DOL Targets ESOP Over Sizable Financial Losses

The U.S. Department of Labor is suing the fiduciaries of a Vermont employee stock ownership plan for violations of the Employee Retirement Income Security Act.

A new lawsuit filed by the Department of Labor (DOL) alleges the fiduciaries of an employee stock ownership plan (ESOP) established by a Vermont employer violated their fiduciary duties of loyalty and prudence.

The suit alleges that First Bankers Trust Services, Inc.’s 2011 purchase of the company on behalf of the ESOP from its two previous owners caused the plan participants to suffer sizable financial losses.

Named in the suit are Sonnax Industries, Inc., a Bellows Falls supplier of automotive drivetrain products; Tommy Harmon, its president and chief executive officer; Frederick Fritz, a board member with substantial company control; and First Bankers, headquartered in Quincy, Illinois. Sonnax, Harmon and Fritz hired First Bankers in 2010 as an independent fiduciary to advise the ESOP on whether, and at what price, to purchase shares of Sonnax from Harmon and Fritz. All defendants are fiduciaries of and parties in interest to the ESOP, according to the DOL.

Background included in the complaint show that early in 2011, the company purchased all of Harmon’s and Fritz’s stock shares for $48.8 million and issued new shares simultaneously which were sold to the ESOP for $10 million. The department’s Employee Benefits Security Administration investigated and found that First Bankers’ valuation that justified the sales “was flawed and its representation of the ESOP during negotiations deficient, resulting in a significant inflation of the purchase price.”

In its suit, the department alleges that the defendants violated ERISA’s prohibited transaction and fiduciary duty provisions. It further alleges First Bankers failed to protect the ESOP in connection with the plan’s purchase of Sonnax stock from Harmon and Fritz; willfully relied on a flawed valuation of the stock; did not prudently investigate the transaction’s merits; and purchased highly leveraged Sonnax stock for far more than fair market value, with the aid and knowledge of Sonnax, Harmon and Fritz.

DOL suggests Sonnax, Harmon and Fritz knew that First Bankers’ work was flawed yet failed to ensure that First Bankers fulfilled its fiduciary duties. They also failed to prevent the ESOP’s purchase at what they knew or should have known was an inflated price, and participated knowingly in First Bankers’ fiduciary breaches and otherwise failed to comply with their own fiduciary duties.

The lawsuit asks the court to order the defendants to restore to the ESOP all losses incurred as a result of their fiduciary breaches, prohibited transactions and other violations for which they are liable plus appropriate lost earnings; require them to disgorge any and all plan assets obtained by them as well as any and all profits earned by them from those assets; enjoin them from serving as fiduciaries, trustees or service providers for any ERISA-covered plan, and enjoin First Bankers Trust Services from receiving any benefits from its indemnification agreements with Sonnax that violate ERISA.

The full text of the DOL complaint is available for download here