ERISA Update Roberta J Ufford Groom Law Group

ERISA Update Roberta J. Ufford Groom Law Group April 18, 2011 1

l l l Pending Disclosure Regulation Investment Advice Other New Guidance DOL Enforcement Issues Litigation Update IRA Issues 2

Disclosure Regulation Trends Highlighting Importance of Disclosure l Retirement system shift to participant-directed defined contribution plans. l Development of fee structures relying on "indirect" and "hidden" direct compensation (retirement and welfare plans). l Media attention/legislative pressure to improve disclosure. l Ongoing class action litigation against plan sponsors and plan service providers.

New Disclosure Regulation l l l Service Provider Disclosure l Amendment of Form 5500 Schedule C ¢ 75 Fed. Reg. 64710 and 64731 (Nov. 16, 2007) l "Point of Sale" – Interim Final 408(b)(2) Regulation ¢ 75 Fed. Reg. 41600 (July 16, 2010) Disclosure to Participants l 75 Fed. Reg. 64910 (Oct 20, 2011) (final regulation) l 75 Fed. Reg. 73987 (Nov 30, 2010) (target date funds) (proposed) l Regulatory Agenda – Pension Benefit Statements SEC Proposed Rule 12 b-2 l 75 Fed. Reg. 47064 (Aug 4, 2010)

Service Provider Disclosure Form 5500 – Schedule C l l Administrator must report all service providers receiving $5000 or more direct and indirect compensation paid by the plan. Applies l if plan has more than 100 participants l to welfare as well as pension plans l to any person receiving compensation in connection with plan services or a position with the plan Administrators required to report to DOL providers who refuse to provide compensation information for 5500 reporting.

Service Provider Disclosure – Interim Final Regulation l l l ERISA prohibits a "party in interest" from providing plan services, unless statutory exemption under § 408(b)(2) applies. l New regulation defines "reasonable arrangement" Providers who do not comply may engage in a "prohibited transaction" under Code § 4975. l Provider may be liable for excise taxes, possibly required to return "excess compensation" to plan. Class exemption provides relief for plan fiduciary (not provider). Requires fiduciary to report provider noncompliance to DOL.

Service Provider Disclosure – Interim Final Regulation l l l In general, covered service providers to covered plans must disclose direct and indirect compensation they expect to receive for providing services. Covered Plans - ERISA-covered pension plans l excludes IRAs, SEPs, SIMPLE accounts, "top-hat" plans l separate regulation pending for welfare plans Covered Service Providers – a person who: (1) expects to receive more than $1000 in direct or indirect compensation, and (2) provides certain fiduciary or non-fiduciary services Form 5500 Schedule C uses similar definition of compensation; but covered plans and providers are not the same.

Service Provider Disclosure – Interim Final Regulation l l l Covered Service Providers – persons who provide: l services as fiduciary or registered investment adviser l recordkeeping or brokerage services to defined contribution plans (e. g. , 401(k)) and provide "designated options" l accounting, auditing, actuarial, appraisal, banking, consulting, custodial, legal, recordkeeping, securities brokerage, insurance, valuation, but only if "indirect compensation" for the services Excludes most providers to "investment funds. " Service providers should consider risk of becoming inadvertently covered.

Service Provider Disclosure – Interim Final Regulation l Required Disclosures l description of services provided to plan l statement of fiduciary status, if applicable l "direct" compensation ¢ excludes payments by plan sponsor or employer l "indirect" compensation ¢ including a description of services provided for indirect compensation and payer identity ¢ includes "non-monetary" compensation l manner of receipt of compensation

Service Provider Disclosure – Interim Final Regulation l l Required Disclosures (con’t) l compensation among "related parties" (subcontractors and affiliates), ONLY if (1) set on a transaction basis (2) charged against investment and reflected in investment value or (3) commissions or other "transaction-based" compensation. l termination compensation – compensation provider expects to receive if arrangement terminates l recordkeeper/broker disclosure (next slide) On request, within 30 days, information requested by plan administrator for "Title I" purposes (e. g. , Form 5500, participant disclosure)

