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Valuation Hindsight Challenged in Recent ESOP Case

This article was co-authored by Amanda Fuller.

A recent U.S. District Court opinion has reiterated the principle that valuations should be based on information known or knowable as of the valuation date. In the case of Fish, et al. v. GreatBanc Trust Company, et al., Case No. 1:09-cv-01668 (N.D. Ill. Sept. 1, 2016), a valuation expert’s opinion was rejected because it relied too heavily on hindsight.

The Antioch Company (Antioch) was founded in 1926. Its well-known (at least in scrapbooking circles) Creative Memories direct-sales business fueled significant growth in the late 1990s and early 2000s, with Antioch revenues reaching approximately $350 million in 2002. In 1979, Antioch established an employee stock ownership plan (ESOP). The Antioch ESOP became the 100% owner of Antioch in 2003, when the remaining non-ESOP shares were redeemed at $850 per share. Less than five years later, Antioch was forced into a Chapter 11 reorganization, rendering the ESOP participants’ shares worthless.

In an action brought under the Employee Retirement Income Security Act of 1974 (ERISA), the plaintiffs, who were participants in the Antioch ESOP, sought more than $233 million in damages, alleging that the plan trustee and members of Antioch’s ESOP Advisory Committee and Board of Directors breached their fiduciary duties in connection with the 2003 share redemption.

In a 131-page September opinion following a 34-day trial, the U.S. District Court found in favor of the defendants, ruling that the defendants did not violate the standards set in ERISA sections 404, 405, or 406 and; furthermore, did not cause the plaintiffs’ alleged damages. Notably, the trustee was found to have “conducted a thorough and vigorous review of the Transaction and worked diligently to protect the ESOP’s interests by negotiating better Transaction terms.” That review process apparently included hiring qualified financial advisors and legal counsel, and scrutinizing their conclusions.

The Court also found that the $850 per share redemption price paid by Antioch in 2003, was no greater than fair market value and that the plaintiffs’ losses resulted from unforeseeable market declines:

Even assuming that plaintiffs succeeded in proving breaches by defendants under ERISA sections 404 and 405, the evidence shows that any such breaches did not cause any damages because (a) as explained in detail above, the Company did not overpay for the non-ESOP shares, and (b) it was not the Transaction that caused the Company to fail and the ESOP participants’ shares to become worthless; rather, the Company failed due to a sales decline caused by market forces and conditions outside the defendants’ control and that defendants could not have predicted in 2003.

The plaintiffs’ offered expert witness testimony suggesting the share price in the 2003 transaction was inflated. The Court was not convinced, finding the expert opinions on behalf of the plantiffs not to be credible because “they are not based on sound or commonly applied valuation methodologies, and are improperly determined ‘from the perspective of . . . hindsight’ based in part on telephone conversations with former Antioch employees sympathetic to plaintiffs more than ten years after the Transaction, rather than from ‘the time the investment was made’ in 2003.”

To the contrary, the Court held that “the consideration paid for the non-ESOP shareholders’ stock was supported by the financial analysis and valuations” conducted contemporaneously by financial advisors engaged around the time of the 2003 transaction as well as testimony from the defendants’ financial expert witness.

Antioch’s per-share value fell precipitously from 2006 to 2008 (see illustration). The Court found that the decline in Antioch’s share value was not caused by the 2003 redemption, but rather by factors generally unforeseeable at that time. Such factors included double-digit decreases in company sales starting in 2006, deterioration of the traditional scrapbooking industry, the emergence of broadband and social media, which altered customer buying habits, and, the financial crisis that began in late 2007 and continued into 2008.

The valuation of a company’s shares is a date-specific exercise. The fair market value of the shares should reflect what was known or knowable as of the valuation date. Among other things, this case demonstrates that retrospective valuations can present significant challenges compared to an analysis performed contemporaneously. In the end, it may be that the Court found the plaintiffs’ claims with respect to the share price in the 2003 transaction to be nothing more than creative memories (pun intended).

