Transcript ERISA UPDATE

ERISA UPDATE
Roberta J. Ufford
Groom Law Group
April 16, 2007
1
Overview
 Pension Protection Act of 2006

Focus on Changes to ERISA’s Fiduciary
Responsibility and Prohibited Transaction
Rules
 Developing Disclosure Requirements


Form 5500, 408(b)(2) Regulations
Participant Disclosure
2
Pension Protection Act of 2006
Overview
Most sweeping change to pension law since 1974.
 800 pages of the 900-page bill amend ERISA and
IRC provisions for retirement plans.
 Revamping single-employer DB plan funding rules.
 Major changes to multi-employer plan funding.
 Major changes affecting cash balance plans,
conversions.
 Changes targeted at defined contribution plans.

Autoenrollment safe harbor, faster vesting of employee
contributions.
 EGTRRA permanence.
 Contribution limits and Roth 401(k).
3
Pension Protection Act of 2006
Fiduciary Provisions
 Addresses issues arising from explosive growth of
participant-directed plans.


Participant advice exemption, mapping, benefit
statements.
Encourage auto-enrollment.
 Mitigate employer stock risk.
 Increase minimum bond, new diversification
requirements, participant notice.
 New provisions intended to simplify management of
plan assets (primarily affects defined benefit plans).
4
Pension Protection Act
Service Provider Exemption
 New ERISA §408(b)(17)


Compare to ERISA § 408(b)(2) services
exemption.
Exempts many routine (and non-routine)
transactions between plans and service
providers that are currently prohibited (unless
an exemption is available, e.g., QPAM).

e.g., credit that facilitates plan administration,
plan purchases or sales of securities and other
property, some plan’s derivatives strategies.
5
Pension Protection Act
Service Provider Exemption
 Background: ERISA prohibits virtually every
transaction between a plan and a party in interest.

Party in interest includes a fiduciary, service provider,
employer, union and affiliates of these.
 Without exemptions, plans would be crippled.
Fiduciaries often cannot know whether a counterparty
in a plan transaction is a party in interest. Some
existing exemptions provide conditional relief.




QPAM (PTE 84-14)
PTE 75-1
PTE 80-26
PTEs 90-1, 91-38
6
Pension Protection Act
Service Provider Exemption
 New ERISA § 408(b)(17) –
 Covers purchases, sales, loans, transfers of plan
assets with service providers.
 Does not apply to –
 Transactions with a fiduciary with discretion over the
assets involved in the transaction
 Transactions with employers or their affiliates not
covered.
 Plan may not pay more (or receive less) than
“adequate consideration.”


If a market, the prevailing exchange price or quoted
price.
If no market, the fair market value determined in good
faith by the fiduciary.
7
Pension Protection Act
Plan Assets Definition
 ERISA does not apply to activities of investment
funds in which ERISA plans invest, if these funds are
deemed NOT to hold plan assets.




REOCs
VCOCs
“Operating companies”
Benefit Plan Invest in Fund is Not Significant
 Benefit Plan Investment is Not Significant if –
 Less than 25% of each class of equity interest in a fund
is held by Benefit Plan Investors (BPIs)
8
Pension Protection Act
Significant Participation Test
 PPA changed the test in two ways:
 Narrowed the definition of “Benefit Plan
Investor”



Count only ERISA plans, 4975 plans (IRAs)
Don’t count foreign or governmental plans
Mandated a “look through” rule


A fund will itself be a BPI when it invests in
another fund only to the extent of plan investment
E.g., if 50% of Fund A’s equity interests are held
by BPIs, only 50% of Fund A’s investment in Fund
B must be counted as an investment by a BPI
when the 25% test is applied to Fund B.
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Pension Protection Act
Significant Participation Test
 Should increase private investment opportunities for
plans
 While helpful to hedge funds, will funds that can
qualify as VCOCs, REOCs “switch”?


