Since the Supreme Court’s ruling in Fifth Third Bancorp v. Dudenhoeffer, courts around the country have overwhelmingly rejected ERISA fiduciary-breach claims by 401(k) plan participants seeking relief related to investments in company stock funds. The Seventh Circuit recently continued that trend by affirming the dismissal of claims brought by participants in the Boeing 401(k) plan, but did so on grounds that (i) the fiduciary responsibilities associated with the company stock fund had been delegated to an independent fiduciary, and (ii) the insider fiduciaries had no duty to disclose corporate inside information to the plan participants or the independent fiduciary. Burke v. The Boeing Co., No. 20-3389 (7th Cir. Aug. 1, 2022). As discussed below, the Seventh Circuit’s opinion provides helpful guidance to plan sponsors and fiduciaries that go beyond the specific circumstances presented in the case. Continue Reading
On August 3, 2022, in a welcome and surprising move, the IRS released Notice 2022-33, providing for an extension for qualified retirement plans to adopt amendments under the Setting Every Community Up for Retirement Enhancement Act of 2019 (“SECURE Act”), the Bipartisan Miners Act of 2019 (the “Miners Act”) (which provided defined benefit plans with an optional reduction in the minimum age for in-service distributions from age 62 to 59½), and the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), the requirement s of which are described here, here, and here.
Specifically, non-governmental qualified plans (including non-collectively bargained plans) will have until December 31, 2025 to adopt any of the optional or required changes under the SECURE Act, Miners Act, and CARES Act. Prior to this guidance, non-governmental and non-collectively bargained plans had until the last day of the plan year beginning on or after January 1, 2022 to adopt these amendments. For calendar year plans that meant amendments had to be made by December 31, 2022. Collectively-bargained and governmental plans had until the last day of the plan year beginning on or after January 1, 2024.
In considering this extension, note that the CARES Act extension only applies to the optional waiver of required minimum distributions for 2020 and does not apply to the optional loan relief or CARES Act distributions. Thus, if a plan adopted any of the CARES Act optional loan relief or distributions, the non-governmental, non-collectively bargained plan must still be amended by the last day of the plan year beginning on or after January 1, 2022.
This extension is welcome for many plan administrators and sponsors who are still waiting for final IRS guidance on many of the SECURE Act’s provisions, including required post-death distribution rules, rules governing the inclusion of long-term part-time employees, and more. The IRS noted in Notice 2022-33 that it expects SECURE Act guidance to be issued with the 2023 Required Amendment list, so all changes under the SECURE, Miners, and CARES Act can be adopted by plan sponsors at the same time.
Updated as of August 4, 2022
The “golden parachute” excise tax regime under Internal Revenue Code Sections 280G and 4999 (“Section 280G” and “Section 4999”, respectively) is at the core of both public and private U.S.-based transactions. While often overlooked, it is crucial to remember that the issues raised by Sections 280G and 4999 can – and do – apply to transactions that do not have a clear U.S. nexus. Careful attention should be paid to golden parachute considerations in any cross-border, non-U.S. transaction if a non-U.S. corporation at any level of the transaction structure (1) employs a U.S. taxpayer or (2) takes a U.S. compensation tax deduction.
Sections 280G and 4999 provide for a dual penalty on certain significant payments that are contingent on a change in control of a corporation to certain significant shareholders, officers, and other highly compensated individuals (“disqualified individuals”). The corporation may lose a compensation deduction, and/or (note, the two do not depend on each other) the individual may face a 20% excise tax, in addition to ordinary income tax, on such payments. Below is a brief summary of the golden parachute tax parachute provisions, and an example of how they may apply to a transaction involving two non-U.S. corporations.
When Do the Golden Parachute Tax Provisions Apply?
Sections 280G and 4999 may apply when a public or private corporation undergoes a change: (1) in the ownership (e.g., more than 50% of the corporation) or effective control (e.g., change in majority of the Board of Directors, or more than 20% of the voting power) of a corporation; or (2) in the ownership of a substantial portion of the assets of a corporation. Section 280G does not apply to S-corporations (whether or not they elect S-corporation tax status), to partnerships or to LLCs (other than those that elect to be taxed as a corporation). But if any corporations are involved in the overall transaction structure of the target entity, including subsidiaries, the golden parachute rules may apply.
Who is a Disqualified Individual?
A disqualified individual is any individual who, at any time during the 12-month period prior to the change of control is (1) an employee or an independent contractor of the corporation; and (2) an (a) officer, (b) 1% shareholder or (c) highly compensated individual, with respect to the corporation (“HCI”). The officer determination is based upon a variety of factors, including the individual’s duties. An HCI is generally defined as the lesser of (1) highest paid 1% of the employee population or (2) 250 highest paid employees (compensation must be in excess of the IRS Highly Compensated Employee compensation limit, which is $135,000 for 2022).
