BNA Pension and Benefits Blog

Thanksgiving Feast or Famine? - DOL Withdraws its Investment-Advice Regulation

The DOL has withdrawn its investment-advice regulation, culminating a process that began with a firestorm of objection regarding the DOL's attempt to implement the PPA's new investment-advice exemptions. The PPA's exemptions were controversial when passed, and became more controversial when the Department interpreted certain fee-leveling requirements in a manner that was perceived to be narrow. Then, in the final regulations, the Department added a new administrative exemption that narrowed the requirements still further, touching off congressional accusations that questioned the regulatory process itself.

The shrillness of some of the rhetoric was, to me (see my prior post on this), unfortunate, as efforts over a long and arduous regulatory process by dedicated public officials became characterized and impugned as special-interest gifts bestowed on the eve of a change in administrations. In an interesting rhetorical twist, which had the intended public-relations consequences, what I would have more neutrally called "inside" advice came to be referred to pejoratively as "conflicted" advice.

With the change in administrations, those upset with the regulations became empowered, and their influence within the DOL increased dramatically, as one might expect. The Department's actions now indicate that there will be some narrowing of the rules, but it remains to be seen whether a reproprosed rule will so narrowly interpret the statutory exemption that it will essentially marginialize it altogether. That could happen if, for example, the level-fee requirements were to be interpreted so as to require structures that are so sanitized that the structures don't involve self-dealing at all, in which case no exemption would be necessary. (I would expect the prior work done regarding the computer-model exemption to be relatively less controversial, and would be surprised if the Department would propose dramatically reversing that aspect of the regulations; we'll have to wait and see.)

To me, what amounts to a regulatory repeal of the statutory exemption would be unfortunate. The PPA struck a legislative balance given the legitimate and crying need that participants have for this advice, on the one hand, and conflicts that may arise, on the other. The Department's new proposals will hopefully not, by fiat, effectively repeal the fee-leveling exemption.

I think it is critically important that a wide range of professional advice be made available to 401(k) participants, who are in desperate need of professional advice. I think that one of the great deficiencies in current retirement policy is that, with the move to a focus on participant-directed defined contribution plans, which is the result of a confluence of events over time, what may be among the most important of investment assets - retirement assets - are left under the management of those (like me) often utterly untrained in how to invest those assets.

The PPA struck a balance that would have facilitated the provision of additional types of advice. Was the balance struck in the statute the precisely correct one? That, of course, is always open to discussion, but Congress did act. There now are proposals in Congress that would recut the rules, in effect eschewing any effort to balance the competing considerations and deciding that no conflict is tolerable, and the approach taken in those proposals is extreme. I think it would be unfortunate if Congress were altogether to take away from employers the ability to arrange for reasonably crafted inside advice delivered with proper safeguards (what I've called "conflict-safe," as opposed to "conflict-free," advice). In any event, though, the Department should credibly implement the rules that have passed, unless and until Congress reverses those rules.

And to what point does that bring us? At a minimum, I would expect the DOL to cut back or reverse the administrative exemption that goes beyond the statute; but we'll have to see how much farther they go in trying to narrow the statutory rules that are already there. At the end of the day, wherever it all lands, I hope that we wind up with a system that permits participants and beneficiaries to have a reasonable shot at accessing a wide range of professional advice to help them through the investment of their retirement nest eggs.

Are Certain Reactions to the Investment-Advice Regulations Ill-Advised?

On January 16, 2009, the Department of Labor announced that it had finalized its work under Sections 408(b)(14) and 408(g) of ERISA, which set forth the PPA's new investment-advice exemptions.  The regulations were scheduled to be published in the Federal Register, and were so published, on January 21.  On January 20, the President's Chief of Staff issued a memorandum, for which there is prior precedent, affecting pending regulations, including regulations like the investment-advice regulations which had not yet gone into effect.  74 Fed. Reg. 4435 (Jan. 26, 2009).  The memorandum raises several possibilities relevant here, including the possibility of an extension of the effective date and a call for additional comments, which, if such steps were to transpire, would seemingly as a practical matter reconvert the regulations into proposals.

