Broker-dealers and financial advisers may have gained some breathing room as a congressional battle to broaden ERISA’s definition of “fiduciary” loses steam. In the following discussion, we will summarize the current state of that battle.
At issue is the innocuous-sounding “Conflict of Interest Rule” proposed by the Employee Benefit Security Administration (“EBSA”), that has nonetheless sparked searing critiques from the investment advice industry, which contends it could dramatically increase costs and reduce access to quality investment advice for millions of American workers. The re-proposal of the controversial rule has been delayed again, this time until January 2015, well after the mid-term elections in November. Assuming a six-month comment period and six months of hearings to develop final regulations, the final rule could be up for a vote in early 2016. But pundits have expressed doubt that such a controversial rule could be passed in an election year, which means that the Conflict of Interest Rule may be stalled indefinitely. Amidst this uncertainty and uproar, many in the benefits community are asking where a new rule would draw the line for determining who is a fiduciary, and how it would impact plan sponsors and participants.
The current definition of investment advice fiduciary still stands as it was established under ERISA in 1974. The regulation sets forth a five-part test, and an individual must satisfy all five of the criteria to be considered an investment advice fiduciary. 29 C.F.R. 2510.3-21(c). To be considered a fiduciary, a person must give investment advice: (1) about the value or advisability of investing in securities or other property; (2) on a regular basis; (3) pursuant to an agreement with the plan; (4) individualized to the specific plan; and (5) with the mutual understanding that such advice will serve as a primary basis for investment decisions. Under the current rule, fee-based advisory services used primarily by the wealthy are subject to a fiduciary duty, but full service and discount brokerage services used primarily by working-class Americans are not. The proposed rule would broaden the definition of fiduciary to include brokerage services offered by broker-dealers, along with the more expensive traditional advisory services.
EBSA proposed the new rule in response to industry changes that have elevated the importance of investment advice to retirement plan participants. Since ERISA was passed in 1974, there have been significant changes in the retirement plan industry. There has been a shift from defined benefit plans to 401(k)-type plans, which give plan participants more responsibility for their own investments. There are also more complex investment products and services available to plans and IRA investors today than there were in the past. Accordingly, investment advice has become more important to plan sponsors when they develop an appropriate menu of investments for their workers, and to workers themselves as they select investments for their individual accounts. With these changes in mind, EBSA sought to broaden the definition of investment advice fiduciary in order to reduce the opportunities for conflicts of interest to compromise the impartiality workers expect when they rely on a financial adviser’s expertise.
The new rule would strip away the “regular basis” requirement of the five-part test, instead starting with a broad definition of “investment adviser” and carving out narrow exceptions. The definition of investment adviser would, subject to certain exceptions, include anyone who (A) receives compensation, directly or indirectly, for the requisite type of advice (e.g., advice, appraisals, or fairness opinions about the value of any investment; recommendations to purchase, hold, or sell any investment; or recommendations as to the management of any investment) and (B) meets one of the following conditions: (i) is or represents his or herself to be an ERISA fiduciary; (ii) is an investment advisor under the Investment Advisor’s Act of 1940; or (iii) provides the advice pursuant to an agreement or understanding that the advice may be considered in connection with investment or management decisions with respect to plan assets and will be individualized to the needs of the plan. Accordingly, much if not all of the full-service and discount brokerage services that broker-dealers offer to plan sponsors and plan participants would be subject to a fiduciary duty under the proposed rule.
The response from the investment advice industry was fast, fierce, and focused on three issues: cost, access, and choice. The dominant criticism was that the proposed rule would drive up the cost of brokerage services as the broker-dealers become fiduciaries, subject to all the duties and potential liabilities that accompany a fiduciary relationship. In fact, the Department of Labor (“DOL”) commissioned a study on the issue, which substantiated the proposed rule’s adverse impact on such costs.
