In Blog 1, I alluded to the rather unique developments that led to the U.S. Congress adopting the Senate Finance Committee’s provision in the legislation that became known as DEFRA, or more formally in the bill, “Tax Reform and Deficit Reduction Act of 1984”. (P.Law 98-369, ESOP tax incentives Sections 541,542,543,544, and 545). The ESOP tax incentives in DEFRA were generally the first impactful tax incentives that led to more ESOPs.
Several advocates for more employee ownerships signaled that they would like to hear the story, to learn, how to expand Federal law to encourage more ESOP creation and operation.
While this JMK-Way Blog 2 is not based on 100% written documentation, but mainly my memory, I am very comfortable that what follows documents how “winning” is done in making law.
So here in JMK-Way blog number 2, I tell the story.
Beginning in 1981, the original champion in Congress for ESOPs, in fact the “creator” of the Federal law sanctioning the creation of employee stock ownership plans, was Senator Russell Long, D-LA, which were in essence the same as stock bonus plans sanctioned by Congress in the Internal Revenue Code enacted in 1921, except that an ESOP could obtain its assets with “borrowed” money—i.e. a leveraged stock bonus plan.
(Under the leadership, and perseverance of the “father” of ESOPs, San Francisco attorney, author, and really philosopher Dr. Louis Kelso, his promotion of having stock acquired with “borrowed” money in order to create a second income for employees and to preserve free enterprise and stop socialism and Marxism—Senator Long, and others who learned of Dr. Kelso’s recommendations, referred to his proposal to “leveraged” stock bonus plan as a “Kelso” plan, or “second income plan”.).
I will not dig into why Congress, after over 20 years beginning in the early 1950’s of the 20th Century began discussing reforming tax and labor laws governing tax qualified deferred retirement savings plans, but not until 1974 did Congress pass so-called “reform” legislation to ensure sponsors of these plans did not flim flam the employees while enriching the top executives of the corporate sponsors of these plans, nor use the plans’ “investments” in corrupt activities, as was the case with the ill-famed Central States Pension Fund, for which evidence was persuasive that this Pension Fund was investing in organized crime controlled activities.
But another factor in Congress enacting ERISA, that was the collapse of the automobile manufacturer, Studebaker, which had a pension plan 100% invested in Studebaker stock, which became worthless when the company went bankrupt in the mid-1960’s. This development caused the “liberal-organized labor community to express opposition to having a pension fund heavily invested in the plan’s company sponsor’s stock.
In short, Studebaker’s employees had no retirement benefits because the assets of the plan, because Studebaker stock, became worthless.
So evidence of corruption abusing pension funds, plus a company plan that had company stock that became worthless, motivated the conservative members of Congress to join forces with the more liberal members of Congress, who were very upset that pension funds like Studebacker’s would deliver nothing to employees as the company stock could become worthless, and employees would have no retirement income to draft a proposed new law giving reforming the law to have a better employer sponsored plan to provide retirement benefits to employees.
So, the House version of the “Employee Retirement Income Security Act”, or “ERISA”, developed by the House Education and Labor Committee was clear, no more than 10% of a legal retirement savings plan could be invested in company stock—pushed by the “union-labor” advocates. Since business interests did not really use much company stock in their plans, their Congressional allies they did not protest this first version of ERISA that limited company stock in a company’s pension plan.
A few corporations did express opposition to the 10% limit on company stock when the second House committee took the proposed ERISA up—the House Ways and Means Committee. This handful of companies had created benefit plans that were invested in company stock in the 19th century, such as Procter&Gamble, and J.C. Penny’s, etc. Their voices, both from corporate leaders back home, and their Washington agents—i.e. lobbyists– were heard by the House tax committee, dominated by conservative Democrats, and the 10% limit was lifted for the old fashioned 1921 Stock Bonus plans which became labelled as on class of “defined contribution” retirement plans compared to the “defined pension” plan, which continued to limit company plan sponsor stock to 10% of total plan assets.
