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ESOP Valuation Experts Might be Harder to Find under Proposed ERISA Changes

By: AccuVal Associates, Inc.

An employee stock ownership plan (ESOP) is a qualified retirement plan under the Employee Retirement Income Security Act (ERISA). ESOPs essentially make it possible for an owner(s) of a business to sell a part or all of a business to the company's employees. This can be beneficial for employee motivation, company growth and success.

ESOPs require annual valuations

The shares of a company that has an ESOP or is planning to establish an ESOP need to be appraised to verify that adequate consideration is being transacted when selling company shares to the ESOP. A valuation of shares is also needed for ESOP administration including when ESOP participants engage in transactions with the ESOP and company, such as redeeming shares upon retirement. These administration valuations are usually conducted annually.

Proposed rule changes may mandate appraisers be ERISA fiduciaries

As an employee benefit plan, an ESOP must be operated for the exclusive benefit of plan participants, which means that fiduciaries must act in the exclusive interest of plan participants and act prudently. Failure to do so may result in legal liability for the fiduciary under the ERISA.

Ever since ERISA was enacted, the typical relationship between an appraiser and an ESOP has been that the fiduciary of the ESOP (i.e., the trustee) would engage an expert appraiser to provide advice regarding the fair market value of the shares. The fiduciary would then make a decision based on this advice as to whether or not a transaction is at fair market value.

In the fall of 2010, the Department of Labor (DOL) proposed ERISA changes that would make ESOP equity appraisers fiduciaries when they perform valuations for an ESOP. More specifically, the proposal would place fiduciary responsibility on those giving investment advice to the ESOP including those providing "advice, appraisals or fairness opinions concerning the value of the securities or other property." Thus, instead of advising the fiduciary of an ESOP on the valuation of stock, the appraiser would become a fiduciary under ERISA in and of themselves.

Under the proposed rules, ESOP share appraisers would:

• be held to fiduciary standard of conduct, which is a higher standard of care/conduct than the current due care or negligence conduct that the ESOP share appraiser has been held to in the past;
• have co-fiduciary liability and responsibilities, which potentially means that the appraiser would share in the fiduciary liability of the other fiduciaries (trustee, management, etc.);
• have personal (entity) liability for breaches of fiduciary duty;
• need to avoid prohibited transactions (for example, actions or transaction that produce perceived conflicts of interest);
• be open to enforcement by the DOL and ESOP participants. Under current rules, appraisers are not directly subject to DOL enforcement; and
• be open to additional IRS scrutiny.

Competing legislation proposed seeking exemption for appraisers

Concerns have been cited that the DOL's proposed rules would increase the cost to hire appraisers and, in turn, the cost to administer ESOPs, discouraging their adoption. Questions have also been raised over the ambiguity surrounding how ESOPs should be appraised and how to allocate responsibility amongst parties if an error does occur.

In December 2010, Senators Bernard Sanders and Patrick Leahy asked the DOL to back off of the proposed regulations for appraisers. On June 21, 2011, Senator Kelly Ayotte formally proposed a bill that would exclude appraisers of ESOPs from fiduciary responsibilities.

Potential impacts on the appraisal industry

If the rule change is approved, it is expected to reduce the number of qualified appraisers that will be willing to practice in the area of ESOP share valuation. Will AccuVal continue to service the ESOP valuation market? Yes. AccuVal will continue to provide equity valuations for ESOPs, as well as structure advice and fairness opinions and other services to companies that have an ESOP or are considering an ESOP. AccuVal will continued to provide additional appraisal services including fixed asset, inventory and intangible asset appraisal work for financing support, tax appeal work, and disposition; purchase price allocation work including intangible assets, as well as equity valuations for non-ESOP shareholders.

It's unknown what the outcome of this debate will be. AccuVal will be closely monitoring discussions in Congress and with the DOL on the matter and will share the outcome with our readers in future newsletters when they are known. Stay tuned.

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About AccuVal
AccuVal provides a broad range of valuation, advisory and asset management solutions that contribute to growth or help ensure survival. We appraise the business enterprise and shareholder equity; bonds; intangibles and intellectual property; machinery and equipment; inventory; real estate and accounts receivables in over 100 industries worldwide. Learn more at www.accuval.net.