[Federal Register Volume 75, Number 96 (Wednesday, May 19, 2010)]
[Rules and Regulations]
[Pages 27927-27934]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-11924]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9484]
RIN 1545-BH04


Diversification Requirements for Certain Defined Contribution 
Plans

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations under section 
401(a)(35) of the Internal Revenue Code (Code) relating to 
diversification requirements for certain defined contribution plans 
holding publicly traded employer securities. These regulations will 
affect administrators of, employers maintaining, participants in, and 
beneficiaries of defined contribution plans that are invested in 
employer securities.

DATES: Effective date: These regulations are effective on May 19, 2010.
    Applicability date: These regulations apply for plan years 
beginning on or after January 1, 2011.

FOR FURTHER INFORMATION CONTACT: R. Lisa Mojiri-Azad or Jamie Dvoretzky 
at (202) 622-6060 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    This document contains final regulations under section 401(a)(35) 
of the Code, which was added by section 901 of the Pension Protection 
Act of 2006, Public Law 109-280 (120 Stat. 780 (2006)) (PPA '06).\1\
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    \1\ Section 901 of PPA '06 also added a parallel provision to 
section 401(a)(35) at section 204(j) of the Employee Retirement 
Income Security Act of 1974, Public Law 93-406 (88 Stat. 829 (1974)) 
(ERISA). Under section 101 of Reorganization Plan No. 4 of 1978 (43 
FR 47713), the Secretary of Treasury has interpretative jurisdiction 
over the subject matter addressed in these final regulations for 
purposes of section 204(j) of ERISA. Thus, the guidance provided in 
these final regulations with respect to section 401(a)(35) of the 
Code also applies for purposes of section 204(j) of ERISA.

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[[Page 27928]]

    Section 401(a)(35)(A) provides that a trust which is part of an 
applicable defined contribution plan is not a qualified trust under 
section 401(a) unless the plan satisfies the diversification 
requirements of section 401(a)(35)(B), (C), and (D). Under section 
401(a)(35)(B), each individual must have the right to direct the plan 
to divest employer securities allocated to the individual's account 
that are attributable to employee contributions or elective deferrals 
and to reinvest an equivalent amount in other investment options 
meeting the requirements of section 401(a)(35)(D).\2\
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    \2\ Section 401(a)(28)(B) provides certain diversification 
rights to participants in an employee stock ownership plan within 
the meaning of section 4975(e)(7) (ESOP). Section 401(a)(28)(B)(v), 
as added by section 901(a)(2)(A) of PPA '06, provides that section 
401(a)(28)(B) does not to apply to a plan to which section 
401(a)(35) applies.
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    Under section 401(a)(35)(C), each individual who is a participant 
who has completed at least three years of service, a beneficiary of a 
participant who has completed at least three years of service, or a 
beneficiary of a deceased participant must be permitted to elect to 
direct the plan to divest employer securities allocated to the 
individual's account and to reinvest an equivalent amount in other 
investment options meeting the requirements of section 401(a)(35)(D).
    Section 401(a)(35)(D)(i) requires an applicable defined 
contribution plan to offer individuals not less than three investment 
options, other than employer securities, to which the individuals may 
direct the proceeds from the divestment of employer securities, each of 
which is diversified and has materially different risk and return 
characteristics.
    Under section 401(a)(35)(D)(ii)(I), a plan does not fail to meet 
the requirements of section 401(a)(35)(D) if it allows individuals to 
divest employer securities and reinvest the proceeds at periodic, 
reasonable opportunities occurring no less frequently than quarterly.
    Under section 401(a)(35)(D)(ii)(II), a plan is not permitted to 
impose restrictions or conditions with respect to the investment of 
employer securities that are not imposed on the investment of other 
assets of the plan. However, this rule does not apply to restrictions 
or conditions imposed to comply with securities laws. The Secretary is 
authorized to issue regulations providing additional exceptions to the 
requirements of section 401(a)(35)(D)(ii)(II).
    An applicable defined contribution plan under section 401(a)(35) is 
a defined contribution plan that holds any publicly traded employer 
securities. A publicly traded employer security is defined as an 
employer security under section 407(d)(1) of the Employee Retirement 
Income Security Act of 1974, Public Law 93-406 (88 Stat. 829 (1974)) 
(ERISA) which is readily tradable on an established securities market. 
Section 401(a)(35)(F)(i) provides that a plan that holds employer 
securities that are not publicly traded employer securities is 
nevertheless treated as holding publicly traded employer securities if 
any employer corporation or any member of a controlled group of 
corporations which includes the employer (determined by applying 
section 1563(a), except substituting 50 percent for 80 percent) has 
issued a class of stock that is a publicly traded employer security. 
However, section 401(a)(35)(F) does not apply to a plan if no employer 
corporation, or parent corporation (as defined in section 424(e)) of an 
employer corporation, has issued any publicly traded employer security 
and no employer or parent corporation has issued any special class of 
stock which grants particular rights to, or bears particular risks for, 
the holder or issuer with respect to any corporation described in 
section 401(a)(35)(F)(i) which has issued any publicly traded employer 
security.
    Section 401(a)(35)(E) provides that section 401(a)(35) does not 
apply to an employee stock ownership plan within the meaning of section 
4975(e)(7) (ESOP) that holds no contributions (or earnings thereunder) 
that are subject to section 401(k) or (m) (generally relating to 
elective deferrals and matching and employee after-tax contributions) 
and the ESOP is a separate plan for purposes of section 414(l) with 
respect to any other defined benefit plan or defined contribution plan 
maintained by the same employer or employers. Section 401(a)(35)(E) 
further provides that section 401(a)(35) does not apply to one-
participant retirement plans (within the meaning of section 
401(a)(35)(E)(iv)).
    Section 401(a)(35) is generally effective for plan years beginning 
after December 31, 2006. Section 401(a)(35)(H) generally provides a 
three year phase-in rule with respect to an individual's right to 
direct the divestment of employer securities attributable to employer 
contributions, except with respect to certain participants who have 
attained age 55. Section 901(c)(2) of PPA '06 includes a special rule 
for a plan maintained pursuant to one or more collective bargaining 
agreements between employee representatives and one or more employers 
that was ratified on or before August 17, 2006. Under this rule, 
section 401(a)(35) is not effective until plan years beginning after 
the earlier of (1) the later of (a) December 31, 2007 or (b) the date 
on which the last of such collective bargaining agreements terminates 
(determined without regard to any extension thereof after August 17, 
2006) or (2) December 31, 2008.
    Section 101(m) of ERISA as amended by section 507 of PPA '06 
requires the plan administrator to furnish a notice to individuals not 
later than 30 days before the first date on which an individual is 
eligible to exercise his or her right to divest employer securities 
with respect to any type of contribution. The notice must set forth the 
diversification rights under section 204(j) of ERISA (which is the 
parallel provision in ERISA to section 401(a)(35)) and describe the 
importance of diversifying the investment of retirement account assets.
    Notice 2006-107 (2006-2 CB 1114 (December 18, 2006)), (see Sec.  
601.601(d)(2)(ii)(b)) includes guidance and transitional rules with 
respect to the diversification requirements of section 401(a)(35). 
Notice 2006-107 also includes guidance regarding the related notice 
requirements of section 101(m) of ERISA, including a model notice. 
Notice 2008-7 (2008-3 IRB 276 (January 22, 2008)), (see Sec.  
601.601(d)(2)(ii)(b)) extends the transitional guidance and 
transitional relief that was included in Notice 2006-107 until the 
final regulations become effective.
    Notice 2009-97 (2009-52 IRB 972 (December 28, 2009)), (see Sec.  
601.601(d)(2)(ii)(b)) extends the deadline for adopting an interim or 
discretionary plan amendment under certain provisions of PPA '06, 
including section 401(a)(35), to the last day of the first plan year 
that begins on or after January 1, 2010.
    On January 3, 2008, proposed regulations (REG-136701-07) under 
section 401(a)(35) of the Code were published in the Federal Register 
(73 FR 421). No public hearing was requested. Written comments 
responding to the notice of proposed rulemaking were received. After 
consideration of all the comments, the proposed regulations are 
adopted, as amended by this Treasury decision. The most significant 
revisions are discussed in the Summary of Comments and Explanation of 
Revisions.

