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Pizzella v. Vinoskey

United States District Court, W.D. Virginia, Lynchburg Division

August 2, 2019

Patrick Pizzella, Acting Secretary of Labor, U.S. Department of Labor, Plaintiff,
v.
Adam Vinoskey, ET AL., Defendants.

          MEMORANDUM OPINION

          NORMAN K. MOON, SENIOR UNITED STATES DISTRICT JUDGE.

         The Employment Retirement Income Security Act of 1974 (ERISA) permits an employer to create an Employee Stock Ownership Plan (“ESOP”). An ESOP is “an employee pension plan that invests primarily in the employer's stock.” Brundle v. Wilmington Trust, N.A., 919 F.3d 763, 769 (4th Cir. 2019). ERISA imposes stringent “duties and obligations on all pension plan fiduciaries, including those of ESOPs.” Id. Among these obligations are robust duties of prudence and loyalty. See 29 U.S.C. §§ 1104(a)(1)(A)-(B). Moreover, ERISA prohibits ESOP fiduciaries from causing a “sale or exchange . . . of any property between the plan and a party in interest.” Id. § 1106(a)(1)(A). However, ERISA provides an exception for party-in-interest transactions where the ESOP “receives no less, nor pays no more, than adequate consideration” for the employer's stock. Id. § 1108(e)(1); Brundle, 919 F.3d at 769.

         In this case, the Secretary of the Department of Labor alleges that an independent transactional trustee (Evolve Bank and Trust (“Evolve”)) and Adam Vinoskey, the CEO of Sentry Equipment Erectors, Inc. (“Sentry”) violated ERISA by approving the Sentry ESOP's purchase of Adam Vinoskey's stock in December 2010 at an allegedly inflated price. Specifically, the Secretary alleges that the $406.00 per share paid for Adam Vinoskey's 51, 000 shares was not the fair market value of the stock, resulting in the ESOP overpaying for the stock by $11, 526, 000.00, which the Secretary seeks to recover for the ESOP. The Secretary alleges that Evolve violated its duties of prudence and loyalty, and that Adam Vinoskey is jointly liable for the ESOP's losses as a knowing participant in a prohibited transaction and as a co-fiduciary of the Sentry ESOP.

         After a week-long bench trial, and for the reasons that follow, the Court holds that Evolve violated § 1106(a)(1)(A) by approving a prohibited party-in-interest transaction for more than adequate consideration; that Evolve failed to live up to ERISA's stringent duties of prudence and loyalty; and that Adam Vinoskey is jointly liable for the losses caused by Evolve's breaches as a knowing participant in a prohibited transaction and as a co-fiduciary of the ESOP. The Court finds that the ESOP overpaid for Adam Vinoskey's stock by $6, 502, 500.00, an amount for which Evolve, Adam Vinoskey, and the Adam Vinoskey Trust are jointly and severally liable.

         I. FINDINGS OF ACT[1]

         A. Sentry Background

         Adam and Carole Vinoskey founded Sentry Equipment Erectors, Inc. in 1980. (Dkt. 34 ¶ 10 (“Vinoskey Answer”)). Sentry designs and sells equipment such as conveyors and bottling machines for soft drink manufacturers, and maintains its principal place of business in Forest, Virginia, near Lynchburg, Virginia. (Vinoskey Answer ¶ 6; Tr.2 178:24-25, 179:1-11 (Vinoskey)).[2] To retain workers, Sentry offered generous benefits, such as the Sentry ESOP and paying 100 percent of employees' health care premiums. (Tr.1179:17-25, 180:1-5 (Holcomb)). Over the decades, Sentry has attracted major corporations as customers, including Coca-Cola, Dr. Pepper, and Snapple. (Tr.4 208:24-25, 209:1-4 (Connor)).

         Adam Vinoskey served as Sentry's CEO and the Chairman of Sentry's Board of Directors, and Carole Vinoskey, who passed away in July 2011, served as Sentry's Secretary/Treasurer. (JX 28 at 3479; JX 69; Tr.1180:14-21 (Holcomb)). Although Adam Vinoskey maintains that “[p]eople came to visit [Sentry] and wanted to buy the company” on at least three occasions over the decades, Sentry has never received any formal offers to purchase the company “that included prices.” (Tr.2 188:12-25, 189:1-17; see also Tr.1 79:21-24 (Lenoir); Tr.4 199:23-25; 200:1-3 (Lenoir)). Because Sentry's clients are primarily concentrated in the soft drink industry, Sentry's income generally varies depending on when bottling plants decide to make large capital improvements. (Tr.1 231:16-21 (Napier); id. 71:3-6, 72:8-9, 73:1-8 (Lenoir); id. 197:9-20 (Holcomb); Tr.4 236:6-25 (Connor); JX 23; PTX M 10:14-20 (Vinoskey Depo., stating that soft drink companies account for 80 percent of Sentry's business)).

         B. Formation of the Sentry ESOP and the 2004 Transaction

         Since “day one” of founding Sentry, Adam Vinoskey aspired for Sentry's employees to eventually own the company “because they helped build it.” (Tr.2 184:7-10, 188:15-17 (Vinoskey)). In pursuit of that goal, Sentry formed an ESOP in 1993. (See JX 1-6). The purpose of the ESOP was to provide employees “with an additional means of accumulating funds for retirement as well as a meaningful stake in the Company, with future economic security and ultimately with an additional source of future income.” (JX 1 at 818; see also Tr.1169:12-25, 170:1-25, 171:1-8 (Holcomb) (noting similar goals)).

         Under the ESOP Plan, the shares of company stock held by ESOP participants would “generally” be voted by the ESOP Trustee(s), except in “certain limited but important corporate matters, such as a sale of all the Company's assets or merger of the Company, ” when ESOP participants would “have the right to instruct the Plan Trustee as to [their] wishes relative to the shares of Company Stock held in [their] ESOP Account.” (JX 1 at 831 (ESOP Plan Summary Description); JX 2 at 111 (Restated ESOP Plan)). From 2006 to at least July 31, 2012, Adam Vinoskey was a named ESOP Trustee. (JX 69 at 95; PTX A-D). The Sentry ESOP had 224 participants as of December 2010. (JX 64 at 528).

         After founding the ESOP, Sentry hired W. William (“Bill”) Gust of the law firm Gentry Locke to provide legal services related to the ESOP. (Tr.2 182:18-25; 183:1-2 (Vinoskey)). Gust recommended that Sentry hire the appraisal company Capital Analysts, Inc. (“CAI”) to conduct annual appraisals of Sentry's stock. (Id. 5:3-14 (Napier); id. 183:24-25, 184:1-6 (Vinoskey); Tr.1 222:2-6 (Napier)). CAI is a valuation firm founded in 1981 by its president Brian Napier. (Tr.2 81:24-25, 82:1-5 (Napier)). Napier is certified to perform valuations by the American Society of Appraisers, and has completed “at least a thousand” ESOP valuations. (Id. 81:3-25; 82:1-14 (Napier)).

