Docket: EBSA-2010-0050 

Definition of the Term ‘‘Fiduciary’’ 

Comment On: EBSA-2010-0050-0001 

Definition of the Term Fiduciary 

Document: EBSA-2010-0050-DRAFT-0006 

Comment on FR Doc # 2010-26236 

Submitter Information 

Name: Al Doland 

Address: 

1 Export Drive 

Sterling, VA, 20164-4421 

Email: adoland@avitecture.com 

Phone: 703-639-1653 

Organization: Avitecture, Inc. 

General Comment 

Sir or Madam: 

The proposal to define ESOP appraisers as fiduciaries would have an adverse effect on employee 

ownership and my company in particular and we oppose it. The immediate effect would be a many 

fold increase in the cost of annual appraisal of my company. The National Center for Employee 

ownership has presented to you a well thought out response to this issue and my company fully 

supports it. I have attached the response for your reference. 

Regards, 

Al Doland 

Vice President and CFO 

Trustee for the Avitecture, Inc. 

Employee Stock Ownership Plan 

Attachments 

PUBLIC 

SUBMISSION 

As of: December 22, 2010 

Received: December 15, 2010 

Status: Pending_Post 

Tracking No. 80bb7adf 

Comments Due: January 20, 2011

Submission Type: Web

EBSA-2010-0050-DRAFT-0006.1: Comment on FR Doc # 2010-26236

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NCEO Response to Department of Labor Proposal to Define ESOP Appraisers as 

Fiduciaries 

Corey Rosen, NCEO Executive Director 

Email: crosen@nceo.org :: Phone: 510-208-1314 

November 30, 2010 

Executive Summary 

This is the first time the National Center for Employee Ownership (NCEO), a private, 

nonprofit membership, information, and research organization, has submitted formal 

comments on Department of Labor regulatory proposals. We have commented here 

because we believe these proposals could have a serious and detrimental impact on the 

number and quality of ESOPs, which in turn would very adversely affect retirement 

security in the U.S. On the other hand, we agree there are faulty ESOP appraisals (as do 

all of the ESOP appraisers who do this work regularly that we consulted on this), and we 

therefore suggest a number of alternatives the DOL could consider to address this issue 

more effectively. 

We identify several key problems with the proposal: 

 1. The absence of final regulations on how ESOPs should be appraised would create 

considerable confusion for courts, ESOP trustees, and appraisers on how to judge 

whether appraisers were following their fiduciary duties, which necessarily would be a 

legally ambiguous question. 

 2. Fewer ESOPs would get started, especially in smaller companies, because costs 

would rise substantially as valuation firms now required fiduciary insurance (assuming it 

could be obtained). This is especially worrisome because the data definitively show that 

ESOPs add not just to total retirement security but also to diversified retirement assets. 

 3. There would be fewer qualified ESOP appraisers because some of the most qualified 

appraisers would drop out of the ESOP appraisal business. 

 4. There would be considerable legal confusion over just who is responsible for the 

errors and how responsibility is allocated. 

 5. Existing case law already provides that appraisers are fiduciaries when effectively 

exercising discretion over plan assets. 

It is difficult to estimate just how common faulty appraisals are, and the discussion in the 

proposed regulations does not indicate how frequent the problem is in the DOL's view. 

We do know, however, that over the last 20 years, there have been only 17 lawsuits 

specifically concerning ESOP appraisals that have made it to court during that time. More 

tellingly, leveraged ESOPs have a default rate that is a small fraction of one percent per 

year, while LBOs in general have default rates several times that high. If appraisals were 

consistently faulty, ESOPs should often be overpaying for stock and ending up unable to 

repay the loan. Of course, there are problematic appraisals that never rise to these levels, 

but the proposal does not attempt to weigh the consequences of the changes suggested 

against the magnitude of the problem. 

We believe there are a number of alternative approaches that may address the problems 

more effectively, including: 
 1. Issue final ESOP valuation regulations: This would provide much clearer guidance to 

existing fiduciaries and appraisers, which should reduce the problem significantly. 

 2. Provide regulatory guidance on what "independence" means: Current law requires 

that appraisers be independent, but this term has never been specifically defined. 

