Laborers Recover Derivative Losses from Advisor
1997 U.S. Dist. LEXIS 12962
LABORERS NATIONAL PENSION FUND, et al., Plaintiffs, v. ANB
INVESTMENT MANAGEMENT AND TRUST COMPANY, and THE FIRST
NATIONAL BANK OF CHICAGO, Defendants.
No. 3:95-CV-2504-T
UNITED STATES DISTRICT COURT FOR THE NORTHERN DISTRICT OF
TEXAS, DALLAS DIVISION
August 15, 1997, Decided
August 15, 1997, Filed; August 18, 1997, Entered
COUNSEL:
For LABORERS NATIONAL PENSION FUND, an employee pension benefit plan, BILL L HARBERT, Board of Trustee, ARTHUR A COIA, Board of Trustee, BRUCE HUGHES, Board of Trustee, R P VINALL, Board of Trustee, ROBERT D SHEEHAN, Board of Trustee, MASON M WARREN, Board of Trustee, BILLY L HARBERT, JR., Board of Trustee, CARL E BOOKER, Board of Trustee, plaintiffs: Edward S Koppman, Attorney at Law, John Patrick Tielborg, Attorney at Law, Paul Featherstone Schuster, Attorney at Law, Akin Gump Strauss Hauer & Feld, Dallas, TX USA.
James S Ray, Michael Barrett, Connerton Ray & Simon, Washington, DC.
For ANB INVESTMENT MANAGEMENT AND TRUST COMPANY, a corporation, THE FIRST NATIONAL BANK OF CHICAGO, a corporation, defendants: W Ted Minick, Attorney at Law, Winstead Sechrest & Minick, Houston, TX USA. Wayne William Bost, Attorney at Law, Winstead Sechrest & Minick, Austin, TX USA.
JUDGES: Robert B. Maloney, U.S. District Judge.
OPINIONBY: Robert B. Maloney
OPINION: FINDINGS OF FACT AND CONCLUSIONS OF LAW
This action came before the Court, Honorable Robert B. Maloney, presiding, on a non-jury trial concluded January 23, 1997. After considering the argument and evidence presented at trial and the post-trial briefs, the Court makes the following findings of fact and conclusions of law. The Court reserves the right to enter more specific findings of fact and conclusions of law should the Court consider it necessary.
Introduction
This action is brought by an employee pension trust fund and its governing board of directors against its professional pension investment management firm, a national bank together with its wholly owned subsidiary, which the trust fund employed to invest certain of its assets and manage these investments on an ongoing basis. Plaintiffs allege that by making certain investments in derivative securities with the pension fund's assets, Defendants breached their fiduciary duties to the pension fund and violated the statutory standards of conduct imposed on Defendants by the Employee Retirement Income Securities Act, 29 U.S.C. @ 1001, et seq. Plaintiffs seek to recover more than $7,000,000 in restitution.
Defendants admit that several of its investment choices did not perform as expected. Nevertheless, Defendants contend that they did not violate any fiduciary duties by investing in a class of security known as interest only strips. Defendants assert that risks are inherent in any individual investment, which is why they properly diversified the fund's portfolio.
Defendants contend that the portfolio, when viewed as a whole, performed adequately. They contend that the use of interest only strips as a "hedge" was a proper business decision based on the information available to them at the time the investments were made.
Findings of Fact
1. Plaintiff Laborer National Pension Fund is an "employee pension benefit plan," and "employee benefit plan," and a "multi-employer plan," as those terms are defined by ERISA.
2. The purpose of the Pension Fund is to provide retirement income to construction industry laborers and other workers employed in Texas and other southern and central states. Currently, 15,000 retirees and beneficiaries receive pension benefits from the Pension Fund, and another 16,000 active workers are covered and earning benefit rights under the Pension Fund.
3. Plaintiffs Bill L. Harbert, Sr., Arthur A. Coia, Bruce Hughes, R.P. Vinall,Robert D. Sheehan, Mason Warren, Billy Harbert, Jr., and Carl Booker, are Trustees of the Pension Fund and collectively constitute the Board of Trustees which is responsible under the Agreement and Declaration of Trust establishing the Pension Fund for governing, operating, and managing the fund. The Trustees are volunteers and are drawn from the ranks of present or retired executives of contributing employers and union officials.
