Court Issues Mixed Ruling in Case Over ESOP Stock Purchase

The court decision highlights the difficulty in determining the fiduciary status of parties and of making claims for equitable relief based on allegations that ESOP stock purchases were overvalued.

In a case arising from the sale of stock of Kruse-Western Inc. to the Western Milling Employee Stock Ownership Plan (ESOP), U.S. District Judge Dale A. Drozd from the U.S. District Court for the Eastern District of California has moved forward some claims and dismissed others.

Background in the opinion explains that Western Milling LLC is a milling and feed manufacturer, and at all relevant times manufactured Western Blend Horse Feed and other animal feed blends. After Western Milling faced legal and financial challenges when hundreds of horses died after being poisoned by an antibiotic included in the feeds provided by Western Milling, the ESOP was established.

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The ESOP is a retirement plan under the Employee Retirement Income Security Act (ERISA) that is primarily invested in the stock of Kruse-Western, the parent company of Western Milling. On the same day the ESOP was created, according to the complaint, GreatBanc Trust Company caused the ESOP to purchase 100% of the outstanding shares of Kruse-Western stock. GreatBanc was appointed trustee of the ESOP by defendants John and Jane Doe 10–20, the individual members of the Kruse-Western Board of Directors. The ESOP purchased the stock from defendant Kruse and John and Jane Doe 20–30 (the selling shareholders), which the ESOP financed by borrowing the entire purchase price of $244 million from Kruse-Western.

Less than two months later, the value of Kruse-Western had dropped to $26.6 million. By the end of 2016, that value had fallen still further, to $24.8 million. By the end of 2017, the value had recovered only marginally, to $27.4 million. Thus, the lawsuit alleges, as of that date, the ESOP had purchased Kruse-Western’s outstanding stock for almost ten times its actual value.

The plaintiff in the case, a former Kruse-Western employee and current participant in the ESOP, alleges that the sale to ESOP did not adequately reflect the future revenue and earnings, given the recurring contamination in Western Milling’s animal feed, nor did it reflect Kruse-Western’s potential liability for wage and hour law violations. It is also alleged that Kruse-Western and its officers knew of these problems at the time of the sale, but the financial projections used to value Kruse-Western’s stock did not account for them.

Four causes of action are alleged against defendants, all of which arise under provisions of ERISA. Count one alleges a violation against the selling shareholders and GreatBanc, alleging that they engaged in a transaction prohibited by ERISA. Count two alleges a violation against the Board defendants who sold Kruse-Western stock to the ESOP, and also contends that these individuals engaged in a transaction prohibited by ERISA. Count three alleges that defendant GreatBanc breached its fiduciary duties to the ESOP. Count four alleges that the Board defendants failed to monitor GreatBanc and ensure that the ESOP paid no more than fair market value for the Kruse-Western stock. On April 15, the defendants moved to dismiss the complaint.

First, defendants argue for dismissal under Federal Rule of Civil Procedure 10(b), which provides that “each claim founded on a separate transaction or occurrence … must be stated in a separate count” if doing so “would promote clarity.” Drozd found that Rule 10(b) is inapplicable. “By its terms, that provision applies only where a single cause of action encompasses multiple transactions or occurrences. Thus, so long as each cause of action addresses only a single transaction or occurrence, Rule 10(b) is satisfied,” he wrote in his opinion.

The defendants also argue that the complaint is deficient under Rule 8(a) in multiple respects. Drozd said most of these arguments are mooted by the discussion that follows; however, he addressed the defendants’ contention that the plaintiff has failed to meet its pleading requirements because he has alleged claims against Doe defendants. Drozd notes that as a general rule, “Doe pleading” is disfavored in federal court. However, the practice is not entirely forbidden, particularly where the identities of alleged defendants are unknown prior to filing the complaint. The complaint lists three groups of Doe defendants: (1) persons serving on the Administration Committee of the ESOP; (2) the individual members of the Kruse-Western Board of Directors; and (3) the shareholders who sold their stock to the ESOP. Drozd said, of the second and third groups, only defendant Kruse is personally known, but the identities of others are almost certainly known to the defendants and should be readily ascertainable in discovery. He permitted the plaintiff to proceed on claims asserted against Doe defendants.

