What is Publicly Traded Stock?

[author: Angela Bohmann]

The Pension Protection Act of 2006 added Section 401(a)(35) to the Internal Revenue Code generally effective for plan years beginning after December 31, 2006. That section provides in general that defined contribution retirement plans that hold employer securities that are publicly traded must give plan participants the right to diversify their amounts out of the employer securities. There are exceptions to that rule for stand alone employee stock ownership plans and one participant plans. This Code section applies to the plan of an employer whose own shares are ”publicly traded”. It also applies to a plan if any member of the employer’s controlled group of corporations has issued a class of stock which is publicly traded.

In a recent private letter ruling, the IRS considered the situation of a company that had a class of preferred stock traded on the over-the-counter bulletin board. The IRS ruled that this stock was not publicly traded because the regulations under Section 401(a)(35) require that the employer security be traded on an exchange registered under Section 6(a) of the Securities Exchange Act of 1934 or under certain foreign exchanges. Under that Act, the New York Stock Exchange and NASDAQ, among others, are registered. However, the over-the-counter bulletin board and the so called “pink sheets” trading systems are not listed exchanges. Therefore, although shares of the employer were traded on the over-the-counter bulletin board, the shares were not treated as “publicly traded” and the plan was not required to meet the diversification requirements of Section 401(a)(35).

Private letter rulings cannot be relied upon by other employers. In addition, employers must be careful about relying on interpretations of a phrase under one tax code section when figuring out what another code section means.  For example, the regulations under Section 409A of the tax code, under which key employees of publicly traded companies must defer payment of deferred compensation for at least six months after separation from service, use a different definition of publicly traded securities that includes over the counter markets.  Nevertheless, this ruling gives an indication of the IRS’s thinking with respect to the definition of publicly traded securities for purposes of the diversification requirement. Employers whose only publicly traded stock is traded on the over-the-counter market or the pink sheets and whose stock is also held in the employer’s qualified defined contribution plan may be able to avoid the diversification requirement.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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