May 2011
The following highlights the most significant New Developments published in the Pension Plan Guide since the last update on April 29, 2011.
During the past month, the United States Supreme Court has clarified the relief that is available under ERISA to plan participants following a plan administrator’s failure to comply with the notice requirements incident to a cash balance plan conversion.
In the lower courts: the Seventh Circuit Court of Appeals has ruled that plan fiduciaries may have breached their fiduciary duties by failing to deliberate and make a documented reasonable decision regarding means of reducing the investment and transactional costs associated with a unitized company stock fund; and a federal court in Kentucky has held that the sponsor of 403(b) plans did not breach its fiduciary duty to properly implement participant investment instructions when it transferred participants' investments in stable value accounts into an asset allocation fund in order to comply with Labor Department regulations governing qualified default investment alternatives.
A CCH Comment addressed problematic issues inherent in securities lending in 401(k) plans. Securities lending refers to the increasingly common practice among 401(k) plan investment options pursuant to which a portion of the assets held in the option on behalf of plan participants are lent out for a period of time to a third party (typically a broker-dealer) that provides collateral to the securities lending agent until the borrowed securities are returned. The cash is reinvested in a collateral pool with the intent of generating greater returns for plan participants. 401(k) plan participants will share in any gain from cash collateral pool reinvestments. However, the participants, who may not be aware of securities lending within the investment option, will also fully bear any loss from the investment.
Finally, this Update features a caution advising service providers that are charged with filing Form 5330 to report corrective distributions, late contributions of employee contributions, prohibited transactions or other matters that they may need to obtain a preparer tax identification number (PTIN) in order to file Form 5330 after January 1, 2011.
NEW DEVELOPMENTS
1. U.S Supreme Court Vacates and Remands Holding Involving Improper Notification of Cash Balance Plan Conversion
ERISA Sec. 502(a)(1) (B) does not authorize the relief awarded by a district court for a plan administrator’s failure to comply with notice requirements concerning the conversion of defined benefit plan to a cash balance plan, the U.S. Supreme Court has ruled. However, the Court found that ERISA Sec. 502(a)(3), which permits “appropriate equitable relief” for violations of ERISA, authorizes forms of relief similar to those provided by the district court. The High Court vacated the judgment and remanded the case for further proceedings.
Employees challenged the adoption of the new plan, claiming that the notice of the plan changes was improper, particularly since the new plan in certain respects provided them with less generous benefits. The federal district court found that the disclosures violated ERISA Secs. 102(a), 104(b), and 204(h) and the notice defects had caused the employees "likely harm." The court reformed the new plan and ordered the employer to pay benefits accordingly, finding its authority in ERISA Sec. 502(a)(1)(B). The Second Circuit affirmed.
The Supreme Court vacated and remanded the decision, holding that, although ERISA Sec. 502(a)(1)(B) does not give the district court the authority to reform the plan, relief is authorized by ERISA Sec. 502(a)(3), which allows a party "to obtain other appropriate equitable relief" to redress violations of ERISA or plan terms. The Court ordered the terms of the plan reformed and directed the employer to enforce the plan as reformed. Because ERISA Sec. 502(a)(3) authorizes "appropriate equitable relief" for violations of ERISA, the relevant standard of harm will depend on the equitable theory by which the district court provides relief, which it will do on remand. There are several equitable principles that it might apply on remand, such as "estoppel" or "surcharge." To obtain relief by surcharge for violations of ERISA Sec. 102(a) and 104(b) the Court held, a plan participant or beneficiary must show that the violation caused injury, but need show only actual harm and causation, not detrimental reliance.
Cigna Corp. v. Amara (U.S. Sup. Ct.) was reported in PEN Report 1889 (May 23, 2011) and reproduced in PEN Report 1890 (May 31, 2011) at Par. 24,009E.
2. Fiduciaries Required to Document Prudence of Retaining Unitized Stock Fund
Plan fiduciaries may have breached their fiduciary duties by failing to deliberate and make a documented reasonable decision regarding means of reducing investment and transactional costs associated with a unitized company stock fund, according to the U.S. Court of Appeals in Chicago (CA-7).
