ESOP Sustainability

We have spent some time examining Why the Number of ESOPs is not Growing at a Faster Rate. One of the major components of the number of ESOPs is the ESOP termination rate. The second phase of a recent ESOP Plan Termination study found that less than 2% of ESOP companies terminated their ESOP each year. While a common perception is that the repurchase obligation is the primary reason for ESOP termination, the study found that over half of the ESOP terminations are a result of receiving an attractive offer the company could not turn down, even though they could handle the repurchase obligation. Other reasons included the aforementioned repurchase obligation, dissatisfaction with the ESOP, and financial difficulties of the company.

Sustainability of ESOP Companies Debate Intensifies discusses the sustainability of ESOPs and asks if there is "something about the ESOP model of employee ownership that makes it impossible to sustain employee ownership through an ESOP more than 10 to 15 years" and explores reasons why ESOPs are being terminated:

1. The trustee is required to maximize the value of plan assets, causing them to accept attractive offers to purchase the company:
   
   Another issue of sustainability comes up with dealing with the ERISA law that the trustee of the ESOP is to maximize the value of plan assets, putting into play the question of does the trustee accept any offer to purchase the company that increases account balances? Can sustainability be changed with a tweak in ERISA law for ESOPs? Is such a tweak desired, or even obtainable given that this law is not a tax law, but a law that would be in the Congressional labor committees which do not have a history of being favorable to ESOPs as retirement savings take priority over the ESOP's ownership purpose, in the labor committees.
   
   As we discussed above, this is the biggest reason for ESOP termination.
   
   
2. The company cannot support the repurchase obligation or would prefer to utilize their cash for other purposes.
   
   
3. The second generation of leadership doesn't support the ESOP (even though they were likely selected by the same leadership that established the ESOP):
   
   The most intriguing one is about how the first generation of ESOP managers, particularly the first CEO of the company when it became ESOP, who loves being ESOP, plans for a succession that results in a new CEO who also values employee ownership? ESOP Association records show that many ESOP companies that drop membership in the Association due to ESOP termination have a characteristic that is simply that the company's first ESOP CEO, and sometimes CFO, have been succeeded with what is called second generation ESOP company management. Often these men and women, in the second generation, see the ESOP as a hindrance to proper use of the companies capital because repurchase obligations are soaking up so much of its available capital. Oddly, often the first generation ESOP leaders hand pick their successors, and assume that their successors will be pro-ESOP.
   
   
4. The participants have been effectively split into a group of "haves" and "have-nots", resulting in the latter group not having the same level of participation in the ESOP. This problem can occur in mature ESOPs when the ESOP loan has been paid in full and the company hasn't adjusted its allocation strategy accordingly to ensure that new employees do not become "lesser" owners than the senior employees that were around when the loan was being repaid.

Missouri Building LLC v. Clark (In re Seferyn), B.A.P. 10th Cir., No. KS-07-094 (May 15, 2008)

Bankruptcy Appellate Panel Upholds IRA Assets Exclusion discusses how a 10th U.S. Circuit Bankruptcy Appellate Panel ruled that ESOP proceeds rolled into an IRA were excludable from the debtor's bankruptcy estate:

Missouri Building argued the ESOP was not a qualified retirement plan because it did not comply with IRS's Revenue Ruling 2004-4, which meant the IRA assets should be counted among the debtor's bankruptcy estate. "The IRS issued a favorable determination letter specific to the ESOP established by Volo Holdings in its organization form at the time of creation. Missouri Building did not present evidence that the ESOP was established and administered in any way other than the way initially approved by the IRS," the court said.

This is consistent with a 2005 Supreme Court Ruling that exempts IRAs from a debtor's bankruptcy estate.

Related Links:

• IRS Revenue Ruling 2004-4 – Prohibited Allocations of Securities in an S Corporation – This revenue ruling pertains to ESOPs, subchapter S corporations, synthetic equity, nonallocation years, and "listed transactions."
• IRC Section 409(p) Anti-Abuse Testing, History of Regulations, and Private Letter Ruling (PLR) 200804023
• In re Christopher Joseph SEFERYN, Debtor. Missouri Building, LLC, Appellant, v. Carl R. Clark, Trustee, and Christopher Joseph Seferyn, Appellees. , 10th Cir.BAP (Kan.), May 15, 2008
• US Supreme Court Extends Bankruptcy Protection to IRAs

Lean and Waste

What is this thing called LEAN ACCOUNTING, an article in the May/June 2008 edition of On Balance, discusses how lean principles revolve around a relentless pursuit to eliminate waste. It defines Lean and waste:

"Lean is a methodology that eliminates waste, simplifies operations and provides customers what they want, when they want at reasonable prices. Lean is not a cost reduction method. It practices shrink cycles and lead times and expedite cash collection. It does not require huge capital investments, plus it focuses on simple common sense, engages all employees and draws on their creativity."

"Waste is anything that adds costs to a product without adding value. Waste can be found anywhere and everywhere. According to lean experts, about 70 percent of work done at most businesses is waste because it does not add value to customers."

The article also discusses how eliminating waste requires an understanding of what the waste it and where to find it, and defines eight categories of waste:

• Over production
  
• Waiting
  
• Transportation
  
• Unnecessary Motion
  
• Over processing
  
• Excess inventory
  
• Defects
  
• Underutilization of Personnel
  
  

Here are some related posts:

• Five Training Points: Ownership, Participation, Open Books, Holistic Wellness, and Lean Enterprise (4/26/2008) – This post discusses lean accounting as one of five potential training points.
  
• Standardized Work and Developing Best Practices/ESOP Q&A (8/12/2007) – This post discusses how employees can be the most effective at developing best practices.
  
• Lean Enterprise Institute (5/29/07) – This post talks about the exclusion and non-participation of people at work. It also defines Lean and discusses the Lean Enterprise Institute and how eliminating waste is an easy way to build ESOP and company value.

In the News: Employee Retires After 60 Years of Employment

Builders Supply Co. of Petersburg, Inc. (Petersburg, VA)

Career spans decades discusses how an employee of Builders Supply Co. of Petersburg, Inc., a Virginia building materials dealer that has had an ESOP in Existence for At Least 25 Years, has recently retired:

Martin decided to retire earlier this month after more than six decades with the same company. "I had to make some room to give the youngsters a chance," he said laughing.

