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ERISA Lawsuit Targets ESOP Scam

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Sunlight exposes incestuous world of ESOP administration

Wilmington, DESet against the backdrop of California’s notorious water wars, the 1974 film “Chinatown,” focuses on the mysterious Evelyn, who must finally explain whether a young girl is her daughter or her sister. The awful truth unfolds. She is murdered – shot through the eye as her daughter or sister screams. Evelyn’s private detective/lover is told to leave it alone; he doesn’t understand what’s going on. His partner utters the grim tagline, “Forget it Jake; it’s Chinatown,” from which the movie takes its title. In Alvarez v. Wilmington Trust, the latest Wilmington Trust ERISA lawsuit, the prize at the center of the story is not water rights, but the vast sums of money held in Employee Stock Ownership Plans, ERISA retirement plans designed to invest primarily in employer stock.

Tangled relationships muddy ERISA fiduciary obligations in the ESOP world. It is incestuous, in a word. But with their retirement savings on the line, “Forget it Jake,” was the last thing the Alvarez plan participants wanted to hear.

Alvarez v. Wilmington Trust

Cindy Alvarez, a former employee of HealthCare Appraisers Inc. (HAI) and a participant in the HealthCare Appraisers Inc. ESOP filed a class action lawsuit against Wilmington Trust as the successor to Wilmington Trust Retirement and Institutional Services Co. (For simplicity, both are referred to hereafter as “Wilmington Trust.”)

Wilmington Trust was the trustee for the ESOP retirement plan on August 26, 2014 when the ESOP acquired 80 percent of HAI’s stock for $28 million. Alvarez claims that, at the time of the transaction, $28 million was more than the fair market value of the shares.

The plan overpaid and she and about 124 other plan participants were harmed. The leveraged (i.e. debt-financed) transaction also allowed the selling shareholders to saddle the plan with tens of millions of dollars of debt.

The tangled web of pre-existing relationships among Wilmington Trust, consulting company Stout Risius Ross LLC, financial adviser CSG Advisors and the selling shareholders suggest that this was not an innocent mistake. Rather, as Alvarez claims, this was a violation of ERISA Sections 404, 406, 409, 410 and 502(a), which require plan fiduciaries to act in the sole interest of plan participants and beneficiaries. One hand does not wash the other when it comes to ERISA plans.

A telling history of employee stock ownership lawsuits

Alvarez relies heavily on Brundle v.Wilmington Trust, an ERISA lawsuit previously decided in the Eastern District of Virginia. Tellingly, it involves the same triumvirate – Wilmington Trust, Stout Risius Ross and CSG Advisors. In Brundle, the mark was an ESOP sponsored by Constellis Group, inc., but it is the same plan.

In Brundle, as in Alvarez, owners of a closely-held company apparently found an exit strategy that involved selling company stock for a marked up price to a newly-minted company ESOP. The ploy converted illiquid stock into cash for the shareholders, with tax benefits and a long-term stream of income on the side. It was a win-win-win for the insiders. Not so much for hapless retirement plan savers.

Wilmington Trust has not been the only purveyor of this plan. The folks who watch employee stock ownership lawsuits may remember Gamino v. KPC Healthcare. The players are different. The details are different. The scheme is basically the same.

Grousing ensues

Wilmington Trust has complained that the rules for valuing closely-held corporate stock really are not clear, and that it acted in good faith. It points to a 2018 letter in which 27 members of Congress complained that the lack of legislative guidance has made it difficult for ESOP companies to make business decisions and to find someone to serve as plan fiduciary. “The Department has also employed counter-productive enforcement tactics, including taking inconsistent positions on legal issues. Ultimately, this investigatory approach is having a destabilizing effect on employee ownership, which ESOP companies fear will result in material losses for workers.” The letter accuses the DOL of “regulation through litigation.”

In translation, that sounds a little like grousing that plan participants, acting through the DOL, are unfair because they use the only tool at their disposal – ERISA lawsuits. What is unfair? On this point, at least, the lawsuits are effective. The DOL apparently doesn’t do film noir.

What should workers do?

This scheme would not work with a publicly-held company because those businesses are subject to SEC disclosure and reporting requirements that make stock valuations relatively transparent. Employees of closely-held corporations are more vulnerable, however. They would be well-advised to seek outside legal advice whenever they are offered a new opportunity to “share in the growth of this exciting company” by participating in a new or soon-to-be formed ESOP retirement plan. If history is any guide, this could be a “tell” – the sign of a brewing plan to transfer employee retirement savings into the pockets of the business’s owners.


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