Unpublished Disposition, 863 F.2d 886 (9th Cir. 1980)

MEMORANDUM^* 

William A. Henry (Henry) and Arthur Jerome Kimball, Jr. (Kimball) instituted this action against defendants alleging violations of the Employee Retirement Income Security Act of 1974, 29 U.S.C. §§ 1001 et seq. (ERISA) and Oregon securities laws. Defendants Frontier Industries, Inc. (Frontier) and William J. Claussen (Claussen) subsequently filed for bankruptcy, and the action against them was stayed. Jack Largent (Largent) is the only remaining defendant. The district court held for Henry and Kimball on the ERISA claim, finding that Largent breached his fiduciary duty under ERISA when he negotiated the withdrawal of $100,000 in cash from Frontier's Employee Stock Ownership Plan (ESOP). The court entered judgment for Largent on the state law claims. Both sides appeal. We affirm.

BACKGROUND

In 1967, Largent started the Jack Largent Company (JLC) and became its officer, director and sole shareholder. During 1969, JLC adopted a contributory and voluntary profit sharing plan (JLC Plan). As of January 31, 1980, the interests of the parties were 100% vested. Henry's interest in the JLC Plan was $63,611.90. Kimball's interest was $44,937.33. Largent's own interest in the JLC Plan was $185,540.67.

In March 1980, Largent sold all his JLC stock to Frontier and resigned all positions with JLC, including his job as the JLC Plan administrator. After the sale, Largent was elected one of eleven directors of Frontier.

On May 27, 1980, Frontier's Board of Directors approved the establishment of an ESOP. Under the terms of the ESOP, the vested interests of the employees in the JLC Plan were utilized to purchase 1,000 shares of Frontier stock, valued at $273.00 per share, which were transferred to the ESOP. At that time, Frontier was in a precarious financial position and required substantial infusions of cash to maintain operations.

Claussen, president of Frontier, was the trustee of the ESOP and sole member of the ESOP's Administrative Committee. In July 1980, Largent requested that Claussen permit him to withdraw his interest in the ESOP and pay him $185,540.67. This amount was equal to Largent's interest in the former JLC Plan when its assets exceeded $500,000. Claussen refused to allow the withdrawal, explaining that there were no funds in the ESOP to pay Largent. Largent was informed that he would have to wait until his retirement age to receive his interest in the ESOP.

Thereafter, Frontier was late in making its first balloon payment of $100,000 to Largent on the stock purchase. Frontier's default gave Largent the option of accelerating the remaining unpaid balance of the purchase price. In view of these developments, the parties restructured Frontier's $800,000 debt to Largent. During the negotiation of this restructuring, the parties agreed to allow Largent to withdraw his interest in the ESOP in the form of $100,000 cash and Frontier's promissory note for $85,540.67.

* LARGENT'S APPEAL

Largent makes three arguments on appeal: (1) the district court based its judgment on a theory not set forth in the pretrial order; (2) Largent was not a fiduciary under ERISA in connection with the withdrawal of his interest in the ESOP; and (3) plaintiffs were not entitled to recover monetary damages from Largent because his withdrawal of funds did not result in a loss to the ESOP nor a profit to Largent.

Largent claims that he was surprised by the court's reliance on the theory that Largent breached his fiduciary duty when he negotiated the withdrawal of his interest in the ESOP. Largent contends that he never had an opportunity to rebut this theory and that the trial court erred in amending the pretrial order sua sponte to include this theory.

Largent's claim of surprise, however, is belied by the transcript of the court's colloquy with counsel on the first day of trial. At that time, the court advised Largent's counsel that the pretrial order would be amended to include a cause of action for breach of a fiduciary duty in connection with Largent's withdrawal of his interest in the ESOP. Moreover, the court offered to continue the proceedings to permit Largent to prepare to meet this theory. Largent's counsel declined the opportunity for a continuance. The district court did not err when it later based its judgment on that theory. The record does not support Largent's contention that he was surprised at trial.

