Internal versus External Trustees Vermont Employee Ownership Center Annual Conference June 10, 2011 PANELISTS: Merri Ash Joe Marx First Bankers Trust Services, Inc. Principal Financial Group 1500 Market Street 5500 Main Street, Suite 304 12th Floor, East Tower Williamsville, NY 14221 Philadelphia, PA (800) 428-2021 x3034 (610) 521-1610 firstname.lastname@example.org email@example.com Dave Fitz-Gerald Carris Reels, Inc. 49 Main Street Proctor, VT 05765 (802) 770-3560 firstname.lastname@example.org 2 ERISA Fiduciary 101 • ERISA Fiduciary Duty Basics – Duty of loyalty – To Act Solely in the Interest of Participants – Exclusive Purpose rule – for the exclusive purpose of providing benefits – Duty of prudence – prudent expert standard (process v. result) – Diversification (ESOP exception--but not from prudence) – Follow plan documents (if not contrary to ERISA) – Avoid Conflicts of Interest • Potential Liability – Personal liability; disgorgement; removal – Co-fiduciary liability – Indemnification – Insurance 3 Potential ESOP Fiduciaries • Plan Sponsor/Board of Directors: appoint/remove other fiduciaries; oversight • Trustee (directed or discretionary): Record owner of shares held by ESOP; acts for “exclusive benefit” of participants; votes shares (but may be directed) • ESOP Committee (if any): interprets plan; reviews claim appeals; may vote shares; may be plan administrator also • Plan Administrator: day-to-day administrative responsibility • Third-Party Administrator (TPA): recordkeeper; nondiscrimination testing; assists Plan Administrator with compliance matters • Accounting Firm: prepares Plan’s financial statements and tax filings • Valuation Firm: annually appraises ESOP shares; may perform valuation of, or financial advisory services for, specific transactions 4 Application of Fiduciary Standards • ESOP stock purchase and/or stock sale transactions – Initial ESOP formation and stock purchase – “Second stage” stock purchase transactions • Fiduciary’s Issues in connection with the Day-to-Day Operations of an ESOP: – Valuation – Voting ESOP stock / Governance Issues – Recordkeeping and Day-to-Day Trust Accounting – Recycling and Repurchase Issues – Duty to monitor fiduciaries and advisors – Conflicts of Interest 5 Trustee Responsibilities I. VALUATION: – Determining Value/stock Price - The Trustee is responsible – What should the Trustee do with the Valuation Report? • Review the Report • Ask questions – Review the approach – Market Approach – Income approach – Asset-based approach 6 Trustee Responsibilities – What should the Trustee do with the Valuation Report (Cont.) • Look over the methodology – How many different methods were used to determine value – Discounted cash flow – Public company comparables – Guideline companies methodology – Capitalized cash flow method – Merger and acquisition method 7 Trustee Responsibilities – Other Valuation-related Information that the Trustee should consider: • Overall solvency of the company • Trends exhibited in the report • Plan Liability versus Fair Market Value • Necessity of the Trustee to discuss issues with management 8 Trustee Responsibilities II. RECORDKEEPING AND DAY-TO-DAY TRUST ACCOUNTING – Payment of the ESOP loan • Notify the Company of pending loan payments due. • Collect the loan payments from the company and make the necessary payments to the bank or back to the company. – All loan payments need to be run through the trust even if the loan is from the company. – Calculate the release of the shares as per the loan documents and make sure that all covenants have not been violated. 9 Trustee Responsibilities – Miscellaneous recordkeeping / Trust Accounting: • Maintain Trust Checking Account • Retain and Maintain Custody of ESOP Stock Certificates • Submit Annual Report and Accounting to Company 10 Trustee Responsibilities – Allocations: • The Trustee serves for the exclusive benefit of the participants and their beneficiaries. The Trustee should check the Allocation Reports to insure that they are correct – Verify the release of shares – Spot check the allocations – Verify the number of shares on the reports to the Trust – Statements for both the allocated and unallocated shares. • Look at the results of the 409(p) test for Sub S ESOPS. Is there a non- allocation year? 11 Trustee Responsibilities – Distributions: • The Trustee makes the distributions to the plan participants as directed by the plan administrator. • The distributions should be verified to the allocation reports before checks are issued. • Prepare the check or stock certificates (if shares are to be paid out). • Compute income tax