In the summer of 2014, there was a public announcement regarding the settlement of some ongoing litigation between the U.S. Department of Labor (the “DOL”) and GreatBanc Trust Company (“GBTC”) (the “Settlement Agreement”). We thought it would be helpful to the ESOP community to summarize our interpretation and ongoing responses to the Settlement Agreement as we plan for our continued involvement as a financial advisor to ESOP companies and ESOP Trustees going forward. This article addresses six important questions, however we recognize that there may be others. We would be delighted to engage in conversations on this topic with anyone interested in doing so.
I – What is This?
The Settlement Agreement stems from an ESOP transaction involving Sierra Aluminum (the “Company”) as the sponsoring ESOP Company and GBTC as the ESOP Trustee. In a lawsuit filed against GBTC, the DOL alleged that GBTC inappropriately relied upon financial projections provided by the Company. In the Settlement Agreement, the DOL called into question the processes that ESOP Trustees undertake to ensure that their financial advisors are adequately reviewing, testing and incorporating projections that are used to approve ESOP transactions. Their position is not new. In fact, plaintiff’s attorneys have recently presented other cases that have centered on the same DOL criticisms.
ESOP cases frequently get settled, but what makes this Settlement Agreement unique is it goes beyond a cash payment regarding the case at hand by (1) taking potential other contentious cases between the DOL and GBTC ‘off the table’ and (2) establishing very clear protocols to follow regarding the broader relationship between ESOP Trustees and their financial advisors. The protocols do not only deal with the specific issue of analytically testing and utilizing projections, but they also cover the ESOP Trustee’s process for assessing the qualifications and independence of financial advisors.
II – How Has This Impacted the ESOP World?
Had the DOL and GBTC settled the Sierra Aluminum case privately, there would likely not be a need for us to write this paper. In most instances, litigation settlements impact one case and one set of litigating parties. Thus, they do not set a precedent in the traditional legal sense. As a condition to settling the case, however, both the DOL and GBTC agreed to openly discuss the Settlement
Agreement in the public domain. Specifically, the DOL fired a warning shot suggesting that other ESOP Trustees should follow the protocols established in the Settlement 2 Agreement. As a result, GBTC approached all of its major ESOP service providers to set forth their expectations. As one might imagine, knowledge of the Settlement Agreement spread very quickly throughout the ESOP community and many institutional ESOP Trustees have since made the business decision to follow suit, even though the ‘safe harbor’ afforded to GBTC does not extend to them.
At this point, even just a few short months after its finalization, the Settlement Agreement is being labeled as a collection of best practices in the ESOP world. Institutional ESOP Trustees and financial advisory firms working in the ESOP world will now be adhering to the Settlement Agreement, specifically as it relates to transactions.
III – What Types of ESOP Events Does This Impact?
The Sierra Aluminum case involved an ESOP transaction, and the protocols in the Settlement Agreement have been interpreted to apply to all ESOP Trustees going forward. So, strictly speaking, the prevailing interpretation in the ESOP community is that the provisions of the Settlement Agreement are intended to apply to ESOP transactions, either at an initiating stage or at a follow-on stage. However, a number of the protocols involving the specific analytics of a valuation can extend beyond transaction analyses to include ongoing ESOP valuations for ongoing plan administration. Accordingly, while some have viewed the provisions of the Settlement Agreement to apply solely to ESOP transactions, we believe that they can be viewed as best practices for annual ESOP valuations. For this reason, we believe the extension of the Settlement Agreement protocols to the full spectrum of ESOP-related valuations is inevitable.
IV – How Does This Impact Prairie’s Work?
Let’s start our answer to this question by categorizing the provisions of the Settlement Agreement into three basic groups: (1) valuation content and analysis, (2) the qualifications of the financial advisor to the ESOP Trustee and (3) the independence of that financial advisor.
V – What Has Prairie Done to Respond to the Trustees’ Requests?
There are two action items we have initiated. First, with regard to the valuation content and analysis pursuant to the Settlement Agreement, we are constructing an appendix to our reports that will assist the ESOP Trustee in their review of these specific items. The appendix will detail the processes, assumptions, calculations and conclusions identified in the Settlement Agreement and tie them into other sections of our report for more detail. The appendix will be part of our report regarding both ESOP transactions and ongoing ESOP valuations for the reasons discussed 4 previously; a best practice for ESOP transaction valuations should also be a best practice for ESOP update valuations used for plan administration purposes.
Regarding the qualifications and independence pursuant to the Settlement Agreement, Prairie is preparing a general qualifications and independence memorandum, which will be updated periodically. The memorandum will be provided to all ESOP Trustee clients and it will include comprehensive responses to all of the questions that surface in the various RFQs. It will be supplemented with project-specific information as requested, which may include things like industry experience, client references and other items, on an opportunity-by-opportunity basis. We believe that the output of these action items will be of significant help to ESOP Trustees in their efforts to comply with the protocols reflected in the Settlement Agreement.
VI – How Will This Impact ESOP Companies?
Companies considering the formation of an ESOP, or existing ESOP companies considering a nextstage ESOP transaction, may find themselves compelled to (1) engage a Company-side advisor or (2) conduct their own analysis. They will likely not have access to an ESOP financial advisor that can carry forward and serve as the financial advisor to the ESOP Trustee. For this reason, it is very likely that transaction timelines will be extended and all-in transaction costs for implementing an ESOP will increase.
While others reacting to the Settlement Agreement may choose to focus solely on its impacts to new ESOP transactions, we believe a better decision is to extend the Settlement Agreement guidelines to ESOP valuations prepared for ongoing administration. We believe that consistency in our work product is an absolute foundation of what we do. Therefore going forward, we will produce all ESOP related reports (transactions and updates) in a similar fashion. Prairie is going to exercise these best practices in everything we do. ESOP Trustees will ask for more detailed information and due diligence meetings may be more time consuming, which may result in an increase in costs to complete the ESOP valuation.
Robert Gross is a Senior Managing Director at Prairie Capital Advisors, Inc. He can be contacted at 630.413.5585 or by email: firstname.lastname@example.org.
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