1250 New Ideas 3-23-78 The ESOP itself cannot be bound to honor the put but may, under the regulations, actually purchase the stock under the option once the put is exercised to the employer. In the case of an employer, such as a bank, which is forbidden by federal or state law from purchasing its own stock, there must be a third party (such as a shareholder or an affiliate) other than the ESOP who is bound to honor the put if one is required. This requirement may make it impossible for a bank to utilize a leveraged ESOP where their stock is not publicly traded. It is hoped that the agencies will revise this requirement to comply with Congressional intent to encourage ESOP financing. Transitional Rules: As proposed, the regulations would have required that any leveraged ESOP loan be amended to conform to all applicable requirements. The issue of retroactivity was not addressed by the Conference Committee report. However, the Senate version of the Tax Reform Act of 1976 contained the language of what became section 803 (h) of the Act. Following the implicit directive of this section, the final regulations contain transitional rules applicable to ESOP loans incurred prior to November 1, 1977.73 ESOP loans incurred prior to January 1, 1976 are not subject to the requirements of the regulations relating to puts, calls or other options, or buy-sell arrangements; the provisions for ESOP liability, default, release from encumbrance; rights of first refusal, put options and other loan terms. Such ESOP loans are, however, subject to the requirements relating to the "primary benefit" provision, use of loan proceeds and reasonable rate of interest, inasmuch as such requirements could be "reasonably anticipated" from the statutory provisions of the ESOP loan exemption. The special "default rule" also applies to such a loan if made to the ESOP by a party in interest, and must have been complied with before November 1, 1977. A leveraged ESOP in effect on July 1, 1974 is not subject to any provisions of the ESOP regulations until June 30, 1984, due to the effective date provisions of ERISA section 414(c)(1). ESOP loans incurred after December 31, 1975, but before November 1, 1977 are generally subject to the rules applicable to pre-1976 loans, plus the ESOP guidelines of T.I.R.-1413. Such a loan is subject to the "default rule" requirements only in the case of a party in interest lender. Such a loan is not subject to the right of first refusal rule and the three special rules relating to "release" and allocation of shares under the level annual payment method. However, the other "release" rules are applicable to stock acquired by the ESOP after November 1, 1977, with the proceeds of a loan incurred prior to that date. The mandatory put option is required for employer stock acquired with ESOP loan proceeds after September 30, 1976, regardless of the date the loan was taken out (or refinanced). For such stock distributed by an ESOP prior to November 1, 1977, the put option must be complied with by December 31, 1977. There are undoubtedly many unamended ESOPs. And it's hoped that retroactive compliance can be effected so long as the provisions of the plan not in compliance have not operated to the detriment of participants. Conclusion: The final ESOP resolutions represent a new approach to employee benefits. Rather than focusing on employee retirement income security, the ESOP's primary goal is to enable employees to derive the benefit of ownership of employer stock. Although ERISA is replete with. references to "primary" and "exclusive" benefit language regarding qualified plans, it appears that the ESOP is intended to operate for the mutual benefit of the employer and its employees.74 For the employer, the leveraged ESOP provides a tax-favored method 3-23-78 The Final ESOP Regulations 1251 of financing its capital requirements. And for the employee it represents a measure of Congressional concern with the recurrent pattern of concentrated capital ownership in the United States.75 In answer to the common criticism that ESOPs put plan participants in an unacceptedly