pjkoehler

RLL, You argue that it is "common" for ESOPs to include an automatic disinvestment and six-year deferred distribution provision even though you're generally talking about ESOPs that qualify for a very narrow exception from the general requirement that employees have the right to demand distribution in shares. Since the vast majority of ESOPs are not sponsored by S Corps or C-corporations with restrictive language in their bylaws, you're view is problematic on just an empirical level. On the one hand you say that "very few former employees want to own stock in their former employer if the company is close-held," but on the other hand you argue that the risk of this outcome justifies a draconian plan provision which strips the vast majority of terminating employees of fundamental incidents of stock ownership, even though they were CURRENT EMPLOYEES when they earned a vested right to their company stock account. It's difficult to imagine a scenario in which the management of a company (not eligible for an applicable exception) is so paranoid about the risk of sharing equity with former employees, that it would still contemplate establishing an ESOP. It seems that you've simply designed a plan provision that's in search of a market.

RLL, Golly - I'm sure it was a pure oversight, but you forgot to mention that right there in the lead in to the article you cite, a reader would find the following: "Providing this conversion feature raises a number of important legal and practical considerations, just some of which are described here. [i wonder which legal and practical considerations aren't discussed in this wonderfully authoritative article.] There is no guidance from the IRS or the Department of Labor on whether such a conversion is permissible (even though it is common) or how best to do it." The author doesn't cite to any verifiable evidence that the disinvestment provison is "common," even though his parenthetical remark is, of course, problematic in light of his admission that he's unaware of any guidance that it's "permissible." If I'm corporate general counsel and I find that the corporation adopted an ESOP with a provison that raises "important and practical considerations" for which there is no authority, my first reaction is to find out if someone did the appropriate risk-management assessment in adopting this provision and, if not (because, for example, it's buried in boilerplate language of a standardized plan document) then I'm going to question the competence of the advisor responsible for this provision. RLL, if an ESOP is going to align the interests of participants with the shareholders, then it's going to have transfer to the participants the incidents of stock ownership, among which is the right to time the disposition of the shares to the shareholder's view of the market. What could be more fundamental to stock ownership? This is precisely why Code Sec. 409(h) requires an ESOP of a closely held corporation (not subject to any applicable exception) to give participants (including former employees) the right to demand employer securities subject to a put option, when the benefit becomes immediately distributable. The disinvestment provision you advocate causes the participant to forfeit the most basic incident of ownership, the right to determine when to sell the shares, even when they've satisfied the plan's vesting requirements. Apparently, you're of the view that it is "common" for ESOP sponsors to want to transfer all incidents of ownership to employees, subject to their termination of employment only for death, disability or retirement. By the way, you've misinterpreted Code Sec. 409(o). That section provides that an ESOP must provide that UNLESS THE PARTICIPANT ELECTS OTHERWISE, the distribution of his vested account balance will not begin later than one plan year after the end of the fifth plan year following termination due to quit or discharge (unless reemployed). The notion that Code Sec. 409(o) supports a provision that imposes a nonelective minimum distribution deferral period of up to six years is utterly bogus. Lastly, the reason that 411(a)(11) is no longer an issue in this thread, is because in advocating you're position you intially failed to disclose a material plan provision (the six-year distribution deferral period), which meant that the account balance was not immediately distributable on termination of employment. In the absence of this disclosure, both Kirk and I assumed that the plan was disinvesting at the time the account became immediately distributable. Since he and I each have more than 25 years of equity-based benefits and compensation experience, that reaction, based on your nondisclosure, might be an indication of how frequently practitioners encounter ESOPs with disinvestment and 6-year mandatory deferred distribution provisions.[Edited by PJK on 08-07-2000 at 06:17 PM]

