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The Employee Ownership Update

Corey Rosen

March 16, 2010

(Corey Rosen)

Court, IRS Say ESOP Account Segregation and Rebalancing Acceptable

There has been some debate in the ESOP community about whether companies can segregate employee accounts into cash at termination (but before distribution) or can rebalance employee accounts at the end of the plan year by moving cash and stock in the accounts around so that all participants have the same percentage of stock and cash. A recent court case and IRS ruling provide support for the notion that both can be done, subject to some reasonable limitations.

In Hoffman v. Tharaldson Motels Inc. Employee Stock Ownership Plan, No. 3:08-cv-109 (D.N.D., Feb. 26, 2010), a U.S. district court ruled that an amendment to the company's ESOP to convert terminated participant accounts into cash was permitted under ERISA. The court reviewed the policy in light of ERISA's "anti-cutback rules." The court noted that, in general, ERISA does protect participant rights to optional forms of benefit. But it also noted that the IRS has created a safe harbor that provides that certain items, such as investments in employer stock, are not protected benefits.

On February 23, 2010, the IRS issued a Response to Technical Assistance Request (#4) on rebalancing and reshuffling. By rebalancing, it meant adjusting account balances so everyone has the same percentage of stock and cash; by reshuffling it referred to converting terminated participant accounts to cash and reallocating the shares to active employee participant accounts. The IRS concluded that if the policies are practiced in a nondiscriminatory manner, they would be acceptable. One important caveat is that if shares have been diversified under the diversification rules, they cannot be subsequently reconverted to shares pursuant to rebalancing.

Settlement Reached in Couturier Case

A settlement has been reached between the former ESOP participants, the Department of Labor, and the defendants in Solis v. Couturier (Civ. 2:08-cv-02732-RRB-GGH, E.D. Ca., filed Mar. 10, 2010). The long-running, complex case has attracted considerable attention for a variety of reasons, most notably the issue of the propriety of the executive compensation received by the former CEO (Clair Couturier) and a Ninth Circuit ruling that enjoined the advancement of legal costs to the defendants. Many people also interpreted the Ninth Circuit ruling as making indemnification in a 100% ESOP ineffective, although it is not clear whether the ruling should be read that way (a district court decision in the Kelly-Moore case in the same circuit was more explicit and broader on this question).

The issue that drove the case was the contention that Couturier received an executive compensation package in excess of $34 million, or about one-third of the company's value. Most of that came from a package granted to him prior to the ESOP. When the company was sold at a considerable profit, some former participants sued. Aside from the sheer amount involved, a key to the complaint was whether ERISA applied to this transaction. Plaintiffs also charged that some of the advisors and fiduciaries were conflicted because they played multiple roles in the transaction. Defendants argued they took all the proper steps to insure the compensation package was legitimate; plaintiffs argued they were working more for Couturier than the trust. Because the case was never fully adjudicated, defendants did not have an opportunity to fully state their position.

Settlements are non-precedential. The settlement requires the various defendants (the corporate attorney, fiduciaries, Couturier, and other parties involved in the transaction) to pay $8 million in cash into a settlement fund for the ESOP and $800,000 to the Department of Labor. The lion's share of that comes from Couturier, who also is giving up property worth an estimated additional $5 million. The settlement specifically enables insurance costs to be used to pay for part of this settlement. In addition, the defendants in the transaction are enjoined from serving in multiple roles in future transactions. Most notably, the corporation's attorney must not serve on a board where he represents the plan; serve as a fiduciary, trustee, or administrator of a plan; and not enter into an indemnification agreements funded by an ERISA-covered plan. The agreement then lists a number of documentary requirements the attorney must provide to clients, all of which essentially restate common good practices about advising clients on valuation procedures, fiduciary duties, and document retention. In short, given all the attention the case has received, the settlement ends up simply reaffirming what are almost universally seen as elements of good practice for ESOP advisors (including practices the corporate attorney has said he already practices).

List of Companies with ESPPs and Other Broad-Based Equity Plans Shows Incidence of Equity Awards

Through a painstaking process of checking individual company Web sites and corporate filings, the NCEO has compiled a list of the largest 1,800 U.S. companies that have broad-based equity plans. Of the 1,821 companies that we researched, we could confirm that 131 offer options to most or all employees, 22 offer other kinds of broad-based equity (of these, six offer options as well), and 498 have employee stock purchase plans (ESPPs). We suspect that some of the other companies on the list also have plans, but do not indicate that in their filings or in the careers section of their Web site.

The Foundation for Enterprise Development paid for part of the research, which involved weeks of staff time. The list is now available for purchase for $200 for NCEO members and $300 for non-members. The list is on an Excel spreadsheet and contains the name of the company, whether they have any kind of plan, and what kind of plan it is.

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