Ask an Expert - ERISA | The Center for Due Diligence

Q: When a plan sponsor amends a plan with 100% immediate vesting and adopts a slower/graded vesting schedule, must the 401(k) plan grandfather existing employees?

WAGNER:

When a plan sponsor amends a plan to change the vesting schedule, three rules generally apply. First, the amendment cannot reduce the vesting percentage applicable to existing employees as of the date the plan is amended, plus subsequent earnings. Second, within a reasonable period after the amendment, the plan must give an employee with three years of service the opportunity to apply the old or new vesting schedule to future contributions. Third, as of the date of amendment, plus subsequent earnings, the plan must apply the greater of the vesting percentages under the old or new vesting schedules to the account balance of all existing employees, not just those with three years of service. In short, when replacing a 100% immediate vesting schedule with a graded vesting schedule, all existing employees are 100% vested in their account balance under the first and third rule. Employees with three or more years of service would no doubt elect to continue with the 100% immediate vesting schedule for future contributions under the second rule. Thus, the plan could apply the graded vesting schedule only to (a) existing employees with less than three years of service and (b) employees hired after the plan is amended. However, the IRS informally - and controversially - interpreted the first rule during 2007 as requiring plans to apply the grandfathered vesting percentage to all existing employees after the plan is amended. In light of the controversial interpretation and the complexity of administering the three rules, some TPAs are encouraging plan sponsors to grandfather all existing employees under the old schedule, and apply the new vesting schedule only to employees hired after the plan is amended.

Q: What planning services can a financial advisor offer with regard to rollovers without running afoul of ERISA when the advisor has a pre-existing relationship with either the plan or the plan participant?

WAGNER:

Where the line should be drawn between services that are permissible under ERISA and those that would result in a violation of an advisor’s fiduciary duty is currently a question on the minds of many people.

Attack on Cross-Selling. The need to find this line arises from the Department of Labor’s campaign to curb the perceived abuses associated with “cross-selling.” The DOL recently defined cross-selling as “using existing clients, plan participants and beneficiaries … to market additional services or products.” The Department believes that cross-selling is particularly prone to abuse when it results in fees being received by an advisor in connection with rollovers to IRAs. The definition of cross-selling and the DOL’s views in this matter were expressed in the preamble to the recently withdrawn investment advice regulations. However, for the most part, the preamble merely restates the position first staked out in the now infamous Advisory Opinion 2005-23A where the Department first articulated its position that responding to participant questions concerning the advisability of taking a distribution or the investment of the amount withdrawn could have fiduciary ramifications.

Advisory Opinion 20050-23A. Advisory Opinion 2005-23A posed three questions, the first of which asks whether an advisor who receives a fee for advising a plan participant on how to invest plan assets or for managing the participant’s account is an investment advice fiduciary. Unsurprisingly, the answer was that a participant level advisor’s directing the investments of a plan made the advisor a fiduciary because of the advisor’s “control” over plan assets.

The second question is the one that has caused all of the uncertainties that advisors now face. It asks whether a recommendation that a participant roll over his or her account balance to an individual retirement account to take advantage of investment options not available under the plan constitutes investment advice with respect to plan assets. The answer was no, because the recommendation to take a distribution did not constitute advice pertaining to plan investments and the recommendation with regard to the investment of withdrawal proceeds concerned funds that were no longer plan assets.

Following this temporary relief, the Department dropped the hammer in the second part of its answer. While the advisor would not be an investment advice fiduciary, the advisor would if they were already a plan fiduciary, still be under the obligations of a fiduciary with respect to the advisor’s rollover recommendations, because the advisor would be “exercising discretionary authority respecting management of the plan.” Under the plan management rationale, the advisor would be subject to fiduciary duties even in responding to participant questions as to the “advisability” of taking a distribution or as to the manner of its investment. The Department went on to point out that if the advisor exercises control over the plan assets so as to cause the participant to take a distribution and roll it into an IRA generating fees for the advisor, a prohibited transaction could result, because plan assets would have been used for the advisor’s benefit.

The third question raised in the advisory opinion was whether a recommendation by an advisor not “connected” with the plan relating to distributions and the investment of distribution proceeds is investment advice or the exercise of control over plan assets, either one of which would make the advisor giving the recommendation a fiduciary. The answer was no, but it still left open the question as to the exact nature of the connection that will get an advisor into trouble. Nevertheless, it is clear that, in the DOL’s view, being a plan fiduciary on some other basis would suffice.

DOL’s Plan Management Theory. The DOL’s reasoning in Question 2 of Advisory Opinion 2005-23A may not be sound. The DOL’s position is that if an advisor has some connection with a plan that makes him a fiduciary, then he becomes a manager of plan assets when he makes any recommendation regarding rollovers and/or their investment. This allows no room for the concept that an advisor may be operating in a nonfiduciary role when engaging in financial planning regarding rollover.

