T.C. Memo. 1999-369

UNITED STATES TAX COURT

WESTCHESTER PLASTIC SURGICAL ASSOCIATES, P.C., Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 13073-97R. Filed November 5, 1999. 

Andrew I. Panken and Robert A. DeVellis, for petitioner.

Mark L. Hulse and Catherine R. Chastanet, for respondent.

MEMORANDUM OPINION

HAMBLEN, Judge: This is an action for a declaratory

judgment regarding the qualification of petitioner's defined

benefit plan and trust. This case was submitted on the

administrative record, pursuant to Rule 217. Unless otherwise

indicated, all section references are to the Internal Revenue
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1Petitioner also has a Money Purchase Pension Plan which it

adopted effective as of Jan. 15, 1972. We note that throughout

both petitioner's and respondent's briefs, both petitioner and

respondent refer to the Defined Benefit Plan and the Money

Purchase Plan as if they were one plan. However, we note that

there are two separate plans: The Defined Benefit Plan and the

Money Purchase Pension Plan. See Morrissey v. Commissioner, T.C.

Memo. 1998-443. Since the petition addresses only the Defined

Benefit Plan and attaches only the Nonqualification Letter for

the Defined Benefit Plan and since the administrative record

contains only the Nonqualification Letter for the Defined Benefit

Plan, we will address only the qualification of the Defined

Benefit Plan. 

Code, and all Rule references are to the Tax Court Rules of

Practice and Procedure. 

On April 3, 1997, respondent issued a final nonqualification

letter to petitioner stating that the Westchester Plastic

Surgical Associates Defined Benefit Plan (the Defined Benefit

Plan) failed to meet the requirements of section 401(a) for the

plan years ending October 31, 1990, and thereafter, and that its

related trust (the Trust) was not tax exempt under section 501(a)

for trust years ending with or within the affected plan years. 

Respondent also revoked the prior favorable determination letter

to petitioner dated December 5, 1988.

The issue for decision is whether petitioner's Defined

Benefit Plan violated the exclusive benefit rule under section

401(a)(2).1
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Background

Petitioner was a corporation existing under the laws of the

State of New York. At the time of the filing of its petition in

this case, petitioner's address was P.O. Box 852, Southampton,

New York. Michael Morrissey (Morrissey) was the owner of all of

the outstanding shares of petitioner's stock from 1972 through

the years in issue. Morrissey was also the president and

secretary of petitioner from inception. 

Petitioner adopted the Defined Benefit Plan effective as of

November 1, 1976. The Defined Benefit Plan received a favorable

determination letter from the Internal Revenue Service dated

December 5, 1988. Since its inception, Morrissey has always been

the sole trustee of the Trust and as such has exercised complete

control over the management and disposition of the Defined

Benefit Plan assets. 

The Defined Benefit Plan ceased benefit accruals in 1990, 

at which time all plan participants were 100 percent vested. The

Defined Benefit Plan terminated pursuant to a resolution of

petitioner's board of directors dated September 4, 1990, and

effective September 26, 1990. When the Defined Benefit Plan

ceased benefit accruals and terminated in 1990, there were two

participants in addition to Morrissey. These two participants

were paid their full benefits in 1990 when the Defined Benefit

Plan terminated. With the payout to these two participants in
- 4 -

2We note that the administrative record contains an

Agreement only for the Trust and not for the Defined Benefit Plan

itself. According to this Agreement, "this Trust * * * forms

part of a Pension Plan of the Employer". Consequently, we find

the Defined Benefit Plan incorporates the Trust.

1990, Morrissey became the sole remaining participant of the

Defined Benefit Plan. 

Under the Agreement for the Trust,2 dated October 25, 1977,

effective November 1, 1976, section 7.01(o) provides that the

trustees shall have the power with respect to the Trust: 

To lend money to a Participant at the then current

rates of interest being charged by commercial banks for

similar loans, in an amount not exceeding the value of such

Participant's Accrued Benefit and all such loans to the

extent they are secured only by the Participant's vested

Accrued Benefit shall be repaid within two (2) years from

the date of such loan. Any loans made pursuant to this subparagraph to the extent they are not secured by the

Participant's vested Accrued Benefit shall be otherwise

adequately secured.

Under the second amendment, effective November 1, 1976, section

7.01(o) was amended to read as follows: 

To lend money to a Participant at the then current

rates of interest being charged by commercial banks for

similar loans, in an amount not exceeding the value of such

Participant's Accrued Benefit, and all such loans to the

extent they are secured only by the Participant's vested

Accrued Benefit shall be repaid within seven (7) years from

the date of such loan. Any loans made pursuant to this subparagraph to the extent they are not secured by the

Participant's vested Accrued Benefit shall be otherwise

adequately secured.