Service Provider Disclosure – Interim Final Regulation Additional Recordkeeper/Broker Disclosure l Investment fees – recordkeepers, brokers and investment fiduciaries of "designated investment alternatives" must disclose investment fund fees ¢ Recordkeepers, brokers must disclose if they make the investment available on their platform. l Recordkeeping fee- a "good-faith estimate" of plan cost for recordkeeping, if recordkeeping fee is not separately stated or is reduced by indirect compensation.

Service Provider Disclosure – Interim Final Regulation l Timing Requirements l Existing service arrangements ¢ before January 1, 2012 effective date l All arrangements ¢ "reasonably in advance" of entering into service arrangement ¢ within 60 days of service provider knowledge of change ¢ within 30 days to correct an error

Plan Expenses – Service Provider Disclosure Service Provider Planning l Inventory services and compensation l Direct/indirect l Meals, entertainment and gifts l Existing clients – comply by 1/1/2012 l Ongoing Procedures ¢ Delivery in advance of entering/renewal of contracts or arrangements ¢ Timely notice of changes/corrections ¢ Timely reply to requests for information

Participant Disclosure – Background l DOL interprets ERISA fiduciary rules to require plan fiduciaries to ensure that participants and beneficiaries responsible for investing their account within the plan are provided with "sufficient information" to make informed investment decisions. l Plan "administrator" is required to provide disclosure, but providers can expect to support disclosure requirements. l Disclosures required by 404(c) have been "optional"– new requirements are mandatory. 14

Participant Disclosure – New Rules l In October 2010, DOL issued final rules under ERISA section 404(a) requiring disclosure of information to participants in directed individual account plans. l 75 FR 64910 (October 20, 2010) l Effective Date – Dec. 20, 2010 l Applicability Date – Plan years beginning on or after Nov. 1, 2011.

Participant Disclosure – New Rules Overview of Required Disclosures l Automatic disclosures – provided on or before the date participant may give investment instructions, and annually l General Investment Information l Administrative Expense Information l Individual Expense Information l Information For Each Designated Alternative ¢ Includes investment performance and fee information in a comparative format l Web site disclosures l On request disclosures

Participant Disclosure – New Rules General Investment Information l Explanation of circumstances under which participants/beneficiaries may give investment instructions, and any limits on instructions l Plan investment alternatives l Investment managers l Description of any brokerage windows, self-directed brokerage accounts, or similar plan arrangements l Description/reference to plan provisions relating to the exercise of voting, tender and similar rights and restrictions on such rights.

Participant Disclosure – New Rules Plan-Level Expenses –Annual Disclosures Administrative Expenses l Explanation of fees and expenses for general plan administrative services charged against participants’ individual accounts. l The basis on which such charges will be allocated to, or affect the balance of, each individual’s account. Individual Expenses l Explanation of fees and expenses charged against participant accounts, on an individual, rather than a plan-wide basis, and which are not reflected in the total annual operating expenses of any investment alternative.

Participant Disclosure – New Rules Plan-Level Expenses – Quarterly Disclosures Administrative Expenses l The dollar amount of general plan administrative fees and expenses actually charged during the preceding quarter to a participant’s account l Explanation (if applicable) that some of the plan’s administrative expenses for the preceding quarter were paid from operating expenses of one or more of the plan’s investment alternatives Individual Expenses l The dollar amount of fees and expenses charged on an individual basis during the preceding quarter to the participant’s account and a description of the services to which the charges relate

Participant Disclosure – New Rules Designated Investments – Automatic Disclosures l Name and category of investment (e. g. , money market, balanced, stocks, bonds, employer stock) l Internet Web site for more information l Performance (1, 5 and 10 years) and comparable information for a broad-based index l Fees – total operating expenses and "shareholder" type fees l Special rules for investments with fixed or stated rates of return and annuities l Glossary (automatic or on a Web site) *Prospectus delivery no longer automatically required.

