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A CARES Act provision offers some relief to employee stock ownership plans by allowing the suspension of required minimum distributions for 2020.

In addition to providing individual stimulus payments and other individual-oriented assistance, the CARES Act contains some provisions aimed at retirement plans, some of which are of particular interest to companies that maintain employee stock ownership plans (ESOPs).

Our employee benefits and executive compensation practice is available to help employers evaluate and troubleshoot potential issues arising from the changing work environment and economic situation caused by the COVID-19 pandemic. This guidance reviews the employee benefits and executive compensation issues that we have been assisting clients with in the last few days.

Please contact the authors or your Morgan Lewis contacts if you have questions related to employee benefits and executive compensation in the midst of coronavirus COVID-19. For updated, comprehensive information about COVID-19, please see our resource page.

Tax laws have long required that qualified retirement plans timely adopt written plan documents and amendments. But what evidence must a plan sponsor provide to an IRS auditor to prove that they have timely adopted a written plan document and required amendments? The IRS recently addressed this question in Chief Counsel Memorandum 2019‑002 (the CCM), which advises that absent extraordinary circumstances, “. . . it is appropriate for IRS exam agents and others to pursue plan disqualification if a signed plan document cannot be produced by the taxpayer.”

The primary question addressed in the CCM was whether a taxpayer can argue that, based on Val Lanes Recreation Center Corp. v. Commissioner, T.C. Memo 2018-92, it meets its burden to have an executed plan document by producing an unsigned plan and evidence of a pattern and practice of signing plan documents. The IRS’s answer as outlined in the CCM is: No, at least not in the absence of extraordinary circumstances.

Taking cues from Colorado, Missouri, Pennsylvania, Iowa, New Jersey, and Virginia, all of which have recently enacted legislation supporting and encouraging the establishment of ESOPs, the states of Texas, Indiana, and Nebraska are now moving forward with their own pro-ESOP initiatives.

Nebraska Law Allows ESOPs to Own CPA Firms

Nebraska Legislative Bill 49 authorizes the ownership of CPA firms by ESOPs, with an ESOP allowed to own up to 49% of a firm. The bill unanimously passed final reading on February 28, and was signed into law on March 6. Most states already allow minority ESOP ownership of CPA firms. Creating more ESOPs in accounting firms is an important step toward making these critical financial advisors of business owners more aware of the important tax advantages and other byproducts (such as increased employee morale and increased employee productivity) that ESOPs create.

The US House of Representatives passed the Main Street Employee Ownership Act (H.R. 5236) on May 8. The bill would be instrumental in facilitating the establishment of employee stock ownership plans (ESOPs) by revamping the rules by which the Small Business Administration (SBA) must abide when assisting small employers interested in transitioning to an employee-owned model. Specifically, it (1) allows the SBA to make loans to companies that can then reloan to ESOPs (prior law only allowed loans made directly to ESOPs), (2) allows ESOP loans to be made under the SBA's preferred lender program (a program providing for expediting the processing of loans with cooperating private lenders), and (3) updates the definition of ESOPs in the current law governing SBA loans so that ESOPs do not need to have full voting rights to qualify.

The bill also makes an exception to an SBA rule that sellers of a company cannot have an ongoing role in the firm. It waives a current SBA requirement for a 10% equity investment in a business transition loan, and it allows financing to be used to cover transaction costs.

Following in the footsteps of states that already have passed pro-ESOP legislation—including Pennsylvania, Iowa, New Jersey, Virginia, and Nebraska—the states of Colorado, Texas, and Missouri are now moving forward with pro-ESOP initiatives.

Colorado House Passes Pro-ESOP Legislation

In April 2017, the Colorado state legislature passed a pro-employee ownership bill (HB17-1214). The bill creates a revolving-loan program to be operated by the Colorado Office of Economic Development and International Trade (OEDIT) and to be funded by gifts and donations. The bill, which now goes to Colorado Governor John Hickenlooper for signature, also requires that the OEDIT train its employees to be sufficiently knowledgeable about employee ownership to be able to recommend it when appropriate and to promote it in OEDIT materials. The bill was sponsored by Colorado State Representative James Coleman (D-Aurora) as well as Rep. Jack Tate (R-Centennial), who said of the bill, "Anything we can do to encourage ownership helping facilitate getting folks on the path of wealth creation, I think is a good thing."

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On September 26, the US Court of Appeals for the Fifth Circuit ruled that a stock-drop complaint against BP and fiduciaries of its 401(k) plan failed to state a plausible claim of imprudence based on insider information under the pleading standards established in Fifth Third Bancorp v. Dudenhoeffer. See Whitley, et. al. v. BP, P.L.C., et. al


The complaint in Whitley stemmed from the decline in BP’s stock price that followed the Deepwater Horizon oil spill in April 2010. The plaintiffs, participants in BP’s retirement plans, including BP’s employee stock ownership plan (ESOP), filed suit in June 2010 in the US District Court for the Southern District of Texas against the company, its affiliates, the oversight committee for the plan, and several of the company’s executive officers. Plaintiffs alleged that the defendants

  • breached their duties of prudence and loyalty by allowing the plan to acquire and hold overvalued company stock,
  • breached their duty to provide adequate investment information to plan participants, and
  • breached their duty to monitor those responsible for managing the company stock fund.

A New York federal appeals court once again rejected a breach of fiduciary duty claim against the now bankrupt Lehman Brothers brought by its employee stock ownership plan (ESOP) participants. In In Re: Lehman Bros. Sec. and ERISA Litig., No. 15-2229 (2d Cir. 2016), the US Court of Appeals for the Second Circuit on March 18 ruled that participants “failed to allege sufficiently” that plan fiduciaries violated their duties under the Employee Retirement Income Security Act (ERISA). The appeals court upheld an earlier July 15, 2015 decision by a US district court in New York to dismiss the complaint.

Soon after Lehman Brothers declared bankruptcy in September 2008, the ESOP participants sued, claiming that ESOP fiduciaries breached their fiduciary duties under ERISA “by continuing to permit investment in Lehman stock in the face of circumstances arguably foreshadowing its eventual demise,” the Second Circuit said. The New York district court dismissed the complaint for the first time in 2011, and the Second Circuit court upheld the dismissal in 2013. Both courts cited a long-held legal principle applicable to ESOPs—the presumption of prudence—to support the defendants’ request for dismissal.

Aspatore Books just released its 2016 edition of Recent Changes in Employee Benefits and Executive Compensation: Leading Lawyers on Understanding ERISA Changes, Navigating Disclosure Guidelines, and Designing Compliance Strategies (Inside the Minds). Employee Benefits partner Brian D. Hector authored the chapter “ESOPs for Owners of Privately Held Corporations,” which discusses how an employee stock ownership plan (ESOP) is a useful succession planning tool for the owners of closely held businesses. This chapter examines the many benefits of ESOPs (including the tax benefits for a company, business owner, and participants) and explains some basic ESOP rules and some common misconceptions.

For more information about this book, please visit the Thomson Reuters website.