In a staff requirements memorandum of June 18, 2004, the Commission directed the Office of the General Counsel (OGC) to expedite rulemaking to develop, in consultation with the NRC staff, amendments to modify 10 CFR part 73 regarding protection of Safeguards Information. The SRM further directed that the amendments are to utilize the flexibility of section 147 of the Atomic Energy Act and are to be consistent with the practices of the Commission in various Orders and Advisories issued since September 11, 2001. The proposed amendments would affect licensees, information, and materials not currently specified in the regulations, but are within the scope of the AEA. The proposed amendments are intended to protect SGI from inadvertent release and unauthorized disclosure which might compromise the security of nuclear facilities and materials.

The NRC is making a preliminary version of the draft proposed rule language available to inform stakeholders of the current status of this 10 CFR part 73 proposed rulemaking. This draft rule language may be subject to significant revisions during the rulemaking process. To meet the Commission's schedule, the NRC is not soliciting early public comments on this draft rule language. No stakeholder requests for a comment period will be granted at this stage in the rulemaking process. Stakeholders will have an opportunity to comment on the rule language when it is published as a proposed rule.

The NRC's draft proposed rule, including early draft rule language, will be posted on the NRC's rulemaking Web site at http://ruleforum.llnl.gov. The NRC may post updates to the draft proposed rule language on the rulemaking Web site.

I. Objectives

The objectives of this proposed rule are to:

1. Ensure Farm Credit banks have adequate liquidity in the case of market disruption or other extraordinary situations;

2. Improve the flexibility of Farm Credit banks to meet liquidity reserve requirements;

3. Strengthen the safety and soundness of Farm Credit banks; and,

4. Enhance the ability of the System to supply credit to agriculture and rural America in all economic conditions.

The System is a nationwide network of borrower-owned lending cooperatives. Congress created the System as a Government-sponsored enterprise (GSE) to provide a permanent, reliable source of credit and related services to American agriculture and aquatic producers. The System meets this broad public need by financing agriculture and related businesses in rural areas. The System obtains funds to provide this financing through the issuance of Systemwide debt securities. 1 Section 1.5(15) of the Farm Credit Act of 1971, as amended, (the Act) permits Farm Credit banks to make investments as authorized by FCA. 2 We issue regulations under section 5.17(a)(9) of the Act to ensure the safe and sound operations of the System.

Our regulatory responsibilities include issuing regulations to ensure the System has adequate liquidity during market disruptions or other extraordinary situations so that it can meet the ongoing financing needs of agriculture and rural America. Under this authority, we issued § 615.5134 requiring Farm Credit banks to maintain a liquidity reserve sufficient to fund operations for approximately 15 days. We also issued § 615.5132 restricting the investment authority of Farm Credit banks to 30 percent of total outstanding loans. The liquidity reserve provision was established to protect the System against potential market disruptions, while the regulatory investment limit prevents Farm Credit banks from using their GSE status to borrow favorably from the capital markets and accumulate large investment portfolios for arbitrage activities.

The liquidity of Farm Credit banks depends largely upon access to the debt markets. Consistent market access is essential to the System's mission of providing financing to agriculture and rural America in both good and bad times. In the event that access to the debt market becomes impeded, Farm Credit banks must have sufficient liquidity to pay for maturing obligations. The importance of sufficient liquidity has become more evident in recent years. Since we established the current minimum liquidity requirement, investors, credit rating agencies, and market participants have become increasingly concerned with liquidity risk in financial institutions, including GSEs. 3 A Basel Committee report also recommends assessing market access under both normal and adverse circumstances. 4 Adverse circumstances directly affecting Farm Credit banks would include systemic events that essentially shut down the financial system, unfavorable events within the agricultural sector, or deterioration in the financial performance of an individual Farm Credit bank that triggers a condition of the Market Access Agreement. 5

The events of September 11, 2001 led to a significant market disruption causing the normal coordination of payments and funding in the markets to break down. The massive damage to property and communications systems resulted in financial institutions collectively growing short of liquidity. The Federal Reserve supplied significant short-term liquidity to market participants, ensuring that the financial systems in the United States continued to function. As a result, the Farm Credit banks and other GSEs continued to raise funds by issuing short-term debt securities.

The events of September 11, 2001, as well as geopolitical instability, corporate scandals, problems of the telecommunications industry, and widespread credit deterioration contributed to a reduction in investors' risk tolerance. Investors were concerned that corporations were overly dependent on short-term debt. Credit rating agencies downgraded several non-financial commercial paper issues, effectively shutting many corporations out of the short-term debt market. By September 2002, the commercial paper market had shrunk by more than 50 percent. Investors also questioned liquidity risk associated with the GSEs' heavy reliance on short-term debt. Most GSEs, including the System, responded by increasing longer term debt issuances and decreasing short-term debt outstanding.

In response to market events, Farm Credit banks also entered a voluntary Common Minimum Liquidity Standard (CMLS) agreement to maintain more than the existing regulatory liquidity reserve requirement. 6 The banks agreed in the CMLS to maintain at least 90 days of liquidity. The two largest housing GSEs had previously implemented similar voluntary liquidity commitments. 7

While the Farm Credit banks operated during the events of 2001 without accessing their liquidity reserve, we support the current industry trend of building a higher liquidity reserve to reduce potential risks from market disruptions of greater duration or magnitude. We also believe that ongoing investor concerns about the safe and sound operations of financial institutions in times of crisis must be addressed, in part, through regulatory action. If access to the debt markets is hindered or investor confidence in Systemwide debt securities erodes for any reason, the System must have adequate liquidity to sustain operations and fulfill its Congressional mandate.

For these reasons, we propose to increase the regulatory liquidity reserve requirement to 90 days. We note that the proposed change is a minimum reserve level. Farm Credit banks may need to set a higher target liquidity reserve minimum as part of their investment management policies, recognizing that in adverse situations a significantly higher liquidity reserve may be needed to protect against prolonged market disruptions.

Additionally, we propose to apply discounts on assets used to fund the liquidity reserve. Farm Credit banks may only use cash and eligible investments to fund the liquidity reserve. The discounts approximate the cost of liquidating an investment portfolio over a short period of time in adverse situations. Investments used to fund the liquidity reserve must be readily marketable. We define readily marketable assets to be investments that can be quickly converted into cash at a reasonable cost and in a timely manner.

We are also proposing two other amendments to our regulations: (1) Changing the eligible investment limit from 30 percent of total outstanding loans to 35 percent of total outstanding loans; and (2) requiring Farm Credit banks to establish and maintain a contingency plan. Under current § 615.5132, each Farm Credit bank may only hold investments equaling no more than 30 percent of the bank's total outstanding loans. This limit, when combined with a larger liquidity reserve requirement, may restrict Farm Credit banks' ability to effectively manage their balance sheet. Therefore, we propose changing the limit to 35 percent of a bank's total outstanding loans.

In order to increase liquidity, Farm Credit banks must either increase liquid investments or the duration of their debt. Increasing the liquidity reserve requirement without a corresponding change in the investment limit could reduce the banks' ability to effectively react to a variety of market conditions. For example, in a declining interest rate environment, a bank may want to shorten the duration of its liabilities to more closely match assets that may be subject to faster prepayments in a declining rate environment. However, if a bank has reached its investment limitation, the minimum liquidity reserve requirement would eventually constrain a bank's ability to shorten the duration of its debt. We believe a change in the limit of eligible investments is warranted to provide the banks with additional flexibility to successfully meet their liquidity needs and accomplish their asset/liability management strategies in all economic conditions. While making the limit less restrictive, we also note that the housing GSE regulatory agencies do not place a ceiling on total investments. 8

We also propose to require Farm Credit banks to have a liquidity contingency plan as part of their investment policies. The proposed changes to our existing regulations are explained in more detail in the section-by-section analysis below.

We propose amending § 615.5132 by changing the current eligible investment limit from 30 percent of total outstanding loans to 35 percent of total outstanding loans. Farm Credit banks use investments to manage short-term surplus funds, meet the minimum liquidity reserve requirement and manage interest rate risk. We believe a limit change to 35 percent of total outstanding loans would provide the banks with more flexibility to successfully meet their liquidity needs and accomplish their asset/liability management strategies. This change would allow Farm Credit banks sufficient latitude to effectively react to rapidly changing market conditions that can impact bank performance while still limiting the banks' ability to arbitrage their GSE status in the debt markets.

We propose amending § 615.5134(a) to establish a minimum liquidity reserve sufficient to fund 90 days of maturing obligations and other bank borrowings. We determined that the existing reserve requirement of approximately 15 days of liquidity, while adequate under normal operations and for short-term disruptions, is insufficient for prolonged market disruption. For example, during the agricultural crisis of the 1980s, the System suffered tremendous financial stress and the market required a higher rate of return for System debt. The Farm Credit banks reacted to the crisis by increasing their liquidity reserves over 220 percent between 1985 and 1986 to protect against further market disruption. 9

We propose a mandatory minimum 90-day liquidity reserve to provide a safeguard for borrowers and investors. Under the proposed minimum, Farm Credit banks will be able to continue to fulfill their mission in a safe and sound manner, even under extreme market conditions. The proposed rule specifies that the reserve amount is based on the discounted value of the liquid assets. These discounts are discussed in section III.B.3. of this preamble.

The proposed rule would also remove the existing liquidity reserve calculation in § 615.5134(a). We believe a specific number of days is less burdensome than the procedure of calculating days and will result in greater accuracy when determining reserve levels.

The proposed rule would require that certain investments used to fund the liquidity reserve carry one of the two highest ratings from a Nationally Recognized Statistical Rating Organization (NRSRO) in order to be counted toward the reserve requirement. Higher rated investments are generally more liquid, less volatile, and can be quickly converted into cash without significant loss. The proposed rule would also allow Farm Credit banks to include investments that are not rated in their liquidity reserves, if the investments are issued by an issuer that has one of the two highest ratings or they are guaranteed by the full faith and credit of the United States Government.

The proposed rule would replace the calculations in § 615.5134(c) with discounts of assets used to fund the liquidity reserve. Each investment would be discounted to consider the cost of liquidating an investment portfolio over a short period of time in adverse situations. We believe a system of discounting assets more accurately reflects true market conditions. For example, investments that are less interest rate sensitive, such as short-term and variable rate instruments that remain below their cap, are given less of a discount because they are exposed to less price risk. The discount for long-term fixed rate instruments is higher because of greater market risk.

The proposed discounting method is calculated as follows:

The proposed rule would add a new § 615.5134(d) requiring each Farm Credit bank to develop a contingency plan in order to ensure the most effective use of the liquidity reserve. The proposed rule would require the plan to be annually reviewed and updated, if necessary. This requirement is similar to the requirement in § 615.5133(a) that the investment management policies be reviewed annually, making all needed changes. We expect a contingency plan to contain a strategy with clear procedures to address liquidity shortfalls in the event of market disruption. The proposed rule would allow the banks to include the contingency plan in their investment policy documents. We encourage the banks to use the Basel Committee report on managing liquidity in banking organizations as a guide when developing the contingency plan.

We propose replacing “Farm Credit banks, bank for cooperatives, and agricultural credit banks,” in § 615.5132 and § 615.5134 with “Farm Credit bank” pursuant to the definition contained in § 619.9140 of our regulations. As a conforming change, we propose removing the definition for “Bank” from § 615.5131(b) because it is unnecessary and redesignating the subsequent paragraphs. We also propose changing § 615.5174(a) to correct the cross-reference to § 615.5131(g) to reflect the redesignation of paragraphs.

We are seeking comments on the procedure for disposing of ineligible investments under § 615.5143. Our existing regulation requires a Farm Credit bank to divest itself of formerly eligible investments that have become ineligible. Divestiture must occur within 6 months unless we have approved a divestiture plan extending the time to divest. Prior to this rulemaking, a Farm Credit bank asked us to provide investment flexibility instead of divestiture when facing unavoidable financial loss. We are seeking comments on this matter, specifically for those situations when general economic conditions cause an investment to become ineligible or when the eligibility of an investment may be restored.

