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Recovery of Attorneys’ Fees and Expenses from the U.S. Government

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Recovery of Attorneys’ Fees and Expenses from the U.S. Government

The U.S. Department of Labor (DOL) has committed to moving forward with the process of establishing final regulations for governing the valuation of companies for employee stock ownership plan (ESOP) transactions. In this one-hour course we will provide an in-depth case study on a landmark trial victory that has had a direct impact on this new development. This course will focus on the ongoing efforts for recovering attorney’s fees and costs in the U.S. Court of Appeals. We will analyze how this effort to recover attorneys' fees and expenses increased pressure on the DOL to clarify ESOP valuations and related transactions for companies and fiduciaries.

Transcript

Good morning. This is Dave Johanson. I'm a senior partner with Hawkins Parnell. We have offices all over the country. A couple of my offices are located in Napa, California, and Los Angeles, California. We also have an East Coast presence. And I've been operating out of the East Coast in our New York office for many years. I'm going to talk to you today about the recovery of attorney's fees and expenses from the US government in the context of a case in which we started representing some individual shareholders and a corporate plan sponsor of a of a qualified retirement plan known as an Esop. Many years ago, the investigation by the US Department of Labor proceeded for 3 or 4 years and then litigation ensued in 2018, followed by a followed by a trial in June of 2018, 2021, and a basically a complete defense victory in September of 2021. Thereafter, we perfected some pleadings in the Ninth Circuit Court of Appeals, in which we sought attorney's fees and expenses on behalf of our client because they had prevailed in this eight year battle with the US government. And that matter went to the ninth Circuit for oral argument in Honolulu, Hawaii in February of this year. And so we'll talk a little bit about that, too. So this is in essence what I intend to cover today. We'll skip some things or go over some things fairly quickly, but we'll focus in on some key aspects. But the context, again, is we're talking about a three year long investigation that ended in 2018, followed by litigation by the US government that lasted three years and then a two year battle involving the recovery of attorney's fees and expenses from the US government. We'll go we'll go over briefly the 2012 transaction December of 2012 transaction that resulted in the investigation. It was it was claimed to be a random opening of an investigation. I don't know if it was so random. We'll talk about some facts supporting actual knowledge of potential ERISA violations that actually didn't. That was one matter that our clients did not succeed on in the motion for summary judgment phase of the case. And then we will go into the content of the complaint. The trustee of the Esop, the qualified retirement plan, died in October of 2018. That changed the dynamics of the matter entirely because the selling shareholders and the company became the prime focus of the action by the US Department of Labor. We'll spend a little bit of time talking about Esop valuations and presentations of experts at trial, post-trial findings of fact and conclusions of law. There are some discovery orders that we'll focus on, but in between there we will talk about the post-trial attempts to recover attorney's fees and expenses and where that's at. The ruling hasn't come down yet. However, there was some very favorable oral argument on this topic in February of 20 2023, preceded by about a year and a half's worth of briefing. Finally, we'll talk about potential legislation and DOL rulemaking regarding valuations. In December of 2012, our client, the corporate client, we weren't representing them at the time, basically established an Esop that we'll call that Client B plus KC. The Esop is an employee stock ownership plan and trust, and the Esop purchased 1 million shares of common stock from the founding shareholders for $40 Million. Mr. Zach Whitney was the independent fiduciary and trustee of these. He executed all the documents and related resolutions, established the fair market value of the company based upon an independent appraisal by Greg Kinzel of Libra Valuation Advisors. The sellers actually met with Elva or Libra in October of 2012 and provided Elva with background information about B plus C and the potential transaction. That turned out to be one of many red flags at the US Department of Labor focused on throughout the litigation. And it was a red flag because they tried to make it seem like Mr. Kinzel and Elva were engaged by the sellers and the company and not by Mr. Zach Whitney, who was the independent fiduciary and trustee of these. They did that throughout the entire investigation and litigation. B Plus KC then met with Mr. Zach Whitney in November of 2012 and formally retained him at the end of November of 2012. He served in that trustee capacity until his untimely death in October of 2018. And we've actually had the unfortunate circumstances of being involved with three different trustees who perished or died during the course of DOL investigations involving ESOPs. During the past 20 years. I've been doing this for almost 40 years, but unfortunately the DOL, when they do attack people who are fiduciaries, they attack them really strongly. And I'm not saying that this was there was a causal connection. However, Mr. Zach Whitney died in October of 2018 after 16. Investigations by the DOL had been ongoing, and the complaint in this matter was filed in March of 2018. So you can draw your own conclusions. Uh, the cake had an outside, independent certified public accountant. They prepared their tax returns for B plus KC and the financial statements on an income tax basis of accounting, which is essentially a cash basis of accounting. They didn't do it on an accrual basis. However, at the time of the transaction in 2012, the the independent appraiser and financial advisor for B plus KC, who was doing a preliminary valuation for purposes of deciding the selling shareholders in the company, deciding whether or not they were going to go forward with an Esop. Um, that person asked the accountants, the CPA, to convert the financial statements to accrual basis accounting statements, and so did the independent appraiser and a financial advisor for the Esop. And that involves reporting revenues when they're earned and expenses when they're incurred. And and quite frankly, results in a better scenario for determining the fair market value of a business because you've got more accurate financial reporting. One or the other red flags that the Department of Labor continued to focus on from 2014 or 15. We think they we actually think they had knowledge of the potential claims dating back to as early as July of 2014. The court, however, did not allow us to pursue discovery in that respect, so we weren't able to prove that particular statute of limitations. Defense. During the course of the trial, the sellers did consider selling to management prior to the Esop transaction in December of 2012. In the fall of 2011, for example, B plus C engaged in very preliminary discussions with Urs Corporation about purchasing its assets or stock without any real due diligence. You are s corporation issued a preliminary non-binding indication of interest, not even a letter of intent in December of 2011 that B plus C provided again very limited financial information in advance of receiving this three page indication of interest from Urs Corporation. And it was and Urs Corporation during the course of the litigation and discovery admitted to doing quote unquote very little due diligence prior to that date. A proposed purchase price, in the indication of interest was set at $15 million. However, it did have a couple of provisions that said that any fair market value of the company should