Before President Donald Trump’s January executive order freezing all regulatory action, the Department of Labor issued long-awaited proposed guidance for employee stock ownership plans seeking to rely on an ERISA-prohibited transaction exemption.
While the Biden-era guidance remains frozen and has no legal effect, it does offer ESOPs some insight into ESOP transactions that involve private company stock. The proposed rulemaking is the first set of formal guidance in nearly 40 years on how Labor views a proper determination of fair-market value of such stock transactions.
Due to the proposal’s heavy reliance on existing ERISA fiduciary standards, responsible plan fiduciaries may wish to consider the now-withdrawn guidance for determining best practices whenever engaging in purchases or sales of private company stock.
This development could be relevant to any estate planners or wealth advisors who work with business owners.
ESOP Fair Value Issue: Background
ESOPs are generally protected under the ERISA-prohibited transaction rules when they purchase private company stock only if the ESOP pays no more than adequate consideration for the stock. “Adequate consideration” is defined under ERISA as the fair-market value of the asset, as determined by the trustee or fiduciary under the terms of the plan in good faith, in accordance with regulations from Labor.
The department, however, has never finalized regulations on point. The closest that Labor came was a set of proposed regulations released in 1988.
The Secure 2.0 Act’s employee ownership provision provided that Labor develop standards and procedures to establish good-faith, fair-market valuation standards for ESOPs that acquire shares of a business.
In January 2025, Labor withdrew the 1988 proposed regulation and replaced it with a proposal that contained a two-part test that would have applied to purchases and sales of private company stock by ESOPs. Under the proposal, ESOP fiduciaries would be required to determine the fair-market value of the stock and use a good-faith process, based on ERISA fiduciary standards, in arriving at the fair-market value.
DOL’s Proposed Two-Part Test
The price of private company stock acquired by an ESOP must reflect the fair-market value of that stock. Pursuant to the DOL proposal, that value must be based on objective factors, rather than circumstances distinct to any particular investor.
The ESOP must consider the purchase as though made on a cash basis (or cash equivalent), disregarding the terms of any debt financing being used to purchase the stock. The fair-market value must be determined as of the date of the transaction, considering all information that is known, or reasonably obtainable, about the stock.
In making their determination, the ESOP fiduciary must use a good-faith process that includes selecting a qualified independent valuation appraiser and overseeing a valuation report that reflects current and accurate information about the transaction and the ESOP sponsor. The fiduciary must exercise fiduciary judgment to ensure that the valuation report is suitable to rely on as a basis for determining the fair-market value of the stock. At all stages in the valuation process, a prudent person standard applies.
Assuming that the ESOP follows the two-part test, the prohibited transaction rules would protect the ESOP if it made a good-faith effort to determine fair-market valuation while the seller of the private company stock provided misleading or incomplete information.
Labor emphasized the potential for abuse in ESOP transactions, highlighting many ERISA violations in its analysis of ESOP transactions over a 20-year period. Those violations include situations where an ESOP paid for a controlling interest in a business yet did not receive such interest, hired biased appraisers, relied on non-comparable companies as valuation benchmarks or disregarded pre-existing debt when determining valuation.
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