In the News: 2008 Innovations Award Winner, Three-Tier Reward System, 600 Hours of Management Training, and Two-Day Personal-Development Leadership Training

HCSS (Houston, TX)

HCSS Receives National Award for Employee Ownership announces that HCSS, a Houston software company serving the construction industry, is a winner of the 2008 Innovations in Employee Ownership Award:

HCSS has been an employee-owned company since 1998. At that time, Rydin sold 25 percent of the company to the employees via an ESOP (Employee Stock Ownership Plan) with the idea of getting HCSS employees to think and act like owners. HCSS now has a three-tier approach to employee ownership with annual cash profit sharing, Stock Appreciation Rights (SARS), and ESOP. Through these tools employees are rewarded financially for the positive impact they have on the company and are able to see how their work affects company performance. For the past 10 years, employees have received substantial profit sharing, both in cash and ESOP stock.

"Having ownership in HCSS is a constant source of motivation for me not only in my specific job, but in any area that will help our company grow," said Blake Driskill, who has worked at HCSS since 1998. "Knowing that my co-workers are also owners means that we all have a shared interest in working together for the benefit of HCSS."

The NCEO website also describes the winner:

HCSS is a fast-growing, industry-leading software company that serves the construction industry. HCSS works hard to make sure that employees do their jobs with an awareness of how they influence success in the business. The result is fiercely loyal customers and employees who provide a level of service unique in their industry because they learn, act, and work with the passion of owners. That passion comes from extensive open-book management and business literacy training at HCSS University, and it also depends on a three-tier reward system that gives employees a wide-spectrum ownership interest. The short-term incentive is a cash bonus program. Stock appreciation rights (SARs) cover the medium-term, and the ESOP rounds out the picture. Recognizing the key role that management plays in nurturing an ownership culture, HCSS invested heavily in management training, with a 50 hour, 12 week course for managers representing over a quarter of the company's employees. Additionally, every employee participated in a two-day personal-development leadership course.

The Innovations in Employee Ownership Award is defined as “an annual award recognizing creative ideas that help make employee ownership stronger, and publicizing those ideas so others can learn from them. Innovations can deal with employee participation, entrepreneurship, communication programs, education, plan design, or other ideas that strengthen employee ownership.”

We discussed some of the 2007 winners in Immediately Focusing on Building an Ownership Culture and Should You Consider An ESOP?

Informational Justice: Using Communication and Education for Risk Management

"What we've got here is failure to communicate." expands on The Risk and Expense of Terminated Participants and how victims of downsizing can perceive their layoff as unfair and retaliate:

But the "What we have here is failure to communicate" situation goes beyond the non-receipt of documents. The grudge part that Mr. Benna alludes to has to do with the plan sponsor's integrity - or lack thereof as perceived by the terminated employee…. So if we translate their academic research into practical retirement plan communication practices, the origins of retaliation, i.e., lawsuits, don't begin with the employee's termination but in the context of the employer's past behavior. Effective, consistent communication and investment education can be good risk management.

The post includes a discussion of When explanations for layoffs are not enough: Employer's integrity as a moderator of the relationship between informational justice and retaliation:

Victims of downsizing often perceive their layoff as being unfair, which can lead to various forms of retaliation. Informational justice, defined as providing employees with adequate explanations in a timely manner, has been prescribed as a way to mitigate the retaliation tendencies associated with unfairness perceptions.

H. Con. Res. 333: Expressing continued support for employee stock ownership plans

Rep. Maurice Hinchey [D-NY] introduced H. Con. Res. 333: Expressing continued support for employee stock ownership plans on April 24, 2008. The bill is cosponsored by Rep. Dana Rohrabacher [R-CA] and has been referred to the House Committee on Education and Labor. Here is the text of the legislation:

HCON 333 IH

110th CONGRESS

2d Session

H. CON. RES. 333

Expressing continued support for employee stock ownership plans.

IN THE HOUSE OF REPRESENTATIVES

April 24, 2008

Mr. HINCHEY (for himself and Mr. ROHRABACHER) submitted the following concurrent resolution; which was referred to the Committee on Education and Labor

CONCURRENT RESOLUTION

Expressing continued support for employee stock ownership plans.

