The US 7 th Circuit Court of Appeals turned aside arguments by ESOP participants that trustee U.S. Trust Co. had failed to adequately determine whether sweepstakes promotions put on by the ESOP’s sponsor impacted the company’s share price. The appellate court also agreed that since the ESOP had paid a reasonable sum for the shares it acquired, the dispute transaction did not fall under the Employee Retirement Income Security Act (ERISA)’s prohibited transaction rules.
According to the court ruling, Foster & Gallagher Inc. (F&G), a direct marketing firm, established an ESOP in 1988. In 1994, F&G executives, including Thomas Foster, Melvyn Regal, and Robert Pellegrino, asked Valuemetrics Inc. to perform an evaluation of F&G shares in the ESOP.
Valuemetrics recommended in 1995 that F&G recapitalize the ESOP. To do so, Valuemetrics suggested that the ESOP purchase $70 million in F&G stock from shareholders, including Foster, Regal, and Pellegrino. At the time, Magna Bank of Illinois served as the ESOP’s trustee. U.S. Trust replaced Magna as the trustee in December 1995.
U.S. Trust hired the Houlihan, Lokey, Howard & Zukin Inc. law firm to offer a written opinion as to whether the proposed recapitalization was fair to the ESOP from a financial point of view. F&G, Valuemetrics, U.S. Trust, and Houlihan eventually agreed the ESOP would purchase F&G stock at the price of $19.50 per share, according to the court record.
In the years following the ESOP recapitalization, several states investigated F&G’s subsidiary, Michigan Bulb Corp., over the company’s sweepstakes promotions.
While Michigan Bulb and F&G settled most of the lawsuits brought by the states, Michigan Bulb’s revenue suffered extensive damage and the company’s revenues declined from $197 million in 1998 to $65 million in 2000. F&G also experienced a decline in gross revenues from $471 million in 1998 to $337 million in 2000, according to the court.
Share Price Drops
As a result of the Michigan Bulb investigations, the value of the ESOP’s F&G shares dropped from $20 per share to just under $9 per share. In addition, the total value of the F&G shares owned by the ESOP decreased more than 90% from a net value of more than $82 million in 1997 to a net value of just over $7 million in 1998.
Two plan participants sued F&G, its board of directors, U.S. Trust, Houlihan, and numerous shareholders alleging they breached their ERISA fiduciary duties by entering the 1995 ESOP transaction.
In February 2004, US District Court Judge Michael Mihm of the US District Court for the Central District of Illinois ruled in favor of U.S. Trust and the other defendants, finding that the ESOP transaction was not a prohibited transaction under ERISA because the sale of stock to the ESOP was for adequate consideration.
According to the appeals court, for stock that is not publicly traded, as in this case, ERISA defines “adequate consideration” to be the fair market value of the stock as determined in good faith by the plan trustee.
The opinion in Keach v. U.S. Trust Co., 7th Cir., No. 04-1901, 8/17/05 is here .
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