Category Archives: ESOP

US Supreme Court to Hear Fifth Third Stock Drop Case

The U.S. Supreme Court granted cert. today to the stock drop case – Fifth Third Bancorp v. Dudenhoefer – out of the 6th Circuit Court of Appeals. The case is not assigned a date yet for oral argument, but Lyle Denniston of SCOTUSblog is guessing that the case may be heard in March because there are open dates in March which have no cases assigned for oral argument yet.

The Court granted cert. on this issue:

“Whether the Sixth Circuit erred by holding that respondents were not required to plausibly allege in their complaint that the fiduciaries of an employee stock ownership plan abused their discretion by remaining invested in employer stock, in order to overcome the presumption that their decision to invest in employer stock was reasonable, as required by the Employee Retirement Income Security Act of 1974, 29 U.S.C. §§ 1101 et seq. (“ERISA”), and every other circuit to address the issue; and (2) whether the Sixth Circuit erred by refusing to follow precedent of this Court (and the holdings of every other circuit to address the issue) by holding that filings with the Securities and Exchange Commission become actionable ERISA fiduciary communications merely by virtue of their incorporation by reference into plan documents.”

The 6th Circuit’s opinion in this case is available here. It is one of the best ERISA opinions written by the 6th Circuit, which is one of the most active Courts of Appeal when it comes to ERISA opinions.

Lyle Denniston’s article about the Court granting cert. in this case is posted at

Today in ERISA History

May 17, 1988 – The Dept. of Labor publishes a Proposed Regulation Relating to the Definition of Adequate Consideration. Even though the regulation, 29 C.F.R. 2510.3-18, is never finalized, it remains the only authority from the DOL on how fair market value should be determined for shares of a closely held corporation. The regulation also requires an independent valuation for ESOP shares of a closely held corporation.

In Advisory Opinion 96-08A (June 26, 1996), the DOL states that:

Section 3(18)(B) of ERISA defines the term “adequate consideration” to mean, in the case of an asset other than a security for which there is a generally recognized market, the fair market value of the asset as determined in good faith by the trustee or named fiduciary pursuant to the terms of the plan and in accordance with regulations promulgated by the Secretary. The Department proposed regulations under section 3(18)(B) on May 17, 1988 (53 Fed. Reg. 17632); no final regulation has been published to date.”

Today in ERISA History

March 29, 2007 – Milton Lily files a lawsuit against the fiduciaries of the Oneida Ltd. Employee Stock Ownership Plan, alleging that the plan’s fiduciaries breached their fiduciary duties under ERISA by: (1) failing to prudently and loyally manage the plan’s assets; and (2) failing to properly monitor the performance of their fiduciary appointees, and remove and replace those whose performance was inadequate. Specifically, he alleges that the plan’s fiduciaries knew or should have known that the plan’s investment in company stock was not a prudent retirement investment between May 28, 2003 to March 20, 2006 and that the fiduciaries acted imprudently by not preventing further investment in Oneida stock and not liquidating the plan’s existing holdings. The lawsuit grows to include participants and beneficiaries in the ESOP between May 28, 2003 to March 20, 2006 and whose accounts included investments in Oneida Ltd. common stock.

According to the complaint, between those dates, the plan held between 1.5 million and 1.8 million shares of Oneida common stock as the plan document required the ESOP to invest primarily in Oneida stock. During that time frame, Oneida suffered a number of setbacks which ultimately led to Oneida filing for bankruptcy protection on March 19, 2006. On May 28, 2003, Oneida common stock was trading for $9.80 per share. On March 20, 2006, Oneida’s stock was trading for $0.075 per share.

On Oct. 4, 2010, the judge approves a settlement of $1.85 million. After expenses of $55,965.06 to the participant’s attorneys, attorneys fees of $555,000 to the participant’s attorneys, case contribution awards, taxes and other expenses approved by the Court, the remaining amount is to be allocated among the class of participants and beneficiaries according to an allocation schedule approved by the Court.

(Note: the first couple of pages of the Complaint are an interesting read because they contain a list of information which the attorneys reviewed before filing this lawsuit, including Form 5500s. Around this time frame, there were a number of similar lawsuits filed, and settled, against similar companies. With the DOL’s Final 408(b)(2) Fee Disclosure Regulations taking effect on July 1, 2012, it will be interesting to see if these types of lawsuits over the failure to properly monitor fiduciaries become more prevalent due to the language of the regs.)