         From 2005 through at least 2015, Napier has drafted and finalized appraisals of Sentry's stock. (PTX A-I; JX 84-86). Between 2005 and 2009, Napier's appraisal of Sentry's stock ranged from $215.00 per share in December 2005, (PTX A at 2502), to $285.00 per share in December 2009, (JX 84 at 267). (See PTX B-D).[3] When Sentry ESOP participants retired, Sentry bought their shares at the price established by Napier's latest appraisal. (Tr.1174:4-7 (Holcomb)). At some point before 2010, upon Gust's recommendation, Sentry developed a working relationship with Corporate Capital Resources (“CCR”), a business that helps companies establish ESOPS. (Tr.2 183:24-25, 184:1-6 (Vinoskey); 139:5-6 (Lenoir)). Michael Coffey served as Sentry's primary contact at CCR. (Id. 184:23-24 (Vinoskey)).

         In 2004, the ESOP purchased 48 percent of Sentry's stock at $220.00 per share. (Vinoskey Answer ¶ 12; Tr.1 222:7-9 (Napier)). Sentry did not hire an independent fiduciary to review the prudence of this transaction. (Tr.2 185:6 (Vinoskey)). The ESOP borrowed a portion of the purchase price from Sentry, and Sentry subsequently made contributions to the ESOP that allowed the ESOP to fully repay the loan by 2010. (Vinoskey Answer ¶ 12). As the debt was paid down, the shares were allocated to individual participant accounts. (Id.). In 2009, 48 percent of Sentry's stock had been allocated to participant accounts, and Adam Vinoskey, through the Adam V. Vinoskey Revocable Trust (“Adam Vinoskey Trust”), owned the remaining 52 percent of Sentry's shares. (JX 84 at 276; Vinoskey Answer ¶ 7). Adam Vinoskey is the trustee of the Adam Vinoskey Trust, exercises control over the Trust's assets, and owns at least 50 percent of the beneficial interest in the Trust. (Vinoskey Answer ¶ 7).

         C. Prelude to the 2010 Transaction: Adam Vinoskey Decides to Sell; Sentry ESOP Hires Evolve; Evolve's Background

         In or around 2010, as Adam Vinoskey approached his anticipated retirement, Adam Vinoskey informed Bill Gust that he was interested in selling all of his shares to the ESOP, a transaction that would give the ESOP 100 percent ownership of Sentry (“the 2010 Transaction”). (Tr.2 184:7-19 (Vinoskey)). Carole Vinoskey planned to retire around the same time, with Barbara Holcomb, Sentry's current Chief Financial Officer (CFO), joining the company in the summer of 2011. (Tr.1164:24-25, 205:12-25, 206:1-20 (Holcomb)). Gust suggested that Evolve Bank and Trust (“Evolve”) be hired as an independent fiduciary to represent the ESOP in the proposed transaction. (PTX M 47:1-10 (Vinoskey Depo.)).

         Evolve is a bank with headquarters in Memphis, Tennessee that has served as a trustee for ESOPS and other trust assets since 2005. (JX 100 at 5, 33). From 2006 to 2016, Kenneth (“Kenny”) Lenoir served as Executive Vice President / Manager of Evolve's trust department, a role in which Lenoir was primarily responsible for Evolve's ESOP trustee business. (Tr.1 35:8-16 (Lenoir); Tr.4 169:12-18 (Lenoir)). Lenoir has worked in the retirement trust business since approximately 1970, and has worked with roughly 500 ESOPs. (Tr.4 168:24-25, 169:1-3 (Lenoir)). Lenoir worked alongside two other individuals in operating Evolve's trustee business: Michael New, who served as Senior Trust Officer from 2006 to 2017, and C. Douglas Kelso, who served as Executive Vice President of Operations from 2007 to 2017. (Tr.1 41:4-16, 43:15-20 (Lenoir); JX 100 at 6-7; PTX K 10:14-24, 15:1-2 (New Depo.)). In 2010, Lenoir, New, and Kelso comprised three out of four members of Evolve's ESOP Administration Committee, which ostensibly “provide[d] an independent review of all proposed ESOP transactions involving the purchase or sale of the sponsor's stock.” (Tr.1 42:19-25, 43:3-8 (Lenoir); JX 100 at 35).[4]

         On November 9, 2010, Bill Gust e-mailed Lenoir, copying New, stating that he had a client in Lynchburg “contemplating the purchase of the remaining shares of S Stock from the two owners who are also the sole Trustees, ” that the “value of the remaining stock as determined by Brian Napier is approx $21 Million, ” and that he “would like to suggest Evolve as the Transaction Trustee if you guys could squeeze another deal in Dec.” (JX 19). Although Napier was aware from conversations with Carole Vinoskey at some point before 2010 that Adam Vinoskey hoped to one day sell his shares to the ESOP, Napier testified that he did not know how Gust came up with a projected value of $21 million for the 2010 Transaction, and that he did not have any conversation with Adam or Carole Vinoskey, or anyone at Sentry, prior to November 9, 2010 about the potential value of Adam Vinoskey's shares. (Tr.1 225:18-22, 226:6-13, 18-25, 227:1-25, 228:1-3). Regardless whether Napier, Gust, Coffey, or some other party computed this estimated $21 million value, a preponderance of the evidence suggests, and the Court finds, that this estimated value drove many of the discretionary choices underlying Napier's 2010 Transaction appraisal, which reached a total transaction value very close to $21 million. (JX 85).[5]

         On November 12, 2010, Evolve sent an engagement letter to Sentry; this engagement letter was a contract in which Evolve agreed to serve as the independent fiduciary to review the proposed sale of Adam Vinoskey's stock to the ESOP, and ensure that the proposed transaction was prudent, the purchase price did not exceed adequate consideration, and “the transaction [was] fair from a financial viewpoint to the ESOP and its participants.” (JX 21 at 35; see also Tr.1 46:25; 47:1-7 (Lenoir)). Evolve's fee would be $27, 500.00. (JX 21 at 35). Evolve agreed to hire CAI as its “independent appraiser and financial advisor, ” as well as the law firm Gentry Locke as its legal counsel. (Id. at 35-36). Under the engagement letter, Sentry agreed to indemnify Evolve for any fiduciary breaches it might commit. (Id. at 36).

         On November 17, 2010, Coffey sent an e-mail to New, copying Gust and Napier, with a copy of the ESOP Plan and various financial analyses, including Coffey's “guesstimate” that the transaction was valued at $20, 931, 963.00. (JX 22 at 3231, 3364-3365). Napier received this email and all attachments, including Coffey's “guesstimate.” (Tr.2 166:20-25, 167:1-15 (Napier)). On the same day, New and Lenoir presented information about the proposed 2010 Transaction to Evolve's ESOP Administration Committee. (JX 24 at 42). Both the meeting minutes and an attachment to the minutes, entitled “ESOP Transaction Trusteeship Checklist, ” state that the approximate size of the transaction was $21 million. (Id. at 39, 40). The checklist noted that the transaction was low risk; that Sentry had strong successor management in place; that Sentry was a debt-averse, closely-held company with good earnings; and that Evolve would use a “[g]ood & [e]xperienced [v]aluation [a]dvisor” for the transaction. (Id. at 41-42).

         On November 18, 2010-the same day as Evolve's visit to Sentry discussed below-the ESOP Administration Committee authorized New to accept the Transactional Trustee engagement on behalf of Evolve, (id. at 39), and Carole Vinoskey signed Evolve's engagement letter on behalf of Sentry, agreeing to Evolve's terms. (JX 21 at 37). At a special meeting of Sentry's Board of Directors on November 19, 2010, the Board adopted a corporate resolution formally appointing Evolve as the ESOP's “Special Independent Trustee” for purposes of “assessing the fairness of the proposed purchase of” Vinoskey's shares by the ESOP and “[i]mplementing [the] purchase if appropriate.” (JX 25).

