Month: December 2004

The Treasury Department and IRS have announced the issuance of Notice 2005-1 which provides guidance (in Question and Answer format) regarding transition rules under recently enacted section 409A of the Internal Revenue Code governing nonqualified deferred compensation plans. (Read about the new rules here.)

The Treasury and IRS state in the Notice that the Notice is only “the first part of what is expected to be a series of guidance with respect to the application of § 409A” and that they “intend to incorporate the principles of [the] notice into additional, more comprehensive guidance in 2005.”

The press release also makes this statement:

IRS Chief Counsel Donald Korb said, “Given the significant changes that section 409A will require for nonqualified deferred compensation plans, we developed this guidance being mindful to avoid establishing rules that could become traps for the unwary.”

The Notice provides that actual amendments to plans can be delayed as late as December 31, 2005 if the plan is operated in good faith compliance with the provisions of § 409A and the Notice during the calendar year 2005. (See Q & A 19.) There is also a provision allowing certain severance plans which are collectively bargained or which do not cover any key employees to delay operational compliance with section 409A until 2006 (as long as the plans are amended on or before December 31, 2005.)

The DOL has issued some important guidance on the subject of “Fiduciary Responsibilities of Directed Trustees” in Field Assistance Bulletin 2004-03 (“FAB”). This article from PlanSponsor.com–“EBSA Issues Directed Trustee Responsibility Guidance“–gives some history behind the FAB:

The FAB was a response to Groom Law Group Chartered’s advisory opinion request filed by Stephen M. Saxon and Jon W. Breyfogle, on behalf of a dozen banks and other financial institutions early in 2004. The request was endorsed by the American Bankers Association.

The FAB retains the DOL’s controversial “knows or should know” standard:

Under section 403(a)(1), a directed trustee is subject to proper directions of a named fiduciary. For purposes of section 403(a)(1), a direction is proper only if the direction is “made in accordance with the terms of the plan” and “not contrary to the Act [ERISA].” Accordingly, when a directed trustee knows or should know that a direction from a named fiduciary is not made in accordance with the terms of the plan or is contrary to ERISA, the directed trustee may not, consistent with its fiduciary responsibilities, follow the direction.

Regarding the subject of following a direction that is “made in accordance with the terms of the plan”, the FAB makes it clear that directed trustees must read and follow the plan documents as well as the investment policy statement and if ambiguities exist, seek clarification from the “plan’s named fiduciary.”

Regarding following a direction that is “not contrary to ERISA”, the FAB provides that the “directed trustee cannot follow a direction that the directed trustee knows or should know would require the trustee to engage in a transaction prohibited under section 406 or violate the prudence requirement of section 404(a)(1)”:

The FAB provides guidance on how directed trustees can satisfy their fiduciary responsibility in avoiding prohibited transactions. The DOL states that the directed trustee “must follow processes that are designed to avoid prohibited transaction” and can “satisfy its obligation by obtaining appropriate written representations from the directing fiduciary that the plan maintains and follows procedures for identifying prohibited transactions and, if prohibited, identifying the individual or class exemption applicable to the transaction.”

With respect to “prudence determinations”, the FAB makes it clear that:

• The directed trustee’s role is “significantly limited.”
• The directed trustee does not have a “direct” or “independent” obligation to determine the prudence of every transaction.
• The directed trustee “does not have an obligation to duplicate or second-guess the work of the plan fiduciaries that have discretionary authority over the management of plan assets.”

The FAB then divides its remarks into two parts: (1) Where directed trustees possess “material non-public information” and (2) where directed trustees merely possess “public information.”

The FAB provides that if “the directed trustee possesses material non-public information regarding a security” that is necessary for a prudent decision, the directed trustee, prior to following a direction that would be affected by such information, “has a duty to inquire about the named fiduciary’s knowledge and consideration of the information with respect to the direction.” The FAB provides this example:

For example, if a directed trustee has non-public information indicating that a company’s public financial statements contain material misrepresentations that significantly inflate the company’s earnings, the trustee could not simply follow a direction to purchase that company’s stock at an artificially inflated price.

If the directed trustee has no more than public information, the FAB makes it clear that the directed trustee “will rarely have an obligation under ERISA to question the prudence of a direction to purchase publicly traded securities at the market price solely on the basis of publicly available information.” The FAB goes on to say that where there are “clear and compelling public indicators, as evidenced by an 8-K filing with the Securities and Exchange Commission (SEC), a bankruptcy filing or similar public indicator, that call into serious question a company’s viability as a going concern, the directed trustee may have a duty not to follow the named fiduciary’s instruction without further inquiry.”

While there is a great deal more here that one could write about from the FAB, I found some of the following footnotes to the FAB to be most interesting:

From Footnote 2: “The Department expresses no view as to whether, or under what circumstances, other procedures established by an organization to limit the disclosure of information will serve to avoid the imputation of information to a directed trustee.”

