Dardaganis v. Grace Capital Inc., 29

• Decision Date: 16 November 1989
• Docket Number: No. 29,D,29
• Citation: 889 F.2d 1237
• Parties: , 11 Employee Benefits Ca 2081 Theofanis DARDAGANIS, Harry Eagleberg, Martin Geller, Arthur Kotoros, Paul Raphael, Philip Simadiris, as Trustees of the Retirement Fund of the Fur Manufacturing Industry, Plaintiffs-Appellees, v. GRACE CAPITAL INC. and H. David Grace, Defendants-Appellants. ocket 88-7611.
• Court: U.S. Court of Appeals — Second Circuit

Page 1237

889 F.2d 1237

58 USLW 2376, 11 Employee Benefits Ca 2081

Theofanis DARDAGANIS, Harry Eagleberg, Martin Geller, Arthur

Kotoros, Paul Raphael, Philip Simadiris, as

Trustees of the Retirement Fund of the

Fur Manufacturing Industry, Plaintiffs-Appellees, v. GRACE CAPITAL INC. and H. David Grace, Defendants-Appellants.

No. 29, Docket 88-7611.

United States Court of Appeals, Second Circuit.

Argued Aug. 30, 1989.

Decided Nov. 16, 1989.

Robert E. Anderson, New York City, for defendants-appellants.

Ronald L. Castle, Washington, D.C. (Rodney F. Page, Arent, Fox, Kintner, Plotkin & Kahn, Washington, D.C., Christopher E. O'Brien, Gaston & Snow, New York City, on brief), for plaintiffs-appellees.

Before FEINBERG and NEWMAN, Circuit Judges, and DUMBAULD, Senior District Judge. ^*

JON O. NEWMAN, Circuit Judge:

This appeal concerns enforcement of the duty ERISA imposes upon fiduciaries of employee benefit plans to act "in accordance with the documents and instruments governing the plan." 29 U.S.C. Sec. 1104(a)(1)(D) (1982). Grace Capital Inc. ("GCI") and H. David Grace ("Grace") appeal from a judgment entered in the District Court for the Southern District of New York (Robert W. Sweet, Judge) awarding the trustees of the Retirement Fund of the Fur Manufacturing Industry (the "Fund") $1,507,174. The Court concluded that GCI and Grace breached their fiduciary duties to the Fund by deviating from the written agreement governing GCI's actions as investment manager of the Fund's assets. We affirm the District Court's finding of liability as to GCI and its finding of personal liability as to Grace but remand for further fact-finding on one of the damage issues.

Background

GCI is a registered investment advisor. Grace is president, chief executive officer, and principal shareholder of GCI. On August 28, 1981, GCI entered into a four-page Investment Management Agreement (the "Agreement") with the plaintiffs, who are trustees (the "Trustees") of the Fund. Under the terms of the Agreement, GCI became investment manager of the assets of the Fund and promised to "manage the [Fund's] Account in strict conformity with the investment guidelines promulgated by the Trustees from time to time and with all applicable Federal and State laws and regulations." The Agreement further provided that Grace would "personally supervise and manage the Account" in behalf of GCI and that any changes in the Trustees' guidelines would have to be in writing in order to be effective. Attached as a one-page exhibit to the Agreement was a list of four guidelines (the "Guidelines"), limiting GCI's investment discretion. Central to the present appeal is the first of these Guidelines, which placed the following restriction on the proportion of fund assets that GCI could invest in common stocks:

(1) Common stocks held shall not exceed 25% of the cost of the securities in the Account. Changes in the market value after the purchase of a security which increases [sic ] the proportion to more than 25% for common stocks shall not violate the standards.

Over the three years that GCI acted as advisor to the Fund, this ceiling on common stock holdings was raised twice: to 35% in May 1982 and to 50% in September 1982. Both of these changes were recorded in the minutes of a Trustees' meeting, a form of documentation that both parties agree satisfies the Agreement's requirement that changes in the Guidelines be in writing. It is also undisputed that at the time of both the May and September 1982 Trustees' meetings, where the Trustees approved a raise in the ceiling, the percentage (on a cost basis) of common stock holdings already exceeded the applicable limit. Prior to a February 1984 Trustees' meeting, GCI proposed a further increase in the ceiling to 70%. During the eight-month period preceding this meeting, the common stock percentage had exceeded the 50% ceiling each month by an average of roughly 15 percentage points. The Trustees refused to increase the ceiling above 50%. Nevertheless, the equity holdings of the Fund's portfolio continued to increase until they reached about 80% in October 1984. At that point Grace and GCI were fired.

At the same time as the percentage of the Fund's equity holdings was increasing, the value of those holdings was decreasing. In June 1983, there had been an unrealized gain of $1,015,651 on equities; by October 1984, there was an unrealized loss of $3,642,045.