Pursuant to section 605(b) of the Regulatory Flexibility Act (5 U.S.C. 601 et seq. ), FCA hereby certifies the proposed rule will not have a significant economic impact on a substantial number of small entities. Each of the Farm Credit banks, considered with its affiliated associations, has assets and annual income over the amounts that would qualify them as small entities. Therefore, System institutions are not “small entities” as defined in the Regulatory Flexibility Act.

For the reasons stated in the preamble, part 615 of chapter VI, title 12 of the Code of Federal Regulations is proposed to be amended as follows:

I. Background

On January 17, 2003, FCA published a notice requesting comment on the regulatory treatment of loan syndications (68 FR 2540). After considering the comments, the FCA Board reaffirmed its long-standing interpretation that loan syndications come within a Farm Credit System (System) institution's direct lending authorities and, therefore, loan syndications to eligible borrowers are subject to the borrower rights requirements of the Act, and corresponding regulations. (69 FR 8407, Feb. 24, 2004)

In their comments on the notice, the Farm Credit Council (FCC) and other System institutions stated that borrower rights are an impediment to System involvement in loan syndication transactions. Loan syndications are multi-lender transactions, generally involving a lead lender and at least one other participating lender, where each lender has a direct contractual relationship with the borrower. Typically, the loan servicing and loan collection procedures are the same for each lender, and these activities are undertaken according to standard agreements among the lenders in the transaction. System institutions commented that it is difficult to enter into these transactions when they have unique disclosure requirements and have to provide distressed loan restructuring rights and the right of first refusal on repurchasing foreclosed property. The commenters stated that commercial lenders see fulfillment of these rights as a delay to loan servicing and collection and they would rather enter into loan syndication transactions with lenders that are not required to offer such rights.

The commenters also stated that borrowers in syndications are generally sophisticated in financial transactions and represented by counsel. Thus, the commenters contend that these borrowers are in an equal bargaining position with qualified lenders and should be free to choose to waive their borrower rights.

Subsequently, we received two petitions under 5 U.S.C. 553(e) asking us to amend § 617.7010(b) to allow borrowers to waive borrower rights in loan syndication transactions. These petitions cited reasons for granting a waiver similar to the previous commenters.

After reviewing System syndication transactions, we have determined that the borrower in these transactions generally possess a very high level of business sophistication. These borrowers are more likely than others to be able to provide a knowing and intelligent waiver of their rights. Therefore, we propose to amend § 617.7010 to allow a borrower to waive borrower rights when receiving a loan from a qualified lender that is part of a loan syndication package with non-System lenders that are otherwise not required by the Act to provide borrower rights. 1 To ensure that the borrower understands the borrower rights being waived and is freely and intelligently waiving those rights, we require that the borrower be advised by legal counsel at the time of the waiver.

We also invite comments on whether we should consider other criteria to further differentiate what borrower and what type of loan syndication transactions should be eligible for a waiver of borrower rights.

The purpose of the waiver is to eliminate instances where borrower rights are an impediment to a borrower receiving credit from a qualified lender through a loan syndication with non-System lenders that are otherwise not required by the Act to provide borrower rights. As previously noted, borrower rights are not compatible with many loan syndication transactions because the servicing and collection practices must be the same for all lenders.

The waiver provision in this proposed regulation is intended to be used only in addressing the problems qualified lenders have encountered in entering into loan syndications due to the requirement to provide the borrower with borrower rights. Section 617.7010(c) provides that this waiver provision is not to be used as a means of circumventing the borrower rights requirements by creating a syndication relationship whose primary purpose is to avoid borrower rights. A syndicated lending package is typically sought when the total credit would exceed the lending institution's lending limit or the risk associated with the total credit would exceed the risk tolerance of the individual lending institution. Our examination process will be mindful of this issue and will take appropriate action to address any abuses of this proposed waiver.

Pursuant to section 605(b) of the Regulatory Flexibility Act (5 U.S.C. 601 et seq. ), the FCA hereby certifies that the proposed rule will not have a significant economic impact on a substantial number of small entities. Each of the banks in the System, considered together with its affiliated associations, has assets and annual income in excess of the amounts that would qualify them as small entities. Therefore, System institutions are not “small entities” as defined in the Regulatory Flexibility Act.

For the reasons stated in the preamble, part 617, chapter VI, title 12 of the Code of Federal Regulations is proposed to be amended as follows:

The collection of information contained in this notice of rulemaking has been previously reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under control number 1545-1341.

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a valid control number assigned by the Office of Management and Budget.

Books or records relating to a collection of information must be retained as long as their contents may become material in the administration of any internal revenue law. Generally, tax returns and tax return information are confidential, as required by 26 U.S.C. 6103.

Regulations (TD 6783) under section 403(b) of the Internal Revenue Code (Code) were published in the Federal Register (29 FR 18356) on December 24, 1964 (1965-1 C.B. 180). These regulations provided guidance for complying with section 403(b) which had been enacted in 1958 in section 23(a) of the Technical Amendments Act of 1958, Public Law 85-866 (1958), relating to tax-sheltered annuity arrangements established for employees by public schools and tax-exempt organizations described in section 501(c)(3). Since 1964, additional regulations have been issued under section 403(b) to reflect rules relating to eligible rollover distributions and minimum distributions under section 401(a)(9).

These proposed regulations would amend the current regulations to conform them to the numerous amendments made to section 403(b) by subsequent legislation, including section 1022(e) of the Employee Retirement Income Security Act of 1974 (ERISA) (88 Stat. 829), Public Law 93-406; section 251 of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) (96 Stat. 324,529), Public Law 97-248; section 1120 of the Tax Reform Act of 1986 (TRA '86) (100 Stat. 2085, 2463), Public Law 99-514; section 1450(a) of the Small Business Job Protection Act of 1996 (SBJPA) (110 Stat. 1755, 1814), Public Law 104-188; and sections 632, 646, and 647 of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) (115 Stat. 38, 113, 126, 127), Public Law 107-16.

The purposes of these proposed regulations are to update the current regulations under section 403(b) to delete provisions that no longer have legal effect due to changes in law, to include in the regulations a number of items of interpretive guidance that have been issued under section 403(b) since the 1964 regulations, 1 and generally to reflect the numerous legal changes that have been made in section 403(b). A major effect of the legal changes in section 403(b) has been to diminish the extent to which the rules governing section 403(b) plans differ from the rules governing other arrangements that include salary reduction contributions, i.e. , section 401(k) plans and section 457(b) plans for State and local governmental entities. Thus, these regulations will reflect the increasing similarity among these arrangements.

Since the existing regulations were issued in 1964, a number of revenue rulings and other guidance under section 403(b) have become outdated as a result of changes in law. In addition, as a result of the inclusion in these proposed regulations of much of the guidance that the IRS has issued regarding section 403(b), it is anticipated that these regulations, when finalized, will supersede a number of revenue rulings and notices that have been issued under section 403(b). Thus, the IRS anticipates taking action to obsolete many revenue rulings, notices, and other guidance under section 403(b) when these regulations are issued in final form. 2 However, the positions taken in certain rulings and other outstanding guidance are expected to be retained. For example, it is intended that a revenue ruling will be issued that substantially replicates and consolidates the existing rules  3 for determining when employees are performing services for a public school. 4

The existing regulations include special rules for determining the amount of the contributions made for an employee under a defined benefit plan, based on the employee's pension under the plan. These rules are generally no longer applicable for section 403(b) because the limitations on contributions to a section 403(b) contract are no longer coordinated with accruals under a defined benefit plan. ( See also the discussion of defined benefit plans below under the heading Miscellaneous Provisions .) However, the rules for determining the amount of contributions made for an employee under a defined benefit plan in the existing regulations under section 403(b) are also used for purposes of section 402(b) (relating to nonqualified plans funded through trusts) and, accordingly, these rules are proposed to be deleted from the regulations under section 403(b). New proposed regulations under section 402(b) would authorize the Commissioner to issue guidance for determining the amount of the contributions made for an employee under a defined benefit plan under section 402(b). See also the request for comments on this guidance under the heading Comments and Public Hearing.

The proposed regulations also include controlled group rules under section 414(c) for entities that are tax-exempt under section 501(a).

Section 403(b) provides an exclusion from gross income for certain contributions made by certain types of employers for their employees to specific types of funding arrangements. There are three categories of funding arrangements to which section 403(b) applies: (1) Annuity contracts (as defined in section 401(g)) issued by an insurance company; (2) custodial accounts that are invested solely in mutual funds; and (3) retirement income accounts which are only permitted for church employees. The exclusion applies only if certain general requirements are satisfied. For purposes of most of these requirements, section 403(b)(5) provides that all section 403(b) contracts purchased for an individual by an employer are treated as purchased under a single contract. Other aggregation rules apply for certain specific purposes, including the aggregation rules under section 402(g) for purposes of satisfying the limitations on elective deferrals (which apply both on an individual basis and to all contributions made by an employer) and the controlled group rules of section 414(b) and (c) for purposes of the general nondiscrimination rules and the contribution limitations of section 415 (which generally apply on an employer-by-employer basis).

Section 403(b)(1)(C) requires that the contract be nonforfeitable except for the failure to pay future premiums. The proposed regulations define nonforfeitability based on the regulations under section 411(a) and clarify that if an annuity contract issued by an insurance company is purchased that would satisfy section 403(b) except for the failure to satisfy this nonforfeitability requirement, then the contract is treated as a contract to which section 403(c) applies. Section 403(c) provides that the value of a nonqualified contract is included in gross income under the rules of section 83, which generally does not occur before the employee's rights in the contract become substantially vested. Under the proposed regulations, on the date on which the employee's interest in that contract becomes nonforfeitable, the contract may be treated as a section 403(b) contract if the contract has at all prior times satisfied the requirements of section 403(b) other than the nonforfeitability requirement. Solely for this purpose, if a participant's interest in a contract is only partially nonforfeitable in a year, then the portion that is nonforfeitable and the portion that fails to be nonforfeitable are bifurcated.

Section 403(b)(12) requires a section 403(b) contract to make elective deferrals available to all employees (the universal availability rule) and requires other contributions to satisfy the general nondiscrimination requirements applicable to qualified plans. These rules are discussed further below under the heading Section 403(b) Nondiscrimination and Universal Availability Rules.

Section 403(b)(1)(E) requires a section 403(b) contract to satisfy the requirements of section 401(a)(30) relating to limitations on elective deferrals under section 402(g)(1). The proposed regulations provide that a contract only satisfies this requirement if the contract requires all elective deferrals for an employee to satisfy section 402(g)(1), including elective deferrals for the employee under the contract and any other elective deferrals under the plan under which the contract is purchased and under all other plans, contracts, or arrangements of the employer that are subject to the limits of section 402(g). This rule is the same as the rule for section 401(k) arrangements.

A section 403(b) contract is also required to provide that it will satisfy the minimum required distribution requirements of section 401(a)(9), the incidental benefit requirements of section 401(a), and the rollover distribution rules of section 402(c).

The proposed regulations address the requirement that annual additions to the contract not exceed the applicable limitations of section 415(c) (treating contributions as annual additions). In accordance with the last sentence of section 415(a)(2), if an excess annual addition is made to a contract that otherwise satisfies the requirements of section 403(b), then the portion of the contract that includes the excess will fail to be a section 403(b) contract (and instead will be a contract to which section 403(c) applies) and the remaining portion of the contract that includes the contribution that is not in excess of the section 415 limitations is a section 403(b) contract. This rule under which only the excess annual addition is subject to section 403(c) does not apply unless, for the year of the excess and each year thereafter, the issuer of the contract maintains separate accounts for the portion that includes the excess and for the section 403(b) portion, i.e. , the portion that includes the amount not in excess of the section 415 limitations.