Company stock funds under 401(k) plan. A company maintained a 401(k) plan, pursuant to which participants were allowed to direct individual contributions to designated mutual funds. Two of the funds were company stock funds (CSFs) which invested exclusively in the common stock of the company and its parent company. The plan also offered various multi-stock funds.
Unitized stock fund. The participants’' claim with respect to fiduciary mismanagement of the company stock funds was based on the structure of the CSFs as unitized stock funds. Under the unitized funds, participants owned units of the fund, rather than shares of the company stock. The CSFs invested almost exclusively in the company's common stock but also contained a small amount (5 percent of the overall value of the fund) of cash or similar highly liquid investments (i.e., cash buffers). Thus, the value of the CSF funds unit was determined by the value of the stock as well as by the value of the fund's cash buffer.
The cash buffer in the funds provided an effective hedge against declines in the value of company stock. However, the participants claimed that the unitized structure of the CSFs caused "investment drag" and "transactional drag" that decreased the return on the investments. Investment drag is a consequence of the cash buffer. Because the return on the cash component of the CSF is lower than the return of the stock component, having cash in the funds when the stock appreciates results in lower returns than could have been expected if the cash portion of the fund had been used to buy more stock.
Transactional drag refers to the transaction costs incurred by a fund in connection with participant transactions (i.e., requests to buy and sell funds). Such costs include brokerage commissions, SEC fees, and other expenses associated with a trade.
Unitized funds allow administrators to net requests to buy and sell against each other in order to minimize transaction costs. However, when transaction costs are incurred they are deducted from the overall value of the fund, rather than allocated to the specific participant who initiated the transaction. Thus, because each participant bears a pro rata share of the fund's total transaction costs (regardless of the number of transactions actually initiated by the participant), infrequent traders effectively subsidize the activities of frequent traders. This incentive to frequent trading also results in higher transaction costs for the fund.
Plan participants claimed that the investment and transactional drags associated with the unitized structure of the CSFs caused investments in the CSFs to underperform direct investments in company stock by $83.7 million between 2000 and 2007. Accordingly, participants charged that the fiduciaries breached their duties under ERISA by failing to minimize or eliminate the investment drag and the transactional drag, either by removing the cash buffer, limiting the frequency of trades, or other measures.
The trial court determined that the plan fiduciary had weighed the costs and benefits of implementing proposed solutions to the problems caused by the investment and transactional drags, but reasonably concluded that the cost of making changes to the CSFs outweighed the benefits. However, the appeals court could find no evidence in the record (e.g., documents, affidavits, deposition testimony) indicating that plan fiduciaries ever engaged in a review and made an actual determination of whether the costs of implementing proposed changes to the CSFs exceeded the benefits of reducing investment and transactional drag.
The failure to balance relevant factors and make a reasonable decision under circumstances in which a prudent fiduciary would do so, the court explained, can be a breach of the prudent man standard of care. Thus, the trial court's summary judgment order on the issue was reversed. However, the determination of whether the fiduciaries actually acted imprudently in failing to make a reasonable decision with respect to modifying and retaining the unitized structure of the CSFs would need to be resolved on remand.
George v. Kraft Foods Global, Inc. (CA-7) was reported in PEN Report 1889 (May 23, 2011) at Par. 24,009C.
3, Unilateral Transfer of Participant Assets from Stable Value to Asset Allocation Fund Complied With Plan Terms and QDIA Regulations
The sponsor of 403(b) plans did not breach its fiduciary duty to properly implement participant investment instructions when it transferred participants' investments in stable value accounts into an asset allocation fund, in order to comply with Labor Department regulations governing qualified default investment alternatives, a federal court in Kentucky has ruled.
The employer argued that the governing DOL rules empower a plan administrator with discretionary authority to transfer a participant's funds among investment options if the participant has failed to provide specific investment instructions. In addition, the employer maintained that it complied with notice procedures that were reasonably calculated to apprise the participant of changes to the plan's investment policies.
