2024 New Years’ Resolutions for Retirement Plans

Over the past few years, numerous pieces of legislation affecting retirement plans have been signed into law, including the Setting Every Community Up for Retirement Enhancement (SECURE) Act, the Coronavirus Aid, Relief and Economic Security (CARES) Act, the Bipartisan American Miners Act, and the SECURE 2.0 Act (the “Acts”). While some of the changes, including both mandatory and optional provisions under the Acts previously became effective, other provisions under the SECURE Act and SECURE 2.0 Act had a delayed effective date. As we enter into 2024, many of the remaining mandatory and optional provisions established under these Acts are now going into effect. As a refresher, we have compiled a brief list of some of the important changes that will affect retirement
plans in 2024:

Long-Term Part-Time (“LTPT”) Employee Rule –
We resolve to permit more part-time employees to defer to our plans.

Beginning January 1, 2024, 401(k) plans are required to allow eligible employees who have at least 500 hours of service over 3 consecutive, 12-month periods beginning on or after January 1, 2021 to participate for purposes of making elective deferrals only, even where the 401(k) plan provides for a longer service requirement for deferral eligibility. See our prior SECURE Act and SECURE 2.0 Act newsletters, linked below, for more details on the LTPT employee rule; however, note that the IRS recently published proposed regulations on the LTPT employee rule, which are not addressed in these newsletters.

Effective January 1, 2025, the SECURE 2.0 Act changed the rule to require only 2 consecutive 12-month periods of service with at least 500 hours of service, and to apply the LTPT employee rule to 403(b) plans.

RMD Age and Roth Accounts –
We resolve to permit our elders to stay in our plans longer (again).

The age at which required minimum distributions (“RMDs”) must commence was increased again by SECURE 2.0, this time to age 73 for individuals who turn age 72 on or after January 1, 2023. Additionally, pre-death RMDs are no longer required for Roth accounts in retirement plans, generally effective for taxable years after December 31, 2023.

New Emergency Withdrawals –
We resolve to permit more access to retirement plan savings.

Beginning January 1, 2024, plan sponsors may add a number of new optional features addressing emergency situations, including:

  • Emergency Expense Distributions – Plans may permit participants to receive one emergency distribution of up to $1,000 per calendar year to cover unforeseeable or immediate financial needs relating to personal or family emergency expenses.
  • Distributions for Victims of Domestic Violence – Plans may permit a participant who is a domestic abuse victim to take a distribution up to the lesser of $10,000 (indexed) or 50% of the participants vested account balance during the 1-year period beginning on the date on which the individual is a victim of domestic abuse by a spouse or domestic partner.
  • Emergency Savings Accounts – Plan sponsors may offer an emergency savings account linked to their defined contribution retirement plan. Participants who are not highly compensated employees may contribute (on a post-tax, Roth basis) a maximum of $2,500 (indexed), or such lower amount that may be set by the plan sponsor. The account must allow for withdrawal by the participant at least once per calendar month, and the first 4 distributions per year from the account cannot be subject to fees or charges.

Mandatory Distribution Threshold –
We resolve to increase our automatic IRA rollover threshold.

The limit on involuntary distributions (i.e., the automatic IRA rollover limit) is increased from $5,000 to $7,000 for distributions occurring on or after January 1, 2024. However, this increase is optional – therefore, the limit under a plan will stay at $5,000 unless the plan administrator takes action to increase it to $7,000.

Roth Employer Contributions –
We resolve to treat employer contributions more like Roth.

Plans may permit employees to designate employer matching contributions or nonelective contributions as Roth contributions if such contributions are 100% vested when made.

Matching Contributions on Student Loan Payments –
We resolve to treat student loan payments like employee deferrals.

Plan sponsors may treat certain “qualified student loan payments” as elective deferrals for purposes of matching contributions.

2024 Resolutions Saved for Another Year

Roth Catch-Up Contribution Requirement is Pushed Back.

SECURE 2.0 required that all catch-up contributions made to a retirement plan by employees paid more than $145,000 (indexed) in FICA wages in the prior year be made on a Roth basis. The original effective date of this requirement was generally January 1, 2024 – however, in September, the IRS provided for a 2-year administrative transition period, which essentially moved the effective date for this requirement from January 1, 2024 to January 1, 2026. This extension provides plan sponsors with additional time to prepare for this new requirement.

Amendment Deadline to Reflect the Acts

IRS Notice 2024-02, released in the last week of December 2023, further extended the amendment deadline for changes made by the Acts. In general, the deadline to adopt an amendment to a qualified plan for required and discretionary changes made by the Acts is now December 31, 2026.

For more in-depth analysis of the new provisions briefly described above, please refer to our prior newsletters linked below:

The Secure Act Becomes Law!

SECURE 2.0 Passes

IRS Relief for Roth Roth Catch-up Requirement

Taxpayer Makes Offer, But IRS Refused

James E. Caan, the movie actor most famous for playing Sonny Corleone in The Godfather, got into IRS trouble regarding the attempted tax-free rollover of his IRA.

