In a decision released on June 29, the Delaware Chancery Court (a trial court) in Seinfeld v. Slager (no, not that Seinfeld) allowed an allegation of corporate waste to survive a motion to dismiss. The allegation: that directors wasted corporate assets by granting themselves restricted stock units in an excessive amount. The case is significant in part because the court is widely regarded as a leading court on corporate governance issues.
This case is interesting because, most often, compensation of non-employee directors is protected under the “business judgment rule” that basically prevents courts from second-guessing the decisions of a board of directors. However, the business judgment rule is generally not available for transactions where directors have a financial interest that could reasonably compromise their independent judgment. In asserting the protection of the business judgment rule, the directors argued that the stock plan under which the awards were granted was stockholder approved and provided a maximum number of 1,250,000 shares that could be subject to an award to any eligible recipient in a year.
This stockholder approval, the defendant directors argued, cleansed their self-interestedness because they were merely implementing the terms of a stockholder-approved plan. In essence, the directors argued that any grants below the stockholder-approved cap were not self-interested because the directors were acting within parameters approved by stockholders. However, the court said, “Though stockholders approved this plan, there must be some meaningful limit imposed by the stockholders on the Board for the plan to be consecrated by [prior case law] and receive the blessing of the business judgment rule [as a result of stockholder approval].” (emphasis in original). With a stock value of $24.79 per share, the maximum meant that each director could receive tens of millions of dollars of compensation and the court did not find that limit to be meaningful enough to survive a motion to dismiss.
Depending on how this litigation progresses through the trial and appellate levels, companies may want to consider including hard-wired grants or maximum share limits, or reevaluating any limits they already have, going forward. If a maximum number of shares or maximum dollar value that non-employee directors can receive in a given year is in the plan, it should be sufficiently tailored so as not to create the ability to grant excessive director compensation. Additionally, if a plan has a maximum number of shares, that number may need to be revisited (and reduced) as the company’s stock price increases.
Every 409A attorney knows the look. It’s a look that is dripping with the 409A attorney’s constant companion – incredulity. “Surely,” the client says, “IRS doesn’t care about [insert one of the myriad 409A issues that the IRS actually, for some esoteric reason, cares about].” In many ways, the job of the 409A attorney is that of knowing confidant – “I know! Isn’t it crazy! I can’t fathom why the IRS cares. But they do.”
There are a lot of misconceptions out there about how this section of the tax code works and to whom it applies. While we cannot possibly address every misconception, below is a list of the more common ones we encounter.
I thought 409A only applied to public companies. While wrong, this one is probably the most difficult because it has a kernel of truth. All of the 409A rules apply to all companies, except one. 409A does require a 6-month delay for severance paid to public company executives. However, aside from this one rule, all of 409A’s other rules apply to every company.
But it doesn’t apply to partnerships or LLCs. Wrong, although again a kernel of truth. Every company, regardless of form, is subject to 409A. However, the IRS hasn’t yet released promised guidance regarding partnerships or LLCs, most of the 409A rules (like the option rules) apply by analogy.
But I can still change how something is paid on a change of control. Maybe, but maybe not. If a payment is subject to 409A, there are severe restrictions on how it can be modified, even on a change of control. Even payments not subject to 409A by themselves can, inadvertently, be made subject to 409A if the payment terms are modified. There is some latitude to terminate and liquidate plans in connection with a change in control, but – word to the wise – these termination payments are very tricky to implement and require a pretty comprehensive review of all plans in place following the change in control.
409A only affects executives. Nope. Any time “deferred compensation” is implicated, 409A applies, even to rank and file. In fact, 409A can have adverse effects for a mind boggling array of employees, including innocuous arrangements like school-year teacher reimbursement programs!
And the definition of deferred compensation is broad, including such items as severance agreements or plans or even bonuses, if paid beyond the short-term deferral period. As a practical matter, many rank and file severance and bonus plans qualify for exemptions that make them not subject to 409A’s restrictions on time and form of payment, but it’s still worth reviewing them to make sure.