Largent contends that his withdrawal of funds from the ESOP was not an exercise of discretionary authority or control over the administration of the ESOP. Consequently, Largent argues, he did not breach his fidicuary duty under ERISA in connection with that transaction. The trial court concluded that Largent's status as a board member and major creditor of Frontier enabled him to negotiate the withdrawal of his interest and to exercise control over the ESOP. We review the court's conclusions of law de novo. United States v. McConney, 728 F.2d 1195, 1200 (9th Cir.) (en banc), cert. denied, 469 U.S. 824 (1984).

For purposes of ERISA, the term "fiduciary" is defined, in pertinent part, as follows:

[A] person is a fiduciary with respect to a plan to the extent (i) he exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets, ... or (iii) he has any discretionary responsibility in the administration of such plan.

29 U.S.C. § 1002(21) (A) (1982).

Henry and Kimball contend that Largent was a fiduciary of the ESOP because he was a secured creditor and a director of Frontier. Largent's status as a secured creditor did not make him a fiduciary of the ESOP. A creditor is generally not under any fiduciary obligation to the debtor or to other creditors and will not be penalized for taking advantage of a strong bargaining position. Krivo Industrial Supply Co. v. National Distillers & Chemical Corp., 483 F.2d 1098, 1104-05 (5th Cir. 1973), modified, 490 F.2d 916 (5th Cir. 1974).

As a director of Frontier, however, Largent was a fiduciary of the ESOP. The ESOP Trust Agreement provides that "the Employer shall be the 'named fiduciary' within the meaning of ERISA and shall be in charge of the operation and the administration of the [p]lan. The Employer shall have the power to delegate specific fiduciary responsibilities." Moreover, members of a corporate board of directors are fiduciaries under ERISA with respect to selection and retention of plan administrators and investments of the trust. Sandoval v. Simmons, 622 F. Supp. 1174, 1211 (C.D. Ill. 1985). Thus, Largent was a fiduciary of the ESOP by virtue of his power to appoint and retain, and his duty to monitor, the member(s) of the Administrative Committee, which implemented the provisions of the ESOP.

As a fiduciary under ERISA, Largent had a duty to act

with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims

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29 U.S.C. § 1104(a) (1) (B) (1982).

Largent breached this standard of diligence by negotiating the withdrawal of his funds from the ESOP at a time when he should have understood that the ESOP was financially endangered. Largent knew that Frontier had been unable to make its first $100,000 balloon payment to Largent in spite of the large infusion of cash from the JLC Plan. In addition, Largent's withdrawal of his $185,540.67 interest in the ESOP was contingent upon his acceptance of a promissory note for $85,540.67.

Moreover, Largent as a board member, had a duty to monitor and review Claussen's performance as trustee and administrator of the ESOP. An ERISA Interpretive Bulletin addresses this responsibility:

At reasonable intervals the performance of trustees and other fiduciaries should be reviewed by the appointing fiduciary in such manner as may be reasonably expected to ensure that their performance has been in compliance with the terms of the plan and statutory standards, and satisfies the needs of the plan.

ERISA Interpretive Bulletin 75-8, 29 C.F.R. Sec. 2509.75-8, at 323 (1987).

In Leigh v. Engle, 727 F.2d 113 (7th Cir. 1984), beneficiaries of an employee benefit plan alleged that the defendants violated fiduciary duties under ERISA by investing the plan's assets in companies involved in corporate control contests. Defendant Engle held a controlling interest in Libco Corporation, which in turn indirectly controlled the appointment and removal of the administrators of an employee benefit plan. The court in Leigh found that although Engle was not obliged to examine every action taken by the plan administrators, he was obliged to act with appropriate prudence and reasonableness in overseeing the administrators' management of the plan. Id. at 135.

Similarly, Largent, as a member of Frontier's board, had an ongoing responsibility to monitor Claussen's conduct to ensure that his performance was in compliance with the plan and applicable statutory standards. Under ERISA, Claussen was required to "discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries...." 29 U.S.C. § 1104(a) (1) (1982).

