By Mike Staton, CPA It is no secret that the Department of Labor (DOL) has a negative view of Employee Stock Ownership Plans (ESOPs). Why? Because ESOPS are inherently not diversified in the stock that is owned by the participant/owners – primarily employer securities. And the individuals selling the stock are the same individuals sponsoring the plan, engaging the trustees and involved in hiring the valuation firm that will ultimately determine the price paid for the shares.
The DOL sees these factors as a direct conflict in the determination of “fairness” in the overall transaction. Which is why thorough documentation and communication of your company’s ESOP plan is key to keeping your plan out of trouble.
The DOL has taken the following measures to make sure ESOP transactions are carefully scrutinized and that participants are being treated fairly:
- A predetermined number of plans will be routinely investigated each year. The selection process is based on information provided through plan reporting, mainly the 5500, and whether or not the plan meets specific parameters looking for any potential ERISA violations.
- Hefty fines will be enforced for plans not meeting appropriate monetary results or proper requirements of fairness.
A large number of penalties on DOL audits stem from the valuation of the shares at the time the plan is set up. The DOL disagrees with the valuation process, they disagree with the projections used in the valuation, or they don’t accept the valuation firm doing the valuation. Make sure your valuation firm has a strong reputation, make sure they have done ESOP’s before and make sure an independent trustee selects the firm. Then document how you selected the firm and list its qualifications.
In addition to valuation issues, lack of communication with participant/owners is another potential source of concern. Communicate with your employees during the process making sure they understand how the value was determined and how the process affects both of you during the inception of the plan and annually thereafter.
Plans that have successfully navigated DOL audits are those that have thoroughly documented the entire process and effectively communicated with its owners. The DOL, with its new incoming leadership, is planning for more regulations to better define this process thereby improving their communications with the ESOP community.
This post was written by:
Michael A. Staton, CPA
Mike is a Certified Public Accountant and is Co-Founder and Managing Director of Alerding CPA Group. Mike has served closely-held businesses for over 30 years and was named the Accounting Advocate of the Year by the U.S. Small Business Administration in 2001.
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