The proposed regulations require that these conditions for the exclusion be satisfied both in form and operation in the section 403(b) contract. Because several of these requirements are based on plan documents—in particular the requirements that elective deferrals satisfy a universal availability rule and that other contributions satisfy the nondiscrimination rules applicable to qualified plans—the proposed regulations require that the contract be maintained pursuant to a plan. For this purpose, it is intended that the plan would include all of the material provisions regarding eligibility, benefits, applicable limitations, the contracts available under the plan, and the time and form under which benefit distributions would be made. This rule does not require that there be a single plan document. For example, this requirement would be satisfied by complying with the plan document rules applicable to qualified plans.

The Treasury Department and the IRS have consulted with the Department of Labor concerning the interaction between Title I of the Employee Retirement Income Security Act of 1974 (ERISA) and section 403(b) of the Code. The Department of Labor has advised the Treasury Department and the IRS that Title I of ERISA generally applies to “any plan, fund, or program * * * established or maintained by an employer or by an employee organization, or by both, to the extent that * * * such plan, fund, or program * * * provides retirement income to employees, or * * * results in a deferral of income by employees for periods extending to the termination of covered employment or beyond.” ERISA, section 3(2)(A). However, governmental plans and church plans are generally excluded from coverage under Title I of ERISA. See ERISA, section 4(b)(1) and (2). Therefore, section 403(b) contracts purchased or provided under a program that is either a “governmental plan” under section 3(32) of ERISA or a “church plan” under section 3(33) of ERISA are not generally covered under Title I. However, section 403(b) of the Code is also available with respect to contracts purchased or provided by employers for employees of a section 501(c)(3) organization, and many programs for the purchase of section 403(b) contracts offered by such employers are covered under Title I of ERISA as part of an “employee pension benefit plan” within the meaning of section 3(2)(A) of ERISA. The Department of Labor has promulgated a regulation, 29 CFR 2510.3-2(f), describing circumstances under which an employer's program for the purchase of section 403(b) contracts for its employees, which is not otherwise excluded from coverage under Title I, will not be considered to constitute the establishment or maintenance of an “employee pension benefit plan” under Title I of ERISA.

These proposed regulations are generally limited to the requirements imposed under section 403(b). In this regard, the proposed regulations require that a section 403(b) program be maintained pursuant to a plan, which for this purpose is defined as a written defined contribution plan which, in both form and operation, satisfies the regulatory requirements of section 403(b) and contains all the material terms and conditions for benefits under the plan. The Department of Labor has advised the Treasury Department and the IRS that, although it does not appear that the proposed regulations would mandate the establishment or maintenance of an employee pension benefit plan in order to satisfy its requirements, it leaves open the possibility that an employer may undertake responsibilities that would constitute establishing and maintaining an ERISA-covered plan. The Department of Labor has further advised the Treasury Department and the IRS that whether the manner in which any particular employer decides to satisfy particular responsibilities under these proposed regulations will cause the employer to be considered to have established or to maintain a plan that is covered under Title I of ERISA must be analyzed on a case-by-case basis, applying the criteria set forth in 29 CFR 2510.3-2(f), including the employer's involvement as contemplated by the plan documents and in operation.

To the extent that these proposed regulations may raise questions for employers concerning the scope and application of the regulation at 29 CFR 2510.3-2(f), the Treasury Department and the IRS are requesting comments. See below under the heading Comments and Public Hearing.

All employee pension benefit plans covered under Title I of ERISA, including plans that involve the purchase of section 403(b) contracts, must satisfy a number of requirements, including requirements relating to reporting and disclosure, eligibility, vesting, benefit accrual, advance notice of contribution reductions, qualified joint and survivor annuities, minimum funding, fiduciary standards, fidelity bonds, and claims procedures. Authority to interpret many of the requirements in parts 2 and 3 of Title I of ERISA (specifically those relating to eligibility, vesting, benefit accrual, minimum funding, and qualified joint and survivor annuities) has been transferred to the Treasury Department and the IRS. See Reorganization Plan No. 4 of 1978, 43 FR 47713, October 17, 1978. As a result, those section 403(b) contracts of a section 501(c)(3) organization that are part of an employee pension benefit plan are subject to requirements parallel to those imposed under sections 401(a)(11) through 401(a)(15), 410, 411, 412, and 417 of the Internal Revenue Code and the regulations promulgated thereunder, since regulations and other guidance issued under those Code sections are applicable for purposes of the parallel requirements in ERISA. Further, although specific references are made to Title I in these proposed regulations, this does not imply that other Title I issues are not applicable.

Section 1450(a) of SBJPA provides that the rules applicable to cash or deferred elections under section 401(k) are to apply under section 403(b) for purposes of determining the frequency with which an employee may enter into a salary reduction agreement, the salary to which such an agreement may apply, and the ability to revoke such an agreement. Based in part on this provision, and taking into account the guidance that has been issued since SBJPA, 5 the proposed regulations would clarify the extent to which section 403(b) elective deferrals are like elective deferrals under proposed and final rules under section 401(k). Specifically, the rules are fundamentally similar with respect to the frequency with which a deferral election can be made, changed, or revoked, including automatic enrollment (plan provisions under which elective deferrals are automatically made for employees unless they elect otherwise), the ability for a deferral election that has been made in one year to be carried forward to subsequent periods until modified, the rule under which irrevocable elections are not treated as elective deferrals, and the requirement that employees have an annual effective opportunity to make, revoke, or modify a deferral election. The rules are also fundamentally similar with respect to the compensation with respect to which the election can be made, e.g., allowing a deferral election to be made for compensation up to the day before the compensation is currently available. Likewise, the proposed regulations explicitly provide that, for purposes of sections 402(g) and 403(b), an elective deferral with respect to a section 403(b) contract is limited to contributions made pursuant to a cash or deferred election, as defined in regulations under section 401(k).

These proposed regulations also include a rule comparable to the anti-conditioning rule at section 401(k)(4). Finally, the proposed regulations include rules similar to those for section 401(k) plans regarding plan limitations to comply with section 401(a)(30) and to pay out section 403(b) elective deferrals in excess of the related section 402(g) limitation.

As a result, under the proposed regulations, the three major differences between the rules applicable to section 403(b) elective deferrals and the rules applicable to elective deferrals under section 401(k) are:

• Section 403(b) is limited to certain specific employers and employees ( i.e. , employees of a State public school, employees of a section 501(c)(3) organization, and certain ministers), whereas section 401(k) is available to all employers, except a State or local government or any political subdivision, agency, or instrumentality thereof.

• Unlike section 401(k), contributions under section 403(b) can only be made to certain funding arrangements, i.e., an insurance annuity contract, custodial account that is limited to mutual fund shares, or church retirement income account, and not to a trust or custodial account that fails to satisfy the custodial account rules at section 403(b)(7) or the retirement income account rules at section 403(b)(9) for churches.

• A universal availability rule applies to section 403(b) elective deferrals, whereas an average deferral percentage rule (the ADP test) and a minimum coverage rule (section 410(b)) apply with respect to elective deferrals under section 401(k). 6

The regulations clarify that if the requirements of section 403(b) fail to be satisfied with respect to an employer contribution, then the contribution is subject either to the rules under section 403(c) (relating to nonqualified annuities) if the contribution is for an annuity contract issued by an insurance company, or is subject to the rules under section 61, 83, or 402(b) if the contribution is to a custodial account or retirement income account that fails to satisfy the requirements of section 403(b).

Issues have been raised about the application of section 403(b) to tax-exempt entities that have State or local government features. These proposed regulations do not attempt to address when an entity is a State (treating a local government or other subdivision as a State) and when it is a section 501(c)(3) organization that is not a State. 7 Thus, for example, these regulations do not provide guidance on the conditions under which a tax-exempt charter school is, or is not, a State entity.

Based on the wording of section 401(k)(4)(B)(i) and (ii), an entity that is both a section 501(c)(3) organization and an instrumentality of a State cannot have a section 401(k) plan. Under sections 457(b)(6) and 457(g), an entity that is both an instrumentality of a State and a section 501(c)(3) organization can have an eligible plan under section 457(b) only if it is funded. However, under section 403(b)(1)(A)(i) and (ii), an entity that is both an instrumentality of a State and a section 501(c)(3) organization could cover any of its employees, regardless of whether they are performing services for a public school.

The exclusion provided under section 403(b) applies only to the extent that all amounts contributed by the employer for the purchase of an annuity contract for the participant do not exceed the applicable limit under section 415 and, with respect to section 403(b) elective deferrals, only if the contract is purchased under a plan that includes the limits under section 402(g), including aggregation under all plans of the employer. The proposed regulations require a section 403(b) contract to include this limit on section 403(b) elective deferrals, as imposed by section 402(g).

A section 403(b) contract may provide for additional catch-up contributions for a participant who is age 50 by the end of the year, provided that those age 50 catch-up contributions do not exceed the catch-up limit under section 414(v) for the taxable year (which is $3,000 for 2004). In addition, an employee of a qualified organization who has at least 15 years of service (disregarding any period during which an individual is not an employee of the eligible employer) is entitled to a special section 403(b) catch-up limit. Under the special section 403(b) catch-up limit, the section 402(g) limit is increased by the lowest of the following three amounts: (i) $3,000; (ii) the excess of $15,000 over the total special section 403(b) catch-up elective deferrals made for the qualified employee by the qualified organization for prior taxable years; or (iii) the excess of (A) $5,000 multiplied by the number of years of service of the employee with the qualified organization, over (B) the total elective deferrals made for the qualified employee by the qualified organization for prior taxable years. For this purpose, a qualified organization is an eligible employer that is a school, hospital, health and welfare service agency (including a home health service agency), or a church-related organization. In the case of a church-related organization, all entities that are in such a church-related organization are treated as a single qualified organization, so that years of service and any section 403(b) catch-up elective deferrals previously made for a qualified employee for any such church are taken into account for purposes of determining the amount of section 403(b) catch-up elective deferrals to which an employee is entitled under any section 403(b) plan maintained by another entity in the same church-related organization. A health and welfare service agency is defined as either an organization whose primary activity is to provide medical care as defined in section 213(d)(1) (such as a hospice), or a section 501(c)(3) organization whose primary activity is the prevention of cruelty to individuals or animals, or which provides substantial personal services to the needy as part of its primary activity (such as a section 501(c)(3) organization that provides meals to needy individuals).

The proposed regulations provide that any catch-up contribution for an employee who is eligible for both an age 50 catch-up and the special section 403(b) catch-up is treated first as a special section 403(b) catch-up to the extent a special section 403(b) catch-up is permitted, and then as an amount contributed as an age 50 catch-up (to the extent the age 50 catch-up amount exceeds the maximum special section 403(b) catch-up).

Any contribution made for a participant to a section 403(b) contract for a taxable year that exceeds either the section 415 maximum annual contribution limit or the section 402(g) elective deferral limit constitutes an excess contribution that is included in gross income for that taxable year (or, if later, the taxable year in which the contract becomes nonforfeitable). The proposed regulations provide that a section 403(b) contract or the section 403(b) plan may provide that any excess deferral as a result of a failure to comply with the section 402(g) elective deferral limit for the taxable year with respect to any section 403(b) elective deferral made for a participant by the employer will be distributed to the participant, with allocable net income, no later than April 15 or otherwise in accordance with section 402(g).

For purposes of determining a participant's includible compensation and years of service—used both for the special section 403(b) catch-up contributions and for employer contributions for former employees—an employee's number of years of service include each full year during which the individual is a full-time employee of the eligible employer plus a fraction of a year for each part of a year during which the individual is a full-time or part-time employee of the eligible employer. A year of service is based on the employer's annual work period, not the employee's taxable year. Thus, in determining whether a university professor is employed full-time, the annual work period is the school's academic year. In determining whether an individual is employed full-time, the amount of work actually performed is compared with the amount of work that is normally required of individuals performing similar services from which substantially all of their annual compensation is derived. An individual is treated as performing a fraction of a year of service for each annual work period during which he or she is a full-time employee for part of the annual work period or for each annual work period during which he or she is a part-time employee either for the entire annual work period or for a part of the annual work period.

