Adapting Your ESOP Plan Design for Generation Y

As you know from reading this blog, we have discussed Employee Motivation and how communications and motivational techniques may be more effective if the Motivational Buttons of each generation are targeted. Employee Ownership: Adapting a Powerful Business Strategy to Attract and Retain the Next Generation of Talent discusses how employee ownership structures will need to be adjusted for the values and career goals of the next generation of talent (often referred to as Generation Y or the Millennials). The article notes that 80% of the "100 Best Companies to Work For" have an ESOP or other form of employee ownership. It also discusses the imminent shortage of talent as predicted in The War for Talent and asks if employee ownership is the "magic bullet" to attract and retain the talent of the future:

The answer is no, not unless employee-owned companies modify employee ownership to appeal to the next generation.

Companies have created many different ways to unleash employee ownership's capacity to increase productivity and loyalty and develop a team of driven employee-owners. Research has shown that what really makes it work is offering enough ownership to have a significant impact on employees' financial future, helping people feel and think like the owners they are, and creating a shared understanding of the company's performance and a common commitment to enhancing it. Building upon these established tactics, modifications will need to be made to attract the next generation of workers whose priorities and lifestyles are very different than those of their parents.

The article notes that allocations based on compensation (e.g. contributions) and tenure (e.g. dividends) can be discouraging to high-performing younger employees, and suggests some plan design changes to make an employee ownership strategy more powerful in the next generation:

To start, employee-owned companies can eliminate their minimum-age requirement for ownership, shorten the hours of service required before allowing participation in the ownership program and offer early program entry dates. Shortening vesting schedules and permitting early diversification would make retirement-based ownership programs more transferable. Adding nonretirement- based ownership programs would allow younger employees to take advantage of the short-term benefits of ownership if they so chose. By making the above modifications to an employee ownership program, employees can think about their ownership as more portable and more accessible.

It also discusses adjusting the education program to provide more emphasis on planning for the future, sharing a summarized version of the actual valuation report, and including the stock price history and average account balance growth on the annual statements.

In the News: Using an ESOP to Quickly Transition Ownership and Management

Atlas Steel Products Co. (Twinsburg, OH)

Atlas Employees Purchase Company discusses how Atlas Steel Products Co. has established an ESOP. The ESOP acquired 100% of the company from the family of the owner, who died in April:

John Adams, formerly Atlas' chief financial officer, has been named president and CEO, responsibilities he assumed a year ago when Burr became ill. Adams said Atlas' management team, in place for the past 10 years, was united in its wish to acquire the company and continue operations in the spirit created by its late owner and chief executive.

"Bo always wanted Atlas to reflect the empowerment of all associates who work here," Adams says. "He always treated associates as owners, and under Bo's leadership each major decision was a true group effort. So it was only natural that we pursue an ESOP. We are grateful to be in a position to execute a transition that we believe will lead to Atlas Steel's continued growth and success."

Following Burr's death, the current management team along with National City Bank put together a plan to transition Atlas into a 100 percent ESOP by mid-summer.

ESOP-Owned CPA Firms, Succession Planning for CPA Firms

The 2008 PCPS Succession Survey provides succession planning revelations, conclusions, and recommendations for CPA firms:

Change is a constant. It isn't something that will happen when certain partners retire; it's something that occurs in firms now, every day. Although the retirement of founding or current partners at some point in the future seems like a milestone event, it will be only one detail in the life of the firm. Succession planning is about sustaining the firm throughout constant change. It should be a regular and ongoing practice.

Creating a written succession plan is a prudent step in the succession planning process. However, very few firms appear to have accomplished this goal. In the 2008 Succession Survey, 35% of multi-owner firms and 9% of sole proprietors (sole owner firms and sole practitioners) had a written succession plan in place, compared to just 25% of multi-owner firms and 8% of sole proprietors in the 2004 survey. While this is an improvement, the profession still has a long way to go. Many firms appeared, however, to understand the importance of succession planning. A total of 67% of multi-owner firms and more than 50% of sole proprietors believed succession planning would be a significant issue for them in the near future. Actual progress had not yet occurred in most cases.

While the 32-page guide takes a look at various succession planning issues, there is not one mention of an ESOP or employee ownership in the guide. This is very unfortunate, as all private companies, including CPA firms, will benefit from considering ESOPs and employee ownership in their succession and business transition planning process. Here are some recent stories about ESOP-owned CPA firms:

• Burr Pilger Mayer (BPM), the largest non-"Big Four" CPA firm in the San Francisco Bay Area, recently announced that they have established an ESOP for its 325 employees:
  
  Mayer noted that the ESOP not only provides new benefits for employees, but also assures that a solid succession plan is in place for those moving up the ladder to partner, as well as those partners approaching retirement. "This is a perfect opportunity for all of us to grow together," he said.

• Succession Strategies - Using an ESOP for Succession Planning discusses ESOPs for CPAs and other professional services companies. It cites HLB Tautges Redpath, Ltd., a 100-percent employee-owned accounting firm, as an example. It was the winner of the 2008 ESOP Company of the Year by the Minnesota/Dakotas Chapter of the ESOP Association:
  
  Through the implementation of employee ownership, the leaders of HLB Tautges Redpath, Ltd. are sharing the pride and responsibility of ownership with employees, planning ownership succession for current and future shareholders, and dispersing profits from growth with all qualified employees annually.
  
  
• Indiana-based CPA firm Katz Sapper & Miller (KSM) is also partially-owned by an ESOP. ESOP funds KSM buyback discusses how their ESOP serves as a powerful retention tool.
  
  An ESOP gives us the opportunity to let everyone participate in the ownership of the company," Miller said. "It's a wonderful retention tool. Many kids coming off campus are influenced by stock-option opportunities. This ESOP goes down that path."
  
  It also discusses one of the major obstacles to ESOP-owned accounting firms. Generally a company must be a C Corporation or an S Corporation. However, if you are a sole proprietorship, LLC, partnership, or other business entity, the business entity could be converted into a C Corporation or S Corporation prior to the creation of the ESOP.
  
