RLL

Do I have to do all your work for you? If you're a member of The ESOP Association, you can check the monthly newsletter (ESOP Report). I know that the PLR was summarized in the "Legal Update" column shortly after it was released to the public. It was also mentioned in outlines of the "Legislative, Regulatory and Case Law Developments" presentations at The ESOP Association's Annual Conference and Two-Day Conference. Also, it was in the similarly titled article in the Journal of Employee Ownership Law & Finance published by the National Center for Employee Ownership. Maybe some other reader of this Message Board can find a cite for you....I'm too busy.

It depends on the specific provisions of the ESOP, as well as your age and the date you terminated employment. You should have been given a summary plan description ("SPD") when you became an ESOP participant. The SPD is required to describe the conditions required to receive benefit payments, etc. Perhaps you failed to make a claim for benefits on a timely basis. Check the SPD and the ESOP plan documents (which must be made available to you upon request) to ascertain whether you have a valid claim.

Employer stock which is not publicly traded must be valued for ESOP purposes by an independent appraiser. The appraiser will apply rules for determining "fair market value" which have been developed over many years for tax purposes and business transactions. The financial condition and performance of the subject company are the primary factors in determining value. The appraiser often applies certain "multiples" to earnings and cash flow to determine fair market value. These multiples will generally be derived from the multiples applicable to comparable companies whose stocks are publicly traded. I think that your boss and you are each partly correct about how stock of a closely held company is valued for ESOP purposes. For specific information on valuation of closely held company stock for ESOP purposes, check the web sites for The ESOP Association (www.esopassociation.org) and the National Center for Employee Ownership (www.nceo.org).

As a general rule, the board of directors elects the president and other officers of a corporation. The shareholders elect the directors. In most ESOPs of closely-held companies, the ESOP's shares are voted (for directors) by the ESOP trustee or by an administrative committee, although some ESOPs provide for the "pass-through" of voting rights to ESOP participants. The trustee and the committee are normally appointed by the board of directors. The provisions of the ESOP plan documents should specify the rules that apply in each situation. Where an ESOP owns more than 50% of the outstanding shares of the corporation, whoever has voting power over the ESOP's shares can elect at least a majority of the directors. If an ESOP owns less than 50% of the outstanding shares, the ESOP shares may elect some of the directors only if the applicable state corporate law, or the corporate charter or bylaws, provide for "cumulative voting" for directors. [This message has been edited by RLL (edited 12-06-1999).]

No problem under IRC Sec. 401(a)(28)(B) .....you are allowing for the diversification of the shares represented by (or included within) the units. See my first response (dated 11/24). Theoretically, you may be allowing for so-called "excess" diversification, but there is no real adverse consequence in doing so. I believe that the IRS will issue a determination letter on ESOP plan provisions which allow what you propose. If so, who can then argue that there is any problem doing what you want? If the ESOP does not include a money purchase pension plan, there would clearly be no problem in allowing for in-service distributions (in unlimited amounts) after a participant has satisfied the age-55, ten years of participation requirements for the ESOP diversification election. If there is a money purchase plan as part of the ESOP, there could be some minor limitation, but nothing that should be a diversification problem. Go ahead! Don't worry so much about what you think you can't do. I think you can do it, and I'm sure that the IRS would not object (if they understood the question). [This message has been edited by RLL (edited 11-30-1999).]

I think there are no real problems with unit allocations in an ESOP. There are many ERISA lawyers who always focus primarily on problems (rather than solutions) and raise all kinds of theoretical issues about anything (or nothing), especially when it involves ESOPs. It must be something they teach in law school....or maybe it's typical for frustrated non-litigators who want to argue about something (or everything).

Kirk.....a lot has happened in the last ten years. I'm surprised that you're showing signs of aging and will publicly admit it.

You have the right to be notified in writing regarding your benefit distribution options. Don't allow them to pressure you into a decision.

The 1977 ESOP regulations, at Sec. 54.4975-11(d)(2), provide that leveraged ESOPs must allocate shares of employer released from a loan suspense account in "non-monetary units" (not necessarily shares). Accordingly, there should be no reason for not allowing the ESOP diversification election to be effected based on allocation units which include shares of employer stock. Based upon your facts, each unit would likely represent more than just shares. There should be no problem since the amount available for the diversification election is not less than would be offered if allocations were made in shares. It's likely that IRS employee plans reviewers would not even understand the issue. I'm certain that an ESOP drafted to provide for diversification as you have described would have no problem in obtaining a favorable determination letter from the IRS.