When is a Payment Contingent on a Change in Control?
A payment that would not have been made but for the change in control is considered to be contingent on a change in control for purposes of the golden parachute tax provisions. Additionally, payments are generally presumed to be contingent on a change in control if the payment occurs within one year before and ending one year after the change in control. However, a payment is not contingent on a change in control if it is substantially certain that the payment would have been made whether or not a change in control occurs.
Golden Parachute Payment Thresholds
Payments contingent on a change in control constitute “parachute payments” if the aggregate present value of such payments equals or exceeds three times a disqualified individual’s “base amount.” “Base amount” is the average annual compensation includable in the disqualified individual’s gross income for the five completed calendar years preceding the change in control date (or if employed by the corporation for fewer than five full calendar years, the compensation averaged over the years during which the disqualified individual was employed), excluding one-time or other non-recurring payments (typically, signing bonuses). If payments contingent on a change in control exceed three times a disqualified individual’s base amount, then the corporation will lose the compensation deduction, and the disqualified individual will be subject to a 20% excise tax, in addition to ordinary income tax, on all payments contingent on the change in control that exceed one times the disqualified individual’s base amount.
Non-U.S. Corporation Example
An example will help illustrate how the golden parachute tax code provisions could apply where there is no U.S. corporation in the transaction or where this no U.S. taxpayer in the transaction.
Assume that a U.K. Corporation acquires 100% of a Canadian corporation and that the CEO of the Canadian corporation is a U.S. taxpayer (i.e., the CEO has the obligation to file taxes in the United States). If that individual receives payments contingent on a change in control that total $6 million and the individual’s base amount is $1 million, the payments would be parachute payments because the $6 million contingent payments exceed three times the individual’s base amount (i.e., 3 * $1 million). Therefore, $5 million (i.e., an amount equal to one times the individual’s base amount – the “excess parachute payment”) will be subject to the 20% excise tax (i.e., an aggregate of $1 million). This is so even where both payors are non-U.S. entities and even if the CEO is not physically present in the U.S., so long as the CEO is a U.S. taxpayer. It is worth noting that if the corporation undergoing the change in control and making the contingent payments in the above example were a U.S. corporation, but the CEO was not a U.S. taxpayer, the U.S. corporation’s compensation deduction would nevertheless be disallowed on the $5 million excess parachute payment, but the CEO would not generally be subject to the 20% excise tax.
Shareholder Approval Exception for Private Companies
For private companies, there is an exception that may apply so that the excise tax and the deduction disallowance provisions will not apply. To be eligible for this exception, the disqualified individuals need to waive their rights to the excess parachute payments and more than 75% of the shareholders of the corporation undergoing a change in control need to approve the payments. Once approved by shareholders, the payments may be made without having the excise tax or deduction disallowance provisions apply. This shareholder approval exception applies to non-U.S. private companies just as it does for U.S. private companies.
It is easy to see how the golden parachute tax code provisions could be overlooked in a transaction that has no clear nexus to the U.S. However, because of the significant tax consequences associated with these provisions, it is worth consulting with your U.S. counsel, so that the parties can be apprised of any potential issues and plan ahead if the target corporation can avail itself of the shareholder approval exception.
The Sixth Circuit recently issued a mixed opinion in a 401(k) plan investment litigation. The Court upheld the dismissal of the plaintiffs’ fiduciary-breach claims relating to the investment management fees and performance of several of the plan’s investment options, but reinstated a claim for breach of fiduciary duty based solely on the plan fiduciaries’ alleged failure to offer less expensive “institutional” share classes of mutual funds.
Plaintiffs were former TriHealth, Inc. employees who sued the company in the U.S. District Court for the Southern District of Ohio, alleging that the TriHealth 401(k) plan fiduciaries breached their duties of prudence and loyalty in connection with plan management. In particular, plaintiffs claimed that the fiduciaries violated the duty of loyalty in choosing investments that benefited third-party investment managers, and the duty of prudence by allowing the plan to pay excessive fees, selecting and retaining investment options that were expensive and underperformed relative to alleged alternatives, and offering “retail” shares of seventeen mutual funds despite the availability of less expensive “institutional” shares of the same funds.
Last year, TriHealth successfully moved to dismiss the complaint. The district court held that plaintiffs failed to plausibly allege that TriHealth acted imprudently with respect to any of their claims.
The Sixth Circuit affirmed the dismissal of most of the claims consistent with its recent decision in Smith v. CommonSpirit Health, No. 21-5964, 2022 WL 2207557 (6th Cir. June 21, 2022), which we discussed in a recent post. First, as to plaintiffs’ claims that the plan’s “average plan expenses” were excessive, the Court held that the claims failed because plaintiffs failed to plead that these fees were high relative to the services provided or that the fees could not be justified by the plan’s strategic goals. Second, the Court rejected plaintiffs’ identification of alleged “available alternatives in the same investment style” as insufficient to plausibly plead imprudence; the plaintiffs were required to show that these cheaper and better performing alternatives were otherwise equivalent to the challenged funds in order to justify the inference that plan fiduciaries used an imprudent process in selecting and retaining them. Third, with respect to their disloyalty claim, plaintiffs failed to allege the “fiduciary’s operative motive was to further its own interests.”