 3. Require that employer stock appraisers be credentialed by a professional appraisal 

organization: Consideration should be given to whether this requirement should specify 

that employer stock appraisers have professional training related to employer stock 

appraisals. 

 4. Set specific standards for fiduciaries with respect to valuation: Rather than creating 

an additional fiduciary with all the problems that arise from that, standards for existing 

fiduciaries could be tightened. 

 5. Establish an industry-DOL advisory committee to seek alternative approaches to the 

problem. 

Complete Response 

Introduction 

The National Center for Employee Ownership, a private, nonprofit membership, 

information, and research organization, has never before submitted formal comments on 

Department of Labor regulatory proposals. We are not a lobbying or trade association. 

Our mission is to provide "the most objective, reliable information possible about broadbased employee ownership plans," including ESOPs. To draw a bright line on this, we 

have avoided commenting on legislative or regulatory matters unless specifically asked to 

do so. We are making an exception in this case, however, because we are concerned that 

this proposal could have serious and negative implications for the retirement security of 

millions of employees. 

We agree there are some ESOP appraisals that are poorly done and/or being performed 

by people who are not truly independent and therefore may have a financial interest in the 

transaction. We also believe there are more effective and less blunt ways of dealing with 

these problems that will have fewer unintended and damaging consequences. 

In this response, we first briefly outline what the data show on the contribution of ESOPs 

to retirement security (full details are available on request). Second, we look at how 

common faulty appraisals might be, admittedly a difficult question to answer very 

precisely. Third, we look at the likely impact of defining appraisers as fiduciaries in terms 

of ESOP adoptions and terminations. Fourth, we look at the issue of the existing law on 

fiduciary responsibilities of plan providers and how that might be affected by this. 

Finally, we suggest some alternative approaches that might help solve the problem 

without causing as much potential damage as the proposal likely will. 

ESOPs and Retirement Security 

It is important first to address the question of why we should even be concerned that the 

new rules are likely to lead to fewer ESOPs and to lead some existing plan sponsors to 

terminate them. It has been national policy, confirmed in a bipartisan fashion over many 

pieces of legislation over the last 36 years, to support these plans. President Obama 

recently told an audience in Virginia that ESOPs are "aligning the interests of workers 

with the interests of the company as a whole." While he noted that this means employees 
are subject to the ups and downs of companies, "theoretically, at least, it's something that 

can help grow companies, because the workers feel like they're working for themselves, 

and they're putting more of themselves into their job each and every day. I think that it's 

something that can be encouraged." But the real test is whether ESOPs are good for 

employee retirement security. 

A common criticism of ESOPs is that they do not provide for adequate retirement 

security because they are too undiversified. While this argument has intuitive appeal, 

research on what actually happens in ESOP companies makes it largely irrelevant. First, 

ESOPs do tend to diversify somewhat over time because private companies often build 

up cash in the plan to handle the repurchase obligation (private company ESOPs are the 

only ones at issue here because public companies do not need an appraisal). ESOPs are 

also required by law to allow diversification to participants aged 55 with 10 years of plan 

participation. Most companies either pay people out or, more commonly, transfer 

diversified assets into a 401(k) plan. Second, diversification outside the ESOP is typical. 

More than half (56%) of ESOP companies offer a second defined contribution retirement 

plan in addition to the ESOP, making them more likely to have a second retirement plan 

than comparable companies are to have any retirement plan. Third, unlike 401(k) plans, 

which are primarily funded by employees and often end up with little or no participation 

among younger and less well-paid employees, ESOPs, by law, are funded primarily by 

the company and include all employees meeting the basic qualified plan rules. 

In other words, ESOPs are less diversified than 401(k) plans or profit sharing plans, but 

ESOP companies tend to provide more retirement assets in more plans, and require less 

of a employee contribution. For most employees (especially the estimated 60% or so who 

do not actively participate in any retirement plan), being 100% undiversified in an ESOP 

with assets is better than being 100% diversified in nothing. 

