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Fiduciary Internal Control Guidelines for ESOP Valuations

Fiduciary Internal Control Guidelines for ESOP Valuations

A fiduciary for the ESOP has the burden of proving that the ESOP has received adequate consideration for its purchase of the employer’s stock. It is important that fiduciaries understand their responsibilities and that the appropriate measures be put into place so that the ESOP transaction can avoid being labeled as a prohibited transaction. The risks and violations can be reduced if the fiduciary engages a specialist that has the professional qualifications, experience and a good reputation within the industry.

Fiduciaries should be aware of the objectives and scope of the specialist’s work and the methods or assumptions being utilized. They should also understand the relationship of the appraiser to the sponsoring Company because the fair market value of employer securities acquired by an ESOP that are not readily tradable or do not have an established market value, are required to be determined by an independent appraiser.

With the increase in litigation surrounding ESOP valuations, DOL officials have identified some key mistakes in appraisals that can make a valuation suspect.

Those mistakes include:

  • No discount applied for lack of marketability;
  • Failure to take into account the risk associated with having only a single supplier or customer;
  • Inflated projections;
  • Inconsistencies between the narrative of the valuation and the mathematical calculations in the appendices;
  • Use of out of date financial information;
  • Improper discount rates;
  • Incomparable benchmark companies – for example using a large public company as a comparable to a small private company; and
  • Failure to test the underlying assumptions.

Below are some useful guidelines that fiduciaries can utilize in order to better ensure that proper controls are in place surrounding ESOP Valuations:

  1. Identify a specialist and evaluate his or her professional qualifications.
  2. Document your understanding of his or her competence, capability, and objectivity, including his or her reputation and standing amongst his or her peers and others familiar with his or her work.
  3. Document your understanding of the nature, scope, and objective of the work that the specialist is to perform.
  4. Evaluate the appropriateness of the specialist’s work, keeping in mind the key mistakes that the DOL has identified as listed above. This evaluation should include an understanding of the specialist’s conclusion regarding the properness of the valuation model used.
  5. Document your understanding of the relevance and reasonableness of the methods and significant assumptions used by the specialist, including a comparison with those methods and significant assumptions used in prior periods.
  6. Document your understanding of the relevance, completeness, and accuracy of the source data used by the specialist.
  7. Evaluate the Plan’s process for the consistency and reliability of information gathered to be provided to the specialist.
  8. Evaluate the reasonableness of actual results against prior historical projections and the achievement of those projections.
  9. Evaluate whether it is appropriate to use the specialist’s work.

Implementing these guidelines can help ESOP fiduciaries meet a potential regulatory or other challenge and demonstrate their fiduciary responsibility over the plan.

For more information or to contact Withum’s team of experts, please fill out the form below.

The information contained herein is not necessarily all inclusive, does not constitute legal or any other advice, and should not be relied upon without first consulting with appropriate qualified professionals for your plan’s individual facts and circumstances.

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