Adequate Consideration Status Update

Part II

For purposes of valuing an ESOP, the question of what is “adequate consideration” has vexed the author and other BV practitioners. In this article, the author shares an update on the DOL’s response to earlier inquiries. Her two previous articles published in QuickRead detailed the earlier efforts to clarify what constituted “adequate consideration” for the valuation of entities held in ESOPs. On October 25, 2024, the OMB received a proposal on the topic from the DOL intended to clarify how shares in ESOPs are valued via adequate consideration.

To date, I have written two QuickRead articles (“Adequate Consideration” Defined? and Adequate Consideration Status Update) detailing the request, and status thereof, for the Department of Labor (DOL) to clarify “adequate consideration”[1] for the valuation of entities held in employee stock option plans (ESOP). On October 25, 2024, the Office of Management and Budget (OMB)[2] received a proposal on the topic from the DOL intended to clarify how shares in ESOPs are valued via adequate consideration.[3]

To summarize, ESOPs are qualified retirement accounts that invest in the shares of a “sponsoring” company. The sponsors (“sellers”) of these companies obtain valuations from valuation professionals which theoretically base their opinions of value upon the DOL’s direction of indicated value. The higher the value, the more support for purchase price to be received by the seller. Shares of the ESOP sponsored companies are then “sold” to employees with the intention of earnings to the employee upon retirement (hence ERISA’s involvement and interest in ESOPs). This structure of occurrences lends itself to obvious conflicts of interest and intentional, or unintentional aptitude to overvalue (i.e., the higher the value, the more positive reception from the client/aka the sponsor). The overvaluing leads to employees having far less invested in their retirement portfolio then what they were led to believe. Since the inception of ESOPs, investors and professionals have requested further clarification from the DOL on this topic to mitigate the occurrence of litigation and ensure that employees invested in ESOPs are planning for retirement properly utilizing fair market value of their ESOP investment.

ERISA Statute 408(e) attempts to ensure the application of fair market value:

• 2550.408e Statutory exemption for acquisition or sale of qualifying employer securities and for acquisition, sale, or lease of qualifying employer real property.[4]

(a) General. Section 408(e) of the Employee Retirement Income Security Act of 1974 (the Act) exempts from the prohibitions of section 406(a) and 406(b)(1) and (2) of the Act any acquisition or sale by a plan of qualifying employer securities (as defined in section 407(d)(5) of the Act), or any acquisition, sale or lease by a plan of qualifying employer real property (as defined in section 407(d)(4) of the Act) if certain conditions are met. The conditions are that:

(1) The acquisition, sale, or lease must be for adequate consideration (which is defined in paragraph (d) of this section);

(2) No commission may be charged directly or indirectly to the plan with respect to the transaction; and

(3) In the case of an acquisition or lease of qualifying employer real property, or an acquisition of qualifying employer securities, by a plan other than an eligible individual account plan (as defined in section 407(d)(3) of the Act), the acquisition or lease must comply with the requirements of section 407(a) of the Act.

… (d) Adequate consideration. For purposes of section 408(e) and this section, adequate consideration means:

(1) In the case of a marketable obligation, a price not less favorable to the plan than the price determined under section 407(e)(1) of the Act; and

(2) In all other cases, a price not less favorable to the plan than the price determined under section 3(18) of the Act (text thereof captured below).

As applies to employee benefit plans:

• In the case of a security for which there is a generally recognized market:
  • The price of the security prevailing on a national stock exchange, if the security is traded on a national stock exchange; or
  • A price that is no less favorable to the plan than the offering price for the security determined by the current bid and asked prices quoted by independent persons, if the security is not traded on a national stock exchange.
• For all other assets, the fair market value of the asset determined in good faith by the plan trustee or a named fiduciary according to the plan and the Employee Retirement Income Security Act of 1974 (ERISA).

(ERISA § 3(18) (29 U.S.C. § 1002(18)).)

Details of the October 25, 2024 DOL Proposal on Adequate Consideration to the OMB

The proposal was authored by the DOL in August of 2024, received by the OMB in the fall of 2024. The impetus for the proposal is derived from the Secure 2.0 Act[5] (a federal law passed in 2022 aimed to assist individuals with retirement fiscal planning) to ensure, for example, that the stock value of the shares in the ESOP are not inflated to benefit the selling shareholder (of whom pays the cost to have the value rendered for purposes of the ESOP). The proposal will remain with the OMB for up to 60 days before being published for a pre-rule public feedback outreach period (inclusive of a broad selective of professionals involved in, and affected by, ESOP valuations).

