Beginning in 2007, certain defined contribution plans that include publicly-traded employer stock as an investment (e.g., some 401(k) plans, but not stand-alone ESOPs) must comply with rules generally allowing participants to divest such stock and reinvest in other investment options. IRS Notice 2006-107, issued in December 2006, provided guidance and transitional rules (see our EmployNews article from August 17, 2007, regarding a DOL rule on the related notice requirement and penalties for notice failures, including a link to the Notice – link). The IRS issued proposed regulations last week, which reinforce the guidance from the Notice with some minor modifications and certain extensions. Highlights of the Notice and proposed regulations include the following:

• The diversification rules apply only to plans with direct ownership of publicly-traded employer stock (including stock traded on a foreign exchange); including plans with non-publicly-traded employer stock if any related employers have publicly-traded stock.
• All employee deferrals and rollover contributions must be eligible for divestment out of employer stock.
• Employer contributions (e.g., matching contributions) must be eligible for divestment out of employer stock for participants with three years of service, although a 3-year phase-in rule (e.g., 33% in 2007, 66% in 2008 and 100% in 2009) applies to participants under age 55.
• There must be at least three alternative investment options, which must be diversified and have different risk and return characteristics, and participants must be allowed to divest employer stock and reinvest in these alternatives at least quarterly.
• Plans generally cannot impose restrictions or conditions on employer stock investments that are not imposed on non-employer stock investments; for example, less frequent divestment of employer stock or more favorable treatment (e.g., greater matching) to participants who remain invested in employer stock.
• However, plans can limit the portion of a participant’s account that may be invested in employer stock, close the employer stock fund, impose fees on other investment alternatives, but not on employer stock investments, or divestments of employer stock, and limit the timing and number of investments in employer stock to limit short-term trading.

During 2008, plans may apply the proposed regulations or continue to rely on Notice 2006-107. Final regulations are expected to be effective beginning with the 2009 plan year.