Opposition Brief — Hall Holding Co., Inc. v. Chao, Secretary, Department of Labor

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No. 02-593

NEE RIPE REDE ONES I me

Jn the Supreme Court of the United-States

HALL HOLDING Co., INC., ET AL., PETITIONERS

ELAINE L. CHAO, SECRETARY OF LABOR

ON PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE SIXTH CIRCUIT

BRIEF FOR THE RESPONDENT IN OPPOSITION

THEODORE B. OLSON

Solicitor General

Counsel of Record

Department of Justice

Washington, D.C. 20530-0001

(202) 514-2217

EUGENE SCALIA

Acting Solicitor of Labor

ALLEN H. FELDMAN

Associate Solicitor

NATHANIEL I. SPILLER

Deputy Associate Solicitor

EDWARD D. SIEGER

Attorney

Department of Labor

Washington, D.C. 20210

Saige eA TE ME

QUESTION PRESENTED

The Employee Retirement Income Security Act

(ERISA) prohibits a fiduciary from causing an em-

ployee benefit plan to engage in a transaction that the

fiduciary knows or should know constitutes a sale or

exchange of property between the plan and a party in

interest. An exception to that rule allows the acquisi-

tion or sale by a plan of qualifying employer securities if

the plan pays no more than “adequate consideration.”

When the employer securities are not publicly traded,

“adequate consideration” means “the fair market value

of the asset as determined in good faith by the trustee

or named fiduciary.” 29 U.S.C. 1002(18)(B). The

question presented is:

Whether fiduciaries fail to pay “adequate considera-

tion” for employer stock that is not publicly traded,

where they fail to determine the fair market value of

the stock in good faith and thereby cause losses to the

plan.

TABLE OF CONTENTS

Page

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ast dean ag thisbillieiancsbaananbtingstn 1

icles deecnccannainabaneiiandennemeabipeimieneianiheies 2

TIT natin chpeteiabecenneinnenesnieinianhocaanieniabinisanumtansts 11

a aac raha dincdaninioneeeniebnes 23

TABLE OF AUTHORITIES

Cases:

Brock v. Robbins, 830 F.2d 640 (7th Cir. 1987)... 15, 18, 19, 21

Cosgrove v. Circle K Corp., 915 F. Supp. 1050

(D. Ariz. 1995), aff’d, 107 F.3d 877 (9th Cir. 1997) ........... 21

Diduck v. Kaszycki & Sons Contractors, Inc., 974

es III ss connscacnnaeihieiieheniptienbaruenansinaninnssagavnense 21

Donovan v. Cunningham, 716 F.2d 1455 (5th Cir.

1983), cert. denied, 467 U.S. 1251 (1984) .........0 20, 21, 22

Elmore v. Cone Mills Corp., 23 F.3d 855 (4th Cir.

ie LL cs nrinaindarennbgietiainanshsenietinitonmies 21

Fink v. National Sav. & Trust Co., 772 F.2d 951

SR RSET le er nec 15

Harris Trust & Sav. Bank v. Salomon Smith

Barney, Inc., 530 US. ZEB (2000) ........rerervevecssesvsessesererereeees 2,12

Herman v. Mercantile Bank, N.A., 143 F.3d 419

es ED seesenreiiienicinctnctnnccininvnetmnnneninmnnnns 10, 11-12, 16, 17-18

Howard v. Shay, 100 F.3d 1484 (9th Cir. 1996),

cert. denied, 520 U.S. 1237 (1997) ........c.srsccvessersssssesseseveree 21-22

Ironworkers Local No. 272 v. Bowen, 695 F.2d 531

UE I cache ineiinenanietninonsonenn 21

Kuper v. Iovenko, 66 F.3d 1447 (6th Cir. 1995) ............000+ 10

Montgomery v. Aetna Plywood, Inc., 39 F. Supp. 2d

SO TE IIIT ss shecnceiehcaieiiniebindelicsunliendionbianeesedanenesione 22

Cases—Continued: Page

Physicians Healthchoice, Inc. v. Trustees of Auto.

(III)

Employee Ben. Trust, 988 F.2d 53 (8th Cir. 1993) .......... 21

Reich v. Valley Nat’l Bank, 837 F. Supp. 1259

GERAIS Es Bs IE tecestricincmnsieenteminiitennenintndaiahinenisintaiinctasimienmsis 22

Roth v. Sawyer-Cleator Lumber Co., 16 F.3d 915

Re AFI ED eihechiicavisnncnineniinersinctsiienienisaiauhitianeisanlnncinkaaiinn 16

Silverman v. Mutual Ben. Life Ins. Co., 138 F.3d 98

(2d Cir.), cert. denied, 525 U.S. 876 (1998) ............ccceeeees 21

Unisys Sav. Plan Litig., In re, 74 F.3d 420 (3d Cir.),

cert. denied, 519 U.S. 810 (1996) ............csscsccsrsssssessseesensees 21

Statutes and regulations:

Employee Retirement Income Security Act of 1974,

er A BE Oe cetcitietentnmernticdinunrieninaninenmes passim

BRU E., TERRI eanccecensecennesennesnsanssennsnmnernnnosiovouesnaie 2,13

Be Ske SIRE ecsentanstrcinniininnenennninnensiinnntaniastoniteiniin 2,13

TER, IED eteniatacrcinnininininnniscnmiitioasiieinantsiec 2

29 U.S.C. 1002(18)(B) ...srsvsesscccsssesssssssseses 3, 9, 10, 13, 19, 21

BP UTA: FID sectnttnncsesscsainesinininennnniitonnmatsiscicniinaniinenaitioine 10, 20

