Employer Stock in 401(k) Plan

Here is a question from an ERISA attorney that I have discussions with from time to time. He isn't sure of where to go here, and, after reading it, neither do I. Any opinions would be appreciated, thanks. The only thing I could think of here would be for the employer to buy back the stock from the plan, but don't know if that would fly.

Private employer has for a number of years permitted employees to elect to invest in employer stock through the 401k. The employer stock is darn-near illiquid from a trading perspective – there just isn’t any real market for it. But, the employer stock regularly pays a pretty decent cash dividend. A lot of the employee population is approaching retirement age. People are starting to request distributions that can’t be processed because the stock is illiquid.

If this was an ESOP, I’d say the trustee should have been managing the stock/cash mix for this. In this case, I think there is still a fiduciary responsibility to act but I’m sort of stuck on what that responsibility might be. I’m also concerned that we’d be violating distribution rules if we just say “sorry, illiquid stock.”

Is the issuer of the employer securities a C corporation or an S corporation?

Does the issuer's certificate of incorporation restrict stock ownership to employees?

What does the plan provide about whether a distribution is, to the extent an account has employer securities, a delivery of the employer securities (and not a payment of money)?

And are you also dealing with securities law violations, just to make it more interesting?

The attorney's response to Peter's reply above was:

Practically speaking, for various reasons relating to corporate law, the current distribution of shares would be difficult or impossible.

Therefore, would buyback of the shares held in the plan by the plan sponsor be an option?

I have the same situation and thankfully the employer deposits cash into the terminated participant's account to purchase, and then retire, the stock, every time without delay.  

The employer pays for an outside valuation of the stock annually, so the price changes once per year. 

It would be inappropriate to attempt even a general answer without seeing much more information, including information that might be improper or unwise to communicate without a lawyer-client relationship.

If your friend the ERISA lawyer wants my suggestions about how to sort the issues, that person is welcome to call me.

Lawyers’ professional-conduct rules allow ways for a lawyer to reveal her client’s confidential information to get another lawyer’s advice about the client’s matter or the lawyer’s conduct. I often help as a lawyer’s lawyer.

I agree with Peter - you could also convert the 401(k) into a KSOP so that the dividends could be deductible to the Employer, if they are as significant as stated.

Unless the stock is publicly traded, there is no 404(c) protection. Fiduciary duties include liquidity.

Also, I concur with Bill's comment as to potential securities law issue.

bzorc, I still agree with all prior answers (which only pointed out problems, not a way forward, unfortunately), but would point out that you can probably find a boutique IRA custodian that would take the rollovers. Of course this assumes that the employee has elected to take an in-kind distribution instead of cash.

"would buyback of the shares held in the plan by the plan sponsor be an option?"

BZorc, be very careful of this alternative.   I'm assuming the plan is a KSOP, in order to permit the fiduciaries to offer an un-diversified investment fund.  Under the ESOP regulations, a purchase by the plan sponsor (a disqualified person) from the plan is required to be priced at the FMV as of the date of the transaction, not at the price determined by an annual valuation.  Otherwise it is a prohibited transaction.

jsample's approach of having the employer contribute cash to retire the shares upon a distribution is safe.

This scenario is described in an NCEO publication on ESOPs called "Don't Do That!"