Whereas in the Employee Retirement Income Security Act of 1974, Congress codified a technique of corporate finance which utilizes employee stock ownership, officially named an employee stock ownership plan (ESOP);

Whereas in the 33 years since the statutory recognition of ESOPs, there have been ample data collected by objective research indicating that the vast majority of corporations sponsoring employee stock ownership through ESOPs are high performing companies that, among other indicia of high performing companies, have better sales, are more sustainable, pay better, and provide more retirement savings compared to similar companies that are not employee-owned; and

Whereas Congress, in more than 15 laws since 1974, has made it explicit that ESOPs are to serve the dual purpose of providing retirement savings and stock ownership for employees, as well as being a financing technique for corporations: Now, therefore, be it

Resolved by the House of Representatives (the Senate concurring), That Congress expresses its continued support for employee stock ownership plans.

The ESOP Association has issued a press release applauding the resolution:

J. Michael Keeling, President of The ESOP Association, had this to say about the Resolution: "I welcome the bi-partisan efforts of Congressman Maurice Hinchey (D-NY) and Congressman Dana Rohrabacher (R-CA). The leadership of these House senior members to reiterate the thirty plus years of support for employee ownership through ESOPs is important. Clearly, change is in the wind but a commitment by Congress to a fair and more equitable form of ownership is as important in the 21st century as in the 20th. On behalf of the 2,500 plus members of The ESOP Association, I urge all members of Congress to co-sponsor this resolution. Research has consistently shown that employee owned companies are high performing, have better sales, and provide more retirement savings compared to their non-ESOP counterparts."

Updates:

• H. Con Res 333 Update – Five Co-Sponsors (6/8/08) - There are currently five co-sponsors to H. Con. Res. 333: Expressing continued support for employee stock ownership plans, which was introduced by Rep Hinchey, Maurice D. [NY-22] on 4/24/2008:
  
  Rep Rohrabacher, Dana [CA-46] - 4/24/2008
  Rep Thompson, Mike [CA-1] - 4/30/2008
  Rep Jones, Walter B., Jr. [NC-3] - 5/15/2008
  Rep McCrery, Jim [LA-4] - 5/15/2008
  Rep Walz, Timothy J. [MN-1] - 5/15/2008
  
• Employee-Owned Top Small Workplaces, IEI, HR 333, and Broad-Based Equity Grants (5/16/08) - "Maurice Hinchey (D-NY) and Dana Rohrabacher (R-CA) have introduced House Concurrent Resolution 333, which states, "Congress expresses its continued support for employee stock ownership plans." The resolution notes that "there have been ample data collected by objective research indicating that the vast majority of corporations sponsoring employee stock ownership through ESOPs are high performing companies that, among other indicia of high performing companies, have better sales, are more sustainable, pay better, and provide more retirement savings compared to similar companies that are not employee-owned." Hinchey is one of the more liberal members of Congress and Rohrabacher one of the most conservative."

Criminal Sentences and Bad Boy Clauses – When ERISA Account Balances Can Be Recovered by the Plan

We recently discussed how a court case provided for Using an Account Balance to Offset Damages Resulting from a Fiduciary Breach. The following items provide some more background on the case, and bad boy clauses, and criminal sentences and ERISA plans:

• "Bad boy" clauses aren't passe after all - but sometimes it takes a judge to do the right thing provides more details about the criminal acts of the case.
  


• It also discusses the pre-ERISA history of Bad Boy Clauses and how they are a violation of the IRC Section 411 vesting requirements.
  


• Qualified Retirement Plan Protection from Creditors discusses how criminal sentences or bad boy clauses are not permitted:
  
  Generally, the terms of a criminal sentence may not order the plan to pay out a participant's benefits to a third party as restitution, even for a crime committed against the employer. For example, suppose an employee embezzled $20,000 from the employer. The employer is not permitted to recover the $20,000 by taking the participant's 401(k) plan assets because of ERISA protection of retirement benefits. There is a limited exception in cases where the crime was committed against the plan. Had the employee stolen $20,000 from plan's assets instead of from the employer, then a Federal court or the U. S. Department of Labor could order the plan administrator to offset the plan's loss against the participant's account. In this case, the participant is presumed to have already received a distribution from the plan for the amount embezzled from the plan.

In the News: Employee Retention, Distinguishing Themselves from Competition, Using Employee Input for Continuous Improvement

Hansen Plastics Corp. (Elgin, IL)

Elgin plastics company's ESOP breaks the mold discusses Elgin, IL based Hansen Plastics Corp., a 100% ESOP-owned plastic moldings company with 60 employees. Their employee averages 10 years of employment and they have a low turnover rate:

The company Hansen currently has 60 employee-owners who have an average of 10 years employment with low turnover, a characteristic that's not uncommon for an ESOP, according to Michael Keeling, president of The ESOP Association.