BEE CD eceninsitecsianctnistnsiivnsniessnlavienseneessivie 2,5, 20, 21

BU BK... TIE) sicsicressssisessievorinisoninninsneisitvoniiiotionls 2

Se TF, EID sestesncnsccnsesininnsnrsinnniisioniins 2,10, 18

Bs TI seesrennsernsasaracimssimsineraninintenvaniivinigeitinianiies 10, 15

Be EFI: PI sineinnisicennceitennninitaienininicsiannanniniian 2,20, 21

Ee. TED seniicictansivilsronninaniesinnensiion 5, 6, 8, 9, 10, 12

BP ETE SERIA) sincsvicsicinsscorssessasorscnnens 2,5, 9, 12, 13

sis devitivinicntososnnitinninianiissipnitncnintesiien 18

a Fe seirvnsninnseniinersaiiinincianiinrinnpaiin 2

BO SEE As RD sicscisncssenessineteennennniigniiiiicanioniainnsoncins 2

Te TD ia itiiscse nase vistiemncininsietininiicsiinaiaanon 19

Be Sieiicsisicevcnsenceoniensinrsinrinrcinnicnivinileeueniaiesanies 9

Ne ries AED inisesnisitnssasivnisnisticnsicinnnhcbioisiiseantinibaiieds 3,13

BE ND ctiicnesiistiiccaieilataintincltimraiiieciasiiniiinin 3,15

SIND isin inieihccaisionensineslaiacsennmniaanbini 3

Miscellaneous:

53 Fed. Reg. (1988):

". ———_SERRRENESRIE SAREE tern vena nee remanent sa Un eenNit en ean 22

In the Supreme Court of the Gnited States

No. 02-593

~ HALL HOLDING Co., INC., ET AL., PETITIONERS

Vv.

ELAINE L. CHAO, SECRETARY OF LABOR

ON PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE SIXTH CIRCUIT

BRIEF FOR THE RESPONDENT IN OPPOSITION

OPINIONS BELOW

The opinion of the court of appeals (Pet. App. 1a-56a)

is reported at 285 F.3d 415. The August 10, 1999,

decision of the district court (Pet. App. 98a-116a) is

reported at 60 F. Supp. 2d 755. The January 9, 1998,

and March 10, 1998, decisions of the district court (Pet.

App. 57a-78a, 79a-85a) are reported at 990 F. Supp. 955.

The magistrate judge’s report and recommended deci-

sion (Pet. App. 86a-97a) and the district court’s August

10, 1999, order (Pet. App. 117a-118a) and post-judgment

decisions (Pet. App. 119a-131a) are unreported.

JURISDICTION

The judgment of the court of appeals was entered on

April 3, 2002. A petition for rehearing was denied on

July 18, 2002. Pet. App. 132a. The petition for a writ of

certiorari was filed on October 15, 2002. The jurisdic-

tion of this Court is invoked under 28 U.S.C. 1254(1).

STATEMENT

1. The Employee Retirement Income Security Act

of 1974 (ERISA) requires the fiduciaries of an employee

benefit plan to discharge their duties with respect to

the plan solely in the interest of the plan’s participants

and beneficiaries and, among other things, with a high

degree of prudence. 29 U.S.C. 1104(a)(1)(A), (B).

ERISA also prohibits a fiduciary from engaging in

certain prohibited transactions, including, among other

things, a sale or exchange of property between a plan

and a party in interest. 29 U.S.C. 1106(a)(1)(A).’

ERISA’s prohibited transaction provision “supple-

ments the fiduciary’s general duty of loyalty to the

plan’s beneficiaries [in 29 U.S.C. 1104(a)] by categori-

cally barring certain transactions deemed ‘likely to

injure the pension plan.’” Harris Trust & Sav. Bank v.

Salomon Smith Barney Inc., 580 U.S. 238, 241-242

(2000) (citation omitted).

An employee stock ownership plan (ESOP) is an

employee benefit plan that invests primarily in stock of

the employer sponsoring the plan. See 29 U.S.C.

1107(d)(5), (6). Because such an employer is a party in

interest, see 29 U.S.C. 1002(14)(C), the sale of employer

stock to an ESOP would be prohibited under ERISA

were it not for an exemption from the prohibitions in 29

U.S.C. 1106(a). That exemption allows an “acquisition

or sale by a plan of qualifying employer securities” if,

among other things, the acquisition or sale is for “ade-

1 A party in interest includes, among others, any employer

whose employees are covered by a plan, and certain related cor-

porate entities and owners. 29 U.S.C. 1002(14)(C), (E), (G).

quate consideration.” 29 U.S.C. 1108(e)(1). For em-

ployer securities that have no recognized market,

“adequate consideration” means, in relevant part, “the

fair market value of the asset as determined in good

faith by the trustee or named fiduciary.” 29 U.S.C.

1002(18)(B).

If a fiduciary breaches his duties to a plan, he is

“personally liable to make good to such plan any losses

to the plan resulting from each such breach, and to

restore to such plan any profits of such fiduciary which

have been made through use of assets of the plan by the

fiduciary, and shall be subject to such other equitable or

remedial relief as the court may deem appropriate,

including removal of such fiduciary.” 29 U.S.C. 1109(a).

The Secretary of Labor, among others, may sue to

obtain such relief. 29 U.S.C. 1132(a)(2).

2. In 1988, petitioner Goldman Financial Group, Inc.

(GFGI), acquired Hall Chemical Company, a company

whose stock is not publicly traded. Pet. App. 4a; Pet. 5.

