The opinion
T.C. Memo. 1999-369
UNITED STATES TAX COURT
WESTCHESTER PLASTIC SURGICAL ASSOCIATES, P.C., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 13073-97R. Filed November 5, 1999.
Andrew I. Panken and Robert A. DeVellis, for petitioner.
Mark L. Hulse and Catherine R. Chastanet, for respondent.
MEMORANDUM OPINION
HAMBLEN, Judge: This is an action for a declaratory
judgment regarding the qualification of petitioner's defined
benefit plan and trust. This case was submitted on the
administrative record, pursuant to Rule 217. Unless otherwise
indicated, all section references are to the Internal Revenue
- 2 -
Code, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
On April 3, 1997, respondent issued a final nonqualification
letter to petitioner stating that the Westchester Plastic
Surgical Associates Defined Benefit Plan (the Defined Benefit
Plan) failed to meet the requirements of section 401(a) for the
plan years ending October 31, 1990, and thereafter, and that its
related trust (the Trust) was not tax exempt under section 501(a)
for trust years ending with or within the affected plan years.
Respondent also revoked the prior favorable determination letter
to petitioner dated December 5, 1988.
The issue for decision is whether petitioner's Defined
Benefit Plan violated the exclusive benefit rule under section
401(a)(2).1
1
Petitioner also has a Money Purchase Pension Plan which it
adopted effective as of Jan. 15, 1972. We note that throughout
both petitioner's and respondent's briefs, both petitioner and
respondent refer to the Defined Benefit Plan and the Money
Purchase Plan as if they were one plan. However, we note that
there are two separate plans: The Defined Benefit Plan and the
Money Purchase Pension Plan. See Morrissey v. Commissioner, T.C.
Memo. 1998-443. Since the petition addresses only the Defined
Benefit Plan and attaches only the Nonqualification Letter for
the Defined Benefit Plan and since the administrative record
contains only the Nonqualification Letter for the Defined Benefit
Plan, we will address only the qualification of the Defined
Benefit Plan.
- 3 -
Background
Petitioner was a corporation existing under the laws of the
State of New York. At the time of the filing of its petition in
this case, petitioner's address was P.O. Box 852, Southampton,
New York. Michael Morrissey (Morrissey) was the owner of all of
the outstanding shares of petitioner's stock from 1972 through
the years in issue. Morrissey was also the president and
secretary of petitioner from inception.
Petitioner adopted the Defined Benefit Plan effective as of
November 1, 1976. The Defined Benefit Plan received a favorable
determination letter from the Internal Revenue Service dated
December 5, 1988. Since its inception, Morrissey has always been
the sole trustee of the Trust and as such has exercised complete
control over the management and disposition of the Defined
Benefit Plan assets.
The Defined Benefit Plan ceased benefit accruals in 1990,
at which time all plan participants were 100 percent vested. The
Defined Benefit Plan terminated pursuant to a resolution of
petitioner's board of directors dated September 4, 1990, and
effective September 26, 1990. When the Defined Benefit Plan
ceased benefit accruals and terminated in 1990, there were two
participants in addition to Morrissey. These two participants
were paid their full benefits in 1990 when the Defined Benefit
Plan terminated. With the payout to these two participants in
- 4 -
1990, Morrissey became the sole remaining participant of the
Defined Benefit Plan.
Under the Agreement for the Trust,2 dated October 25, 1977,
effective November 1, 1976, section 7.01(o) provides that the
trustees shall have the power with respect to the Trust:
To lend money to a Participant at the then current
rates of interest being charged by commercial banks for
similar loans, in an amount not exceeding the value of such
Participant's Accrued Benefit and all such loans to the
extent they are secured only by the Participant's vested
Accrued Benefit shall be repaid within two (2) years from
the date of such loan. Any loans made pursuant to this sub-
paragraph to the extent they are not secured by the
Participant's vested Accrued Benefit shall be otherwise
adequately secured.
Under the second amendment, effective November 1, 1976, section
7.01(o) was amended to read as follows:
To lend money to a Participant at the then current
rates of interest being charged by commercial banks for
similar loans, in an amount not exceeding the value of such
Participant's Accrued Benefit, and all such loans to the
extent they are secured only by the Participant's vested
Accrued Benefit shall be repaid within seven (7) years from
the date of such loan. Any loans made pursuant to this sub-
paragraph to the extent they are not secured by the
Participant's vested Accrued Benefit shall be otherwise
adequately secured.
From February 8, 1984, through December 9, 1988, Morrissey,
as trustee of the Defined Benefit Plan, made a series of six
2
We note that the administrative record contains an
Agreement only for the Trust and not for the Defined Benefit Plan
itself. According to this Agreement, "this Trust * * * forms
part of a Pension Plan of the Employer". Consequently, we find
the Defined Benefit Plan incorporates the Trust.
