ESOP Compliance: Coloring Inside the Lines

Value Management Inc.
Value Management Inc.

In the complex world of ESOP Regulation, it is crucial that the trustee follow all Department of Labor (“DOL”) guidelines. The DOL has become increasingly vigilant, and, as new process agreements have been issued, ESOP trustees must be ever more adherent to compliance protocols. This is not the place to push boundaries or express creativity.


There are three main cases that set the standard for ESOP compliance guidelines: GreatBanc Trust Company Process Agreement (“GreatBanc,” June 2014); First Bankers Trust Services Settlement Agreement (“FBTS,” September 2017); and the James Joyner (“Joyner”) Agreement (September 2017).

Prior to the FBTS and Joyner agreements, the GreatBanc process agreement was the gold standard for compliance. The GreatBanc agreement arose out of litigation related to an ESOP transaction involving Sierra Nevada Aluminum in which GreatBanc served as trustee.

The resulting agreement provided specific guidelines to which GreatBanc must adhere in future transactions, and provided specific guidelines for ESOP trustees with regard to:

  • Selection of the Valuation Advisor
  • Conflicts of Interest
  • Oversight of the Valuation Advisor
  • Financial Statements
  • Fiduciary Review Process
  • Preservation of Documents
  • Fair Market Value
  • Consideration of Clawback
  • Other Professionals

The FBTS Settlement Agreement concluded a suit brought by the DOL accusing FBTS of breaching fiduciary duties as trustee when it approved the sale of Maran, Inc., a private denim manufacturer, to the Maran ESOP. The FBTS Settlement Agreement echoes much of the GreatBanc Process Agreement, with some slightly more stringent requirements. The new policies require that the trustees demonstrate proper consideration of the ESOP as a buyer and/or that the ESOP assume effective control. This might be accomplished by establishing a board with an independent director. Because ESOPs are often created out of tightly held family-owned companies, bringing in an outsider can be controversial. It may also be costly. The independent director should have industry knowledge and business expertise, and persons with that skill set may well be affiliated with local competitors. To avoid this issue, it could be necessary to recruit a director from out of state, which can be expensive.

Specific, additional guidelines required by the FBTS Settlement Agreement include:

  • Trustee must document the steps taken to ensure that the Valuation Advisor receives the most accurate and current information.
  • Three references must be checked before selecting the Valuation Advisor and determining whether the Valuation Advisor has a history of regulatory proceedings related to his/her’s valuation work. (The GreatBanc Process Agreement only addressed prior criminal or civil proceedings).
  • Potential risks that could cause the ESOP to perform below projections must be outlined.
  • Analysis of Valuation Advisor must be done within one calendar year of appointment. (The GreatBanc Process Agreement only required 15 months.)
  • Written records of potential conflicts of interest must be logged.
  • Provide explanation of any discrepancies between present valuation and prior valuations performed within past 24 months.
  • Determine, document and disclose whether terms of any loan the ESOP receives in connection with the transaction are equivalent to terms of any loans between the ESOP sponsor and any executive of the ESOP sponsor made within two years prior to the transaction.
  • Trustee may approve a transaction with the provision that the selling shareholders will compensate the ESOP for any losses or harms caused by or related to statements and materials that did not accurately reflect the sponsor’s financial condition prior to and at the time of the sale.
  • Trustee is duty bound to question projections believed to be unreasonable and require revised projections and/or reject the sale. Documentation for this step is required.
  • Trustee must ensure that selling shareholder provides detail on: prior attempts by either side of transaction to purchase or sell stock in the ESOP within past two years; prior defaults within past five years; management letters from accountants within past five years; any communications with the IRS regarding valuations within past five years.
  • If the trustee approves a transaction in which the ESOP cedes control on a particular facet of management, such as voting on directors, the trustee must document the reasoning and/or consideration behind such a concession. Trustee must also document the converse: in the event that the ESOP pays a premium for control, details must be included. Specific amounts of limitations, considerations, and concessions must be clearly enumerated.

The Joyner Agreement resulted from the case Acosta v. Bat Masonry Company, in which the DOL alleged overvaluation of shares purchased by the ESOP. Joyner served as trustee for the transaction, and the settlement outlined policies that practically mirror the GreatBanc Process Agreement.

The main differences between Joyner and the GreatBanc Process Agreement are summarized below:

  • Trustee must review appraiser every 24 months (up from every 15 months).
  • Clarifies use of unaudited statements.
  • Requires that trustee procure fiduciary insurance or assume title of fiduciary under the ESOP sponsor’s policy. This applied to Joyner as an individual outside trustee; presumably institutional trustees would carry insurance.

Prudent buyers, trustees, and fiduciaries are wise to seek expert counsel throughout the ESOP process to avoid committing violations, undergoing investigation, incurring litigation, and ultimately suffering penalties. To put it simply, sound financial advisors will help you color inside the lines.

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