Mid-Atlantic Chapter ESOP Breakfast Meeting

1. Mid-Atlantic Chapter ESOP Breakfast Meeting Red Hot and Blue ESOP Topics for Chili Weather February 4, 2014

2. Presenters Paul Horn, WorkPlace Consultants, LLC David R. Bogus, ASA, Ellin & Tucker, Chartered Michael R. Holzman, Dickinson, Wright Ben F. Wells, Dinsmore & Shohl, LLP

3. Best ESOP Governance Practices Trustee (or ESOP Committee Directing Outside Trustee) • Annual valuation • Joint engagement letter • Review of draft • Compare w/ prior year assumptions • Meet w/ executives to discuss • Draft to auditor? • Formal adoption

4. Best Governance Practices Annual SH meeting Directed? Pass-thru? Recordation Interaction with BOD Attendance? Minutes? # Meetings? Does % ownership matter? Contributions Checking balance statements / OIA Release of shares 409(p) testing?

5. Best Governance Practices Distributions Is TPA list correct? Diversifications? In accord w/ distribution policy? Thresholds? Delegation Drafting and sending out election forms? Cutting checks and doing tax w/h? Form 945? Issuing 1099-Rs?

6. Best Governance Practices Filings Review Form 5500 Including auditor’s report (if over 100 participants) Plan documents Have latest version plan, SPD, SMM, IRS DL Have stock certificate(s) / updated for share release

7. Wall Street Closes 2013 at Record Highs Standard and Poor’s 500 • Up 29.6% for the Year • Largest gain in 16 years Dow Jones Industrial Average • Up 26.5% for the Year • Largest gain in 18 years

8. Confidence Returns to the Market • Quantitative easing floods the market with cheap cash and buoys asset prices • “U.S. stock surge… driven almost entirely by P/E multiple expansion rather than higher earnings.” -- Goldman Sachs • Boeing (P/E: 24.16) • Price  77% • Earnings  11% • American Express (P/E: 18.59) • Price  48% • Earnings  4.6%

9. Defense and Government Services For 2013, the Government Services stocks were up 58.2%, ahead of the S&P 500 and the NASDAQ, which are up 29.6% and 38.3%, respectively, and ahead of the Defense stocks, which are up 57.2% for the year.

10. Federal IT Services Comparable Analysis

11. Looking Forward Towards 2014 • “The S&P 500 is going to 2014 in 2014” -- Adam Parker, chief U.S. equity strategist at Morgan Stanley • "The economy’s underlying growth rate will accelerate further in 2014 to near +3.5% and risk is growth could be closer to 4%...”– Joseph LaVorgna, chief U.S. Economist at Deutsche Bank • Tailwinds • Inflation • Has ben low due to slow wage growth, excess capacity, and reduced lending activity • Interest Rates • Introduction of Janet Yellen as Chairman of the Fed indicates dovish future policy • Improving Fundamentals • Earnings are projected to improve on the back of economic growth • Risks • European Rebound • Fiscal Policy Uncertainty • Emerging Markets

12. Vetting Client Projections • Vetting by valuation firm • Understanding how they were developed by management • Options when management does not prepare forecasts • Comparison to past performance Forecasted growth vs. historical growth Trends / changes in margins Balance sheet assumptions Capital spending plans

13. Vetting Client Projections • Vetting by valuation firm (cont’d.) • Year on Year forecast comparisons to actual results How good is management at forecasting? • Consistency with management interview and external factors • Adjustments to forecast • Cyclicality/risk profile of different businesses • Reasonableness in light of all factors

14. Utilization of Projections • Utilization in Valuation • Relationship of forecast to other inputs to valuation • Relationship of value conclusions to other methods Conclusions of various methods should generally reconcile When methods yield materially different results – ask questions • Sensitivity to changes in assumptions • Weighting of approach based on confidence/judgment

15. DOL Enforcement of Projection Use • DOL Enforcement – Company Projections • Issue: The FMV of the company is typically based on future projections of the company’s business. A common valuation method is the discounted cash flow method, which relies on management projections. • The cases raise issues such as: Appraiser’s role and their ability to rely on management’s projections. Fiduciary’s duties in checking and vetting projections. What is reasonable and supportable in context? What is the risk and appropriate discount rate in light of the projections and the business circumstances surrounding those projections? How much of this is hindsight based on the economic downturn from the Great Recession? None, according to DOL.

