Employee Benefits & Executive Compensation Blog

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

DOL Finalizes New Prohibited Transaction Exemption for “Investment Advice”, With Statement That Fiduciary Standard May Apply to IRA Rollover Guidance

****UPDATE:  The Exemption described in this notice appears to be covered by the regulatory freeze described in this Memorandum for the Heads of Executive Departments and Agencies, issued by Chief of Staff Ronald A. Klain on January 20, 2021.  Accordingly, we expect the effective date of the Exemption to be postponed for 60 days (until March 22, 2021) to allow review by the Biden administration’s Department of LaborStay tuned.****

On December 18, 2020, the U.S. Department of Labor (the “DOL”) published in the Federal Register a final prohibited transaction class exemption (the “Exemption”) that allows “investment advice” fiduciaries to provide advice that affects their compensation and to engage in otherwise prohibited “principal transactions.”  Importantly, the preamble to the Exemption (the “Preamble”) includes the DOL’s final interpretation of the “five-part test” for purposes of determining when IRA rollover advice constitutes fiduciary “investment advice.”

The Exemption (PTE 2020-02) is set to become effective on February 16, 2021.  At this time, it is not yet clear whether the Biden administration will delay or revoke the Exemption.

By way of background, on July 7, 2020, the DOL issued a guidance package (summarized here) that included the proposed Exemption and formally reinstated the “five-part test” from 1975 to determine what constitutes fiduciary “investment advice” under ERISA and Section 4975 of the U.S. Internal Revenue Code (the “Code”).  The reinstatement of the “five-part test” followed the direction of the U.S. Court of Appeals for the Fifth Circuit on March 15, 2018 to vacate the Obama administration’s 2016 fiduciary rule, and was final when published in July 2020.  Accordingly, any changes to the “five-part test” will require a new proposed rule and comment period.

Below we describe in more detail the DOL’s views on application of the “five-part test” to IRA rollover advice and the Exemption.

Advice to Roll Over Can Be Investment Advice Under the “Five-Part Test”

Under the “five-part test”, a person is considered to be providing “investment advice” only if the person: (i) renders advice as to the value of securities or other property, or makes recommendations as to investing in, purchasing or selling securities or other property, (ii) on a regular basis, (iii) pursuant to a mutual agreement, arrangement, or understanding with the plan, the plan fiduciary or IRA owner that, (iv) the advice will serve as a primary basis for investment decisions with respect to plan or IRA assets, and (v) the advice will be individualized based on the particular needs of the plan or IRA.  A person who meets all five prongs of the test and receives direct or indirect compensation will be considered an “investment advice” fiduciary with respect to the applicable plan or IRA.

Historically, service providers have often taken the position that advice on whether to leave money in a plan or to roll over to an IRA was not provided on a “regular basis” and/or was not provided pursuant to a “mutual” agreement, arrangement or understanding that the advice would serve as a “primary basis” for the decision.  Further, in Advisory Opinion 2005-23A (the “Deseret Letter”), the DOL stated that advice to roll assets from a plan to an IRA was not “investment advice,” because it was not advice with respect to assets of a plan.

In the Preamble, however, the DOL disclaimed its guidance in the Deseret Letter as an “incorrect analysis.”  The DOL now says that the “better view” is that IRA rollover advice is a recommendation to liquidate or transfer the plan’s property to effectuate the rollover.  This means that advice on whether to take a distribution from a retirement plan and roll it over to an IRA (or to roll over from one plan to another plan, or one IRA to another IRA) may be covered by the “five-part test,” if the advice is either part of an ongoing relationship or the start of an ongoing relationship.

In this regard, the DOL has withdrawn the Deseret Letter and stated the following:

  • The full “five-part test” applies for determining whether a service provider is an “investment advice” fiduciary. Whether or not the prongs of the test are satisfied “will be informed by all the surrounding facts and circumstances”;
  • IRA rollover advice may be an isolated and independent transaction that would fail to meet the “regular basis” prong, but the analysis will depend on the surrounding facts and circumstances:
    • In circumstances where an advice provider has been giving financial advice to an individual about investing in, purchasing, or selling securities or other financial instruments through a retirement vehicle subject to Title I of ERISA or the Code, any rollover advice provided to the individual would be considered part of an ongoing advice relationship that would satisfy the “regular basis” requirement;
    • Similarly, where a rollover advice provider will be regularly giving financial advice with respect to the IRA following the rollover (even if it has not otherwise provided any advice before the rollover), the rollover advice would be the start of an advice relationship that would satisfy the “regular basis” requirement; and
    • When the parties reasonably expect an ongoing advice relationship at the time of the rollover recommendation, the “regular basis” prong is satisfied;
  • The determination of whether there is a “mutual” agreement, arrangement, or understanding that the investment advice will serve as a “primary basis” for investment decisions will be based on the reasonable understanding of each of the parties:
  • To be subject to the fiduciary standard, the advice does not need to serve as “the” primary basis of investment decisions: it need only serve as “a” primary basis;
  • Written statements disclaiming a mutual understanding may be considered as part of the analysis, but are not determinative;
  • In evaluating the reasonable understanding of the parties, the DOL intends to consider marketing materials where the advice provider holds itself out as a trusted adviser (or, in the alternative, clearly disclaims any fiduciary relationship or position of trust and confidence); and
  • When a financial service professional makes recommendations that are based on the individualized needs of the recipient or made in accordance with a best interest standard such as the Securities and Exchange Commission’s (“SEC”) best interest standard, the parties “typically should reasonably understand that the advice will serve as at least a primary basis for the investment decision”; and
  • “Hire me” marketing communications generally will not be treated as “investment advice” if not accompanied by an investment recommendation.

