40: Your ESOP Questions Answered


As our regular listeners know, at the end of every recent episode of The ESOP Podcast, we invite you to submit topics for discussion. In this episode, Bret Keisling, Rich Heeter, and Brian Keisling go through that 'grab bag' and answer some of your ESOP questions.


The questions we cover in this episode:

  • Are there rules for the minimum amount of information that management has to share with employee owners?

  • What is the tangible difference is for employee owners at a 100 percent employee owned company versus, say, a 30 percent employee owned company ? And, as a follow-on, which ownership scenario is more common?

  • How long can a company that just became employee owned expect to wait before seeing the results of becoming an ESOP?

  • What is diversification, and why is it used?

  • A hypothetical question: My company wants to make a $3,000,000 capital expenditure that we think will result in a lot of new business. But if we take on debt to finance the plans, the share price will decrease. Can management make certain decisions even though they know it will result in a decreased value?

  • I've heard at conferences that ESOPs can't own real estate. Is this true? And if so, why would there be such a rule?

  • What are prohibited transactions in relation to ESOPs?

Thanks to everyone who submitted questions. Please, keep them coming to Bret@KEISOP.com! We plan to do another Q&A session in the future.


Listen to this episode on Soundcloud. Or subscribe on Google Play or iTunes/Apple Podcasts.


The ESOP Podcast is licensed under a CC BY-NC-ND Creative Commons License.

Episode 40 Transcript

Announcer: 00:12 Welcome to The ESOP Podcast, brought to you by Capital Trustees, keeping you up to date on all things ESOP.


Bret Keisling: 00:22 Hi, and welcome to The ESOP Podcast. This is Bret Keisling.


Rich Heeter: 00:25 I'm Rich Heeter.


Brian Keisling: 00:27 I'm Brian Keisling.


Bret Keisling: 00:28 And we are with Capital Trustees. Thank you for joining us today. So at the end of every episode of the podcast, we invite our listeners to submit questions to us at podcast@captrustees.com, and Rich and Brian, today we're going to review some of the questions that have come to us. That right?


Brian Keisling: 00:46 Yep. We're just going to do sort of a grab bag style question and answer session so that some of the ones that we've heard, you guys are able to get information out there and hopefully answer some questions for people.


Bret Keisling: 00:57 And we would like to be able to tell you that Rich and I are going to hear the questions without any advanced work and we're going to answer off the top of our heads, but we'd be lying, wouldn't we. [Laughter.]


Rich Heeter: 01:09 We would be! [Laughter.]


Bret Keisling: 01:09 The effective way to do this was actually for us to prep and prepare. So with that, Brian, why don't you take it away and give us the first...


Rich Heeter: 01:18 ...and hopefully it will sound like we have prepped and prepared!


Bret Keisling: 01:21 Indeed! So Brian, take it away. Why don't you give us our first question?


Brian Keisling: 01:24 Sure. So the first question we have asks, "Are there rules for the minimum amount of information that management has to share with employee owners?"


Rich Heeter: 01:34 That's a very good question, and we do hear that an awful lot from companies and participants. So there are basic minimum guidelines that the Department of Labor and the IRS say that must be provided to participants at least once a year. And those are things like you have to provide an annual statement of a participant's account indicating what the beginning balance in their account was, what has transpired during the year, any transactions during that account and the updated price of the shares that are held in their account for them. So that's requirement number one, the second requirement. And quite honestly, there's, there's really only two requirements that are mandated and that is the second one is that you have to provide the participants at a plan level a statement of the plan's account. So: total assets, total liabilities, total distributions paid during the course of the year. And that gets filed as part of the Form 5500.


Bret Keisling: 02:59 And Rich, on the Form 5500. Those are publicly accessible for any company.


Rich Heeter: 03:05 Absolutely.


Bret Keisling: 03:05 And the 5500s - Brian, you've done research on the 5500s, they cover any qualified retirement plan?


Brian Keisling: 03:12 Yeah, they, the most often that I see it usually covers either an employee stock ownership plan or a 401K.


Rich Heeter: 03:20 And obviously, being in the retirement plan arena with ESOPs those are the things that we see most often, but it actually pertains to health and welfare benefit plans - there's a whole list of things that are required. So for example, if you have a defined benefit plan or a profit sharing plan, those all have a 5500 form filing requirements.


