Middleton et al v. Stephenson
MEMORANDUM DECISION and Ordergranting 17 Defendant's Motion for Partial Summary Judgment. Signed by Judge Ted Stewart on 12/08/2011. (tls)
IN THE UNITED STATES COURT FOR THE DISTRICT OF UTAH
BRENT MIDDLETON as Trustee of the
National Financial Systems Management, Inc.
Employee Stock Ownership Plan, et al.,
MEMORANDUM DECISION AND
ORDER GRANTING DEFENDANT’S
MOTION FOR PARTIAL
J. HOYT STEPHENSON,
Case No. 2:11-CV-313 TS
This matter is before the Court on Defendant’s Motion for Partial Summary Judgment.
Defendant asks the Court to grant summary judgment on two of Plaintiffs’ claims against him.
The Court will grant the Motion as to both claims for the reasons set forth below.
In 2003, Defendant J. Hoyt Stephenson incorporated National Financial Systems
Management, Inc. (“NFSM”). As part of the incorporation, the board of NFSM created an
employee stock ownership plan (“ESOP”), and put all of NFSM’s stock into the plan, creating
the NFSM ESOP (“the Plan”). Stephenson was designated as a Plan trustee. NFSM’s revenue
came in the form of “management fees” paid to NFSM by two companies also owned by
Stephenson—National Financial Systems, Inc. (“NFS”) and Metronomics, Inc. (“Metro”).
Ninety percent of NFS and Metro’s profits were paid to NFSM.
On October 15, 2007, NFSM purchased NFS. NFSM made an up front payment for a
percentage of the purchase price and issued a promissory note for the balance. On January 15,
2008, NFSM bought Metro in the same manner.
On June 27, 2009, Stephenson entered into “default agreements” with NFSM, in which
NFSM acknowledged it was in default on both the NFS and Metro notes. NFSM then transferred
all NFS and Metro stock back to Stephenson. Stephenson did not refund any payments from
NFSM for NFS and Metro. Stephenson subsequently sold NFS and Metro to another person.
Plaintiffs bring claims under ERISA, claiming that Stephenson violated his fiduciary
duties as trustee of the ESOP by engaging in prohibited transactions with Plan assets when he
bought NFS and Metro as the head of NFSM, and when he entered into default agreements
returning NFS and Metro to himself. Plaintiffs further allege violations of the United States Tax
Code, for the same reasons. Stephenson argues that these transactions were not subject to ERISA
fiduciary duties nor prohibited by the United States Tax Code.
II. STANDARD OF REVIEW
Summary judgment is proper if the moving party can demonstrate that there is no genuine
issue of material fact and it is entitled to judgment as a matter of law.1 The party seeking
summary judgment bears the initial burden of demonstrating an absence of a genuine issue of
See Fed.R.Civ.P. 56(a).
material fact.2 “Once the moving party has properly supported its motion for summary judgment,
the burden shifts to the nonmoving party to go beyond the pleadings and set forth specific facts
showing that there is a genuine issue for trial.”3 “An issue is genuine ‘if the evidence is such that
a reasonable jury could return a verdict for the nonmoving party.’”4
Defendant moves for summary judgment on Plaintiffs’ second and fifth causes of action.
Plaintiffs’ second cause of action alleges violations of ERISA’s prohibited transactions and self
dealing provisions. Plaintiffs’ fifth cause of action alleges that the transactions in question were
prohibited under the United States Tax Code. Both parties agree that all arguments relating to
the second cause of action apply without alteration to the fifth. Thus, each of Plaintiffs’ ERISA
claims will be discussed in turn, and all analysis will be equally applicable to Plaintiffs’ tax code
Plaintiffs first argue that Stephenson has violated 29 U.S.C. § 1106(1)(a). That statute
governs the behavior of fiduciaries of plans like the ESOP in this case. The disputed provision
prohibits a fiduciary from “caus[ing] the plan to engage in a transaction, if he knows or should
know that such transaction constitutes a direct or indirect sale or exchange, or leasing, of any
property between the plan and a party in interest.” Three transactions may fall under the statute:
Celotex Corp. v. Catrett, 477 U.S. 317, 323 (1986).
Sally Beauty Co., Inc., v. Beautyco, Inc., 304 F.3d 964, 971 (10th Cir. 2002).
Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986).
(1) the sale of NFS by Stephenson to NFSM; (2) the sale of Metro by Stephenson to NFSM; and
(3) NFSM’s default agreement, which returned NFS and Metro back to Stephenson.
Plaintiffs’ claims against Stephenson rest on the assumption that, because NFSM was
wholly owned by the ESOP, transacting with NFSM is the same as transacting with the Plan.
ERISA’s definition of a plan does not directly address whether entities within the plan constitute
the plan itself: “any plan, fund, or program which . . . is established or maintained by an
employer . . . to the extent that . . . such plan, fund, or program provides retirement income to
employees.”5 Nor does there seem to be any case that addresses the precise question.6 A close
inspection of the language of § 1106 indicates that the disputed transaction here is not a
transaction between the Plan and a party in interest.
29 U.S.C. § 1002(2)(A) (2008). A Department of Labor regulation interpreting ERISA
provides guidance on what constitutes the assets of a plan, a question that becomes important
further on in this Order. 29 C.F.R. § 2510.3-101. The regulation makes clear that the
investments of a plan are considered assets of the plan. Id. Thus NFSM stock, being an
investment of the NFSM ESOP, is an asset of the NFSM ESOP. However, the regulation does
not actually speak to whether dealing with the company, whose stock is held by the plan, is the
same as dealing with the plan.
Stephenson does cite to one unpublished Ninth Circuit case, Andrade v. Parsons, 1992
WL 182218 (9th Cir. July 31, 1992), which Stephenson claims answers the question. The case
does involve an ESOP and a wholly owned company, and the court does conclude that a
purchase by the company of stocks from purported parties in interest to the ESOP is permissible.
Id. at *3. However, the court’s reasoning is sparse and somewhat confusing. The court holds
that “the type of stock transaction was not a prohibited one, as the [purchased shares] were never
assets (or property) of the plan.” Id. But this seems to avoid the question, which is whether the
wholly-owned company would be considered a plan in the transaction. Even though the
purchased stock was not a plan asset when purchased, if the wholly-owned company could be
considered a plan, then anything the wholly owned company exchanged for the stock would be a
plan asset. In light of this confusion, the Court finds this case unhelpful.
A sale or exchange is commonly understood to encompass the transfer of something
owned by one party in return for something of value owned by the other.7 Here, those parties
would be the Plan and Stephenson. It follows that a sale or exchange between a plan and a party
in interest would involve an exchange of some form of plan property.
A Department of Labor regulation interpreting ERISA—29 C.F.R. § 2510.3-101(a)(2)—
provides guidance on what constitutes the assets of a plan.8 The regulation states that the assets
of an entity in which an ESOP invests are not plan assets if the entity is an operating company.
An operating company is defined as “an entity that is primarily engaged, directly or through a
majority owned subsidiary or subsidiaries, in the production or sale of a product or service other
than the investment of capital.”9
Plaintiffs argue that NFSM is not an operating company because its primary purpose is
the investment of capital. This argument is based on Plaintiffs’ theory that NFSM did not
actually manage NFS and Metro—rather, NFS and Metro’s profits were simply routed to NFSM
because of its favorable tax status. Because NFSM then took that money and “invested” it in
NFS and Metro stock, Plaintiffs argue that NFSM’s primary purpose was in fact to invest capital
The Merriam-Webster Dictionary defines sale as “transfer of ownership of property from
one person in return for money.” Home & Office Ed. at 462 (1998). “Exchange” is “the giving
or taking of one thing in return for another.” Id. at 180.
Another provision of the same regulation, § 2510.3-101(h)(3), also speaks to the issue of
whether the assets of a wholly owned entity belong to the plan. Both parties agree that under this
regulation NFSM’s assets would not be considered Plan assets. Plaintiffs claim, however, that §
101(h)(3) is not the only provision under which NFSM’s assets could be deemed plan assets, and
thus turn their attention to 101(a)(2).
