March 1, 2021
Many traditional 401(K) plans are being replaced with employee stock ownership plans (“ESOPs”). While in many cases an ESOP is a valuable benefit to employees, they are also vulnerable to abuse.
What is an ESOP?
An ESOP is a qualified defined-contribution employee benefit plan designed to invest primarily in the stock of the sponsoring employer. That means, instead of investing the retirement contributions into traditional investment vehicles like stocks, bonds or money market funds, the retirement contributions are invested back into company stock. ESOPs are “qualified” in the sense that the ESOP’s sponsoring company, the selling shareholder and participants receive various tax benefits. For these reasons, ESOPs are often used to give the employees a vested interest in the company’s success and aligning their interests with the company’s shareholders. In some instances, shortly after the sale to employees, the Company stock purchased by the ESOP is reported by the Company to be worth a small fraction of what the ESOP paid for it.
How Does a Private ESOP Work?
In a private ESOP, the sponsoring company sets up a retirement plan solely to purchase the company from the existing shareholders. Sometimes, the ESOP needs to borrow most or all the money necessary to purchase the company stock. Then the future retirement contributions to the plan are used to repay the ESOP debt from purchasing the company. Some ESOPs invest up to 100% of their assets in employer stock. The decision to set up an ESOP to buy the employer stock is often made by corporate insiders who stand to benefit directly from the transaction. Often, the CEO and principal owner of a company picks the ESOP’s trustee who will approve of the sale of company from the CEO to the ESOP (i.e., the employees). The trustee negotiates with the selling shareholder(s) to determine the price the ESOP will pay for the Company shares. To be legal, the price the ESOP pays for the company cannot be more than fair market value. But lawsuits our firm has filed on behalf of employees show that corporate executives abuse ESOP transactions to unload their interests in the company at an inflated price, and saddle employees/participants with tens of millions of dollars of debt which goes to pay the corporate executives who stay at the helm of the company. Shortly after the sale to employees, the value of the company plummets to a fraction of what the employees paid.
How Do Leveraged ESOP transactions Harm Employees/Participants?
Even though ESOPs are technically considered to be retirement plans existing for the benefit of employees, the assets of these plans can be – and often are – used to enrich the management of the company, to create liquidity for existing shareholders, and to serve as a lucrative “exit strategy” for company founders. This can result in significant conflicts of interest, between the management of the company and its employees, and between existing shareholders and the employees who are “buying” the shares via an ESOP. Generally, the employees who are forced into buying the company through their retirement plan are not able to negotiate the price they paid, and they are not able vote on whether to move forward with the purchase. Often, the trustee who is appointed to represent the employees in the ESOP is picked by the selling shareholders and thus may not be acting solely in the best interest of the employees to negotiate a fair price. Also, it can be very difficult for employees to obtain enough information to determine whether the ESOP has paid too much for the company shares.
If you think you may have suffered losses to your retirement savings because of an ESOP transaction, we would be interested in investigating your case. Cohen Milstein’s attorney Michelle Yau is here to answer your questions and to learn about your experience with your ESOP. To schedule a complimentary phone appointment, please call our office at (202) 408–4600.
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