include the the cash that was on the financial statements and not being used for working capital and additional working capital amounts that were in excess of what was needed for the company to operate on a day to day basis. So even though the indication of interest indicated that the price was 15 million, the doll continued to use that as a red flag throughout the litigation. And the actual valuation of that indication of interest was probably closer to 30 million based upon testimony at trial from Mr. Kinzel and Mr. Bowers, who was the CEO of the company. Mr. Kanizsa was the independent appraiser and financial advisor for the Esop and for and the experts who were retained to help defend the company. And the selling shareholders also reached that same conclusion so that the indication of interest was really at $30 million valuation as compared to the $40 million transaction valuation a year later. And the doll continued to try to play this story that it was only a $15 Million indication of interest. And that's why the transaction or $40 Million was improper. As I indicated, the plus cases, cash and working capital back in December of 2011 was approximately $14 Million and end. In December of 2012, it was $15 Million. Another interesting fact, B plus Casey had a couple of years worth of backlog of contracts in December of 2012. So it was a very strong company. The Secretary of Labor ignored this fact throughout the entire litigation and continued to focus on the $15 Million proposed, quote unquote purchase price in the indication of interest. And they did that right up until the end of the trial. So they didn't ever admit that that wasn't an accurate fact. So that was another red flag that the Department of Labor focused on in in advancing its case against our clients, the selling shareholders and the corporation, the Hawaii District Court decided in the end that the indication of interest by us had, quote unquote little relevance to the actual value of B plus Casey, which it should have, quite frankly, reached that conclusion that it had little relevance. The court actually used information that we provided to the court Judge Mollway, during the course of her rulings. She said, quote unquote, an individual makes an offer for 15,000 for a used luxury car with a book value of 40,000 does not, by virtue of making a lowball offer that is never accepted, tend to establish that the car is worth 15,000. So take it to our example. The $15 Million indication of interest had nothing really to do with the ultimate $40 Million transaction value a year later. And yet the doll continued to try to advance that red flag throughout the investigation and and through the litigation of this matter. No agreement was ever reached between the Esop plan, sponsor, the sellers and Urs Corporation. So that deal didn't even happen again. It made no sense to consider that deal for purposes of value and accompany the company. A year later, the sellers were not willing sellers and Urs Corporation was not a willing buyer at any price in November or December of 2011. So again, it was irrelevant and had little relevance, according to Judge Mollway and according to the experts. There was another evaluation that was performed in. In the spring of 2012 and that that one involved. An independent appraiser and financial advisor for B plus. He was he was just essentially helping Biloxi evaluate the indication of interest that it had received from Urs Corporation and working on other business succession planning purposes, including potentially maybe an Esop transaction that was going to happen in the fall. If if if nothing else worked. Jmc The independent appraiser and financial advisor for the company. It expressed some concerns about the reasonableness of B plus Casey's projections because they represented a quote unquote, significant jump. However, again, this is where the DOL took one little set of words from GMP and GMT and used them throughout the litigation to basically take a position that the DOL had a good case for arguing that B plus Casey gave to the independent appraiser for the Esop and Zach Whitney, the trustee. Hockey stick projections in the fall of 2012 that were substantially greater than its past performance. This actually turned out to be another red herring or a red flag that wasn't proper because an evaluation was done of the performance of B plus Casey after the Esop transaction closed in December of 2012, and it was almost spot on in terms of EBITDA for the next five years and its sales performance was substantially greater than the projected performance in 2012. So this was a red herring that that really that dog didn't hunt, quite frankly. Gmc's preliminary valuation was approximately 38 million, which was very close to the ultimate $40 Million transaction value in the fall of 2014 or 2012. And one of the sellers remarked at the time in an email, they remarked, it seems very high, quote unquote. The seller explained that his remark was one of surprise because of the very low ball offer or not offer ers indication of interest. Yet again, the DOL continued to focus on those three words. Seems very high in trying to conclude that the price wasn't fair and it was in excess of fair market value in December of 2012. In early draft valuation by GM, this independent appraiser for the company set the range of the value of the company at between 31 million and 54 million. The 40 million that ultimately resulted in the transaction value was right somewhere within that range. After the sellers provided additional input to GM, GM reduced the higher end of the range down to between 40 and 46 million. So this was, quite frankly, another touchstone that helped document the proper valuation that occurred in the fall of 2012. And again, Judge Mollway in the District Court determined that Gmc's work was accorded very little weight in determining the fair market value of KC. Government made a large issue about this at trial regarding the fact that B plus C shared the GMC valuation with ERs. Given that GMC prepared its work for quote unquote internal purposes only, again, this was a red herring. It didn't matter that B plus KC shared the GMC valuation with ERs because ERs and B plus KC and the sellers never entered into a transaction. So made no no impact whatsoever on any transaction or valuation that actually occurred in this case. Again, a major red herring. Um, because they ended discussions about a potential transaction in the spring of 2012. The company then went on to hire an outside. Independent. Aesop expert Gregory M Hansen of Case, Lombardi and Pettit in Honolulu. And they hired this person, Mr. Hansen, in order to set up the Aesop. And he handled related matters transaction design. He also served as the quarterback for the ultimate Aesop transaction that occurred in December of 2012. During the course of that, the next few months after Hansen was hired by the company by plus in the summer of 2012, in the early fall of 2012, Gmk was being considered as a potential independent appraiser and financial advisor for the Aesop. Again, the doll loves to take words out of context in. Um, emails as they've done in virtually every piece of defense litigation I've defended during my professional career. And they focused on a word in one of Mr. Cubas evaluation emails in which he said he was, quote unquote uncomfortable with accomplishing the valuation for the proposed transaction. It turned out that he was uncomfortable based upon the evidence presented at trial because of a convertible preferred stock structure that he was not familiar with, and he was conscious that he hadn't previously performed evaluation of convertible preferred stock for a company like B plus KC in the past. So we decided he didn't want to be involved in the transaction yet the DOL used that word uncomfortable to try to paint some nefarious plan that the company had to. To basically bilk the Esop out of millions of dollars by using a shady valuation, which none of which was true. The quarterback, Mr. Hanson, advised B plus KC to meet with Mr. Kinzel of LBA in