DOL’s ESOP Valuation Case Against Engineering Firm Falls Flat

The U.S. District Court for the District of Hawaii has issued a decisive ruling in an employee stock ownership plan (ESOP) valuation case known as Walsh v. Bowers.

Writing in the Employee Ownership Blog published by the National Center for Employee Ownership (NCEO), Corey Rosen, NCEO founder and senior staff member, says the ruling represents “one of the most comprehensive rebukes of DOL arguments” in ESOP valuation cases.

Such cases arises when the government, via the Department of Labor (DOL)’s Employee Benefit Security Administration (EBSA), alleges purchase price manipulation and other schemes that may benefit corporate leadership and company owners at the expense of employees who collectively enter into an ESOP founding transaction.

In this case, the defendants owned all the stock in an engineering firm called Bowers + Kubota Consulting Inc. As recalled in the text of the new ruling, the defendants created an ESOP to which they sold all their shares for $40 million. The EBSA then sued the defendants, alleging that they had violated the Employee Retirement Income Security Act (ERISA) by “manipulating data to induce the ESOP to pay more than the company’s fair market value.”

The new ruling, which was technically filed as post-trial findings of fact and conclusions of law issued alongside an order directing entry of judgment in favor of remaining defendants, determines that no ERISA violation has been established.

“Part of the government’s case is based on a preliminary nonbinding indication of interest by a private company to purchase the company for what the government says was $15 million,” the order states. “That indication of interest expressly recognized that the dollar amount needed to be adjusted to reflect the cash and debt on the company’s balance sheet. Had that adjustment occurred, the quoted dollar figure would have risen to about $29 million. In any event, the company never agreed to sell for $15 million, meaning that that figure did not represent what a willing buyer and willing seller would mutually agree to.”

According to the court’s new order, the indication of interest “ends up having little relevance to the fair market value of the company.” The order points out that the government’s arguments cite an expert who valued the company at $26.9 million, but “because that valuation rests on errors, the court is not persuaded by it.”

“The government does not establish that the company was worth less than $40 million on the day of its sale,” the ruling states. “That is, the record does not show that the ESOP paid more than the company’s fair market value. Nor does this court find that [the defendants] breached any fiduciary duty or are liable for any prohibited transaction, as they demonstrate that the company was worth at least $40 million on the day of its sale. Accordingly, this court, following a one-week nonjury trial, finds in favor of [the defendants] and against the government.”

In the NCEO blog, Rosen emphasizes how the judge ruled that the DOL’s valuation “rests on errors” because its expert failed to follow standard valuation practices, used inaccurate and incomplete information about the company’s finances, and improperly compared the price the ESOP paid to a very preliminary lower offer from another company.

“The court noted that the preliminary offer was likely just a negotiating tool, analogizing that an individual who makes an offer of $15,000 for a used luxury car with a Blue Book value of $40,000 does not, by virtue of making a ‘lowball’ offer that is never accepted, tend to establish that the car is worth only $15,000,” Rosen explains. “The court also noted that the ESOP trustee, while accepting a price very close to what the sellers were seeking, saved the company millions of dollars by negotiating a relatively low rate on seller notes used to finance the deal.”

The full text of the order is available here.