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Page 1: ESOP Legal Update - OEOC · ESOP Legal Update Ohio Employee Ownership Center 25th Annual Conference Akron, Ohio April 29, 2011. ... Mary Giganti Waldheger CCoyne Co., L.P.A. 1991

ESOP Legal UpdateESOP Legal Update

Ohio Employee Ownership Center25th Annual Conference

Akron OhioAkron, OhioApril 29, 2011

Page 2: ESOP Legal Update - OEOC · ESOP Legal Update Ohio Employee Ownership Center 25th Annual Conference Akron, Ohio April 29, 2011. ... Mary Giganti Waldheger CCoyne Co., L.P.A. 1991

Promotion and Expansion of Private l h fEmployee Ownership Act of 2011

• H.R. 1244 introduced March 29, 2011,• Counterpart to S.B. 101 introduced January 25, 2011

• Included in the legislation:– 1042 treatment for S corporations (owners of S corporations can sell stock to an ESOP and defercorporations can sell stock to an ESOP and defer capital gains tax on the gain if the proceeds are reinvested in equities of U.S. operating corporations).

– Permit bank lenders a deduction of up to 50% of thePermit bank lenders a deduction of up to 50% of the interest on an acquisition loan (includes certain refinances) where ESOP owns more than 50% of the stock.stock.

Page 3: ESOP Legal Update - OEOC · ESOP Legal Update Ohio Employee Ownership Center 25th Annual Conference Akron, Ohio April 29, 2011. ... Mary Giganti Waldheger CCoyne Co., L.P.A. 1991

H.R. 1244 Cont.H.R. 1244 Cont.

– Provides for a new office in the Department of Treasury  (the S corporation employee ownership assistance office) to “foster increased employee ownership of S corporations.”  Office will provide d d h f deducation and outreach to inform companies and individuals about the possibilities and benefits of S corporation ESOPs and technical assistance to assist S 

ti th t ESOPcorporations that sponsor ESOPs.– Provides that a small business (S or C) that would normally qualify for SBA assistance and programs will still qualify even if the corporation is now owned by an ESOP (each participant is treated as owning his proportionate share of stock in the ESOP).

Page 4: ESOP Legal Update - OEOC · ESOP Legal Update Ohio Employee Ownership Center 25th Annual Conference Akron, Ohio April 29, 2011. ... Mary Giganti Waldheger CCoyne Co., L.P.A. 1991

IRS GuidanceIRS Guidance

• The IRS provided sample language for Section p p g g409(p) transfers to non‐ESOP portion of the plan.  This sample language is on the IRS website.

• Notice 2011 19 provides the definition of readily• Notice 2011‐19 provides the definition of readily tradable on an established securities market.

• According to the IRS Website, as of April 14,According to the IRS Website, as of April 14, 2011, the status of ESOP determination letters:– Form 5310 6/2010F 5300 C l A ll i d– Form 5300 Cycle A – all cases assigned

Cycle B – 1/2008Cycle C, D and E – not assignedCycle C, D and E  not assigned

Page 5: ESOP Legal Update - OEOC · ESOP Legal Update Ohio Employee Ownership Center 25th Annual Conference Akron, Ohio April 29, 2011. ... Mary Giganti Waldheger CCoyne Co., L.P.A. 1991

Case Law – U.S. Supreme CourtCase Law  U.S. Supreme Court

• Conkright v. Frommert, 130 S. Ct. 1640 (2010).g , ( )• A plan administrator’s interpretation of a benefit plan is entitled to deference, even if the plan administrator made a good faith mistake in aadministrator made a good faith mistake in a previous interpretation of the plan.

• Second Circuit ruled when a plan administrator’sSecond Circuit ruled when a plan administrator s first interpretation is unreasonable and violated ERISA, cannot have deference.Chi f J i R b h d i i ( li• Chief Justice Roberts wrote the decision (split decision) and cited Firestone Tire & Rubber Co. v. Bruch 489 US 101(1989)( )

Page 6: ESOP Legal Update - OEOC · ESOP Legal Update Ohio Employee Ownership Center 25th Annual Conference Akron, Ohio April 29, 2011. ... Mary Giganti Waldheger CCoyne Co., L.P.A. 1991

Conkright cont.Conkright cont.

• A single honest mistake should not change theA single honest mistake should not change the deferential standard.

• Deference is important to maintain uniformity• Deference is important to maintain uniformity in employee benefits.

D f ffi i b i• Deference promotes efficiency by encouraging internal administrative resolutions.

• Deferential standards encourage employers to create and maintain benefit plans.

