Author: jfortenberry@fortenberrylaw.com

I know some readers will be delighted to know that there is a new blog called the “Financial Accounting Blog.” (Pointer came from RothCPA.com here.) I hope that the author keeps it up as the topic is one that could really use some coverage and would likely garner a large readership over time.

. . . heard of DivestTerror.org? It is an organization that seeks to play a pivotal role in winning the War on Terror by discouraging public and private pensions plans, college endowments, individual retirement account managers, 401(k) plans, and other investment vehicles from investments in publicly traded companies that operate in terrorist-sponsoring states. The organization has published a report entitled “Terrorism Investments of the 50 States.” According to the report, “on average, America’s Top 100 pension systems invest between 15 and 23 percent of their portfolio in companies that do business in terrorist-sponsoring states.”

. . . read the Motley Fool’s article today by Bill Mann–“Is United Taking Aim at Retirees?“–in which he discusses United’s plans to sidestep its pension obligations.

. . . heard about ftwilliam.com? It is a website established by a former colleague of mine, Tim McCutcheon, which provides on-line document and forms software for the employee benefits professional for a fee. The site offers access to 401(k), profit sharing, money purchase, and target benefit plans in various formats, as well as IRS and PBGC forms. Tim tells me that one of the unique features of his forms software is that it generates all of the required bar codes upon completion of the forms. Check it out.

Two articles this week have commented on health care costs as being a big factor in the sluggish job market. This article from the New York Times–“Rising Cost of Health Benefits Cited as Factor in Slump of Jobs“–notes how temporary employment is up, largely due to the health care cost factor:

The lagging job market has contributed to brisk growth in the temporary employment industry, where jobs may or may not include health benefits. In July, 2.4 million people were working for temporary agencies, according to the Bureau of Labor Statistics. That was a 9 percent increase from a year earlier, compared with an overall increase in the labor force of 1 percent, to 131.2 million.

In addition, this article from the Philadelphia Inquirer–“Fueling job growth? Part-timers” describes how “[e]ven as the unemployment rate has declined in 2004 and economic output is expanding, the growth in the U.S. labor market is coming from part-timers – workers who clock less than 35 hours a week and typically are not offered health benefits.” According to the article, the cost of benefits in general are discouraging employers from committing to additional full-time employees:

Economists say several forces are behind the trend [of a surge in part-time jobs]: “Businesses are getting better at figuring out how to structure work so it is most beneficial to them,” Reamer said. That means, for example, that a company concerned about the soaring cost of health-care benefits and also uncertain about the economy might offer overtime to an existing employee and hire a part-time employee to get additional work accomplished. This allows the company to avoid the extra health-care-benefit costs of full-time workers.

Mark Zandi, chief economist with Economy.com in West Chester, said some growth in part-time workers reflected lifestyle choices of an aging workforce: Some people do not want to put in 40 hours a week. But the main story, he said, is business confidence. Companies are not willing to make the commitment to add full-time employees.

Zandi and others say rising oil prices and the cost of employee benefits, in particular health-care coverage, are making companies think hard about adding full-time staff.

Employers should be careful about the impact part-timers and temporary employees can have on their qualified retirement plans. It is important to note, that part-timers must be allowed to participate in qualified retirement plans, such as 401(k)’s and profit sharing plans, if they have at least 1,000 hours of service during a year and meet the other eligibility requirements for the plan. A part-timer will often meet this 1,000 hour threshold. (Some plans may automatically include part-time employees, without the 1,000 hour threshold, i.e. plans that are based on an elapsed time method of crediting service. You can read this article written by Kirk Maldonado on the subject here.)

