District Court Affirms Withdrawal Liability Calculations, But Appears to Leave an Opening

Working right before the holiday, New Jersey District Court Judge Kevin McNulty issued a lengthy opinion late on July 3 in Manhattan Ford Lincoln, Inc. v UAW Local 259 Pension Fund. The case concerns the withdrawal liability assessed against Manhattan Ford, a withdrawing employer from a multiemployer pension plan and the actuarial assumptions used for the calculations. While this is far from the first case on this topic, it may be instructive to contributing employers who are considering withdrawing from multiemployer plans and for consultants and actuaries who work with these plans.

Before diving too deeply into the case, we need some background for readers who do not work in the multiemployer plan world on a daily basis. As the background is geared toward the more casual reader than to the multiemployer expert, we've intentionally omitted some details.

In 1980, Congress passed and President Carter signed into law the Multiemployer Pension Plans Amendments Act (MPPAA). In part, MPPAA established the concept of withdrawal liability as a means of ensuring that employers who choose to leave those plans pay their fair share of any unfunded liabilities.

For years, one of the frustrations of many who are involved with multiemployer plans has been the lack of guidance on actuarial assumptions particularly the discount rate to be used in determining the vested benefit liability (VBL) under a plan. That said, the statutory language that provides much of the guidance that we have in this arena and the language that the fund's actuary looks to in determining the discount rate to be used in annual actuarial valuations are somewhat instructive.

Quoting from a footnote in Judge McNulty's opinion, "The main upshot, for our purposes, is that under current law, 'each' actuarial assumption must be reasonable for the purpose of minimum funding, whereas they must be reasonable 'in the aggregate' for purposes of withdrawal liability." The language here is strikingly similar yet as we will discuss later, the calculations are often very far apart.

In this particular case, the plan's Enrolled Actuary (EA) used the Segal Blend (a method developed by the Segal Company in the early days of MPPAA) as a means of discounting in order to determine the fund's VBL and therefore the unfunded vested benefits (UVB) as well. To understand this case and the distinctions we will make later, we'll have to get hypertechnical (yet still oversimplified) for a moment to explain the Segal Blend. The Segal Blend essentially does two calculations and blends them. It considers that liabilities that can be settled by plan assets are assumed to have their risk transferred and therefore use PBGC rates (the rates inherent in insurance company annuity settlements) to discount the liabilities. But, for the portion of the liabilities not covered by plan assets, it acknowledges a risk premium and uses the funding interest rate (the EA's best estimate of future investment returns).

In Manhattan Ford, the fund's calculation performed by the EA showed that the withdrawing employer owed a roughly $2.5 million withdrawal liability based on the Segal Blend. The employer challenged the calculation and an arbitrator found in favor of the fund. Manhattan Ford appealed to the District Court.

Judge McNulty found that two essential questions were raised [quoting]:

1. As a matter of ERISA law, must a pension plan's actuary use identical actuarial assumptions to calculate the plan's satisfaction of minimum funding requirements and its unfunded vested benefits ("UVB") for withdrawal liability?
2. Assuming the answer to question 1 is "no," did the Arbitrator err in this case when he found that the discount rate applied by the Pension Fund's actuary to determine Manhattan Ford's withdrawal liability, the Segal Blend, did not render the actuarial assumptions "in the aggregate, unreasonable (taking into account the experience of the plan and reasonable expectations)"?

The Judge found that answer to both questions to be "no" and granted summary judgment to the Pension Fund. Summary judgment is granted only when the Court finds that the movant shows that there is no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of law. Stated differently and from an extremely non-legal perspective, the Court found that even if all of the facts claimed by Manhattan Ford were true, it still had no valid case.

Thinking about this as a consulting actuary or even putting us in the lens of a withdrawing employer, this would appear to leave little room. And, this would appear that based on the fact pattern in this case that at least in the District of New Jersey that the Segal Blend produces results that are not unreasonable (note that the burden of proof here by statute is on the withdrawing employer).

What this opinion specifically does not say, however, is that the EA's judgment is infallible or indisputable. While the opinion did not address this, that the statute gives withdrawing employers the ability to challenge withdrawal liability calculations suggests that ERISA contemplates that there are, in fact, valid challenges.

What might they be?

We've seen a number of calculations of withdrawal liability where all of the discounting is done using PBGC rates. To understand the significance of this, note that in recent years, PBGC rates for this purpose have often been less than 3% while funding interest rates are often in the vicinity of 8%. Conservatively, changing the discount rate from 8% to 3% could increase liabilities by anywhere from 40% to more than 100% depending on the demographics of plan participants. For purposes of an example, let's use 60% and further, for extreme simplicity, let's assume that all liabilities of our hypothetical multiemployer plan are vested.

Suppose our plan has assets of $1 billion and liabilities discounted at 8% of $1 billion. Then, the unfunded liability at 8% is $0. However, decreasing our discount rate to 3% increases our liabilities to $1.6 billion and increases our unfunded liability from $0 to $600 million. That helps us to illustrate the extreme leverage inherent in many of these calculations.

So, to return to some of the questions at hand, let's suppose that the 8% discount rate applied in the annual valuation of the plan is the EA's actuarial assumption. In fact, when he has put it on the Schedule MB to Form 5500, he has asserted under penalty of perjury that it is reasonable. And, he has similarly asserted under penalty of perjury that each of his other assumptions is reasonable. Finally, he has asserted that, in combination, these assumptions offer his best estimate of expected future experience under the plan.

Now, the EA is asked to perform a withdrawal liability calculation. In performing that calculation, he keeps all assumptions except for the discount rate the same as they were for minimum funding. But, he changes the discount rate from 8% to 3%.

If each assumption is individually reasonable, one can extrapolate that the set of assumptions, in the aggregate, is reasonable. 

Given that the unfunded liability has increased from $0 to $600 million and even conceding that the purpose of the measurement is different, this begs the question as to how the revised assumptions (only one is revised), in the aggregate, can also be reasonable.

Withdrawing and potentially withdrawing employers should weigh these issues carefully when withdrawing. In combination with counsel and with other experts including actuaries, they should also weigh these issues when appealing a determination of withdrawal liability.

Everybody Must Get Sued

I logged into my social media this morning and I noticed a pervasive theme. LinkedIn, Facebook, Twitter -- the trend in their highlights or whatever the particular site is calling that section is that somebody is getting sued. In fact, looking at my top highlights on each of those sites, more than 50% of those highlights is that somebody is suing somebody else. That's a frightening sign of the times.

Suppose instead of those sites, there was a site called BenefitsGram or SnapCompensation, what would they look like? Well, there are sites that are a little bit like that -- there's Plan Sponsor's News Dash and Benefits Link's Benefits Buzz, a pair of news consolidator sites. And, when I look at what's trending there, it's the same -- everybody must get sued.

So, why am I writing about this here?

In these days where many of the pundits talk about risk management and de-risking, is there a bigger risk than getting sued? For many companies, there may not be. A big enough lawsuit can put one of them out of business. I could certainly name some where that has happened (I'll skip that part though as I'm sure you have access to Google search as well).

In my world, it's happening around benefits and compensation programs on a more than daily basis. Somebody is getting sued. And, yes, I will agree, many of those lawsuits are frivolous. And, even among the ones that have some substance to them, an awful lot of those should fail on the merits.

The sad part, though, is that among those that should fail on the merits and even those that should succeed, almost all of them could have been avoided.

Defending a lawsuit is expensive. Even if you win, you probably paid an attorney a lot of money to defend you. And, that attorney likely convinced you (rightfully so in most cases) that you needed an expert witness or two or three on your side and you paid them a lot of money as well. So, even if you won, you lost.

What does real winning look like? It looks like not getting sued in the first place. On the contracts side, the key seems to be to write 100 page license agreements (or similar documents) that you know your customers won't read before they sign off on something that is so one-sided that they have no rights at all. On the benefits and compensation side, it's not so simple. Usually, you have to have things like plan documents and those documents have lots of legal requirements to comply with all the laws that Congress touts, but that are festered with so much junk that makes for great PR, but no sense at all.

So, you write those documents or get counsel to do that for you (probably a better idea). And, back in Section 14.23 of one of the documents, somebody wrote a really long and confusing paragraph. and, they left off an s at the end of a word that would have changed a singular to a plural. Voila! Somebody finds that the s is missing and decides that was always intended and not having that s will entitle an entire class of potential plaintiffs to double their benefits or more.

Will they find a court that will allow them to strike the first blow? Do they win at the District Court level? If they do, you have already spent a lot of money and if you want to appeal, you'll have to spend  a lot more.

