EXECUTIVE EDUCATION SERIES:Accounting and Management Issues ofEmployee Stock Ownership PlansPresented by: Hal Hunt, Cindy ...
2Co-presented by To view this webinar in full screen mode, click on viewoptions in the upper right hand corner. Click th...
3Co-presented by ‹#› This webinar is eligiblefor CPE credit. To receivecredit, you will need toanswer periodic pollingque...
4Co-presented byMike Loritz, CPAShareholder913.234.1226 | mloritz@cbiz.comMike has 17 years of experience in public accoun...
5Co-presented byCindy DwyerShareholder913.234.1022 | cdwyer@cbiz.comCindy is the President of MHM Retirement Plan Solution...
6Co-presented by ‹#›Today’s Agenda123ESOP OverviewESOP Plan Accounting and Auditing UpdateComplex ESOP IssuesESOP Legal an...
ESOP OVERVIEW
8Co-presented by 1950s—ESOP concept developed 1970s—Employee Retirement Income Security Act of 1974(ERISA) 1990s—ESOPs ...
9Co-presented by Approximately 11,000 ESOPs in the U.S., covering 10.3million employees (10% of the private sector workfo...
10Co-presented by Defined contribution retirement plan Invested “primarily” in “qualifying employer securities” Tax ben...
11Co-presented by Plan qualification requirements of the IRC require that anindependent valuation of privately held emplo...
ESOP PLAN ACCOUNTING ANDAUDITING UPDATE
13Co-presented byPlan Financial StatementsEvolution of Fair Value Measurements#MHMWebinarFAS 35 (adopt 1981)Plan investmen...
14Co-presented byASU 2011-04 and Topic 820 ASU 2011-04: Provides for more information and transparency abouthow fair val...
15Co-presented byPrivate Company ESOP ExampleDescription Fair Value ValuationTechnique(s)UnobservableInputsRate AppliedSpo...
16Co-presented byPrivate Company ESOP ExampleThe fair value of the sponsor company common stock held by the plan isvalued ...
17Co-presented byLevel 3 Investments Disclosures in 2012: Consideration must be given to the fact that this is publicinfo...
18Co-presented byLevel 3 Investments Disclosures in 2012: As a result, potentially confidential information of a privatec...
19Co-presented byLevel 3 Investments Disclosures in 2012: The example disclosure reflects a straightforward valuationexam...
20Co-presented byLevel 3 Investments Disclosure Controversy: ESOP community submitted a request to the FASB for relieffro...
21Co-presented byPrivate Company ESOP ExampleDescription Fair Value ValuationTechnique(s)UnobservableInputsRate AppliedSpo...
22Co-presented byLevel 3 Investments Disclosure Controversy: An indefinite delay will allow the accounting community towo...
23Co-presented byLevel 3 Investments Disclosure Controversy: The proposal to indefinitely defer these ASU 2011-4requireme...
24Co-presented byLevel 3 Investments Disclosure Controversy: Comments opposing deferral would likely emphasize howimporta...
25Co-presented by Accumulating this information may take time Accumulating this information may be controversial Start ...
COMPLEX ESOP ISSUES
27Co-presented byESOP as S Corp Shareholder ESOP Trust is an eligible S Corporation shareholder ESOP Trust is a tax-exem...
28Co-presented byAdvantages of an ESOP-owned S Corporation Tax savings create additional cash flow which can be usedto fu...
29Co-presented byS Corporation Disadvantages Selling shareholder cannot elect section 1042 rollover andcapital gains tax ...
30Co-presented byS Corporation Anti-abuse - Rules 409(p) Why? To ensure that ESOPs that are established forS Corporation...
31Co-presented byS Corporation Anti-abuse — Rules 409(p) What’s the beef? S Corporation income allocated to stock held b...
32Co-presented byS Corporation Anti-abuse — Rules 409(p) “Disqualified Person” — An individual is a disqualifiedperson if...
33Co-presented byS Corporation Anti-abuse — Rules 409(p) “Deemed-Owned shares” Shares of stock in the S corporation that...
34Co-presented byS Corporation Anti-abuse — Rules 409(p) “Family Unit”1. Individual’s spouse2. Ancestor or lineal descend...
35Co-presented byS Corporation Anti-abuse — Rules 409(p)John & SueAnnDave & Carol’s daughterDave & CarolRobJohn & Sue’s so...
36Co-presented byS Corporation Anti-abuse — Rules 409(p) Nonallocation year A plan year under the ESOP is treated as ano...
37Co-presented byS Corporation Anti-abuse — Rules 409(p)ESOP Plan Outside Plan TotalThomas 500 5,000 5,500Other Participan...
38Co-presented byS Corporation Anti-abuse — Rules 409(p) Synthetic equity — can also be included in thecomputations Stoc...
39Co-presented byS Corporation Anti-abuse — Rules 409(p) Nonallocation year An excise tax (50%) is imposed on the S Corp...
40Co-presented byS Corporation Anti-abuse — Rules 409(p)Plan Ahead –Arks are way easier to buildbefore it floods than duri...
41Co-presented byS Corporation Anti-abuse — Rules 409(p) Summary Before implementing an S Corporation ESOP examine thetes...
42Co-presented byDividends Used for Debt Service Dividends on allocated shares MAY be used for debt service if“return for...
43Co-presented byDividends Paid to an ESOP Example: Suppose a participant receives a dividend of$1,000 on shares allocate...
44Co-presented byDividends Paid to an ESOP Violation may result in an additional employer contributionor a prohibited tra...
45Co-presented byHandling Liquidity or Repurchase Obligation Know the plan document Distribution provisions – Immediate...
46Co-presented byHandling Liquidity or Repurchase Obligation Source of the money to fund distributions Cash contributed ...
