EGTRRA affect on ESOPS

[Guest Ralph]

Hoes does EGTRRA affect dividends for stock of closely-held companies?

[MWeddell]

EGTRRA allows dividends to be deductible on employer stock held by an ESOP if participants are given the election to receive them in cash as pass-through dividends or let them remain in the plan and be reinvested in employer stock. The change affects plan sponsors with publicly-traded or privately-held stock in the same manner -- there's no distinction made in the legislation.

As before, one generally may not give employees an investment decision whether to invest a part of their account in privately-held employer stock or else the stock must be registered under securities laws.

[IRC401]

Doesn't the SEC rule apply only to accounts derived from what the SEC regards as employee money so that there would be no problem reinvesting dividends derived from employer contributions?

[ Please feel free to move the discussion to the SEC board.]

[RLL]

In the early or mid-1980's, the SEC ruled that a section 401(k) cash or deferred election (involving an investment in employer stock) with respect to only bonuses would be exempt from registration under the '33 Act. The SEC held that, unlike a 401(k) salary reduction election, there was no "out-of-pocket" investment by participants. This same rationale might apply with respect to the dividend reinvestment feature of a non-contributory ESOP.

[Kirk Maldonado]

What RLL is referring to is the SEC No-Action Letter issued to

Diasonics, avail. Dec. 29, 1982.

My personal view is that the SEC's reasoning in that letter is flawed, and I don't recommend relying upon it.

[IRC401]

[Please feel free to move this to the SEC Board]

Kirk-

Suppose that a privately held C corporation has a leveraged ESOP (with any 401(k) feature) and pays a dividend on the stock. Prior to the 2001 Act, dividends on stock allocated to participant accounts are reinvested in more stock. After the 2001 Act the plan is amended so that participants have the option to take the dividends or leave them in the plan to be reinvested in employer stock.

Is it your position that the stock should now be registered with the SEC?

Would it have made any difference if the ESOP had a provision allowing for in-service withdrawals?

Thank you.

[Kirk Maldonado]

RLL:

1. The SEC's position is that stock is required to be registered (assuming that there is no exemption from registration) only if employee contributions can be invested in employer stock. I do not believe that dividends should be treated as employee contributions, even if the employee had the right to direct the investment of the dividends.

2. It becomes a lot more difficult where the plan has a in-service distribution feature. The only authority that I'm aware of states that if employees have the right to receive a cash distribution (in lieu of the amounts being invested in employer stock) at the time a profit sharing plan is converted into an ESOP, then the registration requirements would apply.

Thus, the rules can be summarized as follows: If the money is attributable to employer contributions, then investing those amounts in employer stock in the same plan doesn't trigger the registration requirements. However, if those amounts are transferred from one plan to another at the election of the employee (e.g., by means of a rollover contribution), then the registration requirements would apply if the amounts are invested in employer stock in the second plan.

Unfortunately, where there is an in-service distribution feature present, there is no authority. Because the employee has the right to get a distribution of those funds, the employee could be deemed to have contributed those amounts to that plan. However, I think that is a stretch. Consequently, I do not believe that the registration requirements would apply here.

Even if they did, though, you would probably be able to use Rule 701.