[[Page 27929]]

Summary of Comments and Explanation of Revisions

Certain Defined Contribution Plans or Investment Funds Not Treated as 
Holding Employer Securities

    The proposed regulations provided that certain investment funds 
that include employer securities as part of a broader fund were treated 
as not holding employer securities. This exception was limited to the 
extent the employer securities were held indirectly through an 
investment company registered under the Investment Company Act of 1940; 
a common or collective trust fund or pooled investment fund maintained 
by a bank or trust company supervised by a State or a Federal agency; a 
pooled investment fund of an insurance company that is qualified to do 
business in a State; or any other investment fund designated by the 
Commissioner in revenue rulings, notices, or other guidance published 
in the Internal Revenue Bulletin. The proposed regulations also 
provided that this exception was limited to funds where the investment 
is independent of the employer and where the employer securities do not 
exceed 10 percent of the fund.
    Commentators requested that this exception be broadened to include 
funds that are managed by an investment manager within the meaning of 
section 3(38) of ERISA. The final regulations do not provide for this 
expansion because such a fund would not necessarily be holding employer 
securities only as an indirect result of its investment policy. 
However, the final regulations provide that, in the case of a 
multiemployer plan, an investment option will not be treated as holding 
employer securities to the extent the employer securities are held 
indirectly through an investment fund managed by an investment manager 
if the investment is independent of the employer and the percentage 
limitation rule is satisfied.
    The final regulations replace the reference to a fund that is an 
investment company registered under the Investment Company Act of 1940 
with a regulated investment company as described in Code section 
851(a). This change extends the types of investment companies to 
include exchange traded funds, which are unit investment trusts if they 
satisfy section 851(a). The final regulations also retain the rule from 
the proposed regulations that allows the Commissioner to designate 
additional types of funds as eligible for this exception.
    Commentators requested that the percentage limitation rule be 
eliminated. They argued that it would be difficult and costly to 
monitor the investment fund to ensure that the aggregate value of the 
employer securities held in such fund was not in excess of 10 percent 
of the total assets of all the fund's investments. In response to these 
comments, the final regulations provide that the determination of 
whether the value of employer securities exceeds 10 percent of the 
total value of the fund's investments is made for the plan year as of 
the end of the preceding plan year. The determination can be based on 
the information in the latest disclosure of the fund's portfolio 
holdings (for example, Form N-CSR, ``Certified Shareholder Report of 
Registered Management Investment Companies'') that was filed with the 
Securities and Exchange Commission in that preceding plan year.
    The final regulations also provide that in a case where a fund that 
indirectly holds employer securities fails to meet the requirement that 
the investment be independent of the employer (including the situation 
where the fund no longer meets the percentage limitation rule), the 
plan does not fail to satisfy the diversification requirements under 
section 401(a)(35) merely because it does not offer those rights for up 
to 90 days after the investment fund is treated as holding employer 
securities.

