Keach v. U.S. Trust Co.

• Decision Date: 17 August 2005
• Docket Number: No. 04-1901.,04-1901.
• Citation: 419 F.3d 626
• Parties: Debra K. KEACH and Patricia A. Sage, Plaintiffs-Appellants, v. U.S. TRUST COMPANY, formerly known as U.S. Trust Company of California N.A., Defendant-Appellee.
• Court: U.S. Court of Appeals — Seventh Circuit

419 F.3d 626

Debra K. KEACH and Patricia A. Sage, Plaintiffs-Appellants, v. U.S. TRUST COMPANY, formerly known as U.S. Trust Company of California N.A., Defendant-Appellee.

No. 04-1901.

United States Court of Appeals, Seventh Circuit.

Argued December 10, 2004.

Decided August 17, 2005.

COPYRIGHT MATERIAL OMITTED

Sean M. Anderson (argued), Sutkowski & Rhoads, Peoria, IL, for Plaintiffs-Appellants.

Robert N. Eccles (argued), O'Melveny & Meyers, Washington, DC, for Defendant-Appellee.

Before RIPPLE, MANION and WOOD, Circuit Judges.

RIPPLE, Circuit Judge.

Debra Keach and Patricia Sage, participants in the Foster & Gallagher, Inc. Employee Stock Ownership Plan ("ESOP"), filed this action against U.S. Trust Company, N.A. ("U.S.Trust") and others for alleged violations of the Employee Retirement Income Security Act of 1974 ("ERISA"), 29 U.S.C. § 1001 et seq., in connection with the ESOP's December 20, 1995 purchase of shares of Foster & Gallagher, Inc. ("F & G") stock from the defendant F & G officers and directors. The district court conducted a fourteen-day bench trial and then entered judgment in favor of U.S. Trust. Ms. Keach and Ms. Sage now appeal from that decision. For the reasons set forth in the following opinion, we affirm the judgment of the district court.

I BACKGROUND

A. Facts

The facts of this case are, for the most part, undisputed.¹ F & G was a direct mail marketing company engaged in the marketing of gifts, housewares and novelty items. Over time, F & G acquired several companies, many of which marketed horticultural products through the mail. The F & G ESOP began in 1988, when it purchased about thirty percent of F & G's stock from the company's founders. In 1995, after Thomas Foster, CEO and Chairman of the F & G board of directors, became terminally ill, a leveraged purchase of a large number of F & G shares by the ESOP was proposed. At that time, F & G had been enjoying record profitability for several years and was forecasted to continue this trend into the future. On December 20, 1995, the ESOP, with U.S. Trust acting as its trustee, purchased 3,589,743 shares of F & G stock from several F & G officers and directors at a price of $19.50 per share (the "ESOP II transaction"). For the next two years, F & G did enjoy record business; however, in 1998, its profits began to decline steadily until F & G declared bankruptcy in 2001. Ms. Keach and Ms. Sage filed this action in April 2001 after the value of F & G shares had reached less than fifty percent of their original purchase price.

1. Michigan Bulb Company

In 1995, F & G's largest subsidiary was Michigan Bulb Company ("MBC"), a direct mail marketer of horticultural products. MBC conducted direct mail sweepstakes promotions to its customers primarily in three different formats: (1) an "everybody wins" sweepstakes, in which every person who returned an entry form won a "special prize," regardless of whether or not they placed an order; (2) a base sweepstakes that awarded a total of $250,000 annually and had a grand prize of $100,000; and (3) a pre-selected giveaway, in which the winners were determined before the mailing.

In 1991, MBC retained an attorney, John Awerdick, a specialist in advertising law and sweepstakes issues, to review its mailings for compliance with the law. Initially, Awerdick advised MBC that the laws of nine states could be read to prohibit the "everybody wins" type of promotions, and he advised that states increasingly were using prize and gift laws to regulate sweepstakes. In the attorney's view, the level of risk to MBC was difficult to assess because the laws were not enforced strictly. By the spring of 1992, MBC had established a practice of having Awerdick review each new proposed promotion; if he advised MBC not to send out a particular mailing, the mailing was not sent.

