Smith v. Sydnor

• Decision Date: 06 April 1999
• Docket Number: No. 98-2235,CA-98-241-3,98-2235
• Citation: 184 F.3d 356
• Parties: (4th Cir. 1999) N. GLENN SMITH, For himself and all Plan Participants similarly situated on behalf of the James McGraw, Inc., 401(k) Plan, Plaintiff-Appellant, v. GEORGE SYDNOR, JR.; THE MCGRAW GROUP, INCORPORATED, Defendants-Appellees. () Argued:
• Court: U.S. Court of Appeals — Fourth Circuit

Page 356

184 F.3d 356 (4th Cir. 1999)

N. GLENN SMITH, For himself and all Plan Participants similarly situated on behalf of the James McGraw, Inc., 401(k) Plan, Plaintiff-Appellant, v. GEORGE SYDNOR, JR.; THE MCGRAW GROUP, INCORPORATED, Defendants-Appellees.

No. 98-2235 (CA-98-241-3)

UNITED STATES COURT OF APPEALS FOR THE FOURTH CIRCUIT

Argued: April 6, 1999

Decided: July 9, 1999

Appeal from the United States District Court for the Eastern District of Virginia, at Richmond. Richard L. Williams, Senior District Judge.

COUNSEL ARGUED: Richard K. Bennett, MCSWEENEY, BURTCH & CRUMP, P.C., Richmond, Virginia, for Appellant. Adriaen Meredith Morse, Jr., LECLAIR RYAN, P.C., Richmond, Virginia, for Appellees. ON BRIEF: David J. Walton, MCSWEENEY, BURTCH & CRUMP, P.C., Richmond, Virginia, for Appellant. Stephen T. Gannon, James A. Murphy, Stephen T. Perkins, LECLAIR RYAN, P.C., Richmond, Virginia, for Appellee McGraw Group; Hugh M. Fain, III, David Shane Smith, SPOTTS, SMITH, FAIN & BUIS, P.C., Richmond, Virginia, for Appellee Sydnor.

Before NIEMEYER, WILLIAMS, and TRAXLER, Circuit Judges.

Reversed and remanded by published opinion. Judge Williams wrote the opinion, in which Judge Niemeyer and Judge Traxler joined.

OPINION

WILLIAMS, Circuit Judge:

N. Glenn Smith appeals the district court's Rule 12(b)(6) dismissal without prejudice of his derivative action under the Employee Retirement Income Security Act of 1974 (ERISA), 29 U.S.C.A. §§ 10011461 (West 1999). The district court concluded that although Smith's amended complaint alleged that The McGraw Group, Inc. (McGraw),¹ and its President, Chief Operating Officer, and majority stockholder, George W. Sydnor, Jr., breached their fiduciary duties with respect to a 401(k) plan administered by McGraw by engaging in imprudent and self-dealing conduct, Smith's claims were merely a recasting of a claim for benefits, which requires exhaustion of internal plan provisions before Smith could bring an action in federal court. We disagree with the district court's characterization of Smith's claims and conclude that Smith's amended complaint alleges facts that, if proven, establish breaches of fiduciary duties by McGraw and Sydnor independent of a denial of benefits. We further hold that the exhaustion requirement does not apply to a claim for breach of fiduciary duty, and, therefore, Smith was not required to avail himself of administrative remedies before bringing suit in federal court alleging breaches of fiduciary duties as defined by ERISA. Accordingly, we reverse the district court's dismissal of Smith's action and remand with the instruction to reinstate his amended complaint.

I.

Because this case is on appeal from a Rule 12(b)(6) dismissal, we take the following facts as alleged in Smith's amended complaint to be true. See Vickers v. Nash General Hosp., Inc. , 78 F.3d 139, 141 (4th Cir. 1996). On January 1, 1989, McGraw, a corporation primarily engaged in the sale of industrial equipment and parts, established an Employee Stock Ownership Plan (ESOP) for the benefit of its employees. On December 29, 1989, McGraw filed amended and restated Articles of Incorporation to adopt a plan of reorganization. The Articles provided that preferred stock could be issued only to the ESOP or to participants in the ESOP. The Articles also stated that at any time following the earlier of December 19, 1996, or the date at which a loan agreement between McGraw and the ESOP was satisfied, plan participants who held preferred stock pursuant to a distribution from the ESOP could require their stock to be redeemed at a price of $260.31 per share. The Articles also provided that the shares of preferred stock paid cumulative dividends at the rate of eight percent of the par value per year.

Effective January 1, 1993, McGraw converted the ESOP into the 401(k) Savings Plan & Trust (the 401(k) Plan). At all relevant times, George W. Sydnor, Jr. was a trustee and fiduciary with respect to the 401(k) Plan within the meaning of ERISA and was also the President and Chief Operating Officer of McGraw. Prior to September 27, 1996, Kenneth Fisketjon was the Chairman and Chief Executive Officer of McGraw and served as co-trustee of the 401(k) Plan. Prior to September 30, 1996, Sydnor and Fisketjon each held fifty percent of the outstanding common stock in McGraw, which they purchased in December 1989 with the assistance of a large ESOP loan. Willamette Management Associates, which conducted annual appraisal reports of the ESOP preferred stock from 1990 to 1995, concluded in its 1996 draft report, which was delivered to Sydnor and McGraw in August 1996, that the fair market value of the preferred stock was $128.35 per share and that the common stock "ha[d] no residual equity value."

