DOL to Introduce Adequate Consideration Regulations for ESOPs

The Department of Labor (DOL) notified The ESOP Association (TEA) on April 12, 2023, that it would conduct a public notice and comment rulemaking process to further define “adequate consideration” under section 408(e) of the Employee Retirement and Security Act (ERISA). This is a key regulation the ESOP community has sought since the creation of Employee Stock Ownership Plans, or ESOPs, in 1974.

The DOL’s action would provide clarity to sponsoring companies, ESOP professionals and employee owners. The SECURE (Setting Every Community Up for Retirement Enhancement) Act 2.0 directed the DOL to address this issue through the rulemaking process.

The DOL did not provide a definitive timeline for finalizing the regulations, but in a letter to TEA, Assistant Secretary Lisa Gomez noted it would be “relatively soon”.  The degree of interaction among stakeholders and the general public in the DOL process will likely impact the overall timeline.

Current Initiatives

Section 346 of the SECURE Act 2.0. directs the DOL to: 1) set up state centers for employee ownership education, and 2) require guidelines for ESOP appraisals. Much of the efforts related to these directives are already underway.

Set Up State Centers for Employee Ownership Education

The Employee Ownership Expansion Network (EOX) has already established a network of state centers. Weaver is a proud sponsor of the Texas Center for Employee Ownership, which focuses on education of business owners and the general public about issues related to employee ownership, including ESOPs, worker cooperatives and employee ownership trusts. Other organizations such as TEA and the National Center for Employee Ownership or Project Equity may be interested in assisting in the efforts of state centers in partnering with the government or becoming recipients of funding for state centers

Require Guidelines for ESOP Appraisals

The proposed ESOP regulations published in May 1988 define adequate consideration as fair market value most closely resembling the fair market value standard set by the Internal Revenue Service for tax purposes, combined with the prudent-person as acting in good faith.

Effect of Proposed Regulations on Stakeholders

Once adopted, regulations governing adequate consideration may lead to positive changes, but also could open up ESOPs to limitations or drawbacks.

Following are some projections about how clear regulations could impact various sectors of the ESOP community:

Trustees: For trustees, clear DOL guidelines would open the door to smoother implementation of ESOP transactions. Greater certainty and more limited risks for trustees negotiating on behalf of employees would likely reduce duties for trustees negotiating and acting in good faith, and could lead trustees to reduce their fees.

With more clarity about how to determine “adequate compensation,” others may be willing to become trustees for ESOPs, creating a more competitive market for trustee services.

If the regulations become more restrictive or detailed in their approach, however, the opposite could occur. Maintaining quality standards within the negotiation process or fiduciary duties could make the burden of being a trustee more cumbersome, leading to greater risk to trustees and higher costs to sponsoring companies.

Selling Shareholders/Sponsoring Companies: Clear regulations could reduce the perceived or real risk of litigation. The possibility of litigation has been a prohibitive factor for selling shareholders, who cite it as a reason for determining an ESOP is not an appropriate fit for them or the sponsoring company.

If the fear of litigation is reduced, ESOPs could become a more popular way for business owners to sell their company. ESOPs already have several advantages to selling shareholders and sponsoring companies, including significant tax advantages, preservation of corporate culture and flexibility in the timing and structure of the ESOP (refer to our ESOP reference guide for more advantages and considerations of an ESOP).

Employee Owners: If regulations are adopted, employee owners would have a better understanding of when a true breach of fiduciary responsibility regarding adequate consideration has occurred. They would be better able to determine whether litigation is a viable path to restitution, leading to less time and fewer resources lost to litigation for the employee owner, selling shareholder and/or sponsoring companies.   

Attorneys: Clear regulations would give ESOP attorneys better tools for implementing foundationally sound ESOPs. This would hopefully lead to less litigation and quicker dispute resolutions. However, as with the impact on trustees, greater detail or more burdensome regulations could lead to more time and resources spent in ESOP implementation, maintenance and litigation.

ESOP Valuators: With the adoption of clear regulations, ESOP valuation experts may be better able to advise their trustee clients regarding a reasonable range of fair market value. Valuation experts also may be able to look to the courts for further clarification of the fair market value standard if the DOL continues down the path of fair market value as similar to the IRS’ standard of fair market value.

Without insight into the DOL’s potential stance on the regulations surrounding adequate consideration, it is difficult to determine the potential negative effects associated with any potential regulations. If the DOL regulation is too specific, it may narrow the field of negotiation for ESOPs or the flexibility of ESOPs.

Weaver’s ESOP team welcomes collaboration with the ESOP community regarding the adequate consideration regulation throughout the public comment and rule adoption periods. Our team is committed to advancing clarity on regulations for employee owners and ESOP professionals. Contact us for information or assistance.

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