         D. Evolve's Activity Prior to Receiving Napier's Draft Appraisal

         Evolve's due diligence for the 2010 Transaction was rushed and cursory. Lenoir could not remember how many hours Evolve spent on the deal, only that Evolve's work began on approximately November 9, 2010 when Gust reached out and ended on December 20, 2010 when the deal closed. (Tr.1 54:1-21 (Lenoir)). The Court finds by a preponderance of the evidence that the rushed nature of Evolve's due diligence was due to the parties' agreement to close the deal by the end of the tax year, initially by December 17, 2010 and then by December 20, 2010. (Tr.1147:9-16 (Lenoir); see also JX 39; JX 40; JX 42; JX 45). Lenoir testified at trial that he did not know why Adam Vinoskey wanted to close the transaction by the end of 2010. (Tr.1163:19-21 (Lenoir)). But both Napier and Kaplan acknowledged that once the ESOP (a tax-exempt entity) owned 100 percent of Sentry, the company would owe no taxes, supporting a finding that the parties' rush to close the deal was motivated at least in some significant part by the tax benefits that would accrue to Sentry as a result of the 2010 transaction. (Tr.2 109:8-13 (Napier); Tr.4 91:8-13, 123:15-23 (Kaplan)).

         1. Evolve Hires Napier of CAI and Gust of Gentry Locke

         Somewhere between November 11-12, 2010, Evolve interviewed Napier on the phone, and hired him as an independent appraiser for the 2010 Transaction based on CAI's “history representing the trustee of the Sentry firm.” (Tr.1 48:21-25; 49:1-19 (Lenoir)). Evolve had not previously worked with CAI or Napier. (Id.). Prior to formally engaging CAI, Michael New reviewed at least some of Napier's prior appraisals. (PTX K 68:12-24, 69:1 (New Depo.)). On November 29, 2010, Evolve formally engaged CAI as its financial advisor for the 2010 Transaction for a fee not to exceed $7, 500. (JX 27).

         On approximately December 14-15, 2010, Bill Gust of Gentry Locke circulated a letter to Adam Vinoskey, Carole Vinoskey, and Michael Connor, in their roles as co-trustees of the Sentry ESOP / CEO, as well as to Evolve, confirming that Gust would represent Sentry, the Sentry ESOP, and Evolve for purposes of the ESOP Transaction but not Adam Vinoskey personally. (JX 35). Adam and Carole Vinoskey signed the letter as ESOP Trustees, acknowledging Gust's role and consenting to the representation. (Id.). Lenoir agreed at trial that Gust concurrently represented Sentry, the ESOP, and Evolve for purposes of the 2010 Transaction. (Tr.1117:11-18, 122:10-13 (Lenoir)).

         2. Evolve's Review of Due Diligence Checklist & Other Materials

         At some point prior to November 18, 2010, Evolve sent Sentry a due diligence checklist requesting various documents and records from “the past three year period.” (JX 26; Tr.1 75:10-17 (Lenoir)). Michael New compiled this checklist. (Id. 75:6-9; PTX K 61:23-24, 62:1 (New Depo.)). The checklist requested financial statements, corporate governance and transactional documents, shareholder information, operational and real estate information, employment and compensation records, and banking records. (JX 26). At some point on or soon after Evolve's November 18, 2010 visit to Sentry discussed below, Sentry returned a completed checklist to Evolve and sent various documents in response to the checklist. (Tr.1 75:14-24 (Lenoir)).

         In filling out the checklist, Carole Vinoskey noted “DNE” (i.e., “does not exist”) in response to several of Evolve's requests, including Evolve's request for “[a]ny Company business budgets and forecasts, business plan, operations plan or projections . . . for as long as available, ” (JX 26 at 1634; see also Tr.1 77:14-25, 78:1-8 (Lenoir); PTX K 64:14-19 (New Depo.)); and “[b]ona fide offers to purchase the Company in the last five years, ” (JX 26 at 1635; see also Tr.1 79:21-24 (Lenoir)). Carole Vinoskey noted “Amy Emailing” to several requests, such as Evolve's request for “[a]nnual financial reports of the Company for the last five years and quarterly reports for the last eight quarters.” (JX 26 at 1634).

         The record is unclear as to exactly what documents Evolve received in response to the due diligence checklist, but New reviewed all materials Sentry sent in response to the checklist. (PTX K 67:12-23 (New Depo.)). Evolve also reviewed Napier's appraisals from prior years, including Napier's 2009 appraisal, which appraised Sentry's stock at $285.00 per share. (Id. 68:1-10, 69:1-24; Tr.1135:2-3 (Lenoir); JX 84 at 267). Additionally, Evolve reviewed Sentry's bylaws and ESOP Plan. (JX 26 at 1641; PTX K 133:8-24, 134:1-6 (New Depo.)).

         3. Evolve's November 18, 2010 Visit to Sentry

         On November 18, 2010, New and Lenoir toured the Sentry plant, talked with some Sentry employees (primarily mechanics), and then met with Adam and Carole Vinoskey, Gust, and Michael Connor, Sentry's incoming president. (Tr.1 54:11-14, 54:24-25, 55:1-17, 58:1-25 (Lenoir)). This marked Evolve's only visit to Sentry before the 2010 Transaction closed on December 20, 2010. (Id. 128:7-9 (Lenoir)). New took notes during the November 18 meeting. (JX 23; Tr.1 56:23-25 (Lenoir)). During the meeting, New and Lenoir asked about several matters, six of which are of particular importance.

         First, Lenoir asked about how much cash Sentry had on hand, and was told that the company had $6 million at SunTrust Bank. (JX 23; Tr.1 59:24-45, 60:1-14 (Lenoir)). Second, Lenoir inquired about Sentry's Board of Directors, and was told that the Board met once per year. (JX 23). Lenoir stated that it would be a better practice to meet quarterly, and Adam Vinoskey indicated that he would “follow whatever they need to do.” (Id.; Tr.1 60:15-25, 61:1-5 (Lenoir)). At the time, Sentry's Board consisted of Adam Vinoskey, Carole Vinoskey, and another Sentry manager, Wright Lambert, with Adam Vinoskey serving as Chairman. (See, e.g., JX 28 at 3479-3480). Lenoir suggested that Adam Vinoskey stay on as Chairman after the transaction. (JX 23). Gust and Lenoir recommended a five-member Board after the 2010 Transaction consisting of Adam and Carole Vinoskey, Michael Connor, and two outside (i.e., non-manager) Directors. (Id.; Tr.1 62:1-15 (Lenoir)). Lenoir did not include a requirement that two outside Directors be added to the Board in the transaction documents because he thought he and Adam Vinoskey had a “gentleman's agreement” since “Mr. Vinoskey said that he would do what it took.” (Tr.1 62:16-25 (Lenoir)). Lenoir conceded that he “should have had it in the [written] agreement], ” since Evolve could not enforce any “gentleman's agreement” after the transaction closed and Evolve resigned as the independent transactional trustee. (Id. 63:2-20).

