Department of Labor Issues Field Assistance Bulletin on Refinancing ESOP Loans

The Department of Labor (DOL) has issued the first of what will be periodic Field Assistance Bulletin (FAB) on the operation of qualified plans. The advisories are meant to give DOL field officials guidance on how to respond to various plan operational issues. The inaugural FAB is on refinancing leveraged ESOPs.

The bulletin does not address situations in which an ESOP loan is refinanced with the same or shorter terms, usually to obtain a lower rate of interest. That kind of refinancing would clearly be beneficial to plan participants. Instead, it looks at a practice that grew in the 1990s, especially among public companies, of refinancing existing ESOPs to extend the term of the loan. The usual purpose was to spread out ESOP contributions over a longer period of time so that the amount released from the plan was lower on an annual basis. Many of these plans were linked to 401(k) plans. The company set up the ESOP so that the projected amount released annually from the ESOP suspense account as the loan was repaid would be similar to the amount the company would have otherwise contributed as a match to the 401(k) plan. In the 1990s, however, stock values went up faster than companies anticipated, meaning the amounts released from the suspense account were also much larger than anticipated (in a leveraged ESOP, as the loan is repaid, an equivalent number of shares is released each year, so the value of those shares will go up and down with share price). Some companies decided they were overcompensating employees and decided to refinance their loans to spread the release out over a longer period of time. Many ESOP experts (as well as the NCEO) argued that this was improper, that the employees were simply getting the upside of the risk ownership entails, just as they would get less if the stock went down. The new FAB concurs with his view, directing DOL agents to examine these refinancings to assure that if loans are refinanced, the refinancing is for the benefit of the employees, not the company.

Other refinancings, however, could present very different issues. For instance, a company may want to extend the terms of a loan because its cash flow is not as high as projected. In other cases, a loan may be refinanced because the company's payroll has shrunk. and repaying the loan on its original terms could cause violations of contribution limit rules. In these cases, refinancings may be in the interest of employees. Nonetheless, they should still be evaluated in light of the new directive.