Company Stock in a401(k) Plan

[LCARUSI]

If a company offers company stock as an investment option, I believe the company is not required to allow participants to vote the shares. I'm having trouble confirming this point with certainty. Am I correct? (This is not an ESOP.)

Assuming the company is not required to pass through the voting to participants, how do companies handle this? Do companies generally allow participants to vote the shares anyway? If the participants do not vote the shares, who does? If it is the trustee or plan sponsor, are they subject to any particular guidelines for voting the stock?

[QDROphile]

You might want to take a look at ERISA reg section 2550.404©-1(d)(2)(ii)(4) if the plan fiduciaries think they want protection under the 404© safe harbor.

[LCARUSI]

QDROPHILE -

That really isn't my question - but it's certainly an issue to consider.

My question is whether or not the Sponsor must pass through voting rights on the stock to participants?

[QDROphile]

I was trying to add value by bringing up a point that was more likely to be missed in the consideration of your question, and one that might have been sufficient by itself to make up your mind about what to do. Here is a more straight on response: There is no qualification or prohibited transaction requirement outside of ESOPs that compels a pass through. The plan could hold nonvoting stock instead of voting stock. See ERISA 407(d). If the plan terms do not pass through the vote, the trustee, as legal owner, votes the shares. The plan (or trust) document can assign the voting to a fiduciary other than the trustee (beware conflicts of interest, and consider the DOL position on proxy voting). Failure to pass through raises a question. Why did the plan provide for a company stock investment option? A usual answer is that the employer wants an opportunity for the employees to feel like they have a stake in the company. If so, why make them second class stake holders as compared to other shareholders who have a very important ownership right - the right to vote on management of the company? Other answers to the question about having a company stock fund, such as raising capital or preventing a takeover (or some milder version of wanting shares in friendly hands) ought to get some serious reevaluation. All of our clients who are public companies pass through the vote. None of our clients have discretionary company stock investment funds unless they are public companies. I venture that this is the prevailing pattern.

[Guest ESOPwizard]

If the company is not publicly traded and is planning to allow employees to invest 401(k) contributions in employer stock, the company should talk to an SEC attorney first.

[Guest Deborah Grace]

FYI - Even if the stock is publicly traded, the offering of interests to plan participants needs to be registered with the SEC. I believe the form is an S-8.

[Guest dlm]

I believe that the stock only needs registered with SEC if there are participants who live outside of the state in which the corporation exists. We had a situation that was publically traded and the SEC filing was not needed since all ee's in the Plan lived in the State of the corporation.

[Guest woody]

I am a novice here, but I can tell you my company has stock as a match (minimal) and as a fund option in our plan. It is been a big problem as far as valuation and created much higher record keeping cost and has limited us to investment companies who wanted to take our plan. Most big low-cost investment companies do not want our account as so much of the assets is in our own company stock. We are permitted to vote. The stock is placed in a unit trust for valuation purposes and in case of quick liquidation. Personally, I much would have preferred a cash match or no match. If you want to give your employees stock, do them a favor and keep it in options. Perhaps this depends on the industry, but in our plan, it's a problem.

[Guest suziecpa]

Another question -

If you have less than 100 participants in a 401(k) plan and you are a public company who offers company stock as an investment option and also provide the Company match to the Plan in shares of public Company Stock are you required to file an 11K?

I say no, you are exempt as you have less than 100 participants and it does not matter that you are providing matching contibutions in company stock and offering investments. I also think that the ERISA attorney is the one that is reponsible for letting the COmpany know about the requirements to file. The CPA's only perform the certified audit of the Plan.

My boss says look into it. I am pretty sure about my answer,

Shares were registered on form S-8 as required.

Thanks for the input

[Kirk Maldonado]

suziecpa:

If the shares are registered on a Form S-8, the plan must file a Form 11-K, regardless of the size of the plan.

By the way, the vast majority of ERISA attorneys are not terribly proficient on the nuances of securities laws; the number of attorneys who are knowledgeable on both ERISA and securities laws is a pretty select group.

[Guest suziecpa]

hanks so much for the response. I was incorrect though, as I double checked about the S-8 filings. There were no S-8's filed as I guess the shares are not registered and the participant rule would apply and no 11K would be required.