The House version was then considered by the Senate, including the Senate Committee on Finance, or its tax committee, chaired by the super ESOP champion Senator Long. (One can do a blog on why he was so committed to “employee ownership” as when he committed in the mid-1970’s there were no such things as “ESOPs”.). The Senate version of ERISA also did not have the 10% limit on the plan sponsor’s stock in a deferred compensation plan.
After Senate passage of its version, the House and Senate versions go to the “conference committee” where the differences between the House bill and Senate bill are ironed out for final passage and the transmission of the final bill to the President for signature.
To summarize, the ERISA legislation passed by the House and the Senate permitted so called defined contribution plan to have more than 10% company stock if a defined contribution plan, of which the 1921 “stock bonus plan” was included in this category.
But, the bills passed by both the Senate and the House did not authorize a stock bonus plan to use “borrowed” money to acquire company stock. The business voices who “lobbied” for dropping the 10% ceiling on company stock in a stock bonus plan had “won” their protection for their plans which began back in the 19th Century, before there was a Federal income tax law.
Dr. Kelso, and his legal colleagues in the Kelso Law Firm, learned of the “outlawing” of the Kelso Plan, after passage of the House and Senate versions of ERISA.
Leaving out details, Dr. Kelso immediately reached out to Senator, or “Chair” of the Senate tax committee, Senator Long, and informed the Senator how the bill that he was very much responsible for preparing the final version to be sent to the President “killed” Kelso plans. Long story short, Chair Long basically promised to “fix” the problem. And he did.
(Bottom line, other members of Congress on the Committee were not going to fight Chair Long’s instructions to the staff drafting the final version, as they knew on any vote, he would win, as each member had his—only men on Conference Committee back then—top priority in danger of being dropped out of the final bill if he tried to stop anything, that Chair Long could “kill” with his opposition. To put it another way, all the members of the Conference Committee had this or that provision he wanted—and to go against the powerful Chair Long would end in the deletion of the provision that one of Chair Long’s committee member wanted in the final bill to make his constituents back home pleased.
(Side bar—the instructions by Chair Long to the staff of the group drafting the final bill to be sent to the President—employees of the Joint Committee on Taxation and the Legislative Counsel Office—primarily lawyers—resulted in the naming of a leveraged stock bonus plan, in essence the “Kelso” plan that would have to be primarily be invested in company stock, not limited to 10% company stock, and even if stock acquired with borrowed money, was labelled an “employee stock ownership plan” in ERISA, which is quickly referred to by its the acronym “ESOP”.
Yours truly suspects, and I might bet money that I am correct—but hard to prove as many of the drafters of ERISA are no longer living—the naming of a leveraged stock bonus plan, pre-ERISA referred to as a “Kelso” plan to those most familiar with the structure, an ESOP would imply that this exception to the main rule—no more than 10% company stock in a retirement savings plan—was a flim flam, a fable known as in an AESOP fable!
In the early days of ESOPs, really until the mid-1990’s, there were many media references, primarily newspapers writing of a struggling, going broke “ESOP” company as an example of an “ESOP” fable. I have seen even 21st century media references to ESOPs as a “fable”.
As noted, I cannot prove my suspicion.).
But within a couple of years after Chair Long saved the “Kelso” plan, now ESOPs, he saw, as did the ESOP advocates, particularly Dr. Kelso, the number of ESOPs being created was not impressive. Thus, Chair Long instructed his committee staff, and he hired someone to work “new laws to give tax breaks to ESOPs”. The effort really began seriously, with input from top lawyers in California who were part of the Kelso law firm, to develop a comprehensive set of laws to give significant tax breaks to the person(s), and the company(ies) establishing ESOPs.
Meanwhile in the years 1976 into the 1980’s, when some changes were made because they were Chair Long’s proposals were well intentioned, to have more ESOPs created did not have much impact as the “experts” on Kelso plans were not really consulted.
