The Employee Ownership Update
July 1, 2014
Supreme Court Rules on ESOP CaseOn June 25, the Supreme Court ruled in Fifth Third Bancorp v. Dudenhoeffer that there is no presumption of prudence to protect fiduciaries of plans designed to invest in company stock, and specifically employee stock ownership plans (ESOPs).
While the decision eliminated the presumption of prudence rule, it replaces it with a pleading requirement that plaintiffs demonstrate the fiduciary acted imprudently. Most observers agree this will continue to make it difficult to challenge fiduciary decisions about employer stock, although the actual effect will not be known until lower courts begin to apply this ruling.
Based on this ruling, plaintiffs will be required to plausibly allege that (1) there were "special circumstances" requiring fiduciaries to recognize on the basis of public information that the market was over- or undervaluing the stock or (2) based on nonpublic information, the fiduciaries should have taken an alternative action that would not violate securities laws and would not do more harm than good.
The case concerned a public company, Fifth Third Bancorp, which had an ESOP as one component of its 401(k) plan. The company matched employee contributions by contributing stock to the ESOP. The Court clearly viewed this issue through the lens of a public company. The analysis and guidance it provides do not fit easily into a closely held company ESOP model. All of the presumption of prudence cases have been in public companies. This, combined with the enhanced pleading requirements, suggests the impact of this decision on private company ESOP fiduciary decisions will be minimal.
The ruling is available online, as are the NCEO's comments in What the Supreme Court's Dudenhoeffer Decision Means for ESOPs.
New NCEO Study on Default Rates for ESOP LoansBased on an analysis of 1,232 leveraged ESOP transactions at three large banks, 1.3% of ESOP companies in the sample defaulted on their loans in a way that imposed losses on their creditors for loans in effect between 2009 and 2013 (an average annual rate of 0.2%). The defaults accounted for 1.5% of the total value of the ESOP loan portfolio for these companies during this period. The bank data were only available for defaults imposing losses; the data presented here do not include defaults that resulted in loan restructuring where the loans were ultimately repaid or were being paid on the new schedule.
In a parallel analysis, the NCEO also asked ESOP appraisal firms to provide data on defaults that imposed losses on their creditors among the ESOP companies whose stock they appraised between 2009 and 2013. Eighteen firms responded out of the 40 ESOP appraisal firms we asked to provide data. The eighteen responding firms were able to report data on 845 companies over the study period. Of these, 9 (1.1%, or an annual rate of 0.2%) defaulted in a way that imposed losses on their creditors, while 26 (3.1%, or an annual rate of 0.6%) had to restructure their loans but had repaid or were repaying their loans currently.
These default rates seem strikingly low given the economic turmoil of 2008-2011, a period that overlaps and immediately precedes the data represented here. It is difficult to make valid comparisons to data for defaults on leveraged buyouts of non-ESOP companies. The best available comparison data comes from S&P's IQ Credit Pro report on default rates for mid-market companies borrowing less than $200 million. ESOPs would all be in this range, although the median ESOP loan would no doubt still be much smaller than the median for the S&P sample (data for smaller loans is not available). These loans defaulted at 3.75% per year from 2010 to 2013 and 1.99% for the period 2003 to 2013. Defaults here are defined as those imposing losses on creditors.
The full analysis is available online and PDF versions of both a summary report and a full report (PDF).
China Introduces New Regulations to Facilitate Employee Share Purchase PlansThe China Securities Regulatory Commission (CSRC) issued new regulations on June 20 to allow employees to buy shares in listed companies out of their compensation. The shares must be held for 36 months. Total employee shareholdings cannot exceed 10% of the company, and no one individual can own more than 1%. Companies must comply with information disclosure and insider trading rules and other securities regulations. There are no special tax incentives for employees and no requirement for shares to be offered at a discount.
Quoted in BNA, Richard Gu, a senior consultant with Linklaters, noted that although the new regulations do not cover cross-border share plans, non-Chinese companies that invest in companies traded on a Chinese exchange may benefit because "instead of using international shares, they can actually use the shares listed in China."
Chinese workers save much more of their income than workers in other countries, and the CSRC reported that 74% of listed companies had some stock owned by employees. The new rules seem unlikely to spur a great deal of interest, given that people can buy shares on the market at the same price without the holding rules. The regulatory agency, however, said it will next consider tax and other incentives for the plans.