Annual Valuation

[IRA]

My client has a KSOP. It gets only one annual valuation each year and uses that value for the entire year to purchase company stock through 401(k) deferrals (offered as an option under the 401(k) feature -- I know, don't go there).

The client is closely held, but does have two or three brokers who will from time to time trade the shares; assume the stock is considered not traded on an established market.

The FMV for the traded stock is consistently higher than the appraised value. Assume there have been no transactions between the plan and any disqualified person other than contributions of stock for the ESOP and purchases of stock through the 401(k) deferrals. The ESOP is not leveraged.

Is there a problem with using the annual valuation when the client knows that value is lower on a consistent basis when compared to the market price the brokers get for the stock? FYI, the company uses the appraisal value for all relevant purposes, e.g., including for the 404 deduction limits, 415 limits, etc.

Any thoughts would be appreciated.

[QDROphile]

Do the valutions take into account the transactions? What do they say about the transactions? If the valuations do not address the transactions, the fiduciary is not adequately reviewing the valuations for purposes of establishing the value of the shares.

[Guest tmills]

401(a)(28)© requires the use of an independent appraiser to determine the value of securities not readily tradable on an established market, as it appears the stock in question is not. Assuming the appraiser is independent, the trustee reviews and questions the report, etc. I don't see a problem. The fact that the brokers are effectively overpaying, should not be a concern of the sponsor, and I don't see that what they pay can be determined to be FMV. The code (and certainly the document) say use the appraiser's value. If the appraiser has not already factored the transactions you mention into the report, the trustee should at least ask the question. It will be interesting to hear what others say.

[IRA]

The appraiser does take the transactions into account, but the appraisal is done just once a year. It can't take into account subsequent transactions.

The brokers are just selling the stock for what the market will bear. I wouldn't say they are overpaying.

Obviously, if the brokers were selling it for lower than the appraised value then we would have a problem and at a minimum the trustee would have to make an independent determination as to whether the appraised value is the correct value. Here, the appraised value is lower than the "market" value so it seems easy to say no harm to the plan/no foul, at worst it is a self-correcting PT.

Any other thoughts?

[RLL]

The problem with using the appraisal is that it becomes "stale." The year-end valuation does not necessarily represent "fair market value" throughout the year. If the value of the company is rising, KSOP sellers are receiving less than FMV; if value is dropping, KSOP buyers are paying more than FMV. The problem increases with the passage of time. Later in the year the disparity may become significant.

Is the company (or any other party in interest) buying shares from, or selling shares to, the KSOP? If so, there may be prohibited transactions resulting from using a stale valuation.

What disclosure is being provided to participants? Disclosure of material facts may be required to comply with applicable federal and/or state securities laws. In addition, if participants are acquiring or disposing of shares within the KSOP, the fiduciaries should be disclosing the fact that the appraisal is "as of" the prior year-end valuation date and may no longer represent FMV.

The existence of outside trading complicates this situation. Have participants been informed about the outside trading prices for the shares? The changes in trading prices throughout the year may reflect changes in the FMV of the shares from the prior year-end appraisal.

[IRA]

Everyone, good analysis. Thank you. We've got the securities laws aspects covered. On the PT/adequate consideration side, I'm inclined to focus in on the different advice, including that of TMills who said, "If the appraiser has not already factored the transactions you mention into the report, the trustee should at least ask the question" and that the brokers' sales are not necessarily determinative of FMV. Since the purchase of shares by the KSOP from the company is a transaction with a disqualified person, the bottom line is the trustee must in good faith make a determination as to whether the appraised price as of the date of the transaction is adequate consideration. As RLL noted, that value can become "stale."

I think to be prudent the trustee should at least document why he/she thinks the appraisal price is still good despite the brokers' sales. While this may increase administrative expense and burden as the year goes by (purchases are made every payroll period), I'm beginning to believe this is an unavoidable problem with KSOPs. I'm surprised that with all the commentary out there on KSOPs that I found nothing that addresses this.

If anyone has any other thoughts, please chime in.