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The Inside ESOP Fiduciary Handbook
by Corey Rosen, Merri Ash, Jeff Gelburd, and Scott Rodrick
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The third edition has been rewritten throughout. Chapter 1 was updated; chapters 2 and 3 were replaced by a new chapter 2 addressing both topics; chapters 3, 4, and 5 (formerly 4, 5, and 6) were updated; a new chapter 6 was added on recent Department of Labor process agreements with ESOP fiduciaries that provide a useful roadmap on how to manage the valuation process; chapters 7 and 8 were updated; and the appendices were revamped by removing less-used material and adding three new documents (the new appendices 2, 3, and 4), providing a trustee checklist plus forms to evaluate appraisers and appraisals.
The current release of this book (in both print and PDF format) incorporates additional updates made in late 2017 after the initial release of the third edition.
Format: PDF, 143 pages
Dimensions: 6 x 9 inches
Edition: 3rd (March 2017)
Status: Available for electronic delivery
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1. A Review of Basic ESOP Rules
2. The Role of the ESOP Fiduciary
3. Valuation Basics
4. Valuation Q&A for Inside Fiduciaries
5. Potential Penalties and How to Cover Them
6. Guidance from DOL Process Agreements with ESOP Fiduciaries
7. Best Practices in Interaction Between the Board of Directors and Trustees
8. Fiduciary Liability Insurance
Appendix 1: Sample DOL Questions on ESOP Appraisals
Appendix 2: Annual Checklist for Trustees
Appendix 3: Form for Trustees to Evaluate Potential Appraisers
Appendix 4: Evaluating an Appraisal Report
Appendix 5: Additional Resources Online
About the Authors
About the NCEO
From Chapter 2, "The Role of the ESOP Fiduciary"Most closely held ESOP companies still have an individual or committee act as fiduciary. Most often, an individual fiduciary is the CEO, CFO, or other officer of the company. In some cases, the seller to an ESOP is the fiduciary, or is on the fiduciary committee. This creates an obvious conflict of interest, however. An ESOP fiduciary is responsible for carrying out his or her duties with "an eye sole" to the interests of plan participants. A seller would have a hard time actively negotiating for the best deal possible for the ESOP, then running to the other side of the table to protect his or her own interests.
Many owners are reluctant to entrust fiduciary decisions to someone else, of course. That's understandable, but so is the position of the courts when faced with a lawsuit from plan participants, most often over whether the ESOP overpaid for the shares the owner was selling or otherwise operated in a way that was more for the benefit of the owner than for the employees. It doesn't matter if the plan ended up being good for employees too; it is the process that the court focuses on, not the results.
Fiduciary committees are very common. Typically, they have three to five people, but there is no magic number. Most often, they comprise groups of management-level employees, but they may include outsiders, such as an independent board member, financial or legal expert, or former employee. Some committees have nonmanagement employees on the committee as well. While anyone on a fiduciary committee needs to be well-schooled in legal, financial, and operational issues of the plan, this is especially true for nonmanagement employees, who may not be as sophisticated in any of these areas as management employees.
Tables 2-1 and 2-2 break down the prevalence of ESOP trustees by size, percentage of ownership, and S or C status.
From Chapter 6, "Guidance from DOL Process Agreements with ESOP Fiduciaries"Trustees need to document that they have chosen appraisers with appropriate skills specifically to do an ESOP appraisal. That could include having various professional designations, speaking and writing on the subject, providing client lists, references, background checks, etc. This includes inquiring about any regulatory proceedings or investigations involving the appraiser. Although the GreatBanc Agreement requires the trustee to contact references for the appraiser before selecting them, there is no requirement of a minimum number of references a trustee had to contact. In the FBTS Agreement, there must at least three.
Trustees must also show the appraiser does not have conflicts of interest that might induce a conclusion of a higher fair market value than is justified. Such conflicts could include, but are not limited to, having been hired previously by the board, the company, the seller, an ESOP exploratory committee, and/or any other party structuring the transaction (such as an investment bank) to perform work, including but not limited to a preliminary ESOP valuation. The Agreements prohibit the ESOP trustee from hiring such an appraiser for an ESOP transaction. The DOL fears that, for example, if an appraiser does a preliminary ESOP valuation for the seller and then the ESOP trustee hires the same appraiser for the transaction, the integrity of the transaction has been compromised because one of the ESOP's counterparties to the transaction selected the appraiser for the trustee to use—an appraiser that will provide a value acceptable to the counterparty. The best practice, then, is to follow the Agreements and not to use the same appraisal firm that does a preliminary valuation to do the final valuation. In the eyes of some ESOP advocates, this imposes an undue burden in that a seller might have a preliminary appraisal done that suggests an acceptable price only to have a final appraisal at an unacceptable one. Alternatively, the seller can forgo the preliminary appraisal, pay probably $5,000 to $8,000 more for a final appraisal, and find the money has been "wasted" if it is seen as too low (arguably, though, this information will be extremely useful in negotiating a sale to another party). If a trustee does select an appraiser who has done prior work for the company and/or seller, the rationale for this should be thoroughly elaborated upon.
An accurate appraisal depends on accurate projections from the company as to its future earnings. In some cases, the appraiser will simply project past earnings into the future, but if the company believes there will be material changes, then the appraiser will factor these projections into its conclusions.
Some valuation advisors include disclaimers in their engagement agreements saying they accept the financial data from the company at face value. The DOL sees that as too broad. Appraisal firms should show that they have assessed the reasonableness and reliability of these numbers. Trustees can demonstrate proper prudence through such means as requiring companies to make projections from multiple sources (such as the CFO and CEO independently making projections); how accurate prior projections have been; how the projections stack up against what the industry is expected to do in general; whether the company's books are audited, and if not, why not; whether the company has adequate internal controls of financial statements; and so on. Appraisal firms should also show that they have discussed the projections and the process that reached them in detail. Any prior defaults within the past five years by the ESOP and/or the company should be assessed, as should any management letters provided to the ESOP sponsor by its accountants within the past five years. More controversially (and perhaps impractically), the FBTS Agreement requires that the trustee document any information from any employee who has participated in decisions about the transaction and any information from any employee who participated in the transaction who believes the report's conclusions are not indicative of the true value. This may not be a major issue if such information is available, but if the DOL is trying to get trustees to prove a negative (that they can show that there were no such individuals), that may not be practical (and it probably is not what the DOL would require).