Page 7: ESOP Legal Update - OEOC · ESOP Legal Update Ohio Employee Ownership Center 25th Annual Conference Akron, Ohio April 29, 2011. ... Mary Giganti Waldheger CCoyne Co., L.P.A. 1991

Exhaust Administrative RemediesExhaust Administrative Remedies• Swetic v. Community National Bank Corp. (M.D. Fla. 6/2/2010).6/2/2010).

• In general, courts interpret ERISA to require plan participants to exhaust administrative remedies before filing a court action.

• This court reviewed whether the fact that the ESOP stock was worthless and a significant subsidiary wasstock was worthless and a significant subsidiary was shut down permitted a plan participant to file suit prior to exhausting administrative remedies.

• The court ruled, no, the participant must exhaust administrative remedies.  The value of plan assets (even if zero) is not a factor to determine if it is futile to(even if zero) is not a factor to determine if it is futile to pursue administrative remedies.

Page 8: ESOP Legal Update - OEOC · ESOP Legal Update Ohio Employee Ownership Center 25th Annual Conference Akron, Ohio April 29, 2011. ... Mary Giganti Waldheger CCoyne Co., L.P.A. 1991

Must be a Loss to the ESOPMust be a Loss to the ESOP

• Cole Taylor Bank v. Kirk Corp., Bankr. ND Il y p ,9/3/2010.

• ESOP participants claimed breach of fiduciary duty by corporation providing inadequateduty by corporation providing inadequate security for promissory notes issued to participants as payment of their ESOP benefit.

• Court dismissed claim since security for promissory note was a settlor function, not a fiduciary functionfiduciary function.

• Court stated the ESOP was not harmed.  ESOP experienced no loss. p

Page 9: ESOP Legal Update - OEOC · ESOP Legal Update Ohio Employee Ownership Center 25th Annual Conference Akron, Ohio April 29, 2011. ... Mary Giganti Waldheger CCoyne Co., L.P.A. 1991

Timing of Distribution and ValuationTiming of Distribution and Valuation

• McCabe v. Capital Mercury Apparel, S.D. NYMcCabe v. Capital Mercury Apparel, S.D. NY 11/9/2010).

• Participants sued plan sponsor for breach ofParticipants sued plan sponsor for breach of fiduciary duty by paying plan distributions based upon a year old valuation.

• Plan document provides for cash distributions based upon fair market value of company stock as of the allocation date immediately preceding the date of distribution.

Page 10: ESOP Legal Update - OEOC · ESOP Legal Update Ohio Employee Ownership Center 25th Annual Conference Akron, Ohio April 29, 2011. ... Mary Giganti Waldheger CCoyne Co., L.P.A. 1991

McCabe cont.McCabe cont.

• Court found the use of the year old valuationCourt found the use of the year old valuation was reasonable– Interim valuation too expensive (cost one‐third of p (the company’s total value)

– Valuation process was known; followed past ipractice

– Followed plan termsPl ’ bj ti l– Plan sponsor’s reasons were objectively appropriate in light of the then‐prevailing circumstances

Page 11: ESOP Legal Update - OEOC · ESOP Legal Update Ohio Employee Ownership Center 25th Annual Conference Akron, Ohio April 29, 2011. ... Mary Giganti Waldheger CCoyne Co., L.P.A. 1991

Employer’s Right to AmendEmployer s Right to Amend

• Hoffman v. Tharaldson Motels, Inc. ESOP, N. ND off a . a a dso ote s, c. SO , .2/26/2010 and 5/7/2010.

• Original plan document required terminated g p qparticipant to take immediate cash or reinvest company stock account into a stable investment 

taccount.• 2005 plan amendment permitted terminated participants to maintain company stock accountparticipants to maintain company stock account.

• 2006 plan amendment repealed the 2005 amendmentamendment.

Page 12: ESOP Legal Update - OEOC · ESOP Legal Update Ohio Employee Ownership Center 25th Annual Conference Akron, Ohio April 29, 2011. ... Mary Giganti Waldheger CCoyne Co., L.P.A. 1991

Hoffman cont.Hoffman cont.

• 2006 plan amendment not disclosed to2006 plan amendment not disclosed to participants.

• Terminated participants sued for breach ofTerminated participants sued for breach of fiduciary duty and conflict of interest.

• Court ruled plan sponsor has a right to amend• Court ruled plan sponsor has a right to amend the plan.  The right to a particular form of investment (employer stock) is not a protectedinvestment (employer stock) is not a protected benefit under Internal Revenue Code Section 411(d)(6).  This is a permissible cutback.( )( ) p

Page 13: ESOP Legal Update - OEOC · ESOP Legal Update Ohio Employee Ownership Center 25th Annual Conference Akron, Ohio April 29, 2011. ... Mary Giganti Waldheger CCoyne Co., L.P.A. 1991

Hoffman cont.Hoffman cont.