Recognizing that some advisers have relied on the Deseret Letter, the DOL says it will not pursue claims for breach of fiduciary duty or prohibited transactions based on rollover recommendations made before the effective date of the Exemption, if the recommendations would not have been considered fiduciary “investment advice” under the Deseret Letter.

The Exemption

The final Exemption is largely consistent with the proposed Exemption.  It allows an “investment advice” fiduciary to provide advice that affects its compensation if the fiduciary complies with “impartial conduct” standards and satisfies certain other requirements. As described below, the “impartial conduct” standards incorporate ERISA’s principles of prudence and loyalty, and are intended to be aligned with the standards of conduct for investment advice professionals established and considered by other U.S. Federal and State regulators – in particular, the SEC and its Regulation Best Interest.  Notably, the Exemption is available only for eligible fiduciaries who give advice—not for fiduciaries who retain discretion with respect to the plan or IRA.

The Exemption is available for an “investment advice” fiduciary who is a registered investment adviser, broker-dealer, bank, or insurance company, or an employee, agent, or representative of an eligible entity.  Under the Exemption, an eligible investment advice fiduciary could receive direct compensation (such as management fees from a recommended investment) as well as indirect compensation such as 12b-1 fees, trailing commissions, sales loads, mark-ups and mark-downs, and revenue sharing payments from investment providers or third parties.

The Exemption also permits qualifying “investment advice” fiduciaries to enter into and receive compensation with respect to “riskless” and certain other “principal transactions” with a Retirement Investor (i.e., an ERISA plan participant or beneficiary, IRA owner, or fiduciary of an ERISA plan or IRA) where the fiduciary either purchases certain investments from a Retirement Investor for its own account or sells certain investments out of its own inventory to the Retirement Investor.

The Exemption’s critical protective condition is that the adviser must comply with “impartial conduct” standards – namely, the best interest standard described above (which includes prudence and not placing the fiduciary’s financial or other interests (including interests of the financial institution) ahead of the Retirement Investor’s interests); a reasonable compensation standard; and a requirement to make no materially misleading statements.  The Exemption also requires that the “investment advice” fiduciary:

  • Disclose both the financial institution’s and the investment professional’s status as an “investment advice” fiduciary, and provide an accurate description of the services to be provided and material conflicts of interest;
  • If the advice involves a rollover recommendation, document and disclose the reasons that the rollover recommendation is in the Retirement Investor’s best interest (this requirement was not in the proposed Exemption);
  • Establish, maintain and enforce policies and procedures prudently designed to ensure compliance with the “impartial conduct standards”; and
  • Conduct an annual review to ensure compliance with (and detect and prevent violations of) the conditions of the Exemption.

The Exemption is similar in substance to the “Best Interest Contract Exemption” that was vacated along with the Obama Administration’s fiduciary rule, except that it does not give Retirement Investors a separate right of action.

An “investment advice” fiduciary could lose the ability to rely on the Exemption for a period of 10 years for certain criminal convictions, providing misleading statements to the DOL in connection with relying on the exemption, or engaging in an intentional violation or systematic pattern of violating the conditions of the exemption.

The Exemption includes a “self-correction” mechanism for certain violations.  The self-correction mechanism was not included in the proposed Exemption and is available for violations that do not result in any losses to the Retirement Investor (or where the Retirement Investor is made whole by the financial institution for such losses), if (i) the violation is corrected within 90 days after the financial institution learned (or reasonably should have learned) of the violation, (ii) the DOL is notified within 30 days of correction, and (iii) the violation and correction is documented in the annual compliance review.

The Exemption does not cover advice arrangements that rely solely on “robo-advice” without interaction with an investment professional.  Those advice arrangements are covered by the statutory exemption in Sections 408(b)(14) and 408(g) of ERISA and Sections 4975(d)(17) and 4975(f)(8) of the Code and the regulations thereunder.

To facilitate transition, the DOL’s current non-enforcement policy for investment advice professionals that have established policies to comply with the “impartial conduct” standards under the vacated best Interest Contract Exemption and Class Exemptions for Principal Transactions (announced in Field Assistance Bulletin 2018-02) will remain in effect until December 20, 2021.

Proskauer Perspective

The withdrawal of the Deseret Letter is consistent with views the DOL has been stating publicly for some time now.  With a new administration coming into office, we do not think the reinstatement of the “five-part test” or the final Exemption will be the final word from the DOL on this topic.  Stay tuned.

California Independent Contractor Classification Becomes Even More Thorny, as California Supreme Court Holds Strict ABC Test Applies Retroactively

On January 14, 2021, the California Supreme Court decided, at the request of the Ninth Circuit, that its decision in Dynamex Operations West, Inc. v. Superior Court, 4 Cal.5th 903 (2018) applies retroactively. See our California Employment Law Update for more on this significant decision.

Applying the strict “ABC test” for determining whether a worker is an employee or independent contractor retroactively adds yet another, complicating, angle to worker classification in California. In the wake of this decision, businesses that have classified their workers appropriately for federal purposes and that historically classified their workers appropriately for purposes of California state law pre-Dynamex, are left with the perplexing result of nevertheless having potential exposure to liability arising from California’s wage orders (but not, notably, the full panoply of statutes addressed by California’s much broader worker classification law known as Assembly Bill 5 (AB 5”)). In the transactional context, the California Supreme Court’s decision underscores the importance of diligence and attention to worker classification processes and practices where businesses engage independent contractors in California.

