BVR Logo May 6, 2020 | Issue #212-1

BVWire is your go-to source for the latest in the business valuation profession. Highlights for this week include:

ESOP plaintiff appeals case dismissal, leaning on controversial Brundle case

In appealing the dismissal of her lawsuit with the 4th Circuit Court of Appeals, an ESOP plaintiff frequently invokes the Brundle case in which the same appeals court affirmed a $30 million judgment for the ESOP. The dismissal was a rare victory for ESOP defendants after several major court rulings in favor of ESOP plaintiffs.

No harm done: At issue was the 2016 sale of shares in a construction company to an ESOP. An independent trustee oversaw the transaction and an experienced ESOP appraisal firm prepared the valuation underlying the transaction and subsequent annual valuations. The ESOP paid $198 million for an 80% ownership stake in the company (8 million shares). The transaction was financed with a loan from the company and the selling shareholders received warrants that would enable them to acquire additional voting stock. A 2016 year-end annual appraisal, which came about a month after the ESOP’s formation, valued the shares at $64.8 million.

The plaintiff, a former company employee, sued. The gist of the allegations was that the $64.8 million valuation showed the trustee (and other defendants) caused the plan to overpay for company stock. Last fall, the district court dismissed the case, finding the plaintiff had not shown an “injury in fact.” The plaintiff had no standing “to pursue her claims in this Court.”

The court said the plaintiff “fundamentally misunderstands” the transaction and the subsequent valuation. According to the court, the ESOP had taken on debt to obtain the stock. The expected value of the ESOP’s shares, in the short term, would be zero. However, the $64.8 million year-end valuation meant the shares had already appreciated in value by about 33% in less than a month. Rather than suffering an injury, the ESOP “realized an immediate equitable benefit.” The court analogized the situation to obtaining a mortgage when buying a home and ultimately finding the home is worth more than the mortgage. The buyer would be able to buy the house at a discount and “be left with a tidy profit” if she sold the house after paying off the mortgage, the court postulated.

Premature dismissal: The appeal argues the district court prematurely decided the merits of the plaintiff’s claim when it dismissed the case on jurisdictional grounds. The court’s decision was based on “irrelevant and unsupported factual findings.” The appeal maintains the complaint showed the plaintiff had a “personal stake in the outcome of the controversy” by alleging that the contested transaction negatively affected the plaintiff’s retirement account. At this early stage in the litigation (prediscovery), the issue was whether the plaintiff’s complaint stated facts sufficient to show an injury, not whether the plaintiff’s claims had merit. U.S. Supreme Court and 4th Circuit precedent required the district court to take the plaintiff’s allegations as true, the appeal says. The district court violated precedent.

The appeal frequently refers to the heavily litigated Brundle v. Wilmington Trust case. Brundle presented facts similar to those the plaintiff alleged here, the appeal says. It points to the “same unique warrant structure” and says the ESOP valuation here, performed by the appraisal firm that had done the Brundle appraisal, “contained similar errors as those in Brundle.” For example, the ESOP valuation failed to consider that the warrants could “dilute the ESOP’s share of ownership to just 60% of the Company” and the warrants allowed the sellers to “retain elements of control over the Company.” The district court failed to address, “much less assume the truth of,” the plaintiff’s allegation that the ESOP valuation was inflated for these reasons.

The plaintiff calls the district court’s mortgage analogy flawed. For one, it focused on equity values after the contested transaction when the proper inquiry would have been whether the ESOP paid more than fair market value at the time of the transaction. Further, the mortgage analysis assumes the price the ESOP paid was correct and “entirely sidesteps the proper analysis of whether the ESOP paid too much for [company] stock,” the appeal argues. The plaintiff asks the 4th Circuit to reverse the district court and let the case proceed to discovery so she can prove her claims.

Stay tuned for further developments in this case.

A digest of the district court’s ruling in favor of the defendants 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. Digests for Brundle v. Wilmington Trust N.A., 241 F.Supp. 3d 610 (E.D. Va. 2017); Brundle v. Wilmington Trust N.A., 258 F. Supp. 3d 647 (E.D. Va. 2017); and Brundle v. Wilmington Trust N.A., 919 F.3d 763 (4th Cir. 2019), and the courts’ opinions also are available at BVLaw.

Pension Rights Center files amicus brief in support of ESOP plaintiff

A nonprofit consumer organization whose mission is “to protect and promote the retirement security of American workers, retirees, and their families” recently filed an amicus curiae brief in support of the appeal the plaintiff in Lee filed with the 4th Circuit (see above).

The Pension Rights Center expressed concern over the ability of participants in and beneficiaries of ESOPs to bring a lawsuit aimed at enforcing ERISA’s fiduciary rules. ERISA rules are “even more crucial in the case of private company ESOPs than for other retirement plans because of the unique structure of these plans,” the brief says. “ESOPs pose special risks for participants,” the brief claims. It also notes that “ESOPs are not a gift to employees” but represent a form of deferred compensation.

The plaintiff in the Lee case “plausibly alleged” that the trustee breached its fiduciary duties, caused the plan to enter into a prohibited transaction, and caused financial injury, the brief says. In dismissing the plaintiff’s claims at the pleading stage, the district court erred.

The brief notes that Brundle “and numerous other cases” show the plaintiff’s allegations are plausible.

Workers’ retirement savings are lost when an ESOP pays an inflated price for employer stock. If the ESOP pays too much, some of the participants’ potential retirement savings are transferred to the selling shareholders. This happens if the ESOP trustee did not conduct adequate due diligence before approving the purchase price or failed to engage in hard bargaining to get the best deal possible for the ESOP.

