US Labor Dept sues Sonnax, owners, bank to recover losses to Vermont ESOP

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US Labor Dept sues Sonnax, owners, bank to recover losses to Vermont ESOP

Thu, 01/05/2017 - 10:47am -- tim

by Timothy McQuiston Vermont Business Magazine The US Department of Labor issued a press release this morning that says it is suing the principals of one of Vermont's fastest-growing companies, Sonnax Industries, Inc, of Bellows Falls. The suit involves the fiduciaries of a Vermont employee stock ownership plan for violations of the Employee Retirement Income Security Act alleging that First Bankers Trust Services, Inc’s 2011 purchase of the company on behalf of the ESOP from its two previous owners caused the plan to suffer sizable financial losses.

Named in the suit (filed with the US District Court District of Vermont December 28, 2016) are Sonnax, a supplier of automotive drivetrain products; Tommy Harmon, its president and chief executive officer; Frederick Fritz, a board member with substantial company control; and First Bankers, headquartered in Quincy, Illinois. Sonnax, Harmon and Fritz hired First Bankers in 2010 as an independent fiduciary to advise the ESOP on whether, and at what price, to purchase shares of Sonnax from Harmon and Fritz. All defendants are fiduciaries of and parties in interest to the ESOP.

The DOL complaint says, in part, "First Bankers caused the ESOP to overpay for Sonnax stock by millions of dollars." And DOL maintains that Sonnax, Harmon and Fritz knew it was too high, "or should have known."

In an email exchange with Vermont Business Magazine, Harmon said: "We believe that the claims asserted by the US Dept. of Labor against us are without merit. During the process of selling the company to the ESOP, Sonnax, Rick Fritz and I were represented by experts in ESOP transactions and followed their advice throughout the entire process. We are confident that we properly and fairly executed this transaction and that no losses were incurred by the ESOP. In fact, since the creation of the ESOP six years ago, Sonnax has experienced solid growth and created substantial value for all of our employee owners in the ESOP.

"We will vigorously defend ourselves and Sonnax in this matter.  We are confident that the facts will support our position and that we will prevail in this action."


An ESOP is a type of retirement plan that is permitted to invest some or all of its assets in employer stock.  Participants’ benefits depend on the ESOP buying and selling stock for fair market value, so the department intends to make certain that:

  • The price an ESOP pays for the stock reflects its true market value.
  • Those retained to advise an ESOP about the stock purchase fulfill their fiduciary duties under ERISA.
  • Those who sell their shares to an ESOP do not receive a windfall.

Sonnax tooling area. VBM file photos.

On January 3, 2011, the company purchased all of Harmon’s and Fritz’s stock shares for $48.8 million and issued new shares simultaneously which were sold to the ESOP for $10 million. The department’s Employee Benefits Security Administration investigated and found that First Bankers’ valuation that justified the sales was flawed and its representation of the ESOP during negotiations deficient, resulting in a significant inflation of the purchase price.

According to Vermont Business Magazine, Sonnax had revenue of $45.8 million in 2011 and $65.7 million in 2016, with 179 employees in Vermont and 231 system-wide. Sonnnax was named a Best Places to Work in Vermont in 2012 and 2014.

In its suit, the department alleges that the defendants violated ERISA’s prohibited transaction and fiduciary duty provisions. It further alleges First Bankers:

  • Failed to protect the ESOP in connection with the plan’s purchase of Sonnax stock from Harmon and Fritz.
  • Relied on a flawed valuation of the stock.
  • Did not prudently investigate the transaction’s merits.
  • Purchased highly leveraged Sonnax stock for far more than fair market value, with the aid and knowledge of Sonnax, Harmon and Fritz.

Sonnax, Harmon and Fritz knew that First Bankers’ work was flawed yet failed to ensure that First Bankers fulfilled its fiduciary duties, the DOL complaint states. They also failed to prevent the ESOP’s purchase at what they knew or should have known was an inflated price, and participated knowingly in First Bankers’ fiduciary breaches and otherwise failed to comply with their own fiduciary duties.