47Co-presented byHandling Liquidity or Repurchase Obligation Source of the money to fund distributions (Continued) Share...
ESOP LEGAL ANDREGULATORY UPDATEDepartment of Labor Issues
49Co-presented by On October 22, 2010, the Department of Labor (“DOL”)proposed a regulation that would make ESOP valuatio...
50Co-presented byNational Enforcement Project/Fiduciary RegulationProposal/Recent Aggressive Activity Responding to a num...
51Co-presented by 3/4/10 News Release – “[The DOL alleges] violations of theEmployee Retirement Income Security Act (ERIS...
52Co-presented by 2/23/12 News Release – “The U.S. Department of Labor…has announced…funding of a global settlement in th...
53Co-presented byDOL News Releases 7/24/12 News Release – “Because participants’ benefits dependon the ESOP buying and se...
54Co-presented by 12/7/12 News Release – “An investigation by EBSAdetermined that . . . [the trustee] failed to comply wi...
55Co-presented by May 10, 2013 ESOP Association presentation by TimHauser, DOL solicitor in charge of this type of litiga...
56Co-presented byLessons Learned/DOL Suggestions What is the Trustee’s role in selecting a valuationadvisor and approving...
57Co-presented byLessons Learned/DOL Suggestions Read the appraisal, ask questions, and understand it. Underlying assump...
ESOP LEGAL ANDREGULATORY UPDATEIndemnification Issues
59Co-presented byHarris v. GreatBanc Trust Company, Sierra AluminumCompany and the Sierra Aluminum Company ESOP* Arises o...
60Co-presented byHarris v. GreatBanc Trust Company, Sierra AluminumCompany and the Sierra Aluminum Company ESOP* The inde...
61Co-presented byHarris v. GreatBanc Trust Company, Sierra AluminumCompany and the Sierra Aluminum Company ESOP* Section ...
62Co-presented byHarris v. GreatBanc Trust Company, Sierra AluminumCompany and the Sierra Aluminum Company ESOP* The cour...
ESOP LEGAL ANDREGULATORY UPDATEIRS Issues
64Co-presented byCorrecting Plan Errors The Employee Plans Compliance Resolution System("EPCRS") allows plan sponsors to ...
65Co-presented byGeneral Correction Principles Full correction must be made for all participants andbeneficiaries and for...
66Co-presented byNews on 415 Excess Allocations In situations where a plan sponsor maintains a plan orplans which provide...
67Co-presented byIRS Determination Letter ApplicationsPlan sponsors are now generally required to submit plans forfavorabl...
68Co-presented byIRS Determination Letter Applications In connection with that effort, the IRS has gotten yearsbehind in ...
69Co-presented byIRS Determination Letter ApplicationsCommon Issues Being Raised in the DeterminationLetter Process: Requ...
70Co-presented byOther IRS Activities Pertaining to ESOPs Possible consideration of an ESOP prototype Comprehensive upda...
71Co-presented by ‹#›Questions?
72Co-presented by ‹#›If You Enjoyed This Webinar… Join us for these related EES courses: June 13 and 18: ESOPs for theAr...
73Co-presented byMike Loritz, CPAShareholder913.234.1226 | mloritz@cbiz.comMike has 17 years of experience in public accou...
74Co-presented byCindy DwyerShareholder913.234.1022 | cdwyer@cbiz.comCindy is the President of MHM Retirement Plan Solutio...
75Co-presented by ‹#›#MHMWebinarConnect with Mayer Hoffman McCannlinkedin.com/company/mayer-hoffman-mccann-p.c.@mhm_pcyout...
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Webinar Slides: Accounting and Management Issues of Employee Stock Ownership Plans

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This course from Mayer Hoffman McCann P.C. will cover several current and emerging accounting topics that will impact employee stock ownership plans (ESOPs). We will cover recent accounting, legal and regulatory updates and the potential implications of the proposed changes on ESOPs.

The compliance requirements impacting ESOPs are unique and continue to be significant. Understanding these changes will take some effort for ESOP sponsors and their accountants (but less than the effort of not implementing them correctly and then trying to retroactively fix errors).

This course will help you better understand these topics impacting ESOPs:

New accounting pronouncements
New compliance and regulatory updates
Strategies for addressing these changes

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Webinar Slides: Accounting and Management Issues of Employee Stock Ownership Plans

  1. 1. EXECUTIVE EDUCATION SERIES:Accounting and Management Issues ofEmployee Stock Ownership PlansPresented by: Hal Hunt, Cindy Dwyer,Mike Loritz and Robert GrossmanMay 23, 2013
  2. 2. 2Co-presented by To view this webinar in full screen mode, click on viewoptions in the upper right hand corner. Click the Support tab for technical assistance. If you have a question during the presentation, please usethe Q&A feature at the bottom of your screen.Before We Get Started…
  3. 3. 3Co-presented by ‹#› This webinar is eligiblefor CPE credit. To receivecredit, you will need toanswer periodic pollingquestions throughout thewebinar. External participants willreceive their CPEcertificate via emailimmediately following thewebinar.CPE Credit
  4. 4. 4Co-presented byMike Loritz, CPAShareholder913.234.1226 | mloritz@cbiz.comMike has 17 years of experience in public accounting with diversified financialcompanies and other service based companies, including banking, broker/dealer,investment companies, and other diversified companies ranging from audits ofpublic entities in the Fortune 100 to small private entities. He is a member ofMHMs Professional Standards Group, providing accounting knowledgeleadership in the areas of derivative financial instruments, investment securities,share-based compensation, fair value, revenue recognition and others.‹#›#MHMWebinarToday’s PresentersHal Hunt, CPAShareholder913.234.1012 | hhunt@cbiz.comHal leads MHM’s Employee Benefit Plan (EBP) Audit Practice. With over 25years of diverse experience with EBP accounting, auditing and complianceissues, he is also a member of the firm’s Professional Standards Group as EBPsubject matter expert. As the EBP National Practice Leader, Hal is responsiblefor providing internal training, along with providing technical support toengagement teams, serving as engagement quality reviewer and developingresource tools for our EBP audit professionals. He served on the AICPA’sEmployee Benefit Plan Audit Quality Center (EBPAQC) Executive Committeeand is currently a member of the EBPAQC ESOP Task Force.
