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The Employee Ownership Update

Corey Rosen

November 11, 1995

(Corey Rosen)

Senate Rejects Amendment to Restore "Section 133" Interest Income Exclusion for ESOPs

By a vote of 56-42 the Senate rejected an amendment to the budget reconciliation bill to restore section 133 of the Internal Revenue Code. The section provides commercial lenders a 50% interest income exclusion for loans to ESOPs that own over 50% of a company's stock and pass through full voting rights to participants. Lenders typically pass on part of the tax benefit to qualified borrowers, resulting in loan rates 10-15% lower than they would otherwise be. The restrictions on the loans, however, have meant that relatively few ESOPs use them.

The Senate Republicans led the effort to drop the provision in the Senate Finance Committee markup of the bill. They estimated that the cost of the provision would be $1 billion over seven years. In fact, the NCEO and ESOP practitioners agree the real number is probably under $5-$10 million per year. The effort to restore the provision was led by Senators Paul Simon (D-IL) and Jeff Bingaman (D-NM). Senate Majority Leader Robert Dole said the provision was a "major ESOP loophole" whose elimination would help reduce "corporate welfare." The Senate Republicans want to use the money to help pay for income and capital gains tax cuts.

There is no comparable House provision, so the issue will have to be resolved in conference. There does not appear to be much chance that the House conferees will block its adoption, however. The Clinton Administration has taken a neutral stance on the issue. Reportedly, the Treasury Department opposes the provision while the Labor Department favors it.

Court Rules in Favor of ESOP Trustees Who Did Not Diversify Holdings

A U.S. Court of Appeals has ruled that an ESOP trustee cannot generally be held liable for failing to diversify ESOP holdings out of company stock, even if such diversification would have been a more prudent course of investment. The case (Kuper v. Iovenko, CA 6, No. 94-3688, 10/4/95) concerned former employees of the Emery Division of Quantum Chemical. Emery was sold by Quantum in 1989, but the actual transfer of assets took place 18 months later. During that time, Quantum stock fell from $50 to $10, although it went up and down during the period. The Emery employees were still ESOP participants during the 18 months. The court ruled that the trustees have a presumptive right not to diversify because the plan is designed to invest primarily in employer stock.

The same reasoning was used in another appeals court ruling on a similar issue (Moench v. Robertson, CA 3, No. 94-5637, 8/10/95), even though, in this case, the court ruled the trustee should have diversified because the trustees knew, or should have known, that they were continuing to purchase shares in a company whose financial future was very poor. In the Quantum case, the future of the company was much more uncertain. There was at least a legitimate argument that the stock price would rebound during the time period in question.

On another matter in the Quantum case, the court ruled that the date of the appropriate valuation for the sale should be when the assets were transferred. In a decision by another appeals court in a parallel case on the same issue (Wulf v. Quantum Chemical, CA 6, June 1994, 22 BPR 1220, 18 EBC 1449), the court ruled the appropriate date was the day the sale took place.

Microsoft Options Plan Creates Employee Millionaires

Microsoft is famous for making Bill Gates the richest person in America, but the company has made a lot of other people wealthy as well. At an NCEO workshop on broad stock options, Lisa Yeager, Manager of Employee Stock Services for Microsoft, described how the company's ownership plan works. Over 80% of all employees get stock options, which are granted on a discretionary basis on hiring and at an employee's annual review. Management decides who gets options and how many they receive. The options vest over 4 1/2 years and must be exercised within seven years. Employees can sell their shares they day they exercise their options in a cashless transaction that leaves them with the after tax gain on their options' value. Microsoft stock went public in 1986 at a split adjusted price of $1.16; it now trades around $100. As a result, at least 2,000 of Microsoft's 18,000 employees have become millionaires and many more have six-figure amounts.

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