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EMPLOYEE BENEFITS
Recent Developments
January 19, 2007
Curtis L. Harrington
Harrington & Harrington
(562) 594-9784
[email protected]
http://www.patentax.com
Disclaimer: Educational Only
 This Power Point Presentation is Educational Only
and no part of this presentation can be considered as
federal or state tax advice, opinion, or position and is
not intended or written to be used, and may not be
used, for the purpose of (i) avoiding tax-related
penalties under the internal revenue Code or (ii)
promoting, marketing or recommending to another
party any tax-related matters addressed herein, nor
(iii) constituting guidance on any tax or intellectual
property matter.
Pension Protection Act, (PPA) (2006)
Defined Contribution Grading: 3 to 7 year vesting
is replaced by graded 2 to 6 year vesting
Defined Contribution Cliff Vesting 5 years instead
of 3
Qualified Optional Survivor Annuity – which is
some percentage of the joint annuity which would
have otherwise been elected.
PPA-2006 Enhanced PLAN Reporting
 certification that the adjusted funding target attainment
percentage of the plan is not less than 100 percent
 certification relating to requests extending amortization periods
 within the 90th day of each plan year, the plan actuary must
certify to the Secretary of the Treasury and to the plan sponsor
whether or not the plan is in endangered or in critical status
(failure to certify can result in an ERISA penalty of $1,100 per
day)
 Funding Improvements: After the adoption of a funding
improvement plan, it may not be amended to increase benefits
unless the plan actuary certifies that the benefit increase is
consistent with the funding improvement plan
 the construction of a separate mortality table upon request of the
plan sponsor by the actuary based on a plans own experience
CASE LAW DEVELOPMENTS
Short Review of Pre-emption
Suspension of Benefits
Enforcement of Subrogation Rights
Fiduciary Responsibility
Standing Under ERISA
Discretion in Carrying out Settlor Function
Anti-Alienation under ERISA
Various Cases of second half of 2006 Illustrating
problems
Review of Pre-emption
 ERISA’s Preemption Clause preempts state
law which “relates” to employee benefit
plans". (A very loose standard)
 ERISA’s “Saving Clause” omits from
preemption those state laws which are
directly related to insurance.
 The dividing line between these two
characterizations is a rich battleground
Pension vs. Health & Safety
 Recall that ERISA governs both plans which
are “pension like” and which are “health
and safety-like”
 Pension-Like provisions in which rights arer
vested are held to an inviolate standard.
 Health-Like plans can be changed at the
whim of the employer every day or every
week. There is generally no vested right
here
Pre-emption wall
 In addition, pre-emption, regardless of
whether the plan provision is pension-like or
not, builds a wall in which legal action is
severely restricted:
 against the plan by beneficiaries
 against the plan by the states
 by the plan against others
SUSPENSION OF BENEFITS
Heinz v. Central Laborers’ Pension Fund 303
F.3d 802 (7th Cir. Sept. 13, 2002), aff’d, 124
S. Ct. 2230 (June 7, 2004)
 Anti-Cutback Rule
 General rule established under
Heinz: conditions imposed after a
benefit has accrued make the
“accrued benefit less valuable”
whether or not an actual benefit
suspension occurs
Swede v. Rochester Carpenters Pension Fund Cir. Ct. App. Oct 20,
2006, Case Number: 06-0112
 Court instruction to IRS not to revisit
the tax-exempt status in past years of
plans that were amended in reliance
on” other rules and procedures,
cannot be used by a Defendant to
resist applying the Heinz holding
between the non-permitted plan
amendment and the date of the
Heinz holding .
Revenue Procedure 2005-23
General Rule: A plan which adopts a “reforming
amendment” and complies operationally with that
amendment may obtain relief from the retroactive
application of Heinz prior to its June 7, 2004 issuance
 Reforming Amendment must contain the following provisions:
 The original (more restrictive) amendment may not apply to
benefits that have already accrued
 Payment of retroactive benefits to an affected plan
participant must include any appropriate interest or
actuarial increase for benefits that have accrued as of the
applicable amendment date
 The applicable amendment date is the later of the original
amendment’s effective date, or the date of its adoption
Revenue Procedure 2005-76
Plan must provide for the payment of
retroactive benefits, and must be in
operational compliance with the reforming
amendment no later than January 1, 2007
Under the Swede case rationale, any
conforming amendments and actions
should place the employee in at least as
good a position as it would have been if
no cutback had occurred.
