United States: Qualified Retirement Plans: August 2004 Developments

If you, as an ERISA fiduciary, are "floundering" in uncertainty in the aftermath of the mutual fund scandals, you are in good company. At the ABA annual meeting in Atlanta in August, employee benefits attorneys strongly encouraged Labor Department speakers to tell the Department that more guidance is needed by plan fiduciaries on their duties with respect to the mutual funds used as investment options in their participant-directed 401(k) plans. The Labor Department representatives acknowledged the request. They also reported that their investigations of mutual funds continued to focus on, among other things:

• Market timing issues,

• Fee arrangements,

• Service providers that interact with the mutual fund industry, and

• Service providers to pooled investment vehicles.

The Labor Department representatives indicated that it was unlikely that the Department would bring a lawsuit to enforce fiduciary duties against ERISA fiduciaries where the plan's procedures were followed, the fiduciary had the information needed to make a decision, and the fiduciary just "blew it". It was suggested that a lawsuit might be initiated against a fiduciary that got into trouble after failing to follow plan procedures.

We presume the "plan procedures" to be followed should include a plan "investment policy statement" establishing procedures for selecting and reviewing plan investment options for participant-directed 401(k) plans. It may be noted that it is hard to follow procedures that do not exist. Do you know where your plan.s investment policy statement is?

Plan sponsors offering retirement investment advice also are not sure where they stand. The Employee Benefits Research Institute has reported that about 49 percent of plan sponsors now offer retirement investment advice to their workers. The reasons cited for doing so include: the service is offered as part of a package from a plan service provider (51 percent); concern over fiduciary liability and the need to satisfy ERISA Section 404(c) (25 percent); and employee demand (8 percent). Of the firms not providing retirement investment advice, 62 percent cited as the reason for not doing so, their concern about liability associated with providing the advice. In this survey, investment advice was defined as providing advice that was customized to meet the specific goals and needs of an individual and did not include general education about investments.

The Seventh Circuit holds that an employer does not owe a fiduciary duty under ERISA to an employee with respect to future fringe benefit plans, because the employee was a participant in the employer's pension plan. Beach v. Commonwealth Edison Co., No. 03-3907 (Seventh Cir., 8/24/04). The 2-1 decision concluded that the employer owed no fiduciary duty to the employee with regard to an early retirement incentive plan that was not created until six weeks after he retired from the company. The new severance plan was a "stand-alone welfare-benefit plan that does not amend, supplement, or replace any other plan. As it did not come into existence until after [the employee.s] retirement, ComEd did not owe him any fiduciary duty concerning its benefits" according to the majority opinion. The dissenting opinion questioned this approach of tying fiduciary duties to specific ERISA plans and argued that when an employer speaks about new benefits that are related to benefits in a plan under which the employer and employee already have a fiduciary relationship, the employer speaks about the future of plan-related benefits and is speaking in a fiduciary capacity.

The employee specifically asked before retiring whether the company planned to offer an early retirement incentive program and was told by his supervisor and other HR representatives that the company was not considering any such programs and, if they were, his department would not be included. It is these affirmative misstatements that are able to be completely disregarded, in the majority view, because they were not made with respect to an existing ERISA plan. One assumes that life would have been simpler for all if the misstatements had not been made in the first place, and that should be the key lesson of this case.

ERISA's anti-alienation rule does not apply to benefits after they are distributed. This long-standing interpretation of the law was recently affirmed in Hoult v. Hoult, 374 F.3rd 47 (First Cir., 2004). A court order may require a person to deposit his monthly pension check into a bank account in order to satisfy a judgment against him and ERISA's nonalienation rule will not be violated, i. e., these amounts can be reached by creditors.

Here is a warning to plan administrators reviewing proposed Qualified Domestic Relations Orders. The case of Grecian v. Grecian, 2004 Opinion 35 (Idaho Ct. of Appeals) was a dispute between two formerly married people involving a QDRO purporting to divide a 401(k) account balance. We assume that the Plan was involved in the resolution of the dispute and probably incurred expenses associated with the efforts to decide what the QDRO actually required the Plan to do. The proposed QDRO, presented to the Plan in March 2001, called for the division of the participant.s 401(k) account as follows:

The account balance had dropped in value from the divorce date ($64,011.46) to the distribution date ($45,263.31). The plan accepted the order as a QDRO and paid out one-half of the account's current value of $45,263.31. When this distribution was challenged by the alternate payee, the district court held that the alternate payee was entitled to one-half of the value on the date of the divorce (one-half of $64,011.46).