But the Sixth Circuit reversed as to the share class claim, holding that plaintiffs stated a plausible claim of imprudence related to TriHealth’s failure to offer the cheapest share class for certain mutual funds. The plaintiffs showed that many of the plan’s mutual funds offered a cheaper, but otherwise identical share class to larger investors, for which the plan—with nearly half a billion dollars in assets—was large enough to qualify. The Court held that “these allegations permit the reasonable inference that TriHealth failed to exploit the advantages of being a large retirement plan that could use scale to provide substantial benefits to its participants.” The Sixth Circuit noted that facts learned in discovery—such as the existence of revenue sharing arrangements lowering the retail shares’ fees, or facts showing the plan was ineligible for the institutional shares—could disprove these claims, but that “at the pleading stage, it is too early to make these judgment calls.” The Court also held that, in this context, plaintiffs need not specifically allege facts showing the institutional share class is in fact a meaningful benchmark, because “this claim has a comparator embedded in it,” and that any explanations for retail shares’ underperformance fail because the higher fees of otherwise identical funds “guarantee worse returns.”
In reversing the dismissal of the share class claim, the Sixth Circuit joined the Second, Third, Eighth, and Ninth Circuits in allowing imprudence claims based on share class differentials to overcome motions to dismiss. The decision serves as notice to plan fiduciaries that, at least in these circuits, offering anything but the lowest share class of a mutual fund in a 401(k) plan—even if defendants can provide a reasonable explanation for doing so—all but guarantees that in litigation this claim will proceed to discovery. If fiduciaries find themselves facing this claim in one of these circuits, they should consider the prospects of staging discovery in a fashion that will facilitate an early motion for summary judgment following targeted narrow discovery on the rationale for offering the more expensive share class.
You do not need a Lexis or Westlaw subscription to know that major cases and significant judgments have sometimes hinged on the meaning of a single word, or the placement of a single Oxford comma. We have a recent case to add to the list: Weinberg v. Waystar, Inc., et al., which was an executive contract dispute case in Delaware that hinged on a single word: “and.”
The plaintiff, an executive at Waystar, received three option grants. The “call right” provision in the option award documentation allowed the defendants to repurchase the plaintiff’s equity acquired upon exercise of the options upon specified events, including termination without cause and/or a restrictive covenant breach. The plaintiff’s employment was terminated without cause, and she exercised her vested options. The defendants then exercised their call right, repurchasing the plaintiff’s newly acquired equity, pursuant to their interpretation of the call right provision.
As a matter of background, many private companies’ equity incentive arrangements include call rights to allow the company to repurchase equity under a variety of circumstances. The call right serves both strategic and logistical ends. Strategically, many companies do not want ex-employees to participate in the upside of the company’s growth post-termination because these ex-employees are no longer contributing to the company’s success. Logistically, having too many minority holders on the capitalization table can create administrative challenges in the future (e.g. with respect to information rights or payments in connection with an exit event) and could also raise securities law issues. To these ends, call rights are typically triggered upon the termination of an executive’s employment.
Back to the case at hand. The call right provision read:
“The Converted Units shall be subject to the right of repurchase (the ‘Call Right’) . . . during the six (6) month period following (x) the … Termination of such Participant’s employment . . . and (y) a Restrictive Covenant Breach.”
(Emphasis added.) The dispute hinged entirely on the meaning of the word “and” before clause (y).
The plaintiff asserted that the word “and” between “(x)” and “(y)” meant that both conditions had to be satisfied before the defendants could exercise their call right (i.e. the conjunctive interpretation). Under this interpretation, the call right would not be triggered unless the plaintiff’s employment were terminated and the plaintiff were to breach a restrictive covenant. The parties agreed that the plaintiff did not breach a restrictive covenant; so under the plaintiff’s interpretation, the defendant would not have had a right to buy back the equity.
In contrast, the defendants interpreted the word “and” to mean that they could exercise the call right if the plaintiff’s employment were terminated or if she were to breach a restrictive covenant (i.e. the disjunctive interpretation). Under this interpretation, the defendants were within their rights to repurchase the plaintiff’s equity grant on the basis of the plaintiff’s termination alone.
The judge sided with the defendants, concluding based on the language and the surrounding context, that the parties must have intended the disjunctive interpretation: “I find that the plain language of the Call Right provision supports the Defendant’s interpretation because it is consistent with the ‘several’ use of ‘and’ that is used in permissive sentences.” The judge concluded that the provision was analogous to saying “at our resort, you can swim, golf and play tennis”—which would not require participating in all three activities.
