Recent Decision Places Spotlight on Coordination Between DOL and Plaintiffs’ Firms

Defending ERISA claims against an enterprising plaintiffs’ bar is challenging enough. That task becomes even more challenging when the Department of Labor (“DOL”) is working behind the scenes to support private-sector litigants.  For example, the DOL has the power to issue subpoenas for documents and testimony without any pending litigation, which private plaintiffs cannot do.  The DOL, as regulator, can exert pressure on sponsors, fiduciaries and others to sit for interviews, even if no litigation is pending.   Private plaintiffs and their lawyers do not have these advantages – unless the DOL secretly helps them.  To date, evidence of such public-private enforcement coordination has been limited.  But should defense counsel be more concerned about the possibility of the DOL supporting a private plaintiff in pending litigation?  And if such support is occurring, are defendants entitled to access all communications between plaintiffs’ counsel and the DOL about the matter?  A recent federal court ruling by a magistrate judge in the District of Colorado suggests the answer is “yes” to both questions. See Harrison v. Envision Management Holding, Inc. Board of Directors et al., D. Colo. 1:21-cv-00304-CNS-MDB.

In Harrison,the Plaintiffs were former employees of a company that was sold as part of an ESOP transaction.  The plaintiffs sued the ESOP’s fiduciaries for various ERISA violations arising out of the ESOP’s acquisition of the company.  Plaintiffs brought suit in the District of Colorado on behalf of all ESOP participants and the parties eventually proceeded to discovery.

Meanwhile, behind the scenes, the DOL had also been investigating the same transaction. Using its investigative subpoena powers, the DOL, which was not a party to any litigation related to the transaction, had obtained documents from, and conducted interviews of, among others, the ESOP trustee being sued by the private plaintiffs as part of a broader investigation of the trustee by the DOL (whose investigation also covered other transactions).  Unbeknownst to those targets, the DOL was sharing information obtained through that investigation with the private plaintiffs, pursuant to a common interest agreement.

The scheme came to light when, as part of discovery, Plaintiffs sought to obtain a demand letter sent to the ESOP’s trustee, one of the ESOP’s fiduciaries, by the DOL, presumably to get that letter, in which the DOL purportedly accused the trustee of breaching its fiduciary duties, into the record. The trustee refused to produce an unredacted copy of the letter, and Plaintiffs moved to compel its production. The scheme came crashing down when the Court subsequently learned that Plaintiffs had not only already obtained the letter directly from the DOL, but also had been receiving additional documents from the DOL throughout Plaintiffs’ litigation pursuant to the common interest agreement.  

Upon learning of Plaintiffs’ coordination with the DOL, the Court immediately ordered Plaintiffs to produce the common interest agreement and log all documents it had received from the DOL. Among these were summaries of interviews the DOL conducted as part of its own investigation into the ESOP.  When Plaintiffs asserted a common interest privilege and refused to produce these interview summaries, Defendants moved to compel their production.

The Court ultimately granted Defendants’ motion to compel. In so holding, the Court concluded that there was not a sufficiently common legal interest between Plaintiffs and the DOL and that the DOL had therefore waived privilege over the interview summaries when it shared them with Plaintiffs.

The Court’s ruling shed light on potential coordination between the DOL and private litigants and provides several key takeaways for ERISA practitioners going forward:

  • Defense Counsel Should Seek to Identify DOL Coordination at the Outset of the Case. Remarkably, it is unclear whether any of the coordination uncovered in Harrison would have ever been disclosed absent Court intervention. In fact, the Court explicitly noted its “concern[]” that Plaintiffs had failed to previously advise Defendants of his arrangement with the DOL. The ruling thus stands as a stark reminder for defense counsel to use the tools at their disposal to suss out DOL involvement at the outset, including targeted discovery requests that force plaintiffs to identify any potential coordination early in the matter.  Companies should also consider potential coordination agreements when facing DOL investigations. 
  • ERISA Does Not Broaden the Common Interest Exception.  The Court squarely rejected Plaintiffs’ argument that ERISA affords special protection to communications between the DOL and third parties. While the ERISA statute authorizes the DOL to share investigative material with those affected by an investigation, the Court declined to hold that this authority expanded the scope of the common interest doctrine or otherwise protected the DOL’s communications from discovery. To the contrary, the Court held that the DOL’s communications are subject to the same privilege and waiver analyses as any other communications.
  • Plaintiffs and the DOL Face a High Bar in Satisfying the Common Interest Exception.  The decision in Harrison also underscores the uphill battle for plaintiffs seeking to assert the common interest exception over their communications with the DOL. The Court underscored that the common interest doctrine applies narrowly and only where communications are shared in furtherance of a common legal—as opposed to financial or commercial—strategy. Thus, according to the Court, the DOL’s and Plaintiffs’ common interest in “restoring losses” was not sufficiently legal so as to protect their communications from discovery. The Court also carefully scrutinized the precise interests of each party, noting that the DOL’s interest in investigating the Defendant trustee was broader than the claims Plaintiffs were asserting in the litigation and that the DOL admitted that it had not reached any final conclusions about whether the defendant trustee had, in fact, breached their fiduciary duties—fatally undermining any claim of common interest. As the Court put it: “If the DOL has not even formed a position on the merits of this case, how can it develop a common legal strategy with Plaintiffs?” This holding essentially forecloses application of the common interest to DOL communications concerning an ongoing investigation. 

The Harrison decision has also sparked interest on Capitol Hill. Republicans on the House Committee on Education & the Workforce cited the ruling in a recent letter to the DOL’s inspector general calling for an investigation into information sharing between the DOL and outside law firms.  The findings of any investigation could provide even greater insight into the extent of DOL-plaintiff coordination in private litigation.  For its part, the DOL has commented publicly on this recent development, asserting its view that common interest agreements “are a well-established legal tool” that “are used by government and private litigants alike.”[1]  The DOL’s position – which suggests that the use of a common interest agreement in this case is not an isolated incident or out of the ordinary – further highlights the need to be mindful going forward of possible coordination.  Any target of ERISA litigation or an investigation should be sure to take the necessary steps to uncover that coordination as early as possible, and perhaps this may extend beyond cases involving ERISA.

If you have questions, please contact the authors or your regular Thompson Hine attorney.

[1] https://www.napa-net.org/news/2024/11/dol-improperly-shares-information-with-plaintiffs-bar-house-republicans-allege/

Citing resistance from health and welfare plan service providers, the DOL updated its 2021 cybersecurity guidance to clarify that it “generally applies to all employee benefit plans, including health and welfare plans.” This clarification is the only material change in the update. Despite that, the update serves as a useful impetus for employers to survey their current cybersecurity practices with respect to their benefit plans. Why? Security breaches are becoming more common, larger in scope, and resulting in larger liability (How many breach notifications have you received this year? I’m at four). In its report on 2023 breaches, ITRC, a non-profit that tracks publicly available data breach information, noted that (1) the number of breaches is up 72% from 2021 (the previous high); and (2) the breaches victimized more than 353 million people.

  1. Refresh Memory of the Guidance. Some employers may not have thought about the DOL’s cybersecurity guidance since it was released in 2021. As a refresher, the guidance consists of three different component documents, each targeted at a different audience. The first provides security tips to participants (e.g., use strong passwords). The second provides tips to an employer for vetting a potential service provider’s cybersecurity practices during an RFP process (e.g., verify service provider has cybersecurity insurance and examine its history of breaches). The third provides best practices for service providers to use as part of their cybersecurity programs. All three components are available here.
  2. Identify Ways to Incorporate Participant Tips. There is no specific disclosure requirement in the guidance as to when or how to provide the security tips to participants, but the guidance implies a fiduciary obligation to share the information with participants. A simple way to communicate the tips is to add them to other benefit plan participant communications, like summary plan descriptions or enrollment materials. The tips can also be added to a company’s intranet site dedicated to benefits or a service provider’s participant portal.  
  3. Evaluate Current RFP Practices. For companies that have standard, internal processes for conducting an RFP, evaluate what cybersecurity factors already exist (for example, the company’s InfoSec team may already have standard cybersecurity requests for RFP respondents). Then, compare such processes against the DOL guidance and determine if additional measures should be added. If a company relies on a consultant to administer an RFP process, it should require that the consultant to account for the DOL guidance as part of the process. If a company creates an ad hoc process whenever going to market for a service provider, it should identify a way to remind itself about the DOL guidance each time so the guidance is addressed as part of preparing the RFP.
  4. Secure Contractual Commitments. While an employer does not have direct control over a service provider’s cybersecurity program, it can address the DOL’s cybersecurity best practices guidance in its services agreement with the service provider. When negotiating the services agreement, consider the DOL best practices when determining what cybersecurity obligations to impose on the service provider. Likewise, obtain a requirement for the service provider to have appropriate levels of cybersecurity insurance and to indemnify the company for any cybersecurity incident, including costs incurred to protect participants affected by the breach.   

