The A-Z of Having Employer
Stock in Qualified Plans
ASPPA Annual Conference
Richard K. Matta
October 24, 2016
Employer Stock in Qualified Plans
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Where to begin?
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Defined benefit
Typically employer-directed
 Typically employer contributions
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Defined contribution
Employer directed versus participant-directed
Employer contributions versus participant
 Public versus private stock
 ESOP versus non-ESOP
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Potential ERISA Considerations
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Section 404 standards of care
Section 406/407 prohibited
transactions
Special reporting and disclosure
(defined contribution)
ERISA 204(j) right to divest
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Potential Internal Revenue Code
Considerations
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Defined Contribution Plans
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Section 401(a)(35) diversification
requirement
ESOP election
Section 402(e)(4)(B) exclusion for net
unrealized appreciation on in-kind
distribution
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Potential Securities Law
Considerations
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Securities Act of 1933
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“Voluntary and contributory” plans
Registration requirements for public
companies – Rule 428
Safe-harbor exemption for private companies
– Rule 701
Plan as “affiliate” of employer
Securities Exchange Act of 1934
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Resales of securities in the market
Public company reporting
Section 16 regulation of insiders
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Securities Law Background Reading
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SEC Interpretive Release 4790 (1965)
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SEC Interpretive Release 6188 (1981)
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Voluntary and contributory plans defined
Registration of “plan interests” versus
registration of employer securities held by plans
SEC Interpretive Release 6281 (1982)
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Registration requirements for “employee stock
purchase plans” (including qualified plans)
Expands on 1981 Release
SEC Interpretive Release 6867 (1990)
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Streamlined ’33 Act registration requirement on
Form S-8
Updated ‘34 Act reporting on Form 11-K
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Defined Benefit Plans
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ERISA section 404(a) prudence and
diversification
Prohibited transaction considerations
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ERISA section 407(a) 10% holding
limitation
ERISA section 406(a) purchases and sales
between plan and employer
ERISA section 408(e) exemption for QES
“Qualified employer securities” defined in
ERISA section 407(d)(5)
 407(f) 25/50 rule
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Defined Benefit Plans
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Stock acquired as an investment
(typically on the market)
Stock acquired via employer
contribution
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DOL rules treat as a “sale or exchange”
and thus a prohibited transaction*
Section 408(e) may provide exemptive
relief
*The SEC does not treat a contribution as a sale for registration purposes
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Defined Benefit Plans
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Shares held by a DB plan can be
privately placed/not registered
Public resales of restricted/private
placement stock
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Plan generally is considered to be
affiliated with the employer as issuer
Exceptions:
Rule 144 amount and timing
 Rule 144A private resales to institutions
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Defined Contribution Plans
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ERISA section 404(a)(2) provides an
exemption from diversification
Unlike DB plans, all stock is QES:
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ERISA section 408(e) permits up to 100%
employer stock if plan permits
Section 408(e) also permits private/
restricted stock
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Valuation issues
Liquidity issues due to restrictions on in-kind
distributions
Employer stock portion of plan can be
designated as an ESOP
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Defined Contribution Plans
Participant Voluntary Contributions
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Substantially more complicated
employee contributions if can be
invested in employer stock:
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Employer stock fund
Self-directed brokerage window
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SEC Compliance and Disclosure Interpretation
(CD&I) Question 139.33
Notice requirements
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ERISA section 101(m) right to divest
ERISA section 105(a)
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Defined Contribution Plans
Participant Voluntary Contributions
ERISA section 404(c) special conditions for employer securities:
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Certain standards must be met with respect to participant rights to
trade out of a company stock fund
Information provided to shareholders must be passed on to
participants who have invested in the company stock through the
plan
Voting, tender and other rights must be passed through to
participants
Confidentiality procedures must be maintained with respect to the
holding of company stock, and a designated plan fiduciary is
responsible for ensuring that such procedures are adhered to
An independent fiduciary must be appointed if it is determined that
there is a potential for undue employer influence in a participant’s
exercise of rights related to company stock
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Defined Contribution Plans
Participant Voluntary Contributions
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Absent an exemption from registration, employer needs to
register shares and plan interests on Form S-8, and provide
plan participants with a prospectus (may be combined with
SPD for plan) and other shareholder communications
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Employer needs to file annual Form 11-K with respect to
registered plan shareholdings
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It does not matter if the shares are purchased on the open
market
This may be true for self-directed brokerage window as well as
employer stock fund
Form 11-K may be filed with employer's annual Form 10-K
Employer and plan recordkeeper need to establish system to
track participant "purchases" of shares under plan and
register more securities as needed
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Defined Contribution Plans
Participant Voluntary Contributions
Additional SEC issues exist when a 401(k) plan sponsored by a publicly traded company contains
an employer stock fund, even if employees may not direct their contributions into the fund.
