From 2012 to 2014, GreatBanc Trust Company and the Department of Labor (DOL) negotiated an "Agreement Concerning Fiduciary Engagements and Process Requirements" that provides guidance for future ESOP transactions. Although the agreement formally applies only to GreatBanc, the DOL has stated that others would "do well to take notice of" the agreement’s provisions. In the ensuing years, five other trustees have entered into fiduciary process agreements with the DOL. The most recent, entered into between the DOL and Farmers National Bank of Danville, contains provisions that are not in the GreatBanc agreement or the other process agreements; thus, it has created confusion and consternation among ESOP trustees, valuation advisors, and ESOP attorneys.
This publication, whose coauthor Ted Becker represented GreatBanc in the negotiations with the DOL that led to the GreatBanc Fiduciary Process Agreement, is intended to be a resource to those who seek to use the fiduciary process agreements as a guide to an ESOP trustee's obligations. It compares the provisions in the six fiduciary process agreements in detail, quoting and comparing the original language. It cites guidance (if any) relating to each provision, and comments on each provision in light of ERISA, its legislative history and other congressional materials, and other laws and regulations. Furthermore, the authors set forth information about ERISA's standards for ESOP trustee conduct and how those standards affect the interpretation of the fiduciary process agreements.
Table of Contents
The Six Fiduciary Process Agreements
Fiduciary Process Agreement: Preamble
Section A: Selection and Use of Valuation Advisor—General
Section B: Selection of Valuation Advisor—Conflicts of Interest
Section C: Selection of Valuation Advisor—Process
Section D: Oversight of Valuation Advisor—Required Analysis
Section E: Financial Statements
Section F: Fiduciary Review Process—General
Section G: Fiduciary Review Process—Documentation of Valuation Analysis
Section H: Fiduciary Review Process—Reliance on Valuation Report
Section I: Preservation of Documents
Section J: Fair Market Value
Section K: Consideration of Claw-Back
Section L: Other Professionals
Section M (Untitled)
Section K: Control [Non-GreatBanc FPAs Only]
Section M: Insurance Coverage [Joyner Process Agreement Only]
Section N: Indemnification [FNB Process Agreement Only]
About the Authors
About the NCEO
An explanation of the excerpt below:
In this book, each section of the process agreement text being discussed quotes the text of the original GreatBanc Process Agreement (where applicable) in italics like this, followed by guidance and commentary. Substantive differences between each of the Fiduciary Process Agreements (as opposed to merely substituting trustee names, etc.) are noted in bolded and italicized text; in the book, it is set off in a different font than the main text. Citations to individual agreements are placed in [bold italic text in square brackets like this] at the end of quoted text. Square brackets also enclose interpolated comments or ellipses, etc. Where differently numbered versions of a list could become confusing, they are formatted with different indents, as seen below. In the excerpt below, footnotes have been moved to the body of the text because this is a web page.
Section F: Fiduciary Review Process—General
In connection with any transaction involving the purchase or sale of employer securities that are not publicly traded, the Trustee agrees to do the following:
1. Ensure that sufficient time is allowed to fully, completely, and accurately review and analyze the contemplated Transaction prior to agreeing to a redemption transaction or a closing date for the Transaction; [FNB Process Agreement] 
1. Take reasonable steps necessary to determine the prudence of relying on the ESOP sponsor’s financial statements provided to the valuation advisor, as set out more fully in paragraph E above;
2. Critically assess the reasonableness of any projections (particularly management projections), and if the valuation report does not document in writing the reasonableness of such projections to the Trustee’s satisfaction, the Trustee will prepare supplemental documentation explaining why and to what extent the projections are or are not reasonable;
3. Document in writing its bases for concluding that the information supplied to the valuation advisor, whether directly from the ESOP sponsor or otherwise, was current, complete, and accurate. [the non-GreatBanc FPAs replace this subsection 3 with the subsection 3 below]
3. If [trustee] believes the projections are unreasonable, [trustee] shall ask the valuation advisor to account for the unreasonable projections in its valuation, request new and reasonable projections from management, or reject the Transaction. [The fiduciary] must document the basis for its decision. [Non-GreatBanc FPAs]
4. Ensure that the information the valuation advisor obtains from the plan sponsor and purchasing or selling shareholder(s) includes the following, to the extent it exists:
b. Any prior defaults within the past five years by the plan sponsor under any lending or financing agreement;
c. Any management letters provided to the plan sponsor by its accountants within the past five years; and
d. Any information related to a valuation of the plan sponsor provided to the Internal Revenue Service within the past five years. [Non-GreatBanc FPAs]
Section F: Guidance
ERISA does not expressly address the fiduciary review process. There is no official guidance under ERISA specifically on this topic.