October of 2012. This, quite frankly, was probably a mistake because it gave the impression that this B plus KC and the selling shareholders were trying to influence Mr. Kinsley's valuation, which was not true at all based upon the testimony that came out at trial. They were just trying to give Mr. Kinzel background information about the company. What should have happened here is that the the selling shareholders in the company should have met with with Mr. Kinzel, the independent appraiser and financial advisor for the Esop. After for after B plus KC retained an independent fiduciary and trustee, Mr. Zach Whitney. And they should have done that together. So there was no concern about any potential impropriety. There was no impropriety. But the fact that the meeting occurred was a red herring that the DOL focused on throughout the litigation. Also another thing that the doll focused on is a red herring. Again, in my opinion, is that Elva, the independent appraiser and financial advisor for the Esop. Um, engaged a board of trustees of the proposed cases up in approximately October or tried to engage with in October of. 2012, there was a draft letter. There was no signature ever put on that letter by a board of trustees of the proposed ESF. It was sent to one of the founding shareholders. He never signed it. He ultimately signed an engagement letter for Mr. Zack Whitney to be gay, to be engaged as the independent fiduciary for the Esop and independent trustee. And then he signed Mr. Bowers, the founder of the company, signed an engagement letter in which, on behalf of the company in which the company guaranteed to make the financial obligations of the Esop Trust to LBA as the independent appraiser and financial advisor for the Esop. Again, that's just common, ordinary practice. So the DOL tried to conflate that background into proving that the founding shareholders were trustees of the Esop, which was not factually true, and that they had engaged LBA to perform this preliminary evaluation, which again was not true. Um, LDA did provide a preliminary analysis and fair market value for B plus peak no later than November 21st, 2012. That was something that they were engaged to do and did do. The valuation range for that initial valuation was approximately 37 million to 41 million. Again, much, much was made out of the fact that that valuation occurred on 21st November 2012 by LDA prior to the November 26th of 2021, in which B plus C retained Mr. Zach Whitney as the trustee. So that was a probably a foot fault, probably not a good fact. However, there was nothing nefarious about it. And Mr. Zach Whitney went on to serve as an independent trustee and fiduciary of the Esop and hired Mr. Kansal and LDA to be the independent appraiser and financial advisor that could have hired anybody, but they hired Mr. Kansal. Um. During the course of retaining Mr.. Mr. Zach Whitney as the B plus sub trustee, an independent fiduciary. Mr. Hanson, the quarterback for the deal, casually mentioned a potentially sub transaction of 40 million where a $12 million convertible preferred stock deal. He also mentioned the same information about a potential purchase price. The financial advisors for a I.r.c. section 1042 Tax deferred transaction planning. He claimed Mr. Hansen claimed to have learned about the quote unquote $40 million transaction from the selling shareholders. However, they denied that during their trial testimony again. Even though the court didn't conclude that they agreed with the that the court agreed with the denial. The court did not focus on that fact as being a fact that that resulted in any impropriety under ERISA as it related to the transaction. It was Mr. Hanson's words. It was not Mr.. It was not the selling shareholders words. And there was no evidence that the selling shareholders had actually asked for that purchase price. And it certainly was appropriate for the selling shareholders to want a particular purchase price. But that doesn't mean that there's a prohibited transaction related to the Esop transaction. So then we proceeded they proceeded to engage in negotiations involving the Esop transaction. Mr. Zach Whitney negotiated on behalf of the Esop and one of the selling shareholders negotiated on behalf of the selling shareholders. Zach Whitney negotiated the purchase price down by approximately a million. So originally the proposal from the selling shareholders was 41 million, not 40 million. He also negotiated a 3% reduction in the annual interest rate to be charged to the B plus. C is up on a 25 year loan from the selling shareholders to these up to help finance the transaction. It was determined at trial based upon the expert testimony of Gregory K Brown, that that 3% reduction in the interest rate actually resulted in millions of dollars of savings on the $40 Million transaction debt for the selling shareholders or excuse me for the Esop. So this was a benefit of the Esop. They not only received $1 million reduction in purchase price negotiated by Zach Whitney, but they received millions of dollars in interest reductions. I think it was something like if you think about it, it was it was hundreds of thousands of dollars of savings a year over a 25 year period of time. So this was a huge savings in terms of negotiations. However, the secretary, rather than focus on that, those true facts, the Secretary of Labor and the Department of Labor during the course of the presentation of its case and throughout the investigation and throughout discovery and at trial, they alleged in the complaint and and in the expert, the quote unquote, expert fiduciary testimony of Marc Johnson that Mister Zach Whitney negotiated against these during the course of the negotiations. That allegation, in my opinion, was proven to be factually inaccurate at trial. And the doll didn't in the secretary of labor, didn't withdraw its attempt to focus on that statement that that Zach Whitney negotiated against these. Throughout the entire trial. And it was wrong. It was factually inaccurate. Another red herring. Mr. Zach Whitney's due diligence can be described in the next few items. Elva was retained. Mr. Zucchini retained Elva, the independent appraiser and financial advisor for the Esop in an agreement dated December 7th, 2012. Ideally, would have been nice to have more time between that engagement and that formal engagement and the actual closing of the transaction on December 14th of 2012. But that does not make the transaction. Inappropriate. In fact, there was testimony about that that I think we'll get to about the time that Mr. Whitney had to do his job as an independent fiduciary on December 11th, provided Zach Whitney with a preliminary evaluation of in the range of 37.5 million to 41 million. Mr. Zakuani had this preliminary evaluation prior to negotiating the terms of the Esop transaction. He discussed there's evidence that Mr. Zakuani discussed the preliminary evaluation with Alva in advance of the closing. And then on December 14th, LDA sent Mr. Zakuani a summary of its evaluation and concluded that because the fair market value of B plus KC was approximately 41.5 million, the purchase price was 40 million. The B plus KC ease up was not going to pay more than fair market value. Olivier also advised Mr. Zakuani and his fair market value and fairness opinion letter that the terms of the loans by the sellers meaning the 7% interest rate 25 year, $40 Million loan was at least as favorable from a financial point as would be the terms of a comparable loan resulting from arm's length negotiation between independent parties. Um, the actual valuation of B plus C as of the closing date was attached to this summary. It was an actual valuation and that was attached to the fair market value and fairness opinion letter. So all of this seemed in order and appropriate for a transaction of this nature. Again, the time schedule was a little bit quick. A fiduciary expert for the government, Mr. Mark Johnson, loosely opined that Zach Whitney clearly rushed the transaction he billed. According to Johnson, he billed only 30.1 