It sounds bad! This is the type of situation that gives ESOPs a bad reputation and encourages the U.S. Department of Labor and the IRS to continue to have a hostile attitude toward ESOPs. It seems that the ESOP trustee may have an obligation here to take action to protect the ESOP participants' stock ownership interests. With the trustee having knowledge of possible mismanagement, failure to investigate and take appropriate action may be a violation of ERISA's fiduciary rules. If the ESOP owns 80% of the company, whoever controls (has voting power over) the ESOP's shares of company stock can elect a majority of the directors. The board of directors has the power (and responsibility) to appoint and remove management of the company. If the trustee has voting power, perhaps the trustee should call for a special election of directors and throw out the rascals, if appropriate. I hate to hear stories like this. I hope that you and your fellow employees are able to find a solution that will save the company. Good luck! [This message has been edited by RLL (edited 11-23-1999).]

This is an area that is somewhat unclear. Is the feasibility study an expense necessary in the operation and administration of the ESOP? Is the purpose of the feasibility study for the benefit of the ESOP participants or for the benefit of the company and/or the non-ESOP shareholders? Why take the risk of having the payment treated as a violation of ERISA? Why not have the company pay the costs? Since the ESOP's primary source of funds is usually the company (through employer contributions), let the company pay this cost as well. The risk of an IRS or DOL challenge does not justify having the ESOP pay this expense. My guess is that DOL would treat the cost of the feasibility study as an expense which should NOT be paid by the ESOP.

What % of the company does the ESOP own? Who is on the Board of Directors? Who is the ESOP fiduciary with responsibility for investments in company stock? Who says the President isn't doing the right thing? Do you know how the company could be better managed? If the ESOP participants' interests as beneficial shareholders are not being adequately protected, you have recourse under ERISA. You should seek legal advice regarding your rights. An alternative might be to contact the nearest office of the Pension & Welfare Benefits Administration of the U.S. Department of Labor if you like the idea of relying on federal bureaucrats to investigate the situation.

MWeddell is referring to an absurd position taken by the IRS National Office in a series of PLRs during the period 1993-97. This position was obviously incorrect, as it mischaracterized gains on the sale of employer stock as "annual additions" under IRC Sec. 415© and would have denied ESOP participants certain of the allocations resulting from gains on the sale of suspense account shares when an ESOP company is sold. Finally, after years of repeated efforts by a number of ESOP professionals, along with The ESOP Association, and after a Tax Court case was initiated to challenge the IRS in the situation involving the 1997 TAM, the folks at IRS recognized their error and reversed the ridiculous position. A subsequent PLR in 1998 confirmed the IRS change in position. When a situation involves a bona fide (and not "pre-arranged") sale of an ESOP company to an independent third party, there should no longer be a concern over the "415/suspense account shares" issue.

Hello winmac! Your question is difficult to answer in light of your failure to provide more specifics as to your situation. The answer depends on what was promised to the employees. If they were promised a direct issuance of stock, it would not be appropriate to provide it through an ESOP (which results in the deferral of receipt of the shares). In addition, the allocation of shares under an ESOP must be done pursuant to a definite allocation formula which does not discriminate in favor of highly compensated employees and generally may not "single out" individual employees for special treatment. On the other hand, a vague "promise" to provide a group of employees with "stock" might allow for a contribution of shares to an ESOP. What was promised? What are the employees expectations? Was the promise made to all employees or to a select group? Do the employees expect to "get rich quick" when the company does its IPO? What's going on there?

Dividends paid on shares purchased by an ESOP with loan proceeds may be used to make payments on the loan. If the company is a C corporation, such divdends are deductible under IRC Sec. 404(k). If the company is an S corporation, Sec. 404(k) is not available and only dividends on the loan suspense account shares may be used for loan payments. Depending on the timing of the transaction relative to the ESOP's Sec. 415 "limitation year," it may be possible to contribute the additional amount for a separate year within the 415 limits. If the plan documents and loan documents permit it, and if the appropriate ESOP fiduciary agrees, it may be possible to use a portion of the sales proceeds from the suspense account shares to pay the remaining loan principal balance. The treatment of a leveraged ESOP in connection with the sale of a company can be a very complicated area, with many traps for the unwary. I recommend that you seek the advice of professionals experienced in such ESOP transactions.....which have become quite common in recent years. It is too difficult to provide specific guidance in a forum such as this message board....the specific facts of your situation will likely determine the best course of action. There are many IRS PLRs addressing some of these issues...but no one PLR will tell you what approach will work for your client.

A definition of "highly compensated employee" is needed to take advantage of the special IRC Sec. 415©(6) allocation limit provision available to leveraged ESOPs. Also, if there is a 410(B) or 401(a)(4) self-correction provision, which must address HCEs.

IRS has a program for locating missing participants. There are also private services available to help locate. Setting up IRAs in the names of the missing participants is a good approach. But some IRA sponsors won't do it without the signature of the IRA beneficiary.

