As we move into the new year, we are sure to see many new developments in the retirement plan landscape.
Read on for a snapshot of current and significant litigation and regulatory updates.
New Guidance from the Department of Labor Eases Restrictions for Compensating Investment Professionals Who Advise Plan Participants and IRA Holders
- A Prohibited Transaction Exemption the Department of Labor published on December 18th of last year, sets the standards that investment professionals, acting as plan fiduciaries, must satisfy in order to receive compensation that would otherwise constitute a prohibited transaction under ERISA. The exemption is an attempt to align the Department’s position with the SEC’s new Regulation Best Interest (Reg BI) that took effect June 30th of last year. This guidance takes effect February 16th, 2021.
- Investment professionals that satisfy the standards established by this exemption may receive compensation from mutual funds and other investment providers when making recommendations to plan participants and IRA holders. Compensation may be in the form of commissions, 12b-1 fees, sales loads, or mark ups. The standards in this exemption are less restrictive than those in a regulation promulgated during the Obama Administration. That regulation was struck down in 2018 by the U.S. Circuit Court of Appeals on the grounds that it exceeded the Department’s rulemaking authority.
- Compensating investment professionals for their recommendations has been a controversial area that has generated much debate. This latest guidance is no exception. The Public Investors Advocate Bar Association is calling this exemption “a gift to Wall Street.” The main objection is that when investment providers compensate financial professionals who recommend their products, the advice may be conflicted and not in the best interests of the participant. Advocates take the view that this exemption gives plan participants and IRA holders access to advice they could not otherwise afford if they had to pay directly.
- The Department’s attempts to regulate this area go back to a 1975 regulation containing a five-prong test that determines when a person making investment recommendations to plan participants is acting as a plan fiduciary. If someone is considered a fiduciary under this test, that person can be compensated for making recommendations only if he/she satisfies the requirements of this exemption. This five-prong test remains in place. The preamble to the exemption contains a detailed description of the Department’s current view on this test, which arguably is more significant than the exemption itself.
- This latest guidance is based on a temporary policy adopted after the Court of Appeals in 2018 vacated the Obama Administration’s regulation. This guidance may not be the last time we hear from the Department of Labor on this subject. It is possible that the new Democratic administration may move to replace this guidance with a more expansive definition of fiduciary responsibilities and/or with greater restrictions on compensating financial professionals.
- To qualify for the exemption, investment professionals must abide by “impartial conduct standards.” There are three components:
- A recommendation must be in the “best interests” of the participant and must not place other interests ahead of that interest.
- Compensation paid for the recommendation must be reasonable; and
- Statements made with respect to the transaction must not be misleading.
- A key aspect of the guidance is that the Department is walking back its former position that a recommendation to take a plan distribution and roll it to an IRA does not constitute investment advice. Investment professionals will now be treated as acting as a fiduciary where the recommendation to take a plan distribution is part of or the beginning of an on-going relationship.
- The guidance does not directly affect the responsibilities of plan sponsors. Plan sponsors, as fiduciaries, have and continue to have the duty to ensure that any person or organization advising plan participants is acting in their best interests. Plan sponsors must understand how and by whom investment professionals are being paid and whether those payments result in conflicts of interest.
The Department of Labor’s Final Rule on Proxy Voting is More Restrictive than Past Positions
- In August of last year, the Department of Labor published a proposed rule that plan fiduciaries must follow in voting proxies and exercising certain shareholder rights. The final rule was published December 16th of last year and is effective January 15th, 2021. Plan sponsors have until January 31st of next year to comply.
- The rule is mostly of concern to defined benefit pension plans that hold stocks directly. Although there has been some confusion about the proxy voting obligations of fiduciaries of defined contribution plans, the final rule clarifies that it does not apply to shares held in participants’ individual accounts (this includes ESOPs) where voting rights are passed through to participants.
- Sponsors of defined benefits plans must review their written proxy voting policies to ensure they are consistent with the new rule as well as the policies of investment managers voting proxies on behalf of the plan and any proxy advisory firm the plan has retained.
- The Department of Labor has long held the position that voting proxies and exercising other shareholder rights is a fiduciary obligation and plan fiduciaries must exercise these rights in the best interest of plan participants and beneficiaries.
- However, the Department’s position on what factors fiduciaries may take into account has shifted over the years. Democratic administrations have tended to allow more leeway to fiduciaries in proxy voting, while Republican administrations have been more restrictive.
