DOL Alleges Company’s ESOP Creation Was Flawed

Accurate company valuations are critical when it comes to establishing an ESOP, the DOL says in an enforcement action announcement.

The Department of Labor (DOL) contends that, when establishing an employee stock ownership plan (ESOP), a company’s owner sought to inflate the company’s stock price to benefit himself.

The DOL filed a lawsuit in federal court against Dr. Roy Geronemus, owner of the Manhattan-based Laser and Skin Surgery Center of New York, and plan trustee Samuel Ginsberg, alleging the stock valuation process when setting up the Laser Skin and Surgery Center ESOP in 2009 was flawed, and the ESOP’s subsequent $24 million purchase of the stock violated the Employee Retirement Income Security Act (ERISA).

The department’s complaint, filed with the U.S. District Court for the Southern District of New York, seeks to have the defendants restore all losses to the ESOP; have Geronemus disgorge any and all ESOP assets and profits earned by him as a result; require the defendants to undo the prohibited transactions; and bar the defendants from serving as fiduciaries or service providers to any ERISA-covered plans.

The lawsuit says Geronemus appointed Ginsberg, his personal accountant, as the ESOP’s trustee for the sale of Dr. Geronemus’ stock to the ESOP. Ginsberg retained Trenwith Valuation LLC, which valued the company at $48 million, including $24 million for the 400,480 shares sold to the employees. This valuation had several obvious errors, the DOL contends.

First, the company’s valuation was flawed because it relied on data that inflated its value, namely a projection that Geronemus would earn only $663,439 in compensation annually when, in fact, he had and would continue to receive $1 million to $3 million annually. This made the company’s operating costs seem lower than they were. Ginsberg and Geronemus knew, the lawsuit alleges, that Geronemus would make significantly more than $663,439 each year.

Trenwith also valued the company by comparing it to allegedly similar companies. However, five of the 12 companies that Trenwith used for the comparison were based in Europe and listed on European stock exchanges exclusively. They were not appropriate examples to use and were likely chosen to inflate the value of the company.

“As a result of the defendants’ actions, the ESOP significantly overpaid for the stock. These were open and obvious flaws that the defendants knew or should have known, which resulted in a financial loss for the plan and its participants,” says Jonathan Kay, the DOL’s Employee Benefit Security Adminstration regional director in New York. “In addition, the defendants breached their fiduciary duties under ERISA by allowing the ESOP to engage in the prohibited transaction. They must now make restitution of millions of dollars to the plan and its participants.”