ESOP/KSOP Determination Letter Backlog Here to Stay (for now)

Miracle on 34th Street mail
I was fortunate to attend the IRS phone forum on ESOP determination letters last Friday. The webinar was very good. The IRS addressed a number of outstanding issues, and provided some handy tips.

First, the IRS acknowledged that there is currently a lag between when the IRS receives an ESOP/KSOP determination letter application and when that application is reviewed by an agent. Despite their best efforts, the IRS is currently reviewing ESOP determination letter applications received in 2008 during Cycle C. According to the Form 5500 information posted on the DOL’s website, there are approximately 1,300 ESOP/KSOP plans required to be submitted to the IRS for a determination letter during each Rev. Proc. 2007-44 cycle, so unless something drastically changes, the backlog will continue to grow. Like a soldier in an old World War II movie peeling potatoes from a stack of potatoes that only continues to grow, each and every Jan. 31st adds another 1,300 applications to the already existing stack of determination letter applications waiting to be reviewed.

One option the IRS is currently exploring is opening an opinion/advisory letter program for ESOPs/KSOPs in 2018 (the beginning of the next restatement cycle). This would reduce the overall number of ESOP/KSOP determination letter submissions the IRS receives because some plans would have reliance on an opinion/advisory letter and would not be required to file for a determination letter.

Before you ask “why 2018″, think about the steps the IRS has to undertake to accomplish this under the current system stated in Rev. Proc. 2007-44. First, ESOPs/KSOPs are classified as a type of defined contribution plan. Under Rev. Proc. 2007-44, the deadline to submit DC plans for opinion/advisory letters is Jan. 31, 2012. This means that by Jan. 31, 2012, the IRS would need to amend Rev. Proc. 2011-49 to include ESOPs/KSOPs as plans which are eligible for opinion/advisory letters, issue LRMs for ESOPs/KSOPs (LRMs contain suggested language for writing plan documents), and update the opinion/advisory forms to include provisions unique to ESOP/KSOP plans, such as 1042 provisions and exempt loan language. Realistically, this means that the next 6-year cycle for DC opinion/advisory letters, starting in 2018, is the target date for adding ESOPs/KSOPs to the pre-approved plan program.

Imagine how quickly the stack of determination letter applications waiting to be reviewed would shrink if the IRS received approx. 325 applications each cycle instead of approx. 1,300 applications. This would require moving 75% of the existing ESOP/KSOPs on to pre-approved prototype or volume submitter plan documents, which is possible if the IRS commits to making two simple changes in the opinion/advisory program. First, the IRS returns the filing fee to the EGTRRA level of $4,500 per opinion/advisory letter (the current fee is $21,000+ per opinion/advisory letter). Second, the IRS reinstates the National Sponsor category or reduces the number of word-for-word adopters to 10 (the current number of word-for-word adopters required for an opinion/advisory letter is 30).

In the meantime, the IRS has created a webpage showing which plans they are currently reviewing. For example, if you mailed a Cycle D ESOP to the IRS for a determination letter in January of 2010, the odds are pretty good that the submission is sitting on a shelf somewhere waiting for an agent to be assigned to review the application. I’m finding this website to be a handy tool to set expectations with plan sponsors on how long the ESOP/KSOP determination letter process may take.

The good news is that once the plan is assigned to an agent for review, the IRS has created a group of highly trained agents within Employee Plans who only review ESOP/KSOP determination letter applications, so once the review process begins, it should proceed quickly and efficiently. The IRS recognized during the webinar that writing plan documents is a niche among ERISA attorneys, and within that niche, there is a smaller niche of ERISA attorneys that write ESOP/KSOP plan documents. Connecting the small group of ERISA attorneys who actually write ESOP/KSOP plan documents with the group of agents within Employee Plans who are devoted to reviewing those plan documents should speed the entire process up. And, as one of the ERISA attorneys who write ESOP/KSOP plan documents, I hope not only will it make the current process faster and more efficient, but will start a dialogue between the groups which will continue over the next six years and result in a smooth transition between the current process and an ESOP/KSOP opinion/advisory program in 2018.

Other handy tips are included in the handout material, including making sure to check that the determination letter application includes plan documents and amendments that are signed AND dated.

Free ERPA CPE from the IRS on Oct. 28, 2011

On Friday, Oct. 28, 2011, at 2pm ET, the IRS is hosting a free phone forum on Determination Letter Issues Regarding Employee Stock Ownership Plans. The phone forum will focus on technical issues affecting ESOPs and recurring issues noted in ESOP determination letter submission. Speakers are Don Kieffer and Rick Parker with the IRS’ Employee Plans Determination Letter program.

