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Retirement Plans
Fiduciary Update | November 2021

Fiduciary Update | November 2021

In this installment of Fiduciary Update, CAPTRUST digs into newly proposed regulations issued by the DOL embracing the use of ESG investments in retirement plans, looks into a matter of deferred compensation plan structure, and provides an update on the continued flow of 401(k) and 403(b) plan fee litigation and developments.

The ESG Pendulum Swings

As expected, a new proposed regulation has been issued by the U.S. Department of Labor (DOL) embracing the use of environmental, social, and corporate governance (ESG) investments in retirement plans and plan fiduciary involvement in proxy voting. It is titled Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights. Last March, the DOL announced that it would not enforce the recently issued Trump administration rule impacting the use of ESG investments and the active exercise of shareholder rights.

Over the past 40 years, depending on which party controlled the Executive Branch, the DOL has issued guidance either favoring or discouraging the use of ESG investments and the active exercise of shareholder rights. However, the fundamental underlying tenet of the Employee Retirement Income Security Act (ERISA)—that all investment decisions be made exclusively for the benefit of plan participants and beneficiaries—has not changed. Investment returns cannot be sacrificed for other goals, no matter how laudable.

The updated ESG rule continues to embrace this key tenet and provides that the economic impacts of ESG and similar factors may be legitimate considerations in the prudent financial evaluation of investments for use in retirement plans. To use ESG factors in a tiebreaker situation where two investments are essentially the same, plan fiduciaries are not required to conclude that the investments are financially “indistinguishable;” rather, they need to conclude that the investments would equally serve the financial interests of the plan over the appropriate time horizon. Additionally, the new rule removes the chilling special documentation requirement for fiduciaries to use an ESG investment in a tiebreaker situation. The new rule also eliminates the restrictions on use of ESG investments in qualified default investment alternatives (QDIAs).

The updated proxy voting rule reaffirms that it is a fiduciary responsibility to vote proxies in the best financial interests of plan participants and beneficiaries. Proxies should be voted the costs outweigh the benefits. The new rule also removes a recordkeeping requirement imposed by the prior DOL regulation.

The proposed regulation is open for comment until December 13, 2021.

401(k) and 403(b) Plan Fee Litigation Continues Unabated

The last quarter has seen a continued flow of 401(k) and 403(b) plan fee litigation and developments. Here are some highlights:

  • The pending Supreme Court case of Divane v. Northwestern University could create a consistent national pleading standard in these cases, and some judges have stayed—or paused—the proceedings in their retirement plan fees cases until the court’s ruling is issued.
  • A number of cases have made it to the motion-to-dismiss phase. Different outcomes at the district court level mirror the different positions of the U.S. Courts of Appeals that have led to the Supreme Court accepting the Northwestern University case. At the district court level, several cases have been dismissed because they do not include sufficient allegations to proceed. In others, very similar allegations have been found sufficient for the cases to proceed.
  • Some cases have been dismissed or allowed to proceed based on whether the named plaintiffs held the challenged investments in their own plan accounts. Many judges have required that plaintiffs hold the specific investments; others have not.
  • An attorney’s fees award was made in a case settled earlier this year by Columbia University. The settlement amount was $13 million. Of this amount, legal fees were $4.3 million, and each of the seven named plaintiffs received $25,000.
  • One suit was decided in favor of plan fiduciaries on a motion for summary judgment, after more facts had been presented to the judge. The fiduciaries demonstrated a sound process for the evaluation of fees. Alas v. AT&T Services, Inc. (D CD CA 2021)
  • New suits have been filed, and the size of plans being sued is no longer limited to the multibillion dollar plans. For instance, SeaWorld has been sued and their plan has just over $300 million in assets.
When Is a Deferred Compensation Plan Not a Deferred Compensation Plan?