The fact that the hearing for the re-proposed rule was delayed again is a sign that both Congress and the DOL are taking these concerns seriously. While it is true that the way Americans save for retirement looks different today than it did in 1974, the challenge for the DOL is to ensure the cure is no worse than the ailment. The EBSA’s challenge is to draft regulations that protect plan participants and IRA investors from true conflicts of interest resulting in unsuitable investment advice, but that do not have a significant unintended chilling effect on the provision of suitable investment advice. After yet another delay, and with the 2016 election looming, the agency should have plenty of time to find the right balance.
We would like to thank our Summer Associate, Craig Pacheco, for his assistance in preparing this post.
Additional Information: DOL webpage on the Definition of the Term “Fiduciary” Proposed Rule
You may have heard about the potentially crippling blow to ACA (as some have described) dealt by a three-judge panel of the D.C. Circuit Court of Appeals today in Halbig v. Burwell. Basically, a group of individuals and employers challenged the IRS rule that allowed tax credits to help pay for individual coverage through federally-run ACA marketplaces. Their argument was that the literal reading of the statute only allowed these subsidies for individual policies purchased through state-run marketplaces.
At first blush, this might not sound all that important to employers, but it very well could be. If this ruling holds, then it would undercut the ability of the IRS to impose the employer shared responsibility/“play or pay” penalties.
Recall that one triggering event for an employer to be hit with the play or pay penalty is that an employee receives a tax credit for coverage purchased through a marketplace. As this website shows, only 14 states have established their own marketplaces, with one (Oregon) who had one reportedly moving to the federal marketplace next year. (State partnership marketplaces are treated as federal marketplaces for purposes of the tax credits.) If tax credits are not available through the federally-run marketplace, then that would significantly reduce the potential risk of employer penalties.
What about employers who have employees in multiple states with different types of marketplaces? Should Halbig stand, that question is difficult to answer. It would be up to the IRS to interpret how that would work, but it seems plausible that the IRS would say the full penalty amounts would still apply, even if only employees in states with state-run marketplaces can trigger them.
For now, the implications are minimal as nothing is likely to happen yet. The Fourth Circuit Court of Appeals issued a contrary ruling in King v. Burwell shortly after Halbig was released. The full D.C. Circuit could overturn Halbig or one or both of King and Halbig could go before the Supreme Court. Until the difference is resolved, employers would be well-advised to pay attention to these cases, but continue any preparation for compliance with the employer shared responsibility provisions.
In the scheme of things, it was not that long ago that defined benefit pension plans were the main retirement plan game in town. But now – for better or for worse – 401(k) plans rule in the private arena. In the age of constant evolution in technology and streamlining of processes, it can be hard to keep up with the latest and greatest in plan design.
Think about it – the final qualified default investment alternative (QDIA) rules were published not even seven years ago, but now if you don’t have lifecycle or target date funds (TDFs) in your plan and/or you haven’t considered adding them, you may be among the distinct minority of 401(k)s. Statistics indicate that participants like these funds. Fidelity reports that nearly 1/3 of them have invested their entire account balance in a TDF.
Sure, you can rely upon a consultant or an investment advisor to help keep you up to speed on the trends in 401(k) plans, but there are legal issues to consider as well.
Consider brokerage windows – they may be good for offering a wide range of options desirable to sophisticated investors, providing more flexibility in investment options and (possibly) the ability to further diversify a portfolio based on investment in single stocks, bonds or other securities. Bear in mind, however, the options offered in a brokerage window may be more expensive than core plan offerings, there is less oversight over these funds v. the core investment options, and they may be inappropriate for unsophisticated investors given the risks present in these arrangements. There are ways, though, to structure brokerage windows to minimize the risks they present.
The Plan Sponsor Council of America reported in 2013 that 17.1% of plans in its survey offered a self-directed brokerage window, and that 5.6% offered a self-directed mutual fund window.
Mutual funds are still by far the most popular investment vehicle currently offered in 401(k) plans. A study issued by the Investment Company Institute earlier this month noted that, in 2013, 63% of plan assets were held in mutual funds (38% in equity mutual funds). Yet, the plaintiffs’ bar continue its attack on the use of mutual funds in 401(k) plans – claiming that separate or commingled accounts are the more appropriate investment vehicle to be offered in these plans. Their argument generally stems from purported cost savings associated with these investment vehicles; however, it fails to consider the level of comfort participants have with mutual funds – including the fact that they can open the newspaper and see how their funds are performing.