Further reading:



Aronson LLC works with ESOP-owned companies in a variety of capacities. To learn more about benefit plan audits and consulting visit here or contact Amanda Fuller at 301.231.6289. To learn more about feasibility studies, valuations and litigation support click here or contact Bill Foote at 301.231.6299.

Significant Changes to Form 5500 Proposed


The Internal Revenue Service “IRS”, the Department of Labor “DOL” and the Pension Benefit Guaranty Corporation “PBGC” (the agencies) recently proposed significant changes to the Form 5500 requirements for employer sponsored benefit plans. If approved, the changes would be the most significant since implementing the EFAST2 electronic filing system in 2009. As such, the filing system has allowed for easier data collection leaving the agencies anxious to obtain more robust data from plan sponsors about their plans. While the new reporting requirements are scheduled to take effect for plan years beginning on or after January 1, 2019, employers, investment companies, custodians, record-keepers, third-party administrators, and trustees, etc. would be impacted by the new requirements, which could cause rollout delays.

The changes are quite ambitious and clearly reflect the agencies’ desire for additional and more valuable data in the areas of concern. The proposed changes focus on the following areas:

Plan investments

There is continued sentiment that many plans include high-risk, hard to value assets. Proposed modifications to the Schedule H Financial Information, would disclose the assets that create the greatest concern. New information would be gathered on derivatives, limited partnerships, private equity and hedge funds.

Service provider fees and expenses

Fees paid by plan participants continue to be a huge focus, along with continued frustration from the agencies as to how these amounts are being reported via the current Form structure. Additional reporting would be required on the Schedule H, while the  Schedule C Service Provider Information, would be modified to more closely align with the 408(b)(2) indirect compensation reporting for covered service providers. Schedule C reporting would also be required for small retirement and welfare benefit plans along with additional new inquires on the Form.

Information on plan operation and compliance

The 2015 Forms included several new questions focused on plan provisions and testing. Shortly after being released, the agencies relented and eliminated the requirement that these questions be answered. It is not clear at this point when answers to these questions will be required, but they remain a reminder of just how much new information the agencies can obtain. The additional proposed compliance questions revolve around other plan administration areas, including service provider compensation, uncashed checks, default investment alternatives and participant disclosures.

New and enhanced reporting requirements for employer sponsored healthcare arrangements

Employers who sponsor welfare benefit plans, including health plans that generally have greater than 100 participants, are required to file Form 5500. This filing typically consists of the Form itself along with Schedule A Insurance Information, and sometimes Schedule C. Small welfare benefit plans have been exempt from this requirement. However, under the proposed rules, the exemption would be modified. ERISA covered group health plans, regardless of size, would be required to file Form 5500. Additionally, applicable employers would be subject to filing the new Schedule J Group Health Plan Information, which includes a myriad of questions required under the Public Health Service Act.

Other areas impacted by the proposed changes include: additional ESOP questions on Schedule E ESOP Annual Administration, enhanced reporting on Form 5500-SF, new reporting requirements for small plans not eligible for Form 5500-SF, revised Schedule G Financial Transaction Schedules, merger and termination reporting on Schedule H, and changes to Direct Filing Entity “DFE” reporting.

Employers sponsoring ERISA covered plans have been quite fortunate that Form 5500 reporting requirements have generally been reduce over the last 10 to 15 years. This is the first time in quite a while that enhanced Form 5500 reporting requirements are likely. Given the expansive nature of the proposal, some increases are almost certain to be enacted. As previously stated, the proposed reporting changes are a huge undertaking that would greatly impact employers that sponsor retirement plans and/or group health plans. The new reporting for group health plans in particular could present challenges as generating the additional proposed information by health insurance vendors would not be an easy task. Enhanced retirement plan investment fee reporting would also pose difficulties. These challenges will likely result in significant push back from the impacted plan service providers, which has historically resulted in modifications prior to release of the final version.

