We recently discussed the August Recess and the Congressional Company Visit. We have also discussed hosting a Congressional company visit in recent discussions on ESOP Advocacy and ESOP Planning. Here are some links to coverage of Congressional company visits:
Mere Posting of SPD on Intranet Does Not Ensure Actual Receipt discusses Gertjejansen v. Kemper Ins. Co., 9th Cir. 2008 and how the Ninth Circuit Court of Appeals found that posting a summary plan description (SPD) was not sufficient to ensure that a participant actually received it:
In a case heard by the Ninth Circuit Court of Appeals, the court found that the administrator failed to show it properly furnished an employee with a copy of the employers disability plan SPD because the administrator "had submitted nothing on the record to suggest that the mere placement of an updated SPD on [the employer's] intranet site could ensure [the employee] would actually receive the information." As a result, for purposes of defending a claim for disability benefits, the administrator could not rely on language in the electronically posted SPD that unambiguously conferred on the administrator discretionary authority to determine eligibility for benefits and to construe the terms of the plan.
Failure To Furnish SPD Can Lead To Loss Of Deferential Standard Of Review discusses how the failure to ensure the participants actually received the information can have a bearing on the Standard of Review.
Electronic Media Related Links:
SPD Related Links:
Lumber Yard Supply (Great Falls, MT)
Succession plan touted as aid to business discusses the ESOP story of Lumber Yard Supply, a fourth generation family-owned wholesale lumber business based in Great Falls, Montana. Although the majority shareholder was approached by a couple of third-party buyers, the 100-employee company recently opted to establish an ESOP to protect the future of their loyal employees and address their succession planning needs:
Robinson was approached by a couple of would-be buyers for the business that his family established 122 years ago.
"I thought if the business sold to a different company, that new company would need our employees," Robinson said. "I realized, however, that wasn't necessarily the case and that our employees would not be protected."
Robinson, the fourth generation of his family to run the business, says Lumber Yard Supply has loyal workers who have made the company their career.
So he began exploring a different avenue, even though he thought it might be too late to venture down it. As it turned out, creating company ownership among employees was a viable option.
Lumber Yard Supply established an Employee Stock Ownership Plan and recently completed the first buyout. Now employees own about 9 percent of the business' stock through the plan.
"I thought in my case that it was too late to make an ESOP work for my retirement planning," said Robinson, who plans to continue working at least until 2010.
After a lengthy meeting with Ray Wahlert, president of Pacific Steel and Recycling, which is 100 percent owned by employees through their ESOP plan, Robinson learned that wasn't the case.
With the recovery from a catastrophic fire, the establishment of the ESOP, and a succession plan in place, the company is focused on growth and will be expanding the number of branches in the near future:
"Big lumber companies with locations across the Untied States are pulling back and closing locations," he said. "We can go in there with enthusiasm and build strong relationships."
The new branches are providing new opportunities to existing employees and creating new jobs"
"With the new ESOP plan and the expansion, I really felt I wanted to be part of it," Bake said.
Here are some links to recent DOL and IRS rules and publications:
You can stay current on all of the latest qualified retirement plan rules and regulations by going directly to our sister blog, ERISA Rules and Regulations, or checking the left-hand sidebar for the latest updates.
We recently discussed the requirements for an IRC Section 1042 Tax Deferred Sale of Stock to an ESOP. One of the 4 requirements to qualify for Section 1042 sale, as provided under IRC Section 1042(b) - Sales of stock to employee stock ownership plans or certain cooperative – Requirements to qualify for nonrecognition, is to provide a written statement:
(3) Written statement required
(A) In general
The taxpayer files with the Secretary the written statement described in subparagraph (B).
(B) Statement
A statement is described in this subparagraph if it is a verified written statement of—
(i) the employer whose employees are covered by the plan described in paragraph (1), or
(ii) any authorized officer of the cooperative described in paragraph (l), consenting to the application of sections 4978 and 4979A with respect to such employer or cooperative.
How important is the written statement? Sometimes the Magic Words Really Matter describes a 2004 United States Tax Court ruling that found that a taxpayer was unable to exclude the gain on the sale of stock to an ESOP because the written statement requirement was not satisfied:
Mr. Clause wanted to take advantage of Section 1042 of the Internal Revenue Code. Section 1042 allows taxpayers who sell shares of a C corporation to the company Employee Stock Ownership Plan (ESOP) to avoid current tax on their gain if they reinvest the proceeds in publicly-traded securities, if certain other requirements are met. One of the requirements is an election under Section 1042 on a timely-filed tax return.