Please contact any member of the Proskauer Employee Benefits & Executive Compensation Group or the Proskauer Labor & Employment Group with any questions about this post.

To learn more about the California Supreme Court’s decision in Dynamex, listen to our podcast on The Proskauer Benefits Brief:  Legal Insight on Employee Benefits and Executive Compensation.


EEOC Proposed Wellness Regulation Restricts Incentives For Voluntary Programs But Offers Path For Programs That Satisfy ACA Standard

****UPDATE:  These proposed regulations were not published in the Federal Register before President Biden’s inauguration.  In accordance with the Memorandum for the Heads of Executive Departments and Agencies, issued by Chief of Staff Ronald A. Klain, the proposed regulations have been withdrawn for review by the Biden administration.****

On January 7th, the EEOC released proposed new regulations under the Americans with Disabilities Act (ADA) and the Genetic Information Nondiscrimination Act (GINA) for employer-offered wellness programs.  (As of January 15, 2021, the proposed regulations still have not been published in the Federal Register.)  If finalized, the proposed regulations would clarify the extent to which wellness programs that comply with separate regulations issued by the IRS, DOL and HHS on wellness plans issued under Affordable Care Act may be constructed to comply with the ADA and GINA.  It remains to be seen whether the Biden administration will move the proposal forward or go back to the drawing board.


Many employers offer wellness programs to encourage healthy habits, increase productivity, and reduce health plan costs.  Depending on the design of the program and whether incentives are offered, wellness programs raise a number of issues under various federal laws, including ERISA, HIPAA, the ADA, GINA, COBRA, and anti-discrimination laws like the ADEA and Title VII of the Civil Rights Act of 1964.  In the last 20 years, the following rules have been of particular concern for wellness programs that offer incentives, such as a discount on health plan premiums or a prize:

  1. HIPAA prohibits discrimination on the basis of a health factor (such as health status), a medical condition, medical history, or genetic information.
  2. The ADA requires reasonable accommodations for disabilities and prohibits disability-related medical examinations unless they are “voluntary.”
  3. GINA prohibits employers from requesting or using genetic information, which includes family medical history, unless the information is provided “voluntarily.”

The concern is that not providing a wellness plan incentive to someone who fails to satisfy the required conditions can be viewed as a penalty that discriminates on the basis of a health factor and/or that the opportunity cost of giving up an incentive effectively makes the program involuntary.

HIPAA Regulations

Longstanding HIPAA regulations, most recently updated in 2013 to incorporate provisions of the Affordable Care Act, provide a roadmap for a wellness program to comply with HIPAA’s non-discrimination rules.  These regulations divide wellness plans into two categories:

  • Participatory programs, under which there are no significant impediments to participation (physical or otherwise) and incentives are not conditioned on performing any activity that relates to a health factor or on achieving a health factor target. Examples of participatory programs include reimbursement for gym membership or offering an incentive to complete a health risk assessment or get a biometric screening; and
  • Health-contingent programs, where an incentive is conditioned on performing an activity related to a health factor or achieving a health factor target. A health-contingent program can be “activity-based” (where an incentive is conditioned on completing an activity related to a health factor, such as daily exercise, without any requirement to achieve a particular outcome) or “outcome-based” (where an incentive is conditioned on achieving an outcome, such as reducing cholesterol levels or BMI).

The HIPAA regulations allow incentives for participatory programs without restriction, provided they are offered to everyone, and allow health-contingent programs if the following requirements are satisfied:

  1. The program must be reasonably designed to promote health or prevent disease;
  2. The program must be made available to all similarly situated individuals and provide opportunities to qualify for the incentive at least annually;
  3. The program must offer reasonable alternatives for individuals for whom meeting the required standard (e.g., completing an exercise regimen or reducing cholesterol or BMI) is unreasonably difficult due to a medical condition; and
  4. The value of the incentive must not exceed 30% of the applicable health insurance premium (the employee-only premium if the program is offered only to employees, or a family premium if the program is offered to family members). The percentage may be up to 50% for tobacco cessation programs.

Although the HIPAA regulations provided clear standards for wellness programs, the EEOC warned that a program complying with the HIPAA regulations might not comply with separate requirements under the ADA, GINA, or other federal laws.  In particular, the EEOC warned that offering incentives to test for conditions like BMI and cholesterol might violate the ADA’s prohibition against medical examinations that are not voluntary, and that offering incentives to complete a health risk assessment that includes family medical history might violate GINA’s prohibition against involuntary collection of genetic information.

2016 EEOC Regulations Under the ADA and GINA

In 2016, the EEOC issued regulations that resolved the uncertainty under both the ADA and GINA.  Based on comments from stakeholders, the 2016 EEOC regulations said that incentives (whether as a reward or a penalty) would not make a program involuntary if the incentives were not exceedingly valuable.  For this purpose, the EEOC regulations carried over the 30% and 50% caps from the HIPAA regulations, but with slight adjustments. The 2016 EEOC regulations did not distinguish between programs offered inside or outside of the context of an employer-sponsored group health plan.

The clarity afforded by the 2016 EEOC regulations was short-lived, however.  By order of a federal judge, the regulations were vacated, because the EEOC had not provided sufficient data to support its conclusion that 30% (50% for smoking cessation) was the appropriate line to establish that a program was still voluntary.

