employees. Further, the additional 2% tax credit which requires matching employee contributions has not been successful, primarily because the matching provisions are extremely difficult to administer properly.

An increase in the additional investment tax credit for ESOPS should result in an increased interest in the TRASOP concept, while at the same time providing an additional incentive for capital formation. It is most appropriate for this additional incentive to provide the benefit of ownership sharing to the workers.

Tax Credit ESOP Included in Code

S. 3241 would add provisions to the Internal Revenue Code for the permanent recognition of tax credit ESOPS. The ESOP Council believes that this is an important step and that permanent provisions for such ESOPS will overcome the reluctance of certain companies to adopt an ESOP under temporary provisions. The Congress has clearly demonstrated its intent to encourage tax credit ESOPS as a vehicle for providing stock ownership to workers. The time has now come to recognize such ESOPS as a permanent part of the Code. Perhaps such an action will place the Internal Revenue Service on notice that Congress believes that ESOPS are not a temporary part of Federal tax law but will be encouraged as a permanent vehicle.

Voting Rights

S. 3241 would modify the requirement for tax credit ESOPS that voting rights on employer stock be exercised by employees. This requirement has posed a major impediment to the establishment of tax credit ESOPS in the case of closely-held corporations and the ESOP Council strongly endorses the proposed change.

Under S. 3241, the requirement for voting "pass-through" would apply only to ESOPS of publicly-traded companies. This is the approach which was suggested by the staff of the Joint Economic Committee in 1976, following the ESOP hearings held by that Committee in December of 1975.

The present voting rights requirement for tax credit ESOPS poses a major problem for closely-held corporations which do not already provide for the solicitation of proxies for voting of Company stock. The ESOP Council believes that the burden and expense of soliciting proxies from employees in this situation simply is not justified. It is clear that in most cases the stock held by the ESOP will not represent a major portion of outstanding stock and will in no way affect the results of a shareholder vote. Any benefit to ESOP participants provided by voting rights is minimal and in comparison to the cost to the ESOP of providing such rights. We believe that the matter of voting right pass-through to employees should be left in the discretion of the sponsoring company—that is, voting pass-through for ESOPS of closely-held corporations should be an aspect of ESOP design rather than a requirement of law.

Cash Distribution Option

The ESOP Council strongly recommends the adoption of the provision in S. 3241 which authorizes an ESOP to provide an election by a participant to receive a distribution of cash in lieu of stock. In the case of closely-held corporations, it is common for an employee receiving a distribution of stock to be granted a "put option" to sell his stock back to the ESOP or the sponsoring company. In fact, the ESOP loan regulations require a put option in some situations.

Experience has shown that participants in an ESOP of a closely-held corporation generally elect to exercise a put option to sell their stock. In many cases, the result of this repurchase of stock is the equivalent of a cash distribution from the ESOP. The proposed provision for a cash distribution option would alleviate the burden and expense of issuing a stock certificate where the shares are to be immediately resold and would greatly simplify the administration of an ESOP. So long as the option to receive cash is left with the employee, there should be no objection to this provision.

In the past, the ESOP Council has urged the Internal Revenue Service to permit a cash distribution option for ESOPs. We believe that existing law would permit such a change in the regulations. IRS, however, has never looked favorably upon ESOPS and has refused to allow such an option. Accordingly, we urge that legislation be enacted to provide relief to ESOPS in this matter.

Charitable Deduction

S. 3241 would extend charitable contribution treatment under the Code to a "gift" to an ESOP. We strongly endorse this provision and urge the Congress to include it in ESOP legislation. This provision would present an attractive alternative for a wealthy shareholder who may otherwise leave his stock to a private foundation or other charitable institution. A transfer to an ESOP would keep such assets within the tax base rather than "sterilizing" the amounts forever in a tax exempt organization.

We are aware of a number of wealthy shareholders who would take advantage of the charitable deduction provision of S. 3241. We believe that the provision would be an important additional incentive and method for allowing broadened stock ownership opportunities for corporate employees.

