9/29/2014. Recent Legal and Regulatory Developments. Agenda

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1 Recent Legal and Regulatory Developments Ben F. Wells, Esq. Dinsmore & Shohl, LLP (202) Robert F. Schatz, Esq. Schatz Brown Glassman Kossow LLP (860) Agenda GreatBanc Settlement Sierra Aluminum Establishing de facto road map for fiduciary conduct in ESOP Transactions Supreme Court decision - Fifth Third Bancorp v. Dudenhoeffer Reversing the Moench Presumption Other Developments 1

2 GreatBanc Settlement GreatBanc and its insurers will pay: $4,772, to the ESOP $477, in civil penalties GreatBanc agreed to put safeguards in place whenever the company is a trustee or fiduciary to an ESOP that is engaging in the purchase or sale of employer securities that are not publicly traded. GreatBanc Settlement Material Aspects of Agreement Concerning Fiduciary Engagements Selection and use of Valuation Advisor Generally Conflicts of Interest Process Oversight of Valuation Advisor Financial Statements GreatBanc Settlement (cont.) Fiduciary Review Process Generally Documentation of Valuation Analysis Reliance on Valuation Report Preservation of Documents Fair Market Value Consideration of Claw Back Other Professionals Not Exhaustive 2

3 GreatBanc Selection of Advisor Generally Prudently investigate qualifications Take reasonable steps to insure all information is provided to valuation advisor Determine (in advance) whether reliance on advise is reasonable Conflicts of Interest No previous work for company including preliminary valuation No work for ESOP committee or familal relationships GreatBanc Selection of Advisor Process - Written Analysis Reason for selection List of others considered Comparative discussion of qualifications References checked (and results) Discussion of prior criminal and civil proceedings Full explanation of bases for selection Previous documentation (within last 15 months) ok Oversight of Advisor Projections- Identify any conflicts with respect to the projections Document reasonableness of projections in light of past performance and comparable public companies Document rationale for use of any projections in excess of past performance Document any adjustments made to unreasonable projection and why adjustments are reasonable If greater weight is given to one method or another 3

4 Oversight of Advisor Consider effect of the following on stock value, repurchase obligation and prudence of purchase: Document provisions Duration of ESOP loan Age and tenure of Participants Analyze and Document: Ability of sponsor to service debt Whether transaction is fair to all parties Whether terms of financing are market based Overturning of Moench Presumption Moench v. Robertson, (3 rd Cir ) Fiduciaries are presumed to be prudent in holding or offering employer stock unless the company is on the verge of bankruptcy. Adopted by the Second, Fifth, Sixth, Seventh, Ninth and Eleventh Circuits. No circuit specifically rejected it, although some placed limits on it. Dudenhoeffer v. Third Fifth Bancorp Decision: There is no presumption of prudence to protect fiduciaries of plans designed to specifically invest in company stock, including ESOPs. Replaces with a pleading requirement to demonstrate the fiduciary would have acted imprudently. Most observers agree this will continue to make it difficult to challenge fiduciary decisions about employer stock. required to plausibly allege that there were "special circumstances" requiring fiduciaries to recognize on the basis of public information that the market was over- or undervaluing the stock; or based on nonpublic information, the fiduciaries should have taken an alternative action that would not violate securities laws and would not do more harm than good. 4

