Every summer my family and I vacation at a beach notorious for periodically producing huge "back-breaker" waves that if I do not duck under at the right time, can send me tumbling against the rocky sand. Having suffered injury and embarrassment for not keeping ahead of the waves my children seem to be so skilled at avoiding, I have put some procedures in place to ensure that I duck under before these waves crash over me. First and foremost I never turn my back to the ocean, even if there have been no significant waves in the last hour.
I can draw some parallels to managing the responsibilities and risks associated with maintaining a retirement plan. In the current environment, plan governance ought to be a focus of retirement plan sponsors to enable them to prepare for targeted agency audits and to minimize the risk of litigation. Plan governance refers to the structure and processes for overseeing, managing, and administering a retirement plan to ensure that fiduciary and other obligations of the plan are met. An effective governance system can help plan sponsors satisfy their obligations to plan participants, run their plans efficiently, and control legal and other risks facing plan fiduciaries.
Elaine Chao, Secretary of the U.S. Department of Labor (DOL), cautioned plan sponsors several years ago about the need to focus attention at the executive level on the operation and administration of retirement plans stating:
It is more important than ever for CEOs to be aware of and pay attention to pension plan governance. The time has come to move the focus of pension plan governance out of the human resources department and beyond compliance with tax laws. The executive level suite needs to focus on pension plan governance itself, especially the responsibility and liability of pension plan fiduciaries.1
The DOL, or its agency, the Employee Benefits Security Administration (EBSA), is responsible for the administration and enforcement of Title I of the Employee Retirement Income Security Act of 1974 (ERISA). ERISA governs employer sponsored employee benefit plans, most notably legacy defined benefit plans and defined contribution plans, like 401(k) plans. It also covers certain health and welfare plans. Central to EBSA's mission is "deterring and correcting violations of ERISA through strong administrative civil and criminal enforcement efforts to ensure workers receive promised benefits."2 The Internal Revenue Service (IRS) enforces the complex tax laws under Title II of ERISA that plans qualified under Section 401(a) of the Internal Revenue Code of 1986, as amended (the Code) must satisfy. Maintaining a plan's qualified status ensures the taxable employer that it will be entitled to a deduction for contributions to the plan. Preserving the qualified status of a plan maintained by either a taxable or a tax exempt employer preserves the tax exempt status of the attendant trust that holds plan assets, making distributions eligible for preferential tax treatment, like rollover to another tax exempt vehicle, e.g ., an Individual Retirement Account.
If problems arise under a plan governed by ERISA, plan fiduciaries are the ones who are held responsible. Most plan documents designate the "Named Fiduciary" responsible for the oversight of the plan.3 But determining who is a fiduciary is a functional test, and those individuals who exercise authority with respect to the plan are fiduciaries for ERISA purposes too. In addition, although responsibility for certain functions can be delegated from the board of directors to the Named Fiduciary, the board can be held responsible for the delegation and for the continuing oversight of the delegated activities. Further, although plan fiduciaries can seek to insulate themselves from liability for participant directed investments under Section 404(c) of ERISA,4 (of increasing significance in light of the trend towards individual account plans where participants have the ability to direct the investment of their accounts, like a 401(k) plan, and away from defined benefit plans that provide a guaranteed plan benefit), securing and maintaining this protection requires consistent attention to DOL regulations, including timely and appropriate disclosure to plan participants.
Increased focus on the operation and administration of plans by the DOL and the IRS in recent years, to a significant degree, was brought about by the Enron litigation.5 Enron's 401(k) retirement plan consisted of large portions of Enron stock. Company executives, aware of an impending financial disaster sold off their Enron stock but participant accounts were locked down at a critical time. Enron employees filed class action suits against the company, claiming that the company and its directors breached their fiduciary duties under ERISA by knowingly issuing false and misleading public statements about the company's financial condition, which induced employees to invest and maintain their plan assets in company stock at artificially high prices.6
The Enron debacle and accounting scandals paved the way for the enactment of Sarbanes-Oxley Act of 2002 (Sox). In Sox, Congress addressed the abuses that occurred at Enron and in the accounting industry, resulting in sweeping changes to the financial reporting and disclosure requirements of public corporations. SOX also established controls around "blackout periods" for retirement plans, and increased the individual and corporate penalties for criminal violations of ERISA.7 The message sent by Congress in Sox requiring transparency in financial reporting and increased accountability by decision makers for public companies has had a ripple effect on all retirement plans. The regulators have been leading the charge regarding enforcement, and the plaintiff's bar has taken note.
For example, IRS audits have focused on qualified plan administration. Documenting plan procedures can demonstrate to the IRS upon audit that the day to day administration is consistent with the written plan, a fundamental requirement under the Code. In addition, participation in a voluntary correction program under the IRS Employee Plans Compliance Resolution Program requires the plan sponsor to have plan procedures in place.8 The ability to voluntarily correct a plan error can protect against costly fines and penalties if the error is not corrected and the IRS discovers the error upon audit of the plan.
