Whoops! MarshMac Bites Again

This is self-explanatory. It's almost incredible to people who deal with 401(k) plans that anyobody would get a 2.85% wrap fee, and even more astounding that the NYSUT got $3,000,000 for endorsing it. It will be interesting to see the results of the class action suit that should follow.

The lesson here is that the Marsh & McClennan case sets a paradigm for dealing with all the sub-TA fees, incentives, referral fees and all other non-disclosed fees. They will, from here on out, be characterized as kickbacks and bribes paid directly with money from the pockets of participants. It is hard to imagine how a payor or payee can avoid liability, or how an employer or a fiduciary can say they have met their burden all unless of this is disclosed. And, worst of all, this is not limited to ERISA plans, since the claim can be framed as state-law fraud.

More later on this topic.

"NYSUT’S MEMBERS BENEFITS UNIT SETTLES PROBE

Settlement is Part of Ongoing Investigation of Retirement Products

Attorney General Eliot Spitzer today announced an agreement to resolve an investigation of the marketing of retirement products to members of the state’s largest teachers’ union.

Under the agreement, an arm of the New York State United Teachers (NYSUT) will adopt a series of reforms and pay $100,000 to the state to cover costs of the investigation.

The agreement follows a lengthy probe revealing that NYSUT’s Member Benefits unit accepted payments from an insurance company to promote the company’s retirement products to NYSUT members. The unit did not disclose this arrangement and, instead, took steps to conceal it.

"A simple rule that my office has enforced time and time again is that fiduciaries must place the interests of their clients first," Spitzer said. "Accordingly, an office set up to counsel union members on retirement alternatives should always provide objective advice and full disclosure of relevant facts. That did not happen in this instance. But as result of this agreement, reforms have been adopted to ensure that this standard will be met in the future."

The investigation revealed that a retirement product endorsed by the unit – a so-called 403(b) plan offered by the Dutch insurance giant ING and its predecessor, Aetna Life Insurance and Annuity Company– charged investors fees and expenses as high as 2.85 percent per year while delivering only limited benefits. The unit endorsed the plan (even though cheaper alternatives were available) in return for undisclosed payments of as much as $3 million per year.

The unit took pains to hide this "silent partnership" with ING/Aetna. The unit would urge union members to attend financial planning seminars, claiming that: "There’s no sales pitch - they [the seminars] do not promote specific products or services." But contrary to this claim, the seminars were used as a "foot in the door" to promote ING/Aetna retirement products.

In addition, the unit redirected calls it received arising from the retirement seminars to ING/Aetna employees, who answered the phones with their first names only. Callers thought they were talking to NYSUT benefits unit personnel when in fact they were talking to the insurance company’s marketing representatives.

In late 2004, after it became aware of the Attorney General’s investigation of insurance and retirement products, the unit drafted a new disclosure policy, which was described by officials in an internal e-mail as moving from a "try to hid[e] it" approach to a more open approach that included disclosing all payments from ING.

Under today’s agreement, the unit agrees to the following:

* Conduct open bidding for future retirement plan endorsements;

* Provide full disclosure of any and all payments from insurance companies;

* Allow members an opportunity to roll over savings to a new endorsed plan at no cost;

* Provide free and objective investment advice to members; and

* Hire an independent consultant to oversee reforms and report to the Attorney General’s office.

More than 50,000 New York teachers and other school district employees bought into the retirement plan without having been told by the unit of the payments it received from ING/Aetna.

The investigation underlying today’s settlement was conducted by Assistant Attorneys General Peter Dean and Harriet Rosen, under the direction of David D. Brown IV, Chief of the Attorney General’s Investment Protection Bureau.

A broad investigation of the marketing of retirement products continues."

For more detail, see the following:
http://www.oag.state.ny.us/press/2006/jun/NYSUT%20AOD.pdf
http://www.oag.state.ny.us/press/2006/jun/NYSUT%20Member%20Benefits_Exhibits.pdf

A Tale of Two Funds

Before reading the actual decision in Jenkins v. Yager & Mid America Motorworks, Inc., No. 04-4258 (7th Cir. April 16, 2006), I thought it was an unmixed positive case. Write-ups came to the conclusion like "the Seventh Circuit affirmed the decision in favor of the plan trustee." On actually reading the case, it turns out that this is not quite true. In a nutshell, the plan, which looks like a National Auto Dealers Association plan, had a profit sharing feature without directed investments and a 401(k) feature with directed investments. The decision affirmed dismissal with respect to the directed investment portion of the plan and remanded for trial on the undirected profit sharing portion.

