Attorney Seeks Clarity in Guidance on Diversification Requirements Under Pension Law

Reeder, W Thomas

This is to follow-up on our recent discussions about the need for administrative guidance (or, if necessary, a technical correction) regarding the new employer securities diversification provisions in the Pension Protection Act of 2006 (PPA). The requirements in new Code section 401(a)(35) and ERISA section 204(j) as added by section 901 of the PPA -- and by extension the new notice of the right to divest requirements in new ERISA section 101 (m) as added by section 507 of the PPA -- appear to apply to any defined contribution plan that holds publicly traded employer securities, whether participant-directed or not. It also is unclear whether these requirements could apply where employer securities are held indirectly through a collective investment vehicle or through some other diversified investment account. Here are our thoughts and suggestions on these issues.

Exemption for Non-Participant-Directed Plans

For a non-participant-directed plan, the new requirements will either (1) force the plan to hold no employer securities (effectively a limitation more strict than the 10% applied to defined benefit plans), or (2) incur the cost of establishing special investment options and procedures for soliciting (through the notice of the right to divest) and accepting participant investment directions just for employer securities.

It needs to be clarified that the diversification requirements apply only to those defined contribution plans that permit participants to direct the investment of their accounts.

Exemption for Employer Securities Held Through Diversified Vehicles or Accounts

Employer securities are sometimes held within funds or accounts that do not invest primarily in employer securities. For example, a plan may hold employer securities indirectly (e.g., through a collective investment vehicle) or within a diversified account that participants are permitted to transfer out of. These funds or accounts invest in a number of securities at the direction of an investment manager independent of the employer (e.g., index funds or other managed diversified funds). In such a case, the employer security is chosen on its investment merits alone and without regard to the relationship of the issuer to the plan.

The employer stock diversification and notice requirements are unnecessary and should not apply in these circumstances. It should be clarified that these requirements do not apply to either:

• Employer securities held in a collective investment vehicle (i.e., investment fund in which more than one unrelated investor invests) which does not primarily invest in that employer security. (A "collective investment vehicle" would include a mutual fund, a bank collective or group trust, a pooled separate account, a limited partnership or corporation in which more than one unrelated investor or plan invests.)

• Employer securities held in an investment account or vehicle (need not be collective) which does not primarily invest in that employer security.

To comply with U.S. Treasury Regulations, we also inform you that, unless expressly stated otherwise, any tax advice contained in this communication is not intended to be used and cannot be used by any taxpayer to avoid penalties under the Internal Revenue Code, and such advice cannot be quoted or referenced to promote or market to another party any transaction or matter addressed in this communication.