So, what's the message here? Do everything you can to make sure that your intent of each of your plans is clear. Explain with examples. While I don't often praise IRS and Treasury for their mastery of the English language, they are well known for using words such as "the provisions of this paragraph (b) can be illustrated by the following examples" and then they give maybe five examples to make crystal clear what they intended.

You can too.

And you should.

But you probably haven't.

And neither have your counterparts at thousands of other companies.

So, here's your checklist:

1. Address the litigation risks in your plans.
2. Take steps to fix and problems that you have uncovered.
3. If you do get sued, make sure your counsel finds great expert witnesses for you.

Otherwise, everybody must get sued ... with apologies to Bob Dylan and Rainy Day Women #12 and 35.

What Does Your Plan Document Really Say?

What does your plan document really say?

That's right. You read my question correctly. You probably know the words that are there. And, you certainly know what they say. But, would everyone else agree with you? That may be the really key question.

Let's limit our discussion here to retirement plans, both qualified and non-qualified. Those are usually complex documents. They contain an awful lot of words that are intended to both inform the plan participants of their benefits and attendant rights and to tell the person or people administering the plan exactly how to do that. And, we all know that because the English language is so precise that no two people would ever disagree on the meanings of those words, would they? Of course, they would, and they often do.

Perhaps that's a key reason that there is so much litigation related to retirement plans. If a plan participant took his summary plan description (SPD) and calculated his own monthly benefit and determined that it was $2,000 and a few weeks later, he received a benefit determination that his monthly benefit would be $1,000, he's not going to be happy.

Perhaps his reading of the SPD was irrational. Perhaps the SPD specifically says everywhere that pensionable earnings shall be based on the participant's years with highest base pay and he read that to include bonuses and car allowances and equity grants as well.

On the other hand, perhaps his reading was different than yours, but rational. To quote Scooby Doo (I always wanted to quote Scooby Doo in a retirement benefits post), "Rut ro."

How do we avoid this problem?

There are presumably legal safeguards that are typically inserted into a plan document to get past this problem should it occur. Clearly, however, they don't always work. If they did, no plan sponsor would ever lose in litigation. We know that's not reality.

To help to ensure that you're not one of those litigation losers, wouldn't it make sense to have an independent review of those documents?

I'll leave it up to the attorneys to tell you how that should be structured. But, I am going to tell you that it's important to have attorneys and non-attorneys working together on this review.

Why? Attorneys certainly know how to read documents, especially the ones that they write. But, in practice, they won't be administering your plan. And, a person without legal training may read those legal words differently than an attorney will.

Additionally, since we are talking about retirement plans here, administration may include what I've heard a number of attorneys refer to as a dirty word -- math. While some are very good at it, I've heard many attorneys say that math was always their worst subject in school. They fought through it, but they never understood it.

And, sometimes, those plan documents serve to prove that. Suppose the attorney wrote the document to mean exactly what he thought it was supposed to. But, perhaps to a person with a little bit better understanding of the math involved, the calculation would work out differently. I'll say it again -- rut ro.

Use counsel as you should. Consider getting them to engage consultants on your behalf who can help them and you to understand when your plan may be interpreted differently than they had intended. By saving litigation costs down the road, it may be the cheapest money you've ever spent.

Thinking About the Year Ahead in Benefits and Compensation

I was talking to a member of the benefits press the other day and after the formal interview (for an article) was over, the reporter, looking for ideas for 2017 articles, asked for a favor. Paraphrasing, if I were running a Benefits or Compensation, or HR function at a good-sized company, what are some things that I would make sure that I did in 2017 including perhaps some things I had not done in the past?

I thought that was a pretty good topic. It's something I think about from time to time and frankly, I'm hoping that that reporter will think of me in the future when writing on some of those topics.

But, if you are reading this, you might be one of my faithful (or first-time) readers and you probably don't want to wait for those articles. So, I'll give you a little preview with a few of my thoughts.

Be a Better Partner

I know -- that sounds strange for Human Resources. People in HR virtually always think of themselves as good partners for the rest of their organization. But, perhaps surprisingly to our HR heroes, their colleagues might not agree.

To Finance, HR is a cost center. Face it, HR doesn't make money. HR doesn't have a product. HR doesn't sell goods and services. HR costs money. And, because of that, Finance may not think of HR as good partners. So, if you want to be better thought of by Finance, think in terms of dollars and cents. When you find a solution that saves money, make sure your Finance partners know about it and make sure you get some credit for it.

Somewhat similarly, Legal may think of you as a litigation risk. After all, there may be more laws on the books that deal with how an employer treats an employee than any other area. And to Legal, each one of those may represent a risk. Legal would like nothing better than to know that you have sound processes and procedures and probably more importantly that you are following them. It's amazing in reading through employment litigation how often a case falls apart for the employer because they had a set of procedures and they left a few steps out in, for example, terminating an employee.

Oops!

Implementing Those Partnerships

It's great to think about those partnerships, but thinking about them isn't very useful if we don't do something with those thoughts. Let's consider Finance first.

Most every element of your department has a cost associated with it. For 2017, I'm sure you have budgets. But, how about years after 2017? That's a little bit tougher, isn't it? Some of your costs are controllable. You can manage your payroll by the general cost-of-living type increases that you provide. How about your pension commitments? That's a tough one, huh?

First off, your actuary should be on top of that. You should never be getting a pension surprise from year to year or even quarter to quarter. You're not one of those who is getting surprises, are you? If you are, you don't need to be.

I've spoken with benefits people in the past who tell me that's a nice goal, but we just don't have much budget, we really don't have time and we don't have the staff to work with you so that you can get us what might be useful to us.

Suppose I told you that you don't need much budget. This is a very inexpensive project. In fact it's so inexpensive that more often than not, we'll save you more than you spend.

Suppose I told you that we don't need much of your time. In fact, I'm going to round up and say I need 15 minutes of it, but in reality 2 or 3 minutes will probably suffice. Although, to be fair, when I do have results for you, you'll probably want to save an hour or more to go through what we've found for you. After all, what good would discovered savings do you if you didn't actually know how to get them.

And, then there's that staff that you don't have to get us information and answer our questions. Don't worry -- I said that I don't need more than a few minutes of your time. It turns out that I don't need your staff's time either. It's true. All of what I said is true.

Turning now to partnering with Legal, you don't want your department to be thought of as a litigation risk, do you? Well, with respect to each of your plans and programs, you probably have a whole bunch of processes and procedures?

• Are they current? When was the last time they were updated? When was the last time anyone even looked at them?
• Are you following them? Every one of them?
• Do they still make sense? Would you make changes to them not because the law changed since that would necessitate changes, but because they're just not really appropriate in 2017?

I know, this all seems a bit pie in the sky. But, read through your favorite benefits digest tomorrow. There's probably something in there about litigation. What went wrong that caused a lawsuit to have a chance?

• A committee did not use a well-reasoned process in selecting plan investments.
• A committee actually had such a process, but didn't follow it.
• A plan document was vague enough that two reasonable people might interpret it differently. Counsel is telling you that you will win because of this notion sometimes known as "Firestone deference" (essentially, the administrator of a plan should have broad latitude in its administration), but even if you win, litigation may be costly and eat up a lot of your resources.
• You had a low performing individual in the company whose supervisor doesn't like documenting performance reviews, so when that individual was terminated, there was no written basis on which to do it.

I could go on, but you get the gist. But looking at all those things is tedious and you just don't have the staff to do it, but there is a solution.

Happy New Year. Have a great 2017.

Laws Affecting Benefits and Compensation Nearly Always Failures

I suspect that the authors of every law that affects employee benefits and compensation have good intentions when they draft those laws. As T.S. Eliot said however, "Most of the evil in this world is done by people with good intentions."

Where do these laws go wrong? To understand this, it's helpful to understand the process.

Usually, bills are drafted by Congressional staffers perhaps with the assistance of outside experts, often lobbyists. From there, bills are introduced and then haggled over by 435 people with no subject matter expertise in one chamber of Congress and then by 100 people with a similar lack of subject matter expertise in the other chamber. Once the sausage has been ground sufficiently, a bill may be approved and passed to the President for signature.

What could possibly go wrong?

Assuming that nothing could go wrong up until that point, these bills that by this point in the process have become laws leave it up to the various government agencies to create regulations that help to implement these laws. Some of the regulations make sense, and then there are the others.

Looking at this as someone who doesn't work for one of those agencies, it strikes me that each of them seeks to assert their power where possible. After all, if a government agency cannot show that it has power, why should it not simply cease to exist?

Further, if between Congress and the various government agencies, a bill and then law has not been messed up, there is still the court system to fall back on.

