This document provides an overview of corporate governance risks and best practices for companies with employee stock ownership plans (ESOPs). It discusses the roles and responsibilities of various parties like shareholders, boards of directors, management, ESOP trustees, and ESOP committees. It also explores the intersection of corporate and ERISA fiduciary duties, particularly regarding executive compensation and corporate transactions. The presentation aims to help attendees understand governance issues that can lead to litigation and ways to reduce conflicts between corporate and ESOP interests.

1. Daniel N. Janich Robert Rachal Kevin Kolb
ESOP Fiduciary Duties &
Corporate Governance:
Compliance & Litigation Perspectives
April 14, 2016
Presented by:

2. Presentation Goals
• Understanding Corporate
Governance Risks in ESOP Owned
Companies
• Learn Best Practices to Reduce
Litigation & Increase Business
Success
• Explore Ways to Manage Potential
Corporate Governance vs. ESOP
Administration Conflicts
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3. What Do We Mean By Corporate
Governance?
• Allocation of duties among
shareholders, BOD & management
to achieve continued company
growth and success
• Subject to state corporate law and
corporate bylaws
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4. Roles of Company Players
• Shareholders: elects BOD; vote on
extraordinary corporate matters
• BOD: hires and evaluates
management; appoints ESOP
trustee; makes strategic business
decisions
• Management: runs day-to-day
company operations
• Governed by State Corporate Law
3

5. Additional Corporate Governance in
ESOP Companies
• Two additional governance layers
 ESOP Trustee(s)
 BOD’s ESOP Committee
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6. Role of ESOP Trustee
• Governed by ERISA Law
• Overriding Duty to Protect Interests
of ESOP Participants & Beneficiaries
• Represents Participants and
Beneficiaries by virtue of
shareholder status
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7. Role of BOD’s ESOP Committee
• Governed by Corporate Law &
ERISA Law
• Adopt, Amend or Terminate ESOP
Plan
• Determine Company Contributions
to ESOP
• Oversee ESOP Plan Administration;
Appoint Trustee(s)
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8. Corporate Governance Standards
• BOD must act in “good faith”
exercising reasonable care
• Business Judgment Rule (gross
negligence standard of review)
• BOD & Management must act in best
interest of corporation and its
shareholders, not solely in self-
interest (duty of loyalty)
• Do Corporate Employees also have
ESOP responsibilities?
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9. ERISA Fiduciary Standards
• Applicable to ESOP Plan
Administration
• Fiduciaries must act with “highest
standards of prudence, skill, care”
and solely in interest of plan
participants
• Fiduciary standard (highest level
of care standard of review)
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10. ERISA Fiduciary Duties
• Duty of Prudence: Act with care,
skill, prudence and diligence of
Prudent Person in like
circumstances
• Duty of Loyalty/Exclusive Purpose:
Act exclusively in the interest of
plan participants and beneficiaries
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11. ERISA Fiduciary Duties (cont’d)
• Follow Plan Documents provided
they are consistent with ERISA
• Protect Plan from Non-Exempt
Prohibited Transactions by
Inadvertent Conflict of Interest
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12. Who Is An ERISA Fiduciary?
• Who Does the Plan or Trust Identify
as Fiduciary?
• Fiduciary is anyone who exercises
discretionary authority & control over
management or disposition of plan
assets. ERISA §3(21)(A). Includes
Plan Administrator and Trustee
• Trustee may be “directed &
independent” or “corporate insider”
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13. The Plan Administrator:
ESOP Fiduciary’s Primary
Responsibilities
• ERISA Compliance To Ensure Tax-
Exempt Status
• Administer ESOP Fairly
• Is the Plan Administrator also a
Corporate Employee?
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14. Trustee: ESOP Fiduciary’s Primary
Responsibilities
• Shareholder representative who elects
BOD & votes shares
• Pass Through Voting by Law or Plan
• Monitor corporate management and BOD
to ensure no harm to ESOP plan
participants’ interests
• Stock Valuation
• Due Diligence for Hire of Outside
Advisors
• Is the Trustee also a Corporate
Employee?
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15. The Danger of Wearing Multiple
Hats
• Settlor v. Fiduciary Functions
• When Corporate Decision Conflicts
With Fiduciary Responsibilities
• Conflicts Arise Between
• Company/ESOP
• BOD/ESOP
• Management & ESOP
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16. ESOP Fiduciary Duties and
Corporate Governance:
Some Teachings From the Cases
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17. The basic structure: Grindstaff v. Green approved
ESOP structure in which ESOP trustees and
company directors appoint each other.
• Does that create enhanced duties on ESOP trustees to
protect interests of participants?
Hot topic issues creating blurred lines:
• Executive compensation – when does it become an
ERISA fiduciary issue for the ESOP trustees?
• Husvar v. Rapoport and Eckelkamp v. Beste – courts
deferring to plaintiffs’ choice of claim and forum.
• Johnson v. Couturier – protecting ESOP from self-dealing in
corporate pay.
Fiduciary & Corporate Governance- Litigation
Examples
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18. Hot topic issues creating blurred lines (cont):
• Corporate events impacting ERISA fiduciary duties:
Armstrong v. LaSalle Bank and corporate merger’s impact
on stock valuation and repurchase obligations.
• Breakdown of roles in ESOP acquisitions: Perez v.
Bruister as a cautionary tale.
• Fraud or malfeasance: Canale v. Yegan and ERISA
trustee’s need to bring derivative action to protect the
company.
Fiduciary & Corporate Governance- Litigation
Examples
17

