Will ESOPs Finally Get Regulatory Clarity?

One of the key obstacles to the creation of employee stock ownership plans is the lack of clear rules from the Department of Labor on private stock valuation.

ESOPs are employer-sponsored, tax-advantaged and ERISA-governed plans that provide company shares as part of employee compensation.

A report published by Matrix Global Advisors on Tuesday stated that regulatory uncertainty “has a chilling effect on investment and innovation” because it makes it difficult to “assess risk.” Without clear regulatory guidance on how private equity should be valued, ESOP sponsors rely on court judgments and DOL enforcement actions as guidance for stock appraisal.

In this context of ambiguity, ESOPs are vulnerable to lawsuits because there are no clear rules for pricing such stock. This increases costs and risks and deters potential ESOP sponsors, according to the report.

Alex Brill, a senior research fellow at the American Enterprise Institute and the author of the report, says, “I think the regulatory uncertainty around ESOP valuation is a significant impediment for the industry, the most pressing concern right now.”

Michael Kreps, a principal in Groom Law Group, explains that public stock can easily be valued because it has a market price. Private equity does not have that benefit, but the appraisal industry has its own standardized methods for determining prices.

Kreps says the lack of effective rules from the DOL leaves industry actors asking, “Will the regulators accept their methodologies” of appraisal? The challenge for ESOPs, Kreps continues, is that they need to figure out “what the DOL can live with.”

According to Kreps, the DOL proposed a valuation rule in 1998, but that process was abandoned. In the meantime, DOL has “preferred not to tell us” what methods should be used and instead has relied on an approach of “we know when we see it, and when we don’t like it, we will deal with it through litigation.” This approach has a “destabilizing” influence on ESOP sponsors, Kreps says.

He says a new rule from the DOL “needs to focus on substance. We need to move past procedure.” Kreps wants the DOL to describe how to value different interests, some of which can be difficult to appraise, such as “control and appreciation rights,” as well regulatory risks.

The SECURE 2.0 Act of 2022 requires the DOL to create regulations for ESOP valuation, but no deadline was set. Brill said he hopes for a proposal in early 2024, and Kreps adds employee ownership has been a high priority for the administration of President Joe Biden, but he is unsure of when to expect a proposal.