The Eternal Revenue Service?

Frank and Ernest provide some IRS humor here. (From artist Bob Thaves at Comics.com.)

More on FASB's Pension Disclosure Proposal

The LA Times today reports in this article–“More Pension Plan Disclosure Ordered–on FASB‘s decision to require disclosure of investment strategies which companies use for their pensions. (See previous post here.) The article reports FASB as saying that it will order the changes “as part of efforts to shine a brighter light on corporate pension programs, amid fears that many such plans may be inadequate to meet promised benefits.” The article quotes Lynn Dudley, vice president and general counsel for the American Benefits Council, who criticizes the decision by FASB on the grounds that it “could be used by employee groups to pressure companies to alter their investment strategies to suit a particular group’s purpose.” According to the article, Ms. Dudley notes that “to bow to such pressure would violate pension rules [i.e. ERISA] that require employers to be fiduciaries, acting in the best interest of all participants.”

UPDATE: Plan Sponsor reports on the proposed pension disclosure rules: “Details Emerge on FASB Pension Disclosure Proposal.”

Tax Foundation Report: Higher Cost of Living Means Higher Federal Taxes

A report from the Tax Foundation quantifies how much higher federal income tax payments are for taxpayers who live where the cost of living is high, even when they have the same standard of living as similarly situated taxpayers who live where the cost of living is low: “Federal Income Tax Burden Falls Ever Harder on Taxpayers in Areas with High Cost of Living.”

Tax Foundation Report: Higher Cost of Living Means Higher Federal Taxes

A report from the Tax Foundation quantifies how much higher federal income tax payments are for taxpayers who live where the cost of living is high, even when they have the same standard of living as similarly situated taxpayers who live where the cost of living is low: “Federal Income Tax Burden Falls Ever Harder on Taxpayers in Areas with High Cost of Living.”

A Legal Battle in Luzerne County, Pennsylvania Over Pension Investments

Last weekend, the Philadelphia Inquirer had this interesting article: “A bitter lesson on pensions: Are local governments, such as Pa.’s Luzerne County, able to run them?” The article highlights a lawsuit being brought in Luzerne County, Pennsylvania by the county pension board against current and past county commissioners, plus the outside managers who used to handle county pension investments. According to the article, the suit alleges commissioners and the contractors they hired entered into unauthorized contracts to buy inappropriate investments “in exchange for political contributions” over the last 15 years. The defendants have asked the court to dismiss the suit.

Christopher Cullen, a Scranton lawyer who, with Philadelphia’s Schnader Harrison law firm, represents the plaintiffs, says that the lawsuit is the first of its kind in Pennsylvania and predicts that the theme of the lawsuit will have widespread application in other states as well. The article quotes Don Trone, who heads the Center for Fiduciary Studies at the University of Pittsburgh and serves on the U.S. Labor Department pension advisory board, as saying: “You’re going to see many lawsuits like this as more people learn about the abuses that have been going on, from mutual-fund trading to pay-to-play.”

In a related article today, “Court won’t stop Casey from auditing Pa. pension plans“, the Inquirer reports that the Commonwealth Court of Pennsylvania has refused to bar Auditor General Robert P. Casey Jr. from auditing Pennsylvania state workers’ and teachers’ pension plans, allowing the dispute to proceed toward trial. The article notes that Casey wants to examine how the funds hire money-management firms, which are paid more than $250 million yearly in fees. He has also said he plans to examine whether campaign contributions by the fund managers have affected the investment process. The article reports that the Commonwealth Court, citing “persuasive and logical” rulings that upheld similar audits in New York and Philadelphia, in an opinion written by Judge Doris A. Smith-Ribner, overruled objections by the pension funds, which sought to deny Casey the right to conduct performance audits and the right to demand pension-fund documents.

FASB Will Require More Disclosure of Pension Data

In a meeting today, the Financial Accounting Standards Board decided to make further changes to disclosure requirements for pensions. Reuters reports via the New York Times: “FASB Requires More Disclosed Pension Data.” Also, the Wall Street Journal has this: “Rule to Require Companies to Disclose Pension Holdings.” The New York Times article quotes a FASB board member as stating that under the new rule “companies would have to describe the investment strategy used for their pension assets, for example, their policy on derivatives and any prescribed strategy on investing.”

