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Best Practices for ESOP Trustee and ERISA Compliance

Posted by Marc S. Schechter | Jun 03, 2019

In a recent Fourth Circuit case, an ESOP trustee was found to have caused the trust to overpay for corporate stock by almost $30 million. The court found that the trustee failed to comply with their fiduciary duty to act in the best interests of the ESOP participants. This case can be used as an example to highlight best practices for ESOP trustees and ERISA compliance.

In Brundle v. Wilmington Tr., N.A., owners of a closely held corporation sold the company to an Employee Stock Ownership Plan (ESOP). A plan participant later filed a fiduciary duty claim against the ESOP trustee, claiming the ESOP overpaid for the stock and improperly enriched the company owners at the expense of the employee participants. After trial, the court concluded the trustee had breached its fiduciary duties to the tune of $29,773,250 in overvalued stock.  

The valuation of the company stock showed several “red flags indicating that these projections were inflated,” which the trustee appeared to ignore or downplay. The court identified four major problems with the trustee's decision-making process, including control premiums and future stock warrants.

The plan was structured in such a way that the sellers would retain control of the board even after selling to the ESOP. The sellers, as warrant holders, would retain the ability to appoint a majority of the board of directors. The warrants did not create immediate value but the sellers could capture the warrants' value by selling the warrants back in the future or sell the company.

Control premiums involve paying a higher amount to acquire a controlling share of the company. In this case, the valuation included a 10% control premium despite the fact that the ESOP had no power to control the company. The valuation failed to discount the stock for the lack of control, especially in light of the increased value with the control premium.

DOL Scrutiny in ESOP Transactions

ESOP deals may see increased scrutiny by the Department of Labor (DOL) when valuation includes control premiums and controlling sellers that can sell back warrants in the future. The more the ESOP transaction strays from standard ESOP deals, the more the DOL and employee participants may look at the valuation of the company stock.

Other DOL settlements involving claims of overvalued stock in ESOP transactions include:

Other takeaways for ESOP trustee best practices include the duty of prudence for a fiduciary to act solely in the best interest of the ESOP participants and their beneficiaries. The sellers may have an interest in getting the most value from selling the company to the ESOP but the fiduciary is required to consider value to the participants and beneficiaries in paying fair market value for the stock.  

Fiduciaries should also document the fiduciary review process, conduct oversight of the appraiser, be actively involved in the valuation process, and do not blindly rely on the appraiser's valuation.

San Diego ERISA and ESOP Law Firm

If you have any questions about fiduciary best practices for trustees in ERISA compliance, the law firm of Butterfield Schechter LLP is here to help. We are San Diego County's largest law firm with a focus on employee benefits law. Contact our office today with any questions on how we can help you and your business succeed.

About the Author

Marc S. Schechter

Marc Schechter specializes in the areas of employee benefits, ERISA, and business matters.


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