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.
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.
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 ...