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BENEFITS AND COMPENSATION REPORT: Department of Labor Announces Qualified Default Investment Alternatives; Stable-Value Funds Excluded
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March 31, 2008
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Thelen Reid Brown Raysman & Steiner LLP
The Pension Protection Act of 2006 encouraged automatic enrollment in individual account plans by amending ERISA §404(c) to provide a safe harbor for plan fiduciaries who invest participant assets in the absence of participant investment direction. Once participants have been given an opportunity to direct the investment of their funds and fail to do so within a specified time, a plan fiduciary may invest those assets in a qualified default investment alternative (QDIA) and qualify for the safe harbor, assuming specified conditions are met.
The Department of Labor has published final regulations that permit three types of QDIAs, all of which offer a mix of stocks and bonds (target date, life cycle and similar funds; balanced funds; and managed accounts). These rules became effective December 24, 2007.
The insurance and stable value industry had lobbied intensively for stable value funds to be included as QDIAs but were unsuccessful. In the final regulations, the Department of Labor explained its decision to exclude stable value funds by saying that when such investments are the exclusive component of a participant's account, they would "not over the long-term produce rates of return as favorable as those generated by products, portfolios and services included as qualified default investment alternatives, thereby decreasing the likelihood that participants invested in capital preservation products will have adequate retirement savings."
Although the department did not include stable value funds as QDIAs, it did provide three concessions to the industry. First, participant default funds placed in stable value investments before December 24, 2007, will be grandfathered provided all other requirements of the regulations are met. Second, QDIAs offered through variable annuity or similar contracts will not lose their safe harbor status provided all other terms of the exemption are met. Finally, after December 24, 2007, a plan sponsor may invest participant assets in a stable value fund for up to 120 days and still retain the safe harbor protection. After that initial 120 day period, however, the stable value fund will not be a permissible default investment.
Click here for the press release announcing the final regulations.
Click here for the fact sheet summarizing the final regulations.
Click here for the full text of the final regulations.
– Ben Delancy
(202) 508-4081
bdelancy@thelen.com
DOL Revises Timing of Participant Benefit Statements
The Pension Protection Act of 2006 requires that the plan administrator of an individual account plan (such as a 401(k) plan, employee stock ownership plan or profit sharing plan) provide a benefit statement to plan participants: (1) at least once each calendar quarter for participants who have the right under the plan to direct the investment of the assets in their accounts; or (2) at least once each calendar year for participants who do not have the right to direct the investment of their accounts.
The Department of Labor has issued Field Assistance Bulletin 2006-03, which provides that benefit statements furnished to participants within 45 days after the relevant period (i.e., the calendar quarter or calendar year) would constitute good faith compliance. This 45-day period presented logistical problems for plans that were unable to complete their quarterly or annual plan administration within the allotted time. To satisfy the 45-day requirement, some plan administrators considered giving benefit statements containing outdated information from the previous period and then supplying participants with an updated statement upon completion of the plan's administration. That approach would have been costly to plan sponsors and confusing to plan participants.
On October 12, 2007, the Department of Labor released Field Assistance Bulletin 2007-03, which provides welcome relief to plan sponsors regarding the timing of participant statements for plans that do not provide for participant direction of investments (i.e., plans that must provide participant benefit statements at least once each calendar year). Under FAB 2007-03, individual account plans that do not provide for participant direction of investments have until the date on which the annual Form 5500 Annual Return/Report is filed by the plan to provide benefit statements to participants.
Click here for the full text of FAB 2007-03.
– Ben Delancy
(202) 508-4081
bdelancy@thelen.com
§409A Update – IRS Extends Documentary Compliance Deadline for Deferred Compensation Plans
The Internal Revenue Service has announced several significant developments regarding Internal Revenue Code §409A. They cover nonqualified deferred compensation plans, broadly defined to include any arrangement that defers compensation more than 2˝ months after the year in which it is earned. According to IRS Notice 2007-78:
|  | Plan documents need not comply fully with §409A until December 31, 2008.