Sonia, You're going to have to analyze the plan document to determine if the definition of "compensation" for CODA purposes includes the severance pay to which you refer. If it doesn't, case closed. If you determine that the definition includes such severance pay and there is a valid pre-existing CODA election with respect to such pay, then you have an issue that has yet to be resolved (to which KJohnson refers as the subject of a battle royale in a prior thread). You first have to distinguish between the form of severance pay in terms of whether it was paid for the performance of past services to the employer (arguably "compensation" to which 401(k) may apply) or for the loss of a job (a mere welfare benefit to which 401(k) does not apply). Generally, the closer in time to the employee's date of termination, the better factual basis you have for arguing that the severance pay was compensation for performance of past services. If you conclude that it was compensation for the performance of services, you then get to the grand issue: Whether an employee's cash or deferred election controls the pre-tax treatment of amounts of compensation paid after the date of termination? The contributors to the prior thread have been waiting for a plan sponsor that would be so inclined to obtain a legal opinion or seek a PLR on this issue. Think your company would be interested?

If you believe the standard mantra in ESOP literature, you'd think that employers establish ESOPs in order to align the interests of participants with the shareholders. I think you'll find that the public policy considerations underlying the favorable treatment of ESOPs in the Code, as expressed in JCT Committee Minutes, is that it's intended to be a tool for providing employees with equity interests in their employers. An ESOP provision that disinvests the employee in company stock automatically and then makes the employee wait for up to 6 years to obtain a distribution, while the proceeds of the sale of his shares are subject to indefinite investment restrictions, in order to accomodate the business purposes of the employer of not incentifying employees with substantial balances to terminate (and perhaps commence competition with the employer) is utterly antithetical to any reasonable notion of "equity." Any rational investor would think that such an arrangement doesn't compensate him for the risk of holding the security in the first place. Aside from insider trading and other regulatory restrictions, shareholders generally possess the unfettered right to dispose of their equity position and reinvest in another security. While ESOPs don't provide that much latitude to dispose of the employer securities, imposing more stringent distribution restrictions erodes any alignment of participant and shareholder interests. I question how common this arrangement really is. Perhaps other commentators have a view on this. By the way a quick check of the model ESOP in the BNA Tax Management Portfolio on ESOPS (No. 354) (Workpaper No. 1), which is designed for closely held corporations, provides that the vested company stock and cash accounts are immediately distributable on termination. The mandatory distribution deferral period that you've described isn't even included as an option.

Dawn, the right to invest in employer securities is clearly within the class of "other rights and features" subject to the requirement that it be both (i) currently available (satisfies the ratio percentage test of Reg. Sec. 1.410(B)-2(B)(2)) and (ii) effectively available (satisfy the "smell" test on a facts and circumstances basis) to a nondiscriminatory group of employees. Reg. Sec. 1.401(a)(4)-4(e)(3)(iii)©. If you're plan allows for immediate distribution on termination of employment and further allows employees who defer distribution to continue to hold employer securities in their deferred vested acccounts, an amendment the imposes the disinvestment feature would have to grandfather the existing terminated participants, as well as the accrued benefits of current participants, to satisfy the special testing rule set forth in Reg. Sec. 1.401(a)(4)-4(B)(3).

RLL, I don't think anyone reading this thread could devine what you mean by "these ESOPs." It's taken some time to find out that "these ESOPs" impose a unique 6-year deferred distribution provision for pre-retirement severance, which is just a discretionary, plan design feature. I've drafted and advised on many ESOPs and never encountered such a feature, which seems particularly inappropriate in an K-SOP, such as Dawn has described, because it would probably adversely impact the participation rate of NHCEs. The administrative cost of maintaining records on all terminated participants for up to 6 years, including those subject to an involuntary cashout, is obviously not a selling point for such plans. For many middle market companies, the pool of former participants terminating during the last 6 years could well approach or even exceed the pool of current participants. If the employer experiences significant turnover, such a provision would result in a significant percentage of plan assets invested in nonemployer securities, which is clearly inconsistent with the basic ESOP requirement that the plan be "designed to invest primarily in Employer Securities." I suspect that the Service is issuing favorable determination letters because with the 6-year deferred distribution period the disinvestment occurs before the account becomes immediately distributable. So on these new facts there is no 411(a)(11) issue, just the negative effects described above. If, as you argue, participants in ESOPs sponsored by closely held corporations not subject to the Code Sec. 409(h)(2) exception don't elect distributions in stock, then why disinvest their accounts and lock them into the plan for 6 years? Why not design the plan to allow them to elect an immediate cash distribution, i.e. to disinvest themselves voluntarily, and get rid of them. [Edited by PJK on 08-03-2000 at 02:24 PM]