Mr. Clause did his part, reinvesting the proceeds. His CPA prepared his return excluding the gain. Unfortunately, the tax returns failed to include an election required under the Section 1042 regulations. The taxpayer failed to convince the Tax Court that "substantial" compliance had been achieved. The judge says:
"Having not literally complied with the election requirements in the statute and the regulation, petitioner argues that he substantially complied with the requirements of section 1042 and should, therefore, receive the benefits of the section because the failure to file the elections was 'purely administrative in nature'. We disagree."
The moral? It's best not to count on the kindness of tax administrators; better to say the magic words demanded by the rules when you file your returns, even if they seem silly. Mr. Clause's heirs will now presumably discuss the additional $395,279 tax on the failed ESOP rollover with the hapless CPA who prepared the return for the rollover year.
Substantial Compliance No Substitute for Filing Election discusses the details of the case and some observations:
Evidence of intent is an essential requirement to overcome a failure to file an election. Taxpayers can argue substantial compliance when they have provided most of the information required by the statute or regulations and the omitted information is not significant. Omitting income that otherwise would be excluded under a duly filed election from a tax return is not sufficient evidence of intent. The defense of substantial compliance generally will be unsuccessful in instances where the essential requirements of making the election clearly appear in the governing statute or regulations.
ESOP Rules for Government Contractors Finalized explains the May 2008 final ruling for Accounting for the Costs of ESOPs Sponsored by Government Contractors. The ruling provides more certainty by clearly defining the allowable cost as the contractor's contribution, including interest and dividends. This differs with the fair market value definition provided under Statement of Position 93-6, Employers' Accounting for Employee Stock Ownership Plans. The article also discusses the remaining concerns about dividends and notes that stock valuations remain subject to audit by the Defense Contract Audit Agency (DCAA):
Keep in mind that ESOP stock valuations remain subject to DCAA audit. Should the DCAA determine that ESOP shares were over valued, the DCAA could attempt to disallow a portion of an ESOP contribution.
We continue our coverage of the story of EBO Group by sharing Eight Ways to Foster Innovation - Lessons from the EBO Group:
We previously discussed EBO Group in the following posts:
The Minneapolis/St. Paul Business Journal recently named the winners of its 10th annual Best Places to Work competition:
To be eligible for the project, companies had to have offices in the 11-county metro area and at least 10 full-time employees, or be based in Minnesota with at least 1,000 full-time employees. Nearly 250 companies participated in this year's Best Places to Work, with 158 qualifying. To qualify, a certain percentage of employees had to complete an online survey, conducted by Wichita, Kan.-based Quantum Market Research, rating their employers' work environment, people practices, personal growth and development opportunities, people in the organization. how things work day-to-day and how the company embraces innovations/new ideas.
20% of the listed honorees are members of the ESOP Association and involved with ESOPs in some capacity:
This month, the National Bureau of Economic Research (NBER) published working papers relevant to ESOPs and employee ownership:
Between one-third and one-half of employees participate directly in company performance through profit sharing, gainsharing, employee ownership, or stock options. This flies in the face of concerns about the free rider problem and worker risk aversion in group incentives, and raises many questions about the effects on firms and workers. This paper lays out the major reasons we may see such "shared capitalism" plans, and reviews recent nationally representative surveys on the prevalence of these plans. We also introduce the NBER shared capitalism data, based on questions added to the 2002 and 2006 General Social Surveys (GSS) and more than 40,000 employee surveys from 14 companies with different combinations of shared capitalism plans. We find that while shared capitalism exists broadly throughout the economy, it is more likely in larger establishments. The free rider effect may be countered by the use of other policies to create productive teamwork and a cooperative culture: shared capitalism is positively linked to workplace decision-making, training, job security, teamwork, the ability to easily observe co-worker performance, and low levels of supervision. Also, more risk-averse employees avoid participating in several types of shared capitalism, but two-thirds of even the most risk-averse employees in these companies say they want shared capitalism as part of their pay package. The effects of these plans for both workers and firms are more fully explored in accompanying papers.
