United States District Court, C.D. Illinois
February 12, 2004.
DEBRA K. KEACH and PATRICIA SAGE, Plaintiffs,
U.S. TRUST COMPANY, et al., Defendants
The opinion of the court was delivered by: MICHAEL MIHM, District Judge
I. SUMMARY OF FINDINGS
In 1995, Foster & Gallagher, Inc. ("F&G") was enjoying multiple
years of record profits, and the management forecast projected additional
years of record profit into the future. On December 20, 1995, the F&G
Employee Stock Ownership Plan ("ESOP"), with U.S. Trust Co. ("U.S.
Trust") as its trustee, purchased 3,589,743 shares of F&G stock from
Thomas Foster ("Foster"), Melvyn Regal ("Regal"), A. Robert Pellegrino
("Pellegrino"), and several other officers and directors at a price of
$19.50 per share. For the next two years, F&G continued to enjoy
record profits, even exceeding the projections in the management
forecast. However, in 1998, F&G's profits began a steady decline that
ended when the company declared bankruptcy in 2001. This trial looked at
what happened to cause F&G to go from boom to bust and addressed the
question of whether any of the Defendants breached a fiduciary duty to
the ESOP that resulted in the loss of the value of the F&G stock held
by the ESOP.
By the end of the 14-day bench trial in this matter, essentially four
claims were left on the table for judicial determination: (1) whether
Foster, Regal, and Pellegrino breached a fiduciary duty by failing to
disclose material information in connection with the 1995 stock purchase
transaction; (2) whether Foster, Regal, and Pellegrino breached a
fiduciary duty by causing the ESOP to enter into a prohibited
transaction; (3) whether U.S. Trust breached a fiduciary duty by causing
the ESOP to enter into a prohibited transaction; and (4) whether U.S.
Trust breached a fiduciary duty by failing to take action to investigate
and pursue claims against participants in the 1995 stock purchase
transaction after the value of F&G stock precipitously declined.
Based on the evidence presented at trial, the Court finds that neither
Foster, Regal, nor Pellegrino attempted to conceal material information
or knowingly made anything less than full disclosure of such information
to U.S. Trust and its due diligence team in connection with the 1995
stock purchase transaction. Accordingly, no duty to disclose material
information was breached.
The Court further finds that the ESOP did not pay more than adequate
consideration for the stock purchased on December 20, 1995. Although
Plaintiffs argued that the fair market value of the F&G stock was
substantially less than the $19.50 price that was paid per share and that
U.S. Trust did not conduct a good faith/adequate investigation, these
arguments were premised on the presumption that information concerning
dependency on sweepstakes marketing and increased governmental regulation
of the sweepstakes marketing industry posed either a material risk to
F&G in 1995 or a future material risk that was reasonably foreseeable
at the time. The weight of the evidence indicated that F&G's officers
and directors did not consider
these issues to be material at the time, as evidenced by the following:
(1) an otherwise inexplicable conversion to a Subchapter S corporation in
1997 (which would only have had positive tax consequences for a company
expecting continued profitability); (2) the undersubscription of another
stock purchase transaction by the ESOP in 1997 because many officers and
directors believed that the stock was worth much more and would continue
to increase in value; (3) the immediate refusal of Foster and Regal to
sell their remaining shares to the company at $25.00 per share in 1997;
and (4) an unsecured $10 million loan from Regal and the Foster Estate to
F&G in 1999 in order to assist the recovery of the company. Nor were
such issues deemed material by the four lenders that performed their own
due diligence investigation prior to loaning F&G $70 million to finance
the 1995 stock purchase transaction at favorable interest rates and
without requiring collateral. Some of those same lenders agreed to loan
an additional $100 million on the same terms in 1997. Uncontroverted and
credible testimony at trial from an industry expert also established that
such issues were not material at the time of the 1995 stock purchase
transaction and did not present a reasonably foreseeable material risk of
future harm to F&G. Given these findings, in conjunction with three
expert valuations placing the fair market value of F&G stock well in
excess of $19.50 per share and the less credible valuation supporting
Plaintiffs' position that the value of the stock was substantially less
than $19.50 per share, the Court must conclude that the 1995 stock
purchase transaction was for adequate consideration and that Foster,
Regal, Pellegrino, and U.S. Trust are entitled to the protection of an
exemption under § 408(e) of ERISA on Plaintiffs' prohibited transaction
Finally, as the evidence of record established that the cause of the
loss to the ESOP was not any material risk to the value of F&G stock due
to sweepstakes dependency or governmental regulation of the sweepstakes
industry in connection with the stock purchase by the ESOP on December
20, 1995, the investigation and preservation of claims against
participants in the 1995 stock purchase transaction as requested by the
Plaintiffs would have been fruitless and fufile. Thus, U.S. Trust could
not have breached any fiduciary duty by failing to take the requested
This is an important case to the parties involved, and is also
important to many people who have not been directly involved in the
litigation but were participants in the F&G ESOP. It is important to
the Plaintiffs, who lost their jobs, benefits, and funds expected to
provide for their retirement when F&G closed its doors in 2001. It is
important to the Defendants, whose professional reputations and personal
integrity have been called into question and some of whom also lost their
jobs and investments when F&G declared bankruptcy. This case is also
important to the community, as F&G was a Peoria institution for many
years, and its former officers and employees are well known in this
community as neighbors, friends, and personal acquaintances. The Court
recognizes the importance of this case and has immersed itself in the
facts and arguments of record in order to give this litigation the
scrupulous care and attention that it deserves.
The loss of F&G was tragic, and it is completely reasonable for the
people who suffered from its demise to want to understand what happened
and assign blame to anyone who could have caused the loss. The Court is
very sympathetic to the Plaintiffs and the losses that they have suffered
and would have liked nothing more than to have
been able to restore to them what they had lost. However, the Court's
sympathy cannot change the proven facts of record or the governing law in
order to reach a more compassionate result.
What happened to F&G in 2001 may or may not have been the result of
mismanagement or poor business decisions in response to the drastic
industry change that occurred in 1998. The Court cannot find on the
record before it that F&G's demise was brought about by any breach of
fiduciary duty in connection with the 1995 stock purchase transaction.
Accordingly, the Court finds in favor of Defendants U.S. Trust, Regal,
and Pellegrino and against Plaintiffs on the breach of fiduciary duty
claims asserted in the First, Third, and Fifth claims for relief asserted
in the First Amended Complaint.*fn1
The Court would be remiss if it did not note the exemplary quality of
the legal representation of all parties in this case. The attorneys were
always completely prepared and presented the evidence in a totally
professional manner. Hundreds of exhibits were admitted and presented
seamlessly. While acting as aggressive advocates on behalf of their
clients, counsel for Plaintiffs and Defendants pursued their advocacy in
a highly civil manner. No trial judge could ask for anything more.
II. FINDINGS OF FACT
Foster & Gallagher. Inc. and Its Employee
Stock Ownership Plan
1. At the time of its incorporation in 1951, F&G specialized in
marketing gifts, housewares and novelty items through direct mail. In
subsequent years, F&G expanded through the acquisition of several
companies and as of December 1995 maintained several operating companies
or "trade styles" including Breck's, Breck Holland, N.V., Spring Hill
Nurseries, Magazine Marketplace, Inc., Magazine Marketplace
Telemarketing, Inc., Mauna Loa Macadamia Nut Company of Hawaii, The
Popcorn Factory, Michigan Bulb Company (which itself consisted of four
separate tradestyles), Stark Brothers Nurseries, Childcraft, and
HearthSong. Several of these companies specialized in marketing
horticultural products, including flower bulbs.
2. In 1995, Foster was Chairman of the Board of Directors of F&G
and was also a Director of Michigan Bulb Company ("MBC"). Foster died on
July 11, 1996, and Ellen D. Foster was the executrix of his estate.
3. Defendant Regal was at all relevant times a shareholder and
executive of F&G. In 1995, he was Vice Chairman of the Board of
Directors of F&G and a Director of MBC.
4. Defendant Pellegrino was at all relevant times a shareholder and
executive of F&G. In 1995, Pellegrino was President of F&G, as
well as a Director of both F&G and MBC.
5. On January 1, 1988, F&G established an ESOP that operated as a
defined contribution, leveraged employee stock ownership plan, covering
substantially all employees of F&G and its subsidiaries. F&G was
the sponsor of the ESOP.
6. The ESOP initially purchased 3,587,573 shares of F&G stock from
certain shareholders, including Foster and Regal, using a $3 million cash
contribution from F&G and $47 million from the proceeds of a loan
through F&G. All ESOP contributions were to be controlled by a trustee
"acting under a Trust which forms a part of the Plan."
7. LaSalle National Bank ("LaSalle Bank") was the original trustee of
the ESOP. LaSalle Bank was replaced as trustee of the ESOP on March 3,
1989, by Community Bank of Greater Peoria (later known as Magna Bank or
Trust Company ("Magna Bank")). In August 1995, Defendant U.S. Trust was
retained at trustee specifically in conjunction with a proposed purchase
of additional F&G stock by the ESOP ("ESOP II").
8. On December 20, 1995, U.S. Trust was formally appointed as successor
trustee, and Magna Bank was given notice of its removal as trustee of the
ESOP. Upon receiving confirmation of U.S. Trust's acceptance of the
trusteeship, Magna Bank accepted its removal and waived any technical
notice requirements.*fn2 From that point on December 20, 1995, forward,
U.S. Trust was successor trustee and a fiduciary with respect to the
ESOP. In this capacity, U.S. Trust held the plan assets, managed the
assets of the ESOP, made distributions to participants, administered the
payments of interest and principal on certain loans, and made the
decision to consummate the 1995 stock purchase transaction on behalf of
9. Plaintiffs Debra K. Keach and Patricia A. Sage were employees of
F&G and participants in the ESOP.
MBC and Its Sweepstakes
10. In 1992, F&G explored the possibility of acquiring MBC. MBC was
a direct mail marketer of bulbs, plants, and seeds, primarily for home
gardens. MBC performed all of its advertising, mailing, order processing,
warehousing, and shipping from its home office in Grand Rapids, Michigan.
11. MBC had four primary tradestyles: Michigan Bulb, Flower of the
Month, Rockwood Gardens, and Home and Garden Value-Mart. MBC used a
sweepstakes program as part of its direct mail advertising. MBC's
promotions had a "[s]trong sweepstakes orientation."
12. In anticipation of its acquisition of MBC, F&G sent several
employees to MBC's facilities to perform due diligence inquiries intended
to confirm the possibility of synergistic effects, identify areas for
potential improvement, and determine whether and how to integrate MBC
into F&G's existing operations.
13. F&G ultimately purchased MBC in October 1992. Foster, Regal and
Pellegrino were the directors of MBC, which appears to have been a
formality, as there were no board of directors meetings for MBC that were
separate and apart from F&G board meetings.
14. F&G made a number of post-acquisition changes to MBC, including
improved storage facilities, new product development, a renewed focus on
service, and better training of customer service employees. It also hired
a new president, Robert Ostertag ("Ostertag"), and shifted some
experienced personnel from other F&G operations.
15. Following these changes, MBC's customer retention rate increased
from approximately mid-20% retention at the time of the acquisition to a
rate of 30% or more by the beginning of 1995, which was considered to be
within industry norms. MBC's revenues also grew dramatically following
the acquisition, from $68.4 million in 1993 to $91.4 million in 1994, and
$68 million in the first half of 1995.
16. As part of its direct mail marketing, MBC utilized a sweepstakes
program typically consisting of three elements: (a) an "everybody wins"
sweepstakes where everyone that returned an entry wins a "special prize"
regardless of whether or not they placed an order; (b) a base sweepstakes
that awarded a total of $250,000 annually and had a $100,000 grand prize;
and (c) a color-coded or pre-selected giveaway in which the winners were
determined before the mailing. For 1995, MBC's "special prizes" were a
package of flower seeds or a gift certificate for a free family portrait
from Olan Mills.
17. MBC's combination Order Form and Prize Validation and Claim Form
included a "Prizewinner Release" to be initialed by the "verified First
Round Winner" giving MBC permission to use the winner's name and likeness
for advertising and publicity purposes should the winner receive the
$100,000.00 Grand Prize. Immediately below the Prize Validation and Claim
Form was MBC's Order Form. The back of the Prize Validation and Claim
Form and Order Form included an "URGENT MESSAGE" from the "PRIZE
DISTRIBUTION CENTER," which stated in part: "THE LAWS OF PROBABILITY ARE
ON YOUR SIDE if you have been issued a pre-selected winning color-coded
18. In 1991 MBC retained an attorney, John Awerdick, a specialist in
advertising law with a focus on sweepstakes, to review its mailings for
the law. Awerdick interacted directly with Thomas Stumb ("Stumb"),
MBC's chief financial officer, who was responsible for dealing with
outside counsel and regulatory agencies.
19. Awerdick initially advised MBC that the laws of nine states could
be read to bar the "everybody wins" approach used by MBC, that
sweepstakes were increasingly being regulated by state prize and gift
laws, and that risk assessment was difficult because the laws were not
being heavily enforced. He also advised MBC that certain states required
disclosure of the odds of winning or of prize value and regulated the use
of "specially selected" and similar language. Awerdick subsequently
assisted MBC in responding to inquiries from regulatory agencies and
consumers concerning its sweepstakes promotions.
20. By the spring of 1992, MBC had established a procedure for
developing new promotions in which each proposed promotion was reviewed
by Awerdick at two different stages. If Awerdick advised MBC not to send
a particular mailing out for some reason, the mailing was not sent out.
21. In connection with the due diligence of MBC by F&G in 1992,
Pellegrino knew that "some states didn't like" the "everybody wins"
sweepstakes used by MBC, and were discussing eliminating "everybody wins"
sweepstakes. Pellegrino understood an "everybody wins" sweepstakes to
include sweepstakes mailings where everyone that returns an entry wins a
prize. Nonetheless, F&G "did not see anything that disturbed" them
with respect to MBC's sweepstakes, including the "everybody wins"
22. In August 1992, Regal received a memorandum in connection with
F&G's due diligence of MBC that listed "Increased state regulation of
sweepstakes C first
round winner" as a global concern to MBC's business. Regal explained this
global concern as meaning that each state had different sweepstakes rules
and, if those rules varied from state to state, MBC could have difficulty
making mailings on a cost efficient basis, such that increased state
regulation on what could be put in a catalogue on sweepstakes could have
an effect on MBC's business.
23. MBC's dependency on sweepstakes was also considered a possible
"threat" to its business. According to Regal, this meant that changes in
state laws could prevent MBC from mailing its sweepstakes promotions into
24. In August 1993, Awerdick advised MBC about pending sweepstakes
legislation in Illinois, and advised that the Illinois legislation was
not the only new law in the area nor the last that would pass. Awerdick
had already advised MBC about new laws in Georgia and Arkansas, and
promised to update MBC on legislation in Minnesota, Nebraska, Wyoming,
Tennessee and perhaps other states which might affect sweepstakes.
25. In a letter dated February 23, 1994, to F&G's accountant, Price
Waterhouse L.L.P., with copies to F&G and MBC representatives, Awerdick
referred to "unasserted claims" and then advised that promotional
sweepstakes were regulated directly or indirectly in all fifty states, as
well as under federal law, and that "[t]rends in the regulation of
sweepstakes are noteworthy." Awerdick's letter went on to state:
Increasingly, states are using consumer protection
laws to regulate sweepstakes further. In particular, a
number of states are regulating some promotions in
which every recipient of a mailing is advised that he
or she is a prize winner. Many of the Company's [MBC
and Flower of the Month Club, Inc.] mailings include
such a statement. Generally, either through statutory
language or as a matter of prosecutorial discretion,
these "gift and prize" laws are being applied against
businesses using "900" telephone numbers, offering
time shares, vacation homes and camp sites,
or requiring attendance at a sales presentation to
receive a prize. I know of no current attempts to
enforce these laws against traditional conventional
direct mail sweepstakes operators. However, the
Company would be required to make fundamental changes
in many of its mailings if a "prize and gift" statute
were applied to the "everybody wins" element of its
promotions. Michigan Bulb's management has been
advised of the risks raised by these state statutes.
Sweepstakes dependency and governmental regulation were not noted
as material risks to MBC either by Awerdick, or in Price Waterhouse's
audited financial statements for that year.
26. Awerdick wrote a similar letter to Price Waterhouse dated February
22, 1995. That letter contained a paragraph substantially similar to the
passage quoted in the foregoing paragraph, except that the February 22,
1995, letter deleted the sentence, "I know of no current attempts to
enforce these laws against traditional conventional direct mail
sweepstakes operators," which had been included in Awerdick's 1994 letter
because by that time, MBC had received a sweepstakes inquiry from the
North Carolina Attorney General. Awerdick also indicated that there was a
trend among states to use consumer protection laws to regulate
sweepstakes, particularly where businesses were using 900 numbers,
offering time shares, vacation homes, camp sites, or required attendance
at a sales presentation to win a prize. Awerdick advised MBC of these
risks, but never advised MBC to stop using "everybody wins" promotions or
warned that any required changes would result in a significant adverse
financial impact for MBC. Again, sweepstakes dependency and governmental
regulation were not noted as material risks to MBC either by Awerdick, or
in Price Waterhouse's audited financial statements for that year.
Attorney General Inquiries
27. MBC, like other mail order companies, regularly received inquiries
from third parties, such as Attorneys General, Better Business Bureaus,
and Action Lines. In fact, MBC received 5,769 inquiries from such third
parties in 1992, 3,269 in 1993, 4,413 in 1994, and 3,326 in 1995.
28. MBC's president, Ostertag, reported to Pellegrino. Pellegrino
talked with Ostertag three to four times a week, and knew of inquiries
from state attorneys general.
29. Dale Fujimoto ("Fujimoto"), MBC's Senior Vice President of
Marketing, testified that these inquiries amounted to less than 1% of the
approximately 17 million promotions that were mailed by MBC during these
time frames and were routinely handled in the normal course of business.
These inquiries were considered to be a routine part of the direct mail
order business and were not viewed as a matter of concern to either MBC
or F&G management.
30. In and before 1995, MBC had responded to inquiries regarding
sweepstakes from the attorneys general of Arkansas, Indiana, Iowa,
Maryland, Michigan, Nebraska, North Carolina and Oregon. Many of those
inquiries involved MBC's "everybody wins" promotions. Other inquiries
involved disclosure of the odds of winning in connection with MBC's
31. Specifically, the inquires received by MBC in and before December
a. Inquiries from the Arkansas Attorney General's
Office in April 1992 and June 1993 regarding the
Arkansas Mail and Telephone Consumer Product
Promotion Fair Practices Act.
b. A December 1, 1994, inquiry from an Assistant
Attorney General with the Consumer Protection
Section of the North Carolina Department of Justice
asserting that various representations in MBC's
mailing were deceptive and that the "everybody
wins" element of MBC's mailing violated North
c. An August 18, 1995, inquiry from the Maryland
Attorney General's office regarding a notification
which gave the impression that the recipient was
the winner of a sweepstakes and attached a copy of
Maryland's Consumer Protection Act which prohibited
d. On September 22, 1995, Awerdick responded to a
consumer complaint from the State of Michigan by
advising Stumb that they "need to discuss the piece
involved too. It is an old one which refuses to die
but may need the assistance of Michigan's most
notable forensic physician (the honorable Dr. K.)."