         Third, Lenoir inquired about Michael Connor's employment status and compensation. Adam Vinoskey stated that Connor would be “running the show” by December 15, 2010 or January 1, 2011. (JX 23). Adam Vinoskey further stated that he had a verbal agreement to pay Connor $300, 000 per year plus some unspecified percentage of Sentry's profits. (Id.). Lenoir indicated that an outside Board member should chair the compensation committee that eventually determined Connor's exact compensation. (Id.; Tr.1 66:4-13 (Lenoir)). Connor stated during the meeting that he expected 2011 to be a more challenging year for Sentry than 2010, although Adam Vinoskey stated that 2011 would be a good year. (JX 23; Tr.1 72:8-13 (Lenoir)). Connor stated that Sentry would likely need to diversify into the food sector because the beverage sector had experienced slower growth than it had historically but that no capital would be used to achieve that diversification within the next six to seven years “because of the way [Sentry] [has] postured themselves.” (JX 23; Tr.1 72:8-9, 73:1-8 (Lenoir)). At trial, Connor similarly testified that, in 2010, he believed Sentry “needed to diversify . . . into other industries.” (Tr.4 236:6-25 (Connor)).

         Fourth, Lenoir suggested that Sentry could raise its value and save money by requiring employees to pay part of their health insurance costs, but Adam Vinoskey unequivocally refused to consider this. (Tr.2 205:1-25 (Vinoskey); see also Tr.1 88:18-25, 89:1-6, 100:3-10 (Lenoir); JX 33). Fifth, Lenoir asked whether there were any projections of Sentry's future performance, and Adam Vinoskey stated that Sentry had never forecasted. (JX 23). Finally, Lenoir inquired whether Sentry had ever received serious offers to purchase the company, and Carole Vinoskey replied that, although Sentry had received informal inquiries, the company had never received an official offer. (Id.).

         E. Napier's 2010 Transaction Appraisal

         1. Napier's Capitalization of Cash Flow Methodology and Past Appraisals

         In performing appraisals for Sentry, Napier utilized the “capitalization of cash flow” methodology.[6] (Tr.1 222:10-12 (Napier)). Under this income-based (as opposed to market- or asset-based) approach, an appraiser arrives at a stock value by dividing a measure of earnings (i.e., “cash flow”) by a capitalization rate, which is calculated by subtracting a company's assumed growth rate from the discount rate. (Id. 222:17-25, 223:1-6, 237:2-13 (Napier)). The capitalization of cash flow methodology does not require projections of a company's future performance. (Id. 222:13-16 (Napier)).

         In calculating Sentry's cumulative cash flows, Napier utilized a five-year look-back period until 2008, when Napier began using a three-year look-back period. (Id. 235:1-16 (Napier); Tr.2 7:9-17 (Napier); Tr.3 161:3-5, 162:1 (Messina); see also JX 96 at 24, Figure 18 (Messina's Report showing switch to three-year period in 2008 and continuing through the 2010 Transaction appraisal)).

         In computing the capitalization rate, Napier generally measured a company's assumed growth rate using “[s]ome measure of historic performance against . . . anticipated inflation, ” which typically resulted in a growth rate between zero and 3-4 percent. (Tr.1 223:7-15 (Napier)). Broadly defined, the discount rate is “the expected rate of return (or yield) that an investor would have to give up by investing in the subject investment” and generally reflects the “size, liquidity risk, and character of the investment in the subject firm.” (Id. 239:18-22 (Napier); see also JX 84 at 301). More specifically, the discount rate is the sum of the “risk free rate” (i.e., the rate on long-term U.S. Treasury bonds), an “equity risk premium” determined using empirical studies in appraisal literature, and a subjective “company-specific risk premium” determined in large part by a company's size. (Tr.1 240:22-25, 241:1-2 (Napier); Tr.2 23:17-25, 24:1-25 (Napier)).

         Napier's 2009 appraisal illustrates how the capitalization of cash flow methodology works in practice. For his 2009 appraisal, Napier computed the discount rate at 18.5 percent. (JX 84 at 306). Napier then subtracted a 2 percent growth rate from the discount rate, to reach a 16.5 percent capitalization rate, which he then adjusted for growth by dividing by 1.02 (1 plus the growth rate of 2 percent), for a final capitalization rate of 16.2 percent. (Id.; Tr.1 241:5-19 (Napier)). Napier calculated the cash-flow-to-equity value to be capitalized by adding Sentry's earnings (plus depreciation amortization and adjusted for working capital changes) and operating working capital (adjusted for long-term debt), and subtracting Sentry's capital expenditures from its earnings. (Tr.1 242:10-20 (Napier)). This resulted in a per share value of $48.59, which, when divided by the 16.2 percent capitalization rate, resulted in a stock price of $300.00 per share. (JX 84 at 306-307; Tr.1 242:21-25, 243:1-7 (Napier)). Napier then applied a discount of 5 percent for lack of marketability and liquidity, resulting in a final stock price of $285.00 per share. (Tr.1 243:14-25 (Napier); JX 84 at 309-311).

         Using the capitalization of cash flow methodology, Napier appraised Sentry's common stock at $215.00 per share as of December 2005, (PTX A); $220.00 per share as of December 2006, (PTX B); $241.00 per share as of December 2007, (PTX C); $285.00 per share as of December 2008, (PTX D), and $285.00 per share as of December 2009, (JX 84 at 267).

         Although Napier generally computed a stock value using an asset-based methodology, he never gave the asset-based approach any weight, as he felt this methodology ignored intangibles such as good will and the going concern value of a business. (Tr.1 237:2-6, 238:14-17 (Napier)). Napier similarly did not use a market-based methodology because he could not find enough comparable companies on which to base this analysis. (Id. 237:7-10 (Napier)).

         Both for his past appraisals and the 2010 Transaction appraisal, Napier also declined to use another income-based approach: the discounted cash flow (DCF) methodology. (Id. 238:2-13 (Napier)). DCF “estimates the available cash flow an investor would expect the subject company to generate over the life of the business.” (JX 96 at 28). Each year's estimated available cash flow is discounted “to its present value equivalent using an appropriate rate of return.” (Id.). The business's “residual value” at the end of the projection period is similarly estimated and “discounted to its present value.” (Id.). “The summary of these values equals the enterprise value, ” from which the company's current debt is then subtracted to reach the fair market value of the company's equity. (Id.). Essentially, DCF “takes [a company's] stream of cash flows and uses a discount rate to tell you what that stream of cash flows is worth today.” (Tr.3 44:6-8 (Messina)). Since DCF is, by default, calculated on a controlling-interest basis, additional discounts may be necessary to account for the actual degree of control a buyer is acquiring. (Id. 33:23-24, 34:1-6 (Messina)).

         Napier is generally of the opinion that DCF is an inappropriate methodology for ESOP valuations, unless a company has a history of “detailed forecasts.” (Tr.1 223:16-25, 224:1-10 (Napier); see also JX 30 at 208 (Napier's notation in 2010 Transaction draft appraisal that DCF is “inappropriate to valuations for ESOP purposes” in part because “application of projected operations is . . . extremely difficult for most closely-held companies”). Since Sentry did not have forecasts or projections, Napier used the above-described capitalization of cash flow method. (Tr.1 224:11-17 (Napier)).

         Both experts who testified about Napier's 2010 Transaction appraisal employed DCF. Dana Messina, the Secretary's expert on the fair market value of Sentry's stock in December 2010, founded a valuation firm, Kirkland Messina, in 1994. (JX 96 at 37). Messina holds an M.B.A. from Harvard Business School and served as CEO of Steinway Musical Instruments from 1996 to 2011. (Id.). Frank (“Chip”) Brown, Defendants' expert, holds a Master's in Accounting from the University of Virginia and is currently employed as a Senior Vice President at First Bankers Trust Services. (Tr.4 254:11-22, 255:3-7 (Brown)). Brown is a certified public accountant and has been performing valuations for ESOPs since approximately 2004-2005. (Id. 255:8-13, 18-20 (Brown)).

