Opinion ID: 747621
Heading Depth: 2
Heading Rank: 1

Heading: Background--Plaintiffs

Text: 5 In the mid-1960s, it appears, the City of Louisville established a pension system for its police officers. The system, which is operated by a governing body commonly referred to as the board of trustees, is funded with appropriations from the city and with contributions from participating police officers. 6 The trustees of the pension fund engaged Stock Yards Bank & Trust Co. to manage a portion of the fund's assets. In 1977 plaintiff R. Keith Cullinan, who was employed by the bank as a trust officer for a number of years, 1 was placed in charge of investing these holdings. 7 Since January of 1990 Mr. Cullinan has been the president and chief executive officer of plaintiff Cullinan Associates, Inc., an investment management firm of which Mr. Cullinan is a shareholder. Through Cullinan Associates he has continued to manage a portion of the police pension fund's assets. Cullinan Associates is compensated for its services by fees that are generally set as a percentage of the assets under its management. 8 In his work for the pension fund, both as an employee of the bank and as an employee of Cullinan Associates, Mr. Cullinan has made extensive use of a technique known as covered call option writing. A call option is a contract that gives the purchaser of the option the right to buy shares of stock in a specified company at a specified price within a specified period of time. If the market price of the stock fails to rise above the specified price before the option has expired, the holder of the option will have no incentive to exercise the call, and the seller (or writer) of the option will get to keep the premium paid by the purchaser without having to part with any shares of stock. If the market price of the stock does rise above the price specified in the option, on the other hand, the holder of the option can be expected to exercise the call--and the writer of the option, while still retaining the premium, will have to part with the stock for less than its current worth. 2 9 If the writer of the option does not already own the stock--if the option is naked, in the argot of the trade--the writer will have to buy shares on the open market in the event of a call. But the option writer need not buy shares if the option is covered; the writer of a covered option can meet the call with stock the writer already owns. The writing of covered options is thus considered more conservative than the writing of naked options. 10 Both techniques generate brokerage commissions that would not have to be paid if the options were not written. Stockbrokers benefit from option writing whether share prices rise, fall, or stay the same. If the market price of a security on which options have been written does not rise too much during the option period, the writer of the option likewise stands to benefit. 11 Although views differ as to the extent to which option writing makes sense from the option writer's standpoint, a majority of the members of the board of trustees of the police pension fund appear to have been well satisfied with the performance of the portion of the assets managed by Mr. Cullinan. A study conducted by a brokerage firm in March of 1988 showed that over the preceding ten years the assets managed by Mr. Cullinan produced an annual return of 14.75%. Another brokerage firm calculated that the return had been 15.01% per annum. The net return for 1992 was 11.5%, and for 1993 it was 13.2%. The record does not disclose what the returns would have been had Mr. Cullinan made the same stock selections without employing the covered option writing technique, 3 but the Cullinan affidavit says that during 1992 and 1993 the police pension fund made profits of $2,397,680 on covered call options that expired without having been exercised. 12 In addition to managing assets for the police officers' pension fund, Mr. Cullinan provided investment management services to the Louisville Firefighters' Pension Fund during a period that began in 1978 and ended in August of 1986. He used the covered call option writing technique for the firefighters' assets as well. The record does not disclose what percentage of the fund's total assets he managed, but Stock Yards Bank received more than half the city's 1985 contribution to the firefighters' fund. For the five years ended March 31, 1985, we are told, the performance of the total portfolio of the firefighters' fund was ranked near the top of a group of 100 comparable funds.