Yesterday, the Ninth Circuit issued an opinion in Tibble v. Edison International (Case: 10-56406, 03/21/2013), affirming the Central District of California district court’s ruling in a 401(k) fee case brought under ERISA. The district court had rejected most claims but had entered judgment totaling just over $300,000 for the plaintiff beneficiaries on claims regarding the selection of certain mutual fund investment options, where lower-priced share classes were available in the same funds. Highlights from the decision include:
Statute of Limitations
- The Ninth Circuit rejected a “continuing violation theory” in favor of a bright-line rule that the act of designating an investment for inclusion starts the running of ERISA’s six-year SOL.
- Beneficiaries did not have “actual knowledge” of the alleged deficiencies in the process for selecting retail class mutual funds for the plan’s investment line-up, and, therefore, ERISA’s three year SOL does not apply.
- The panel also held that Section 404(c) (a “so-called” safe harbor that can relieve a plan fiduciary from liability arising from the investment choices made as a direct and necessary consequence of a participant’s exercise of control) did not preclude a merits consideration of plaintiffs’ claims.
Class Certification
- The panel declined to consider defendants’ arguments that class certification was improper since this issue was raised for the first time on appeal.
Revenue Sharing and Standard of Review of Fiduciary Breach Claims
- The Ninth Circuit panel affirmed the district court’s grant of summary judgment to defendants on the claim that revenue sharing between mutual funds and the administrative service provider violated the plan’s governing document and was a conflict of interest. Looking to the Supreme Court’s prior holdings (Firestone Tire & Rubber Co. v. Bruch, Metropolitan Life Insurance Co. v. Glenn and Conkright v. Frommert) on standard of review and agreeing with the holdings of the Third and Sixth Circuits (and rejecting the rulings of the Second Circuit), the Ninth Circuit panel held that, as in cases challenging denials of benefits, a “usual” abuse of discretion standard of review applied to this case which concerns potential violations of fiduciary duties and conflicts-of-interest because the plan granted interpretive authority to the administrator.
Use of Mutual Funds, Short-Term Investment Fund and Unitized Stock Fund
- The Court also ruled that defendants did not violate their duty of prudence under ERISA by including in the plan’s investment menu (i) mutual funds, (ii) a short-term investment fund “akin” to a money market fund, and (iii) a unitized company stock fund.
Finally, the panel affirmed the lower court’s holding, after a bench trial, that the defendants were imprudent in deciding to include retail-class shares of three specific mutual funds in the plan menu because Edison failed to investigate the possibility of institutional-class alternatives.
Target date retirement funds generally refer to a related group of investment funds that automatically rebalance and become more conservative as a participant moves towards a designated retirement year. Many 401(k) and profit sharing plans use target date retirement funds as the qualified default investment alternative (QDIA). In that case, when a participant fails to make an affirmative election regarding how his or her qualified defined contribution plan accounts should be invested, contributions are allocated to a target date fund based on the date the participant will attain retirement age, usually designated as age 65. Use of a QDIA relieves a plan fiduciary of liability related to the return generated on the investment fund. Also, participants who do not want to actively manage their accounts are increasingly using target date retirement funds.
In February 2013, the Department of Labor (DOL) issued tips for ERISA plan fiduciaries regarding the selection and monitoring of target date retirement funds in an ERISA plan. The fact sheet can be found on the DOL’s website. The list of tips includes the following:
- Establish a process for comparing and selecting the target date retirement funds
- Establish a process for the periodic review of selected funds
- Understand the fund’s investments – the allocation in different asset classes, individual investments, and how these will change over time
- Review the fund’s fees and investment expenses
- Inquire about whether a custom or non-proprietary target date fund would be a better fit for your plan
- Develop effective employee communications
- Take advantage of available sources of information to evaluate the fund and recommendations you received regarding the fund selection
- Document the process
The DOL fact sheet explains each of these tips in greater detail and provides a roadmap for complying with ERISA’s fiduciary duty requirement for selecting and monitoring these types of funds. You can use these tips to ensure compliance by your ERISA plan fiduciaries.
