Bankruptcy of Grocery Chain Demonstrates Need for ESOP Protection
Consequences of ESOP Failure are Severe to ESOP Beneficiaries
Thankfully, many American ESOP companies have developed into strong successful companies able to deliver impressive retirement benefits to their employee participants. This reality was once only a dream of ESOP visionaries such as Louis Kelso. Kelso wished to provide American employees a chance to invest in their employer over the long haul and reap the rewards of that investment throughout their retirement years.
As numerous as these ESOP success stories are – and as uplifting as it is to exhibit pride in the success of any ESOP company – there are also some ESOP “wipeouts” that shouldn’t be neglected. When an ESOP company fails or loses much of its value, its employee owners often absorb much of the collateral damage. This is unfortunate not only because employee owners dedicated their entire adult lives to the ESOP but also because they are least able to absorb a loss of asset value as large as that involved in an ESOP failure. Theoretically, lawyers and others may seek to recover assets, judgments, insurance proceeds, overdue receivables, and so on for the benefit of ESOP beneficiaries. Even when these efforts are successful – and they often aren’t – they take years to materialize and result in only pennies-on-the-dollar recovery to ESOP beneficiaries and participants.
A recent ESOP bankruptcy illuminates these various concepts. Iowa-based ESOP Dahl’s Foods Inc. – which was ranked in the Top 100 largest majority employee-owned companies (97% ESOP-owned) – declared bankruptcy in November 2014. It then quickly sold all of its real estate and operational assets to pay off its debts. Months later, it was determined that the ESOP may have a “small pool of money” left to distribute to the ESOP employee beneficiary participants. Specifically, some $1 million may be available to distribute to some 900 ESOP employee participants (approximately $1,000 per participant).
The attorneys handling the bankruptcy noted that this was a rare instance where any assets were available for ESOP participants; in most cases, all assets are used to satisfy the claims of creditors to the ESOP company. In an ESOP bankruptcy, ESOP employee participants are last to be paid any money generated from asset sales; they are paid only after secured and unsecured creditors’ debts are satisfied and other claims against the ESOP are resolved. The attorneys handling the Dahl’s Foods bankruptcy also opined that some other sources of money could be available to be distributed to ESOP participants, with the caveat that the resolution of the claims, lawsuits, and documentation required to gather the money could take several years.
The ESOP Protection Trust is designed to avoid many of the undesirable outcomes seen in the Dahl’s Foods Inc. bankruptcy. In the event of a complete “wipeout” of the value of company stock, the Trust may restore up to half of the lost value. The ESOP Protection Trust is designed to provide a meaningful recovery, not just the “dregs” and “crumbs” left over after everyone else has had their claim against the ESOP company resolved. The Trust seeks to accomplish loss reimbursement in a timely manner, without all the complications, expense, and uncertainty involved in lawsuits and other claim resolution procedures.
Founded in 1931 by Wolverine Thilbert Dahl, the first Dahl’s stores were located in Des Moines. The company was ahead of its time in facilitating drive-through grocery pickups and debit card purchases. It expanded into Kansas before suffering from competitive pressure generated by regional groceries Hy-Vee (also one of the Top 100 largest majority employee-owned companies) and Fareway as well as national mega stores Target and Walmart.
Investments & Wealth Monitor Publishes Article on Stock Protection Fund
Authors Explain How SPF Complements Exchange Funds
In the May-June issue of Investments & Wealth Monitor, a bimonthly educational magazine written by award-winning authors throughout the financial industry, Thomas Boczar and Elizabeth Ostrander of Intelligent Edge Advisors published a 9-page article entitled Stock Protection Funds: The Inverse of Exchange Funds. The article discusses the problem of stock concentration, the Stock Protection Fund as a solution to that problem, and the specific reasons why the SPF serves as an optimal risk management solution for concentrated stockholders.
Investments & Wealth Monitor is published by the Investment Management Consultants Association (IMCA). IMCA sets the standards and practices for the investment management consulting profession and provides investment consultants and wealth managers with the credentials and tools required to best serve their clients. As of June 30, 2015, IMCA served 6,939 CIMA certificants (Certified Investment Management Analysts) and 848 CPWA professionals (Certified Private Wealth Advisors).
Trusts & Estates Publishes Article on Stock Protection Fund
Authors Explain Benefits of New Strategy
In its April 2015 issue, Trusts & Estates, a highly-regarded peer-review journal and website for wealth management professionals, published a 10-page article entitled Stock Protection Trusts: Use an SPT to Manage Concentration Risk. The article was authored by Thomas Boczar and Elizabeth Ostrander of Intelligent Edge Advisors. The article discusses the problem of stock concentration, the innovation of Stock Protection Trusts as a solution to that problem, and the specific reasons why the SPT serves as an optimal risk management solution for concentrated stockholders.
StockShield to Sponsor NCEO’s 2015 Employee Ownership Conference
More than 1,400 Attendees Expected at Country's Premiere Gathering on Employee Ownership
StockShield is proud to sponsor the 2015 Employee Ownership Conference being held April 20-23 at The Sheraton Denver Downtown Hotel in Denver, Colorado. As the nation’s premiere gathering on employee ownership, the National Center for Employee Ownership’s annual conference features interactive presentations and lectures from hundreds of top employee ownership experts and experienced leaders from successful employee-owned companies.
