ESOP: Segregation of accounts

[Guest John Nelson]

Many ESOP plan documents allow the Plan Administrator to segregate the vested portion of a participant's account into a separate savings account following the participant's termination of employment. The segregated account is credited with interest, and no longer shares in the Plan's gains or losses attributable to company stock.

The idea, as best as I can summarize, is to limit the rewards and risks of stock ownership to those participants who are still working for the company and thereby contributing to the company's success. (Of course, segregation of accounts into an interest-bearing savings account might turn out to be a good deal for the former employees if the value of the company stock later goes down.)

The ESOP certainly can't force former employees to withdraw their vested benefit (at least in those circumstances where the vested benefit is greater than $5K), but can the ESOP in effect "force" these participants out of company stock (subject of course to the participant's right to later demand distribution in the form of company stock)? What are the statutory/regulatory authorities to permit this?

Thank you.

[Kirk Maldonado]

I think that you have a serious Section 411(a)(11) issue.

[BeckyMiller]

Kirk - Are you saying that this is a significant detriment, as discussed in Rev. Rul. 96-47? I know Alan Tawshunsky discussed an ESOP type situation at a professional session. In his hypothetical, he suggested that if the participant had several investment options, including a company stock fund and former employees were allowed to stay in all options, but the company stock fund, he would not see it as a "significant detriment."

In the question posed, the segregation went into a savings account. That could be a significant detriment as was discussed in the ruling if the shares have been doing very well and the interest rate on the segregated amounts are consistently lower.

I can see lots of fiduciary issues, particularly in many plans where the fiduciary is permitted to segregate, but not required to segregate. So I am not a big fan of this provision.

But, if this language is in the plan document and they have received a determination letter, does the sponsor have any protection? Does that protection change if the language was permissive, not mandatory?

[KJohnson]

Corey Rosen reports in his column on the NCEO website that there was a TAM allowing this back in November 2001. You can find the column here

http://www.nceo.org/columns/cr116.html

I haven't gone back to look for it. If you do, will you post it?

Also, I couldn't locate the actual edition, but apparently the Journal of Employee Ownership Law and Finance had an article about this issue in the Winter 2000 edition.

[Kirk Maldonado]

1. Remember that a TAM or PLR is only binding on the employer that receives it.

2. The blurb in Corey Rosen's column does not state that the TAM squarely faced the issue as to whether or not this arrangement violates 411. (That doesn't mean that the TAM didn't directly address this question, though.)

3. Getting a favorable determination letter should protect you if the language in the plan is specific.

4. I wouldn't make the plan language permissive; it is much safer to be mandatory. If it is permissive, then you have fiduciary issues.

5. I think that you are OK if you allow the participant to choose whether the account remains invested in company stock or is invested in some other fashion. The problem arises because some ESOPs require that the amounts can no longer be invested in company stock once the participant's employment is terminated.