The U.S. Department of Labor recently prevailed in a district court of Virginia case involving multiple Employee Stock Ownership Plan (ESOP) valuation issues.
The case involved allegations that the selling shareholder, who was also a fiduciary of the employee stock ownership plan, as well as the bank hired to represent the ESOP as an independent fiduciary, breached their fiduciary duties by allowing the plan to overpay for the shareholder’s stock.
The district court issued a lengthy ruling on the case which addressed multiple common valuation practices such as normalization adjustments, discounting, capitalization rates, and proper look-back periods for the purposes of capitalization. For example, the Court found that:
- The conclusion of value was strikingly close to an initial estimated value that had been floated by ESOP counsel and advisors at the inception of the transaction;
- The appraisal was performed on a controlling basis even though the seller/owner and his wife were still going to be two of three ESOP co-trustees and occupy two of three company director seats;
- Almost of all of the appraiser’s assumptions, including his capitalization rate, fluctuated significantly relative to previous appraisals that he had performed on the company and all in a direction towards a conclusion of higher value;
- The appraiser did not obtain financial projections or prepare his own and get management buy-in and the appraisal utilized only a capitalized cash flow method to the exclusion of a discounted cash flow method(discounted cash flow method); and
- The ESOP trustee raised many concerns with the draft appraisal but did not follow through and then went ahead and agreed to a purchase price before reviewing the final appraisal.
This case reminds us that (1) much discussions were needed to justify the departure from previous yearly valuations and big rise of stock value, (2) an impartial review of the valuation results might have red flagged the flaws, (3) the fiduciaries would have been wise to remember that fiduciary duties imposed by ERISA are “the highest known to the law” and any decisions made in fiduciary capacity should have been made with an “eye single to the interests of the participants and beneficiaries.” (4) a genuine negotiation with respect to the purchase price should be conducted.
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