ESOPs Fables: Why OTC Markets Is Trying To Make It Easier For Employees To Own Stock In Their Companies

We all know how unprepared Americans are as a whole are for retirement. Just google “retirement crisis.” The statistics are ugly.

There are too many reasons to list as reasons why many Americans do not have enough money saved for retirement. Stagnant wages coupled with rising life expectancies, healthcare costs, tuition costs, and housing costs all surely contribute. But, the bottom line is that too many retirees and soon-to-be retirees simply have not accumulated the assets they need.

If you break down that problem—the lack of long-term asset accumulation—there’s good news and bad news. The good news is that companies have the tools to solve this problem. The bad news is that not everyone has equal access to these benefits.

There are three common employee benefits that allow for asset accumulation:

• Pension plans, in which employers contribute to a centrally managed fund
• 401(k)s, in which employees contribute to funds of their choosing
• Employee Stock Ownership Plans, or ESOPs, in which employers form a trust allowing employees to purchase company stock, which is then held in a retirement account

Private sector pension plans have fallen by half since the early ’90s, with only about 4% of private-sector workers having access to a pension today. While pension plans seem unlikely to make a comeback in the private sector, they are at least still common practice in public sector jobs. (And even pensions that are underfunded can be covered by the Pension Benefit Guaranty Corporation.)

The Pew Charitable Trusts found that 35% of private-sector workers over the age of 22 don’t work for a company that offers a 401(k). But a new Department of Labor rule is bent on improving that.

Employee stock ownership, on the other hand, has not had as much institutional support.

As of 2016, the most recent year for which data is available, there were only 6,624 ESOPs in the United States, according to the National Center for Employee Ownership. These plans cover approximately 14.2 million participants, 10.6 million of whom are currently employed and covered by an ESOP. (For context, as of August 2019 there were 132.16 million full-time employees in the United States, according to the Bureau of Labor Statistics.)

One of the biggest reasons for the lack of available ESOPs is the regulation currently in place.

Outdated Regulations

Like their 401(k) counterparts, ESOPs are significantly more common in larger companies. But while the Department of Labor has recently taken steps to widen access to 401(k)s among smaller companies, the same cannot be said for ESOPs.

This is because current regulations significantly restrict the ability of many small public companies that do not trade on an exchange to offer ESOPs to their employees. These restrictions stem from whether the company’s securities are traded on an “established securities market”.

According to the current IRS regulations, a company can only use its public trading price to offer an ESOP if its stock is traded on an “established securities market”, allowing the company to peg the value of their stock’s price to the value of the stock offered to employees. However, the decades-old definition of “established securities market” for ESOP purposes includes only national securities exchanges (such as the Nasdaq and New York Stock Exchange).

Securities of non-exchange-traded companies—like the more than 600 U.S.-based companies with securities that trade on the OTCQX and OTCQB markets and collectively employ over 100,000 workers—do not fall into this category. Despite having a public price that is recognized for accounting and financing purposes, these companies are forced to treat their stock as “private.” For a private company to offer an ESOP, it must undergo an independent annual private valuation to determine the value of its stock, as well as offer a put option to all employee participants—obligating the company to repurchase employee stock upon request.

This poses a significant challenge for smaller companies who don’t necessarily have the capital to buy back their own stock or fund an independent appraisal every year.

A Win-Win Benefit

From an employee point of view, ESOPs can be a crucial method of funding retirement.

A study from Inequality.org found that employees with ESOPs get paid more, have 2.2x the retirement assets, and are less likely to be laid off. And companies that offer ESOPs see an increase in revenue, stock price, and sales per employee, according to The ESOP Association.

“Employee ownership is a key tool in combating income inequality and supporting small company growth. We are actively working with lawmakers to introduce meaningful ESOP legislation,” said Cass Sanford, associate general counsel at OTC Markets Group. “Making this small fix would give small company employees across the U.S. the opportunity to participate in corporate wealth generation and save for retirement.”

The question now is whether regulators will modernize their nearly decades-old language and open up this opportunity to more workers.

OTC Markets is a content partner of Benzinga

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