withholding. Prepare the appropriate tax reporting forms and send withholding timely to the IRS. 12 Trustee Responsibilities III. Voting of ESOP Shares – Voting Pass-Through: Distribute “adequate” Information to Participants to permit an informed vote – Voting Pass-Through: – Confidential Tabulation of Participant Directions on allocated shares and voting in accordance with those directions – How does Trustee vote Unallocated Shares? – How does Trustee Vote Unvoted Shares? – How does Trustee Vote voted but disqualified Shares? – Non-Pass Through Voting: – Trustee votes ESOP Shares on shareholder issues which are not subject to Pass-Through requirements (e.g., Election of Directors) 13 Trustee Responsibilities IV. ESOP Stock Recycling vs. Corporate Stock Repurchase – If the Company purchases distributed ESOP shares, is it a Fiduciary decision? – If the ESOP purchases distributed ESOP shares, is it a Fiduciary decision? – What if Company offers to repurchase ESOP Shares from the ESOP so that the ESOP can distribute cash in lieu of shares? • If stock is sold by the ESOP to the Company, the sale is a party-in- interest transaction and must be done at a fair market value as determined at time of the sale, not as of last annual valuation date. 14 Trustee Responsibilities V. Conflicts of Interest – Officers or directors of sponsor may serve as trustee, plan administrator, or ESOP committee member – Duty to all shareholders as officer/director, but ERISA fiduciary duty is “solely” to and for participants – General: ESOP’s interests may conflict with management’s 15 Trustee Responsibilities V. Conflicts of Interest (Cont.) Conflicts Issue: Conflicts Issue: Conflicts Issue: Value of ESOP Equity “Power” Sharing Stock vs. non-ESOP Compensation Former Owner / Stock Arrangements Current Officers 16 Which Hat is On When a Company Executive or Owner is also the Internal fiduciary, there may be a conflict (duty to stockholders v. duty to plan participants) THINK: In what capacity am I acting in making this decision? 17 Trustee’s Annual ESOP Checklist Note 1: the "Period" represents the time either Before (-) or After (+) First Day of Plan Year to complete the task Note 2: specific due dates are for calendar year end. Dates marked with an " * " are date certain Period Duty Description 1 - 2 mos Distribution Ensure Diversification & RMD Distributions for current & next plan year 2 - 2 mos Investment Engage Valuation Firm 3 - 1 mos Distribution Engage Third Party Administrator 4 31-Jan * Compliance Last day to Prepare and Mail IRS Form 1099-R AND IRS Form 945 5 + 1 mos Distribution Determine Participant Eligibility 6 28-Feb * Compliance Last day to Prepare and Mail IRS Form 1096 7 + 2 mos Distribution Review Share Release Calculation & Allocation 8 + 2 mos Investment Review Financial Statements of underlying Company 9 15-Mar Compliance Last day to Receive Company Contribuiton for prior plan year (unless corporate return is extended) 10 + 3 mos Investment Read Valuation Report & Establish Price 11 + 3 mos Distribution Review Allocation Report & Distribute Participant Statements 12 + 3 mos Compliance Distribute Diversification Notices 12 1-Apr * Compliance Last day for RMD payments to any participant who turned 70&1/2 in prior year 13 + 4 mos Distribution Review & Prepare Participant Distribtuions 14 + 5 mos Corp Governance Review Proposals & Nominated Directors 15 + 5 mos Corp Governance Distribute Proxy Information to Participants 16 + 6 mos Compliance Last day to Execute Diversification Elections 17 + 6 mos Corp Governance Attend Annual Meeting 18 + 6 mos Corp Governance Vote Proxy 19 +7 mos Compliance Last day to file 5500 (can be extended 2&1/2 mos) 20 30-Sep Compliance Last day to Distribute Summary Annual Report (within 2 mos after filing tax return) 21 +10 mos Distribution Review Repurchase Obligation Study 22 23 31-Dec * Compliance Last day for RMD distributions 24 Occasionally Compliance Distribute Summary Plan Discription to new participants 25 Occasionally Corp Governance Review Corporate Actions, Budgets & Plans 26 Occasionally Corp Governance Engage Plan & Trust Legal Advisor 27 Occasionally Custody Collect, Receive and Invest Asset revenues (divs or S-Corp earnings) 28 Occasionally Custody Accept Employer Contribution(s) 29 Occasionally Investment Engage in Assets Purchases or Sales 30 Occasionally Investment Prepare and Process Loan Payments 31 Recurring Compliance Monitor Plan & Trust compliance with apllicable laws & regulations 32 Recurring Custody Hold, Control and Maintain assets 33 Recurring Investment Determine Plan Investment Prudence Premise “Is