May 2008 Vol. XI, No. 1


These past several months have been busy indeed with respect to tax and ERISA law changes affecting most types of tax-qualified, executive compensation and welfare benefit arrangements.  This Newsletter highlights the salient issues of which you should be aware, including the new Internal Revenue Service and Department of Labor regulations, pension plan amendment requirements, and employment law changes.  

We proudly announce that Marcia Wagner has been named by The 401(k) Wire as one of the One Hundred Most Influential People in the Defined Contribution Industry.  In making its assessment, The 401(k) Wire states:

“Plan sponsors seeking passionate counsel need look no further than Marcia Wagner.  Certainly, her existing clients are more loyal than most.  During her two decades in ERISA law Wagner has made her name staking out the sponsor’s side.  One of her notable stands was insisting that plan sponsors needed an independent advisor even as Fidelity attempted to provide advice through a captive advisor.  Needless to say, Fidelity eventually partnered with Ibbotson.” [1]

Ms. Wagner has been listed in The Best Lawyers in the U.S. for 2008, and has been selected as one of The Best Lawyers in America for 2008, both for ERISA/Employee Benefits Law.

Ms. Wagner was featured on Bloomberg TV on May 8, 2008 and quoted in Bloomberg News regarding the effect of the subprime fallout on pension plans.  Ms. Wagner continues to lecture, and write extensively and has recently published several articles in the Bureau of National Affairs, Tax Management Compensation Planning Journal.

Diane Goulder Cohen and Dennis T. Blair have published in the Benefits Law Journal a well-received article entitled, “Employee Plans Compliance Resolution System: A Guide for the Novice.”  Al Lurie, Marcia Wagner, Dennis Blair and Barry Newman are significant contributing authors to a soon-to-be published seminal treatise on ERISA law.

To learn more about our team and practice, please visit our website at  In the event you desire legal advice or consultation, please feel free to contact any member of The Wagner Law Group.


A............ DOL Proposes Safe Harbor for Employee Contributions to Small Plans
1.    Background 
2.    The Proposed Safe Harbor
3.    Welcome Relief
B............ DOL Publishes Revisions to Form 5500 for 2009.
1.    Overview of Schedules
2.    Form 5500 SF (Short Form)
3.    Form 5500 Reporting for 403(b) Plans
C............ Proposed DOL Rules Require Plans’ Service Providers to Disclose Fees and Conflicts of Interest.
1.    Background and Overview 
2.    Scope
3.    Disclosure Requirements
4.    Prohibited Transaction Exemption 

A............ IRS Determination Letter Program for Tax-Qualified Retirement Plans
B............ Stock Diversification Proposed Regulations
C............ Qualified Default Investment Alternatives
1.    Final DOL Rules Define Qualified Default Investment Alternatives
2.    Use of QDIAs or Mapping to Implement Change of Investment Options
D............ ERISA Litigation.
1.    Supreme Court Decides that 401(k) Plan Participants Have Standing to Sue.
2.    401(k) Fee Litigation – Different Treatment of Motions to Dismiss
3.    Stock Drop Cases Churn On 

A............ ADEA Exemption Allows Retiree Health Plans to Coordinate with Medicare.
1.    Erie County Decision 
2.    Implications
3.    ADEA Exemption 
4.    Reactions to the Exemption 
5.    Conclusion 

A............ Massachusetts Bill Mandating Treble Damages for Violations of State’s Wage and Hour Provisions Becomes Law.
B............ Family and Medical Leave Act Expansion.
1.    Overview of the FMLA Changes
2.    Issues to be Addressed in the Upcoming Final DOL Regulations
3.    Implications for Plan Sponsors

A............ Voluntary Correction Program for Code Section 409A Violations
1.    Background 
2.    Correction in the Same Taxable Year – Section II of Notice
3.    Correction in a Subsequent Taxable Year – Section III of Notice
4.    Information and Reporting Requirements

Please note footnotes appear in [ ] at the end of the newsletter.


A. DOL Proposes Safe Harbor for Employee Contributions to Small Plans

On February 29, 2008, the U.S. Department of Labor (“DOL” or “Department”) proposed a safe harbor for sponsors of plans with fewer than 100 participants who transmit employee elective contributions to a plan within seven (7) business days of the sponsor’s withholding or receipt of the contributions.  Under the safe harbor, these contributions will be considered to have been deposited with the plan in a timely fashion for purposes of Title I of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”).  Although the safe harbor is not yet finalized, the Department has indicated that plans with fewer than 100 participants may rely on the safe harbor pending the publication of final regulations.

1. Background.

ERISA provides that employee contributions to a plan must be forwarded to the plan trustee as of the earliest administratively practicable date following the employer’s receipt or withholding of the contributions.  This date is determined based on a facts and circumstances test.  Plan sponsors who hold employee contributions beyond a reasonable date may be exposed to a number of ERISA fiduciary and prohibited transaction violations.

Comment:The Department has taken an increasingly aggressive position on the matter, in some cases arguing that employee contributions could reasonably be segregated from an employer’s general assets within two (2) business days following an employee’s payday.  Although DOL regulations appear to offer a safe harbor through the 15th day of the following month, the DOL has never viewed this as a safe harbor nor “reasonable.”

2. The Proposed Safe Harbor.

The key features of the proposed safe harbor are: (i) participant contributions will be considered to have been deposited with the plan in a timely fashion when such contributions are deposited within seven (7) business days of the date the employer receives or withholds the contributions; (ii) the safe harbor is available to plans with fewer than 100 participants at the beginning of the plan year; (iii) the safe harbor applies to employee contributions to defined contribution plans as well as contributory defined benefit plans, contributory multiemployer defined contribution plans, and contributory welfare benefit plans; (iv) the safe harbor is applicable to employees’ elective deferrals as well as loan repayments; and (v) participant contributions will be considered deposited when placed in an account of the plan, without regard to whether the contributed amounts have been allocated to specific participants or investments of such participants.  The rules would also apply to post-tax contributions to welfare plans (e.g., employee contributions to a long term disability plan funded through a VEBA).

3. Welcome Relief.

A plan sponsor who utilizes the safe harbor will enjoy the certainty of compliance with certain requirements of ERISA.

Comment: Now that DOL has set a clearly defined standard, it is likely to scrutinize the timing of deposits even more than it has in the past.  Small employers currently taking more than seven (7) business days to remit employee contributions and loan payments should take immediate action to accelerate those deposits to comply with this new standard.

Comment: The proposed regulations offer no relief for plans with 100 or more participants.  The Department is still considering whether any safe harbor should apply to these larger plans, and has invited comments regarding the need for and impact of such additional relief. 

B. DOL Publishes Revisions to Form 5500 for 2009

The DOL has published revisions to Form 5500 and has delayed the effective date for the requirement of electronic filing of Form 5500.  The new forms and electronic filing requirement apply to plan years beginning on or after January 1, 2009 (Forms filed in 2010).

1. Overview of Schedules.

    The following provides an overview of the Schedules that have the most extensive changes.

2. Form 5500 SF (Short Form)

The DOL adopted a new two-page Form 5500-SF (Short Form) for certain small plans that:  (i) cover fewer than 100 participants; (ii) are eligible for the small plan DOL independent audit waiver; (iii) do not hold any employer securities; and (iv) have 100% of the plan assets  invested in assets with a readily ascertainable fair market value.

Most Short Form filers would not be required to file any schedules, except defined benefit plans will have to file a Schedule SB.

3. Form 5500 Reporting for 403(b) Plans

Effective for plan years beginning in 2009, ERISA 403(b) plans will be subject to the same annual reporting requirements that apply to ERISA-covered plans.  In addition, large (100 or more participants) 403(b) plans will be subject to the annual independent audit requirement.