In measuring the amount of work of an individual performing particular services, the work performed is determined based on the individual's hours of service (as defined under section 410(a)(3)(C)), except that a plan may use a different measure of work if appropriate under the facts and circumstances. For example, a plan may provide for a university professor's work to be measured by the number of courses taught during an annual work period if that individual's work assignment is generally based on a specified number of courses to be taught.

In determining years of service, any period during which an individual is not an employee of the eligible employer is disregarded, except that, for a section 403(b) contract of an eligible employer that is a church-related organization, any period during which an individual is an employee of that eligible employer and any other eligible employer that is within the same church-related organization with that eligible employer is taken into account on an aggregated basis. In the case of a part-time employee or a full-time employee who is employed for only part of the year, the employee's most recent periods of service are aggregated to determine his or her most recent one-year period of service, as follows: the employee's service during the annual work period for which the last year of service's includible compensation is being determined is taken into account first; then the employee's service during the next preceding annual work period based on whole months is taken into account; and so forth, until the employee's service equals, in the aggregate, one year of service.

Under section 403(b)(3), a former employee is deemed to have monthly includible compensation for the period through the end of the taxable year of the employee in which he or she ceases to be an employee and through the end of each of the next five taxable years of the employee. The amount of the monthly includible compensation is equal to 1/12 of the former employee's includible compensation during the former employee's most recent year of service. Accordingly, a plan may provide that nonelective employer contributions are continued for up to five years for a former employee, up to the lesser of the dollar amount in section 415(c)(1)(A) or the former employee's annual includible compensation based on the former employee's compensation during his or her most recent year of service.

The proposed regulations do not address the extent, if any, to which the exclusion from gross income provided by section 403(b) applies to contributions made for former employees ( e.g., whether a contribution may be made for a former employee if the contribution is with respect to compensation that would otherwise be paid for a payroll period that begins after severance from employment) other than as provided under the five-year rule at section 403(b)(3), described above under the heading Special Rule for Former Employees. The Treasury Department and the IRS expect to issue separate guidance on this issue, potentially addressing this question with respect to not only section 403(b), but also sections 401(k), 457(b) (for eligible governmental plans), and 415(c).

Section 403(b)(12)(A)(i) requires that employer contributions and employee after-tax contributions made under a section 403(b) contract satisfy a specified series of requirements (the nondiscrimination requirements) in the same manner as a qualified plan under section 401(a). These proposed regulations do not adopt the good faith reasonable standard of Notice 89-23 for purposes of satisfying the nondiscrimination requirements of section 403(b)(12)(A)(i). These nondiscrimination requirements include rules relating to nondiscrimination in contributions, benefits, and coverage (sections 401(a)(4) and 410(b)), a limitation on the amount of compensation that can be taken into account (section 401(a)(17)), and the average contribution percentage rules of section 401(m) (relating to matching and after-tax contributions). The nondiscrimination requirements are generally tested using compensation as defined in section 414(s) and are applied on an aggregated basis taking into account all plans of the employer. See the discussion below under the heading Controlled Group Rules For Tax-Exempt Entities.

The nondiscrimination requirements do not apply to section 403(b) elective deferrals. In addition, the only nondiscrimination requirement that applies to a governmental plan, within the meaning of section 414(d), is the limitation on compensation (section 401(a)(17)).

Under section 403(b)(12)(A)(ii), a universal availability requirement applies under which all employees of the eligible employer must be permitted to elect to have section 403(b) elective deferrals contributed on their behalf if any employee of the eligible employer may elect to have the organization make section 403(b) elective deferrals. Under the proposed regulations, the universal availability requirement is not satisfied unless the contributions are made pursuant to a plan and the plan permits elective deferrals that satisfy the universal availability requirement. The proposed regulations generally provide that the universal availability requirement applies separately to each common law entity, i.e., to each section 501(c)(3) organization, or, in the case of a section 403(b) plan that covers the employees of more than one State entity, to each entity that is not part of a common payroll. The proposed regulations allow an employer that historically has treated one or more of its various geographically distinct units as separate for employee benefit purposes to treat each unit as a separate organization if the unit is operated independently on a day-to-day basis.

The proposed regulations include the statutory categories that are exceptions to the universal availability rule, and provide that, if any employee listed in any excludable category has the right to have section 403(b) elective deferrals made on his or her behalf, then no employees in that category may be excluded. The categories generally are: employees who are eligible to participate in an eligible governmental plan under section 457(b) which permits contributions or deferrals at the election of the employee or a plan of the employer offering a qualified cash or deferred election under section 401(k); employees who are non-resident aliens; employees who are students performing services described in section 3121(b)(10); and employees who normally work fewer than 20 hours per week. Additionally, Notice 89-23 included transition rules for certain other exclusions that are not in the statute: employees who make a one-time election to participate in a governmental plan instead of a section 403(b) plan; employees covered by a collective bargaining agreement; visiting professors for up to one year under certain circumstances; and employees affiliated with a religious order who have taken a vow of poverty. The proposed regulations do not adopt these transition rules. See the reference to these exclusions below under the heading

The nondiscrimination and the universal availability requirements do not apply to a section 403(b) contract purchased by a church, which is specially defined for this purpose, and generally does not include a university, hospital, or nursing home.

The nondiscrimination and universal availability requirements are in addition to other applicable legal requirements. Specifically, these requirements do not reflect the requirements of Title I of ERISA that may apply with respect to a section 403(b) plan, such as the ERISA vesting requirements. Another example is that, while employees who normally work fewer than 20 hours per week may be excluded under the universal availability rule, employers who maintain plans that are subject to Title I of ERISA should be aware that Title I of ERISA includes limitations on the conditions under which employees can be excluded from a plan on account of not working full time and that these limitations would generally not permit an exclusion for employees who normally work fewer than 20 hours per week. See section 202(a)(1) of ERISA and regulations under section 410(a) of the Code (which interpret section 202 of ERISA).

The proposed regulations reflect the statutory rules regarding when distributions can be made from a section 403(b) contract. Thus, amounts held in a custodial contract attributable to employer contributions (that are not section 403(b) elective deferrals) may not be paid to a participant before the participant has a severance from employment, becomes disabled (within the meaning of section 72(m)(7)), or attains age 59 1/2 . This rule also applies to amounts transferred out of a custodial account ( i.e. , to an annuity contract or retirement income account), including earnings thereon. In addition, distributions of amounts attributable to section 403(b) elective deferrals may not be paid to a participant earlier than when the participant has a severance from employment, has a hardship, becomes disabled (within the meaning of section 72(m)(7)), or attains age 59 1/2 . Hardship is generally defined under regulations issued under section 401(k).

The proposed regulations would reflect the requirements of section 402(f) relating to the written explanation requirements for distributions that qualify as eligible rollover distributions, including conforming the timing rule to the rule for qualified plans.

Where the distribution restrictions do not apply, a section 403(b) contract is permitted to distribute retirement benefits to the participant after severance from employment or upon the prior occurrence of an event, such as after a fixed number of years, the attainment of a stated age, or disability. The proposed regulations include a number of exceptions to the timing restrictions, e.g. , the rule for elective deferrals does not apply to distributions of section 403(b) elective deferrals (not including earnings thereon) that were contributed before January 1, 1989.

The proposed regulations define severance from employment in a manner that is generally the same as the proposed regulations under section 401(k), 8 but provide that a severance from employment occurs on any date on which the employee ceases to be employed by an eligible employer that maintains the section 403(b) plan. Thus, a severance from employment would occur when an employee ceases to be employed by an eligible employer even though the employee may continue to be employed by an entity that is part of the same controlled group but that is not an eligible employer, or on any date on which the employee works in a capacity that is not employment with an eligible employer. Examples of the situations that constitute a severance from employment include: an employee transferring from a section 501(c)(3) organization to a for-profit subsidiary of the section 501(c)(3) organization; an employee ceasing to work for a public school, but continuing to be employed by the same State; and an individual employed as a minister for an entity that is neither a State nor a section 501(c)(3) organization ceasing to perform services as a minister, but continuing to be employed by the same entity.

The proposed regulations include rules similar to those in the existing regulations relating to the minimum distribution requirements of section 401(a)(9), but with some minor changes (for example, omitting the special rules for 5-percent owners). Thus, section 403(b) contracts must satisfy the incidental benefit rules. Existing revenue rulings provide guidance with respect to the application of the incidental benefit requirements to permissible nonretirement benefits such as life, accident, or health benefits. 9

The proposed regulations include rules reflecting that loans can be made to participants from a section 403(b) contract.

The proposed regulations include limited rules relating to qualified domestic relations orders (QDROs) under section 414(p). Section 414(p)(9) provides that the QDRO rules only apply to plans that are subject to the anti-alienation provisions of section 401(a)(13), except that section 414(p)(9) also provides that, except to the extent set forth in regulations—there are currently no regulations under section 414(p)—the section 414(p) QDRO rules apply to a section 403(b) contract. These proposed section 403(b) regulations clarify that the section 414(p) QDRO rules apply to section 403(b) contracts for purposes of applying section 403(b).

The proposed regulations include a number of rules regarding the taxation of distributions and benefits from section 403(b) contracts, including the statutory provision that only amounts actually distributed from a section 403(b) contract are generally includible in the gross income of the recipient for the year in which distributed under section 72, relating to annuities. The regulations also reflect the rule that any payment that constitutes an eligible rollover distribution is not taxed in the year distributed to the extent the payment is directly rolled over or transferred to an eligible retirement plan. The payor must withhold 20 percent Federal income tax, however, if an eligible rollover distribution is not rolled over in a direct rollover. Another provision requires the payor to give proper written notice to the section 403(b) participant or beneficiary concerning the eligible rollover distribution provision. Notice 2002-3 (2002-2 I.R.B. 289), provides a sample of the safe-harbor notice that the payor may furnish to satisfy this requirement.

As described above, section 403(b) only applies to contributions made to certain funding arrangements, namely: amounts held in an annuity contract, in a custodial account that is treated as an annuity contract under section 403(b)(7), or in a church retirement income account that is treated as an annuity contract under section 403(b)(9). The proposed regulations require that contributions to a section 403(b) plan be transferred to the insurance company issuing the annuity contract (or the entity holding assets of any custodial or retirement income account that is treated as an annuity contract) within a period that is not longer than is reasonable for the proper administration of the plan, such as transferring elective deferrals within 15 business days following the month in which these amounts would otherwise have been paid to the participant.

The proposed regulations provide that, except where a custodial or retirement income account is treated as an annuity contract, an annuity contract means a contract that is issued by an insurance company qualified to issue annuities in a State and that includes payment in the form of an annuity, but does not include a contract that is a life insurance contract, as defined in section 7702, an endowment contract, a health or accident insurance contract, or a property, casualty, or liability insurance contract. The regulations include a special transition rule relating to life insurance contracts issued before the effective date.

Rev. Rul. 67-361 (1967-2 C.B. 153), and Rev. Rul. 67-387 (1967-2 C.B. 153), provided for certain State plans to be treated as qualifying as annuities under section 403(b). Rev. Rul. 82-102 (1982-1 C.B. 62), revoked this interpretation (in connection with the 1974 enactment of section 403(b)(7) which allowed custodial accounts), but provides section 7805(b) relief for arrangements established in reliance on these rulings, i.e. , for arrangements established on or before May 17, 1982. The proposed regulations contemplate that the section 7805(b) relief provided by these rulings would be continued. This relief would be limited to State section 403(b) plans established on or before May 17, 1982 satisfying either of the following requirements: (i) benefits under the contract are provided from a separately funded retirement reserve that is subject to supervision of the State insurance department or (ii) benefits under the contract are provided from a fund that is separate from the fund used to provide statutory benefits payable under a State retirement system and that is part of a State teachers retirement system to purchase benefits that are unrelated to the basic benefits provided under the retirement system, and the death benefit provided under the contract cannot at any time exceed the larger of the reserve or the contribution made for the employee.

