This turns out to be a hard thing to research very well because of data limitations. What we do have is a 2010 analysis by NCEO’s Loren Rodgers of the Form 5500 data for companies with 100 or more employees (smaller companies do not have to file enough data on the amounts contributed to plans to provide comparisons). The analysis showed that 56% of ESOP companies have a 401(k) plan, which is a hair better than similar non-ESOP companies. ESOP companies with 401(k) plans contributed about 3% of pay to the 401(k) plans; employees put in about 3 times that. That can’t tell you t he match formula, however, because some people put in more than the amount needed to get the maximum match (e.g., if it is 50% up to 6% deferred, some people still put in 10%). We cannot tell from that if this is a reduction in what went in before the ESOP. Anecdotally, our sense is that a lot of companies do reduce what goes into the 401(k) or profit-sharing plan, but most don’t reduce it to zero.
There is no single best approach. All boards have a duty to hire and fire the CEO and determine the CEO’s pay. But beyond that, it is really a case-bycase situation. Boards rarely would get involved in more than a purely advisory way for more than the top five or so executives. The larger the company, the more likely a board will review and set executive pay for a few key people, but most typically, the board allows the CEO to make recommendations for executive pay that it then approves or suggests changes to.
It may be more productive for boards to think about pay philosophy for executives. How much should be in short-term incentives, and what should the drivers be (profits, individual performance, some critical goal for the year, etc.)? Should the company use equity compensation, and if so, in what form and with what rules? Boards may want to engage a compensation consultant, preferably with ESOP experience, to help think this through. Boards may also want to set parameters or caps for total executive pay, but not actual amounts.
The NCEO has a survey of how ESOP companies compensate executives that may be useful in this process.
They do, but they almost never are an issue. Top-heavy ESOPs and other defined contribution plans are those allocating more than 60% of the benefits to a defined group of highly paid “key employees.” A key employee is an employee making over $175,000 in 2018 (indexed annually), a 5% owner, or a 1% owner with a compensation over $150,000. If a plan is top-heavy, the company must contribute at least—3% of pay to the ESOP or a lesser amount equal to the percent of pay the topheavy group receives. Because ESOPs almost invariably contribute the same percentage of pay to everyone (up to the maximum salary cap) or contribute on a more level formula, the 3% test is not a problem. Generally, the only way to violate the rules is if an ESOP contribution is triggered by employee deferrals into the plan and/or a 401(k) plan.
The DOL has taken a more aggressive stance on some ESOP transactions, but although the number has grown in recent years, it is important to keep in mind these investigations have affected a very small minority of cases. Note that investigations are different from routine audits, which are more common. The DOL has focused on transactions between the ESOP and sellers. It has not done much on ongoing ESOPs. The key issues have been valuation and deal structures. The DOL has alleged that some appraisals are excessively optimistic, perhaps relying on inaccurate data, while some deal structures, especially those using warrants for sellers, are providing an excessive rate of return on seller financing. The investigations have almost entirely focused on transactions with outside trustees, and often have focused on particular trustees and advisors. It is not clear why that is the case. It may be that other transactions are more conservatively structured or that it is easier for the DOL to identify these independently trusteed transactions.
While there has been a great deal of disagreement and controversy in the ESOP community about the DOL’s assumptions for valuations and deal structures, deals that are conservatively structured have rarely been a target, although there are exceptions. The NCEO has filed a Freedom of Information Act request to learn more about the scope and nature of DOL investigations.
There is no legal or regulatory requirement for this. But it is a good idea to make sure that all current fiduciaries have this training and that it be refreshed every few years. That can be through your provider, the NCEO (which has an inexpensive training program that can be done remotely), or by attending conferences.