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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.

You also can read a sample issue of the entire newsletter (July-August 2011).

Sample Article from the July-August 2015 Issue:

Rethinking Inside Fiduciaries

Most ESOP companies have inside trustees, often one or more managers. More and more ESOP companies are moving toward outside trustees, however. The NCEO's 2012 governance survey showed that 37% of companies now have outside trustees.

Companies choose to have inside trustees for two primary reasons. One is cost. The NCEO data indicated that directed outside trustees had a median annual cost of $19,000 while the median compensation for independent trustees was $25,000. Costs go up with company size. This is not a huge investment, but is an expense many ESOP companies think they do not need to take on. The second is a fear that an outside trustee may force the company to do things it would not otherwise do.

These concerns are understandable, but neither costs nor control may be the issues companies think they are.

Trustees have a number of obligations:
  1. Buying and selling plan assets, including employer stock.
  2. Hiring qualified advisers.
  3. Determining that the ESOP is paying no more than fair market value.
  4. Assuring that the plan is operated in accordance with plan documents and ERISA; if the two conflict, ERISA rules govern.
  5. Making sure the terms of any ESOP loan are reasonable.
  6. Voting and/or directing the tendering of shares in the trust for which plan and ERISA rules do not require pass-through voting.
  7. Deciding whether to follow participant voting or tendering directions on unallocated or undirected shares.
  8. Responding to legitimate offers to purchase the company.
  9. Acting to protect plan interests with respect to corporate actions that could harm the interests of plan participants.

Valuation is the most critical and demanding of these. In an interview published in the NCEO issue brief Current Perspectives on ESOP Valuation and Enforcement, Tim Hauser, deputy assistant secretary for program operations of the Employee Benefits Security Administration, detailed the DOL's concerns with valuations that the Department sees as inadequately vetted by ESOP trustees. The recent agreement between GreatBanc Trust and the Department of Labor lays out a detailed set of steps trustees need to take to make sure the appraisal meets ERISA standards. While that agreement only applies to GreatBanc, many in the ESOP community view it as an important guideline for any ESOP trustee. The detail of the process makes it clear that trustees need to be spending considerable amounts of time (days, not hours) in their appraisal reviews and need to bring specific expertise to the table.

Are the Cost Savings of Insider Trustees Real?

Assuming your company tries to meet these standards, how much time will trustees have to spend on getting trained, reviewing the appraisal, making sure the plan is operated in compliance with the law and the plan document, and all the other duties of a trustee? It is reasonable to assume that each trustee should spend two or more weeks per year on these matters. If a $175,000-per-year CFO is the trustee, that is about $7,000 per year. If you have a trustee committee, costs will start to approach the costs of an outside trustee.

Even if this does work out to lower cost, there is an implied cost of fiduciary risk. Having an outside trustee is not a bulletproof vest against adverse litigation or DOL actions, but it creates a much stronger demonstration of prudence.

Control Issues

The second concern is control. If the trustee is independent, it is possible the trustee will force changes in such matters as executive pay or perquisites, board composition, acquisition strategies, or how offers are initially responded to by the board. In practice, however, none of these things is at all common. Trustees are very reluctant to exercise an aggressive shareholder role. The business judgment rule makes it difficult to contest board decisions. While trustees will vote for the board and possibly urge outside directors, it is also rare for trustees to oppose nominees of the board. Instead of a confrontational style, trustees are more likely to seek cooperative ways to work with the board to identify best corporate practices. That expertise can be very valuable.

If this is an insurmountable issue, companies can have directed trustees. A directed trustee is chosen from the same pool as independent trustees and does all of what an independent trustee does, but is told what to do by a board, an ESOP administrative committee, or an individual employee. The directing party retains fiduciary responsibility. Directed trustees still must make sure plan rules and ERISA are followed. Directed trustees add expertise and save costs for inside fiduciaries, but do not reduce fiduciary risk. Although they are directed, they are not exempt from fiduciary risk. While they owe deference to the decisions made by whoever is directing them, if they believe the directions are clearly outside of what the plan or ERISA requires, they have to act in the same way an independent trustee would. Directed trustees bring the benefits of outside expertise, but lessen the control risk. Because they are directed, however, they do not add as much to the demonstration of prudence as independent trustees (although they do add some in that the company is getting expert advice).

In short, if you still have inside trustees, it may be time to take a second look.