The DOL cited the Supreme Court decision in Varity Corp. v. Howe as the support for its plan management theory. This case involved a plan sponsor that had held meetings and provided materials which misled plan participants about the likely future of their plan benefits. The question, which was ultimately resolved against the plan sponsor, was whether the plan sponsor was wearing its fiduciary hat when it made these communications. While the court approved the finding that the plan sponsor had been acting in a fiduciary capacity, this conclusion was made on the basis of the specific factual context in which the misleading statements were made. This made the case into one of very limited precedential value. In other words, in order to decide whether an advisor is a plan manager, it is necessary to look at the facts and circumstances of each case. You cannot simply impose a blanket rule, as the Department seems to have done, that turns everyone who happens to have a plan connection into a plan manager if he provides financial planning services as to distributions and rollovers.

Let me provide an example of the plan management theory being applied in an overly broad manner. Suppose an advisor provides participant level investment advice to one participant in a very large plan. The advisor is an investment advice fiduciary as to that participant. At some point, a second participant for whom the advisor provides wealth management services, but not plan investment advice, asks whether he should engage in a rollover and the advisor responds with advice. The advisor is a plan fiduciary as to the first participant but has no control over the assets in the second participant’s plan account. It is hard to believe that the advisor should be treated as a plan asset manager, and, hence a fiduciary, with regard to his advice to the second participant. DOL regulations specifically state that an investment advice fiduciary is not deemed to be a fiduciary regarding any plan assets with respect to which the investment advice fiduciary does not have or exercise any authority or control. As illustrated by the Varity Corp. decision, this concept should also apply to plan managers.

Guidelines for Advisors. The legal underpinning of the DOL’s position may be shaky, but that does not diminish the agency’s ability to make life miserable for financial advisors who engage in conduct that the Department deems to be abusive. As already noted, the preamble to the Department’s recent investment advice regulations reiterated the position articulated in Advisory Opinion 2005-23A. Moreover, there have been situations where cross-selling activity has, in fact, been abusive, as in the recent case of Young v. Principal Financial Group.

So how can an advisor protect himself? In my experience, this question is most pressing in situations where a financial advisor has been providing participant level advice to a plan participant who then asks whether he should take a distribution and how they should invest it. Note that in Question 2 of Advisory Opinion 2005-23A, the DOL set up the question so the advisor would be responding to a question about the “advisability” of taking a distribution and the assumption was that the response would be in the form of a “recommendation.”

In other guidance, specifically, the DOL’s interpretive bulletin relating to participant education, the Department has indicated that certain information and materials are not “advice” or “recommendations.” This includes information regarding the terms of the plan, for example, the circumstances under which the plan allows distributions. It also includes information relating to the benefits of plan participation and the impact of pre-retirement withdrawals on retirement income. Finally, the advisor can provide information on the investment alternatives available under the plan, including past and current investment performance, the objectives and risk and return characteristics of the investment and asset allocation models geared to hypothetical individuals with different time horizons. If limited in this manner, there are no restraints on an advisor’s helping and educating the participant. The key is to avoid any reference to a proper or desirable course of action, including the appropriateness of any particular investment option. If an advisor is committed to a hard sell in capturing rollover business, this approach may not work. However, a neutral presentation of investment information is likely to be appreciated and rewarded by many participants.

Note that current DOL guidance does not specifically state whether an advisor can present asset allocation models that are available outside of the plan. Obviously, this would assist the participant in assessing whether they should take a distribution in order to access such investment alternatives. This would be particularly true for a participant nearing retirement if the model portfolios are for hypothetical individuals with a short time horizon. This should not be treated as a recommendation or the giving of advice, provided that the model is accompanied by a statement that other investment alternatives with similar risk and return characteristics may be available and the advisor identifies where the participant may find information on such other investment alternatives. Once again, staying out of trouble requires an advisor to avoid making a recommendation, and the best way to do this is to make a balanced and neutral presentation.

So this is where I would draw the line when a financial advisor is already providing participant level advice to an individual who is approaching retirement. The issues become more difficult, although not insurmountable, if the advisor provides plan level advice, because of the perception of added authority and reliability that this position may entail. But under any circumstance, the fiduciary advisor is not prevented from servicing a plan participant, as long as the advisor limits the information that is presented so as to avoid making specific recommendations while giving the participant the tools to make their own decision.

Q: 401(k) plans often have a provision that allows the sponsor to distribute account balances of terminated employees with balances less than $1,000. Given that many plans have a number of terminated accounts with very small balances, is there some diminutive amount that can be forfeited rather than paid out? Some of these accounts would incur distribution costs in excess of their balance.

WAGNER:

There is no rule allowing for forfeiture of small accrued benefits or account balances. On the other hand, there is no mandatory 20% withholding on amounts valued under $200.

Q: I have a client about to retire and she has a question. Her SPD states: "If you are single when you retire, your normal form of benefit is a ten-year certain & life annuity. If you die before the ten-year period, the payment will continue to your beneficiary (ies) for the remainder of the period." Unlike the benefit for a married individual who has a joint & 50% survivor annuity, the SPD does not state if the benefit would be reduced. How does she find out what her beneficiary would receive if she dies before the end of the ten-year period?

