Transcript Legal & Leg Update

ESOP Legal Update
The Ohio Employee Ownership Center
21st Annual Conference
Fairlawn, OH
April 20, 2007
Dale R. Vlasek
McDonald Hopkins Co., LPA
600 Superior Avenue
Cleveland, OH 44114
216-348-5400
[email protected]
Tom Potts, Jr.
Fiduciary Trust Services
5120 Commerce Circle
Indianapolis, IN 46237
317-888-1400
[email protected]
Tim Jochim
Jochim Co., L.P.A.
673 Mohawk St., Ste. 202
Columbus, OH 43206
614-444-1190
[email protected]
Topics to be Covered
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Case Law and Regulatory Update.
Pension Protection Act and other Legislation.
Legal Role of ESOP Trustee.
Shifting Trends?
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Summers v. State Street Bank, No. 05-4005 (7th Cir., 6/28/06).
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U.S. Court of Appeals for the 7th Circuit upheld a lower court that
State Street Bank did not violate its fiduciary duties by failing to sell
UAL stock in the ESOP more quickly.
However, the court, citing Kuper v. Iovenko, 66 F.3d 1447, indicated
that an ERISA plan “may not be interpreted to include a per se
prohibition against diversifying an ESOP” and that investing trust
assets imprudently or letting them remain invested imprudently is
irresponsible behavior.
The court also indicates that a duty to diversify comes from excessive
risk imposed on employee-shareholders; in this case by the rise in
debt to equity ratio of the employer’s stock.
Shifting Trends?
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See also:
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FirsTier Bank v. Zeller, 16 F.3d 907 (8th Cir. 1994).
In re WorldCom, Inc. ERISA Litig., 354 F.Supp.2d
423 (S.D. NY 2005).
Department of Labor – FAB 2004-03
Hill v. Tribune, 2006 U.S. Dist. LEXIS 71244 (N.D.
Ill. 2006).
Agway v. Magnuson, 2006 U.S. DIST LEXIS 74670
(N.D. N.Y. July 13, 2006).
Shifting Trends?
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But, see:
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In re General Motors, 2006 U.S. Dist. LEXIS 16782 (E.D. MI.
April 6, 2006) which found the directed trustee contractually
obligated to invest only in employer stock and cash or other
short term investments.
Pedraza v. The Coca-Cola Company, 2006 U.S. Dist. LEXIS
76212 (N.D. Ga. Sept. 29, 2006); following Wright v. Oregon
Metallurgical Corp., 360 F.3d 1090 (9th Cir. 2004) and relying
on “brink of collapse” theory.
Smith v. Delta Air Lines, 422 F.Supp.2d 1310 (N.D. Ga. 2006);
also following Wright and the impending collapse theory.
Shifting Trends?
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Wright v. Oregon Metallurgical Corporation, 360 F.3d
1090 (9th Cir. 2004).
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Court concluded that if the underlying fiduciary direction itself
is not in violation of ERISA, then the directed trustee’s
compliance with that direction will not serve as a basis for
liability.
Compare Herman v. Nation Bank, 126 F.3d 1354 (11th Cir.,
1997), regarding lawful directions to trustee.
Independent Trustees
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Armstrong v. Amsted Industries, 2004 U.S. Dist. LEXIS
14776 (N.D. Ill. 2004) and Armstrong v. LaSalle Bank (7th
Cir., 2006).
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Where a trustee is independent and has experience administrating
ESOPs, a court should grant deferential review and not substitute its
judgment for that of the trustee, unless the trustee’s decision is found
arbitrary and capricious.
It is not the responsibility of the ESOP trustee to independently
investigate the business decisions of the plan sponsor’s management
(related to costly acquisition).
7th Circuit Court of Appeals remand to trial court on issue of whether
LaSalle Bank, Trustee, should have performed analysis of repurchase
obligation after costly acquisition; ignoring changed circumstances
may be imprudent.
Respondeat superior claims related
to stock in 401(k)
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In re: Cardinal Health, Inc., 424 F.Supp.2d 1002 (S.D.
Oh. 2006).
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Following Kling v. Fidelity Management Trust Co., 323
F.Supp.2d 132 (D.Mass. 2004), the court found that plaintiffs’
respondeat superior claim against defendant directors is
applicable to claims brought under ERISA and thus denies
defendant Cardinal’s motion to dismiss.
Directed trustee, Putnam, dismissed as defendant but case
may proceed against Cardinal on issue of failure to sell
company stock in 401(k).
Stock in 401(k)
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DiFelice v. US Airways, Inc., No. 1:04cv889 (E.D. Va.,
6/26/06).
