Harley v. Minnesota Mining and Mfg. Co.

• Decision Date: 31 March 1999
• Docket Number: No. Civ. 4-96-488(JRT/RLE).,Civ. 4-96-488(JRT/RLE).
• Citation: 42 F.Supp.2d 898
• Parties: Carol HARLEY and James L. Raber, individually and on behalf of others similarly situated, Plaintiffs, v. MINNESOTA MINING AND MANUFACTURING COMPANY, Defendant.
• Court: U.S. District Court — District of Minnesota

42 F.Supp.2d 898

Carol HARLEY and James L. Raber, individually and on behalf of others similarly situated, Plaintiffs, v. MINNESOTA MINING AND MANUFACTURING COMPANY, Defendant.

No. Civ. 4-96-488(JRT/RLE).

United States District Court, D. Minnesota.

March 31, 1999.

COPYRIGHT MATERIAL OMITTED

Alan M. Sandals, Sandals, Langer & Taylor, Philadelphia, PA, and Seymour J. Mansfield, Mansfield & Tanick, P.A., Minneapolis, MN, for plaintiffs.

Paul M. Wolf and Andrew Keyes, Williams & Connolly, Washington D.C., and James M. Dawson, Felhaber, Larson, Fenlon & Vogt, Minneapolis, MN, for defendant.

MEMORANDUM OPINION AND ORDER

TUNHEIM, District Judge.

Plaintiffs, individually and on behalf of all others similarly situated, brought this action against defendant Minnesota Mining and Manufacturing, Co. ("3M"), alleging that 3M breached its fiduciary duty under section 404(a)(1)(B) of the Employee Retirement Income Security Act ("ERISA"), 29 U.S.C. § 1104(a)(1)(B), by failing to invest prudently the assets of the 3M Employee Retirement Income Plan ("the Plan"). In an Order dated September 25, 1997, the Court certified a class of all participants and beneficiaries of the Plan ("the Class").

This matter is now before the Court on the Class's motion for partial summary judgment on the issue of liability as to its "prohibited transaction" claim, defendant's cross-motion for dismissal or summary judgment on this claim, and defendant's motion for summary judgment (seeking dismissal of this action in its entirety). For the reasons set forth below, the Class's motion is denied, 3M's cross-motion is granted, and 3M's motion for summary judgment is denied.

BACKGROUND

The Plan is a "defined benefit plan" subject to the terms of ERISA, 29 U.S.C. § 1001 et seq. As a defined benefit plan, the Plan is obligated to pay only a defined benefit to its participants upon retirement. It is a massive entity, encompassing thousands of participants and beneficiaries and containing total assets in excess of $4 billion.

It is undisputed that 3M is a fiduciary of the Plan and is responsible for overseeing the investment of Plan assets. 3M delegated this responsibility to its "Pension Asset Committee" ("the PAC"). 3M also has a staff dedicated to overseeing fund investments and assets. In 1990, members of the PAC decided to invest $20 million in Plan assets in Granite Corporation ("Granite" or "the fund"), a "hedge fund" containing collateralized mortgage obligations ("CMOs").¹

Tony Estep, Granite's investment manager at the time 3M was first exploring an investment in Granite, initially met with 3M staff and gave the staff certain marketing materials about the fund. These materials stated that Granite's strategy would produce very high returns while investing in "low risk instruments." These materials also indicated the fund would maintain a "market neutral" strategy. However, Granite's 1990 Private Placement Memorandum ("PPM"), which 3M received shortly after the initial meeting with Estep, made clear that the investment faced substantial risks, including interest rate risks, potential difficulties in predicting market movements, possible illiquidity, and the risk of proportionally greater losses due to the use of leveraging. Moreover, the PPM disclosed that the fund's strategy may depend on the investment manager's ability to predict market movements and that there could be no assurance that a market neutral position could be achieved.

