Special Issue 2007

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Focus on ESOP Financial Advisory Services

Editors for This Issue: James G. Rabe and Aaron M. Rotkowski

ESOP Litigation Insights

Prudent Process: Emerging Guidelines for ESOP Fiduciaries from Court Decisions
Theodore M. Becker, Esq., and Julie A. Govreau, Esq.
Courts are increasingly concerned with the process followed by ESOP fiduciaries. This discussion outlines several judicial decisions that provide an overview of what the courts consider to be a prudent process. In defending against claims of breach of fiduciary duty, the ESOP fiduciary who follows these judicial guidelines should have an easier time demonstrating that a prudent process was followed.

Goodin v. Innovative Technical Solutions: Protected under ERISA Anti-Cutback Provision?
Michel St. Martin
In this U.S. District Court (Hawaii) decision, former employees brought an action on behalf of themselves and the benefit plan against their former employer corporation. The former employees alleged that the employer corporation wrongfully eliminated their right to receive put options for in-kind distributions of nonpublic stock. In the Innovative Technical Solutions decision, the District Court had to address numerous issues related to the employee rights that ERISA provides to both ESOP and 401(k) plans.

ESOP Financial Advisory Services Insights

Reasonable Key Executive Compensation in Majority ESOP-Owned Employer Corporations
James G. Rabe and Kelly (“Bucky”) Wright
This discussion provides (1) an overview of factors that financial advisers typically consider in the determination of reasonable executive compensation for ESOP majority- owned employer corporations. This discussion also provides a review of certain ESOP- related court cases that focus on the determination of reasonable executive compensation.

Leveraged ESOP Employer Stock Valuation Issues
Hope Taylor
It is important for valuation analysts to consider the appropriate standard of value when valuing the employer corporation stock in a leveraged ESOP. The appropriate standard of value is fair market value (FMV). This discussion considers how the employer corporation stock FMV should be influenced by the income tax shield related to the leveraged ESOP employer stock acquisition.

The Independent Financial Adviser’s Solvency Opinion in ESOP Leveraged Stock Purchase Transaction
Malcolm R. Hartman and Jacquelyn DeRosa
Secured lenders often require that a transactional solvency opinion be issued at the time of a leveraged ESOP purchase of employer corporation stock. These ESOP employer stock purchase transactions may include the leveraged acquisition of a noncontrolling block of employer stock, of a controlling block of employer stock, or of 100 percent of the employer corporation stock. Typically, in such leveraged transactions, the lending institution will want assurance that the subject transaction does not involve a fraudulent conveyance. With regard to the leveraged ESOP employer stock purchase transaction, these solvency opinions are typically prepared by an independent financial adviser. This discussion presents a “checklist” of due diligence procedures that the financial adviser will typically consider in a transactional solvency analysis. This particular checklist relates to a leveraged ESOP sponsor company stock acquisition transaction solvency analysis. This checklist can be used as a procedural guide by the independent financial adviser. Or, this checklist can be used by the employer corporation management, the secured lender, the ESOP trustee, or the selling shareholders involved in the process of reviewing the independent financial adviser’s solvency analysis and/or solvency opinion.

ESOP Administration Insights

2006-2007 Legislative, Regulatory, and Judicial Events Impacting ESOPs
Gregory M. Hansen, Esq.
All qualified plans (including employee stock ownership plans, or ESOPs) are affected by legislative changes (Congress), regulatory changes (IRS and Department of Labor regulations and interpretative guidance), and judicial decisions (case law) on an ongoing basis. This discussion summarizes the key events that have occurred during 2006 and early 2007.

The Growing Requirements on ESOP Third Party Administrators of Privately Held Companies
Richard E. Phenneger
This discussion provides an overview of the documents that an ESOP third party administrator should require, why they are required, and how they should be used. In addition, this discussion also describes the increased responsibilities that often fall upon the ESOP third party administrator when dealing with (1) an S corporation ESOP and (2) the proper planning for the ESOP repurchase liability.

