Opinion ID: 1615949
Heading Depth: 1
Heading Rank: 1

Heading: Evidence as to Imprudence of Investments in the Equity Fund.

Text: In regard to the equity fund, the court found that the purchase of seventeen of the twenty-four designated equity fund securities had been imprudent. As to these seventeen securities, the court found it unnecessary to decide whether their sale was imprudent but did conclude that the sale of five of the remaining seven securities had been imprudent. Evidence was introduced showing that in 1973 the board of directors of First Alabama reduced to writing what it considered to be minimum standards of safety. Al Byrne, the vice president and senior trust officer of the bank admitted, however, that these standards were followed prior to 1973 as unwritten guidelines and were generally so followed at the time in which the sales and purchases in question were made. These standards were: (1) A rating of B + or better by the Standard and Poor ratings (S & P) (B + being an average rating and B being a speculative rating); (2) a minimum of 1,500,000 shares of stock in the hands of the public; and (3) annual sales of at least $100 million. Byrne testified that the bank generally invested in companies with at least ten years' experience in business and a record of increased earnings. He stated that the companies would generally be rated by one of the rating services. First Alabama claimed that the bank's minimum standards were primarily designed for individual trusts, rather than common trust funds, yet Byrne stated that when purchases were made for the two common funds, bank policy required that those minimum standards adopted by the bank be followed. Evidence was also presented showing that deviations were permitted from these standards adopted by the board of directors with the approval of the trust investment committee so as to accomplish its goals. The plaintiffs offered evidence that these standards had not been followed. For example, Associated Coca-Cola, Cox Broadcasting, Rust Craft Greeting Cards and Sealed Power were rated B + but failed to meet the Bank's requirement of one hundred million dollars in annual sales. In addition, the following stocks failed to meet the minimum requirement of a B + rating: American Garden Products; Ames Department Stores; Beverage Canners; CNA Financial; Elixir Industries; First Mortgage Investors; Hav-a-Tampa; Kinney Services; Loomis Corp.; Mortgage Associates; Transamerica Corp.; Universal Oil Products; and Wynn Oil Co. Dr. Robert Johnston, chairman of the finance faculty of the School of Business of George Mason University and expert witness for the plaintiffs, testified that First Alabama, as trustee, should have invested defensively. According to Johnston, a trustee should first provide for the safety of the principal and then obtain an adequate return. He based his conclusions upon a treatise by Dr. Benjamin Graham, which stated seven criteria for testing the safety of investments. These criteria were (1) a minimum of $100 million in annual sales; (2) a current ratio of at least two to one (current assets should be twice current liabilities); (3) a net working capital to long-term debt ratio of at least one to one (net working capital being current assets less current liabilities and long-term debt meaning obligations that mature in more than one year); (4) earnings stability (positive earnings for the last ten years); (5) a good dividend record; (6) an earnings growth measure of at least one-third per share over a ten-year period, averaging the first three years and the last three years to remove extremes; (7) a moderate price earnings ratio of no more than fifteen to one; and (8) a moderate ratio of price to assets of no more than one and one half to one. Johnston believed that a trustee should not purchase stocks which failed to meet any one of these standards. Applying these standards, Johnston concluded that: 1. The purchase of the Allied Chemicals stock did not meet standards 6 and 7. 2. [] The purchase of the American Garden Products stock did not meet standards 1, 4, 5, 6, 7, and 8. 3. [] The first purchase of Ames Department Stores stock failed standards 1, 5, 7, and 8. The second purchase of Ames Department Stores stock failed standards 1, 5, and 8. 4. The first purchase of Amfac stock failed standard 3. The second purchase of Amfac stock failed standards 3 and 7. The third purchase of Amfac stock failed standards 2 and 3. 5. [] The purchase of Associated Coca-Cola stock failed standards 1, 2, 3, 5, 7, and 8. 6. [] All four purchases of Beverage Canners stock failed standards 1, 4, 5, 6, 7, and 8. 7. The first purchase of Blue Bell stock failed standard 8. The second purchase of Blue Bell stock passed all eight standards. 8. [] The purchase of CNA Financial stock failed standards 4, 5, and 6. 9. [] Both purchases of Cox Broadcasting stock failed standards 1, 3, 5, 7, and 8. 10. [] All three purchases of Elixir Industries stock failed standards 1, 2, 4, 5, 6, 7, and 8. 11. [] The purchase of First Mortgage Investors stock failed standards 1, 5, 7, and 8. 12. Both purchases of Green Giant stock satisfied all eight standards. 