Metzler v. Graham

United States Court of Appeals,

Fifth Circuit.

No. 95-11129.

Cynthia A. METZLER, Secretary of the United States Department of
Labor, Plaintiff-Appellant,

v.

Jack V. GRAHAM, Defendant-Appellee.

May 13, 1997.

Appeal from the United States District Court for the Northern
District of Texas.

Before JOLLY, JONES and PARKER, Circuit Judges.

EDITH H. JONES, Circuit Judge:

The Secretary of the United States Department of Labor alleges

that Jack V. Graham violated his fiduciary duties under the

Employee Retirement Income Security Act ("ERISA") as plan

administrator of the Graham Associates, Inc. ("GAI") pension plan

by failing to diversify the plan investments and by self-dealing.

Specifically, the Secretary complains that Graham failed to

diversify the plan assets by investing 63% of them in a single

tract of undeveloped real estate, and he sacrificed the plan's best

interests by buying land near other parcels in which he owned an

interest. We agree with the district court's conclusion that under

the circumstances before us, Graham did not violate 29 U.S.C. §

1104(a)(1)(A) and (C), and we therefore affirm.

I. Background

Graham is the president and sole owner of GAI. He also serves

as the sole trustee and administrator of a defined contribution

1
benefit plan established in 1975 to provide retirement, death and

disability benefits to the employees of GAI. At the end of 1984,

the plan had 123 participants and $2,740,735 in assets. Graham

owned approximately 20% of the plan assets.

Before 1985, Graham invested the plan assets in a mixture of

short-term certificates of deposit in denominations of less than

$100,000, short-term U.S. Treasury Securities, cash and cash

equivalents.

In April 1985, Graham paid $1,743,011 ($1.65 per square foot)

on behalf of the plan for 24.251 acres of undeveloped land (the

"Property") in the Great Southwest Industrial District in Grand

Prairie, Texas, a suburb of Dallas. The Property is zoned for

light industrial use. GAI had done civil engineering work on the

property for the prior owners. Graham personally owned an interest

in two parcels adjacent to the property and in another parcel

nearby.1 The investment in the Property represented 63% of the

plan assets. The remaining 37% was invested as before.

At the time of the purchase, Graham obtained an independent

appraisal valuing the Property at $2,154,000 ($2.00 per square

foot). At the end of 1985, an independent appraiser valued the

property at $2,900,000 ($2.75 per square foot). Graham envisioned

selling the Property within a short period of time, but this did

1
The two adjacent parcels are the Westfork Tract, a 174 acre
tract, and the ESO Tract, an 11 acre tract. The Westfork Tract was
owned by the Westfork Partnership in which Mr. Graham had a 33%
interest. The ESO Tract was owned by the ESO Partnership in which
Mr. Graham had a 95% interest. The 360 North Joint Venture Tract
was another nearby tract in which Mr. Graham owned a 33% interest.

2
not transpire. Instead, since acquiring the Property, the plan has

paid maintenance and taxes but has earned no income from it. The

court found, however, that the Property has at least maintained its

value and that no plan participants had lost benefits as a result

of the purchase.2

The Secretary brought this suit under Sections 502(a)(2) and

(5) of ERISA. 29 U.S.C. § 1132(a)(2) and (5). The Secretary

alleged that the investment of 63% of the plan's assets in one

piece of real estate violated Graham's duty to diversify plan

assets. The Secretary also alleged that Graham violated his duty

of loyalty by purchasing the land without taking precautions to

ensure the purchase was in the best interests of the plan

beneficiaries. After a bench trial, the district court entered

findings of fact and concluded that Graham did not violate his duty

to diversify or his duty of loyalty. The Secretary now appeals.

II. Duty to Diversify.

ERISA requires a plan fiduciary to

discharge his duties with respect to a Plan solely in the
interest of the participants and beneficiaries ... by
diversifying the investments of the Plan so as to minimize the
risk of large losses, unless under the circumstances it is
clearly prudent not to do so.

29 U.S.C. § 1104(a)(1)(C). No statute or regulation specifies what

constitutes "diversifying" plan investments, but the legislative

history provides this guidance:

2
The Secretary's expert testified that, as of the time of
trial, the Property was appraised at $1,835,000, an amount that
exceeded the purchase price. Graham's expert testified that, as of
the time of trial, the Property was worth $3,275,000.

3
 The degree of investment concentration that would violate this
requirement to diversify cannot be stated as a fixed
percentage, because a fiduciary must consider the facts and
circumstances of each case. The factors to be considered
include (1) the purposes of the plan; (2) the amount of the
plan assets; (3) financial and industrial conditions; (4)
the type of investment, whether mortgages, bonds or shares of
stock or otherwise; (5) distribution as to geographical
location; (6) distribution as to industries; (7) the dates
of maturity.

