Track Two: The Roles of Boards of Directors and Trustees in ESOP Companies

Transcription

1 Track Two: The Roles of Boards of Directors and Trustees in ESOP Companies The California/Western States Chapter of The ESOP Association: The 2018 Chapter Conference Thursday, October 4, :15 p.m. 4:15 p.m. Presented by: Jessica Martines Operations Manager Rachel J. Markun Partner

2 Overview What Is Corporate Governance; What is Different in ESOP-Owned Companies; Rules on Voting ESOP Shares; Role of the Board of Directors; Special Considerations for Directors of ESOP Companies; Corporate v. ERISA Standards; ESOP Fiduciary s Tasks; Actions of Directors and Management Subject to ERISA; Handling Conflicts of Interest; and Proactive Measures for Governance Success 2

3 What is Corporate Governance? The Process of allocating authority and responsibility among a company s shareholders, the Board of Directors, and management Shareholders elect the Directors and vote on extraordinary corporate matters. Board of Directors oversees the company, responsible for hiring and evaluating senior management, and appointing the Trustee(s) and other fiduciaries. Management runs the company s day-to-day operations. 3

4 What Is Different in ESOP-Owned Companies? It has an additional governance layer with the Trustee or of the ESOP; and/or The Employee Retirement Income Security Act ( ERISA ) governs the trust (not corporate law). Employees have expectations (and say) as beneficial owners of the Company through the shares held in their ESOP account. The interaction between governance systems can: o Lead to problems, or o Enhance value. 4

5 What Is Different in ESOP-Owned Companies? (Continued) Success in an ESOP-owned company includes the general business objectives: Business survival and growth; and Increase in stock value. However, success in an ESOP-owned company also includes the following goals: Repurchase of company stock from departing employees; Adequate provision for employee retirement; and Employee participation in operational decisions to increase quality, productivity, and profitability. 5

6 What Is Different in ESOP-Owned Companies? (Continued) ERISA fiduciaries must protect participant interests as retirees, not as employees Board of Directors and Trustees-Independent Fiduciaries must seriously consider bona fide purchase offers. How does an ESOP Committee operate in this goverance setting? Typically, the ESOP Committee is not charged with fiduciary duties What is the New Harbinger Committee structure? 6

7 What Is Different in ESOP-Owned Companies? (Continued) The ESOP Trust is the legal shareholder of record. The ESOP s Trustee votes the shares held by the ESOP Trust ESOP Participants are beneficial owners of the shares that are allocated to their ESOP accounts. No direct voting rights; Special voting rules apply to certain major corporate events and may be extended for other events New Harbinger advisory vote for the Board of Trustees 7

8 Rules on Voting ESOP Shares Section 409(e) of the Internal Revenue Code of 1986, as amended (the Code ): At private ESOP companies each participant in the plan is entitled to direct the plan as to the manner in which voting rights under securities of the employer which are allocated to the account of such participant are to be exercised with respect to any corporate matter which involves the voting of such shares with respect to the approval or disapproval of any corporate merger or consolidation, recapitalization, reclassification, liquidation, dissolution, sale of substantially all assets of a trade or business or otherwise provided in any regulations. 8

9 Rules on Voting ESOP Shares (Continued) This provision of law is often referred to as passthrough voting. Section 409(e) of the Code is silent on the voting to elect the Board of Directors. A survey on corporate governance conducted by the National Center for Employee Ownership ifound that the majority limit employee participation in voting to the requirements under Section 409(e) of the Code. 9

10 Role of the Board of Directors Make business judgments intended to grow shareholder value; Set corporate strategic goals and business strategy; Review corporate financial statements; Declare C corporation dividends or make S corporation distributions; Evaluate and approve significant corporate transactions, including complete sale of the company or its assets; Balance the interests of corporate constituents; Determine contributions to qualified plans; 10

11 Role of the Board of Directors (Continued) Establish corporate standards and conduct; Appoint officers and periodically evaluate their performance; Advise senior management, evaluate their performance, and determine their compensation; Facilitate succession planning; Address other corporate governance issues; Establish one or more committees to help the Board of Directors fulfill its duties; Retain independent advisors to Board of Directors and its committees; 11

12 Role of the Board of Directors (Continued) Adopt, amend, and/or terminate ESOP and other qualified plans; Appoint ERISA fiduciaries for qualified plans and provide oversight to such ERISA fiduciaries; and Approve and make discretionary and/or mandatory contributions to the ESOP and other qualified plans. 12

13 Special Considerations For Directors of ESOP Companies Director s Qualifications This is specific to each company but generally expect: Business Acumen Familiarity with the industry Experience with ESOPs (preferable) Director s Compensation: Must be reasonable under the circumstances Bench mark for industry If Director is also an employee, no additional compensation For outside Directors: Travel expenses (within reason) and generally a fixed fee for attending meetings 13