C. Proposed DOL Rules Require Plans’ Service Providers to Disclose Fees and Conflicts of Interest

1. Background and Overview

On December 13, 2007, the DOL issued its long-awaited proposed rule on the subject of 401(k) fee disclosures.  The Department issued this rule against a backdrop of increased Congressional attention and media scrutiny, and it is likely to be contentious.  This Newsletter explains the key features of the proposed rule.

ERISA §408(b)(2) provides relief from ERISA’s prohibited transaction rules for service contracts or arrangements between a plan and a party in interest if the contract or arrangement is reasonable, the services are necessary for the establishment or operation of the plan, and no more than reasonable compensation is paid for the services.  The DOL has proposed amending the regulations under ERISA §408(b)(2) to (i) clarify what constitutes a “reasonable contract or arrangement” and (ii) require more comprehensive written disclosures concerning plan contracts with service providers. 

Currently, the regulations under DOL Reg. §2550.408b-2(c) state only that a contract or arrangement is not reasonable unless it permits the plan to terminate without penalty on reasonably short notice.  The DOL now proposes to add that, in order for a contract or arrangement for services to be reasonable, it must require a service provider to disclose (i) the compensation it will receive, directly or indirectly, and (ii) any conflicts of interest that may arise in connection with its services to the plan. 

Comment: The rules are proposed to take effect 90 days after being finalized.  It is unclear at this point as to how the rules will be applied to existing contracts or arrangements.

Comment: The DOL’s proposed rules are the second of three fee-related regulations that will be issued.  The first set of regulations have already been released and govern disclosures to the government (via the Form 5500), and the third set of regulations will govern disclosures to participants. 

2. Scope

a.  Limited to 3 Types of Service Providers.  The proposed rules are limited to contracts or arrangements to provide services by service providers who: (i) provide services as a fiduciary under ERISA or under the Investment Advisors Act of 1940; (ii) provide banking, consulting, custodial, insurance, investment advisory (plan or participants), investment management, recordkeeping, securities or other investment brokerage, or third party administration services, regardless of the type of compensation or fees they receive; and (iii) receive any indirect compensation in connection with accounting, actuarial, appraisal, auditing, legal or valuation services.

The DOL believes the compensation arrangements for service providers in the first two categories are most likely to give rise to conflicts of interest.  Note that service providers in the third category only have to comply if they receive indirect compensation (e.g., revenue sharing) from the arrangement. 

If the service provider falls within one of the above categories, then the contract or arrangement must satisfy the disclosure requirements in order to be deemed reasonable regardless of the nature of any other services provided or whether the plan is a pension plan, group health plan, or other type of welfare benefit plan.  The DOL cautions that plan fiduciaries still need to satisfy their general fiduciary obligations with respect to the selection and monitoring of all service providers, including obtaining and considering appropriate disclosures before contracting with service providers.

b. Limited to Services to Employee Benefit Plans.  The rules apply only to contracts or arrangements for services to employee benefit plans.  They do not apply to contracts or arrangements with entities that are merely providing plan benefits to participants and beneficiaries, rather than providing services to the plan itself (e.g., if a fiduciary contracts on behalf of a welfare plan with an HMO, the doctor that is part of the network is not considered a service provider to the plan).

3. Disclosure Requirements.

If a service provider falls within one of the three above-referenced categories, in order for a contract or arrangement to be reasonable within the meaning of ERISA §408(b)(2) and the regulations, the service provider must disclose to the plan fiduciary, in writing, to the best of its knowledge, the following: 

a. Services and Compensation.  The service provider must disclose all services to be provided to the plan and, with respect to each such service:

Furthermore, if a service provider offers a bundle of services to the plan that is priced as a package, rather than on a service-by-service basis, then only the service provider offering the bundle of services must provide the required disclosures.  However, this service provider is not required to disclose the fee allocation unless the fees are separately charged against a plan’s investment (e.g., management fees paid to mutual fund advisors) or on a transaction basis (e.g., brokerage commissions, soft dollars). 

b. Conflicts of Interest.  The service provider must disclose information about different types of relationships or interests that raise conflicts of interests for the service provider in performing plan services.  For example, service providers must disclose whether they: 


The contract or arrangement must include a representation by the service provider that, before the contract or arrangement is entered into, all the above required information has been provided to the responsible plan fiduciary.  All of the required disclosures need not be contained in the same document and may be provided in electronic format.  In addition, there is no specified timeframe to disclose the information other than prior to entering the contract. 

During the term of the contract, any “material” change to the previously furnished information must be disclosed within 30 days knowledge of such change.

4. Prohibited Transaction Exemption

Although the proposed rules shift the burden from the plan sponsor to the plan service providers, failure to comply with the proposed regulations will result in a prohibited transaction, which will impact the plan sponsor.  As a result, the DOL has also proposed a class exemption that would provide relief for a plan fiduciary that enters into a contract that is not “reasonable,” because, unknown to the fiduciary, the service provider failed to comply with its disclosure obligations under the proposed regulations.  To qualify for relief, plan fiduciaries must:

The notice to the DOL must contain the following information: (i) plan’s name and number; (ii) plan sponsor’s name, address, and EIN; (iii) plan fiduciary’s name, address, and telephone number; (iv) service provider’s name, address, phone number, and if known, EIN; (v) description of the services provided to the plan; (vi) description of the information that the service provider failed to furnish; (v) date on which such information was requested in writing from the service provider; and (vi) a statement as to whether the service provider continues to provide services to the plan. 

In addition, the fiduciary must also determine whether to terminate or continue the contract or arrangement by evaluating the nature of the particular disclosure failure and determining the extent of the actions necessary under the facts and circumstances.  Factors to consider, among others, are:  the availability, qualifications, and costs of potential replacement service providers, and the responsiveness of the service provider in furnishing the missing information. 

The exemption will be effective 90 days after the publication of the final exemption. 

Comment: There is currently no requirement for non-fiduciary service providers to supply any specific types of information to plan fiduciaries.  Now, the DOL is proposing to make service providers disclose extensive information, including the identity of third parties from whom it indirectly receives fees or compensation as a result of having a connection with the plan.  Bottom line:  Non-fiduciary service providers are going to be regulated by the DOL.

It is unclear at this point how the proposed rules will be applied to current contracts and arrangements, and the DOL will need to provide clarification.  If current contracts are impacted, there is a short timeframe for compliance (90 days after the final rules are issued).  Plan sponsors and service providers should begin preparing now to meet the required disclosure requirements. 

The fee and conflict of interest disclosures represent significant internal tracking and communication challenges for large/complex companies.  In addition, the ongoing obligation to meet the 30-day disclosure deadline of material changes, will also result in similar challenges.   

While the controversy around 401(k) fees, reported several times in prior Newsletters, clearly drove the DOL’s promulgation of these regulations, all ERISA-covered plans, including health and welfare plans, would be affected.   


A. IRS Determination Letter Program for Tax-Qualified Retirement Plans

As discussed in several of our previous Newsletters, the IRS processes applications for determination letters using a staggered five-year system.  A determination letter is the method by which a plan sponsor seeks the Internal Revenue Service’s approval that the form of a plan complies with all legal requirements.  Under this system, each individually designed retirement plan is assigned to one of five “cycles” (12-month periods starting on February 1 and ending the following January 31) based upon the last digit of the sponsor’s federal employer identification number (“EIN”).  These cycles are as follows:

EIN ends in:


First day of initial cycle:

Last day of initial cycle:

1 or 6


February 1, 2006

January 31, 2007

2 or 7


February 1, 2007

January 31, 2008

3 or 8


February 1, 2008

January 31, 2009

4 or 9


February 1, 2009

January 31, 2010

5 or 10


February 1, 2010

January 31, 2011

Additional rules apply to plans sponsored by controlled groups, governmental plans, multiple employer plans and other special situations.  The cycles will begin again on February 1, 2011, when the second Cycle A opens.
The initial Cycle A and Cycle B have both closed.  If your EIN ends in a 1, 2, 6 or 7 and you sponsor an individually designed qualified retirement plan that was not submitted for a determination letter during the applicable period, please contact our office as soon as possible to discuss your options.