  Most accounting firms are configured as limited liability partnerships or professional corporations, which don't allow employee ownership beyond the principals. But Katz Sapper's purchase of KSM, its consulting and tax services entity, cleared the way for the move. KSM, an S corporation that pays no federal tax, owns the entire Katz Sapper accounting practice and, thus, can be employee-owned.
  
• SS&C Business & Tax Services, Inc. is "a tax and accounting services firm, which is over 50% employee owned through an ESOP."

If you are aware of any other ESOP-owned CPA firms, please let me know and I will add them to this post.

Succession Survey

For your reference, I have included a partial outline of the topics discussed in The 2008 PCPS Succession Survey:

1. Succession Planning Overview
   
   
   1. Developing Future Leaders
      
      
2. Succession Planning – Multi-Owner Firms
   
   
   1. Expectations for Owners' Retirement
      
   2. Retirement Agreements
      
   3. Owner Compensation — Existing Owners and Retired Owners
      
   4. Owners' Involvement with Firm after Retirement
      
   5. Calculation of Retirement Buyouts
      
   6. Occurrences That Will Force a Change in Duration or Amount of Buyout
      
   7. Owner Non-Compete Provisions
      
   8. Transitioning Soon-to-Be-Retired Owners and Their Clients
      
   9. Challenges Firms are Trying to Address That Hamper Succession Planning
      
   10. Likely Transition of the Firm when the Senior Owners Retire
       
   11. The Firm Environment and People Management in Multi-Owner Firms
       
   12. Creating an Environment to Facilitate Succession Transition
       
       
3. Succession Planning – Sole Proprietors
   
   
   1. Succession planning at sole proprietor CPA firms
      
   2. Practice Continuation Agreements
      
   3. Non-compete Clause for Disabled/Retired Owner/Proprietor
      
   4. Buy-Back of Practice Should Disability Heal
      
   5. Plans for Existing Employees
      
   6. Short-Term Disability: Quality Controls to Ensure Work Quality
      
   7. Client Transitioning Plans in the Case of Retirement
      
   8. The Firm Environment and People Management in Sole Proprietor Firms
      
      
4. Succession Best Practices
   
   
   1. General succession best practices
      
   2. Create the Plan
      
   3. Fix Retirement Issues
      
   4. Develop Future Leaders
      
   5. Succession Planning: The Process
      
   6. Retirement Concerns
      
   7. Developing Future Leaders and Client Transition
      
   8. Sole proprietor succession best practices
      
   9. Create the Plan
      
   10. Consider a Practice Continuation Agreement
       
   11. Practice Continuation Questions
       

Presidential Candidate Senator McCain Declares Support for Employee Stock Ownership Plans (ESOPs)

A press release announces that Republican Presidential Candidate Senator John McCain released a statement declaring his support for ESOPs:

WASHINGTON, Sept. 23 /PRNewswire-USNewswire/ -- Today, The ESOP Association was pleased to receive a statement by Republican Candidate for President, Senator John McCain, declaring his support for employee stock ownership through the employee stock ownership plan (ESOP) model. This statement was conveyed to The ESOP Association by a Senior Policy Advisor to the McCain-Palin Campaign. It reads as follows:

"For millions of Americans owning a stake in the company they work for is extremely rewarding. Many Americans are able to 'work for themselves' through their participation in Employee Stock Ownership Plans (ESOPs). These broadened ownership plans allow American workers the ability to participate directly in the growth and success of the companies for which they work.

About 90 percent of ESOPs are in small businesses with less than 500 employees. We all know that small and entrepreneurial businesses are the lifeblood of the American economy. These businesses that are often unable to match the substantial health care and other benefits that are normally provided by major corporations, due to the cost, are able to provide employees increased retirement benefits and stable employment because of ESOPs. Research has shown that ESOP-owned companies are usually more productive and profitable than other companies, as well as having better survival rates.

For these reasons, I am proud to support ESOP-owned companies and the role they play in the American economy. As President, I would endorse efforts to learn from the successes of ESOP companies and see how their positive impact can be expanded."

The President of The ESOP Association, J. Michael Keeling, had this comment in response to Senator McCain's statement:

"Senator McCain's statement will be welcomed with gratitude by the ESOP community. The Senator is the first candidate for the highest office in our nation to endorse employee ownership through an ESOP and to pledge support for these important national polices since former President Ronald Reagan. Senator McCain's statement wasn't demanded by any interest group or spurred by any questionnaire. He is committed to these goals, and The ESOP Association will share his statement with its 2,500 members and the one million ESOP participants working for Association members. Again, I emphasize that The ESOP Association welcomes Senator McCain's commitment to this cause."

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.

Public and Other Large Company ESOPs

Should Public and/or Large Employers Have ESOPs? discusses the recent Overly Sensational Anti-ESOP Coverage. It mentions a minority opinion that the coverage is not important to the ESOP community because large ESOP companies do not provide "real" ownership and asks if this is a valid position:

So the issue arises, should the ESOP community throw, to use the hottest term in politics, "throw big companies with ESOPs, or even employee stock ownership schemes under the bus?"

From this vantage point, the answer is no. Around 50% of Americans work for large employers, most publicly traded. To say that these people cannot be owners undermines the entire philosophical reason for having employees BE owners. The Association's Vision would have to be changed, as it does not say only employees of small businesses should be owners.

Relevant Discussions in Recent Posts

• Study Asserts Broader Employee Ownership and Participation Improves Company Performance and Social Welfare and Study: ESOP Companies Have Productivity Advantage which Increases with More Employee Participation and Decreases as Firms Get Larger found that the effectiveness of employee ownership may lessen as firms get larger.
  
• Research: Shared Capitalism, Shirking, Workplace Performance, Employee Ignorance, and Innovation found that shared capitalism is more likely to exist in larger companies.
  
• The NCEO's Employee Ownership 100 contains many examples of successful large company ESOPs.

Using ESOPs for Economic Development at the State Level

Employee Ownership as a Model for Securing, Sustaining Business looks at employee ownership as a tool for economic development for the state of Minnesota:

Employee ownership in Ohio

The article uses Ohio as a model for implementing employee ownership models at the state level:

Regardless of the legal structure chosen, Ohio points to employee ownership as a key to industrial stability and sustainability.

