Pros and Cons of Internal vs. External ESOP Trustees—Post Enron GreatBanc Trust Company 45 Rockefeller Plaza, Suite 2056 New York, NY Karen Bonn, Vice President (212)

2 Trustee must act:  Solely in the interest of participants and beneficiaries;  For the exclusive purpose of providing benefits and defraying expenses of administering the plan;  With the care, skill, prudence and due diligence, which under the circumstances, a prudent man would act in similar circumstances; and  In accordance with the plan, as long as the plan and trust are consistent with ERISA

3 Prudence Duty  Courts likely to defer to the judgment of an independent and experienced trustee unless the trustee acted in an “arbitrary or capricious” manner  Procedural diligence, not substantive perfection  Avoid acting in an “arbitrary or capricious” manner –Trustee is familiar with plan documents and applicable legal standards –Trustee relies on plan documents and applicable legal standards –Trustee documents diligence, reasoning and decisions

4 Liability for Another Fiduciary  May not delegate fiduciary duties, but plan may allocate duties among separate fiduciaries  Except in “aiding and abetting” situations, fiduciary not liable for breach by co-fiduciary of allocated responsibilities  Knowing participation in, or concealment of, an act or omission known to be a breach  Enabling another fiduciary to breach by breaching one’s own fiduciary duty

5 Liability for Another Fiduciary (cont.)  Knowing of a breach and failing to make reasonable efforts to remedy the breach  Basic principle: silence in the face of a breach is not acceptable - “reasonable efforts” to remedy the breach are required

6 Duties of the Trustee  Analyze proposed transactions  Vote employer securities  Diversification  Annual valuation  Communications

7 Analysis of Proposed Transaction  Independently negotiate price and terms on behalf of participants  Investigate solvency of the corporation  Engage in a diligent, independent investigation  Engage advisors and scrutinize findings

8 Voting Employer Securities  May follow directions to the extent doing so does not violate ERISA  Trustee fiduciary responsibilities may not be delegated  Follow plan document

9 Electing Board of Directors  Review biographies  Interview members  Draft letter to participants requesting direction  Count the vote and report results  Maintain confidentiality

10 Diversification  ESOP trustees not held to same diversification requirements as other plan fiduciaries  Congress carved out an exception for ESOP fiduciaries  Deciding to sell company stock

11 Annual Valuation  Assets of trust must be valued at least annually  Trustee establishes value  Financial Advisor reports to the trustee not the Company

12 Annual Valuation  Examine methodology  Question assumptions  Understand conclusion  High value; low value; FMV

13 Communications  Trustee must keep accurate detailed records  Trustee must submit an annual report to the company  Trustee must prepare and submit Schedule P for Form 5500

14 Directed Fiduciary  Directed by internal ESOP committee  Directions must be “proper”  Overriding ERISA fiduciary duty  Determine whether a conflict of interest exists

15 Recent Developments for Fiduciaries  Amsted Case  Champlain Enterprises Case  Enron Litigation  IRS Audit Guidelines  Department of Labor Interpretive Bulletin

16 Amsted Case  Court states the “the decisions of independent and experienced fiduciaries garner deferential review, while decisions of fiduciaries with a conflict of interest … do not receive such deference”  ESOP trustee was not required to make an independent investigation of acquisition  Court emphasized the extensive monitoring activity taken by the ESOP trustee

17 Amsted Case (cont.)  Ruled that no one would have predicted the unprecedented increase in repurchase obligation resulting from drop in stock price  Acquired company price was determined by auction in an arm’s-length transaction  A mere showing of a drop in FMV of shares of an ESOP is not sufficient to establish imprudence of the ESOP trustee

18 Amsted Case (cont.)  Decision –Court will not substitute its judgment when trustee is independent and experienced –Judicial review of independent trustee is highly deferential –Decision upheld unless independent trustee is found to have acted arbitrary and capricious –ESOP trustee is not responsible for second guessing decisions of management –ESOP trustee continues to have a duty to monitor management to protect the pension benefits of ESOP participants

19 Champlain Enterprises Case  ESOP trustee did not have supporting notes or minutes to verify questions asked and discussions had  ESOP trustee has burden to show that value is determined by the fiduciary “in good fair”  “Focus of the Good Faith inquiry is not on the end – the final product – but on the means – the conduct of the fiduciary is getting to the final product”  Court found that the trustee had little documentation of the actions it had taken

20 Enron Litigation  DOL amicus brief and separate lawsuit against fiduciaries –Duty to disclose vs. duty not to mislead

21 Enron Litigation Lessons  Executives who also serve as plan fiduciaries have dual loyalties and do not have a lesser fiduciary standard –Critical to make it clear when executive is acting in each capacity – greater risk occurs when it is unclear which “hat” executive is wearing –When communicating with participants, dual-hat executives are presumed to act as fiduciaries –Corporate position and inside information is two-edged sword: enhanced expertise is a plus, but non-public information is a burden

22 Enron Litigation Lessons (cont.)  Appointing a fiduciary carries with it the duty to monitor closely the fiduciary’s performance. –Duty to act when appointed fiduciary knows of possible breach –Could include duty to assure that the appointed fiduciary has accurate information on employer’s financial condition –Not a responsibility to carry out appointed fiduciary’s duty but to oversee and perhaps replace appointed fiduciary

23 Enron Litigation Lessons (cont.)  Speaking to participants about the security of their benefits, investment of their plan assets, or company stock as an available investment can cause an executive to be acting as a fiduciary –Discourage executive management from making statements perceived by participants as intended to influence typical participant behaviors (e.g. when and how to contribute, invest, or take a distribution )  A fiduciary has a duty not to mislead plan participants and to correct misleading information from others. –If a fiduciary knows or should know that participants have been given misleading information, silence and inaction constitute breach of duty of loyalty

24 Enron Litigation Lessons (cont.)  A fiduciary has a higher duty to disclose information if necessary for participants to protect their retirement benefits  Information known to fiduciary –Resignation is not sufficient –Not dependent on participant request

25 Enron Litigation Lessons (cont.)  Fiduciaries have a continuing obligation to assure that investment in employer stock is prudent –Duty of prudence overrides plan design requiring investment in employer stock –As with other duties implicating prudence rule, a showing of procedural diligence is critical –Sliding scale for prudence - as “alarms go off, duty to act increases

26 IRS Audit Guidelines  “There would be more credibility to the determination of value if the trustee is truly independent of the employer”  “If the employer appointed his CFO as the ESOP Trustee, we might have concern about the extend to which the owner could exert control over the trustee”  “The employer could use a committee to act on behalf of the ESOP, in which case, it may seem more difficult to influence several people. However, if the committee, contained a senior official who could steer or influence the committee, the employer may be exercising indirect control of its actions”

27 Department of Labor Interpretive Bulletin  A policy that contemplates monitoring of management or corporation in which a plan owns stock is consistent with a fiduciary’s obligation under ERISA  Items to be monitored include executive compensation, mergers and acquisitions, debt financing, etc.