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Dale R. Vlasek Tom Potts, Jr. Tim Jochim McDonald Hopkins Co., LPA Fiduciary Trust Services Jochim Co., L.P.A. 600 Superior Avenue 5120 Commerce Circle.

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Presentation on theme: "Dale R. Vlasek Tom Potts, Jr. Tim Jochim McDonald Hopkins Co., LPA Fiduciary Trust Services Jochim Co., L.P.A. 600 Superior Avenue 5120 Commerce Circle."— Presentation transcript:

1 Dale R. Vlasek Tom Potts, Jr. Tim Jochim McDonald Hopkins Co., LPA Fiduciary Trust Services Jochim Co., L.P.A. 600 Superior Avenue 5120 Commerce Circle 673 Mohawk St., Ste. 202 Cleveland, OH Indianapolis, IN Columbus, OH ESOP Legal Update The Ohio Employee Ownership Center 21st Annual Conference Fairlawn, OH April 20, 2007

2 Topics to be Covered Case Law and Regulatory Update. Pension Protection Act and other Legislation. Legal Role of ESOP Trustee.

3 Shifting Trends? Summers v. State Street Bank, No (7 th Cir., 6/28/06). – U.S. Court of Appeals for the 7 th Circuit upheld a lower court that State Street Bank did not violate its fiduciary duties by failing to sell UAL stock in the ESOP more quickly. – However, the court, citing Kuper v. Iovenko, 66 F.3d 1447, indicated that an ERISA plan “may not be interpreted to include a per se prohibition against diversifying an ESOP” and that investing trust assets imprudently or letting them remain invested imprudently is irresponsible behavior. – The court also indicates that a duty to diversify comes from excessive risk imposed on employee-shareholders; in this case by the rise in debt to equity ratio of the employer’s stock.

4 Shifting Trends? See also: – FirsTier Bank v. Zeller, 16 F.3d 907 (8 th Cir. 1994). – In re WorldCom, Inc. ERISA Litig., 354 F.Supp.2d 423 (S.D. NY 2005). – Department of Labor – FAB – Hill v. Tribune, 2006 U.S. Dist. LEXIS (N.D. Ill. 2006). – Agway v. Magnuson, 2006 U.S. DIST LEXIS (N.D. N.Y. July 13, 2006).

5 Shifting Trends? But, see: – In re General Motors, 2006 U.S. Dist. LEXIS (E.D. MI. April 6, 2006) which found the directed trustee contractually obligated to invest only in employer stock and cash or other short term investments. – Pedraza v. The Coca-Cola Company, 2006 U.S. Dist. LEXIS (N.D. Ga. Sept. 29, 2006); following Wright v. Oregon Metallurgical Corp., 360 F.3d 1090 (9 th Cir. 2004) and relying on “brink of collapse” theory. – Smith v. Delta Air Lines, 422 F.Supp.2d 1310 (N.D. Ga. 2006); also following Wright and the impending collapse theory.

6 Shifting Trends? Wright v. Oregon Metallurgical Corporation, 360 F.3d 1090 (9 th Cir. 2004). – Court concluded that if the underlying fiduciary direction itself is not in violation of ERISA, then the directed trustee’s compliance with that direction will not serve as a basis for liability. – Compare Herman v. Nation Bank, 126 F.3d 1354 (11 th Cir., 1997), regarding lawful directions to trustee.

7 Independent Trustees Armstrong v. Amsted Industries, 2004 U.S. Dist. LEXIS (N.D. Ill. 2004) and Armstrong v. LaSalle Bank (7 th Cir., 2006). – Where a trustee is independent and has experience administrating ESOPs, a court should grant deferential review and not substitute its judgment for that of the trustee, unless the trustee’s decision is found arbitrary and capricious. – It is not the responsibility of the ESOP trustee to independently investigate the business decisions of the plan sponsor’s management (related to costly acquisition). – 7 th Circuit Court of Appeals remand to trial court on issue of whether LaSalle Bank, Trustee, should have performed analysis of repurchase obligation after costly acquisition; ignoring changed circumstances may be imprudent.

8 Respondeat superior claims related to stock in 401(k) In re: Cardinal Health, Inc., 424 F.Supp.2d 1002 (S.D. Oh. 2006). – Following Kling v. Fidelity Management Trust Co., 323 F.Supp.2d 132 (D.Mass. 2004), the court found that plaintiffs’ respondeat superior claim against defendant directors is applicable to claims brought under ERISA and thus denies defendant Cardinal’s motion to dismiss. – Directed trustee, Putnam, dismissed as defendant but case may proceed against Cardinal on issue of failure to sell company stock in 401(k).