Cycle C recently opened, and sponsors whose EIN ends in a “3” or an “8” should have received a letter explaining the determination letter process and the actions that will have to be taken.  Governmental plans also must be filed during Cycle C. 

Although we strive to maintain accurate records, based on our past experience, changes in organizations and EINs are not always communicated to us.  If you would like to confirm or update any information we may have regarding your organization (including your EIN), please contact our office.

Because this firm, and more importantly the IRS, believes that having a current determination letter represents a best practice for all plan sponsors, we strongly recommend that we apply on behalf of our clients for updated determination letters during the appropriate cycle.  The determination letter system anticipates that plans will file for a new determination letter only once every five years, but plans must still be amended from time to time as the law and regulations governing tax-qualified plans change.  As always, we will contact you if changes are needed to your plans if this firm has drafted and is responsible for maintenance of your plans.

B. Stock Diversification Proposed Regulations

On January 3, 2008, the IRS issued proposed regulations on the new diversification requirements for certain defined contribution plans offering employer stock as an investment option.  These requirements apply only to publicly traded companies. 

Participants cannot be required to invest salary deferrals in company stock, and they must be permitted to re-direct employer contributions invested in company stock upon the completion of three (3) years of service.  Elections to redirect such investments must be allowed on the same frequency as other plan investment elections but not less than quarterly; however, some “reasonable” restrictions are allowed to comply with insider-trading rules or to prevent short-term trading of the company stock.  The plan is permitted to impose a reasonable fee for the divestiture transactions.

The following types of plans are exempt from the new rules:

The proposed regulations are effective for plan years beginning on or after January 1, 2009, but plans are permitted to implement the new rules earlier.
C. Qualified Default Investment Alternatives

1. Final DOL Rules Define Qualified Default Investment Alternatives.

Under the Pension Protection Act (“PPA”), sponsors of defined contribution plans that offer participant-directed investments may direct the contributions from participants who do not make an investment choice to qualified default investment alternatives (“QDIAs”).  The DOL issued final regulations defining the rules applicable to QDIAs.

Assets for which a participant has not made an investment choice must be invested in one of the following three types of investments that the DOL has determined are QDIAs:

a. An investment that is diversified to minimize risk while providing varying degrees of long-term appreciation and capital preservation through a mix of equities and fixed income investments based on the participant’s age, target retirement date or life expectancy (e.g., lifecycle funds and targeted-retirement-date funds);

b. An investment that is diversified to minimize risk while providing varying degrees of long-term appreciation and capital preservation through a mix of equities and fixed income investments, consistent with a target level of risk appropriate for participants of the plan as a whole (e.g., balanced funds); and

c. An investment management service with a fiduciary allocating specific participants’ individual account assets to achieve varying degrees of long-term appreciation and capital preservation through a mix of equity and fixed income investments offered under the plan, based on the individual’s age, target retirement date or life expectancy (e.g., managed accounts).

One vehicle missing from the approved list is a capital preservation investment, such as a money market or stable value fund, which many plans had used for default investments in order to avoid investment losses.  The DOL believes that although a stable value fund can play an important role in a diversified portfolio that constitutes a QDIA, over the long term, it will not produce rates of return as favorable as those generated by the three approved investment vehicles.  The rules do permit the use of stable value funds as QDIAs under limited circumstances.  First, default investments made in a stable value fund before December 24, 2007 do not have to move solely because of the regulations.  Second, stable value funds may be QDIAs for up to 120 days after the date of a participant’s first elective contribution, provided the money is then shifted to a regular QDIA.  Money market funds do not appear to be acceptable as a QDIA for even these limited purposes.

The participant or beneficiary must have had the opportunity to direct the investment himself but did not do so.

The participant must be given a notice explaining the circumstances under which assets in his account may be invested in a QDIA.  The notice must be given to the participant by the latest of the following dates: (i) at least 30 days before he becomes eligible for the plan, (ii) at least 30 days before his funds are first invested in a QDIA, or (iii) the date of plan eligibility, but only if the participant has the opportunity to make a permissible withdrawal of the elective contributions, without additional tax or penalty.

Notice must also be provided to all participants at least 30 days before the start of each subsequent plan year.

The employer must provide the participant with informative material relating to the QDIA investment, including a description of the circumstances under which assets in his account may be invested in a QDIA; an explanation of his right to elect not to have contributions made or to direct the investments himself; a description of the QDIA, including investment objectives, risk and return characteristics, fees and expenses; and an explanation of where the participant can obtain investment information concerning other investment alternatives under the plan.

A participant or beneficiary whose assets are invested in a QDIA by default must be permitted to transfer part or all of those assets to any other investment alternative available under the plan, as often as other participants who elected to invest in the QDIA can transfer their money, but at least once every three months.  The transfer may not be subject to restrictions, fees or expenses (including surrender charges, liquidation or exchange fees, redemption fees and similar expenses), other than basic investment management, distribution and service fees.

In addition to the QDIA, the plan must offer a broad range of investment alternatives.  This requirement is similar to that required under regulations relating to Section 404(c) of ERISA, which provides similar fiduciary relief for individual account plans that permit participants to exercise control over assets in their accounts.

Comment: A plan does not have to qualify as a Section 404(c) plan for its fiduciaries to take advantage of the relief offered under the QDIA regulations.

2. Use of QDIAs or Mapping to Implement Change of Investment Options.

The creation of QDIAs has brought to the forefront the question of whether it is better from a fiduciary perspective, when revising a plan’s investment options, to map the old funds to new funds with similar characteristics or, to transfer all investments to a QDIA.   Each approach has different strengths and weaknesses from the standpoint of protection from fiduciary liability.

a. QDIAs.  Without regard to whether a plan satisfies the requirements of Section 404(c), the QDIA rules protect a fiduciary from liability for loss by reason of a fiduciary breach, subject to the condition that the participant on whose behalf the investment is made had the opportunity to direct the investment of the assets in his account but failed to do so.[3]  In other words, in order to obtain relief from potential liability, it is not enough that an account be invested in an investment option that qualifies as a QDIA; there must also be a failure to provide investment instruction by the participant.  By itself, the transfer of assets to a QDIA pursuant to the revision of a plan’s investment menu would not be the result of such a default and, therefore, would not qualify for relief.

In certain cases, it may be possible to structure the process for transferring funds to the new set of investment options so that the necessary participant default is deemed to occur.  Thus, participants could be given notice at least 30 days in advance of the transfer to the QDIA that such a transfer will be made unless the participant notifies the plan administrator that the participant wishes to have his current investments transferred directly to such one or more of the new investment options as are specifically chosen by the participant.

A disadvantage of attempting to comply with the QDIA rules is the potential volatility of QDIAs.  Except in certain narrowly-defined circumstances not applicable to investment menu changes, money market and stable value funds do not qualify as QDIAs.  As a matter of policy, the Department of Labor has limited QDIAs to investment products that emphasize long-term appreciation and include a significant equity component.  Thus, a QDIA that is used as a transition investment when a plan’s investment options are being changed is more likely than pre-PPA default funds to suffer a decline in value during the blackout period that may generate complaints by participants.

b. Mapping.  The PPA added Section 404(c)(4) to ERISA which makes relief from liability for losses available for mapping that constitutes a “qualified change in investment options.”  Relief is conditioned on satisfaction of the following requirements:

While the new mapping rules are generally favorable to employers, a practical problem looms as to how they will be applied in those circumstances where there is no similar fund or there is uncertainty as to whether the old and new funds are sufficiently comparable.  Plan fiduciaries may be vulnerable to a later claim that the replacement investment was not reasonably similar.  Thus, fiduciaries would be well advised to establish a prudent process for reviewing information on the characteristics of the old and new investments and to document the reasons for a decision to use a particular new investment as the successor to a terminated investment.

c. Conclusion.  In many respects, the QDIA and mapping approaches are similar.  For example, each approach requires that advance notice be furnished to the participant and gives the participant the power to specify a different investment option than would otherwise have been made in the course of the investment changeover.  The notice concerning alternative investments may be combined with the blackout notice.