14 Corporate vs. ERISA Standards Corporate law generally presumes good faith by members of the Board of Directors making a Business Judgment, applying a gross negligence standard of review. ERISA holds fiduciaries to the highest standards of prudence, skill and care; ERISA fiduciaries must act solely in the interests of plan participants and beneficiaries. 14

15 Corporate vs. ERISA Standards (Continued) A person serving as both a member of the Board of Directors and an ESOP Fiduciary remains subject to the corporate standard when acting as a grantor terminating or amending a plan or when reviewing purely corporate functions. This is not a bright line rule for ESOP Companies ERISA fiduciaries are personally liable for breaches of their ERISA duties. 15

16 Corporate vs. ERISA Standards (Continued) Corporate Fiduciary Standards (Delaware) Business Judgment Rule: Courts presume that the directors act or take no action based on information, in good faith and in honest belief that such actions or inactions are in the best interests of company. Shareholders bear the burden of proof to overcome such presumption they must demonstrate that the directors violated their duties of care, loyalty or good faith. 16

17 Corporate vs. ERISA Standards (Continued) Corporate Fiduciary Standards (Delaware) Duty of Care: Directors duty to inform themselves, prior to making decision, of all material information reasonably available and to act with requisite care in making a corporate decision. o Gross Negligence Standard: Where Business Judgment Rule applies, Directors liability for breach of duty of care exists only if the adjudicator finds the directors actions or omissions are grossly negligent. 17

18 Corporate vs. ERISA Standards (Continued) Corporate Fiduciary Standards (Delaware) Duty of Loyalty: Directors duty to refrain from self-interested transactions with the company unless the transactions are entirely fair. o o Directors may lose the Business Judgment Presumption if Duty of Loyalty breach is established and/or Directors acted out of self-interest. Acting in self-interest: If a Director is on both sides of transaction, or derives personal financial benefit that was not provided to corporation and shareholders generally. 18

19 Corporate vs. ERISA Standards (Continued) ERISA Fiduciary Standard: Solely in the Interest of plan participants and beneficiaries; For the exclusive purpose of providing benefits to participants and beneficiaries; With the Care, Skill, Prudence and Diligence under the circumstances then prevailing that a Prudent Person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of like character and with like aims; and In conformance with the Plan and Trust documents so long as the documents are consistent with ERISA (ERISA 401(a); 29 U.S.C. 1104(a)). 19

20 Corporate vs. ERISA Standards (Continued) ERISA Fiduciary Standard: Solely in the Interest of plan participants and beneficiaries; For the exclusive purpose of providing benefits to participants and beneficiaries; With the Care, Skill, Prudence and Diligence under the circumstances then prevailing that a Prudent Person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of like character and with like aims; and In conformance with the Plan and Trust documents so long as the documents are consistent with ERISA (ERISA 401(a); 29 U.S.C. 1104(a)). 20

21 ESOP Fiduciary s Tasks Who is an ERISA fiduciary? Named fiduciary in the plan document or trust instrument ESOP Trustee(s) directed & independent or insiders Anyone who exercises any discretionary authority & control over management or disposition of plan assets. ERISA 3(21); 29 U.S.C. 1002(21)(A) Could, in theory, include: o o o o o Board of Directors ESOP Advisory Committee Plan Administrator Company Executives not typically Outside advisor but only if s/he makes a fiduciary decision 21

22 ESOP Fiduciary s Tasks (Continued) General Duties: Follow the Plan document (Must have read and be familiar with document terms in order to follow it) Know there are circumstances where ERISA requires Trustees to override the Plan and/or participant and/or Company direction Protect the Plan from non-exempt prohibited transactions by being sensitive to potential and real conflicts of interest (ERISA 3(14), ; 29 U.S.C (14), ) 22

23 ESOP Fiduciary s Tasks (Continued) Primary Duties: Assure that the ESOP Trust (the ESOT ) pays no more than fair market value for company stock (or any other asset that the ESOT acquires); Ensures that the ESOP is administered fairly without discrimination as provided by the Internal Revenue Code of 1986, as amended (the Code ), ERISA, and the regulations issued thereunder (collectively, Applicable Law ); Ensures that ESOP participants receive all required information and disclosures as provided under Applicable Law; 23

24 ESOP Fiduciary s Tasks (Continued) Primary Duties (Continued): Ensuring that the ESOP and ESOT obtain and retain their legal qualifications under the Code and are amended as required under Applicable Law, from time to time; and Voting the shares of company stock held by the ESOT when note required to be passed-through to ESOP Participants. 24

25 Actions of Directors and Management Subject To ERISA Directors: Effective control over the actions of the Named Fiduciaries of the ESOP: Egregious Example: Directing the ESOP Trustee to Sell Employer Securities; Appointment of ESOP Fiduciaries: This includes monitoring such ESOP Fiduciaries post-appointment; Directors are obligated to act in a prudent manner; Failure to make mandatory contributions: Atypical scenario for ESOPs; 25

