As the lawsuit against the U.S. Sugar ESOP proceeds in U.S. District Court for the Southern District of Florida, it continues to fascinate. Today, the International Herald Tribune is reporting that the company has announced employees owning shares through the ESOP will not be permitted to attend the annual shareholders meeting. Such an announcement is just one twist in this ESOP saga worthy of Gone with the Wind.
According to the amended complaint filed with the district court on May 4, 2008, the ESOP was created when U.S. Sugar went from a publicly traded company to a privately traded company in the 1980s. The employees, through the ESOP, became the largest shareholder in U.S. Sugar, holding approximately 35% of the shares. As a privately traded company, there is no market for the shares other than the provision in the ESOP which provides that U.S. Sugar will buy a participant’s shares in the ESOP when they retire, and the shares are then retired. The DOL addressed an issue the U.S. Sugar ESOP was having with OBRA in Advisory Opinion 97-06a, which unfortunately does not provide much detail on how U.S. Sugar morphed its two defined benefit plans into the U.S. Sugar ESOP.
The lawsuit includes allegations that U.S. Sugar is paying retirees less than fair market value for the shares, that the ESOP has no representation on the U.S. Sugar Board of Directors despite being the largest shareholder, and that there are various conflict of interest and fiduciary issues with the ESOP. As this lawsuit works it way through the court system, I expect it will redefine ERISA case law as it relates to ESOPs.
Technorati Tags: Pension Protection Act, ppa, ESOP, U.S. Sugar, Advisory Opinion 97-06a, ERISA
2 responses so far ↓
1 Corey Rosen // May 28, 2008 at 7:14 pm
This case could indeed be significant, but there is a better chance it won’t. As I read what has been presented so far, the issue is whether the ESOP can pay departing participants a control price for the shares or not. When someone wants to buy a company, they pay a premium for control. That’s why shares in public companies often bump up substantially when there is a takeover bid. As an individual owner, you have no ability to control the company directly, but as a buyer of majority ownership, you would. That right is worth a lot of money.
The buyer may also be offering a price that reflects synergistic value. If a strategic buyer believes that U.S. Sugar would be more profitable as part of the buyer than a stand-alone entity, then U.S. Sugar is worth more per share to that buyer than a financial buyer, who does not capture these synergies.
Let’s now imagine that the ESOP trustee decided in any given ESOP to match the synergistic buyer’s price for existing employees. That would mean profits were being drained to pay off current employees, harming the interests of future employees. The law is explicit is preventing ESOPs from paying a synergistic price. That also protects employees when the ESOP buys shares from outside owners. Paying a synergistic price would clearly harm the interests of participants in that case only for the befit of non-ESOP owners.
Control price presents a similar issue. If the ESOP does not own a majority of the stock (as it does not here), but pays for a right it does not have, who is hurt and who gains? Outside sellers clearly gain a lot. So do early departees. But long-term employees see their stock decline as a result, and the extra cost can even imperil the company’s financial stability. In fact, the most common cause of lawsuits by participants against trustees in an ESOP is paying too much for ESOP shares form outside shareholders, often because of an incorrect assumption of control or synergies.
Because ESOPs must use fair market value in all transactions, as determined (by law) by what an outside financial buyer would pay for the shares, it cannot pay one price to employees and another (higher) price to other people.
In short, this case is not as straightforward as it might at first blush appear. It may still be that the trustees undervalued ESOP shares for other reasons, or were otherwise unfair to employees, but the simple fact that the ESOP did not offer what an outside buyer offered is not only a correct conclusion, but a necessary one under the law to protect employees.
2 Nick Adamy // May 29, 2008 at 1:04 pm
Corey Rosen is absolutely right, there is no indication that the valution was anything other than fair market value. Even if the appraiser was aware of the offer, unless it was clear that the offer was going to be accepted by the board, to incorporate the offer price into the fair market valuation of the stock would have been inappropriate.
This case does, however, highlight the difficult position that ESOP fiduciaries and boards of ESOP companies may find themselves in. By definition, the per share fair market value of a minority interest in a closely-held company will always be lower than a controlling interest or strategic value. This means that just about any reasonable controlling interest offer for an ESOP company is likely to be materially higher than the appraised ESOP stock price.
Such an offer puts the board and ESOP trustee in a difficult fiduciary position. This is one reason why many ESOP companies end up being sold, often at surprising low valuations.
That isn’t to say that management acted appropriately in this case. Unfortunately, regardless of how this turns out, I’m afraid that this case is going to drive a lot more unnecessary sales of ESOP companies because of nervous fiduciaries.
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