16. DOL Enforcement of Projection Use • DOL Enforcement – Company Projections • Some issues raised in DOL’s litigation: Are recent good years representative of future expectations? Consideration/incorporation of bad years (mean reversion) Realistic assumptions on future growth in light of company and economic circumstances?

17. Legal Update • Status of proposed DOL Fiduciary regulations • Final Rules on Net Investment Income Tax • Distributions from qualified plans, including ESOPs, are tax exempt • 404(k) dividends are not subject to tax nor is Net Unrealized Appreciation (“NUA”) • People Care Holdings ESOP Lawsuit Settlement with DOL ($10M) • Scrutiny of financial projections in light of loss of a key contract

18. Legal Update (continued) • Ries Enterprises, Inc. v. Commissioner • Court found 409(p) violation, came to correct conclusion although disqualified person analysis is flawed • Larry E. Austin et al. v. Commissioner • Written up in the WSJ as “A Novel Way to Skirt Taxes” • A pre 409(p) (pre 2001) arrangement to have the ESOP own 100% of the issued and outstanding stock while 95% of synthetic equity is issued to the two founders • Motion for summary judgment was denied

19. Legal Update (continued) • Fifth Third Bank v. Dudenhoeffer • Deals with Moensch holding that ESOP investment in employer stock is presumed to be prudent • Plaintiffs alleged breach of fiduciary duty due to failure to sell bank shares in 2007 • District court dismissed since plaintiffs did not plead facts sufficient to overcome presumption • 6th Circuit reversed, holding that presumption is not applied at the pleading stage • Also held that ESOPs are not subject to a different standard • Holding conflicted with other circuits (2nd, 3rd & 11th)

20. Legal Update (continued) • Fifth Third Bank v. Dudenhoeffer • Result of holding: ESOPs must go through discovery process before they are able to have a case dismissed • Defendants appealed to US Supreme Court. • Cert. granted 12/13/2013 • Arguments scheduled for 4/2/2014 • DOL filed amicus brief with Supreme Court • Supported grant of cert. • But argued that Moensch presumption should not apply at any stage of litigation

21. Legal Update (continued) • Perez v. PBI Bank • Complaint filed 1/2/2014 in USDC, ND Indiana • ESOP purchased company shares for $40 million • DOL alleged overpayment due to • “earn out” agreement • Incentive stock options (ISOs) • Seller note interest rate • Governance agreement • Flaws in valuation methodology

22. Legal Update (continued) • Perez v. PBI Bank (cont’d) • Earn out agreement • Entered into before ESOP transaction • Company redeemed 20% of shares in exchange for earn out payment • Payment was 40% of earnings over projections • Payable after seller notes repaid • Valuation did not mention • ISOs • Plan allowed issuance of ISOs to management • Up to 20% interest in company • Valuation reduced by approx. 2%

23. Legal Update (continued) • Perez v. PBI Bank (cont’d) • Seller note interest rate • “One day loan” transaction • Seller note carried 12% interest rate • DOL argued rate was excessive • Compared to “inside” loan rate of 5% • Bank loan rate of 8.25% • Governance agreement • Specified Board members as selling shareholders and certain company officers • Applied so long as seller notes remained outstanding • DOL argued was not reflected in valuation and transfer of rights was a PT

24. Legal Update (continued) • Perez v. PBI Bank (cont’d) • Valuation methodology • No marketability discount • No discount for lack of control • Failure to account for earn-out • Failure to adequately account for ISOs • No answer filed yet

25. QUESTIONS?