Compliance May 18, 2010

IRS Issues Final Regs on Diversification Requirements for Company Stock

The Internal Revenue Service is issuing final regulations under section 401(a)(35) of the Internal Revenue Code (Code) relating to diversification requirements for certain defined contribution plans holding publicly traded employer securities.
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Section 401(a)(35) of the Code was added by section 901 of the Pension Protection Act of 2006 and generally provides that an applicable defined contribution plan allow each individual who is a participant who has completed at least three years of service, a beneficiary of a participant who has completed at least three years of service, or a beneficiary of a deceased participant to elect to direct the plan to divest employer securities allocated to the individual’s account and to reinvest an equivalent amount in other investment options. The regulations say the plan must offer individuals not less than three investment options, other than employer securities, to which the individuals may direct the proceeds from the divestment of employer securities, each of which is diversified and has materially different risk and return characteristics.  

The IRS said a plan does not fail to meet the requirements if it allows individuals to divest employer securities and reinvest the proceeds at periodic, reasonable opportunities occurring no less frequently than quarterly. A plan is not permitted to impose restrictions or conditions with respect to the investment of employer securities that are not imposed on the investment of other assets of the plan, other than restrictions or conditions imposed to comply with securities laws. 

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The agency made changes to the proposed regulations in response to comments and also clarified provisions of the regulations. For example, the final regulations provide that, in the case of a multiemployer plan, an investment option will not be treated as holding employer securities to the extent the employer securities are held indirectly through an investment fund managed by an investment manager if the investment is independent of the employer and the percentage limitation rule is satisfied. 

The proposed regulations provided that certain investment funds that include employer securities held indirectly through an investment company registered under the Investment Company Act were treated as not holding employer securities. The final regulations replace the reference to a fund that is an investment company registered under the Investment Company Act of 1940 with a regulated investment company as described in Code section 851(a).  

The IRS said this change extends the types of investment companies to include exchange traded funds, which are unit investment trusts if they satisfy section 851(a). The final regulations also retain the rule from the proposed regulations that allows the Commissioner to designate additional types of funds as eligible for this exception. 

The final regulations also provide that the determination of whether the value of employer securities exceeds 10% of the total value of the fund’s investments – for exception from the diversification rule – is made for the plan year as of the end of the preceding plan year, and can be based on the information in the latest disclosure of the fund’s portfolio holdings (for example, Form N-CSR, “Certified Shareholder Report of Registered Management Investment Companies”) that was filed with the Securities and Exchange Commission in that preceding plan year. 

The final regulations provide that the prohibition on restrictions or conditions with respect to the investment of employer securities applies to any direct or indirect restriction on an individual’s right to divest an investment in employer securities that is not imposed on an investment that is not employer securities, as well as a direct or indirect benefit that is conditioned on investment in employer securities. It also provides clarification with respect to the exception for frozen funds. 

Finally, the final regulations provide that a plan is generally permitted to allow transfers to be made into or out of a stable value fund more frequently than a fund invested in employer securities and expand the list of permitted indirect restrictions to provide that a plan may provide for transfers out of a QDIA more frequently than a fund invested in employer securities. 

The IRS said the regulations will affect administrators of, employers maintaining, participants in, and beneficiaries of defined contribution plans that are invested in employer securities, and will be effective May 19, when the regulations are published in the Federal Register. The regulations apply for plan years beginning on or after January 1, 2011. 

The final regulations are available here.  

The Markets May 18, 2010

Investors Turn to U.S. Equities in Face of Eurozone Concerns

Investors have sought refuge in U.S. markets in the week that eurozone states delivered a financial package to allay sovereign debt concerns, according to the BofA Merrill Lynch Survey of Fund Managers for May.
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The survey shows how global investors are buying U.S. equities and retaining confidence in the U.S. dollar, while the survey’s risk indicator experienced its largest one-month fall since 2003. Average cash balances rose to 4.3% of portfolios from 3.5% in April, and the proportion of investors overweight in global equities slipped sharply to a net 30% from a net 52% in April, according to a release of the results.  

The number of respondents overweight in U.S. equities ticked upwards in April. A net 66% of the panel expects the dollar to appreciate the most of the reserve currencies. The gulf in confidence between U.S. and European corporate profit has reached a seven-year high, BofA Merrill Lynch said.  

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A net 33% of respondents believe that the outlook for corporate profits is most favorable in the U.S. while a net 41% say that the outlook is least favorable in the eurozone. That spread of 74 percentage points is the widest since July 2003. The number of U.S.-based investors expecting double-digit earnings growth has risen to a net 54% from 50% in April. 

“May’s survey highlights a flight to the U.S., driven by the uncertainty in Europe and underscores a positive U.S. growth outlook,” said Michael Hartnett, chief Global Equities strategist at BofA Merrill Lynch Global Research, in the release.

Investors Lose Confidence in Eurozone and Emerging Markets 

Concerns in both the eurozone and emerging markets have shaken investors' confidence in global equities and growth prospects for the global economy, according to the BofA Merrill Lynch Survey of Fund Managers for May. The number of investors who believe the global economy will strengthen in the next 12 months fell to a net 42% from a net 61% in April.  

Confidence in earnings also slipped. A net 47% of respondents say that profits will improve in the next year, down from a net 67% in April.  

The survey points to deepening negative sentiment towards Europe, according to a press release. A net 46% of the panel expects the euro to depreciate, up significantly from a net 23% in April. A net 30% of investors say that the eurozone is the region they would most like to underweight, the lowest reading recorded in the survey. The figure in April was just a net 13%.  

The regional survey echoes this pessimism with European investors reducing their expectations of improved growth to the lowest in a year. A net 23% expect Europe's economy to strengthen in the year ahead, down from a net 62% in April.  

Japanese fund managers are more bullish about their macro prospects than their counterparts in all other regions with a net 71% expecting the economy to strengthen in the coming year. 

Positive sentiment towards emerging market equities has dipped to its lowest since early 2009. The number of respondents overweight in global emerging markets (GEM) equities stands at a net 19% this month, down from a net 31% in April. The proportion of the panel saying that emerging markets have the most favorable outlook for corporate profits is a net 23%, compared with a net 34% a month ago. 

GEM fund managers have turned more bearish on China than any month since February 2009. The regional survey shows that a net 29% of GEM investors expect the Chinese economy to weaken in the next 12 months compared with a net 5% predicting a stronger economy in April.

Ninety percent of European investors say that the European Central Bank (ECB) will not raise rates in 2010, up from 62% a month ago. 

One in four respondents to the global survey expect no rate rise by the U.S. Federal Reserve before April 2011, compared with one in 10 respondents a month ago. Only 39% of the panel expects a rate increase in 2010, compared with 56% in April. These readings mirror a fall in the number of investors forecasting higher global core inflation a year from now, down to a net 35% from a net 46% in April. 

A total of 202 fund managers, managing a total of US$530 billion, participated in the global survey from May 7 to May 13. A total of 170 managers, managing US$341 billion, participated in the regional surveys. The survey was conducted by BofA Merrill Lynch Research with the help of market research company TNS.

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