The article discusses the involvement of the Ohio Employee Ownership Center (OEOC) and its findings:

Kent State's OEOC has worked with 566 Ohio companies and retiring owners in the past 20 years. A minority of those firms was successfully converted to ESOP ownership. A survey of 118 such companies, however, found that better than 80 percent were equal to or superior to competitive industry peers in profitability, rate of capital investment and growth in employment - important factors for all local and regional economic planners.

Indiana's ESOP Initiative (IEI)

The article references the recent efforts of Indiana's ESOP Initiative (IEI).

Business Information Flow and Academic Discussions

It also stresses the importance of exploring how business information flows from the state level to the local level and to the business community. It also stresses the importance of including ESOPs and other employee ownership in academic discussions:

"And business schools in Minnesota, which seems to be one of the last growth professions in the state, should make sure that students learn about ESOPs, cooperatives and other employee-owned business models."

Takeover Defense Mechanism?

The article mentions using ESOP's as a takeover defense strategy. While this strategy was more common in the 1980s, it is not utilized often today. If you are looking for more historical information, ESOPs in Merger and Acquisitions in Large Companies provides a good discussion of how some ESOPs were used in the 1980s to prevent hostile acquisitions or to save failing companies, often times with bad long-term results.

Other Local Initiatives

Here are some additional initiatives not discussed in the article:

• Vermont Employee Ownership Center (VEOC)
• Minnesota Employee Ownership Fund

Zell and Tribune Class Action Lawsuit

Tribune, Zell Named in Employees' Suit discusses how six current and former L.A. Times reporters have filed a federal class action lawsuit (CV08-06040) alleging that Sam Zall and other Tribune officials failed to uphold their fiduciary duty to the ESOP:

The lawsuit, filed in a Los Angeles federal court, alleges Tribune and Mr. Zell have failed to uphold their fiduciary duty to the company's employee stock-ownership plan, Tribune's majority owner. The lawsuit also claims Mr. Zell and other Tribune officials have improperly raided worker pension funds.

"Zell and his accessories threaten to destroy the Tribune Company and its assets," the lawsuit says. "They are doing so illegally, without consideration for the employee-owners."

In December, Mr. Zell led an $8.2 billion buyout with an unusual twist: The stock plan, known as an ESOP, became the majority owner, while Mr. Zell invested about $315 million in exchange for a promissory note and warrants to buy 40% of the company. The deal weighed down Tribune with nearly $13 billion in debt, but the ESOP structure allowed Tribune to avoid most federal income taxes.

The lawsuit, which seeks class-action status, encapsulates months of employee frustration about Mr. Zell and the buyout deal. As deteriorating newspaper advertising and the deal's debt weigh on Tribune, Mr. Zell has slashed employee rolls and pared news pages at company papers. He has invested in other areas of the company, including Tribune's local television stations.

The plaintiffs are or were newsroom employees for the Los Angeles Times, Tribune's biggest paper and the nexus of complaints about Mr. Zell's oversight of Tribune. The plaintiffs are Dan Neil, a Pulitzer Prize-winning columnist for the L.A. Times; Jack Nelson, a former Washington bureau chief for the paper, and four former writers: Corie Brown, Henry Weinstein, Myron Levin, Walter Roche Jr.

Zell Calls Suit Claims 'Frivolous' discusses Sam Zell's response to the lawsuit:

In a statement Wednesday, Mr. Zell said the lawsuit's allegations are "frivolous and unfounded." He said Tribune would seek to dismiss the case. The plaintiffs are seeking class-action status.

Mr. Zell, who has cast his efforts to remake Tribune as a collective undertaking, has said employees on the whole have embraced changes.

In a note to employees Wednesday, he cast the lawsuit as an affront to that spirit of togetherness. "There is a difference between questioning authority or challenging the 'business as usual attitude,' and maligning the company in public," Mr. Zell said. "That's just bad judgment and does no one any good."

We have discussed the Tribune Company ESOP buyout at length in this blog. Employees File Lawsuit Over Tribune ESOP discusses the complaint and the size of the plans and the potential attorney's fees:

The complaint is not a good read from a pension geek standpoint. In 115 pages, the complaint failed to tell a clear ERISA-related story typical of defined benefit plans which are converted to ESOPs which then lead to litigation. I am hopeful that the forthcoming motions to dismiss or motions for summary judgment will provide more details about the frozen Tribune Company Employees' Pension Plan which was merged into the Times Mirror Pension Plan which had an ESOP then merged into the Times Mirror Savings Plan, and at some point these plans became the Tribune ESOP.

A quick check of the filed Form 5500s reveal that these are not small plans. For example, the Tribune Company Employee Stock Ownership Plan for 2003 had over 11,000 participants and beneficiaries, and total assets of over $800 million. The Tribune Company Master Retirement Savings Trust had over $2.2 billion in assets for the 2006 plan year listed on Schedule H of Form 5500. A really interesting part of this litigation to watch will be the ultimate attorneys fees awarded when this litigation ends.

Putting Newspapers On Trial discusses the case and the state of the newspaper industry:

Sam Zell was sued in Federal Court in California yesterday by a group of current and former Tribune Company employees. They did a lot more than go after the billionaire they say ruined their company--you could make the case that they've put the fast-changing newspaper business on trial, too…

A case like this seems inevitable. Zell has been something of a lighting rod for all that journalists fear about the future of newspapers since taking over Tribune. He has evaluated reporters by how many column inches they produce, turned editorial publications like the Los Angeles Times Magazine over to advertiser control and laid off at least 1,000 employees…

Zell himself is only named in two of the complaint's eight counts. Most counts focus on Tribune's existing and past board of directors, as well as various trustees for the ESOP. The complicated structure of the multi-part buyout deal may be the reason why. Zell was only personally involved in it during an early stage loan to Tribune that funded the repurchase of some of its stock.

At that time, he allegedly convinced the ESOP to pay too much for Tribune in acquiring the rest of its public stock--$38 per share versus a more reasonable value of something under $10.

