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How The U.S. Department of Labor Changed ESOP Transactions - CMBA News and Information

CMBA Updates & Legal News

Posted by: Jackie Baraona on Aug 1, 2019
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During October 2010, the Employee Benefits Security Administration (EBSA) of the U.S. Department of Labor (DOL) issued a proposed regulation to update the definition of a fiduciary under the Employee Retirement Income Security Act (ERISA). Within a year, the EBSA and DOL withdrew the proposed regulation in the face of Congressional and pension and securities industry opposition. In particular, organizations that served trustees of employee stock ownership plans (ESOPs) opposed the proposed regulation.

In an artful strategic move, the DOL shifted its focus from regulation to litigation to remedy the increased level of less-than-prudent leveraged ESOP transactions packaged by investment banking firms. The key component of the litigation strategy involved settlement agreements with major ESOP trustee organizations which became the “de facto” standard for all leveraged ESOP transactions.

The settlements required defendant trustees to apply more rigorous procedures to assure the reliability of appraisals and the terms of ESOP transaction financing by requiring merit assessment of appraiser qualifications, documentation of appraisal methods and assumptions, confirmation of appraisal decisions, and the use of more reliable and current financial statements. The settlements establish a process for the qualification and use of valuation advisors (VAs), the information relied upon by the VAs and fiduciary oversight and review by transaction trustees.

VA Selection

The GreatBanc Trust Co. Process Agreement (the “Process Agreement”) required a written analysis addressing reasons for selection, listing all VAs considered, discussing qualifications and consulted references, noting court proceedings against the VA, and explaining the prudence of a VA selection. A trustee need not re-investigate the qualifications of VAs it has used in the past if the trustee certifies that it previously performed the analysis within a 15-month period immediately before the current transaction and that the information it relied on is still accurate.

The First Bankers Trust Co. Settlement Agreement (First Bankers”) added a requirement that trustees list at least three consulted references and consider regulatory investigations into the valuation advisor. A trustee need not re-investigate the VA if it performed an analysis in the preceding calendar year. The selection requirements of the Joyner Settlement (Joyner) were the same as the Process Agreement. The Alpha Settlement Agreement (Alpha) included the same selection requirements as the Process Agreement. Its re-investigation provisions were the same as First Bankers.

Fiduciary Oversight and Review

The settlement agreements required certain fiduciary oversight and review processes, including requirements for financial and economic analysis, financial statement and fairness analysis, and VA report assessment.

Financial Analysis

The Process Agreement required investigation of economic and financial information. VAs must identify people who provided projections and inquire into conflicts of interest. First Bankers required a written record of that investigation. Alpha required reasonable inquiry into projections.

Under all the agreements, VAs must compare projections to historical data and investigate returns on assets and equity, EBIT and EBITDA, capital expenditure ratios, revenue growth, and cash flow ratios. VAs must explain why they disregard any metrics. They must set out in writing the bases for concluding that comparable companies are actually comparable, including size, customer concentration, and earnings volatility. They must explain discounts applied to multiples and, if no discount is applied, explain why.

VAs must also consider how ESOP document provisions affect repurchase obligations, transaction prudence, and stock value. First Bankers and Alpha added requirements to describe risks facing the ESOP sponsor that could cause financial performance to fall below projections.

Financial Statements & Fairness Analysis

The agreements set out requirements for financial statements. Subject to certain exceptions, ESOP trustees and valuators must work from CPA-prepared audited and unqualified financial statements for the preceding five years. If the sponsor provided unaudited or qualified statements, the trustee must determine whether reliance on those statements is prudent and document its bases for its belief. The trustee may not proceed with the transaction if reliance would be imprudent. First Bankers and Alpha allow trustees to proceed with qualified and unaudited financial statements if sellers who are disqualified persons indemnify the ESOP for harms arising from those statements.

The agreements also required a fairness analysis. Trustees must determine whether transactions are fair from a financial perspective, fair to the ESOP relative to other parties, and whether the terms are market-based, commercially reasonable, and in the ESOP’s best interest.

Report Assessment

The agreements included requirements for assessing reports. Trustees must ensure VAs complied with the requirements, above, and independently review financial statements and projections to determine whether reliance thereon is reasonable and prudent. Under First Bankers and Alpha, if projections are unreasonable trustees must ask the VA to account for the unreasonable projections. They must prepare a written analysis of reports that addresses marketability discounts, control premiums, economic projections, sponsor strengths and weaknesses, discount rates, financial statement adjustments, reliability of historical financial data, material assumptions, treatment of corporate debt, methodologies, the sponsor’s ability to service liabilities, and reasonably foreseeable risks of the transaction.

In making these conclusions, trustee personnel must read and understand valuation reports, question underlying assumptions, and inquire into consistency of information and conclusions. The trustee must document personnel responsible for reviewing valuation reports and record and explain personnel disagreements. If reasonableness, prudence, or consistency are doubtful, trustees must reject the transaction.

Other Requirements

The agreements required that trustees not cause ESOPs to engage in leveraged stock purchase transactions where the principal of the debt exceeds the fair market value of acquired stock. The agreements also required trustees to consider the appropriateness of claw-back provisions. Finally, the agreements required trustees to preserve notes and documents, including the full names and contact information of each member of the trustee’s fiduciary committee, all notes and records on the votes of trustee committee members who voted on the transaction, and all communications between the trustee and its personnel and the ESOP sponsor, non-ESOP parties, and any of the sponsor’s advisors.

DOL crafted these agreements for broad application to achieve its goal of guidance through litigation. However, some provisions are narrowly tailored to particular situations. For example, many provisions in Joyner applied specifically to an individual acting as an ESOP transaction trustee. Trustees and their advisors should consult the settlement agreements to determine applicability to their unique situation.

1 Solis v. GreatBanc Trust Company et al, No. 5:1201648 (C.D. Cal. 2014).

2 Perez v. First Bankers Trust Servs. Inc., 1:1208646 (S.D.N.Y. 2017).

3 Perez v. BAT Masonry Co., Inc., No. 6:1500028 (W.D. Va. 2015).

4 Acosta v. Mueller, No. 2:1301302 (E.D. Wis. 2017)

Tim Jochim is a Partner in the Columbus, Ohio, office of Walter | Haverfield LLP and a national authority on business succession and employee stock ownership plans (ESOPs). He is a trusted advisor to clients on corporate governance, corporate finance, ESOPs, M&A and employee benefits. Publications include Employee Stock Ownership and Related Plans (Greenwood Press, 1982). He is rated band 2 by Chambers & Partners USA and AV Preeminent by Martindale-Hubbell. He is also a Fellow of the American College of Employee Benefits Counsel. Tim serves as a member of the board of directors of four ESOP-owned companies. Tim can be reached at (614) 246-2152 or at

Mike Sorice is a law clerk in the Columbus, Ohio, office of Walter | Haverfield LLP and a third-year law student at the Ohio State University Moritz College of Law. Mike can be reached at (614) 246-2262 or at



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