In a very detailed decision, a
district court found that members of Antioch Company’s Board and ESOP
Advisory Committee (EAC) did not violate their fiduciary duties during a
transaction to make the employee stock ownership plan (ESOP) 100%
employee-owned years before the company declared bankruptcy.
Defendant
GreatBanc & Trust Company was the ESOP’s transactional trustee in
2003. The Antioch Board gave GreatBanc the independent discretion to
determine whether to tender the ESOP’s shares in the transaction.
Because the transaction would not close if GreatBanc tendered the ESOP
shares, GreatBanc was given effective veto power over the transaction.
GreatBanc exercised its discretion to decline the tender offer and it
thereby allowed the transaction to close. GreatBanc and plaintiffs
settled shortly before trial, so GreatBanc is no longer a defendant in
the suit.
Plaintiffs claim that, based on the actions defendants
took in connection with the 2003 tender offer transaction, defendants
are liable for breaching their fiduciary duties to the ESOP, enabling
other fiduciaries’ breaches, and causing a prohibited transaction, in
violation of sections 404, 405 and 406 of the Employee Retirement Income
Security Act (ERISA). However, U.S. District Judge Jorge Alonso in the
U.S. District Court for the Northern District of Illinois, first
determined that members of the EAC were not fiduciaries, so they did not
violate any fiduciary duties. Since GreatBanc had discretion over the
transaction, it was a fiduciary.
As far as the duty to monitor
fiduciaries claim, the court noted that the Antioch Board of Directors,
not the EAC, possessed the power to appoint and remove GreatBanc.
Plaintiffs contend that whether the duty to monitor is breached depends
on the facts and circumstances of each case, and their duty to monitor
claim is not derivative of an underlying breach of fiduciary duty by the
appointed fiduciary, nor does it depend directly on whether the
appointed fiduciary committed an underlying breach. Defendants say the
duty to monitor does depend on whether the appointed fiduciary committed
a breach.
Regardless of who has the better of this argument,
Alonso said the court must analyze whether GreatBanc breached its
fiduciary duty anyway, in order to resolve plaintiffs’ co-fiduciary
claim under section 405 of ERISA. He assumed for the sake of argument
that defendants are correct that plaintiffs must prove an underlying
breach of fiduciary duty by GreatBanc to prevail in their duty to
monitor claim against defendants under section 404.
NEXT: No Breach of Fiduciary Duty by GreatBancBut Alonso found that, far from
demonstrating a breach of fiduciary duty by GreatBanc, the record shows
that GreatBanc conducted a thorough and vigorous review of the
transaction and worked diligently to protect the ESOP’s interests by
negotiating better transaction terms. He added that, even assuming that
plaintiffs did establish an underlying breach by GreatBanc, or that, as
plaintiffs have argued, the law does not require them to do so to
prevail on their section 404 claim, they have still failed to prove that
defendants breached their duty to monitor GreatBanc.
Alonso
noted that the duty to monitor requires only monitoring “at reasonable
intervals” to ensure that “performance has been in compliance with the
terms of the plan and statutory standards, and satisfies the needs of
the plan.” There were only four months between GreatBanc’s retention and
the closing of the 2003 transaction. In that time, the evidence shows
that GreatBanc representatives met with the Board of Directors on two
separate occasions. In addition, at the Board meeting on October 16,
2003, the management team presented the Board with a written and verbal
report about GreatBanc’s negotiating positions and GreatBanc’s financial
and analytical rationales supporting its position (which at the time
was that the transaction was not fair to the ESOP). Moreover, Antioch’s
Board supplemented this monitoring by utilizing members of Antioch’s
management team as contact points with GreatBanc. Nancy Blair was in
frequent communication with GreatBanc and its advisers during the
negotiation of terms extrinsic to the tender offer that would allow for a
fairness opinion, and reported to Board members about those
communications.
Alonso said the court need not decide whether
ERISA imposes a duty to inform because, even if there is such any such
duty, plaintiffs have not proved that defendants breached it.
In
addition, co-fiduciary liability claims under ERISA section 405 are
derivative of an underlying breach of fiduciary duty, meaning that
plaintiffs must prove a breach of fiduciary duty by GreatBanc in order
to impose liability on defendants. Because plaintiffs failed to prove
that GreatBanc breached any duty to the ESOP, no co-fiduciary claim
against defendants exists, so Alonso entered judgment for defendants on
plaintiffs’ section 405 claim.
