ESOP trustee’s failure to vet valuation causes significant overpayment


Brundle v. Wilmington Trust N.A., 2017 U.S. Dist. LEXIS 35811 (March 13, 2017)

Trustee performance was at the center of a recent case, featuring a nontraditional ESOP structure. The court, doing it what it said the trustee should have done but did not do, scrutinized the valuation of the ESOP’s financial advisor and found it had obvious deficiencies. Had the trustee engaged with the valuation, it would have discovered numerous weaknesses and prevented the ESOP from overpaying for the company stock, the court concluded.

When, in 2013, the principal shareholders in a private security firm wanted to sell their shares, they decided an ESOP was a perfect “exit strategy.” An investment bank advising on ESOP formation devised “a more advanced 100% structure” that would allow the sellers to sell most of their interest but still keep control over the company.

The company’s two major clients were two governmental agencies. At the relevant time, about 70% of the company’s revenue was tied to just two contracts.

The ESOP was represented by an experienced trustee, which retained a noted ESOP valuation firm. The latter valued the company under the discounted cash flow analysis and guideline company method (GCM) and decided the proposed purchase price was fair to the ESOP from a financial point of view. The trustee approved the transaction.

Some seven months after the transaction, the company ran into financial problems and sold itself to a competitor. The ESOP was terminated. The DOL began an investigation into the short-lived plan, and two plan holders filed suit. Only the instant case survived.

The court found the trustee was liable for causing the ESOP to overpay by about $28 million. So what went wrong?

In terms of the valuator’s DCF analysis, the court’s focus was on what it considered the questionable nature of the management forecasts that formed the basis of the valuator’s DCF analysis, as well as the valuator’s inadequate accounting for the risk related to customer concentration. The court also was perplexed by the valuator’s use of a control premium in the context of the GCM analysis. It noted the trustee’s failure to probe the valuator’s reasoning given the ESOP specifically was structured to keep the sellers in control of company management.

For more on the court’s decision, click here.


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