Employers and service providers have been afforded ample time to prepare for the changes and how the agencies respond to the public’s comments is worth watching. There is no doubt that it is much easier for the agencies to gather and analyze information on employer sponsored plans and they are very interested in the benefits and associated costs of that which is being provided. As an employer, be preparing for change.

Please contact Mark Flanagan of Aronson’s Compensation and Benefits Practice at 301-231-6257 to further discuss the impact of the proposed Form 5500 changes.


ESOP Valuations: Are You Performing Your Fiduciary Responsibilities?

Employee Stock Ownership Plans (ESOPs) are increasingly becoming a target for review by the Department of Labor (DOL) due to the additional degree of difficulty and complex structure associated with these benefit plans. Aronson recently attended the annual conference for the National Center for Employee Ownership (NCEO) which confirmed one of the significant areas drawing attention from the DOL, and others, is the valuation of employer securities that are not publically traded. There is an increased focus when this valuation is related to a significant stock transaction.

It is the responsibility of the ESOP Trustee, either internal or external, to determine the fair value of the privately held company stock in an ESOP. ESOP Trustees have fiduciary responsibilities to the plan, as they are making investment decisions on behalf of participants, for which they can be held personally liable.

To determine the fair value of privately held company stock, the ESOP Trustees will typically hire an independent valuation company. The valuation company gathers information from plan sponsor management via interviews, projections and analysis to determine the fair value of the employer stock. The value of the stock may be determined using multiple methods carrying various weights based on the specific circumstances of the employer. This valuation is presented to the ESOP Trustees for review and approval. It is important to note that, although an independent valuation company calculates the fair value, it is the ESOP Trustees who have the ultimate responsibility to accept the fair value, thereby determining the fair value of the company stock on behalf of the participants in the ESOP.

Where the ESOP Trustees may be vulnerable in carrying out their fiduciary responsibility is a thorough examination of company projections used in the discounted cash flow method within the income approach to calculate the fair value of privately held stock. In June 2014 GreatBanc Trust Company settled with the DOL, resolving allegations the ESOP Trustee violated the Employee Retirement Income Security Act (ERISA) by allowing the ESOP to purchase stock for more than fair market value. This was due to the Trustee’s failure to adequately inquire into the use of unrealistic and aggressively optimistic projections of the company’s future earnings and profitability.

ESOP Trustees should perform a due diligence review over the forecasts prepared by company management to be used in calculating fair value of company stock. A good measure of these forecasts is past performance. Also, if the plan in question is long-standing, compare the forecasts from several years ago to actual results to determine how successful company management is at projecting future earnings.

As part of their settlement with the DOL, GreatBanc agreed to a set of policies and procedures (Process Requirements) that they must follow when they are acting as an ESOP Trustee to purchase or sell company securities not publically traded.  These Process Requirements provide ESOP Trustees with insight into the DoL’s expectations of the Trustees’ responsibilities in determining the fair value of privately held company stock. Phyllis C. Borzi, Assistant Secretary of Labor for Employee Benefits Security, said, “Others in the industry would do well to take notice of the protections put in place by this agreement.”.

Although the DOL has not mandated the use of the Process Requirements, it is a best practice for ESOP Trustees to follow them. This is particularly true for valuations involving stock transactions, but it has implications to the annual valuation as well.

It is critical for ESOP Trustees to document their review, considerations, and conclusion of the valuation of company stock, including management projections. Do not be afraid to inquire and push back on unreasonable projections as there is a fiduciary responsibility to do so. After a thorough review of the valuation is performed, the conclusion may be there is adequate evidence to support the fair value calculated by the valuation company. Documentation of the review of the facts and circumstances in “real time” is key, as an investigation can occur several years after the determination of fair value for company stock has been taken.

For more information about your duties as an ESOP Trustee or plan sponsor, please contact Aronson’s Employee Benefit Plan Services Group at 301.231.6200.

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