The New EEOC Proposal

After reconsideration, the EEOC now has issued new proposed regulations under both the ADA and GINA.  The proposed regulations address the court’s concern with the 2016 regulations by specifying that any incentive that is more than de minimis would render a program involuntary.  But the proposed ADA regulation offers a new “safe harbor” that would allow health plans to offer bigger incentives to participate in certain health-contingent wellness programs—but not to provide family medical history or other genetic information—if the requirements under the HIPAA regulations are satisfied.

De Minimis Incentive Standard

The proposed regulations provide that any incentive that is more than de minimis generally renders a program involuntary.  The proposed regulations do not define “de minimis,” but they offer a few examples:  A water bottle or a gift card of “modest” value would be de minimis; but an incentive as small as $50 per month, a gym membership, or a plane ticket would exceed the de minimis threshold.

Like the 2016 regulations, the proposed regulations also prohibit employers from requiring participation, limiting coverage or benefits due to lack of participation, taking adverse action for non-participation or failure to achieve a health outcome, or requiring consent to the disclosure of information to a third party. In addition, the proposed ADA regulations maintain the requirement from the 2016 regulations that information regarding medical conditions or histories be kept confidential and maintained in separate files (with limited exceptions).  Both regulations limit the employer’s ability to receive employee information other than in aggregate form.

New ADA “Safe Harbor” for Health-Contingent Programs in Group Health Plans

As noted above, the proposed ADA regulations (but not the proposed GINA regulations) contain an important exception to the de minimis incentive limitation that is designed to align with the HIPAA framework.  This exception is based on an ADA rule that allows an entity administering a benefit plan to address underwriting risks to the extent not inconsistent with state law.  As proposed, a wellness program can qualify for this safe harbor if the following conditions are satisfied:

  1. The program is designed based on risks and not as a subterfuge to evade the purposes of the ADA’s equal employment provisions.
  2. The program is a health contingent program that is integrated into (or independently qualifies as) a group health plan that is subject to the HIPAA regulations. The proposed rules outline various factors for determining whether a program is integrated into a group health plan—for example, whether the incentive is limited to employees enrolled in the plan, whether the incentive is tied to cost sharing or premiums under the plan, whether the program’s vendor has a contract with the plan, and whether the plan includes the welfare program as a term of coverage.
  3. The value of the incentive falls within the limit set by the HIPAA rules (30% of the cost of coverage, or 50% for programs designed to reduce tobacco use).

The proposed GINA regulations do not contain a similar exception.  Accordingly, incentives that are more than de minimis may not be conditioned on an employee providing family medical or other genetic information.  (For this purpose, a spouse’s medical history generally counts as family medical information.)  For example, if an incentive is offered to complete a health risk assessment, employees would need to be told that they can qualify for the incentive even if they do not respond to the questions requesting family medical history or other genetic information.

Comments Sought

A comment period will be open for 60 days after the proposed regulations are published in the Federal Register. Specific areas about which the EEOC is seeking input include whether the regulations should include disclosure requirements, what types of incentives should be treated as de minimis, and how employers use information from health risk assessments and biometric screenings.

Proskauer Perspective

The proposed regulations balance the need to prohibit incentives that have a coercive effect, while still clearing a path wellness programs that rely on testing and health risk assessments to control plan costs.  Time will tell whether the rules are finalized in their current form.  In the meantime, employers maintaining wellness programs should consult with counsel on how best to manage compliance obligations and mitigate risk.

Additional Relief for FSA Benefits

As part of the COVID-19 relief package passed by Congress earlier this week, the federal government expands on earlier relief issued by the Internal Revenue Service (IRS) for health and dependent care flexible spending account benefits (FSAs). Under these temporary rules, plan sponsors may give their employees additional time to use their FSA account balances and to make changes to their FSA elections. These changes are optional and require plan amendments.

Read below for more details about this relief, including the deadlines to make plan amendments.

No Limit on FSA Carryovers and New Dependent Care Carryover

As described in our earlier blog related to the IRS relief, FSAs generally are subject to a “use it or lose it” rule, pursuant to which employees must use their account balances for eligible expenses incurred during the plan year, subject to limited exceptions that allow a carryover of unused amounts to the next plan year (only $550 for 2020 and $560 for 2021) and a 2 ½ month grace period for both health and dependent care FSAs. Significantly, the new legislation eliminates the health FSA carryover limit, allowing employees to carry over any unused amounts from the 2020 or 2021 plan year to the next plan year, and also permits dependent care FSA carryovers for those years, which is not permitted under current law. As a reminder, the IRS guidance issued earlier this year did not relax the carryover rules, but did increase slightly the health FSA carryover limit.

Extension of FSA Grace Periods

Under current law, health and dependent care FSAs may allow participants to be reimbursed for claims incurred during a 2 ½ month grace period following the end of the plan year, unless the health FSA includes a carryover provision. The new legislation extends the permissible grace period to 12 months following the end of the plan year (or presumably a period that is shorter than 12 months), for plan years that end in 2020 or 2021. Under the earlier IRS guidance, plans with grace periods expiring before December 31, 2020 and non-calendar year plans ending before December 31, 2020 were allowed to extend their grace periods until the end of 2020.  As an example, a plan with a July 1, 2019 to June 30, 2020 plan year was allowed to extend its grace period to permit employees to incur expenses for an additional six months (through December 31, 2020). With the new relief, the plan can extend the grace period further, through June 30, 2021.