In 2010, the NCEO conducted the definitive research on this question by using all of the 

Form 5500 returns for ESOPs nationally and other defined contribution plans. ESOP 

companies, by definition, have at least one defined contribution plan: the ESOP. More 

than half of them (56%) have a second defined contribution plan, likely a 401(k). In 

comparison, the Bureau of Labor Statistics reports that 47% of companies overall have a 

defined contribution plan. In other words, an ESOP company is more likely to have two 

defined contribution plans than the average company is to have any. 

The average ESOP company contributed $4,443 per active participant to its ESOP in the 

most recently available year. In comparison, the average non-ESOP company with a 

defined contribution plan contributed $2,533 per active participant to its primary plan that 

year. Controlling for plan age, number of employees, and type of business increases the 

ESOP advantage to 90%-110% above the non-ESOP companies in our sample. 

The value of the assets contributed by the company to all defined contribution plans in 

ESOP companies is substantially higher than the value in non-ESOP companies. 

Controlling for company size, industry, and plan age, the average ESOP participant in the 

average ESOP company has company-sourced defined contribution assets worth 2.22 to 
2.29 times as much as the assets held by the average participant in the average company 

with a non-ESOP defined contribution plan. This ESOP difference is an estimate. The 

data do not allow us to calculate the actual value of the assets per participant in combined 

defined contribution plans or the source of the accumulated assets. The data do show how 

much of each year's contribution is from the company, and this number is stable over the 

years. We believe it provides a reasonable basis to estimate how much of the 

accumulated assets in the average employee's account was originally a company 

contribution. 

The results confirmed a 1998 study by Peter Kardas and Jim Keogh of the Washington 

Department of Community, Trade, and Economic Development and Adria Scharf of the 

University of Washington. This study used 1995 employment and wage data from the 

Washington State Employment Security Department, 1995 data on retirement benefits 

from a survey of companies, and federal Form 5500 data for 1995. The study matched up 

102 ESOP companies with 499 comparison companies in terms of industrial 

classification and employment size. The study found the average value of all retirement 

benefits in ESOP companies was equal to $32,213, with an average value in the 

comparison companies of about $12,735. Looking only at retirement plan assets other 

than ESOPs, the ESOP companies had an average value of $7,952, compared to $12,735 

for non-ESOP companies. Given that based on the most recently available Form 5500 

data, the typical ESOP is actually about 17% invested in diversified assets other than 

company stock (with participant-directed diversifications typically not part of this 

because they are transferred or paid out), employees in ESOP companies would have had 

about as much in diversified assets as employees would have in all assets in non-ESOP 

companies. In ESOP companies, the average corporate contribution per employee per 

year was between 9.6% and 10.8% of pay per year, depending on how it is measured. In 

non-ESOP companies, it was between 2.8% and 3.0%. 

Private companies fund ESOPs at these high levels because they are usually used to buy 

the shares of existing owners in a tax-favored way, and the high levels are needed to 

make the purchase. It is highly unlikely that these same companies, if they did not have 

an ESOP, would fund their retirement plans at anything close to these levels. So 

discouraging ESOPs would lead to a significant reduction in company-funded 

contributions to retirement plans. 

How Common Are Poor or Conflicted Appraisals? 

We agree with the DOL that there are faulty ESOP appraisals. We believe most of these 

faulty appraisals come from two sources: 

 1. Appraisers who only occasionally do ESOP valuations and do not become 

sufficiently educated in the special issues ESOPs raise. In our experience talking with 

hundreds of ESOP companies every year, we find that a large majority of appraisals are 

done by a relatively small number of firms that specialize in this work. However, a 

significant minority does not use these firms. 

 2. Appraisers who have a financial interest or other conflict with the company. 
We believe these problems have become less frequent as ESOPs have matured. Early on, 

valuation models sometimes used "investment banker" approaches that were too 

aggressive. The ESOP valuation community was in its early stages, and there had not yet 

been time to develop the kind of intense and frequent dialogue among members of the 

community that now regularly goes on in conferences and meetings as well as in various 

publications. This does not mean that problems have disappeared, but they do seem to be 

much less common. 