But, the Senate Finance Committee version of the 1984 tax law, referenced as the Deficit Reduction Act of 1984, or DEFRA, had a set of tax benefits to encourage the creation of ESOPs. (They applied only to C corporations ERISA trusts, as a trust such as an ESOP was not eligible S corporate stock owners in 1984—not true in 21st Century due to work of Senator Long’s successor, former Louisiana Senator John Breaux, who orchestrated the now very important laws that incentived S corporations to be owned by an ESOP, especially 100% owned. Senator Breaux retired in 2005.).
The most impactful ESOP tax incentive in DEFRA was the deferral of capital gains tax on the gain realized by the seller of stock of a privately held company to an ESOP—which are in general 98% of corporations in the US.
So when the Conference Committee began in July 1984 on the different versions of DEFRA, no surprise there was no, zero, tax incentive provisions in the House bill to encourage the creation of ESOPs.
Really, only one member of the House tax committee, a Republican, Bill Frenzel of Minnesota was openly pro-ESOP; on other hand, the fifth ranking Democrat on the Committee, Pete Stark of California felt ESOPs were awful retirement savings plans, was very critical of Dr. Kelso, and was set to “kill” ESOP. Not as vehement opponent of ESOPs, as Congressman Stark, but very set on his view ESOPs were flim flam to benefit the selling owner not the employees, was the top Republican on the House Ways and Means Committee, and thus a major voice in the Conference between the House and Senate tax committees, Barber Conable of New York.
But the legislative genius in getting his favored provisions becoming law, Chair Long, began his effort weeks before the formal Conference Committee sessions to have the pro-ESOP provisions of the Senate bill accepted by the House conferees..
(If you keep reading you will learn about President Reagan and ESOPs.).
For Chair Long to “win” having his ESOP provisions included in the final DEFRA bill, it would require the powerful Chair of the House tax committee, whose turn it was to be the Chair of the Conference Committee on the two different versions of DEFRA, Dan Rostenkowski of Chicago, Illinois, to be supportive of including the Senate ESOP provisions in the final bill.
Thus, Chair Long approached Chair Rostenkowski one on one, and asked weeks before the formal meeting of the House-Senate conference, and, in general, asked “Are you okay with adding the Senate ESOP provisions to the final bill approved for the President’s signature?”.
I feel very comfortable that Chair Rostenkowski, who wanted a variety of provisions in the final bill and knew he needed Chair Long’s support, said, “Senator, you have no problem with me on those ESOP provisions, but the Department of Treasury is going to be opposed, and I do not see how we will have 5 House members be for your ESOP provisions.”
To explain—there would be 8 House members of the House tax committee on the Conference Committee—to agree to a Senate provision that was not in the House version of DEFRA would require 5 of the 8 to support the Senate version.
Of the 8, 5 were to be Democrats, and 3 Republicans. Chair Long assumed that to include the pro-ESOP tax incentives in the final ERISA bill he needed all 5 Democrats to vote for the pro-ESOP tax incentives, because the leader of the 3 Republican members, ranking member Conable would be able to have the other two Republicans vote no on ESOPs.
(Treasury top officials were the Administration’s voice during any work on major tax legislation, as the Chair would ask after a provision was debated by the Conference members, “Mr. Secretary, what is the Treasury Department’s position on this provision?” And when the Treasury official said, “The Administration opposes”, all 3 Republicans would vote against the provision as in 1984, the President was a Republican, Ronald Reagan.
Now let’s move on a few weeks.
First, I, on retainer by The ESOP Association to represent the Association as a lobbyist, and along with the then top staff officer of The ESOP Association, joined Luis Granados, at a meeting with the number one voice on tax matters for the Administration, Deputy Assistant Secretary of Treasury for Tax Policy, Ron Pearlman, in his office.
