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ERISA UPDATE

Roberta J. Ufford

Groom Law Group

April 16, 2007

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Overview

Pension Protection Act of 2006 Focus on Changes to ERISA’s Fiduciary

Responsibility and Prohibited Transaction Rules

Developing Disclosure Requirements Form 5500, 408(b)(2) Regulations Participant Disclosure

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Pension Protection Act of 2006 OverviewMost sweeping change to pension law since 1974. 800 pages of the 900-page bill amend ERISA and

IRC provisions for retirement plans. Revamping single-employer DB plan funding rules. Major changes to multi-employer plan funding. Major changes affecting cash balance plans,

conversions. Changes targeted at defined contribution plans.

Autoenrollment safe harbor, faster vesting of employee contributions.

EGTRRA permanence. Contribution limits and Roth 401(k).

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Pension Protection Act of 2006 Fiduciary Provisions Addresses issues arising from explosive growth of

participant-directed plans. Participant advice exemption, mapping, benefit

statements. Encourage auto-enrollment.

Mitigate employer stock risk. Increase minimum bond, new diversification

requirements, participant notice. New provisions intended to simplify management of

plan assets (primarily affects defined benefit plans).

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Pension Protection Act Service Provider Exemption New ERISA §408(b)(17)

Compare to ERISA § 408(b)(2) services exemption.

Exempts many routine (and non-routine) transactions between plans and service providers that are currently prohibited (unless an exemption is available, e.g., QPAM).

e.g., credit that facilitates plan administration, plan purchases or sales of securities and other property, some plan’s derivatives strategies.

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Pension Protection Act Service Provider Exemption Background: ERISA prohibits virtually every

transaction between a plan and a party in interest. Party in interest includes a fiduciary, service provider,

employer, union and affiliates of these. Without exemptions, plans would be crippled.

Fiduciaries often cannot know whether a counterparty in a plan transaction is a party in interest. Some existing exemptions provide conditional relief. QPAM (PTE 84-14) PTE 75-1 PTE 80-26 PTEs 90-1, 91-38

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Pension Protection ActService Provider Exemption New ERISA § 408(b)(17) –

Covers purchases, sales, loans, transfers of plan assets with service providers.

Does not apply to – Transactions with a fiduciary with discretion over the

assets involved in the transaction Transactions with employers or their affiliates not

covered. Plan may not pay more (or receive less) than

“adequate consideration.” If a market, the prevailing exchange price or quoted

price. If no market, the fair market value determined in good

faith by the fiduciary.

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Pension Protection ActPlan Assets Definition ERISA does not apply to activities of investment

funds in which ERISA plans invest, if these funds are deemed NOT to hold plan assets. REOCs VCOCs “Operating companies” Benefit Plan Invest in Fund is Not Significant

Benefit Plan Investment is Not Significant if – Less than 25% of each class of equity interest in a fund

is held by Benefit Plan Investors (BPIs)

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Pension Protection ActSignificant Participation Test PPA changed the test in two ways:

Narrowed the definition of “Benefit Plan Investor”

Count only ERISA plans, 4975 plans (IRAs) Don’t count foreign or governmental plans

Mandated a “look through” rule A fund will itself be a BPI when it invests in

another fund only to the extent of plan investment E.g., if 50% of Fund A’s equity interests are held

by BPIs, only 50% of Fund A’s investment in Fund B must be counted as an investment by a BPI when the 25% test is applied to Fund B.

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Pension Protection ActSignificant Participation Test Should increase private investment opportunities for

plans While helpful to hedge funds, will funds that can

qualify as VCOCs, REOCs “switch”? Continue to qualify first investment? Must test at every “acquisition”

If the change is effective for transactions occurring after 8/17/06, may a Fund that has no new “acquisitions” after that date switch from a VCOC strategy to the significant participation test?

How will public plans react?

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Pension Protection ActCross Trading ERISA § 406(b)(2) prohibits a fiduciary from

representing a plan and another investor in a transaction between them, such as a cross-trade.

New §408(b)(19) Exempts the purchase and sale of a security

between a plan and any account managed by the same investment manager.

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Pension Protection ActCross Trading New § 408(b)(19) conditions

Advance Approval: The cross trading must be authorized in advance by a fiduciary of each plan, following disclosure by manager.

Approves program, not each trade Plan Size: More than $100 million in assets.

