Employee Benefits & Executive Compensation Blog

The View from Proskauer on Developments in the World of Employee Benefits, Executive Compensation & ERISA Litigation

Clarification on Extension of Amendment Deadlines for CARES Act Provisions

On September 26, 2022, the IRS released IRS Notice 2022-45, which corrected a potential oversight in IRS Notice 2022-33, discussed in detail hereNotice 2022-33 had extended the deadline to adopt certain retirement and savings plan amendments required by the Setting Every Community Up for Retirement Enhancement Act of 2019 (“SECURE Act”) and the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) from December 31, 2022 to December 31, 2025, but the extension did not apply for certain CARES Act provisions, including: penalty-free coronavirus-related distributions, increasing the permissible loan amount, and delaying repayment of loan amounts.

Notice 2022-45 rectifies this inconsistency, deferring the deadline to adopt changes covered by Section 2202 of the CARES Act—i.e., penalty-free coronavirus-related distributions, increasing the permissible loan amount, and delaying repayment of loan amounts—from December 31, 2022 to December 31, 2025.  In addition, Notice 2022-45 similarly extends the deadline for adopting qualified disaster distribution provisions pursuant to the Taxpayer Certainty and Disaster Tax Relief Act (“Relief Act”).  The notice explains that the purpose of this clarification was to ensure that all amendments required by the SECURE, CARES, and Relief Acts can be adopted in a single amendment.

This clarification is welcome for many plan administrators and sponsors as it eliminates confusion from some amendments being deferred but others being due this year.

Practical Considerations for New Pay vs. Performance Disclosure Requirement

The SEC’s final rule on Pay Versus Performance becomes effective on October 8, 2022, and will require new executive compensation disclosures for the upcoming proxy season (for annual proxy statements that include executive compensation disclosure for fiscal years ending on or after December 16, 2022). The new rule implements a requirement of the 2010 Dodd-Frank Act that public companies disclose “a clear description” of compensation paid to their top executives, including information “showing the relationship between executive compensation actually paid and the financial performance of the issuer.” Continue Reading

Second Circuit Decision Illustrates Importance of Following Claims Procedures, and Drastic Consequences of Procedural Misstep

In McQuillin v. Hartford Life and Accident Ins. Co., 36 F.4th 416 (2d Cir. 2022), the U.S Court of Appeals for the Second Circuit restored a claimant’s action for disability benefits due to the plan administrator’s failure to adhere to a procedural deadline.  The Court concluded that the administrator’s failure resulted in automatic exhaustion of the claimant’s administrative remedies—which meant the claimant could go straight to court.

Background

Under ERISA, a claimant generally may not bring a suit for benefits unless the claimant has timely exhausted his or her rights under the plan’s administrative claims procedure.  When this process is followed, a court’s review of the administrative decision is generally subject to an “arbitrary and capricious” standard—which means that the court defers to the plan administrator’s decision and will not overturn it unless the court finds an abuse of discretion.

In contrast, if the administrator does not follow the requirements of the Department of Labor’s regulation on claim and appeal procedures, the claimant will be deemed to have exhausted his or her administrative rights.  When this happens, the claimant may go straight to court, where the court can review the claim without an administrative record to guide the court’s review.

The McQuillin Case

In McQuillin, the claimant had appealed the plan administrator’s denial of his application for long-term disability benefits.  Under the appeal procedures, the administrator was required to render a decision on review within 45 days after the claim was received.  The administrator timely informed the claimant that it had made a decision and that the claimant’s application would be forwarded to a claims department for further consideration.  But the administrator did not provide any further follow-up.  After the 45-day review period had passed, the claimant filed a complaint in federal court.

The Second Circuit held that the administrator’s response lacked finality and therefore did not satisfy the procedural requirement to render a decision within 45 days after the claim was received.  As a result of the failure to “strictly adhere” to the procedure, the claimant was deemed to have exhausted his administrative remedies.  Consequently, the case was remanded to the District Court for further proceedings.

Proskauer’s Perspective

The Second Circuit’s decision illustrates the importance of carefully following the regulatory requirements for administrative claims procedures.  Had the procedures been strictly followed, the court would have been obliged to defer to the administrative record and the administrator’s decision.  By failing to adhere strictly to the procedural requirements, the plan’s administrator lost an opportunity to develop a record to guide the court’s review.

