Monday, 09 April 2018
All transactions involving the purchase or redemption of employer stock by an Employee Stock Ownership Plan (“ESOP”) must be conducted at fair market value. This assures that the statutory prohibited transaction exceptions available to compliant ESOPs will apply. Fair market value for private companies must be determined by an independent appraisal. This would include annual valuations and, more important, the valuation of the ESOP’s critical acquisition of the employer stock that it is required to maintain as its “principal investment.”
ESOP appraisals can be influenced by misleading information provided by company management. Appraisers can even give their approval to ESOP transactions that leave the employer-sponsor insolvent as in the case of the Chicago Tribune ESOP. The resulting litigation was concluded by a settlement agreement with the Department of Labor that charges ESOP fiduciaries with the responsibility of performing their own due diligence investigation of any ESOP appraisal report.
A recent Department of Labor settlement agreement with First Banker Trust Services (“FBTS”) resolves three separate cases and outlines additional valuation guidelines that ESOP fiduciaries (including the employer-sponsor of an ESOP) should consider any time they deal with a valuation report issued by the ESOP appraiser, or “Valuation Advisor.”
Each of the three cases alleged that FBTS approved ESOP transactions without undertaking a thorough investigation of the value of the company stock involved. Because the stock valuations were based on unrealistic projections of future company earnings, they overstated the value of the stock of each sponsor. As a result, the three subject ESOPs allegedly overpaid for the stock purchased by each of them. As part of the settlement agreement, FBTS also agreed to pay $15.75 million to the three ESOPs.
The FBTS settlement agreement sets out the following requirements and, although they technically apply only to FBTS, ESOP trustees and administrative committees should consider them as generally applicable compliance guidelines (these are just highlights of the new requirements):
The selection process for any Valuation Advisor must include at least three references and review of any regulatory proceedings involving the Advisor. The Valuation Advisor cannot have previously worked for either the ESOP sponsor or a committee of its employees.
Any valuation report must comment on, among other things, the financial impact of a proposed ESOP transaction and related securities acquisition debt on the ESOP sponsor (remember the Tribune ESOP!).
Valuation reports should be based on audited financial statements of the sponsor for the prior five year period. If unaudited or qualified financial statements are used, any selling shareholders who are officers, managers or directors of the ESOP sponsor must agree to compensate the ESOP for any losses attributable to inaccuracies in the sponsor’s financial statements.
If the ESOP pays a control premium for company stock, ESOP fiduciaries must document that the ESOP is obtaining voting control in fact. Any limitations on such voting control must be identified and valued in terms of amounts paid to the ESOP as “consideration” for those limitations.
Valuation reports must consider whether a proposed ESOP loan is at least as favorable to the ESOP as any loan between the ESOP sponsor and any of its executives in the prior two years.
The ESOP trustee must provide the Valuation Advisor certain specific information about the sponsor, including offers to purchase or sell its stock in the prior two year period as well as any sponsor defaults under a loan agreement, any management letters from the sponsor’s accountant and information relating to any sponsor valuations provided to the IRS during the prior five years.
The ESOP trustee must consider whether or not it is appropriate to include a purchase price adjustment or claw-back provision in any share purchase agreement in order to take into account a future corporate event or other event that might adversely affect the value of the sponsor’s stock.
The ESOP trustee must meet certain documentary requirements, including a certification by its employees who participated in decision making with respect to an ESOP transaction that they have read the valuation report and considered the reasonableness of its underlying assumptions and value conclusion.
ESOP sponsors and financial institutions involved in ESOP transactions should consider the new territory staked out in the FBTS settlement agreement. First of all, note the requirement that company insiders agree to compensate the ESOP for errors in company financial statements if those statements are not audited financial statements. Second, the normal practice of assigning a control premium in the valuation of majority stock interests purchased by ESOPs must now be questioned by ESOP fiduciaries. This means that typical arrangements that leave incumbent management in control of the voting of ESOP stock must not only be investigated by ESOP fiduciaries but also may require the fiduciaries to determine a value for any such limitations on control – and to provide that the ESOP be “compensated” accordingly.
Wednesday, 07 February 2018
Nick Saban is the highest paid college football coach in the country. In 2017, he was reportedly paid $11 million by the University of Alabama. If he is paid that amount in 2018, the recently passed Tax Cuts and Jobs Act (the “Act”) will impose an excise tax on Alabama, his employer, of over $2 million!