WORKER RESPONSES TO SHIRKING UNDER SHARED CAPITALISM (NBER Working Paper No. 14227):
Group incentive systems have to overcome the free rider or 1/N problem, which gives workers an incentive to shirk, if they are to succeed. This paper uses new questions on responses to shirking from the General Social Survey and a special NBER survey of workers at over 300 worksites in 14 companies that have some form of group incentive pay to examine how well workers can monitor their peers and what they do when the peers are not working up to speed. The paper finds that: 1) most workers say that they can detect fellow employees who shirk; 2) many report that they would speak to the shirker or report the behavior or a supervisor, and many report that they did so in the past; 3) the proportion that takes action against shirkers is greatest among workers paid under group incentive systems, in smaller companies, and in companies with good employee-management relations; 4) group incentives interact with high-performance human resource policies such as employee involvement teams, training, task variety, low levels of supervision, and good fixed wages to induce more workers to act against shirking; 5) workers in workplaces where there is more anti-shirking behavior report that co-workers work harder, encourage other workers more, and report that their workplace facility is more effective in ways that should raise productivity and profits.
This paper uses data from NBER surveys of over 40,000 employees in hundreds of facilities in 14 firms and from employees on the 2002 and 2006 General Social Surveys to explore how shared compensation affects turnover, absenteeism, loyalty, worker effort, and other outcomes affecting workplace performance. The empirical analysis shows that shared capitalism has beneficial effects on all outcomes save for absenteeism and that it has its strongest effects on turnover, loyalty, and worker effort when it is combined with: a) high-performance work policies (employee involvement, training, and job security), b) low levels of supervision, and c) fixed wages that are at or above market level. Most workers report that cash incentives, stock options, ESOP stock, and ESPP participation motivate them to work harder. The interaction of the effects of shared capitalism with other corporate policies suggests that the various shared capitalist and other policies may operate through a latent variable, "corporate culture".
This paper examines how shared capitalism compensation systems - those that link employee pay to company performance - affect diverse employee outcomes. It uses two data sets: the national GSS survey that provides a broad representative view of the extent of the programs; and the NBER Shared Capitalism Project surveys of workers in 14 companies that use shared capitalism programs extensively. We find that greater involvement in the programs is generally linked to greater participation in decisions, higher quality supervision and treatment of employees, more training, higher pay and benefits, greater job security, and higher job satisfaction. We also find positive interactions of shared capitalism with high-performance policies in predicting participation in decisions and overall job satisfaction, and negative interactions of shared capitalism with close supervision in affecting almost all of the outcomes. Overall the results support the idea that workers can gain by sharing, but whether this happens is contingent on other workplace policies.
Who Has a Better Idea? Innovation, Shared Capitalism, and HR Policies (NBER Working Paper No. 14234):
We investigate the relationship of "shared capitalist" compensation systems - profit/gainsharing, employee ownership, and stock options - to the culture for innovation and employees' ability and willingness to engage in innovative activity. Using a large dataset with over 25,000 employee surveys in over 200 worksites of a large multinational organization, we find that both shared capitalism compensation and high performance work policies contribute to these innovation outcomes. Owning company stock is the most consistently positive compensation variable in predicting both an innovation culture and willingness to engage in innovative activity. We also find that shared capitalism and high performance work policies have stronger effects in predicting an innovation culture when they are combined, and that the effects of shared capitalism and high performance work policies are partially, but not wholly, mediated through greater employee alignment with company strategy. The findings are consistent with agency theories predicting that the principal agent problem can be addressed by a combination of shared incentives and cooperative culture which encourages mutual monitoring and opportunities to share information.
Does Employee Ignorance Undermine Shared Capitalism? (NBER Working Paper No. 14236):
The potential of shared capitalism to improve individual and organizational performance through financial incentives depends on employees knowing about and participating in compensation plans that link rewards to performance. This paper therefore analyzes a survey of employees from multiple companies to assess the extent to which employees are ignorant about company, group, and individual-based incentive pay plans and ESOPs. The findings reveal significant amounts of employee ignorance in both under- and overstating the extent to which such plans apply to them individually.
Related Links:
The ESOP Association announced that they have submitted comments to the IRS concerning the
Sample Plan Language for IRC Section 409(p) Transfers:
August 18, 2008 (Washington, DC) – On August 15, 2008, The ESOP Association submitted comments to the Internal Revenue Service (IRS) concerning Sample Plan Language for Section 409(p) Transfers. Section 409(p) ensures that an S ESOP arrangement is a broad-based employee ownership plan. The comments asked the IRS to make clear that the sample language represents a permitted approach to correction but is neither mandatory nor the exclusive method for preventing a possible violation of the complex provisions of 409(p). The ESOP Association comments included language changes that would expand the situation to which the preventative approach could apply. "
The comments were drafted by Laurence A. Goldberg, Susan Lenczewski, Richard Acheson, and Karen Ng, and were reviewed by Riva Johnson:
We appreciate the efforts of the Service in providing this assistance to taxpayers affected by Section 409(p) of the IRC. In our view, the SPL may be helpful in certain limited circumstances, but may not be the preferred method of correction in many other circumstances. For this reason, (1) we request that the Service make clear that the sample language represents a permitted approach to correction, but is neither mandatory nor the exclusive method for preventing a possible violation; and (2) we enclose suggested language changes to the SPL that would expand the situations to which this preventive approach could apply. Please see the enclosed version, which is redlined to show our suggested changes.
