Company Stock as Plan Investment

[Dougsbpc]

We administer a 90 participant 401(k) Profit Sharing Plan where salary deferrals are self-directed but profit sharing money is pooled.

The company that sponsors the plan is privately held mostly by employees of the company (though not through an ESOP). Next year, two long-time principals will be retiring and selling their stock. It appears the plan qualifies as an eligible individual account plan and can therefore have more than 10% of assets invested in company stock (actually, in their case it would be about 12%). Question: Is it possible for the plan to simply write a check to these individuals in exchange for their stock?

Suppose a few years from now the plan wishes to sell the stock. Can it sell the stock to the company?

Thanks

[jaemmons]

The plan cannot purchase the stock directly from the shareholders. If they do, then they have just entered into a prohibited transaction which could potentially disqualify the plan.

The shareholders would need to sell their stock back to the company, but most privately-held companies attach a put option to the stock certs which allows them to buy back the issues from the non-ee shareholder at the current appraisal value. When they buy back the shares they become treasury stock which cannot be held as an investment by the plan.

[Kirk Maldonado]

jaemmons:

Read ERISA Section 408(e).

[jaemmons]

Kirk,

Thank you for the cite, but I still do not see how the stock qualifies as "qualified employer securities". Maybe I am looking at it the wrong way, so if you could explain how ERISA 408(e) applies in this case, I would appreciate it.

[Kirk Maldonado]

jaemmons:

Why do you think it doesn't qualify? What statutory provision does it flunk?

[jaemmons]

Although I acknowledge that the stock is a "qualified employer security" (a retraction from my previous reply), the nature of the transaction gives rise to the fact that it may not be in the best interests of the participants for the plan to purchase the stock. Two "longtime" principals are selling their stock?? Why isn't the employer buying the stock? If the plan were buying stock from any other employees, besides two which potentially qualify as fiduciaries, I wouldn't raise the issue. I agree with Kirk, that the stock transaction would qualify under ERISA 408 and Sec.1107, but you must also look at whether it is in the best interests of the plan participants. Given all of the "stock" issues being brought to light with other companies, I would exercise caution with allowing for this transaction to take place.

[Kirk Maldonado]

jaemmons:

I think that your prior postings were very misleading.

You are only now saying that you don't think that the transaction is a good idea sttrictly from a policy perspective.

Your prior comments stated that the transactions didn't comply with the statutes.

I take offense at people that post materially misleading replies.

[Dougsbpc]

Thanks much for your replies on this!

ERISA Sec 408(e) then indicates that sections 406 (prohibited transactions), specifically sale or exchange between the plan and a party in interest and 407 (qualifying employer securities) do not apply to the acquisition or sale by a plan of qualifying employer securities. So it appears the plan could directly purchase stock from principals (whether or not considered parties in interest). Also then it seems as though the plan could eventually sell the stock back to the company.

Of course before stock is purchased, the company would be required to get a stock evaluation and no commision could be charged on the sale of that stock.

Does this sound correct?

Thanks again.

[Kirk Maldonado]

My recommendation is that you have an independent fiduciary represent the plan on the transaction. Believe me, if you get in a fight with the DOL or a participant lawsuit, having used the services of an independent fiduciary is the best protection you could have.

Ideally, the independent fiduciary would have its own ERISA counsel. As a compromise, the plan could have its own ERISA counsel.

If this sounds expensive, I have client that have spent literally millions of dollars fighting ERISA lawsuits.

[mbozek]

Not following the procedures suggest by Kirk could have other adverse consequences such as imparing a sale of the company that sponsors the plan because of questions involving the valuaton of the securities or compliance with ERISA. I recently represented a buyer in due dilligence who was proposing to buy the stock of a company that was the subject of a dormant DOL investigation that had been going on for 5 years regarding the securities issued to an ESOP. The buyer passed on the acquisition because there was no guarantee that the DOL would close ESOP investigation.

[Kirk Maldonado]

My experience is that the DOL never forgets an investigation. I've had them dormant for as long as four years, but I've never yet seen them forget about an investigation. The moral of the story is that you can't take any comfort in the fact that you don't hear anything from the DOL for an extended period of time.

[jaemmons]

Kirk,

After having reread ERISA 408e and 1107, I felt that the stock met the definition of "qualified employer securities", as I did not feel that stock already issued and outstanding met the "qualification" definition. However, my opinion on the nature of the transaction was only brought to light after the assessment on the type of securities involved. I apologize if you were "mislead" by my replies, but I felt that the first issue to discuss was whether or not the stock was "qualified" which I did admit I may have been misinterpreting.

Practioners are allowed to disagree, but I don't see where I had "materially mislead" you with any of my prior comments. I guess all I can say is "sorry you feel that way."

[Kirk Maldonado]

jaemmons:

My recommendation to you is to not state items as being absolute facts unless you know them to be. That may require that you reread the statutes before you post replies. Had I not intervened, your erroneous postings would have mislead a lot of readers.

Given the fact that you have posted two erroneous replies in this thread alone, I would wish that you would take the time to do your homework before you state things as being absolute facts.

If you aren't willing to do that, as a courtesy to the readers you should caveat your response with the statement that you haven't read the statute in a long time.

Stating things as being facts when you have no idea what is the right answer is reprehensible.

[jaemmons]

Kirk,

Wow, I haven't been scolded like that in 30 years! My "erroneous" statement was an admitted one based upon a misinterpretation of an ERISA statute. However, your comments seem to border on the personal side. My suggestion to you is that you need to get off of your high horse and realize that EVERYONE errs once in a while and that our profession is not above this human characteristic. Plus, this is an informal discussion board where the opinions are sometime incorrect and are justly rectified in a professional manner. To point out an error in my judgement is one thing, but to do so with such a condescending tone, leads me to believe that you need to not take things so personally.

Your suggestion has been duly noted and I will take it under advisement the next time I post a reply. Good day.

[Kirk Maldonado]

jaemmons:

Despite the fact that I have over 1,000 postings, I have never "scolded" another poster.

What triggered my reaction was that I felt that you were not making innocent misinterpretations of the law.

Your positions were so fundamentally inconsistent with the statute and stated in such a conclusory manner that I felt that you were opposed to the transaction from a policy perspective, and you were just using the argument that the transaction violated the statute as a ruse. In other words, I felt that you were not being forthright as to why you were really against the transaction.

However, I will take you at your word that those were honest mistakes, and I apologize if I have offended you.

[david rigby]

Interesting discussion (well, sort of).

Just in case readers want to see the statute referenced: http://www4.law.cornell.edu/uscode/29/1108.html