Earlier this year, current and former participants of two ERISA-governed health plans filed complaints alleging the same novel legal theory: that plan fiduciaries violated ERISA by mismanaging the plan’s prescription drug benefits.  In both complaints, plaintiffs alleged that the mismanagement was caused in part by the plans paying excessive and unreasonable fees to their respective pharmacy benefit managers (PBMs), resulting in participants paying unreasonably high prices for prescription drugs.

Although both cases are still in the early stages of litigation, the issue of constitutional standing is expected to play a key role in whether plaintiffs’ claims bypass the pleading stage.  The U.S. Constitution requires plaintiffs to establish standing to bring a claim in federal court.  This means a plaintiff must show they suffered an “injury in fact,” i.e., an injury that is (i) concrete and particularized and (ii) actual or imminent, rather than conjectural or hypothetical.  Moreover, the injury must be fairly traceable to the challenged action of the defendant and likely to be redressed by a favorable decision by the court.

Because the health plans at issue in these excessive fee cases are self-funded and the employer – not the participant – pays the cost of benefits after the participant’s deductible is met, we expect defendants to argue that the plaintiffs have not suffered injury in fact because the participant’s costs are not impacted.  In other words, to the extent excessive fees are paid to PBMs, those fees are paid by the employer, not the participants – the participants have no “skin in the game.”

Similar arguments have been made as to claims in the retirement plan and MEWA contexts, and those cases may offer useful insight into the viability of a constitutional standing argument in the excessive health plan fee cases.   For example:

  • Thole v. U.S. Bank, N.A, 590 U.S. 538 (2020) – In 2020, the Supreme Court addressed whether participants in a defined benefit pension plan had standing to bring claims alleging the plan fiduciaries’ failure to prudently manage the plan’s aggressive investment portfolio caused nearly $750 million in plan losses.  The Court concluded the plaintiffs did not have standing and affirmed the Eighth Circuit’s dismissal of the claims.  The Court reasoned that, because the plan provided for a benefit amount regardless of the plan asset performance, participants would receive the full value of their benefits even if the assets had been mismanaged; therefore, plaintiffs had not suffered an injury in fact required to bring the claims.  The Court stated that its reasoning would not apply in the context of a defined contribution plan, where participants’ benefits are tied to the value in their accounts. 
  • Winsor v. Sequoia Benefits & Ins. Servs., LLC 62 F.4th 517 (9th Cir. 2023) – In Winsor, the Ninth Circuit, relying on Thole, affirmed dismissal of the claims of MEWA participants that the MEWA fiduciaries approved payment of excessive insurer fees from the MEWA funds.  As in Thole, the Winsor complaint contained no allegations that plaintiffs did not receive their health benefits under the MEWA. The Ninth Circuit reasoned that a health plan is analogous to a defined benefit retirement plan because participants receive a set level of benefits regardless of the MEWA’s management, and that there was no allegation that the plaintiffs did not receive those benefits.  The Ninth Circuit also noted that participants failed to allege facts sufficient to tie the alleged fiduciary breaches to the allegedly higher premiums paid by the plan.
  • Knudsen v. Met Life Group, Inc., 2023 U.S. Dist. LEXIS 123293 (D.N.J. 2023) – Similar to Winsor, the District Court for the District of New Jersey dismissed for lack of standing claims challenging a health plan’s failure to use drug rebate profits to lower participant costs under the plan.  The court analogized the health plan at issue in the case to the defined benefit retirement plan at issue in Thole, noting that the plan’s benefits and annual premiums do not depend on or fluctuate with the plan’s profits or losses. Because the plaintiffs did not allege they did not receive the benefits promised under the plan, the plaintiffs lack standing.  The Knudsen plaintiffs appealed the ruling to the Third Circuit. 

In the context of claims alleging excessive PBM fees, because the costs of any allegedly excessive fees are born primarily by the employer, and because participants’ benefits under the plan do not depend on PBM fees paid, these holdings suggest that it may be difficult for plan participants to establish sufficient injury to give them constitutional injury to bring claims.

Until the law is more developed, health plan sponsors should continue to assess their risk of similar excessive fee-type claims.  Sponsors can take certain steps to mitigate those risks including:

  • Establish a welfare plan fiduciary committee (or similar structure) that meets regularly;
  • Conduct regular RFPs for service providers (including TPAs, PBMs, brokers and consultants);
  • Understand the fee structure for each plan provider and taking prudent steps to conclude that fees and expenses charged by plan providers are “reasonable”;
  • Establish structured procedures for monitoring service providers and other delegates (including TPA, PBMs, brokers and consultants);
  • Document meetings and decisions sufficient to demonstrate consideration of all important details;
  • Maintain plan claims procedures; administering claims in accordance with procedures (oversee and monitor claims administrator);
  • Oversee compliance with federal laws applicable to health and welfare plans (e.g., COBRA and HIPAA);
  • Monitor significant/high-profile regulatory developments and related enforcement;
  • Safeguard participant data through implementation of cybersecurity best practices; and
  • Consider obtaining fiduciary liability insurance.

If you have questions, please contact the authors or your regular Thompson Hine attorney.

Effective January 1, 2024, the Setting Every Community Up for Retirement 2.0 Act (“SECURE 2.0”) allows employers to make matching contributions under defined contribution plans based on employees’ qualified student loan payments.  Although student loan matching contribution programs could provide a significant new benefit for employees with student loan obligations, few employers have amended their plans to implement such programs because further regulatory guidance is needed.

Background

As borrowers in the United States have $1.75 trillion in student loans (both federal and private), the topic of student debt has come under the national microscope in recent years.[1]  In 2023, 28 million people restarted federal student loan payments after a nearly 42-month pandemic-related moratorium.[2]  Although student loan debt is typically associated with younger people, it affects individuals of all ages.  In 2024, about 8.8 million individuals aged 50 and older, including retirees, owe $380 billion in student loans.[3]

Given that student loans impact so many individuals in the workforce, SECURE 2.0’s student loan matching programs are important for employers and employees alike.  For employers, they can be a unique tool for both recruiting and retaining talented employees.  Many student borrowers may delay saving for retirement while they focus on paying down student debt, foregoing free money from employers in the form of a retirement plan matching contribution.  Student loan matching contribution programs allow employees to balance student loan obligations and retirement planning by allowing employees to take advantage of matching contributions to begin saving for retirement while also making payments toward student loans.

Statutory Framework

SECURE 2.0 provides that a defined contribution plan can provide matching contributions based on a participant’s “qualified student loan payments” on a “qualified education loan” incurred by a participant to pay “qualified higher education expenses.”   Student loan payments qualify for matching contributions only (1) to the extent that loan payments do not exceed the annual limit on elective deferrals under Code section 402(g) (reduced by any elective deferrals made under the defined contribution plan) and (2) if the employee certifies annually to the employer that loan payments have been made.  Employers may rely on the employee’s self-certification that the employee has made loan payments.

A plan implementing a student loan matching contribution program must satisfy the following criteria: 

  • The plan must provide matching contributions on elective deferrals at the same rate as contributions on qualified student loan payments;
  • The plan must provide matching contributions on qualified student loan payments only on behalf of employees otherwise eligible to receive matching contributions on elective deferrals;
  • All employees eligible to receive matching contributions on elective deferrals must also be eligible to receive matching contributions on qualified student loan payments; and
  • The plan must provide that matching contributions on qualified student loan payments vest in the same manner as matching contributions on elective deferrals.

