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November 13, 1996
The Third-Party Trustee Working Group respectfully
submits its report and recommendation to the 1996 ERISA Advisory Council
session.
THE WORKING GROUP'S PURPOSE AND SCOPE
In 1993, the ERISA Advisory Council's Defined
Contribution Working Group began the first phase of a three-phase study.
The third phase, studied during 1995, considered the question whether
defined contribution plans provide employees with an adequate source of
retirement income. In the course of the Working Group's considerations, we
heard testimony relating to protection concerns for defined contribution
plans. The Report of the Working Group on Defined Contribution Adequacy
contained the following statement:
Defined Contribution plans are not insured by the
Pension Benefit Guaranty Corporation (PBGC). Assistant Secretary of Labor
Olena Berg has indicated that one of the concerns facing the Department in
the defined contribution arena is the failure of employers to make timely
remittance of contributions deducted from employees' payroll. The Pension
Rights Center advised the Advisory Council that a worker has little or no
recourse when an employer embezzles defined contribution funds. The Center
noted that the existing statutory protections are inadequate to protect
these losses. In their experience, troubled plans have either no fidelity
bond or it has lapsed. In many instances, Form 5500's have not been filed
for years, with no investigation commenced in response. The Pension Rights
Center recommended the defined contribution plans should all be trusteed
by independent third-party trustees. Moreover, these trusts should be
maintained only by banks, brokerage houses and other financial
institutions which are authorized to exercise trust posers over combined
capital and surplus in excess of a stated amount by regulations issued by
the Secretary of Labor (See section 412 of ERISA as a model).
The Third-Party Trustee Working Group was then formed
and charged with taking testimony to determine whether the utilization of
independent third-party trustees would further protection of plan assets
and/or plan participants.
An initial determination was made to consider the
protections that independent third-party trustees could provide to both
defined benefit and defined contribution plans.
WORKING GROUP PROCEEDINGS
Following its initial meeting, the Working Group held
three public hearings at which it heard from individuals from a diverse
group of organizations whose insights and knowledge of this area were
important to the group's deliberations:
Charles Lerner, Esq. (Director of Enforcement for the
Pension and Welfare Benefits Administration)
Samuel W. Halpern, Esq. (Executive Vice President and
General Counsel, Bear Stearns Fiduciary Services)
Robert Nagle, Esq. (Independent Third-Party Trustee)
Mark E. Freitas (Managing Director, Frank Crystal
Financial Services)
Catherine Shavell, Esq. (Counsel for State Street Bank
and Trust Company)
Steve Anderson, Esq. (Marsh McClellan)
Ian Dingwall (Chief Accountant, Office of Chief
Accountant for
the Employee Benefits Security Administration)
Barbara Uberti, Esq. (Vice President, Wilmington Trust
Company)
John Barth, (Principal of Institutional Client
Services, The Vanguard Group)
R. Gregory Barton, Esq. (Principal Vanguard
Institutional Legal Department)
A brief synopsis of the oral testimony is included in
this report as Appendix 1.
The Working Group received written testimony from
Frederick D. Hunt, Jr. of the Society of Professional Benefit
Administrators and supplemental written testimony from Barbara Uberti,
Esq. (Wilmington Trust Company) and Charles Lerner (EBSA). We received
copies of the following written materials: a copy of Senator Barbara
Boxer's 401(k) Pension Protection Act, S. 1837; ERISA Advisory Council
member James O. Wood in an article entitled "Why We Need Pension
Reform"; an article entitled, "ERISA's Authorization of
Unlimited Fiduciary Self- Dealing: Employer Stock Acquisition by Defined
Contribution Plan Trustees", by Barry D. Hunter and a March, 1996
article from the American Institute of Certified Public Accountants,
Journal of Accountancy entitled "Senate Bill to Crack Down on Fraud
Would Change the Way CPAs Do Pension Plan Audits".
The complete record of the Working Group's proceedings,
including official transcripts and summaries of oral testimony, the
written testimony and materials submitted by witnesses, is available from
the office of the ERISA Advisory Council.
A list of the members of the Working Group can be found
in Section VI.
EXECUTIVE SUMMARY
ERISA specifically provides that officers and employees
of a corporation and union officials can serve as fiduciaries in employee
benefit plans. ERISA section 408(c)(3) states that nothing in ERISA
section 406 (prohibited transactions) shall be construed to prohibit any
person from serving as a fiduciary in addition to being an officer,
employee, agent or other representative of the party in interest.
Our Working Group received testimony from members of
the financial services industry, government officials as well as
individuals and institutions serving as independent fiduciaries. It was
determined that independent third-parties could enhance both protection
and performance of qualified plans. The benefits of utilizing independent
third-parties include enhanced expertise, independence in decision-making
regarding transactions involving plan assets and a party in interest and
additional safeguards over the flow of monies in and out of a plan
together with cross-checks to ensure accuracy.
Witnesses from the financial services industry informed
us that few additional protections would be provided to plan participants
by requiring third-party trustees. It was noted that "the critical
day-to-day functions that affect the participant's account are really
performed by the plan recordkeeper, with the plan trustee having limited
oversight responsibility." (Mr. John Barth, Vanguard). There are plan
sponsors who keep their own records for defined contribution plans and
"those cases"...present "a great potential for
abuse"... an independent recordkeeper "could go an awfully long
way" to prevent that sort of abuse. (Ms. Barbara Uberti, Wilmington
Trust).
Witnesses from insurance institutions indicated that
having a single person who is plan administrator, recordkeeper, trustee
and investment advisor without any independent advisor, presents an
underwriting risk for fidelity and fiduciary insurance because of the
absence of checks and balances.
James O. Wood's article "Why We Need Pension
Reform" indicated that there is only a 1% chance that a qualified
plan will be reviewed by EBSA. The Office of Chief Accountant provided
statistical data indicating that they will only be able to examine a
fraction of the deficient filings and barely address those who do not
file. Each of the current 1993 and 1994 databases include over 16,000
filings with major deficiencies. Data was also provided relating to the
level of errors in accountant's reports that were submitted. In a random
sample, the Office of the Chief Accountant determined over 19 percent of
the accountant's reports were deficient.
Ultimately, however, none of the witnesses recommended
mandating an independent third- party recordkeeper. The witnesses did
recommend mandating certain changes to ERISA's reporting and disclosure
rules which would provide critical and inexpensive safeguards to plan
participants.
Testimony from government officials and the financial
services industry consistently held that one of the single most effective
cross-checks and enforcement mechanisms is letting participants know, by
participant statements, the status of retirement benefits. Timely
disclosure and confirmation of the recordkeeping activities affecting
participants individual benefits is a critical safeguard.
The disclosure provisions in Sections 105(a) and 209(a)
(1) of ERISA currently only provide for participant statements, only once
a year upon request.
Witnesses also recommended mandating reconciliation of
participant records and trust records and requiring a certification by the
plan administrator that the reconciliation was done in the summary annual
report. The Secretary is specifically empowered under ERISA sections
103(b)(5) and 104(a)(2) to require such a certification.
Finally, the Working Group received written and oral
testimony relating to the absence of limitations, under current law, on
the amount of employer securities held in defined contribution plans.
Based upon the foregoing, the Working Group has several
recommendations, which are described below:
-
The Secretary should take whatever
steps necessary to implement a requirement of automatic issuance of
periodic participant statements. This inexpensive, practical step will
enable participants to act as a primary level of review of the correct
operation of a plan and safety of plan assets. The Working Group
believes this action is sufficiently important to warrant an amendment
to ERISA, as necessary.
-
Consistent with the first
recommendation, the Working Group heard testimony that there is no
current requirement that there be a reconciliation of participant
records and trust records in defined contribution plans and this
fundamental step is a cornerstone of prudent recordkeeping. The
Secretary should amend Department of Labor regulations to provide for
mandatory reconciliation of participant records and trust records in
defined contribution plans and a certification to that effect in
summary annual reports.
