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Serving on any corporate board is a serious responsibility. Serving on an ESOP company board adds the additional responsibility of understanding how ESOP law and best practices interact with corporate law and best practices. Special ESOP issues such as valuation, the repurchase obligation, S corporation anti-abuse rules, monitoring fiduciaries, stricter considerations for executive pay, changes in corporate capitalization, and responding to takeover bids, among others, demand at least a working knowledge of ESOP requirements.
In the third edition, the lengthy and detailed first chapter has been updated and revised throughout by a new attorney-author with extensive experience in the field. The third edition also replaces the former chapter 2 with a new chapter on creating and sustaining an effective board, adds a new chapter on board leadership as a competitive advantage, updates the chapter on Department of Labor fiduciary process agreements, replaces the chapter on D&O and fiduciary insurance with a new one on the same topic, replaces the chapter on our 2016 ESOP corporate governance survey with one on the 2021 survey, updates the chapter on ESOP basics, and updates the company acquisition policy in the appendices.
The NCEO also offers a 90-minute remote training program for board members by the NCEO's founder, Corey Rosen.
Table of Contents
1. Governing the ESOP Company: A Basic Legal Review of Fiduciary Considerations for the Board of Directors
2. Creating and Sustaining an Effective ESOP Company Board
3. Board Leadership as a Competitive Advantage to the ESOP Company
4. Putting the DOL Fiduciary Process Agreements to Use in an ESOP Company
5. The Role of the Board in Selling an ESOP Company
6. Directors, Officers, and Fiduciary Liability Insurance for ESOP Companies
7. The 2021 ESOP Corporate Governance Survey
8. ESOP Basics for Board Members
Appendix A: Sample Company Acquisition Policy
Appendix B: Sample Questions to Ask Potential Acquirers
Appendix C: Key ESOP Issues: Informational Letter to a Potential Acquirer
About the Authors
About the NCEO
From Chapter 1, "Governing the ESOP Company: A Basic Legal Review of Fiduciary Considerations for the Board of Directors" (footnotes omitted)
As noted above, the concept of the duty of care is not immutable; that is to say, it is not a principle that applies uniformly to all factual situations. Thus a board member of a bank has a different kind of duty of care than a board member of a firm that makes office furniture. A board member’s duty of care is also modified for some decisions when the company has an ESOP shareholder.
According to ERISA, a person is an [ERISA] fiduciary with respect to an ESOP if the person “exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets…, or if [he/she] has any discretionary authority or discretionary responsibility in the administration of such plan.” The fiduciary responsibilities under ERISA are an even higher standard of prudence to act “with the care, skill, prudence and diligence under the circumstances then prevailing 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.” Referred to as the “prudent expert” standard, the courts have confirmed that it is not enough that a fiduciary acted with a pure heart if such act is with an empty head. Given the character of an ESOP as a qualified retirement plan, the board of directors of a corporation that has an ESOP shareholder also has certain ERISA fiduciary responsibilities with respect to the ESOP. For example, the Department of Labor regulations indicate that members of a board of directors that is responsible for the selection and retention of plan fiduciaries (e.g., the selection of the ESOP trustee) are exercising “‘discretionary authority or discretionary control respecting management of such plan’ and are, therefore, [ERISA] fiduciaries with respect to [its ESOP shareholder].” Therefore, they must act as prudent experts with respect to such selection and retention. However, “their responsibility, and consequently, their liability, is limited to the selection and retention of fiduciaries.” The board of directors should be mindful of decisions that are made subject to the higher ERISA fiduciary standard, and this is discussed later in this chapter.
Here are a few specific suggestions for how the board should undertake this next level of examination and understanding:
From Chapter 5, "The Role of the Board in Selling an ESOP Company"
A potential acquirer is unlikely to provide its price until it has sufficient data to determine the price. Therefore, it will request financial information to allow it to provide a preliminary price. I recommend providing very limited high-level data until you are satisfied that their other responses indicate that the potential acquirer is seriously interested and has the financial capability to complete the transaction. The limited financial data would include revenue, gross profit, and “adjusted or normalized” EBITDA for the current and prior several years. No information should be provided until the potential acquirer signs a confidentiality and nondisclosure agreement. It is never appropriate to provide the potential acquirer with any valuation reports.
It is appropriate and reasonable to request a nonrefundable deposit from potential acquirers to confirm they are serious and to compensate the company for the time and effort that will be required to provide information and go through the due diligence process. The deposit would be applied to the purchase price if the sale is completed and kept if the sale is not completed.
From Chapter 7, "The 2021 ESOP Corporate Governance Survey" (figures and tables omitted)
Larger companies (greater than $50 million in revenue) are more likely to have at least one independent director (81%) compared to smaller companies (69%). There is also a strong relationship between having an independent director and being 100% ESOP-owned. Among 100% ESOP-owned companies, 81% have an independent director, compared to 54% of other companies.
In selecting independent directors, specific knowledge and industry expertise stand out as the most important factors; ESOP expertise, relationships with key constituents (e.g., contacts/clients in the industry), and other board experience are also important, but much less strongly so.
A slight majority of respondents, 51%, report that the company CEO is also the chair of the board. This is an approximately 10% decrease from the 2016 survey. Size is a factor here: smaller companies are more likely to have the CEO serve as board chair. Fifteen percent of companies have an independent board chair, and 21% have a former executive as their chair.
The survey asked about six types of pay for directors. Figure 7-3 details the percentage of respondents who offer each category.
Most companies pay their directors a retainer and/or a fee per meeting, although some also pay equity or deferred compensation. Table 7-1 shows percentiles of amounts paid for each of those components for each type of director. (Percentiles are not shown for categories with fewer than 10 respondents.)