Diversification

[stephen]

What is the proper method of correction if a company fails to offer the election to qualifying participants? In some instances, the qualifying election period has already passed.

[BeckyMiller]

I am not sure that there is a "proper" method for correction. I would look to the fundamental principal behind the whole correction concept - put the affected participant into the same position that he or she would have been had the diversification election been offered.

1. That means that the participant had a choice. Since it is 20/20 hindsight at this point, I think you have to assume that the participant would have made whatever choice would have been correct based upon the known facts following the original election date.

2. If that meant that the participant would have diversified, treat them as having diversified at that price. Provide them with lost earnings. To the extent that the shares earned income while in the plan for this period, I think you can reduce the adjustment for lost earnings by these actual earnings. But, that is personal opinion.

3. If that means that means that they wouldn't have diversified (stock price rapidly rising at a faster rate than other investment options.) I think you have to deal with the potentially tougher question. What additional opportunities, if any, do you have to give them to diversify. Can you just ask them what they want to do at the point the error is discovered? Does the failure to meet the statutory standard subject the plan to the broader issues of securities law effects, penalties on distribution, etc.?

4. In either case, do you have to give them future diversification elections to make up the ones they missed? I think it would be clear that if you missed the first 2 elections, the participant gets the remaining 4. But, what if, as you outlined, they missed all 6 election periods? I have heard competent ESOP advisors suggest that the correction would require just one election at 50% and others suggest that the participant should be granted more periods.

Obviously, this is an unsettled area. Periodically, Peat Marwick will publish a summary of recent settlements under the voluntary correction program. You might see if you can find one of those listings and see if this question has been submitted to the IRS by some other poor unfortunate.