ESOP Ownership Structure, Corporate Governance, and the Relationship between the Trustee, Board of Directors, and the ESOP Administrative Committee

I am often asked about how the ESOP ownership structure works. This post will explore corporate governance and the relationship between the Trustee, Board of Directors, and the ESOP Administrative Committee. Let's start with some terminology:

• Corporate Governance – Corporate governance is "the set of processes, customs, policies, laws and institutions affecting the way a corporation is directed, administered or controlled."
  
  
• Shareholders – The shareholders are the owners of the company. One of their primary responsibilities is to elect the members of the Board of Directors.
  
  
• Board of Directors – The Board of Directors represents the shareholders, is the highest level of management in a company, and is responsible for governing the company. A Board of Directors can consist of inside members (usually executive management) and/or outside members (not employed by the company, brought in for expertise and/or an impartial perspective). Some of their responsibilities include:
  
  • Preserving shareholder value
    
  • Selecting, reviewing the performance of, and approving the compensation of the chief executive.
    
  • Approving the financial statements of the company
    
    
• ESOP – An employee stock ownership plan (ESOP) is a qualified retirement plan as provided under the Employee Retirement Income Security Act (ERISA).
  
  
• Plan Fiduciary – Any person exercising discretionary authority or control over the management of the plan or plan assets.
  
  
• ESOP Plan Sponsor – The employer.
  
  
• Plan Administrator – The individual(s) with authority and discretion over the management of the plan. Unless another individual or entity (e.g. ESOP Administrative Committee) is specifically assigned, the Plan Sponsor is the Plan Administrator. The administrator(s) is a Plan Fiduciary.
  
  
• ESOP Administrative Committee – The ESOP Administrative Committee is usually appointed by the Board of Directors and serves as the Plan Administrator.
  
  
• Trustee - The ESOP assets, which primarily consist of the stock of the company, are required to be held in a trust by a Trustee. The Trustee is the individual(s) with authority and discretion over the plan assets. The Trustee(s) is a Plan Fiduciary. For many ESOPs, including many small, closely held companies, a member of management acts as the Trustee.
  
  
• Sole Benefit of Plan Participants – The Trustee, as a Plan Fiduciary, is required to act in the sole interest of plan participants, maximizing the long-term value of the assets of the trust (the stock of the company).
  
  
• Legal Shareholder – The Trustee is the legal shareholder of the ESOP's shares.
  
  
• Legal Voting Requirements – The Trustee is legally required to pass-thru voting to the employees for major issues (e.g. liquidation, sale of all or substantially all the assets, recapitalization, merger)
  
  
• Plan Document – The plan document specifies the voting rules. Unless provided by the plan document, the Trustee is not required to pass-thru other decisions such as voting for the Board of Directors, selling the stock, etc., and generally exercises the voting rights. The Trustee will generally vote according to the direction of the ESOP Administrative Committee.
  

So, what is the relationship between the Trustee, Board of Directors, and the ESOP Committee? The Trustee is selected by the Board of Directors or management (which is selected by the Board of Directors). The Trustee votes the ESOP shares for the election of the Board of Directors. The ESOP Administrative Committee is usually selected by the Board of Directors and generally consists of members of management. This "circular" selection process often leaves the same people in charge of the company and the ESOP.