Continue to qualify first investment?
Must test at every “acquisition”
 If the change is effective for transactions occurring
after 8/17/06, may a Fund that has no new
“acquisitions” after that date switch from a VCOC
strategy to the significant participation test?
 How will public plans react?
10
Pension Protection Act
Cross Trading
 ERISA § 406(b)(2) prohibits a fiduciary from
representing a plan and another investor in a
transaction between them, such as a crosstrade.
 New §408(b)(19)

Exempts the purchase and sale of a security
between a plan and any account managed by
the same investment manager.
11
Pension Protection Act
Cross Trading
 New § 408(b)(19) conditions

Advance Approval: The cross trading must be
authorized in advance by a fiduciary of each
plan, following disclosure by manager.


Approves program, not each trade
Plan Size: More than $100 million in assets.
12
Pension Protection Act
Cross Trading
 Pricing (similar to mutual fund rules):
 Cash transaction
 Security for which market quotations are
readily available
 Price is determined under SEC Rule 17a-7(b);
 No brokerage commission or other fee is
charged (except customary and disclosed
transfer fees).
 Reporting: Detailed quarterly reports of all
cross trades to the plan fiduciary;
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Pension Protection Act
Cross Trading
 Annual Compliance Review: Must designate
a person to issue an annual compliance
report for clients, signed under penalty of
perjury.
 Policies and Procedures: Must establish and
follow written policies and procedures that are
“fair and equitable”.

DOL published interim final rules establishing
requirements for manager policies and
procedures. 72 Fed. Reg. 6473 (Feb. 12,
2007).
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Pension Protection Act
Cross Trading
 Open issues, exemption may not apply –

Where one of the two plans is a plan
sponsored by the IM or its affiliate (PTE
requires approval of an independent fiduciary)


Ex. Collective fund where IM’s plan is an investor
Where IM can’t absorb the commission – PTE
prohibits any commission or fee; issue for
small managers without broker/trader affiliates
15
Pension Protection Act
Other Exemptions
 Block Trading – ERISA § 408(b)(15)
 Alternative Trading Systems – ERISA §
408(b)(16)
 Prohibited Transactions involving securities, if
corrected within 14 days of discovery - ERISA
§ 408(b)(20)
16
Pension Protection Act
Bonding Requirements
 Current Rule under Section 412
 Fiduciary or persons who “handle” assets
must be bonded for loss from dishonest.
 10% of amount handled, up to $500K.
 Exemptions
 Banks
 Insurance Companies
 New Exemption: § 412(a)(2): Exempts
registered broker-dealers subject to fidelity
bond requirements of a SRO
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Pension Protection Act
Bonding
 Bond Amount Increased: If a plan holds
employer securities, the bond is increased
from $500K to $1M.



Even the fiduciary is not the manager of the
stock, it must double its bond.
Institutional fiduciaries already have trouble
finding capacity at $500K.
Technical corrections? Limit increased bond
to actual managers of securities or accounts
invested primarily in securities.
18
Pension Protection Act of 2006
Investment Advice
 Background – Providing “investment advice” is a
fiduciary act. A person who advises plans or
participants to invest in an investment product that
pays the adviser or its affiliate fees and commissions
may violate ERISA’s prohibited transaction rules (i.e.,
section 406(b)).
 Approaches to participant advice programs –



Independent advice services, Adv. Op. 2001-09
(SunAmerica).
Adviser levels or offsets fees so that advice does not
change adviser’s compensation, Adv. Ops. 1997-15A;
2005-10A (Frost/COUNTRY BANK).
Rely on class exemptions, e.g., PTE 84-24, 77-4, 75-1.
19
Pension Protection Act of 2006
Investment Advice
 New ERISA §408(b)(14) exempts –
 the provision of investment advice to a plan participant
by a “fiduciary adviser,” and
 The adviser’s receipt of direct or indirect compensation
(including sales commissions and other fees) as a
result of plan investments pursuant to the advice.
 Only covers advice provided under an “eligible
investment advice arrangement.”

