Pros and Cons of Internal vs. External ESOP Trustees—Post Enron
GreatBanc Trust Company45 Rockefeller Plaza, Suite 2056
New York, NY 10111-2000
Karen Bonn, Vice President(212) 332-3251
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Trustee must act:
♦ Solely in the interest of participants and beneficiaries;
♦ For the exclusive purpose of providing benefits and defraying expenses of administering the plan;
♦ With the care, skill, prudence and due diligence, which under the circumstances, a prudent man would act in similar circumstances; and
♦ In accordance with the plan, as long as the plan and trust are consistent with ERISA
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Prudence Duty
♦ Courts likely to defer to the judgment of an independent and experienced trustee unless the trustee acted in an “arbitrary or capricious” manner
♦ Procedural diligence, not substantive perfection
♦ Avoid acting in an “arbitrary or capricious” manner
– Trustee is familiar with plan documents and applicable legal standards
– Trustee relies on plan documents and applicable legal standards
– Trustee documents diligence, reasoning and decisions
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Liability for Another Fiduciary
♦ May not delegate fiduciary duties, but plan may allocate duties among separate fiduciaries
♦ Except in “aiding and abetting” situations, fiduciary not liable for breach by co-fiduciary of allocated responsibilities
♦ Knowing participation in, or concealment of, an act or omission known to be a breach
♦ Enabling another fiduciary to breach by breaching one’s own fiduciary duty
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Liability for Another Fiduciary (cont.)
♦ Knowing of a breach and failing to make reasonable efforts to remedy the breach
♦ Basic principle: silence in the face of a breach is not acceptable - “reasonable efforts” to remedy the breach are required
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Duties of the Trustee
♦ Analyze proposed transactions
♦ Vote employer securities
♦ Diversification
♦ Annual valuation
♦ Communications
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Analysis of Proposed Transaction
♦ Independently negotiate price and terms on behalf of participants
♦ Investigate solvency of the corporation
♦ Engage in a diligent, independent investigation
♦ Engage advisors and scrutinize findings
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Voting Employer Securities
♦ May follow directions to the extent doing so does not violate ERISA
♦ Trustee fiduciary responsibilities may not be delegated
♦ Follow plan document
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Electing Board of Directors
♦ Review biographies
♦ Interview members
♦ Draft letter to participants requesting direction
♦ Count the vote and report results
♦ Maintain confidentiality
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Diversification
♦ ESOP trustees not held to same diversification requirements as other plan fiduciaries
♦ Congress carved out an exception for ESOP fiduciaries
♦ Deciding to sell company stock
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Annual Valuation
♦ Assets of trust must be valued at least annually
♦ Trustee establishes value
♦ Financial Advisor reports to the trustee not the Company
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Annual Valuation
♦ Examine methodology
♦ Question assumptions
♦ Understand conclusion
♦ High value; low value; FMV
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Communications
♦ Trustee must keep accurate detailed records
♦ Trustee must submit an annual report to the company
♦ Trustee must prepare and submit Schedule P for Form 5500
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Directed Fiduciary
♦ Directed by internal ESOP committee
♦ Directions must be “proper”
♦ Overriding ERISA fiduciary duty
♦ Determine whether a conflict of interest exists
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Recent Developments for Fiduciaries
♦ Amsted Case
♦ Champlain Enterprises Case
♦ Enron Litigation
♦ IRS Audit Guidelines
♦ Department of Labor Interpretive Bulletin
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Amsted Case
♦ Court states the “the decisions of independent and experienced fiduciaries garner deferential review, while decisions of fiduciaries with a conflict of interest … do not receive such deference”
♦ ESOP trustee was not required to make an independent investigation of acquisition
♦ Court emphasized the extensive monitoring activity taken by the ESOP trustee
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Amsted Case (cont.)
♦ Ruled that no one would have predicted the unprecedented increase in repurchase obligation resulting from drop in stock price
♦ Acquired company price was determined by auction in an arm’s-length transaction
♦ A mere showing of a drop in FMV of shares of an ESOP is not sufficient to establish imprudence of the ESOP trustee
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Amsted Case (cont.)
♦ Decision
– Court will not substitute its judgment when trustee is independent and experienced
– Judicial review of independent trustee is highly deferential
– Decision upheld unless independent trustee is found to have acted arbitrary and capricious
– ESOP trustee is not responsible for second guessing decisions of management
– ESOP trustee continues to have a duty to monitor management to protect the pension benefits of ESOP participants
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Champlain Enterprises Case
♦ ESOP trustee did not have supporting notes or minutes to verify questions asked and discussions had
♦ ESOP trustee has burden to show that value is determined by the fiduciary “in good fair”
♦ “Focus of the Good Faith inquiry is not on the end – the final product – but on the means – the conduct of the fiduciary is getting to the final product”
♦ Court found that the trustee had little documentation of the actions it had taken
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Enron Litigation
♦ DOL amicus brief and separate lawsuit against fiduciaries
– Duty to disclose vs. duty not to mislead
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Enron Litigation Lessons
♦ Executives who also serve as plan fiduciaries have dual loyalties and do not have a lesser fiduciary standard
– Critical to make it clear when executive is acting in each capacity – greater risk occurs when it is unclear which “hat”executive is wearing
– When communicating with participants, dual-hat executives are presumed to act as fiduciaries
– Corporate position and inside information is two-edged sword: enhanced expertise is a plus, but non-public information is a burden
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Enron Litigation Lessons (cont.)
♦ Appointing a fiduciary carries with it the duty to monitor closely the fiduciary’s performance.
– Duty to act when appointed fiduciary knows of possible breach
– Could include duty to assure that the appointed fiduciary has accurate information on employer’s financial condition
– Not a responsibility to carry out appointed fiduciary’s duty but to oversee and perhaps replace appointed fiduciary
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Enron Litigation Lessons (cont.)
♦ Speaking to participants about the security of their benefits, investment of their plan assets, or company stock as an available investment can cause an executive to be acting as a fiduciary
– Discourage executive management from making statements perceived by participants as intended to influence typical participant behaviors (e.g. when and how to contribute, invest, or take a distribution)
♦ A fiduciary has a duty not to mislead plan participants and to correct misleading information from others.
– If a fiduciary knows or should know that participants have been given misleading information, silence and inaction constitute breach of duty of loyalty
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Enron Litigation Lessons (cont.)
♦ A fiduciary has a higher duty to disclose information if necessary for participants to protect their retirement benefits
♦ Information known to fiduciary
– Resignation is not sufficient
– Not dependent on participant request
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Enron Litigation Lessons (cont.)
♦ Fiduciaries have a continuing obligation to assure that investment in employer stock is prudent
– Duty of prudence overrides plan design requiring investment in employer stock
– As with other duties implicating prudence rule, a showing of procedural diligence is critical
– Sliding scale for prudence - as “alarms go off, duty to act increases
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IRS Audit Guidelines
♦ “There would be more credibility to the determination of value if the trustee is truly independent of the employer”
♦ “If the employer appointed his CFO as the ESOP Trustee, we might have concern about the extend to which the owner could exert control over the trustee”
♦ “The employer could use a committee to act on behalf of the ESOP, in which case, it may seem more difficult to influence several people. However, if the committee, contained a senior official who could steer or influence the committee, the employer may be exercising indirect control of its actions”
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Department of Labor Interpretive Bulletin
♦ A policy that contemplates monitoring of management or corporation in which a plan owns stock is consistent with a fiduciary’s obligation under ERISA
♦ Items to be monitored include executive compensation, mergers and acquisitions, debt financing, etc.