“The department alleges that the defendants breached their fiduciary responsibilities to act solely in the interest of the plan and its participants with care, skill, prudence and diligence, and solely in accordance with the plan’s documents as required by law. Instead, they placed their own interest above those of the plan’s participants who put their trust in the plan, its trustee and other fiduciaries,” said Susan Hensley, EBSA’s regional director in Boston.

“The alleged actions taken by the defendants improperly disadvantaged the ESOP and its participants. We’ve filed this suit so that the losses are restored to the plan and other corrective action will be taken for the benefit of the participants,” said Michael Felsen, the department’s regional solicitor in New England.

The lawsuit asks the court to:

  • Order the defendants to restore to the ESOP all losses incurred as a result of their fiduciary breaches, prohibited transactions and other violations for which they are liable plus appropriate lost earnings.
  • Require them to disgorge any and all plan assets obtained by them as well as any and all profits earned by them from those assets.
  • Enjoin them from serving as fiduciaries, trustees or service providers for any ERISA-covered plan.
  • Enjoin them from future ERISA violations.
  • Enjoin First Bankers Trust Services from receiving any benefits from its indemnification agreements with Sonnax that violate ERISA.

The EBSA’s Boston Regional Office investigated the case, and senior trial attorneys Nathan P. Goldstein and Gail E. Glick and trial attorney Niamh E. Doherty in the department’s Regional Office of the Solicitor in Boston are litigating. Workers, retirees and employers may contact EBSA toll free at 866-444-3272 to speak with a benefits advisor, or through

In an email exchange with Vermont Business Magazine, DOL spokesman Ted Fitzgerald said:

"The violations alleged in the complaint stem from the transaction: the sale of the stock to the ESOP.

"The complaint alleges that the defendants’ violations resulted in the ESOP overpaying for the company.

"The complaint asks the court to order the Defendants, First Bankers Trust Services, Inc. (the Independent Fiduciary for the transaction), Sonnax Industries, Inc. , Harmon and Fritz to  restore the overpayment and all losses incurred as a result of their violations, as well as other corrective actions listed in the news release and complaint.

"I refer you to the complaint for details.

"The defendants are aware of the suit."

Well known Vermont ESOPs include King Arthur Flour (1996) in Norwich and Gardener's Supply (1987) in Burlington.

Paul Millman, founder of Chroma Technology, which also is off Imtec Lane in Bellows Falls and a neighbor with Sonnax, said there "seems to be an overstatement of value."

Millman said, "My understanding is there's a question of collusion with the fiduciary." He added that he had no more information than that presented in the DOL complaint. 

Millman said he was disappointed to learn of the DOL suit. He knows many employees there and Harmon, but has not talked to him about the DOL action.

Chroma, which designs and manufactures optical filters, also is an expanding, home-grown company that is employee owned, but not an ESOP. 

Millman said his company uses a stock bonus plan, but is considering going to an ESOP. Unlike many employee-owned companies, Millman's started out as employee owned. 

Chroma did $30.1 million in sales in 2016. It received approval in December 2016 to build a 36,800-square-foot addition to double its space at a cost of up to $20 million. 

CHRONOLOGY OF EVENTS (as described in DOL complaint)

"11. In late 2009 or early 2010, Harmon and Fritz decided to explore selling their

combined 100% ownership stake in Sonnax. They initially tried to sell the Company to

strategic buyers or private equity. However, they received little interest, and the few

initial indications of interest they did receive set out prices below the value Harmon and

Fritz believed Sonnax to be worth. Harmon and Fritz eventually decided to explore the

possibility of selling to an ESOP. In or around August 2010, Harmon contacted his

outside counsel who referred him to Steiker, Fischer, Edwards & Greenapple, P.C.