The proposed regulations define a custodial account as a plan, or a separate account under a plan, in which an amount attributable to section 403(b) contributions (or amounts rolled over to a section 403(b) contract) is held by a bank or a person who satisfies the conditions in section 401(f)(2), if amounts held in the account are invested in stock of a regulated investment company (as defined in section 851(a) relating to mutual funds), the special restrictions on distributions with respect to a custodial account are satisfied, the assets held in the account cannot be used for, or diverted to, purposes other than for the exclusive benefit of plan participants or their beneficiaries, and the account is not part of a retirement income account, as described below. This requirement limiting investments to mutual funds is not satisfied if the account includes any assets other than stock of a regulated investment company.

The proposed regulations include a number of special rules for church plans. Under section 403(b)(9), a retirement income account for employees of a church-related organization is treated as an annuity contract for purposes of section 403(b) and these regulations. Under the proposed regulations, the rules for a retirement income account are based largely on the legislative history to TEFRA. The proposed regulations define a retirement income account as a defined contribution program established or maintained by a church-related organization under which (i) there is separate accounting for the retirement income account's interest in the underlying assets ( i.e. , it must be possible at all times to determine the retirement income account's interest in the underlying assets and distinguish that interest from any interest that is not part of the retirement income account), (ii) investment performance is based on gains and losses on those assets, and (iii) the assets held in the account cannot be used for, or diverted to, purposes other than for the exclusive benefit of plan participants or their beneficiaries. For this purpose, assets are treated as diverted to the employer if the employer borrows assets from the account. A retirement income account must be maintained pursuant to a program which is a plan and the plan document must state (or otherwise evidence in a similarly clear manner) the intent to constitute a retirement income account.

If any asset of a retirement income account is owned or used by a participant or beneficiary, then that ownership or use is treated as a distribution to that participant or beneficiary. The proposed regulations provide that a retirement income account that is treated as an annuity contract is not a custodial account (even if it is invested in stock of a regulated investment company).

A life annuity can generally only be provided from an individual account by the purchase of an insurance annuity contract. However, in light of the special rules applicable to church retirement income accounts, the proposed regulations permit a life annuity to be paid from such an account if certain conditions are satisfied. The conditions are that the amount of the distribution form have an actuarial present value, at the annuity starting date, that is equal to the participant's or beneficiary's accumulated benefit, based on reasonable actuarial assumptions, including assumptions regarding interest and mortality, and that the plan sponsor guarantee benefits in the event that a payment is due that exceeds the participant's or beneficiary's accumulated benefit.

Under these proposed regulations, both custodial accounts and retirement income accounts would be subject to an exclusive benefit requirement similar to the exclusive benefit requirement applicable to qualified plans. Section 403(b)(7)(B) provides for a custodial account to be treated as a tax exempt.

When these regulations are issued as final regulations, to the extent permitted by the Commissioner in future guidance, assets held under a custodial account or a retirement income account may be pooled with trust assets held under qualified plans.

The proposed regulations include controlled group rules under section 414(c) for entities that are tax-exempt under section 501(a). Under these rules, the employer for a plan maintained by a section 501(c)(3) organization (or any other tax-exempt organization under section 501(a)) includes not only the organization whose employees participate in the plan, but also any other exempt organization that is under common control with such organization, based on 80 percent of the directors or trustees being either representatives of or directly or indirectly controlled by an exempt organization. The proposed regulations include an anti-abuse rule and would also allow tax exempt organizations to choose to be aggregated if they maintain a single plan covering one or more employees from each organization and the organizations regularly coordinate their day to day exempt activities. For a section 501(c)(3) organization that makes contributions to a section 403(b) contract, these rules would be generally relevant for purposes of the nondiscrimination requirements, as well as the section 415 contribution limitations, the special section 403(b) catch-up contributions, and the section 401(a)(9) minimum distribution rules.

These controlled group rules for tax-exempt entities generally do not apply to certain church entities. Comments are requested below under the heading Comment and Public Hearing on whether these rules should be extended to such church entities.

The proposed regulations do not include controlled group rules for public schools. As noted above (under the heading Overview ), it is anticipated that, when these regulations are issued as final regulations, guidance may be issued providing controlled group safe harbors for public schools taking into account the existing safe harbors in Notice 89-23.

The proposed regulations include a number of rules that address the circumstances under which a section 403(b) plan may be terminated or assets may be exchanged or transferred.

The proposed regulations, if adopted as final regulations, would not only permit an employer to amend its section 403(b) plan to eliminate future contributions for existing participants, but would allow plan provisions that permit plan termination with a resulting distribution of accumulated benefits. In general, the distribution of accumulated benefits would be permitted only if the employer (taking into account all entities that are treated as the employer under section 414 on the date of the termination) does not make contributions to another section 403(b) contract that is not part of the plan (based generally on contributions made to a section 403(b) contract during the 12 months before and after the date of plan termination). In order for a section 403(b) plan to be considered terminated, all accumulated benefits under the plan must be distributed to all participants and beneficiaries as soon as administratively practicable after termination of the plan. A distribution includes delivery of a fully paid individual insurance annuity contract. Eligible rollover distributions would not be subject to current income inclusion if rolled over to an eligible retirement plan.

The proposed regulations prohibit an employer that ceases to be an eligible employer from making any further contributions to the section 403(b) contract for subsequent periods. In this event, the contract can be held under a frozen plan or the plan could be terminated in accordance with the rules regarding plan termination.

Under certain conditions, the proposed regulations permit the following exchanges or transfers:

• A section 403(b) contract is permitted to be exchanged for another section 403(b) contract held under the same section 403(b) plan if the following conditions are satisfied: (1) The plan provides for the exchange, (2) the participant or beneficiary has an accumulated benefit immediately after the exchange at least equal to the accumulated benefit of that participant or beneficiary immediately before the exchange (taking into account the accumulated benefit of that participant or beneficiary under both section 403(b) contracts immediately before the exchange), and (3) the contract received in the exchange provides that, to the extent a contract that is exchanged is subject to any section 403(b) distribution restrictions, the contract received in the exchange imposes restrictions on distributions to the participant or beneficiary that are not less stringent than those imposed on the contract being exchanged.

• A section 403(b) contract is permitted to be transferred to another section 403(b) plan ( i.e. , the section 403(b) contracts held thereunder, including any assets held in a custodial account or retirement income account that are treated as section 403(b) contracts) if the following conditions are satisfied: (1) The participant or beneficiary whose assets are being transferred is an employee of the employer providing the receiving plan, (2) the transferor plan provides for transfers, (3) the receiving plan provides for the receipt of transfers, (4) the participant or beneficiary whose assets are being transferred has an accumulated benefit immediately after the transfer at least equal to the accumulated benefit with respect to that participant or beneficiary immediately before the transfer, and (5) the receiving plan provides that, to the extent any amount transferred is subject to any section 403(b) distribution restrictions, the receiving plan imposes restrictions on distributions to the participant or beneficiary whose assets are being transferred that are not less stringent than those imposed on the transferor plan. In addition, if a plan-to-plan transfer does not constitute a complete transfer of the participant's or beneficiary's interest in the section 403(b) plan, then the transferee plan must treat the amount transferred as a continuation of a pro rata portion of the participant's or beneficiary's interest in the transferor section 403(b) plan ( e.g. , a pro rata portion of the participant's or beneficiary's interest in any after-tax employee contributions).

• A section 403(b) plan may provide for the transfer of its assets to a qualified plan under section 401(a) to purchase permissive service credit under a defined benefit governmental plan or to make a repayment to a defined benefit governmental plan.

Additional plan-to-plan transfer rules may apply in the event that a plan-to-plan transfer is made to or from a section 403(b) arrangement that is subject to Title I of ERISA. See section 208 of ERISA and regulations under section 414(l) of the Internal Revenue Code (which are the regulations interpreting section 208 of ERISA).

These proposed regulations generally require a section 403(b) plan to be a defined contribution plan. This requirement would not apply to certain church plans. Specifically, section 251(e)(5) of TEFRA permits a church arrangement in effect on September 3, 1982 (the date TEFRA was enacted) to not be treated as failing to satisfy the exclusion allowance limitations of section 403(b)(2) merely because it is a defined benefit plan and these regulations would allow such a plan to be continued. Any other defined benefit plan in existence on the effective date of these regulations that has taken the position, based on a reasonable interpretation of the statute, that it satisfies section 403(b) would not be subject to the requirement in these regulations that the plan be a defined contribution plan for pre-effective date accruals, and such a plan might seek to take the position that it satisfies the section 401 qualified plan rules for subsequent accruals (assuming it satisfies those rules with respect to those accruals).

These proposed regulations also include proposed amendments to regulations under section 3121(a)(5)(D), defining salary reduction agreement for purposes of the Federal Insurance Contributions Act (FICA). The text of the proposed amendments is the same as that of temporary regulations being issued under section 3121(a)(5)(D) in this same issue of the Federal Register . The proposed regulations under section 3121(a)(5)(D) would be applicable on November 16, 2004.

These regulations (other than the proposed amendments to regulations under section 3121(a)(5)(D)) are proposed to be generally applicable for taxable years beginning after December 31, 2005. However, there are certain transition rules. Under one transition rule, for a section 403(b) contract maintained pursuant to a collective bargaining agreement that is ratified and in effect when the final regulations are issued, the regulations would not apply until the collective bargaining agreement terminates (determined without regard to any extension thereof after the date of publication of final regulations). Under another transition rule, for a section 403(b) contract maintained by a church-related organization for which the authority to amend the contract is held by a church convention (within the meaning of section 414(e)), the regulations would not apply before the earlier of (i) January 1, 2007 or (ii) 60 days following the earliest church convention that occurs after the date of publication of final regulations. These proposed regulations cannot be relied upon until adopted in final form.

It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations.

It is hereby certified that the collection of information in these regulations will not have a significant economic impact on a substantial number of small entities. This certification is based upon the determination that respondents will need to spend minimal time (an average of 1/2 hour per year) giving the statutorily required notice to departing employees. Therefore, a Regulatory Flexibility Analysis is not required under the Regulatory Flexibility Act (5 U.S.C. chapter 6).

Pursuant to section 7805(f) of the Internal Revenue Code, this notice of proposed rulemaking will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact on small business.

Before these proposed regulations are adopted as final regulations, consideration will be given to any written comments (a signed original and eight (8) copies) or electronic comments that are submitted timely to the IRS. Comments are requested on all aspects of the proposed regulations. In addition, comments are specifically requested on the clarity of the proposed regulations and how they can be revised to be more easily understood. All comments will be available for public inspection and copying.

Comments are also requested on the following:

• As indicated above, the IRS expects to obsolete a number of revenue rulings, notices, and other guidance when these regulations are issued in final form, including guidance that is now outdated as a result of changes in the law, and guidance that will become outdated by final regulations. Other previously issued guidance is expected to continue in effect. Comments are requested as to whether any previously issued guidance should be added or deleted from either list, with respect to the scope of this obsolescence, and also with respect to whether there are any aspects that should to be preserved in the guidance that is expected to be obsolete.

• The Treasury Department and the IRS are requesting comments describing the issues and suggesting methods of clarifying the interaction between the employer activities required under these proposed regulations for an arrangement to satisfy section 403(b) and the employer conduct that will give rise to the establishment and maintenance of an employee pension benefit plan covered under Title I of ERISA. The Treasury Department and the IRS will forward a copy of the comments on this issue to the Department of Labor.

• These proposed regulations authorize the Commissioner to issue rules to determine the amount of contributions for a participant in a defined benefit plan under section 402(b) (relating to the tax treatment of contributions to nonqualified plans). Comments are requested on the methodology and assumptions that should be used for this purpose, including specifically whether the methodology and assumptions should be the same as those currently in the regulations under section 403(b), whether revisions should be made to reflect the possibility that a nonqualified plan might include an early retirement subsidy, and whether the assumptions currently applicable under the section 403(b) regulations should be updated (for example, to match the assumptions in Rev. Proc. 2004-37 (2004-2 I.R.B. 26), relating to determining the extent to which certain pension payments made to a nonresident alien are not U.S. source income).

• With respect to includible compensation, comments are requested on whether the Treasury Department and IRS have the authority to permit 403(b) plans to use compensation, as defined in section 415(c)(3) without regard to section 415(c)(3)(E), in lieu of the definition of includible compensation under section 403(b)(3) and, if so, whether this should be done.