• This case recognizes an employer’s right toThis case recognizes an employer s right to amend the plan and to implement a stock cash‐out feature for company stock of terminated p yparticipants.

• The case is proceeding on another claim – thatThe case is proceeding on another claim  that the ESOP trustee paid too much for the stock.  Class certification has been approved for two ppseparate classes; 1) terminated‐employee participants and 2) active‐employee participants.

Page 14: ESOP Legal Update - OEOC · ESOP Legal Update Ohio Employee Ownership Center 25th Annual Conference Akron, Ohio April 29, 2011. ... Mary Giganti Waldheger CCoyne Co., L.P.A. 1991

Protection from Retaliatory Discharge

• Momchilov v. McIlvaine Trucking International, g ,Inc., N.D. OH 3/24/2010 and 12/2/2010.

• Momchilov was employed as director of human resources and was a member of the ESOPresources and was a member of the ESOP administrative committee.

• The administrative committee became concernedThe administrative committee became concerned over the management of the company (100% owned by ESOP).  There were allegations of the president not handling company financespresident not handling company finances appropriately or handling himself as president appropriately.

Page 15: ESOP Legal Update - OEOC · ESOP Legal Update Ohio Employee Ownership Center 25th Annual Conference Akron, Ohio April 29, 2011. ... Mary Giganti Waldheger CCoyne Co., L.P.A. 1991

Momchilov cont.Momchilov cont.

• Momchilov attended an ESOP workshop and o c o atte ded a SO o s op a ddiscovered that she had the authority to 1) investigate the situation, and 2) make changes to h ’the company’s governance.

• Momchilov made a request for copies of plan d t T k l t h fi ddocuments.  Two weeks later, she was fired.

• Momchilov claims she was fired for exercising her rights as an ESOP participant and member of therights as an ESOP participant and member of the administrative committee, in violation of ERISA Section 510 and the whistle blower statute.

Page 16: ESOP Legal Update - OEOC · ESOP Legal Update Ohio Employee Ownership Center 25th Annual Conference Akron, Ohio April 29, 2011. ... Mary Giganti Waldheger CCoyne Co., L.P.A. 1991

Momchilov cont.Momchilov cont.

• In December, 2010, Momchilov requested leave , , qto amend her complaint to add that her termination was in violation of public policy (she saw a lawyer) However after reviewing thesaw a lawyer).  However, after reviewing the president’s deposition transcript as a whole, the court did not agree with Momchilov as the 

id t t t d th t h t i t dpresident stated that she was terminated because he believed she was trying to overthrow management.  The deposition, read as a whole, g p , ,rather than focusing on a few words, is covered by her original complaint, that she claims she was terminated for exercising her rights under ERISAterminated for exercising her rights under ERISA.  

Page 17: ESOP Legal Update - OEOC · ESOP Legal Update Ohio Employee Ownership Center 25th Annual Conference Akron, Ohio April 29, 2011. ... Mary Giganti Waldheger CCoyne Co., L.P.A. 1991

Momchilov cont.Momchilov cont.

• Issues (1) whether ERISA Section 510 applies to aIssues (1) whether ERISA Section 510 applies to a fiduciary as well as a participant, and (2) whether ERISA grants authority to a fiduciary to change g y y gmanagement.

• The court’s denial of Momchilov’s motion toThe court s denial of Momchilov s motion to amend strongly suggests that ERISA does not grant a fiduciary a right to change management.g y g g g

• Momchilov voluntarily dismissed the case without prejudice on February 27, 2011.p j y ,

Page 18: ESOP Legal Update - OEOC · ESOP Legal Update Ohio Employee Ownership Center 25th Annual Conference Akron, Ohio April 29, 2011. ... Mary Giganti Waldheger CCoyne Co., L.P.A. 1991

Sales and MergersSales and Mergers

• Bacon v. Stiefel Laboratories, Inc. (S.D. FL aco . St efe abo ato es, c. (S. .5/27/2010).

• Stiefel terminated the stock bonus plan on p1/1/2009 and gave participants the option to “put” the shares back to the company at $16 469/ h$16,469/share.

• During this time period, Stiefel was discussing a potential merger with GlaxoSmithKlinepotential merger with GlaxoSmithKline.

• The merger closed shortly thereafter, at a price  of $68 515/shareof $68,515/share.

Page 19: ESOP Legal Update - OEOC · ESOP Legal Update Ohio Employee Ownership Center 25th Annual Conference Akron, Ohio April 29, 2011. ... Mary Giganti Waldheger CCoyne Co., L.P.A. 1991

Bacon cont.Bacon cont.

• Employees sued based upon ERISA and state p oyees sued based upo S a d statesecurities law violations.

