In Plasterers' Local Union No. 96 Pension Plan v. Pepper, 663 F.3d 210 (4th Cir. 2011), the Fourth Circuit Court of Appeals addressed whether the failure to investigate or diversify plan investments constitutes a breach of fiduciary duty and causes damages. As detailed below, the Fourth Circuit held that, even when there is a failure to investigate or diversify, plaintiffs must still prove that the investments were imprudent in light of the prevailing circumstances, including plan goals and demographics, and that the imprudent investments caused loss.
Current trustees of a multi-employer pension plan sued two former trustees over their investment of the plan's assets. After a predecessor plan had suffered substantial financial losses in the 1970s and 1980s, the Board of Trustees (Board), which consisted of the former trustees and other trustees, implemented a new defined contribution plan in 1987. In creating this new plan, the Board's objective was to avoid further losses of the plan's assets; as the Board members stated, they did not "want to lose a dime of the men's money." In February 1992, the Board voted to invest the plan in bank CDs of less than $100,000, and in 1995, the Board determined that part of the assets also could be invested in one- and two-year Treasury Bills. In 2001, the Board asked an investment banker to make an investment presentation, but one of the former trustees asked him to leave. Later, the Board asked the banker to draft a portfolio discussing alternative investment strategies. It was not clear from the record if this proposal was discussed, and the Board voted not to change the plan's investments because they were pleased with the security of the investments. Thus, from 1995 until the former trustees left in 2005, the plan was invested in CDs worth $90,000 and one- to two-year Treasury Bills.
District Court Decision
The current trustees who took over in 2005 sued the former trustees, claiming they failed to adequately investigate and diversify plan investments. The current trustees' expert witness testified that a prudent investment strategy would have been 50% in the S&P 500 and 50% in a bond portfolio. The current trustees' expert claimed that this strategy would have resulted in $432,000 more in earnings for the three-year period of December 2002 to December 2005, but admitted his 50% stock/50% bond portfolio was only $103,000 better if applied to the six-year period of 1999 to 2005. The former trustees' expert opined that the conservative bank CD/T-Bill investment strategy could be prudent under the prevailing circumstances, including: (i) there was a declining union membership; (ii) this was a defined contribution plan investing the members' accounts; (iii) the markets had been uncertain in the early and mid-2000s; and (iv) the Board's stated conservative objectives. The former trustees also argued that their conservative portfolio outperformed the current trustees' expert's 50% stock/50% bond portfolio over the six-year period. After a bench trial, the district court ruled in favor of the current trustees. In doing so, the district court ruled that the former trustees breached their duty to investigate alternative investment strategies, and adopted the current trustees' damages estimate of $432,000 for the 2003 to 2005 time frame. The district court admitted this period was "somewhat picked out of the air," but justified its decision on the grounds that it was within the statute of limitations and was a period in which the former trustees had not investigated alternative investment strategies.
Fourth Circuit Decision
The Fourth Circuit reversed and remanded. The Fourth Circuit agreed that there was a failure to investigate and to diversify, but held that this does not necessarily mean the investment was imprudent and caused loss. Joining the Second, Third, Fifth, Sixth, Eighth, Ninth, Eleventh and D.C. Circuits, the Fourth Circuit held that the alleged fiduciary breach must cause loss to be actionable, and that only an imprudent investment — not simply a failure to investigate or diversify — could cause loss.1 In evaluating this prudence, the Fourth Circuit explained that fiduciary duties must be evaluated "under the circumstances then prevailing" and for an enterprise "of like character and with like aims." The Fourth Circuit further advised the district court that in making its finding on remand, the district court must consider the reasons why the fiduciaries had not diversified, and had instead followed a conservative investment strategy, including but not limited to considering: (i) the plan's size and type; (ii) the plan members' demographics; and (iii) the Board's goals and objectives. The Fourth Circuit also addressed causation and damages. With regard to causation, the Fourth Circuit noted that all courts require plaintiffs to prove a prima facie case of breach that caused loss, but noted there was a circuit split (which it did not resolve) on which party must show that the loss resulted from that breach. With regard to damages, the Fourth Circuit noted that the time period used was critical to measuring any damages, and held that the district court's adoption of a three-year period without justification was error. The Fourth Circuit held the district court must instead justify whatever period it adopts, and noted that the parties had offered various arguments, including ERISA's three-year and six-year statute of limitations, that depended on certain factual findings.
The Fourth Circuit's reference to evaluating fiduciary investment prudence "under the circumstances then prevailing" and for an enterprise with "like character and with like aims" is significant. The Board's stated goal was to avoid loss, and given the plan's demographics (apparently an aging and declining workforce) and plan type (a defined contribution plan involving investment of the member's accounts), this goal may ultimately be considered reasonable "under the circumstances then prevailing." Particularly when compared against the market turmoil occurring both during and after the relevant period (e.g., the "dot-com" bust and the great recession of 2008), it is not so clear that this conservative strategy was inherently imprudent under those circumstances. Indeed, it appears that whether the current trustees' more aggressive proposed 50% stock/50% bond portfolio is more profitable depends on the time period chosen. Of interest in light of the Board's stated goals, this 50/50 portfolio carried with it a significant risk of loss to justify the mixed returns. The Fourth Circuit's holding in this case is also consistent with the Supreme Court's recent ruling in Cigna Corp. v. Amara, 131 S. Ct. 1866 (2011). In Amara, the Court made clear that courts cannot use judge-made short cuts to avoid ERISA's harm and causation requirements. Although Amara arose under a different civil enforcement provision of ERISA (Section 502(a)(3) versus Section 502(a)(2)), both cases require proof of actual harm and causation to justify findings of fiduciary breach and remedy. Finally, this case teaches the importance of procedural prudence. Even if the former trustees' ultimately prevail based on a finding that their investment strategy turned out to be substantively prudent, they have undergone the risk and costs of trial. Neither the district court nor the Fourth Circuit approved of what appears to have been a "set and forget" investment strategy, and there is still a risk it may be found substantively imprudent on remand. In contrast, the procedural prudence of holding periodic meetings in which alternative investment strategies are evaluated and the strategy chosen is justified in light of the prevailing circumstances and plan goals, provides a powerful defense and may have defeated any claim and obviated the need for trial.
Robert Rachal is a Senior Counsel in Proskauer Rose's Employee Benefits, Executive Compensation & ERISA Litigation Practice Center, resident in Proskauer's New Orleans office. His practice focuses on ERISA litigation.
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