A plan using the mapping approach must satisfy the requirements of Section 404(c) whereas the QDIA rules do not mandate Section 404(c) compliance.  Nevertheless, the QDIA rules contain elements that are similar to some of the Section 404(c) requirements, such as the requirement that the plan offer a broad range of investments [4]

The mapping approach is subject to a strong recommendation that decisions concerning the transfer of funds from a discontinued investment option to a new investment option be made pursuant to prudent process involving written substantiation of the reason for each decision.  If a loss occurs, adherence to such a process can be used to show that deference was given to the participant’s original investment decision.  The nature of the QDIA approach is inconsistent with the establishment of such a procedure.  However, the possibility of an investment loss by a QDIA during the blackout period can result in dissatisfaction by participants that an employer would prefer to avoid.  Whereas problems arising from the mapping approach can be controlled by adhering to a process, the vulnerability of the QDIA approach is subject to market forces that the employer cannot influence.  Therefore, the mapping approach may be preferable if exposure to liability for investment losses is a primary concern.

There could be a third option which combines mapping and QDIA where participants who have made investment elections are mapped over to substantially similar investment options under the new platform, whereas participants who have not made investment elections under the old platform have their assets transferred to a QDIA.  That could well combine the best of both worlds.

D. ERISA Litigation

1. Supreme Court Decides that 401(k) Plan Participants Have Standing to Sue.  

a. LaRue Case.  The much anticipated question of whether an employee can sue to recover losses in his 401(k) plan account when the plan sponsor or other fiduciary mishandles his account has now been answered in the affirmative by the Supreme Court.  Anticipating this decision, the Sixth Circuit Court of Appeals also decided a case making relief available for fiduciary breaches that only affect some of a plan’s participants.

In LaRue v. De Wolff, Boberg & Associates, Inc., decided on February 20, 2008, the Supreme Court focused on Section 502(a)(2) of ERISA, a provision that allows participants and beneficiaries to sue for “appropriate relief under Section 409” of ERISA.  Section 409, in turn, provides that any person who is a fiduciary with respect to a plan who breaches any of the responsibilities, obligations, or duties imposed on fiduciaries by Title I of ERISA “shall be personally liable to make good to such plan any losses to the plan resulting from each such breach ….”  (Italics added.)  In LaRue, a plan participant sought to use these provisions to recover a loss of $150,000 suffered when the plan administrator failed to properly implement the participant’s instructions as to how his account should be invested.

In reviewing LaRue’s claim against the plan administrator, the Fourth Circuit Court of Appeals had affirmed a district court judgment for the defendant administrator on the ground that recovery under Section 502(a)(2) of ERISA must inure to the benefit of the plan as a whole, not to particular persons with rights under the plan.  Why this should be so as a matter of policy was a focal point of the oral argument before the Supreme Court, with Justice Breyer posing the hypothetical situation of a 401(k) plan consisting of 1,000 diamonds, half of which were stolen by a corrupt trustee.  Justice Breyer asked why it should matter whether the diamonds came from one central safe deposit box or whether they were kept in separate boxes and labeled with the names of individual participants. 

In ruling for LaRue, the Supreme Court’s opinion (by Justice Stevens) picked up on this theme stating that, “[w]hether a fiduciary breach diminishes plan assets payable to all participants and beneficiaries, or only persons tied to particular individual accounts, it creates the kind of harms that concerned the draftsmen of §409” and for which recovery under Section 502(a)(2) is available.  A concurring opinion by Justice Thomas (in which Justice Scalia joined) noted that, “[b]ecause a defined contribution plan is essentially the sum of its parts, losses attributable to the account of an individual participant are necessarily ‘losses to the plan’ for purposes of §409(a).”
Nevertheless, the LaRue saga is not over.  As noted in Justice Stevens’ opinion, LaRue must prove his allegations that the plan administrator breached its fiduciary obligations and that those breaches had an adverse impact on the value of plan assets.  Further, LaRue will have to overcome any defenses raised by the administrator which might include the objections that LaRue did not give his alleged investment directions in accordance with the requirements of the plan, that he failed to exhaust the plan’s administrative remedies before bringing his legal action and that he failed to assert his rights in a timely fashion.  There seems to have been some question as to how diligent LaRue was in ensuring that his investment instructions were carried out which might become a factor if and when the case actually goes to trial.

As suggested by Chief Justice Roberts in another concurring opinion, there is also nothing to prevent the lower courts from considering an argument that LaRue’s claim is more properly regarded as a claim for plan benefits under Section 502(a)(1)(B) of ERISA than a claim under Section 502(a)(2) based on a fiduciary breach.  This could preclude the fiduciary claim and make available additional defenses, such as the exercise of the plan administrator’s discretion to interpret plan terms and to determine benefit eligibility.

Comment: Plan sponsors and administrators should take the opportunity to review their plan and investment procedures and policies to ensure that participants’ investment decisions are being implemented properly and in a timely manner.  Plan sponsors and administrators should also take steps to ensure that appropriate investment records are being maintained.  Self-audit procedures can be a helpful mechanism to ensure proper plan administration, both with regard to investments and as to the operation of the plan more generally.

b. Sixth Circuit Gives An Affirmative Answer to the Standing Question.  In the meantime, the Sixth Circuit Court of Appeals, in Tullis v. UMB Bank, N.A., 2008 WL 215535 (6th Cir. 2008), has indicated its belief that a Section 502(a)(2) claimant need not seek relief in a representative capacity for the entire plan.  In Tullis, two 401(k) plan participants sued a bank trustee, because it knew of, but failed to inform the participants of, fraud perpetrated by their investment advisors.  The two participants requested the plan to bring suit against the bank for fiduciary breach, but the plan refused, citing an indemnity clause in the trust agreement holding the bank harmless.  When the participants filed their own action, the district court granted a motion to dismiss, finding, among other things, that they lacked the standing to sue under Section 502(a)(2). 

In reversing the lower court and upholding the plaintiffs’ claims, the Sixth Circuit disagreed with the reasoning of the Fourth Circuit in LaRue and held that the goal of ERISA was to ensure that relief is available in cases of fiduciary breach.  Basing its decision squarely on Section 502(a)(2) of ERISA, the Sixth Circuit concluded that the plain language of the statute compelled the conclusion that individual participants should have standing to seek recovery for plan assets without resort to a class action.  There was no hint in the Sixth Circuit’s opinion that the claim should have been made directly against the plan as a claim for benefits.  This may be an early indication that the lower courts will not require claims of fiduciary breach by defined contribution plan participants to go forward only as an action against the plan.

2. 401(k) Fee Litigation – Different Treatment of Motions to Dismiss.

a. Failure to State a Claim in Deere.  In the latter half of 2006 and early 2007, a number of lawsuits were brought against large employers alleging that 401(k) plans that they sponsored had charged participants’ accounts investment related fees and expenses that were inappropriate and/or excessive and that participants received inadequate disclosure regarding such fees and expenses.  The defendants routinely filed pre-discovery motions to dismiss which were generally denied.  The arguments for dismissal are based on the contention that the complaint fails to set forth facts that could give rise to a breach of fiduciary duty.  Courts have been reluctant to dismiss a case before there has been fact finding that could support a claim.  A major exception to this trend is Hecker v. Deere, 2007 WL 1874367 (W.D. Wis. 2007), which granted early stage motions to dismiss made by the employer, Deere & Company, and two Fidelity entities that were plan service providers.