"The factual scenario is something of a novel one," says Ian Downes, an ERISA litigator with the law firm Dechert. He says cases like this one could drag on for years and can result in millions of dollars in attorney's fees for a plaintiff's firm involved in the suit.

Does a Dying Industry Guarantee Pension Litigation? also ponders the issue:

One thing in particular caught my eye in the article, which relates to its discussion of the underlying problems in the newspaper industry and how it relates to the lawsuit; one of the class plaintiffs comments that those problems are not with the product turned out by the reporters, but with the industry's difficulties with "monetizing the product online." As someone who used to read three newspapers a day in law school and now skims three or more a day on-line and on my blackberry without spending a dime for the content, I can only say amen to that. I am not sure, though, that this point really has anything to do with the validity or viability of the suit itself, other than to the extent of pointing out the underlying problems that gave rise to the transaction that allegedly harmed the ESOP participants and gave rise to the class action. Either way, the story illustrates an important point, which is that there is a need for caution in any transaction of this nature that is going to impact the dollar value of stock held in ESOP plans, in light of fiduciary obligations that run in tandem with such plans.

Employee Ownership Case Studies

Over the last few months we have discussed the Broad Dissemination of Employee Ownership Teaching Materials, the first ever MBA Course in Employee Ownership, and the benefits of including employee ownership in academic discussions. Making Our Way Ever Further Into the Halls of Academe discusses teaching by case study, the "latest rage in business and entrepreneurship education," and how the development and implementation of employee ownership case studies can spread the employee ownership concept:

The Experiential Classroom has been a great platform from which to make the case that employee ownership ought to be a fundamental part of any curriculum in business or entrepreneurship. It also reveals the incredible power of case teaching. Case teaching helps students develop a broad understanding of a subject area, and it offers a way for business and entrepreneurship professors to easily integrate new concepts like employee ownership into their programs.

We have spent the last year developing two employee-ownership-related case studies which, through our connections with students and faculty, have the potential to spread the employee ownership concept farther and faster than almost any other method we can imagine. These studies offer great business education opportunities and raise many significant and widely applicable business issues.

These first two studies, for example, involve issues such as the need to expand the manufacturing capability of a high-tech firm to accommodate higher volume product lines and the need to reconsider the total cost of an employee benefit package in a softening economy. On their own, these case studies are compelling and interesting, but both of the companies studied also share employee ownership as a core value, and that shared core value plays an important role in the issues presented.

Lehman Brothers and More Overly Sensational Anti-ESOP Coverage

Lehman Files for Bankruptcy, Merrill Sold discusses the recent news involving Lehman Brothers Holdings Inc. and Merrill Lynch & Co., who were both mentioned after the Bear Stearns sale as being companies that were more than 25% employee-owned. UPDATE: Lehman Workers Brace For The Worst discusses the impact of the Lehman bankruptcy on the employees and once again uses a broad brush to paint employee ownership negatively:

A further blow is that about 25% of Lehman is employee-owned, which means that most employees lost their savings as well as their job.

"Shareholders are toast," Jay said, and strongly criticized employee-stock ownership plans in general.

"From an employee standpoint, it's one of the worst things to get," he said. " You're definitely taking on more risk if you work for an entity that pays you in part with stock."

We recently experienced More of the Same overly sensational anti-ESOP coverage of the Fannie Mae and Freddie Mac bailouts. It is essential that the ESOP community continue to Counter Negative ESOP Coverage with the Facts. While we wait to learn more about the employee ownership details of Lehman Brothers, keep the following in mind:

• Studies have shown that a typical ESOP participant has about three times the total retirement assets of a non-ESOP participant.
  
• Studies have shown that ESOP companies are more likely to have another diversified retirement plan than non-ESOP companies.
  
• A typical ESOP participant has diversified assets about equal to those of the non-ESOP participant.

ESOP Companies More Likely to Use SARSs or Phantom Stock, HR 6419, and 409(p) SPL

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

• New NCEO Survey Looks at Use of Equity Compensation Plans in Private Companies
  
• Bill Would Provide Tax Exclusion for Employer Stock Held for 10 Years
  
• IRS Publishes Sample 409(p) Language
  

The Update discusses a new NCEO survey that looked at the use of equity compensation plans:

We found that 67.5% of the non-ESOP companies used stock options, with 27.5% using restricted stock and 23.0% using stock appreciation rights or phantom stock. ESOP companies were much likely to rely on stock appreciation rights or phantom stock (56.9%), with 41.2% using options, and 26.1% using restricted stock.

It also discusses H.R. 6419: To amend the Internal Revenue Code of 1986 to exclude from gross income compensation received by employees consisting of qualified distributions of employer stock, which would exclude from gross income compensation received by employees consisting of qualified distributions of employer stock, and notes that the bill will likely face opposition because of the risk of holding employer stock for an extended period.

The Sample Plan Language (SPL) for IRC Section 409(p) Transfers and The ESOP Association Comments on the SPL are also discussed in the Update. The Update notes that the SPL should be considered sample language and not mandatory:

Other parts of the suggested plan language deal with the order of the transfers, taking shares first from those with the largest number of ESOP and deemed-owned shares. An IRS spokesman told BNA that the language was simply sample language that would automatically pass a compliance test; it did not preclude other approaches.

What Business Professionals Should Know About Employee Ownership

Employee Ownership: What Every Professional Service Provider Ought to Know discusses what all business professionals should know about employee ownership:

• Employee Ownership: Good for the Bottom Line – In addition to being a recruiting and retention tool, providing employees with some of their compensation in equity reduces the cash wage rate and encourages employees to minimize expenses. Most importantly, employee ownership can improve the financial results of the company:
  
  

  But in the long run, the most compelling reason that business leaders are interested in establishing some form of employee ownership is the extensive compilation of research studies that have consistently found that companies achieve better financial results with employee ownership than without it. Employees who have a stake in the performance of the company show greater concern for the company's financial results and apply themselves in more productive ways to reach that goal. The icing on the cake is that, not only does the company become more productive, but the job of managing and directing the company becomes easier and more enjoyable since the whole team lines up behind the goal of business results, embracing the things that make "their" company more successful and valuable.
  

