Tribune’s ESOP Trustee Violated Its Fiduciary Duties

GreatBanc contended that the ESOP's purchase satisfied the intent of the publicly traded rule. But the court disagreed.
Robert WillensDecember 13, 2010

In a case heard this year entitled Neil v. Zell et al, _F.Supp.2d_ (N.D. Ill. 2010), the transaction at issue relates to the Tribune Corp.’s employee stock ownership plan (ESOP). Specifically, on April 1, 2007, the ESOP purchased from the company 8,928,571 newly issued unregistered Tribune shares for $28 per share. In exchange for the shares, the ESOP gave Tribune a promissory note in the principal amount of $250 million, to be paid over 30 years.

In addition to being unregistered, the shares were subject to a trading limitation. In approving the purchase, GreatBanc Trust Co., the ESOP’s fiduciary, agreed that the shares would be transferable only in certain circumstances, namely: a public offering registered under the Securities Act of 1933; under Rule 144 or 144A of the Securities and Exchange Commission; or some other unspecified legally available means of transfer.

On April 25, 2007, Tribune began a tender offer to repurchase up to 126 million of its publicly traded shares. Following the repurchase, the company merged with the ESOP and all of the Tribune shares not held by the ESOP were retired or cancelled, making the ESOP Tribune’s sole shareholder. As a result, the issue is whether GreatBanc, by agreeing to the initial transfer of stock to the ESOP, violated its fiduciary duties. The court held that it did so violate such duties.

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Readily Tradable
ESOPs are exempt from the Employee Retirement Income Security Act’s (ERISA) bar on the purchase of employer stock as long as the plan meets certain requirements. One is that the stock purchased must satisfy the definition of qualifying employer securities (QES). That is, the securities must be “common stock issued by the employer. . .which is readily tradable on an established securities market.” (See Section 409(l) of the Internal Revenue Code.) As a result, the employer securities purchased by an ESOP must meet the definition of that term in Section 409(l).

In an earlier order, the court suggested that the securities purchased by the ESOP were not readily tradable because although other Tribune stock was available for purchase on the market, the ESOP could not sell its own shares at the time of purchase. GreatBanc argued, however, that even if the shares were not readily tradable when they were acquired by the ESOP on April 1, 2007, they were readily tradable when they were allocated to plan participants on April 1, 2008. The court concluded that this argument is “unsatisfying” because Section 409(l) refers to stock that “is” readily tradable and not to stock that “will be” readily tradable.

GreatBanc urged the court to adopt the Internal Revenue Service reading of readily tradable as meaning publicly traded as defined in Regulation Section 54.4975-7(b)(1)(iv). Under that regulation, publicly traded refers to a security that is either (1) listed on a national securities exchange registered under Section 6 of the Securities Exchange Act of 1934 or (2) quoted on a system sponsored by a national securities association registered under Section 15A(b) of the act.

Accordingly, GreatBanc contended that the ESOP’s purchase satisfied the intent of the publicly traded rule. But the court disagreed and noted that more important than the rule’s intent are its actual requirements, none of which were met by the shares purchased. Thus, the ESOP could not possibly have satisfied the rule’s intent.

Finally, GreatBanc referred to Section 4975(e)(7)(A) of the tax code, which requires that an ESOP be “designed to invest primarily in QES.” Emphasizing the words “designed” and “primarily,” GreatBanc suggested that an ESOP is not required to invest primarily in QES at all times. GreatBanc argued that the ESOP satisfied Section 4975(e)(7)(A) even if the shares were not QES when they were acquired because Tribune “went private” within months of the acquisition. Because the company was taken private, the ESOP’s shares were QES — which the ESOP was designed to hold for a long period of time.

GreatBanc’s reading, the court observed, would treat the requirement that investments be primarily in QES as being aggregated over the life of the plan, rather than as imposed at every single moment of the plan’s life. The court rejected this interpretation. It noted that an aggregation approach is not the most “natural reading” of the statute. Moreover, such an approach would allow a trustee to engage in massive self-dealing for one day, so long as the ESOP held a sufficient amount of QES for every other day of the plan’s life.

In the stock purchase at issue in this case, the ESOP did not acquire any QES; it was not, therefore, designed to invest primarily in QES. The ESOP’s purchase of unregistered stock subject to a trading restriction did not meet the definition of employer security found in Section 409(l). Therefore, in the court’s view, the purchase was a transaction expressly prohibited by ERISA.

Contributor Robert Willens, founder and principal of Robert Willens LLC, writes a weekly tax column for