Section F: Comment
Section F addresses issues that the DOL considers to be of importance in connection with an ESOP stock transaction—an appropriate amount of time to assess the transaction, an adequate review of financial statements and projections, and consideration of certain business and financial matters that the DOL views as affecting an assessment of the company’s value. The areas of inquiry identified in Section F—financial statements, projections, offers, defaults, accounting issues, and valuation information provided to the IRS—are generally reasonable areas to investigate when evaluating a potential ESOP transaction.
A determination of the appropriate level of inquiry and the extent of information necessary to assess an ESOP transaction should be made in view of the Legal Framework. The DOL and attorneys for ESOP participants in lawsuits have argued that the ESOP trustee’s obligation is to make sure that the ESOP pays the lowest possible price for the stock and obtain compounded annual returns of 15% or more (which are the goals of private market purchasers of companies). Private market purchasers of companies seek high returns for a number of reasons, which can include pressure from their investors, financing pressure, or as part of a portfolio that includes purchases of multiple companies, some of which may yield no returns or losses. The DOL and attorneys for ESOP participants also have argued that ESOP trustees should obtain “quality of earnings” reports, independently prepared projections, and other materials that private equity buyers might obtain. The due diligence that a private equity company might perform on a subject company can cost $1 million to $2 million or more, which might be justified by the character and aims of a private equity firm, but is cost-prohibitive for most ESOP transactions. None of this is required under ERISA.
A determination of how much time is “sufficient” to assess an ESOP transaction depends on the nature of the transaction and the scope of an ESOP trustee’s fiduciary obligations. ERISA requires a trustee to evaluate the “fair market value” of the employer stock. Fair market value is the standard of value that ERISA requires for ERISA’s prohibited transactions exemption for ESOP purchases or sales of employer stock as well as for annual valuations, reporting, distributions, and other purposes. There is no difference in the valuation standard. As used throughout ERISA, fair market value has the same meaning, which is the widely accepted standard of value in the valuation field. Qualified appraisers need to take an appropriate amount of time to assess the subject company in view of the particular facts and circumstances, but fair market value estimates do not require many months to prepare, nor do they require the same level of inquiry and assessment that a private equity buyer might employ in view of its return requirements, financing arrangements, risk tolerances, investor pressures, business pressures, and other factors.
The Fiduciary Process Agreements do not merely require the ESOP trustees to ask the valuation advisor about the reasonableness of financial statements and projections; the ESOP trustees who are party to a Fiduciary Process Agreement have the obligation to make the reasonableness determination. Under the case law discussed above, a trustee who is not a party to a Fiduciary Process Agreement may rely on a qualified, independent valuation advisor without having to make its own, independent inquiry into specific matters that are within the area of expertise of the valuation advisor (unless such an inquiry is required under the circumstances for the reliance to be reasonable). That level of inquiry requires a good-faith effort to understand the advisor’s work and that there are no red flags that would call into question the reliability of the advisor’s advice. Principles of a fair market value appraisal inform the assessment of the reliability of projections and the determination of what, if any, adjustments to the valuation should be made to account for optimistic projections.
Contrary to commonly voiced misunderstandings about the use of projections, optimistic projections are not unusable, and valuation advisors do not blindly rely on projections. An ESOP trustee’s “critical” assessment of projections, and determination of whether the projections are “reasonable,” would seem to require the trustee to allow the valuation advisor to conduct an investigation and then ask the valuation advisor to explain the results of that investigation, with the trustee asking questions and probing the valuation advisor’s methods and conclusions. If the projections are optimistic, but the valuation advisor has identified the optimism and can adjust the valuation downward to account for risks that the company will not meet its projections, then a prudent ESOP trustee would likely want the valuation advisor to apply its experience and knowledge in that process, subject to the ESOP trustee’s reasonable oversight and review. The ESOP trustee would then document the information that the ESOP trustee received, the questions the ESOP trustee asked, the explanation provided by the advisor, and that there are no inconsistencies or red flags.
The impact of a prior offer to purchase a company is widely misunderstood in ESOP litigation, but courts in other contexts have correctly explained why such offers may have no bearing at all on an assessment of fair market value. The effect that prior attempts to buy or sell stock may have on current fair market value is another matter to be addressed by experienced and professional valuation advisors. A “low-ball” offer by a private-party purchaser may have no relevance if the private-party purchaser did not follow the rules for a fair market value estimate, did not provide detail about how it arrived at its offer price, did not give sufficient indication that its offer was serious and in an advanced stage of development, indicated contingencies and areas of inquiry that remained, or for myriad additional reasons. The prudent ESOP trustee would ask the valuation advisor to explain the importance, if any, of prior offers, probe the valuation advisor’s assessment, and document the trustee’s ultimate conclusion.
The FBTS, Alpha, and FNB Fiduciary Process Agreements’ requirement that the trustee obtain information about defaults, accountant letters, and information provided to the IRS also requires the trustee to assess the impact of this information on a fair market value assessment, which ordinarily should be an aspect of the valuation advisor’s expert assessment and guidance.