The comments discussed the following:
We recently discussed EBO Group in Using Innovation and Employee Ownership to Achieve Continuous Success, Diversify Lines of Business, Retain Employees, and Address Succession Planning Objectives. "Why would you want to turn your employee-owners into venture capitalists?" is from this year's Ohio Employee Ownership Center's (OEOC) annual conference and tells the story of EBO Group from the Chairman's perspective:
So why would you want to turn your employee-owners into venture capitalists?
Faster growth—if you're not happy with the growth that you have, maybe you should be looking at doing something like this.
Greater profits—we have definitely seen greater profits focusing on growth markets and doing some reinvention.
Job creation.
Excitement—there is definitely a lot of excitement when you start something new within your organization.
Diversification—if you are stuck on one market and riding the cycle of that market, diversifying can definitely help. It can especially help out in the shop where peoples' jobs are dependent on a steady flow of work. By stretching, by diversifying, you can switch the shop employment from one side of the business to the other side, and we have seen a real benefit in doing that.
But the number one reason, the thing we all love, is to watch our stock grow, and it is a great way to grow your stock value.
These are all good reasons for thinking about starting a new venture within your ESOP.
It also discusses the natural advantages ESOP companies have over other companies, where you can find ideas for new ventures, and funding.
The August 14, 2008 Employee Ownership Update is online and discusses the following:
Using Innovation and Employee Ownership to Achieve Continuous Success, Diversify Lines of Business, Retain Employees, and Address Succession Planning Objectives
The Update discusses how EBO Group, a Sharon Center, Ohio based ESOP holding company, engages their employees to be innovative, enabling them to enter new markets and constantly redefine themselves. EBO Group, or Excellence By Owners, defines their company structure and ownership culture on their company website:
EBO Group, Inc. is an innovative employee-owned company structure comprised of subsidiary companies that develop and commercialize products for a variety of markets.
As its name suggests, EBO Group, or Excellence By Owners, is dedicated to the concept of employee-owners working towards a common goal of continuous success through Excellence at every level of the operation. All EBO Group employee-owners share in the rewards of the success enjoyed by each of the subsidiary companies. This structure motivates the organization to flourish in a culture of teamwork and inter-company cooperation. Resources shared across the entire EBO Group create a unique agility, promoting rapid reaction to market opportunities and is the basis for exceptional customer service.
Employee-ownership is a valuable long-term benefit which attracts and keeps talented individuals at all levels of the organization; it fosters creativity and a spirit of entrepreneurial innovation in a vibrant work environment. It is a roadmap for succession planning, offering a long-term business stability that is a key to building lasting relationships with suppliers and customers.
From concept to design to manufacture to quality assurance and ultimate customer satisfaction, the employee-owners of EBO Group take pride in living up to their name, Excellence By Owners.
2007 eVolution of Manufacturing: EBO Group Inc., Leading the brainstorm provides more details by exploring how the company identified two risks, having a product line in a single industry and a lack of ownership transition and management succession planning, and responded by using the above-mentioned innovation and employee ownership to expand into other industries and have systems in place to continuously implement change. As part of this effort, they require each employee to submit a one-page EBO – Excellence By Objective Form:
"Every quarter, each employee turns in a one-page EBO form to his or her supervisor that includes ideas for change or projects they want to pursue in addition to their normal duties... "The best ideas in your company come from the people that actually are doing the work," says President Keith Nichols. "Every company's got to go through some constant change, be it major or minor, to keep up with whats going on in their industry and what's going on in the general marketplace. If they don't do that, eventually they'll become a dinosaur. Its a necessity for long-term survival."…Nichols believes in giving employees the freedom to come up with their own ideas and giving permission to pursue them. "A lot of companies make the mistake that they don't allow people to pursue what their passions are," he says. "If we can pursue somebody's passion, and it fits our business model, that's what we'll do."