The Second Circuit’s decision did not specify a standard of review for the District Court to apply and the plan administrator’s views might still be relevant.  But the lesson is clear: the process matters, and a misstep can take the decision out of the administrator’s hands.

Seventh Circuit Provides Hope for ERISA Plan Sponsors and Fiduciaries Defending Investment Fee & Performance Litigation

The Seventh Circuit recently provided a ray of sunshine in what has largely been a gloomy stretch for plan sponsors and fiduciaries defending ERISA breach of fiduciary duty claims based on allegedly excessive investment and administrative fees and investment underperformance.  In this particular case, Oshkosh emerged victorious with the Seventh Circuit affirming the dismissal—at the motion to dismiss stage—of claims that it mismanaged its 401(k) plan by paying excessive recordkeeping fees, failed to ensure investment options were prudent, and unreasonably maintained high-cost investment advisors.  The case is Albert v. Oshkosh Corp., No. 21-2789, 2022 WL 3714638, __F.4th __ (7th Cir. Aug. 29, 2022).

Background

Albert, a former employee and participant in the Oshkosh 401(k) plan, advanced several ERISA fiduciary-breach and prohibited transaction claims based on what have become relatively common allegations related to excessive fees and investment underperformance.  First, Albert alleged that the plan paid excessive recordkeeping fees and failed to regularly solicit competitive bids.  Second, he alleged that the plan paid excessive investment management fees and, in particular, that the plan would have paid lower fees by investing in a more expensive share class with a revenue sharing component that theoretically would rebate all revenue sharing fees to the plan participants.  Third, Albert alleged that certain actively managed funds should not have been offered because they are more expensive than passively managed funds.  Fourth, Albert alleged that the plan offered personalized investment advisor services that were unreasonably expensive.  Lastly, in addition to these more commonly asserted claims, Albert also alleged that the plan failed to provide a detailed explanation of how revenue sharing payments were calculated in Form 5500 filings and that the plan’s payment of fees to its service providers resulted in violations of ERISA’s prohibited transaction rules.

The district court dismissed the complaint prior to the Supreme Court’s decision in Hughes v. Northwestern University, 142 S. Ct. 737 (2022), which notably vacated and remanded another Seventh Circuit ruling affirming dismissal of fee and investment claims.

The Seventh Circuit’s Decision

The Seventh Circuit affirmed the dismissal of all claims.  As a preliminary matter, the Court concluded that Albert had Article III standing to pursue his claims because his investment in “at least some actively managed funds” was sufficient to confer standing on a motion to dismiss, but the issue could be revived with additional discovery and on class certification.

Turning to Albert’s substantive allegations, the Court made the following rulings:

  • Allegations about recordkeeping fees, devoid of context regarding the actual recordkeeping services provided, did not move the “claim from possibility to plausibility.” In so ruling, the Court explained that there is no requirement for fiduciaries to regularly solicit bids from service providers.
  • Addressing Albert’s novel share class theory, the Court observed that the complaint’s basis for alleging that revenue sharing would have caused the plan participants to pay a lower amount of net fees was flawed because Albert had no basis for alleging that the revenue sharing proceeds would have actually been rebated to plan participants. The court observed that the plan’s Form 5500 did not disclose to whom revenue sharing proceeds are paid—to the recordkeeper as profits, or to the plan participants.  As revenue sharing proceeds do not always entirely redound to the investors’ benefit, one cannot arrive at net cost figures simply by subtracting revenue sharing from the investment management expense ratio, and Albert did not allege more.
  • Albert’s allegation that certain actively managed funds in the plan were imprudent because they were more expensive than passively managed funds was threadbare and failed to provide a comparison to a meaningful benchmark.
  • Albert provided no basis for comparison between the investment advisor service fees paid and fees paid to other service providers, and merely stating on information and belief that defendants did not solicit competitive bids from other service providers was insufficient to state a claim.
  • Albert’s prohibited transaction claims were circular. The Court explained that it would lead to absurd results and frustrate ERISA’s purpose to hold that a viable prohibited transaction claim was asserted merely because an entity providing services to a plan (which definitionally is a party-in-interest) received a fee for those services.
  • There is no requirement to disclose detailed information on how revenue sharing is calculated in Forms 5500.

