ESOP Fiduciaries Held Personally Liable in Bungled Plan Termination


Fiduciaries of an employee stock ownership plan are personally liable for more than $874,705 in losses resulting from their mishandling of the plan’s termination, the U.S. District Court for the Northern District of California ruled on Oct. 24.

Following a one-day bench trial on damages, Judge James Donato held that the losses suffered by the participants in the plan sponsored by California Pacific Bank were also losses to the plan for which the fiduciaries are personally responsible.

“The case exemplifies the need for plan sponsors to have read and understood their plan document and to maintain accurate plan records,” Rebecca Miller, senior director at audit, tax and consulting firm RSM US LLP, told Bloomberg BNA in an Oct. 28 e-mail. “Frequently for more common plans, such as 401(k) plans, plan sponsors can rely on their third party administrator or other advisors to keep plan operations in line. Such plans usually hold liquid marketable investments and operate within well understood rules.”

“But for ESOPs, where the risk of self-dealing is always evident and plan design is frequently very unique to the plan sponsor’s circumstances, it is particularly critical that the plan sponsor and other plan fiduciaries fully understand and carefully execute their duties and completely document their actions,” Miller said.

Facts of the Case

California Pacific Bank, a privately-held bank that extends credit to small, minority-owned businesses, terminated the ESOP in December 2010. The shares appraised at $12.75 per share under an appraisal performed by the bank prior to termination. According to testimony at the damages trial, the shares had no value outside of the bank.

Under the plan documents, when a termination or partial termination of the plan occurred, each affected participant became 100 percent vested in his or her account. Payment to the participants had to be in cash as soon as practicable after liquidation of the trust assets and no later than one year after the termination date.

The ESOP distributed its shares in June 2011 in the form of bank stock held by the plan, deposited into each participant’s individual retirement account, rather than a cash distribution required under the plan.

Some plan participants later received some cash for their bank shares in the form of payments from purchases of shares made mainly by the bank’s senior credit officer.

In July 2015, the court ruled that the bank had mismanaged the assets of the ESOP and that the fiduciaries improperly diverted to the bank an account receivable that belonged to the plan, in violation of the Employee Retirement Income Security Act (see related story, DOL Gets Partial Win in ESOP Case, Settles Another for $1 Million).

Losses to the Plan

At issue in the damages trial was whether the Labor Secretary had adequately explained why the deficient cash or interest distribution to certain plan participants were “losses to the plan” under ERISA Section 409(a), which makes the fiduciaries personally liable to cover those losses.

The Secretary made this showing, the court held. “Receiving illiquid Bank shares rather than cash amounts to a loss” to plan participants and under the circumstances also should be deemed losses to the plan, the court ruled.

The court rejected the plan trustees’ argument that two of the plan participants didn’t lose money because they were “happy” to sell their bank shares for less than their appraised value. “Happiness is not a recognized exception to the plain terms of an ERISA plan, and defendants failed to provide any basis in the case law or statute that would excuse noncompliance on that ground,” it said.

The court imposed joint and several liability on the four individual plan fiduciaries and ordered payments of plan principal and interest distributed to the affected participants.

Under joint and several liability, the DOL can seek payment of 100 percent of the damages from any or all of the liable fiduciaries.

Problems and Lessons Learned

Miller said, “There were so many problems in this case–plan trustees who apparently had little understanding of their duties, plan fiduciaries who failed to retain adequate documentation of plan assets, plan fiduciaries who failed to read and understand the plan’s terms and thus made distributions in stock when the plan specifically required cash distributions, plan fiduciaries who failed to keep sufficient accounting records to allocate all of the plan’s assets to plan participants and so on.“

“The lessons learned from this are simple–read your plan, follow its terms, keep accurate financial records, properly segregate plan assets from plan sponsor assets and when confronted with an unusual transaction, just as a plan termination, read everything again and seek experienced assistance,” Miller said.

See related story, DOL Wins ESOP Mismanagement Lawsuit Against California Bank.

Stay on top of the latest industry trends and news coverage with a free trial to the Benefits Practice Resource Center.