Final Cost Accounting Rules
The Update revisits the final rules for Accounting for the Costs of ESOPs Sponsored by Government Contractors, noting how they have removed most of the uncertainty of how the costs of funding an ESOP would be reported:
Under these rules, reimbursements will be for the market value of the shares at the time a contribution is made. In a leveraged ESOP, this means the cost basis of the shares when purchased, not the accounting value under the American Institute of Certified Public Accountants' Statement of Position (SOP) 93-6, which requires a compensation charge based on the value of the shares released at the time they are released. Under the new rules, the cost will be assignable to a cost accounting period only to the extent an allocation is made to participant accounts by the tax return filing date, including any permissible extensions. For leveraged ESOPs, the allowability of the costs will follow Federal Acquisition Regulation Part 31, which allows companies to charge the costs of principal and interest on an ESOP loan provided the stock is acquired at fair market value.
It also recognizes some uncertainty about dividends used to repay a loan:
The rules also state that dividends used to repay a loan are allowed as a cost. However, there is some uncertainty about this as a Boston office of the Cost Accounting Standards Board recently denied reimbursement for dividends.
Broad-based Equity Awards
The Update discusses Give Everyone a Prize? Employee Stock Options in Private Venture-backed Firms, a 2005 study that found that broad-based equity awards in venture-backed companies are common and effective:
This study investigates the impacts on the equity values of private venture-backed firms of the organizational depth to which they grant employee stock options. I develop two hypotheses. First, applying the reasoning of Demsetz and Lehn (1985), I propose that firms’ equity values will be unrelated to the optimal component of stock option grant depths. Second, I hypothesize that firms’ equity values will be more negatively related to the suboptimal component of stock option grant depths when options are not granted deeply enough than when they are granted too deeply. The latter asymmetry stems from the differential contribution of senior versus junior employees to equity value. Using the fitted and residual values from a model of stock option grant depths in private venture-backed firms as proxies for the optimal and suboptimal stock option grant depth components, I find evidence consistent with these hypotheses.
The ESOP Association website describes Employee Ownership Month (EOM):
For almost 20 years, The ESOP Association and its member companies have been celebrating Employee Ownership Month every October. It is a celebration of the incredible spirit of employee ownership and an opportunity to educate employee owners about the tremendous benefits of employee stock ownership plans (ESOPs).
It is also an opportunity to educate the public, elected officials, and the media as to why employee ownership through ESOPs is good public policy.
Companies celebrate with picnics to honor their employee owners, hold roundtable discussions with local public officials and organizations to spread the word about employee ownership, and some hold awards ceremonies to honor outstanding employees.
It also contains a link to the Employee Ownership Month 2008 Press & Event Planning Kit, a 52-page guide that covers the following:
The Public Relations Strategies section provides some tools to promote your EOM event:
The Kit also includes a list of suggested event ideas:
October is Employee Ownership Month – Plan to Celebrate! also discusses EOM and how, in addition to celebrating employee ownership, it is a time to "gain a deeper understanding of their ownership programs and share this powerful business strategy with others," as well as a time to recognize the efforts of your employees, start or revisit your educational programs, and market your employee ownership efforts to your customers and community:
Share your ownership culture with others during Employee Ownership Month by throwing an open house and inviting the media, elected officials and potential clients to celebrate with you. Take out an ad in your local newspaper or pursue radio and television interviews. Use an employee breakfast, picnic, teambuilding retreat, or essay or poster contest to call attention to this unique approach to doing business.
Additional Information and Ideas
A recent order by the United States District Court Northern District of New York, Lilly v. Oneida Ltd. Employee Benefits Administrative Committee, Case No.6:07-CV-0340 (NPM/GJD) (N.D.N.Y. May 8, 2008), found that the Oneida participants can continue their claim of fiduciary breach.
The plan in question was a defined benefit plan with a floor-offset ESOP arrangement. The last time you may have heard of this arrangement was with Enron, which ironically was being discussed in this PBGC testimony describing floor-offset ESOP arrangements:
Under the floor-offset arrangement, the benefit computed under the final pay formula was "offset" by the benefit amount the ESOP account could provide. For example, consider a participant who began working for Enron during the years the floor-offset arrangement was in effect. Assume the participant's final pay formula benefit is $600 per month, and the ESOP is able to provide $400 per month at retirement. The participant would receive the ESOP account plus $200 per month from the defined benefit plan ($600 minus the $400 ESOP offset). As this example shows, the participant would receive a combined benefit that was never less than the benefit under the final pay formula ("the floor"). If the ESOP is able to provide more than $600 per month, the participant would receive the entire ESOP account but would not be entitled to a benefit from the defined benefit plan (because the $600 was fully offset by the ESOP)…
Enron's floor-offset arrangement is not common. The Omnibus Budget Reconciliation Act (OBRA) of 1987 generally banned ESOP offset arrangements in which more than 10% of the combined asset values of the defined benefit plan and the ESOP plan are invested in employer securities. However, OBRA contained a "grandfather" provision that permitted ESOP offset arrangements that were already in existence to remain in effect. Enron's floor-offset ESOP arrangement and those of about 150 other companies were permitted under the "grandfather" provision.