In August 1985, the Trustees brought suit, alleging that both defendants had breached a fiduciary duty, 29 U.S.C. Sec. 1104(a)(1)(D), by failing to abide by the documents governing the plan and were thus liable to the Fund, under section 1109(a), for any losses the Fund sustained as a result of the breach. ¹

The district court granted a motion for partial summary judgment on the issue of liability. Dardaganis v. Grace Capital Inc., 664 F.Supp. 105 (S.D.N.Y.1987). The Court held that section 1104's requirement that fiduciaries abide by the plan documents together with the Agreement's provision that GCI manage the account "in strict conformity with the investment guidelines" required the Court to conclude, as a matter of law, that "[a]ny violation of the terms of [the] Agreement constitutes a breach of Grace Capital's fiduciary duty under Sec. 1104(a)(1)(D) and creates liability to the Fund under 29 U.S.C. Sec. 1109." Id. at 108. The District Court rejected defendants' argument that there were factual disputes as to whether preferred stock was subject to the equity percentage limit and whether the percentage was intended to be a strict limit or only a rough guideline. The Court found that the Agreement required GCI to conform to the 50% limitation--by liquidating stock, if necessary--even when cash withdrawals by the Trustees to meet Fund obligations resulted in an increase in the percentage of common stock above the 50% line. The Court also rejected defendants' arguments that the Trustees waived strict adherence to the 50% Guideline by not earlier enforcing it while aware of its violation. The Court held that such a defense under New York contract law is not a valid defense in an action for breach of fiduciary duty under ERISA. 664 F.Supp. at 109-10.

With respect to Grace, the Court found that, although he did not sign the Agreement in his personal capacity, he nevertheless became a fiduciary to the Plan because he was not only president, chief executive officer, and principal shareholder of GCI, but also was "solely responsible for all investment decisions made on behalf of the Fund account." Id. at 111. The Court initially denied summary judgment as to damages, finding that neither theory of "losses" to the Plan, 29 U.S.C. Sec. 1109(a), offered by the parties was in accord with our opinion in Donovan v. Bierwirth, 754 F.2d 1049 (2d Cir.1985). Judge Sweet interpreted Donovan as requiring, in this context, a comparison of what the Plan actually earned with what it would have earned had GCI invested only 50% of the Fund's account in equities. For the purpose of litigating the damages question, Judge Sweet directed the parties to assume that the money invested in these excess holdings of stock would have been invested in the Fund's non-equity holdings during the relevant time period and would have returned a comparable yield.

In a second decision, Dardaganis v. Grace Capital Inc., 684 F.Supp. 1196 (S.D.N.Y.1988), the Court analyzed the expert affidavits of both sides and granted summary judgment to the plaintiffs on the issue of damages. After defendants' motion for reargument was denied and the District Court made some minor alterations in its judgment, this appeal followed.

Discussion

I. Scope of Fiduciary Duty Under Section 1104(a)(1)

GCI raises two principal objections to the District Court's liability holding. First, it maintains that the Court erred in concluding, at the summary judgment stage, that GCI violated the Guidelines because there was a dispute as to whether the parties intended the 50% ceiling to be a strict limit or only a rough benchmark, as GCI maintains is the custom in the industry. Second, it argues that a fiduciary's failure to abide by the plan documents is not necessarily a breach of duty, but that liability requires conduct that was not prudent under the circumstances. The District Court correctly rejected both of these arguments.

With respect to the character of the 50% ceiling, the Agreement plainly stated that GCI would manage the account "in strict conformity with the investment guidelines promulgated by the Trustees." We need not consider whether such language in a plan document covered by section 1104 requires a finding of liability even for small percentage deviations from a prescribed limit. In this case, GCI greatly exceeded the 50% ceiling during a 16-month period preceding its termination in October 1984. For most of this period, the portfolio's equity holdings exceeded 65%; for the last five months these holdings exceeded 75%. In light of these undisputed facts, the District Court correctly ruled that no reasonable fact-finder could conclude that GCI had complied with the Guidelines.

Nor does the defendant's claim that the parties agreed not to regard shares of preferred stock as "equities" for purposes of the ceiling preclude summary judgment as to liability. As the District Court noted, the percentage of preferred stock in the portfolio was only 4%. Even if this 4% were subtracted from the total equity percentages relied upon by the District Court, the fact remains that GCI allowed the portfolio, over an extended period of time, to hold a percentage of common stock far in excess of 50%.

The District Court was also correct to reject defendant's argument that the Trustees' awareness that GCI had exceeded the 50% limit without voicing any objection raised a factual issue precluding summary judgment. As the District Court noted, ERISA's requirements that employee benefit plans be put in writing, 29 U.S.C. Sec. 1102,...