Opinion ID: 11895
Heading Depth: 1
Heading Rank: 2

Heading: Duty to Diversify.

Text: ERISA requires a plan fiduciary to 8 discharge his duties with respect to a Plan solely in the interest of the participants and beneficiaries ... by diversifying the investments of the Plan so as to minimize the risk of large losses, unless under the circumstances it is clearly prudent not to do so. 9 29 U.S.C. § 1104(a)(1)(C). No statute or regulation specifies what constitutes diversifying plan investments, but the legislative history provides this guidance: 10 The degree of investment concentration that would violate this requirement to diversify cannot be stated as a fixed percentage, because a fiduciary must consider the facts and circumstances of each case. The factors to be considered include (1) the purposes of the plan; (2) the amount of the plan assets; (3) financial and industrial conditions; (4) the type of investment, whether mortgages, bonds or shares of stock or otherwise; (5) distribution as to geographical location; (6) distribution as to industries; (7) the dates of maturity. 11 H.R.Rep. No. 1280, 93d Cong., 2d Sess. (1974), reprinted in 1974 U.S.Code Cong. & Admin. News 5038, 5084-85 (Conference report at 304). Without minimizing the importance of the usual need for diversification of a plan's portfolio, however, the foregoing open-ended facts and circumstances list ought to caution judicial review of investment decisions. It is clearly imprudent to evaluate diversification solely in hindsight--plan fiduciaries can make honest mistakes that do not detract from a conclusion that their decisions were prudent at the time the investment was made. 12 To establish a violation, a plaintiff must demonstrate that the portfolio is not diversified on its face. Id. at 5084; Reich v. King, 867 F.Supp. 341 (D.Md.1994). Once the plaintiff has established a failure to diversify, the burden shifts to the defendant to show that it was clearly prudent not to diversify. In Re Unisys Savings Plan Litigation, 74 F.3d 420, 438 (3d Cir.1996). Prudence is evaluated at the time of the investment without the benefit of hindsight. 13 We review the district court's factual findings and inferences under a clearly erroneous standard and its legal conclusions de novo. Reich v. Lancaster, 55 F.3d 1034, 1044-45 (5th Cir.1995). 14 The district court credited Graham's testimony that, in purchasing the Property, he was attempting to increase the return on the plan's investments which previously had been entirely in short-term monetary or cash equivalent investments. The court found Graham knowledgeable in industrial-warehouse property, particularly those sites located in Grand Prairie. Before purchasing the Property, Graham discussed the purchase with the Plan's accountant, lawyer and actuary, as well as the Plan's major participants. 3 The major plan participants also had considerable experience in commercial real estate development in the area. A contemporaneous independent appraisal valued the property significantly higher than its purchase price. Graham believed the property was undervalued and anticipated selling it by 1986. The court concluded that Mr. Graham exercised proper due diligence and prudence. 15 The court ultimately concluded that Mr. Graham had not violated his duty to diversify so as to minimize risk of large loss by investing 63% of the Plan's assets in one parcel of real property. The court found that at no time relevant has there been a 'risk of large loss,'  and, given the 1985 non-diversified conditions of the portfolio, value of the real estate then and now, and the purchase price paid, ... his purchase decision was clearly a prudent one under all the circumstances at the time as viewed from the standpoint of a prudent man acting in a like capacity. The court also observed that no participants had lost benefits, nor were they likely to lose benefits in the future as a result of the purchase of the Property. 4 Id. at 11. 16 The Secretary contends that, as a matter of law, purchasing the Property constituted a failure to diversify on its face and that Graham did not prove at trial that it was clearly prudent not to diversify under the circumstances. We disagree. Even assuming arguendo that the plan's purchase of the property meant that the plan was not diversified on its face, we affirm the district court's decision because its findings demonstrate that, under the circumstances, it was clearly prudent not to diversify. 17 Both the diversification requirement and the clearly prudent exception to diversification must be analyzed from the perspective of what both parties acknowledge as their purpose: to reduce the risk of large loss. Several factors specific to this case indicate that Graham did not imprudently introduce a risk of large loss by purchasing the Property. First, the plan was not required to make payments to beneficiaries until age 65, death, or disability, and the average age of the plan participants was 37 years when the Property was purchased. Accordingly, the cash then remaining in the plan was sufficient to cover projected Plan payouts for the next 20 years. 5 The relative youth of the participants made it appropriate to evaluate the risk of the plan investments over an extended time frame, thus minimizing the risks associated with short-term fluctuations in asset values. 6 18 Second, at the time of the purchase, an important concern to Graham, and an ominous risk of large loss, was the prospect that high inflation would return. According to Graham's expert William Allbright, when the plan's holdings consisted solely of cash and short term instruments, there was little hedge against inflation. The purchase of real estate historically had provided excellent protection against inflation and could reasonably have been seen as an effort to diversify the portfolio to offset that risk. 7 The purchase of the Property achieved greater diversity in plan assets than had existed. 19 Third, the significant cushion between the purchase price and the contemporaneous independent appraisal, and fourth, Graham's expertise in the development of this type of industrial property further support the conclusion that the investment in the Property was a prudent one. 20 The district court did not clearly err in crediting all this evidence and finding that the investment did not carry a risk of large loss at any relevant time. We reject the secretary's criticism of this finding. Under the circumstances of this case, irrespective whether the purchase of the Property in 1985 meant that the plan was not diversified on its face, it was clearly prudent not to diversify. 21 The Seventh Circuit addressed a similar situation in Etter v. J. Pease Constr. Co., 963 F.2d 1005 (7th Cir.1992). In Etter, the plan invested $112,850 of its $127,993.43 in assets, or about 88%, in a single piece of local real estate. Id. at 1008. The plan trustees although not 'sophisticated' investors, were experienced in real estate and knew the local market and development potential in the county. Id. The trustees were partners with the Plan in the purchase, investing their own funds in the same property. Id. The court of appeals affirmed the district court's conclusion that it was clearly prudent not to diversify under the circumstances. Id. at 1011. Specifically, the court of appeals approved the trial court's consideration of the trustee's knowledge of real estate, knowledge of area development, and investigation of the property. Id. See also Reich v. King, 867 F.Supp. 341, 344-45 (D.Md.1994) (investment of 70% of plan assets invested in residential mortgages in one county; held clearly prudent not to diversify where administrator, a plumbing contractor, was knowledgeable about local real estate market and conducted sufficient investigation). 8 22 The Secretary argues that the Etter decision and the district court decision allow satisfaction of the prudence requirement to wipe out the separate and independent requirement of diversification. We disagree. When there is a lack of diversification, the statute requires the trustee to show that it was clearly prudent not to diversify. 29 U.S.C. § 1104(a)(1)(C). In Etter, the district court found that it was prudent not to diversify plan funds at the time of the Glacier Ponds investment. 963 F.2d at 1011. The Etter court looked at numerous factors, such as the investigation of the purchase, the evaluation of other investment alternatives, and the relative expertise of the trustee--all factors which are relevant to whether there was a risk of large loss. See id. Similarly, the district court in this case evaluated numerous factors, discussed above, which are directly relevant to the prudence of the failure to diversify (assuming the portfolio was not sufficiently diverse), in order to determine whether there was a risk of large loss. Both the diversification requirement and the statutory allowance of non-diversification in circumstances when it is prudent not to diversify are primarily concerned with minimizing the risk of large loss. The court's explicit finding that there was not a risk of large loss, based on his conclusion that Graham put on the more persuasive case, minimizes the Secretary's concern about weakening ERISA's diversification requirement.