Continuing our series of posts reporting on the recent TE/GE meetings, today we focus on the audit trends and issues that the IRS officials in attendance identified. In addition to providing insight on the IRS’s focus, the list serves as a good compliance checklist for plan sponsors. Are you making these errors? If so, you can (and should) fix them now before the IRS comes knocking.
Areas of Focus. At the outset, it’s helpful to know where the IRS is looking for trouble, so you can have some idea where agents are coming from when you get the dreaded audit letter. The officials at TE/GE gave these insights:
- Most audits are focused on 3 or 4 particular issues depending on the market segment (i.e., the business of the employer) and the size of the plan (generally less than 100 participants is a small plan while other plans are considered large). The IRS did not give examples of the issues on which they are focusing, but to the extent you or your advisors are aware of other IRS audits in your market segment and for plans of your size, you may be able to identify them.
- There is no current targeted audit project for governmental plans.
- 403(b) plans will be an area of focus going forward.
- With regard to 401(k) audits, there will be a heavy emphasis on internal controls. They mentioned this multiple times, so it’s a good idea to review and document your internal controls now so that you are prepared when the IRS audits.
- For defined benefit plans, they said they will focus on “issues around [the Pension Protection Act].” They did not elaborate, but presumably this will involve a focus on operational compliance with PPA changes.
Audit Trends. The IRS also identified a few common audit trends. Most of these are unsurprising, but again, serve as a good checklist for plan sponsors.
- First, they identified the following general trends:
- Failure to timely amend documents for law changes
- Failure to follow plan terms
- Using the incorrect definition of compensation for contribution, benefit calculation, or testing purposes
- Eligibility compliance issues, such as failing to exclude ineligible employees or include eligible ones
- On a more specific note, they identified the following as issues that were particularly prevalent in 401(k) plans:
- Failing to have internal controls (did we mention that they thought this was important?)
- Increases in plan loan defaults due to administrative errors (see our prior post about doing a quarterly checkup)
- Failing to make the top heavy minimum contribution in a top heavy plan (this is a bigger issue for smaller plans)
- In the 403(b) area, they reported that the following issues were common:
- Deferrals exceeding the 402(g) limit ($17,500 for 2013)
- Failure to comply with the universal availability rules
- Contributions in excess of the maximum limits under 415 ($51,000 for 2013)
- Plan loans that violate the loan rules on maximum loan amounts or maximum repayment periods (and, in some cases, have no documentation at all for the loan)
- Hardship distributions where insufficient documentation is obtained to demonstrate the hardship.
One of the sadder tasks encountered by a plan administrator is sorting out who is the appropriate recipient of benefits when a participant has been murdered by the intended beneficiary of such benefits. Over time, we have advised many plan administrators in handling situations like this one dealing with their pension, 401(k), life insurance and accidental death plans and, in doing so, have developed a variety of alternatives each with varying levels of cost and risk. These alternatives, each of which is summarized in more detail below, include: (1) commencing an interpleader action, (2) securing a receipt, release, and refunding agreement, and (3) obtaining an affidavit of status (e.g., heirship).
In arriving at these alternatives, we have considered applicable law, including state statutes and ERISA preemption. Most individual states have enacted so-called “slayer” statutes, which generally provide that an individual who kills the decedent cannot benefit from his or her crime and, therefore, forfeits all benefit rights he or she possessed as the primary beneficiary. While some courts have held that these state slayer laws may be preempted under ERISA’s broad preemption doctrine, a similar result is likely to be reached through applicable federal common law principles. In fact, an Eastern District of Pennsylvania court recently addressed this situation in In re Estate of Burklund (January 28, 2013). The Burklund court declined to decide the ERISA preemption issue since the Pennsylvania state law and the federal common law that would apply if ERISA preempted Pennsylvania’s slayer’s act are essentially the same in a “slayer” situation and further noting that several district courts have taken this approach. In this case, the court ruled that the wife (also the primary beneficiary of her husband’s employer-sponsored life insurance and accidental death policy) was barred from receiving any benefits from her husband’s insurance policy following her first-degree murder conviction for the husband’s death. The son was, instead, deemed to be the appropriate beneficiary since he had been designated as the contingent beneficiary named under such policies.