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| | Plan operations must comply with the final §409A regulations effective January 1, 2008, except as otherwise specifically provided in the Notice.
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| | Before the end of 2007, plans must specify in writing §409A-compliant times and forms of distributions.
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| | The IRS intends to adopt a limited voluntary compliance program for unintentional §409A violations.
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This update summarizes the important provisions of the Notice, released on September 10, 2007, and suggests how employers could proceed during the remainder of 2007.
Plan operations must comply with the final §409A regulations effective January 1, 2008. The Notice did not change the effective date of the final §409A regulations. Except as otherwise provided in the Notice, beginning January 1, 2008, plans must comply in operation with §409A and the final regulations.
Plan documents need not comply fully with §409A until December 31, 2008. In general, employers need not adopt final §409A amendments to their plan documents until December 31, 2008. During 2008, deferred compensation arrangements will not violate §409A merely because plan provisions do not comply with §409A if the plan is operated in accordance with §409A, the final regulations and the Notice and, before the end of 2008, the plan is amended retroactively to January 1, 2008. Except as specifically provided in the Notice, by December 31, 2008, a plan must contain all required provisions and must accurately reflect the operation of the plan during 2008, including terms and conditions under which any initial deferral elections or subsequent elections were permitted, and how the operation of the plan satisfied §409A.
Before the end of 2007, plans must specify in writing §409A-compliant times and forms of distributions. Despite the general extension for plan amendments, before the end of 2007 plans must contain written provisions that comply with the requirements of §409A regarding the time and forms of distributions. A plan that contains both compliant and noncompliant provisions (e.g., a haircut provision) regarding the time and form of distributions will be treated as complying with §409A during 2008 if it disregards the noncompliant provisions and removes the noncompliant provisions before 2009. If a plan fails to specify in writing a potential payment event, the addition of that new distribution event must comply with the final regulations, which means in many instances that it also must comply with the subsequent deferral rules.
Employers may choose to adopt a separate written document containing §409A-compliant distribution provisions. As long as the deferred amounts to which each designated time and form of payment applies are objectively determinable, the separate document may apply to specified plans, to unspecified plans or a combination.
Plan distribution provisions will comply with §409A even if they do not specify whether the plan uses a default rule or one of the many alternatives allowed by the final regulations. For example, a plan merely identifying "separation from service" as a distribution event will comply with the Notice during 2008 as long as the plan complies in operation with any of the options for defining separation from service and is amended before the end of 2008 to reflect the actual operation. The later adoption during 2008 of an alternative definition of separation from service will not be treated as a change in the time or form even if the adoption of the new definition would result in a payment being made earlier or later. Once an event has occurred in 2008 and is either treated as a distribution event or not with respect to a deferred amount, the service recipient and the service provider cannot change the definition of the distribution event with respect to that deferred amount.
Similarly, provisions relating to the six-month delay for specified employees need not be added to plans before 2008, but plans must comply in operation with that requirement during 2008 and, to the extent that an employer uses any alternative approach to compliance other than the default rules provided in the final §409A regulations, the employer must be able to demonstrate the method and consistent application of the method during 2008 to all plans and all specified employees.
The Notice also discusses compliance with the rules applicable to distributions at a specified payment date or payments according to a fixed schedule. The Notice identifies circumstances in which designated payment provisions may be added or deleted during 2008 without being treated as a change in the time and form of distribution.
The Notice clarifies the effect of certain modifications to employment agreements. The Notice describes circumstances in which the definition of "good reason" in an existing employment agreement may be modified before the end of 2007 so that amounts payable upon voluntary termination for "good reason" will be considered subject to a substantial risk of forfeiture and may qualify for one or more exceptions to §409A for amounts payable solely upon involuntary termination. The Notice also describes circumstances in which the grant of a right to deferred compensation in an extended, renewed or renegotiated employment agreement will not be treated as a substituted right to deferred compensation.