Stumb understood the reference to "Dr. K" to refer
to Dr. Kevorkian, known as the death doctor. After
a meeting with two representatives of the Michigan
Attorney General's office in June 1996, MBC's Stumb
agreed that that particular solicitation was
"misleading and cannot be defended."
e. An October 4, 1995, inquiry from the Indiana
Attorney General's office, stating that MBC "may
have violated" the state's Promotional Gifts and
Contests Act and requesting that MBC agree to
enter into an Assurance of Voluntary Compliance.
f. On October 11, 1995, the Iowa Department of Justice
wrote to MBC, suggesting that MBC's solicitation
sent to an Iowa consumer did not comply with
Iowa's Prize Notification Law and requesting that
MBC immediately discontinue use of all prohibited
solicitations in Iowa.
g. On December 14, 1995 the State of Nebraska Attorney
General issued a Civil Investigative Demand to
MBC. The demand was received by MBC on December
32. To a casual observer lacking the context that was provided during
the trial, this list of inquiries might well appear ominous, and it might
seem that the officers and directors of F&G were negligent for not
having been more concerned about these inquiries. However, it is
important to note that none of these inquiries ultimately led to any
enforcement action against MBC or otherwise had a material financial
impact or other adverse consequences on MBC. These inquiries were each
resolved without further action after MBC's Attorney Awerdick provided
additional information indicating why MBC believed that its practices
were either exempt from or not in violation of state law. The resolution
of such inquiries was considered to be a routine part of the mail order
33. Defendants' sweepstakes expert Stephen Durchslag ("Durchslag"), an
attorney at a reputable Chicago law firm with many years of experience in
the field, provided credible and unrefuted testimony that while the
inquiries received by MBC in 1995 did need to be addressed, sweepstakes
law experts would not have considered them to have been serious or an
indication that MBC was at risk of substantial regulatory or enforcement
problems. Rather, the receipt of consumer contacts and letters of inquiry
from state attorneys general following up on consumer complaints is par
for the course in the sweepstakes marketing industry, and the frequency
inquiries received was not surprising given the large number of customer
contacts distributed by MBC. Durchslag also testified that the
sweepstakes and regulatory issues that were experienced by MBC prior to
December 20, 1995, were not material at that time and that his answer
would remain the same even if the time frame were expanded to include the
inquiries which were formally resolved by voluntary assurance or
settlement with the states of Michigan, Connecticut, and Vermont in the
years that followed.
34. Plaintiffs offered the expert testimony of Professor Charles Linke
("Linke"), a retired professor of finance and business finance/investment
consultant, that during the course of his engagement for this litigation,
he asked a librarian to perform a computer database search for articles
involving sweepstakes. Several of those articles were admitted into
evidence at trial. Although Linke thought that some reference to
sweepstakes risk should have been included in Houlihan's valuation as
part of an inquiry into whether MBC could sustain its record of profits
over time, he could not say that, given the literature available and
knowledge of MBC's record of profits, F&G management should have
foreseen that the company would fail in 1998. Linke also conceded that
from his review of the literature, it appeared that states were not
trying to eliminate sweepstakes marketing, but rather trying to establish
some regulations to address deceptiveness, and no one in 1995 predicted
the total collapse of the sweepstakes market. Durchslag echoed the
observation that the collapse of the sweepstakes marketing industry that
occurred in 1998 was not foreseeable in 1995.
35. Given the fact that in 1995, experts in the industry did not
foresee the collapse of the sweepstakes marketing industry, it would be
unreasonable to suggest
that F&G's officers and directors should have been able to predict that
the sweepstakes marketing industry would collapse or encounter serious
problems in the foreseeable future.
36. Plaintiffs' experts Linke, Wolski, and James Hitchner ("Hitchner")
suggested that because there were some articles about sweepstakes issues
in newspapers, periodicals, trade journals, everyone involved in the ESOP
II transaction should have known that sweepstakes posed a material risk
to F&G. However, while these articles are certainly part of the
historical mosaic of what the realities were in 1995, many of the
articles did not address the marketing practices used by MBC. Durchslag
noted this distinction in his testimony, describing the news articles as
insignificant to the industry and mostly addressing marketers who were
not actually selling products, telemarketer abuses, and instances of
outright fraud. Defendants' valuation expert, Robert Reilly ("Reilly"),
also performed industry research and noted that the articles in existence
prior to December 20, 1995, were largely from the general press, which he
considered to be less reliable than industry journals, as well as the
fact that many of the articles were not specifically relevant to F&G
or businesses like it.
37. Plaintiffs did not offer expert testimony on the important point of
a contemporaneous observation of trends within the sweepstakes marketing
industry or the state of the industry itself in 1995, which is the key
inquiry here, as the Court must determine what was and was not a material
risk in December 1995, hopefully without simply relying on the distorting
effects of hindsight. Defendants' expert, Durchslag, was the only legal
expert witness presented at trial who was actively involved in the
sweepstakes marketing industry in December 1995 and the preceding
years; he testified to the state of the industry based on his personal
involvement and experience.
38. Durchslag testified that sweepstakes had been a legitimate and
important part of a promotional mix to involve and reach customers since
1890. He indicated that MBC's use of fictional names on customer
communications, which was repeatedly criticized by Plaintiffs at trial,
was an accepted practice in the industry to avoid privacy intrusions for
the customer service representatives and provide continuity over time.
39. Unlike Plaintiffs' experts, Durchslag was truly an expert in the
field of sweepstakes marketing at the time of the 1995 transaction and
was not testifying based on recent research attempting to recreate the
state of the industry with the benefit of hindsight. Consequently, his
testimony was more credible.
40. Given this expert testimony, the Court cannot find that there was
anything about the frequency or nature of customer or third party
inquiries that either caused or should have caused F&G to have been
on notice of a present or future material risk associated with its
sweepstakes marketing. The Court must also conclude that at the time of
the 1995 transaction, there was no material risk to F&G resulting
from either MBC's sweepstakes dependency or government regulation of the
direct mail/sweepstakes marketing industry.
Annual ESOP Valuations by Valuemetrics
41. Valuemetrics, Inc. ("Valuemetrics") performed an annual valuation
of F&G shares for the ESOP every year from 1988 through 1994.
42. Valuemetrics determined that the fair market value of the capital
stock of F&G was $99.7 million on a marketable minority basis as of
December 31, 1992. At that time, MBC was separately valued at $21 million
on a minority basis
43. Valuemetrics determined that the fair market value of the capital
stock of F&G was $117 million on a marketable minority basis as of
December 31, 1993. At that time, MBC was separately valued at $34 million
on a minority basis.
44. Valuemetrics determined that the fair market value of the capital
stock of F&G was $162 million on a marketable minority basis as of
December 31, 1994. According to Valuemetrics, F&G had increased in
value by about $45 million, or 38%, in 1994. Although Valuemetrics did
not separately value MBC, MBC's projected operating income was about 50%
of F&G's total projected operating income for 1994 through 1999.
45. In 1995, MBC accounted for about 61% of F&G's total earnings.
The 1995 Stock Purchase Transaction
46. Foster learned in the summer of 1994 that he was dying and took
steps to get his estate in order and to provide for the transition of the
management of F&G. 47. Valuemetrics, which had been retained as a
financial advisor with the 1988 ESOP and had since conducted the year-end
stock valuations for Magna Bank as the ESOP trustee, was asked to
determine what options were available for liquidating a portion of Foster
and Regal's stock, as well as possible strategies for ownership
transition. Valuemetrics analyzed several alternatives, including
bringing in a new shareholder to purchase shares from Foster and Regal or
selling the company to a strategic third party buyer, an initial public
offering ("IPO"), and a second ESOP. The
stated goals of Foster and Regal were to provide at least 50% immediate
liquidity of their F&G stock and to maximize the present value of their
after-tax proceeds received from the sale of the stock and their residual
shares of F&G stock. The stated goals of F&G were to maintain adequate
operating cash flows to allow the pursuit of other acquisitions and
investment opportunities, to broaden the ownership of its stock to its
employees, and to provide sufficient financial incentives for key
employees to successfully manage the company. Valuemetrics estimated that
F&G could take on an additional $75 million in debt and still maintain
its working capital requirements.
48. Foster expressed a concern that F&G's "present corporate product
lines, and their attendant sales and profits, will not likely make
desirable disclosure fodder" for an IPO but also expressed a desire for
F&G to continue as a viable legacy business in a closely-held, private
company. At trial, Plaintiffs suggested that Foster's comment was an
early explanation of a later effort to conceal information regarding
MBC's sweepstakes marketing practices. However, the credible weight of
testimony established that the comment was an acknowledgement that F&G's
primarily mail-order horticultural business was not glamorous or "sexy"
enough to spark the public interest necessary to make an IPO successful.
49. Valuemetrics recommended the $70 million leveraged ESOP from among
the various alternatives, because it met the most objectives of any
option. The board also concluded that the ESOP transaction was the only
option that would guarantee that Foster & Gallagher as they knew it
would not be liquidated, restructured, or relocated to another part of
the country by a new owner, potentially leaving its employees jobless.
50. In early 1995, Foster, Regal, Pellegrino and others began a series
of meetings to plan ESOP II. In March 1995, Attorney Joseph Z. Sudow
("Sudow"), of Kavanagh, Scully, Sudow, White & Frederick, P.C. (the
"Kavanagh Firm"), who was F&G's corporate attorney, advised Foster
and Regal that for a re-leveraged ESOP II, they should think in terms of
an amount of leverage that would not affect F&G's ability to generate
enough cash to service the debt obligation. Sudow further advised Foster
and Regal that "ERISA generally provides that a fiduciary (which could
include not only the trustee, but officers, directors and control
shareholders) shall discharge his or its duties solely in the interest of
the participants and beneficiaries and for the exclusive purpose of
providing benefits to participants and beneficiaries and for defraying
reasonable expenses of administering the plan. . . .'"
51. For purposes of the ESOP II transaction, Sudow and the Kavanagh
Firm represented Foster and Regal personally. Other counsel, namely
Mayer, Brown & Platt, was retained to represent F&G in the
52. On March 16, 1995, Valuemetrics offered to assist the ESOP
administrative committee and F&G's board of directors in outlining
and reviewing the significant elements of a subsequent sale or sales of
stock to the ESOP. By March 23, 1995, Foster had told Dickes, F&G's
Executive Vice President, to go ahead with the Valuemetrics proposal.
53. In May 1995, Valuemetrics formally issued its ESOP valuation of
F&G as of December 31, 1994, for which all of the substantive work had
been completed prior to the end of 1994. In this valuation, Valuemetrics
determined that the fair market value of F&G capital stock was $162
million on a marketable minority basis.
54. By the time the valuation formally issued, Valuemetrics was also
consulting with F&G about ownership transition strategies and the
expanded use of the ESOP as a means of achieving the desired purchase or
liquification of the stock holdings of the selling shareholders,
including Foster and Regal. Based on the assumption that the shareholders
wanted liquidity in the near term and for F&G to remain healthy and
viable, Valuemetrics concluded that: (1) a large leveraged ESOP ($50-70
million) or a recapitalization would meet those goals; (2) an ESOP of
this size would be able to acquire a significant number of shares but
would not be able to buy all of the remaining shares; (3) the selling
shareholders could take advantage of favorable tax treatment; (4) a
recapitalization would allow the shareholders to sell their entire
interest but would result in capital gains tax; and (5) an initial public
offering ("IPO") of the stock would be less desirable because the market
might restrict the amount of shares the controlling shareholders could
sell as part of the IPO.
55. Given the primary goals of these shareholders, Valuemetrics found a
leveraged ESOP transaction and a recapitalization or sale of F&G to a
strategic buyer to be "far superior" options.
56. Concerned that Magna Bank did not have the necessary expertise and
sophistication to manage the ESOP II transaction or continue as trustee
once the ESOP became the majority shareholder of F&G, in June 1995, the
F&G Board solicited recommendations from Valuemetrics for an experienced
institutional trustee to assist them. Due to the sophistication of the
proposed transaction, Valuemetrics recommended LaSalle Bank, U.S. Trust,
and State Street Bank & Trust as trustees.
57. In 1995, Norman Goldberg ("Goldberg") was the manager of U.S.
Trust's Washington, D.C. office and acted on behalf of its Special
Fiduciary Committee when U.S. Trust served as an institutional trustee
for transactions involving ERISA issues. Prior to joining U.S. Trust,
Goldberg had held several positions relating to fiduciary duties under
ERISA plans, including eight years supervising most of the ERISA
litigation brought by the Secretary of Labor. Only a few firms and
investment brokers provide this kind of specialized service.
58. In late June 1995, Goldberg sent Sudow a letter and copies of
articles that described U.S. Trust's services. According to the materials
provided by Goldberg:
a. Fiduciaries of employee benefit plans that acquire
and hold employer securities are required to make
investment decisions that are often financially
complex and are made more difficult by the
conflicts typically inherent in such transactions
by virtue of management and/or other "insider"
b. The "standards under which independent fiduciaries
are expected to act are in many respects complex,
requiring the close scrutiny of experienced
professionals who are involved in the difficult
business of investment decisions on a day-to-day
c. ERISA generally holds fiduciaries to a higher
standard than imposed on fiduciaries under the
common law, and the standard of scrutiny is at its
highest level when a fiduciary is acting on behalf
of a leveraged ESOP.
d. An independent fiduciary acting on behalf of an
employee benefit plan in a transaction involving
employer securities should perform a diligent and
review of all relevant facts and also assure that
all information on which judgments will be based is
e. The extent to which a fiduciary may properly rely
on the opinion of a financial advisor depends on
whether material information exists that would
render the opinion invalid or unreliable, and on
the reasonableness of forecasts on which the
valuation is based.
59. In June 27, 1995, Lyle T. Dickes ("Dickes"), F&G's Executive Vice
President, distributed an Interoffice Memo to Regal, Foster, Pellegrino
and others about the discussion agenda for "Norman Goldberg's-U.S. Trust
60. On June 28 and 29, 1995, Goldberg traveled to Peoria and met with
Foster, Regal and others in F&G's board room. Goldberg described the
meeting as "a fairly expansive discussion." Goldberg engaged "in a
lengthy conversation about Foster and Gallagher, its history, the reasons
for the transaction, the nature of the business, their expectations" to
get a clear understanding of the company. MBC was described as a
"meaningful part of the company," and Goldberg understood where MBC fit
into F&G's tradestyles and that it had a sweepstakes component.
F&G management, including Regal and Pellegrino, also interviewed
Goldberg about his and U.S. Trust's experience with ESOP and ERISA
61. In a telephone call on June 30, 1995, Goldberg advised Dickes that
U.S. Trust's fee for the proposed transaction would be $75,000. Goldberg
also advised that the expected range of cost for legal fees in connection
with the transaction would be from $40,000 to $60,000.
62. By July 5, 1995, F&G had reached an agreement with U.S. Trust
for its fee schedule regarding the contemplated ESOP transaction, which
included fees for the transactional decision and a three-month period of
follow-up services as the independent fiduciary.
63. In July 1995, Valuemetrics issued another valuation, reporting that
as of July 20, 1995, the value of F&G stock on a control basis was
64. In July 1995, Sudow proposed to Foster, Regal and Pellegrino "that
Pelle[grino], Lyle [Dickes], Fred [Stuber, F&G's Senior Vice President
of Finance and Secretary] and Mike [Norbutas, F&G's Treasurer] be out in
front as the committee that carries out the instruction from the Board
[implementing ESOP II] (so that there is no apparent conflict of interest
on the part of Tom [Foster] and Mel [Regal])." Regal understood that
because of the conflict of interest referred to by Sudow, Regal and
Foster should not be part of the due diligence if the ESOP II transaction
65. On August 28, 1995, U.S. Trust entered into an engagement letter
with Sonnenschein, Nath & Rosenthal (the "Sonnenschein Firm") to
confirm the terms and conditions on which the firm would represent U.S.
Trust with respect to the proposed transaction.
66. Goldberg met with F&G representatives in Chicago on August 28,
1995, to further discuss the proposed transaction. On August 30, 1995,
Goldberg wrote to Regal to confirm the understanding and agreement
between F&G and U.S. Trust "with respect to certain professional
services to be provided by U.S. Trust to the Foster & Gallagher, Inc.
Employee Stock Ownership Plan and related Trust established by the
Company (collectively, the `Plan')." Among other things, the letter
1. Foster and Gallagher, Inc. (the "Company") desires
to retain U.S. Trust Company of California, N.A.
("U.S. Trust") as the independent trustee of the
Foster & Gallagher, Inc. Employee Stock Ownership
Plan (the "ESOP") in conjunction with a possible
purchase of Company stock by the ESOP and related
actions (hereinafter collectively referred to as
the "Proposed Transaction".
2. It is understood that in exercising its
responsibilities pursuant to this Agreement, U.S.
Trust will rely on the written opinion of the
Plan's independent financial advisor that (i) the
consideration to be paid by the Plan is not in
excess of "adequate consideration" within the
meaning of Section 3(18) of ERISA; (ii) the
Proposed Transaction is fair and reasonable to the
Plan from a financial point of view; and (iii) the
terms and conditions of the acquisition loan are
fair and reasonable to the ESOP from a financial
point of view (the "Financial Opinion"). If for any
reason the Financial Advisor does not provide the
Financial Opinion in form satisfactory to U.S.
Trust at or prior to the Closing, U.S. Trust will
not be required to make a final determination
whether to participate in the Proposed
Transaction. Although the fees and expenses
incurred by U.S. Trust pursuant to this Agreement
will be paid by the Company, it is understood that
U.S. Trust's sole professional responsibilities are
to the Plan and the Plan Participants.
3. The Company will furnish or cause to be furnished
to U.S. Trust or its Financial Advisor all current
and historical financial and other information
regarding the Company requested by U.S. Trust to
perform its obligations hereunder. The Company
represents that the information which it provides
will be accurate and complete in all material
respects to the best of its officers' knowledge
and it is understood that U.S. Trust will rely on
the accuracy of that representation to carry out
its responsibilities pursuant to this Agreement.
The engagement letter also included a provision indemnifying U.S. Trust
from liability unless U.S. Trust was found to have acted negligently. On
August 31, 1995, Dickes signed the engagement letter with U.S. Trust on
behalf of F&G.
67. Regal had met with representatives of Houlihan, Lokey, Howard &
Zukin ("Houlihan") in June 1995. On July 10, 1995, before U.S. Trust had
been engaged to act in connection with the 1995 ESOP II transaction,
Houlihan wrote to Regal to confirm that Houlihan would provide a fairness
opinion for the proposed transaction for a fee of $35,000. The letter
went on to say that when the transaction was defined and the trustee
determined, Houlihan would send an engagement letter.
