ESOPs feel heat from campaign against abuses

A Department of Labor push to curb employee stock ownership plan abuses is catching more plan sponsors and their fiduciary consultants for a variety of transgressions.

Those transgressions include overvalued stock, ill-timed stock purchases, conflicts of interest and outright plan mismanagement.

In the past year alone, investigators with the Labor Department's Employee Benefits Security Administration, which oversees all types of benefit plans, have worked with the DOL's Office of the Solicitor to bring lawsuits seeking nearly $100 million in repayments to ESOP plans for questionable transactions, and settled other sizable cases.

“It seems like we've seen increased audit activity and an increased desire to litigate more,” said Brian D. Hector, partner with law firm Morgan Lewis & Bockius LLP in Chicago. “The aggressiveness of the litigation has increased, too.”

“The number of lawsuits in the past six months is unprecedented,” agreed J. Michael Keeling, president of the ESOP Association in Washington, which represents 1,600 companies with stock ownership plans.

ESOP stock purchases are typically used to free up operating cash, avoid capital gains or to cash out departing executives, who would otherwise have big tax bills. That makes it tempting, say officials, for company executives to hire appraisers who will give firms the price they want for the stock, and supposedly independent fiduciaries who will green-light the transactions.

EBSA officials and their counterparts in the Office of the Solicitor pay particular attention to closely held companies, where the combination of hard-to-value assets and possible conflicts of interest among company executives with fiduciary responsibilities can create potential for abuse or insufficient oversight.

When the transaction involves freeing up cash to produce big executive payouts, EBSA investigators take notice. EBSA staffers are also on the lookout for plan participants not getting proper benefits from the transactions, or losing their right to diversify accounts or sell shares.

And advisers who rubber stamp valuations or stock purchases are getting increased scrutiny.

EBSA officials say they appreciate that a lot of the decisions made in ESOP transactions involve judgment calls; they insist they are only focusing on the ones that are beyond common judgment. One example: an appraiser who was also a convicted felon hired to justify a $12 million stock purchase that enriched the company owner.

“There is no question that some ESOP folks aren't saints,” said Mr. Keeling of the ESOP Association, who concedes that ESOPs present unique opportunities for abuse, particularly in smaller companies that often fly under regulators' radar. But he argues that many alleged overvaluation cases are “Monday-morning quarterbacking” of the stock market.

Discouraging ESOP mistakes has been a national enforcement priority for the EBSA since 2005. To date, the Labor Department has closed 1,306 civil cases and 13 criminal investigations involving ESOP transactions.

But the effort has ramped up recently as investigators find more flagrant or careless mistakes being made by company executives or the people they hire to help them oversee company stock transactions.

Some of the largest cases, money-wise, were brought or settled in the last year. The most high-profile one was last month, when Sherwin-Williams Co., Cleveland, agreed to put $80 million into its ESOP, rather than fight the EBSA over charges that the $2.5 billion plan misused the process solely to gain the tax advantage for providing the stock.

According to EBSA documents, the 34,591 plan participants “did not actually receive stock or retirement benefits in amounts close to what the plan spent on the transactions or that the company claimed on its government filings.” The company argued that the claims were without merit, but settled to avoid costly litigation.

EBSA officials also went after GreatBanc Trust Co., which as trustee of the plan had discretionary authority over the transaction. EBSA officials also forced GreatBanc to audit all of its contracts with pension plans investing in employer stock in the past six years. That review will demonstrate “transparent and consistent loyalty” to plan participants, James Staruck, president and CEO of Lisle, Ill.-based GreatBanc Trust, said in a statement.

There are other recent examples of increased attention from EBSA:

• In January 2012, EBSA reached a settlement with Chicago-based Tribune Co. and some of its 13,020 ESOP participants, who had also brought their own suits, to get back $32 million from a $250 million stock purchase made as the company faced bankruptcy.


• In April 2012, the Labor Department sued executives with telephone retailer Parrot Cellular plus the independent fiduciary and investment manager, Consulting Fiduciaries Inc., over a $28 million stock purchase that involved more than 90% of the company's stock and simultaneously gave the principal owner $16 million in deferred compensation.


• A $71 million stock purchase of 49% of outstanding company stock prompted a lawsuit against apparel maker Maran Inc. and its independent fiduciary and trustee, First Bankers Trust Services, for allegedly allowing overpriced stock purchases. The suit, filed in U.S. District Court in New York in November, said federal officials want the money returned to the plan, which had $399,434 as of Dec. 31, 2011, according to the company's Form 5500, and to have First Bankers barred from serving as an ESOP plan fiduciary. Both companies pledged to fight the lawsuits but declined to comment.

Executives at firms involved in appraising ESOP transactions are not thrilled by the increased attention, and are worried that their liability will increase when the DOL produces a final fiduciary standard later this year.

ESOP proponents say what is expected to be a broader definition of a fiduciary will make the process more confusing, and leave plan sponsors more vulnerable to class action lawyers when participants are not happy with stock prices. To prevent that, they have convinced Sen. Kelly Ayotte, R-N.H., to introduce legislation exempting appraisers from the fiduciary standard, arguing that Congress likes using ESOP tax incentives as a way of spurring job growth.

“We're not trying to deter these transactions. We just want them to occur at the right price,” said Tim Hauser, associate solicitor of Labor for the plan benefits security division. “The real question is, is it in the plan's interest? We hope people will do a much more conscientious job.”