- The new rule rejects previous guidance that non-pecuniary factors referred to as social, environmental, and corporate guidance concerns (“ESG”) may be considered. Under the new rule, in voting proxies and exercising other shareholders rights, plan fiduciaries may not vote in favor of social or political positions if these do not advance the financial interests of plan participants. Proxies must now be voted solely in accordance with the plan’s economic interests, considering only factors that affect the value of the plan’s investments.
- This rule is a companion to the new rule on ESG investing and manifests the same general skepticism of ESG investing. When the proposed rule was published last August, Department officials voiced their concerns about what they perceive as the out-sized role played by the proxy advisory firms plans often retain to advise them on proxy voting. It is the belief of Department officials that the recommendations of these firms have become politicized and are often based on non-economic factors resulting in recommendations that are not consistent with the obligation of fiduciaries to always act in the best interests of plan participants. The Department is also concerned that plan fiduciaries overpay for the services of these firms.
- The new rule resolves the longstanding question of whether fiduciaries must vote every proxy. In fact, Department officials, in publishing the new rule, expressed their concern that fiduciaries should not expend plan resources voting proxies where the issue at stake will not have a significant economic impact on the plan. In deciding whether to vote proxies fiduciaries may:
- Vote proxies per management’s recommendations (with conditions for additional analysis of matters involving conflicts of interest or a significant economic impact).
- Vote proxies only on specific proposals that are substantially related to significant business activities such as mergers and corporate buy backs; and
- Refrain from voting proxies unless a plan’s investment in the issuer exceeds a specified threshold.
The COVID-19 Relief Bill Contains Some Further Minor Relief for Retirement Plans
- After an eight month stop and start endurance test, Congress passed the COVID-19 Relief Bill ($900 Billion) and the Consolidated Appropriations Act, 2021 ($1.4 Trillion) which funds the federal government through September of this year. This legislation was signed into law by President Trump on December 27th of last year. There are a few provisions in the COVID-19 Relief Bill that affect retirement plans.
- Most importantly, the COVID-19 Relief Bill allows employers that laid off a significant portion of their work force due to the pandemic, to avoid the 100-percent vesting requirement in the event of a partial termination. A partial termination is presumed to have occurred if the number of plan participants declines by at least 20 percent in a plan year. The Bill provides that a partial termination did not occur in either 2020 or 2021 if the number of participants on March 31st, 2021 is at least 80 percent of the number of participants on March 13th, 2020.
- The CARES Act contained provisions easing access to plan accounts for participants affected by the pandemic. This included penalty free in-service distributions up to $100,000; the expansion of loan limits to 100 percent of the vested account balance up to $100,000, and the suspension of loan payments. These provisions were temporary. The expanded plan loan provisions expired September 23rd, and the withdrawal provisions on December 31st of last year.
- Non-COVID-19 Disaster relief
- Now, under the Consolidated Appropriations Act for 2021, for 180 days after enactment (June 25th, 2021), an in-service distribution of $100,000 may be taken in connection with any event declared to be a disaster by the President. As with CARES Act distributions, there are no penalties; income taxes due may be spread out over three years and participants have up to three years to repay the distribution.
- This extension applies on the same basis to the expanded CARES Act loan limits. Also, loan payments due during this 180-days period may be postponed for up to one year from the original due date.
- Hardships taken for the purpose of purchasing a principal residence that were not used for such purpose may be repaid to the plan.
Restatement Process is Beginning for Volume Submitter Documents
Current Cycle Opened August 1st of Last Year
- Plans adopting their recordkeeper’s volume submitter document must obtain an opinion letter from the Internal Revenue Service stating the document reflects all applicable legal requirements.
- Every six years, these pre-approved documents must be restated to comply with new legal requirements. The most recent cycle (referred to as “Cycle 3 DC”) for 401(k), profit sharing, and money purchase pension plans) opened August 1st, 2020. The restatement process in this cycle must be completed by July 31st, 2022.
- This means that in the near future, plan sponsors who have not already heard from the provider of their plan document, will be notified about the restatement process. Not a great deal of effort is required on the part of plan sponsors beyond reviewing the new adoption agreement to ensure it accurately reflects the plan design.
- Cycle 3 documents will not reflect legislative changes since 2017. Therefore, these documents will not include the recent changes to hardship withdrawals rules, the SECURE Act, or the CARES Act. The deadline to amend plans retroactively for this legislation is as follows:
- Bipartisan Budget Act (Hardship Withdrawals): The applicable deadline is the employer’s tax filing deadline, plus extensions, for 2020.
- SECURE Act: Last day of the plan year beginning in 2022.
- CARES Act: Last day of the plan year beginning in 2022.