The One-Stop ESOP Blog

ERISA Records Retention Policy

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Sat, 11 Jul 2009 16:35:00 +0000

Hang On To Your Records discusses two records retention guidelines, the "7-Year Rule" (business records) and the "6-Year Rule" (ERISA records):

But there's an additional retirement plan component to all of this, particularly as the July 31 deadline for filing a Form 5500 for most retirement plans approaches. The myth here is that retirement plan records only have to be retained for a period of at least six years after the date of the filing of an ERISA-related return or report, and that the materials should be preserved in a manner and format (electronic or otherwise) that permits ready retrieval. All records that support the plan's annual reporting and disclosure should be retained, this myth goes.

The post goes on to state that you should maintain records for the life of the plan. This is certainly the most conservative approach. While you may rely on your service providers to maintain your records, remember that it is the responsibility of the Plan Administrator (usually the company) to maintain and retain your records. I recommend that you start by understanding your internal records retention policy as well as the policy of your service provider(s). You should work with your counsel and ESOP consultant to develop a detailed records retention plan.

Record Retention Guide discusses the ERISA retention requirements and states that "all plan-related materials should be kept for a period of at least six years after the date of filing of an ERISA-related return or report, and the materials should be preserved in a manner and format (electronic or otherwise) that permits ready retrieval." It provides a list of documents that a plan must retain for ERISA purposes:

The original signed and dated plan document, and all original signed and dated plan amendments. Make sure the dates and signatures are easily visible;
Copies of all corporate/partnership actions and administrative committee actions relating to the plan;
Copies of all communications to employees. These include Summary Plan Descriptions, Summaries of Material Modifications, and anything else describing the plan that is provided to participants or beneficiaries. Remember to include copies of videos, slides, and e-mails;
A copy of the most recent determination letter from the IRS, or the form to request that determination letter, if one is pending;
All financial reports, including Trustees' reports, journals, ledgers, certified audits, investment analyses, balance sheets, and income and expense statements;
Copies of Form 5500;
Payroll records used to determine eligibility and contributions including details supporting any exclusion from participation. It is critical that sponsors keep complete census data, not just data on those who are eligible;
Hours of service and vesting determinations;
Plan distribution records, including Form 1099Rs;
Corporate income tax returns (to reconcile deductions);
Evidence of the plan's fidelity bond;
Documentation supporting the trust's ownership of the plan's assets;
Copies of all documents relating to plan loans, withdrawals, and distributions. Include copies of spousal consents;
Copies of nondiscrimination and coverage test results;
Any other plan-related materials, such as claims against the plan;

It also discusses retaining electronic records:

According to DOL regulations, electronic media may be used for purposes of complying with the record retention requirements provided the following requirements are met:

The recordkeeping system has reasonable controls to ensure the accuracy of the records;
The recordkeeping system should be capable of indexing, retaining, preserving, retrieving and reproducing the electronic records. The retrieval issue becomes more interesting as equipment is updated and upgraded. For example, records retained on floppy disks may fail this test, if no system drives are maintained to read that media;
The electronic records can be readily converted into legible paper copies;
The electronic recordkeeping system is not subject to restrictions that would inappropriately limit the access to the records.

Most original paper records may be disposed after they are transferred to an electronic recordkeeping system, provided the recordkeeping system complies with the above requirements. It is important to note that the original may not be discarded if it has legal significance or inherent value in its original form (e.g., notarized documents, insurance contracts, stock certificates, and documents executed under seal).

Henry v. Champlain Enterprises, Inc.

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Mon, 06 Jul 2009 17:40:00 +0000

Sotomayor's Second Circuit ERISA Cases provides commentary on five Second Circuit opinions authored by the Supreme Court nominee Sonia Sotomayor, including one ESOP-related case, Henry v. Champlain Enterprises, Inc., 445 F.3d 610 (2d Cir. 2006):

Participants in an Employee Stock Ownership Plan (ESOP) sued U.S. Trust, the plan fiduciary for violating ERISA in connection with the sale of stock to the ESOP. It was alleged that U.S. Trust violated its fiduciary duty to ESOP participants by failing to ensure that a fair price was paid for the stock. The district court found that U.S. Trust violated its fiduciary duty under ERISA and awarded damages. Sotomayor reversed.

The district court found that U.S. Trust failed to produce sufficient documentation of the investigation it undertook in the months leading up to the sale of the stock. According to Sotomayor, however, the detailed notes taken on behalf of U.S. Trust at a key meeting indicated that U.S. Trust had acted with prudence and gave rise to a strong inference that critical issues had been addressed by U.S. Trust before the sale of the stock.

Conceding that various issues needed to be reconsidered by the lower court, Sotomayor set aside the district court's judgment and damages award and sent the case back to the district court for further consideration.

In addition to providing information about the nominee, it also illustrates the importance of documenting the steps you take to Meet Your Fiduciary Responsibilities.

In case you were wondering, Henry v. Champlain Enterprises, Inc. (N.D.N.Y. 2007) was eventually dismissed:

In view of the foregoing, it is not necessary to reach the preliminary matters identified by the Second Circuit. See Henry IV, 445 F.3d at 621-22. Specifically, because the ESOP sustained no damages regardless of the valuation determination, it is unnecessary to further identify the specific errors in the CommutAir valuation, the reasons that a fiduciary such as U.S. Trust should have in all prudence detected those errors, and why an award of prejudgment interest, attorney fees and costs would be appropriate. All of those issues have been made moot by the Agreement of February 28, 2006.

Accordingly, it is ORDERED that all of plaintiffs' claims are DISMISSED and the complaint is DISMISSED in its entirety.

What is the Long-Term Impact of Eliminating Employee Ownership and Control?

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Wed, 01 Jul 2009 23:18:00 +0000

The July 1, 2009 Employee Ownership Update is online and discusses the following:

Special Employee Voting Rights End at SAIC
SEC Approves Path for Monetizing Employee Options
Things Not to Do in an ESOP
NCEO Update

The Update discusses how Science Applications International Corporation (SAIC) has changed their corporate structure, effectively eliminating the employee control of the company, and how the corporate structure and ownership culture has evolved since the IPO:

Science Applications International Corporation (SAIC), once the second-largest majority employee-owned company in the U.S., has changed its stock structure to eliminate the 10-to-1 voting rights that preferred shares held by employees were given when the company went public three years ago. Shareholders (including employees) voted on the change in June. SAIC's board concluded that the arrangement (similar to one at Google) was putting off potential investors. SAIC stock has been basically flat since its IPO, after consistently rising by about 15% per year over its 30-plus years as a private employee-owned company. The culture at SAIC has changed substantially since the IPO. Once structured around a series of semi-autonomous (and sometimes competing) teams, the company has now moved to a more traditional corporate model. SAIC is one of a number of majority employee-owned companies to go public, most of whom share a similar history. At the start, leaders pledge to maintain the company's employee ownership culture along with substantial actual ownership. Over time, both the culture and the ownership share tend to dwindle.

Dr. J. Robert Beyster, the founder of SAIC, discussed the change in SAIC's Employee-Ownership Continues to Shift; Blasi Speaks. In his blog post he shared the four key advantages of providing employee ownership and control:

In my book, The SAIC Solution, I pointed out four key advantages that we enjoyed over our competition because of the kind of employee ownership we practiced at SAIC. These key advantages included:

Employee ownership allows a focus on long-term goals.
Employee ownership helps attract and retain a superior workforce for decentralized growth.
Employee ownership facilitates the alignment of key corporate constituencies.
Employee ownership at SAIC promotes corporate flexibility and adaptability to maintain customer focus.

Employee ownership is important because it is fair for all employees to share with other investors and top management in the value that all of the workers created as a total team. Research now provides strong evidence that the combination of broad-based incentives like employee ownership with teamwork, performance management, and highly trained employees contributes to corporate performance and innovation. This evidence shows that employee ownership is also very good for non-employee shareholders and investors.