SECURE 2.0 also addresses some nondiscrimination testing issues related to student loan programs.  Generally, loan payments are not treated as contributions under a plan, except that loan payments can be treated as elective deferrals for purposes of 401(k) safe harbor rules.  For ADP testing under Code section 401(k)(3)(A)(ii), participants receiving matching contributions on loan payments can be tested separately.

Additional Guidance Is Needed

SECURE 2.0 directs the Department of Treasury to issue regulations:

  • Permitting a plan to make matching contributions for qualified student loan payments at a different frequency than other matching contributions, provided that the frequency is not less than annually;
  • Permitting employers to adopt reasonable procedures for a participant to submit a claim for a qualified student loan payment matching contribution (e.g., a submission deadline), provided that the deadline is not earlier than 3 months after the close of each plan year; and
  • Providing a model amendment which can be adopted to implement a compliant student loan matching contribution program.

The anticipated regulations are a good starting point for guidance.  However, there are other significant administrative complexities for implementing a student loan matching contribution program that have not yet been addressed.  Further regulatory guidance regarding the following topics will assist plan sponsors in implementing student loan matching contribution programs:  

  • Annual Certification    
  • Code section 401(m)(4)(D) provides that a participant must certify annually to the employer that payments have been made on student loans, and Code section 401(m)(13)(c) provides that an employer may rely on the participant’s certification.  What type of information must the participant certify to the employer?  Must the employee register the loan with the employer prior to making payments?  Does the employer have recourse against the employee if false information is certified regarding the loan?
  • Payment of loans on behalf of an individual other than the participant
  • Code section 401(m)(4)(D) specifies that the loan must be “incurred” by the employee. If the participant guarantees, cosigns, or otherwise has responsibility with respect to a loan for the education of another individual (such as a spouse, child, or dependent), can the participant’s payments toward such obligation qualify for a student loan matching contribution?
  • Limitations on Higher Education
  • Code section 401(m)(4)(D) provides a complex definition of “eligible educational institution” which refers to other Code provisions and the Higher Education Act of 1965.  Additional guidance would help clarify what types of educational programs qualify.
    • Additionally, can employers craft limitations on the types of educational loans for which they will provide matching contributions?  For example, can employers limit their student loan matching contributions to loans for education at 4-year universities only, excluding community colleges or technical schools?  Can employers limit matching contributions to loans for education in certain fields related to the employer’s line of business?
  • Nondiscrimination Testing
  • Code section 401(m)(13)(B)(iv) specifies that the participants receiving a match related to loan payments can be tested separately for purposes of ADP testing.  However, how must employers correct nondiscrimination testing issues related to matching contributions made on behalf of qualified student loan payments, such as excess deferrals for highly compensated employees?
  • Forfeitures
  • Can employers use forfeitures to offset the cost of matching contributions made on behalf of qualified student loan payments?

Conclusion

Student loan matching contribution programs offer employers with defined contribution plans a new tool to attract and retain talented employees.  These programs will assist employees, particularly younger people, in saving for retirement while also satisfying loan obligations.  Guidance from the IRS, the timing of which is unclear, will assist plan sponsors in implementing student loan matching contribution programs to further the goals of both employers and employees.  Practitioners do expect regulatory authorities to provide guidance, but the timing for such guidance is unclear.

[1] “2024 Student Loan Debt Statistics: Average Student Loan Debt,” Forbes.com (https://www.forbes.com/advisor/student-loans/average-student-loan-debt-statistics/).

[2] “A First Look at Student Loan Repayment After the Payment Pause,” U.S. Department of Education, Homeroom Blog (https://blog.ed.gov/2023/12/a-first-look-at-student-loan-repayment-after-the-payment-pause/).

[3] “2024 Student Loan Debt Statistics: Average Student Loan Debt,” Forbes.com (https://www.forbes.com/advisor/student-loans/average-student-loan-debt-statistics/).

Believe it or not, the due date for annual Form 5500 filings is once again approaching.  As a reminder, Forms 5500 are due by the last day of the seventh month following the end of the plan year.  A 2½ month extension will automatically be granted upon filing a Form 5558.  For calendar year plans, a Form 5558 must be filed by July 31 for an extension to file Form 5500 by October 15.

Changes to Form 5500 for 2023 Filings

  • Participant-count methodology:  Previously, “active participants” included all individuals who were eligible for a plan.  Beginning with filings for the 2023 plan year, the “active participants” only includes those individuals with account balances in the plan.  This change is important for plans that are near the 100-participant threshold which requires an annual plan audit by an independent qualified public accountant (IQPA).  Keep in mind that the “80-120 participant rule,” which permits a plan to file as a small plan (thus avoiding the IQPA audit) as long as the plan filed as a small plan in the year prior, remains unchanged.
  • Financial information required on the Schedule H:  The Schedule H has always required reporting of administrative expenses; however, the reporting was limited to categories for professional fees, contract administrator fees and investment advisory and management fee and a catchall category of other fees.  Beginning with the filing for the 2023 plan year, the category of “professional fees” has been eliminated, but reporting on the following additional categories is required:
  • Salaries and allowances
  • Recordkeeping fees
  • IQPA audit fees
  • Bank or trust company trustee/custodial fees
  • Actuarial fees
  • Legal fees
  • Valuation/appraisal fees
  • Other trustee fees and expenses.

The additional categories are meant to increase transparency.  However, plan sponsors should remember that Form 5500 filings are public and the additional disclosures relating to fees paid by plans could come with additional scrutiny by the Department of Labor (DOL) or plan participants.  Thus, plan fiduciaries should continue to scrutinize fees paid by plans and ensure that fees paid are for reasonable administrative services and fees are commensurate with services provided.

  • Schedule R, new “Part VII”:  This new disclosure on Schedule R requires a plan to report whether it satisfies coverage and nondiscrimination tests through a combination with other plans under the permissive aggregation rules.  Note that a plan need not disclose whether coverage and nondiscrimination testing has passed or failed, but simply requires a statement as to whether the plan has been permissively aggregated with other plans to pass testing.  Additionally, a plan that uses a design-based safe harbor will now be required to note as much on the Form 5500 and will have to include whether the plan uses a prior year or current year ADP testing methodology.  Lastly, if a plan uses a pre-approved plan document, the date the pre-approved plan received an IRS Opinion Letter and the Opinion Letter serial number must also be reported.

DOL Review of Forms 5500

As Forms 5500 are publicly available, Forms 5500 should be reviewed and scrutinized before filing with the DOL.  The DOL routinely uses information from Forms 5500 to identify potential violations.  The DOL is currently focused on the reporting of late contributions.  The DOL’s plan asset rules require that employee deferrals and loan repayments be segregated from the employer’s general assets as soon as administratively practicable, but in no event later than the 15th business day following the end of the month in which such amounts are withheld from wages.  However, this rule is not a safe harbor and more often than not, “as soon as administratively practicable” is much sooner than the 15th business day following the end of the month in which such amounts are withheld from wages.  Plans are required to report on Form 5500, Schedule H if there has been a failure to timely transmit any participant contributions.  The DOL regularly sends letters to plan sponsors who have reported late contributions inviting them to self-correct via the DOL’s Voluntary Fiduciary Correction Program. 

Mitigation of Litigation

Forms 5500 which are publicly available include data that can be mined for potential inconsistencies and irregularities.  Fee and expense information has frequently been cited in lawsuits alleging excessive fees.  Recent lawsuits have also targeted plans related to the use of plan forfeitures using data obtained from Forms 5500.  Plan fiduciaries should be aware of the importance of the information being reported on Forms 5500 and in the annual audit reports and how such information could potentially be cited in litigation.

Conclusion

Third parties are often responsible for the preparation of the annual Forms 5500.  However, plan fiduciaries should not rely solely on outside parties to complete Forms 5500 on their own.  Forms 5500 are signed under the penalty of perjury and thus should be reviewed closely to ensure that the information reported is accurate and the signer understands the information being reported.

Imagine you’re a plan administrator who receives an angry letter from an out-of-network provider.  The letter explains that before treating a plan participant, the provider called to confirm the participant’s eligibility for out-of-network coverage and to authorize treatments at certain rates under the plan.  Now that treatment has been rendered, the provider is demanding payment for its services and threatening to bring state law breach of contract claims to recover amounts owed by the plan.

