Employee Benefits Law Report

DOL proposes a more practical rule for electronic ERISA disclosures

On Oct. 23, 2019, the Department of Labor (DOL) released a proposed rule for electronic delivery of ERISA disclosures. Although the DOL already allows for electronic delivery under the 2002 Electronic Safe Harbor, its availability is limited and technology quickly outpaced its usefulness. The proposed rule creates a new, additional safe harbor the DOL calls the “Notice and Access” safe harbor that will allow for electronic delivery as a default method of delivery for certain ERISA Title I disclosures. At this point, the safe harbor applies only to ERISA-governed retirement plans, and does not reach health and welfare benefit plans, though the DOL reserves a section in the proposed regulations for potential future application to required disclosures for such plans.

How does it work?

First, the plan administrator must notify all participants and beneficiaries that the default method of delivery for plan disclosures will be changing. Naturally, this initial notice must be furnished on paper, even for participants who currently receive disclosures under the 2002 safe harbor. The notice must also allow participants the opportunity to opt out of electronic delivery.

Second, administrators must provide an electronic “notice of internet availability” for each ERISA disclosure at the time the disclosure is made electronically available to the participant. The DOL requires the notice to:

  • Be furnished on its own, separately from any other notice
  • Contain certain language describing the document covered and its URL
  • Allow the participant to opt out of electronic delivery or request a free paper copy
  • Be written in a manner calculated to be understood by the average participant

Although the notice of internet availability must be furnished on its own, , that notice itself can apprise participants and beneficiaries of the availability of multiple ERISA disclosures.

Third, the administrator must make the ERISA disclosure accessible on a secure website. The disclosure must be available to the participant by the time it must be furnished under ERISA and must remain there until it is superseded by a subsequent version of that disclosure. The ERISA disclosure must, essentially, be available to participants as a word-searchable, downloadable, and printable PDF.

Who and what is covered by the safe harbor?

Unlike the 2002 safe harbor, which was available only to employees who were “wired at work” or participants who affirmatively consented to electronic delivery, the “notice and access” safe harbor will be available to all participants, beneficiaries, and any other individuals that are entitled to the covered documents. The only requirement is that the individual provide the administrator with an electronic address or internet-connected mobile-computing-device number (i.e., an email address or a smartphone number), or be provided an electronic address by the employer.

The proposed safe harbor will cover documents that are required to be furnished to participants under ERISA Title I, except for any document that is furnished only upon request. This means any document that must be furnished solely because of passage of time or a specific triggering event is included. This includes the following documents:

  • Summary plan descriptions
  • Summaries of material modifications
  • Summary annual reports
  • Annual funding notices
  • 404a-5 investment-related disclosures
  • Qualified default investment alternative notices
  • Blackout notices
  • Pension benefit statements

Surely, somewhere, the Lorax is crying tears of joy.

What can plan administrators do?

Right now? Nothing. The “notice and access” safe harbor won’t be effective until 60 days after the final rule is published and the DOL is not allowing reliance on the proposed rule, on which the DOL is seeking public comment through Nov. 22, 2019. After the safe harbor rule is finalized and effective though, plan administrators will be able to greatly expand their use of electronic distribution of documentation (or gain more comfort in the processes they might already be following).

The beauty and danger of the DOL proposed rule is that it is purposely and purposefully broadly-worded to allow for innovations in technology. For instance, the requirement that the participant have an email address or a smartphone number allows for creative methods of notice: Email? Text? In-app or push notifications? So long as the safe harbor is met, it would seem all of the above are acceptable to the DOL. But just because you can do something, doesn’t mean you should. To avoid DOL scrutiny, administrators should be careful not to push participants past their technological comfort zones.

And although the proposed rule requires an initial notice that a plan is changing its default notice method, expect a rough transition. As plan administrators (and the Supreme Court) know, just because a participant receives a notice, doesn’t mean they’ve read it or even opened it. This means many participants will not be aware of the change to electronic disclosures until they realize they haven’t received a paper notice in a really long time. To ease the transition, in addition to the required paper notice, plan administrators should consider notifying participants using every method they currently use to communicate with participants (e.g., website pop-ups, website banners, direct messaging, texts, email, etc.). But, at the very least, this is progress.

Final IRS hardship regulations – Less of a hardship to take and administer

Special thanks to Victoria Hanohano-Hong, Porter Wright law clerk, for her assistance on this article.