Interpleader
When a substantial amount of benefits are involved and/or a plan administrator is aware of multiple parties who will potentially assert a claim on the benefits, an interpleader action may be the most appropriate course of action. In essence, an interpleader action involves the plan administrator paying the entire benefits into the court and having the potential claimants become parties to the litigation. The claimants proceed against each other and the court determines which of the claimants is legally entitled to the benefits. While an interpleader may be prohibitively expensive (and burdensome from a time and cost perspective) for a plan administrator if a small amount of benefit is involved, it is one of the only manners in which a plan administrator can gain certainty that it will not have to pay out the dispute benefits to more than one party making such a claim. Thus, the time and money invested may be worthwhile.
Receipt and Refunding Agreement
In situations where a plan administrator chooses not to proceed with an interpleader action (perhaps on account of the cost or time involved with such an action), obtaining a receipt, release, and refunding agreement may serve as an attractive alternative. By securing such an agreement, the signing payee/beneficiary acknowledges that he/she has received the proceeds, and further agrees to immediately refund to the plan(s) the amount of any excess or improper distribution. A receipt, release, and refunding agreement may be used in conjunction with an affidavit of the party’s relationship with the participant (discussed below) to minimize the chance the recipient would need to refund any amount that was initially distributed. However, unless the signing payee/beneficiary voluntarily agrees to repay the inappropriately distributed amounts, a plan administrator may have to commence litigation to enforce the agreement. Even if that litigation is successful, there is a possibility that a plan administrator may not be able to secure repayment if the signing payee/beneficiary is “judgment proof.” Thus, this alternative is not without risk.
Affidavit of Status
Where a plan administrator is paying out benefits to a party on account of their relationship to the decedent/participant, a plan administrator may choose to secure an affidavit from the payee/beneficiary as to that relationship. For example, if (1) a participant in a 401(k) plan dies without a designated (i.e., named) beneficiary, (2) his spouse murdered him and, (3) the plan provides that the surviving children of the participant would be the appropriate beneficiary, then it might make sense to secure an “affidavit of heirship” from a surviving child stepping forward affirming that such child is and ever was the only known child of the decedent/participant. As suggested above, by using this type of affidavit in conjunction with a receipt, release, and refunding agreement, the plan administrator preserves an “undo” feature to the initial distribution in case another beneficiary is subsequently discovered.
In no way do the enumerated alternatives described above constitute an exhaustive list. We are constantly seeking more creative and effective methods to ensure that the proceeds are paid to the appropriate recipient. In addition, the appropriate strategy to undertake largely depends on the factual circumstances facing the plan administrator. Do you have any other alternatives that you’d like to share?
In this second post in our series of reflections from the recent Tax Exempt/Government Entities meeting with IRS and DoL officials, we’ll focus on the areas the DoL officials identified as enforcement priorities and some of the specific items they highlighted.
Health Plans. As we previously posted, the DoL is starting to look at health plans and compliance with health care reform specifically. They have also discovered that many plans lack what they consider to be a formal plan document. They are starting to ask not just for proof of the plan document’s existence, but also proof of when it was adopted, going back to January 1, 2010. Plan sponsors who have not adopted wrap plan documents for their health plans may want to consider implementing those soon.
ESOPs. ESOP enforcement continues to be a priority. The officials stated that they believe appraisers are arguably already fiduciaries on the theory that they are providing investment advice (although, in our view, that position is not without its flaws). They noted that trustees still have a duty to prudently select the appraisers and that, even if the appraiser is prudently selected, the trustee still has an obligation to make sure the assumptions on which the valuation is based are reasonable under the circumstances. They also said that trustees should be wary of a seller’s role in selecting the appraiser. Oh, and trustees should also read the appraisal.
Officials identified the following more egregious practices that they see (which serves as a good list of “watch-outs” when reviewing valuations):
- No discount applied for lack of marketability;
- Failure to take into account the risk associated with having only a single supplier or customer;
- Inflated projections;
- Inconsistencies between the narrative of the valuation and the math in the appendices;
- Use of out of date financial information;
- Improper discount rates;
- Incomparable comparable companies – for example using a large public company as a comparable to a small private company; and
- Failure to test the underlying assumptions.