The Notice confirms that 2007 transition period elections to change the time and form of distributions may result in payments being excluded from §409A. Until the end of 2007, a plan may permit new elections regarding the time and form of distributions. Participants taking advantage of this transition rule may change an election to cause the right to compensation, or a portion of that right, to be excluded from §409A because a payment becomes either a short-term deferral or qualifies for one of the exceptions applicable to distributions payable solely upon involuntary termination. Plan amendments pursuant to this transition relief may not (1) affect amounts that otherwise would be distributed in 2007 or (2) cause an amount to be distributed in 2007 that would not otherwise be distributed in 2007.
The IRS intends to adopt a limited voluntary compliance program for unintentional §409A violations. Perhaps the best news contained in the notice is the confirmation that the IRS expects to announce in the near future a voluntary compliance program for unintentional operational failures. The Notice indicates that the program is likely to include a method for curing failures during the same taxable year in which the failure occurred and also limited taxation for other failures.
What to do for the remainder of 2007?
Employers who have not yet begun to revise their plans have been given a slight reprieve, but they are not completely off the hook. Even though final amendments need not be completed until the end of 2008, the Notice still requires that plans contain §409A-compliant distribution provisions before the end of 2007. Furthermore, except to the extent specifically allowed by the Notice, changes after 2007 to those distribution provisions must comply with the subsequent deferral rules.
Accordingly, before the end of 2007, employers should:
| | Determine which distribution events and forms of distribution to include in their plans.
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| | Include those distribution provisions in existing plan documents or in a separate document used just for that purpose.
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| | Review the alternative definitions permitted by the final §409A regulations for distribution events. Although employers may adopt alternative definitions during 2008, they should begin the year having selected the definitions they initially intend to use.
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| | Obtain participant elections for 2008 deferrals.
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| | Keep in mind elections permitted by existing transition relief, including the ability during 2007 to change existing elections regarding the time and form of distribution.
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| | To the maximum extent possible, continue to work on §409A compliance. The final regulations will become effective January 1, 2008, and plans must comply in operation from that date forward. Employers may want to have final drafts or near-final drafts by that time.
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– Ben Delancy
(202) 508-4081
bdelancy@thelen.com
No ERISA Violation for 'Revenue Sharing' by Retirement Plan Investment Providers, Court Rules
The Employee Retirement Income Security Act does not require plan sponsors or service providers to disclose revenue sharing fee information to participants, the U.S. District Court for the Western District of Wisconsin has held.
In a memorandum opinion dismissing a lawsuit against John Deere, Inc. and two subsidiaries of Fidelity Investments, the court held that ERISA's statutory provisions contain limited and finite disclosure requirements that are not supplemented by ERISA's general fiduciary mandates. The court also held that the defendants could not be liable for allegedly excessive fees charged by Fidelity's mutual funds.
The ruling is the first to dismiss one of the recent spate of ERISA lawsuits filed across the country challenging the common practice of revenue sharing. Click here to view the full text of the court's opinion.
The thrust of the lawsuits is that revenue sharing results in the payment of excessive and undisclosed fees, both of which are alleged to violate ERISA. Revenue sharing is not a defined term in ERISA, but it generally refers to a compensation practice in which 401(k) plan investment providers allocate - or "share" - a portion of their asset-based fees to other plan service providers. This has become an increasingly common practice, especially among so-called "bundled" service providers, like Fidelity, that offer a range of investment and administrative services to plans through more than one corporate sibling. In the John Deere case, the investment management arm of Fidelity (Fidelity Management and Research Company) provided investment vehicles to the John Deere plan while Fidelity Management and Trust Company acted as plan trustee and recordkeeper. In order to offset some of the cost of providing trust and recordkeeping services, Fidelity Management and Research allocated a portion of its asset-based fees to Fidelity Trust. As indicated in the court's decision, Fidelity disclosed to the plan and its participants neither the existence nor the amount of that revenue sharing.
