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Read a sample issue of the entire newsletter (September-October 2015).Sample Article from the May-June 2016 Issue:
Creative Ideas on Dividends, Distributions, and the Have/Have Not ProblemIn the NCEO's 2010 repurchase obligation survey, only one third of respondents were confident that their companies would avoid the so-called "have/have-not" problem, in which most of the value in the ESOP is concentrated among the accounts of relatively few participants.
A common cause is companies paying substantial dividends (in C corporations) or earnings distributions (in S corporations). For simplicity, this article will refer to both as "dividends." Dividends can lead to a have/havenot problem because more senior and higher paid people tend to receive a disproportionate share of dividends and, often, of shares released by the dividends.
This article describes some simple ways to help address or prevent this problem, followed by a creative concept that was developed at the ESOP-owned company Wawa.
Allocate Suspense Account Shares Based on Flatter Allocation FormulaDividends paid on allocated shares must be allocated pro-rata to share balances, but not all companies know that they have flexibility with regard to shares released from a suspense account because of these payments. Those shares can be based on the company's normal allocation formula or, if anti-discrimination tests are met, a formula that is more favorable to newer employees (such as extra allocations for people in their first X years).
Contribute Shares to Newer EmployeesA company can also contribute shares to the plan with an allocation formula that favors newer employees. This could be combined with a more conventional schedule for cash contributions used to repay a loan. Similarly, a company could contribute cash using a formula that favors newer employees and use the cash to acquire shares as they become available in the plan.
Rebalancing and Account SegregationBoth have the effect of moving shares into the accounts of newer employees in companies where most or all of the shares have been allocated but the company is continuing to make cash contributions. Both approaches move shares into the accounts of newer people so they can also benefit from dividends or distributions.
Wawa's Combined Annual Addition ApproachWawa, the iconic chain of convenience stores and gas stations, is an S corporation with over 22,500 employees and is 41% ESOP-owned. Its leaders came up with a creative idea that deals with a scenario where substantial distributions are paid annually, and many senior employees have large account balances. The specifics of their plan may not apply to other companies, but the general concept may.
The Wawa solution is to set an annual target percentage of pay that would be provided from all annual additions, both contributions and distributions or dividends. In Wawa's case the level is 11%, but companies could choose their own target.
Suppose a company targets annual additions to be 10% of annual pay. The company has both allocated and unallocated shares. Dividends paid on allocated shares must be allocated based on relative share balance.
For some participants, dividends will equal 10% or more of compensation, and those participants would receive no additional allocations of shares from the suspense account and no annual contributions. Some participants will receive less than 10% of pay in dividends, and those participants will receive allocations from the suspense account. Some participants will still have received less than 10% of payroll from dividends and shares released from suspense, and those participants will receive contributions to make up the difference. Contributions can be made in stock or in cash, which then may be used to buy available shares in the plan.
Either way, newer employees' accounts will hold more shares so they also can start getting distributions in future years. Companies using this policy generally should release shares from the suspense account based on an allocation formula that is non-discriminatory and not based on share balance (such as relative pay).
Companies doing this must conduct an annual anti-discrimination test to ensure that the impact of this policy is not to favor any highly compensated employee (legally defined as an employee earning $120,000 or more in 2016). If any such employee receives an excess as a result of any contributions (as opposed to allocations from dividends or distributions), contributions would need to be reduced.
There could be many variations on this approach, but the key idea is to limit the impact of distributions or dividends on the have/have-not problem by reducing annual contributions for people who have large numbers of shares. Because this does not fall within the safe harbor rules for ESOP allocations, it is critical to work with counsel and plan administrators on the design of this approach.
Are These Approaches Right for You?Some companies and advisors argue that none of these approaches should be used. Ownership, they believe, includes the right to the distributions of earnings, and more senior people who have stayed around deserve the extra allocations. Younger employees, seeing the value of staying around, will do just that.
On the other hand, people tend to greatly discount future rewards while placing a very high emphasis on perceived fairness. Turnover in companies is related primarily to work culture and perceptions of fairness, not perceived values of long-term rewards. But each company is different, and each must decide what works best for its own culture and workforce.