- 5 -
loans to himself: On February 8, 1984, Morrissey as trustee of
the Defined Benefit Plan executed an installment note whereby the
Defined Benefit Plan lent $13,000 of plan assets to Morrissey at
a rate of interest of 11 percent. On August 27, 1985, Morrissey
as trustee of the Defined Benefit Plan executed an installment
note whereby the Defined Benefit Plan lent $50,000 of plan assets
to Morrissey at a rate of interest of 12 percent. On December 3,
1985, Morrissey as trustee of the Defined Benefit Plan executed
an installment note whereby the Defined Benefit Plan lent $5,500
of plan assets to Morrissey at a rate of interest of 10 percent.
On January 3, 1986, Morrissey as trustee of the Defined Benefit
Plan executed an installment note whereby the Defined Benefit
Plan lent $14,500 of the plan assets to Morrissey at a rate of
interest of 10.5 percent. On February 12, 1988, Morrissey as
trustee of the Defined Benefit Plan executed an installment note
whereby the Defined Benefit Plan lent $20,000 of plan assets to
Morrissey at a rate of interest of 9.75 percent. On December 9,
1988, Morrissey as trustee of the Defined Benefit Plan executed
an installment note whereby the Defined Benefit Plan lent $2,000
of plan assets to Morrissey at a rate of interest of 11.5
percent.
According to the administrative record provided in this case
the six loans and their interest rates were as follows:
- 6 -
Date of Loan Obligee Loan Amount Interest Rate
2/8/84 Defined Benefit Plan $13,000 11%
8/27/85 Defined Benefit Plan 50,000 12
12/3/85 Defined Benefit Plan 5,500 10
1/3/86 Defined Benefit Plan 14,500 10.5
2/12/88 Defined Benefit Plan 20,000 9.75
12/9/88 Defined Benefit Plan 2,000 11.5
Total 105,000
These six notes all fail to state when payments are due or
when repayments should be made. None of the six installment
notes require Morrissey to provide security or collateral for the
loans. None of the installment notes state a maturity date.
The administrative record provided in this case contains no
evidence that Morrissey made any repayments on any of the six
loans from the Defined Benefit Plan, and we so find. In
Morrissey v. Commissioner, T.C. Memo. 1998-443, we found that on
October 19, 1990, Morrissey transferred to the Money Purchase
Plan his 50-percent interest in two parcels of unencumbered real
estate sited in Southampton, New York. We stated: "The record
does not show that * * * [Morrissey] ever transferred any asset
to the * * * [Defined Benefit Plan] in repayment of moneys that
he borrowed from it." We also stated: "Indeed, it appears that
* * * [Morrissey] continues to owe the * * * [Defined Benefit
Plan] the money (with interest) that it lent to him because he
- 7 -
has never transferred any value to the * * * [Defined Benefit
Plan] to repay these amounts."
Morrissey signed a form titled "Employee's Waiver of Portion
of Benefit Not Funded Upon Distribution of Plan's Assets Pursuant
to Plan Termination Effective: September 26, 1990," in which he
waived his right to any unfunded benefits, to the extent that the
Defined Benefit Plan assets were insufficient to provide the
actuarial equivalent of his normal retirement benefit on the date
of benefit distributions. This form states, in pertinent part:
I. The undersigned, a Participant in the captioned
Plan, hereby agrees that, to the extent Plan
assets as of the date of benefit distributions
are insufficient to provide (on a lump sum basis)
the actuarial equivalent of said Participant's
normal retirement benefit entitlement, the said
Participant waives his right to any portion of
said benefit not funded as of such date.
For the plan year ending October 31, 1989, the Form 55003
for the Defined Benefit Plan reports total plan assets as of the
beginning of the plan year of $179,296 and $191,680 at the end of
the plan year. In addition, the Form 5500 reports $129,031 as
"any loan or extension of credit by the plan to the employer, any
fiduciary, any of the five most highly paid employees of the
employer, any owner of a 10% or more interest in the employer, or
relatives of any such persons." Furthermore, the Form 5500
3
The Form 5500 is the Annual Return/Report that must be
completed for Employee Benefit Plans.
- 8 -
reports that the employer owes $231,796 in contributions to the
plan which are more than 3 months overdue.
The Schedule B4 of Form 5500 for the Defined Benefit Plan
for the plan year ended October 31, 1989, reports the current
value of the assets accumulated in the Defined Benefit Plan as of
the beginning of the plan year as $368,279, which includes a
prior year funding deficiency of $188,983.5 In addition, the
Schedule B reports the total present value of vested benefits as
of the end of the plan year for participants as $335,384.
Furthermore, the amount of contribution certified by the actuary
as necessary to reduce the funding deficiency to zero is
$231,796.6
4
The Schedule B contains Actuarial Information for the
Employee Benefit Plan and is attached to the Form 5500.
5
$368,279 - $188,983 = $179,296.
