A new U.S. Senate bill would exclude appraisers of employee stock ownership plans (ESOPs) from the U.S. Department of Labor’s new definition of fiduciary. S. 1232 says,
Section 3(21)(A) of the Employee Retirement Income…Security Act of 1974 (29 U.S.C. 1002(21)(A)) is amended by inserting ‘and except to the extent a person is providing an appraisal or fairness opinion with respect to qualifying employer securities (as defined in section 407(d)(5)) included in an employee stock ownership plan (as defined in section 407(d)(6)).’
The DoL issued a proposed rule to revamp the definition of fiduciary under ERISA last October (see Rules/Regs: Wider World).
Some commentators complained he proposal would hold down the number of ESOPs being started because of additional costs arising from the new need for fiduciary insurance and would ultimately lead to fewer qualified appraisers because some would drop out of the business (see Fiduciary Expansion Proposal Could Hurt ESOPs).
However, one commenter contended incorrect ESOP valuations are not unusual, and the impact of such errors on plan participants is severe (see Law Firm Supports Making ESOP Valuators Fiduciaries). (PLANSPONSOR.com – Bill Would Exclude ESOP Appraisers from Fiduciary Rule, 7/1/2011.
I checked with a trusted colleague, Corey Rosen, Founder of the National Center for Employee Ownership. Here’s his take:
The DOL’s proposal would require appraisers to get additional and costly fiduciary insurance. There is a lot of uncertainty about how much this would cost or how available it would become, but it would probably double or triple appraisal costs, making ESOPs less appealing to smaller companies. More important is that current law places the burden on ESOP trustees to vet the appraisal carefully. They now would be less likely to do that, saying it is the appraiser’s duty. So any possible gain in appraisal quality will be more than offset by less scrutiny of their work.
The DOL has never issued regulations on what an ESOP appraisal should be. That step would be far more effective in getting more reliable appraisals than costly and uncertain efforts to come to standards through litigation. The DOL should also consider establishing standards for ESOP appraiser qualifications.
Overall, the DOL proposal is a very inefficient and potentially damaging way to solve a problem that the data suggest is not that common. While there are bad appraisals, less than .2% of all ESOPs default on debt and only an average of two-three valuation lawsuits on ESOPs go to court each year. If appraisals were so overblown, these numbers would be much higher.
Employee ownership should be encouraged. In the largest and most significant study to date of the performance of ESOPs in closely held companies, Douglas Kruse and Joseph Blasi of Rutgers University found that ESOPs increase sales, employment, and sales/employee by about 2.3% to 2.4% per year over what would have been expected absent an ESOP. ESOP companies are also somewhat more likely to still be in business several years later. This is despite (or perhaps because of) the fact that ESOP companies are substantially more likely than comparable companies to offer additional retirement benefits along with their ESOP.
Congress should amend the bill to instead require regulations from DOL. Let’s not risk spoiling a good thing.