-
Participants rely on timely and
accurate reporting by Plan Sponsors to the Department of Labor.
Testimony was received that there is a large scale failure to file,
failure to file financial statements or financial statements that are
filed are materially deficient. The Secretary should assure, that
where legally required financial statements are not filed or are
deficient, that the Department has sufficient resources available to
investigate and remedy the noncompliance.
-
The Secretary should have a study
conducted regarding special issues and concerns in
reporting/administration of under 100 lives plans. The Secretary has,
by regulation, eliminated the audit requirement for all under 100
lives plans. We have heard testimony regarding risks associated with
having a plan where a single person acts as plan administrator,
record-keeper, trustee and investment advisor, and no fiduciary
insurance has been purchased. We have heard further testimony that
this is substantially more likely to occur in under 100 lives plans.
The Working Group is concerned about the cost/benefit tradeoffs here
but has been presented evidence that plans fitting the foregoing
profile lack cross-checks, safeguards and controls which financial
institutions deem essential and the insurance industry require for the
underwriting of fiduciary/fidelity insurance.
-
The Secretary should continue
support of the Pension Audit Improvement Bill (S 1490) to require
specific training for auditors of qualified plans.
-
The Secretary should have a study
conducted on the advisability of limiting the amount of employer
securities held in defined contribution plans.
FINDINGS AND RECOMMENDATIONS
I. Defining Terms
One of the first challenges faced by the Working Group
was a determination of what was meant by the term "Independent
Trustee". An initial inquiry was whether an Independent Trustee was
an independent party who had been delegated fiduciary duties? Apart from
the named fiduciary of section 402(a) of ERISA, a person is a plan
fiduciary "to the extent" he (i) exercises discretionary
authority or control over plan management or any authority or control over
management or disposition of plan assets, (ii) renders investment advice
regarding plan assets for a fee or other compensation or has authority or
responsibility to do so, or (iii) has any discretionary authority or
responsibility in plan administration. ERISA section 3(21)(A). Early
Department of Labor regulations state that certain positions, such as plan
trustee or plan administrator, "by their very nature" carry
fiduciary status. 29 C.F.R. § 2509.75-8 at D-3.
However, it was not determined to be critical to our
function to make a determination as to whether a particular party was or
was not a fiduciary. Rather the essential focus was the service that
individual or institution provided to the plan and what way, if any, would
an independent party providing that service provide extra protections to
the participants or plan assets.
One service would be the Trustee/Asset Custodian. If
the institution that served as custodian for plan assets did not also have
responsibility for investment management of plan assets, it would be
called the Directed Trustee. The Trustee/Asset Custodian safeguards
trusteed assets, pays benefits upon instruction from Plan Administrator
and executes and records investment transactions. Trust Agreements
uniformly provide that the Trustee is responsible only the funds it
actually receives and to pay benefits and bills as directed by authorized
parties.
The Investment Advisor/Manager advises regarding
overall investment policy and investments, selects and evaluates
investments and invests plan assets subject to certain guidelines.
The Recordkeeper maintains the participant and
beneficiary information provided by the plan sponsor as to age, service,
compensation, entry date, termination date and marital status, to the
extent applicable. The Recordkeeper also maintains election forms for each
participant and beneficiary. Additionally, the Recordkeeper allocates
contributions, distributions, loans distributions and repayments and
withdrawals to each participant's account as provided by the plan sponsor.
This core function of maintaining records of the entitlements of the
participants and beneficiaries and for monies that go in and out of the
plan, may be performed by the Plan Administrator alone or in conjunction
with a Third-Party Administrator. In the defined benefit context, the
Actuary has the task of calculating funding requirements and limitations,
accumulated benefit obligations and individual benefit amounts.
The appointment of certain advisors, whether or not
they are fiduciaries, may be on an ongoing basis or for purposes of a
particular transaction.
II. Existing Legal Framework
A. Statutory
ERISA section 408(c)(3) states that nothing in ERISA
section 406 (prohibited transactions) shall be construed to prohibit any
person from serving as a fiduciary in addition to being an officer,
employee, agent or other representative of the party in interest.
Consequently, ERISA specifically provides that officers and employees of a
corporation and union officials can serve as fiduciaries in employee
benefit plans.
B. Case Law
There is case law holding that the failure, in certain
situations of divided loyalties with clear potential for conflicts of
interest, to seek independent, disinterested advice, amounted to a breach
of fiduciary duty. In Donovan v. Bierwith, 680 F.2d 263 (2nd Cir. 1982),
cert denied, 459 U.S. 1069 (1982) the Court addressed a situation where
the Trustees of a stock option plan, in the midst of a takeover attempt,
decided to purchase securities in the marketplace and not to tender the
shares already held by the Plan. The Court plainly felt that the trustees'
sole purpose was to block the buy-out offer without consideration of the
best interests of the plan participants. Section 404(a)(1)(4) of ERISA
imposes a basic duty on plan participants to act "solely in the
interest" of plan participants and beneficiaries. The Court held:
Although officers of a corporation who are trustees of
its pension plan do not violate their duties as trustees by taking action
which, after careful and impartial investigation, they reasonably conclude
best to promote the interests of participants and beneficiaries simply
because it incidentally benefits the corporation or, indeed themselves,
their decisions must be made with an eye single to the interests of the
participants and beneficiaries. Restatement of Trusts 2d § 170 (1959); II
Scott on Trusts §170, at 1297-99 (1967) (citing cases and authorities);
Bogert, The Law of Trusts and Trustees §543 (2d ed. 1978). This, in turn,
imposes a duty on the trustees to avoid placing themselves in a position
where their acts as officers or directors of the corporation will prevent
their functioning with the complete loyalty to participants demanded of
them as trustees of a pension plan. Id. at 271.
The Second Circuit, in Donovan v. Bierwith, held that
the activities of two of the Trustees "in opposing the offer
precluded their exercising the detached judgment required of them as
trustees of the Plan, and that the only proper course was for the trustees
immediately to resign so that a neutral trustee or trustees could be
swiftly appointed to serve for the duration of the tender offer." Id.
at 271-72.
The necessity for fiduciaries to find independent,
neutral substitutes is emphasized even more clearly in Leigh v. Engle, 727
F.2d 113 (7th Cir. 1984). It was held that profit-sharing Trustees
breached ERISA's exclusive purpose rule when they failed "to make
intensive and independent investigation of available options to ensure
that they acted in the best interest of plan beneficiaries in the midst of
a corporate control contest in which they were actively involved and had
substantial interests. The Seventh Circuit states that it views
"favorably the suggestion of the Secretary of Labor...that the
preferred course of action for a fiduciary of a plan holding or acquiring
stock...who is also an officer, director or employee of a
party-in-interest seeking to acquire or retain control, is to resign and
clear the way for the appointment of a genuinely neutral trustee to manage
the assets involved in the control contest." Id. at 132.
Danaher Corp. v. Chicago Pneumatic Tool Co., 7 E.B.C.
1616 (S.D.N.Y. 1986), involved another takeover of an ESOP. The court held
that it was inappropriate for the corporation president to serve as ESOP
trustee during the tender offer, since his personal interests in continued
employment conflicted with his duty to act in the interests of plan
beneficiaries in deciding whether to tender plan shares. In Danaher, the
court appointed a neutral trustee to replace the corporation president.
The Department of Labor has sought, in appropriate
cases, to have trustees removed and for new trustees to be selected or to
have an independent fiduciary operate the plan either entirely for in
certain transaction(s). Such a result may be achieved by court order or
settlement.