         Messina testified that DCF “is the most widely used valuation methodology, ” (Tr.3 26:13-16), and wrote in his report that DCF can be more reliable than Napier's capitalization of earnings methodology because DCF “considers the financial performance of future years.” (JX 96 at 12; see also Tr.3 43:24-25, 44:1-8 (Messina)). Brown also acknowledged this feature of DCF, noting in his report that the “DCF method inherently is based on a long-term investment horizon based on the estimates of future earnings by the company.” (JX 98 at 24 ¶ 67). Although Brown stated in his report that Napier's capitalization of earnings method is “an accepted mathematical way of calculating the fair market value” and that it would be a “mistaken impression” to conclude that DCF is “much more robust than the CAI capitalized earnings method, ” (JX 98 at 44-45), Brown himself employed DCF, (see, e.g., id. at 30), and testified that it is an appropriate methodology to assess the fair market value of Sentry as of December 20, 2010. (Tr.5 47:16-24 (Brown)).[7] Moreover, as discussed below, Evolve itself expressed concern that Napier did not utilize DCF. (See, e.g., JX 30 at 166; JX 31 at 161). Accordingly, although Napier's capitalization of cash flow methodology is not necessarily inappropriate or unreliable if applied correctly, the Court finds that DCF is, on the margins, a more widely-used methodology for evaluating the fair market value of closely-held stock.[8]

         2. Napier's Draft Appraisal for the 2010 Transaction

         On December 9, 2010-ten days after Evolve engaged CAI-Napier e-mailed a draft appraisal to Michael New and Bill Gust. In his draft appraisal, Napier valued Sentry's shares at $405.73 per share, which would equate to an overall transaction price of $20, 692, 230.00 for Adam Vinoskey's 51, 000 shares. (JX 29 at 5576, 5579, 5586). This price was strikingly close to the “approx[imately] $21 million” transaction value included in the November 17, 2010 e-mail Napier received from Michael Coffey twelve days prior to Evolve formally engaging CAI for the 2010 Transaction. (JX 22 at 3231, 3365; Tr.2 166:20-25, 167:1-15 (Napier)).

         The Secretary points to various alleged flaws in Napier's 2010 Transaction appraisal. Since these flaws are relevant to Evolve's review of Napier's draft appraisal (discussed below), and since all appeared in Napier's final appraisal (also discussed below), the Court will address each alleged flaw at this juncture.

         i. Napier's Controlling-Interest Assumption

         Napier computed the 2010 Transaction appraisal on a controlling-interest basis. (JX 85 at 1803). As discussed at various points below, many of the discretionary choices Napier made reflected his view that the ESOP would gain total control over Sentry as a result of the 2010 Transaction. (Id. at 1809; Tr.2 33:19-25 (Napier)). The Court will reach legal conclusions about control in Section II. Here, the Court finds as a factual matter by a preponderance of the evidence that the ESOP did not stand to gain total control over Sentry after the 2010 Transaction.

         Under the Sentry ESOP Plan and Sentry's bylaws, the Board of Directors has the power to appoint and remove ESOP Trustees, (JX 2 at 134; see also JX 7 at 1857), and the ESOP Trustees in turn have the power to vote the ESOP's shares in all but “certain limited but important corporate matters, such as a sale of all the Company's assets or merger of the Company.” (JX 1 at 831; JX 2 at 111). In these limited matters, ESOP participants “have the right to instruct the Plan trustee as to [their] wishes relative to” their shares. (Id.). Under Sentry's bylaws, the Board of Directors is elected by an annual vote of Sentry shareholders. (JX 7 at 1852, 1854). After the 2010 Transaction, the ESOP would have been the sole shareholder, and the ESOP Trustees would have been able to unilaterally vote the ESOP's shares to elect Directors, since the election of Directors is not one of the “important corporate matters” listed in the ESOP Plan. (JX 7 at 1854; JX 2 at 111). Under the bylaws, the shareholders (i.e., the ESOP and its Trustees after the transaction) can remove any Director and elect his or her successor at a special meeting called for that purpose, but only the Board can, by majority vote, remove and replace officers appointed by the Board (such as ESOP Trustees). (JX 7 at 1857-58). The bylaws call for annual shareholder meetings and for “special [shareholder] meetings” as called for by the President, Vice President, Secretary, or Board of Directors, or upon application to the Secretary by shareholders holding at least one-tenth of Sentry's stock. (Id. at 1852).

         Prior to the 2010 Transaction, Sentry's Board of Directors consisted of Adam and Carole Vinoskey, and a Sentry co-founder, Wright Lambert. (JX 28 at 3479-80). Although Evolve had a “gentleman's agreement” that the Board would be expanded to include outside Directors, no requirement for this expansion was added to the transaction documents. (Tr.1 62:16-25 (Lenoir)). Prior to the 2010 Transaction, Adam and Carole Vinoskey served as two of Sentry's three ESOP Trustees. (JX 69; JX 6 at 56; JX 24 at 40; JX 35). There is no evidence that Evolve took any steps to ensure that the Vinoskeys would step down as Trustees after the transaction, and in fact they did not. (JX 69). Finally, Carole Vinoskey served as Sentry's Secretary prior to the 2010 Transaction and remained in this role after the transaction. (See, e.g., JX 3 at 44; JX 4 at 49; JX 5; JX 69). Here again, there is no evidence that Evolve took any action to ensure that Carole Vinoskey stepped away from this role after the transaction.

         The implications of Sentry's corporate structure and leadership personnel are clear enough: Absent changes removing Adam and Carole Vinoskey as ESOP Trustees, the Vinoskeys could exert total control over how to vote the ESOP's shares in the vast majority of corporate matters as two out of the three ESOP Trustees. If the ESOP wanted to remove Adam and Carole Vinoskey as Directors, Adam and Carole Vinoskey would have to agree not to reelect themselves as Directors at the annual shareholder meeting or agree to remove themselves at a special meeting, since Adam and Carole Vinoskey, as two out of three ESOP Trustees, would be empowered to vote the ESOP's shares in electing and removing Directors without taking instruction from the ESOP participants. If the ESOP wanted to remove Adam and Carole Vinoskey as ESOP Trustees, the ESOP would have to petition the Secretary (Carole Vinoskey) to call a special meeting of the Board of Directors, a body that, absent changes, would have been elected by Adam and Carole Vinoskey as ESOP Trustees and that, absent changes, would have included Adam and Carole Vinoskey as two out of three Directors. Assuming Carole Vinoskey would call a special meeting for the purpose of firing herself and her husband as ESOP Trustees, the Vinoskeys, as two of the three Directors, would have to agree to fire themselves as Trustees.

         Essentially, given the lack of provisions in the transaction documents altering Sentry's corporate structure, reducing the Vinoskeys' leadership roles, or ensuring that the ESOP could control the Board and the ESOP Trustees with relative ease, Adam and Carole Vinoskey stood to retain a tight grip over Sentry after the 2010 Transaction. Under these circumstances, the Court finds by a preponderance of the evidence that the Sentry ESOP did not stand to gain total control over Sentry after the 2010 Transaction, and that Brian Napier's assumption that the ESOP would gain total control simply by purchasing 100 percent of Sentry's stock was unreasonable.