The company filed for bankruptcy in 2006 and the PBGC took over the defined benefit plan and argued that the participants would still receive payment by the PBGC and therefore not lose any benefits. The participants argued that the floor-offset ESOP arrangement was a funding mechanism for the DB plan and that they lost rights as a result of the fiduciary breach, including the following:
Six Signs You Don't Care About Workers shares six indicators that employees are not a top priority:
We have extensively discussed LaRue v. DeWolff, Boberg & Assoc. Inc., No. 06-856 (Feb. 20, 2008). We have also discussed Cook v. Campbell, 482 F. Supp.2d 1341 (M.D. Ala. 2007), one of the first cases to consider LaRue's impact on individual claims involving an ESOP. The district court case rejected the attempt to revive a fiduciary breach case. Alabama District Court Rejects Application of LaRue in ESOP Participant Suit provides a detailed analysis of the case and some important takeaways:
The Cook decision is important in a post-LaRue world because of the careful distinctions that the district court has drawn between 401(k) plans and ESOPs, essentially treating ESOPs more like defined benefit plans subject to the Supreme Court's prior holding in Russell, which requires that damages in ERISA cases flow through the plan for the benefit of all plan participants. The decision is also encouraging as it shows that at least one court has not interpreted the LaRue decision to be as broad as many have opined that it would be.
The latest Employee Ownership Blog post, Future of ESOPs, contains a discussion of where the ESOP industry sees ESOPs and employee ownership in twenty years:
U.S. Sugar's sweet deal provides a detailed look at Florida's Purchase of the 187,000 Acres of Land Owned by U.S. Sugar Corp., including a review of the outstanding U.S. Sugar ESOP litigation:
The company is privately owned, so valuing it is tough, as there is not a public market in the company's shares. The company is controlled by the Charles Stewart Mott Foundation and its benefactors, including the longtime chairman of the company, William S. White, who is married to Mott's granddaughter. Even though the Foundation owns just 19 percent of the shares, it controls the complicated process of picking the board of directors and therefore keeps control within the Mott family. Employees own 38 percent of U.S. Sugar, through an Employee Stock Ownership Plan (ESOP) started in the 1980s.
One indication of a value for the company, then, is what it has paid employees who retire and cash out their ESOP shares. And that value is at the heart of a federal lawsuit now being contested in West Palm Beach.
Some former employees maintain they were low-balled by the company when they were paid $180-$204 a share over the past five or six years. Especially since, unknown to them at the time, a suitor was offering U.S. Sugar's board much more. Nashville banker, agriculturalist and investor Gaylon Lawrence twice in the past three years offered to pay $293 a share for the sugar company. And he thought he had a deal; in August 2005, according to the federal lawsuit, Lawrence reached an agreement with U.S. Sugar's then-CEO, Robert Dolson, for the $293-a-share purchase -- which the lawsuit calls "an extraordinarily valuable offer" that was 50 percent higher than what employees were being paid for their shares and 91 percent higher than the shares' fair market value that some charity shareholders declared in IRS filings.
U.S. Sugar's board apparently didn't appreciate the offer, according to the lawsuit. Suddenly, Lawrence found Dolson out of the picture, suddenly retired with an unexpected $10 million payment from the board. White took over negotiations and in 2006, the board voted to reject the offer, which Lawrence repeated in 2007 with the same result.
The employees' lawsuit portrays the company as buying up their shares at rock-bottom prices and then retiring those shares, increasing the size of company insiders' holdings without having to buy a single share personally. As mechanization replaced the need for employees and those workers' shares were retired, the Mott family's holdings became more and more valuable. Just in time for the state's offer of $350 a share.
The article also contains comments from Corey Rosen, executive director of the National Center for Employee Ownership (NCEO). He notes that since the ESOP owns a minority interest, the value is going to be less than that of a controlling interest. He also discusses the outstanding litigation and whether the state is overpaying for U.S. Sugar:
Rosen said the lawsuit over the value of the ESOP shares is pretty typical for ESOP litigation and that it will be very hard to win for the employees. He also said it is very difficult to tell if, based on the company's own valuation of shares for employees, whether the state is overpaying for U.S. Sugar.