Sitting in the nice office of Dep. Asst. Secretary Pearlman with wonderfully comfortable leather sofa’s to sit on, Luis made a pitch for the Senate ESOP provisions based on a general presentation ESOPs were good for employees.
Dep. Asst. Sec. Pearlman said that the Administration would be strongly opposed to helping ESOPs—saying that they were bad retirement savings plans, that current owners were cashing in their stock at ridiculously high prices being paid to them by the ESOP, and that ESOP companies hardly ever succeeded.
At that point, Luis, started throwing transcripts of one Ronald Reagan’s remarks about employee stock ownership, and Kelso plans-not just once, but many times on his famed radio show, in remarks he had made when Governor of California, and even once or twice in other obscure appearances that were transcribed, that praised ESOPs as the savior of free enterprise, that they made more people invested in the capitalistic economy, and the ones he knew of in California were very successful. (Side note is that I was told that several “Kelso Plans” had been created by a man whose last name was Jorgenson—cannot recall first name—when he sold stock to the Plan in several private companies he owned in the San Francisco area; and that this man, or a close friend of his, was a person who was part of Ronald Reagan’s circle of friends. In turn, the Jorgensen companies were successful, and Ronald Reagan knew that employee ownership could be good for the employees, and the free enterprise economy.).
Clearly this proof of President Reagan’s support of ESOP made Dep. Asst. Secretary Pearlman uncomfortable with his firm statement the Administration would oppose the pro-ESOP provisions, and he noted that he had another appointment and the meeting needed to end. He nicely thanked us for coming, and that his office would continue to review the pros and cons of ESOPs.
A few weeks later—and I do not know whether the meeting was requested by the top official at the 1984 Department of Treasury, Don Regan, or by Chair Long —the Chair and his staff aide who’s total focus was on ESOP law, Jeff Gates met, with Secretary Regan at the Treasury Department. To make the story short—Secretary Regan said, and I paraphrase from words said to me by Mr. Gates, “Why I think ESOPs are great, and so does the President! We will make it clear when the House tax conferees and the Senate tax conferees meet that the Administration is 100% in support of your pro-ESOP provisions!”
Done deal—in the Conference Committee, when the issue of whether to put the pro-ESOP Senate proposals into final law, the general score would be 2 of the 3 major actors, the Administration and Senators would be for the ESOP provisions, as Chair Long put them in the Senate version of DEFRA!
The Conference Committee met in public session, in middle of July, and the key focus for Chair Long was on the five Democrat members from the Ways and Means Committee, as there was no question that all the Senators on the Conference Committee would be 100% “for” their Chair, Senator Long, and his proposal to expand tax incentives for ESOPs, as I can never recall any Senator on the Finance Committee being against what Chair Long wanted on ESOPs—no matter what they thought of the ESOP model as a retirement savings plan—a Senator on the Committee did not “go” head to head against what Senator Long sincerely wanted.
Thus, before the Conference Committee met, the big question for ESOP advocates was “how would the House conferees vote on the Senate proposal to expand ESOPs?”. (I will leave out the nitty gritty of the formal process of how a “conference” committee consisting of senior members from the House and Senate Committees that were the proposing group to the House and Senate reconciled final specific language of the proposed law.).
Who were the 8 House members from the House Ways and Means Committee? The Chair, as mentioned Dan Rostenkowski; second most senior House Democrat Sam Gibbons of Florida; third Jake Pickle of Texas –side bar from 1972 to 1981, I was the Congressman’s Chief of Staff–; third was Charles Rangel, New York City, representing primarily Harlem section of Manhattan; fourth Pete Stark of Oakland, California.
Of these five Democrats before the Conference met, two were solid supporters of the ESOP laws—Congressmen Pickle and Rangel. (Congressman Pickle based on how impressed he was visiting an ESOP company in his district during a rather competitive race for re-election in 1980; and Congressman Rangel who had actually introduced the House version of the ESOP proposals that Chair Long had first introduced in the Senate in 1981. Also assumed Congressman Rangel did so looking to have Chair Long’s support for a provision that was important to New York City somewhere down the road.).