Time to pay up, right?  Not so fast; a recent Ninth Circuit case may provide a means for plans that receive such letters to avoid such claims.  In Bristol SL Holdings, Inc. v. Cigna Health & Life Ins. Co., 2024 U.S. App. LEXIS 13096 (9th Cir. 2024) (“Bristol”), the Ninth Circuit Court of Appeals held that an out-of-network provider’s state law claims for reimbursement were preempted by ERISA (and therefore could not be brought against the plan administrator) where the provider had engaged in a plan-prohibited practice called “fee forgiving,” on the grounds that the claims had both a “reference to” and a “connection with” the plan administrator’s plan.  The decision is a good reminder for plan administrators to confirm that administrative practice is consistent with plan terms or, at minimum, well-documented plan procedures, which, under the Bristol court’s reasoning, could result in preempted state law claims.

What Is Fee Forgiving?

“Fee forgiving” is a practice in which a provider charges an ERISA plan for a rendered service but does not charge the patient the copay or deductible owed for the service under the plan.  While fee forgiving may be great from a patient perspective (free health care!), it’s not always as generous as it seems.  For example, an out-of-network provider that routinely waives costs for patients may be attempting to hide the true cost of what it is billing—such as unnecessary or expensive services.  In addition, fee forgiving theoretically can drive up insurance costs by eliminating financial incentives for patients to seek cheaper care from their plans’ in-network providers.  As a result, some ERISA health plans contain language permitting insurers to deny reimbursement to providers that engage in fee forgiving.

Bristol Decision

Facts of the Case

In Bristol, a drug rehabilitation and mental health treatment center received reimbursements from an ERISA plan administrator for services the center rendered to plan participants as an out-of-network provider.  Before accepting plan participants as patients, the center would call the plan administrator to confirm participant eligibility for out-of-network benefits and to determine appropriate reimbursement rates.  The plan administrator reimbursed the center under this system until it suspected the center was “fee forgiving”—a practice directly addressed in the plan documents through language permitting the plan administrator to deny reimbursement of charges for which participants were not billed (i.e., for which fees were forgiven).  Based on the plan language, the plan administrator stopped reimbursing the center for claims suspected to involve fee forgiving.  The plan administrator sent the center a letter detailing its concerns and requesting proof of patient payment amounts owed under the plan.

Following the center’s bankruptcy, its successor-in-interest brought state law claims for breach of contract and promissory estoppel against the plan administrator, seeking reimbursement for service claims denied on account of the fee forgiving.  The Ninth Circuit Court of Appeals held that although the administered plans technically covered the patients and treatment for which plaintiff sought reimbursement, the claims “related to” the plans and were therefore preempted by ERISA.

ERISA Preemption

The Supreme Court has created two tests to determine whether a state law “relates to” an employee benefit plan and is preempted by ERISA.[1]  Under the first test, courts consider whether a state law has a “reference to” an ERISA plan.  The “reference to” test requires ERISA preemption if a state law claim is premised on the existence of an ERISA plan, the plan’s existence is essential to the claim’s survival, or the claim provides alternative enforcement mechanisms for ERISA plan obligations.  Under the second test, courts consider whether a state law has a “connection with” an ERISA plan.  The “connection with” test requires ERISA preemption if a state law governs a central matter of plan administration, interferes with nationally uniform plan administration, or if acute economic effects of the law force the plan to adopt a particular coverage scheme or restrict its choice of insurers.

Bristol Holding

In reaching its decision in Bristol, the Ninth Circuit explained that the plaintiff’s claims had both a “reference to” and an “impermissible connection” with the plans at issue and were thus preempted by ERISA.

Under the “reference to” test for ERISA preemption, the Ninth Circuit explained that by using state law claims to try to recover plan-covered payments discussed over the phone with the plan administrator, plaintiff sought to obtain a remedy that is not available under ERISA.  As a result, plaintiff’s state law claims were preempted for attempting to provide an alternative enforcement mechanism.  The Court also noted that by using plan reimbursement rates to calculate damages, plaintiff’s state law claims specifically relied on the terms of the plan administrator’s plan and thus were preempted as being premised on the existence of an ERISA plan.

Under the “connection with” test for ERISA preemption, the Ninth Circuit explained that allowing liability on the state law claims would intrude on a central matter of plan administration—specifically, the plan administrator’s system of first verifying out-of-network coverage and authorizing treatment by phone, and subsequently conditioning reimbursement on whether a provider had secured payments owed by plan participants.  The Court noted that plaintiff’s theory—which would require reimbursement based on the verification calls in clear violation of plan’s prohibition on fee forgiving—would render the prohibition moot and would impermissibly force plans to choose between their plan terms and their prior authorization programs.  Additionally, the Court reasoned that using state contract law to bind insurers to their verbal representations—rather than determining reimbursements in accordance with ERISA plan terms—would interfere with national uniform administration of ERISA plans.  For each reason, the Court determined the plaintiff’s claims had an impermissible connection with an ERISA plan and were therefore preempted.

Thompson Hine’s Takeaways

Although its holding specifically addresses ERISA’s preemption of state law claims where a plan administrator denied payment based on fee forgiving provisions, plan administrators threatened with state law litigation to recover out-of-network provider payments should consider the implications of the Bristol decision.  Plans looking to protect themselves against such claims denied on a similar basis should consider whether the plan document prohibits fee forgiving, and if not, whether such a provision should be added.  To the extent a plan does prohibit fee forgiving and plan administrators have relied on the prohibition to deny out-of-network provider reimbursements, such reliance should be well-documented.  More broadly, plan administrators should assess whether the plan reflects administrative practices in approving or denying claims and, if not, consider making necessary amendments to the plan or formalizing plan procedures; this could support ERISA preemption if a claims decision were challenged under state law. 

Plans should also keep in mind that Bristol does not eliminate all types of state law claims by out-of-network providers.  The Bristol holding itself explains that some circuits have allowed state law misrepresentation claims to proceed where providers rendered certain services based on insurers’ misrepresentations regarding participant eligibility for the services.  Similarly, some courts have held that ERISA will not preempt third-party reimbursement claims triggered by the absence of an ERISA plan (i.e., claims seeking reimbursement for costs of care provided when patients lacked ERISA plan coverage).  However, Bristol could provide a compelling preemption defense—at least in the Ninth Circuit—to ERISA plans against conflicting state-imposed liabilities that run contrary to established plan procedures, and in support of processes (such as fee forgiving exclusions, preauthorization, and benefits verification) critical to plan administration. 

Ultimately, although ERISA preemption is a largely fact-specific inquiry, the Bristol decision may serve as an additional tool for plans and plan administrators to protect themselves against state law claims for services denied in accordance with plan terms.

[1] Gobeille v. Liberty Mut. Ins. Co., 577 U.S. 312, 319 (2016).

In a previous blog post, we provided an overview concerning whether plan service provider agreements may be required to be disclosed to participants under Section 104(b)(4) of ERISA. A recent district court decision in California puts a renewed spotlight on this issue for employers and plan administrators who may receive these types of document requests. In Zavislak v. Netflix, Inc., 2024 U.S. Dist. LEXIS 17427, (N.D. Cal. Jan. 31, 2024), the court held that the plan administrator of a health plan was not required to provide a participant with copies of various service provider agreements. 

While the Zavislak decision provides a detailed analysis of the topic, the issue of whether service provider agreements must be disclosed remains unsettled across other jurisdictions. Accordingly, plan administrators who receive such requests should consider the extent to which such agreements must be provided based on case law in the applicable jurisdiction.

Statutory Framework

Section 104(b)(4) of ERISA requires a plan administrator to furnish copies of specific plan documents within 30 days after receiving a written request from a participant or beneficiary. The specified documents that must be provided upon request include the latest updated summary plan description, the latest annual report, any terminal report, the bargaining agreement, trust agreement, and documents that fall within a “catch-all” of “other instruments under which the plan is established or operated.” 

Courts are authorized, in their discretion, to impose penalties of up to $110 for each day that the requested documents are not provided within 30 days. 