Participant Disclosure Example – Variable Return Investments

Participant Disclosure Example – Fee and Expense Information

Participant Disclosure – New Rules Designated Investments – Web site Disclosures l Name of investment issuer l Objectives and goals* l Principal strategies (including type of assets) and principal risks* l Portfolio turnover rate* l Performance data (updated quarterly)* l Fees and expenses* *provided in a manner consistent with SEC Form N 1 -A

Investment Advice – ERISA Definition l l ERISA and Advisers Act employ different definitions of "advice. " l Advice requiring RIA registration may not result in ERISA fiduciary status. l Brokers exempt from RIA registration may still provide fiduciary "advice" for ERISA purposes. Under current DOL regulations, "fiduciary" investment advice requires (1) recommendations, (2) which are individualized, (3) provided on a regular basis, (4) with mutual understanding that advice will be a "primary basis" for decisions, and (5) for a fee. l Sales presentations, fund menu offerings, and participant education (IB 96 -1) generally are not "fiduciary advice" under this definition.

Investment Advice – ERISA Definition l l l DOL has proposed amendments that would expand definition of "fiduciary" advice. l 75 FR 65263 (October 22, 2010). l Hearings held March 1 and 2. Under the proposed regulation, a person provides "fiduciary" advice if the person -l provides "advice" as defined, l has one more defined relationships to the plan, and l receives a fee. Some limitations on scope are provided.

Investment Advice – ERISA Definition "Advice" under the proposed rule includes: l advice/appraisals concerning the value of securities or property, l recommendations as to advisability of investing in, purchasing, holding or selling securities or other property, and l recommendations as to "management" of securities or other property (includes proxy voting and manager recommendations). DOL asked for comments on including advice relating to "rollovers" in investment advice definition.

Investment Advice – ERISA Definition l l A person who provides "advice" will be a fiduciary if the person is any of the following l any person who agrees to be, or is, a fiduciary (or an affiliate of a fiduciary), l any RIA, and l a person providing advice if there is mutual agreement that the advice will be considered, and will be individualized to the needs of the plan, or a participant or beneficiary. New test eliminates "regular basis" and "primary basis" elements of current test.

Investment Advice – Definition l Limitations – not fiduciary advice if: l Advice recipient knows (or reasonably should know) that the advice is provided by (or on behalf of) a seller or purchaser, and person making recommendations is not undertaking to provide impartial advice. l With respect to individual account plans, services are limited to investment education (IB 96 -1), offering an investment menu, and general information about menu options, if there is written disclosure that there is no undertaking to provide impartial advice. l Only a general report or statement reflecting value of investments, unless no generally recognized market for assets involved and statement is used as a basis for plan to make distributions to participants.

Investment Advice – Issues l l l Recordkeeper Considerations l Sample and customized fund menus l Fund monitoring services Rollover Advice Disclaimers Required by Sellers Exception Periodic Reporting by Trustees/Custodians Appraisers and Consultants

Participant Investment Advice l ERISA § 408(b)(14) exempts (i) provision of advice to participants of participant-directed plans by a “fiduciary adviser” and (ii) receipt of compensation by fiduciary adviser or an affiliate resulting from the advice, if conditions of ERISA Section 408(g) are met. l ERISA Section 408(g) describes two Eligible Arrangements: l Level-fees: Adviser’s fees do not vary based on advice. l Computer Model: Adviser provides advice using a computer model certified by an independent expert.

Participant Investment Advice l Proposed Reg. § 2550. 408 g-1 generally tracks requirements under Section 408(g). l Plan fiduciary must authorize arrangement for plan. l Advice is provided under an “eligible arrangement. ” l Detailed participant disclosure, including all program fees and the fiduciary adviser’s compensation arrangement. (proposed rule provides non-mandatory form). l Annual independent audit of services. ¢ 75 Fed. Reg. 9360 (March 2, 2010).