The participants charged, however, the employer's decision to transfer the participants' investment funds from the stable value funds directly contradicted the plans' summary plan descriptions. The participants' argument was based on ERISA Sec. 404(a)(1)(4), which requires a fiduciary to act in accordance with the documents and instruments governing the plan insofar are as they are consistent with ERISA.
Initially, the court noted that, under the safe harbor QDIA rules of ERISA Reg. 2550.404c-5(b)(1), the fiduciary of an individual account plan that allows for participant direction of investments will not be liable for losses that are the direct and necessary result of the investment of all or part of a participant's account in a qualified default investment alternative. In order for the safe harbor to apply (and the participant to be deemed to have exercised control over account assets) the participant must have: been provided with notice about the QDIA; been allowed the opportunity to alter the investment allocation from the QDIA to another investment alternative; and failed to have acted on the opportunity to direct the investment of assets in those accounts. The court concluded that the employer complied with the requirements of the safe harbor.
The court further rejected the argument that the plan administrator violated the terms of the plans' SPDs, which stated that a participant's affirmative election controlled until a new election was made. The SPDs were subordinate to the plans, which apprised participants that the failure to make an investment election could result in the transfer of accounts to the QDIA.
Bidwell v. University Medical Center, (DC KY) was reported in PEN Report 1887 (May 9, 2011) at Par. 24,008Z.
4. Securities Lending in 401(k) Plans Poses Risks to Plan Participants
401(k) plan investment options (e.g., money market funds, stable value funds, and equity funds (mutual funds and collective investment funds)) increasingly engage in securities lending, pursuant to which some of the assets held in the option on behalf of plan participants are lent out for a period of time to a third party (typically a broker-dealer) that provides collateral to the securities lending agent until the borrowed securities are returned. The cash is reinvested in a collateral pool with the intent of generating greater returns for plan participants. 401(k) plan participants will share in any gain from cash collateral pool reinvestments. However, the participants, who may not be aware of securities lending within the investment option, will also fully bear any loss from the investment.
The Senate Special Committee on Aging recently held hearings examining multiple issues, such as withdrawal restrictions and lack of adequate disclosure, relating to securities lending with cash collateral reinvestment in retirement plans. The following discussion details the structure of securities lending arrangement and highlights the main issues of concern.
Withdrawal restrictions. 401(k) plan sponsors have complained of restrictions inhibiting the withdrawal of plan assets from investment options that lend securities in exchange for cash collateral. Under such restrictions, plan sponsors may be allowed to: take only in-kind (rather than cash) distributions; withdraw amounts over stages (reducing the loan over a period of time); or withdraw a maximum percentage of between 2 and 4 percent per month of the value of its interest in the fund.
Service providers typically place restrictions on employer withdrawals during economic downturns where the cash collateral pool has been invested in assets that have lost value and have become difficult to trade, resulting in losses. As a consequence of the losses, the pool may not match the amount that the investment option needs to return the cash collateral and pay rebates (see below) to borrowers, thus, triggering the withdrawal restrictions.
Even when economic conditions allow restrictions to be relaxed, however, withdrawals may continue to be conditioned on liquidity sufficient to allow the withdrawals to be processed entirely in cash. Such restrictions are designed to prevent "runs" on collateral pools in which certain clients exhaust all the available liquidity, leaving other clients with effectively depleted assets.
Employers subject to withdrawal restrictions may have difficulty in meeting their fiduciary responsibility to change investment options when dictated by prudence. Thus, while withdrawal restrictions generally do not apply to individual participants, the restrictions could adversely affect their holdings.