"It's a complicated, detailed process to wade through all the financials," he said. "It's hard to say on its face did the state pay too much, even though there had been other lower offers for the company."
The July 31, 2008 Employee Ownership Update is online and discusses the following:
The Update discusses how a recent study of S Corp ESOP Legislation Benefits and Costs found that S ESOPs are a net gain for taxpayers:
The increased performance of ESOP companies, plus the fact that foregone taxes on earnings are ultimately paid by employees when they start to take benefits out some time after termination, mean that S ESOPs are a net gain for taxpayers. In addition, when employees do pay tax on their distributions, they pay on the basis of (generally) appreciated stock, with part of that appreciation due to the company's ability not to pay taxes in the interim. Given assumptions about their tax rates, the authors conclude that, on balance, the Treasury is likely to end up with more revenue this way than if the income was taxed earlier.
The Update also discusses private letter ruling (PLR) 200827008 and the reason that ESOP companies enter into a Price Protection/Floor Price Agreements:Many ESOP companies have multiple ESOP transactions. In some companies, after the first purchase of shares, often 30% to 50%, a second transaction is done to buy more shares. Other companies that are 100% ESOP-owned do additional leveraged transactions to acquire other companies. In either case, the new debt taken on can lower the price of the shares already in the plan. To deal with this, many ESOP companies offer some kind of price protection for existing participants. Sometimes that is limited to people over a certain age and/or to people getting distributions in the next x number of years. A floor price is set, and the company makes up the difference, if any, when the distribution is made.
The cases against Bear Stearns provides an update on more than 20 lawsuits related to the Bear Stearns transaction, including litigation from former participants in the ESOP:
Former employees vs. Bear
A handful of former employees who were investors in the Bear Stearns' Employee Stock Ownership Plan (ESOP) allege that senior Bear executives, among others, breached their fiduciary duties by failing, among other things, to prudently manage the ESOP's investment in Bear stock and inform employees about the risk of that investment.
Study: S ESOP Companies Create Jobs and Savings for Workers and Have Higher Productivity, Profitability, Job Stability, and Job Growth discussed a new study that found that S ESOPs create new jobs and savings that would not have otherwise been earned. Here is the abstract for S Corp ESOP Legislation Benefits and Costs: Public Policy and Tax Analysis:
Samuel Zell's acquisition of the Tribune Company in December 2007 using an S corporation employee stock ownership plan (S ESOP) brought S ESOPs to national attention. An S ESOP is a trust that holds shares of an S corporation (a closely held corporation whose shareholders are taxed on a pass-through basis similarly to partners in a partnership) for the benefit of the corporation's employees. S ESOPs, which have only existed since 1998 are not as well known as C ESOPs, an ESOP that holds shares of a C corporation (a separately taxed corporation). Enron, Polaroid and United Airlines, all of which had ESOPs when they went bankrupt, were C corporations.
Perhaps because they have only existed for ten years, little academic attention has focused on S ESOPs. In this paper we draw on the extensive existing employee ownership literature to describe the benefits and costs to employees, to firms and to society at large from the legislation that authorizes S ESOPs, and, where possible, we quantify these costs and benefits. We estimate that annual contributions to S ESOPs on behalf of employees total $14 billion, which represent additional compensation that would not have been paid without an ESOP. Annual gains attributable to increased job stability also save employees approximately $3 billion annually. Accumulated stakes, which are essentially forced savings and usually do not displace other savings, lead to additional annual accruals of $34 billion. Employers pay for ESOP contributions out of firm-level productivity and sales gains of $33 billion annually attributable to employee ownership. We estimate that one quarter of the annual gain, $8 billion ultimately goes to the federal treasury, which thereby also benefits from the adoption of S ESOPs.
The working paper covers the following:
UPDATE 8/6/08: The study results are discussed in S ESOPs Create More Revenue for the Treasury.
What is a price protection or floor price agreement?
When an ESOP borrows money, the debt and related interest expense taken to finance the shares is an additional liability of the company. Although this liability will be partially offset by the tax benefits of an ESOP, it will still reduce the post-transaction value of the company. This temporary reduction in value will get smaller as the loan is repaid.