68. In late September 1995, U.S. Trust entered into an engagement
letter with Houlihan. Houlihan was engaged to provide assistance in
evaluating the transaction from a financial perspective and to render a
written opinion to U.S. Trust as to whether the proposed stock
transaction was fair to the ESOP from a financial point of view for a fee
of $35,000. The engagement letter provided that although Houlihan would
report solely to U.S. Trust, F&G would pay Houlihan's fees and
expenses. Further, Houlihan would use, rely on, and assume the accuracy
of, "without independent verification, data, material, financial
forecasts and projections and other information with respect to the
Company [F&G] and its agents, counsel, employees and representative[S]."
There is no claim in this case that Houlihan was in any way unqualified
to serve as the financial advisor to U.S. Trust, and it is undisputed
that Regal and Pellegrino understood that Houlihan was a nationally
recognized financial advisor with substantial ESOP expertise.
69. On September 30, 1995, Valuemetrics issued its first transaction
memorandum to the F&G board of directors describing a proposed offer to
sell 2,916,667 shares to the ESOP at $24.00 per share. Valuemetrics noted
that the memorandum included certain statements, including projections,
with respect to the anticipated future performance of F&G and cautioned
that: (1) such statements were based on various estimates and assumptions
by F&G, which estimates and assumptions might or might not prove to be
correct; (2) although the projections contained therein had been prepared
with significant good faith input from F&G's management, such
projections involved significant elements of subjective judgment and
analysis and would be materially different if different estimates and
assumptions were employed; and (3) no representation was made as to the
accuracy of any such
statements, and there could be no assurance that the projected results
would be obtained.
70. Pellegrino provided background information to Valuemetrics, and
approved "top line" financial information provided to Valuemetrics.
Pellegrino reviewed the projections with Regal, and Foster also looked at
the projections. Regal reviewed the projections, and understood that
Valuemetrics, U.S. Trust and Houlihan were relying on the projections
provided by F&G management.
71. The ESOP II transaction as initially proposed can be summarized as
follows: (1) F&G's board of directors would authorize the conversion of
the current Executive Incentive Plan ("EIP") from a book value basis to a
market value basis, which would create a significant income tax benefit
to F&G; (2) F&G's management employees would have the opportunity to
exercise 527,141 EIP options at an average exercise price of $4.60 per
share; (3) of the 2,916,667 total shares offered to the ESOP, 1,790,243
shares would be offered on a pro-rata basis from Foster and Regal, and
1,126,424 shares would be offered by management, either through the sale
of existing shares or through the exercise of options granted as part of
the EIP; and (4) those employees who sold shares to the ESOP would have an
opportunity to purchase, on a pro-rata basis, 626,858 newly issued,
restricted shares at market value. Following this transaction, the ESOP
would have a majority ownership interest in F&G.
72. On October 6, 1995, Regal sent a confidential interoffice memo to
Foster, Pellegrino and others, advising that on Tuesday, October 17,
1995, Goldberg and Michael Shea ("Shea") of U.S. Trust and Martin Sarafa
("Sarafa") and Todd Strassman ("Strassman") of Houlihan would be at
F&G to perform due diligence regarding the
ESOP II transaction. Regal advised that Goldberg, Shea, Sarafa and
Strassman would want to spend about forty-five minutes with the heads of
the various functional areas, and asked the recipients to keep their time
flexible that day.
73. On October 17, 1995, Goldberg, Shea, Sarafa, and Strassman met with
executives of F&G to perform due diligence regarding the ESOP
transaction. They met with Regal, Pellegrino, Frederick Stuber
("Stuber"), Dickes, Sudow, Ostertag, and others a various times for most
of the day. Regal, Pellegrino, Dickes, Ostertag, and Stuber each sold
shares to the ESOP on December 20, 1995.
74. Ostertag, who was then President and CEO of MBC and later became
President and CEO of F&G, was involved in the meetings with Houlihan
and U.S. Trust on October 17, 1995. Ostertag gave an overview of MBC,
including an explanation of changes that he had made since becoming
president in 1992 and strategies for the future of the company. He also
discussed some risks to the business, including increased postage rates,
Department of Agriculture regulations, and competition from Wal-Mart and
other mass retailers entering the horticultural market.
75. Goldberg recalls a discussion that day with Ostertag involving MBC
and its sweepstakes marketing. Ostertag discussed "the success and
general role that sweepstakes played in" MBC. Ostertag also discussed
that MBC's average customer was over fifty years of age, with an average
income of about $35,000, with a high school education, and "tied to
sweepstakes." Ostertag described MBC's business as marketing driven, in
comparison to the other F&G businesses which were merchandise driven,
and noted MBC's desire to develop other promotions as part of an overall
strategy to diversify and broaden its customer base.
76. MBC's mailings to its "house file" of past customers had increased
from twenty to twenty-six to thirty-four promotions per year. Ostertag
told Goldberg that MBC had "started ramping up circulation" in 1995.
Ostertag related that from January to June 1996, MBC expected to mail 17
million sweepstakes pieces. MBC was beginning to try to sell more and
different products, like jewelry and comforters, to its house file.
77. Ostertag was asked about risks associated with MBC's business and
responded that MBC's management does not put the business at risk.
Ostertag said that retail competitors like Wal-Mart and K-Mart were a
risk but that those retail competitors could not compete, that postage
factors were a small problem, and that MBC needed new names for mailing
78. At the October 17, 1995, meeting, Ostertag did not identify
government regulation of sweepstakes as a risk. Nor did any other F&G
representative identify either dependency on sweeps or possible
government regulation of sweepstakes as a risk to MBC during the October
17, 1995 meetings. There was no discussion that MBC's dependency on
sweepstakes was a negative. There was no discussion about any pending
attorney general investigations into MBC's sweepstakes marketing, and no
discussion regarding state laws that regulated MBC's sweepstakes
marketing. F&G representatives did not give Houlihan any reason to
believe that there were any negative issues relating to MBC's
79. During the October 17, 1995, meeting, Regal told Sarafa and
Strassman that the key to MBC was sweepstakes, that sweepstakes would be
the key to new product growth, and that normally sweepstakes do not
generate loyal customers. The
gist of Regal's comments was that MBC would continue to use sweepstakes
and that sweepstakes would be one of the keys to driving the future
growth of MBC.
80. Credible testimony from F&G officers indicated that state
regulation and sweepstakes issues were not considered to be material at
any time prior to the ESOP II transaction.
81. While exact percentages of revenue may not have been known, the
U.S. Trust team was well-aware that MBC was a major profit center for
F&G and that MBC used sweepstakes marketing as its primary sales
82. During this meeting, Shea recalls being provided with a number of
MBC catalogs, but it was more for him and Goldberg to see the various
types of catalogs and offerings so they could better understand the
overall business. Shea does not recall anything specifically about the
sweepstakes solicitations he saw that day.
83. Ostertag took Shea on a tour of MBC's facilities in Grand Rapids on
October 18, 1995. Ostertag testified that Fujimoto, Stumb, and Dave
Grimm, MBC's senior vice presidents, accompanied them on the tour. The
tours that MBC provided typically included the mail room, customer
service, and data entry, as well as an area in which the creative
department was located. Ostertag does not remember any discussions with
Shea on October 18, 1995, regarding sweepstakes, and does not recall Shea
asking to review any of MBC's files.
84. Shea does not specifically recall the individuals he met with in
Grand Rapids on October 18, 1995. He does recall receiving an explanation
of how one organizes a catalog, but does not specifically recall anything
else about the meetings in Grand Rapids. Shea does not recall any
discussions on October 17 or 18, 1995,
regarding any pending regulatory investigations into MBC's sweepstakes
marketing or the number of customer complaints that MBC received with
respect to sweepstakes marketing.
85. On the record presented at trial, the Court cannot find that
Foster, Regal, or Pellegrino attempted to conceal information or make
less than full disclosure to the U.S. Trust team either in connection
with the October 1995 meeting or at any other time leading up to the
transaction. The evidence indicated that Regal and other F&G officers
directed F&G employees to provide all information requested by the
U.S. Trust team, and they were never informed that the U.S. Trust team
had been denied access to any information or had met with any resistance.
86. During roughly the same time frame, B.A. Securities, a subsidiary
of Bank of America corporation, conducted its own diligence of F&G and
issued a private placement memorandum for potential lenders in the
prospective ESOP transaction. The memorandum stated that F&G intended to
issue a $70 million loan to the ESOP for the purpose of financing the
ESOP's purchase of stock from existing shareholders and sought a
corresponding loan from institutional lenders. Although the memorandum
stated that F&G was subject to Federal Trade Commission regulations
governing advertising and trade practices, it did not identify
sweepstakes as an inherently risky promotional tool or identify any legal
or regulatory sweepstakes risk. By November 20, 1995, BA Securities had
successfully located four institutional lenders, including two lenders
from the 1988 ESOP transaction, who, in combination, were willing to loan
F&G the requested $70 million on favorable terms (e.g., no collateral
and at a low interest rate) that were acceptable to F&G.
87. Ostertag had mentioned during the meeting with U.S. Trust and
Houlihan that MBC did have a strategic plan document that had been
prepared in August 1995, but Shea and Goldberg did not review any MBC
strategic plans during that meeting. Rather, some time between the
meeting and the closing of the transaction, Goldberg and Shea received
MBC's 1996-1998 strategic plan. Both Sarafa and Strassman also received
and reviewed MBC's 1996-1998 strategic plan.
88. MBC's 1996-1998 strategic plan included prioritized lists of
threats for each of MBC's business units. Those threats included
governmental regulation and dependency on sweepstakes, among others.
Testimony from F&G and MBC officers at trial consistently and credibly
indicated that the reference to governmental regulation was not a
specific concern with respect to sweepstakes but rather involved the
regulatory oversight applicable to MBC as a direct mail marketer of
horticultural products and the effect that increased privacy regulations
would have on MBC's ability to use mailing lists and its customer
database in particular. Dependency on sweepstakes was explained as a
general need to diversity MBC's marketing strategies to reach a broader
customer base. Sarafa and Goldberg both testified that they had the same
understanding of these "threats" based on the presentations given on
October 17, 1995.
89. A comparison of MBC's 1996-1998 strategic plan to previous planning
documents reveals that governmental regulation and dependency on
sweepstakes had moved several places down on the prioritized list of
threats, having been replaced by concerns about increasing paper and
postage costs. From 1993 to 1995, when the 1996-1998 strategic plan was
drafted, governmental regulation had dropped from
number three to number four in priority, while dependency on sweepstakes
had plummeted from number one in priority to number five.
90. After they received and reviewed MBC's strategic plan, Sarafa and
Strassman did not ask anyone what the threat of "governmental regulation"
meant, because Sarafa understood that the threat of "governmental
regulation" was primarily related to privacy, and did not have any
understanding it included sweepstakes concerns.
91. Goldberg would have seen MBC's 1996-1998 strategic plan and would
probably have read it through before December 20, 1995. Goldberg
understood the threat of governmental regulation to refer to privacy
92. Shea did not have any discussions with anyone from F&G on or
before December 20, 1995 regarding the governmental regulation or
dependency on sweepstakes threats mentioned in MBC's strategic plan.
93. On October 19, 1995, Goldberg contacted Dickes and informed him
that both U.S. Trust and Houlihan were skeptical of the $24.00 share
price derived by Valuemetrics and requested that any due diligence
material sent to Houlihan also be sent to U.S. Trust.
94. After assimilating the information received from F&G into its
analysis, Houlihan presented U.S. Trust with a quantitative analysis of
F&G's financials versus the offer price of $24.00 per share. As was
its normal practice, U.S. Trust did not disclose this quantitative
analysis to any F&G shareholder, so as not to impair its bargaining
position. After reviewing Houlihan's quantitative analysis, U.S. Trust
determined that Valuemetrics' analysis was optimistic in certain respects
Houlihan to prepare a new analysis which reflected a lower valuation
range for the shares. For the same reasons, U.S. Trust also did not
provide a copy of this new analysis to any F&G shareholder.
95. On October 26, 1995, Valuemetrics issued an Analysis of Value for
the ESOP purchase in which it concluded that the value of F&G as of
October 24, 1995, ranged from $298.5 to $311.4 million on a marketable
control basis. Valuemetrics' analysis did not take into account any risk
associated with MBC's sweepstakes marketing.
96. At a meeting on October 26-27, 1995, the F&G board adopted a
resolution approving the concept for the proposed $70 million ESOP II
transaction and authorizing the officers of F&G to take all steps
necessary and proper to bring about the completion of the transaction
with such changes as the F&G's executive committee might deem necessary
and proper and final approval of F&G's board as to the price to be paid
to the selling shareholders by the ESOP trust. The members of F&G's
executive committee, which consisted of Foster, Regal, and Pellegrino,
were authorized to approve changes to the proposal.
97. At the same meeting, F&G's board was advised that MBC had
received three new sweepstakes inquiries from Indiana, Iowa and Maryland
in October 1995. Again, these were seen as routine inquiries and not a
reason for concern.
98. Magazine Marketplace, Inc. ("MMI") was F&G's magazine subscription
agency that marketed subscriptions through direct mail using a $7 million
top prize sweepstakes as its primary promotional tool. On November 2,
1995, F&G announced the closure of MMI, which had been contemplated for
some period of time. Although a
memo announcing the closure made reference to "changes in the
stampsheet/sweepstakes business" having "a very negative effect on the
magazine agency business," the evidence at trial established that the
closing was largely due to MMI's inability to profitably compete in the
stampsheet business and the unavailability of names for future mailing
99. During the due diligence for the ESOP II transaction, Goldberg,
Shea, Sarafa, and Strassman were all aware that MMI was being closed.
100. In conducting their review of the proposed transaction, Houlihan
and U.S. Trust considered F&G's ability to service the $70 million
corporate debt created to finance the 1995 ESOP transaction and the
effect of that debt on the value of F&G stock. Houlihan and U.S.
Trust concluded that F&G would remain viable and be able to service
101. Defendants' expert James Ahstrom, a former investment banker who
specialized in leveraged ESOP transactions, testified that he applied
standard measures used in the investment community for determining a
company's ability to service debt to F&G's financial data at the time
of the transaction and determined that those measures indicated that
F&G would be fully capable of servicing the additional debt incurred
in the 1995 ESOP transaction.
102. No expert testimony challenging the conclusions reached by
Houlihan, U.S. Trust, or Ahstrom with respect to F&G's ability to
service its debt following the 1995 ESOP transaction was presented at
103. Price negotiations involving F&G, U.S. Trust, Valuemetrics,
and Houlihan continued during the month of November 1995. U.S. Trust
communicated to F&G that
its valuation range was below the $24.00 offer price, and a conference
call was arranged for November 7, 1995, to discuss the differences in the
two valuation analyses.
104. Despite Valuemetrics' efforts to persuade U.S. Trust of the merits
of its valuation, U.S. Trust reiterated to some members of F&G
management in a subsequent conference call that it was still unconvinced
that the $24.00 valuation was appropriate. In order to allow some room
for negotiation, U.S. Trust suggested a share price of $18.50, which was
at or near the low end of the Houlihan's value range. U.S. Trust believed
this to be a conservative price that would allow some negotiation leeway
before approaching the $19.81 per share midpoint of Houlihan's estimated
fair market value.
105. Foster and Regal were extremely unhappy with U.S. Trust's offer.
They summarily rejected the $18.50 offer price and negotiations broke
off. Because of the disparity between the price that U.S. Trust was
willing to approve and the price the selling shareholders were willing to
accept, serious doubt existed as to whether the transaction would
actually go forward.
106. Several days later, talks resumed and by November 29, 1995, the
parties tentatively agreed to a price of $19.50 per share subject to
further due diligence by U.S. Trust and the completion of appropriate
documentation. Although the selling shareholders did not know it at the
time, this $19.50 share price was less than the midpoint of the value
range determined by Houlihan for the F&G shares.
107. The $19.50 purchase price represented a considerable increase in
value over the $8.57 per share that the ESOP's appraiser determined to be
the fair market
value of F&G shares on a marketable minority interest basis as of
year-end 1992. However, Defendants provided expert testimony at trial by
Ahstrom who determined that the increase from the stock value on a
minority basis at year-end 1992 to the agreed purchase price of $19.50
per share valued on a control interest basis in late 1995 was roughly
proportionate to the increase in several measures of financial
performance, including adjusted pretax unleveraged income. The
contemporary analyses by Valuemetrics and the retrospective valuation by
Defendants' valuation expert Reilly, whose firm performs approximately
400-500 ESOP appraisals annually, also supported the fairness of the
108. On November 29, 1995, U.S. Trust announced that it was willing to
recommend that the ESOP purchase a controlling block of F&G shares at
$19.50 per share.
109. On November 29, 1995, F&G's board of directors passed a
resolution authorizing the amendment and restatement of the F&G ESOP and
Trust and directing that Magna Bank be removed as trustee of the ESOP and
that U.S. Trust be appointed as successor trustee. The resolution
authorized each of the company's officers to notify Magna Bank of its
removal and of the appointment of U.S. Trust as its successor and also
authorized F&G's executive committee to proceed with the ESOP
transaction at a price of $19.50 per share.
110. In a letter authored by Regal on behalf of F&G and dated
December 4, 1995, F&G notified Magna Bank that it was being removed
as trustee of the ESOP "subject to our providing you with satisfactory
written evidence of the appointment of a
successor and of the successor trustee's acceptance of the trusteeship."
Magna Bank acknowledged its receipt of the removal letter on December 6,
111. Regal also authored a letter dated December 4, 1995, on behalf of
F&G, informing U.S. Trust that it was being appointed as successor
trustee of the ESOP and asking U.S. Trust to accept the appointment in
writing. However, U.S. Trust's special fiduciary committee did not
formally accept the ESOP custodial account until it met on December 19,
112. Valuemetrics issued a second transaction memorandum on December
7, 1995, that indicated that the ESOP II transaction would involve the
transfer of 3,589,743 shares at $19.50 per share price. This was a
greater number of shares than was anticipated in Valuemetrics' first
transaction memorandum and would result in the ESOP holding a larger
ownership interest in F&G. The memorandum was prepared from information
furnished by F&G and advised that "[t]he Trustee should perform its own
independent investigation of the Company." "The information contained in
the Memorandum does not purport to present a complete picture of the
business or prospects of F&G or other risks inherent in any equity
investment in the Company. Neither the Company nor any of its advisors
makes any representation or warranty as to the accuracy or completeness
of this Memorandum."