Discretionary management programs and advice to
plan sponsors (e.g., fund selection) are not covered.
 Available for advice provided after Dec. 31, 2006.
20
Pension Protection Act of 2006
Investment Advice
 ERISA § 408(b)(14) — “Eligible Arrangements”
 Two types of “eligible arrangements”
 adviser’s fees do not vary based on advice, or
 Adviser provides advise using a computer model
certified annually for an independent expert.
 Plan fiduciary must authorize arrangement for plan.
 Detailed participant disclosure, including all program
fees and the fiduciary adviser’s compensation
arrangement. (DOL required to issue model form).
 Annual independent audit of services is required.
21
Pension Protection Act of 2006
Investment Advice
 ERISA § 408(b)(14) — Plan Sponsor “Shield”
 Plan sponsor or other fiduciary who selects an “eligible
investment advice arrangement” —



does not fail to meet ERISA requirements solely
because the sponsor contracts for or arranges for the
provision of advice to participants,
has no duty to monitor specific investment advice
provided by a fiduciary adviser,
but, still must prudently select and monitor the fiduciary
adviser.
22
Pension Protection Act
Investment Advice
 FAB 2007-01 Clarifies Some 408(b)(14) Conditions
 Eligible Advice Arrangements – Fee Leveling


DOL clarifies that the “fiduciary adviser” is the financial
institution and individuals representing the financial
institution who provide the advice.
Fees of affiliates may vary. This allows a firm to provide
advice about products marketed by its affiliates, even if
affiliate’s fees could change based on advice provided.
23
Pension Protection Act of 2006
Investment Advice
 FAB 2007-01
 Pre-PPA Advice Guidance – Interpretations under DOL
Advisory Opinions (SunAmerica and COUNTRY Bank)
are not affected. (PPA provides that existing
exemptions are not altered.)
 Plan Sponsor Shield – DOL explains that sponsor
duties and liability are the SAME when sponsor relies
on the new statutory exemption, or follows another
approach in engaging an adviser to plan participants.
24
Pension Protection Act of 2006
Investment Advice
 Outstanding Questions



May advisers provide “off-model” advice in
response to participant questions?
Models must consider ALL plan options; what
about employer stock?
DOL may issue a broader exemption for IRAs
if it concludes that computer models are not
feasible.

DOL RFP asked whether computer models are
feasible for IRAS.
25
Pension Protection Act
Undirected Balances
Undirected Account Balances: Background

ERISA § 404(c) relieves fiduciaries from liability for losses
that are a “direct and necessary” result of participants’
exercise of control.


Regulations require “affirmative” participant directions.
Plan fiduciaries must direct investments if participants do
not. “Undirected” participant account balances result –


in auto-enrollment plans, because participants are not
required to provide investment instructions to enroll, or
if participant account balances were allocated to a deleted
investment option (typical in plan conversions).
26
Pension Protection Act
Undirected Balances
 Current standard for undirected balances —
 Fiduciaries must invest undirected account balances
“prudently,” giving “appropriate consideration” to relevant
facts and acting accordingly. ERISA § 404.
 PPA extends ERISA § 404(c) protection to fiduciaries —
 if the plan provides for investing participant account
balances in “default investments” in the absence of
affirmative investment elections, and
 for a “qualified change in investment options” (i.e., mapping),
in accordance with DOL regulations.
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Pension Protection Act
Default Investments
 New ERISA § 404(c)(5) - a participant is treated as
exercising control over his or her plan account “in the
absence of a direction,” if the account is invested according
to DOL regulations.
 DOL required to issue regulations within 6 months on
appropriateness of designating default investments that
include a "mix of asset classes consistent with capital
preservation, long-term capital appreciation, or a blend of
both."
28
Pension Protection Act
Default Investments
 DOL proposed regulations defining a “qualified
default investment alternative” (“QDIA”).

