Category: Erisa

Have a great holiday season! No posts here until the end of the year.

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.

Imagine the following scenario: A CPA and owner of a public accounting firm is sole trustee of the firm’s 401(K) plan and is responsible for investing, managing, and controlling the plan’s assets. Over a span of three years, the CPA decides that the plan can loan money to a number of companies in which the CPA owns a minority interest. The loans which amount to around $700,000 will bear interest at 12%, and will provide a good return for the plan. Because the CPA does not own 50% or more of the companies to which the plan will be loaning money, the CPA figures he won’t run afoul of the prohibited transaction provisions. (Under Code Sec. 4975 , a tax is imposed on a disqualified person (e.g., a plan fiduciary or a 50% or more owner of the plan sponsor) who participates in a prohibited transaction which includes a loan between a plan and a disqualified person.) Those were the facts in the recent Tax Court case of Joseph R. Rollins, TC Memo 2004-260.

However, the IRS had a different view of the transactions in that case. The IRS pulled out its arsenal of sections 4975(c)(1)(D) and (E) of the Internal Revenue Code and claimed that the CPA had committed prohibited transactions. Under those provisions, the IRS claimed that the “loans were transfers of the [p]lan’s assets that benefited” the CPA under sec. 4975(c)(1)(D) of the Code, and that the the loans were dealings with the plan’s assets in the CPA’s own interest under sec. 4975(c)(1)(E) of the Code. The IRS contended that the CPA was a disqualified person with respect to the plan in two capacities: (a) A fiduciary of the Plan (sec. 4975(e)(2)(A)), and (b) the 100-percent owner of the employer sponsoring the plan. The IRS held that the CPA benefited from the loans in that the loans enabled the borrowers–all entities in which the CPA owned interests–“to operate without having to borrow funds at arm’s length from other sources.”

When the Tax Court reviewed the facts, the court agreed with the IRS that the loans were prohibited transactions under section 4975(c)(1)(D), but held that it was unnecessary to decide whether the the CPA had also violated section 4975(c)(1)(E).

What were the CPA’s excise taxes that he had to pay for the prohibited transactions? Roughly $164,000, a hefty penalty for what in the end looked like a fairly good deal for the plan. The Tax Court reiterated its position that, just because an investment is good for a plan, doesn’t matter when it comes to applying the prohibited transaction rules:

After a review of the statutory framework and legislative history of section 4975 and the case law interpreting ERISA section 406, we conclude that the prohibited transactions contained in section 4975(c)(1) are just that. The fact that the transaction would qualify as a prudent investment when judged under the highest fiduciary standards is of no consequence. Furthermore, the fact that the plan benefits from the transaction is irrelevant. Good intentions and a pure heart are no defense.

Moral of the story: No matter how good an investment looks for a plan, ERISA fiduciaries, trustees, and certain owners and entities should get competent legal advice regarding application of the prohibited transaction rules when entering into transactions with retirement plans, especially in cases where common ownership exists or conflicts of interest issues are present. In the end, the court, in the portion of the opinion where it addressed the issue of whether or not it should impose the additional tax for failure to file an excise tax return, actually seemed to penalize the CPA for not obtaining competent advice:

Relying on his own understanding of the law, petitioner chose to sit “on both sides of the table in each transaction.” . . . Relying on his own understanding of the law, petitioner did not see any need to file section 4975 tax returns to report any of the transactions. . . . Petitioner’s good-faith belief that he was not required to file tax returns does not constitute reasonable cause under section 6651(a)(1) unless bolstered by advice from competent tax counsel who has been informed of all the relevant facts. Stevens Bros. Foundation, Inc. v. Commissioner, 39 T.C. 93, 133 (1962), affd. on this point 324 F.2d 633, 646 (8th Cir. 1963). There is no such evidence in the record in the instant case.

Also, the case is worth reading alone for its detailed discussion of the history behind the prohibited transaction rules.