The defendants argue that the allegation that the selling shareholders and GreatBanc engaged in a prohibited transaction in violation of ERISA must be dismissed because it fails to assert that defendant Kruse and the selling shareholders were fiduciaries to the ESOP, and the complaint does not include a prayer for “appropriate equitable relief,” even though plaintiff is required to include this by law. The parties agree that GreatBanc is unquestionably a fiduciary to the ESOP; however, as to the selling shareholders, the defendants say the complaint contains no allegations indicating that they are themselves fiduciaries to the ESOP. Drozd agreed, noting that rather than alleging that the selling shareholders are fiduciaries, the complaint instead defines the selling shareholders as “parties in interest” within the meaning of ERISA.

According to Drozd, in the specific context of ERISA claims, whether the relief sought can be characterized as legal or equitable turns on whether the money or property sought is “in the defendants’ possession.” “The complaint in this case contains no such allegations. With respect to the selling shareholders, the allegations of the complaint state merely that they ‘participated in the sale of the company … and received in total $244 million in cash and loans from the ESOP for the company.’ There is no allegation that the proceeds from this sale were directed to any particular account over which plaintiff might have a valid claim,” Drozd noted.

However, the plaintiff argues that there is no requirement “that the funds or property must be identified in the complaint.” Imposing such a requirement at the pleading stage would, in plaintiff’s view, require him “to engage in a significant degree of pre-filing investigation and obtain information peculiarly in the possession of the defendant that is normally part of the discovery process in civil actions.” Yet, Drozd said he is bound by prior case law that the plaintiff has not persuasively argued that it may be meaningfully distinguished from this case. He dismissed the cause of action due to the plaintiffs’ failure to allege the location of the funds or property, but granted the plaintiff leave to amend.

As for the defendants’ argument that the plaintiff’s first cause of action must be dismissed against defendant GreatBanc because the transaction in question was “made for adequate consideration,” Drozd found nothing in the complaint establishing that the consideration paid in the transaction at issue was adequate. He denied the defendants’ motion to dismiss the first cause of action as to defendant GreatBanc.

For other counts in the complaint, there was disagreement as to whether the Board defendants are fiduciaries. Drozd considered the definition of fiduciary in ERISA and said, “Of particular relevance to this case, the Ninth Circuit has recognized that under the definition of a fiduciary, ‘where members of an employer’s board of directors have responsibility for the appointment and removal of ERISA trustees, those directors are themselves subject to ERISA fiduciary duties, albeit only with respect to trustee selection and retention.” Drozd noted that the second cause of action is unrelated to the appointment of GreatBanc as trustee but relates to the sale of Kruse-Western’s stock, contending that because the Board defendants were fiduciaries of the ESOP, any transaction between the ESOP and themselves effectively amounted to self-dealing in violation of ERISA. Drozd said such an allegation is not cognizable under ERISA unless the complaint plausibly alleges that the Board defendants exercised control over the ESOP and caused it to buy the Kruse-Western stock. He dismissed the plaintiff’s second cause of action with leave to amend.

The defendants contend that the complaint contains insufficient factual allegations to state a claim that GreatBanc breached its fiduciary duty to the ESOP. Drozd looked at the Supreme Court decision in Fifth Third v. Dudenhoeffer, saying that it required a plaintiff to allege “special circumstances,” which “might include something like available public information tending to suggest that the public market price did not reflect the true value of the shares.” But, he noted that in the current case, the stock is privately held, so that logic breaks down. He rejected the defendants’ argument in favor of dismissal of the third cause of action. “Defendants will be free to argue that the amount paid was in fact an accurate reflection of the value of Kruse-Western’s stock, and that they are therefore entitled to summary judgment. Such a factual dispute, however, cannot be resolved at the motion to dismiss stage of this litigation,” Drozd wrote.

