SAR Program - How much is too much?

Our 100% ESOP S Corp has a SAR’s program for senior leadership and board members that creates a huge amount of synthetic equity. In fact synthetic equity is now almost 30 % of all outstanding shares of stock. At the end of this year this program will pay out almost 4 million dollars to these select shareholders.This is a company that only makes 5 million net income on average annually.  

It appears they are staying just within 409(p) testing , but they just merged the 401k with the ESOP to help with this ratio testing. I’m afraid they are going to get even more bold in coming years in creating more synthetic equity. Employees now need to contribute to 401k to get matching ESOP shares. I’m concerned that Managment and board may be acting unethically and hurting value of average employees retirement benefits.

There is also some self dealing going on with leases and sales of builiding owned by board member to the company. Same three board members and CEO appear to be the main beneficiary of all this. Any recommendations about what to do next would be appreciated. 

What is Board doing to document that they have market-priced these executive positions  and are paying them reasonably ?

Just so you have some perspective, a lot of what you are concerned about is a matter of state corporate law and is not directly governed by ESOP considerations.  The ESOP is a shareholder (being a majority shareholder is nice; minority shareholders just get screwed).  As an ESOP participant, most of your rights relating to how the business of the company is run is derivative of shareholder rights.  Shareholders of private corporations have surprisingly few rights and most state corporate law gives management a lot of latitude (the "business judgment rule") about how to run the business, albeit tempered by conflict of interest rules.  Majority shareholders have the right to control management by electing or dismissing board members, not by evaluating business decisions.  ERISA and ESOP rules come into play through the fiduciary.  The shareholder rights of the ESOP are exercised by a fiduciary, who is charged with acting in the best interests of the shareholder (the ESOP participants).  If the fiduciary is not attentive or is not properly exercising its rights (electing and dismissing board members) based on prudent attention, thus allowing management to go beyond the usual disgusting bounds of greed, the the fiduciary may have liability and the Department of Labor may be interested in fiduciary malfeasance.  The Department of Labor is particularly sensitive about ESOPs, but not always very savvy about limitations on ESOP rights based on corporate law.  You may not like what is going on as business conduct, but it may well be within corporate law propriety.  If it is not, and the fiduciary is either not paying attention or is one of the band of thieves and not taking appropriate action to replace the wrongdoers, the DOL might be of some assistance or might be a saber to rattle if concerned participants want to confront the fiduciary or management.  The DOL is also interested in inappropriate valuation of shares, but valuation is a very mushy subject.

It is true you have very few rights directly.

Do you know who is the trustee is?

I am willing to be told I am wrong by the various lawyers but from all the ESOP conferences I have been to I get the impression the trustee has a fiduciary obligation to make sure the executive compensation is  at market prices.  They ought to be demanding the board document the process they are doing to make sure that is true.  

If one of the executives is the trustee that is obviously more difficult.  Also, the board gets to pick the trustee and the trustee gets to vote for the board members.  I have heard of stories over the years where there is a race between the trustee to replace the board members before they replace the trustee type of conflicts. 

I also get the impression if they hired an outside compensation consultant and they documented this was all market rate you have a difficult time winning.

As for the buildings and leases their might be what is known as a Prohibited Transaction (PT).  A PT can causes excise taxes and disgorgement of profits.  However if they are working with lawyers and consultants to cut that fine of an edge on the 409(p) test my guess is they are running the PT questions by the lawyers also.  You need more information before you known about a PT.  It really matters if the board members are employees also.  Some of the lawyers here might be able to give you a better idea what you would need to look for to see if there are any indications of PTs. 

Thanks for the great feedback ! The knowledge of this group is a terrific resource. It seems like documentation of rationale for executive and board compensation is a key issue. Board members are not employees yet it appears they are receiving hundreds of thousands of dollars worth of stock appreciation rights along with employees in the Managment company ( the organization has a Managment Holding company that was spun off a few years ago and several operating companies) . Is it  unusual for independent board members to be so richly compensated? Are board members and CEO typically considered fiduciaries or only the trustee? It seems like there is a valid argument with face validity for this group acting in their own best interest and NOT  in the sole interest of beneficiaries and with the prudence of a well informed expert on the subject matter of pension fund governance. I understand about the circular hiring relationship with board and trustee in esop’s. It seems a bit absurd on the face of it , but understand that’s the law now.

Has anyone had experience or heard of circumstances when group of average employees went directly to trustee to discuss significant concerns like this and ask for changes? There is no ESOP committee. Would that awareness after meeting and hearing about concerns create a greater level of accountability for her to ensure she performs her fiduciary responsibilities related to this SAR program and other matters like the board member selling and leasing property to the company (PT). We do know who trustee is. She is independent. However , she does not communicate directly with employees now. Not that she refuses to- just doesn’t currently make that a practice. How about retaliation to employees who question such a large cash drain by leaders. Does ERISA protect such action? 

57 minutes ago, Esop2 said:

How about retaliation to employees who question such a large cash drain by leaders. Does ERISA protect such action? 

It appears the courts are split on whether ERISA 510 protection applies to internal complaints or only to complaints to Federal or State authorities.  

https://www.gpo.gov/fdsys/pkg/USCOURTS-mied-1_12-cv-10946/pdf/USCOURTS-mied-1_12-cv-10946-0.pdf

Quote

 

Section § 510 of the Employee Retirement Income Security Act of 1974, 29 U.S.C. §1140, protects an employee who "has given information . . . in any inquiry or proceeding relating to [ERISA]." The question in this case is whether § 510 extends its protections to an employee’s unsolicited, internal complaint to his employer that it has violated ERISA.

The issue has split the circuits. The Second, Third, and Fourth Circuits hold that § 510 does not protect such complaints; the Fifth, Seventh, and Ninth Circuits hold that it does.1 The Sixth Circuit has not yet had occasion to address the issue. For the reasons detailed below, the Court concludes that in this case § 510 does not protect the plaintiff’s unsolicited, internal complaint — an email to his employer threatening to report its ERISA violations to state and federal authorities — because it was unconnected to any "inquiry or proceeding."

 

Thank you! So if an employee shareholder made an official compliant to DOL , for example, before addressing directly with fiduciary they  are more likely to be protected by ERISA?