Second Thoughts on Floor Price Protection?

In the NCEO's new issue brief Floor Price Protection in ESOP Transactions, ESOP experts describe various approaches and issues related to providing plan participants protection against the impact of debt on stock prices after a second-stage ESOP leveraged transaction. The practice is common, but Ed Renenger of Stevens & Lee Employee Benefits Group noted in an email to us that the IRS, at least informally, has raised some concerns. In response to a question at an IRS call-in on the determination letter prices, a question was asked about how the IRS felt about price protection in which the impact of the debt was not considered in valuing ESOP shares of the protected group. The IRS representative responded:

"Well, quite frankly, we don't like it. Now valuation is generally an operations issue and on the determination side, we're reviewing the plan to see that you've got plan provisions that are compliant with the law. Here you have a plan provision which says this is what we're going to do when we conduct a valuation. And the valuation that we're going to conduct is basically going to ignore a substantial factor that might influence or affect the fair market value of the underlying security...

"We don't like this for two reasons. One, you have a provision that is setting the plan up to perform a valuation that won't necessarily reflect true value. Number two, this is really a hypothetical future event that you're asking us to endorse at the time the submission is made. You're saying without regard to any debt that is incurred by the ESOP to the shareholder to a later purchase of the stock in a leverage transaction, that's talking about something that's going to happen in the future that you want us to basically approve today. We would say, "I don't think that's appropriate. We would have a problem with it."

As Renenger noted, this is not a statement of formal IRS policy, and it only applies to putting this language in the plan document as opposed to developing it as a practice outside the plan. Still, it does suggest the IRS could have concerns, albeit they have not to date challenged plans with this structure.

We would be very interested in getting more comments on this.