Department of Labor investigations of employee benefit plans can be challenging experiences for employers. The time demand can be a significant drain on the business, and the employer needs to be concerned about potential issues the investigator may raise. We believe the best defense is a good offense: we like our clients to take their responsibilities seriously well before an investigation. But employers are sometimes surprised that an investigator asks questions that were not asked by the auditors who conducted independent financial statement audits over the years. As a JD/CPA (double geek) I can tell you this audit is only one step in the ERISA fiduciary due diligence process. But, I thought it would be helpful to seek the input of a CPA who has been a member of both the Executive Committee of the American Institute of Certified Public Accountants (AICPA), Employee Benefit Plan Audit Quality Center, and the AICPA Employee Benefit Plans Expert Panel – James E. Merklin, partner in charge of Assurance Services at Bober Markey Fedorovich, an independent CPA firm. Jim was gracious enough to share his perspective, as follows:
When ERISA was enacted in 1974, one of the provisions required (in general) that plans in excess of 100 participants provide audited financial statements with their annual reports. Some plan sponsors will consider an audit to be akin to an insurance policy that their plan is in good shape and would meet the scrutiny of regulatory authorities if examined. But audits were never intended to serve in that kind of capacity and so there is clearly an expectation gap between what these plan sponsors think they are getting with the annual audit and the service that plan auditors are actually rendering. But – if there are indeed compliance problems, would you rather catch these yourself or let the regulators find them on examination and come in with Thor’s hammer to resolve the problems?
The purpose of an audit of the financial statements is to allow an auditor to express an opinion as to whether the financial statements and related footnotes and supplemental schedules for a benefit plan are prepared in accordance with accounting principles generally accepted in the USA. Auditors are required to follow procedures that are dictated by the American Institute of CPAs and/or the Public Companies Accounting Oversight Board in arriving at their opinions covering the financial statements of the benefit plan. In many cases, the auditor doesn’t even express an opinion on the financial statements – there are provisions within ERISA that allow the plan sponsor to limit the scope of the audit to exclude work on investments, investment income and investment transactions if the investments are certified by a qualified institution (a bank, an insurance company or a regulated trust company.) When the audit is limited as described here, the auditor cannot express an opinion on the financials due to the significance of what has been excluded from the audit scope.
Again, the main focus of the financial statement audit is on the presentation in the financial statements. One of the assertions underlying a financial statement is that the plan is a qualified plan and thus exempt from income taxes, and in support of that assertion auditors will perform some testing to look at compliance with the plan document and regulations. However, this level of testing is not intended to provide absolute assurance that any deviations would pass the scrutiny of the regulators (Internal Revenue Service and/or Department of Labor) but rather to identify for the auditor as to whether there is a sign that the plan is so grossly in violation of terms or law that their tax status would be at risk, or that any material misstatements to the financial statements whether due to error or fraud, are identified and reflected appropriately therein. Remember IRS/DOL penalties are the responsibility of the plan sponsor / administrator and not of the plan itself, so the plan’s financials would not be misstated if there were no mention of such risks within those financial statements.
So – are there risks to the plan that might be reasons to dig in to a plan deeper than a financial statement audit might? Absolutely – following is just a sprinkling of some areas that would be worth paying attention to.
- What is the correct definition of compensation per plan document? Is the plan actually applying this definition correctly?
- Are there any instances of late remittances of participant contributions and loan repaymentss?
- Are there any instances of failure to comply with participant elections?
- Are there any instances of improper application of eligibility provisions of the plan?
- Have there been any instances of calculations of improper vesting and employee distributions?
- Has there been turnover among your employees who have responsibilities relating to the plan, and are the current personnel adequately trained? How do you make certain that the plan is being operated in accordance with the plan document? Who is responsible for making certain that the plan document is timely amended and restated?
- What oversight does the plan sponsor perform with regard to third party administration of the plan?
- What is the plan’s stated investment strategy? How is that reflected in the investments offered to participants?
Many benefit plan auditors are capable of helping you with an assessment of these and many other compliance risks to your plans. I would recommend that, if you wish to use your plan auditor to assist you with an assessment, you verify first that they have the qualifications to be positioned to do so. That means that not only are they are doing a lot of benefit plan audit work but also a lot of tax reporting and compliance work. And I also strongly recommend that such assessments be conducted in conjunction with the plan’s qualified ERISA legal counsel; in fact, performance of compliance assessments under the attorney’s privilege would be most protective to the plan’s interests.