ICI also reports that the cost of investing in mutual funds has declined since the start of this century. Between 2000 and 2013, the expense ratio in the average equity mutual fund held in a 401(k) plan decreased by 25%. Participants and beneficiaries investing in mutual funds through 401(k) plans (as opposed to investing in the average equity mutual fund outside of 401(k) plans) is less than half the cost – 58 basis points.
While charging a “sales load” previously was rather common in funds offered in 401(k) plans, ICI now reports that 86% of 401(k) plan mutual fund assets were invested in no-load funds at the end of 2013.
Since introduction of the Roth plan investment option in 2006, this feature has quickly gained popularity. The recent Fidelity report also indicates that there was a 21% increase in Roth investment features from 2009 to 2013. A total of 42% of plans offer this feature according to that report.
While we all may have chuckled a bit upon the introduction of the ACA, QACA and EACA rules (even if solely because of the funny acronyms), the use of automatic features in plans have proven to be very popular. Automatically enrolling participants and/or automatically increasing their deferral elections has dramatically improved levels of participation and deferral rates. Fidelity reports that 25% of 401(k) plans now offer automatic enrollment; that figure increases to 60% when looking at large plans.
Being an ERISA plan fiduciary is hard work, particularly in the current landscape of evolving plan and investment structures – coupled with increased regulation and scrutiny. There is no “one size fits all” approach to 401(k) plan design; however, prudence may dictate regular review of the plan’s structure and consideration of whether any changes may be desirable and appropriate for the plan’s population.
Basically, the FAQ said that an elimination of any contraceptives from coverage under a plan is a considered a “material reduction” in covered benefits triggering the shorter 60-day notice period for a summary of material modifications. The usual deadline is 210 days after the end of the plan year in which the change is effective (although most tend to communicate sooner).
The bottom line is this: if a plan of a closely held business eliminates coverage for any contraceptive item or service, it has to distribute an SMM or revised SPD within 60 days after the change.
There has always been some ambiguity around what constituted “material” in this context. The regulations speak in terms of what “the average plan participant [would consider] to be an important reduction in covered services or benefits” making it a judgment call. By contrast, this FAQ sets a standard (at least for contraceptives) that the elimination of even one item or service is material.
Even sponsors who do not qualify, or are not considering, eliminating contraceptive products or services should take note. The DOL could potentially use this FAQ to argue that other reductions are material as well.
Facts. Beginning in 2007, Fifth Third Bank began experiencing a large number of mishaps, most of them associated with borrowers not repaying their loans when due. As a result, Fifth Third’s stock price suffered the same phenomenon as that of virtually every other publicly traded financial institution in the world during the great recession: it dropped precipitously, falling 74% from July 2007 to September 2009. With the benefit of hindsight, plaintiffs brought a class action lawsuit against the fiduciaries of the Fifth Third 401(k) Plan, alleging that all of this should have been patently obvious based on public and nonpublic information allegedly possessed by the fiduciaries. The plaintiffs asserted that the fiduciaries should have taken one or more of the following actions with respect to the company stock fund in the 401(k) Plan: (1) sell the stock before it declined; (2) refrain from purchasing any more Fifth Third stock; (3) cancel the Plan’s company stock option; and (4) disclose the inside information allegedly in their possession so that the market would appropriately adjust its valuation of Fifth Third stock downward and the Plan would as a result no longer be overpaying for it.
The Supreme Court’s Ruling. Much of the decision focuses on whether the so-called “Moench” presumption of prudence attaches to a fiduciary’s decision to allow or continue the investment of plan assets in company stock when the governing plan documents direct that such investment shall be made. This presumption was originally articulated by the Third Circuit in the case of Moench v. Robertson, and was subsequently adopted by every circuit which had considered the matter, although there was some disagreement regarding whether the presumption applied at the pleading or evidentiary phase. The Supreme Court Justices read and reread ERISA’s statutory language, looked in every nook and cranny, and directed their law clerks to do the same, but ultimately they were unable to find even a single word in the statute which accorded such a presumption of prudence. The Court then concluded that the Circuit Courts had made it all up, and that no such presumption existed.