From February 8, 1984, through December 9, 1988, Morrissey,

as trustee of the Defined Benefit Plan, made a series of six
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loans to himself: On February 8, 1984, Morrissey as trustee of

the Defined Benefit Plan executed an installment note whereby the

Defined Benefit Plan lent $13,000 of plan assets to Morrissey at

a rate of interest of 11 percent. On August 27, 1985, Morrissey

as trustee of the Defined Benefit Plan executed an installment

note whereby the Defined Benefit Plan lent $50,000 of plan assets

to Morrissey at a rate of interest of 12 percent. On December 3,

1985, Morrissey as trustee of the Defined Benefit Plan executed

an installment note whereby the Defined Benefit Plan lent $5,500

of plan assets to Morrissey at a rate of interest of 10 percent.

On January 3, 1986, Morrissey as trustee of the Defined Benefit

Plan executed an installment note whereby the Defined Benefit

Plan lent $14,500 of the plan assets to Morrissey at a rate of

interest of 10.5 percent. On February 12, 1988, Morrissey as

trustee of the Defined Benefit Plan executed an installment note

whereby the Defined Benefit Plan lent $20,000 of plan assets to

Morrissey at a rate of interest of 9.75 percent. On December 9,

1988, Morrissey as trustee of the Defined Benefit Plan executed

an installment note whereby the Defined Benefit Plan lent $2,000

of plan assets to Morrissey at a rate of interest of 11.5

percent. 

According to the administrative record provided in this case

the six loans and their interest rates were as follows:
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 Date of Loan Obligee Loan Amount Interest Rate

 

2/8/84 Defined Benefit Plan $13,000 11%

8/27/85 Defined Benefit Plan 50,000 12

12/3/85 Defined Benefit Plan 5,500 10

1/3/86 Defined Benefit Plan 14,500 10.5

2/12/88 Defined Benefit Plan 20,000 9.75

12/9/88 Defined Benefit Plan 2,000 11.5

 Total 105,000

These six notes all fail to state when payments are due or

when repayments should be made. None of the six installment

notes require Morrissey to provide security or collateral for the

loans. None of the installment notes state a maturity date. 

The administrative record provided in this case contains no

evidence that Morrissey made any repayments on any of the six

loans from the Defined Benefit Plan, and we so find. In

Morrissey v. Commissioner, T.C. Memo. 1998-443, we found that on

October 19, 1990, Morrissey transferred to the Money Purchase

Plan his 50-percent interest in two parcels of unencumbered real

estate sited in Southampton, New York. We stated: "The record

does not show that * * * [Morrissey] ever transferred any asset

to the * * * [Defined Benefit Plan] in repayment of moneys that

he borrowed from it." We also stated: "Indeed, it appears that

* * * [Morrissey] continues to owe the * * * [Defined Benefit

Plan] the money (with interest) that it lent to him because he
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3The Form 5500 is the Annual Return/Report that must be

completed for Employee Benefit Plans.

has never transferred any value to the * * * [Defined Benefit

Plan] to repay these amounts."

Morrissey signed a form titled "Employee's Waiver of Portion

of Benefit Not Funded Upon Distribution of Plan's Assets Pursuant

to Plan Termination Effective: September 26, 1990," in which he

waived his right to any unfunded benefits, to the extent that the

Defined Benefit Plan assets were insufficient to provide the

actuarial equivalent of his normal retirement benefit on the date

of benefit distributions. This form states, in pertinent part:

I. The undersigned, a Participant in the captioned 

Plan, hereby agrees that, to the extent Plan 

assets as of the date of benefit distributions 

are insufficient to provide (on a lump sum basis) 

the actuarial equivalent of said Participant's 

normal retirement benefit entitlement, the said 

Participant waives his right to any portion of 

said benefit not funded as of such date.

For the plan year ending October 31, 1989, the Form 55003

for the Defined Benefit Plan reports total plan assets as of the

beginning of the plan year of $179,296 and $191,680 at the end of

the plan year. In addition, the Form 5500 reports $129,031 as

"any loan or extension of credit by the plan to the employer, any

fiduciary, any of the five most highly paid employees of the

employer, any owner of a 10% or more interest in the employer, or

relatives of any such persons." Furthermore, the Form 5500
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4The Schedule B contains Actuarial Information for the

Employee Benefit Plan and is attached to the Form 5500.

5$368,279 - $188,983 = $179,296.

6Funding standard account statement for plan year ending

Oct. 31, 1989:

Charges to funding standard account:

Prior year funding deficiency $188,983

Employer's normal cost for plan 

 year as of 11/1/88 25,643

Interest 17,170

Total charges 231,796

Credits to funding standard account: -0- 

Funding deficiency 231,796

reports that the employer owes $231,796 in contributions to the

plan which are more than 3 months overdue. 

The Schedule B4 of Form 5500 for the Defined Benefit Plan

for the plan year ended October 31, 1989, reports the current

value of the assets accumulated in the Defined Benefit Plan as of

the beginning of the plan year as $368,279, which includes a

prior year funding deficiency of $188,983.5 In addition, the

Schedule B reports the total present value of vested benefits as

of the end of the plan year for participants as $335,384. 