Participant Investment Advice l Compared to 2009 rule (withdrawn), the new proposed rule: l Does not provide relief for “off-model advice” if a computer model is used. l For level fee arrangements, (i) requires that entity’s fees are “level” - even if individual agent/representative’s fees do not change based on advice provided, and (ii) limits fees received by fiduciary advisers from affiliates. l Importantly, does not change EBSA’s other prior regulation, exemptions, interpretative or other guidance addressing participant advice programs. ¢ E. g. , dollar-for-dollar offset and ‘Sun. America’ programs are preserved.

Other New Guidance – Target Date Funds l DOL/SEC guidelines for Target Date Funds advise fiduciaries/participants evaluating target date funds to consider: l “Investment Style” - active or “hands-off” approach? l Fund Prospectus – understand the strategy and risks of fund, and underlying funds. l How the Investment Will Change Over Time– understand when the fund will reach its most conservative mix; whether at or after the target date; whether participant risk tolerance matches the fund. l When Will Participant Access the Fund – does the fund’s investment mix at target date fit with future plans? l Fees – understand costs of fund and underlying funds. ¢ http: //www. dol. gov/ebsa/pdf/TDFInvestor. Bulletin. pdf

Other New Guidance – Target Date Disclosure l l DOL regulations implementing relief for investments in qualified default investment options designate "target date" funds as a possible "QDIA". l 72 FR 60452 (October 24, 2007); l 73 FR 23349 (April 30, 2008). Proposed amendment of QDIA regulation would – l cross-reference participant disclosure regulation l amend participant disclosure regulation and QDIA regulation to include new disclosure requirements for target date funds. l 75 FR 73987 (November 30, 2010).

Other New Guidance – Target Date Disclosure l Amendments would require disclosure to explain – l how asset allocation may change over time and when most conservative allocation will be achieved (chart or other graphical representation); l intended age group, relevance of any date in name, and assumptions about whether participants will withdraw or contribute after that date; and l participant may still lose money, even near retirement date.

Other New Guidance – Fiduciary Conflict Interpretation l DOL Advisory Opinion 2011 -03 A (Feb. 4, 2011) l Applies fiduciary self-dealing prohibition (ERISA § 406(b)) to manager affiliate of global financial institution. Mitsubishi Bank (“MB”) (Up to 100%) Mitsubishi Group Broker – Dealers (“MBDs”) (Up to 19. 9%) Aberdeen PLC AAM (ERISA Manager) 36

Other New Guidance – Fiduciary Conflict Interpretation DOL Advisory Opinion 2011 -06 A l Because MBDs are not parties in interest to AAM plan clients based on common ownership through MB, AAM not per se prohibited from directing trades to MBDs. l BUT, must still examine facts/circumstances. Some key considerations: l There may be a disqualifying affiliation (so that AAM could not direct trades to MBDs) if substantial and close control of AAM by common parent. l If objective criteria/policies for selecting brokers limits AAM’s exercise of fiduciary judgment, AAM may not be prohibited from directing plan transactions to MBDs. l Under PTE 84 -14 (QPAM Exemption) MBDs not “related” parties of AAM.

