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Center for American Progress Issues Report on Mitigating Risks of ESOPs

Think tank says inclusive capitalism should be encouraged while mitigating the associated risks

Center for American Progress Issues Report on Mitigating Risks of ESOPs

The Center for American Progress (“CAP”) has released a comprehensive 32-page report entitled “Mitigating Risk to Maximize the Benefits of Employee Ownership.”

The report is intended to “start a dialogue about how to better protect workers while still offering the benefits of inclusive capitalism.” It offers a thorough evaluation of the financial benefits and risks associated with ESOPs, particularly for employee-owners who are vital to the ESOP’s success.

Drawing on a large body of research, the report concludes that, from a public policy perspective, the risks associated with ESOPs are outweighed by the wealth-generating benefits ESOPs regularly produce for employee-owners. This conclusion is based primarily on two considerations: (a) unlike most public companies, ESOPs allow employees to directly participate in corporate profitability; and (b) because of employee loyalty, tenure, and motivation, ESOPs are less likely to experience catastrophic failures as compared to their non-ESOP peers, although the report acknowledges that some failures are inevitable, even among ESOP companies.

After reaching this conclusion, the report considers how ESOPs can be further improved by focusing on mitigating the risks associated with concentrated stock positions. The report correctly points out that although ESOPs have a strong historical track record of growth and stability, no business is immune to failure and, when they do fail, the consequences for ESOP participants can be more severe than the consequences for equity holders in non-ESOP companies because their job security will be affected as well as their investment in employer stock.

It is this vulnerability of ESOPs and their participants that the report fully considers in its concluding pages. The report commends ESOPs for pursuing various ways of reducing risk to employee-owners, including participation in the ESOP Protection Trust. The report doesn’t fully explore the differences between traditional means for dealing with risk, which are generally focused on mitigating the risk of lack of diversification, and the EPT’s approach, which reimburses losses on concentrated stock positions when they occur, regardless of the source of the losses.

Further Reading

Bankruptcy of Grocery Chain Demonstrates Need for ESOP Protection

Consequences of ESOP Failure are Severe to ESOP Beneficiaries

Bankruptcy of Grocery Chain Demonstrates Need for ESOP Protection

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.

Further Reading

Investments & Wealth Monitor Publishes Article on Stock Protection Fund

Authors Explain How SPF Complements Exchange Funds

Investments & Wealth Monitor Publishes Article on Stock Protection Fund

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

Trusts & Estates Publishes Article on Stock Protection Fund

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 to Sponsor NCEO’s 2015 Employee Ownership Conference

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 Quantifies Risks and Rewards of a Concentrated Stock Position

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.

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Further Reading