The IRS recently published final regulations, which amend the hardship withdrawal rules for 401(k) and 403(b) plans. The regulations reflect statutory changes to 401(k) and 403(b) plans, including changes made by the Bipartisan Budget Act of 2018. Most of the changes are optional and do not require employer adoption; some are not optional. The following changes are mandatory for plans that allow hardship withdrawals and may require plan amendments (the deadlines for which are noted at the end of this post).

Remove six-month contribution suspension

Prior rules prohibited employee deferrals for six months following a hardship withdrawal. Congress removed this rule to encourage continued retirement savings. Now, employers will be prohibited from suspending employee contributions following a hardship withdrawal. Continue Reading

Sellers beware: Recent court case shows sellers – as well as ESOP fiduciaries – should be engaged in ESOP due diligence and valuation process

As we have explained in prior ESOP blogs, the Department of Labor (DOL) remains acutely concerned with private company employee stock ownership plan (ESOP) valuations in the formation of ESOPs. In particular, trustees who approve an ESOP trust’s purchase of shares from a seller must demonstrate that they have satisfied ERISA’s fiduciary duties with respect to the share purchase price. Specifically, trustees (whether independent or internal) need to demonstrate the due diligence and valuation procedures they undertook prior to authorizing the share purchase by the ESOP were thorough and resulted in payment of no more than fair market value (“adequate consideration” in ERISA terminology) for the shares of stock of the company. Otherwise, the DOL (as well as private plaintiffs) may hold trustees liable for making the ESOP trust whole in the event of overpayment to the seller. This focus on trustees often leads selling business owners to wonder if they are immune from liability and thus not expected to be engaged in the due diligence process. The answer is that they are not immune.

A recent federal District Court case decided in the DOL’s favor demonstrates that even selling owners in an ESOP transaction need to be engaged in the process and alert to whether the price they are being offered for their shares is well above fair market value (i.e., more than adequate consideration such that the transaction would rise to the level of a prohibited transaction under ERISA). In this case, which was brought by the DOL against the ESOP trustee and the selling owner, the court held the ESOP trustee and the selling owner in an ESOP transaction to be jointly and severally liable for over $6.5 million in damages, which was the amount that the court adjudged that that ESOP overpaid for the purchase of its shares of stock from the selling owner. The case, Pizzella v. Vinoskey out of the Western District of Virginia, could yet be appealed, but the District Court’s holding still provides valuable lessons to selling owners in an ESOP transaction, most notably the following:

The due diligence process cannot be rushed.

The due diligence process itself is vitally important in an environment where a selling owner often wants a transaction to close as quickly as possible, in part to get paid as quickly as possible, but also to keep the leadership succession plan in progress. The court in Vinoskey provides a cautionary tale about rushing the process. The judge concluded that due diligence was “rushed and cursory…” explaining that fewer than 2 ½ months elapsed between the time the independent ESOP trustee was engaged and the ESOP transaction’s closing date. The judge felt that such a quick turnaround time contributed to a lack of due diligence (and a lack of negotiations between the ESOP trustee and the appraiser) that otherwise might have produced a purchase price for the shares that was lower (and closer to a reasonable fair market value). A quick turn-around on an ESOP transaction is not absolutely a red flag, but when a deal moves quickly it is even more important to document the due diligence process in detail to demonstrate that fiduciary duties were not sacrificed for speed in closing the transaction.

Multiple valuation methods, especially including discounted cash flow, should be considered to calculate fair market value of a company.

In the ESOP transaction in Vinoskey, only one valuation method was used by the appraiser, and it was not the widely-accepted discounted cash flow method. Typically, independent appraisers apply more than one valuation method and use the varying results to calculate fair market value for a company. The appraiser in this transaction used only one method, and further, did not sufficiently justify use of this method alone over other generally accepted methods.

Ask questions if the purchase price offered exceeds the fair market value calculated under prior appraisals.

The company in Vinoskey had received annual appraisals each year for its stock because it had been a minority ESOP-owned company prior to the transaction that became subject to the suit. Those appraisals (which were done by the same appraiser retained for the subject transaction) had ranged between $215-$285 per share over the preceding five years. The price that the ESOP trust paid per share upon assuming 100% of the shares was $406. While the District Court did not expect the seller to know the details of the appraisal methods and ERISA fiduciary duties, it surmised that he and the ESOP trustee should have at least asked questions after seeing such a large premium in comparison to prior appraisal amounts, and, in the case of the ESOP trustee, pushed harder for answers from the appraiser. The difference in valuation amounts year-to-year, coupled with the speed to close the transaction, indicated to the court that sufficient due diligence was not performed to ensure that the ESOP paid only adequate consideration for the shares, resulting in a prohibited transaction to the tune of $6,5 million.

