Many businesses use Employee Stock Ownership Plans (ESOPs) to incentivize employees and as a succession planning tool for owners as they look to turn the business they created into a successful and thriving affair without selling it off to another company. ESOPs are governed, in part, under ERISA regulations. As with all ERISA-governed benefits plans, the role and responsibilities of the fiduciary are paramount.
The fiduciaries of an ESOP are the individuals with the authoridy to make decisions regarding plan investments, control plan assets, and handle plan administration. This includes the who are responsible for investing in company stock or other assets as directed by the plan documents. ESOPs can be funded by issuing new company shares, with cash, or with borrowed funds. ESOP fiduciaries (frequently the trustees) arrange for an independent valuation of the business, make sure the transactions and processes are in the best interest of the ESOP members, and approve any other transactions. ESOP transactions are regulated by the Department of Labor.
Pizzella v. Vinoskey
In this case, Evolve Bank and Trust served as the trustee and fiduciary for Sentry Equipment Erectors, Inc. It was alleged that, during their time as trustee for Sentry, the bank violated its duties of prudence and loyalty when it purchased 51,000 shares from Sentry’s founder, owner, and CEO. These shares represented a 52% ownership interest in the company. The ESOP purchased these shares at a price of $406 per share for a total of $20.7 million.
According to the trustee, the goal of the transaction was to be fair to both the plan participants and the CEO. Further investigation revealed that Evolve never engaged in negotiation over the stock price but instead went with the first offer submitted. A company representative had shared an estimate with Evolve which turned out to have been calculated using questionable inputs in the valuation model.
These questionable inputs included improperly valuing the ownership interest as controlling, which it was not, due to the Company’s by-laws. Further questionable inputs included a lack of performance forecasts and adjusted earnings that removed healthcare benefits currently offered by the company. Finally, the appraiser used inconsistent capitalization rates for this appraisal that increased the value of the transaction. Previous valuations of the company’s shares conducted by the ESOP had placed the shares at between $215 and $285 in value.
The court held that the stock price should have been per share, resulting in a $11.5 million overpayment to the CEO. As a result of these failures of diligence, Evolve had violated its duties of prudence and loyalty. Further, the CEO was jointly liable since he was a knowing participant in the transaction and a co-fiduciary to plan participants.
While ESOPs can be an excellent way for an owner to hand over the business to loyal employees and cash in on his or her hard work, managing the transition in compliance with strict regulations governing these transactions requires careful planning. The ERISA attorneys at Hall Benefits Law work with clients who are interested in implementing an ESOP to discuss the practical aspects of the plan both during implementation and going forward. Give us a call at 678-439-6236 today, or visit the Hall Benefits Law website to learn more.
Hall Benefits Law, LLC
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