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Employee Benefits Developments February 2006

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RULINGS, OPINIONS, ETC.

IRS Proposes Regulations on Designated Roth Contributions. The Internal Revenue Service (IRS) issued proposed regulations addressing the taxation of distributions of designated Roth contributions made to an Internal Revenue Code (IRC) § 401(k) or 403(b) plan. A qualified distribution from a designated Roth account is not includable in the individual’s gross income. A qualified distribution is one that is made after a five-taxable-year period that is either made:

on or after the date the individual attains age 59 ½ ,
after the individual’s death, or
after the individual becomes disabled.

The proposed regulations provide that a five-taxable-year period begins on the first day of the employee’s taxable year for which the employee first had designated amounts as Roth contributions and ends when five consecutive taxable years have been completed. Unlike Roth IRA accounts, the taxation of a nonqualified Roth account distribution from a 401(k) or 403(b) arrangement is not treated as a return of contributions first. Rather, the proposed regulations provide for a pro-rata recovery of the separately accounted for Roth contributions and earnings. With respect to distribution of employer securities as part of a qualified distribution, the distribution is not includable in gross income and the basis of the security will be the fair market value on the date of distribution. The proposed regulations, generally, will be applicable for taxable years beginning on or after January 1, 2007. However, certain provisions are proposed to be effective for taxable years beginning on or after January 1, 2006, because they address compliance issues for the earlier period. (Fed. Reg. Vol. 71, No. 17, 4320).

Investment Advisers Retained by Individual Plan Participants Are Fiduciaries Under ERISA. Participant-directed investments are becoming the norm when it comes to individual account retirement plans (e.g., 401(k) plans), and some participants engage and pay fees to their own investment advisers to assist in making investment decisions for their plan accounts. A recently published DOL advisory opinion reminds us that an individual who advises a plan participant, in exchange for a fee, on how to invest the assets in the participant’s account, or who manages the investment of a participant’s account, is an ERISA (Employee Retirement Income Security Act of 1974) fiduciary with respect to the plan. Even if the plan intends to meet the requirements of ERISA § 404(c) and shifts fiduciary responsibility to the participant, the financial planner or investment adviser selected by the participant would be liable for imprudent investment decisions because those decisions would not have been the direct and necessary result of the participant’s exercise of control, even though the participant selected the financial planner or investment adviser. The other fiduciaries of a plan that intends to meet the requirements of ERISA § 404(c) would not be liable as fiduciaries for either the selection of the financial planner or investment adviser or for the results of the financial planner’s or investment adviser’s decisions or recommendations; nor would the other plan fiduciaries have any obligation to advise the participant about the selection of the financial planner or investment adviser or their investment decisions or recommendations. (DOL Advisory Opinion 2005-23A).

CASES

Wal-Mart’s Union Exclusion Language in SPD May Proceed as ERISA Claim. We hope our readers would be aware that provisions governing collectively bargained employees’ participation in retirement plans need to be carefully drafted. It has been a standing position of the National Labor Relations Board (NLRB) that a mere statement that union employees are not eligible to participate is an unfair labor practice. Rather, the plan terms should state collectively bargained employees do not participate in the plan unless the collective bargaining agreement provides for participation. The difference in the language indicates to those employees who may be considering joining a collective bargaining unit that their continued participation in benefit plans will be determined as a result of the negotiated collective bargaining agreement.

Certain Wal-Mart employees in Kingman, Arizona, were attempting to organize into a collective bargaining unit. Wal-Mart’s 401(k) plan document clearly indicated that collectively bargained employees will participate only if the collective bargaining agreement so provides. However, Wal-Mart issued a new summary plan description (SPD) that stated “contractually excluded and certain other union representative associates are not eligible for coverage.” According to court records, the NLRB investigated Wal-Mart’s actions and issued a complaint and, in February 2003, concluded the union exclusion in the SPD violated provisions of the National Labor Relations Act (NLRA). Walmart has filed exceptions to the Administrative Law Judge decision and the NLRB action is continuing to proceed.

Certain employees have filed an action claiming that the provision in the SPD also violated ERISA because the SPDs were misleading and inaccurate, and by placing the union exclusion in the SPD, Wal-Mart violated its fiduciary duties, engaged in a transaction prohibited by ERISA, and interfered with their ability to obtain benefits in violation of ERISA.

