Introduction and background
Retirement plan fiduciaries, whose plans contain employer stock funds, may be faced with the challenges of managing a non-employer stock fund within their plans after a corporate reorganization. Typically this situation occurs when a company separates a portion of its business to form a second, newly independent, publicly traded company. If the company that initiates the transaction sponsors an existing company stock fund in its benefit plan, the plan will, post-transaction, have a second, non-company stock fund because of the reorganization. (The "spun" company will find itself in the same situation; it will also have a non-company stock fund — that of the company from which it was spun).
The Employee Retirement Income Security Act (ERISA) requires diversification of plan assets, with the notable exception of employer stock funds, defined under ERISA Section 407 as "qualifying employer securities" (see 29 CFR § 2550.407d-5). Any single stock fund — whether employer or non-employer — would generally represent the riskiest option in any plan. Non-employer stock funds clearly present an additional legal risk to retirement plan fiduciaries, since they aren't protected under ERISA, as they fail to qualify as qualifying employer securities. In situations such as the one described above, a plan fiduciary should deliberately and carefully take steps to evaluate the prudence of maintaining the non-employer stock fund within the plan.
This article provides a roadmap for plan fiduciaries who inadvertently find themselves in this dilemma and decide to liquidate the non-employer stock fund.
Common steps to liquidate non-employer stock funds
- Freeze the non-employer stock fund once it's created. As a plan fiduciary, it's important to freeze the non-employer stock fund so that, upon creation of the non-employer stock fund, participants are prohibited from adding assets to the non-employer stock fund. In advance of the upcoming reorganization, plan fiduciaries should communicate to plan participants that, upon the transaction date, additions to the non-employer stock fund won't be permitted.
- Design a liquidation strategy. It's imperative that the liquidation of the non-employer stock fund be conducted prudently. First, common law requires that the non-employer stock fund, once created, be managed no differently from any other investment option under the plan while it exists within the plan. Second, plan fiduciaries should set a target date (the "sunset date") for liquidation. The sunset date is when the non-employer stock fund will cease to exist. In many cases, the sale of shares held in the non-employer stock fund takes weeks to accomplish. For this reason, when setting the sunset date, a plan fiduciary should take into consideration insider trading restrictions (blackouts) for certain plan participants, earnings release dates, typical trading volumes of the non-employer stock and the overall equity market. Once the sunset date is established, the plan should be amended to memorialize the sunset date of the non-employer stock fund.
- Communicate to plan participants. Plan fiduciaries should circulate a well-crafted communication to plan participants explaining the sunset date and the final sales period leading up to that sunset date. Plan fiduciaries should work with the plan record-keeper to determine whether a blackout is necessary; to determine when to freeze in-kind distributions, if applicable; and to determine how the proceeds from the sales of the non-employer stock will be reinvested during the final sales period. Periodic reminders should also be circulated to plan participants, reminding them of the sunset date and the actions they may take with their investment in the non-employer stock fund. Communications should be as detailed as possible while preserving the fiduciary's flexibility to manage the liquidation in the best interest of plan participants.
- Events leading up to the final sales period. The events leading up to the final sales period include selecting a broker or transition manager, or using the record-keeper to conduct the trades if they have a trading desk; negotiating a reasonable fee for the trades; determining who will bear the cost of the trades; establishing the authority to direct trades with the plan trustee, broker, transition manager and/or record-keeper (including any preparing any necessary trust document amendments and providing authorized signatures to the record-keeper or broker); and conducting trade analysis and preparing the template trading instructions.
- The final sales period. Keeping in pace with the established strategy, the plan fiduciary should direct sales of the non-employer stock to the broker, transition manager or record-keeper. Daily records should be maintained on the number of shares traded each day. In Gallagher's experience, record-keepers aren't equipped to reinvest the proceeds from company stock share sales daily, so for multi-week company stock fund liquidations, the fund will actually contain more cash than stock near the end of its life. A good liquidation strategy therefore balances the market impact of company stock sales with the expected foregone gains from delaying reinvestment into an alternative option. Gallagher typically recommends reinvestment of proceeds from a liquidated company stock fund into the plan's qualified default investment alternative (QDIA). Gallagher also considers brokerage commissions on liquidations — in our experience, they're often outdated and high, and can be negotiated downwards.
- Conversion. Noting that trading shares typically takes two business days to settle, the last trade date should be two business days before the sunset date. Once the final trades settle, the cash proceeds held in the non-employer stock fund (or the investments made with cash proceeds in the low-risk investment alternative) should then be converted by the broker, transition manager or record-keeper to the chosen investment medium (usually the plan's QDIA).
- Final statistics. Once the conversion has been made, statistics of the final sales proceeds should be prepared and saved in the plan administration files.
What can an independent fiduciary do?
An independent fiduciary (IF) such as Gallagher can be engaged at the onset to perform all of these steps on behalf of the plan fiduciaries. Independent fiduciaries serve as special-purpose fiduciaries, engaged by the plan fiduciaries to serve as their surrogate when a conflict of interest arises that requires that an experienced and knowledgeable third party decision-maker step in and make a decision on behalf of the plan, when the law requires the use of an independent fiduciary decision-maker, or to mitigate risk.
Also, after the spinoff, there may be significant out/underperformance of the non-employer stock. Having a general liquidation timeline in place before the spinoff occurs may help to mitigate fiduciary risk. Hiring an experienced IF such as Gallagher to manage the process from start to finish is also another way to mitigate fiduciary risk.
If you would like more information on our IF decision-making services with respect to non-employer stock funds, or any other of our services, please call Area Senior Vice President and Area Counsel Darin Hoffner directly at (212) 918-9662.