  5. 5. 5Co-presented byCindy DwyerShareholder913.234.1022 | cdwyer@cbiz.comCindy is the President of MHM Retirement Plan Solutions and a Shareholder ofMayer Hoffman McCann P.C. She supervises staff, oversees technical research,and provides quality control services. She has previously served as the nationalChairperson of the American Institute of Certified Public Accountants EmployeeBenefits Technical Resource Panel (TRP) and has recently been reappointed asa member of the TRP. Additionally, Cindy has been a recurring speaker at theAmerican Institute of Certified Public Accountants National Conference onEmployee Benefit Plans. Cindy is also a committee member and current chair ofthe Employee Benefits Institute sponsored by UMKC School of Law.‹#›#MHMWebinarToday’s PresentersRobert D. GrossmanPartner, Lathrop & Gage LLP816.460.5831 | rgrossman@lathropgage.comMr. Grossman is a nationally-recognized ESOP authority with extensiveexperience representing owners, management and fiduciaries of employee-owned companies. ESOP transactions have involved private as well as publiccompanies in a variety of industries including advertising, architecture,automotive, banking, chemicals, commodities trading, construction, energy,engineering, financial services, health care, insurance, manufacturing,pharmaceuticals, printing, professional and other services, retail, security andtelecommunications.
  6. 6. 6Co-presented by ‹#›Today’s Agenda123ESOP OverviewESOP Plan Accounting and Auditing UpdateComplex ESOP IssuesESOP Legal and Regulatory Update4
  7. 7. ESOP OVERVIEW
  8. 8. 8Co-presented by 1950s—ESOP concept developed 1970s—Employee Retirement Income Security Act of 1974(ERISA) 1990s—ESOPs became eligible to hold shares ofS-Corporations in 1998 2000s—Clarification and definition of abusiveS-Corporation ESOP structures, IRC 409(p) in 2001Source: The ESOP AssociationESOP Timeline#MHMWebinar
  9. 9. 9Co-presented by Approximately 11,000 ESOPs in the U.S., covering 10.3million employees (10% of the private sector workforce)across a wide spectrum of industries 5,000 ESOP companies are majority-owned by the ESOP 4,000 ESOP companies are 100% owned by the ESOP 2,000 ESOP companies are minority-owned by the ESOP Approximately 3,700 (1/3) are S-Corporation ESOPs At least 70% of ESOP companies are or were leveraged,meaning they used borrowed funds to acquire the employersecurities held by the ESOP Total assets owned by U.S. ESOPs is estimated to be $870billionSource: The ESOP AssociationESOP Population#MHMWebinar
  10. 10. 10Co-presented by Defined contribution retirement plan Invested “primarily” in “qualifying employer securities” Tax benefits and related compliance matters Key issues arise when debt is used to acquire company stock: Direct loan — between lender and ESOP Commercial lenders Seller financing Participant puts of shares back to ESOP for note from ESOP Indirect or 2–step loan Lender to plan sponsor, sponsor to ESOP Mirror terms are not required Internal loan Sponsor to ESOP with no associated borrowing by sponsorESOP Basics#MHMWebinar
  11. 11. 11Co-presented by Plan qualification requirements of the IRC require that anindependent valuation of privately held employer securities,(acquired after December 31, 1986), must be performedannually. However, the DOL strongly encourages all ESOPs holdingprivate securities to obtain such an independent valuationand requires a valuation for any employer securitypurchase or sale transactions between the plan and a partyin interest. This annual valuation is used to allocate shares toparticipant accounts, and to redeem shares from retiringplan participants to put back to the employer. Valuations are also used for annual ESOP administrationand reporting purposes.ESOP Basics#MHMWebinar
  12. 12. ESOP PLAN ACCOUNTING ANDAUDITING UPDATE
  13. 13. 13Co-presented byPlan Financial StatementsEvolution of Fair Value Measurements#MHMWebinarFAS 35 (adopt 1981)Plan investments valuedat fair valueASU 2009–12 “NAV” (adopt 2009)- Use of NAV as a practicalexpedient for valuation- Additional disclosures and hierarchyASU 2011–04 (adopt 2012)- Description of valuation processes for L3- Unobservable inputs table (quantitative) for L3- Public entities to disclose allL1 and L2 transfers- Public entities to provide narrative descriptionof sensitivity of FV to changes in unobservableinputs (qualitative)ASU 2010–06 (adopt 2010)- Disaggregate hierarchy disclosures by “natureand risk” class for all FV assets and liabilities- Disclose transfers between L1 and L2- Other new disclosuresFAS 157 (adopt 2008)- Apply new FV definition- Hierarchy disclosuresFSP FAS 157–4 (adopt 2009)Disaggregate hierarchy disclosures by“nature and risk” category for equity anddebt securitiesASU 2010–06 (adopt 2011)Expanded disclosure ofL3 activity
  14. 14. 14Co-presented byASU 2011-04 and Topic 820 ASU 2011-04: Provides for more information and transparency abouthow fair value is determined for investments that arenot traded in an active public market. It is that new information that has drawn theattention of the ESOP community. FASB Accounting Standard Update (ASU) 2011-04:Measurement (Topic 820): Amendments to Fair ValueMeasurement and Disclosure Requirements
  15. 15. 15Co-presented byPrivate Company ESOP ExampleDescription Fair Value ValuationTechnique(s)UnobservableInputsRate AppliedSponsor CompanyCommon Stock$92,320,000 Discounted CashFlowWeightedaverage cost ofcapital11.1%Long-termrevenue growthrate4.2%Long-term pretaxoperating margin10.3%Discount for lackof marketability17%MarketComparableCompaniesEBITDA multiple 11.3Revenue multiple 2.0Discount for lackof marketability17%Example Disclosure Level 3 Investment ValuationTechniques and Inputs — Private Company ESOP
  16. 16. 16Co-presented byPrivate Company ESOP ExampleThe fair value of the sponsor company common stock held by the plan isvalued at fair value based upon an independent appraisal. This appraisalwas based upon a combination of the market and income valuationtechniques consistent with prior years. Plan management has concludedthat market participants would also recognize a discount for lack ofmarketability.The valuation process involves plan management’s selection of anindependent appraiser under contract for a term of 3 years with the right tocancel such contract at any time. Plan management accumulates the datafor the appraiser from the audited financial statements of the Company. Theappraiser prepares a preliminary report which plan management, along withthe ESOP trustee, reviews in detail, discusses and approves. The results ofthis process are documented in minutes of the plan fiduciary.