A Varied Approach by Courts

 The scope of the statute’s “catch-all” provision remains unsettled. In particular, courts have taken a varied approach as to whether service provider agreements are “instruments under which the plan is established or operated” and must be disclosed. Some courts do not require disclosure of service provider agreements and other plan-related documents that do not govern the relationship between the plan participant and the employer.[1] Other courts have taken a more expansive approach to disclosure on the basis that there can be times where a service provider agreement does impact a plan’s operation. For instance, the District of Utah required disclosure of a claims administration agreement because the agreement “detail[ed] the division of responsibilities between the Plan Administrator and the Claims Administrator.”[2]

Zavislak Decision

In Zavislak, the district court addressed whether a plan administrator should be assessed statutory penalties for failing to provide various documents requested by a plan beneficiary, including service provider agreements. In the case, the plaintiff made her initial request in January 2021, but the company’s benefits manager did not receive it, as employees were working from home during the COVID pandemic. A month later, the plaintiff sent a second request for documents. The employer responded but withheld several categories of documents.

The Court analyzed four categories of documents and found that they were not required to be produced:

  • Administrative services agreements. The court concluded that the employer’s services agreements between the plan and its third-party administrators (“TPAs”) were not required to be disclosed to plan participants because such agreements “governed only the relationship between the plan provider and claims administrator, and not the relationship between the plan participants and the provider.” Zavislak, 2024 U.S. Dist. LEXIS 17427, at *68-69. In addition, the court noted that while one of the services agreements provided information about claims and appeals deadlines, that information was separately provided to participants in other benefit disclosures. 
  • The TPA’s internal documents (e.g., plan matrices and similar documents). The plaintiff argued that he should have been provided a “plan matrix” maintained by the TPA that kept track of clients’ various benefits. The court concluded that the TPA’s matrix was an internal document that did not govern the plan.
  • Documents incorporated into SPD. The court addressed whether two documents that were incorporated by reference in the plan’s SPD—a preventive care guide and a prior authorization list—were required to be disclosed. The court concluded that because the plaintiff had received copies of both documents free of charge once he contacted the TPA to request them (a procedure that was outlined in the SPD), these documents were not improperly withheld.
  • The TPA’s Medical Management Form and other internal documents. The court determined that a medical management form, utilization review process document, and other related documents used by the TPA for its internal purposes did not need to be disclosed because the documents did not govern the plan.

Finally, the Court held that draft versions of SPDs for the Plan did not need to be produced because the administrator is only required to provide the “currently operative, governing plan documents” at the time of the request.

The Court ultimately imposed a reduced penalty of $6,465 on the employer ($15 per day for 431 days between the date of the request and the date of production of certain documents that the employer was required to provide). The $15 rate was reduced from $110 due to the “exceptional circumstances” accompanying the COVID-19 pandemic as well as lack of bad faith on the employer’s part. 

Takeaways

The Zavislak decision is one of the most detailed analyses by a court on the scope of ERISA Section 104(b)(4). As such, it is likely that Zavislak will be cited by both litigants and courts in similar disputes involving participant requests for documents, including service provider agreements. Nevertheless, the legal issue of whether service provider agreements must be disclosed remains unsettled. Plan administrators who receive such requests should consider the extent to which agreements must be provided based on case law in the applicable jurisdiction. As part of this analysis, plan administrators will likely need to review the terms of the agreement. 

Also, the litigation over the propriety of the employer’s response to a document request lasted nearly three years and almost went to trial. The district court issued a 63-page written opinion. The sheer effort that went into litigating and adjudicating this dispute is remarkable. It highlights the need for employers to take ERISA document requests seriously. Failure to do so can be costly.

[1] See, e.g., Hively v. BBA Aviation Benefit Plan, 2007 U.S. Dist. LEXIS 119348 (June 27, 2007), aff’d, 331 F. App’x 510, 511 (9th Cir. 2009) (holding that service agreement “does not fall within the scope of § 1024(b)(4) because it does not establish any rights of Plan participants and beneficiaries, and relates ‘only to the manner in which the plan is operated.’”); Morley v. Avaya Inc. Long Term Disability Plan For Salaried Employees, 2006 U.S. Dist. LEXIS 53720, at *18-19 (Aug. 3, 2006) (holding that a services agreement “between the Plan and the Claims Administrator as to each party’s respective duties and obligations . . . is not a plan document or a document ‘under which the plan is established or operated” under ERISA § 104(b)(4)).

[2] M. S. v. Premera Blue Cross, 553 F. Supp. 3d 1000, 1036-40 (D. Utah 2021). See also Mondry v. Am. Family Mut. Ins. Co., 557 F.3d 781, 796 (7th Cir. 2009) (similar).

Potentially signaling a new wave of litigation, AT&T Inc. and AT&T Services, Inc. (AT&T) were hit with a class-action lawsuit on March 11, 2024 filed in the United States District Court for the District of Massachusetts relating to the 2023 transfer of $8 billion of their pension liabilities – covering approximately 96,000 participants in AT&T’s pension plan – to Athene Holding Ltd. (Athene). State Street Global Advisors Trust Company (State Street), which served as the independent fiduciary for the transaction, was also named as a defendant in the lawsuit.

Two days later, on March 13, 2024, former employees of Lockheed Martin Corporation (Lockheed Martin) filed a similar lawsuit in the United States District Court for the District of Maryland relating to two separate transfers of pension plan liabilities to Athene: a transfer in 2021 of $4.9 billion of Lockheed Martin’s pension liabilities, covering 18,000 pension plan retirees and beneficiaries, and a transfer in 2022 of $4.3 billion of pension liabilities, covering 13,600 pension plan retirees and beneficiaries. The transfers included liabilities from both Lockheed Martin’s hourly and salaried pension plans.

The lawsuits come at a time when plan sponsors, due to a range of factors including the relatively favorable interest rate environment, have an increased interest in de-risking activities, including transferring some or all of a pension plan’s liabilities to an insurer through the purchase of one or more group annuity contracts, known as a pension risk transfer or “PRT.” Additionally, the industry awaits an overdue report from the Department of Labor (DOL) to Congress on existing guidance on fiduciary duties under the Employee Retirement Income Security Act of 1974 (ERISA) when selecting an annuity provider that may preview changes to that guidance. Together, the outcome of these cases and the report to Congress could have far-reaching implications for sponsors and plan fiduciaries engaging in PRTs. Additionally, the lawsuits could potentially set the stage for the First Circuit and the Fourth Circuit (of which the District of Massachusetts and the District of Maryland are part, respectively) to weigh in on the pleading standard for prohibited transactions claims under ERISA, which would add to the current circuit split on this issue.

BACKGROUND

Defined benefit pension plans typically provide a guaranteed dollar amount of benefits to plan participants in the form of monthly annuity payments upon retirement (although plans may allow participants to elect an optional lump sum payment). Companies that sponsor a defined benefit plan (pension plan) are responsible for making all contributions required to ensure the plan has enough money to pay promised benefits and, unlike with respect to 401(k) and other defined contribution plans, assume the risk that assets will not be sufficient.

The law permits pension plan sponsors to transfer some or all of the pension plan liabilities to an insurance company through the purchase of group annuity contracts that satisfy certain legal requirements. Sponsors may decide to do a PRT (which may include terminating the plan altogether) for a number of reasons, including to eliminate the future risk that the plan assets will underperform, requiring significant company contributions, and to reduce volatility in company retirement contributions (by shifting future employer contributions to a defined contribution plan). Sponsors may also engage in a PRT to decrease the administrative cost of an ongoing pension plan, including premiums due to the Pension Benefit Guaranty Corporation (PBGC).

IB 95-1

The decision to do a PRT, whether or not the plan is terminated, is made by the plan sponsor and is a “settlor” decision. By contrast, the implementation of the sponsor’s PRT decision, including selection of an annuity provider, is fiduciary and accordingly done by a plan fiduciary. Fiduciary, but not settlor, actions are subject to the fiduciary standards under ERISA, including the requirement to act prudently and solely in the interest of the plan participants and beneficiaries.