H.R.Rep. No. 1280, 93d Cong., 2d Sess. (1974), reprinted in 1974

U.S.Code Cong. & Admin. News 5038, 5084-85 (Conference report at

304). Without minimizing the importance of the usual need for

diversification of a plan's portfolio, however, the foregoing

open-ended "facts and circumstances" list ought to caution judicial

review of investment decisions. It is clearly imprudent to

evaluate diversification solely in hindsight—plan fiduciaries can

make honest mistakes that do not detract from a conclusion that

their decisions were prudent at the time the investment was made.

To establish a violation, a plaintiff must demonstrate that

the portfolio is not diversified "on its face." Id. at 5084;

Reich v. King, 867 F.Supp. 341 (D.Md.1994). Once the plaintiff has

established a failure to diversify, the burden shifts to the

defendant to show that it was "clearly prudent" not to diversify.

In Re Unisys Savings Plan Litigation, 74 F.3d 420, 438 (3d.

Cir.1996). Prudence is evaluated at the time of the investment

without the benefit of hindsight.

We review the district court's factual findings and

inferences under a clearly erroneous standard and its legal

conclusions de novo. Reich v. Lancaster, 55 F.3d 1034, 1044-45

(5th Cir.1995).

4
 The district court credited Graham's testimony that, in

purchasing the Property, he was attempting to increase the return

on the plan's investments which previously had been entirely in

short-term monetary or cash equivalent investments. The court

found Graham knowledgeable in industrial-warehouse property,

particularly those sites located in Grand Prairie. Before

purchasing the Property, Graham discussed the purchase with the

Plan's accountant, lawyer and actuary, as well as the Plan's major

participants.3 The major plan participants also had considerable

experience in commercial real estate development in the area. A

contemporaneous independent appraisal valued the property

significantly higher than its purchase price. Graham believed the

property was undervalued and anticipated selling it by 1986. The

court concluded that Mr. Graham "exercised proper due diligence and

prudence."

The court ultimately concluded that Mr. Graham had not

violated his duty to diversify so as to minimize risk of large loss

by investing 63% of the Plan's assets in one parcel of real

property. The court found that "at no time relevant has there been

a "risk of large loss,' " and, "given the 1985 non-diversified

conditions of the portfolio, value of the real estate then and now,

and the purchase price paid, ... his purchase decision was clearly

a prudent one under all the circumstances at the time as viewed

3
The other plan participants were consulted not only about the
advisability of the purchase of the Property in general but about
whether to purchase only half the Property or the entire 24-acre
lot. The consensus was to purchase the entire Property.

5
from the standpoint of a prudent man acting in a like capacity."

The court also observed that no participants had lost benefits, nor

were they likely to lose benefits in the future as a result of the

purchase of the Property.4 Id. at 11.

The Secretary contends that, as a matter of law, purchasing

the Property constituted a failure to diversify on its face and

that Graham did not prove at trial that it was clearly prudent not

to diversify under the circumstances. We disagree. Even assuming

arguendo that the plan's purchase of the property meant that the

plan was not diversified on its face, we affirm the district

court's decision because its findings demonstrate that, under the

circumstances, it was clearly prudent not to diversify.

Both the diversification requirement and the clearly prudent

exception to diversification must be analyzed from the perspective

of what both parties acknowledge as their purpose: to reduce the

risk of large loss. Several factors specific to this case indicate

that Graham did not imprudently introduce a risk of large loss by

purchasing the Property. First, the plan was not required to make

payments to beneficiaries until age 65, death, or disability, and

the average age of the plan participants was 37 years when the

4
The court further observed "that in the ten (10) plus years
since the Property was purchased, the last four (4) of which have
been in this litigation, the parties have spent several hundreds of
thousands of dollars in this litigation. The Court finds that much
of this money has been spent by the U.S. taxpayer. The Court finds
that it is uncontroverted that to date from the inception of this
Plan in 1973 not one single beneficiary has lost one dime of
benefits to which he or she is entitled. The Court finds that it
is not likely that any of them will, at least not as a result of
the purchase of this Property by the Plan in 1985." Id.