In July 2003, the U.S. District Court for the Western District of Arkansas dismissed that ERISA complaint finding that jurisdiction of the entire matter was preempted by the jurisdiction of the NLRB under the NLRA. The U.S. Court of Appeals for the Eighth Circuit has overturned the federal district court’s decision. The Eighth Circuit found the district court has jurisdiction to proceed with this matter under ERISA and remanded the case back to the federal district court.

While this decision does not find that the language contained in the SPD in any way violates ERISA, employers should be careful in all communications regarding the description of the ability of collectively bargained employees to participate in their employee benefit plans. Lack of care could result not only in actions by the NLRB but, at least in the Eighth Circuit, claims of a violation of ERISA. (Lupiani v. Wal-Mart Stores, 8th Cir., 2006).

High Stakes in Troubled Waters. Most corporate financial officers are well aware of potential personal risk involved in handling FICA taxes and income tax withholding. If these monies are not timely paid over to the government, responsible individuals can be held both financially and criminally liable. Similar legal risks are involved when individual elective contributions for retirement plans are withheld from employee paychecks. Here’s a case that ups the ante a little more.

Wesley Walker served as the CEO of War Enterprises Inc. (Enterprises). While he denied having any discretion or control over the payroll process, withholdings, and plan deposits, Walker discovered through an IRS investigation that Enterprises was delinquent in its deposits of payroll taxes and retirement plan contributions that were withheld from payroll. To avoid some draconian actions threatened by the IRS on the tax withholdings, Walker managed to find personal assets plus borrowings from family members to pay the IRS liability. Now Walker finds himself in trouble with the Department of Labor (DOL) as well over the plan contributions. The DOL filed suit alleging that the monies he garnered to satisfy the corporate obligations of Enterprises constituted corporate funds which the DOL claims are “plan assets.” Walker, by exercising control over plan assets, became a fiduciary of the plan; and the failure to pay those assets into the plan constitutes a breach of fiduciary responsibility. The district court denied Walker’s motion to dismiss the suit and ordered a trial to commence in March. (Chao v. Rhoades, M.D. Car., 2006).

ERISA Fiduciary Status Is Added “Bonus” for Insurance Broker Who Stole Plan Assets. Brittian Day, an insurance broker, apparently made money the old fashioned way—he stole it by selling, and accepting hundreds of thousands of dollars in premium payments for, fake insurance policies in connection with 29 ERISA-covered employee benefit plans. Day sent the plans invoices for various insurance policies, the plans paid the invoices by sending checks to Day, and Day deposited the checks in his corporate account. Instead of using the payments from the plans to purchase insurance, however, Day kept the money and provided the plans with bogus insurance policies. Needless to say, the DOL took a dim view of this practice and filed a complaint against Day in which the DOL alleged Day had violated his fiduciary duties by engaging in an illegal scheme to misappropriate insurance assets. Day asked the federal trial court to dismiss the DOL’s complaint, which the trial court declined to do—summary judgment in favor of the DOL was granted and Day was ordered to pay about $1 million in damages. Day naturally appealed, arguing that he was not an ERISA “fiduciary.” Day argued that “he was simply an insurance salesman” and that “he did not exercise any discretion over the plans’ assets.” The federal appellate court didn’t buy Day’s argument and affirmed the trial court’s decision, finding that ERISA does not require the existence of discretionary control or authority when it comes to the disposition of plan assets—an individual can be an ERISA fiduciary if he or she exercises any authority or control over the management or disposition of plan assets. Day obviously made the bad choice of exercising his “control” over the “disposition” of funds remitted for premium payments by absconding with those funds—an exercise of “control” that earned him the lofty designation of ERISA fiduciary. The breach of his ERISA fiduciary duty made Day personally liable for the damages awarded by the court. Ouch!  (Chao v. Day, D.C. Cir., 2005).

Justice Department Files Class Action Lawsuit Under USERRA. On January 12, the Justice Department filed a class action lawsuit against American Airlines Inc., alleging the carrier violated the Uniformed Services Employment and Reemployment Rights Act of 1994 (USERRA). This is the first class action suit filed by the Justice Department under USERRA. The complaint lists three lead plaintiffs who represent a class of approximately 1,000 American Airlines pilots.