Bret Keisling: 03:49 Brian, you're responsible at Capital Trustees for accessing the Form 5500. Where do you get them?


Bret Keisling: 03:56 I personally get them straight from the Department of Labor website, but you can also get them from brightscope.com or FreeERISA.com.


Bret Keisling: 04:04 Excellent. So, Rich, you've covered the two things that are required on an annual basis. Is there anything else that the participants are entitled to?


Rich Heeter: 04:11 Sure. They are entitled to a copy of the summary plan description that must be provided to them usually upon enrollment and anytime that there's a material change to the plan or to the documents. And they are also entitled to a copy of the actual plan document itself. Generally that's in, you know, you have to request that. That's not something that the employer typically provides to everybody, but if they receive a request for it, they have to provide it.


Bret Keisling: 04:52 So that covers what a company is required to share with participants, but are they allowed to share more than what's required, if they choose?


Bret Keisling: 04:59 Oh, absolutely. Brian. And there are a number of conversations and presentations at conferences regarding open book management, how much information to share, and that's a little bit of a different subject. That's kind of a management tool and speaks to culture and communication. So a company could share everything if they chose, but we wanted to focus on what they're legally required to share. And Rich a participant goes in and says, "Hey, I'd like the Summary Plan Description," or, "I'd like one of the other documents," that they're entitled to, the company should provide that. Is it a little bit different, every so often companies informed that a participant wants something via letter from participant's attorney. Does that change the company's thinking at all?


Rich Heeter: 05:46 Yeah. I think anytime the word attorney comes into play, it certainly rises to a different level and you have to, you know, look at what's the reason it's being requested, what are they looking for, why are they looking for it? You know, a lot of times we'll see a question be asked that a participant wants a copy of the valuation report. I think that's probably the most common document that gets asked for and that does not get shared with a participant.


Brian Keisling: 06:32 Uh, why not?


Rich Heeter: 06:34 Because first of all, it is the trustees' valuation report. It was prepared solely for the purpose of the trustee to analyze the value. It's not the company's report, it's not their report to give to a participant. And there's a number of, it's only one part of a, one tool that's used by the trustee on determining valuation rear and I think there's a lot of information in it that would either be, could be misinterpreted and misunderstood. You know, it's not the average participant is not a valuation expert. So, it's just not as a normal course released to somebody. That being said, I think if, I mean if you were into a legal proceeding, then the attorneys get involved and decide what you know, who it's going to be released to and under what circumstances and those types of things as if it's, or if it's a governmental request.


Bret Keisling: 07:46 And Rich, what I'm going to do is suggest that we refer back to Episode 13 where Scott Stitt was our guest, and Scott pointed out, just to put a final touch on if you hear from a participant's council, is if somebody has bothered to hire an attorney to get information, one should assume that one is in a legal situation. And that's not legal advice - as you know. I don't practice law anymore - that is just common sense. So if you hear from somebody attorney, and let's also be clear, occasionally participants will have legitimate complaints or concerns and it's understandable why they lawyered up, but there are also some attorneys who are looking for clients and know that if the company is large enough and ESOP could lead to a class action or some major litigation and there are the requests are not so much addressing a real concern but rather kicking the tires, looking for trouble.


Rich Heeter: 08:45 It's a fishing expedition.


Bret Keisling: 08:47 So when we get calls from our clients, if they've received anything from council, you want to handle them one way, but broadly, Brian, and we'll move onto the next question, we believe that the information beyond the minimum requirements that every company must share, we believe that how much information shared should be a management decision based on the culture of the communication and the big picture and not on a one off issue.


Rich Heeter: 09:14 Agreed.


Brian Keisling: 09:17 Our next question is being asked mainly from the perspective of the participants, but you guys should feel free to open it up however you want. It asks what the tangible difference is for employee owners at a 100 percent employee owned company versus say a 30 percent employee owned company?


