The IRS recently issued final regulations on the diversification requirements generally applicable to defined contribution plans that hold publicly traded employer securities. Those diversification requirements generally provide that participants and beneficiaries in defined contribution plans must have the right to divest amounts invested in employer securities and to reinvest an equivalent amount in other investment options. The final regulations are largely similar to proposed regulations published in January 2008. However, the final regulations:
- No longer treat a multiemployer plan as holding employer securities if they are held indirectly through an investment fund managed by an independent investment manager and do not exceed 10 percent of the fund;
- Provide that the determination of whether the value of employer securities exceeds 10 percent of the total value of the fund’s investments is made for the plan year as of the end of the preceding plan year; and
- Provide that when a fund that indirectly holds employer securities fails to meet the requirement that the investment be independent of the employer (including a situation when the fund no longer meets the percentage limitation rule), the plan does not fail to satisfy the diversification requirements merely because it does not offer those rights for up to 90 days after the investment fund is treated as holding employer securities.
Under the diversification rules, a plan may not restrict a participant’s right to invest in or to divest employer securities any more than it restricts any other plan investment options. However, the final regulations modify some of the permitted restrictions and provide that:
- A plan may have more frequent transfers to and from stable value funds and qualified default investment alternatives than a fund invested in employer securities.
- A plan may not allow reinvestment of divested amounts in the same employer securities account, but may allow investment of those amounts in another employer securities account if the only difference between the two accounts is the Code §402(e)(4) cost or other basis.
- Under a transitional rule, certain leveraged ESOPs may allocate matching contributions to an otherwise frozen employer stock fund.
The final regulations are effective for plan years beginning on or after January 1, 2011. A plan may rely on Notice 2006-107, the proposed regulations, or the final regulations to satisfy the diversification requirements until the final regulations are effective.