DOL sues over ESOP; trustee launches Daubert attack

BVWireIssue #188-1
May 2, 2018

ESOP valuations
daubert, expert testimony, breach of fiduciary duty, discounted cash flow (DCF), fair market value (FMV), reliability, overpayment, employee stock ownership plan (ESOP), adequate consideration, Department of Labor

In a developing ESOP case, the court recently excluded a chunk of the government expert’s damages testimony and dismissed one of the counts for lack of damages evidence. However, the trustee’s multifaceted attack on the expert’s qualifications was not successful and the government’s “overpayment” claim is still alive.

Unreliable methodology: In 2004, the owners of a Virginia company sold 48% of their company stock to an ESOP for $220 per share. Late in 2010, they decided to sell the remaining 52% interest. An independent trustee and an independent valuation firm acted on behalf of the plan. In an early draft, the valuator said it would be fair to the ESOP to pay $405.73 per share based on the present value of the company’s future cash flow. The trustee noted a valuation from a year ago indicated a $285-per-share price. The valuator explained the increase in value by noting, among other things, the ESOP owners would control the company as a result of the transaction. The trustee accepted the explanation. A final appraisal said a price between $405.73 per share and $408.58 per share would be fair to the ESOP. On recommendation of the trustee, the owner ultimately accepted $406 per share.

The Department of Labor sued, alleging the trustee breached its fiduciary duty to the ESOP by causing the plan to pay more than fair market value. In a separate count, the government alleged the trustee improperly allowed the value of existing stocks to decrease as a result of the transaction. The government relied on expert testimony to support its claims.

The trustee challenged the damages expert’s qualifications under Federal Rule of Evidence 702 and claimed the expert’s calculations were unreliable under Daubert. The expert did not have business valuation experience, was not a CPA or CFA, and was not part of the ESOP community—that is, he did not know the standard applicable to ERISA transactions, the trustee noted. The court disagreed, finding the expert had been qualified as a witness in many other ESOP cases. It said the expert had significant experience in the private equity industry, a background that “provides guidance on the sort of diligence required in this transaction.”

However, the court agreed with the trustee that there were some insurmountable problems with valuation methodology or the way the expert applied a valid methodology. In terms of the overpayment claim, the court found the expert incorrectly applied the guideline public company method and precluded him from using it for his valuation. Further, the expert’s approach to determining damages that existing shareholders allegedly incurred due to the transaction “does not provide any basis to figure out what those damages would be.” Because there was no damages testimony to sustain this count, it collapsed. The rest of the case will go forward.

A digest of Acosta v. Vinoskey, 2018 U.S. Dist. LEXIS 64094 (April 17, 2018), and the court’s opinion, will be available soon at BVLaw.

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