The Employee Ownership Update
November 1, 2006
Pension Protection Act Provides Easier ESOP/401(k) Safe Harbor TestThe new automatic enrollment provisions for 401(k) plans in the Pension Protection Act allow companies to meet the 401(k) testing rules if they provide automatic enrollment (that is, employees opt out instead of opting in) that has the following features:
- There are matching or non-elective employer contributions to the plan of not less than 3% of pay for all participants, regardless of deferrals or a match, or at least a 100% match for the first 1% deferred and a 50% match for the next 5% deferred. The matching percentage test applies to deferrals of non-highly compensated employees.
- Employees agree to a minimum salary deferral of 3% in the first year, 4% in the second, and 5% in the third.
There is wide consensus in the retirement planning community that employees are not deferring enough into 401(k) plans, and too many eligible participants do not participate at all. Automatic enrollment generally results in a significant increase in participation and deferrals. The new safe harbor test is effective for plan years after December 31, 2007.
While it may be easier to satisfy the safe harbor tests under the new rules, it is also expected that companies will be less likely to offer company stock as an employee investment choice. Proposed rules on default investments for automatic enrollment plans exempt a fiduciary from liability if the investments meet certain criteria. Employer stock would not be among these available choices, except in the very limited circumstances in which the stock was held by a registered investment company or pooled investment vehicle independent of the company. Employer matches in stock, however, are not covered by this rule.
More Stock Option Dating ProblemsThe Securities and Exchange Commission has expanded its inquiry into backdated stock options to over 100 companies. SEC Enforcement Division Director Linda Thomsen also has promised to pursue "spring-loading" cases (issuing options just before the release of good news). Earlier comments by SEC Commissioner Paul Atkins were that spring-loading is not insider trading, and may actually be good for shareholders by making it "cheaper" to compensate executives. The remarks generated considerable outrage in the press and investing public. At least 46 executives have resigned or been fired, and additional accounting charges taken so far exceed $5 billion.
Meanwhile, Glass Lewis, a proxy advisory firm, has found that the Sarbanes-Oxley Act may not have discouraged backdating as much as investors expected. The law requires reporting of option grants within two days of the award, but the study found the SEC is routinely granting extensions of filing deadlines and rarely imposing penalties of any substance. Looking at late filings between 2004 and 2006, Glass Lewis found that at least 6,000 option grants to executives had questionable timing.
Finally, Eric Dash wrote in the New York Times (October 30, 2006) that many executives appear to have reported the exercise date of their options at a time other than they actually occurred in order to save taxes. For instance, at Symbol Technologies, certain executives were allowed to push back the exercise date for their options to the time when the share price was the lowest over a 30-day period, thus minimizing the spread they have to report for taxes. The extent of the practice is unknown, however.