In 1995, the DOL issued Interpretive Bulletin 95-1 (IB 95-1), which provides guidance to fiduciaries in discharging the fiduciary’s duties under ERISA when selecting an annuity provider for a pension plan. IB 95-1 was issued as part of the response to the failure of Executive Life Insurance Company in 1991, after the insurer’s portfolio of junk bonds took a hit. Generally, IB 95-1 advises fiduciaries to select a “safest annuity available” unless under the circumstances it would be in the interest of participants and beneficiaries to select a different insurer.

IB 95-1 lists a number of factors that DOL states a fiduciary should consider when selecting an annuity provider, including the insurer’s investment portfolio; the size of the insurer compared to the proposed contract; the level of the insurer’s capital and surplus; the insurer’s exposure to liability; the structure of the contract; and the availability of additional protection through state guaranty associations. Many plan fiduciaries consider additional factors not listed in IB 95-1, including enterprise risk management; asset-liability management; profitability and financial strength; and administrative capabilities. DOL included a reminder in IB 95-1 that the fiduciary nature of the selection of any annuity provider requires the selecting fiduciaries to act solely in the interest of participants and beneficiaries and for the exclusive purpose of providing benefits to the participants and beneficiaries as well as defraying reasonable expenses of administering the plan, meaning of course a fiduciary should not select the lowest priced annuity provider solely to maximize financial benefits for the plan sponsor. Although IB 95-1 does recognize cost and other considerations may lead to situations where it may be in the interest of participants and beneficiaries to vary from a safest annuity available, it notes that cost and such other considerations should not be used to justify putting benefits at risk by selecting an insurer that is not safe.

Review of IB 95-1

SECURE 2.0 directs DOL to review IB 95-1, in consultation with the ERISA Advisory Council, to determine whether amendments to the bulletin are “warranted” and report to Congress on the findings of the review and an assessment of risk to plan participants. It generally is understood that Congress’s direction came, in part, because of concerns some parties have raised regarding private equity-owned annuity providers.

The DOL’s review and report was to be completed by December 29, 2023. While at the time of this writing the DOL has not yet issued its report to Congress, the ERISA Advisory Council issued a statement in August 2023 with the Council’s positions and recommendations relating to IB 95-1.

Among the Council’s recommendations was that the DOL update IB 95-1 to provide that fiduciaries should consider the following: (1) an insurer’s ability to fund annuities in the long-term; (2) whether an insurer invests in riskier and/or less liquid assets; (3) whether a higher level of reserves is appropriate for insurers with riskier and/or less liquid investments; and (4) the risk of potential self-dealing or conflicts of interest when an insurer is owned, or the insurer’s portfolio is managed in part, by a private equity firm. The Council further recommended that the DOL’s guidance should clarify that fiduciaries are not prohibited from considering insurers that are invested in risky assets.

CLAIMS AGAINST AT&T AND STATE STREET

In the lawsuit against AT&T, the plaintiffs, who are former AT&T employees, take issue with the 2023 PRT to Athene, which transferred $8 billion of pension plan liabilities for the benefits of 96,000 participants and beneficiaries. Plaintiffs allege that the annuity purchase resulted in profit to AT&T of approximately $350 million, and a loss to participants of ERISA and PBGC protection. Plaintiffs further allege that Athene, which is owned by a private equity firm, has highly risky investments, including offshore reinsurance with Athene affiliates, which make it unsafe, and that AT&T chose Athene only because Athene was cheaper than other annuity providers.

Plaintiffs bring two types of claims against AT&T and State Street relating to the PRT. The first set of claims is for breach of fiduciary duty, alleging that AT&T and State Street (as a co-fiduciary) breached their duties to plan participants by selecting Athene, an allegedly unsafe insurer. As a result of this breach, plaintiffs allege, participants are at increased and substantial risk of not receiving their benefits, have lost ERISA protections, and have a decreased value of their pension benefit. There is no allegation that any participants have actually experienced any losses.

The second set of claims alleges AT&T and State Street engaged in prohibited transactions involving (1) State Street, when AT&T caused the plan to engage State Street, (2) Athene, when AT&T and/or State Street caused the plan to purchase the annuity contract from Athene, and (3) AT&T, when State Street caused the plan to purchase the annuity, which benefited AT&T. The complaint simply alleges that these parties were “parties in interest” at the time of the applicable transactions – implicating ERISA’s prohibited transactions rules – and does not address whether the transactions involved unreasonable compensation or were otherwise not covered by a statutory exemption.

The plaintiffs ask the court to order (1) AT&T and State Street to guarantee the annuities purchased from Athene, (2) AT&T to be secondarily liable for plaintiffs’ pension benefits, (3) reinstatement of the putative class as plan participants, and (4) disgorgement of profits earned from the annuity purchase, among other things.

ALLEGATIONS AGAINST LOCKHEED MARTIN

The factual allegations against Lockheed Martin are substantially similar to those made against AT&T. Plaintiffs bring claims for breach of fiduciary duty against Lockheed Martin, alleging that Lockheed Martin’s decision to do the PRTs to Athene was a breach of fiduciary duty, and also that Lockheed Martin failed to monitor unnamed fiduciaries who made the decision to place the annuities. As a result, plaintiffs allege there is an increased and significant risk that they will not receive their benefits and, therefore, a decrease in the value of their benefits.

Plaintiffs also claim that Lockheed Martin engaged in a prohibited transaction when it engaged in the PRTs to Athene. Unlike the plaintiffs in the AT&T lawsuit, the Lockheed Martin plaintiffs further allege that the transactions do not qualify for any statutory prohibited transaction exemption because Athene received more than reasonable compensation for the services provided to the pension plans.

Plaintiffs seek disgorgement of profits, and the posting of security by Lockheed Martin to ensure plaintiffs receive their benefits. Unlike plaintiffs in the AT&T case, these plaintiffs are demanding a jury trial.

THOMPSON HINE’S TAKEAWAYS

We expect that the defendants in these cases will seek dismissal of the claims. Not only must the plaintiffs sufficiently allege facts to support a fiduciary breach claim, but plaintiffs must also sufficiently allege that they suffered an injury in connection with the transfer of their benefits to Athene. Plaintiffs’ arguably speculative and conclusory allegations regarding the risk to their benefits transferred to Athene may not meet this pleading standard. Any advances beyond a motion to dismiss could have significant implications for plan fiduciaries selecting annuity providers.

The lawsuits may also have implications for ERISA plan fiduciaries more broadly. Neither the First Circuit nor the Fourth Circuit have weighed in on the pleading standard for prohibited transaction claims, but several other circuits, including the Second, Third, Seventh, and Tenth Circuits, require plaintiffs to allege transactions involved unreasonable compensation, conflict of interest, self-dealing, or the absence of a statutory prohibited transaction exemption. A few other appellate courts have interpreted the prohibited transaction provisions more expansively, which has led to a circuit split on this issue. This case could potentially present an opportunity for additional circuits to weigh in on the pleading standard for prohibited transaction claims.

For now, fiduciaries should continue to follow the guidance in IB 95-1 and be mindful of their fiduciary duties under ERISA. Fiduciaries also should be on the lookout for any amendments to IB 95-1 or related guidance from the DOL, which may address similar allegations made by the plaintiffs in this case.

On October 31, the U.S. Department of Labor (DOL) issued the proposed Retirement Security Rule (Proposed Rule), which would amend the existing rule that defines when a person is an investment advice fiduciary under the Employee Retirement Income Security Act of 1974, as amended (ERISA), and the Internal Revenue Code of 1986, as amended (Code). The DOL simultaneously issued proposed amendments to various class prohibited transaction exemptions (Exemptions), which are intended to narrow and harmonize the exemptions available to address conflicts of interest with respect to investment advice.

As discussed in this bulletin, the Proposed Rule and amendments to Exemptions – if finalized as drafted – would significantly expand which parties may be considered investment advice fiduciaries under ERISA and the Code and impose new and expanded requirements on investment firms and professionals that rely on Exemptions in their work with retirement investors. The following is a high-level summary of the more than 500-page Proposed Rule and amendments; we expect to provide additional insight in the future.

Background

ERISA imposes significant fiduciary obligations on individuals responsible for the operation and management of workplace employee benefit plans, including retirement plans (e.g., 401(k) and defined benefit plans). Among other obligations, ERISA fiduciaries must act for the exclusive benefit of plan participants and beneficiaries, act in accordance with a prudent expert standard, follow the governing plan documents unless contrary to ERISA, and diversify plan assets to minimize the risk of large losses unless it is clearly prudent not to do so. The consequences of breaching those fiduciary duties can be significant, including disgorgement of profits and restoration of plan losses.

