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ERISA Lawsuit Nets Nearly $9.4 Million for Plan Participants

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Plan fiduciaries overcharged ESOP for company stock

St. Paul, MNThe U.S. Department of Labor has announced an agreement to settle Walsh v. Reliance Trust Co. that will restore nearly $9.4 million to participants in the Kurt Manufacturing Company Employee Stock Ownership Plan (ESOP). The ERISA lawsuit alleged that plan fiduciaries caused the ESOP to buy all the outstanding company stock for nearly $10 million more than it was worth. The sellers of the stock included company directors and the chairman of the board. The DOL claimed that the sellers either knew or should have known that the price was significantly inflated.

The defendant board members are also permanently barred from serving as ERISA fiduciaries or providing services to the ESOP. They are prohibited from voting on their own compensation, selecting the ESOP's valuation firm, and will lose their stock appreciation rights and severance compensation when they terminate their employment.

The settlement takes place in the context of ESOP lawsuits that tell a similar tale of fiduciary malfeasance and double-dealing over the funds that employees have set aside for retirement.

The chicken house problem

Privately held companies, because their stock is not traded on a public market, are relatively free from financial reporting requirements and other forms of oversight. A particularly high-profile New York real estate firm specializing in luxury buildings may come to mind.

This makes the task of valuing company stock more complicated than it would be if there were a fair market price to refer to. Ordinarily, in this situation, this is done by comparing the private company to established public companies of comparable size and growth in the same industry. Reputable companies do this with the assistance of independent outside advisors.

But these advisors are hired by corporate management. Where managers have a financial interest in the transaction that is at odds with the financial interests of retirement plan participants, the independence and judgment of an outside advisor may come into question. The outside advisor also has a financial stake of its own in keeping its contract with the company.

All in all, it can look like the fox guarding the henhouse. In this situation, however, that tasty hen is a tasty pot of money saved by workers in anticipation of retirement.

Did the stock more than double in value?    

Kurt Manufacturing Co. makes metal parts like hydraulic fittings and hoses and a kind of vise the company describes as “legendary.” Before the sale of the stock to the ESOP, the shares had been valued at between $13 and $33 per share. The company structured its stock appreciation rights awards around a moderately higher share value of $55.14. When the ESOP purchased the outstanding stock in 2011, it paid $85 per share.

That looks odd. Were the corporate insiders who sold the stock stripping assets out of the ESOP to fill their own pockets?

Problem solved (until tomorrow)

Reliance Trust Co., the plan trustee, was accused of rubber-stamping the deal without making any inquiry of its own into the price. Company fiduciaries, including members of Kurt’s board and management team, have been similarly accused of failing to oversee Reliance Trust. Finger-pointing ensued all around. On behalf of the ESOP plan participants, the DOL sued Reliance Trust, several directors and the ESOP.

Settlements make no finding of illegal behavior. This one, however, does move money back to those who were allegedly defrauded. It also regulates the future conduct of those in charge of overseeing the plan that holds the workers’ money.

The ESOP participants will be made whole, to the extent possible given the passage of eleven years. Reliance will be replaced as trustee by GreatBanc Trust Co., and a new independent valuation firm will be appointed. Individual board members will lose significant sources of future stock-based income, and the board will be expanded to seven members. Reliance and the named directors will pay a hefty penalty to the DOL.

What about tomorrow?

For other folks who participate in an ESOP, especially one established by a smaller, privately owned business, the bad news is that getting your employer to operate within the requirements of the law is largely up to you at first. 

The good news is that the Employee Retirement Income Security Act (ERISA) requires those who have control over a retirement plan or its assets to act solely in the interest of participants and beneficiaries and for the exclusive purpose of providing benefits and paying plan expenses. They must act prudently to minimize the risk of large losses.

If something looks funny, it likely is. If you see something, say something. Vigilance is your first defense. The other good news is that, as with Walsh v. Reliance Trust Co., sometimes the underdog wins.


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