Furthermore, the amount of contribution certified by the actuary

as necessary to reduce the funding deficiency to zero is

$231,796.6 
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7This $423,476 includes the prior year funding deficiency of

$231,796. $423,476 - $231,796 = $191,680.

The Form 5500 for the Defined Benefit Plan for the plan year

ended October 31, 1990, reports that the Defined Benefit Plan was

terminated during this plan year, that a termination resolution

was adopted this plan year, and that no trust assets reverted to

the employer. It further reports that there was $257,639 of

contributions that was more than 3 months due. In addition, it

reports the following information:

Assets Beginning of year End of year

Cash $646 $2,295

Receivables 38,922 40,063

Investments

 Real estate and mortgages -0- 137,270

 Loans to participants:

Mortgages -0- -0-

Other 152,112 -0- 

 Total investments 152,112 137,270

Total assets 191,680 179,628

 Liabilities

Total liabilities -0- -0- 

Net assets 191,680 179,628

The Form 5500 also reports expenses of $20,653 which represented

distribution of benefits directly to participants.

The Schedule B for the year ended October 31, 1990, reports

$423,4767 as the current value of assets accumulated as of the

beginning of the year. It reports $341,583 in total vested

benefits, $9,900 to one terminated participant, and $331,683 to
- 10 -

8Funding standard account statement for plan year ending

Oct. 31, 1990:

Charges to funding standard account:

Prior year funding deficiency $231,796

Employer's normal cost 554

Interest 18,588

Addtl. interest due to late

 contributions 6,701

Total charges 257,639

Credits to funding standard account -0- 

Funding deficiency 257,639

two active participants. It further reports no contributions

made to the Defined Benefit Plan by the employer. In addition,

the Schedule B reports $257,6398 as the contribution necessary to

reduce the funding deficiency.

The Form 5500 for the Defined Benefit Plan for the plan year

ended October 31, 1991, reports total plan assets of $179,628 at

the beginning of the plan year and $171,003 in plan assets at the

end of the plan year. It further reports plan income of -$8,625. 

In addition, it reports that the plan at any time held 20 percent 

or more of its assets in any single security, debt, mortgage,

parcel of real estate, or partnership/joint venture interests and

that the dollar amount was $124,021. 

The activity in petitioner's Defined Benefit Plan Trust

account at the Bank of New York for account No. 015-268675 was as

follows:
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Date Withdrawal Deposit Balance

8/27/85 $1,333.20 --- $53,352.07

8/27/85 50,000.00 --- 3,352.07

10/15/85 --- $1,127.20 4,479.27

11/25/85 --- 1,333.20 5,812.47

12/03/85 5,500.00 673.91 986.38

1/13/86 14,500.00 13,654.49 140.87

4/14/86 --- 1,059.80 1,200.67

10/07/86 3.00 1,028.36 2,226.03

1/14/87 --- 20,903.40 23,129.43

2/12/88 20,000.00 1,146.72 4,276.15

12/9/88 2,000.00 282.64 2,558.79

 1 2,000.00 --- 558.79

1We are unable to decipher this date from the record, and it

is immaterial to the outcome of this case.

The activity in petitioner's Defined Benefit Plan Trust

account at the Bank of New York for account No. 015-283294 was as

follows:

Date Withdrawal Deposit Balance

7/31/90 $671.18 $671.18

8/16/90 1,600.00 2,271.18

4/04/91 74.20 2,345.38

Discussion

This Court may exercise jurisdiction over a declaratory

judgment action if there is an actual controversy involving a

determination by the Secretary with respect to the initial or

continuing qualification of a retirement plan. See sec. 7476(a);

Loftus v. Commissioner, 90 T.C. 845, 855 (1988), affd. without

published opinion 872 F.2d 1021 (2d Cir. 1989).
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9Respondent seems to think that the Defined Benefit Plan and

the Money Purchase Plan are one plan, as it appears respondent

has combined the loans from both plans. See supra note 1. We

previously found that from Nov. 14, 1979, to Feb. 17, 1989, the

Defined Benefit Plan and Money Purchase Plan made 23 loans to

Morrissey. See Morrissey v. Commissioner, T.C. Memo. 1998-443. 

In addition, we previously found that Morrissey transferred to

the Money Purchase Plan his 50-percent interest in two parcels of

unencumbered real estate and that he never transferred any value

to the Defined Benefit Plan to repay his loans from the Defined

Benefit Plan assets. See id.