I have heard the theory that minority voting control and ownership by employees will unleash SAIC's stock price. I hope the stock price does well but I want to make clear that there is nothing magical about employees owning little of a company. I believe that broad-based employee ownership at all levels was a critical factor in making SAIC so successful in the first place. I hope that the four advantages cited above don't completely evaporate as the company's employee-ownership culture continues to shift to one that is focused on public ownership and Wall Street. I will watch with great interest.

Corey Rosen provides some additional insight on the likelihood of the company sustaining its ownership culture:

Employee owned companies that go public almost invariably see not just the voting power of employees but the ownership culture fade as well. And just as invariably, when they go public, they pledge to retain that culture. A lot of the things that employee ownership companies do to maintain that culture are problematic when public. For instance, open-book management principles can run into insider trading problems. Policies that focus on the long-term value of engaged, participative employees, such as resorting to layoffs only as a last resort or spending considerable resources on training, can cut into short-term profits, displeasing investors whose focus rarely extends beyond the next quarter. High employee involvement in decisions at various corporate levels, as well as their own work, is seen in some quarters as bad management. More egalitarian pay structures are disfavored; investors typically what most incentives to focus just on a few key people (the people who "really matter"). Wall Street likes the conventional; companies like SAIC prospered by being very unconventional.

That's not to say the task is impossible. Many high-tech companies kept their culture (Google, most notably), but investors seem more ready embrace these practices in software companies because it is somehow seen as inherent to the work they do to be more participative. A few other companies, such as Procter & Gamble, have been largely successful in retaining their culture as well. But it is a tough, and usually, losing battle.

For additional information, SAIC vote could end control by employees - Preferred shares would be converted into common stock is a June 19, 2009 pre-vote article that discussed SAIC's ownership culture history and the significance of the vote. Preferred becomes common at SAIC - Shareholders vote for stock conversion is a June 20, 2009 article that discussed the results of the vote.

The Update also discusses the June 17, 2009 ruling by the Securities and Exchange Commission (SEC) that allows employees with vested stock options to use them as collateral in Self-Regulatory Organizations; International Securities Exchange, LLC; Order Granting Approval to a Proposed Rule Change, as Modified by Amendment No. 1, Relating to Margin Requirements (Release No. 34-60127; File No. SR-ISE-2007-121):

On December 24, 2007, pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (the "Act"),¹and Rule 19b-4 thereunder,²the International Securities Exchange, LLC (the "Exchange" or "ISE") filed with the Securities and Exchange Commission (the "Commission") a proposed rule change to modify its margin requirements to facilitate, under certain circumstances, the ability of account holders to use vested and currently exercisable compensatory employee stock options ("Vested Employee Options") issued by publicly traded companies as collateral for writing call options that have the same underlying security as the Vested Employee Options. On April 29, 2009, ISE filed Amendment No. 1. The proposed rule change was published for comment in the Federal Register on May 13, 2009.³The Commission received no comments on the proposed rule change.

I recommend that you check out the redesigned and reorganized NCEO website.

Craig v. Smith, 2009 WL 438635 (S.D. Ind. Feb. 20, 2009)

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Mon, 29 Jun 2009 14:49:00 +0000

The U.S. District Court, Southern District of Indiana, recently ruled in Craig v. Smith, 2009 WL 438635 (S.D. Ind. Feb. 20, 2009) that a company and its ESOP are jointly and severally liable for a breach of fiduciary duties by violating the terms of the plan document and IRC Section 409(h)(5) - Right to demand employer securities; put option - Payment requirement for total distribution by issuing a 10-year promissory note rather than the statutory limit of 5 years:

(h) Right to demand employer securities; put option

(5) Payment requirement for total distribution

If an employer is required to repurchase employer securities which are distributed to the employee as part of a total distribution, the requirements of paragraph (1)(B) shall be treated as met if—

(A) the amount to be paid for the employer securities is paid in substantially equal periodic payments (not less frequently than annually) over a period beginning not later than 30 days after the exercise of the put option described in paragraph (4) and not exceeding 5 years, and

(B) there is adequate security provided and reasonable interest paid on the unpaid amounts referred to in subparagraph (A).

For purposes of this paragraph, the term "total distribution" means the distribution within 1 taxable year to the recipient of the balance to the credit of the recipient's account.

The plan document required "a promissory note which provides that it shall become due and payable in full if the purchaser defaults in payment of any installment payment" as security. The court ruled that the acceleration clause requiring full payment in the event of default constituted adequate security.

The court also issued a ruling on the amount of the judgment.

ESOP Plan Sponsor Held Liable for Issuance of 10-Year Note to Satisfy Repurchase Obligation provides additional analysis of this case, including how an ESOP administrative committee does not eliminate the fiduciary responsibilities of the company:

The court found that the company was a fiduciary because it was the plan administrator. Although the company delegated most of its responsibilities to an ESOP committee, the court stated that the company retained a duty to monitor the ESOP committee and that it failed to do so. In this regard, the court noted that the president, a vice president, and the treasurer of the company were members of the ESOP committee and that they all knew that the ESOP committee was violating the plan and the Code when it approved the issuance of a 10-year note to Craig. The court stated that the ESOP committee members could not "simply forget the information they obtain as ESOP committee members when they are acting as corporate officers." Although the company's fiduciary duties were narrower than the duties of the ESOP committee, the company nevertheless violated its fiduciary duty to monitor the ESOP committee when officers of the company knew of the plan's violation and took no action to correct it.

It also discussed how a participant can only waive rights under ERISA on a knowing and voluntary basis and how the court stated that "ERISA does not excuse the violations of Plan terms because of good intentions."

Elimination of 2010 AGI Income Limitation to Convert an IRA to a Roth IRA

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Wed, 24 Jun 2009 18:26:00 +0000

The Pension Protection Act of 2006 (PPA) provided for Rollovers to Roth IRAs beginning January 1, 2008. Making a Good Deal for Retirement Even Better discusses how the AGI income limitation for most individuals will be eliminated in 2010 and how to prepare for any IRA conversions.

It discusses how you can pay the taxes in 2010 or take advantage of a one-time option to spread the converted amount equally over your 2011 and 2012 tax returns:

The law does provide some wiggle room, however: You can report the amount you convert in 2010 on your tax return for that year. Or, you can spread the amount converted equally across your 2011 and 2012 tax returns, paying any resulting tax in those years. For example, if you convert $50,000 next year and choose not to declare the conversion on your 2010 return, you must declare $25,000 on your tax return for 2011 and $25,000 on you return for 2012. The two-year option is a one-time offer for 2010 conversions.

As tempting as the conversion sounds, the article discusses how it makes no sense to convert if you are using the IRA to pay the taxes:

Financial planners uniformly say it makes no sense to convert to a Roth unless you can pay the taxes from a source other than your IRA. If you need to tap your IRA for the tax money, you're defeating, in part, the purpose of the conversion: to maximize the long-term value of the Roth.

You will still be responsible for any Required Minimum Distributions (RMDs), noting that 2009 RMDs were waived by WRERA.

It also discusses the strategy of maxing out your IRA contributions and then converting them to a Roth and the benefits of setting up two sets of accounts for each investment:

John Blanchard, a 41-year-old executive recruiter in Des Moines, Iowa, has "maxed out" IRA contributions for himself and his wife since 2006 in anticipation of the 2010 rule change. He plans to convert about $34,000 in holdings next year. "If they would let me do more, I would do more," he says. "This planning is purely for retirement."

You could continue this strategy each year after that—opening a traditional IRA and converting it to a Roth. In fact, you would have to use this approach if your income exceeds the limits for making Roth contributions.

But how do you do this—over a number of years—without winding up with multiple Roth accounts? Mr. Slott recommends holding two Roths. When you first convert the assets, put them in your "new" Roth. That way, if that holding suffers a loss in the first year, you can recharacterize it as a traditional IRA so you don't have to pay tax on value that no longer exists. (More on that below.) If the account increases in value before that deadline expires, you could then transfer the assets to your "old" Roth—after the time to recharacterize expires. Each year, you could repeat those two steps…

It's also a good idea to put converted holdings in a new account, rather than an existing Roth. Here's why: If the value of your converted assets falls further—after you have paid taxes on their value—you can change your mind, "recharacterize" the account as a traditional IRA, and, in turn, no longer owe the tax. Later on, you could reconvert the assets to a Roth again. (See IRS Publication 590 for the timing details.) This dilutes the tax benefit if you've combined those converted assets with other Roth holdings that have appreciated in value.