SUBROGATION RIGHTS
Insurance Accident Plans typically include a
provision which gives them a claim to any
monies recovered from the accident victim
from others (typically the person who
caused the accident)
The insurance plan typically enforces its
rights against its own insured who obtain
the double coverage. Without a
subrogation provision, the accident victim
would get a double recovery (which may
be permitted in the victim’s jurisdiction.
History
Great-West Life & Annuity Ins. Co. v. Knudson (2002) 534
US 204 (Jan. 8, 2002):
 ERISA Section 502 does not provide a plan with
method of enforcing the plan’s subrogation provisions
against participants or beneficiaries
 Where participant obtained personal injury recovery
against third party tortfeasor, Plan was not able to
obtain reimbursement
 Comment:: it may be beneficial to consider the use of
an insurance company contractor and to compute the
value of subrogation ability against the increased cost of
using a contractor
Sereboff v. Mid Atlantic Medical Services, Inc.
(2006, S.Ct.) 2006 WL 310754
 The Supreme Court unanimously affirmed the Fourth Circuit’s
decision that a group health plan’s claim against a plan
beneficiary’s third-party recovery fund for the reimbursement
of advanced payment of medical benefits was one for “other
appropriate relief” allowed by ERISA
 MAMSI’s action was brought to enforce the “Acts of Third
Parties” provision, which thus qualified it as an equitable
remedy
 Comment: Here we see something other than subrogation, but
the enforcement of a “trust like” duty on a third party fund.
FIDUCIARY RESPONSIBILITY
Termination or Modification of Benefits
General Rule for Notice of
Termination / Alteration of Benefits:
Except for group health plans, ERISA contains no
specific requirement for notifying welfare benefit plan
participants and beneficiaries of the termination of their
plan.
Comment: Remember that ERISA has an inviolate
standard for plans relating to pension & retirement, but
for “health & welfare plans” the employee has a much
higher vested ownership expectation threshold and
without a specific requirement in ERISA, there is no
such per se requirement.
Peralta v. Hispanic Business, Inc., 419
F.3d 1064 (9th Cir. Aug. 18, 2005)
 Court held that the plan sponsor has a fiduciary duty to notify
beneficiaries and participants promptly of the termination of
coverage
 Although the 210 day notice requirement under ERISA Section
104(b)(1) was satisfied; the court found that the plan fiduciary had
an even more basic duty to provide timely notice of a plan
termination under ERISA Section 404(a)(1)
 However, ERISA does not provide the plaintiff with a remedy
Comment: again, the omission inures to the benefit of the plan by a
holding that a fiduciary duty was breached. Note that this is a
Health-like plan and not a pension-like plan. Protections in
health-like plans are typically reached by fiduciary duty.
Fiduciary Duties
Prudent Person Standard
 Securities and Exchange Commission v. Capital Consultants,
LLC, 397 F.3d 733 (9th Cir. Feb. 2, 2005)
 A receiver in charge of distributing assets from a litigation
recovery, was not in violation of ERISA for enforcing an
offset provision which required a 50 percent offset against
recoveries from third parties, even though receiver was an
ERISA fiduciary
 ERISA’s fiduciary duty provisions do not prohibit such
offsets and the receiver was not otherwise legally
obligated under ERISA to favor ERISA plans over nonERISA plans. A fiduciary is a “rights balancer” and not an
unbridled advocate for the plan.
Standing Under ERISA Section 502(a)(2)
 Massachusetts Mutual Life Insurance Co v. Doris Russell,
473 US 134 (1985, S. Ct.): Actions for breach of fiduciary duty
under ERISA Section 502(a)(2) must be brought in a
representative capacity on behalf of the plan as a whole,
and not for the benefit of individual participants
 Barker v. American Mobil Power Corp, (1995, CA9) 64 F.3d 1397:
Remedies for alleged fiduciary breach must inure to the
benefit of the plan (rather than individual participants), or
to all plan participants
 Comment: Again note the similarity to the corporate
shareholder’s derivative actions.