Rather than stopping at the point of simply deciding the issue presented, the Court elected to offer some advice to the lower courts regarding how meritless stock drop cases might be weeded out, perhaps because the lower courts, at least in the eyes of the Supreme Court, had gotten the law in this area so wrong for so long. The Court stated that, in the case of a publicly traded security, allegations that a fiduciary should have recognized from publicly available information alone that the market was over- or under-valued are “implausible”, at least in the absence of special circumstances. The Court noted that ERISA fiduciaries have little hope of outperforming the market, and so may, as a general matter, prudently rely on market price.
Under this standard, is it even possible to plead a breach of fiduciary prudence as it relates to investment decisions involving a publicly-traded company stock fund? The Court left this question open with the following observation: “We do not here consider whether a plaintiff could nonetheless plausibly allege imprudence on the basis of publicly available information by pointing to a special circumstance affecting the reliability of the market price as ‘an unbiased assessment of the security’s value in light of all public information.’” To even have a chance of succeeding in stock drop litigation based solely on publicly available information, therefore, plaintiffs would have to prove that the plan fiduciaries were aware or should have been aware of a special circumstance which would lead to the conclusion that the most efficient market in the history of mankind was not operating efficiently with respect to the value of the company’s stock. The Moench presumption of prudence has been replaced with the Dudenhoeffer presumption of an efficient public market. Unlike the Moench presumption, which was rebuttable, the Dudenhoeffer presumption appears to be virtually irrebuttable. To our brethren in the plaintiffs’ bar who make their living handling stock drop cases, we offer the following words of encouragement: Good luck with that.
The Court next moved to a discussion of the plaintiffs’ allegations that the plan fiduciaries failed to act on the basis of nonpublic information. The Court noted that the duty of prudence does not require a fiduciary to break the law. Presumably, therefore, litigation premised on the theory that fiduciaries should have taken action which would have violated the securities laws should be dismissed. The Court also instructed the lower courts faced with stock drop claims to consider whether the suggested fiduciary action (e.g., deciding to liquidate a company stock fund or disclose material nonpublic information) might do more harm than good by causing a drop in the value of the stock already held by the plan.
Reaction from the Department of Labor. The Department of Labor, which had filed an amicus brief in support of the plaintiffs’ position, immediately declared victory, once again proving the ability of Washington bureaucrats to put a positive spin on any defeat. The DOL blog post may be found here.
Lessons from Dudenhoeffer. The Dudenhoeffer decision suggests that fiduciaries in charge of monitoring a company stock fund should not only review and analyze press releases, SEC filings, and other publicly available information, but should also build the following considerations into their fiduciary process:
1. In considering publicly available information with respect to company stock, fiduciaries should determine whether any special circumstance exists affecting the reliability of the stock’s market price as an unbiased assessment of the stock’s value that would make reliance on the market’s valuation imprudent.
2. It is still a bad idea to have insiders serve on the committee which oversees the company stock fund. Consider removing insiders from the investment committee, or at least consider vesting sole authority to oversee the company stock fund in a subcommittee consisting solely of non-insiders.
3. In the event an insider does serve on the committee tasked with overseeing the company stock fund, and the insider comes into possession of material nonpublic information suggesting the company’s stock is overvalued, the insider should consider whether he or she could take action with respect to the company stock fund consistent with the securities laws that a prudent fiduciary in the same circumstances would not view as more likely to harm the fund than to help it.
The decision also suggests a possible change to the historical approach to drafting plan language relating to plan investments in company stock. Many practitioners had hardwired language into the plan document mandating investments in company stock in order to place the fiduciaries in the best position to claim the Moench presumption of prudence. Given the demise of the Moench presumption, such language would no longer appear to be helpful, and may even prove detrimental in the situation in which the plan fiduciaries desire to discontinue the company stock fund. Assuming the portion of the plan which invests in company stock is an employee stock ownership plan (“ESOP”), consider language which simply recites that the ESOP portion of the plan has been designed to invest primarily in employer securities.