  17. 17. 17Co-presented byLevel 3 Investments Disclosures in 2012: Consideration must be given to the fact that this is publicinformation: all 5500s including the audited financial statements arePUBLICLY accessible on the DOL’s EFAST2 website GAAP departure is possible, but Form 5500 requiresdisclosure of the existence of a GAAP departureASU 2011-04 Fair Value
  18. 18. 18Co-presented byLevel 3 Investments Disclosures in 2012: As a result, potentially confidential information of a privatecompany ESOP sponsor could be accessed by: competitors potential acquirers of the company attorneys looking for potential litigation on the share price or other potentially adverse partiesASU 2011-04 Fair Value
  19. 19. 19Co-presented byLevel 3 Investments Disclosures in 2012: The example disclosure reflects a straightforward valuationexample. Disclosures become more complicated when based uponthe fair value of the underlying assets of the company. The potential risk of disclosing confidential informationmay be reduced by the complexity of the disclosure. In contrast, a company with a very simple valuation model,such as a multiple of EBITDA times a discount, is morelikely to be concerned about the transparency of thefinancial information it is disclosing.ASU 2011-04 Fair Value
  20. 20. 20Co-presented byLevel 3 Investments Disclosure Controversy: ESOP community submitted a request to the FASB for relieffrom these requirements. On April 30, 2013, FASB issued an Exposure Draft for aproposal to indefinitely defer the reporting of thequantifiable aspects of the inputs. If approved, the last column of the table from the previousillustration would be omitted.ASU 2011-04 Fair Value
  21. 21. 21Co-presented byPrivate Company ESOP ExampleDescription Fair Value ValuationTechnique(s)UnobservableInputsRate AppliedSponsor CompanyCommon Stock$92,320,000 Discounted CashFlowWeightedaverage cost ofcapital11.1%Long-termrevenue growthrate4.2%Long-term pretaxoperating margin10.3%Discount for lackof marketability17%MarketComparableCompaniesEBITDA multiple 11.3Revenue multiple 2.0Discount for lackof marketability17%Example Disclosure Level 3 Investments Valuation Techniquesand Inputs — Private Company ESOP
  22. 22. 22Co-presented byLevel 3 Investments Disclosure Controversy: An indefinite delay will allow the accounting community towork with the DOL to see if some method could beachieved to mask this potentially confidential informationfrom the general public. FASB is trying to balance the objective of: providing sufficient information to the intended users of thefinancial statements, with the conflict created by publicly exposing such information tounintended and possibly adverse parties.ASU 2011-04 Fair Value
  23. 23. 23Co-presented byLevel 3 Investments Disclosure Controversy: The proposal to indefinitely defer these ASU 2011-4requirements follows an exposure draft process: a 30-day comment period began May 1 and ends May 31,2013 If approved, deferral would be immediate and in effect untilthe employee benefits community, the DOL and others resolvethe issue. Indefinite deferrals may last multiple years.ASU 2011-04 Fair Value
  24. 24. 24Co-presented byLevel 3 Investments Disclosure Controversy: Comments opposing deferral would likely emphasize howimportant such disclosures are for: the DOL in selecting plans for audit lawyers representing participant rights public interest groups like the Pension Rights Counsel interested plan participants etc.ASU 2011-04 Fair Value
  25. 25. 25Co-presented by Accumulating this information may take time Accumulating this information may be controversial Start now Discuss with your auditor Encourage discussions with trustee, legal counsel andvaluation advisor See if valuation advisor can include an “Auditor” section inreport with the table information Review the footnote before it is finalizedAction Items: ASU 2011-04 Level 3Investments Disclosures
  26. 26. COMPLEX ESOP ISSUES
  27. 27. 27Co-presented byESOP as S Corp Shareholder ESOP Trust is an eligible S Corporation shareholder ESOP Trust is a tax-exempt entity Income passed through to the ESOP is not taxed ESOP is not subject to unrelated business income tax 100% ESOP owned S Corporation becomes a tax-exemptentity
  28. 28. 28Co-presented byAdvantages of an ESOP-owned S Corporation Tax savings create additional cash flow which can be usedto fund -- ESOP loan repayments Repurchase obligations Capital expenditures Acquisitions Terminated participants cannot demand a distribution ofstock
  29. 29. 29Co-presented byS Corporation Disadvantages Selling shareholder cannot elect section 1042 rollover andcapital gains tax deferral Limitation on contribution deductions 25% limit without increased allowance for ESOP loaninterest Concern with section 409(p) anti-abuse rules Inability to defer distributions to terminated employees Distributions on financed shares with an outstanding loancannot be delayed until loan is repaid
