Court Finds Red Flags Ignored in ESOP Valuation

Fiduciaries were ordered to restore $6,502,500 to the plan for an overpriced purchase.

A federal court judge has ordered the former CEO of a Virginia packaging equipment company and the bank that acted as a transactional fiduciary of the company’s employee stock ownership plan (ESOP) to restore $6,502,500 to the plan.

An investigation by the U.S. Department of Labor’s (DOL) Employee Benefits Security Administration (EBSA) found that Adam Vinoskey, former CEO of Sentry Equipment Erectors Inc., and Evolve Bank and Trust violated the Employee Retirement Income Security Act (ERISA). The breach occurred in December 2010 when Vinoskey and Evolve approved the ESOP’s purchase of Vinoskey’s stock at an inflated price. Specifically, the ESOP paid $406 per share for Vinoskey’s 51,000 shares, which was an overpayment given the stock’s fair market value. In 2009, the stock was appraised at $285 per share.

Despite Senior U.S. District Judge Norman K. Moon’s previous decision throwing out part of a DOL expert’s testimony, he found that Evolve caused a prohibited transaction under ERISA by failing to ensure that the ESOP paid no more than adequate consideration for Vinoskey’s stock. He also concluded that Evolve violated its duties of prudence and loyalty and that Vinoskey is jointly liable for Evolve’s breaches as a knowing participant in a prohibited transaction and as a co-fiduciary. “As a result of these breaches, the Sentry ESOP overpaid for Adam Vinoskey’s stock by $6,502,500.00, an amount for which Evolve, Adam Vinoskey, and the Adam Vinoskey Trust are jointly and severally liable,” Moon wrote in his opinion.

In his 100-page decision, Moon explained that as a fiduciary to the ESOP, Evolve Bank failed to notice, question or investigate several red flags that appeared in the appraisal of the stock that was used to set the $406 per share price. For example, Moon concluded that the appraiser’s decision to add back half of Sentry’s health care costs—particularly without analyzing the ramifications of that add-back in terms of profits and worker retention—was unreasonable given Vinoskey’s clear statement that Sentry would not cut health care expenses, and the appraiser’s understanding that Sentry’s health care benefits had a major impact on worker satisfaction, recruitment and retention.

In addition, Moon found that the appraiser unreasonably added back Sentry’s ESOP contributions when calculating Sentry’s net-adjusted income. Such add-backs or “normalizations” without other adjustments are appropriate only if an appraiser believes that “removing this expense” would have “no impact on the company going forward.” Moon said that such normalizations are highly discretionary and typically favor the seller in a transaction. The appraiser’s apparent assumption that Sentry could eliminate the ESOP without negative repercussions was unreasonable, since the express purpose of the ESOP was to increase worker satisfaction and productivity, and since it is highly unlikely that the ESOP participants would move to eliminate an attractive retirement benefit.

Moon also cited as red flags the appraiser’s use of inconsistent capitalization rates in annual appraisals since 2005 and the decision to use a three-year look-back period in the appraisal to compute Sentry’s average yearly cash flow, rather than a longer look-back period. Several other red flags were cited in the opinion.

Moon held that Vinoskey violated ERISA when he accepted a $406 per share price at a time when he knew, or should have known, that Sentry’s stock was worth less than that price.