Unintended Consequences: ESOPs and ERISA 50 years later
ESOPs ended up under ERISA, not by design, but because the legislative father of the ESOP Senator Russell Long was able to seize upon the extraordinary legislative opportunity to add ESOPs to the much larger pension reform bill. One consequence was that the Department of Labor (DOL) ended up sharing oversight functions for ESOPs with the IRS.
The IRS, with a few exceptions, has performed its role as an objective watchdog agency, going after the bad guys when violations were discovered, such as its pursuit of S ESOP scams. In contrast the DOL, motivated by its ideologized opposition to undiversified retirement plans, which began in the 1970s, promulgated ESOP policies that have significantly thwarted ESOP growth, and have often alleged abuses that were not supported by objective facts and/or extended investigations for periods exceeding 3 years. The Bowers + Kubota litigation is the most recent egregious example.
ESOP Future
For ESOPs to have the future robust growth that their stellar record supports, major changes are required in the near-term future. At the top of the list are:
- New DOL adequate consideration regulations are needed with specific safe harbor “best practice” procedures.
- Fiduciaries and board members, management and others deemed to be functional fiduciaries need to be insulated from class action law suits by following the “best practice” procedures referred to above.
I believe that without these changes employee ownership through ESOPs will experience decline. More and more owners and companies will be unwilling to subject themselves to the risk of DOL harassment and litigation and class action litigation. Some ESOPS have been and will continue to be replaced by other forms of employee ownership that do not offer employees nearly the same well-defined and protected benefits. Two recent examples that surfaced in the past decade are Employee Ownership Trusts (EOTs) and the private equity (PE) model now being used by a number of the largest M&A firms. While both of these models offer the possibility of significant payouts to most or all of the employees of the company, their applications are limited.
For fifty years ESOPs have uniquely provided employees with stock ownership they can and do identify with, enabling them to think like owners. This identifiable ownership, fueled by significant tax benefits, is sorely needed in today’s economy. ESOPs enjoy strong bi-partisan support, a rarity in today’s polarized legislative environment. Congress needs to take rapid and decisive action to protect and grow this unique broadened ownership program.
Ron Gilbert has been providing ESOP consulting work since the 1970s, where he began his ESOP career working for Louis Kelso, and was one of the first ten NCEO members.
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