Milofsky v. American Airlines, 2005, CA5) 404 F.3d 338,
vacd & remd (2006, CA5) 2006 WL 488622
 401(k) plan participants lacked standing to bring
an ERISA Section 502(a)(2) breach of duty claim on
behalf of the plan because they were seeking only
individualized relief
 Vacated and remanded on March 2, 2006,
(Milofsky v. American Airlines, 2006 WL 488622, vacg &
remg (2005, CA5) 404 F.3d 338)
 Comment: Again, the analogy to the approach for
Section 502 standing is to that of shareholder
derivative suits.
Exercising Discretion in Carrying
Out Settlor Functions
Beck v. PACE International Union, 2005 U.S. App. LEXIS 23190 (9th
:
The sponsor of a single employer plan breached its
fiduciary duties when, rather than investigating whether it
should merge its pension plan with a multiemployer pension
fund, the employer decided without much analysis to
annuitize the plan so as to terminate it
Cir. 2005)
Comment: Similar to the “duty to bargain” even where a plant is
closing, there is a “duty to try and save a pension plan in
trouble” rather than terminating it (when it is sick).
Anti-Alienation under ERISA
United States v. Novak, 9th Circuit, No. 04-55838 (March 23,
2006), the Ninth Circuit Court of Appeals held that the
government could garnish vested pension benefits under a
restitution order despite the anti-alienation provision of ERISA
Comment: This case might be viewed as enabling federal invasion
of pension plans, but the facts were so terrible that it is unclear
as to how it will be viewed if the facts were not so severe. The
employee garnished had a long history of continuing THEFT of
his employer’s telephone board equipment ($millions) sold in
interstate commerce, and the convicted employee was subject to
federal restitution order of over $1 million (even though the
pension was only about $147,000).
Miscellaneous Recent Cases
 Paul Bard V. Boston Shipping Association; International
Longshoremen's Association Pension Plan (1stt Cir.Ct. App. Dec
19, 2006) No. 06-1810. The plan is liable where its employee
was prejudiced by plan numerous regulatory violations
(summary plan description not updated since 1988; The resoning
for denial of benefits was withheld during a battery of appeals;
Plan terms are disregarded because employee was so
prejudiced)
 COMMENT: Will the increase in reporting and notification
provisions of under Pension Protection Act 2006 will put plans
at further risk without an increased level of vigilance? YES
Miscellaneous Recent Cases
 Richard Coleman et al, v. PBGC. (DC Columbia, Dec.
5, 2006) No. 055496. Agreement to remove improper
terms from a plan is effective if the removed provision
is honored, and proper memorialization of the proper
change will not form the basis of a challenge under
the “operational compliance requirement.” of Treas.
Reg. 1.411(d)-4, Q&A 8(c). COMMENT: The
Retirement Equity Act of 1984 (“REA”), Pub. L. No.
98-397, 98 Stat. 1426 (26 U.S.C. and 29 U.S.C.)
prohibits discretionary benefit provisions in pension
plans, and both employers and employees should
rigorously test plan provisions to this standard.
Miscellaneous Recent Cases
 Hutchison v. Fifth Third Bancorp (6th Cir. Ct. App, Nov.
30, 2006) No: 05-4389. Contractual sweetheart
promises in an agreement between merging
corporations to provide a company's pre-merger
employee benefit (ESOP) plan (a third party?) additional
money availability to ESOP plan members was held to
be pre-empted, even where plan participants
benefitting under the offer were induced to vote their
shares in favor of the merger. COMMENT: If the
conditions and contract had been drawn between the
Plan (trustees) and the merging company, this case
might have had a different outcome. The plan was not
a party to the agreement, and was not lied to.
Miscellaneous Recent Cases
 Tocker v. Philip Morris Co. (2nd Cir. Ct. App, Nov 22, 2006)
No.: 04-5904. Making an Exceptions to plan provisions even for
the generous benefit of an employee can trigger extreme liability.
Employee seemingly diagnosed with a terminal illness is granted
an extraordinary retirement benefit, including a lump sum and
long term disability simultaneously (not available to other
employees under the plan). The employee brought suit for
inclusion of the 10-12 years of employment time corresponding
to his long term disability period. It was held that the head of
the plan may have breached his fiduciary duty by not informing
the employee (whom no one expected to survive more than 2
years) of the effect on his retirement of the job termination in the
“special package”. COMMENT: Any “special deal” in lieu of a
“regular plan provision” should be examined with the same
scrutiny as you would apply to a new plan.
