Employee Stock Ownership Lawsuit Unmasks Brazen Corporate Fraud

Riverside, CAThe allegations made in Gamino v. KPC Healthcare are pretty lurid, especially as ERISA lawsuits go. Even apart from the loaded handgun and the slashed tires, the Complaint tells a tale of shocking financial malfeasance.

The lawsuit claims that in 2015 Kali Pradip Chaudhuri, the sole shareholder of KPC Healthcare, sold the company to a newly created employee stock ownership plan, the KPC Healthcare, Inc. Employee Stock Ownership Plan (the “ESOP”) at a grossly inflated price. It was more than 400 percent what Chaudhuri had paid two years earlier. Evidence suggests that, the price paid by the ESOP notwithstanding, the value of the company had actually declined in those years.

The net effect was that Chaudhuri was able to strip assets out of the ESOP for his own personal benefit, in violation of the fiduciary strictures of ERISA. That, however, is simply the “plain beige” version of the story.

Financial fraud in Technicolor   

Integrated Healthcare Holdings, Inc., the predecessor to KPC Healthcare, had been a publicly traded company, and thus subject to public reporting requirements and some degree of SEC oversight. But it was a shell company, with no material operations until March 10, 2005. On that date it purchased four Orange County, California hospitals. These included Western Medical Center in Santa Ana; Western Medical Center in Anaheim; Coastal Communities Hospital in Santa Ana; and Chapman Medical Center in Orange. Integrated Healthcare bought the hospitals with debt financing provided by Chaudhuri.

Dr. Chaudhuri already had a significant reputation in Southern California, and Integrated Health’s acquisition of the hospitals was met with vocal public opposition. One of his other companies, KPC Medical Management Inc., went bankrupt shortly after acquiring Medpartners, a Southern California provider network. The bankruptcy shuttered 38 California clinics, left 300,000 patients without medical care, and led some to accuse Chaudhuri of financial mismanagement and self-dealing.

A group of doctors created a competing acquisition group to buy the Orange County hospitals, hoping to prevent a repeat of the Medpartners debacle.  They were ultimately intimidated into silence, however, by litigation threats and other forms of harassment. That is where the loaded handgun and the slashed tires figure into the story.

Integrated Healthcare was ultimately successful in acquiring the hospitals, after agreeing to a reduced role for Chaudhuri. Slowly however between 2005 and 2010, Chaudhuri acquired all the stock of Integrated Healthcare. He took the company private in 2014 and changed its name to KPC Healthcare in 2015.

Later that same year, Chaudhuri sold KPC Healthcare to the ESOP for $227,107,262. To finance the purchase, the ESOP borrowed $217,107,262 from KPC Healthcare. The remaining $10,000,000 was paid with a cash contribution from KPC Healthcare.

To simplify that tangled trail, the money went from the company that was being sold, to the ESOP, to Chaudhuri. In a star turn of gas lighting, Chaudhuri publicly characterized his sale of the stock to the ESOP as a “gift.”

The raid was complete. Chaudhuri finalized his purchase of the company in 2013 for roughly $51,827,374. He sold the company two years later for $227,107,262, taking with him the pot of money set aside for employee retirement savings. He made roughly $175,280,000 on the deal.  Not a drop of blood was shed. In fact, neither regulators nor those in charge of safeguarding employee retirement money made a sound.

Why did the dog not bark?

The insiders

One of the principal reasons that no one at KPC Healthcare objected to this transaction was the fact that it was a privately held company, not subject to outside oversight. That is one of the main differences between a publicly traded and a private or family-held company.

The other was the web of personal relationships that existed among the key players. Chaudhuri was both the Chairman of the Board and the CEO of KPC Healthcare and allegedly continued to exercise operational control even after the company was sold to the ESOP. William E. Thomas was the Secretary and member of the company’s Board of Directors. He was also General Counsel and Vice President of the KPC Group of Companies, an umbrella company. He had been Chaudhuri’s long-time personal lawyer.

Kali Priyo Chaudhuri, Chaudhuri’s son, was the Chief Financial Officer of the company and a director. Chaudhuri, his son and Thomas made up a majority voting bloc on the Board of Directors. Dr. Sumanta Chaudhuri , Chaudhuri’s daughter, was the Chief Medical Officer at two of the hospitals.

Officers and the Board of Directors often play a key role in appointing members of the various investment and administrative committees charged with retirement plan oversight. Members of those committees, themselves, are often officers and directors.
Alerus Financial, the outside advisor chosen to act as a Trustee of the ESOP for purposes of the 2015 sale, also inexplicably failed to do any due diligence as a fiduciary to the ESOP. According to the Complaint, it failed to exercise any scrutiny over the price ultimately paid by the ESOP to Chaudhuri.

What’s wrong here?

It’s hard to know where to start. But from the perspective of the ESOP participants who have been bilked out of retirement savings, the Complaint focuses on two main areas of ERISA. The first is the “party-in-interest” rules that generally forbid insider deals involving family members, legal counsel and others who have a financial interest at odds with the interests of participants. Thomas and the three Chaudhuris are covered by the party-in-interest prohibitions.

The second is the fiduciary duty rules that require fiduciaries, including plan management committees, to act in the sole interest of participants and beneficiaries. Gamino v. KPC Healthcare is still in its early phases. It is one to watch, however, in the evolving saga of employee stock ownership lawsuits.