Fourth Circuit Rules Ex-Bank President Can't Rely on Flawed Audit Report

Posted on July 8, 2008 by Jeffrey V. Mehalic

The principal issue presented in this appeal is whether Grant Thornton LLP (Grant Thornton), an accounting firm retained by First National Bank of Keystone (Keystone), in response to an investigation by the Office of the Comptroller of the Currency (OCC) into Keystone’s banking activities, owed a duty of care under the West Virginia law of negligent misrepresentation to Gary Ellis, who allegedly relied on oral statements made by Stan Quay (Quay), a Grant Thornton partner, and a Grant Thornton audit report of Keystone’s 1998 financial statements in deciding to accept the job as president of Keystone. We hold that Grant Thornton owed Ellis no such duty under West Virginia law.

Ellis v. Grant Thornton LLP, 2008 WL 2514182 (4th Cir. 2008).

    In a bench trial before Judge David A. Faber of the Southern District of West Virginia, Ellis obtained a verdict of $2,419,233, based on the court’s finding that Grant Thornton negligently misrepresented Keystone’s financial condition, knowing that Ellis would rely on such misrepresentations in deciding whether to go to work for Keystone.
   
    And bear in mind that Grant Thornton's misrepresentation was not insignificant: it failed to uncover that Keystone had overestimated the value of its loans by $515 million.  Ultimately, the FDIC paid $664 million to cover Keystone's losses after its collapse.

    In addressing Grant Thornton's appeal, the Fourth Circuit had to predict how the Supreme Court of Appeals of West Virginia would rule on Ellis’ claim of negligent misrepresentation because the Supreme Court has not addressed directly or indirectly this issue,

    Although the district court had relied on First Nat. Bank of Bluefield v. Crawford, 386 S.E.2d 310 (W.Va. 1989) in ruling for Ellis, the Fourth Circuit found that, “other than the adoption of the Restatement [(Second) of Torts § 552] approach, the Bank of Bluefield court gave no further meaningful guidance concerning under what circumstances an accountant can be liable to third parties for negligent misrepresentations under §552.”

    The Fourth Circuit found that other courts had  set forth six factors based on the Restatement's language, which emphasize the third party's reliance on the inaccurate information.  Unlike Ellis' situation, however, the application of those factors focuses on the accountant or auditor's knowledge or intention that the third party will rely on the information.

    This decision provokes – to me, at least – an obvious question: why should Ellis’ reliance on the flawed Grant Thornton audit be any different than the bank management's or the OCC’s reliance on the audit?  The audit report stated on its first page that it was for the information and use of Keystone’s management and its regulatory agencies and “should not be used by third parties for any other purpose.”  But does that absolve Grant Thornton of liability if its employees misrepresented -- in any other context, lied about -- Keystone's condition? 
   
    Apparently it does.  But there is something fundamentally wrong with this decision.  The Fourth Circuit declined to employ any type of "foreseeability" standard, even though it is reasonably foreseeable that a third party like Ellis will rely on the audit report, or the representations made to him by Grant Thornton employees, who did not preface their statements with the type of disclaimer found on the first page of the audit report. 
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Florida Offers to Buy U.S. Sugar for $1.75 Billion

Posted on June 30, 2008 by Jeffrey V. Mehalic

    Last month, I wrote about the class action filed by employees of U.S. Sugar, who claim that their shares of company stock have been devalued as a result of mismanagement and self-dealing by the company’s officers.  In 1983, the employees participated in an ESOP (employee stock ownership plan) which traded their participation in a pension plan for ownership of the company’s stock, which is not publicly traded.  Thus, the employees have to depend on what the company is willing to pay to redeem their shares, which, according to allegations in the lawsuit, has been far less than what the shares are actually worth. 

    Then, last week, in an unexpected development, Florida Governor Charlie Crist announced that, as part of the restoration of the Everglades, Florida is willing to pay U.S. Sugar $1.75 billion for its 187,000 acres in four counties in southern Florida.  The company would lease the property back from Florida for six years, then go out of business.  Here are the statements issued by U.S. Sugar and by Governor Crist’s office, and an Associated Press story in today’s New York Times, which reports that the proposed purchase is moving forward.  

    This post by Suzanne Wynn in her Pension Protection Act Blog notes that the ESOP participants (U.S. Sugar's employees), as the owners of the largest block of stock, are the largest group affected by the purchase. 

    Although a lot has been written already about Florida’s proposal (and that’s all it is at this point), I have not seen any discussion of how a purchase price for the employees’ shares of stock would be formulated.  This deal may represent an opportunity for U.S. Sugar’s employees (and remaining shareholders) to obtain some value for their stock, but it does not seem to affect the issues in the litigation.