Why is Congress picking on Alabama?
Well, the Act applies not only to Alabama but also to other tax-exempt organizations. In order to level the playing field between tax-exempt and for-profit entities, the Act imposes a 21 percent excise tax on compensation in excess of $1 million paid to “covered employees” (the organization’s top five earners for the current and any preceding tax year). This excise tax also applies to excess “parachute payments” made to covered employees upon separation from employment. In the for-profit realm, such payments are penalized with a loss of the employer’s corresponding income tax deduction.
So, who are the likely targets of the new tax? In addition to football coaches, college presidents and highly paid executives of public charities come to mind. However, there is an exception for compensation paid to doctors, nurses, veterinarians and other licensed professionals for providing medical services. So, superstar physicians may not subject their tax-exempt employers to the new excise tax.
Tax-exempt employers may want to consider deferred compensation arrangements for executives in order to reduce current compensation. Medical service providers like public hospitals that pay compensation primarily for medical services may want to revise physician employment agreements to separate compensation paid for administrative and teaching services from compensation paid directly for medical services. In any event, there is no grandfather provision so the excise tax will apply to existing compensation arrangements for taxable years beginning after December 31, 2017 (that’s January 1, 2018 for employers with calendar tax years).
Thursday, 11 January 2018
Your retirement plan may have an outside third party administrator (TPA) to assist with plan administration. However, a TPA typically is not a fiduciary to the plan and does not act as “plan administrator” (that’s usually the employer itself as provided in a typical TPA services agreement). This leaves the employer ultimately responsible for the plan’s compliance with all applicable legal requirements. So, even if your TPA makes a mistake, the employer is likely on the hook for any resulting liability because the TPA’s services agreement usually imposes damage limits and employer indemnities that protect the TPA.
An independent service provider (maybe your current TPA) can be engaged to act as the “plan administrator” pursuant to Section 3(16) of ERISA. As a 3(16) fiduciary, the service provider assumes fiduciary responsibilities in administering the plan. The 3(16) fiduciary is responsible for all compliance activities, including the following:
- Determining employee eligibility
- Retaining plan service providers
- Preparing and filing annual reports
- Maintaining fidelity bond coverage for employees who handle plan assets
- Interpreting and applying plan provisions
- Distributing summary plan descriptions and supplements on a timely basis
- Preparing an investment policy statement
- Administration of participant loans, hardship withdrawals, as well as benefit computations and distributions
- Distributing participant notes such as summary annual reports and, as applicable, annual qualified default investment alternative (QDIA) notices, safe harbor notices and investment fee disclosures
- Reviewing and acting on reports of plan investment advisors and any private auditor
- Reviewing and implementing qualified domestic relations orders (QDROs)
Are your bases covered on all of the above? If your TPA is not involved in these compliance functions, are they adequately performed by your own employees? If not, your plan may need help from an outside service provider or even a 3(16) fiduciary.
Engaging a competent 3(16) fiduciary should provide any retirement plan the maximum compliance protection available. Just bear in mind that the employer still retains a legal obligation to prudently select the 3(16) fiduciary and to monitor the fiduciary’s ongoing performance of its duties.
Thursday, 07 December 2017
Many of us have believed that every ERISA plan must have both a plan document and a summary plan description (“SPD”). An SPD is required for all ERISA plans in order to explain them in plain English. ERISA also requires subject plans to have a “written instrument” and it is the usual practice, for retirement plans in particular, to have both a plan document and an SPD.
In the absence of a separate plan document, can a plan’s SPD itself also satisfy the ERISA “written instrument” requirement? A recent decision of the Firth Circuit Court of Appeals (Rhea v. Alan Ritchey, Inc. Welfare Benefit Plan) says yes.
Because many insured group health plans have no documentation other than an SPD, this decision may provide a defense to employers who are sued because their group health and other welfare plans are documented only by an SPD and, therefore, are alleged to fail to meet ERISA’s so-called “plan document” requirement.
In reaching its decision in Rhea, the Fifth Circuit rejected arguments that the defendant’s SPD was deficient because it referenced a separate, non-existent “plan document.” The Court also found that the SPD’s short hand description of procedures for amending the plan and its funding arrangement satisfied applicable ERISA requirements.
