Compliance April 30, 2020

Family Owners Charged with ESOP Buyback Violations in New ERISA Lawsuit

The lawsuit is directly tied into another in which Wilmington Trust agreed in January to a settlement valued at $5 million.

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A new Employee Retirement Income Security Act (ERISA) lawsuit has been filed in the U.S. District Court for the Western District of Kentucky, Louisville Division, naming a laundry list of defendants that includes various trusts, individuals and corporate entities.

ISCO Industries Inc., a global customized piping solutions provider based in Louisville, Kentucky, is the most recognizable of the defendants. Other defendants includes trusts into and out of which the proceeds of the sale of employer stock have been paid, as well as the family owners of ISCO Industries Inc.

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The lawsuit is directly related to another filed recently under ERISA, which Wilmington Trust agreed to settle in January to the tune of $5 million. In the new case against ISCO, the plaintiffs seek “relief relating to losses they incurred in connection with the sale of stock of ISCO Industries Inc. from a now terminated employee stock ownership plan [ESOP] in which they were participants back to the prior owners of that stock at a grossly deficient price in a prohibited and imprudent transaction.”

While it is not normally necessary to describe in detail most of the plaintiffs and defendants named in a case of this nature to understand its arguments and potential merit, in this particular matter it is essential to understand who several of the defendants are. For their part, the plaintiffs were all participants in the ISCO Industries Inc. ESOP. Their interests in the ISCO ESOP were vested on or before February 14, 2018, according to the complaint.

The complaint details its list of defendants as follows: “Defendant Stephen C. James is a Louisville-based consultant. Mr. James became the trustee of the ISCO ESOP in the fall of 2017, after the Kirchdorfers determined to replace then-trustee Wilmington Trust, N.A., for its reluctance to approve buyback transaction described further below. At the time, Mr. James had very limited experience serving as an independent trustee for an ESOP and instead was the full-time CFO [chief financial officer] of a large chain of dental practices.”

The complaint continues: “Defendant James J. (Jimmy) Kirchdorfer, Jr., is the chair and CEO of ISCO, a company his father, James J. Kirchdorfer Sr., formed in 1962. Defendant Mark T. Kirchdorfer is president of ISCO and Jimmy’s brother. The various trust defendants all are structured for the benefit of the Kirchdorfer family and were among the purchasers of ISCO stock in the buyback transaction described further below. The plan administrator of the ISCO ESOP was a committee appointed by ISCO’s board of directors, which at all relevant times was controlled by Jimmy and Mark Kirchdorfer. Indeed, publicly available information indicates that they have been ISCO’s only or majority directors at all relevant times.”

The complaint further alleges that Jimmy and Mark Kirchdorfer were “the sole or controlling directors of ISCO” enjoying “full authority to dictate membership of the committee charged with administering the ESOP.”

With those facts laid out, the complaint notes that ISCO formed the ISCO ESOP in 2012, with the Kirchdorfers and their trusts agreeing to sell the outstanding shares of ISCO stock to the ESOP for $98 million, or approximately $24.50 per share. In connection with the sale, the complaint states, ISCO loaned the ESOP $98 million to fund the transaction. Wilmington Trust, then serving as trustee, represented the ESOP in that transaction. The now-settled lawsuit that targeted Wilmington Trust directly alleged that the firm had violated its ERISA duties in agreeing to “a dramatically inflated valuation and price for the shares of ISCO stock as of 2012.”

“By summer 2016, with ISCO experiencing financial doldrums, the Kirchdorfer defendants saw an opportunity to buy back the ISCO stock they had sold to the ESOP four years earlier and began plotting to do so,” the complaint states. “Because the price for any buyback would necessarily be determined in large measure based on trailing 12 months of financial results and informed financial forecasts for the coming year, the timing of any buyback necessarily would have a major impact on the appropriate sales price.”