hours. It was testimony that maybe Mr. Zach Whitney had not recorded all of his hours. Mr. Johnson claimed that Mr. Zach Whitney did only minimal work and improperly relied on LBA, which Johnson argued did not qualify as an independent appraiser because of their work in October in creating a preliminary valuation. Again, the court didn't find that to be persuasive in its findings of facts and conclusions of law. Gregory Brown, the expert ERISA fiduciary expert on behalf of the company and the selling shareholders. He his testimony differed dramatically from Mr. Johnson's. He testified that Mr. Whitney's due diligence was sufficient and consistent with those of other fiduciary ERISA fiduciaries under similar circumstances. He, the court focused on who had the burden of proof on this issue. The court concluded that originally government had that responsibility and said it failed to satisfy the burden, focusing on the deficiencies in Mr. Johnson's expert witness report on behalf of the government. That did not detail what kind of of a review another trustee would have conducted under similar circumstances and stating that Zach Whitney only spent roughly 28 hours on the transaction without indicating Mr. Johnson didn't indicate how that compared to what other ERISA producers would have done on a similar transaction. So again, the court determined in its findings of facts and conclusions of law that Mr. Brown's position was well taken in this respect. Mr. Johnson's position was not in supported the defense evidence entirely on this issue, meaning essentially Zach Whitney may have done more work, but what he did was sufficient. There were also a number of valuation concerns and issues. And these these valuation concerns and issues are the ones that in addition to all the other red herrings that we've gone over, really helped the. Government kind of dig a hole for themselves as it relates to the whole issue of. Of going into trying to recover attorney's fees under the equal access to justice. Act against the government. So I know there's a long lead into this. I know I've been talking for a while already, but I wanted to give you the background before I went into exactly how you try to attack someone like the government and achieve attorney's fees and expenses in a case like this. Mr.. Mr. Steve Sherman, who's the managing director of Loop Capital Financial Consulting in Chicago, was the government's expert valuation witness, I say quote unquote expert. The court identified many flaws in Mr. Sherman's valuation work. Sherman testified that as of 14th December of 2012, the fair market value of B plus KC was approximately 26.9 million, not 14 million. In reaching that conclusion, Sherman deducted approximately almost 3 million in light of what he deemed to be a B plus KC Aesop's Limited control of B plus KC. This is very interesting because the evidence that they the government relied upon in determining that there should be a $3 million discount for limited control was evidence that was not known or knowable on the actual date of the transaction on 14th December 2012. So the so Judge Mollway just determined that Mr. Sherman's conclusion in this respect was was wrong. The court found that Sherman, quote unquote, significantly and unreasonably undervalued, end quote. B plus KC Court also noted that, quote, Not only does this render Mr. Sherman's ultimate valuation unreliable, it also undermines the usefulness of his critique of Lvas valuation. So what the court was saying. Mr. Sherman's valuation work was faulty, and his analysis of the independent appraiser for the Esop and the actual transaction is critique of that valuation is faulty. The court found that Sherman's valuation appears to have ignored a number of the uniform standards of professional appraisal practice. Uspap. Mr. Kenneth Pilla of the Marcum Group was one of the defendants expert Esop valuation witnesses. He opined that the application of Uspap is mandatory and Mr. Sherman chose to basically just ignore it in this in this transaction. Mr. Peer testified that Mr. Sherman. Mr. Sherman's failure to follow uspap, quote unquote introduced substantial errors, end quote, into Mr. Sherman's valuation analysis. He testified further that Sherman should have interviewed fee plus cases, management and the failure to do so violated uspap scope of work and competency rules. They those rules require research and analysis to be sufficient to produce credible results and to be conducted in a manner that is not careless or negligent. It was certainly careless or negligent for the DOL and Mr. Sherman and the Dol's internal evaluation experts not to interview B plus cases management as it related to their valuation work. And the government really didn't provide an explanation, satisfactory explanation of this respect during the litigation. They could have had access to B plus case management and they never asked to have that access and they were never declined to have that access. Mr. P also testified that Mr. Sherman erred in how he treated the sub consultant fees that B plus Casey basically passed through to its clients. So I think there was approximately what happens is B plus Casey Pass passes through its sub consultant fees charged by its sub consultants without any markup to its clients. So for example, if P plus Casey had 10 million of those sub consultant fees during a particular year, it would just pass those directly through to its clients and not obtain any profit on that. Um. Mr. Sherman, however, treated those pass through sub consultant fees as B plus expenses, which Sherman then incorrectly deducted from B plus Casey's cash flow and determining the fair market value of B plus. Casey Sherman admitted during trial testimony that he treated 10.521 million as sub consultant fees and expenses, which he deducted and determining the fair market value of B plus Casey as of 14th December 2012. And he didn't provide any corresponding revenue increase in his revenues that he projected in the valuation work that he did. So he took a negative. He took a deduction for it, but he didn't give a positive. So it basically meant that he overstated B plus Casey's expenses of operations by $10.5 million. We already talked about this. I mentioned the limited control discount that was applicable. Sherman testified that this discount related to his conclusion that after the sale, the seller's continued to exercise meaningful control of B plus C well, that he focused on the fact that they received substantial bonuses without documenting approval by Zakuani. Mr. Pierre, the expert for the defence, faulted Sherman in this respect and in reference to actual Uspap advisory opinion number 34, which indicates that only with market evidence that data subsequent to the effective date was consistent with market expectations as of the valuation date, is it appropriate to use subsequent data in the absence of such evidence? And this is directly a quote from that advisory opinion. The effective date should be used as a cut off date for data considered by the appraiser. The court then concluded, which it should have, that Sherman's reliance on matters occurring after the sale to the Esop to apply a limited control discount appears to have contravened the appraisal standards of uspap, limiting the facts to be considered to things that were known or knowable on the actual date of the transaction. Sherman also did something highly unusual. He created a hypothetical set of earnings before interest taxes, depreciation and amortization or EBITDA in Lvas analysis. It used an EBITDA of approximately 9.235 million. Sherman claimed that this amount exceeded historical amounts. This was for 2012. Sherman concluded on his own that it shouldn't be 9.235 million. It should be 4.8 million. That was his just out of thin air. He criticized B-plus cases, very detailed financial projections in this respect. Um, the defense also had another expert, Ian Rusk, who is, I believe in Rhode Island. And Mr. Rusk, we retained him as an expert for our clients, noted that Sherman's dismissal of Beak plus cases, financial