9 Stock in 401(k) DiFelice v. US Airways, Inc., No. 1:04cv889 (E.D. Va., 6/26/06). – Offering company stock as one of 13 investment options in a 401(k) plan, even when the stock was very risky, is not a breach of fiduciary duty. – Employees did not have to choose company stock and should have known it was a high-risk investment. – US Airways appointed an independent fiduciary for the company stock fund once it filed for bankruptcy. – True and accurate information and unfettered ability to trade in and out of choices is required.

10 Stock Purchase by ESOP Henry v. Champlain Enterprises, 468 F.Supp2d 368 (N.D. N.Y. 2007). – Failure of ESOP Trustee to produce notes with respect to stock purchased by ESOP did not support finding of breach of fiduciary duty. – Requires determination by trial court of errors or flaws in Trustee’s diligence process. – “Enhancements” may not be sufficient to overcome target price issue. – On remand, the court dismissed plaintiffs’ complaint which had damages as an essential element of all causes of action as a result of a new stock purchase agreement resulting in no damages.

11 Potential Breach? Evanson v. Price, 2006 U.S. Dist. LEXIS (E.D. Cal. September 29, 2006). – ESOP trustees were executive participants in employer’s SAR. – Plaintiffs found letters indicating that benefits from the SAR would grossly inflate participants’ compensation in excess of market rates by 30% - 50%. – Complaint is based on harm done to the ESOP as a result of the overpayment of benefits from the SAR. – The court denied motions to dismiss.

12 Payroll Practices Larimore v. Grant, 2006 U.S. Dist. LEXIS (W.D. Ky. July 17, 2006). – The court followed Sixth Circuit authority in finding that the employer-plan sponsor’s creation of a second benefit plan that was intended to benefit one employee (similar to benefits he would have received had he been eligible to participate in the ESOP), and the employer’s practice of paying performance bonuses were both payroll practices and thus, the employer was not acting in its fiduciary capacity with regard to the ESOP when creating the other plan or paying bonuses.

13 Pension Protection Act of 2006 and ESOPs Primary purpose is to address the funding problems of defined benefit plans. Certain diversification rules apply to defined contribution plans invested in publicly traded employer securities: – At any time if related to employee contributions. – After three (3) years of service if employer contributions. – Does not apply to stand alone ESOP with no 401(k) or (m) provisions.

14 Pension Protection Act of 2006 and ESOPs (cont’d) PPA made the changes enacted in the Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”) permanent. (initially scheduled to “sunset” after 2010). The EGTRRA changes which are now permanent include: Increased contribution deduction limits from 15% to 25% of compensation. 401(k) contributions not counted in contribution limit (were counted previously). Increased Section 401(k) limit up to its current $15,000 limit with catch-up contribution (currently $5,000).

15 Pension Protection Act of 2006 and ESOPs (cont’d) Increased the Section 415 limit from lesser of 25% of compensation or $30,000 to the current limit of the lesser of $44,000 or 100% of compensation. Increased the annual compensation limit from $150,000 to its current limit of $220,000. ESOP dividends may be reinvested in company stock at option of the participant and the employer will receive deduction. S-corporation ESOP anti-abuse rules made permanent.

16 Pension Protection Act of 2006 and ESOPs (cont’d) Effective for plan years starting in 2007, the PPA amended ERISA to require that individual account plans, such as ESOPs, provide participants with a periodic pension statement. If the participant or beneficiary has the ability to direct the investment of his/her account the statement must be given once each calendar quarter. – Likely to include ESOPs which permit the mandatory diversification inside the ESOP (rather than transferring to another plan such as the company’s 401(k) plan). If the participant or beneficiary does not have the right to direct the investment of his/her account, the statement must be given once each calendar year.

17 Pension Protection Act of 2006 and ESOPs (cont’d) Effective for contributions made for plan years beginning after December 31, 2006, the vesting schedule must be at least as fast as one of the following: Three year cliff (0%, 0%, 100%). Six year graded (0%, 20%, 40%, 60%, 80%, 100%). Eligible rollover distribution to IRAs expanded to include non-spousal beneficiaries.

18 ESOP Promotion and Improvement Act of 2005 H.R and S Permits Section 1042 treatment for sale of employer stock to S Corp ESOP. Permits pass through to ESOP participants of profit distributions by S Corp without 10% early distribution penalty. Currently on hold in both House and Senate.