• With respect to the universal availability rule, comments are requested on whether the requirement should apply separately to employees covered by a collective bargaining unit. Comments are also requested on whether plans that exclude any of the following additional types of employees (as has been permitted under Notice 89-23) should be permitted to continue to exclude these types of employees for at least some period of time: employees who make a one-time election to participate in a governmental plan described in section 414(d) instead of a section 403(b) plan; professors who are providing services on a temporary basis to another public school for up to one year and for whom section 403(b) contributions are being made at a rate no greater than the rate each such professor would receive under the section 403(b) plan of the original public school; employees who are affiliated with a religious order and who have taken a vow of poverty where the religious order provides for the support of such employees in their retirement; and employees who are covered by a collective bargaining agreement.

• The controlled group rules in these proposed regulations for tax-exempt entities generally do not apply to certain church entities. Comments are requested on whether these rules should be extended to such church entities.

A public hearing has been scheduled for February 15, 2005, at 10 a.m. in the IRS Auditorium (7th Floor), Internal Revenue Building, 1111 Constitution Avenue, NW., Washington DC. All visitors must present photo identification to enter the building. Because of access restrictions, visitors will not be admitted beyond the immediate entrance area at the Constitution Avenue entrance more than 30 minutes before the hearing starts. For information about having your name placed on the building access list to attend the hearing, see the FOR FURTHER INFORMATION CONTACT section of this preamble.

The rules of 26 CFR 601.601(a)(3) apply to the hearing.

Persons who wish to present oral comments at the hearing must submit electronic or written comments and an outline of the topics to be discussed and the time to be devoted to each topic (a signed original and eight (8) copies) by January 25, 2005. A period of 10 minutes will be allotted to each person for making comments. An agenda showing the scheduling of the speakers will be prepared after the deadline for receiving outlines has passed. Copies of the agenda will be available free of charge at the hearing.

The principal authors of these regulations are R. Lisa Mojiri-Azad and John Tolleris, Office of the Division Counsel/Associate Chief Counsel (Tax Exempt and Government Entities), IRS. However, other personnel from the IRS and the Treasury Department participated in their development.

Accordingly, 26 CFR parts 1 and 31 are proposed to be amended as follows:

This proposal addresses the following local rules: ICAPCD Rules 403 and 405. In the Rules and Regulations section of this Federal Register , we are approving these local rules in a direct final action without prior proposal because we believe these SIP revisions are not controversial. If we receive adverse comments, however, we will publish a timely withdrawal of the direct final rule and address the comments in subsequent action based on this proposed rule. Please note that if we receive adverse comment on an amendment, paragraph, or section of this rule and if that provision may be severed from the remainder of the rule, we may adopt as final those provisions of the rule that are not the subject of an adverse comment.

We do not plan to open a second comment period, so anyone interested in commenting should do so at this time. If we do not receive adverse comments, no further activity is planned. For further information, please see the direct final action.

Section 312(b)-(e) of the Magnuson-Stevens Fishery Conservation and Management Act (16 U.S.C. 1861a(b) through (e)) (the Act) generally authorized fishing capacity reduction programs (programs). In particular, section 312(d) of the Act (section 312(d)) authorized industry fee systems (fee systems) for repaying fishing capacity reduction loans (reduction loans) which finance program costs.

Subpart L of 50 CFR part 600 contains the framework regulations (framework regulations) generally implementing section 312(b)-(e) of the Act.

Sections 1111 and 1112 of the Merchant Marine Act, 1936 (46 App. U.S.C. 1279f and 1279g) generally authorized reduction loans.

Section 212 of Division B, Title II, of Public Law 108-7 (section 212) specifically authorized a $46 million program (groundfish program) for that portion of the limited entry trawl fishery under the Pacific Coast Groundfish Fishery Management Plan whose permits, excluding those registered to whiting catcher-processors, were endorsed for trawl gear operation (reduction fishery). Section 212 also authorized a fee system for repaying the reduction loan partially financing the groundfish program's cost. The fee system includes both the reduction fishery and the fisheries for California, Washington, and Oregon coastal Dungeness crab and pink shrimp (fee share fisheries).

Section 501(c) of Division N, Title V, of Public Law 108-7 (section 501(c)) appropriated $10 million to partially fund the groundfish program's cost.

Public Law 107-206 authorized a $36 million reduction loan financing up to $36 million of the groundfish program's cost.

Section 212 required NMFS to implement the groundfish program by a public notice in the Federal Register . NMFS published the groundfish program's initial public notice on May 28, 2003 (68 FR 31653) and final notice on July 18, 2003 (68 FR 42613). Anyone interested in the groundfish program's full implementation details should refer to these two notifications.

The groundfish program's maximum cost was $46 million, consisting of a $10 million appropriation and a $36 million reduction loan. Voluntary participants in the groundfish program relinquished, among other things, their fishing permits and licenses in the reduction fishery and the fee share fisheries, their fish catch histories in these fisheries, and their vessels' worldwide fishing privileges in return for a reduction payment whose amount the participant's bid determined.

On July 18, 2003, NMFS invited groundfish program bids from the reduction fishery's permit holders. The bidding period opened on August 4, 2003, and closed on August 29, 2003. NMFS scored each bid's amount against the bidder's past ex-vessel revenues and, in a reverse auction, accepted the bids whose amounts were the lowest percentages of the revenues. This created reduction contracts whose performance was subject only to a successful referendum about the fee system required to repay the reduction loan.

Bid offers totaled $59,786,471. NMFS accepted bids totaling $45,662,471. The next lowest scoring bid would have exceeded the groundfish program's maximum cost. The accepted bids involved 91 fishing vessels as well as 239 fishing permits (91 in the reduction fishery, 121 in the fee-share fisheries, and 27 other Federal permits).

In accordance with the section 212 formula, NMFS allocated portions of the prospective $35,662,471 reduction loan to the reduction fishery and each of the six fee share fisheries, as follows:

(1) Reduction fishery, $28,428,719; and

(2) Fee share fisheries:

(a) California Dungeness crab, $2,334,334,

(b) California pink shrimp, $674,202,

(c) Oregon Dungeness crab, $1,367,545,

(d) Oregon pink shrimp, $2,228,845,

(e) Washington Dungeness crab, $369,426, and

(f) Washington pink shrimp, $259,400.

NMFS next held a referendum about the fee system. The reduction contracts would have become void unless the majority of votes cast in the referendum approved the fee system. On September 30, 2003, NMFS mailed ballots to referendum voters in the reduction fishery and the six fee share fisheries. The voting period opened on October 15, 2003, and closed on October 29, 2003. NMFS received 1,105 responsive votes. In accordance with the section 212 formula, NMFS weighted the votes from each of the seven fisheries. Over 85% of the weighted votes approved the fee system. This successful referendum result removed the only condition precedent to reduction contract performance.

On November 4, 2003, NMFS published another Federal Register document (68 FR 62435) advising the public that NMFS would, beginning on December 4, 2003, tender the groundfish program's reduction payments to the 91 accepted bidders. On December 4, 2003, NMFS required all accepted bidders to permanently stop all further fishing with the reduction vessels and permits. Subsequently, NMFS:

(1) Disbursed $45,662,471 in reduction payments to 91 accepted bidders;

(2) Revoked the relinquished Federal permits;

(3) Advised California, Oregon, and Washington about the relinquished state permits;

(4) Arranged with the National Vessel Documentation Center for revocation of the reduction vessels' fishery trade endorsements; and

(5) Notified the U.S. Maritime Administration to restrict placement of the reduction vessels under foreign registry or their operation under the authority of foreign countries.

Section 501(c) also requires the groundfish program, among other things, to ensure “that the owners of * * * [groundfish program reduction vessels] will operate only under the United States flag or be scrapped as a reduction vessel pursuant to section 600.1011(c) of title 50, Code of Federal Regulations.”

NMFS has completed the groundfish program except for implementing the fee system and providing for certain aspects of the reduction vessels' post-reduction operation. This action proposes to implement the groundfish program's fee system. A later action will separately propose regulations providing for certain aspects of the reduction vessel's post-reduction operation and such other groundfish program matters as may require regulation.

Sections 600.1013 of the framework regulations govern the payment and collection of fees under a fee system.

Basically, the first ex-vessel buyers (fish buyers) of post-reduction fish subject to a fee system (fee fish) must withhold the fee from the trip proceeds which the fish buyers would otherwise have paid to the parties who harvested and first sold (fish sellers) the fee fish to the fish buyers. Fish buyers calculate the fee to be collected by multiplying the applicable fee rate times the fee fish's full delivery value. Delivery value is the fee fish's full fair market value, including all in-kind compensation or other goods or services exchanged in lieu of cash.

Fish buyers collect the fee when they withhold it from trip proceeds, and fish sellers pay the fee when the fish buyers withhold it. Fee payment and fee collection is mandatory, and there are substantial penalties for failing to pay and collect fees in accordance with the applicable regulations.

Section 600.1014 governs fish buyers' depositing and disbursing collected fees as well as their keeping records of, and reporting about, collected fees.

Basically, fish buyers must, no less frequently than at the end of each business week, deposit collected fees in segregated and Federally insured accounts until, no less frequently than on the last business day of each month, they disburse all collected fees in the accounts to a lockbox which NMFS specifies for this purpose. Settlement sheets must accompany these disbursements. Fish buyers must maintain specified fee collection records for at least three years and submit to NMFS annual reports of fee collection and disbursement activities.

All parties interested in this proposed action should carefully read the following sections of the framework regulations, whose detailed provisions this action proposes to apply to the groundfish program's reduction loan and the fee system for repaying the reduction loan:

(1) Section 600.1012;

(2) Section 600.1013;

(3) Section 600.1014;

(4) Section 600.1015;

(3) Section 600.1016; and

(4) Applicable portions of Section 600.1017.

Section 212 provided an option for NMFS to enter into agreements with California, Washington, and Oregon regarding groundfish program fees in the fee share fisheries. While this would not have involved actual fee collection (because both section 312(d) and the framework regulations require fish buyers to collect the fee), it would have allowed fish buyers to use existing state systems for post-collection fee administration.

After all three states enacted legislation which would allow them to function in this capacity, NMFS evaluated the feasibility of exercising the section 212 option. NMFS concluded, however, that the option was not feasible because, among other reasons:

(1) The state systems sometimes:

(a) Assess and collect fees based on pounds rather than on dollars,

(b) Neither assess nor collect fees at the point of fish sale, and/or

(c) Involve quarterly fee disbursements;

(2) One state's legislation regarding this option authorizes participation of a state agency different from the one administering the existing state system (and might require amendment);

(3) One state's legislation regarding the section 212 option expires in less than two years;

(4) All states indicated that funding and staffing, under the section 212 option, for the reduction loan's 30-year term would be problematic; and

(5) The states' collection systems are dissimilar and, without significant modification, might not promote efficient and uniform groundfish program fee collection.

Accordingly, NMFS decided that the section 212 option was not feasible at this time.

NMFS intends to enter into landing and permit data sharing agreements with the states in order for NMFS to receive landing and permit information that will allow it to ensure full groundfish program fee payment, collection, and disbursement under the framework rule provisions.

NMFS proposes, in accordance with section 600.1013(d) of the framework regulations, to establish the initial fee applicable to the reduction fishery and to each fee share fishery by Federal Register notification and by separate mailed notification to each fish seller and fish buyer affected of whom NMFS then has notice. This notification will not occur until after NMFS has adopted a final rule following its review of public comment about this proposed rule. Until such notification actually occurs, fish sellers and fish buyers should neither pay nor collect the groundfish program fee. Prospectively, however, the initial fee rates would be:

(1) Reduction fishery, 5%; and

(2) Fee share fisheries:

(a) California Dungeness crab, 1.24%,

(b) California pink shrimp, 4.24%,

(c) Oregon Dungeness crab, 0.55%,

(d) Oregon pink shrimp, 2.33%,

(e) Washington Dungeness crab, 0.16%, and

(f) Washington pink shrimp, 1.50%.