• Court dismissed state securities law claims as preempted by ERISA.

• Court stated that the company did not have a duty to disclose the merger discussions, but did have a duty to provide information on the value of the stock The company may have a duty toof the stock.  The company may have a duty to disclose that there was a question on the value of the stock.

Page 20: ESOP Legal Update - OEOC · ESOP Legal Update Ohio Employee Ownership Center 25th Annual Conference Akron, Ohio April 29, 2011. ... Mary Giganti Waldheger CCoyne Co., L.P.A. 1991

Sales and Mergers Cont.Sales and Mergers Cont.

• Peck v. Chopp, W.D. MI 6/14/2010.pp, / /• ESOP participants of an auto supplier sued CEO for breach of fiduciary duty.

• Company is in bankruptcy.• ESOP participants allege CEO failed to take steps to maximize the value of shares and that theto maximize the value of shares and that the ESOP share value dropped significantly due to the CEO’s handling of the sale of the business (e.g., 

h i h i h hno‐shop agreement with one suitor, even though there were other potential offers, fail to open bid process, etc.).p , )

Page 21: ESOP Legal Update - OEOC · ESOP Legal Update Ohio Employee Ownership Center 25th Annual Conference Akron, Ohio April 29, 2011. ... Mary Giganti Waldheger CCoyne Co., L.P.A. 1991

Peck cont.Peck cont.

• Court stated pure business decisions by anCourt stated pure business decisions by an ERISA employer are not covered by ERISA.

• Court must examine the CEO’s conduct andCourt must examine the CEO s conduct and determine if his actions involved the management or administration of the plan (actionable under ERISA) or if his actions were merely a business decision that had an effect 

ERISA l ( i bl don an ERISA plan (not actionable under ERISA).

Page 22: ESOP Legal Update - OEOC · ESOP Legal Update Ohio Employee Ownership Center 25th Annual Conference Akron, Ohio April 29, 2011. ... Mary Giganti Waldheger CCoyne Co., L.P.A. 1991

ERISA DisclosuresERISA Disclosures

• Kanoski v. Sterling Paper, S.D. OH 10/4/2010.• Plaintiff’s counsel wrote to company counsel to request 

copies of ERISA documents.• The attorneys talked and plaintiff’s counsel gave additionalThe attorneys talked and plaintiff s counsel gave additional 

time to respond.• Company did not produce the documents.• Company claims request was not properly made request• Company claims request was not properly made, request 

not made to the plan administrator, and there was no written authorization that plaintiff’s counsel was requesting on plaintiff’s behalf.on plaintiff s behalf.

• Court ruled that request is proper when made to the attorney of the plan administrator.  Court also ruled it was not necessary for plaintiff’s counsel to have writtennot necessary for plaintiff s counsel to have written authorization to act on plaintiff’s behalf.

Page 23: ESOP Legal Update - OEOC · ESOP Legal Update Ohio Employee Ownership Center 25th Annual Conference Akron, Ohio April 29, 2011. ... Mary Giganti Waldheger CCoyne Co., L.P.A. 1991

Stock Drop CasesStock Drop Cases

• Wilson v. Venture Financial Group, W.D. WA p,1/24/2011.– Court approved $750,000 settlement.KSOP that was not required to invest in company– KSOP that was not required to invest in company stock.

– This was privately‐held stock and court acknowledged h h l ld di f kthat the plan could not divest of company stock already owned.

– However, Court stated that the plan could have stopped offering the company stock (stop offering a “bad thing”).  Settlement related to the additional purchases of stock.

Page 24: ESOP Legal Update - OEOC · ESOP Legal Update Ohio Employee Ownership Center 25th Annual Conference Akron, Ohio April 29, 2011. ... Mary Giganti Waldheger CCoyne Co., L.P.A. 1991

Stock Drop Cases Cont.Stock Drop Cases Cont.

• Dann v Lincoln National Corp E D PADann v. Lincoln National Corp., E.D. PA 2/10/2011.

• Stock dropped 90%• Stock dropped 90%.

• Court ruled that unless the fiduciary decisions ll d h i l i hactually caused the investment losses in the 

employer stock, the plan fiduciaries cannot be h ld li bl f h lheld liable for the losses.

Page 25: ESOP Legal Update - OEOC · ESOP Legal Update Ohio Employee Ownership Center 25th Annual Conference Akron, Ohio April 29, 2011. ... Mary Giganti Waldheger CCoyne Co., L.P.A. 1991

Questions?Questions?

Mary GigantiMary Giganti

Waldheger C Coyne Co., L.P.A.99 C k d S 01991 Crocker Rd., Ste. 550

Cleveland, OH 44145

(440) 933‐7649

mgiganti@healthlaw [email protected]