Fiduciary Compliance in ESOP Transactions: Recent DOL Settlement Agreements

Transcription

1 Presenting a live 90-minute webinar with interactive Q&A Fiduciary Compliance in ESOP Transactions: Recent DOL Settlement Agreements Implications of GBTC, FBTS and Alpha Settlement Agreements, Guidance for Avoiding Litigation TUESDAY, MAY 22, pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: Eliot T. (Eli) Burriss, Partner, McDermott Will & Emery, Dallas J. Christian Nemeth, Partner, McDemott Will & Emery, Chicago Emily Rickard, McDermott Will & Emery, Washington, D.C. Roberta Casper Watson, Partner, The Wagner Law Group, Boston The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions ed to registrants for additional information. If you have any questions, please contact Customer Service at ext. 1.

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5 Fiduciary Compliance in ESOP Transactions: Recent DOL Settlement Agreements May 22, 2018 Presented by: Eli Burriss Chris Nemeth Emily Rickard Roberta Watson

6 I. Overview Recent litigation and audit activity is focusing on process 6

7 What s a Fiduciary? A fiduciary is any person, committee, or entity that has discretionary authority or control over the ESOP s administration, exercises any discretionary authority or control over ESOP funds, or renders investment advice for a fee Generally: ESOP administrators Trustees Directors and officers Named fiduciaries ESOP advisors and consultants

8 Roles and Responsibilities ESOP Trustee [Shareholder] Appointed by the Board Elects the Board Approves certain major transactions Oversees the valuation process and sets the annual share value Board of Directors Oversees the corporate business via board meetings and board committees Appoints the officers Creates and appoints committee members ESOP Committee [ESOP Committee may be an ERISA fiduciary] Audit Committee Compensation Committee Monitors appointed ERISA fiduciaries Management Operations of the business Committees Delegated duties 8

9 Corporate/ERISA Intersection Board of Directors is charged with appointing plan fiduciaries (e.g., the trustee, ESOP Committee, plan administrator) Cannot do so haphazardly Properly Appoint Fiduciaries Carefully evaluate candidates and document the selection process Verify that candidates qualifications are consistent with their duties Require that those to whom legal responsibility has formally been delegated assume an active role and exercise that responsibility Provide training to internal fiduciary candidates Trustee is not permitted to delegate Trustee duties (cotrustee relationship) 9

10 Board Responsibilities (vis-à-vis the ESOP) Appoint and monitor ESOP Trustee Direct trustee per plan document While directed action may be limited on an annual basis, the board must make sure it provides direction in those instances where a directed trustee is required to act (e.g., election of the members of the board of directors) Plan administration responsibility Determine ESOP contributions Oversee ESOP distribution process Adopt, amend and/or terminate ESOP Evaluate repurchase liability May be delegated to a plan committee Declare dividends/distributions to be paid to shareholders 10

11 Trustee Responsibilities Maintain custody of plan assets Updated stock certificates for released shares Manage liquid assets Investment requirements? Is the trustee directed? Receive contributions and dividends/distributions Make ESOP loan payments Oversee participant distributions Based on plan administrator direction Determine fair market value of shares held by ESOP Vote ESOP shares May be directed Monitor board of directors Must properly elect the board of directors 11

12 Potential Liabilities A fiduciary does not guarantee good results all results are viewed in hindsight and poor results will not result in liability if at the time the decision was made the fiduciary followed a prudent process, free from inappropriate conflicts of interest Participants, beneficiaries, and the DOL may take legal action against ESOP fiduciaries for breaches of fiduciary duties Fiduciaries are personally liable to make good on ESOP losses caused by fiduciary breach Companies can indemnify fiduciaries, unless breach was willful or criminal ERISA also provides for recovery of attorneys fees and costs to prevailing party at the discretion of the court ERISA does not permit plaintiffs to recover damages in excess of lost benefits and attorneys fees and costs no punitive damages 12

13 II. PROCESS AGREEMENTS 13

14 Litigation Environment Through a series of recent settlements, the (DOL) has outlined the process steps fiduciaries should follow in connection with a transaction involving a purchase from, or sale to, an ESOP. Perez v. GreatBanc Trust Co. Acosta v. First Bankers Tr. Servs., Inc.; Acosta v. BAT Masonry; Acosta v. Mueller. Alpha Investment ConsultingGroup, LLC 14