Although the decision in Rhea recognizes the reality that most sponsors of insured group health plans do not have a separate plan document, note that many of those plans do not even have an SPD. This is because their insurance company has provided only an insurance company “certificate of coverage.” That type of documentation as well as SPDs that lack all the required provisions are not covered by the decision of the Court in Rhea.
Sponsors of insured group health plans with only an SPD and not a separate plan document can relax – but only if their SPD’s satisfy the applicable ERISA “written instrument” requirements. Also bear in mind that there are other reasons to have a separate plan document. SPDs are prepared by insurance companies and may not include optional provisions that plan sponsors frequently include in separate plan documents. Also, more employers are adopting “wrap plan” documents that consolidate all of their welfare benefits such as group health, group life and group disability plans into a single plan to allow ERISA annual reporting on just one Form 5500.
Wednesday, 08 November 2017
It's a Familiar Story
You or your retirement plan’s third party administrator (TPA) need to make a benefit distribution to an ex-employee. But the employer’s records are out of date and the former employee cannot be located. Worse yet, the missing participant has attained age 70½ so the plan is required to make minimum distributions (RMDs) but cannot do so.
Can you sit back and wait for the missing ex-employee to come forward and claim their benefits? If they never show up, can you forfeit their benefits?
The U.S. Department of Labor (DOL) is reported to be targeting retirement plans with missing participants for audit. By examining Form 5500 annual reports, the DOL discovered that some plans were reporting a larger number of terminated vested participants who were not receiving benefits. Worse yet, the DOL was able to contact a significant number of these “missing” participants by simply sending a certified letter to their last known address. As a result, the DOL has reportedly initiated a national audit campaign targeting plans with missing participants with a view towards treating lackadaisical efforts to locate them as a breach of fiduciary duty. And, the IRS can weigh in with additional penalties for failure to make RMDs to those ex-employees who have attained age 70½.
What to do? Well, the IRS has recently provided a get out of jail card that works if you follow the mandated procedure for finding missing participants. So, what is the secret sauce?
If the plan has taken all of the following steps, the IRS will not challenge your plan for failure to make RMDs:
- Searched plan and related plan, sponsor, and publicly-available records or directories for alternative contact information.
- Used any of the search methods below:
- A commercial locator service;
- A credit reporting agency; or
- A proprietary internet search tool for locating individuals.
- Attempted contact via United States Postal Service certified mail to the last known mailing address and through appropriate means for any address or contact information (including email addresses and telephone numbers).
Also bear in mind that the DOL expects employees to be proactive and take steps to locate missing participants before their benefit start dates.
Takeaway: You or your plan’s TPA need to take appropriate steps to locate missing participants before their plan benefits are payable. This is likely to be successful with a significant number of ex-employees. However, for those who stay missing, you will want to follow the IRS drill set out above before those participants reach age 70½.
Thursday, 28 September 2017
Most larger group health plans are self-funded, which means the employer, not an insurer, is primarily responsible for paying benefits. These plans also are likely to require employee contributions towards the cost of benefits, and those contributions typically are paid to the employer (not a trust) on a pre-tax basis through a cafeteria (Section 125) plan.
Is a self-funded group health plan with more than 100 participants required to have an annual audit? There seems to be a difference of opinion among professionals on this question. But let’s look at the rules on group health plans and other “welfare plans.”
The applicable Department of Labor regulations provide certain welfare plans “relief” from the annual audit requirement. The instructions for the annual report (Form 5500) refer to DOL Technical Release 1992-01 for clarification of the exemption. That release bases the availability of relief from the audit requirement for welfare plans with more than 100 participants on whether or not the contributory plan provides benefits “solely from the general assets of the employer.” If employee contributions are used for any purpose other than paying group health or HMO premiums, then benefits are not deemed to be paid solely from the employer’s general assets – and the audit requirement would apply. This is set out in the following extract from the DOL release:
In accordance with the terms of the regulations, the relief afforded by [the regulations] is not available to any welfare plan with respect to which benefits or premiums are paid from a trust. Moreover, even in the absence of a trust…the exemptive relief would, in the absence of additional relief, be available only to those contributory welfare plans which apply participant contributions toward the payment of premiums in accordance with the terms of the regulations. For example, a welfare plan that applies participant contributions directly to the payment of benefits (or indirectly by way of reimbursement to the employer) would not qualify for exemptive relief because the benefits under such a plan could not be considered as paid solely from the general assets of the employer.
