Imagine if you were playing on a baseball team and the opposing players argue that you are violating the rules of soccer. That’s what it’s like when private parties and the Department of Labor challenge ESOP valuations, say speakers during a recent BVR webinar. Plaintiffs play a very different valuation ballgame, which confounds experts who go up against them in a dispute involving allegations that an ESOP paid more than “fair market value” for stock of the sponsor company.

The webinar speakers, attorney Richard Pearl (McDermott Will & Emery LLP) and valuation expert and former ESOP trustee Jim Joyner (Integra Valuation Consulting LLC), discussed some fundamental issues under ERISA and valuation concepts that they believe plaintiffs, the DOL, and many courts “are just getting wrong.” For example:

• ERISA does not require ESOP trustees to act like private-equity buyers;

• ERISA requires assessment of “fair market value,” not some other standard of value such as investment value;

• Expert witnesses with extensive experience purchasing companies, but no experience in fair market value appraisals, have no place in ESOP litigation;

• ESOPs do not have to obtain “unfettered” control of the company; and

• Regulation by litigation and enforcement actions does not provide guidance to ESOP practitioners on ESOP transactions.

Making matters worse, many courts have been led into error, and the number of ESOPs has been declining recently. The situation has gotten to the point where various organizations, including the American Society of Appraisers (ASA), have filed amicus briefs in support of appraisers and trustees. The speakers discussed the appeal regarding the Lee case (Lee v. Argent Trust Co.), a private action that a district court dismissed. The ASA and National Center for Employee Ownership (NCEO) had filed amicus briefs on behalf of the defendants. After those amicus briefs were filed, the plaintiff voluntarily dismissed her appeal.

This issue of BVWire has more details on the opinion in the Lee case.

A recording of the webinar, Class-Action Litigation Involving ERISA/ESOP Valuation Issues, is available if you click here (purchase required unless you’re a BVR Training Passport holder or subscriber to the BVResearch Pro platform).

Appeal in Lee ESOP case dismissed; ESOP class action also close to resolution

The last few weeks have seen the end of two ESOP litigations that have drawn a lot of attention from the ESOP community. They include the Lee case in which the plaintiff appealed the district court’s dismissal of her complaint for failure to show an injury as well as a class action against Raydon Corp., the trustee, and various individuals for alleged ERISA violations related to a 2015 company stock sale.

Dismissal in Lee case: The case centered on the 2016 sale of company stock to an ESOP. The transaction was financed with a loan from the company. The ESOP paid $198 million for an 80% ownership stake in the company. A 2016 year-end annual appraisal that came about two weeks later valued the shares at $64.8 million. The defendant trustee oversaw the transaction; an experienced ESOP appraiser prepared the valuation underlying the transaction and subsequent annual valuations.

The plaintiff’s complaint suggested that the two figures showed the trustee overpaid for company stock, but a district court, last fall, dismissed the case. The court said the plaintiff “fundamentally misunderstands” the transaction and the subsequent valuation and that the ESOP “realized an immediate equitable benefit.”

In her appeal to the 4th Circuit Court of Appeals, the plaintiff asserted that the facts in her case were similar to those in the Brundle case in which the 4th Circuit had affirmed the district court’s substantial judgment for the plaintiff. The trustee, in turn, asked the 4th Circuit to affirm the dismissal, arguing the allegations pled in Brundle were “far different—and more significant—than the barebones allegations in the Complaint here.” “Federal courts are called to sort viable ERISA claims from those that are merely would-be clones of Brundle,” the trustee said.

Both sides received support from amici. The amicus brief of the Pension Rights Center (PRC) argued the plaintiff made plausible allegations that the trustee caused the plan to overpay for company stock. ESOP trustees don’t always conduct “real world’” due diligence or try to obtain the best price possible for the ESOP, the PRC claimed. The amicus brief of the American Society of Appraisers retorted that the practices of “real world” buyers (i.e., private equity buyers) are “incompatible with ERISA’s requirements and fundamental valuation principles.” The ASA noted the standard of value applicable to ESOP transactions is fair market value, which is “not the lowest possible price a [private equity] buyer might pay.”

On July 16, the 4th Circuit granted “the motion to dismiss this appeal,” noting there did not appear to be opposition to the dismissal. This marks the end of the case.

Settlement underway in Raydon case: This case arose out of a 2015 transaction in which shareholders in Raydon, a company providing simulation and training technology for military outfits, including the U.S. Army, sold company stock to an ESOP for $60.5 million. The transaction followed the owner’s failed attempt to sell the company and the loss of an important contract with the army. The transaction also included contested million-dollar payments to two director defendants in exchange for noncompetes. An independent trustee oversaw the ESOP transaction. At the end of 2015, the fair market value of company stock was $5.11 million. Two years later, the stock was valued at $4.55 million. The plaintiff was a participant in the ESOP and alleged the trustee and selling shareholders engaged in a prohibited transaction (i.e., paying more than fair market value for company stock) and the trustee and others breached their fiduciary duties to the ESOP.

In March 2020, the federal district court granted the plaintiff’s motion for class certification, finding the plaintiff alleged sufficient facts to show she suffered an injury “fairly traceable to Defendants’ conduct.” The court said the plaintiff also showed she was a member of the proposed class of plaintiffs.

On July 20, the parties filed a joint notice of settlement in which they state they “have reached agreement on the monetary and primary non-monetary terms of a proposed class action settlement.” They said they would seek approval of the court under the applicable statute and asked the court to stay the action in the meantime.

Check out our earlier reporting in BVWire on the appeal in the Lee case. Also, a digest of the district court’s dismissal in Lee v. Argent Trust Co., 2019 U.S. Dist. LEXIS 132066 (Aug. 7, 2019), and the court’s opinion are available to subscribers of BVLaw.