Largent knew or should have known that Claussen faced conflicting loyalties to the beneficiaries of the ESOP in negotiating the withdrawal. Prior to the withdrawal, the ESOP was in a weak financial condition. Largent appropriated to himself the last remaining cash available to Frontier, to the detriment of the other ESOP beneficiaries. Instead of monitoring Claussen's conduct so as to protect the employees' interests in the ESOP, Largent prompted Claussen to negotiate a preferential withdrawal of Largent's interest in the ESOP.

The district court ordered that Largent return the $100,000 in cash that he received from the ESOP. Largent contends that the court erred because Largent was entitled to the money distributed to him, and the withdrawal did not entirely deplete the ESOP assets.

At the time Largent negotiated the withdrawal, there was a small amount of cash left in the ESOP. In order to pay Largent $100,000, the ESOP had to borrow $91,100 from Frontier. Although the payment to Largent reduced his interest in the ESOP to zero, the effect of the transaction was to leave the ESOP with a substantial liability to Frontier.

Furthermore, ERISA clearly allows the plaintiffs to maintain an action for damages, if Largent, a fiduciary, profited by using the ESOP assets:

Any person who is a fiduciary with respect to a plan who breaches any of the responsibilities, obligations, or duties imposed upon fiduciaries by this subchapter shall be personally liable to make good to such plan any losses to the plan resulting from each such breach, and to restore to such plan any profits of such fiduciary ... and shall be subject to such other equitable or remedial relief as the court may deem appropriate....

29 U.S.C. § 1109(a) (1982).

When Largent withdrew his money from the ESOP in August 1980, the ESOP had only 1,000 shares of Frontier stock. The stock was almost valueless. Despite this fact, Largent's 40% interest was calculated by reference to the balance in the JLC Plan before it was converted into the ESOP. At that time, the JLC Plan's assets totaled over $500,000. Even if Largent's withdrawal had been proper, it should have been tied to the diminishing value of Frontier stock, as were the interests of the other participants in the ESOP. Because Largent received more than his share of the ESOP assets, he breached his duty to the employees by profiting from his withdrawal.

II

THE CROSS APPEAL

A. Sale of Securities Under Oregon Securities Laws

Plaintiffs alleged claims against Largent for violation of the requirement that securities offered for sale or sold in Oregon be registered, Or.Rev.Stat. Sec. 59.055 (1987), and for violation of Oregon's anti-fraud statute, Or.Rev.Stat Sec. 59.115 (1987). Application of these statutes is triggered by a "sale" of "securities." The district court held that "the conversion of the Plan to an ESOP was not a sale of securities because that type of transaction is specifically exempted" from the registration requirement of Sec. 59.055. Henry and Kimball appeal this decision. A district court's interpretation of state law is reviewed under the same de novo standard under which interpretations of federal law are reviewed. In re McLinn, 739 F.2d 1395, 1397 (9th Cir. 1984) (en banc).

Oregon Blue Sky laws should be construed liberally "to afford the greatest possible protection to the public." Jost v. Locke, 65 Or.App. 704, 673 P.2d 545, 552 (1983).

Oregon law defines "security" to include an interest in a pension plan: " 'Security' means a ... certificate of interest or participation in a pension plan or profit-sharing agreement...." Or.Rev.Stat. Sec. 59.015(16) (a) (1987) (emphasis added). Thus, Henry's and Kimball's interests in the JLC Plan and the ESOP were securities.

The Oregon statute defines "sale" to include "every contract of sale of, contract to sell, or disposition of, a security or interest in a security for value." Id. Sec. 59.015(14) (a). We are unaware of any Oregon case law construing section 59.015(14) (a). The terms "sale" and "value" have been interpreted by the SEC, however, and we see no reason not to be guided by that interpretation in the absence of governing Oregon law.

For a sale to occur with regard to the interests of participants in an employee benefit plan, the participants must make an investment decision and furnish something of value. Employee Benefit Plans; Interpretations of Statute, SEC Release No. 33-6188, Summary p 2, 45 Fed.Reg. 8960, 8961 (1980). "Value" includes "all ordinary forms of consideration, such as cash, property, services, or the surrender of a legal right." Id., Pt. III(A), 45 Fed.Reg. at 8969.

