Real Estate Investor Standard
In applying ERISA's prudent person standard in other cases, courts have recognized that "ERISA's prudence standard is not that of a prudent lay person but rather that of a prudent fiduciary with experience dealing with a similar enterprise." Mason Tenders, 909 F. Supp. at 886; see also Donovan v. Mazzola, 716 F.2d at 1231. In fact, in the "well-settled standards for evaluating the prudence of a [fiduciary]'s acts . . .' [a fiduciary]'s lack of familiarity with investments is no excuse . . . [because they] are to be judged according to the standards of others acting in a like capacity and familiar with such matters.'" See Mason Tenders, 909 F. Supp. at 886 (quoting Katsaros, 744 F.2d at 279).
In this case, the "enterprise" in which Defendants invested was Somerset Ridge, a real estate purchase and development project. Defendants took a variety of actions over a lengthy period of time with regard to this investment, which must be evaluated both individually and collectively. See Davidson v. Cook, 567 F. Supp. 225, 236-37 (E.D. Va. 1983) (stating that a fiduciary's "failure to take any of these steps [to insure the prudence of an investment], standing alone, [may not] constitute such imprudence" but multiple omissions together can "constitute such neglectful practice that the Court cannot conclude a prudent investor in similar circumstances would have acted in the same manner"). Accordingly, the Court concludes that in analyzing Defendants' activities, Plaintiff must show that Defendants' course of conduct with regard to the Somerset Ridge project was not that "of a prudent fiduciary with experience dealing with a similar enterprise," Mason Tenders, 909 F. Supp. at 886 — i.e., their actions were not the actions of a prudent real estate investor.
B. Pre-and Post-Purchase Fiduciary Duties
Defendants argue that the Court's review of their decision to invest in Somerset Ridge must be limited to the procedures they followed for investigating the prudence of the initial investment. While it is true that an ERISA "fiduciary's independent investigation of the merits of a particular investment is at the heart of the prudent person standard,"Fink v. National Savings and Trust Co., 772 F.2d 951, 957 (D.C. Cir. 1985), Defendants fail to recognize that a fiduciary's duties under ERISA apply to the totality of their investment actions, Davidson v. Cook, 567 F. Supp at 236-37.
First, regardless of the adequacy of a fiduciary's initial investment investigation procedures, a fiduciary also has a responsibility to prudently and thoroughly analyze the full implications of that investigation in order to make the best purchase decision. See Fink, 772 F.2d at 957 (stating that carrying out investigation procedures is not enough — "the fiduciaries [must think] about them"); Howard v. Shay, 100 F.3d 1484, 1488-89 (9th Cir. 1996) (stating that a court's review of fiduciary duties must include a focus "on the thoroughness of the investigation into the merits of the transaction" such that the fiduciary "must . . . make certain its reliance on the expert's [information] and advice is reasonably justified under the circumstances"); In re Unisys Savings, 173 F.3d 145, 153 (3d. Cir. 1999) (stating that ERISA's prudence requirement asks "whether a fiduciary employed appropriate methods to investigate and determine the merits of a particular investment") (internal quotations and citation omitted) (emphasis added).
Thus, in determining Defendants' liability in this case, the Court must look not only to their investigation procedures, but also to the methods used to carry out those procedures as well as the thoroughness of their analysis of the data collected in that investigation.
Second, when a fiduciary has decided to purchase a particular property, a fiduciary has an ongoing duty to manage the investment with reasonable diligence because the "fiduciary duty under ERISA is continuous." Mason Tenders, 909 F. Supp. at 888. In this case, Plaintiff alleges that Defendants' investment in Somerset Ridge was imprudent, at least in part, because they failed to adequately manage and develop the property after its purchase. See Whitfield v. Cohen, 682 F. Supp. 188, 196 (S.D.N.Y. 1988) (finding that a fiduciary "had a duty to monitor performance with reasonable diligence and to withdraw the investment if it became clear or should have become clear that the investment was no longer proper for the Plan"). Accordingly, in deciding whether Defendants have violated their fiduciary duties under ERISA, the Court will also examine the prudence of their pre-and post-purchase activities relating to Somerset Ridge.
C. Requirement to Exercise Prudence with Each Investment in the Portfolio
Defendants argue that the Court must limit its review of their possible imprudence by examining their investment activities for the Union Funds' whole portfolio, not by focusing solely on the Somerset Ridge project. In support of this "whole portfolio" prudence argument, Defendants rely on a Department of Labor regulation, which states, in relevant part, that "the scope of such fiduciary's investment duties," depends on what "the fiduciary knows or should know . . . including the role the investment plays in that portion of the plan's investment portfolio." 29 C.F.R. § 2550.404 (a)(1). However, Defendants' reliance on this regulation as the basis of a restricted review of their individual investment actions is misplaced.