The court rejected plaintiffs' claims that the lack of revenue sharing disclosure violated ERISA. Rather, noting that the Department of Labor is engaged in a regulatory effort to require revenue sharing disclosure, the court held that nothing in the current statute or regulations directly requires such disclosure. "Whether, as a policy matter, additional reporting of revenue sharing arrangements should be required" was not for the court to decide. Instead, the very existence of the regulatory initiative "unequivocally confirms" that the lack of such disclosure does not violate current ERISA standards. The court also refused to expand ERISA's general fiduciary obligations to include a separate duty to disclose fee information. Rather, disclosure requirements are "generally limited to those expressly prescribed by the statutory language" of ERISA.
The court then turned to the plaintiffs' contention that John Deere and Fidelity breached their fiduciary duties because the investment options offered by the plan all charged excessive fees. The court first held that defendants could not be liable for any losses because the plan fit into the safe harbor of ERISA §404(c). Although typically raised as an affirmative defense, plaintiffs suggested in their complaint that defendants did not meet the disclosure requirements in the Department of Labor's §404(c) regulations, apparently attempting to pre-emptively take away the defense. The defendants, in their motion to dismiss, argued that the §404(c) defense does apply and that it shields them from any liability occurring as a result of participants' exercise of control over their individual accounts.
The court agreed with defendants. According to the court, the only component of the §404(c) safe harbor that was in dispute was the regulations' disclosure requirements. The court appeared to assume that the plan met the balance of the extensive safe harbor conditions. Examining the plan documents that were part of the record, the court then found that on "their face it appears that the disclosures provide precisely" the information required by the regulations. As is the case with the statutory disclosure requirements of ERISA, the §404(c) regulations do not expressly require disclosure of revenue sharing information. In addition, according to the court: "There is nothing to suggest that receiving this additional nonprescribed information would effectively enhance investment decisions."
In what ultimately may be the most controversial portion of the opinion, the court held that defendants were insulated from fiduciary liability because, even if the revenue sharing arrangements caused the plan and participants to pay excessive fees, the payments resulted from the participants' exercise of control over the investments. Noting that the plan provided, as an investment option, an open brokerage window that made available more than 2,500 mutual funds to participants, the court wrote that it is "untenable to suggest" that all of the funds charged excessive expense ratios. "The only possible conclusion," the court wrote, "is that to the extent participants incurred excessive expenses, those losses were the result of participants exercising control over their investments within the meaning of the safe harbor provision" of §404(c). Even assuming that defendants had "failed to satisfy their fiduciary obligation to consider expenses when selecting mutual fund investment options, they are nevertheless insulated from liability by the safe harbor provision because of the nature and breadth of funds made available to participants under the plans."
The court's holding appears to be at odds with the Department of Labor's interpretation of §404(c) - generally shared by ERISA practitioners - that plan fiduciaries remain responsible for prudently selecting and monitoring a plan's investment options. Plan fiduciaries are not liable for the individual investment choices of participants but are generally understood to remain liable if they permit imprudent investment options to be among the choices available for participants. For this reason, there always has been a healthy skepticism among plan sponsors about the value of §404(c)'s protection. The court's holding on this issue represents a significant departure from the current understanding of the safe harbor provision, and if it is allowed to stand or is upheld on appeal, it will dramatically enhance the value of §404(c) liability protection.
Finally, in two short paragraphs, the court dismissed the Fidelity defendants for the same reasons John Deere was dismissed. In addition, because the trust agreements between John Deere and Fidelity Trust "unequivocally provide" that John Deere has "sole responsibility for selection of plan investment options," neither of the Fidelity defendants could be fiduciaries with respect to the plan's investment decisions and "accordingly could not be liable for breach of fiduciary duty on the claims."