According to the complaint, American Airlines classified the time the pilots took for military leave as a “leave of absence.” This designation denied the pilots the ability to accrue vacation and sick time while serving in the military. The status designation also denied the pilots the ability to bid on flight schedules. American Airlines did not deny these types of benefits to pilots who took comparable time off due to illness, union service, or jury duty.

Employers must be sensitive to how they designate military leave time and the effects of that designation. It should be noted that the complaint does not allege the denial of either health care or pension benefits. By filing this action, the Justice Department is demonstrating its willingness to utilize USERRA to protect even lesser employee benefits for people serving in the military. (Woodall v. Am. Airlines Inc., N.D. Tex., filed 1/12/06).

Surviving Spouse Prevails Over Children in QPSA-QDRO Duel. Under a recent ruling by the U.S. Court of Appeals for the Ninth Circuit, a surviving second spouse is entitled to a qualified preretirement survivor annuity (QPSA) under two pension plans, despite a requirement in the deceased participant’s divorce decree that the participant’s children be named as plan beneficiaries. A participant in two defined benefit pension plans, Michael Hamilton was divorced from his first wife in 1996. The marital dissolution order required Michael to name his children as his beneficiaries under the pension plans until the youngest child reached age 18. The order made no reference to the rights of a surviving spouse. Shortly after the divorce, Michael married Mary and named her the beneficiary under the plans. In 2002, Michael died in a car accident. At the time of his death, he was still married to Mary and both children were under the age of 18. Both plans provide that if a vested participant dies before retirement, benefits will be paid to a surviving spouse. If there is no surviving spouse, a lump sum death benefit will be paid to the beneficiary designated by the participant.

Both Mary and the children claimed benefits under the plans—Mary as a surviving spouse, and the children as beneficiaries by right of the marital dissolution order. Following the plans’ determinations that Mary was entitled to the QPSA, the children sued. The federal district court found in favor of the children, holding that the dissolution decree was a valid qualified domestic relations order (QDRO), and the designation of the children as alternate payees in the QDRO took precedence over Mary’s rights as surviving spouse. On appeal, the Ninth Circuit reversed. The federal appellate court concluded a QDRO can divest a surviving spouse of his or her statutorily guaranteed right to a QPSA only if the QDRO expressly assigns surviving spouse rights to a former spouse. The federal appellate court found the childrens’ rights as beneficiaries under the purported QDRO are not sufficient to overcome the surviving spouse’s right to a QPSA. (Hamilton v. Washington State Plumbing & Pipefitting Industry Pension Plan,
9th Cir., 2006).

ERISA Preempts TRO Requiring Maintenance of Beneficiary Designation. Citing ERISA preemption, a Kansas district court found the wife of a deceased participant in a life insurance plan was not the beneficiary of her estranged husband’s policy, despite a state court temporary restraining order (TRO) mandating that she be maintained as the named beneficiary of the policy. In the wake of Cathi Irwin’s 2003 petition for divorce from her husband Stephen, a state court issued a TRO restraining both parties from changing the beneficiaries of their life insurance. Less than a month later, Stephen signed a change of beneficiary form naming his father, Donald, the primary beneficiary of his policy. On Stephen’s death, both Cathi and Donald claimed the death benefit under the policy and the dispute ended up in federal court. The court ruled Donald was the proper named beneficiary under the plan at the time of Stephen’s death, rejecting Cathi’s claim that the TRO should be enforced. Finding consideration of the TRO would run counter to the express provision in ERISA that directs plan administrators and fiduciaries of employee welfare plans to make decisions according to the plan documents, the court held ERISA preempts the TRO. However, Cathi was not entirely abandoned by the court, which determined it has equitable power under Kansas law to create a constructive trust of insurance proceeds when it determines there is an unjust enrichment to the named beneficiary. Because Stephen intentionally defied the TRO by changing his beneficiary, the court determined it may enforce Stephen’s legal obligation under the TRO by imposing a constructive trust for the benefit of Cathi on the life insurance proceeds after they are awarded to Donald. (Irwin v. Principal Life Insurance Co., D. Kan., 2006).