As an ESOP matures, the company may want to change the form and/or timing of its distribution rules. There are three issues that need to be considered when doing this:
The three most common changes companies want to make are to the timing of distributions, moving from lump-sum distributions to installments, or changing from a distribution in one form (stock or cash) to the other. You usually can do any of these, provided the affected benefits have been in the plan for at least five years and the changes are not applied in a discriminatory way (changing the rules just for higher-paid people, for instance). Because each situation can have its own specific issues, discuss this with qualified experts first.
The case law history on these changes is sparse but supportive of this view. The ESOP company Builders Supply wanted to move from immediate lump-sum distributions to distributions in stock in installments after a five-year delay. In other words, they wanted to make all three of the changes companies typically make. In Lee v. Builder’s Supply Co., Inc. ESOP and Firstier Bank, a court let them do this. Tharaldson Motels moved from stock distributions to cash; employees sued when the stock price rose. The case was ultimately settled. A similar issue came up in Del Rosario v. King & Prince Seafood Corp., with the 11th Circuit ruling in 2011 that this change was allowable. In Pfeifer v. Wawa, Inc. and Cunningham v. Wawa, Inc. plaintiffs sued over a change that issued their distributions in cash and not shares. Those cases both settled before the courts could decide whether this change violated ERISA.
An argument could be made that changes in the timing of distributions should be done only for either unvested shares or for distributions that have not already started (extending a two-year schedule to five, for instance, after the first year of distributions), but nothing in the case law addresses such a change.
Changes to the timing of distributions are usually made because the company thinks it will be better able to handle future repurchase needs this way. That may be true, but slower is not always better. If your stock price is going up faster than your cost of money, and you either have the cash or can borrow it at lower rates, then delaying distributions will just end up costing you more money.
A good repurchase study can help companies make the right choice. Companies should provide whoever is doing the study with careful projections about who might be leaving in the next several years as well as who has the right to diversify and what history suggests about how much will be diversified. The study should model different scenarios for stock price changes, and the company should weight the probability of each outcome to decide on the most prudent course.
Changes to the form of distribution may also be made for financial reasons, but many companies move to policies like account segregation (purchasing shares at termination and reinvesting them but not paying out the benefit until the distribution starts later) as a way to protect former employees from risk, get more shares back in the plan more quickly, and/or retain any stock price growth benefits for those working there.
Just because you can make these changes, and even if the finances suggest you should, does not mean they are a good idea. If changing your distributions adversely affects morale, it could cost you a lot more money than not making changes.
Delaying the repurchase is almost invariably a tough sell. If you have told people they will start getting paid out after two years, but now it will be five and in installments, the perceived value of the ESOP will drop for most people — and it will drop by more than the actual present value of the change. That’s because people tend to overweight risk and time delays, at least compared to an economically rational calculation. Money paid out five years from now that has a present value based on an economic model incorporating risk, interest rates, inflation, etc. of, say, $10,000, will seem to most people more like $5,000. The same thing is true for risk. Delaying repurchase increases the uncertainty of what you will get, and people tend to value risk at about twice what an economic model would conclude.
Moving from stock to cash (or cash to stock) is simpler. If your stock value has been doing well and you change to cash, that might be a very prudent decision for people nearing retirement age. They should usually be more diversified. But many of these people will see this as a downgrade. That is what the King & Prince, Tharaldson, and Wawa suits were about. But what if you switch from cash to stock and the stock price goes down? Now people will be angry about that.
If you have good reasons to make any of these changes, explain them carefully, simply, and often. If the changes are good for the company, then they are also usually good for most employee-owners. Treat people like owners and explain your thinking. You may still have upset employees, but much less so than if the changes come as a surprise.