The Department of Labor is soliciting comments about the viability of their website. You can give them your thoughts and suggestions for improvement here.

The Department of Labor is soliciting comments about their website. You can give them your thoughts and suggestions for improvement here.

After making my way through the newly-proposed and voluminous (100+ pages) 403(b) regulations (mentioned here in this previous post), one of the items that stands out overall is the plan document requirement. Proposed regulation section 1.403(b)-3(b)(3) provides:

A contract does not satisfy paragraph (a) of this section unless it is maintained pursuant to a plan. For this purpose, a plan is a written defined contribution plan, which, in both form and operation, satisfies the requirements of this section and sections 1.403(b)-4 through 1.403(b)-10. For purposes of this section and sections 4.1403(b)-4 through 1.403(b)-10, the plan must contain all the material terms and conditions for eligibility, benefits, applicable limitations, the contracts available under the plan, and the time and form under which benefits distributions would be made. . .

How will this new requirement impact whether or not a 403(b) plan ends up falling under the purview of ERISA? Although the IRS states in the regulations that having a plan document would not necessarily lead to the application of ERISA, it is expected that the DOL will provide guidance on this issue. Here is what the regulations have to say on the plan document requirement and the application of ERISA:

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

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

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

McDermott Will & Emery also comments on the issue in their article on the new regulations here. (From Benefitslink.com.)The article makes the point that the plan document requirement may impact “whether the plan document will effectively supersede and control the main contractual document between the employer and the 403(b) vendor (such as a 403(b) group annuity contract issued by an insurer).”

By the way, in the recent “Extra Special Edition of the Employee Plans News” published by the IRS, Carol Gold, Director of EP, indicates that the IRS is not yet ready to begin implementation of a 403(b) determination letter program until the 403(b) regulations are finalized. She notes, however, that the proposed regulations do indeed “move the ‘403(b) plan’ closer to the concept of a ‘qualified plan’ and leaves the door open for the development of such a program for 403(b) plans in the near future. Here is most of what she had to say:

This week, proposed regulations under section 403(b) were published in the Federal Register. These regulations take the important step of requiring a 403(b) contract to be maintained pursuant to a plan in order for amounts contributed by employers for the purchase of annuity contracts to be excluded from the gross income of employees. For purposes of the regulation, a plan is a written defined contribution plan which must satisfy the applicable requirements of the regulation both in form and operation. Furthermore, the proposed regulation provides rules by which 403(b) plans may be terminated.

Clearly, the proposed regulations move the “403(b) plan” closer to the concept of a “qualified plan”. However, we anticipate it will be a while yet before the regulations are finalized. Nevertheless, we recognize that if 403(b) annuity contracts are treated as ”plans” under the regulations when finalized, there will be more of an impetus to create a program to review plans and plan amendments, and possibly to issue determination letters on those plans or amendments.

We would welcome the opportunity to work with the public on considering such a program. At this point, however, we feel it would be premature to actively develop such a program prior to the finalization of the regulation. Therefore, I would suggest that we continue to exchange ideas about what a program could look like while agreeing that substantive change will have to wait a little longer.

Don’t miss this important decision from the Seventh Circuit written by Circuit Judge Richard Posner which discusses “partial terminations” in the context of when participants must receive 100% vesting: “Matz, et al. v. Household International Tax Reduction Investment Plan.” (An interesting aspect of the case was the fact that the case was in its 9th year of litigation. Many employers automatically vest participants in such transactions in order to avoid the risk of protracted litigation such as occurred in this case.) The issue in the case as framed by Judge Posner was this:

The question is the correct approach to deciding whether an ERISA pension plan-in this case a defined-contribution plan in which the employer matched contributions that its employees made by means of payroll deductions to individual retirement accounts-has been partially terminated.