6
Property was purchased. Accordingly, the cash then remaining in

the plan was sufficient to cover projected Plan payouts for the

next 20 years.5 The relative youth of the participants made it

appropriate to evaluate the risk of the plan investments over an

extended time frame, thus minimizing the risks associated with

short-term fluctuations in asset values.6

5
In addition, at the time of the purchase, the plan had been
receiving significant annual cash contributions from GAI. For
example, in 1985, GAI contributed $553,715 in contributions to the
plan. Although these substantial contributions did not continue in
the years after the purchase, Graham's expert, William Allbright,
testified that the reasonable expectation that such large
contributions would continue supports the prudence of Graham's
decision. The substantial cash contributions not only would
provide further cushion for any plan needs, but could also be
expected to dramatically reduce the portion of the plan assets
allocated to the Property.
6
The Secretary contends that the plan horizon should not be a
factor in evaluating the whether the trustee has appropriately
diversified to reduce the risk of large loss, since losses are not
postponed until the investment is liquidated, citing Donovan v.
Bierwirth, 754 F.2d 1049, 1057-58 (2d Cir.1985) (Bierwirth II ).
The Bierwirth II court was not faced with the same situation
present here: an injunction had already been issued on the basis
that the trustees acted improperly and the Bierwirth II court was
discussing the proper measure of loss to the Plan and its timing.
Id. at 1052. We express no opinion concerning the Bierwirth II
rationale because we are not asked to determine the appropriate
time to measure actual loss to the plan, but rather to determine
what factors the fiduciary may consider in evaluating the
portfolio's risk of large loss. We think it is entirely
appropriate for a fiduciary to consider the time horizon over which
the plan will be required to pay out benefits in evaluating the
risk of large loss from an investment strategy. It is an entirely
different question than determining when and how to measure damages
to make the beneficiaries whole once a trustee has been found to
have breached his fiduciary duty. The other cases relied on by the
Secretary also involved trustees who had already been found liable
and were only concerned with the measure of damages. See Davidson
v. Cook, 567 F.Supp. 225, 240 (E.D.Va.1983), aff'd mem. 734 F.2d
1 (8th Cir.1984) and Freund v. Marshall & Ilsley Bank, 485 F.Supp.
629, 642-43 (W.D.Wis.1979)

Furthermore, the language relied on in Bierwirth II is

7
 Second, at the time of the purchase, an important concern to

Graham, and an ominous "risk of large loss," was the prospect that

high inflation would return. According to Graham's expert William

Allbright, when the plan's holdings consisted solely of cash and

short term instruments, there was little hedge against inflation.

The purchase of real estate historically had provided excellent

protection against inflation and could reasonably have been seen as

an effort to diversify the portfolio to offset that risk.7 The

clearly dicta: in that case the stock purchased in the
breaching transaction had been sold prior to the damages
determination, mooting the issue of when to fix the loss. Id.
at 1057. In writing this part of the opinion, clearly not
required by the dispute before it, the court explicitly
disagreed with common law decisions holding otherwise. See In
re Whitely, 33 Ch.D. 347, 354-55 (Ct.App.1886), aff'd sub nom.
Learoyd v. Whitely, 12 App.Cas. 727 (House of Lords 1887).
7
Allbright testified that the extended plan horizon further
supported Graham's decision to diversify into real estate.
Relevant portions of his testimony include:

Q. Is it conceivable that a plan that has a time horizon
of starting with a census average age of 37 years old
could be too conservative?

A. Yes.

Q. Is it possible that such a plan that had itself
invested in nothing but short-term government securities
might really have been too conservative at that point in
time?

A. Yes.

Q. What is the main thing the plan is trying to protect
itself from like the Graham profit-sharing plan?

A. From the devastation of inflation, to provide
inflation-protected benefits so that, upon retirement
age, these people will have a right to receive benefits
that at least have kept up with the cost of living.

Q. Do you believe that short-term government securities

8
purchase of the Property achieved greater diversity in plan assets

than had existed.

Third, the significant cushion between the purchase price and

the contemporaneous independent appraisal, and fourth, Graham's

expertise in the development of this type of industrial property

further support the conclusion that the investment in the Property

was a prudent one.

The district court did not clearly err in crediting all this

evidence and finding that the investment did not carry a "risk of

large loss" at any relevant time. We reject the secretary's

criticism of this finding. Under the circumstances of this case,

irrespective whether the purchase of the Property in 1985 meant

that the plan was not diversified on its face, it was clearly

prudent not to diversify.

The Seventh Circuit addressed a similar situation in Etter v.

J. Pease Constr. Co., 963 F.2d 1005 (7th Cir.1992). In Etter, the

can provide that type of [protection] from inflation?

A. I don't believe they do, and it's supported by
statistical information that they do not.

Q. Do you believe sir, is it your opinion that in or
around April of 1985, that actually the Graham
profit-sharing plan needed to diversify?

