DOL Proposes Rule to Clarify ‘Adequate Consideration’ for ESOP Transactions

The Department of Labor has issued a proposed regulation aimed at clarifying the term “adequate consideration” regarding the valuation of employer stock in employee stock ownership plan transactions, as required under the Employee Retirement Income Security Act.

The proposal seeks to strengthen protections for plan participants while providing fiduciaries with clear guidance on determining the fair market value of employer stock in these transactions.

Section 408(e) of ERISA permits ESOPs to engage in transactions involving employer stock, provided the transactions meet specific conditions, including the requirement of “adequate consideration.” Under ERISA section 3(18)(B), “adequate consideration” for assets without a recognized market, such as closely held employer stock, must reflect the fair market value of the asset, as determined in good faith by the ESOP trustee or fiduciary.

The proposed regulation also aligns with the SECURE 2.0 Act of 2022, which mandates formal guidance on acceptable standards for determining the fair market value of business shares acquired by ESOPs. This provision, Section 123 of SECURE 2.0, is effective for plan years beginning after December 21, 2027.

Questions and disputes about the fair market value of company stock have often been the subject of ERISA litigation, with fiduciary breaches alleged when the equity is believed to be mispriced.

According to a 2023 report by Matrix Global Advisors, the lack of valuation rules had deterred ESOP creation.

Highlights From the Proposal

The proposed rule introduces updated standards and procedures for fiduciaries tasked with determining the fair market value of employer stock during ESOP transactions. Key elements include:

1. Good faith determination: The rule emphasizes that fiduciaries must determine the fair market value in good faith, ensuring that valuations are transparent and based on sound methodologies;
2. Consultation with Treasury: Developed in collaboration with the Department of the Treasury, the rule provides comprehensive guidance to help fiduciaries adhere to best practices in valuing non-publicly traded securities; and
3. Withdrawal of 1988 proposal: The DOL formally withdrew a proposed regulation from 1988, acknowledging the need for modernized guidance that reflects current market practices and legislative updates.

By clarifying what constitutes “adequate consideration,” the DOL aims to reduce ambiguity and enhance compliance among ESOP fiduciaries. The rule underscores the importance of thorough documentation and rigorous valuation methods to protect the interests of plan participants and ensure the integrity of ESOP transactions.

“The ESOP Association and our community have waited 50 years for an adequate consideration rule,” said James Bonham, president and CEO of the ESOP Association, an advocacy organization for ESOP companies, in a statement Thursday. “We will carefully review the DOL’s approach and provide substantial feedback on behalf of our membership, which the DOL should strongly factor before any final rulemaking. Our goal is to make it easier, more transparent, and less costly for ESOPs to be formed and operated. More Americans should have the opportunity to receive the benefits of an ESOP, and this regulation should have that goal as well.”

The DOL’s proposed rule is open for public comment, offering stakeholders an opportunity to provide input on the guidance. The deadline for comments is 75 days from the date the proposal is published in the Federal Register. Comments will be considered before finalizing the regulation, which could set a new standard for ESOP transactions involving employer stock.