Prohibition on Restrictions or Conditions

    Section 401(a)(35)(D)(ii)(II) provides that a plan is not permitted 
to impose restrictions or conditions with respect to the investment of 
employer securities that are not imposed on the investment of other 
assets of the plan. Like the proposed regulations, the final 
regulations provide that the prohibition on restrictions or conditions 
with respect to the investment of employer securities applies to any 
direct or indirect restriction on an individual's right to divest an 
investment in employer securities that is not imposed on an investment 
that is not employer securities, as well as a direct or indirect 
benefit that is conditioned on investment in employer securities.
    The proposed regulations provided for a number of permitted 
restrictions and conditions. The proposed regulations would have 
permitted a plan to impose a restriction or condition either directly 
or indirectly because of applicable securities laws or because the plan 
becomes an applicable defined contribution plan, limits investments in 
employer securities, limits trading frequency, does not permit 
investment in a frozen fund, imposes a fee on other investment options 
that is not imposed on the investment in employer securities or imposes 
a reasonable fee on the divestment of employer securities, or allows 
investments to be made in a stable value or similar fund more 
frequently than other investment funds.
    A commentator requested clarification with respect to the exception 
for frozen funds. The commentator requested that a frozen fund include 
a plan that reinvests employer security dividends in additional 
employer securities as long as the plan does not permit any further 
investment in employer securities. The final regulations clarify that 
the plan is permitted to allow reinvestment of dividends paid on 
employer securities. The final regulations also clarify that the frozen 
fund exception is only available for a plan that does not have another 
employer securities fund.
    Commentators requested that the list for permitted indirect 
restrictions or conditions be expanded to include certain defined 
contribution plans that make matching contributions in employer 
securities and allow participants to divest employer securities 
attributable to such contributions, but do not permit participants to 
later elect to reinvest any portion of their account balances in 
employer stock. The final regulations do not adopt this suggestion. The 
IRS and the Treasury Department (Treasury) have concluded that the 
inability to reinvest in employer securities generally acts as a 
material deterrent to an individual who might otherwise have elected to 
diversify his or her account balance of employer securities. However, 
the final regulations provide a transitional rule for certain leveraged 
ESOPs. An employer stock fund does not fail to be a frozen fund merely 
because of the allocation of employer securities that are released as 
matching contributions from the plan's suspense account that holds 
employer securities acquired with an exempt loan under section 
4975(d)(3). This transitional rule only applies to employer securities 
that were acquired in a plan year beginning before January 1, 2007, 
with the proceeds of an exempt loan within the meaning of section 
4975(d)(3) which is not refinanced after the end of the last plan year 
beginning before January 1, 2007. This transitional rule was added 
because these leveraged ESOPs cannot cease allocations of employer 
securities acquired with an exempt loan that are held in a suspense 
account without significant effect on the company's debt arrangements.

[[Page 27930]]

