Compliance March 17, 2017

Decision Finds Wilmington Trust Liable for ESOP Damages

The firm has been deemed liable for violations stemming from a “rushed” ESOP valuation—although some claims of wrongdoing leveled against the firm at trial were denied.
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Following a bench trial in a complex employee stock ownership plan (ESOP) lawsuit, a district court has held that Wilmington Trust is liable for violating Section 1106(a)(1)(A) of the U.S. Code, but not liable for violating parts (a)(1)(B) or (b) of that section.

The lead plaintiff in the case is a former employee of Constellis Group, Inc., and a former participant in an employee stock ownership plan (ESOP) created and terminated by the private security firm. Defendant Wilmington Trust N.A. “was the trustee for the ESOP in connection with Constellis’ creation of the ESOP.”

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Background included in the text of the decision, handed down by the U.S. District Court for the Eastern District of Virginia, shows that creating the ESOP involved the purchase of 100% of Constellis’ voting stock in December 2013. Less than a year after the ESOP was created, according to the decision, “all its stock was sold.”

Plaintiffs alleged that the 2013 purchase “involved transactions and payments prohibited by the Employee Retirement Income Security Act of 1974, 29 U.S.C. § 1106, resulting in the ESOP paying an inflated price for the Constellis stock.” Specifically, plaintiffs alleged that the $4,235 per share paid in 2013 “was not the fair market value of such stock, resulting in the ESOP overpaying for the stock by $103,862,000, which plaintiff seeks to recover for the ESOP.”

In the end the court ruled that Wilmington is liable for causing nearly $30 million in damages to the ESOP—far below what participants claimed they were entitled to, but a significant result nonetheless.

Case documents show the ESOP in question was created through an extensive process of projections and analysis, which included discussion of multiple potential approaches and wide swings in valuation projections made by contracted experts. 

NEXT: The shortest lived ESOP on record? 

The lengthy text of the decision outlines the recent history of the company, explaining how equity ownership had transitioned within the firm prior to its acquisition by another competitor. After some early shifts and reorganizations, the company approached its general counsel about forming a new ESOP in June of 2013. Leadership at the time apparently viewed the ESOP both “as an exit strategy while being consistent with the vision of Constellis as a company focused on taking care of its employees.”

The company leadership, according to the text of the decision, debated whether to pursue a traditional ESOP structure or a structure under which 90% of the shares would be sold to the ESOP, while the remaining 10% would be exchanged for “equity-like warrants.” The warrants would be “financial instruments entitling the sellers to buy back equity in Constellis at a designated price, known as the strike price, during a certain period of time.” This would allow the sellers as warrant holders to retain significant elements of control over the company, most notably the ability to appoint a majority of the board of directors. Under the proposed plan, the ESOP was to borrow from the sellers to buy their stock, meaning the sellers would also become the company’s creditors.  

For its services as trustee, Wilmington charged Constellis a flat fee of $150,000 to be paid regardless of whether or not the ESOP transaction closed. If the transaction closed, the firm would also receive a minimum payment of approximately $80,000 per year in fees for serving as ongoing trustee. The court finds no evidence these were unreasonably assessed.

Problems arose when it came to the step of valuing the closely held company, according to the decision. One early estimate received by the firm pegged its value at just $165 million. However more generous estimates of $290 million and $345 million were also made, and the final settling price paid by the ESOP was close to the top end of these estimates. A significant portion of the bench trial was apparently spent dissecting the various methods used by various contracted experts to reach the final figure.

In the end the court found that Wilmington “rushed its evaluation of the Constellis ESOP, failed to follow its own policies, and failed to adequately vet [other valuators’] conclusions.” This became a pressing issue for employees when company leadership terminated the ESOP just seven months after its creation, during the subsequent sale of the company to another organization, ACADEMI, for a total purchase price of $281 million. The transaction resulted in the termination of the ESOP and thereby cemented significant participant losses compared with the previous valuations.

The full text of the decision is here. 

Client Service March 17, 2017

DB Plan Providers Not Shying Away From Enhancing Platforms

DB plan providers are enhancing participant and plan sponsor services, and innovating plan design.
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With the number of active defined benefit (DB) plans dwindling, it makes one wonder if DB administration providers are investing in updates, enhancements or improvements to their offerings.