Extension of Dependent Care Age Limit

The new legislation includes a provision to address situations where a dependent child attained age 13 (the age limit for dependent care reimbursements) during the pandemic, before the employee was able to use all of their dependent care account funds for the year. Under this provision, a dependent care FSA that has an enrollment period that ended by January 31, 2020 (for the most recent plan year) may allow reimbursement of expenses through the end of the plan year, or through the next plan year when the child attains age 14 (solely with respect to any unused balance from the prior year).

Mid-Year FSA Election Changes

In general, employees may only make FSA plan changes during a plan year if the employee experiences a change in status event under the IRS rules. Similar to the earlier IRS guidance, which allowed mid-year election changes in 2020 regardless of whether the employee experienced a change in status event, the new legislation allows plan sponsors to permit prospective mid-year election changes to FSA elections in plan years ending in 2021 without regard to a change in status. Unlike the IRS relief for 2020 (which also applied to other health plan elections), this relief appears to be limited to FSAs.

Post-Termination Health FSA Reimbursements

Employees generally may only receive reimbursement from a health FSA for expenses that are incurred while employed, subject to COBRA rights. The new legislation includes a provision that permits plan sponsors to allow reimbursements through the end of the 2020 or 2021 plan year in which participation ends, including any grace period or extended grace period. The impact of this change is not entirely clear, since employers generally offer COBRA rights under health FSAs in any event (unless the excepted benefit rules permit otherwise). It is possible that the regulators are merely clarifying that a plan sponsor may now allow a former employee to continue to incur claims and receive reimbursements without requiring the employee to make a COBRA election and premium payment.

Deadline for Adoption of Plan Amendments

If a plan sponsor chooses to adopt any of the above changes, which may apply retroactively, the applicable plan documents must be amended by the last day of the first calendar year beginning after the end of the plan year in which the amendment is effective. Accordingly, for calendar year plans, amendments effective in 2020 must be adopted by December 31, 2021, and amendments effective in 2021 must be adopted by December 31, 2022. Plan sponsors also should communicate the changes to affected employees in time to be useful.

U.S. Supreme Court: No ERISA Preemption for State Law Regulating PBMs

In a unanimous (8-0) opinion authored by Justice Sotomayor, the U.S. Supreme Court held that an Arkansas state law regulating rates at which pharmacy benefits managers (PBMs) reimburse pharmacies is not preempted by ERISA.  (Justice Barrett took no part in the consideration or decision of the case.)  While most people would not think of ERISA preemption issues as affecting their daily lives, the Court’s opinion could have greater implications than one might imagine given that at least forty states currently regulate some aspect of PBM activities, and the significant impact PBMs have on the cost of pharmaceuticals.


PBMs serve as intermediaries between drug purchasers, such as group health plans, and drug wholesalers and manufacturers.  They negotiate rates with local pharmacies on behalf of their customers, the drug purchasers; dispense medications directly to consumers through mail service and specialty drug pharmacies; and negotiate rebates with drug manufacturers for certain of the drugs used by their customers.

In 2015, Arkansas passed legislation in response to growing concerns that reimbursement rates set by PBMs were often too low to cover pharmacies’ costs, and that many local pharmacies, particularly rural and independent ones, were at risk of closing.  The law also permits an Arkansas pharmacy to refuse to sell a drug if the PBM’s reimbursement rate is lower than the pharmacy’s acquisition cost.  In effect, the law requires PBMs to reimburse intrastate pharmacies at a price equal to or higher than each pharmacy’s wholesale cost.

The Pharmaceutical Care Management Association, which represents the 11 largest PBMs in the country, sued the Attorney General of the State of Arkansas, alleging that the state law is preempted by ERISA because it contains a prohibited reference to ERISA.

The Eighth Circuit held that ERISA preempted the Arkansas statute because it both “related to” and “had a connection with” ERISA-governed employee benefits plans.  In so ruling, the Eighth Circuit opined that the state law made an “implicit reference” to ERISA by regulating PBMs that administer ERISA plan benefits, and that the law was “impermissibly connected” with ERISA plans because it “governed central matters of plan administration” by mandating an appeal process for pharmacies to challenge PBM reimbursement rates.

The Supreme Court’s Decision

The Supreme Court disagreed.  In overturning the Eighth Circuit’s decision, the Supreme Court concluded that the Arkansas law amounted to “cost regulation,” which does not bear an “impermissible connection with or reference to ERISA.”  The Court observed that the state law does not “refer to” ERISA because it equally applies to all PBMs, regardless if they manage an ERISA plan.  The Court also explained that requiring PBMs to reimburse pharmacies at or above their acquisition costs “does not require plans to provide any particular benefit to any particular beneficiary in any particular way.”  Instead, the law “simply establishes a floor for the cost of the benefits that plans choose to provide.”

Proskauer’s Perspective

As noted, at least forty states currently regulate some aspect of PBM activities.  The PBM industry has adapted to the growing number of states regulating PBMs by, in some cases, charging customers in certain states more for the same drugs than in other states, to reflect increased costs borne by the PBMs as a consequence of state regulations.  The Supreme Court’s decision concluding that states may impose cost regulations on PBMs without fear of ERISA preemption may lead to further state-level regulatory initiatives directed at PBMs, but the ability of PBMs potentially to pass through the costs imposed by such regulations onto their customers may act as a counterweight.