A failure to allow part-time employees who earn 1,000 hours during the year and who otherwise qualify to participate in a plan can have unpleasant consequences for employers if they are ever audited by the Internal Revenue Service. The correction method prescribed by the IRS for such errors is contained in Rev. Proc. 2003-44:

.05 Exclusion of an eligible employee from all contributions or accruals under the plan for one or more plan years. The permitted correction method is to make a contribution to the plan on behalf of the employees excluded from a defined contribution plan or to provide benefit accruals for the employees excluded from a defined benefit plan. If the employee should have been eligible to make an elective contribution under a cash or deferred arrangement, the employer must make a QNC (as defined in § 1.401(k)-1(g)(13)(ii)) to the plan on behalf of the employee that is equal to the actual deferral percentage for the employee’s group (either highly compensated or nonhighly compensated). If the employee should have been eligible to make employee contributions or for matching contributions (on either elective contributions or employee contributions), the employer must make a QNC to the plan on behalf of the employee that is equal to the actual contribution percentage for the employee’s group (either highly compensated or nonhighly compensated). Contributing the actual deferral or contribution percentage for such employees eliminates the need to rerun the ADP or ACP test to account for the previously excluded employees. Under this correction method, a plan may not be treated as two separate plans, one covering otherwise excludable employees and the other covering all other employees (as permitted in § 1.410(b)-6(b)(3)) in order to reduce the amount of QNCs. Likewise, restructuring the plan into component plans under § 1.401(k)-1(h)(3)(iii) is not permitted in order to reduce the amount of QNCs.

In other words, the mandated form of correction is for the employer to (1) include the employee as a participant in the plan and (2) put the participant in the same position as if he or she had not been excluded. For instance, if the employer maintains a profit sharing plan and fails to include an eligible employee, the correction is making up contributions the employer would have had to put in for the employee if the employee had not been improperly excluded, plus earnings. For a defined benefit plan, the plan must provide benefit accruals for the excluded employee.

However, in a 401(k) plan, the correction under IRS rules is for the employer to make the 401(k) contribution to the plan on behalf of the employee and to make up the match as well, plus earnings. (The 401(k) contribution amount that the employer must put in for the employee is equal to the average deferral percentage for the employee’s group, i.e. either nonhighly compensated or highly compensated group, as applicable.) Sounds like a windfall to the employee, doesn’t it? The IRS’s thinking in this is that the employee shouldn’t be required to make up 401(k) contributions that it would have made in the past if it had been correctly allowed to participate.

In addition, in a IRS Field Directive issued Nov. 22, 1994, the IRS made it clear that excluding “part-time employees” as a classification is improper under a plan since it would impose an “indirect service requirement on plan participation that could exceed one year of service.”

For those of you who could use a little non-ERISA humor for the day, just read this order from Federal District Judge Sam Sparks who had this to say to some lawyers involved in a case before the court:

When the undersigned accepted the appointment from the President of the United States of the posiition now held, he was ready to face the daily practice of law in federal courts with presumably competent lawyers. No one warned the undersigned that in many instances his responsibility would be the same as a person who supervised kindergarten. . . The Court simply wants to scream to these lawyers, “Get a life” or “Do you have any other cases?” or “When is the last time you registered for anger management classes?”

(From David Giacalone)

Law.com has also posted this article about the order: “‘Antagonistic Motions’ Spark Retort From Judge.”

Here’s an excerpt from an interesting article worth reading from Internetnews.com on the topic of how blogs and wikis are beginning to be utilized in the corporate setting: “Blogs: the Marketing Killer“:

The tried and true marketing and PR departments may one day make the endangered species list thanks to a rush of corporate interest in blogs and RSS feeds.

Weblogging — or blogging — is taking social networking to new heights. And with the improvements to the technology, the personal journals are now supplying tens of millions of bits of information every day. Now multi-million dollar corporations looking for cheap and effective ways of getting their message out are using the technology to their advantage.

The TaxGuru has posted a cartoon here which illustrates in humorous fashion how an ERISA section 510 claim* might arise. The caption of the cartoon reads: “I know you’re three weeks away from retirement, but it’s either fire you now or I have to fork out for another gold watch.” Sadly enough, similar sorts of scenarios involving pension and health benefits have been the subject of much litigation as you can read about in this previous post here. I suppose one would argue that in the cartoon, the watch is not really a “benefit” protected by ERISA. However, that issue–when are in-kind benefits covered by ERISA?–reminds me of the well-known “grocery voucher” case decided last year–Musmeci et al. v. Schwegmann Giant Super Markets, Inc. et al.–in which the employer provided regular grocery vouchers to retirees when they retired from the employer with certain age, service, and position. When a qualifying employee retired, the employer would send the retiree a set of four grocery vouchers worth a total of $216 each month. These vouchers were valid for a period of thirty days, redeemable only at stores owned by the employer.

