EBSA Publishes Directed Trustee Guidance. On December 17, 2004, the Employee Benefits Security Administration (EBSA) published guidance regarding the Department of Labor’s views on the responsibilities of directed trustees under the Employee Retirement Income Security Act of 1974 (ERISA). This guidance may be of particular interest to directed trustees of plans investing in employer securities. While the guidance, from a directed trustee’s perspective, appears relatively benign and suggests that a directed trustee’s responsibilities are “significantly limited” under ERISA, a directed trustee nevertheless is a fiduciary under ERISA and must exercise its duties prudently and solely in the interest of the plan participants and beneficiaries. According to the bulletin:

When a directed trustee knows or should know that a direction from a named fiduciary is not proper (i.e., is not made in accordance with the terms of the plan or is contrary to ERISA), the directed trustee may not, consistent with its fiduciary responsibilities, follow the direction.
The nature and scope of a directed trustee’s fiduciary responsibility does not change merely because the directed trustee, in carrying out its duties, raises questions concerning whether a direction is “proper” or declines to follow a direction that the directed trustee does not believe is a proper direction. For example, if a named fiduciary changes a direction in response to a directed trustee’s inquiries or information, the directed trustee does not become primarily responsible for the prudence of the direction.
A directed trustee must follow processes that are designed to avoid prohibited transactions. A directed trustee could satisfy this obligation by obtaining appropriate written representations from the directing fiduciary that the plan maintains and follows procedures for identifying prohibited transactions.
A directed trustee does not have an independent obligation to determine the prudence of every transaction. The directed trustee does not have an obligation to duplicate or second-guess the work of the plan fiduciaries that have discretionary authority over the management of plan assets and does not have a direct obligation to determine the prudence of a transaction.
If a directed trustee knows a named fiduciary is failing to discharge its obligations in accordance with ERISA’s requirements, the directed trustee may not simply follow directions from the breaching fiduciary.
The directed trustee’s obligation to question market transactions involving publicly traded stock on prudence grounds is quite limited. The primary circumstance in which such an obligation could arise is when the directed trustee possesses material non-public information regarding a security.
Absent material non-public information, a directed trustee, given its limited fiduciary duties as determined by statute, will rarely have an obligation under ERISA to question the prudence of a direction to purchase publicly-traded securities at the market price solely on the basis of publicly available information.

(EBSA Field Assistance Bulletin 2004-03)

IRS Publishes Final 401(k)/401(m) Regulations. On December 29, 2004, the Internal Revenue Service (IRS) published final regulations governing the operation of Internal Revenue Code (IRC) § 401(k) plans. The final regulations are effective for plan years beginning after 2005. Plan sponsors, however, may apply these rules to any plan year that ends after December 29, 2004, as long as the rules are or have been applied for the entire year and succeeding years. For plan years ending on or before these effective dates, the plan must conform to prior regulations. Highlights of the regulations include:

Restrictions on the ability of plan sponsors to use “bottom-up” or “targeted” qualified non-elective contributions (QNECs) as a method for satisfying non-discrimination testing;
Restrictions on the use of targeted matching contributions to circumvent the limitation on targeted QNECs;
Clarification that employers administering hardship withdrawals on the basis of medical expenses and post-secondary educational expenses generally may ignore changes in the definition of “dependent” enacted by the Working Families Tax Relief Act of 2004;
Modification of the safe harbor hardship withdrawal rules to allow withdrawals for funeral expenses and expenses for the repair of a primary residence;
Prohibition of pre-funding contributions, with limited exceptions, before an employee performs services, and pre-funded contributions may not be taken into account for ADP/ACP testing purposes or used to accelerate deductions;
With respect to a cash or deferred arrangement (CODA) under a plan that includes an employee stock ownership plan (ESOP), elimination of rules requiring disaggregation of ESOP and non-ESOP portions of the plan for ADP/ACP testing purposes;
Anti-abuse rules under which an IRC § 401(k) plan may not engage in repeated changes to testing procedures and plan provisions as part of an effort to increase deferral rates for highly compensated employees.