As an example, let's consider Internal Revenue Code Section 401(k). Essentially, it was added to the Code by the Revenue Act of 1978. And, while it was a throw-in, as we all know, once 401(k) plans were truly discovered, they took off in their popularity.

There are several things that we know about 401(k) plans. They are qualified retirement plans, thus governed by ERISA. They provide tax deductions and are thus also governed by the Internal Revenue Code. They have become very popular, so the amount of plan assets in many 401(k) plans is massive.

So now, let's look at the evolution of a current nightmare.

401(k) plans were created by the Revenue Act of 1978. They provided employees with an opportunity to save money for retirement on a tax-favored basis. Employers have the ability to match those employee deferrals and receive a tax deduction for those matching contributions. The Investment Committee (or some similar name) for the plan or its designee is responsible for selecting and monitoring investments in the plan. In that role, the Committee must act in the best interests of plan participants and in a fiduciary manner.

What does that mean?

The old regulations were very vague. Vagary has led to different courts imparting their wisdom in different ways. To be acting in the BEST interest of plan participants, what does a committee need to do? Does it need to find the LEAST expensive investment options? Does it need to find the HIGHEST returning investment options? If not, then how close to that optimum? Where is the bright line?

So, now we have new Department of Labor (DOL) fiduciary regulations. What they do more of than anything else is make more people fiduciaries of the plans than were before. Or, if they don't, then they certainly make clearer who the fiduciaries are and establish that there are, in fact, a lot of fiduciaries out there. Does this mean that more people will  be sued for fiduciary breaches?

Looking back, Section 401(k) should have been a great addition to the Code. And, weighing everything, perhaps it was (although regular readers of this blog will know my opinion that the addition of Section 401(k), more than anything else, probably ruined the American retirement system). But, over time, through this process, the 401(k) plan has become a mess. Each government agency thinks it has turf to protect. Employers feel that they have to offer a 401(k) plan, but few are equipped to handle one according to the current state of regulation and litigation.

The good news is that 401(k) plans through the Revenue Act of 1978 don't represent the only benefits or compensation law that is broken. Yes, that's also the bad news.

Consider these:

• The Pension Protection Act of 1987 and the Pension Protection Act of 2006 have probably done more to drive down the number of US pension plans than any other laws.
• A provision in the Multiemployer Pension Reform Act of 2014  that was intended to address the problem of serious underfunding in plans such as the Central States Teamsters Plan was dealt its first major setback specifically with respect to the Central States Teamsters Plan.
• The million dollar pay cap in Code Section 162(m) that was designed to limit executive compensation has done more to increase executive compensation than probably all other legislation combined.
• The Affordable Care Act of 2010 as we are seeing with announcements of 2017 exchange premiums is making health care anything but affordable.
• The Pension Benefits Guaranty Corporation's (PBGC) shortsightedness in addressing its self-determined shortfall has taken millions of participants out of the pension system thus increasing the PBGC's shortfall.

I could go, but you get the picture.

The Private Equity Multiemployer Plan Problem ... Litigated

For years, private equity funds have managed to do a good job of using the controlled group rules of Internal Revenue Code Section 1563 to avoid some of the complexities associated with them. In fact, where a single private equity group maintains multiple funds, it has typically ensured not having to deal with these rules by divvying up the ownership of any company among its funds. However, the United States District Court for Massachusetts may have dealt a serious blow to these strategies.

Section 1563(a) contains the key language specific to controlled groups.

(a)Controlled group of corporations For purposes of this part, the term “controlled group of corporations” means any group of—

(1)Parent-subsidiary controlled group One or more chains of corporations connected through stock ownership with a common parent corporation if—

(A)

stock possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote or at least 80 percent of the total value of shares of all classes of stock of each of the corporations, except the common parent corporation, is owned (within the meaning of subsection (d)(1)) by one or more of the other corporations; and

(B)

the common parent corporation owns (within the meaning of subsection (d)(1)) stock possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote or at least 80 percent of the total value of shares of all classes of stock of at least one of the other corporations, excluding, in computing such voting power or value, stock owned directly by such other corporations.

Long time followers of this blog may recall that Scott Brass has been fodder for issues specific to private equity funds in the past. Once again, we deal with Sun Capital Partners, here known by Sun Capital Partners III, III QP, and IV.

Scott Brass, Inc. was a bankrupt company essentially held 30% by Sun Capital III and 70% by Sun Capital IV. After going bankrupt, Scott Brass stopped contributing to the New England Teamsters pension fund and was assessed a withdrawal liability by the multiemployer plan.

Under the Multiemployer Pension Plan Amendments Act of 1980 (MPPAA), members of a controlled group may be jointly and severably liable for withdrawal liability payments. But, Sun Capital argued that Scott Brass was neither part of a controlled group with parent Sun Capital III nor one with parent Sun Capital IV.

The courts thought differently. Relying on ERISA Section 4001, in which we see outlined the PBGC's definition of controlled group, the courts in this case looked at substance over form. That is, the courts saw that there is, in fact, a single entity that owns Scott Brass, Inc,, despite the complex legal structure that was developed surrounding the company. In fact, the Managing Partners of Sun Capital freely admitted that the structure that they created was largely to avoid the possibility of joint and several liability for withdrawal liability.

The court ruled in favor of the Teamsters Fund. While this will surely be appealed to the First Circuit and perhaps to the Supreme Court if the First Circuit fails to overturn, this case provides an avenue by which multiemployer plans may seek payments of withdrawal liability that have previously not been available to them.

Private equity funds in similar situation should consider these potential liabilities both in due diligence and in their ongoing risk management assessments.

Is Your Executive Plan Top-Hat?

Most larger companies and some smaller ones provide many of their higher paid employees the opportunity to participate in a nonqualified retirement plan often referred to as a Supplemental Executive Retirement Plan or SERP. The rationale for having such a plan is spelled out in ERISA. The regulations specifically grants "top-hat" status to plans that are limited to a select group of management or highly compensated employees. The plan must also be unfunded (and for those people who say that lots of top-hat plans have assets set aside, that is informal funding in a rabbi trust or through insurance products or some other means).

Before going further, I'd be remiss if I did not mention that my motivation for posting this is a recent series on top-hat plan litigation in Mike Melbinger's blog.

So why should an employer or employee care if their plan is a top-hat plan or not? According to regulations under ERISA Section 104, top-hat plans are exempt from the participation, funding, vesting, and fiduciary rules under ERISA. As we shall see, this can be critically important, especially in the current statutory environment.

Backpedaling just a bit because this will help the less knowledgeable reader to understand why top-hat plans exist, let's consider what it could mean to be in a top-hat group. ERISA was enacted in 1974 to provide certain protections for employees in retirement and certain welfare benefit plans. When a plan is exempt from some of the key provisions of ERISA, it fails to provide those protections. So, being in a top-hat plan could alert a participant that he or she might not need those protections.

As some authors, mostly attorneys, have pointed out, the last year or two has seen more than the usual amount of litigation related to top-hat plans. In the typical situation, either an individual thinks that they were improperly excluded from a top-hat plan (in my completely non-legal view, this would be a tough claim to make) or because they were in a plan that was treated by their employer as being a top-hat plan, but they thought that it did not satisfy the criteria for being top-hat.

Depending on your viewpoint, the latter is either an easy claim or a difficult claim to make. Why is that? It's been more than 40 years since the passage of ERISA and we still don't have formal DOL guidance telling us what a top-hat group is. Some have argued that an individual may properly be in a top-hat group by being either management or highly compensated or both. Despite the current definition of highly compensated (Internal Revenue Code Section 414(q)) not existing until late 1986, some have argued that satisfying that criterion is sufficient. Many years ago, the DOL floated a concept that a person should be eligible for a top-hat group that a person would be eligible if their compensation was at least two times (three times in a separate informally floated concept) the Social Security Wage Base. And, finally, there is the concept that a person may rightfully be in a top-hat group if by the nature of their position, they have the ability to influence the design and amount of their compensation and benefits package.

So, knowing that we currently don't know what a top-hat group actually is, why do we care?

Suppose your company sponsors what it believes to be a top-hat plan and it turns out that it's not top-hat. Then, it's going to be subject to some fairly onerous provisions that could create massive current costs in some cases and unsolvable compliance issues in others.

Consider the following scenario.