RLL, the disinvestment that took place on the facts in RR 96-64 was also automatic. What you may be struggling with is the meaning of "consent" as that term is applied in Sec. 411(a)(11). If a participant terminates employment and is faced with the choice of either taking an immediate distribution or suffering the automatic disinvestment of his account (i.e. the loss of the potential appreciation in the employer securities), then even if he elects a distribution, the logic of RR 96-64 is that the plan is paying it without his "consent," which I think you'll agree does not comport with Sec. 411(a)(11). Besides, any disinvestment takes that portion of the plan assets outside the ESOP exception under ERISA from the prudent expert and diversification fiduciary standards. How will the investment of the proceeds on the sale of the employer securities be handled. Does the plan just leave the fiduciaries exposed, or does the document create a ERISA Sec. 404© plan within the ESOP to permit limited participant self-direction? Isn't that either going to (1) expose the fiduciaries to significantly greater fiduciary liability for handling assets of a plan that they probably thought was virtually fail-safe from a fiduciary liability standpoint because it was an ESOP, or (2) significantly increase the administrative expenses of the plan for the terminated vested employees by operating their accounts on a self-directed accounts in compliance with ERISA Sec. 404©? Regarding ESOPs that don't qualify for the Code Sec. 409(h)(2) exception, are you really suggesting that it makes administrative sense to disinvest the accounts of deferred vested participants, subject to reinvestment in employer securities if the participants subsequently demand distribution in employer stock? It seems that you aren't achieving very much in exchange for the risk that the plan is violating 411(a)(11). As a practical matter, where are those shares going to come from, sense they aren't in the participant's account? If you really want to chill terminated vested participants from hanging around, it is better to design the plan so that they have a limited election period (e.g. 90 days) from date of termination to elect a distribution, otherwise, they can't take a distribution until a specified distribution event occurs (death, disability of attainment of early retirement age). While qualified plans can't involuntarily cash out all terminated vested employees, they aren't required to give them the unfettered discretion to take a distribution any time. Such a plan provision is probably more responsible for the phenomenon than the prospect of obtaining future appreciation in employer securities. Sec. 411(d)(6) will make it difficult to amend existing plans that permit terminated employees to elect a distribution any time, but employers sensitive to this issue that are adopting new plans would be better advised to draft them with highly restricted distribution dates as an incentive not to defer distribution.

RLL, the involuntary disinvestment in employer securities that you're describing is the direct result of an employee (not subject to automatic cashout) failing to "consent" to an immediate distribution when his/her account first becomes immediately distributable. That, RR 96-47 seems to say, imposes "signficant detriment" on such participants who fail to consent to a distribution. Sec. 411(a)(11) requires a plan to obtain the participant's "consent" to a distribution in the form of a voluntary decision by the participant. The logic of the ruling is that a plan that imposes a "signficant detriment" on a participant who fails to consent effectively coerces the participant to elect a distribution. Coercion is obviously inconsistent with the notion of consent. You've made no argument other than the mere admininstrative convenience of the plan sponsor that would justify such a provision. That was certainly the case on the facts considered in RR 96-47. I assume that you aren't arguing that a plan containing such a disinvestment provision, but to which the Sec. 409(h)(2) exception doesn't apply, could possibly satisfy the general requirement that an employee have the right to demand distribution in the form of employer securities. Your position, therefore, would seem to that a very small percentage of ESOPs, whose sponsors are governed by bylaws that contain the necessary restrictive language, are not only exempt from the requirement that it provide the right to demand distribution in employer securities (which we agree on) under Sec. 409(h), they are also exempt from the consent requirements of Code Sec. 411(a)(11). I can't imagine what policy reasons Congress would have had for exempting such a narrow population of ESOPs from a basic qualification requirement. In view of the holding in RR 96-47, that seems like a very aggresive tax filing position based only on anecdotal evidence and unpublished, informal remarks.