The $35,662,471 principal amount of the reduction loan began accruing interest on March 1, 2004 at a fixed interest rate of 6.97%.

The Assistant Administrator for Fisheries, NMFS, determined that this proposed rule is consistent with the Magnuson-Stevens Fishery Conservation and Management Act and other applicable laws.

In compliance with the National Environmental Policy Act, NMFS prepared an EA for the final notice implementing the groundfish program. The EA discusses the impact of the groundfish program on the natural and human environment and resulted in a finding of no significant impact. The EA considered the implementation of this fee collection system, among other alternatives. Therefore this proposed action has earned a categorical exclusion from additional analysis. NMFS will send the EA to anyone who requests it (see ADDRESSES ).

This proposed rule has been determined to be not significant for purposes of Executive Order 12866. NMFS prepared an RIR for the final notice implementing the groundfish program. NMFS will send the RIR to anyone who requests it (see ADDRESSES ).

NMFS prepared an IRFA as required by Section 603 of the Regulatory Flexibility Act. The IRFA, describes the impact this proposed rule, if adopted, would have on small entities. A summary of the IRFA follows. NMFS will send a complete copy to anyone who requests it (see ADDRESSES).

Description of Reasons for Action and Statement of Objective and Legal Basis: Section 212 of division B, Title II, of Public Law 108-7 (section 212) specifically authorized a $46 million fishing capacity reduction program for that portion of the limited entry trawl fishery under the Pacific coast Groundfish Fishery Management Plan whose permits, excluding those registered to whiting catcher-processors, were endorsed for trawl gear operation (reduction fishery). Section 212 also authorized a fee system for repaying the reduction loan partially financing the groundfish program's cost. The fee system includes both the reduction fishery and the fisheries for California, Washington, and Oregon coastal Dungeness crab and pink shrimp (fee share fisheries).

Section 501(b) of Division N, Title V, of Public Law 108-7 (section 501(b)) appropriated $10 million to partially fund the groundfish program's cost. Public Law 107-206 authorized a $36 million reduction loan financing up to $36 million of the groundfish program's cost. Pursuant to section 212, NMFS implemented the groundfish program by initial public notice on May 28, 2003 (68 FR 31653) and final notice on July 18, 2003 (68 FR 42613).

NMFS has completed the groundfish program except for implementing the fee system and providing for certain aspects of the reduction vessels' post-reduction operation. This action proposes to implement the groundfish program's fee system.

Description of Small Entities to Which the Rule Applies: The Small Business Administration (SBA) has defined all fish harvesting businesses that are independently owned and operated, not dominant in its field of operation, and with annual receipts of $3.5 million or less as small entities. In addition, processors with 500 or fewer employees, involved in related industries such as canned and cured fish and seafood, or preparing fresh fish and seafood, are also considered small entities. According to the SBA's definition of a small entity, virtually all of the approximate 1,800 catcher vessels are considered small entities. This includes the remaining 172 groundfish trawl permits and over 1,600 fee share permits.

Description of Recordkeeping and Compliance Costs: Please see collection-of-information requirements listed below.

Duplication or Conflict with Other Federal Rules: This rule does not duplicate or conflict with any Federal rules.

Description of Significant Alternatives Considered: Three alternatives have been considered: (1) Status Quo (no fee system); (2) Statutorily Mandated Reduction Program with Fee Collection; and (3) Statutorily Mandated Reduction Program with Fee Collection Cooperation by States.

Status Quo (Alternative 1): Under the status quo, vessel profitability would not be affected. The status quo represents a significant alternative compared to the proposed action because it minimizes impacts on post reduction fishermen because they do not pay fees on landings, however, this alternative was not chosen because it is contrary to Pub. Law 107-206.

Statutorily Mandated Reduction Program with Fee Collection (Alternative 2): Under Alternative 2, the preferred alternative, the first ex-vessel buyers (fish buyers) of post-reduction fish subject to a fee system (fee fish) would withhold the fee from the trip proceeds which the fish buyers would otherwise have paid to the parties who harvested and first sold (fish sellers) the fee fish to the fish buyers. Fish buyers calculate the fee to be collected by multiplying the applicable fee rate times the fee fish's full delivery value. Delivery value is the fee fish's full fair market value, including all in-kind compensation or other goods or services exchanged in lieu of cash. This is the preferred alternative because it is mandated by Pub. Law 107-206.

Statutorily Mandated Reduction Program with Fee Collection Cooperation by States (Alternative 3): Like Alternative 2, Alternative 3 would have an adverse effect on vessel profitability; though the extent of that adverse effect it is not yet clear. Alternative 3 would leave the design of the fee collection system to the individual states. This alternative was not chosen because such state systems would:

(a) Assess and collect fees based on pounds rather than on dollars,

(b) Neither assess nor collect fees at the point of fish sale, and

(c) Involve quarterly fee disbursements.

In addition, one state's legislation regarding fee collection authorizes participation of a state agency different from the one administering the existing state system. Another state's fee collection legislation expires in less than two years. Furthermore, all states indicated that funding and staffing for the reduction loan's 30-year term would be problematic. Finally, the states' collection systems are dissimilar and, without significant modification, might not promote efficient and uniform groundfish program fee collection.

Steps the Agency Has Taken to Mitigate Negative Effects of the Action: With the lack of available cost data, increases in revenues may serve as a proxy for increased profitability. Further, in light of available revenue data, and assuming that each individual vessel shares in the increased revenues resulting from the groundfish program, the comparison of the relative effects of the program versus the effects of the fees show that overall economic benefits of the program would still be greater than the relative fees charged under this rule. NMFS is not aware of any other measures that could reduce the impact on small entities and still meet statutory requirements. However, NMFS welcomes comments that relay such ideas.

This proposed rule contains collection-of-information requirements subject to the Paperwork Reduction Act (PRA). OMB has approved these information collections under OMB control number 0648-0376. NMFS estimates that the public reporting burden for these requirements will average:

(1) 2 hours for submitting a monthly fish buyer settlement sheet;

(2) 4 hours for submitting an annual fish buyer report; and

(3) 2 hours for making a fish buyer/fish seller report when one party fails to either pay or collect the fee.

These response estimates include the time for reviewing instructions, searching existing data sources, gathering and maintaining the data needed, and completing and reviewing the information collection. Send comments regarding this burden estimate, or any other aspect of this data collection, including suggestions for reducing the burden, to both NMFS and OMB (see ADDRESSES ).

Notwithstanding any other provision of law, no person is required to respond to, and no person is subject to a penalty for failure to comply with, an information collection subject to the requirements of the PRA unless that information collection displays a currently valid OMB control number.

NMFS has determined that this proposed rule will not significantly affect the coastal zone of any state with an approved coastal zone management program. This determination has been submitted for review by the States of Washington, Oregon, and California.

Fisheries, Fishing capacity reduction, Fishing permits, Fishing vessels, Intergovernmental relations, Loan programs business, Reporting and recordkeeping requirements.

For the reasons in the preamble, the National Marine Fisheries Service proposes to amend 50 CFR part 600 as follows:

1. The authority citation for part 600 is revised to read as follows:

2. Section 600.1102 is added to subpart M to read as follows:

The reef fish fishery of Puerto Rico and of the U.S. Virgin Islands is managed under the Fishery Management Plan for the Reef Fish Fishery of Puerto Rico and of the U.S. Virgin Islands (FMP). The FMP was prepared by the Council and is implemented under the authority of the Magnuson-Stevens Fishery Conservation and Management Act (Magnuson-Stevens Act) by regulations at 50 CFR part 622.

Grammanik Bank lies on the shelf edge approximately 7 miles (11.3 km) south of Water Island, St. Thomas, U.S. Virgin Islands. The actual coral bank extends 1.05 miles (1.69 km) along the shelf edge and is approximately 328 ft (100 m) wide at its widest point. Researchers at the University of the Virgin Islands have documented that yellowfin grouper aggregate to spawn on Grammanik Bank from February through April each year, with peak spawning occurring around the full moon in March.

Yellowfin grouper are a long-lived, slow-growing species and, therefore, have a higher susceptibility to overfishing. Based on the preferred stock status criteria alternatives contained in the Council's Draft Amendment to the Fishery Management Plans (FMPs) of the U.S. Caribbean to Address Required Provisions of the Magnuson-Stevens Fishery Conservation and Management Act (SFA Amendment), yellowfin grouper would be considered to be undergoing overfishing, and the stock would be considered to be overfished.

Prior to 2000, the yellowfin grouper spawning aggregation appears to have been relatively unexploited. However, anecdotal information from fishermen indicates that significant quantities of yellowfin grouper were harvested from Grammanik Bank during the spawning aggregations in recent years. Underwater visual censuses conducted by researchers at the University of the Virgin Islands in March 2002 and 2003 revealed only small numbers of yellowfin grouper (i.e., 50 to 60) present during the peak spawning period. Based on this apparent reduction in abundance, representatives of the University of the Virgin Islands and two environmental organizations recently expressed concern about the apparent increased fishing mortality on the yellowfin grouper spawning aggregation and recommended that emergency action be undertaken to protect yellowfin grouper during the peak spawning period. After considering all available information, including commercial landings data from the U.S. Virgin Islands that support the SFA Amendment's discussion of the overfished status of the yellowfin grouper stock, visual census data from researchers at the University of the Virgin Islands, and other relevant biological studies referenced in the supporting environmental assessment (EA), the Council, at its August 2004 meeting, requested NMFS to draft a rule that would implement interim measures to protect yellowfin grouper during the 2005 spawning season. Consistent with the Council's request, this proposed rule would implement interim measures to protect the yellowfin grouper spawning aggregation during the 2005 spawning season. Subsequent, long-term protection of the spawning aggregation would be addressed in measures contained in the SFA Amendment, which is currently under development and, if approved by NMFS, would be expected to be implemented in mid to late 2005.

This proposed rule would prohibit fishing for or possession of any species of fish, other than a highly migratory species, within the Grammanik Bank closed area from February 1, 2005, through April 30, 2005. For the purposes of this rule, the term “highly migratory species” means bluefin, bigeye, yellowfin, albacore, and skipjack tunas; swordfish; sharks (listed in appendix A to 50 CFR part 635); white marlin, blue marlin, sailfish, and longbill spearfish. The Grammanik Bank closed area encompasses an area approximately 2.5 nm (4.6 km) by 2.75 nm (5.1 km) and is bounded by rhumb lines connecting, in order, the following points:

At this time, NMFS has not determined that the interim measures that this proposed rule would implement are consistent with the national standards of the Magnuson-Stevens Act and other applicable laws. NMFS, in making that determination, will take into account the data, views, and comments received during the comment period on this proposed rule.

This proposed rule has been determined to be not significant for purposes of Executive Order 12866.

NMFS prepared an EA for the interim measures that this proposed rule would implement. The EA discusses the impact on the environment as a result of this rule. A copy of the EA is available from NMFS (see ADDRESSES ).

NMFS prepared an initial regulatory flexibility analysis (IRFA) as required by section 603 of the Regulatory Flexibility Act. The IRFA, which is contained in the EA, describes the economic impact this proposed rule, if adopted, would have on small entities. A description of the action, why it is being considered, and the legal basis for this action are contained at the beginning of this section in the preamble and in the SUMMARY section of the preamble. A summary of the analysis follows. A copy of this analysis is available from NMFS (see ADDRESSES ).

The proposed rule is intended to protect an important spawning aggregation of yellowfin grouper, to help arrest the decline in the resource, and to support its recovery. The Magnuson-Stevens Act, as amended, provides the statutory basis for the rule.

The proposed rule is intended to implement, on an interim basis, an action currently included in the Draft SFA Amendment. The SFA Amendment is expected to be implemented prior to the 2006 fishing year. This proposed rule would be an interim action providing protection of an important yellowfin grouper spawning aggregation during the 2005 spawning season and would expire prior to the implementation of the SFA Amendment. No duplicate, overlapping or conflicting rules have been identified.