But to Martin, retirement does not mean relaxation. He comes in every day to help his former colleagues for five or more hours. And he still holds stock in the company that he plans to sell in five years to invest in other stock.

In the News: Succession Planning, Empowering Employees, Improving Recruiting, Creating Selling Point, and Improving the Bottom Line

The Newberry Group (St. Charles, MO)

We previously discussed how a global IT consulting firm sold their company to an ESOP as part of a Strategy for Continued Growth and Contributing to the Economic and Philanthropic Development of the Community. Some additional reasons why Newberry sold to an ESOP are examined in Newberry hands off company to employees: A look toward long-term viability:

• To Provide a Succession Planning Solution
  
  "Founders can't act as though they're going to live forever," Brenda Newberry, the company's chairman and chief executive officer, said of the decision to shift ownership to employees. She says the move is about the future of the company - not next quarter, but once she and husband Maurice, the company's president and chief operating officer, leave the business (which, by the way, she says is not in their immediate plans).
  
  
• To Empower Employees to Be More Responsible
  
  Some Newberry associates say they expect their partial ownership to change their habits at work.
  
  "I think it does change mind-sets," said Richard Berry, a senior computer systems analyst in Newberry's security practice. "I believe people are just a little more responsible about wastefulness and thinking about the future of the company when they have this direct stake."
  
  
• To Improve Recruiting
  
  A veteran of corporate security practices who came to Newberry from information technology stalwart EDS, Berry expects employee ownership to help the company's future recruiting efforts, as well. "I believe that for recruiting top-notch people, it gives us an edge," Berry said.
  
  
• To Create an Additional Selling Point to Customers
  

  He also thinks it's a selling point, giving potential clients the assurance that Newberry's employees are committed to the job at hand.
  

• To Improve the Bottom Line
  
  Because the company is entirely employee-owned, Newberry is a tax-exempt entity. That, Maurice Newberry says, gives the company additional capital to grow.

SPD Language Providing Less Plan Benefits Overrules Plan Document Language

In Conflict Between Plan Document and SPD, SPD Prevails to Participant’s Detriment discusses how Kolpacke v. CSX Pension Plan, No. 07-1959 (CA6, May 21, 2008) found that the SPD prevailed in a conflict between the plan document and the SPD, even if the SPD provided less benefits to the participant:

The SPD provided that the plaintiff's benefit under the plan would be reduced by railroad retirement benefits, which are the railroad industry's version of social security benefits. The participant argued that the plan document did not provide for this reduction in benefits, thus the conflict. Plaintiff also argued that CSX was estopped from reducing his benefits by an offset for railroad retirement because CSX provided him with a letter stating that his benefit had already been offset for railroad retirement and would be reduced no further. 9 days after the participant elected to retire, CSX corrected this mistake.

The district court granted summary judgment to CSX. Even though the benefit calculation made according the language in the SPD provided less benefits to the participant than the language in the plan document, the participant did not prevail. In the opinion, the district court cited to Anderson v. Chrysler Corp., 99 F.3d 846 (7th Cir. 1996) for the proposition that where the plan itself gives the employee greater benefits and protection, it should control.

The important takeaway is to make sure your plan document and SPD contain the same plan provisions.

We discussed this topic in detail in Conflicts Between the Plan Document and the Summary Plan Description (SPD), including discussions about the following:

• The plan document and the SPD are written at different times
• The plan document and the SPD are written in different styles
• The plan document and the SPD are written by different people
• Recent court cases provide that the SPD provisions and the interpretation of the provisions overrule the plan document if they benefit the participant
• Recent court case indicates absence of language in the SPD is not fatal if language is in other plan documents
• Do participants even read the SPD?
• How do you resolve a conflict?
• What is a way to minimize the risk of errors?

Broad Dissemination of Employee Ownership Teaching Materials

Earlier this year we discussed the first ever MBA Course in Employee Ownership and the benefits of including employee ownership in academic discussions. A recent press release discusses how the Employee Ownership Foundation and the Foundation for Enterprise Development are providing a grant "to disseminate employee ownership teaching materials":

The Aspen Institute is an international nonprofit organization dedicated to fostering enlightened leadership and open-minded dialogue. As part of the Institute's Business and Society Program, the Center for Business Education (CBE) maintains close ties with major MBA programs in 23 countries. A grant to disseminate employee ownership teaching materials from the Foundation for Enterprise Development (FED) to the CBE of the Aspen Institute received substantial funding from the Employee Ownership Foundation. This grant funds the CBE network, publications, distribution systems and awards program to identify and disseminate employee ownership teaching materials to over 110 business schools. This collaborative project by the Foundation, FED, and CBE was initiated in March 2008.

Here is some additional information on the various organizations mentioned in the press release:

• The Foundation for Enterprise Development (FED) was established by Dr. J. Robert Beyster, founder of Science Applications International Corporation (SAIC), to promote "business principles and practices that encourage free enterprise and advance science and technology innovations with impact on nationally important interests."
  
• According to the press release, the Employee Ownership Foundation is the ESOP Association's "affiliated 501 (c)(3) organization dedicated to promoting employee ownership" and the core cause of the Foundation "is the belief that employee ownership will improve American competitiveness, increase productivity through greater employee participation, and strengthen our free enterprise economy."
  
• The Aspen Institute is a nonprofit organization "dedicated to fostering enlightened leadership and open-minded dialogue".
  
• The Business and Society Program is an Aspen Institute program designed to develop leaders:
  
  The Business and Society Program is dedicated to developing leaders for a sustainable global society. Through dialogues and path-breaking research, we create opportunities for executives and educators to explore new pathways to sustainability and values-based leadership. BSP's websites, www.CasePlace.org and www.beyondgreypinstripes.org, are the leading sources of innovative curriculum in top business schools around the world. The Business and Society Program is an independently-funded policy program of the Aspen Institute.
  
  
• The Aspen Institute's Center for Business Education (CBE) is part of the Business and Society Program. It "encourages future business leaders to innovate at the intersection of corporate profits and social impacts. Our goal is bold and long-term: to radically re-orient the MBA degree to embrace the principles of corporate citizenship and sustainability."
  