According to the opinion, “as a result of a series of reorganizations of subsidiaries of Household, a total of 2,396 of the 11,955 participants in Household’s plan ceased to be participants.” The issue was whether such reorganizations should result in the participants attaining 100% vesting in the plan. Here’s what Judge Posner had to say:

So where to draw the line? The IRS, which is not famous for encouraging tax windfalls, draws it at 20 percent. As we look back upon the course of this litigation, now in its ninth year and its third interlocutory appeal to this court, we find ourselves drawn back to the IRS’s position. Not because it is entitled to Chevron deference-we adhere to our holding that it is not-but because, having toyed with the alternatives, we think it is the best available and we respect the IRS’s experience in formulating tax rules.

The court provides a table of all of the cases and rulings on the issue of what constitutes a “partial termination” and makes the following statements about the results:

In 20 of the 21 cases and rulings, if 20 percent or more of the participants lose coverage, there is a finding of a partial termination, and if fewer than 20 percent do, a partial termination is not found. The exception is the Sea Ray case, where a 27.9 percent loss of coverage was held not to be a partial termination because the loss was the consequence purely of economic conditions; the employer was not motivated by any desire to obtain a tax benefit or reallocate pension benefits to favored participants in the pension plan.

In an effort to make the law as certain as possible without opening up gaping loopholes, we shall generalize from the cases and the rulings a rebuttable presumption that a 20 percent or greater reduction in plan participants is a partial termination and that a smaller reduction is not. How rebuttable? One can imagine cases in which a somewhat smaller reduction in the percentage of plan participants would be tax-driven and might on that account be thought a “partial” termination, and other cases, like Sea Ray, in which the reduction is perhaps not so far above 20 percent that further inquiry is inappropriate. We assume in other words that there is a band around 20 percent in which consideration of tax motives or consequences can be used to rebut the presumption created by that percentage. A generous band would run from 10 percent to 40 percent. Below 10 percent, the reduction in coverage should be conclusively presumed not to be a partial termination; above 40 percent, it should be conclusively presumed to be a partial termination.

The court then vacated and remanded the case, stating that a remand was necessary for the district court to consider additional “facts and circumstances.” The court noted that it had considered whether or not to “invite the IRS to submit an amicus curiae brief” advising the court of its “current view of the proper approach to determining partial termination” but “decided not to do so because of the great age of the case.” The court went on to emphasize that “should the IRS decide on its own to revisit the issue” the court “would give [the IRS’s] views significant weight” and “therefore the rule we have just formulated for deciding such cases as this should be considered tentative.”

Query: With Judge Posner being the likely author of the appeal in the IBM cash balance plan decision, can we glean anything from this Household opinion which could lead us to believe that Judge Posner might uphold the cash balance plan as being not violative of ERISA in the IBM appeal? (Read about the cash balance plan controversy here in an article from the Journal of Financial Planning as well as in previous posts here and here.) Statements in the opinion like–“[W]e respect the IRS’s experience in formulating tax rules,” the IRS’s views should be accorded “significant weight,” and the emphasis in the opinion on “mak[ing] the law as certain as possible,” coupled with the precedence of 3 out of 4 district court opinions upholding cash balance plans, might lead us to speculate that Judge Posner could provide a reversal.

Some related reading: “What Will Judge Posner Do Next? Balm or Bomb for Cash Balance Plans?” by Alvin D. Lurie (via Benefitslink.com). Lurie makes the following statement regarding Judge Posner and ERISA cases:

Judge Posner, who admits to enjoy(ing) ERISA cases which he finds frequently difficult and fascinating (see Posner, How I Approach the Decision of an ERISA Case, NYU Review of Employee Benefits and Executive Compensation 2002, ch. 14, hereafter “NYU”) waded into this unforgiving terrain with gusto and acumen. . . ”

Also, a personal glimpse of Judge Posner here.

Interesting article about the fallout from the Aetna Health Inc. v. Davila case: “Lawsuits against health plans crumble in wake of Supreme Court ruling: Federal appeals courts in New York and Georgia have dismissed cases that they originally said could go forward.” Excerpt:

Two federal appeals courts recently reversed decisions that originally gave subscribers the right to go forward with such cases. The rulings both take into consideration the high court’s June decision that Texas patients could not proceed with their HMO lawsuits. . .