Deere sponsored and administered 401(k) plans for its employees.  The plans offered 20 Fidelity investment options while trustee, recordkeeping, and administrative functions were handled by Fidelity Management Trust Company and Fidelity Management and Research Company.  (Significantly, the Deere plan also made available a brokerage window that provided participants with access to more than 2,500 other mutual funds.)  The complaint alleged that the defendants violated their fiduciary duties in two ways: first, by providing investment options with excessive and unreasonable fees and costs; and, second, by failing to adequately disclose information about the fees and costs to plan participants.

With respect to the first allegation, the court held that Deere was not liable for losses due to excessive fees, because it met the requirements of the safe harbor provided by Section 404(c) of ERISA.  This position contradicts the Department of Labor’s view that the safe harbor is not available unless ERISA’s requirements of loyalty and prudence are satisfied with respect to the initial selection of the investments that are made available on the investment platform.  The Deere court indicated its view that such a fiduciary breach did not affect the applicability of the Section 404(c) defense “because of the nature and breadth of the funds made available to participants under the plan.”  In other words, if a plan provides enough investment offerings, there is no liability for placing poor performers on the investment platform.  This holding is controversial and has been challenged in an appeal.

As to the second allegation involving disclosure to participants of indirect costs, such as revenue sharing, the Deere court found nothing in ERISA or applicable regulations, including the general fiduciary obligations thereunder, that would require such a disclosure.  The court reasoned that to mandate disclosure of revenue sharing would require judicial expansion of a detailed statutory and regulatory scheme. 

On December 13, 2007, the Department of Labor issued proposed regulations that condition exemption from ERISA’s prohibited transaction rules on making such disclosures to plan fiduciaries, having previously amended the Form 5500 instructions to require fee disclosure.  While it is not clear that the Deere court would regard the proposed rules as relevant, the Department of Labor’s views may be cited on any appeal, and the Department has filed an amicus brief generally in favor of the plaintiff’s case to the Court of Appeals.

Comment: The Court of Appeals decision, which should be rendered in the near future in the Deere case, will have tremendous implications for the 401(k) fee litigation cases and whether, in general, they move forward or not.  A ruling in favor of the plaintiffs could lead to many more class actions suits against plan sponsors and investment advisors alleging fiduciary breaches with respect to fees and expenses 401(k) plans have borne.

b. Plaintiff in Phones Plus Allowed to Proceed.   In contrast to the Deere case, the federal district court in Phones Plus, Inc. v. Hartford Financial Services Group, Inc. 2007 WL 3124733 (D. Conn. 2007), which on October 23, 2007 denied a motion to dismiss, adopted a far more lenient approach to the plaintiff’s pleadings. 

The plaintiff, a sponsor of a 401(k) plan, alleged that Hartford Life Insurance Company and its holding company parent, as well as the 401(k) plan’s investment adviser, had breached their fiduciary duties as a result of revenue sharing agreements that Hartford had entered into with various mutual fund companies.  Hartford moved for dismissal on the ground that it was not a fiduciary and that, in any case, revenue sharing payments are not plan assets.  The investment adviser also moved for dismissal on the ground that investigating Hartford’s receipt of revenue sharing payments was beyond the limited scope of its fiduciary obligations as an investment adviser and that, in any event, it did not know of and did not receive any of the revenue sharing payments.  The motions to dismiss with respect to both defendants were denied.

The most significant aspect of the Phones Plus decision may lie in the court’s conclusion that it is possible to allege a set of facts (to be proven in subsequent phases of the case) under which revenue sharing payments are plan assets.  As to Hartford Life’s status as a fiduciary, the court ruled that the company’s power to add, delete or substitute mutual funds to or from the plan’s menu of funds could render it a fiduciary, notwithstanding Department of Labor Advisory Opinion 1997-16A that reached a contrary conclusion on similar facts.  The court noted that the question of fiduciary status is inherently factual and depends on the particular actions or functions performed on behalf of the plan.  The advisory opinion was held to be inapplicable, because its facts differed from the facts alleged by the plaintiff.  For example, Hartford gave a plan only 30 days’ advance notice when it proposed to make a change in its fund lineup, whereas under the advisory opinion the plan had been given 120 days to accept proposed changes or to reject them and terminate the contract.

As to the investment adviser’s contention that it had no duty to investigate Hartford’s receipt of revenue sharing, the court indicated that the scope of the adviser’s fiduciary duties was  a matter to be determined by interpreting the terms of the advisory agreement.  This enabled the court to conclude that the plaintiff had made allegations as to the adviser’s obligation to investigate, discover, and inform the plaintiff of allegedly unlawful or excessive fees that might be substantiated during a trial.

3. Stock Drop Cases Churn On

Courts have continued to review fiduciary responsibility in so-called stock drop cases targeting companies that required or allowed the investment of retirement plan assets in a nondiversified company stock fund offered as part of a plan.  One of the most significant recent decisions in this category was DiFelice v. US Airways Inc., 497 F.3d 410 (4th Cir. 2007), decided in August of last year.  The Fourth Circuit Court of Appeals held that US Airways did not breach its fiduciary duties by allowing 401(k) plan participants to continue investing in company stock during the period leading up to the company’s bankruptcy filing.

The plan in US Airways offered 13 different investment options, including the company stock fund.  The company’s already tenuous financial condition was exacerbated by the attacks of September 11, 2001, and the price of its stock suffered a precipitous decline.  The case focuses on the conduct of the company and its Pension Investment Committee, acting as the plan administrator, subsequent to this drop in the stock’s price and up to the bankruptcy filing the following August.  During this period, the company hoped to resurrect its fortunes by applying for a federally guaranteed loan, although its efforts in this regard eventually failed because of its inability to obtain concessions from labor, creditors and lessors.  Shortly before applying for the loan, the company appointed an outside independent fiduciary for the company stock fund.  During the critical period, the Pension Investment Committee continuously monitored the stock fund and held at least four meetings at which it considered whether to continue to offer the fund as a plan investment.  The Committee also met with outside counsel who indicated that it was unnecessary to discontinue the fund at that time, perhaps relying on the fact that the stock price had experienced a slight rebound and, as of April, 2002, was holding steady.  However, once US Airways filed for bankruptcy, the independent fiduciary directed the closure of the stock fund and transferred any of its remaining cash to the plan’s money market fund.

US Airways employees brought a class action against the company, the independent fiduciary of the stock fund, and the plan’s trustee.  The claims against the trustee and the independent fiduciary were eventually dismissed, and after a six-day bench trial, judgment was granted to the company, as well.  The employees appealed the lower court’s judgment in favor of the company arguing that it had breached its ERISA duties of prudence by insufficiently monitoring the performance and prospects of the stock fund.  The Fourth Circuit rejected this argument emphasizing that prudence is a matter of process not of hindsight.  According to the Fourth Circuit, the relevant question is “whether the fiduciary engaged in a reasoned decision-making process consistent with that of a prudent man,” and, based on the facts, it concluded that this question could be answered affirmatively.  It noted that, unlike other stock drop cases (e.g. the Enron litigation), the employees were not compelled to invest in the company stock fund and were free to trade in and out of the fund until it was closed.

The appellate court also found no evidence of a breach of loyalty, noting that an allegation of a conflict of interest cannot be based solely on the corporate position of a plan fiduciary.