19 Presidential Panel on Federal Tax Reform Panel recommended that all defined contribution plans would be replaced by “Save at Work Plan” (no discussion of ESOPs). President’s proposed fiscal year 2008 budget commencing October 1, 2007, contains Treasury Department recommendation that all “contributory plans” be replaced by Employee Retirement Savings Account (“ERSA”). Treasury recommendation seems to have no effect upon stand alone ESOPs.

20 Rev. Proc and Remedial Amendment Cycle for IRS Determination Letters Individually designed plans, including ESOPs, must be amended or restated every five years for IRS determination letter. First cycle was 12 months ending and fifth cycle is 12 months ending Any plan submitted out of cycle, including new plans, will not be considered until all on-cycle applications are considered. Procedure is detrimental to timely approval of ESOPs and IRS in considering changes.

21 Some Legal Requirements To keep an “eye-single” to the best interests of the plan participants To pay no more than adequate consideration for the stock To monitor the financial status of the company (i.e. monitor its investment) To diversify the holdings of the plan

22 What the courts are saying Trustee must adequately investigate the purchase of stock Documentation should be ample to prove investigation Trustee should negotiate the price to be paid for the stock Trustee can be liable if price is too high

23 What the DOL is focusing on Possible prohibited transactions Extent of negotiations Fairness of the terms of the sale “Inside” trustee vs. independent trustee Expertise of financial advisors

24 What can be learned? Substantial due diligence is required Document, document, document Hire only competent, seasoned experts Review experts’ work thoroughly Make sure all issues are resolved Trustee works for and on behalf of the participants

25 Dale R. Vlasek, McDonald Hopkins Dale R. Vlasek, Member, Business Department & Chair for Employees Benefits Practice Group Dale is Chairman of the Employee Benefits Practice Group. He focuses his practice on all employee benefit matters including pension, profit sharing and 401(k) planning design, operation and compliance matters, ESOPs, welfare benefit plans (e.g. group health, life, dependent care programs) design, operation and compliance matters, ERISA litigation, and multi-employer pension plans. He serves as benefits counsel to a number of middle-market and larger companies. Dale is licensed to practice in Ohio and Iowa. Education University of Iowa, J.D., high distinction, Order of the Coif (1982) University of Iowa, Ph.D. (1978) Cleveland State University, M.A. (1972) Cleveland State University, B.A. (1970) Admissions Ohio (1987), Wisconsin (1982), Iowa (1982) Professional Associations Cleveland Bar Association, Ohio State Bar Association, Iowa State Bar Association, Midwest Pension Conference, Worldwide Employee Benefits Network (WEB), ESOP Association Awards and Honors Named Ohio Super Lawyer, Cincinnati Magazine ( ), Named one of the “Best Lawyers in America” by Corporate Counsel Magazine, 2006 Dale R. Vlasek McDonald Hopkins 600 Superior Avenue Cleveland, OH

26 Fiduciary Trust Services, Inc. Tom Potts, President and CEO of Fiduciary Trust Services, Inc., located in Indianapolis, Indiana Tom specializes in providing independent fiduciary/trustee services to ESOPs. He currently serves both as “transaction trustee” as well as ongoing trustee for ESOPs in the Midwest and nationwide. Tom is a frequent presenter at ESOP seminars in the Midwest. Tom Potts, Jr. Fiduciary Trust Services 5120 Commerce Circle Indianapolis, IN

27 Jochim Co., L.P.A. Tim Jochim, President and primary shareholder of Jochim Co., L.P.A.: National authority on employee stock ownership plans (ESOPs) and business succession. The firm also has expertise in corporate finance, merger/acquisition and employee benefits. Adjunct professor of corporate finance at the Capital University School of Law, Columbus, Ohio. Member of corporate boards and frequent speaker to business and trade organizations. Author of Employee Stock Ownership and Related Plans (Greenwood Press, 1982), and of articles published in Ohio Business (October, 1988), The Journal of Employee Ownership Law and Finance (Fall, 1998), Taxation for Accountants (July, 1998) and Taxation for Lawyers (September-October, 1998). Co-founder of the Ohio Chapter of The ESOP Association and a member of the legislative committee of The ESOP Association. Recognized in Marquis Who’s Who in the Midwest and in Benton’s Who’s Who. Jochim Co., L.P.A. 673 Mohawk Street, Suite 202 Columbus, OH


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