projections as not supported by historical results was certainly an error because the company's earnings were trending substantially up in 2012. In fact, it had a two plus years worth of huge backlog of contracts, and Mr. Rusk concluded that Mr. Sherman's projections were not Mr. Sherman's projections were not accurate and that the company's projections were not inaccurate. The court found again against Mr. Sherman in his analysis. The court thought that this hypothetical or corrected EBITDA for 2012 should have taken into account those relevant circumstances identified by Mr. Rusk as it related to projections, and that the failure to do so again rendered Mr. Sherman's EBITDA unreliable. Furthermore, the court concluded that Sherman should have known that his, quote unquote, corrected EBITDA of 4.9 million. Was too low because the actual EBITDA for B plus C as of December 31st, 2012 was 7,000,002 million more than Sherman's hypothetical amount, and that the difference between the 9.2 and the 7 million was simply e sub contributions and bonuses and things of the other of that nature which were legitimate at bats. I think I've already mentioned this. The projections that Mr. Niesel of LDA used for 2014 through 2017, which he obtained from the selling shareholders in the company, he used a 5% growth rate. The actual growth rate for B plus C between 2014 and 2017 was actually 10 to 14%. And LDA testified at trial that there was no more detailed financial projections. That they've received from any other company than those provided by B plus C. Another fact that happened again at Red Herring was that the government utilized the testimony of Marcus Pecquet CPA, who provided an inaccurate analysis of Elva's December 14th, 2012. Valuation of B plus Casey. For some reason, Picquet, who was the record keeper for the B plus Casey sub, created his own inaccurate analysis of Elva's valuation in April of 20th April 2018, after the litigation was filed because he was worried he was going to be implicated in this in this potential litigation. So he came up with a valuation that showed that the valuation was overstated as of December 14th, 2012. Of course, that was debunked throughout evidence presented throughout the trial. I'm not going to go into all of these detailed findings of fact and conclusions of law. I am going to skip over the next couple of pages. However, these will be available in the written materials that can be made available to the attendees. I think there's just one thing I want to point out. If you could skip ahead. There is one here that I thought was worth talking about. Um, allegations regarding purported rush transaction. We we have talked about that and the experts did address this and the prudent process that Mister Zach Whitney followed. Um, one of the things I wanted to note was the court included that record does not support the Government's suggestion that the sellers and Zach Whitney conspired to arrange a $40 Million deal. This I talked about earlier. The sellers the court concluded knowing what a seller wants does not make a buyer complicit in wrongdoing. So the fact that even though Mister, the selling shareholders did not make a demand for $40 million prior to closing the deal, the fact that they would have. Communicated some kind of a range that they wanted to the independent appraiser and financial advisor for the Esop and to the independent fiduciary doesn't make that doesn't make the independent appraiser and the independent fiduciary complicit in any wrongdoing just because they know that information. Also think one other point I want to raise here in terms of this findings of fact and conclusions of law is that the court concluded that the government, quote unquote, simply did not prove that the seller should have better monitored Zach Whitney to ensure that he was acting in the best interest of the beak, plus Aesop to prevent the Aesop from being damaged. There was ample evidence presented at trial that showed that the that the selling shareholders and the company gave neutral and detached information to Zach Whitney and Kinzel that they didn't influence them in any inappropriate way and let them do their job and that they and that Zach Whitney and Kinzel established the value in good faith based upon Mr. Kenzo's valuation and that the company didn't pay more than fair market value for the stock. The the actual. The actual findings of facts and conclusions of law are actually kind of interesting. So if you have a chance, please take a look at them. The doll did not appeal the trial court's findings of facts and conclusions of law. This is where we get to the meat of this presentation. And I wanted to provide you the background in order to get here. Factual background B plus Casey, the Esop plan sponsor has subsequent to the to the favorable, very favorable trial result in September of 2021 has sought to recover costs of litigation and attorney's fees and expenses from the government under the Equal Access to Justice Act. The trial court approved the recovery of almost all of the taxable costs of the defense. Those types of things are deposition costs, transcript fees, copying fees and those types of things. However, for some reason, the lower court ruled that the attorney's fees and non taxable costs under the e.g.r. The Equal Access to Justice Act were not available because the DOL was quote unquote substantially justified in asserting its complaint. Hours, plus Kubota Consulting and the selling shareholders appealed the trial court ruling. They allege that the doll was not substantially justified in first in pursuing its investigation and then in asserting its complaint, and that to do so after all of these red herrings turned out to be red herrings, was to act in bad faith. And that's essentially the argument that we made at the Ninth Circuit in February of this year and made in the pleadings the written pleadings prior to that date. The appeal urges the Ninth Circuit to consider the differences between the broad investigatory powers that the government, the doll has and the Secretary of Labor has under ERISA, and the decision to file and maintain the litigation without substantial justification following the extensive investigation that was conducted by the doll or, as I said, oral argument occurred on February 15th of 2023. It's one thing, as the court ruled in the lower court, it's one thing to maintain an investigation and maybe they could have maintained an investigation at the start. However, I would argue that if an independent person actually looked at the facts that I had access to as I defended this client, that they would not have brought any litigation against the company and the individual defendants in this matter. It's quite another thing to maintain a litigation after a 3 or 4 year investigation, to maintain litigation for another three years and never to yield on any of the red herrings that discovery suggested that you should yield on. So it's that conduct of continuing to litigate all those years, never admitting anything that was, you know, for example, and this is a civil case, but in a criminal case, the government has a right to provide exculpatory information to defendants. And and the government here, quite frankly, when I first got involved in this business, I thought government was here to help you to actually find the truth. But what I've noticed as I've spent almost 40 years defending clients in investigations and ensuing litigation and class action litigation, but I've noticed is they don't really care about the facts. I haven't seen that evidenced during the course of the investigations that I've defended. For many people, they only care about creating soundbites to advance their positions in litigation, in my opinion, based upon my experience. Um. The Esop Association. Which is a national non-profit organization that supports the creation and maintenance of employee stock ownership plans, as filed an amicus curiae brief. It's called a Friend of the Court brief in favor of the appeal that my clients made in this matter. Esop Association