Corporate governance protections should be included in the transaction documents.

The court explained that in the transaction at issue, the sellers and the ESOP trust had a “gentleman’s agreement” to add independent or non-interested individuals to the ESOP’s board of directors, and to have those independent directors determine executive compensation, so as to effectuate the ESOP’s post-transaction controlling interest. Yet, these terms, in addition to other items, were not included in the covenants in the stock purchase agreement itself, and the court used this to find that the ESOP did not stand to gain actual control via the transaction even though it acquired 100% of the shares of the company. A seller might argue that it is not his or her responsibility to include such terms when a trustee, represented by legal counsel, does not push to include such a term in the documents. As a party-in-interest to the transaction though, such a seller must pay attention to the operative terms of the transaction. The District Court judge in Vinoskey assessed liability here, in part, for a failure to do so.

Engaging an independent trustee after the transaction may provide more protection against fiduciary liability than being an insider trustee.

After selling to an ESOP in a standard transaction, the sellers have to decide whether to have an outside independent trustee (either an individual or financial institution) be the trustee of the ESOP going forward, or whether to appoint a corporate insider to be the trustee. Insider trustees are less expensive than independent third-party trustees, but they raise inherent fiduciary concerns about whether they are serving the best interests of ESOP participants in that role, or other corporate interests. The judge in this case expressed this very concern. In this transaction, the company hired an independent fiduciary to negotiate the ESOP transaction. After the transaction, however, corporate insiders continued to comprise two of the three trustees for the ESOP. These same individuals also comprised a majority of the company’s board of directors. Because of those facts, the court concluded that the insiders, and not the ESOP, retained control of the company. As such, the court held that the ESOP’s payment of a “control premium” for acquiring 100% of the shares was unreasonable and inconsistent with ERISA’s fiduciary duties.

Post-transaction debt forgiveness related to seller financing did not cure a fiduciary breach or reduce damages.

The court held that the ESOP trust’s loss was equal to the inflated purchase price that it paid for the shares minus the stock’s fair market value on the date of the transaction—as determined by the court. The court concluded that the fair market value on the date of the transaction was $278.50 per share, which resulted in the ESOP trust overpaying by $6,502,500.

The defendants argued that these damages should be reduced because four years after the transaction, the seller forgave a large portion of the debt that the trust owed to him. Further, defendants argued that the participants in the ESOP had a higher value per share after the transaction than they had before the transaction. The court held that those factors were irrelevant to the question at hand – whether the ESOP overpaid for the purchase of the shares at time of purchase. The debt incurred at the transaction prevented the ESOP from making other investments, and so the damages were to be calculated based on the facts on the transaction date, not on subsequent events.

There is no doubt that the facts in this case could be explained away as an example of bad facts making bad law, but that gives short shrift to a very valid underlying point – that the selling owner in an ESOP transaction also has a vested interest in ensuring proper due diligence in the valuation process, and could be held jointly and severally liable where an ESOP’s shares are overvalued to the benefit of the selling shareholder. It will be interesting to see if this decision is appealed, and, if so, what happens on appeal. In the meantime, sellers should be mindful of the fact that they too, need to be engaged in the due diligence and valuation aspects of ESOP transactions.

Sixth Circuit nonqualified deferred compensation plan decision highlights importance of Code Section 409A compliance and ERISA claims procedures

We often receive questions about whether different types of bonus plans and nonqualified deferred compensation plans (NQDC plans) are subject to ERISA. We explain that being subject to ERISA may be a good thing for an NQDC plan, particularly with respect to resolving disputes and claims for benefits. Even if it is questionable whether an NQDC plan is subject to ERISA (i.e., because it arguably does not provide retirement benefits or covers only one person), sometimes it might make sense to include ERISA claims procedures and file a top hat letter. A recent case—Wilson v. Safelite Grp., Inc.—in which the Sixth Circuit held that ERISA preempts state contract and tort law claims, illustrates the benefits of being an ERISA plan.