District Court Dismisses ERISA Fee Litigation against 401(k) Plan for Failure to Exhaust

A federal district court in Georgia recently dismissed claims brought by a participant in the Rollins, Inc. 401(k) Plan (the “Plan”), on behalf of a putative class of all plan participants, alleging that defendants breached their fiduciary duties by charging excessive recordkeeping fees, selecting and retaining costly and underperforming funds in the Plan and failing to diversify the Plan’s investment options. Defendants moved to dismiss on the basis that plaintiff’s claims were barred by her failure to exhaust the Plan’s administrative remedies prior to filing suit, among other reasons. In response, plaintiff argued that her claims were “deemed exhausted” because the Plan did not provide an administrative procedure for breach of fiduciary duty claims and because exhaustion would be futile. The court sided with defendants, first explaining that in the Eleventh Circuit, the exhaustion requirement is not limited to individual benefit claims under a particular plan, but also applies to claims arising from the substantive provisions of ERISA, such as those here. The court rejected plaintiff’s “deemed exhausted” argument because the Plan broadly defined “claim” as “any grievance, complaint or claim concerning any aspect of the operation or administration of the Plan or Trust, including but not limited to claims for benefits and complaints concerning the investments of Plan assets.” Given this definition, the court held that the Plan’s provisions requiring exhaustion of “claims” encompassed plaintiff’s claims for statutory breaches of fiduciary duty. The court also rejected plaintiff’s argument that exhaustion would be futile and an “empty exercise in legal formalism” because the lawsuit was in its infancy and the development of a factual record through the administrative process would be beneficial. The court also noted that the Eleventh Circuit disfavors a finding of futility where a plaintiff “completely bypasse[s]” the administrative process, as was the case here.

The case is Fleming v. Rollins, Inc., No. 19-cv-5732 (N.D. Ga. Nov. 23, 2020).

Delegating Fiduciary Responsibilities Related to ESOP Results in Dismissal of ERISA Stock-Drop Claims

Among the many lawsuits Boeing confronted following the disclosure of problems with the 737 Max was a class action brought by participants in the Boeing Voluntary Investment Plan who invested in the Boeing ESOP.  The plaintiffs alleged that the Boeing defendants breached their ERISA fiduciary duties by concealing problems with the 737 Max, which allegedly caused Boeing’s stock price to be artificially inflated and ultimately to decline once the problems with the 737 Max were made public.

The Boeing defendants succeeded in their motion to dismiss the participant’s claims.   Burke v. The Boeing Company, No. 19-cv-2203, 2020 WL 6681338 (N.D. Ill. Nov. 12, 2020).  The district court first concluded that the defendants had no fiduciary responsibility over the ESOP.  In so ruling, the court determined that the investment committee had delegated all fiduciary responsibilities related to the ESOP to an independent fiduciary and that no defendant in the action had fiduciary responsibilities related to the ESOP.

The court next concluded that, even if defendants were ESOP fiduciaries, the plaintiffs failed to satisfy the rigorous pleading standard set forth in Fifth Third Bancorp v. Dudenhoeffer, 573 U.S. 409 (2014).  The court determined that the plaintiffs failed to plausibly plead that a prudent fiduciary could not conclude that public disclosure of the problems with the 737 Max would do more harm than good to the ESOP.  Given the fact that the 737 Max was subject to “ongoing, fast-paced, and highly publicized investigations” during the class period, a prudent fiduciary could plausibly believe that public disclosure of the problems would do more harm than good.  The court also criticized the Second Circuit’s decision in Jander v. Retirement Plans Committee of IBM, 910 F.3d 620 (2d Cir. 2018) because it was “neither the best application of the Dudenhoeffer pleading standard nor the generally accepted approach.”

Proskauer’s Perspective:  The Boeing decision is notable for at least two reasons.  First, the district court’s conclusion confirms that a plan sponsor or fiduciary ought to be able to effectively delegate all fiduciary responsibilities concerning a company stock fund to an independent fiduciary so they will not be responsible for alleged fiduciary-breach claims following a stock drop.  Second, the district court’s express criticism of the Second Circuit’s decision against IBM could help limit exposure from claims based on a new proliferation of company stock fund suits.

DOL Issues Final “ESG” Rule Restricting ERISA Fiduciary Consideration of Non-Pecuniary Investment Factors

On October 30, 2020, the U.S. Department of Labor (the “DOL”) issued a final rule on factors for selecting plan investments, which restricts “do-good” or “ESG” investing.  In response to public comments, the final rule rolls back some of the restrictions and burdens from its proposed rule issued in June (summarized here), but it reaffirms the DOL’s longstanding position that ERISA requires plan fiduciaries to treat the financial interests of plan participants and beneficiaries as paramount when making investment decisions.  The final rule states that “ESG” funds may be offered in a 401(k)- or 403(b)-type plan where participants direct investments, but the selection is subject to conditions that could pose a challenge.

Consistent with the proposed rule, the final rule generally requires ERISA plan fiduciaries to base investment decisions on financial factors alone and prohibits fiduciaries from selecting investments based on non-pecuniary considerations.  Given the lack of a precise or generally accepted definition of “ESG,” the final rule instead refers to “pecuniary” and “non-pecuniary” factors in delineating the relevant fiduciary investment duties to be followed by plan fiduciaries.