  
• CASEPLACE.org, an Aspen Institute online resource, contains "up-to-date case studies, syllabi, and innovative teaching materials on business and sustainability — from corporate governance to sustainable development." The employee ownership topic currently contains 28 entries.
  

Cook v. Campbell, 482 F. Supp.2d 1341 (M.D. Ala. 2007)

Court Says LaRue Ruling Doesn't Apply to ESOP Challenge discusses Binita L. Cook et. al. v. Boyd F. Campbell, No. 2:01cv1425-ID (M.D. Ala., May 5, 2008), a district court case that rejected an attempt to revive a fiduciary breach case, Binita L. Cook et. al. v. Boyd F. Campbell, No. 2:01cv1425-ID (M.D. Ala., March 30, 2007), based on the LaRue ruling. The case involved an ESOP, which is “designed to invest primarily in qualifying employer securities”:

"There is no allegation that Plaintiffs could make individual choices as to how the ESOP was funded or that Plaintiffs' losses occurred based on [defendant's] failure to adhere to Plaintiffs' individual directives as to how their accounts (i.e., their proportional share of company stock) were to be maintained," the court said in its opinion.

UPDATED 6/2/2008 to include links to both the original Memorandum Opinion and Order and the Plaintiffs’ Motion to Reconsider.

UPDATED 6/2/2008 to include information from the June 2, 2008 Employee Ownership Update:

"In Binita L. Cook et. al. v. Boyd F. Campbell, No. 2:01cv1425-ID (M.D. Ala., May 5, 2008), a district court ruled that a previously decided ESOP case could not be reopened in light of the new legal standard set out in LaRue v. DeWolff, the Supreme Court case that allowed individual defined contribution plan participants to sue for damages to themselves, as opposed to the plan as whole.

In this case, the court had previously denied a claim by the plaintiffs concerning the alleged failure of the fiduciary of an ESOP at Central Alabama Home Health Services to provide for a proper valuation concerning the ESOP's purchase of shares. Now the plaintiffs sought reconsideration in light of LaRue. The court found, however, that even if the plaintiffs' allegations were valid, the actions of the fiduciary would affect the entire plan, not just individual participants. LaRue was premised on the difficulty a plaintiff might have in getting damages when the relief would apply only to that individual and a plan-wide remedy would thus be impractical or inequitable. Here, a plan-wide remedy was already available. Moreover, the court cited the concurring opinion of Chief Justice Roberts expressing concern that LaRue not be read to allow cases to proceed where existing administrative remedies had not been exhausted, as the court found they had not been in this case.

The decision, while hardly surprising in light of the facts of the case, does provide some comfort to those concerned that LaRue would open up another avenue for plaintiffs to plead arguments that would not succeed under prior law."

Using ESOP Planning to React to Changing Times

ESOPs In Changing Times discusses how ESOP companies and fiduciaries need to “plan and react” and reiterates the importance of ESOP Planning:

• Economic Change – "The valuation process raises fiduciary and management issues, including employee communications, benefits calculations, procedural prudence, and strategic planning."
  
  
  • Look closely, communicate clearly – Revisit your assumptions and projections used in the valuation. Have your ESOP appraiser assist you in communicating the appraisal process to the participants.
    
  • Calculate realistically – Revisit valuation methods and avoid managing/manipulating the stock price to minimize fluctuations.
    
  • Think "demonstrable prudence" – Consider obtaining an independent trustee or fairness opinion as needed.
    
  • Know Your Corporate Duties Too – Ensure responsibilities are being performed by the appropriate parties. For example, the Company is responsible for the repurchase obligation. "Be sure your parties and their process, and the plan document optimally protect the company and the ESOP fiduciaries. Additionally, corporate planning may require opinions to be obtained by management in addition to those annual ESOP update opinions."
    
  • Don't wait until the last minute – Plan ahead to avoid delays and don't procrastinate. Proactively address issues and communicate with the ESOP team.
    
    
• Political Change – What impact will the upcoming political change have on tax (and therefore ESOP) policy?
  
  
  • A resurgence in tax deferred sales of companies to ESOPs? – An increase in capital gains rates could create an increase in IRC Section 1042 transactions.
    
  • Your ESOP voice counts! - "The fact that there are multiple seats on the House Ways and Means Committee that are open in this election portends a need for an active effort in educating policy makers." Inviting representatives to visit your ESOP company is most likely more effective than sending letters.
    
  • The S in revision? –"S corporations contemplating ESOPs or companies contemplating an S corporation election should seriously examine those alternatives in 2008."
    
    
• Changes In The Law – C'est LaRue? –As a result of the LaRue Decision, plan sponsors should "review their fiduciary structure and ensure their processes involving their transactions, administration valuation and other service providers are up to snuff…ESOP companies should ensure that the employer does not become the plan administrator by default or by terms of the plan. This is particularly important for corporations with outside independent directors who may not wish to be unwittingly legally responsible for fiduciary decisions. Similarly, independent fiduciaries may be advisable for many ESOP companies.
  
  
• A Resurgence of ESOPs? – There will be more than 5 million baby boomer-owned companies looking for Ways to Sell or Transition their business.
  
  
• What To Do? –"ESOP sponsors should take pause in 2008 as they handle their routine annual compliance and fiduciary matters and periodic plan amendments to assess their entire ESOP situation and look to their future plans. Note though, there really are no "routine" matters involving ESOPs. With great tax and benefits advantages, comes complexity."
  

If ESOP planning is not a part of your administration process, you should schedule an ESOP planning meeting as soon as possible to get the process started.

