The long-simmering feud between Fidicuary Network (FN) founder and former CEO Mark Hurley and its largest investor, Emigrant Bank (EB) CEO Howard Milstein, is headed for court.

Last Friday, Hurley filed a lawsuit against EB, New York City real estate billionaire Milstein and five other EB principals alleging they sought to sabotage the sale of FN by tarnishing the reputation of Hurley and management so they could buy out them at bargain prices. Hurley is seeking a jury trial in County Court in Dallas, where FN was headquartered, and more than $150 million in damages.

On November 21, EB announced it had acquired Hurley’s 25 percent interest and replaced him as CEO with Karl Heckenberg. No price was disclosed.

The lawsuit claims that EB management hired private detectives to “tail” Hurley and discover damaging information about him during his divorce earlier this year in order to “derail” any sale. Ultimately, a court would deny EB’s attempt to include “confidential documents” relating to his divorce in investment banking materials describing FN’s financial conditions.

It also claims that in November 2017 Barry Friedberg, an EB director, submitted a “letter to the editor” of RIAbiz, an industry website, estimating that the value of FN was in the range of $70 million to $80 million, far less than it had been valued at six earlier. Friedberg publicly indicated his intent to replace FN management and named Heckenberg as a “CEO in waiting.”

At that time, several heads of FN portfolio firms sent letters to EB complaining about making their dispute public, arguing that the biggest challenge for RIA firms was recruiting new talent. A public airing of the feud, they claimed, would only make that task more difficult.

In his new role, Heckenberg is believed to be spending the last few weeks after Thanksgiving meeting with FN portfolio companies, many of whom had long relationships with Hurley.

"Mr. Hurley’s allegations are completely false and defamatory,"  an Emigrant Bank spokesperson told Financial Advisor. "His complaint is nothing more than a series of baseless – and at times bizarre – allegations, most of which have little to do with the transaction in question. We have no doubt the court will agree once all the facts are presented."

When FN was put up for sale this year, its former management charges that EB interposed a series of demands and parameters for banker selection that “dampened interest” from banks. “It also demanded that a series of false and defamatory allegations about the integrity of management be shown to prospective bankers and bidders” to discourage both bankers and potential acquirers.

EB’s goal was to portray the FN sale as a low-value, “distressed asset with problematic management rather than what it actually was, a fast-growing highly valuable company with widely respected management in a very attractive segment of the financial services industry.” The complaint noted that FN was valued by a third party at $160 million in 2011 when it was a much smaller concern. Though that valuation arguably was excessive, FN’s cash flow today is five times what it was seven years ago.

In one part of the lawsuit, Hurley's attorneys asserts that the true value of FN today is closer to $318 million. In another part, they suggest it could in the $500 million range.

Hurley did not return phone calls, but his attorneys spoke via e-mail.“Our clients believe that defendants engaged in a calculates, scorched-earth campaign to unlawfully seize control of FN,” said William Brewer III, partner at Brewer Attorneys & Counselors and lead counsel for the plaintiffs. “Defendants’ actions, we allege, intentionally depressed the value of FN, allowing them to acquire it at a bargain-basement price, and ultimately gain profits to which they weren’t entitled.”

By July 25 of this year, 23 indicative bids were received by Evercore, the investment bank. Initial interest reportedly was strong.

Then EB’s alleged “scorched-earth tactics” were initiated. EB “even threatened FN’s founder, its investment banker and its highest-bidding potential acquirer with lawsuits and reputational damage,” the complaint said. Threatening a potential acquirer is highly unusual and rarely occurs except in hostile takeovers. But Hurley and his attorneys maintain these tactics enabled EB to buy the firm “for pennies on the dollar.”

FN, along with Focus Financial Partners and United Capital, was one of the first aggregation-consolidation vehicles launched in the 2005-2007 era. Unlike most other entities, FN did not acquire majority equity interests or engage stock swaps in affiliated concerns. Instead, it opted to purchase minority stakes and provide transition financing so that founding partners could receive liquidity from next-generation advisors looking to succeed them. As a result, management still owns a controlling interest in FN portfolio companies.

When FN was launched, Hurley partnered with EB, which acquired a 75 percent stake in the firm.  Their agreement was for nine years.  Thereafter, either party could force a transaction.  EB had a call and Hurley had a right to force a sale of the entire company.  However, in order to complete a deconsolidation transaction in 2011, designed to strengthen EB's balance sheet following the financial crisis, with Virgo Investments, EB agreed to delay its call right until the earlier of Hurley exercising his forced sale right or Dec 1, 2017.  If EB elected not to exercise its call, it was still protected by a right of first refusal (ROFR) at the end of the sales process, provided it paid a substantial breakup fee, believed to be 10 percent, to the high bidder.

The 44-page complaint, accompanied by more than 700 pages of exhibits and appendices, details an unpleasant relationship that was strained from the start and turned toxic early on. “For more than a decade, Milstein, with the assistance of the other defendants, demanded that FN employees agree to draconian contractual terms,” the document says. “While operating through EB, Milstein initially demanded that potential bankers for the sale process be given a highly-unattractive set of terms to dampen bankers’ interest in representing FN. Pursuant to Milstein’s directive, defendants instigated successive, baseless legal actions. They published scurrilous, material misstatements regarding FN’s finances and the integrity of its leadership team."

The complaint continued to charge that, "Collectively, these bad- faith dilatory tactics had Milstein’s desired effect of eliminating the competition and wresting control of FN from its founder for pennies on the dollar.”