In 1990, GFGI decided to create an ESOP for the em-

ployees of Hall Chemical. Pet. App. 60a; see id. at 4a-

5a. The ESOP was to be “leveraged,” which means that

the ESOP, upon being established, would borrow

money and then use the money to buy qualifying em-

ployer securities. Jd. at 8a n.5, 60a. The ESOP was to

repay the debt from cash contributions that Hall

Chemical was to make on behalf of its employees. Jd. at

8a n.5, 58a-59a.

Petitioners George Ahearn and Michael Shields were

officers of Hall Chemical and the trustees of the Hall

Chemical ESOP. Pet. App. 4a, 59a-60a, 62a. They had

no input into the price the ESOP was to pay for the

stock, however. Id. at 28a-3la, 75a. Petitioner Kath-

leen Keating made that decision in her capacity as a

GFGI employee, subject to the approval of petitioner

David Goldman, who controlled GFGI and its sub-

sidiaries. Jd. at 6a-7a, 75a. Keating determined that

the ESOP would pay $3.5 million, a price that Goldman

accepted. Jd. at 7a.

Keating explained that the $3.5 million purchase

price was based on an expert’s valuation of Hall Chemi-

cal Company. Pet. App. 5a-6a, 7a. That expert, James

Cunningham, had valued Hall Chemical Company as

worth between $32.4 and $37.4 million. Jd. at 6a, 92a,

102a. Keating took the mid-point of that range ($34.9

million), multiplied it by the amount of stock to be

purchased (9.9%), and then rounded up the result

($3.4551 million) so that the ESOP paid more than the

midpoint. Jd. at 6a-7a, 32a. Keating made no down-

ward adjustments to the $3.5 million purchase price to

reflect the fact that the ESOP was purchasing only a

minority interest in a privately held company, adjust-

ments that Cunningham testified that he would have

made if he had been told that the ESOP was only

purchasing a minority interest. Jd. at 24a-25a, 11la.

Keating also made no downward adjustment to Cun-

ningham’s valuation to reflect the fact that the ESOP

did not actually purchase shares of Hall Chemical Com-

pany, the company that Cunningham had valued. In-

stead, the ESOP was purchasing shares of a GFGI

subsidiary (Hall Holding Company) that in turn owned

Hall Chemical. Jd. at 8a. Hall Holding was worth less

than Hall Chemical because it had liabilities and

“negative accounts receivable” that Hall Chemical did

not have. Jd. at 93a, 112a-113a.

As a result of Keating’s determinations, the ESOP

obtained a loan for $3.5 million from other GFGI pen-

sion plans and used the loan proceeds to buy 110 shares,

or 9.96%, of Hall Holding Company. Pet. App. 8a, 61a.

The Secretary sued petitioners, alleging that peti-

tioners were fiduciaries who had violated ERISA’s pro-

hibited transaction provision, 29 U.S.C. 1106(a)(1)(A),

by having the ESOP buy stock for more than adequate

consideration. Pet. App. 57a.

3. a. The district court initially denied the Secre-

tary’s motion for summary judgment on liability. Pet.

App. 70a-78a. The court reasoned that the stock trans-

action would violate 29 U.S.C. 1106(a)(1) unless peti-

tioners paid “adequate consideration” for it. Pet. App.

71a. The court concluded that a fiduciary does not pay

“adequate consideration” unless the fiduciary, in deter-

mining the fair market value of the stock, complies with

the general fiduciary requirements in 29 U.S.C. 1104(a),

to act solely in the interest of plan participants and

beneficiaries, for the exclusive purpose of providing

them benefits, and as prudent persons would act under

the circumstances. Pet. App. 7la-72a. Petitioners could

not prove that they acted prudently in determining the

fair market value of the stock purchased by the ESOP,

the court reasoned, because none of them “was acting

on behalf of the ESOP when it was determined how

much the ESOP would pay for the Hall Holding stock.”

Id. at 75a.

The court also concluded, however, that a violation of

29 U.S.C. 1106(a)(1) does not occur unless petitioners’

imprudence caused a loss to the plan. Pet. App. 76a. To

decide whether a loss occurred, the court asked

“whether an objective, reasonable fiduciary would have

concluded, after conducting a prudent investigation,

that $3.5 million was too high a price to pay for 110

shares of Hall Holding stock.” Jbid. Because the

parties’ experts disagreed on the value of the stock, and

because the court saw “probable flaws” in both experts’

valuations, the court concluded that material factual

disputes on the value of the stock precluded summary

judgment. Jd. at 77a-78a.

b. On reconsideration, the court concluded that, re-

gardless of whether a loss occurred, petitioners violated

29 U.S.C. 1106(a)(1). Pet. App. 79a-85a. Instead, the

court stated that “the issue of loss goes to the appropri-

ate remedy,” and that the court would consider that

issue at trial. Pet. App. 84a. To assist the court in

resolving that issue, the court referred the case to a

magistrate judge for a recommendation on the fair

market value of the Hall Holding stock purchased by

the ESOP. See id. at 86a.

c. The magistrate judge recommended a finding that

the Hall Holding stock was worth $2,731,174.75, or

$768,825.25 less than the ESOP paid for it. Pet. App.

