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Employee Benefits Developments April 2006

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RULINGS, OPINIONS, ETC.

HHS provides guidance on the permitted disclosure of PHI
The U.S. Department of Health and Human Services (HHS) recently updated its website’s Frequently Asked Questions section with an answer regarding the permitted disclosure of protected health information (PHI). In the update, HHS explains that Health Information Portability and Accountability Act (HIPAA) privacy rules permit people acting on a plan’s behalf to disclose a covered individual’s relevant PHI to family members, close friends, or others who have been identified as being involved with that individual’s care or payment of care. Disclosure is not permitted if the covered individual objects or, in the case of the covered individual’s absence or incapacity, if those acting on behalf of the plan infer that the disclosure is not in the covered individual’s best interests. (Available at www.hhs.gov/ocr/hipaa).

EBSA extends mental health parity rules
On March 20, the Employee Benefits Security Administration (EBSA) announced a technical amendment extending the interim final regulations under the Mental Health Parity Act (MHPA) from December 31, 2005, to December 31, 2006. The amendment conforms the regulatory sunset date to the statutory sunset date, which was extended on December 30, 2005, as part of the Employee Retirement Preservation Act. The original MHPA statute contained a sunset provision under which MHPA rules would no longer apply to benefits for services furnished on or after September 30, 2001. MHPA has been amended four times before to extend the sunset date. MHPA amended the Employee Retirement Income Security Act (ERISA) and the Public Health Service Act to require that annual or lifetime dollar limits for mental heath benefits be no lower than the dollar limits for medical/surgical benefits offered by a group health plan. MPHA applies to group health plans that offer both mental health and medical/surgical benefits. However, MPHA does not require plans to offer mental health benefits.

Limited 409A transition relief for prohibited plans
Responding to widespread confusion over the effective date of provisions relating to the use of offshore trusts or financial health triggers in connection with amounts deferred under a nonqualified deferred compensation plan, the Internal Revenue Service recently issued Notice 2006-33, providing a grace period for affected plans to comply with certain provisions of Section 409A of the Internal Revenue Code (IRC). With respect to amounts payable under a nonqualified deferred compensation plan, IRC § 409A(b) generally prohibits the use of offshore trusts or restrictions on assets in connection with a change in the financial health of the employer. Under Notice 2006-33, plans containing the noncompliant provisions will not trigger the penalty provisions under § 409A so long as the plans are brought into compliance by December 31, 2007. The grace period applies to assets set aside, transferred, or restricted on or before March 21, 2006, including earnings on those assets.

CASES

ESOP escrow account is a plan asset
The U.S. District Court for the Southern District of Alabama denied, in part, the motion to dismiss a fiduciary breach claim against an employee stock ownership plan (ESOP) sponsor’s president. The ESOP participants argued that sponsor president Marjorie Snook breached her fiduciary duties by creating a merger-related escrow account that received money that otherwise would have gone to the ESOP in the transaction. The court ruled the escrow account was a “plan asset.” As a result, the president may be subject to the fiduciary standards of ERISA.

Gulf Telephone, sponsor of the ESOP, was heavily invested in the stock of Gulf Coast Services Inc., a holding company for Gulf Telephone. In 1999, Madison River Telephone Co. merged with Gulf Coast by acquiring all of its shares. As part of the merger agreement, an escrow account was funded with $25 million of the nearly $313 million purchase price. ESOP participants argued that the $25 million diverted to the escrow account should have instead gone to the ESOP.
The court reasoned that since the ESOP owned Gulf Coast common stock, “it appears that the ESOP had a vested interest in the [escrow] account as it is part of the purchase price of their stock.” Therefore, the escrow account is a plan asset and the sponsor’s president may have fiduciary responsibilities with regard to it. Although the court noted that whether Marjorie actually behaved in a manner that made her a fiduciary is a fact-intensive issue to be decided at trial, this case exemplifies the potentially broad reach of ERISA fiduciary obligations. (Eslava v. Gulf Telephone Co., S.D. Ala., 2006).