When the employer terminated the grocery voucher program due to financial difficulties and a sale of the business, the retirees sued claiming they were vested in a pension benefit plan under ERISA. The district court held that the voucher program did indeed qualify as a pension benefit plan under ERISA. On appeal, the Fifth Circuit agreed and upheld the district court’s opinion that the CEO and others were liable as fiduciaries of the plan and that the plaintiffs were entitled to monetary relief for benefits denied.

In reaching its decision, this is what the court had to say about in-kind benefits:

To determine whether ERISA applies to the Voucher Plan, we begin our analysis with an examination of the language of the statute itself. ERISA defines an “employee pension benefit” plan as:

any plan, fund, or program which was heretofore or is hereafter established or maintained by an employer or by an employee organization, or by both, to the extent that by its express terms or as a result of surrounding circumstances such plan, fund, or program . . . provides retirement income to employees. . . 29 U.S.C. § 1002 (2) (A) (i).

The parties agree that [the employer] established a “program.” Thus, the primary issue this court must resolve is whether the vouchers issued pursuant to [the employer’s] Voucher Plan provided the Plaintiffs with “retirement income.”

Neither ERISA’s statutory provisions nor the federal regulations define the term “income.” However, they do not affirmatively require that the pension benefit be paid in cash. Moreover, the Department of Labor (DOL) refused to declare as a general policy whether in-kind benefits are regulated by ERISA. See ERISA Advisory Op. (March 26, 1999), 1999 ERISA LEXIS 11. We have likewise found no controlling case law directly addressing the issue. . .

Even if we were to adopt the plain or ordinary meaning of “income,” our conclusion would be the same. As noted by the Supreme Court in Lukhard v. Reed, the term “income” is commonly understood to mean a “gain or recurrent benefit usually measured in money.” Lukhard v. Reed, 481 U.S. 368, 374 (citing Webster’s Third International Dictionary 1143(1976)). Because the vouchers provided a gain or benefit to . . . employees and could readily be measured in money, they would constitute income as the term is generally understood.

In addition to holding that the voucher program constituted a benefit plan subject to ERISA, the Fifth Circuit affirmed the lower court’s decision that the CEO and other defendants were fiduciaries of the “plan” or voucher program, stating that the term “fiduciary” was to be “liberally construed in keeping with the remedial purposes of ERISA” and that “the term should be defined not only by reference to particular titles, but also by considering the authority which a particular person has or exercises over an employee benefit plan.? The court went on to hold that a fiduciary breach had occurred when the fiduciaries had not fulfilled their statutory duties under ERISA–namely ERISA’s disclosure and reporting obligations, minimum funding requirements, and the requirement that the plans assets be held in trust. The court opined that if the plan had been properly funded, the plaintiffs would have been protected upon a sale of the business.

It is interesting to note here that the court ruled that the retirees’ claims were not covered by the employer’s liability policy since claims were self-insured up to a limit of $250,000. One of the issues in the case was whether this $250,000 amount applied to each individual claim by participants, or to the aggregate claims as a whole. The court ruled that it applied to each individual claim and vacated the lower court’s judgment against the insurance company.

Moral of this story: While the facts of this case were unusual, employers should not make light of those in-kind benefit programs they provide for retirees. They could be subject to ERISA, and those who administer them could be plan fiduciaries personally liable under ERISA for failure to comply with statutory requirements.

*ERISA section 510 provides:

It shall be unlawful for any person to discharge, fine, suspend, expel, discipline, or discriminate against a participant or beneficiary for exercising any right to which he is entitled under the provisions of an employee benefit plan, this subchapter, section 1201 of this title, or the Welfare and Pension Plans Disclosure Act (29 U.S.C. 301 et seq.), or for the purpose of interfering with the attainment of any right to which such participant may become entitled under the plan, this subchapter, or the Welfare and Pension Plans Disclosure Act. It shall be unlawful for any person to discharge, fine, suspend, expel, or discriminate against any person because he has given information or has testified or is about to testify in any inquiry or proceeding relating to this chapter or the Welfare and Pension Plans Disclosure Act. The provisions of section 1132 of this title shall be applicable in the enforcement of this section.

