Business of Benefits : Employee Benefits Lawyer & Attorney : Law Office of Robert J. Toth, Jr. : 403(b) Plans, Annuity & Insurance Law : Business of Benefits Blog

Freedom and liberty are not merely themes sounded by politicians in political campaigns, or in rousing marches by military bands (though I am personally  particularly fond of them!), nor are they ideas which you will typically see being discussed in a piece about retirement issues. But they are themes woven into the fabric of our our everyday life, without our often even even being aware of them. They form not only the basis of our own civil society, but (believe it or not) are deeply embedded in the holy texts of the major religions. 

But there is a risk nowadays in even referencing these two grand ideas in today's political environment: instead of being viewed as the firm basis of how the vast majority of us quietly operate, they seem to have been outrageously hijacked by political extremists (such as of the libertarian/Ron Paul/ Tea Party sort-of which I am not so inclined) for some specific end.

In spite of all that, there is something well worth mentioning along these lines about the striking impact of the work we do, something we are not prone to see while working the fine minutiae of our chosen profession.

If we step back for a minute, we can see the extraordinary policy underlying 408(b)(2), the prohibited transaction rules and the exclusive benefit rules (which apply even to non-ERISA plans).  These rules seek to set aside and protect from others the individual wealth of those who accumulate benefits under these plans. It became pretty plain to me while reading Absolute Monarchs, by John Norwich (a history of the Catholic Popes, which really is a brief history of the absolute power of royalty as well as the church over individuals), where, historically, an individual's financial well being was wholly dependent on the whims of powers that be.

We now have something very odd in man's modern history. The value of the funds which are now protected for participants in retirement plans by the Code, ERISA or both approximates 85% of the value of publicly traded securities in the United States.  Though this seemingly huge amount is not yet adequate to establish broad retirement security, it is material enough to take note: these pooled funds are outside of the legal reach of the unaccountable "whims" of those who have something other than the best interests of the participants at heart.  Imagine that. A significant and growing portion of society's wealth is institutionally dedicated in funded pools to the individual's well being, which are difficult to access by an abusive use of power which has so often corrupted society-and jeopardized freedom and liberty-in the past. 

The only way this really works, however, is by things like 408(b)(2); by enforcement of the prohibited transaction rules; and by giving serious attention to the exclusive benefit rules. And all of this is dependent on what appears to be non-sensical minutiae upon which we daily work.

There is a reason I like doing what I do......

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 A while back, I did a piece on the manner in which the 408(b)(2) regs applied to the variable investment accounts under a group annuity contract held by a retirement plan, in particular, 401(k)plans; and a "light" piece on its application to general account products. In that I hear more and more rumblings  about the "fixed investment" portion of these accounts under 408(b)(2), it may be helpful to take another, more detailed look at how that reg applies to such accounts.

The first thing that comes to mind when looking at the regs for these purposes is the thing I noted in that previous blog: regardless of what you may think about 408b2 and the requirements now imposed by the rules, this reg has been craftfully drafted. The pieces fit together nicely, and complex issues with regard to investment products have been meaningfully addressed in as simple and direct manner as possible.There may be a few interpretaive issues that need to be resolved (which is to be expected), and 403(b) issues continue to be a serious challenge, but this is a fine piece of technical writing.

So it is with the "guaranteed account," "stable value fund" or "fixed account" within these group annuity contracts.  The 408(b)(2) pieces fit well together.

First, it may be helpful to read my piece on general accounts, and how they work. This can go a long way in understanding why 408b2 applies in the way it does. It is one of my favorites, because it includes a Dick Van Dyke clip from "Mary Poppins." That blog only generally addressed the 408b2 issue.

Next, the fiduciary needs to know whether or not the investment account is a contractual obligation of the insurer,  backed by the "general assets" of the insurer, or if it is part of a "separate account" (see my above noted blog on this). Confusion may arise from the variety of marketing names these funds may be called: the general account product will sometimes be called a "stable value fund" (typically because the crediting rate is set by use of an unrelated, third party index), which may be confused by a "stable value" mutual fund or collective trust interest which is offered under the annuity contract's variable investment separate accounts.