The final regulations, incorporating what had been a related proposed class exemption, came after a long, deliberative and consultational process.  On the same day as the DOL's January 16 announcement, Rep. George Miller (D-CA), the chairman of the House Education and Labor Committee, and Rep. Rob Andrews (D-NJ) issued a statement slamming the DOL's action.  Their concluding statement was that, “[a]s we transition to a new administration, we will use every tool at our disposal to block implementation of this harmful regulation.”

For myself, I think that the result is regrettable, and I believe that the regulatory efforts both reflect Congressional intent and provide an important basis for the provision of expert financial advice to participants and beneficiaries that historically may not have had ready access to such advice.  The fever pitch that certain members of Congress seem happy to generate by attacking the advisory community at a time when it may be relatively easy to do is to me unfortunate, to the extent that such a backdrop obscures the issues and makes rational discourse on them difficult or impossible.  I guess I shouldn't be surprised when an issue like this becomes politicized, but I can still be disappointed.  

The great irony here in my view is that the DOL personnel involved with the development of these rules were anything but pro-employer and pro-advisor.  There has arguably been a consistently pro-participant bent generally running throughout EBSA from the senior through the junior levels, notwithstanding that the administration of which the DOL has most recently been a part at the time was stridently Republican.  One need only look at the DOL's reaction to the PPA proposals and to the eventual enactment of the PPA, to the approaches taken in connection with the 5500s and 408(b)(2), etc., in order to get a sense of the DOL's concerns, approach and sensibilities.  Thus, the notion that the "Bush administration" was somehow here "still scrambling to give Wall Street a last-minute payback" on its way out the door seems quite unfair.  Rather, I think we more simply had diligent and committed DOL professionals who wanted to see the careful and balanced work they did in furtherance of implementing a statutory directive come to fruition, rather than evaporate in the wake of the inauguration. 

It is understandably the flavor du jour to vilify Wall Street, and, to be sure, there patently is a difference of opinion out there regarding the pros and cons of the investment-advice exemptions.  However, wherever one comes out on the PPA's new exemptions and the DOL's rulemaking in connection therewith, it seems hard to argue with the basic point that participants in participant-directed plans need high-level help and guidance regarding their management of these most-important investment assets.  I would prefer that the open questions on this critical matter get resolved by a careful examination of the statute and what informed it, not through highly charged, emotional descriptions of what we now have before us and how we got to this point.  But (with apologies for the grammar that's about to follow), that's just me . . .  
 

How Far Does a Pension Plan Have to Go to Persuade Participants to Make the Decisions that Are Right for Them Individually?

Today's (7/30/2008) Pension & Benefits Daily issue reports on the litigation following the sad death of Mr. Allen Anderson, a hard-working man who died of cancer, Anderson v. Board of Trustees of the Northwest Ohio United Food and Commercial Workers Union and Employers' Joint Pension Fund, N.D. Ohio, No. 3:07 CV 576, 7/28/08.

This is not the usual case of a participant's having been denied treatment or coverage by a hard-hearted insurance company. Rather, when Mr. Anderson's medical leave was about to expire and he asked about his options, the administrator of his pension and welfare plans suggested that he return to work briefly, to renew his entitlement to a limited period of free extended health coverage. He did that, and, as a result, was apparently able to continue receiving the medical care his doctors recommended. However, that meant he did not retire, so he did not elect a pension with a 10-year guaranteed payment feature. Since he was unmarried, no death benefits were payable from the pension plan when he died soon after returning to active-employment status, although life insurance benefits were paid through the welfare plan.

The court held that it was a fiduciary breach for the plan representatives to fail to discuss the option of retiring with a generous death benefit with Mr. Anderson, when he asked about his choices. (It was mentioned, but not discussed, because Mr. Anderson said he was determined to go back to work and beat his cancer.)

I can't figure out whether this is an important decision or an anomaly. As I read the facts, it looks as if this participant was treated with great compassion by the plan representatives, his union and his employer, and they turned themselves inside out to try to accommodate his needs. Yet the court says he was treated "with great iniquity"--maybe the iniquity was the cancer, not the treatment by the plan, but it's amazing that the publication services could read the opinion, drenched as it must have been in the judge's tears.