(J.A. at 143.)

In 1996, McGraw began experiencing financial difficulties that led to discussions with Columbia Naples Capital, L.L.C. (CNC) concerning a potential investment of capital in McGraw. CNC signed a letter of intent in June 1996 to invest several million dollars in McGraw in exchange for approximately forty-five percent of the common stock. CNC, like other prospective purchasers and investors, was concerned about McGraw's obligation to repurchase the preferred stock at $260.31 per share, plus dividends. To avoid this problem, CNC proposed that McGraw redeem the preferred stock. McGraw contacted Willamette to see if it was willing to give an appraisal of the value of the preferred stock to support the transaction between CNC and McGraw. Willamette refused to give such an opinion because it would be inconsistent with its prior appraisal, which allocated all of the equity value of McGraw to the preferred stock and none to the common stock.

Undeterred by Willamette's refusal to give a positive appraisal report, on September 30, 1996, Sydnor and McGraw hired Charles Merriman of Scott & Stringfellow, Inc., to give a"fairness opinion." Merriman opined that $70.00 per share was "adequate consideration" for the purchase of the preferred stock. On the same day, Sydnor, acting on behalf of himself, the 401(k) Plan, and McGraw, consummated a series of transactions with CNC. Acting as sole trustee of the 401(k) Plan following Fisketjon's resignation as co-trustee, Sydnor accepted McGraw's "offer" to purchase the preferred stock for $70.00 per share, an amount far less than the $260.31 value per share provided by the Articles of Incorporation plus the unpaid dividends of $104.15 per share, which totaled $364.46 value per share of preferred stock. This price of $70.00 per share was also much less than the appraised fair market value of $128.35 per preferred share calculated by Willamette in its latest draft report. As part of the same transaction, Sydnor retained his common shares in the company, exchanged a note for additional common shares, and received several stock options, resulting in his ownership of approximately twenty-five percent of the recapitalized company. Sydnor also obtained a three-year employment contract and other benefits to the detriment of the preferred shareholders.² "Fisketjon agreed to sell his common stock to . . . McGraw for a total value of approximately $584,387.02 or $66.23 per common share." (J.A. at 141.)

N. Glenn Smith was an employee with McGraw from October 1968 until December 1997. On February 16, 1998, Smith submitted his distribution request and pursuant to his election, received a cash distribution in March 1998 of $24,893.88, representing the value of his 401(k) account. On April 22, 1998, Smith brought suit against Sydnor and McGraw, alleging, inter alia, that they breached their fiduciary duties to participants in the 401(k) Plan. After Sydnor and McGraw filed Rule 12(b)(6) motions to dismiss, Smith moved for leave to file an amended complaint. At a hearing on Sydnor's and McGraw's motions to dismiss, the district court granted Smith's unobjected-to motion to amend his complaint. Smith filed an amended complaint on behalf of himself and employees and former employees of McGraw who were beneficial owners of shares of preferred stock of McGraw pursuant to the ESOP and on behalf of the 401(k) Plan.

Count One of the amended complaint alleged that Sydnor and McGraw breached their fiduciary duties as trustees for the 401(k) Plan in violation of ERISA §§ 404 and 406, 29 U.S.C.A. §§ 1104 and 1106, respectively,³ by (1) selling the preferred stock at a grossly undervalued price and engaging in self-dealing conduct throughout the transactions to the detriment of the Plan participants and beneficiaries; (2) failing to employ the appropriate methods to investigate the investment, and, thus, failing to act with the care and skill of a prudent person; (3) causing the 401(k) Plan to sell its assets to a party in interest; (4) dealing with the 401(k) Plan's assets in their own interest and/or for their own account; (5) acting in a capacity involving the 401(k) Plan on behalf of a party whose interests were adverse to the 401(k) Plan and its participants; and (6) receiving consideration for their own personal account from CNC (and from CNC and/or McGraw in Sydnor's case) in connection with a transaction involving 401(k) Plan assets. Count Two alleged that McGraw failed to discharge its duties as a co-fiduciary with respect to the 401(k) Plan in violation of ERISA § 405, 29 U.S.C.A. § 1105,⁴ by (1) participating in and/or concealing Sydnor's numerous breaches of fiduciary duty, (2) failing to take reasonable efforts to remedy Sydnor's numerous breaches, and (3) failing to fulfill its own fiduciary duties under 29 U.S.C.A. § 1104(a)(1). Count Three alleged ultra vires conduct by McGraw. Count Four alleged breach of contract by McGraw. Pursuant to ERISA §§ 409 and 502, 29 U.S.C.A.§§ 1109 and 1132, respectively,⁵ the amended complaint sought damages in the amount of $1,303,623.50 plus unpaid dividends on behalf of the plaintiff class.

On July 21, 1998, the district court issued a Memorandum...