The DOL has filed an amicus brief (access it here) supporting a petition for en banc rehearing in this case–QualChoice, Inc. v. Rowland–decided by the Sixth Circuit last May. (Thanks to Benefitslink.com for the pointer.) The case involved the common scenario of a health plan advancing money to a participant for medical expenses arising from an accident, with the participant then obtaining a settlement against a third-party tortfeasor, and the health plan seeking reimbursement for the medical expenses under the health plan’s reimbursement provision. The case involves the legal controversy over the Great-West case and what a plan can recover as “appropriate equitable relief” under the Supreme Court’s 2002 decision in Great-West.

The DOL argues in its brief that the Sixth Circuit in QualChoice was wrong in holding “that a fiduciary’s action to enforce a plan reimbursement provision is a legal action, regardless of whether the plan participant or beneficiary recovered from another entity and possesses that recovery in an identifiable fund.” The DOL goes on to state that such a holding is inconsistent with the Supreme Court’s analysis in Great-West. The DOL then emphasizes how the Sixth Circuit’s decision could exacerbate the conflict in the circuit courts over the issue (i.e. the circuit courts are split) and could negatively impact health plans in general:

In addition to being in conflict with the decisions of other circuits and in significant tension with Supreme Court precedent, the panel’s decision is of exceptional importance for other reasons: by reading section 502(a)(3) to disallow enforcement of subrogation provisions because they are grounded in contract, the decision is likely not only to add significantly to the costs borne by ERISA health care plans, but could also prevent participants and fiduciaries from bringing suit under section 502(a)(3) to enforce the terms of the plan.

As of 2002, an estimated 137 million people participated in private sector employer-sponsored health care plans covered by ERISA. Many of these plans contain reimbursement/subrogation provisions. Indeed, in 2000, the largest provider of subrogation services in the United States reported subrogation recoveries that averaged $4.8 million for every one million persons covered by its client. See Healthcare Recoveries, Inc., SEC Form 10K (Mar. 27, 2001). By flatly prohibiting such recoveries, the panel’s decision is likely to have a large economic impact on health care plans in this Circuit, and may lead some employers to respond by dropping or decreasing coverage.

Furthermore, under the logic of the panel’s reasoning that section 502(a)(3) does not allow enforcement of a plan subrogation provision because it is grounded in contract, no attempt to enforce a plan term would be permissible. This reads out of section 502(a)(3) the right to “enforce . . . the terms of the plan.” 29 U.S.C. § 1132(a)(3). Such a construction may have unforeseen consequences on the enforcement of ERISA beyond the subrogation context, and should be avoided under ordinary rules of statutory construction.

It will be very interesting to see how the court responds to the petition for rehearing and whether or not the Supreme Court will eventually step in again to try to make sense out of this very muddled area of the law.

With all of the political debate and media attention over employees losing their jobs due to outsourcing*, it is important to remember the possible exposure to liability that can occur as employers consider the option of outsourcing in its many forms. While time will not permit going into all of the legal exposure that can arise, two such areas of vulnerability that come to mind are as follows:

1. Liability under ERISA. ERISA section 510 prohibits an employer from discharging an employee for the purpose of interfering with the attainment of any right to which the employee may become entitled under an ERISA plan. Courts have held that such practices as terminating employees based on benefits cost to the employer or changing the status of an individual from “employee” to “independent contractor” for such purposes have violated ERISA. What this means is that employers who terminate employees for the wrong reasons can be exposed to section 510 claims from disgruntled employees under ERISA. The issue is particularly relevant in today’s work environment as employers are faced each year with the daunting and reoccurring task of containing benefits costs.

How does the issue apply to employers who outsource work to outside contractors? According to the U.S. Supreme Court in the case of Inter Modal Rail Employees Ass’n v. Atchison, Topeka & Santa Fe Railway Co. , an employer cannot outsource work to a sub-contractor where the purpose of the outsourcing is to interfere with the benefit plan rights of plan participants. The employer in that case outsourced its employees to another company that did not provide equal health and pension benefits, and allegedly did so for the purpose of cutting its own health and pension benefits cost. The court held that the employer could be held liable for violation of section 510 of ERISA.