risky posture, Senator Russell Long, the legislative patron saint of employee ownership, responds, "Detractors have argued that there is an unacceptable risk to an employee's future security if his retirement fund is invested entirely in his employer. They claim that the financial failure of an employer inflicts double damage because it means the loss of both job and retirement income. To that argument one must respond that there are no devices today other than employee stock ownership plans which are capable of widespread application within the U.S. economy and which can make significant holders of capital out of the vast majority of consumer units who own no significant productive capital of any kind. Fifty years of intensive application of the principles of conventional fixed-benefit pension and profit-sharing plans have not created this opportunity. In fact, as mentioned earlier, fewer and fewer persons own capital today; the capital ownership base was ten times larger at the turn of the century than it is today. One can only conclude that the argument regarding the excessive risk an ESOP creates for an employee's future should not be heeded when balanced against the tremendous financial gain an ESOP avails to an employee.”76 Thus, the ESOP brings a populist perspective to the employee benefits field. Because its purpose differs, the tests by which its acceptability will be measured are likewise different. Although the ESOP operates within the general framework of ERISA, its underlying ownership ethic brings to ERISA a slightly different measure of plan acceptability. The final ESOP regulations bring both a more reasonable and a more realistic approach to the establishment and administration of ESOPs. Prior to the publication of the final regulations, the ESOP was plagued with uncertainty regarding its treatment at the hands of the IRS and the Labor Department. However, it is now quite clear that Congress fully intends to carve out an ESOP exception from ERISA in order to bring about the debt financed purchase of employer stock for the benefit of employees. The regulations appropriately caution fiduciaries to "excise scrupulously their discretion in approving ESOP loans."77 The ESOP is intended to grant employees access to ownership while also giving the employer a less expensive means to finance capital growth and transfers in ownership. The ESOP concept represents an attempt to build a financial structure that will benefit both the employee and the employer. The ESOP should be used only when appropriate and only when it can serve the valid objectives of the employer corporation and its shareholders while also providing for employee stock ownership in a manner consistent with the fiduciary requirements of ERISA. Footnote TABLE OF CITATIONS (1) T.D. 7506, Reg. §§ 54.4975-7(b), ¶ 85,177* & 54.4975-11, ¶ 85,177*. D.O.L. Reg. §§ 2550.408b-3, ¶ 90,297* & 2550.407d-6, ¶ 90,297*. Following footnotes will cite only the IRS Regulations. (2) Prop. Reg. §§ 54.4975-11, ¶ 94,169* & 54.4975-7(b), finalized 9-2-77, ¶ 85,177,* and D.O.L. Prop. Reg. §§ 2550.407d-6, ¶ 90,297 & 2550.408b-3, ¶ 90,297 appearing at 41 FR 31833 & 41 FR 31870 respectively. 1978 P-H Inc. Pension-See Cross Reference Table for latest developments 1073 (4) ERISA § 408(b) (3), 80,408* & I.R.C. § 4975(d)(3), ¶ 77,565*. 3-23-78 (5) § 219 (f) of 1921 Revenue Act exempted from the income tax laws income from a trust created by an employer as part of a "stock bonus or profit-sharing plan for the exclusive benefit of some or all of his employees." A similar tax exemption was not provided to pension plans until the Revenue Act of 1926. (6) Rev. Rul. 46, 1953-1 C.R. 287, ¶ 69,306*, updated by Rev. Rul. 71-311, 1971-2 C.B. 184, ¶ 65,780.