The company uses employee ownership as a way to distinguish them from their competition:

"When we do a sales pitch, usually what this potential customer wants to know is, why to go with us," said Roy Lilly, president and CEO, "We have a completely different, positive attitude. These employees have stock in the company."

The company is run by a three-person Board of Directors and an ESOP Committee and the company uses Open-Book Management, which increases quality and productivity:

When employees are a company's owners, they have a vested interest in the company's bottom line, which increases quality and productivity, explains Vice President of Operations Tim Bayer. "No one is departmentalized," he said. Employees have open access to the company's statements of profits and losses.

The company also credits part of its growth and success to the input of the employees:

Hansen's growth and success is also based on internal changes and advancements, due in large part to the input to management provided by the employee-owners, according to Lilly.

Outside his office door, which is directly adjacent to the manufacturing area, sits a stack of bright pink "Continuous Improvement" forms, filled with workers' suggestions, each of which Lilly carefully considers. Throughout the work area, Lilly can point out machinery that once took one person per machine to operate, but through employee input has increased efficiencies that require only one person for four or five machines.

UPDATE 4/29/08:

Breaking the mold: Hansen Plastics competes globally provides a company profile, discusses how they compete globally, and how the ESOP was setup to reward long-term employees and serve as a morale builder:

Before stepping down, Watermann sought to reward Hansen's longtime employees who helped fuel the company's steady growth, according to Lilly.

"He found this ESOP (employee stock ownership plan) option and decided to sell the business to us," Lilly said.

He said the nice thing about ESOP is that employees need not purchase the company out of their own pocket. "You buy it from company profits -- so it didn't cost employees any money," Lilly said.

He described ESOP as a morale builder as well, "because when an employee makes a bad part -- it gets them right where it hurts -- in their wallet."

Five Training Points: Ownership, Participation, Open Books, Holistic Wellness, and Lean Enterprise

Steve Sheppard's latest blog post, Five Degrees of Connection, discusses his upcoming trip to Nicaragua and some training topics:

I'll be visiting communities and organizations that week, as is normally the case in my travels, which seek to strengthen themselves economically, socially and sustainably. What some hope to access through the Foundation is a methodology or mindset to employ for this developmental process. So consider the potential topics that I will be sharing with the disenfranchised poor as possible training topics: Ownership- The fundamentally different mindset in people when they own something as opposed to leasing, renting, borrowing or any other relationship; Participation- The importance of having involvement from every participant is that each person possesses a piece of the puzzle; Open Books- How can anyone truly understand their survival when they aren't provided with the rules of their game?; Holistic Wellness- Every organization is made up of dimensions that define its health and sustainability, including intellectual, social, emotional, spiritual occupational and physical components; Lean Enterprise- Every human undertaking is made up of processes, and every process has the opportunity to be improved.

Whether we are talking about our companies or our countries, he notes that we all have the same needs:

The need to be part of something bigger than ourselves, the need to contribute, to be regarded as having value, to recognize all the facets of our being, to be able to work for success in something: these are attributes that connect us. It's true within our companies, our nations, our world. The sooner we recognize and accept this fundamental truth, the sooner we begin to unlock the potential and magic that resides in us, individually and collectively.

As you ponder his post and how it affects you and your ESOP, here are some discussions of how the five topics relate to ESOPs:

• Ownership - Employee Motivation
• Participation - Participative Management is a Key Driver to Exceptional Business Performance
• Open Books - Open-Book Management
• Holistic Wellness - Eudaimonic Well-Being and Factors in Happiness
• Lean Enterprise - Standardized Work and Developing Best Practices

IRC Section 409(p) Anti-Abuse Testing, History of Regulations, and Private Letter Ruling (PLR) 200804023

PLR 200804023 was published on January 25, 2008 and is the first 409(p) anti-abuse private letter ruling.

Purpose of IRC Section 409(p) Anti-Abuse Testing

The purpose of the IRC Section 409(p) anti-abuse compliance test is to ensure that an S Corporation ESOP is providing broad-based coverage that benefits rank-and-file employees. It is a very complex test that must be passed every day of the plan year and penalties are so severe that failing is not a practical option. If disqualified persons own more than 50% of deemed-owned shares, then there is a nonallocation year and the plan fails the test. Disqualified persons, deemed-owned shares, and nonallocation year are among the terms defined in the PLR Analysis section below.