19. • ESOP had a common structure in which the board selected and
controlled the ESOP that then elected the directors pursuant to a
board committee’s recommendation.
• Union struck over acquiring “pass through” voting rights so that each
participant could vote for directors, but lost.
• Court rejected the various challenges to the ESOP’s refusal to
implement “pass through” voting:
• Management entrenchment is a common and known feature of ESOPs,
and Congress has not seen fit to upset this.
• Contrary to the DOL’s claim, voting in regular board elections is not a
“plan asset.”
• Amending the ESOP plan to add “pass through” voting is settlor, not
fiduciary conduct.
Query: Does management entrenchment create enhanced
duties on ESOP trustees to protect the interests of participants?
Grindstaff v. Green, 133 F.3d 416 (6th Cir. 1998).
Approving Board Self-Perpetuation and Control of
ESOP
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20. • In theory the normal operation of a business is typically a corporate,
not ERISA, function subject to corporate fiduciary duties.
• For corporate fiduciary duties the standards and burdens, e.g., the
“business judgment rule,” illustrate court’s general unwillingness to
interfere with or second-guess business decisions.
• In an ESOP, however, executive compensation can sometimes be a
fraught area. Employee-participants may resent the pay of senior
executives, while entrenchment and control of the ESOP can lead
to claims of self-dealing.
• Husvar v. Rapoport and Eckelkamp v. Beste suggest a plaintiff can bring
claims under either state corporate law or ERISA fiduciary law.
• Johnson v. Couturier illustrates the ERISA exposures if a court
concludes executive compensation rose to the level of self-dealing.
Executive Compensation in an ESOP: A
Corporate or ERISA Fiduciary Duty – or Perhaps
Both?
19

21. • Husvar v. Rapoport , 430 F.3d 777 (6th Cir. 2005) –
executive compensation as corporate fiduciary
duty:
• ESOP participants alleged breach of corporate fiduciary
duties when the company’s executives granted
themselves substantial compensation even though the
company was not doing well financially.
• Court found plaintiffs did not plead an ERISA claim – they
instead challenged business decisions made by the
company’s directors.
Executive Compensation in an ESOP: A
Corporate or ERISA Fiduciary Duty – or Perhaps
Both?
20