In fact, you might consider opening a separate Roth for each type of investment you make with the converted money. That way, you could "cherry-pick the losers," recharacterizing investments that perform poorly, suggests Mr. Slott. Let's say you made two types of investments—one that doubled in value and another that lost everything. If those investments were in the same Roth, the account value would appear unchanged. But if they were in separate accounts, you could recharacterize the one that suffered—and allow the one doing well to continue appreciating in value as a Roth.

The advantages of Roth IRAs include tax-free withdrawals (generally), tax diversification, no Required Minimum Distributions (RMDs) requirements, and your heirs don't owe income taxes on withdrawals (though the Roth assets are included in an estate's value and must be taken over the lifetime of the beneficiary)

You can choose to roll over all, none, or a portion of an IRA balance, how you should try to avoid rolling over qualified plan assets into the IRA prior to conversion, and the complications created by the pro-rata rule:

The trickiest part of paying the tax for a Roth conversion involves the IRS's pro-rata rule. In short, you can't cherry-pick which assets you wish to convert.

Let's say you have a rollover IRA (from an employer's 401(k) plan) with a balance of $200,000, and an IRA with $50,000. The latter contains $40,000 in nondeductible contributions made over a number of years. As much as you might wish, you can't convert the $40,000 alone—tax-free—to a Roth IRA.

Rather, you have to follow the pro-rata rule. The IRS says you must first add the balance in all your IRAs—in this case, $250,000. Then you divide nondeductible contributions by that balance: $40,000 divided by $250,000. This gives you the percentage—16%, in our example—of any conversion that's tax-free. So, let's say you want to convert $30,000 of your two IRAs to a Roth. The amount of the conversion that would be tax-free would be $4,800 ($30,000 x 0.16)….

"If you're thinking about doing a Roth conversion, leave your 401(k) alone" rather than rolling it into an IRA beforehand to keep your share of nondeductible contributions higher in the calculation above, says John Carl, president of the Retirement Learning Center LLC in New York, which works with investment advisers. And if you've already rolled over your 401(k) into a traditional IRA, you may want to roll it back—a move that many employer plans allow, he adds.

To prepare, you should fund an IRA before December 31, organize your paperwork and prepare documentation for any nondeductible IRA contributions, and determine how you are going to pay for the taxes

The article also includes an Interactive graphic and a link to a Roth Calculator. Other online calculators are also available to assist those who would like to use real numbers:

The Motley Fool – Which will provide more retirement income?
Roth 401(k) or Traditional 401(k)? – Use this calculator to help determine if a Traditional 401(k) or Roth 401(k) might be best for you.
Roth IRA Calculator – Use this calculator to compare the Roth IRA to an ordinary taxable investment.
Roth IRA Conversion – This calculator will show the advantage, if any, of converting your IRA to a Roth.
Roth vs. Traditional IRA – Use this calculator to determine which IRA may be right for you.

Studies: 29% of Companies Have or Intend to Modify Match, Making 401(k) and Financial Education and Advice Available is Top Priority.

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Tue, 23 Jun 2009 10:28:00 +0000

Over the last few months we have discussed how to reduce or eliminate a Traditional Match, a Mid-Year Safe Harbor Match, and a Mid-Year Safe Harbor Nonelective Contribution, and we have discussed Communicating 401(k) Benefit Cuts. We have also discussed Conflicting Surveys on whether employers are reducing or eliminating matching contributions.

401(k) plan benefits: Rethinking plan design for challenging times reports the results of a Grant Thornton LLP survey that explored the impact of the current economic downturn on the employer match feature:

Clearly, the economic downturn is causing many companies to reevaluate their 401(k) plan design carefully, and in many cases, rethink their 401(k) plan strategy. Based on the survey responses, many plan sponsors are assessing whether or not to reduce or eliminate the matching contribution feature under their plans. As part of this plan design assessment, companies may want to consider the potential impact of any such change on future participation in the 401(k) plan by eligible employees. Since many employees, especially the so-called "non-highly compensated employee" group, participate in 401(k) plans because of the matching contribution feature, a key challenge faced by plan sponsors is assessing the impact of reducing or eliminating the matching contribution feature on future plan participation rates. Although generating cost savings are certainly important in a tough economic climate, an ancillary effect of a change in the company matching contribution is the impact on nondiscrimination testing and the resultant correlation to the benefits available under the 401(k) plan for key executives. This could lead to problems in how the company continues to attract, retain and motivate talent, particularly its most critical and top-performing employees, while managing its overall benefit plan costs.

The report provides a summary and supporting information on the results of the survey:

Prevalence of matching contribution feature in 401(k) plans

Almost 87 percent of companies reported that their 401(k) plans provided for matching company contributions prior to 2009.

Modification of matching contribution feature in 401(k) plans

Approximately 29 percent of companies have already modified, or currently intend to modify, the matching contribution feature in their 401(k) plans during the 2009 plan year. Two-thirds of these respondents reported that they will eliminate the match entirely, and 22 percent intend to reduce, but not completely eliminate, the matching contribution during 2009. The remaining 11 percent indicated that they expect to increase the match during 2009.

Impact of modification of matching contribution feature under 401(k) plans

While approximately 34 percent of companies felt that the reduction or complete elimination of the matching contribution feature would make it less likely that the special nondiscrimination tests (the ADP/ACP tests) for 2009 would be passed, approximately 38 percent reported that they did not expect any significant changes in the test results between the 2008 and the 2009 plan years. Almost 10 percent indicated that they felt the test results would actually improve during the 2009 plan year.

Safe harbor 401(k) plans

Approximately one-third of companies with a matching contribution in their 401(k) plans indicated that they currently have a "safe harbor" 401(k) plan. Approximately 27 percent of the plan sponsors with a safe harbor plan indicated that they are considering the reduction or complete elimination of the matching contribution feature during the 2009 plan year.

Impact of modification of match under safe harbor 401(k) plans

Approximately two-thirds of companies with a safe harbor plan that are considering a modification to the match felt that the reduction or elimination of the matching contribution feature will have a negative impact on future plan participation.

Automatic enrollment 401(k) plans

Almost 36 percent of companies with a matching contribution currently have an automatic enrollment feature in their 401(k) plan. Almost 31 percent of these plan sponsors indicated that they are considering the reduction or complete elimination of the matching contribution feature during the 2009 plan year.

Impact of modification of match under automatic enrollment 401(k) plans

Almost 47 percent of companies with an automatic enrollment feature that are considering a modification to the match felt that the reduction or elimination of the matching contribution feature will lead to more participants opting out of automatic enrollment, while 31 percent felt that this would not result in more participant opt-outs.

A press release announces the results of Getting Retirement Savings Back on Track - Employer Views on the 401(k) and Financial Education in the Workplace, a study by CFO Research Services in collaboration with Charles Schwab. As you review the results, consider the potential impact that the New Finance Rules may have on plan sponsors providing financial education and advice to their employees:

Senior Executives Give Current 401(k) System a "B" Grade, Say Workplace Education is Key to Improvement

SAN FRANCISCO--(BUSINESS WIRE)--Charles Schwab, in collaboration with CFO Research Services, today released the details of a new study "Getting Retirement Savings Back on Track: Employer Views on the 401(k) and Financial Education in the Workplace," which reveals that a majority of senior finance and human resource executives in corporate America support the 401(k) as an effective savings tool for retirement. According to the study, employers believe they play a role in improving the 401(k) as a benefit for employees, including making 401(k)-specific and general financial education more available in the workplace.

