Home »

The Employee Ownership Report

NewsletterConcisely written for leaders in employee ownership companies and for service providers in the field, the NCEO's bimonthly newsletter, the Employee Ownership Report, is the most efficient way to stay informed about legal issues, current events, best practices, breaking research, management approaches, and communications ideas for employee ownership companies.

Available exclusively to NCEO members, the Employee Ownership Report is delivered in hard copy and all issues back to 1997 are available in the members-only area of the Web site.

Nonmembers are invited to read the sample article below from the current issue of the newsletter. Every time a new issue appears, the sample article on this page will be replaced by one from the new issue. Join online for only $90 to receive the Employee Ownership Report and all our other membership benefits.

Read a sample issue of the entire newsletter (September-October 2015).

Sample Article from the November-December 2016 Issue:

What Boards Should Know About the Department of Labor and ESOPs

This article is condensed from a chapter by Corey Rosen in the newly released ESOP Company Board Handbook, 2nd ed.

The Department of Labor (DOL) is the primary regulatory agency overseeing ESOPs. Its task is to make sure that ESOPs are operated for the "exclusive benefit of plan participants." The DOL assesses a variety of issues, the most important of which are that:

The board of directors normally appoints the named ESOP fiduciaries. The fiduciary may be the trustee only, or, in some companies, an ESOP fiduciary committee that directs the trustee. A fiduciary is anyone who makes a decision or causes a decision to be made concerning plan assets. Boards can become fiduciaries if they direct the trustee (not something we recommend) or if they take actions that indirectly cause a fiduciary to make a decision, such as approving misleading financial information provided to appraisers. Boards also must monitor the performance of fiduciaries and/ or trustees to make sure they perform their duties properly. So while the DOL's primary focus is on the trustee and/or named fiduciaries, because the board can be considered a fiduciary, and because it is important in any event to make sure the plan is run for the benefit of participants, boards need to understand how the DOL views and regulates ESOPs. The DOL pays particular attention to transactions between the ESOP and sellers to the ESOP, especially if it sees the price the sellers receive as excessive or the terms of the financing (such as with seller warrants) as unfair to the plan.

The GreatBanc Process Agreement

In 2014, the Department of Labor and GreatBanc Trust Company signed a landmark agreement as part of a settlement of a lawsuit. The agreement applies only to GreatBanc but is widely seen as outlining the DOL's favored approach. Some in the ESOP community argue the settlement's terms do not apply to every transaction, but boards need to know what the settlement entails and make appropriate decisions in appointing and monitoring fiduciaries and/or trustees (see our publication on this). There are several key elements:

The Information Valuation Firms Use Must Be Accurate and Realistic: The DOL is concerned that some ESOP valuations are based on excessively optimistic or otherwise misleading financial projections. Valuation firms should be able to document how they got the information and ensured the numbers are realistic. Boards can help this process by making sure management projections come from and/or are reviewed by more than one source.

The Appraisal Firm Must Be Independent and Qualified: The fiduciary must document that the appraisal firm is not only qualified but also independent. This can be a sticky issue for some transactions. The DOL argues that an appraiser hired by the board or seller for a preliminary valuation should not be the appraiser doing the appraisal for the fiduciary when the actual transaction takes place. The best practice is to either (1) have the trustee hire a different firm for the ESOP transaction or (2) have the trustee hire the appraisal firm for both the preliminary and transaction appraisals.

Plan Operations Are Factored into the Valuation: Plan provisions such as diversification can affect valuation. Similarly, the repurchase obligation should be factored into the appraisal. Boards have two duties here. First, they must ensure fiduciaries consider these factors. But boards ultimately make the decisions about plan rules and how the repurchase obligation is handled. These decisions are "settlor" functions, not fiduciary duties. Boards also must think about how the rules for the plan and repurchase strategies can best protect the company's long-term sustainability.

Make Sure Debt Service Is Manageable: Many recent lawsuits in ESOPs that resulted in significant settlements or judgments arose because the ESOP took on more debt than it could manage, causing the company to ultimately fail or see its stock price fall dramatically. Fiduciaries must ensure appraisers are aware of debt service capacity, and boards should not approve taking on excessively risky debt.

Financing Terms for Seller Notes Should Be Reasonable: Some ESOP transactions involve warrants for the seller in return for a lower interest rate than can be justified by the risk of the debt; some such transactions have been very aggressive. Fiduciaries must be able to document that the terms are fair and do not put the ESOP or company at excessive risk. Boards should not approve such terms in the first place.

Valuation Approaches and Assumptions Must Be Properly Considered and Weighted: Fiduciaries should be able to show that valuation discounts have been considered and are reasonable. The varying approaches to valuation must also be justified and appropriately weighted.

Processes Should Be Documented: Fiduciaries should be careful to document what they have done in sufficient detail to show compliance with the issues raised here.