Completely Remove Illiquid Private Company Stock from Plan

[Anagoge]

Imagine a standard corporate 401(k) plan (not ESOP, etc.) with illiquid private company stock as an investment in the plan (<2% of plan assets). The company now believes that including the stock in the plan may not have been a good idea, due to additional fidicuary risk, accounting complications, limited liquidity, limited company growth, etc. They don't want to move the stock to another plan, but completely remove it from the existing plan somehow.

What are their options to remove the company stock, beyond terminating the plan? Can they have it valued by an independent third party (which they already do) and credit the participants with cash in the plan in exchange for buying back the stock? Or can they force the stock out some other way? I don't think they can force distribute the stock out to IRAs for each active participant, since there is no distributable event to make that legal.

Do they have any reasonable options to eventually get to a plan with no company stock in it? I haven't been able to locate any white papers or DOL guidance on this topic.

[Peter Gulia]

Does this plan provide participant-directed investment?

If so, does a participant's power to direct apply to her whole plan account, or only some portions of it?

Did each participant choose to allocate employer securities to her account? Or did another fiduciary decide to contribute employer securities to participants' accounts?

Was the investment in employer securities a discretionary fiduciary decision? Or did the plan document mandate investment in employer securities?

[Anagoge]

The plan is participant directed. All investment options are participant chosen, though stock purchases can only happen when shares are available, either when participants currently holding stock are offering it for trade for cash at the current valuation price, or when the board approves an offering of stock to the plan for participants to purchase. These purchases are rare and have not happened in a few years, with the exception of sales to roll out accounts for terminated participants. The stock is valued regularly by an independent third party.

The employer securities were purchased by choice by each individual participant (not given by the employer as profit sharing, etc.). They have not received any requests from non-terminated participants to cash out their company stock the last few years, despite the stock being worth less than it was 5-6 years ago. Part of the reason is probably the tiny % of plan assets the stock represents. And I don't believe many/any participants have more than 10% of their individual account allocated to the stock.

The plan document does not mandate investment in company stock or offering it in the plan. There is a short investment policy statement of sorts that has some guidelines for the operational procedures of the stock (maximum % it can be of any account, how/when to purchase, when to value it, etc.), but it appears to be separate from the plan document.

[Peter Gulia]

What if the corporation offers to pay each participant's account a purchase price per share that an independent fiduciary finds is more than what would be the fair market value? Could the corporation offer a purchase price high enough that every participant would be motivated to tender her account's shares?

[ESOP Guy]

Why can't the plan sponsor just require the people to sell the stock? I mean if they don' think it is an appropriate invesment for the plan then why can't they remove it from the plan? They remove mutual funds that no longer fit the plan all the time. Ok, most of the time they replace it with a new mutual fund they think is better or the same type but you can force participants out of investments in a plan the last time I checked. The fact it is participant directed doesn't change the fact the trustee is the trustee and has powers of the trustee. It also doesn't change the fact they shouldn't allow people to choose an investment that doesn't belong on a plan.

[QDROphile]

ESOP Guy is correct. The exact procedures for taking stock out of the plan depend on whether the employer determines not to allow the stock as an investment or the fiduciary determines that the stock is not allowed. Plan terms and any administrative investment procedures must be followed or changed, and the transaction must be conducted in accordance with the prohibited transaction exemptions. If the plan provides for distribution of employer securities, then the appropriate steps must be taken to comply with section 411(d)(6).

[Anagoge]

I think the company is in a difficult situation, since I believe many employees are interested in maintaining the stock in the plan (no complaints about it being there and no requests to sell) and even purchasing new stock, but the management may not be as excited about the fiduciary responsibility, added complexity, and risk involved (should the company's fortunes decline).

They could offer to buy the stock back at a fair price, but I'm not sure how well that would go over. Ideally, they would be able to extract the stock from the plan into IRAs so the employees could optionally keep it that wanted it, but remove the fiduciary responsibility and risk of having it in the plan. I don't think that is possible though, without IRS penalties, due to there being no distributable event triggering the distribution. They are not currently allowing new purchases of stock due to the feeling of risk and stock declines they experienced in the 2007 market crash.

Currently, terminated employees are cashed out of their stock at the current stock valuation and the stock is not distributed in-kind.

I will float the buy out idea, but I'm not convinved they will bite.

[BG5150]

The trustees have to weigh the pros and cons of eliminating the stock as an investment.

One one hand, it seems as the participants want it in there. (Why, if the company itself sees not much upside to the stock?)

On the other hand, the trustees must act in (what they believe to be) the best interests of the participants. That may or may not coincide with participant wishes.

If the participant really like owning a part of the company, could the existing stock be left in the plan, and other opportunities be offered outside the plan to purchase the securities? And not allow any new purchases within the plan? (I've seen this done numerous times with fund lineups). Make sure you allow the participants the ability to get out and move to other funds if they want to. This way, I think, the trustees are covered somewhat. The plan is no longer offering a "bad" investment, except to the people who really decide to be in it.

A couple thoughts that may or may not mean anything:

Does it cost a lot to value the stock? Can that cost be borne by the participants as a group, or only those who have it as an investment?

Could the plan sponsor send out a memo stating: "Hey, really really don't think this stock is a good fit for your retirement plan, so you can get out if you want. Don't blame us if that investment does not perform to your liking."

[ESOP Guy]

Could the plan sponsor send out a memo stating: "Hey, really really don't think this stock is a good fit for your retirement plan, so you can get out if you want. Don't blame us if that investment does not perform to your liking."

Wouldn't putting in writing that they don't think the stock is a good fit for a retirement plan pretty much be putting in writing they aren't doing their job as fiduciaries by allowing an investment in the plan that doesn't belong there? In all seriousness wouldn't that memo become Exhibit A in a stock drop lawsuit by the plaintiff's attorney?

[BG5150]

Maybe at one point, it was a viable option, and now it isn't. From what it seems, the company is not forcing people into the stock.

Plans do this all the time, but probably with the "it's not a good investment" line.

Fund A is no longer available for new investments. We have chosen fund X as its replacement. You can leave your money in A, or transfer it to any other investment allowable in the plan.

Replace "Fund A" with this company's "stock investment".