Is the Clarification Truly Necessary?

I believe it can be argued that every valuation engagement has the potential to possess a bias, whether intentional or not, and that it is the responsibility of the valuation professional to always ensure they apply the utmost objectivity and neutrality to their work as humanly possible. In the litigious world that we live in, further direction on the quantification of adequate consideration and measures of good faith,[6] I believe, will only supplement the quality of ESOP valuations. To obtain a benchmark of comparable understandings on the topic, I reached out to several valuation colleagues of mine who do a minimum of five ESOP valuations per year (and have for the past ~five years, at a minimum) to see if in fact this is a concern of those “in the trenches” of ESOP valuation work. To my surprise, the consensus was “no”. When pushed for elaboration, feedback included that the demand for clarification on the topic was simply a way for the government to have more involvement (alluding to perhaps applying taxes or other fiscal measures to ESOPs) and unnecessary fear on the side of the “academics” pushing for the clarification. More commonly though, the feedback pragmatically noted that the valuations for ESOPs, at least as they have seen, have not differed from other valuation work of entity operations and that, as a result, their valuations reflect an accurate fair market value of the entity in question.[7]

Perhaps there is merit in what was said by those that I spoke to on the topic. For example, to play devil’s advocate, if a valuation professional applies the applicable association standards to their work product as intended, who is ultimately at fault if the valuation of the ESOP company in question is grossly overvalued?[8] Is this truly the result of the DOL for not providing more detail on the interpretation of the meaning behind/quantification thereof, of “adequate consideration” and other ESOP valuation application directive? To be clear, I am of the camp that more governing body specification on this topic would be better … perhaps a testament to the strong C in my DISC profile?

In Conclusion

As of the date of writing, December 08, 2024, further details on the DOL’s October 25^th proposal shared with the OMB has not been published. I, as many others in and around the world of ESOPs anxiously await these details. Expect a summarization of the proposal in my next installment of this QuickRead “definition of adequate consideration in the world of ESOP valuations” article series. In the meantime, I hope everyone has a wonderful holiday season and I hope to see many of you at a future NACVA conference.

[1] For more detail refer to section 408(e) of the Employee Retirement Income Security Act of 1974 (“ERISA”)

[2] OMB’s mission is to assist the President in meeting policy, budget, management, and regulatory objectives and to fulfill the agency’s statutory responsibilities https://www.whitehouse.gov/omb/

[3] https://www.reginfo.gov/public/do/eAgendaViewRule?pubId=202404&RIN=1210-AC20

[4] https://www.law.cornell.edu/cfr/text/29/2550.408e – August 1, 1980.

[5] https://www.irs.gov/newsroom/secure-2-point-0-act-changes-affect-how-businesses-complete-forms-w-2

[6] Reminder: NACVA General and Ethical Standards apply to all work done as a NACVA member/credentialed designee.

[7] Per this individual, they had been doing ESOP valuations for many years without DOL issue and that the “ESOP companies do well after closing.”

[8] Baring the use of accurate financial records.

---

Trisch Garthoeffner, ABV, CVA, MAFF, EA, MAcc, has 20+ years of experience in providing business valuation and financial consulting services. She is an Accredited Business Valuator (ABV) through the AICPA, a Certified Valuation Analyst (CVA) and Master Analyst in Financial Forensics (MAFF) through the NACVA, an IRS representative (Enrolled Agent or EA), and a court certified expert witness. Additionally, she has her master’s in accounting with a concentration in business valuations (MAcc). In 2020, she was nominated as a NACVA Standards Board (SDB) member; in 2021, nominated vice-chair; in 2022, served as chair; and is a current Executive Advisory Board appointed advisor to the SDB. She is a past Florida State Chapter President for NACVA, a current member of the NACVA exam task force (providing teaching for the preparation of the CVA exam for valuation expert candidates nationwide), a board member and quarterly author for the QuickRead periodical, a past treasurer of the Florida Academy of Collaborative Professionals, and a past vice-president of the Southwest Florida Chapter of Collaborative Professionals and current member. In her spare time, she enjoys spending time with her daughter, antiquing, and fostering animals for the local Humane Society.

Ms. Garthoeffner can be contacted at (239) 919-3092 or by e-mail to trisch@anchorbvfs.com.