The IRS issued a February 23, 2010 Response to Technical Assistance Request #4 with regard to ESOP rebalancing and ESOP reshuffling provisions. The memo was issued three days prior to the Hoffman v. Tharaldson Motels Inc. Employee Stock Ownership Plan, D.N.D., No. 3:08-cv-109, 2/26/10 ruling and defines rebalancing and reshuffling:

• Rebalancing – "the mandatory transfer of employer securities into and out of participant ESOP accounts, usually on an annual basis, designed to result in all participant accounts having the same proportion of employer securities."
  
• The memo notes that a plan provision that allows participants to opt out is "not a rebalancing provision, but is rather a provision providing for participant-directed investment elections."
  
  
• Reshuffling – "the mandatory transfer of employer securities into or out of ESOP accounts, not designed to result in an equal proportion of employer securities in each account."
  
• Other terms for reshuffling are segregations of accounts or cash conversion of accounts.
  
• Historically we have seen reshuffling and rebalancing used interchangeably. However, since the IRS has clearly differentiated between the two, we will make it a point to use these definitions going forward.

In December we provided a brief description of the differences:

Rebalancing

• When a plan rebalances, shares are "reshuffled" as needed so each participant will has the same proportion of cash and stock at the end of the plan year. The reshuffling is processed with an internal repurchase of shares (a.k.a recycling).
  
• This approach provides a method to get shares to newer employees and help manage the "haves vs. have nots" scenario that occurs in many mature ESOPs.
  
• This IRS has stated that this approach cannot be used to solve IRC Section 409(p) Anti-Abuse Testing issues.

Reshuffling

• Also known as segregation of accounts or cash conversion of accounts.
  
• Reshuffling occurs when the company buys all or some of the shares of the accounts of participants that have separated service from the company. The cash is invested in other prudent investments until distribution.
  
• Reshuffling prevents former employees from sharing in future gains.
  
• Reshuffling protects former employees from sharing in future losses in the value of the company and provides them with additional diversification.
  
• This strategy is used by many ESOP companies to manage their repurchase obligation, enabling them to purchase the shares of terminated participants at the current fair market value. This approach essentially speeds up the repurchase obligation to the time of segregation. Assuming an increasing stock value, this strategy accelerates your repurchase obligation in the short-term and reduces it in the long-term.
  
• Reshuffling can also free up more shares for allocation.
  
• The 2006 Final IRC Section 409(p) Regulations indicate that "Targeted reshuffling", or only reshuffling when needed to satisfy the IRC Section 409(p) Anti-Abuse Testing requirements, would most likely be discriminatory because it would usually provide HCEs with an investment opportunity that NHCEs do not have. Targeted reshuffling was not specifically mentioned in the memo. [Another term included in similar discussions, mandatory diversification or forcing certain or all participants to diversify when they are eligible, was also not addressed in the memo.]

Check back for more analysis of the February 23, 2010 memo.