Highland Trial Witness Says Daugherty Incentive Plan Doubted

Jan 17, 2014 8:33 pm ET

(Updates with cross-examination in 25th paragraph.)

Jan. 17 (Bloomberg) -- Highland Capital Management LP’s chief compliance officer told a Dallas jury that an incentive program for former executive Patrick Daugherty’s team was unwound over questions about its legality.

Thomas Surgent, who is also deputy general counsel for the investment firm suing Daugherty, testified yesterday he ended the vehicle known as Sierra Verde in part because of a belief Daugherty was “self-dealing.”

Highland, which according to its website manages $17.7 billion, sued Daugherty after he quit in September 2011, accusing him of disparaging the firm and improperly disclosing information. Daugherty, who was chief of the firm’s Stressed Special Situations and Private Equity Investing, countersued, saying the firm and co-founder James Dondero hurt his reputation and owe him money.

“Did you do it to deprive Pat Daugherty of any money?” Marc Katz, a lawyer for Highland, asked Surgent about the decision to unwind Sierra Verde.

“No,” Surgent said. He was the second witness to take the stand in the state court trial that started yesterday.

Dallas County District Judge Martin Hoffman, who is presiding over the trial, said it’s expected to last at least three weeks.

Internal Secrets

Katz, in his opening statement to the jury of nine women and three men, said Daugherty resigned in anger and then disclosed internal secrets.

Highland sued in April 2012, about two weeks after Daugherty testified against Dondero and on behalf of Dondero’s wife, Becky, in a divorce proceeding.

Katz said Daugherty had been paid $26 million from 1998 to 2011. As he was negotiating his exit pay, Daugherty took 59,000 company documents, which he copied or e-mailed to himself, and recorded phone calls with company employees, Katz said.

Daugherty’s lawyer, Ruth Ann Daniels, told jurors that Daugherty is owed millions of dollars. Daugherty’s relationship with Dondero soured after he demanded in 2011 that his compensation terms be put into writing, and the tension grew after he quit and testified in Dondero’s divorce, she said.

Dondero then used his control over the firm’s incentive compensation plans “to exact revenge on Pat Daugherty,” Daniels said.

Incentive Programs

Surgent, who took the witness stand yesterday, continued his testimony today, answering questions about two firm incentive programs from which Daugherty claims he is owed money, Sierra Verde and Highland Employee Retention Assets, or HERA.

The compliance chief said yesterday that Sierra Verde, which Daugherty formed in 2010, was meant to compensate Daugherty and members of his team for work they did for companies Highland owned.

Equity from those companies was placed in Sierra Verde in return for services by Highland, the compliance officer said.

The program was ended out of concern that it might not comply with government regulations and firm policy, and could create liability risks for the company, Surgent said.

In one instance, Daugherty backdated the acquisition of an unidentified holding, then valued at $2,040 a share, to reflect a date when it was priced at $640 a share, giving Daugherty and other Sierra Verde participants an immediate gain of the difference, Surgent said.

Surgent called it “self-dealing.”

‘Burned Out’

Cross-examining Surgent today, defense lawyer William Chaney pivoted from Sierra Verde to HERA and the impact a 2012 letter and ensuing lawsuit had on Daugherty’s participation in it.

Chaney showed Surgent a January 2012 cease-and-desist letter sent to Highland by Daugherty’s lawyers that said Dondero and others there were making defamatory statements that Daugherty left the firm for lifestyle reasons and that he was “burned out.”

Surgent said under questioning that within weeks of its receipt, Daugherty was removed from HERA’s board and its bylaws were amended to include penalties for former employees who might make disputed claims or bring lawsuits.

Chaney described a “loser pays” provision added to the HERA plan that would make someone like Daugherty pay even if they prevailed in their dispute.

Surgent said it was true.

Buyout Offers

Highland’s compliance officer also said Daugherty was offered nothing for his HERA shares in early 2013 when Highland made an offer to buy out all 39 of the plan’s participants.

Surgent testified that $2.1 million was deducted from Daugherty’s HERA account for the cost of the current litigation between Daugherty and Highland, reducing the value of their offer to him to zero.

Returning to Sierra Verde, Surgent told Chaney that while Daugherty owned 20 percent of the vehicle, Dondero owned 24 percent and was listed as its manager on the paperwork that set up the vehicle.

The lawyer showed Highland’s compliance chief a document signed by Dondero that also valued at $640 the share price Surgent had said were evidence of Daugherty’s self-dealing.

“It only shows that he executed it. It doesn’t mean he read it,” Surgent testified. He said Dondero would have signed the document without reading if Daugherty presented it to him.

“You are speculating when you say Mr. Daugherty presented it to him,” Chaney said.

“Yes,” Surgent replied.

Chaney asked why Sierra Verde and the supposedly undervalued stock award in the company owned by Highland was allowed to stand for more than a year and only unwound after Daugherty left.

“Only Pat knew about the gaming of the pricing of the option grants,” Surgent said.

The trial will continue next week.

The case is Highland Capital Management LP v. Daugherty, 12-04005, District Court of Dallas County, Texas, 68th Judicial District (Dallas).

--Editors: Fred Strasser, Peter Blumberg