Bret Keisling: 09:37 And Rich, let me just jump in very broadly and then I'll turn it over to you. If the ESOP owns 30 percent, it's essentially the same as any minority shareholder, which is you can often go in and get out voted by the majority shareholder. So in terms of company operations and that sort of thing, where we're the trustee for a number of minority-interest ESOPs, the fact of the matter is our role at that point is still to ensure that the laws are being followed and that everything according to ERIS and Department of Labor guidance is being followed. But if a company that's majority owned decides to rent office space, that might be more vast or anything, there's not necessarily anything any minority shareholder could do. Correct?


Rich Heeter: 10:26 Yes. Yeah.


Bret Keisling: 10:27 So, Rich. Besides that, just framing it that there's not much that the minority shareholder can do. Are there any other benefits as to the question or differences?


Rich Heeter: 10:36 Well, I think it comes down to, many times, ownership, management, culture and communication. You know, there's a saying, we use it a lot. I'm not sure where I first heard it, but, you know, there are companies that *have* an ESOP, whether they be, you know, a minority, you know, 30 percent ESOP or a 100 percent owned ESOP company, they *have* an ESOP. And then there's other companies that *are* an ESOP. They have that culture, you know, they've always had it prior to becoming an ESOP many times. So whether they own 100 percent, 30 percent, 50 percent somewhere, you know, anywhere across that spectrum, they treat employees and the ESOP differently than other companies that may just view it as just another employee benefit and many times not necessarily a fully engaged, meaningful benefit.


Bret Keisling: 11:50 That makes sense. The other thing, the question was framed as tangible benefits to the participant. The one thing that we need to do is kind of take a couple of steps backwards and look at a bigger picture. If you're a 100 percent ESOP and therefore you are not paying any federal tax, that's going to go, that money that would've gone to the government is going to go into the company, fuel the operations, fuel whatever. That hopefully, if the company is doing well and all things being equal is going to an increase in share value, which ultimately the participants will benefit from. Although it's not necessarily direct correlation. It's a 100 percent ESOP can do things...


Rich Heeter: 12:35 ...As an S-Corp....


Bret Keisling: 12:36 ...As an S-Corp. Yes, absolutely. So, that also would be a bigger picture benefit where they would all benefit 100 percent.


Brian Keisling: 12:45 As an aside, are you guys able to comment on which ownership scenario is more common. Are most ESOP's 100 percent employee owned? Are most in the 30 percent range? Somewhere different?


Bret Keisling: 12:59 We can't quantify in terms of whether it's 30 percent. We can take a little bit of a stab, which is not going to be educated. I would assume Rich just, there's probably a larger percentage of minority ESOPs than 100 percent.


Rich Heeter: 13:16 Right. Although I think that it is becoming -- more and more companies are moving to that 100 percent ownership structure, just realizing the benefits of, you know the tax benefits to the company and to the employees. While many of many of the ESOPs may start out as a minority, I think there's a very high percentage of them that ultimately move to that 100 percent status.


Bret Keisling: 13:50 And I even think for a lot of them that start off as a minority, it's with the intent that ultimately will be 100 percent, but there's a little bit of this is new to the selling shareholders. So it's let's sell 20 percent. Let's see how this 35 percent, let's see how it works. And then ultimately they may get to 100 percent, but we're certainly as we're recording this at the end of August 2018, we're working on several transactions right now where there are additional tranches, additional steps in the achievements and shares.


Bret Keisling: 14:22 Great. So our next question asks, how long a company that just became employee owned can expect to wait before seeing the results of becoming an ESOP.


Bret Keisling: 14:33 Six hours! [Laughter.] ...Or 17 years. [Laughter.] Brian, it's a great question, and Rich and I are kind of chuckling, not that it's a funny question, but boy, that's really difficult to quantify! First of all, let's talk big picture stuff. Generally speaking with an ESOP transaction, that's going to be leveraged and that means you're going to take on debt to finance the transaction. And as most of our listeners should be aware, debt has probably the easiest direct correlation to value. If you have a lot of debt, your value is going to be reduced. And if as you reduce the debt, you're going to get an increase in shares just from that debt. So right off the bat, depending on the leveraging, it could be three, four or five years before there's an appreciable increase in value.