Frequent internet users are likely familiar with the demotivational posters at despair.com, such as this one on retirement. If a recent study by a partner at the Mercer consulting firm is to be believed, then they should perhaps add another one to the list: switching from pensions to 401(k)s.
As reported here, the researcher compared two companies: one that replaced its pension with a 401(k) in the late 90’s and one that did not. In the company that replaced the pension, the researcher found dissatisfaction by younger employees as older employees remained employed and thus prevented the younger employees from advancing. As the article notes:
[The replacement of a pension with a 401(k)] affected job mobility “velocity,” Nalbantian found, and the percentage of people moving into new positions, whether vertically or horizontally, stalled at 11 percent. This, in turn, accelerated the exit of more talented people who saw advancement potential evaporating, the research found.
On the other hand, at the firm with a pension, velocity remained at about 18 percent.
This is an interesting data point, but the study has some limitations. There could be a great many other factors, such as organizational culture, changes in leadership, the availability or lack of availability of other benefits (such as retiree health). The bottom line: by comparing only two companies, there are a great many variables that are not controlled.
However, the study does underscore an important consideration for employers making the switch: consider what effect it could have and try to adjust accordingly. Offering more generous 401(k) benefits, or enhancing other benefit offerings, may be important in ensuring a smooth transition from the DB to the DC world.
Additionally, now many providers are offering products that create lifetime income opportunities inside DC plans. The IRS recently issued helpful guidance in this regard with its qualified longevity annuity contract regulations. These options were not available until recently, and may help make the transition less difficult for employees as well.
Unless you’ve been hiking Mount Kilimanjaro for the last month, you’ve no doubt heard about Speaker Boehner’s proposed lawsuit against the President. The Speaker, and apparently many House Republicans, are upset that the President has not, in their view, upheld his oath of office by faithfully executing the laws passed by Congress.
A draft resolution released last week shows that the focus of the lawsuit will be none other than the already much-litigated Affordable Care Act. Regardless of how one feels about the lawsuit or ACA, it’s impossible to ignore the great irony in House Republicans suing the President for not faithfully executing over a law they’ve tried to repeal some 40 times.
It’s easy to see the political reason, though: the Republicans think it’s a bad law and that the President and Congressional Democrats should have to campaign with its perceived flaws being fully realized. The President’s delays do not allow that to happen, and effectively insulates him and his party from having to face voters angry over the ACA, in the Republicans’ view.
But the real question is this: what if Speaker Boehner wins? Set aside the merits, for a minute, and consider that possibility.
Take, for example, the “play or pay” employer mandate. The Speaker wins and now what? Is the delay no longer effective? Does that mean that penalties could be assessed against employers in 2014 (and small employers in 2015) even though they thought they had a pass?
And what of the nondiscrimination rules under the ACA that apply to insured plans? Those have been on hiatus since 2010. Will there be penalties assessed for those failures now?
While those results are theoretically possible, they seem practically unlikely. A judge would hopefully recognize that there weren’t solid rules for the administration to implement and for employers to follow. Such a “gotcha” would unfairly punish a non-party to the lawsuit (employers) and a court would hopefully recognize that. Additionally, the Speaker is unlikely to ask for those results as a remedy since they would have the opposite effect of currying favor with the people.
Regardless of where or how this goes, it will make for interesting political theatre, but hopefully the fallout, if any, will be minimal to employers still grappling with the ACA.
Following a spate of district court cases in response to United States v. Windsor, 133 S. Ct. 2675 (2013), some same-sex surviving spouses are asking retirement plan sponsors to review previously denied death benefit claims. Among them has emerged Passaro v. Bayer Corp. Pension Plan in the United States District Court in Connecticut, which attempts to reach into the past to claim Qualified Preretirement Survivor Annuity (“QPSA”) benefits post-marriage, but pre-Windsor. The key issue in this case will be the retroactive application of Windsor to qualified retirement plans.