Suppose you have a DB SERP with 20 participants. Further suppose that for whatever reason, this plan is found to not be a top-hat plan. Assuming that the company is large enough, then the plan will fail the minimum participation rules and it will necessarily (unless the company has only highly compensated employees) fail the minimum coverage tests. Full vesting must occur generally within 5 years of entry and that entry must occur not later than age 21 with 1 year of service. The plan must be funded according to ERISA's minimum funding rules. And, those plan assets must be invested according to ERISA's fiduciary standards. But, the plan will still not be a qualified plan as it doesn't meet all of the Internal Revenue Code's standards under Section 401(a).

If the plan is not qualified, it must be a nonqualified plan of deferred compensation. That makes the plan subject to Code Section 409A. So, let's throw in one more wrinkle. Let's suppose the company also sponsors a qualified DB plan and let's suppose that the qualified plan is less than 80% funded. Now, you are between a rock and a hard place. Setting aside assets (funding) for the nonqualified plan will violate Code Section 409A which will subject participants to a very large unplanned additional tax liability. (By the way, those participant will likely have to find a way to pay those taxes perhaps without having access to the deferred compensation assets in order to pay them.) Not funding the SERP will cause the plan to fail to meet minimum funding standards which will result in excise taxes under IRC 4971.

Ouch!

What should an employer do?

I've been told by more than one attorney that it is unlikely that you can get a formal legal opinion that your top-hat group is, in fact, a bona fide top hat group.

If you can't get a formal legal opinion, perhaps the best way to get comfort is to get an outsider with expertise in this area to assist with an independent analysis.

Looking at a history of case law and DOL opinion on the topic, one might consider these elements:

• The percentage of the workforce in the top-hat group
• The relative pay of the top-hat group as compared to the pay of those people not in the top-hat group
• Whether the top-hat group was selected by the Board as compared to being, for example, any employee with the title Vice President or higher
• Whether individuals in the top-hat group, especially those among the lower-paid in the group, have significant management responsibilities
• Whether individuals in the group need the protection of ERISA

Nobody really knows. But, having an independent analysis might show that an employer is acting in good faith in determining the group. Given the downside of getting it wrong, it may just be worth it to find out.

Finally, I want to reiterate that I am not an attorney and I have no qualifications to provide legal advice. As such, nothing in this post or anything else that I write should be construed as legal advice or as the practice of law.

Fees and Higher Cost Asset Classes in Retirement Plans

Earlier this week, I wrote about Bell v Anthem and the rampant litigation over fees in defined contribution plans. I thought I'd take this one step farther today and discuss a few related topics.

Since this post in particular is highly legal in nature and deals with a number of investment topics, I am going to reiterate that I am not an attorney and do not provide legal advice nor am I a CFA, CFP, or RIA, and I do not provide investment advice. Any of either that you glean from this piece is at your own risk and is not intended.

For the most part, the fee-related class action suits have been about failure of the plan sponsor and its committee to properly follow its own Investment Policy and to fail to use the least expensive funds available when it does. Suppose the retirement plan in question along with its committee believe that it's in the best interest of plan participants to have a truly diversified set of investment options available to them in the plan. And, by truly diversified, they have included a set of alternative investments and hedge funds. Many plans do not.

Alternative investments as a group tend to be expensive. One might argue that it takes a more unique skill set to manage them and that simple supply and demand justifies the higher fee structure. Whether that argument holds water or not is not the purpose here, but in any event, you just don't see inexpensive alternative investment funds. Hedge funds tend to be among the most expensive of all. Seen as the ultimate in risk and reward, fees are usually extraordinarily high when compared to other asset classes.

Now, we return to the ERISA requirements that a fiduciary act in the best interests of plan participants and that expenses not be more than reasonable (as an aside, I don't think the word reasonable should ever be in the statute because your idea of reasonable may incorrectly differ with my correct idea of reasonable ... just kidding).

What makes an expense reasonable? In the case of an S&P 500 index fund, we would expect the returns before subtracting out expenses to be virtually identical for two funds, and therefore would hope that the funds with expenses toward the lower end of the spectrum available for the plan would be considered reasonable. Two international real property funds, on the other hand, will not have the same returns. And, each probably only has one share class (in other words, there is not a retail and wholesale or institutional). If Fund A has been returning (over the last 10 years) 14% per year before subtracting expenses and Fund B only 11% per year before subtracting expenses, does Fund A justify a higher level of expenses?

I don't know.

Could you get sued if you offer Fund A in your plan with expenses at 3.5% rather than Fund B with expenses at 2%? Yes, you could. Would you win that suit? I don't know.

The whole concept raises an interesting question that I touched on the other day. With all of these 401(k) lawsuits, is it prudent to offer a 401(k) plan? Is it prudent to be on the Investment Committee of a 401(k) plan? Is it prudent to offer a fund lineup in a 401(k) plan over which you could get sued, but on which you have absolutely no idea on which merits or lack thereof the case would be judged?

I don't know the answer to any of those questions, but I think they are food for thought.

Three decades ago, the defined benefit plan was king and defined contribution plans were far more often thought as a supplemental means of saving. This concept makes more sense to me.

Is it time for a return? Is it time for a return if you have all of the characteristics of that 401(k) plan without the attendant litigation risk? I think maybe it is.

Will Fee Litigation Kill the 401(k)?

401(k) litigation is going mad. In two of the most publicized cases, Tibble v Edison and Hecker v Deere, there may have been something legitimate for plaintiffs to complain about. In the latest case, however, this one fashioned as Bell v Anthem, the litigation makes this blogger wonder why a company would offer a 401(k) plan at all.

Essentially, all of this litigation stems from ERISA Section 404(c) which among other things establishes that a retirement committee and its members individually are to act in a fiduciary manner in the best interests of plan participants with respect to the plan. For years, issues under 404(c) were not litigated, and in fact, most of us weren't entirely sure how to apply 404(c).

As plans have gotten bigger and the number of investment options has grown significantly, some attorneys have found this to be particularly fertile ground for litigation. In some cases, the issues have been judged by the courts to be clear.

As an example, suppose that XYZ Investment Company offers a large cap equity fund. Not only does XYZ offer that fund, but it has two share classes -- a retail class to which it charges accounts a fee of 80 basis points and a wholesale or institutional class to which it charges a fee of 40 basis points. This is a large difference and to the extent that a plan sponsor and committee have the leverage to have the institutional class as compared to the retail class in its fund lineup, they should.

You can do the math if you choose. Using something as simple as the Rule of 72 (you can google it if you are not familiar to estimate the results), Ms. W's account balance will double approximately every 15.6 years while Mr. R's will double about every 17.1 years. Or said, differently, at the end of 35 years, Ms. W will have roughly 3 years of excess returns over Mr. R, at least on her initial deferral. Her more recent deferrals will have smaller amounts of excess returns.

Is this material? I don't know; you tell me. Is it significant enough that the plan committee should be held liable if they opted for retail class instead of institutional? That's up to the courts.

Now, we return to Bell v Anthem. The plan in question is large. Its assets total roughly $5 billion. A plan of that size certainly has the leverage to get the least expensive share classes available for its participants, regardless of whose funds they are placing in the plan. Even the big players drool over the prospects of picking up a large mandate in a plan that big.

In the particular case, all but two of the funds offered were Vanguard funds. Vanguard has a reputation, supported by data, in the industry as having one of the lowest fee structures of anyone out there.

Of the funds that were not Vanguard, one was the Touchstone Sands Capital Select Growth Fund (Institutional Class) with a 1.31% expense ratio according to Touchstone's website. The other was the Artisan Midcap Value Fund (Institutional Class) with an expense ratio in the vicinity of 1.15% according to Artisan's website.

None of the Vanguard funds had expense ratios exceeding 0.5%. The Vanguard Target Date Funds had expense ratios of less than 0.2%. Index funds in the plan had expense ratios ranging from 24 basis points down to 4 basis points. Very few knowledgeable observers would consider those expenses to be high, and in fact, most plan advisers that I know would consider them low.

Plaintiffs, however, allege that the 4 basis point fee is too high, as there was an asset class available for the same fund that only charged 2 basis points. I saw that and wondered how material that is.

Going back again to the rule of 72, I compared the two different expense ratios. With an expense ratio of 2 basis points, an initial investment would double with a 5% gross investment return about every 14.46 years. With the 4 basis point expense ratio, it would double about every 14.52 years. That's a difference of less than one month.

Could Anthem have had the less expensive fund? Probably. Are there any complications associated with it? I haven't looked into that? Was the committee and its members guilty of some sort of fiduciary malfeasance by offering the higher cost (4 basis point) fund to its participants? The courts will have to decide that.

The issues in the suit continue. It contends that because of the size of the plan that even the Institutional Class Fund is not good enough. Instead, the suit contends, Anthem could have negotiated separate Anthem accounts at an even lower cost.