3M contends, without specification, that it made this investment after almost a year of its own investigation and analysis of the Granite strategy. The Class notes, however, that after Deborah Weiss, 3M's Manager of Pension Investments, recommended the Granite investment to the PAC, the PAC voted to make the investment after a brief (ten to twenty minute) discussion.² The Class further claims it was naive for Weiss and the PAC to accept Granite's representations that it could earn a very high, fixed rate of return while investing in low risk instruments. As set forth above, these representations were in conflict with the warnings of risk in the PPM, which only Weiss and 3M's ERISA counsel read. Moreover, Weiss had received information from other fixed-income investment managers suggesting that CMOs may have illiquidity problems, may be difficult to analyze, and may face substantial fluctuations in returns based on changes in prepayments. Yet no member of Weiss's staff or the PAC conducted a thorough, independent analysis of the risks associated with Granite's investment strategy. Likewise, although Weiss understood that the CMO market may be "thinly traded," neither she nor other staff or PAC members undertook an investigation to determine whether Granite's valuations were valid or to unearth the risks associated with a potentially illiquid market.³

Weiss had limited exposure to CMOs prior to recommending the investment to the PAC. She also never conducted a background check on Estep, who, it turns out, did not have much experience with CMOs before starting Granite. It also appears undisputed that no member of the PAC committee or the Plan's staff who participated in the decision to invest in Granite had expertise in evaluating or investing in CMOs.⁴ In fact, several members testified that they did not understand information Granite had given to them about the securities it was purchasing. Despite the PAC members' lack of expertise, at no time — before investing or during the period the Plan was invested in Granite — did 3M hire an "outside advisor" (in addition to Granite's managers) to evaluate the Granite investment or Granite's strategy.

After Estep resigned in 1991, David Askin took over as investment manager of Granite. The Class contends that withdrawal from Granite would have been appropriate at this point because Granite's returns had been far below the projected, "stable" high returns set forth in the marketing materials. Shortly thereafter, Askin formed Askin Capital Management ("ACM"), which served as Granite's investment manager throughout the rest of the relevant period. 3M personnel undertook minimal investigation of the impact on Granite from Estep's withdrawal and no investigation of Askin's experience. Weiss did talk to three other institutional investors in the fund: two chose to remain, and one decided to divest. She also interviewed Askin, but does not recall discussing his experience. Askin in fact had little previous experience managing and trading CMOs. According to the Class, this perfunctory review of Askin contradicted 3M's own stated policy of reviewing anew an investment in a fund with a new investment manager.

In implementing the Granite strategy, ACM was to purchase different and often volatile classes of CMOs which would respond to interest rate movements in various ways. At least in theory, these purchases were supposed to ensure that Granite remained market neutral and maintained a stable value despite changes in interest rates. ACM's application of the strategy also involved a high degree of leverage; in other words, the fund purchased CMOs on margin substantially in excess to investor equity to boost return. Despite its low returns under Estep, 3M's investment in Granite generated a 68.5% return prior to the market collapse in March 1994.

3M left to Granite's investment managers the task of implementing the Granite strategy.⁵ 3M personnel therefore did not participate in the decisions regarding the selection of Granite's securities. In essence, 3M selected Granite's investment managers to implement Granite's strategy and relied on these managers once these Plan had invested.

Weiss and other staff members received periodic reports from ACM and would monitor Granite's returns.⁶ However, 3M personnel never conducted their own, independent analysis of Granite's risk position or strategy at any time during the investment.⁷ They also never evaluated whether ACM's valuations were accurate, whether its strategy had changed over time, or whether — given fluctuations in the market and other circumstances — the risks of the fund's investments had changed. In fact, Weiss and her assistant testified that 3M did not have sufficient staff to closely monitor Granite.

Both the 1990 and 1993 PPMs provided that the Plan would compensate Granite's managers through a performance-based "incentive" fee equal to fifteen percent of any increase in value in excess of the London Interbank Offered Rate ("LIBOR"). The Plan was to pay these fees annually, on the anniversary date of its investment, based on performance during the preceding twelve months. Both PPMs also indicated that the payment of these fees created an "inherent or potential" conflict of interest.⁸ 3M only paid incentive fees to ACM once, on March 31, 1993, in the amount of approximately $1.1 million. 3M offers the opinion of one of its investment experts that this fee was reasonable compensation for ACM's services.

Following a significant and, according to 3M, unprecedented rise in interest rates in February and March 1994, the CMO market and Granite in particular experienced significant difficulties. As interest rates rose, the value of the CMOs owned by Granite dropped dramatically. To make matters worse, brokerage firms began demanding additional money from Granite to serve as margin for the leveraged CMOs Granite held. Because Granite was severely leveraged by this point, it collapsed and ultimately was liquidated. 3M wrote off the investment in its entirety.

During the investigation and litigation that followed Granite's downfall, it was revealed that Wall Street securities dealers had colluded wrongfully to foreclose on the loans they had made to the fund. In addition, Askin admitted to investors that he had inflated improperly the value of Granite's portfolio in February 1994. It also became obvious that ACM had failed to implement the purported strategy of remaining market neutral. In May 1994, Weiss told the PAC...