  30. 30. 30Co-presented byS Corporation Anti-abuse - Rules 409(p) Why? To ensure that ESOPs that are established forS Corporations provide broad based employee coverage,and to benefit rank and file employees as well as highlycompensated employees and historical owners
  31. 31. 31Co-presented byS Corporation Anti-abuse — Rules 409(p) What’s the beef? S Corporation income allocated to stock held by the ESOPis not subject to income or unrelated business income tax(UBIT), whereas S Corporation income allocated to stockheld by any other qualified plans IS subject to unrelatedbusiness income tax Prohibited allocation rules — no portion of the planattributable to employer securities may accrue during a“nonallocation” year to “disqualified persons”
  32. 32. 32Co-presented byS Corporation Anti-abuse — Rules 409(p) “Disqualified Person” — An individual is a disqualifiedperson if:1. The aggregate number of “deemed-owned shares” ofsuch individual and the individual’s family unit is at least20% of the number of all deemed-owned shares or2. The number of “deemed-owned shares” held only by theindividual is at least 10% of the number of all “deemed-owned shares”
  33. 33. 33Co-presented byS Corporation Anti-abuse — Rules 409(p) “Deemed-Owned shares” Shares of stock in the S corporation that are allocated to theindividual’s account under the ESOP, and such person’sshare of the stock held by the ESOP which has not beenallocated under the plan (i.e., shares held in a suspenseaccount)
  34. 34. 34Co-presented byS Corporation Anti-abuse — Rules 409(p) “Family Unit”1. Individual’s spouse2. Ancestor or lineal descendant of the individual or of theindividuals spouse3. Siblings of the individual or the individual’s spouse, andany lineal descendant of a sibling4. The spouse of any individual described in (2) or (3)
  35. 35. 35Co-presented byS Corporation Anti-abuse — Rules 409(p)John & SueAnnDave & Carol’s daughterDave & CarolRobJohn & Sue’s sonRob’s family unit: Rob, John, Sue, Ann, Dave & CarolJohn’s family unit: John, Sue, Rob & Annmarried
  36. 36. 36Co-presented byS Corporation Anti-abuse — Rules 409(p) Nonallocation year A plan year under the ESOP is treated as anonallocation year if, at any time during the plan year Disqualified persons own at least 50% of the outstanding Scorporation shares (both shares outside the ESOP and“deemed-owned shares” in the ESOP)
  37. 37. 37Co-presented byS Corporation Anti-abuse — Rules 409(p)ESOP Plan Outside Plan TotalThomas 500 5,000 5,500Other Participants 3,500 0 3,500Total 4,000 5,000 9,000% held by Thomas 12.5% 61% Thomas is a Disqualified Person because he owns atleast 10% of the deemed owned shares. Must now look at is total ownership in the company Since his total ownership is at least 50%, this is aproblem
  38. 38. 38Co-presented byS Corporation Anti-abuse — Rules 409(p) Synthetic equity — can also be included in thecomputations Stock options Warrants Restricted stock Deferred issuance stock right Non qualified deferred compensation plans
  39. 39. 39Co-presented byS Corporation Anti-abuse — Rules 409(p) Nonallocation year An excise tax (50%) is imposed on the S Corporation the disqualified person is treated as having received adistribution in the amount of the prohibited allocation ESOP no longer eligible for the prohibited transactionexemption with respect to any outstanding loan to theESOP S Corporation income is subject to UBIT Results in plan disqualification
  40. 40. 40Co-presented byS Corporation Anti-abuse — Rules 409(p)Plan Ahead –Arks are way easier to buildbefore it floods than during.
  41. 41. 41Co-presented byS Corporation Anti-abuse — Rules 409(p) Summary Before implementing an S Corporation ESOP examine thetest and all family relationships. Address synthetic equity. ESOPs with numerous, broad-based employeeparticipation generally should not have a problem passingthe section 409(p) test but watch family relationships. Testing should be done at the beginning of the plan year;corrective action must be taken AFTER preliminary testingbut BEFORE any formal allocation is made. Annually, make sure your third party administrator isperforming this test and review the results.
  42. 42. 42Co-presented byDividends Used for Debt Service Dividends on allocated shares MAY be used for debt service if“return for value” rule is satisfied. IRC §404(k) (aka “DividendShort Fall”) Shares allocated to participant due to use of dividends mustat least equal in value the dividend dollars applied. Other allocations to account due to contributions cannot beused to satisfy this test. Typically any shortfall is made up through allocation ofshares attributable to dividends paid on collateral IMPACT: This is a condition of the right to use dividends fordebt service. Violation may result in an additional employercontribution or a prohibited transaction, subject to correction.