Is this practical? I don't know. Does ERISA hold fiduciaries to that standard? I don't know. If it does, would I want to be on a defined contribution plan's investment committee? Absolutely not.

My reading of ERISA suggests to me that a fiduciary is to take reasonable care in acting in the best interests of plan participants. It strikes me that reasonable care includes making good decisions. It does not strike me that reasonable care requires each committee and committee member to spend enough time to make the best decision possible.

Perhaps I am wrong though. It wouldn't be the first time.

But, let's return to the separate accounts. How long would it have taken Anthem to negotiate those separate accounts? How good a deal would they get? Since that negotiation would be on behalf of plan participants, could they charge their time back to those participants? I don't know.

Either way, if this sort of suit becomes the norm, it's time to get rid of employer-sponsored individual account plans. Businesses are in business to provide products and services. When their 401(k) plans change the way they do business, it's time to stop.

Are You Handling Your FICA Taxes on Deferred Compensation Properly?

FICA taxes on nonqualified deferred compensation (NQDC) were never a big deal. Chances were that if you had NQDC that your pay was well over the Social Security Wage Base. So, while there were situations where that was not the case, the IRS largely ignored the issue. There just weren't enough situations where it applied and there wasn't enough tax revenue in it to worry about enforcement.

Then came the uncapping of Medicare wages. That is, employees and employers were required to pay HI (Medicare) taxes on all wages, not just those up to the wage base. Suddenly, large amounts of NQDC were subject to this tax and it mattered.

For the last few years, there was a court case in Michigan related to payment of FICA taxes. I had largely forgotten about Davidson v. Henkel, but another blog reminded me of it (thanks Mike Melbinger). In the case, Henkel failed to pay FICA taxes on behalf of Plaintiff Davidson and others in the class leaving that class with a significant (to them) tax liability including penalties.

Why do we care? Why am I taking the time to write about this?

Most NQDC plans are drafted by or reviewed by attorneys (as they should be). While this is not always the case, in the typical situations, the plans are somewhat boilerplate in nature. In my personal experience, counsel often does not ask the client all of the details about how the plan will actually be administered. Frankly, even when they do ask, the client may not know. After all, the client may not be administering the plan on its own.

The plan document is a legal document. When that document says that the company shall remit FICA tax, it must. When the document instructs how or when FICA taxes will be calculated, that is what must happen.

In many plans, this is really a non-issue. There may only be one way to calculate these amounts and taxes will be due annually. In defined benefit (DB) SERPs and Restoration Plans however, there are multiple ways of handling the FICA situation. Most prominently, the sponsor may calculate (and remit) FICA taxes when they are reasonably ascertainable (a technical term from the regulations, but for many, this means at the employee's date of termination from the company) or by early inclusion which essentially means that FICA is calculated and paid annually. Early inclusion is sometimes more beneficial than waiting until retirement, but it is also more administratively complex.

Some plan documents leave the option of payment entirely to the discretion of the sponsor or administrator. Others specify that there will or will not be early inclusion.

What does yours say? Do you know?

Suppose your plan specifies early inclusion and you've not been doing that, do you have a problem? You might.

In fact, in my experience, more companies than not are not particularly on top of the administration of their NQDC plans. They've never particularly focused on compliance with these FICA rules or, even worse, Code Section 409A.

Oftentimes, it will be a good investment to have someone assist you in making sure the processes in this regard are being handled properly.

DOL Weighs in Again on Top-Hat Plans

ERISA contemplated so-called top-hat plans. In fact, it spelled out exactly what was contemplated in providing this opportunity for nonqualified deferred compensation so clearly that the legislative intent could never be misconstrued.

No, it didn't.

As is often the case when bills go from staffer to staffer and then to the floors of the houses of Congress, the bills tend to emerge with run-on sentences often punctuated by a myriad of commas making Congressional intent something upon which otherwise knowing people cannot agree.

Perhaps, some day they will learn.

No they won't, not in my lifetime anyway.

In any event, in a case (Bond v Marriott) concerning top-hat plans in front of the 4th Circuit Court of Appeals, the Department of Labor (DOL) wrote an amicus brief providing its opinion on the statutory wording around top-hat plans.

So, I know that those not familiar are just itching to find out. What does the statute say?

Congress gave us an exception to certain provisions of ERISA for a "[p]lan which is unfunded and is maintained by an employer primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees."

What is the primary purpose of a top-hat plan? Is it to be primarily for providing deferred compensation to a select group that is composed of management or highly compensated employees? Or, is it to be for providing deferred compensation to select group that is composed primarily of management or highly compensated employees?

It's one of those great questions that has confounded us through the ages. No, actually, it's a question that has confounded a select group of us since the passage of ERISA in 1974. To add to that confounding just a bit, everyone who practices in this field knows what a highly compensated employee is. The term is well defined in Code Section 414(q). But wait, Section 414(q), as written, has only been around since 1986 (added by Tax Reform) meaning that perhaps for these purposes, we don't even know what a highly compensated employee really is.

In its amicus brief, the DOL gives us its opinion, one that it claims to have held at least since 1985 and perhaps longer. The DOL tells the court that the primary purpose should be the provision of deferred compensation [for this select group] and that other purposes might include retaining top talent, allowing highly compensated individuals to defer taxation to years with lower marginal tax rates, or avoiding certain limitations applicable to qualified plans in the Internal Revenue Code. DOL further tells us that it does not mean that the select group may be composed primarily [emphasis added] of management or highly compensated employees or that the plan may have some other secondary purpose which is not consistent with its primary purpose.

The brief goes on to give us the judicial history around the provision and of course informs us which case law got it right and which did not. But, the DOL is clear in its claims and steadfastly denies that exceptions should be allowed.

I may be missing something here regarding the DOL. I think that the DOL has regulatory purview over ERISA. While the DOL has ceded that purview most of the time to the IRS where the Internal Revenue Code has a conforming section, that does not seem to be the case here. Could the DOL not have written regulations in 1975 or 1985 or 1995, or 2005 clarifying who, in fact, is eligible for participation in a top-hat plan? Or did they think it so clear that it was not worth their effort, despite being befuddled by decision after decision handed down by federal courts?

I know that when I got into this business, coincidentally in 1985, the more experienced people who taught me instructed that top-hat plans were to be for a group that was primarily management or highly compensated. In fact, it is difficult, in my experience to find practitioners who learned otherwise.

Perhaps that's wishful thinking. Perhaps, on the other hand, it's wishful thinking on the DOL's part. Perhaps the case will go to the US Supreme Court eventually so that nine wise jurists can put their own spin on it and settle this argument once and for all.

Until then, ...

Care is in Order in HR

In the corporate world, human resources is often the ugly stepsister. It's a department that spends money rather than making it, always has someone annoyed at it and is rarely viewed as an asset to the company. You may choose to disagree with those assertions, but that's not what this piece is about.

Just the other day, I wrote about being clear in your documents. Today, I move along the spectrum from clarity to care.

My motivation for writing this is a Supreme Court case fashioned as Yates v United States. It's not a case that relates to human resources. It's not a case that relates to anything that most HR departments ever even think about.

It's about fishing. Yes, you read that right. Mr. Yates is a commercial fisherman. And, in that role, Mr. Yates has some people who work for him. Mr. Yates and his workers were caught with undersized grouper and were ordered to leave them in the boat as evidence. Mr. Yates ordered his men to throw the grouper back in the water and they did. Mr. Yates was charged with a crime.

Of course he was, you might think. He and his workers were violating federal law by catching undersized grouper.

Hold on. That's not what he was charged with violating. Mr. Yates was charged with violating the Sarbanes-Oxley Act (SOX or SarbOx). You remember SOX. It was passed in 2002 to help the federal government to combat underhanded business practices such as those that were found at Enron. But, in this case, Mr. Yates was accused of the destruction of "any record, document, or tangible object" for the purpose of obstructing a federal investigation. Had he been found guilty and lost his appeal(s), he could have had to serve 20 years in a federal penitentiary.

Okay, so you just know that I am going to tell you that SCOTUS voted 9-0 to throw this case out. Wrong. The vote was 5-4 with Justice Kagan joining the utlra-conservative wing of the Court on the side that felt that Mr. Yates should, in fact, suffer the consequences of SarbOx). (By the way, you should all consider reading Kagan's dissent as it is the first one that I have seen that references Dr. Seuss.)

So, what's my point?

We all need to take care. Congress especially should take care, It is often their loose wording of the bills that they pass that causes this sort of unintended consequence.

