In recent years, the Department of Labor (DOL) has had a laser-like focus on valuation issues when privately held companies establish employee stock ownership plans (ESOP). In particular, the DOL is concerned with valuations that rely upon unrealistic growth projections, which lead to the ESOP paying too much (in the DOL’s view) for the shares of employer stock. The DOL has raised this issue in litigation, and in 2014, it entered into a settlement agreement with GreatBanc Trust Company (GreatBanc). While the GreatBanc settlement is legally binding only on GreatBanc, the DOL promoted it as a set of best practices for trustees to demonstrate that they satisfied their fiduciary duties in an ESOP transaction. The trustee community largely followed suit, and the due diligence process for ESOP transactions typically follows procedures outlined in the GreatBanc settlement.

The DOL has since updated these procedures. Towards the end of 2017, the DOL entered into new settlement agreements with trustees—one set of settlement agreements with the institutional trustee First Bankers Trust Services Inc. (First Bankers) and one with an individual trustee named Joyner (1).

The latest settlement agreements are largely similar to the GreatBanc settlement agreement, although they also reflect a few cases where the DOL’s thinking has evolved (or in the case of Joyner, applied the process requirements in a way that is fitting to an individual trustee). While these settlements are aimed primarily at trustees and their valuation advisors, employers who are considering sponsoring an ESOP as well as the lenders (including both banks and the selling shareholders) to ESOP sponsors should pay attention to these settlements as well. If a portion of the sale proceeds must be returned to the trust, that could affect the amount that the selling shareholders ultimately receive, particularly if the sellers financed part of the deal. In some situations, depending on the transaction documents, an ESOP sponsor may be required to indemnify an ESOP trustee. As a result, the company and its lenders could pay a price if the trustee violates its ERISA fiduciary duties with respect to the valuation process.

In general, these agreements focus on the following issues:

  1. Selection of a Valuation Advisor. The trustee needs to document the steps it took to select the appraiser who performed the valuation of the company. In particular, the trustee needs to demonstrate that the appraiser was qualified to perform the valuation and had no conflicts of interest with the company. An appraiser should not have performed a feasibility study or preliminary valuation for the company, and the trustee needs to consider whether any other work that the appraiser performed for the company creates a potential conflict.
  2. Oversight of the Appraiser. The trustee also needs to demonstrate that it was actively engaged in the valuation process and did not blindly rely on the appraiser. For example, the trustee needs to be able to understand the projections and assumptions underlying a valuation and explain how those are reasonable.
  3. Fiduciary Review Process. The trustee also should consider how the ESOP terms affect the repurchase obligation and whether the plan can service the loan if the projections are not satisfied.

All of these issues and others should be documented. That’s consistent with general ERISA fiduciary advice—document every key decision and the reasons for making those decisions. The goal is for the fiduciaries to be able to produce a record that shows that they acted prudently and solely in the best interest of ESOP participants and their beneficiaries.

That, in turn, leads us to the real message for anyone considering adopting an ESOP: engage an experienced and well-qualified team of professionals. While an ESOP transaction is similar to stock purchases by third parties, the qualified plan and ERISA fiduciary aspects of ESOPs require specialized knowledge. A team of experienced professionals can navigate these issues. When structured properly, ESOPs often can be a great fit for a company and its employees.

(1) Acosta v. BAT Masonry Co, Inc., No 6:15-cv-0028-EKD-RSB, (W.D. Va. 2017), consent order filed Sept. 29, 2017.