Section 2550. 404(a)(1) does not — and could not — contradict or supercede the fiduciary's statutory duty to "be prudent in each investment decision." 29 U.S.C. § 1104 (a)(1)(B) (emphasis added). In fact, directly contrary to Defendants' arguments, the Secretary stated that Section 2550.404(a)(1)
is not intended to suggest . . . that a particular plan investment should be deemed to be prudent solely by reason of the propriety of the aggregate risk/return characteristics of the plan's portfolio. . . . [A]ppropriate consideration of an investment to further the purposes of the plan must include consideration of the characteristics of the investment itself.44 Fed. Reg. 37224 (June 26, 1979) (emphasis added); see also Pl.'s Reply at 7 and n. 2.
Section 2550.404(a)(1) further explains that the duty of a fiduciary is to ensure that each type of investment is proper, with regard to diversification, risk aversion, etc., given the overall purpose of the portfolio. See Meyer v. Berkshire Life Insurance Company, 250 F. Supp.2d 544, 565-66 (D. Md. 2003) (finding that the Secretary's regulations set forth the various facts and circumstances a fiduciary must consider in order to ensure a prudent investment). In sum, while a fiduciary may consider the prudence of an individual investment in the context of the "whole portfolio," such consideration does not immunize or permit any individual investment to be less than prudent.
Not only have many courts rejected a "whole portfolio" approach by analyzing individual investment decisions to determine whether an ERISA fiduciary has breached a fiduciary duty, see discussion § I.B. supra, but our Circuit has stated that "to make prudent investments, the fiduciary has a duty to [research and analyze] the merits of a particular investment." Fink 772 F.2d at 951 (emphasis added); but see Laborers Nat'l Pension Fund v. Northern Trust Quantitative Advisors, 173 F.3d 313, 322 (5th Cir. 1999) (finding that "the district court erroneously judged the [challenged] investment in isolation . . ., instead of according to the modern portfolio theory required by ERISA policy as expressed by the Secretary's regulations"). Given ERISA's overall intent "to prevent [employee benefit plan] abuses," courts have "frowned upon [the type of] narrow assessments" of loss that Defendants suggest and have instead tailored "the method for ascertaining a loss . . . to the type of breach claimed." Chao v. Moore, 2001 WL 743204, *7.
Accordingly, the Court will examine whether Defendants breached their fiduciary duties with respect to the specific Somerset Ridge investment — not only in the context of the Union Funds' whole portfolio but also with respect to the prudence of the individual investment.
III. The Court Will Apply the Burden-Shifting, "Make Whole" Standard to Determine the Extent of Defendants' Liability.
Under ERISA, fiduciaries are liable for losses resulting from their imprudent investment of plan assets. 29 U.S.C. § 1109(a). In this case, it is undisputed that the Somerset Ridge investment resulted in a loss. However, the parties disagree regarding the extent of that loss and who bears the burden of persuasion regarding the extent of Defendants' liability for any alleged imprudence.
Under Plaintiff's theory for determining liability, once she has proven that Defendants breached their fiduciary duty by investing in Somerset Ridge and that their investment resulted in a loss, the burden shifts to Defendants to prove that the loss was not caused by any imprudent activity on their part. In addition, Plaintiff argues that Defendants are liable for "make whole" damages — i.e., the amount they lost in the Somerset Ridge project as well as the amount a prudent investment would have earned.
Under Defendants' theory for determining liability, Plaintiff bears the entire burden of proving that any loss suffered by the Union Funds was the direct result of specific acts of imprudence by Defendants regarding Somerset Ridge. Defendants also argue that they are only liable for the actual out-of-pocket loss that resulted from the Somerset Ridge project — i.e., the difference between the amount they invested in the project and the amount of its eventual sale.
The parties also discuss the issue of prejudgment interest, but the Court will defer ruling on this issue until after trial as prejudgment interest will only be applicable upon a finding that Defendants are liable for damages.
A. Shifting Burden of Proof
ERISA does not state the extent to which a plaintiff shall bear the burden of proving liability for "losses" resulting from the alleged imprudent acts of a fiduciary, and courts are split on the issue of whether defendants carry any of this burden. The complex interplay between the alleged breach of duty on the part of a fiduciary and liability for ERISA plan losses has resulted in a circuit split regarding the appropriate burden of proof for determining overall ERISA liability.
Some circuit courts have found that once a plaintiff has proven a breach of fiduciary duty and a prima facie case of loss to the plan, the burden of persuasion shifts to the defendant to prove that the loss was not caused by his breach of duty. See Martin v. Feilin, 965 F.2d 660, 671 (8th Cir. 1992); Whitfield v. Lindemann, 853 F.2d 1298, 1304-1305 (5th Cir. 1988). Other circuit courts have found that a plaintiff must show an identifiable loss resulting directly from the fiduciary's imprudent actions to prove causation for damages. See In re Unisys Saving Plan Litigation, 74 F.3d 420, (3rd Cir. 1996); Silverman v. Mutual Benefit Life Ins. Co., 138 F.3d 98, 104 (2d Cir. 1998); Willet v. Blue Cross of Alabama, 953 F.2d 1335, 1343 (11th Cir. 1992).