Monica Gallagher, a Jacksonville-based partner responsible for October Three’s DB administration services, says, “There’s no question the provider space for DB plans has shrunk.” She explains that in the early 70s into the 80s, there were best in class providers and plan sponsors could pick someone who could do something excellent. Then there was a wave of total retirement outsourcing (TRO), but plan sponsors found it hard to find a provider good at all types of retirement plans. Some big companies got out of the DB business; they had to choose where to invest their technology.

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But, Gallagher says the providers dedicated to the DB space are making innovations. She notes that even sponsors of frozen plans have responsibilities to participants.

Richard Sych, president and consulting actuary, Hooker & Holcombe, who also is based in West Hartford, Connecticut, says it depends on the provider and which market in the DB space they service. “We service the small to mid-sized plan market, and we’ve actually been growing,” he says. He notes that Hooker & Holcombe gets new business from larger providers, because once a plan is hard frozen, it doesn’t need as much attention, so it makes more sense to move the client to a firm that serves small to mid-size plans.

Timothy Ryor, SVP and practice lead, actuarial services, Hooker & Holcombe, who is based in West Hartford, Connecticut, says providers to large plans are not getting out of business, but they are focusing efforts on larger clients. “So smaller clients are getting under-serviced. We’ve been successful in offering solutions and lower fees to them.”

Ryor adds, “One of the trends we are seeing is a move to pension outsourcing, where plan sponsors turn over administration from human resources.” He explains that human resources (HR) professionals that had a background in DB administration are retiring, and generally new HR employees are not getting up to speed.

NEXT: DB providers investing in enhancements

Gallagher notes that some providers dedicated to the DB administration business are looking at online features. “Participants have always been able to go online and run retirement scenarios, but some providers have expanded that to allow participants to retire online,” she says. “They can fill out paperwork online, upload documentation, choose their tax election and method of payment. It’s a recent innovation that helps participants and is efficient for plan administrators.”

Another innovation is providing DB plan sponsors with self-service, Gallagher adds. They can access call notes and case management notes to confirm correct answers are being given or where the participant is in the process.

According to Ryor, with larger providers focusing on larger clients, Hooker & Holcombe has developed a platform for interactive capabilities. Participants can do projections online and calculate benefits. He says these types of services vary in the market.

Gallagher says with the Pension Protection Act (PPA) giving cash balance plans the opportunity to tie interest credits with market returns, plan design innovation is something new in the DB market. She sees cash balance plans will become more popular as plan sponsors question whether defined contribution (DC) plans can do the job like DBs. Plan sponsors can provide a pension without the same volatility, and participants will be able to see an account value just like in DC plans.

Ryor also says some of the innovation for ongoing, active plans relates to plan design. “A lot of new DB plan generations are cash balance plans. They tend to be smaller plans or for larger plans, they tend to be more for professional services firms, such as attorney firms. Cash balance plans allow for greater tax-deferred savings, and are in part inspired by DC plans not having good returns and not offering enough benefits,” he states.

NEXT: What to look for in a DB plan provider

When looking at DB plan providers, plan sponsors should question when they developed their software and how easy it is to enhance it, according to Gallagher. She adds that consultants who were around when DBs were dominant can do searches for industry standards using market research—they don’t necessarily use requests for proposals (RFPs). “Most plan sponsors benchmark their providers when contracts are up for renewal to see what else is in the marketplace,” Gallagher states.

She also says looking at fees is important, noting that some DB plan sponsors are surprised that fees aren’t reduced when they freeze their plans.

For those DB plan sponsors that want to do all or some plan administration in-house, there are still providers that offer technology solutions for internal use, Gallagher adds.

“Identify what you want and what firm can help you achieve that,” Ayor says.

He suggests plan sponsors look for depth of knowledge—a provider that knows DB plans and the client’s type of DB plan. In addition, sponsors should look at a provider’s technology. What is the plan sponsor looking to provide for participants? He adds that plan sponsors should question the type of fees a DB provider charges.

Ayor suggests flexibility is important for plan sponsors. “The one area we do see those comprehensive services provided to the mid-market is through insurance companies. But a lot of the plans they service are frozen, and ultimately the insurance company is looking into selling annuities. They are asset accumulators. If plan sponsors don’t want to be tied to a product, they need to look for a provider that is not tied to product,” he says.

“Some DB plan providers are getting out of the business; others are investing to make enhancements. This is good for plan sponsors as well as recordkeeping of these plans, and it improves participant satisfaction. It is an efficiency game,” Gallagher concludes.

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