Litigation has been an ongoing concern for the ESOP community. To many advocates, much of the litigation activity is unwarranted. On the other hand, there are people in the Department of Labor (DOL) and a few plaintiff law firms who believe that ESOPs are inherently too risky and that they are too often set up more to benefit selling owners than employees. This book looks at what we can learn from trends in ESOP litigation in the last few years. Chapter 1 examines the costs of ESOP litigation in private companies over the last 10 years. When the total amount awarded is divided by the number of private ESOP companies, the average per-company cost is modest. Chapter 2 summarizes the important cases in ESOP litigation in the last five years. The most important event was the issuance of several process agreements between the DOL and institutional trustees. Chapter 3 argues that litigation by the DOL and the plaintiff’s bar has discouraged some trustees from working in this field. The chapter provides a roadmap for trustees to set up practices to minimize this risk. Finally, chapter 4 discusses a recent, potentially seminal case involving the sale of a company to an ESOP where the court ruled decisively for the defendants.

Product Details

9 x 6 inches
(March 2023)
In stock

Table of Contents

1. The Costs of Private Company ESOP Litigation, 2013–2022
2. Key Recent Decisions and Trends in ESOP Litigation in Closely Held Companies
3. The Practice and Risks of Being an ESOP Trustee
4. The Defendant’s Win in a Landmark Case from the Viewpoint of the Defendant’s Expert
About the Authors
About the NCEO


From chapter 1, "The Costs of Private Company ESOP Litigation, 2013–2022"

One way to think about these costs is that the average annual total is about $38.5 million, plus unreported litigation costs. Give that in any of these years, there have been about 6,200 private company ESOPs, this averages about $6,200 per year per company (and perhaps as much as $7,500 per year if we add unreported litigation costs). Of course, that is not how these amounts are paid, but it provides context to compare what companies and/or ESOP trustees pay per company in fiduciary insurance. That amount varies with the size of the company and policy limit, but would be a lower number, indicating that, overall, fiduciary insurance is in the black for insurers. These numbers, of course, are just averages, and any one very large payout may put a strain on an insurance carrier.

We can also look at the value of the judgment relative to the purchase price the ESOP paid. The settlement or decision cost averaged 11.8% of the purchase price the ESOP paid. This applies only to the valuation cases and does not include the 18 cases included in the Wilmington Trust settlement because those numbers are not available. (The Wilmington joint settlement applied to 21 cases, but 3 of these had already reached settlement agreements and are included in table 1-1.)

From "The Practice and Risks of Being an ESOP Trustee"

Regulations should be created through an open, fair process that encourages public comment and includes community input. By nature, this process will be fully vetted and incorporate well-established valuation principles, deal structures, and professional interests. Instead, the DOL has engaged in a practice of regulation through litigation by the creation of process agreements with individual litigants. Further uncertainty is created because the Employee Benefits Security Administration (EBSA), the DOL’s enforcement arm, has different approaches across the regional branches. An issue may or may not be brought up and prioritized based on the specific EBSA office seeking enforcement. All of this has resulted in inconsistency, uncertainty, and unfair results via Monday-morning quarterbacking.

The closest thing to regulation we have today is a series of process agreements between particular fiduciaries and the DOL. This process began with the “Agreement Concerning Fiduciary Engagements and Process Requirements for Employer Stock Transactions” dated June 2, 2014, between the DOL and GreatBanc Trust Company. Even though the standards set forth in these process agreements are binding only on the parties to the agreement, the DOL issued a press release stating, “others in the industry would do well to take notice of the protections put in place by this agreement.” That statement creates the appearance that the DOL is circumventing what should be a fair and open regulatory process.

The DOL has entered into several similar settlements in the time since, seeking to establish quasi-regulation. Regulation through litigation creates inconsistent law, applies inconsistent standards, and circumvents a fair and open process. Indeed, trustees are quick to take note of each successive process agreement as each seems to build upon predecessor agreements as the DOL’s enforcement priorities change. Clear and consistently applied standards are necessary to avoid Monday-morning quarterbacking that continues to occur long after transactions have closed. This uncertain environment is an unfair use of the legal system, appears to deter the creation and continuation of ESOPs, runs contrary to clear congressional intent, and leads to costly litigation.

From "The Defendant’s Win in a Landmark Case from the Viewpoint of the Defendant’s Expert"

Primarily as a result of these violations, the DOL expert’s conclusions were deemed flawed. Overall, his assumptions were found to be speculative and unfounded, and his reasoning was fatally flawed. Pia identified certain key flaws in the DOL expert’s analyses and methodologies:

  • He attempted to dismiss both the LVA and GMK valuations in one fell swoop by treating the non-binding indication of interest letter from URS like a bona fide offer, which he concluded was somehow representative of the fair market value of B+K at or near the time of the transaction. This is not consistent with general standards and practices of valuation.
  • The DOL expert relied on erroneous assumptions in developing his own modified forecasts for B+K, essentially superseding and replacing management’s forecasts with his own. Below are several factors that Pia specifically pointed out:
    • A failure to understand the historical pattern of subcontractor expenses and how to properly account for them in the forecast period. Had the DOL expert queried management about this key element of the forecast, he would have learned that B+K completed several large projects for the U.S. Army Corps of Engineers in the period before the ESOP was adopted, which required heavy use of subcontractors. Subcontractor expenses are passed through without markup to the customer and do not contribute to profitability; thus, they are not included in forecasts. Additionally, management does not include potential large contracts in its forecasts because they only occur occasionally. Thus, with no forecasted large projects, subcontractor expenses were expected to revert to their average level.
    • The choice to use a stub period in the DCF benefit stream provided by management. This short period was inconsistent with the trend the company experienced and essentially ignored approximately $3.9 million in free cash flows from the 2012 period. This choice was made despite the following statement in the DOL expert’s report: “Thus, it is reasonable to assume that revenue would meet Management’s expectations for 2012 which is consistent with our analysis.”
    • A related failure to adequately analyze B+K’s construction order backlog.