it possible to put in sufficient safeguards to allow an insider to do a good job of acting as an ESOP trustee?” Many Hats CFO – BOD - Trustee Carris Reels Internal Trustee Perspective More Disciplined Since Majority ‘95 • Training for Trustees • Checklists of Tasks • Scheduled Meetings • Meetings Documented • More than just determining stock value Trustee Meeting Schedule and Checklist Trustees Meetin g# 1 2 2009 2010 Monday 2/16/2009 Monday 2/15/2010 Wednesday 3/11/2009 Wednesday 3/10/2010 Duties 3 Wednesday 5/13/2009 Wednesday 5/12/2010 4 Wednesday 8/12/2009 Wednesday 8/11/2010 5 Wednesday 11/11/2009 Wednesday 11/10/2010 Quarter • Administration Task Task number 1 2 3 4 5 Engage Administrator 1 √ • Review Administration 2 √ Investing Engage Recordkeeper Review Recordkeeper's Allocation Reporting 3 4 √ √ • Statements Distributed 5 √ Diversification Diversification Notice Required Minimum Distributions 6 7 √ √ Eligibility Properly Determined 8 √ • Valuation Distributions Properly Made Engage Attorney 9 10 √ √ Engage Valuation Advisor 11 √ • Oversight Review Valuation Report Determine Stock Value 12 13 √ √ Review Loan Payments to the Bank 14 √ • Exercise Review Reconciliation of Bank Account Review Contributions from Company to Plan Review Nominated Slate of Directors 15 16 17 √ √ √ shareholder Receive Instruction from Steering Committee Attend Annual Shareholder Meeting 18 19 √ √ Review Corporate Actions 20 √ rights Review Corporate Financial Statements Review Corporate Planning 21 22 √ √ √ √ √ √ Confirm Physical Location of Stock Certificates 23 √ Review Plan Documents 24 √ Review Audit 25 √ Engage Auditors 26 √ Filing of IRS form 5500 27 √ Filing of IRS form 1099-Rs and form 1096 28 √ Filing of IRS form 945 29 √ Reevaluated our Trustee Program 2009 - 2010 • Worked with a leading ESOP consultant • Entire ESOP committee was trained in Trustee Duties (25 people) • Researched what other ESOP companies do • Set pre-requisites, training requirements and evaluation procedures Which Has A Higher “Standard”? Board of Directors or Board of Trustees? Trustees Standard “highest known to law” Board of Directors Board of Trustees • “Run” the company • “Run” the trust • Answer to the shareholders • For Benefit of participants • Duty of care, i.e. being • IRS/DOL/ERISA - Government informed • Beyond Prudent • Duty of loyalty, i.e. interest of – with the care, skill, prudence and the company diligence under the circumstances then prevailing • As “appointing fiduciaries,” that a prudent person acting in a Board has a duty under ERISA like capacity and familiar with to monitor the actions of the such maters would use in the ESOP Trustee and, if necessary, conduct of an enterprise of like character and with like aims take corrective action Prudent Person? Who Wants to be Interrogated by the Department Of Labor? Fantasy Fiduciary IDUCIARY Fantasy Trustee Committee? A) 5 Trustees B) 4 Trustees C) 3 Trustees D) 2 Trustees Fantasy Trustee Committee Choice A Fantasy Trustee Committee Choice B Fantasy Trustee Committee Choice C Fantasy Trustee Committee Choice D Reevaluated our Trustee Program Composition Criteria Trustee Selection Structure of Process Position Composition • Minimum 3 Composition Criteria • Maximum 7 • Probably end up at 5 • 1 finance, 1 HR Trustee • + 1-2 “experts” • + 2-3 “non-experts” representation of Selection Structure of Process Position locations Criteria • For “non experts” • HS diploma or GED Composition Criteria • Understand and support the Carris culture • Strong math aptitude • Ability to read and understand Trustee legal documents in English • Ability to understand business dynamics • No felonies? Selection Structure of • Employee owner in good standing Process Position • Must attend ESOP committee meetings Selection Process • Application process Composition Criteria • Subcommittee screens for eligibility • ESOP Committee votes Trustee Selection Structure of Process Position Structure of Position • Annual re-appointment by Board of Directors Composition Criteria • Otherwise, minimum 6 year expectation • ESOP committee reviews Trustee trustees annually, with Board of Directors oversight • 12 hour annual education Selection Structure of requirement Process Position • Stipend Circular Loop Each Has Some Responsibility For The Other ESOP Committee Board of Board of Directors Trustees ESOP Committee Reevaluated our Trustee Program Composition Criteria Trustee Selection Structure of Process Position Even after evolving the role of the trustee over the past 16 years, most people in the company take most of what the trustees do for granted! QUESTIONS?