We appreciate the input! James E. Merklin’s biography, and his contact information, are here. DOL guidance on ERISA fiduciary responsibilities is here.
Hot off the press are the final regulations for the employer shared responsibility provisions of the Affordable Care Act (more commonly referred to as the “pay-or-play mandate”). In fact, the regulations are so new that they will not actually be published in the Federal Register until tomorrow, February 12. For those of you who are dying to get a first glimpse, a pre-publication version can be found here.
While the regulations are extensive (227 pages), many of the provisions of the proposed regulations have been retained. However, there are a couple important transition rules buried in the final regulations that provide a welcomed reprieve from the pay-or-play mandate for certain employers.
The pay-or-play mandate was initially set to take effect beginning in 2014. In July 2013, the IRS issued Notice 2013-45, which delayed the pay-or-play mandate until 2015 for all employers. The final regulations retain this delay, but also provide an extended delay for smaller “large employers.” This would include employers with an average of 50-99 full-time employees (including full-time equivalent employees), with full-time generally being defined under the Affordable Care Act as an average of 30 or more hours per week (assuming Congress does not change the full-time employee definition to 40 hours per week as is currently being considered). Employers with an average of 50-99 full-time employees are not subject to the pay-or-play mandate until the first plan year beginning on/after 1/1/2016, provided the employer:
- does not reduce its workforce between 2/9/2014 and 12/31/2014 in order to avail itself of the extended delay (i.e., to fall within the 50-99 employee range);
- satisfies certain coverage maintenance requirements for the period beginning on 2/9/2014 and ending on the last day of the first plan year beginning on or after 1/1/2015; and
- certifies that it satisfies all of the foregoing requirements on a designated form.
If an employer satisfies these requirements, the employer would not face any assessable penalty under code Section 4980H(a) or (b) for any calendar month during 2015 (for calendar year plans) or any calendar month during the portion of the 2015 plan year that falls in 2016 (for non-calendar year plans).
The final regulations also contain a favorable transition rule for larger “large employers” (i.e., those with 100+ full-time employees (including full-time equivalent employees)). While these employers are still subject to the pay-or-play mandate beginning in 2015, the final regulations loosen the rules governing the application of the “no coverage penalty” for 2015. As a reminder, this penalty applies if a large employer fails to offer coverage to at least 95% of its full-time employees and their dependents. Employers that do not satisfy this coverage requirement are subject to a penalty of $2,000/year (adjusted for inflation after 2014) for each full-time employee (less first 30 full-time employees).
For the 2015 plan year only, the final regulations alter these rules a bit for employers with 100+ full-time employees. Under the modified rules, an employer with 100+ full-time employees will not face a “no coverage penalty” if the employer offers coverage to at least 70% of its employees and their dependents. Further, if an employer with 100+ full-time employees is subject to the “no coverage penalty” by virtue of covering less than 70% of its full-time employees, the penalty is equal to $2,000/year for each full-time employee (less first 80 full-time employees).
These transition rules should come as a welcome surprise to employers who are currently working through the inherent difficulties of complying with the pay-or-play mandate. However, employers should keep in mind that these transition rules are temporary and limited. So, while putting pay-or-play planning on the backburner until late 2014 (or late 2015 for employers with 50-99 full-time employees) might seem attractive, employers should begin working with trusted advisors now to make sure they are ready when they face the full brunt of these rules.
In light of health care reform, we anticipate ERISA preemption cases to start popping up more frequently. Two recent decisions demonstrate that ERISA preemption is complicated, except when it isn’t. In Liberty Mutual Ins. Co.v Donegan, Second Circuit Judge Dennis Jacobs explains the complicated nature of ERISA preemption. This opinion may be helpful for anyone to develop a better understanding of the topic and its history. (Shameless plug alert: you also may want to see the preemption chapter that I edit in ERISA: A Comprehensive Guide.)