The National Center for Employee Ownership Research Project on ESOP Terminations
Katherine Gilbert
This discussion summarizes the results of the first phase of a research project sponsored by the National Center for Employee Ownership. This discussion describes the results of this research project regarding the reasons why sponsor companies terminate their employee stock ownership plans.

The Decisions That Will Shape Your Employee Stock Ownership Plan Distribution Policy
Lynn H. DuBois, Esq.
ESOP sponsor company managements typically make many complex decisions regarding the ESOP distribution policy. The timing of distributions, amount of destitutions, and form of payment (i.e., cash or stock) are all elements of the distribution policy that will affect the sponsor company cash flow and other corporate objectives. This discussion will focus on the various elements that comprise the ESOP distribution policy.

The Importance of a Repurchase Obligation Study
Ken Hohman
With the myriad of procedures required to establish an employee stock ownership plan (ESOP), a sponsor company forming an ESOP may overlook the repurchase obligation associated with ESOP-owned employer stock. A repurchase obligation is the liability that results when ESOP participants put their employer corporation shares back to the sponsor company. Typically, this liability will be relatively small in the years immediately after the initial ESOP formation. And, typically, this liability will increase substantially as the ESOP participants are granted a legal right to sell the employer corporation stock acquired through the ESOP back to the sponsor company. A repurchase obligation study will help ESOP employer corporations to better manage this liability. Having a periodic repurchase obligation study performed for an ESOP is more than a good idea. It may also save the ESOP sponsor company considerable time, effort, and money.

Defining the Roles of and ESOP Committees
Mark I. Bogart, Esq.
This discussion provides an overview of (1) the ERISA fiduciary standards, (2) the source of authority for and the duties and responsibilities of the ERISA committee, (3) the scope of authority for and the duties and responsibilities of the ESOP committee, and (4) differentiation between the fiduciary and the settlor functions.

Success in Business Ownership Succession Planning
Myron E. Sildon, Esq.
In many closely held businesses, ownership transition/succession planning is ignored until the company owner is forced (by imminent retirement, death, disability, or other circumstances) to confront the issue. If the closely held company owner does not carefully plan for the ownership transition of the business, he or she may face undesirable consequences such as (1) unnecessary taxes, (2) the sale of the business at less than optimal terms, or (3) operational problems caused by the loss of key people. Thoughtful and timely ownership transition/succession planning can avoid these problems.

Fair Value Measurement Insights

Fair Value Measurements: A Summary of SFAS No. 157
J. Edward Ketz, Ph.D.
The FASB recently issued a Statement of Financial Accounting Standards entitled Fair Value Measurements. This Statement, SFAS No. 157, defines fair value and provides guidance with respect to the fair value measurement of a reporting entity assets and liabilities. In addition, SFAS No. 157 establishes generally accepted accounting principles (GAAP) for financial statement presentation and financial reporting disclosures. SFAS No. 157 discusses the application of fair value measurements to assets and liabilities; it establishes a fair value hierarchy; and it creates new disclosure requirements. Valuation analysts (especially ESOP employer stock valuation analysts) should have an understanding of how these fair value measurement requirements affect the financial statements of the valuation subject company (and particularly the financial statements of an ESOP sponsor company).

ESOP Editorial Insights

Post-Leveraged Transaction Sponsor Company Stock Price Decreases—Is There a Better Way?
Chuck Morn
In the typical leveraged ESOP employer stock purchase transaction, the sponsor company borrows funds from a financial institution and loans the funds to the ESOP. The ESOP uses the “mirror loan” proceeds to purchase employer corporation shares from selling stockholders. After the leveraged stock purchase transaction, the per share value of the employer stock decreases. This is because the sponsor company has assumed a bank loan to fund the ESOP’s stock purchase. In this editorial, the author explains why he believes this economic phenomenon is unfair to ESOP participants. The author also proposes several accounting and valuation procedures to eliminate the recognition of the post-leverage sponsor company stock price decrease.

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