Since the enactment of the Employee Retirement Income Security Act (ERISA) in 1974, Employee Stock Ownership Plan (ESOP) transactions have been heavily scrutinized by Employee Benefits Security Administration (EBSA), the enforcement arm of the U. S. Department of Labor. Historically, EBSA has seen ESOPs as an area fraught with opportunity to benefit companies and its owners at the expense of employees who participate in an ESOP. The ESOP community has asked EBSA for guidance on ESOP transactions for decades. But EBSA has provided no official guidance and instead has taken a stance of enforcement by litigation. This has resulted in a chilling effect on establishment of ESOPs nationwide since EBSA has been second-guessing ESOP transactions and filing suit against plan fiduciaries.
A little background on ESOPs - ERISA provides that certain transactions between a plan (here, the ESOP) and a party in interest (here, the Company or shareholders selling company shares to the ESOP) are prohibited. However, ERISA provides a specific exemption for a transaction where an ESOP buys shares of company stock for “adequate consideration”. While ESOP professionals have followed this edict for years, EBSA has continued to challenge the process through which the value of stock is determined – not by statute or other official guidance but by litigating those cases it believed violate ERISA. From a practical standpoint, it is hard to comply with a law where no official guidance has been provided by the agency that enforces that particular law.
As such, Congress recently passed the Retire Through Ownership Act (RTOA) that amends ERISA to codify the use of the long-accepted methodology of valuing closely held stock by affirming that a plan fiduciary may in good faith rely on a valuation prepared by an independent valuation professional if they relied upon the principles set forth in Revenue Ruling 59-60. This revenue ruling (from 1959) has long been hailed as the foundation for business valuation. Now, it is codified into ERISA as President Trump signed the RTOA into law on October 15.
One more point of interest for ESOPs: EBSA maintains a priority list for investigations. Since the 1980s, ESOPs have been on that list and EBSA has taken a keen interest in investigating new ESOPs as soon as it learns of them (via annual report Form 5500 filing or otherwise). This year, ESOPs have been removed from that priority list. This does not mean that EBSA will not perform investigations of ESOPs. But it does remove ESOPs from EBSA’s bullseye that has been present for decades.
If you or your company have ever considered an ESOP transaction but were concerned about the governmental scrutiny, now is the time to reconsider an ESOP as a company benefit and exit strategy for shareholders. If you are interested in learning more about ESOPs, contact the author or your BGW attorney.
