The Department of Labor on Jan. 16 unveiled a rule proposal aimed at providing a roadmap for employers to more accurately value employee stock ownership plans.
Governed by Employee Retirement Income Security Act, ESOPs primarily invest in stock issued by the employer that sponsors the plan, but often, employer stock is not publicly traded and there is no ready market price, the DOL’s Employee Benefits Security Administration noted in its proposal.
The proposed regulation, which focuses on the term “adequate consideration,” will ensure the plan does not pay more for the stock or sell it for less than its fair market value, the DOL said.
Under ERISA, adequate consideration is “the fair market value of the asset as determined in good faith by the trustee or named fiduciary pursuant to the terms of the plan and in accordance with regulations promulgated by the secretary [of Labor]”.
The proposal gives plan fiduciaries principles-based guidance on how to value employer stock, consistent with their obligations as ERISA fiduciaries, the DOL said.
Under no circumstances is the plan “exempt from ERISA’s prohibited transaction provisions if the plan pays more than fair market value to acquire employer stock or sells its holdings of employer stock for less than fair market value, because in these situations, the adequate consideration requirements are not met,” the proposal states.
Further, the proposal requires that plan fiduciaries determine fair market value through a “good faith process designed to ensure a sound conclusion as to the stock’s fair market value in conformity with the fiduciary standards of prudence and loyalty” under ERISA.
Key components of a good faith process include the fiduciary’s prudent selection of a qualified independent valuation adviser; prudent oversight of a written valuation report that reflects current, complete and accurate information about the issuer of the employer stock and the ESOP transaction; and the prudent review of the valuation report to ensure it can reasonably be relied upon as a basis for determining the price at which the transaction can occur, according the proposal.
The DOL also issued a proposed safe harbor exemption for sellers and plan fiduciaries interested in creating a new ESOP that will purchase employer stock as required by ERISA.
Both proposals will have 75-day comment periods upon publication in the Federal Register.
“The proposals give fiduciaries important guidance on how to get these transactions right in compliance with their duties of care and undivided loyalty to ESOP participants and beneficiaries,” said Assistant Secretary for Employee Benefits Security Lisa M. Gomez, in a statement. “The proposals, which reflect input received by stakeholders as well as the department’s own experience in reviewing ESOP transactions, provide important guidance for ESOP fiduciaries and will help safeguard against overpayment for employer stock by ESOPs and their participants.”
The ESOP Association, an ESOP advocacy group, said a fair and transparent rule governing adequate consideration is a necessity to spur new ESOP formation in the U.S. and to provide regulatory clarity for existing ESOPs.
“We will carefully review the DOL’s approach and provide substantial feedback on behalf of our membership, which the DOL should strongly factor before any final rule-making” said James Bonham, president and CEO of The ESOP Association, in a statement. “Our goal is to make it easier, more transparent, and less costly for ESOPs to be formed and operated. More Americans should have the opportunity to receive the benefits of an ESOP, and this regulation should have that goal as well.”
SECURE 2.0, a retirement security package Congress passed in 2022, included a provision directing the Labor secretary, in consultation with the Treasury secretary, to issue formal guidance for acceptable standards and procedures to establish good faith fair market value for shares of a business to be acquired by an ESOP.