6
Funding standard account statement for plan year ending
Oct. 31, 1989:
Charges to funding standard account:
Prior year funding deficiency $188,983
Employer's normal cost for plan
year as of 11/1/88 25,643
Interest 17,170
Total charges 231,796
Credits to funding standard account: -0-
Funding deficiency 231,796
- 9 -
The Form 5500 for the Defined Benefit Plan for the plan year
ended October 31, 1990, reports that the Defined Benefit Plan was
terminated during this plan year, that a termination resolution
was adopted this plan year, and that no trust assets reverted to
the employer. It further reports that there was $257,639 of
contributions that was more than 3 months due. In addition, it
reports the following information:
Assets Beginning of year End of year
Cash $646 $2,295
Receivables 38,922 40,063
Investments
Real estate and mortgages -0- 137,270
Loans to participants:
Mortgages -0- -0-
Other 152,112 -0-
Total investments 152,112 137,270
Total assets 191,680 179,628
Liabilities
Total liabilities -0- -0-
Net assets 191,680 179,628
The Form 5500 also reports expenses of $20,653 which represented
distribution of benefits directly to participants.
The Schedule B for the year ended October 31, 1990, reports
$423,4767 as the current value of assets accumulated as of the
beginning of the year. It reports $341,583 in total vested
benefits, $9,900 to one terminated participant, and $331,683 to
7
This $423,476 includes the prior year funding deficiency of
$231,796. $423,476 - $231,796 = $191,680.
- 10 -
two active participants. It further reports no contributions
made to the Defined Benefit Plan by the employer. In addition,
the Schedule B reports $257,6398 as the contribution necessary to
reduce the funding deficiency.
The Form 5500 for the Defined Benefit Plan for the plan year
ended October 31, 1991, reports total plan assets of $179,628 at
the beginning of the plan year and $171,003 in plan assets at the
end of the plan year. It further reports plan income of -$8,625.
In addition, it reports that the plan at any time held 20 percent
or more of its assets in any single security, debt, mortgage,
parcel of real estate, or partnership/joint venture interests and
that the dollar amount was $124,021.
The activity in petitioner's Defined Benefit Plan Trust
account at the Bank of New York for account No. 015-268675 was as
follows:
8
Funding standard account statement for plan year ending
Oct. 31, 1990:
Charges to funding standard account:
Prior year funding deficiency $231,796
Employer's normal cost 554
Interest 18,588
Addtl. interest due to late
contributions 6,701
Total charges 257,639
Credits to funding standard account -0-
Funding deficiency 257,639
- 11 -
Date Withdrawal Deposit Balance
8/27/85 $1,333.20 --- $53,352.07
8/27/85 50,000.00 --- 3,352.07
10/15/85 --- $1,127.20 4,479.27
11/25/85 --- 1,333.20 5,812.47
12/03/85 5,500.00 673.91 986.38
1/13/86 14,500.00 13,654.49 140.87
4/14/86 --- 1,059.80 1,200.67
10/07/86 3.00 1,028.36 2,226.03
1/14/87 --- 20,903.40 23,129.43
2/12/88 20,000.00 1,146.72 4,276.15
12/9/88 2,000.00 282.64 2,558.79
1
2,000.00 --- 558.79
1
We are unable to decipher this date from the record, and it
is immaterial to the outcome of this case.
The activity in petitioner's Defined Benefit Plan Trust
account at the Bank of New York for account No. 015-283294 was as
follows:
Date Withdrawal Deposit Balance
7/31/90 $671.18 $671.18
8/16/90 1,600.00 2,271.18
4/04/91 74.20 2,345.38
Discussion
This Court may exercise jurisdiction over a declaratory
judgment action if there is an actual controversy involving a
determination by the Secretary with respect to the initial or
continuing qualification of a retirement plan. See sec. 7476(a);
Loftus v. Commissioner, 90 T.C. 845, 855 (1988), affd. without
published opinion 872 F.2d 1021 (2d Cir. 1989).
- 12 -
Petitioner contends that the Defined Benefit Plan did not
violate the exclusive benefit rule and therefore should remain
qualified. Respondent contends that the Defined Benefit Plan is
not a qualified plan within the meaning of section 401(a) for
plan year ended October 31, 1990, and thereafter because its
investments and Morrissey's transfer of real property, on October
19, 1990, in an attempt to repay loans to him, violated the
exclusive benefit requirement. Specifically, respondent contends
that the Defined Benefit Plan failed to satisfy the exclusive
benefit rule by investing almost all of its assets in 23 loans to
the plan trustee.9
Section 404(a)(1)(A) provides that contributions to a
pension trust are deductible by the employer if the trust is
exempt from tax under section 501(a). In order for the trust to
be entitled to tax-exempt status under section 501(a), a
retirement plan must be established by an employer and meet all
the requirements of section 401(a). See Professional & Executive
9
Respondent seems to think that the Defined Benefit Plan and
the Money Purchase Plan are one plan, as it appears respondent
has combined the loans from both plans. See supra note 1. We
previously found that from Nov. 14, 1979, to Feb. 17, 1989, the
Defined Benefit Plan and Money Purchase Plan made 23 loans to
Morrissey. See Morrissey v. Commissioner, T.C. Memo. 1998-443.
