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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 I’ve had a number of responses to my “Timing and the ERISA Account” blog of last week: this topic seems to be front and center with a number of folks right now. Given the sorts of comments I received, I thought I’d expand a bit from that initial, almost cryptic, blog.

“ERISA Accounts,” or “Fee Recapture Accounts,” or “ERISA Budgets” are growing in popularity, and are becoming a frequent feature in the 401(k) and 403(b) space. They take two forms: a “credit” with the plan vendor, where the vendor pays up to a certain, agreed-upon amount for plan administrative services as part of the vendor ”package;’ or the “funded” sort where the vendor actually makes a cash payment to the plan, usually based on some sort of revenue sharing schedule. These typically include 12b-1 fees generated from mutual funds, but may also include such things as surrender charge reimbursements or other negotiated items.

In 2007, the ERISA Advisory Council’s Working Group on Fiduciary Responsibilities and Revenue Sharing Practices issued a report which did a nice job on lying out a number of key issues related to this practice. It also recommended that the DOL issue guidance regarding the treatment of revenue sharing received by a plan, specifically regarding the allocation of revenue sharing received by a plan. The DOL has had its hands full in the past few years, so it is little wonder that it has yet to act on providing this guidance.

There all sorts of issues which come up related to these accounts, but the most pressing of them appears to be associated with the funded accounts: the structure of these accounts within the plan (are they like forfeiture accounts?); the method of the allocation of those funds to participant accounts once expenses have been paid; and the timing of those allocations. My previous blog just addressed the timing issue.

The structure of these funded accounts is actually interesting: recordkeepers aren’t generally accustomed to establishing an employer level account, and many recordkeeping systems are not well suited for this function.  The employer level accounts that do exist are typically forfeiture accounts, and the rules governing them can differ from the ERISA Account-which also means that there are a number of different reasons you want to somehow account for ERISA Account deposits differently than forfeitures. These Accounts probably need to be adopted by some formal action of the plan’s fiduciary, in accordance with the authority it is (hopefully) granted in the plan document, which also discuss how they will be used and eventually allocated. Absent that, the general fiduciary authority within the document will need to be relied upon.

With regard to how these funds may be allocated to participant accounts (particularly where there is an “excess” left after certain plan expenses have been paid. Remember, at least in the funded accounts, they cannot be used for settlor expenses. There are interesting prohibited transaction issues as well if the unfunded credits are used for settlor functions), there seems to be a growing sense that ERISA requires that there be some sort of “matching up” of these allocations with the assets which generated them. There is little doubt that this could be an acceptable method of allocation, and there is at least one vendor which I know of which, very nicely,  closely tracks this.

What seems to be getting lost in the discussion related to these allocations is the fundamental rule that participants only have a beneficial interest in the plan. They have no right to any asset, and they only have the right to direct the investment of their accounts because the employer has decided to let them do so instead of the fiduciary. Any funds generated by those investments are due to the plan, not necessarily to any particular participant. Whatever allocation method is chosen by the fiduciary need only be prudently made. It is telling that in Field Assistance Bulletin 2006-01, the DOL stated that (in addressing the allocation of class action settlement proceeds):

“…. a fiduciary’s decision must satisfy the “solely in the interest of participants” standard of section 404(a)(1) of ERISA. In this regard, a method of allocation would not fail to be “solely in the interest of participants” merely because the selected method may be seen as disadvantaging some affected participants or groups of participants. In deciding on an allocation method, the plan fiduciary may properly weigh the competing interests of various participants or classes of plan participants (e.g., affected versus current participants) and the effects of the allocation method on those participants provided a rational basis exists for the selected method and such method is reasonable, fair and objective.”

In short, though “tying back” the ERISA Account payment to the participant account which generates them will generally be considered prudent (though I can see circumstances where it would not be, such as if it were expensive to do so), and can be a good "market differentiator" for a vendor, I think it is a mistake to claim that this is the result demanded by ERISA.

For all these Accounts, there are also a number of interesting 408(b)(2), Schedule C and Schedule A issues with which plan sponsors and vendors must cope-and which I will not address here.

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It is not often that one gets to hearken back to the very basic law governing 401(a) plans in addressing an issue, but one of the key questions related to the funding of “ERISA Accounts” provides just such an opportunity. One of the most fascinating of the issues related to these accounts (and there are a number of them coming out of the woodwork as their popularity grows, as well as a number of thoughtful papers being written on these accounts) is the question of how long can the funds can remain in the ERISA Account before needing to be allocated to participant accounts.

