The Employee Ownership Update
April 12, 2002
House Approves Retirement Plan Reforms: Bill Follows Lines of Bush Proposal, ESOPs Largely UnaffectedOn a 255 to 163 vote, the House passed H.R. 3762, the Pension Security Act. The bill follows the general outlines of President's Bush's proposal for retirement plan reform, but adds some significant new initiatives. On a 223-187 vote, the House rejected an amendment in the nature of a substitute offered by Congressman George Miller (D-CA) that closely paralleled the bill that passed the Senate Health, Education, Labor, and Pension Committee's bill. The vote followed party lines closely, although 22 Democrats did vote against it. The Senate Bill, detailed in my column of March 21, has much stricter provisions than the House bill.
The key provisions of the House bill, as they might apply to ESOPs, are described below:
- Coverage: Diversification rules apply to all 401(k) plans in public companies and public company ESOPs that are used to match employee deferrals into retirement savings plans. Other rules generally apply to all defined contribution plans.
- Diversification of employer stock contributions: After three years of service during which benefits have been received, or three years after the end of the plan year in which employer stock is contributed to an employee account, employees could diversify employer stock they have received as matching contributions into a choice of at least three other investment options. The second option would allow diversification only for those shares contributed three years earlier; the first for all shares currently in the employee's account. This will be gradually phased in over five years at 20% of stock contributed per year, except for those employees in ESOPs covered by the bill who have a diversification election option that provides for greater diversification rights. The choice of which three-year alternative to follow is the employer's. The rule applies only to employer stock contributed after the effective date of the legislation.
- Diversification of employee deferrals: Employees could immediately diversify their own deferrals.
- Lockdowns: Employers would have to notify employees at least 30 days in advance of any significant period in which employees will be unable to trade.
- Diversification notices: Employees would receive periodic notices on the advantages of diversifying their accounts. Companies failing to do so would be fined.
- Employee education: There would be a new tax deduction for employees to pay for the cost of retirement planning services.
- Employee education: Companies can have plan administrators or other investment advisors provide advice to employees on investments without being subject to fiduciary risk, provided safeguards are met for disclosing potential conflicts.
- Relaxed coverage and discrimination tests: The Secretary of the Treasury is directed to write regulations allowing defined contribution plan sponsors to use pre-1989 rules for coverage testing and pre-1994 rules for allocation of benefits. The Secretary is also directed to develop new rules to allow a facts and circumstances exception to current mechanical rules governing the line of business regulations. The pre-1989 coverage rules allowed employers to cover 70% or more of eligible employees, or 80% of all eligible employees if 70% or more of the employees are eligible (meaning the plan benefits at least 56% of all employees, not just all eligible employees). Current rules require coverage of 70% or more of all non-highly compensated employees or coverage such that the percentage of non-highly compensated covered employees is at least 70% of the number of covered highly compensated employees. The pre-1994 allocation rules allowed a "facts and circumstances" exception to allocation rules. The Secretary is directed to draft specific guidelines for when rules for coverage and allocation can be relaxed to these earlier guidelines.
Impact on ESOPs and Employee Ownership in 401(k) PlansThe bill should have very little if any impact on all but a handful of ESOPs, and those only in public companies where the ESOP is combined with a 401(k) plan. Private companies with employer stock in 401(k) plans are also unaffected by the new diversification rules. Public companies 401(k) plans and combined ESOP/401(k) plans will have to offer diversification, but the provisions allow enough flexibility that it is unlikely that companies will find these new rules a significant disincentive to match in employer stock. The relaxed coverage rules will have little impact on ESOPs as almost all ESOPs go beyond minimum coverage rules voluntarily.
OutlookThe addition of the provision allowing employers to avoid fiduciary obligations when using plan administrators to provide investment advice to employees caused the bill to lose its key Democratic sponsor, Benjamin Cardin (D-MD). The largely party-line vote in the House augurs a similar partisan battle in the Senate, where the Democrats' slim majority will probably produce a stronger version of the legislation. The relaxed coverage requirements also will be a lightning rod for Democratic criticism. It is entirely possible that the entire matter will be put off till next year if members of Congress on both sides decide they would prefer to use it as an election issue or if the two Houses cannot agree on a compromise. Despite all this, reform this year is still a real possibility.
House Passed Retirement Reform Bill Precludes IRS Withholding RulesThe retirement reform bill passed by the House includes a provision that prohibits the IRS from imposing planned withholding requirements for ISOs and ESPPs. The IRS has proposed regulations, effective 2003, that would require employers to withhold payroll (but not income) taxes on stock option exercises or purchases under incentive stock option (ISO) plans or employee stock purchase plans (ESPPs). Employer groups have argued the withholding would be at best very burdensome and at worst impractical. They have also noted that the tax would be imposed even though employees might later sell the stock at a loss or might exercise their options when no longer on the payroll. Some employers have said they might stop offering some of these plans if they had to withhold.
Prospects for the provision remain uncertain, especially given its $20 billion price tag. The strong support, however, suggests passage is a possibility.