• Selecting the Right Tools from the Tool Box – Employee ownership vehicles include ESOPs, stock purchase plans, stock options, synthetic equity, nonqualified deferred compensation, restricted compensation, etc.
  
  
• ESOP: the Supercharged Tool for Ownership Sale/Transfer to Employees – The article notes how an ESOP can be an "unbeatable route" for a business owner looking at business transition alternatives.
  
  
• Breathing Life into the Concept: Ownership Culture – Studies have demonstrated that ESOP companies with a high level of participation and a consistent ESOP communication and training program are more productive and grow faster than non-ESOP companies:
  

  Keep in mind that the performance improvements that have been seen at employee ownership companies have come about because the employees have adopted new and better attitudes about their company and their work. These healthier attitudes generate more productive behaviors in the employees – behaviors like treating customers more politely; sticking with a task to be sure it is done completely to the last detail; cooperating with colleagues to complete a complex project in the best way rather than engaging in turf battles and angling for personal credit. These new behaviors do not spring instantly and automatically into existence because the employees have received a stock option grant or an award of shares in an ESOP account. Rather, management needs to educate employees about the whole picture – what the employee ownership program is, how it works, and exactly how superior company performance will ultimately put wealth in their pockets. Once a shared understanding of this new opportunity is established, management can encourage a healthy, team-oriented, goal-focused way of operating, with an esprit de corp that celebrates company successes and builds pride on the part of employee-owners in "their" company.

September 12 Deadline for Certain ESOP Transactions

California’s Franchise Tax Board (FTB) Notice 2008-4 – Resolution of Certain ESOP Transactions discussed the opportunity for taxpayers who filed a tax return that included "certain ESOP transactions" to resolve their accounts to avoid the noneconomic substance transaction (NEST) penalty. In order to resolve the "certain ESOP transactions" that may be subject to the NEST penalty, taxpayers must submit a signed and completed closing agreement by today (September 12), and pay all tax, penalties, and interest.

Ralston Purina Co. v. Commissioner, 131 T.C. No. 4 (September 10, 2008)

Deductible Redemptive Dividends Used to Fund ESOP Distributions discusses how the courts allowed a company to use redemptive dividends to make distribution payments in Boise Cascade Corp. v. U.S. (9th Cir., No. 01-36086, 5/20/03) and General Mills v. United States, No. 06-3547 (D. Minn. 1/14/08).

Yesterday, the Tax Court held in Ralston Purina Co. v. Commissioner, 131 T.C. No. 4 (September 10, 2008) that IRC Section 162(k) – Stock reacquisition expenses renders payments to an ESOP that were distributed to terminated participants nondeductible under IRC Section 404(k) because they are in connection with a redemption of stock:

P, a Missouri corporation, claimed a deduction under I.R.C. sec. 404(k) for payments made to its employee stock ownership plan in redemption of P's preferred stock owned by the plan, where the proceeds of that payment were distributed to employees terminating their participation in the plan. R argues that payments to redeem stock are not deductible under either I.R.C. sec. 404(k)(1) or (5), or in the alternative that deduction of these payments is barred by the provisions of I.R.C. sec. 162(k).

Held: I.R.C. sec. 162(k) renders the payments nondeductible because the payments are in connection with a redemption of stock. The result to the contrary reached by the U.S. Court of Appeals for the Ninth Circuit on almost identical facts in Boise Cascade Corp. v. United States, 329 F.3d 751 (9th Cir. 2003), respectfully will not be followed.

Tax Court Denies Deduction for Payments Made to Redeem Preferred Stock Held by ESOP; Declines to Follow Ninth Circuit provides a summary of the case:

The taxpayer claimed a deduction under section 404(k) for payments made to redeem preferred stock held by its employee savings plan (the proceeds were then distributed to retiring or terminating employees). The IRS countered that these payments were essentially equivalent to redemption dividends (under section 302(b)(1)) and therefore were not deductible.

Before the Tax Court, the taxpayer asserted that a deduction for the payments to redeem the preferred stock was allowable and in support of its argument, relied on a decision of the Ninth Circuit in a case based on almost identical facts—Boise Cascade Corp. v. United States, 329 F.3d 751 (9th Cir. 2003) (ESOP preferred stock redemption payments were allowed as deductions because the distribution payments made to withdrawing ESOP participants were not made "in connection with" redemption of stock; accordingly, section 162(k) did not apply).

The Tax Court disagreed and because an appeal from this case would lie with the Eighth Circuit, declined to follow the decision of the Ninth Circuit. Here, the Tax Court found that section 162(k) precludes a deduction of the redemption payments, and specifically rejected the Ninth Circuit's interpretation of the phrase "in connection with."

Tax Court Refuses to Follow 9th Circuit, Says § 162(k) Precludes Deduction for Payment Made to ESOP for Stock Redemption notes that Conopco, Inc. v. United States, No. 2:2004cv06025 (D.C. N.J. 12/8/04) is another case that allowed redemptive dividends to make distribution payments and that General Mills v. United States and Conopco, Inc. v. United States are both on appeal.

Related Links:

• Tax Court addresses controversial ESOP dividend deduction issue

Courts Will Not Always Enforce Plan Document Provisions If They Differ From SPD

Summary Plan Descriptions Under Scrutiny discusses how, despite the disclaimer language, courts will not always enforce the plan document provisions if they are different than the SPD provisions:

Most Summary Plan Descriptions ("SPDs") contain disclaimer language stating that in case of conflict between the SPD and the Plan documents, the Plan documents will always govern. In fact, sometimes SPDs are given less attention than we benefits lawyers recommend, usually due to cost or other factors and because people often believe that the disclaimer language will protect them. However, whatever the reason, it appears that the courts are not always willing to enforce provisions of a Plan document that are not disclosed in the SPD, despite the disclaimer language.

We also discussed this issue in SPD Language Providing Less Plan Benefits Overrules Plan Document Language.

