Valuation Hindsight Challenged in Recent ESOP Case

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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:

http://www.prnewswire.com/news-releases/fifteen-week-esop-trial-results-in-defense-ruling-for-kmk-law-clients-300328830.html

https://www.hklaw.com/publications/District-Court-Rules-on-ERISA-Liability-of-Board-and-ESOP-Advisory-Committee-Members-in-ESOP-Transactions-09-08-2016/

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.

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