The DOL recently settled a suit against Professional Fiduciary Services (PFS) related to a 2012 transaction in which PFS served as trustee in an ESOP acquisition of outstanding company stock. Following the playbook, DOL alleged PFS breached its fiduciary duties by causing the ESOP to pay more than fair market value for the shares.
The company was Contractors Register Inc., a New York-based company that provides construction search engines. According to Bloomberg, the company publishes regional directories and databases for the construction industry. In 2010, the company’s shareholders recapitalized most of their equity in the company with long-term, low-interest notes. The company’s capital structure was highly leveraged, but the balance sheet showed over $90 million in cash. The remaining shareholder then wanted to sell his interest to employees via an ESOP. The acquisition, which took place in late 2012, left the ESOP with 100% of the company stock.
PFS was engaged as independent trustee. PFS hired an independent appraisal firm and a law firm to act as trustee counsel.
Familiar complaint: The DOL’s complaint alleged PFS breached its fiduciary obligations to the plan by failing to scrutinize the valuations underlying the transaction and overlooking red flags, such as overly aggressive revenue projections, which produced an inflated valuation of the company’s stock. Among other things, the DOL objected to the projected 2.2% compound annual growth rate for 2013 to 2017. The DOL said the appraiser did not explain how the company would achieve this growth rate but simply relied on management projections. Further, projections of capital expenditures and working capital needs were unreasonable. Also, there was no real negotiation over the purchase price.
The seller offered to sell the outstanding shares for $26,770,000. The independent valuator arrived at a value range between $26.2 million and $40.5 million, with a midpoint of $32.9 million (3.4 to 4.1 times average EBITDA). PFS agreed to a price of $26.7 million. The seller provided 100% of the financing in the form of a note from the company. There were no warrants or other claims on equity.
The DOL sued PFS in December 2019. In December 2020, the parties agreed to a settlement in mediation.
Settlement: Under the recent settlement, PFS will pay $750,000 to the ESOP in three installments. Also, PFS and its president, John Michael Maier, agreed that Maier would no longer accept engagements to serve as trustee in new ESOP formation transactions. PFS notes that the settlement does not prevent PFS/Maier from accepting engagements to sell ESOP stock, serving as successor trustee, undertaking stock acquisitions for existing ESOPs, undertaking, releveraging transactions, and continuing to serve as trustee for existing clients. PFS also agreed not to accept indemnification from CRI or other ESOP clients for breach of fiduciary duties violations. Under the settlement, PFS and Maier do not admit to any breach of their fiduciary duty to the CRI ESOP.