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The Employee Ownership Update

Corey Rosen

September 14, 2010

(Corey Rosen)

NCEO Completes Study on ESOPs as Retirement Benefits

In a project funded by the Employee Ownership Foundation, the NCEO did an extensive analysis of ESOP companies using data from the U.S. Department of Labor. Unlike prior research, the study carefully compiled data from multiple plans within a single company. It comes to several clear conclusions:

The full study is available at this link (19-page PDF), and the supplemental tables are at this link (12-page PDF).

DOL Issues Interim Disclosure Regulations for Service Providers

The Department of Labor (DOL) has issued interim regulations for certain service providers to qualified retirement plans that will require additional disclosures to clients (75 Fed. Reg. 41600, July 16). The regulations are under ERISA Section 408(b)(2), which exempts providers from prohibited transaction requirements if they have "reasonable" service arrangements with plans, plan sponsors, and/or parties in interest. The regulations apply to plan fiduciaries, record-keepers, and investment advisors receiving payments from the plan, as well as any other provider (such as an attorney or appraiser) who will receive "indirect" compensation for services to a related party (typically, the company). Indirect compensation includes payment from the plan sponsor. The rules will be more complicated for providers of 401(k) plan services, where fee arrangements are more complicated. For ESOP providers (attorneys, appraisers, record-keepers, and paid fiduciaries, most notably), the regulations will require that there be a specific written agreement outlining the scope of work, direct and indirect compensation, termination compensation, and manner of receipt. Investment entities, brokers, and their fiduciaries that hold plan assets (such as the investments from an ESOP non-stock account) must provide information on fees and expenses related to the investments. Record-keepers must provide additional information, including estimates of the costs of their various services.

ROBS, ERSOPs, and Ersatz ESOPs

In the last few years, there has been quite a bit of promotion of something called an "ERSOP" (employee rollover stock ownership plan). The idea is that someone wanting to start a business can take funds out of a retirement plan at one company and roll them into a new plan at a startup company, using the funds to buy company stock. The new plan could be an ESOP, but is more likely to be a profit sharing or 401(k) plan because the regulations are simpler.

This is perfectly legal if done right, but the promoters were generally recommending something that was too good to be true. One site that said it had approval for hundreds of such plans and the whole process would cost $4,000.

Now the IRS has chimed in. It calls the plans, charmingly enough, ROBS (rollovers as business startups). In an October 1, 2008, memorandum (available in PDF format at this link), the IRS stated that "employees in some arrangements have not been notified of the existence of the plan, do not enter the plan or receive contributions or allocable shares of employer stock. Additionally, we have identified that plan assets are either not valued or are valued with threadbare appraisals. Required annual reports for some plans have not been filed. In several situations, we have also found that the business entity created from the ROBS exchange has either not survived, or used the resultant assets on personal, nonbusiness purchases."

The IRS is particularly concerned that these plans will not have appropriate valuations and will fail the anti-discrimination tests. In an August 27, 2010, call-in meeting, the agency said it was now taking a particularly hard look at these plans as potential abusive transactions. While it is true that the IRS has issued letters of determination for these plans, that is far from their saying that the operation of these plans is legitimate, so anyone thinking of doing this needs to act with great caution to do it properly.

Interestingly, the IRS has also uncovered another popular scam that may remind ESOP veterans of an ESOP scam. When S ESOPs were created, promoters of dubious ethics started selling the idea that a company could split off a management company from the operating company, put a 100% ESOP in the management company, then funnel all the profits of the operating company into the management company. The IRS shut that down as a listed transaction. Now the same idea has surfaced, only the management company is setting up a defined benefit plan, again funneling all the profits of the operating company to the management company to fund it. Look for the IRS to shut these down too.

Higher CEO Pay Doesn't Link to Better Performance

According to a new report prepared by PROXY Governance, Inc., for the Investor Responsibility Research Center Institute, "Higher relative [CEO] pay clearly has not gone hand-in-hand with superior shareholder returns. A regression analysis (R-value of 0.118) shows no meaningful correlation between higher relative pay and higher relative returns. Changes in quarterly shareholder return may be an insufficiently robust measure of changes to the intrinsic value of a firm. Additional regression analysis of relative performance on other GAAP-based performance measures, however, also found little to no correlation across the broad Russell 3000 sample."

The report looks at how companies where CEOs get paid more than company performance would justify tend to use skewed comparison samples to set CEO pay. The full report, Compensation Peer Groups at Companies with High Pay, is available at this link (PDF format).

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