As a result of recent litigation, the Department of Labor (DOL) established procedures that trustee fiduciaries should follow when engaging in an employee stock ownership plan (ESOP) transaction. The ESOP buys stock from one or more shareholders at a price determined by an ESOP fiduciary. At least nine out of ten ESOP companies are privately held corporations. ERISA generally requires fiduciaries to rely on an independent appraisal expert to determine the stock’s fair market value. If the DOL finds that the fiduciary relied on an inadequate appraisal, they can also determine that the fiduciary breached its duties and possibly violated ERISA’s prohibited transaction rules.
The following steps surfaced as a result of the recent DOL litigation:
Selecting the Company Appraiser
The trustee should maintain documentation of the steps it takes to select the professional who performs the company valuation. This documentation should endorse the appraiser as being qualified to perform valuations, as well as demonstrate that the appraiser has no conflicts of interest with the company. The appraiser should not be the same person who performed the feasibility study or preliminary valuation for the company.
Overseeing the Appraiser
Trustees must be able to demonstrate their involvement in the valuation process and that they did not blindly follow the appraiser’s lead. The trustee needs to understand the projections and assumptions used and make sure the reasonableness of the assumptions can be easily explainable.
Fiduciary Review Process
As part of the valuation review and transaction decision, the trustee should consider how the terms of the ESOP affect the repurchase obligation and whether the plan will be able to service the purchase loan if the projections are not met.
In conclusion, keep in mind that the trustee fiduciary is the party responsible for understanding the risks posed by transactions between privately held companies and ESOPs. The fiduciary is responsible for requesting information about possible government audits or legal actions, industry risk, and any financial and legal disclosures.