Then there is the decision that demonstrates when preemption isn’t complicated. Seventh Circuit Court of Appeals Judge Richard Posner is blessed with the gift of being able to make even an ERISA opinion an interesting read, especially when he is annoyed. In Kolbe & Kolbe Health and Welfare Benefit Plan v. Medical College of Wisconsin, Inc., a plan paid $1.7 million for a child’s health care treatment, before concluding the child was not a dependent of the employee plan participant. Asserting both ERISA claims and state law breach of contract claims, the plan sought repayment. The district court dismissed the suit, and awarded attorneys’ fees to the hospital as Rule 11 sanctions for filing what the judge considered to be frivolous claims.
The 7th Circuit appellate court affirmed the dismissal of the ERISA claims, but reversed the dismissal of the breach of contract claim because it disagreed with the district court’s conclusion that the claim was preempted by ERISA. The appellate court also reversed the imposition of sanctions, on the grounds that the claims were colorable and had been made in good faith, and remanded the case for consideration of the breach of contract claim.
On remand, the district court issued summary judgment in favor of the hospital. The plan appealed, and this is where the hospital crossed a line: it cross-appealed, complaining about the district court’s refusal to sanction the plan under Rule 11 after the plan established that the breach of contract claim was preempted by ERISA. In other words, it ignored the appellate court’s ruling. As Judge Posner explained:
The hospital defied us. It is the hospital that is lucky to escape being sanctioned.
While we chose these cases to tee up the topic of ERISA preemption, there is another point we want to make with Kolbe & Kolbe. Clients want aggressive litigators. We get that. But if you are going to play in the litigation sandbox, you need to know when it is time to pick up your toys and go home. The hospital got to keep $1.7 million, and demanding Rule 11 sanctions here was like throwing sand in the other kid’s face.
When I first started practicing law, a veteran in this area told me that the only way to make sense of the Internal Revenue Code was to understand that each provision existed so that Congress could make money. Does that explain why, as we reported last year, the American Taxpayer Relief Act of 2012 allowed any amount in a non-Roth account in eligible retirement plans (401(k) plans, 403(b) plans, and governmental 457(b) plans) to be converted to a Roth account in the same plan, whether or not the amount was distributable? Previously, plans could allow participants to convert their pre-tax accounts to Roth accounts only with respect to amounts the participants had a right to take out of the plan. Well, by taxing the amounts so converted from pre-tax to Roth, this change in the tax law is expected to produce an extra $12 billion in revenue for the federal Treasury. Does that make participants who convert their pre-tax amounts to Roth amounts suckers? Not at all.
While it’s easy to be cynical about Congress, let’s give Congress credit for understanding the policy reasons for wanting to allow more flexible tax planning. This type of change has been long supported by the employee benefits community because of the flexibility it gives participants in choosing when to recognize taxable income under their retirement plans. The problem was that without guidance from the IRS, plan sponsors were reluctant to amend their plans to adopt such a feature.
Recently, the IRS published Notice 2013-74 (the “Notice”), which provides additional guidance that plan sponsors had been seeking. The guidance gives plan sponsors much flexibility in how they offer an in-plan Roth conversion feature. In many cases, the flexibility will be the greatest if plan sponsors amend their plans by December 31, 2014. As such, we recommend that plan sponsors consider whether an in-plan Roth conversion feature will be attractive to participants, and if so, act sooner rather than later to amend their plan documents. This blog will explain in more detail why participants may value such a feature and the flexibility that the IRS gave plan sponsors in the Notice.
If you are a board member or senior executive of a company that is rapidly failing, what do you about employee benefits? No one has ever liked my answer: freeze the benefits. This is counterintuitive advice for someone who is trying to keep the company afloat, and who would be personally affected by the loss of benefits. But let me explain why this is so important, using a complaint that was recently filed by the DOL, and the facts as they were alleged.
In January 2010, Home Valu ceased operations due to financial difficulties. Creditors then filed an involuntary petition for Chapter 7 bankruptcy in the U.S. Bankruptcy Court for the District of Minnesota (Minneapolis). According to the complaint, Home Valu employees and beneficiaries incurred approximately a half million dollars of health care expenses that were not covered as of the filing. The company may purchase stop-loss coverage for large claims, but the coverage does not protect the employees from the company’s inability to pay.
Section 704(a)(11) of the Bankruptcy Code provides:
If, at the time of the commencement of the case, the debtor (or any entity designated by the debtor) served as the administrator (as defined in section 3 of the Employee Retirement Income Security Act of 1974) of an employee benefit plan, continue to perform the obligations required of the administrator.