CCF being abandoned for DCF, NACVA speakers say

The capitalized cash flow (CCF) method has been all but abandoned for the time being in favor of the discounted cash flow (DCF), points out Chris Hamilton (Arxis Financial Inc.). What’s more, he is factoring the impacts more into the benefit streams than in the risk factor. Hamilton spoke during one of the “Hardball With Hitchner” sessions at the NACVA and the CTI’s 2020 Business Valuation and Financial Litigation Super Conference, which was held live online over five full days (June 15 to June 19).

Outside the box: Be aware that you are not limited to a five-year DCF—you can use two years, three years, or whatever time frames you feel are appropriate. Jim Hitchner (Valuation Products and Services), who moderated the session, says he is using a three-step approach: Step 1 is to examine whether the subject firm can even survive over a certain time frame; Step 2 is to determine whether the firm can improve and to what extent; and Step 3 is to estimate some level of normalized operations post-pandemic. How this analysis pans out can help determine your discrete periods. What’s more, consider using different risk rates for different discrete time periods.

This is just one of the many tips on doing valuations amid the current pandemic offered during the conference. For more, see the article “25 Tips on Dealing With COVID-19 From the NACVA Conference” in the August issue of Business Valuation Update. For nonsubscribers, we are making this issue available on a stand-alone basis—along with other issues that include practical advice on dealing with valuations amid the pandemic.

Extra: A replay of the NACVA conference is underway online all this week. Click here for more information.

Reminder to take the A/E firm valuation survey

If you haven’t done so already, please take a few minutes to respond to a survey on the architecture, engineering, and environmental consulting industries (A/E firms) for the A/E Business Valuation and M&A Transaction Study, 8th edition, from Rusk O’Brien Gido + Partners. The study includes data from distinct stock transactions along with supplemental data from publicly available sources and is the most comprehensive and reliable study of its kind for this industry. If you participate in the survey, you will get $200 off the $399 study price. To complete the survey, which will take around 25 minutes, click here. For comparison purposes, the study’s seventh edition—and prior editions—are available if you click here. Thank you!

D&P surveys impairments in the
Asia-Pacific region

Close to a third of the companies surveyed in the Asia-Pacific (APAC) region anticipate taking a goodwill impairment, according to a survey report from Duff & Phelps. Also, about 53% of the participants mentioned that their company has started to make downward adjustments to their cash-flow projections to reflect the impact of COVID-19. As to the economic outlook, almost half of the survey participants believe that the current economic downturn will be over by the end of the 2021 survey. The survey polled over 600 finance executives and advisors from the APAC region.

Updated guide bridges Canadian valuation standards to IVS

The CBV Institute is Canada’s valuation professional organization (VPO) whose members have the Chartered Business Valuator designation. They adhere to the CBV Institute Practice Standards, which are largely consistent with the International Valuation Standards (IVS), although some differences do exist. To assist its members in applying IVS, CBV Institute has published an update to its guide, A Bridge From CBV Institute Practice Standards to IVS, to highlight areas of differences between the two sets of standards. Click here to download a copy of the guide.

Extra: The CBV Institute’s 2020 Business Valuation Congress was canceled, but the organization offers the sessions as a series of webinars. Click here for more information.

BV movers . . .

People: Justin Pate has joined Tampa, Fla.-based Vision Point Capital full-time as a financial analyst; he is a recent graduate of Tampa University who interned with the firm for the past five months … Ben Grimaldi has been promoted to senior associate in the business valuation department at Akron, Ohio-based Apple Growth Partners … Jolene Fraser, CPA, CFF, CFE, a managing director in the forensic, litigation, and valuation services group at EisnerAmper, San Francisco, was named chair of the California Society of CPAs for the 2020-21 term … Bryan Browning, CFA, ASA, has retired after 35 years with Valuation Research Corp. (VRC); he is staying on in a consulting capacity, continuing to share his experiences, and serve VRC clients … Rupesh Shah and Aaron Terry have joined FTI Consulting as managing directors in its energy, power, and products practice.

Firms: RoseRyan (Newark, Calif.) has entered into a new strategic partnership with AST Private Company Solutions to use Astrella, a new cloud-based software-as-a-service platform that brings together blockchain technology, artificial intelligence (AI), and predictive analytics … San Francisco-based BPM LLP expands in southern California by combining with Warnick Maestas & Maroney (WMM) of Irvine, Calif., on August 1 … Naperville, Ill.-based Sikich LLP is expanding its presence in central Illinois by adding Heinold Banwart of East Peoria, Ill., in a deal expected to close on August 31 … Stout has launched a new intellectual property advisory and transactions practice, a fully integrated team of investment bankers, valuation and dispute experts, attorneys, and technical experts.

Please send your professional and firm news to us at editor@bvresources.com.

CPE events

• Valuation of Inventory: Taking Stock of the Guidance, August 20, 10:00 a.m.-11:40 a.m. PT/1:00 p.m.-2:40 p.m. ET. Featuring: Anthony J. Pumphrey (Valuation Research Corp.). Part of BVR’s Special Series on Fair Value.

Given divergences in both practice and guidance, inventory valuation can seem challenging. This webinar illustrates simple, straightforward modifications to the valuation of inventory that you can incorporate into your valuation process.

• Excelling in Litigation and Dispute-Related Valuations: How to Not Get Caught Bringing a Knife to a Gunfight, August 25, 10:00 a.m.-11:40 a.m. PT/1:00 p.m.-2:40 p.m. ET. Featuring: Sean Saari (Marcum LLP) and Bob Ranallo (Marcum LLP).

How to prepare yourself, and your valuation report, when you know your work will be subject to review and critique in a litigation or dispute setting is discussed.