  43. 43. 43Co-presented byDividends Paid to an ESOP Example: Suppose a participant receives a dividend of$1,000 on shares allocated to his account in the ESOP.The $1,000 is used to repay the exempt loan. 20 sharesare released and returned to the participant. The sharevalue at the end of the plan year is $40 per share, or $800for the 20 shares returned. This is $200 less than the valueremoved from the account. “Dividend short fall” or “return of value” issue
  44. 44. 44Co-presented byDividends Paid to an ESOP Violation may result in an additional employer contributionor a prohibited transaction, subject to correction Particular issue for an S Corporations as correctionmethods may be limited Dividend short fall rules do not apply to shares held in thesuspense account A rising stock price does not guarantee that the plan will nothave a dividend short fall issue
  45. 45. 45Co-presented byHandling Liquidity or Repurchase Obligation Know the plan document Distribution provisions – Immediate pay-out, delay for 5 years, installments? Annually prepare a Repurchase Obligation Study Properly plan for cash flow requirements
  46. 46. 46Co-presented byHandling Liquidity or Repurchase Obligation Source of the money to fund distributions Cash contributed and distributed Shares remain in plan and are reallocated in same ratio as cashwas withdrawn from active participant accounts Shares distributed and repurchased by ESOP with cash Where did the cash come from? Shares distributed and repurchased by ESOP with note Securities acquisition note subject to all of the leveraged ESOPrules Shares distributed and repurchased by Plan Sponsor Repurchase transaction is outside the plan
  47. 47. 47Co-presented byHandling Liquidity or Repurchase Obligation Source of the money to fund distributions (Continued) Shares repurchased from ESOP by Plan Sponsor andcash distributed to participants Party in interest transaction Price paid is not less than adequate consideration on thetransaction date (all other distribution methods can, generally,use value as of prior valuation date).5/23/201347
  48. 48. ESOP LEGAL ANDREGULATORY UPDATEDepartment of Labor Issues
  49. 49. 49Co-presented by On October 22, 2010, the Department of Labor (“DOL”)proposed a regulation that would make ESOP valuationadvisors “fiduciaries” under ERISA. In the proposal, the DOL makes reference to a nationalenforcement project maintained by its Employee BenefitsSecurity Administration (“EBSA”) designed to identify andcorrect violations of ERISA in connection with ESOPs According to DOL, “one of the most common violations found isthe incorrect valuation of employer securities.” “A common violation found in the ESOP national enforcementproject arises in cases where plan fiduciaries have reasonablyrelied on faulty valuations of securities prepared by professionalappraisers.”National Enforcement Project/Fiduciary RegulationProposal/Recent Aggressive Activity#MHMWebinar
  50. 50. 50Co-presented byNational Enforcement Project/Fiduciary RegulationProposal/Recent Aggressive Activity Responding to a number of public comments andtestimony, the DOL announced in September, 2011that it would re-propose its fiduciary regulation. DOL has indicated that the re-issuance of the newfiduciary rule might be published in July, 2013, but itwill likely be later than that. In the meantime, over the past 3 years, DOL has takenan aggressive position with respect to ESOPs, hasbrought a series of lawsuits and has not shied awayfrom the press.#MHMWebinar
  51. 51. 51Co-presented by 3/4/10 News Release – “[The DOL alleges] violations of theEmployee Retirement Income Security Act (ERISA) thatresulted in losses to the company-sponsored ESOP.” 3/11/10 News Release – “The U.S. Department of Laborhas obtained consent judgments providing for restitution ofmore than $12 million. . . .” 6/8/11 News Release – “The plans’ fiduciaries, includingtrustees and members of the boards of directors of thecompanies that sponsored the plans, allegedly allowed theplans to pay excessive prices for the stock, used flawedvaluations for the stock transactions, failed to select aqualified appraiser for the stock transactions, and providedinaccurate and incomplete information to the appraiser andhis firm. Litigation against remaining defendants isongoing.”DOL News Releases#MHMWebinar
  52. 52. 52Co-presented by 2/23/12 News Release – “The U.S. Department of Labor…has announced…funding of a global settlement in theamount of $32 million to be allocated among the TribuneEmployee Stock Ownership Plan’s participants, and to payfor legal and administrative expenses.” 4/25/12 News Release – “The Department alleges in thesuit that a reasonable value for the company as ofNovember 2002 was far less than the amounts paid for thecompany stock and the total deferred compensationagreements entered into with [defendant].”DOL News Releases#MHMWebinar
  53. 53. 53Co-presented byDOL News Releases 7/24/12 News Release – “Because participants’ benefits dependon the ESOP buying and selling stock for fair market value, thedepartment intends to make certain that the price an ESOP paysfor the plan sponsor’s stock reflects its true market value, thoseretained to advise an ESOP about the stock purchase fulfill theirfiduciary duties under ERISA and those who sell their shares toan ESOP do not receive a windfall.” 10/2/12 News Release – “The suit alleges that…[the] appraiser’sreport presented unrealistic and aggressively optimisticprojections of [the company’s] future earnings and profitability.” 11/29/12 News Release – “ESOP participants depend on theplan to buy and sell sponsor-company stock at fair market value.The department is committed to making sure that the onesresponsible for making these decisions are fulfilling their fiduciaryduties to protect the interests of the ESOP participants.”#MHMWebinar
  54. 54. 54Co-presented by 12/7/12 News Release – “An investigation by EBSAdetermined that . . . [the trustee] failed to comply with itsduty to understand the valuation report that set thepurchase price, identify and question assumptions in thereport, and verify that the conclusions in the report wereconsistent with the company’s financial data.” 2/21/13 News Release – “the Department concluded that,as a result of . . . violations of . . . fiduciary duties and thedesign of the transactions, the stock purchases did notprovide benefits to the plan and its participantscommensurate with the amount the plan paid for the stock,the transactions were not primarily for the purpose ofproviding benefits to plan participants, the transactions didnot promote employee ownership of [the company].”DOL News Releases#MHMWebinar