Rich Heeter: 15:24 Also, you know, you have the vesting component for a new plan and most commonly it's over six year period of time. It can be a, the other alternative is a zero percent for the first three years, and then all then at the end of year, three year 100 percent vested, so you can either have gradual vesting or clip or what we call cliff vesting and you know, so it takes time for participants to have value accumulate in their account that's actually theirs a, you know, in the event that they were to leave and ESOP. So there's a number of factors as to, it can be if you pay down - if a company pays down - debt very rapidly and if they're having, you know, exceptional years, you're going to notice that pretty quickly, that appreciable value. It also depends, uh, on the structure of the ESOP as to what the length of, uh, of the, of what we call the internal loan note between the ESOP and the company, you know, if it's a five year loan, those shares are going to be allocated to participants' accounts very rapidly. If it's a 30 year period, uh, you know, they're getting one-30th of the shares released every year, so it's a, so the, the release period and the benefit plan has more shares available to it for not only current participants but future participants, but as it's shorter or it's a number that gets into their account early on is not as rapid as if it was a short term. So it's a balancing act in, in plan design there. So, uh, so I think the best answer is: It depends!


Bret Keisling: 17:22 And you're exactly right. And it also depends on the industry you're in right now. The economy by many measures is doing very, very well and companies are doing well. That's not universally true. If you're in a challenging industry, uh, as we've pointed out, oftentimes, Rich, on the podcasts and our presentations and just in the six years that the Capital Trustees has been together is an ESOP won't make a bad company a good company, and ESOP can make a good company, a great company, and we believe that. But if you're not, if your company is not geared for profitability, just the fact that they're an ESOP is not going to result in immediate value to participants. What's next? Brian?


Brian Keisling: 18:04 Our next question is what is diversification and why is it used?


Rich Heeter: 18:11 So that's a very interesting question and we can probably have a full-blown podcast on that subject as well as others in the future. We will probably have a future guest talk about diversification issues.


Bret Keisling: 18:29 Rich, we actually have that on the schedule for this fall. We didn't want to tell you because I know how excited you get when we bring experts in to talk diversification! [Laughter.] But, absolutely that's going to be a topic -- and many of these questions will be full-blown podcast topics this fall.


Rich Heeter: 18:49 Great. So at a high level, and we're definitely not going to get into the weeds as to how diversification works, but what it s an opportunity to allow participants that are approaching retirement age to essentially diversify or spread out some of their ESOP values into other investment vehicles. It's under the approach of, you probably shouldn't have all of your eggs in one basket. And obviously in an ESOP, it is heavily concentrated into one stock and that's your employer stock. Now, many times that stock in addition to your 401K , that's the company stock is performing very well and it may be performing better than many of your alternatives out there. But, sometimes again, depending upon the industry, it may be wise to diversify. And the government has put into place under ERISA the mandate that individuals that are at least age 55 and have been in the ESOP plan for 10 years or more, are eligible to diversify a portion of their ESOP account holdings into other investments. And that's done over a, can be done over a six year period of time. And it also, it's available to both active and former employees if the requirements are met. So for example, as I said, you can be eligible once you hit age 55, you're eligible over a six year period of time and in each year an eligible participant can elect a distribution not to exceed 25 percent of the number of shares that have ever been allocated to their account. And that is then reduced by the number of shares that you may have previously diversified. And then in the sixth year, the final year of eligibility, a participant can elect a diversification distribution not to exceed 50 percent of the remaining number of shares ever allocated to their account. So you have the, the participant has the - they, they are not required to diversify. You don't have to make a diversification election every year. You can, you can do it in your two. And then in year three and then four and then six, if you want. Each year it's considered a separate diversification election. And typically you have the ability to, to roll that money, you can, depending upon what the, what your plan says, the distribution options, if there are other investment funds within the ESOP, you can transfer to one of those investments. You can transfer to another qualified plan of the employer that has at least three or more investment funds such as your 401K plan, or you can a distribute it and roll it out to your individual IRA account. If you take it in cash, you're then subject to the, you're under 59 and a half, which typically you are, if you start diversification at age 55, you would face the tax penalties for early distribution. But again, it's your option. As far as timing goes, there's certain rules about when you have to give notification to a participant. The Internal Revenue Code says you have to provide a notice to participants of their eligibility to diversify no later than 90 days after the plan year end. There's a problem with that though, in that by 90 days after the end of the year, we typically don't know what the number of shares or the value are, because the annual update process hasn't taken place yet. So, and then it says that the employer must comply with election no later than 180 days after the plan year end. Many times still the same problem exists. You get, you know, if you're at a calendar year end many times by, by June, you do, you still haven't had the valuation completely updated in it and the allocations made, so we still don't know what we're eligible to diversify for. So what are the best practices that companies can take on - and many attorneys in and plan administrators have come up with the process of you issue a preliminary notice to the participants within that 90 day window, giving the best data that you have available at the time. It's nonbinding, but you're, but you're telling them that they are eligible to diversify. And then when the stock values and balances are known, you send out another notification and, and with the election form, giving them, okay, here's now your values and here's what you're eligible for. And then within 100, 80 days of that period of time, you need to make the distribution. So if it's not possible, then do it as soon as possible, uh, but the, the key is give notice and then do your best to get it done in that period of time.