87a. The magistrate judge based his recommendation

on the valuation of Hall Chemical by petitioners’ expert

(Cunningham), as adjusted to reflect: the ESOP’s

purchase of the less valuable Hall Holding, rather than

Hall Chemical, stock; the fact that the ESOP was

purchasing only a minority interest; and the fact that

the ESOP was purchasing shares in a closely held com-

pany that were not readily marketable. Jd. at 92a-94a.

d. The district court adopted the magistrate judge’s

recommendation concerning plan losses in part, re-

jected it in part, and found that the fair market value of

the Hall Holding stock purchased by the ESOP was

$2,450,451.00, or $1,049,549.00 less than the ESOP paid

for it. Pet. App. 98a-118a. Like the magistrate judge,

the district court accepted the valuation of Hall Chemi-

cal Company by petitioners’ expert Cunningham as the

starting point for the valuation. Jd. at 105a. Rather

than take the “approximate mid-point” of Cunning-

ham’s range of values ($32.4 million to $37.4 million),

however, the district court took the lowest value of the

range “to provide the ESOP members any benefit of

the doubt on the valuation.” Jd. at 104a. The court also

corrected a mathematical error of the magistrate judge,

but otherwise accepted his recommended adjustments

to Cunningham’s valuation. Jd. at 102a, 105a-113a.

The district court did not “refuse[] to consider evi-

dence on what price a hypothetical prudent fiduciary

would have paid for the Hall ESOP stock,” as petition-

ers assert. Pet. 7.2, The court considered petitioners’

evidence but did not credit it as much as Cunningham’s

because the expert they proffered (Karen Brown) “did

not actually value the stock of either Hall Holding or

Hall Chemical,” while Cunningham did. Pet. App. 105a;

see also id. at 118a (Brown was admittedly “retained to

discuss only Cunningham’s methodologies, not whether

his actual calculations were correct”). The court also

effectively found that the fair market value of the stock

($2,450,451) was what a hypothetical prudent fiduciary,

acting in accordance with ERISA’s duty of loyalty to

participants, would have paid for the stock. See id. at

100a (whether the court used “reasonable hypothetical

fiduciary” standard or “objective value” standard for

determining fair market value of the stock was “a

2 Petitioners incorrectly assert that the magistrate judge “de-

clined to consider the only evidence presented on what a hypo-

thetical reasonable fiduciary would have paid.” Pet. 7. That evi-

dence came from Karen Brown, who testified on behalf of peti-

tioners. See Pet. App. 104a. The magistrate judge considered

Brown’s testimony. See id. at 87a (noting that “{e]ach of the three

major witnesses has strengths and weaknesses”; observing that of

the three, “Brown is an expert in evaluating ESOPs,” but “was not

asked to render an opinion on the value of the Hall Holding

minority interest held by the” ESOP, and concluding that there-

fore “(t]he testimony of each major witness was credited in part

and not credited in part.”).

distinction without a difference”); id. at 10la (“the fair

market value of the stock and the value of the stock as

determined by a reasonable hypothetical fiduciary

looking after the interests of the ESOP (i.e., not [peti-

tioners]), should be the same’).

4. In the court of appeals, petitioners argued that

the district court erred by granting summary judgment

when material factual disputes existed on the question

of whether they violated their fiduciary duties and by

holding them liable for a violation of 29 U.S.C.

1106(a)(1) without considering what a reasonable hypo-

thetical fiduciary would have paid for the stock pur-

chased by the ESOP. Pet. App. 17a-18a. Petitioners

did not, however, challenge the district court’s calcula-

tion of lusses based on its determination of the stock’s

value. See Appellants’ C.A. Br. 22-28, 43-50. Instead,

they argued that the ESOP’s participants were not

harmed by the overpayments, that giving them the

cash difference between the $3.5 million paid by the

ESOP and the $2,450,451 fair market value of the stock

would be to provide benefits the participants never

earned or expected, and that the Internal Revenue

Code barred such an award. Id. at 48-50; Pet. App.

5la-55a. The court of appeals rejected all of those

arguments.*

a. The court concluded that no material issues of fact

existed as to whether petitioners breached their fiduci-

ary duties, for two reasons. Pet. App. 23a-33a. First,

the court reasoned that a fiduciary cannot rely on an

3 The court of appeals also considered and rejected arguments

that GFGI was not a proper party defendant and that petitioners

Hall Holding and Goldman were not fiduciaries. Pet. App. 18a-23a.

Petitioners do not challenge the court’s decision on those issues.

i: i i i. ee mI LAI i Bn Se ARE CRT

expert’s valuation of a company unless the fiduciary,

among other things, gives the expert complete and

accurate information and makes certain that reliance on

the expert’s advice is reasonably justified under the

circumstances. Jd. at 25a-26a. Petitioners failed to do

either, the court reasoned. Jd. at 26a-27a. The court

also concluded that petitioners had committed “clear

violations” of their fiduciary duties by the “uniquely

careless and haphazard manner in which the Hall

Chemical ESOP was created.” Jd. at 32a. In particular,

the court noted that the ESOP’s trustees were not

involved in setting the price the ESOP would pay for

the stock it purchased, and that the person primarily

involved in setting the price (petitioner Keating) used a

valuation of the wrong company, cuarged the ESOP

extra by rounding up the purchase price, and otherwise

failed to act in the interests of the ESOP. Id. at 28a-

33a. ‘3

b. Based on statutory language, the court of appeals

concluded that petitioners violated 29 U.S.C.

1106(a)(1)(A) because, whether or not a “hypothetical

reasonable fiduciary” would have paid as much, “defen-

dants did not make a good faith determination as to the

price of the Hall Holding stock.” Pet. App. 40a; see

generally id. at 33a-5la. The court reasoned that 29

U.S.C. 1106(a)(1) prohibits transactions in which an em-

ployee benefit plan purchases stock from an employer,

that the exception to this prohibition in 29 U.S.C.

1108(e) applies only if the purchase is for “adequate

consideration,” and that “adequate consideration” in the

case of a closely held corporation such as Hall Holding

is defined by 29 U.S.C. 1002(18)(B) to mean “the fair

market value of the asset as determined in good faith

by the trustee.” Pet. App. 38a. The definition of

“adequate consideration” thus has “two distinct parts,”

the court reasoned: “First, there is the ‘fair market

value’ part, then there is the ‘as determined in good

faith by the trustee’ part.” Jbid. Because petitioners

did not engage in a good faith determination of fair mar-

ket value, the court concluded that they did not pay

“adequate consideration” under the ERISA definition

of that term. Jd. at 40a-41a.