Despite the above authority, the accounting community has focused on whether or not the subject welfare plan funds benefits through a trust. Of course, if there is a trust, the audit requirement clearly applies as stated in the first sentence of the above extract. However, the above text goes on to deal with the applicability of the exemption to contributory welfare plans that do not use a trust. So it seems clear that the audit requirement does not turn entirely on the question of whether or not the plan is funded through a trust. But note Q&A 18 published by the American Institute of Certified Public Accountants which states that relief from the audit requirement for contributory self-funded welfare plans with more than 100 participants is based on whether or not the plan is funded through a trust:
Assume a partially insured H&W plan where the employer pays claims to a certain level and then reinsurance assumes the liability. There are over 100 participants, and the employer and employees each pay a portion of the premiums. The employee share is paid on a pretax basis through a section 125 plan. There is no trust established, but at year end there may be a minimal payable to the third party administrator for regular monthly charges and a small reinsurance receivable, depending on timing. Does this plan require an audit?
No, the plan does not require an audit. According to the fact pattern described, no separate trust exists to hold the assets of this plan, and therefore it is not a funded plan for ERISA purposes. ERISA exempts unfunded plans from the requirement to perform an annual audit. Participant contributions made through a section 125 cafeteria plan are not required to be held in trust per DOL Technical Release 92-1, and as long as no trust is being utilized, no audit requirement exists. (Source: AICPA Audit and Accounting Guide, Employee Benefit Plans, March 2004, Appendix A paragraphs A.25 and A.28.)
So, are the accountants right in saying that self-funded group health plans with more than 100 participants – and no trust – are always exempt from the annual audit requirement? Can that conclusion be sustained by the technical release quoted above? For sponsors of larger self-funded group health plans, the answer spells the difference between ERISA compliance and non-compliance. Remember, any plan annual report that is filed without a required plan audit is not complete and triggers a Department of Labor non-filing penalty of up to $2,063 per day.
Takeaway: Well, should you trust the accountants on this one? We are open minded, but we’re betting that the larger self-funded group health plans with employee contributions are required to have annual plan audits.
Friday, 21 July 2017
Consider a typical retirement plan sponsored by a private employer. The employer is a fiduciary to the plan along with employees who individually serve as trustees or members of the plan’s investment or retirement committee.
The employer may (should!) have concerns about the liability associated with its fiduciary status. Let’s say you are the person asked by the employer to look into this matter.
There are a number of steps you might take to protect plan fiduciaries from liability. One thing you might consider is engaging an investment advisor to act as a co-fiduciary along with the in-house staff responsible for the plan. But let’s say you take another step and engage an “investment manager” to take on “all” responsibility for plan investments. In this case, the hired investment manager actually makes all decisions about plan investment and, as a “discretionary” advisor, only notifies the employer afterwards as to specific investment transactions.
At this point, in-house fiduciaries are exempt from liability for the specific investment decisions made by the investment manager. But are the in-house fiduciaries completely off the hook?
A recent federal district court decision, Perez v. WPN Corp, et al., elaborates on what in-house fiduciaries are required to do in exactly this situation. The court holds that the plan fiduciaries who appoint the investment manager are still responsible for “monitoring” the investment manager’s performance. This duty includes adopting routine monitoring procedures, following those procedures, reviewing the results of the monitoring procedures and, most important, taking any action required to correct any performance deficiencies of the investment manager. So, whether you pick an investment advisor to act as a co-fiduciary or an investment manager to make all the decisions on plan investments, in-house fiduciaries still need to review the conduct of these professionals and take action when necessary.
- There’s no risk-free way to put your retirement plan on autopilot. Having quality service providers is a good idea but they cannot relieve you, your company or your other in-house fiduciaries from all responsibility for investment and administrative decisions.
- Some financial advisory firms charge extra to act as “investment managers.” You may find that the “extra protection” afforded by this arrangement is not really worth the additional expense.