13. [] The purchase of Hav-a-Tampa stock passed all eight standards. 14. [] The Kinney Services securities were convertible preferred securities and should not have been in the equity portfolio. 15. [] Both purchases of Loomis stock failed standards 1, 3, 4, 5, and 6. 16. [] The purchase of the Mortgage Associates stock failed standards 1, 4, 5, 6, 7, and 8. 17. The purchase of the Pabst Brewing stock passed all eight standards. 18. The purchase of Purolator stock failed standards 7 and 8. 19. [] All four purchases of Rust Craft Greeting Cards stock failed standards 1, 2, 7, and 8. 20. [] The purchase of Sealed Power stock failed standards 2, 3, 7, and 8. 21. The first purchase of Syntex stock failed standards 7 and 8. The second purchase of Syntex stock failed standard 8. 22. [] The first purchase of Transamerica stock failed standards 6, 7, and 8 with standards 2 and 3 not being applied. The second and third purchases of Transamerica stock failed standard 6 with standards 2 and 3 not being applied. 23. [] The first purchase of Universal Oil stock failed standards 2, 6, and 7. The second purchase of Universal Oil stock failed standards 2 and 6. 24. [] The Wynn Oil stock failed standards 1, 4, 5, 6, 7, and 8. The bank, however, contested Johnston's opinion by testimony from Walter McConnell, an investment banker from New York, who stated that Graham's book was intended for amateurs and not trustees. Also, Johnston on cross-examination was forced to admit that only five of the thirty stocks in the Dow Jones industrial average would meet these criteria. Johnston did not believe that a trustee could protect the principal against inflation by investing in common stocks. However, he did believe buying stocks in an old established company which paid high dividends is better than investing in a new venture. Walter McConnell, as an expert witness for the bank, listed various criteria to be applied in testing the soundness of an investment. Among these were the stability of the company, its financial soundness, its debt/equity ratio, the quality of its management, the company's product, and its standing in the industry. He testified that those criteria would not be affected by market cycles or ups and downs in the market. He stated that in his opinion the investments were prudent, though he could not say that his company had recommended the purchase of these stocks while he was an adviser. McConnell testified that he believed a trustee must take inflation into account in making trust investments. He stated that the most popular approach was to invest in the very best companies, i.e., the best growth companies. The idea was that with companies whose earnings and dividends were growing faster than inflation one would be protected against inflation. Another approach, according to McConnell, was not as popular but was still used by some large banks. This approach was to buy stocks in companies that were not well known, i.e., not well recognized and which were selling at much lower prices than the stocks of better known companies. McConnell analyzed the twenty-four stocks at issue and concluded they had a faster growing rate than the general market, and their earnings were also growing faster than the general market, but they were selling at a lower price-earnings ratio. He concluded that First Alabama used a rational investment approach and that the purchases of these twenty-four stocks were prudent. He further testified that S & P ratings were not intended to be used as investment recommendations and that experienced analysts do not use S & P ratings as a guide to sound investments. He further testified that it would be imprudent to buy or sell solely because of the S & P ratings, because one would not be using judgment in his decisions. Evidence was also introduced showing that the S & P ratings were issued with a warning that they should not be used solely as market recommendations. Eldon Davis, a former trust investment officer of the bank, who was the trust investment officer at the time the investments were made, testified for First Alabama by deposition. He stated that in 1971 and 1972 the stock market was very high. The Favorite 50 stocks were selling at extremely high prices so he decided to seek out securities that were undervalued in relation to the higher priced ones. He further stated that he did not rely on prospectuses, because the SEC requires a prospectus to be plastered with a high degree of risk, and will not let you say anything good about the securities, i.e., will not allow a prospectus to make favorable forecasts or projections. He likewise stated that he saw little difference in stocks rated B, or speculative, and B +, or median, since the rating services just don't understand the business they are in. It was Davis's opinion that it is best to buy securities in the growth cycle of a company and not after it has matured. First Alabama also introduced evidence from brokers who had made recommendations as to the stocks in question. Yet, Davis stated that at no time were they recommended as safe investments. Evidence was also presented that the recommendations were from brokers who had an interest in inducing the purchase of the stock.