Okay then, it only applies to employees, right? Wrong again. Directors and other independent contractors are subject to 409A’s grip. There are some exemptions, but, again, they are difficult to implement.
What’s the company’s tax burden if we screw up? This question itself is not a misconception, but the unstated assumption – that it’s the company’s liability – is. The penalties fall entirely on the employee, director, or contractor.
But put yourself in the shoes of an executive who, unexpectedly, gets hit with a 409A penalty. The executive may argue that the employer designed the plan and the employer administered the plan. The executive’s role was to work, possibly even contribute his or her own money to the plan, and reap the benefit down the road. The IRS rules say that something got messed up and the executive owes substantial additional taxes – perhaps even before payment is made from the plan – through no fault of the executive.
What’s the first thing the executive does? Turn to the employer and loudly proclaim, “Make me whole.”
In addition, employers can also have additional direct withholding and reporting penalties. Depending upon culpability, those penalties can be very large.
The bottom line is that 409A potentially applies to anyone who hires anyone else to do anything for them – and does not pay them immediately.
Hopefully, you, the responsible plan fiduciary to an ERISA retirement plan, are happily ensconced in your office, reviewing thorough and compliant ERISA Section 408(b)(2) disclosures from the plan’s covered service providers. But what if you didn’t receive the disclosure, or if it is inadequate?
The Department of Labor (“DOL”) regulations provide that the plan fiduciary must request the missing information in writing from the service provider. Guidance does not dictate a specific timeframe under which the fiduciary must make this request; it must be done “upon discovering” that the service provider failed to disclose. Presumably this would be within a reasonable time after the fiduciary determined the disclosure had not been provided or was inadequate. What constitutes a “reasonable” timeframe may depend on how many disclosures you have to review. Of course, if no disclosure at all was provided, those requests should go out posthaste.
If, after the written request is made, the covered service provider fails to comply within 90 days, the fiduciary must notify the DOL of the service provider’s failure to disclose in order to protect the plan from a prohibited transaction. The notice to the DOL must be filed not later than 30 days following the earlier of: (1) the service provider’s refusal to provide the information requested by the plan fiduciary; or (2) 90 days after the plan fiduciary’s written request is made. The DOL has posted a model fee disclosure failure notice. Currently, the notice may be mailed or emailed to the DOL, but last Monday, a direct final rule was published that announces a new online submission process for such notices. As of the date of this post, the online system was still under development by the DOL. Notices may still be mailed to the DOL even after the online system is up and running, and the DOL has provided a new dedicated mailing address in the direct final rule. Because it is not clear whether that new dedicated mailing address should be used immediately or beginning with the effect date of the direct final rule (September 14, 2012), prudent fiduciaries will mail any such notices to both the old (as published in the February 3, 2012 final rule) and new mailing addresses.
Aside from notifying the DOL, a plan fiduciary who does not receive a disclosure or has only an inadequate disclosure will need to determine whether to terminate the arrangement with the covered service provider, in accordance with the ERISA fiduciary duty of prudence. If the information that was requested by the plan fiduciary and was not provided relates to future services, the plan fiduciary must terminate the arrangement as soon as possible.
It’s hardly news that private sector employees’ retirement accounts took a serious hit in the 2008 financial crisis. In addition, availability of retirement plans in the workplace has declined and small employers have opted not to participate in the private pension system to a greater extent than large employers. To California’s credit, the state’s government is trying to do something about this, but will it work?
Background – California’s Proposed Solution
California’s Legislature is currently considering the California Secure Choice Retirement Savings Act, which would create a public retirement savings plan for private sector workers who do not have access to employer-sponsored retirement savings plans. Employees would have to contribute (3% in the first year) unless they opt out and employers would be allowed to contribute. The plan, including contribution limits, would be modeled after an IRA with interest tied to 30-year Treasuries. All employers (with 5+ employees) that do not already offer a retirement savings plan would be required to arrange for their employees’ participation, but employers’ day-to-day involvement is intended to be minimal.