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SCOTUS Rules in ERISA Conflict of Interest Appeal

Posted on June 25, 2008 by Jeffrey V. Mehalic

    An issue that always has to be addressed in ERISA disability claims is the standard of review to be applied to the plan administrator’s decision.  If the plan language does not confer discretion on the administrator, then the court reviews any decision under a de novo standard.  However, if the plan gives discretion, then the administrator’s decision is reviewed under an abuse of discretion standard.  

    But there can be another scenario, one that has confounded litigants, lawyers, and courts for years.  It is where the plan administrator, which makes the decision about a claimant’s entitlement to benefits, is also the plan insurer and therefore responsible for paying benefits.

    Courts have long recognized the conflict of interest that exists, even if they have not been sure how to deal with it.  That’s why the Supreme Court of the United States’ decision in Metropolitan Life Insurance Company v. Glenn, 2008 WL 2444796 (June 19, 2008),was so eagerly awaited.

    In Glenn, Metropolitan (“MetLife”) administered Sears, Roebuck & Company’s long-term disability plan and also paid the benefits.  Sears’ plan’s language conferred discretion on Metropolitan, which meant that its decision whether to award benefits would be reviewed under the abuse of discretion standard.

    Wanda Glenn applied for and received LTD benefits because she was able to show that she could not perform the material duties of her own job (the “own occ” standard).  After 24 months, however, the plan’s standard for proving disability changed, and required her to prove that not only could she not perform her own job, but that she could not perform the material duties of any gainful occupation for which she was reasonably qualified (the “any occ” standard).

    MetLife found that she did not satisfy this standard and denied her claim for benefits.  The District Court for the Southern District of Ohio affirmed the denial, and Glenn appealed to the United States Court of Appeals for the Sixth Circuit.

    In reversing the denial of Glenn’s benefits, the Sixth Circuit relied on a combination of factors, including MetLife’s conflict of interest (the others factors were specific to the treatment of Glenn’s claim).   MetLife appealed to the Supreme Court.

    In an opinion written by Justice Stephen Breyer for a majority of five justices, the Court affirmed the Sixth Circuit and identified two questions to be answered: the first, posed by MetLife, is “whether a plan administrator that both evaluates and pays claims operates under a conflict of interest in making discretionary benefit determinations.”  The second question, posed by the Solicitor General, is “’how’ any such conflict should ‘be taken into account on judicial review of a discretionary benefit determination.’”  

    Personally, I find the second question to be much more significant than the first.  Courts have noted for years the existence of a conflict of interest when the “entity that administers the plan, such as an employer or an insurance company, both determines whether an employee is eligible for benefits and pays benefits out of its own pocket.”  The real issue is how a court is supposed to deal with the conflict.

    The Court relied on principles of trust law in concluding that “for ERISA purposes a conflict exists,” and identified several reasons. 

The employer’s own conflict may extend to its selection of an insurance company to administer its plan (an employer may be more interested in a company that offers low rates instead of one that has accurate claim processing);

ERISA imposes higher-than-marketplace quality standards on insurers (ERISA requires a plan administrator to adhere to a special standard of care; and

A legal rule that treats insurance company administrators and employers alike in respect to the existence of a conflict can nonetheless take account of the circumstances to which MetLife points so far as it treats those, or similar, circumstances as diminishing the significance or severity of the conflict in individual cases

    Regarding the thornier problem of how to account for a conflict, the Court repeated its statement from Firestone Tire & Rubber Co. v. Bruch, 489 U.S. 101, 109 S.Ct. 948, 103 L.Ed.2d 80 (1989), that a conflict “should be weighed as a factor in determining whether there is an abuse of discretion.”

    The Court pointed out that the standard of review should not change, however, which “in practice could bring about near universal review by judges de novo-i.e., without deference-of the lion’s share of ERISA plan claims denials.”  Rather, the Court envisioned that a conflict of interest is a “factor” to be considered in addition to other considerations.  This was the approach taken by the Sixth Circuit; it considered the conflict, but may not have found it to be determinative of Glenn’s appeal in view of other factors.

    Interestingly, in his partial concurrence, Chief Justice John Roberts cautioned that the majority’s approach would bring about a change in the standard of review:  “The end result is to increase the level of scrutiny in every case in which there is a conflict-that is, in many if not most ERISA cases-thereby undermining the deference owed to plan administrators when the plan vests discretion in them.” 