New IRS Guidance on PEO Retirement Plans

Something to be thankful for, I guess, would be the new IRS guidance on PEO retirement plans: Rev. Proc. 2003-86. (via Benefitslink.com). S. Derrin Watson, Esq. has already weighed in on the guidance in this: “First Look at Rev. Proc. 2003-86.” The new Revenue Procedure clears up some of the unanswered questions of the previously issued Rev. Proc. 2002-21 (via Mr. Watson’s website) which mandated that certain actions be taken with respect to PEO retirement plans prior to the end of 2003.

Medicare Bill Passed the Senate

This just in from the Washington Post that the Medicare bill passed the Senate (54-44) early this morning: “Senate Passes Medicare Bill.” The Wall Street Journal also reports: “Senate Passes Medicare Bill, Sends It to Bush for Signing.

An Unsuccessful ERISA Legal Challenge to Market-Timing Restrictions

With recent market-timing allegations in the current mutual fund investigation, there has been much discussion around the practice of placing restrictions on frequent trading in 401(k) plans. Such restrictions are usually drafted into the prospectus, the Summary Plan Description (“SPD”) and the plan document governing the 401(k) plan. Has anyone challenged the legality of such restrictions under ERISA? The answer is yes and the case is Straus v. Prudential Employee Savings Plan, 253 F. Supp 438 (E.D.N.Y. 2003).

In the Straus case, participants in the company’s employee savings plan brought an action against the company, the plan, and the plan administrator (collectively the “defendants”), alleging violations of ERISA and promissory estoppel. Participants in the case brought a motion for preliminary injunction to prevent defendants from enforcing the plan’s restrictions on the participants’ right under the plan to transfer funds from one investment option to another in unlimited amounts.

What the Plan, SPD, and Prospectus said about market-timing: The provisions contained in the plan, the SPD and the prospectus in Straus were as follows:

  • The Plan gave employees the right to reallocate their contributions to a different fund and to transfer money into and out of these funds, but indicated that there might be restrictions on some transactions. It also stated that the Administrative Committee might decline to implement investment instructions where it deemed appropriate and that the Administrative Committee had the power to adopt “rules and procedures” to govern “[a]ll Participant elections and directions under the terms of the Plan.”
  • The SPD set out the rules for making changes and transfers, but then stated that in certain situations (for example, excessive trading, etc.), there might be limitations regarding transfers. The SPD referred participants to the fund prospectus(es) and/or fact sheets for more information on any trading restrictions that might apply to the investment option(s) that participants might choose, and to the online Terms and Conditions on the plan web site for more details. (The court noted that the SPD did not contain the Plan provision that stated the Committee might decline to implement investment instructions where it deemed appropriate.)
  • The fund prospectuses warned that frequent trading of shares in response to short-term market fluctuations, a practice known as “market timing,” could disrupt the management of the fund and explained that fund managers might be forced to sell securities at inopportune moments in order to have enough cash available to redeem the shares of those engaging in market timing trades, thus damaging the overall health of the fund. For this and other reasons, the prospectuses advised investors that fund managers reserved the right to refuse purchase orders and fund exchanges if the fund manager believed the transaction would have a disruptive effect on the portfolio.

What the plaintiffs had to say about market-timing: The plaintiffs (as plan participants) claimed that they had “educated themselves about the various investment options and developed strategies for maximizing the return on their investment.” They acknowledged that they “paid close attention to world events and market shifts in managing their investments” and explained that “understanding the economic effects of the events of September 11, 2001, the tensions in the Middle East, and the Enron and WorldCom bankruptcies, to name a few, was critical to their strategy for protecting their retirement funds.” They claimed that, in reaction to these events, they had regularly transferred large amounts of money—sometimes in the hundreds of thousands of dollars—into and out of different Plan investment vehicles several times per month, that such transfers were permitted under the Plan, and that they had been investing in this manner very successfully for several years before Prudential began imposing restrictions on them.

