On October 5, 2010, the U.S. District Court for the Southern District of New York in In re Beacon Associates Litigation, 09-cv-777 (LBS) (S.D.N.Y. Oct. 5, 2010) issued a lengthy and complicated ruling on motions to dismiss the complaint in an action involving investments with Bernard Madoff made through a feeder fund (the “Fund”). The complaint, which asserted violations of ERISA’s fiduciary provisions as well as other state and federal laws, is brought against the sponsor of the Fund (the “Sponsor”) and the firm that provided advice to the Sponsor (the “Advisor”), among other defendants. While the court’s opinion addresses numerous issues under ERISA and other laws, much of the ERISA analysis is focused on whether the Advisor was an ERISA fiduciary with respect to ERISA plans that invested in the Fund for having rendered “investment advice” within the meaning of ERISA Section 3(21)(A)(ii).
With respect to the plaintiffs’ investment advice theory of fiduciary liability, the complaint alleged that the Fund’s offering memorandum provided to potential investors (including ERISA plans) stated that the Sponsor would, after consulting with the Advisor, allocate assets of the Fund among investment managers selected and monitored by the Sponsor, but that a substantial majority of the Fund’s assets would be placed with a single manager. The plaintiffs further alleged that, once the Fund began operating, over 70% of the Fund’s assets were invested with Madoff, who had been introduced to the principals of the Sponsor by the Advisor. A consulting agreement between the Sponsor and the Advisor further provided that the Advisor would perform administrative services for the Sponsor in return for 50% of management fees earned by the Sponsor (and 50% of any fees the Sponsor received as a result of introducing third parties to Madoff). In 2008, after the facts concerning Madoff’s Ponzi scheme became public, the Fund was liquidated, with investors – including ERISA plans – allegedly incurring significant losses. The complaint asserts that the Advisor was an ERISA fiduciary because it rendered investment advice within the meaning of ERISA, and breached ERISA fiduciary duties by failing to recommend that the Fund end its relationship with Madoff when it became suspicious of his investment activities years before his fraud became public.
The Advisor moved to dismiss the ERISA claims on the ground that it was not a fiduciary because it had not rendered investment advice within the meaning of ERISA Section 3(21)(A)(ii) or Department of Labor (“DOL”) regulations thereunder. See 29 C.F.R. Section 2510.3-21(c)(1) (the “Regulation”). The Sponsor did not dispute that it was an ERISA fiduciary for purposes of the motion to dismiss, and the decision assumes without addressing the question that the Fund's assets are plan assets for purposes of ERISA.
The court denied the Advisor’s motion on several grounds. First, relying on DOL authority, the court held that “advice” under the statute includes not only advice concerning particular investments, but also recommendations regarding investment managers. Second, the court held that the Advisor’s recommendations could constitute ERISA investment advice, even though they were provided to the Sponsor and not the ERISA plans, because the Sponsor was alleged to be a fiduciary with authority to make investment decisions regarding the plan’s assets. Third, the court held that the complaint’s allegations were sufficient to state a claim that the Advisor’s advice was “individualized … based on the particular need of the plan[s]” within the meaning of the Regulation because the plaintiffs alleged that the advice had been provided to the Fund on an ongoing basis and in connection with the Advisor’s long-term relationship with the Sponsor. Fourth, the court rejected the Advisor’s argument that it had not provided investment advice “for a fee” within the meaning of the statute. Although the fees the Advisor received were for administrative services received under its consulting agreement with the sponsor, the court noted that the Fund’s offering memorandum specifically referred to the advisory services to be performed by the Advisor. Lastly, the court held that the complaint sufficiently alleged that the Advisor’s advice was “a primary basis” for the Fund’s decision to invest with Madoff, given that there was no indication that the Sponsor had received substantial advice from any other party and the Advisor had introduced the sponsor to Madoff.
While the court dismissed a number of claims against the Advisor and other defendants, the ERISA breach of fiduciary duty claims against the Advisor survived because the court concluded that the complaint sufficiently alleged that the Advisor had provided investment advice within the meaning of ERISA.