(69 Fed. Reg. 78144)

IRS Provides More Guidance on Automatic Rollovers. On December 28, 2004, the IRS released further guidance, in Q & A form, on the rules under which retirement plans must automatically roll over into IRAs all mandatory cash-outs that exceed $1,000 if a participant fails to make an affirmative election with respect to the distribution. Highlights of the new guidance include:

A plan must provide that, when making a mandatory cash-out that exceeds $1,000 and qualifies as an eligible rollover distribution, the mandatory cash-out will be paid out in a direct rollover to an IRA, unless the recipient elects either to receive the cash-out directly or to have it rolled into another eligible retirement plan.
The automatic rollover rules apply to qualified retirement plans, to governmental plans described in IRC § 414(d), to IRC § 403(b) plans, and to church plans described in IRC § 414(e).
While the automatic rollover rules generally take effect for mandatory cash-outs made on or after March 28, 2005, plans will have until the end of 2005 to establish administrative procedures for processing automatic rollovers.
If a plan participant is subject to the automatic cash-out rules, the plan administrator, using the participant’s last known address, may execute the documents necessary to establish the recipient IRA with a financial institution selected by the plan administrator.
A plan sponsor may amend its plan to eliminate the mandatory cash-out rule without violating the anti-cutback rules of IRC § 411(d)(6).

(IRS Notice 2005-5)

New Benefit Rights for Employees on Military Leave. President Bush signed the Veterans’ Benefits Improvement Act of 2004 (the VBIA) on December 10, 2004. The VBIA enacts new employer obligations with respect to employees on military leave under the Uniform Services Employment and Reemployment Rights Act (USERRA). Under the VBIA, employers offering health care coverage to employees must allow employees covered by USERRA to continue health coverage for themselves and their covered dependents for up to 24 months. Previously, USERRA only required employers to offer health coverage for 18 months. This new rule is effective for employees who are eligible to elect continuation coverage under USERRA after December 9, 2004. Effective March 10, 2005, the VBIA also requires employers to provide employees entering military service with a notice of the rights, benefits and obligations of the employee and the employer under USERRA. The VBIA directs the Secretary of Labor to publish model notice language by March 10, 2005. The notice requirement can be satisfied by posting a notice in those workplace locations where the employer customarily posts notices for employees.

FASB 123: FASB Issues Final Rules on Accounting for Stock Compensation. On December 16, the Financial Accounting Standards Board (FASB) issued a final standard, FASB Statement No. 123 (FASB 123), on accounting for stock-based compensation. FASB 123 includes the controversial requirement that a company count stock options and other stock-based payments as an expense against earnings. FASB believes Statement 123 will provide users of financial statements with more complete and neutral financial information by requiring that the compensation cost related to stock-based payment transactions be recognized in financial statements. FASB 123 applies to a wide range of stock-based compensation arrangements, including stock options, restricted stock plans, performance-based awards, stock appreciation rights, and employee stock purchase plans. Public entities (other than those filing as small business issuers) will be required to apply FASB 123 in the first interim or annual reporting period that begins after June 15, 2005. Public entities that file as small business issuers will be required to apply FASB 123 in the first interim or annual reporting period that begins after December 15, 2005. Non-public entities will be required to apply FASB 123 in the first annual reporting period after December 15, 2005.

IRS Issues Guidance Concerning Abusive S Corporation ESOPS. Where an ESOP (i.e., employee stock ownership plan) owns S corporation stock, taxation on corporate earnings can be deferred because the S corporation is not a separate taxable entity and the ESOP itself is tax-exempt. Noting a risk for abuse with this type of ownership structure, Congress adopted special provisions under the Economic Growth and Tax Relief Reconciliation Act of 2001 to limit the establishment of S corporation ESOPs to those that provide for broad-based employee coverage and that benefit rank-and-file employees as well as highly compensated employees and principal owners. In the December 17 Federal Register, the IRS issued proposed and temporary regulations to address certain abusive practices of ESOPs that own S corporation stock. The regulations further define terms in the law, such as who is a disqualified person, and when a non-allocation year occurs. The regulations also contain rules for determining whether a transaction is intended specifically to avoid the S corporation ESOP anti-abuse provisions. The temporary regulations became effective December 17, 2004, and apply to plan years beginning after 2004. TD 9164 and REG 129709-03 can be found at 69 Fed. Reg. 75,455 and 69 Fed. Reg. 75,492, respectively.