Bret Keisling: 25:03 Excellent. That was very thorough. I had a very thorough response on why I think it's important to hire people from multiple backgrounds and bring different viewpoints together. But apparently that's not the diversification that you're talking about today. [Laughter.] So we will save that for another topic. Although your diversification and mine are both important.


Brian Keisling: 25:25 So the next question that was sent to me is presented as sort of a hypothetical. The question is, my company wants to make a $3,000,000 capital expenditure that we think will result in a lot of new business. But if we take on debt to finance the plans, the share price will decrease. Can management make certain decisions even though they know it will result in a decreased value?


Bret Keisling: 25:47 Yes. And before I answer the question, Brian, I need to come clean on something. This particular question was submitted by *me* and actually is going to be one of the topics we cover at the [ESOP Association PA/DE NY/NJ] Multi-State Conference [in Hershey, PA] where I'm presenting on Thursday, September 13th at 8:00 AM with Ed Willis and Michael Gore. And so this is just an advanced preview of one of the questions we'll be covering during our presentation. And for those of you who know me in real life, yes, I admitted that an organization has scheduled me to present at 8:00 AM! Rich - Any concern with that? [Laughter.] Oh, so at any rate to the question...


Rich Heeter: 26:31 No, no concern. As long as it's 8:00 AM Pacific Time!


Bret Keisling: 26:37 Oh, I'll let them know that I was confused. So, Brian, this is a question that comes up quite frequently and we think it is an important question. And where the confusion comes in is what is meant by the duty to preserve share value, or protect it, and that sort of thing. And generally speaking, businesses all the time are going to come up with expansion plans and where the confusion in employee owned companies seems to be is that if you take on debt and it's going to result in a reduction in the share price, is it appropriate or are you undercutting the share price among the employees? Further, it gets a little bit complicated. Let's say that you take, I think the question had a $3,000,000 example and you make this expenditure a year or two before someone's going to retire. The share price gets decreased as a result of the ongoing debt and someone just coincidentally is retiring during that decreased share price. Is that, quote unquote, "unfair" to that participant? And one of the things that we have to do is remember that before employee owned companies are ESOPs, they're companies, they're businesses, and there are all kinds of decisions that businesses are going to make that may have an effect on share price, but the share price is a temporary barometer to a long-term picture. So if you are a manufacturing company and you come to us as the trustee and you don't have to come to us as trustee, I'm just saying that if you did and said, hey, we want to make this $3,000,000 investment and over the course of 10 years we think it's going to bring us $10,000,000 worth of, of, of return on the investment through increased sales and increased productivity, etc. But there's going to be a couple of years share a price decrease because of the debt. Our response is going to be, by all means, make that investment. It's a solid business investment and the fact that there's a couple of years where there will be an increase in share value is necessary. Otherwise you avoid the decrease in share value, but also avoid the increase that comes from that capital expenditure. Rich, do you agree?


Rich Heeter: 28:55 No, that's a, that's a very good point.


Bret Keisling: 28:57 Where we come in and where we caution, and again, this is one of those outliers that I don't know that we've ever personally seen it with our clients, but management can't make a decision that is designed to decrease share price. So for example, if a management team is looking at a repurchase obligation problem or a diversification problem in terms of the costs of it and they say, hey, if we borrow $3,000,000, that will depress the share price so that we don't have to pay so much and repurchase obligations, we would shut that down in a heartbeat. That's not an appropriate use, but just decisions that are made in the regular course of business that are going to have an up and down effect. That's just business.