Assessing the frequency of these problems is difficult. Naturally, the DOL sees mostly 

the problem cases, and with over 10,000 private companies with ESOPs and ESOP-like 

plans, it would only take a very small percentage to produce a fairly large number. The 

best we can do to make an indirect assessment is look at the number of legal cases 

involving valuation and how often ESOPs default. It would be valuable to know how 

many faulty appraisals the DOL finds on audit to add to this. 

The NCEO conducted a comprehensive review of litigation over employer stock in 

defined contribution plans between 1990 and 2010. We believe we located virtually every 

case. There were 175 court cases filed on these issues, 141 of which involved private 

companies. Of these 141 cases, only 17 concerned valuation, or fewer than one per year. 

Of course, just because a case is never filed does not mean all the other appraisals were 

acceptable, but this is a remarkably low figure given the litigation that occurs in all 

qualified plans and the amounts per participant that are often at stake in ESOPs. 

Valuation cases were also less common than claims over distributions. 

A more indirect way to look at this issue is how often ESOP companies default on their 

ESOP loans. There can be many reasons why an ESOP company defaults, including 

unanticipated changes in the economy or a company's market. But an excessively high 

initial valuation (presumably generally the DOL's concern, as opposed to excessively low 

one that would favor employees) should put a company at substantially more risk. Based 

on data from plan providers we obtained in 2010, as well as Form 5500 data, we estimate 

the default rate on ESOP loans at about 0.2% per year, compared to estimates of 3% to 

6% for leveraged buyouts in general. Most ESOPs are leveraged, at least to start, so this 

suggests that, at least, valuations are rarely excessively overstated. 

What Would Happen If Appraisers Are Defined as Fiduciaries? 

If appraisers now are deemed fiduciaries, appraisal costs would increase dramatically. 

Just how much they would increase is impossible to predict, although appraisers we 

asked about this expect it could double or triple the costs, meaning an added $20,000 to 

$60,000 for initial appraisals and about half that or somewhat more for ongoing 

appraisals. This assumes that insurance companies will write these kinds of liability 

policies. Given that this is a new and uncertain market, it is difficult to say just how 

quickly and efficiently this might or might not develop. 

The effects of this are predictable: 
 * Fewer ESOPs would get started, especially in smaller companies. This is especially 

worrisome because these smaller companies are the least likely to provide any kind of 

funded retirement plan for employees, or, indeed, any plan at all. 

 * There would be fewer appraisers available to do ESOP work. That could drive up 

costs further. 

 * Some of the most qualified appraisers told us in an informal survey of experienced 

ESOP appraisers we conducted that they would stop doing ESOP appraisals. Ironically, 

the firms most aware of the fiduciary risks are precisely those with a lot of ESOP 

experience, so more appraisals might get done by less qualified appraisers more willing 

to take the fiduciary risk or not understanding its potential cost. 

 * There would be considerable legal confusion over just who is responsible for the 

errors. If the valuation firm is a fiduciary, then do the ESOP trustees who are supposed to 

have vetted the transaction now have a legitimate defense that they can and should have 

relied on the greater expertise of their co-fiduciaries? Even if cases do not go to trial or 

audit, it seems reasonable to expect that trustees, especially inside trustees, might now 

believe that their role is just to sign off on an appraisal and let the fiduciary responsibility 

rest with the party most responsible for it and the most knowledgeable about how to 

perform the appraisal. 

While the proposed regulations might exclude some poorly qualified and/or conflicted 

appraisers, a desirable end, it would do so at a tremendous cost to retirement security that 

is hard to justify. 

Issues Under Existing Law 

In Mertens v. Hewitt Assocs., 508 U.S. 248 (1993), the Supreme Court defined 

fiduciaries not in formal terms but: 

 in functional terms of control and authority over the plan (see 29 U.S.C. § 

1002(21)(A), thus expanding the universe of persons subject to fiduciary duties--and to 

damages--under § 409(a). Professional service providers such as actuaries become liable 

for damages when they cross the line from advisor to fiduciary; must disgorge assets and 

profits obtained through participation as parties in interest in transactions prohibited by § 