The court concludes that it was imprudent and a breach of fiduciary duty for the TPA to fail to counsel him to retire with the 10-year continuous and certain pension form, because that would have provided death benefits for his family (he lived with his mother). The judge says that it was ridiculous to believe Mr. Anderson’s repeated brave statements about continuing to work and conquering his cancer, since he was clearly terminally ill.

But, based on the facts recited in the opinion, the judge seems to have reached the wrong conclusion as a matter of fact. If Mr. Anderson had retired, his retiree health insurance would have been inadequate to cover his medical costs. The plan, the union and the employer conspired to prolong his active-participant status so he could keep the health coverage he needed. Mr. Allen made the RIGHT decision, based on their advice, and the court calls it a breach of fiduciary duty.

What am I missing? Would the court have understood it better if the case hadn’t gone on summary judgment? (From the opinion, it does not appear that the court was presented with a dollar comparison of the value of the health insurance to Mr. Anderson personally versus the value of the death benefit to his mother and brother.) Is this case a dramatic extension of the “duty to inform” line of opinions, or just the melodramatic conclusion to a sad end-of-life story?

Another Piece of the Extended Puzzle - Proposed DOL Regulations Reach to General Prudence Rules

Issues relating to fees to service providers have become high-profile issues, with a proliferation of indirect-fee class actions and the inevitable follow-on press reports. These issues have given rise to a four-piece puzzle, with activity regarding (i) regulations under ERISA Section 408(b)(2), (ii) the rules governing Form 5500, Schedule C, (iii) the "404(c)" rules for covered plans with participant-directed investments, and (iv) a number of legislative proposals in Congress.

The issue is clearly front-burner for the DOL, which is trying to proceed with a coordinated new regime that would have a real impact on the quantity and quality of information available to participants. There has already been movement in the first two arenas, with proposed 408(b)(2) regulations and new rules for Form 5500, Schedule C, both of which have been controversial. Congress has proceeded, too, with the proposed Miller bill. The only theater that had remained dark was the one relating to the 404(c) rules.

Section 404(c) is the section that gives plan fiduciaries the opportunity to limit their liability in the case of plans which provide for participant-directed investments and which satisfy the regulatory Section 404(c) requirements. Thus, the DOL had broad discretion to impose such informational requirements as it saw fit under Section 404(c). Showing how much attention it is giving to the question of participant information, though, the DOL took this opportunity to expand the expected scope of its rulemaking and issue rules proposed to apply under ERISA's general prudence rules, whether or not the protection of Section 404(c) is sought. The general prudence rules, like the 404(c) rules, give the DOL a fairly free regulatory hand, as there is no clear limitation on the abilty to add regulatory color on what it means to be proceeding in accordance with general prudence-type considerations.  Thus, the new proposals would generally apply to all plans under which participants have the right to direct investments, even if the plan sponsor is willing to forego Section 404(c) relief. It is clear that that the DOL is making a concerted effort to establish a set of rules that will significantly change the nature of the information that is broadly available to participants in plans where they direct their own investments.

It remains to be seen whether the market will view the balance that has so far been struck by the DOL as being the right one. I expect the comment process regarding this particular piece of the puzzle to be extremely active in terms of submissions on all sides of the market, including participant-advocacy groups, employers, financial services organizations and administrators. One thing seems certain - the old rules, with a much more generic approach to the provision of information, seem eventually to be a thing of the past.

Now the DOL is FAQuing It - Having Fun with "Funds" on the Form 5500

Issues relating to fees to service providers have become high-profile issues, with a proliferation of indirect-fee class actions and the inevitable follow-on press reports.  These issues have generated activity in four theaters: (i) the regulations under ERISA Section 408(b)(2), (ii) the rules governing Form 5500, Schedule C, (iii) the "404(c)" rules for covered plans with participant-directed investments, and (iv) a number of legislative proposals in Congress.  The DOL has moved forward in the first of these two arenas with proposed 408(b)(2) regulations and new rules for Form 5500, Schedule C, which have turned out to be flashpoints in the market for a firestorm of controversy affecting financial services organizations and plan sponsors alike.  Much (but not all) of the controversy has centered around the DOL's attempt to expand certain rules to a variety of types of indirect compensation and, apparently, in some cases, compensation for supposed indirect services, particularly in the context of fees surrounding "investment funds."