15 Perez v. GreatBanc Trust Co. First significant process agreement. Does not have the force of law. However, DOL cautions that fiduciaries would be well-advised to adhere to the process. 15

16 Perez v. GreatBanc Trust Co. First significant process agreement. Does not have the force of law. However, DOL cautions that fiduciaries would be well-advised to adhere to the process. 16

17 Perez v. GreatBanc Trust Co. Selection of Valuation Advisors. Avoid conflicts of interest. In selecting a valuation advisor, the Trustee will prepare a written analysis addressing the following topics: The reason for selecting the particular valuation advisor; A list of all the valuation advisors that the Trustee considered; A discussion of the qualifications of the valuation advisors that the Trustee considered; A list of references checked and discussion of the references views on the valuation advisors; Whether the valuation advisor was the subject of prior criminal or civil proceedings; and A full explanation of the bases for concluding that the Trustee s selection of the valuation advisor was prudent. 17

18 Perez v. GreatBanc Trust Co. Selection of Valuation Advisors. If the Trustee selects a valuation advisor from a roster of valuation advisors that it has previously used, the Trustee need not undertake anew the analysis outlined above if the following conditions are satisfied: the Trustee previously performed the analysis in connection with a prior engagement of the valuation advisor; the previous analysis was completed within the 15 month period immediately preceding the valuation advisor s selection for a specific transaction; the Trustee documents in writing that it previously performed the analysis, the date(s) on which the Trustee performed the analysis, and the results of the analysis; and the valuation advisor certifies that the information it previously provided pursuant is still accurate. 18

19 Perez v. GreatBanc Trust Co. Oversight of Valuation Advisor Trustee has an affirmative duty to monitor the valuation advisor. The Trustee will request that the valuation advisor document the specific items in the valuation report If the report does not contain those items, the Trustee should prepare supplemental documentation of the following items to the extent they were not documented by the valuation advisor. 19

20 Perez v. GreatBanc Trust Co. Oversight of Valuation Advisor Document in writing reasonableness of projections used in connection with proposed transaction. Consider whether projections are reasonable in light of company s five-year historical averages or compare to comparable group of public companies. Consider the following metrics: Return of assets; Return on equity; EBIT and EBITDA; Ration of capital expenditure to sales; Revenue growth rates; Ratio of free cash flow to sales. 20

21 Perez v. GreatBanc Trust Co. Oversight of Valuation Advisor Document whether any metrics are unreasonable or should be disregarded. If public company comparables are used, explain the basis for including selected companies as comparable. Document materials assumptions regarding revenue projections if they exceed historical performance. Explain any adjustments to historical or projected financial metrics. Explain any weighting of valuation methodologies. Specific documentation regarding fairness. 21

22 Perez v. GreatBanc Trust Co. Analysis of Financial Statements Trustee must request audited, unqualified financial statements for five years. If qualified financial statements are provided, determine whether it s prudent to rely on them. Critically assess reasonableness of projections. 22

23 Perez v. GreatBanc Trust Co. Financial Statements Trustee must document analysis of final valuation report: Marketability discounts; Minority interest and control premiums; Projections; SWOT analysis; Discount rates used; Adjustments to historical financial statements; Industry risks; Company comparables; Material assumptions and testing of those; and Corporate debt. 23

24 Perez v. GreatBanc Trust Co. Document Preservation Information regarding Trustee s committee or persons who made any material decisions regarding the proposed transaction. Vote regarding the transaction and a signed certification that committee members or others who made material decisions on behalf of the Trustee read the valuation report, understood its assumptions, and considered the reasonableness of the report s assumptions and conclusions. All notes and records of the Trustee made or considered. All communications with services providers, such as valuation advisor. 24

25 First Bankers Trust Services Supplemented and amended the GreatBanc process agreement. Again, does not have the force of law. 25

26 First Bankers Trust Services Selection of Valuation Advisors. Avoid conflicts of interest. Adds to the conflict of interest analysis of GreatBanc Adds a committee of employees of the plan sponsor to list of parties that would give rise to a conflict of interest. 26

27 First Bankers Trust Services Selection of Valuation Advisors. Adds regulatory proceedings and investigations to the list of items that must be analyzed in the report addressing the retention of the valuation advisor. States that a written report is not necessary if the valuation advisor was selected from a roster of valuation advisors that it has previously used or who was previously approved in connection with Trustee s vendor risk management program. Narrows the prior analysis exception from preparing the written analysis of the valuation advisor to one year. 27