On February 23, 1994, and February 22, 1995, Awerdick provided letters to F & G's outside auditor, Price Waterhouse, in which he discussed trends in the regulation of sweepstakes. The 1994 letter noted:

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 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 of these state statutes.

R.271, Ex.186. The 1995 letter contained substantially similar language to that quoted directly above, except that it deleted the sentence, "I know of no current attempts to enforce these laws against traditional conventional direct mail sweepstakes operators," because MBC had received an inquiry about its sweepstakes from the Attorney General of North Carolina. Although Awerdick informed MBC of these risks, he never advised MBC to stop using "everybody wins" promotions. Nor did he ever advise MBC that any changes required to bring its sweepstakes into compliance with the state laws would have a significantly adverse impact on MBC's financial situation.

MBC received thousands of inquiries each year from state attorneys general ("state inquiries"), better business bureaus, action lines and others about its promotions. In and before December 1995, MBC had responded to inquiries from the attorneys general of eight states. Dale Fujimoto, MBC's senior vice president of marketing, testified that such inquires were viewed as part of the routine of the direct mail order business and were not considered a source of concern. None of the state inquiries resulted in an enforcement action against MBC or otherwise had material adverse consequences on MBC. At trial, U.S. Trust's expert Stephen Durchslag, an attorney with thirty-seven years' experience in the field of promotions and advertising law, including sweepstakes, testified that the legal environment surrounding sweepstakes in 1995 was favorable and that he and other sweepstakes experts would have considered these type of inquiries to be normal and not an indication that MBC was at risk of significant regulatory or enforcement problems.

2. ESOP II Transaction

F & G retained Valuemetrics, Inc. ("Valuemetrics") as its financial advisor to help structure the proposed ESOP II transaction. 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 per share.

U.S. Trust served as an independent trustee for the ESOP to consider the merits of the proposed transaction. U.S. Trust, in turn, engaged Houlihan, Lokey, Howard & Zukin ("Houlihan") to assist it in valuing the transaction and to render a written opinion to U.S. Trust as to whether the transaction was fair to the ESOP from a financial perspective. On October 17, 1995, Norman Goldberg and Michael Shea of U.S. Trust and Martin Sarafa and Todd Strassman of Houlihan met with F & G executives to perform corporate due diligence for the stock transaction. At that meeting, Goldberg of U.S. Trust also spoke with Robert Ostertag, president of MBC at the time, about MBC and its sweepstakes promotions. At the October 17 meeting: (1) Ostertag did not identify government regulation of sweepstakes as a risk; (2) no F & G representative identified either the primary role of sweepstakes to MBC's business or possible government regulation of sweepstakes as a risk; and (3) there was no discussion of MBC's dependency on sweepstakes being a negative, of the pending state inquiries or of state laws that regulated MBC's sweepstakes marketing. Shea also toured the MBC facilities and spoke with additional members of MBC's management. Testimony from F & G officers, found to be credible by the district court, indicated that state regulation and sweepstakes issues were not considered to be material factors in the ESOP II transaction at any time.

Around this same time, B.A. Securities, a subsidiary of the Bank of America corporation, conducted its own due diligence of F & G and issued a private placement memorandum for potential lenders into the prospective ESOP II transaction. The memorandum did not identify sweepstakes as an inherently risky promotional tool or identify any legal or regulatory risk. By November 20, 1995, four institutional lenders, in combination, were willing to loan F & G the requested $70 million on favorable terms for the ESOP II transaction.

After its inquiries into F & G and MBC, Houlihan prepared an analysis for U.S. Trust of F & G financials with respect to the offer price of $24 per share. Based on Houlihan's analysis, U.S. Trust determined that Valuemetrics' analysis was too optimistic in some respects. Houlihan prepared a new analysis reflecting a lower valuation range for the price of the F & G shares. On November 7, 1995, U.S. Trust suggested a share price of $18.50; F & G officers rejected the offer and negotiations broke off. Negotiations later resumed, and, 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, subject to further due diligence by U.S. Trust.

On December 19, 1995, Houlihan presented a report to U.S. Trust concluding that the midpoint value of the F & G stock was $19.81 per share at the time. In preparing this fairness opinion,...