113. The December 7, 1995 transaction memorandum further stated:
This Memorandum includes certain statements, including
projections, with respect to the anticipated future
performance of the Company. Such statements are based
on various estimates and assumptions by the Company,
which estimates and assumptions may or may not prove
to be correct. Although the projections contained
herein have been prepared with significant input from
the Company's management in good faith, such
projections involve significant elements of subjective
judgment and analysis and would be materially
different if different estimates and assumptions were
employed. No representation is made
as to the accuracy of any such statements, and there
can be no assurance that the projected results will be
114. Pellegrino provided the "top line" sales projections to
Valuemetrics, after reviewing the projections with Regal. Foster also
reviewed the projections. These three individuals collectively received
about $50 million from the ESOP in the December 1995 transaction: Foster
received $33,120,789.00; Regal received $13,414,284.00; and Pellegrino
received $4,126,648.50. However, to say that Pellegrino received
$4,126,648.50 on December 20, 1995, is somewhat misleading, as the record
reflects that he reinvested a substantial portion of the proceeds in more
shares of F&G stock. Pellegrino testified that after paying taxes on the
sale of his shares and reinvesting in additional shares, the amount of
cash left over was relatively small.
115. The December 7, 1995, transaction memorandum projected that MBC
would provide almost fifty percent of F&G's income from 1995 to 2000.
December 1995 Legal Due Diligence
116. The Sonnenschein Firm acted as counsel for U.S. Trust in the
December 1995 ESOP transaction and was retained to perform legal due
diligence, as well as to prepare the documentation for the transaction.
In light of the uncertainty as to whether the ESOP II transaction would
proceed, U.S. Trust had requested the Sonnenschein Firm "not to get into
heavy levels of due diligence" until late November or early December
1995. Accordingly, as of late November or early December 1995,
Sonnenschein "literally had to do all of the diligence."
117. There is no claim that Sonnenschein was not qualified to serve as
U.S. Trust's legal advisor, and it is undisputed that Regal and
Pellegrino understood that the Sonnenschein Firm was nationally
recognized as having substantial ESOP expertise.
118. The billing partner in the Sonnenschein Firm was responsible for
pulling the teams together that did the work and assuring that a total
finished product was delivered. A core set of seven attorneys was
assigned to review the 1995 ESOP transaction. These attorneys were
divided into three teams: ERISA/IRS compliance; corporate; and
lending/financial. According to the billing partner, the due diligence
conducted by the corporate team was to be the type of diligence in which
an investor investing in the same amount and type of stock investment
would normally engage. In other words, the corporate team was to engage
in the same level of due diligence that a normal buyer, be it a plan or
not a plan, would have engaged in before it borrowed money and purchased
119. On December 12, 1995, the Sonnenschein Firm faxed a Legal Document
Review Memorandum to the Kavanagh Firm requesting certain documents to be
provided for review. Among the documents requested were copies of any
significant correspondence with any regulatory agencies.
120. Attorney Karen Stumpe ("Stumpe") from the Kavanagh Firm testified
that she probably reviewed the files in her documents to look for
responsive documents and discussed the requests with Stephen Bartley
("Bartley"), F&G's Corporate Controller in 1995 who subsequently became
Vice President of Finance, to make sure that he understood what was being
requested. However, she did not recall having provided documents in
response to the inquiry and did not review F&G's production to the
Sonnenschein Firm. She did not recall the specifics of any conversations
that she may have had with anyone from the Sonnenschein Firm, nor did she
recall having requested
MBC to send documents to the Sonnenschein Firm or asking anyone at
F&G to assemble documents from MBC to send to the Sonnenschein Firm.
121. Sonnenschein also conducted Lexis document searches to determine
if there were any unreported judgments or pending lawsuits involving
F&G or its subsidiaries and UCC searches to look for outstanding
122. On December 13, 1995, an associate in the Sonnenschein Firm first
heard of F&G and the U.S. Trust transaction when he was given a memo and
advised by a partner in the firm's corporate department that he "may be
asked to do some due diligence relating to the company." The associate
had taken the Illinois bar examination in the summer of 1994 and had
started working at the Sonnenschein Firm in September 1994 in the
securities, corporate and tax department. He understood that the purpose
of the legal due diligence was to establish that there were no
significant legal impediments to the transaction and to provide U.S.
Trust with a basis for having exercised reasonable care in its fiduciary
duty in analyzing the transaction. The associate was advised that other
law firms representing B.A. Securities and the lenders for the ESOP II
transaction had already conducted legal due diligence relative to the
transaction, and that the Sonnenschein Firm was to provide supplementary
legal due diligence to assure that there were not any surprises.
123. At about 9:30 p.m. on December 13, 1995, the associate received a
call at home from a partner in the Sonnenschein Firm indicating that he
would need to go to Peoria the next day to do due diligence because "the
transaction was on an expedited basis."
124. After he arrived at F&G in Peoria on December 14, 1995, the
associate went over "each and every item on the due diligence request
list with Mr. Bartley." The associate was provided full access to F&G's
records, including materials that had been provided to directors in
connection with F&G's quarterly board meetings. He reviewed the board
books that the directors received at these meetings "for a number of
125. Regal and Pellegrino were copied on the due diligence request list
and testified that they instructed F&G officers and employees to
cooperate fully with the due diligence efforts and to provide any
requested information. They both further testified that they were never
informed that F&G's production had been deficient in any way. That
testimony was credible. There is no evidence in the record establishing
that Foster was copied on the due diligence request list.
126. Bartley testified that in addition to providing internal
documents, he requested documents from outside sources, including audit
response letters from F&G's independent auditor, which were then
forwarded to the Sonnenschein firm. Among those audit response letters
were letters from Attorney Awerdick notifying Price Waterhouse of the
North Carolina inquiry and discussing the possible impact of a change in
the regulatory environment on MBC's sweepstakes promotions.
127. When asked who at F&G was responsible for responding to the
portion of the Sonnenschein document request seeking copies of
settlements, judgments, significant correspondence with regulatory
agencies, governmental licenses/permits, and information concerning
pending or threatened litigation or regulatory actions, Bartley stated
that it was his understanding that such legal matters would have been
handled and produced by F&G's outside counsel.
128. On December 16, 1995, the associate "tried to complete all of the
due diligence inquiries that [he] had made and make sure that [he] had
been provided satisfactory answers or documents responsive to the
requests in the list," and then returned to Chicago. As far as the
associate was aware, he was the only attorney responsible for gathering
data on all matters responsive to the due diligence request. He made
general inquiries into pending legal matters, but did not follow-up by
asking for specific additional documents referenced in the materials that
he reviewed, such as the letters of inquiry from the state attorney
generals or responses from Attorney Awerdick.
129. The associate prepared handwritten notes and typed up an
"incomplete set" of those notes, but did not prepare a written report on
his due diligence. His typed notes included as an open issue as of
December 17, 1995, "Tom Stumb re Michigan Bulb legal matters." The
associate did not recall whether he spoke to Stumb in December 1995.
However, Stumb testified that he did not have any discussions with any
representative of the Sonnenschein Firm on or before December 20, 1995.
130. The associate had copies of Awerdick's audit response letters in
his file but does not remember anything about them. Awerdick's audit
response letters for 1994 and 1995 stated that MBC would have to make
"fundamental changes" to its marketing if prize and gift statutes were
applied to the "everybody wins" element of MBC's promotions. It is
undisputed that the associate did not speak to Awerdick in December 1995,
and there is no evidence in the record that suggests that anyone else
from the Sonnenschein firm spoke with Awerdick in connection with the
legal due diligence process.
131. In December 1995, the associate knew that MBC "ran a sweepstakes
program" and had been told by someone at F&G that MBC's sweepstakes
program "was similar to Publishers Clearinghouse sweepstakes program." He
knew that a large percentage of F&G's business was attributable to
MBC, but did not know what MBC's three major sweepstakes promotions were,
what MBC's first round prize was, or how many mailings were made by MBC.
132. On December 18, 1995, the associate met with a Sonnenschein
partner and went over the due diligence request list. The associate told
the partner that he had not "found anything significant in [his] due
diligence review." He reported on "a piece of litigation pending with a
woman by the name of Voiten who made those cats for the popcorn tins,"
but does not recall reporting anything about sweepstakes.
133. Before his deposition was taken in this case on May 17, 2002, the
associate had never seen: (a) the letter to MBC dated October 4, 1995,
from the State of Indiana Office of the Attorney General regarding MBC's
possible violation of Indiana's Promotional Gifts and Contests Act; (b)
the letter to MBC dated October 11, 1995, from the State of Iowa
Department of Justice stating that an MBC solicitation did not comply
with Iowa's Prize Notification Law; (c) the letter to MBC dated December
1, 1994, from the North Carolina Attorney General's Office regarding
MBC's failure to provide a satisfactory response to letters dated August
9 and October 26, 1994, as well as a second complaint that had been filed
against MBC; (d) the letter to MBC dated December 14, 1995, from the
Nebraska Attorney General's Office regarding a Civil Investigative Demand
upon MBC; (e) the letter to MBC dated June 16, 1993, from the Office of
the Attorney General of the State of Arkansas regarding MBC's suspected
violations of the Arkansas Mail and Telephone Consumer Product Promotion
Fair Practices Act and Act 137 of 1993 requiring the registration of
telephonic sellers; (f) the MBC Interoffice Memorandum to Patino from
Ostertag dated August 9, 1993, regarding Illinois Sweeps legislation; (g)
the memorandum and attachments to Awerdick dated September 18, 1995, from
Stumb regarding his request to respond to a consumer letter dated
September 14, 1995; (h) the facsimile to Stumb from Awerdick dated July
10, 1995, faxing a "draft" response to a customer complaint by a Michigan
consumer; (i) the letter to the Michigan Attorney General dated May 4,
1995, from a consumer regarding a "fraud claim against MBC"; (j) the
letter to Foster dated May 23, 1995, from a consumer advising that he had
reported MBC to the Washington Attorney General's Office. These documents
were arguably responsive to the Sonnenschein Firm's December 12, 1995,
due diligence request. Bartley, who had spoken with Attorney Stumpe
regarding this process, understood that outside counsel was responsible
for and would have provided this type of legal documents.
134. Stumpe testified that she didn't provide copies of such documents
because she didn't have them. She didn't know anything about the
regulatory process or inquiries outside of what she read in reviewing the
135. Accordingly, it appears that some documents that were arguably
requested, such as those referenced in ¶ 133, were not provided.
Based on the evidence presented at trial, the Court does not believe that
this was intentional, or that Foster, Regal, or Pellegrino encouraged or
had any knowledge of this deficiency in the document production.
136. Again, Durchslag's credible and unrefuted expert testimony
established that the inquiries and investigations of MBC by state
attorneys general were a routine part of the direct mail/sweepstakes
marketing business and did not present a material threat to MBC in
137. Having said that, there is a complete absence of evidence in the
record, documentary or testimonial, from the partner supervising the
corporate due diligence team for the Sonnenschein Firm. There are no
notes or memoranda to the file or anything else concrete in this record
to support a finding that this partner did anything by way of substantial
analysis of the issues involved in this case. Nor is there any indication
that he was ever aware of MBC's extensive use of sweepstakes marketing or
governmental regulatory inquiries but concluded that they did not present
material issues. The record reflects only that this partner is no longer
with the Sonnenschein Firm and could not be located to testify in this
case. Therefore, he was not presented as a live witness, and his
deposition was never taken.
138. The only evidence indicating that corporate legal due diligence
actually occurred is what was provided by the young associate. The record
is devoid of any evidence indicating the substance of any communications
between the corporate due diligence team and U.S. Trust. No written
report was prepared regarding this aspect of the legal due diligence, and
no notes memorializing any conversations between the associate and the
partner in the Sonnenschein Firm who supervised the corporate due
diligence or between the supervising partner of the corporate team and
Goldberg were introduced at trial. Thus, there appears to be a
substantial gap in the legal due diligence performed by the Sonnenschein
Firm. Although it is possible that the
corporate due diligence was fully explored and discussed, it is not
possible for the Court to reach this conclusion on the record presented
139. If Goldberg had seen Awerdick's February 22, 1995, letter to Price
Waterhouse L.L.P., which advised that MBC would have to make "fundamental
changes" in its mailings if certain prize and gift laws were applied, and
Stumb's October 19, 1995, memorandum contained in the October 1995
F&G board book, advising that MBC had received sweepstakes inquiries
from three states in two weeks in October 1995, Goldberg "would have
asked for a further understanding from the company." However, Goldberg
testified that based on what he knew about the state of the industry, it
would not have affected the outcome of the transaction.
140. Awerdick's February 22, 1995, letter and Stumb's October 19, 1995,
memo were within the scope of the Sonnenschein Firm's due diligence
requests and were apparently received during its due diligence visit
because the documents were produced from the firm's files pursuant to a
subpoena issued in this case.
141. On or before December 20, 1995, Goldberg had only a general
understanding of MBC's sweepstakes promotional program and did not focus
specifically on the "everybody wins" promotion. On or before December 20,
1995, Goldberg was not aware that the percentage of MBC's sales generated
by sweepstakes was between 80-85%.
Closing the ESOP II Transaction
142. On December 18, 1995, Stuber contacted Magna Bank and informed its
trust officer that the closing would occur on the ESOP transaction on
December 19, 1995, and that U.S. Trust would be executing the documents
as successor trustee of
the ESOP. Stuber faxed Magna Bank a copy of a draft Collateral Custody
Agreement, which identified U.S. Trust as the trustee of the ESOP and
Magna Bank solely as the collateral agent and the custodian of the
purchased F&G shares.
143. Although Magna Bank had a contractual right to require thirty days
written notice of its removal, Magna Bank did not voice any objection to
U.S. Trust acting as trustee at the closing, ask to attend the closing of
that transaction, try to prevent the closing, or request or attempt to be
involved in the decision on whether the ESOP should enter into the
transaction. Magna Bank executed a final version of the Collateral
Custody Agreement and accepted the benefits of the 1995 transaction by
receiving fees in its new roles of collateral agent and custodian. There
is no evidence that Magna Bank ever asserted that it was still trustee at
the time of the ESOP transaction or that its approval was necessary to
the transaction or that it ever took any action to challenge the ESOP
transaction on any grounds.
144. Houlihan presented its report dated December 19, 1995, to U.S.
Trust. Houlihan concluded that the fair market value of F&G's equity
after consideration of existing debt, future non-cash compensation, and
associated tax benefits was $233 million. According to Houlihan's
analyses, the midpoint value of the stock was $19.81 per share at the
time of the transaction.
145. Houlihan's December 19, 1995, presentation to U.S. Trust included
a one-page Strengths-Weaknesses-Opportunities-Threats ("SWOT") analysis.
The SWOT analysis mentioned MBC under "strengths" (MBC offered "greater
product variety than competing mass merchants") and under "Opportunities"
(MBC had "recently introduced several non-horticultural tradestyles").
The threats catalogued by Houlihan did not
include government regulation of sweepstakes or any risk with respect to
146. Houlihan had a copy of MBC's 1996-1998 Strategic Plan dated August
1995 in its file.
147. In connection with the 1995 ESOP II transaction, Houlihan did
not: (a) visit MBC's offices in Grand Rapids; (b) speak to Stumb,
Fujimoto, or Awerdick; (c) review any of the specific sweepstakes mailings
that MBC sent to its customers or prospective customers; (d) conduct any
investigation into the market conditions of sweepstakes or research
anything relating to the sweepstakes industry; (e) know what percentage of
MBC's sales were generated by sweepstakes marketing or what percentage of
F&G's business was sweepstakes oriented; (f) know what MBC's three main
sweepstakes marketing approaches were; (g) know what MBC awarded to its
customers as the first round prize; (h) know that the financial
projections used in the F&G valuations were prepared by management who
were also selling shareholders in the transaction; or (i) know of any
correspondence, actions, inquiries, memos, or conversations with any
state attorneys general related in any way to any part of the business of
148. Plaintiffs' expert Gregory Wolski, a Certified Public Accountant
with Ernst & Young, suggested that the risks associated with MBC's
sweepstakes marketing practices were not given proper attention in
valuing the F&G stock. He testified that if appropriate diligence had
been conducted, a prudent investor would have concluded that there was
too much risk and made a decision not to enter into the ESOP II
transaction. However, Wolski is not an expert in the field of sweepstakes
was not in a position to credibly opine on the materiality of any
risk presented by sweepstakes dependency or governmental regulation in
December 1995. Given Durchslag's credible and unrefuted expert testimony
that the inquiries and investigations of MBC by state attorneys general
did not present a material threat to MBC in December 1995, the Court
finds Wolski's testimony to be unpersuasive.
149. Wolski criticized the statement in Houlihan's engagement letter
that they would not independently verify the accuracy and completeness of
the financial information supplied to them by F&G. Similarly,
Plaintiffs' expert Thomas Bagley ("Bagley") testified that a prudent
buyer would not have assumed that the information provided by selling
shareholders was correct.
150. In connection with its opinion, Houlihan to some degree relied
upon the financial forecasts and projections provided to it and assumed
that they had been reasonably prepared and reflected management's best
then-available estimates of the future financial results and conditions
of F&G. Houlihan did not independently verify the accuracy and
completeness of the information supplied to it with respect to F&G and
expressly did not assume any responsibility with respect to the
information supplied to it with respect to F&G. In expressing its
opinion, Houlihan also relied on the Officer's Certificate from Dickes
dated December 20, 1995.
151. However, it is not accurate to say that Houlihan did no
independent analysis of F&G's financial prospects or blindly accepted
the hopes and representations of F&G officers. To the contrary, the
record indicates that Houlihan, along with Shea of U.S. Trust, performed
exhaustive analyses of the information provided and conducted independent
valuation analyses. In evaluating the transaction from a financial
perspective, it is clear that they looked behind the management
projections to the underlying financial history and challenged the
forecasts as "too aggressive" after diligent inquiry and deliberation.
152. F&G's management did not give Sarafa any reason to believe
that there were any negative issues relating to MBC's sweepstakes. As far
as he knew, "sweepstakes" was not a bad word. On or before December 20,
1995, Sarafa understood "dependency on sweeps, possible threats" to mean
that if MBC were going to substantially increase market share, the
company would have to attract certain groups of customers that it
currently was not attracting just with sweeps, and MBC needed to have a
diversified promotional strategy beyond sweeps. On or before December 20,
1995, Sarafa was not aware that in 1995 MBC received approximately 26,900
written sweepstakes complaints from its customers, nor did he know that
these inquiries represented only .03% of MBC's mailings for the year.
153. In doing "industry research," Houlihan looked at the direct mail
and catalog industry generally. During this research, Houlihan did not
find anything related to the regulation of sweepstakes. Sarafa's
understanding in December 1995 was that in the industry at that time,
there were no issues being raised with regard to sweepstakes.
154. U.S. Trust's Special Fiduciary Committee, comprised of six voting
members, had to approve each engagement involving employer stock in an
employee benefit plan. Upon completion of the due diligence and prior to
the closing of a transaction, the Special Fiduciary Committee would meet
to review the work of U.S. Trust and its financial and legal advisors;
the Special Fiduciary Committee's approval was required in order to
proceed with, or to effect the closing of, any transaction.
155. On December 19, 1995, U.S. Trust's Special Fiduciary Committee
met, and the ESOP transaction was approved. There were no discussions
about pending regulatory investigations into MBC's sweepstakes. Goldberg
testified that U.S. Trust was not aware of pending investigations at that
156. When asked what steps he took to make sure that the threats to
F&G's business listed in Houlihan's SWOT analysis were accurate,
Goldberg responded in part that he and Shea would have reviewed the page
with the SWOT analysis and that, "based on what we knew and what had been
explained to us, that this reasonably captured the threats associated
with the company as we understood it."
