The Conflicted Committee: A Fiduciary Fable
Donovan v. Bierwirth, 680 F.2d 263 (2nd Cir., 1982)
Once Upon a Time… in the 1980’s to be more specific… there were a lot of hostile acquisitions of publicly traded corporations. Grumman Corporation was the target of one of these hostile take-overs; Mr. Bierwirth was its CEO. The aggressor was LTV Corporation.
As the story goes, the Grumman Corporation Pension Plan not only declined to tender its stock but purchased an additional 1,158,000 shares at an average price of $38.27 per share, at a total cost of $44,312,380. But we are getting ahead of ourselves.
The Pension Plan owned approximately 525,000 shares of Grumman Corporation common stock when the wolf appeared at its door looking to acquire a minimum of 50.01% – a controlling interest – of the outstanding Grumman common stock and convertible securities for $45 per share. In the two trading days prior to the offer, Grumman at prices ranging between $23 7/8 and $27 1/4.
The Grumman Board of Directors vehemently opposed the tender offer. “We are better than that,” they said. But they didn’t really say why.
The Grumman Retirees Club decided what was good from Grumman was good for its retirees, so it purchased an advertisement appearing in Newsday, a Long Island newspaper, discouraging Grumman retirees from tendering their stock to LTV.
Because retirement plan trustees are the legal owners of the assets of the plan, it was up to the Grumman Pension Plan trustees whether to tender the Plan’s 525,000 shares to LTV. Those trustees were none other than Grumman’s own CEO, CFO, and its Treasurer. After a half hour discussion, the trustees not only voted not to tender the 525,000 Grumman shares held by the Plan, they decided to buy additional shares to help defeat the tender offer. The trustees bought 1,158,000 additional shares of Grumman stock at the prevailing market price. The day before the tender offer was announced, Grumman stock sold for $26.75 per share. The next day, after announcement of the tender offer, the price rose to $35.88 per share. When the trustees made the purchases, Grumman stock was selling at $36 to $39.34.
The tender offer ultimately failed, and the price of Grumman stock dropped in the next month to approximately the pre-tender offer level of $23 per share.
The Secretary of Labor, the avenger of ERISA plan participant’s rights and the keeper of all things fiduciary, was – shall we say – miffed. Within a week of the purchase of additional shares, it was in court seeking injunctive relief (i.e., “stop already!”), appointment of a receiver (i.e., “this trustworthy guy will now be in charge”, and recoupment of the Plan’s losses (“give back the money, fools!”).
When the dust cleared, approximately seventeen months after the stock was purchased, the Trustees sold the stock at a net average profit of $11.41 per share or $13,212,780 total.
So, was everyone happy? Was the case dismissed because the Plan made money on the trustees’ shenanigans? Well, initially, the District Court judge said, “no harm, no foul.” But eventually, the Court of Appeals cried foul indeed.
ERISA imposes three different, yet overlapping, standards on fiduciaries. A fiduciary must discharge her duties “solely in the interests of the participants and beneficiaries.” The fiduciary must do this “for the exclusive purpose” of providing benefits to those participants and beneficiaries. And the fiduciary must comply “with the care, skill, prudence, and diligence under the circumstances then prevailing” of the traditional “prudent man”.
The fault of the Grumman trustees was in the helter-skelter manner in which the “no-sale” and “purchase more” Plan investment decisions were made. An incidental benefit to Grumman may had been defensible if, after a careful and impartial investigation, they reasonably concluded that their actions were in the best interests of Grumman participants and beneficiaries.
In addition, it is permissible for corporate officers to be plan trustees, and therefore plan fiduciaries. But the trustees had a duty to avoid placing themselves in a position where their acts as officers or directors of the corporation would prevent their functioning with the complete loyalty to participants demanded of trustees by ERISA. The court felt that “the trustees’ meeting was treated quite casually-something to be attended to when the hectic pace of fighting the tender offer would permit.” The trustees did not solicit the advice of independent counsel. They failed to do a thorough job in ascertaining the facts with respect to the LTV pension funds, even though the unfunded liabilities of LTV’s pension plans was a principal ground for their action, and they failed to investigate whether anything could be done to protect the Grumman pension fund in the event of an acquisition of Grumman by LTV.
But most important to the court was the way the trustees swiftly moved from the decision not to tender or sell the shares already in the Plan to the decision to invest more than $44,000,000 in the purchase of additional Grumman shares. Bierwirth had concluded that a further investment in Grumman shares had to be “the right thing for us to do”. But even after he said that, the trustees did essentially nothing to determine whether the purchase of additional shares of Grumman stock, at prices inflated by the tender offer, was a good investment. If the tender offer failed, it was very likely the stock price would sink. If it succeeded, “the Plan would be left as a minority stockholder in an LTV-controlled Grumman” – a point that seemed not to even have been considered. The Grumman trustees failed their fiduciary responsibilities.
It didn’t matter that they made a profit when they did so.
The Moral of the Story
The exercise of fiduciary responsibilities is a process. Success is not measured on the results. If there is no prudent process, the result is suspect. And if fiduciaries are impossibly compromised, they should at least seek independent advice.