Dividend Deduction

S. 3241 would permit a corporate tax deduction for dividends on Company stock which are "passed through" an ESOP to participating employees. We strongly support this provision as a method of allowing current tangible benefits of stock ownership to be enjoyed by workers. Existing law permits dividends to be passed through to employees under an ESOP, but the dividend deduction would provide a tax incentive for companies to effect dividend payments to the workers. One of the biggest obstacles to the effective use of an ESOP as an employee incentive plan is the fact that the benefits of stock ownership are largely deferred until retirement, death or other termination of service. The pass-through of dividends to ESOP participants will allow employees to receive a current benefit on the same basis as direct shareholders receive dividends. In order to jutsify the administrative expense of a dividend pass-through and to encourage companies to provide this benefit to workers, a deduction for such dividends is appropriate. The result would be the widespread participation by employees in stock ownership benefits under ESOPs.

Other Provisions of S. 3241

The present rules for tax credit ESOPS require that every employee who participated in the ESOP at any time during the year be entitled to share in that year's ESOP contribution. S. 3241 would change this requirement to allow allocations to be made only to participants employed at year-end. The ESOP Council strongly supports this change, as it will provide greater ease in administration of an ESOP and will allow the full benefit of the tax credit to be provided to current employees (rather than to former employees in part).

S. 3241 would require that at least one-half of the tax credit for ESOP contributions be represented by "new issue" stock. Inasmuch as some companies have adopted ESOPs in reliance on the rules of the 1975 Tax Reduction Act which extend through 1980, we suggest that the requirement for "new issue" stock be modified to recognize this problem. Our recommendation is to allow each company electing the ESOP tax credit to elect ESOP contributions up to the 2% additional investment tax credit or the 1% of payroll credit (rather than requiring an "all or nothing" election). For years prior to 1981, the "new issue" stock requirement should apply only to ESOP contributions in excess of the current 1% additional investment credit. For years after 1980, and for all ESOP tax credits based on covered payroll, the requirement for one-half of the contribution being represented by "new issue" stock could be maintained in order to recognize the use of an ESOP as a vehicle for capital formation.

Other provisions of S. 3241 will correct certain problems relating to the tax treatment of ESOP contributions and distributions. The ESOP Council endorses these technical changes and believes that they will result in greater simplicity for ESOP participants and will correct certain problem areas under existing legislation.

S. 3291

OTHER PENDING LEGISLATION

Last week Senator Gravel introduced S. 3291 for the purpose of raising the contribution limitations for ESOPS from 25% to 50% of covered payroll. The ESOP Council supports the concept of increased ESOP contributions as a way to increase the opportunities for ownership-sharing by employees.

Although an increase to 50% of payroll is quite large, we believe that added incentives will be beneficial to the objective of providing greater stock ownership by workers. The provisions of S. 3291 would be a welcome addition to the Ex

panded Employee Stock Ownership Act of 1978 and is consistent with the intent of Congress and the objectives of the ESOP Council.

ERISA Improvements Act

S. 3017 was introduced several months ago by Senators Williams and Javits to make changes and improvements to ERISA. The ESOP Council suggests that S. 3017 be modified to provide certain beneficial relief to ESOPS under existing provisions of Federal and state securities laws.

We suggest that S. 3017 provide that all stock distributed by an ESOP maintained by an SEC reporting company be deemed "unrestricted", in order that employees will not be subject to resale restrictions under Rule 144 under the Securities Act of 1933. We suggest that Section 12(g) of the Securities Exchange Act of 1934 be clarified to assure that stock held by an ESOP will be deemed to be held only by one shareholder, in order to avoid the possibility of an ESOP forcing a company to register with SEC under that Act. We suggest that S. 3017 provide that normal elections by employees regarding ESOP participation and distribution not be deemed a securities offering under the 1933 Act. Finally, we recommend that open-market purchases of stock by an ESOP not be subject to the restrictions imposed under SEC Rule 13e-2. These changes would facilitate the operation of ESOPS in both publicly-traded and closely-held companies. Finally, provisions should be added to S. 3017 to alleviate certain problems for ESOPS under state "blue sky" laws. These problems will be discussed below.

S. 2788

On May 15, 1978, the Committee on Commerce, Science and Transportation reported the Regional Rail Reorganization Act Amendments of 1978. Included in S. 2788 was a provision requiring the Consolidated Rail Corporation to establish an ESOP for its employees in conjunction with the proposed additional Federal financing of Conrail. The ESOP Council strongly endorses the concept of requiring employee stock ownership as a condition for corporations receiving Federal assistance.

S. 3223

On June 22, 1978, Senator Gravel introduced a bill authorizing tax-favored treatment for General Stock Ownership Plans. The GSOP concept is related to the ESOP concept and provides a vehicle for the broadening of stock ownership among all citizens.