Here, the bankruptcy trustee sought to recoup any payments the company made in its final three months, on the basis that the company was insolvent in its final months of operation, and the matter is still pending. This DOL filing suggests that the bankruptcy trustee has not helped these employees, which is a terrible result for people who believed they had medical coverage.
Register now for one or more webinars in our OFCCP series!
If you are a federal contractor or subcontractor, you will want to be sure your team is ready to handle its expanded affirmative opportunity requirements. Consider participating in Porter Wright’s upcoming OFCCP regulation webinars, or passing this invitation along to the person responsible for compliance.
Are You Ready for the New OFCCP Regulations?
Wednesday, January 15, 2014
2:15 p.m. EST
The most sweeping changes in federal affirmative action regulations in many years take effect in March 2014. The new regulations expand the affirmative action requirements for covered veterans and disabled persons. For the first time, federal contractors and subcontractors will be responsible for specific outreach, hiring and advancement efforts for covered veterans and disabled persons, and will be responsible to show good faith efforts to reach specific goals for those groups.
At this program, we will discuss the new regulations and provide you with tips for how best to come into compliance, including the necessary revisions for your written affirmative action plans (AAPs).
Two Additional Affirmative Action Compliance Programs
Also, because so many companies will be revising their AAP’s in the first quarter of 2014, we will have two additional webinar presentations that will give helpful tips for compliance with federal affirmative action laws, including best practices for revising your AAPs and for handling an audit by the OFCCP.
Tips for Developing and Updating Affirmative Action Plans
Wednesday, January 29, 2014
2:00 p.m. EST
At this session, we will discuss:
- Effective, reasonable and defensible steps to prepare the required statistical analysis for your AAP.
- Best practices for writing meaningful plans of action and narrative portions of AAPs.
- Incorporating the new obligations concerning disabled persons and veterans.
Tips For Handling OFCCP Audits
Wednesday, February 12, 2014
2:00 p.m. EST
At this session, we will discuss:
- Desk audit strategies for reducing the likelihood of onsite audits.
- Compensation analysis issues.
- Negotiating the best results when OFCCP makes adverse findings.
Register for all or some of these programs here.
I am not a fan of binding arbitration in the context of ERISA plans, and a new Sixth Circuit decision, Schafer v. Multiband Corp., demonstrates why.
Two individuals (Schafer and Block) founded a company. As part of a series of corporate transactions, two employee stock ownership plans (“ESOPs”) were formed. Schafer and Block were appointed as trustees of the ESOPs, and entered into indemnification agreements with mandatory arbitration clauses. While the DOL was investigating its suspicion that the ESOPs had purchased stock at inflated prices, and with knowledge of this, Multiband entered into a purchase agreement to buy the holding company. As part of the transaction, Multiband entered into indemnification agreements that contained essentially the same provisions as the prior agreements.
Subsequently, the DOL informed Schafer and Block that it believed they had breached their fiduciary duties by allowing the ESOPs to purchase stock at inflated prices, and offered to settle for $42 million. Schafer and Block asked Multiband to indemnify them in accordance with the agreements, and Multiband refused. Schafer and Block agreed to settle with the DOL, paying $1,450,000 each, and Multiband again refused to indemnify them.
Frommert v. Conkright, the Xerox “actuarial heresy” floor-offset plan case is back. This time, the Second Circuit has ruled that the new interpretation of the plan is unreasonable, and that ERISA’s “notice provisions” were violated.
Stating, “SPDs are central to ERISA,” the Court concluded that the SPD (summary plan description) did not satisfy 29 C.F.R. § 2520.102-3(l) because the SPD did not describe the offset provision in question in more detail. The Court held, “the Plan and its related SPDs violate ERISA’s notice provisions” and “Plaintiffs’ notice claims fall under Section 502(a)(3).” Frommert has been remanded to the district court, for consideration of what equitable relief might be available under Section 502(a)(3). If it finds no equitable remedy, it is to determine what interpretation of the plan is reasonable.