J.P. Morgan Quantifies Risks and Rewards of a Concentrated Stock Position
40% of Russell 3000 stocks have suffered a permanent 70%+ catastrophic loss
J.P. Morgan has published a 42-page study entitled The Agony & The Ecstasy: The Risks & Rewards of a Concentrated Stock Position. Analyzing both S&P 500 and Russell 3000 stock performance from 1980 through 2014, J.P. Morgan reached several sobering conclusions:
- Over the past 25 years, there has been substantial “creative destruction.” Even in the S&P 500 — the most prestigious index of American business — an estimated 320 companies were removed for reasons of business distress. “What this tells us is that companies, even very successful ones, face a steady drumbeat of competitive, regulatory and operational risks.”
- Approximately 40% of all Russell 3000 companies have suffered a permanent 70% decline in their stock’s value, often due to factors outside of management’s control. These exogenous factors include commodity price risks, changes in U.S. or foreign government policy on tariffs and/or trade, unconstrained expansion by competitors, and technological innovation. “Even the best management team is hard-pressed to cope with these types of unforeseeable challenges.”
- A “meaningful number of companies” are always “suffering sharp, unrecovered price declines at any given time, even during an economic expansion.”
While acknowledging that stock concentration can be an effective engine of wealth creation, it concluded that “continued concentration may ultimately destroy wealth.”
StockShield’s patented risk management solutions — both the Stock Protection Fund and ESOP Protection Trust — are premised on the harsh realities that J.P. Morgan highlights: the loss of wealth caused by continued stock concentration with no protection in place. Our primary objective is to reduce the number of large losses caused by stock concentration while preserving the opportunity for concentrated stock holders to generate substantial wealth well in excess of broad market returns.
ESOP Companies and Fiduciaries Can Successfully Manage ESOP Risk
Supreme Court Decision Highlights Fiduciary Issue for ESOP Companies
Employee Stock Ownership Plans (ESOPs) are one of the best ways to accumulate substantial retirement savings, according to the National Center for Employee Ownership, but they are not without risk, as demonstrated by last week’s Supreme Court decision in Fifth Third Bancorp v. Dudenhoeffer. In that case, Fifth Third’s ESOP lost 74% of its value.
In its decision, the Supreme Court ruled unanimously that ESOP Fiduciaries are not entitled to a “presumption of prudence” when buying, holding, or selling company shares. In other words, ESOP Fiduciaries are subject to the same standard of prudence as other ERISA Fiduciaries. However, failing to diversify the ESOP is not evidence of a lack of prudence, given that the whole purpose of an ESOP is to invest primarily, if not entirely, in company stock.
In reaching its decision, the Court established a new set of standards for plaintiffs to demonstrate that a fiduciary is imprudent. While these apply primarily to publicly traded companies, and legal experts expect the decision to have little direct impact on privately held ESOPs, it does refocus attention on the issue of fiduciary risk that has always been present for closely-held ESOP companies.
No Free Pass
While diversification is not required, the Court made it clear that ESOP Fiduciaries do not get a free pass just because the plan is an ESOP. If a company’s stock falls precipitously, litigation risk remains a significant issue, even if the company has done all the right things in making decisions about buying, holding, and selling shares. The plaintiff’s bar and the Department of Labor are likely to remain active in this field and may be emboldened by the Court’s decision.
A variety of circumstances could unfold making company stock appear an imprudent investment (i.e. unlikely to provide financial retirement benefits to participants and beneficiaries). Although past history suggests that companies that use proper appraisal and fiduciary processes are likely to prevail, litigation can be extraordinarily costly and time consuming, and there is no guarantee that a court will not see things differently. Aside from litigation risk, moreover, most companies feel an obligation to employees to provide a good retirement benefit.
ESOP Companies and Fiduciaries can successfully respond to this new legal landscape by mitigating the risk of their ESOP’s company stock without limiting its upside potential.
The ESOP Protection Trust pools cash from strong mature ESOP companies and uses that cash to reimburse eligible losses on company stock after a 5-year or 10-year term. If there are no losses over that time, all ESOP companies get their money back from the ESOP Protection Trust while ESOP participants retain their stock’s full upside gain (i.e. substantial retirement savings).
Corey Rosen, founder of the National Center for Employee Ownership, says, “This is an important step for ESOPs and one that can substantially strengthen plans. Companies should seriously consider it.”
Rosen recently joined the Board of Directors of StockShield, Inc., the SEC-registered broker-dealer that’s been developing the ESOP Protection Trust for the past two years.
In the “Post-Dudenhoeffer” world, the ESOP Protection Trust can help ESOP Companies and Fiduciaries in at least three ways:
- Deter Litigation. Lawsuits are filed when company stock loses value. By helping prevent losses to the ESOP, the ESOP Protection Trust acts as insulation against the substantial cost and distraction of ERISA litigation (e.g. motions to dismiss, class certification, discovery, trial, and beyond).
- Prevent Personal Liability. ESOP Fiduciaries, including potentially Directors and Officers, can be held personally liable for holding company stock in ESOPs if the stock price falls and Fiduciaries failed to act to prevent the losses.
- Improve Likelihood of Achieving Early Motion to Dismiss. In the event of litigation, participation in the ESOP Protection Trust can be a powerful affirmative defense in demonstrating that Fiduciaries acted prudently and did not fail to act to prevent losses, helping secure an early motion to dismiss.