Although S. 3223 does not provide any additional incentives for ESOPS and will not directly affect ESOP companies, the ESOP Council endorses any technique which results in the diffusion of capital ownership on an equitable basis. H.R. 12094

The proposed Voluntary Job Preservation and Community Stabilization Act would provide for a new Federal financing program for troubled companies and would encourage the adoption of ESOPS in connection with this financing. The ESOP Council endorses any program which encourages the creation of new ESOPS and believes that the Congress should give preference under any Federal financing program where an ESOP is utilized to provide ownership-sharing opportunities for workers.

General

REGULATORY PROBLEMS FOR ESOP

The ESOP Council believes that the Federal agencies have not fully complied with the mandate of section 803 (h) of the 1976 Tax Reform Act, in which the Congress expressed its intent to encourage the adoption of ESOPS and cautioned that regulations and rulings of the agencies were not to hinder the establishment and operation of ESOPs. Notwithstanding Section 803 (h), both the Internal Revenue Service and the Department of Labor, those agencies charged with the responsibility for the enforcement of ERISA, continue to maintain their past hostile attitudes toward the ESOP concept.

It is clear that Congress has found ESOPs to be consistent with the objectives of ERISA. The intent of an ESOP as an employee benefit plan is to provide employees with the opportunity to share in the ownership of their employer. For some yet unexplained reason, both IRS and DOL continue to be skeptical of ESOPS and have not accepted the clearly stated intent of Congress. The agencies have continued to impose oppressive requirements for ESOPS, have failed to

promulgate sufficient guidelines necessary to the proper operation of ESOPS, and have made little effort to attempt to deal directly with the potential abuses of ESOPS. Rather, the agencies appear to take the position that all ESOPs are inappropriate as employee benefit plans. It appears that the message of Congress regarding ESOPS has not yet been effective in obtaining an appropriate response from the agencies.

Put Option Requirement under ESOP Regulations

On September 2, 1977, final regulations were published relating to "leveraged ESOPS."To a large extent, these regulations reflected the "instructions" set out in the Conference Report under the 1976 Tax Reform Act for the rewriting of the onerous ESOP regulations proposed on July 30, 1976. There are, however, certain remaining problems for ESOPS under the final regulations, reflecting a failure to fully comply with the intent of Congress.

For example, the ESOP loan regulations impose an onerous "put option" requirement applicable to certain stock distributed to employees from an ESOP. The proposed regulations had required a two-year duration for the put option. The Conference Report had suggested a put option period "considerably shorter" than two years. The response of IRS was to require a fifteen-month put opion under the final regulations. It is certainly doubtful that fifteen months is "considerably shorter" than two years. It is also clear that a put option for a shorter period is sufficient to protect employees.

The put option provisions of the proposed regulations did not permit an installment for tendered stock. The Conference Report suggested that installment payments over a "reasonable period" should be permitted. The final regulations generally require installment payments to be no longer than five years under an ESOP put option, while at the same time IRS permits other qualified plans of deferred compensation to make installment distributions over periods of fifteen years or longer. Further, the regulations require that installment payments under an ESOP put option be "adequately secured", while no such requirement is applicable to installment distributions under other plans. This requirement for "adequate security" has the effect of changing the status of an ESOP participant from that of shareholder to preferred creditor, a result which is clearly not supported by the law and should be modified.

Finally, the put option requirement of the final ESOP regulations makes it impossible, in some situations, for national and state banks to utilize "leveraged" ESOPS for the benefit of employees. Both IRS and DOL have acknowledged this problem, but both have been unwilling to provide relief from the onerous requirements. It appears that the agencies will not react favorably when presented with ESOP problem areas unless specifically directed to do so by Congress.

The cash distribution option provision included in S. 3241 should solve certain of these problems relating to the put option requirement for ESOPs. Interestingly, such an option has been suggested to IRS on numerous occasions over the past three years. It is clear that such an option would be permissible under existing Income Tax Regulations, but IRS continues its refusal to make interpretations in the ESOP area which will avoid problems for ESOP companies and participating employees. Again, we must seek the assistance of Congress in solving an ESOP problem which IRS could easily solve itself under existing law.