brief makes a really good argument. It argues that the DOL has aired over many years in its interpretation of Orissa's adequate consideration standard that permits sales to an Esop from a related party that are conducted in good faith and at prices not exceeding fair market value. The brief asserts that DOL was not substantially justified in suing under its incorrect standards for establishing adequate consideration. So what? What is that standard? This is what I argued at the Ninth Circuit. The DOL argues that there is an actual fair market value test and it doesn't focus on the the real test. The real test is that the independent. Trustee has to determine in good faith the fair market value of the company based upon an independent appraisal. It doesn't. The standard is not that the independent fiduciary and independent appraiser have to be accurate, entirely or correct. It's not a valuation test. It's a more of a procedural test, substantive procedural test in which there's got to be a good faith determination of the fair market value of the company based upon an independent appraisal. And the government's always argued that that's not necessary. It's just if if you don't if it's for more than fair market value, then the defense loses. And that's not the standard. And that's what we argue that the Ninth Circuit, that's what the Esop Association argued in its amicus curiae brief. And we will wait and see what the what the Ninth Circuit says about that. The oral argument was very interesting. And they we took seven minutes and the government and then we reserved three minutes. The government was pummeled with questions by the Ninth Circuit throughout the oral argument. So we're hoping for a good result. Never can guarantee what that result will be, but it certainly is possible that these will inexpensive will be formally recovered in this matter under the GA. The HDR standards require either substantial justification or bad faith, not both substantial justification and bad faith. Even the conduct of the government in advancing red herrings, herrings throughout the litigation all the way through trial, we took the position and also given the fact that the government was using the wrong standard of evaluation in the case and also based upon the fact that government hasn't promulgated a final adequate consideration regulations since May of 1988 to let people know what the standards are. We argued bad faith in this appeal, and so did our our clients. We argued bad faith on behalf of our clients. The secretary attempts to confuse the standards under the e.R. Relevant to this appeal. The secretary, the appellant does not need to demonstrate both a lack of substantial justification by the secretary and bad faith to be entitled to attorney's fees under the e.R. The showing of either lack of substantial justification or bad faith by the Secretary is necessary to permit attorney's fees to be recovered. And that's how we argued. The secretary had. In our opinion, the secretary had no proof of any ERISA violations at trial. For example, testimony of of the secretary's appraisal expert was objectively, quote unquote unreliable, according to the trial court, contained notable errors, according to the trial court, that should have never been submitted during this litigation, as the court ruled. Unfortunately for the government, however, Sherman's opinion contained notable errors that may have amounted to an undervaluation of 13.5 million 10.5 million relating to the sub consultant fees, plus 2.9 million relating to the limited control discount. If 13.5 million is added to Sherman's valuation of 26.9 million, the total is 40.4 million, which is very close to the actual sales price in the in the B plus case. The transaction secretary's also the secretary's prudent expert, failed to testify What steps the sub trustee, Zach Whitney, should have taken and why he failed to do so. He didn't detail what kind of review another trustee might have done. Study simply concluded, rather than taking the time to properly supervise and evaluate the process. Zach Whitney seemed proud of bringing the transaction to conclusion based on a tight and entirely artificial time frame that that's insufficient to meet the government's burden, according to the court. How Mr. Johnson testified. The secretary's overly aggressive insistence that the appellant's financial projections underlying the December 2012 transaction appraisal were flawed also was without any factual basis. And these sites are to the record in this slide is overly aggressive insistent that the US nonbinding indication of interest one year before the December 2012 Esop transaction was a valid offer to purchase at $50 Million and not at the obviously higher amount of $30 Million was an indication to the independent appraiser that the $40 Million purchase price was somehow improper, also was fatally flawed and without factual basis as determined by the trial court. Ultimately, there was no reasonable support for the secretary's factual allegations in this case. The district court's abuse of discretion is most clearly found in the very phrases that the Secretary repeatedly advocates in his responsive briefs as sufficient grounds for the the district court's ruling. However, the secretary takes the references out of context. District Court concluded. Quote unquote. This court determines, based on the evidence submitted at trial, the government was substantially justified in bringing this action. As discussed in detail in this court's post-trial findings of fact and conclusions of law, which the court does not rehash here, the government had every right to be suspicious of the circumstances surrounding the sale of the company. Indeed, perhaps the air would have been avoided if the District Court had rehashed the detail in its earlier findings. The District Court's post-trial findings of facts and conclusions of law distinguished between the appropriate nature of the investigations into the sale of the company, the use up and the lack of evidence the government presented at trial with the following paragraph. The government was looking at a high sale price that had been shared ahead of time with the sub trustee. But not knowing what a seller wants does not make a buyer complicit in wrongdoing. The government was also faced with an appraiser who had initially been dealing with the sellers who were forming the Esop, then transferred its services to the trustee. Ultimately, providing an appraisal in a very short timeframe was fairly close to the limited valuation set by the original Gmq valuation. For his part, the trustee documented only about 30 hours of work that that the government had suspicions and opened an investigation appears entirely warranted, as the court said. But when the government filed this lawsuit, it took on the burden of proving its that its suspicions were reflected. In fact, what has happened in the trial of this case is that the government failed to carry that burden. Not for want of effort or trying, but for want of what appears to be want of evidence. And that's what we argued at the at the Ninth Circuit oral argument. We argued that there was really no evidence that supported the government's position. So why did they perpetuate this investigation for three years and then the litigation for another three years before the court had to finally tell them that they didn't have enough evidence? The government should have determined this well in advance. It's quite frankly, the basis for why this case, this case does stand for the principle that the government either acted in bad faith by prosecuting this litigation or without a substantial justification for continuing to litigate this case throughout trial. After the secretary determined that the investigation merited a lawsuit that had, at its core the allegation that there was a excessive, fair market value price for purposes of the Esop transaction in 2012, the Secretary needed to have some evidence that reasonably supported this allegation. Yet an examination of the district court's findings of facts