                               In the
 United States Court of Appeals
                For the Seventh Circuit
                           ____________

No. 05-3417
JUAN ARMSTRONG, et al., on behalf of themselves
   and others similarly situated,
                                       Plaintiffs-Appellants,
                            v.

LASALLE BANK NATIONAL ASSOCIATION,
                                                   Defendant-Appellee.
                           ____________
              Appeal from the United States District Court
         for the Northern District of Illinois, Eastern Division.
                No. 01 C 2963—James B. Moran, Judge.
                           ____________
       ARGUED JANUARY 17, 2006—DECIDED MAY 4, 2006
                           ____________


  Before CUDAHY, POSNER, and WOOD, Circuit Judges.
  POSNER, Circuit Judge. Amsted Industries, Inc., a manufac-
turer of railroad and other transportation equipment, has for
many years been owned entirely by its employees (includ-
ing retired employees) through an Employee
Stock Ownership Plan (an ESOP), which is subject to ERISA.
29 U.S.C. §§ 1104(a)(2), 1107(b), (d)(6); Steinman v. Hicks, 352
F.3d 1101, 1102-03 (7th Cir. 2003); In re Merrimac Paper Co.,
420 F.3d 53, 63 (1st Cir. 2005). Employees begin receiving
stock shortly after they join the company, and over the years
2                                                 No. 05-3417

the value of an employee’s holding can grow to a consider-
able amount. When an employee leaves Amsted’s employ,
his stock is (or rather was until recent changes in the plan
that have precipitated this litigation) redeemed in full and
at once by the company for cash. The plaintiffs, representing
a class consisting of all participants in the ESOP, charge that
the ESOP’s trustee, LaSalle National Bank, made an impru-
dent valuation of the company’s stock, causing heavy losses
to the class members. The district court granted summary
judgment for LaSalle.
  A critical stage in the administration of an ESOP of a
company whose shares are not traded is establishing the
price at which an employee who leaves the company
can redeem his shares. If the price is set too low, em-
ployees who leave will feel short-changed. If it is set too
high it may precipitate so many departures that it en-
dangers the firm’s solvency. Setting a price for redemp-
tions is difficult because by definition there is no market
valuation of stock that isn’t traded.
  The price of Amsted’s stock was reset every year. Before
the recent amendments to the ESOP, it was set on Septem-
ber 30 but an employee had until June 30 of the follow-
ing year to decide whether by quitting the company to
redeem his stock at the September 30 value. Thus a drop in
the stock’s value between September 30 and the following
June 30 would increase the departure rate because em-
ployees who didn’t expect the value to recover could
truncate their loss by redeeming their stock at the higher
September value.
  In August 1999 Amsted bought Varlen Corporation, a
manufacturer of trucking equipment, for some $800 million.
This was a big acquisition for Amsted; Amsted’s value on
the eve of the acquisition probably did not exceed the
No. 05-3417                                                3

purchase price of Varlen. There is no contention that
Amsted overpaid, however; it outbid the next highest
bidder by only fifty cents a share.
  Amsted financed the acquisition by taking out a $1 billion
unsecured bank loan, which replaced its previous debt;
so after completing the acquisition it had a $200 million
unused line of credit ($1 billion minus $800 million). We
do not know how much additional credit it could have
obtained, and on what terms, but apparently not much,
as we shall see. What is certain is that the acquisition
increased Amsted’s debt-equity ratio, and hence the risk
to its employee-shareholders, assuming they could not
offset it by altering their stock portfolios; presumably
most of the employees had the bulk of their financial assets
in the ESOP.
  On September 30, 1999, a month after the acquisition,
a consulting firm (Duff & Phelps) hired by LaSalle
valued Amsted’s stock at $184 a share. This was 32 percent
higher than the previous year’s valuation. The Dow Jones
index of 30 industrials had increased by that amount,
though we have no reason to think that Duff & Phelps
was merely assuming that Amsted was about as good a
performer as the average company in the index. (More on
valuation later.) LaSalle accepted Duff & Phelps’s valuation.
  Given Amsted’s limited unused credit line, it was impor-
tant that its shares not be valued at a price that would
precipitate so many employee departures, and therefore so
many redemptions, as to create financial problems for the
company. In recent years (1996 to 1999), the annual percent-
age of the workforce that had left the company, weighted by
stock ownership, had, as shown in the following chart,
varied in a tight band between about 9 and 11 percent. But
4                                                    No. 05-3417

back in 1990 it had hit 13 percent, more than double the rate
the year before.