On July 14, the DOL issued FAQs intended to help with the administration and implementation of the new 5500 rules.  To its credit, using the efficient FAQ mechanic, the DOL is reacting quickly to a real need in the marketplace for guidance as to how these rules will work.  Putting aside the question as to whether everyone will agree with everything the DOL has done in the FAQs, it was critical that the DOL start to get on the record as to a range of seminal interpretive questions.  (And, thankfully, the FAQs were released almost a full week before the release of the The Dark Knight, so that I could read them without being distracted by what I'm anxiously hoping will be One of the Greatest Movies Ever Made.)

I'm writing here to take note of an arguably arcane but ultimately critical and interesting feature of the FAQs, relating to the nature of what is an "investment fund" for purposes of the new 5500 rules.  It did not go unnoticed by some that the new rules seemed to latch onto the concept of "investment funds" as a major underpinning of when the new indirect-type rules apply; however, the concept appeared to spring suddenly from within the authority, and didn't have a firm express basis is that which had come before.  (Yeah, it's a "lawyer point," I guess, in a group of FAQs with more direct practical implications, but, then again, I'm a lawyer.)  The issue was made more vexing by the fact that the new rules did not tap into the existing regime for look-throughs to investing plans, the so-called "plan asset" regulations (as modified by ERISA as recently amended), but rather went down this new, undefined "investment fund" road.

Thus, the scope of the "investment fund" concept, and by extension the very scope of a substantial portion of the new rules, became subject to something of a cloud right from the get-go.  For example, what is an "investment fund" anyway?  How do hybrid entities, like REOCs (real estate operating companies) and VCOCs (venture capital operating companies) under the "plan asset" regulations fit in?  How does the general "operating company" concept overlay on top of the fund analysis?  These questions, and the lack of any answers (or even discussion) regarding them, resulted in a significant analytical detour right out of the interpretive gate.

Well, Q&A 7 of the new FAQs is packed with a lot of information and goes a long way towards shedding light on how the DOL views these matters.  There is the description by example of what "investment fund" means, where the DOL says in a parenthetical: "e.g., mutual funds, collective investment funds."  (It may not seem like much, but it was more than we had.)  There is the posing of the basic question of whether compensation received in connection with the management of VCOCs, REOCs and other operating companies needs to be reported, and there is the DOL's pithy and straightforward (and, to me, clearly correct and appropriate) answer, "No."  There is the clarification that, notwithstanding the foregoing, fees or commissions received by a manager or adviser in connection with an investment in an operating company could be reportable.  And, underscoring the extent to which the DOL really seems to have created a whole new quasi-"plan asset" framework in the context of the reporting rules, the DOL states: "This answer would not be affected by whether the VCOC, REOC, or other operating company were wholly owned by a plan such that [under the "plan asset" regulations] the assets of the entity would be deemed to be plan assets."

This last nuance indicates that the formalistic approach under the bedrock "plan asset" rules falls, in the reporting context, to what may be a more intuitive analysis.  As a result, essentially all that matters here is whether there is an operating company present effectively to block the look-through, not whether the entity's assets technically are "plan assets." (The need to apply the technical rules to determine whether an entity is a VCOC or REOC (or other operating company) is still present.)  It remains to be seen whether this new conceptual approach will eventually be given application for other ERISA purposes.

The foregoing is just one small aspect of an important set of FAQs, and shows, even standing alone, how interesting the development of the reaction to the fees issue has been and probably will continue to be.  In this regard, note also that, in Q&A 40, the DOL states: "In an effort to address the concerns of both service providers and plans, the Department has decided that, with respect to those employee benefit plans which are dependent on service providers for information necessary to complete the Schedule C, the plan administrator will not be required for 2009 plan year reports to list a service provider on line 4 of the Schedule C [which basically calls for the listing of uncooperative service providers] as failing to provide information necessary to complete the Schedule C if the plan administrator receives from the service provider a statement that (i) the service provider made a good faith effort to make any necessary recordkeeping and information system changes in a timely fashion, and (ii) despite such efforts, the service provider was unable to complete the changes for the 2009 plan year."  Bravo - this relief (which presumably will spawn quite a lot of "statements") is extremely welcome in light of the fact that, as shown above, on even the most basic gateway issues there is a great deal of new concepts, analyses and information to digest.   

