An Employee Stock Ownership Plan is an employee benefit plan recognized under federal law. An ESOP provides employees with "beneficial" title to stock in the corporation where they are employed. Such stock is held in trust, with the "legal" title held by one or more trustees, who are typically executives of the corporate employer.
In reality an ESOP is usually a way for a "privately held" corporation to raise capital while shifting risks of such financing from corporate executives to employees. The stock of a "privately held" corporation is not traded on a public exchange--typically only a handful of current and former corporate executives own any shares. If the company needs or wants a sizable influx of capital, the company may need to pledge its stock as collateral for a loan. Corporate executives can decide to spread the risk of encumbered corporate stock from themselves to their employees by creating an ESOP. They obtain the loan with corporate stock as collateral, and the employees become the proud owners, wholly or in part, of the company where they work. But their newly acquired stock is mortgaged. Whether it will ever be worth its assessed value will depend on the success of the business plan and circumstances that prompted the loan.
Despite their new status as beneficial shareholders, the employees won't get to exercise any authority over corporate business directly; their shares will be voted for such purposes by the individuals, typically a corporate committee, designated for such decisions of the ESOP. Here's where it gets tricky: While voting those shares of stock on corporate decisions, or while otherwise monitoring corporate decisions on behalf of the ESOP, the ESOP committee is acting as a "fiduciary" of the shareholder employees. That is, they have a legal duty to look out for the best interests of the shareholder employees. So, what if those ESOP decision-makers are corporate insiders, deciding the amount of their own executive compensation to be paid by the corporation? From a legal standpoint, they have created a situation where they are fiduciaries with a "conflict of interest" between themselves and the shareholder employees--their unbridled discretion as to how much they themselves will be compensated directly affects the corporate balance sheet, which in turn affects the value of the ESOP assets, the corporate stock. The more they pay themselves, the worse the corporate balance sheet. Any lawyer with any experience in advising fiduciaries would tell them that's a really bad idea. Nonetheless, as long as the company appears to be doing reasonably well and the conflicted fiduciaries resist the temptation of grossly hogging the corporate trough, the conflict of interest will probably go unnoticed.
But if they do hog the corporate trough in relationship to the overall financial health of the corporation, it gets very interesting. A federal court recently concluded that corporate decisions regarding executive compensation by conflicted ESOP fiduciaries that effectively imperiled the value of corporate stock amounted to a form of "plan administration" for purposes of the fiduciary duties under ERISA, the federal statute governing employee benefit plans. A prior decision by another federal appeals court held that such corporate decisions concerning executive compensation did not, in and of themselves, amount to "plan administration," but ESOP decision-makers nonetheless had a fiduciary duty under ERISA to make sure the ESOP shareholders weren't getting fleeced by corporate insiders. Under that view, allowing excessive executive compensation to go unchallenged could amount to a breach of fiduciary duty, even if the ESOP trustees' fiduciary duty would effectively require them to sue themselves to replenish corporate assets! (That's why an attorney experienced in fiduciary matters would have warned them that the conflict of interest was a bad idea.) More generally, state courts have held that ESOP shareholders have the same rights as typical corporate shareholders to call for an "accounting" of corporate assets to examine matters of corporate governance such as executive compensation.
With executive compensation within some companies being ridiculously excessive in light of the overall financial difficulties of the companies, complex legal issues implicated by executive compensation within the context of ESOPs will continue to be the subject of substantial litigation.