                   40
       % of Shares 30
       Outstanding
                    20
       Tendered for
        Purchase 10
                    0
                    85


                         88


                              91


                                   94


                                           97


                                                00
                  19


                         19


                              19


                                   19


                                           19


                                                20
                                    Year



  If the percentage of redemptions in 2000 had turned out
to be 10 percent, the average for the previous four years, the
cost of redemptions would have been only about
$100 million. Amsted could easily have financed that
expense by borrowing against its unused line of bank credit,
or alternatively out of its cash flow. Amsted had earned net
income of $56 million in 1999; in addition it made annual
cash contributions, equal to 10 percent of each employee’s
compensation, to the ESOP in lieu of contributing to a
pension plan for its employees, though the record does
not indicate the total amount of those annual contribu-
tions and diverting them to redemptions would hurt cur-
rent employees.
  The redemption rate in 2000 turned out to be not 10
percent but 32 percent. Redeeming cost the company
$330 million, creating liquidity problems that caused
Amsted to amend the ESOP to eliminate departing em-
ployees’ right to a lump-sum distribution (their shares
would henceforth be redeemed over four years), to defer
eligibility for distributions generally to five years after the
employee left the company, and to make other changes
No. 05-3417                                                 5

in the plan—all adverse to the members of the plaintiff class.
Amsted’s shares were revalued that year at only $90 and the
next year at $44.
   The reason for the surge in departures and therefore
redemptions is not entirely clear. But the Dow Jones Indus-
trial average, although it actually rose by 2 percent between
September 30, 1999, the date on which Amsted’s stock
was valued, and June 30, 2000, the date on which employees
could by quitting redeem their shares at the price that had
been set on September 30, fell 12 percent between January
1, 2000, and June 30, 2000. That may have made
the employees skittish about continuing to own Amsted
stock. Of course Amsted might do better than the companies
in the Dow Jones index—but it might also do worse.
  In addition, many workers were reaching an age at
which they would want to retire, and many of them had
accumulated substantial amounts of Amsted stock through
the ESOP. Of Amsted’s 3,000 employee-shareholders, 735
owned in the aggregate $560 million worth of Amsted stock
at the $184 redemption price set in September of 1999. And
the 800 employee-shareholders who were at least 55 years
old or had more than 30 years of service with the company
had amassed Amsted stock worth almost $300 million. The
average annual number of redemptions in previous years
had been 485, so it is easy to see how a surge in departures
could quickly swallow up the $200 million unused line of
credit plus other available cash; apparently Amsted was not
able to cover the expense of the redemptions with additional
borrowing.
  Assuming that Amsted stock was the principal financial
asset of most employees, they were underdiversified and
therefore at risk of experiencing a large decline in their
overall wealth if the price of the stock fell. One cannot
infer from the concentration of their wealth in the stock of
6                                                 No. 05-3417

one company that they liked risk and were therefore indiffer-
ent to the risk imposed on them by the lack of diversifica-
tion. Remember that Amsted contributed an amount equal
to 10 percent of the employee’s salary to the purchase of
stock in the ESOP; there is no suggestion that an employee
could have persuaded Amsted to give the money to him
instead so that he could purchase a diversified portfolio.
Nor is it suggested that risk-averse workers shy away from
working for companies that have ESOPs.
  For the reasons just indicated, the Amsted ESOP was
ripe for a “run” in 2000; and the more employees who left,
redeeming their shares for cash at $184 a share, the
more acute Amsted’s liquidity problem would be and
therefore the greater the incentive of other employees to
leave before the house caved in. The question is whether
LaSalle, as the ESOP’s trustee, behaved imprudently in the
face of this risk.
     The duty of an ERISA trustee to behave prudently
in managing the trust’s assets, which in this case con-
sisted of the assets of the ESOP, is fundamental. This is true
even though, by the very nature of an ESOP, the trustee
does not have a general duty to diversify, though such a
duty can arise in special circumstances. Steinman v. Hicks,
supra, 352 F.3d at 1106. The duty to diversify is an essen-
tial element of the ordinary trustee’s duty of prudence,
given the risk aversion of trust beneficiaries, but the absence
of any general such duty from the ESOP setting does not
eliminate the trustee’s duty of prudence. If anything, it
demands an even more watchful eye, diversification not
being in the picture to buffer the risk to the beneficiaries
should the company encounter adversity. There is a sense in
which, because of risk aversion, an ESOP is imprudent per
se, though legally authorized. This built-in “imprudence”
No. 05-3417                                                   7