A photo printing firm founded in the late 1970s had gained success by late 1989 and established a deferred compensation plan for selected employees. The plan was intended to be a so-called top hat plan that is offered to a select group of management or highly compensated employees—and is exempt from most of ERISA’s requirements. The chief executive officer (CEO) of the firm selected the individuals who would benefit, and the company made contributions to the plan in their names. In the early 2000s, times had changed, and the company was struggling. By 2004, the company was in dire financial straits. At that time, the CEO told the chief operating officer that the deferred compensation plan would have to be terminated and its assets used to pay business operating expenses. The plan was not formally terminated, but the assets were depleted. By 2008, the firm could not pay its creditors and eventually went out of business. Approximately two-thirds of the participants in the deferred compensation plan received no benefits from the plan.

Some of the disappointed plan participants sued to get their account balances from the deferred compensation plan. In most situations, this suit would have a small likelihood of success. Deferred compensation plans are not always funded, and if assets are set aside to pay benefits, they are subject to the claims of creditors. However, the plan in this situation was not properly structured. The participants did not meet ERISA’s requirement that they be a select group of management or highly compensated employees. Six of 18 participants were neither highly compensated nor managerial, and the plan included 18 of the company’s 60 employees. (Although the judge’s decision did not turn on this factor, 10 percent inclusion in plans like this is a rule of thumb.) Because the plan did not meet ERISA’s top hat requirements, the plan was a defined contribution plan covered under ERISA and subject to ERISA’s vesting, fiduciary, and other rules. As a result, the assets in the plan were not subject to the claims of creditors. Rather they were required to be held for the exclusive benefit of plan participants and their beneficiaries. Further proceedings in the case will determine how much each participant is entitled to. Browe v. CTC Corporation (2nd Cir. 2021)

The issue of whether deferred compensation plans are properly structured to cover only a select group of management or highly compensated employees is a current focus area for the DOL.

Early COVID-19 Market Losses Hit 401(k) Distributions

Behan Bros., Inc., established a 401(k) plan for its employees. Unlike the daily valued plans commonly seen today, this plan had an annual valuation at the end of each year. If a participant requested a distribution, they would receive the value of their account as of December 31 of the preceding year. However, in “extraordinary circumstances” the plan administrator had the discretion to declare a special valuation date.

Three Behan Bros. employees retired in 2018. In early 2020, as the COVID-19 pandemic spread around the world causing significant equity market declines, the three participants each requested distributions of their account balances based on the December 31, 2019, valuation. In view of the significant market drop at the beginning of 2020, the plan administrator declared a special valuation date of April 30, 2020, for the distribution calculations. The change in valuation dates resulted in a $55,000 reduction in the distributions to the retirees.

Unhappy with this outcome, the retirees sued, challenging the use of a special valuation date calculations. Finding for the plan administrator, the court noted the plan administrator’s duties run to the plan as a whole and said it was well within the plan administrator’s discretion to declare the special valuation date and make distributions on that basis. Lipshires v. Behan Bros., Inc. (D RI 2021)

Beneficiary Change Fails: Ex-Husband Wins

Sally and Clifford Hogen divorced in 2002, and their divorce decree did not address who would be the beneficiary of Sally’s 401(k) plan upon her death. In May 2008, Sally submitted a change of beneficiary form in an apparent attempt to remove Clifford. The form identified three beneficiaries, each of whom was to receive 33.3 percent. Unfortunately, the plan required that beneficiaries be designated to receive whole percentages, so the change was not processed. The plan sponsor reached out to Sally about the issue after the erroneous form was submitted, but she did not reply.

After Sally died in 2019, the balance of her 401(k) account was paid to Clifford, who remained as her named beneficiary. Sally’s personal representative filed suit to recover the 401(k) plan account. The judge observed that ERISA governs the plan’s payment of benefits and the beneficiary designation on file would be followed. The personal representative also attempted to recover the 401(k) amount from Clifford under state law claims that were equally unavailing. Gelschus v. Hogen (D MN 2021)