WAGNER:

Simple, have the plan sponsor/administrator ask the plan's actuary what the exact monthly benefit would be under the ten-year certain payment option. If requested, they are required by law to provide that information.

Q: What expenses can be paid from qualified plan assets and what expenses should be paid by the plan sponsor?

WAGNER:

In general, non-settler expenses, i.e., expenses necessary, desirable or prudent for the operation, administration and maintenance of a plan may be paid from plan assets. Settler expenses, expenses associated with functions normally performed by the employer, like determining plan design, may not be paid from plan assets. If there is uncertainty, an ERISA attorney should be consulted before paying expenses with plan assets.

Q: What impact will the ease of obtaining class action certification have on the retirement plans market, particularly the small plan market?

WAGNER:

Ease in obtaining class certification motivates the tort bar to keep searching for ERISA breaches to create a harmed or aggrieved class. This provides a means to seek restitution for plan participants and fees for class action lawyers. Small plan sponsors are particularly vulnerable to class action suits. The commonality of using the same investment platform, financial advisor or third party administrator could put small plan sponsors in a very difficult position. Small plan sponsors simply don't have the resources or sophistication to defend themselves. Even with their resources, large plan sponsors have had a difficult time defending against 401(k) fee litigation, which is primarily class action based.

Q: What impact will the 7th Circuit’s Deere decision have on the industry?

WAGNER:

The decision will be valuable to other sponsors and vendors defending against similar class actions. It is also a push back for those attempting to redefine the fiduciary standard upward. It must, however, be watched carefully because it could have unintended consequences, including legislation that would have a major impact on the industry.

Q: When an adopting employer terminates participation in a multi-employer plan, would transferring the assets into a newly established SIMPLE or SEP plan satisfy the requirements for establishing a new plan?

WAGNER:

In a multi-employer plan, the type of successor plan, the level of contributions, accrual/contribution rates and appropriate funding are dependent upon the collective bargaining agreement as well as what has been negotiated and committed to. The employer must also satisfy and withdrawal liabilities. Due to the complexity of the issues, a skilled attorney should be involved in the process.

Q: How significant is the recent class action certification of the pending excessive fee lawsuits against large plan sponsors and what do you expect to happen as a result of these decisions?

WAGNER:

Nationwide Classes and Company Classes are the two distinct types of class certification associated with 401(k) plan fee litigation.

Nationwide Classes
There are numerous lawsuits pending in federal courts in which sponsors of 401(k) plans are challenging their recordkeepers' receipt of "revenue sharing" payments from mutual fund companies. Some plaintiffs are seeking nationwide class certification on behalf of all of the plans serviced by the specific recordkeeper.

Ruppert v. Principal (District Court, Southern District of Iowa, 2008) is an example of a 401(k) fee lawsuit brought against Principal, in which the court ruled that the plaintiff could not maintain the action on behalf of a class consisting of the thousands of different 401(k) plans serviced by Principal.

If a fee lawsuit can be maintained on behalf of a nationwide class, it should be noted that the stakes of any single lawsuit could be huge, i.e., the fees at issue would include not only those associated with the plan sponsored by the plaintiff, but also the fees across the service provider's entire customer base. The potential outcome could be catastrophic. However, there is at least some degree of likelihood that a nationwide class will be certified by a district court in the not too distant future.

Company Classes
In the case of George v. Kraft Foods (District Court, Northern District of Illinois 2008), the court granted plaintiff's motion for class certification in the 401(k) fee case brought against Kraft Foods Global, Inc. The Kraft case is the fourth 401(k) fee case in which a court has granted class certifications (see Exelon Corp, ABB, Inc. and United Technologies Corp.). However, class certification was denied in the fee case against Northrop Grumman.

Like the plaintiffs in the nationwide class cases, the Kraft plaintiffs allege the defendants breached their fiduciary duties by allowing excessive fees and expenses to be charged to the plan and by failing to properly disclose such fees and expenses to plan participants. In the complaint, the putative class was defined to include "all persons who were or currently are participants or beneficiaries of the Plan, and those who will become participants of the Plan in the future.” Defendants tried to get the class dismissed for being overly broad, but the court upheld the class by holding that, in general, there is sufficient "typicality" of interests among all members of the class against Kraft.

Permitting current, former and future employees to constitute a certified class magnifies the potential exposure employers face in the fee litigation cases, and could lead to very high damages.

Q: What penalties could be assessed and what participant reimbursement would be available to participants when a program is limited to poorly performing proprietary funds and includes an undisclosed 0.50% additional participant fee? When informed of the poor performance and the undisclosed fee by another advisor, the three person committee in this situation elected to continue with the chairman’s personal advisor as the plan advisor, but without the undisclosed fee.

WAGNER:

This situation raises fiduciary concerns and could result in a fiduciary breach. The remedy for breach of fiduciary responsibility would be to make the participants whole. ERISA is a personal liability statute and in addition to making the participants whole, the DOL could impose penalties, in general, of up to 20% of the transgression. The IRS may also impose penalties, in general, of up to 15% of the transgression amount.