More than 200 senior finance and human resources executives from large companies in various industries across the nation were questioned about their perceptions of 401(k) plans and the role companies should play in helping their employees plan for retirement. Key findings include:

Eighty percent think greater access to 401(k) investment planning advice is more important for employees now than it was a year ago.
Two-thirds (66%) believe that making broader financial education in the workplace is more important for employees now than a year ago.
Despite negative performance, 51 percent of executives report no change in their 401(k) plan participation rate.
Sixty-three percent say employee concerns over personal finances are creating a more difficult work environment.

According to the study, nearly nine in 10 (88%) of executives report that employees within five years of retirement are very concerned about the adequacy of their retirement planning and more than half of respondents (58%) believe that employees losing confidence in the 401(k) plan is one of the most significant challenges their company will face in the coming year relative to retirement planning.

"Executives recognize that their employees are more anxious about their retirement prospects, and not surprisingly, that apprehension is felt more deeply by those who are closer to retirement," noted Steve Anderson, head of retirement plan services at Charles Schwab. "But what we have found both in this study and through our interactions with companies as a retirement plan provider is that today, employers are more prepared -- and more committed -- to playing a lead role in providing people with access to financial education."

When asked about the importance of different 401(k) plan features, 87 percent of employers say that offering 401(k) investment advice was important to their company's retirement plan – second in importance only to offering a company matching contribution (96%). In addition, 57 percent of respondents report that employee requests for 401(k) advice have increased since September 2008, and 39 percent say that employee requests for broader financial education, such as budgeting and debt management, have increased during the same time period.

Employers Grade 401(k) a "B"

Executives in the survey give little indication that the weak economy or losses in investment value necessitate any widespread changes to 401(k) plans. Respondents report confidence in the underlying structure of their 401(k) plans and believe recent account value losses are linked primarily to the performance of the overall economy, as opposed to problems with the current 401(k) system. When asked to grade the 401(k), a majority of executives surveyed (56%) give the current system a "B", affirming that it is working and needs only slight improvements. (See Figure 1 below)

Figure 1. Finance and human resources executives alike think that the fundamentals of the 401(k) system still work, even in the face of declining investment values. If you used an academic scale to grade the 401(k) system as it currently stands, what grade would you give it?
"A" – The current system works and doesn't need to be changed at all	9%
"B" – The current system works and only needs slight modification	56%
"C" – The current system is generally working, but could use a number of improvements	32%
"D" – The current system is not working and needs wide-scale changes	2%
"F" – The current system does not work and needs to be replaced	1%

Proposed Changes to Improve Americans' Retirement Savings

While the employers surveyed express faith in the fundamentals of the 401(k) system, they also acknowledge that economic troubles have generated more concern among employees and exposed the need for improvements.

According to the study:

Seventy-six percent of respondents said that making investment advice for 401(k) plans more available in the workplace will have a positive impact on employees.
One quarter (25%) are already offering more individualized 401(k) advice to employees in place of broader 401(k) education campaigns, educational brochures and workplace group meetings.
Employers surveyed also show commitment going forward to some existing 401(k) plan features. Seventy-six percent say target-date retirement funds are an important feature to offer in plans, and 66 percent say that automatically enrolling employees into a plan when they are hired is important.
When asked to rate the importance of different factors when evaluating a 401(k) plan provider, employers top three items are financial stability of the plan provider (91%), quality of investment choices available (88%), and mix of investment choices available (84%).

"Consistent with what we are seeing among our own plan sponsor clients, the employers participating in the study and their employees have a very level-headed approach to the 401(k) despite market turmoil," added Anderson. "Employers believe that the 401(k) will continue to be one of the most important tools people have at their disposal to save for retirement."

Issuing and Cancelling Stock Certificates for Stock Distributions

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Mon, 22 Jun 2009 12:40:00 +0000

Last October we discussed technical advice memorandum (TAM) 200841042, which confirmed that ESOP Stock Distributions Subject to Immediate Put Option to Company are Stock Distributions eligible for net unrealized appreciation (NUA) treatment. One of the biggest takeaways from this TAM is the documentation of a distribution process accepted by the IRS. While the documented distribution process has been helpful, questions have come up about the process of issuing and cancelling stock certificates. The distribution process discussed in the TAM involved cancelling the Plan's stock certificate, issuing new certificates to the Plan and to the participant, and then cancelling the participant's stock certificate upon redemption of the shares by the company. The TAM also cited IRS Revenue Ruling 81-158, 1981-1 C.B. 205 - Taxability of beneficiary under a trust which meets the requirements of section 401(a), which provides that a profit sharing distribution occurs upon the delivery of stock certificates to a transfer agent with instructions to reissue them in the name of the distributee.

Should you go through the process of issuing and cancelling stock certificates for each stock distribution? Be Careful to Preserve Beneficial Taxation of ESOP Stock Distributions provides another perspective on the TAM and some takeaways that address the stock certificate issue:

1. It is important to make ESOP stock distributions very carefully, so that the special taxation method is preserved for a former employee who wants to report the "net unrealized appreciation" as a capital gain and pay a lower rate of tax, in lieu of an IRA rollover.

2. It is not necessary to physically distribute a stock certificate to the former employee, if he immediately sells the stock back to the employer. However, it is crucial that the ESOP, the distribution documents and the operating procedures clearly provide that the employee is receiving stock from the ESOP and is immediately selling the stock to the employer.

3. The ruling DOES NOT consider the situation where the ESOP itself purchases the stock from the terminated employee, instead of a purchase by the employer. There is some language in the ruling that implies a sale back to the ESOP would not be eligible for the special method of taxation without first issuing the stock certificate to the employee. Therefore, if the ESOP is purchasing the stock from a terminated employee, and the employee will not be rolling over to an IRA, best practice would be to actually issue a stock certificate to the terminated employee which will then be immediately sold back to the ESOP.

4. What your ESOP and the distribution documents say (and don't say) can be crucial in preserving beneficial tax advantages for the ESOP participants. Those administering the ESOP may have a fiduciary duty to assure the special taxation method is preserved. Your ESOP and distribution documents should be reviewed in light of this IRS ruling.

While issuing and cancelling stock certificates for each stock distribution may end up being overkill and unnecessary, if you want to take a conservative approach, you should consider implementing the best practice of issuing and cancelling stock certificates. At a minimum, you should discuss your stock distribution procedures with an ESOP consultant or attorney.

New Finance Rules May Hurt 401(k) Plan Sponsors

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Fri, 19 Jun 2009 18:29:00 +0000

Earlier this week a Historic Overhaul of Finance Rules was announced:

Consumers: Creates agency with powers over mortgages, credit cards, savings accounts and annuities.

Shareholders: Pushes companies to give investors a greater say on executive compensation.

Hedge Funds: Brings hedge funds under federal regulation for first time.

Home Buyers: Requires lenders to hold a portion of new loans, a big change to the mortgage market.

Derivatives: Brings private trading of complex instruments onto big exchanges.

Big Change in Store for Brokers in Obama's Oversight Overhaul discusses how the changes would hold brokers to a higher fiduciary standard:

Buried in President Obama's proposed regulatory overhaul is a change that could upend Wall Street: Brokers would be held to a higher "fiduciary" standard that would compel them to place their client's interests ahead of their own.

Currently, brokers are only required to offer investments that are "suitable," which means they can't put clients in inappropriate investments, such as a highly risky stock for an 80-year-old grandmother. The move could change the way products are sold and marketed and even how brokers are compensated...

The proposal addresses a long-simmering debate over how brokers and investment advisers, who have traditionally offered more financial-planning advice, are regulated.

For years, investment advisers -- regulated by the Securities and Exchange Commission as part of the Investment Advisers Act of 1940 -- have been held to a fiduciary standard, meaning that in serving the clients, they have to put their clients' interests first. Brokers were excluded from that definition of investment advisers as long as they didn't get paid special compensation for that advice, and gave it as "solely incidental" to their brokerage services.

But over the years, that distinction became more blurred as brokers held themselves out as financial planners, even as they continued to operate under the more lenient standards. Making matters more confusing is the fact that some brokers became dually registered, operating under a suitability standard when they are selling products, but under a fiduciary standard when doling out investment advice....