The judge also noted that the purchase price for the call right varied depending on whether the plaintiff’s termination was with cause or without cause (another common feature of call right provisions). The judge said that distinction would be rendered “meaningless” if the conjunctive interpretation of the provision were correct. It would not make sense to have a “no cause” purchase price if the call right required both termination and breach of a restrictive covenant.
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At the end of the day, the word choice did not change the outcome, but that would ignore the cost of defense. This case is a good reminder that, in drafting, every word matters.
On July 8, 2022, the Pension Benefit Guaranty Corporation (“PBGC”) published its much anticipated final rule on the special financial assistance (“SFA”) available to certain troubled multiemployer plans under the American Rescue Plan Act of 2021 (“ARPA”).
As we previously described in our client alert, ARPA provided for cash payments from the PBGC to eligible plans that were supposed to be in the amount necessary for the plans to pay benefits and administrative expenses through the plan year ending in 2051. In July 2021, the PBGC released an interim final rule (the “IFR”), which provided various details on the SFA program, including how the SFA amount would be calculated for an eligible plan, as we previously explained in detail. But the devil is always in the details, and there were a number of questions raised by the IFR, including whether the assumptions and conditions established by the IFR would provide enough SFA for all eligible plans to remain solvent through 2051.
Responding to a number of comments on the IFR, the PBGC’s final rule made several changes to the IFR. Most notably, the final rule attempted to address the concerns that some plans would not receive sufficient SFA to remain solvent through 2051. It also addressed concerns that plans that previously implemented benefit suspensions under the Multiemployer Pension Reform Act of 2014 (“MPRA”) would be disadvantaged if they sought ARPA relief and, as required, revoked their MPRA suspensions.
These and other key changes made by the PBGC in the final rule are summarized below.
- Methodology and Assumptions to Calculate Special Financial Assistance
Separate Investment Return Assumptions for SFA and Non-SFA Assets. In order to calculate the amount of SFA to which an eligible plan is entitled, the IFR prescribed a single investment return assumption equal to the lesser of the interest rate used for funding standard account projections in the most recent zone status certification completed before 2021 or 200 basis points plus the third segment rate in the last four months prior to the filing of the application. At the same time, the IFR required a plan to invest its SFA in investment grade-bonds, which were yielding far less than that rate.
For many plans, this meant that the PBGC would provide SFA necessary to maintain solvency through the plan year ending in 2051 assuming the SFA it provided would earn more than it actually could in light of the investment restriction. The result was that some of these plans would become insolvent before 2051 even with the SFA.
The final rule addressed this issue by calculating SFA using separate investment return assumptions for SFA and non-SFA assets. For SFA assets, the assumption is 67 basis points plus the average of the three segment rates for the month in which the average is the lowest among the four months prior to the filing of the application. For non-SFA assets, the assumption is the one that previously applied, except that the third segment rate for the “cap” is the lowest in the last four months prior to the filing of the plan’s application.
Proskauer observation: The assumptions provided in the final rule are more likely to match a plan’s actual experience, making eligible plans more likely to maintain their solvency through 2051.
SFA Amount for MPRA Plans. The final rule increases (potentially significantly) the amount of SFA available to plans that implemented suspensions under MPRA as of March 11, 2021 in response to concerns that trustees of such plans had to grapple with whether to avoid insolvency indefinitely (the standard required to implement suspensions under MPRA) and forego SFA or accept SFA and reinstate benefits (as required by ARPA to receive SFA) and jeopardize the plan’s long-term viability.
The final rule allows a MRPA plan to apply for the greatest of: (1) the SFA amount for non-MPRA plans; (2) the amount sufficient to ensure that the plan will project increasing assets at the end of the 2051 plan year; or (3) the present value of reinstated benefits, including both make-up payments for previously suspended benefits, as well as payments of the reinstated portion of the benefits expected to be paid through 2051.
Proskauer observation: By providing for sufficient SFA to ensure that a plan will project increasing assets at the end of the 2051 plan year, the PBGC is using a standard that approximates the position the plan would be in if it maintained its MPRA suspension. Thus, trustees of plans with MPRA suspensions are no longer in the unenviable position of having to decide whether to sacrifice long-term solvency to obtain ARPA relief.
SFA Amount for Non-MPRA Plans. Under the final rule, the amount of SFA to a non-MPRA plan is calculated as the lowest dollar amount for which, as of the last day of each plan year during the SFA coverage period (which ends in 2051), the plan’s projected SFA assets and projected non-SFA assets are both greater than or equal to zero. This methodology was changed from the present value methodology in the IFR because of concerns raised about how the present value calculation was affected by the timing of cash flows.