History of IRC Section 409(p) Regulations

Here is a recap of the history of the IRC 409(p) regulations:

• IRC Section 409(p) - Qualifications for tax credit employee stock ownership plans - Prohibited allocations of securities in an S corporation (2001) – Section 409(p) was added to the code in 2001. For S corporation ESOPs in existence on March 14, 2001, Section 409(p) is effective for plan years beginning after December 31, 2004.
  
• Proposed and Temporary Regulations (2003) – Proposed and Temporary Regulations were issued July 21, 2003 and are generally applicable with plan years ending after October 20, 2003.
  
• Proposed and Temporary Regulations (2004) – Proposed and Temporary Regulations were issued December 16, 2004 and are generally effective for plan years beginning on or after January 1, 2005.
  
• Final Regulations (2006) – Final Regulations were issued on December 16, 2006 and generally applicable with respect to plan years beginning on or after January 1, 2006.

PLR Analysis

• Precedential status - IRC Section 6110(k)(3) - Precedential status provides that a Private Letter Ruling cannot be "used or cited as precedent."
  
  
• Disqualified person - The requesting company requested a ruling that there is not a nonallocation year because there are no disqualified person under IRC Section 409(p)(4). IRC Section 409(p)(4)(A) - Qualifications for tax credit employee stock ownership plans - Prohibited allocations of securities in an S corporation – Disqualified person – In general defines a disqualified person for 409(p) purposes:
  

  (A) In general
  

  The term "disqualified person" means any person if—
  

  (i) the aggregate number of deemed-owned shares of such person and the members of such person's family is at least 20 percent of the number of deemed-owned shares of stock in the S corporation, or
  

  (ii) in the case of a person not described in clause (i), the number of deemed-owned shares of such person is at least 10 percent of the number of deemed-owned shares of stock in such corporation.
  

• Synthetic equity - The submitting company is an S Corporation and does not maintain any type of non-qualified deferred compensation plan, phantom stock plan, stock option plan, restricted stock plan, stock appreciation rights plan, or other plan that constitutes synthetic equity as defined in IRC Section 409(p)(6)(C) - Qualifications for tax credit employee stock ownership plans - Prohibited allocations of securities in an S corporation – Definitions – Synthetic equity:
  

  (C) Synthetic equity
  

  The term "synthetic equity" means any stock option, warrant, restricted stock, deferred issuance stock right, or similar interest or right that gives the holder the right to acquire or receive stock of the S corporation in the future. Except to the extent provided in regulations, synthetic equity also includes a stock appreciation right, phantom stock unit, or similar right to a future cash payment based on the value of such stock or appreciation in such value.
  
  

• Deemed-owned shares - The submitting company is controlled by a family and several members of the family, including cousins and a child of one of the cousins, are participants in the ESOP. No one person owns 10% or more of the deemed-owned shares (as defined in IRC Section 409(p)(4)(C) - Qualifications for tax credit employee stock ownership plans - Prohibited allocations of securities in an S corporation – Disqualified person – Deemed-owned shares):
  

  (C) Deemed-owned shares
  

  (i) In general The term "deemed-owned shares" means, with respect to any person—
  

  (I) the stock in the S corporation constituting employer securities of an employee stock ownership plan which is allocated to such person under the plan, and
  

  (II) such person's share of the stock in such corporation which is held by such plan but which is not allocated under the plan to participants.
  

  (ii) Person's share of unallocated stock For purposes of clause (i)(II), a person's share of unallocated S corporation stock held by such plan is the amount of the unallocated stock which would be allocated to such person if the unallocated stock were allocated to all participants in the same proportions as the most recent stock allocation under the plan.
  
  

• Family Attribution for disqualified person purposes - IRC Section 409(p)(4)(D) - Qualifications for tax credit employee stock ownership plans - Prohibited allocations of securities in an S corporation – Disqualified person – Member of family defines the family attribution requirements for determining a disqualified person for 409(p) purposes:
  

  (D) Member of family
  

  For purposes of this paragraph, the term "member of the family" means, with respect to any individual—
  

  (i) the spouse of the individual,
  

  (ii) an ancestor or lineal descendant of the individual or the individual's spouse,
  

  (iii) a brother or sister of the individual or the individual's spouse and any lineal descendant of the brother or sister, and
  

  (iv) the spouse of any individual described in clause (ii) or (iii).
  

  A spouse of an individual who is legally separated from such individual under a decree of divorce or separate maintenance shall not be treated as such individual's spouse for purposes of this subparagraph.
  