29 C.F.R. § 2510.3-101(c).
for NFS and Metro, and, by extension, Stephenson. In his reply brief, Stephenson describes the
structure of NFSM and the responsibilities of its employees:
NFSM was established to provide management, administrative and employee
leasing service for NFS and Metro. At the time stated, NFSM had over 120
employees, while NFS and Metro had no employees. NFSM had a contractual
duty to provide, and did provide, general accounting, bookkeeping . . . and
business services to enable NFS and Metro to meet their obligation to their
customers. NFS and Metro held contracts with health club customers that
obligated them to provide accounts receivable management and club management
software services tailored to the health and fitness club industry. Together, NFS
and Metro serviced over 600 locations with over 500,000 members. Virtually the
only income NFSM received was income from NFS and Metro paid under the
NFS and Metro Management Agreements for the services summarized above.10
Though this detail was provided for the first time in Stephenson’s reply brief, the Court notes
that Plaintiffs offered no evidence demonstrating that NFSM was not so structured. Plaintiffs
thoroughly investigate NFSM’s tax returns in pursuit of their “favorable tax status” theory, but
do not comment on the fact that NFSM employed 120 people, much less offer facts showing that
these employees invested capital as their primary responsibility. In light of Stephenson’s
statement about what the employees of NFSM did, and the evidence supporting it, the Court
assumes that Plaintiffs offered no contrary evidence because there was none to offer.
Accordingly, the Court finds that NFSM, with its many employees, provided management
services and was not primarily in the business of investing capital. This finding necessitates a
finding that NFSM was an operating company.
Because NFSM is an operating company, the Plan’s property is limited to NFSM stock.
Furthermore, because no NFSM stock was sold or exchanged in the disputed transactions, the
Docket No. 25, at 4.
transactions cannot have been between the Plan and a party in interest. Accordingly, the Court
finds that NFSM’s dealings with Stephenson as owner of NFS and Metro were not transactions
between the Plan and a party in interest, and thus were not subject to the prohibited transaction
provisions of 1106(a)(1).
Plaintiffs rely heavily on Marshall v. Snyder11 to upend this analysis. According to
Plaintiffs, Marshall held that RPI, a company wholly owned by an ERISA plan, could not spend
its money without complying with ERISA fiduciary requirements—implying that RPI’s money
was plan property. Strictly speaking, this is a correct characterization. But the court’s holding
did not actually turn on whether RPI was owned by the plan. In Marshall, RPI administered the
plan,12 was funded with payments from the plan, and, it turned out, was using those funds to pay
people who were not actually doing work for the plan.13 The court’s holding was not that RPI
was subject to fiduciary duties because it was wholly owned by the ESOP. Rather, RPI was
subject to fiduciary duties because it administered the plan. In contrast, NFSM is not an
administrator for the Plan, and was not using funds paid to it by the Plan for administrative
services to pay for other things. Thus, Marshall’s holding that RPI could not spend its money
without complying with ERISA fiduciary duties has no application to the instant case.
Plaintiffs’ statutory interpretation argument to the contrary is also unavailing. The
relevant provision of ERISA prohibits a fiduciary from engaging in a transaction that “constitutes
430 F. Supp. 1224 (E.D.N.Y. 1977).
Id. at 1228.
Id. at 1229.
a direct or indirect . . . sale or exchange, or leasing, of any property between the plan and the
party in interest.” Plaintiffs, citing the well accepted principle that a statute must be read so as to
give each word effect, argue that if the statute doesn’t prohibit the transaction at issue then the
word “indirect” is redundant. In other words, Plaintiffs ask the Court to read the relevant
provision to prohibit both exchanges/sales of property between the plan and a party in interest
(direct sales) and exchanges/sales between parties in interest and things owned by the plan
(indirect sales). But an inspection of the statutory language demonstrates that “indirect” need not
encompass the situation here in order to have a separate meaning from “direct.” Both “direct”
and “indirect” modify the verbs that follow—“sale,” “exchange,” and “leasing”—which, in turn,
define transactions that take place between the plan and a party in interest. Read with this
relationship in mind, the language would prohibit both (1) a sale that was directly to a party in
interest from the plan and (2) a sale by the administrator of plan assets to a third party, which
third party then gives the same assets to a party in interest (as long as the administrator knew or
should have known the property was headed to a third party). Reading the statute this way, it is
not necessary to make “indirect” applicable to the present situation—one where a plan is
“indirectly” involved in a prohibited transaction because a company it owns is buying something
from a purported party in interest—in order to save “indirect” from redundancy.