To attend, you register by going to the IRS’ website and completing the registration information. Once registered, the IRS will email you a link containing information on how to connect to the phone forum.

ESOP Style Over Substance Loses in Tax Court

“These transactions lacked economic substance and economic purpose and were entered into for the primary purpose of obtaining tax benefits.”

In Weekend Warrior Trailers, Inc., et al. v. Commissioner, T.C. Memo 2011-105 (May 19, 2011), the U.S. Tax Court addressed a tax deficiency resulting from a fancy corporate two-step that included the creation and demise of an ESOP within a 3-year time period.
In 1988, Mark Warmoth started a company.

In 1995, he incorporated it as a C-corp and named it Weekend Warrior.

On January 1, 2003, Weekend Warrior elected S corporation status. From 1995 through 2009, Mr. Warmoth was the only shareholder of Weekend Warrior.

On Nov. 14, 2002, Mr. Warmoth incorporated Leading Edge and received all 10,000 of Leading Edge’s shares of stock. According to the Tax Court, Mr. Warmoth was suppose to pay $20,000 for the shares but failed to do so. Leading Edge also elected S corporation status. Mr. Warmoth was the only member of Leading Edge’s board of directors, its CEO and President. Leading Edge and Weekend Warrior shared the same address and phone number.

Effective Dec. 15, 2002, Leading Edge established a deferred compensation (NQDC) plan to benefit Mr. Warmoth. The Board, which consisted solely of Mr. Warmoth, was to decided annually which employees were entitled to participate in the NQDC plan.

On Dec. 28, 2002, Leading Edge adopted an ESOP and a 401(k) plan, effective Dec. 1, 2002, with Mr. Warmoth and one other person as trustees. On Dec. 18, 2002, Mr. Warmoth sold 9,990 shares of Leading Edge stock to the ESOP for $1.50 per share, leaving Mr. Warmoth with the remaining 10 shares of Leading Edge stock. The plan executed a promissory note to Mr. Warmoth for the shares for $14,985.

Also on Dec. 28, 2002, Weekend Warrior and Leading Edge entered into an agreement signed by Mr. Warmoth on behalf of both companies. Leading Edge agreed to provide design, personnel and management services to Weekend Warrior. In exchange, Weekend Warrior paid Leading Edge an initial payment of $4,175,000 plus agreed to make monthly payments to Leading Edge based upon Weekend Warriors’ gross sales with Leading Edge guaranteed a minimum monthly payment. As part of the personnel agreement, in 2003 Weekend Warrior transferred all of their employees to Leading Edge, and Leading Edge leased those employees back to Weekend Warrior at a mutually-agreed to rate.

On June 1, 2004, Leading Edge executed a stock repurchase agreement and acquired all 9,990 shares of its stock from the ESOP for $150,000. The Tax Court states that the reason for this transaction was the change to Code section 409(p) which made the ESOP unattractive. After the stock repurchase, Mr. Warmoth again became Leading Edge’s sole shareholder.

After Dec. 31, 2004, Leading Edge became inactive and, according to the Tax Court, the ESOP was terminated and converted into a profit-sharing plan.

The IRS challenged the deductions Weekend Warrior paid to Leading Edge for design and management fees for 2002, 2003 and 2004. The IRS did not challenge the amounts paid between the two companies for personnel services.

The IRS argued that Leading Edge should be disregarded for Federal income tax purposes because it lacked a legitimate business purpose and economic substance and was formed solely for the purpose of obtaining tax benefits. Mr. Warmoth argued that there were several potentially legitimate reasons for incorporating Leading Edge, including the desire to motivate the rank-and-file employees by establishing an ESOP. The Tax Court rejected that reason, stating that viewing the ESOP through the lens of the deferred compensation plan that solely benefited Mr. Warmoth cast doubt that the benefits to rank-and-file employees were more than minimal.

The Tax Court did find that, even though Leading Edge was not formed for a valid business purpose, it engaged in sufficient business activity to be respected as a separate entity for tax purposes. Some of that sufficient business activity included providing personnel services to Weekend Warrior, maintaining investment and bank accounts, paying its employees by check, adopting a retirement plan, keeping books and records, engaging a professional to appraise its stock and following corporate formalities.
Even though the Tax Court found that Leading Edge was a separate entity for tax purposes, the Tax Court agreed with the IRS, in part, finding that the management fees were not necessary or reasonable, and therefore were not deductible under Code section 162.