From Footnote 4: “We note that section 409 of the Sarbanes-Oxley Act of 2002, 15 U.S.C. 78(m)(l), requires public companies to disclose “on a rapid and current basis” material information regarding changes in the company’s financial condition or operations as the SEC by rule determines to be necessary or useful for the protection of investors or in the public interest. The SEC has recently updated its disclosure requirements related to Form 8-K, expanding the number of reportable events and shortening the filing deadline for most items to four business days after the occurrence of the event triggering the disclosure requirements of the form. 69 FR. 15594 (Mar. 25, 2004). Not all 8-K filings regarding a company would trigger a duty on the part of a directed trustee to question a direction to purchase or hold securities of that company. Only those relatively few 8-Ks that call into serious question a company’s ongoing viability may trigger a duty on the part of the directed trustee to take some action.”

From Footnote 5: “A directed trustee’s actual knowledge of media or other public reports or analyses that merely speculate on the continued viability of a company does not, in and of itself, constitute knowledge of clear and compelling evidence concerning the company sufficient to give rise to a directed trustee’s duty to act.”

From Footnote 7: “Nothing in the text should be read to suggest that a directed trustee would have a heightened duty whenever a regulatory body opens an investigation of a company whose securities are the subject of a direction, merely based on the bare fact of the investigation.”

Also, this quote from the Plan Sponsor article noted above:

In response to the FAB, Groom’s Saxon said in a statement, “We appreciate the Department’s guidance and are still analyzing it. The guidance did not go as far as we would have liked, and certainly we would never concede that a directed trustee is a fiduciary. The case law here is not clear. Notwithstanding this, the FAB sends a message, loud and clear, to the plaintiffs’ bar that ordinary directed trustees are no longer fair game for class action lawsuits. The Department agrees with us that directed trustees who by contract have no investment responsibilities will not be liable for losses that arise simply because of a drop in stock prices. That game is over,” Saxon added.

This announcement from Treasury today:

As part of an ongoing effort to improve ethical standards for tax professionals and to curb abusive tax avoidance transactions, the Treasury Department and the Internal Revenue Service today issued final regulations amending Treasury Department Circular 230.

Circular 230 is applicable to attorneys, accountants and other tax professionals who practice before the IRS. The revisions to Circular 230 provide standards of practice for written advice that reflect current best practices and are intended to restore and maintain public confidence in tax professionals. These revisions ensure that tax professionals do not provide inadequate advice, and increase transparency by requiring tax professionals to make disclosures if the advice is incomplete.

From the Associated Press:

A carefully crafted legal opinion from a reputable tax adviser with no financial stake in the matter can be useful in protecting investors from penalties in case the IRS later attacks. The new rules aim in part at making clear what kinds of opinion letters work, and which don’t.

Please note that the revised Circular 230 does not reflect certain amendments made by the American Jobs Creation Act of 2004 signed into law on October 22, 2004. The Circular states as follows:

On October 22, 2004, the President signed the American Jobs Creation Act of 2004, Pubic Law 108-357, (118 Stat. 1418)(the Act), which amended section 330 of title 31 of the United States Code to clarify that the Secretary may impose standards for written advice relating to a matter that is identified as having a potential for tax avoidance or evasion. The Act also authorizes the Treasury Department and the IRS to impose a monetary penalty against a practitioner who violates any provision of Circular 230. These final regulations do not reflect amendments made by the Act. The Treasury Department and the IRS expect to propose additional regulations implementing the Act’s provisions.

You can also access some Proposed Regulations here which set forth standards for State or local bond opinions and were issued in conjunction with the Circular.

An article from SHRM entitled “Year-End Pay and Bonuses: More Employees Rewarded as ‘Top Performers” (subscription required) provides these statistics regarding estimated pay increases for 2005:

Average pay increases for 2005 are still projected to be around 3.5 percent. But while pay budgets remain tight overall, employers are continuing to differentiate their workforce based on performance. For 2005, according to a survey released Dec. 13 by Mercer HR Consulting, as regards average base pay increases:

• Highest-performing employees are expected to receive 4.9 percent.

• Average performers are expected to receive 3.2 percent.

• Weak performers are expected to receive 1.0.

The article goes on to note, however, that pay increases for 2005 will likely be eaten up “by taxes, inflation and higher benefit insurance costs” and that many employees will be “underwhelmed” by their net increases.

Yesterday, FASB issued some long-awaited stock option expensing rules. The news release is here and the full text of FASB Statement 123 (revised 2004) Share-Based Payment is here [pdf]. The press release states that approximately 750 public companies in the U.S. are already “voluntarily applying Statement 123?s fair-value-based method of accounting for share-based payments or have announced plans to do so.”

PlanSponsor.com has a good article here.

In an audio interview with Bisnow on Business, U.S. Senator Rick Santorum, R-PA., third ranking Republican in the U.S. Senate, gave his views about reforming the tax code. An excerpt from a summary of the interview:

“[F]undamental reform of the tax code will be hard to do anytime soon” because people are not in agreement on whether the key problem is the tax code’s complexity, the harm some of its provisions do to U.S. global competitiveness, inefficiency in collecting revenue, or not using the tax code enough to solve problems in America.