5 Dudenhoeffer -- Implications for Closely Held ESOP Companies The Fifth Third ESOP contributed company stock as a match based on salary deferrals. Most ESOPs make contributions that are not linked to employee contributions. The Court decided a stock drop case for a public company. The analysis does not fit easily into a closely held company ESOP model. All presumption of prudence cases have involved public companies. This, combined with the enhanced pleading requirements, has convinced some commentators to conclude the impact on private company ESOP fiduciary decisions will be minimal. Does Absence of Prudence Presumption Matter in to a Private ESOP Trustee Has been a non-issue in closely held ESOP company litigation. Very few closely held ESOPs allow employee contributions. In closely held companies, the trustee must be able to show that the price paid was not more than fair market value based upon 3 rd Party appraisal. Purchase never assumed to be prudent unless Trustee pays no more than adequate consideration. Trustees can sell the shares only if another party offers to buy them. Is the offer one that is financially preferable to holding on to the shares? Do Trustees have an additional duty of inquiry or investigation in times of financial distress? PLR May 29, 2014 Issue: Waiver of 60-day rollover requirement (I.R.C. Sec. 402(c)(3)(A)) Participant failed to rollover ESOP distribution within the period and sought a waiver. Distribution to participant was in the form of stock that was redeemed for cash and 4-year note. Election was Trustee-to-Trustee rollover of of stock to Bank IRA and repurchase of Stock from IRA with cash and Note. Participant discovered that Bank did not accept custody of Note. Result: Waiver of 60 day rollover requirement waived by IRS. Practice tip: Employer/Participant could have avoided the issue by preplanning with Participant s Bank or by setting up a rollover IRA with a Bank or Broker that accepts custody of rollover Notes. 5

6 TAM Shares held as security for an ESOP Loan may be released either based on principal payments or principal + interest Requirements for principal only method: Periodic payments at a rate at least equal to level payments over no more than 10 years (including extensions) Only interest as determined under standard loan amortization tables is disregarded TAM ESOP Loan entered into in equal monthly installments of principal only Interest paid in arrears Note extended until 2009 and monthly payments reduced Pledge agreement specified P+I method Plan document specified P+I, unless loan met requirements for principal only method DOL audited plan in 2005 Found that principal only method was used from TAM Company agreed to recalculate release of shares using P+I method IRS holds that loan was a prohibited transaction Exempt loan rules include a documentary and an operational requirement PT excise tax (15% of amount involved) imposed for each year of the loan from 1999 until correction (but statute had run on earlier years) Amount involved for purposes of the excise tax means interest on the loan 6

7 Field Assistance Bulletin re Missing Participants Issue: How can the fiduciaries of terminated defined contribution plans fulfill their obligations under ERISA to locate missing participants and properly distribute the participants account balances? Replaces FAB (Note: Since 2014, IRS and SSA have discontinued their letter forwarding service.) Background: Fiduciary s has obligation to use reasonable efforts to locate Missing participants to get distribution directions. If unable to locate, Fiduciary s choice of a distribution option for a missing participant is itself a fiduciary decision. Field Assistance Bulletin re Missing Participants (Cont.) Background (Cont.): Reasonable expenses in trying to locate missing Participant may be charged to Participant s account. Fiduciaries must be able to demonstrate compliance with requirements electronically or on paper (i.e., what actions they took and what decisions they made). Search Steps (must consider costs v. Account size): First class mail or electronic notification. (Note: Use Certified mail little cost; easy way to ascertain if location possible.) Free Internet Searches. Field Assistance Bulletin re Missing Participants (Cont.) Search Steps (Cont.): Check related plans and employer records (e.g., Health plan may have updated contact information). Check with designated beneficiary. If these not fruitful, based on cost v. size of missing Participant s account, consider using fee based internet searches, commercial locator services, credit reporting agencies, information brokers, etc. Distribution Options: Establish IRA for missing participant use Safe Harbor guidance under I.R.C. Regs. 404A-2 re selection of custodian and choice of investment for accounts <$5K. 7

8 Field Assistance Bulletin re Missing Participants (Cont.) Distribution Options (Cont.): Establish an interest bearing federally insured Bank account i/n/o Missing Participant. Transfer amount to state unclaimed property fund. NOTE: Use caution re above as non-ira rollover options result in missing Participant incurring taxable distributions. Such distributions are subject to mandatory withholding and possible additional taxes for premature distributions and for the interest accruing on Bank account after distribution (i.e., the interest is includible in the missing participant s income and thus taxable). Unacceptable Distribution Options: 100% Income Tax Withholding! Ben F. Wells, Esq. Dinsmore & Shohl, LLP (202) ben.wells@dinsmore.com Robert F. Schatz, Esq. Schatz Brown Glassman Kossow LLP (860) rschatz@esopplus.com 8