The IRS also challenged the sale of Leading Edge stock to the ESOP, stating that it lacked a business purpose because the true purpose of establishing the ESOP was not to provide an incentive for the employees due to the short lifespan of the plan and the fact that as soon as the changes to Code section 409 made the ESOP arrangement less appealing from a tax standpoint, the retirement plan’s shares were redeemed and the company’s founder once again became Leading Edge’s sole shareholder. Because the IRS first asserted this issue on brief, the Tax Court declines to consider whether the sale of Leading Edge stock to the retirement plan lacked a business purpose.

IRS Schedules Hearing on Proposed Regs on ESOPs

The IRS has scheduled a hearing on the Proposed Regulations affecting Employee Stock Purchase Plans Under Internal Revenue Code section 423 for Thursday, January 15, 2009, at 10am (also known as the Thursday before the Inauguration).

Originally issued on July 29, 2008, and effective on January 1, 2010, these proposed regulations provide a “comprehensive set of rules governing stock options issued under an employee stock purchase plan” and “incorporate substantially all of the rules contained in the existing regulations under section 423″. I was hopeful that these proposed regulations would be finalized and make the Cycle D Cumulative List so ESOPs required to restate by January 31, 2010 could incorporate these proposed regulations.

So if you are able to find a hotel room in D.C. for January 15, 2009, please give me a call. I want to attend this hearing because there are a number of issues in these proposed regulations which warrant considered discussion by the entire ESOP community.

[tag]pension protection act, ppa, ESOP, IRS, ERISA[/tag]

Employees File Lawsuit Over Tribune ESOP

When the Tribune Company was purchased by Samuel Zell by utlizing an ESOP, one question was how long would it take before the litigation began. Today, that question was answered when a group of current and former employees filed suit in the U.S. District Court for the Central District of California. A copy of the complaint is available here.

The complaint is not a good read from a pension geek standpoint. In 115 pages, the complaint failed to tell a clear ERISA-related story typical of defined benefit plans which are converted to ESOPs which then lead to litigation. I am hopeful that the forthcoming motions to dismiss or motions for summary judgment will provide more details about the frozen Tribune Company Employees’ Pension Plan which was merged into the Times Mirror Pension Plan which had an ESOP then merged into the Times Mirror Savings Plan, and at some point these plans became the Tribune ESOP.

A quick check of the filed Form 5500s reveal that these are not small plans. For example, the Tribune Company Employee Stock Ownership Plan for 2003 had over 11,000 participants and beneficiaries, and total assets of over $800 million. The Tribune Company Master Retirement Savings Trust had over $2.2 billion in assets for the 2006 plan year listed on Schedule H of Form 5500. A really interesting part of this litigation to watch will be the ultimate attorneys fees awarded when this litigation ends.

[tag]pension protection act, ppa, ESOP, Tribune, ERISA[/tag]

IRS Issues Sample Plan Language for Transfer for ESOP’s S Corp Shares to Prevent Nonallocation Year

In a Special Edition of Employee Plan News, dated July 1, 2008, the IRS provides some guidance on sample language under Code section 409(p) for the Transfer of an ESOP’s S Corporation Shares. This plan language is designed to prevent a nonallocation year by transferring assets from the accounts of disqualified persons to the non-ESOP portion of the plan according to Treas. Reg. 1.409(p)-1(f). A nonallocation year can occur when disqualified persons, as defined in Code section 409(p)(4), own or are deemed to own 50% of the outstanding stock of an S corporation.

The sample plan language provided by the IRS for Code section 409(p) transfers is:

Non-ESOP Portion of Plan

    1. Non-ESOP Portion. Assets held under the Plan in accordance with this Section are held under a portion of the Plan that is not an employee stock ownership plan (ESOP), within the meaning of section 4975(e)(7) of the Internal Revenue Code. Amounts held in the portion of the Plan that is not an ESOP (the Non-ESOP portion) shall be held in accounts that are separate from the accounts for the amounts held in the remainder of the Plan (the ESOP portion). The statements provided to Participants and Beneficiaries to show their interest in the Plan shall separately identify the amounts held in each such portion. Except as specifically set forth in this Section, all of the terms of the Plan apply to any amount held under the Non-ESOP portion of the Plan in the same manner and to the same extent as to any other amount held under the Plan.