Hurdle 1 – Would the plan be preempted by ERISA? ERISA generally preempts state laws that “relate to” private sector employee retirement or welfare plans which makes California’s efforts in this area problematic. Is California’s plan a “plan” under ERISA, or merely a payroll practice? Will the plan be “sponsored” by the private employers in the manner that an ERISA plan is “sponsored”?
Certainly, proponents of the California plan have taken steps to avoid ERISA preemption. For example, recent amendments specify that employer contributions would only be allowed if they would not cause the plan to be treated as an employee benefit pension plan under ERISA. Also, the plan’s IRA-like structure and minimal employer involvement are most likely intended to have the plan avoid ERISA preemption. Proponents argue employers’ involvement would constitute only a payroll practice, rather than a retirement “plan” under ERISA. Opponents argue that although the plan takes steps to eliminate an employer’s liability and responsibility, employers will have added operational costs associated with answering questions, collecting forms, and transferring contributions to the plan and these ongoing operational costs and activities make the arrangement employer-sponsored, subjecting the plan to ERISA.
Hurdle 2 – Would contributions be tax deferred? The legislation describes the employees’ accounts as modeled after a traditional IRA, but without in fact creating an IRA or creating an ERISA plan. Therefore, it is unclear how participating employees could enjoy the federal tax benefits associated with typical deferral arrangements.
Hurdle 3 – Would the state be liable for funding shortfalls? Perhaps most alarming for California taxpayers, opponents argue that the state will ultimately be liable in the event of a funding shortfall. The plan is structured to shield the state from liability by having private firms manage the portfolio, purchasing insurance for any funding shortfalls, and notifying employees that the program is not guaranteed by the state. However, opponents argue that the cost of insurance to cover market risk, longevity risk, benefit guarantees set by the plan, and risks regarding administration would be prohibitively high, if this type of insurance even exists. And even with this insurance, plan participants would most likely still look to the state (or their employers) if the insurer go under.
What happens if the plan is successful? Wouldn’t a state like California be awfully tempted to find a way to access those funds, particularly in light of its funding shortfall for public pensions? If the bill does make it through the California Legislature, it will likely prompt other states to move on similar legislation. In the event this legislation does pass, lawsuits regarding the described issues undoubtedly will follow.
What are your thoughts?
We thank our Summer Associate, Anne Jumpe, for her help in preparing this post.
In Bidwell v. University Medical Center, Inc., the Sixth Circuit ruled that an employer was not liable for resulting financial losses when it transferred assets in participants’ retirement plan accounts from a stable value fund to a Qualified Default Investment Alternative (“QDIA”) even though the participants had previously elected the stable value fund. For those unfamiliar, QDIAs are funds in which a participant’s account can be invested if the participant fails to give investment direction. QDIAs are designated by the plan administrator and have greater risk (and thus the potential for greater returns) than stable value or similar conservative funds, which may not keep pace with inflation. The plan administrator is protected from having to make participants whole for investment losses for amounts invested in QDIAs, provided the procedural rules of the regulations are followed.
In the case, University Medical Center (“UMC”), maintained a 403(b) retirement plan (which is similar to a 401(k) plan for a non-profit employer). Under the plan, employees who never made an investment election were defaulted into a stable value fund. Employees could also affirmatively elect to invest in the stable value fund, which both plaintiff employees in this case had done.