A. Yes.

Q. And do you have any—can you give us any input as to
whether you think that the diversification into real
estate was a good or bad idea?

A. I think the diversification step into real estate at
the time to accomplish the objectives of the plan which,
again, were to provide inflation-protected benefits was
a good decision.

9
plan invested $112,850 of its $127,993.43 in assets, or about 88%,

in a single piece of local real estate. Id. at 1008. The plan

trustees "although not "sophisticated' investors, were experienced

in real estate and knew the local market and development potential

in the county." Id. The trustees were partners with the Plan in

the purchase, investing their own funds in the same property. Id.

The court of appeals affirmed the district court's conclusion that

it was clearly prudent not to diversify under the circumstances.

Id. at 1011. Specifically, the court of appeals approved the trial

court's consideration of the trustee's knowledge of real estate,

knowledge of area development, and investigation of the property.

Id. See also Reich v. King, 867 F.Supp. 341, 344-45 (D.Md.1994)

(investment of 70% of plan assets invested in residential mortgages

in one county; held clearly prudent not to diversify where

administrator, a plumbing contractor, was knowledgeable about local

real estate market and conducted sufficient investigation).8

8
The district court in King awarded the defendant attorneys'
fees as the prevailing party under the Equal Access to Justice Act,
28 U.S.C. § 2412(d)(1)(A). Id. On appeal of that award, the Fourth
Circuit affirmed the district court's finding that the Secretary's
position was not even "substantially justified" under the Act.
Reich v. Walter King Plumbing & Heating Contractor, Inc., 98 F.3d
147, 152 (4th Cir.1996). The Secretary argued that the
concentration of assets in real estate mortgages in a single
geographical area exposed the plan to four specific risks of large
loss: default risk, interest rate risk, inflation risk, and
liquidity risk. Id. However, the court concluded that the
Secretary "did not identify any specific reasons suggesting the
likelihood of a significant downturn in the local economy, a sudden
change in interest rates, a drastic increase in inflation, or an
unexpected demand for benefit payments." Id. The district court in
King appropriately credited testimony reflecting "the actual
realities of mortgages in Frederick County" to determine that the
plan did not face the risk of large losses due to
non-diversification. 867 F.Supp. at 344-45.

10
 The Secretary argues that the Etter decision and the district

court decision allow satisfaction of the prudence requirement to

wipe out the separate and independent requirement of

diversification. We disagree. When there is a lack of

diversification, the statute requires the trustee to show that it

was clearly prudent not to diversify. 29 U.S.C. § 1104(a)(1)(C).

In Etter, the district court found that it was prudent "not to

diversify plan funds at the time of the Glacier Ponds investment."

963 F.2d at 1011. The Etter court looked at numerous factors, such

as the investigation of the purchase, the evaluation of other

investment alternatives, and the relative expertise of the

trustee—all factors which are relevant to whether there was a risk

of large loss. See id. Similarly, the district court in this case

evaluated numerous factors, discussed above, which are directly

relevant to the prudence of the failure to diversify (assuming the

portfolio was not sufficiently diverse), in order to determine

whether there was a risk of large loss. Both the diversification

requirement and the statutory allowance of non-diversification in

In the present case, there is no significant interest
rate risk because the plan paid cash for the Property; there
was no significant liquidity risk because the plan's cash
position could cover any potential claims for benefits; and
there was no significant inflation risk because the evidence
suggested that the purchase of the property provided long-term
protection from inflation. The only one of the four risks
argued by the Secretary in King that was associated with
Graham's purchase of the Property is that of a significant
downturn in local real estate. While such a temporary
downturn in fact occurred in Texas real estate, there was no
suggestion at trial that, from the standpoint of a reasonable
investor in 1985, such a downturn was foreseeable or even
likely.

11
circumstances when it is prudent not to diversify are primarily

concerned with minimizing the risk of large loss. The court's

explicit finding that there was not a risk of large loss, based on

his conclusion that Graham put on the more persuasive case,

minimizes the Secretary's concern about weakening ERISA's

diversification requirement.

III. Duty of Loyalty

The Secretary also alleged that Graham violated his duty of

loyalty as plan trustee by not appointing a neutral fiduciary or

taking other precautions before purchasing the Property. ERISA §

404(a)(1) provides that

a fiduciary shall discharge his duties with respect to a plan
solely in the interest of the participants and beneficiaries
and—

(A) for the exclusive purpose of:

(i) providing benefits to participants and their
beneficiaries; and

(ii) defraying reasonable expenses of administering
the plan ...