    If you're interested in knowing more about MetLife v. Glenn (and who wouldn't be?), I recommend the knowledgeable and insightful comment and analysis of Roy Harmon at Health Plan Law, Brian King at ERISA Law Blog,  Steven Rosenberg at Boston ERISA & Insurance Litigation Blog, Paul Secunda at Workplace Prof Blog, Suzanne Wynn at Pension Protection Act Blog, and Mark DeBofsky at DDBlog.

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Lawsuit Challenges Member's Expulsion from Fraternal Organization

Posted on June 21, 2008 by Jeffrey V. Mehalic

    For the past few months, any story in The New York Times about West Virginia has discussed Don Blankenship or the Supreme Court of Appeals or both.  But a story in Monday’s edition focused attention on a lawsuit filed in the Circuit Court of Kanawha County (Charleston), West Virginia by Frank J. Haas against the West Virginia Masonic organization and its top officers.  Haas v. Montgomery, Civil Action No. 08-C-1035 (May 30, 2008).

    (In the interest of disclosure, I have known Frank for several years and appeared before him in his capacity as a West Virginia administrative law judge.)

    The lawsuit alleges that Frank, a former West Virginia Grand Master, was expelled from the Masons as a result of his successful efforts to reform the organization and eliminate practices that were, at best, anachronistic and, at worst, illegal:

During his Masonic career and as Grand Master, Plaintiff Haas supported various progressive reforms in Masonry reflecting the will of the majority of the members of Defendant Grand Lodge which reforms were consistent with and promoted rules and regulations designed to respect and protect the constitutional and other rights of all Masons and prospective Masons.  The proposed changes and reforms were not only morally right but were consistent with and designed to bring Masonic laws and attitudes into conformity with the substantial public policy of the State of West Virginia and the United States of America.

Plaintiff Haas' goal was to make Masonry more tolerant, friendly, decent and accepting of everyone regardless of nationality, race, religion or disability.

During the 2006 Annual Meeting, the members of Defendant Grand Lodge voted approval of various reforms proposed by Plaintiff Haas that were in his opinion designed to make Masonry more tolerant, friendly, decent and accepting of all Masons and prospective Masons.  These reforms and proposals were intended to rid Masonry in West Virginia of the Orwellian, repressive, regressive and unconstitutional practices that were and are clearly unconstitutional and against the substantial public policy of this State.

    The lawsuit raises questions about membership in a fraternal organization, such as whether a member is entitled to due process if he is to be expelled from the membership, and, if so, what type of due process.   

    But I think the more important question presented by the action is the public policy aspect: can an organization, even one that is private and fraternal, take punitive action against a member for activities that are intended to rid the organization of illegal or unethical practices?  I would hope the answer is no, but that’s what the lawsuit will decide.

    For more local coverage of the lawsuit, here are articles that appeared in the The Charleston Gazette and the (Charleston) Daily Mail, as well as some entries from a blog called Freemasons For Dummies (which did not think much of the Times’ article).

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WV Supreme Court Rules in Dissenting Shareholders' Rights Case

Posted on June 15, 2008 by Jeffrey V. Mehalic

    The Supreme Court of Appeals of West Virginia issued a decision on June 13 dealing with dissenting shareholders’ rights, an aspect of corporate law that the Court does not often address. 

    In Dodd v. Potomac Riverside Farm, Inc., 2008 WL 2390159 (June 13, 2008), the Court, in a per curiam opinion, considered rulings from the Circuit Court of Berkeley County, West Virginia, which established the fair value of the appellants’ shares in a corporation that owned a family farm and the rate of interest to which the appellants were entitled, and addressed the appellees’ motion for attorney’s fees.   

    The statute under which the appellants dissented from the proposed corporate action, West Virginia Code § 31-1-123, has since been repealed, but applied to the action because it was in effect when the appellants filed their lawsuit. 

    The Court’s rulings are specific to the facts of the appeal and do not represent any new pronouncements of law.  All but one of the Court’s syllabus points address the standard of review to be applied to a circuit court’s rulings, and the other one holds that prejudgment interest is simple in nature, unless a statute or regulation provides otherwise. 

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When Is A Resignation Not A Resignation?, Part 2

Posted on June 14, 2008 by Jeffrey V. Mehalic

    Last week, I wrote about the peculiar wording of Mike Garrison’s announcement that he was stepping down as West Virginia University's president, in which he avoided using the word “resign” to describe his departure.  It seemed that there was a reason that he did not affirmatively state that he was resigning, which was reinforced by the statement issued by the WVU Board of Governors (it follows Garrison's statement), which acknowledged his departure from the position without using the word “resign” to describe his action.  (I sent an e-mail to Garrison last Saturday, asking if there was any reason he didn't use the word "resign" in his announcement, but he has not responded.)