In addition, we previously found that Morrissey transferred to
the Money Purchase Plan his 50-percent interest in two parcels of
unencumbered real estate and that he never transferred any value
to the Defined Benefit Plan to repay his loans from the Defined
Benefit Plan assets. See id.
- 13 -
Leasing, Inc. v. Commissioner, 89 T.C. 225, 230 (1987), affd. 862
F.2d 751 (9th Cir. 1988). In determining whether a plan is
qualified under section 401(a), the operation of the trust is
relevant as are its terms. See Winger's Depart. Store, Inc. v.
Commissioner, 82 T.C. 869, 876 (1984); Quality Brands, Inc. v.
Commissioner, 67 T.C. 167, 174 (1976); see also sec. 1.401-
1(b)(3), Income Tax Regs.
Section 401(a)(2)10 provides that for a trust forming part
of an employer's pension plan to be exempt, it must be
impossible, at any time before the satisfaction of all
liabilities with respect to the employer's employees and their
beneficiaries under the trust, for any part of the corpus or
income to be used for, or diverted to, purposes other than for
the exclusive benefit of those employees or beneficiaries.
10
Sec. 401(a) provides, in pertinent part, as follows:
SEC. 401(a). Requirements for Qualification.--A trust
created or organized in the United States and forming part
of a stock bonus, pension, or profit-sharing plan of an
employer for the exclusive benefit of his employees or their
beneficiaries shall constitute a qualified trust under this
section--
* * * * * * *
(2) if under the trust instrument it is
impossible, at any time prior to the satisfaction of
all liabilities with respect to employees and their
beneficiaries under the trust, for any part of the
corpus or income to be * * * used for, or diverted to,
purposes other than for the exclusive benefit of his
employees or their beneficiaries * * *
- 14 -
"[T]he phrase 'purposes other than for the exclusive benefit of
his employees or their beneficiaries' includes all objects or
aims not solely designed for the proper satisfaction of all
liabilities to employees or their beneficiaries covered by the
trust." Sec. 1.401-2(a)(3), Income Tax Regs.
Petitioner contends that, with Morrissey as the sole trustee
and sole participant of the Defined Benefit Plan since 1990,
there is no violation of the exclusive benefit rule. In support
of its contention, petitioner asserts that two of three Defined
Benefit Plan participants were paid their benefits in full in
1990. Thus, petitioner asserts that the sole remaining
participant, Morrissey, controls the Defined Benefit Plan and his
retirement and could arrange for the plan to have liquid assets
by repaying the loans to him at any time since he had assets with
which to accomplish this.
In addition, petitioner contends that the prudent investor
rules, a safe harbor when dealing with the exclusive benefit
issue, have not been violated. In support of its contention,
petitioner asserts that Morrissey, the trustee, weighed the risks
and benefits of making loans to Morrissey, the individual.
Petitioner further asserts that if the loans turned out to be a
bad investment for the Defined Benefit Plan, the only party who
is harmed is Morrissey, the sole remaining Defined Benefit Plan
participant. Accordingly, petitioner contends that Morrissey,
- 15 -
the trustee, after weighing the risks and benefits, was entitled
to have the trust make loans to Morrissey, as evidenced by
promissory notes, without violating fiduciary standards.
Petitioner also maintains that the notes included a
reasonable rate of interest and that Morrissey, at the time the
loans were made, had the ability to repay. Petitioner further
maintains that when his economic situation changed, he repaid the
loans with real estate instead of cash. Consequently, petitioner
contends that since Morrissey, as of 1990, was not of retirement
age, it is premature to conclude that as of that date, the trust
would not have funds available for distribution to him upon his
retirement. Petitioner asserts that the real property interests
transferred into the Money Purchase Plan and the Defined Benefit
Plan as repayment of the loans have markedly appreciated in value
to the point where it is reasonable to conclude that the
investments were in fact prudent. Petitioner further asserts
that a simple refinancing of the property could have provided for
both liquidity and diversity whenever Morrissey chose to do so.11
Respondent contends that the investments in the 23 loans
failed to provide the Defined Benefit Plan with a fair rate of
return, sufficient liquidity, adequate security, and diversity of
11
We note that many of petitioner's contentions apply to the
Money Purchase Plan and not to the Defined Benefit Plan. See
supra note 1. Morrissey transferred nothing of value to the
Defined Benefit Plan.
- 16 -
investments. Respondent further contends that the 23 loans were
not isolated incidents but reflected an investment policy
benefiting the plan trustee as an individual. Additionally,
respondent contends that the 23 loans did not comply with the
Defined Benefit Plan provisions.12
Whether a plan has been operated for the exclusive benefit
of employees and their beneficiaries is determined on the basis
of the facts and circumstances. See Feroleto Steel Co. v.
