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The Employee Ownership Update

Corey Rosen

September 25, 1995

(Corey Rosen)

New NCEO Study on Repurchase Obligation

Privately held ESOP companies must repurchase their shares from departing employees. This "repurchase obligation" can be substantial. The employee-owned Peoria Journal Star Company, for instance, has had to put itself up for sale because it stock value has gone up beyond its capacity to repurchase the shares. A new NCEO survey of 85 randomly selected ESOP firms shows that 66% have done a repurchase study, but only 41% have a specific repurchase plan. Almost all the repurchasing is done through company cash flow (49%) and contributions to the ESOP (41%). All other methods, such as corporate owned life insurance (COLI) and debt, account for less than 10% combined.

COLI Threatened

One of the most touted solutions to the repurchase obligation is corporate owned life insurance (COLI). The House Republican tax bill, however, would eliminate special tax preferences for COLI. Under existing laws, companies do not have to pay tax on the build-up in premium value on life insurance polices they take out on employees. They can, however, take a tax deduction for money they borrow against these values. This tax hedge has made COLI attractive to many corporations (not just ESOPs). Wal-Mart (which offers ownership to all employees) takes out policies on almost all its employees.

Court Rules on Duty of ESOP Fiduciary to Buy Company Stock

ESOPs are legally intended to be plans that are primarily invested in employer stock. This does not exempt their fiduciaries, however, from the prudence requirement that any particular decision to buy employer stock must be a financially sound one. So when is investing in employer stock, as provided by the plan, not a good idea? In Moench v. Robertson (CA 3, No. 94-5637, 8/10/95), a federal appeals court ruled that an ESOP fiduciary is entitled to a presumption that it acts in accordance with ERISA by buying company stock. However, this presumption can be overridden if the fiduciary fails to act prudently by making purchases when it knows, or should know, that the company's prospects are poor.

In this particular case, trustees of the ESOP at First National Bank of Toms River, N.J., continued to invest in company stock even in the face of a share price decline from $18.25 in 1989 to $6 in 1990. The trustees continued to buy shares until 1991, when the stock had dropped to 25 cents. Several bank insiders had expressed doubts about the company, but the trust committee did not even meet to consider the issue. The trustees thus showed no record of appropriate diligence or consideration of why the investment in company stock would make sense. The court consequently ruled in favor of plaintiffs seeking to restore value to the participants.

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