Proskauer’s Perspective

The ruling in Oshkosh tends to validate our previous advice that the Supreme Court’s decision in Hughes was a much narrower decision than the plaintiffs’ bar (and some in the defense bar) initially pronounced, and thus should not lead to a trend toward denying motions to dismiss.  The Supreme Court did not address the plausibility of any of the underlying claims that the Seventh Circuit dismissed but merely held that the Seventh Circuit relied on an inappropriate “investor choice” theory to support dismissal.  In so ruling, the Supreme Court also instructed courts considering motions to dismiss ERISA complaints to apply the pleading standard set forth in Twombly, which allowed for the consideration of obvious and lawful explanations for the alleged wrongdoing, and that “due regard” must be given to the “reasonable judgments a fiduciary may make based on her experience and expertise.”  Notwithstanding an initial set of discouraging post-Hughes opinions denying motions to dismiss, which we wrote about here, the more recent trend has turned in a more favorable direction.  In addition to the ruling in Oshkosh, the Sixth Circuit (in two separate cases) and two district courts have affirmed dismissal of similar fee and investment claims (discussed here and here).  These decisions show that in a post-Hughes environment, courts will still (and arguably must) dismiss complaints that fail to strictly adhere to the applicable pleading standards.

Nevertheless, many courts continue to deny motions to dismiss based on substantially similar allegations.  In those instances where prevailing on a motion to dismiss remains unlikely, consideration should be given to filing instead an early motion for summary judgment, in which the court will have an opportunity to resolve factual issues that would otherwise have prevented the motion to dismiss from being granted.

In all events, with weekly (sometimes daily) class action complaints being filed, plan sponsors and fiduciaries are well advised to continue making sure that they have implemented appropriate procedures for monitoring plan administrative and investment management fees, and investment performance.

Fifth Circuit Rules that DOL Advisory Opinion Is Subject to Judicial Review and Invalidates DOL Advisory Opinion on Health Insurance

On August 17, 2022, the U.S. Court of Appeals for the Fifth Circuit held that a Department of Labor (“DOL”) advisory opinion, which found that an insurance plan was not governed by ERISA, was unenforceable under the Administrative Procedure Act (“APA”).  In doing so, the court ruled that the DOL advisory opinion constituted a “final agency action” subject to judicial review. The case is Data Marketing Partnership, LP v. Department of Labor, No. 20-11179, 2022 WL 3440652, __F. 4th __ (5th Cir. 2022).

By way of background, in 2018, Management Services, LLC (“Management Services”), the general partner of Data Marketing Partnership, LP (“Data Marketing”), applied for a DOL advisory opinion seeking a finding from the DOL that the health insurance plan it envisioned providing for limited partnerships was governed by ERISA as an “employee welfare benefit plan.”  Absent such a finding by the DOL, the insurance plan would be governed by more restrictive state insurance mandates that limit rights of subrogation and reimbursement.

The following year, not having received the opinion, Management Services filed suit in the District Court for the Northern District of Texas, seeking a declaratory judgment that ERISA would apply and an injunction prohibiting the DOL from issuing an opinion to the contrary.  Thereafter, the DOL issued an advisory opinion finding that ERISA would not govern the insurance plan because the limited partners were not sufficiently connected to the business to be employees for purposes of ERISA.  The plaintiffs then amended their complaint to challenge the opinion under the APA.  The DOL argued that the advisory opinion was not subject to judicial review under the APA because the DOL reserves its rights to later change its position, and thus the advisory opinion is not a “final agency action for which there is no other adequate remedy in a court.”  The district court, siding with Management Services, held the advisory opinion unenforceable and permanently enjoined the DOL from not recognizing the ERISA-status of the plan.

