The board of directors of Bowers + Kubota Consulting, Inc. recently won an employee stock ownership plan (ESOP) fiduciary/breach case brought against them by the Department of Labor. See Walsh v. Bowers, et al., No. 1:18-cv-00155-SOM-WRP (D. Haw. Sept. 17, 2021). After a full trial on the merits, the district-court judge entered judgment in favor of the defendants, largely based on the court’s rejection of the DOL’s critiques of the valuation upon which the trustee relied. What is perhaps most interesting about the court’s decision is the contrast between the discussion in this case of fundamental ERISA and valuation concepts, on the one hand, and the discussion of fundamental ERISA and valuation concepts in two other cases in which courts entered judgment against the defendants.
As background, the DOL in Bowers alleged that the Bowers + Kubota Consulting, Inc. Employee Stock Ownership Plan paid too much when it purchased company stock for $40 million. The DOL sued two individuals, both board members and selling shareholders, for allegedly inducing the ESOP to more than “adequate consideration,” which is defined in ERISA as the “fair market value” as determined in good faith by the trustee. One of the issues the court considered was whether the ESOP’s trustee did, in fact, cause the ESOP to pay more than “fair market value” for the stock.
Importantly – and we cannot emphasize this enough – “fair market value” is a legally mandated “standard of value” that trustees, valuation advisors and courts must consider when assessing the propriety of an ESOP stock transaction. According to a leading valuation treatise, a “standard of value” in any valuation exercise is a fundamental question that must be determined at the outset of any valuation assignment, because the standard of value “describe[s] the fundamental premises on which the reported values will be based.” In addition to fair market value, there are other standards of value, with different rules, inputs, assumptions, and outcomes. These include, among others, “equitable value,” “liquidation value,” “net asset value” and “investment value.” But fair market value is the specific valuation standard that is required by ERISA for purposes of ESOP stock transactions.
The principal reason why the judge in Bowers rejected the DOL’ claims was because the judge understood some key foundational principles of fair market value – which the courts in similar ESOP fiduciary/breach cases did not even discuss (much less understand). The judge in Bowers quoted and cited Uniform Standards of Professional Appraisal Practice (USPAP), which require interviews with company management (or information gathered through discovery) in order for the appraiser to understand the asset being valued. The DOL’s expert failed to interview management or otherwise gather information through discovery, and this contributed to “a notable error” the DOL’s expert made with respect to consultant fees that the expert deducted from the estimated value. The judge also quoted and cited USPAP for the principle that a fair market value appraisal is estimated as of the date of the valuation; the DOL’s expert relied on events occurring after the sale in order to assess control issues and to further discount the value of the company.
Contrast the Bower’s court’s reliance on third-party valuation authority with the courts’ analyses in similar ESOP fiduciary/breach cases. Those decisions are devoid of any discussion of important, core principles of ERISA and valuation. The judge in Bowers emphasized the fact that a fair market value estimate must “represent what a willing buyer and willing seller would mutually agree to.” However, the judges in two similar cases ignored this requirement, choosing to accept as “fair market value” a price that some particular buyer might prefer to pay, without considering the contrary pressure exerted by a willing seller.
The Bowers decision supports the notion that the successful defense against claims of ESOP overpayment requires witnesses, experts and attorneys who fully understand ERISA principles and valuation principles and can fully educate the judge. Third-party authority, both with respect to ERISA concepts and valuation concepts, assists judges with understanding complex and nuanced principles that often support approaches that valuation advisors and ESOP trustees take when appraising stock for purposes of an ESOP transaction.