4. Defendant American National Bank and Trust Company of Chicago is a national banking association.
5. Commencing in 1971 and continuing until 1994, the Pension Fund and American were parties to an agreement for the provision of professional investment management services to the Pension Fund.
6. In or about 1988, American created ANB as a wholly-owned subsidiary out of its existing division known as the Investment Management Group (IMG).
7. Defendant ANB Investment Management and Trust Company is a for-profit company engaged in the business of managing the investments of pension funds and other institutional investors.
8. Officers of IMG who were transferred to ANB also remained officers of American. IMG employees and officers transferred to ANB continued to perform the same investment management functions for the Pension Fund as they had before ANB's creation.
9. In or about 1994, American sold ANB to the First National Bank of Chicago, a "sister" bank owned by the same holding company as American.
10. American was vested by the Pension Fund's Board of Trustees with discretionary control over the investment and re-investment of certain Pension Fund assets, subject to certain guidelines set by the Board of Trustees and to the fiduciary standards of ERISA.
11. The 1971 investment management agreement between the Pension Fund and ANB authorized ANB to invest the Pension Fund's assets in such securities, "as in its absolute discretion it deems suitable, utilizing all available counsel it deems appropriate and necessary, but within the framework of an investment policy approved by the trustees."
12. The contract required ANB to submit to the Trustees a written statement as to the long range investment policy it proposed to follow and to "act within the boundaries of this policy until such time as the Trustees advise, in writing, that they no longer desire to follow such policy, or until the original policy has been replaced with a new and revised policy statement."
13. From the inception of the relationship, it was understood that the Trustees had a very low tolerance for risk of loss of principal, particularly with regard to fixed income investments. As early as 1975, the Trustees directed ANB to report to them whenever a loss of 10% or more was incurred on an individual security.
14. In 1976, the Trustees adopted a written set of investment guidelines. The guidelines limited the investment discretion of ANB and other investment managers retained by the Pension Fund.
15. The guidelines stated that, "It will be the policy of the Trustees to invest the assets of the Fund with care in those vehicles which should preserve the principal while recognizing the need for income and appreciation with minimal risk."
16. The investment guidelines required that all investments fall within either of two classes: (1) "federal or federal agency obligations," or (2) corporate bonds of the highest three quality grades. The guidelines did not specifically prohibit interest-only strips.
17. The Trustees relied on ANB to help keep the investment guidelines updated and to apprise the Trustees of any changes in the investment market that might affect the appropriateness of the guidelines.
18. In 1991, ANB used $ 11,000,000 of the Pension Fund's assets to purchase for the Pension Fund's fixed income account three derivative investments known by the industry as stripped interest-only mortgage-backed securities. In 1992, ANB sold these IOs at a price that caused the Pension Fund to realize a loss of about 40% of the principal invested. 19. IOs were invented in the late 1980s. They are created by dividing the stream of principal and interest payments made by homeowners whose mortgages are included in a fixed pool of mortgages. Investors holding IOs are entitled to share only in the interest portion of the mortgage payments flowing through the pool. The principal portion of the mortgage payments are shared by investors holding other types of securities.
20. When homeowners refinance or otherwise repay their mortgages in the pool, the stream of interest payments on those mortgages ceases and is not replaced by additional mortgages. Accordingly, as the mortgages on the pool are prepaid, the stream of payments to which IOs are entitled decreases and will cease altogether when all the mortgage pools are paid off. 21. IOs are interest-rate sensitive. As interest rates for mortgage loans decline, the rate at which mortgages in a pool are paid off increases as homeowners refinance their mortgages to take advantage of the lower rates. The deeper the decline in interest rates, the faster will be the rate of prepayment of mortgages.
22. In addition to interest rates, other factors, such as changes in tax laws or changes in the way mortgages are structured can increase the risk of prepayment.
23. Some IOs are issued by federal agencies and the repayment of these mortgages are guaranteed by these agencies against default; however, no government agency guarantees that interest will be paid until the maturity date of the mortgages.
24. At the time ANB purchased the IOs, the Trustees were unaware of the invention of IOs and were unfamiliar with the risks associated with them.