And it was assumed that Chair Rostenkowski would be “for” Senator Long’s ESOP proposals, based on what he had said to the Senator weeks before the Conference Committee meeting. I assumed, however, that Chair Rostenkowski had told Senator Long he would be supportive for a tactical reason of having Chair Long be “for” what he, Rostenkowski supported. (Chair Rostenkowski was always coy about what he really wanted in the final conference bill version to not have Chair Long automatically be “against” something he wanted in the bill. Since he had never openly said anything positive, or done anything positive about ESOP law as Chair of the House Ways and Means Committee, ESOP advocates were skeptical that he would really push his House colleagues to be for the Senate ESOP provisions. And candidly read below and one will see that he obviously thought the longstanding position of Treasury would be against promoting ESOPs, and in Conference out of the three decision “groups”, the House and Administration would be thumbs down for more ESOP incentives, and thus the ESOP provisions would be dropped or severely changed to be ineffective. It was thought that Chair Rostenkowski did not care if the ESOP provisions would be “killed”, but that Chair Long would not “blame” him since he had told Chair Long he would be for the proposals.).
Note I said 8 members of the House conference committee members—I have mentioned five Democrats. There was three senior Republicans.
I have mentioned the most senior Republican, and thus the most important voice for the Republicans from the House on the Conference Committee, Barber Conable, was very negative towards the ESOP form of a qualified retirement savings plan. And 90% of the time, his view of what was in the House tax bill would also be the view of his two Republican colleagues, who would want to have a unified position as the minority party’s representatives on the Conference committee.
Moving forward, it was about 1 AM in the morning, and the Conference committee had reached agreement on the many, many differences in two versions of DEFRA except for two or three—one was the ESOP provisions to encourage creation of more ESOPs. Chair Rostenkowski had intentionally held those provisions for resolution towards the end, as he wanted to keep Senator Long of the mind that Chair Rostenkowski would be a voice among his Democrats to be “for” the pro-ESOP provisions. (No evidence that Senator Long or his staff knew of Congressman Starks strong opposition to ESOPs.).
Chair Rostenkowski asks the staff tax experts to explain the Senate ESOP provisions; he notes that the House bill does not contain any ESOP provisions. Then he asks the representative of Treasury, John Chapoton, “Mr. Asst. Secretary, what is the Administration’s position on the Senate ESOP provisions?” Mr. Chapoton speaks into his microphone, “The Administration is in favor of the Senate ESOP provisions and urge their adoption.”
I can assure all readers—when those words were spoken, there was an incredible look of shock, surprise, and incredulous disbelief on Chair Rostenkowski’s face. He turns in his chair towards the committee top staff aide, and from a distance he seems to be saying, with negative tone, “Why didn’t you tell me the Administration’s position was in favor of ESOPs?” The staffer seems to shrug his shoulders with “I never dreamed that the Administration would be ‘for’ ESOPs!”
Well it was late, members were tired; some had not really had a decent meal since lunch time.
And often when the House and Senate came upon a different position in a conference committee for which an ahead of time compromise had not been reached, Chair Rostenkowski declares a recess, for members to get a break, maybe a snack, and even catch a nap in the wee hours of the day.
So the members took a break, except for Chair Long. He knew that he needed two more votes from the Democrats from the House, so the House position would be 5 for the ESOP provisions, and 3 Republicans against. (He somehow, knew or suspected that the top Republican Barber Conable would keep his two colleagues against the “Democrat” position.
So Chair Long went to work, personally talking, urging, the two Democrats, Congressmen Gibbons and Stark to support the position of the Chair, Rostenkowski, and perhaps count on Chair Long making sure in the future a provision these two men might want Chair Long make sure it was in a future Senate bill.
He began wandering around the area around where the Conference committee met, the grand room of the House Ways and Means Committee, plus side offices of tax committee staff, and even personal offices.