As to the directed investment portion, the court found that ERISA 404(c) was not the only route to avoiding fiduciary claims where participants can control their own accounts. To do this, the court felt it had to find an "implied exception", which certainly doesn't jump off the page, in ERISA 403(a). However, the fundamental logic, which is that (1) if ERISA 404(c) is a safe harbor, there should be other ways that aren't as safe, and (2) the DOL Regulations specifically contemplate other routes to compliance. (See DOL Regs. 2550.404c-1(a)(2): "The standards set forth in this section are applicable solely for the purpose of determining whether a plan is an ERISA section 404(c) plan and whether a particular transaction engaged in by a participant or beneficiary of such plan is afforded relief by 404(c). Such standards, therefore, are not intended to be applied in determining whether, or to what extent, a plan which does not meet the requirements for an ERISA Section 404(c) plan or a fiduciary with respect to such a plan satisfies the fiduciary responsibility or other provisions of Title I of the Act." The real meat of the decision on this point, however, is in the recitation of how conservative the funds were, the extensive conversation with a Raymond James RIA, the ready availability to employees of investment-related materials, and the fact that the sponsor had annual meetings with employees at which the RIA made a presentation. Given that record of attention and thoroughness, the court reasonably concluded that there was no breach of duties.

So far, so good. At this point, it looks like the case is an example of what I have always called the "I have always relied on the kindness of strangers" defense. It certainly stands for the notion that if you are intelligent and attentive, and hire the right advisers, you can forget about some of the ticky-tacky stuff in the DOL regulations (e.g., statement that the plan is intended to qualify under ERISA 404(c), name address and phone number of plan fiduciary, arguably the prospectus for the investments where ordinary investors don't read it (which is pretty much every prospectus for every investment a plan would even think about making available), voting rights materials (again, where real folks don't look at them), minimum quarterly investment direction), and the standards for the array of investments and their relationships). It also makes no distinction between participants who have acted on their choices and those who have not. If there are employer securities involved, it is probably a good idea to jump through all the hoops for ERISA 404(c) compliance, because employer securities make courts justifiably nervous.

The profit sharing portion of the plan presented a very different picture. The court started citing the employer's deposition, which contained a lot of I dunno answers. The same funds were used as investments, but the employer couldn't answer questions about the mix initially set up, changes to the mix or rebalancing. The Seventh Circuit remanded for further proceedings as to the profit sharing fund.

This means two things. First, I am going to have to start distinguishing between defenses that permit or require real reliance ("I have always relied..."), such as penalty cases under the Code, and fiduciary reliance on advisers, which should be described as "I have always listened to the advice of strangers and made my own informed decisions." (Since the second one is not very snappy, I'll probably have to come up with two brand new names.) Second, always get your advisers to cover all the bases for you.

If, because the exciting issues were under the directed investment part of the plan, both parties' lawyers paid less attention to the profit sharing fund, Defendant's lawyers will probably try to get better answers from the Raymond James RIA. Then, whether they can get those better results will likely determine the outcome of the case.

One last note. Somehow or other, the DOL has decided it disagrees with the decision. It's hard to reconcile that with the language for DOL Regs. 2550.404c-1(a)(2) cited above I have no idea. Given the content of the regulations cited and the fact that thus decision is now on the books, it would seem to be too late for DOL to close this particular barn door.

Final 403(b) Regulations for 2007?

The IRS announced last week that final 403(b) regulations will be issued this month and that they will be effective for 2006.

I am willing to take the IRS at its word as to issuance, although they could be delayed a month or two. The second element, making them effective for 2007, is more problematic. For starters, the 403(b) industry is not exactly designed for efficiency. Second, both charities and governments have more cumbersome processes for taking "corporate" action. Third, lots of employers (e.g., school districts) have an array of 403(b) products from different vendors and will be getting different advice from each. Fourth, six months isn't much time anyway. Last, effective dates seem to be pushed back infinitely for governmental employers. Employers should move as quickly as possible, but the regulations will probably not go into effect until 2007.