The employees also argued that the lower court had erroneously based its conclusion that the company had not breached its fiduciary duties by improperly applying the modern portfolio theory.  This theory holds that investing in a risky security as part of a diversified portfolio is an appropriate means of increasing return while minimizing risk, and it was noted that the US Airways plan offered varied investment options that covered the range of the risk/return spectrum.  The Fourth Circuit ultimately concluded that there was no basis for reversing the lower court because the lower court’s decision had not rested on the application of the modern portfolio theory.  While the lower court’s reference to the theory was not a reversible error, the Fourth Circuit felt that its relevance had been overstated, and it noted that, standing alone, the theory cannot provide a defense to a claimed breach of the duty to act prudently.  Thus, the prudence of each investment or class of investments must be evaluated individually.

According to the Fourth Circuit, “a fiduciary cannot free himself from his duty to act as a prudent man simply by arguing that other funds, which individuals may or may not elect to combine with a company stock fund, could theoretically, in combination, create a prudent portfolio.”  The Fourth Circuit’s view that investment options must be judged individually refutes the basis on which dismissal was granted in the Deere case, discussed above, where the possibility of investing in a wide range of alternative funds was thought to insulate a fiduciary from liability for selecting an investment option with excessive or unlawful fees for inclusion in the investment menu. 


A. ADEA Exemption Allows Retiree Health Plans to Coordinate with Medicare

The Equal Employment Opportunity Commission (“EEOC”) has issued the long-awaited, final rules on its exemption from the Age Discrimination in Employment Act (“ADEA”) that officially permits employers to continue the common practice of coordinating retiree health plans with Medicare (or comparable state retiree health benefit plans).  The exemption allows employers to provide retirees who are eligible for Medicare with reduced health care coverage as compared to the benefits that are provided to younger retirees, without attempting to defend this practice by demonstrating compliance with the “equal cost or equal benefit” defense requirements of the ADEA.

ADEA, generally speaking, applies to employers with at least 20 employees and prohibits discrimination against an employee or job applicant who is at least 40 years of age.  It is the view of the EEOC that the ADEA also applies to retired employees.

1. Erie County Decision.

The EEOC exemption effectively overrules the decision by the U.S. Court of Appeals for the Third Circuit in Erie County Retirees Association v. County of Erie,220 F. 3d 193 (3rd Cir. 2000) which held that Erie County, Pennsylvania violated ADEA for its own retirees by coordinating its retiree health plans with Medicare eligibility.  Erie County had covered all retirees over age 65 through a Medicare HMO.  Retirees not yet eligible for Medicare were covered by a point of service plan that allowed enrollees to select between an HMO and a traditional indemnity option.  The Third Circuit ruled that ADEA prohibits an employer from treating retirees differently based on Medicare eligibility, unless the employer could meet the “equal benefit or equal cost” defense.  This defense would require an employer to provide equal benefits to younger and older retirees or to provide inferior benefits to older retirees only if it could prove that the cost of those inferior benefits was not less than the cost of the younger retirees’ benefits.  To make matters more difficult, the Third Circuit also ruled that the employer could not include the costs that Medicare incurs on behalf of older retirees in applying an equal cost defense.

After the case was remanded to the lower court, Erie County conceded it could not use the equal cost defense.  The lower court then found that the older retirees’ benefits were inferior to the younger retirees’ benefits.  In addition to the fact that the older retirees were not allowed to choose between different forms of coverage (HMO vs. traditional indemnity), while the younger retirees could choose either type of plan, the older retirees were required to pay a greater portion of the total cost of their coverage than younger retirees.  Also, the health plan for younger retirees did not restrict participants to a prescription drug formulary, while the plan for older retirees did contain such a restriction. 

To comply with the Third Circuit’s decision, Erie County was caught in a bind where it would have to either: (a) increase the older retirees’ health benefits to match the younger retirees’ health benefits, or (b) cut the younger retirees’ health benefits to match the older retirees’ health benefits.  Not surprisingly, Erie County chose the second alternative.  It transferred all younger retirees from the point of service plan to an HMO plan similar to one available to retirees over age 65.  Erie County also required employees not yet eligible for Medicare to pay a monthly amount for such coverage equal to the monthly Medicare Part B premiums paid by retirees over age 65.

2. Implications.

Although the Erie County decision applied only in the Third Circuit (Delaware, New Jersey, Pennsylvania, Virginia), the case had implications for employers throughout the country that sponsor retiree health, life or other welfare benefit plans that differentiate in coverage between pre-65 and post-65 Medicare-eligible retirees.  For example, Erie County called into question several popular retiree health plan designs, including: (i) requiring that post-65 retirees use Medicare HMOs but not requiring managed care for pre-65 retirees; (ii) discontinuing retiree medical coverage when a retiree reaches age 65; (iii) providing certain benefits to pre-65 retirees, such as outpatient prescription drug coverage, that are not provided to post-65 retirees; and (iv) establishing different employer subsidies for post-retirement health benefits of pre-65 and post-65 retirees. 

Because of the dramatic increases in the cost of retiree health coverage, the EEOC was concerned that the decision by the Third Circuit would cause other employers to reduce or eliminate health coverage for younger retirees.  For example, some employers might have discontinued providing pre-age 65 retirees with early retirement coverage through the health plan established for active employees if the employers could not end the coverage when retirees become eligible for Medicare.  This could occur because many employers would not want to incur the additional cost of supplementing Medicare coverage for older retirees in order to match health coverage provided to early retirees.

3. ADEA Exemption.

Using its statutory authority to create reasonable exemptions to the ADEA when it is in the public interest, the EEOC issued a regulatory exemption that would allow employers to reduce or eliminate employer-provided retiree health coverage for retirees eligible for Medicare (or a state-sponsored retiree health benefits program).  The exemption applies both to existing and new employer-provided retiree health benefit plans.

Therefore, under the exemption, an employer would not engage in age discrimination if it provides greater benefits to early retirees and then reduces or eliminates the benefits when a retiree enrolls in Medicare.  Employers could also reduce or eliminate retiree health benefits once a retiree becomes eligible for Medicare or state health coverage, even if the retiree does not actually enroll in those benefits. 

The exemption specifically permits “carve-out” plans which reduce the benefits available under a retiree health care plan by the amount payable by Medicare or a comparable state health plan.  Employers may make Medicare, or the state plan, the primary payer of health care benefits for the older retirees.  In addition, an employer may apply the exemption to the health care benefits of the spouse or dependents of the retiree.  Because health care benefits provided to a spouse or dependent need not be identical to the benefits provided to retirees, those benefits may be altered, reduced or eliminated when the spouse or dependent becomes eligible for Medicare, regardless of whether similar action is taken with respect to the benefits of the retiree.

The exemption only covers the narrow practice of coordinating employer-sponsored retiree health benefits with enrollment or eligibility for Medicare or a comparable state health benefit program.  The EEOC emphasized that all other aspects of retiree benefit programs and practices related to former employment are not affected by this ADEA exemption.  The EEOC also stressed that its enforcement of the ADEA rules for group health plans of active employees will not be affected by the exemption.  Therefore, this exemption does not apply to benefits that are provided to current, active employees, even if they are at or over the age of Medicare eligibility (that is, age 65 or older).

However, before the exemption could go into effect, the AARP sued the EEOC challenging the exemption’s validity, claiming that the exemption was arbitrary, capricious, an abuse of discretion and not in accordance with the ADEA.  After a lower court prevented the EEOC from issuing final regulations while the case was pending, this case also came up before the Third Circuit in AARP v. EEOC, 489 F.3d 558 (3rd Cir. 2007), which ruled that, under the plain language of the law, any provision of the ADEA may be subject to an exemption by the EEOC if the exemption is reasonable, necessary and proper in the public interest.  The court said this exemption for retiree health care coverage met the criteria because the current interpretation of the law would generally lead to a reduction in retiree benefit coverage, as it had in the Erie County situation.  It therefore allowed the EEOC to issue the final exemption.