". . . The only difference is what is being traded for the option. In one case it is labor. In the other it is money. . . ." I agree with Derrin's conclusion regarding option attribution for purposes of HCE and Key Employee determination, but his comments are inconsistent with his previous analogy of proprietary and compensatory stock options regarding the holding in RR 89-64. The necessary "condition" to which he refers is the employee's performance of future service in exchange for the right to exercise the option. This is precisely what makes the traditional compensatory option a bilateral, rather than a unilateral contract. When an investor purchases a publicly traded option on the open market, he possesses the enforceable right to exercise before the option expiration date, which is the subject matter of the contract. But when an employer grants an employee a compensatory option in exchange for the employee's future employment, that "condition" makes the contract executory on both sides, i.e. the employee does not have the enforceable right to exercise until the condition lapses. Thus, the contract is executory on both sides, i.e. bilateral. The investor's purchase of the option contract for money is a completed transaction, but an employee cannot tender future services, thus leaving its obligation performable, but far from fully performed. Keep in mind that this is an extension of the holding of RR-89-64, which is fine for HCE and Key Employee determination purposes, but not free from doubt for "controlled group" determination purposes.[Edited by PJK on 08-02-2000 at 05:55 PM]

Derrin, I think you're argument by analogy that official guidance applicable to the language of Sec. 318(a)(4) that is verbatim identical to the language of Sec. 1563(e)(1) ought to apply with equal force is logical. But in the absence of official guidance on point, I don't think you can say that IRS acquiesence on audit is free from doubt. I doubt there are many law firms that would provide an opinion letter or accounting firms that would provide a tax opinion based purely on an analogy argument at more than a more probable than not level of authority. I think you're previous analysis misses a key issue. RR 89-64, in clarifying the phrase "at the election of the shareholder" as used in RR 68-601, says that it is intended to distinquish between a unilateral right to acquire stock (as the ruling ultimately holds regardless of whether or not there is a delay in the right to exercise) and a "bilateral contract." The issue is whether or not a compensatory stock option granted pursuant to a stock option agreement entered into between an employee or nonemployee and the issuer of the securities is a "bilateral contract." Certainly, any first year law school student should analyze the traditional compensatory stock option granted to an employee as a bilateral contract, rather than a unilateral contract (such as a proprietary stock option traded on the open market) where the employee must perform future services in order to obtain the issuer's performance under the agreement. So one way the IRS could limit the holding in RR 89-64, is to take the position that it applies only to proprietary option contracts bought and sold on the open market; not to most compensatory stock option grants, which, of course, is what this thread is focused on. [Edited by PJK on 08-02-2000 at 01:34 PM]

Code Sec. 409(h)(2)(B)(ii)(I) provides an exception to the designed-based requirement that the plan provide a participant entitled to a distribution with the right to demand payment in employer securities. The issue you raise is whether or not an ESOP can provide that the share accounts of terminated vested participants (not subject to the involuntary cashout rules) can be automatically disinvested in employer securities, leaving their accounts invested in nonemployer securities until they elect to receive a distribution. I don't see how this Code Section gives you much comfort. It's all about distribution of the account. What about the accounts of terminated vested participants that may defer distribution for a considerable period of time, i.e who do not consent to an immediate distribution within the meaning of Code Section 411(a)11)? What about their potential loss of future appreciation in the shares? Reg. Sec. 1.411(a)-11©(2) says that the requisite element of "consent" to a distribution that is not subject to automatic cashout is not satisfied if a "significant detriment is imposed under the plan on any participant who does not consent to a distribution." Rev. Rul. 96-47 held a plan in which terminated participants who did not consent to an immediate distribution and who chose to leave their account balances in the plan were automatically disinvested from their investment fund choices and invested in a money market fund until distributed were subject to "significant detriment." Therefore, the IRS ruled that the loss of the right to maintain their investments was tantamount to an immediate distribution without a valid consent.