The Wall Street Journal has a good editorial today entitled “The Social Security Crisis.” Excerpt:

Back in the 1930s, when the country was shaking off the Great Depression, it became apparent that the elderly were especially suffering — not only had they lost income and assets but there was no time for them to recoup. And so was born FDR’s greatest contribution to the welfare state. The notion was that Social Security would nick a little bit off everybody’s paycheck with a payroll tax and then redistribute that money to anybody over retirement age. The holding pen for this pay-as-you-go transfer was called, brilliantly if dishonestly, a “Trust Fund.”

Demography made the whole arrangement work for a long time. In the 1930s there were 41 workers for every one retiree; the payroll tax could thus be set at a low rate — about 2% for the first $3,000 of earnings. . .

The article goes on to note how the ratio of workers to retirees has fallen over the years–how in 1950, it had dropped to 16 workers to one retiree and now it is just three to one.

The article makes this critical point:

The immediate problem is that payroll taxes during the surplus period that began in the 1980s were not saved in the mythical Trust Fund; instead the taxes were used to finance other government spending. . .

I enjoyed this editorial cartoon from the TaxGuru.

The DOL has posted on its website the “Report of the Working Group on Fee and Related Disclosures to Participants.” The consensus of the working group (which was appointed by the Advisory Council on Employee Welfare and Pension Benefit Plans to study “fee and related disclosures to participants in defined contribution plans”) is for “additional disclosure of fees in defined contribution plans that seek the protections of ERISA section 404(c).” (The Advisory Council was created by ERISA to provide advice to the Secretary of Labor). Brief summary of the recommendations:

(1) “The profile prospectus of each investment option should be delivered to each employee upon eligibility to participate.”

(2) “Participants must be given materials (like a glossary) that explain the meaning of the terms used in the profile prospectus (or other like document) coincident with the delivery of the profile prospectus.” (In other words, a document explaining a document.)

(3) “To the extent that an annual statement is provided by the recordkeeper, the statement must provide the expenses of each investment option expressed as a ratio along with other information provided about the investment options. There must also be an identification of the investment expenses that are paid entirely or in part by the plan sponsor.”

(4) “The DOL should provide a sample model disclosure format that is available on its web site.”

Excerpts from testimony to the working group:

Louis Campagna, Chief, Division of Fiduciary Interpretations, Office of Regulations and Interpretations, US Department of Labor, Washington D.C.:

In choosing the funds menu, the plan fiduciary needs to examine the fees, which must be at a reasonable level given the services and their quality. In the 1997 Advisory Opinion (the “Frost Opinion”), it was stated that compensation to a service provider needs to be reasonable taking into account services provided as well as other compensation the service provider receives such as from asset fees.

Mercer Bullard, President and Founder Fund Democracy, Inc. and Assistant Professor of Law, University of Mississippi:

Professor Bullard speculates that participants do pay higher fees than other investors because fees are less transparent in qualified plans. He also believes that 401(k) participants’ investments perform better than the investments of individuals outside of 401(k) plans. He attributes this to the fact that 401(k) investors trade less often than other investors partially because their objectives are long-term and partially because of inertia.

Bruce Ashton, President, ASPA and partner of Reish, Luftman, Reicher & Cohen:

The current rules relating to the disclosure of plan related fees and expenses only go so far in disclosing to the plan participant what he or she is really paying out. ASPA believes that plan participants should receive full and complete disclosure of all fees and expenses paid out of plan assets that can be reasonably identified. Further, this disclosure should be provided in a meaningful and understandable format. To minimize administrative burdens, the disclosure could be distributed in conjunction with the plan participants regular year-end statement. Although specific disclosure of the amount actually charged to a participant’s account may be preferable, the burden of providing this individualized information is significant, and providing such information could have a chilling effect on the creation and maintenance of such plans.

Norman P. Stein, Professor of Law, University of Alabama:

Clear and understandable disclosure of fees is still important. Uniformity of presentation is necessary so that participants have the same information about all investment options. The disclosure must also provide examples of how fees affect the rate of return and of how fees can make it more expensive to move in and out of investment options. He also points out the DOL does not have expertise in the area of investments. The SEC does, however, have expertise in this area. Therefore, the DOL should consult with the SEC when designing rules for these kinds of disclosures. Nevertheless, the DOL has more expertise in designing the format of such a disclosure than the SEC, so the DOL should prescribe the format.

Regarding the types of disclosure favored by the working group, here is what they had to say:

[T]he working group saw examples of investment statements showing the expense of each investment option expressed as a ratio for each fund in which a participant was invested as of the date of the statement. The working group believes that this is pertinent information that is helpful in making the investment decision. This information can also be presented in an understandable format.

One example was in materials distributed in connection with Russell Ivinjack’s testimony. It consisted of a table having the following information going across the page: fund name, fund type, objective/strategy, risk level and expense ratio. Another example was in materials distributed by Dennis Simmons and Stephen Utkus who were from the Vanguard Group. The sample all-in fee report and the sample fund fact sheet are attached as exhibits to this report. The sample all-in fee report is substantially similar to the DOL Fee Disclosure Form.