BNA Pension and Benefits Blog

The house passed its version of ERISA in the fall of 1973. The Senate approved its version in February of 1974. There were many differences to be reconciled by the Conference, which got underway in April of that year. One of them, however, was not the preemption of state law rule, which was the same in both bills. It provided for "subject matter" preemption. States were precluded from legislating with respect to matters addressed in ERISA. For example, no state could have imposed a vesting standard for retirement income plans because ERISA had a vesting rule for retirement income plans. Likewise, the other minimum standards (participation, accrual) and the funding standards. And no state could have imposed fiduciary standards on any kind of employee benefit plan because ERISA's rules applied to all plans. But that preemption rule could not have been used to prevent states from regulating, e.g., health care plans, in areas in which ERISA does not regulate. It was believed by the ERISA drafters that subject matter preemption was sufficient to prevent states from regulating that which Congress was regulating, and thus gave plan sponsors protection against having to cope with a multitude of differing state schemes that sought to do so.

And you all remember your high school civics textbook explanation of the role of conference committees in Congress: they reconcile differences between the respective bills passed by each of the houses, but they don’t mess with provisions that are the same in both bills.

So how, then, did we wind up with the utterly different, and much broader, preemption rule that was in ERISA as enacted? And why does the enacted provision say, "(1) the term 'State Law' includes all laws, decisions, rules, regulations, or other State action having the effect of law, of any State," and "(2) the term 'State' includes a State, any political subdivision thereof, or any agency or instrumentality of either, which purports to regulate, directly or indirectly, the terms and conditions of employee benefit plans covered by this title"?

Late in the Conference, a delegation of big business and big labor clambered up the Hill and confronted the conferees. The subject matter preemption rule, they said, had to be dramatically broadened, and if the conferees wouldn't change it, they threatened to combine their forces and defeat the conference substitute when it was brought to the floor of each house. What had gotten them so exercised?

For big business, it was the Monsanto case, in which the Supreme Court of Missouri had just upheld the assertion by the Missouri Insurance Commissioner that he had authority to regulate a self-insured health care plan sponsored by Monsanto. The big companies saw the specter of 50 state insurance commissioners miring them in a swamp of inconsistent regulations. For the unions, it was the efforts of some of the state supreme courts, acting in their capacity as arbiters of the ethics of the bar licensed to practice in their states, to outlaw "closed panel" legal services plans. The unions liked closed panel plans because they were cheaper to operate and easier to manage, and they were incensed that the bars of various jurisdictions that wanted more expensive plans and didn't like the idea of being managed were thwarting their effort to bring affordable legal services to their members. Take note that among the strongest advocates of "open panel" plans—plans in which participants were free to use any lawyer licensed in the jurisdiction— was the Litigation Section of the American Bar Association.

Facing the double-whammy of big business and big labor, the conference principals caved and directed the staff to work something out. The staff, already shattered by marathon sessions with a cast of thousands trying to reconcile serious differences in the two houses' bills and facing the very real deadline of an impending impeachment of our 37^th President (all believed that there was going to be an impeachment by the late summer of '74, and all knew that, if the ERISA conference substitute was not adopted by both houses before that point, it would be put off until the next Congress, and the two houses then would have to start all over again, literally from the beginning). So staff did what we all do when our choices are narrowed and become painfully clear—they hastily drafted what the business and labor lobbyists told them to draft. The logic was overpowering—get it done quickly because there is much else to do and very little time in which to do it.

But here's the human interest story. On the day the conference substitute came before the Senate, staff of four of the key senators scripted a colloquy for them to explain the operation of the new preemption rule. The senators, however, botched it. Badly. So badly, that it came out sounding as though they had decided to revert back to the original subject matter preemption and call the bluff of the Bigs. Sitting in the gallery that afternoon were two ABA Litigation Section lawyers who had come out from Chicago to observe. They heard what they heard, were ecstatic, zipped out to National Airport, and hopped on a plane back to Chicago to report their victory.

In the meantime, the Senate staff kicked into action. They hustled into the clerk's office, where the stenographers' transcripts were being edited, and began a little editing of their own. In short order, they had unbotched the colloquy. The next morning, the ABA envoys eagerly tore the plain brown wrapper off their newly arrived Congressional Record. Quel surprise!  In their anguish, they called a Labor Department lawyer who they knew had also listened to the colloquy. "You heard it," they said. "This is the exact opposite of what the senators said." He replied, "Do you see the words in the Record? That's what you heard." Not without some sympathy, he added, "Don't you know that the victors always write the history books?"

