THE NEW SOUTH CHAPTER OF THE ESOP ASSOCIATION FALL CONFERENCE - ATLANTA, GEORGIA OCTOBER 22, 2009

1. THE NEW SOUTH CHAPTER OF THE ESOP ASSOCIATIONFALL CONFERENCE - ATLANTA, GEORGIAOCTOBER 22, 2009 Jay Van Heyde, Esquire Connie S. Woodmansee Attorney at Law Pension Consultant Dean Mead Swerdlin & Company 800 N. Magnolia Avenue 5901 Peachtree Dunwoody Road Suite 1500 Building B, Suite 170 Orlando, Florida 32803 Atlanta, Georgia 30328 407-428-5108 678-775-5548 jvanheyde@deanmead.com cwoodmansee@swerdlin.net

2. ESOP DISTRIBUTIONS AND UNDERTANDING DIVERSIFICATION IMPORTANCE OF DISTRIBUTION AND DIVERSIFICATION PLAN PROVISIONS AND/OR POLICIES Creates the company’s repurchase obligation Negatively impacts the company’s cash flow Requires tax planning Requires management of participant expectations Effects employee morale (“When can I eat the dangling carrot?”)

3. ESOP DISTRIBUTIONS AND UNDERTANDING DIVERSIFICATION KEY CONSIDERATIONS IN SETTING DISTRIBUTION AND DIVERSIFICATION PROVISIONS AND/OR POLICIES Impact on repurchase obligation and cash flow Lender and bonding company covenants Leverage vs. non-leveraged ESOP C corporation vs. S corporation HR considerations Impact on current vs. former employees

4. ESOP DISTRIBUTIONS AND UNDERTANDING DIVERSIFICATION BASIC DISTRIBUTION RULES Code §409(o) mandates outer limits for commencement of distributions of post 1986 stock Death, disability and normal retirement - one (1) year rule Must commence not later than 1 year after close of year of death, disability or normal retirement Other separation from service - six (6) year rule Must commence not later than 1 year after close of year which is the 5th year following the year of separation from service

5. ESOP DISTRIBUTIONS AND UNDERTANDING DIVERSIFICATION Financed securities delay rule No distributions of financed securities required until exempt loan paid in full C corporation vs. S corporation application of rule Delay available for “employer securities acquired with the proceeds of a loan described in Section 404(a)(9)” Section 404(a)(9)(a) describes almost all ESOP loans, but §404(a)(9)(c) excludes S corporations from §404(a)(9) tax deduction provisions Does the delay apply to S corporations?

6. ESOP DISTRIBUTIONS AND UNDERTANDING DIVERSIFICATION Required minimum distributions Code §401(a)(9) creates “required beginning date” Later of age 70-1/2 or retirement Retirement rule does not apply to 5-percent owners Limited distribution period Code §409(o)(1)(C) creates maximum distribution periods Requires at least substantially equal annual payments (not less frequently than annually) Generally, maximum five (5) year installment period Can be up to ten (10) years for large accounts

7. ESOP DISTRIBUTIONS AND UNDERTANDING DIVERSIFICATION Normal consent rules apply Consent required if distribution before later of age 62 or normal retirement age, if vested value exceeds $5,000 If over $1,000, automatic rollover or reduced cash out rules apply Form of ESOP distributions Cash Normal for S corporation ESOPs Stock Code §409(h) provides a right to demand employer securities Exceptions to demand feature include companies with charter or bylaw restrictions, S corporations and banks that may not redeem or purchase their own stock Code §409(h) also provides a put option if securities not readily tradeable are distributed

8. ESOP DISTRIBUTIONS AND UNDERTANDING DIVERSIFICATION BASIC DIVERSIFICATION RULES Code §401(a)(28) general rule - - private stock “Qualified Participants” (a “QP”) have right to diversify a portion of employer stock QP requirements - attained age 55 and has 10 years of participation The diversification right exists during the “Qualified Election Period” (the “QEP”) The QEP is the 6 year period beginning with the plan year person becomes a QP

9. ESOP DISTRIBUTIONS AND UNDERTANDING DIVERSIFICATION Code §401(a)(28) general rule - - private stock (continued) QP may require diversification of up to 25% of account Up to 50% in the last year of the QEP Election to be made during 90 days after each year in QEP Employer response to diversification Distribution within 90 days after end of election period Transfer to IRA or another plan Offer at least 3 investment options in ESOP/KSOP

10. ESOP DISTRIBUTIONS AND UNDERTANDING DIVERSIFICATION The finer points of diversification Application of 25% rule Assume QP has 100 shares and in year one diversifies 20%, leaving 80 shares In year two, QP is allocated 20 new shares, and then has 100 shares Maximum year two diversification is 10 shares ? 120 total shares allocated to account ? 30 shares (120 x 25%) is maximum diversification ? 20 shares diversified for year one ? 10 shares left to diversify

11. ESOP DISTRIBUTIONS AND UNDERTANDING DIVERSIFICATION Diversification problems How does participant decide within 90 days if no valuation? How is process completed within 180 days - - valuation problem? What if the ESOP has extra pre-age 55/10 diversification?

