This publication provides the first comprehensive analysis of Department of Labor ESOP investigations ever conducted, the result of a multi-year effort by the NCEO to obtain data on these investigations. It begins with a discussion of how much ESOPs are at risk, DOL investigative practices, investigation outcomes, valuation issues, and preparing defensible forecasts. A case study then walks the reader through an investigation scenario to illustrate how to make transactions more defensible. Finally, the NCEO’s analysis of DOL investigations presents our data and conclusions, supported by many informative tables. An appendix adds remarks by the DOL’s Tim Hauser on ESOPs and the DOL.
“This first-of-its-kind study makes a critical contribution to understanding the DOL’s investigations of ESOPs and what to do about them.”
—Theodore (Ted) Becker, McDermott Will & Emery
Table of Contents
1. Understanding and Responding to Department of Labor ESOP Investigations
2. Prerequisites for Defensible ESOP Transactions: A Case Study
3. Data on EBSA’s Civil ESOP Investigations, FY 2007–2017
Appendix: ESOPs and the Department of Labor
About the Authors
About the NCEO
From "Understanding and Responding to Department of Labor ESOP Investigations"
Once resolved, ideally you will get a “no action” letter. Many investigations end this way. If there’s an agreement, there will be a penalty, often relatively modest. Voluntary compliance, however, could resolve an investigation and would not involve a penalty. If action by the responsible party or parties or the plan is required, voluntary compliance letters are the most common way to resolve issues. You will work with the DOL to correct the violation. The process may be iterative, with you getting feedback in the process from the DOL. You will be able to do this as a private settlement agreement (meaning the results are not published except pursuant to a Freedom of Information Act [FOIA] request or a decision by the DOL to publish them, neither of which are common) or a consent judgment. If participants want copies of documents that have been provided in the investigation, including the settlement agreement, they may be entitled to them under the FOIA. You should discuss with the DOL entering into a formal release of claims, possibly including any other parties to the transaction. The DOL has shown some willingness to do this.You should discuss with the DOL entering into a formal release of claims, possibly including any other parties to the transaction. The DOL has shown some willingness to do this.
From "Prerequisites for Defensible ESOP Transactions: A Case Study" (footnote omitted)
The best defense is to use an income-based approach in the terminal period of a DCF analysis and then as a backtest to look at the implied EBITDA multiple against common-sense benchmarks, including multiples available from GF Data Resources LLC. The advantage of using the DCF approach to calculate the terminal value is the enhanced granularity. For instance, the terminal value will factor in the cash flow impact of (1) capital expenditures and (2) ongoing investments in working capital as the subject company grows. Giving up on this level of detail within the time horizon of the DCF analysis often presents problems by obscuring key assumptions. As a fiduciary, the trustee must understand all of the key assumptions. They cannot be buried.
The DOL argued all of the transaction support and deal design documentation was focused on the “financial engineering.” Virtually nothing dealt with the employee benefits resulting from the deal. There was one worksheet that showed the loan payments as a percentage of eligible payroll, but nothing showing share allocations, benefits to participants, repurchase obligations, etc. If the company had met its targets and paid the ESOP loan off in seven years, the earnings would have to remain strong to cover the allocation of 100% of the company equity to a retirement plan, but that was not measured. The repurchase obligation was largely ignored. All of this could raise issues about how a fairness opinion would have viewed this transaction from the standpoint of existing ownership in the ESOP.
From "Data on EBSA’s Civil ESOP Investigations, FY 2007–2017"
This discontinuity comes through clearly in the ESOP investigation data. Table 3-2 compares the amounts in each recovery category between cases closed in FY 2007–2014 and cases closed in 2015 or later.
Table 3-2 makes two facts clear. First, EBSA’s reported total recovery amounts from ESOP investigations declined dramatically between these two time periods. Second, this decline was driven almost entirely by a drop in “prohibited transaction corrected” recoveries, which seems in turn to result from a change in how EBSA reported its investigation outcomes: Before 2015, Total Monetary Recoveries included instances where the value of the entire ESOP transaction was counted rather than the amount of money actually paid back to the plan or participants following the investigation.
This shift makes pre- and post-2015 monetary recoveries apples and oranges—they cannot be usefully compared to each other. This report restricts its analysis of monetary recoveries to include only cases closed in FY 2015 onward.
The OAPC category appears in the data for the first time in 2015, and it seems that this category includes some results that would earlier have been classified as prohibited transaction corrections. For example, Koerner v. Copenhaver, No. 1:12-cv-01091-JBM-BGC (C.D. Ill. Nov. 3, 2014), involved a $3.4 million ESOP transaction and resulted in a $650,000 settlement. EBSA marked the ESOP investigation related to this case as closed in June 2015 and recorded the results as $366,533 in Plan Assets Restored (which could correspond to the amount of the settlement that was restored to the plan, after fees and costs) and $3,033,467 in OAPC, which together sum to exactly $3.4 million, the total amount of the ESOP transaction.
Unless otherwise noted, this report uses total monetary recoveries as the best available measure of the total financial result of the investigation. We exclude SPAR and OAPC results from our analysis, as the DOL excludes these results from its Total Monetary Recoveries calculation, and it appears that these categories involve a calculated value of administrative corrections (often simply the amount of the entire ESOP transaction or loan) that do not reflect actual monetary transfers to the plan or participants.