Some Additional Reflections on MetLife

Way back in 1989, in the Bruch v. Firestone decision, the Supreme Court told us that a plan decision-maker’s rejection of a benefit application would be subject to de novo judicial review . . . unless the plan included magic words vesting the decision-maker with DISCRETION.  If the decision-maker has discretion, the trial court’s review of the decision must be deferential, only to be reversed if “an abuse of discretion,” “unreasonable” or “arbitrary and capricious.” 

Within 30 minutes of the decision, every lawyer worth his salt or at least seeing an opportunity to generate some fees, wrote a letter to every client with an employee benefit plan saying, in effect, pay me some money to review your plan to make sure it gives you discretionary authority and, if it does not, pay me a little more money to amend your plan to give you discretionary authority.  Any plan today whose benefit rejections are subject to de novo judicial review (for lack of the magic words) probably has a potential malpractice action against its attorney.  In the real world we live in, the default principle of de novo review of Firestone is a dead letter.

But the Supreme Court said something else in Firestone:  a court, when it is reviewing a benefit rejection by a decision-maker armed with discretionary review, should consider, as a factor, any conflict of interest of the decision-maker.  One clause in one sentence is all we got explaining this.  We didn’t know, for example, how to tell whether a decision-maker had a Firestone conflict, and we didn’t know what a reviewing court was to make of such a conflict?  Does it mean de novo review?  Does it mean a little bit less deference?  Or something else entirely? 

Well now, 19 years later, the Supreme Court has decided to give us an answer to these questions.  It was not worth the wait.

Look first at the majority opinion.  Here is the two sentence version of the majority opinion: in deciding whether a conflicted plan decision-maker’s rejection of a benefit claim is an abuse of discretion, a district judge should consider and weigh all factors, of which a conflict is one factor.  The conflict is not too important, though, if the plan has structural safeguards against decision-maker bias, such as erecting a wall between the “claims administrators and those interested in firm finances.”

Here are three problems with the majority opinion.

1.    There are now two levels of discretionary review: first, the plan claims administrator has discretion in deciding whether the plan should pay benefits, and second, the district court has discretion in deciding whether the plan claims administrator’s decision was an abuse of discretion.  (When a district court is given authority to “balance” all relevant factors, an appellate court will generally not reverse the district court’s decision unless the district court abused its discretion.) 

The cynic in me says that this means that most cases will turn on whether a district court judge is philosophically oriented toward business autonomy or consumer protection.  Of course, the cynic in me also says that this will not be a very serious break from the past.  What may be a break from the past, though, is that an appellate court will have a bit more trouble reversing a decision it does not like.  (Frank Cummings makes these points in a comment he wrote in response to Andrew Oringer’s discussion of MetLife.)

2.  The issue that no one discusses about Firestone is the standard against which a claims administrator’s discretion is tested.  (And this should be a key issue whether or not there is a conflict.)  What does it mean to abuse discretion?  Courts talk endlessly around this issue but never focus on exactly on how discretion is evaluated.  Oh sure, we know some things.  You can’t treat some participants radically differently from other participants: that would be arbitrary.  You can't ignore undisputed evidence.  That would be wrong. But these are examples of arbitrary decisions.  They do not define the boundaries of the discretion that a plan administrator may not abuse. 

So when we say that an administrator has discretion, what do we mean?  Here are a few possible suggestions:

1)  When a plan vests an administrator with discretion, it means that the administrator will resolve all interpretative and evidentiary questions against the claimant.  (And if this is what it means, should plans make some sort of disclosure to participants so that they understand this?)  Here, the standard against which decisions are evaluated is “defensible even if not correct result.”