    Commentators suggested that the special rule for a stable value or 
similar fund be expanded to allow transfers out of a stable value fund 
or similar fund more frequently than other funds. In response to 
comments, the final regulations provide that a plan is generally 
permitted to allow transfers to be made into or out of a stable value 
fund more frequently than a fund invested in employer securities. Thus, 
a plan that includes a broad range of investment alternatives as 
described in section 401(a)(35)(D)(i), including a stable value or 
similar fund, does not impose an impermissible restriction merely 
because it permits transfers into and out of the stable value or 
similar fund more frequently than the other funds (taking into account 
any restrictions or conditions imposed with respect to the other 
investment options under the plan).
    Commentators requested clarification as to the meaning of a stable 
value or similar fund. The final regulations provide that a stable 
value or similar fund means an investment product or fund designed to 
preserve or guarantee principal and provide a reasonable rate of 
return, while providing liquidity for benefit distributions or 
transfers to other investment alternatives (such as a product or fund 
described in Department of Labor Regulation section 2550.404c-
5(e)(4)(iv)(A) or (v)(A)).
    One commentator noted that the Department of Labor regulations for 
qualified default investment alternatives (QDIAs) require QDIAs to be 
restriction-free for 90 days. The commentator requested clarification 
that the restriction-free 90-day period does not cause a plan to 
violate the prohibition on imposing a restriction or condition with 
respect to employer securities that is not imposed on other 
investments. However, the commentator further stated that service 
providers will have difficulty administering restrictions only after 90 
days and therefore requested that the final regulations permit 
restriction-free transfers for QDIAs permanently. The final regulations 
expand the list of permitted indirect restrictions to provide that a 
plan may provide for transfers out of a QDIA (within the meaning of 
Department of Labor Regulation section 2550.404c-5(e)) more frequently 
than a fund invested in employer securities.
    A commentator requested clarification concerning plans being 
permitted to restrict reinvestments in only one employer stock fund 
when the plan allows investment in another employer stock fund, 
provided that the stock contained in each fund has the same 
characteristics except for differences in the tax cost basis of the 
trust. The final regulations provide that any applicable tax 
consequences are disregarded in determining whether a plan imposes an 
indirect restriction or condition on an individual's right to divest an 
investment in employer securities. Accordingly, a plan is permitted to 
provide that an individual may not reinvest divested amounts in the 
same employer securities account but is permitted to invest such 
divested amounts in another employer securities account where the only 
relevant difference between the separate accounts is the section 
402(e)(4) cost (or other basis) of the trust in the shares held in each 
account.
    Several commentators requested clarification regarding the 7-day 
rule in the proposed regulations. The preamble to the proposed 
regulations explained that the 7-day rule was an example and not the 
exclusive method to limit trading frequency. The permitted restriction 
for trading frequency provides that a plan is permitted to impose 
reasonable restrictions that are designed to limit short-term trading 
in employer securities. Thus, the 7-day rule, which was mentioned in 
the preamble to the proposed regulations, is an example and other 
short-term trading restrictions (such as a restriction based on 
multiple trades within a specified period) are allowable if they meet 
the reasonably designed standard.

Miscellaneous

    Commentators requested clarification with respect to an ESOP that 
has been satisfying the diversification requirements under section 
401(a)(28) by distributing the portion of the participant's account 
covered by an election within 90 days after the period during which the 
election may be made, but which is now subject to the diversification 
requirements under section 401(a)(35). Such a distribution option does 
not satisfy the diversification requirements under section 401(a)(35). 
These commentators were concerned that an amendment which eliminates 
this distribution option would be a violation of the anti-cutback rules 
under section 411(d)(6). Section 1107 of PPA '06 provides that any 
amendment which is made pursuant to a provision of PPA '06 will not 
fail to meet the requirements of section 411(d)(6) unless otherwise 
provided by the Secretary of the Treasury.\3\ Thus, an amendment to an 
ESOP which is now subject to the diversification requirements under 
section 401(a)(35) that eliminates the distribution option available 
for ESOPs subject to the diversification requirements under section 
401(a)(28), as permitted under section 1107 of PPA '06, would not 
violate the anti-cutback rules under section 411(d)(6).
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    \3\ See also section 411(d)(6)(C)(ii).
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    In addition, it is expected that guidance will be issued in the 
near future exercising the authority under Sec.  1.411(d)-4, A-2(d)(4), 
to permit elimination of such a distribution option with respect to an 
ESOP that is subject to section 401(a)(35) after the end of the limited 
period to which section 1107 of PPA '06 applies. The guidance will 
permit elimination of such a distribution option during the extended 
remedial amendment period permitted with respect to section 401(a)(35) 
under Notice 2009-97, that is, to the last day of the first plan year 
that begins on or after January 1, 2010.

Effective/Applicability Date

    The final regulations are effective and applicable for plan years 
beginning on or after January 1, 2011.
    For the period after the statutory effective date and before the 
regulatory effective date set forth in the preceding sentence, a plan 
must comply with section 401(a)(35). During this period, a plan is 
permitted to rely on Notice 2006-107, the proposed regulations, or 
these final regulations for purposes of satisfying the requirements of 
section 401(a)(35).

Special Analyses

    It has been determined that these final regulations are 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, and, because 
Sec.  1.401(a)(35)-1 would not impose a collection of information on 
small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) 
does not apply. Pursuant to section 7805(f) of the Code, the notice of 
proposed rulemaking preceding this regulation was submitted to the 
Chief Counsel for Advocacy of the Small Business Administration for 
comments on its impact on small business.

Drafting Information

    The principal authors of these regulations are Dana A. Barry, 
formerly of the Office of Division Counsel/Associate Chief Counsel (Tax 
Exempt and Government Entities), and R. Lisa Mojiri-Azad, Office of 
Division Counsel/Associate Chief Counsel (Tax Exempt and Government 
Entities). However,

[[Page 27931]]

other personnel from the IRS and the Treasury Department participated 
in the development of these regulations.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by adding an 
entry in numerical order to read as follows:

    Authority:  26 U.S.C. 7805 * * *
    Section 1.401(a)(35)-1 is also issued under 26 U.S.C. 
401(a)(35). * * *


0
Par. 2. Section 1.401(a)(35)-1 is added to read as follows:


Sec.  1.401(a)(35)-1  Diversification requirements for certain defined 
contribution plans.