ERISA broadly defines the term “fiduciary” and applies a functional test: a person is a fiduciary to the extent he or she engages in certain conduct (or has the authority to do so), including a person who provides investment advice for a fee, direct or indirect, with respect to a plan’s monies or property. In 1975, the DOL adopted a rule defining when a person is a fiduciary as a result of providing investment advice to a plan (Five-Part Test). Under the Five-Part Test, a person is considered to provide investment advice if that person:

  • Renders advice to the plan as to the value of securities or other property, or makes recommendations as to the advisability of investing in, purchasing, or selling securities or other property;
  • On a regular basis;
  • Pursuant to a mutual agreement, arrangement, or understanding with the plan or plan fiduciary;
  • For which the advice will serve as a primary basis for investment decisions with respect to the plan; and
  • For which the advice will be individualized based on the particular needs of the plan.

If adopted, the Proposed Rule would replace the Five-Part Test. In the preamble to the Proposed Rule (Preamble), the DOL describes the need for a new test to reflect the current retirement landscape – namely, the move away from defined benefit plans to defined contribution plans such as IRA and 401(k) plans. The DOL first sought to replace the Five-Part Test based on a similar rationale in 2010, specifically that in its view, the Five-Part Test no longer adequately protects retirement investors. The DOL further notes in the Preamble that similar rule changes have been adopted by the SEC (for broker-dealers and their registered representatives) and many states in accordance with an NAIC model regulation (for insurance agents). The Proposed Rule and proposed amendments to the Exemptions are the latest chapter in what to date has been a 13-year process.

The Proposed Rule

The Proposed Rule replaces the Five-Part Test with a two-part test designed to impose fiduciary status in circumstances in which investors “can and should reasonably place trust and confidence in the financial services provider.”

Under the Proposed Rule, a person is an investment advice fiduciary if, for a fee or other compensation:

  • The person makes a recommendation of any securities transaction or other investment transaction or any investment strategy involving securities or other investment property to a retirement investor; and
  • The person provides the advice or recommendation in one of the following contexts:
  • The person has discretionary authority or control, whether or not pursuant to an agreement, arrangement, or understanding, with respect to purchasing or selling securities or other investment property for the retirement investor;
  • The person makes investment recommendations to investors on a regular basis as part of their business, and the recommendation is provided under circumstances indicating that the recommendation is based on the retirement investor’s particular needs or individual circumstances and may be relied upon by the retirement investor as a basis for investment decisions that are in the retirement investor’s best interest; or
  • The person making the recommendation represents or acknowledges that they are acting as a fiduciary when making investment recommendations.

Key Definitions

Retirement investor. Defined in the Proposed Rule to include the plan, plan fiduciary, plan participant or beneficiary, IRA (including, among others, HSAs), IRA owners or beneficiary, or IRA fiduciary.

Recommendation. While not explicitly defined in the Proposed Rule, the DOL views a recommendation as “a communication that, based on its content, context, and presentation, would reasonably be viewed as a suggestion that the retirement investor engage or refrain from taking a particular course of action.” Whether a communication is a recommendation depends on the facts and circumstances of a particular situation.

For a fee or other compensation, direct or indirect. If the person (or any affiliate) receives any explicit fee or compensation, from any source, for the advice or the person (or any affiliate) receives any other fee or compensation, from any source, in connection with or as a result of the recommended purchase, sale, or holding of a security or other investment property or the provision of investment advice, including, but not limited to, commissions, loads, finder’s fees, revenue sharing payments, shareholder servicing fees, marketing or distribution fees, mark-ups or mark-downs, underwriting compensation, payments to brokerage firms in return for shelf space, recruitment compensation paid in connection with transfers of accounts to a registered representative’s new B-D firm, expense reimbursements, gifts and gratuities, or other non-cash compensation.

What’s Changed?

In expanding the types of recommendations covered, the Proposed Rule significantly alters certain requirements of the Five-Part Test that, in the DOL’s view, have resulted in investment professionals avoiding fiduciary status in situations in which retirement investors would reasonably expect them to act in their best interests.

Divergence From the Five-Part Test

The regular basis prong. Under the Five-Part Test, recommendations must be made on a regular basis to be considered investment advice. As such, many providers take the position that one-time advice to an investor – regardless of the nature of the advice – does not constitute investment advice. It’s worth noting that the DOL itself previously interpreted the Five-Part Test consistent with that position in an opinion letter issued in 2005, which was subsequently withdrawn during 2020 with an explanation that its interpretation of the test had changed.

The Proposed Rule eliminates the regular basis requirement as currently formulated and instead focuses on whether the person provides recommendations to investors on a regular basis as part of his or her business. Rather than evaluating the specific nature of the relationship between the person and an individual retirement investor, the Proposed Rule would evaluate more broadly whether the person is in the business of providing investment recommendations to investors generally. As a result, one-time advice to a specific investor would not escape coverage under the Proposed Rule simply because it was provided once or for the first time to an individual investor.

The mutual agreement and primary basis prongs. Under the Five-Part Test, advice must be rendered pursuant to a mutual agreement that the advice will serve as a primary basis for the investor’s investment decisions. These requirements permit investment professionals to potentially defeat fiduciary status by disclaiming fiduciary status in their written agreements with investors or to argue that if an investor consulted with various professionals, the professional’s advice was not a “primary basis” for the investor’s decisions.

The Proposed Rule eliminates these formal requirements and instead focuses on the reasonable understanding of the nature of the relationship. Important to this analysis is how investment providers market themselves and describe their services. In the Preamble, the DOL notes that the use of certain titles (e.g., financial consultant, financial planner, or wealth manager) “routinely involves [service providers] holding themselves out as making investment recommendations that will be based on the particular needs or individual circumstances of the retirement investor and may be relied upon as a basis for investment decisions that are in the retirement investor’s best interest.”

The Proposed Rule also specifically rejects the utility of disclaimers under certain circumstances, noting that disclaimers “will not control to the extent they are inconsistent with the person’s oral communications, marketing materials, applicable State or Federal law, or other interactions with the retirement investor.” In other words, an investment professional cannot engage in conduct that the DOL believes would lead an investor to believe that the professional is acting in a fiduciary capacity and at the same time disclaim such status.

Familiar Expansion to Rollover Advice

One major consequence of the departure from the Five-Part Test is the expansion of the rule to cover rollover recommendations. Specifically, the Proposed Rule applies both to recommendations regarding the decision to rollover and to recommendations on how securities or other investment property should be invested immediately after rollover, transfer, or distribution. This expansion is unsurprising, as the DOL has attempted to regulate rollover recommendations in the past. According to the DOL, this expansion is warranted because rollover decisions are among the most important decisions a retirement investor may make in his or her lifetime. Additionally, advice concerning the initial investment of assets post-rollover implicitly requires an investment adviser to consider the alternative of leaving the retirement investor’s assets in the current plan or account.

The Proposed Rule also covers recommendations of others to provide investment advice or management services and advice regarding account arrangements such as whether to hold assets in a brokerage or advisory account.

Lessons Learned From Vacatur of 2016 Rule

In an attempt to address concerns raised by the Fifth Circuit in its 2018 decision vacating a similar DOL rule issued in 2016, the DOL clarified that, while broad, the definition of investment advice is not intended to capture all interactions with retirement investors. For example, a person would not become a fiduciary solely by engaging in their own general marketing activities to a retirement investor unless the marketing efforts include specific investment recommendations that, standing alone, would constitute investment advice under the Proposed Rule. The Preamble also discusses certain other circumstances, such as wholesaling activities and the application of the Proposed Rule to platform providers and pooled employer plans. While these activities and the typical functions of these service providers often do not involve communications that would rise to the level of investment advice, the determination would depend on the specific facts and circumstances involved. The DOL also notes in the Preamble that valuation services are not covered by the Proposed Rule.