Please note: While these plans may be intended to satisfy Code Sec. 401(a) and, therefore, are subject to Code Sec 414(B), which requires aggregation of the employee groups for various qualification requirements under the Code, their qualified status is irrelevant to determining whether they are separate Form 5500 filing entities. The plans you've described and their related trusts, constitute separates funds or arrangements for purposes of the definition of "employee pension benefit plan" set forth in ERISA Sec. 3(2)(A) (i.e. the assets of each plan are only available to pay the benefits of the participants of that plan). They are also among the plans specified in Part 1 of Subchapter D of Chapter 1 of the Code and established and maintained by separate employers for purposes of Code Sec. 6058. The regs under Sec. 6058 make no reference to controlled group principles in defining the term "employer" for purposes of satisfying the "employer" annual return requirement. Reg. Sec. 301.6058-1(B). So even if these plans failed to satisfy any of the employee benefit requirements specified in Code Sec. 414(B), pertaining to plans maintained by members of a controlled group of corporations, they would still be separate Form 5500 filing entities. Therefore, the participant-counting rules would apply to each plan separately.

The plans you've described are clearly separate filing entities, i.e. this is not a multiple employer plan; but separate and distinct ERISA Title I plans, requiring separate 5500s with, presumably, different PINs. While Section 2, page 6 of the Instructions to the 1999 Form 5500 is not a model of clarity, I think you are on solid ground in determining each plan's participant count separately (for purposes of determining each plan's status as a "small plan" or a "large plan"). Furthermore, the participant-counting rules described on page 12 of the instructions regarding lines 6 and 7 make no reference to controlled group principles. Assuming that each plan contains language that excludes the employees of the other company, applying controlled group principles, simply because the 2 plans may be aggregated for various employee benefit requirements under the Code, would be a stretch. Since neither plan had 100 or more participants as of the beginning of the plan year, each plan would be subject to the "small plan" reporting regime.

I think we should be careful framing questions in the abstract about compensatory arrangments that are inherently contractual and which, therefore, vary greatly. I've never heard of a stock option time-vesting arrangement other than in the context of the optionee's performance of future services (whether as an employee or nonemployee). So I don't understand the distinction you're making between time vesting and service-based vesting. Vesting is usually either future service-based or performance-based or both. Also bear in mind that vesting and the right to exercise are by no means linked. For example, the concept of "reverse vesting" or permitting the optionee to exercise prior to satisfying the vesting requirements is gaining increasing popularity as a means of facilitating the early exercise of an Sec. 83(B) election. While it can be argued that nonvested option grants should be disregarded under the applicable option attribution rules for determining controlled group status until the lapse of substantial restrictions or the options become freely transferrable by analogy to the Section 83 rules that defer the inclusion in gross income until such time, there's no compelling need in theory for symmetry between the timing of the inclusion in gross income of property transferred for the performance of services and the attribution of shares for controlled group determination purposes. It is common for a stock option plan to provide that all unvested options granted to an employee expire automatically on termination of employment (or shortly thereafter) and for a stock option agreement to provide that any unexercised vested options are automatically cancelled within a time certain (recall the ISO rule that requires cancellation within 90 days of termination). So you could argue that options that might expire should also be ignored. But that is the nature of an option. It might not be exercised. I think the better rationale is that having been granted, the shares subject to the option end up being attributed to the optionee until the option lapses or is otherwise forfeited.[Edited by PJK on 07-31-2000 at 06:05 PM]

