Another ESOP trustee in trouble over valuation

Perez v. First Bankers Trust Services, Inc., 2017 U.S. Dist. LEXIS 52117 (March 31, 2017)

For the second time in March 2017, a court found an ESOP trustee liable for causing the plan to overpay. The most recent decision chronicles in exhaustive detail how the trustee failed the plan in terms of ensuring that no more than fair market value would be paid for the seller’s shares. The concerns the court identified were remarkably similar to the ones the court in the earlier Brundle decision noted: a failure to scrutinize management projections and inadequate risk assessment.

The plaintiff in the instant case is the Department of Labor. At the center of the transaction was a New Jersey site preparation construction company that was primarily active in homebuilding. In April 2007, the ESOP bought 38% of company stock from the company’s majority shareholder for $16 million. A professional trustee represented the ESOP; the trustee retained a financial advisor known for its ESOP experience.  

The financial advisor’s engagement letter included a disclaimer that the firm would rely on information the trustee and the company provided. The advisor would “accept this information as being accurate without independent verification.” The seller’s financial advisor provided an offering memo that included an overview of the industry and the company’s top customers, as well as projections of future performance. Customer concentration—one major homebuilder was responsible for almost 60% of the company’s revenue in 2006—was an issue, but the offering memo suggested the company was “steadily diversifying away from” the top customer. The memo was inconsistent in that it gave the actual numbers showing a greater dependency on the top customer. The memo included forecasts the company had provided as well as a disclaimer that the seller’s financial advisor did not independently verify any of the information it received from the seller.

Neither the ESOP’s financial advisor nor the trustee inquired into the basis for the projections or into any statements about the company’s competitive landscape or industry trends. Rather, for its draft valuation, the ESOP’s financial advisor essentially used the projections in the offering memo and made some upward adjustments. Significantly, the draft valuation report did not include an industry analysis.

The valuator performed two analyses, one based on the discounted cash flow method and the other based on the market multiple method. Weighting both results equally yielded a fair market value that was slightly higher than the seller’s $16 million offering price. Therefore, the valuation firm concluded paying the seller’s price was fair to the ESOP from a financial perspective. The trustee, relying on the financial advisor’s expertise, approved the transaction.

The court said the trustee neglected its duty to engage with the valuation. For more on the court’s discussion, click here.