Appeal from a Decision of the United States Tax Court No. 16247-92
Before ESCHBACH, KANNE, and EVANS, Circuit Judges.
Gary Eyler, the former CEO and majority shareholder of Continental Training Services, Inc. (CTS), disputes excise taxes assessed against him by the Commissioner of Internal Revenue in 1992. The Commissioner determined that Eyler, as the majority owner of CTS stock, engaged in a prohibited transaction with CTS's employee stock ownership plan (ESOP) when he sold $10 million worth of CTS stock to the ESOP in December 1986.
Eyler appealed the Commissioner's determination to the Tax Court. After a 1995 trial, the Tax Court concluded that Eyler was not exempt from liability for excise taxes imposed in connection with his sale of CTS stock to the ESOP because he failed to establish: (1) that the fair market value per share of CTS stock on the transaction date was at least $14.50 per share; or (2) that any fiduciary named in the ESOP made a good-faith determination that the fair market value per share of CTS stock on the transaction date was at least $14.50.
Eyler appeals the Tax Court's decision and we have jurisdiction under 26 U.S.C. sec. 7482(a). We apply the same standards of review to a Tax Court decision that we would apply to district court determinations in a civil bench trial: We review questions of law de novo; we review factual determinations, as well as application of legal principles to those factual determinations, for clear error. Estate of Whittle v. Commissioner, 994 F.2d 379, 381 (7th Cir. 1993). Although the record may contain conflicting evidence on some points, we note that the Tax Court's role, as the finder of fact, is "[t]o draw inferences, to weigh the evidence, and to declare the result." Helvering v. National Grocery Co., 304 U.S. 282, 294, reh'g denied, 305 U.S. 669 (1938). And, "[w]here there are two permissible views of the evidence, the factfinder's choice between them cannot be clearly erroneous." Anderson v. Bessemer City, 470 U.S. 564, 574 (1985).
The Internal Revenue Code imposes a two-tier excise tax on prohibited transactions between an ESOP and disqualified persons. 26 U.S.C. sec. 4975(a) and (b). A prohibited transaction includes any sale of stock between a plan and a disqualified person, and a disqualified person is an owner of 50 percent or more of the stock of a corporation whose employees are covered by the plan. secs. 4975(c)(1)(A), 4975(e)(2)(E). Section 4975(a) imposes a yearly 5-percent tax on the amount involved. Section 4975(b) imposes a second tier of tax equal to 100 percent of the amount involved if the prohibited transaction is not corrected (i.e., reversed) within the taxable period. Eyler was assessed on both tiers.
Since 1973, when Eyler started CTS, he was its sole or majority shareholder as well as its chairman of the board and chief executive officer. CTS operated a series of vocational schools to train truck drivers and heavy equipment operators. Government deregulation of the industry resulted in enormous growth for CTS. Enrollment at CTS schools surged from about 2,000 students in 1980 to more than 37,000 students in 1986. At one time, CTS employed 900 people; it was the largest proprietary vocational training system in the United States. By 1986, the company was even looking to expand to Europe and Canada.
In 1985, as growth of his company really took off, Eyler began exploring either selling CTS or taking it public. CTS received inquiries and solicitations from a number of investment banking firms about going public, merging, or just being sold. In particular, Eyler received an offer from Waste Management Systems in November 1985 to purchase his CTS stock. After discussing the offer with a financial consultant, Bernard Perry of Merrill Lynch (who later became chief financial officer and a director of CTS), and one of CTS's attorneys, Gregory Hahn (who later became general counsel and an officer and director of CTS), Eyler rejected it as inadequate.
In early 1986, Eyler and CTS decided to take the company public through an initial public offering (IPO). Prudential-Bache Securities (Pru-Bache) and Raffensperger, Hughes & Co. were retained by CTS as underwriters in connection with the IPO. From the spring through fall of 1986, Pru-Bache and Raffensperger conducted a due diligence investigation which consisted of reviewing the financial records and history of CTS, visiting the company's facilities, interviewing the management, and evaluating financial and economic forecasts. As a result of the investigation, an estimated price range of $13 to $16 per share was established within which the stock of CTS might possibly be offered to the public in the IPO. This estimated price range was not to be binding, and the underwriter was free to market the stock outside of it. The stock would not be sold pursuant to the proposed IPO until a final price, which could have fallen outside the estimated range, was established.
As of August 1, 1986, there were 4,999,950 shares of CTS issued and outstanding, all of which were owned, for practical purposes, by Eyler. Pru-Bache prepared a preliminary prospectus, relying on financial information for CTS for the fiscal year ending June 30, 1986, which was filed with the Securities and Exchange Commission on September 10, 1986. The proposed IPO provided for 2,200,000 shares to be sold to the public -- 1,450,000 shares from Eyler and 750,000 from CTS. This would increase the total outstanding shares of CTS stock by 750,000 to 5,749,950.
After setting the proposed offering price range of $13 to $16 per share, the underwriters attempted to determine whether there was interest in purchasing CTS stock in the neighborhood of that price. Marketing the proposed IPO to potential purchasers during October and the first week of November 1986, Pru-Bache and Raffensberger determined that the "circle of interest" for CTS stock at $13 to $16 was only around $1 million.
A few words about the IPO market. The market is sensitive and cyclical; timing is crucial. Fluctuations in the market are commonly referred to as the "Wall Street window." When the window is open, the opportunity is ripe for an IPO; when the window is closed, the IPO market is weak. Swings in the IPO market relate either to activity in the overall market or in a particular industry. At the time CTS contemplated its IPO, there was a general decline in the market, closing the window of opportunity. Consequently, in November 1986, CTS, relying upon advice by its underwriters, postponed its IPO. The plan was to wait and hope for improvement in the market.
Meanwhile, in November 1986, Eyler decided to look into establishing an employee stock ownership plan for CTS and thereafter sell a substantial portion of his shares of CTS stock to the ESOP. On November 24, 1986, CTS approached the American Fletcher National Bank to negotiate a $10 million loan to be secured by the shares to be sold to the ESOP by Eyler. CTS's financial consultant, Mr. Perry, handled the negotiations with the bank. Prior to approving the loan, the bank performed a due diligence investigation of CTS and sought two opinion letters from attorneys. First the bank obtained and relied upon a letter which indicated that the proposed loan and ESOP transaction did not violate or constitute a nonexempt prohibited transaction under either the Internal Revenue Code or the Employee Retirement Income Security Act of 1974 (ERISA). The second letter obtained and relied upon showed that CTS had the corporate power to enter into the loan transaction. Neither letter contained any specific opinion or reference to whether the ESOP's purchase of CTS stock was for "adequate consideration" or whether the proposed purchase price of $14.50 constituted fair market value.
At a CTS board meeting on December 12, 1986, Perry explained the current financial statements of CTS and compared them to its financial projections. The IPO was again brought up, but no action taken. Instead, the board turned its attention to the proposed ESOP, the terms of which were presented by Perry. The ESOP included a provision, called a "put option," granting each employee a right to sell CTS stock to the company or the ESOP trustee at fair market value upon distribution of such stock to the employee. The plan further provided that the sale price upon exercise of the option could be paid in annual installments, bearing a reasonable rate of interest, over a maximum of 5 years. Under the terms of the ESOP, CTS was designated plan administrator and named fiduciary. CTS's duties under the plan included appointing and overseeing the plan committee. After discussion and questions concerning the ESOP, the board approved the establishment of the plan under the terms proposed by Perry during the meeting: the ESOP would borrow $10 million from the bank, with the loan ...