Finally, defendants move for dismissal of the fourth cause of action, which alleges that the Board defendants violated ERISA by failing to monitor GreatBanc. Specifically, it contends that the Board defendants breached their duties under ERISA both by failing to ensure that the ESOP paid no more than fair market value for Kruse-Western’s stock, and by failing to ensure that GreatBanc took remedial action after Kruse-Western’s stock lost value. Defendants argue that because the complaint contains only conclusory allegations in support of this cause of action, it must be dismissed.

However, Drozd found additional, non-conclusory allegations in the complaint that indicate a failure to monitor. He said the complaint does allege that defendants failed to investigate, as any such investigation would have been revealed on a Form 5500 filed with the Department of Labor. In addition, the allegation that the value of Kruse-Western’s stock lost most of its value almost immediately after it was purchased by the ESOP, when combined with the allegation that GreatBanc took no remedial action following this decline in value, makes it quite plausible that the Board defendants failed to act with care, skill, prudence, or diligence in overseeing GreatBanc. These allegations are sufficient to survive a motion to dismiss.

Drozd directed the plaintiff to, within twenty-one days from the date of service of his order, either file a first amended complaint or notify the court that he intends to proceed only with the claims found cognizable in the order.

Investment Product and Service Launches

Northern Trust builds portfolio analytics tool; Transamerica lowers multiple investment fund fees; Mesirow Financial issues U.S. small cap sustainability vehicle; and more.

Art by Jackson Epstein

Art by Jackson Epstein

Northern Trust Builds Portfolio Analytics Tool

Northern Trust has launched a new investment analytics tool, providing institutional investors with insights when tracking and analyzing risk and performance across portfolios.

This latest enhancement from Northern Trust’s Investment Risk and Analytical Services (IRAS) group introduces Performance RADAR, a new proprietary reporting tool offering a contemporary user experience for accessing performance, attribution, contributions and ex-post risk results online across individual and aggregated portfolios.

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“Performance RADAR allows asset owners and asset managers to amalgamate and synthesize large amounts of complex data though flexible visualization tools,” says Serge Boccassini, product lead – Investment Accounting and Analytic Solutions at Northern Trust. “Our clients can find information quickly using powerful graphics and intuitively compare performance results. The result is that we provide clients with greater insights into their analytics—faster and more efficiently than ever before.” 

American Century to Launch New Suite of Investment Solutions

American Century Investments has hired three senior portfolio managers for the investment team supporting Avantis Investors, a new suite of broadly diversified, tax-efficient and low-cost investment solutions slated to launch later this year. Ted Randall, Mitchell Firestein and Daniel Ong bring 45 years of combined investment management experience to their new roles.   

Working with the firm’s Chief Investment Officer Eduardo Repetto Ph.D., Randall, Firestein and Ong will manage a range of investment solutions across market capitalizations and geographies. In late June, the firm filed a registration statement with the Securities and Exchange Commission to offer five new equity strategies. Available in exchange traded fund (ETF) and mutual fund vehicles, the new strategies are expected to rely on a proprietary investment approach based on market prices and designed to capture higher expected returns.

Randall has prior experience as a portfolio manager and vice president at Dimensional Fund Advisors (DFA), where he managed U.S., international developed and emerging market portfolios. During his 17-year tenure at DFA, Randall also led the research group’s trading support efforts and its management of security data. In this role, he designed portfolio management and trading applications to optimize the rebalancing and management of portfolios. Randall earned his master’s degree in business administration from the UCLA Anderson School of Management and holds a bachelor’s degree in business administration with a concentration in finance from the University of Southern California.

Prior to joining Avantis Investors, Firestein was a senior portfolio manager and vice president at DFA, where he led a team of investment professionals that managed approximately $40 billion in emerging market equity portfolios. He was responsible for strategy and portfolio oversight, implementation, and performance analysis. Firestein started his investment career at DFA in 2005 as a trading assistant supporting the international equity desk after graduating from Tulane University with a bachelor’s degree of science in management and finance. 