    West Virginia Public Radio posted this article on its website on Wednesday, which suggests that Garrison is not resigning from his position as WVU president, even though he may not be in the position after September 1.

    I wrote earlier that because Garrison’s employment agreement is silent regarding any compensation owed to him if he resigns, he is entitled to only his annual compensation and associated benefits though September 1.

    That was accurate, but incomplete, because the period of time that is now relevant is between September 1, 2008 and June 30, 2010, when Garrison's contract with the BOG expires.  And his compensation for that period of time appears to be set by paragraph 16:

Notwithstanding the provisions of paragraph 7 [which makes Garrison responsible to the BOG through its chairman], the Board commits to employ you as its President, or in some other capacity, in a position to be determined by it, at the Presidential salary provided for herein and as increased from time to time by the Board, for a term ending on June 30, 2010, unless (i) you voluntarily resign or retire, or (ii) you are terminated, all as provided for herein.

    So it looks like the careful avoidance of the word “resign” was no accident, and was intended to enable Garrison to continue to receive his salary of at least $255,000 per year, working in some other capacity, until June 30, 2010.

    Corporations and businesses negotiate severance packages and golden parachutes with departing executives as a matter of course.  On Thursday, two executives at Lehman Brothers were removed from their positions, and reassigned elsewhere in the company.

    But the difference between a corporation such as Lehman Brothers and WVU, among many others, is that a corporation is answerable in such matters only to its shareholders, while a public educational institution does not have such a limited constituency.  If the speculation about Garrison's future is correct, and we may not know for sure until much closer to September 1, there will be significant opposition to his continued employment by the BOG.

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When Is A Resignation Not A Resignation?

Posted on June 6, 2008 by Jeffrey V. Mehalic

    Mike Garrison's "resignation" today as president of West Virginia University
presents a timely opportunity to review his employment agreement, including its provisions for severance pay.  I put resignation in quotation marks not to be sarcastic, but because Garrison's announcement about his departure was vague.  Here is Garrison's  statement, in which he says that he will stay in office until September (presumably September 1), but for whatever reason, does not affirmatively state he is resigning.

    There was some question whether September was chosen in order to entitle Garrison to additional or supplemental compensation if he stayed in office at least one year (he took office on September 1, 2007, which was moved up from his original start date of September 21).  Here is the May 10, 2007 letter from the West Virginia University Board of Governors to Garrison, which serves as his employment agreement. 

    The agreement, which describes Garrison's service as "at the will and pleasure of the Board," requires him, in the event of his resignation, to give "at least sixty days notice before [his] last day in the office."  Garrison's term as president under the agreement was scheduled to end on June 30, 2010.

    This recent article in the Daily Mail reported that Garrison would receive his yearly salary of $255,000 if he was discharged without cause by the Board of Governors prior to June 30, 2008.  If he was discharged without cause after June 30, 2008 but before June 30, 2010, he would be entitled to six months' salary.  A termination for cause, as defined in the employment agreement, would not entitle Garrison to any further compensation. 

    Because the employment agreement is silent regarding any compensation owed to Garrison if he resigns, he is entitled to only his annual compensation and associated benefits through the remainder of his time as president.

    I think Garrison's decision not to state that he is resigning  has some significance, but I cannot see how he is entitled to continued compensation as WVU's president after he voluntarily leaves the position, regardless of how he describes his departure. 

   

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Rodriguez Testifies He Was Forced to Accept $4 Million Buyout

Posted on June 5, 2008 by Jeffrey V. Mehalic

    The parties in West Virginia University’s breach of contract case against former head football coach Rich Rodriguez agreed not to release the videos of the depositions taken in the case, but fortunately for us, there is no such prohibition against releasing the transcripts themselves, as noted by this post from the blog published by the West Virginia University Sports & Entertainment Law Society. 

    So for your reading enjoyment, here are the deposition transcripts for WVU Athletic Director Ed Pastilong, Rodriguez, and Rodriguez’s agent, Mike Brown. 

    Here's one tidbit from Rodriguez's deposition.  According to this Associated Press story in USA Today last month, Rodriguez testified that in August 2007, several members of the WVU Board of Governors told him that his outstanding demands for the football program would be met once Mike Garrison was president of WVU.  The problem is that when the BOG members allegedly made those statements, WVU was conducting a supposedly nationwide search for the position and Garrison was simply one of the applicants. 