Trelease v. Metro. Life Ins. Co., 2008 U.S. Dist. LEXIS 66400 (D.N.J. Aug. 29, 2008)

Trelease v. Metro. Life Ins. Co., 2008 U.S. Dist. LEXIS 66400 (D.N.J. Aug. 29, 2008) was discussed in the September 8 BNA Daily Tax Report. The case alleges that, upon the March 2003 advice of the defendants, the plaintiffs established a management company that was intended to be a 100% ESOP-owned S Corporation that would be exempt from federal taxes. While it is unclear whether the transaction was a Management S Corporation ESOP Transaction as discussed in IRS Announcement 2005-80, 2005-2 I.R.B. 967 – Settlement Initiative (#21), it is clear that the arrangement was in violation of the IRC Section 409(p) Anti-Abuse Regulations. In addition to clearly violating the anti-abuse regulations, a subchapter S election was never filed.

Insurance Broker Malpractice Claims Avoid ERISA Preemption Defenses discusses the facts of the case:

The court was confronted with a complex set of facts that could have easily confused the central issue of ERISA preemption.

First, the complaint was "lengthy" and the transactions were complex. The complaint described "a complex program which defendants allegedly sold to plaintiffs with promises of retirement and tax savings . . ."

Second, though the plaintiffs sued the defendants in state court, alleging state law causes of action such as breach of contract, breach of the duty of good faith, negligence and so forth, the plaintiffs also alleged breach of fiduciary duty, misrepresentation of federal tax treatment and, most troubling:

that the broker defendants "fail[ed] to administer the ESOP and related profit sharing plan . . [and] "misrepresentations as to the tax consequences of an ERISA plan . . .

Metropolitan Life Insurance Company with the consent of the other defendants, removed to federal court pursuant to 28 U.S.C. § 1441(a), whereupon the plaintiffs moved to remand the lawsuit to state court.

The United States District Court found that the plaintiffs were not considered participants, beneficiaries or fiduciaries, and therefore the claims do not fall under ERISA Section 502(a):

The previous analysis has shown plaintiffs are not plan beneficiaries and defendants are not fiduciaries as defined by ERISA. The Court holds that defendants have failed to show plaintiffs' claims are subject to complete preemption pursuant to section 502(a).

The lawsuit has been remanded to the state court.

In the News: Running the Company While Becoming Semi-Retired, Motivating Employees to Achieve High Morale and Low Turnover

STERLING Engineering, Inc. (Maryville, TN)

30 years of success: Retiring Sterling Engineering founder turning company over to employees discusses the story of Sterling Engineering, Inc., a Tennessee engineering company founded in 1979. The company implemented an ESOP in 2002, allowing the seller to become "semi-retired" while continuing to help run the company:

"This company does not have an end date tied to my desire or my ability to keep running the company. Ownership is distributed among all the employees. As they retire, stock will be repurchased and then redistributed back to everybody in the organization," Charles Sterling said.

He estimates that the ESOP will add somewhere between 10 to 40 percent to a long-term employee's retirement portfolio.

"It's a win-win situation because it creates an opportunity for ownership mentality regardless of age, experience or position in the firm," he said. "Everybody has real ownership, which should lead to stronger work ethic and accountability to one another."

Kelly Sterling said the employees bring cost-saving ideas to management without being prompted. "It's cool to see things like that," she said.

Charles Sterling admitted to being "semi-retired," saying, "By the end of this year, Kelly and I will have no more ownership in the company. We'll be employed at their pleasure. It will be completely employee-owned."

It also discusses how the company holds frequent celebrations events such as potluck lunches. A commitment to regular social events is one way to improve or sustain Employee Motivation.

Ownership plans provide incentives to employees discusses their ESOP in more detail. The company was sold to an ESOP despite being advised that the 41-employee company might be too small or not as profitable. [It is important to note that 41 employees are generally more than sufficient to successfully support an ESOP (assuming the company is otherwise a strong ESOP candidate)]:

Instead, Sterling essentially sold the company to its employees through an employee stock ownership plan, or ESOP, even though some advised him that the 41-employee company might be too small and that the move might not be the most profitable approach for him.

"I'm an ownership-mentality person. I just feel like if people can grasp that concept, they can be to some degree owners of things that affect their lives," Sterling said. "Of course, their employment is huge in that regard. That's part of what triggered my interest in ESOPs."

His respect for his employees and desire to preserve the company contributed to the decision.

The article discusses some of the advantages that an ESOP provides for owners of family-run businesses and small corporations, including providing an additional retirement benefit at no cost to the employees, providing many tax benefits to the company, and potentially allowing the seller to defer taxes.

It also compares the sense of ownership to owning your first car:

"One thing I can compare it to: If your folks bought you your first car, you probably didn't take care of it as much as the first one you bought yourself," Horton said. "When you are an owner, it raises the awareness, but also the feeling that this is not just a job. This is part of my future."

Employees are encouraged to contribute ideas for making the company more profitable.

"When you are just an employee somewhere, you really are not conscious about, 'Hey, if I leave the light on overnight, it is going to reduce the profitability of the company.' Whereas, if you are an owner, it is a little different," Horton said.

Like most ESOP companies that combine employee ownership with a strong ownership culture, morale is high and turnover is low:

At Sterling Engineering, morale is high and turnover is low, a result supported by the ESOP but due largely to the open and employee-friendly management style of Charles Sterling, Jones said.

S Corporations are More Stable, Provide Increase Job Satisfaction and Higher Organizational Commitment

Executive Briefing discusses a recent S Corporation study that we discussed in Study: S ESOP Companies Create Jobs and Savings for Workers and Have Higher Productivity, Profitability, Job Stability, and Job Growth:

Subchapter S Has Benefits, Remains Controversial

Subchapter S corporations that are owned by employees through employee stock ownership plans (ESOPs) generate some 85,000 new jobs each year and create $14 billion in new savings for workers that otherwise would not have been earned, according to a working paper by two University of Pennsylvania professors.

The study is one of the first to closely examine ESOP arrangements at so-called S corporations—mostly small companies eligible for special tax status and exemption from corporate income tax. Congress began allowing ESOPs to own S-corporation shares a decade ago.

Study authors Michael Knoll and Steven Freeman, who received some funding from an ESOP industry group, says research suggests that S-corporation ESOP companies are more stable than other types of companies and that employee ownership is associated with increased job satisfaction and higher organizational commitment.

