Employee Stock Ownership Plans – Understanding the Risks and Rewards

December 13, 2022

By Michelle C. Yau and Daniel R. Sutter

Employee Stock Ownership Plans (ESOPs) are retirement plans that are set up to invest solely in the stock of the employer.

Among other things, ESOPs offer the company and employee participants various tax benefits, making them “qualified” plans that are regulated by the Employee Retirement Income Security Act (ERISA). If managed properly, and in accordance with ERISA, ESOPs can be help employees save for retirement.

Traditionally used by smaller, privately held companies, ESOPs can be used by larger, publicly held companies and can complement 401(k) retirement plans. Similar to the 401(k)-vesting period, an ESOP participant earns an increased portion of company shares in the plan for every year of service. When an employee retires or resigns, they can “cash out” of the ESOP and claim their nest egg.

Vulnerabilities and Potential for Abuse

Unfortunately, ESOPs are vulnerable to abuse that is difficult for participants to detect. ESOPs provide a mechanism that allows an owner to transfer ownership of a company to its employees. While Congress permits ESOPs to encourage employee ownership of companies, it was aware that owners can use ESOPs to receive more money for their interest in the company than it’s actually worth. To protect employees from these abuses, Congress put stringent requirements on employees that choose to use ESOPs.

ERISA requires that ESOPs be managed prudently and with undivided loyalty to the employee-ESOP participant, and imposes strict “prohibited transaction” restrictions on owners wishing to use an ESOP for their employees.

Employees and ESOP participants suffer the consequences of an ESOP overpaying for a company. Overpayment not only reduces the amount of retirement savings a participant will ultimately earn, but also can put a strain on a company’s financial health that may imperil job security.

Fortunately, ESOP-participants that are harmed by a mismanaged ESOP can seek redress and assert their rights under ERISA.

Real Life Examples

Case in point. We are representing approximately 750 employee ESOP beneficiaries of the Casino Queen Hotel & Casino, the former famed riverboat casino which moved on land in 2007 to East St. Louis, Illinois.

In the complaint, we allege that the owners of Casino Queen tried to sell the casino to third party buyers for years. Unsuccessful, they decided to create their own buyer and established the Casino Queen ESOP for the purpose of buying 100% of the company’s outstanding common stock for $170 million.

The Complaint explains how, employees were told initially that the ESOP was a great opportunity that would lead to the creation of greater wealth, this alluring promise was revealed to be a mere illusion.

The Complaint alleges numerous ERISA violations, including that the ESOP’s trustee concealed that the ESOP had significantly overpaid for the company stock in 2012, and that they engaged in other ERISA violations, including selling all the casino’s real property out from under the ESOP.

The lawsuit names as Defendants several people who profited handsomely from the sale of the casino.

We also represent the employees of the following private companies in ESOP litigation. Plaintiffs’ allegations in those cases are summarized below:

  • Western Milling, an agribusiness, specializing in fertilizer, pesticides, seeds, and animal feed formulas, where the Kruse family, among others, formed Western Milling ESOP to buy 100% of outstanding Kruse-Western stock for over $244 million. Just two months after the transaction, Kruse-Western stock was valued at just 10% of what it was previously valued.
  • World Travel, a full-service concierge travel management company. In 2017, the founders of the company created the ESOP and then sold 100% of their World Travel stock to the newly created ESOP at an above-market price. Further, despite selling 100% of their stock ownership and touting that the company is 100% employee owned on its website, the founders have retained full control of the company.
  • Triad Manufacturing, a vertically integrated design and manufacturing company that builds retail store environments, nationally and globally.  Allegedly the owners of the company and the ESOP’s Trustee, GreatBanc Trust Company, breached their fiduciary duties by selling 100% of the owner’s company stock to the newly created Triad ESOP. Approximately two weeks later, Triad’s stock dropped nearly 97%.
  • Envision Radiology, an outpatient radiology company with locations in five states. Allegedly, the original owners and top ex of Envision Management Holding, Inc. as well as Argent Trust Company (which served as the trustee to the ESOP), breached their fiduciary duties to the ESOP and engaged in prohibited transactions in connection with the sale of Envision company stock to the newly created Envision Management Holding, Inc. Employee Stock Ownership Plan in 2017.
  • W BBQ Holdings, Inc., the owner of Dallas BBQ, a restaurant and catering chain in New York City that serves low-cost barbeque and beverages. Allegedly, the controlling members and shareholders of W BBQ Holdings and the trustee of the WBBQ ESOP, caused the ESOP to engage in transactions that are prohibited under ERISA and breached their fiduciary duties to the ESOP in connection with the sale of the company to the ESOP at a dramatically inflated price over fair market value.
  • Western Global Airlines, a cargo transportation company that serves more than 400 airports in 134 countries. The owners created the Western Global ESOP to buy a large stake in Western Global from them. But, because the newly created ESOP had no funds, the owners sought to finance the loan by issuing hundreds of millions in junk bonds at a high interest rate. Unable to attract sufficient investors, the ESOP was born saddled with massive debt with an unreasonably high interest rate.

Early Warning Signs

While early warning signs are hard to detect, there are certain themes these cases have in common.

  • An ESOP is quickly created
  • No to little information is given to employees about the ESOP and projected benefits
  • Employees have no voice, no vote in the creation of the ESOP or the selection of the trustee
  • The ESOP overpays, i.e., over fair market value, for shares of the company stock or other company assets
  • Employees have no voice, no vote in the ESOP’s transactions

Employees are best served when they understand the risks and rewards of ESOPs. Please contact us if you have concerns about your company’s ESOP.

Michelle C. Yau, Esq. –

Mary J. Bortscheller, Esq. –

Kai Richter, Esq. –

Daniel R. Sutter, Esq. –

Eleanor Frisch, Esq. –

Ryan Wheeler,

Cohen Milstein Sellers & Toll PLLC
1100 New York Avenue, N.W., Suite 500
Washington, D.C. 20005
Telephone: 888-240-0775 or 202-408-4600