Additional ESOP Valuation Litigation Targets Wilmington Trust

A new Employee Retirement Income Security Act (ERISA) lawsuit filed in the U.S. District Court for the District of Delaware accuses Wilmington Trust N.A. of certain fiduciary breaches related to stock price services provided to an employee stock ownership plan (ESOP) client.

Technically speaking, the lead plaintiff is seeking class action status in the suit and has named Wilmington Trust as the defendant due to its identity as the successor to the Wilmington Trust Retirement and Institutional Services Co., which was the trustee for the HealthCare Appraisers Inc. (HAI) ESOP during its establishment some years ago. The ESOP in question acquired shares of HAI in 2014, according to the lawsuit, with Wilmington Trust serving as its trustee.

The text of the lawsuit cites alleged violations of ERISA Sections 404, 406, 409, 410 and 502(a). According to the lead plaintiff, these violations occurred when an inflated valuation provided by Wilmington Trust caused the ESOP to buy shares of HAI for more than fair market value.

Background information in the text of the complaint suggests that, at all relevant times for this lawsuit, HAI was a privately held company and a party in interest to the ESOP. The suit claims that, on August 26, 2014, the ESOP acquired 80% of HAI’s stock, or 800,000 shares. Working with Wilmington Trust as its trustee, the ESOP allegedly paid $28 million for the shares.

The complaint states that the deal was in part financed by a $10 million term note, by junior subordinated notes from the selling shareholders (i.e., certain top executives of the HAI organization) and by promissory notes to the selling shareholders. According to the text of the complaint, HAI issued warrants to the selling shareholders in exchange for the remaining 20% of HAI stock, which represented 40% of the total equity of HAI.

“Wilmington Trust represented the plan and its participants as trustee in the ESOP transaction,” the complaint states. “It had sole and exclusive authority to negotiate the terms of the ESOP transaction on the plan’s behalf.”

After spelling this out, the complaint alleges that the ESOP transaction having been undertaken at that price and under those leveraged terms allowed the selling shareholders to “unload their interests in HAI above fair market value and saddle the plan with tens of millions of dollars of debt to finance the transaction.”

“Wilmington Trust failed to fulfill its ERISA duties, as trustee and fiduciary, to the plan and its participants, including plaintiff,” the complaint states.

Other notable facts alleged in the complaint are that the selling shareholders were advised by CSG Partners in the ESOP transaction. At the same time, Wilmington Trust allegedly hired Stout Risius Ross (SRR) to provide it with a valuation of HAI for the ESOP transaction. The trustee firm also allegedly hired Taylor English Duma LLP to provide it with a legal opinion for the ESOP transaction.

As cited in the complaint, the U.S. District Court for the Eastern District of Virginia has previously decided a case with the same trustee (Wilmington Trust), the same kind of transaction (a leveraged ESOP transaction), the same seller-adviser (CSG) and the same valuation-adviser to the trustee (SRR).

“The ESOP community is very incestuous and SRR became excessively familiar with CSG, who could observe its valuation methods, and SRR even shared its valuation strategies at a very granular level with CSG while it was advising the trustee on the acquisition of company stock,” the complaint states. “Wilmington Trust, CSG and SRR have done multiple ESOP transactions together, yielding tens of millions of dollars in overpayments to selling shareholders and saddling employees with overvalued stock and excessive debt. In the wake of litigation over Wilmington Trust, CSG, and SRR ESOP transactions, Wilmington Trust has sued SRR twice for providing flawed valuations.”

As the plaintiffs suggest, the Wilmington Trust company has indeed been involved in other ESOP litigation related to these types of allegations. In fact, in May, the U.S. Secretary of Labor announced an agreement with Wilmington Trust had been reached, requiring it to pay a combined $80 million to 21 ESOPs for which it served as trustee and $8 million to the government.

In a statement on that matter, Wilmington Trust said it was “pleased to resolve all claims in these cases and avoid what could have been a protracted and expensive legal proceeding.”

“While we deny all allegations with respect to these claims, we feel that this settlement is the best way for all parties to move forward,” the firm said. “As always, we believe we have acted in accordance with all applicable laws, industry best practices and will continue to carry out our legacy and commitment to quality client services. ESOP trustees work with accredited valuation professionals, lawyers and other experts in an attempt to purchase closely held companies for fair market value. Valuing unique, closely-held businesses is a complex process. ESOP appraisers follow longstanding methods set forth under the Standards of Professional Appraisal Practice. DOL has not issued any definitive guidance to help ESOP trustees or issued regulations relating to company valuations or the manner in which trustees approach stock purchases.”

A representative for the firm declined to comment on the new litigation, citing the firm’s policy not to discuss pending litigation. However, insight about the industry’s general point of view on these issues can be found in a 2018 letter in which members of Congress accused the Department of Labor (DOL) of “regulation through litigation” and asked that clear guidance regarding valuation and other important issues be developed.