We know that the IRS has taken a clear position on the timing of the “spend down” of a forfeiture account, and that funds in the forfeiture account must generally be allocated within the plan year that forfeiture is made (this rule, by the way, would not apply to 403(b) plans). But this is based on 401(a)(8) and the required treatment of forfeitures of contributions under 1.401-7(a)- and the ERISA Account deposit is not a forfeiture. We also know that the DOL has, at least on one occasion, deferred to the prudence standard (see, for example, FAB 2006-1) in managing these accounts.

We do know that a plan document needs to contain language outlining the management of the ERISA Account (and that the Account should be accounted for separately from the forfeiture account), unless the fiduciary is otherwise able to establish procedures under its general fiduciary authority. But what should be the standard under the Code that the plan should adopt?

I think the answer goes back to the “exempt purpose” rules which govern tax-exempt organizations. If I recall my research as a first year associate in Detroit with the good Rasul Raheem, Dr. Willard Holt, Richard Smart and Roland Bessette, under the tutelage of the fine Stan Kirk, the trust of a 401(a) plan is, after all, an exempt organization under 501(a), and the assets of a tax exempt organization are to be used in the fulfillment of the organization’s exempt purpose.  The exempt purpose of a 401(a) trust is, of course, to provide a pension or profit sharing benefit exclusively for employees or their beneficiaries. So, hanging on to the funds in this ERISA Account for too long and not using them for providing this benefit or supporting the operation of the plan would be a failure to use the assets of the "exempt organization" in furtherance of the trust’s exempt purpose. This, ultimately, really leaves you with that “reasonable” period that the DOL suggests to be the standard.

This may also mean that there may not be a standard for a non-ERISA 403(b) plans (as they are neither not subject to 401(a) or the fiduciary standards of ERISA). Any effort to impose a standard would have to be related somehow to the failure to purchase an annuity for an employee. But that may not even matter, for the tax exempt organization would not be otherwise taxed on that amount anyway, and it is not an event which would disqualify the plan.

With 403(b) plans in mind, by the way, make sure the 403(b) ERISA Account is invested in mutual funds or in an annuity account, not just to some holding account at a financial institution. See my blog on “The Trouble With 403(b) Cash.”

I knew that research I first did years ago when trying to figure out how a pension fund worked would eventually turn out to be useful sometime…….

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In the summer of 1999, I left my position as in-house counsel for an insurance company and returned to the private practice of law. As a result, I rolled the funds held in my 401k plan into an IRA. I was a complete novice when it came to investing at the time but had recently heard a commentator on NPR claim the rise of the Internet represented a paradigm shift in the global economy. Based upon this information, I moved half of my retirement funds into a “New Economy Fund” and the other half into a “ContraFund.”   When the dot.com bubble burst a year later, I realized I could have fared just as well if I had flushed half of my money down the toilet and stuck the other half under my mattress.

Several years later, one of my friends – a Vice President in the Claims Department of my prior employer – decided to retire. The company was owned by General Electric at the time, and its 401(k) plan offered a surprisingly paltry array of investment options - most of which were dogs. Because the price of GE stock had skyrocketed under Jack Welsh’s leadership, my friend chose to roll all of his retirement plan funds into GE stock. A year later, he too would have been in about the same shape as if he had flushed half his funds down the toilet. 

Needless to say, my friend and I would have benefited greatly from the counsel of an investment professional at the time we made these decisions. However, no advisor reached out to us and, now that I have spent the past several years providing legal counsel to advisors in the retirement plan industry, I understand why.

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By now it should be apparent the Department of Labor (“DOL”) has opened a proverbial can of worms by proposing to expand the category of service providers who will be subject to ERISA’s fiduciary standard. Not only has the proposal been met with a tidal wave of negative comments from industry insiders, but Members of Congress from both parties have also weighed in with their objections.

While it may come as a surprise that an attorney who works with retirement plan professionals would support the DOL’s attempt to expand the fiduciary standard, I actually agree with the assertion that a change in the law is needed. As in-house counsel for a broker-dealer that supported the nation’s largest network of independent retirement plan professionals, I pushed hard to require our registered representatives to adopt the principles that form the basis for the proposed rule. Specifically, I encouraged our registered representatives to consider moving their practice to a fee-based advisory platform and affirm their fiduciary status. For those unwilling to make the switch, I pushed to require client agreements that affirmatively stated the representative was not intending to act in a fiduciary capacity. Like the DOL, I have my share of battle scars from the effort.

