What are the consequences for not complying with the ESOP Diversification Requirements? How would you correct this error?

Diversification is a qualification issue for an ESOP. As such it is eligible for correction under the EPCRS program. The updated EPCRS program was just released in Rev. Proc. 2001-17. Theoretically, this would be corrected like any other failure to make a distribution. (Participant must be given the right to make the elections, they must be made whole, as if the election right had been granted at the correct time, etc.)

Whether self-correction is possible or you need to go in to the IRS for relief would depend upon how many years the error has been going on, the amounts involved, etc.