CHICAGO - The United Airlines bankruptcy case could threaten the existence of employee stock ownership plans by forcing fiduciaries to sell the stock whenever it drops beyond a typical market movement, making ESOPs more like an actively managed investment.
"It would be the death knell (for) ESOPs," said J. Michael Keeling, president, The ESOP Association, Washington.
The case is unique because UAL Corp. is the only publicly traded company whose stock is majority owned and controlled by an ESOP, experts said.
Depending on the outcome of the UAL case, fiduciaries could be concerned that their failure to sell stock in a downturn, or even buy it in an upturn, could be construed as failure to see potential trouble in the company - and a basis for litigation by participants.
State Street Bank & Trust Co., Boston, the UAL ESOP fiduciary, is in court seeking permission for discretion to sell the stock in order to fulfill its duty and act in what it perceives as the best interest of participants.
Eugene R. Wedoff, a U.S. Bankruptcy Court judge in Chicago, temporarily ordered State Street to limit sales of the stock. He acted after creditors' concerns that more ESOP sales might jeopardize control of the company and endanger potentially lucrative net operating losses, or NOLs, which could shelter taxes if UAL should regain profitability.
A full hearing on the order is scheduled for Feb. 6.
The sales halt underscores a conflict that was noted in the court between federal pension law, which gives fiduciaries discretion to manage assets in the best interest of plan participants, and bankruptcy law, which gives creditors some standing in trying to protect corporate assets to reorganize a company.
"There is clearly a clash of laws here," said Mr. Keeling. "In bankruptcy, you have a different set of laws designed not to protect employees or shareholders, but creditors."
Legal liability question
The case could also answer the issue of whether a fiduciary might be legally liable for failing to sell a stock before the price declined significantly, or when a sponsoring company faced financial trouble.
"I don't look at what State Street is doing as far-fetched," Mr. Keeling said. "It is a wise course of action for State Street to get some kind of court decision to cover itself" under the Employee Retirement Income Security Act.
Mr. Keeling said the ESOP trustees "strengthened their hand" against possible litigation by bringing in State Street as an independent fiduciary in September.
"The inclination of ERISA people is to say, `ERISA has to rule; my assets are going south; I have to sell. What's this nonsense about NOLs?"' But Mr. Keeling worried about the case being interpreted by fiduciaries to actively trade ESOP shares.
"That is absolutely my great fear," Mr. Keeling said. "I am fearful that this idea that any asset declining in value has to be taken out of the ERISA plan ... would be the death knell of ESOPs."
"Employees are not day traders," Mr. Keeling said. "All shares will go up or down in value. To set a principle that a decline in value would cause selling the stock ... is antithetical to the creation of ownership value of an ESOP."
Both Mr. Keeling and Corey Rosen, executive director for the National Center for Employee Ownership, Oakland, Calif., said there were few legal precedents involving ESOP sales. Both mentioned a 1995 case in the U.S. Court of Appeals in Philadelphia involving an ESOP at Statewide Bancorp, Toms River, N.J.
As Judge Morton I. Greenberg stated in that opinion, "This case requires us to decide the following difficult question: To what extent may fiduciaries of ... ESOPs be held liable under ... ERISA for investing solely in employer common stock, when both Congress and the terms of the ESOP provide that the primary purpose of the plan is to invest in the employer's securities."
More stock acquired
Messrs. Keeling and Rosen noted trustees in the Statewide case acquired more stock, even though they should have known the bank had financial difficulty.
"The ESOP is presumed to own a (sponsor's) stock, but there comes a point when facts and circumstances are so overwhelming trustees should not acquire stock," Mr. Keeling said. "But does that apply to getting rid of the stock?"
With limited court precedent, Mr. Rosen said, "I think it's unlikely" that fiduciaries will interpret the case as a sign to sell in any bad news about a stock.
"The UAL case might say if you are about to go bankrupt, you think you should sell," Mr. Rosen said. "But ESOPs don't have bankruptcies too often."
Messrs. Keeling and Rosen doubt the UAL case will set a precedent in terms of reconciling the conflict between bankruptcy law and ERISA. Nor do they believe the case will prompt Congress to amend ERISA and bankruptcy laws to reconcile the conflict.
Mr. Rosen said in general, some restriction on trading shares in an ESOP is a good idea.
"You don't want employees selling shares," he said. "Otherwise the company loses its character as employee-owned." But he said nothing in the law prohibits sales by employees, if permitted by a plan.
In the case of United, a rule relaxing sales by employees "would have helped a lot," Mr. Rosen said.