On appeal, the Fifth Circuit reviewed two main issues: (i) whether the advisory opinion was subject to judicial review as a “final agency action,” as defined in the APA; and (ii) if yes, whether the opinion was “arbitrary and capricious.”  The court held in the affirmative on both counts and remanded.  On the finality of the advisory opinion, the Fifth Circuit explained that for the advisory opinion to be considered final it must consummate the DOL’s decision making process and be an action from which legal consequences will flow.  The Fifth Circuit found both here since the advisory opinion determined the status of insurance plan and it was “not subject to further Agency review.”  The Fifth Circuit also rejected the DOL’s argument that the advisory opinion cannot be final since the agency can “change its positions or its reasons for the decision after more fact finding” because whether or not the DOL reverses course in the future did not change the fact that the advisory opinion was final when issued.

As to the second issue, the Fifth Circuit reasoned that the advisory opinion was arbitrary and capricious because it relied on a definition of “working owner” that was “materially different” from the one applied in prior guidance.  The Fifth Circuit held that the DOL’s failure to explain its departure from the prior definition resulted in the kind of “unexplained inconsistency” that is the “hallmark” of arbitrary and capricious agency action.

The Fifth Circuit, having resolved the two main issues presented, affirmed the vacatur of the advisory opinion and remanded for further proceedings on whether the limited partnerships were employees of the general partner and whether the injunction permanently restraining the DOL from refusing to recognize the ERISA-status of the plan is an appropriate remedy.

Practical Implications

DOL advisory opinions are perceived as reliable representations of the agency’s interpretation of ERISA and often respond to technical questions not directly addressed in the DOL’s formal rules.  If a court can set aside an advisory opinion, plan sponsors may think twice before relying on such guidance in designing and implementing key elements of their plans.  Even the recipient of a favorable opinion may question its worth.  While it is too soon to know whether the Fifth Circuit’s decision is an anomaly or a harbinger of greater judicial oversight of advisory opinions, employer plan sponsors, especially those in the Fifth Circuit, will want to pay close attention to future developments in this area.

DOL Proposes Significant Changes to the QPAM Exemption – What You Need to Know

On July 27, 2022, the U.S. Department of Labor (the “DOL”) issued notice of a proposed amendment (the “Proposed Amendment”) to Prohibited Transaction Class Exemption 84-14 (which is commonly referred to as the “QPAM Exemption”) that would (as described in more detail below) significantly amend certain of the exemption’s conditions, including:

  • increasing the equity/net worth and assets under management thresholds to qualify as a “qualified professional asset manager” (“QPAM”);
  • adding a new requirement for a QPAM to notify the DOL if it will be relying on the exemption;
  • specifically including foreign criminal convictions in the list of criminal convictions that would make a QPAM ineligible to rely on the exemption;
  • adding new types of prohibited misconduct that would make a QPAM ineligible to rely on the exemption;
  • requiring upfront terms in the QPAM’s written management agreement that would apply in the event the QPAM became ineligible to rely on the exemption as a result of a specified criminal conviction or participation in prohibited misconduct (including indemnification for certain resulting losses/costs);
  • providing for a one-year winding-down period to minimize the impact of a QPAM losing the ability to rely on the exemption as a result of a specified criminal conviction or participation in prohibited misconduct;
  • clarifying the requirement that the terms of the applicable transaction and related negotiations be the sole responsibility of the QPAM; and
  • adding a recordkeeping requirement.

If finalized, the Proposed Amendment would have far-reaching effects on employee benefit plans subject to Title I of ERISA and individual retirement accounts (“IRAs”) subject to Section 4975 of the Code (collectively, “Plans”), and investment funds and separate accounts holding “plan assets” of one or more such Plans (“Plan Asset Entities”).  The Proposed Amendment would affect investment managers managing Plan Asset Entities (including eliminating the ability of certain managers to qualify as a QPAM), employers/plan sponsors of Plans, IRA owners and other fiduciaries responsible for engaging or monitoring investment managers, as well as counterparties to Plan Asset Entities seeking to rely on the QPAM Exemption.

Background

The prohibited transaction rules under Section 406(a)(1)(A)-(D) of ERISA prohibit, among other things, sales, leases, loans and the provision of services between Plans and certain parties related to those Plans referred to as “parties in interest.”[1]  In light of how broadly the term “party in interest” is defined, some Plans could have hundreds or thousands of “parties in interest,” which often results in the practical assumption that every counterparty is a prohibited “party in interest” and every transaction requires an exemption from the prohibited transaction rules.  The alternative would require potentially extremely costly and burdensome (as well as potentially inaccurate) “party in interest” diligence for every transaction involving a Plan (which would be even more difficult for a Plan Asset Entity holding “plan assets” of many Plans).