He learned quickly that Congressman Stark was a no vote, no to ESOPs, or better in Congressman Stark’s view those “.od.amn” ESOPs.
The Conference came back from the break—Chair Rostenkowski again polled the members of the House on the Conference Committee, and it was 4 to 4, no to ESOP incentives, as a tie vote is deemed under parliamentary procedure to be a negative vote.
(The Dem switching his vote was Congressman Gibbons of Florida, who told the tale that he was trying to get some sleep on his office couch, and in came Senator Long for about the third or fourth time, “begging him” to be for the ESOP provision.). True of not, Congressman Gibbons said to me once, “Senator Long was bugging me so much, and would not stop, I knew I would never get any rest unless I agreed to be for his ESOP provisions. (I can make the case that he really just wanted to have a chit from Senator Long for future trading for something he wanted the Senate to agree to.).
There was another break; time was reaching 3 AM or so.
I cornered Mr. Gates, and said that I recalled that Congressman John Duncan from Tennessee, who was the second ranking Republican conference member, had visited an ESOP company in his district. And that visit was written up in The ESOP Association’s newsletter, and implied that Congressman Duncan was impressed.
Remembering how a company visit to an ESOP company in 1980 in Austin, Texas had made my former boss Jake Pickle pro-ESOP, I suggested to Gates that he have Senator Long “lobby” Mr. Duncan to change his vote and be for the Senate ESOP provisions by reminding him of his visit to a company in his district, Knoxville, Tennessee, that made recreational boats “SEA-RAY”, and saying that our nation needed more companies like SEA-RAY. (An aside, SEA-RAY is no longer an ESOP company as it was acquired by a larger company.).
Gates did convey what I said to Senator Long, just as the members were coming back into the conference room after a break. I saw Senator Long speaking to Congressman Duncan up where the members were sitting. Then Senator Long asked Chair Rostenkowski for another vote on the ESOP provisions. And when the role was called among the House members Chair Rostenkowski, Congressmen Gibbons, Pickle, Rangel, and Duncan all voted to accept the Senate ESOP provisions—the vote was now 5 to 3 for the key ESOP provisions of 1984 DEFRA law to be adopted. (Of course Congressmen Stark and Conable, and Texas Congressman John Archer, a close ally of his ranking member Conable, voted no.).
When Duncan voted yes, it was Congressman Conable who had a look of surprise on his face—candidly, more of a look of “What are you doing? How can you be for ESOPs?” compared to Chair Rostenkowski’s look of surprise, and bewilderment when he learned that because of one Ronald Reagan, the Republican Treasury Department was “for” the ESOP tax incentives.
A fascinating story of how the ground breaking, so important laws encouraging ESOPs were adopted by the Conference, and thus the Congress, around 4 to 5AM one summer day in 1984.
BUT, I tell the story not because it was sort of interesting if one wonders about the details of how a Congressional group came to make law favorable to ESOPs beyond the basic tax incentives for contributions to an ERISA plan.
I tell the story because for ESOPs to win in Congress, and to win big, and to win consistently, having a member of Congress visit an ESOP company in his/her district is the most effective, most important tactic to gain a vote in Congress by a member than any other tactic. Other tactics can be positive—such as a DC visit by ESOP employees; such as a letter, email, phone call to a Congressional office asking for the member to take a pro-ESOP position by sponsoring positive ESOP proposals, or opposing a proposal that will discorage negative government laws, or actions by government regulatory agencies that are anti-ESOP. But it was a visit to an ESOP company in their districts that moved two key votes, one from a Democrat and the other from a Republican that effective ESOP tax incentives became law, and directly led to more ESOP creation.
This blog has many words; but it still requires reading between the lines to truly understand how Senator Long’s persistence put ESOPs near the top of arrangements that get special tax treatment under US tax laws.
(Stay tuned for more blogs in the future.).