Reports say that some providers are charging on the order of $3000 to help meet the written plan document requirement. We are hoping that our solution, which is quick, efficient, written to avoid fiduciary status and a lot less money will become popular. Employers need to be very careful about not volunteering for a fiduciary status that they do not have to assume.

I am looking forward to the 414 part of the final regulations. The IRS operates under way too many different standards for nonprofit/governmental employers. These included 414 (which appears to require an 80% board control), 415 (50% board control by the employee), the church plan and governmental plan standards in 414 and ERISA, the requirements for getting a group determination letter of tax-exempt status and the operated, supervised or controlled by or in connection with standard for determining private foundation status. It would be far preferable if one set of standards were used, even if that requires legislation. Wherever the line is drawn, a lot of analysis and hard decisions will need to be made, as multiple 415 limitations disappear or appear, as plan become or cease being multiple employer plans, among other possible effects. Any line is better than no line, so that at least people know what to do, but one line would be preferable.

Should be exciting, at least. And maybe this will help trigger the professionalism and efficiency improvements that 403(b) markets need so much.

What's a Top-Hat Plan?

There are two basic ways a court can end up deciding whther a plan is a top-hat plan or not. The first is to decide under ERISA exemption provisions, and the second is in a claim for benefits where the sponsor is bankrupt. In In re IT Group, Inc., 2006 WL 1421016 (3rd Cir. 2006), the Third Ciruit got one of the latter. The case not only looks at top-hat status, but also clearly pijnts out the downside of being "unfunded".

The claimants were participants who alleged that the plan required the establishment of rabbi trust, with all the customary disclaimers in the plan and the trust agreement. The decision also assumed that the plan was for a select group of management and highly compensated employees. so that funding was the only real issue.

The court decided that this was a case of first impression. Footnote 3 says "In previous cases involving deferred compensation plans offered to management and highly compensated employees, we have always assumed, without further examination, that ERISA’s “top hat” exemption applies. See, e.g., Goldstein v. Johnson & Johnson, 251 F.3d 433, 435 (3d Cir. 2001) (considering the proper scope of judicial review of an administrator’s decision to deny benefits owed under a top hat plan); Senior Executive Benefit Plan Participants v. New Valley Corp. (In re New Valley Corp.), 89 F.3d 143, 148 (3d Cir. 1996) (“Both plans at issue are top hat plans . . . .”); Kemmerer v. ICI Americas Inc., 70 F.3d 281, 284 (3d Cir. 1995) (“The dispute on appeal centers around [an] executive deferred compensation plan, which like all such plans is commonly referred to as a ‘top hat’ plan.”)."

