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Mini-cast 49: Who Controls an ESOP, Anyway?

In this episode of The ESOP Mini-cast, Bret Keisling discusses control of an ESOP company from the perspective of the employee owner, with simple practical examples.

We explain why every court decision and settlement agreement is important to employee owners, and the difference between “controlling” a board of directors, and having its support.


Mini-cast 49 Transcript

Announcer: 00:04 Welcome to The ESOP Mini-cast brought to you by Capital Trustees. A great way to wrap up the week.

Bret Keisling: 00:19 Hello, friends. Thanks for listening to The ESOP Mini-cast. I'm Bret Keisling. Our topic today who controls on ESOP, anyway? We'll spend a few minutes today talking about controlling an ESOP company from the perspective of employee-owners. By employee owner, I'm referring to anyone who's a plan participant, which can include both current and former employees and please remember as you listen to this mini cast, these views are my own. They are not those of Cap Trustees or any of its team members and this doesn't constitute advice or guidance of any kind.

Bret Keisling: 00:53 Whenever there's a new court decision or settlement agreement, news coverage and social media commentary inevitably characterize the result as if it were a zero sum game. Either it's a victory for the DOL against greedy selling shareholders and/or incompetent trustees, or when the defendant wins it's a victory for the trustee against an overreaching government, in this case, the Department of Labor. But if you're an employee owner, you may wonder whether this or any court case settlement or agreement is relevant to you. The answer is definitely yes. Regardless of how anyone feels about a particular court decision or settlement agreement, each adds at least some clarity to defining the fiduciary duty to act solely in the best interests and what is meant by serving the best interests of the employee owners. A recent US District Court decision in Virginia determined that the ESOP trustee breached its fiduciary duty to the employee owners by overpaying for stock during a 2010 transaction. The opinion discussed many issues including whether it was appropriate for the ESOP trust to pay a premium for control of the company while not actually having control of the company. Of course, ESOP lawyers, valuation advisors and trustees are going to parse this and other decisions and come up with findings to change their practices and to make adjustments based on current legal guidance.

Bret Keisling: 02:19 Only the employee owners of companies that are subject of the litigation will see any direct financial benefit from it. But every decision, as I've said, continues to define the trustee's fiduciary duty to act in the participant's best interest. Here's a few examples to explain how a trustee could pay more than fair market value for shares of stock and not be nefarious about it at all. Let's say you decide to buy a house. You happen to drive by a house that you love and it's on the market for $150,000 you have $150,000 available, cash on hand. You agree to pay the list price, you're a willing buyer and the current owners a willing seller. That's the definition of fair market value. Now, let's say you decide you want to buy the same house for $150,000 but you only have enough cash for a 20% deposit and you need bank financing for the rest. The bank's going to hire an appraiser and if the appraisal determines the house is only worth $100,000 that's all the bank is going to loan you. Now that exact same house no longer has a fair market value of $150,000 because even though you're still a willing buyer, you can't get the financing. So in our example, in that case, the fair market value is now about a hundred thousand if you're willing to buy in, the seller would sell.

Bret Keisling: 03:43 So let's assume you take the bank financing and the seller agrees to sell you the house for $100,000. Think back to the 2008 mortgage crisis in the United States. When real estate values plummeted, the banks weren't on the hook for the loss of value and the house appraiser wasn't on the hook either. The buyers, in this case, you were left on the hook, even though the appraisal indicated a certain value and the bank loaned you the money, those facts didn't matter. You were responsible if your mortgage defaulted.

Bret Keisling: 04:10 Now let's take the examples I just gave and put them in the ESOP context of paying fair market value. But you're not looking to buy a house, you're looking to buy an ESOP company. And you're not a private buyer, you're a trustee acting on behalf of the participants. You're still getting the value appraised and you're not able as a matter of law to pay more than fair market value. So you consult with valuation advisors and lawyers and you make the best deal possible when buying the company. But just like the mortgage crisis of 2008, the trustee must rely on the advice of professionals but the trustee has personal liability for overpaying while the advisors do not. So that explains how a trustee could in good faith pay more than fair market value and still be held responsible just as many homeowners were left on the hook in 2008.

Bret Keisling: 05:02 Now let's talk about what is meant by control in the context of who quote unquote controls a company and the board of directors. I'll give you three non-ESOP examples. Two are about famous people and companies you've heard of, Miramax and Uber, and one example that probably covers a few million CEOs.

Bret Keisling: 05:21 At Miramax. Harvey Weinstein was a co-founder and major shareholder. For many years he controlled the board of directors in that they were loyal to him and in many cases they owed their positions on the board to him. When the horrendous accusations came up, Weinstein lost the support of the board and he was fired. Fortunately, he's also been arrested, but we'll save that for another day. But the point is, Weinstein from one day to the next still had the relationships, still had the quote unquote control of the board, but after the accusations came out, he no had the support of the board. So control was meaningless without the support.

Bret Keisling: 06:02 Similarly, Travis Kalanick was a co-founder of Uber and its CEO. Like Miramax many Uber board members probably owed their seat to Kalanick and in that sense, he controlled the board. But in 2017 when a myriad of troubling facts came out about Uber and Kalanick, he lost the support of the board and he was fired. Unlike Weinstein, however, Kalanick remains a significant Uber shareholder and still has a seat on its board of directors, but he no longer controls the Uber board or Uber itself.

Bret Keisling: 06:35 Final example, probably an oversimplification, but any time a CEO leaves a company for any reason other than they wanted to, it almost always means they lost the support of the Board, even if they used to control the board. So in that sense, who controls an ESOP company? Whoever has the support of the board of directors.

Bret Keisling: 06:56 Now, if you're an employee owner and you've gone to any of the great conferences from The ESOP Association and NCEO, or you've maybe heard talk on podcasts, you'll hear occasionally someone say that the trustee as an ultimate act could fire boards of directors or sue management, et cetera, if things were really, really bad. To put this in context, if you're an employee owner and your trustee is taking action to replace the board, that sort of thing, it's going to send such a bad message to lenders, suppliers, customers, and very, very importantly, the employee owners. So to the extent that something that the trustee can just charge in on a horse and assert control, it's a very oversimplification of a complicated and important process.

Bret Keisling: 07:53 So today we had a very simple look at why ESOP related court decisions are important to you as an employee owner and tried to explain in, again, rather simple terms what is meant by control, both in the paying for control of an ESOP and in controlling the board of directors. If you have any comments or if there are topics you'd like to see discussed on future podcasts, please drop us an email at that's Bret with one "t" at K E I S O P dot com.

Bret Keisling: 08:27 Meanwhile, as we start the Labor Day weekend, I hope you have a meaningful time this weekend. If you make up part of the labor force, thank you for helping our country be what it is. My goal for next year to turn more workers into employee owners. I'm Bret Keisling. Thanks for listening. We'll talk to you next week. Bye bye.


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