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Employee Benefits Developments July 2006

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RULINGS, OPINIONS, ETC.

IRS issues guidance on revoking Section 83(b) election
If, in connection with the performance of services, a person receives property that is not transferable and is subject to a substantial risk of forfeiture, the person is not taxed on the property until the property is transferable or the substantial risk of forfeiture expires. Section 83(b) of the Internal Revenue Code, however, permits a person to elect to include as compensation the value of the property at the time of transfer. An 83(b) election must be filed with the Internal Revenue Service (IRS) no later than 30 days after the date of the property transfer and may only be revoked with IRS consent. Revenue Procedure 2006-31 provides guidance on the requirements for making such a request. The request must be made under the same procedures for requesting a letter ruling. The requested revocation will only be granted if the person making the election was under a mistake of fact as to the underlying transaction. The IRS and the Revenue Procedure note that neither a mistake as to the value (or decline in value) of the property for which the election was made nor the failure of anyone to perform an act that was contemplated at the time of the transfer constitutes a mistake of fact for this purpose. Further, the failure of the person to understand the substantial risk of forfeiture or to understand the tax consequences of making the 83(b) election is not considered a mistake of fact.

CASES

Accountant/TPA as ERISA fiduciary, part two
As reported in our June 2005 issue, the Tenth Circuit Court of Appeals found accountant Ted Madsen to be an ERISA fiduciary because he had the authority to write checks on behalf of a plan that was to provide insurance coverages. The individual receiving the checks misappropriated over $600,000 in plan assets. On remand, the District Court for the District of Utah ruled Madsen violated his fiduciary duties because, during a seven-year period during which the transactions occurred, he never sought verification that the money had been properly invested. The court found that “a prudent man of ordinary skill and care would have confirmed at least once in seven years that the funds he disbursed wound up in their intended repository ….” (David P. Coldesina D.D.S., P.C. Employee Profit Sharing Plan & Trust v. Estate of Simper, D. Utah, 2006)

The court finds no serious consideration of early retirement
In May 1999, Silvia Rashid asked her supervisor if her employer had plans to offer an early retirement incentive program. The supervisor relayed her question to the president of Pennsylvania Power Co., who informed Rashid that there would be no early retirement incentives in the near future. Rashid retired in July 1999. In October 1999, a business plan was developed that called for several cost-cutting measures, including a workforce reduction. Later in 1999, the director of employee benefits of Pennsylvania Power was directed to devise an early retirement incentive program, and the program was adopted in January 2000. Rashid sued and her lawsuit was dismissed on a summary judgment motion. Rashid appealed to the Third Circuit, which affirmed the lower court’s decision. The federal appellate court cited a three-prong standard set out in a prior case that “serious consideration of a change in plan benefit exists when (1) a specific proposal (2) is being discussed for purposes of implementation (3) by senior management with the authority to implement the change.” The Third Circuit found that the first time a specific proposal may have arose was in October 1999, three months after Rashid retired. Therefore, no serious consideration was being given to an early retirement incentive at the time Rashid made her inquiry. (Rashid v. First Energy Corp. Pension Plan, 3d Cir., unpublished, 2006)

No retroactive exhaustion requirement for plan lacking a claims procedure
Reversing a district court decision, the U.S. Court of Appeals for the Second Circuit ruled that a plan participant was not required to exhaust administrative remedies before bringing a federal suit for benefits where the plan did not contain an exhaustion requirement until after the lawsuit
was filed.

Martin Coyne, while employed by Sterling Drug, Inc. (Sterling), participated in the company’s supplemental benefit plan (top hat plan). In the ensuing years, Sterling underwent several corporate changes, first being acquired by Eastman Kodak (Kodak) and then later acquired by Bayer. Coyne continued to work for Sterling until the acquisition by Bayer, at which time he became an employee of Kodak. During these corporate transactions, there was confusion about which company had responsibility for Coyne’s top hat plan. When Coyne and Kodak inquired about Bayer’s responsibility for paying benefits to Coyne under the Sterling plan, Bayer did not respond. Kodak made the first payment under the top hat plan to Coyne, and then Coyne and Kodak filed suit against Bayer for recovery of benefits.

After the lawsuit was filed, Bayer amended the top hat plan to impose an administrative remedy exhaustion requirement. The U.S. District Court for the Southern District of New York denied Kodak and Coyne’s request for summary judgment, finding Bayer’s amendment could be applied retroactively. On appeal, the U.S. Court of Appeals for the Second Circuit vacated the decision and remanded the benefit determination to the district court.