Commissioner, 69 T.C. 97, 107 (1977); sec. 1.401-1(b)(3), Income
Tax Regs.; see also Bernard McMenamy, Contractor, Inc. v.
Commissioner, 442 F.2d 359 (8th Cir. 1971), affg. 54 T.C. 1057
(1970); Time Oil Co. v. Commissioner, 258 F.2d 237, 238-239 (9th
Cir. 1958), remanding 26 T.C. 1061 (1956). If a violation of the
exclusive benefit rule is found, then we look to the totality of
the transgressions that occurred in assessing whether it is an
abuse of discretion for the Commissioner to disqualify the plan.
The discretion to disqualify a plan should be exercised with
restraint, however, because the Department of Labor and the
Internal Revenue Service have a broad range of alternative
remedies available to ensure that a trust is properly
12
Again, we note that respondent has combined the Money
Purchase Plan and the Defined Benefit Plan, as we have previously
found that Morrissey made a series of six loans to himself from
the Defined Benefit Plan assets.
- 17 -
administered. See Winger's Depart. Store, Inc. v. Commissioner,
supra at 887-888.
We previously have held that the standards for fiduciary
behavior set forth in the Employee Retirement Income Security Act
of 1974 (ERISA), Pub. L. 93-406, sec. 404(a)(1), 88 Stat. 877,
current version at 29 U.S.C. sec. 1104 (1994), may be used to
help determine whether the exclusive benefit rule has been
violated. See Ada Orthopedic, Inc. v. Commissioner, T.C. Memo.
1994-606; see also Calfee, Halter & Griswold v. Commissioner, 88
T.C. 641, 652 (1987) ("the standards of title I and title II [of
ERISA] were closely coordinated by Congress specifically to
develop a unified set of rules"). ERISA section 404(a)(1)
requires a plan fiduciary to discharge his or her duties for the
exclusive purpose of (1) providing benefits to participants and
their beneficiaries and (2) defraying reasonable expenses of
administering the plan. Additionally, the fiduciary must (1)
perform those duties with the care, skill, prudence, and
diligence under the circumstances then prevailing that a prudent
investor 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, (2) diversify investments to minimize the risk of
large losses, unless diversification clearly is not prudent under
the circumstances, and (3) discharge those duties in accordance
with the documents and instruments governing the plan to the
- 18 -
extent they are consistent with the provisions of ERISA title I.
See id. The legislative history of ERISA section 404(a),
however, cautions: "It is expected that courts will interpret
the prudent man rule and other fiduciary standards bearing in
mind the special nature and purposes of employee benefit plans
intended to be effectuated by the Act." H. Rept. 93-533, at 12
(1973), 1974-3 C.B. 210, 221.13 Thus, we must "recognize that a
fiduciary's duties are circumscribed by Congress' overriding goal
of ensuring 'the soundness and stability of plans with respect to
adequate funds to pay promised benefits.'" Acosta v. Pacific
Enters., 950 F.2d 611, 618 (9th Cir. 1991) (quoting 29 U.S.C.
sec. 1001 (1988)).
The Department of Labor regulations state that a fiduciary
will satisfy the prudent investor requirements of ERISA section
404(a)(1)(B) if the fiduciary (i) gives appropriate consideration
to the relevant facts and circumstances of the investment or
investment course of action and (ii) acts accordingly. See 29
C.F.R. sec. 2550.404a-1(b)(1) (1997). Pursuant to those
regulations, "appropriate consideration" shall include, but is
not necessarily limited to:
13
The quoted material from H. Rept. 93-533, at 12 (1973),
1974-3 C.B. 210, 221, describes H.R. 2, 93d Cong., 2d Sess. sec.
111(b)(1) (1974), as reported by the House Committee on Education
and Labor, on Oct. 2, 1973, which became ERISA sec. 404(a)(1).
- 19 -
(i) A determination by the fiduciary that the
particular investment or investment course of action is
reasonably designed, as part of the portfolio * * *, to
further the purposes of the plan, taking into consideration
the risk of loss and the opportunity for gain (or other
return) associated with the investment or investment course
of action, and
(ii) Consideration of the following factors * * *
(A) The composition of the portfolio with regard
to diversification;
(B) The liquidity and current return of the
portfolio relative to the anticipated cash flow
requirements of the plan; and
(C) The projected return of the portfolio
relative to the funding objectives of the plan.
29 C.F.R. sec. 2550.404a-1(b)(2).
The Department of Labor requirements appear consistent with
criteria set forth by the Commissioner in Rev. Rul. 69-494, 1969-
2 C.B. 88, for testing compliance with the exclusive benefit
requirement of section 401(a)(2). Those criteria are: (1) Cost
must not exceed fair market value at the time of purchase; (2) a
fair return commensurate with the prevailing rate must be
provided; (3) sufficient liquidity must be maintained to permit
distributions in accordance with the terms of the plan; and (4)
the safeguards and diversity that a prudent investor would adhere
to must be present. We previously have indicated that the
criteria listed in Rev. Rul. 69-494, supra, although not binding
on the Court, are relevant to a determination as to whether the
prudent investor requirements have been satisfied. See Winger's
- 20 -
Depart. Store, Inc. v. Commissioner, 82 T.C. 869 (1984); Feroleto
Steel Co. v. Commissioner, supra; see also Ada Orthopedic, Inc.
v. Commissioner, supra.