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Pension Protection ActCross Trading Pricing (similar to mutual fund rules):

Cash transaction Security for which market quotations are

readily available Price is determined under SEC Rule 17a-7(b); No brokerage commission or other fee is

charged (except customary and disclosed transfer fees).

Reporting: Detailed quarterly reports of all cross trades to the plan fiduciary;

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Pension Protection ActCross Trading Annual Compliance Review: Must designate

a person to issue an annual compliance report for clients, signed under penalty of perjury.

Policies and Procedures: Must establish and follow written policies and procedures that are “fair and equitable”. DOL published interim final rules establishing

requirements for manager policies and procedures. 72 Fed. Reg. 6473 (Feb. 12, 2007).

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Pension Protection ActCross Trading Open issues, exemption may not apply –

Where one of the two plans is a plan sponsored by the IM or its affiliate (PTE requires approval of an independent fiduciary)

Ex. Collective fund where IM’s plan is an investor Where IM can’t absorb the commission – PTE

prohibits any commission or fee; issue for small managers without broker/trader affiliates

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Pension Protection ActOther Exemptions Block Trading – ERISA § 408(b)(15) Alternative Trading Systems – ERISA §

408(b)(16) Prohibited Transactions involving securities, if

corrected within 14 days of discovery - ERISA § 408(b)(20)

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Pension Protection ActBonding Requirements Current Rule under Section 412

Fiduciary or persons who “handle” assets must be bonded for loss from dishonest.

10% of amount handled, up to $500K. Exemptions

Banks Insurance Companies New Exemption: § 412(a)(2): Exempts

registered broker-dealers subject to fidelity bond requirements of a SRO

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Pension Protection ActBonding Bond Amount Increased: If a plan holds

employer securities, the bond is increased from $500K to $1M. Even the fiduciary is not the manager of the

stock, it must double its bond. Institutional fiduciaries already have trouble

finding capacity at $500K. Technical corrections? Limit increased bond

to actual managers of securities or accounts invested primarily in securities.

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Pension Protection Act of 2006 Investment Advice Background – Providing “investment advice” is a

fiduciary act. A person who advises plans or participants to invest in an investment product that pays the adviser or its affiliate fees and commissions may violate ERISA’s prohibited transaction rules (i.e., section 406(b)).

Approaches to participant advice programs – Independent advice services, Adv. Op. 2001-09

(SunAmerica). Adviser levels or offsets fees so that advice does not

change adviser’s compensation, Adv. Ops. 1997-15A; 2005-10A (Frost/COUNTRY BANK).

Rely on class exemptions, e.g., PTE 84-24, 77-4, 75-1.

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Pension Protection Act of 2006Investment Advice New ERISA §408(b)(14) exempts –

the provision of investment advice to a plan participant by a “fiduciary adviser,” and

The adviser’s receipt of direct or indirect compensation (including sales commissions and other fees) as a result of plan investments pursuant to the advice.

Only covers advice provided under an “eligible investment advice arrangement.” Discretionary management programs and advice to

plan sponsors (e.g., fund selection) are not covered. Available for advice provided after Dec. 31, 2006.

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Pension Protection Act of 2006 Investment Advice ERISA § 408(b)(14) — “Eligible Arrangements”

Two types of “eligible arrangements” adviser’s fees do not vary based on advice, or Adviser provides advise using a computer model

certified annually for an independent expert. Plan fiduciary must authorize arrangement for plan. Detailed participant disclosure, including all program

fees and the fiduciary adviser’s compensation arrangement. (DOL required to issue model form).

Annual independent audit of services is required.

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Pension Protection Act of 2006Investment Advice ERISA § 408(b)(14) — Plan Sponsor “Shield”

Plan sponsor or other fiduciary who selects an “eligible investment advice arrangement” —

does not fail to meet ERISA requirements solely because the sponsor contracts for or arranges for the provision of advice to participants,

has no duty to monitor specific investment advice provided by a fiduciary adviser,

but, still must prudently select and monitor the fiduciary adviser.

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Pension Protection ActInvestment Advice FAB 2007-01 Clarifies Some 408(b)(14) Conditions

Eligible Advice Arrangements – Fee Leveling DOL clarifies that the “fiduciary adviser” is the financial

institution and individuals representing the financial institution who provide the advice.

Fees of affiliates may vary. This allows a firm to provide advice about products marketed by its affiliates, even if affiliate’s fees could change based on advice provided.