         The Court makes the further factual finding that Evolve understood the ESOP would not gain total control over Sentry after the transaction. As mentioned above, Evolve had reviewed Sentry's bylaws and the ESOP Plan. (PTX K 133:24-26, 134:1-6 (New Depo.); JX 26 at 1641). Evolve was also aware of other indicators that Adam Vinoskey did not intend to fully relinquish control over Sentry, such as Adam Vinoskey's intention (at Evolve's recommendation) to stay on as Chairman of the Board of Directors and Adam Vinoskey's refusal on November 18, 2010 to entertain cutting health benefits after the 2010 Transaction. (See Tr.1 88:18-25, 89:1-6, 100:3-10 (Lenoir)). Evolve took this refusal seriously enough to request that Napier not add-back half of Sentry's health-care expenses, suggesting that Evolve understood who would essentially remain in control of Sentry after the 2010 Transaction: Adam Vinoskey. (JX 33, 34).

         Moreover, the Court finds that Evolve never seriously probed whether it was appropriate for Napier to conduct his appraisal on a controlling-interest basis. Although New stated in his December 11, 2010 e-mail to Napier that Evolve would “like the report to include a discussion of the modifications that were made to your methodology to account for the ESOP acquiring a controlling interest in the company as compared to the minority interest approach utilized in the past, ” (JX 33), there is no evidence that Evolve ever questioned the substance of Napier's underlying assumption that the ESOP was acquiring total control of Sentry. (JX 34). In response to New's request, Napier added two bullet points to the final appraisal (which, as discussed below, Evolve did not review) directing the reader to other charts showing the add-back of Sentry's excess land, cash, ESOP contributions, and health-care expenses. (JX 85 at 1809). But Napier did not add any thorough explanation of why it was appropriate to assume that the ESOP would be able to exert total control over Sentry even as the owner of 100 percent of Sentry's shares given Sentry's likely post-transaction corporate structure and leadership personnel.

         ii. Napier's Healthcare Expenses & ESOP Contributions Add-back

         When calculating Sentry's net income, Napier made various “normalization adjustments” by adding back projected cost savings, including an add-back of half of Sentry's health care costs. (Tr.2 42:15-17 (Napier); see also JX 85 at 1856). This add-back had the effect of increasing Napier's calculation of representative cash flow by $650, 000, adding $5.3 million to Napier's enterprise value calculation and raising the stock price for the 2010 Transaction by $50.00 per share. (Tr2 62:1-9, 156:12-25, 157:1-7 (Napier); see also Tr.3 70:2-7 (Messina)).

         As discussed in more detail below, Lenoir and New questioned Napier about the appropriateness of this add-back given Adam Vinoskey's clear statement on November 18, 2010 that he would not consider cutting health expenses after the transaction. (JX 34 at 162; Tr.2 43:22-25, 44:1-10, 148:9-14 (Napier)). Napier declined to remove this add-back because, in his view, the ESOP would gain total control over Sentry after the 2010 Transaction, and an “absolute controlling shareholder would look at those expenses of a hundred percent of the health care benefits and make adjustments to increase the earnings of the company.” (Id. 43:2-8, 44:3-10, 156: (Napier)). Napier was aware, however, that Sentry had no business plan to reduce health care costs, that Adam Vinoskey was opposed to reducing health care costs, and that Sentry's generous health care benefits were a major factor in Sentry's ability to attract workers. (Id. 45:18-21, 148:15-25 (Napier); see also Tr.1180:17-22 (Holcomb, acknowledging that Sentry's health care benefits facilitate worker retention)). Yet Napier still elected to add back half of Sentry's health care costs without considering the effect such cuts would have on employee retention and productivity, and without thoroughly explaining in his report how or why his assumptions about control required this add-back. (Tr.2 149:11-17, 150:1-5 (Napier); Tr.3 83:7-11, 218:20-25, 219:1-16 (Messina, noting offsetting benefits of Sentry's health care costs Napier did not consider)). Ultimately, it was Evolve's decision to leave the health care add-back in the 2010 Transaction appraisal. (Tr.4 202:2-5 (Lenoir, conceding this point)).

         The Court concludes that Napier's decision to add back half of Sentry's health care costs-particularly without analyzing the ramifications of that add-back in terms of profits and worker retention-was unreasonable given Adam Vinoskey's clear statement that Sentry would not cut health care expenses, and Napier's understanding that Sentry's health care benefits had a major impact on worker satisfaction, recruitment, and retention. Moreover, Napier's decision to add back half of Sentry's health care expenses based on an assumption that the Sentry ESOP would fully gain control of Sentry after the 2010 Transaction is unreasonable given the Court's conclusion above that the Sentry ESOP did not, in fact, stand to gain total control of Sentry. Indeed, even assuming that the ESOP stood to gain full control over Sentry, it still would have been questionable to assume that the ESOP participants would vote in favor of cutting their own generous health care benefits. Finally, neither Messina nor Brown added back any of Sentry's health care expenses, (Tr.5 92:12-15, 107:21-25 (Brown); id. 125:13-22 (Messina)), and Evolve itself noted that the health-care add-back was inappropriate in its review of Napier's draft appraisal. (See, e.g., JX 33 at 161).

         Similarly, the Court finds that Napier unreasonably added back Sentry's ESOP contributions when calculating Sentry's net-adjusted income. (JX 85 at 1856; Tr.2 49:1-8, 49:24-25, 50:1-13 (Napier)). As Messina testified, such add-backs or “normalizations” without other adjustments are appropriate only if an appraiser believes that “removing this expense” would have “no impact on the company going forward, ” such that, for instance, Sentry “could have eliminated [the] ESOP and nothing would have happened with sales, ” profit, or employee turnover. (Tr.5 122:14-25, 123:1-18). Messina testified, and the Court finds, that such normalizations are highly discretionary and typically favor the seller in a transaction. (Id. 122:1-12). Napier's apparent assumption that Sentry could eliminate the ESOP without negative repercussions was unreasonable, since the express purpose of the ESOP was to increase worker satisfaction and productivity, and since it is highly unlikely that the ESOP participants would move to eliminate an attractive retirement benefit. (See JX1 at 818; Tr.1169:12-25; 170:1-25; 171:1-8 (Holcomb)). There is no evidence before the Court that Evolve noticed or questioned Napier's add-back of Sentry's ESOP contributions.

         III. Napier's Inconsistent Capitalization Rates

         As described above, appraisers utilizing the capitalization of cash flow methodology arrive at a stock value by dividing a measure of earnings (i.e., cash flow) by a “capitalization rate, ” which is calculated by subtracting a company's assumed “growth rate” from the “discount rate.” (See, e.g., Tr.1 222:17-25, 223:1-6 (Napier)). The discount rate is comprised of the sum of a risk-free rate, typically measured by reference to the rate on U.S. Treasury bonds, (Tr.2 23:17-22 (Napier); see, e.g., JX 85 at 1839); an equity risk premium, which Napier calculated using published studies on equity risk, (Tr.2 23:23-25, 24:1-6 (Napier)); and a company-specific risk percentage, based on subjective assessments of a company's size and other company-specific characteristics bearing on risk. (Id. 24:7-17 (Napier)). Changes in the discount rate have a major impact on stock price: generally, the higher the discount rate, the lower the stock price, and vice versa. (Tr.3 51:6-9 (Messina); Tr.4 296:7-11 (Brown)). Napier measured a company's growth rate using "[s]ome measure of historic performance against . . . anticipated inflation," which, according to Napier, typically resulted in a growth rate between zero and 3-4 percent. (Tr.l 223:7-15 (Napier)). Generally, the higher the capitalization rate, the lower the stock price, and vice versa. (Tr.3 51:21-25, 52:1-3, 55:14-16 (Messina)).