Rich Heeter: 29:42 Right. There's a lot of decisions that because of as a result of the decision, it will impact share value, many times temporarily. It's a little different when, when the company decides to make a decision to transact with other, you know, for additional shares, let's say with the ESOP, because in that case the value will go down if they're going to incur debt to do it, but there's not a corresponding asset per se that that's going to increase value or revenue. Where in the example that was provided, it was a $3,000,000 investment of capital into the company for its operations as opposed to $3,000,000 of capital leaving the company.


Bret Keisling: 30:39 For a retirement party for a popular upper management. That would be problematic.


Rich Heeter: 30:46 Right.


Bret Keisling: 30:46 That's not what we're talking about here.


Rich Heeter: 30:47 Right.


Bret Keisling: 30:47 Yeah. Excellent.


Brian Keisling: 30:50 Our next question asks: I've heard at conferences that ESOPs can't own real estate. Is this true? And if so, why would there be such a rule?


Bret Keisling: 30:58 This is one of the areas Brian, that is born from confusion and there are a couple of different components of the confusion. First off, we need to differentiate between "the company" and "the trust." There's - Rich, can you explain the qualified securities as it relates to what the trust can own?


Rich Heeter: 31:20 So, in an ESOP the plan is designed to predominantly hold qualified employer securities, that is the common stock of the sponsoring company or preferred convertible stock sometimes. So, but many times the trust will hold other assets, as part of the plan, such as cash. Many times it will hold, it can hold, other individual stocks as part of the diversification of the trust's holdings once all the stock has been allocated in there and additional cash contributions have been made. you want to invest that cash so it will be invested in other stocks. It could be mutual funds, it could be insurance, just about anything that's an allowable investment of a retirement plan can be held there. And real estate is one of those assets. Whether or not it's a good idea is another question, and whether it should hold it or not versus whether it can hold it and whether it should be at the trust level or should it be at the company level.


Bret Keisling: 32:52 And Rich, and I have a little bit of a different view at least until we meet in the middle. I happen to think that if a founder of a company or a sole shareholder at a company would buy the property that we often see - and they're often set up in a different entity for liability reasons, legal reasons, tax reasons, whatever - but if it was good for an individual who is an owner, then it's good for ESOPs as well. But there's a big caveat there. Let us say that you are a large insurance brokerage and we happened a couple of years ago to sell one of these. That was a fairly large company. And let's say that they had happened to own their real estate. Well, if they own a three or four story building that houses their company and the office has worked from there, to me, that can be a very prudent way to avoid rent, etc., etc. If on the other hand, this company that needs three or four floors worth of offices goes out and buys a 12 story building now they're a landlord, now the value of the ESOP could go down because they don't have tenants, they don't have, you know, things that are completely unrelated to traditional operations there, to me, it gets to be more speculative than would be appropriate for an employee owned company.


Rich Heeter: 34:17 Yeah. I think in one case you're, you're, you're talking about, you know, the possibility of, of exchanging, having ownership in lieu of paying rent so you have an asset offsetting what you would've paid. So it's going to kind of wash in your value many times versus being as I think as you said, as a landlord and having it been primarily an investment property.


Bret Keisling: 34:47 And we have, Rich, a couple of clients who have that scenario. Not prohibited and our clients do it as well as they can. We just point out if you take the example of the insurance brokerage, kind of taking you off your game, you know. Now you are a landlord with everything that entails. So there is no hard and fast prohibition from owning real estate. That is a misnomer from the conferences that does come up. However, just because it's permissible does not make it a necessarily a good idea or a good idea in every circumstance.


Rich Heeter: 35:22 It comes down to a, say, like most things in life and in business, it's a facts and circumstances.


Bret Keisling: 35:31 Yep.


Brian Keisling: 35:32 All right. Our next question is another one that gets straight to the point. What are prohibited transactions in relation to ESOPs?