2)  When a plan vests an administrator with discretion, it means that the administrator will strive to reach a correct legal judgment.  Note that the reason for judicial discretion here is not to save money by reducing benefits, but to minimize litigation costs, since the plan’s expenses in litigating a benefit denial would arguably be lower than under de novo judicial review.  Here, the standard against which decisions are evaluated would be “the process was fair and the administrator was neutral and fair.”

3)  When a plan vests an administrator with discretion, it means that the administrator will apply his special understanding of the employer and its employees in resolving benefit claims.  Here the standard against which decisions would be evaluated would be “legally correct unless the special circumstances of the employer and employee make a different approach defensible.”

4)  When a plan vests an administrator with discretion, it means that the administrator knows the price point at which the employer will terminate or cutback the plan and will consider this point in deciding close benefit questions. I’m not even going to attempt to construct the standard against which decisions would be evaluated under this understanding of discretion.

5)  When a plan vests an administrator with discretion, it means that the administrator will endeavor to make benefit decisions that conform to employee understanding of the plan.  Here the standard against which decisions would be evaluated would be “reasonably in accord with the reasonable expectations of plan participants.” 

The majority opinion probably best accords to 2), but most plan sponsors, at least at some level, probably would endorse 1), and 1) certainly comes closest to explaining judicial decision-making, at least in the pre-MetLife world.  But all of these standards are consistent with the idea of a plan administrator exercising discretion, even though they would sometimes produce markedly different outcomes. 

3.  The majority opinion does not fully resolve the question of when a plan administrator has a conflict, but certainly hints that conflicts are the rule, not the exception.  (Justice Robert’s dissent emphasizes this point.)  The question, though, is whether there are always conflicts. 

Let me posit two the two classic situations where at least some people would have argued, pre-MetLife, that the claims administrator did not face a conflict:  First, an overfunded defined benefit plan.  The approval of a claim will not come directly out of the employer’s pocket, but the employer will be affected by the approval, either in the form of increased future contributions or a reduced potential reversion.  But does this a conflict make?  (Maybe the one situation where there would be no conflict is where a defined benefit plan is overfunded and provides that all surplus assets will be allocated to plan participants.)  Second, an employer who contracts with a third party claims decision-maker who decides but does not pay claims.  Since the employer will choose the firm, and the employer may want to choose a firm that will reduce its costs, the firm may have a financial interest in rejecting close claims. 

(The majority opinion sort of endorses, or almost endorses, a similar argument about employers selecting insurance companies, since the premiums they charge will partly reflect their claim review policies.  It says “For one thing, the employer’s own conflict may extend to its selection of an insurance company to administer its plan.  An employer choosing an administrator in effect buys insurance for others and consequently (when compared to the marketplace customer who buys for himself) may be more interested n an insurance company with low rates than in one with accurate claims processing.”) 

So, will almost every case pose a conflict, as Justice Roberts suggests in his dissent?  And will this mean elevated review in all situations?  The majority opinion is a bit circular here.  The conflict will not count much if the one who makes decisions is walled off from the folks concerned about his or her employer’s bottom line.  But if the decision maker is sufficiently walled off so as not to care about the employer’s profitability, why is there a conflict at all?  If we say, well, there is still some potential for conflict because you cannot really wall off any employee from concerns about the employer’s bottom line, how can we say with any real confidence that the conflict is really only a small one, as the majority seems to want us to say?

What about the dissents.  We can ignore Kennedy’s dissent, which says I agree with the majority decision but think we should give MetLife a chance to show that its conflict was insignificant. 

Justice Robert’s decision is the opposite:  I agree with the majority that MetLife was really, really wrong when it rejected Glenn’s claim, but I disagree with virtually everything else that the majority opinion says, especially that a district court, in exercising review over a claims denial, must take into account every conflict, no matter how infinitesimal.  Justice Roberts would have preferred a standard that said, in effect, a conflict only matters if it affected the claims process; conflicts don’t matter, in this formulation, unless the plaintiff can demonstrate that the claims administrator in fact yielded to the conflict.  My guess is that under the Roberts’ formulation, plaintiffs would hardly ever be able to persuade a court to consider a conflict, unless of course there is a whole lot of discovery and quite possibly an involved trial, because credibility of witnesses would sometimes if not often be central to the determination of whether a conflict infected the decision-making. 