Proskauer observation: Although many commenters hoped that the PBGC would provide all plans with SFA in amounts similar to those available to MPRA Plans, the PBGC stated that it believed that doing so would be inconsistent with the Congressional intent behind APRA.
Contribution Rate Increases after July 9, 2021. In projecting a plan’s resources to calculate its SFA amount, the final rule disregards contribution rate increases that are agreed to on or after July 9, 2021. The PBGC noted that this rule eliminated the incentive for bargaining parties to wait until after the plan receives its SFA to negotiate contribution increases.
Proskauer observation: This appears to exclude increases that are required by a rehabilitation plan that were not incorporated into an employer’s collective bargaining agreements as of that date.
- Permissible Investments
The IFR only allowed plans that receive SFA to invest the SFA assets in high-quality, investment-grade bonds and certain other permissible investments that would be expected to yield similar returns. Many commenters expressed concern that this would make it harder (if not impossible) for many eligible plans to stay solvent until 2051, particularly in light of the investment return assumption described above.
The final rule pivoted from the IFR and altered the requirements for permissible investments of SFA assets. The final rule allows plans to invest up to 33% of its SFA assets in “return-seeking assets” (e.g., publicly traded, U.S. dollar denominated common stock; equity funds that invest primarily in public shares; and certain debt instruments of domestic issuers that are not investment-grade bonds). The remaining 67% of SFA must still be invested in investment-grade fixed income instruments.
Proskauer observation: The PBGC acknowledged that it took a conservative position in the IFR because ARPA expressly authorized PBGC to approve investments in asset classes other than investment grade bonds. However, PBGC stated that it wished to go through the notice and comment period under the IFR before expanding to other asset classes. By allowing a limited amount of additional diversification in the investment of SFA, the final rule attempts to balance the security of the taxpayer-funded SFA and the need to achieve investment returns to maintain solvency.
- Special Withdrawal Liability Rules
Phased Recognition of SFA. Under the IFR, all of the SFA received by a plan was immediately treated as plan assets for withdrawal liability calculations. The final rule modifies this approach by phasing-in the treatment of SFA of a plan asset over time. The phase-in period begins from the first year the plan receives SFA through the end of the plan year that the plan is projected to exhaust SFA assets. The PBGC is seeking public comments on this aspect of the final rule.
Use of Mass Withdrawal Assumptions: The IFR required plans that receive SFA to calculate withdrawal liability for all withdrawing employers using the conservative mass withdrawal interest rate assumptions established by the PBGC. The final rule continues to require plans to use these rates until the later of: (1) 10 years after the end of the plan year in which the plan receives payment of SFA; or (2) the last day of the plan year in which the plan no longer holds SFA or any earnings in a segregated account. However, it refined the second date to prevent plans from holding a small amount of SFA just to extend the period during which this rule applies by providing that it is the last day of the plan year by which the plan projects it will exhaust its SFA assets, extended by the number of years, if any, that the first plan year of payment is after the plan year that includes the SFA measurement date.
- Conditions on a Plan that Merges with a Plan that Receives SFA
In response to comments and uncertainty as to the restrictions and conditions that apply when a plan that receives SFA merges with another plan, the PBGC clarified the conditions that apply to those merged plans, as detailed in the following chart:
Application of Restrictions and Conditions After a Merger
Applies to merged plan
Does not apply to merged plan
|·Restrictions on uses of SFA
·Transfer or merger approval
·Withdrawal liability settlement approval
·Must file annual compliance statement
·Comply with periodic audit from PBGC
|·Restrictions on prospective benefit increases
·Restrictions on allocation of plan assets
·Restrictions on allocating expenses
|·Retroactive benefit increase: plan may apply for a waiver, but, absent a waiver, continues to apply to participants in the SFA plan
·Contribution decreases: plan may apply for a waiver, but, absent a waiver, continues to apply to employers who had obligation to contribute to SFA plan
·Allocating contributions and other income: plan may apply for a waiver, but, absent a waiver, continues to apply to contributions or income relative to the SFA plan before the date of the merger
·Withdrawal liability calculation: no waiver; conditions required to be applied to determine unfunded vested benefits (UVBs) that arose under the SFA plan before the date of the merger for purposes of allocating UVBs under ERISA § 4211(d) and determining withdrawal liability
- Other Conditions for SFA
PBGC generally maintained the other conditions it imposed on plans that receive SFA. However, the final rule made a few changes to the conditions. For example, with respect to the prohibition on benefit increases, it added a process pursuant to which a plan may request approval from PBGC to increase benefits if 10 years have passed since the end of the plan year in which SFA was paid and the plan will avoid insolvency notwithstanding the benefit increase.