But ESOPs do have an Achilles' heel: a lack of funding diversity that can leave workers who rely on them for retirement in a lurch—a scenario that played out at Enron. "Any time a firm goes bankrupt, nearly all equity is lost, so when firms with substantial employee ownership become insolvent, workers can lose not only their jobs and careers, but their retirement stakes as well," the authors wrote.

S-corporation ESOP companies became the subject of some scrutiny more recently when real estate magnate Sam Zell used the special tax status to finance his 2007 purchase of the Tribune Publishing Co. Some policy-makers questioned whether the special tax status afforded to S-corporation ESOP companies should be used to finance such transactions.

Why CPAs Must Know About Employee Stock Ownership Plans (ESOPs)

I will be presenting Why CPAs Must Know About Employee Stock Ownership Plans (ESOPs) on Friday, September 12, 2008. This is a Wisconsin Institute of Certified Public Accountants (WICPA) program, but you do not need to be a member to attend. At only $40 (for members and nonmembers), this program provides a great way to earn 4 CPE credits and learn more about ESOPs:

Northeast TGIF Meeting -Why CPAs Must Know About Employee Stock Ownership Plans (ESOPs)

Date: 9/12/2008 Time: 8:30am - 12:00pm (Registration at 8:00am) City: Green Bay Facility: Radisson Inn Green Bay, Green Bay Description: Did you know: You can sell a portion of your company to your employees while retaining control of the company, thereby enabling you to access and diversify an otherwise illiquid asset. You can defer, or in some cases, altogether avoid federal and state income taxation on the sale of all or a portion of your company. The portion of S Corporation income attributable to an ESOP is exempt from federal income taxes (and in many cases state income taxes). Research has found that ESOP companies appear to increase sales, employment, and sales per employee by about 2.3% to 2.4% per year over what would have been expected absent an ESOP. (The National Center for Employee Ownership) Whether you own or work for a private company or are a CPA in public practice, you owe it to your company, your clients, and yourself to make sure you are familiar with the pros, cons, and possibilities of all of your business transition alternatives, including ESOPs. Including ESOPs in your due diligence process will provide you with another tool to maximize the after-tax sale proceeds and help achieve your succession planning objectives. This session will explore how ESOPs work, discuss how the valuation of a company is determined, compare ESOPs to other business transition alternatives, and review some local and national ESOP case studies.

Please feel free to contact me directly if you have any questions about the program.

In the News: Succession Plan and Investment Opportunity, Incentive to Make Customer Service and Customer Retention a Top Priority

Indiana IT Company Becomes Employee Owned is a press release that describes how the AME Group, an Indiana IT consulting group, has sold the remainder of their company to an ESOP as part of a succession plan:

In 1998, Burkhart, Olson and Koenig began thinking about a succession plan for the company, as well as an investment opportunity for employees, and decided on an employee stock ownership plan (ESOP). To ensure that the company's history and values would remain the same in the future, they sought out a program that would empower employees as company owners. With the help of a Board of Trustees, they became an ESOP by selling 50.1% of the company to the employees. Since 1998, the company's shares have been continually distributed to the employees. After seeing the benefit of the ESOP over the last 9 years, Burkhart, Olson and Koenig decided to create a plan to sell their remaining shares, making The AME Group 100% employee owned. Earlier this year, the Board of Trustees began negotiations to have employees acquire the remaining shares.

It notes how the ESOP provides the employees with a greater incentive to make customer satisfaction and customer retention a top priority:

"The founders of our organization have always given back to the employees of The AME Group," said Mark Gerkin, President of The AME Group. "Giving back to the employees and effectively making them the owners of the company acts as an incentive for them to perform at their absolute best. Now they not only want to perform well as an employee, but also as an owner. This helps to push customer satisfaction and customer retention even more, making them both a top priority of our company."

Research: Risk and Diversification, Shared Compensation and Participation in Decision-Making

Research: Shared Capitalism, Shirking, Workplace Performance, Employee Ignorance, and Innovation shared some ESOP and employee ownership working papers from the National Bureau of Economic Research (NBER). Here are links to two additional ESOP and employee ownership related working papers:

Risk and Lack of Diversification under Employee Ownership and Shared Capitalism (NBER Working Paper No. 14229):

Some analysts view risk as the Achilles Heel of employee ownership and to some extent variable pay plans such as profit sharing and gainsharing. Workers in such "shared capitalist" firms may invest too much of their wealth in the firm, contrary to the principle of diversification. This paper addresses whether the risk in shared capitalism makes it unwise for most workers or whether the risk can be managed to limit much of the loss of utility from holding the extra risk. We create an index of financial security based on worker pay and wealth, and find that workers who feel financially insecure exhibit fewer of the positive outcomes associated with shared capitalism, and are less interested than other workers in receiving more employee ownership or even more profit sharing in their workplaces. This response is substantially lessened, however, when accounting for worker empowerment, good employee relations, and high-performance work bundles that appear to buffer worker response toward risk and increase interest in shared capitalism plans. We also discuss portfolio theory which suggests that
any risky investment -- including stock in one's company -- can be part of an efficient portfolio as long as the overall portfolio is properly diversified. We show that given estimates of risk aversion parameters, workers could prudently hold reasonable proportions of their assets in employee stock ownership of their firm with only a modest loss in utility due to risk. A good strategy for firms is to personalize individual portfolios on the basis of worker characteristics and preferences, developing investment strategies that would diversify each worker's entire portfolio in ways consistent with individual risk preferences.

Complementarity of Shared Compensation and Decision-Making Systems: Evidence from the American Labor Market (NBER Working Paper No. 14272):

This paper examines the relationship between shared capitalist modes of pay and shared modes of decision-making via employee involvement and related committees and between them and measures of productivity and worker well-being in two data sets: the employee based Worker Participation and Representation Survey and the California Establishment Survey. It finds in both data sets that the forms of shared compensation are complementary in the sense that they are more likely to be found together than if firms chose them separately; that shared compensation systems are positively associated with shared decision-making; and that combining shared compensation systems and employee involvement has greater impacts on outcomes than each system by itself.