- Consider other alternatives to mitigate fiduciary liability. This may include steps like adopting a suitable investment policy statement or obtaining fiduciary insurance. Other possibilities are outlined in “Your Fiduciary Duty – And What to Do About It” that can be viewed here.
Thursday, 18 May 2017
You’re a successful business owner and you’d like to plan ahead. Professionals are urging you to prepare a “succession plan” – but you look at it as a retirement plan. Getting out of the daily grind might be nice, but giving up your life’s work and your legacy business? Maybe not so nice. No matter how they sugar coat it, “succession planning” looks like you’re calling it quits.
Whether they call it a succession plan, an exit plan or a retirement plan, it usually amounts to a transaction where you cash in your chips and your legacy business goes away. And, as soon as you sign that transaction document, you may no longer have any input in the conduct of your own business.
Is there another way? Can you cash your chips, continue your legacy business and still have a hands-on role? Can you have your cake and eat it too? The answer for you very well may be “yes!”
An employee stock ownership plan (“ESOP”) may allow you to sell your business to your employees in a non-adversarial, tax-advantaged transaction and continue to manage operations by electing directors of your choosing. You can participate in the business as much or as little as you would like. Want to taper off over the next ten years or so? No problem!
In this way, ESOPs can treat the two major non-financial issues facing business owners “in transition”: the end of the business involvement of a lifetime, and the likely loss of the legacy business itself.
The Takeaway: If a business transition is in your future, make sure an ESOP purchase is on your short list.
Monday, 03 April 2017
If your organization sponsors a 401(k) or other retirement plan, you or someone in your organization is a fiduciary to that plan. You may have hired a service provider to administer the plan (a third party administrator, or “TPA”), but the buck stops with your organization. This is because the fine print in your TPA’s service agreement says the official “Plan Administrator” is the employer, not the TPA. This means the employer has the ultimate responsibility for the plan’s ERISA compliance.
On the investment side, the plan’s trustee or investment committee will be a responsible plan fiduciary. The investment fiduciary must act with the care, skill, prudence and diligence of a prudent person “familiar with such matters.”
This is a prudent expert standard. So ask yourself, do the people making investment decisions for your plan have a financial or investment background? If not, you need to consider engaging a professional investment advisor to assist with investment decisions.
What does all this mean to you?
Plan fiduciaries do not have to make perfect decisions but they do need to exercise diligence in their deliberation on both administrative and investment matters. It is always advisable to document fiduciary deliberations as the best defense to a claim of fiduciary misconduct. Remember, good intentions never justify fiduciary misconduct including any inattention to fiduciary duties. As one federal judge put it: “A pure heart and an empty head are not an acceptable substitute for proper analysis.”
There are other steps that plan sponsors take to help their plan fiduciaries:
- Hire an investment advisor, adopt an investment policy statement – and follow it!
- Meet with your investment advisor at least annually to review plan investments – and document these discussions.
- Perform self-help compliance checkups for your plans using IRS and Department of Labor websites.
- Consider fiduciary insurance (that’s not the plan’s ERISA fidelity bond).
- Get professional help when you need it, and consider using independent legal counsel to assure the confidentiality of sensitive plan-related information.
The Takeaway: Take another look at the bullet points immediately above. Is there any good reason not to follow each of those protective steps?
Friday, 03 March 2017
Many 401(k) plan sponsors have wisely selected investment professionals to assist in selecting the plan’s investment menu, typically a listing of various mutual funds. Other plan sponsors may allocate this duty to company officers and other key employees. In either case, the resident plan fiduciaries (the company officers and key employees who act on behalf of the sponsor as plan administrator or trustee) have a legal duty to “select and monitor” plan investments and, in the case of sponsors who have hired investment professionals – to monitor not only investment performance but also the performance of the investment professionals.
So, how do you “select and monitor?”
There’s only one hard and fast rule: Document what your investment-related decisions are and how you made them. But here are some guidelines on how to proceed:
- Investigate available investment providers. This may include banks, insurance companies, stockbrokers and mutual fund companies and their broad array of investment options. Then solicit specific information on several investment programs. This could be done in a standard format such as a request for proposal (RFP).