This case was particularly notable because it also involved violations of Internal Revenue Code Section 409A of the Internal Revenue Code and related guidance (Code Section 409A). While the issue in the case was whether the plan was subject to ERISA, we want to focus on two other important items that may not as easily be noticed. One is the limits of a Code Section 409A “savings clause” in an NQDC plan. The other is the importance of following ERISA claims procedures with respect to NQDC plans. Continue Reading

Individual coverage HRAs: A potential alternative to traditional group health plan coverage?

In a reversal of previous Obama Administration guidance, the Trump Administration recently finalized regulations that provide for a new type of health reimbursement arrangement—the individual coverage HRA. In a previous blog, we briefly discussed the potential for the individual coverage HRA to provide large employers who are subject to the Affordable Care Act (ACA) employer coverage mandate with a cost-effective alternative for meeting those requirements. To recap, under the ACA, large employers (those with 50 or more full-time employees) must offer full-time employees ACA-compliant coverage or face potential penalties. Under current rules, simply offering an HRA without also offering more traditional group health plan coverage would not satisfy those requirements.

The new regulations change that result. If the HRA meets certain requirements, it can be offered in lieu of traditional group health plan coverage and be used by employees to purchase individual health insurance coverage. Providing an individual coverage HRA that meets the various regulatory requirements would satisfy an employer’s obligations under the ACA employer coverage mandate. From our perspective, this provides large employers with a potentially more flexible and cost-effective way to meet ACA requirements. What follows is a more in-depth look at the individual coverage HRA requirements. Continue Reading

New health reimbursement account rules provide alternative path to Affordable Care Act compliance

Seemingly unfazed by the recent setbacks with the Association Health Plan regulations, the Departments of Treasury, Labor and Health and Human Services have released new health reimbursement (HRA) regulations that could reshape the group health plan landscape by providing employers with potentially cheaper options than traditional group health plan coverage for satisfying Affordable Care Act (ACA) requirements.

While we are still digesting the regulations (they come in at a whopping 497 pages), the guidance provides for two new types of health reimbursement accounts (HRAs); Individual Coverage HRAs and Excepted Benefit HRAs.

Individual Coverage HRAs

From our perspective, this is the bigger development. Currently large employers (those with 50 or more employees) must offer full-time employees ACA-compliant group health plan coverage or face potential penalties. Merely offering an HRA without an accompanying offer of traditional group health plan coverage would not satisfy this employer coverage mandate.

That would change under these regulations. Starting in 2020, these Individual Coverage HRAs could be offered as an alternative to traditional group health coverage. An employer could offer the Individual Coverage HRA to all of its employees, particular groups of employees, or new employees only. If the HRA/offer is structured appropriately—is offered on the same terms/conditions to all within a defined class, is offered only to those who are not also eligible for traditional group health plan coverage, is affordable, and meets other requirements—that offer would be treated as an offer of coverage for ACA employer coverage mandate purposes.

Functionally, the Individual Coverage HRA would be similar to any other HRA—it would be used to reimburse medical expenses up to a maximum amount per year (as determined by the employer). The primary difference between current HRAs and Individual Coverage HRAs is that the latter could be used to reimburse premiums for individual health insurance coverage, on or off an exchange.

Because this provides a potentially much cheaper option for satisfying the ACA employer coverage mandate, this may be a very attractive option for employers in 2020 and beyond (when this is available). This may also provide a nice option for small or mid-size employers who, while not subject to the ACA employer coverage mandate, want to provide some medical plan assistance to their employees, short of offering a traditional group health plan.

Excepted Benefit HRAs

While the Individual Coverage HRA has the most potential to shake up the group health plan landscape, the second new HRA—the Excepted Benefit HRA—is also an interesting new option.

Currently, HRAs are considered group health plans, which means they are subject to the full scope of the ACA rules. This effectively means that employers cannot offer standalone HRAs—an employer can only offer an HRA if it is integrated with a group health plan that meets the various ACA rules.

This new Excepted Benefit HRA would change those rules. An employer could offer this new arrangement alongside a traditional group health plan, and would be available even to those that opt out of the traditional plan. In other words, it allows for limited standalone HRAs that are exempt from the ACA requirements, provided the employee was actually offered the traditional group coverage.