22. • Compare Eckelkamp v. Beste, 315 F.3d 863 (8th
Cir. 2002) – executive compensation can trigger
ERISA fiduciary duties:
• Defendants were both ESOP trustees and corporate
officers. Plaintiffs claimed they breached their ERISA
fiduciary duties by overcompensating themselves.
• Court rejected ERISA claim on the merits: Company was
extraordinarily successful ,and critique of their
compensation failed to factor this in.
• State law derivative claim was also preempted by ERISA:
• Same facts, same parties, seeking same relief as ERISA
fiduciary claim. Allowing participants to assert rights granted
to ESOP trustees would alter plan administration.
Executive Compensation in an ESOP: A
Corporate or ERISA Fiduciary Duty – or Perhaps
Both?
21

23. • Former president, and in-house and outside
counsel were both corporate directors and ESOP
trustees.
• Over a period of several years outside counsel created
several very generous executive compensation plans for
the president.
• Pursuant to a merger of the ESOP-owned company into a
shell company, the president received a buy-out valued at
$35 million, or what appears to be about two-thirds of the
value of the ESOP-owned company.
Executive Compensation in an ESOP: Johnson v. Couturier, 572
F.3d 1067 (9th Cir. 2009) & ERISA Exposures From Claims of
Self-Dealing
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24. • Court noted difficulty in distinguishing between
corporate and ERISA fiduciary roles in the area of
executive compensation.
• Held it was appropriate to impose ERISA fiduciary duties
on transactions in which the individual could self-deal at
the expense of the ESOP.
• Court enforced preliminary injunction (i) freezing
former president’s assets and (ii) barring the
ESOP-owned company from advancing anyone’s
defense costs.
• Found it likely that fiduciary breach occurred.
• Found that company’s assets were effectively ESOP
assets.
Executive Compensation in an ESOP: Johnson v. Couturier, 572
F.3d 1067 (9th Cir. 2009) & ERISA Exposures From Claims of
Self-Dealing
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25. • Amsted Industries cashed out its participants at once when
they left the plan. Valuation was as of September 30th and
was locked in for nine months, up to June 30th.
• Court believed Amsted may have been primed for a run on
redemptions:
• Recently acquired a similar sized company with $800 million in
debt.
• 800 employees were at least 55 years old and held $300 million
in ESOP stock.
• Stock market in general was falling.
• Amsted’s trustee set redemption price at $184 for 2000, had
32% redemptions instead of prior rates of around 10%.
• Created liquidity problem because much of debt limit had been
used for corporate acquisition.
• Stock dropped to $90 the next year and company restricted
ESOP redemptions, now paid out over multiple years.
Armstrong v. LaSalle, 446 F. 3d 728 (7th Cir. 2006)
Corporate Events & ERISA Fiduciary Duties
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26. • Court said it would give deference to the ESOP trustee’s
setting of the stock’s redemption price, but required proof
that the trustee actually exercised its discretion by
considering the risk of a run on the ESOP.
• Suggested that lowering redemption price to reflect marketability
discounts would have dampened redemptions.
Court noted that inherent risk of ESOPs may require a more
watchful eye by ESOP trustees to lower risk where they can.
Query: Amsted has professional outside directors. But what
happens with an insular board? Does this same heightened
analysis apply when an insular structure for board and trustees
creates the risk of conflicts between managers and the ESOP
owners?
Armstrong v. LaSalle, 446 F. 3d 728 (7th Cir. 2006)
Corporate Events & ERISA Fiduciary Duties
25

27. • ESOP acquired 100% of the company (a DirecTV installer) from the
founder (Bruister) in multiple transactions over several years.
Bruister, his employee, and his outside CPA served as the ESOP
trustees.
• Judge Jordan found Bruister to be a fiduciary, and thus on both
sides of the transactions, for the sales:
• Although Bruister abstained from voting, he did not abstain from the
process, e.g., he attended trustee meetings and gave his opinions to his
employee and his CPA.
• Bruister had undue influence over his employee, and Bruister was a
friend and major client of the CPA.
• Bruister’s attorney had substantial influence over the nominally
independent valuator, who was supposed to be working for the ESOP.
Perez v. Bruister, 54 F. Supp. 2d 629 (S.D. Miss. 2014)
Breakdown of Roles in an ESOP Acquisition
26