Treasury Issues Guidance on New Deferred Comp Provision. A new provision of the IRC, added by the American Jobs Creation Act of 2004, provides that amounts deferred under a non-qualified deferred compensation plan are currently taxable to the extent not subject to a substantial risk of forfeiture and not previously included in gross income unless certain requirements are met. On December 20, the Treasury Department and IRS issued a notice providing transitional guidance under this provision. Highlights of the notice are set forth below:

The scope of coverage of the new provision is outlined through definitions of a “non-qualified deferred compensation plan,” a “plan” and the “deferral of compensation.”
Guidance is provided on the application of the new provision to welfare plans, IRC § 457 plans (i.e., non-qualified deferred compensation plans of governmental employees and non-church controlled tax-exempt employers), stock appreciation rights, and arrangements between partners and partnerships.
The notice provides a definition of a “substantial risk of forfeiture”.
An exception from the definition of non-qualified deferred compensation is provided for amounts actually or constructively received by the service provider within a short period following the lapse of a substantial risk of forfeiture.
While the notice does not provide generally applicable methods for calculating the amount of deferrals for a given year, guidance is offered for calculation of the amount of deferrals before January 1, 2005, for purposes of applying the effective date provisions.
A further exception from the definition of non-qualified deferred compensation excludes certain non-statutory stock options from coverage.
A limited exception from the definition of non-qualified deferred compensation is provided for certain stock appreciation rights that do not present potential for abuse or intentional circumvention of the purposes of the new provision.
The notice addresses what constitutes a change in ownership or effective control of a corporation, or in the ownership of a substantial portion of the assets of a corporation.
The notice provides circumstances under which payments under a non-qualified deferred compensation plan may be accelerated, such as to meet the requirements of a domestic relations order or conflict of interest divestiture requirements.
The new statutory provision generally is effective with respect to amounts deferred (i.e., earned and vested) after 2004, and the notice provides guidance on the effective date provisions and transition relief. It also addresses when a plan under which a deferral is made will be considered materially modified after October 3, 2004.
The notice addresses when a non-qualified deferred compensation plan may be amended to allow a participant to terminate participation in the plan, or cancel an outstanding deferral election with respect to amounts deferred after 2004, or to conform the plan to the provisions of IRC § 409A with respect to amounts deferred after 2004.
Certain information reporting and wage withholding requirements are addressed with respect to deferred amounts.

IRS Notice 2005-1 can be found on the IRS website at http://www.irs.gov/pub/irs-drop/n-05-01.pdf.

Santa Leaves New HIPAA Guidance Under Employee Benefits Tree. Spring vacation plans? April in Paris, perhaps? Not for your friendly employee benefits manager, as he or she may well be expending great effort to meet the April 20 deadline for compliance with the security standards of the Health Insurance Portability and Accountability Act of 1996 (HIPAA). Unsure of how to begin? Fret not. Just in time for the holidays, the Centers of Medicare & Medicaid Service (CMS) of the Department of Health and Human Services released “Security 101 for Covered Entities,” the first in a series of seven papers providing implementation guidance on the security standards, often referred to as the HIPAA Security Rule, which govern the use and disclosure of electronic protected health information. As noted above, all covered entities (e.g., health plans, health care clearinghouses, certain health care providers) generally must be in compliance the Security Rule by April 20, 2005, except for small health plans which must comply by April 20, 2006. Topics of future papers include: administrative safeguards; physical safeguards; technical safeguards; organizational policies and procedures; documentation requirements; basics of risk analysis and risk management; and implementation for the small provider. “Security 101 for Covered Entities,” offering an overview of the Security Rule and its intersection with the HIPAA Privacy Rule, can be found on the CMS website at http://www.cms.hhs.gov/hipaa/hipaa2/education/Security%20101_Cleared.pdf.

This newsletter is a periodic publication of Hodgson Russ LLP and should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own lawyer concerning your own situation and any specific legal questions you may have.