Petitioner contends that the Defined Benefit Plan did not

violate the exclusive benefit rule and therefore should remain

qualified. Respondent contends that the Defined Benefit Plan is

not a qualified plan within the meaning of section 401(a) for

plan year ended October 31, 1990, and thereafter because its

investments and Morrissey's transfer of real property, on October

19, 1990, in an attempt to repay loans to him, violated the

exclusive benefit requirement. Specifically, respondent contends

that the Defined Benefit Plan failed to satisfy the exclusive

benefit rule by investing almost all of its assets in 23 loans to

the plan trustee.9

Section 404(a)(1)(A) provides that contributions to a

pension trust are deductible by the employer if the trust is

exempt from tax under section 501(a). In order for the trust to

be entitled to tax-exempt status under section 501(a), a

retirement plan must be established by an employer and meet all

the requirements of section 401(a). See Professional & Executive
- 13 -

10Sec. 401(a) provides, in pertinent part, as follows:

SEC. 401(a). Requirements for Qualification.--A trust

created or organized in the United States and forming part

of a stock bonus, pension, or profit-sharing plan of an

employer for the exclusive benefit of his employees or their

beneficiaries shall constitute a qualified trust under this

section--

 * * * * * * *

(2) if under the trust instrument it is

impossible, at any time prior to the satisfaction of

all liabilities with respect to employees and their

beneficiaries under the trust, for any part of the

corpus or income to be * * * used for, or diverted to,

purposes other than for the exclusive benefit of his

employees or their beneficiaries * * *

Leasing, Inc. v. Commissioner, 89 T.C. 225, 230 (1987), affd. 862

F.2d 751 (9th Cir. 1988). In determining whether a plan is

qualified under section 401(a), the operation of the trust is

relevant as are its terms. See Winger's Depart. Store, Inc. v.

Commissioner, 82 T.C. 869, 876 (1984); Quality Brands, Inc. v.

Commissioner, 67 T.C. 167, 174 (1976); see also sec. 1.401-

1(b)(3), Income Tax Regs.

Section 401(a)(2)10 provides that for a trust forming part

of an employer's pension plan to be exempt, it must be

impossible, at any time before the satisfaction of all

liabilities with respect to the employer's employees and their

beneficiaries under the trust, for any part of the corpus or

income to be used for, or diverted to, purposes other than for

the exclusive benefit of those employees or beneficiaries. 
- 14 -

"[T]he phrase 'purposes other than for the exclusive benefit of

his employees or their beneficiaries' includes all objects or

aims not solely designed for the proper satisfaction of all

liabilities to employees or their beneficiaries covered by the

trust." Sec. 1.401-2(a)(3), Income Tax Regs. 

Petitioner contends that, with Morrissey as the sole trustee

and sole participant of the Defined Benefit Plan since 1990,

there is no violation of the exclusive benefit rule. In support

of its contention, petitioner asserts that two of three Defined

Benefit Plan participants were paid their benefits in full in

1990. Thus, petitioner asserts that the sole remaining

participant, Morrissey, controls the Defined Benefit Plan and his

retirement and could arrange for the plan to have liquid assets

by repaying the loans to him at any time since he had assets with

which to accomplish this. 

In addition, petitioner contends that the prudent investor

rules, a safe harbor when dealing with the exclusive benefit

issue, have not been violated. In support of its contention,

petitioner asserts that Morrissey, the trustee, weighed the risks

and benefits of making loans to Morrissey, the individual. 

Petitioner further asserts that if the loans turned out to be a

bad investment for the Defined Benefit Plan, the only party who

is harmed is Morrissey, the sole remaining Defined Benefit Plan

participant. Accordingly, petitioner contends that Morrissey,
- 15 -

11We note that many of petitioner's contentions apply to the

Money Purchase Plan and not to the Defined Benefit Plan. See

supra note 1. Morrissey transferred nothing of value to the

Defined Benefit Plan. 

the trustee, after weighing the risks and benefits, was entitled

to have the trust make loans to Morrissey, as evidenced by

promissory notes, without violating fiduciary standards. 

Petitioner also maintains that the notes included a

reasonable rate of interest and that Morrissey, at the time the

loans were made, had the ability to repay. Petitioner further

maintains that when his economic situation changed, he repaid the

loans with real estate instead of cash. Consequently, petitioner

contends that since Morrissey, as of 1990, was not of retirement

age, it is premature to conclude that as of that date, the trust

would not have funds available for distribution to him upon his

retirement. Petitioner asserts that the real property interests

transferred into the Money Purchase Plan and the Defined Benefit

Plan as repayment of the loans have markedly appreciated in value

to the point where it is reasonable to conclude that the

investments were in fact prudent. Petitioner further asserts

that a simple refinancing of the property could have provided for

both liquidity and diversity whenever Morrissey chose to do so.11

Respondent contends that the investments in the 23 loans

failed to provide the Defined Benefit Plan with a fair rate of

return, sufficient liquidity, adequate security, and diversity of
- 16 -

12Again, we note that respondent has combined the Money

Purchase Plan and the Defined Benefit Plan, as we have previously

found that Morrissey made a series of six loans to himself from

the Defined Benefit Plan assets. 

investments. Respondent further contends that the 23 loans were

not isolated incidents but reflected an investment policy

benefiting the plan trustee as an individual. Additionally,

respondent contends that the 23 loans did not comply with the

Defined Benefit Plan provisions.12

Whether a plan has been operated for the exclusive benefit

of employees and their beneficiaries is determined on the basis

of the facts and circumstances. See Feroleto Steel Co. v.