Additionally, in applying the prudent investor rule, it has
been stated:
Under ERISA, as well as at common law, courts have focused
the inquiry under the "prudent man" rule on a review of the
fiduciary's independent investigation of the merits of a
particular investment, rather than on an evaluation of the
merits alone. As a leading commentator puts it, "the test
of prudence--the Prudent Man Rule--is one of conduct, and
not a test of the result of performance of the investment.
The focus of the inquiry is how the fiduciary acted in his
selection of the investment, and not whether his investments
succeeded or failed." In addition, the prudent man rule as
codified in ERISA is a flexible standard: the adequacy of a
fiduciary's investigation is to be evaluated in light of the
"character and aims" of the particular type of plan he
serves. [Donovan v. Cunningham, 716 F.2d 1455, 1467 (5th
Cir. 1983); fn. ref. omitted; citations omitted.]
Thus, the ultimate outcome of an investment is not proof that the
investment failed to meet the prudent investor rule. See
DeBruyne v. Equitable Life Assur. Socy. of U.S., 920 F.2d 457,
465 (7th Cir. 1990); see also Norton Bankruptcy Law and Practice
2d, sec. 156:9 (1997-98).
By examining the totality of transgressions that Morrissey
committed, we can assess whether it was an abuse of discretion
for respondent to disqualify the Defined Benefit Plan.
Morrissey, as sole shareholder of petitioner--the plan sponsor--
failed to make required contributions to the Defined Benefit
Plan. For the plan year ended October 31, 1989, the Schedule B
- 21 -
of Form 5500 reports the total present value of vested benefits
for participants as of the end of the plan year as $335,384.
Moreover, the Form 5500 reports that petitioner owes $231,796 in
contributions which are more than 3 months overdue. Thus, the
contributions petitioner owes to the Defined Benefit Plan
represent more than two-thirds of the participants' vested
benefits. For the plan year ended October 31, 1990, the Schedule
B of Form 5500 reports the total present value of vested benefits
for participants as of the end of the plan year as $341,583. In
addition, the Form 5500 reports $257,639 in contributions that
petitioner owes the trust which are more than 3 months overdue.
Thus, the contributions petitioner owes to the Defined Benefit
Plan represent 75 percent of the participants' vested benefits.
For the plan years ended October 31, 1988, 1989, and 1990,
petitioner owed contributions to the Defined Benefit Plan of
$188,983, $231,796, and $257,639, respectively. This pattern of
increasing overdue contributions each plan year shows that
petitioner was consistently not making contributions to the
Defined Benefit Plan even though the participants' vested
benefits were increasing. Moreover, on this record petitioner
has not shown that it refrained from taking deductions for
contributions to the Defined Benefit Plan which it was not
making. The problem is thus exacerbated.
- 22 -
Morrissey essentially used the Defined Benefit Plan as a
checking account, on which interest accumulated tax free, and not
as a retirement vehicle. From February 8, 1984, through December
9, 1988, Morrissey, as trustee of the Defined Benefit Plan, made
a series of six loans from the Defined Benefit Plan assets to
himself, for a total of $105,000. The Forms 5500 for the plan
years ended October 31, 1989 and 1990, report loans as of the
beginning of each plan year of $129,031 and $152,112,
respectively. The six notes all fail to state when payments are
due or when repayments should be made. Furthermore, none of the
six installment notes require Morrissey to provide security or
collateral for the loans. Additionally, none of the installment
notes state maturity dates.
It is clear from examining the activity in the Trust account
at the Bank of New York that Morrissey was using the Defined
Benefit Plan as a checking account for his personal needs rather
than as a retirement plan for the exclusive benefit of
petitioner's employees and beneficiaries. From February 8, 1984,
through December 9, 1988, Morrissey repeatedly took loans from
the Defined Benefit Plan leaving minimal cash balances. From
February 12, 1988, forward the cash balance in the Defined
Benefit Plan Trust account was less than $5,000, even though the
vested benefits of participants as of the end of the plan years
ended October 31, 1989 and 1990, were $335,384 and $341,583,
- 23 -
respectively. This repeated taking of loans from the Defined
Benefit Plan and leaving minimal cash balances in the Trust
account was clearly imprudent and contrary to the purpose of
ERISA. The purpose of ERISA was not to establish a tax-exempt
pocketbook for Morrissey.