Accordingly, the court rejected the position of the

Eighth Circuit majority in Herman v. Mercantile

Bank, N.A., 143 F.3d 419 (1998). Pet. App. 34a-38a. In

Mercantile Bank, the court concluded that “[e]ven if a

trustee fails to make a good faith effort to determine

the fair market value of the stock, ‘he is insulated from

liability if a hypothetical prudent fiduciary would have

made the same decision anyway.’” 143 F.3d at 421

(citation omitted). The Sixth Circuit in this case re-

jected that analysis because it “gives no weight to

the good faith determination under [29 U.S.C.

1002(18)(B)].” Pet. App. 38a.

The court of appeals also rejected petitioners’ argu-

ment that the Secretary had to prove that a fiduciary

violation caused harm to the plan to establish an

ERISA violation. It explained that 29 U.S.C. 1106(a)(1)

creates categories of per se violations requiring no

proof of harm to the plan. Pet. App. 48a-44a. Accord-

ingly, the court distinguished its earlier decision in

Kuper v. Iovenko, 66 F.3d 1447 (6th Cir. 1995), which

held that ESOP fiduciaries did not violate ERISA’s

prudence requirement, 29 U.S.C. 1104(a)(1)(B), by con-

tinuing to hold employer securities, where the plaintiffs

had failed to prove that a reasonable fiduciary would

have sold the stock and diversified into other invest-

ments. Pet. App. 4la-48a. Because Kuper considered

only a violation of 29 U.S.C. 1104, it does not require

reading a causation element into 29 U.S.C. 1106, the

court stated, “and such a reading is far beyond the

scope of the issues presented in that case.” Pet. App.

43a.

ce. Having determined liability, the court rejected

petitioners’ challenge to the district court’s monetary

award because their arguments were “based upon

faulty premises” and lacked “any authority for their

claims.” Pet. App. 51a. As discussed above, petitioners

argued that when the ESOP paid $3.5 million for stock

worth $2,450,451, the ESOP and its participants were

not harmed. The court of appeals explained that the

overpayment did harm the ESOP and its participants

because the ESOP incurred more debt than it should

have incurred and therefore the participants had to

wait longer to become fully vested in the stock and

received a smaller return on the stock than they should

have received. Jd. at 52a-55a. Petitioners also argued

that giving participants the amount of the overpayment

($1,049,549, plus interest) would constitute benefits that

the participants never earned or expected or could

legally obtain under the Internal Revenue Code. Id. at

55a. It “is simply not true” that the benefits were not

earned, the court stated, because “benefits such as an

ESOP are not a gratuity . . . but a form of deferred

wages.” Jd. at 55a (internal quotation marks omitted).

The court added that petitioners had provided no

authority to show that the Internal Revenue Code

prohibited an award within the district court’s wide

latitude to remedy ERISA breaches of fiduciary duty.

Id. at 55a-56a.

ARGUMENT

The decision of the court of appeals is correct and

does not conflict with any decision of this Court. Al-

though the decision below disagreed with the analysis

the Eighth Circuit used in Herman v. Mercantile Bank,

N.A., 143 F.3d 419 (1998), the result in this case would

be the same under either analysis, making further

review of the asserted circuit conflict unnecessary.

Petitioners’ other asserted conflicts do not exist. The

decision below also creates none of the “dangerous

uncertainty in the area of ESOP jurisprudence” that

petitioners posit. Pet. 18. Further review by this

Court therefore is not warranted.

1. The court of appeals correctly concluded that

petitioners violated ERISA in purchasing the Hall

Holding stock for $3.5 million on behalf of the ESOP. As

discussed above, the court followed a three-step analy-

sis. First, the court concluded that petitioners had not

engaged in a good faith investigation into the fair

market value of the Hall Holding stock purchased by

the ESOP. Second, the court concluded that the stock

purchase was therefore a prohibited transaction under

29 U.S.C. 1106(a)(1)(A) because petitioners’ failure to

investigate in good faith meant that the stock purchase

was not for “adequate consideration,” as required for

petitioners to obtain an exemption from Section

1106(a)(1)(A). Third, the court upheld the district

court’s calculation of plan losses caused by petitioners’

violation of ERISA because petitioners did not chal-

lenge those calculations but instead made arguments

that “would confound any rational investor,” Pet. App.

52a, were “baffling,” id. at 58a, and “simply not true.”

Id. at 55a.

The court of appeals’ analysis is correct. Section

1106(a)(1) of ERISA “categorically bar[{s] certain trans-

actions deemed ‘likely to injure the pension plan.’”

Harris Trust & Sav. Bank v. Salomon Smith Barney

Inc., 580 U.S. 238, 241-242 (2000) (citation omitted).

The sale of stock between the ESOP and Hall Holding

Company is one such transaction because Hall Holding

is a party in interest to the ESOP, see 29 U.S.C.

1002(14)(C), (E), and prohibited transactions include a

“sale or exchange * * * of any property between the

plan and a party in interest.” 29 U.S.C. 1106(a)(1)(A).

Thus, ERISA prohibited the stock sale unless an

exemption permitted it.

The exemption at issue here, the terms of which the

court decided were not satisfied, permits an “acquisi-

tion or sale by a plan of qualifying employer securities”

if, among other things, the acquisition or sale is for

“adequate consideration.” 29 U.S.C. 1108(e)(1). For

stock that is not publicly traded, such as the Hall

Holding stock, “adequate consideration” means, in rele-

vant part, “the fair market value of the asset as deter-

mined in good faith by the trustee or named fiduciary.”