* (7) P.L. 93-236 (1/2/74) ESOP defined in § 102(5) thereof. (8) I.R.C. § 4975(e) (7), ¶ 77,565*. See also ERISA § 407(d) (6), ¶ 80,407*. (9) P.L. 93-618 (1/3/75). In granting loan guarantees in connection with projects in trade impacted areas, the Trade Act gives preference to a corporation which agrees to finance 25 percent of the principal through an ESOP. 19 USC § 2373(d) and (e). (10) A corporation is allowed an additional 1% investment tax credit (through 1980) if the amount of that 1% is contributed to a TRASOP. Under § 301(e) of the 1975 Act, as added by § 803 (d) of the 1976 Tax Reform Act ¶ 80,983*, a further additional 2% investment tax credit is allowed for TRASOP contributions if that 2% is matched by employee contributions. Special restrictive requirements apply to TRASOPs. The ESOP regulations finalized on 9/2/77 did not include the TRASOP regulations. (11) Long, "Employee Stock Ownership Plans: Spreading the Wealth to the Average American Worker", 26 Am. U.L. Rev. 515 (1977); Kurland, "Beyond ESOP: Steps Toward Tax Justice", 29 The Tax Executive, 187 and 386 (1977); Speiser, "ESOP, Kelso and Economic Justice", N.Y. State L.J. 552 (November, 1975); O'Hara and Crawford, "Will Every Corporation Have an E.S.O.P.? Senator Long Makes It Hard to Say No", 61 A.B.A.J. 1287 (1975). (12) ERISA § 407 (d) (6) (A), ¶ 80,407*. See also I.R.C. § 4975 (e) (7) (A), ¶ 77,565*. (13) ERISA § 3(2), ¶ 80,021*, includes as an "employee pension benefit plan" a plan which either (a) provides retirement income to employees, or (b) results in a deferral of income by employees for periods extending to the termination of covered employment or beyond. See also ERISA § 402(b) (1), ¶ 80,402*, which requires a funding policy consistent with the objectives of the plan. (14) Reg. § 1.401-1(b) (1) (ii) & (iii), ¶ 63,069*. Compare to Reg. § 1.401-1(b) (1) (i), ¶ 63,069*. (15) Comments of Senator Ted Stevens of Alaska. 122 Cong. Rec. § 13429-30 (daily ed. Aug. 4, 1976). (16) Reg. § 1.401-1 (a) (2) (iii) & (b) (1) (iii), ¶ 63,069*. (17) Reg. § 54.4975-11 (a) (2), ¶ 85,177*. (18) Reg. $ 54.4975-11(b), ¶| 85,177*. །། (19) ERISA § 407(d) (3) (A) (ii), ¶ 80,407*. (21) (22) The ERISA Conference Report, H. Rept. 93-1280 (8/12/74), states that the "conferees expect that the courts will interpret this prudent man rule (and the other fiduciary standards) bearing in mind the special nature and purpose of employee benefit plans" and notes the "special purpose" of eligible individual account plans which "commonly provide for substantial investments in employer securities." (23) ERISA §§ 406(a)(2), ¶ 80,406* & 407, ¶ 80,407*. (24) Reg. § 54.4975-11 (a) (5), ¶| 85,177*. (25) Reg. $ 54.4975-11 (a) (6), ¶ 85,177*. "Conversion" is generally effected through an amendment of the existing plan. (26) Reg. § 54.4975-11(a) (6), ¶ 85,177*. See I.R.C. § 411(d) (3), ¶ 80,411* & 3-23-78 Footnote The Final ESOP Regulations Reference 1253 Reg. § 1.411(d)-2(c), ¶ 85,176*. See also Reg. § 1.401-6(b)(1), ¶ 63,074* and ERISA § 4041(f), ¶ 80,941*. (27) See Eaves v. Penn, 426 F. Supp. 830 (1976), where rescission of a profitsharing plan conversion to an ESOP was ordered by reason of a finding of violations of ERISA § 404 (a) (1), ¶ 80,404*. See also Ludwig, "Conversion of Existing Plans to Employee Stock Ownership Plans," 26 Am.U.L. Rev. 632. (28) Reg. § 54.4975-11(e), ¶ 85,177* & Prop. Reg. § 54.4975-11(e) (2) & (3), ¶ 94,169*. (29) Reg. § 54.4975-11(d) (1), ¶| 85,177*. (30) Reg. §§ 1.401-1 (a) (2) (ii), (b)(1) (ii) & (iii), (3), ¶ 63,069* & 1.401-4 (a), ¶ 63,072* (31) Reg. (32) Reg. (8), ¶ 85,177* 1.402(a)-1(b) (2) (ii), ¶ 63,085* § 54.4975-11(c) & (d)(2), ¶ 85,177* See also Reg. § 54.4975-7(b) (33) Reg. § 54.4975-11(c) & (d)(2), ¶ 85,177* I.R.C. §401(a) (4), ¶ 75,401* & Reg. § 1.401-4(a)(1) & (2) (iii), ¶ 63,072*, Reg. § 1.401-1(b)(1) (ii) & (iii), ¶ 63,072*. Compare Rev. Rul. 70-125, 1970-1 C.B. 87, ¶ 65,642*. (34) Reg. § 54.4975-11(d) (3) & (4), ¶ 85,177*. (35) Reg. § 1.401-1(b) (2), ¶ 63,072*. (36) Prop. Reg. § 54-4975-11(d), withdrawn 9/2/77, ¶ 94,169*. (37) § 301 (d) (5) of 1975 Tax Reduction Act, ¶ 80,903. See also Prop. Reg. § 1.46-8(d) (7), ¶ 94,129*. (38) Prop. Reg. § 1.301-1(1), withdrawn 9/2/77. (39) I.R.C. § 317(b) provides that a redemption is the acquisition by a corporation of its stock from a shareholder in exchange for property. I.R.C. § 318 (a) (2) (B) (i) & (3) (B) (i) preclude attribution of ownership from or to an employees' trust