Thanks for your help, these boards are great.

Sue

[Kirk Maldonado]

suziecpa:

Just because the shares were not registered on a Form S-8 does not mean that they shouldn't have been.

If employee contributions can be used to buy employer stock, then those shares must be registered on a Form S-8 (and a Form 11-K must be filed).

Failure to register those shares gives participants a rescission right, which they will exercise if the stock price goes down. In other words, if the shares weren't registered (even though they should have been), the company should consider itself the guarantor that the stock price won't go down.

In today's market place, that is not an enviable place to be in.

[401 Chaos]

Help! We have a 401(k) plan that originally filed an S-8 a few years ago and has just discovered that it blew through the registered shares a couple of years ago. Of course, the value of the stock has declined considerably during that period as well. We are trying to research possible correction alternatives or at least exploring whether there is any option rather than rescission but we are not finding much information--either in the benefits or securities world--on how to handle in a 401(k) plan. Is anybody aware of good discussion of this issue or have tips on how to sort through. Nobody externally has raised an issue with the lack of registration but we're assuming not correcting past violations is not a viable option. Thanks.

[QDROphile]

A common practice in this dilemma is to run for luck through the one-year statute of limitations period. But you really should engage competent counsel to advise about the choices and consequences.

[401 Chaos]

thanks QDRO. We are getting counsel involved.

By "run for luck through the 1 year statute of limitations" do you mean fix the issue by filing new S-8 for future investments but take no action with respect to past violations and just hope no participant seeks to rescind?

If that's the case, it would seem there would arguably be ERISA fiduciary obligations to alert participants to the rescission apart from the securities law issues if not to affirmatively correct. Seems it is also probably impossible for a company to remain silent on these issues in its other securities filings. I see from the most recent Dell 10-K, for example, that they potentially failed to register some 37 million shares over the past several years and that they acknowledge certain participants might have rescission rights and that they may be subject to civil penalties, etc. but didn's see where they had taken any action to correct.

[QDROphile]

Tell me more about why the fiduciary should be suggesting that the participants might take some action when the participants got exactly what they bargained for and expected and were not harmed by the technical failure to register. I don't think a fiduciary has a duty to provide a windfall to participants. Also, the rescission is likely to be an administrative burden to the plan. It is also stupid to have the employer in a fiduciary position. Sorry, can't resist that gratuitous comment, but the fiduciary issue might not be confusing things if better planning had been done in the first place.

[GBurns]

What about the voting rights?

[401 Chaos]

QDRO, I don't really disagree with your comments. Some would have preferred they get rid of the employer stock fund long ago for a host of reasons.

I don't know though how the Plan Administrator (knowing of the potential right to rescind) can remain silent about the participants' ability to reverse their losses over the past couple of years given the fiduciary's obligation to act solely in the best interests of the participants. I agree they all got exactly what they wanted / sought and had all the information they would have had if the S-8 had been filed, etc. At the end though it seems this "windfall" would clearly be in the participants best interests and thus the fiduciary's duty might be pretty clear. (If some participant really wanted the stock, they could just elect not to rescind.) I think this is a bit absurd for an immaterial foot fault but am just not seeing a clear way around for a fiduciary that is aware of the issue. While acknowledging that this isn't the best arrangement, if you take as a given that the fiduciary knows about the issue, do you think they really can sit on that knowledge because it only provides the participants a windfall?

[BeckyMiller]

On voting rights - go to IRC Section 401(a)(22).

401(a)(22) If a defined contribution plan (other than a profit-sharing plan) --

401(a)(22)(A) is established by an employer whose stock is not readily tradable on an established market, and

401(a)(22)(B) after acquiring securities of the employer, more than 10 percent of the total assets of the plan are securities of the employer,

any trust forming part of such plan shall not constitute a qualified trust under this section unless the plan meets the requirements of subsection (e) of section 409. The requirements of subsection (e) of section 409 shall not apply to any employees of an employer who are participants in any defined contribution plan established and maintained by such employer if the stock of such employer is not readily tradable on an established market and the trade or business of such employer consists of publishing on a regular basis a newspaper for general circulation. For purposes of the preceding sentence, subsections (b), ©, (m), and (o) of section 414 shall not apply except for determining whether stock of the employer is not readily tradable on an established market.