This two-step approach suggests that “notice provisions” refers not only to Section 102 SPD content requirements, but also to Section 204(h) notices to applicable individuals prior to an amendment to reduce their future benefit accruals. In this opinion, the Second Circuit referenced its 2006 ruling that an amendment takes place at the moment when employees are properly informed of a change through provision of an SPD that complies with other ERISA requirements. Subsequently, in CIGNA Corp. v. Amara, the U.S. Supreme Court reiterated the distinction between plan amendments made by plan sponsors, and summary plan descriptions prepared by plan administrators, even when the same entity fills both roles, and held that an SPD does not amend a plan. As the U.S. Supreme Court reminded us in Heimeshoff v. Hartford, the plan is the center of ERISA, and the focus on the written terms of the plan is the linchpin of the system.
Whether the plan administrator provided an SPD that satisfied the content requirements of Section 102, and whether the plan administrator provided a Section 204(h) notice in accordance with the plan sponsor’s plan amendment, are two different questions. Yet the 2006 and 2013 Frommert decisions do not discuss the Section 204(h) notice content requirements, just the SPD requirements.
As I mentioned in my Heimeshoff v. Hartford blog, the U.S. Supreme Court has agreed to review Dudenhoeffer v. Fifth Third Bancorp, now captioned Fifth Third Bancorp v. Dudenhoeffer. The Court granted certiorari on the question as originally framed:
Whether the Sixth Circuit erred by holding that Respondents were not required to plausibly allege in their complaint that the fiduciaries of an employee stock ownership plan (“ESOP”) abused their discretion by remaining invested in employer stock, in order to overcome the presumption that their decision to invest in employer stock was reasonable, as required by [ERISA], and every other circuit to address the issue.
Thus, the Court rejected the DOL’s request to reframe the question, rule that an ESOP is an investment that is subject to divestment and prudence review in the same manner as other investments, rule that the presumption does not exist at the initial state, and rule that the presumption of prudence does not exist, at all. (The Court did not take the second question, regarding the summary plan description.)
I have been blogging about ERISA basic principles and respect for boundaries, and just got a little help from the U.S. Supreme Court. In Heimeshoff v. Hartford Life & Accident Insurance Company, a unanimous decision, the Court upheld the three-year statute of limitations set forth in the terms of the ERISA benefit plan document. The Court held that while a cause of action does not commence until the plan issues a final denial in the claims appeal process, the plan and its participants can agree to commence the limitation period before that time (here, at the proof of loss due date).
The Plan Is at the Center of ERISA
In resolving the circuit split, the Court explained that under U.S. Supreme Court authority (Order of Unite Commercial Travelers of America v. Wolfe), a limitations period is enforceable provided it is of reasonable length and there is no controlling statute to the contrary. This approach necessarily allows the parties to agree to the length of a limitation, and its commencement.
Citing CIGNA Corp. v. Amara, the Court found this agreement approach particularly well-suited in the context of ERISA claims, given the “particular importance of enforcing plan terms as written in §502(a)(1)(B) claims.” The Court explained, “The plan, in short, is at the center of ERISA,” citing US Airways, Inc. v. McCutchen. Citing Curtiss-Wright Corp. v. Schoonejongen, the Court further explained that because the rights and duties are built around reliance on the face of written plan documents, the Court would not presume from statutory silence that Congress intended a different approach here. The Court further reminded us, “This focus on the written terms of the plan is the linchpin of a ‘system that is [not] so complex that administrative costs, or litigation expenses, unduly discourage employers from offering [ERISA] plans in the first place,’” citing Varity Corp. v. Howe, emphasis added. In other words, the United States (Department of Labor, et al.) as amicus curiae got it backwards with their argument that ERISA, not the plan, controls, and that the plan terms violated ERISA’s structure.
This makes me feel so much better about the fact that the U.S. Supreme Court decided on Friday to review Dudenhoeffer v. Fifth Third Bancorp. In that case, the United States has made virtually the same argument, regarding plan provisions requiring investment primarily in employer securities that purportedly violate ERISA structure. Keep in mind, the Court knew on Friday that it was about to announce this unanimous decision. We can hope the Court decides this argument is backwards, too. But I digress.
In finding the provision reasonable, the Court observed that the vast majority of states require certain insurance policies to include three-year limitation periods that run from the date proof of loss is due. But the Court also rejected arguments about applying state law regarding statutes limitations, because the plan terms controlled.