         As demonstrated by the table below from Messina's report, Napier computed a capitalization rate of at least 16.2 percent in every annual appraisal since 2005, but his capitalization rate for the 2010 Transaction appraisal dropped to 12.2 percent.[9] (JX 85 at 1844). Just eleven days after the 2010 Transaction closed, the capitalization rate in Napier's December 31, 2010 appraisal rose to 18.2 percent. (JX 86 at 1471). Napier's 2011 appraisal used a capitalization rate of 18 percent. (PTX E at 1560).

         (Image Omitted)

         (JX 96 at 15, Figure 11). The following table demonstrates how the various inputs Napier used to calculate the capitalization rate changed over time:

CAI's Inconsistent Discount Rates


12/31/2007

12/31/2008

12/31/2009

11/30/2010

12/31/2010

12/31/2011

Risk free rate 4.6% 3.0% 4.5% 4.0% 4.2% 4.0%
Equity risk and size premia 10.8% 11.8% 6.0% 5.5% 6.0% 6.0%
Company specific risk 6.0% 4.0% 8.0% 6.0% 8.0% 8.0%
Discount rate 21.4% 18.8% 18.5% 15.5% 18.2% 18.0%
Growth 3.0% 2.0% 2.0% 3.0% 0.0% 0.0%
Capitalization Rate 18.4% 16.5% 16.2% 12.2% 18.2% 18.0%
Source: Capital Analysts, Inc. Sentry Valuation from 2007 to 2011

(JX 96 at 16, Figure 12).[10] As this table demonstrates, Napier's risk-free rate dropped from 4.5 percent in 2009 to 4 percent for the 2010 Transaction appraisal, because of fluctuations in rates on U.S. Treasury bonds. (JX 84 at 304; JX 85 at 1841; Tr.2 34:20-25, 35:1-4 (Napier)). The Court finds that this particular decision was reasonable. (See Tr.3 91:20-1 (Messina, noting that the "risk-free rate may change . . . slightly")). However, the Court finds by a preponderance of the evidence that Napier adjusted the equity risk and company-specific risk percentages in an unreasonable manner, apparently for the purpose of arriving at a lower discount rate and thereby raising the stock price for the 2010 Transaction.

         With respect to equity risk, this percentage dropped from 6 percent in 2009 to 5.5 percent for the 2010 Transaction. (JX 84 at 304; JX 85 at 1841). Napier testified that he tries to keep this percentage "within the 5-to-6 percent range" as recommended by ESOP appraisal literature, and selected 5.5 percent for the 2010 Transaction appraisal "since this is a controlling-interest valuation," and "the expectation is that the benefits in the lower risk of control will be imputed into the discount rate.” (Tr.2 24:1-6, 35:8-13). As discussed above, the Court finds that the ESOP did not stand to gain full control over Sentry. But even assuming that the ESOP stood to gain total control, the Court still finds Napier's decision with respect to equity risk questionable, as Napier's appraisal did not cite control as the reason for his decision to lower the equity risk percentage to 5.5 percent. Moreover, the Court finds Messina's testimony persuasive that it is generally inappropriate to consider control when calculating the discount rate. (Tr.3 37:17-25, 38:1-7, 56:2-20, 93:2-4; Tr.5 131:12-24). Thus, although Messina testified that “the equity risk premium may change slightly” from one appraisal to the next, (Tr.3 91:20-22), Napier's sole justification for decreasing the equity risk percentage for the 2010 Transaction-an assumption that the ESOP stood to gain unfettered control over Sentry-renders this decision unreasonable.

         With respect to Napier's company-specific risk calculation, this figure dropped from 8 percent in 2009 to 6 percent in the 2010 Transaction appraisal. (JX 96 at 16; JX 84 at 304; JX 85 at 1841). Napier testified that company-specific risk depends in large part on a company's size, but Napier conceded that Sentry's size had not changed in any way that would justify a 2 percent drop in company-specific risk between 2009 and the 2010 Transaction. (Tr.2 24:23-25, 36:5-11). Rather, Napier based his “subjective judgment” to decrease company-specific risk to 6 percent on “the benefits of control and lower risk of control.” (Id. 36:13-19 (Napier); see also Tr.5 94:16-19 (Brown, agreeing that company-specific risk is one of the more subjective aspects of calculating a discount rate)). Again, Napier's appraisal did not cite control as a justification for lowering the company-specific risk percentage, and the Court finds persuasive Messina's testimony that it is inappropriate to consider control when calculating the discount rate. (Tr.3 37:17-25, 38:1-7, 56:2-20, 93:2-4; Tr.5 131:12-24). Moreover, as discussed above, the ESOP was not acquiring total control of Sentry through the 2010 Transaction. Napier's discretionary choices about equity risk and company-specific risk had the effect of lowering the discount rate for the 2010 Transaction to 15.5 percent, a rate Napier conceded at trial was “certainly on the low end.” (Tr.2 150:20-23 (Napier); see also Tr.1101:8-13 (Lenoir, acknowledging that Napier's discount rate in the 2010 Transaction appraisal was unusually low)).

         Additionally, the Court finds by a preponderance of the evidence that Napier unreasonably raised the growth rate from 2 percent in 2008 and 2009 to 3 percent for the 2010 Transaction. Here again, Napier testified that he decided to increase the growth rate to 2 percent because the Sentry ESOP would be gaining total control over Sentry as a result of the 2010 Transaction. (Tr.2 38:5-7, 95:13-19). And, here again, the Court finds this explanation untenable: the Sentry ESOP did not stand to gain total control over Sentry, and Napier did not cite control (or any other factor) as a justification for this change in growth rate. Moreover, Messina testified persuasively that a 3 percent perpetual growth rate would be an aggressive assumption for the vast majority of companies. (Tr.3 65:11-25, 66:1-16). Additionally, Napier's decision to increase the growth rate is at odds with the trend of Sentry's earnings and cash flow: Sentry's earnings in 2009 and 2010 were lower than in 2008, when Napier chose a 2 percent growth rate. (Tr.2 40:7-9 (Napier)).