ERISA Accounts/Budgets. While not an enforcement area, officials expressed the view that excess revenue sharing, 12b-1, and other investment fees that are held in ERISA Accounts or ERISA Budgets should be used to pay proper plan expenses. If there are excesses, they should ideally be allocated to the individuals whose investments generated the fees. However, they acknowledged that this is an area where “rough justice” may be necessary, especially if the excess revenue sharing, 12b-1, and other investment fees are small.
Other Areas. Other areas of focus include:
- Direct investigations of consultants and advisors to plans and plan administrators
- Bankruptcies of plan sponsors – particularly with regard to employee contributions which the Bankruptcy Code expressly states are not part of the Bankruptcy estate and may not be used to satisfy creditors
- Appellate & Amicus participation – The DoL has been very active filing Amicus briefs in employee benefits litigation as part of an effort to influence the court’s outcome. The official from the DoL Solicitor’s office said that one practitioner referred to them as “officious intermeddlers” to which he (jokingly) replied, “That’s what we’re shooting for.”
As we have said before, these statements, the statements are informal and non-binding, and thus cannot be relied upon as official guidance.
Last week I (Chris) had the good fortune to travel on Lisa’s behalf to Baltimore to attend an annual meeting of benefits practitioners with government representatives from the DoL and IRS national offices. It served as a great opportunity to hear what guidance may be in the pipeline and what enforcement issues are catching the government’s attention. Plan sponsors should take heed because those items getting the government’s regulatory or enforcement attention tend to (1) be very common and (2) serve as a good compliance check. Over the next week or so, we’ll cover what they said and what you should be looking for coming down the pike. First up: the Department of Labor’s regulatory agenda. Based on statements from DoL officials:
- No additional guidance is planned on the ERISA 408(b)(2) service provider fee disclosures at this time. They talked with many service providers and felt that, in general, where there was ambiguity, the providers made reasonable interpretations.
- Regarding the reproposal of the definition of “fiduciary,” they are looking to draw a bright-line distinction between investment education (non-fiduciary) and investment advice (fiduciary). They may also include a prohibited transaction exemption for individuals who accidentally cross the line.
- On lifetime income options in DC plans, there are three areas of focus:
- Showing the income stream the participant’s account balance could generate (this will likely be the first area on which guidance will be issued).
- Including education about retirement planning (e.g., whether to select an annuity).
- Guidance for plan administrators on selecting annuity providers.
- For target date funds, they said they hope to have a final rule on required disclosures in November. They also are hoping to release tips for plan sponsors on selecting TDFs.
- Finally, on the advisory opinion front, they are considering whether to release an advisory opinion on whether so-called “ERISA Accounts” or “ERISA Budgets” are considered plan assets and how they should be handled. These are accounts that contain rebates of revenue sharing and other fees from mutual funds and have been a regulatory gray area ever since they first appeared on scene. (The DoL representative also alluded to an opinion on the clearing of swaps under Dodd-Frank, which has already been released.)
As with all statements by government representatives, the statements are informal and non-binding, and thus cannot be relied upon as binding. However, in the absence of any other information, the DoL’s comments should give plan sponsors some idea of the developments they can expect to see from the DoL in the weeks and months to come.
Disclaimer/IRS Circular 230 Notice
A representative from the Atlanta Regional Office for the Department of Labor recently spoke at an Atlanta Bar Association luncheon and provided some insight into the Employee Benefits Security Administration’s enforcement priorities and some other interesting facts:
- With regard to the need for fiduciary training that we wrote about previously, the representative confirmed that investigators generally only require proof of training if the plan sponsor/administrator has agreed to receive training as part of a settlement agreement following an audit. However, they generally will inquire as to whether the plan sponsor/administrator has had fiduciary training as part of a routine audit.
- The representative also confirmed that EBSA has started to audit for health care reform compliance (at least for the provisions that are currently effective).
- They are also looking at HIPAA compliance for both plan sponsors and service providers, and particularly HIPAA portability (e.g., creditable coverage notices, and the like) compliance by service providers. A focus on creditable coverage notices seems unusual since PPACA will eliminate preexisting conditions in 2014.