In this case, our Circuit has not resolved the issue of which party bears the burden of proving ERISA damages. In addition, Plaintiff has made a persuasive argument in support of burden-shifting, arguing that those circuit courts that have chosen to place the entire burden on the plaintiff have failed to "conform with ERISA, a statute founded on the common law of trusts . . . [in which] the fiduciary must bear the risk of uncertainty as a consequence of his breach of fiduciary duty." Pl.'s Memo. at 16 (internal quotations and citations omitted).
While Defendants cite Fink, 772 F.2d at 962 (Scalia J., concurring in part and dissenting in part), in support of their argument that Plaintiff bears the burden of proving that their acts directly caused the ERISA losses, see Defs.' Memo. at 11, this section of the concurrence and dissent merely states that a fiduciary's breach of the duty to properly investigate does not automatically lead to a breach of the duty to invest prudently — it does not discuss which party bears the burden of proof regarding damages.
Given that where "there are ambiguities in determining loss, courts resolve them against the trustee in breach", Chao v. Moore, 2001 WL 743204, *8 (internal quotations and citation omitted), this Court will apply a shifting burden of proof in this case: once the Secretary has proven a breach of fiduciary duty and a prima facie case of loss to the plan, Defendants must then prove that the loss was not caused by their breach of fiduciary duty.
B. "Make Whole" Damages
ERISA does not define what constitutes an imprudent investment "loss" for which fiduciaries are responsible under 29 U.S.C. § 1109(a). However, courts have determined that ERISA's legislative history "indicates that Congress' intent was to provide the full range of legal and equitable remedies available in both state and federal courts.'"Donovan v. Bierwirth, 680 F.2d at 1052 (quoting H.Rep. No. 533, 93d Cong., 2d Sess., reprinted in 1974-3 U.S. Code Cong. Ad. News 4639, 4655). Thus, Plaintiff argues that Defendants are liable for "make whole" damages totaling (1) the amount lost from the imprudent Somerset Ridge investment and (2) the amount a prudent investment would have earned. Plaintiff's position is adequately supported by the case law. See Meyer, 250 F. Supp.2d at 572 (stating that "the proper measure of damages is the difference between the investments1 actual value and the value prudent investments would bear") (internal quotations and citation omitted);Donovan v. Bierwirth, 680 F.2d at 1056 (determining that the "appropriate remedy in cases of breach of fiduciary duty is the restoration of the trust beneficiaries to the position they would have occupied but for the breach of trust . . . [, which] requires a comparison of what the Plan actually earned on the [challenged] investment with what the Plan would have earned had the funds been available for other [investments]"); Chao v. Moore, 2001 WL 743204, *8 (finding that "comparing the return on the improper investment with that of a reasonably prudent alternative investment represents an appropriate means of assessing damages under 29 U.S.C. § 1109") (internal quotations and citation omitted).
In fact, Defendants acknowledge that there is support for Plaintiff's "make whole" damage request, but they argue that the Secretary has not met her burden to make such a claim. Defs.' Memo, at 16. However, whether Plaintiff has met a particular burden is a factual issue to be resolved at trial and does not go to the appropriate legal standard that the Court should apply when determining damages.
Likewise, while Defendants argue that there is no established methodology for assessing "prudent timely real estate management" or for calculating the exact amount of damages under the "make whole" standard, see Defs.' Memo, at 10, 15-16, these are issues that must be decided in the context of actual expert testimony presented at trial.
Accordingly, the Court will use the wide discretion ERISA provides to district courts to fashion equitable relief, see Katsaros v. Cody, 744 F.2d 270 at 281, and compute any damages incurred by the Union Funds that were caused by Defendants' imprudence on the "make whole" theory. Thus, losses will be calculated by adding the amount lost on the Somerset Ridge project and the amount a prudent real estate investment would have made for the Union Funds during the same time period. See Donovan v. Bierwirth, 680 F.2d at 1058 (acknowledging that the make whole "determination is of necessity somewhat arbitrary" and stating that the "trial court must have discretion to fix a reasonable time at which the actual performance of the improper investment will be measured and compared with the earnings performance which would have been realized but for the breach").
For the foregoing reasons, the Court concludes that it will broadly apply ERISA's prudent person standard when determining Defendants' liability and that it will apply the burden-shifting, "make whole" standard to the extent of Defendants' liability for their alleged imprudence.
Now that the parties have the Court's ruling on the significant threshold legal issues in this case, it is to be hoped that they can rethink the possibility of resolution of this matter.