The Labor regulations provide that a plan may use different computation methods for different computation periods. If it uses the standard hours counting method for all periods, then the plan cannot require more than 1,000 Hours of Service during the eligibility computation period to credit the employee with a full year of participation for eligibility purposes or require more than 1,000 Hours of Service during the vesting computation period to credit the employee with a full year of participation for vesting purposes. On the other hand, such a plan could require more than 1,000 Hours of Service during an accrual computation period to credit the employee with a full benefit accrual unit (i.e. a full "year of participation" for benefit accrual computation purposes), so long as an employee who is credited with at least 1,000 Hours of Services is credited with a partial benefit accrual unit that is at least equal to a ratable portion of a full accrual unit. See 29 CFR Sec. 2530.200b-1 and 2530.204-2© and (d). So, for example, a 401(k) plan that provides for an allocation of the company matching contribution for employees credited with at least 2,000 Hours of Service, must also allocate to the accounts employees who are credited with 1,000 Hours of Service, 50% (1,000/2,000) of the allocation they would have otherwise received had they been credited with at least 2,000 Hours of Service. Such service crediting rules are not uncommon among defined benefit plans covering hourly paid workers. They are rare among 401(k) plans, since the rules tend to interfere with the plan's ability to satsify the ACP test, besides probably having a negative employee relations impact. I'm not positive, but I suspect the LRMs don't permit such service crediting rules in standardized or nonstandardized 401(k) prototypes plans.

Regarding the treatment of elective deferrals under Code Sec. 401(k) in computing the deduction limit under Code Sec. 404(a)(7), see Code Sec. 404(a)(11) (compensation is not "paid" until actually received, i.e. elective deferrals are excluded from "compensation"). Regarding the imposition of a limitation on annual compensation in computing the deduction limit under Code Section 404(a)(3)(A)(i), see Code Sec. 404(l), which incorporates the limitation set forth in Code Sec. 401(a)(17) by reference.

Most of your questions reflect "form-over-substance" concerns that don't impact the tax and ERISA treatment of the plan. Take a look at Rev. Proc. 92-64 and 92-65. If the firm can live within the constraints of the model rabbi trust and the guidance regarding trusts section, then you're probably better of conforming to it.

If you are using the IRS model rabbi trust, you shouldn't need an amendment. Section 2© of the model trust says that the Company may pay benefits directly to participants under the plan. Assuming the trust adopted the optional revocability provision set forth in Section 1(B) of the model trust, the Company retains the power to direct the Trustee to return the assets allocable to the discharged benefit liability, without creating an "exclusive purpose" issue under Section 1(d). You'll observe that model trust prohibits employer reversions only if the trust is irrevocable. See Section 4 of the model trust. Even if the plan doesn't have language analogous to Section 2© of the model trust, the employer has no obligation to contribute to the rabbi trust, so it could obtain a reimbursement by offsetting its future contributions to the trust by the amount of the payments made directly from nontrust assets. If the plan is an individual account plan, this would be a simple bookkeeping adjustment, in effect reallocating the assets attributable to the account balance of the recipient to active participants.

I'm guessing that the securities of the foreign parent are not registered under the Securities Act of 1933. A foreign issuer may rely on one of several exemptions: (1) private placement, (2) a Regulation D offering or (3) a Rule 701 offering. If the stock option plan will be broad-based, then Rule 701 provides the most flexibility. Rule 701 does not restrict the number of offerees or their level of sophistication. It's principal limitation is that it only applies to arrangements that are part of a compensatory plan, that is not part of a capital-raising device. Under the rule, the maximum value of securities that may be sold in a 12-month period is the greatest of: (1) $1 million; (2) 15% of the foreign issuer's total assets, or (3) 15% of the value of the outstanding securities of the class subject to the option plan. No disclosure other than a delivery of a copy of the relevant benefit plan is required by Rule 701 so long as sales do not exceed $5 million in a 12-month period. If an issuer sells securities with an aggregate offering price of more than $5 million, the issuer must provide disclosure to each individual optionee holding an exercisable option, not just those who acquire shares after the $5 million threshhold is exceeded. These disclosures include financial statements including in the case of foreign issuers, a U.S. GAAP reconciliation and unaudited financial statements for the prior 2 fiscal years. Foreign issuers may wish to structure their option grants to U.S. employees to avoid exceeding the $5 million limit, so that they do not have the burden of preparing financial information not otherwise required by their home country.

