As part of the comprehensive “SECURE 2.0” retirement plan legislation enacted in December 2022, Congress directed the U.S. Department of Labor (DOL) to issue a long delayed and much needed regulation defining the term “adequate consideration” for purposes of the rules governing stock purchase and sale transactions by Employee Stock Ownership Plans (ESOPs). The DOL initially issued a proposed rule relating to the definition of “adequate consideration” in 1988; however, the absence of a final DOL regulation since 1974 (when ERISA was first enacted) has created uncertainty in business valuations for closely held corporations. This uncertainty has impeded the formation of ESOPs and resulted in costly litigation challenging ESOP stock purchases. On April 12, 2023, the DOL announced that it would conduct a public notice and comment rulemaking process to further define “adequate consideration” under section 408(e) of ERISA, which outlines the rules under which stock sales to ESOPs are permitted. It is expected that this regulation will be published in late spring or early summer of 2024. Although it remains to be seen what form the DOL regulation will take, and whether it will create new risks for ESOP transactions, most practitioners in the field are anticipating this guidance will resolve basic issues about valuation process and methodology, clearing the way for more ESOP transactions. 
 
The ESOP Association has published a model regulation in the hope and expectation that DOL will piggyback on that proposal. You can see the ESOP Association’s proposal here. The proposal incorporates the familiar “willing buyer/willing seller” valuation theory from the long-established IRS guidance, and the requirement that the valuation process be conducted in good faith.   
 
We reached out to several valuation professionals to get their opinion about what the DOL regulation may mean for ESOP valuations:
 
Peter Briggs, lead valuation consultant for Shareholder Strategies out of Charlottesville, Virginia, had this to say:
 
“Be careful what you wish for. I do not believe the DOL has experienced a soul-cleansing enlightenment regarding ESOPs.”
 
Jim Joyner, a valuation advisor, and frequent ESOP transaction trustee, made the following comment:   
 
“For the past several years, Congress and the ESOP community have been urging the DOL to move away from its hostile enforcement stance towards ESOPs, which has chased professional trustee firms out of the industry and stymied the growth of employee ownership. After more than four decades of delay, the DOL is in the final stages of publishing essential guidance that will shape the formation of new ESOPs. If they do this well, ESOP fiduciaries could see a shift from attack to assistance and renewed growth in employee ownership. Surely, the ESOP Association’s exemplary language will influence the DOL to publish a regulation that opens the way for many new ESOPs.”
 
As noted above, many ESOP practitioners are guarded in their expectations about the new DOL regulation. While we hope the new regulation will be a “game-changer” for business owners thinking about transferring ownership to their employees through an ESOP, there is concern that DOL could make the current level of valuation uncertainty worse. The devil will be in the details of the new regulation. 
 
Stay tuned for our next advisory memo, after the DOL adequate consideration regulation is published. In the meantime, if you have any questions about what the new rules may mean for you, please feel free to contact a member of our ESOPs team.