Once the Department of Labor issued its final QDIA regulation, UMC selected an acceptable QDIA and prepared to transfer all assets invested in the stable value fund to the QDIA. As required by the QDIA regulations, UMC sent a letter to all participants whose accounts were going to be transferred asking them to respond if they preferred to stay in the stable value fund. The plaintiffs claimed they never received that letter. (However, UMC was able to present evidence that it had mailed the notice letters using first class mail to the plaintiffs’ respective addresses.) The plaintiffs alleged they did not find out that their accounts were moved to a QDIA until they received a quarterly report a few months later. Unfortunately, their accounts were transferred to the QDIA in 2008 (not a great time to move out of a stable value fund) and lost a combined $100,000 in the less than three months they were invested in the QDIA. Plaintiffs sued to recover the lost amount, claiming that UMC had breached its fiduciary duty.
The Sixth Circuit said that UMC did not breach its duties to the plaintiffs and that the QDIA regulations shielded UMC from liability for the loss. The court stated that it was clearly the intent of the DOL to incentivize employers to utilize QDIAs instead of stable value funds and that the regulations protected employers from liability when they made decisions for participants in the face of inaction by those participants.
This decision is notable because the court held that the employees could have their funds reinvested in the QDIA despite their prior affirmative election to invest the stable value fund. The court concluded that the plaintiffs had to make an election after the plan administrator sends the QDIA notice to avoid having their accounts invested in the QDIA. However, regardless of the legalities (which should be analyzed fairly closely before implementing such a strategy), employers should also consider the employee relations concerns that can arise with moving funds to a QDIA. Many employees who did not make an election in the first place are not likely to care, but employees who have made affirmative elections may take exception to the plan administrator “offering” to reinvest their funds unless they “re-elect.”
We thank our Summer Associate, Jess Zimmerman, for his help in preparing this post.
Everybody knows that everybody likes sports. According to the Sports Business Journal, employers are parleying their ties to sports teams, leagues and events into employee benefits. Internal marketing of a company’s sports sponsorship can boost morale, provide perquisites, enhance recruiting and publicize corporate philanthropy
For example, according to the Sports Business Journal, Discover Financial Services, an official sponsor of the National Hockey League, was able to display the Stanley Cup in its suburban Chicago headquarters for a half-day after the Blackhawks won the Stanley Cup in 2010. Workers were welcome to pay a visit to have a look and even have their pictures taken with the trophy. This year, the Cup was displayed in Discover’s New Castle, Del. office as a reward for winning an internal call center contest.
Other examples include pre-game hospitality sessions, free or discounted game tickets and discounted team merchandise, either as special rewards for exemplary performance or for general availability to employees.
OMG! Can you inadvertently create a taxable fringe benefit under the Internal Revenue Code or an employee welfare benefit plan subject to ERISA’s reporting and disclosure requirements by providing these sports perks to employees? On the tax question, occasional parties and occasional tickets to sporting events are generally treated as non-taxable de minimis fringe benefits under section 132 of the Code. On the ERISA question, there is no direct guidance in the governing regulations; however holiday gifts such as turkeys or hams are not included in the definition and it appears that the smaller and more occasional the employee reward, the less likely that the Department of Labor will assert that it constitutes an employee benefit plan subject to ERISA. Likewise, the sky is not the limit. If the perks are given too often or the value is too high (think season tickets or Oprah’s iPad giveaway), they will not qualify as de minimis fringe benefits, they will be subject to income and payroll taxes, they may constitute an ERISA employee benefits plan, and they may make the company look silly to employees.
Please share your thoughts and experience on this subject.
Lately, there has been considerable concern about stop loss coverage. In a brief two-and-one-half page notice published in the May 1 Federal Register, the IRS, Department of Labor, and Department of Health and Human Services (the agencies regulating the Patient Protection and Affordable Care Act (“PPACA” or “health reform”)) requested information on 13 topics relating to stop loss coverage. On June 26, the National Association of Insurance Commissioners (“NAIC”) ERISA (B) Working Group considered revising the NAIC Stop-Loss Insurance Model Act (which states can use to update their stop-loss insurance laws) in a manner that would increase the minimum aggregate attachment point for stop-loss coverage from $20,000 to $60,000. The Self-Insurance Institute of America (“SIIA”) recently sent a letter to the NAIC opposing the proposed increase.