Miscellaneous Recent Cases
 Northcutt v. General Motors Hourly-Rate Employees Pension
Plan (7th Cir. Ct. App, Nov 22, 2006, No: 05-4484. Contractual
self-help (setoffs) are available to enforce plan provisions for
Social Security reimbursement. The use of the Social Security
basic retirement & disability base in pension computations to
reduce employer contributions for the amounts attributable to
Social Security extends to contractual “self help” deductions,
even where employees receive a lump-sum from the government
and thereafter squander it. COMMENT: Although the Plan
clearly wins under the broad public policy of “building onto”
Social Security as a deductible base (a permitted disparity in
plan discrimination testing), it would be helpful if Plans included
this provision along with a waiver, especially at the time that
lump sum payments are made.
Miscellaneous Recent Cases
 Hooven v. Exxon Mobil Corp. (3rd Cir. Ct. App. Oct 20,
2006) Case Number: 04-3773. In a time consuming
merger where things develop slowly, an omission in the
Summary Plan Description are not fatal where
continued employment with the merged companies, or
the divested division (owned by purchasing company)
continues throughout the period. COMMENT:
Employees should watch the transformaiton of the plan
like a hawk, as continuing to work after amendments
will likely constitute waiver. In the alternative, the SPD
is often considered a small matter unless it has a big
effect, and here the SPD “omission” wasn’t big.
Miscellaneous Recent Cases
 Miller v. Xerox Corp. Retirement Income Guarantee Plan (9th
Cir. Ct. App, Sep13, 2006) No: 04-55582. Use of “creative”
phantom accounts to adjust the retirement of employees
returning from retirement will be stricken. This was one of the
problems with the Cooper v. IBM Personal Pension Plan 243 F
Supp. 2d 1010 (S.D. Ill. 2003) cash balance conversion case.
Taking a deduction based upon prior lump sum retirement
payment PLUS time accrual in the employment break period is
forbidden. COMMENT: An actuary should be utilized to reintegrate a return to service, with a computed valuation and
which is agreed upon and assented to by both the employee and
the employer PRIOR to re-hire; real actuarial accounting will
always be favored over phony phantom accounts.
CIRCULAR 230
Impact on Benefits Practitioners?
 Circular 230 governs practice before the IRS of
Attorneys, CPA’s and Enrolled Agents.
 Section 10.35 of Circular 230 (introduced in 2005)
defines “Covered Opinions” as written advice by a
Circular 230 practitioner relating to any transaction
that the IRS considers to be a “tax avoidance”
transaction published under 26 CFR 1.6011-4(b)(2).
 Practice before the IRS goes beyond dealings which
occur directly with the IRS
Why did the IRS focus on this Document?
 Tax Opinions can be used to shield a taxpayer
against the imposition of penalties. This mechanism
is covered elsewhere in the Internal Revenue Code,
and has traditionally been used to protect good faith
taxpayers who choose a path of action based upon
assurances by a tax practitioner as to the propriety or
outcome of the action.
 By placing a control in the document which governs
the actions of tax practitioners, the IRS has chosen
not to eliminate the benefit to taxpayers from
obtaining a prophylactic opinion or advice, but
instead to place the burden on the tax practitioner.