and conclusions of law establishes that there was no reasonable support to justify the government's suspicions and the filing and prosecution of the complaint in this matter. The district court acknowledged that the government pointed to a number of circumstances that the government viewed as suspicious. Rather than accepting that the evidence presented a reasonable basis for suspicions but less than needed for the secretary's burden of proof. The court rejected the plausibility of these suspicions in its findings of facts and conclusions of law. The court basically rejected all the evidence suggesting that the pricing was inflated, noting the analysis of the secretary's expert contained notable errors and was unreliable. Given the breadth of the information accumulated in the secretary's over three year investigation. The filing of a lawsuit that raised a series of ERISA violations based on the ESOPs acquisition at an improper alleged improper sales price in December of 2014 required substantial justification in the form of reasonable evidentiary grounds to support the assertion that the price was improper. Yet the district court found that the Secretary secretary didn't have credible a credible challenge to the actual sales price, an agency's continuation of an investigation and litigation for more than six years that knew to be baseless is, in my opinion, a prime example of bad faith. Again, maybe they had a few suspicions back in 2014 and 15, but however, those suspicions were proven to be true progressively from 2015 through 2021. And the court, in its findings of facts and conclusions of law, reached the conclusion at the end that there was just nothing really to support. I was asked that question in oral argument by one of the senior judges and and because I took a pretty strong position that there really was no evidence that supported the government's position. Obviously, there were some suspicions, but there were no real conclusory evidence that was supported by facts that really supported the government's position in this case. And that's why I believe they acted in bad faith and certainly without substantial justification. And as detailed in the brief of the Esop Association, the the Secretary also advocated for a flawed interpretation of Orissa's exception to the related party related party prohibited transaction rules found in Section 408 of Orissa. That's an exemption that allows a transaction between a party and interest and a plan to take place as long as it meets the requirements of the exemption. It was patently unreasonable for the Secretary to advocate that a failure to show fair market value alone voids the Orissa Section 408 exemption without regard to what the good faith standard. Again, we've talked about this before. The plain text of the statute references adequate consideration as being the fair market value of the asset, as determined in good faith by a fiduciary or fiduciary in accordance with regulations prescribed by the Secretary. So it's not just a fair market value alone standard. It's a good faith or procedural standard. Substantive procedural standard as well. Long standing opinions under ERISA emphasized that the importance of the good faith component in the definition of adequate consideration is is one of the primary issues dating back to Donovan v Cunningham in many years ago. That's the piece that the government left out in its case in this matter, and that it tried to argue that there was simply a fair market value standard and there wasn't a good faith standard. And the Esop Association made that point very clear during the course of the of its amicus curiae brief. Uh, also, I think one of the other issues that came up at the at the ninth Circuit was in trying to perfect this claim for attorney's fees and expenses on behalf of the corporation that sponsored the Esop. The Secretary has ignored the statutory mandate for almost 50 years, and indeed, the congressional intent expressed back in 1974 that the Secretary should promulgate final regulations detailing the adequate consideration standard, including the good faith component. Instead, the Secretary has focused its attention, his attention on itself or her attention on a self-serving legal strategy of defining adequate consideration in litigation. So legislating through legislation, legislating through litigation, and uses this inconsistent and confusing valuation theory. The Secretary comes up with in all these cases as an abuse to attack, to provide unjustified attacks on ESOPs of all kinds throughout the country. It's no coincidence that the Secretary's unjustified position in this action not only compelled the filing of an amicus curiae brief by the Esop Association in this case, but also prompted the Esop Association's filing of a petition under the Administrative Procedure Act on September 22nd, 2022, to compel the Secretary to issue final regulations defining adequate consideration. We can certainly make that available to any of the attendees as as requested. The Esop Association petition reiterates the Secretary's practice of unreasonable concessions as found in this particular action, stating as follows. Rather than issue regulations, the Department has chosen to pursue a policy of regulation by litigation. Pattern is familiar. The Department conducts a years long, expansive and expensive investigation of the Esop transaction. Leading it to investigate. An Esop trustee concludes that for reasons supported neither by Orissa's text nor existing case law. Trustee failed to satisfy the adequate consideration exemption in connection with one or more Esop transactions, and then they go on a series of investigations of that particular trustee for many years and have destroyed many trustees, quite frankly, in that respect. The Hawaii District Court had the opportunity to address these concerns in a narrow context. It the unreasonable legal positions asserted by the Secretary in this action document that the Secretary was not substantially justified in bringing this action to assert ERISA violations. In fact, by ignoring the Orissa statute for the last 50 years and not defining what adequate consideration is, that to me is bad faith. That's what the Esop Association argued. That's what I argued on behalf of the Esop plan Sponsor. There, the secretary asserted a series of unreasonable standards regarding risks as requirement for prudent negotiation in the transaction. At issue here, all of which the district court flatly rejected in finding that equity's negotiation ended up saving the company millions of dollars. Again, that's a finding of fact by Judge Molloy. The secretary unreasonably asserted the price of the December transaction was inflated without any real credible challenge to the prices. I've indicated these can clearly these conclusions all clearly refute the secretary's allegations in the complaint that despite a list of red flags like Whitney did not question the valuation or the assumptions on which it was based, the red flags and the red herrings were determined to be untrue and not accurate, and the court didn't provide them any any real credence in its findings of facts and conclusions of law. But our clients, the appellants in this matter, then submitted to the to the US Court of Appeals for the Ninth Circuit that the Secretary's positions in this action did not have a reasonable basis either in law or in fact. As such secretary was not substantially justified and the district court abused its discretion in ruling otherwise. And in fact, as I read the opinion a couple of times afterwards, I really like the findings of facts and conclusions of law. I couldn't reconcile that The findings of fact and conclusions of law by Judge Molloy with the ultimate decision on the attorney's fees request by our clients in this matter. I believe that the secretary acted in bad faith by tendering expert testimony that was so obviously flawed and unreliable and contained notable errors and omissions, as the district court concluded in the lower court. Such expert, quote unquote testimony and conduct by