When an ESOP enters into a second stage transaction (a.k.a. any purchase after the initial one), the value of the company will experience another post-transaction reduction in value. This decline could negatively impact ESOP participants and the other shareholders of the company if they are looking to take a distribution of their account or sell their shares. In order to protect the participants holding the pre-transaction ESOP shares, the ESOP can negotiate a price protection agreement, often referred to as a floor price agreement, which would provide that the company would repurchase the pre-transaction ESOP shares at a minimum guaranteed price. The purpose of the floor price is to protect the participants' accounts, particularly accounts who will be taking a distribution in the near future, from the decline in value from the leveraged transaction. The price can be a fixed price, an adjusted price determined by a formula, or the value determined by the independent appraiser adjusted to remove the effect of the related ESOP debt.
A recent private letter ruling (PLR), PLR 200827008, found that a floor price agreement would not create an additional class of stock for purposes of IRC Section 1361(b)(1)(D) - S corporation defined - In general.
PLR Analysis
(b) Small business corporation
(1) In general
For purposes of this subchapter, the term "small business corporation" means a domestic corporation which is not an ineligible corporation and which does not—
(A) have more than 100 shareholders,
(B) have as a shareholder a person (other than an estate, a trust described in subsection (c)(2), or an organization described in subsection (c)(6)) who is not an individual,
(C) have a nonresident alien as a shareholder, and
(D) have more than 1 class of stock.
(l) Classes of stock—(1) General rule. A corporation that has more than one class of stock does not qualify as a small business corporation. Except as provided in paragraph (l)(4) of this section (relating to instruments, obligations, or arrangements treated as a second class of stock), a corporation is treated as having only one class of stock if all outstanding shares of stock of the corporation confer identical rights to distribution and liquidation proceeds. Differences in voting rights among shares of stock of a corporation are disregarded in determining whether a corporation has more than one class of stock. Thus, if all shares of stock of an S corporation have identical rights to distribution and liquidation proceeds, the corporation may have voting and nonvoting common stock, a class of stock that may vote only on certain issues, irrevocable proxy agreements, or groups of shares that differ with respect to rights to elect members of the board of directors.
(2) Determination of whether stock confers identical rights to distribution and liquidation proceeds—(i) In general. The determination of whether all outstanding shares of stock confer identical rights to distribution and liquidation proceeds is made based on the corporate charter, articles of incorporation, bylaws, applicable state law, and binding agreements relating to distribution and liquidation proceeds (collectively, the governing provisions). A commercial contractual agreement, such as a lease, employment agreement, or loan agreement, is not a binding agreement relating to distribution and liquidation proceeds and thus is not a governing provision unless a principal purpose of the agreement is to circumvent the one class of stock requirement of section 1361(b)(1)(D) and this paragraph (l). Although a corporation is not treated as having more than one class of stock so long as the governing provisions provide for identical distribution and liquidation rights, any distributions (including actual, constructive, or deemed distributions) that differ in timing or amount are to be given appropriate tax effect in accordance with the facts and circumstances
(iii) Buy-sell and redemption agreements—
(A) In general. Buy-sell agreements among shareholders, agreements restricting the transferability of stock, and redemption agreements are disregarded in determining whether a corporation's outstanding shares of stock confer identical distribution and liquidation rights unless—
(1) A principal purpose of the agreement is to circumvent the one class of stock requirement of section 1361(b)(1)(D) and this paragraph (l), and
(2) The agreement establishes a purchase price that, at the time the agreement is entered into, is significantly in excess of or below the fair market value of the stock.
Agreements that provide for the purchase or redemption of stock at book value or at a price between fair market value and book value are not considered to establish a price that is significantly in excess of or below the fair market value of the stock and, thus, are disregarded in determining whether the outstanding shares of stock confer identical rights. For purposes of this paragraph (l)(2)(iii)(A), a good faith determination of fair market value will be respected unless it can be shown that the value was substantially in error and the determination of the value was not performed with reasonable diligence. Although an agreement may be disregarded in determining whether shares of stock confer identical distribution and liquidation rights, payments pursuant to the agreement may have income or transfer tax consequences.
(B) Exception for certain agreements. Bona fide agreements to redeem or purchase stock at the time of death, divorce, disability, or termination of employment are disregarded in determining whether a corporation's shares of stock confer identical rights. In addition, if stock that is substantially nonvested (within the meaning of §1.83–3(b)) is treated as outstanding under these regulations, the forfeiture provisions that cause the stock to be substantially nonvested are disregarded. Furthermore, the Commissioner may provide by Revenue Ruling or other published guidance that other types of bona fide agreements to redeem or purchase stock are disregarded.
(C) Safe harbors for determinations of book value. A determination of book value will be respected if—
(1) The book value is determined in accordance with Generally Accepted Accounting Principles (including permitted optional adjustments); or
(2) The book value is used for any substantial nontax purpose.
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