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Pension Protection Act of 2006Investment Advice FAB 2007-01

Pre-PPA Advice Guidance – Interpretations under DOL Advisory Opinions (SunAmerica and COUNTRY Bank) are not affected. (PPA provides that existing exemptions are not altered.)

Plan Sponsor Shield – DOL explains that sponsor duties and liability are the SAME when sponsor relies on the new statutory exemption, or follows another approach in engaging an adviser to plan participants.

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Pension Protection Act of 2006Investment Advice Outstanding Questions

May advisers provide “off-model” advice in response to participant questions?

Models must consider ALL plan options; what about employer stock?

DOL may issue a broader exemption for IRAs if it concludes that computer models are not feasible.

DOL RFP asked whether computer models are feasible for IRAS.

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Pension Protection Act Undirected Balances

Undirected Account Balances: Background ERISA § 404(c) relieves fiduciaries from liability for losses

that are a “direct and necessary” result of participants’ exercise of control.

Regulations require “affirmative” participant directions.

Plan fiduciaries must direct investments if participants do not. “Undirected” participant account balances result –

in auto-enrollment plans, because participants are not required to provide investment instructions to enroll, or

if participant account balances were allocated to a deleted investment option (typical in plan conversions).

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Pension Protection ActUndirected Balances

Current standard for undirected balances — Fiduciaries must invest undirected account balances

“prudently,” giving “appropriate consideration” to relevant facts and acting accordingly. ERISA § 404.

PPA extends ERISA § 404(c) protection to fiduciaries — if the plan provides for investing participant account

balances in “default investments” in the absence of affirmative investment elections, and

for a “qualified change in investment options” (i.e., mapping), in accordance with DOL regulations.

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Pension Protection ActDefault Investments New ERISA § 404(c)(5) - a participant is treated as

exercising control over his or her plan account “in the absence of a direction,” if the account is invested according to DOL regulations.

DOL required to issue regulations within 6 months on appropriateness of designating default investments that include a "mix of asset classes consistent with capital preservation, long-term capital appreciation, or a blend of both."

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Pension Protection ActDefault Investments DOL proposed regulations defining a “qualified

default investment alternative” (“QDIA”). 71 Fed. Reg. 56806 (Sept. 27, 2006).

3 types of QDIA: target retirement date accounts, balanced accounts, managed accounts. Each must be managed by an investment manager or

a registered investment company. Other conditions: initial and annual notice to

participants about default and right to provide alternative instructions; participants must have right to change options; plan offers “broad range” of options.

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Pension Protection ActMapping Relief New ERISA § 404(c)(4) - participants are treated as

“exercising control” over their accounts in a “qualified change in investment options” if participant provided prior instructions.

A “qualified change” is a reallocation of the participant’s account among other plan options or new plan options, if — replacement options (including their risk and return

characteristics) are “reasonably similar” to replaced options previously elected by the participant.

Notice to participants at least 30 days/not more than 60 days before change must compare options and inform participants how their account will be invested if they don’t object.

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Pension Protection ActOther DC Plan Relief New ERISA § 404(c)(1)(A)(ii) extends 404(c) relief

during “black-out” periods to fiduciaries who comply with ERISA requirements in authorizing and implementing a black-out. Black-out period defined by ERISA § 101(i)(7).

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Pension Protection ActEmployer Stock Provisions Diversification - DC plans must permit participants to

diversify allocations to employer securities and notify participants at least 30 days before they become eligible to diversify. (Treasury to provide model notice.) Must be able to sell stock acquired by elective deferrals at

least quarterly. Must be able to sell stock acquired with non-elective and

matching contributions after 3 years of vesting service. (Transition rule for participants under age 55.)

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Pension Protection ActBenefit Statements

Amendments to ERISA § 105(a) require — Quarterly statements for participant-directed DC plans.

Statements must include report of value of each investment, explanation of right to change investment allocations and the importance of a diversified portfolio, and notice about investing information on DOL’s website.

Annual statements, if DC plan is not participant directed. DB plans must provide statements every 3 years, or annual

notice of how to request a statement of benefits. FAB 2006-03 provides interim guidance. Pre-PPA — statements required only once per year, on

request.

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Disclosure Regulation

Background Litigation Trends Pending Regulation

Amendments to Service Exemption Form 5500 Amendments to 404(c) Regulations

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Disclosure Regulation - Background

Forms of Compensation Paid by the plan, e.g., typical fees for plan

administration, investment management, securities transactions. Some fees are invoiced; some costs reflect in

investment return (e.g., unitized funds may “hide” expenses).