In the complaint, the plaintiff alleges that the pension plan denied him benefits of a QPSA in violation of the terms of the plan and of governing federal law. The state of Connecticut recognized same-sex marriages beginning November 12, 2008, and the plaintiff was married in the state later that month. The spouse vested under the plan died in January 2009. When the plaintiff requested benefits under the plan, the plan sponsor denied the request citing section 3 of the Defense of Marriage Act (“DOMA”). On June 26, 2013 the Supreme Court declared section 3 of DOMA unconstitutional in Windsor, and the plaintiff unsuccessfully appealed the denial of plan benefits in early 2014. The plaintiff then filed his complaint in May 2014.
The question here is whether the Court’s decision in Windsor can have a retroactive effect to require payment of a QPSA to a surviving spouse when the pensioner died before the opinion was issued. The complaint states that the plaintiff, as a result of the Windsor decision, qualified and qualifies as a spouse at any and all times relevant to the question of his entitlement to a mandatory QPSA under the plan. While the complaint does not state a legal rationale for the retroactive entitlement to the QPSA, one can assume that the argument is simply that because the relevant law was held unconstitutional in Windsor, the plan sponsor should act as though the law never existed at all and pay benefits to the surviving spouse although his marriage was not recognized under federal law until four years after the pensioner’s death.
Historically, the Supreme Court’s application of retroactivity of federal laws has been varied, and it has taken into account practical considerations in both criminal and civil cases. The seminal case considering retroactivity in criminal cases was Norton v. Shelby County, 118 U.S. 425 (1886) which announced a seemingly bright line rule, “[a]n unconstitutional act is not a law … it is, in legal contemplation, as inoperative as though it had never been passed.” The major distinction that subsequent courts have made when considering the question of retroactivity is the more serious nature of criminal cases involving a loss of freedom, compared with civil cases involving a loss of property. In modern jurisprudence there is no assumption that new decisions will be applied retroactively in either civil cases or criminal cases, and for this reason, any reliance on the 1886 statement rests on a rickety foundation. The modern test for retroactive application in the civil context was set forth in Chevron Oil Co. v. Huson, 404 U.S. 97 (1971), which permits a court to deny retroactive effect to a “new principle of law” if such a limitation would avoid “injustice or hardship” without unduly undermining the “purpose and effect” of the new rule. Because Passaro is a civil case involving a dispute over property, one can make a fair assumption that the Chevron Oil framework will figure prominently in the District Court’s analysis.
It should be noted that there has been a recent circuit split on the issue of civil retroactivity and the continuing vitality of the Chevron Oil test. On June 4, 2014 the District Court for the Eastern District of Pennsylvania wrote that, “[w]hile the Supreme Court has not explicitly disavowed the Chevron Oil retroactivity analysis, the weight of authority holds that Chevron Oil has for the most part been superseded” by a broader test that favors retroactive application in civil cases. Z&R Cab, LLC v. Phila. Parking Auth., 2014 U.S. Dist. LEXIS 76565. The District Court noted that from 1997 through 2009 the 1st, 3rd, 5th, 7th and 9th Circuit Courts recognized an implied overruling of at least part of the Chevron Oil test by two Supreme Court cases from the mid-nineties: Harper v. Virginia Department of Taxation, 509 U.S. 86 (1993) and Reynoldsville Casket Co. v. Hyde, 514 U.S. 749 (1995). The 2nd Circuit, which would have jurisdiction over the Passaro case, continues to follow the Chevron Oil test. Shah v. Pan Am Servs., 148 F.3d 84, 91 (2d Cir. 1998).
