Is There a Problem with ESOPs?
Other issues involve the failure to provide participants with the specific benefits required or allowed under ESOPs, such as voting rights, ability to diversity their accounts balances at certain times and the right to sell their shares of stock when received. The DOL has also been paying special attention to the refinancing of ESOP loans in since the issuance of Field Assistance Bulletin 2002-1 (FAB 2002-1).
FAB 2002-1 states that at a minimum, in determining whether to cause an ESOP to engage in a refinancing, a fiduciary must make a careful assessment of the costs and benefits conferred upon the ESOP and the likely consequences of a failure to refinance, and ensure that the transaction is “arranged primarily in the interest of participants and beneficiaries.” 29 C.F.R. § 2550.408b-3(b)(2). It is the view of the DOL that, consistent with the obligation to consider “all the surrounding circumstances” pursuant to § 2550.408b-3(c)(1), an ESOP fiduciary must, in considering any refinancing of an ESOP loan that results in an extension of the period over which stock will be allocated to participant accounts, assess the extent to which the refinancing is consistent with the documents and instruments governing the plan, including loan and related agreements. The DOL also believes that an ESOP fiduciary also should assess the extent to which such an extension is consistent with the reasonable expectations of the plan’s participants and beneficiaries, as might be determined by reference to the plan’s summary plan description or other disclosures describing the funding and benefits of the plan.
As a result of the ESOPs unique nature, there has been an increase in the number of DOL lawsuits and an increase in the number of reviews and investigations by the DOL which include the closer scrutiny of ESOPs. Most of the large private cases have been class actions and the recent litigation trends for ESOPs have been surrounding:
- Proper valuations
- The reasonableness of management projections included within the valuations of the stock
- Employment-related agreements with seller, including whether the impact of the employment agreement was considered in valuing the stock and whether agreements raised a conflict of interest and self-dealing
- Consideration of the FMV of the ESOP note used to pay for the stock
- Control premiums
- FMV and plan restrictions
- Complex transactions and fiduciary duties
- The ESOPs subsequent acquisition of stock from participants
- ESOP-owned company indemnification of ESOP fiduciaries
What we can learn from litigation is that process is important. Plans may want to consider engaging an independent fiduciary to review and approve the ESOP transaction. This process should be documented. Fiduciaries should also encourage valuation experts to test and challenge critical assumptions and fiduciaries should also oversee and challenge experts to justify assumptions and advice. Economic substance is also critical, so it is important that valuation experts have access to all critical business and financial information and if applicable, document how employment agreements were considered in the valuation.
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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 appropriately qualified professionals for your plan’s individual facts and circumstances.
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