Though FN acquired interests in four firms and reportedly had four other deals lined up prior to the financial crisis, that event proved to be a turning point. In August 2008 as the crisis was unfolding, the lawsuit alleges Milstein became “enraged” following a story in a New York newspaper that was highly critical of EB’s penchant for investing in new ventures.

Consequently, the lawsuit claims that Milstein sought to terminate the FN venture and told Hurley to fire all his employees and wind down FN’s operations. After discovering that the FN employees had contracts requiting EB to pay them for the contract’s duration, Milstein reportedly ordered Hurley to rehire them, which he did.

According the suit, Hurley told Milstein he would look for another investor. Milstein reversed course yet again, the lawsuit claims, viewing Hurley’s efforts “as a challenge to his authority.”

At about that time, certain changes to the way FN structured transactions made it far more complex for the young firm to complete deals. In 2008, Milstein required FN to reclassify all its investments in RIA firms as debt, not equity, according to the complaint. The key motivation appears to be an effort to satisfy regulatory capital requirements, though that is not clearly spelled out. The document maintains that the net result of this change was to dramatically reduce the number of firms FN could invest in from 18,000 to 4,000.

While FN and much of the asset-light, RIA industry recovered relatively quickly from the financial crisis, many banks did not. The lawsuit maintains EB experienced serious difficulties due to bad investments in mortgage-backed securities and other underperforming investments.

Cited in the complaints are a 2009 story from Crain’s New York Business entitled, “Meet New York’s Wobbliest Bank,” about EB and another 2010 Crain's story claiming EB had yet to repay its TARP loan. Hurley’s lawyers maintain such negative publicity may well have scared RIA firms from doing deals with FN.

To deal with EB’s purported financial woes, Milstein diverted Hurley and other FN personnel to projects that would strengthen EB’s balance sheet. From EB’s viewpoint, this may have made sense. In the late 1980s, Hurley took a leave from Goldman Sachs’s financial institutions group to work at Resolution Trust Co. created to address the S&L crisis of that era. Utilizing Hurley's experience in the distressed lending world may have helped EB but it also could well have slowed FN’s growth.

Restructuring of EB’s position in FN continued. With Dodd-Frank’s increased tier 1 capital requirements looming, the lawsuit says Milstein instructed Hurley to find a minority investor for FN so EB could deconsolidate its balance sheet and generate capital by reducing its stake in FN below 50 percent. Virgo Investments, a private equity firm, bought the stake at what the lawsuit contends were “absurdly favorable” terms requiring them to receive 200 percent of its capital investment before any other distributions to EB. The investment also valued FN at $160 million, or 40 times cash flow.

Between 2011 and 2015, an “uneasy détente” existed between EB and FN. In December 2015, Hurley first became able to exercise his forced sale right. Convinced he had EB’s support, he began to solicit other bidders.

“Unbeknownst to Hurley, the prospect of his exit from FN triggered a multiyear scorched-earth campaign by defendants to sabotage the sale process and wrest control of FN at a price far below its fair market value,” the complaint states. “Insidiously, defendants also sought to erode the industry-leading reputation and relationships Hurley had cultivated, thereby preventing Hurley from competing with FN after his exit. As communicated by their longtime associate, David Seldin, during August 2017, Milstein and Friedberg wanted to ensure that Hurley “w[ould] never be able to raise capital again.”

Eventually, EB and Hurley would go to arbitration, after which awarded Hurley over $1 million in reimbursed attorneys’ fees.

The lawsuit then charges that Hurley’s “exercise of his Forced Sale Right should have triggered a process by which the parties selected a third-party investment banker to solicit potential bids in an orderly, value-maximizing fashion. Instead, it triggered a flurry of attempts by EB and Milstein to produce either a failed sales process or a very low price for FN.”

The lawsuit, which does not disclose what price EB ultimately offered to buy out Hurley and FN executives, raised some questions about future of the RIA consortium. Earlier this year, EB sold a majority interest in HPM Partners to Don Marron’s Lightyear Capital.  HPM has about 1,700 high net worth clients and nearly $9 billion in assets.

Heckenberg has been quoted in other publications saying he and EB want FN to acquire more firms but added that they want to focus on quality over quantity. However, the complaint contends that one criticism EB had of Hurley may have been that he was too selective about acquisitions.

At the same, Hurley has indicated that EB diverted the attention of FN management while restructuring the bank in the post-crisis era in ways that narrowed the number of companies who fit with EB’s capital structure dramatically. FN is hardly  the only aggregator to discover that while many RIAs were eager to talk about deals, few ultimately were willing to complete them, particularly during the bull market of the last decade when most firms enjoyed steadily rising revenues. Moreover, FN only sought to do transition-financing deals with firms with a deep next-generation  bench, and thus avoided firms where the founding partners were simply looking to cash out.

As a passive, minority investor, EB does not have ownership control over FN portfolio companies. If a senior partner at an FN-affiliated RIA wants to sell shares to a junior partner and finance it herself, she reportedly can. It’s not at all clear whether EB will see to maintain FN’s passive structure or will seek to reconfigure it.

DISCLOSURE: Hurley, who was a frequent contributor to Financial Advisor, did not return repeated phone calls. Howard Milstein, who together with others executives at his New York Private Bank & Trust, was the subject of a cover story in Financial Advisor’s sister publication, Private Wealth.