The Second Circuit's decision in Marshall v. Snyder,
572 F.2d 894 (2nd Cir. 1978), outlines the legislative history and
statutory authority for removal of trustees and appointment of a temporary
receiver. The Secretary of Labor, in the interest of the beneficiaries of
certain union employee benefit plans, sought to remove the trustees of
these plans, and to void certain transactions undertaken by said trustees.
It was alleged that the trustees misused funds for various reasons
including what the trustees claimed was for compensation and office
refurbishing. p. 896. The plaintiff requested the District Court to
appoint a temporary receiver to assume the trustees' duties. The
defendants argued inter alia, that a receiver appointed to take over their
duties was not only not warranted, but not explicitly provided for in
ERISA. The Second Circuit relied upon ERISA 409(a), 29 U.S.C. §1109(a),
that provides that "any person who is a fiduciary with respect to a
plan who breaches any of the duties imposed on fiduciaries by the statute
not only is personally liable to make good to the plan any losses
resulting from the breach, but also is subject to such other equitable or
remedial relief as the court may deem appropriate, including removal of
such fiduciary." (emphasis added). ERISA section 502(a)(5), 29 U.S.C.
§1132(a)(5) "empowers the Secretary to bring a civil action: (A) to
enjoin any act or practice which violates any provision...or (B) to obtain
other appropriate equitable relief: (i) to redress such violation or (ii)
to enforce any provision...." . The Second Circuit cited legislative
history of ERISA, including Senate Report #93-383. The report, appearing
in U.S.Code Cong. & Admin.News, at p. 4989, stated in relevant part
that "It is expected that a fiduciary...may be removed for repeated
or substantial violation of his responsibilities, and that upon removal
the court may, in its discretion, appoint someone to serve until a
fiduciary is properly chosen in accordance with the plan." (emphasis
added).
In Katsaros v. Cody, 744 F.2d 270 (2nd Cir. 1984), the
defendant trustees were found to have violated their fiduciary duties
under ERISA for making an unauthorized loan and failing to collect on an
aborted loan. The District Court, among other relief, appointed a
"fund manager to oversee the operation of the fund" for a fixed
amount of time. The Second Circuit affirmed, modifying only by saying the
manager should perform until "successor trustees are appointed by the
union and employer association who meet with court's approval" Id. at
282. The Court relied upon the same legislative history and statutory
authority as in Snyder.
The Second Circuit found that any amendment of the
trust agreement which made the trustees immune from removal, even in the
event of their malfeasance...." to be a violation of ERISA section
401(a)(1), 29 U.S.C. 1101(a). Levy v. Local Union Number 810, 20 F.3d 516,
519 (2nd Cir. 1994). Moreover, the Court noted a Department of Labor
opinion letter which considered the question whether the appointment of
benefit fund trustees for life, in the absence of fiduciary misfeasance
was compatible with fiduciary responsibilities imposed by ERISA.
Department of Labor, Pension & Benefit Welfare Programs, Opinion 85-41
A, December, 1985 (1985) ERISA LEXIS 3) (hereinafter "DOL
Opinion"). The Department reasoned that the congressional mandate of
"high standards of loyalty and prudence," Id. at *2, implied a
requirement "that the conduct of [the fund trustee] should be subject
to effective oversight on behalf of plan participants and
beneficiaries." Id. at *2-*3. This goal required that arrangements
with fiduciaries be subject to termination "on reasonably short
notice under the circumstances so the plan would not become locked into an
arrangement that may become disadvantageous." Id. at *3. The
Department observed that these "principles ... may be frustrated
where a plan sponsor ... can [remove a trustee and appoint a successor]
only upon successfully bringing such charges as misfeasance or incapacity
..." Id. The Department concluded that, notwithstanding removability
for misfeasance, "a lifetime term of appointment ... would be
inconsistent with ERISA's fiduciary responsibility provisions." Id.
at *2.
The Southern District of New York, in International
Brotherhood of Teamsters v. Garage Employees Local Union Number 272, 1992
WL 235173 (S.D.N.Y. 1992), ruled that an International Union acted
properly under the "emergency situation" provision of its own
constitution by appointing a temporary trustee; the defendant union was
found to have "been 'advised of the reason for the appointment' of
the temporary trustee...", even though the IBT Constitution does not
mandate advisement. Thus, the defendant was issued a mandatory injunction
requiring them to recognize the temporary trustee and to allow him access
to the union's records, etc.
III. Evidence of Need for Further Protections
The Working Group heard testimony from Mr. Ian Dingwall,
the chief accountant from EBSA's Office of Chief Accountant. One of the
office's essential functions is to oversee the Form 5500 reporting system.
In 1992, there were about 708,000 private pension plans and about six
million health and welfare plans. Only funded welfare benefit plans are
required to file a Annual Report Form 5500. In 1996, the Office of Chief
Accountant will oversee over 1 million annual reports with a staff of 19
which includes both accountants and reporting compliance specialists.
The Form 5500 filings are first keypunched into a
database at the Internal Revenue Service and are subjected to about one
hundred edit tests. A letter is sent in order to perfect the filing. There
were 438,000 edit test failures on the 1989 returns. The number of edit
test failures has decreased progressively over the years. The latest
figures show that in 1992 there were 264,465 edit test failures.
The most egregious deficiencies selected for review
are: (1) where the accountant's report is missing, (2) the accountant's
report contains a material qualification and (3) schedules are missing.
Mr. Dingwall testified that in 1993 database, there are 21,663 deficient
filings; 2,924 without accountant's opinions. In the database in April of
1996 for the 1994 plan year (two year lag), there are 16,863 filings that
have a major deficiency, 2,109 missing an accountant's report. Due to the
present size of the staff at the Office of Chief Accountant, they can only
examine approximately 1,700 filings per year.
There is also an enforcement effort with respect to
plans which have stopped filing without filing a terminal report, or
simply failed to file one or more reports. In the last four years there
have been 77,000 filers who just stopped filing or did not file one or
more years. There is but one individual in the Office of Chief Accountant
who reviews the non-filer cases. He can examine only about 240 cases a
year. Mr. Dingwall expressed the opinion that the failure to file an
accountant's report, particularly after a history of compliance, is some
indication that "there's a problem with the plan." Similarly,
the failure to file an accountant's report is also an indication that of
underlying problems.
Mr. Dingwall also testified to the adequacy of the
audits that performed in plans that submitted an accountant's report. In
1992, the Office of Chief Accountant pulled a sample of 276 audit
engagements and went on site, pulled the work papers, looked at the
results of the review and concluded that 19% of the audits were deficient.
Another 33% of the audit reports failed one or more of the ERISA reporting
disclosure requirements. If this average of deficiency is projected over
the population of audits, then approximately 6,000 and 12,000 audits would
not be done in accordance with general accounting standards and the assets
involved would be between $44 billion and $214 billion.
Mr. Dingwall noted that while the office budget is
approximately $1.5 million, it collects over $12 million in penalties a
year. The office collected over $46 million in the delinquent filer
program.
The Working Group also received materials from the
Department of Labor relating to its pension payback program and 401(k)
enforcement results. It was noted that in 1993 there were over 170,000
401(k) plans nationwide covering 23.4 million people with combined assets
totalling $613 billion.
In 1995, after DOL's Employee Benefits Security
Administration (EBSA) began registering an increase in the number of
complaints about 401(k) plans, the agency launched an enforcement program
aimed at increasing protection of employees' 401(k) contributions.
As part of the overall 401(k) enforcement initiative,
Secretary of Labor Robert B. Reich initiated the Pension Payback Program
on March 6, 1996. This voluntary compliance enforcement program allowed
employers to restore delinquent contributions plus lost earnings to their
plans without penalty. Eligible employers who participated in the program
could avoid civil and criminal sanctions, including civil injunctions,
criminal prosecutions or criminal fines, excise taxes, and civil money
penalties.