Looking forward

Critics of the Association Health Plan rules—including the U.S. District Court for the District of Columbia, which ultimately struck those rules down—argued that those rules were a not-so-veiled attempt at an end-around on the ACA. We expect that these new HRA rules will be challenged on the same grounds. But, if these new HRA rules survive those challenges, they have a very real chance of changing the group health plan landscape going forward by providing a potentially simpler, more cost-effective option for employers to meet their ACA obligations.

Please check back with us, as we intend to issue future updates that provide you with a closer look that at these new rules. In the meantime, the Departments have issued additional guidance that elaborates on these options, including a News Release, FAQs, and model notices to be used in connection with these new arrangements (here and here).

IRS issues guidance on excise tax on executive compensation of tax-exempt entities

The IRS recently issued Notice 2019-09 (Notice), which provides guidance with respect to the 21 percent excise tax on remuneration in excess of $1 million and excess parachute payments by “applicable tax exempt organizations” (ATEOs) applies under Code Section 4960. In general Code Section 4960 and the Notice apply concepts from Code Sections 162(m) (which denies a deduction to publicly traded corporations with respect to payments of compensation in excess of $1 million to certain covered employees) and 280G (which, along with Code Section 4999, imposes an excise tax and disallows a deduction with respect to excess parachute payments). Code 4960 was added to the Internal Revenue Code as part of the tax reform legislation enacted in December 2017. While the IRS and Treasury Department intend to issue more detailed guidance in future proposed regulations, the Notice shows that Code Section 4960 will have a significant impact on compensation practices – particularly with respect to severance and deferred compensation – that ATEOs pay to key employers.  Continue Reading

IRS publishes transition relief regarding part-time employees and 403(b) plans

The IRS recently issued Notice 2018-95 (the Notice), which clarifies the circumstances under which part-time employees must be given the opportunity to make deferral elections under their employers’ 403(b) plans. In particular, the Notice provides transition relief from the once-in-always-in (OIAI) condition for excluding part-time employees. Tax-exempt and governmental employers who sponsor 403(b) plans will want to confirm that they are including and excluding part-time employees correctly under this latest guidance. Continue Reading

IRS letter ruling generates interest in employer student loan benefit plans, but be aware of testing and other issues

The Internal Revenue Service (IRS) recently issued a private letter ruling, PLR 201833012 (PLR) that has generated interest among employers about student loan benefit programs. An IRS official at a recent conference, however, cautioned practitioners to read the PLR because the scope of the PLR is more narrow than what some headlines may have led people to believe. In particular, the PLR did not allow employers to authorize distributions from 401(k) plans to allow employees to repay their student loans. Instead, the PLR allowed an employer to make nonelective contributions to the company’s 401(k) plan on behalf of employees who were paying off student loan debt. To receive that benefit, the employees were required to opt out of receiving the normal matching contribution. In other words, the plan that was the subject of the PLR was quite unique. While it is encouraging to see the IRS support innovative plan designs that provide a benefit that employees value, it is important to understand what the PLR addressed and what it did not address before employers create their own plans. Specifically, the PLR held only that this benefit did not violate the contingent benefit rule. The PLR did not address other practical questions that employers will need to resolve before implementing their own similar program. We describe these items below. Continue Reading

Recent IRS guidance affects corporate tax deductibility of public company executive compensation arrangements and related proxy statement disclosures

We previously blogged about how the Tax Cuts and Jobs Act (the Act) amended Internal Revenue Code Section 162(m). In general, the amended Code Section 162(m) restricts the ability of publicly traded companies to recognize a tax deduction for amounts paid to “covered employees” in excess of $1 million. It does this primarily by expanding the groups of individuals who are classified as covered employees and restricting the scope of the arrangements that are exempt from the $1 million deduction limit. The Act left many questions unanswered, and the IRS recently answered some of those questions by publishing transition guidance in Notice 2018-68 (the Notice). The most notable takeaway from the Notice is that the ability of arrangements to be grandfathered under prior Code Section 162(m) is more limited than many practitioners had hoped for.

The guidance from the Notice will require public companies to evaluate both the design and administration of their executive compensation plans. Doing so is important both to preserve the tax deductibility of grandfathered amounts and to consider the best way to align executive compensation with increasing shareholder value in the new tax environment. Companies also will need to be able to explain these issues as part of their compensation discussion and analysis in their proxy statements. To manage these issues, public companies should consider taking the following actions with respect to their executive compensation plans: Continue Reading