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 or 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 were 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—the original investment, interest earned and the total.
In April, 1982, a new controller, Arnold Hecht, was hired by Cohen. 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 to 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 ended 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 v. Cohen lies in two key facts. First, the case was decided on summary judgment. 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 prescriptive affirmative duties for fiduciaries. Prior to Cohen, the DOL’s usual method of operation had been to look at cases after the fact to determine whether an act should or should not have been done. A typical DOL response has been, “We can’t tell you whether or not you can do that, but after the fact, we’ll examine all the circumstances and render a decision whether it was appropriate or not.” In Cohen, 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. (If you want government bonds, what is his experience in government bonds?)
Examine his experience with other plans like yours (by implication, you do not want to be the first pension fund on the block with a new money manager).
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 manager’s qualifications including: His reputation in the investment industry; the references of other clients; and 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 accounting 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 the 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 within a reasonable time whether an agent to whom he has delegated a trust power is properly carrying out his responsibilities.” The court stated that if a fiduciary is negligent in selecting, instructing or supervising an agent, he will be liable. “Cohen had a duty to monitor Penvest’s performance with reasonable diligence and to withdraw the investment if it became clear or should have become 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 the 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 to the plan establish a breach of his fiduciary obligation to monitor the performance of the plan’s investments.” Cohen was found personally liable for $637,412, was permanently enjoined from engaging in potentially violateable fiduciary duties in the future, and a qualified money manager was appointed.
From a professional investment consultant’s standpoint, it seems clear that there are five things that could have been done if the trustee had been listening. Together they may have alleviated the liability question and probably eliminated the investment problem in the first place.
Cohen could have had professional assistance in drafting written investment objectives specifically for the Miller Druck Plan. They could have established an investment strategy tailored to fit the investment objectives of the Miller Druck Plan. They could have undergone a thorough manager search with the appropriate due diligence to evaluate and select investment managers who were qualified to manage assets according to the strategy tailored to fit the investment objectives of the Miller Druck Plan. They could have established a precise system of monitoring and evaluating the investment performance of the money managers on a regular basis. They could have used competent professionals to assist them through this process.
With respect to the investments of ERISA related funds, the frightening question is, “How many other trustees out there aren’t listening?”