4. Reactions to the Exemption.

In its News Release on the implementation of the exemption, the EEOC says that “the Erie County decision would have made most existing retiree health plans unlawful...which would force employers to reduce or eliminate the retiree health benefits they currently provide....  EEOC’s new rule will ensure that employers can continue to offer their retirees much needed health benefits.”  It then went on to point out that not only employers were opposed to the Erie County ruling but also labor unions and other organizations, such as the AFL-CIO, the American Federation of Teachers, the Society for Human Resource Management and the American Benefits Council which also recognize that the Erie County decision would have resulted in the reduction or elimination of post-employment health care coverage by many employers.

On the other hand, AARP’s legislative policy director said that, “It is a wrong-headed move to legalize discrimination, allowing employers to back off their health-care commitments based on nothing more than age.”  Another AARP official said that this exemption would give “employers free rein to use age as a basis for reducing or eliminating health care benefits for retirees 65 or older.”  AARP, therefore, appealed the decision to the U.S. Supreme Court. 

5. Conclusion.

The Supreme Court has determined it will not review the AARP decision, ending the litigation.  As noted by the president of the American Benefits Council, “The new rule is a victory for common sense and for retirees.  Retiree health care coverage has been declining for many years.  Without this exemption, many more retirees, especially early retirees, could find themselves without employer-sponsored coverage” because employers would not be given the freedom to design their retiree health plans in a manner that takes into account the growing cost of health care benefits and the differing needs of retirees at different stages of retirement.


A. Massachusetts Bill Mandating Treble Damages for Violations of State’s
Wage and Hour Provisions Becomes Law

On April 14, 2008, Senate Bill 1059 became law when Governor Deval Patrick neither signed nor vetoed the legislation.  Under this statute, Massachusetts courts will be required to award treble damages (i.e., triple the amount of lost wages or other benefits) whenever an employee prevails in a wage and hour claim under state law. 

Previously, courts had interpreted language in the Commonwealth’s wage and hour statutes as giving courts the discretion to award treble damages in cases where the employer’s conduct was egregious.  The new law will allow courts no discretion, requiring the award of treble damages for every violation of state wage and hour laws.  The new law will take effect on July 13, 2008.

Comment: Even inadvertent violations based on an employer’s good-faith misunderstanding of its legal obligations will be subject to treble damages.

The Commonwealth has numerous wage and hour statutes, the applications of which are often confusing and unclear to employers.  These laws govern, among other matters: (i) timely payment of wages; (ii) minimum wage; (iii) overtime payments; (iv) tip payments; and (v) incentive compensation (bonuses and commissions).

The new requirement of mandatory treble damages, coupled with existing provisions for mandatory payment of a prevailing employee’s reasonable attorney’s fees and costs, will increase the frequency with which these claims are brought as well as the potential liabilities faced by employers.  This means that it is important that Massachusetts employers ensure that their wage and hour practices are fully compliant with state law.

B. Family and Medical Leave Act Expansion

On January 28, 2008, the President signed the National Defense Authorization Act into law.  Section 585 of that Act contains amendments to the Federal Family and Medical Leave Act (“FMLA”).  These FMLA amendments have important implications for employers subject to the law.  They also have important implications for group health plans due to the existing FMLA requirement that group health coverage be continued during periods of FMLA leave.

Prior to the amendment, the FMLA provided that an eligible employee is entitled to a total of 12 weeks of unpaid FMLA leave during any 12-month period:  (i) because of the birth of the employee’s child and to care for the child after birth; (ii) because of the placement of a child with the employee for adoption or foster care; (iii) to care for the employee’s child, spouse or parent with a serious health condition; or (iv) because of the employee’s own serious health condition that makes the employee unable to perform the functions of his job.  To be eligible for such leave, the employee must have worked for the employer for at least 12 months and for at least 1,250 hours in the 12-month period preceding the employee’s leave and be employed at a worksite at which the employer employs at least 50 employees (or the total number of employees employed by that employer within 75 miles of that worksite is at least 50).


1. Overview of the FMLA Changes.

The Act creates the following two new types of FMLA leave:

a. Care for Servicemember.  An employee who is the spouse, son, daughter, parent or next of kin (i.e., nearest blood relative) of a covered servicemember is now entitled to a total of 26 weeks of leave during a 12-month period to care for the servicemember.  A servicemember is a member of the Armed Forces, including National Guard or Reserves, who is undergoing medical treatment, recuperation, or therapy (including on an outpatient basis) for a serious injury or illness.  The injury or illness must have been incurred while on active duty, and it must be an injury or illness that may render the servicemember unfit to perform the duties of his office, grade, rank or rating.  For an employee taking this new type of leave, along with FMLA for any other purpose (e.g., birth of a child), the combined total leave required during one 12-month period is 26 weeks.  This became effective on the law’s enactment.

b. Leave for a “Qualifying Exigency.  The list of reasons for which employees may take up to 12 weeks of leave (in one 12-month period) has been expanded to include the following: leave needed for a “qualifying exigency” rising out of the fact that the employee’s spouse, son, daughter or parent is on active duty (or has been notified of an impending call or order to active duty) in the Armed Forces in support of a contingency operation.  This type of leave will become effective once the DOL issues final regulations.  In the interim, the DOL encourages employers to provide this type of leave to qualifying employees.

These new types of leave are folded into the existing statutory framework.  As a result, existing FMLA provisions relating to intermittent leave, reduced leave schedules, the substitution of paid leave for unpaid FMLA leave, required notices and medical certifications generally apply to these new types of leave.

2. Issues to be Addressed in the Upcoming Final DOL Regulations.

On February 11, 2008, the DOL proposed new rules relating to FMLA generally.  These proposed rules include further guidance on the FMLA’s notice requirements, the definition of an “eligible employee,” and when an employee may take leave to care for a family member.  The rules also include a lengthy discussion of the new military family leave requirements and raise many questions on which the DOL sought public comments.

3. Implications for Plan Sponsors

The requirement to maintain group health plan benefits during FMLA leave will apply to these new types of leave.  The Act does not contain any new provisions relating to how the employer may collect the employee’s share of the premium payment during leave.  However, similar to the previous rules, it prohibits recovering employer-paid premiums when employees fail to return to work due to the continuation, recurrence or onset of a service member’s serious health condition.  Employers may require certification from the service member’s health care provider in these circumstances.

Comment: Group health plan documents and other employee benefits communications materials frequently summarize the circumstances when employees are entitled to leave under the FMLA or discuss when the employer may recover premiums paid.  Those documents may need to be amended to be consistent with these new FMLA provisions. 


A. Voluntary Correction Program for Code Section 409A Violations

In Notice 2007-100, the Internal Revenue Service and the Treasury announced a voluntary correction program for operational violations of Internal Revenue Code (the “Code”) Section 409A.

1. Background.

As discussed in previous Newsletters, Code Section 409A, added by Section 885 of the American Jobs Creation Act of 2004, broadly governs the taxation of all manner of nonqualified deferred compensation.  Under Code Section 409A(a), amounts deferred under plans of nonqualified deferred compensation for all tax years are taxed currently to the extent not subject to a substantial risk of forfeiture and not previously included in income, unless the plan meets the substantive requirements of Code Section 409A.  Failure to comply with the requirements of Code Section 409A in both form and operation results in inclusion in income of amounts deferred under the nonqualified deferred compensation plan plus a 20% excise tax penalty together with interest at the underpayment rate plus 1%.  Code Section 409A is Draconian; minor glitches in plan terms or operation can trigger significant penalties.

Comment: Given the very real potential for huge sanctions, the creation of a voluntary correction program is as helpful as it is necessary.