EBSA – National Enforcement Projects l l l l Delinquent Contributions l Contributory Plans Criminal Project l (Final Participant Contribution Regulation 75 FR 2068 (Jan 14, 2010)) Plans in Bankruptcy/Abandoned Plans Employee Stock Ownership Plans Consultant/Adviser Project Participant and Beneficiary Complaints 5500 Desk Reviews/Non-Filer Enforcement Health Fraud/Multiple Welfare Arrangements l See www. dol. gov. ebsa/erisa_enforcement. html

Litigation – 401(k) Fee Lawsuits l l Claims by participants against plan sponsors allege: l Service arrangements with “unreasonable, ” “hidden” and “excessive” fees are imprudent. l Plan sponsor fiduciaries did not understand/recognize revenue sharing arrangements. l Fiduciaries did not disclose to participants in “proper detail and clarity” fees and expenses, including “revenue-sharing. ” Claims against financial institutions and other service providers (by participants and/or plan sponsors) allege: l Service provider is a fiduciary based on selection of plan options and/or failure to disclose fees, and l Breached fiduciary duties by failing to disclose and engaging in prohibited transactions, e. g. , “using” plan assets, self-dealing, receiving kickbacks.

Litigation – 401(k) Fee Lawsuits l Hecker v. Deere & Co. , 496 F. Supp. 967 (W. D. Wisc. 2007), aff’d 556 F. 3 d 575 (7 th Cir. 2009). l Court dismissed participant claims against plan committee and Fidelity. l Fidelity not a fiduciary because plan sponsor selected plan investment options. l Revenue-sharing not material and need not be disclosed to participants. l Because plan offered a broad selection of funds, offering allegedly expensive fund options not a fiduciary breach. l ERISA section 404(c) defense also precluded liability for fund selection.

Litigation – 401(k) Fee Lawsuits l l Court dismissed claims alleging Citi. Street was a "functional" fiduciary by virtue of offering an investment menu. l F. W. Webb Co. v. State Street Bank and Trust Co. , No. 09 Civ. 1241 (S. D. N. Y. Aug. 21, 2010). Recordkeeper not a fiduciary merely because it offered a limited fund menu and could modify the menu with notice. Court noted that recordkeeper creates its menu before the existence of any contractual relationship with a plan and is free to design investment menus for prospective clients. l Zang v. Paychex, Inc. , No. 08 -CV-6046 L (W. D. N. Y. Aug. 2, 2010).

Litigation – 401(k) Fee Lawsuits l l In suits by plan sponsors against insurers offering group annuity contracts to 401(k) plans (insurers receive fees from mutual funds offered through these contracts), courts have held that insurers may be, or are fiduciaries. l Charters v. John Hancock Life Ins. Co. , 583 F. Supp. 2 d 189 (D. Conn. 2007); Phones Plus, Inc. v. The Hartford Financial Services Group, Inc. , 2007 WL 3124733 (D. Conn 2007); Haddock v. Nationwide Fin. Services, Inc. , 419 F. Supp. 2 d 156 (D. Conn. 2006). Court granted motion for class certification in Haddock, concluding that plan by plan decision on Nationwide’s fiduciary status is not required. l 262 F. R. D. 97 (D. Conn. 2009); compare Ruppert v. Principal Life Ins. Co. , 2007 WL 2025233 (S. D. Iowa 2007) (denying motion for class certification).

Litigation – 401(k) Fee Lawsuits l l Court granted Fidelity motion to dismiss because plaintiff did not allege Fidelity was a fiduciary in setting its compensation or selecting plan investment options. l Columbia Air Services, Inc. v. Fidelity Management Trust Co. , 2008 WL 4457861 (D. Mass. 2008). Court dismissed claims in plan sponsor suit against Principal. For purpose of its motion, Principal did not disclaim fiduciary status. Court (i) followed Deere, holding that revenue sharing need not be disclosed, and (ii) held that Principal’s fees were not unreasonable, because factored into fees charged to the plan. A motion for reconsideration by 8 th Circuit has been filed. l Ruppert v. Principal Life Ins. Co. , 4: 07 -CV-00344 (S. D. Iowa Nov. 5, 2009).