The Legacy of an ESOP Company

After reviewing the list of ESOPs in Existence for At Least 25 Years, Steve Sheppard reflects on his personal ESOP experiences in The Best of ESOP Is Yet To Come. He discusses his personal satisfaction in watching his former company change, improve, and evolve, as they were one of the 2008 AACE Award Winners:

The value of this is in the legacy. The adoption of an ESOP can be a wonderfully exciting, motivating thing for members of a company. But the longer-range success of an ESOP is whether those noble, inspirational notions that gave birth to the ESOP are sustainable, maintainable, from one generation of stewards to the next, whether the philosophies that gave rise to wealth-sharing, equity-building, involvement, opportunity and all of the other empowering elements of ESOP can be perpetuated successfully, in answer to

"What have I left behind?" The 2008 AACE Award for Foldcraft generates perhaps even greater satisfaction for me than the earlier national awards because it represents the next generation of ESOP owners at Foldcraft and the depth of the ownership sensibility in them. The company has never been, is not now, and never will be a workplace heaven. But it still clearly has the drive to become all that it can be and to take all of its members along for the trip…Foldcraft members can never know precisely what might have become of the company without the ESOP, but they can experience the reality and potential of the enterprise the way it is today, the impacts they can choose to make today, and the way they need it to be for tomorrow's world. Along the way, as they wonder about what Foldcraft might have been like sans ESOP, the awards and recognitions give them some affirmation that they're at least doing some of those things that have made for other great ESOP companies. (Significant stock appreciation in a wobbly stock market environment also affirms those initiatives!)

Employee-Owned Top Small Workplaces, IEI, HR 333, and Broad-Based Equity Grants

The May 15, 2008 Employee Ownership Update is online and discusses the following:

• Indiana Initiates ESOP Support Program
• Hinchey, Rohrabacher Introduce Pro-ESOP Resolution in Congress
• Many Compensation Consultants Ignore Research Supporting Broad-Based Equity Plans
• Take the NCEO Survey on Equity Compensation in Closely Held Companies
• Winning Workplaces Webinar on Employee Ownership

The Update discusses the Indiana's ESOP Initiative (IEI) and H. Con. Res. 333: Expressing continued support for employee stock ownership plans. It also discusses how five of the 2007 Top Small Workplaces are employee-owned and how two of the five, Reflexite and Phelps County Bank, will be presenting an employee ownership webinar, Building an Ownership Mentality Among Employees. For more information about the Top Small Workplaces and the presenting companies, here are some links to prior blog posts:

• ESOPs in Existence for At Least 25 Years (4/17/08)
• Eudaimonic Well-Being and Factors in Happiness (4/7/08)
• More Top Small Workplaces Coverage/Employee Ownership Month (10/9/07)
• In the News: Benefits, Risks, and Challenges of Employee Ownership, Maintaining an Ownership Culture as the Company Grows (10/04/07)
• In the News: Top Small Workplaces, High Retention Rates, Thinking Entrepreneurially, and Feeling Empowered (10/2/07)
• Combining Broad-Based Employee Ownership and Participation in the Management Process (5/7/07)

The Update also discusses how many compensation consultants ignore the evidence that links broad-based equity grants to improved corporate performance, noting that "there is, in fact, ample evidence linking broad-based equity grants to improved corporate performance, while equity grants to top executives produce at best mixed results.":

It's hard to say whether the continuing bias is the result of simple ignorance, a self-serving desire to tell executives (who pay compensation professionals' bills) that only executives matter, or a too-facile assumption that individuals below top executives rarely affect how the company does. The continued existence of this bias, however, remains a major barrier to more progress on broad-based grants.

2008 ESOP Association Award Winners

Yesterday we discussed the 2008 AACE Award Winners. The ESOP Association has announced the rest of the 2008 ESOP Association Award Winners:

The ESOP Association works to promote the best and brightest throughout the ESOP community. Each year the Association names an ESOP Company of the Year and an Employee Owners of the Year as well as presents awards to Chapters that have done extraordinary work throughout the year. Below are the 2008 ESOP Award Winners.

Life Service Award Winner
Judith L. Kornfeld Honored with Life Service Award

Employee Owner of the Year
Rita Tucker Named 2008 Employee Owner of the Year by The ESOP Association

ESOP Company of the Year
Carris Reels Named 2008 ESOP Company of the Year by The ESOP Association

ESOP Chapter of the Year
Carolinas Chapter Named Chapter of the Year by The ESOP Association

Chapter Officer of the Year
Dan Marcue of Woodward Communications, Inc. Named Chapter Officer of the Year by The ESOP Association

Employee Ownership Month Poster Contest
Consolidated Shoe Co., Inc. Named 2008 Employee Ownership Month Poster Contest Winner

Membership Recruitment
Merri Ash of First Bankers Trust Services, Inc. Receives Membership Recruitment Award from The ESOP Association

Outstanding Board of Governors Member
Cindy Turcot Named 2008 Outstanding Board of Governors Member by The ESOP Association

Outstanding Chapter Development
Mid-Atlantic, Carolinas, and Ohio/Kentucky Chapters Recognized by The ESOP Association for Outstanding Membership Development

Outstanding Chapter Membership Recruitment
Ohio/Kentucky Chapter of The ESOP Association Recognized for Outstanding Membership Recruitment

AACE Award Winners
The ESOP Association Honors Members for Excellence in “Employee Ownership” Communications

We discussed the 2007 award winners in 30th Annual ESOP Conference: ESOPs: Creating a REAL Ownership Society.

Nelson v. Hodowal, 512 F.3d 347, 2008 WL 90057, (7th Cir. January 2, 2008)

This abstract discusses Nelson v. Hodowal, 512 F.3d 347, 2008 WL 90057, (7th Cir. January 2, 2008) and affirms that ERISA fiduciaries do not have a legal duty to disclose to participants that they are selling their stock:

In Nelson et al. v. Hodowal et al., the plaintiffs' employer matched employee contributions in company stock. Some months after the company merged with another, the stock value dropped sharply. The plaintiffs sued the original company executives for failing to anticipate the impending drop. They also contended executive fiduciaries intentionally misled workers, withdrawing personal investments in company stock. The executives contended they expected to be replaced by the new company. The Seventh Circuit Appeals Court affirmed the lower court's ruling for the defendants. The court ruled plan fiduciaries are not required to tell participants about their own stock sales, even if they disclose the fact to a third party advisor.