Thankfully, the QPAM Exemption provides broad exemptive relief from those prohibited transaction restrictions for transactions between a “party in interest” with respect to a Plan and a Plan Asset Entity holding “plan assets” of such a Plan, where the Plan Asset Entity is managed by a QPAM and the other Plan protective conditions of the QPAM Exemption are met.  If the QPAM Exemption is available, it minimizes the need to perform any such “party in interest” diligence and often provides comfort to the parties to the transaction that a “party in interest” prohibited transaction will not occur.  Accordingly, it is quite common for Plan fiduciaries, investment managers and counterparties to seek or require compliance with the QPAM Exemption whenever available (even where it might not be necessary because, for example, another exemption is available or an exemption might not be required because the transaction is not likely to otherwise be prohibited).

In order to qualify as a QPAM with respect to a Plan, the relevant entity must be either a bank, a savings and loan association, an insurance company, or a registered investment adviser that meets certain financial requirements and acknowledges in writing that it is a fiduciary to the Plan.  However, one of the Plan protective conditions of the exemption (which is particularly relevant to the Proposed Amendment) provides that a QPAM would become ineligible to rely on the exemption for a period of 10 years if the QPAM, or various affiliates or five percent or more owners of the QPAM, are convicted of certain crimes.

The Proposed Amendment

In light of significant changes in the financial services industry since the exemption was originally drafted in 1984, the DOL is now seeking (in its view) to modernize the QPAM Exemption accordingly.  Below is a high-level summary of the material aspects of the DOL’s proposed changes.

The DOL is accepting comments on the Proposed Amendment through September 26, 2022.  The Proposed Amendment provides that, if finalized, it would become effective 60 days after the date of publication of the final amendment in the Federal Register.  The Proposed Amendment does not provide for any grandfathering of existing QPAMs or QPAM management agreements.  Accordingly, if the Proposed Amendment is finalized in its current form, existing QPAM management agreements would need to be amended in order to comply with the revised conditions of the exemption.

Increase of equity/net worth and assets under management thresholds to qualify as a QPAM

The Proposed Amendment would increase the financial thresholds necessary for an entity to qualify as a QPAM, to reflect prior inflation (and provides that the DOL would also publish future annual inflation adjustments) as follows:

  • The equity capital or net worth threshold (as applicable) for a bank, a savings and loan association and an insurance company would increase from $1,000,000 to $2,720,000;
  • The current assets under management threshold for a registered investment adviser would increase from $85,000,000 to $135,870,000; and
  • The shareholders’ or partners’ equity threshold for a registered investment adviser would increase from $1,000,000 to $2,040,000.

Requirement for a QPAM to notify the DOL if it will be relying on the exemption

The Proposed Amendment would add a new requirement that a QPAM must notify the DOL by email that it is relying on the QPAM Exemption.

  • A QPAM must report the legal name of each business entity relying on the exemption and any name under which the QPAM may be operating.
  • The notice will only need to be provided once, unless the QPAM changes its legal or operating name, or the QPAM is no longer relying on the exemption.
  • The DOL will publish on its website a list of QPAMs who have provided such notification to the DOL.

Specific inclusion of foreign criminal convictions in the list of criminal convictions that would make a QPAM ineligible to rely on the exemption

As noted above, a QPAM would become ineligible to rely on the QPAM Exemption for a period of 10 years if the QPAM, or various affiliates or five percent or more owners of the QPAM, are convicted of certain crimes (a “Criminal Conviction”).  Although there has been some uncertainty as to whether foreign criminal convictions were included, the Proposed Amendment would remove any such ambiguity and provide that foreign criminal convictions, in addition to domestic criminal convictions, would make a QPAM ineligible to rely on the exemption. Such foreign criminal convictions would include convictions “by a foreign court of competent jurisdiction for any crime … however denominated by the laws of the relevant foreign government, that is substantially equivalent to” one of the enumerated U.S. federal or state crimes identified in the exemption.