2. Correction in the Same Taxable Year – Section II of Notice.

The Notice provides certain penalty-free relief for corrections that are made in the same year as the error.  To be eligible for relief, the error must constitute an “unintentional operational failure.”  Plan drafting errors are not eligible for relief.  An “unintentional operational failure” means an unintentional failure to comply with plan provisions that satisfy the requirements of Code Section 409A or an unintentional failure to follow the requirements of Section 409A in practice due to one or more inadvertent errors in the operation of the plan.  Only the following failures may be corrected:  (i) failure to defer a correct amount into the plan; (ii) a violation of the required six-month delay for distributions in the case of separations from service by key employees of public companies; (iii) the deferral of an excess amount; or (iv) an error in determining the proper exercise price of a stock right.

The Notice establishes the following threshold requirements for relief: (i) the employer must meet certain information and reporting requirements (described below) and must take reasonable steps to avoid recurrence of the failure; (ii) where a similar error has occurred, the employer must be able to demonstrate that it has adopted policies and procedures to reasonably ensure that the failure will not recur; (iii) relief is not available in a year in which the employer experiences a substantial downturn in its business or operations that indicate that it would not be able to pay the deferred compensation when due; and (iv) in the case of audit or examination, the taxpayer has the burden of establishing that the requirements of the Notice have been satisfied.


Where the amounts erroneously paid or made available exceed the Code Section 402(g)(1)(B) limit (i.e., $15,500 in 2008) and the employee is an “insider,” an interest adjustment is required based on the short-term applicable federal rate under Code Section 1274(d)(1).  An “insider” is defined under Section 16 of the Securities Exchange Act to mean generally officers, directors, and more-than-10% owners.

b. Payments Violating the Six-Month Delay Requirement for Key Employees of Public Companies.  A violation of the six-month delay for a distribution from a nonqualified deferred compensation plan to a key employee of a public company upon separation from service may be corrected if the key employee repays the amount that was untimely paid or made available.

c. Correction of Excess Deferred Amounts.  When the inadvertent operational failure involves a credit to a deferred compensation plan that should have been currently paid to an employee, correction requires that the employer pay the erroneously credited amount to the employee by the end of the employee’s tax year.  Additionally, the amount of deferred compensation to which the employee has legally binding right as of the end of the year must be adjusted accordingly for the rate of return.

d. Correction of Exercise Price of Otherwise Excluded Stock Rights.  The final Code Section 409A regulations contain an important exception under which “stock rights” (i.e., stock options and stock appreciation rights) are exempt from regulation as deferred compensation if, among other things, the exercise price is not less than the underlying stock’s fair market value (“FMV”) on the date of the grant.  Where this requirement is not satisfied, the stock right is treated as subject to Code Section 409A from the date of grant.  Where, by virtue of an inadvertent operational failure, a stock right is granted at less than FMV, the Notice provides relief if, before the stock right is exercised and not later than the last day of the employee’s tax year in which the grant occurs, the exercise price is reset to an amount equal to or exceeding the FMV of the underlying stock on the grant date.

3. Correction in a Subsequent Taxable Year – Section III of Notice.

The Notice provides limited relief for certain inadvertent unintentional errors that are corrected not later than the second calendar year following the year in which the error occurred, so long as the amount involved does not exceed the limits prescribed by Code Section 402(g) (i.e., $15,500 in 2008).  This relief is only available for corrections made before January 1, 2010.  To be eligible for correction the error must be one of the following: (i) failure to defer the correct amount into the plan, resulting in an incorrect payment not exceeding the Code Section 402(g) limit; (ii) a payment not exceeding the Code Section 402(g) limit that violates the six-month delay for distributions to specified employees of public companies; or (iii) an excess deferral not exceeding the Code Section 402(g) limit.

a. Failure to Defer the Correct Amount into the Plan.  This provision addresses instances in which deferred compensation is inadvertently paid to an employee in violation of the plan’s terms in an amount less than the Code Section 402(g) limit and the error is not discovered in the year in which the payment occurred.  So long as the error is discovered within two years, and the correction made before 2010, the amount of tax due is limited in two important respects:  first, only the erroneous payment is subject to tax, and second, while the 20% excise tax is applied, the interest penalty is waived.

b. Payment that Violates the Six-Month Delay for Distributions to Key Employees.  The rules that apply to inadvertent operational errors relating to payments in violation of the six-month delay for distributions to key employees of public companies in connection with separations from service under the Notice are similar to those described above in connection with deferral failures.  Amounts affected by the violation are taxed, but the sanctions are limited.

c. Excess Deferrals.  If an amount is erroneously credited to an employee as deferred compensation, relief is available so long as the amount at issue does not exceed the Code Section 402(g) limit ($15,500 for 2008).  Correction must be made not later than the last day of the year in which the error is discovered, or, if later, by the 15th day of the third month following the date of discovery.  Adjustment may be made for earnings and losses, but this is not required.  The employee must include the amount in income and pay the 20% excise tax, but the interest penalty does not apply.

4. Information and Reporting Requirements.

To take advantage of the relief afforded by the Notice, employers are required to satisfy certain reporting requirements.

a. Correction Under Section II.  Where the correction is under Section II (other than in connection with a correction relating to stock rights), i.e., correction is made in the same tax year, the employer must attach to its timely filed federal income tax return a statement entitled “Section 409A Relief under Section II of Notice 2007-100” setting out the name and taxpayer identification number of affected employees and whether the employee is an insider.  The employer’s statement must identify the nonqualified deferred compensation plan involved in the correction and provide a brief description of the error, the circumstances under which it occurred, the amount involved, the steps taken to correct the error and the dates of such steps, and a statement to the effect that the error is eligible for correction under the terms (and that the employer has otherwise met all the requirements) of the Notice.  The employer must also furnish to each affected taxpayer a copy of the employer’s statement no later than the date it would provide a Form W-2 or 1099.

b. Correction Under Section III.  Where the correction is under Section III, i.e., correction is made in a subsequent tax year, similar requirements apply.  The employer must attach to its timely filed federal income tax return a statement entitled “Section 409A Relief under Section III of Notice 2007-100” setting out the name and taxpayer identification number and other identifying information of affected employees.  Where the same or substantially similar operational failures have occurred with respect to multiple employees, certain additional information is required, including identification of the plans involved, a brief description of the failures and the circumstances under which they occurred, a description of the steps taken to avoid recurrence, and a statement that the operational failure is eligible for correction under the Notice and that the employer has taken all actions required for such correction.

The taxpayer must attach to his timely filed federal income tax return for the year in which the failure is discovered a statement entitled “Section 409A Relief under Section III of Notice 2007-100” that includes much of the information described above. 

Comment: The breadth of Code Section 409A, together with its unforgiving regulatory interpretations, will result in many inadvertent operational violations with respect to which voluntary correction ought to be available.  The Wagner Law Group does not believe that such relief should be confined to operational violations.  Plan documentation failures should also be eligible for relief, at least where the error or failure arose despite good faith efforts at compliance.

Comment: We commend Treasury and the IRS for establishing this program of voluntary compliance, but would like to see it expanded along the lines of tax-qualified plans’ successful voluntary correction programs.


[1] This story has been reprinted with permission from The, a copyrighted news site published by InvestmentWires, Inc.

[2] “Compensation or fees” include money or any other thing of monetary value (e.g., gifts, awards, and trips) received or to be received, directly from the plan or plan sponsor or indirectly (i.e., from any source other than the plan, the plan sponsor, or the service provider) by the service provider or its affiliate in connection with the services to be provided pursuant to the contract or arrangement or because of the service provider’s or affiliate’s position with the plan.

[3] DOL Regulation §2550.404c-5(c)(2).

[4] The QDIA rules also require that participants have the ability to transfer out of a QDIA into the plan’s other investments at least quarterly.  However, most blackout periods are considerably shorter than three months, and consequently, this aspect of the QDIA rules will generally be inapplicable.