Since 401(k) plans CAN be stock bonus plans, you should see if this applies. Note that "readibly tradable" is not the same thing as registered.

[QDROphile]

The fiduciary has to weigh consequences and benefits. I think the situation is likely to have some adverse consequences for the plan (the participants in general). The fiduciary's knowledge of some benefit for some participants does not lead to an automatic conclusion to publicize a securities law violation or push for rescission offers. I did not advocate a particular conclusion, but you have to be careful about a knee-jerk reaction.

[401 Chaos]

QDROphile,

Thanks again for your thoughts. I appreciate your point about needing to weigh the pros and cons. I guess given the large decline in stock price in recent months I was assuming the value (windfall) associated with a rescission would pretty easily outweigh the adverse consequences on the plan but your point about the fiduciary not assuming that is well taken.

FWIW, looks like auditors will likely make company disclose this in its financials so the issue is likely to be disclosed to the public at large and would not be exclusive knowledge of the fiduciary. Still not sure exactly how the fiduciary should think about it's duties / obligations if general disclosure of the issue and potential rescission rights doesn't spark participants to take action--i.e., wonder if fiduciary really needs to push for the rescission on behalf of participants or if it could wash its hands of whole issue by simply having it disclosed and permitting individual participants following up if they desire.

What a mess.

[PAL]

Another question I have related to this is what shares would the participants be entitled to resind? The ones bought after the registered shares ran out, the shares you designate as not being covered? If there is a lot of activity, how would you be able to figure that out exactly which shares those were?

[401 Chaos]

Another question I have related to this is what shares would the participants be entitled to resind? The ones bought after the registered shares ran out, the shares you designate as not being covered? If there is a lot of activity, how would you be able to figure that out exactly which shares those were?

PAL,

I think it would be a real mess but yes in general I think it would apply to any shares purchased after the number of registered shares ran out. It should be possible to determine the time of exhaustion of the registered shares and sort of draw a line for all transactions after that. A number of the unregistered shares will have been sold but it should still be possible to determine if those shares were sold at a loss and make participants whole. In essence, the rescission would basically guarantee that nobody would have lost money on the sales. Earthlink (Mindspring) filed an S-3 back in 2004 that goes into extensive detail on how the rescission would be handled for different participants.

I do suppose it might be possible for some sort of statute of limitations to apply but I'm still not following how the 1 year statute of limitations QDROphile referenced fits in with the 401(k) plan context.

Again, I understand that a fiduciary would have to weigh the pros and cons of such a right but in cases where there is a significant drop in stock price, the effect on the plan would seem to pale in most cases even if the fiduciary had to file suit and litigate the issue on behalf of participants. Of course, the effect on the plan sponsor / employer could be enormous--and might even put them out of business in some cases which could be very bad for active participants--but I am not sure that impact on / cost to the employer should weigh into the fiduciary's analysis with respect to participants' benefits under the Plan.

I remain puzzled that there seems to be little to no press on the issue with respect to the Dell 401(k) Plan. If I were a disgruntled former employee who lost money on Dell shares, I think I would be exploring possible class action suits. Maybe that's not possible though.

Edit: I just did some digging on the Dell situation since the time of my initial post on this and discovered that Dell filed an S-1 a couple of weeks ago providing a rescission offer to what appears to be those participants purchasing shares since March 31, 2006. The amount of repurchases there was limited because Dell had temporarily halted purchases of their shares in 2007 due to their failure to file current returns and I believe they take the position that the general statute of limitations for rights of rescission lapsing 1 year after the offer is made should mean that no participants would have had a legal right to rescind but for their voluntary offer to do so.

That position, however, would not really help in our case since our plan had no blackout on the shares--we just got a new S-8 up as quickly as possible after discovering the issue--and thus had many purchases within the 1 year statute of limitations period. Ignoring the potential rescission rights in hopes that the statute of limitations will run as QDRO suggested brings me back to my initial question / concern with how the plan administrator could really keep silent on this. I do note that the Benefits Committee for the Dell Plan appears to have separate counsel and entered into standstill / tolling agreement with the company to try and preserve participants' rights.