157. Shea does not specifically recall any discussions with anybody
from F&G regarding governmental regulation or dependency on sweepstakes
as possible threats. According to Shea, there was "a general discussion
of risks, opportunities, weaknesses and threats of the company that
ensued during our due diligence period," and Houlihan's SWOT analysis
"reflects the strengths, weaknesses, opportunities and threats of
Michigan Bulb as they were described to us on or before December 20,
158. During the December 19, 1995, meeting of the Special Fiduciary
Committee, Houlihan made a presentation to U.S. Trust's Special Fiduciary
Committee but did not discuss anything regarding MBC's sweepstakes
159. The closing for the 1995 ESOP transaction was held on December 19
and 20, 1995, in Chicago, Illinois. At closing, opinion letters were
provided from Sonnenschein and Houlihan.
160. Houlihan's opinion letter advised that it had reviewed the 1995
ESOP transaction and had determined that:
[T]he consideration to be paid by the ESOP for the
Company's securities in the Transaction is not greater
than adequate consideration for such securities; the
Transaction is fair and reasonable to the ESOP from a
financial point of view, the loan between the ESOP and
the Company, taken as a whole, is fair and reasonable
to the ESOP from a financial point of view; and the
interest rate, with respect to such loan, is fair and
reasonable to the ESOP from a financial point of
161. Houlihan's report also reflected its consideration of the impact
of the corporate debt associated with 1995 ESOP transaction on F&G's
share value and ability to repay the debt. Specifically, the report
contained "Covenant Testing" analyses reflecting F&G's ability to
meet its loan obligations under the assumption that F&G met its
management's financial projections and under another assumption that it
fell somewhat short of those projections.
162. Sonnenschein's opinion letter stated that its "representation of
the Trustee with respect to the matters addressed by this opinion has
been limited to matters involving the compliance with the Employee
Retirement Income Security Act of 1974, as amended (`ERISA') and the
Internal Revenue Code of 1986, as amended (the `Code')." The opinion
We have not, for purposes of this letter, been
retained to perform, nor have we performed, any
independent review or investigation of any statutes,
ordinances, laws, rules, regulations, agreements,
instruments, contracts, orders, writs, judgments,
rules or decrees to which the Company, the Plan or the
Trust may be a party or to which the Company, the Plan
or the Trust or any property of any of them may be
subject, or by which the Company, the Plan or the
Trust or any property of any of them may be bound,
except ERISA, the Code and regulations and rulings
issued thereunder; nor for purposes of this letter,
have we been retained or engaged to perform, or
performed, any independent review or investigation as
to the existence of any actions, suits, proceedings,
orders, investigations or claims before or by any
court, arbitrator, or governmental department,
commission, board, bureau, agency or instrumentality
threatened against or relating to the Company, the
Plan or the Trust or any property of any of them.
163. The Sonnenschein Firm advised U.S. Trust that in acting as the
ESOP trustee, it was subject to certain standards of procedural due
diligence involving factual examination and obtaining expert legal and
financial advice. The opinion also stated that the Sonnenschein Firm's
opinions were premised upon the assumption that such due diligence had
occurred and that U.S. Trust had arrived at its findings by way of a
prudent and thorough investigation of circumstances currently prevailing,
the application of sound business principles of valuation, and in
reliance on the Financial Advisor's Opinion, the advice of the Financial
Advisor, and the advice of its legal counsel.
164. The Sonnenschein Firm's opinion letter discussed U.S. Trust's
duties of prudence and diligence at length and advised that, in general,
whether a fiduciary has satisfied the requirements of Section 404(a)(1)
of ERISA is a factual question which must be determined based upon expert
financial and business judgments.
165. In discussing the duties of prudence and diligence imposed on U.S.
Trust, the Sonnenschein Firm also stated:
Regulations under Section 404(a)(1)(B) of ERISA
provide that with regard to an investment or
investment course of action taken by a fiduciary of a
plan pursuant to his investment duties, the
requirements of Section 404(a)(1)(B) of ERISA are
satisfied if the fiduciary (A) has given appropriate
consideration to those facts and circumstances that,
given the scope of such fiduciary's investment
duties, the fiduciary knows or should know are
relevant to the particular investment or investment
course of action involved, including the role the
investment or investment course of action plays in
that portion of the plan's investment portfolio with
respect to which the fiduciary has investment duties;
and (B) has acted accordingly.
29 C.F.R. § 2550.404(a)-1(b).
A fiduciary must discharge his duties with the care,
skill, prudence and diligence under the circumstances
then prevailing of "the traditional `prudent man'."
Donovan v. Bierwirth, 680 F.2d 263
, 271 (2d Cir.
1982). Prudence is thus measured according to the
objective prudent person" standard developed in the
common law of trusts. Donovan v. Mazzola, 716 F.2d 1226
1231 (9th Cir. 1983). Subjective good-faith simply
does not come into play. Leigh v. Engle, 727 F.2d 113
124 (7th Cir. 1984). The focus of the inquiry under
the prudent man rule is on the fiduciaries'
independent investigation of the merits of a
particular investment rather than an evaluation of the
merits alone. Donovan v. Cunningham, 716 F.2d 1455
1467. The test of prudence focuses on whether the
fiduciaries, at the time they engage in a
transaction, have employed the appropriate methods to
investigate the merits of the investment and to
structure the investment. Mazzola, 716 F.2d at 1232.
166. The Sonnenschein Firm gave U.S. Trust a range of advice regarding
whether it would be appropriate for U.S. Trust to rely on a financial
advisor that would rely upon F&G's financial projections. U.S. Trust
was advised to evaluate the financial advisor's opinion and be satisfied
that it was reasonable to rely on the opinion, because ultimately U.S.
Trust as trustee was making the decisions of whether to close the
transaction, whether the transaction was prudent, and whether the various
other components were satisfied.
167. The Sonnenschein Firm did not provide any opinion to U.S. Trust as
to whether U.S. Trust had in fact adequately investigated the financial
forecasts and projections that were provided by F&G. The billing partner
in the firm was aware that the financial forecasts and projections had
been prepared by some of the selling shareholders, and advised U.S. Trust
to undertake a more skeptical and questioning review.
168. Dickes, in his capacity as Executive Vice President of F&G,
executed an Officer's Certificate certifying that the financial
statements and other business and financial information were true and
complete when given and remained true, that the projections of the future
financial condition of F&G were based on assumptions that
remained true, and that there had been no adverse developments for
F&G since the information and projections were provided.
169. On December 20, 1995, F&G's executive committee, comprised of
Foster, Regal and Pellegrino, unanimously passed a resolution authorizing
the Vice Chairman or any Vice President of F&G to execute and deliver
certain documents, including the Note Agreement between F&G and the
lenders, $19,999,998.50 Series A Senior ESOP Notes, $50,000,000 Series B
Senior ESOP Notes, the F&G Employee Stock Ownership Trust as amended
and restated effective December 20, 1995, and the F&G Employee Stock
Ownership Plan as amended and restated effective January 1, 1995. The
resolution also authorized the officers of F&G to take "all other
such actions that are necessary and proper to effectuate the above
resolution. . . ." Pursuant to this authority, Regal, acting on behalf
of F&G, appointed U.S. Trust as trustee of the ESOP and signed the
amended and restated Employee Stock Ownership Trust that same day.
170. U.S. Trust accepted the appointment as successor trustee of the
ESOP on December 20, 1995, and Magna Bank was notified of U.S. Trust's
171. Also on December 20, 1995, U.S. Trust executed the various closing
documents on behalf of the ESOP and made written findings in connection
with the ESOP II transaction. In the written findings, U.S. Trust
expressly noted its reliance on the opinions it received from Houlihan,
the Sonnenschein Firm as counsel to the trustee, the Kavanagh firm as
general corporate counsel to F&G, the firm of Mayer, Brown & Platt as
special ERISA counsel to F&G, and Price Waterhouse, as well as
Valuemetrics' transaction memorandum, the representations and warranties
of F&G and its controlling shareholders, and the pertinent finance
documents. U.S. Trust stated that
the terms and conditions of the transaction were prudent and reasonably
designed to further the purposes of the ESOP, satisfied the requirements
of Section 408(e) of ERISA and Section 4875(d)(13) of the Internal
Revenue Code, and also that the purchase price of the shares did not
exceed the fair market value of the shares.
172. Goldberg signed these findings on behalf of U.S. Trust.
173. As part of the ESOP II transaction, U.S. Trust entered into a
Stock Purchase Agreement with Foster, Regal, Pellegrino, and other
F&G officers and directors. Paragraph 5.7 of the Stock Purchase
Agreement stated in relevant part:
Neither the Company nor any Subsidiary is engaged in
or a party to any legal action, suit, investigation,
arbitration or other proceeding pending or, to the
best knowledge of each Controlling Shareholder and the
Company, threatened, against or affecting the Company
or any Subsidiary or any of their respective
properties at law or in equity or before or by any
governmental department, commission, board, bureau,
agency or instrumentality, and neither the Company nor
any Subsidiary has been charged with or, to the best
knowledge of each Controlling Shareholder and the
Company, is under investigation with respect to any
violation of any provision of federal, state or other
applicable law or administrative regulation which is
likely to materially and adversely affect the
properties, business, prospects, profits or condition
(financial or otherwise) of the Company and its
Subsidiaries, nor is there any basis for any of the
foregoing. The Company and the Subsidiaries are in
compliance with all applicable laws, except those of
which a violation would not and, so far as each
Controlling Shareholder can now foresee, will not,
individually or in the aggregate, materially adversely
affect the properties, business, prospects, profit or
condition (financial or otherwise) of the Company and
174. In entering into the Stock Purchase Agreement, U.S. Trust caused
the ESOP to use the proceeds of a $70 million loan to purchase 3,589,743
F&G shares from F&G shareholders. Each of the selling shareholders
signed a written receipt for the purchase price.
175. In order to make the loan to the ESOP, F&G entered into a Note
Agreement with the four institutional lenders: Harris Trust & Savings
Bank"), the Northwestern Mutual Life Insurance Company, LaSalle Bank, and
the Northern Trust Company. Under the terms of the Note Agreement, the
institutional lenders agreed to lend F&G just under $70 million dollars
on an unsecured basis.
176. F&G loaned the full $70 million to the ESOP conditioned upon
the ESOP using the money to purchase shares of F&G, and therefore,
the ESOP could not have used any part of the $70 million to buy stock in
some other company or to purchase some other investment.
177. The appropriate debt level was determined before U.S. Trust agreed
to a share price, so the amount of leverage did not change when U.S.
Trust negotiated the share price from $24.00 to $19.50 per share.
Instead, the ESOP simply purchased a larger number of shares with the $70
million than had originally been anticipated. Had the share price been
higher than $24.00 per share, the ESOP would simply have purchased a
smaller number of shares for the $70 million.
178. The ESOP, through U.S. Trust, used the $70 million loan to
purchase 3,589,743 shares of F&G common stock at $19.50 per share. A
significant portion of these shares were purchased from F&G's founders,
Foster and Regal. In addition, a number of F&G's officers and directors
were allowed to exercise stock option rights and sell to the ESOP shares
granted to them under F&G's Executive Incentive Plan ("EIP"). Most of
the net proceeds from the sale of those shares, after the payment of
taxes and the applicable option price, were reinvested by F&G management
in newly issued shares of F&G stock at a price of $19.50 per share.
179. Plaintiffs' expert Hitchner testified that the true value of the
F&G stock as of December 20, 1995, was actually $10.85 per share.
Hitchner did not perform his own
independent evaluation. He arrived at his conclusions after making
certain modifications to the valuation performed by Defendants' expert
Reilly to reflect what he believed to be a more appropriate magnitude of
risk based on his conclusion that Reilly's adjustment for sweepstakes
risk was inadequate, and neither Valuemetrics nor Houlihan had considered
this factor in their analyses.
180. Specifically, Hitchner considered the 6% reduction that Reilly
used to reflect sweepstakes risk to be insufficient and instead
implemented a 10% reduction to reflect the specific company risk
attributable to sweepstakes marketing. He thought that a higher Beta (a
measurement of a company's debt/equity mix) than that used by Reilly
should have been used and that Reilly should have used the Gordon Growth
Model to determine the terminal value in his analysis. However, Hitchner
conceded that the percentage of company specific risk selected by any
given valuation professional was completely subjective and that there
were different sources for deriving predicted Betas, so that valuation
professionals could obtain different Betas for the same company as a
result of having consulted different sources. Additionally, Reilly
testified that his use of market-derived exit multiples to determine the
terminal value for purposes of the valuation analysis was an acceptable
alternative to the Gordon Growth Model and cited Hitchner's own book on
business valuation as support for this assertion.
181. Reilly cited authority for the proposition that any single risk
factor generally warrants a premium in the 0-5% range, and the precise
percentage used is a subjective exercise of the valuator's judgment.
Because he had determined that all of the other layers of risk in his
analysis were in the 4-6% range, and he wanted to add another layer of
risk to reflect the level of sweepstakes risk that he had been directed
assume, he selected a 6% company specific risk premium and obtained
a fair market value of $24.00 per share. However, Reilly testified that
even assuming that Hitchner's selection of a 10% risk premium was more
appropriate, the value of F&G's stock would still have been $22.15
per share, which is still more than what the ESOP actually paid for it on
December 20, 1995.
182. Hitchner also criticized the use of a 20% control premium as an
inappropriate value enhancement except in a case where a strategic buyer
was making the purchase that was believed to guarantee at least a 20%
increase in cash flow/future profits. In contrast, Reilly and Houlihan's
Sarafa both testified that the use of a control premium was appropriate
to reflect the fact that by consummating the ESOP II transaction, the
ESOP was effectively purchasing a controlling block of stock and would
change from a minority position to being the majority shareholder of F&G
as a result. Reilly and Sarafa stated that the key consideration in
performing the valuation was to determine what the buyer would be
obtaining through the purchase, which in this case meant determining what
an informed buyer would be willing to pay to obtain a controlling
interest in F&G. Because the ESOP would then have the power to determine
the management of the company or assert other control prerogatives and
could ultimately resell its stock to another buyer down the road as a
majority position, the use of a control premium was justified; Reilly and
Sarafa both indicated that it is the potentialities rather than what the
ESOP actually intended to do with its ownership interest that is
relevant. Reilly also testified to the existence of, and reliance by
valuation professionals on, proposed regulations under ERISA allowing a
premium in this type of situation. After considering the balance of
the expert testimony, the Court finds the explanation given by Reilly and
Sarafa to be more persuasive.
183. Plaintiffs did not produce an independent valuation of the F&G
stock. The Court finds Reilly's testimony to be more credible than
Hitchner's testimony because Hitchner primarily substituted different
numbers into Reilly's analysis without providing any satisfying
explanation of why the substitutions were economically valid. Reilly gave
lengthy testimony with respect to the interrelationships between the
various numbers in the discounted cash flow valuation analysis and
indicated that the interplay between the numbers, with the exception of
the independent company specific risk premium, would not permit the type
of selective changes made by Hitchner. The Court found this testimony to
be persuasive, particularly in the absence of any contrary explanation
from Hitchner. Additionally, Hitchner conceded that if an acknowledged
expert in the sweepstakes regulatory industry opined that the sweepstakes
issues faced by MBC were not a material risk to the future of F&G, he
would reconsider his opinion as to the propriety of the 10% company
specific risk premium. Durchslag's testimony to precisely that effect, in
combination with the fact that Hitchner's other criticisms are largely
subjective exercises of judgment, provide a further basis for discounting
his valuation opinion.
184. Even if Reilly's determination of fair market value was upwardly
biased, the Court finds that any necessary corrections supported by the
record in this case would not have resulted in a fair market value of
less than what was paid on December 20, 1995.
185. Based on the record at trial, the Court finds that $19.50 per
share was reasonable and adequate consideration for the F&G stock.
Thus, the ESOP did not pay more than adequate consideration or the fair
market value of the stock purchased in the ESOP II transaction.
186. Effective March 1, 1996, Foster stepped down as F&G's CEO and
Chairman. He then passed away on July 11, 1996.
187. For two years after the December 20, 1995, stock purchase
transaction, F&G continued to enjoy record profits.
188. Following the ESOP II transaction, consumers and state attorney
general offices continued to inquire into MBC's compliance with the law.
Legal reports to F&G's board of directors routinely reported on the
increasing enforcement and change of sweepstakes laws. Goldberg commonly
received legal reports to F&G's board of directors, and attended some
F&G board meetings during which pending legal matters were discussed.
189. On April 12, 1996, an Investigator with the Consumer Protection
Division of the Michigan Attorney General wrote to Ostertag and advised
that the office had received many complaints about MBC since early 1995.
190. Since he was retained in 1991, Awerdick had advised MBC that the
laws of at least nine states could be read to bar the "everybody wins"
approach. However, he also advised that the laws were ambiguous and
seldom enforced. Awerdick indicated that if states were to enforce
certain laws, MBC would have to change its mailings. However, prior to
December 20, 1995, he had never advised MBC that any of
its practices were illegal or that it needed to discontinue any of
its sweepstakes marketing practices. It wasn't until June 1996 that
Awerdick even recommended that MBC stop using the term "special prize,"
call it an "award," avoid saying "win," and disclose the value of the
191. In June 1996, MBC personnel met with two representatives of the
Michigan Attorney General's office to discuss the increasing number of
complaints that the Michigan Attorney General was receiving regarding
MBC's sweepstakes. MBC's Stumb, who was at that meeting, recognized that
at least one of the "first round winner" solicitations used by MBC in a
Flower of the Month mailing was "misleading and cannot be defended."
192. In July 1996, the State of Connecticut filed a lawsuit against
MBC, among 14 other sweepstakes companies, as part of a joint
state-federal program called "Project Jackpot." The complaint against MBC
alleged in part that MBC's "everybody wins" promotions had violated
Connecticut law by representing that a recipient was a "winner" or had
been "selected" to receive a prize or opportunity, when in fact MBC's
solicitations were simply a promotional scheme designed to make contact
with prospective customers for the sale of its merchandise and all or a
substantial number of those receiving MBC's solicitations were notified
that they were "winners." The suit was filed without notice or any
contact from the Connecticut Attorney General, so MBC had no opportunity
to address or resolve the allegations prior to the litigation being
193. In August 1996, Awerdick advised MBC that because the Federal
Trade Commission ("FTC") had made "everybody wins" promotions a priority,
probably be increased scrutiny of MBC's promotions. He also questioned
whether MBC's overall promotional approach could be seen as "too
194. In August 1996, Goldberg, Shea and another representative of U.S.
Trust traveled to Grand Rapids, Michigan for a special presentation by
Ostertag, who had replaced Foster as Chief Executive Officer of F&G,
and various officers of MBC. Either during that meeting or shortly
thereafter, U.S. Trust was informed of the Connecticut action, and the
action was also discussed at F&G's February 1997 board meeting, which
Goldberg attended. During the board's discussion, Ostertag explained his
belief that the lawsuit did not have a material basis, and F&G's
management expressed its confidence, based on MBC's past ability to deal
with state agencies in an effective and professional manner, that the
action could be handled in the normal course of business and did not
represent a fundamental threat to MBC.