29 U.S.C. 1002(18)(B).

The definition of “adequate consideration” therefore

requires two things, as the court said: fair market

value, and “good faith by the trustee or named fiduci-

ary” in making the determination of fair market value.

Petitioners failed to establish that the “good faith”

requirement had been met, both because the trustees of

the ESOP had no input into the price the ESOP was to

pay for the stock and because the persons who did

determine the price were not acting in the interests of

the ESOP and did not provide their expert with all the

information he needed to make a proper evaluation.

Pet. App. 25a-26a, 28a-33a, 75a-76a. Accordingly,

petitioners failed to establish that the stock sale was

exempt from 29 U.S.C. 1106(a)(1)(A)’s prohibition on

such sales.

Petitioners do not dispute that they failed to under-

take a good faith investigation into the fair market

value of the stock purchased by the ESOP. Nor do they

—— ——

challenge the court’s calculation of losses to the ESOP.

Instead, they argue that because valuation profession-

als may not reach the same conclusion as to the value of

stock in a closely-held company, the test for “adequate

consideration” should be deemed satisfied if the price

an ESOP fiduciary pays for such stock is “objectively

reasonable—that is, consistent with what a hypotheti-

cal prudent fiduciary would pay.” Pet. 20. Petitioners

assert that, if that test is satisfied, “there is no prohib-

ited transaction, no loss to the plan, and no monetary

damages may be assessed against the fiduciary even if

its investigation was imperfect in some manner.”

Pet. 21.

Petitioners’ arguments are incorrect. First, petition-

ers overlook the fact that the amount they paid was not

objectively reasonable. Second, although valuation of a |

closely-held company is an inexact science, that is not a

reason to disregard the statutory definition of “ade-

quate consideration,” which requires more than a deter-

mination of fair market value. That definition also

includes a requirement that the plan’s fiduciaries con-

duct a good faith investigation because such an investi-

gation ensures that, despite uncertainties as to the

stock’s value, the fiduciary has attempted to get the

best possible price for the ESOP. Eliminating the good

faith requirement would allow fiduciaries to do what

petitioners did here: They could act on behalf of the

seller rather than on behalf of the ESOP, and charge

the ESOP extra by rounding up numbers. See Pet.

App. 33a. They could also rely on a valuation that,

because it omitted factors that lowered the value of the

stock that was acquired, “it is difficult to believe that

any prudent person would use.” Jbid. Breaching fidu-

ciaries should not be allowed to argue that the losses

found by the court to have been caused by their errors

should be excused because some “hypothetical prudent

fiduciary” might have reached the same result.

Indeed, courts have held the prudence standard to be

violated where the fiduciary failed to conduct an ade-

quate investigation even if, unlike here, that conduct

caused no loss to the plan. In that circumstance, the

fiduciary may still be liable for “appropriate injunctive

relief such as removing the offending trustees from

their positions.” Brock v. Robbins, 830 F.2d 640, 647

(7th Cir. 1987); Fink v. National Sav. & Trust Co., 772

F.2d 951, 961, 962 (D.C. Cir. 1985) {Sealia, J., concur-

ring) (“{bJreach of the fiduciary duty to investigate and

evaluate would sustain an action to enjoin or remove

the trustee,” but would “not sustain an action for the

damages arising from losing investments”); see 29

U.S.C. 1109(a) (remedies for breach of fiduciary duty

include “such other equitable or remedial relief as the

court may deem appropriate, including removal of such

fiduciary”).

For those reasons, petitioners err in suggesting that

proof of loss must be shown to establish a violation of 29

U.S.C. 1106. Furthermore, petitioners are incorrect in

arguing that “(t]he only evidence in this case con-

cerning causation was that the price paid by the Hall

ESOP fiduciaries was well within the range of value

that a hypothetical prudent fiduciary would have paid.”

Pet. 21. There was ample evidence to the contrary,

which the district court credited in determining plan

losses. See Pet. App. 104a-114a. The district court also

effectively found that the fair market value of the stock

($2,450,451) was what a hypothetical prudent fiduciary

would have paid for the stock. See id. at 100a (whether

the court used “reasonable hypothetical fiduciary” stan-

dard or “objective value” standard for determining fair

market value of the stock was “a distinction without a

difference”); id. at 10la (fair market value “should be

the same” as the value of the stock “determined by a

reasonable hypothetical fiduciary looking after the

interests of the ESOP”). Thus, there is no merit to peti-

tioners’ argument that the court of appeals “concluded

that the Hall ESOP suffered a loss simply because the

District Court determined a lower value for the Hall

Holding stock than did Petitioners (or the hypothetical

prudent fiduciary or, for that matter, the Magistrate

Judge).” Pet. 8-9.

2.a. Petitioners argue that review should be granted

because the decision below conflicts with the Eighth

Circuit’s decision in Mercantile Bank. Pet. 9, 11-13.

There is some tension between the treatment of the

“hypothetical prudent fiduciary” in the decision below

and in Mercantile Bank. That tension, however, is

- irrelevant to the result in this case and does not amount

to a conflict in the courts of appeals warranting this

Court’s review.

