1042 recycling/fiduciary issues

[Dawn Hafner]

Employer restricts stock ownership only to employees and the ESOP. Prior 1042 transaction was done with the ESOP. When participants are terminating, the employer is purchasing the shares that were in their account back from the ESOP, and using those shares to 1) give stock to management 2) recontribute to the plan.

Issues:

1) 1042 taint is gone when the stock leaves the plan, so recontributed stock is clean as far as 1042 is concerned

2) Because of the stock ownership restrictions, stock is never really distributed from the plan. The purchase of stock is actually a transaction between the ESOP and the employer, not the participant and the employer, so Put Option requirements have no application. Because this is a transaction between the ESOP and the employer (related parties), the stock must be valued as of the date of the purchase.

3) Also a consideration should be the fact that the ESOP trustees are making a fiduciary decision regarding whether it is in the participant's best interest to sell the stock back. I have a hard time justifying the fact that the employer is buying the stock and recontributing it to the plan to get rid of 1042. How can this be supported as a fiduciary decision when the purpose is clearly to benefit 25%+ shareholders?

Comments? Suggestions?

Also, does anyone have the exact cite that requires valuation as of the transaction date for #2 above?

Thanks.

[RLL]

Hi Dawn ---

If the ESOP needs cash to distribute benefits, what choice do the trustees have under the plan documents? Where else will the cash come from? Are there non-stock assets in the ESOP? Does the plan document allow the distribution of shares subject to a mandatory repurchase by the employer?

If there's no other way for the ESOP to make the benefit distributions, the purpose is not to benefit the more-than-25% shareholders.

I'm troubled by your statement that repurchased shares are "given" to management. Isn't there a requirement that the shares be "earned" ?

[RLL]

Dawn ---

The requirement for valuation as of the transaction date is found in ERISA sections 408(e) and 3(18). The repurchase of stock by the employer from the ESOP is a party-in-interest transaction which qualifies for the PT exemption only if it's at a price not less favorable to the ESOP than fair market value. Obviously, this can only be determined as of the transaction date. See the DOL proposed regulation on "adequate consideration" under section 3(18). Also, check out the "valuation" provisions of the IRS's ESOP "requirements" regulations at section 54.4975-11(d)(5).