However , they still manage to cite other decisions on unfunded welfare plan status, as follows: The Eighth Circuit Court of Appeals has examined this issue from both sides. In considering whether a death benefit plan supported by a life insurance policy was subject to ERISA’s substantive requirements, it stated that “[f]unding implies the existence of a res separate from the ordinary assets of the corporation.” Dependahl v. Falstaff Brewing Corp., 653 F.2d 1208, 1214 (8th Cir. 1981). The plan was “funded” because the insurance policy provided “a res separate from the corporation” to which beneficiaries could look for payment of benefits under the plan. Id. On the other hand, an excess benefit plan that specified that the rights of the beneficiary under the plan would “be solely those of an unsecured creditor” was unfunded, even though the employer had purchased an insurance policy to help it finance the plan, because the policy in that case “simply became a general, unpledged, unrestricted asset of the [employer] and those . . . assets in turn would be used to fund [the] plan.” Belsky v. First Nat’l Life Ins. Co., 818 F.2d 661, 663-64 (8th Cir. 1987). Similarly, the Second Circuit Court of Appeals has observed that a plan under which benefits were to be paid “‘solely from the general assets of the employer’” is unfunded. Demery v. Extebank Deferred Compensation Plan, 216 F.3d 283, 287 (2d Cir. 2000) (quoting Gallione v. 17 Flaherty, 70 F.3d 724, 725 (2d Cir. 1995)). More recently, it adopted a standard first articulated in Miller v. Heller, 915 F. Supp. 651 (S.D.N.Y. 1996):
the question a court must ask in determining whether a plan is unfunded is: can the beneficiary establish, through the plan documents, a legal right any greater than that of an unsecured creditor to a specific set of funds from which the employer is, under the terms of the plan, obligated to pay the deferred compensation?” Demery, 216 F.3d at 287 (quoting Miller, 915 F. Supp. at 660). Applying this test, the court found that a deferred compensation plan that was financed using life insurance contracts, the proceeds of which were kept in a separate account, was unfunded. According to the court, the plan’s terms did not “give plaintiffs a greater legal right to the funds in the Deferred Compensation Liability Account than that possessed by an unsecured creditor.” Id. Although the account was separate, it was part of the “general assets” of the corporation, and the plan was therefore “unfunded as a matter of law.” Id. The Fifth Circuit Court of Appeals employed a similar analysis, but also considered the tax treatment of the plan. In Reliable Home Health Care, Inc. v. Union Central Insurance Co., 295 F.3d 505 (5th Cir. 2002), it surveyed the decisions of the other courts of appeals, and noted that the Department of Labor had provided the following guidance: “‘[A]ny determination of the ‘unfunded’ status of an ‘excess benefit’ or ‘top hat’ plan of deferred compensation requires an
examination of the facts and circumstances, including the status of the plan under non-ERISA law.’” Id. at 513 (quoting Dep’t of Labor, Pension & Welfare Benefit Programs, Op. Ltr. 92-13A, 1992 ERISA LEXIS 14, at *7 (May 19, 1992)). More specifically, the court emphasized DOL’s advice that the tax consequences of the plan should be considered in the analysis, id. (citing DOL Op. Ltr. 92-13A, 1992 ERISA LEXIS 14, at *7), and noted a district court’s holding that “a ‘plan is more likely than not to be regarded as unfunded if the beneficiaries under the plan do not incur tax liability during the year that the contributions to the plan are made,’” id. at 514 (quoting Miller, 915 F. Supp. at 659). Combining all of this information, the court devised the following test: in determining whether a plan is “funded” or “unfunded” under ERISA, a court must first look to the surrounding facts and circumstances, including the status of the plan under non-ERISA law. Second, a court should identify whether a [plan] is funded by a res separate from the general assets of the company. Id. 4As noted above, a plan under which the beneficiaries do not incur tax liability during the year that the contributions to the plan are made is “more likely than not” an “unfunded” plan. Miller v. Heller, 915 F. Supp. 651, 659 (S.D.N.Y. 1996). This is so because the tests for taxation of deferred compensation and for funding status ovelap–deferred compensation is not taxable as current income only where the future payment of the compensation is somehow uncertain, i.e., where the assets used The Reliable court concluded, under this test, that a death benefit plan was unfunded. Like the plans at issue in Demery and Belsky, the plan was financed through the purchase of life insurance contracts on behalf of participating employees. However, those contracts belonged to the company, not the participating employees. Plan participants were prohibited from contributing to the plan, and did not treat the company’s contributions to the plan on their behalf as taxable income. Thus, the plan was unfunded and exempt from ERISA’s substantive provisions. Id. at 514-15. We agree with our fellow courts of appeals that the keys to the determination of whether a plan is “funded” or “unfunded” under ERISA are (1) whether beneficiaries of the plan can look to a res separate from the general assets of the corporation to satisfy their claims; (2) whether beneficiaries of the plan have a legal right greater than that of general, unsecured creditors to the assets of the corporation or to some specific subset of corporate assets. We may also consider the plan’s intended and actual tax treatment. We will analyze the to pay participants’ claims are also subject to other creditors’ claims. Thus, the fact that a plan qualifies for deferred taxtreatment strongly supports the conclusion that it was unfunded.
See Dep’t of Labor, Pension & Welfare Benefit Programs, Op. Ltr. 92-13A, 1992 ERISA LEXIS 14, at *7 (May 19, 1992) (noting that “the tax consequences to trust beneficiaries should be accorded significant weight” in determining whether a plan is “funded” or “unfunded”)."

Th Court then determined (1) that the plan was a top-hat plan, (2) that the employees were not entitled to a priority claim in the bakruptcy, and (3) that no one involved with the plan had breached any fiduciary duties.

This decision is not overwhelmingly important for Sections 403(b) and 457, certainly not as important as an effort to determine what constitutes a select group. Nonetheless, it points out the fact that some legalese has a purpose, and shows what language needs to be included in nongovernmental Section 457 plans.