Addition of new types of prohibited misconduct that would make a QPAM ineligible to rely on the exemption

The Proposed Amendment would add a new category of misconduct that may lead to ineligibility to rely on the QPAM Exemption for 10 years, referred to as “participating in Prohibited Misconduct.”

  • “Prohibited Misconduct” would be defined as: (i) any conduct that forms the basis for a non-prosecution or deferred prosecution agreement that, if successfully prosecuted, would have constituted a Criminal Conviction; (ii) any conduct that forms the basis for an agreement, however denominated by the laws of the relevant foreign government, that is substantially equivalent to a non-prosecution agreement or deferred prosecution agreement described above; (iii) engaging in a systematic pattern or practice of violating the conditions of the exemption; (iv) intentionally violating the conditions of the exemption; or (v) providing materially misleading information to the DOL in connection with the conditions of the exemption. Prohibited Misconduct described in clauses (iii) through (v) above would be determined through “an investigation by the appropriate field office” of the DOL.
  • “Participating in” such misconduct includes not only active participation but also knowingly approving of the conduct or having knowledge of such conduct without taking appropriate and proactive steps to prevent such conduct from occurring, including reporting the conduct to appropriate compliance personnel.
  • When a QPAM’s ineligibility is linked to participating in Prohibited Misconduct, the DOL will provide the QPAM with a written warning and an opportunity to be heard.  If the QPAM does not respond to the warning or fails to convince the DOL otherwise, the DOL will issue a “Written Ineligibility Notice” to the QPAM.

Requirement to include new upfront terms in the QPAM’s written management agreement

The Proposed Amendment would require a QPAM to include certain standards of integrity, considered by the DOL to be a fundamental requirement of a QPAM, in the QPAM’s written management agreement with its client Plans.

  • Specifically, the Proposed Amendment would require the QPAM’s written management agreement to provide that in the event the QPAM, or an its affiliate or a five percent or more owner of the QPAM, (i) engages in conduct resulting in a Criminal Conviction or (ii) receives a Written Ineligibility Notice from the DOL, the QPAM would not restrict its client Plan’s ability to terminate its arrangement with the QPAM or withdraw from the applicable Plan Asset Entity managed by the QPAM for at least a period of 10 years.
  • The QPAM would be prohibited from imposing any fees, penalties, or charges on the client Plan in connection with such termination or withdrawal (except for reasonable fees, appropriately disclosed in advance, that are specifically designed to prevent generally recognized abusive investment practices or to ensure equitable treatment of all investors in a pooled fund in the event such withdrawal or termination may have adverse consequences for all other investors, provided any such fees are applied consistently and in a like manner to all such investors).
  • The QPAM’s written management agreement would be required to include a provision requiring the QPAM to indemnify, hold harmless, and promptly restore actual losses to each client Plan for any damages directly resulting from a violation of applicable laws, a breach of contract, or any claim arising out of the QPAM’s ineligibility to rely on the exemption as a result of a Criminal Conviction or receipt of a Written Ineligibility Notice. Actual losses include losses and costs arising from unwinding transactions with third parties and from transitioning Plan assets to an alternative asset manager as well as costs associated with any exposure to excise taxes under Section 4975 of the Code.
  • The QPAM would also be required to contractually agree not to employ or knowingly engage any individual that participated in the conduct that is the subject of a Criminal Conviction or Written Ineligibility Notice.

One-year winding-down period to minimize the impact of a QPAM losing the ability to rely on the exemption as a result of a Criminal Conviction or receipt of a Written Ineligibility Notice

Any QPAM that becomes ineligible to rely on the exemption as a result of a Criminal Conviction or receipt of a Written Ineligibility Notice must engage in a winding-down period, which is only available to existing Plan clients.  During such one-year period, the QPAM must fully comply with the conditions of the exemption, it must ensure that it manages each Plan’s assets prudently and loyally, and it must comply with the following additional conditions:

  • Within 30 days, the QPAM must provide notice to the DOL and each of its client Plans stating: (i) its failure to satisfy such condition of the exemption and the resulting initiation of the one-year winding-down period; (ii) that it will not restrict the ability of its client Plans to terminate or withdraw from its arrangement with the QPAM nor impose fees, penalties, or charges on the client Plan in connection with such terminating or withdrawal; and agrees to indemnify, hold harmless, and promptly restore losses to the client Plan resulting therefrom; and (iii) an objective description of the facts and circumstances upon which the Criminal Conviction or Written Ineligibility Notice is based, written with sufficient detail to fully inform the client Plan’s fiduciary of the nature and severity of the conduct so that such fiduciary can satisfy its fiduciary duties of prudence and loyalty with respect to hiring, monitoring, evaluating, and retaining the QPAM in a non-QPAM capacity;
  • No later than the date it becomes ineligible to rely on the exemption, the QPAM must not employ or knowingly engage any individual that participated in the conduct that was the subject of the Criminal Conviction or Written Ineligibility Notice;
  • The QPAM may not engage in new transactions in reliance on the exemption for existing client Plans; and
  • After the one-year winding-down period expires, the QPAM may not rely on the exemption until the expiration of the 10-year ineligibility period unless it obtains an individual exemption from the DOL permitting it to do so. The Proposed Amendment would also add new requirements with respect to any application for such an individual exemption.

Clarification of the requirement that the terms of the applicable transaction and related negotiations be the sole responsibility of the QPAM

The Proposed Amendment would clarify that a QPAM must not permit other “parties in interest” to make decisions regarding Plan investments under the QPAM’s control, and that the QPAM must have sole responsibility over the terms of transactions, commitments, investment of Plan assets, and any associated negotiations.

  • A “party in interest” should not be involved in any aspect of a transaction, aside from certain ministerial duties and oversight associated with Plan transactions, such as providing general investment guidelines to the QPAM. Under the Proposed Amendment, there would be no relief under the exemption for any transaction that has been planned, negotiated or initiated in whole or in part by a “party in interest” to the Plan and presented to the QPAM for approval.
  • The Proposed Amendment would also provide that the exemption would apply only in connection with a Plan Asset Entity that is “established primarily for investment purposes” and that no relief would be available for any transaction that is planned, negotiated, or initiated by a “party in interest”, in whole or in part, and presented to a QPAM for approval because the QPAM would not have sole responsibility with respect to such a transaction and the role of the QPAM is not to act as a mere independent approver of a transaction.

Addition of a recordkeeping requirement

The Proposed Amendment would requires a QPAM to maintain records for six years demonstrating compliance with the exemption.

  • The records must be maintained in a manner that is reasonably accessible at a QPAM’s customary business location during normal business hours for examination by the DOL, the IRS, other federal or state regulators, any Plan fiduciary, any contributing employer or employee organization whose members are covered by the Plan, and any Plan participant or beneficiary.
  • However, such parties are only permitted to access records relevant to their transactions, and the QPAM does not need to provide access to privileged trade secrets or privileged commercial or financial information of the QPAM.

*          *          *

As noted above, if finalized in its current form, the Proposed Amendment would significantly impact investment managers acting or seeking to act as QPAMs, Plan fiduciaries responsible for engaging or monitoring QPAMs and counterparties relying or seeking to rely on the QPAM Exemption.

For ERISA Plan fiduciaries, it is also important to recognize that ERISA’s fiduciary duties of prudence and loyalty apply in the context of hiring, monitoring and retaining/firing an investment manager regardless of whether the investment manager qualifies as a QPAM or may utilize the QPAM Exemption.

We will continue to monitor any developments in this area and, as always, remain available to answer any questions you may have.

[1] Similar rules exist under Code Section 4975(c)(1)(A)-(D)) with respect to “disqualified persons.”  For purposes of this discussion, any references to the prohibited transaction rules under Section 406 of ERISA and “parties in interest” apply equally to the prohibited transaction rules under Section 4975 of the Code and “disqualified persons.”

Seventh Circuit Affirms Dismissal of ERISA Stock-Drop Case

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

IRS Guidance Extends Deadline for SECURE & CARES Act Amendments

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

Stranger in a Strange Land: Surprising Applications of U.S. Golden Parachute Rules in Cross-Border Transactions

Background

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.

Conclusion

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.

Sixth Circuit Upholds Dismissal of Some Investment Fee and Performance Claims But Allows Mutual Fund Share Class Claim to Proceed to Discovery

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.”

Proskauer’s Perspective

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.

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