ERISA Class Action Defense Cases-Nelson v. Hodowal: Seventh Circuit Affirms Defense Judgment In ERISA Class Action Holding Plan Fiduciaries Not Required To Disclose "Facts That May Lead To Idiosyncratic Reactions discusses the appeal in more detail:

The sole issue on appeal was "whether the defendants had to tell the participants that the defendants were selling most of their own stock in IPALCO-not only stock held through the Thrift Plan, but also stock that the defendants were able to acquire by exercising vested options that they had received in their roles as managers or directors of Indianapolis Power & Light." Nelson, at *2. In essence, plaintiffs argued that defendants implicitly promoted AES as a good investment "while by divesting their own holdings they demonstrated that their true beliefs were otherwise," a form of implied deceit referred to by the securities law as "scalping." Id. The district court had rejected this argument and expressly found that "the defendants actually (and reasonably) believed everything they told the participants, and that they sold IPALCO stock, and cashed out their options, only because AES had announced that it would replace the management team at Indianapolis Power & Light." Id. In other words, "[t]he defendants were on their way out the door and had no more reason to hold IPALCO (or AES) stock than to hold any other utility stock, and substantial reasons to diversify." Id. Plaintiffs did not challenge these findings on appeal, id., at *3…

ESOPs Contribute to a More Fair and Just Society

Opinion 2: House Resolution Celebrate ESOP Successes is an opinion piece written by the President of the ESOP Association. It recognizes the bi-partisan efforts to affirm ESOPs in H. Con. Res. 333: Expressing continued support for employee stock ownership plans and urges all members of Congress to "get on board and co-sponsor House Concurrent Resolution 333 for a more fair and just society":

Since 1974, the ESOP model of employee ownership has been most effective in transferring ownership at a substantial rate to average-pay employees over a short period of time.

Thanks to ESOPs, millions of Americans have become significant owners in the companies where they work. Because in a free enterprise system, ownership is both a reward and a risk, there are cynics who question whether average-pay employees should be exposed to the risks of ownership.

Other than a degree of irritation that these cynics have an elitist "let them eat cake attitude" toward hard working, middle class Americans, everyone should take notice of the overwhelming data collected over the past 30 plus years of ESOP success stories for ESOP participants and their companies.

The op-ed shares The Benefits of ESOPs and Employee Ownership to Companies and The Benefits of ESOPs and Employee Ownership to Employees. It also discusses The Economic Performance of ESOP Companies and the importance of making ESOPs a major part of building a "more prosperous, more just, and more equal" society.

2008 AACE Award Winners

Congratulations to the 2008 AACE Award Winners! The ESOP Association Honors Members for Excellence in 'Employee Ownership' Communications describes the Annual Awards for Communications Excellence (AACE) Award selection process and announces the 2008 Award winners:

• Category 1-A, Total Communications Program, 100 or fewer employees
  
  • Winner: Sebago Technics, Inc., Westbrook, ME
    
  • Runner Up: Worm's Way, Inc., Bloomington, IN
    
    
• Category 1-B, Total Communications Program, 101 - 500 employees
  
  • Winner: MidSouth Building Supply, Inc., Springfield, VA
    
  • Runner Up: Dakota Supply Group, Fargo, ND
    
    
• Category 1-C, Total Communications Program, 501 - 1,000 employees
  
  • Winner: Hypertherm, Inc., Hanover, NH
    
  • Runner Up: Woodward Communications, Inc., Dubuque, IA
    
    
• Category 1-D, Total Communications Program, 1,001 - 5,000 employees
  
  • Winner: Burns & McDonnell Engineers-Architects, Kansas City, MO
    
  • Runner Up: American Systems Corporation, Chantilly, VA
    
    
• Category 2, Young ESOP
  
  • Winner: BL Companies, Inc., Meriden, CT
    
    
• Category 3, Audio Visual
  
  • Winner: Harrell Remodeling, Inc., Mountain View, CA
    
  • Runner Up: Dakota Supply Group, Fargo, ND
    
    
• Category 4-A, Printed Materials, 250 or fewer employees
  
  • Winner: Cisco-Eagle, Inc., Dallas, TX
    
  • Runner Up: Dental Health Services, Long Beach, CA
    
    
• Category 4-B, Printed Materials, over 250 employees
  
  • Winner: Pacific Steel & Recycling, Great Falls, MT
    
  • Runner Up: Van Meter Industrial, Cedar Rapids, IA
    
    
• Category 5-A, Educational Materials, Print
  
  • Winner: Foldcraft Company, Kenyon, MN
    
  • Runner Up: PBI/Gordon Corporation, Kansas City, MO
    
    
• Category 5-B, Education Materials, ESOP Intranet
  
  • Winner: Murray Insurance Associates, Inc., Lancaster, PA
    
  • Runner Up: ComSonics, Inc., Harrisonburg, VA
    
    
• Category 6-A, External ESOP Advertising, Print
  
  • Winner: Brookshire Brothers, Ltd, Lufkin, TX
    
  • Runner Up: American Systems Corporation, Chantilly, VA
    
    
• Category 6-B, External ESOP Advertising – Website
  
  • Winner: Van Meter Industrial, Cedar Rapids, IA
    
  • Runner Up: Woodward Communications, Inc., Dubuque, IA
    
    
• Category 7-A, Special Events, Promotions, 250 or fewer employees
  
  • Winner: Kapco/Valtec, Brea, CA
    
  • Runner Up: Carl Warren & Company, Placentia, CA
    
    
• Category 7-B, Special Events, Promotions, over 250 employees
  
• Winner: Carris Reels, Rutland, VT
  
• Runner Up: Social & Scientific Systems, Inc. Silver Spring, MD

Here is a link to the 2007 AACE winners., and here is the rest of the press release:

WASHINGTON, May 12 /PRNewswire-USNewswire/ -- The ESOP Association is pleased to announce the 2008 winners of the Annual Award for Communications Excellence (AACE). The AACE Awards are sponsored each year by the Association to recognize the outstanding communications and educational programs of its members. The awards will be presented May 12, 2008 at the Association's Annual Conference in Washington, DC to companies who have excelled in communicating the ESOP (employee stock ownership plan) and its meaning to employee owners.

AACE Award winners are chosen by a panel of five judges made up of both management and non-management employee owners, each of whom has demonstrated active experience and interest in the field of ESOPs and employee ownership communications. Awards are based on: overall quality and quantity of employee owner education, contributions of employee owners, integration of the ESOP into company culture, frequency of ownership communications, involvement and/or response of employee owners, encouragement of ownership attitudes, clear explanations, creative ideas, graphic design, and technical quality… The core cause of The ESOP Association is the belief that employee ownership will improve American competitiveness, increase productivity through greater employee participation, and strengthen our free enterprise economy.