29 U.S.C. § 1104(a)(1)(A). The Secretary contends that Graham did

not discharge his duties solely in the interest of the participants

because he owned interests in nearby parcels of land. Graham's

other investments were allegedly enhanced in value by the plan's

purchase of the Property, and the other parcels were in competition

with the Property for potential buyers. The conflict was

particularly evident, the Secretary urges, because Graham used a

single agent to market the Property along with the other parcels in

which he had an interest; this situation allegedly created the

12
temptation to prefer Graham's personal property investments over

the plan's Property in the marketing process.

Nevertheless, the district court concluded that Graham did not

breach his fiduciary duty of loyalty, stating that:

merely because Graham was a partner in other real estate
investments in the area it was not a breach of his fiduciary
duty to acquire the land on behalf of the Plan, nor was it,
under the specific facts of this case, a breach of his
fiduciary duty to try to market the Plan's Property in a
package along with the property he had an interest in, since
doing so provided a larger market of potential purchasers.

The court further found that Graham's control of the adjacent

parcels "actually inured to the benefit of the Plan."

On appeal, the Secretary contends that there is no evidence

that Graham took necessary steps to alleviate the potential

conflict before purchasing the property. Specifically, the

Secretary argues that given the potential conflict, Graham should

have either appointed a neutral fiduciary to administer the plan or

taken "every feasible precaution to see that [he] had carefully

considered the other side, to free [himself], if indeed this was

humanly possible, from any taint." Donovan v. Bierwirth, 680 F.2d

263, 271-72 (2d Cir.), cert. denied 459 U.S. 1069, 103 S.Ct. 488,

74 L.Ed.2d 631 (1982).

Graham counters that he at all times acted solely in the

interests of the plan in making the purchase of the Property.

Graham's other interests in adjacent property were known to the

plan participants, and a majority in interest of the participants

concurred in the decision to purchase the Property. Graham

investigated the soundness of purchasing the property as a plan

13
investment by obtaining an independent appraisal of the property,

consulting the plan's actuary, accountant and lawyer, and

conducting enough analysis to convince himself that the investment

was in the plan's best interests. The district court clearly

credited this evidence of fair dealing in reaching its conclusion,

and the court's findings are not clearly erroneous or infected with

legal error.

It should be remembered that the Bierwirth case and other

decisions relied on by the Secretary involved the commitment of

plan assets to corporate control contests in which the plan

trustees' jobs were at stake. 680 F.2d at 271. See also Leigh v.

Engle, 727 F.2d 113 (7th Cir.1984). Judge Friendly articulated the

corporate directors' duties in Bierwirth with a particular eye to

the fact that the control contest was "an unusual situation

peculiarly requiring legal advice from someone above the battle."

Bierwirth, 680 F.2d at 272-73. Indeed, in the appeal after remand,

the court noted that since plan fiduciaries may often "be called

upon to make decisions regarding tender offers and other contests

for corporate control ... there is a need to deter abuses in these

areas, where the temptation to misuse funds often may be especially

strong." Bierwirth II, 754 F.2d at 1055-56 (citations omitted).

Graham's ownership of neighboring parcels is a far cry from that

type of conflict. The level of precaution necessary to relieve a

fiduciary of the taint of a potential conflict should depend on the

circumstances of the case and the magnitude of the potential

conflict. Furthermore, even under those decisions, the district

14
court's findings that Graham reasonably believed he was acting in

the participants' best interests, that Graham acted prudently in

his decision to purchase the property, and that Graham's decisions

inured more to the plan's benefit than to his own would support

affirmance of the verdict. See Bierwirth, 680 F.2d at 271 ("...

officers of a corporation who are trustees of its pension plan do

not violate their duties as trustees by taking action which, after

careful and impartial investigation, they reasonably conclude best

to promote the interests of participants and beneficiaries simply

because it incidentally benefits the corporation or, indeed,

themselves" as long as their decisions are "made with an eye single

to the interests of the participants and beneficiaries") and Leigh,

727 F.2d at 127 (consistent use of plan's assets in interest of

plan beneficiaries over an extended period of time in control

contests would be probative of the propriety of the trustee's

actions).

There was no evidence that in purchasing or marketing the

Property Graham ever placed his interests over the plan's interest

or ever failed to keep "an eye single to the interests of the

participants and beneficiaries." See Bierwirth, 680 F.2d at 271.

We agree with the district court's conclusion that "clearly Graham

did not breach his fiduciary duty of loyalty."

IV. Conclusion

For the foregoing reasons, we AFFIRM the decision of the

district court that the Secretary take nothing in this action.

15