Participants bear risk of loss. Plan participants bear the ultimate risk of loss from the cash collateral pool investments in securities lending programs (while realizing only a portion of the return). Securities lending agreements may reimburse participants for losses caused by the default of the borrower, but generally do not reimburse participants for losses that the cash collateral reinvestment pool may sustain. However, because securities lending agents gain when the collateral pool makes money, they have an incentive to take more risks with the underlying assets of the investment options, both by investing in riskier assets and by delaying the sale of those assets. Securities agents thus shielded from the consequences of such investments could pose a heightened risk to plan participants.
Participants receive only partial return on investment. It is important to note that while plan participants may earn a return on securities lending transactions with cash collateral reinvestment, the return is not symmetrical to the losses that participants can incur from declines in the cash collateral pool investments. Participants only receive a return when the reinvested cash collateral earns more than the amounts owed to the cash collateral pool manager and the broker-dealer. Thus, broker-dealers and securities lending agents may obtain most of the gain earned on the cash collateral reinvestment. The plan sponsor splits the remaining return between the securities lending agent and plan participant (e.g., 80 percent to participants and 20 percent to the securities lending agent). The amount received by the plan may also be used to offset custody fees and administrative expenses to enhance participant portfolio returns.
The issues inherent in securities lending in 401(k) plans were the subject of a CCH Comment published in PEN Report 1888 (May 16, 2011) at Par. 27,081
5. Preparer Tax Identification Number Still Required File Form 5330
Individuals who are paid to prepare Form 5500s and Form 1099S do not have to obtain a preparer tax identification number (PTIN) Many service providers that prepare Form 5500 are also charged with filing Form 5330 to report corrective distributions, late contributions of employee contributions, prohibited transactions or other matters. However, the relief available to 5500 preparers does not apply to preparers of Form 5330. These providers will still need to obtain a PTIN in order to file Form 5330 after January 1, 2011.
Preparer tax identification number. Under IRS Reg. 1.6109-2, all tax return preparers who are compensated for preparing, or assisting in the preparation of, all or substantially all of a U.S. federal tax return or claim for refund must obtain a PTIN prior to filing any return after 2010. Each preparer must obtain their own individual PTIN. Multiple individuals or offices may not share a PTIN.
Individuals who have not obtained (or renewed) a PTIN by January 1, 2011 may still be able to prepare returns. However, they would first need to sign up through the online registration system, pay the required fees, and obtain (or renew) a PTIN.
Form 5500 preparers. The IRS had indicated that all individuals who are compensated for preparing or assisting in the preparation of all or substantially all of a federal tax return or claim for refund are required to obtain a PTIN and, if applicable, successfully pass a competency examination. However, the IRS had not clearly stated whether the program applied to preparers of the Form 5500 Series. The 2009 and 2010 versions of Form 5500 did not provide for inclusion of a preparer's PTIN. Absent definitive clarification, speculation had arisen that the PTIN requirements would be applied to all Form 5500 preparers beyond individuals who perform clerical and incidental services (e.g., inputting information into data fields of preparation software or electronically filing returns prepared by another party).
Forms excluded from PTIN requirements. All tax returns, claims for refund, or other tax forms submitted to the IRS are considered tax returns or claims for refund for purposes of the PTIN requirements. However, incident to the authority to specify the forms, schedules, and other forms that qualify as tax returns or claims for refund, the IRS may provide for exceptions. Thus, an individual would not be required to obtain a PTIN in order TO prepare for compensation all or substantially all of any form specifically identified by the IRS as not subject to PTIN requirements.
The IRS has definitively indicated in Notice 2011-6 that the Form 5500 is not subject to the PTIN requirements. In addition the IRS has provided a specific exclusion for: Form 5300 (Application for Determination of Employee Benefit Plan); Form 5307 Application for Determination for Adopters of Master or Prototype or Volume Submitter Plans); Form 5310 (Application for Determination for Terminating Plan); Form 8717 (User Fee for Employee Plan Determination, Opinion, and Advisory Letter Request); the Form 1099 series; and the W-2 series.
The IRS may further modify the list in the future. However, the IRS has not currently provided an exemption for preparers of Form 5330.