28. • Judge Jordan also found that the valuator was not
independent:
• The valuator had offered to cut his appraisal fee if Bruister first
retained him to do a feasibility study. Even Bruister’s expert
conceded that would impact his independence.
• The valuator was eager to please the seller’s attorney, including
discussing providing future work for him. He also regularly
emailed Bruister to tout the advantages of an ESOP transaction.
• The valuator shared drafts exclusively with Bruister and his
attorney, and raised his valuations based on their input.
Perez v. Bruister, 54 F. Supp. 2d 629 (S.D. Miss. 2014)
Breakdown of Roles in an ESOP Acquisition
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29. • Judge Jordan’s telling comments:
“The duty of loyalty was breached from start to finish. The initial
structure of the ESOT provided three trustees—Bruister and two
individuals loyal to him. There were no independent or
professional fiduciaries. . . .In sum, these were not arms length
transactions.”
. . .
“The Court feels compelled to say that Defendants seem like
decent people; they are certainly likable. But the ESOP and
ESOT were structured in a way that offered little protection for
participants. The ESOT board was comprised of the seller and
two lay trustees who worked for and were personally loyal to him.
None had sufficient knowledge about business valuation, and
there was no independent fiduciary (something Defendants’
expert Kaplan said he would have recommended).”
Perez v. Bruister, 54 F. Supp. 2d 629 (S.D. Miss. 2014)
Breakdown of Roles in an ESOP Acquisition
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30. • Insurance company owned by ESOP failed
because of fraud and malfeasance.
• Although corporate acts were not subject to
ERISA fiduciary duties, trustees knowledge
of their bad actions imposed a duty on
them to act to protect the ESOP:
• E.g., they should have brought a derivative
action on behalf of the ESOP as
shareholder.
Canale v. Yegen, 782 F. Supp. 963 (D.N.J. 1992)
ESOP Trustees Need To Protect from Fraud and Malfeasance
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31. • When the matter is “pressure tested” in litigation,
courts are going to expect high standards from
ESOP trustees.
• Courts are often skeptical of trustee action and
judgment when conflicts are present.
• Courts expect to see evidence the trustee acted in
ESOP’s interests, not management’s or own interests.
• Independent professional trustee can be very helpful to
ameliorate or eliminate conflicts.
• Courts also impose high standards of care and
prudence: If not have expertise, trustees need to
acquire it by retaining professional outsiders.
Some Take-Aways From the Cases
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32. • Fiduciary Duty solely to the ESOP Participants
(as retirees, not as employees)
• Appointed and monitored by the Board of
Directors (search committee, interview process,
references?)
• Elects Board of Directors
- At shareholder meeting or via shareholder consent
- Nominating Committee
- Review qualifications
• Monitor Senior Management
ESOP Trustee
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33. • Valuation of stock held in ESOP trust
• Analysis of proposed transactions – protecting
ESOP from paying more than FMV for company
stock, or selling for less than FMV.
• Voting of ESOP shares
-Directed or Discretionary?
-How to vote unallocated or undirected
shares?
• Follow the Plan document!
Key ESOP Trustee Duties
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34. • Officer / Employee – Familiar with the Company
• Do not charge a fee
• May already have trust and respect of participants
• May not have sufficient experience with ESOPs
and related valuation or transaction issues
• Typically have full-time day job; may not have
enough time to devote to trustee duties
• Heightened level of scrutiny by DOL and the
courts
Inside Trustee
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35. • Independent from Plan Sponsor
• Expert at ESOP related issues and managing
ESOP Trust as full “daytime” job
• Lack of in-depth knowledge of Company but
possesses extensive ERISA knowledge
• Fee service
• Better positioned to protect plan sponsor from
unanticipated expense and potential substantial
liability
• CRITICAL: Should use outside trustee where
purchase offer, etc. might personally affect inside
trustee or is beyond competence of insiders
Outside Trustee
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36. • Conflicts can arise where there is overlap of
Directors, Officers and Trustees:
• Stock Valuations
• Corporate Acquisitions – Risk > Reward?
• Bona fide purchase offers
• Executive Compensation
- Compensation Committee
- Compensation Study
- Necessary to attract and retain key
management
- Excessive compensation is the problem
Potential Conflicts Involving Inside Trustees
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37. • Other Recurring Matters
- Trustee attendance at Board meetings
- Attendance at annual shareholders’ meeting
- Review of financial statements
(times of crisis)
Trustee – BOD Interaction Issues
36