– Ben Delancy
(202) 508-4081
bdelancy@thelen.com
Retiree Health Plans Can Coordinate with Medicare, Court Holds
Retiree health plans that coordinate with Medicare may allow Americans to retire earlier.
This is because the unavailability of affordable health coverage forces many seniors to continue to work until they (and their spouses) become eligible for Medicare. Employers willing to fill the coverage gap have been frustrated by legal challenges that restricted plan design options, making retiree health care too costly for most employers.
In 2000, a federal court held that the Age Discrimination in Employment Act (ADEA) prohibited a reduction in retiree health benefits when retirees become eligible for Medicare. Erie County Retirees Assn. v. County of Erie, 220 F.3d 193 (3d Cir. 2000).
The Equal Employment Opportunity Commission tried to address the problem in April 2004 by approving a rule allowing coordination of retiree health benefit plans with Medicare. But on March 30, 2005, the U.S. District Court for Eastern District of Pennsylvania permanently enjoined the EEOC from issuing that rule. American Association of Retired Persons v. Equal Employment Opportunity Commission, 383 F.Supp.2d 705 (E.D.Pa. 2005).
On June 4, 2007, the 3rd U.S. Circuit Court of Appeals lifted the injunction and ruled that the proposed regulation is within the EEOC's authority under the ADEA and is valid under to the requirements of the Administrative Procedure Act. American Association of Retired Persons v. Equal Employment Opportunity Commission, 2007 WL 1584385 (3d Cir. 2007).
Employers with retiree health plans should review their plans to ensure that they follow and are taking full advantage of the EEOC guidelines. Other employers may want to consider offering retiree health plans to address the coverage problems for their early retirees.
– Tonie Bitseff
(415) 369-7036
tbitseff@thelen.com
Pension Liability Makes Decision to Outsource Costly
An employer in the building and construction industry paid a big price for its decision to outsource a portion of its business. The employer's business included both manufacture and installation of wood products. The employer contributed to the Oregon-Washington Carpenters-Employers Pension Trust Fund on behalf of its installation employees.
In late 2003, the employer closed its installation operations, terminated the collective bargaining agreement that required its contributions to the fund, sold its installation equipment, and then subcontracted for installation services with the company that purchased the equipment and hired some of its employees.
The fund sought money from the employer to pay for a portion of unfunded plan benefits. Federal law authorizes certain types of pension plans (generally involving a union) to collect money for underfunding of the plan when an employer leaves the plan (called "withdrawal liability").
An arbitrator concluded that the employer did not owe withdrawal liability. A court overturned the arbitrator's decision. Oregon-Washington Carpenters-Employers Pension Trust Fund v. Boden Store Fixtures, Inc., D. Ore., No. CV 06-1379-HU. The court held that the outsourced work was substantially the same as the work performed by Boden's former installation employees. Therefore, Boden did not escape withdrawal liability by subcontracting the services.
This case illustrates one of the reasons why it is often easier (and less expensive) to join a pension plan than to exit from it. Legal counsel should be consulted before taking either of these steps.
– Tonie Bitseff
(415) 369-7036
tbitseff@thelen.com
Institutional Investors Recommend Internal Governance Reform
Managers of institutional investment funds, such as pension plans, should voluntarily adopt "basic policies" to improve their own governance, according to a report issued on June 4 by a committee of the Stanford Institutional Investors' Forum. The report recommended five "best practice" principles that, if followed, would curb potential fund abuses and improve transparency.
Managers of large public pension funds, who often have taken the lead in demanding corporate governance reform, must shift their attention to reforming their own rules, according to committee chairman Peter Clapman. Citing allegations of public pension fund abuse in several states, as well as scandals at endowment and charitable funds, Clapman noted that "fundamental fund governance standards ought to exist to safeguard beneficiaries' assets from questionable - and often illegal - practices, and to protect the taxpayers, who end up footing the bill when institutional investors fail."