Need PTIN to file Form 5330 reporting excise tax
Form 5330 (Return of Excise Taxes Related to Employee Benefit Plans) is filed to report:
An amended From 5330 will also need to be filed to:
Service providers who are responsible for filing Form 5330 will be required to obtain a PTIN to complete the form. As a consequence, J. Reed Cline, QPA, QKA, a technical consultant at Benefit Consultants Group, notes in the Spring 2011 Issue of the CCH Journal of Pension Benefits : “So, now the IRS gets an annual "annuity" of $50 and the processing firm gets $14.25 for the registration of each person in your office who works on the Form 5500 because they might prepare a Form 5330“
Cline explains that a person who is actually licensed to practice before the IRS (CPA, actuary, attorney, ERPA, or enrolled agent), will not have to take an exam to get or keep the PTIN, as existing continuing education requirements for those designations will be sufficient. However, parties who do not have such a credential, but may have obtained a QKA, CPC, QPA, or any of the industry designations, may still be required to take an exam.
In addition, other providers who have never received any "official" designation are subject to the PTIN requirement, and, thus, may need to incur the expense of taking the exams and complying with continuing education requirements. Cline further cautions that, under the regulations governing the PTIN and Circular 230, even those who gather information, especially if they speak with the client, will need to obtain a PTIN, although it will never be reported anywhere. Moreover, the IRS is on record, Cline explains, as saying that having only one person with a PTIN in a firm will not be acceptable if anyone else is "assisting" in preparing the Form 5500 (which then leads to the PTIN required 5330).
Finally, Cline observes that a provider who does not have a PTIN, but secures one before the exams come out, will have until 2013 to pass the exam. Other providers, however, will need to pass the exam before obtaining a PTIN.
PEN ENHANCEMENTS
1. Rolling PEN Revision. A significant value added feature of PEN that should be highlighted is the ``rolling revision,’’ in which important developments in the pension and benefits field are reflected in PEN Explanations within a short period of time following release. Reflecting legislation, court cases, Final and Proposed Regulations, Revenue Rulings, Revenue Procedures, Letter Rulings, Opinion Letters, Field Assistance Bulletins and other releases by IRS, DOL, PBGC, SEC and other governmental agencies allows PEN to be the most current and up-to-date resource available.
2. Latest Benefit Practice Portfolio Analyzes Rules for Terminating 403(b) Plans. Employers are allowed to terminate 403(b) plans and provide for the distribution of accumulated plan benefits to participants and beneficiaries. However, a termination will not be effective unless and until all accumulated benefits under the plan are distributed to participants and beneficiaries. In addition, 403(b) plans that hold elective deferrals or that invest in custodial accounts may be subject to distribution restrictions.
The termination of plans and the distribution of accumulated benefits can prove problematic. In order to address possible issues, the IRS has recently issued guidance that explains and illustrates the requirements applicable to distributions from terminating plans. This guidance is the subject of the latest Benefit Practice Portfolio.
The Portfolio, “Implementing Distributions Under Terminating 403(b) Plans,’’ is available exclusively to Internet subscribers. To access select “Pension Explanations” and click on “Benefit Practice Portfolios.”
Benefit Practice Portfolios Provide Practitioner Oriented Insight on Pension Law. Benefit Practice Portfolios are available to internet subscribers to the CCH Pension Plan Guide. These Portfolios, usually written by nationally recognized experts, provide insights into specific areas of pension law. There are well over 150 Portfolios on a host of diverse subjects, written for pension and benefits practitioners.
A sampling of recent Benefit Practice Portfolios includes:
3. DB/K Document from ftwilliam.com is Industry First for Leveraging DB/K Plans
In an industry first, ftwilliam.com, which provides third-party administrators (TPAs) and other retirement plan professionals integrated Software as a Service (SaaS) workflow solutions, has launched its all-new DB/K document. The DB/K document (see CCH Pension Plan Guide ¶136 ), which wraps a 401(k) document (the 401(k) component) and either a cash balance or a defined benefit document (the DB component) together into one plan, is an important tool for individuals working with those types of documents.