What the court had to say about market-timing: The court held that the participants did not have a right, under the plan or ERISA, to transfer funds from one investment option to another in unlimited amounts. The court also held that in blocking participants’ transfers of funds from one investment option to another and in promulgating trading policies, the plan administrator was exercising powers that it possessed under the terms of the plan and was not deemed to have amended the plan in violation of ERISA and plan procedures. The court also stated:

In their brief, plaintiffs attempt to salvage this claim by arguing that, while the SPD may have contained a general reference to limitations on excessive trading, the plan never defined excessive trading in any way, nor were plan employees able to explain what it meant when plaintiffs inquired into the matter. Since no one could explain the specifics of this limitation, they conclude, by implication “no such limitation on ‘excessive trading’ existed….” . . . Such reasoning is clearly spurious. A non-specific limitation is nonetheless a limitation. To argue as plaintiffs have is akin to arguing that since your mother did not tell you how long you were grounded for, you must not be grounded. Indeed, such arguments only serve to prove the opposite point, namely that a general limitation was in place and that plaintiffs were well aware of its existence.

Additional rulings of the court:

  • The retroactive application of policies modifying rules governing participants’ transfers of funds did not violate ERISA.
  • Where defendants never made any promise of a right to have unlimited fund transfers between different investment options, defendants were not estopped from limiting participants’ ability to transfer funds under the plan.

What plan sponsors can learn from the decision: The primary focus of the case in deciding against the plaintiffs was the language contained in the plan document, the SPD and the prospectus. While not entirely consistent and bullet-proof, the language was deemed to have been sufficient to inform participants (who were claiming an unlimited right to make trades) of the plan administrator’s right to place restrictions on “market-timing” activities. Query: What result would been reached if the plan document had not contained the necessary language, but the prospectus and the SPD had contained this language? Query: What result would have been reached if the plan document had contained the necessary language, but the prospectus and the SPD had not contained this language?

It is important that plan sponsors examine their plan documents, SPD’s and prospectuses to determine what, if any, language addresses this issue. With all of the focus now on curbing market-timing practices, it is probable that more legal challenges could ensue, and so, plan sponsors should make sure that all documents surrounding the plan comport with all of the rules, policies and procedures which are being administered.

For those companies whose employees have been market-timing in their 401(k) plans, where plan documents contained language prohibiting these types of trades, plan fiduciaries likely would be exposed to claims of fiduciary breach since fiduciaries have not administered the plan “in accordance with plan documents.” ERISA section 404(a)(1)(D). Also, plans which have not been operated in accordance with plan documents could technically run the risk of disqualification with the IRS.

Where plan participants have been market-timing and the plan document is silent, but the prospectus contains language restricting such trades, plan documents should be amended to conform to the trading restrictions contained in the prospectus. If restrictions on market-timing are being instituted for the first time with changes to plan language and language in the SPD and prospectus being made, the issue arises as to whether or not Sarbanes-Oxley would require a 30-day advance notice. That issue will be saved for another day . . .

An Unsuccessful ERISA Legal Challenge to Market-Timing Restrictions

With recent market-timing allegations in the current mutual fund investigation, there has been much discussion around the practice of placing restrictions on frequent trading in 401(k) plans. Such restrictions are usually drafted into the prospectus, the Summary Plan Description (“SPD”) and the plan document governing the 401(k) plan. Has anyone challenged the legality of such restrictions under ERISA? The answer is yes and the case is Straus v. Prudential Employee Savings Plan, 253 F. Supp 438 (E.D.N.Y. 2003).

In the Straus case, participants in the company’s employee savings plan brought an action against the company, the plan, and the plan administrator (collectively the “defendants”), alleging violations of ERISA and promissory estoppel. Participants in the case brought a motion for preliminary injunction to prevent defendants from enforcing the plan’s restrictions on the participants’ right under the plan to transfer funds from one investment option to another in unlimited amounts.

What the Plan, SPD, and Prospectus said about market-timing: The provisions contained in the plan, the SPD and the prospectus were as follows:

  • The Plan gave employees the right to reallocate their contributions to a different fund and to transfer money into and out of these funds, but indicated that there might be restrictions on some transactions. It also stated that the Administrative Committee might decline to implement investment instructions where it deemed appropriate and that the Administrative Committee had the power to adopt “rules and procedures” to govern “[a]ll Participant elections and directions under the terms of the Plan.”
  • The SPD set out the rules for making changes and transfers, but then stated that in certain situations (for example, excessive trading, etc.), there might be limitations regarding transfers. The SPD referred participants to the fund prospectus(es) and/or fact sheets for more information on any trading restrictions that might apply to the investment option(s) that participants might choose, and to the online Terms and Conditions on the plan web site for more details. (The court noted that the SPD did not contain the Plan provision that stated the Committee might decline to implement investment instructions where it deemed appropriate.)
  • The fund prospectuses warned that frequent trading of shares in response to short-term market fluctuations, a practice known as “market timing,” could disrupt the management of the fund and explained that fund managers might be forced to sell securities at inopportune moments in order to have enough cash available to redeem the shares of those engaging in market timing trades, thus damaging the overall health of the fund. For this and other reasons, the prospectuses advised investors that fund managers reserved the right to refuse purchase orders and fund exchanges if the fund manager believed the transaction would have a disruptive effect on the portfolio.

