Stock Plan Cash Holding Suits Tee Up Questions of Funds’ Purpose

A handful of new lawsuits challenging employee stock ownership plans with significant cash holdings could force courts to grapple with the differences between traditional retirement plans and those aimed at giving workers an ownership stake in their companies.

In recent months, several employee-owned companies have been targeted in federal court lawsuits over how they invest the portion of their ESOP assets that isn’t held in company stock. These lawsuits say ESOPs sponsored by Aluminum Precision Products, Pride Mobility Products Corp., Aerotech Inc., and Wilson Electric Services Corp. kept millions of dollars in overly conservative investments like cash equivalents and ultra-short term bonds earning paltry returns ranging between 0.5% and 1.5%.

These low-yield investments—which accounted for between $4 million and $12 million of the relevant plans’ assets—are inappropriate for workers trying to save for retirement, according to the series of cases led by Minneapolis-based law firm Engstrom Lee LLC. These plans lost out on between $3.3 million and $6.9 million because of this investment strategy, the lawsuits say.

ESOPs give workers an avenue for becoming part owners of their companies by allowing them to hold employer stock in individual accounts. Proponents of ESOPs tout them as a way for workers to share in the rewards of their labor while improving employee motivation and retention and combating wealth inequality.

There are about 6,500 ESOPs covering more than 14 million participants as of 2024, according to data from the National Center for Employee Ownership.

Litigation involving ESOPs typically centers on whether workers were forced to overpay for their stake in the company.

The new cases represent a departure from that trend by criticizing plans that hold large amounts of cash-equivalent investments in addition to employer stock. The success of this legal push may turn on whether judges see ESOPs as retirement savings vehicles focused on maximizing returns or as distinct programs primarily concerned with pursuing different goals.

Legitimate Reasons

Attorneys identified several legitimate reasons for an ESOP to have substantial cash holdings.

An ESOP may hold cash to facilitate repurchases of shares held by employees exiting the plan, Lindsey H. Chopin, a principal at Jackson Lewis PC in New Orleans, said. The holdings could also act as a hedge against the rest of the plan, she said.

ESOPs are “innately risky” because of their concentration in a single-stock investment, Chopin said. Having a conservative hedge may be a reasonable strategy when looking at an overall portfolio, she said.

Carl Engstrom, who represents the plaintiffs in these cases, disputed the idea that such an investment strategy could be prudent over the past several years, while investors were navigating high levels of inflation.

“It’s hard to defend a strategy of holding a material amount of assets in cash during that period of time given the rates of return,” Engstrom said. “Losing your purchasing power consistently over time isn’t hedging—that’s actually just losing money.”

‘Very Different Animal’

The lawsuits may be built on a faulty premise, according to some attorneys interviewed by Bloomberg Law.

ESOPs are a “very different animal” than traditional retirement plans and the people running them don’t have the same duty to maximize returns, Rick Pearl, a partner with Faegre Drinker Biddle & Reath LLP in Chicago, said.

ESOPs are commonly misunderstood as retirement plans, Pearl said. While they can be used that way, Congress has been very clear that ESOPs aren’t principally understood as retirement plans, according to Pearl.

“Congress knew full well that an ESOP wasn’t diversified, that it can be very risky, and that there will be ebbs and flows in stock price over time,” Pearl said. “This wasn’t meant to replace 401(k)s or pension plans; this was meant as something totally different.”

ESOPs are unique and not solely intended to guarantee retirement benefits, and they impose greater risks on workers’ assets than a typical diversified retirement plan by their very nature, José M. Jara, counsel for Fox Rothschild LLP in Morristown, N.J., said.

But ESOP managers still have a responsibility to think about the best interests of their participants, Engstrom said.

“Folks running ESOPs need to embrace the same ideology of fiduciary plan management in terms of both prudence and loyalty and ultimately thinking single-mindedly about what is the best way to help employees reach their goals in managing these plans,” he said.

Context Key

One key factor in how the cases fare may be the type of effort spent informing judges about the differences between ESOPs and traditional 401(k) plans, which are frequently challenged in court for their investment decisions and fees.

Judges accustomed to seeing 401(k) litigation may need more information about how ESOPs are fundamentally different and not subject to the same fiduciary obligations, said Pearl, who typically represents benefit plan sponsors and isn’t involved in these cases.

“My sense is that judges may need extra statutory help in understanding how to apply ERISA to a particular plan or particular situation, and these cases are no different,” he said.