• The Section 318 attribution rules do not apply for purposes of determining a disqualified person - The PLR confirms that the family attribution rules under IRC Section 318(a) - Constructive ownership of stock – General rule do not apply for purposes of determining a 409(p) disqualified person. Therefore, only the cousin and their child are aggregated for disqualified person determination purposes.
  
  
• Nonallocation year - Consistent with IRC Section 409(p)(3)(B) - Qualifications for tax credit employee stock ownership plans - Prohibited allocations of securities in an S corporation – Nonallocation year – Attribution rules, the PLR also confirms that the family attribution rules under IRC Section 318(a) - Constructive ownership of stock – General rule do apply for purposes of determining whether there is a nonallocation year as defined by IRC Section 409(p)(3)(A) - Qualifications for tax credit employee stock ownership plans - Prohibited allocations of securities in an S corporation – Nonallocation year – In general:
  

  (3) Nonallocation year
  

  For purposes of this subsection—
  

  (A) In general
  

  The term "nonallocation year" means any plan year of an employee stock ownership plan if, at any time during such plan year—
  

  (i) such plan holds employer securities consisting of stock in an S corporation, and
  

  (ii) disqualified persons own at least 50 percent of the number of shares of stock in the S corporation.
  

  (B) Attribution rules
  

  For purposes of subparagraph (A)—
  

  (i) In general The rules of section 318(a) shall apply for purposes of determining ownership, except that—
  

  (I) in applying paragraph (1) thereof, the members of an individual's family shall include members of the family described in paragraph (4)(D), and
  

  (II) paragraph (4) thereof shall not apply.
  

  (ii) Deemed-owned shares Notwithstanding the employee trust exception in section 318(a)(2)(B)(i), an individual shall be treated as owning deemed-owned shares of the individual.
  

  Solely for purposes of applying paragraph (5), this subparagraph shall be applied after the attribution rules of paragraph (5) have been applied.

The IRS, Section 267, and Deducting Accrued Expenses for Less Than 100% S Corporation ESOPs

ESOP Update: Deduction Disallowance Under Section 267 discusses how the Large & Mid-Size Business Division (LMSB) of the IRS, a division that "serves corporations, subchapter S corporations, and partnerships with assets greater than $10 million," issued a memorandum on September 28, 2007 (LMSB-04-0907-064) identifying an emerging issue that could affect some ESOP companies:

An "emerging issue" is defined as a tax issue that has been identified through pre-filing initiatives or surfaced in current examinations by an industry or specialty area that an LMSB Director believes that guidance to field examiners is needed. Once an emerging issue is identified, examiners are required to contact the Issue Owner or Coordinator if the issue is present in their tax case to gain insight on the issue and provide feedback on the issue to the Coordinator."

The memorandum discusses IRC Section 267 - Losses, expenses, and interest with respect to transactions between related taxpayers and advises IRS representatives to look for violations involving related persons:

"Section 267 of the Code generally disallows loss recognition on a sale or exchange of property between related persons. It also states that deductions for amounts paid to a related party can only be taken in the year in which the related party includes such amounts in its income."

The article notes that ESOP participants qualify as indirect shareholders of the S corporation and are considered related persons. This could create an issue for accrual basis companies that are less than 100% ESOP-owned:

"For companies that are accrual basis taxpayers, in order to avoid an inadvertent violation of Section 267 of the Code, it is recommended that accrued expenses be examined. Accrued expenses that are impacted could include, but are not limited to, accrued wages, accrued bonuses, and accrued vacation pay. Although the issue is equally applicable to a 100% S corporation ESOP, since the S corporation income is allocated to the ESOP that is exempt from tax, any audit adjustment required by Section 267 of the Code would have no current year impact, and therefore has the practical effect of only impacting partially owned S corporation ESOPs.

Fiduciary Convicted of Filing False IRS Form 5500

Company President Pleads Guilty to Lying on Form 5500 and Employer Fined for Lying on Form 5500 discuss how a company president and fiduciary misused plan assets and was convicted of filing a false IRS Form 5500:

The court imposed $153,000 in penalties and fines and a one-year term of federal probation upon Thomas. In 2002, Thomas instructed custodian New England Life Insurance Company to issue a check of $200,000 to the plan trustees. The funds were deposited at a bank in the name of the plan. Subsequently, Thomas withdrew funds from the bank account to invest in other business interests. Thomas must have returned the money to the plan because the case summary indicated that the plan did not suffer a loss. The false statement related to question 4d (of Schedule H or I) in which the DOL asks whether the plan has engaged in a prohibited transaction with a party-in-interest. Although the more serious violation was the misuse of plan assets, the government utilized the false statement on the Form 5500 to extract the guilty plea from the company president.