(for which the trustee is of course not culpable) requires him
to be especially careful to do nothing to increase the risk
faced by the participants still further.
  Before proceeding further we must consider whether
our review of the trustee’s decisions in administering an
ESOP, particularly the choice of a redemption price,
should be deferential or plenary.
  In general, judicial review of the decisions of an ERISA
trustee as of other trustees is deferential unless there is a
conflict of interest, which there is not here. Firestone Tire &
Rubber Co. v. Bruch, 489 U.S. 101, 111-15 (1989); Rud v. Liberty
Life Assurance Co., 438 F.3d 772, 775-76 (7th Cir. 2006). And
an ESOP trustee is an ERISA trustee. Yet in Eyler v. Commis-
sioner, 88 F.3d 445, 454-56 (7th Cir. 1996), we conducted a
plenary review of the performance of the decisions of an
ESOP trustee (though without discussion of the standard of
review), as did the Ninth and Fifth Circuits in Howard v.
Shay, 100 F.3d 1484, 1488-89 (9th Cir. 1996), and Donovan v.
Cunningham, 716 F.2d 1455, 1473-74 (5th Cir. 1983), respec-
tively, though other courts have in similar cases applied the
deferential standard of abuse of discretion. Kuper v. Iovenko,
66 F.3d 1447, 1458-60 (6th Cir. 1995); Moench v. Robertson, 62
F.3d 553, 571 (3d Cir. 1995); Ershick v. United Missouri Bank,
N.A., 948 F.2d 660, 666-67 (10th Cir. 1991).
  It may seem odd to speak of standards of judicial re-
view in the present context. Such standards are usually
meant to guide an appellate tribunal asked to overturn the
rulings or findings of a trial-level adjudicator, such as a
judge or jury or administrative law judge, or (coming
closer to home) an ERISA trustee asked to determine a
beneficiary’s entitlement under a welfare plan. LaSalle
was doing nothing analogous to adjudication in fixing a
$184 redemption price of Amsted shares in 1999. Still,
8                                                 No. 05-3417

there are rules as to how much deference a court should
give nonadjudicators, a pertinent example being the
business-judgment rule, which decrees a light hand for a
court asked to invalidate a business decision. E.g., Omnicare,
Inc. v. NCS Healthcare, Inc., 818 A.2d 914, 927-28 (Del. 2003).
Whether a valuation is prudent seems rather similar in
character to whether a business decision is sensible. They
are both judgmental.
  But there is a difference. A trustee is not an entrepreneur.
His services are more like those of a professional. He is
supposed to be careful rather than bold. And care is some-
thing that courts are more comfortable in appraising than
entrepreneurial panache, as when they decide that a driver
was negligent because he failed to exercise due care and as
a result injured a pedestrian. It is natural for a court to
consider whether a trustee was prudent rather than whether
he abused his discretion.
  In arguing that LaSalle placed the ESOP’s participants
at unnecessary risk, the plaintiffs emphasize LaSalle’s
seeming failure to consider the effect on the liquidity of
the ESOP’s assets of Amsted’s having taken on so much
debt in order to buy Varlen. It was obvious that if redemp-
tions exceeded $300 million, Amsted might encounter a
serious liquidity problem that would force it to change
the ESOP to the detriment of the remaining employees.
There is no evidence that LaSalle thought about this possi-
bility, let alone that it tried to reduce the risk by lowering
the redemption price, which by dampening the redemption
rate would reduce the threat to liquidity. LaSalle appears to
have been confident that the future would be just like the
past. That may have been the best prediction, but it may
have been incautious for LaSalle to act on it. The best
prediction may be that one’s house will not burn down,
No. 05-3417                                                       9