406, and pay related civil penalties, see § 502(i), 29 U.S.C. § 1132(i); and (assuming 

nonfiduciaries can be sued under § 502 (a)(3)) may be enjoined from participating in a 

fiduciary's breaches, compelled to make restitution, and subjected to other equitable 

decrees. All that ERISA has eliminated, on these assumptions, is the common law's joint 

and several liability, for all direct and consequential damages suffered by the plan, on the 

part of persons who had no real power to control what the plan did. Exposure to that sort 

of liability would impose high insurance costs upon persons who regularly deal with and 

offer advice to ERISA plans, and hence upon ERISA plans themselves. There is, in other 

words, a "tension between the primary [ERISA] goal of benefitting employees and the 

subsidiary goal of containing pension costs." Alessi v. Raybestos Manhattan, Inc., 451 

U.S. 504, 515 (1981); see also Russell, 473 U. S., at 148, n. 17. We will not attempt to 

adjust the balance between those competing goals that the text adopted by Congress has 

struck. 
The court here is thus supporting the argument that a balance must be struck between the 

costs fiduciary status would impose on providers and the benefits it would provide, 

coming down on the side of non-fiduciary status for providers unless they exercised some 

functional control. With ESOPs, the law already specifically locates that functional 

control with the plan fiduciary or fiduciaries, who can be, and are, sued for failing to 

assure proper valuations. 

On the other hand, the Mertens case does not simply preclude action against plan 

providers. ERISA Section 406(a) specifically refers to transactions in which parties-ininterest may not participate. Federal courts of appeals have unanimously held that ERISA 

Section 502(a)(3) can be used to take action against parties-in-interest in prohibited 

transactions, at least for equitable relief. In those cases where appraisers actually are 

exercising discretion or control with respect to the structuring of an ESOP transaction, 

they already are fiduciaries and are subject to liability for breach of fiduciary duty under 

existing law. 

Under this theory, appraisers could be sued if they have conflicts of interest, addressing 

one of the principal concerns at issue in the proposed regulations. Of course, appraisers 

can also be sued (and have been) by plan trustees, most commonly the successor trustee 

in an ESOP, for simply making faulty appraisals. 

If appraisers are deemed to be fiduciaries, would it not make sense, using this same line 

of argument, to name plan administrators, attorneys, and other advisors fiduciaries as 

well, even if they do not have specific discretionary authority? For instance, there have 

been more ESOP legal cases filed for improper distributions or allocations than for 

appraisals. As with valuations, ESOP trustees often rely on the advice of the plan 

administrators on these issues. If it seems wrong to declare that all administrators are 

fiduciaries, consider that the logic for naming them fiduciaries is the same as for naming 

appraisers as fiduciaries, namely that the ESOP trustee is, in effect, ceding authority to 

them. The same could be said for trustees who follow an attorney's advice on plan design 

and a financial advisor who provides a feasibility study. 

A more serious concern may be that the courts routinely reject the proposed valuation 

regulations as law or guidance. Naming appraisers as fiduciaries could make it even 

harder to sue than suing untrained fiduciaries relying on their experts' reports and advice. 

An appraiser's own judgment will be the heart of the case, and the "range of value" will 

be a pure judgment call. Competing experts will go head to head. DOL experts could 

have a hard time testifying based upon "their experience as fiduciaries" (which is the 

standard for an expert to testify) as to what they would have done in such a transaction. 

The pool of ESOP appraisers will also be shallower, so the DOL will have even fewer 

qualified experts (appraisers who have acted as fiduciaries) to draw from. 

Alternative Remedies 

While deeming appraisers to be fiduciaries seems then an excessively blunt tool to solve 

the problem, we acknowledge that there is a problem in some cases, and it does make 

sense to address it. 
In our own work, we have tried to do this by helping ESOP trustees and other fiduciaries 

understand just what their legal responsibilities are by providing substantial educational 

material and meetings at which we outline these responsibilities in detail. We also advise 

people at every opportunity that their appraisal firms should have substantial ESOP 

experience and have no other financial relationship of any kind with the firm. 

The DOL could take several steps that would prove very helpful: 

 1. Issue final ESOP valuation regulations: The DOL here is proposing to ask appraisal 

firms to become fiduciaries, but then, in effect, telling them there are no clearly 

articulated standards for determining fair market value. This seems unreasonable. If there 

were regulations, ESOP trustees and other fiduciaries would have a much clearer sense of 

what to look for in a valuation, and ESOP appraisers would have clear standards to 

follow. 