Check with the National Center for Employee Ownership (at nceo.org) and The ESOP Association (at esopassociation.org). These non-profit organizations are the best sources of information on all aspects of ESOP design and administration. [This message has been edited by RLL (edited 11-10-1999).]

Even if the shares are "worth" more to the ESOP (by reason of the ESOP's tax exemption), the ESOP may not pay the selling shareholders more than "adequate consideration" (fair market value) under ERISA Section 3(18). Fair market value is determined by an independent appraiser based on a hypothetical willing buyer-willing seller analysis, which would not consider the ESOP's tax exemption. Note that an ESOP has a tax-exemption applicable to dividends on employer stock whether the employer is an S corporation or a C corporation. The fact that an ESOP is generally tax-exempt does not justify charging an ESOP more for employer stock than another buyer (presumably not tax-exempt) would pay for the stock.

A premium for S corporation status is not appropriate. The tax savings (if any)resulting from an S corp election does not make the company increase in value except to the extent that such tax savings are actually realized by the company. From the company's standpoint, the ESOP is no different from any shareholder....it will receive the same per share dividends (S corporation distributions) as any shareholder. The fact that the ESOP is not subject to tax on its S corp dividends is no different than if the ESOP received dividends from a C corporation. The ESOP's tax exemption does not make the shares of the selling shareholders worth more.....so why should the ESOP pay more?

You are entitled to receive an individual account statement for each year in which you still have an account balance under the ESOP....even if you have terminated employment. The account statement does not have to be provided automatically...but must be provided to you upon request (but not more than once per year). With regard to the plan number, it's probably no big deal....maybe a mistake...but so what? Why get picky about the plan number? Concentrate on securing the information and benefits to which you are entitled. If you're still having problems after requesting information, find an ERISA benefits claims lawyer or contact the nearest local or area office of the Pension and Welfare Benefits Administration of the U.S. Department of Labor.

Beth---you have identified the biggest issue as that of repurchasing the employer stock from the ESOP. It not only takes a buyer with cash, it would require that an ESOP fiduciary approve the ESOP's sale of stock. If the sale is to the company that sponsors the ESOP (or to a related party), the fiduciary should be independent of the company and its shareholders. The purchase price must be no less than fair market value, but the fiduciary may demand a "premium" above fair market value as a condition of approving the sale by the ESOP. If the plan is converted into a money purchase plan, it cannot own employer stock in excess of 10% of plan assets, per ERISA Sec. 407(a). A profit sharing plan may continue to hold up to 100% of its assets in employer stock, so long as it is designated as an eligible individual account plan under ERISA Sec. 407(B). An ESOP is generally considered to be invested "primarily" in employer stock if such stock constitutes more than 50% of total plan assets. There is no requirement that employer stock continue to be contributed to the ESOP or that additional stock be allocated to participants' accounts. Unless the ESOP has available cash, it is unable to acquire additional shares on its own. If there is no means for repurchasing the ESOP's stock, you might consider "freezing" the ESOP as a separate account under an ongoing profit sharing plan. Also, you should consider how to address (on an ongoing basis) certain ESOP requirements under the IRC, such as diversification under Sec. 401(a)(28)(B), voting rights under Sec. 409(e) and the right to receive distributions in employer stock under Sec. 409(h)(1)(A). Beth----if you're doing a lot of ESOP work for your clients, you should join the National Center for Employee Ownership (at www.nceo.org) and The ESOP Association (at www.esopassociation.org). Both organizations provide good info for professionals, have good technical meetings, etc. [This message has been edited by RLL (edited 10-20-1999).]

A charitable contribution of Sec. 1042 "qualified replacement property" ("QRP") is treated the same as a contribution of any other stock. Subject to the limits on charitable deductions under IRC Sec. 170, the fair market value of the QRP will be deductible and there is no recognition of gain on disposition of the QRP.

A non-leveraged ESOP is likely to be far less dilutive to the President (the client) and can provide the same use of "pre-tax" corporate dollars. A leveraged ESOP would usually be beneficial to the corporation and the client only when there's a Sec. 1042 transaction in which the seller will take a reduced purchase price (reduced sufficiently to offset the dilution resulting from leveraging the ESOP). Paying Mr. "Big Bucks" Lawyer to do a complicated leveraged ESOP transaction may benefit the lawyer....but isn't it the client we're trying to benefit here?

I'd be very concerned about relying on a discussion of ESOPs in a book written about life insurance. I strongly recommend getting your information on ESOPs from a more objective source, such as the two non-profit organizations (The ESOP Association and the National Center for Employee Ownership), referred to above. There are also many other books, etc., specifically about ESOPs, which are not limited to the use of ESOPs with life insurance.