Alert December 14, 2011

Fourth Circuit Holds Trustees Are Liable Only If Their Fiduciary Breach Caused the Plan’s Loss

In Plasterers’ Local Union No. 96 Pension Plan v. Pepper, No. 10-1364 (4th Cir. December 1, 2011), the Fourth Circuit affirmed the district court’s findings that trustees of a multi-employer pension plan breached ERISA fiduciary duties by not diversifying plan investments and by failing to prudently investigate investment alternatives for the plan.  However, the district court’s holding that the trustees were liable to the plan was reversed because the Fourth Circuit concluded that the lower court never undertook to determine what losses, if any, resulted from the trustees’ breaches of duty.

In 1992, the trustees established an investment strategy designed to avoid losses.  In accordance with this strategy, plan assets were invested solely in certificates of deposit with various banks and one- or two-year Treasury bills.  For 12 years, the trustees never seriously considered any alternatives to this investment strategy.  After the trustees were removed from their positions in 2004, the new trustees sued them, asserting violations of the duties of prudence and diversification under Section 404(a)(1)(B) and (C) of ERISA.  At trial, the plaintiffs’ expert testified that a prudent investment strategy for the plan would have been to invest one-half of the assets in an equity index and the other half in an aggregate bond index. 

The district court found the defendant trustees liable under ERISA Section 409(a) (which imposes liability for fiduciary breaches), holding that, as part of their ERISA duty of prudence, the trustees had an obligation to investigate alternative investment strategies, which they had not done.  The district court also found that defendant trustees had breached their duty to diversify plan investments.  The court determined damages for these breaches by comparing the plan’s actual investment return for the three-year period of 2003 through 2005 to the return the plan would have had if invested in a 50/50 equity/bond mix as advocated by the plaintiffs’ expert.  Using this method, damages exceeded $430,000.

In vacating the district court’s judgment and remanding the case, the Fourth Circuit criticized the district court’s analysis in several respects, even though it did not find fault in the lower court’s holdings that the defendant trustees had violated their fiduciary duties to investigate and diversify.  The appeals court emphasized that, in this context, a causal link between a fiduciary’s breach and the plan’s loss is a prerequisite to liability under ERISA Section 409(a): “simply finding a failure to investigate or diversify does not automatically equate to causation of loss and therefore liability.”  In the Fourth Circuit’s view, the defendant trustees’ failure to investigate could result in a loss to the plan, and liability for the trustees, only if the actual investments they selected were found to be imprudent – a finding the district court had not made.  “Because the court never found that the failure to investigate investment options led to imprudent investments or otherwise found that the investments were objectively imprudent, its analysis lacked the essential element of causation.”  The court of appeals also noted that the district court had failed to address whether the plan’s lack of diversification was “clearly prudent under the circumstances,” as required by ERISA Section 404(a)(1)(C).  The Fourth Circuit instructed that, on remand, in determining whether the investments selected by the defendant trustees were prudent, the district court was to focus on the specific facts and circumstances of the plan, including its size and type (the plan was a defined contribution plan), the demographics of plan participants, and the defendant trustees’ goal and objectives in establishing its investment strategy.

The Fourth Circuit also criticized the district court’s analysis regarding damages.  It faulted the district court’s use of the 2003 to 2005 timeframe for measuring damages, observing that the district court had acknowledged that this period “had been picked out of the air.”  It emphasized the critical role played by selection of the applicable time frame in fixing damages in this context, noting that using the period 1999 to 2005 instead of the period selected by the lower court would have reduced damages by over $300,000.  The appeals court directed that, on remand, the district court (if it does find the defendant trustees liable) “must articulate the reasoned basis for awarding damages based on a particular time frame.”

The Plasterers’ decision illustrates that, while determining whether a breach has occurred is often given central focus in ERISA fiduciary cases, issues related to causation of loss and the determination of damages can frequently be just as important.