And, to come full circle, it obviously is not true that conferees cannot mess with a provision that is alike in both bills. They cannot mess with it only if a member objects to their having done so when the bill comes up for final passage.

So, that's how a relatively modest preemption rule was replaced by a hastily drafted, much broader rule that may be the most litigated provision in the statute.

If you could draft a new ERISA preemption rule, what would it say?

Steve Sacher

Jones Day

April 2, 2008

Last month the Supreme Court resolved, at least for one case, this question: Do individual employees have a cause of action when a fiduciary violates its responsibilities with respect to the assets in an individual’s defined contribution account? In the case, LaRue v. Dewolff, Boberg & Associates, Inc. (42 Empl. Benefits Cas. 2857), the Court held that an individual does have a cause of action. The judgment was unanimous, but Justice Roberts wrote a mystifying and mischievous concurring opinion, joined by Justice Kennedy, which might raise a question as to whether the issues purportedly addressed by the Court are really settled.

The case involved straightforward facts: a participant in a defined contribution plan gives investment instructions with respect to his account. The plan fiduciary, to whom the instructions were given, does not follow them. The account suffers a loss, and the participant brings a civil action against the fiduciary to recover the loss. Does ERISA provide jurisdiction for such a civil action?

The fiduciary argued no, because relief against a fiduciary (except for equitable relief) is available only if the fiduciary caused harm to the entire plan , as opposed to this situation in which the harm was to a participant. This argument was quite plausible given earlier Supreme Court decisions interpreting the scope of ERISA Sections 502(a)(2) and 409. (Section 409 provides, in part, that a fiduciary “is liable to make good to [the] plan any losses to the plan resulting from” the fiduciary breach.)

The Court, though, said that the loss in this case--even though felt by only a single plan participant--was still a loss to the plan under Section 409.

My initial reaction to the decision recalls a quote from “The Godfather,” when Marlon Brando, presiding over a meeting of the five families to establish a peace, asks “How did things ever get this far?” How could we, more than 30 years after ERISA, still be debating whether a participant in a defined contribution plan has a cause of action against a fiduciary whose breach reduced the value of the employee’s account?

But now, thanks to LaRue, the issue is settled. Or is it?

Justice Roberts wrote separately. His opinion says that LaRue’s true claim was a claim for benefits under Section 502(a)(1)(B) of ERISA and that “it is at least arguable that a claim of this nature properly lies only under § 502(a)(1)(B). . . . If LaRue may bring his claim under § 502(a)(1)(B), it is not clear that he may do so under § 502(a)(2) as well.”

Justice Roberts says this is important, because under Section 502(a)(1)(B), it is clear that a participant ordinarily has to exhaust administrative remedies and that a plan can grant a fiduciary a significant degree of discretion in determining benefit eligibility and the meaning of plan terms.

Although Justice Roberts does not expressly say so, it is also possible that if the action is under section 502(a)(1)(B), there may be no relief at all—LaRue’s action was an attempt to get the fiduciary to make good the plan’s loss; how would that be possible under section 502(a)(1)(B), where the fiduciary would not even be the proper defendant? (Maybe if there is a loss, the loss would have to be recovered ratably from the accounts of all participants. Now that would be a happy result for the other participants. Now could they bring an action against the plan fiduciaries for not suing the fiduciary responsible for causing LaRue a loss? And would that be actionable only under section 502(a)(1)(B), since they are basically saying the same thing that Justice Roberts says Larue is saying: “My benefit should be larger”? I can see an endless cycle of complaints here.)

The most unfortunate thing about Justice Roberts’ concurrence is that it ensures us a new period of uncertainty. Certainly every fiduciary defendant will seize on Justice Roberts' words, and courts will have to figure out just what the concurrence means and if any Justices, other than Justices Roberts and Kennedy, may in the future be sympathetic to the concurrence’s rather odd position.

I should add that it is particularly odd, given that Justice Roberts, at least in his confirmation hearings, suggested that he wanted the Court to speak, as often as possible, with a single voice. In LaRue, he opts for point, counterpoint.

[Ed. Note: For coverage of the LaRue decision see 34 Pens. & Ben. Daily (Feb. 21, 2008); 35 Pens. & Ben. Rep. 467  (Feb. 26, 2008); and 42 Empl. Benefits Cas. 2857.]