("Steiker"), a law firm specializing in ESOPs. Steiker recommended bringing its

affiliated firm, SES Capital Advisors, Inc., onboard as a financial advisor to Harmon and

Fritz. Harmon and Fritz agreed, and hired SES and Steiker (collectively, "SES") as its

financial and legal advisor.

"12. Harmon and Fritz estimated the equity value of the Company to be in the

range of $48 to $60 million. Privately, SES expressed misgivings about this range. In an

internal email in September 2010, SES stated "there is a lot of risk attached to [Sonnax]

achieving its projections." SES concluded that Sonnax was likely worth about $40

million or $44 million, depending on whether two affiliated real estate LLCs (the

"LLCs") were included in the deal. Based on internal discussions, SES advised Harmon

and Fritz that a $40 to $42 million price range (excluding the LLCs) was "highly likely,"

a $42 to $48 million was "somewhat likely," and anything much above $50 million

would subject Harmon and Fritz to liability as "ERISA fiduciaries."

"13. Harmon, Fritz and SES wanted to finalize the deal by the end of calendar year

2010 and worked quickly to hire a trustee to negotiate on behalf of the ESOP. SES and

First Bankers frequently worked together. On October 4, 2010, SES contacted First

Bankers about becoming the ESOP trustee. SES informed First Bankers that Harmon and

Fritz were seeking a price in the range of $50 to $55 million, and that they intended to

use Stout, Risius, Ross ("SRR") to value the Company on behalf of the trustee. SES

cautioned First Bankers that they were in a "horse race with private equity," so they

would need to work quickly to get a deal done. First Bankers expressed interest and

agreed to use SRR and work quickly. Harmon and Fritz selected First Bankers as


"14. On October 12, 2010, SES made the following offer to First Bankers on

behalf of Harmon and Fritz: the Company would (a) purchase (or "redeem") Harmon's

and Fritz's stock for $55 million (the "Redemption Transaction"), financed by a bank

loan and promissory notes to Harmon and Fritz; and (b) concurrently issue new shares,

100% of which would be sold to the ESOP for $10 million (the "ESOP Purchase")

(collectively, "the 2011 Transaction").

"15. SES followed-up with SRR a few weeks later to inform it that Harmon and

Fritz would need a counteroffer soon. First Bankers quickly arranged a meeting with

SRR, and First Bankers' outside counsel, Katten Muchin Rosenman LLP ("Katten") for

November 2, 2010. In preparation therefor, SRR provided First Bankers a cursory

valuation of the Company (the "Initial Guidance").

"16. Only a small subset of First Bankers' committee designated to approve the

Sonnax deal actually attended the November 2 meeting. At the meeting, SRR observed that Harmon's and Fritz's $55 million asking price was based on financials that did not

account for rent liability to the LLCs, which LLCs the parties had decided not to include

in the deal. First Bankers made a counteroffer of $49 million, which was determined in

part by simply factoring the LLC rent liability into Harmon's and Fritz's asking price.

Harmon and Fritz quickly accepted.

"17. SES had suggested that Harmon and Fritz hold off on formally retaining First

Bankers until after they received a counteroffer from First Bankers and SRR. On

information and belief, Sonnax formally retained First Bankers as Trustee only after the

transaction price was set at $49 million pursuant to an engagement letter signed by

Harmon with an effective date ofNovember 1, 2010. The engagement letter set forth the

duties of First Bankers as Trustee. Among other things, First Bankers "ha[ d] complete

discretionary responsibility with respect to the Transaction ... [and] for the acquisition of

employer securities for the Plan." The engagement letter set First Bankers' compensation

for the 2011 Transaction at a one-time fee of $30,000.

"18. Negotiations over the subsequent few months largely concerned other terms of

the deal, such as Harmon's employment agreement. If First Bankers or its team

questioned anything, SES was prepared to push back. For instance, on November 11,

2010, First Bankers' attorney, Katten, contacted SES to inquire about tax issues on a

separate deal the two were negotiating. SES responded that "[New York City] tax

lawyers [such as Katten] have a unique habit of creating issues where none exist .... [I]f

there is a real[] problem with your tax colleague on any of this, we are really going to

have an issue not only for this deal but for future deals." In subsequent internal emails, SES stated that they would "need to figure out [] whether to pull Katten out of the

Sonnax deal."