The brief explains the prohibited-transaction allegation. “A corporate insider’s sale of stock to an ESOP is per se prohibited because such transactions are ‘likely to injure the [ ] plan.’” The transactions are only permitted if the trustee can demonstrate that the ESOP did not pay more than “adequate consideration,” i.e., fair market value. “In fact, the trustee’s duty of undivided loyalty to the ESOP participants requires it to act like a real-world buyer who would negotiate with the sellers to try to get the best possible price for the ESOP,” the brief says.

It notes that cases such as Brundle, Perez v. Bruister, and Pizzella v. Vinoskey illustrate that ESOP trustees don’t always conduct “real world’” due diligence or try to obtain the best price possible for the ESOP.

The brief says the plaintiff “sufficiently alleged an injury in fact” and asks that the 4th Circuit reverse the district court’s dismissal and allow the plaintiff to conduct discovery. According to the amicus brief, “[i]f the instant case comes back to the 4th Circuit, it may very well be in the same posture as Brundle—an appeal following a trial in which the trial court ordered a substantial judgment based on a finding that the ESOP trustee violated its fiduciary obligations.”

DOL announces big ESOP settlement with Wilmington Trust

In yet another ESOP development, the Secretary of Labor recently announced that it reached a settlement with Wilmington Trust NA, an international financial services firm with expertise in serving as trustee in major ESOP transactions.

The DOL’s news release, dated April 30, 2020, says the settlement ends three DOL lawsuits and 18 investigations by the Employee Benefits Security Administration (EBSA) against Wilmington Trust. All proceedings alleged that Wilmington Trust breached its ERISA duties by causing the respective ESOP to overpay for company stock.

The settlement requires Wilmington Trust to pay $80 million to 21 ESOPs as well as $8 million to the government for the losses it allegedly caused to the ESOPs. In agreeing to the settlement, Wilmington does not admit or deny the allegations.

For more details on the companies whose ESOP transactions gave rise to the suits and allegations, click here.

Should you consider a special COVID-19 premium?

During a recent webinar, a question came up as to whether or not valuation analysts should be separately identifying a risk rate associated with the impact of COVID-19 on a subject company. This notion has been kicking around for a while, apparently surfacing back in the 2008-2009 financial crisis. The webinar presenter, Jim Alerding (Alerding Consulting), cited from an article written during that time: “Distressed entities generally have higher risk profiles and lower profitability levels compared to their healthy competitors, and a proper discount for distress, usually at least 20%, therefore must be built into the valuation.”

While most valuers would certainly agree with the first part of this statement, the idea of a rule of thumb for a separate discount is another matter. “I’m not sold on this,” says Alerding. “It’s better to build the risk into the cash flows and discount rate.” Of course, when you do that, you have to be careful not to double count the risk. Plus, Alerding advises that, when you do come up with a final cost of capital rate, you need to take a step back and ask whether it makes sense for the subject business.

David Lurvey, Timothy O’Brien, and George J. Schultze wrote the article quoted above, “Hidden Treasures: Techniques for Valuing Distressed Enterprises,” which was published by the Turnaround Management Association.

A recording of Alerding’s webinar, Valuing Distressed and Impaired Companies in the Time of Coronavirus, is available if you click here (purchase required for nonsubscribers).

IRS adds locations to job postings for BV experts

A few weeks ago, we alerted you that the IRS was looking to fill six open positions for experienced business appraisers. The agency has now added several cities, including San Francisco and San Jose, Calif., to the job posting. The salary ranges from $92,568 to $137,045 per year, and the positions have the title of financial analyst (business appraiser). The posting says: “As a Financial Analyst (Business Appraiser) in the IRS you will perform unique, sometimes controversial and precedent setting appraisals of businesses and business interests where the appraisal can have significant tax impact, tax compliance, affect large segments of the taxpayer(s) population, and have the potential to suggest needed legislative change.” To get all the details, including job description, experience requirements, locations offered, how to apply, and more, click here.

NACVA adds to credentialed ranks

In the first quarter of 2020, 96 members of the National Association of Certified Valuators and Analysts (NACVA) earned the Certified Valuation Analyst (CVA) credential, according to an announcement. Also, two members earned the Master Analyst in Financial Forensics (MAFF) credential. These members completed the training, exam, and credentialing processes for the two credentials.

IVSC extends comment period on inventory guidance

The International Valuation Standards Council (IVSC), the independent standard-setter for the global valuation profession, has extended the comment period to June 30 for its exposure draft on the valuation of inventory. The exposure draft addresses several themes, with particular attention to changes in the top-down method. Comments on the draft, “IVS 230—Inventory Exposure Draft,” can be sent to The valuation of inventory project resulted from feedback received during the agenda consultation process the IVSC conducted in 2017 and 2018, and the Business Valuation Board, with support from the Standards Review Board, has led it.

BV movers . . .

People: David Gaynor, ASA, has joined L.A.-based Marshall & Stevens as a managing director in the firm’s national Financial Valuation Practice and its national Healthcare Valuation Practice; he will be in the firm’s New York City office … Former Delaware Supreme Court Chief Justice Leo Strine has joined the law firm of Wachtell, Lipton, Rosen & Katz; he previously served as chancellor of the Delaware Court of Chancery, where he left a deep imprint through his often-lengthy opinions, full of quotable comments and courtroom asides.

Firms: A strategic partnership has been formed between Spain-based Equidam, an online valuation platform for startups, and Equifund (Wilmington, Del.), an equity crowdfunding platform that delivers vetted, early-stage investment opportunities … The valuation professionals at Houston-based Weaver will join their colleagues in the firm’s assurance, tax, risk advisory, forensics, and transaction advisory practices to expand the firm’s offerings to include restructuring and turnaround services in addition to CFO advisory services; both services are designed to help companies respond to their biggest challenges, such as the economic consequences of the coronavirus pandemic.

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