It is not up to us to decide whether or not the court came to the right answer as to the meaning of the language in the QDRO. Our point is that the proposed QDRO language seems ambiguous concerning treatment of gains and losses in the account after the marriage termination date, especially in light of the decline in value of the account to the date the QDRO was submitted for review. We think that the time to deal with that kind of ambiguity in a proposed QDRO is when it is presented to the plan administrator for approval. That action, in this case, could have saved a lot of trouble and expense for the Plan.

ERISA preemption bars state law malpractice claims against ERISA plans. In June 2004 the U. S. Supreme Court unanimously ruled that ERISA preempted two HMO subscribers' claims that their HMOs violated state law by refusing to cover certain medical services. The Supreme Court held that the two subscribers' state law claims fell within the scope of ERISA, and were preempted by ERISA, because the claims did not arise independently of ERISA or of the terms of the plans. Aetna Health Inc. v. Davila, 124 S. Ct. 2488, 32 E.B.C. 2569 (2004). Preemption means, in effect, that the dispute must be resolved under ERISA and not under state law. This is not popular with plaintiffs alleging malpractice because ERISA does not provide for punitive damages as do most state malpractice laws.

In June the Supreme Court also vacated an Eleventh Circuit opinion that found that a plaintiff's malpractice claim against an HMO could be heard in state court because it involved mixed issues of eligibility and treatment. The Eleventh Circuit relied on an earlier Supreme Court decision (Pegram v. Herdrich, 530 U. S. 211 (2000), to reach that conclusion. On remand, the Eleventh Circuit reversed its earlier holding, based on Davila, and concluded that the plaintiff's malpractice claim was preempted, because he was suing the HMO and not his treating physician or the employer of the treating physician.

First conviction occurs for violation of HIPAA privacy rules. The conviction was obtained in a plea agreement entered into by an employee of a Seattle health system that used a patient's name and identifying information to obtain credit cards then used to make large purchases for the benefit of the employee.

The IRS published final regulations on incentive stock options (ISOs) that are generally consistent with proposed regulations issued in 2003. (T.D. 9144, Aug. 3, 2004). ISOs are described in Internal Revenue Code Section 421. The rules provide that if an employee holds for a required period of time shares of stock obtained on exercise of an ISO, any gains on sale of the stock will be capital gains (and the employer does not receive a corresponding compensation expense deduction). A number of specific requirements apply to determine if an option qualifies as an ISO. For example, the exercise price cannot be less than the fair market value of the underlying stock on the date of grant; an ISO plan must be approved by shareholders; and the amount of stock options that can be finally granted as ISOs in a year to an employee may not be more than $100,000.

The final regulations include several points, highlighted by the IRS, as being responsive to comments received on the proposed regulations. In addition to specific substantive changes that should be reflected in the terms of an ISO plan, the following general changes are included in the final regulations:

• Under the final rules, in the event of an assumption or substitution of options as the result of a corporate transaction, "employee" is deemed to include a former employee within the three month period following termination of his or her employment relationship.

• The employment relationship, under the final rules, is deemed to continue while an individual is on a three month or less military leave, sick leave, or other bona fide leave of absence, or if longer, the person's right to employment with the employer granting the option is provided by statute or contract. The proposed regulations used the phrase "guaranteed by statute or contract." This was found to be too absolute and could be read to exclude absences under the Family and Medical Leave Act (FMLA) or the Uniformed Services Employment and Reemployment Rights Act (USERRA), where reemployment rights are protected but not guaranteed.

• In the final regulations, a revised example now illustrates that, where an ISO plan is assumed in connection with a corporate transaction, additional shareholder approval may be avoided if the consolidation agreement contains adequate provisions.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.