But, perhaps more than other corporate functions, HR needs to take care. HR and its programs tends to be subject to lots of laws that either were never intended for HR or had a small component that was that was embedded in a much larger law. When the latter occurs, that benefits or compensation or workplace practice component tends to be drafted very quickly by people who may not have particular experience in that area.

Nobody can keep up with all of this stuff. But, plaintiff's bar seems to look for unusual wording in statute that can be applied in ways that would appear to have never been intended by the drafters.

So, I give a word (several actually) to the wise. No matter how sound your practices appear to be, it may wise to consider how they could be twisted and misconstrued to violate something. Can someone argue discrimination on the basis of age, gender, race, ethnicity, religion, sexual orientation, or anything else because of your well-intentioned policies? As strange as it seems, the prudent approach may be to work backwards. Start by assuming that your policies violate everything possible and work backwards to prove that they don't.

And don't forget to read about the application of One Fish, Two Fish, Red Fish, Blue Fish to Sarbanes-Oxley.

Say What You Mean in Your Documents

I've long been a proponent of saying what you mean in your plan documents, be they related to benefits, compensation, or anything else. If you know what your intent is, what could possibly be the harm in saying so.

One of my colleagues was good enough to point me in the direction of Gill v Bausch and Lomb, a 2nd Circuit case in which the plan document drafting was a bit sloppy. Without going into all the gory legal details, as I feel certain you can find an article written by an attorney that will do so, the case hinges on whether under the terms of the nonqualified plan, a retired participant is a Retiree or a Participant. It is entirely clear that defendants wanted these individuals to be participants, but it was just as clear to the court that they were Retirees who were eligible for different, more favorable treatment.

All of this could have been avoided. I'm certain that the attorneys who drafted the plan document took all reasonable care in doing so, but attorneys are human and they miss things. In my experience, in benefit and compensation plans, when they do miss something, it is most likely to be administrative or calculational in nature.

You see, very few attorneys who practice in these areas ever actually administer a plan or perform calculations related to a plan. So, when an attorney writes a plan document, it is almost always crystal clear to that particular attorney how he or she would interpret it. Sometimes, others would not agree.

I have seen documents that ask the person performing the calculations to exercise mathematical prowess that does not exist in homo sapiens. I have seen administrative practices written into plans that sounded really good, except that those practices could not actually be followed by any third party administrator.

Before I rant further, let me say that most document work done by most attorneys is very good. I am not trying to disparage the entire legal community here. But, there is always room to make a document say exactly what is intended.

While some would tell me that flexibility, especially when given to the administrator, is a good thing, I beg to differ. If we consider a not entirely hypothetical situation, Plan A is administered by TPA B from 2000 until 2013. TPA B used the discretion in Plan A's document to set certain practices that were convenient within their systems. At the end of 2013, the sponsor of Plan A fired TPA B and hired TPA C to administer the plan. TPA B's notes on its practices and procedures were pretty good, but did not cover every little detail of some of the discretionary practices. Without intending to, TPA C changed some of the administrative practices.

That may or may not be a big deal, but it's a lawsuit just waiting to happen.

I have a few suggestions. I have rarely gotten an attorney to agree with me on all of these (often some, but rarely all), but I am going to say them anyway.

• Have the document reviewed by someone who could or will be administering it. See what they think it says to do.
• Have the calculational elements reviewed by someone who understands how the calculations are supposed to work.
• And for the most controversial of them all, put something in the plan document that looks like "the intent of this section is illustrated by the following example." That's right. If you mean that a result is to be rounded to 4 decimal places, put it in the example. If you mean that rounding takes place after the second step and that 3 more calculations are done after that, put it in the example. If a methodology applies to active and retired participants, put that in the example.

You do want to win those lawsuits or better yet, not be sued at all.

Frommert Redux Again

ERISA is a funny law. I guess there are other funny laws as well, but I haven't worked with most of them as often as I have worked with ERISA. Consider the somewhat curious ERISA litigation patterned as Frommert v Conkright (you can read the most recent verdict here.

I'm not quite certain when the original case was brought, but I am certain that I was not yet eligible to make 401(k) catch-up contributions and I started making them in 2007. Since then, the 2nd Circuit Court of Appeals has heard the case three times (well, it hasn't always been exactly the same case). If it follows the pattern that it has thus far, it may even make it to the Supreme Court for a second time. Frankly, I don't know how often that happens, but it doesn't feel like it happens a lot.

So, why is ERISA a funny law? Much like lots of other American laws (and the Constitution for that matter), it was written in a somewhat different era. You know how that goes. As time moves on and creative minds are brought to bear, stuff happens. Not everything that happens could have been contemplated when the law was written.

You need an example? There are a lot of people out there in legal land who refer to the US Constitution as a nearly perfect document (I have heard it referred to that way virtually ever since I knew it existed). In fact, it's only been amended 17 times since the Bill of Rights and one of those amendments was passed to repeal an earlier amendment. So, one could argue that with an average of one amendment being passed and left in roughly every 15 years, it was pretty good.

Okay, what did the Constitution say about the internet? I was pretty sure it was silent on the matter, but I checked (ctrl-F lets you do that pretty quickly). It's not in there. So, how do courts rule on matters related to the internet. They use this legal mumbo-jumbo known as a precedent and then they often construe a relationship from one case to another. And, at the end of the day, it seems to this non-attorney that a judge or panel of judges will determine what they think is the correct answer and then leave it up to a smart, young law clerk to find them a rationale.

At its core, Frommert is about something known to retirement plan experts as a floor-offset plan. Essentially, a participant is entitled to a minimum benefit (the floor) and company defined contributions represent an offset. Since one piece of the benefit (DB) is expressed as an annual annuity and the other an account balance, performing the offset calculation requires that an administrator convert one piece of the calculation to be parallel with the other. This is done using a concept known as actuarial equivalence.

The concept of actuarial equivalence allows us to convert an account balance to an annuity or conversely. So, there's only one way to do this, right? Wrong!

The actual conversion depends on a set of actuarial assumptions, in this case the discount rate and the rate of mortality. Said differently, an account balance will pay you a different amount of money annually for the rest of your life depending upon how long you live and what interest rate is earned on the money.

The math in a floor-offset arrangement is funny, in much the same vein as ERISA is funny. Calculations, even when performed in the fairest sense possible produce unexpected results. One thing about them is certain, however, they tend to provide, relatively speaking, much larger benefits for the higher paid employees than for the lower ones. And, there is nothing in ERISA that specifically tells an administrator how to address every possible situation.

How funny are they? In Frommert (III), the court found a situation where it considered two virtually identical employees. Each retired in 2005 with the same final average earnings. Each had been hired in 1980. Employee A, however, was a rehired employee, having also worked for the company from 1960 to 1970. Employee B was a new hire in 1980. Solely because of that earlier period of employment, Employee A had a smaller benefit than Employee B. That is, Employee A was essentially penalized for his earlier period of employment.

Among other things, the court found that if this was a result of the offset calculation methodology that the method of offset was unreasonable and violated ERISA. Further, it found that the notices provided by the employer (Xerox) to employees about this plan were insufficient. So, the case is remanded (yet again) to the District Court where it will be re-heard, undoubtedly re-appealed regardless of the verdict and will very possibly once again wind up at the Supreme Court. I wonder how many of the plaintiffs will still be alive by the time this case is finally put to rest.

In Network or Out of Network -- Courts Decide

It's been the same with every health plan that I can remember being in. There is always a communication to me that I am responsible for determining whether the provider that I choose to see is in network or not. Frankly, it's never seemed fair.

Consider that health care payers don't always update their websites with changes immediately. Doctor's offices don't want to be responsible for telling their patients in which networks they are participating providers. So, the easy way out is to put the burden on the insured who really has no good way to divine the answer.

Enter Killian v Concert Health Plan. This case was eventually argued en banc (for the lay people among us including me, that means that it was heard by all the judges of the Court) before the 7th Circuit Court of Appeals (housed in Chicago). The Court, as I read it, ruled for the plaintiffs. For plan participants, this is good news. For insurers and perhaps for plan sponsors, it's not as good.

The most important (to me) facts were as follows:

• Susan Killian was a cancer patient.
• She suffered from lung cancer which spread to her brain.
• The first hospital that she went to (in network) said they could not operate, but sought a second opinion.
• The second opinion was provided at Rush University Medical Center that thought they could successfully operate.
• She was admitted for successful brain surgery, but died a few months later.
• The Killians (Susan Killian was married to James) received only out of network reimbursement for services at Rush.

This seems fairly normal, doesn't it? Well, it would be, if not for this fact pattern:

• Mrs. Killian's insurance card had on it several toll-free numbers that insureds could call to ask questions about their coverage.
• Mr. Killian called one before Mrs. Killian's surgery.
• The representative said there was no information on the hospital (Rush), but to "go ahead with whatever had to be done."