Streamline Your Business

25 Ways to Simplify Your Business shares 25 tips to simplify and streamline your business:

TECHNOLOGY

1. Serve it up.
   
2. Phone it in.
   
3. Take it online.
   
4. Hit the web.
   
   MONEY
   
   
5. Bank on it.
   
6. File taxes electronically.
   
7. Pay now, not later.
   
8. Upgrade your accounting systems.
   
9. Make your (bench) mark.
   
10. Obey the urge to merge.
    
    MANAGEMENT
    
    
11. Hire strategically.
    
12. Stay on schedule.
    
13. Rent a CFO.
    
14. Tighten your supply chain.
    
15. Outsource your HR function.
    
16. Have fewer staff meetings.
    
    MARKETING
    
    
17. Do some data mining.
    
18. Leverage partnerships.
    
19. Go directly to the consumer.
    
20. Get the message.
    
21. Consolidate your advertising legwork.
    
    PERSONAL TIME
    
    
22. Decide what to outsource.
    
23. Create boundaries.
    
24. Shorten your to-do list.
    
25. Love your inner Luddite.

More Negative ESOP Coverage

In More of the Same, I discussed the latest by-the-formula, overly sensational New York Times anti-ESOP article. The New York Times and ESOPs also discusses the "steady drumbeat arising from The New York Times against ESOPs and employee ownership":

Bear Stears was first, then U.S. Sugar, and now Fannie Mae and Freddie Mac are being highlighted as poster children for how bad an ESOP can be for a company. As a point of note here, Freddie Mac does NOT have an ESOP. However, the article goes out of its way to create tangential links between ESOPs and failing companies using all the above examples as reasons why individuals should not own stock in their companies.

It's truly the height of arrogance to believe that average pay individuals should not own stock in the companies they work for. If this were true, there would be no small businesses, no family run companies in America. Subscribing to this theory, everyone would work for a salary and be happy with it. It's elitism at its worst.

ESOP Advocacy, Congressional Company Visits, and one-on-one discussions with elected officials are some ways that ESOP companies can share how ESOPs Contribute to a More Fair and Just Society.

17th Annual ESOP Economic Performance Survey (EPS)

The results of the Employee Ownership Foundation's 17th Annual ESOP Economic Performance Survey (EPS) are discussed in 92.4% of Companies State ESOPs are Good Business Survey Reveals Positive Results for ESOP Companies:

September 2, 2008 (Washington, DC) – Results from the Employee Ownership Foundation's 17th Annual ESOP Economic Performance Survey prove the decision to become employee-owned means enhanced company performance and greater wealth creation for employee owners.

In 2008, 92.4% of survey respondents reported that creating employee ownership through an ESOP (employee stock ownership plan) was "a good business decision that has helped the company." In the 17 years this survey has been conducted, this is the highest figure ever reported with the average over the last nine years at approximately 88%. In addition, 70.5% indicated the ESOP positively affected the overall productivity of the employees; another record number reported in this category where the average has been 63%. In terms of profitability, 66% of companies responding reported that profitability increased over the prior year and 71% stated that revenue increased.

"I find these numbers to be even more impressive in a year when many companies have been hurt by the slow economy," said J. Michael Keeling, President of the Employee Ownership Foundation. "For over 30 years, we in the ESOP community have been saying that employee owned companies are higher performing, have high employee retention rates, and have employees that are more motivated and productive. It's time for our national leaders to start promoting policies to encourage more companies to become employee owned through an ESOP to create a more fair and equitable society."

In addition, the survey asked companies to indicate their performance in 2007 relative to 2006:

• 66% indicated a better performance; 21% indicated a worse performance; 13% indicated a nearly identical performance as previous year
  
• 71% indicated that revenue increased; 29% indicated that revenue did not increase
  
• 66% indicated profitability did increase; 34% indicated that profitability did not increase
  
• 70.5% of survey respondents indicated the ESOP improved the overall productivity of the company's employees
  
• 51% of companies that responded indicated they have created an employee participation program since establishing the ESOP
  

The 2008 Economic Performance Survey was distributed to The ESOP Association's approximately 1,400 members in June 2008. The results are based on 421 responses.

Creating an ESOP is a Good Business Decision and The Economic Performance of ESOP Companies discuss the results of last year's Economic Performance Survey.

More of the Same

Worker Assets Shrink at Fannie and Freddie is the latest by-the-formula, overly sensational anti-ESOP article. This time the companies are Fannie Mae and Freddie Mac, but the theme of the article is the same:

• The stock was worth $X, now it is only worth $Y. No mention of any stock sales, purchases, transfers, and distributions that would also impact the value of the plan. No other significant discussion of the problems facing the company or industry or any other perspective on the decline in value of the company.
  
• Executives made $Z in compensation, without mention how much is payable in stock and options. In fairness, this article contains a limited discussion in this area.
  
• No or limited details on if the employee have any of their contributions at stake. Most ESOPs are completely funded by the employer, and do not require the employees to put any of their own money at risk.
  
• No accusations or other discussion of fraud or misconduct by the plan fiduciaries.
  
• No mention that an ESOP by definition is "designed to invest primarily in qualifying employer securities".
  
• No or limited information provided about typical ESOP companies. Instead, the article inaccurately implies that this ESOP is reflective of the entire ESOP universe.
  
• No or limited information on the other retirement plans provided by the company. No mention of how studies have found that ESOP companies are generally more diversified than their non-ESOP counterparts:
  
• Studies have shown that a typical ESOP participant has about three times the total retirement assets of a non-ESOP participant.
• Studies have shown that ESOP companies are more likely to have another diversified retirement plan than non-ESOP companies.
• A typical ESOP participant has diversified assets about equal to those of the non-ESOP participant.

Related Links:

• ESOPs In the News
• Sovereign Bancorp ESOP Issues: Reasonable Interest Rates and Prudent Investments
• U.S. Sugar ESOP Issues
• Bear Stearns, High Concentrations of Employer Stock, Statistics: Company Stock in 401(k) Plans
• Too Concentrated in Employer Stock
• Countering Negative ESOP Coverage with the Facts
• Differences between Bear Stearns and Enron