The extension for amending plans for compliance with Code section 409A and the final regulations thereunder under Notice 2007-86 does not mean that companies or individuals should wait to address these issues until later this year.  During the course of an IRS examination, one company received an information and document request from the IRS agent inquiring regarding what the company was doing to comply with Code section 409A.  The IRS is interested in how companies are preparing to comply, what will your or your client's answer be?

In preparing for Code section 409A compliance, it is important to study carefully the transition rules because these can be helpful tools in addressing arrangements that may not be able to continue in the same manner as they have operated in the past under Code section 409A.  Each situation needs to be addressed considering the operations of the plan, the company's payroll system and the administration system for the plan.  It is important to consider not only operations today in working to design the plan for compliance, but also how operations will work in the future and how to structure arrangements considering the impact of mergers and acquisitions on the non-qualified deferred compensation plans.

During the interim it is also important to review operational foot faults in light of the relief provided under Notice 2007-100.  The corrections available under Notice 2007-100 should be carefully reviewed and the notice obligations under such Notice must be followed to be able to receive the benefits of the corrections provided. 

During 2008, companies need to develop their own internal compliance policies and procedures for Code section 409A, including identifying all plans and arrangements potentially subject to Code section 409A, creating a procedure to identify what new agreements or arrangements need to be reviewed under Code section 409A, limiting the internal personnel who can send communications about plans or enter into agreements to avoid inadvertent documentary compliance issues, coordinating plans (particularly those that are linked to qualified plans, other non-qualified benefits or that have unique offset arrangements), collecting documentation showing compliance in operation, and determining how to deal with problems under either the transition rules, good faith compliance, one of the exemptions in the final regulations,  or fixing violations under Notice 2007-100.  It is also important to consider whether the issue is not addressed in the final regulations or Notice 2005-1 and can be addressed as being in "good faith compliance."   It is important to remember there is no remedial amendment period for compliance with Code section 409A.

After 2008 based upon the currently existing guidance, you will not be able to fix bad documents, most bad plan designs, bad substitutions or discounted stock options that have been exercised. The IRS is asking about 409A preparations, it is time to begin work on your answer.

When PBGC takes over a terminated plan, it becomes the trustee and may invest the assets of the plan in the full range of investments available to other ERISA plan trustees. By law, PBGC must invest its premiums in debt obligations. Through most of its history, PBGC invested most of the trust funds assets in stocks and other non-debt asset classes to diversify its portfolio. However, in 2004, PBGC began a shift away from equities to bonds. As a result, 72% of PBGC's total assets were fixed-income securities at the end of its last fiscal year (September 30, 2007). PBGC this week announced it is moving back to a more diversified portfolio, investing 55% of its $55 billion portfolio in stocks and alternative investments.(Click here for the BNA story in the Pension & Benefits Daily.)

Over 75 percent of PBGC's assets were in the trust funds at the end of its last fiscal year and thus able to be invested in stocks and other asset classes. This means the PBGC has much the same flexibility that private plan fiduciaries have to build a diversified portfolio, since any diversified pension portfolio is likely to have more than 25% in fixed income securities. Under the new policy, stocks and fixed income securities will each represent 45 percent of PBGC's portfolio, with the remaining 10 percent invested in alternative investments.

This is good news for plan participants and for defined benefit plan sponsors. PBGC's shift to fixed income securities was an attempt to match its assets with its liabilities. However, at the time it was adopted, PBGC had a deficit of over $11 billion. Unfortunately, going to an immunized portfolio when you don't have enough assets to pay all benefits means you simply lock in the deficit.

There is ample evidence that a diversified portfolio will yield a higher return with less risk over time than one heavily weighted toward fixed income securities.

Is 45-45-10 the right mix of stocks, bonds and alternative investments? Hard to tell without seeing the full study. But it is certainly a step in the right direction. Kudos to Director Millard and the PBGC Board (the Secretaries of Labor, Treasury and Commerce) for taking this step.

On April 23, 2008, BNA will present a conference on "401(k) Plan Fiduciary Compliance: What Plan Sponsors Need to Know," at the Ritz Carlton Pentagon City in Arlington, Virginia.

The conference will feature top officials from Treasury and DOL, as well as experienced practitioners.

Conference co-chairs Nell Hennessy and Phyllis Borzi (former co-chairs of the BNA Pension & Benefits Advisory Board) have put together a dynamic, authoritative, and interesting program.