Caltagirone v. NY Community Bancorp, Inc., 2007 U.S. App. Lexis 29516 (2d Cir. Dec. 20, 2007)

Appellate Court Affirms District Court Finding That Plaintiffs Lacked Standing To Sue summarizes Caltagirone v. NY Community Bancorp, Inc., 2007 U.S. App. Lexis 29516 (2d Cir. Dec. 20, 2007):

"The plaintiffs in this case alleged that they were participants in an ERISA plan that suffered losses due to fiduciary breaches…The district court held that neither plaintiff was a "participant" in the plans with statutory standing to sue and granted the defendants' motion to dismiss. The plaintiffs appealed…In its decision on appeal, the U.S. Court of Appeals for the Second Circuit explained that the rights of action that the plaintiffs sought to assert were available only to "participants, beneficiaries, or fiduciaries of an employee benefit plan." A "participant" is "any employee or former employee of an employer . . . who is or may become eligible to receive a benefit of any type from an employee benefit plan."

One of the plaintiffs terminated the day prior to the merger and was therefore never an employee of the acquiring company. The Court found that, even though the employee was still a 401(k) participant, they had never been a participant in a plan administered by the defendants and therefore lacked standing to sue.

The other participant received a distribution of their 401(k) balance prior to the acquisition, but rolled the funds into an IRA administered by the bank. Since the employee was no longer a plan participant, she had no claim. This participant was also an ESOP participant, but had no claim because ESOP participants automatically receive allocations of shares and ESOP fiduciaries do not have the authority to choose investments under the plan:

"This plaintiff also participated in an Employee Stock Ownership Plan (ESOP). Unlike with her Savings Plan account, this plaintiff continued to hold her NYCB ESOP account after she left NYCB and through the end of the class period. The Second Circuit pointed out, however, that the plaintiffs' theory of fiduciary breaches had "no application to the actions of the ESOP administrators" because participants in the ESOP, unlike those in the Savings Plan, could not chose among a variety of investment options but were instead granted shares of NYCB by virtue of their employment. Thus, the "failure-to-disclose" and the "imprudent-investment" allegations had no possible application to the ESOP plan, because neither the administrators nor the participants had the power to choose their investments under this plan. Accordingly, the circuit court found that this plaintiff did not have a claim for benefits relating to her ESOP account, and it affirmed the district court's decision."

Elaws Advisors: Mimic the Interaction of a DOL Representative

The DOL website contains a series of elaws (employment laws assistance for workers and small businesses) Advisors designed to help employers and workers understand their rights and responsibilities under the DOL's federal employment laws. The elaws Advisors are intended to mimic the interaction an individual would have with a DOL representative. We discussed the ERISA Fiduciary Advisor elaw in a prior post. Here is a listing of the current elaw Advisors:

• Drug-Free Workplace Advisor
  
• ERISA Fiduciary Advisor
  
• Family & Medical Leave Act (FMLA) Advisor
  
• Federal Contractor Compliance Advisor
  
• FirstStep Employment Law Advisor
  
  • FirstStep Employment Law Overview Advisor
    
  • FirstStep Recordkeeping, Reporting, and Notices Advisor
    
  • FirstStep Poster Advisor
    
    
• Fair Labor Standards Act (FLSA) Advisor
  
  • FLSA Coverage & Employment Status Advisor
    
  • FLSA Overtime Calculator Advisor
    
  • FLSA Overtime Security Advisor
    
  • FLSA Hours Worked Advisor
    
  • FLSA Child Labor Rules Advisor
    
  • FLSA Section 14 (c) Advisor (Special Minimum Wage)
    
    
• Health Benefits Advisor
  
• Health Benefits Advisor for Employers
  
• MSHA Online Forms Advisor
  
• MSHA Training Plan Advisor
  
• MSHA Fire Suppression & Fire Protection Advisor
  
• OSHA Confined Spaces Advisor
  
• OSHA Fire Safety Advisor
  
• OSHA Hazard Awareness Advisor
  
• OSHA Lead in Construction Advisor
  
• OSHA Software Expert Advisors
  
• Poster Advisor
  
• REALifelines Advisor
  
• Small Business Retirement Savings Advisor
  
• Uniformed Services Employment & Reemployment Rights Act (USERRA) Advisor
  
• Veterans' Preference Advisor
  
• e-VETS Resource Advisor
  
• Worker Adjustment and Retraining Notification Act (WARN) Advisor

Indiana's ESOP Initiative (IEI)

State to help employees buy out companies discusses a new Indiana State Treasury program that will subsidize bank loans with the goal of encouraging more Indiana business to sell to an ESOP.

Taxpayers will more than recoup the program's annual cost of $500,000 a year because of the tendency of ESOP companies to stay in the state and not outsource work overseas, Mourdock said. ESOPs also help workers save for retirement and create incentive at all employment levels to make the companies succeed.

"This is one more thing we can do to help existing businesses keep those jobs," he said in an interview.

The $500,000 will be taken from the $400 million to $700 million the state typically has invested in banks.

The article also discusses the risks to the taxpayers:

Mourdock said the main risk to taxpayers is the potential for companies to fail. The most likely scenario for failure would be owners' deserting the companies shortly after the sale and leaving less-experienced managers to cope.

However, he said he is trusting banks to conduct thorough credit analysis, as they would if the subsidy weren't available.

The article notes that Baby Boomer business owners are among the most obvious candidates for an ESOP.

While the Indiana Bankers Association supports the concept, they are concerned about the length of the potential loan (the program is only available for three years instead of the seven to 10 years of a typical ESOP transaction) and the education that the bankers will need to handle the complex nature of ESOP transaction.

The article notes that more than 200 ESOP companies exist in the state, and specifically mentions Herff Jones (Indianapolis, IN) and Wood-Mizer Products Inc. (Indianapolis, IN), both discussed in In the News: Maintain the Culture and Say Involved in the Business/ESOPs as an Exit Strategy/On Track for Continued Growth/Strong Management-Employee Relations, and Telamon Corporation (Carmel, IN), a technology company that formed an ESOP in 1999.