Covered Opinion Standards
When giving covered opinions, practitioners must (among other
things)
 Use reasonable efforts to identify and ascertain the facts
(Independent Efforts, rather than reliance on the client)
 Not base the opinion on unreasonable facts
 Relate the law to the facts
 Not base the opinion on unreasonable assumptions
 Provide his or her conclusion as to the likelihood that the
taxpayer will prevail on the merits with respect to each
significant federal tax issued considered in the opinion
Practical Effect
 Turns every comment into a potential COVERED OPINION
 Turns every small opinion tangential to a tax transaction which
might be required to have a “COVERED OPINION” into a
“COVERED OPINION”
 Turns an INTENDED task to produce a “COVERED OPINION”
into a MAJOR PROJECT having a cost and depth equivalent to a
MAJOR RESEARCH PROJECT not unlike the size of a dictionary
 Exponentially raises the cost to the client for providing an
opinion from a few thousand dollars to the cost for producing a
“MAJOR PROJECT”
 Most Practitioners have simply stopped preparing opinions
Minimum “Employment” Listed
Transactions from IRS Website
 401(k) Accelerated Deductions
 S Corporation ESOP Abuse of Delayed Effective Date for Section
409(p)
 Collectively Bargained Welfare Benefit Funds under Section
419A(f)(5)
 Certain Trust Arrangements Seeking to Qualify for Exemption
from Section 419
 Abusive Roth IRA Transactions
 S Corporation ESOP Abuses: Certain Business Structures Held to
Violate Code Section 409(p)
 Deductions for Excess Life Insurance in a Section 412(i) or Other
Defined Benefit Plan
Imposition of sanctions and
monetary penalties
 Sanctions for violations of Circular 230
include Suspension, disbarment in their
representation of taxpayers before IRS and
censure
 Monetary penalties may also be imposed in
addition to other disciplinary action and may
equal the gross income derived from the
conduct giving rise to the penalty
Covered Opinion Standards
When giving covered opinions, practitioners must (among other
things)
 Use reasonable efforts to identify and ascertain the facts
(Independent Efforts, rather than reliance on the client)
 Not base the opinion on unreasonable facts
 Relate the law to the facts
 Not base the opinion on unreasonable assumptions
 Provide his or her conclusion as to the likelihood that the
taxpayer will prevail on the merits with respect to each
significant federal tax issued considered in the opinion
Covered Opinion Effect
 The issuance of an Opinion might violate the standard and subject you to
discipline from the IRS Office of Discipline
 A Tax Court, U.S. District Court or other court’s holding that the standards
were not met could result in an ethical violation and disbarment.
 A holding that the Standard was not met might also allow your efforts to be
colored as being in collusion with the client to perpetrate a fraud on the
government and subject the practitioner to liability as a co-conspirator in a
fraudulent tax scheme.
 Any covered opinion would have to be considered as a large information
gathering and investigation project to insure that the standards are met and
exceeded.
Effect on Retirement Plans
 Enrolled Actuaries cannot rely as much upon
client/employer provided data in computing benefits
for plan participants. Additional Investigation will
be required.
 Combined effect of Circular 230 with the additional
duties under PPA 2006 will place an even greater
burden on Enrolled actuaries, especially as to the
depth to which investigations relating to their
expanded duties must be performed, including target
attainment percentage and endangered or in critical
status.
Effect on Plan Service Providers
 Enrolled Actuaries, Tax Attorneys, and Accounts will be less able to rely upon
the data provided from the client and will be statistically forced to have
greater personal oversight and inspection of company records and books
when signing documents relating either to PBGC Form 1 or Form 5500 and
associated documents. Because boilerplate disclaimer language cannot be
incorporated into the form signatures, the only choice is due diligence,
resulting in a rise in client costs.
 Previous isolated systems, wherein the client provided data to an accounting
service who provided summaries to various practitioners in turn, will either be
duplicated by practitioners doing the same job twice, or else will undergo a
shift of services to the practitioners, at least in part.
 The combination of the above will tend to favor more vertically integrated
practitioners who can bring the data investigation and treatment function inhouse.
Employer/Supervisor Penalties
 Moreover, a monetary penalty may also be assessed
against an employer if the employer, firm or entity
knew, or reasonably should have known, of the
conduct.
 Given the organizational nature of PLAN service firms,
additional levels of supervisors will be needed, as well as
increased internal controls to eliminate potential liability
imposed by Circular 230.
What legal advice may be covered?
