A novel approach to determining damages owed by an investment adviser to two defined contribution retirement plans in an ERISA fiduciary-duty breach was part of a decision including a $15 million reimbursement request handed down recently by a New York federal judge.
Plan sponsors should note that the defendant, WPN Corp., was ordered by the judge in part to pay $9.6 million to compensate for the amount the court determined plan holders at the former steel manufacturer, Severstal Wheeling, lost by following the firm’s investment recommendations. WPN advised the Severstal Retirement Committee to invest the plans’ $38 million assets in a narrowly concentrated basket of energy-sector stocks, and in 2009 liquidated the equities and proposed other high-risk investments.
In Severstal Wheeling Inc. Retirement Committee v. WPN Corp., No. 1:10-cv-00954 (S.D.N.Y., Aug. 10, 2015), U.S. District Court for the Southern District of New York Judge Laura Taylor Swain on Aug. 10 ruled that WPN failed to manage and diversify the Severstal plans’ assets, properly advise its fiduciaries or obtain fiduciary insurance to cover claims such as the one brought by Severstal’s retirement committee in this suit.
Prudent Diversification
Lack of diversification alone is not a fiduciary breach, but Judge Swain said specifically that the “[d]efendants failed to structure the division of Combined Trust assets in a manner that was prudent under the circumstances and to manage the assets of the Severstal Trust in a manner consistent with their contractual and fiduciary duties.” She also ruled that WPN failed to render investment advice consistent with its fiduciary duties, including the failure to inform the retirement committee of the need to diversify the transferred portfolio immediately in 2008.
The committee continued to pursue the case after the plan’s sponsor, RG Steel, a successor to Severstal Wheeling, entered bankruptcy and remaining assets had been distributed to the participants, according to a press report.
Judge Swain, relying on Donovan v. Bierwirth, 754 F.2d 1049 (2nd Cir., 1985), said that the correct measure of damages against a breaching ERISA fiduciary in this case is the most profitable of otherwise equally plausible investment strategies, if the violating fiduciary could not prove that the funds would have earned less than the amount [placed] on the fiduciaries found to be in breach of their duty.” She continued that WPN was unable to meet that burden, based on calculations the court made that took into account the reduction in value of the Severstal plans during the time in question and the lost earnings that the plans could have made.
The plaintiffs provided four measures for the returns that the plans could have earned, if invested in a diversified, proper way.
The decision said that WPN transferred Severstal’s retirement assets from a pooled employee benefit plan trust — known as the Combined Trust — to a separate trust for the plans in November 2008. The adviser allegedly invested the plans’ assets in the undiversified energy-sector stocks, then liquidated the equities in March 2009 and allowed the assets to remain undiversified until July 2009. The defendants proposed in May 2009 to invest the fund’s cash assets in mortgage-backed securities at a time of extreme global market turmoil and recession brought about by a collapse in that investment sector.
The Severstall Wheeling Retirement Committee, the plaintiffs in this case, terminated WPN in May 2009 and hired another investment adviser that recommended the plan’s assets be placed in a mix of equities, bonds and cash, and the shift was implemented in July 2009. The lawsuit was filed in February 2010.
Part of Judge Swain’s ruling of ERISA breach arose from WPN’s failure to follow the plan committee’s instructions to invest the assets in the same proportion as they had been in the earlier Combined Trust.
Award Calculation
Applying the Donovan standard, the federal district court awarded the plaintiffs $9.6 million, including the $4.7 diminution in value and the lost earnings. Further, WPN was ordered to pay $5.3 million in pre-judgment interest. The court also ordered disgorgement of the defendants’ management fees and pre-judgment interest from 2009 at the rate of 9 percent, determined from an agreement by the parties to be governed by New York law.
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