George Parker Young, the Texas attorney who represented the two patients in the case before the Supreme Court this summer, said lawyers have been discussing other claims that could be made against HMOs in state courts.

For example, one Supreme Court justice raised the question of suing under the idea of fiduciary duty.

“It’s going to be an interesting court fight,” Young said.

Interesting article from Workforce Insights entitled “In the Balance: The Future of Pension Rights.” The article discusses the future of the cash balance plan and suggests that the cash balance plan controversy may be headed for the U.S. Supreme Court:

IBM’s cause – which has become the cause of pension sponsors generally – may not end at the Circuit Court in Chicago. The issue seems likely to wind up in the Supreme Court, especially if the split that has already shown up at the District Court level also occurs among the Circuit Courts of Appeals. There also could be legislation.

The Treasury has urged Congress to act. It told the lawmakers last February that the split among federal judges “has created uncertainty about the basic legality of these plans. Removing that uncertainty is critical to preserving the vitality of the defined benefit system, which provides retirement income security for millions of American workers and their families.”

Lyle Denniston is a veteran Supreme Court reporter, having covered the highest court for 46 years. He thus has covered one out of every four Justices ever to sit on the Court. Denniston is now reporting on the Court for SCOTUSblog, a Web site devoted to news and information about the Court, and for the NPR Boston affiliate, WBUR.

CBS MarketWatch is reporting: “California starts probing insurers: Spitzer suit spawns other investigations across U.S.” Excerpt:

California Attorney General Bill Lockyer has started an investigation into alleged bid rigging by insurance firms and brokers, the latest sign that Eliot Spitzer’s probe of the industry is spreading from New York to other states. Lockyer’s investigation, announced late Friday, will focus on possible violations of California’s antitrust law, known as the Cartwright Act, as well as potential fraud by companies.

According to the article, Lockyer said in a statement that “[a]ny insurance company or broker violating these laws will be held accountable.”

Also, in October of this year, California issued proposed regulations setting forth the fiduciary duties owed to a client by brokers. For more information, read the Public Notice, the Initial Statement of Reasons for the regulations, and the text of the proposed regulations. A portion of the regulations provide as follows:

2184.4 Fiduciary duty

(a) A broker who places his or her own financial or other interest above that of his or her client violates Insurance Code section 790.02.
(b) A broker violates Insurance Code section 790.02 if, with either new or renewal business, he or she: (1) Fails to provide the client with the proposal of a best available insurer; (2) Advises a client to select an insurer other than a best available insurer; (3) Advises a client not to select a best available insurer from among multiple insurers suggested to the client; (4) Fails to take reasonable measures to obtain a quote from an insurer that might be a best available insurer.

According to this press release, “failure to comply could result in fines of up to $10,000 per incident, issuance of a cease and desist order by the Commissioner, and/or the revocation or suspension of a company or broker’s license.”

(How this law would interact with ERISA with respect to brokers who are fiduciaries under ERISA is a good topic for future discussion.)

In addition, on Tuesday, California voters rejected the proposed law requiring businesses to provide health insurance for their workers or to pay into a state health coverage fund: “Mandatory health insurance loses narrowly.” (Previous posts on SB2 here.) If voters had not rejected it, many had predicted that there would have been legal challenges to the legislation under ERISA.

Finally, here’s a good article from Trucker Huss on another interesting development in California: “Discretionary Clauses in Disability Insurance Policies Ruled Illegal in California.” (From Benefitslink.com) According to the article, “[t]he California Department of Insurance and a federal district court have both recently held that the use of so called “discretionary clauses” in disability insurance policies, including those issued to plans governed by ERISA, violates California law and that the state law in this regard is not preempted by ERISA.”

(There’s never a dull moment in California!)