The Court cited five points in combination in coming to its decision:

1. Mr. Killian did appear concerned/interested in whether the providers were in or out of network.
2. Mr. Killian did follow the instructions on Mrs. Killian's insurance card by calling one of the toll-free numbers and inquiring about the in versus out of network status
3. Mr. Killian informed a representative (at the toll-free number) that he was looking to determine whether the surgery would be paid for as in network
4. Mr. Killian was told by the representative at the toll-free number to "go ahead with whatever had to be done."
5. Mr. Killian acted as a reasonable person would in extrapolating from that that the services would be covered as in network.

What the Court decided was that Mr. Killian may now pursue a claim against his deceased wife's health plan for breach of fiduciary duty. What Mr. Killian will actually do and how a court will rule on that matter is not clear, but this is the first case that I am personally aware of where the burden of determining in versus out of network status has been shifted somewhat by the Courts.

I'm not an attorney, so I'll leave the rest of the analysis to those with formal legal training. That said, as a health plan participant who has at times during his own lifetime been frustrated by the same determination, this feels like a step toward protection of plan participants who do act diligently.

Federal Court On the Money in Pension Case

I am stunned. Defined benefit pension plans and their funding measures and funding rules are a very complicated topic. In fact, federal judges (for private plans, they must be federal as ERISA preempts state law) often struggle to understand the intricacies of defined benefit plans.

I can't blame them. Congress has written statute that is so twisted as to make it extremely difficult for experts at the IRS to provide regulations and for trained actuaries to them implement. These are people who spend much of their working lives worrying about the rules underlying pension plans. For a judge with little or no formal pension training to see through the fog is a really nice change.

So, what's it all about, [Alfie]?

In Palmason v Weyerhauser, as I understand it, plaintiffs brought suit because Weyerhauser invested too large a portion of its qualified pension assets in risky asset classes, primarily alternatives (while the opinion doesn't specify, generally pension assets are considered invested in alternative assets when those assets are classified as none of cash, fixed income, or equity, e.g., real estate or infrastructure). At some point, the plan became underfunded.

It's time for an explanation. And, the Court got this one right. Measures of the funded status of a pension plan can be on many different bases. For accounting purposes, we have two different measures of the obligations (often referred to as plan liabilities) of a plan each based on a discount rate which is determined based on yields of fixed income instruments on the last day of the fiscal year. The Pension Benefit Guaranty Corporation (PBGC) looks at the plan's liabilities based on the rates at which PBGC thinks those obligations could be settled in the event of plan termination (this tends to produce a particularly high liability). IRS (and ERISA) funding rules are theoretically similar to accounting rules, but due to smoothing techniques and a constant stream of funding relief rules, a plan's funding liability (sometimes referred to As AFTAP) may be far less than these other liabilities.

In the Court's opinion, it points out that plaintiff must have standing to sue when the claim is filed. Attorneys could give you chapter and verse as to why this is the case and what generates standing, but I'll keep it simple. Under ERISA, generally, to sue for monetary damages, one must be able to show monetary harm.

In a US qualified defined benefit pension plan, a participant (except in the case of certain plan terminations) is entitled to a payment from a pool of assets. Those assets are used to pay the benefits of all plan participants. So, unlike a defined contribution plan, a diminution in plan assets may not affect the ability of the plan to pay benefits to a particular participant.

In any event, plaintiff's expert pointed out that the plan was funded 76% or 85.5% at the time the suit was filed. These were apparently accounting and PBGC measures, but not funding measures.

How can a participant be harmed by the funding level in a defined benefit plan if the plan is not being terminated? Essentially, there are two ways:

• If a plan's AFTAP is less than 80%, a participant's ability to receive a lump sum payment may be eliminated in part or in full.
• If a plan's AFTAP is less than 60%, a participant's future accruals will cease [perhaps temporarily].

The plan was not close to either of these conditions. Near the date that the suit was filed, the AFTAP was likely in the vicinity of 100% or more.

While I do not have access to the report or testimony of plaintiff's expert, it would appear that he focused on the measures that he did because they helped his client's case. Perhaps he did this because he realized that participant had no case otherwise. 

Would you as an expert take a case where the only testimony that you could provide would be that which only purpose would be to obfuscate the real point?

Judge Lasnik was not pleased. Rarely, if ever, have I seen a pension case where the judge calls out an expert by name and essentially criticizes his testimony for ignoring the real facts of the case. I hate to criticize my actuarial brethren as oftentimes, judges have not understood really relevant testimony from actuaries and made, shall we say, interesting rulings, but in this case, the judge saw the smoke and mirrors and appropriately, in my opinion, shot down the expert. 

More On Private Equity and Retirement Plans

Just last week, I wrote about the ruling in Teamsters v Scott Brass. If you didn't read it, of course I think you should. The case, on its surface, focused on whether a private equity holding company (forgive me if I am not using the term exactly as an attorney would) and its funds were liable for multiemployer plan withdrawal liability when one of the fund companies that happened to participate in a multiemployer pension plan declared bankruptcy. The key to the First Circuit ruling was that the so-called Sun Funds were considered to be trades or business. In my previous post, I gave a bit of an explanation of the court's rationale for this. If you want a more detailed legal analysis, you can find one here.

I had an interesting conversation on this topic yesterday with an ERISA attorney who happens to no longer be practicing law. As the conversation progressed, we each realized (I think we already did, but to hear someone else agree with you makes it sink in a bit more) how complex this can be.

Think about the way a private equity company typically runs its portfolio. The holding company does make decisions about who will be in management at the portfolio companies. The holding company also usually makes some decisions about the way those business will be run. But, the holding company usually does not bother itself with the administrative details ("administrivia" if you need a cute little made-up word to describe this) of its portfolio companies' businesses. It leaves them to the individual companies.

Who cares?

The holding company should care. The portfolio companies should care. The employees of the portfolio companies should care. The officers and or directors of the holding company should care.

Consider a simple, but not irrational (purely hypothetical, however) private equity fund portfolio (we'll call it Fund 1):

• Amazing Architects of Alaska
• Brilliant Babysitters
• Creative Candles 
• Dreamy Doctors and Dentists of the Dakotas
• Excellent Embroidery Experts
• Fabulous Florists
• Groovy Gambrelers (a gambreler is a person who prepares animal carcasses)
• Happy Hypnotherapists of Hilo and Honolulu

Most of these companies have qualified retirement plans. The babysitters, all being young and also low-paid have never considered the day that they might retire, so they don't yet have one. All of the others have a 401(k) plan, but the embroiderers and florists don't have any matching contributions in theirs. At the same time, the doctors and dentists also have a profit sharing feature as well as a defined benefit plan to maximize their tax savings and their ultimate retirement benefits.

Still, who cares? For each company, these are the same benefits that they had before they were acquired by Fund 1.

In light of Scott Brass, all of the companies should care. They are part of a controlled group of corporations now. That means that unlike what they did when they were separate self-contained entities, they now must perform their nondiscrimination, coverage, and minimum participation testing on a controlled group basis. 

What does that mean in practice? Isn't this just administrivia? Let's consider some of the issues that we have here.

• Company D has the highest-paid workers in the controlled group as well as the highest concentration of highly compensated employees (HCEs). Company D also has the richest benefits. And, Company D provides something known as benefits, rights, and features that no other portfolio company does. 
• Company B is the lowest paid. It has only nonhighly compensated employees (NHCEs) who receive no retirement benefits.
• Companies E and F have employees who are generally low-paid, but they get no matching contributions.

Do you get the picture yet? Fund 1 has a mess. Worse yet, by the magic of a fact pattern that I just created for this scenario, Fund 1 had a mess for the 2012 plan years (all calendar years). 

In a nutshell, the mess can be described this way. HCEs in total had benefits that were far more generous than NHCEs. Those HCEs also had benefits, rights, and features (BRFs) on a basis that was discriminatory in their favor for 2012. 

The good news is that there is a retroactive correction period to fix this problem (it ends on October 15, 2013). The complicating news is that the only way to fix the problem now is to provide additional benefits and BRFs to NHCEs. In other words, because of the extremely rich benefits at Company D, Companies B, E, and F are going to need to provide additional benefits.

The innocent onlooker says that's great. Surely, those poor babysitters, embroiderers and florists deserve something. But, benefits cost money. Who is going to pay for them? If we give benefits to babysitters, then that business goes from being profitable to one that is losing money. But, if we don't then, the plans for Company D risk disqualification.

