ESOPs and Investing Non-Employer Stock Assets 

When it comes to Employee Stock Ownership Plans (ESOPs), much of the focus tends to be on employer stock. However, fiduciary responsibility extends beyond just managing these shares. It also includes the “Other Investments” account within the ESOP, which can significantly impact the financial wellbeing of plan participants.

The importance of fiduciary duty cannot be overstated.

Recent litigation

As seen in recent litigation, the management of Other Investments is crucial. In a Pennsylvania case, participants of an ESOP have alleged that the trustees’ overly conservative investment strategy resulted in significantly lower returns. This case underscores the need for ESOP fiduciaries to act in the best interest of participants, ensuring that investments are both prudent and aligned with long-term financial goals.

Why Would an ESOP Have Other Investments?

ESOPs may accumulate Other Investments for several reasons:

• Accumulation of S-Corp Distributions / Dividends: ESOPs in S-corporations may receive distributions or dividends, which can be reinvested into various assets.
• Repurchase Obligation Reserve: A portion of the reserve for repurchasing shares from departing participants is often held within the ESOP.
• Exceeding Targeted Benefit Levels: Sometimes, the targeted benefit levels may exceed distributions, necessitating the accumulation of additional investments.
• Reducing Stock Held by Former Participants: To manage the stock repurchase obligations and reduce the stock held by former participants, ESOPs may invest in other assets.

The Uniqueness of ESOP Investment Strategies

Each ESOP is unique, and there is no one-size-fits-all solution for investing the Other Investments account. The strategy should be tailored to the specific circumstances of the ESOP, considering factors such as the following:

• Size of Other Investments: The larger the Other Investments, the more critical it is to have a well-defined investment strategy.
• Percentage of Participant Accounts: When Other Investments make up a significant portion of participant accounts, careful management becomes even more important.
• Composition of Participant Holdings: If some participants only hold Other Investments, it’s crucial to ensure these assets are managed effectively.
• Long-Term Holdings: Anticipating that Other Investments will remain in the ESOP for a long period calls for a robust and strategic investment plan.

Action Items for ESOP Fiduciaries

To ensure that these investments are managed effectively and in the best interest of participants, ESOP fiduciaries should consider the following actions:

• Hiring an Investment Advisor: Engaging a professional investment advisor can provide expert guidance and help develop a sound investment strategy tailored to the ESOP’s unique needs.
• Creating an Investment Policy Statement (IPS): An IPS is a critical document that outlines the investment strategy, objectives, and guidelines for managing the ESOP’s Other Investments. It ensures consistency and provides a clear framework for decision-making.

Effective management of Other Investments within an ESOP is important for protecting participants’ financial futures and fulfilling fiduciary duties. Recent litigation further highlights the risks of an overly conservative investment approach and the importance of aligning investment strategies with the best interests of participants. By understanding the unique needs of their ESOP and implementing a prudent investment process, fiduciaries can help their participants towards the path to a secure retirement.

Conrad Siegel is an employee benefit consulting firm that provides consulting services for ESOPs and retirement plan investments.

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