As for the ERISA section 406
claims, Alonso assumed the transaction was, if not an indirect sale or
exchange between the plan and a party in interest within the meaning of
section 406(a)(1)(A), at least an indirect use of plan assets for the
benefit of a party in interest within the meaning of 406(a)(1)(D). The
whole purpose of engaging GreatBanc as an independent trustee was to
remove defendants from the ESOP’s decision as to whether or not to
tender its shares in the transaction because defendants had conflicts of
interest. “It would be a bizarre logic that would hold them accountable
for ‘causing’ the ESOP to engage in a transaction when they hired an
independent trustee for the specific purpose of deciding whether to
cause the ESOP to engage in the transaction (by declining to tender its
shares) or not, in accord with the independent trustee’s independent
determination of which alternative was in the ESOP’s best interests,”
Alonso wrote in his opinion. “The parties cite little law to help the
court decide this question. In the end, it need not do so because
defendants have clearly established that the company purchased the
outside shareholders’ shares for ‘adequate consideration’ within the
meaning of the statutory exemption of section 408(e), so the defendants
cannot be liable for causing a prohibited transaction under section
406(a).”
NEXT: The caseIn the years preceding the
transaction, Antioch had experienced dynamic growth in sales and
virtually every other financial metric, including its share price. In
the years following the transaction, however, sales dropped
precipitously, and the share price dropped along with them. In late
2008, Antioch reorganized its capital structure through a Chapter 11
bankruptcy, and the new capital structure did not include an ESOP.
Contending
that the ESOP’s shares of Antioch stock became worthless due to the
transaction, plaintiffs filed a lawsuit against defendants Lee Morgan,
Asha Morgan Moran and Chandra Attiken, all of whom were either former
members of the Board of Directors at Antioch and/or Antioch’s internal
EAC.
Between 1999 and 2002, the Antioch ESOP allocated any
dividends or distributions paid on the common stock held in the Antioch
ESOP 75% based on the annual compensation of each participant and 25%
based on the account balances of each participant. The allocation method
fit with Antioch’s corporate culture because it allowed newer employees
at its subsidiary Creative Memories, who had smaller account balances,
to share more in Antioch’s increasing revenue and profits. The IRS
approved the amended plan and method of allocation, and the change was
implemented in January 1999.
At some point in late 2002, however,
Antioch became aware of an IRS Technical Advice Memorandum (TAM), in
which the IRS ruled that a similar method of allocating subchapter S
distributions was improper and, instead, distributions must be allocated
100% on account balance—a method of allocation that, in the case of
Antioch, would enrich long-tenured employees at the expense of the newer
employees who were driving the company’s recent success.
While a
TAM describes the IRS’s position only with respect to a specific
taxpayer, and this particular TAM did not address or bind Antioch,
Antioch’s advisers agreed that it was nevertheless prudent for Antioch
to reconsider its practices. In January 2003, Antioch held a meeting to
explore its options related to the ESOP in light of the legal issues
with its allocation method, including the IRS position on dividend
allocation. At the meeting, company representatives, lawyers, and
professionals from Deloitte & Touche discussed different concepts
that would resolve the apportionment problem caused by the IRS ruling.
Under one of Deloitte’s proposals, the ESOP would become the 100% owner
of Antioch’s stock.
Deloitte created the outline for the general
structure of the transaction. As structured by Deloitte, the company—not
the ESOP—would purchase the shares sold in the transaction.
According to the court opinion,
Antioch’s board amended the plan to give GreatBanc authority to decide
how to vote ESOP shares with respect to the transaction. The company and
its advisers engaged in due diligence, and the company provided
financial projections to the advisers. Ultimately, approximately 90% of
ESOP participants voted in favor of the transaction and the transaction
closed.
At the time that the transaction reached the due
diligence stage, the company was aware of some risks and threats to the
business. For example, a 2001 Annual Report stated, “The biggest cloud
over our organization, in my opinion, is our obligation to repurchase
our stock from both ESOP participants as they retire and from other
stockholders . . . The potential impact on our cash position is huge.”
Also, Creative Memories growth was being threatened by the competition
of digital photos.
The company disclosed the threats facing
Antioch to GreatBanc and its advisers. There was no evidence that the
Board did not properly consider or account for those concerns, nor did
plaintiffs introduce any expert or fact evidence that the concerns
should have caused the Board or GreatBanc to abandon the transaction,
the opinion noted.
In the years after the transaction, the
company experienced much larger than predicted levels of share
redemptions. In 2004 alone, departing ESOP employees put approximately
$109 million in ESOP shares to the company. But, no evidence exists that
the increased number of shares put were caused by any transaction term.
In 2006, the company experienced a double-digit sales decline
for the first time, which continued in 2007. No testimony or evidence in
the trial links this sales decline to the transaction, while numerous
witnesses testified that the sales decline was in no way linked to the
transaction. During the 2006 through 2008 timeframe, several
unforeseeable (as of 2003) systemic market factors unrelated to the
transaction contributed to the company’s decline and ultimate
bankruptcy. Despite the company’s decline in sales, Antioch made all
scheduled periodic payments on all of its debt—including its secured
bank debt and the newly issued promissory notes to former Antioch ESOP
participants—in a timely manner from the date of the transaction through
June 2008.