Indiana's ESOP Initiative (IEI)

The Indiana state website contains the following executive summary of the IEI:

Indiana's ESOP Initiative (IEI) was created by State Treasurer Richard Mourdock to promote and encourage the formation of new Employee Stock Ownership Program (ESOP) companies in Indiana.

ESOPs have a clear track record of creating wealth, encouraging entrepreneurial attitude, and increasing productivity. The key to retaining Indiana jobs is increasing productivity. As Treasurer Mourdock has often said, "one of the best reasons to help Indiana companies become employee-owned is that no group of employee-owners have ever, ever, ever, ever moved their company to Mexico or China!"

In order for the IEI to achieve its goals, Treasurer Mourdock is providing a $50 million investment through a "link-deposit" program to assist Indiana banks in funding ESOP transactions.

Treasurer Mourdock is also announcing that Credit Suisse, who is managing $150 million of Indiana's Public Employees Retirement Fund targeted for investment in Indiana, will consider on a case by case basis the purchasing of equity in an Indiana company for the purpose of completing an ESOP transaction.

In addition, Treasurer Mourdock has assembled an "ESOP toolbox" of resources and information for business owners and employees wanting to learn more about ESOPs and professional organizations that can assist with their creation. The ESOP toolbox will continually be updated with new information as it becomes available to IEI.

ESOP Linked-Deposit Program

The website also contains a description of the ESOP Linked-Deposit Program:

General Guidelines

A company must have their headquarters located in the State of Indiana, conduct a significant portion of their operations in Indiana, and employ the majority of their employees in Indiana while participating in the ESOP Linked-Deposit Program.

The Treasurer of State will NOT make any judgment on the credit quality of any applicant but will rely solely on the credit evaluation provided by the financial institution(s) providing the transactional loan. An applicant may not have an established ESOP prior to participating in the ESOP Linked-Deposit Program. (The program is for new ESOPs only.)

Investment Guidelines

At least 10% of ownership in the company must be transferred to the ESOP in the initial transaction. The maximum amount that will be available to a company participating in the ESOP Linked-Deposit Program will be $5 million. Funds will be deposited in the form of 12 month certificates of deposit (CDs) with an approved depository as defined by the Indiana Board for Depositories. The CDs will be renewed on a yearly basis for up to 3 years. a.The interest rate on the CDs will be determined by the Treasurer of State. i.The financial institution may charge the borrower up to 3.25% more than the rate received by the Treasurer of State on its CDs. b.CDs will be purchased by the Treasurer of State on the first and fourth Thursday of each month. The interest rate for new CDs may be adjusted on a quarterly basis at the discretion of the Treasurer of State's Office

Additional Requirements

1) A company must provide the following information to the IEI:

a)A complete business plan. b)Resumes of key managers and substantial evidence of their commitment to service after the ESOP Linked-Deposit Program is completed. c)A complete transition plan. d)Names and contact information of the firms that created the ESOP trust and did the financial evaluation of the company.

Limitations of ESOP Loans

1)Availability of funding. 2)The financial institution assumes all credit risk. In the event of default by the ESOP, the linked-deposit will be terminated at the maturity of the CDs being held by the lending institution.

Press Release

Here is a link to the press release:

State Treasurer Richard Mourdock Announces Launching of $50 Million Indiana's Employee Stock Ownership Program (ESOP) Initiative

Indiana's ESOP Initiative's (IEI) mission: Promoting Hoosier ESOPs, preserving Hoosier jobs

INDIANAPOLIS (May 08, 2008) – State Treasurer Richard Mourdock announced the designation of $50 million and the launch of IEI for the purpose of assisting Indiana businesses to become ESOP companies, which will preserve Hoosier jobs.

"It's not only critical that the state continues to bring new jobs to Indiana, but it's absolutely essential that Indiana keeps the jobs it currently has," asserted Treasurer Mourdock. "IEI's mission is to encourage Indiana businesses to become ESOP companies and preserve Hoosier jobs."

Treasurer Mourdock has placed the IEI within the Treasurer of State's Office and has created an "ESOP toolbox" of information regarding current Hoosier ESOP companies, organizations that provide professional services to ESOP companies, and educational materials about ESOP governance.

The $50 million designated for IEI and its mission is set up as a "linked-deposit" program through the Treasurer of State's Office. In the ESOP Linked-Deposit Program, the Treasurer of State will purchase certificates of deposit from local financial institutions at reduced rates of interest, and in turn the financial institutions will provide loans at reduced rates of interest to Indiana businesses becoming Hoosier ESOP companies. The initial rate financial institutions will be charging to Indiana businesses through the ESOP Linked-Deposit Program will be 4.25%. The State of Indiana will not be a guarantor or man any of the risk of default on loans made under this program.

"ESOP companies have a track record of creating wealth, encouraging the entrepreneurial spirit, and increasing productivity," explained Treasurer Mourdock. "Furthermore, no group of employee-owners has ever, ever, ever, ever moved their company to Mexico or China!"

Updates:

• Employee-Owned Top Small Workplaces, IEI, HR 333, and Broad-Based Equity Grants (5/16/08) - "Indiana State Treasurer Richard Mourdock has introduced a program to encourage banks to loan to ESOPs. The state will buy certificates of deposit from those institutions at reduced rates, increasing their funds available to loan. Banks then would loan these funds to new or existing Indiana ESOP companies for 4.25% (this is the current rate; it will change as interest rates change). The program will cost the state $500,000 annually, but Mourdock (himself a former ESOP participant) believes that the program will create a net increase in state revenues because ESOPs tend to keep jobs and business activity in the state."

In the News: More Responsibility and Better Decision-Making

South Mountain Co. (West Tisbury, MA)

Stonington to Host Economic Summit discusses the former owner of South Mountain Co., which we discussed in In the News: Employee Ownership Success Stories, and his support for employee ownership:

In 1987, Abrams sold his design and build business, South Mountain Co. He sold it to himself and his employees.

He has documented his experiences with creating an employee-owned construction company on Martha's Vineyard in "The Company We Keep."

"I'm a great advocate and a great believer in employee ownership," said Abrams. "There are tremendous benefits. When people make decisions and share in the benefits and the consequences, better decisions result. When we own it, we take better care of it."

