A Step Towards Guidance Instead Of Regulation By Litigation In The ESOP Space

JurisdictionUnited States,Federal
Law FirmGoodwin Procter LLP
Subject MatterEmployment and HR, Litigation, Mediation & Arbitration, Retirement, Superannuation & Pensions, Employee Benefits & Compensation, Employment Litigation/ Tribunals, Trials & Appeals & Compensation
AuthorMs Alison Douglass, DeMario Carswell and Andrew Hill
Published date25 April 2023

Employee Stock Ownership Plans (ESOPs), their sponsors and participants, and other industry players will welcome the news announced by the ESOP Association on April 14, 2023, that the Department of Labor (DOL) has committed to move forward with public notice-and-comment rulemaking to establish a clear definition regarding the "adequate consideration" requirement for ESOP acquisitions.1 This long-awaited announcement follows the passage of bipartisan legislation late last year, which included the SECURE 2.0 Act of 2022 (SECURE 2.0 Act). The SECURE 2.0 Act includes provisions seeking to establish a more conducive environment for ESOP creation and maintenance. Specifically relevant to ESOPs-of which there are nearly 6,500, with more than 13.9 million participants investing over $1.6 trillion as of 20202-was the WORK Act (Section 346 of the SECURE 2.0 Act).

This commitment from the DOL is in response to the passing of the SECURE 2.0 Act as well as an Administrative Procedure Act petition submitted by the ESOP Association to the DOL last year, which specifically requested that the DOL not only define adequate consideration but do so through a formal notice-and-comment rulemaking process. The DOL's commitment should ensure the issuance of a rule consistent with the WORK Act's requirement that it "issue formal guidance" for "acceptable standards and procedures to establish good faith fair market value for shares of a business to be acquired by an employee stock ownership plan."3 Decision-makers for ESOPs, including those responsible for ESOP valuations or for responding to DOL inquiries, have long awaited this kind of guidance. While ESOP transactions are inherently prohibited transactions in violation of the Employee Retirement Income Security Act of 1974, as amended (ERISA), they are permitted as long as the transaction meets the adequate consideration exemption. In order for an ESOP transaction to meet the adequate consideration exemption, an ESOP must not pay more than "fair market value of the [shares] as determined in good faith by the trustee or named fiduciary pursuant to the terms of the plan and in accordance with regulations promulgated by the Secretary." 4 However, before this commitment, the DOL had never provided or agreed to provide formal regulations or guidance for the valuation process. Even after the Fifth Circuit reprimanded the DOL in Donovan v. Cunningham5 for failing to promulgate such regulation, the closest the DOL had come to doing so...

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