Why don't stock sales require pass-through votes? Definition of "best interest of plan participants"?

[RS]

Hello,

I have attempted to search for an answer to this question on this site and elsewhere and found nothing - apologies if I am missing the obvious. It seems very strange to me that a sale of all assets requires a pass through vote, but a sale of all stock that accomplishes effectively the same thing does not. Is there a good reason for this I am missing?

My other question is if there is relevant law clarifying which plan participants a trustee is expected to act in the best interest of, and the meaning of best interest. A sale that multiplies the stock value is obviously in the financial interest of those close to retirement that likely have the most shares. The further from retirement an employee is, the more uncertain this is. The sale will certainly provide a short term financial benefit, but the long term effects depends on what the future growth of the company would have been without a sale. I saw a claim that in a situation where an offer was made for 10 times the ESOP's value where the purchaser built in a plan to lay off all of the employees (who are plan participants), a trustee is required to ignore the layoff aspect because they are only acting in the best interest of plan participants, not employees. I can see the logic, but this seems like a very peculiar definition of "best interest" and "plan participant" that stretches credulity.

First time poster here, didn't see any pinned rules to avail myself of - please let me know if I have made any faux pas!

Thanks!

[ESOP Guy]

On 1/9/2020 at 6:49 PM, RS said:

Hello,

I have attempted to search for an answer to this question on this site and elsewhere and found nothing - apologies if I am missing the obvious. It seems very strange to me that a sale of all assets requires a pass through vote, but a sale of all stock that accomplishes effectively the same thing does not. Is there a good reason for this I am missing?

My other question is if there is relevant law clarifying which plan participants a trustee is expected to act in the best interest of, and the meaning of best interest. A sale that multiplies the stock value is obviously in the financial interest of those close to retirement that likely have the most shares. The further from retirement an employee is, the more uncertain this is. The sale will certainly provide a short term financial benefit, but the long term effects depends on what the future growth of the company would have been without a sale. I saw a claim that in a situation where an offer was made for 10 times the ESOP's value where the purchaser built in a plan to lay off all of the employees (who are plan participants), a trustee is required to ignore the layoff aspect because they are only acting in the best interest of plan participants, not employees. I can see the logic, but this seems like a very peculiar definition of "best interest" and "plan participant" that stretches credulity.

First time poster here, didn't see any pinned rules to avail myself of - please let me know if I have made any faux pas!

Thanks!

I will let one of the lawyers answer about the voting rules.  When a client of mine asks about it I tell them to talk to an ERISA attorney that knows ESOPs.  What I can tell you is I have worked in the ESOP field for decades and I find when votes do and don't happen to be a bit odd.  

But based on all the conversations I have had and discussions at conferences you have the correct logic when you say:

a trustee is required to ignore the layoff aspect because they are only acting in the best interest of plan participants, not employees. I can see the logic, but this seems like a very peculiar definition of "best interest" and "plan participant" that stretches credulity.

The one thing I will say is that price doesn't have to be the only criteria in this decision by the trustee.  A 10x price might make it hard to say "no" regardless of the facts.  My understanding is just because the price exceeds the current appraised value doesn't mean the trustee has to vote to sell.  I am not sure I can give a good example but I have clear memory of attorneys telling me that more than once.   it really is a complete facts determination and price is just one of the facts.  A very important fact but not the only one that has to be looked at. 

The other oddity is I have had some people tell me even if the employees vote to not sell there can be cases where the trustee ought to ignore the vote and vote to sell the company.   Once again not my area of expertise but I get the impression that the participant vote doesn't have to always be binding.  it isn't clear to me what happens if the employees vote one way and the trustee doesn't think that is the prudent decision.   This stuff gets murky fast and maybe I am not helping you much.  

The NCEO and ESOP Association will have publications for sale that might help point you in the right direction.  They tend to not be dense legal manuals but overviews.  They are priced pretty low so there isn't much risk but the footnotes sometimes are helpful to guide a next step.

Here is an example.

https://www.nceo.org/Responding-Acquisition-Offers-ESOP-Companies/pub.php/id/324

Hope I helped more than I hurt....

[Cardscrazy]

I wonder if an asset sale is likely to put the participants out of work so they get to vote and give cover to the trustee and management.  In a stock sale they should mostly retain their jobs so no need for a vote that management hates to hand over to the whim of the working class.  

[Peter Gulia]

Which matters call for participant-directed voting of an ESOP’s shares (if the shares are not publicly traded) sometimes might vary according to a relevant State law.

 

IRC § 409(e)(3)   Requirement for other employers

If the employer does not have a registration-type class of securities, the plan meets the requirements of this paragraph only if each participant or beneficiary in the plan is entitled to direct the plan as to the manner in which voting rights under securities of the employer which are allocated to the account of such participant or beneficiary are to be exercised with respect to any corporate matter which involves the voting of such shares with respect to the approval or disapproval of any corporate merger or consolidation, recapitalization, reclassification, liquidation, dissolution, sale of substantially all assets of a trade or business, or such similar transaction as the Secretary may prescribe in regulations.

 

IRS Publication 6392 explains an IRS view that there might be nothing to pass through for directed voting if relevant State law does not provide for shareholders to vote on a matter.  https://www.irs.gov/pub/irs-pdf/p6392.pdf

 

States’ laws vary about which decisions require a vote of a corporation’s shareholders.

[RLL]

A sale of stock does not involve a shareholder vote.  It is an investment decision to sell by the owner of the stock.  It does not involve a corporate action (such as a merger) that requires a vote of shareholders.  No vote needed, so there’s no vote to pass-thru to ESOP participants.  

[Degrand]

As a practice matter, you usually don't go through the cost of a pass-through vote without knowing that transaction will be approved.  I agree with ESOP guy, you don't take into account the lost of a job because an ESOP is retirement account not a guarantee of future job.

[Luke Bailey]

On ‎1‎/‎13‎/‎2020 at 8:59 PM, RLL said:

A sale of stock does not involve a shareholder vote.  It is an investment decision to sell by the owner of the stock.  It does not involve a corporate action (such as a merger) that requires a vote of shareholders.  No vote needed, so there’s no vote to pass-thru to ESOP participants.  

But if for some reason, e.g. a 100%-owned ESOP company and an egalitarian group of participants, you wanted a stock sale to be subject to shareholder vote, you could put it in the company's bylaws, don't you think?

[Degrand]

Any expansion of voting rights are included the ESOP plan document rather the bylaws.  The reason is participants are not legally the owner of the company stock.  The trustee is the legally owner. If you want to have participant vote on stock sales, it has to be in the plan document.   

[Luke Bailey]

Degrand, maybe, and a good point. Probably could put it both places to be sure, but I'm glad you agree with basic notion that one could, if he or she wished, expand voting rights to include sales of stock. Thanks.

[Degrand]

The key to remember is the participants are only beneficial owners except in limited circumstances and don't have all of the ownership rights as a ordinary shareholder.   I am not sure that the bylaws allowing for expanded voting rights would change that relationship without amending the plan document.