The Impact of Appraisals on the Potential Liability of ESOP Fiduciaries

This is an interesting story on a number of levels. The article tells the tale of the Department of Labor suing the fiduciaries of an ESOP for failing to properly scrutinize and challenge an appraiser’s report valuing company stock, which was used to support the price paid by the plan for company stock. The article illustrates a significant problem in ESOPs that hold private company stock, which is the need to have appraisers set the price of the stock for purposes of the ESOP’s operations. This becomes a closed circle in valuation, consisting of the plan fiduciaries and the appraiser; no one else really plays a role or is involved. This absence of sunlight creates an environment in which, if the plan and/or the fiduciaries have a motivation to do so, the valuation of the ESOP holdings – i.e., of the portion of the company owned by the employees – can be distorted. Even in the absence of a motivation to do so, this closed process, in which there is no competing public market valuing the holdings or other outside check on the valuation, can result in a distorted valuation out of sheer error. The only check on that potential problem are the fiduciary obligations of the ESOP’s fiduciaries, and the enforcement tools, whether of the DOL or participants, provided by breach of fiduciary duty litigation, which allows participants and/or the DOL to pursue fiduciaries for problems that crop up in this process.

One of the most important takeaways from the article, as well as from my own experience in ESOP litigation, is the fact that the fiduciaries of ESOP plans should not assume they can simply obtain a valuation, treat it is correct, rely on it, and be safe from potential personal liability for a fiduciary breach. As the article points out, the fiduciaries, even when they rely on an appraisal report, can violate their fiduciary obligations, and be liable for doing so, if they do not properly analyze and vet the appraisal. ESOP plan fiduciaries should not simply receive an appraisal, use the numbers in it to run the plan, and put the report in a drawer; they need to analyze it, quiz the appraiser, and test its numbers. Only these later steps – and only when done well - will give those fiduciaries any real protection from breach of fiduciary duty litigation involving the valuation of ESOP assets.