Kelso founder of eemployee stock ownership plans image

ESOPs Fables

Employee Stock Ownership Plans, also known as ESOPs, were the brainchild of a lawyer and economist from San Francisco, Louis O. Kelso, who believed that selling his company to employees was the best way to ensure its future. In 1956, Kelso created the first ESOP and his employees became owners of Peninsula Newspapers.

ESOPs are a way for a company to provide employees with ESOP shares which are held in trust until the employees leave the company or retire, at which point the shares are sold, and the employee is paid for his or her investment. ESOPs are designed to provide an incentive for employees to stay with the company long-term and to foster a sense of ownership for employees while maintaining a strong financial foundation for the company. For a thorough explanation of ESOPs, visit the National Center for Employee Ownership (NCEO) website.

ESOPS under scrutiny

ESOPs took a while to catch on, but now they are very popular. According to the NCEO, as of 2010, approximately 28 percent of Americans owned employer stock through ESOPs, and that number continues to grow as companies add ESOPs to their employee offering. But as their popularity increases, so do complaints about how ESOPs are run. A spate of lawsuits recently allege that outside appraisers are overvaluing companies and misleading employees about their stake in the company. It’s also alleged that some companies are not communicating key issues to their employees about what’s going on in the company that may impact the company’s value. Employees who rely on the ESOP as a key aspect of their retirement have been left with nothing in some cases.

Labor Secretary Thomas Perez recently likened current valuation practices to the real estate bubble era. His agency and others are currently looking at ways to tighten rules around ESOPs and their valuation. The hope is to design new guidelines for outside appraisers who value the companies while developing new rules to govern how employees get information about the value of their stock. The goal: To put the interests of workers first.

Looking out for the employee

The Wall Street Journal outlined a few recent cases in which companies have truly mislead their employees about the stock price. Employees wound up with little or in some cases no value for their investment – and a very poor outlook for retirement.

Many groups are vulnerable while these practices continue. Certainly, firms that value ESOPs need to set very good standards for their employees – and definite consequences for appraisers who don’t uphold the standards. Companies need to take the idea of employee ownership very seriously, and work hard to live up to the aspirations of an employee-owned company that Kelso envisioned when he first came up with the idea, communicating the good and bad news to employees about their stock so that employees can make educated decisions about how to invest.

While we’re all still operating on the idea of trust rather than a set of federal guidelines on these issues, it’s a good idea to consider if your company is at risk. Companies that operate ESOPs should take a second look at the firms they work with for valuation and make sure they’re above-board, but also consider purchasing fiduciary liability coverage in case there is a law suit about the company’s valuation. And certainly any company that’s providing appraisals should be aware of the exposure they’re facing right now, paying attention to new developments in the industry and in regulations, and making sure they’re covered for any liabilities in the meantime.

If we can help you work through some of these issues, please contact us.