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Employee Benefits Developments June 2006

RULINGS, OPINIONS, ETC.

PBGC requires electronic filing of premium declarations
On June 1, the Pension Benefit Guaranty Corporation (PBGC) published a rule requiring sponsors of insured defined benefit pension plans to submit their premium information filings to the PBGC electronically. Effective July 1, 2006, the new rule requires sponsors of plans with 500 or more participants to electronically file premium information for plan years beginning on or after January 1, 2006. The electronic filing requirement will not become mandatory for plans with fewer than 500 participants until the 2007 plan year. The rule does not require electronic payment, only electronic filing of premium information. The electronic filing requirement also does not apply to information sponsors must file to comply with a PBGC request for information in connection with a premium compliance review. Plans may apply for exemptions on a case-by-case basis—exemptions for good cause will be granted in appropriate circumstances. Filings may be submitted through the PBGC’s on-line e-filing application (“My Plan Administration Account,”
or “My PAA”). (71 Fed. Reg. 31077).

IRS completes EPCRS overhaul
The Employee Plans Compliance Resolution System (EPCRS) is a comprehensive system of correction programs that allows sponsors of retirement plans to correct plan qualification failures and continue to provide employees with retirement benefits on a tax-favored basis. On May 5, 2006, the Internal Revenue Service (IRS) issued Revenue Procedure 2006-27, which updates and expands the types of failures that may be corrected under EPCRS.

Some of the more significant EPCRS changes include the following:

A new correction method for 401(k) plans that exclude eligible employees from participation; 

New methods for correcting plan loan failures;

An alternative correction method for failures to obtain spousal consent;

Elimination of the determination letter application requirement where certain plan errors are corrected by plan amendment; 

A streamlined correction procedure under VCP where the only operational defect is a failure to timely adopt certain amendments required for recent law changes (e.g., good-faith Economic Growth and Tax Relief Reconciliation Act amendments); 

A new compliance fee schedule for missing plan amendments (i.e., amendments required to have been made for recent tax law changes) discovered by the IRS while processing a determination letter application;

New rules on the availability of EPCRS to correct failures where the plan or plan sponsor is a party to an abusive tax-avoidance transaction; and 

In appropriate cases, a waiver by the IRS of the excise tax for violations of the 401(a)(9) minimum distribution requirements.

The new EPCRS rules generally are effective September 1, 2006. However, some of the new EPCRS provisions, including the compliance fee for nonamenders discovered during a determination letter application review, are effective May 30, 2006. Plan sponsors are permitted, at their option, to apply the provisions of Revenue Procedure 2006-27 beginning May 30, 2006.

DOL expands and simplifies voluntary fiduciary correction program
In April, the Department of Labor (DOL) published a 2006 update of the Voluntary Fiduciary Correction Program (VFCP), simplifying and expanding the original VFCP published in 2002. The VFCP is intended to promote compliance with the Employee Retirement Income Security Act of 1974 (ERISA) by encouraging employers to voluntarily self-correct certain violations of the law.

The 2006 update of the VFCP includes four additional transactions that are eligible for correction under the program. These transactions are:

A new category of participant loan transactions for breaches involving level amortization;

The addition of a category of transactions for defaulted loans;

The purchase of an illiquid asset from a party in interest to which a statutory or administrative exemption applied; and

Violations involving the use of plan assets to pay settlor expenses.

Related to the 2006 update of the VFCP, the DOL also adopted an amendment to Prohibited Transaction Exemption 2002-51 (PTE 2002-51) to provide conditional relief from the payment of excise taxes for certain VFCP transactions under a class exemption. The expanded relief applies to the purchase of an illiquid asset by the plan from an interested party and to the use of plan assets to pay settlor expenses.

The 2006 update of the VFCP also eliminates the notice requirement for violations involving de minimis delinquent participant contributions and loan repayments. The effective date for both the 2006 update of the VFCP and the amended PTE 2002-51 is May 19, 2006.