Commissioner, 69 T.C. 97, 107 (1977); sec. 1.401-1(b)(3), Income

Tax Regs.; see also Bernard McMenamy, Contractor, Inc. v.

Commissioner, 442 F.2d 359 (8th Cir. 1971), affg. 54 T.C. 1057

(1970); Time Oil Co. v. Commissioner, 258 F.2d 237, 238-239 (9th

Cir. 1958), remanding 26 T.C. 1061 (1956). If a violation of the

exclusive benefit rule is found, then we look to the totality of

the transgressions that occurred in assessing whether it is an

abuse of discretion for the Commissioner to disqualify the plan. 

The discretion to disqualify a plan should be exercised with

restraint, however, because the Department of Labor and the

Internal Revenue Service have a broad range of alternative

remedies available to ensure that a trust is properly
- 17 -

administered. See Winger's Depart. Store, Inc. v. Commissioner,

supra at 887-888.

We previously have held that the standards for fiduciary

behavior set forth in the Employee Retirement Income Security Act

of 1974 (ERISA), Pub. L. 93-406, sec. 404(a)(1), 88 Stat. 877,

current version at 29 U.S.C. sec. 1104 (1994), may be used to

help determine whether the exclusive benefit rule has been

violated. See Ada Orthopedic, Inc. v. Commissioner, T.C. Memo.

1994-606; see also Calfee, Halter & Griswold v. Commissioner, 88

T.C. 641, 652 (1987) ("the standards of title I and title II [of

ERISA] were closely coordinated by Congress specifically to

develop a unified set of rules"). ERISA section 404(a)(1)

requires a plan fiduciary to discharge his or her duties for the

exclusive purpose of (1) providing benefits to participants and

their beneficiaries and (2) defraying reasonable expenses of

administering the plan. Additionally, the fiduciary must (1)

perform those duties with the care, skill, prudence, and

diligence under the circumstances then prevailing that a prudent

investor acting in a like capacity and familiar with such matters

would use in the conduct of an enterprise of a like character and

with like aims, (2) diversify investments to minimize the risk of

large losses, unless diversification clearly is not prudent under

the circumstances, and (3) discharge those duties in accordance

with the documents and instruments governing the plan to the
- 18 -

13The quoted material from H. Rept. 93-533, at 12 (1973),

1974-3 C.B. 210, 221, describes H.R. 2, 93d Cong., 2d Sess. sec.

111(b)(1) (1974), as reported by the House Committee on Education

and Labor, on Oct. 2, 1973, which became ERISA sec. 404(a)(1).

extent they are consistent with the provisions of ERISA title I. 

See id. The legislative history of ERISA section 404(a),

however, cautions: "It is expected that courts will interpret

the prudent man rule and other fiduciary standards bearing in

mind the special nature and purposes of employee benefit plans

intended to be effectuated by the Act." H. Rept. 93-533, at 12

(1973), 1974-3 C.B. 210, 221.13 Thus, we must "recognize that a

fiduciary's duties are circumscribed by Congress' overriding goal

of ensuring 'the soundness and stability of plans with respect to

adequate funds to pay promised benefits.'" Acosta v. Pacific

Enters., 950 F.2d 611, 618 (9th Cir. 1991) (quoting 29 U.S.C.

sec. 1001 (1988)).

The Department of Labor regulations state that a fiduciary

will satisfy the prudent investor requirements of ERISA section

404(a)(1)(B) if the fiduciary (i) gives appropriate consideration

to the relevant facts and circumstances of the investment or

investment course of action and (ii) acts accordingly. See 29

C.F.R. sec. 2550.404a-1(b)(1) (1997). Pursuant to those

regulations, "appropriate consideration" shall include, but is

not necessarily limited to:
- 19 -

(i) A determination by the fiduciary that the

particular investment or investment course of action is

reasonably designed, as part of the portfolio * * *, to

further the purposes of the plan, taking into consideration

the risk of loss and the opportunity for gain (or other

return) associated with the investment or investment course

of action, and

(ii) Consideration of the following factors * * *

(A) The composition of the portfolio with regard

to diversification;

(B) The liquidity and current return of the

portfolio relative to the anticipated cash flow

requirements of the plan; and

(C) The projected return of the portfolio

relative to the funding objectives of the plan. 

29 C.F.R. sec. 2550.404a-1(b)(2).

The Department of Labor requirements appear consistent with

criteria set forth by the Commissioner in Rev. Rul. 69-494, 1969-

2 C.B. 88, for testing compliance with the exclusive benefit

requirement of section 401(a)(2). Those criteria are: (1) Cost

must not exceed fair market value at the time of purchase; (2) a

fair return commensurate with the prevailing rate must be

provided; (3) sufficient liquidity must be maintained to permit

distributions in accordance with the terms of the plan; and (4)

the safeguards and diversity that a prudent investor would adhere

to must be present. We previously have indicated that the

criteria listed in Rev. Rul. 69-494, supra, although not binding

on the Court, are relevant to a determination as to whether the

prudent investor requirements have been satisfied. See Winger's
- 20 -

Depart. Store, Inc. v. Commissioner, 82 T.C. 869 (1984); Feroleto

Steel Co. v. Commissioner, supra; see also Ada Orthopedic, Inc.

v. Commissioner, supra.