    (a) General rule--(1) Diversification requirements. Section 
401(a)(35) imposes diversification requirements on applicable defined 
contribution plans. A trust that is part of an applicable defined 
contribution plan is not a qualified trust under section 401(a) unless 
the plan--
    (i) Satisfies the diversification election requirements for 
elective deferrals and employee contributions set forth in paragraph 
(b) of this section;
    (ii) Satisfies the diversification election requirements for 
employer nonelective contributions set forth in paragraph (c) of this 
section;
    (iii) Satisfies the investment option requirement set forth in 
paragraph (d) of this section; and
    (iv) Does not apply any restrictions or conditions on investments 
in employer securities that violate the requirements of paragraph (e) 
of this section.
    (2) Definitions, effective dates, and transition rules. The 
definitions of applicable defined contribution plan, employer security, 
parent corporation, and publicly traded are set forth in paragraph (f) 
of this section. Applicability dates and transition rules are set forth 
in paragraph (g) of this section.
    (b) Diversification requirements for elective deferrals and 
employee contributions invested in employer securities--(1) General 
rule. With respect to any individual described in paragraph (b)(2) of 
this section, if any portion of the individual's account under an 
applicable defined contribution plan attributable to elective deferrals 
(as described in section 402(g)(3)(A)), employee contributions, or 
rollover contributions is invested in employer securities, then the 
plan satisfies the requirements of this paragraph (b) if the individual 
may elect to divest those employer securities and reinvest an 
equivalent amount in other investment options. The plan may limit the 
time for divestment and reinvestment to periodic, reasonable 
opportunities occurring no less frequently than quarterly.
    (2) Applicable individual with respect to elective deferrals and 
employee contributions. An individual is described in this paragraph 
(b)(2) if the individual is--
    (i) A participant;
    (ii) An alternate payee who has an account under the plan; or
    (iii) A beneficiary of a deceased participant.
    (c) Diversification requirements for employer nonelective 
contributions invested in employer securities--(1) General rule. With 
respect to any individual described in paragraph (c)(2) of this 
section, if a portion of the individual's account under an applicable 
defined contribution plan attributable to employer nonelective 
contributions is invested in employer securities, then the plan 
satisfies the requirements of this paragraph (c) if the individual may 
elect to divest those employer securities and reinvest an equivalent 
amount in other investment options. The plan may limit the time for 
divestment and reinvestment to periodic, reasonable opportunities 
occurring no less frequently than quarterly.
    (2) Applicable individual with respect to employer nonelective 
contributions. An individual is described in this paragraph (c)(2) if 
the individual is--
    (i) A participant who has completed at least three years of 
service;
    (ii) An alternate payee who has an account under the plan with 
respect to a participant who has completed at least three years of 
service; or
    (iii) A beneficiary of a deceased participant.
    (3) Completion of three years of service. For purposes of paragraph 
(c)(2) of this section, a participant completes three years of service 
on the last day of the vesting computation period provided for under 
the plan that constitutes the completion of the third year of service 
under section 411(a)(5). However, for a plan that uses the elapsed time 
method of crediting service for vesting purposes (or a plan that 
provides for immediate vesting without using a vesting computation 
period or the elapsed time method of determining vesting), a 
participant completes three years of service on the day immediately 
preceding the third anniversary of the participant's date of hire.
    (d) Investment options. An applicable defined contribution plan 
must offer not less than three investment options, other than employer 
securities, to which an individual who has the right to divest under 
paragraph (b)(1) or (c)(1) of this section may direct the proceeds from 
the divestment of employer securities. Each of the three investment 
options must be diversified and have materially different risk and 
return characteristics. For this purpose, investment options that 
constitute a broad range of investment alternatives within the meaning 
of Department of Labor Regulation section 2550.404c-1(b)(3) are treated 
as being diversified and having materially different risk and return 
characteristics.
    (e) Restrictions or conditions on investments in employer 
securities--(1) Impermissible restrictions or conditions--(i) General 
rule. Except as provided in paragraph (e)(2) of this section, an 
applicable defined contribution plan violates the requirements of this 
paragraph (e) if the plan imposes restrictions or conditions with 
respect to the investment of employer securities that are not imposed 
on the investment of other assets of the plan. A restriction or 
condition with respect to employer securities means--
    (A) A restriction on an individual's right to divest an investment 
in employer securities that is not imposed on an investment that is not 
employer securities; or
    (B) A benefit that is conditioned on investment in employer 
securities.
    (ii) Indirect restrictions or conditions--(A) Except as provided in 
paragraph (e)(3) of this section, a plan violates the requirements of 
this paragraph (e) if the plan imposes a restriction or condition 
described in paragraph (e)(1)(i)(A) or (B) of this section either 
directly or indirectly.
    (B) A plan imposes an indirect restriction on an individual's right 
to divest an investment in employer securities if, for example, the 
plan provides that a participant who divests his or her account balance 
with respect to the investment in employer securities is not permitted 
for a period of time thereafter to reinvest in employer securities.
    (C) A plan does not impose an indirect restriction or condition 
merely because there are tax consequences that result from an 
individual's divestment of an investment in employer securities. Thus, 
the loss of the special treatment for net unrealized appreciation 
provided