The federal appellate court held the administrative remedy was “deemed exhausted” under 29 C.F.R. § 2560.503-1(l). This statute provides in part that “in the case of the failure of a plan to establish a claims procedure … a claimant shall be deemed to have exhausted the administrative remedies available under the plan …” Although the statute does not specify when a plan must establish a claims procedure, the court reasoned that allowing a plan to delay adopting such procedures until after litigation had begun would undermine the spirit and purpose of the law. (Eastman Kodak Co. v. STWB Inc., 2nd Cir., 2006)

QDRO may be entered after death of alternate payee
Courts have frequently been asked to rule on the validity of qualified domestic relations orders (QDROs) issued after the deaths of plan participants. The Minnesota Court of Appeals recently faced an interesting variation on the usual posthumous QDRO dispute when it was asked to rule on the validity of a domestic relations order issued after the death not of the participant, but of the alternate payee. A 2003 divorce decree dissolving the marriage of Richard and Loydene May awarded Richard half of Loydene’s “401(k) account.” Although Loydene’s attorney drafted a proposed QDRO dividing her retirement account, the plan administrator rejected the order (due in part, no doubt, to the fact that Loydene’s retirement benefits as a federal postal worker did not include a 401(k) account). Richard, who had remarried, died before a revised order could be submitted to the plan. Richard’s new wife, Kathryn, asked the court to permit submission of a posthumous order claiming Richard’s share of the retirement benefits. The state district court ruled in Kathryn’s favor and ordered the drafting of a new QDRO that would award Richard’s interest in Loydene’s pension directly to Kathryn. On appeal, the state appellate court found that Richard’s marital interest in Loydene’s pension could be awarded not to Kathryn, but to his estate. The court ruled that the death of a former spouse after the entry of a divorce decree awarding him an interest in his ex-wife’s pension but before the issuance of a QDRO does not preclude the entry of a QDRO after his death. (May v. May, Minn. Ct. App., 2006)

Failure to respond to plan information request leads to employer penalties
Penalties imposed on plan administrators under ERISA for failing to provide requested plan information were enacted to ensure that covered employees have adequate access to plan information. While an employer may not be formally designated as the plan administrator, the employer may be considered the plan administrator in cases where the employer is shown to control administration of a plan, where the employer has held itself out as the plan administrator, or where a participant would have difficulty ascertaining the identity of or contacting the designated administrator. In a recent case, ICI Paints was found not to have provided a timely response to repeated requests for information regarding an employee’s pension benefit following her termination. ICI Paints argued it should not be subject to any penalties because it was not the designated plan administrator for the pension plan in question. ICI Paints argued the plan administrator, according to plan documents, was a retirement/pension committee. Because ICI Paints could not provide evidence identifying the committee and because there was evidence that ICI Paints controlled plan administration and held itself out as the plan administrator, however, the U.S. District Court for the Northern District of Ohio rejected ICI Paints’ argument that it was not the plan administrator. Accordingly, the federal district court found the information request submitted to ICI Paints was a request to the plan administrator, and that ICI Paints may be subject to statutory penalties for failure to provide the requested information. (Minadeo v. ICI Paints d/b/a The Glidden Co., N.D. Ohio, 2006)

U.S. Airways stock approved as 401(k) investment
The financial troubles of the airline industry have been well publicized. After U.S. Airways went into bankruptcy, it faced a lawsuit by an employee and 401(k) plan participant alleging breaches of fiduciary duty in allowing U.S. Airways’s stock to remain as a 401(k) plan investment. Also named as defendants in the class action were the 401(k) plan’s directed trustee, Fidelity Management, and an independent fiduciary engaged by U.S. Airways. After dismissing claims against the plan trustee and independent fiduciary, a trial proceeded on the question of whether U.S. Airways breached its duty by failing to remove the company stock as an investment choice. In the course of handling its 401(k) plan, the company had been careful to advise participants about the risks involved in choosing the company stock fund, the value of diversifying plan investments among the 13 funds in the plan, and the distressed financial outlook of U.S. Airways. Participants had no restrictions in moving in and out of the company stock fund. In concluding that there was no fiduciary breach, the U.S. District Court for the Eastern District of Virginia determined a 401(k) plan fiduciary could continue to offer employer stock as an investment option as long as the fiduciary provides participants with

a range of investment options,

true and accurate information regarding the risk and return characteristics of those options, and

the unfettered ability to trade in and out of the various investment options.

At least in this trial, careful plan administration protected fiduciaries from liability even where the company is experiencing severe financial problems. (DiFelice v. U.S. Airways, Inc., E.D. Va., 2006)