Additionally, in applying the prudent investor rule, it has

been stated:

Under ERISA, as well as at common law, courts have focused

the inquiry under the "prudent man" rule on a review of the

fiduciary's independent investigation of the merits of a

particular investment, rather than on an evaluation of the

merits alone. As a leading commentator puts it, "the test

of prudence--the Prudent Man Rule--is one of conduct, and

not a test of the result of performance of the investment. 

The focus of the inquiry is how the fiduciary acted in his

selection of the investment, and not whether his investments

succeeded or failed." In addition, the prudent man rule as

codified in ERISA is a flexible standard: the adequacy of a

fiduciary's investigation is to be evaluated in light of the

"character and aims" of the particular type of plan he

serves. [Donovan v. Cunningham, 716 F.2d 1455, 1467 (5th

Cir. 1983); fn. ref. omitted; citations omitted.]

Thus, the ultimate outcome of an investment is not proof that the

investment failed to meet the prudent investor rule. See

DeBruyne v. Equitable Life Assur. Socy. of U.S., 920 F.2d 457,

465 (7th Cir. 1990); see also Norton Bankruptcy Law and Practice

2d, sec. 156:9 (1997-98).

By examining the totality of transgressions that Morrissey

committed, we can assess whether it was an abuse of discretion

for respondent to disqualify the Defined Benefit Plan. 

Morrissey, as sole shareholder of petitioner--the plan sponsor--

failed to make required contributions to the Defined Benefit

Plan. For the plan year ended October 31, 1989, the Schedule B
- 21 -

of Form 5500 reports the total present value of vested benefits

for participants as of the end of the plan year as $335,384. 

Moreover, the Form 5500 reports that petitioner owes $231,796 in

contributions which are more than 3 months overdue. Thus, the

contributions petitioner owes to the Defined Benefit Plan

represent more than two-thirds of the participants' vested

benefits. For the plan year ended October 31, 1990, the Schedule

B of Form 5500 reports the total present value of vested benefits

for participants as of the end of the plan year as $341,583. In

addition, the Form 5500 reports $257,639 in contributions that

petitioner owes the trust which are more than 3 months overdue. 

Thus, the contributions petitioner owes to the Defined Benefit

Plan represent 75 percent of the participants' vested benefits. 

For the plan years ended October 31, 1988, 1989, and 1990,

petitioner owed contributions to the Defined Benefit Plan of

$188,983, $231,796, and $257,639, respectively. This pattern of

increasing overdue contributions each plan year shows that

petitioner was consistently not making contributions to the

Defined Benefit Plan even though the participants' vested

benefits were increasing. Moreover, on this record petitioner

has not shown that it refrained from taking deductions for

contributions to the Defined Benefit Plan which it was not

making. The problem is thus exacerbated.
- 22 -

Morrissey essentially used the Defined Benefit Plan as a

checking account, on which interest accumulated tax free, and not

as a retirement vehicle. From February 8, 1984, through December

9, 1988, Morrissey, as trustee of the Defined Benefit Plan, made

a series of six loans from the Defined Benefit Plan assets to

himself, for a total of $105,000. The Forms 5500 for the plan

years ended October 31, 1989 and 1990, report loans as of the

beginning of each plan year of $129,031 and $152,112,

respectively. The six notes all fail to state when payments are

due or when repayments should be made. Furthermore, none of the

six installment notes require Morrissey to provide security or

collateral for the loans. Additionally, none of the installment

notes state maturity dates. 

It is clear from examining the activity in the Trust account

at the Bank of New York that Morrissey was using the Defined

Benefit Plan as a checking account for his personal needs rather

than as a retirement plan for the exclusive benefit of

petitioner's employees and beneficiaries. From February 8, 1984,

through December 9, 1988, Morrissey repeatedly took loans from

the Defined Benefit Plan leaving minimal cash balances. From

February 12, 1988, forward the cash balance in the Defined

Benefit Plan Trust account was less than $5,000, even though the

vested benefits of participants as of the end of the plan years

ended October 31, 1989 and 1990, were $335,384 and $341,583,
- 23 -

respectively. This repeated taking of loans from the Defined

Benefit Plan and leaving minimal cash balances in the Trust

account was clearly imprudent and contrary to the purpose of

ERISA. The purpose of ERISA was not to establish a tax-exempt

pocketbook for Morrissey.