[[Page 27932]]

under section 402(e)(4) with respect to employer securities is 
disregarded. Similarly, a plan does not impose an impermissible 
restriction or condition merely because it provides that an individual 
may not reinvest divested amounts in the same employer securities 
account but is permitted to invest such divested amounts in another 
employer securities account where the only relevant difference between 
the separate accounts is the section 402(e)(4) cost (or other basis) of 
the trust in the shares held in each account. (See Sec.  1.402(a)-1(b) 
for rules regarding section 402(e)(4).)
    (2) Permitted restrictions or conditions--(i) In general. An 
applicable defined contribution plan does not violate the requirements 
of this paragraph (e) merely because it imposes a restriction or a 
condition set forth in paragraph (e)(2)(ii) or (e)(2)(iii) of this 
section.
    (ii) Securities laws. A plan is permitted to impose a restriction 
or condition on the divestiture of employer securities that is either 
required in order to ensure compliance with applicable securities laws 
or is reasonably designed to ensure compliance with applicable 
securities laws. For example, it is permissible for a plan to limit 
divestiture rights for participants who are subject to section 16(b) of 
the Securities Exchange Act of 1934 (15 U.S.C. 78f) to a reasonable 
period (such as 3 to 12 days) following publication of the employer's 
quarterly earnings statements because it is reasonably designed to 
ensure compliance with Rule 10b-5 of the Securities and Exchange 
Commission.
    (iii) Deferred application of the diversification requirements--(A) 
Becoming an applicable defined contribution plan. An applicable defined 
contribution plan is permitted to restrict the application of the 
diversification requirements of section 401(a)(35) and this section for 
up to 90 days after the plan becomes an applicable defined contribution 
plan (for example, a plan becoming an applicable defined contribution 
plan because the employer securities held under the plan become 
publicly traded).
    (B) Loss of exception for indirect investments. In the case where 
an investment fund described in paragraph (f)(3)(ii)(A) of this section 
no longer meets the requirement in paragraph (f)(3)(ii)(B) of this 
section that the investment must be independent of the employer 
(including the situation where the fund no longer meets the percentage 
limitation rule in paragraph (f)(3)(ii)(C) of this section), the plan 
does not fail to satisfy the diversification requirements of section 
401(a)(35) and this section merely because it does not offer those 
rights with respect to that investment fund for up to 90 days after the 
investment fund ceases to meet those requirements.
    (3) Permitted indirect restrictions or conditions--(i) In general. 
An applicable defined contribution plan does not violate the 
requirements of this paragraph (e) merely because it imposes an 
indirect restriction or condition set forth in this paragraph (e)(3).
    (ii) Limitation on investment in employer securities. A plan is 
permitted to limit the extent to which an individual's account balance 
can be invested in employer securities, provided the limitation applies 
without regard to a prior exercise of rights to divest employer 
securities. For example, a plan does not impose a restriction that 
violates this paragraph (e) merely because the plan prohibits a 
participant from investing additional amounts in employer securities if 
more than 10 percent of that participant's account balance is invested 
in employer securities.
    (iii) Trading frequency. A plan is permitted to impose reasonable 
restrictions on the timing and number of investment elections that an 
individual can make to invest in employer securities, provided that the 
restrictions are designed to limit short-term trading in the employer 
securities. For example, a plan could provide that a participant may 
not elect to invest in employer securities if the employee has elected 
to divest employer securities within a short period of time, such as 
seven days, prior to the election to invest in employer securities.
    (iv) Fees. The plan has not provided an indirect benefit that is 
conditioned on investment in employer securities merely because the 
plan imposes fees on other investment options that are not imposed on 
the investment in employer securities. In addition, the plan has not 
provided a restriction on the right to divest an investment in employer 
securities merely because the plan imposes a reasonable fee for the 
divestment of employer securities.
    (v) Stable value or similar fund. A plan is permitted to allow 
transfers to be made into or out of a stable value or similar fund more 
frequently than a fund invested in employer securities for purposes of 
paragraph (e)(1)(ii) of this section. Thus, a plan that includes a 
broad range of investment alternatives as described in paragraph (d) of 
this section, including a stable value or similar fund, does not impose 
an impermissible restriction under paragraph (e)(1)(ii) of this section 
merely because it permits transfers into or out of that fund more 
frequently than other funds under the plan, provided that the plan 
would otherwise satisfy this paragraph (e) (taking into account any 
restrictions or conditions imposed with respect to the other investment 
options under the plan). For purposes of this section, a stable value 
fund or similar fund means an investment product or fund designed to 
preserve or guarantee principal and provide a reasonable rate of 
return, while providing liquidity for benefit distributions or 
transfers to other investment alternatives (such as a product or fund 
described in Department of Labor Regulation Sec.  2550.404c-
5(e)(4)(iv)(A) or (v)(A)).
    (vi) Transfers out of a qualified default investment alternative 
(QDIA). A plan is permitted to provide for transfers out of a QDIA 
within the meaning of Department of Labor Regulation section 2550.404c-
5(e) more frequently than a fund invested in employer securities.
    (vii) Frozen funds--(A) General rule. A plan is permitted to 
prohibit any further investment in employer securities. Thus, a plan is 
not treated as imposing an indirect restriction merely because it 
provides that an employee that divests an investment in employer 
securities is not permitted to reinvest in employer securities, but 
only if the plan does not permit additional contributions or other 
investments to be invested in employer securities. For this purpose, a 
plan does not provide for further investment in employer securities 
merely because dividends paid on employer securities under the plan are 
reinvested in employer securities.
    (B) Transitional relief for certain leveraged employee stock 
ownership plans (ESOPs). An employer stock fund does not fail to be a 
frozen fund under this paragraph (e)(3)(vii) merely because of the 
allocation of employer securities that are released as matching 
contributions from the plan's suspense account that holds employer 
securities acquired with an exempt loan under section 4975(d)(3). This 
paragraph (e)(3)(vii)(B) only applies to employer securities that were 
acquired in a plan year beginning before January 1, 2007, with the 
proceeds of an exempt loan within the meaning of section 4975(d)(3) 
which is not refinanced after the end of the last plan year beginning 
before January 1, 2007.
    (4) Delegation of authority to Commissioner. The Commissioner may 
provide for additional permitted restrictions or conditions or 
permitted indirect restrictions or conditions in revenue rulings, 
notices, or other