the secretary solicitors had literally little or no prospect of success and was so obviously wrong, in my opinion, as to be frivolous and fatally flawed. As such, it constitutes bad faith and they used the wrong standard of valuation as well. Bye. Finally, they ignored the ERISA statute and congressional intent and have failed to prescribe rules of the game on valuation for almost 50 years. This, to me is bad faith. So bad faith hopefully equates to achieving recovery of attorney's fees from the government. If it's not bad faith. It it it at least at a minimum, is a conclusion which hopefully the ninth Circuit will support, that the government did not have substantial justifications for its positions. As as I've explained to you during the last roughly hour of my presentation here. There were a number of discovery orders against the doll. In this case, those discovery orders were basically are summarized in this presentation. I'm going to skip over the next couple of slides to get to the end here. But suffice it to say, let's go to page 37, if we could. I'll just summarize the discovery orders. Um. Originally, the magistrate judge awarded $141,000 in fees and some costs against Secretary of labor in favor of of the defendants in this matter. Following a 14 month discovery dispute over the Secretary of Labor's failure to provide to produce documents and provide sufficient privileged logs and declarations supporting the assertion of governmental privileges. Despite the Secretary's continued failings, which included, I think, 4 or 5 different. A declarations under penalty of perjury from a secretary of labor official. Despite those, the court failed to find a waiver of government privileges and held an award of attorney's fees and costs was was appropriate and proper, though. So that was, again, the failure of the government to provide reduced documents when requested and discovery plus provides sufficient privilege logs resulted in the magistrate judge concluding that there were $141,000 of fees. The Court Judge Mollway cut those down to 63,000. But that's one of the largest awards of sanctions I've ever seen during my practice of law during the last almost 40 years. With respect to the Secretary of Labor's continued assertions of privilege in certain redactions, the court determined that the defendants need for the materials and the interest in accurate fact finding did not outweigh the Government's interest in nondisclosure. I will tell you that the failure to gain access to those redacted materials made it impossible for our clients to proceed under a statute of limitations defense. The three year statute of limitations, which we also thought was relevant in this case, however, we just did not win that battle. I'm going to skip over this. There's just a quick which is unrelated to the topic of this case, recovering attorney's fees. So we'll skip over this slide which deals with the government subpoena power. It just simply says that the government has the right to to subpoena from third parties, not just parties involved in the matter. And it's a really strong right. And this you know, so when they get into these investigations, the subpoena power is extreme and it can result in substantial cost to comply with those subpoenas. Um, the doll has been quite silent since September of 2021 when we prevailed in this case. And I have a feeling that if and again, who knows, we may or may not succeed in the Ninth Circuit on behalf of our clients, but let's cross our fingers that we get a recovery of the attorney's fees and expenses that are warranted because of the government's lack of substantial justification or bad faith. Hopefully that's what the Ninth Circuit concludes. We'll wait and see. But the government has been the doll has been a little bit reticent to make filings since the September of 2021 loss. We will see that ultimately in the Secure Act two Act of 2022, which was enacted on December 29th, 2022, Congress is now directed as directed the doll to promulgate regulations on the determination of fair market value for purposes of an Esop purchase. Hopefully that happens and hopefully that helps. A. Explain or help unlock some of the confusion that has allowed the doll to bring these cases against many unsuspecting folks over the last 50 years. In a letter issued to the Esop Association on April 12th, 2023, the doll actually did commit to promulgating such regulations. Although the doll did not provide a timeline for such rulemaking process, this commitment from the doll does represent a significant shift in the doll's approach to ESOPs. We hope that continues to head in that direction. There will be an opportunity for public comments and hearings on those final regulations and the defense that we made in this case as it relates to trying to obtain attorney's fees and expenses that may go away after this. If the government actually does issue these regulations and tells people who are considering ESOPs and Fiduciaries and others selling shareholders what the definition of fair market value really is so that they can comply with it, as the government indicates. And we don't get into these cases in which we have to defend a case for almost seven years and then go to the Ninth Circuit in order to get an award of attorney's fees and expenses against the government, which, of course, we hope ultimately happens in this case. Thank you very much for your time. I went over by a minute or two, but hopefully that was of some value to everyone. And I really appreciate the opportunity to talk to you today about this this case and the topic of trying to obtain attorney's fees and expenses from the government under the Equal Access to Justice Act after a successful defense of an investigation and litigation that lasted for almost seven years. Thank you for your time.

Presenter(s)

DJ
David Johanson
Partner
Hawkins Parnell & Young, LLP

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                                                                                        July 2, 2025 at 11:59PM HST

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                                                                                        Available
                                                                                        Credits
                                                                                        • 1.0 law & legal
                                                                                        Available until

                                                                                        June 29, 2028 at 11:59PM HST

                                                                                        Status
                                                                                        Approved
                                                                                        Credits
                                                                                          Available until
                                                                                          Status
                                                                                          Not Eligible
                                                                                          Credits
                                                                                            Available until
                                                                                            Status
                                                                                            Not Eligible
                                                                                            Credits
                                                                                              Available until
                                                                                              Status
                                                                                              Pending

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