appropriate to use same valuation firm for minority ESOP shareholders

[EGB]

Is it necessarily inappropriate for an ESOP to retain the same valuation firm to value the stock and issue a fairness opinion as is retained by the majority shareholders for a merger of the companys ponsoring the ESOP? Assume the valuation firm is truly independent of the company and the shareholders. Aware of any cases, DOL audit, etc. where one of the issues is the use of the same valuation firm for both the majority shareholders and the minority ESOP?

Also, it is necessarily inappropriate in a merger to have the majority shareholders participate in an earnout, but not the ESOP -the ESOP is to be paid some sort of premium since it cannot participate in the earnout? The ESOP is being terminated in connection with the merger. Aware of any cases, DOL audit, etc. where an issue involves no earnout for the ESOP?

Any comments are appreciated. Thanks.

[RLL]

Hi beth ---

If there is a possibility that the ESOP and the majority shareholders may be treated differently in the merger, there is clearly a conflict of interest for the valuation firm to represent both. How can one firm represent both sides in the negotiation as to the merger consideration to be received by the various parties?

The valuation firm ceases to be "truly independent" when it is retained by the majority shareholders. What's the objection to having the ESOP independently represented? Is there an independent fiduciary for the ESOP?

I do know of several merger situations involving ESOPs in which the DOL objected to multiple representation by the valuation firm.

[EGB]

RLL-- thanks for your response.

As the facts turn out, the same valuation firm is not being used for both the majority and the minority with respect to the merger. Rather, the 70% majority shareholder (also a trustee of the plan) recently used the valuation firm to value the company for purposes of assisting said shareholder in making transfers to an LLC and GRATS that said shareholder was establishing. Now, the trustees (there are three) want the same firm to issue a fairness opinion and valuation for the merger, just for the ESOP, but not for the majority shareholders. This same firm is also anticipated to evaluate the stock of the Company as of 12-31-02 for allocation purposes (a different firm has been used in the past for the annual valuation). So, the question really is whether there is any conflict in this valuation firm handling the fairness opinion given that it recently valued the company for the majority shareholder and trustee on an estate planning matter and given that it will handle the 12-31-02 valuation. The trustees want to use this particular valuation firm for a few reasons; first, it is a well-recognized, excellent valuation firm in which they trust to do a good job; second, economies of scale - because of the recent valuation, the firm has much of the information needed to issue a fairness opinion and thus will not have to start from scratch - lesser fees; and third, because the firm has a headstart, it can issue the opinion more quickly. The valuation firm is comfortable that it does not have a conflict.

RLL - are the DOL objections regarding the use of the same valuation firm that you referred to in the form of DOL opinion letters?

[RLL]

Hi beth ---

The opinion of the valuation firm that it doesn't have a conflict sounds like the major investment banking firms' saying there's no conflict when the investment research people are generating investment banking business from the companies they are rating. Ask NY AG Elliot Spitzer about that.

Your situation involves an ESOP which is not represented by an independent fiduciary. It appears that there is a possibility that the ESOP may be treated differently from the majority shareholder (who also happens to be an ESOP trustee). The big "fairness" issue here is the different treatment of the ESOP.

Under these circumstances, I would strongly recommend retaining an independent fiduciary to represent (and negotiate on behalf of) the ESOP in this transaction.

Alternatively, you should have the majority shareholder resign as an ESOP trustee and have the two remaining trustees (I assume that they aren't related to the majority shareholder....hopefully, they can demonstrate that they're acting independently) retain legal counsel and a financial adviser (that are truly independent of the majority shareholder) to assist in negotiating the terms of the merger on behalf of the ESOP.

The situations in which DOL objected to multiple representation by a valuation firm involved investigations and litigation.

[IRC401]

Beth-

People who do valuations for estate tax purposes tend to value on the low side so that the client will owe a lower amount of estate or gift tax (assuming that the IRS doesn't challenge the valuation). The trustees should regard anyone who does any estate or gift work for a majority shareholder as having a conflict of interest (possibly including the current auditors) and hire independent consultants, probably including valuation specialists who do not have a major estate valuation practice. An independent valuation for the ESOP could cause serious problems for the majority shareholder's estate planning (which may be an unspoken reason why he wants to use the same firm). Why didn't the majority shareholder use an exsiting ESOP valuation to value his shares???????

[Kirk Maldonado]

I concur in the remarks made by RLL.