    Rodriguez’s testimony is being cited by some who opposed Garrison’s selection as evidence that the search was rigged and not intended to find the best candidate for the position.  The depositions of Garrison and his chief of staff, Craig Walker, are scheduled for later this month.

    In other news regarding WVU v. Rodriguez, the (Charleston) Daily Mail reported that the parties are required to complete mediation by August 1, but WVU does not seem inclined to settle for less than the $4 million buyout.  Monongalia County Circuit Judge Robert Stone has scheduled a hearing on dispositive motions for November 10. 

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U.S. Sugar Employees Claim Company Insiders Cheated Them

Posted on May 30, 2008 by Jeffrey V. Mehalic

    In The New York Times yesterday, Mary Williams Walsh wrote about the situation faced by thousands of employees of U.S. Sugar, who participated in an ESOP (employee stock ownership plan) in 1983, which traded their participation in a pension plan for ownership of the company’s stock.  But as more employees reach retirement, they have discovered that their shares are not as valuable as they expected. 

    U.S. Sugar's shares are not traded publicly, so their value is determined by what the company is willing to pay to redeem them.  Then, once an employee cashes in his or her shares, the shares are retired, which critics of the plan allege makes it easier for insider groups to maintain control, because the pool of shares is getting smaller.

    According to the article, the company’s board turned down two offers by the Lawrence Group, a large agribusiness concern from Sikeston, Missouri,  to buy the shares for $293 each, even though the company was paying employees from $194 to $205 per share at the time.  The employees claim that they were not told about the offers or given the chance to sell their shares at the higher price. 

    To make matters worse, U.S. Sugar hired an outside appraisal firm to evaluate the Lawrence Group’s second offer, which was made in early 2007.  The appraiser determined that U.S. Sugar’s break-up value was $2.5 billion, or $1,273 per share.  Based on that estimate, U.S. Sugar rejected the Lawrence Group’s bid as inadequate, but did not increase the purchase price offered to employees.

    The employees have filed a class action, Johnson v. White, Civil Action No. 08-CV-80101 (M.D. Fla.), which is described on this Website set up by their counsel, Colson Hicks Eidson. The site has most of the court filings from PACER in PDF format. 

    The most recent filing is an amended complaint filed on May 2, 2008, which alleges claims for breach of fiduciary duty against the company’s directors and officers and for violations of ERISA and equitable relief under ERISA Section 502(a)(3).  

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Chesapeake Cancels Plans to Build Regional HQ, Blames WV Supreme Court's Rejection of Appeal

Posted on May 29, 2008 by Jeffrey V. Mehalic

    There is already one casualty from the Supreme Court of Appeals of West Virginia's rejection of Chesapeake Energy Corporation’s petition for appeal from the $404 million verdict in Estate of Garrison G. Tawney v. Columbia Natural Resources, LLC.

    Today, Chesapeake announced that it is canceling plans to build a $35 million regional headquarters in Charleston, and blamed the Supreme Court’s decision not to hear its appeal.   Here is George Hohmann's article about the decision in today's (Charleston) Daily Mail.

   Chesapeake issued this media statement today:

On Thursday May 22nd, the West Virginia State Supreme Court issued a unanimous (5-0) decision against hearing NiSource and Chesapeake's appeal in the Tawney case.  Chesapeake inherited the lawsuit when it purchased Columbia Natural Resources in 2005.

This decision was stunning, as it means we will not have the opportunity to challenge the verdict issued in Roane County in January, 2007.  While we hold a less significant amount of the liability in the verdict, we do believe it sends a profoundly negative message about the business climate in the state.  The reality of this decision is that nobody in West Virginia, similarly situated, has a guaranteed right of appeal in the judicial system.  Chesapeake plans to join NiSource in appealing the case to the U.S. Supreme Court.

As a result, Chesapeake Energy has made the decision to cancel plans to build a new regional headquarters building in Charleston, WV.

We remain committed to our people and our operations in West Virginia and the Appalachian Basin. Chesapeake's Eastern Division will continue to be managed from Charleston, but we will do it from leased space.

--Scott Rotruck, Vice President -Corporate Development

    I have no doubt that Chesapeake is frustrated by the rejection of its appeal, but that was always a possibility.  Unlike federal district court, with its right of appeal, nearly all appeals from West Virginia state courts are discretionary. 

    Chesapeake’s reaction strikes me as a case where its assessment of the success of its appeal may have been based on considerations such as the amount of the verdict, its investment in the local economy, or the prominence of the defendants, and Chesapeake is dismayed that the Supreme Court did not agree with its view.

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