The difference between Roberts and the majority, then, appears to be on who will bear the burden of proving the importance, or non-importance, of the conflict.  Under the majority, the plan must prove that the conflict probably did not affect the decision, while under Roberts, the participant would have to prove that the conflict probably did affect the decision. 

The separate dissent of Justice Scalia and Thomas found even Justice Roberts’ dissent unconscionably unfair to the employer.  A conflict, in their view, should be irrelevant: all that should matter is whether the decision is reasonable.  There are other plausible ways of thinking about the Scalia/Thomas dissent, but exploring them would be a waste of whatever bandwidth would be required. 

Distinguishing among Employees Based on Pension Status

[Note to all: what follows are purely personal opinions, in no way attributable to employer or clients.]

The US Supreme Court's decision in Metropolitan Life Ins. Co. v. Glenn (6/19/2008) is commanding a lot of attention from ERISA practitioners.  I suspect that is because the decision is expected to shift the odds in contests over disability claims, which provide a lot of grist for ERISA litigation and now are likely to yield richer settlements. For those of us who focus on retirement plan design and benefit policy, Kentucky Retirement Systems v. EEOC, also handed down on 6/19/2008, is the more interesting decision. The headline: it is legal for employers to discriminate against employees based on their eligibility for a pension.   

In Hazen Paper Co. v. Biggins (1993), the Court held that an employer did not violate the Age Discrimination in Employment Act (ADEA) by terminating an employee shortly before he would have had 10 years of service and therefore vested in his pension.  There the Court held that pension status was not presumptively a “proxy for age”.  Since vesting was not explicitly age-related, a termination based on Mr. Biggins’s pension status was not actionable unless he could show that his age – not his closeness to vesting – was the “actual motivating factor.”

To summarize and oversimplify, in Kentucky Retirement Systems the Court held that it was legal to provide lower benefits to police and firefighters who retire on disability at or near retirement age than to those who would have had to wait longer to qualify for regular retirement.  Relying on Hazen Paper but moving well past it, the Court held that pension status is not a proxy for age here even though, in the Kentucky case, age is an explicit element of pension eligibility. 

At issue was a rule that gave credit to public safety officers retiring on disability pensions for the number of extra years of service they would need to qualify for full retirement. As a result, a younger disabled police officer or firefighter could get more pension credit than an older one who was closer to retirement age and therefore didn't need as much of an eligibility boost.  Since the motivation was to give all police and firefighters decent pensions even if they became disabled early in their careers, rather than to treat older public safety officers worse than younger ones, Justice Breyer and his colleagues in the 5-man majority concluded that this pension-based discrimination was as benign as the one alleged in Hazen Paper.

Doesn’t this turn employment discrimination doctrine on its head?  What happened to the principle that an employer has a mighty burden to prove that its differential treatment of employees was justified, when it draws a line between categories of employees that appears to be based expressly on age?  Compare, for example, Meacham v. Knolls Atomic Power Laboratory, which the Court also handed down on June 19, 2008 and which confirms that employers have that burden even in disparate-impact cases under ADEA.

Cutting through the discussion and legal analysis in the Kentucky case – as perhaps only a non-litigator might dare to do – the answer seems to be that the Supreme Court is uncomfortable with imposing unanticipated costs on pension plans, even if that means living with a little questionable discrimination.  The Court describes six circumstances that demonstrate the conclusion that the pension design was not “actually motivated” by an intent to discriminate against older employees, but five of them basically boil down to the fact that, hey, it’s a pension plan. 

I suspect another powerful concern was the one the Court gives for granting certiorari: “the potentially serious impact of the Circuit’s decision upon pension benefits provided under plans in effect in many states” along with the point made in Kentucky’s brief and highlighted in the opinion: the “large increase in pension liabilities, potential reduction in benefits for all disabled persons, or both…” The Court was more direct in voicing this concern in Manhart and Norris, where it found that Title VII of the Civil Rights Act outlaws gender-based discrimination but made its ruling prospective only, leaving Ms. Manhart and Ms. Norris without relief.  In tone it also calls to mind the raft of lower court decisions rejecting ADEA-based challenges to cash balance conversions, not to mention the Third Circuit’s ultimate Erie County decision.