In summing up the case for employee ownership and the responsibility it encourages, Abrams cites an observation made by New York Times columnist Tom Friedman: "In the history of mankind, nobody has ever washed a rented car."

While their employee ownership structure is a worker cooperative and not an ESOP, ESOP companies can benefit from learning about their ownership culture and company philosophy. The former owner is also the author of The Company We Keep: Reinventing Small Business for People, Community, and Place:

Like virtually all titles in its category, The Company We Keep: Reinventing Small Business for People, Community, and Place, by John Abrams, Chelsea Green Publishing Company, 2005 makes a case for strong workplace values and shows how we can ultimately profit from such a strategy. But unlike most of its fellow volumes, this book is also a personal tale, one liberally sprinkled with wisdom about ideas small and large that the author has accumulated during his 30+ year journey as founder of the South Mountain Company, a Martha's Vineyard design and building firm. Through a commitment to community entrepreneurship, Abrams has seen the company grow and prosper. At the same time, he's experimented with a revolutionary employee ownership model that challenges the traditional business model of unchecked growth. While The Company We Keep tells the personal success story of this revolutionary company, that's just the beginning of all the places it goes. Written in a down-to-earth conversational voice and laced with insightful side trips that offer additional lessons, Abrams examines the role business can and should play in creating and sustaining healthy communities. He sets down a framework for a model of employee ownership and community involvement that works. In the words of the author, "This is a book about a different way of doing business in today's world, a way based on workplace democracy, shared ownership, staying small, building community, making a commitment to place, and long term thinking." Rejecting the myth that short-term profits are the only indicator of business health and wealth, Abrams offers eight cornerstone principles. He shows how building a company upon these principals to serve the needs of employees inside, the community outside, and the environment both depend upon can create a business that's successful by traditional and nontraditional measures alike. To that end his book is part entrepreneurial business plan, part guide to democratizing the workplace, and part prescription for strong local economies. A series of detailed appendices explain how his company set up its employee ownership program, how meeting facilitation and consensus decisions work, and how Abrams performed a community visioning for Martha's Vineyard. This places much of the how-to nuts and bolts in the back of the book, preventing this technically oriented material from bogging down the breezy main text with nitty-gritty. The result is a thoroughly readable and eminently enjoyable book, and an important new addition to the library of anyone concerned with finding better ways to create a better world.

DelRosario and Taylor v. King & Prince Seafood Corporation

U.S. District Court Opinion Rendered in King & Prince Seafood Corporation ESOP Litigation discusses the opinion rendered by the U.S. District Court for the Southern District of Georgia in DelRosario and Taylor v. King & Prince Seafood Corporation. The article summarized the findings as follows:

"In summary, the court declined to find that plaintiffs had a valid claim to benefits based upon the plan's distribution policies, and found that the trustees had not violated the terms of the plan in fashioning distribution policies. The court left open the possibility of some form of remedy for violation of the consent rule, underscoring the importance of plan administrators' responsibility to provide timely and proper notice to participants. The court also recognized the validity of considering repurchase obligations in connection with distribution policies and declined to second guess the business judgment of trustees in crafting distribution policies."

While the facts and circumstances of this case are unique, here are some takeaways from the case:

1. Repurchase liability funding decisions such as using ESOP cash instead of redeeming the stock is a matter of business judgment.
   
   
2. Changing the distribution policy to manage the repurchase liability is reasonable.
   
   
3. Changing the distribution policy, rather than amending the plan, is not a violation of the anti-cutback rule. This is consistent with IRC Section 411(d)(6)(C) - Minimum vesting standards - Special rules - Accrued benefit not to be decreased by amendment - Special rule for ESOPs, which provides that the distribution provisions of ESOPs may be modified in a nondiscriminatory manner.
   
   
4. Participants must be provided with the appropriate forms and a notice that meets the 402(f) Safe Harbor Notice requirements no less than 30 days (subject to waiver) and no more than 180 days before the date of which a distribution is made. The article discusses the failures in this case that the resulted from not satisfying the 402(f) requirements:
   
   "The court explained that while the trustees may have implemented the distribution rules in accordance with the ESOP and ERISA, it could not find that rank and file terminated participants were apprised of the material rules of the distribution policy. The court found that participants were not provided consent forms more than 30 days prior to distribution, in violation of the rule. The court further found that the failure of the notices to apprise participants of their right to defer distribution until age 65, of their option to roll stock into an IRA, of the availability of the put option periods, and of the tax consequences of their decision violated the consent rule, as did the failure of the notices to inform participants that they would receive a year old valuation."
   
   
5. In addition to ensuring that you are using the most current fair market value, you also need to make sure the value has not become stale. Here is an excerpt from ESOP Planning: Distributions:
   
   Is the fair market value that you are using an accurate reflection of the market value or has the value become "stale"? If you pay someone a distribution on December 15, 2007, based on the December 31, 2006 stock value, the value is almost 350 days old. Some experts would argue that you are not paying the participant at fair market value. Does a stock value become "stale"? If so, when? There is no clear guidance in this area, and the determination of if and when a value becomes "stale" is subjective and is based on the facts and circumstances of your situation.

UPDATE 5/12/08:

Is ESOP Sponsor Liable for Paying Out Sooner Than Required? is an Employee Ownership Update from 2006 that reviews the then pending lawsuit:

In an unusual lawsuit, former employees of King & Prince Seafood are charging that a change in ESOP distribution rules to pay out former participants three years after departure instead of five violated ERISA's anti-cutback requirements. The plan was also changed so that the payout was based on the valuation as of the end of the prior year, rather than when the payout occurred. Paying out sooner than the law requires and basing payments on the last valuation are common plan provisions in ESOPs. A district court certified the case for class action. Employees were upset because under the old rules, they would have received substantially more than under the new ones because the company's stock price rose sharply in the year of the payout. The case Del Rosario v. King & Prince Seafood Corp., No. CVF 204-036 (S.D. Ga. 3/7/06) now must be decided on its merits, but it is a novel theory that what would normally be perceived to be a change in the plan to benefit employees could be interpreted as damaging them by not allowing them the maximum possible time to hold onto their shares.

Order (3/7/06)