In Mercantile Bank, the Secretary alleged that a

fiduciary had violated ERISA by failing adequately to

investigate the value of closely-held stock and by

purchasing the stock for more than its fair market

value. 143 F.3d at 421. The district court found no vio-

lation because “the fair market value of the stock,

whatever it was precisely, was sufficiently close to

what [the fiduciary] paid that, even if [the fiduciary] did

overpay slightly, [the fiduciary] had no reason to know

that he was overpaying.” /d. at 422. In affirming the

district court, the Eighth Circuit reasoned that, al-

though an ESOP may purchase stock only for “ade-

quate consideration,” a trustee who fails to make a good

faith effort to determine the fair market value of the

stock is “insulated from liability if a hypothetical

prudent fiduciary would have made the same decision

anyway.” Id. at 421 (quoting Roth v. Sawyer-Cleator

Lumber Co., 16 F.3d 915, 919 (8th Cir. 1994)). Con-

struing the district court’s decision in that case to have

found that a hypothetica! prudent fiduciary “could have

and would have paid what [the actual fiduciary] paid for

the stock,” and reviewing that finding for clear error,

the Kighth Circuit affirmed the district court’s decision.

Id. at 422.

In the instant case, the court of appeals disagreed

with the Eighth Circuit’s view that the statutory

requirement of “adequate consideration” is satisfied

regardless of the fiduciary’s good faith so long as a

hypothetical prudent fiduciary “would have made the

Same decision anyway.” Pet. App. 36a (citations

omitted). The court of appeals, however, did not dis-

turb the district court’s finding that petitioners’ con-

duct caused losses to the ESOP because a “hypothetical

prudent fiduciary” would not have paid as much for the

company’s stock. Thus, the court of appeals’ rejection

of the “hypothetical prudent fiduciary” standard in

determining whether petitioners violated ERISA is

irrelevant to the result in this case; whether that stan-

dard was applied, as in Mercantile Bank, as a touch-

stone in determining the existence of an ERISA

violation, or, as here, in determining whether the plan

incurred losses from the violation, the result would be

the same: petitioners would be liable for a fiduciary

breach and have to pay for $1,049,549 in plan losses.

Accordingly, although the difference between the

Sixth and Eighth Circuits could be of Signilicance in a

case in which there is no proof of loss and the only

remedy sought is the removal of the fiduciary, it has no

significance in a case like this, in which there is concrete

proof of loss. In a case such as this, both courts would

agree that there was a violation of ERISA, that damage

occurred, and that the fiduciary is liable for damages to

make good to the plan for the loss. See Mercantile

Bank, 143 F.3d at 421-422; id. at 423-428 (Bright, J.,

dissenting). Accordingly, further review in this case to

resolve the differing analyses applied by the Sixth and

Eighth Circuits would be unwarranted.

b. Petitioners also argue that the decision below

conflicts with the Seventh Circuit’s decision in Robbins.

That is incorrect, because Robbins did not decide the

issue presented here and in fact supports the decision

below.

In Robbins, fiduciaries failed properly to investigate

an insurance contract they obtained for an ERISA plan.

830 F.2d at 642, 646. The Secretary alleged that they

violated ERISA’s prudence requirement, 29 U.S.C.

1104(a)(1)(B), as well as a prohibited-transaction pro-

vision that forbids “furnishing of goods, services, or

facilities between the plan and a party in interest,” 29

U.S.C. 1106(a)(1)(C). Robbins, 830 F.2d at 643-644. The

district court concluded that the Secretary failed to

establish either violation because the fees paid by the

plan for the contract were objectively reasonable and

the plan suffered no losses. Jd. at 645. “In essence, the

district court concluded that if a trustee enters into a

contract with a fee provision with which a hypothetical

prudent trustee would also agree, then the trustee does

not violate his duties under ERISA even if, when

entering into the contract, the trustee has no idea

whether or not the provision of the contract is rea-

sonable.” Jd. at 646.

The court of appeals in Robbins affirmed the finding

that there had been no prohibited transaction. Rob-

bins, 830 F.2d -at 644-645. The court relied on an

exemption from the prohibited transaction provision at

issue in that case, for “reasonable arrangements with a

party in interest for office space, or legal, accounting, or

other services necessary for the establishment or

operation of the plan, if no more than reasonable com-

pensation is paid therefor.” Jd. at 644 (quoting 29

U.S.C. 1108(b)(2)). Because the court of appeals agreed

with the district court that the fees paid under the

contract were objectively reasonable, it held that the

fiduciaries could rely on that exemption. 830 F.2d at

644-645.

The court of appeals in Robbins, however, reversed

the district court’s conclusion that the fiduciaries had

not violated ERISA’s prudence requirement. Robbins,

830 F.2d at 646-648. The court agreed with the district

court that “[iJf trustees act imprudently, but not dis-

honestly, they should not have to pay a monetary

penalty for their imprudent judgment so long as it does

not result in a loss to the Fund.” Jd. at 647. But, quite

logically, it held that they could be liable for appropri-

ate equitable relief even if there was no monetary loss

as a result of the imprudence. Jd. at 647-648.

The holding in Robbins on the prohibited-transaction

issue creates no conflict with the decision below be-

cause the court in Robbins construed a materially dif-

ferent ERISA exemption. The provision at issue in

Robbins allows contracts between a plan and a party in

interest “if no more than reasonable compensation is

paid therefor.” 29 U.S.C. 1108(b)(2). That provision has

no requirement that reasonableness be determined in

good faith by the fiduciary. The “adequate considera-

tion” provision at issue here has such a good faith

requirement. See 29 U.S.C. 1002(18)(B). The Seventh

Circuit’s interpretation of the service provider exemp-

tion in 29 U.S.C. 1108(b)(2) is thus entirely consistent

with the Sixth Circuit’s interpretation of the “adequate

consideration” definition in 29 U.S.C. 1002(18)(B).