"19. On December 22, 2010, SRR provided a draft valuation report (the "Draft

Report") to First Bankers that included new analysis and significantly greater detail than

it had provided in the Initial Guidance. First Bankers left the transaction price

unchanged, except for a $200,000 reduction to $48.8 million based on a recent

distribution to Harmon and Fritz. First Bankers informed SES that it was giving final

approval to the deal.

"20. On December 27, 2010, Sonnax formally adopted the ESOP with an effective

date of October 1, 2010.

"21. On January 3, 2011, SRR provided First Bankers with a fairness opinion

which concluded the $48.8 million Redemption Transaction price and the $10 million

ESOP Purchase price were fair. On that same day, the Company redeemed 100% of its

outstanding shares from Harmon and Fritz for $48.8 million, and sold 100% of newly

issued shares to the ESOP for $1 0 million.

"22. The Company financed the Redemption Transaction through $15 million in

cash provided pursuant to a bank loan, and $33.8 million in subordinated promissory

notes to Harmon and Fritz. As part of the Redemption Transaction, Harmon and Fritz

also obtained stock appreciation rights and warrants (described below). The Plan

financed the ESOP Purchase through a $10 million promissory note financed and backed

by the Company.

"23. On January 10, 2011- a full week after the 2011 Transaction- SRR

completed its final valuation report of the Company (the "Final Report"). The Final Report set forth a new methodology for valuing the Company and different figures than

those in either the Draft Report or Initial Guidance. The $48.8 million Redemption

Transaction and $10 million ESOP Purchase prices, however, remained the same.

"24. For work performed subsequent to the 2011 Transaction, First Bankers

received, among other compensation, an ongoing asset-based fee based on a percentage

of the assets held by the ESOP."



"25. The 2011 Transaction was approved on behalf of the ESOP by First Bankers,

who was hired as Trustee solely to represent the interests of the ESOP and its participants

and beneficiaries.

"26. First Bankers had a duty to make certain that its reliance on SRR's advice was

reasonably justified under the circumstances. First Bankers was obligated to read SRR's

valuation reports, understand the reports, and identify, question and test SRR's

underlying assumptions. In addition, First Bankers was obligated to verify the accuracy

of the data SRR relied on, and to ensure that SRR's conclusions were both internally

consistent and consistent with the data provided. First Bankers failed to comply with

these duties under ERISA for, inter alia, the following reasons.

"27. SRR valued the Company using two methodologies standard in the appraisal

industry: the Discounted Cash Flow ("DCF") and the Guideline Company methods. The

DCF method has three primary components: (1) cash flow projections; (2) a discount

rate; and (3) terminal value. Terminal value refers to the cash flow a company is

expected to generate in perpetuity expressed as a present value. A company's terminal

value has an implicit rate of growth. That is, the present value of the company's cash flow in perpetuity factors in a rate at which the company and its cash flow will grow. A

common terminal growth rate is between 2 and 4%.

"28. SRR's implied terminal growth rate was over 8%. It is highly unlikely that a

company could grow in perpetuity at a rate that is so far beyond a common terminal

growth rate, and well beyond even the historic U.S. gross domestic product growth rate.

By contrast, for its valuation, SES used a growth rate of 4%. Accordingly, First Bankers

knew or should have known that the terminal value on which it based its price was

fundamentally flawed. On information and belief, however, First Bankers never

questioned this assumption. In so doing, First Bankers caused the ESOP to overpay for

Sonnax stock by millions of dollars.