12. ESOP DISTRIBUTIONS AND UNDERTANDING DIVERSIFICATION CODE SECTION 411(d)(6) - THE FLEXIBILITY ROADBLOCK The general rule Participant’s accrued benefit cannot be decreased by amendment Includes elimination of optional forms of benefit Optional form of benefit - what is covered? Includes timing, form and method of distribution Does not include investment options, right to direct investments, right to defer, and similar rights

13. ESOP DISTRIBUTIONS AND UNDERTANDING DIVERSIFICATION The ESOP exception Code §411(d)(6)(C) provides ESOP relief Allows ESOP modifications of “distribution options in a nondiscriminatory manner” Regulatory interpretation A particular payment schedule (lump sum or installments) may be eliminated if the stock is not publicly traded Distributions in the form of stock may be eliminated if the employer becomes substantially employee owned, or if the company becomes an S corporation Cash distributions may be eliminated if the employer stock becomes readily tradable Silent with respect to timing of distribution changes

14. ESOP DISTRIBUTIONS AND UNDERTANDING DIVERSIFICATION Case law Lee v. Builder’s Supply Co., Inc. Employee Stock Ownership Plan, 1995 WL 795222 (D. Neb., March 23, 1995) Prior policy - lump sum cash payment with 60 days of termination New policy - deferred payment and altered the form The change complied with the ESOP exception to the anti-cutback rule

15. ESOP DISTRIBUTIONS AND UNDERTANDING DIVERSIFICATION CONSIDERATIONS PRIOR TO MODIFICATION OF DISTRIBUTION OR DIVERSIFICATION PROVISIONS OR POLICIES Update repurchase liability study Prepare short and long term cash flow analysis S corporations - analyze 409(p) testing impact Review HR considerations

16. ESOP DISTRIBUTIONS AND UNDERTANDING DIVERSIFICATION EXAMPLE OF CHANGE TO DISTRIBUTION POLICY Company background ESOP established in 1997 Over 600 employees Converted to 100% S corporation structure - 2008 New plan effective January 1, 2008

17. ESOP DISTRIBUTIONS AND UNDERTANDING DIVERSIFICATION Pre-2008 distribution rules Committee decides on delay and spread of distributions Delay up to sixth (6th) year after termination (depending on type of term) Spread up to five (5) years of installments Pre-2009 practice Distribution in year after termination Full payout in year one (1)

18. ESOP DISTRIBUTIONS AND UNDERTANDING DIVERSIFICATION Impact of pre-2009 practice Employees have an incentive to leave if fully vested High cash flow impact in some years New plan distribution practice Payout begins in year following termination Payout years depends on account balance: > 1 year for accounts < $25,000 > 2 years for accounts between $25,001 and $50,000 > 3 years for accounts between $50,001 and $75,000 > 4 years for accounts between $75,001 and $100,000 > 5 years for accounts > $100,000

19. ESOP DISTRIBUTIONS AND UNDERTANDING DIVERSIFICATION Impact of new rule Lower cash flow impact, especially 2009 to 2011 More consistent cash flow Easier to predict cash flow since payments spread Former employees need to leave a solid, long-term foundation

20. ESOP DISTRIBUTIONS AND UNDERTANDING DIVERSIFICATION ANOTHER CORPORATION’S MODIFICATION - DOES IT WORK? Plan document terms Carefully follow Code §409(o) Separation from service - six (6) year delay Five (5) or more installments Permits a “distribution policy” acceleration

21. ESOP DISTRIBUTIONS AND UNDERTANDING DIVERSIFICATION The distribution policy prior to the downturn Commence distributions in year after termination Five (5) year installments But, $300,000 minimum installment (resulting in some fast payouts) Reason for accelerated policy - stock was rising rapidly - get rid of “former employees” Numerous participants consented to installment distributions Numerous participants received one (1) to three (3) installments, with stock still in the ESOP

22. ESOP DISTRIBUTIONS AND UNDERTANDING DIVERSIFICATION Then the downturn hit - new policy Six (6) year delay rule re-applied Applied the rule to former participants in pay status -- i.e., former participants had installments remaining Example of policy, if former participant already got installment #1 in year 1, then installment #2 will be made in year 7 Company claims Code §411(d)(6)(C) ESOP exception applies to cut-back to this installment delay situation

23. ESOP DISTRIBUTIONS AND UNDERTANDING DIVERSIFICATION Then the downturn hit - new policy (continued) Never addressed that the former participants in pay status had to consent to the distribution (Code §411(a)(11)) Was that consent essentially a contract? Seems like it The document and Code §409(o)(1)(C) required “substantially equal periodic payments (not less frequently than annually)” Would the resulting payment pattern meet the requirement? Arguably no

24. ESOP DISTRIBUTIONS AND UNDERTANDING DIVERSIFICATION Jay Van Heyde, Esquire Connie S. Woodmansee Attorney at Law Pension Consultant Dean Mead Swerdlin & Company 800 N. Magnolia Avenue 5901 Peachtree Dunwoody Road Suite 1500 Building B, Suite 170 Orlando, Florida 32803 Atlanta, Georgia 30328 407-428-5108 678-775-5548 jvanheyde@deanmead.com cwoodmansee@swerdlin.net