Proposed Amendments to Class Prohibited Transaction Exemptions

Along with the Proposed Rule, the DOL issued proposed amendments to various Exemptions. At a high level, these amendments are intended to harmonize, when appropriate, the requirements for prohibited transaction relief for investment advice fiduciaries, regardless of the investment product or service involved. Based on the amendments, investment advice fiduciaries must now rely on one of two exemptions to address conflicted advice: PTE 2020-02 and PTE 84-24.

PTE 2020-02

PTE 2020-02 permits investment advice professionals to receive compensation for advice that would otherwise run afoul of ERISA’s and the Code’s prohibited transaction provisions if certain requirements are satisfied. In general, financial institutions and their financial professionals relying on the exemption must:

  • Acknowledge fiduciary status in writing;
  • Disclose their services and material conflicts;
  • Meet the Impartial Conduct Standards (prudence and loyalty requirements, receipt of no more than reasonable compensation, and avoid making misleading statements about transactions or related matters);
  • Adopt policies and procedures prudently designed to ensure compliance with the Impartial Conduct Standards and mitigate conflicts of interest that could otherwise cause violations of those standards;
  • Document and disclose the specific reasons that any rollover recommendations are in the retirement investor’s best interest; and
  • Conduct an annual retrospective review.

The proposed amendment expands the availability of the Exemption to certain providers (including pooled plan providers and robo-advisers) and clarifies and expands on a variety of current requirements, including the obligation to provide additional disclosures (automatic and upon request), the disqualifying provisions, and the winding down requirements.

PTE 84-24

PTE 84-24 currently permits certain purchases of insurance or annuity contracts or investment company securities and permits insurance agents or brokers, pension consultants, and principal underwriters to receive compensation as a result of those purchases.

The proposed amendment eliminates reliance on the Exemption for investment advice transactions (which would be subject to PTE 2020-02 for relief), except for those involving the receipt of commissions or fees in connection with recommendations by independent producers involving annuities or other insurance products not regulated by the SEC. PTE 84-24 provides relief in those narrow circumstances, subject to requirements similar to those of PTE 2020-02.

PTEs 75-1, 77-4, 80-83, 83-1, and 86-128

The proposed amendment to PTEs 75-1, 77-4, 80-83, 83-1, and 86-128 would eliminate reliance on those Exemptions for conflicts arising from the provision of investment advice:

Exception. No relief from the restrictions of ERISA section 406(b) and the taxes imposed by Code section 4975(a) and (b) by reason of Code sections 4975(c)(1)(E) and (F) is available for fiduciaries providing investment advice within the meaning of ERISA section 3(21)(A)(ii) or Code section 4975(e)(3)(B) and regulations thereunder.

Discussion and Effective Date

The Proposed Rule and proposed Exemption amendments would, as proposed, significantly expand ERISA fiduciary status in a variety of circumstances and limit the relief available to resolve conflicted advice. Plan fiduciaries and potentially impacted investment professionals should carefully review the proposals and monitor further developments. We anticipate that there will be a large number of comments submitted to the DOL regarding the Proposed Rule and that, if adopted, the resulting final rule will face legal challenges.

The Proposed Rule and Exemption amendments provide that they will be effective 60 days after publication of a final rule or final amendments in the Federal Register, though the DOL has requested comments on the proposed timeline and whether additional time may be needed before the rule and amendments become effective.

On September 29, 2023, the Department of Labor (DOL) issues Advisory Opinion 2023-01A (Opinion) approving Citibank’s Diverse Asset Manager Program (Program) as it relates to plans subject to the Employee Retirement Income Security Act of 1974 (ERISA). The Opinion provides a road map primarily for pension and 401(k) plan sponsors who wish to increase the portion of plan assets that are invested with diverse investment managers without running afoul of ERISA’s rules.

Under the Program, which is part of Citibank’s larger Action for Racial Equity designed to address the “racial wealth gap” affecting the business environment in which Citibank operates, Citibank commits to pay all or part of the fees of diverse asset managers for the ERISA plans it sponsors. In this groundbreaking Opinion, the DOL concluded that (1) Citibank’s establishment of the Program and payment of investment management fees under the Program are settlor, not fiduciary, actions; (2) plan fiduciaries do not violate their fiduciary duties by taking into account Citibank’s commitment to payment of fees under the Program; and (3) for Citibank’s defined contribution plans, the Program does not constitute improper influence by a plan fiduciary or sponsor for the purpose of preventing participant control under ERISA section 404(c). The Opinion prescribes certain safeguards with respect to the Program to assure that Citibank’s actions are considered settlor actions and that an Investment Committee’s fiduciary decisions are not subject to a conflict of interest.

While the legal complexities around corporate supplier diversity, equity and inclusion (DEI) initiatives have recently grown, so too has the business rationale and need for such programs for many companies. For those companies, creative approaches to achieving DEI objectives while mitigating legal risks are valuable. Plan sponsors may therefore want to work with ERISA counsel to determine how to use the Opinion as a guide in considering similar programs.

The Program

The details of the Program are described more fully in the Opinion, but at a high level, the Program is structured as follows:

Fee Subsidy. Citibank allocates a pre-determined amount of diverse manager fee subsidies to each ERISA plan it sponsors, subject to certain caps on total fees paid under the Program as well as to an individual manager and agrees to pay for or subsidize a diverse manager’s fees for a minimum of three years.

  • An investment manager will qualify as a diverse manager for purposes of the Program if it has a total minority or female ownership of at least a specific percentage set forth in the Program, such as 50%, as determined by a Nasdaq-affiliated database, or another database unaffiliated with Citibank.
  • No investment manager who is a party in interest or in which Citibank has an interest would be eligible under the Program.

Manager Selection Process. In selecting investment managers, Citibank expects that the plan fiduciary (the Investment Committee for a plan) will perform an initial search of managers based on pre-determined criteria (such as the manager’s credentials, AUM, experience) and then narrow down the candidates based on additional factors, such as proposed fees. During the narrowing process, Citibank’s commitment under the Program to pay all or a portion of a diverse manager’s fees could be considered.

  • The fiduciary’s selection of managers is in its full and complete discretion. The Program will not provide Citibank with any rights regarding investment manager selections or allocations and will not mandate that a plan fiduciary engage in any particular search or selection processes.

Fee Disclosure. In disclosing the fees of an investment manager that manages a private fund offered to participants of one of Citibank’s defined contribution plans, Citibank expects that the plan fiduciary will disclose the fund’s expense ratio without regard to Citibank’s payment of fees under the Program. However, Citibank’s payment of fees under the Program also will be disclosed to participants.

The Program will be publicized as part of Citibank’s reporting of its Action for Racial Equity initiatives but is not designed to produce a monetary or other tangible financial benefit to Citibank.

The DOL’s Opinion

In the Opinion, the DOL reached three conclusions in respect of the Program:

  1. Citibank’s Actions Are Settlor. In establishing the Program and paying any diverse manager fees under the Program, Citibank is acting as a settlor, not a fiduciary, under ERISA.
  2. A Fiduciary May Consider Subsidized Fees. Citibank’s payment of fees under the Program is a financial factor that may be considered, as one of many factors, by a prudent fiduciary in selecting an investment manager.
  3. ERISA Section 404(c) Is Still Available. ERISA section 404(c) limits liability of a plan fiduciary for investment losses where a participant or beneficiary exercises control over the assets in their individual account. However, DOL regulations provide that a participant or beneficiary is not considered to exercise control over their account where they are subject to “improper influence” by a plan fiduciary or sponsor. The DOL concluded that disclosure of the Program or payment of fees under the Program would not constitute improper influence for the purpose of ERISA section 404(c).

Implications of Opinion

The Opinion provides an alternate pathway to reflect diversity factors in the context of selecting investment managers under ERISA plans generally. Prior to the Opinion, the principal pathway was consideration of those factors by the applicable plan fiduciary in its discretion as relevant to the risk and return analysis subject to ERISA’s fiduciary duty rules. With this Opinion, an alternative pathway is now available for a plan sponsor to design its plan in a manner intended to further its corporate DEI initiatives without subjecting that design choice to ERISA’s fiduciary duty rules.

Thompson Hine represented Citibank in obtaining this innovative Advisory Opinion, however this advisory bulletin is solely issued by Thompson Hine LLP.