Once you know that fund is a fixed obligation of the insurer from its general account, you need to see what kind of Covered Service Provider (CSP) is the insurer.  It will not be considered an "A" type with regard to the fixed account, because it is not a fiduciary with regard to the management of the assets of the general account backing its contractual promise (a book could be written on this point, alone).  It may be a "B" type of CSP if, under the contract, the insurer is a "recordkeeper."  It will not typically be a "C"  type of CSP because, even though it is insurance, the insurer will not usually receive indirect compensation (as that term is defined by 408b2) related to that account (but keep in mind that these contracts may be part of an annuity where separate accounts are used-and thus indirect comp typically received-for which "C" status may occur). 

What needs to be disclosed?

-If the plan will only buy a group annuity contract with a fixed fund from the insurer, and the insurer will not provide any participant level recordkeeping services, then the insurer may not even be a CSP that will need to report under the new 408(b)(2) regs. The only complication will be the reporting of commissions. 

-If the insurer is a "B" CSP, then two things will need to be reported:  (i) a description of any compensation that will be charged directly against the account balance in connection with the acquisition, sale, transfer of, or withdrawal from the product, like surrender charges; and (ii)  description of any ongoing expenses such as mortality and expense charges or contract charges.

What will NOT need to be reported, however, is any "spread" between the crediting rate under the contract and the investment return on the insurers' general account, as the regs specifically exempt "operating expenses" from needing to be reported from a fixed account.

Didn't say it would be easy, but it all does fit together nicely.....

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Any discussion on any tax issue addressed in this blog (including any attachments or links) is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code or promoting, marketing or recommending to another person any transaction or tax-related position addressed therein. Further, nothing contained herein is intended to provide legal advice, nor to create an attorney client relationship with any party.    

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Retirement plan lawyers, both in house and outside counsel, may well want to take note of Bank of New York Mellon's recently reported troubles related to potentially widespread  and fraudulent use of unfair currency exchange rates in their dealings with unsuspecting state and local pension plans.  If there is a basis for these charges, and f they were as widespread and as sustained as alleged to be, we may have our first prime example of how SOX Section 307 and SEC's "Part 205" Rules (which implement Section 307) can implicate employee benefit lawyers. This is because it would be hard to believe that there wasn't a lawyer somewhere in the organization that shouldn't have been aware of the practice (as these rules apply not only to corporate law staffs, but to lawyers in the business lines as well).

Much of the Sarbanes Oxley Act n 2002 ("SOX") was designed to address many of the corporate abuses arising from the Enron, Tyco and Worldcom fiascoes, and it included enhanced protections for corporate whistleblowers.  Buried within this statute was Section 307, an obscure section which imposed duties upon lawyers who deal with publicly traded companies the duty to "report up" certain corporate malfeasance of which they became aware in their practice.  The challenge with these rules is they seem to clash, in many respects, with the state law rules governing the attorney client privilege. In house counsel have challenging enough circumstances, where their client is the corporation and not the officers who seek their counsel.  This awkward pressure merely increased with the passage of SOX. The stakes became higher, as well: failure to report properly would effectively result in a ban from ever representing a publicly traded client, whether in house or as outside counsel.

I wrote an analysis describing the impact of Part 205 on employee benefit lawyers for ALI-ABA in 2005. In that article, I struggled to describe sensible circumstances where benefit lawyers would be impacted, and where the reporting up obligation would be imposed. This is because the only corporate malfeasance required to be reported under SOX are those which would result in a material impact on the company's financials, and it seemed at the time that it would be one heckuva stretch to reach the materiality standard in our line of work.

BNYMellon really is an eye opener. For manufacturing companies, there really is rare opportunity for the employee benefit lawyer to trip Part 205 obligations, other than issues related to underfunded pension plans and executive stock programs.  BNYMellon, however, demonstrates that this is a very real possibility for attorneys representing financial service companies which do retirement business. Considering the fact the value of retirement plan holdings are some 85% of the value of publicly traded securities in the U.S., and where many companies' financial stake in the retirement business continues to grow, it occurs to me that the potential circumstances where SOX may be implicated will only become greater.

Part 205 requires the establishment of written procedures to insure compliance.   Though pure corporate, tax and M&A lawyers have always been well versed in such matters, financial service companies may want to check these procedures to make sure that retirement law staffs (including those in the business lines) are well within the loop.

For those curious on the nuts and bolts of the operations of Part 205 in the employee benefit practice (and there are quite a few), I invite you to read the ALI-ABA paper.

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