According to the complaint, by August 2017, ISCO’s financial fortunes had begun to look up, “dramatically so,” as a result of a confluence of events including Hurricane Harvey, which had the effect of driving great demand for industrial piping at the same time that a large part of the supply was being eliminated. The complaint says the company had experienced a similar trend in 2006 and 2007 in the wake of Hurricane Katrina.

“As a result, Jimmy Kirchdorfer accelerated the plot to take ISCO’s stock back from the ESOP, including by expressing his views that the ESOP was inconsistent with the company’s business circumstances and pressuring plan participants to write out short narratives for him to the effect that they disliked the ESOP and did not value ownership of ISCO stock through the plan, for use in his strategy to terminate the ESOP,” the complaint states.

The complaint then alleges that, in October 2017, ISCO executives gathered in person in Louisville to finalize financial forecasts for 2018. The alleged consensus view of the numerous executives present was that 2018 would be a stellar year financially in light of the continuation of trends that had emerged in the second half of 2017.

“Of course, those forecasts necessarily would need to be reflected in any fair sales price for ISCO stock,” the complaint states. “As a result, at the forecast meeting, Jimmy Kirchdorfer repeatedly and uncharacteristically attacked the forecasts as too high, demanding that they be lowered.”

Subsequently, James, in his role as the new trustee for the plan, approved the plan’s sale of ISCO stock back to the Kirchdorfer defendants for $96.6 million. Thus, according to those values, the outstanding shares of ISCO were worth about $1.4 million less in 2018 than when the ESOP was formed in 2012, “despite that the company was substantially more profitable, and facing a rosy forecast, when the ESOP terminated than when it was formed.”

“Mr. James made no inquiry of any ISCO sales executives concerning the company’s forecasts or valuation, and to plaintiffs’ knowledge, did not solicit the opinion of any participants, much less conduct even an informal survey of participants concerning the proposed transaction or its terms,” the complaint states. “Fully anticipating that the true forecasts would come to fruition, the Kirchdorfer defendants became the owners of ISCO’s stock on February 14, 2018, so that they, and not the plan participants, could enjoy those record-breaking financial results.”

The complaint concludes its technical fiduciary breach and prohibited transaction allegations by calling on the court to issue various remedies including re-establishment of the ESOP, monetary compensation and the installment of an independent trustee.

In response to a request for comment about the litigation, David Haick, ISCO general counsel, provided the following: “ISCO is aware of this complaint which was filed by three former employees of the company. The allegations and claims made by these plaintiffs have absolutely no merit in law or fact, and ISCO intends to vigorously defend itself in the matter.”

The full text of the complaint is available here.

Administration April 30, 2020

Plan Sponsor Due Diligence in a Demanding Time for Recordkeepers

Plan sponsors can show compassion for their recordkeepers, while at the same time ensuring their plans are operating smoothly.

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While recordkeepers are under considerable pressure, they are showing compassion for plan sponsors and participants during the coronavirus pandemic. From waiving fees to offering additional financial help, retirement plan recordkeepers, third-party administrators (TPAs) and advisers, as well as financial wellness providers, are stepping up to assist plan sponsors and employees in a number of ways.

Plan sponsors can, in turn, show compassion for their recordkeepers, while at the same time ensuring their plans are operating smoothly.

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In a blog post on The Wagner Law Group’s website, attorneys say operating during this time “places unfathomable strain” on recordkeepers’ business continuity plans (BCPs) “and creates new challenges for compliant operations.” The attorneys list action items for retirement plan service providers.

The Coronavirus Aid, Relief and Economic Security (CARES) Act created a new emergency retirement plan distribution option dubbed the “coronavirus related distribution,” or “CRD” for short. A CRD can be drawn from a defined contribution (DC) plan or from individual retirement accounts (IRAs) in any amount up to $100,000. The law also doubled the amount of loans that participants can take—from $50,000 or 50% of their account balance, whichever is lower, to $100,000 or 100% of their account balance.

