U.S. Labor Department looking closely at ESOP valuations

The U.S. government is increasing scrutiny of valuations of employee stock ownership plans (ESOPs), looking for inflated estimates of the worth of a company’s shares, according to an article in the June 23 Wall Street Journal. The Labor Department is plaintiff in 15 lawsuits related to ESOPs, with most of the cases claiming shoddy valuations, and some alleging that appraisals were deliberately inflated, harming the plan and participating employees.

Company owners can defer taxes on capital gains when they sell all or part of a company to an ESOP, and employer contributions to ESOPs are generally tax deductible. More than 13.4 million U.S. workers were part of an ESOP in plan in 2011 (the latest year data is available), up 7.5 percent from 2006.

Valuations are an integral part of an ESOP plan, as 95 percent of the estimated 6,800 U.S. companies with an ESOP are closely held and not widely traded. Valuations are necessary when the ESOP is established and annually in subsequent years to determine the repurchase price at an employee’s retirement, departure or death.

According to the Journal article, federal officials are expected to propose new rules in 2015 to toughen standards for outside appraisers who prepare valuations for ESOPs. Currently there are no minimum qualifications for appraisers who value ESOPs or any specific guidance or rules related to how the appraisals are performed.

The Labor Department is also scrutinizing trustees with a fiduciary duty to employees participating in a plan. A settlement with GreatBanc Trust Co. spelled out practices for GreatBanc to follow, including taking “reasonable steps” to make certain that an appraiser gets accurate and current information to use in the valuation analysis.

ESOP valuations require a reasonable and well-defended valuation analysis, performed by a qualified appraiser, in order to meet the needs of the large number of ESOP stakeholders. Shenehon Company has more than 30 years of experience in business valuations and can prepare valuation analysis for use at the formation of an employee stock ownership plan as well as annual ESOP valuations. For more information, contact Bill Herber at 612-333-6533 or bherber@shenehon.com.