Morrissey made no repayments on any of the six loans from

the Defined Benefit Plan. The Form 5500 for the plan year ended

October 31, 1990, reports total plan assets of $191,680 as of the

beginning of the plan year, including $152,112 in loans to

Morrissey and $646 in cash. Furthermore, it reports total plan

assets of $179,628 as of the end of the plan year, including

$137,270 in real estate and mortgages and $2,295 in cash. The

Form 5500 seems to suggest that Morrissey repaid all or part of

the $152,112 in loans that he owed to the Defined Benefit Plan

with $137,270 in real estate. However, we previously found that

Morrissey transferred his 50-percent interest in two parcels of

unencumbered real estate to the Money Purchase Plan and that he

never transferred any value to the Defined Benefit Plan to repay

his loans from the Defined Benefit Plan assets. See Morrissey v.

Commissioner, T.C. Memo. 1998-443. Moreover, the administrative

record contains no deeds or other evidence that any real estate

was transferred to the Defined Benefit Plan. Consequently, even

though the Form 5500 reports that the Defined Benefit Plan holds
- 24 -

$137,270 in real estate at the end of the plan year, we find that

Morrissey transferred no real estate to the Defined Benefit Plan.

Neither interest nor principal payments were ever made to

the Defined Benefit Plan. As trustee of the Defined Benefit

Plan, Morrissey made no attempt to collect any of the outstanding

six loans. Rather than collecting on the loans, Morrissey signed

a form titled "Employee's Waiver of Portion of Benefit Not Funded

Upon Distribution of Plan's Assets Pursuant to Plan Termination

Effective: September 26, 1990", in which he waived his right to

any unfunded benefits, to the extent that the Defined Benefit

Plan assets were insufficient to provide the actuarial equivalent

of his normal retirement benefit on the date of benefit

distributions. Consequently, Morrissey never paid any interest

or principal on the loans, and when he terminated the Defined

Benefit Plan, he intended not to repay his obligation to the

Defined Benefit Plan. It was inconsistent with the prudent

investor rule for the Defined Benefit Plan to have made those

loans and then to have allowed them to remain outstanding under

the circumstances. The purpose of ERISA is to provide retirement

benefits, not to provide a tax-free checking account to Morrissey

from which he can withdraw money at any time as loans and then

waive his obligation to repay. Morrissey's waiver of his rights

to any unfunded benefits, when most of his benefits under the

Defined Benefit Plan remained unfunded, coupled with the
- 25 -

termination of the Defined Benefit Plan, was contrary to the

purpose of ERISA.

In Winger's Depart. Store, Inc. v. Commissioner, 82 T.C. 869

(1984), the trustees of an employer-sponsored defined benefit

pension plan lent a major portion of the trust's assets to the

employer, through the employer's sole shareholder, to meet the

company's working capital needs. The loans were unsecured,

interest payments to the trust were delinquent, and most of the

principal was not repaid. The sole shareholder and his spouse

were cotrustees of the trust, and most of the benefits under the

plan accrued to the sole shareholder. We found that the trust

had not been operated for the exclusive benefit of the employees

and their beneficiaries, and we upheld the Commissioner's

determination that the related plan was no longer qualified under

section 401(a).

In Ada Orthopedic, Inc. v. Commissioner, T.C. Memo. 1994-

606, the trustees of an employer-sponsored defined benefit plan

lent a substantial portion of the plan's assets through unsecured

loans to participants, relatives, and friends of the trustees. 

Some of the loans were made or extended without written

promissory notes, and principal and interest remained unpaid on

some of the loans. In addition, the trust acquired real property

by unrecorded quitclaim deeds without investigating title and

subsequently lost that property upon foreclosure of preexisting
- 26 -

mortgages; the trust invested in a tax-shelter partnership in

which one of the trustees acquired three loose diamonds, the

largest of which could not be located; and the plan disbursed

plan assets to nonparticipants without explanation. We found

under those circumstances that the trust's investment practices

violated the exclusive benefit rule. Accordingly, we upheld the

Commissioner's determination that the plan was no longer

qualified.

In Shedco, Inc. v. Commissioner, T.C. Memo. 1998-295, the

trustee of an employer-sponsored defined benefit pension plan

lent $2,250,000, representing approximately 90 percent of the

plan's assets, through an unsecured loan to a construction

company in which the trustee had served as executive vice

president until his retirement. The proceeds from the loan were

used for general working capital needs, and when the loan was

made, the construction company could have obtained funds from

several other sources. The trustee did not consult with counsel

or with the plan's actuarial firm about making the loan before

the plan lent the money to the construction company. The

construction company agreed orally to make semiannual principal

payments on the note of $250,000 each. It made two such

payments, and it made monthly payments of interest in accordance

with the terms of the note until it encountered problems in

Arizona's real estate economy. The construction company's
- 27 -

inability to repay the loan resulted from a downturn in the real

estate market and not from impropriety on its part. We found

that although the loan failed to meet the prudent investor test,

it was an isolated violation of that test, did not exhibit

indifference to the continued well-being of the plan, and was not

an attempt to manipulate the plan's assets for the benefit of

persons other than the plan's beneficiaries. We therefore found

that the loan did not violate the exclusive benefit rule. 