Nationwide’s 401(k) product comes under attack
In today’s competitive 401(k) plan market, it is common practice for mutual fund companies to compensate 401(k) plan providers who include their funds in the 401(k) products the providers offer to employers who sponsor plans. If an employer plan buys into an arrangement of this kind, the fiduciaries must not allow the provider to select the plan’s investments; investment authority must reside with, and be exercised by, the employer, trustee, or other fiduciary. When an employer, trustee, or other fiduciary permits a 401(k) provider to select (or remove) plan investments without the fiduciary’s approval, under circumstances where the provider receives compensation from the funds it selects, the fiduciary has caused the plan to engage in a prohibited transaction and must take action to correct it. Failure to do so could leave the fiduciary exposed to enforcement action by the Department of Labor or plan participants.

The kind of arrangement described above was at issue in Haddock v. Nationwide Financial Services Inc., (D. Conn. 2006). In Haddock, the trustees of the Flyte Tool and Dye Company Inc. 401(k) Profit Sharing Plan sued Nationwide Financial Services and Nationwide Life Insurance Co. (collectively, Nationwide), claiming that Nationwide had engaged in prohibited self-dealing because it had received compensation from funds it had selected for the plan. In an effort to prevent a costly trial, Nationwide made a motion to dismiss the lawsuit, arguing that it had acted solely as a vendor of a bundled 401(k) product (including investments), which it had offered to the plan and which the plan’s fiduciaries (and not Nationwide) had adopted on behalf the plan. Because the facts were not clearly in favor of either Nationwide or the plan, and because the trustees had alleged facts that, if true, would support their claim that Nationwide had selected the plan’s investments, the court refused to dismiss the case. The true facts, the court noted, would be decided at trial.

As this case illustrates, the reasonableness of fees associated with bundled arrangements is not the only fiduciary issue. Haddock brings to light another issue employers and fiduciaries must address when they buy into arrangements that involve revenue sharing between mutual funds and the companies that market them to employer plans. (Haddock v. Nationwide Financial Services Inc., D. Conn., 2006).

ERISA benefits not protected against victim restitution recovery
In a split decision, the U.S. Court of Appeals for the Ninth Circuit has ruled the Mandatory Victims Restitution Act of 1996 (MVRA) provides an exception to ERISA’s anti-alienation rule. Ray Novak set up a scam with his wife where she ordered costly communication equipment that he then stole and resold. After being caught and convicted, Novak was ordered to pay $3.3 million in restitution to the corporate victim of his crime. To collect on the restitution, the government sought and obtained a writ of garnishment. When the government attempted to attach Novak’s qualified pension benefit, however, a federal district court quashed the writ, based on ERISA’s anti-alienation provision, which precludes most assignments or offsets from qualified plan benefits, including the collection of civil money judgments and debts owed by a participant to the employer maintaining a plan. With one dissent, the federal appellate court overruled the district court decision and determined the MVRA is a valid exception to the ERISA rule because it is a specific collection statute, designed to provide victims of crime with restitution, and it is enforced by the government in the same manner as tax liens, which are also enforceable against qualified ERISA pension benefits. While the presence of a strong dissent in this case suggests that we may see more debate in this area, the MVRA may place an additional premium on a criminal conviction in cases where the perpetrator of the crime has accumulated pension benefits. (United States v. Novak, 9th Cir., 2006).

COBRA small employer exception: corporate officers not counted if not paid employees
An employer that normally employs fewer than 20 employees on a typical business day during the preceding calendar year may qualify for a small employer exemption under the Consolidated Omnibus Budget Reconciliation Act (COBRA). But what would happen if an employer has corporate officers who voluntarily perform services on a part-time basis for which they are neither paid a salary nor otherwise treated as employees? Would those officers have to be counted in deciding whether the employer qualifies for the small employer exception? A federal trial court in Georgia decided that those corporate officers do not have to be counted as employees for purposes of the COBRA small employer exception.

The University Yacht Club employed Jeffrey Giddens as its general manager and terminated his employment in 2003. Mr. Giddens sued the Yacht Club for failing to offer the COBRA continuation coverage to which he thought he was entitled. In deciding whether the Yacht Club normally employed at least 20 employees during 2002, the federal district court considered whether the Yacht Club’s officers can be considered “employees” for purposes of COBRA. Notwithstanding special perks such as special parking spaces, preferential seating at special events, free attendance at annual parties, and free maintenance services, the district court determined the officers are not employees. In reaching its decision, the court focused on a number of factors, including the fact that the officers are not hired but are elected and serve on a voluntary basis, and the fact that the officers receive neither a salary nor typical employee benefits, such as health insurance. (Giddens v. University Yacht Club Inc., N.D. Ga., 2006).