-----Original Message----- 

From: Skip Heffernan [mailto:sheffernan@mac.com] 

Sent: Wednesday, January 05, 2011 11:17 AM 

To: EBSA, E-ORI - EBSA 

Cc: Cindy Cerro; Jeff Gackstatter; Ken Clark; Sid Scott 

Subject: Definition of Fiduciary Proposed Rule 

My company, Total Water has been 100% employee owned ESOP since 2003. 

It is a great benefit to all the employees. Current proposed 

regulations for making appraisers fiduciaries would make companies like 

ours unable to become ESOPs because of the cost and legal risks. We 

agree with the attached summary from the National Center for Employee 

Ownership on this issue. 

Thanks, 

Skip Heffernan 

President 

Total Water Treatment Systems, Inc. 

Madison, WI 

sheffernan@mac.com 

608-516-0372 cell 
1 

The National Center for Employee Ownership

1736 Franklin St., 8th Floor, Oakland, CA 94612 

Phone (510) 208-1300; Fax (510) 272-9510

E-mail customerservice@nceo.org

Web www.nceo.org

Response to Department of Labor Proposal to Include ESOP 

Appraisers as Fiduciaries

Corey Rosen, Executive Director of the National Center for Employee Ownership 

crosen@nceo.org, 510-208-1314, www.nceo.org 

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: 
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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 broad-based 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. 
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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.

1

 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

 

1

 The Bureau of Labor Statistics reports that 47% of U.S. companies offer any type of defined contribution 

retirement plan. See http://www.bls.gov/ncs/ebs/benefits/2009/ownership/private/table01a.htm. 
4 

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 companyfunded 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. 
5 

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: 

u 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. 

u There would be fewer appraisers available to do ESOP work. That could drive up costs further. 

u 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. 

u 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 
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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 nonfiduciary 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-in-interest 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.2

 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 thesplan 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. 

 

2 See Herman v. SC Nat'l Bank, 140 F 3d 1413 (11th Cir 1998); Reich v. Stangl, 73 F 3d 1027, 1030-34 

(10th Cir); Landwher v. Dupree, 72 F 3d 726 (9th Cir 1995); Reich v. Compton, 57 F 3d 270 (3d Cir 

1995); and Reich v. Rowe, 20 F 3d 25 (1st Cir 1994). 
7 

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-thanjustified 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. 
8 

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.