The attorneys note that recordkeepers that offer volume submitter or master prototype plan documents will have to amend the plans and distribute a summary of material modifications to allow for the CRD withdrawal. “Given the challenges to document execution and obtaining signatures, the negative election process should be considered where available,” the attorneys advise providers.

Paul Neuner, managing director and founding partner of Concurrent Advisors, says the negative election process is common among recordkeepers. “Many recordkeepers have used negative election and provided an extremely narrow window to make the necessary modifications,” Neuner says. “This is largely due to timing and number of plans they serve. If a sponsor desires to sign, then it would be prudent for them to be in a conversation with the vendor.”

However, Marcia Wagner, owner of The Wagner Law Group, tells PLANSPONSOR it is more prudent for sponsors to get actual signatures if they are running an individually designed plan. “With respect to the signature requirement, there is a distinction between individually designed plans and standardized and non-standardized plans,” Wagner says. “Only in very limited circumstances has the absence of a written signature been excused by the IRS in connection with an individually designed plan. Standardized and non-standardized plans operate on a different basis. They will frequently provide a default version of a plan amendment, and if the plan sponsor has no objections to the amendment, no further action is required.”

The Wagner Law Group suggests recordkeepers train their call center representatives to discuss loans, in-service withdrawals, COVID-19-related withdrawals and the consequences of each. Recordkeepers need to ensure they have the supervision in place to ensure these reps are only providing education, not advice, the legal group says.

“While a plan sponsor can certainly inquire of a recordkeeper if it is adequately training its call center employees to respond to the new questions that they will be receiving, the recordkeeper is in a better position to make that determination than the plan sponsor,” Wagner says.

The Wagner Law Group says many recordkeepers are closing offshore call centers and may be facing staffing challenges if a significant number of employees are required to quarantine because of the coronavirus. It also says that with increased call center volume, if possible, recordkeepers should expand their call centers. The group suggests one way to address this need is to turn to a broker/dealer (B/D) firm with the capacity to provide call center services and/or to redeploy staff from other departments.

Neuner believes inquiring about adequate staffing, particularly as call volumes are spiking, is an important question for sponsors to be asking of their recordkeepers. “Plan sponsors should never have a ‘set it and forget it’ mindset as it relates to running a retirement plan, especially if the vendor is serving as a directed trustee,” he says. “The sponsor should have regular checks and balances for various types of vendor activities.”

The Wagner Law Group says that besides ensuring recordkeepers’ call centers are operating smoothly, “firms should also confirm that all of their [recordkeepers’] operations (e.g. investing, trading, investor relations, compliance, required recordkeeping) are all functioning as anticipated under their business continuity plans [BCPs], even if such functions are occurring remotely.”

Wagner thinks it is unlikely that the contracts sponsors have with their recordkeepers reference BCPs, but, more likely, they do address how the recordkeeper will be able to continue to function in the event of an emergency. “While the existing agreement with the recordkeeper may not specifically reference business continuity plans,” she says, “it may contain a force majeure provision. That provision, in all likelihood, will not address pandemics but may address generally how the recordkeeper is to respond in an emergency situation. The plan sponsor could inquire how the business continuity plan has been working and if there have been any glitches, but if it is informed that everything is working well, it probably has no further duty of inquiry.”

Recordkeepers with BCPs that do not have procedures for pandemics should add them in, The Wagner Law Group blog says. Recordkeepers’ BCPs should call for having emergency contact information for all staff and using cloud-based systems to reduce the risk of inadequate security around mobile devices, the law firm adds.

The blog says that while the U.S. government has not indicated when the stay-at-home guidelines in place across much of the country are likely to be lifted, recordkeepers should be prepared to continue operating under their BCPs for the next three to six months.

Neuner says “the pressure on recordkeepers is tremendous. Call centers are receiving increasing call volumes and huge swings in activity, with much of the conversations from concerned to panicked participants.” It is important for sponsors to help their participants weather the current market volatility by focusing on the long term, he says.

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