Court, IRS Say ESOP Account Segregation and Rebalancing Acceptable

There has been some debate in the ESOP community about whether companies can segregate employee accounts into cash at termination (but before distribution) or can rebalance employee accounts at the end of the plan year by moving cash and stock in the accounts around so that all participants have the same percentage of stock and cash. A recent court case and IRS ruling provide support for the notion that both can be done, subject to some reasonable limitations.

In Hoffman v. Tharaldson Motels Inc. Employee Stock Ownership Plan, No. 3:08-cv-109 (D.N.D., Feb. 26, 2010), a U.S. district court ruled that an amendment to the company's ESOP to convert terminated participant accounts into cash was permitted under ERISA. The court reviewed the policy in light of ERISA's "anti-cutback rules." The court noted that, in general, ERISA does protect participant rights to optional forms of benefit. But it also noted that the IRS has created a safe harbor that provides that certain items, such as investments in employer stock, are not protected benefits.

On February 23, 2010, the IRS issued a Response to Technical Assistance Request (#4) on rebalancing and reshuffling. By rebalancing, it meant adjusting account balances so everyone has the same percentage of stock and cash; by reshuffling it referred to converting terminated participant accounts to cash and reallocating the shares to active employee participant accounts. The IRS concluded that if the policies are practiced in a nondiscriminatory manner, they would be acceptable. One important caveat is that if shares have been diversified under the diversification rules, they cannot be subsequently reconverted to shares pursuant to rebalancing.