ERISA and Fiduciary Liability 2019 Evolving risk landscape

ERISA and Fiduciary Liability - 2019 Evolving risk landscape for plan sponsors and fiduciaries

The Presenter Philip Reed is a risk advisor to high-profile organizations and executives. He draws on his experience resolving claims targeting corporate executives to map risks presented by emerging trends. 1

26 U. S. Code § 409 A - Inclusion in gross income of deferred compensation under nonqualified deferred compensation plans (a) Rules relating to constructive receipt (1) Plan failures (A) Gross income inclusion (i) In general If at any time during a taxable year a nonqualified deferred compensation plan— (I) fails to meet the requirements of paragraphs (2), (3), and (4), or (II) is not operated in accordance with such requirements, all compensation deferred under the plan for the taxable year and all preceding taxable years shall be includible in gross income for the taxable year to the extent not subject to a substantial risk of forfeiture and not previously included in gross income. (ii) Application only to affected participants Clause (i) shall only apply with respect to all compensation deferred under the plan for participants with respect to whom the failure relates. (B) Interest and additional tax payable with respect to previously deferred compensation (i) In general If compensation is required to be included in gross income under subparagraph (A) for a taxable year, the tax imposed by this chapter for the taxable year shall be increased by the sum of— (I) the amount of interest determined under clause (ii), and (II) an amount equal to 20 percent of the compensation which is required to be included in gross income. (ii) Interest For purposes of clause (i), the interest determined under this clause for any taxable year is the amount of interest at the underpayment rate plus 1 percentage point on the underpayments that would have occurred had the deferred compensation been includible in gross income for the taxable year in which first deferred or, if later, the first taxable year in which such deferred compensation is not subject to a substantial risk of forfeiture.

Topics • • • History of ERISA Fiduciaries and their responsibilities Types of Plans Enforcement Litigation trends 2019 Insurance Considerations

Bend, Indiana

ERISA: A Timeline Studebaker closes Bend, Indiana plant. 4, 000 employees lose their pension ($15 million). 1950’s Struggling auto maker Studebaker-Packard “increases” pension benefits four times. December 1963 401 (k) added to internal revenue code, allowing deferred tax on plan contributions 1974 Congress passes the “Employee Retirement Income Security Act” - President Ford signs into law. Pension Benefit Guaranty Corporation (PBGC) created. 1978 September 2004 PBGC intervenes in Enron Bankruptcy, results in 17, 000 retirees receiving their full benefits ($320 million). 5

ERISA – American Express Corp creates first pension plan in 1875 – Studebaker fails in ’ 63 leaving thousands without pension assets. – 1974 ERISA enacted; PBGC created to insure plan promises – With the benefit of hindsight; pension plans largely unsustainable – have vanished from private employers. 401 k’s replaced pensions, with the employee bearing investment risk. (2017: 15% private sector employees have DB pensions) – Public Pensions are not subject to ERISA but… Bakersfield, Detroit, Illinois all examples of continuing challenge to have funding keep pace with benefit promises. Today’s plan funding shortfall: over one TRILLION dollars. (2017: 74% public sector employees have DB pensions) 6

Categories of ERISA Plans • Welfare benefit plans – Medical – Disability – Etc. • Pension benefit plans – Defined Benefit Plans – Defined Contribution Plans • 401 (k) • ESOP • Multiemployer / Labor Management Trusts

Who is a Fiduciary ? ERISA’s fiduciary duties apply to anyone who: • • exercises any discretionary authority or control over a plan exercises any authority or control over a plan’s assets has any discretionary authority in administering a plan; or provides investment advice to a plan for a fee. Note settlor function as distinct: • Settlor activities arise out of the establishment and design of the plan. Creating and changing benefit plans are settlor functions. 8

Fiduciary Duties • Plan fiduciaries are subject to a heightened standard of care – “the highest duty known under the law”; even higher than the duties imposed on corporate directors and officers – and not protected by the “business judgment rule” • Duty of Loyalty – to act for the exclusive purpose of administering the plan and providing benefits to participants and beneficiaries. • Duty of Prudence – act with the care, skill and diligence that a prudent person acting in like capacity and familiar with such matters would use” 9

A note about ERISA remedies and pre-emption • ERISA provides prescribed (“exclusive”) remedies for any violations – Benefits – Fees, Fines, Penalties – Attorney’s fees (sometimes) • Non-ERISA (state law governed plans) – May allow punitive damages – May allow consequential damages – May allow types of actions (common law/state law) not outlined in ERISA • Pre-emption and vehicle emissions; Federal District Court

ERISA Enforcement Department of Labor (DOL) • Employee Benefits Security Administration (ESBA) – Notice “to determine whether any person has violated or is about to violate any provision of Title I of ERISA” • ESBA has primary enforcement authority – Breaches of Duty – Prohibited Transactions 11

ERISA Enforcement Phases of an ESBA investigation: 1. 2. 3. 4. Initial letter, request for documents. – – – Not required to define scope of investigation or target. “Notice of Investigation” Subpoena if failure to cooperate – No findings/no action; de minimis (finding no action); voluntary compliance (10 -day letter); litigation or criminal referral Request to Interview plan sponsors, administrators, trustees, named fiduciaries, functional fiduciaries and/or service providers. Not under oath but should be taken seriously… ESBA (internal) “Report of Investigation” and regional office director decides whether to take further action Closing Letter 12

