dolAccording to a June 23, 2014 Wall Street Journal article entitled “U.S. Increases Scrutiny of Employee-Stock Ownership Plans” (here), the federal government is “stepping up scrutiny of how U.S. companies are valued for employee-stock ownership plans.” This increased scrutiny includes increased litigation activity, often alleging that ESOP share valuations are flawed. The targets of this litigation include not only the appraisers who valued the shares but also the plan trustees that have fiduciary duties to “put the interests of workers first.”


As of fiscal 2011, the latest year for which information is available, about 6,800 U.S. companies had employee stock ownership plans, involving more than 13.4 million workers. The plans have amassed total assets of $940 billion. For many of the workers participating in these plans, the ESOP is the principal or sole retirement benefit.


According to the Journal article, the government contends that “some owners are selling stakes in their companies to employee-stock-ownership plans at inflated prices.” The U.S. Department of Labor is the plaintiff in 15 current ESOP-related lawsuits, virtually all of which involve alleged “shoddy estimates” of company shares. The agency has filed a total of 28 ESOP-related lawsuits since October 2009, double the number of lawsuits filed during the previous six years. Since the start of fiscal 2010, the Department of Labor has recovered over $241 million through lawsuits and through investigations that were resolved without a lawsuit being filed, nearly all of which involve valuations.


According to the lawsuits described in the article, the target in many of these lawsuits is the appraiser that provided the valuation although the article notes that “the agency also is getting tougher on trustees who work on behalf of employee-stock ownership plans – and have a fiduciary duty to put the interests of workers first or face financial liability if things go wrong.”


Problems often emerge when company management are involved in the appraisal process. According to the article, 95% of companies with ESOPs are closely held, forcing appraisers to rely heavily on company management for information.


The Journal article primarily is focused on lawsuits brought by the U.S. Department of Labor, but as several of the examples cited in the article make clear, company employees often file their own separate lawsuits when earlier share price valuations prove to have been inflated. While these employee lawsuits often also target the appraisers, the targets of the employee lawsuits often involve the plan trustees.


The Journal article makes it clear that in many cases there may be good reason for the government’s scrutiny of ESOPs. Valuation issues clearly are a recurring problem. Many insurance industry professionals know that for purposes of management liability insurance ESOPs are sometimes viewed as a riskier class of business than are other private companies.


However, the article does make it clear that there are certain factors than can help avert faulty appraisals, such as through the requirement that the ESOP obtain a share price evaluation when a stock plan is started and a requirement that workers are told once a year how much their shares are worth. The presence of factors showing that the appraiser performing the appraisal was independent and that the appraisal was not influenced by management (such as through management provided revenue estimates) also may help avoid problem valuations. The presence of these and other factors supporting the share valuation the company uses could help reassure insurance underwriters about companies with ESOPs.