ESOP Protection Trust

Protected ESOPs can provide strong results in a wide variety of market environments

Overview

Employee Stock Ownership Plans (ESOPs) can be generous retirement plans. When company stock gains value, ESOP participants can retire with several hundred thousand (or more) in their ESOP accounts. At the same time, company stock can also lose value for a wide range of reasons (e.g. market risks, technological innovations, changes in government policy, etc.).

Thanks to innovation in the field of stock concentration risk management, losses on company stock can now be substantially reduced or even eliminated.

Instead of an ESOP investing all of its assets in company stock, StockShield believes it is prudent for ESOPs to invest a small percentage of its ESOP (e.g. 1% or 2% per year) in a new form of mutualized risk protection, called the ESOP Protection Trust. The ESOP Protection Trust pools capital from a diverse group of participating ESOPs, helping provide protection against the estimated 13% risk that an ESOP will lose more than half its value over a 5-year period.

Key Points

  1. Helps ESOP fiduciaries meet their duty to protect the ESOP
  2. Helps deter litigation and reduce regulatory risk
  3. Risk of large losses is distributed among many high-quality ESOP Companies
  4. ESOPs remain concentrated in a single stock while mitigating the substantial downside risks
  5. ESOPs continue to retain their stock's full upside potential (both capital appreciation and dividends)

Key Benefits

Increased retirement security

ESOPs are invested primarily in a single stock. While preserving all upside opportunity, the ESOP Protection Trust also addresses the vulnerability posed by stock concentration, reducing the risk of large losses and helping protect the value of ESOP assets for the benefit of ESOP Participants and their Beneficiaries.

Reduced risk of litigation

If a lawsuit is brought against an ESOP fiduciary, any liability could be personal, as ERISA does not permit indemnification of fiduciaries for breaches of fiduciary duty. When an ESOP Company participates in the ESOP Protection Trust, large losses may be substantially reduced. In the case of a lawsuit, participation in the ESOP Protection Trust may be useful in demonstrating a commitment to protect the ESOP against large losses.

Improved employee morale

An innovation that reduces the impact of large losses is welcomed by ESOP Participants who rely on the ESOP to provide for their financial security. Knowing that their employer has their best interests in mind can only increase morale and by extension the Employee-Owner's commitment to the health and vitality of the Company.

Reduced regulatory risk

The Department of Labor (DOL) has increased lawsuits against ESOPs by 400% in the last four years compared to the prior eight years. The DOL is focused on restoring losses to plans. The ESOP Protection Trust helps companies address the DOL’s concerns and may reduce the ESOP Company’s regulatory risk.

Frequently Asked Questions

As J.P. Morgan and others have concluded, the "odds are stacked against the average concentrated holder" over the long run. Since 1980, some 40% of Russell 3000 companies have suffered a permanent 70% decline in the value of their stock. Because of this ineradicable uncertainty, it is prudent for companies to invest in risk management solutions that mitigate catastrophic risks outside your control – to help protect everything you and your Employee-Owners have built so far.

Interested companies first complete a screening questionnaire. We then conduct due diligence requiring specific information regarding the company’s past, present, and future. All information received will be kept strictly confidential. Eligibility requirements include reasonable relative valuations of company stock; history of a stable or appreciating equity value; stable corporate history; highly-regarded management team; financial strength as measured by profitability, balance sheet liquidity and appropriate financial leverage; and quality valuation and legal advisors.

Yes, even if a company meets all eligibility criteria, we will eliminate it from consideration if we learn it poses any substantial risks to the group. In addition, each participating company must represent and warrant it complies with all applicable laws and regulations, knows of no significant pending litigation negatively affecting its business or its assets, and is not in possession of any material adverse information about itself. Perhaps most importantly, our financial interests are completely aligned with participating companies, as we earn the bulk of our compensation only in the event of a successful outcome. Losses reduce or eliminate our success fee paid at the end of the term of the trust.

Annual cash deposits can be as low as 0.5% (half of 1%) of the value of company stock protected by the ESOP Protection Trust. Participating companies are eligible for a refund of up to 80% of their deposits at the end of the term of the trust (to the extent funds are available after issuing restorative payments to ESOPs), so the actual cost could be as low as 0.10% (one-tenth of one percent) per annum. There is a one-time $5,000 application fee for each participating company and an annual $5,000 fee that covers all Trust administrative expenses.

Cash will be invested in a portfolio of U.S. Treasury Securities. The credit risk involved will be that of the U.S. Government.

The ESOP Protection Trust injects cash (restorative payments) into ESOPs that have sustained a more than 50% decline in the value of company stock. Declines in value less than 50% are not covered. The EPT is designed to be able to absorb at least two 100% losses in a pool of ten companies. In the highly unlikely event of more than two 100% losses, payouts will be reduced proportionately to match the size of eligible losses relative to the size of the cash pool; companies will not be required to deposit any more cash to offset the losses.

Participating companies must annually provide us a cumulative Total Return metric – a positive or negative percentage – on their company stock relative to the starting value upon inception of the Trust. In general, Total Return takes into account price appreciation or depreciation, adjusted for any stock splits, as well as any form of dividend income or other distribution.

Resources

Additional Information
  • New Trust Protects Fiduciaries of ESOP Companies Download PDF
Further Reading

Find out more

We understand ESOP fiduciaries are required to conduct due diligence and documentation of procedural prudence when evaluating the ESOP Protection Trust. We, and our legal counsel, are prepared and available to assist at all stages throughout your process. To request online access to our information package, please contact us at info@stockshield.com or 310.203.8844.