Any trial lawyer knows the value of a good analogy.
In a recent damages ruling in a complex ESOP case, the Western District of Wisconsin composed a musical metaphor to explain its philosophy on ERISA damages.
InChesemore v. Alliance Holdings, Inc., No. 3:09-cv-00413 (W.D. Wis. June 4, 2013), Judge William M. Conley awarded $14.2 million to participants in two employee stock ownership plans (ESOPs): the Alliance ESOP and the Trachte ESOP. The Court awarded to the Alliance Plan roughly $7.8 million, to be paid by Alliance Holdings and its President and trustee of the Alliance ESOP, David Fenkell. $6.4 million was to be paid to the Trachte ESOP by that ESOP’s trustees. The Court, however, required “the more culpable” Alliance ESOP trustee, Fenkell, to indemnify the Trachte ESOP Trustees. Fenkell was the “unquestioned conductor” while the others were “mere musicians”
The controversy arose from a complex leveraged buyout orchestrated by Alliance Holdings and Fenkell. Alliance specialized in purchasing companies with ESOPs, merging these ESOPs into an Alliance ESOP, and then selling the companies for a profit. Alliance attempted to employ this strategy when it acquired Trachte Building Systems, Inc. in 2002, but it could not find a suitable buyer. So, at the direction of Alliance and Fenkell, a newly formed Trachte ESOP purchased Trachte’s stock. The defendants then spun off the Alliance ESOP to merge with the newly formed Trachte ESOP. Soon after the transaction, the value of Trachte stock dropped and so did the account balances of plan participants.
Plaintiffs filed suit in 2009, alleging that Alliance, two of its subsidiaries, the Alliance ESOP, Fenkell, and the Trachte ESOP Trustees had engaged in a prohibited transaction under Section 208 of ERISA, 29 U.S.C. 1058, and breached their fiduciary duties. After finding the defendants liable for breaches of fiduciary duty and prohibited transactions, the Court, on June 4, 2013, ordered defendants to restore the plaintiffs’ accounts in the Alliance ESOP to their pre-transaction value — at a cost of roughly $7.8 million.
The Court also awarded damages to a class of Trachte ESOP plaintiffs. The court previously determined that the leveraging of Alliance ESOP accounts inflated the purchase price for Trachte and caused the Trachte ESOP to overpay for the company’s stock. The Court measured damages according to what it found to be the amount of the purchase overpayment. The Court rejected the plaintiffs’ proposed measure of damages (namely the $38 million purchase price minus the value of the now worthless stock). The Court found that in light of the 2008 financial crisis, plaintiffs failed to show that the fiduciary breaches caused the company’s collapse. Plaintiffs did show that the breaches caused the Trachte ESOP to overpay for the company by about $8.3 million. The Court rejected defendants’ argument that the value would have been wiped out by the financial crisis anyway, noting that whether plaintiffs would have later lost the overpayment was beside the point. Since there was some overlap between damages to the class of all plaintiffs and the Trachte subclass, the Court reduced the overpayment to account for the reinstatement of the Alliance ESOP subclass of plaintiffs into the Alliance ESOP. The Trachte ESOP Trustees were thus ordered to pay over $6.4 million.
Although the damages relating to overpayment stemmed from the breaches of the Trachte Trustees, the Court ordered Fenkell and Alliance to indemnify them. It noted that “Fenkell was the unquestioned conductor and the Trachte Trustees mere musicians.” The Court singled Fenkell out as “far and away the most culpable party.” To that end, beyond indemnification, the Court ordered him to disgorge the profits realized from his sale of phantom stock if Trachte would agree to return it to him. This sum amounted to nearly $2.9 million. He was also removed as trustee of the Alliance ESOP.
The Court’s nearly $17 million award shows the potential risk of engaging in transactions a court may find to be manipulative. In assessing most of the liability to Fenkell, the Court noted it “was increasingly impressed by Fenkell’s complete recall of minor details and sophisticated understanding of ERISA transactions, as well as the law governing those transactions.” But as this award shows, a keen knowledge of ERISA cannot always get a fiduciary off the hook for breaching duties owed to plan participants.
While the case largely serves as a cautionary tale for those engaged in novel ESOP transactions, it also shows that courts do take a rational view of ERISA damages. The Court rejected the plaintiffs’ attempt to recover the full Trachte purchase price because that damage model did not account for broader market factors that affected returns on the ESOP’s investment. And the Court assigned liability primarily to the individual it felt bore the most culpability, rather than the less responsible ESOP trustees.