The IRS, for its part, expressly considered retroactivity in Notice 2014-19, issued April 4, 2014. The Notice makes clear that qualified retirement plan operations must reflect the outcome of Windsor as of June 26, 2013. The Notice further states that the plan sponsor may amend a qualified retirement plan to reflect the outcome of Windsor for some or all purposes as of a date before June 26, 2013 (emphasis added). However, the Notice cautions that recognition of same-sex spouses for all purposes under a plan prior to June 26, 2013 may trigger requirements that are difficult to implement retroactively, and may create unintended consequences. Therefore, while the IRS leaves open to plan sponsors the option to amend their plan retroactively, it does not require them to do so. The deadline to adopt a plan amendment is December 31, 2014 for most plan sponsors. In the meantime, we will be closely following developments in this and similar cases.
We thank our summer associate, Craig Pacheco, for his assistance in preparing this post.
You’ve seen all the headlines… Supreme Court issued its decision in the Hobby Lobby case on the last day of its 2013-2014 term. Sure, maybe it wasn’t as closely watched and groundbreaking as the Court’s -2012 decision upholding key provisions of the Patient Protection and Affordable Care Act (“ACA”), but it is a very big deal for certain employers. Which ones?
Well, as discussed in our post following the Hobby Lobby oral arguments, the owners of certain closely-held for-profit organizations (namely Conestoga, Hobby Lobby, and Mardel) challenged the ACA’s preventive care requirement mandating coverage of all FDA-approved contraceptive drugs, devices, and related services.
While these companies do not object to most contraceptives now required to be provided by ACA’s market reforms, they oppose certain forms of emergency contraception (which they believe are abortifacients) and certain contraceptive devices (IUDs) on religious grounds. The crux of the lawsuit is that these organizations believe the ACA’s contraceptive mandate violates the rights afforded them both statutorily – under the Religious Freedom Restoration Act (“RFRA”) – and constitutionally – under the Free Exercise Clause of the First Amendment. Legally, the primary issue before the Court was whether RFRA’s protections for any “person” whose religious exercise is substantially burdened by government extends to corporations.
In a 5-4 ruling, the high Court held that the HHS contraceptive mandate violates RFRA as applied to closely-held corporations. Writing for the majority, Justice Alito described that the court saw no reason to hold closely-held corporations to a different standard than non-profits. Relying on the definition of “person” set forth in the Dictionary Act, the majority indicated there was no justifiable basis to exclude for-profit corporations from this definition (particularly in light of the government’s concession that nonprofit can be a person under RFRA and the lack of any reason to distinguish these two groups of corporations).
After dismissing certain arguments made by HHS (including that the objecting for-profits could simply drop coverage and pay the “play or pay” penalty) the majority found that since HHS was able to make an “accommodation” available to nonprofit corporations that have religious objections to the contraceptive mandate, it saw no reason why the same system could not be made available when the owners of for-profit corporations have similar religious objections.
The accommodation at issue here is one that allows “eligible organizations” (i.e., certain nonprofits) that oppose providing coverage for some or all of any contraceptive services otherwise required to be covered on religious grounds to certify their status and objections to their insurer or TPA. By certifying, they do not have to cover the objectionable contraceptive coverage under their plans. The insurer or TPA receiving this certification must separately make the objectionable contraceptives available for women in the health plan of the nonfprofit, at no cost to the women or to the organization.
Interestingly, the Court also stated that the government could, if it chose, directly pay for the contraceptives to which the companies objected as another “least restrictive means” of accommodating the contraceptive mandate. However, the Court did not articulate, and we are not aware of, any statutory authority that would permit such a direct payment by HHS. Therefore, while this is a theoretical possibility, it does not appear to be a practical one.
While the majority concluded that “th[e] system [applied to non-profits] constitutes an alternative that achieves all of the Government’s aims while providing greater respect for religious liberty”, it is unclear at this stage whether the HHS will extend the same or a similar accommodation to closely-held organizations. What is clear is that the majority’s decision means that the contractive mandate cannot be enforced against objecting closely-held corporations.
Justice Alito expressly stated that the majority’s ruling is very specific, and since the decision relies on RFRA statutory grounds, it did not reach the constitutionality issue. Thus, it does not expressly hold whether a corporation has religious rights under the First Amendment.
