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

From: John Menke [mailto:JMenke@MENKE.com] 

Sent: Wednesday, January 19, 2011 11:28 PM 

To: EBSA, E-ORI - EBSA 

Subject: FW: Definition of Fiduciary Proposed Rule 

Menke & Associates, Inc. is a consulting firm that specializes in the 

design and installation of ESOPs. Based upon our 35 years of experience 

in designing and installing ESOPs for privately held firms, we believe 

that the proposed rule is unworkable. We understand the need to 

clarify the respective duties and responsibilities that apply to ESOP 

fiduciaries and to ESOP appraisers. However, we believe that the 

proposed rule violates certain fundamental principles of trust law. 

That said, we do believe that the proposed rule can be modified to 

accomplish your objectives without violating long established 

principles of trust law. 

The Department of Labor's proposed rules defining adequate 

consideration (29 C.F.R. §2510.3-18) make it clear that while a 

fiduciary may act pursuant to the report of an independent appraiser, 

the fiduciary bears the ultimate responsibility to make a prudent 

decision. 

Similarly, the courts have uniformly held that the fiduciary bears the 

ultimate responsibility despite relying on the advice of outside 

experts. See Howard v. Shay, 100 F.3d 1484 (9th Cir. 1996), cert. 

denied, 520 U.S. 1227 (1997) (a fiduciary "is required to make an 

honest, objective effort to read the valuation, understand it, and 

question the methods and assumptions that do not make sense"); Donovan 

v. Mazzola, 716 F.2d 1226, 1234 (9th Cir. 1983) (counsel's asserted 

advice that expenditure was prudent does not immunize trustees); 

Katsaros v. Cody, 744 F.2d 270, 279 (2d Cir), cert denied, 469 U.S. 

1072 (1984); Donovan v. Cunningham, 716 F.2d 1455, 1474 (5th Cir. 1983) 

(fiduciaries may rely on appraisal but it "is not a magic wand"; 

fiduciaries bear responsibility for assuring that appraisals are 

complete and up to date), cert. denied, 467 U.S. 12511 (1984); Thompson 

v. Avondale Indus., Inc., 29 EBC 2865 (E.D. La. 2003); Reich v. Valley 

Nat'l Bank of Arizona, 837 F. supp. 1259 (S.D.N.Y. 1993); Andrade v. 

Parsons Corp., 12 EBC 1954 (C.D. Cal. 1990), aff'd 1992 U.S. App. LEXIS 

18220 (9th Cir. 1992); Whitfield v. Cohen, 682 F. Supp. 188, 194 

(S.D.N.Y. 1988); Donovan v. Walton, 609 F. Supp. 1221, 1227 n.10 

(S.D. Fla. 1985); Donovan v. Tricario, 5 EBC 2057,2064 (S.D. Fla. 

1984); Davidson v. Cook, 567 F. Supp. 225, 236 (E.D. Va. 1983), aff'd 

mem., 734 F.2d 10 (4th Cir), cert. denied, 469 U.S. 899 (1984). 

In the ESOP arena, many owners of privately-held firms have been able 

to avoid personal fiduciary liability by appointing an "independent 

fiduciary" who assumes complete fiduciary responsibility and liability 

for approving and executing specific transactions that involve the 

purchase of company stock by an ESOP or the sale of company stock by an 

ESOP. The independent fiduciary in these situations discharges his 

fiduciary responsibility by (1) conducting his or her own due diligence 

investigations, (2) obtaining an adequate consideration report (and in 

some cases a fairness opinion) from an independent appraiser, and (3) 
by reviewing the adequate consideration report (and the fairness 

opinion, if any) to determine (a) the reasonableness of the 

assumptions, (b) the correctness of the methodology, and (c) the 

reasonableness of the final conclusion. 

The proposed rule would obviate this procedure. The proposed rule 

would treat the independent appraiser as an ERISA fiduciary. 

Accordingly, the so called independent fiduciary would be entitled to 

rely upon the "expert" fiduciary, and the independent fiduciary would 

seldom if ever be held liable for a breach of fiduciary duties. The 

result would be the opposite of what is intended. The independent 

fiduciary would provide less due diligence and less oversight than 

exists under the current procedures. 

Changing the existing rule in those cases where the ESOP has appointed 

an independent fiduciary would also overrule a long line of cases in 

which the courts have held that "a fiduciary is a person who exercise 

any power of control, management or disposition with respect to monies 

or other property of an employee benefit fund, or has the authority or 

responsibility to do so." Farm King Supply v. Edward D. Jones & Co., 

884 F.2d 288, 292 (7th Fir. 1989), citing Forys v. United Food & 

Commercial Worker's International Union, 829 F.2d 603, 607 (7th Cir. 