Filing an Incorrect IRS Form 5500 discusses the significant ramifications of filing an incorrect IRS Form 5500.

DOL Proposed Regulation – Amendment of Regulation Relating to Definition of ‘‘Plan Assets’’ Participant Contributions proposes a safe harbor that will consider deposits made within the 7-business day period as if they were made on "the earliest date on which such contributions can reasonably be segregated from the employer's general assets."

Field Assistance Bulletin No. 2008-01 – Fiduciary Responsibility for Collection of Delinquent Contributions provides "guidance to field investigators on the responsibilities of plan fiduciaries and trustees with respect to monitoring and collecting delinquent employer and employee contributions."

What a DOL Auditor is Looking For When Auditing an ESOP

Paul Windsor, an investigator from the Employee Benefits Security Administration (EBSA) of the Department of Labor (DOL), presented What to Expect from an Employee Benefits Security Administration Investigation on April 15, 2008, at the Spring Conference of the ESOP Association – Wisconsin Chapter. Here are some highlights of the presentation:

• Not Official Views of the DOL – The presentation started with the caveat that the presentation represents the views of the presenter only and not the official views of the DOL.
  
  
• What does the EBSA Investigate – What does the EBSA investigate?
  
  
• Fiduciary Duty of Loyalty and Prudence (ERISA Section 404(a), 29 U.S.C. Section 1104(a) - Fiduciary duties - Prudent man standard of care)
  
  
• Prohibited Transactions: Certain transactions between the plan and parties-in-interest are prohibited absent an exemption (ERISA Section 406(a), 29 U.S.C. Section 1106(a) - Prohibited Transactions - Transactions between plan and party in interest)
  
  
• Conflicts of Interest (ERISA Section 406(b), 29 U.S.C. Section 1106(b) - Prohibited Transactions - Transactions between plan and fiduciary)
  
  
• How Investigations are Identified – Investigations are identified through computer targeting (off of the IRS Forms 5500), referrals from the IRS and other agencies, information from the media, bankruptcy and other filings, complaints (participants, fiduciaries, informants, attorneys, etc.), and private lawsuits.
  
  
• Objective of Investigation – It is better to cooperate during the investigation. The purpose of the investigation is as much for educational purposes as it is for compliance. They try to not penalize voluntary compliance whenever possible. Their goal is to fix and move on. However, they are required to notify the IRS of the investigation.
  
  
• ESOP Specific Information – In addition to the standard information request, they will interview the fiduciaries and may ask for the corporate information such as the Board of Directors minutes, articles of incorporation, and the financial statements. They are looking for conflicts of interest and making sure the ESOP is behaving like an owner and seeking the maximization of profits.
  
  
• ESOP Fidelity Bonding Requirements – One of the biggest problems is the failure to comply with the ESOP Fidelity Bonding Requirements. Typical problems include not having enough coverage, not having the bond in the name of the plan, and not providing the required coverage for each plan of the company.
  
  
• Disclosures – They are checking to make sure that you have satisfied the Summary Plan Description (SPD) and Summary of Material Modifications (SMM) requirements. ERISA requires that you update the SPD every 10 years, assuming there are no plan changes. Most likely, your plan will have made some changes and you will need to update it every five years. In addition, you must provide a SMM "not later than 210 days after the close of the plan year in which the modification or change was adopted."
  
  
• Decision-making – Who is actually acting as the plan administrator (or administrative committee) and trustee? Is it the same individuals that are defined in the plan documents or is someone else (such as the CEO) actually making the decisions? If there is a third-party involved (e.g. directed trustee or TPA), are the fiduciaries reviewing and taking responsibility for the work?
  
  
• Conditions of ESOP loan in event of default –They review the loan documents and the conditions of loan in the event of default. They will sometimes find draconian penalties and other collection and call provisions that do not comply with 29 CFR 2550.408b-3(e) - Loans to Employee Stock Ownership Plans:
  
  An exempt loan must be without recourse against the ESOP. Furthermore, the only assets of the ESOP that may be given as collateral on an exempt loan are qualifying employer securities of two classes: Those acquired with the proceeds of the exempt loan and those that were used as collateral on a prior exempt loan repaid with the proceeds of the current exempt loan. No person entitled to payment under the exempt loan shall have any right to assets of the ESOP other than:
  
  (1) Collateral given for the loan,
  (2) Contributions (other than contributions of employer securities) that are made under an ESOP to meet its obligations under the loan, and
  (3) Earnings attributable to such collateral and the investment of such contributions.
  