The final rule is structured as an amendment to the DOL’s “investment duties” regulation set forth at 29 C.F.R. § 2550.404a-1, and provides as follows:

  • Investment decisions must be based only on pecuniary factors (i.e., factors that a fiduciary prudently determines are expected to have a material effect on risk/return in light of the plan’s investment objectives and funding policy), except in the event of a “tie-breaker” (as discussed below).
    • Consistent with the text of the proposed rule, the preamble once again acknowledges that an “ESG”-type factor could be considered a “pecuniary” factor under certain circumstances. For example, a fiduciary may conclude that board/management diversity or a company’s environmental record would have a material financial effect on the investment.
    • However, the preamble also cautions against concluding too hastily that “ESG”-type factors are actually “pecuniary.”
    • Of note to multiemployer plans, the preamble specifically states that increasing participant contributions or otherwise benefiting union labor generally is not a “pecuniary” factor that may be considered outside of the “tie-breaker” context.
  • A plan fiduciary may not subordinate the financial interests of plan participants and beneficiaries to other objectives, and may not sacrifice investment return or take on additional risk to promote non-pecuniary goals.
  • When making an investment decision, a plan fiduciary is required to consider reasonably available alternatives with similar risks in order to satisfy its duty of prudence.
    • The preamble states that this rule does not require scouring the market or considering every possible alternative.
  • A plan fiduciary may consider non-pecuniary factors as a “tie-breaker” between two or more investment alternatives if the fiduciary is unable to distinguish them on pecuniary factors alone, provided that the fiduciary documents (i) why considering only pecuniary factors was not sufficient to make the decision, (ii) how the selected investment compares to the considered alternative(s) in light of the plan’s diversification, liquidity, cash flow requirements and funding objectives, and (iii) how the applicable non-pecuniary factor(s) is consistent with the financial interests of the plan participants and beneficiaries.
    • The proposed rule permitted consideration of non-pecuniary factors to break ties only in the case of “economically indistinguishable” investments. The DOL has relaxed the standard in response to public comments questioning the feasibility of the proposed approach.
    • Not surprisingly, the preamble encourages fiduciaries to make “tie-breaker” decisions based on pecuniary factors alone.
  • The general requirement to evaluate investments based solely on pecuniary factors applies to a 401(k)- or 403(b)-type plan fiduciary’s selection and retention of available plan investment alternatives (other than brokerage window or self-directed brokerage account investment options). However, the final rule does not categorically prohibit including an investment option that supports non-pecuniary goals (for example, in response to participant demand) if the following conditions are satisfied:
    • The plan otherwise provides a “broad range of investment alternatives”;
    • The decision to include the investment option is based on “pecuniary” factors only (outside of the “tie-breaker” context); and
    • A fund or model portfolio with objectives, goals or principal investment strategies that take non-pecuniary factors into account may not be used as, or as a component of, a qualified default investment alternative (QDIA), even if it may otherwise be permissible as a non-QDIA investment alternative. The DOL suggests in the preamble that plan fiduciaries should review any potential QDIA’s prospectus or similar disclosure document to ensure that it does not include, consider or indicate the use of non-pecuniary factors (including, for example as a “screening strategy,” where certain types of controversial activities or investments are categorically excluded).
  • The DOL has helpfully clarified that the final rule applies only to “designated” investment alternatives (e., alternatives that are selected and monitored by plan fiduciaries). The final rule does not apply to self-directed brokerage windows and similar arrangements that enable participants to select investments beyond those specifically designated by the plan.

Although the final rule is set to become effective 60 days after publication in the Federal Register, 401(k) and 403(b)-type plans will have until April 30, 2022 to make any changes that are necessary to comply with the requirements related to the selection or retention of QDIAs.

Key Takeaway:  Although the DOL has cleared a path for ERISA fiduciaries to consider “ESG” factors when making investment decisions and to offer “ESG” funds in a 401(k)- or 403(b)-type plan, the path remains relatively narrow as the final rule still requires that selection of the investment option be based solely on pecuniary factors (outside of the “tie-breaker” context).  Accordingly, decisions with respect to “ESG” require careful deliberation, balancing of risks, and documentation.

PBGC Provides Temporary Flexibility for Variable-Rate Premium Calculations

In late September, the Pension Benefit Guaranty Corporation (the “PBGC”) published Press Release 20-04 and issued Technical Update 20-2 providing flexibility in the calculation of variable-rate premiums for plan sponsors who take advantage of extended pension contribution deadlines for 2020—even in certain circumstances where the plan sponsor has already completed its PBGC premium filing.

The Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) allows plan sponsors to delay until January 1, 2021 the payment of minimum required contributions to tax-qualified defined benefit pension plans that would otherwise be due in 2020.  The IRS subsequently clarified in Notice 2020-61 that the extended deadline under the CARES Act also applies to discretionary contributions in excess of the required minimum.  However, the impact of taking advantage of either of these extended deadlines on the calculation of PBGC variable-rate premiums due in the interim was unclear.

The PBGC’s variable-rate premium is based on a plan’s unfunded vested benefits.  When calculating the unfunded vested benefits, “prior year contributions” are taken into account if paid by the date of the premium filing.  The premium filing is normally due on the 15th day of the 10th calendar month that begins on or after the first day of the year for which the premium is being paid (i.e., for a calendar year plan, the premium filing deadline is generally October 15th).

Under the PBGC’s new guidance, the deadline to receive “prior year contributions” that are taken into account is extended to January 1, 2021 for premium filings due on or after March 1, 2020 and before January 1, 2021.

Importantly, the PBGC’s guidance does not extend the deadline for premium filings, and filings cannot reflect contributions that have not been made.  Plan sponsors that want to take advantage of the guidance must instead amend their filings by February 1, 2021 to revise the variable-rate premium calculation data after the eligible “prior year contributions” are paid to the plan.  The plan sponsor can then elect to either receive a refund of their premium overpayment or credit that amount toward the following year’s premium.  The PBGC’s Technical Update provides additional details on how to amend a premium filing.

