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The Employee Ownership Update

Loren Rodgers

October 3, 2016

(Loren Rodgers)

Appeals Court Rules That Dudenhoeffer Ruling Does Not Apply to Private Company

In Allen v. GreatBanc Trust Co., the Seventh Circuit overturned a lower court ruling that dismissed a case over an ESOP valuation at the ESOP for Personal Touch Company. The company's stock price dropped just over 50% after the valuation. The plan's trustee, GreatBanc, argued that post-transaction stock prices are common because of the debt, but plaintiffs argued that GreatBanc failed to conduct an adequate investigation of the stock price and approved an interest rate on the ESOP loan two points above what banks were normally charging.

The district court ruled against the plaintiffs, concluding they had to argue special circumstances under Dudenhoeffer but failed to do so. The special circumstances doctrine was developed by the Supreme Court to replace the presumption of prudence (the so-called "Moench presumption"), but was crafted in a way that seemed only to apply to public companies. It relies on showing that the market prices were misleading in some way, a difficult standard to meet, or that fiduciaries should have acted in inside information the market did not have, which could violate securities laws.

The Department of Labor filed a brief in the case and argued along with the plaintiffs that that the Dudenhoeffer rule should apply only to public companies. The Seventh Circuit agreed and ruled that plaintiffs could continue their case on the basis on issues other than plausible alternatives, specifically that the valuation was improper.

The position and decision are notable for their implications for private companies. The presumption of prudence arguably never was an issue for private company litigation, and the doctrine only came up twice in the 26 years that the NCEO has been tracking litigation. If the Dudenhoeffer rule does not apply to private companies, the legal landscape for private companies with ESOP likely looks much like it did before the Supreme Court's decision.

Employees Increasingly Value Equity Compensation Plans: Fidelity Study

In a study released on September 14, Fidelity reports that an increasing number of employees see equity compensation as their most important company benefit. Most employees reported that company stock plans give them a sense of ownership, and about half report that stock compensation increases their loyalty to the company.

The percentage of respondents who said that company stock is their most important benefit increased to 16% in the current survey, up from 10% in a similar 2010 survey by Fidelity.

Among employees who had sold stock they acquired through the company's equity compensation plan, 40% had held onto the stock for more than two years.

Empowering Employees through Stock Ownership Act Passes Ways and Means Committee

A bill to help employees in closely held companies defer taxation from the gain on exercised stock options and restricted stock units for shares that are not yet liquid has passed a key House Committee. H.R. 5719, the "Empowering Employees through Stock Ownership Act," passed the House Ways and Means Committee by a unanimous vote. The bill would allow employees to defer taxation on the gain from stock options or restricted stock units for whichever is later:

One-percent owners, CEOs and CFOs, and any of the top four compensated employees at any time during the last 10 years cannot qualify for this treatment. They lose their preferential treatment under this bill when they become excluded.

Awards must be made available to at least 80% of a company's employees on more than a de minimis basis, and they must be granted the awards with the same rights and privileges. The bill says that the company should use the guidelines under Code Section 423(b)(5), which covers employee stock purchase plans, to determine what this means. Typically, it involves such terms as vesting rules, forfeiture, redemption options, how the awards are allocated, etc. Barbra Baksa, executive director of the National Association for Stock Plan Professionals, says this provision leaves room for considerable uncertainty, as do some other sections of the bill.

UK Labour Party Supports Right of First Refusal for Worker Buyouts

Jeremy Corbyn, the leader of the Labour Party in the United Kingdom, announced on September 15 that he supports policies that "create a 'Right to Own,' giving workers facing a change of ownership or closure of a firm the first refusal in putting together a worker-owned alternative." Corbyn, who describes himself as a democratic socialist, made the commitment during his campaign to retain the leadership position in the Labour Party. On September 24, the party did vote to retain him.

Employee Ownership and Economic Inequality

In a September 28 article in the Stanford Social Innovation Review, Marjorie Kelly argues that the "quiet ownership revolution now underway across the country" is a key part of the solution to economic inequality.

Author biography and other columns in this series

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