On this understanding of the statute, the exchanged property would have to reach the
party in interest or the plan, either directly or indirectly, to be a prohibited transaction. The
present transaction is clearly not covered. NFSM has entered into direct transactions with
Stephenson as owner of NFS and Metro, and the transaction stopped there. Money and a
promissory note were given to Stephenson, NFS and Metro stock was given to NFSM. But NFS
and Metro were never subsequently delivered or sold to the Plan. Nor did the Plan give NFSM
the money it used to purchase the companies from Stephenson. Accordingly, there has never
been a transaction between the plan and the party in interest, either direct or indirect.
In addition to these arguments, it is well accepted that “the ERISA scheme envisions that
employers will act in a dual capacity as both fiduciary to the plan and as employer. ERISA does
not prohibit an employer from acting in accordance with its interests as employer when not
administering the plan or investing its assets.”14 This is true even if the actions taken by the
employer negatively affect the value of ESOP assets.15 Thus, as a separate ground for denying
Plaintiffs’ prohibited transaction claim, it appears that if Stephenson was not acting in his role as
plan trustee when he participated in the decision to buy or relinquish NFS and Metro, he was not
required to comply with fiduciary responsibilities.
NFSM voted, through its board, to purchase NFS and Metro and to relinquish them. The
purchase was not undertaken or paid for by the Plan. Though the parties dispute to what extent
Stephenson participated in the decision, even if the Court were to assume that Stephenson was
fully involved, the outcome would remain the same. The decision was made for NFSM as a
business and not the for the ESOP, with NFSM capital by NFSM board members acting in their
Phillips v. Amoco Oil Co., 799 F.2d 1464, 1471 (11th Cir. 1986).
Phillips v. Amoco Oil Co., 614 F. Supp. 694, 717 (D. Ala. 1985) (“[T]he fiduciary duty
provisions of ERISA are not implicated in the sale of a business or a portion of a business merely
because the terms of the sale will affect the terms and conditions of contingent future benefits.”).
NFSM capacities. Thus, the Court finds that, to whatever extent he was involved in the
decisions, Stephenson was not subject to fiduciary responsibilities when making them.
In light of the foregoing, the Court holds that there is no material dispute of fact as to
whether Stephenson has violated § 1106(a)(1) and that Stephenson is entitled to judgment as a
matter of law because: (1) the sale of NFS and Metro, as well as their return to Stephenson, were
not transactions between a plan and a party in interest, and (2) to the extent Stephenson took part
in the transactions, he was not acting on behalf of the plan and thus was not subject to ERISA
Plaintiffs also argue that Stephenson violated § 1106(b)(1) and (2). Section (b)(1)
prohibits a fiduciary from “deal[ing] with the assets of the plan in his own interest or for his own
account.” The supposed assets of the plan that Stephenson has dealt with “in his own interest”
would be the cash used to buy NFS and Metro and then NFS and Metro themselves. But as
discussed above, these are not plan assets under 29 C.F.R. § 2510.3-101(a)(2). Accordingly,
Stephenson cannot have violated § (b)(1) when he received money, or the companies, from
Section (b)(2) prohibits a fiduciary “in his individual or in any other capacity [from
acting] in any transaction involving the plan on behalf of a party (or represent a party) whose
interests are adverse to the interest of the plan or the interests of its participants or beneficiaries.”
As discussed above, the transactions between NFSM and Stephenson involved no plan property.
Accordingly, they cannot reasonably be seen as transactions with the plan. Thus, even though
Stephenson engaged in a transaction with NFSM in his capacity as owner of NFS and Metro, he
was not transacting with the Plan, and therefore cannot be subject to § (b)(2).
For the same reasons set forth above, the Court finds that the Defendant is entitled to
summary judgment on Plaintiffs’ tax code claims.
Based on the foregoing, the Court grants summary judgment in favor of Stephenson on
causes of action two and five of Plaintiffs’ Complaint. The hearing on this Motion currently set
for Wednesday, December 21st is stricken. It is therefore
ORDERED that Defendant’s Motion for Partial Summary Judgment (Docket No. 17) is
DATED December 8, 2011.
BY THE COURT:
United States District Judge
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