However, while I agree with the DOL’s goal, I cannot support its methodology for bringing about this change. Specifically, I believe the proposed rule (as currently drafted) violates the constitutional separation of powers by permitting an executive branch agency to rewrite existing law rather than interpreting the law as it is currently written.

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I would think that it is a basic law of physics that, whenever you attempt to apply a number of different and complicated principles to a single object, that the consequences on that object will be hard to predict, or even readily ascertained.

So it is with a potential impact 408(b)(2) may have on many 501(c)(3) sponsors of ERISA 403(b) plans. It shows up when you take an 403(b) ERISA plan, impose a fundamentally new set of basic principles (by way of the 2007 403(b) tax regulations); revoke its exemptive relief  from reporting requirements (the Form 5500); while nearly simultaneously superimposing a tremendous new disclosure scheme (participant and service provider disclosures);  there are inevitably going to be some unusual results.

Take a typical example. A hospital sponsors an ERISA 403(b) plan with 10,000 current employees. Over time, it has merged with a number of different hospitals, each which had separately maintained its own 403(b) arrangements in the past with a wide number of vendors. The hospital, in anticipation of the problems with the 2007 tax regulations, consolidated all the affiliates plans into a single platform on 1/1/2009.

Over its history, though, it and its affiliated hospitals had selected and deselected a number of other vendors (no one is quite sure how many) many with whom they have long lost contact.

All of these contracts over the history of the plans have been owned by the individual participants. Though the employer did have an audit done, it did not report many of those "lost" deselected vendor contracts, as it didn't know much about them or the vendors. They reported those old plans as merging with the 2009 Form 5500.

The deselected vendors all still have some old contracts that participants have hung onto,  even after those participants have left the employee of the hospital. The records of the vendor shows that these were ERISA contracts, and that they earn a "mortality and expense", or some other contract charge, and they are indeed "recordkeepers" for the investments in those contracts as defined by 408(b)(2). In order to prevent that compensation from being prohibited, and from the need to be prudent, the vendor decides to make the required disclosures to the hospital's "responsible plan fiduciary-" with whom they have not had contact for many years.

Imagine that fiduciary's surprise when it receives these "blasts from the past," the ghosts of decisions made long ago, often by folks with which they were never affiliated with at the time decisions were made. 

The hospital never knew about these contracts for which they are receiving disclosures, but can't ignore them.  They have just completed all of their work with regard to participant fee disclosures, but now someone is telling them that there may be a dozen more companies' investment products upon which they have to report. They also just filed their 2010 Form 5500, and didn't report many of these contracts as assets of the plan.  

Now what? This is just one scenario, they are others which may be likely once vendors seek to comply with 408(b)(2) on their books of old ERISA contracts. Though the regulator view may be that this flushing of old contracts is a good thing, it can actually be quite a mess to sort through-including whether or not you still have relief and can exclude them from compliance responsibility under Rev Proc.2007-71, and just at a time when the IRS is beginning their 403(b) 2009 audits. I suspect that the management of the problems can only resolved by closely looking at all of the particular facts which will apply to the plan.

I leave it to your imagination as to the myriad of difficulties this may cause; as there are potentially many. I also may be wrong, and this may never happen.......

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I drafted the following article for the DCPI Weekly Exchange as part of an ongoing series of comments on fiduciary issues.  DCPI's newsletter can be accessed (with a free subscription) at http://www.dcpinstitute.com.

As I review advisors’ websites and advisory agreements, I sometimes see “plan design consulting” as a service offered to retirement plan clients. While there is nothing inherently wrong with assisting clients with the design of their plans, I would caution that the DOL has long viewed such services as being materially different from other non-fiduciary activities. 

Specifically, in a publication entitled “Guidance on Settlor v. Plan Expenses,” the DOL noted:

The department has taken the position that there is a class of activities which relates to the formation, rather than the management, of plans. These activities, generally referred to as settlor functions, include decisions relating to the formation, design and termination of plans and, except in the context of multi-employer plans, generally are not activities subject to Title I of ERISA. Expenses incurred in connection with settlor functions would not be reasonable expenses of a plan.

While the same publication claims that, “Plan design expenses clearly constitute settlor expenses and, therefore, are not payable by the plan,”[1] the basis for the DOL’s position is less than clear.  In fact, the term “plan design” is never used in ERISA. Neither is “settlor expenses.” Instead, the DOL appears to draw support for its position from the law’s emanations and penumbras. 