Such issues include:
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"Discretionary transactions" under the plan by insiders need to be reported under Section
16(a) and tracked for Section 16(b) short swing profit liability purposes
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Under § 306(a) of the Sarbanes-Oxley Act and SEC rules thereunder, if plan participants are
temporarily unable to direct amounts into or out of the employer stock fund, insiders'
trading in employer securities outside the plan will be limited
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Discretionary transactions include participant-directed movements of account balances into or out of the
employer stock fund, and loans or hardship withdrawals funded from moneys in the employer stock fund
Plan administrator must notify issuer of employer securities in advance of any black-out periods, see ERISA section 101(i)(2)(E)
Employer needs to address shares held in participants' accounts in reporting beneficial
ownership in annual proxy;
If the plan distributes shares to participants, the following issues arise:
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participant resale issues
NYSE and NASDAQ rules on shareholder approval of equity compensation plans may require
compensation committee (rather than Board) approval of plan amendments
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ESOPs
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Investment Requirement – An ESOP must be designed to invest "primarily"
in qualifying employer securities; Code section 4975(e)(7)
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This has been interpreted to mean that, at all times, at least 51% of the ESOP's assets
must be invested in qualifying employer securities
In order to meet this rule, employers typically designate only the employer stock fund
as the ESOP
Eligibility Requirement – Only employees within the controlled group are
eligible for ESOP shares
Voting Requirement – Assuming the Company's stock is registered under
§ 12 of the Securities and Exchange Act of 1934, the ESOP must permit each
participant to direct the voting of the stock allocated to his or her account;
Code section 409(e)
Distribution Timing Requirement – An ESOP must permit distributions to
begin no later than one year after the end of the plan year during which a
participant terminates employment on account of retirement, disability or death
or, if the participant resigns or is dismissed, no later than one year after the
end of the fifth plan year following the plan year during which the participant
terminates employment, and subject to certain periodic payment requirements
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ESOPs - continued
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Distribution Form Requirement – Participants must be permitted to demand that their
benefits be distributed in the form of employer securities - absent such a demand, benefits
may be distributed in cash; Code section 409(h).
Diversification Requirement – Participants must be permitted to diversify their accounts
into assets other than employer securities in accordance with certain requirements; Code
sections 401(a)(35) and 401(a)(28)
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Assuming participants (including non-vested participants) will be permitted to diversify
amounts into and out of the employer stock fund in the same manner as other
investment funds, and the Plan is already drafted to meet ERISA 404(c), these
requirements should be met
Dividend Deduction Option – Under a special deduction rule, the Company may deduct
dividends paid with respect to shares held in the ESOP, provided (1) the dividends are
distributed to the participants in cash (either directly or from the plan no later than 90 days
after the end of the plan year in which the Plan receives the dividends) or (2) participants
are permitted to elect that the dividends either be distributed in cash or reinvested in more
shares; Code section 404(k)
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The requirements for this special deduction feature are subject to special rules on
timing, vesting, hardship withdrawals and election period; Notice 2002-2
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ESOPs - continued
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Other ESOP considerations
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Leveraged versus non-leveraged
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Special accounting issues for leveraged ASC 718-40 (loans/release of shares)
Annual valuation for private stock
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Employer Stock Litigation
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In 2014, the Supreme Court in in Fifth
Third Bancorp v. Dudenhoeffer, 134
S. Ct. 2459, concluded that ERISA
fiduciaries are no longer entitled to a
presumption that they acted
prudently in investing in employer
stock
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9
Employer Stock Litigation
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Dudenhoeffer provided new guidance regarding the duties of
plan fiduciaries, particularly those of publicly traded
companies:
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With respect to publicly traded employer stock, plan fiduciaries
who do not possess inside information may rely solely on the
market price to ensure that company stock is properly valued
Where plan fiduciaries have knowledge of material, non-public
information, the opinion makes clear that ERISA does not require
the fiduciaries to violate securities laws by trading on such
information (i.e., removing the company stock fund)
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However, the opinion counsels that fiduciaries could have a process in
place for evaluating whether to freeze investment in employer stock or
to publicly disclose material, non-public information
Importantly, such a process may be aimed at determining whether no
prudent fiduciary could conclude that doing so would cause more harm
to the plan than good
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Employer Stock Litigation
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Post-Dudenhoeffer litigation:
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Amgen (S. Ct. 1/25/16) (artificially inflated, insider information) – reversed and remanded to
9th Cir.
BP (S.D. Tex. 10/30/15) (artificially inflated, public and insider information) – dismissed.
Citigroup (SDNY 5/13/15) (poor performance, public and insider information) – dismissed
Delta Airlines (11th Cir. 7/29/15) (poor performance and artificially inflated, public
information) – dismissal affirmed
Hill Brothers (N.D. Miss. 3/28/16) (artificially inflated, insider information) – dismissed
HP (N.D. Cal. 6/15/15) (artificially inflated, insider information) – dismissed
Invacare (N.D. Ohio 8/28/15) (artificially inflated, insider information) – MTD denied
JC Penney/Evercore (D.D.C. 2/17/16) (poor performance, public information) – dismissed
JC Penney (E.D. Tex., 9/29/15) (poor performance, insider information) – MTD denied
JPMorgan (S.D.N.Y. 1/8/16) (artificially inflated, insider information) – dismissed
Kodak (WDNY 12/17/14) (poor performance, public information) – MTD denied
Lehman Bros. (SDNY 7/10/15) (artificially inflated, public and insider information) – dismissed
RadioShack (N.D. Tex. 1/25/16) (poor performance, public and insider information) dismissed
State Street (6th Cir. 11/10/15) (poor performance, public information) – grant of summary
judgment affirmed
UBS (SDNY 9/29/14) (poor performance & artificially inflated, public and insider information) –
dismissed for lack of constitutional standing, and aff’d on appeal
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