The change also will give investors more power if they take their broker to court. "If a fiduciary violates his duty -- that is, gives advice which is contaminated by self-interest -- he could be sued not only for damages that have been caused for this advice but could also be sued for punitive damages," says Boston University's Ms. Frankel.

Tougher Financial Regulation Proposals May Hinder 401(k) Plan Sponsors discusses how the change to the fiduciary standard would impact 401(k) plan sponsors:

The proposed change could have big consequences for small plan sponsors, or those with 100 to 300 employees, which typically use brokers to manage their plans. "These employers should find out if their brokers are going to take on this additional responsibility or if it is a deal breaker," Ledbetter said. "Some brokers might decide they don't want to do this because the risk is too high."

As a result, some small plan sponsors might have to find new brokers to manage their plans, he said.

Another concern that some experts have about the proposal is that if it becomes law, it might actually end up watering down how fiduciary standards are currently defined.

"My concern is that they impose a fiduciary standard on brokers but they end up watering it down," said Don Stone, president of Chicago-based Plan Sponsor Advisors. "That would be bad news for all 401(k) plan sponsors."

SMLR’s Annual Fellowship Program

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Tue, 16 Jun 2009 12:03:00 +0000

The June 12, 2009 Employee Ownership Update is online and discusses the following:

Cleveland Launches Major Worker Cooperative Initiative
Rutgers Announces Shared Capitalism Fellowship Awards
Index of British Public Companies with Broad-Based Ownership Outperforms the Market
NCEO LinkedIn Network Reviews Recent Studies and Thinking on Executive Equity Pay

The Update discusses the Shared Capitalism Fellowship Program:

Rutgers University's School of Management and Labor Relations (SMLR) announced that 11 top experts and up-and-coming scholars of employee ownership, profit sharing, and broad-based stock options have been awarded fellowships to study the role that shared capitalism plays in corporations and the economy in general.

SMLR's new annual fellowship program was established with a major gift from J. Robert Beyster and Mary Ann Beyster of La Jolla, California, with a grant from the Foundation for Enterprise Development.

Employee Engagement and Employee Ownership

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Mon, 15 Jun 2009 12:14:00 +0000

He's Just Not That Into You: What Employees Really Think of Their Employers discusses how a recent survey found that less than one third of employees are engaged in their work. It compares the employee engagement issue to parenting young children:

Our emotional needs and issues, it seems, go back to our earliest years. Research and experience seem to make clear that what our four-year-old at home wants and what our forty-year-old at work wants is: a) to feel that they are part of an important, worthwhile group – something larger than themselves; and b) to feel appreciated, valued and respected within that group for their contributions as a teammate. The discussion around the topic of employee engagement, it seems, dances around these twin aspirations. Truly engaged employees feel that they are part of an organization whose purpose, vision and conduct they truly respect, and who also feel that, within the organization, they are appreciated and respected both as a person and for the work they do there.

The article then discusses the connection between employee ownership and employee engagement:

Still, employee ownership has attributes that inherently foster employee engagement. If we think of employee engagement in terms of the two considerations noted above – being part of an organization you respect, and feeling respected by the people of the organization – we can see that employee ownership contributes to both of these dimensions. When you own an interest in a business and you are empowered to help shape the fortunes of that business through participative practices like open-book management, you tend to see greater significance in the organization and how it fares – a greater sense of purpose in your work and your team's work. In contrast, playing the role of hired help who is brought in to do work for the benefit of an organization owned by others is less likely to leave you feeling that you are contributing to a cause that you see great purpose in.

It is equally apparent that employee ownership tends to foster a sense that employee-owners are respected within the organization. Being an owner, after all, is inherently a role that carries an enhanced sense of dignity and status relative that of a mere employee. It represents a kind of citizenship in the organization that is frequently denied to those in traditional employee roles. And, if legal ownership is enhanced with participative involvement – practices that keep employee-owners well-informed of business activity and call for their input – employee-owners will likely feel that they matter to the organization, and that they are respected as contributing partners.

ESOP-Owned Bank Thrives

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Wed, 10 Jun 2009 06:00:00 +0000

Last November we discussed how Thriving ESOP-Owned Banks like the Paducah Bank & Trust Company Keep Employee Turnover Low.

Shared Ownership Helps Bank Thrive in a Downturn discusses how Paducah, a Top Small Workplaces winner and 23% ESOP-Owned, increased their earnings by 24% in 2008 in large part to their commitment to their employees and the community:

Marketing Director Susan Guess has worked with the bank for 10 years and highlights the option for ownership as fundamental to the organization's nature as one of the country's Top Small Workplaces. "We all are a part of achieving that success and we all share in the rewards that are associated with making good decisions and providing superior service," she says.

Paducah Bank's President, Wally Bateman, similarly argues that the ownership program serves to reinforce these values of foresight and quality service. "As an employee sees modest beginnings turn into hundreds of thousands of dollars, it's pretty easy for them to keep their eye on the ball," he says, adding, "Our employees know that it's going to be a long haul. They're not chasing one quarter to the next. If we hold true and steady, in the end the reward for them is going to be tremendous."

In recalling how industry conditions soured nationally, Bateman cites the fundamentals. "In any industry, I think greed has a lot to do with it," he says. "It's a lack of attention to the risk. People try to grow way too fast, and they're so hung up on the numbers."…

Beyond excellent service at the teller window, the bank is held in high esteem among community members in terms of its wider involvement, development and donations. Citing one statistic he's particularly proud of, Bateman explains that for 15 years running Paducah employees have maintained 100 percent participation in The United Way, making the bank the largest single contributor to their local campaign.

2009 Scholarship Award Winners

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Tue, 09 Jun 2009 19:40:00 +0000

2009 Edmunson Scholarship Award Winners announces the winners of the 2009 Charles R. Edmunson Scholarship:

Wayne Violette and Julie Giantonia of BL Companies, Inc., Meriden, CT
Kathy Althoff and Cathy Jordon of CarePro Health Services, Cedar Rapids, IA
Lisa St. John of CHART Rehabilitation of Hawaii, Inc., Honolulu, HI
Kelly Doyle and Lindsay Grace of Hypertherm, Inc., Hanover, NH
Natalya Steinke and Deborah Morelli of MMC Corp, Overland Park, KS
Krys Spare and Barb McMullen of the Monroe Publishing Company, Monroe, MI
Joanne Schwartz and Janelle Hoftiezer of Priority Sign, Inc., Sheboygan, WI
Heather Seid and Nicholas Verna of Social & Scientific Systems, Inc., Silver Spring, MD
Bev Bachmeier and Bob Engkvist of Summers Manufacturing Co., Inc., Maddock, ND
Aaron Lauinger of Ulteig Engineers, Inc., Fargo, ND

Cost to Establish and Maintain an ESOP

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Mon, 08 Jun 2009 18:45:00 +0000

Twelve Bogus Reasons Not to Do an ESOP (and Seven Good Ones) contains a list of twelve fallacies that are are commonly cited as reaons to not implement an employee stock ownership plan (ESOP):

ESOPs have excessively high legal and administrative costs, especially for small firms
The ESOP cannot match what other buyers will offer
The employees don't have the funds to buy the company
Employees must invest in other retirement plans to diversify their investment
Companies have to make a fixed contribution every year
Bank credit for an ESOP loan is not available
Companies have to keep repurchasing their own shares
Management must share financial information with employees
Younger employees are more concerned with short-term cash than with potential retirement benefits
ESOPs are difficult for employees to understand and appreciate
ESOPs do not improve corporate performance
You can only do an ESOP in a public company

COST TO ESTABLISH AND MAINTAIN AN ESOP

Today's post is focused on reason #1: ESOPs have excessively high legal and administrative costs, especially for small firms

To be sure, an ESOP is more expensive than, say, setting up a 401(k) plan, but it is a lot cheaper than selling a business almost any other way. An ESOP will probably cost $50,000 to $100,000 to set up and run the first year and, for most companies with under a few hundred people, $15,000 to $30,000 annually. Selling to another company involves, usually, some tens of thousands of dollars in legal, accounting, and valuation fees, plus, if there is a broker, as there often is, another 5% to 10% of the transaction. There is no broker in an ESOP. So for most sellers of all but the smallest companies, an ESOP is actually much cheaper than selling some other way.