  55. 55. 55Co-presented by May 10, 2013 ESOP Association presentation by TimHauser, DOL solicitor in charge of this type of litigation: “ESOPs serve profoundly important social purposes likeretirement savings and employee empowerment.” “The point of DOL enforcement is to make sure those goals areadvanced.” “The goal is making sure abuses do not occur, recognizing thatthey are a small minority.” DOL views ESOPs solely as retirement plans under ERISA. As a result, they are subject to the fiduciary responsibilities rulesof ERISA. Exclusive Benefit Rule Prudency Rule Plan Document Rule The importance of “adequate consideration.”Recent Comments By DOL Representative#MHMWebinar
  56. 56. 56Co-presented byLessons Learned/DOL Suggestions What is the Trustee’s role in selecting a valuationadvisor and approving a valuation report? Who hires the valuation advisor? Investigate the qualification of the valuation advisor Does the expert have all the relevant and current financialdata?#MHMWebinar
  57. 57. 57Co-presented byLessons Learned/DOL Suggestions Read the appraisal, ask questions, and understand it. Underlying assumptions Valuation methodologies Does the narrative discussed match the financial data? Heavy concentration in one or a handful of customers Be wary of rosy, hockey-stick type projections Sensitivity testing ”Assume a reversion to the mean” Analysis of so-called “comparable” companies Discounts for minority interests and/or marketability Have there been other offers? Procedural prudence and documentation#MHMWebinar
  58. 58. ESOP LEGAL ANDREGULATORY UPDATEIndemnification Issues
  59. 59. 59Co-presented byHarris v. GreatBanc Trust Company, Sierra AluminumCompany and the Sierra Aluminum Company ESOP* Arises out of lawsuit filed by DOL in September, 2012alleging various violations under ERISA. The Trustees engagement letter contained anindemnification provision pursuant to which the plansponsor agreed, subject to the applicable provisions ofERISA, to indemnify the Trustee, its officers, directors,employees and agents (the "Indemnitees") for any loss,cost, expense or other damage, including attorneys fees,suffered by the lndemnitees resulting from or incurred withrespect to any legal proceedings related in any way to theperformance of services under the engagement letter, thePlan or the trust.*(USDC, Central District of California, March 15, 2013)#MHMWebinar
  60. 60. 60Co-presented byHarris v. GreatBanc Trust Company, Sierra AluminumCompany and the Sierra Aluminum Company ESOP* The indemnification obligation would not apply, however, if theloss, cost, expense or damage was determined in a finaljudgment by a court of competent jurisdiction to have resultedfrom: The gross negligence of willful misconduct of the Indemnitee; or The violation or breach of any fiduciary duty imposed under ERISAon the Indemnitee Furthermore, in the event it was ultimately determined that theIndemnitees were not entitled to indemnification, the agreementrequired them to reimburse the plan sponsor for any fees orexpenses previously advanced. DOL argued that since the ESOP owned 100% of the stock ofthe plan sponsor, enforcement of the indemnification provisionwould harm the ESOP since the assets of the plan sponsorwould be depleted.*(USDC, Central District of California, March 15, 2013)#MHMWebinar
  61. 61. 61Co-presented byHarris v. GreatBanc Trust Company, Sierra AluminumCompany and the Sierra Aluminum Company ESOP* Section 410(a) of ERISA states that "any provision in anagreement or instrument which purports to relieve afiduciary from responsibility or liability for any responsibility,obligation or duty... shall be void as against public policy." In dismissing the DOLs claim, the court determined that theindemnification provision in this particular case did not runafoul of ERISA § 410(a) noting that the terms of theagreement expressly prohibited indemnification if a courtentered a final judgment finding the Trustee liable forbreach of its fiduciary duties under ERISA.*(USDC, Central District of California, March 15, 2013)#MHMWebinar
  62. 62. 62Co-presented byHarris v. GreatBanc Trust Company, Sierra AluminumCompany and the Sierra Aluminum Company ESOP* The court further distinguished the indemnificationagreement in this case from the agreement at issue inJohnson v. Couturier (9th Cir. 2009): The Couturier indemnification agreement did not excludeindemnification for fiduciary breaches. The plan sponsor in Couturier was no longer an operatingcompany. As a result, liquidation proceeds of the companypayable to the ESOP would be reduced, dollar for dollar, bythe amount of the indemnification payments. Generally speaking, assets of the plan sponsor should notbe treated as plan assets.*(USDC, Central District of California, March 15, 2013)#MHMWebinar
  63. 63. ESOP LEGAL ANDREGULATORY UPDATEIRS Issues
  64. 64. 64Co-presented byCorrecting Plan Errors The Employee Plans Compliance Resolution System("EPCRS") allows plan sponsors to correct various types offailures to comply with the requirements of the InternalRevenue Code. Revenue Procedure 2013-12 updates the comprehensivesystem of correction programs available under EPCRS. There are three components to EPCRS: Self-Correction Program ("SCP") Voluntary Correction Program ("VCP") Audit Closing Agreement Program ("Audit CAP")#MHMWebinar
  65. 65. 65Co-presented byGeneral Correction Principles Full correction must be made for all participants andbeneficiaries and for all taxable years (whether or not thetaxable year is closed). The plan should be restored to the position it would havebeen in had the failure not occurred. The correction method should be "reasonable andappropriate."#MHMWebinar
  66. 66. 66Co-presented byNews on 415 Excess Allocations In situations where a plan sponsor maintains a plan orplans which provide for elective deferrals and nonelectiveemployer contributions (other than matching contributions),it is not uncommon to have allocations that would exceedthe 415 limits. A question had arisen as to whether or not it was possibleto argue that a plan had the requisite practices andprocedures in place to prevent the occurrence of a 415(c)violation if these excesses were occurring every year. Under Revenue Procedure 2013-12, it is clear that a plansponsor will not be treated as failing to have establishedpractices and procedures in place if excess annualadditions are regularly corrected by a return of electivedeferrals to affected employees within 21/2 months afterthe end of the plans limitation year.#MHMWebinar
  67. 67. 67Co-presented byIRS Determination Letter ApplicationsPlan sponsors are now generally required to submit plans forfavorable determination letters every five years on a cycledetermined by the last digit of their employer identification number.#MHMWebinarLast Digit of EIN Required Cycle Submission Date1 or 6 A 1/31/122 or 7 B 1/31/133 or 8 C 1/31/144 or 9 D 1/31/155 or 0 E 1/31/16The IRS has made a concerted effort to understand ESOPs and,about 5 years or so ago, appointed a small group of specially-trained agents (called the "ESOP cadre") to review all ESOPsubmissions.