DOL publishes guidance on mutual fund settlement proceeds
In a field assistance bulletin, the DOL has published guidelines on the proper handling of proceeds that may be paid to a qualified plan following settlements of improper mutual fund trading practices. In cases handled by the Securities and Exchange Commission (SEC), an independent distribution consultant (IDC) is appointed to distribute settlement proceeds or other recovered assets to the relevant mutual funds. For many qualified 401(k) plans, for example, the mutual funds are held in “omnibus accounts” with an intermediary such as a broker-dealer, underwriter, recordkeeper, or insurance company. The DOL has stated that once settlement proceeds are received by a plan or its intermediary from the IDC, the settlement proceeds become “plan assets.” As such, plan fiduciaries are required to hold the assets in trust and to allocate them to participant accounts in a manner that is solely in the interest of plan participants and beneficiaries. The guidance provides that if the settlement arrangement with the IDC establishes a particular method for allocating settlement fund proceeds among various accounts, a fund intermediary may safely follow that method in compliance with ERISA standards. Otherwise, the intermediary or plan administrator will be required to adopt a reasonable and prudent method of allocation. The allocation may take into account cost considerations. Direct expenses may be paid out of settlement proceeds, but an intermediary, other service provider, or the plan sponsor may not obtain any compensation from these arrangements beyond reimbursement of direct expenses. Plan fiduciaries are not required to allocate settlement proceeds precisely to participants directly affected by the mutual fund malfeasance, but the allocation method must be reasonable, fair, and objective. Any plan receiving proceeds from a mutual fund settlement of SEC or similar charges should review this bulletin in connection with its allocation of funds. (DOL Field Assistance Bulletin 2006-1 (April 19, 2006)).

CASES

Unfunded means unfunded
The Third Circuit Court of Appeals recently examined what it means to be an unfunded “top hat” deferred compensation plan. IT Corporation (IT) adopted a deferred compensation plan in 1996. As most top hat plans do, the plan provided that it was limited to participation by non-employee directors and employees who are part of a select group of management or highly compensated employees. The plan document specified that it “constitutes an unfunded plan” and that participants possess “no legal or equitable right, interest or claim in any property or assets of” IT or its affiliates and that the obligation under the plan is “merely that of an unfunded and unsecured promise to pay money in the future.” The IT plan, like many plans, had a related so-called “rabbi trust.” The trust agreement provided that any assets contributed were to be held “subject to the claims of the company and the subsidiary creditors in an event of their insolvency.” No assets were ever contributed to the rabbi trust.

In 2002, IT and its related entities filed for bankruptcy protection. Participants in the plan brought an action in Bankruptcy Court, claiming that the plan did not qualify for unfunded top hat status under ERISA and was subject to ERISA’s funding and fiduciary duty requirements. Applying this theory, the participants argued that IT was obligated to set aside in a trust for participants assets beyond the reach of IT’s creditors in an amount sufficient to fund the benefits. Participants also alleged that the former president and CEO of IT promised them the company would fund the trust and insure that benefits would be paid in full if the company ever faced the prospect of bankruptcy.

The Third Circuit upheld the Bankruptcy Court and District Court decisions against the participants. The Third  Circuit looked at the clear language of all plan documents, communications, and trust and found clear statements that the plan was intended to be unfunded and that there were no amounts to be set aside not subject to the risk of creditors. Further, the court found that because the plan documents were clear and unambiguous, the alleged statements of the former president and CEO regarding possibly funding a so-called secular trust could not be admitted into evidence to modify the terms of the plan. Accardi v. IT Corp. (In re IT Group Inc.), (3d Cir., 2006).

Battle joined over severance plan
Employers have been successful in dismissing lawsuits brought under state law claims of fraud, misrepresentation, and breach of contract on the grounds that these claims are preempted by ERISA. Here’s a federal district court case out of the Eastern District of New York that comes out differently. Barry Engler worked for Cendant Corporation for 25 years. The type of work he did was being outsourced to IBM. Engler received a letter from IBM offering employment with IBM on the Cendant account. He also received a letter from Cendant telling him that IBM would recognize service with Cendant “for all purposes” including credits in the IBM pension plan. Engler took the IBM job. Shortly thereafter, he received another letter from Cendant describing several IBM employee benefit arrangements that would be available to him as a former Cendant employee if he signed a general release not to sue Cendant.

This letter described a severance plan that would take into account Cendant service if he was terminated other than for cause during his first 24 months at IBM. Engler signed the release. Twenty-seven months after he started with IBM, Engler was terminated and offered severance pay based only on his 27 months of service with IBM. Engler sued both Cendant and IBM, and the amended complaint covered both ERISA claims under the severance plan and state law claims against Cendant for fraud, negligent misrepresentation, and breach of contract based on the letters sent to Engler and his action in accepting the IBM job. The court dismissed the ERISA complaint against Cendant because Engler’s claim has nothing to do with a plan maintained by Cendant. The court ordered the case to proceed as an ERISA claim for benefits against IBM and as valid state law claims against Cendant. The courtroom door is open to Engler to prove his case that he entered into an agreement to leave Cendant and accept the IBM job in exchange for counting his Cendant service in the IBM plans and that Cendant fraudulently or negligently misrepresented the arrangement with IBM in order to induce him to leave Cendant. Engler v. Cendant Corporation and International Business Machines Corporation (E.D.N.Y. 2006).