but that doesn’t means that it’s prudent to allow one’s fire-
insurance policy to lapse.
   LaSalle had, it is true, a balancing act to perform. For if it
slashed the redemption price, departing employees
would have cause for complaint and LaSalle might find
itself sued, just as it has been, only by another set of plain-
tiffs. We must not seat ESOP trustees on a razor’s edge. We
agree therefore with those courts that review the ESOP
trustee’s balancing decision deferentially. Caterino v. Barry,
8 F.3d 878, 883 (1st Cir. 1993); Edwards v. Wilkes-Barre
Publishing Co. Pension Trust, 757 F.2d 52, 56-57 (3d Cir. 1985);
Foltz v. U.S. News & World Report, Inc., 865 F.2d 364, 374
(D.C. Cir. 1989); Northeast Dept. ILGWU Health &
Welfare Fund v. Teamsters Local Union No. 229 Welfare Fund,
764 F.2d 147, 162-63 (3d Cir. 1985); Ganton Technologies, Inc.
v. National Industrial Group Pension Plan, 76 F.3d 462, 466-67
(2d Cir. 1996). Even if, as we assumed in Eyler, the general
standard of review of an ESOP’s decisions for prudence is
plenary, a decision that involves a balancing of competing
interests under conditions of uncertainty requires an
exercise of discretion, and the standard of judicial review of
discretionary judgments is abuse of discretion.
   But a discretionary judgment cannot be upheld when
discretion has not been exercised. United States v.
Cunningham, 429 F.3d 673, 679 (7th Cir. 2005); Miami Nation
of Indians of Indiana, Inc. v. U.S. Dept. of Interior, 255 F.3d 342,
350 (7th Cir. 2001). We cannot find in the record as now
constituted (a significant qualification, since the case is
before us as a result of a grant of summary judgment) any
indication that LaSalle considered how best to balance the
interests of the various participants in the ESOP in the novel
circumstances created by Amsted’s acquisition of Varlen.
LaSalle acted as if nothing had changed, without (so far as
10                                                No. 05-3417

appears) attempting to determine the consequences of the
acquisition for the risk borne by the ESOP’s participants. A
trustee must discharge his duties “with the care, skill,
prudence, and diligence under the circumstances then prevail-
ing that a prudent man acting in a like capacity and familiar
with such matters would use in the conduct of an enterprise
of a like character and with like aims.” 29 U.S.C. §
1104(a)(1)(B) (emphasis added); see also Moench v. Robertson,
supra, 62 F.3d at 572-73. A trustee who simply ignores
changed circumstances that have increased the risk of loss
to the trust’s beneficiaries is imprudent. Whether that is an
accurate characterization of LaSalle’s conduct is a critical
issue requiring exploration by the district court.
  Should that issue be resolved in LaSalle’s favor, the
court will have to consider whether LaSalle, although
exercising discretion, abused it. One way to pose the
question—we do not say the only way—is to ask whether it
was unreasonable for LaSalle, in the circumstances that
confronted it, to fail to apply a “marketability discount” to
the redemption price.
  We do not know how Duff & Phelps arrived at the
$184 figure for the value of Amsted stock on September 30,
1999. A likely possibility is that it computed the average
price-earnings ratio of companies that are in businesses
similar to Amsted’s but the stock of which is publicly
traded, and that it then multiplied Amsted’s earnings by
that ratio and finally that it adjusted the ratio (and hence the
valuation of Amsted’s stock) on the basis of factors that
distinguish Amsted from the average firm in the compari-
son group. See generally Daniel Bayston, “Valuation of
Closely Held Companies,” Duff & Phelps, LLC,
http://www.duffandphelps.com/3_0_index.htm?3_3_1_c
ontent_arc, visited Apr. 7, 2006. One of those factors was the
relative illiquidity of Amsted stock.
No. 05-3417                                                  11

   The less marketable a property is, the lower its market
value; shares in closed-end mutual funds typically trade
at prices lower than the prices of the stocks held by the
funds because the mutual-fund investor cannot sell his
share of the stocks in the mutual fund’s portfolio other
than by selling shares of the fund. A participant in an ESOP
is in a parallel position: he can sell his shares of his em-
ployer’s stock only by quitting his job. And the ESOP could
always be changed by Amsted—ultimately it was—to limit
redemptions in the event of a run, thus further reducing the
liquidity of the participant’s investment. The average person
would therefore prefer to own shares in a publicly traded
company than in Amsted (if they were priced the same)
even if the two companies had identical cash flows and risk
profiles. And so they wouldn’t be priced the same. By
increasing the probability of a run, the Varlen acquisition
increased the probability that rights of redemption by
Amsted’s employee-shareholders would be fur-
ther restricted, and so the acquisition created a further threat
to liquidity.
   There are techniques for calculating a marketability, or
illiquidity, discount, see Z. Christopher Mercer, “A Primer
on the Quantitative Marketability Discount Model,” CPA
Journal, July 2003, www.nysscpa.org/cpajournal/2003/
0703/dept/d076603.htm, visited Apr. 6, 2006, but we
shall not speculate on what they might have yielded if
applied to Amsted, or on how far a trustee can deviate from
them before he can be adjudged imprudent. These are issues
for exploration on remand if it is determined that LaSalle
did not fail to exercise discretion.
                                  REVERSED AND REMANDED.
12                                           No. 05-3417

A true Copy:
       Teste:

                      _____________________________
                       Clerk of the United States Court of
                         Appeals for the Seventh Circuit




                USCA-02-C-0072—5-4-06