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Offering company stock as one of 13 investment options in a
401(k) plan, even when the stock was very risky, is not a
breach of fiduciary duty.
Employees did not have to choose company stock and should
have known it was a high-risk investment.
US Airways appointed an independent fiduciary for the
company stock fund once it filed for bankruptcy.
True and accurate information and unfettered ability to trade in
and out of choices is required.
Stock Purchase by ESOP
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Henry v. Champlain Enterprises, 468 F.Supp2d 368
(N.D. N.Y. 2007).
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Failure of ESOP Trustee to produce notes with respect to stock
purchased by ESOP did not support finding of breach of fiduciary
duty.
Requires determination by trial court of errors or flaws in Trustee’s
diligence process.
“Enhancements” may not be sufficient to overcome target price issue.
On remand, the court dismissed plaintiffs’ complaint which had
damages as an essential element of all causes of action as a result of
a new stock purchase agreement resulting in no damages.
Potential Breach?
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Evanson v. Price, 2006 U.S. Dist. LEXIS 75029 (E.D.
Cal. September 29, 2006).
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ESOP trustees were executive participants in employer’s SAR.
Plaintiffs found letters indicating that benefits from the SAR
would grossly inflate participants’ compensation in excess of
market rates by 30% - 50%.
Complaint is based on harm done to the ESOP as a result of
the overpayment of benefits from the SAR.
The court denied motions to dismiss.
Payroll Practices
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Larimore v. Grant, 2006 U.S. Dist. LEXIS 49743 (W.D.
Ky. July 17, 2006).
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The court followed Sixth Circuit authority in finding that the
employer-plan sponsor’s creation of a second benefit plan that
was intended to benefit one employee (similar to benefits he
would have received had he been eligible to participate in the
ESOP), and the employer’s practice of paying performance
bonuses were both payroll practices and thus, the employer
was not acting in its fiduciary capacity with regard to the ESOP
when creating the other plan or paying bonuses.
Pension Protection Act of 2006
and ESOPs
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Primary purpose is to address the funding problems of
defined benefit plans.
Certain diversification rules apply to defined
contribution plans invested in publicly traded employer
securities:
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At any time if related to employee contributions.
After three (3) years of service if employer contributions.
Does not apply to stand alone ESOP with no 401(k) or (m)
provisions.
Pension Protection Act of 2006
and ESOPs (cont’d)
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PPA made the changes enacted in the Economic Growth
and Tax Relief Reconciliation Act of 2001 (“EGTRRA”)
permanent. (initially scheduled to “sunset” after 2010).
The EGTRRA changes which are now permanent include:
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Increased contribution deduction limits from 15% to 25% of
compensation.
401(k) contributions not counted in contribution limit (were
counted previously).
Increased Section 401(k) limit up to its current $15,000 limit with
catch-up contribution (currently $5,000).
Pension Protection Act of 2006 and
ESOPs (cont’d)
Increased the Section 415 limit from lesser of 25% of
compensation or $30,000 to the current limit of the
lesser of $44,000 or 100% of compensation.
 Increased the annual compensation limit from
$150,000 to its current limit of $220,000.
 ESOP dividends may be reinvested in company stock
at option of the participant and the employer will
receive deduction.
 S-corporation ESOP anti-abuse rules made
permanent.
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Pension Protection Act of 2006 and
ESOPs (cont’d)
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Effective for plan years starting in 2007, the PPA amended ERISA
to require that individual account plans, such as ESOPs, provide
participants with a periodic pension statement.
If the participant or beneficiary has the ability to direct the
investment of his/her account the statement must be given once
each calendar quarter.
– Likely to include ESOPs which permit the mandatory
diversification inside the ESOP (rather than transferring to
another plan such as the company’s 401(k) plan).
If the participant or beneficiary does not have the right to direct the
investment of his/her account, the statement must be given once
each calendar year.
Pension Protection Act of 2006 and
ESOPs (cont’d)
• Effective for contributions made for plan years
beginning after December 31, 2006, the vesting
schedule must be at least as fast as one of the
following:
• Three year cliff (0%, 0%, 100%).
• Six year graded (0%, 20%, 40%, 60%, 80%, 100%).
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Eligible rollover distribution to IRAs expanded to
include non-spousal beneficiaries.
ESOP Promotion and Improvement Act of 2005
H.R. 3111 and S. 1319
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Permits Section 1042 treatment for sale of employer
stock to S Corp ESOP.
Permits pass through to ESOP participants of profit
distributions by S Corp without 10% early distribution
penalty.
Currently on hold in both House and Senate.
Presidential Panel on Federal Tax
Reform
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Panel recommended that all defined contribution plans
would be replaced by “Save at Work Plan” (no discussion of
ESOPs).
