By Loren Rodgers, NCEO Executive Director
This newsletter contains initial results of the NCEO’s research project on DOL investigations, first unveiled at our annual conference in April. Much more detail is in the article on the front page, but it’s easy to boil down the results so far: about 1.4% of ESOPs per year have a DOL investigation closed with results involving a monetary recovery. Those monetary recoveries include such things as payments to the ESOP trust, payments to participants directly, and penalties. The amounts of these recoveries can be large, and they are also highly concentrated in a limited number of cases. The 25 largest monetary recoveries are all above $25 million. Those 25 companies represent 2% of all investigations closed with results, but 53% of all monetary recoveries. Most investigations close with much smaller recoveries, and the median recovery is $96,000.
I see three lessons that those involved in ESOPs can learn from the results of our analysis so far.
Lesson 1 is that you must be ready to defend your decisions, because failure to do so can be extremely costly. The most obvious way to be ready to defend yourself is to have done everything right, and that means educating yourself about what it looks like when an ESOP is not properly managed. These monetary recoveries largely connect to transactions rather than ongoing operations, so both sellers and service providers need to keep up to date on the fiduciary process agreements, best practices in valuation, and what types of transaction structures have led to costly legal troubles. The NCEO describes red flags in ESOP transactions and publishes extensively about what causes legal trouble.
A related issue is that it is not sufficient to do the right thing. People involved in ESOP transactions need to document that that they did the right things, in the right ways, for the right reasons. Contemporaneous documentation is essential. The NCEO can help in this process. In the members area, we have an extensive set of forms, templates, and checklists that, if followed, will take you a long way down the road to documented compliance.
Lesson 2 is that penny wise may be pound foolish. Prospective sellers to ESOPs should invest in advisors with experience in the field. They should hire trustees without a perception of conflict, and that increasingly means outside trustees, especially during any transactions. Good advisors can not only help you make your case if an investigation happens, they can help you avoid the red flags that may trigger an investigation in the first place. Even if an investigation closes without any results, the cost to your company may still be high in terms of the time invested by your staff and the fees you will pay to your advisors.
Lesson 3 is that, for the vast majority of companies, DOL investigations do not change the calculation about whether it makes sense to create or maintain an ESOP. The majority of settlements are not game-changing amounts. Figure 1 on page 10 is a vivid illustration of the distribution of risk.
The NCEO’s analysis of this data is ongoing, and you will see more results from us in the coming months. We are also working with the DOL and ESOP experts to be sure we make the best use of this data.