The trustees of Drug Fair, Inc.'s profit-sharing plan appear to have won the first round in a suit brought by disgruntled employes who allege in court papers that their future retirement benefits suffered when the company stock in which the plan was heavily invested plummeted. A basically similar case involving the Marriott Corp. is also winding its way through the judicial system.
"The (Drug Fair employes') chances of success were substantially weakened" (by the judge's decision), said Larry Hass, a securities lawyer with Groom & Nordberg who was asked to comment on the issues. On the other hand, he added that the judge's failure to dismiss a fraud complaint in the Drug Fair case "doesn't bode well for the (trustees) in the Marriott case."
Three Drug Fair employes had alleged in a 1978 suit that profit sharing plan trustees, who include Drug Fair's president and chairman plus Riggs National Bank, had violated pension laws by investing so much of their profit sharing plan's assets in Drug Fair stock, holding it while the price was falling (from $30 a share in 1970 to $3.37 in 1974) and then selling it back to the company at a price lower than they could have received on the open market. The suit asked for $10 million in compensatory and punitive damages on behalf of 800 employes covered by the fund.
According to Pensions & Investiments magazine, the Drug Fair case is believed to be the first ever in which concentration of employer securities in a profit sharing plan is challenged. The Employe Retirement Income Security Act of 1974 sets limit of 10 percent on the amount of employer stock that can be in the portfolio of a defined benefit plan, but none on profit sharing plans.
Last October U.S. District Court Judge Thomas A. Flannery dismissed most of the complaints against the trustees. He found the investment in company stock had not been improper, nor was its sale back to the company at list price. The rejected claim, the court ruled, "boils down to nothing more than an assumption that the defendants somehow, if only they had tried hard enough, could have obtained more profit from the sale."
In Hass's opinion, Flannery's ruling pretty much cut the heart out of the Drug Fair employes' case. But the judge asked for a more definite statement on alleged violations of securities fraud laws by the trustees. Last week attorneys for the employes alleged in court papers that whereas the trustees had told plan participants investments were made for their benefit, they inadequately disclosed their investment policies by not telling the employes that some part of the fund would always be invested in Drug Fair stock. In his October ruling the judge had remarked, "It certainly appears to have been no great secret that the plan held Drug Fair stock."
Hass believes the fact that Flannery did not dismiss the fraud count is not a good omen for the Marriott trustees. Besides allegations of secruities fraud in the Marriott case there are also allegations of fiduciary violations involving conflict of interest. The suit was filed in 1977 in U.S. District Court in Baltimore by waitress Velma O'Neill who alleged that her retirement benefits were cut in half. According to Marriott's annual reports the value of its stock fell from $31.93 in 1972 to $12.80 in 1975, the year she was discharged. And, according to papers filed in court on behalf of O'Neill and other employes in 1972 half of the pension fund portfolio consisted of Marriott stock by 1975 that portion had been reduced to 31 percent.
Nevertheless, Michael S. Gordon, attorney for O'Neill and other employes, has alleged in court papers that the trustees have violated their own guidelines that no more than 20 percent of the fund be invested in company stock. Moreover, Gordon claims in court papers that between 1972 and 1975 some Marriott executives sold at least 273,272 shares of company stock worth $6.2 million from their own accounts. It is alleged that when the stock had risen from a December 1973 low of $16.81 to 20.33, the defendants and other insiders sold $135,214 shares worth $2.7 million. (There were 33 million shares of Marriott outstanding in 1975.)
Immediately after the insider activity the stock began to decline, reaching a low of $6.66 in December 1974. Gordon speculates that the desinclination of pension fund trustees -- some of whom are the same Marriott executives -- to sell stock during that period could have been based on a desire to keep up the price of the stock while they were unloading.
Gordon has also alleged in court documents that the trustees violated state fiduciary laws by making $1.3 million in loans to developer Walter J. Kassuba in the early 1970s. Kassuba, one of the nation's largest builders, declared Chapter 11 bankruptcy in 1973, listing $110 million in mortgage loans outstanding to realty trusts and $402 million in mortgage liabilities to corporations and insurance companies.
The Securities and exchange Commission is now believed to be conducting an inquiry into possible violations raised by the suit. Tom Burke, a Marriott spokesman, charged that Gordon was responsible for getting the SEC into the case by seeking publicity in the media. Burke declined to discuss the O'Neill case except to say, "We think the whole suit lacks merit. There is no evidence of wrong doing. We will defend ourselves in court."