Ong also served as a senior portfolio manager and vice president at DFA for 14 years. Ong’s responsibilities spanned across managing international developed and emerging markets equity strategies, leading the emerging markets desk, and engaging with clients. Prior to that, he was an account manager at Metropolitan West Asset Management and a structure analyst at Pacific Investment Management Company. Ong is a CFA charterholder and earned a bachelor’s degree in economics from the University of California and an earned his master’s degree in finance and accounting from the University of Chicago Booth School of Business.

Transamerica Lowers Multiple Investment Fund Fees

Transamerica has reduced its fees for multiple investment funds, effective August 1 and August 2.

Fees were reduced by up to 13 basis points for certain classes of the following investments, representing more than $11.4 billion in assets as of June 30: the Transamerica Short-Term Bond; Transamerica Large Cap Value; Transamerica Intermediate Muni; Transamerica Unconstrained Bond; Transamerica U.S. Growth (effective August 2); Transamerica WMC U.S. Growth VP (effective August 2); and Transamerica Aegon U.S. Government Securities VP.

“At Transamerica, we strive to provide strong investment returns and competitive fees. Today’s announcement illustrates that commitment to our mutual fund, variable annuity, and retirement plan customers,” says Marijn Smit, head of Transamerica Asset Management, Inc.

Transamerica Asset Management, Inc. advises 69 mutual funds, 58 underlying funds for its variable annuity and variable life products, and five DeltaShares exchange-traded funds (ETFs).

Sun Life Financial Announces First Sustainability Bond Issuance

Sun Life Financial Inc. will issue $750 million dollars’ worth of principal amount in Canada, of Series 2019-1 Subordinated Unsecured 2.38% Fixed/Floating Debentures. The offering is expected to close on August 13.

The Debentures will represent Sun Life’s inaugural sustainability bond in Canada and marks the first issuance of a sustainability bond by a life insurance company globally.

In March 2019, Sun Life published its Sustainability Bond Framework, outlining its criteria for the bonds. Distinguishing them from green bonds, Sun Life’s bond and its Sustainability Bond Framework include criteria for both green and social assets. Potentially eligible social investments focus on access to essential services, facilities and equipment that contribute to the long-term health of communities while delivering excess returns to investors, such as infrastructure investments for hospitals or childcare centers. Sun Life’s Sustainability Bond Framework and an independent second party opinion by Sustainalytics on the framework’s alignment with the International Capital Markets Association’s Sustainability Bond Guidelines are available publically on Sun Life’s Investor Relations website. 

“We’re proud to be the first life insurance company globally to issue a sustainability bond. At Sun Life, our purpose is to help our clients achieve lifetime financial security and live healthier lives. This issuance demonstrates our commitment to embed sustainability into our business while contributing positively to society and advancing technologies that enable a healthier future,” says Melissa Kennedy, executive vice president, chief legal officer and executive sponsor of Sustainability, Sun Life. “The financial market plays a key role in the transition to sustainable practices and we’re pleased to broaden the opportunities for sustainable investments in Canada.”

Mesirow Financial Issues U.S. Small Cap Suitability Vehicle

Mesirow Financial has released its Small Cap Value Sustainability Fund. This vehicle capitalizes on the firm’s U.S. Small Cap sustainable investment strategy while addressing the increasing desire of institutional, corporate and individual investors to emphasize responsible investing within well-diversified portfolios.

“With this strategy, we link environmental, social and governance [ESG] factors with our fundamental assessment of macro, sector and company-specific trends,” notes Kathryn Vorisek, senior managing director and head of Equity Management at Mesirow Financial. “We believe that actively incorporating well-defined ESG factors can offer attractive investment potential—and a lower overall portfolio risk profile—while driving positive environmental and societal outcomes.”

“Social responsibility has been a core value of Mesirow Financial since its founding in 1937,” remarks Dominick Mondi, president and CEO of Mesirow Financial. “For decades, we have served as a catalyst for positive change in our communities, and so it is a natural extension to incorporate environmentally and socially sound principles as we design investment solutions for our clients.”

Going forward, the firm says it will continue to seek positive impact through active engagement with companies and further integration of ESG elements into a growing line-up of investment strategies and solutions that are good for society and good for investors.

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