Top Current Business and Legal Trends Impacting Fiduciary Liability

Excessive Fee Litigation • May 2015: SCOTUS decision – Tibble v. Edison: the Court held that plan fiduciaries have a continuing duty to monitor trust investments and remove imprudent ones. – Plaintiffs filed over 60 excessive fee cases, mainly targeting non-profit educational institutions. 14

Best Practices • Act affirmatively to review and possibly change: – – How investment options are added or removed Vendor and Mutual Fund fees Fee transparency with plan participants Procedure in place for recordkeeping services and any revenue sharing 15

Cyber Exposure • Claims against plan sponsors that allege that they (or the plan fiduciaries) failed to properly vet service providers cybersecurity. – Triple threat: personally identifiable information, personal credit information and personal health information are all at risk – Note HIPAA may also be triggered for mishandled medical information – Crossover between fiduciary liability, cyber liability and EBE&O (handling of records. ) 16

Underfunded defined benefit plans • 2007 funding level for S&P 500: 101% • 2018 funding level for S&P 500: 85% • It is generally believed that fiduciaries engage in riskier investments if plans are underfunded 17

Arbitration • Munro v. University of Southern California: US district court held that USC cannot mandate plan participants arbitrate their claims. • USC attempted to enforce the employment arbitration agreement to dispute about breach of plan fiduciary duty • Arbitration can cut both ways – In Shafer v. Multiband (2014) an arbitrator denied two trustees request for indemnification. Court held that the arbitrator misapplied the law but would not reverse his decision because “arbitration is meant to be final”.

ACA Health Plans – Section 1557 • Incorporates non-discrimination provisions from various Acts (Civil Rights, Title IX, etc. ) • Prohibits a member of a protected class (race, gender, age, and disability) from being excluded from participating in, being denied the benefits of, or being subjected to discrimination under a “health program or activity. ” • Gender includes gender identity 19

ACA Health Plans – Section 1557 Potential sources of claims concerning coverage options • Plan drug pricing tiers that may be discriminate (ex: HIV drugs) • Availability/pricing of treatments for gender/transgender (gender dysphoria) 20

Best Practices • Work with experienced counsel when designing coverage options to prevent distinctions or discrimination on the basis of protected classes. 21

Best Practices • Avoid naming the plan sponsor as a fiduciary – The plan sponsor is the “settlor” – Consider naming a plan committee as the fiduciary • Avoid naming key corporate officers as fiduciaries (CEO, CFO, GC) – These individuals will often have greater potential for conflicting duties of loyalty and confidentiality 22

Best Practices • Carefully craft delegation authority (for example to an investment advisor) and beware of “permavendor” arrangements; • Reviewing performance and pricing regularly • Encourage diversification • If company stock is to be offered include the option hard wired into the plan document instead of at the investment committees discretion 23

Best Practices • Read the Plan Document • Keep fiduciaries informed and properly trained • Review agreements with outside fiduciaries to make certain that fiduciary status is accepted in the contract 24

Self-Dealing • Using proprietary funds that profit the sponsor – or other services, like recordkeeping – above market rates. 25

Fiduciary Liability Insurance

Employee Benefits E&O Insurance • Often included in the General Liability policy • Meant to cover clerical failures (meaning little or no discretion applied) – – Failure to enroll in correct plan Improper benefit payment / determination Etc. • May overlap with fiduciary coverage

Fiduciary Liability Insurance • Generally, claims alleging breaches of ERISA duties are excluded from directors and officers (“D&O”) policies. • Fiduciary liability policies are typically available for a fraction of the cost of D&O, cover fiduciaries • Personal liability is a risk fiduciaries assume – ERISA plans cannot indemnify fiduciaries – ERISA plan “waivers” of fiduciary liability are invalid as a matter of law – Employers (plan sponsors) may indemnify – but: • Financial inability; legal impossibility; unwilling if perceived bad conduct

Fiduciary Liability Insurance • Coverage typically attaches to a “claim” against an “Insured” for a “wrongful act” in connection with a sponsored plan • Claim generally means a written demand or lawsuit • Insured generally means the plan sponsor, any fiduciaries, and settlors* • Wrongful act typically refers to any alleged error or omission in connection with the duties as respects the plan

Fiduciary Liability Insurance • Claim • Investigation • Interview of an Insured Person • Benefits Due Exclusion • Duty to Defend • Voluntary Compliance (next slide)

Fiduciary Liability Insurance • Voluntary Correction Program - sublimit • Employee Plans Compliance Resolution System (EPCRS) – – Administered by the IRS Self report violations Pay amounts owed; and Fees, fines, penalties, attorney costs • which can’t be paid from plan assets

Source Materials • Fiduciary Liability Litigation Trends; Marsh Q 4 2018 • Who may sue you and why: how to reduce your ERISA risks and the role of fiduciary liability insurance; Chubb; Lars C. Golumbic; June 2017