“The combined DB/K document is definitely an industry trend right now and after listening to our customers, we’re excited to be the first to offer this unique plan,” said Tim McCutcheon, General Manager of ftwilliam.com. “As DB/K plan safe harbor compliance becomes more popular with businesses, ftwilliam.com is in position to support customers with the new DB/K wrap option.”
The new DB/K “wrap” document is available in the ftwilliam.com retirement plan document package.
4. 2011 Edition of U.S. Master Pension Guide Now Available
The 2011 U.S. MASTER™ PENSION GUIDE is now available for purchase. The book provides a comprehensive explanatory overview of qualified retirement plans and other retirement arrangements, reflecting up-to-date law changes and regulations. Benefit COLAs, calendars, and tables reflect the year 2011 figures.
The book begins with a survey of the different types of plans from which an employer may choose and then describes the procedures for obtaining plan qualification. Rules governing minimum participation, coverage and vesting, nondiscrimination, distributions, reporting and disclosure, funding, and fiduciary standards are covered in separate chapters. Examples and pointers are used to illustrate the rules. The five final chapters cover the special rules applicable to 401(k) plans, ESOPs, tax-sheltered annuities, IRAs, and nonqualified arrangements. The book is one of the more efficient means of keeping current on the constantly changing rules governing qualified plans, especially in the areas of funding, reporting and disclosure, and cash and deferred arrangements.
The 2011 U.S. MASTER™ PENSION GUIDE is available for $89.95 from CCH INCORPORATED, 4025 W. Peterson Ave., Chicago, IL 60646-6085 or by calling 1-800-248-3248 and asking for book no. 0-4537-500. Discounts are available for multiple copies.
5. Keeping Up with PPA Guidance
The Pension Protection Act of 2006 represents the most sweeping overhaul to the pension law in more than 30 years. In addition to making myriad changes to the Internal Revenue Code and ERISA, the PPA requires government agencies to issue perhaps hundreds of guidance items over the next several years.
Keeping track of these guidance issuances will be a monumental task for pension and benefit practitioners. CCH has created a valuable search aid --the Table of PPA Guidance --which allows practitioners to quickly locate PPA guidance items. The Table lists official guidance issued by government agency (Internal Revenue Service, Department of Labor, Pension Benefit Guaranty Corporation, and joint agency releases), form of guidance, date of issuance, short description of the guidance, and the CCH paragraph number at which the guidance item may be found in full text. Internet customers can quickly link from the Table to a specific guidance item. The Table of PPA Guidance is designed to help busy practitioners stay abreast of the continuing flow of PPA issuances and is available exclusively to CCH PENSION PLAN GUIDE subscribers.
The Table of PPA Guidance is at PEN Par. 51C.
6. Comprehensive Plan Reporting and Disclosure Calendar Chart
Employee benefit plans are subject to numerous reporting and disclosure requirements that require information to be provided to plan participants and beneficiaries and filed with the IRS, DOL, PBGC, and other government agencies. Failure to comply with any applicable reporting requirement can result in significant penalties.
In order to assist plan administrators and others in satisfying their reporting obligations, PEN features a plan reporting calendar that neatly encapsulates all of the various reporting requirements. The calendar lists the reports required in a calendar year in chronological order. In addition, the calendar highlights the subject matter of a report and indicates both the party required to file the report and the party to whom the report must be directed.
The Plan Reporting Calendar is at PEN Par. 36.
7. Check "Calendars . Tables . Interest Rates" for Quick Answers
Electronic and print customers of the CCH Pension Plan Guide can find many pertinent pension facts and figures by consulting the handy "Calendars. Tables. Interest Rates" section of the Guide.
Some of the helpful features of this section are:
Print customers will find the "Calendars . Tables . Interest Rates" division in Volume 1 of their Guide. Internet customers will find the same information by selecting "Pension Plan Guide" under the "CCH Pension Explanations" blue bar, then clicking on "Tables and Other Documents," the first item on the menu.