As a starting point you want to familiarize yourself with the "plan asset" regulations set forth in DOL Reg. Sec. 2510.3-102, which provide that amounts that an employer withholds from an employees paycheck for contribution to a pension benefit plan become "plan assets" as soon as they "can be reasonably segregated from the employer's general assets," but in no case later than the 15th business day of the month following the month in which the amounts were withheld. The outside limit is definitely not a safe harbor and I've never heard of a case in which the DOL accepted the argument that the outside limit was the earliest date on which they could be reasonably segregated. In most cases, the DOL looks at the level of sophistication of the payroll processing system in place and makes a judgment, in light of the employer's ability to process other payroll deductions. There's no bright line, but in my experience, unless your client is running an antiquated or manual system and so thinly capitalized that it's economically infeasible to upgrade it (tax-exempts are sometimes able to make this sort of factual argument), the DOL would probably not accept a period of more than 10 business days from the date the amounts were withheld. Keep in mind that the nature of the prohibited transaction, which also involves a violation of the ERISA trust requirement and a breach of fiduciary responsibility by the employer, arises because the employer holds "plan assets" outside of ERISA trust solution. A timely filing of Form 5330 may satisfy the Code's tax payment and tax return filing requirements, but it doesn't relieve the fiduciary of exposure to civil penalties. If this is an isolated, minor failure to timely deposit funds within this timeframe, self-correction is probably satisfactory, but you may want to take a closer look at the client's deposit timing, after an objective determination of the "earliest date" under the "plan asset" regs. For chronic violations, it might make sense to consider the DOL's Voluntary Fiduciary Compliance Program, which covers delinquent participant contributions. A successful application results in a no-action letter with respect to DOL civil penalties that otherwise apply.

As a starting point you want to familiarize yourself with the "plan asset" regulations set forth in DOL Reg. Sec. 2510.3-102, which provide that amounts that an employer withholds from an employees paycheck for contribution to a pension benefit plan become "plan assets" as soon as they "can be reasonably segregated from the employer's general assets," but in no case later than the 15th business day of the month following the month in which the amounts were withheld. The outside limit is definitely not a safe harbor and I've never heard of a case in which the DOL accepted the argument that the outside limit was the earliest date on which they could be reasonably segregated. In most cases, the DOL looks at the level of sophistication of the payroll processing system in place and makes a judgment, in light of the employer's ability to process other payroll deductions. There's no bright line, but in my experience, unless your client is running an antiquated or manual system and so thinly capitalized that it's economically infeasible to upgrade it (tax-exempts are sometimes able to make this sort of factual argument), the DOL would probably not accept a period of more than 10 business days from the date the amounts were withheld. Keep in mind that the nature of the prohibited transaction, which also involves a violation of the ERISA trust requirement and a breach of fiduciary responsibility by the employer, arises because the employer holds "plan assets" outside of ERISA trust solution. A timely filing of Form 5330 may satisfy the Code's tax payment and tax return filing requirements, but it doesn't relieve the fiduciary of exposure to civil penalties. If this is an isolated, minor failure to timely deposit funds within this timeframe, self-correction is probably satisfactory, but you may want to take a closer look at the client's deposit timing, after an objective determination of the "earliest date" under the "plan asset" regs. For chronic violations, it might make sense to consider the DOL's Voluntary Fiduciary Compliance Program, which covers delinquent participant contributions. A successful application results in a no-action letter with respect to DOL civil penalties that otherwise apply.

DFVC definitely works as a penalty abatement tool for both DOL and IRS. The IRS has publicly stated that it will not assert its late filing penalty if the deliquency comes to its attention after a DFVC filing. I had the occaision to test this when a client of mine got the standard IRS late filing penalty after a DFVC filing. When I brought the informal policy to the attention of the IRS staff, he completely backed off and withdrew the penalty notice. A "reasonable cause" statement might work if you have a persuasive (i.e. authentic) "reasonable cause." Reg. Sec. 301.6652(g)-5(B) gives you very little guidance. Ignorance of the filing requirement is probably a nonstarter and, since the statement has to be signed under penalty of perjury, it would be unwise for the employer to embellish the facts. The DOL has no statutory authority to accept a "reasonable cause" excuse in lieu of imposing the statutory penalty for a late filing (at least that's been the Department's mantra for many years). So, taking the reasonable cause approach to avoid paying the DFVC sanction leaves the plan exposed to the risk that if the IRS doesn't accept the "reasonable cause" statement, you wont have the protection of having made a DFVC filing, so the IRS can hit the plan with the full late filing penalty, as well as the DOL.

