Should an ESOP disclose M&A negotiation details on a Diversification Notice?

A 100% ESOP-owned company has received a letter of intent to be acquired by a private equity company.  The transaction is expected to be a stock sale about 40% above the 12/31/2023 FMV.  Should the expected sale price be disclosed on the diversification notice?  At least 2 of the diversification eligible participants have or will have knowledge of the sale discussion at the time the notices are scheduled to be distributed, but the rest of the eligible group may not know all the details.  Please assume the diversification is timely based upon the availability of the final FMV, I'm only concerned about the fiduciary responsibility of providing the information necessary to make an appropriate election.

Can they legally do that?  In many cases until the sale is final both sides are bound by confidentiality agreements that don't let them speak about the negotiations and possible sale. 

Also, letter of intent doesn't sound final.  So if the deal can be broken disclosing it could cause people to not sell their shares and could be harmed if the sale falls through.

You are rightfully concerned to worry about fiduciary responsibility.  There are court cases where such people have been forced to pay people who sold at the lower price to make them whole to the sale price.  However, given things like above disclosing it might not be allowed or even right.

This client needs to go to an ERISA attorney who is very familiar with this topic.  You can find times where the answer will be to delay payments until more is known.   I have seen cases where the recommendation is to not pay anyone, diversification nor terminated participants even if it goes past the next year end.   Obviously that raises questions of what about the law that says they have to be paid. This is very tricky becasue there are some large possible liabilities for people. 

You need something better than free advice on this forum for this one unless it is the free advice to find good paid advice.

This is a delicate situation. The fiduciary will want to have the benefit of advice of competent legal counsel as a matter of prudent administration and, separately and cynically, protection from liability. That makes any specific observations in this forum irrelevant.

Gratuitous comment: ESOPs tend to provide the most difficult fiduciary problems because ESOPs have so many incompatibilities with ERISA principles.

Agree with both comments above. In many cases, we recommend that ESOPs still make a timely distribution/diversification payment as elected by the participant, but provide true-up payments after the transaction closes for the difference between the per-share distribution/diversification value and the per-share transaction value. There are a few ways to do this, each with its own complications.

You'd need to decide where to draw the line on who gets a true-up payment; often, we will start with those who received plan distributions/diversifications after a binding LOI has been entered. But this is a judgment call in each case.

Concur with QDROphile that an ESOP involves conflicting interests at every turn.

Concur with ESOP Guy’s observation about considering a letter of intent and any other express or implied agreement for not revealing confidential information.

Concur with ESOP Guy’s observation about considering a fiduciary’s duty of communication.

Also, impartiality. Consider that some employees can be helped by disclosure, and some employees can be harmed by disclosure.

Here are a few of many further questions one might suggest to help the fiduciaries get lawyers’, accountants’, appraisers’, and others’ advice and think through some of the many conflicting duties:

When is the next day a participant can do (or choose not to do) something?

Is that day before, on, or after the next regularly scheduled valuation date?

Might there be a need for an earlier valuation?

If the dealmaking with the might-be acquirer proceeds to a due-diligence phase, how many of the target’s employees would be involved in collecting information to furnish to those executives who communicate with the acquirer?

Is it feasible to restrict the target’s communications from and to the might-be acquirer to only the CEO, CFO, and CLO?

Might disclosing the acquirer’s interest harm the company’s value because some executives and some talented employees might leave before the acquirer delivers an offer and before the target gets stay agreements?

Might not disclosing the might-be acquirer’s interest harm the company’s value because some executives and some talented employees suspect an acquisition and, not knowing the acquirer’s identity, might leave quickly?

How much or how little protection does the company get from nondisclosure, nonsolicit, noncompete, and garden-leave agreements.

Recognizing conflicts between the company’s interests and the ESOP’s interests, should those people who will negotiate or communicate with the acquirer resign, recuse, or be removed from the plan fiduciary committee?

Recognizing conflicts between a human’s interests, including her interests regarding future employments or engagements and compensation, and the ESOP’s interests, should those people who are so conflicted resign, recuse, or be removed from the plan fiduciary committee?

Does a lawyer or accountant who regularly advises the company have a personal-interest conflict regarding the circumstances of a might-be acquisition?

Does a lawyer or accountant who regularly advises the ESOP have a personal-interest conflict regarding the circumstances of a might-be acquisition?

If the ESOP owns the company, is it feasible, to distinguish between what otherwise might be settlor decisions (including those EBECatty invites) and fiduciary decisions. Every decision deals with the plan’s asset and management of it.

This is not advice to anyone.

16 hours ago, QDROphile said:

This is a delicate situation. The fiduciary will want to have the benefit of advice of competent legal counsel as a matter of prudent administration and, separately and cynically, protection from liability. That makes any specific observations in this forum irrelevant.

Gratuitous comment: ESOPs tend to provide the most difficult fiduciary problems because ESOPs have so many incompatibilities with ERISA principles.