This is one of the fallacies that I see when reviewing mainstream ESOP coverage and talking to non-ESOP business professionals. The cost to implement an ESOP can be significantly less than other forms of business transition. In addition to the tax and legal expenses, a third party sale often involves a broker charging 5-10% of the transaction price. There is no broker involved in an ESOP transaction.

For smaller firms, I want to point out that I am seeing fees lower than the $50,000 - $100,000 that was quoted in the article. Smaller firms should be able to establish an ESOP using qualified ESOP experts for as low as $25,000 to $30,000 and maintain an ESOP for as low as $10,000 to $15,000 per year. More complex structures can push a deal closer to the $50,000+ discussed in the article, but a basic ESOP structure can be established for less without sacrificing the quality of expertise that you are receiving.

Employee Ownership Roundtable and Shared Capitalism Fellowship Program

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Fri, 05 Jun 2009 11:44:00 +0000

Last week we discussed the Current State of Employee Ownership in the academic world. Employee Ownership Foundation and University of Pennsylvania's Center for Organizational Dynamics Hold 2nd Annual Symposium on Employee Ownership discusses the 2nd Annual Roundtable Conversation among Scholars and ESOP Leaders:

The 2009 symposium was broken up into two sessions: morning – how fit and resilient are ESOP companies in the current economic crisis?; afternoon – given their stability and long-term perspectives, are ESOP companies hotbeds for green management and making the business case for sustainable development?...

The paper by Logue and Yates was a jumping off point for the participants that led the discussion on to broader topics such as the survivability of ESOP companies, a question that has yet to be answered in the ESOP community. In fact, the idea that the survival of an ESOP company and the survival of a company are two distinctly different topics that needed to be considered separately was an issue on the table that led to more questions the community and advocates in the room agreed needed to be answered such as – if the ESOP buys the company time before failing, do you still consider it a failure if it did stay in business and keep people employed after it should have folded? Another key issue for discussion was whether employee representation on a company's board of directors is a good or bad development.

The afternoon session quickly morphed into a rapid fire discussion on sustainability of ESOP companies and what needs to be done to make the ownership model a sustainable business model in the larger business community. The question about the value of an ESOP company and whether it can weather an economic crisis better than a traditionally organized business was a very engaging topic for those present as well.

Also, a recent press release announced a shared capitalism fellowship program:

Rutgers Awards Fellowships on Shared Capitalism

School of Management and Labor Relations brings together top experts

May 22, 2009

NEW BRUNSWICK, N.J. – At a time when policymakers and academics are examining fundamental questions about corporate governance and the shape of American capitalism, Rutgers University's School of Management and Labor Relations (SMLR) has brought together – for the first time – 11 top experts and up-and-coming scholars of employee ownership, profit sharing and broad-based stock options to learn about the role that shared capitalism plays in corporations and the economy in general.

SMLR's new, annual fellowship program was established with a major gift from J. Robert Beyster and Mary Ann Beyster of La Jolla, California, with a grant from the Foundation for Enterprise Development.

Dean David Finegold noted that SMLR has some of the world's leading faculty who study employee ownership and is building on that strength to expand research in the field. "The idea of the interdisciplinary fellowships is to bring together and support scholars in a broad range of fields in the social sciences and humanities, and at a range of academic institutions, to carry out independent research under the mentorship of Rutgers' experts in the field," Finegold said.

The fellowship program is coordinated by two Beyster faculty fellows at Rutgers, professors Joseph Blasi and Douglas Kruse. The first cohort of Beyster fellows will work on a wide variety of projects.

Edward Carberry, an assistant professor in business-society management at the Rotterdam School of Management and the first Beyster visiting professor, will report on how employee ownership influences the distribution of power and wealth within corporations.
Joe Hsueh, a doctoral candidate in systems dynamics at MIT's Sloan School of Management, will build an educational computer simulation on the dynamic effects of alternative investment strategies, timing of those strategies for a technology start-up, and tradeoffs of decisions related to compensation and ownership. It also will simulate their impact on employee motivation, productivity, risk, product development, revenue growth, wealth creation and distribution.
Pierre Kremp, a doctoral candidate in sociology at Princeton University, will probe the diffusion of stock ownership in the United States and its consequences on wealth inequality, including a comparison of employee stock ownership and nonemployee stock ownership.
Fidan Ana Kurtukus, an assistant professor of economics at the University of Massachusetts at Amherst, will explore how firms facing different economic conditions use one form of shared capitalism or another to buffer against economic shocks.
Blasi, a professor of human resource management at SMLR, is examining the social and economic history of shared capitalism and related government policy in the United States.
Kruse, a professor of human resource management at SMLR, is analyzing decades of academic scholarship in shared capitalism.

A second group of Rutgers fellows, supported by a grant from the Employee Ownership Foundation, are:

Yuan Jiang, a doctoral candidate in industrial relations and human resources at SMLR, will begin a teaching position at Indiana-Purdue University next year and will consider the relationships among various forms of employee ownership programs and employees' cooperative behaviors to achieve team and company goals.
Nien-Chi Liu, an associate professor and director of the Graduate Institute of Human Resource Management at the National Central University in Taiwan, will investigate broad-based stock incentives and corporate performance and governance.
Paige Ouimet, an assistant professor at the Kenan-Flagler Business School at the University of North Carolina at Chapel Hill, will evaluate how employee ownership programs influence within-firm dynamics among management, labor and shareholders, and how any surplus associated with increased productivity following the adoption of an employee ownership plan is shared among these groups.
Ajnesh Prasad, a doctoral candidate in organizational behavior and industrial relations at the Schulich School of Business at York University in Toronto, will delve into the relationship between organizations' employee ownership plans and their level of engagement with corporate social responsibility.
Peter Thompson, an assistant clinical professor at the College of Business Administration at the University of Illinois at Chicago, will perform an innovative laboratory behavioral economics study of employee ownership.

The fellows program complements the creation of the J. Robert Beyster Professorship of Employee Ownership at SMLR, the "world's first endowed professorship in this field," according to Finegold.

Loan Covenant Best Practices

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Thu, 04 Jun 2009 11:44:00 +0000

Loan Covenants Tighten Up shares some best practices to consider when talking to a lender:

Negotiate and monitor ratios. – Track your key financial ratios monthly.
Prepare to be audited. – Be aware of all the costs associated with providing audited financial statements.
Watch out for a positive cash flow covenant.
Get ready for new rate structures. – Many lenders now have a floor and are using the higher of prime or Libor.
Be prepared for more stringent "personal guarantees."
Know what's typical. – This section includes a great discussion of typical requirements (e.g. insurance, regular financial statements, corporate and guarantor's tax returns).

More Analysis of the Proposed Regulations to Suspend Safe Harbor Nonelective Contributions

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Wed, 03 Jun 2009 12:28:00 +0000

In mid-May we discussed how proposed Treasury Regulation [REG–115699–09] – Suspension or Reduction of Safe Harbor Nonelective Contributions provides for the Suspension or Reduction of Safe Harbor Nonelective Contributions Mid-Year for both a traditional safe harbor plan and a qualified automatic contribution arrangement (QACA). The proposed regulations provide similar guidance to eliminating the safe harbor nonelective contributions that already exist for Mid-Year Safe Harbor Matching Contribution Changes. Unlike reducing or eliminating the match, the nonelective contribution may only be eliminated if there is a substantial business hardship. Needed Relief for Suspension of Safe Harbor Nonelective Contributions Arrives—With a Catch raises concerns with the fourth substantial business hardship requirement that "it is reasonable to expect that the plan will be continued only if the waiver is granted":

While it appears likely that many plan sponsors would meet the first three criteria during these turbulent economic times, the last factor may not apply in many cases and, without further guidance, we do not know how much weight the IRS will give it. In fact, in a recent newsletter discussing the May guidance, the IRS does not list this last factor at all. Perhaps the IRS will provide further insight on the importance of this last factor in connection with finalizing this guidance.

