ESOPs: good for employees but facing an uncertain future


A recent article in the New York Times extols the virtues of employee ownership through employee stock ownership plans (ESOPs). And trade groups for employee-owned businesses have noted bipartisan Congressional support for ESOPs. But ESOP experts (trustees and appraisers) worry that the Department of Labor’s antagonistic attitude toward ESOP transactions, validated by key victories in court, has stymied ESOP formation.

Great performance record: As the Times article explains, ESOPs are a vehicle for owners to sell their company to their employees. ESOPs are particularly attractive to owners of family or small businesses who want to ensure that the company remains intact and its employees, who were instrumental to the flourishing of the company, are able to keep their jobs and build up a decent retirement account. 

The article cites research from Rutgers University’s School of Management and Labor Relations and the Employee Ownership Foundation that shows employee-owned companies have done better at retaining jobs for workers than nonemployee-owned companies during the COVID-19 crisis. Also, employees in companies that have an ESOP often are able to save more for retirement than employees with other retirement plans, including 401(k)s, because of the ESOP structure and also because employees as part-owners of the company are motivated to work extra hard. 

Undue scrutiny: The article acknowledges that there are downsides. Owners selling to an ESOP won’t get the highest price because ESOPs, by law, must not pay more than fair market value for company stock. Also, ESOP transactions are complex as ESOPs are subject to the regulatory scrutiny of the Department of Labor.

This is where the problem lies for many ESOP professionals. They believe that, rather than encourage the creation of ESOPs, the DOL in recent years has cast doubt on their legitimacy through relentless investigations or threats of investigations into ESOP transactions and lawsuits against ESOP trustees and selling shareholders. In 2018, a group of Congressional members similarly complained that the DOL was undermining ESOPs.

Misunderstandings: In several key cases (e.g., Brundle and Vinoskey), courts have ruled in favor of the DOL and assessed steep damages against the ESOP trustees overseeing the contested transactions as well as the owner/seller in the Vinoskey case. The appraisal profession has been particularly troubled by some of the valuation-related rulings the trial courts have issued. The concern is that these rulings, based on a lack of understanding of fundamental valuation principles, may become precedent. In its amicus brief in support of the Vinoskey appeal to the 4th Circuit, the ASA recently tried to “correct” numerous valuation-related “misunderstandings” by the trial court related to valuation methodology and the concept of control. In another case, the ASA has sought to educate the reviewing court on the concept of fair market value, the standard applicable in ESOP transactions.

Lack of guidance: The ESOP community faults the DOL for failing to issue a set of regulations that would serve as guidance to ESOP transactions. ESOP practitioners also have lamented the DOL’s lack of interest in working with the ESOP community on resolving issues. They say this attitude contrasts with the IRS’ openness to cooperation with the appraisal community.

The New York Times article quotes a wealth advisor saying that, given the potential tax benefits derived from the ESOP structure, “ESOPs may become more popular next year if the Democrats hit the trifecta and raise the capital gain rates to 39 percent.” 

But, if you believe some ESOP professionals, the opposite may also happen. There won’t be enough experts to work on ESOPs as, increasingly, firms and individuals are abandoning the field for fear of becoming entangled in costly litigation with the DOL. 

At this point, the future prospects for ESOPs are anyone’s guess.

Digests and the various court opinions for Pizzella v. Vinoskey and Brundle v. Wilmington Trust N.A. are available at BVLaw (subscription required).


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