Anyone with discretion over the administration or management of an employee stock ownership plan (ESOP) may be a plan fiduciary. That amounts to a legal responsibility to act prudently and solely in the interests of ESOP plan participants.
The most obvious ESOP fiduciary is the ESOP trustee, but they’re not the only individual held accountable for fiduciary oversight of the plan. Plan sponsors, officials, administrators, members of the plan investment committee, and other parties-in-interest may be plan fiduciaries.
The Department of Labor’s (DOL’s) Employee Benefit Security Administration (EBSA) offers the Voluntary Fiduciary Correction Program (VFCP) for fiduciaries to self-correct certain violations, to protect the ESOP’s tax-qualified status—and therefore protect the plan benefit on behalf of participants. Note that the VFCP is not the same program as the Internal Revenue Service’s (IRS’s) VCP (Voluntary Correction Program) for self-correcting tax violations.
Generally, a VFCP-eligible, self-discovered, self-corrected prohibited transaction that is documented as fully addressed and corrected, thus making the plan and participants whole, can avoid penalties.
On the other hand, breaches not covered by the VFCP, or not fully and appropriately corrected using the program, may be subject to significant penalties. In addition, EBSA reserves the right to investigate at any time to determine whether the information provided to the VFCP is true and whether the claimed corrective action was actually taken.
This blog post is not a substitute for qualified legal advice. Consult with trusted advisors and legal counsel upon uncovering or suspecting an issue with any qualified plan.
Common ESOP Fiduciary Compliance Risks
Some of the most frequently corrected violations under the VFCP include prohibited purchases, sales, and exchanges; improper loans; delinquent participant contributions; and improper plan expenses. Covered transactions are listed in detail on the DOL’s website. Here are a few concrete examples of ESOP fiduciary compliance risks:
- Improper valuation of company stock or failure to obtain an independent valuation
- Engaging in prohibited transactions, such as self-dealing or transactions with parties-in-interest
- Incorrect use of 1042 deferral election
- Failure to monitor and manage conflicts of interest
- Inadequate oversight of plan service providers
- Failure to prudently select and monitor investments
- Failure to timely deposit employee contributions or not following the plan's vesting schedule
- Failing to act solely in the interest of ESOP participants and beneficiaries
- Failing to diversify ESOP plan investments
- Failing to pay adequate consideration for ESOP transactions
Who Should Use the VFCP?
Along with the named ESOP trustee, plan fiduciaries can include the plan administrator, any administrative or investment committee, and others. Anyone who may be held liable under ERISA (Employee Retirement Income Security Act of 1974) for fiduciary breach is allowed to “voluntarily apply for relief from enforcement actions,” according to the DOL, as long as they fully comply with the process and satisfy all self-reporting and correction requirements.
To qualify for relief from enforcement actions, individuals using the VFCP must accurately and fully disclose, correct, and document any violations. Applications deemed incomplete or unacceptable by EBSA may be rejected and subject to follow-up enforcement, which can include penalties.
Because compliance is so fundamental to protecting ESOP plan participants, it’s hard to overstate the importance of identifying and correcting violations with the utmost urgency. The DOL created the VFCP in response to requests from those in the employee benefits field, and claims that it has been a success in helping simplify fiduciaries’ path to compliance.
Any fiduciary of any plan that is not “Under Investigation” as defined by VFCP may correct any violation listed as eligible under Internal Revenue Code Section 4975(a). Eligible parties who correctly document acceptable correction of a specified violation receive a no-action letter from EBSA.
How the VFCP Works
Applicants or their authorized representatives complete a VFCP application and provide all required supporting documentation. Generally, information submitted documents the violation as well as its acceptable correction.
Generally, corrections typically require an applicant to:
- Conduct a proper valuation of plan assets
- Restore to the plan the principal plus the greater of:
- Lost earnings, starting on the date of the loss and extending to the recovery date, or
- Profits resulting from the use of the principal amount, starting on the date of the loss and extending to the date the profit is realized
- Pay fees and/or appraisal costs associated with correcting the transaction(s) and recalculating participant balances
- Make supplemental distribution payments to former employees, beneficiaries, or alternate payees, and provide proof of the payments
- Submit a signed and dated Penalty of Perjury statement (Any subsequent additions of information need to be accompanied by a signed and dated Penalty of Perjury statement.)
Potential Consequences of Breach of Fiduciary Duty
Plan fiduciaries are always better off approaching the Department of Labor to address problems when they discover them rather than waiting. As undesirable and distressing as it may be to have discovered oneself — and the ESOP — in a position to use the VFCP, the choice not to self-correct is far riskier, and can include:
- Personal liability for losses suffered by ESOP participants and beneficiaries as a result of fiduciary breaches. The fiduciary could have to pay damages, restitution, interest, and legal fees out of their own pocket
- Civil penalties and enforcement actions by the DOL or the IRS for violating ERISA or the tax code. This could escalate to audits, investigations, fines, excise taxes, disqualification of the ESOP, and removal of the fiduciary
- Criminal liability for fraud, theft, embezzlement, or other crimes involving the ESOP assets that could result in imprisonment, fines, and forfeiture of assets
- Private lawsuits by ESOP participants, beneficiaries, or other parties who have an interest in the plan. Claims could include breach of fiduciary duty, breach of contract, negligence, or other causes of action
Minimize ESOP Fiduciary Risk With Expert Support
Fiduciaries should be diligent in reviewing plan documents and operations, as well as working closely with their advisory teams to ensure compliance. As a plan sponsor, it's important for you to understand the terms of your plan and your plan document, so that you can constantly assess whether the administration is being performed correctly.
Who can help? Look to trusted advisors, including:
- CPA firms that offer ESOP consulting, tax preparation, audit, and valuation services
- Advisory firms that offer ESOP feasibility, implementation, restructuring, acquisition, repurchase, and record-keeping services
- Law firms that offer ESOP legal counsel, transaction guidance, fiduciary representation, and litigation defense services
- Valuation firms that offer ESOP valuation, fairness opinion, controversy resolution, and DOL audit response services
Our ESOP consultants, in collaboration with your legal counsel, can help you identify and address compliance issues, and support proper VFCP filing. But the best solution is always prevention, and that means working with experts from the beginning. Our free ESOP Administration Timeline Workbook can also help your teams plan for, and adhere to, filing deadlines for compliance. Click below to download yours today.