The PBGC’s guidance provides welcome relief for plan sponsors that elect to take advantage of the extended contribution deadlines provided by the CARES Act and the IRS, and ensures that they are not “penalized” from a variable-rate premium perspective for doing so.

To Vote, or Not to Vote, That is the DOL’s Proxy Voting Question for ERISA Fiduciaries

On September 4, 2020, the Department of Labor (“DOL”) published a proposed rule (the “Proposed Rule”) that would confirm its position that ERISA’s fiduciary duties of prudence and loyalty apply to an ERISA plan fiduciary’s exercise of shareholder rights, including proxy voting, proxy voting policies and guidelines, and the selection and monitoring of proxy advisory firms.

The Proposed Rule reflects the DOL’s attempt at clarifying its prior proxy voting guidance that “may have led to some confusion or misunderstandings.”  In particular, the DOL acknowledged that there is a view among some that ERISA plan fiduciaries are required to vote all proxies – the Proposed Rule makes clear that is not the case.  The Proposed Rule instead provides that an ERISA plan fiduciary is permitted to vote proxies only when it prudently determines that the matter being voted upon would have an economic impact on the plan after the costs of research and voting are taken into account, and that a fiduciary is prohibited from voting proxies otherwise.  The DOL expressly states in the preamble that there is no presumption that abstaining from voting proxies is a per se fiduciary breach; rather, fiduciaries are required to vote proxies in a manner that is in the best interests of the plan, which requires a consideration of the likely impact on the plan’s investment performance in light of the size of the plan’s holdings in the issuer relative to the total investment assets of the plan, the plan’s percentage ownership in the issuer, and the costs involved.

Consistent with the DOL’s recent ESG guidance (summarized here) relating to the investment of plan assets, the Proposed Rule would amend the DOL’s “investment duties” regulation at 29 C.F.R. 2550.404a-1 and provide that, when exercising a plan’s shareholder rights (including proxy voting), an ERISA plan fiduciary is prohibited from subordinating the financial interests of the plan to any non-pecuniary objective or from sacrificing investment returns or taking on additional risks in order to promote non-financial goals.  In addition, the Proposed Rule would require a plan fiduciary to:

  • investigate material facts that form the basis for exercising such shareholder rights (e.g., a plan fiduciary may not adopt a practice of following the recommendations of a proxy advisory firm without appropriate supervision and a determination that the firm’s guidelines are consistent with the economic interests of the plan);
  • maintain records on exercises of shareholder rights, including records that demonstrate the basis for such decisions (in particular, it is the DOL’s stated view that fiduciaries must be prepared to articulate the anticipated economic benefit of proxy-vote decisions in the event they decide to vote); and
  • exercise prudence and diligence in the selection and monitoring of persons selected to advise or otherwise assist with exercises of shareholder rights (and where the authority to vote proxies or exercise other shareholder rights has been delegated to an investment manager or proxy advisory firm, a responsible plan fiduciary shall require such manager or firm to document the rationale for proxy voting decisions or recommendations sufficient to demonstrate that the action was “based on expected economic benefit to the plan”).

The Proposed Rule specifically provides that:

  • a plan fiduciary “must vote” any proxy where the fiduciary prudently determines that the matter being voted on would have an economic impact on the plan after considering the factors described above and costs involved in voting; and
  • a plan fiduciary “must not vote” any proxy unless it prudently determines that the matter would have an economic impact on the plan after considering such factors and costs.

However, recognizing that determining whether or not to vote proxies may be resource-intensive and often will exceed the potential economic benefits to the plan, the DOL has proposed examples of permitted policies that fiduciaries may adopt that are intended to reduce the need for fiduciaries to consider proxy votes that are unlikely to have an economic impact on the plan, including:

  • a policy of voting proxies in accordance with the recommendations of management (provided that fiduciaries may retain the right to “override” such a general policy if prudence so dictates in a particular situation);
  • a policy to focus voting resources only on particular types of proposals that the fiduciary has prudently determined are substantially related to the corporation’s business activities or likely to have a significant impact on the value of the plan’s investment, such as proposals relating to corporate events, repurchases of shares, issuances of additional securities with dilutive effects on shareholders, or contested director elections; and
  • a policy of refraining from voting on proposals or particular types of proposals when the size of the plan’s holdings in the issuer relative to its total investment assets is below a quantitative threshold that the fiduciary prudently determines, considering the plan’s percentage ownership of the issuer and other relevant factors, is sufficiently small that the outcome of the vote is unlikely to have a material impact on the investment performance of the plan’s portfolio (or plan assets under management in the case of an investment manager).

The Proposed Rule would require that these policies be reviewed at least every two years.

The Proposed Rule further provides that the DOL’s Interpretive Bulletin 2016-01, which may be interpreted to permit consideration of a broader set of factors when making determinations regarding proxy voting, no longer reflects the view of the DOL and would be removed from the Code of Federal Regulations if the Proposed Rule is finalized.

The DOL has invited comments on all aspects of the Proposed Rule, which are due by October 5, 2020.

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In the meantime, ERISA plan fiduciaries should carefully review their proxy voting policies and practices – including those applicable to investment managers and proxy advisory firms that exercise these rights on behalf of the plan – and be prepared to make any necessary changes in the event the Proposed Rule is finalized.