Implications of ASU 2011-4 for sponsors of ESOPs


Conservatism. Consistency. Conformity. These are the big “C’s” of financial reporting. But at a recent conference of employee stock ownership plan (ESOP) sponsors and advisors, another “C” joined the dialogue. That is Controversy, and the subject is fair value. That is not surprising, as the reporting and measurement of fair value in financial statements has been controversial for quite some time and among many parties. This most recent controversy is centered on what was apparently an obscure change in disclosures requirements for fair value. 

FASB Accounting Standard Update (ASU) 2011-4, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs , was issued in an effort to conform U.S. accounting standards to international standards with respect to the definition of and disclosures with respect to fair value. A specific aspect of that project was to provide users of the financial statements with more information and transparency about how value is determined for investments that are not traded in an active public market.  It is that new information that has drawn the attention of the ESOP community.

Among other requirements, the disclosures for nonpublic entities for periods beginning after December 15, 2011, e.g., 2012 calendar year reports, must include a description of the valuation process for the fair value of the sponsor company common stock held by the plan and a table that discloses the valuation methodology, the critical assumptions in that methodology and a quantification of each assumption.  For a hypothetical company with an ESOP, this disclosure (in part) may look something like the following:

Description of Valuation Process (in part): The fair value of the Sponsor Company common stock held by the Plan is valued at fair value based upon an independent appraisal. This appraisal was based upon a combination of the market and income valuation techniques consistent with prior years. The appraiser took into account historical and projected cash flow and net income, return on assets, return on equity, market comparables in earnings and revenue. Plan management has concluded that a market participant would also recognize a discount for lack of marketability.

The valuation process involves the plan fiduciary’s selection of an independent appraiser under a written contract for a term of three years with the right to cancel such contract at any time.  Company management accumulates the data for the appraiser from the audited financial statements of the Company and prepares the models for future growth or profitability expectations.  The appraiser prepares a preliminary report which Company management, along with the ESOP fiduciary, reviews in detail, discusses, modifies, if appropriate and ultimately, approves. The results of this process are documented in minutes of the plan fiduciary.

The following table represents the valuation techniques used to measure fair value, and the significant unobservable inputs and the values of those inputs:


Fair Value

Valuation Technique(s)

Unobservable Input

Rate Applied

Sponsor Company Common Stock


Discounted Cash Flow

Weighted average cost of capital


Long-term revenue growth rate


Long-term pretax operating margin


Discount for lack of marketability


Market Comparables

EBITDA multiple


Revenue multiple


Discount for lack of marketability



It is easy to understand how this satisfies the objective of the fair value disclosures. It provides information to the statement user on the process used by the fiduciary in estimating value and which factors of company performance are relevant to that value. The controversy has arisen because the financial statement of an employee benefit plan that covers 100 or more participants is subject to audit under the Employee Retirement Income Security Act of 1974, and those audited financial statements are uploaded to the Department of Labor’s (DoL) EFAST2 database , which can easily be accessed via the internet by anyone who knows the company name. This means that competitors of this private company, potential acquirers for this company, attorneys looking for potential litigation on the share price, or other potentially adverse parties have unrestricted access to this potentially confidential information. 

This confidentiality issue has prompted the ESOP community to submit a request to the FASB for relief from these requirements. The FASB discussed this request at the March 20th FASB Education Session.  At the meeting, the FASB staff member described the concern that some private companies were having with the potentially confidential nature of this information. Those at the Education Session expressed sympathy with that concern but did not arrive at a proposal to revise the standard to modify these disclosures. Instead, their focus was on the DoL’s web page and whether there was some means to eliminate this information from public view and whether such action would trigger an issue with the auditor’s report, as it applies to the whole filing and not a redacted filing.

The issue was viewed as sufficiently important that it was addressed at the April 10, 2013 meeting of the FASB. At that meeting, they approved the issuance of an Exposure Draft to indefinitely defer the reporting of the quantifiable aspects of the inputs. The ED will be subject to a 30 day comment period. If approved, the last column of the table in the above illustration would be omitted. The suggestion of an indefinite delay was to allow the accounting community to work with the Department of Labor to see if some method could be achieved to mask this potentially confidential information from the general public. In arriving at this position, the FASB members strove to balance the objective of providing sufficient information to the intended users of the financial statements with the conflict created by publicly exposing such information to unintended and possibly adverse parties.

In the interim, plan fiduciaries are facing the looming deadline for the 2012 Form 5500 filing. The possible reporting relief does not eliminate this disclosure. It will merely omit the most controversial element.  Thus, parties responsible for the financial reports of benefit plans holding employer securities must choose a course of action. The following tips may help in planning such course:

1.      The ESOP fiduciary and appraiser should agree on which information would be included in the fair value disclosure table and the description of the valuation process to comply with the applicable reporting framework. This is not the same as what they are willing to disclose. This is the starting point: What is the plan’s process and inputs used for determining stock value?

2.      Company management, the ESOP fiduciary, the ESOP appraiser, the ESOP auditor and ESOP legal counsel should schedule a meeting to discuss the nature and content of the required disclosures. The example given above reflects a relatively straightforward valuation example. These disclosures become more complicated when the value of the company is based upon the fair value of the underlying assets of the company. In that case, the risk of disclosing confidential information is reduced by the complexity of the disclosure. In contrast, a company with a very simple valuation model – such as a multiple of EBITDA times a discount, is more likely to be concerned about the transparency of the financial information it is disclosing. To facilitate the consistent presentation of this information, the plan sponsor may want to suggest that the ESOP appraiser add an “Auditor Section” to the valuation report to address this information and reduce the risk of error.

3.      The ESOP fiduciary should be reviewing these footnotes in detail for consistency with the plan’s operation and effective communication. The discussion of fair value may be in the fair value footnote, but it also may be covered in the general discussion of the plan. It is important that all such disclosures be consistent.

4.      If the concern arises that some of the required disclosure could harm the company and thus, the interests of ESOP participants and beneficiaries, discussion with the fiduciary, legal counsel and plan auditor should include how much information can be disclosed, which elements are challenging, etc.  This risk should be significantly reduced if the Exposure Draft to defer disclosure of the quantitative elements is approved. If the failure to disclose financial information results in the auditor concluding there is a departure from generally accepted accounting principles (GAAP), the fiduciary must recognize that this conclusion would be clearly marked in question 3 of Schedule H of Form 5500. Thus, the DoL is immediately advised of the GAAP departure, is likely to review the financial report, and may reject the filing and impose a fine for the failure to file a complete and accurate Form 5500.

This exercise is likely to be time consuming. The best advice to sponsors of ESOPs or any other employee benefit plan that hold employer securities is to start working on this now.