- Application Process
The final rule maintained the IFR’s priority and metering process. However, it also added a new process that allowed plans that file after March 11, 2023 and before the end of 2025 (as well as plans in priority groups 5 and 6) to file a “lock-in application” if the PBGC closes the application process temporarily due to metering. This pro forma e-mail application would allow the plan to lock in its base data (i.e., SFA measurement date, census data and interest rates) even though it cannot yet formally apply due to the temporary closure.
Proskauer observation: The new “lock-in application” process avoids a situation in which a plan that has already performed all of the work necessary to complete its application has to redo all of its calculations because the application process is temporarily shut down due to metering.
To further address timing concerns raised by commenters, the PBGC also changed the definition of the SFA measurement date from the last day of the calendar quarter immediately preceding the initial filing date to the last day of the third calendar month immediately preceding the initial filing date.
Plans that previously applied for SFA are permitted to supplement their applications to take advantage of the final rule, and plans that have already received their SFA may receive a second SFA payment based on the supplemental application.
* * *
The final rule is effective August 8, 2022, and will generally apply to both new SFA applications and previously submitted SFA applications if the plan submits a supplemental application. The final rule contains several other changes and nuances that we have not described here. Plans, employers, and other interested parties should consult with counsel regarding these details. The PBGC’s website also provides a host of additional resources regarding the SFA program. The authors thank summer associate Mallory Knudsen for her contribution to this blog post.
In April, we wrote here about the discouraging trend of opinions allowing commonly asserted breach of fiduciary duty claims in 401(k) and 403(b) plan investment litigation to survive motions to dismiss. While it may be too soon to declare a reversal of that trend, three recent decisions dismissing these types of claims present some hope for plan sponsors and fiduciaries that in appropriate cases they may be able to avoid the costs and burdens of class action discovery. In particular, the Sixth Circuit became the first Court of Appeals to affirm the dismissal of a 401(k) fee litigation since the Supreme Court’s decision in Hughes v. Northwestern University, 142 S. Ct. 737 (2022), and two district courts dismissed similar claims.
The Sixth Circuit’s Decision
In Smith v. CommonSpirit Health, a 401(k) plan participant claimed that defendants breached their fiduciary duty of prudence by offering actively managed investments despite the availability of lower-cost and better-performing index funds. Smith v. CommonSpirit Health, No. 21-5964, 2022 WL 2207557 (6th Cir. June 21, 2022). The participant alleged that not only were actively managed funds more costly in general, but that specific funds in the plan underperformed relative to similar index funds over three- and five-year periods. She also alleged that the plan’s recordkeeping and management fees were excessive as compared to industry average costs published in surveys by NEPC and Brightscope/ICI.
We previously blogged here on the Eastern District of Kentucky’s September 2021 opinion dismissing the complaint. The district court rejected plaintiff’s investment-specific allegations insofar as they relied on comparisons to passively managed funds—which the court held were not “ideal comparators”—over a “relatively short” five-year period. Plaintiff’s challenge to the plan’s recordkeeping fees similarly was rejected for failure to identify other providers that would have provided the same services at a lower cost.
In its recent decision, the Sixth Circuit affirmed the dismissal of the case. First, the Court held that the participant’s allegation that defendants acted imprudently by offering actively managed funds in the plan’s investment lineup did not give rise to an inference of a breach. In so ruling, the Court emphasized the important role that actively managed funds can play in a plan’s investment lineup despite their comparatively higher fees, particularly for employees hoping to realize above-average returns in the long-term through a mix of high-growth and defensive investment strategies. The Court went so far as to suggest that the failure to offer any actively managed options might be imprudent.
Second, while the Court acknowledged that the selection of specific actively managed funds could be found imprudent under ERISA, it rejected the participant’s claim here because, as other circuit courts have held, a plaintiff cannot challenge a fund’s prudence based on alleged underperformance by merely “pointing to a fund with better performance.” Here, the participant’s claims centered on the plan’s default investment option—the actively managed suite of Fidelity Freedom Funds—and compared its performance to that of a Fidelity-managed index fund over a five-year period. While the Fidelity Freedom Funds’ returns trailed those of the index fund in each of the five years, the Court found that this did not, without more, violate the duty of prudence. The Court reasoned that a “five-year snapshot” of performance was insufficient to show a violation of the process-based duty of prudence because “[a] side-by-side comparison of how two funds performed in a narrow window of time, with no consideration of their distinct objectives, will not tell a fiduciary which is the more prudent long-term investment option.” Moreover, according to the Court, allowing short periods of underperformance to dictate an investment’s prudence would “lead to the disappearance” of actively managed funds—which may well-serve the objectives of some investors—from 401(k) plans entirely. As the Court put it, “[a] retirement plan acts wisely, not imprudently, when it offers distinct funds to deal with different objectives for different investors.”
Third, the Court rejected the participant’s claim that the plan paid excessive recordkeeping fees because she failed to provide the necessary context for her allegations. While the participant compared the plan’s fees to industry averages, she did not allege that the services provided to the plan were equivalent to those provided to the plans comprising those averages, nor that the surveyed plans were sufficiently similar to this one.