The program's grace period ended Sept. 7, 1996. The
following results were achieved:
The Department received 170 notifications;
notifications were received from employers located in 38 states.
$4.8 million in delinquent contributions and lost
earnings were reported returned to plans during the grace period.
Contributions repaid to plans ranged from $43.07 to
over $200,000.
16,800 participants were included in affected plans.
Since the initiation of the increased 401(k)
enforcement efforts, 1,178 investigations have been opened, including 434
that have been closed (744 remain open), and $9.8 million has been
returned to 401(k) plans.
$5.7 million from 87 different companies of the 434
closed cases.
approximately $4.1 million by voluntary compliance from
companies among the 744 open investigations.
Of the $9.8 million, $8.7 million is employee
contributions and $1.1 million is employer contributions.
Since the beginning of the project, there have been 59
criminal cases opened - 46 are still pending. Six cases have resulted in
guilty pleas. Criminal court-ordered restitution totalling $99,804 has
been made.
Charles Lerner, Esq., Director of Enforcement for
Pension and Welfare Benefits Administration indicated that the 401(k)
enforcement effort is not based upon a random selection of 401(k) plans
but rather in response to participant complaints based upon their
participant statements. Both Mr. Lerner and Mr. Robert Nagle discussed
various cases regarding improper loans and imprudent investment activity
that culminated in the appointment of an independent third-party trustee.
A number of witnesses commented that curbing abuses was
a more pressing concern for defined contribution plans than defined
benefit plans, as defined benefit plans have most of their benefits
insured by the PBGC. In addition, one witness commented that defined
benefit plans would require the services of an actuary who would serve as
an independent recordkeeper and thus a cross-check for any questionable
distributions. (Testimony of Barbara Uberti, Wilmington Trust Company).
IV. Enhancement to Protection and Performance Provided
by Independent Third-Parties
Witnesses before the Working Group described a variety
of (roles in which independent third-parties could enhance both protection
and performance to qualified plans. The roles ranged from enhanced
expertise and independence, curing and replacing trustees in breach,
providing safeguards and cross-checks to the flow of monies in and out of
a plan and to provide cross- checks to ensure accuracy. The witnesses
outlined a series of "best practices" provided by the financial
services industry to provide accuracy and prevent pension abuse.
The Working Group heard testimony from Samuel W.
Halpern, Bear Stearns that the general benefits of an independent
fiduciary included: (1) Enhanced expertise; (2) Enhanced independence and
(3) Reducing/spreading the plan's fiduciary risk.
He noted that an independent fiduciary could provide
invaluable expertise in structuring and supervising a plan's investment
activities in areas of complexity beyond the expertise of the named
fiduciaries; i.e. structuring and monitoring brokerage activities such as
soft dollar arrangements or commission recapture programs, developing and
adjusting asset allocations, due diligence etc.
There is also a need for enhanced independence when a
particular transaction requires an independent advisor or decision maker
regarding a proposed transaction involving plan assets and a party in
interest. (See Section II B.) Such transactions could include tender,
proxy voting or work-out situations regarding employer securities or sale
or in-kind contributions of non- qualifying employer securities or real
estate or qualifying employer securities or real estate beyond statutory
limits
Finally, to the extent that the independent party is
truly a fiduciary, then the independent party is taking on liability and
fiduciary exposure for whatever the decision making process is involved.
Barbara Ann Uberti, Esq. (Wilmington Trust Company)
described the three major movements of money through a employee benefit
plan; plan contributions; plan investing and plan distributions.
Ms. Uberti noted that plan contributions can be
misappropriated if they are not remitted to the trust. Under standard
trust agreements, the trustee is only responsible for monies that it
actually receives. All aspects of the appropriate plan contribution,
whether or not discretionary, are not generally known to the
trustee/custodian. The amount and timing of the contribution is known to
the recordkeeper and plan administrator in a defined contribution plan and
the actuary/recordkeeper and plan administrator in a defined benefit plan.
These parties should already have a complete audit of payroll, list of
participants, an analysis of the plan and other factors affecting
contributions. Ms. Uberti noted there are plan sponsors who keep their own
records for defined contribution plans and "those
cases"...present "a great potential for abuse". She
indicated that an independent recordkeeper "could go an awfully long
way" to prevent that sort of abuse.
Requiring participant statements that set forth the
amount of the employer and employee contribution, "would align
everyone's interest"..."let the people who really care about
it"..."have the ability to look at the flow of money and make
sure it is right". Barbara Uberti recommended a requirement for
automatic participant statements, at least annually.
Another area of control recommended by Barbara Uberti
was mandatory reconciliation of participant records and trust records.
Employee benefit assets can also be diluted by improper
investments. Ms. Uberti noted that, under current law, a defined
contribution plan can invest all of its assets in employer securities. If
a substantial amount of plan assets are invested in employer securities
and "the company goes downhill, you can lose your job and your
retirement benefits at the same time". Barbara Uberti recommended
limiting the amount of employer securities that can be held by defined
contribution plans (except ESOPS) and prohibit the requirement that
matching contributions be invested in employer securities.
The Working Group received a copy of Senator Barbara
Boxer's proposed 401(k) Pension Protection Act, S. 1837. The Bill notes
that defined benefit pension plans are prohibited by ERISA from investing
more than 10% of their assets in securities and real estate of the company
sponsoring the pension plan, but not defined contribution plans. The Bill
would amend ERISA to provide the same limitation to defined contribution
plans and provides a grandfather rule to existing holdings in excess of
this limit.
Barbara Uberti noted that plan distributions were
"the simplest way to steal from a plan". The plan sponsor simply
directs a payment of a benefit, a loan or a bill from trust assets. The
trustee/custodian is not well-suited to prevent this abuse as a standard
trust agreement requires them to pay benefits as directed and expenses as
directed, as long a the person who directed the payment was authorized to
do so. Again, Barbara Uberti noted that an independent recordkeeper could
curb this form of abuse, as a cross-check to payments not authorized by
the plan records and/or plan document. Another control possibility would
be third-party authorizations for distributions that are unlikely to be a
big expense.
It was noted that plan distributions is another place
where the reconciliation of participant records and trust records would
help.
John Barth (Vanguard) also emphasized that few
protections would really be provided to plan participants by requiring
third-party trustees. He noted that "the critical day-to-day
functions that affect the participant's account are really performed by
the plan recordkeeper, with the plan trustee having limited oversight
responsibility".
John Barth emphasized that one of the most important
protections provided to defined contribution participants was timely
disclosure and confirmation of recordkeeping activities affecting their
individual accounts. The information included on the statement should
include, at a minimum, a summary of each of the investments that the
participant is investing in, starting with a beginning balance which
should agree with the ending balance of the previous period. It should
include activity for the period which would be contribution activity, any
withdrawals, distributions or loans, repayment of loans, transfer or
exchange activity, unrealized gain or loss and a demonstration of market
value at the end of the statement. Mr. Barth testified that cost of
quarterly statements per year, per participant is approximately $5.00 to
$10.00 per year. Their firm only charges $5.00. With new technology, many
financial services institutions perform daily valuations and provide
access to account information by voice network or through the internet.
The types of risks that adequate controls and
cross-checks safeguard against include errors or mistakes in plan
administration, mistakes in participant's deferral calculations,
contribution allocations, investment exchanges, distribution payouts,
loans and loan repayments.
Mr. Barth also agreed that reconciliation of
participant records and trust records was an essential control and
cross-check. Rather than mandate that this be done by a third-party he
suggested that in the summary annual report, the plan administrator would
have to certify, under penalty of perjury, that trust records were
reconciled to the participant records. Mr. Barth indicated he could not go
so far as to mandate the use of third-party recordkeeper due to the cost
factor and the potential for discouraging small employers to start plans.
