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.

ESOPS: 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.

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. – myau@cohenmilstein.com

Kai Richter, Esq. – krichter@cohenmilstein.com

Daniel R. Sutter, Esq. – dsutter@cohenmilstein.com

Ryan Wheeler, Esq. – rwheeler@cohenmilstein.com

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

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.

Contact Us

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