For decades, the ESOP community has asked the Department of Labor (DOL) to provide regulations regarding “adequate consideration.” The desired regulations would provide needed guidance to trustees and other fiduciaries on how to ensure that ESOP transaction terms are fair to participants, and that the price paid for company stock does not exceed fair market value.
A brief history of DOL regulations on ESOPs
The DOL previously proposed adequate consideration regulations in 1988 but withdrew them after receiving comments that the proposed regulations would not be workable. Since then, particularly since a 2005 enforcement initiative, rather than proposing new regulations, the DOL has investigated newly formed ESOPs and taken legal action against many of them. Many of these cases have settled, and the DOL has pointed to the terms of these settlement agreements as reflecting the DOL’s view on how ESOP transactions should be conducted.
Challenges faced by the ESOP community
This type of regulation by litigation has created administrative complexities for ESOP transactions. The ESOP community has largely worked through these challenges, but continues to want a more formal set of guidance for parties looking to form ESOPs. Congress responded to this concern when it passed SECURE 2.0 in 2022 and included a directive to the DOL to issue formal guidance on the matter.
Recent developments and withdrawn proposals
The ESOP community was hopeful at the prospect of finally getting clear, fair, and reliable standards regarding adequate consideration. Instead, history repeated itself (or if it didn’t repeat, it rhymed). Although the DOL proposed regulations, they were quickly withdrawn due to an executive order from President Trump as the DOL had not published the proposed regulations in the Federal Register.
However, withdrawing the proposed regulations is probably for the best since there were some unexpected surprises (to say the least) in the proposed regulations. This resulting break in the action gives all sides much needed time to catch their collective breath and come up with a new workable set of guidelines.
The future outlook for ESOP regulations + advice for business owners
In the meantime, the ESOP community will continue to follow the best practices that have developed from the DOL settlement agreements, court decisions, comparable tax regulations and standards from the valuation community over the past fifty years since ERISA’s enactment.
Business owners looking for an exit or succession planning strategy should talk with experienced counsel who can help them decide if an ESOP is the right fit, and if so, to guide them through a transaction.
