Role of the employee stock ownership plan trustee
By Neil M. Brozen, CPA, Ventura ESOP Fiduciary Services
March 8, 2022
As a qualified retirement plan (QRP) under Section 401(a) of the Internal Revenue Code, an employee stock ownership plan (ESOP) is required to have a trustee. The trustee of any QRP is not legally required to be independent, but it is highly recommended they be so for any ESOP transaction (e.g., purchase of company stock, sale of company stock to a third party, etc.) or if they plan on being an ongoing trustee. Independent or not, a trustee’s duties are the same. And as a fiduciary, they are required to act solely in the best interests of the participants and their beneficiaries.
In a transaction to purchase company stock, the ESOP trustee acts as the buyer on behalf of the plan participants and the trust, and the trustee cannot pay more than fair market value for the stock, as determined by the trustee’s valuation firm. In addition, the terms of the financing must be commercially reasonable, and the transaction must be fair from a financial perspective.
While it is the company’s board that is responsible for deciding to put the company on the market as well as negotiating the terms of the sale, the ESOP trustee can act as seller in a transaction to sell company stock or all the company’s substantial assets. In such situations, the trustee is required to make an investment decision to sell if the value of the offer is greater than the projected share value in the next 3–5 years. The trustee cannot consider future employment when helping to sell a company.
On top of other duties, one of the main responsibilities of an ongoing ESOP trustee is to determine the fair market value of the shares owned by the ESOP on the last day of the plan year every year it is active. To do so, the trustee engages an independent, experienced ESOP valuation firm to prepare a draft valuation report, which the trustee then carefully reviews to determine if the value reported is reasonable for ESOP administration. The resulting updated share price is then sent to the third-party administrator (TPA), who is responsible for preparing participant statements.
Another trustee responsibility is to monitor the board of directors, attending one or more board meetings as a guest or observer to fulfill their duty. Board members should prepare for such a meeting by reading the board package in advance, then actively participate in the meeting itself. The trustee relies on the board to fulfill its duty to monitor the performance of the management team and company.
The trustee is also the legal owner of the stock and the custodian of trust assets, which means that the stock certificate should be in their name and they should hold the certificate, unless it’s held as collateral for a stock-acquisition loan. Any bank or investment accounts also need to be in the trustee’s name, even if the assets are managed by a third party.
The trustee is responsible for receiving contributions, dividends and distributions from the company as well as making loan payments if the ESOP borrowed money to purchase the company stock.
Trustees are responsible for ensuring that participants receive their vested account balance when entitled to receive their distributions. Institutional trustees typically process participant distributions themselves, whereas other trustees rely on a third-party administrator or a third-party payer to pay distributions, withhold taxes as required, pay the taxes to the IRS and issue appropriate tax forms to participants and file them with the IRS. The trustee wires funds to the payor of the distributions.
Approximately 60% of ongoing ESOP trustees are company employees. The risks of serving as an ongoing internal trustee is minimal and there is no cost. Afraid of losing control, many companies are hesitant to engage an independent trustee, feeling that they usually don’t know as much about the company as internal trustees. However, internal trustees have many conflicts of interest, since they are usually members of the management team, on the board, are an ESOP participant, and/or may have an incentive plan that’s tied to the annual share price.
The vast majority of ESOP transaction trustees are independent, as the transactions they oversee have significant risk and are scrutinized by the Department of Labor. It would also be very difficult for an employee or group of employees to negotiate an ESOP purchase transaction because they would likely be negotiating with their boss.
Neil Brozen is the president of Ventura Fiduciary Services. Mr. Brozen has provided ESOP trustee services since 2005 — for two institutional trustees, between 2005 and spring 2016, and as individual ESOP trustee, starting in July 2016. He has been responsible for more than 350 ESOP in that time and currently serves as trustee for 135 ESOPs in 26 states. You may reach him at nbrozen@venturaesop.com.
The Minnesota Center for Employee Ownership serves as a free unbiased source for education and resources around all forms of employee ownership. With 52,000 business owners over the age of 55 in Minnesota exiting their business in the next 3–5 years, there is a crisis looming. What will happen to their legacy, employees, community? Business owners will look to their advisers on how best to exit. Contact us for more information on how we can be a resource for you at www.mnceo.org or Sue Crockett, executive director at scrockett@mnceo.org