There are two general classes of small business entities that would be directly affected by the rule: commercial fishing vessels and for-hire fishing vessels. The Small Business Administration defines a small business that engages in commercial fishing as a firm that is independently owned and operated, that is not dominant in its field of operation, and that has annual receipts up to $3.5 million per year. The revenue benchmark for a small business that engages in charter fishing is a firm with receipts up to $6.0 million.

There are an estimated 342 registered commercial fishing vessels in the U.S. Virgin Islands. The majority of participants are part-time fishermen. Total annual average dockside revenues from commercial fishing activity are estimated at $1.72 million, or an average of $5,000 per registered vessel. Given the average revenue estimates of the fleet, all commercial entities are determined to be small business entities. It cannot be precisely determined how many of the commercial vessels that operate in the U.S. Virgin Islands would be affected by the proposed rule, though the rule would apply to all commercial fishing vessels. NMFS assumes that indirect impacts would be incurred industry-wide, and that all the commercial fishing entities that would be affected by the rule are small entities.

An estimated 27 year-round charter fishing operations operate in the U.S. Virgin Islands, with an unknown number of seasonal operations. No information exists on the business profile of this fleet. However, the average gross revenue for charter vessels operating in Florida is estimated at $68,000, and ranges from $26,000 (South Carolina) to $82,000 (Alabama) for other areas in the southeastern U.S. No information exists to suggest that the revenue profile of charter vessels that operate in the U.S. Virgin Islands is substantially different from these estimates, so NMFS concludes that all charter vessels operating in the U.S. Virgin Islands are small business entities. It cannot be determined how many of the charter vessels that operate in the U.S. Virgin Islands would be affected by the proposed rule, though the rule would apply to all charter vessels. NMFS assumes that indirect effects would be incurred industry-wide, and that all the charter fishing entities that would be affected by the rule are small entities.

The rule does not impose any reporting or record keeping requirements.

Since the proposed rule would apply to all commercial and charter fishing entities and all entities operating in the fishery are assumed to be small entities, the criterion of a substantial number of the small business entities will be met.

The outcome of “significant economic impact” can be ascertained by examining two issues: disproportionality and profitability. The criterion for disproportionality is whether the regulations place a substantial number of small entities at a significant competitive disadvantage to large entities. All entities affected by the proposed rule are considered small entities so that the issue of disproportionality does not arise. The criterion regarding profitability is whether the regulations significantly reduce profit for a substantial number of small entities. No precise estimates of the profits of either the commercial fishing vessels or the charter vessels that are expected to be affected by the proposed rule are available. However, even though it is recognized that not all water habitat is equally productive, the proposed rule would affect only approximately 3 percent of the available water area in the less than 100-fathom (183-m) depth range and close the area to fishing for only 25 percent of the year. Thus, less than 1 percent of available fishing area and time would be affected. Although it is likely that harvests from this area during this time period may exceed 1 percent by a negligible amount for certain species or fishing operations, the proposed restriction is expected to be sufficiently small so as to not substantially affect the profits of a substantial number of small entities.

Including the no-action alternative, five alternatives were considered in addition to the proposed rule. The no-action alternative would not impose any closure in the target area, thereby allowing all current fishing practices. This would eliminate all short-term adverse impacts expected to result from the closure. However, spawning protection of yellowfin grouper would not be provided, thereby forgoing the benefits of rebuilding the stock, and the action would, therefore, not be consistent with the Council's intent. The remaining four alternatives differ in the geographic size and time duration of the closure. Alternative 3 would establish closure over a larger geographic area than the proposed rule, 17.5 nm 2 (60 km 2 ) vs. 6.88 nm 2 (28.60 km 2 ), but would not encompass the entire period during which yellowfin grouper are known to spawn, thereby potentially negating the purpose and effectiveness of the closure. However, potential benefits to coral habitats, to the extent they occur within the proposed boundaries, could be greater than those in Alternative 2. Alternatives 4 and 6 would only establish closure in a 1 nm 2 (3.4 km 2 ) area, an area insufficient to afford the necessary protection. Alternative 4 would additionally not encompass the full spawning period and may allow fishing pressure to significantly impact an aggregation that is still present in the latter half of April. Alternative 6 would encompass the entire spawning period, but would continue the closure longer than is believed necessary. Alternative 5 would encompass 5 nm 2 (17.2 km 2 ), smaller than that in Alternative 2 but possibly affording sufficient geographic scope. However, Alternative 5 would also extend the closure for an additional month, which is longer than necessary and would, therefore, impose unnecessary adverse impacts. In addition, potential benefits to coral habitats, to the extent they occur within the proposed boundaries, could be slightly less than those in Alternative 2. Among the alternatives, only the proposed alternative meets the geographic and temporal scope necessary to meet the management objectives.

For the reasons set out in the preamble, 50 CFR part 622 is proposed to be amended as follows:

1. The authority citation for part 622 continues to read as follows:

2. In § 622.33, paragraph (a)(4) is added to read as follows:

The commercial fishery for grouper in the Gulf of Mexico is managed under the Fishery Management Plan for the Reef Fish Resources of the Gulf of Mexico (FMP). The FMP was prepared by the GMFMC, and implemented under the authority of the Magnuson-Stevens Fishery Conservation and Management Act. A moratorium on the issuance of new commercial reef fish permits was established by Amendment 4 to the FMP in May 1992. The moratorium has been maintained since that time with the implementation of Amendments 9, 11, and 17, and is scheduled to expire on December 31, 2005. The GMFMC is currently finalizing Amendment 24 to the FMP that would again extend the moratorium.

The GMFMC anticipates that additional future action may be necessary to control effort in the Gulf of Mexico grouper fishery by further restricting the number of participants. The GMFMC has been advised by NMFS that the grouper resources of the Gulf EEZ are fully exploited, especially red grouper and the aggregate of deep-water groupers, and the fisheries currently operate under restrictive quotas. As such, the GMFMC is concerned that the current level of participation and effort in the grouper fishery of the Gulf of Mexico may not be maximizing the economic benefits that could be derived from the resource and that future increases in participation or effort could further reduce economic benefits. In anticipation of future action to establish an IFQ for the grouper fishery of the Gulf of Mexico, at its October 2004 meeting, the GMFMC approved a motion stating:

Should the GMFMC take future action to further restrict participation in the fishery, it may use October 15, 2004, as a possible control date regarding the eligibility of catch histories. Implementation of any program to restrict access in the grouper fishery would require preparation of an amendment to the FMP and publication of a notice of availability of the amendment with a comment period, publication of a proposed rule with a public comment period, approval of the amendment, and issuance of a final implementing rule.

Consideration of a control date does not commit the GMFMC or NMFS to any particular management regime or criteria for eligibility in the commercial grouper fishery. The GMFMC may or may not make use of this control date as part of the qualifying criteria for participation in any future IFQ or other management program for the Gulf of Mexico grouper fishery. Fishermen are not guaranteed future participation in a fishery regardless of their entry date or intensity of participation in the fishery before or after the control date under consideration. The GMFMC subsequently may choose a different control date or a management regime that does not make use of a control date. The GMFMC also may choose to take no further action to control entry or access to the fisheries, in which case the control date may be rescinded.

The Magnuson-Stevens Act requires that each Regional Fishery Management Council submit any FMP amendment it prepares to NMFS for review and approval, disapproval, or partial approval. The Magnuson-Stevens Act also requires that NMFS, upon receiving a FMP amendment, immediately publish a notice in the Federal Register that the amendment is available for public review and comment.

The Council adopted Amendment 82 in June 2004 and clarified it in October 2004. If approved by NMFS, this amendment would establish a framework for management of the AI directed pollock fishery. The Consolidated Appropriations Act of 2004 (Public Law (Pub. L.) 108-199, Sec. 803) requires the AI directed pollock fishery to be allocated to the Aleut Corporation for economic development of Adak, Alaska. This action would establish the allocation of the directed pollock fishery to the Aleut Corporation and would specify the management provisions for this fishery.

Public Law 108-199 requires the Aleut Corporation's selection of participants in the AI directed pollock fishery and limits participation to American Fisheries Act (AFA, Pub. L. 105-277, Title II of Division C) qualified entities and vessels equal to or less than 60 feet (18.3 m) in length overall (LOA) with certain endorsements. Section 803(b) restricts the annual harvest of pollock in the AI directed pollock fishery by vessels equal to or less than 60 feet (18.3 m) LOA to less than 25 percent until 2009, and to less than 50 percent prior to 2013. These vessels must receive 50 percent of the directed pollock fishery allocation starting in 2013 and beyond. An FMP amendment and associated regulatory amendments are needed to implement these and other measures necessary to manage this fishery pursuant to provisions specified in Pub. L. 108-199.

Prior to Pub. L. 108-199, the AI directed pollock fishery was managed pursuant to the AFA. The AFA allocated the AI directed pollock fishery to specific harvesters and processors named in the AFA and specified in regulations at 50 CFR part 679. Public Law 108-199 allocates all of the AI directed pollock fishery to the Aleut Corporation. The implementation of Pub. L. 108-199 requires the amendment of AFA provisions in the FMP and in the regulations at 50 CFR part 679 to provide for the allocation of the AI directed pollock fishery to the Aleut Corporation and for the management of this fishery.

The management provisions of Amendment 82 include:

1. Allocation of the AI directed pollock fishery to the Aleut Corporation;

2. Harvest specifications provisions including limits on the size of the annual total allowable catch (TAC) of pollock, the seasonal apportionment of pollock TAC, the Council's policy on the methods of funding the AI directed pollock fishery within the 2 million metric ton (mt) maximum annual optimum yield for groundfish of the BSAI, and the Council's policy on reallocating unharvested amounts of the AI pollock allocation to the Bering Sea pollock allocation;

3. Fishery monitoring provisions including restrictions on having pollock from more than one area on a vessel at one time, observer and scale requirements, catch monitoring control plans for shoreside and stationary floating processors, and the Aleut Corporation's responsibilities for ensuring the harvest does not exceed the quotas;

4. Limitations on the pollock allocation to AFA qualified vessels and to vessels equal to or less than 60 feet (18.3 m) LOA until 2013, when at least 50 percent of the allocation must be to vessels equal to or less than 60 feet (18.3 m) LOA;

5. Reporting requirements; and

6. A new AI Chinook salmon prohibited species catch limit and revisions to Chinook salmon savings areas closure requirements.

Pollock is an important prey species for the endangered and threatened Steller sea lion populations. The Steller sea lion protection measures evaluated in the 2000 and 2001 Biological Opinions (see ADDRESSES ) were considered in the development of the management provisions of Amendment 82. The protection measures for Steller sea lions include spatial and temporal dispersion of pollock harvest. The pollock fishing closure areas in the AI would remain unchanged under Amendment 82 to ensure spatial dispersion of fishing effort. To temporally disperse harvest of prey species, the Steller sea lion protection measures implemented in the BSAI apportion 40 percent of pollock harvest to the A season and 60 percent to the B season. Amendment 82 would continue to temporally disperse pollock harvest with no more than 40 percent of the acceptable biological catch (ABC) authorized to be harvested in the A season. The total harvest of pollock in the Bering Sea subarea, including any rollover of unharvested AI pollock, also would remain well below the ABC so that overall harvest would be in proportion to biomass and less likely to compete with Steller sea lions for prey. Both of these harvest provisions satisfy the intent of the Steller sea lion protection measures.

Public comments are being solicited on proposed Amendment 82 through January 18, 2005. A proposed rule that would implement Amendment 82 will be published in the Federal Register for public comment at a later date, following NMFS' evaluation under the Magnuson-Stevens Act procedures. Public comments on the proposed rule must be received by the end of the comment period on the amendment in order to be considered in the approval/disapproval decision on the amendment. All comments received on the amendment by the end of the comment period, whether specifically directed to the amendment or to the proposed rule, will be considered in the approval/disapproval decision. Comments received after that date will not be considered in the approval/disapproval decision on the amendment. To be considered, comments must be received not just postmarked or otherwise transmitted by close of business on the last day of the comment period.