Employee Stock Ownership Plans (ESOPs), their sponsors and participants, and other industry players welcomed the news announced by the ESOP Association this spring that the U.S. Department of Labor committed to moving forward with public notice-and-comment rulemaking to establish a clear definition regarding the “adequate consideration” requirement for ESOP This long-awaited announcement followed the passage of bipartisan legislation late last year, which included the SECURE 2.0 Act of 2022 (SECURE 2.0 Act). The SECURE 2.0 Act included provisions seeking to establish a more conducive environment for ESOP creation and maintenance. Specifically relevant to ESOPs—of which there are nearly 6,500, with more than 13.9 million participants investing over $1.6 trillion as of —was the WORK Act (Section 346 of the SECURE 2.0 Act).
This commitment from the DOL was in response to the SECURE 2.0 Act as well as an Administrative Procedure Act petition submitted by the ESOP Association to the DOL last year, which specifically requested that the DOL not only define “adequate consideration” but do so through a formal notice-and-comment rulemaking process. The DOL’s commitment should ensure the issuance of a rule consistent with the WORK Act’s requirement that it “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 employee stock ownership Decision-makers for ESOPs, including those responsible for ESOP valuations or for responding to DOL inquiries, have long awaited this kind of guidance. While ESOP transactions are inherently prohibited transactions in violation of the Employee Retirement Income Security Act of 1974, as amended (ERISA), they are permitted as long as the transaction meets the adequate consideration exemption in ERISA Section 408(e). In order for an ESOP transaction to meet the adequate consideration exemption, an ESOP must not pay more than “fair market value of the [shares] 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 However, before this commitment, the DOL had never provided or agreed to provide formal regulations or guidance for the valuation process. Even after the Fifth Circuit reprimanded the DOL in Donovan v. for failing to promulgate such regulation, the closest the DOL had come to doing so was the issuance of proposed regulations in 1988. These proposed regulations were never finalized, and many industry insiders said the regulations did not provide clear guidance on what would be deemed adequate consideration.
The industry has been seeking clear standards on the process necessary to ensure that an ESOP transaction is for no more than fair market value, as required to meet the adequate consideration exemption under ERISA. In the absence of the type of formal guidance that the DOL has now committed to providing, the industry has had to look for insights in the terms of settlement agreements that the DOL entered into regarding ESOP-related processes and practices. For example, in 2014, the DOL reached a settlement agreement with GreatBanc Trust Company (GreatBanc) following an investigation relating to GreatBanc’s role as trustee in a transaction for the Sierra Aluminum ESOP. While the case was resolved without the filing of a public lawsuit, the DOL made the GreatBanc settlement agreement public as it set forth what the DOL considered to be best ESOP valuation. The GreatBanc settlement agreement was the first time the DOL used this strategy as a way of advising the industry of its preferred process standards. Since the GreatBanc settlement, the DOL and specific fiduciaries providing process standards have entered into five publicly-available settlementThese settlement agreements were based on the facts particular to each case and binding only on the parties involved, and they create a patchwork of standards that is not entirely consistent. The inconsistencies among the terms of various agreements have thus created uncertainty as to what the DOL requires, recommends, or prohibits. This in turn has left ESOPs and their fiduciaries susceptible to expensive investigations and possible litigation.