Proposed Regulations on "Exiting" Safe Harbor Nonelective Issued discusses how the proposed regulations can be combined with the Maybe Nonelective Notice to provide more employer discretion:

Therefore, if the employer wishes to have total discretion regarding the use of the safe harbor nonelective during the plan year, the employer must use the maybe notice, which permits the employer total discretion whether to commit to the safe harbor nonelective during the plan year. The new proposed exiting rules thus complement and work in tandem with, but do not replace, the maybe notice option. The IRS has requested comments on the proposed regulations, and is considering imposing an additional requirement as to the minimum notice content requirements, that would include a specific requirement to describe the possibility of exiting the safe harbor contributions (which, under the proposed regulations, now would apply both to the safe harbor match and the safe harbor nonelective).

It also notes how, if certain requirements (substantial business hardship, acquisition or disposition) are met, plan termination will allow the plan to maintain its safe harbor status in the year of termination, how the IRC Section 401(a)(17) compensation limit ($245,000 in 2009) must be prorated as of the date of the reduction or elimination of the contribution (potentially creating problems for plans that fund contributions throughout the year), and how the plan will face Potential Top Heavy Testing Issues (which, combined with the added nondiscrimination testing requirements of no longer being a safe harbor, could add additional administration expenses).

Sponsors were eligible to begin relying on the proposed regulations for amendments adopted after May 18. You should note the amendment requirement and how it is not consistent with the traditional end of the plan year amendment discretionary rules.

Considering Subsequent Events in the ESOP Appraisal

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Tue, 02 Jun 2009 06:00:00 +0000

We have recently discussed valuation issues created by the current economic environment, including Declining Valuation Multiples, How Public Company PE Ratios Impact an ESOP Valuation, and Employee Communications and Involvement in Tough Economic Times. Economic Crisis Raises Questions About Business Valuation Standards discusses some of the new questions and issues that valuation professionals and ESOP fiduciaries face in today's environment:

The current global economic crisis, in combination with the body of accepted professional standards and case law on business valuation, has led to uncertainty over the current application of business valuation standards. In particular, uncertainty exists concerning what kinds of company-specific events directly resulting from the crisis can be addressed in a valuation report. Specifically, it is unclear when events that have occurred after a particular valuation date, but before the preparation of the valuation report for that period, should be included in such a report. Now more than ever, business valuation professionals and those seeking the services of such professionals, such as ESOP fiduciaries, need clarification.

IRS regulations and business valuation standards generally provide that events occurring after the valuation date are not considered in the valuation:

For example, IRS Revenue Ruling 59-60 states, "Valuation of securities is, in essence, a prophesy as to the future and must be based on facts available at the required date of appraisal." Similarly, the Institute of Business Appraisers' Business Appraisal Standards state, "An appraisal shall be based upon what a reasonably informed person would have knowledge of as of a certain date . . . . Information unavailable or unknown on the date of valuation must not influence the appraiser or contribute to the concluding opinion of value."

It notes how court cases (e.g. Estate of Noble v. Commissioner, T.C. Memo 2005-2 (2005), Estate of Jung v. Commissioner, 101 T.C. 412 (1993)) have allowed information after the valuation date to be considered, using a "known or foreseeable" standard as of the date of the valuation. The cases considered the subsequent events to be "evidence" of the value as of the valuation date rather than something that affected the value.

It also discusses some of the many new questions resulting from the current environment:

Was the extensive fallout from the economic crisis foreseeable? More specifically, if the downturn has had a particularly onerous effect on a certain industry or business, was that effect foreseeable and should it be included in a valuation?

Although it is clear that unforeseeable subsequent events such as natural disasters or the death of a critical employee cannot be taken into account for valuation purposes, valuation professionals need guidance as to whether certain subsequent events directly resulting from the economic crisis are truly foreseeable and therefore required to be included in business valuations…The answer to the question of how much of this was foreseeable for a particular company as of a certain valuation date may depend on what that company or industry was facing at that certain point in time…

Valuation professionals are clearly required to take the economic climate into account, but whether specific events resulting from the economy should be taken into account is a much more uncertain matter..Determining what was in fact foreseeable for a particular company as of the valuation date will undoubtedly require careful evaluation of a variety of factors, including all potential legal implications. Valuation professionals must come to a clear understanding of what should and should not be included in each instance, as holders of equity interests in failing businesses and the businesses themselves may argue that such subsequent events should not be used if they will lead to what they consider to be a premature decrease in their stock's value.

Total Employment at Largest Employee Owned Companies Grew 6.1%

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Mon, 01 Jun 2009 06:00:00 +0000

The May 29, 2009 Employee Ownership Update is online and discusses the following:

Employee Ownership 100 List for 2009
Australian Government Withdraws Proposals on Equity Plan Taxation; Pledges to Come Up with New Approach
German Unions Press for Employee Ownership
NCEO Sets Up New LinkedIn Group

The Update discusses the Updated Employee Ownership 100:

The total number of employees in these companies grew to 598,500 in 2009, up from 580,500 in 2008, 579,000 in 2006, and 506,000 in 2005. As usual, Publix Super Markets topped the list, with 142,000 employees. The smallest companies on the list had 1,000 employees. Fifteen of the companies were supermarkets or (in one case) convenience stores, 15 were in construction or construction services, and 9 were in engineering and or architecture.

Total employment at the 94 companies that were on the list in both 2008 and 2009 grew 6.1% over last year, partly from acquisitions and partly from internal growth. Of the six companies that dropped off the list, two publicly traded companies had ceased to be majority employee-owned (SAIC and Journal Communications), three were sold (each was profitable at the time), and one private company no longer met the qualification rules. The Tribune Company is the only company on the list in bankruptcy. It is still owned by the ESOP, pending reorganization.

Current State of Employee Ownership

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Wed, 27 May 2009 06:00:00 +0000

View of Employee Ownership from the Hill covers some reasons to be excited about employee ownership, including the Employee Ownership Fellowship Program, the Employee Ownership Award and First Professorship in Employee Ownership, and the Curriculum Library on Employee Ownership (CLEO). It notes that there have not been any negative ESOP proposals in the Obama budget and no recent indications of negative legislation. However, it also discusses the work that still needs to be done to get Washington to include employee ownership in the public policy conversation:

It just goes to show that we still have far to go. Yes, there are many great projects focusing on employee ownership in the works and we are proud of what we have accomplished so far, but making in roads with members of Congress, their staffs, and thought leaders of national media, academia, and think tanks is still a challenge this community needs to focus on.

IRS Will Continue to Litigate Deductible Redemptive Dividends

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Tue, 26 May 2009 11:44:00 +0000

The IRS has stated that it will continue to pursue deductible redemptive dividends (e.g. General Mills, Inc. and Ralston Purina Co.):

"we are litigating these cases" and "we are not settling them"

Circuits Split on Deductibility of Proceeds From Stock Redemption Used to Satisfy ESOP Distribution Obligations discusses the circuit split between the Eighth Circuit (General Mills, Inc. v. United States, No. 08-1638 (8th Cir., January 26, 2009)) and the Ninth Circuit (Boise Cascade Corp. v. U.S. (9th Cir., No. 01-36086, 5/20/03)). The split is on whether or not a corporation is entitled to a deduction under IRC Section 404(k) - Deduction for dividends paid on certain employer securities for the proceeds from a stock redemption that were used to fund cash distributions. It also notes that the IRS's intent to continue to litigate may mean that the Supreme Court will eventually need to decide this issue.

Brief of the ERISA Industry Committee, The Grocery Maufacturers Association, The National Association of Manufacturers and the Organization for International Investment in Support of Appellee's Petition for Rehearing En Banc is an amicus brief that supports a rehearing of the case en banc.

Updated Employee Ownership 100/LinkedIn

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Fri, 22 May 2009 15:27:00 +0000

The latest NCEO Employee Ownership 100 is now online.