Directed trustee exonerated in United Air Lines ESOP case
In another airline case, State Street Bank, as directed trustee of the United Air Lines (UAL) employee stock ownership plan (ESOP), defended its actions in continuing to hold UAL stock as its market price plummeted enroute to the airline’s bankruptcy. The U.S. Court of Appeals for the Seventh Circuit reviewed the confusing statutory picture facing the trustee of any ESOP—where the trustee is directed by the plan document and statutory rules to primarily hold employer stock as a principal purpose of the plan and is also obligated to act in the sole interest of participants and beneficiaries, which may require abrogating the purpose of the ESOP by replacing employer stock in the trust with some other investment. On September 10, 2001, UAL stock had fallen 25 percent from its price at the beginning of the year. In the immediate aftermath of September 11, the price dropped another 50 percent, and in October the CEO sent a letter to employees describing the company’s dire financial picture and its struggle “just to survive.” The stock price fell another 20 percent following publication of the letter. State Street Bank’s action in continuing to hold UAL stock in the ESOP was claimed by the plaintiffs to be a breach of the ERISA fiduciary requirements. In denying this claim, the Seventh Circuit upheld a federal district court decision that the plaintiff was unable to meet the burden of proof in identifying a point at which the directed trustee was duty bound to break the dictates of the plan and start diversifying its assets. This burden may be higher in the context of a publicly traded employer where the stock market theoretically takes into account market risks and potential for recovery in the prices at which stocks are traded. Based on the evidence the plaintiffs produced, the federal appellate court was unable to conclude that the trustee was required to act on the assumption, at some point, that the market was overvaluing UAL stock. The risks of acting as an ESOP trustee remain, but at a slightly reduced level following this decision. (Summers v. State Street Bank & Trust Company, 7th Cir., 2006)

Teachers’ early retirement payments are FICA wages, despite surrender of tenure rights
The U.S. Court of Appeals for the Sixth Circuit ruled that early retirement payments to public school teachers are wages subject to FICA taxes, even if the teachers gave up their tenure rights in exchange for the payments. The ruling resolved a split in the Sixth Circuit between two federal district courts in Michigan. In Appolini v. United States, the U.S. District Court for the Western District of Michigan ruled early retirement payments to tenured teachers were wages subject to FICA taxes. In a similar case, Klender v. United States, the U.S. District Court for the Eastern District of Michigan came to the opposite conclusion, finding that payments made to teachers in exchange for relinquishment of their tenure rights did not constitute wages for purposes of FICA tax. On appeal, the Sixth Circuit consolidated the cases, affirming Appolini and reversing Klender. The federal appellate court noted early retirement was available only for teachers who had served a minimum number of years, indicating that the payments were made for services performed rather than for surrender of tenure rights. According to the court, because the payments arose out of the employment relationship and were conditioned on a minimum number of years of service, the payments were essentially severance payments and were thus FICA wages. The relinquishment of tenure rights was seen as merely a byproduct of the buyout. As the court pointed out, “just because a teacher relinquishes a right when accepting early retirement does not convert what would be FICA wages into something else.” The opinion resolved the conflict on the issue within the Sixth Circuit but created a conflict among circuits nationally, as the U.S. Court of Appeals for the Eight Circuit held in 2001 in North Dakota State Univ. v. United States (8th Cir., 2001) that payments to teachers who relinquished tenure rights were not subject to FICA taxes. (Appolini, et al. v. United States, 6th Cir., 2006)

Retirees not entitled to vested dental benefits
NSTAR Electric and Gas Corporation (NSTAR) established an early retirement program in 1997 and another in 1999. Eligible non-union employees choosing to retire under these programs received company-paid medical and dental benefits. The same early retirement program benefits were extended to eligible union employees by virtue of certain labor agreements governed by the Labor Management Relations Act (LMRA).

In late 2002, NSTAR notified the union and non-union retirees that their company-provided dental benefits would cease upon attainment of age 65. In separate lawsuits, disenfranchised union and non-union retirees sued NSTAR, claiming NSTAR could not terminate the dental benefits at age 65 because it had promised vested lifetime benefits. In each case, the federal appellate court ruled in favor of NSTAR. (Senior v. NSTAR Electric and Gas Corporation (1st Cir., 2006); Balestracci v. NSTAR Electric and Gas Corporation (1st Cir., 2006))

In Balestracci, where the plaintiffs were retired non-union employees, the federal appellate court focused on the ERISA documentation (i.e., the dental plan documents and related summary plan descriptions) and found that those documents had expressly reserved to NSTAR the right to amend, modify, or terminate benefits at any time, including promises of lifetime benefits. In Senior, where the plaintiffs were retired union employees, the First Circuit examined the applicable labor agreements and found those agreements did not establish that the union and NSTAR intended NSTAR to be unconditionally obligated for lifetime dental benefits. The court rejected the union retirees’ argument that the LMRA creates a presumption in favor of vesting when welfare benefits are promised by a labor agreement, holding instead that traditional principles of labor contract interpretation apply. Applying these principles of contract interpretation, which permitted examination of the relevant ERISA documentation, the court found NSTAR had the right to amend or terminate the dental plan at any time and for any reason.

Balestracci and Senior highlight the importance of documenting and communicating the employer’s right to modify or terminate benefits at any time and for any reason. Not only should this reservation of rights appear in the official plan documents, it should also appear in all employee communications concerning the benefit, including, most importantly, the summary plan description.