In a ROBS redemption, shares must be priced in accordance with a written Opinion of Value prepared by a professional appraiser. Redeeming any shares at a different value, whether inside or outside the plan, violates the ERISA requirement that the shares be redeemed at fair market value (“FMV”). Ignoring the appraised FMV would jeopardize the ROBS exemption from the prohibited transaction (“PT”) rules, under ERISA section 408(e); and it could also be a breach of fiduciary duty by the plan trustees under ERISA.
The consequences for the PT would be the requirement that the transaction be reversed, and that a 15% excise tax be reported and paid on the amount involved in the PT. In this case, the amount involved would be the difference between the FMV (appraised) value and the actual price paid. As anyone who has prepared excise tax reporting knows, the amount involved, and the excise tax, will quickly grow over time until the PT is corrected and reported, which may result in painfully high excise taxes.
As for the fiduciary breach, it’s not clear how exactly the Department of Labor might enforce a finding of this particular breach of fiduciary duty under ERISA, but one possibility would be requiring the plan trustees to foot the bill for correction, and to pay the excise tax, out of their own pockets.
The ERISA policy behind the FMV rule is to ensure that the plan shareholder is treated fairly alongside other shareholders. It seems straightforward, but situations may arise that tempt the plan fiduciaries to permit a ROBS redemption at a lower price, or sometimes even a higher price, than FMV.
A common scenario in which a corporation might be tempted to use a too-low valuation of shares would be a redemption to remove all of the ROBS stock from the plan. Not surprisingly, the company would like to pay the plan the lowest possible price in the redemption. However, giving into the temptation to redeem at a lower than FMV would be a fiduciary breach and a PT.
But what about redeeming at a price higher than FMV? This desire could arise in a ROBS company with more than one ROBS participant-owner, when the company and one of the participant-owners wish to part ways. A formerly harmonious partnership of ROBS owners, now disrupted, may become emotionally charged. For the sake of getting the soon-to-be-former owner out of the picture as quickly as possible, in the course of negotiations, the parties may be tempted to ignore the FMV appraisal and redeem the departing shares at a higher value. On one hand, this seems like a win for the plan, which would benefit from a higher value than ERISA requires. The harm in this view is that the stock value of the remaining ROBS participant-owners would be diminished after such a redemption, at least temporarily. Even if the parties on both sides of the transaction agree to a value other than FMV, they are not permitted to benefit one plan participant at the expense of others.
Therefore, it is always recommended that the ROBS corporation and participating parties find a way to conduct all transactions in shares at FMV.