TRASOP Regulations

Regulations relating to tax credit ESOPS under the 1975 Tax Reduction Act were first proposed in July, 1976, at the same time as the regulations relating to leveraged ESOPS and ESOP loans. These regulations have not yet been finalized. It has been almost two years since the final rules for tax credit ESOPS were included in the 1976 Tax Reform Act. IRS has provided absolutely no further guidance in this area.

We believe that this delay is inexcusable. We believe that the absence of guidelines from IRS has caused many companies to elect not to establish tax credit ESOPs. Perhaps it would be appropriate to include in S. 3241 a provision requiring IRS to publish its regulations within a specified time period, in order to avoid the problem of companies not providing ownership-sharing opportunities to employees merely because IRS has failed to provide guidelines.

Valuation Regulations

Section 3(18) of ERISA authorizes the Department of Labor to prescribe regulations for determining the "fair market value" of company stock to be acquired by an ESOP. In the event ERISA's definition of "adequate consideration"

is not satisfied, the sale of stock to an ESOP by a party in interest may be a prohibited transaction.

It has been almost four years since the enactment of ERISA, and no guidance on the issue of valuation has been provided by DOL. We believe that, as a minimum, DOL could have issued temporary regulations stating that IRS rules for valuing corporate stock would be applicable to ESOP transactions.

The valuation area is critical in the case of an ESOP for a closely-held corporation which has no "generally recognized market" for its stock. Both IRS and DOL have often stated that valuation of closely-held corporate stock is an area of possible abuse of ESOPS. Yet DOL has failed to provide the guidance required by ERISA. Perhaps the DOL approach will be to provide no guidance, then to audit (along with IRS) and find ERISA violations, and then to return to Congress with examples of abuse which justify "anti-ESOP" legislation. If the agencies are seriously concerned about preventing abuses and protecting the interests of ESOP participants, the valuation regulations should be made a matter of top priority within DOL. How long must we wait for necessary guidance?

Advance Approval of ESOP Transactions

The ESOP Council recognizes the potential for abuse in ESOP transactions. We recognize the need to assure that ERISA's provisions are applied to protect the interests of ESOP participants. We agree with the direction of the ERISA Conference Report that ESOPS be subject to "special scrutiny" and the direction of the Conference Report under the 1976 Tax Reform Act that ESOP regulations "should deal directly with possible abuses." Both IRS and DOL have, in our opinion, failed to provide a mechanism to effect this stated intent of Congress.

We suggeest, therefore, a legislative remedy to this problem. This remedy has been suggested to the agencies in the past, but both DOL and IRS have failed to implement it. We suggest that IRS be required, by legislation, to establish a procedure for advance approval of ESOP transactions. Such a procedure would allow the parties to a proposed sale of stock to an ESOP to present the deails of the transaction (including valuation, terms of purchase, loan terms. etc.) to IRS in advance, in order to receive a ruling that such transaction will not be a prohibited transaction under ERISA. Such a procedure would merely be an extension of the existing advance rulings procedure to include a determination of factual issues, such as valuation.

The existence of an advance approval procedure would place IRS in the position of being able to protect the interests of ESOP participants, by reviewing the proposed transaction terms in advance. In addition, all partise to the transaction would have the assurance in advance that there is no violation of ERISA's prohibited transaction rules. If IRS and DOL are now able to make such determinations after-the-fact, through the audit procedure, there is no reason the same determinations cannot be made in advance.

It is clear that no regulations or rulings can be published to provide complete guidance on the propriety of every ESOP transaction. Particular facts and circumstances of each case will be unique. It is only through an advance approval procedure, administered in good faith by IRS, that potential abuses of the ESOP concept can be protected against. In this way, ESOP transactions will be structured properly and employees will be provided with the opportunities for ownership-sharing under the assurances that ERISA's protections will be complied with. Prudence Regulations

The Department of Labor published proposed regulations under ERISA's "prudent man" rule last April. Although the Congress had stated in Section 803 (h) of the 1976 Tax Reform Act that ESOPS were not to be treated as "conventional retirement plans", the proposed prudence regulations made no attempt to recognize the special purpose of an ESOP as an employee benefit plan which provides for stock ownership for workers.

Last month, the ESOP Council submitted comments to DOL pointing out the omission in the prudence regulations of the special nature of ESOPs and other plans designed to invest in employer securities. We believe, however, that DOL will again fail to provide sufficient assistance to ESOPs and will continue its position that ESOPS are improper as employee benefit plans. It is only when Congress specifically takes action that the agencies are somewhat responsible. Perhaps