Early Diversification?

[TBob]

An ESOP for an S-Corporation has all of the match and profit sharing contribution tied up in employer stock. The plan has not been in existance for 10 years yet so they haven't encountered the diversification requirement yet. Deferral contributions are invested in mutual funds but participant have the ability to transfer a portion of their deferrals to ER stock once per year.

The plan sponsor is wondering if there is anything preventing them from allowing the participants to diversify their investments now? The document does not appear to address this question directly (Corbel ESOP Document). Is there anything restricting them from allowing diversification once a year. If they can allow this now, is there a percent of the participants account that it would be prudent to limit the diversification to?

Any thoughts would be appreciated.

[RLL]

It is certainly OK to allow for diversification options beyond what is required under the Internal Revenue Code. The ESOP plan document must be amended to allow for the new diversification options that will be made available to the participants.

You mentioned that a Corbel ESOP Document is being used. I hope that an experienced lawyer is advising the company with respect to the ESOP. Inasmuch as employee elective deferrals are already being used to purchase employer stock, there is a need to provide sufficient disclosure (regarding the company and its stock) to participants to assure compliance with applicable federal and state securities laws (with respect to the offering of stock). Making available expanded diversification options will involve additional events that may require further securities law disclosures (with respect to the opportunities for participants to sell employer stock).

Another concern should be assuring that there will be sufficient liquidity to honor participant requests to diversify out of employer stock, such as matching up buyers and sellers. In addition, close attention should be paid to the valuation of employer stock and the timeliness of the appraisal.