For example, in Advisory Opinion 97-03A, the DOL indicated its position was required, in part, by the following language in §403(c)(i):

(T)he assets of a plan shall never inure to the benefit of any employer and shall be held for the exclusive purposes of providing benefits to participants in the plan and their beneficiaries and defraying reasonable expenses of administering the plan. 

In order to tie its position to this statute, the DOL must necessarily conclude employers do not form retirement plans “for the exclusive purpose of providing benefits to participants in the plan” but, instead, primarily to further their own interests. To be fair, our Supreme Court has opined that employers derive some incidental benefits by forming a retirement plan (e.g., in the recruitment and retention of employees).[2] Surprisingly, though, the DOL brushed aside any reliance on this argument, arguing that such incidental benefits are not sufficient to convert an activity into a “settlor expense.”[3]

As a result, advisors should be forgiven for not having a good understanding of when their advice becomes a “plan design expense” that cannot be paid from plan assets. The best guidance the DOL has offered in that regard is that, “Typically, plan design expenses are incurred in advance of the adoption of the plan or a plan amendment.”[4] 
 

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I drafted the following article for the DCPI Weekly Exchange as the first of an ongoing series of comments on fiduciary issues.  DCPI's newsletter can be accessed (with a free subscription) at http://www.dcpinstitute.com.

Okay, I will admit it.  I have not spent my entire legal career focused upon ERISA.  In fact, before joining National Retirement Partners as in-house counsel to its broker-dealer and registered investment advisory firm, I served as counsel to an insurance company and, yes, as a plaintiff's attorney. 

However, having such varied experience can sometimes provide a more nuanced perspective.  Take, for example, the ongoing debate regarding the benefits and drawbacks of serving as an investment advisor to ERISA-qualified plans under section 3(21)(a)(ii) or as an investment manager under section 3(38). 

If you were to merely read ERISA, you would likely conclude there are significant differences in the potential liability being assumed under each role.  After all, an investment advisor, by definition, merely provides advice to the ultimate decision-maker.  By contrast, an investment manager manages the fund's assets on a discretionary basis.  In fact, section 405(d)(1) of ERISA specifically provides immunity to plan trustees for the acts or omissions of an appointed investment manager. 

Unfortunately, some commentators have attempted to use these statutory differences to assert that investment advisors have no legal liability because they are providing nondiscretionary advice, while investment managers completely shield plan sponsors from legal liability by acting with discretion.  Upon closer inspection, however, these theoretical distinctions quickly break down. 

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But, first, another note of introduction......

It is with great pleasure to announce that my friend and fellow pink-shirted compatriot (many of our industry colleagues may fondly remember THAT story!) Sandy Koeppel has decided to join us as Of Counsel, and to have some fun following his illustrious career at Prudential.  Together with myself, Phil Troyer and Conni Toth, we intend to continue to contribute helping make the U.S. retirement system - which we are all so passionate about - work better. Sandy brings a tremendous wealth of experience in guaranteed lifetime income from employer plans to the marketplace (I invite you to read his bio), and intends to continue to carry this torch. Between us all, we offer substantial knowledge of the design, marketing and distribution of these products.

Sandy, as he mentions below, has also formed Plan Income Consulting & Evaluation Services, LLC (PLICES), a consulting firm which has affiliated with this firm and which provides advisors, vendors and employers consulting services related to guaranteed income products.  

Drop Sandy a note at sek@rtothlaw.com.

Now, his first blog:

The shift from Defined Benefit to Defined Contribution plans as the primary workplace retirement vehicle has eroded the confidence and jeopardized the retirement security of a vast number of American workers and their families. The recently published EBRI 2011 Retirement Confidence Survey finds that confidence among workers in their ability to have a comfortable retirement has dropped to an all-time low. According to the EBRI survey,

"the percentage of workers not at all confident about having enough money for a comfortable retirement grew from 22 percent in 2010 to 27 percent, the highest level measured in the 21 years of the RCS. At the same time, the percentage very confident shrank to the low of 13 percent." The RCS further states that "56 percent of workers expect to receive benefits from a defined benefit plan in retirement, only 37 percent report that they and/or their spouse currently have such a benefit with a current or previous employer. Therefore, up to 19 percent of workers may be expecting to receive the benefit from a future employer—a scenario that is becoming increasingly unlikely, since private-sector employers, in particular, have been cutting back on their defined benefit offerings."