Supreme Court declines to rule on validity of posthumous QDRO
The U.S. Supreme Court has declined to review a decision by the U.S. Court of Appeals for the Third Circuit requiring a pension plan to recognize a property settlement agreement as a qualified domestic relations order (QDRO), even though it was not deemed “qualified” until after the participant’s death. When Ed Rutyna and Rita Files divorced in 1998, their property settlement agreement provided that Rita would be entitled to 50 percent of Rutyna’s benefits under ExxonMobil’s defined benefit plan. Rita’s attorney notified the plan administrator of the divorce and requested a sample QDRO and information about the accounts. The plan administrator provided the requested information to Ed’s attorney, who failed to forward the information to Rita. At the time of Ed’s death in 2001, before Ed commenced receiving benefit payments, no QDROs had been filed with the plan. Following a denial of her request for survivor benefits from the defined benefit plan, Rita argued that the property settlement agreement was a QDRO, providing for a separate 50 percent interest in Ed’s benefits. The plan administrator determined that the property settlement agreement did not meet the requirements of a QDRO, in part because it did not specifically provide for a separate interest in the benefits. Rita subsequently obtained a second order from the divorce court, providing that the property settlement agreement was a QDRO with an effective date that preceded Ed’s death. However, the plan administrator refused to accept a QDRO that was entered after the date of the participant’s death. Following a series of appeals, Rita sued the plan, requesting payment of her benefits in accordance with the property settlement agreement and the posthumous court order.

Reversing a lower court decision in favor of the plan, the appeals court held the property settlement agreement awarded Rita a 50 percent interest in her ex-husband’s pension and that nothing in ERISA precluded her from pursuing a QDRO after his death to enforce an interest that existed prior to his death. The petition to the Supreme Court asked the court to decide several key issues raised by the appeals court decision, including whether a domestic relations order that does not meet ERISA’s requirements for a QDRO can create rights that may be enforced at any time through a QDRO, and whether a posthumous court order can assign to a former spouse a portion of a deceased participant’s pension benefits where no QDRO existed before the participant’s death. ExxonMobil Pension Plan v. Files (U.S. Supreme Ct., cert. denied, May 22, 2006).

Supreme Court validates ERISA health plan reimbursement provision
Health plans are often called upon to pay the medical expenses of a covered employee or dependent who sustains an injury as a result of the negligence of a third party. In an effort to shift financial responsibility for these injuries from the plan to the negligent party, most health plans include a provision that requires a covered person who receives benefits under the plan to reimburse the plan for those benefits from funds the covered person recovers from a third party (e.g., the negligent party or his or her insurance company). Resolving a split among the federal courts of appeal with respect to the issue of whether a fiduciary may sue to enforce a third party reimbursement provision of this kind, the Supreme Court in Sereboff v. MidAtlantic Med. Servs., Inc. held a fiduciary may do so provided the plan document identifies a particular fund from which reimbursement will be sought (e.g., personal injury settlement proceeds) and the share of the fund to which the plan will be entitled, and the fiduciaries seek reimbursement from identifiable funds within the possession and control of the participant.

In Sereboff, Marlene Sereboff and her husband were injured in an automobile accident resulting, at least in part, from the negligence of a third party. As a result of the injuries sustained in the accident, the health plan sponsored by Ms. Sereboff’s employer provided medical benefits to the Sereboffs totaling approximately $75,000. The Sereboffs sued the negligent party and settled for $750,000. After the suit was settled, the health plan sued the Sereboffs, seeking to collect from the settlement the medical expenses it had paid on the Sereboffs behalf. The Sereboffs disputed the plan’s right to the funds but agreed to set aside $75,000 of the settlement proceeds pending the outcome of the lawsuit. Like the federal district court and U.S. Court of Appeals for the Fourth Circuit before it, the Supreme Court found in the plan’s favor and ordered the Sereboffs to pay the plan the $75,000 they had set aside. In so finding, the court noted that ERISA permits fiduciaries to pursue equitable remedies (including equitable liens) to enforce the terms of a plan. The Supreme Court held where a plan contains a properly worded reimbursement provision (i.e., it identifies both the fund from which reimbursement will be made and the share of the fund to which the plan is entitled), as the plan in Sereboff did, settlement proceeds in the possession or control of a covered person are subject to an equitable lien in favor of the plan. Thus, an action to impose and enforce an equitable lien arising from a properly drafted third party payment provision is an action authorized by ERISA. Sereboff v. MidAtlantic Med. Servs., Inc. (U.S. Supreme Ct., May 15, 2006).

In light of Sereboff, plan sponsors should review their plans to ensure that the plan and SPD contain appropriate third party reimbursement language. Furthermore, plans should establish procedures to identify and monitor claims that could implicate the plan’s third party recovery provisions to ensure timely assertion of liens on amounts recovered by covered persons from third parties.