Get more information and register online: legaledge.bna.com.

-- Sarah Stevens, managing editor, BNA Pension & Benefit Publications

            Several weeks ago, the ERISA Industry Committee (ERIC) published a new proposal for retirement savings in the United States billed as a “New Benefit Platform for Life Security.” 

            As the first prong, the proposal suggests that there be three types of retirement savings: (1) a defined benefit plan, called a “Guaranteed Benefit Plan,” (2) a defined contribution plan, called a “Retirement Savings Plan” and (3) a short-term security account.  These plans could be offered independently or in combination with one another to provide additional retirement resources beyond Social Security.

            The Program focuses on providing sufficient incentives to maintain and expand employer participation and encourage individuals to contribute to their own retirement security. If implemented, the program would significantly simplify the current system, ideally make it more equitable to employers and employees and expand participation.  The program contains several supplementary initiatives including educational financial planning services, a regulatory program to provide full disclosure of fees and expenses and pre-established limits on both before and after tax contributions for each of the three types of plans.

            While the New Benefit Platform for Life Security has much to recommend it, very little has been written about it and few in the benefits practitioner community seem to have noticed it.

            You can follow the links here to see a copy of the Core Structure for Life Security Plan (the “Summary”) and a longer version that spells out some of the details (see pages 13-17 of report, found in pages 23-27 of this document).

            What do you think of this proposal?  Might it be improved by requiring that employers of a certain size actually be required to offer all three types of plans in combination?

As expected, the 401(k) fee disclosure case against Deere & Company was the first to be decided, since the District Court for the Western District of Wisconsin has a reputation as a "rocket docket."  Many people, myself included, had thought the complaints in these 401(k) fee cases contained sufficient fact allegations that courts would wait until after discovery to decide them. Unexexpectedly, the court dismissed the case based on the complaint and the plan documents. Hecker v. Deere & Co., Case No. 06-C-719-S (W.D. Wisc. June 21, 2007). The facts of the Deere plan may, however, distinguish it from most other plans and make it less significant as a precedent in the other pending 401(k) fee cases, at least at the motion to dismiss stage.

The SPD provided that:

The costs of administering the Plan are paid by the Company. Participants incur no transaction fees or sales loads on funds purchased and sold through the Plan’s standard plan options.... All fund investors indirectly pay any fund-level expenses, such as management fees, asset-based sales charges (12b-1 fees), and other fund expenses, as detailed in the fund’s prospectus....

Of the 26 funds specifically offered by the plan, 23 were Fidelity Funds. However, the plan also offered a mutual fund brokerage account through which participants could select from among 2500 other mutual funds unaffiliated with Fidelity. Fidelity received direct payment for its trust services from Deere; the plan paid no additional fees to Fidelity.

The court concluded that:

The disclosure in the reports and prospectuses accurately reflect the expenses actually paid to the fund manager for fund management as evidenced by the allegations that the same fees are charged to all retail fund customers. To the extent that the charge includes profit, it is unlikely that the fund sponsor would know or be in a position to control its redistribution among related corporations, corporations, a fact conceded in defendants’ brief. There is no evidence of intent in the statute or regulations to reach this type of detail.

The court found that the recent proposals to expand disclosure of indirect fees and provide additional disclosure supported the conclusion that such expanded disclosure is not required under current law.

There appears to have been no dispute that the Deere plan satisfied the ERISA section 404(c) requirements other than requirements related to fee disclosure. The court concluded that the existing regulations do not require disclosure of revenue sharing, only the amount of the fees which were adequately disclosed. Nor did the court feel that disclosing the revenue sharing arrangements would have enhanced the participants' investment decisions:

In assessing the likely return on an investment the fees netted against the return are certainly relevant, but knowing the subsequent distribution of those fees has
no impact on the investment’s value.

The court concluded that the participants had adequate opportunity to choose funds other than the designated Fidelity Funds because of the mutual fund brokerage window and therefore their investment in the designated funds and therefore they exercised the requesite control over the investments in selecting the Fidelity Funds to insulate the Deere fiduciaries from any liability under section 404(c)'s safe harbor even if the plaintiffs could prove that the fees in the Fidelity Funds were excessive.

Most plans don't offer a brokerage window, so the Deere case is clearly distinguishable. However, the court's conclusions about the extent of disclosure required under current law, both under the general ERISA provisions and section 404(c), would protect most plan fiduciaries if followed by other courts. Stay tuned for the rest of the story, since there are still a number of these cases pending.

