Section 401(k) Plans and Employee Ownership

Fourth Edition (2003); softcover, 152 pp. (6" x 9"). $25 for NCEO members; $35 for nonmembers.

In recent years, company stock has become a popular investment choice in 401(k) plans; as a result, the 401(k) plan has become one of the main vehicles of employee ownership in the U.S. However, in the wake of Enron’s collapse, the use of company stock in 401(k) plans has become controversial. Now in a new edition revised in late 2003, this book discusses in detail how company stock is used in 401(k) plans and how such arrangements can work alone or in conjunction with employee stock ownership plans (ESOPs).

Preface
The 401(k) Plan As an Employee Ownership Vehicle
Company Stock in 401(k) Plans: Trends and Prospects
Recent Litigation over Company Stock in 401(k) Plans
Corporate Governance Issues Raised by a 401(k) Plan’s Investment in Employer Stock
401(k) and ESOP Securities Law Issues
Reaching an Optimal Level of Employee Ownership in a Profit Sharing/401(k) Plan
Techniques for Managing Employee Ownership in 401(k) Plans
Dividend Deductions for Public Companies with 401(k) Plans
Converting a 401(k) Plan to an ESOP and Creating a KSOP
ESOP/401(k) Combinations: Administrative Issues and Perspectives
Using Your 401(k) Plan as an Incentive to Improve Corporate Performance

Excerpts

From Chapter 2, "Company Stock in 401(k) Plans: Trends and Prospects"

After the collapse of Enron, news stories, proposed legislation, and the drumbeat of advice from advisors on the importance of diversification all spurred some companies to offer more choices in their 401(k) plans, including allowing employees to diversify earlier out of company stock. In an unpublished study released in April 2002, the Boston Research Group surveyed 100 participants who had company stock in their 401(k) accounts both before and after Enron. The small sampling size meant there was a 9.8% margin of error. While almost all of the participants were aware of the issues raised by Enron, only one in eight decreased his or her investment in company stock. The average company stock holding was 30%, with one-third holding more than 50%. Still, 85% of the respondents said they were “comfortable” with their investment choices. Interestingly, when asked what was a prudent percentage to be in company stock, two-thirds said 15% or higher and half 25% or higher, indicating that employees thought other people should be more diversified than they were themselves.

From Chapter 4, "Corporate Governance Issues Raised by a 401(k) Plan’s Investment in Employer Stock"

In 1994, the DOL issued Pension and Welfare Benefits Administration Interpretive Bulletin 94-2 ("IB 94-2") to set forth the DOL's views regarding (1) the duty of plan fiduciaries to vote the proxies appurtenant to shares of stock held by a plan, (2) the maintenance of statements of investment policy by plan fiduciaries, and (3) shareholder activism by plan fiduciaries. Although IB 94-2 does not expressly address the holding of employer stock by a plan, these topics are clearly relevant to such an investment.

Part 1 of IB 94-2 expands upon the DOL's often-made assertion that the fiduciary act of managing plan assets that consist of shares of stock includes the act of voting the proxies that are appurtenant to such shares. Here the DOL delves into some detail regarding the identity of the person who should vote such proxies in particular situations. IB 94-2 makes it quite clear that some plan fiduciary is ultimately responsible for proxy voting, and that the "buck" does, indeed, stop on the desk of the plan's trustee(s), the plan's "named fiduciary," or an investment manager.

For purposes of this analysis, what is most important is the emphasis that the DOL places upon this act of proxy voting and the DOL's understanding that a plan's vote can affect the value of the assets it holds. To the extent that the plan's named fiduciary does not carry out the responsibility for voting proxies, it must necessarily monitor the activities of the fiduciary that does perform this task. It is the DOL's view that this duty to monitor requires the creation and maintenance of appropriate records and documentation. This should be a signal to the wary fiduciary that DOL investigators will ask for such material when they conduct plan audits.

From Chapter 9, "Converting a 401(k) Plan to an ESOP and Creating a KSOP"

Matching contributions in the form of company stock also should be valued at the time of contribution to avoid the potential for being labeled as a “prohibited transaction” by the Internal Revenue Service (IRS). In Commissioner v. Keystone Consolidated Industries, Inc. (May 24, 1993), the U.S. Supreme Court ruled that contributions of property other than cash pursuant to an employee benefit plan may constitute prohibited transactions under Section 4975(c)(1)(A) of the Code, whether or not the property is encumbered, if they are made to satisfy a funding obligation of the plan sponsor. Here, the Court considered a situation in which Keystone Consolidated Industries, Inc., contributed five trucking terminals and other real property, rather than cash, to its defined benefit pension plan to satisfy its minimum funding obligation for the year and found that a transfer of property in satisfaction of indebtedness is treated as a “sale or exchange” of property between a plan and a disqualified person. Although the form of this transfer was a “contribution,” not a “sale,” the Court ruled that a transfer of property in satisfaction of indebtedness is treated as a “sale or exchange” because the property was exchanged for diminution of the employer’s funding obligation.

The Court distinguished the situation in which property is contributed other than in satisfaction of a “funding obligation,” e.g., where “[a]n employer with no outstanding funding obligation wishes to contribute property to a pension fund to reward its employees for an especially productive year of service.” Such a contribution would not constitute a prohibited transaction unless the property contributed was encumbered. It would appear that contributions required under a money purchase pension plan that is part of an ESOP would constitute a “funding obligation” because such a contribution is subject to the minimum funding requirements of Section 412 of the Code and Section 302 of the Employee Retirement Income Security Act of 1974, as amended (ERISA). There is still the question of whether matching contributions pursuant to a 401(k) plan or a KSOP would constitute a “funding obligation.” Nevertheless, assuming that company stock contributed pursuant to a 401(k) plan, a KSOP, or an ESOP is properly valued (including through use of an independent appraisal for a closely held company), the Court’s opinion in Keystone should not raise serious concerns for a plan sponsor.

How to Order

Use our online order form for secure, instant ordering.
Or phone the NCEO (510-208-1300) with your credit card in hand.
Or, if you already have an order form, fax or mail it with your payment (credit card information or check).