  68. 68. 68Co-presented byIRS Determination Letter Applications In connection with that effort, the IRS has gotten yearsbehind in reviewing ESOP submissions and in respondingto determination letter requests. During 2010, the IRS published their response to several"Requests for Technical Assistance" dealing with topicssuch as (i) permissible definitions of "10 years ofparticipation" for purposes of statutory diversification, (ii)plan rebalancing and reshuffling and (iii) converting theaccounts of terminated participants from company stockinto cash or other investments. In recent weeks, we have finally seen a flurry of responseswith respect to ESOP documents filed in 2010.#MHMWebinar
  69. 69. 69Co-presented byIRS Determination Letter ApplicationsCommon Issues Being Raised in the DeterminationLetter Process: Required elimination of language describing the use of proceeds arising fromthe sale of ESOP suspense account shares to pay debt and the advancecharacterization of such proceeds as earnings (not subject to IRC § 415). Acceptable language regarding the avoidance of a non-allocation year inconnection with IRC § 409(p). Specifying whether the plan sponsor is a C corporation or an S corporation. Elimination of employer or plan administrator discretion in connection withthe conversion of Company Stock accounts into cash following a severancefrom employment. Conversion of Company Stock accounts into cash in the case of a formeremployee that goes to work for an entity that precludes its employees fromhaving an interest in certain entities pursuant to a conflict of interest policy. Supplemental Diversification.#MHMWebinar
  70. 70. 70Co-presented byOther IRS Activities Pertaining to ESOPs Possible consideration of an ESOP prototype Comprehensive update/overhaul of ESOP regulatoryscheme Requested information from the ESOP Association L&RCommittee regarding update of exempt loan regulations Refinancings which extend the term of an exempt loan Multiple outstanding loans Periodic vs. annual releases Loan forgiveness and release fraction Reasonable interest rate safe harbor Repayment of loan from third party sales Loan subordination provisions What happens when the value of shares released by the use ofdividends on allocated shares is insufficient Permissible length of exempt loans#MHMWebinar
  71. 71. 71Co-presented by ‹#›Questions?
  72. 72. 72Co-presented by ‹#›If You Enjoyed This Webinar… Join us for these related EES courses: June 13 and 18: ESOPs for theArchitecture/Engineering/Construction Industry Oct. 24: The Role of ESOPs in Private Equity Firms Nov. 14 and 19: Employee Benefit Plan Accounting IssuesUpdate Read these related publications: MHM Messenger 11-13: FASB Proposal Affects EmployeeBenefit Plans Employee Stock Ownership Plan Primer
  73. 73. 73Co-presented byMike Loritz, CPAShareholder913.234.1226 | mloritz@cbiz.comMike has 17 years of experience in public accounting with diversified financialcompanies and other service based companies, including banking, broker/dealer,investment companies, and other diversified companies ranging from audits ofpublic entities in the Fortune 100 to small private entities. He is a member ofMHMs Professional Standards Group, providing accounting knowledgeleadership in the areas of derivative financial instruments, investment securities,share-based compensation, fair value, revenue recognition and others.‹#›#MHMWebinarToday’s PresentersHal Hunt, CPAShareholder913.234.1012 | hhunt@cbiz.comHal leads MHM’s Employee Benefit Plan (EBP) Audit Practice. With over 25years of diverse experience with EBP accounting, auditing and complianceissues, he is also a member of the firm’s Professional Standards Group as EBPsubject matter expert. As the EBP National Practice Leader, Hal is responsiblefor providing internal training, along with providing technical support toengagement teams, serving as engagement quality reviewer and developingresource tools for our EBP audit professionals. He served on the AICPA’sEmployee Benefit Plan Audit Quality Center (EBPAQC) Executive Committeeand is currently a member of the EBPAQC ESOP Task Force.
  74. 74. 74Co-presented byCindy DwyerShareholder913.234.1022 | cdwyer@cbiz.comCindy is the President of MHM Retirement Plan Solutions and a Shareholder ofMayer Hoffman McCann P.C. She supervises staff, oversees technical research,and provides quality control services. She has previously served as the nationalChairperson of the American Institute of Certified Public Accountants EmployeeBenefits Technical Resource Panel (TRP) and has recently been reappointed asa member of the TRP. Additionally, Cindy has been a recurring speaker at theAmerican Institute of Certified Public Accountants National Conference onEmployee Benefit Plans. Cindy is also a committee member and current chair ofthe Employee Benefits Institute sponsored by UMKC School of Law.‹#›#MHMWebinarToday’s PresentersRobert D. GrossmanPartner, Lathrop & Gage LLP816.460.5831 | rgrossman@lathropgage.comMr. Grossman is a nationally-recognized ESOP authority with extensiveexperience representing owners, management and fiduciaries of employee-owned companies. ESOP transactions have involved private as well as publiccompanies in a variety of industries including advertising, architecture,automotive, banking, chemicals, commodities trading, construction, energy,engineering, financial services, health care, insurance, manufacturing,pharmaceuticals, printing, professional and other services, retail, security andtelecommunications.
  75. 75. 75Co-presented by ‹#›#MHMWebinarConnect with Mayer Hoffman McCannlinkedin.com/company/mayer-hoffman-mccann-p.c.@mhm_pcyoutube.com/mayerhoffmanmccanngplus.to/mhmpcblog.mhm-pc.comslideshare.net/mhmpcfacebook.com/mhmpc
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