Litigation – 401(k) Fee Lawsuits l l Braden v. Wal-Mart Stores, Inc. , 590 F. Supp. 2 d 1159 (W. D. Mo. 2008), decision vacated 588 F. 3 d. 585 (8 th Cir. Nov. 25, 2009). l District court dismissed, but 8 th Circuit remanded, holding that fiduciaries must disclose “material” information to participants, including fund expense and revenue sharing information. Tussey v. ABB Inc. , 2008 WL 379666 (W. D. Mo. 2008). l In case similar to Deere, court denied motions to dismiss by ABB and Fidelity; trial held January 2010. Martin v. Caterpillar, Inc. , Civil Action No. 1: 07 -CV-01009 (C. D. Ill. November 5, 2009) l Settled for $16. 5 million ($5. 8 million in attorneys fees) plus Caterpillar agreement to certain restrictions on plan operations. Tibble v. Edison Int’l, 2010 WL 2757153 (C. D. Cal. July 8, 2010) l After bench trial, court held that using retail class shares instead of institutional class shares was a fiduciary breach.

Litigation – Directed Trustee Issues l l l On appeal, DOL amicus brief argues directed trustee of 404(c) plan had duties in connection with manager hired by participant and accurate valuation of assets. l Tullis v. UMB Bank, N. A. , 640 F. Supp. 2 d 974, (N. D. Oh. 2009) Investment manager could be liable for "black-out" penalty. l Roholt Vision Institute, Inc. , 401(K) Profit Sharing Plan, et al. v. Principal Life Insurance Company, et al. , No. 5: 09 -CV-02431, 2010 U. S. Dist. LEXIS 71070 (N. D. Oh. July 15, 2010) Court allows participant claim that plan fiduciaries and directed trustee breached fiduciary duties by transferring funds to QDIA. l Falcone v. DLA Piper US LLP Profit Sharing Plan, No. 09 -5555 (N. D. Cal 2010)

IRAs – Background l l Most IRAs not subject to ERISA l IB 99 -1 establishes conditions for payrolldeduction IRAs, not subject to ERISA. Prohibited transaction excise tax provisions under Code § 4975 apply to IRAs l A “disqualified person” (including service providers and fiduciaries) who engages in a prohibited transaction is liable for excise taxes. l Disqualification is penalty if IRA owner engages in a prohibited transaction.

IRAs – Background l Automatic IRA Act of 2010 (S. 3760/H. R. 3760) l Employers who do not offer a tax-qualified retirement plan would be required to offer an auto. IRA, or pay $100 per employee per year. ¢ Requirement would “phase in, ” beginning with firms with 100 or more employees. ¢ Employees participate if age 18, with 3 months employment, must affirmatively opt-out. l Default would be 3% employee contribution; no employer contribution; standardized investments. l Senate program would include approved federally approved providers list.

IRAs – Litigation l l l Disqualification affects bankruptcy exemption l In re: Willis, 2009 WL 2424548 (Bankr. D. Fla. Aug. 6, 2009) IRA Rollover Desk Issue l Young v. Principal Financial Group, 547 F. Supp. 2 d 965 (S. D. Iowa 2008) Valuation Responsibilities l Cohen v. First Trust Corp. Retirement Accounts, Inc. , et. al. No. 09 -cv-01356 (D. Colo. June 10, 2009)

IRA Issues – Problem Transactions l l “Co-investments” of Personal and IRA Funds l BUT see DOL AO 2000 -10 A (July 27, 2000) Transactions with family members, real estate that the IRA owner may occupy, or other IRA owner business interests l See DOL AO 2011 -04 A (Feb. 3, 2011) and AO 2006 -09 A (Dec. 19, 2006) IRA owner may not grant security interest in non. IRA assets to cover potential IRA indebtedness. l DOL AO 2009 -03 A (Oct. 27, 2009) Decision to take a distribution not “fiduciary” act. l DOL AO 2009 -02 A (Sept. 28, 2009)

Questions? Roberta J. Ufford, Esq. - (202) 861 -6643 Groom Law Group, Chartered 1701 Pennsylvania Avenue, NW Suite 1200 Washington, DC 20006 rju@groom. com