- Timely deposits of 401(k) contributions, a long-time focus of the DoL, continues to be a priority. In this regard, the representatives noted that they generally interview the plan sponsor to determine what is timely based on the complexity of the plan sponsor’s payroll(s). However, they reiterated that the 15th day of the month after the contributions are collected is not a safe harbor.
- They are taking hard look at plan loans to make sure they are administered to meet the necessary criteria for the ERISA prohibited transaction exemption. The representative noted to make sure your plan allows for loans if loans are being made from the plan (Yes, this seems obvious, but you’d be surprised).
- Audits of employee stock ownership plans (ESOPs) continue to be a national priority, particularly with respect to valuations. While a great many ESOPs are well-functioning, there is unfortunately ample opportunity for mistakes and even abuse, which puts them under DoL scrutiny.
In terms of takeaways for plan sponsors, they strongly encourage plan sponsor to read the service provider statements they receive, rather than just paying them without reviewing them. When issues arise during audit, they also are prone to ask, “did you read the plan?” which suggests that it might be a good idea to read it (as difficult as that may be in spots). Finally, they noted that if you show amounts as “other assets” or “other income” on the Schedule H for your Form 5500, you are likely to hear from them.
Of course, these are informal, non-binding views of the representative and cannot be taken as authoritative statements of the DoL/EBSA. Nevertheless, they are informative of the types of items that investigators may be looking for if they come knocking on your door.
A list of other DoL/EBSA enforcement priorities is available here.
This recent post on the Plan Sponsor Council of America’s website states that the Department of Labor has recently requested evidence of fiduciary training as part of its audits. While there is no express ERISA requirement that fiduciaries be trained, the DoL seems to take the view that training is evidence of a fiduciary properly exercising his or her duty of prudence. (It also happens to be one of our New Year’s Resolutions for fiduciaries too.)
The first step is deciding whom to include. Basically, a fiduciary is (1) anyone with discretionary authority over the management or administration of an ERISA plan, (2) anyone with discretionary authority over the management or disposition of its assets, or (3) anyone who provides investment advice for a fee. (Individuals in category (3) should have their own training already.) Fiduciaries of the plan include the trustee, the plan administrator, the person responsible for reviewing claims or appeals, and any designated administrative committees.
When scheduling a training session, you should ensure that all the relevant individuals are included. For example, if you have a plan committee that meets regularly, all of its members should be trained. If there is a separate investment committee, those individuals should also be trained. (If you do not have a designated plan or investment committee, you should consider one or both to help establish clearer lines on who has fiduciary responsibility and liability.) Whether or not you have a committee (but especially if you do not), you should identify which individuals have responsibility for the plan administration and have them trained as well.
In addition, you should consider whether any board of directors members or members of management who have authority to appoint fiduciaries should be trained on their limited duty of oversight of their appointees. This will help them understand the nature of their role and responsibilities as delegating fiduciaries.
A common mistake some plan sponsors make is to assume that the third party administrator they have hired is the “plan administrator.” In fact, that is almost always not the case. Most TPAs specifically state in their service contracts that they are not fiduciaries, and in particular, place the ERISA title of plan administrator on the company. The bottom line is that if you’re a plan sponsor and you don’t think anyone in your workforce is a fiduciary, you’re mistaken.
In our experience, the initial fiduciary training usually takes a couple of hours or so to make sure that all the bases are covered and there is sufficient time for questions. Depending on the scope and types of plans involved, it may take longer. Periodic updates can be shorter if the fiduciaries have been trained recently.
Based on the information in the PSCA post, it appears the DoL expects training to occur at least annually. Newly hired individuals, or individuals who assume fiduciary roles for the first time, should also be trained promptly. While annual training is probably a “platinum” best practice, for many plan sponsors, that can be difficult both in terms of scheduling and cost. However, the key is to make sure it is done, done well, and done with some regularity to keep everyone up to date.
Have you done your fiduciary training? If not, what are you waiting for?
As reported by BNA Pension and Benefits Daily on December 19, 2012, an Internal Revenue Service (“IRS”) official again confirmed in a December 18 webcast that the Prime rate + 1% may not be a reasonable interest rate under the Internal Revenue Code prohibited transaction rules which apply to loans from qualified plans. We discussed previous remarks by IRS officials some time ago.