The City Ordinance requires as a term of contracting with the City that every person or entity that enters into or amends a contract or lease with the City not discriminate during the term of the lease or contract in the provision of benefits "between employees with domestic partners and employees with spouses . . . where the domestic partnership has been registered with a governmental entity." See S.F. Admin. Code § 12B.1(B) and § 12B.2(B). The Ordinance aims to require that parties doing business with the City not discriminate based on sexual orientation or marital status. The Ordinance applies to any employee benefits but includes a non-exclusive illustrative [*6] list that includes bereavement leave, family medical leave, health benefits, membership and membership discounts, moving expenses, pension and retirement benefits or travel benefits. Id. at §§ 12B.1(B), § 12B.2(B). As enacted, the Ordinance's nondiscrimination policies apply to: (i) any of the contractor's operations within San Francisco, (ii) a contractor's operations on real property outside of San Francisco owned by the City or which the City has a right to occupy, (iii) a contractor's work in other places outside the City within the United States where work related to a City contract is being performed, and (iv) any of a contractor's operations elsewhere in the United States. Id. at §§ 12B.1(d)(i)-(iv). In Air Transport Association of America v. City and County of San Francisco (ATA), 992 F. Supp. 1149 (N.D. Cal. 1998), the court found that § 12B.1(d)(iv) of the Ordinance is impermissibly extraterritorial under the dormant Commerce Clause, and for the additional reason that the Ordinance offends the Due Process Clause of the Fourteenth Amendment. See also Air Transportation Assoc. of America v. City and County of San Francisco, 1999 U.S. Dist. LEXIS 8747.

Kirk: I don't think the conflict-of-interest argument is very persuasive. Don't you think the employer/issuer of the security has a whopper of a conflict in offering shares to its employees, who at best have only limited voting rights and who probably don't vote their shares anyway. It's a great way for management to insulate themselves (i.e. protect their jobs) from the oversight of shareholders whose only focus is on shareholder value. It really comes down to applying the principles of modern portfolio theory at the participant level, which are not biased one way or the other, about employer securities. Now you can argue that the evaluation of these principles is beyond the ability of most small investors and, therefore, they are subject to manipulation. I've heard of no evidence to support such an allegation. FinancialEngines, for example, was formed and operated by a Nobel laureate in economincs from Stanford Univ. (Bill Sharp). The focus of these firms is not on the particular securities the investor selects, but on measuring the risk-adjusted total portfolio rate of return, so s/he can make better informed decisions.

I think what you are saying is that the loan policy does or should permit the participant to have a $1,000 loan "from the match source only," and secure that loan, which then becomes an interest-bearing asset of the matching contribution account, by pledging a $100 security interest in the matching account and a $900 security interest in his deferral account. Sounds ok, but it's kind of unusual and you'll need special language in the note and security agreement to satisfy the "adequately secured" PT exemption. Except in the case of a principal residence plan loan, the adequacy of the security is not a requirement for avoiding a "deemed distribution." A loan is treated as a "deemed distribution" because it violates one of the requirements set forth in Code Sec. 72(p)(2) in form or operation. For example, the failure to make a scheduled payment by the end of the loan policy's grace period violates the "level amortization" requirement in operation. See Prop. Treas. Reg. 1.72(p)-1, Q&A-3. A loan that satisfied the exemption requirements under Code Section 72(p) at origination and continued to be a fully performing asset (no defaults) is not a "deemed distribution" merely because it ceases to be "adequately secured" before it is repaid. Theoretically, this could happen if the participant's plan account experiences significant unrealized depreciation. [Edited by PJK on 07-17-2000 at 02:17 PM]