Lastly, the participant’s similar allegations regarding the plan’s average investment management fees, without more, failed because they were devoid of context and merely reflected the fact that the plan offered several actively managed funds.
District Court Decisions
Federal district courts in Missouri and Utah reached conclusions similar to the ones reached by the Sixth Circuit. Riley v. Olin Corp., No. 21-cv-1328, 2022 WL 2208953 (E.D. Mo. June 21, 2022); Matney v. Barrick Gold of N. Am. Inc., No. 20-cv-275, ECF No. 68 (D. Utah June 21, 2022).
Like Smith, both cases involved claims by plan participants that defendants breached their fiduciary duties by allowing the plans to incur excessive investment management and recordkeeping fees.
In Riley, the court rejected both of the participants’ fee-related claims. The court rejected the participants’ excessive recordkeeping fee claim, which was based primarily on metrics from an NEPC survey of over 100 other plans, and materials, such as expert opinions, submitted in other cases regarding the average amount plans should pay in recordkeeping fees. The court explained that the NEPC survey was not an appropriate comparator because it did not detail the specific services provided to the surveyed plans, and the materials submitted in other cases were not “meaningful benchmark[s]” because the fees charged by “different and entirely unrelated plans sa[id] nothing about the reasonableness of the [p]lan’s recordkeeping fees here.”
The court also rejected the participants’ reliance on the Brightscope/ICI survey (mentioned above) to compare mutual fund fees to those charged by cheaper collective trust versions because the ICI survey was not a “meaningful benchmark” insofar as it only considered plan size and high-level investment style and provided no information about fund holdings, investment style, or strategy. As for fees charged by individual funds, the court noted that courts “routinely” find collective trusts not to be meaningful comparators for mutual funds, and that the participants alleged only that the mutual funds were more expensive, with no comparisons of their underlying asset allocations.
In Matney, the court denied the participants’ motion for reconsideration of a prior ruling dismissing their complaint. In its previous dismissal, the court rejected the plan participants’ use of cherry-picked funds as a basis for challenging the plan’s investment management fees, and held that averages from a “401(k) Average Book” were not “meaningful benchmark[s]” against which to evaluate the plan’s recordkeeping fees. The plaintiffs moved for reconsideration based in part on their view that the Supreme Court’s decision in Hughes constituted an intervening change in controlling law. The court declined to revisit its original order, agreeing with defendants that Hughes (which was decided prior to the court’s previous dismissal) did not justify reconsideration here.
The decisions in Smith, Riley, and Matney are a breath of fresh air for plan sponsors and fiduciaries, particularly given that most courts have denied motions to dismiss very similar claims since the Supreme Court’s ruling in Hughes. While we continue to believe that the overall track record of motions to dismiss warrants consideration of an early motion for summary judgment as an alternative, these decisions reinforce the fact that a motion to dismiss may still be a proper strategy in appropriate cases.
Employers and other group health plan sponsors are left with much to consider following the U.S. Supreme Court’s decision in Dobbs v. Jackson Women’s Health Organization, which overruled the Supreme Court’s prior landmark decisions in Roe v. Wade and Planned Parenthood v. Casey. Those cases solidified a federal constitutional right to obtain an abortion and prohibited state regulation placing an “undue burden” on that right.
Without Roe and Casey, approximately half of all U.S. states now (or likely will soon) ban or significantly limit reproductive health services, including abortion, and some state laws threaten to impose liability on those who assist an individual in obtaining an abortion. As a result, employers and other benefit plan sponsors are left wondering about the future of health plan coverage for reproductive healthcare, the permissibility of travel reimbursements to assist employees in traveling to jurisdictions where abortion remains legal, and other related issues.
In this complex legal environment, different questions arise depending on whether a group health plan is insured or self-insured, the jurisdictions in which the plan operates, and a variety of other factors. Our guidebook answers common questions facing employers and other plan sponsors working through the impact of Dobbs and can be downloaded here.
Proskauer’s Task Force on Reproductive Healthcare Benefits is assisting employers and multiemployer health plans as they begin to navigate the legal and practical environment in the post-Dobbs world. Future updates will be posted on our blog, www.erisapracticecenter.com, to which you can subscribe here.
Perhaps channeling the old adage of “if it ain’t broke, don’t fix it,” the IRS recently released Notice 2022-27 extending through December 31, 2022 its temporary relief from the requirement that spousal consent for plan distributions or loans be witnessed in person.
As discussed in greater detail in our earlier posts (here and here), in response to the COVID-19 National Emergency, the IRS issued guidance temporarily allowing a notary or plan representative to witness spousal consent electronically via live video, provided certain conditions are met. This relief was originally issued in June 2020 and due to expire on December 31, 2020, but then was extended twice under the same conditions.
