A recent settlement between United States Department of Labor (“DOL”) and trust company GreatBanc has resulted in a list of safeguards that should be considered best practices by trustees of employee stock ownership plans (“ESOP”). In Perez v. GreatBanc Trust Company, the DOL sued Illinois-based GreatBanc, Trustee to California’s Sierra Aluminum Co.’s ESOP, in the United States District Court for the Central District of California, claiming the trust company failed to adequately inquire into an inaccurate prediction for the future earnings and profitability of Sierra and permitted the plan to purchase stock belonging to Sierra’s executives for more than fair market value. The DOL and GreatBanc reached a settlement in June 2014.

As conditions of the settlement, GreatBanc agreed to make $4,772,727.27 in payments to the ESOP and pay $477,272.73 in civil penalties, as well to abide by the terms agreed to with the DOL. While the agreement governs only the relationship between GreatBanc as Trustee to this ESOP, it is a “cookbook” of trustee practices crafted by the DOL that will serve as guidance and warning for all trustees of ESOPs.

Here are highlights from the agreement:

  • Selection and Use of a Valuation Advisor. This provision ensures that in all transactions involving the purchase or sale of employer securities that are not publically traded, the trustee will hire a qualified valuation advisor. The trustee is required to investigate the advisors qualifications and document the selection process (requiring a written analysis of the reason why the particular valuation advisor was selected, a list of all those considered for the position, a list of checked references, whether the advisor was ever subject to criminal or civil proceedings, and a full explanation of the reason for the selection advisor); take reasonable steps to determine that the valuation advisor receives complete, accurate and current information necessary to value the securities and prudently determine whether reliance on the advisor’s recommendation is reasonable before entering into that transaction. The trustee must avoid any conflicts of interest by not using a valuation advisor for a transaction that has previously performed work for or on behalf of the ESOP. The process for selecting this advisor must be documented. Once the advisor is selected, the trustee must request a valuation report from the advisor must be promptly completed.
  • Financial Statements. The trustee must request that the company provide the trustee and the valuation advisor with audited unqualified financial statements prepared by a CPA for the preceding five years.
  • Fiduciary Review Process. The trustee must document its analysis of any final valuation relating to a transaction purchasing or selling employer securities. The documentation must address several specific topics, including marketability discounts, minority interests and control premiums, projections of the company’s future economic performance, an analysis of the company’s strengths and weakness, and discount rates chosen, among others. The trustee must analyze this valuation report and document its review. If the valuation report is found to inconsistent with the analysis, the trustee should not proceed with the transaction.
  • Fair Market Value. The trustee must not cause the ESOP to purchase employer securities for more than their fair market value or sell employer securities for less than their fair market value. If the principle amount of debt financing the transaction exceeds the securities’ fair market value, the transaction cannot be completed.
  • Claw-Back. The trustee must consider whether it is appropriate to request a claw-back arrangement or other purchase price adjustment to protect the ESOP against adverse consequences when evaluating proposed stock transactions. This consideration will be documented by the trustee.

Although the GreatBanc/DOL agreement may go beyond what is legally required, trustees of ESOPs should take note of the extensive documentation required by both the trustee and the valuation advisor when making any purchases or sales of ESOP stock. Though extensive, the DOL seems to suggest that the more detailed the supporting analysis and documentation of the trustee’s activities and decisions, the better.

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