Litigation brings home how fragile our common understanding of ERISA can be. Until the 9th Circuit decided Beck v. PACE International Union, 427 F. 3d 668, 673 (2005), practitioners understood that the only ways to distribute participants' benefits under a terminating defined benefit plan were annuities or lump sums. Unfortunately, the 9th Circuit didn't find it so clear. Yesterday's unanimous Supreme Court decision ultimately confirmed practitioners' understanding. However, Justice Scalia's analysis made it clear that it wasn't as clear as we had all thought.

While holding that a merger was the continuation of a plan rather than an acceptable way to terminate a plan, Justice Scalia pointed out in footnote 3 that:

We would not have to decide that question of statutory interpretation if Crown's pension plans disallowed merger. Any method of termination permitted by §[4041](b)(3)(A)(ii) must also be one that is "in accordance with the provisions of the plan." Crown thus could have drafted its plan documents to limit the available methods of termination, so that merger was not permitted.

Who would have ever thought to put such a provision in a plan? Instead of looking at the provisions of the plan that set forth the distribution methods, all of which would have been annuities or lump sums, Justice Scalia seems to be requiring defensive drafting to make it clear that the means of distribution permitted by the plan are the only means of distribution permitted on termination.

Who knows what other things might be read into a plan. Can we anticipate all of them? Hopefully, Justice Scalia's footnote, which is clearly dicta, won't turn into precedent or our plans will grow ever longer and less understandable. Defensive drafting, like defensive medicine, has a cost.

[Editor's note: More information on the Supreme Court's decision in Beck v. PACE International Union may be found in the June 12 edition of BNA's Pension & Benefits Daily.]

Much has been made of the fact that employers are increasingly turning to 401(k) plans rather than defined benefit plans. Employers are implementing a number of strategies to help employees achieve retirement security in this brave new world. Most of these strategies, such as automatic enrollment and automatic increases in participant deferrals, focus on the asset accumulation phase. At the BNA conference earlier this year on Redesigning Pension Plans and Executive Compensation, Henry Eickelberg of General Dynamics talked about an innovative program that a number of large employers negotiated to help their employees buy annuities at reasonable prices.

The employer group isn't offering the annuities in their qualified plans but instead is making them available to employees for both plan rollovers and direct investment. The annuities include both fixed annuities, with and without inflation protection, and variable annuities. The group negotiated low commissions (.5% on the fixed annuity product). The good news is that these annuities are not limited to the employer group but are available to the public so other employers can bring them to the attention of their employees and financial planners can consider them for their clients. You can check them out at on the website for the Elm Income Group.

Years ago, before the Department of Labor issued its guidance on purchasing the safest available annuity for participants in terminating plans, Interpretive Bulletin 95-1, I advised a client that the standard was "Would you purchase an annity for your mother (not your mother-in-law) from this carrier." So I was intrigued years later by an article that Ron Gebhardstbauer wrote for the Women's Institute on a Secure Retirement (WISER) on the advice he gave his mother at age 77. She began receiving the required minimum required distributions at age 70 1/2 and he determined  that she would do better with an annuity than with the annual payouts, with the added advantage that she wouldn't see her annual payouts decrease as she got older. (Ron is the Senior Pension Fellow for the American Academy of Actuaries and the former Chief Actuary for the PBGC, so he can readiy figure these things out, unlike the rest of us.) I recently checked with Ron and his mother is still enjoying her annuity in her mid-80s.

You may be able to find a better deal through your own plan. I compared the payout on a single-life annuity for a male age 70 from Elm for someone who has $100,000 to invest to the same annuity offered by the federal Thrift Savings Plan (TSP), the 401(k) plan for federal employees. The annual payout under the Elm annuity was slightly less ($814 compared with $834 from TSP). Similar results for a female beginning payouts at age 60 ($605 from TSP versus $664 from Elm). However, most employers don't offer annuities to their DC plan participants and, even if they do, they may not have rates as competitive as TSP. The Elm annuities are definitely worth checking out. And kudos to the employer group that made an effort to bargain these good rates for their employees.

I'd be interested in hearing about any other sources for annuities that offer better rates. With the increasing elimination and freezing of defined benefit plans, employees will need to engage in self-help on the payout side of the 401(k) ledger just as they have to do on the investment side.