A settlement with the Department of Labor (DOL) regarding an employee stock ownership plan (ESOP) transaction and a Supreme Court decision that sponsors of retirement plans that offer company stock as an investment option are not entitled to a presumption of prudence gave ESOP plan sponsors a few things to contemplate.
However, the specific implications depend on the type of ESOP a plan sponsor has.
Corey Rosen, founder of the Oakland, California-based National Center for Employee Ownership (NCEO), notes that publicly traded companies account for a relatively small percentage of ESOPs, but because the companies are big, they may have a large amount of assets in ESOPs. For these companies, the ESOP tends to be integrated into a 401(k) plan; they more often have company contributions that are related to employee deferrals, and employees can purchase or redeem stock. These types of ESOPs rarely own more than 5% of a company’s shares.
The majority of ESOPs (95%) are sponsored by closely held, or private, companies. These ESOPs tend to hold a large percentage of the company’s stock—increasingly they hold 100% of a company’s stock because the ESOPs are typically used to purchase shares from existing owners, Rosen tells PLANSPONSOR. These companies, which Rosen calls ESOP companies, create a culture of ownership; they market themselves as employee-owned, it’s an integral part of the way they think of themselves as a company and the way employees think.
Rosen notes that when considering the presumption of prudence litigation history—he’s been tracking every case since 1990—there have been only two cases involving closely held companies. In one case, the presumption of prudence was one of a number of issues, not the critical issue.
“For public companies, the presumption of prudence says the plan sponsor can invest in stock and does not have to constantly make decisions about investing in anything else. In private companies, there is nothing else; if they didn’t primarily invest in company stock, they wouldn’t have a true ESOP,” Rosen says. “Private companies are not affected by the decision in Fifth Third Bancorp v. Dudenhoeffer, and will not be. They don’t need to think about that.”
According to Rosen, it is hard to tell right now what publicly traded companies should do following the Dudenhoeffer decision. He notes that very few other cases have been remanded due to the Supreme Court decision, and the ones that have been remanded haven’t been decided yet. “The question is, do the substitute standards for determining the prudence of company stock offered by Supreme Court make it harder or easier for participants to prevail in their claims,” he says, adding that the presumption was more important for publicly traded companies because their ESOPs are typically part of a 401(k) for which trustees have to determine if company stock is the right investment option to offer participants.
"It wouldn’t bother me if public companies de-emphasized employer stock,” Rosen says. “If they are not thinking of themselves as employee-owned, it’s better to just see their plans as retirement savings vehicles, not ownership vehicles.”
NCEO has found that employee ownership makes employees more productive and ESOP companies tend to perform better. If a plan sponsor is choosing to offer company stock for these reasons, it could offer the ESOP as a stand-alone plan fully funded and only funded by the company, and offer a separate retirement plan. Rosen notes that closely held companies are more likely to offer a retirement savings plan separate from the ESOP than any company is to offer any retirement plan.
If a publicly traded company wants to continue to offer employer stock in its 401(k) plan, the result in Dudenhoeffer shows they certainly want to have an independent trustee, Rosen says. “In some companies, fiduciary decisions are made by insiders who have conflicts of interest. They don’t want executives that have enough stock options to buy small countries to make decisions about company stock in the retirement plan.”
Rosen also recommends plan sponsors establish guidelines about the maximum percentage of total holdings participants may have in company stock. If a participant’s balance goes over the maximum, the excess would be invested in something else.
Plan sponsors should get periodic updates about performance of the company’s stock, and be transparent. In addition, communications should warn employees about the risks of investing their deferrals in company stock.
“I think it’s important to put the Dudenhoeffer decision in context; it’s about a publicly traded company offering company stock as an option to employees, so it applies to a narrow range of circumstances,” says Jerry Ripperger, who leads the ESOP team at The Principal Financial Group.
Ripperger tells PLANSPONSOR the settlement GreatBanc Trust Co. agreed to in litigation with the DOL applies to more circumstances because it involved a true ESOP. In 2012, the DOL sued GreatBanc, as trustee to the Sierra Aluminum Co. ESOP, alleging it allowed the plan to purchase stock from Sierra Aluminum’s co-founders and top executives for more than fair market value. GreatBanc and its insurers settled the case for $5.25 million. The company also agreed to put safeguards in place whenever the company is a trustee or fiduciary to an ESOP that is engaging in transactions involving the purchase or sale of employer securities that are not publicly traded.
Ripperger believes the settlement will produce a couple of results for ESOPS: a greater number of ESOPs will be externally trusteed—even if not externally trusteed on a regular basis, The Principal suggests it for transactions—and more sell-side advisers will be used for transactions, by both the company and the ESOP trustee. He says these extra protections for plan participants are a good thing.
According to Ripperger, The Principal has not seen an impact in the volume of requests to set up an ESOP, but the GreatBanc settlement will impact how ESOPs are formed going forward. “The first thing we would ask is ‘What are you trying to achieve by setting up an ESOP, are you divesting part of the ownership of the organization?” he says. “The answer to that will inform whether Dudenhoeffer or the GreatBanc proceedings determines the governance of the plan.”
Ripperger says companies don’t have to get out of company stock, they just have to make sure have good governance in place. “Establish clearly documented and defined governance procedures, audit them regularly to make sure they apply, and have good legal counsel to make sure the i’s are dotted and t’s are crossed.”
He adds that one of the biggest lessons from both litigation outcomes is that sound governance is a good investment in any Employee Retirement Income Security Act (ERISA) plan. Plan sponsors should look at plan governance as an investment and not as an expense.
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