26 Actions of Directors and Management Subject To ERISA (Continued) Directors (Continued): Formulation of an Investment Policy Statement for the ESOP if there are non-stock assets; and Implementation, amendment, and termination of an ESOP: o This does not include the initial design of the ESOP plan document. 26

27 Actions of Directors and Management Subject To ERISA (Continued) Management: Employee Communications: Answering questions about the ESOP; Noting changes in the ESOP; Making statements regarding the future of the ESOP; and Plan Administration: Reporting data for record keeping purposes; Making ESOP related disclosures as required under Applicable Law; Maintaining and retaining the company s ESOP related records; and Filing the ESOP s annual return (Form 5500). 27

28 Actions of Directors and Management Subject To ERISA (Continued) Directors and Management: General Business Decisions (e.g., setting and paying salaries, contracting with customers, etc.) typically are NOT subject to the ERISA fiduciary requirements, however, such decisions are subject to the higher ERISA fiduciary standards under certain circumstances, such as the following: o o The ESOP is the sole shareholder of a holding company that is in liquidation (under the rationale that decisions affecting the corporate assets will directly or indirectly affect the ESOP s assets); or The directors and/or officers have a non-waivable conflict of interest (such as may happen when the company is in financial distress). 28

29 Handling Conflicts of Interest Conflicts of Interest may arise: o Between the Company and the ESOP; o Between managers and the ESOP; o Between Board of Directors members and the ESOP and the ESOP Trustee/Independent Fiduciary; and/or o Between the ESOP Trust and the other shareholders. When and how does it arise? Most common scenario: Sale of Company stock or assets Other scenarios: Executive Compensation; Management of the ESOP repurchase obligation; and Audit of the Company s financial statements. Why do people overlook it? 29

30 Handling Conflicts of Interest The Board of Directors must serve the shareholders (and not management). Non-ESOP-owned companies: Outside shareholders and outside members of Board of Directors oversee managers to avoid their selfdealing. ESOP-owned companies: Outside members of Board of Directors and ESOP Trustee(s)- Independent Fiduciary serve the purpose of oversight. 30

31 Handling Conflicts of Interest (Continued) Information provided only from management may be skewed to benefit management. Key to managing conflicts (potential or otherwise) is independent oversight Non-management Directors; Outside Directors; Institutional Trustees; and/or Committees of the Board of Directors, comprised of disinterested Directors and possibly non-directors. 31

32 Case Study How New Harbinger Publications, Inc. approaches corporate governance as a majority ESOP-owned company. Election of Board 32

33 Proactive Measures for Governance Success Establish and document procedural prudence in all decisions; Educate key decision-makers with respect to corporate and ERISA fiduciary standards; Consult experts (legal, accounting, etc.), as needed; Maintain adequate directors and officers and ERISA fiduciary liability insurance; Read and understand the ESOP plan documents; and Be truthful, honest and open in dealing with all relevant people and facts when making decisions that may affect the Company s stock value. 33

34 Questions? Thank you Contact Information: Jessica Martines Operations Manager New Harbinger Publications, Inc Shattuck Avenue Oakland, CA T: (800) F: (800) Rachel J. Markun Partner Hawkins Parnell Thackston & Young LLP 1776 Second Street Napa, CA T: (707) F: (707)

35 Brief Bio: Jessica Martines Jessica Martines is the Operations Manager at New Harbinger Publications, Inc. 35

36 Brief Bio: Rachel J. Markun Rachel J. Markun is a Partner in the Napa and San Francisco offices of Hawkins Parnell Thackston & Young LLP. Ms. Markun advises clients regarding the corporate, tax and fiduciary issues relating to ESOPs and employee benefit plans. She has represented plan fiduciaries, employers and financial institutions in connection with legislative and regulatory initiatives relating to the Internal Revenue Code, ERISA, the federal securities laws, and the California tax laws. She has extensive tax expertise relating to tax-exempt entities including matters involving unrelated business tax issues and all aspects of retirement plan qualification issues. She represents retirement plan corporate sponsors in a variety of matters, including Internal Revenue Service audits and U.S. Department of Labor investigations. Ms. Markun has an active practice in addressing ERISA issues in litigation matters and in addressing regulatory matters involving ESOPs. She has extensive experience in substantive ERISA issues and in preparing defense strategies for ERISA cases, including privilege issues, co-fiduciary liability issue and damages issues. She counsels many ESOP companies and fiduciaries on a range of compliance, best practices and risk management issues. Ms. Markun is a frequent lecturer and author on corporate, tax and fiduciary issues relating to ESOPs and employee benefit plans. 36