While primarily focused on public pension plans, endowments and charitable trusts, the report suggests that its best practices principles can be adopted by all large institutional investors, including Taft-Hartley pension plans, hedge funds, mutual funds and insurance funds. According to the report, institutional funds should:
| | Improve transparency by clearly defining and providing public access to their governance rules.
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| | Develop a strong and clearly articulated leadership structure to prevent abuses and avoid potential conflicts of interest.
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| | Educate internal staff about key attributes of the fund, its obligations and investment strategy.
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| | Establish a clear approach to dealing with conflicts of interest, including the formation of a proper compliance authority to which trustees and staff can report.
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| | Appropriately define responsibilities and delegate these duties among fund trustees, staff and outside consultants.
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– Ben Delancy
(202) 508-4081
bdelancy@thelen.com
IRS Changes Limitations on "Covered Employees" Subject to §162(m)
The Internal Revenue Service has issued Notice 2007-49 addressing identification of "covered employees" subject to the limit on deductible compensation imposed by Internal Revenue Code §162(m) and eliminating the uncertainty that had existed since the Securities and Exchange Commission amended its executive compensation disclosure rules on September 6, 2006.
Effective immediately, "covered employees" for purposes of §162(m) will include only employees who as of the close of the employer's taxable year are either: (i) the principal executive officer or an individual acting in that capacity; or (ii) employees whose total compensation for that year is required to be reported to shareholders pursuant to the Securities Exchange Act because that employee was among the three highest compensated officers for the taxable year, other than the principal executive officer or the principal financial officer. According to the notice, the principal financial officer, or an individual acting in that capacity, will not be a covered employee unless the principal financial officer also: (i) is acting as the principal executive officer as of the close of the employer's taxable year; or (ii) holds another officer position and is among the highest three compensated officers.
Until Congress amends §162(m) or the IRS issues further guidance, companies will have only four covered employees, and their covered employees no longer will mirror their named executive officers for purposes of SEC disclosure. A legislative change still is possible. Earlier this year, an amendment significantly expanding the reach of §162(m) was included in a minimum wage bill. This provision was not included in the final legislation, but it is likely to be introduced again in the future because it was estimated to raise $105 million in tax revenue over 10 years.
The notice was published on June 18, 2007, in Internal Revenue Bulletin 2007-25.
– Ben Delancy
(202) 508-4081
bdelancy@thelen.com
Case Shows Importance of Summary Plan Description
A recent case highlights the importance of providing a carefully worded summary plan description. A U.S. District Court held that a summary plan description controlled over a plan document with conflicting terms. Citizens Insurance Co. of America v. Pitney Bowes Software System Employee Medical and Health Care Service Corp., 2007 U.S. Dist. LEXIS 15737 (E.D. Mich. 2007).
At issue was whether the plan or an auto insurer should provide primary payment for medical bills incurred after a plan participant was injured in an automobile accident. The auto insurer would have been the primary payer applying the plan document's terms, but the summary plan description omitted the applicable plan provision.
Based on this case's holding, this vulnerability extends beyond participant lawsuits and includes conflicts with insurers and other plans.
Although this is the first reported case to apply the summary plan description's terms instead of the plan document's terms to a dispute between the plan and a third party, this is not an isolated case. Numerous cases emphasize that without a carefully drafted summary plan description, the plan is vulnerable. Other cases hold that the plan document trumps a summary plan description if the plan document contains a benefit that the summary plan description does not describe.
Although Pitney Bowes might not survive appeal and might be limited to the specific factual situation, plan sponsors should recognize the potential problems created if a plan's summary plan description is not totally consistent with the plan document in all material respects.
– Tonie Bitseff
(415) 369-7036
tbitseff@thelen.com
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For more information about the issues covered in this report, please contact Benjamin I. Delancy in our Washington, D.C. office at 202-508-4081 or at bdelancy@thelen.com or contact your Thelen attorney. For more information about Thelen's Construction and Government Contracts Department, click here.
©2007 Thelen Reid Brown Raysman & Steiner LLP
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