  If the documents do not comply, the solution will be to rewrite the loan documents and there will most likely not be a penalty. However, they are required to inform the IRS, who may assess an excise tax or other penalty.
  
  
• Release of Shares – He discussed math errors, using the correct release method, and the most current amortization schedule.
  
  
  • Math errors – They find a lot of mistakes with the math and stressed the importance of being responsible for the work of TPAs.
    
  • Using the correct method – They discussed making sure that the release method is provided in the plan and loan documents and that the release method meets the requirements of 29 CFR 2550.408b-3(h) - Loans to Employee Stock Ownership Plans. When using the special rule (a.k.a. principal-only method), the term of the loan must not exceed 10 years and the repayments must be at least as rapid as level payments over 10 years.
    
  • Using the most current amortization schedule – An important component of the general rule (a.k.a. principal and interest method) is the future principal and interest payments. The balance as of the last day of the plan year on the amortization schedule should coincide with the actual loan balance and the future payments should be re-amortized according to the terms of the plan document and the interest rate as of the last day of the plan year. You cannot automatically use the original amortization schedule every year.
    
    
• ESOP Loan Refinancing – As provided for in Field Assistance Bulletin 2002-1, which discusses the fiduciary obligations in connection with the refinancing of an exempt ESOP loan, the DOL is looking to confirm that the refinancing of an ESOP loan is solely in the interest of the plan participants and beneficiaries.
  
  
• Valuation of shares – This is an area that they have not historically looked at enough, but have identified it as an area that they will watch more closely.
  
  
  • Selection process of choosing valuation firm – What is the selection process for choosing the independent appraiser (see Hiring a Qualified, Independent Valuation Firm and Reviewing and Approving the Valuation Report)? Is due diligence performed on a regular basis? Did you go through the Request for Proposal (RFP) process or have you done any other comparison shopping?
    
  • On-Site Visit – When is the last time your valuation firm made an on-site visit?
    
  • Information Used by the Valuation Firm – Who looks at the information provided to the valuation firm? Is it reviewed internally before it is sent? How many people are involved in the process?
    
    
• Corporate governance – They look closely to income paid to and company contracts with officers and other key employees of the company. They are looking to understand why the arrangements exist and whether they are in the best interests of the participants.
  
  
• Put Option – 29 CFR 2550.408b-3(k)(4) - Loans to Employee Stock Ownership Plans requires that participants receiving a distribution of employer stock of a company that is not readily tradable on an established market must be given a put option. It also provides that the put option may be satisfied with a promissory note if certain requirements are met:
  
  The provisions for payment under a put option must be reasonable. The deferral of payment is reasonable if adequate security and a reasonable interest rate are provided for any credit extended and if the cumulative payments at any time are no less than the aggregate of reasonable periodic payments as of such time. Periodic payments are reasonable if annual installments, beginning with 30 days after the date the put option is exercised, are substantially equal. Generally, the payment period may not end more than 5 years after the date the put option is exercised. However, it may be extended to a date no later than the earlier of 10 years from the date the put option is exercised or the date the proceeds of the loan used by the ESOP to acquire the security subject to such put option are entirely repaid.

If a plan is using promissory notes, they are looking to make sure that the note is properly secured (i.e. there is adequate security provided) and note that the fiduciary could be held personally liable.
  

ESOP Advocacy and The ESOP Promotion and Improvement Act of 2007 (S. 1322)

Last week we discussed an Update on Section 3701 of the Rangel Tax Proposal. The latest Employee Ownership Blog post suggests that now is the time to discuss The ESOP Promotion and Improvement Act of 2007 (S. 1322) with your Senators:

"Now is the time to contact your Senators and talk to them about this legislation. In light of the legislation introduced by Representative Charles Rangel, now is the time to reach out to your member of Congress. Contact their office and ask to arrange a visit to your company. If you can't arrange a visit to your company, make an appointment to go see them, or send a letter from the employee owners telling him/her why the ESOP is so important to your company and employee owners and what they can do to keep these jobs in their community."