While it is true that oftentimes it is difficult for employees to prove that an employer terminated an employee for the purpose of interfering with benefits, employees have prevailed in many instances. A well-known example of the type of evidence that can prevail in a section 510 case appears in McLendon v. Continental Can Company, 749 F. Supp. 582 (D.N.J. 1989), aff’d sub nom., McLendon v. Continental Can Co., 908 F.2d 1171 (3d Cir. 1990) in which a sophisticated benefits liability avoidance system was utilized by the employer. Employees were able to show that the employer had devised a computer program which identified employees who were close to meeting the age and service requirements for certain pension benefits so that such employees could then be targeted for termination. The court in McLendon had no trouble in finding that the employer had violated section 510 of ERISA.

Others may recall the recent case of Millsap et al. v. McDonnell Douglas Corporation (read about it here and here) in which plaintiffs achieved a $36 million settlement for claims brought against their employer, alleging that the employer closed one of its plants for purposes of preventing employees from attaining eligibility for benefits under their pension and health care plans. The damaging evidence in that case were memos from the actuaries analyzing the reduction in benefits which would occur if the plant were closed. One such memo prepared by the actuaries (which was apparently not protected by attorney-client privilege) considered “various what if scenarios, analyzing the effect on costs and savings if the company decided to reduce heads.” The kinds of costs analyzed included “pension cost, savings cost, savings plan cost, health care cost, and just direct overhead cost.” According to the court in that case, the employees were only required to show that the employer’s alleged desire to block the attainment of benefits rights was a “determinative factor” in the challenged decision, i.e. the claimant was not required to show that it was the sole reason for closing the plant.

2. Liability under FLSA. A troubling decision for employers that was issued late last year in the Second Circuit (covering New York, Connecticut, Vermont)–Zheng v. Liberty Apparel Co –held that an employer who outsourced certain tasks to a subcontractor in the garment industry was a “joint employer” for Fair Labor Standards Act (“FLSA”) purposes. The case is troubling because most courts in the past had looked to a “control” test to determine whether the contracting company was an employer for purposes of FLSA. However, the court in Zheng held that an employer could be deemed to be a “joint employer” if the employer had “functional control,” but not “formal control,” over the workers. In holding for the plaintiffs in the case and utilizing a factors test , the court stated that “although an entity’s exercise of an employer’s formal prerogatives-hiring and firing, supervising schedules, determining rate and method of payment, and maintaining records-may be sufficient to establish joint employment under the FLSA, it is not necessary to establish joint employment.” (The Zheng factors used by the court were: (1) whether the contracting employer’s premises and equipment were used for the work being done by the employees; (2) whether the subcontractor had a business that could or did shift as a unit from one putative joint employer to another; (3) the extent to which the employees performed a discrete line-job that was integral to the contracting employer’s process of production; (4) whether responsibility under the contracts could pass from one subcontractor to another without material changes; (5) the degree to which the contracting employer or its agents supervised the work being done; and (6) whether the employees worked exclusively or predominantly for the contracting employer.)

In light of the Zheng case and the ripple effect it might have in other districts, all employers, not just those with facilities in New York, Connecticut and Vermont, are being urged to review all of their subcontracting and outsourcing arrangements with counsel and to re-evaluate these arrangements. Given the FLSA’s harsh remedial scheme, the case could have a chilling effect on legitimate outsourcing arrangements which, according to the Zheng court, occupy a “substantial and valuable place” in the way American companies of all sizes do business.

Conclusion: While there are many business reasons for embarking upon a path of outsourcing, the case law demonstrates how, under ERISA, making the decision to outsource for the wrong reasons could come back to haunt the employer. In addition, outsourcing could lead to problems under the FLSA if employers who outsource are deemed to be “joint employers” under the factors cited in Zheng. When considering this option, employers need to be wary that, while outsourcing may save costs, it could also lead to unexpected lawsuits and result in exposure to liability in some circumstances.

(*Outsourcing is the delegation of a business process to an external service provider. The service provider is then responsible for the hiring of employees to accomplish the delegated business process.)