Morrissey made no repayments on any of the six loans from
the Defined Benefit Plan. The Form 5500 for the plan year ended
October 31, 1990, reports total plan assets of $191,680 as of the
beginning of the plan year, including $152,112 in loans to
Morrissey and $646 in cash. Furthermore, it reports total plan
assets of $179,628 as of the end of the plan year, including
$137,270 in real estate and mortgages and $2,295 in cash. The
Form 5500 seems to suggest that Morrissey repaid all or part of
the $152,112 in loans that he owed to the Defined Benefit Plan
with $137,270 in real estate. However, we previously found that
Morrissey transferred his 50-percent interest in two parcels of
unencumbered real estate to the Money Purchase Plan and that he
never transferred any value to the Defined Benefit Plan to repay
his loans from the Defined Benefit Plan assets. See Morrissey v.
Commissioner, T.C. Memo. 1998-443. Moreover, the administrative
record contains no deeds or other evidence that any real estate
was transferred to the Defined Benefit Plan. Consequently, even
though the Form 5500 reports that the Defined Benefit Plan holds
- 24 -
$137,270 in real estate at the end of the plan year, we find that
Morrissey transferred no real estate to the Defined Benefit Plan.
Neither interest nor principal payments were ever made to
the Defined Benefit Plan. As trustee of the Defined Benefit
Plan, Morrissey made no attempt to collect any of the outstanding
six loans. Rather than collecting on the loans, Morrissey signed
a form titled "Employee's Waiver of Portion of Benefit Not Funded
Upon Distribution of Plan's Assets Pursuant to Plan Termination
Effective: September 26, 1990", in which he waived his right to
any unfunded benefits, to the extent that the Defined Benefit
Plan assets were insufficient to provide the actuarial equivalent
of his normal retirement benefit on the date of benefit
distributions. Consequently, Morrissey never paid any interest
or principal on the loans, and when he terminated the Defined
Benefit Plan, he intended not to repay his obligation to the
Defined Benefit Plan. It was inconsistent with the prudent
investor rule for the Defined Benefit Plan to have made those
loans and then to have allowed them to remain outstanding under
the circumstances. The purpose of ERISA is to provide retirement
benefits, not to provide a tax-free checking account to Morrissey
from which he can withdraw money at any time as loans and then
waive his obligation to repay. Morrissey's waiver of his rights
to any unfunded benefits, when most of his benefits under the
Defined Benefit Plan remained unfunded, coupled with the
- 25 -
termination of the Defined Benefit Plan, was contrary to the
purpose of ERISA.
In Winger's Depart. Store, Inc. v. Commissioner, 82 T.C. 869
(1984), the trustees of an employer-sponsored defined benefit
pension plan lent a major portion of the trust's assets to the
employer, through the employer's sole shareholder, to meet the
company's working capital needs. The loans were unsecured,
interest payments to the trust were delinquent, and most of the
principal was not repaid. The sole shareholder and his spouse
were cotrustees of the trust, and most of the benefits under the
plan accrued to the sole shareholder. We found that the trust
had not been operated for the exclusive benefit of the employees
and their beneficiaries, and we upheld the Commissioner's
determination that the related plan was no longer qualified under
section 401(a).
In Ada Orthopedic, Inc. v. Commissioner, T.C. Memo. 1994-
606, the trustees of an employer-sponsored defined benefit plan
lent a substantial portion of the plan's assets through unsecured
loans to participants, relatives, and friends of the trustees.
Some of the loans were made or extended without written
promissory notes, and principal and interest remained unpaid on
some of the loans. In addition, the trust acquired real property
by unrecorded quitclaim deeds without investigating title and
subsequently lost that property upon foreclosure of preexisting
- 26 -
mortgages; the trust invested in a tax-shelter partnership in
which one of the trustees acquired three loose diamonds, the
largest of which could not be located; and the plan disbursed
plan assets to nonparticipants without explanation. We found
under those circumstances that the trust's investment practices
violated the exclusive benefit rule. Accordingly, we upheld the
Commissioner's determination that the plan was no longer
qualified.
In Shedco, Inc. v. Commissioner, T.C. Memo. 1998-295, the
trustee of an employer-sponsored defined benefit pension plan
lent $2,250,000, representing approximately 90 percent of the
plan's assets, through an unsecured loan to a construction
company in which the trustee had served as executive vice
president until his retirement. The proceeds from the loan were
used for general working capital needs, and when the loan was
made, the construction company could have obtained funds from
several other sources. The trustee did not consult with counsel
or with the plan's actuarial firm about making the loan before
the plan lent the money to the construction company. The
construction company agreed orally to make semiannual principal
payments on the note of $250,000 each. It made two such
payments, and it made monthly payments of interest in accordance
with the terms of the note until it encountered problems in
Arizona's real estate economy. The construction company's
- 27 -
inability to repay the loan resulted from a downturn in the real
estate market and not from impropriety on its part. We found
that although the loan failed to meet the prudent investor test,
it was an isolated violation of that test, did not exhibit
indifference to the continued well-being of the plan, and was not
an attempt to manipulate the plan's assets for the benefit of
persons other than the plan's beneficiaries. We therefore found
that the loan did not violate the exclusive benefit rule.