- Analyze costs and investment characteristics of available investments and select the investment menu that offers diversified investment options at competitive prices. Remember, your plan is not “free” if your participants pay administrative costs through reduced returns on their plan investments. So, get a handle on this kind of indirect compensation (“revenue sharing”) and make sure you take it into account.
- The general requirement is endorsed by the Supreme Court in the Tibble opinion as a “separate” duty of a trustee to “monitor trust investments and remove imprudent ones.” You should review investment results on a periodic basis with a view towards replacing laggards in your plan’s investment array.
- Compare investment results with criteria set out in your plan’s investment policy statement, or IPS (yes, having an IPS is a good idea). Also, document your decision-making process to prove that in-house plan fiduciaries have performed this duty.
The Takeaway: Process, process, process! Just going through the procedure suggested above – and providing documentary proof – could satisfy an IRS or Department of Labor inquiry even if your plan has mediocre investment results.
Friday, 03 February 2017
The Affordable Care Act (ACA) has tied the hands of employers who would like to reimburse employees for the cost of their individual health insurance coverage. Under the ACA, tax-free reimbursement of employee health insurance costs was not permitted through a health reimbursement arrangement (HRA) unless it was “integrated” with an employer-provided group health plan. Stand-alone HRAs were prohibited even for small employers that were not subject to the ACA mandate to offer group health coverage.
However, in the waning days of the Obama administration, the President signed the 21st Century Cures Act which allows “small employers” to adopt Qualified Small Employer HRAs (QSEHRAs) to reimburse covered employees for their own health insurance premiums as well as other qualified medical expenses.
Small employer means an employer that does not employ at least 50 full-time plus “full-time equivalent” employees. In other words, employers that are not required to offer ACA coverage to their employees. Full-time employees for this purpose are those working 30 or more hours per week. If a small employer does maintain a group health plan, it cannot provide QSEHRA reimbursement benefits.
QSEHRA benefits must be offered to all eligible employees. Some employees can be excluded (those under age 25, those who have been employed fewer than 90 days, part-time and seasonal employees). Annual reimbursement benefits are limited to $4,950.00 (individual) and $10,000.00 (family) with a proration of these limits for partial plan years. No employee contributions are permitted. Also, employees must personally maintain ACA minimum essential coverage to avoid taxable income on reimbursement benefits. There are additional employee notice and tax reporting requirements.
The Takeaways: For small employers with employees covered by individual ACA policies, a QSEHRA can provide tax advantaged benefits at whatever benefit level the employer selects up to the permitted maximum. Qualifying employers with a young work force may find this benefit particularly attractive as it is young workers who are paying significantly increased premiums for individual ACA coverage.
For shareholders of S corporations, their QSEHRA eligibility needs to be reviewed because of existing limits under the Internal Revenue Code on those who may have “other coverage” available through a spouse or otherwise. S corporation shareholders need to consult a tax professional if they intend to participate in their corporation’s QSEHRA. Additional guidance from the IRS on QSEHRA’s is expected, and such guidance could affect the current understanding of QSEHRA requirements.
Monday, 02 January 2017
Entrepreneurs who work hard and build a business over decades realize that, at some point, they need to think about slowing down and stepping back. Frequently, planning and specific decisions about transition are put off. Entrepreneurs worry about two things that can make delay an attractive option. Number one is a concern about their standard of living if they sell their business. Number two is facing the prospect of disposing of the entrepreneur’s legacy business that may represent a lifetime of work and achievement.
Both of these concerns are very real. First, after payment of transaction costs and taxes, the possible investment of the net proceeds of the sale of the business very well may result in a reduced cash flow to the entrepreneur and family. And, unless there’s a family member who is capable – and interested – in taking over the business, the entrepreneur justifiably feels that the legacy business may have to be surrendered. Both of these factors make it hard to let go - or even to think about letting go.
Here’s something for the reluctant entrepreneur to consider: there is a way to defer or even avoid taxes on the sale of your business, to undertake a transaction without the aggravation and delay of dealing with pesky buyers, to sell your business in installments or a lump sum - and still not give up control!
These results can be attained if the business is sold to its current employees through an employee stock ownership plan, or ESOP.
Maybe the entrepreneur you know would be more willing to plan for a business transition if he or she were aware of these ESOP possibilities.
The Takeaway: ESOPs can be more than just retirement plans and for many entrepreneurs, they offer the best succession solution.