195. On September 18, 1996, Awerdick wrote to the Connecticut Attorney
General, stating in part: "The fact that Michigan Bulb offers real
products distinguishes it from the scam artists at whom the Federal Trade
Commission and your office aimed Project Jackpot."
196. MBC ultimately settled with the State of Connecticut in August
1998. MBC agreed to pay the State of Connecticut $20,000 in costs and was
enjoined from: (a) "representing, either directly or impliedly, that any
Connecticut consumer was a "winner" or had been "selected" for receipt of
a prize opportunity, when in fact, the enterprise is simply a promotional
scheme designed to make contact with prospective customers, or all or a
substantial number of those "entering" receive the same "prize" or
"opportunity," and (b) representing that any consumer has won a prize
when in fact that consumer has
merely become eligible to win a prize. MBC was further enjoined from
violating certain requirements regarding disclosure of odds and retail
value of prizes. Testimony at trial indicated that this settlement was a
business decision that had very little impact on MBC's financial
197. In December 1996, Awerdick sent a list of twenty-one "prize and
gift states" to MBC that had been circulated at a conference that he had
attended. MBC's sales to those twenty-one states regulating "everybody
wins" promotions from January 1, 1996, through December 22, 1996, totaled
over $50 million. In comparison, MBC's total revenues for 1996 were
projected to be about $115 million.
198. In February 1997, the Vermont Attorney General's Office notified
MBC that it was opening an investigation into MBC's sweepstakes
promotions after having received a consumer complaint that Flower of the
Month advertising was deceptive and misleading. As with the Connecticut
lawsuit, MBC ultimately resolved the matter in July 1998 by entering into
an Assurance of Discontinuance with the State of Vermont under which it
agreed to restrict its promotions to Vermont consumers, and also agreed
to pay $50,500 to the State of Vermont for attorney's fees and
investigative costs, including $1,000 to be paid to the consumer that had
filed the initial complaint that led to the investigation. Again, the
trial testimony indicated that the Vermont settlement had very little
financial impact on the company.
199. As Vermont and Connecticut accounted for a very small percentage
of MBC's sales, MBC decided that it was more cost effective to
discontinue any mailings into those states rather than to prepare special
promotions for Vermont and Connecticut residents.
200. Defense expert Durchslag testified that it is not unusual for
companies to enter into settlements or voluntary assurance agreements for
business reasons or to stop marketing to states that present specific
201. The agreements to purchase stock through which the EIP
participants reinvested the proceeds of their sale of stock in the 1995
ESOP transaction contained an annual put provision which allowed the EIP
participants to sell back all or a portion of their EIP shares to F&G. In
1997, F&G's Board of Directors offered the ESOP the opportunity to
purchase the vested shares available for sale under the EIP agreements at
$18.62 per share, the value determined in the ESOP's valuation for
year-end 1996. Although F&G made record profits again in 1996, the per
share value was actually lower as a result of factoring in the additional
debt assumed by F&G as a result of the 1995 ESOP II transaction.
202. Although the F&G board authorized the purchase of up to
$1,000,000 in F&G shares, the transaction was undersubscribed and only
28,920 shares were tendered by F&G management (amounting to only
$538,490.40 of the $1,000,000 authorized). Several members of F&G
management, including Ostertag, declined to sell because they believed
that the value of the stock would continue to increase. On June 30,
1997, the ESOP purchased the available shares at the price of $18.62 per
share. In order to fund the transaction, F&G made a voluntary
contribution to the ESOP of $538,490, above and beyond F&G's normal
203. During 1997, the possibility of the ESOP purchasing those F&G
shares still owned by Regal and Foster's Estate also arose. At least one
bank involved in the ESOP II transaction, Harris Bank, indicated its
willingness to make an additional loan
approximating $100 million to F&G to finance this further purchase of
F&G stock. However, this further purchase by the ESOP did not come to
fruition for several reasons, including the insistence of Regal and
Foster's estate upon a purchase price in excess of $25.00 per share
because they thought the stock was worth more than the value reflected in
the 1996 year-end valuation.
204. During 1997, F&G also converted to a Subchapter S corporation,
which would have allowed the company to avoid paying taxes on a
substantial portion of any profits. As Subchapter S corporations are
unable to take a deduction for business losses, the conversion would only
have made sense if F&G's officers and management expected the company to
continue to achieve significant profits.
205. In October 1997, MBC entered into an Assurance of Discontinuance
with the Michigan Attorney General regarding MBC's sweepstakes practices.
Under the Assurance of Discontinuance, MBC agreed:
That it would not engage in violations of Section 6 of
the Michigan Consumer Protection Act, by agreeing not
to distribute after December 31, 1997, any
solicitation from Michigan for sweepstakes in which
some recipients have been preselected as winners while
other have not been preselected, unless: (a) the
solicitation included a disclosure of the number of
preselected winners and the fact that an individual
must respond to such solicitation in order to
determine whether or not the individual is a winner;
or, (b) the solicitation included in the Official
Rules a disclosure which would enable the individual
to determine from the contents of the mailing whether
or not the individual is a preselected winner. The
individual will be referred to those rules in the
portion of the mailing which most completely describes
The Assurance of Discontinuance did not require MBC to admit to any
violation of Michigan law and expired at the end of three years. MBC was
aware of the requirements that were to be included in the agreement and
had already tested sweepstakes promotions containing conforming language.
Based on these tests, MBC
had estimated the impact on customer response rates and had incorporated
an expected impact into its plans and projections for 1998.
206. By October 1997, MBC agreed with Awerdick that "non-everybody
wins" versions of its promotions would be sent to at least eleven states
that had particularly strict laws regarding that type of promotion. MBC
had sales of almost $23 million to those eleven states in 1996. MBC also
tested alternative formats for these states and incorporated the results
of those tests into its 1998 plans and projections.
207. Based on its test results and taking into account both changes
made to conform with the Michigan assurance and the separate promotions
for the "non-everybody wins" states, MBC budgeted a 6.5% decrease in
sales for the 1998 Spring season and no impact for the 1998 Fall season.
208. Although he routinely received copies of the quarterly board books
and attended some F&G board meetings, Goldberg was not specifically
aware that MBC made this particular change to its marketing practices in
209. MBC, having experienced record-breaking sales and profits in 1997,
for the fifth consecutive year, was in the process of introducing
non-sweepstakes promotions. Reflecting MBC's and, more generally
F&G's growing success, Valuemetrics concluded in its annual ESOP
valuation that as of December 31, 1997, the fair market value of F&G
stock on a control interest basis had risen to $20.33 per share.
210. The undersubscription of the 1997 stock purchase transaction,
conversion of the company to a Subchapter S corporation, and immediate
refusal of the Foster Estate and Regal to sell their remaining shares at
$25.00 per share suggest that state
regulation and sweepstakes issues were still not considered to be
material threats even two years after the ESOP II transaction.
211. In the early weeks of 1998, MBC was performing as budgeted using
the new sweepstakes formats and remained confident in the adjustments it
212. On January 8, 1998, the Indiana Attorney General's office sent a
Civil Investigative Demand regarding an investigation being conducted by
213. In February 1998, a number of news stories appeared concerning
particular sweepstakes practices used by American Family Publishers and
Publishers Clearinghouse. The focus of these initial stories was on an
elderly gentleman who traveled to Tampa, Florida, to claim American
Family Publishers' grand prize, which was in the range of $10 million.
Employees of American Family Publishers apparently treated him rudely and
sent him away. The gentleman subsequently returned to American Family
Publishers, this time bringing along members of the media. When he was
again rudely turned away, the story of the incident was widely reported
in newspapers and other media.
214. According to Defendants' expert Durchslag, the dramatic change in
the regulatory enforcement climate that followed this public outcry was
unexpected by sweepstakes professionals.
215. Although MBC did not use many of the sweepstakes practices at
issue in the news stories, the effect of the negative publicity on
consumers' reactions to sweepstakes in general caused an immediate and
dramatic drop in MBC's consumer response rates.
216. As is common in the marketing field, MBC generally made its
marketing commitments well in advance of the time that they would
actually be issued. As a result, substantial amounts of money had been
expended in the fall of 1997 for promotions that would not be sent out
until the spring season of 1998. The effect of the lower response rates
was compounded by the fact that MBC had not foreseen this unprecedented
level of negative publicity and had already financially committed itself
to future promotions based on higher expected response rates.
217. A number of former MBC and F&G officials uniformly testified
that they believed the principal cause of MBC's economic reversal was the
wave of adverse publicity that began in February 1998 as a result of
actions by American Family Publishing and Publisher's Clearinghouse.
218. Moreover, Regal, Pellegrino and Ostertag gave this same
explanation in writing as early as April 1998, long before even the
possibility of a lawsuit had arisen. In April 1998, they wrote a letter to
co-workers that was generally disseminated to F&G employees and stated:
The primary cause for the first quarter loss was an
overall decline in response rates for the Michigan
Bulb ("MBC") spring mailings. Response rates produced
lower revenue, even though we spent more on
advertising and promotional activities. Management
believes the decline in the MBC business is directly
attributable to the negative media coverage in
broadcast and newspapers relating to sweepstakes
promotions by American Family Publishing, featuring Ed
McMahon and Dick Clark. Unfortunately, the Media and
consumers alike do not differentiate among sweepstakes
219. Following the incident with American Family Publishers in February
1998, the negative publicity surrounding sweepstakes and its impact on
F&G's finances became a regular subject of discussion at F&G board
meetings, which Goldberg attended.
220. In May 1998, F&G's counsel reported to F&G's board of directors
that: "Michigan Bulb for many years has used sweepstakes as a business
development tool. From time to time these activities attract the
attention of consumer protection regulators in various jurisdictions."
F&G's counsel reported on investigations of other sweepstakes marketers
by various states and advised that taken as a whole, these activities and
the publicity surrounding them had led to a change in the sweepstakes
environment in which MBC competed. According to F&G's counsel, state
authorities were taking the position that sweepstakes must not only
include disclosures that assure their legality, but sweepstakes' sponsors
must make those disclosures in a manner that would be understandable to
unsophisticated consumers. According to F&G's counsel, "In some cases,
Attorneys General are enforcing picayune provisions of their state's laws
which in the past were not generally applied to national marketers.
Additionally, legislatures in a number of states are considering stricter
sweepstakes laws." The May 1998 report from counsel went on to discuss
active investigations into MBC's sweepstakes practices by six states and
221. By June 1998, MBC was proceeding to modify its business with the
goal to be compliant in all states and with the American Family
Publishers' Assurance. In addition to the change not to send `"everybody
wins' in states that prohibit it" and the color-coded language change
pursuant to the agreement with the Michigan Attorney General, MBC made
additional modifications to:
a. Eliminate "Finalist," "Final Round," and "First
b. Stop using deadline dates unless those dates were
c. Eliminate double meanings, and
d. Improve understandability.
At that time, MBC recognized the risk of making changes to its mailings
without testing, and that the impact on the short-term response rate
because of these changes was unknown.
222. In June 1998, MBC's sweepstakes strategy included a business
formula adjustment of creating excitement with other promotional formulas
besides "hard core sweepstakes." MBC's 1998 sweepstakes strategy included
the creation of a new sweeps business based on the "Three C's," meaning
clean, compliant, and customer friendly.
223. Also in 1998, MBC proceeded to make sweepstakes changes described
in a four-page outline prepared by MBC's attorneys describing "general
devices used by Michigan Bulb which could be construed as deceptive,"
ranging from "[o]veremphasis on the value of the special prize," "[u]se
of checks, bonds vouchers and other entry vehicles which appear
inherently valuable," using "[I]osing codes that imply the recipient is a
winner," "[u]sing an Order Form as a Sweepstakes Activation Device,"
using "[m]isleading or inaccurate names for Components and Departments,"
using "fabricated prize files and internal memos," "[c]laiming the
recipient is a winner, with qualifying language in fine print or on the
next page or footnoted at the bottom of the page," implying "that [a]
prize is waiting to be delivered when in reality its winner has not even
been selected," and using "False/Unenforced deadlines." These and similar
devices had been used by MBC before December 20, 1995.
224. The negative publicity spawned class actions and multi-state
enforcement actions against other direct mail marketers and legislative
hearings which in turn fed
further negative publicity and decreased customer interest in direct mail
sweepstakes as a whole, adversely affecting companies employing direct
mail sweepstakes regardless of whether those companies engaged in the
actual sweepstakes practices being criticized.
225. In the summer of 1998, a putative class action was filed against
MBC and five other companies challenging the companies' sweepstakes
promotions. The plaintiffs in that action ultimately offered to settle
their claims against MBC in return for a payment of $90,000. The case had
not been resolved when F&G declared bankruptcy.
226. In August 1998, the Indiana Attorney General's office advised that
it would be investigating MBC as part of a multi-state investigation on
behalf of a number of states and requested that MBC produce certain types
of documents. The office indicated no connection whatsoever between the
1998 multi-state investigation and its earlier inquiry into MBC's
practices in 1995. After requesting documents from MBC, there is no
indication in this record that the Indiana Attorney General's office
continued to pursue the multi-state investigation against MBC.
227. In its October 1998 report on legal matters to F&G's board of
directors, F&G's counsel reported: "The seriousness of the
anti-sweepstakes sentiment faced by Michigan Bulb and other direct
marketing companies that use sweepstakes as a primary marketing tool
probably cannot be overstated."
228. Valuemetrics prepared a report dated December 31, 1998, opining as
to the value of F&G common stock on that date. The 1998 Valuation was
transmitted to U.S. Trust on or about July 8, 1999. The 1998 Valuation
concluded that as of December 31, 1998, the value of F&G common stock
was $8.52 per share on a control
interest basis. The 1998 Valuation stated, "[F&G]'s sales have flattened
in 1998 as a result of declines related to their sweepstakes business.
The sweepstakes industry severely dropped off in 1998 as a result of the
negative press addressing abuses in the industry." The 1998 Valuation
also stated, "[w]ith changes in the sweepstakes industry occurring as a
result of the negative press it has received and the congressional
investigations, [F&G]'s ability to generate profitable new sales has
been dramatically curtailed."
229. The first time Goldberg learned that the share value of F&G
had dropped from roughly $20.00 to $8.52 was shortly before July 8, 1999.
230. Beginning with this decline in 1998, MBC's revenue bases suffered
extensive damage. Over the next three years, MBC's gross revenue declined
from $197 million in 1998, to $116 million in 1999, to $65 million in
2000. During the same time period, F&G also experienced a decline in
gross revenues from $471 million, to $368 million, to $337 million.
231. In the midst of this downturn, Regal and the Foster Estate made a
personal loan of $10 million to F&G in 1999 to help the company recover.
That loan was never repaid.
232. In response to F&G's financial troubles, U.S. Trust assumed a
more active role in attempting to salvage the company. For example,
rather than agree to a suggestion during F&G's February 1999 board
meeting that the company file bankruptcy, Goldberg led an effort to
explore the possible sale of F&G to strategic investors. To that end,
Goldberg and F&G management met with representatives of
several investment banks, who advised management not to sell F&G but
instead to address F&G's problems and attempt to negotiate better terms
with the ESOP lenders.
233. The dramatic decline in MBC's response rates ultimately led to
MBC's and F&G's financial decline. In September 1999, the ESOP
Administrative Committee reported that on December 31, 1998, the value of
the ESOP's F&G shares was $8.52 per share, as compared to the reported
value of $20.33 per share on December 31, 1997. The total value of F&G
shares owned by the ESOP decreased by more than $83 million in 1998, and
the reported net value of ESOP assets, after deducting liabilities,
decreased more than 90% from a net value of more than $82 million on
December 31, 1997, to a net value of just over $7 million on December
234. On January 30, 2001, before the filing of the present suit,
Plaintiffs' attorneys wrote to U.S. Trust and members of the ESOP
administrative committee and requested certain documentation information
regarding the ESOP. Counsel for the committee responded by providing
certain documents pursuant to ERISA § 104(b)(4), 29 U.S.C. § 1024(b)(4),
and indicating that the committee would not provide documents or
information not required to be disclosed under that provision. Shortly
thereafter, The Sonnenschein Firm responded on behalf of U.S. Trust,
explaining that U.S. Trust considered the letter by the committee's
counsel to be fully responsive. Plaintiffs initially asserted that U.S.
Trust's refusal to provide them with the specifically requested
information amounted to an independent breach of fiduciary duty.
However, such claim was not addressed during closing arguments and is not
reflected in Plaintiffs' Summary of Claims; accordingly, the Court
considers this claim to have been withdrawn by Plaintiffs.
235. On February 28, 2001, Ostertag advised all F&G employees that
F&G would be ceasing all sweepstakes marketing activities conducted
by MBC. According to Ostertag, beginning in 1998, the nation had been
bombarded with negative publicity focused on sweepstakes marketing, and:
The continuous legislative and regulatory attention
and pressures, along with the almost constant negative
publicity, has served for all practical purposes, to
kill sweepstakes marketing as a method of customer
contact and development for those involved in direct
marketing. Certainly, it has had a tremendous impact
on the business fortunes of Foster & Gallagher. . .
. This negative sweepstakes environment has subjected
the entire corporation to an unsure future including
layoffs, loss of jobs, and a significant reduction in
our ESOP share value.
236. According to Ostertag, senior management, F&G's board of
directors, and the ESOP trustee all agreed that pulling MBC out of
sweepstakes was the most prudent action to take at that time.
237. In an F&G Spring 2001 newsletter, Ostertag stated that "F&G's
debt and ESOP capital structure restrict reinvestment in our core
businesses, let alone investment to develop new business revenue
238. On July 2, 2001, F&G and its subsidiaries filed for bankruptcy
in the United States Bankruptcy Court for the District of Delaware.
239. In early August 2001, U.S. Trust entered into a Joint Defense
Agreement with certain other defendants to defend the claims brought by
plaintiffs in this case.
240. Upon the advice of the Sonnenschein Firm, U.S. Trust entered into
Tolling Agreements with many of its co-defendants in this case in late
2001 in order to preserve any claims that might exist against them for
statute of limitations purposes.
241. On July 29, 2002, by order of the United States Bankruptcy Court
for the District of Delaware, in connection with the liquidation of
F&G and its subsidiaries, the
ESOP was terminated, and U.S. Trust thereafter ceased to be trustee
to the ESOP. According to U.S. Trust, the shares of F&G have been
cancelled and are now worthless.
242. On or about October 3, 2002, current and former participants were
mailed notices informing them of the termination. The notices explained
that any claims, rights or causes of actions that may be asserted by or
on behalf of the ESOP were being distributed to the former and current
participants and expressly stated that Plaintiffs in this action had
suggested that the ESOP may have claims against parties to the 1995
243. Between December 20, 1995, and July 2, 2001, when F&G filed
for bankruptcy, F&G was making its quarterly payments of principal
and interest that became due to the ESOP lenders to pay off the loan from
the 1995 transaction.