The Office of Civil Rights (“OCR”) of the U.S. Department of Health and Human Services (“HHS”) is required to conduct periodic audits of compliance with the Privacy, Security and Breach Notification Rules under the Health Insurance Portability and Accountability Act (“HIPAA”).
In Phase I, which closed on December 31, 2012, OCR conducted 115 performance audits. Now, OCR is preparing for Phase II.
To have a broad range of covered entities audited in Phase II, OCR is sending electronic pre-audit surveys to 550-800 eligible entities this summer. The pre-audit surveys are designed to ascertain the size, location, services and best contact information of the covered entities.
OCR is expected to select 350 covered entities for audit (232 health care providers, 109 health plans and 9 health care clearinghouses). Audit notifications and request letters will be mailed to selected covered entities in the fall of 2015.
The Phase II audits will differ from Phase I audits in many respects:
The actual audits of covered entities will be conducted from October 2014 through June 2015 and for the most part will be internally staffed and involve desk audits. Requested documents must be submitted electronically via email or other electronic media. The data requests from OCR will specify content and file organization, file names and any other document submission requirements. Covered entities will have two weeks to respond. Only requested data submitted on time will be assessed.
Auditors will not contact the covered entity for clarifications or to ask for additional information so it is important that submitted documentation is complete and up-to-date. Failure to submit response to request may result in a referral for regional compliance review.
The Phase II audits will be more narrowly focused based on the deficiencies identified in the Phase I audits. The audit protocols for covered entities are projected to be distributed as follows:
- 100 covered entities will be audited on the Privacy Rule with the first round of audits in 2014 focusing on the notice of privacy practices and individuals’ access to their own protected health information and shifting in the second round of audits in 2015 to implementation of safeguards and training.
- 100 covered entities will be audited on the Breach Notification Rule with the emphasis on content and timeliness of required notifications.
- 150 covered entities will be audited on the Security Rule with the audits conducted in 2014 focusing on the risk analysis and risk management and possibly shifting in the second round of audits in 2015 to device and media controls and transmission security.
Business Associates will also be audited. Audited covered entities will be asked to identify and provide contact information for their business associates. From this pool, OCR will identify at least 50 business associates (at least 35 IT-related business associates and 15 non-IT related business associates) for audit in 2015.
Steps to Take Now
Although we don’t know the specifics of the final data requests, covered entities and business associates should take steps now to review their HIPAA documents so that any deficiencies can be addressed prior to an audit. Plan sponsors should pay particular attention to the targeted audit areas:
- Notice of Privacy Practices. Ensure that the notice has been updated for the 2013 final omnibus rule. Gather documentation evidencing the distribution (and posting on the health plan intranet site, if applicable) of the revised notice.
- Individual Access. Review written policies relating to an individual’s right to access his or her own protected health information and ensure that it has been updated for the 2013 final omnibus rule. Gather copies of individual’s requests for access and the responses to such requests.
- Safeguards and Training. Review existing safeguards and update as necessary to protect the privacy of protected health information. Gather training materials as well as documentation evidencing the training of workforce members.
- Breach Notification. Review written policies for identifying breaches and providing the required notification to affected individuals, the media and HHS. Ensure that such policies have been updated for the 2013 final omnibus rule. Gather documentation of any breach assessments, and furnished notifications.
- Security Rule. Obtain copy of most recent risk assessment and corresponding risk management plan. Consider whether circumstances have changed so that conducting a new risk assessment is warranted. Gather copies of the policies relating to device and media controls for equipment and hardware that may contain protected health information and transmission securities (e.g., encryption).
In connection with Phase I, OCR established a comprehensive protocol containing the requirements to be assessed in its performance audits. At last check, the protocol had not yet been updated to reflect the 2013 final omnibus rule but it still offers helpful insight as to the type of documentation OCR is likely to seek in this upcoming round of audits.
While Phase I audits focused on bringing covered entities into compliance, Phase II and future audits are expected to be more focused on enforcement (i.e., imposition of civil monetary penalties or resolution agreements). Thus, the importance of getting your HIPAA documents in order sooner rather than later cannot be overemphasized.