Participant Diversification Requirement

Employers are being inundated with a press of new guidance issued by government agencies on many new employee benefit requirements with which the failure to comply can result in some fairly stiff penalties.  Guidance such as that issued by Treasury at the beginning of this month on section 901 of the Pension Protection Act of 2006 (the Act) which establishes participant diversification rights for publicly traded employer securities held in defined contribution retirement plans (other than certain ESOPs).  While the guidance is certainly welcomed because it fills some "need to know" gaps in the short run, the Notice raises some immediate significant areas of concern for employers.

The Act establishes as a new plan qualification requirement (new Code section 401(a)(35)) for investment diversification applicable to publicly traded employer securities held by defined contribution plans and certain ESOPs.  IRS Notice 2006-107, provides guidance on the new Act diversification rules, one of which requires 30 days advance notice to participants before the first day that participants are eligible to direct diversification of their accounts out of employer securities.  The Notice provides employers with some breathing space and advises employers that the new participant notice requirement can be satisfied as late as January 1, 2007, for calendar year plans.  This still means, however, that employers have to figure out who must get the notice and what the notice should say and send it by year end. 

One issue is whether employers that already allow participants to diversify out of employer stock (i.e., their plans already contain full diversification rights), have to advise participants by January 1, 2007, of their right to do so, which likely would be duplicative especially if the information already is contained in an SPD).  The Notice contains a model notice (requiring customization), but the IRS has requested comments on ways to improve the model notice.

While the reason for the new statutory provision is to ensure that participants in defined contribution plans (sponsored by publicly traded employers) receive diversification rights where the employer's plan invests in comapny stock, has a company stock fund or matches employee contributions with company stock, as a result of ENRON and the spate of litigation that followed in its wake, many employers already have modified their plans to allow employees to diversify out of employer stock.  What is hitting many employers who have already provided for diversification out of employer stock in their defined contribution plans is how to comply with these notice requirements.  Does it make sense for an employer to send out 50,000 notices to employees in its 401(k) plan by the end of the year telling them about a right they already have (and presumably already know about)?

Some government representatives at Treasury and the IRS have pointed to an alternative purpose of the employee notice -- to educate employees concerning the importance of diversifying their investments.  When asked whether an employer needs to send notices (by year end) to employees in plans that already contain the required diversification, these representatives have suggested that notices may still be required.

Should publicly traded employers with defined contribution plans holding company stock send out notices before the end of the year even if their defined contribution plans satisfy the diversification requirements of the statute?  Although some practitioners think this is absurd, this practitioner thinks it is better to be safe than sorry.  Any thoughts?

Comments

[Nell Hennessy]

In response to Diane's blog, not to mention other comments raising the question of why send notices to participants in plans that already permitted diversification, DOL on December 20 issued Field Assistance Bulletin NO. 2006 - 03. In Q&A 7 of the FAB, DOL acknowledged that it would only confuse participants to send notices about the new diversification rights if they already those rights under their plan and that those same participants would be getting similar information about their right to diversify with their quarterly statements. Unfortunately, most plans had already rushed to send the notice after DOL officials had informally indicated that the new notice was required.

The FAB also contained useful guidance about the quarterly statement requirement. Q&A 3 clarifies that the first statements are not required until 45 days after March 31, the close of the first quarter. Q&A 5 provides model language on investment principles. Statements may be provided electronically, following IRS guidance on acceptable electronic delivery methods, and plans that permit participants to access their accounts online continuously will be in compliance if they offer participants the right to receive a paper statement at no cost (Q&A 2).

The FAB is available on the DOL website at http://www.dol.gov/ebsa/regs/fab_2006-3.html. A welcome Christmas present.

[diane fuchs]

Yes, the conceptual basis for the provision is to allow participants the right to diversify out of employer stock, but also critical is to teach participants about the importance of diversification...a key component of the notice requirement in the statute, the guidance and the model Notice. Nothing in the new law requires that the participant divest him or herself of company stock. If the employer provides the availability of alternative investment vehicles and the participant is given full information about the importance of diversifying and still wants to either leave funds in the employer stock vehicle or wants to divest and later reinvest in employer stock, there is nothing that would prohibit that (except, of course, where the ERISA employer stock diversification rules come into play). Of course, an employer does not have to have an employer stock investment vehicle in the plan, but if it does, and an amendment to the plan is needed to allow a participant to reinvest previously divested amounts (and the employer wants to allow that reinvestment), then an amendment would be indicated.

[diane fuchs]

I agree that the guidance is not clear but I tend to think that the assumption underlying the guidance is that if there is an employer stock fund or other employer stock investment vehicle in the plan, then the participant can choose to reinvest in employer stock using that same fund or vehicle. The statute and the guidance clearly contemplate that a participant should not be restricted from chosing to reinvest in employer stock. Specifically, the last paragraph in the Notice in section D.1. discusses a prohibited restriction on reinvestment in employer stock. This occurs where, after a participant divests his or her employer stock account, a plan provision restricts reinvestment in employer stock. Such a time restriction is not permitted. Whether a plan amendment is needed to allow reinvestment in an existing fund or other employer stock vehicle in the plan may be a matter of the terms of a particular plan.

[Tom Rogers]

My question is whether a 401(k) plan that makes profit sharing contributions in employer stock, permits employees to divest out of such stock at any time, but does not permit employees to invest into employer stock is required under Code section 401(a)(35)(D)(ii)(II) (as interpreted in Notice 2006-107 section III.D.1) to be amended to permit employees to invest into employer stock after they have divested out of it. The guidance (or lack thereof) seems a little unclear to me but seems to require the plan be amended to permit employees to invest in employer stock. Although, I can somewhat see the reasoning behind the reinvestment clause, in this case it would seem to be defeating the idea of diversification.

Any thoughts?