It was noted that Vanguard always sends confirmations
to participants and he recommended "requiring confirmation
checks". He noted that when Vanguard receives a notification of
change of address from a participant, a confirmation is sent to the old
and new address.
V. Existing Gaps in Protection
No mandatory issuance of periodic participant
statements
Charles Lerner (EBSA), Barbara Uberti (Wilmington
Trust), John Barth (Vanguard) and Ian Dingwall (EBSA) all indicated that
one of the single most effective cross-checks and enforcement mechanisms
is letting participants know, by participant statements, the status of
retirement benefits.
Section 105(a) of ERISA generally requires an
administrator of an employee pension benefit plan to furnish to any
participant or beneficiary who so requests in writing, a statement
indicating, on the basis of the latest available information, the total
benefits accrued and the nonforfeitable pension benefits, if any, which
have accrued, or the earliest date on which such benefits will become
nonforfeitable.
Similarly, section 209(a)(1) of ERISA generally
requires the plan administrator of a pension plan subject to Part 2 of
title of the Act to make a report, in accordance with regulations of the
Secretary of Labor, to each employee who is a participant under the Plan
and who requests such report, terminates service with the employer, or has
a one year break in service. The report required under ERISA section
209(1) must be sufficient to inform the employee of his or her accrued
benefits which are nonforfeitable.
Under both sections, ERISA section 105(a) and ERISA
section 209(a)(1), no participant is entitled to more than one report
during any single 12-month period.
Consequently, in order to require automatic issuance of
periodic participant statements, sections 105(a) and 209(a)(1) of ERISA
would have to be amended. Although there are proposed regulations at
2520.105-1 and a Request For Information was issued in the Federal
Register, Volume 58, No. 246 on December 27, 1993, neither seeks to
require automatic issuance of periodic participant statements.
It was noted by the witnesses that most of the
financial services institutions that serve as trustee/custodian and
recordkeeper issue these statements automatically. The cost is relatively
minor; between $5.00 and $10.00 per year per participant. A requirement
that the annual statements now required by request, be issued
automatically, would be a vast improvement. It is contemplated that
regulations would take advantage of existing advances in technology.
It was unanimously agreed by the witnesses that timely
disclosure and confirmation of the activities in a participant's
retirement account is the key to protecting the assets and ensuring
against errors. No one of us would consider depositing our monies in a
bank or a brokerage house which only provided annual statements upon
request. We should ask our pensioners to a practice which is inexpensive
to implement and essential to the safety and accuracy of their retirement
benefit.
Consequently, it is our recommendation to mandate
automatic disclosure of periodic participant statements.
No mandatory reconciliation of participant records and
trust records
There is no current requirement that there be a
reconciliation of participant records and trust records. Over 100 lives
plans must file audits with their Form 5500, but under 100 lives plans do
not have be audited. Barbara Uberti (Wilmington Trust) noted ..."if
the bank account and book got reconciled every month, you would know if
something were missing". Arguably, it would be the essence of
imprudence for someone to never balance one's checkbook, yet qualified
plans are not required to do so. Advisory Council Member Marilee P. Lau, a
member of the Advisory Council and an Assurance Officer with KPMG Peat
Marwick LLP, stated at a full Board Meeting that such reconciliation
should be done monthly, otherwise it would be, "like reconciling your
bank account once a year. You've got to close the bank account in order to
be able to do that."
Subsequent to the hearing, Barbara Uberti supplemented
her testimony with a letter summarizing information received from
recordkeeping and accounting firms to determine the cost of reconciling
participant records. From these discussions, she recommended reconciling
small- to medium-size plans on an annual basis and larger plans on a
quarterly basis. For both large and small plans, the number of
transactions and the number of investment funds determines the cost of
reconciliation. Large firms estimate that it takes two hours per fund per
plan per period for reconciliation of a large plan done on a quarterly
basis, charging $100 per hour. For example, if a plan has five investment
options, the annual reconciliation cost would be $4,000. It would cost
$500-$1,000 to reconcile a small plan with five investment funds on an
annual basis. These estimates apply to ongoing reconciliation.
John Barth (Vanguard) noted that, with the technology
available today, "it would not be that complicated to do a
reconciliation". Mr. Greg Barton, who also appeared for Vanguard,
said that "What you'd really be looking at for the small mom-and-pop,
20-employee [establishment], is a requirement to provide an annual
statement, and at the bottom of that statement would be certification
under penalty of perjury by the plan administrator that the assets were
reconciled". Ian Dingwall (EBSA) also suggested improving the summary
annual report, "the things that they actually get in their
hands".
ERISA sections 103 and 104 provide for the publication
and filing of annual reports with participants and the Secretary of Labor,
respectively. Section 103(b) provides that the financial statement in the
annual report shall contain certain specified information and under
Section 103(b)(5):
Such financial and actuarial information including but
not limited to the material described in subsections (b) and (d) of this
section as the Secretary may find necessary or appropriate.
ERISA section 104(a)(2)(A)&(B) provides:
(2)(A) With respect to annual reports required to be
filed with the Secretary under this part, he may by regulation prescribe
simplified annual reports for any pension plan which covers less than 100
participants.
(B) Nothing contained in this paragraph shall preclude
the Secretary from requiring any information or data from any such plan to
which this part applies where he find such data or information is
necessary to carry out the purposes of this title nor shall the Secretary
be precluded from revoking provisions for simplified reports for any such
plan if he finds it necessary to do so in order to carry out the
objectives of this title.
Consequently, it is our recommendation to mandate
reconciliation of participant records and trust records and require a
certification by the plan administrator that the reconciliation was done
in the summary annual report. We submit that the Secretary is specifically
empowered under ERISA sections 103(b)(5) and 104(a)(2) to require such a
certification.
Failure to consider risk factors in
reporting/administration of under 100 lives plans
Charles Lerner, Esq. (EBSA) testified to a number of
cases which the Department of Labor, though settlement or court order, had
an independent trustee appointed due to malfeasance on the part of the
existing trustees. The cases involved improper "loans" or
failure to remit contributions. He noted:
In the settlement of our cases, our civil cases,
typically we are talking about obtaining money from a fiduciary insurance
policy. The losses are often in the hundreds of thousands and
millions of dollars, which are often beyond the means or availability of
the trustees themselves, and thus you're looking at the fiduciary
insurance policy as the major source of funds that are being put back
into the plan.
As a consequence of Mr. Lerner's remarks, we heard
testimony from two individuals representing fidelity and fiduciary
insurance carriers. We heard from Mark E. Freitas (Frank Crystal Financial
Services) and Steve Anderson, Esq. (Marsh McClellan). Fidelity insurance
is required by Section 412 of ERISA, which requires that every fiduciary
of an employee benefit plan and every plan who handles funds or other
property of the plan shall be bonded. Both Mr. Freitas and Mr. Anderson
indicated that fidelity insurance was first-party coverage that provides
protection to the named insured against losses sustained by fraudulent or
dishonest acts. Each individual must be bonded for at least 10 percent of
the amount of plan funds he handles and in no case for less than $1,000.
No individual need be bonded for more than $500,000 with respect to a
single plan unless the Secretary of Labor (after a hearing) requires a
larger bond. The cost of fidelity insurance is relatively inexpensive with
respect to the ERISA section 412 and the minimum requirements. Mr. Freitas
indicated it was approximately a few hundred dollars per bond. One reason
for the low cost was the fact that there are relatively few claims made
against fidelity bonds. Coverage becomes expensive with respect to the
large investment advisors who, for example, have 500 plans. They have to
purchase a limit per plan. Both Mr. Freitas and Mr. Anderson could
recommend increasing the 10% limitation under section 412 of ERISA, as
long as this increase did not apply to investment advisors.