"29. First Bankers further erred in relying on SRR's valuation because it adopted

aggressive growth projections that were inconsistent with Sonnax's historical

performance. Like terminal value, growth projections are another key component in the

valuation of a company. SRR obtained five years of growth projections from Sonnax,

Harmon, Fritz and SES (as it did much of the other underlying financial information) and

simply plugged the projections into its valuation model. These projections, however, are

flawed for a number of reasons. The projections forecasted robust and steadily increasing

revenue and margin growth for Sonnax. Sonnax based these projections on five historical

years surveyed. However, each of the five years forecasted was higher than Sonnax's

best historical year, which itself was significantly higher than any of the other four

historical years. And the steadily rising growth assumed in the projections is undermined

by the erratic and often declining growth in the five historical years surveyed. In fact,

SES itself privately noted that "there is a lot of risk attached to [Sonnax] achieving its projections." Like SES, First Bankers knew or should have known that the projections

were overly aggressive and flawed. Instead, it relied on the flawed projection to

determine the transaction price, and thereby caused the ESOP to overpay by, on

information and belief, millions of dollars.

"30. As part ofthe 2011 Transaction, Harmon, Fritz and key management

personnel received a substantial number of warrants (which grant the right to purchase

Sonnax shares in the future at a set price) and stock appreciation rights ("SARs"). When

exercised or earned, warrants and SARs dilute current ownership of a company. This

dilutive effect must be taken into account when determining the fair market value of a

company. SRR never properly accounted for the dilutive effect the warrants and SARs

provided to Harmon, Fritz and other management as part of the 2011 Transaction would

have on the ESOP's ownership of the Company. For instance, SRR's Final Report only

accounts for the impact of the bank loan and promissory notes on Sonnax's fair market

value. It makes no mention, however, of the impact of the warrants and SARs. In so

doing, SRR' s valuation further inflated the value of Sonnax stock and caused additional

damages to the ESOP.

"31. In light of the fundamental valuation flaws and woefully deficient

investigation and negotiation described above, First Bankers' reliance on SRR's

valuation was unreasonable and its representation of the ESOP inadequate. As a result,

First Bankers caused the ESOP to significantly overpay by millions of dollars for highly

leveraged Sonnax stock, thereby failing to loyally and prudently represent the interests of

the ESOP and its participants and beneficiaries.

"32. For their part, Sonnax, Harmon and Fritz were the Plan Administrators who

also had selected and could remove First Bankers as Trustee. In this capacity, Sonnax,

Harmon and Fritz were obligated to monitor the activities of First Bankers, to remove

First Bankers as Trustee ifthey knew, or should have known, that First Bankers was not

acting in compliance with its fiduciary duties under ERISA, and to otherwise comply

with their own ERISA fiduciary duties.

"33. In light of the fundamental valuation flaws and woefully deficient

investigation and negotiation described above, Sonnax, Harmon and Fritz knew or should

have known that the work performed by their co-fiduciary First Bankers was flawed, and

they knowingly participated in such work. For instance, Sonnax, Harmon and Fritz knew

or should have known First Bankers was relying on aggressive and overly optimistic

projections which they had provided and even their own advisors acknowledged were

unrealistic. Sonnax, Harmon and Fritz also knew or should have known about, and

indeed participated in, First Bankers' improper investigation and negotiation which, inter

alia, were done in haste and not in good faith, using the appraiser that SES desired, and

without meaningfully reducing Harmon's and Fritz's inflated asking price, which

Harmon and Fritz knew or should have known was too high. In so doing, Sonnax,

Harmon and Fritz failed to ensure that First Bankers fulfilled its fiduciary duties, failed to

remove First Bankers as Trustee, failed to prevent the ESOP's purchase of shares at a

price they knew, or should have known, was inflated, participated knowingly in First

Bankers' fiduciary breaches, and otherwise failed to comply with their own fiduciary

duties to act prudently and solely in the interests of the ESOP participants and



Sonnax owner sells to managers

Bellows Falls-based Sonnax Industries named to SBA 100 for growth

Source: MONTPELIER, Vt. – The US Department of Labor 1.5.2017