244. After December 20, 1995, F&G made more than $53 million in cash
contributions to the ESOP. At or about the same time as F&G made the
quarterly payments to the ESOP lenders, F&G would make bookkeeping
entries to reflect a contribution by F&G to the ESOP in the same amount
as the quarterly payment and then a payment of the same amount by the
ESOP to F&G. These bookkeeping entries resulted in a reduction of
principal and interest owed by the ESOP to F&G by the exact same amount
as F&G reduced the amount owing to the ESOP lenders. As a result, in
2001, when F&G filed for bankruptcy, the total outstanding principal due
by F&G to the ESOP lenders, and by the ESOP to F&G was the same
amount, namely $34,558,252.84.
245. During the course of the bankruptcy, F&G sold assets to pay
down monies owed to the ESOP lenders as well as other creditors of
F&G. However, this did not alter the indebtedness of the ESOP to
F&G. As a result, the ESOP still owes F&G $34,558,252.84 on its
original $69,999,998 million loan.
III. CONCLUSIONS OF LAW
1. Plaintiffs bring their claims under the Employee Retirement Income
Security Act of 1974 ("ERISA") § 502(a)(2), 29 U.S.C. § 1132(a)(2) for
appropriate relief under ERISA § 409, 29 U.S.C. § 1109, and under ERISA
§ 502(a)(3), 29 U.S.C. § 1132(a)(3). This Court has jurisdiction
pursuant to ERISA §§ 502(e)(1) & (f), 29 U.S.C. § 1132(e)(1) & (f), and
28 U.S.C. § 1331.
2. Venue is proper pursuant to ERISA § 502(e)(2),
29 U.S.C. § 1132(e)(2), because the ESOP was administered in this
district and the breaches complained of took place in this district.
3. ERISA is a comprehensive remedial statute designed to protect the
interests of participants in employee benefit plans and their
beneficiaries by establishing standards of conduct responsibility, and
obligation for fiduciaries of employee benefit plans. 29 U.S.C. § 1001:
Shaw v. Delta Airlines, Inc., 463 U.S. 85.90(1983). One of the declared
purposes of Congress in adopting ERISA was to increase the likelihood that
participants and beneficiaries under employee benefit plans would receive
their full benefits as promised. 29 U.S.C. § 1001b(c)(3).
4. One type of employee benefit plan subject to the provisions of ERISA
is an ESOP. An ESOP is an ERISA plan that invests primarily in the
employer's stock. 29 U.S.C. § 1 107(d)(6)(A). A leveraged ESOP, the
type at issue in the instant case, is an
ESOP which borrows money from a third party in order to invest in
the employer's stock. 29 U.S.C. § 1108(b)(3).lf a leveraged ESOP is
created, the employer is obligated to make cash contributions to the
ESOP, which in turn uses the cash to retire the loan debt. Donovan
v. Cunningham, 716 F.2d 1455, 1459 (5th Cir. 1983). After the ESOP
borrows money for a stock purchase, the stock is placed in a "suspense
account." As the ESOP makes loan payments using the cash contributions
from the corporate sponsor, stock is released from the suspense account
and is placed into the ESOP participants' individual accounts.
5. F&G was an employer engaged in commerce or in an industry or
activity affecting commerce within the meaning of ERISA. ERISA §
4(a), 29 U.S.C. § 1003(a)(1).
6. The ESOP was an employee pension benefit plan within the meaning of
ERISA § 3(2), 29 U.S.C. § 1002(2) and a plan within the meaning
of ERISA § 3(3), 29 U.S.C. § 1002(3).
7. F&G is or was at all relevant times the sponsor of the ESOP
within the meaning of ERISA § 3(16), 29 U.S.C. § 1002(16).
8. Plaintiffs are participants in the ESOP within the meaning of ERISA
§ 3(7), 29 U.S.C. § 1002(7).
9. Defendant U.S. Trust was trustee of the ESOP and a fiduciary with
respect to the ESOP. ERISA § 3(21)(A), 29 U.S.C. § 1002(21)(A).
Fiduciary Duties Under ERISA
10. ERISA imposes the highest standard of conduct known to law on
fiduciaries of employee pension plans. Reich v. Valley National Bank
837 F. Supp. 1259, 1273 (S.D.N.Y. 1993), quoting Donovan v. Bierwirth,
680 F.2d 263 (2nd Cir. 1982); Kuper v. lovenko, 66 F.3d 1447, 1453 (6th
Cir. 1988). However, this is not equivalent to a standard of absolute
liability, as ERISA fiduciaries are only required to exercise prudence,
not prescience or omniscience. Frahm v. Equitable Life Assurance Society
of the United States, 137 F.3d 955, 960 (7th Cir. 1998); DeBruyne v.
Equitable Life Assurance Society of the United States, 920 F.2d 457, 465
(7th Cir. 1990).
11. Under the section 404(a) duty of loyalty, ERISA fiduciaries must
act "solely in the interest of plan participants and beneficiaries," for
the "exclusive purpose" of providing benefits to them. Engle, 727 F.2d at
125-126; Newton v. Van Otterloo, 756 F. Supp. 1121 (N.D. Ind. 1991).
12. ERISA fiduciaries must also discharge their duties "with the care,
skill, prudence and diligence under the circumstances then prevailing
that a prudent man acting in a like capacity and familiar with such
matters would use in the conduct of an enterprise of like character and
with like aims." ERISA § 404(a)(1)(B), 29 U.S.C. § 1104(a)(1)(B). That
being said, the Court cannot ignore the fact that in the context of this
case, a prudent person acting in like capacity would be acting as a
fiduciary to an ESOP, which Congress has recognized to have a
significantly different nature and purpose than traditional employee
benefit plans. Vartanian v. Monsanto Co., 131 F.3d 264, 269 (1st Cir.
1997), citing H.R. Conf. Rep. No. 93-1280, at 302 (1974); 131 Cong. Rec.
13. ESOPs are, by definition, "designed to invest primarily in
qualifying employer securities" and serve as a vehicle for employees to
obtain an ownership interest in their employer. 29 U.S.C. § 1107(d)(6)(A).
As the investment choices of an
SOP fiduciary are effectively limited to a decision of whether or not to
purchase shares of the employer company, the focus is generally on the
adequacy of consideration and the good faith basis for the fiduciary's
determination that the ESOP is not giving more than adequate
consideration for the stock. Howard v. Shay, 100 F.3d 1484, 1489 (9th
Cir. 1996); Martin v. Feilen, 965 F.2d 660, 665 (8th Cir. 1992).
14. When a fiduciary has dual loyalties, his independent investigation
into the basis for a particular investment decision that presents a
potential conflict of interest must be both intensive and scrupulous to
satisfy ERISA. Donovan v. Bierwirth, 538 F. Supp. 463 (E.D.N.Y. 1981),
modified on other grounds, 680 F.2d 263 (2d Cir.), cert. denied,
459 U.S. 1069 (1982).
15. Even if not asked, ERISA fiduciaries must make "full and complete"
disclosure and "communicate material facts affecting the interests of
beneficiaries." Anweiler v. American Elec. Power Serv. Corp., 3 F.3d 986,
991 (7th Cir. 1993); Bowerman v. Wal-Mart Stores. Inc., 226 F.3d 574, 590
(7th Cir. 2000).
16. This duty to provide material information arises under ERISA § 4
04(a), 29 U.S.C. § 1104(a). Bowerman, 266 F.3d at 590. This duty requires
disclosure to other fiduciaries acting on behalf of the plan's
beneficiaries. Glaziers and Glassworkers Union Local No. 252 Annuity
Fund, 93 F.3d at 1182 (3rd Cir. 1996); Midwest Community Health Service,
Inc. v. American United Life Insurance Co., 255 F.3d 374, 379 & 375-6
(7th Cir. 2001).
Fiduciary Claims Against Foster. Regal and
17. It is undisputed that Foster, Regal, and Pellegrino were not named
fiduciaries within the meaning of ERISA.
18. Nevertheless, even if not a named fiduciary, one is a fiduciary
with respect to an ERISA plan if, inter alia, "he exercises any
discretionary authority or discretionary control respecting management of
such plan or exercises any authority or control respecting management or
disposition of its assets . . . or . . . he has any discretionary
authority or discretionary responsibility in the administration of such
plan. Such term includes any person designated [by named fiduciaries]
under section 405(c)(1)(B) [29 U.S.C. § 1105(c)(1)(B)]."
29 U.S.C. § 1002(21)(A)(i) & (A)(iii).
19. The power to appoint and remove plan fiduciaries makes members of a
board of directors fiduciaries, requiring adherence to the ERISA
standards. Leigh v. Engle, 727 F.2d 113, 133-34 (7th Cir. 1984).
20. The Court finds that Foster, Regal and Pellegrino were fiduciaries
with respect to the selection of U.S. Trust as successor trustee for the
ESOP. However, any fiduciary duties owed by these individuals did not
extend beyond December 20, 1995, as the evidence at trial did not
establish that they exercised any discretionary authority or control over
the management or assets of the ESOP at any other time or in any other
21. Plaintiffs contend that Foster, Regal, and Pellegrino failed to
disclose material information about MBC's sweepstakes marketing to U.S.
Trust and its advisors. However, this claim must fail as the evidence
adduced at trial did not establish that any of these three individuals
withheld or attempted to conceal material information from the U.S. Trust
team. To the contrary, Foster is not even listed as having received a
copy of the due diligence request list, and there is nothing in the
record that demonstrates that he was even involved in the document
production for the Sonnenschein Firm.
Testimony at trial also indicated that Regal and Pellegrino, who
did receive a copy of the document request, instructed the management and
other employees of F&G to provide access to anything and everything
that was requested.
22. The record would also reflect that neither Regal nor Pellegrino
were ever informed by anyone that F&G's production was less than
adequate or that the Sonnenschein Firm had not received any information
that had been requested. Thus, there is no basis for finding that F&G
management had any reason to know that their understanding that arguably
responsive legal documents were being produced by outside counsel was
23. Plaintiffs' claim would fail for the additional reason that the
Court has found that MBC's sweepstakes marketing practices and the
governmental regulatory inquiries that existed prior to December 20,
1995, did not pose a material risk to F&G. Accordingly, Foster, Regal
and Pellegrino could not have breached any fiduciary duty to provide
material information to U.S. Trust regarding these subjects.
24. There was likewise no evidence that Foster, Regal, or Pellegrino
effectively induced U.S. Trust to approve and proceed with the ESOP II
transaction through the use of fraudulent and/or negligent
misrepresentations and omissions.
25. A fiduciary responsible for appointing a plan trustee or
administrator has "a duty to monitor appropriately" the actions of the
appointed trustee or administrator. Engle, 727 F.2d at 135. Although
Plaintiffs had asserted a claimed breach of fiduciary duty against
Foster, Regal, and Pellegrino based on an alleged failure to monitor
U.S. Trust after its appointment, Plaintiffs abandoned pursuit of this
claim during trial.
26. Additionally, the Seventh Circuit has found that ERISA directs
courts to look beyond a fiduciaries' formal authority with respect to the
plan and to consider what real authority they had over plan investment by
virtue of their having appointed the plan administrators, Id. For
example, the court in Engle noted that by choosing the particular
administrators that were selected, the fiduciary had obtained de facto
control over plan investment decisions.
27. The Court does not understand Plaintiffs to have asserted any
breach of fiduciary duty in connection with the decision to appoint U.S.
Trust as the transactional trustee for purposes of the ESOP II
transaction or as successor trustee to Magna Bank. However, even assuming
that such a breach was alleged, the evidence produced at trial did not
support a finding that U.S. Trust was anything other than a highly
qualified, independent trustee. The evidence presented at trial did not
establish that Foster, Regal, and Pellegrino, acting as shareholders,
officers, and members of the executive committee of F&G, exercised
extensive control over the structure and orchestration of the December
20, 1995, transaction such that they effectively retained de facto
control over the transaction, or that the selection of U.S. Trust as
trustee for the ESOP was so inextricably intertwined with the desired end
of effectuating the stock purchase transaction that the act of appointing
the trustee essentially exercised de facto control over the plan's assets
and management. In fact, the evidence established that the ESOP II
transaction was almost abandoned because of U.S. Trust's refusal to share
the basis for its valuation determination or agree to the share price
sought by the selling shareholders. These actions by U.S. Trust
contradict any assertion that Foster, Regal, and Pellegrino retained de
facto control over the transaction.
28. As the record does not establish any exercise of de facto control
by Foster, Regal, and Pellegrino, Plaintiffs have failed to prove that
these individuals breached any fiduciary duty in connection with the
appointment of U.S. Trust as successor trustee of the ESOP.
Prohibited Transaction Claims
29. ERISA prohibits transactions between an employee benefit plan and a
"party in interest" (ERISA Section 3(14), 29 U.S.C. § 1002(14)) because
of the obvious conflicts of interest and the high potential for abuse and
injury to the plan. ERISA § 406, 29 U.S.C. § 1106. Therefore, a
fiduciary with respect to a plan is not permitted to cause the plan to
engage in a transaction if he knows or should know that such transaction
constitutes a direct or indirect: (a) sale or exchange of any property
between the plan and a party in interest; (b) loan of money or other
extension of credit between the plan and a party in interest; or (c)
transfer to, or use by or for the benefit of, a party in interest of any
assets of the plan. ERISA § 406(a), 29 U.S.C. § 1106(a).
30. It is undisputed that on December 20, 1995, U.S. Trust caused the
ESOP to purchase $70 million in shares of F&G from Foster, Regal,
Pellegrino and other parties in interest to the ESOP within the meaning
of ERISA § 3(14), 29 U.S.C. § 1002(14). The purchase of shares in F&G
by the ESOP on December 20, 1995 was a transaction which constituted a
sale or exchange of property between the ESOP and one or more parties in
interest within the meaning of ERISA § 406(a)(1)(A),
29 U.S.C. § 1106(a)(1)(A).
31. Accordingly, unless the December 20, 1995 transaction was exempt
from ERISA's prohibited transactions pursuant to the exemption set forth
in § 4 08 of ERISA,
29 U.S.C. § 1108, U.S. Trust would have violated ERISA when it
caused the ESOP to purchase those shares.
32. The exemption set forth in § 408(e) provides in
Sections 406 and 407 shall not apply to the
acquisition or sale by a plan of qualifying employer
securities (as defined in section 407(d)(5)) . . .
(1) if such acquisition, sale, or lease is for
adequate consideration (or in the case of a
marketable obligation, at a price not less favorable
to the plan than the price determined under section
407(e)(1)), (2) if no commission is charged with
respect thereto, and (3) if (A) the plan is an
eligible individual account plan (as defined in
section 407(d)(3)). . . .
Section 407(d)(5), 29 U.S.C. § 1107(d)(5) then defines a "qualifying
employer security" to include the stock of the employer, and §
407(d)(3)(A), 29 U.S.C. § 1107(d)(3)(A), then defines an "eligible
individual account plan" to include an ESOP.
33. There is no evidence that any commission was paid in connection
with the ESOP II transaction, as U.S. Trust was paid a predetermined fee
that did not depend upon whether the transaction was actually
consummated. Thus, the real issue under the § 408(e) exemption is whether
the ESOP paid more than adequate consideration for the shares it
purchased on December 20, 1995.
34. A fiduciary who claims that ERISA § 408 exempts a transaction from
the prohibitions of ERISA § 406(a) has the burden of proving that the
employer securities were purchased for no more than adequate
consideration within the meaning of ERISA § 3(18), 29 U.S.C. § 1002(18).
35. Since there was no public market for F&G's shares, adequate
consideration is the fair market value of the shares determined in good
faith by U.S. Trust. ERISA § 3(18), 29 U.S.C. § 1002(18). This
definition has two distinct parts the
"fair market value" part and the "as determined in good faith by
the trustee" part both of which must be proven by the fiduciary.
36. "Fair market value" is the price at which the property would change
hands between a willing buyer and a willing seller, neither being under
any compulsion to buy or to sell and both having reasonable knowledge of
relevant facts. Eyler v. Commissioner, 88 F.3d 445, 451 (7th Cir. 1996).
37. The "good faith" requirement establishes an objective rather than a
subjective standard of conduct, which is assessed in light of all
relevant facts and circumstances. Montgomery v. Aetna Plywood, Inc.,
39 F. Supp.2d 915, 937 (N.D. III. 1998).
38. "ESOP fiduciaries will carry their burden to prove that adequate
consideration was paid by showing that they arrived at their
determination of fair market value by way of a prudent investigation in
the circumstances then prevailing." Chao v. Hall Holding Co., 285 F.3d 415,
437-38 (6th Cir. 2002), citing Donovan v. Cunningham, 716 F.2d 1455,
1467-68 (5th Cir. 1982); Eyler, 88 F.3d at 455.
39. The ultimate outcome of an investment is not proof that a fiduciary
acted imprudently. DeBruvne, 920 F.2d at 465. Again, the fiduciary's duty
of care "requires prudence, not prescience," and the appropriateness of
an investment is to be determined from the perspective of the time the
investment was made, not from hindsight. Id.
40. A trustee has a duty to seek independent advice where he lacks the
requisite education, experience and skill, but it must ultimately make
its own decision based on that advice. Yet before relying an advisor's
opinion, the fiduciary must
conduct a prudent and sufficient investigation and make certain that
reliance on the advisor's advice is reasonably justified under the
circumstances. Chao, 285 F.3d at 430; Cunningham, 716 F.2d at 1473-4; In re
Unisys Savings Plan Litigation, 74 F.3d 420, 435 (3rd Cir. 1996)
("ERISA's duty to investigate requires fiduciaries to review the data a
consultant gathers, to assess its significance and to supplement it where
41. Assigning qualified individuals with appropriate experience to work
in concert with financial and legal advisors who are also highly
experienced is evidence that a trustee conducted a prudent investigation.
Howard, 100 F.3d at 1489; Martin, 965 F.2d at 671.
42. Here, the primary individuals assigned by U.S. Trust to work on the
F&G transaction were Goldberg and Shea. The evidence presented at
trial indicated that both Goldberg and Shea were qualified for this
assignment and had substantial past experience in ESOP transactions;
Plaintiffs have made no argument to the contrary.
43. U.S. Trust engaged Houlihan, a qualified valuation firm with
extensive experience in ESOP transactions, to work on the transaction and
worked in tandem with Houlihan to evaluate the financial aspects of the
transaction. Plaintiffs have not suggested that Houlihan was not an
experienced and qualified valuation expert.
44. Houlihan issued an opinion indicating that, based on its
independent analysis and valuation, the median of the range of fair
market value for F&G stock was $19.81 per share. Accordingly, Houlihan
opined that the $19.50 price per share was not greater than adequate
consideration for the securities, the transaction was fair and reasonable
to the ESOP from a financial point of view, the loan between the ESOP
F&G was fair and reasonable from a financial point of view, and
the interest rate for the loan was fair and reasonable from a financial
point of view.