Fiduciary liability insurance, by contrast, is a
third-party coverage providing protection for the named insured for claims
made against it by parties who allege damage as a result of a breach of
fiduciary duty under ERISA or other negligence on the part of the named
insured in managing or administering plan assets. Fiduciary insurance is
not required by law. Typically, the claim is in the form of an actual
lawsuit seeking recovery for the damage that has allegedly been caused by
the named insured. When fiduciary liability insurance is for trustees, it
is basically a directors and officers liability policy and is relatively
inexpensive. It is approximately a few thousand dollars. When fiduciary
liability insurance is for investment advisory liability or professional
liability, is substantially more in cost, at a minimum of ten thousand
dollars.
Both Mr. Freitas and Mr. Anderson indicated that, if
you have a single person who is plan administrator, recordkeeper, trustee
and investment advisor, that situation presents an underwriting risk,
because "you don't have checks and balances, the insurance companies
feel that there is a greater temptation" (Freitas); underwriters get
"very concerned where you have a company that may be dominated by a
sole owner or an owner that is a controlling owner, shareholder, where
that individual is functioning in a position where he or she is making a
majority of the decisions in-house for the plan".(Anderson)
Barbara Uberti (Wilmington Trust) noted there are plan
sponsors who keep their own records for defined contribution plans and
"those cases"...present "a great potential for abuse".
She indicated that an independent recordkeeper "could go an awfully
long way" to prevent that sort of abuse.
Under ERISA section 104(a)(2)(A), the Secretary of
Labor may prescribe simplified annual reports for pension plans with fewer
than 100 participants. The Secretary issued regulations permitting plans
with fewer than 100 participants to file an annual report without the
accountant's report. See Labor Reg. §2520.103-1(c).
The foregoing illustrates that the financial services
institutions that service employee benefit plans consider plans were no
independent party participates as recordkeeper, investment advisor, plan
administrator or trustee as an underwriting risk. There are no checks and
balances, no sign offs, no independent controls and thus, such a plan
presents an underwriting risk. Mr. Dingwall, when asked about the 100 life
rule said ..."audits are expensive, no doubt about it. This is the
balancing act that we all try to do. But it should be balanced in relation
to the risk that's associated with the plan, I think, not the number of
participants".
Mark Freitas (Frank Crystal), Steve Anderson (Marsh
McClellan), Barbara Uberti (Wilmington Trust Company) and John Barth
(Vanguard) all conceded the foregoing scenario of a plan sponsor assuming
all the roles of a plan without the use of any independent advisors is
likely only to occur in the under 100 lives plan.
As a consequence, we deem it advisable for the
Secretary to consider, in the reporting requirements of the under 100
lives plans, what plans present "underwriting risk factors" and
what additional protections might those plans be required to meet;
including, but not limited to, one or more of the following: independent
recordkeeper; fiduciary insurance; auditors report every three years etc.
Failure to provide sufficient staffing to resolve
deficiencies in annual reporting
James O. Wood's article "Why We Need Pension
Reform" indicates that there is only a 1% chance that a qualified
plan will be reviewed by EBSA. Ian Dingwall (EBSA) dramatically
illustrated that his office can only perform 1,700 per year while in the
1993 database, there are 21,663 deficient filings, 2,924 without
accountant's opinions. In the database in April of 1996 for the 1994 plan
year (two year lag), there are 16,863 filings that have a major
deficiency, 2,109 missing an accountant's report. In the last four years
there are 77,000 filers who just stopped filing or did not file one or
more years. There is one individual in the Office of Chief Accountant who
reviews the non-filer cases. He can examine only about 240 cases a year.
Ian Dingwall expressed the opinion that the failure to file, particularly
after a history of compliance, is some indication that "there's a
problem with the plan". The failure to file an accountant's report is
a "tip off" that there is a problem with the plan.
Moreover, the efforts of the Office of Chief Accountant
actually generates revenue for the United States Treasury. Mr. Dingwall
noted that while their budget is approximately $1.5 million they collect
over $12 million in penalties a year. They collected over $46 million in
the delinquent filer program.
The written commentary from the Society of Professional
Benefit Administrators recommended a central phone number for reporting
real or suspected problems in plans (a 911 for benefits). They indicated
that "[t]he current reporting system is dysfunctional. You need to
call a regional office who may or may not follow up".
The obligation to report to the Secretary serious
violations that auditors discover, specified in the Pension Audit
Improvement Bill (S 1490), will have little impact if there is not the
staff in the Department of Labor to respond to these reports.
It is recommended, at a minimum, that the Secretary
seek additional staffing to enable it to have sufficient resources
available to investigate and remedy noncompliance. Members of the Working
Group suggested that advances in technology and interagency dialogue with
the IRS might be the source of other innovative solutions.
Failure to require specific training for auditors
In 1992, the Office of Chief Accountant pulled a sample
of 276 audit engagements and went on site, pulled the work papers, looked
at the results of the review and concluded that 19% of the audits were
deficient. Another 33% of the audit reports failed one or more of the
ERISA reporting disclosure requirements.
Mr. Dingwall noted that the Pension Audit Improvement
Bill (S 1490) created a continuing professional education requirement for
plan auditors. One can not even audit an employee benefit plan unless you
had 16 hours of continuing professional education. The bill also requires
that the auditor be subject to peer review every three years.
It was noted in an article entitled "Senate Bill
to Crack Down on Fraud Would Change the Way CPAs Do Pension Audits",
American Institute of Certified Public Accountants, Journal
of Accountancy, March, 1996, that the AICPA supports
the bill and has worked closely with the Department of Labor to strengthen
ERISA audits.
Employer securities held in defined contribution plans
We received oral testimony and written materials which
noted that under current law, a defined contribution plan can invest all
of its assets in employer securities. Pursuant to ERISA sections 407(d)
and 408(e)(3)(A), eligible individual account plans are specifically
authorized to invest up to 100 percent of plan assets in employer
securities. The duties of diversification imposed under ERISA's fiduciary
duty Section 404(a)(1) are specifically lifted in cases where the eligible
individual account plan undertakes self-dealing transactions in employer
stock (ERISA Section 404(a)(2)), although arguably the prudent man
standard remains applicable.
Barry Hunter describes the failure to limit the amount
of employer securities that can be held by a defined contribution plans
together with ERISA's authorization to allow plan sponsors to act as
investment managers as an "authorization of unlimited fiduciary
self-dealing". Moreover, he states these rules conflict with
overlapping trading rules adopted by the Securities and Exchange
commission, were a corporate insider is prohibited from either purchasing
or selecting stock without first disclosing all material, nonpublic
information in his or her possession.
If a substantial amount of plan assets are invested in
employer securities and "the company goes downhill, you can lose your
job and your retirement benefits at the same time". (Barbara Uberti,
Wilmington Trust). She recommended limiting the amount of employer
securities that can be held by defined contribution plans (except ESOPS)
and prohibit the requirement that matching contributions be invested in
employer securities.
The Working Group received a copy of Senator Barbara
Boxer's proposed 401(k) Pension Protection Act, S. 1837. The Bill notes
that defined benefit pension plans are prohibited by ERISA from investing
more than 10% of their assets in securities and real estate of the company
sponsoring the pension plan but not defined contribution plans. The Bill
would amend ERISA to provide the same limitation to defined contribution
plans and provides a grandfather rule to existing holdings in excess of
this limit.
The issue relating to limiting employer securities
defined contribution plans was raised at our last hearing without an
opportunity for opponents of the idea to be given an opportunity to
present their views. A member of our Working Group indicated that there
are many companies that have savings, plus stock savings plans which are
designed to create an identity of interest between employees and their
Company. It was noted that if they were prohibited from offering the
stock, it doesn't mean that they take the dollars and put it into other
benefits. The benefits may just disappear.
The Working Group found that this is a complex issue
which warrants further study and we recommend a study of the advisability
of limiting the amount of employer securities in defined contribution
plans.