President’s proposed fiscal year 2008 budget commencing
October 1, 2007, contains Treasury Department
recommendation that all “contributory plans” be replaced by
Employee Retirement Savings Account (“ERSA”).
Treasury recommendation seems to have no effect upon
stand alone ESOPs.
Rev. Proc. 2005-66 and 2006-6
Remedial Amendment Cycle for IRS Determination Letters
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Individually designed plans, including ESOPs, must be
amended or restated every five years for IRS determination
letter.
First cycle was 12 months ending 1-31-2007 and fifth cycle
is 12 months ending 1-31-2011.
Any plan submitted out of cycle, including new plans, will
not be considered until all on-cycle applications are
considered.
Procedure is detrimental to timely approval of ESOPs and
IRS in considering changes.
Some Legal Requirements
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To keep an “eye-single” to the best interests of
the plan participants
To pay no more than adequate consideration
for the stock
To monitor the financial status of the company
(i.e. monitor its investment)
To diversify the holdings of the plan
What the courts are saying
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Trustee must adequately investigate the
purchase of stock
Documentation should be ample to prove
investigation
Trustee should negotiate the price to be paid
for the stock
Trustee can be liable if price is too high
What the DOL is focusing on
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Possible prohibited transactions
Extent of negotiations
Fairness of the terms of the sale
“Inside” trustee vs. independent trustee
Expertise of financial advisors
What can be learned?
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Substantial due diligence is required
Document, document, document
Hire only competent, seasoned experts
Review experts’ work thoroughly
Make sure all issues are resolved
Trustee works for and on behalf of the
participants
Dale R. Vlasek, McDonald Hopkins
Dale R. Vlasek, Member, Business Department & Chair for Employees Benefits Practice Group
Dale is Chairman of the Employee Benefits Practice Group. He focuses his practice on all employee benefit
matters including pension, profit sharing and 401(k) planning design, operation and compliance matters, ESOPs,
welfare benefit plans (e.g. group health, life, dependent care programs) design, operation and compliance matters,
ERISA litigation, and multi-employer pension plans. He serves as benefits counsel to a number of middle-market
and larger companies. Dale is licensed to practice in Ohio and Iowa.
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Education
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University of Iowa, J.D., high distinction, Order of the Coif (1982)
University of Iowa, Ph.D. (1978)
Cleveland State University, M.A. (1972)
Cleveland State University, B.A. (1970)
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Admissions
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Professional Associations
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Ohio (1987), Wisconsin (1982), Iowa (1982)
Cleveland Bar Association, Ohio State Bar Association, Iowa State Bar Association, Midwest Pension Conference, Worldwide
Employee Benefits Network (WEB), ESOP Association
Awards and Honors
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Named Ohio Super Lawyer, Cincinnati Magazine (2005-2006), Named one of the “Best Lawyers in America” by Corporate
Counsel Magazine, 2006
Dale R. Vlasek
McDonald Hopkins
600 Superior Avenue
Cleveland, OH 44114
216-348-5452
[email protected]
Fiduciary Trust Services, Inc.
Tom Potts, President and CEO of Fiduciary Trust Services, Inc., located in
Indianapolis, Indiana
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Tom specializes in providing independent fiduciary/trustee services to ESOPs.
He currently serves both as “transaction trustee” as well as ongoing trustee for ESOPs
in the Midwest and nationwide.
Tom is a frequent presenter at ESOP seminars in the Midwest.
Tom Potts, Jr.
Fiduciary Trust Services
5120 Commerce Circle
Indianapolis, IN 46237
317-888-1400
[email protected]
Jochim Co., L.P.A.
Tim Jochim, President and primary shareholder of Jochim Co., L.P.A.:
National authority on employee stock ownership plans (ESOPs) and business succession. The firm also has
expertise in corporate finance, merger/acquisition and employee benefits.
Adjunct professor of corporate finance at the Capital University School of Law, Columbus, Ohio.
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Member of corporate boards and frequent speaker to business and trade organizations.
Author of Employee Stock Ownership and Related Plans (Greenwood Press, 1982), and of articles published
in Ohio Business (October, 1988), The Journal of Employee Ownership Law and Finance (Fall, 1998), Taxation
for Accountants (July, 1998) and Taxation for Lawyers (September-October, 1998).
Co-founder of the Ohio Chapter of The ESOP Association and a member of the legislative committee of The
ESOP Association.
Recognized in Marquis Who’s Who in the Midwest and in Benton’s Who’s Who.
Jochim Co., L.P.A.
673 Mohawk Street, Suite 202
Columbus, OH 43206
614-444-1190
[email protected]