Use of exempt loan proceeds

[Guest Cribbet]

Publicly traded company sponsors ESOP. The company wants to facilitate diversification of the accounts. Therefore, participants will be allowed to diversify the portion of their accounts currently invested in company stock. To accomplish this, the company wants to make an exempt loan to the ESOP adequate to cover the diversification so that the trustee will not have to sell company stock. The loan will be secured only by the company stock. Is this an impermissible use of exempt loan proceeds, since the trustee already owns the company stock?

[RLL]

Hi Cribbet ---

The proceeds of an "exempt" ESOP loan under IRC section 4975(d)(3) and ERISA section 408(B)(3) can only be used by the ESOP to acquire employer stock or to refinance an existing ESOP loan. Such an "exempt" ESOP loan cannot be used to provide funds for ESOP diversification.

However, if the proposed loan did not involve a party in interest (it is not from or guaranteed by a party in interest, such as the employer), it would likely not fall within the purview of the prohibited transaction rules....although it would still be subject to the fiduciary rules of ERISA section 404(a)(1).

An easier solution might be to amend the ESOP to provide for effecting diversification through benefit distributions (rather than through investments under the ESOP). Shares of employer stock could then be distributed to participants who elect diversification. If the trustee or employer did not want employer stock distributed, it is possible (under a DOL prohibited transaction class exemption) for the employer to make interest-free loans to the ESOP for funding cash benefit distributions.