Circular 230 covers written advice about:
 “listed transactions”
 any partnership or other entity, any investment plan or arrangement or
any other plan or arrangement the principal purpose of which is the
avoidance or evasion of any federal tax
 any partnership or other entity, any investment plan or arrangement or
any other plan or arrangement, a significant purpose of which is the
avoidance or evasion of any federal tax, if such significant purpose
advice is one of the following:
 A “reliance” opinion
 A “marketed” opinion
 Condition of confidentiality, or
 Contractual protections
“Tax Avoidance” Defined
 “Tax avoidance” is not something that is
wrong or unlawful
 “[o]ne who avoids tax does not conceal or
misrepresent. He shapes events to reduce or
eliminate tax liability and, upon the
happening of the events, makes a complete
disclosure.” Internal Revenue Manual
9.1.3.3.2.1 (7/29/98)
Qualified Plan Issues Exception
 “Covered Opinions” do not include advice that
concerns the qualification of a qualified plan
 Except for advice regarding a listed transaction or
where the “principal purpose” of the plan or
arrangement is the avoidance or evasion of taxation
 “Concerns the qualification” must be interpreted
very narrowly
Covered Advice Could Also Include:
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Section 79 “early distribution” tax
Sections 105 and 106 health benefits
402 distributions, rollovers, direct transfers
404 deductions
409A nonqualified deferred compensation plans
412 minimum funding
403(b) plans
457 plans
Stock options
Mergers and acquisitions
Golden parachutes
Taxation to alternate payees
Pension Potential Gray Areas Include:
 Qualified plan and trust documents
 Merger and Acquisition Agreements
 Cover letters transmitting documents
 Situations where a plan turns out to be not qualified
 SPD and SMM
 402(f) Notices
 204(h) Notices
Enrolled Actuaries Are Uncertain
 The Enrolled Actuaries Society have been pressing the
IRS for answers to specific questions about the new
Circular 230 Rules because of the Continued
uncertainty in its application:
 Confirmation as to whether establishment or maintenance
of a qualified retirement plan is a transaction, “the principal
purpose of which is the avoidance or evasion of any tax
imposed by the Internal Revenue Code (IRC).”
 Whether making calculations and measurements based on
an understanding of the law is tantamount to giving an
opinion of the law.
Enrolled Actuaries Are Uncertain (Contd)
 Whether communicating, in writing, the results of actuarial
computations — constitutes the rendering of a covered
opinion.
 The meaning, scope and breadth of the exception in
Circular 230 enabling enrolled actuaries regarding the
establishment of the qualification of a qualified plan.
 Guidance on clarification of the provisions of Section 10.33
outlining “best practices.” (This would seem to point out a
“financial engineering” conflict between the plan
beneficiaries who seek maximum funding to maximally
insure an abundant supply of retirement funds versus the
plan sponsors who are seeking to satisfy minimum funding
in order to satisfy the rules and reduce costs.)
How Does This Affect
Anyone Dealing with Tax?
 Just about any letter sent to a client which
is involved in Business Planning could be
held to have a tax effect. (Recall that
Attorney Client privilege is for “legal
advice” rather than business advice and
that “work product” deals with
communications in anticipation of
litigation
Potential Circular 230 Opinions
 Just about any letter sent to a client with tax advice or
planning with a tax effect?
 A short e-mail with tax or business advice (either yours
or another’s) which could affect the tax treatment?
 Sent a client a memorandum with a small tax advice
component?
 Responded to a client’s simple question?
DISCLAIMER LEGENDS
Popular way in which practitioners are avoiding
Circular 230 requirements is to include a legend
which states that the written advice is not to be used
to avoid penalties
Every accounting firm and almost every legal practice
has added these legends to their written client
communications
Here’s My Legend
 Circular 230: Pursuant to the June 2005 US Treasury Department
Regulations, I am now required to advise you that, unless
otherwise expressly indicated, any federal tax advice contained
in this communication, including attachments and enclosures, is
not intended or written to be used, and may not be used, for the
purpose of (i) avoiding tax-related penalties under the internal
revenue Code or (ii) promoting, marketing or recommending to
another party any tax-related matters addressed herein. This
communication may contain material protected under attorneyclient privilege and/or work product doctrine. If you are not the
intended recipient, please contact the sender at
[email protected] or by telephone at (562) 594-9784, and
destroy the original transmission and its attachments without
reading them or saving them to disk. Thank you.
Will the legend Solve the Problem?
 NO, it will not cover comments on a listed
transaction!
 Because a legend won’t protect a communication
which is directly contrary to the prohibited action, a
legend only works if the advice is NOT regarding:
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A listed transaction
A principal purpose (tax avoidance) transaction
A transaction with confidentiality
A transaction with contractual protection
And if the goal is to avoid a marketed opinion the legend
must be much more detailed
Legend Requirements
 Prominently disclosed
 “Readily apparent” to the reader
 Not a footnote
 Separate section
 Same size typeface as analysis of facts and law
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