45. Before it could rely on Houlihan's opinion in connection with the
December 20, 1995 transaction, U.S. Trust had a duty to verify that the
information on which Houlihan's opinion was based was accurate and that
Houlihan's assumptions made sense. The record indicates that U.S. Trust
did precisely that in this case.
46. Both U.S. Trust and Houlihan went to considerable lengths to
understand F&G's business and independently assess the merits of the
ESOP II transaction, including interviewing members of management,
visiting F&G's facilities, reviewing business plans, and examining
47. The record is also clear that U.S. Trust and Houlihan probed and
challenged a number of assumptions in Valuemetrics' evaluation before
developing their own independent evaluation that formed the basis for a
price per share at closing that was almost 20% less than the selling
shareholders' offering price.
48. While Sarafa and Strassman of Houlihan knew that MBC used
sweepstakes marketing extensively and that MBC was a main revenue center
for F&G, Houlihan did not consider the risk of governmental regulation
of the sweepstakes industry or any threat posed by MBC's dependency on
sweepstakes in assessing the value of F&G stock. Considering the record
in its entirety, it is clear that the reason why Houlihan did not factor
these circumstances into its valuation analysis is that no one at the
time of the 1995 transaction, including experts in the area of
sweepstakes marketing, either knew or reasonably should have known that
these matters posed any
material risk to F&G or could be expected to pose any material risk to
F&G in the foreseeable future.
49. Thus, with respect to the financial/valuation aspect of the
transaction, U.S. Trust investigated the December 20, 1995, transaction
with the care, skill, prudence, and diligence that a prudent man acting
in a like capacity and familiar with such matters would use in the
conduct of an enterprise of like character and with like aims and could
properly have relied on Houlihan's expert analysis.
50. U.S. Trust also engaged the Sonnenschein Firm, a respected law firm
known for its expertise in ERISA litigation, to perform the legal due
diligence and serve as its legal advisor for the transaction. Plaintiffs
have not suggested that the Sonnenschein Firm was not an experienced and
qualified legal expert.
51. U.S. Trust obtained an extensive opinion from counsel with regard
to ERISA and IRS matters in connection with the December 20, 1995,
transaction, and the Court finds no fault with that portion of the
Sonnenschein Firm's services. However, a careful review of that written
legal opinion would have revealed that it was confined solely to the
ERISA/IRS aspect of the transaction and expressly excluded any
consideration of any other laws. The testimony at trial indicated that it
was the custom in the industry for there to be no formal written report
documenting the results of corporate legal due diligence. The Court finds
this custom in the industry unacceptable. When a trustee is being asked
to determine whether an ESOP should purchase $70 million of the
employer's stock, every aspect of the legal due diligence must be
meticulously documented, for two reasons: (1) so that the trustee has
clear, unambiguous advice upon which to base an informed decision; and (2)
so that there is a
clear and unambiguous written record in existence by which to later
test the appropriateness of the trustee's decision making process if that
52. The evidence established that U.S. Trust's counsel did conduct some
corporate legal due diligence of F&G with respect to issues other
than ERISA and IRS matters. However, it appeared to be a rush job, during
which there is no evidence in the record that potentially relevant issues
made known to the attorneys with the Sonnenschein Firm received any
follow-up or clarification.
53. Specifically, U.S. Trust's counsel was provided with Awerdick's
audit letters and legal reports to F&G's board of directors containing
references to recent inquiries by three state attorney general's into
MBC's sweepstakes, but there is no evidence that any additional inquiries
were made. There were also references to perceived "threats" from
sweepstakes dependency and government regulation in MBC's strategic
plans. U.S. Trust's counsel reported on matters like litigation over the
pictures of cats on popcorn tins and a supplier agreement that might have
needed approval, but there was no evidence in the record indicating that
he even mentioned the pending inquiries from state attorneys general
regarding MBC's sweepstakes or conducted enough of an investigation to
reasonably determine whether such inquiries were material. Testimony at
trial suggested that such matters would be routinely discussed and
presented orally during the legal due diligence process. While this may be
true, and an appropriate investigation may in fact have been done, there
was a complete failure to document any such efforts. That failure to
document precludes the Court from making a finding that an adequate
corporate legal due diligence was conducted.
54. There is no evidence indicating that the Sonnenschein Firm ever
communicated any concerns to U.S. Trust about the adequacy of the time
available to conduct legal due diligence, any lack of cooperation on the
part of F&G, or the existence of inquiries from state attorneys general
into MBC's sweepstakes marketing practices. Absent the communication of
any material concerns, Goldberg of U.S. Trust presumed that there were
55. Goldberg testified that had he been provided with the same
information provided to U.S. Trust's counsel, he would have asked for a
further understanding in order to determine the materiality of the
information. However, Goldberg stated that given his understanding of the
industry, the outcome of the transaction would not have been different.
56. Had there been further investigation into the sweepstakes
inquiries, the uncontroverted evidence of record indicates that U.S.
Trust would have discovered that none of the state attorney general
inquiries received by MBC prior to December 20, 1995, had resulted in any
enforcement action or negative consequences to the company and that the
inquiries pending at that time were expected to be resolved in the normal
course of business without any material consequences. While sweepstakes
marketing was beginning to receive a higher degree of scrutiny from
governmental regulatory agencies, and therefore posed the possibility of
a greater likelihood of enforcement through consumer protection laws, the
evidence presented at trial indicated that 1995 was a "quiet" period in
the industry from a regulatory perspective.
57. Defendants' expert Durchslag testified that experts in sweepstakes
law would not have considered the few state inquiries received by MBC in
1995 to be
material or a sign of significant impending regulatory problems.
Accordingly, there is no basis for the assertion that consideration of
sweepstakes risk by a prudent investor would have reduced the value of
F&G stock or caused a prudent investor not to engage in the ESOP II
transaction at all. The fact that U.S. Trust and its legal advisor did
not identify a risk that the Court finds was not material cannot be
considered evidence of an imprudent or bad faith investigation for
purposes of precluding an otherwise applicable exemption under § 4 08(e).
58. Plaintiffs' expert Wolski testified that U.S. Trust's performance
was deficient for failing to utilize an independent accounting firm as
part of the due diligence team to review F&G's financials. However,
Wolski testified that he had never worked on an ESOP transaction and was
not experienced in the area of ESOPs, so his testimony in this regard is
entitled to little weight. While hiring an independent CPA firm might be
an advisable undertaking when considering a major stock purchase in a
non-ESOP transaction on the open market, there is nothing in the record
indicating that such a step is legally required in an ESOP transaction or
that a qualified financial advisor's review of the independently audited
financial statements as part of its analysis would not be compliant with
the standards and practices of prudent ESOP trustees. Additionally, the
Court notes that Wolski testified that his fees incurred through the time
of his testimony were approximately $350,000.00. As Wolski was engaged to
review the due diligence performed in connection with the 1995 stock
purchase transaction and did not perform the audit/financial review that
he testified should have been done by a CPA firm in this case, it would
appear that the kind of expert assistance that he recommended would be
cost prohibitive in many ESOP transactions.
59. As the $19.50 purchase price was supported by the valuations
performed by Valuemetrics and Houlihan, as well as by the retrospective
valuation performed by Reilly, and the Court has found the testimony by
Plaintiffs' expert Hitchner that the value of F&G stock in 1995 was
lower than $19.50 per share to be less credible, and the record does not
demonstrate that U.S. Trust either arrived at its determination of fair
market value imprudently or acted in bad faith, the Court finds that the
ESOP II transaction was not for more than adequate consideration.
60. The December 20, 1995, purchase of shares in F&G by the ESOP was
therefore exempt from ERISA's prohibited transactions, and Plaintiffs'
prohibited transaction claim against U.S. Trust must fail.
61. Plaintiffs have also asserted a prohibited transaction claim
against Foster, Regal, and Pellegrino. This claim is essentially based on
the theory that these individuals, acting as the executive committee,
effectively controlled whether the ESOP II transaction would proceed
through the appointment of U.S. Trust as trustee and had a corresponding
duty to oversee the due diligence conducted by the U.S. Trust team. When
questioned at trial as to how U.S. Trust could have functioned as an
independent trustee if the members of F&G's executive committee (who
were also selling shareholders) were supervising its due diligence
process, Plaintiffs' counsel clarified that the duty of oversight was
really coextensive with the fiduciary duty to provide accurate and
62. The Court has previously determined that Foster, Regal, and
Pellegrino did not breach any fiduciary duty by failing to disclose or
attempting to conceal any material information in connection with the
ESOP II transaction. It is also clear from the
record that Foster, Regal, and Pellegrino could not have breached any
fiduciary duty by causing the ESOP to enter into a transaction prohibited
by ERISA § 406, because it was U.S. Trust, and not these individuals,
that made the independent decision that caused the ESOP to purchase
shares in F&G on December 20, 1995, and any argument that U.S. Trust was
anything other than an independent trustee has previously been rejected.
Thus, there is no reason why Foster, Regal, and Pellegrino would not also
be entitled to the protection of the § 408(e) exemption.
Claim Against U.S. Trust for Failure to Take
Following the December 20. 1995 Transaction
63. A fiduciary's duty to investigate the plan's administration is not
limited to the time before such investments were made. Rather, "[o]nce
the investment is made, a fiduciary has an ongoing duty to monitor
investments with reasonable diligence and remove plan assets from an
investment that is improper." Harley v. Minnesota Mining and Mfg. Co.,
42 F. Supp.2d 898, 906-07 (D.Minn.1999), affirmed, 284 F.3d 901
Cir. 2002); see also, Barker v. American Mobil Power Corp., 64 F.3d 1397
1402-04 (9th Cir. 1995); Morrisey v. Curran, 567 F.2d 546
, 549 n.9 (2nd
64. U.S. Trust commonly received legal reports to F&G's board of
directors after the 1995 transaction, and Goldberg attended some F&G
board meetings during which legal matters were discussed, including
inquiries from state attorneys general, the Assurance of Discontinuance
with the State of Michigan, and settlements with Connecticut and Vermont.
Goldberg testified that he was aware of these incidents shortly after
they occurred. Testimony at trial also indicated that U.S. Trust also
took an active role in the annual valuation process.
65. Plaintiffs have made much of the fact that U.S. Trust made no
investigation to determine whether the ESOP had any recourse against any
of the parties or advisors involved in the 1995 transaction after the
dramatic decline in ESOP share value reported for December 31, 1998, or
even up to the time that this lawsuit was filed. However, Plaintiffs'
argument is premised on the assertion that the 1995 transaction was an
imprudent investment at the time the ESOP II transaction occurred. That
assertion was not borne out by the evidence presented at trial.
66. It is important to note that because Plaintiffs' theory of the case
was premised on this assertion, the focus of Plaintiffs' monitoring claim
was the argument that, when business started going bad for F&G in
1998, U.S. Trust should have gone back and investigated the circumstances
surrounding the 1995 transaction in order to preserve any claims against
the participants in that transaction. Plaintiffs did not claim that as
the value of F&G stock began to decline, U.S. Trust should have
asserted its prerogative to become more actively involved in the
management of the company or to have taken certain steps to correct
corporate mismanagement in the post-February 1998 business climate.
67. Goldberg credibly testified that the reason he made no
investigation into any recourse against those involved in the 1995
transaction was because he had been monitoring the situation at F&G and
was confident that the reason for the decline in ESOP share value was the
wave of adverse publicity following the incident with American Family
Publishers in February 1998 and the precipitous drop in response rates
that ensued thereafter. Thus, he did not consider the claims suggested by
Plaintiffs to have had any real merit.
68. As the Court has rejected the assertion that Foster, Regal, and
Pellegrino breached any fiduciary duty owed to the ESOP in connection
with the 1995 transaction, any such claim would have been without merit.
69. Any claim against Houlihan would have been similarly unmeritorious,
as there was no flaw with Houlihan's performance of its role as financial
advisor to U.S. Trust in connection with the ESOP II transaction. The
sweepstakes risk that Plaintiffs claim should have been included in
Houlihan's analysis was not of the magnitude suggested by Plaintiffs and
was not a material risk in December 1995. Accordingly, the fact that this
information was not factored into Houlihan's analysis was not erroneous,
as it would have had no material effect on the validity of the valuation
70. To the extent that the Sonnenschein Firm failed to conduct proper
legal due diligence, a claim against the firm would not have yielded any
recovery for the ESOP, as there is no evidence of record indicating that
a more thorough investigation into MBC's sweepstakes marketing practices
by state attorneys general would have stopped the ESOP transaction from
occurring, caused the transaction to proceed at a lower share price, or
prevented the decline in value of the ESOP's shares of F&G stock
beginning in 1998. To the contrary, the evidence produced at trial
established that full knowledge of the information about MBC's
sweepstakes marketing practices and governmental inquiries that existed
on December 20, 1995, would not have changed the outcome of the
transaction, and that the loss in value of the ESOP's shares was caused
by the dramatic decline in customer responses following the unprecedented
wave of anti-sweepstakes publicity in 1998.
71. Plaintiffs suggest that U.S. Trust should have pursued claims
against Foster, Regal, and Pellegrino for breach of duty owed to the ESOP
by virtue of the representations and warranties contained in the Stock
Purchase Agreement, yet there is no evidence establishing that there was
any such breach. Those warranties included a warranty that F&G and its
subsidiaries "are in compliance with all applicable laws, except those of
which a violation would not and, so far as each Controlling Shareholder
can now foresee, will not, individually or in the aggregate, materially
adversely affect the" business of F&G and its subsidiaries. As it was
reasonably believed by both F&G management and experts in the field at
the time that governmental inquiries related to sweepstakes marketing
were not material concerns, the warranties made by Foster, Regal, and
Pellegrino were not false or breached.
72. Plaintiffs have cited no authority requiring a prudent ESOP trustee
to pursue every conceivable claim that a plan could have brought against
third parties regardless of its perceived merit. Accordingly, given the
prior findings of the Court, there is no basis for Plaintiffs' suggestion
that U.S. Trust should have investigated and pursued claims against
Foster, Regal, Pellegrino, Houlihan, or the Sonnenschein Firm. Any such
claims would only have caused the ESOP to expend substantial resources on
Claim that U.S. Trust Acted Without Authority
73. Plaintiffs originally claimed that in consummating the 1995 stock
purchase transaction, U.S. Trust acted without authority because Magna
Bank's removal as ESOP trustee was not complete on December 20, 1995. As
a result, Plaintiffs asserted that U.S. Trust and Magna Bank were
co-trustees at that time and that U.S. Trust could
not have acted on behalf of the ESOP without Magna Bank's consent.
As the record in this case established that Magna Bank was aware of the
ESOP II transaction but made no effort to object to U.S. Trust acting as
trustee at closing, ask to attend the closing itself, try to prevent the
closing, or make any attempt to be involved in the decisionmaking
process, and Plaintiffs presented no evidence that Magna Bank asserted
that it was still trustee at the time of the ESOP II transaction, that
its approval was necessary, or that Magna Bank ever took any action to
challenge the ESOP II transaction on any grounds, Magna Bank either
waived or ratified any technical defects in the process of its removal as
trustee of the ESOP. A directed verdict to this effect was entered in
favor of U.S. Trust at trial.
Liability for Breach of ERISA Fiduciary Duties
74. A fiduciary who breaches any of the responsibilities, obligations,
or duties imposed upon fiduciaries by Title I of ERISA is personally
liable to make good to the plan any losses to the plan resulting from
each such breach, and to restore to the plan any profits which have been
made through use of assets of the plan by the fiduciary. ERISA § 409,
29 U.S.C. § 1109.
75. The "resulting from" language means that "a causal connection is
required between the breach of fiduciary duty and the losses incurred by
the plan." Brandt v. Grounds, 687 F.2d 895, 898 (7th Cir. 1982); Silverman
v. Mutual Benefit Life Insurance Co., 138 F.3d 98, 104 (2nd Cir. 1998).
76. The burden of proving that any loss was not caused by the
fiduciary's breach is upon the fiduciary. Secretary of Labor v. Gilley,
290 F.3d 827, 830 (6th Cir. 2002); Chao, 285 F.3d at 438-39; Engle, 727
F.2d at 138-39; Roth v. Sawyer-Cleator
Lumber Co., 61 F.3d 599, 605 (8th Cir. 1995) ("If a breach of fiduciary
duty caused the Plan to purchase Company stock which declined in value,
the causal link between the breach and the loss is established, even if
the Company stock would have inevitably declined in value.")
77. As the Court has found no breach of any fiduciary duty owed by
Foster, Regal, or Pellegrino, there is no occasion to consider the
question of damages on Plaintiffs' claim against them.
78. As the Court has found no breach of fiduciary duty by U.S. Trust in
relying on the opinion of Houlihan as its financial advisor or failing to
investigate and take action to preserve claims on behalf of the ESOP,
there is no occasion to consider the question of damages on these claims.
79. The Court has found that on the record in this case, the
Sonnenschein Firm's failure to identify a risk that was not material was
not evidence of an imprudent or bad faith investigation for purposes of
precluding an otherwise applicable exemption under § 4 08(e). As ERISA §
406 only prohibits an ESOP trustee from purchasing employer securities
from parties in interest if the trustee does not meet the requirements of
ERISA § 408(e), and the Court has found that U.S. Trust has satisfied
the requirements of the § 408(e) exemption, there is no occasion to
consider the question of damages on Plaintiffs' prohibited transaction
80. Alternatively, even assuming that U.S. Trust had breached a
fiduciary duty by improperly relying on the inadequate legal due
diligence conducted by the Sonnenschein Firm, U.S. Trust has met its
burden of demonstrating that any loss to the ESOP was not caused by any
such breach. The portion of the corporate legal due
diligence that was either overlooked or undocumented, namely the
regulatory inquiries made by state attorneys general into MBC's
sweepstakes marketing practices and the risk of sweepstakes dependency,
was not a material consideration with respect to the propriety of the
ESOP II transaction and posed no actual or reasonably foreseeable
material risk to F&G at the time of the 1995 transaction. There is no
credible evidence of record establishing that any different actions by
U.S. Trust would have had any impact on the outcome of the ESOP II
81. Moreover, the record established that the cause of the loss to the
ESOP was the decline in customer response rates brought on by the adverse
publicity following the American Family Publishers incident in February
1998, as well as possible acts of corporate mismanagement related
thereto, and not any material risk to the value of F&G stock due to
sweepstakes dependency or governmental regulation of the sweepstakes
industry in connection with the ESOP II transaction on December 20, 1995,
as suggested by the Plaintiffs.
82. There is therefore no occasion to consider the question of damages
on Plaintiffs' claim against U.S. Trust for breach of fiduciary duty
based on its reliance on the legal due diligence performed by the
For the reasons set forth above, the Court finds in favor of Defendants
U.S. Trust, Regal, and Pellegrino and against Plaintiffs on the breach of
fiduciary duty claims asserted in the First, Third, and Fifth claims for
relief in the First Amended Complaint.
The Court will contact the parties in the near future to schedule a
telephonic conference call at which the process for resolving the
remainder of this litigation will be discussed.