Rich Heeter: 35:42 That's an interesting question. So there's a number of what was determined to be prohibited transactions and there are certain exemptions as it, from the prohibited transaction rules as it pertains to ESOPs. The prohibited transactions are put forth, the rules are by the IRS, and the penalties associated with them, as well as the Department of Labor. So prohibited transactions in regards to ESOP include any direct or indirect sale exchange, lending of money, extension of credit, various other transactions between a qualified plan, which is what an ESOP is, and a quote "disqualified person," which is a person with any of certain relationships to the plan such as an owner, selling shareholder, company director that can be deemed to be a "disqualified person." So if you were to enter into a prohibited transaction, there's tax penalties associated with that. One of the prohibited transactions under ERISA is a qualified retirement plan can't buy its own employer securities to be held in the plan, however ESOPs get an exemption from the prohibited transaction rules which allows them to purchase those employers securities. Otherwise, it would have been - you wouldn't have ESOPs - because obviously a ESOPs are designed to hold primarily employer securities. The other thing that you, that would result in a prohibited transaction, and this is probably the one that we see the most of, is the overpayment of the purchase price to a party of interest in a transaction. So, the majority owner of a company that's going to do an ESOP transaction is determined, let's say in this case, that the company is worth $5,000,000, decides to do a 100 percent transaction. And during the course of that transaction based on the valuation that's on behalf of the fiduciary or the trustee, in this case, it's determined that the value is $8,000,000, and the trustee enters into that agreement and pays the eight, pays the $8,000,000 for those shares. And then ultimately upon investigation or audit, it's determined that they overpaid for those shares. There was, you know, there could have been any number of errors that were, that were done that the trustee relied upon to come up with that number and their valuation advisor. And it's determined that they overpaid by three million dollars in this case, that would result in a prohibited transaction. There would be penalties and fines and excise tax, and it could, could ultimately caused the plan to become a disqualified in extreme cases.


Brian Keisling: 39:38 And who are those penalties and fines paid to - is it the Department of Labor? If there was too much money paid in a transaction, does that get balanced out at all? How does that get dealt with?


Rich Heeter: 39:49 So there's a couple different provisions. So there's the excise tax is paid to the IRS in the prohibited transaction guidelines. There are also, depending upon what the, what the nature of that prohibited transaction is, can result in fines and penalties and charges by the Department of Labor as well. So it could be a multi-pronged penalty and fines being assessed, and it can be assessed against the trustee, can be assessed against the company. It depends who was involved in the transaction. So who the party of interest was that did the transaction. So prohibited transactions, not a good thing. That's why they're prohibited. Because they're trying to make sure that everything is done in solely for the best interests of the participants and the beneficiaries as it relates to an ESOP.


Bret Keisling: 41:13 Great. Well thank you for that answer. We hope that everyone got a lot out of us answering these questions today. We really enjoy receiving questions to have answered and as always, our listeners are invited to send additional questions that we will address on an upcoming episode to podcast@captrustees.com. I'd like to thank Capital Trustees managing directors, Bret Keisling and Rich Heeter, for joining us today and for answering those questions and we hope that you'll join us again next week on #TrusteeTuesday for The ESOP Podcast. Goodbye everybody.


Rich Heeter: 41:47 Goodbye.


Bret Keisling: 41:48 Goodbye everybody.


Brian Keisling: 41:50 Do you have feedback about this or any other episode of The ESOP podcast? Do you have a topic you'd like for us to discuss on the show? Would you like to appear on the podcast as a featured guest or a panelist in a group presentation? Then we want to hear from you! Send us an email to podcast@captrustees.com. Thanks for listening.


Announcer: 42:13 Thank you for listening to The ESOP Podcast. Brought to you by Capital Trustees and their managing directors, Bret Keisling and Rich Heeter. Production assistance provided by Brian Keisling and Third Circle, Inc. Logo design by Bitsy Plus design and music created by Max Keisling. Join us again next time for The ESOP Podcast.


Standard Disclaimer: The views expressed herein are my own and don't represent those of my own firms or the organizations to which I belong. Nothing in the podcast should be construed as guidance or advice of any kind in any field and the fact that I mentioned an organizational website or an advocate or a company on a podcast does not reflect an endorsement, but if you've heard your name or your group's name mentioned on this podcast, I'd love to have you come on and talk about it yourself.

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