The Working Group recommends implementation of these
proposals.
VI. Members of the Working Group
Victoria Quesada, Working Group Chair
Law Office of Victoria Quesada
Vivian L. Hobbs, Working Group Vice-Chair
Arnold and Porter
Joyce Mader
O'Donoghue & O'Donoghue
Jim Hill
State of Oregon
Thomas J. Healey
Goldman, Sachs and Company
David Hirschland
International Union, United Automobile, Aerospace
and Agricultural Implement Workers of America, United
Auto Workers
Zenaida Samaniego
Equitable Life Assurance Society of the United States
Judith Mares, Chair of the Advisory Council
Mares Financial Consulting, Inc.
APPENDIX 1
SUMMARY OF ORAL TESTIMONY
The testimony presented to the Working Group is
recorded in the verbatim transcripts of the Council. It is further
summarized in the Executive Summary prepared of each Working Group
meeting. Therefore, the following constitutes a brief summary of the oral
testimony of each witness who testified before the Working Group on
Exploring the Utilization of Third-Party Trustees to Protect Plan
Participants.
May 7, 1996 Meeting
Charles Lerner, Director of Enforcement for the DOL
Pension Welfare Benefits Administration ("EBSA")
Charles L. Lerner described his responsibilities as the
oversight and conduct of EBSA's enforcement program, which is in the
national office, but is administered primarily through its 15 field
offices.
Mr. Lerner reminded the Council that the idea of
mandating third-party trustees is not a new one. In 1990, Congress
proposed legislation (H.R. 2664) that would have amended ERISA to require
that the assets of all single employer pension and welfare plans be held
in trust by joint trusteeship. Then Assistant Secretary of Labor David
George Ball testified against H.R. 2664, noting that joint trusteeship
would increase both the cost and administrative burden of providing
benefits.
Mr. Lerner discussed some of the cases in which the
enforcement office has been involved where it has appointed an independent
trustee to resolve the dispute. In Leigh v. Engle, 727 F.2d 113 (7th Cir.
1983) beneficiaries of employee benefit plan brought action against plan
administrators and others for alleged violations of fiduciary duties under
ERISA. In Danaher Corp. v. Chicago Pneumatic Tool Co., 635 F. Supp. 236 (S.D.N.Y.
1986) the court found it improper for president of the company to act as a
trustee of an ESOP where company was subject to takeover bid. Two union
representatives violated ERISA's exclusive purpose rules, in Brock v.
Hendershot, 840 F.2d 339 (6th Cir. 1988), where one fiduciary was held
liable for influencing local unions to choose specific dental program and
other representative negotiated agreements resulting in new members to
dental program. Trustee and other defendants were ordered to pay $1
million to an independent trustee for losses caused when they loaned plan
money to company and plan participants in Reich v. Hosking, 20 EBC March
7, 1996.
The enforcement office has also been engaged in a
number of investigations dealing with 401(k) plans and failure of
employers to forward employee contributions.
June 18, 1996 Meeting
Samuel W. Halpern, Executive Vice President and General
Counsel, Bear Stearns Fiduciary Services
Mr. Halpern discussed the varying roles of the
Independent Fiduciary. An Independent Fiduciary may or may not be a
trustee as technically defined by ERISA. Independent fiduciaries may serve
(1) on an ongoing basis, for example acting as an investment manager or
rendering "investment advice" or (2) for a specific transaction.
The benefits which an Independent Fiduciary could provide include special
expertise, enhanced independence, and a reduction of the plan's fiduciary
risk. Some ongoing functions falling within the scope of an Independent
Fiduciary's responsibility could include development and adjustment of
asset allocation, selection of investment managers, implementation of
controls over risk and expense, evaluation of investment performance, and
structuring and monitoring of brokerage activities. Some examples of
specific transactions which may call for an Independent Fiduciary include:
the sole or in-kind contribution of employer securities or employer real
estate between a sponsor and its plan, a merger of bank collective trusts
or mutual funds sponsored by affiliated financial institutions which are
themselves ERISA fiduciaries, or tender-offer or work-out situations
regarding the securities of a party in interest (such as a plan sponsor)
which the plan owns.
The type and level of Independent Fiduciary fees would
depend on the precise nature and scope of the functions required, the
liability to be faced by the Fiduciary, including the extent of pending or
threatened litigation, and the extent to which the benefits to the client
were quantifiable.
Robert Nagle, Independent Third-Party Trustee
Mr. Nagle described his experience as a court appointed
trustee for several pension plans and as a neutral trustee for several
multi-employer benefit plans. He pointed out that the mandating of
third-party trustees would require a change in the law. It is his opinion
that the extent there are abuses in pension plan administration, they are
more of a problem for defined contribution plans than defined benefit
plans since the latter have most of their benefits insured by the PBGC.
Mr. Nagle pointed out that smaller plans seem to be more prone to abuse
because (1) audited financial statements were not required for those with
under 100 participants and (2) there is often only one person running the
plan without oversight from an independent trustee or an auditor. The only
negative to a broader audit requirement or mandating a third party trustee
would be that of cost.
Mark Freitas, Managing Director, Frank Crystal
Financial Services
Mr. Freitas discussed fidelity and fiduciary insurance
coverage, their costs and market capacities. He defined fidelity insurance
as a first-party contract which protects the funds of the plan from theft
and fraudulent acts of employees or other parties, whereas fiduciary
liability insurance is a third-party contract which is used to protect the
trustee for administering the plan and investment advisors for giving
investment advise. Costs range from $200-$500 per fidelity/bond plan
(maximum liability is $500,000) to a few thousand dollars for a plan
trustee and at least $10,000 for investment advisors. There are about 7-8
insurers who write fidelity bonds (capacity ranges from $25-100 million),
fewer who carry fiduciary liability coverage. Custodians, either bank or
brokerage house, typically have fidelity bonds, while bout 50% of
registered investment advisors carry fiduciary insurance.
Catherine Shavell, Counsel for State Street Bank and
Trust Company
Ms. Shavell opened her testimony by stating that there
are significant custodian and trustee of ERISA funds in the market and
that State Street's experience is mainly in the large plan area. She said
that their world is trying to respond to the needs of plans and plan
sponsors to do what is necessary for them to establish their plans.
Ms. Shavell stated that she had picked up the chart of
key providers from the morning session and that she wanted to make a few
amendments to the chart. She said that she thought that there were many
more fiduciaries involved in the plans than the group might have
contemplated. Trusteeship involves a spectrum of services from custodial
service to full investment control, providing reporting services not just
to the Department of Labor, but also to the plan sponsor and plan
participants. Additional regulation will result in additional cost.
When asked by Ms. Quesada about what would be ways to
improve protections for plan participants that would be unobtrusive and
not add layers of regulation, Ms. Shavell stated that for protection to
plans from a custodial and banking perspective, it is important to
establish the authenticity of trading instructions in order to know that
authorized transactions are being performed without the presence of a
rogue trader or an invasion. Ms. Shavell wants to be sure that she is
paying benefits to the right people.
In response to a question from Ms. Mares regarding
responsibilities for setting accounting policy or evaluation policy, Ms.
Shavell said that they have to follow the generally accepted accounting
principles and produce a report that reflects correct values of assets and
transactions. Ms. Shavell was unable to quantify the cost difference to a
plan sponsor between a custodial arrangement and full investment control.
She explained that costs depend on investments chosen, volume and the
investment management mandates active separately managed accounts cost
more than an index strategy.
Steve Andersen, Marsh McClellan
Mr. Andersen discussed fidelity and fiduciary
insurance, particularly as they pertain to companies who buy within their
insurance portfolio coverage for plans within their organizations.