These findings along with other results of this survey are disturbing and demonstrate that American workers not only are uninformed but feel challenged, concerned, and threatened about potential declines in their future lifestyle in retirement.

 With the passage of the Pension Protection Act, Congress recognized the need to instill defined benefit-like outcomes into the defined contribution plan universe. The PPA enables plan sponsors to include in their DC plans features such as automatic enrollment, automatic contribution escalation and gain fiduciary protection by offering qualified default investment alternatives deploying professional money management. These important first steps do much to replicate for workers the defined benefit plan experience in the asset accumulation stage. However, up to now, most DC plans do not offer the critical and essential missing piece to assure retirement security: guaranteed lifetime income. There are many reasons for this failure. Chief among them include: legal uncertainty about the rules and standards that apply to the choice of providers; unsettled tax issues (e.g. applicability of qualified joint and survivor annuity rules) associated with new and innovative forms of guaranteed lifetime income; cost and administrative burdens; lack of demand among participants; lack of guidance from the Department of Labor delineating between advice and education for distribution planning and the availability of out-of-plan (retail) vs in-plan (institutional) guaranteed lifetime income solutions if it is desired.    

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But first, an introduction.... 

Today, we are pleased to introduce the writings of Phil Troyer, who has just joined our firm.  Phil brings a fascinating and badly needed skill set to the retirement plan world: a deep knowledge of the broker-dealer and retirement plan advisor marketplace; practical experience on how ERISA, and its fiduciary rules, actually work (and don't work) in that part of the market;  and, rare for our world, being deeply grounded in how insurance liability coverage actually works for fiduciaries and plans.  Check out his bio n the "About" section of this website, and feel free to contact him at pjt@rtothlaw.com.

Phil's blog piece on being a naked fiduciary:

Are You a Naked Fiduciary?

Much has been written about the Department of Labor’s proposal to broaden the definition of “investment advice” to bring more service providers under the fiduciary standard of care. However, lost in the plethora of articles summarizing its potential effects is a question that should be foremost on the mind of every registered representative who provides services to qualified plans; namely, will I be left without insurance coverage (i.e. “naked”) if I am deemed to be a fiduciary as a result of providing investment advice to my plan clients? 

The answer - which may come as a shock to many representatives - is that it depends. Specifically, it depends upon the specific language used in their professional liability policy to exclude coverage for claims arising from the insured’s status as a fiduciary of an ERISA-qualified plan. 

The basis for the ERISA-fiduciary exclusion contained in most E&O policies is understandable because serving as an officer or administrator of a retirement plan is not generally considered to be a service broker-dealers offer to their clients.[1] Furthermore, separate “ERISA Fiduciary Liability” policies are available for individuals who serve as named fiduciaries of a qualified plan. As a result, insurance carriers have a justifiable reason for ensuring their professional liability policies are not used to bootstrap coverage when a registered representative happens to serve as an officer or administrator of a qualified plan.  Unfortunately, though, these exclusions are not always drafted with sufficient care.

For example, a policy that excludes coverage for “any services performed by any Insured acting as a fiduciary under ERISA,” creates a significant landmine for registered representatives with retirement plan clients because - even under the current definition of “investment advice” - they could be deemed to have acted in a fiduciary capacity by providing investment recommendations to the plan on a regular basis. Obviously, this risk will increase dramatically if the DOL’s expanded definition is enacted to remove the requirement that the recommendations be provided on a regular basis.

Conversely, exclusions based upon the insured’s status as a “named fiduciary, as defined by ERISA” miss the point that the law allows a plan’s named fiduciaries to “designate persons other than named fiduciaries to carry out fiduciary responsibilities.”[2] As a result, the exclusion may not be sufficient to prohibit coverage for a registered representative who was not specifically designated as a fiduciary by the plan but is later deemed to be acting as one as a result of providing management or administrative services to it on a contractual basis.

If insurance companies intend to exclude coverage for services not typically performed by registered representatives (i.e., managing or administering a qualified plan) while preserving coverage for services which are (i.e., providing recommendations regarding investments), then the carriers should be careful to base their exclusionary language on the activity being performed as opposed to the insured’s status as a fiduciary under ERISA. 

At the same time, registered representatives would be well served to dust off their E&O policies to determine whether they will currently have coverage if they are deemed to be a fiduciary under ERISA – especially before a new definition of “investment advice” makes it more likely to occur. Otherwise, they could find they were walking around naked at the time they most needed coverage.

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