The Employee Ownership Update
March 12, 2002
ESOPs in Closely Held Companies Now Unlikely to Be Affected by Enron LegislationAs Congress continues to deliberate on reforming retirement plan law in the wake of Enron, it is becoming clear that closely held company ESOPs will probably not be substantially affected by any likely changes. In the Senate, the legislation introduced by Senator Kennedy (described below) will serve as the Democratic position; the Republican position appears to be coalescing around the Bush proposal. The Kennedy bill would affect closely held company ESOPs only in a few ways. For companies with over 100 participants in their plans, employees would have to be able to elect half the plan's trustees. In addition, the company would have to issue quarterly financial statements, standards for who is a fiduciary would be somewhat expanded, and fiduciary insurance would be mandated (most ESOP companies have it anyway). The Bush proposal, by contrast, does not effect ESOPs in closely held companies at all.
The Kennedy bill's trustee provisions are among its most controversial and seem very unlikely to survive the Congressional process. That means that, at most, ESOPs in closely held companies would be subject to relatively minor additional procedural requirements. In the House, it appears likely that the Bush bill, or a variant of it, will serve as the likely legislative vehicle, so any eventual compromise legislation between the two bodies looks very positive for closely held company ESOPs.
Public Company ESOPsThe scenario for public company ESOPs is somewhat murkier. All the principal legislative proposals would exempt stand-alone ESOPs from any diversification requirements. However, the Kennedy bill would add the additional fiduciary and employee representation issues outlined above. In addition, all the major proposals would apply diversification rules to combination ESOP/401(k) plans. It appears very likely that these plans would be required to offer diversification of employer contributions of company stock after not more than three years (Bush and Kennedy both have this provision). The Kennedy bill further limits plans so that if employees can invest in company stock, employers cannot match in company stock.
The likely impact of this is unclear. Industry groups are vigorously opposing both the Bush and Kennedy proposals. Industry groups say that these rules will discourage employers to contribute to 401(k) plans, but many consultants to whom we have spoken on this say that they do not think a three-year diversification requirement would make a lot of difference in employer behavior since most employees probably would not diversify very much stock very quickly.
Caps on Employer Stock in Plans Appear DeadOne legislative outcome is now very clear: there will not be caps on the amount of employer stock in 401(k) plans or KSOPs, nor will employer matches of company stock receive a lower tax deduction. Proposals along these lines are receiving little support. The Report of the Department of the Treasury on Employer Stock in 401(k) Plans outlines the Administration's view on this, arguing that such caps would discourage employer matches, would be too arbitrary in light of varying employee financial needs, and would be difficult to administer. The Department estimated that one in five participants in 401(k) plans would have to sell stock if a 20% cap on company stock were imposed.
Kennedy Introduces Retirement BillSenator Edward Kennedy has introduced legislation that is expected to serve as the retirement law focus for Senate Democrats. The bill is expected to be marked up favorably by the Senate Labor Committee, but its prospects on the floor of the Senate are more uncertain. The House is expected to pass less stringent legislation more along the lines of the Administration's proposals. Industry groups, however, have pledged to fight both bills.
Kennedy's bill, S. 19292, is titled the "Protecting America's Pension Act of 2002." Its principal provisions affecting employee ownership are:
- Rules in this section of the bill apply to 401(k) plans and combined ESOP/401(k) plans in public companies, but not to stand-alone ESOPs or ESOP or 401(k) plans in closely held companies.
- Employers could contribute company stock to a 401(k) plan or combined ESOP/401(k) plan (KSOP), or employees could buy stock through the plan, but not both.
- Employees could diversify their own deferrals immediately; employer contributions on employer stock could be diversified after the stock had been in the plan three years.
- The Secretary of Labor is instructed to make recommendations on what to do about employer stock in 401(k) plans in closely held companies.
- Rules would be tightened for providing misleading information on company stock or failing to provide material information on company stock; executive sales would have to be disclosed.
- In plans with more than 100 participants, employees would have to be able to elect half the trustees of the plan, with a neutral party breaking ties.
- Workers would receive a 30-day notification of "lockdowns."
- Adequate fiduciary insurance would be required.
- Companies would be allowed to hire qualified independent financial advisers to provide advice on retirement planning without subjecting the advisers to fiduciary liability.
- Employers would be required to provide information about benefits of diversification.
- The definition of fiduciaries who could be sued would be expanded to anyone who participates in a breach of fiduciary responsibility or conceals facts that lead to a breach.