Fidelity claims require proof of dishonesty or fraud and cannot be based
on negligence. Loss experience has been very small. On the other hand,
fiduciary claims are typically in the form of actual lawsuit seeking
recovery for alleged damage resulting from breach of fiduciary duty or
other negligence on part of named insurance in administering or managing
plan assets. It covers defense costs of named insurance in addition to
settlement amount or adverse judgement. Underwriting considerations
include internal audits and controls, independent trustees, claim
experience, employee communications, plan size and controlling owner (as
in small plans).
Ian Dingwall, Chief Accountant of the DOL Office of the
Chief Accountant, Employee Benefits Security Administration ("EBSA")
Ian Dingwall explained that, in his capacity as chief
accountant, he heads three programs. These three programs are designed to
(1) improve the quality of audits, (2) oversee the reporting compliance
program, and (3) audit the Thrift Savings Plan for all government
employees.
Mr. Dingwall explained that, with respect to reporting
and compliance, his office looks at three things: (1) whether required
annual reports are filed; (2) whether they are filed timely; and (3)
whether the reports meet the filing requirements.
Mr. Dingwall pointed out that in the 1993 database,
there were 21,663 deficient filings, 2,924 without accountant's opinions.
In the database in April of 1996 for the 1994 plan year, there were 16,863
filings that have a major deficiency, 2,109 missing an accountant's
report. In the 1994 plan year, there were 107 annual reports that are
greater than 100 million that have these kinds of deficiencies. He stated
that there have been 77,000 non-filers over the last four years, all of
which have been notified by the IRS.
Mr. Dingwall testified that he believes his office is a
revenue maker for the federal government, collecting at least $1 million
per month in penalties. All revenue collected goes directly to the U.S.
Treasury, not the EBSA.
Mr. Dingwall's department recently surveyed its 1992
audits. Of the 276 audits tested, 19% failed to meet one or more of the
ten professional auditing standards. In addition, another 33% failed one
or more of the ERISA reporting and disclosure requirements. Mr. Dingwall
acknowledged, that, for the approximately 20,000 deficient cases received
in any given year, his office has only the capacity to review 1700.
September 10, 1996 Meeting
Barbara Ann Uberti, Vice President, Wilmington Trust
Company
Barbara Ann Uberti presented testimony on behalf of the
American Banker's Association. First, Ms. Uberti explained the traditional
role of bank trustees for employee benefit plans. In that role, banks have
the following basic duties: (1) custody of assets; (2) benefit payments;
(3) investment management; (4) participant recordkeeping and (5) plan
reporting.
Second, Ms. Uberti advised the Council to focus on how
money moves in and out of plans. Money moves through plans in three ways:
(1) money comes into the plan -- plan contributions; (2) money is invested
by the bank -- plan investments; and (3) money is paid out of the plan,
e.g., benefit payments, plan loans and payments to outside providers --
plan distributions.
By tracking money movement, she said, you can track the
ways of misappropriating plan assets. First, employee benefit assets can
be misappropriated before they go to the trust where an employer fails to
remit a contribution. Second, employee benefit assets can be improperly
invested, which would result in a diminution of employee benefit funds.
Third, employee benefit assets can be distributed inappropriately, either
as a benefit payment to a nonparticipant or to a subterfuge for the plan
sponsor or service provider.
Next, Ms. Uberti outlined controls that exist for each
of the ways money moves. Controls in place today for plan contributions
include ERISA obligations, bank regulators who perform audits such as the
Comptroller of the Currency, Federal Reserve, OTS, OCC, DOL and IRS, and
bank practices and procedures, involving assurance of deposit
authorization and internal reporting. She suggested additional controls to
ensure that plan contributions get to the bank. Key among her
recommendations is requiring participant statements setting forth the
amount of the employer and employee contributions.
Controls for plan investments are ERISA obligations and
diversification rules, competent investment managers, limited holdings of
employer securities and bank procedures and practices, among others.
Additional control possibilities could include limiting holdings of
employer securities, affirmative reporting obligations on the trustee and
trustee inquiry and follow-through on unusual investments.
With respect to plan distributions, a major concern is
stopping both fraudulent benefit payments and payment of fraudulent bills
initiated by plan sponsors. Present controls insuring proper plan
distributions include, again, ERISA standards, bank regulators, practices
and procedures. Two additional solutions to control distribution problems
are third-party authorization and mandatory reconciliation of participant
and trust records.
The major hurdle in implementing additional controls in
each of these three areas is the cost of compliance, she said. Uberti
emphasized that third-party authorization for distributions is unlikely to
be a big expense, but that the reconciliation process could be costly. She
was unable to quantify these costs at the time of the hearing.
Subsequent to the hearing, Ms. Uberti supplemented her
testimony with a letter to Ms. Quesada summarizing information she got
from calling several recordkeeping and accounting firms to determine the
cost of reconciling participant records. From these discussions, she
recommended reconciling small to medium size plans on an annual basis and
larger plans on a quarterly basis. For both large and small plans, the
number of transactions and the number of investment funds determines the
cost of reconciliation. Large firms estimate that it takes two hours per
fund per plan per period for reconciliation of a large plan done on a
quarterly basis, charging $100 per hour. For example, if a plan has five
investment options, the annual reconciliation cost would be $4,000. It
would cost $500-$1,000 to reconcile a small plan with five investment
funds on an annual basis. These estimates apply to ongoing reconciliation.
John E. Barth, Principal of Institutional Client
Services, The Vanguard Group R. Gregory Barton, Principal Vanguard
Institutional Legal Department
John E. Barth and R. Gregory Barton, testifying on
behalf of Vanguard Institutional Client Services and Vanguard
Institutional Legal Department, told the Council that few protections
would be provided to plan participants by requiring third party trustees,
because plan trustees generally have limited oversight and reporting
responsibilities. In most plans, the critical day-to-day functions
affecting participants' accounts are performed by the plan's recordkeepers.
They recommended that ERISA mandate that defined
contribution plans be required to provide participants with comprehensive
account statements summarizing all recent contribution, investment and
distribution activity occurring within their individual plan accounts on a
regular, e.g., semiannual or quarterly basis. They estimated that the cost
of these statements would be nominal -- $5-$10 per participant per year.
Frederick Hunt, Jr., President of the Society of
Professional Benefit Administrators ("SPBA")
Written testimony was submitted by Frederick D. Hunt,
Jr. Mr. Hunt's testimony first spelled out the common misconception that a
Third-Party Administrator might be a third-party trustee. By definition, a
Third-Party Administrator ("TPA") is just a contracted entity
hired to carry out some delegated functions. Plan sponsor/trustees, on the
other hand, are the official plan administrator and fiduciary referenced
in ERISA. Hunt further advised the Council to use the term "Outside
Trustees" instead of third-party Trustees.
Mr. Hunt testified that he did not think it is
appropriate to require "independent custodians" to submit annual
statements to plan participants. He stated that this requirement would be
costly and duplicative. He also reiterated that TPAs are hired for
specific functions -- they do not have access to the financial and
personnel data needed to compile participant reports. ERISA places this
responsibility where it belongs -- with the plan trustees.
APPENDIX 2
SELECTED BIBLIOGRAPHY
ARTICLES
James O. Wood, "Why We Need Pension Reform",
Benefits Quarterly, Third Quarter 1995.
* Barry D. Hunter, "ERISA's Authorization of
Unlimited Fiduciary Self-Dealing:
Employer Stock Acquisition by Defined Contribution Plan
Trustees",
Journal of Pension Planning and Compliance, Fall, 1994.
* "Senate Bill to Crack Down on Fraud Would Change
the Way CPAs Do Pension Audits", American
Institute of Certified Public Accountants, Journal of
Accountancy, March, 1996.
LEGISLATION
* Senator Barbara Boxer's 401(k) Pension Protection
Act, S. 1837
If you have questions, please call the Council's
Executive Secretary at 202-219-8753.
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