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

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## Record

- **Collection:** Supreme Court brief
- **Document type:** Opposition Brief
- **Published:** January 1, 2003
- **Citation:** 537 U.S. 1168

## Text

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
IT ss ccsieterhenitienssabenineiaianinbnanantdnsennmmmeigineiaueiannwes 1
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)

IV

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

2

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).

3

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

4

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-

5

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

6

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

Tf

7

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.”).

8

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

9

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,”

10

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

11

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

12

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

13

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

—— ——
a

14

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

15

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

16

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

17

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

18

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

19

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).

20

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

21

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)).

22

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).

23

CONCLUSION
The petition for a writ of certiorari should be denied.
Respectfully submitted.

THEODORE B. OLSON
Solicitor General

EUGENE SCALIA

Acting Solicitor of Labor

_ ALLEN H. FELDMAN

Associate Solicitor
NATHANIEL I. SPILLER

Deputy Associate Solicitor

EDWARD D. SIEGER
Attorney
Department of Labor

DECEMBER 2002

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40386015_0585%3A2. Public record. Not legal advice.