In recent years, plan administrators typically set the interest rate for plan loans as the Prime rate + 1% in effect on the first of the month during which the loan is originated (or a similar set date). The IRS official indicated that there is no safe harbor under the rules for Prime rate + 1%, Prime rate + 2%, or any other rate. Instead, plan fiduciaries charged with establishing the rate should periodically perform due diligence to determine prevailing rates in the market place for similar loans. A co-presenter offered that a similar loan should be considered a secured loan, citing a loan secured by a certificate of deposit or other similar property.
What’s on your next 401(k) committee agenda? Adding consideration of an appropriate interest rate for plan loans is prudent.
It is that time of the year again for making those New Year’s resolutions – spending more time with family and friends, exercising more, losing weight, quitting smoking, and becoming a better plan fiduciary. Here are our top ten New Year’s resolutions for plan fiduciaries for 2013:
- Obtain/review fiduciary liability insurance policies. Fiduciary liability insurance generally covers liability or loss resulting from the fiduciary’s acts or omissions and is a fiduciary’s “first line of defense.” Policies should be reviewed to ensure adequate coverage and protection in scope and amount.
- Practice procedural prudence. Being a good fiduciary is all about having a procedural prudent process. For each fiduciary decision you should: inquire, analyze, consider alternatives, get help and advice if needed, and document the process, actions and basis for the decision.
- Hold regular plan fiduciary/committee meetings. Plan fiduciaries should meet periodically (we recommend at least quarterly) to consider information regarding plan investment performance, selection, and oversight of plan investments, investment managers, service providers, and other plan administrative matters. Minutes of the meetings should be kept to help demonstrate that the fiduciaries have engaged in a prudent process of analyzing and assessing relevant issues.
- Review, and if necessary revise, your plan’s investment policy statement. The investment policy statement should establish guidelines and procedures for selecting, monitoring, and removing investment funds and manager. Plan fiduciaries must monitor the statement and keep it current to ensure investment decisions are made in a rational manner and to further the purpose of the plan and its funding policy.
- Monitor performance of investment funds and investment managers. Fiduciaries should monitor plan investments and investment managers on an ongoing basis to ensure that they are meeting the criteria set forth in the investment policy statement. Fiduciaries should follow the statement in selection, monitoring and removal of investment funds and managers.
- Review and monitor plan expenses and fees. With the new DOL regulations on fee disclosure, fiduciaries must make sure all required fee disclosures are made timely and monitor fees on a regular basis. Fiduciaries should establish a policy for ongoing plan expense and fee monitoring and benchmarking.
- Consider an audit to ensure compliance with the ERISA 404(c) and qualified default investment alternative (QDIA) requirements. ERISA Section 404(c) provides limited protection to fiduciaries of participant-directed individual account plans from fiduciary liability for participants’ investment losses; provided that the plan complies with the requirements described in 404(c).
- Conduct a compliance review of your plan documents. Since fiduciaries should make decisions by following the applicable plan documents (e.g., plan, summary plan descriptions, investment policy, trust, committee charters, delegations, etc.), fiduciaries should make sure plan documents are consistent with each other and with actual practice.
- Consider hiring professionals and other service providers to help perform certain fiduciary tasks. Keep in mind that fiduciaries still have the duty to monitor plan service providers, including making sure their fees are reasonable if their fees are paid by the plan.
- Provide fiduciary education and training to plan fiduciaries. “The single most important role a plan sponsor serves is being a fiduciary. With increased complexity in plan design, communications, and investment selection, a fiduciary’s job is becoming increasingly challenging,” said David Wray, President of the Profit Sharing/401k Council of America (PSCA). These challenges, coupled with the fact that any ERISA fiduciary who fails to comply with the applicable standard of conduct may be held personally liable for any plan losses resulting from their breach, make it vital that all ERISA fiduciaries receive periodic training. The simple act of providing fiduciary training to your organization’s ERISA fiduciaries will help establish a record of “procedural prudence” and is the major step to minimizing fiduciary liability. Bryan Cave’s Employee Benefits & Executive Compensation Group has carefully developed comprehensive fiduciary training programs, which can be easily customized for any group of plan fiduciaries.