Okay, you got me, this is just a bad dream, isn't it? Nope, this stuff happens and it happens frequently. To date, many private equity companies have chosen to ignore it, but post-Scott Brass, ignorance is probably not bliss.

These problems can be fixed, but not many people know how to do it. Such a person must have a good knowledge of the law, the suite of nondiscrimination regulations, and the mathematical/actuarial skills to perform the calculations.

There aren't very many of us. Call me ...

Ruling Affects ERISA Compliance Issues for Private Equity Funds

Just last week, the First Circuit Court of Appeals ruled in New England Teamsters v. Scott Brass Holding Corp. So, what's the big deal and why am I writing about it here? Well, Scott Brass Inc. was wholly owned by a combination of Sun Capital Partners III and Sun Capital Partners IV, a pair of private equity funds under the Sun Capital Partners umbrella. Scott Brass participated in the New England Teamsters & Trucking Industry Pension Fund. When Scott Brass went into bankruptcy protection, it was assessed a withdrawal liability.

The District Court accepted the argument of Sun Capital Partners that their funds were not "trades or businesses" and were therefore not liable for withdrawal liability payments. But, the Appeals Court held that the Sun funds invested in Scott Brass "with the principal purpose of making profit." Further, although Sun argued that it had no employees, the Court noted that the partners of the Sun funds had and exercised the authority to hire, fire, and compensate employees of Scott Brass. Additionally, partners of the Sun funds were "actively involved in management and operation" of the company.

The implications of this ruling are potentially far more significant than just this withdrawal liability case. Diligent readers (I certainly hope I have a few) may recall that nearly two years ago, I wrote on retirement compliance issues for private equity funds. At least a few readers wrote to me to tell me that private equity funds were exempt because they were not, in fact, businesses.

Pshaw!

While I am not an attorney and am therefore not technically qualified to opine on what the Appeals Court said, I can read. This seems to make clear to me that at least in the states of Maine, Massachusetts, New Hampshire, and Rhode Island as well as the Commonwealth of Puerto Rico, private equity funds can be businesses. Since there primary purpose generally is to make a profit and since they tend to exercise some management authority over the companies in their portfolios, it strikes me that this ruling can be construed to make them (where they have 80% common ownership) a controlled group of companies.

So, private equity funds beware. This means that:

• you and your partners might be jointly and severally liable for funding of qualified retirement plans in the controlled group
• all those retirement plans in the controlled group are subject to the nondiscrimination, coverage and minimum participation rules of ERISA and the Internal Revenue Code
• we could say the same about welfare benefit plans and their nondiscrimination requirements

Of course, there are other requirements and pitfalls, but I thought it worth it to point out a few. The effect here could be significant. How many companies that are owned by private equity funds, for example, do their nondiscrimination testing on a controlled group? Or, conversely, how many do not? 

Somebody out there is going to latch onto this and stir up some trouble. The question to me is will other circuits follow the first?

No Ma DOMA

The times, they are a-changing. When the Defense of Marriage Act (DOMA) became law in 1996, it defined marriage, for federal purposes as between one man and one woman. From a human resources standpoint, this has been causing problems for years. And, actually, at least for the time being, it will continue to cause problems.

Unless you were hiding under a rock last week, you know that in United States v Windsor, the Supreme Court overturned the key provisions of DOMA making legal (or at least failing to make illegal, but I guess those are the same things) marriage between one woman and another woman or one man and another man. I won't get into whether this will also open the door for polygamist or incestual marriages; this is for another prognosticator, far more clairvoyant than I.

I'll discuss some of the new issues, but first I digress. Often in this blog, I discuss things related to the Employee Retirement Income Security Act (ERISA). ERISA is federal law. By statute, generally, it preempts state law. Therefore, DOMA affected ERISA plans. Marriage has been defined under federal law. But, marriage is also defined under state law, and as we all know, there are 50 states. This leaves room for 50 separate laws. I will describe this as not a pretty picture.

Anyone with virtually any knowledge of ERISA knows that bona fide spouses have certain special rights under ERISA. Among them are these (by no means an exhaustive list):

• In some plans, spouses are entitled to preretirement death benefits. So, in the case where two people of the same gender were legally (under state law) married before this case was overturned and the participant died, is the spouse retroactively entitled to preretirement death benefits? Suppose they are and suppose those benefits were already paid to someone else, does that mean that the plan can recoup the money that it already paid to another beneficiary? Does it mean that the plan must recoup the money it paid to another beneficiary?
• In the event of divorce, spouses may be entitled to qualified domestic relations orders (QDROs) or qualified medical child support orders (QMCSOs). I think this one is generally simpler. You see, divorce orders, even where QDROs and or QMCSOs could apply are not required to include them. But, wait, there's more. Suppose two individuals had been legally married under state law, but not under federal law and got divorced. And, suppose the value of a pension that one of them had was not considered in a divorce settlement because of DOMA. Would a court revisit this? That's pretty complicated.
• Participants in an ERISA health benefits plan can make pre-tax contributions for spousal (and spouse's children) benefits. They missed the opportunity in some cases. How does this get rectified?
• And, since spouses are generally eligible for coverage under these plans, that makes them eligible for COBRA coverage. But, COBRA coverage needs to be elected on a timely basis. And, in fact, it needs to be offered on a timely basis. And, this is another one where I can see the problem, but don't know the answer.
• Many elections under ERISA require spousal consent. Since ERISA is federal law, spouses who had been valid under state law did not have the opportunity to give consent in these situations. So, obviously, they didn't give such consent. Now what?

And, then there are the tax issues. Does a legally married same-sex couple get to refile taxes? For how many years? For open tax years only, or are they entitled equal protection? What about their employers who offered same sex marriage benefits? Do they get to refile taxes? Suppose they covered domestic partners as well? Are they covered by this decision in states that don't yet condone same-sex marriage? (I don't think so, but please don't come to me for legal advice that I am neither qualified nor authorized to provide).

Finally, I can't leave this topic without commenting on a special issue that arises in my home state for the last 25 years. Georgia, at least since I have been a resident, has chosen to simplify its income tax process by basing it on one's federal tax filing. Suppose a same-sex couple was legally married in a state that permits it (Georgia does not yet permit it). Further suppose that couple now chooses to file their federal income taxes as "married" or using their other option of "married, but filing separately." Georgia income tax forms tell me that I must file for state purposes using the same status as I do for federal purposes. Do we still do this? If a same-sex married couple can't do it, then are other couples entitled to not do it? How does this work?

What does the Supreme Court think of this? Actually, the justices probably don't care. it's not their problem. They've made their decisions. Implementation, except where it does not comport with their rulings, is neither their purview nor their concern. Maybe they should all need to take a turn in a human resources department. On second thought, maybe not.

M&A Post McCutchen

Yesterday, I wrote about US Airways v. McCutchen. Today, I consider another practical application.

For those who didn't read yesterday's post or have already forgotten, McCutchen was clear in telling us that in the case of employee benefit plans, unambiguous plan provisions are controlling. What we also learn is that where plan provisions are ambiguous, well, we don't know exactly what we learned.

Now, let's consider the M&A world. Typically, when one organization is looking at buying another, a due diligence process starts. The acquiring company and its representatives (attorneys, accountants, consultants, etc) review documents, properties, and virtually everything else of any value that the potential acquisition may have. Typically, among the last of those elements to be reviewed are those that may fall under human resources, among them compensation and benefits programs.

Let's go back to McCutchen. Suppose the proposed deal is a stock sale, one in which the acquirer purchases the assets and liabilities of the other company. Among those liabilities are any resulting from benefits and compensation programs. Suppose one of the plans has terms that are vague. Further suppose that there is no particular documentation of the interpretation of those vague terms.

In my experience, representations and warranties frequently do not protect against such an occurrence. Consider a defined benefit pension plan. If the acquiring company has the opportunity to review all the documents and does, but in the case of this plan spends its time reviewing the results of actuarial calculations, what happens if the actuary is taking a reasonable, but incorrect interpretation of vague plan provisions. Perhaps the interpretation is based on the explanation of a benefits manager who retired years ago. Perhaps there is little if any documentation.

In a post-McCutchen world, this could be problematic. Perhaps the plan's obligations are larger than the acquirer has reason to know.

How can the acquiring company deal with this? During due diligence, review the plan provisions side-by-side with determinations of benefits. If every provision seems clear and the benefits determinations seem to confirm this, then things are probably just fine. If they are not, take particular care before the deal is done.

Again, typically, this sort of review is done by attorneys and accountants. Typically, neither has any experience with plan administration and often, neither has experience with actual determination of benefits. Ask an expert for help.