A closely held corporation wants to repurchase company stock from its formerly-leveraged ESOP.

However it wants to use a "note" from the Company to the plan to do this!

Seeking confirmation that (a) this would be a prohibited transaction; (B) it is likely to be a fiduciary breach (imprudent investment), independent of PT rules; © this would render the ESOP a non-ESOP; and (d) the correct approach would be to terminate the ESOP and distribute cash or stock, as the case may be, to participants, after obtaining a valuation of the company by an independent appraiser, as of the date the employer purchases company stock.

Hi Christine ---

(a) You are correct that the issuance of a note by the company to its ESOP would be a prohibited extension of credit under ERISA section 406 and IRC section 4975.

(B) Assuming that the PT rules were not in the law, this may or may not be a fiduciary breach....although approval by a truly independent fiduciary might be the most appropriate way to effect this transaction by the ESOP.

© The ESOP would become a non-ESOP; if it were not to be terminated, it should be converted into another type of plan.

(d) Termination of the ESOP may be a better way to accomplish this, but not necessarily. I don't know enough about the facts here to agree with you at this point. And you still should have an independent fiduciary involved. These circumstances may require that a "premium" be placed on the valuation of company stock. Who's going to give instructions to the "independent" appraiser and who's going to "accept" the appraisal?

Can the employer "freeze" the ESOP and periodically buy stock back from the plan in annual increments?

This presumes another qualified plan would be established for ongoing contributions (cash).

Christine ---

Yes...the ESOP may be "frozen," and the employer may offer to purchase stock from the ESOP (for cash) annually. But there should be an independent fiduciary representing the ESOP to negotiate the highest possible sales price for the benefit of ESOP participants.

Just to amplify RLL's response somewhat, there must be a new valuation done each year for purposes of the sale.

Thank you gentlemen, for the helpful comments.

Christine ---

You're welcome....but what makes you think that we're gentlemen?

I know for a fact that Kirk is a gentleman OTP - over the phone. I extrapolated from that . . .

Seriously, though, if due to periodic repurchases of stock by the employer the frozen plan's percentage of employer stock goes below, say, 50% (i.e. is no longer the "primary" plan investment), but is not below 10% (permissible threshhold for non-ESOP), is the plan in disqualified status, or is there a fiduciary breach by virtue of plan asset allocation?

Just wondering . . .

Christine ---

I'm always serious.....

Maybe the ESOP should be "converted" (by amendment) into a (non-ESOP) profit sharing plan in conection with the "freezing." I assume that there is no current ESOP loan or other reason to maintain "ESOP status."

Please note that ERISA section 407(d)(3)(A) includes profit sharing plans as "eligible individual account plans" which are not subject to the 10% limit on investments in employer stock, per section 407(B).