Provider compensation from third parties, e.g., commissions, soft dollars, 12b-1 and other fees from mutual funds, “non-cash” compensation. Some third party payments are not “compensation” for

plan services.

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Disclosure Regulation - Background

Plan

Mutual Fund

Service Provider

(trustee, recordkeeper or broker/adviser)

Investments (plan pays managements and other fees)

Commissions/Other Fees•e.g., 12b-1 fees•Paid by fund or agent

Plan Service Fees

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Disclosure Regulation - Background

Fiduciary Service Providers – If a payment is in connection with a provider’s fiduciary act, Provider cannot accept the payment; or must rebate the payment against fees plan might otherwise pay). E.g., 401(k) plan recordkeeper/investment provider

with fiduciary authority to select plan investment options generally must rebate or offset fees received from mutual funds.

DOL Adv. Ops. 1997-15A (May 22, 1997) and 2005-10A (May 11, 2005).

Certain exemptions allow provider to pretain commissions/management fees, e.g., PTE 75-1, 77-4, 84-24.

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Disclosure Regulation - Background

Non-Fiduciary Providers - A Provider may accept payments from third parties, IF the payment is not caused by a fiduciary act. E.g., plan recordkeeper/investment provider who

merely offers a "platform" of investments from which plan sponsor choose, are not plan fiduciaries and may retain frees from mutual funds.

See DOL Adv. Ops. 2003-09A (Aug. 25, 2005) and 1997-16A (May 22, 1997)

The opinions recognize that offering a typical 401(k) investment platform doesn’t make a recordkeeper a fiduciary.

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Disclosure – Litigation Trends

Haddock v. Nationwide Financial Services, Inc. Civ. Action No. 3.01cv1552 (SRU) (D. Conn, February 24,

2006) Lawsuit by 401(k) plan sponsors filed in 2001 relates to

Nationwide’s receipt of fees from unaffiliated investment companies (“funds”) offered as investment options under variable annuity contracts.

Under a typical service arrangement, each plan sponsor choose a group of funds for its plan from those Nationwide made available under its annuity contract. Nationwide selected available funds based in part on

revenue sharing paid by funds.

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Disclosure – Litigation Trends

Haddock v. Nationwide Financial Services, Inc. (con’t) Denying Nationwide’s motion for summary judgment,

court held – Nationwide was a plan fiduciary because it retained

discretion to add/delete fund options. Nationwide may have been a fiduciary in choosing funds

for its platform. Revenue sharing payments from funds could constitute

“plan assets.” Even if revenue sharing payments are not “plan assets,”

Nationwide’s receipt of revenue sharing could have involved prohibited transactions.

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Disclosure – Litigation Trends

New class actions allege plan fiduciaries imprudently allowed plan providers to receive “revenue-sharing” payments. Plaintiffs allege plan fiduciaries – caused plans to enter service arrangements under

which the plan and participants paid “unreasonable fees” and “hidden and excessive fees,”

did not understand/recognize revenue sharing arrangements, and

did not disclose to participants in “proper detail and clarity” the transactions, fees and expenses

E.g., Loomis v. Exelon Corp., Case No. 1:06-cv-04900 (filed Sept. 11, 2006 N.D. III). NOTE: Court dismissed claims for investment issues; claims for excessive fees may proceed. (N.D. Ill. Feb. 21, 2007).

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Disclosure –Litigation Trends

Latest class actions include claims against providers as well as plan sponsor fiduciaries. Complaints allege: Directed trustee/investment provider is a fiduciary based on

its trustee status, investment manager status, and limits placed on investments the plan may offer to participants (primarily proprietary funds).

Provider (and sponsor) are not disclosing actual plan expenses to participants, including revenue sharing.

Provider (and sponsor) allow participants to pay excessive fees under the plan.

All revenue sharing is “plan assets,” which should be restored to participants.

E.g. Hecker v. Deere & Co., Fidelity Management Trust Company, et al., Case No. 06-C-0719-S (filed Dec. 8, 2006, D. Wisc.)

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Litigation Trends

Retirement Product Disclosure – Settlement Agreement

In a settlement with the New York State Attorney General, ING agreed to pay restitution and implement a standard format for retirement product disclosure.

Settlement relates to ING 403(b) Retirement Program endorsed by NY State Teachers’ Union. ING and Union did not disclose to teachers expense reimbursements that ING paid to Union.