[[Page 27933]]

guidance published in the Internal Revenue Bulletin.
    (f) Definitions--(1) Application of definitions. This paragraph (f) 
contains definitions that are applicable for purposes of this section.
    (2) Applicable defined contribution plan--(i) General rule. Except 
as provided in this paragraph (f)(2), an applicable defined 
contribution plan means any defined contribution plan which holds 
employer securities that are publicly traded. See paragraph (f)(2)(iv) 
of this section for a special rule that treats certain plans that hold 
employer securities that are not publicly traded as applicable defined 
contribution plans and paragraph (f)(3)(ii) of this section for a 
special rule that treats certain plans as not holding publicly traded 
employer securities for purposes of this section.
    (ii) Exception for certain ESOPs. An employee stock ownership plan 
(ESOP), as defined in section 4975(e)(7), is not an applicable defined 
contribution plan if the plan is a separate plan for purposes of 
section 414(l) with respect to any other defined benefit plan or 
defined contribution plan maintained by the same employer or employers 
and holds no contributions (or earnings thereunder) that are (or were 
ever) subject to section 401(k) or 401(m). Thus, an ESOP is an 
applicable defined contribution plan if the ESOP is a portion of a 
larger plan (whether or not that larger plan includes contributions 
that are subject to section 401(k) or 401(m)). For purposes of this 
paragraph (f)(2)(ii), a plan is not considered to hold amounts ever 
subject to section 401(k) or 401(m) merely because the plan holds 
amounts attributable to rollover amounts in a separate account that 
were previously subject to section 401(k) or 401(m).
    (iii) Exception for one-participant plans. A one-participant plan, 
as defined in section 401(a)(35)(E)(iv), is not an applicable defined 
contribution plan.
    (iv) Certain defined contribution plans treated as holding publicly 
traded employer securities--(A) General rule. A defined contribution 
plan holding employer securities that are not publicly traded is 
treated as an applicable defined contribution plan if any employer 
maintaining the plan or any member of a controlled group of 
corporations that includes such employer has issued a class of stock 
which is publicly traded. For purposes of this paragraph (f)(2)(iv), a 
controlled group of corporations has the meaning given such term by 
section 1563(a), except that ``50 percent'' is substituted for ``80 
percent'' each place it appears.
    (B) Exception for certain plans. Paragraph (f)(2)(iv)(A) of this 
section does not apply to a plan if--
    (1) No employer maintaining the plan (or a parent corporation with 
respect to such employer) has issued stock that is publicly traded; and
    (2) No employer maintaining the plan (or parent corporation with 
respect to such employer) has issued any special class of stock which 
grants to the holder or issuer particular rights, or bears particular 
risks for the holder or issuer, with respect to any employer 
maintaining the plan (or any member of a controlled group of 
corporations that includes such employer) which has issued any stock 
that is publicly traded.
    (3) Employer security--(i) General rule. Employer security has the 
meaning given such term by section 407(d)(1) of the Employee Retirement 
Income Security Act of 1974, as amended (ERISA).
    (ii) Certain defined contribution plans or investment funds not 
treated as holding employer securities--(A) Exception for certain 
indirect investments. Subject to paragraphs (f)(3)(ii)(B) and (C) of 
this section, a plan (and an investment option described in paragraph 
(d) of this section) is not treated as holding employer securities for 
purposes of this section to the extent the employer securities are held 
indirectly as part of a broader fund that is--
    (1) A regulated investment company described in section 851(a);
    (2) A common or collective trust fund or pooled investment fund 
maintained by a bank or trust company supervised by a State or a 
Federal agency;
    (3) A pooled investment fund of an insurance company that is 
qualified to do business in a State;
    (4) An investment fund managed by an investment manager within the 
meaning of section 3(38) of ERISA for a multiemployer plan; or
    (5) Any other investment fund designated by the Commissioner in 
revenue rulings, notices, or other guidance published in the Internal 
Revenue Bulletin.
    (B) Investment must be independent. The exception set forth in 
paragraph (f)(3)(ii)(A) of this section applies only if the investment 
in the employer securities is held in a fund under which--
    (1) There are stated investment objectives of the fund; and
    (2) The investment is independent of the employer (or employers) 
and any affiliate thereof.
    (C) Percentage limitation rule. For purposes of paragraph 
(f)(3)(ii)(B)(2) of this section, an investment in employer securities 
in a fund is not considered to be independent of the employer (or 
employers) and any affiliate thereof if the aggregate value of the 
employer securities held in the fund is in excess of 10 percent of the 
total value of all of the fund's investments for the plan year. The 
determination of whether the value of employer securities exceeds 10 
percent of the total value of the fund's investments for the plan year 
is made as of the end of the preceding plan year. The determination can 
be based on the information in the latest disclosure of the fund's 
portfolio holdings that was filed with the Securities and Exchange 
Commission (SEC) in that preceding plan year.
    (4) Parent corporation. Parent corporation has the meaning given 
such term by section 424(e).
    (5) Publicly traded--(i) In general. A security is publicly traded 
if it is readily tradable on an established securities market.
    (ii) Readily tradable on an established securities market. For 
purposes of this paragraph (f)(5), except as provided by the 
Commissioner in revenue rulings, notices, or other guidance published 
in the Internal Revenue Bulletin, a security is readily tradable on an 
established securities market if--
    (A) The security is traded on a national securities exchange that 
is registered under section 6 of the Securities Exchange Act of 1934 
(15 U.S.C. 78f); or
    (B) The security is traded on a foreign national securities 
exchange that is officially recognized, sanctioned, or supervised by a 
governmental authority and the security is deemed by the SEC as having 
a ``ready market'' under SEC Rule 15c3-1 (17 CFR 240.15c3-1).
    (g) Applicability date and transition rules--(1) Statutory 
effective date--(i) General rule. Except as otherwise provided in this 
paragraph (g) and section 901(c)(3)(A) and (B) of the Pension 
Protection Act of 2006, Public Law 109-280 (120 Stat. 780 (2006)) (PPA 
'06), section 401(a)(35) is effective for plan years beginning after 
December 31, 2006.
    (ii) Collectively bargained plans--(A) Delayed statutory effective 
date. In the case of a plan maintained pursuant to one or more 
collective bargaining agreements between employee representatives and 
one or more employers ratified on or before August 17, 2006, section 
401(a)(35) is effective for plan years beginning after the earlier of--
    (1) The later of--
    (i) December 31, 2007; or
    (ii) The date on which the last such collective bargaining 
agreement