By way of background, stop loss coverage is a form of reinsurance that protects self-funded plan sponsors from high-dollar claim amounts from individual participants (“individual stop loss”) or from a high cost of claims from the plan as a whole (“aggregate stop loss”). The stop loss insurance has a particular point, called the attachment point, which the claims (either individually or in the aggregate) must reach before the insurer will reimburse the employer for the cost of claims.
The agencies professed to having very little information on, and several concerns relating to, stop loss coverage for self-funded plans, especially for small employers that do not hold health plan assets in trust. One concern of the federal agencies is that stop loss coverage with low attachment points could allow small employers to circumvent health reform. Self-funded plans are exempt from some (but not all) of the provisions of PPACA. For example, insured plans in the small group market will generally be required to cover specified categories of “essential health benefits” (which are still being defined). Self-funded plans, however, are not. Self-funded plans are also exempt from the medical loss ratio rebate requirements.
The agencies also worried that small employers with healthy employees could purchase stop loss coverage with attachment points so low that the stop loss insurance would effectively function as health insurance. For example, if a stop loss policy had an attachment point of $5,000, it would effectively be a very high deductible health plan.
On the other side, as reported by Bloomberg BNA, the SIIA argued that raising the attachment point would force smaller, self-insured employers to cut benefits because of the increased benefit costs they would incur with a higher stop-loss attachment point. The SIIA also noted that a small employer which chose to self-insure because its population was “healthy” could quickly have its population become “unhealthy” if a single employee developed a chronic or catastrophic condition.
The NAIC’s proposed model act would, if adopted by a state, effectively eliminate concerns about avoidance of PPACA’s insured plan mandates. As a practical matter, some states already prohibit stop loss policies with low attachment points (and California currently has such a law under consideration, which SIIA also opposes). Additionally, the agencies may consider action of their own to address this perceived “loophole” if they don’t like the answers to their questions.
This debate illustrates that there are a host of issues surrounding health reform that have yet to be resolved. It is important to note that resolution of these issues will not depend entirely on recommendations such as those under consideration by the NAIC, as states do not always adopt the NAIC recommendations in their recommended form or, may choose to make additional changes to their stop loss insurance laws beyond those recommended by the NAIC.
By July 1, 2012, administrators or other fiduciaries of most retirement plans should have received plan level disclosures from all of the plan’s covered service providers. The disclosures should describe the types of services being provided, the status of the covered service provider as an ERISA §3(21) or registered investment advisor fiduciary, the type and amount of compensation the covered service provider receives from the plan, various investment-related disclosures and the manner of receipt of compensation. (As discussed in more detail in our prior post). Plan fiduciaries (including plan administrators) have certain duties with respect to the receipt of this information and with respect to the possible failure to have a covered service provider disclose the information.
The plan fiduciaries must satisfy themselves that they have received the disclosures from all covered service providers who are required to provide the information. The fiduciaries must read, understand, and evaluate the information in order to determine that the fees identified in the disclosures are reasonable and that the services being provided and paid for are appropriate and necessary for the administration of the plan. This does not mean that every plan should pay the lowest possible amount for services, but rather that the fiduciaries must determine that the fees being paid are reasonable with respect to the quality of necessary services being provided.
The failure of a plan to pay reasonable fees for necessary services will result in a potentially expensive prohibited transaction for the plan’s fiduciaries. If not promptly and properly addressed (as discussed below), this could expose fiduciaries to taxes, penalties, and litigation.
Once the fiduciaries have reviewed the information, it would make sense to have a meeting to discuss the disclosures and confirm that the fees are reasonable and that the services are necessary. This may require the assistance of the plan’s investment advisor who should be able to benchmark the fees by comparing them to fees charged to plans by other providers for similar services or by conducting an actual or hypothetical Request for Proposal. For small plans that do not engage the services of an independent investment advisor to assist them with this process, the burden falls directly on the shoulders of the fiduciaries who must use the marketplace to make the appropriate determinations.