38. • Typically the most important trustee activity (aside
from transactions)
• Choosing Valuation Firm
-reasons for selecting
-list of those considered, and qualifications
-background check (civil/criminal)
-Independence (reports to the trustee, not the
Company or the BOD)
Annual Stock Valuation
37

39. • Comprehensive Diligence Process including
meetings with management
• Confirming adequacy, accuracy &
reasonableness of company financial data
provided to valuation firm (Audit?)
• Reviewing assumptions & methodologies used by
appraiser for reasonableness (standard
approaches? consistency?)
• Document!!!
• Communication with Board of Directors and ESOP
Participants
Annual Stock Valuation (cont)
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40. • Purchases and Sales are most common
• Engage in a diligent, independent investigation
(interview management, understand business and
reasons for transaction, projections)
• Independently negotiate price and terms
• Engage advisors and ensure documents reflect
terms which have been agreed to
• Document process!!
Analysis of Proposed ESOP Transaction
39

41. • Is Trustee required to sell if the offering price is
greater than the current appraised value of the
company?
• In a word, NO
• Look long term, not short (retirement plan)
• Projected value of shares in future vs. net cash
received at closing (value of losing “S” corp tax
deferral)
• CRITICAL: Trustee should rely on guidance
from the Board of Directors – if they believe they
can deliver greater value long term than is
provided for in the offer, why sell?
Sale of ESOP Company
40

42. • Run the Company
• Make Management / Strategic Decisions
• Set Compensation (but *do* monitor)
• Look for Acquisitions / Sale Opportunities
What doesn’t a Trustee do?
41

43. • Size of ESOP ownership does not affect
trustee fiduciary duties to participants –
same process whether 1% or 100% ESOP
• Size CAN impact influence ESOP trustee
has over the Board and corporate
governance in general.
• Where ESOP is in a majority ownership
position and can vote to replace one or
more board members, then the ESOP
trustee can be catalyst for corporate
change.
ESOP Size Does Matter
42

44. • Truth, honesty and open dealing with all relevant
people and facts when making decisions that may
affect stock value.
• Taking care to maintain ESOP independence
when conflicts of interest arise within the BOD or
Trustee(s).
• Using Plan Sponsor’s company assets in a
manner consistent with the best interests of
shareholder(s).
• Providing the ESOP Trustee(s) with sufficient
information and independent resources to protect
ESOP participants.
Key Factors for Governance Success
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45. Some Key Takeaways
• Understand significant risks of wearing
multiple hats
• Understand the role that process and
procedures play to protect individuals in
corporate governance and ESOP
administration
• Understand the need to document all
decision making
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46. Presenters
Daniel N. Janich
Holifield Janich & Associates PLLC
(312) 332-4222 - djanich@holifieldlaw.com
Robert Rachal
Proskauer Rose
(504) 310-4081 - rrachal@proskauer.com
Kevin Kolb
GreatBanc Trust Company
(630) 810-4514 - KKolb@greatbanctrust.com
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47. Thank You
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