Accordingly, we concluded that the extension of the loan did not
cause the plan to fail to satisfy the requirements of sections
401(a) and 501(a).
Our examination of the facts in this case leaves no doubt
that the Defined Benefit Plan was not managed for the exclusive
benefit of the employees. While the detailed facts of this case
are not identical with those in Winger's Depart. Store, Inc. v.
Commissioner, supra, or in Ada Orthopedic, Inc. v. Commissioner,
supra, the ultimate thrust of those cases is equally applicable
here. The facts in Winger's and Ada Orthopedic reveal investment
philosophies that were not aimed primarily at providing benefits
for the employees and their beneficiaries in general but instead
were aimed at benefiting the plan sponsors or certain
individuals. Indeed, the investment practices in those cases
involved flagrant violations of the exclusive benefit rule.
- 28 -
There is no question but that improper trust administration
and investment policies may result in violations of the exclusive
benefit rule. See Winger's Depart. Store, Inc. v. Commissioner,
supra at 886. As in Winger's Depart. Store, Inc. v.
Commissioner, supra at 882, a major portion of the assets of
petitioner's pension trust was lent to Morrissey, petitioner's
sole shareholder and trustee of the Defined Benefit Plan. As in
Winger's Dept. Store, Inc. v. Commissioner, supra at 882, during
the years in issue, interest thereon not only was delinquent but
also was never paid, and all of the principal remains
outstanding.
The instant case is distinguishable from Shedco, Inc. v.
Commissioner, supra. The loan in that case was sought because
the trustee believed it would be a good investment for the plan,
and not because he sought a benefit for himself (other than as a
beneficiary of the plan). The loan proceeds were not diverted
for the personal benefit of the plan trustee. Interest was
stated on the note at market rate, and payments were being made
until the construction company began to experience financial
difficulties. Moreover, the construction company's inability to
repay the loan resulted from a downturn in Arizona's real estate
market and not from impropriety on its part.
In the instant case, Morrissey's notes were backed by
nothing more than Morrissey's vested Accrued Benefit.
- 29 -
Furthermore, the loan proceeds flowed back to Morrissey.
Moreover, neither interest nor principal payments were ever made
to the Defined Benefit Plan. Indeed, when the Defined Benefit
Plan was terminated, nothing of any value was transferred to the
Defined Benefit Plan. Rather, Morrissey signed a form titled
"Employee's Waiver of Portion of Benefit Not Funded Upon
Distribution of Plan's Assets Pursuant to Plan Termination
Effective: September 26, 1990", in which he waived his right to
any unfunded benefits, to the extent that the Defined Benefit
Plan assets were insufficient to provide the actuarial equivalent
of his normal retirement benefit on the date of benefit
distributions. By allowing himself to obtain loans from the
Defined Benefit Plan and then waiving his right to unfunded
benefits at termination, Morrissey used the Defined Benefit Plan
assets as a ready source of cash for his immediate personal needs
as opposed to income for retirement.
In our opinion, the failure to make required contributions
owed to the Defined Benefit Plan, the lending of a large portion
of the Defined Benefit Plan's liquid assets through loans to the
trustee secured only by his vested Accrued Benefit, the failure
to pay any interest or repay the principal by the date of
termination of the Defined Benefit Plan, and the waiver by the
trustee of his right to any unfunded benefits combine to prove
that the Defined Benefit Plan was not managed for the exclusive
- 30 -
benefit of the employees, but for the immediate as opposed to the
retirement benefit of Morrissey. The Defined Benefit Plan was
used as a personal bank account by Morrissey for loans that were
made without regard to risk or prior repayment history. These
facts support respondent's disqualification of the Defined
Benefit Plan.
Also, and perhaps more important, our decision is based on a
determination that the entire investment philosophy of the
Defined Benefit Plan was aimed not at providing benefits for the
employees but at making capital available to Morrissey. The
manipulation of pension plan assets by a trustee who is also the
sole shareholder of the plan sponsor is a clear example of an
exclusive benefit rule violation. See Ada Orthopedic, Inc. v.
Commissioner, T.C. Memo. 1994-606.
In the instant case, we find the indifference toward the
continued well-being of the plan that we found in Winger's
Depart. Store, Inc. v. Commissioner, 82 T.C. 869 (1984), and Ada
Orthopedic, Inc. v. Commissioner, supra. Under the circumstances
of this case, we hold that, because petitioner's Defined Benefit
Plan did not operate for the exclusive benefit of employees for
the plan years ending October 31, 1990, and thereafter, it failed
to be qualified during those years under section 401(a) and hence
failed to satisfy the requirements of section 501(a) tax
- 31 -
exemption. Accordingly, respondent properly revoked the
qualified status of the Defined Benefit Plan.
We have carefully considered all remaining arguments made by
the parties for holdings contrary to those expressed herein, and,
to the extent not discussed above, find them to be irrelevant or
without merit.
To reflect the foregoing,
Decision will be entered
for respondent.