ING 403(b) Program competed with 403(b) products offered to teachers by other providers.

Orders available at www.oag.state.ny.us/press/2006/Oct/oct10a_06.html

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Litigation Trends

ING- NY Atty General Settlement Agreement “One-Page Disclosure”

States “all-in” investment cost, as a percentage of account balance.

Chart shows how fees affect account balances over time.

Informs investors that fund companies may pay ING to be included as investment options, and that ING and the funds are seeking to profit.

Does not include separate disclosure of fee rates or amount paid by funds to ING, individual fund fees, or contract changes.

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Disclosure Regulation Services ExemptionDOL is developing a provider “incentive” to disclose, if

not a duty. Because a provider is a “party in interest,” its provision of

services to the plan requires an exemption. As a party in interest, Provider would be liable for excise tax

(pension) or section 502(i) penalties (welfare) if the services are not exempt.

Current section 408(b)(2) regulations require — services are “necessary and appropriate,” the arrangement is “reasonable,” and no more than “reasonable compensation” is paid.

See 29 CFR § 2550.408b-2.

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Disclosure Regulation Services Exemption DOL likely to make disclosure a condition of exemption. Likely to require disclosure of information sufficient to permit

plan fiduciary to consider whether – the plan pays reasonable fees for services, the service provider's total compensation (including

third party fees) is “reasonable,” and any conflicts of interest affect the service provider's

advice.

“This amendment will ensure plan fiduciaries are provided or have access to information necessary to determine whether an arrangement is reasonable…this regulation is needed to eliminate the current uncertainty…”

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Disclosure Regulations Services Exemption Possible Disclosure Model - FAB 2002-03 addresses

disclosure of “float” income by service providers. To avoid potential prohibited transactions, service providers should disclose —

circumstances where float is earned, when “float” period may begin and end, and rate earned on float.

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Disclosure Regulation – Form 5500

Schedule C, filed by plan administrator, requires reporting on service provider compensation paid by the plan.

For years, Schedule C Instructions have required reporting of “indirect” compensation, including “finder’s fees” and other fees and commissions received in connection with plan transactions.

But, typically not reported … 2004 ERISA Advisory Council Report - Service provider

compensation paid indirectly by mutual fund revenue sharing typically not reported.

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Disclosure Regulation – Form 5500

DOL has proposed changes to Schedule C, effective for 2008 plan year. 71 Fed. Reg. 41392, 41616 (July 21, 2006).

Schedule C changes expected to “clarify” reporting requirements and ensure plan officials obtain information necessary to review reasonableness of compensation, taking into account “revenue sharing or other financial relationships” and potential conflicts of interest that might affect services.

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Disclosure Regulation – Form 5500

Proposed Schedule C changes would — Require reporting of “indirect compensation” received by

most service providers. “Indirect compensation” would include all amounts paid in

connection with plan services, or the recipient’s position with the plan.

Require some third party payments to be reported on an unallocated basis.

Require “float” to be reported in dollars.

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Disclosure to Participants

Current Participant Disclosure Requirements Summary plan description (SPD) – Must describe

circumstances that could result in a fee or charge imposed on the participant’s account.

See 29 CFR § 2520.102-3(l). ERISA section 404(c) regulations

Automatically, transaction fees/expenses that affect the value of the participant’s account

On request, annual operating expenses of investment options (as a percent of net assets) and performance net of expenses

See 29 CFR §§ 2550.404c-1(b)(2)(i)(B)(1) and (2).

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Disclosure to Plan Participants

DOL is considering changes to regulations for participant-directed plans under section 404(c).

DOL says that rulemaking is needed –

“to ensure that the plan participants…are provided the information they need, including information about fees and expenses, to make informed investment decisions . . .”

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Disclosure to Plan Participants

DOL review of 5500 filings revealed that only 50% of participant-directed plans are identified as "404(c) plans.“ DOL may be considering — Applying the same disclosure requirements to all

participant directed account plans, whether or not the plan is a 404(c) plan (requires finding a disclosure duty).

Both automatic and on-request disclosure requirements. A role for electronic information in new disclosure regime. DOL Request for Information

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Disclosure to Plan Participants

Possible changes based on 2004 ERISA Advisory Council Recommendations Deliver a “profile prospectus” (or equivalent) for each plan

investment option. Require investment education for participants. Include investment expense information on annual

statements provided to participants. DOL should provide a sample model participant disclosure

format.