Substantially all assets invested in employer stock

[LIBERTYKID]

ESOP provides for all salary deferrals and matching contributions to be invested in employer stock. Plan intended to provide for the standard 55 and 10 diversification option. Participants are now asking for an election out of stock on a yearly basis. (must have been something in the news lately). Will the plan still remain an ESOP if this yearly election is provided?

1. I assume the percentage of stock held by the ESOP will have to be monitored to ensure compliance with the primarily invested in employer stock requirement. Let's assume more than 50% of assets will always remain in employer stock.

2. It appears that what is being done is making the 55 and 10 diversification option more liberal. I previously asked a question re: this and was told it can be done but there may be securities concerns. I think the right to demand employer securites would apply to the shares that are diversified prior to a particiipant attaining 55 and 10.

What am I missing? Any comments.

[IRC401]

1. See ERISA section 407(B).

2. If elective deferrals are being invested in employer stock, and the stock is not publicly traded, have you discussed securties law issues with a securities attorney.

[LIBERTYKID]

With regard to No. 2, the plan is publically traded. With regard to No. 1, if we call the plan as ESOP, provide for the proper voting rights, diversification, and right to elect employer shares with regard to the salary deferral contributions, then doesn't the plan still meet the exception set forth in 407(B)(2)(iii)?

[Kirk Maldonado]

The statute says that an ESOP is must be designed to be primarily invested in employer stock; it does not say that the plan's asssets must be actually primarily invested in employer stock.

[IRC401]

You are correct about the ESOP exception. I forgot how big of a loophole that Congress left.

What you are missing is that there will probably be some legislation that results from the Enron debacle. (I didn't state that it would be good legislation.) If Congress repeals the ESOP exception and the plan needs to let all participants move their

401(k) accounts out of employer stock, is the plan prepared to deal with that change in the law?

[Kirk Maldonado]

I would be very skeptical about the chances for legislation, in effect, undoing all existing ESOPs. I can't remember a single piece of deleterious ESOP legislation that was retroactive.

This isn't to say that there might not be a prospective change, but such a retroactive change would bankrupt many, if not most, employers sponsoring ESOPS.

Even as short-sighted as Congress is, I can't believe that they would do something that incredibly stupid (and punitive).

[IRC401]

Kirk-

I am not suggesting that Congress would undo all ESOPs. What I am suggesting is that Congress might remove cash or deferred arrangements from ESOPs (which is what I thought they thought (incorrectly) that they were doing in 1997 after the Color Tile bankruptcy).

I am also not suggesting that they would do anything retroactively, but they might require all 401(k) money to have diversification rights as of some date in the near future, which is what it appears that Bush wants for both 401(k) and match money. [Note: I am relying on news reports; I haven't read the bills.]

As for adverse retroactive ESOP legislation, remember IRC 2057 ?

[Kirk Maldonado]

IRC 401:

Now that you viewpoint has become more clear, I think we are in agreement.

I don't think that the ESOP community would strongly fight divorcing Section 401(k) features from ESOPs.

I could forsee some addiitonal expansion of the diversification requirements.

Section 2057 was a total fluke. It represents perhaps the all-time low mark in Congressional legislative drafting skills.

I don't think that it is precedent for retroactive changes in the future. It conferred a unintentional benefit that was devoid of any public policy behind the unintended benefit. It was the result of people being asleep at the switch.

[RLL]

Hi IRC401 and Kirk ---

It appears that the President's proposal would adversely affect those companies (particularly closely-held companies) that provide a matching contribution to an ESOP that is either combined with or separate from the 401(k) plan. This is a common arrangement in ESOP companies. A closely-held ESOP company would find it very difficult to live with a rule allowing all participants with three years of service to be able to sell company stock (provided as a match) at any time. The ESOP community does not welcome this change as it will adversely affect many ESOP companies. Hopefully, if this becomes law, it will include appropriate and fair transitional rules and effective date provisions.

Kirk is correct about the corrective amendment to IRC section 2057. It was not adverse ESOP legislation...but rather was a correction to close a clearly unintended loophole in an ESOP tax incentive (which was also closed by the IRS on an interpretive basis). That corrective legislation was strongly supported by the ESOP community....just as the addition of the S corporation loophole-closing ESOP provision in last year's tax bill was strongly supported by the ESOP community.

Closing such unintended loopholes in ESOP legislation is not adverse to ESOPs, but rather promotes the proper uses of ESOPs. This becomes necessary when unscrupulous, so-called "professionals" and other promoters devise abusive schemes to take improper (and unintended) advantage of tax incentives provided by Congress for legitimate social/business purposes.

[Kirk Maldonado]

I should clarify my prior remark. I don't think that the ESOP community would violently oppose legislation precluding a Section 401(k) feature from being part of an ESOP. My comment was focused solely upon employee contributions being invested in employer stock.

I wasn't focusing upon the matching contributions.

I think that the proposed diversification rules for matching contributions would have a deleterious effect. Rather than encouraging employers to make the contributions in cash, my prediction is that employers will simply stop making any matching contributions.

In fact, if participants keep bringing lawsuits based on Section 401(k) plans, I predict that employers simply won't sponsor them.

I think that any legislation will, in the long-term, hurt the employees that it is intended to protect. With friends like that, who needs enemies?