What does Kentucky Retirement System mean for pension design?  Well, it says that employers can take pension eligibility into account in drawing lines.  For example, it may give comfort to employers considering phased-retirement type programs under which they would offer a little less in the way of current benefits to employees who are continuing to work while drawing part or all of their pension, or offering active employees a choice between receiving a current pension and continuing to accrue additional benefits.  Certainly whatever extra leeway this gives employers will have to be exercised reasonably and without discriminatory intent, including the intent to propel older workers into retirement.

It is refreshing to see Washington institutions opening opportunities for creative benefit plan design, for a change.

Common Errors in Qualified Plans: It's Time for Spring Cleaning!

I have come to realize that "As time marches on" -- so do the errors in our client's retirement plans. So, with "spring cleaning" in the air, I decided to clean out the garage of plan errors and list, in no particular order, some of the errors that have occurred over the past year. The type of error might not be new -- but the resulting consequences clearly explain the often used phrase -- "No Good Deed Goes Unpunished."

I encourage you to do your own self-cleaning and feel free to add to my list. Here are 5 of my favorites for the year. As I continue to clean I will post more and I encourage you to do the same:

1.  A. Error: Distributions of large single-sum amounts to retirees that were never eligible to participate (and therefore never accrued a benefit) under the defined benefit plan.

B. Correction: Rather than try to amend the plan retroactively to include the affected group (that was valued at 25 million), we opted to take the IRS approved approach – ask for the money back. Well, 20 claims later and potential lawsuits pending we find ourselves looking at the TPA who, on its own accord, made the distributions in error.

2.  A. Error: Failure to make payments on individual plan loans.

B. Correction: Following the IRS guidance, repayment was requested in the manner outlined in EPCRS. I am always amazed to find that no matter how long the "loan payment holiday" was – in this case – up to 3 years, affected participants are still surprised that they owe the money on the original loan. In the future the client is giving serious consideration to putting on the loan document "THIS IS NOT A GIFT."

3.  A. Error: Improper vesting applied – some people were credited with too much vesting service – others had too little credited.

B. Correction: Adjust years of service according to the actual years of employment with 1000 hours or more. Sounds easy – try it some time – I dare you. With new payroll software and the ability to do manual overrides; adjusted service dates; adjusted DOH; adjusted DOT; customized coding; etc. – it's next to impossible to replicate employee's exact tenure at a large company. In my practice – the more sophisticated the payroll process, the harder it is to recreate the past.

We have opted to use assumptions (our way of applying rough justice) and have the issue pending with the IRS for approval in the VCP.

4.  A. Error: Improper deferral based on wrong definition of compensation was used.

B. Correction: Adjust prior deferrals based on the correct use of compensation. Again – not rocket science. In fact, this error is noted by IRS as the most recurring in their VCP program. The issue that I have found to be the most difficult is when a large client has so many pay codes and the language in the plan document (defining pensionable earnings) is so vague – that nobody really knows what type of compensation is eligible and what is not. Frankly, this begs the question – how does the employer know that the wrong definition of compensation was used in the first place? When I presented that to the employer – the response I got was – "You know it when you see it!" It's time – once again – for the litigators.

5.  A. Error: Improper application of the benefits formula under a defined benefit plan. Resulted in participants receiving excess benefits.

B. Correction: We decided to cure the error in 2 stages. First we asked for the excess to be returned. If it is returned we decided to gross-up the employee outside of the plan from corporate assets. If it is not returned we contributed the excess amount into the plan's trust. Second, we discovered that the error occurred based on the actuarial firm's independent interpretation of the benefit formula. It was shocking to the client that the actuary, on his own, decided to interpret the formula in such a manner that was inconsistent with the plain meaning of the written plan document. Needless to say, the actuarial firm paid for the correction, including the filing fee and attorneys' fees. It's good to have a signed, updated vendor agreement.