25. ANB did not advise the Trustees about the risks associated with the purchase of IOs. The Trustees learned about the risks associated with IOs only after they realized a loss.
26. ANB had the opportunity to discuss with the Trustees the risks and benefits of investing in IOs. ANB failed to take advantage of this opportunity.
27. The person responsible at ANB for purchasing the IOs, Tom Pierce, failed to consider the investment guidelines or whether IOs would violate the spirit of those guidelines. Had Pierce properly disclosed the risks associated with IOs to the Trustees, they would have, in all likelihood, specifically excluded them.
28. Pierce did not believe that clients in general could adequately assess their own needs or state them in a manner consistent with "cutting-edge" modernportfolio theory.
29. Maintaining a diverse portfolio is the standard in the fund-management industry.
30. It is appropriate and desirable in certain circumstances to purchase
investments that perform well in different economic climates. For example, some investments perform well in times of high interest rates, while others perform well in times of low interest rates. Purchasing both types of investments at the same time to offset risk is known as "hedging." Using proper hedging techniques, investment managers may make investments which, taken individually, are considered to be of moderate to high risk, but when considered together are considered to be of relatively low risk.
31. In certain limited circumstances, IOs may be properly used to hedge other investments. In this case, the evidence does not show that IOs were being used to hedge. Rather, the evidence shows, and the Court so finds, that the IOs were purchased because Pierce was convinced that interest rates would continue to rise.
32. Other investment vehicles are available that may serve as a hedge without the same risk of loss to principal.
33. IOs are not directly equivalent to "junk bonds" in terms of bond ratings. A junk bond is a bond that has a rating below the first four bond-quality grades. Nevertheless, in terms of risk to the principal investment, the Court deems investment in IOs to be equal to or more risky than junk bonds.
34. During the period when the relevant IOs lost money, unusual and unexpected economic conditions prevailed. Many experts in the industry made the same or similar predictions as Pierce.
35. At the time the investments were made, Pierce had enough information available to him to know that a complete loss of principal was possible if his predictions did not come true.
36. Investing in IOs was inappropriate and inconsistent with the purpose of the plan and the wishes of its participants. Under the facts of this case, a prudent investment manager would not consider the maximum rate of return on the IOs purchased, which was about the same as other low to moderate risk investments in which the principal is guaranteed, as justifying the risk of a total loss of principal.
37. Although the loss to the individual investments was substantial, it appears that the portfolio managed by Pierce performed at an adequate or average level when considered as a whole. Nevertheless, investment in IOs was not consistent with the Trustees' stated guidelines.
38. Plaintiffs' expert on damages testified that the net loss to the Pension Fund $7,161,548.91. The Court finds the expert's testimony credible, relevant, and based on accepted and sound economic and accounting principles. Defendants failed to produce any credible testimony to rebut this calculation.
39. The Court finds that Plaintiffs have established, by a preponderance of evidence, that Defendants breached their fiduciary duty and that this breach proximately caused them injury in the amount of $ 7,161,548.91.
40. The evidence showed that the Trustees desired, in addition to a risk-adverse portfolio, that the individual investments meet a minimum threshold of principal security. Pierce did not appear concerned with this desire. His attitude was that clients often did not understand what was in their best interests.
41. Clients have a right to determine what risks they are willing to take. The evidence shows that IOs were a new and exotic investment vehicle. Under the facts of this case, it would be unreasonable to rule that the Trustees should have specifically excluded IOs from the portfolio.
42. A prudent investment manager would not consider this type of investment appropriate for the Pension Fund in light of the Pension Fund's guidelines. It does not matter that other investment consultants in the industry held the opinion that IOs were appropriate for modern investment portfolios or that the portfolio as a whole made an adequate return. The evidence does not show that the Trustees were properly apprised of the unique risks associated with IOs so that they could have the opportunity to specifically exclude them if they so desired and the evidence in this case indicates that they would have.
Conclusions of Law
1. The Court has federal question subject matter jurisdiction over this action because Plaintiffs' claims arise under the laws of the United States. 28 U.S.C. @ 1331. No defendant has asserted a legitimate objection to the personal jurisdiction of this Court. Venue is proper.
