New DOL ESOP Enforcement Efforts

The Assistant Labor Secretary for the Employee Benefits Security Administration, Ann Combs, has told the BNA Pension & Benefits Reporter (January 4, 2005) that the Labor Department will begin a special enforcement project on employer stock in defined contribution plans. Combs said a key issue will be valuation, noting that "one of the most common problems we've found with ESOPs is the incorrect valuation of employer stock. . . . We're looking at a sample of stock plans throughout the country to see how widespread the valuation problem is." She said other issues will be examined as well, including "voting rights, exercise of put options, the ability to diversify account balances at certain times, and compliance with the Department guidance on ESOP refinancing."

Just how serious a threat is this to well-intentioned ESOPs? For companies using experienced, qualified professionals, chances are this will not represent a serious problem, although it may be a nuisance for those companies the DOL chooses to investigate. Outside of S corporation ESOP scams, Combs is correct that valuation issues are the dominant cause of significant ESOP problems. Most ESOP lawsuits that go to trial concern valuation problems. Companies run into trouble in two ways. Some simply fail to use qualified, independent appraisers. More common are overly aggressive appraisals relying on generally unaccepted assumptions, unrealistic data, or, in some cases, fraud. Well-intentioned ESOPs that carefully follow the rules should not have a problem with these issues. A more uncertain issue is how aggressive the DOL will be concerning valuation theory. For instance, will it reject any control premiums in phased transactions in which the ESOP acquires a minority interest now and the right to acquire control later? If history (all history is past) is a guide, agency enforcement efforts typically do not themselves result in breaking new ground on legal theory, so this result seems less likely. It is certainly possible, however, that the DOL, based on what it learns, will consider issuing new guidance on ESOP valuation issues.

The other matters are more procedural. If a company uses experienced ESOP counsel and administrators, these areas should not result in problems.