 2. Provide regulatory guidance on what "independence" means: Current law requires 

that appraisers be independent, but this term has never been specifically defined. There is 

some question of whether this means the appraisal firm can do other work for the 

company, such as financial modeling, that may make it easier to do an appraisal. There 

are good arguments on either side of this, but we have not seen this be a significant 

problem. More troublesome is a situation where the appraisal firm or a firm associated 

with the appraisal firm would gain from a higher-than-justified price when the ESOP 

buys stock from a seller because a lower price could mean the company chooses not to do 

an ESOP. Setting a clear demarcation of independence for initial transactions, then could 

be a useful step. The ESOP Association asked for such guidance some years ago, but 

there has been no response. 

 3. Require that employer stock appraisers be credentialed by a professional appraisal 

organization: Consideration should be given to whether this requirement should specify 

that employer stock appraisers have professional training related to employer stock 

appraisals. For instance, the American Society of Appraisers (ASA), the Institute of 

Business Appraisers (IBA), the National Association of Certified Valuation Analysts 

(NACVA), and the American Institute of Certified Public Accountants (AICPA) all 

provide rigorous coursework, demonstration report submission review procedures, and 

proctored testing for business valuation credentials. 

 Each of the above-mentioned organizations has adopted professional business 

valuation standards. Among these professional valuation standards, the American 

Institute of Certified Public Accountants (the largest of these organizations) has adopted 

and issued a Statement of Standards on Valuation Standard No. 1: Valuation of a 

Business, Business Ownership Interest, Security, or Intangible Asset (SSVS). As SSVS is 

adopted by state accountancy laws, SSVS is already the "law of the land" for 

approximately 500,000 CPAs. However, these SSVS valuation standards are as 

applicable to non-CPAs as they are to CPAs. And SSVS could be adopted for all 

employer stock appraisers. Similarly, the American Society of Appraisers (ASA) has 

developed the ASA Principles of Appraisal Practice and Code of Ethics the ASA 

Business Valuation Standards, and the Uniform Standards of Professional Appraisal 

Practice. The ASA also has an ESOP-specific appraisal track, with a recertification 

program. 
 It may be worth considering requiring an "ESOP valuation certification" from an 

appraisal organization. In the presence of such a requirement, organizations would 

undoubtedly develop programs that DOL could then certify and monitor. 

 4. Set specific standards for fiduciaries with respect to valuation: Rather than creating 

an additional fiduciary with all the problems that arise from that, standards for existing 

fiduciaries could be tightened to require that (1) at least one fiduciary certify in writing 

that he or she has the requisite financial skills to read and understand a valuation report; 

(2) sign an acknowledgement that the fiduciary is responsible for judging the 

appropriateness of the appraisal, not just accepting it because it was performed by an 

appraiser, and (3) sign a statement acknowledging financial liability as a fiduciary. It 

would also be very helpful if the DOL could develop a checklist of issues fiduciaries 

should look for and ask about in responding the appraisal reports. 

 5. Establish an industry-DOL advisory committee to address the problem: The ESOP 

appraisers we spoke or corresponded with universally agree that there are poor appraisals, 

and that this is a problem that needs effective resolution. While this response outlines 

some of the key ideas, an alternative would be to create a council of people in the 

industry and the DOL to evaluate which steps could be taken most effectively. 

Conclusion 

We understand and appreciate the DOL's concern to protect plan participants from 

practices that can be harmful to their retirement security. Our organization was formed 

not to promote employee ownership per se, or try to make sure there are simply more 

employee ownership plans no matter how effective they are, but to do all that we could to 

research and disseminate facts about employee ownership. We believe that the unbiased 

truth will encourage the kind of employee ownership that benefits employees and society. 

It has been our privilege to work with various people at EBSA over the years to provide 

what we believe is objective feedback on plan practices. 

We believe, however, that the remedy proposed here will, in the end, result in less 

retirement security for employees, not more. We believe there are more appropriate steps 

to take. 

We appreciate your consideration of these comments.