28 First Bankers Trust Services Oversight of Valuation Advisor States that the trustee, prior to approving a transaction, request that the VA document the following items or prepare or request the preparation of supplement documentation of the factors identified (similar to GreatBanc factors). Must also describe the risks facing the plan sponsor that could cause the plan sponsor s financial performance to fall materially below the projections relied upon by the valuation advisor. 28

29 First Bankers Trust Services Oversight of Valuation Advisor Focus on prior valuations Must explain any material differences between the most recent prior valuation of the plan sponsor performed within the last 24 months by any valuation firm for any purpose. Comment on the use on unqualified financial statements. If used, stock purchase agreement must contain a provision requiring the selling or purchasing shareholders who are offices, managers, or members of the board of directors of the plan sponsor to compensate ESOP for any losses or other harms caused by or related to financial statements that did not accurately reflect plan sponsor s financial condition. 29

30 First Bankers Trust Services Oversight of Valuation Advisor Must ensure that the financial statements provided to the financial advisor include the following, to the extent they exist: Prior attempts by purchase or selling shareholders to purchase or sell stock in the plan sponsor within the prior 2 years; Any defaults under lending or financing agreement within the last 5 years; Any management letters to accountants within past 5 years; and Any information relating to valuation of the plan sponsor provided to the IRS in the prior 5 years. 30

31 Alpha Investment Consulting Group LLC Selection of Valuation Advisors. Avoid conflicts of interest. Similar to First Banker Trust. 31

32 Alpha Investment Consulting Group LLC Selection of Valuation Advisors. Must investigate outcome of regulatory proceedings. 32

33 Alpha Investment Consulting Group LLC Oversight of Valuation Advisor Similar to GreatBanc No reference to vendor management system. 33

34 Alpha Investment Consulting Group LLC Oversight of Valuation Advisor Must document in writing why projections are or are not reasonable. 34

35 Alpha Investment Consulting Group LLC Analysis of Financial Statements Similar provision as required in First Bankers Trust regarding use of unqualified financial statements. 35

36 Alpha Investment Consulting Group LLC Financial Statements Alpha agreed to determine whether a fairness opinion is required. If so, shall not proceed without one. 36

37 Alpha Investment Consulting Group LLC Document Preservation 37

38 III. Best Practices 38

39 Prudent Process Proper Process is critical: Proper selection of appraiser Proper information provided to appraiser Review the report Ask questions Review the valuation approach(es) Review and question methodology used to determine value Document review process 39

40 Development/Use of Projections Understand the projection process Who is creating and providing the projections to the fiduciary? What experience does the company/management have in creating projections? Understand the risks facing the company and review how this information was used when preparing the projections Company provided projections should be scrutinized to determine that reliance on such projections was reasonable How do they compare to past performance? Are the future projections for new business reasonable? Internal consistency Do they account for risk appropriately? 40

41 Development/Use of Projections Understand use of company-specific risk or adjusted projections (by the buyer) to provide a sensitivity analysis as to the use of projections Trustee must evidence its review and understanding of the financial analysis conducted by the trustee s financial advisor 41

42 Valuation Process and Report Report should include key details: Company specific information Industry requirements Market share considerations Specific identification of materials reviewed by the preparer Customer concentration concerns Discussion of premiums/discounts deserves high level of scrutiny: Control premium evidence of control in fact? Discounts question and understand selection of discount rate The trustee must evidence a review and understanding of the valuation process and report. 42

43 Negotiating Transaction Review and understand initial transaction structure Identify transaction terms that are not fair or favorable to the ESOP Conduct negotiation process solely in the interest of ESOP participants and their beneficiaries Look for and negotiate for items that can help ESOP 43

44 Understanding Governance Requirements Fiduciary should analyze any requirements regarding former sellers board rights Fiduciary should be aware of any company requirement to have independent board member(s) on the board of directors Implement (where appropriate) committee structures within the board of director requirements 44

45 Documentation of the Process Involvement and participation in the process should be evident Who was involved? What material were provided/who reviewed? Was the appropriate expertise had/available? Identify substantive meetings and exchange of information Maintain evidence of team interactions (trustee (trustee representative), counsel, and/or financial advisor) Document negotiation of transaction terms 45

46 Key Takeaway Litigation tends to focus on transactions.remember that process is as important during the administrative process also. Ensuring plan fiduciaries are appropriately carrying out their roles and responsibilities is key. 46

47 Questions? 47