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By Richard L. Kesner, President
The CommonWealth Group
On March 7, 1988, Judge Sweet of the Southern District Court of New York found Malcolm Cohen personally liable for $627,431 for violating his fiduciary responsibilities with respect to the investments of the Miller Druck employee benefit plan. Whitfield v. Cohen, 9 EBC 1739.
Miller-Druck was a New York marble and stone provider to the building construction industry. Malcolm Cohen was the sole Trustee of the Miller Druck plan. He also was the president of the company and the majority shareholder. In 1980, the plan had slightly in excess of $270,000. At that time, a co-trustee named Fagone advised Cohen that a man named Bidell was interested in managing the assets of the plan. Bidell had an investment management firm called Penvest. Fagone advised Cohen that Bidell was a smart person who could do the job. Fagone was a glazer with no educational background or employment experience in finance or investments. The extent of Cohen’s knowledge about Penvest’s investment policy was that he knew Penvest “invested in second mortgages which were a relatively conservative type of investment.”
There were a number of things Cohen didn’t know about Penvest. He did not know Bidell’s educational background or his employment experience. He didn’t know of any other pension plans, which had placed money with Penvest. He did not receive any references nor recommendations about Penvest and did not seek alternate proposals from other investment management firms. Cohen did not seek professional advice regarding the qualifications of Penvest. He did not determine whether Penvest was registered with the SEC as an investment advisor and did not inquire as to the fees.
Nevertheless, on December 24, 1980, Cohen transferred $270,000 to Penvest for investment purposes and gave them an additional $10,000 in July 1981. The plan never got a written description of the investments made by Penvest, but they did receive monthly statements consisting of three figures: original investment, interest earned, and the total.
In April 1982, Cohen hired a new controller, Arnold Hecht. In examining the assets of Miller Druck, including the plan, Hecht was concerned that there was no description of plan investments. Cohen told Hecht to write Penvest, which Hecht did with no reply. Hecht told Cohen that Penvest was not responding, whereupon Cohen instructed him to write again. Again, no response. Finally, in October 1983 the plan received financial documentation from Penvest – an unaudited financial statement for the fiscal year ending January 31, 1983. Hecht finally wrote Penvest at Cohen’s request in October 1983, asking for the return of $100,000 of the Miller Druck assets. Penvest sought debtor protection under Chapter 11 and Miller Druck never received any money. The court ordered Cohen to pay the plan $637,412 – the original $270,000 investment plus the balance as “lost opportunity cost” – calculated by using the adjusted prime rate.
The significance of Whitfield c. Cohen lies in two key facts. First, the case was deciding on summary judgement. That is, Justice Sweet took all the facts in the case and construed them against the Department of Labor and in favor of Cohen; and after doing that; concluded that Cohen still had no defense. Secondly, for the first time, the DOL set down proscriptive affirmative duties for fiduciaries. The DOL brought in an expert witness-an investment consultant, Richard Ennis. Ennis testified on behalf of the DOL as to the minimum standards of prudence, which govern a fiduciary’s selection and continued use of an investment manager.
According to Ennis and the DOL, for a trustee to prudently invest ERISA plan assets he must do the following:
- Evaluate the qualifications of the investment person.
- Examine his experience in the type of investments you want.
- Examine his experience with other plans like yours.
- Evaluate the educational credentials of the person responsible for investing.
- Ascertain that the manager has the appropriate federal and state registrations as an investment manager.
- Make or have made an independent assessment of the managers qualifications including:
- His reputation in the investment industry.
- The references of other clients.
- The advice of a consultant.
- Examine his past performance record.
- Determine the reasonableness of the fees.
- Review the contract and other documents which govern the relationship.
- Insure that adequate reporting and periodic account is made available.
The findings of the court are compelling to plan trustees. In response to the defense that Cohen wasn’t familiar with investments, the court replied, “A trustee’s lack of familiarity with investments is no excuse; under an objective standard, trustees are to be judged ‘according to the standards of others acting in a like capacity and familiar with such matters’.” The court concluded that a trustee has a duty to seek out a consultant for help with investment management process, “A trustee has a duty to seek independent advice where he lacks the requisite education, experience and skill…” “The failure to make any independent investigation and evaluation of a potential plan investment is a breach of fiduciary obligations.
Assessing Cohen’s contention that he should be excused because of lack of experience in investments, Justice Sweet said, “That he may not have possessed the requisite education, experience, and skill to make a particular investment decision does not excuse his negligence.”
Nonetheless, the court did not find Cohen liable because he improperly selected a money manager. Because to do that Justice Sweet said we would have to determine that the investments made by Penvest were improper for the Miller Druck plan. We do not have to do this now, continued Judge Sweet, because, “Cohen’s common law and ERISA responsibilities as a trustee did not end with the initial decision to invest plan assets with Penvest…A fiduciary must ascertain with a reasonable time whether an agent to whom he has delegated a trust power is properly carrying out his responsibilities.” The court said that if a fiduciary is negligent in selecting, instructing, or supervising an agent he would be liable. “Cohen had a duty to monitor Penvest’s performance with reasonable diligence and to withdraw the investment if it became clear that the investment was no longer proper for the plan.”
When Cohen tried to claim a safe harbor because he appointed a money manager, the court stated simply that if the selection and continued use had been done in accordance with the law and prudent standards set above, trustees would not be held liable for any resulting loss. However, Cohen did not follow prudent procedures. “Cohen’s failure to apprise himself of the nature of the investments made by Penvest on behalf of the plan and his acquiescence in Penvest’s failure to account the plan establish a breach of his fiduciary obligation to monitor the performance of the plan’s investments.”
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