71 Fed. Reg. 56806 (Sept. 27, 2006).
 3 types of QDIA: target retirement date accounts,
balanced accounts, managed accounts.

Each must be managed by an investment manager or
a registered investment company.
 Other conditions: initial and annual notice to
participants about default and right to provide
alternative instructions; participants must have right
to change options; plan offers “broad range” of
options.
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Pension Protection Act
Mapping Relief
 New ERISA § 404(c)(4) - participants are treated as
“exercising control” over their accounts in a “qualified
change in investment options” if participant provided prior
instructions.
 A “qualified change” is a reallocation of the participant’s
account among other plan options or new plan options, if —

replacement options (including their risk and return
characteristics) are “reasonably similar” to replaced options
previously elected by the participant.
 Notice to participants at least 30 days/not more than 60
days before change must compare options and inform
participants how their account will be invested if they don’t
object.
30
Pension Protection Act
Other DC Plan Relief
 New ERISA § 404(c)(1)(A)(ii) extends 404(c) relief
during “black-out” periods to fiduciaries who comply
with ERISA requirements in authorizing and
implementing a black-out.

Black-out period defined by ERISA § 101(i)(7).
31
Pension Protection Act
Employer Stock Provisions
 Diversification - DC plans must permit participants to
diversify allocations to employer securities and notify
participants at least 30 days before they become eligible
to diversify. (Treasury to provide model notice.)


Must be able to sell stock acquired by elective deferrals at
least quarterly.
Must be able to sell stock acquired with non-elective and
matching contributions after 3 years of vesting service.
(Transition rule for participants under age 55.)
32
Pension Protection Act
Benefit Statements
 Amendments to ERISA § 105(a) require —
 Quarterly statements for participant-directed DC plans.





Statements must include report of value of each investment,
explanation of right to change investment allocations and the
importance of a diversified portfolio, and notice about investing
information on DOL’s website.
Annual statements, if DC plan is not participant directed.
DB plans must provide statements every 3 years, or annual
notice of how to request a statement of benefits.
FAB 2006-03 provides interim guidance.
Pre-PPA — statements required only once per year, on
request.
33
Disclosure Regulation
 Background
 Litigation Trends
 Pending Regulation



Amendments to Service Exemption
Form 5500
Amendments to 404(c) Regulations
34
Disclosure Regulation - Background
Forms of Compensation
 Paid by the plan, e.g., typical fees for plan
administration, investment management, securities
transactions.

Some fees are invoiced; some costs reflect in
investment return (e.g., unitized funds may “hide”
expenses).
 Provider compensation from third parties, e.g.,
commissions, soft dollars, 12b-1 and other fees from
mutual funds, “non-cash” compensation.

Some third party payments are not “compensation” for
plan services.
35
Disclosure Regulation - Background
Plan
Investments (plan pays managements and
other fees)
Plan Service
Fees
Service Provider
Mutual
Fund
Commissions/Other Fees
•e.g., 12b-1 fees
•Paid by fund or agent
(trustee, recordkeeper or
broker/adviser)
36
Disclosure Regulation - Background
 Fiduciary Service Providers – If a payment is in
connection with a provider’s fiduciary act, Provider
cannot accept the payment; or must rebate the
payment against fees plan might otherwise pay).


E.g., 401(k) plan recordkeeper/investment provider
with fiduciary authority to select plan investment
options generally must rebate or offset fees received
from mutual funds.
 DOL Adv. Ops. 1997-15A (May 22, 1997) and 200510A (May 11, 2005).
Certain exemptions allow provider to pretain
commissions/management fees, e.g., PTE 75-1, 77-4,
84-24.
37
Disclosure Regulation - Background
 Non-Fiduciary Providers - A Provider may accept
payments from third parties, IF the payment is not
caused by a fiduciary act.

E.g., plan recordkeeper/investment provider who
merely offers a "platform" of investments from which
plan sponsor choose, are not plan fiduciaries and may
retain frees from mutual funds.