Accordingly, we concluded that the extension of the loan did not

cause the plan to fail to satisfy the requirements of sections

401(a) and 501(a). 

Our examination of the facts in this case leaves no doubt

that the Defined Benefit Plan was not managed for the exclusive

benefit of the employees. While the detailed facts of this case

are not identical with those in Winger's Depart. Store, Inc. v.

Commissioner, supra, or in Ada Orthopedic, Inc. v. Commissioner,

supra, the ultimate thrust of those cases is equally applicable

here. The facts in Winger's and Ada Orthopedic reveal investment

philosophies that were not aimed primarily at providing benefits

for the employees and their beneficiaries in general but instead

were aimed at benefiting the plan sponsors or certain

individuals. Indeed, the investment practices in those cases

involved flagrant violations of the exclusive benefit rule.
- 28 -

There is no question but that improper trust administration

and investment policies may result in violations of the exclusive

benefit rule. See Winger's Depart. Store, Inc. v. Commissioner,

supra at 886. As in Winger's Depart. Store, Inc. v.

Commissioner, supra at 882, a major portion of the assets of

petitioner's pension trust was lent to Morrissey, petitioner's

sole shareholder and trustee of the Defined Benefit Plan. As in

Winger's Dept. Store, Inc. v. Commissioner, supra at 882, during

the years in issue, interest thereon not only was delinquent but

also was never paid, and all of the principal remains

outstanding. 

The instant case is distinguishable from Shedco, Inc. v.

Commissioner, supra. The loan in that case was sought because

the trustee believed it would be a good investment for the plan,

and not because he sought a benefit for himself (other than as a

beneficiary of the plan). The loan proceeds were not diverted

for the personal benefit of the plan trustee. Interest was

stated on the note at market rate, and payments were being made

until the construction company began to experience financial

difficulties. Moreover, the construction company's inability to

repay the loan resulted from a downturn in Arizona's real estate

market and not from impropriety on its part. 

In the instant case, Morrissey's notes were backed by

nothing more than Morrissey's vested Accrued Benefit. 
- 29 -

Furthermore, the loan proceeds flowed back to Morrissey. 

Moreover, neither interest nor principal payments were ever made

to the Defined Benefit Plan. Indeed, when the Defined Benefit

Plan was terminated, nothing of any value was transferred to the

Defined Benefit Plan. Rather, Morrissey signed a form titled

"Employee's Waiver of Portion of Benefit Not Funded Upon

Distribution of Plan's Assets Pursuant to Plan Termination

Effective: September 26, 1990", in which he waived his right to

any unfunded benefits, to the extent that the Defined Benefit

Plan assets were insufficient to provide the actuarial equivalent

of his normal retirement benefit on the date of benefit

distributions. By allowing himself to obtain loans from the

Defined Benefit Plan and then waiving his right to unfunded

benefits at termination, Morrissey used the Defined Benefit Plan

assets as a ready source of cash for his immediate personal needs

as opposed to income for retirement. 

In our opinion, the failure to make required contributions

owed to the Defined Benefit Plan, the lending of a large portion

of the Defined Benefit Plan's liquid assets through loans to the

trustee secured only by his vested Accrued Benefit, the failure

to pay any interest or repay the principal by the date of

termination of the Defined Benefit Plan, and the waiver by the

trustee of his right to any unfunded benefits combine to prove

that the Defined Benefit Plan was not managed for the exclusive
- 30 -

benefit of the employees, but for the immediate as opposed to the

retirement benefit of Morrissey. The Defined Benefit Plan was

used as a personal bank account by Morrissey for loans that were

made without regard to risk or prior repayment history. These

facts support respondent's disqualification of the Defined

Benefit Plan.

Also, and perhaps more important, our decision is based on a

determination that the entire investment philosophy of the

Defined Benefit Plan was aimed not at providing benefits for the

employees but at making capital available to Morrissey. The

manipulation of pension plan assets by a trustee who is also the

sole shareholder of the plan sponsor is a clear example of an

exclusive benefit rule violation. See Ada Orthopedic, Inc. v.

Commissioner, T.C. Memo. 1994-606.

In the instant case, we find the indifference toward the

continued well-being of the plan that we found in Winger's

Depart. Store, Inc. v. Commissioner, 82 T.C. 869 (1984), and Ada

Orthopedic, Inc. v. Commissioner, supra. Under the circumstances

of this case, we hold that, because petitioner's Defined Benefit

Plan did not operate for the exclusive benefit of employees for

the plan years ending October 31, 1990, and thereafter, it failed

to be qualified during those years under section 401(a) and hence

failed to satisfy the requirements of section 501(a) tax
- 31 -

exemption. Accordingly, respondent properly revoked the

qualified status of the Defined Benefit Plan. 

We have carefully considered all remaining arguments made by

the parties for holdings contrary to those expressed herein, and,

to the extent not discussed above, find them to be irrelevant or

without merit.

To reflect the foregoing,

Decision will be entered

for respondent.