What the plaintiffs had to say about market-timing: The plaintiffs (as plan participants) claimed that they had “educated themselves about the various investment options and developed strategies for maximizing the return on their investment.” They acknowledged that they “paid close attention to world events and market shifts in managing their investments” and explained that “understanding the economic effects of the events of September 11, 2001, the tensions in the Middle East, and the Enron and WorldCom bankruptcies, to name a few, was critical to their strategy for protecting their retirement funds.” They claimed that, in reaction to these events, they had regularly transferred large amounts of money—sometimes in the hundreds of thousands of dollars—into and out of different Plan investment vehicles several times per month, that such transfers were permitted under the Plan, and that they had been investing in this manner very successfully for several years before Prudential began imposing restrictions on them.

What the court had to say about market-timing: The court held that the participants did not have a right, under the plan or ERISA, to transfer funds from one investment option to another in unlimited amounts. The court also held that in blocking participants’ transfers of funds from one investment option to another and in promulgating trading policies, the plan administrator was exercising powers that it possessed under the terms of the plan and was not deemed to have amended the plan in violation of ERISA and plan procedures. The court also stated:

In their brief, plaintiffs attempt to salvage this claim by arguing that, while the SPD may have contained a general reference to limitations on excessive trading, the plan never defined excessive trading in any way, nor were plan employees able to explain what it meant when plaintiffs inquired into the matter. Since no one could explain the specifics of this limitation, they conclude, by implication “no such limitation on ‘excessive trading’ existed….” . . . Such reasoning is clearly spurious. A non-specific limitation is nonetheless a limitation. To argue as plaintiffs have is akin to arguing that since your mother did not tell you how long you were grounded for, you must not be grounded. Indeed, such arguments only serve to prove the opposite point, namely that a general limitation was in place and that plaintiffs were well aware of its existence.

Additional rulings of the court:

  • The retroactive application of policies modifying rules governing participants’ transfers of funds did not violate ERISA.
  • Where defendants never made any promise of a right to have unlimited fund transfers between different investment options, defendants were not estopped from limiting participants’ ability to transfer funds under the plan.

What plan sponsors can learn from the decision: The primary focus of the case in deciding against the plaintiffs was the language contained in the plan document, the SPD and the prospectus. While not entirely consistent and bullet-proof, the language was deemed to have been sufficient to inform participants (who were claiming an unlimited right to make trades) of the plan administrator’s right to place restrictions on “market-timing” activities. Query: What result would been reached if the plan document had not contained the necessary language, but the prospectus and the SPD had contained this language? Query: What result would have been reached if the plan document had contained the necessary language, but the prospectus and the SPD had not contained this language?

It is important that plan sponsors examine their plan documents, SPD’s and prospectuses to determine what, if any, language addresses this issue. With all of the focus now on curbing market-timing practices, it is probable that more legal challenges could ensue, and so, plan sponsors should make sure that all documents surrounding the plan comport with all of the rules, policies and procedures which are being administered.

For those companies whose employees have been market-timing in their 401(k) plans, where plan documents contained language prohibiting these types of trades, plan fiduciaries likely would be exposed to claims of fiduciary breach since fiduciaries have not administered the plan “in accordance with plan documents.” ERISA section 404(a)(1)(D). Also, plans which have not been operated in accordance with plan documents could technically run the risk of disqualification with the IRS.

Where plan participants have been market-timing and the plan document is silent, but the prospectus contains language restricting such trades, plan documents should be amended to conform to the trading restrictions contained in the prospectus. If restrictions on market-timing are being instituted for the first time with changes to plan language and language in the SPD and prospectus being made, the issue arises as to whether or not Sarbanes-Oxley would require a 30-day advance notice. That issue will be saved for another day . . .