The Independent Review of an ESOP Valuation Report - Part 1



Under the Employee Retirement Income Security Act (ERISA), an ESOP's named fiduciary is charged with the responsibility of determining whether the consideration paid in a transaction represents adequate consideration.  The named fiduciary also has this same responsibility with respect to the annual update valuation.  In the case of a private company, adequate consideration is fair market value as determined in good faith by the named fiduciary in accordance with the provisions of the plan and the regulations of the Department of Labor.

Fiduciaries can fulfill this responsibility by undertaking the valuation themselves.  However, if the independent fiduciary does not have the experience or expertise to make the type of valuation, they may use an independent financial advisor or business appraiser to help them meet these responsibilities.  However, even if an independent financial advisor or business appraiser is used, the fiduciary is still responsible for determining adequate consideration by critically reviewing and evaluating the appraiser's valuation report and approving it.

In Donovan v. Cunningham (716 F.2d 1455 (1983)), the Court commented that:

An independent appraisal is not a magic wand that fiduciaries may simply wave over a transaction to ensure that their responsibilities are fulfilled. It is a tool and, like all tools, is useful if used properly. To use an independent appraisal properly, ERISA fiduciaries need not become experts in the valuation of closely held stock, they are entitled to rely on the expertise of others. [italics and bolding added here and below]

The Court recognized that ERISA fiduciaries may not be experts in business valuations nor are they required to become an expert in business valuations.

In Howard v. Shay, the Court commented:

The fiduciary is required to make an honest, objective effort to read the valuation, understand it, and question the methods and assumptions that do not make sense. If after a careful review of the valuation and a discussion with the expert, there are still uncertainties, the fiduciary should have a second firm review the valuation.

In the Couterier settlement (the Settlement), the Department of Labor (DOL) commented on the standards expected of fiduciaries in connection with an ESOP valuation.

The Settlement requires the Attorney in the Couterier matter to spell out, in a written communication, the ESOP fiduciaries' duties in reviewing the independent valuation report.  One of these duties is to:

Determine that the appraiser's opinion letter is justified by reading, and understanding the opinion and any supporting documents in the independent appraiser's opinion letter, including identifying, questioning, and testing assumptions that underlie the opinion, verify that conclusions in the opinion a, the Court commented that the data, analysis, and conclusions are internally consistent, and if necessary, retain additional expert support to aid understanding and addressing any problems with the valuation report and other deemed necessary reports and/or advice and supporting documents.

Although the settlement in Couterier does not establish precedent for other legal disputes, it is important to take notice of the standards expected of fiduciaries with respect to ESOP valuation reports - an ESOP fiduciary is held to a standard of care applicable to all ERISA plan fiduciaries known as a "prudent expert", the highest fiduciary standard under the law.

Most third-party trustees have a working knowledge of valuation theory and application and are capable to competently review the valuation report.

However, many internal trustees do not have a working knowledge of valuation theory and application and are not able to discern whether or not an ESOP valuation report is credible and can be relied upon.  They just simply do not have the requisite training and background to review an ESOP valuation report.

As a result of the DOL's requirement to retain an expert to assist in reviewing the valuation report, some trustees are hiring an independent valuation firm to review the valuation report.

 

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