Moreover, the Seventh Circuit’s holding in Robbins

on the prudence issue supports the Sixth Circuit’s

decision here. Both courts held that the “hypothetical

prudent fiduciary” concept is not a defense to liability

under ERISA, even if it may be relevant in assessing

plan losses.

ec. Petitioners also argue that the court of appeals

construed 29 U.S.C. 1106(a) not to have a causation

requirement, and that the decision below therefore con-

flicts with appellate decisions requiring proof of causa-

tion of loss to a plan as a prerequisite to imposing

monetary liability on an ERISA fiduciary for violations

_ of 29 U.S.C. 1104. Pet. 10, 15-18. In their view, the

court below departed from those cases by construing

the prohibited transactions in 29 U.S.C. 1106(a) “to be

‘per se’ violations of ERISA as to which liability for

monetary damages may be established in the absence of

causation,” Pet. 16, and created a conflict with Donovan

v. Cunningham, 716 F.2d 1455 (5th Cir. 1983), cert.

denied, 467 U.S. 1251 (1984), and Robbins because those

cases require that 29 U.S.C. 1106(a) be construed the

same way as 29 U.S.C. 1104(a). Pet. 10, 17-18.

Petitioners’ premise—that the court below allowed

liability for monetary damages to be imposed in the

absence of causation—is incorrect. As discussed above,

the court held first that a showing of “causation” is not

required to establish a violation under 29 U.S.C.

1106(a). Pet. App. 4la-44a. Addressing monetary

liability, however, the court then went on to consider

and reject petitioners’ attempt to establish that the vio-

lation caused no harm to the ESOP or its participants.

Id. at 51a-56a. The court thus found that losses had

been caused by the breach and measured the damages

accordingly. The court’s decision is therefore consistent

with decisions of other courts of appeals that have

imposed monetary liability on a fiduciary only for plan

losses caused by a breach of the fiduciary’s duty under

various ERISA provisions.‘

Moreover, neither Robbins nor Cunningham held

that cases under 29 U.S.C. 1106(a) must be analyzed the

same way as cases under 29 U.S.C. 1104(a). Petitioners’

quotation from Robbins for that proposition is in fact a

summary of the district court’s reasoning in Robbins,

which the Seventh Circuit rejected. See Robbins, 830

F.2d at 644 (quoted passage), 647-648 (Seventh Circuit

holding that fiduciaries violated 29 U.S.C. 1104(a) even

though they did not violate 29 U.S.C. 1106(a)). In

Cunningham, the Fifth Circuit held ‘that a fiduciary’s

obligation under 29 U.S.C. 1104(a) to act prudently is

incorporated into the “good faith” part of the definition

of “adequate consideration” in 29 U.S.C. 1002(18)(B).

716 F.2d at 1466-1468. The court did not hold, as peti-

tioners appear to assume, that the prohibited trans-

action provisions should incorporate a loss-causation

requirement from 29 U.S.C. 1104(a).

3. Finally, the court’s decision in this case creates no

“dangerous uncertainty in the area of ESOP jurispru-

dence.” Pet. 18. Decisions of other courts of appeals

have made clear to ESOP fiduciaries many of the re-

quirements for valuing stock in a closely held company.

4 See Pet. 15 n.4 (citing Silverman v. Mutual Ben. Life Ins. Co.,

138 F.3d 98, 104 (2d Cir.), cert. denied, 525 U.S. 876 (1998); In re

Unisys Sav. Plan Litig., 74 F.3d 420, 445 (3d Cir.), cert. denied, 519

U.S. 810 (1996); Elmore v. Cone Mills Corp., 23 F.3d 855, 864 (4th

Cir. 1994) (en banc); Physicians Healthchoice, Inc. v. Trustees of

Auto. Employee Ben. Trust, 988 F.2d 53 (8th Cir. 1993); Diduck v.

Kaszycki & Sons Contractors, Inc., 974 F.2d 270, 279 (2d Cir.

1992); Ironworkers Local No. 272 v. Bowen, 695 F.2d 531, 536 (11th

Cir. 1983); Cosgrove v. Circle K Corp., 915 F. Supp. 1050, 1066 (D.

Ariz. 1995), aff’d, 107 F.3d 877 (9th Cir. 1997) (Table)).

See, e.g., Howard v. Shay, 100 F.3d 1484, 1489 (9th Cir.

1996), cert. denied, 520 U.S. 1237 (1997); Cunningham,

716 F.2d at 1467-1468; see also Reich v. Valley Nat’

Bank, 837 F. Supp. 1259, 1272 (S.D.N.Y. 1993). The

court below followed those decisions. See Pet. App.

25a-26a (adopting requirements, set out in Howard,

that an ESOP fiduciary must follow when relying on an

expert’s valuation); id. at 39a-40a (following Cunning-

ham and Valley National Bank, and plain statutory

language, in requiring a fiduciary to undertake a good

faith determination of fair market value).

Nothing in the court’s decision changes the rule,

recognized by the Department of Labor, that ESOP

fiduciaries receive “some leeway in the area of ESOP

valuations.” Pet. 20; see 53 Fed. Reg. 17,632, 17,633

(1988).° That leeway applies, however, only to fiduciar-

ies who act in good faith, 7.e., those who undertake a

prudent and independent investigation in valuing the

stock of a closely-held company. Pet. 20 Where, as

here, fiduciaries fail to act in good faith, they are

entitled to less latitude. :

5 As petitioners note (Pet. 19 n.6) the Department proposed a

regulation that was never finalized. Nevertheless, the proposed re-

gulation “is widely considered and followed.” Montgomery v.

Aetna Plywood, Inc., 39 F. Supp. 2d 915, 919 n.1 (N.D. Ill. 1998).

CONCLUSION

The petition for a writ of certiorari should be denied.

Respectfully submitted.