    2. Transfers from ESOP to Non-ESOP Portion of Plan. (a) In the case of any event that the Plan Administrator determines would cause a nonallocation year (as defined in section xxx of the Plan) to occur (referred herein as a “nonallocation event”), shares of employer stock held under the Plan before the date of the nonallocation event, shall be transferred from the ESOP portion of the Plan to the Non-ESOP portion of the Plan as provided in (2)(a). Actions that may cause a nonallocation event, include, but are not limited to, a contribution to the Plan in the form of shares of employer stock, a distribution from the Plan in the form of shares of employer stock, a change of investment within a Plan account of a disqualified person (as defined in section xxx of the Plan) that alters the number of shares of employer stock held in the account of the disqualified person, or the issuance by the employer of synthetic equity as defined by section 409(p)(6)(C) of the Internal Revenue Code and section 1.409(p)-1(f) of the Treasury Regulations. A nonallocation event occurs only if (i) the total number of shares of employer stock that, held in the ESOP account of those Participants who are or who would be disqualified persons after taking into account the Participant’s synthetic equity and the nonallocation event, exceeds (ii) 49.9% of the total number of shares of employer stock outstanding after taking the nonallocation event into account (causing a nonallocation year to occur as described in Section xxx of the Plan). No transfer under this section shall be greater than the excess, if any, of (i) over (ii). Before the nonallocation event occurs, the Plan Administrator shall determine the extent to which a transfer is required to be made and shall take steps to ensure that all action necessary to implement the transfer are taken before the nonallocation event occurs.

    (b)(1) Except as provided for in (b)(2), at the date of the transfer, the total number of shares transferred, as provided for in (a)(1), shall be charged against the accounts of Participants who are disqualified persons (i) by first reducing the ESOP account of the Participant who is a disqualified person whose account has the largest number of shares (with the addition of synthetic equity shares) and (ii) thereafter by reducing the ESOP accounts of each succeeding Participant who is a disqualified person who has the largest number of shares in his or her their account (with the addition of synthetic equity shares. Immediately following the transfer, the number of transferred shares charged against any Participant’s account in the ESOP portion of the Plan shall be credited to an account established for that Participant in the Non-ESOP portion of the Plan.

    (2) Notwithstanding (b)(1), the number of shares transferred shall be charged against the accounts of Participants who are disqualified persons (1) by first reducing the account of the Participant with the fewest shares (including synthetic equity) who is a disqualified person and who is a Highly Compensated Employee (as defined in Section xxx of the Plan) to cause the Participant not to be a disqualified person, and thereafter reducing the account of each other Participant who is a disqualified person and a Highly Compensated Employee, in order of who has the fewest ESOP shares (including synthetic equity). A transfer under this (b)(2) only applies to the extent that the transfer results in fewer shares being transferred than in a transfer under (b)(1).

      (c) (1) If two or more Participants described in (b) have the same number of shares, the account of the Participant with the longest service shall be reduced first.

        (2) Beneficiaries of the Plan are treated as Plan Participants for purposes of this section.

    3. Income Taxes. If the Trust owes income taxes as a result of unrelated business taxable income under section 512(e) of the Internal Revenue Code with respect to shares of employer stock held in the Non-ESOP portion of the Plan, the income tax payments made by the Trustee shall be charged against the accounts of each Participant or Beneficiary who has an account in the Non-ESOP portion of the Plan in proportion to the ratio of the shares of employer stock in such Participant’s or Beneficiary’s account in the non-ESOP portion of the Plan to the total shares of employer stock in the non-ESOP portion of the Plan. The Employer shall purchase shares of employer stock from the Trustee with cash (based on the fair market value of the shares so purchased) from each such account to the extent necessary for the Trustee to make the income tax payments.

The IRS is requesting comments on this sample language language until August 15, 2008. This plan language can be used now pending the comment period.

[tags]Pension Protection Act, ppa, IRS, ESOP, S Corporation, nonallocation, ERISA[/tags]

State of Florida to Buy US Sugar While US Sugar ESOP Litigation Continues

In a fascinating and completely unexpected twist to the U.S. Sugar ESOP class action lawsuit, the governor of Florida today announced that the State of Florida will buy U.S. Sugar for $1.75 billion. With the purchase, Florida will gain control over 187,000 acres of farmland in the northern Everglades while leasing the land back to U.S. Sugar for at least the next 6 years.

As the largest block of shareholders, the participants in U.S. Sugar’s ESOP will be the largest group of individuals affected by this purchase. Florida’s announced goal with this purchase is to gain control of the U.S. Sugar acreage to aid its plans to resurrect the Everglades. I originally wrote about the US Sugar ESOP litigation here.

More Information:

[tags]Pension Protection Act, ppa, US Sugar, ESOP, Florida, ERISA[/tags]