@QDROphile @ESOP Guy The question of legal counsel is getting tricky as this marks the second case where the reported "ERISA" attorney who helped structure the transaction, setup the plan, and continues to maintain the document, has bowed out of any questions about the sale and subsequent Plan Termination as discussing the Termination presents a conflict of interest.  We will likely turn to the independent trustee for their guidance as well. 

Initial thoughts are to process only the ongoing installment distributions, dependent on the status of the sale transaction after the next 45 days.  As it proceeds though, discussions by the Board of Directors and due diligence/disclosure efforts will cause the 2 aforementioned diversification eligible participants to be aware of the offer.

The trustee will determine if another valuation or fairness opinion is required once the binding offer is produced.

@EBECatty Good idea on true-up payments!

What would you all think about a diversification notice that delays the election until the transaction is finalized under the premise that the value can't be determined until then?

@Peter Gulia Thank you for the hypotheticals, those will be handy to help navigate these discussions with the Sponsor and their advisors!!

I am surprised that the independent fiduciary is not already involved in various aspects. Perhaps it is a special purpose independent fiduciary with very limited scope.

For the moment, let's shift focus away from issues related to disclosing information to participants who must make personal decisions about their ESOP interest, and focus on what the plan document says about voting rights. 

• Do participants have the right to vote shares allocated to their accounts on the sale of the company or the assets of the company, on a dissolution of the company, or conversion of the company to another corporate status? 
• Are there provisions that allow participants to vote unallocated shares? 
• Does the plan designate each participant as a plan fiduciary?  

If the plan specifies that the participants must be involved in the decision to sell the company, then the participants will need access to information sufficient for them to make decisions.

There are important differences between and among a letter-of-intent stage, a due-diligence time, receiving a conditional offer, negotiating a definitive agreement, required or permitted announcements of the agreement (if any), and seeking approvals.

Yet, Paul I is right that knowing what would be called for in one or more of the later stages might influence a decision-maker’s thinking for one or more of the earlier stages.

9 hours ago, Paul I said:

For the moment, let's shift focus away from issues related to disclosing information to participants who must make personal decisions about their ESOP interest, and focus on what the plan document says about voting rights. 

• Do participants have the right to vote shares allocated to their accounts on the sale of the company or the assets of the company, on a dissolution of the company, or conversion of the company to another corporate status? 
• Are there provisions that allow participants to vote unallocated shares? 
• Does the plan designate each participant as a plan fiduciary?  

If the plan specifies that the participants must be involved in the decision to sell the company, then the participants will need access to information sufficient for them to make decisions.

I hate to sound catty, but this is completely off-topic.  100% you are putting the cart before the horse, talking about end-game procedures.  My concern is about the intervals we are faced with now, and the prudence or duty to disclose information related to the administration procedures that the document is requiring now, but that must be balanced against the idea that doing so harms the participant who follows through.  So far we have:

1. Don't diversify at all.

2. Pass a price protection floor policy to guarantee the buyout payment if higher than the pye fmv.

3. Wait and see who knows what and how much can actually be said in a month or so.

4. Blindly follow the document as written, as that is the only obligation really beholding to the sponsor at this time. 

I stand by the idea 1 or 2 is what I see the most with 1 being very common.

I see the virtue of 2.

One of the big issues here really is can they even tell the employees.   I can't tell you how many times in the decades I have worked in the ESOP world I have been looped in by management they are in talks and told to keep the number of people in my own firm who are told to a minimum.  They want their ESOP TPA's input but the non-disclosure agreements make it very hard to tell the employees.   The fact the sale isn't final means you don't in fact have any actual hard numbers to give the employees. 

I have seen deals at the letter of intent stage fall through.   In the end almost no one in the company knew anything about how close the company came to be sold.  

I get the whole retirement plan issues but you can not lose track of the regular business issues and balance them with retirement plan issues.  

Once again there are court cases out there where people got paid and shortly later the company was sold for a lot more.  A court required fiduciaries to disgorge gains to pay people who took a distribution at the lower price to get them up to the sales price. 

Paying a good attorney who can look at all the facts whole can guild the fiduciaries is cheap insurance in my mind here.  

For what it's worth, I think practically speaking option 2 covers the most ground. You followed the document (and law) by allowing diversifications during the plan year based on the most recent valuation, but have built in a mechanism to ensure the participants are not harmed in the end. 

The deal is not close enough to know the final transaction value. If there's not a binding LOI, one more month will not produce a final deal value either. At this point in the year, you'll be lucky to close by year-end, which means you'll need to decide if you want to skip payouts altogether for the entire 2024 plan year. As I'm sure you've seen, deals fall apart well past the signed LOI stage, so in my mind trying to approximate the deal value a month from now and pay it to diversifying participants is a non-starter.

An interim valuation would not help, in my view, unless it also accounted for the pending sale, likelihood of closing, etc. 

Option 1 presumably would require an explanation to participants, as ESOP Guy notes. I'm not sure what added benefit would be achieved by not diversifying at all. Plus, it seems to me that it would pretty clearly violate the plan document and statutory diversification requirements. In almost all cases with a strategic buyer, the deal value will be higher than the most recent valuation (if it's not, that's a separate fiduciary concern), so in reality you're likely only to be increasing prior payments.