[[Page 27934]]

terminates (determined without regard to any extension thereof); or
    (2) December 31, 2008.
    (B) Treatment of plans with both collectively bargained and non-
collectively bargained employees. If a collective bargaining agreement 
applies to some, but not all, of the plan participants, the definition 
of whether the plan is considered a collectively bargained plan for 
purposes of this paragraph (g)(1)(ii) is made in the same manner as the 
definition of whether a plan is collectively bargained under section 
436(f)(3).
    (2) Regulatory effective/applicability date. This section is 
effective and applicable for plan years beginning on or after January 
1, 2011.
    (3) Statutory transition rules--(i) General rule. Pursuant to 
section 401(a)(35)(H), in the case of the portion of an account to 
which paragraph (c) of this section applies and that consists of 
employer securities acquired in a plan year beginning before January 1, 
2007, the requirements of paragraph (c) of this section only apply to 
the applicable percentage of such securities.
    (ii) Applicable percentage--(A) Phase-in percentage. For purposes 
of this paragraph (g)(3), the applicable percentage is determined as 
follows--

------------------------------------------------------------------------
   Plan year to which paragraph (c) of this section      The applicable
                       applies:                          percentage is:
------------------------------------------------------------------------
1st...................................................                33
2nd...................................................                66
3rd and following.....................................               100
------------------------------------------------------------------------

     (B) Special rule. For a plan for which the special effective date 
under section 901(c)(3) of PPA '06 applies, the applicable percentage 
under this paragraph (g)(3)(ii) is determined without regard to the 
delayed effective date in section 901(c)(3)(A) and (B) of PPA '06.
    (iii) Nonapplication for participants age 55 with three years of 
service. Paragraph (g)(3)(i) of this section does not apply to an 
individual who is a participant who attained age 55 and had completed 
at least three years of service (as defined in paragraph (c)(3) of this 
section) before the first day of the first plan year beginning after 
December 31, 2005.
    (iv) Separate application by class of securities. This paragraph 
(g)(3) applies separately with respect to each class of securities.

Steven T. Miller,
Deputy Commissioner for Services and Enforcement.
    Approved: May 5, 2010.
Michael F. Mundaca,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2010-11924 Filed 5-18-10; 8:45 am]
BILLING CODE 4830-01-P