See DOL Adv. Ops. 2003-09A (Aug. 25, 2005) and 199716A (May 22, 1997)
The opinions recognize that offering a typical 401(k)
investment platform doesn’t make a recordkeeper a
fiduciary.
38
Disclosure – Litigation Trends
Haddock v. Nationwide Financial Services, Inc.

Civ. Action No. 3.01cv1552 (SRU) (D. Conn, February 24,
2006)
 Lawsuit by 401(k) plan sponsors filed in 2001 relates to
Nationwide’s receipt of fees from unaffiliated investment
companies (“funds”) offered as investment options under
variable annuity contracts.
 Under a typical service arrangement, each plan sponsor
choose a group of funds for its plan from those
Nationwide made available under its annuity contract.

Nationwide selected available funds based in part on
revenue sharing paid by funds.
39
Disclosure – Litigation Trends
Haddock v. Nationwide Financial Services, Inc. (con’t)
 Denying Nationwide’s motion for summary judgment,
court held –




Nationwide was a plan fiduciary because it retained
discretion to add/delete fund options.
Nationwide may have been a fiduciary in choosing funds
for its platform.
Revenue sharing payments from funds could constitute
“plan assets.”
Even if revenue sharing payments are not “plan assets,”
Nationwide’s receipt of revenue sharing could have
involved prohibited transactions.
40
Disclosure – Litigation Trends
 New class actions allege plan fiduciaries imprudently
allowed plan providers to receive “revenue-sharing”
payments. Plaintiffs allege plan fiduciaries –



caused plans to enter service arrangements under
which the plan and participants paid “unreasonable
fees” and “hidden and excessive fees,”
did not understand/recognize revenue sharing
arrangements, and
did not disclose to participants in “proper detail and
clarity” the transactions, fees and expenses

E.g., Loomis v. Exelon Corp., Case No. 1:06-cv-04900
(filed Sept. 11, 2006 N.D. III). NOTE: Court dismissed
claims for investment issues; claims for excessive fees
may proceed. (N.D. Ill. Feb. 21, 2007).
41
Disclosure –Litigation Trends
 Latest class actions include claims against providers as well as
plan sponsor fiduciaries. Complaints allege:
 Directed trustee/investment provider is a fiduciary based on
its trustee status, investment manager status, and limits
placed on investments the plan may offer to participants
(primarily proprietary funds).
 Provider (and sponsor) are not disclosing actual plan
expenses to participants, including revenue sharing.
 Provider (and sponsor) allow participants to pay excessive
fees under the plan.
 All revenue sharing is “plan assets,” which should be
restored to participants.

E.g. Hecker v. Deere & Co., Fidelity Management Trust
Company, et al., Case No. 06-C-0719-S (filed Dec. 8, 2006, D.
Wisc.)
42
Litigation Trends
Retirement Product Disclosure – Settlement
Agreement

In a settlement with the New York State Attorney
General, ING agreed to pay restitution and implement
a standard format for retirement product disclosure.
 Settlement relates to ING 403(b) Retirement Program
endorsed by NY State Teachers’ Union. ING and
Union did not disclose to teachers expense
reimbursements that ING paid to Union.
 ING 403(b) Program competed with 403(b) products
offered to teachers by other providers.
 Orders available at
www.oag.state.ny.us/press/2006/Oct/oct10a_06.html
43
Litigation Trends
ING- NY Atty General Settlement Agreement
 “One-Page Disclosure”



States “all-in” investment cost, as a percentage of
account balance.
Chart shows how fees affect account balances over
time.
Informs investors that fund companies may pay ING to
be included as investment options, and that ING and
the funds are seeking to profit.
 Does not include separate disclosure of fee rates or
amount paid by funds to ING, individual fund fees, or
contract changes.
44
Disclosure Regulation
Services Exemption
DOL is developing a provider “incentive” to disclose, if
not a duty.
 Because a provider is a “party in interest,” its provision of
services to the plan requires an exemption.

