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ULICO CASUALTY COMPANY v. CLOVER CAPITAL MANAGEMENT

ULICO CASUALTY COMPANY, Plaintiff,
v.
CLOVER CAPITAL MANAGEMENT, INC., Defendant.



The opinion of the court was delivered by: HOWARD MUNSON, Senior District Judge

MEMORANDUM DECISION AND ORDER

Plaintiff Ulico Casualty Company ("Ulico"), instituted this lawsuit against Defendant Clover Capital Management, Inc.("Clover"), under §§ 404 (a) (1) (B); 404 (a) (1) (D) — Fiduciary Duties — Prudent Man Standard, and 405(a)(2) — Liability for breach of a co-fiduciary — Circumstances given rise to liability, of the Employment Retirement Income and Security Act ("ERISA"), 29 U.S.C §§ 1104 (a) (1) (B); 1104 (a) (1) (D); and 1105 (a) (2). A state common law breach of contract cause of action was dismissed as preempted by the ERISA as part of a decision made May 11, 2001, by the Hon. Thomas J. McAvoy in a prior summary judgment motion made in this case. This non-jury case was tried before this court on January 29, 30, and February 3, 4, 5, 2003.

  Plaintiff Ulico underwrote fiduciary liability coverage to the Funds and their Trustees. Clover Capital Management, Inc. is an asset manager for individuals, employee benefit plans, endowments and foundations, and is a registered investment advisor. Laborers International Union of North America Local 35 Pension Fund, Local No. 322 Pension Fund and Carpenters Local No. 120 Pension Fund (collectively the "Funds") are employee pension benefit plans within the meaning of ERISA 29 U.S.C. § 1002 (2)(A). Clover became the investment manager for all three Locals in February/March 1995. Local 35 ended its relationship with Clover on March 23, 1999, and Locals 322 and 120 did so on May 1, 2000.

  The complaint asserts that the defendant has breached ERISA fiduciary obligations while managing assets of the Funds' pension plans. Before this court are the questions of whether defendant breached and ERISA duty by (1) failing to satisfy the "prudent man" standard of 29 U.S.C § 1104(a)(1)(B) and (D), by not conducting a careful analysis before selling the Fund's major assets at a loss, and 29 U.S.C. § 1105(a)(2) his not complying with § 1104(a)(1) enabled another fiduciary to commit a breach. The following constitutes the court's findings of fact and conclusions of law pursuant to Rule 52 (a) of the Federal Rules of Civil Procedure. This action was begun as a result of previous lawsuits brought by the United States Department of Labor (DOL) against the Trustees of these three unions pension Funds alleging that they had improperly invested in Z-Bonds and sold them at a significant loss to the Funds. Z-Bonds are a class, or tranche, of Collateralized Mortgage Bonds ("CMOs") which are real estate mortgage investment conduit bonds that are derivative of mortgage-backed securities. These bonds are considered volatile because an upward change in the interest rate could result in a appreciable decrease in their market value.

  Background and Findings of Fact

  The witnesses' testimony laid out in detail the events and individual actions taken regarding the Funds' purchase and sale of their Z-bonds investments.

  From 1988 to 1995, the trustees of the Funds retained W.J. Nolan & Company ("Nolan"), a broker in mortgage backed securities, to invest in fixed income securities on behalf of the Funds. Starting in 1992 and proceeding through 1994, Nolan acquired Z-bonds for the Funds. At the end of 1994, the Funds portfolio of investments purchased by Nolan consisted principally of Z-bonds. During that same year, the market value of Z-bonds dropped substantially.

  At a joint meeting of the boards of Trustees of the Funds, held August 10, 1994, Stephen Thomas, of O'Sullivan Associates, the Funds actuary and monitor, addressed the Trustees. He stated that the returns on the W.J. Nolan brokerage account looked poor, the Trustees should consider retaining an investment manager. The Funds actuarial strength, relied in part, on the current market value of the investment assets, and not the yield to maturity of those assets. Actuarial funding is based upon the market value of assets. The market value of the Funds' assets consist of investment yield and market value fluctuations, appreciation and depreciation are counted and included in the value of the securities, and even if a security pays a guaranteed yield, for actuarial purposes and governmental reporting, it must looked at each year. (Thomas Dep. 47-50). This is emphasized on page 5 of the minutes of the August 10, 1994 meeting, the second paragraph from the bottom recites that "since benefits improvements are based on market value assets, it is no consolation to rely on return only, even if the investments are held to maturity." (Id.)

  Market value increase or decrease from the prior year and actuarial information are reported to the government on Form 5500 prepared by the Funds' accountants. This means that fluctuating market value in the assets held by a pension fund have very direct consequences on the way the government perceives their funding activities. Tr. 616-18 (Holmer), Defendant's Exhibits 100-102.

  In the fall of 1994, the Funds' Trustees decided to retain other investment managers for their Nolan portfolios. At the request of Gerald Scotti, the Funds manager, on September 27, 1994, Clover's William Wilson made an oral and written presentation to the Trustees describing the services Clover was prepared to provide to the Funds.

  In the presentations to the trustees of each of the Funds, Clover's representative stated that attempting to predict interest rate changes was a highly risky undertaking and it virtually guaranteed poor long term results. Consequently, Clover would not attempt to predict interest rates in its bond management efforts. Clover called it portfolio objective "Income Emphasis" having approximate mixed targets of 70% fixed income securities and 30% equity securities. (Tr. 375-76) Tr. 15 (Bergeron) Clover described its "market risk" fixed management approach where fixed income instruments with short, medium and long maturities are utilized to achieve a maturity with an average duration of approximately 8 to 10 years and an average duration of approximately 5 years. (Tr. 389-90)The trustees also received a detailed presentation booklet describing Clover's investment style with respect to equities and fixed income investments.

  After the presentations were made to the trustees of the Funds by the various investment manger entities, the trustees of each of the Funds voted to hire Clover as an investment manager, and to transfer the securities in the Nolan portfolio to Clover's management.

  The trustees further resolved that a portion of the assets assigned to Clover would eventually be transferred to one or more investment managers. For the Local 35 Fund, the transfer would be made to Loomis, Sayles & Company ("Loomis Sayles")which would result in Clover and Loomis Sayles having an equal amount of the assets formerly in the Nolam portfolio; for the Local 120 Fund, a transfer would be made that would result in HGK Asset Management, Loomis Sayles and Clover managing approximately equal portions of all pension funds available for investment; and for Local 322, a transfer of $1 million of assets to Manning & Napier, an existing investment manager for Local 322.

  In January 1995, after Clover had evaluated all the Nolan Z-bonds in the various management portfolios, it decided to liquidate the Nolan Z-Bonds to cash and transfer the proceeds pro rata to the other invest managers as soon as possible. The other managers of the Funds had advised Clover that they were not interested in acquiring any of the Z-Bond securities either. Tr. 393. Liquidating the Z-Bonds would produce cash for funding the other managers' accounts and permit Clover's to ...


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