As you may have seen in our left -hand side bar, you can follow the One-Stop ESOP Blog on LinkedIn by joining The One-Stop ESOP Blog Group. You may also be interested in the NCEO's LinkedIn Group, the NCEO Employee Stock Ownership Network.

Southwest Airlines Employee Ownership Culture

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Wed, 20 May 2009 14:16:00 +0000

We recently mentioned Southwest Airlines when discussing a Different Way to Quantify Your Ownership Culture. Southwest Airlines President Emeritus Colleen Barrett on the Power of an Ownership Culture discusses how employee ownership, Open-Book Management, and an ownership culture built on trust have contributed to the success of Southwest Airlines:

At any given time, 13 to 15 percent of Southwest's stock is owned by its employees through a profit-sharing plan with the option to purchase additional stock. "Employees feel like owners because they are owners," says Colleen. "Ownership is one of the things our employees are most proud of. How can you expect people to have passion and excitement for what they do if they're not owners? We've had flight attendants and mechanics leave Southwest as millionaires."

"Everything is negotiated," says Colleen. "We give employees the opportunity to criticize and question us. Southwest doesn't often need to conduct surveys or hire consultants to determine what we are doing wrong or well. The employees tell us face-to-face year-round. We have open books, we're transparent and we're all-inclusive in telling employees what's happening.

It also discusses how they hire people for their individuality, sense of humor, and potential team mentality:

"Another thing that's unique about Southwest is its sense of humor," says Colleen. "We use words that corporate America doesn't. Our stock exchange symbol is LUV. We give employees a lot of freedom. We don't want them to be cookie-cutter copies of each other. When most people go to work, they take off their personal demeanor. Then they go home and act like themselves again. We hire people for their individuality, and we want to share that with the passengers. We test for a sense of humor. We want them to laugh. We watch their interactions with others outside of the formal interview. You can train anyone to move a bag from one place to another. A team mentality is what we're looking for."

Proposed Regulations Allow Suspension or Reduction of Safe Harbor Nonelective Contributions Mid-Year

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Mon, 18 May 2009 14:29:00 +0000

IRS Proposes Rules Allowing Employers to Suspend or Reduce Safe Harbor Nonelective Contributions discusses the release of proposed Treasury Regulation [REG–115699–09] – Suspension or Reduction of Safe Harbor Nonelective Contributions effective for amendments adopted after May 18, 2009. The proposed regulations would permit an employer that incurs a substantial business hardship to reduce or suspend safe harbor nonelective contributions during a plan year, providing an alternative to terminating the safe harbor plan:

The proposed regulations would amend Sec. Sec. 1.401(k)-3 and 1.401(m)-3 to permit an employer sponsoring a safe harbor plan described in section 401(k)(12) or 401(k)(13) that incurs a substantial business hardship (comparable to a substantial business hardship described in section 412(c)) to reduce or suspend safe harbor nonelective contributions during a plan year. These proposed regulations would provide an employer an alternative to the option of terminating the employer's safe harbor plan in such a situation.

The proposed regulations would allow for the reduction or suspension of safe harbor nonelective contributions under rules generally comparable to the provisions relating to the reduction or suspension of safe harbor matching contributions. Under these rules, a plan that reduces or suspends safe harbor nonelective contributions will not fail to satisfy section 401(k)(3), provided that:

(1) All eligible employees are provided a supplemental notice of the reduction or suspension;

(2) the reduction or suspension of safe harbor nonelective contributions is effective no earlier than the later of 30 days after eligible employees are provided the supplemental notice and the date the amendment is adopted;

(3) eligible employees are given a reasonable opportunity (including a reasonable period after receipt of the supplemental notice) prior to the reduction or suspension of the safe harbor nonelective contributions to change their cash or deferred elections and, if applicable, their employee contribution elections;

(4) the plan is amended to provide that the ADP test will be satisfied for the entire plan year in which the reduction or suspension occurs, using the current year testing method; and

(5) the plan satisfies the safe harbor nonelective contribution requirement with respect to safe harbor compensation paid through the effective date of the amendment.

The proposed regulations would also provide that the supplemental notice requirement is satisfied if each eligible employee is given a notice that explains:

(1) The consequences of the amendment reducing or suspending future safe harbor nonelective contributions;

(2) the procedures for changing cash or deferred elections and, if applicable, employee contribution elections; and

(3) the effective date of the amendment.

The proposed regulations would further provide that these same rules that apply to safe harbor plans under Sec. 1.401(k)-3 also apply to safe harbor plans under Sec. 1.401(m)-3, except that the plan must be amended to provide that the ACP test will be satisfied for the entire plan year in which the reduction or suspension occurs using the current year testing method.

Because the reduction or suspension of safe harbor contributions can be effective no earlier than the later of 30 days after the notice is provided to all eligible employees and the date the amendment is adopted, an employer that wants to reduce or suspend safe harbor contributions during a year could not implement this change by adopting the amendment at the end of the plan year. In addition, a plan that is amended during the plan year to reduce or suspend safe harbor contributions (whether nonelective contributions or matching contributions) must prorate the otherwise applicable compensation limit under section 401(a)(17) in accordance with the requirements of Sec. 1.401(a)(17)-1(b)(3)(iii)(A). Furthermore, a plan that is amended to reduce or suspend safe harbor contributions is no longer a plan described in section 401(k)(12), 401(k)(13), 401(m)(11), or 401(m)(12) for the entire plan year. Accordingly, such a plan is not described in section 416(g)(4)(H) and, thus, will be subject to the top-heavy rules under section 416.

The regulations refer to IRC Section 412(c) for the definition of a substantial business hardship, which refers to IRC Section 412(d)(2) - Minimum funding standards - Variance from minimum funding standard - Determination of business hardship:

(2) Determination of business hardship

For purposes of this section, the factors taken into account in determining temporary substantial business hardship (substantial business hardship in the case of a multiemployer plan) shall include (but shall not be limited to) whether or not—

(A) the employer is operating at an economic loss,

(B) there is substantial unemployment or underemployment in the trade or business and in the industry concerned,

(C) the sales and profits of the industry concerned are depressed or declining, and

(D) it is reasonable to expect that the plan will be continued only if the waiver is granted.

Survey: ESOP Companies Experienced Five-Year Stock Growth

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Mon, 18 May 2009 10:31:00 +0000

The May 15, 2009 Employee Ownership Update is online and discusses the following:

ESOP Companies Show Strong Five-Year Stock Growth
What Stories Do Your Customers Tell About You?
Backdate Update: Yes, Backdating Really Did Cause Significant Shareholder Damage
Ownership Thinking Meeting

The Update discusses a recent NCEO survey that reported that approximately 88% of surveyed ESOP companies experienced stock growth from 2003 to 2008, with 54% experiencing at least 10% growth, and 23% experiencing 20% or more growth. The discussion of Quantifying Your Ownership Culture continued with Southwest and Publix Supermarkets examples.

It also discusses the impact the backdating scandal had on share prices and judgments:

Looking at the days around the announcement of the backdating problem at a company, stock prices dropped seven percent below the market-adjusted expected price, and stayed that way for several weeks afterwards. Looking over a one-year period after the Wall Street Journal story opened the backdating controversy, normalized returns for a portfolio of scandal-tainted companies dropped between 15% and 20%, depending on what comparison benchmarks are used... Judgments in the settled cases, for instance, have averaged 1.5% of pre-scandal market capitalization in class action suits and .23% in shareholder derivative suits (a very difficult kind of suit to win).

Reasons to Establish an ESOP

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Fri, 15 May 2009 13:47:00 +0000

Top 10 Reasons to Consider Employee Ownership shares ten reasons every business should consider establishing an ESOP:

It improves the bottom line.
It makes managing the business easier and more fun.
It supplies the glue with which to build a business-oriented culture.
It makes work more meaningful.
It serves as a currency for attracting talent.
It facilitates ownership succession in closely held businesses.
It enables business owners to access the value of their equity without paying capital gains taxes.
It affords access to a unique form of highly subsidized finance.
It creates wealth in places it would not otherwise exist.
From a national policy perspective, it fosters a more equitable and effective brand of capitalism.