1987). Under these cases, a showing of authority or control requires 

"actual decision-making power" rather than the type of influence that a 

professional advisor may have with respect to decisions to be made by 

the trustees or fiduciaries that it advises. Id.; Pappas v. Buck 

Consultants, Inc., 923 F.2d at 535; Laborers' Pension Fund v. Arnold, 

2001 WL 197634, at *3-5 (N.D.ILL Feb. 27, 2001). The application of 

the proposed rule in those cases where the ESOP has appointed an 

independent fiduciary would make the ESOP appraiser liable as an ERISA 

fiduciary even though the ESOP appraiser is not the person who 

exercises the power to negotiate and execute the transaction. The 

application of the proposed rule in these situations would be both 

unfair and unnecessary. 

To the extent that there have been abuses of the valuation process, it 

occurs in those cases where the ESOP fiduciaries consists of 

individuals rather than institutional trustees or independent 

fiduciaries. Common law principles going back to the reign of Edward 

III (1327 -1377) allow any individual to act as a fiduciary, provided 

that the individual is competent and does not have a criminal record. 

In some cases, however, individual fiduciaries are not fully qualified 

to review an appraisal report to determine the reasonableness of the 

assumptions and the correctness of the methodology. 

The solution is not to mandate that all fiduciaries must be 

institutional trustees or that all ESOP appraisers must be deemed to be 

ERISA fiduciaries. Rather, the solution may be to require that the 

appraisal report must be "audited" by an independent CPA firm in all 

cases where the ESOP fiduciary is neither an institutional trustee nor 

an independent fiduciary. This rule would be similar to the existing 

IRS requirement that all qualified plans must be audited by an 

independent CPA firm if the plan has more than 100 participants. 

Granted, implementation of this rule would add to the cost of 

maintaining an ESOP in those cases where the ESOP does not have an 

institutional trustee or an independent fiduciary. However, this cost 

would be relatively nominal, and would be far less than the costs that 
would be incurred if all ESOPs were required to have an institutional 

trustee or if all ESOP appraisers were deemed to be ERISA fiduciaries. 

Further, requiring that the appraisal report be reviewed by an 

independent CPA firm is far more likely to prevent fraudulent 

valuations and erroneous valuations than would be the case if ESOP 

appraisers were merely put on notice that they may potentially be held 

liable as an ERISA fiduciary. 

In summary, we believe that any rule that proposes to shift the primary 

fiduciary liability to the ESOP appraiser regardless of the appraiser's 

actual decision-making authority is unfair and unworkable. What is 

needed instead is a rule that follows existing case law in holding the 

person with the actual decision-making authority liable as an ERISA 

fiduciary, but adds the additional requirement that all individual 

fiduciaries must secure an outside CPA audit of the appraisal report 

before making their final decision. We believe that implementation of 

this requirement will eliminate almost all of the abuses and mistakes 

that the DOL has observed in reviewing ESOP appraisals, and it will do 

so without subjecting ESOP appraisers, most of whom are competent and 

conscientious, to undue risk and liability as ERISA fiduciaries. 

Lastly, it should be noted that any question of divided loyalties on 

the part of an ESOP appraiser has already been addressed in the 1988 

DOL proposed rules defining adequate consideration as follows: 

"It should be noted that, under these proposed provisions, an appraiser 

will be considered independent of all parties to a transaction (other 

than the plan) only if a plan fiduciary has chosen the appraiser and 

has the right to terminate that appointment, and the plan is thereby 

established as the appraiser's client. Absent such circumstances, the 

appraiser may be unable to be completely neutral in the exercise of his 

function." 

Under this provision, an ESOP appraiser is already charged with the 

fiduciary duty to provide his client, the ESOP fiduciary, with a 

professional valuation report that is the product of proper due 

diligence and the application of correct methodologies to the known 

facts and to reasonable assumptions. If the ESOP appraiser fails to 

discharge his duties to his client in a professional and competent 

manner, he can and should be held fully liable for professional 

negligence and/or professional malpractice in a state court action in 

the state where he resides or where he performs his services. An 

action for professional malpractice is not something, however, that 

should come under federal jurisdiction or under the jurisdiction of the 

DOL. Conversely, if the appraisal report is properly prepared and the 

appraiser also renders an opinion that the terms of the transaction are 

fair (but not necessarily ideal) to the participants, the ESOP 

appraiser should not be held liable as an ERISA fiduciary if the 

subject company later turns out to be a poor investment. Whether or 

not an investment subsequently turns out to be a good investment or a 

poor investment turns upon many factors other than price and terms. 

The ESOP fiduciary is responsible for making the actual investment 

decision on behalf of the ESOP. Since the ESOP appraiser has no say in 

the final investment making decision, the ESOP appraiser should not be 

held liable as an ERISA fiduciary. To say otherwise would be 

tantamount to saying that the ESOP appraiser is always the true 

fiduciary and that the plan fiduciary is nothing more than a directed 
fiduciary who may have secondary liability but never the primary 

liability. Clearly such a rule would violate fundamental principles of 

trust law and would be unworkable. 

Very truly yours, 

John D. Menke 

President & CEO 

Menke & Associates, Inc. 

(415) 362-5200 Phone 

(415) 398-2260 Fax 

jmenke@menke.com