The 5th U.S. Circuit Court of Appeals has found that fiduciaries of Bruister and Associates, Inc. (BAI) employee stock ownership plans (ESOPs) violated their duties of prudence and loyalty under the Employee Retirement Income Security Act (ERISA) regarding company stock purchases to the ESOP.

In a three-year period from 2002 to 2005, BAI’s owner Herbert C. Bruister sold 100% of his BAI shares (also representing 100% of BAI’s outstanding shares) to BAI’s employees through a series of transactions with the ESOPs.  Bruister and Amy O. Smith are named defendants in the suit.

The trustees set the sales price for each transaction based on valuations of BAI’s fair market value performed by Matthew Donnelly. The Department of Labor (DOL) and other named plaintiffs dispute whether Donnelly was truly independent and whether the trustees’ reliance on his valuations was reasonably justified. The basic claim is that the valuations were inflated, which caused the ESOP, and therefore BAI’s employees, to pay too much for the BAI stock. BAI suffered serious business reverses and went out of business in August 2008.

The appellate court found the U.S. District Court for the Southern District of Mississippi did not err in finding “[t]he  duty  of  loyalty  was  breached  from  start  to  finish.”  The 5th Circuit noted that among other things, the lower court found that Bruister: fired the ESOP’s counsel for being “too thorough;” caused David Johanson, Bruister’s personal lawyer, to influence Donnelly’s supposedly independent valuations to get the highest selling price he could for himself; caused Donnelly to send “valuation drafts to the seller [Bruister] before sending them to the buyers [ESOP trustees] to whom he owed his sole allegiance;” cut the ESOP’s counsel out of all communications regarding valuation; adjusted assumptions and figures used by Donnelly to obtain a higher valuation; and generally, did not “speak up for the ESOP participants.” 

The District Court also concluded that the trustees were affected by Bruister’s self-interest and thus failed to act solely in the interest of the ESOPs’ beneficiaries and participants. According to the appellate court, testimony from the trustees challenged the lower court’s findings, but the testimony was “far from sufficient to demonstrate clear error” on the district court’s part.

The appellate court also agreed with the District Court’s findings that the trustees, including Smith, conducted insufficient investigation into Donnelly’s background and qualifications; overlooked communications in which “Donnelly and Johanson were obviously working together to increase the value” of the shares in question; failed to inform Donnelly of significant information and risk factors for the company that should have influenced his valuation; and failed to double-check or significantly review Donnelly’s ultimate conclusions. 

In its opinion, the 5th Circuit wrote: “The trustees’ actions were not those of prudent men.”

In 2014, the U.S. District Court for the Southern District of Mississippi issued a judgment and order requiring fiduciaries to pay more than $6.48 million to the two employee stock ownership plans sponsored by BAI. The appellate court approved this amount.

Last month, a federal judge has entered a consent order expanding substantially the scope of a previous judgment and order between the DOL and Johanson. The judgment settled the DOL’s allegations that Johanson and his prior law firm committed contempt of a previous consent order.

The 5th Circuit’s opinion goes on to clarify some of the legal issues surrounding leveraged ESOP sales presented by the case. The text of the opinion is here.