If a fiduciary determines that the disclosures are inadequate or that a covered service provider did not make the disclosures, there are steps the fiduciary must take to rectify the failure to receive the information that we will address in a later post.
Plan fiduciaries cannot simply ignore all of the information that they recently received. They must take affirmative steps to act upon that information, consult with relevant advisors to the extent appropriate, and make appropriate fiduciary decisions with respect to it.
Just when you thought we were done with lawsuits over health reform, you may be surprised to learn that there is and could be more litigation in 2015. Several dozen cases have been filed by various religious organizations pertaining primarily to mandates with respect to contraception. Later litigation, if it arises, will likely be about the employer “play or pay” (aka shared responsibility) penalties/taxes.
Under PPACA, the employer penalties/taxes are triggered when an employer either (a) doesn’t offer coverage or (b) offers coverage that is “unaffordable” or “does not provide minimum value” (we’re still waiting on definitive guidance on those terms). However, for the penalties/taxes to be triggered, at least one of an employer’s employees has to receive premium assistance (i.e., a tax credit) or a cost-sharing reduction on insurance purchased through an exchange. However, the tax credit in Section 36B of the tax code requires that the exchange be established by a State (whether this State-run exchange limitation also applies to cost-sharing reductions is less clear).
Here’s the rub: if a State fails to implement an exchange on its own, the federal government is supposed to create a fallback exchange for that State. But note the last sentence in the paragraph above. According to the statute, policies purchased on a federally-run exchange are not eligible for the tax credits (or, possibly, cost-sharing reductions). This means that, in a State with a federally-run exchange, it is theoretically possible for an employer not to be assessed a penalty because employees in that state should not be eligible for tax credits (and possibly cost-sharing reductions). Note that Texas governor Rick Perry recently stated that his State will not establish an exchange, and it is assumed that some others might take this position.
The IRS has “solved” this problem in its regulations by saying that the tax credits apply to any exchange, State- or federally-run. Some commentators have suggested that this is beyond the IRS’s statutory authority, meaning that they are going beyond what the law allows. The IRS counters by saying its rule is consistent with the purposes of the statute.
As a practical matter, multi-state employers may not get away so easy, as they are likely to have employees in States that operate their own exchanges. Additionally, most employees eligible for the tax credit will likely also be eligible for cost-sharing reductions and the statute appears to allow those reductions for coverage through the federal exchanges. Finally, depending on the results of the November elections, the statute could be revised to be clearer that the tax credits apply to all exchange coverage, not just coverage from State-based exchanges.
If the statute is not revised and a small employer in a state with a federally-run exchange is assessed a penalty/tax because an employee receives a premium tax credit, that employer may challenge the assessment on the grounds that the IRS’s rules are beyond its statutory authority. This means we will continue court-watching well into 2015 and beyond.
We’re working on putting together a series of roundtables to help our clients and friends discuss their worries and strategies to deal with health reform/PPACA now that the Supreme Court has weighed in. We want to make sure the program is helpful and impactful so we want to hear from YOU. What are your biggest compliance concerns? What do you want to hear more about?
- Summaries of benefits and coverage,
- Form W-2 reporting of the cost of health coverage,
- $2,500 limit for health FSAs,
- How to handle medical loss ratio rebates,
- Preparing for the 2013 increase in Medicare tax,
- 90-day limitations on waiting periods,
- The “shared responsibility” (aka “play or pay”) penalties for employers,
- Increased incentives for wellness programs,
- Non-discrimination rules for insured health plans,
- Automatic enrollment in health plans for employers with at least 200 employees,
- Why employers need to consider the impact of the Supreme Court ruling on Medicaid expansion, or
- Anything else?
What strategies have you heard about that you would like to discuss more? Please leave us a comment below or drop a line to your Bryan Cave benefits contact and let us know your thoughts!