The Risk and Expense of Terminated Participants

Terminated Employees Can Be Toxic to the Health of Your Plan uses LaRue v. DeWolff, Boberg & Assoc. Inc., No. 06-856 (Feb. 20, 2008) as an example of why plans should act quickly to move the accounts of terminated participants out of the plan. It stresses the fiduciary responsibilities that apply to both current and terminated participants:

"This applies to all participants, including those who are no longer employed by the company," he says. "Inactive participants are entitled to documents such as new Summary Plan Descriptions (SPD), material modifications to the SPD, the Summary Annual Report, notice of all IRS filings, participant statements, and if requested, the Plan document and the entire Form 5500." Every investment and provider change, including fund replacements, additions, or deletions, must also be communicated.

The article asserts that the PPA will increase the number of terminated participants with account balances, ultimately increasing the expense and risk of the plan. It suggests using plan advisors to provide advice and safe harbor IRA rollovers as ways to proactively minimize the risk.

"Plan advisors should seize this opportunity to provide education and objective, qualified help as well as access to a variety of quality IRA products that are appropriate retirement savings vehicles. In addition, it's prudent to rollover the assets of retiring or terminating participants and roll-out the accounts of former employees into safe harbor IRAs. These steps will keep plan participants invested in retirement and help advisors and their sponsors lower plan costs, reduce administrative headaches, and lessen liability exposure."

Some of these issues are not applicable to ESOPs. In addition, ESOPs must consider additional issues like the future repurchase obligation. Nonetheless, the article provides a good discussion of some of the fiduciary responsibilities that remain for terminated participants.

DOL Automatically Generated Letter – Late Deposit of Elective Deferrals

DOL Correspondence on Late Deposit of Elective Deferrals discusses how the DOL has been automatically generating letters to plan sponsors who indicate on the IRS Form 5500 that they failed to deposit deferrals in the required time period, even if the sponsor included an attachment that indicated it had been corrected. The article still recommends the use of the attachment or footnote:

"Despite the fact that the attachment is optional for a Schedule I and despite the fact that the DOL apparently does not review the schedule or the attachment before sending the letter, we continue to encourage the use of the attachment (or a footnote describing the correction) to forestall a potential DOL investigation. Since the DOL generally reviews the Form 5500 before commencing an investigation, we believe the attachment describing the correction will influence the DOL to focus on plans where Form 5500 does not disclose whether a correction has occurred."

The automatically generated letter contains a reference to the Voluntary Fiduciary Correction Program (VFCP), a program that "encourages voluntary compliance by self-correcting violations of the law. The program also helps plan officials understand the law and gives immediate relief from payment of excise taxes under a class exemption." The article addresses the implication that the sponsor will be subject to a DOL audit if they do not utilize the VFCP:

"Although a plan sponsor always should consider VFCP, the plan sponsor should not feel unnecessarily pressured into filing under the program. A plan sponsor should weigh the benefits of the program (elimination of the prohibited transaction excise tax) against the costs of filing under the program (cost of hiring an attorney to file). Many small and medium sized plan sponsors will conclude the costs of the program outweigh its benefit. Since the prohibited transaction excise tax usually is negligible, these plan sponsors generally prefer to self-correct and pay the excise tax."

The article concludes by recommending that the sponsor should respond to the DOL and advise that they have corrected using the VFCP methodology and paid the excise tax:

"In every situation of which we are aware, once the DOL receives information that the late deposit has been corrected, it does not pursue the matter further."

Newspaper Guild Exploring Employee Ownership

Times Co. puts Maine newspapers on market discusses how the Seattle Times Co. is trying to sell its Maine newspapers and hopes to complete a sale within a year. Newspaper guild retains advisor, announces exploration of bid for Blethen Newspapers notes that the Portland Newspaper Guild has hired a consultant and is exploring an employee ownership model to purchase the Blethen Maine Newspapers:

"The Newspaper Guild welcomes any ownership alternative for the Blethen Maine Newspapers that continues to recognize the importance of union representation of its work force," the labor group said in a release. "The Guild also believes that an employee-ownership model backed by community-minded investors would likely serve as the best structure for preserving local control and journalistic integrity."

ESOPs in Existence for At Least 25 Years

The ESOP Association Announces Silver ESOP Award Winners is a press release announcing 129 ESOP Association companies that have had an ESOP for at least 25 years. Because the list only recognizes Association members, it is not comprehensive. Please let me know if you are or know of an ESOP that has been in existence for 25 or more years and I will add it to the list. I will also add links to individual press releases and related articles as they become available:

• Abt Associates Inc., Cambridge, MA
  
• Advertising Checking Bureau, New York, NY
  
• Agri-King, Inc., Fulton, IL
  
• Air Turbine Propeller Company, Zelienople, PA