In addition, the DOL has stepped up its enforcement activities in recent years. DOL audits are targeting the timeliness of the transmission of employee contributions to 401(k) plans, and the allocation of fees and expenses to employee benefit plans subject to ERISA. The DOL reports on its website that as of September 30, 2005, it recovered $380 million for participants in 401(k) plans, and obtained 159 criminal indictments against those responsible for plan administration. For the second quarter of fiscal year 2007 (through March 31, 2007), the DOL closed 487 civil investigations, 416 with corrected violations and has recovered $27,438,311 on behalf of employee benefit plans.9
A number of class action lawsuits against large companies challenging the appropriateness of fees paid to investment advisors were filed last fall and are still making their way through the courts.10
In early June the United States Supreme Court agreed to review a case, LaRue v. DeWolff, Boberg & Associates, Inc., 450 F. 3d 570 (4th Cir. 2006), cert. granted, 551 U.S. ___ (2007), involving a claim that the plan administrator breached its fiduciary duty under ERISA. The question before the Supreme Court is whether a participant can bring suit in his own capacity and not on behalf of the plan as a whole and what remedy ERISA provides to an individual 401(k) plan participant who suffered a $150,000 loss to his account due to a fiduciary breach. If the participant prevails in LaRue, increased litigation by individual plan participants could follow, making it wise for plan sponsors to have the ability, when necessary, to demonstrate compliance with the myriad of rules that govern plans subject to ERISA.
Plan governance today means active and not passive governance. Enforcement by the agencies responsible for oversight, an active plaintiff's bar, a recent study by the Government Accountability Office11 and a Congressional hearing regarding plan fees12 indicate that plan fiduciaries should take steps to ensure the following:
The plan document designating the named fiduciaries is consistent with the board manual
The plan document is consistent with plan operation and is submitted in a timely manner to the IRS for a determination of the plan's qualified status
Plan documents, including the summary plan description forms and the administrative manual are consistent
The investment policy statement that sets forth how plan assets are invested is periodically reviewed and approved by the plan fiduciaries
The process for monitoring investment performance is tailored to the kind of investments the plan is authorized to make
Criteria used to select plan fiduciaries for oversight of plan investments is documented
Fiduciaries charged with overseeing plan investments have sufficient knowledge to monitor the investment returns, or they should hire a consultant to help them interpret results
Key decisions of the plan fiduciaries are documented
Procedures to ensure that the requirements for protection under Section 404(c) of ERISA are satisfied and that written and electronic participant disclosure is updated in "real time"
A process exists for selecting service providers and monitoring their fees
Establishing a strong system of plan governance should help protect against:
Agency audits that can result in fines or penalties and/or suit by the DOL to enforce ERISA, including through criminal sanctions
Negative impact on employee trust and morale if plans are not properly administered
Participant suits to enforce the fiduciary duty provisions under ERISA and the costs to defend or settle claims
Increased costs to obtain fiduciary insurance coverage, or inadequate coverage if the costs of insurance become prohibitive due to repeated litigation
A qualified audit by the plan's independent auditor
Negative publicity affecting the company generally
The goal in putting a system of plan governance in place is not to get bogged down in the wave of current litigation or agency enforcement initiatives that could be expensive to resolve and ultimately have a negative impact on your company's productivity and its bottom line. It's all really just about having an awareness of the current environment, implementing and following some common sense policies and procedures and not turning your back on a huge oncoming wave.
1 Elaine Chao, U.S. Secretary of Labor, Department of Labor, Get It Right: Responsibilities of an ERISA Fiduciary, Address at the Yale School of Management (May 28, 2004).
2 U.S. Dept. of Labor Employee Benefits Security Administration Mission Statement, www.dol.gov/ebsa/aboutebsa/org_chart.html#mission.
3 ERISA Section 402(a)(2), 29 USC 1102(a)(2).
4 29 USC 1104(c).
5 Fred Reish & Bruce Ashton , Lessons from the Enron Litigation, (July 2005), www.reish.com/publications/article_detail.cfm?ARTICLEID=538.
6 Mark Jickling , The Enron Collapse: An Overview of Financial Issues, Cong. Research Serv., RS21135 (2002), http://fpc.state.gov/documents/organization/9267.pdf.
7 29 U.S.C 1131; United States Sentencing Commission, Increased Penalties under the Sarbanes-Oxley Act of 2002, (Jan. 2003), http://www.ussc.gov/r_congress/S-Oreport.pdf.
8 Revenue Procedure 2006-27, I.R.B. 2006-22.
10 See, e.g., Beary v. Nationwide Life Ins. Co., No. 2:06-cv-00967-EAS-MRA (S.D. Ohio Nov. 15, 2006); Beary v. ING Life Ins. & Annuity Co., No. 3:07-cv-00035-MRK (D. Conn. Jan. 8, 2007); Beesley et al v. International Paper et al , No. 3:06-cv00703-DRH-CJP (E.D. Illinois Sept. 11, 2006).
12 Are Hidden 401(k) Fees Undermining Retirement Security: Hearing Before the H. Comm. on Education and Labor, 110th Cong. (2007).
Denise Trujillo is a Partner in McKenna Long & Aldridge LLP's Employee Benefits and Executive Compensation Group. Prior to joining the firm, Ms. Trujillo was an in-house counsel for many years and also worked in the Employee Plans Division at the Internal Revenue Service. She gratefully acknowledges the assistance of Daniel Higginbotham, a summer associate, in the preparation of this article.