2. The Pension Fund is covered by ERISA. 29 U.S.C. @ 1003.
3. Plaintiffs Bill L. Harbert, Sr., Arthur A. Coia, Bruce Hughes, R.P. Vinall, Robert D. Sheehan, Mason Warren, Billy Harbert, Jr., and Carl Booker, are fiduciaries with respect to the Pension Fund. 29 U.S.C. @@ 1002(21). They are authorized by statute to bring suit on behalf of the fund.29 U.S.C. @ 1132(a) & (b).
4. Because standing is a jurisdictional prerequisite to the court entering judgment in a party's favor, it has the obligation to raise the issue sua sponte. FED. R. CIV. P. 12(h)(3); Bender v. Williamsport Area Sch. Dist., 475 U.S. 534, 546-57, 89 L. Ed. 2d 501, 106 S. Ct. 1326 (1986).
5. Although the Pension Fund itself has the capacity to sue and be sued as an artificial entity, 29 U.S.C. @ 1132(d)(1), it lacks standing to bring claims under ERISA's enforcement provisions because it is neither a "participant," "beneficiary," or "fiduciary," as defined by ERISA. See Coleman v. Champion Intern./Champion Forest Prod., 992 F.2d 530, 533 (5th Cir. 1993).
6. ANB was at all relevant times a fiduciary with respect to the Pension Fund. 29 U.S.C. @ 1002(21)(A).
7. As a fiduciary, ANB was required to perform its investment management responsibilities in accordance with ERISA's "prudent man" standard of fiduciary conduct as set for in 29 U.S.C. @ 1104(a).
8. These fiduciary duties are the "highest known to the law." Donovan v. Bierwirth, 680 F.2d 263, 272 n.8 (2nd Cir. 1982). In the ERISA context, fiduciaries have a duty to inquire into the particular needs of a plan and its participants. Lanka v. O'Higgins, 810 F. Supp. 379, 388 (N.D.N.Y. 1991).
Reasons for Judgment
Defendants breached their fiduciary duty to Plaintiffs. Plaintiffs are entitled to recover damages proximately caused by this breach. The Court will enter judgment according to the findings of fact and conclusions of law.
Plaintiffs request an award of prejudgment interest and attorneys' fees. The Court will not address these issues at this time. Plaintiffs may move for an award of prejudgment interest pursuant to Rule 59 and attorneys fees pursuant to Rule 54(d). The Court deems the briefing on the issue of prejudgment interest to be insufficient to award it at this time.
Signed this 15th day of August, 1997.
Robert B. Maloney
U.S. District Judge
FINAL JUDGMENT
This action came before the Court on a non-jury trial concluded January 23, 1997, Honorable Robert B. Maloney, presiding, and the issues having been duly considered and a decision having been rendered:
It is ORDERED and ADJUDGED that, on the claims of Plaintiffs Bill L. Harbert, Sr., Arthur A. Coia, Bruce Hughes, R.P. Vinall, Robert D. Sheehan, Mason Warren, Billy Harbert, Jr., and Carl Booker, as Trustees of Plaintiff Laborer National Pension Fund, against Defendants ANB Investment Management and Trust Company and American National Bank and Trust Company of Chicago, for restitution under ERISA, Plaintiffs shall recover from Defendants $7,161,548.91.
It is FURTHER ORDERED and ADJUDGED that Plaintitfs Bill L. Harbert, Sr., Arthur A. Coia, Bruce Hughes, R.P. Vinall, Robert D. Sheehan, Mason Warren, Billy Harbert, Jr., and Carl Booker, as Trustees of Plaintiff Laborer National Pension Fund, shall recover post-judgment interest at the rate of 5.56% per year from the date of entry of the final judgment until paid on the total of the above listed amounts.
It is FURTHER ORDERED and ADJUDGED that the claims of Plaintiff Laborer National Pension Fund are dismissed without prejudice.
It is FURTHER ORDERED and ADJUDGED that Plaintiffs' claims against Defendant The First National Bank of Chicago are dismissed with prejudice.
It is FURTHER ORDERED and ADJUDGED that all relief not specifically granted herein is denied.
Signed this 15th day of August, 1997.
Robert B. Maloney
U.S. District Judge
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