Here, it is undisputed that at the time of the conversion of the assets in the JLC Plan to the ESOP, plaintiffs' interests in the JLC Plan were 100% vested. The conversion transformed Henry's and Kimball's vested interests in the JLC Plan into shares of Frontier stock. Thus, they furnished something of "value" in the form of their vested interest in the JLC Plan in connection with the conversion to an ESOP.

However, the SEC does not find a sale where "employees have no investment decision with respect to the proposed conversion," i.e., "the conversion will occur without giving employees any choice in the matter...." Securities Act Definitions Release No. 33-6188, [1980 Transfer Binder] Fed.Sec.L.Rep. (CCH) p 1051 (Feb. 1, 1980). Plaintiffs had no opportunity to accept or reject the assumption of the JLC assets by the ESOP. Therefore, they made no investment decision.

Henry and Kimball argue that by refraining from challenging the conversion of the JCL pension plan into the Frontier ESOP plan, they made an investment decision. We disagree. A decision by them to retire and cash in their interests in the retirement fund might have qualified as an investment decision, see Foltz v. U.S., News & World Report, Inc., 627 F. Supp. 1143, 1160-61 (D.D.C. 1986), but the mere decision not to challenge the adequacy of the terms of the conversion surely does not. Cf. Dept. of Economic Dev. v. Arthur Anderson & Co., 683 F. Supp. 1463, 1476 (S.D.N.Y. 1988), and Freschi v. Grand Coal Venture, 551 F. Supp. 1220, 1229-30 n. 9 (S.D.N.Y. 1982) (both noting that a decision to rescind a contract based on fraud is not an investment decision). We conclude, therefore, that no "purchase" or "sale" occurred in connection with the conversion of JLC Plan assets into the ESOP.

B. Registration of Securities Under Oregon Law

Oregon law makes it unlawful for any person to offer or sell any security in Oregon unless the security is registered, or the security or the sale is exempt from registration. Or.Rev.Stat. Sec. 59.055 (1987). Because we have concluded that no purchase or sale occurred in connection with the conversion of JLC Plan assets into the ESOP, there was no violation of section 59.055. Moreover, section 59.035(4) explicitly exempts from registration " [a]ny offer, sale, transfer or delivery of securities to a ... pension or profit-sharing trust...." Or.Rev.Stat. Sec. 59.035(4) (emphasis added).

C. Anti-Fraud Claim Under Oregon Securities Law

Plaintiffs contend that the conversion of the Plan to the ESOP involved violations of the anti-fraud provisions of Oregon Securities Law. Oregon Revised Statute section 59.135 makes it unlawful for anyone, in connection with the sale or purchase of securities:

1. To employ any device, scheme, or artifice to defraud.

2. To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they are made, not misleading.

3. To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person....

The district court held that the conversion of the JLC Plan to an ESOP was not a sale of securities because that type of transaction is specifically exempt from registration under Oregon law. For this reason, the court did not reach the merits of the anti-fraud claim.

The anti-fraud provisions of Oregon law apply to all sescurities transactions, whether or not they are exempt from registration. Pratt v. Kross, 276 Or. 483, 555 P.2d 765, 767 (1976). The court in Pratt stated: "In commencing a discussion whether the transaction involved a security within the meaning of the fraud provision, it must be kept in mind that this problem is not related to a determination whether a security is required to be registered...." Id. Thus, district court erred in tying plaintiffs' anti-fraud claim to the registration requirements under Oregon securities laws.

However, because the anti-fraud provision, section 59.135, applies to the sale or purchase of securities, it is inapplicable in this case. Therefore, despite the district court's error, we find that the district court did not need to address the merits of the anti-fraud claim.

CONCLUSION

We AFFIRM the district court's judgment that Largent breached his fiduciary duty under ERISA when he negotiated a withdrawal of his pre-conversion share of the assets in the ESOP. We also AFFIRM the district court's judgment that Largent did not violate the registration requirements or the anti-fraud provision of the Oregon securities law.