As a party in interest, Provider would be liable for excise tax
(pension) or section 502(i) penalties (welfare) if the services
are not exempt.
 Current section 408(b)(2) regulations require —
 services are “necessary and appropriate,”
 the arrangement is “reasonable,” and
 no more than “reasonable compensation” is paid.
 See 29 CFR § 2550.408b-2.
45
Disclosure Regulation
Services Exemption
 DOL likely to make disclosure a condition of exemption.
 Likely to require disclosure of information sufficient to permit
plan fiduciary to consider whether –
 the plan pays reasonable fees for services,
 the service provider's total compensation (including
third party fees) is “reasonable,” and
 any conflicts of interest affect the service provider's
advice.
“This amendment will ensure plan fiduciaries are provided or have
access to information necessary to determine whether an
arrangement is reasonable…this regulation is needed to eliminate
the current uncertainty…”
46
Disclosure Regulations
Services Exemption
 Possible Disclosure Model - FAB 2002-03 addresses
disclosure of “float” income by service providers. To
avoid potential prohibited transactions, service
providers should disclose —



circumstances where float is earned,
when “float” period may begin and end, and
rate earned on float.
47
Disclosure Regulation – Form 5500
 Schedule C, filed by plan administrator, requires reporting
on service provider compensation paid by the plan.
 For years, Schedule C Instructions have required
reporting of “indirect” compensation, including “finder’s
fees” and other fees and commissions received in
connection with plan transactions.
 But, typically not reported …

2004 ERISA Advisory Council Report - Service provider
compensation paid indirectly by mutual fund revenue
sharing typically not reported.
48
Disclosure Regulation – Form 5500
 DOL has proposed changes to Schedule C, effective for
2008 plan year.

71 Fed. Reg. 41392, 41616 (July 21, 2006).
 Schedule C changes expected to “clarify” reporting
requirements and ensure plan officials obtain
information necessary to review reasonableness of
compensation, taking into account “revenue sharing or
other financial relationships” and potential conflicts of
interest that might affect services.
49
Disclosure Regulation – Form 5500
 Proposed Schedule C changes would —
 Require reporting of “indirect compensation” received by
most service providers.



“Indirect compensation” would include all amounts paid in
connection with plan services, or the recipient’s position
with the plan.
Require some third party payments to be reported on an
unallocated basis.
Require “float” to be reported in dollars.
50
Disclosure to Participants
 Current Participant Disclosure Requirements

Summary plan description (SPD) – Must describe
circumstances that could result in a fee or charge
imposed on the participant’s account.
 See 29 CFR § 2520.102-3(l).

ERISA section 404(c) regulations


Automatically, transaction fees/expenses that affect
the value of the participant’s account
On request, annual operating expenses of
investment options (as a percent of net assets) and
performance net of expenses
 See 29 CFR §§ 2550.404c-1(b)(2)(i)(B)(1) and (2).
51
Disclosure to Plan Participants
 DOL is considering changes to regulations for
participant-directed plans under section 404(c).
 DOL says that rulemaking is needed –
“to ensure that the plan participants…are
provided the information they need, including
information about fees and expenses, to make
informed investment decisions . . .”
52
Disclosure to Plan Participants
 DOL review of 5500 filings revealed that only 50% of
participant-directed plans are identified as "404(c) plans.“
DOL may be considering —




Applying the same disclosure requirements to all
participant directed account plans, whether or not the plan
is a 404(c) plan (requires finding a disclosure duty).
Both automatic and on-request disclosure requirements.
A role for electronic information in new disclosure regime.
DOL Request for Information
53
Disclosure to Plan Participants
 Possible changes based on 2004 ERISA Advisory
Council Recommendations

Deliver a “profile prospectus” (or equivalent) for each plan
investment option.

Require investment education for participants.

Include investment expense information on annual
statements provided to participants.

DOL should provide a sample model participant disclosure
format.
54