qualified under § 401(a), 80,401. (40) 122 Cong. Rec. § 16015 (daily ed. September 16, 1976). (41) Prop. Reg. § 54.4975-11(a)(7) (ii), ¶ 94,169* & Reg. § 54.4975-11(a) (7) (ii), ¶ 85,177*. (42) S. Rep. No. 93-1298 on H.R. 10712 (Trade Reform Act of 1974); S. Rep. No. 94-36 on H.R. 2166 (Tax Reduction Act of 1975); S. Rep. No. 94-938 on H.R. 10612 (Tax Reform Act of 1976). (43) Reg. § 54.4975-11 (f) (1) & (2), ¶ 85,177*. (44) Prop. Reg. § 54.4975-11(a)(8)(iii), ¶ 94,169*, (d) (3) & (f) (3) & Reg. § 54.4975-11, ¶ 85,177*. (45) Prop. Reg. § 54.4975-11(b)(2), ¶ 94,169*, withdrawn 9/2/77. The proposed regulations also covered the purchase of life insurance to fund death benefits for participants. use (46) ERISA § 406 (a) (1) (D), ¶ 80,406*, prohibits the direct or indirect ". by or for the benefit of, a party in interest, of any assets of the plan . . ." See also I.R.C. § 4975 (c) (1) (D), ¶ 77,565*. (47) ERISA § 404(a)(1)(A) & (B), ¶ 80,404*. Also, the "exclusive benefit of employees" requirement of I.R.C. § 401(a), ¶ 75,401*. (48) I.R.C. § 101(a) (1), ¶ 75,101*. (49) I.R.C. § 264 (a) (1), ¶ 75,264*. (50) Reg. § 54.4975-11 (a) (7) (i), ¶ 85,177*. (51) Reg. § 54.4975-7 (b), ¶ 85,177*. (52) The scope of ERISA's prohibited transactions provisions and exemptions thereunder will relate only to the "lending of money or other extension of credit between the plan and a party in interest." See ERISA § 406 (a) (1) (B), ¶ 80,406* and I.R.C. § 4975 (c) (1) (B), ¶ 77,565. The guarantee of a loan (direct or indirect) constitutes an "extension of credit." See Reg. § 54.4975-7(b) (1) (ii), ¶[ 85,177*. 1978 P-H Inc. Pension-See Cross Reference Table for latest developments 1254 Footnote New Ideas Reference 3-28-78 (53) Prop. Reg. § 54.4975-7(b) (1) (i), ¶ 85,177*. See also ERISA § 406(b), ¶ 80,406 & I.R.C. § 4975(c) (1) (E), ¶ 75,565. (54) Reg. § 54.4975-7 (b) (2), ¶ 85,177*. (58) Prop. Reg. § 54.4975-7 (b) (2) (i) (B), withdrawn 9/2/77. (59) See ERISA § 407 (d) (1), (5), (7) & (e), ¶ 80,407*. See also I.R.C. §§ 4975 (e) (8), ¶ 77,565* & 503 (e), ¶ 75,503*. Regulations relating to the definition of "qualifying employer security" were published with the final ESOP regulations as Reg. § 54.4975-12, ¶ 85,177* & D.O.L. Reg. § 2550.407d-5, ¶ 90,297*. Compare to I.R.C. § 402 (a) (3), ¶ 75.402*. (61) S. Rep. No. 93-1298 (11/26/74) on H.R. 10710 (Trade Reform Act of 1974); S. Rep. No. 94-36 (3/17/75) on H.R. 2166 (Tax Reduction Act of 1975). Reg. § 54.4975-7 (b) (5), ¶| 85,177*. (62) (63) Section 7 of the Securities Exchange Act of 1934 grants power to the Federal Reserve Board to prescribe regulations governing the amount of credit extended or maintained on any nonexempt security. Under this authority, the Board has adopted Regulation U (banks), Regulation T (brokers and dealers) and Regulation X (borrowers). (64) Reg. § 54.4975-7(b) (6), ¶ 85,177*. (65) Reg. § 54.4975-7(b) (13), ¶ 85,177*. (66) Reg. § 54.4975-7(b) (7), ¶ 85,177*. See also ERISA § 408(b)(3)(B), ¶ 80,408 & I.R.C. § 4975(d) (3) (B), ¶ 77,565*. (68) Reg. § 54.4975-7 (b) (9), ¶ 85,177*. (69) Reg. § 54.4975-7(b) (10), ¶ 85,177*. (70) Reg. § 54.4975-7(b) (11) & (12) (ii), ¶| 85,177*. (71) Reg. §§ 54.4975-7(b) (12) (iii), ¶ 85,177* & 54.4975-11(d) (5), ¶ 85,177*. (72) Reg. § 54.4975-7(b) (12) (iv) & (v), ¶| 85,177*. (73) Reg. § 54.4975-7(b) (15), ¶ 85,177*. (74) See, for example, the floor statement of Senator Ted Stevens in opposition to the proposed ESOP regulations. 122 Cong. Rec. § 13429-30 (daily ed. Aug. 4, 1976). (75) Staff of the Joint Economic Committee, Congress of the United States, 94th Cong., 2d Sess., Broadening The Ownership of New Capital: ESOPS And Other Alternatives (Joint Comm. Print 1976) (76) Long, supra note 11, at 518. (77) Reg. § 54.4975-7 (b) (2) (ii), ¶ 85,177*. See also Rev. Rul. 69-494, 1962-2 C.B. 88, 65,610*, which discusses the "exclusive benefit" rule of I.R.C. §401(a), 75,401*, in the context of the sale of employer securities to an employees' trust. It appears that an ESOP creates a certain "unity of interests" between employer and employees. *P-H Pension and Profit Sharing. |