Following those two extensions, the relief was scheduled to expire at the end of this month. Notice 2022-27 now further extends the relief through the end of 2022. The conditions for obtaining relief (described in our first post) remain unchanged.
Although the IRS stated that it does not expect a further temporary extension (due to easing public health precautions in connection with the pandemic), the IRS is currently reviewing comments it previously received from stakeholders regarding whether to make the relief permanent. The Notice reiterates that the IRS will use the formal regulatory process (including an additional notice and comment period) if it proposes permanent changes to the physical presence requirement.
Plan administrators should be aware of this guidance and should continue to ensure that electronic witnessing meets all of the conditions set forth in the temporary relief.
“Report cards” may bring to mind evaluating middle school students, not CEOs of multi-billion dollar companies. But over the last decade, some companies have adopted a CEO “self-assessment” for evaluating the performance of CEOs. This approach can take a myriad of forms, ranging from an informal discussion with the CEO to having the CEO prepare a formal report addressing performance issues.
Consider the following: An Intelligize search completed in May 2022 for publicly filed proxy statements that contain “self-assessment” or “self-evaluation” within three words of “CEO” returns 623 results. While admittedly imprecise and anecdotal, this survey of proxy disclosures suggests that some public companies now incorporate CEO self-assessment as part of their review of CEO performance.
The proxy disclosure of the CEO self-assessment process varies, depending on the issuer. For example, consider the following disclosures from the 2022 proxy statements for International Business Machines Corporation (“IBM”), McKesson Corporation (“McKesson”) and Akamai Technologies, Inc. (“Akamai”):
- IBM: “The Chair of the Compensation Committee works directly with the Committee’s compensation consultant to provide a decision-making framework for use by the Committee in determining annual incentive payouts [to the] Chairman and CEO. This framework considers the Chairman and CEO’s self-assessment of performance against commitments in the year, both qualitative and quantitative, and also considers progress against strategic objectives, an analysis of IBM’s total performance over the year and the overall Company incentive score. The Committee considers all of this information in developing its recommendations, which are then presented to the independent members of the IBM Board of Directors for further review, discussion, and final approval.”
- McKesson: As part of the assessment of year-end results, the “CEO presents an assessment of his individual performance results to the Board and discusses his goals for the new fiscal year.”
- Akamai: “With respect to his own compensation, the CEO conducts a self-assessment of prior year performance. The Board (without the participation of the CEO) then discusses and evaluates the Chief Executive Officer’s performance. The TL&C [Talent, Leadership & Compensation] Committee is the ultimate decision-maker with respect to the compensation of our Chief Executive Officer and other NEOs.”
The actual components of the CEO self-assessment vary from company to company.
- Some companies may follow a “free form” approach, which allows the CEO to set forth the key metrics or goals he or she views as relevant and the extent of his or her achievement. Others provide a set of financial and non-financial goals (such as leadership milestones) that need to be addressed.
- As to time frame, some focus on the most recently completed fiscal year; others focus on goals that stretch over a longer period (such as a three- or five-year budget period), and may include progress on succession matters if the CEO is approaching retirement.
- In line with the current focus on ESG goals, the CEO may be expected to address progress on environmental and social issues.
- There may be a “catch-all” category, where the CEO is expected to address “misses” or areas for improvement.
How is the self-assessment used? Frequently for compensation purposes, often in connection with assessing CEO achievement of non-financial metrics underlying the annual incentive plan (“AIP”) and related payouts under the AIP (such as strategic and operational goals separate from earnings per share (“EPS”) growth, total shareholder return (“TSR”) and other financial metrics). Second, at a more general level, as a “reality check”—the fact is that the tone, candor and “feel” of a self-evaluation, in many cases reading “between the lines,” can provide the Board with a helpful overview of the CEO’s view of his or her performance and whether there is any “disconnect” between that view and the current operations and future prospects of the company. The audience for the CEO self-assessment is generally the Compensation Committee (but could include other Directors serving on committees that touch on CEO performance, a committee of independent Directors, or even the full Board). Issues relating to privilege also have to be considered when using CEO self-assessments, so counsel should be consulted as part of the implementation of a self-assessment protocol.
We close with some observations from Mark Nadler, a friend of the Firm and the founder of Nadler Advisory Services; Mark (along with his late brother David Nadler) has been a pioneer in advising CEOs and Boards. Mark warns against focusing only on the CEO’s achievement of financial metrics, particularly when the company has had a good year. In Mark’s view, financial metrics are “lagging indicators,” so regardless of how well the company has performed in any given year, it is important to focus on the future, and see how the CEO is contributing to the next year’s performance and the overall future of the company. As part of that non-financial “future oriented” emphasis, Mark recommends that the self-assessment take into account strategy, talent development, company culture and leadership—all factors that remain important for the long game.