         Napier conceded that his choices about equity risk, company-specific risk, and growth were discretionary and had the effect of raising the stock price for the 2010 Transaction. (Tr.2 60:7-25, 61:1-24). As discussed in further detail below, Evolve noticed Napier's unusually low discount rate and raised it with Napier in an email. (JX 33). But there is no evidence in the record that Evolve specifically probed Napier's discrete decisions surrounding equity risk, company-specific risk, and the growth rate. Moreover, Napier made no changes to the discount rate as a result of his conversation with Lenoir and New. (Tr.2 150:24-25, 151:1 (Napier); compare JX 30 at 208, with JX 85 at 1841).

         iv. Napier's 3-Year Lookback Period for Assessing Sentry's Cash Flows

         The Secretary and Messina critiqued Napier for employing a three-year look-back period in the 2010 Transaction appraisal to compute Sentry's average yearly cash flow at $4.5 million. (JX 85 at 1856). Messina contends that using only a three-year look-back period had "the effect of lifting the average cash flow result and increasing the valuation," (JX 96 at 24), because Sentry's earnings peaked from 2008-2010. Indeed, Napier's table of Sentry's yearly cash flows (displayed below) shows higher earnings in, for instance, 2007-2009, but significantly lower earnings in, for instance, 2004-2006:

         (Image Omitted)

         (JX 85 at 13). Messina testified that a seven-year look-back period would have been more reasonable, as a longer look-back period would have captured both Sentry's peaks and valleys. (JX 96 at 14; see also Tr.3 59:2-12 (Messina)). Napier testified that an appraiser's decision about the temporal length of the look-back period is subjective and favored Adam Vinoskey "to a small extent." (Tr.2 57:15-25, 58:7-16). Napier testified that using a three-year average period was "about the same" as using a five-year average. (Id. 57:18-21). But Napier also testified that when a company experiences significant variation in its yearly income, as Sentry did, (see, e.g., JX 84 at 312; JX 85 at 13), it can be important to use a look-back period temporally broader than 3 years when capitalizing cash flows. (Tr. 1 245:5-8 (Napier)).

         Because Napier's use of a three-year look-back period began in 2008 rather than in his 2010 Transaction appraisal, [11] the evidence does not support a finding that Napier intentionally employed a three-year look-back period specifically for the purpose of inflating the 2010 Transaction stock price and benefitting Adam Vinoskey. However, the Court nonetheless finds that a longer look-back period of at least five years (as Napier consistently used in his pre-2008 appraisals) would have more accurately captured Sentry's business cycle, which centers around the soft drink industry, with income varying depending on when bottling plants decide to make large capital improvements. (Tr.1 231:16-21 (Napier); id. 71:3-6, 72:8-9, 73:1-8 (Lenoir); id. 197:9-20 (Holcomb); Tr.4 236:6-25 (Connor); JX 23). Indeed, although he stated that Napier's three-year look-back period was “not necessarily” inappropriate, Brown employed a six-year period in his DCF analysis. (Tr.5 71:9-15 (Brown); JX 98 at 17).

         There is no evidence that Evolve noticed or questioned Napier's three-year look-back period, even though Lenoir testified that he personally “looked at three, five, and six years of profit” when assessing the fair market value of Sentry's stock, and even though Napier's subjective choice to use a three-year average benefited the seller rather than the ESOP. (See Tr.1131:10-14; PTX K at 114-115 (New Depo., noting that he did not recall noticing the look-back period “at all”)).

         v. Napier's Working Capital Assumption

         In the 2010 Transaction appraisal, Napier made certain assumptions about how much “working capital” Sentry required to operate. “Working capital” is a measurement of the amount of cash required to operate a business, reached by subtracting a company's current liabilities from the company's current assets. (Tr.1188:11-17 (Holcomb); Tr.2 73:13-15 (Napier); Tr.5 118:3-8 (Messina)). Working capital and stock price are negatively correlated: the lower the working capital percentage, the higher the stock price, and vice versa. (Tr.2 66:2-14 (Napier)).

         Since 2004, Sentry has kept least 30 percent of its total assets in cash. (Tr.2 78:18-25, 79:1-11 (Napier)). In his 2010 Transaction appraisal, however, Napier assumed that Sentry required 10 percent of its total assets of $22, 535, 299 in cash (i.e., $2, 253, 530 in cash) to operate. (JX 85 at 1835). Napier based this assumption on two factors. First, Napier reviewed Robert Morris Associates studies for the North American Industry Classification System (NAIC) code showing “the reported percent of total assets attributable to cash was somewhere between 6 and 7 percent of total assets, ” a figure Napier then raised to 10 percent for Sentry, even though he concluded elsewhere in his report that companies comparable to Sentry do not exist on the public market. (Tr.2 64:2-12 (Napier)). Second, Napier based his working capital assumption on conversations with Carole Vinoskey, who felt that Napier's assumption that Sentry needed approximately $2.25 million to operate was “high.” (Id. 65:1-8 (Napier)). Napier's assumption that Sentry could operate with 10 percent of its total cash assets had the effect of adding $68.15 to the 2010 Transaction price. (Id. 65:20-23 (Napier)).

         Napier had discretion in choosing the 10 percent working capital figure. (Id. 65:24-25, 66:1 (Napier)). Messina assumed that Sentry could operate on a 15 percent working capital basis, (Tr.5 116:15-25 (Messina)), while Brown assumed that Sentry could operate on a 5 percent working capital basis. (Id. 56:9-13 (Brown); JX 98 at 16).[12]

         For three reasons, the Court finds by a preponderance of the evidence that Napier's assumption that Sentry could operate with $2.5 million in cash (i.e., 10 percent of its total assets) was unreasonable. First, Napier conceded that since 2004, Sentry had at least 30 percent of its total assets in cash, (Tr.2 78:18-25, 79:1-11 (Napier)), suggesting that his 10 percent figure was low as compared to Sentry's historical cash reserves. Second, Adam Vinoskey testified that he “wouldn't be sleeping very well” if Sentry had only $2.5 million in cash, that operating with such a low amount would be a “good trail to failure, ” and that he “never tried to let [Sentry] get below probably . . . $15 million.” (Tr.2 214:1-25, 215:1-10). Although Vinoskey did not testify that Sentry absolutely required $15 million in cash to operate, his reticence at the idea that Sentry could operate on only $2.5 million in cash has some bearing on the reasonableness of Napier's working capital assumption and calls into question whether Napier sufficiently discussed his working capital assumption with Sentry's management.

         Third, in a post-transaction appraisal of Sentry completed on December 31, 2010-just eleven days after the 2010 Transaction closed-Napier changed his working capital assumption to 20 percent rather than 10 percent. (JX 86 at 30; see also JX 96 at 26 (Messina Report noting this shift)).[13] This abrupt shift strongly suggests, and the Court finds by a preponderance of the evidence, that Napier manipulated his working capital assumption in the 2010 Transaction appraisal for the purpose of raising the stock price in Adam Vinoskey's favor. There is no evidence that Evolve ever noticed or questioned Napier's working capital assumption.

         vi. Napier's Decision to Add Back Cash and Land

         After calculating Sentry's discounted future income, Napier added the value of Sentry's excess cash and land ($6, 641, 800 and $552, 000, respectively) to arrive at Sentry's enterprise value. (JX 85 at 1847). This addition raised Napier's stock price for the 2010 Transaction by $73.81 per share. (Id.). Napier had omitted excess cash and land from his appraisals prior to the 2010 Transaction appraisal. (Tr.2 102:23-25 (Napier)). The Secretary concedes that “Napier was correct to include the cash and land in his Transaction Appraisal, ” (dkt. 211 at 33), and, indeed, Messina also added back Sentry's excess cash and land in the same amounts as Napier in his report. (JX 96 at 33, Fig. 25; id. at 25, Fig. 19; Tr.3 166:20-25, 167:1, 20-25, 168:1-3 (Messina)). The Court finds Messina's testimony persuasive that the excess land and cash should also have been added back for Napier's prior appraisals. (Tr.3 38:8-13, 167:2-19 (Messina)). Thus, the Court finds that Napier's decision to add back Sentry's excess cash and land was technically proper but illustrative of Napier's inconsistent discretionary choices for the 2010 Transaction appraisal, choices apparently motivated by a desire to reach the estimated $21 million transaction value and to raise the stock price in Adam Vinoskey's favor.

         vii. Napier's ...


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