Not All Plan Failures are Created Equal: Inventing the Code §409A Correction Program

2008 Winner of the Paul Faherty Tax Law Writing Competition

INTRODUCTION

In March of 2008, Bear Stearns proved once again that no corporation is impervious to a financial collapse. Bear Stearns suffered an old-fashioned bank run when liquidity issues rendered it unable to meet creditor demands. This situation forced Bear Stearns to arrange a deal with JPMorgan Chase and the Federal Reserve Bank for financing. On the day this arrangement was announced, Bear Stearns’ stock plummeted 47 percent, closing at $30 per share. A few days later, Bear Stearns was sold to JPMorgan Chase for $2 per share. In less than 100 hours, Bear Stearns stock fell from $67 per share to $2 per share. For a company 30 percent employee-owned, the executives took action to salvage some value for their employees.

The Bear Stearns collapse can properly be characterized as an “Enron situation.” Bear Stearns was like Enron because the executives knew of the Company’s impending demise but failed to alarm the public or its shareholders. But Bear Stearns was different from Enron in an important way. Bear Stearns’ executives could not accelerate distributions from their non-qualified deferred compensation plans before its collapse without harsh penalties.

A few years before Bear Stearns collapsed, the fraudulent conduct of Enron executives brought to light how executives abused the Internal Revenue Code’s (the “Code”) deferred compensation principles. Enron executives accelerated distributions from their non-qualified deferred compensation plans, while the rank and file employees lost their retirement funds,which were invested in Enron when it went bankrupt.14 In contrast, Bear Stearns’ President and Chief Executive Officer Alan Schwartz reportedly lost $115.7 million dollars in the value of his holdings in company stock.

In the wake of Enron and before Bear Stearns’ collapse, Congress added Code §409A as part of the American Jobs Creation Act of 200416 in an effort to correct the system. The new requirements under Code §409A have created compliance issues for executives and their corporations. All non-qualified deferred compensation plans must comply with the requirements under Code §409A(a) in form and in operation. The esoteric nature of Code §409A(a) and its regulations make administration difficult. Consequently, the U.S. Department of the Treasury (the “Treasury Department”) and the Internal Revenue Service (the “Service”) have decided to create a program for correcting certain non-qualified deferred compensation plan failures.

Instituting a correction program for employee benefit plan failures is not a new concept.For several years, the Service has administered the Employee Plans Compliance Resolution System (“EPCRS”) to allow a plan qualified under Code §401(a) to correct certain failures that would otherwise cause the plan to be disqualified. While the current EPCRS program has undergone several reconstructions, the current Code §409A(a) correction program is in its infant stage. On December 20, 2007, the Treasury Department and the Service released Notice 2007-100 outlining a limited self-correction program.

This article reviews the current Code §409A(a) correction program and analyzes several issues related to creating the program, including whether the Treasury Department and the Service have legal authority to create it. The first section of this article discusses the history of Code §409A(a) and its requirements.

The second section reviews Notice 2007-100 and provides an analysis of several issues related to the Notice. The third section reviews a few authoritative and administrative issues related to the development of the Code §409A(a) correction program. The fourth section suggests measures that should accompany the creation of an effective correction program under Code §409A(a). The fifth and final section provides concluding thoughts on the issues discussed in this article.

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