Caan had two IRA accounts at UBS, a multinational investment bank and financial services company. One account held cash, mutual funds and exchange-traded funds (ETF) and the other account held a partnership interest in a hedge fund called P&A Multi-Sector Fund, L.P.

Because the hedge fund was a non-publicly traded investment, UBS required Caan to provide UBS with the year-end fair market value to prepare IRS Form 5498. Caan never provided the fair market value as of December 31, 2014. UBS issued a number of notices and warnings to Caan and finally on November 25, 2015, UBS resigned as custodian of the P&A Interest. UBS issued Caan a 2015 Form 1099-R reporting a distribution of $1,910,903, which was the value of the P&A Interest, used as of December 31, 2013. Caan’s 2015 tax return reported the distribution as nontaxable.

In June 2015, Caan’s investment advisor Michael Margiotta resigned from UBS and began working for Merrill Lynch. In October 2015, Margiotta got all UBS IRA assets to transfer to a Merrill Lynch IRA, except for the P&A Interest. The P&A Interest was ineligible to transfer through the Automated Customer Account Transfer Service. In December 2016, Mr. Margiotta directed the P&A Fund to liquidate the P&A Interest and the cash was transferred to Caan’s Merrill Lynch IRA in three separate wires between January 23 and June 21, 2017.

In April 2018, the IRS issued a Notice of Deficiency for the 2015 tax year asserting that distribution of the P&A Interest was taxable. On July 27, 2018, Caan requested a private letter ruling asking the IRS to waive the requirement that a rollover of an IRA distribution be made within 60 days. In September 2018, the IRS declined to issue the ruling.

Caan died July 6, 2022. In the Estate of Caan v. Commissioner, 161 T.C. No. 6 (October 18, 2023), the Tax Court ruled that Caan was not eligible for a tax-free IRA rollover of the P&A Interest for three reasons. First, to be a nontaxable rollover the taxpayer may not change the character of any noncash distributed property, but here, the P&A Interest was changed to cash before being rolled-over. Second, the contribution of the cash occurred long after the 60-day deadline. Third, only one rollover contribution is allowed in any one-year period, but Caan had three contributions. The Court also determined the 2015 fair market value of the P&A Interest.

Finally, the Tax Court determined that it has jurisdiction to review the IRS denial of the 60-day waiver request and that the applicable standard of review is an abuse of discretion. The Court ruled there was no abuse of discretion because Caan changed the character of the rollover property and even if the IRS waived the 60-day requirement, the rollover would still not be tax-free.

The case highlights some of the potential dangers in holding non-traditional, non-publicly traded assets in an IRA.

Regulatory Update and Recent SEC Actions

REGULATORY UPDATES

Recent SEC Leadership Changes

On January 10, 2023, the Securities and Exchange Commission (the “SEC”) announced the appointment of Cristina Martin Firvida as director of the Office of the Investor Advocate, effective January 17, 2023. Ms. Martin Firvida was most recently the vice president of financial security and livable communities for government affairs at the American Association of Retired Persons (“AARP”). As the investor advocate, Ms. Martin Firvida will lead the office that assists retail investors in interactions with the SEC and with self-regulatory organizations (“SROs”), analyzing the impact on investors of proposed rules and regulations, identifying problems that investors have with financial service providers and investment products, and proposing legislative or regulatory changes to promote the interests of investors.

On January 11, 2023, the SEC announced that Paul Munter has been appointed as chief accountant. He has served as acting chief accountant since January 2021. In addition to continuing to lead the Office of the Chief Accountant (“OCA”), he will also assist the SEC in its oversight of the Financial Accounting Standards Board (“FASB”) and the Public Company Accounting Oversight Board (“PCAOB”). Mr. Munter joined the SEC in 2019 as deputy chief accountant in charge of OCA’s international work. Before joining the agency, Mr. Munter was a senior instructor of accounting at the University of Colorado Boulder. He had previously retired from KPMG, where he served as the lead technical partner for the U.S. firm’s international accounting and International Financial Reporting Standards (“IFRS”) activities and served on the firm’s panel responsible for establishing firm positions on the application of IFRS.

On January 13, 2023, the SEC announced that Renee Jones, director of the Division of Corporation Finance, departed the agency and was replaced by Erik Gerding, effective February 2, 2023. Mr. Gerding previously served as the Division’s deputy director. Mr. Gerding joined the SEC in October 2021 and led the Legal and Regulatory Policy in the Division of Corporation Finance. He has taught as professor of law and a Wolf-Nichol Fellow at the University of Colorado Law School, where he has focused in the areas of securities law, corporate law, and financial regulation. Mr. Gerding previously taught at the University of New Mexico School of Law. He also practiced in the New York and Washington, D.C., offices of Cleary Gottlieb Steen & Hamilton LLP, representing clients in the financial services and technology industries in an array of financial transactions and regulatory matters.

Boards File Comment Letters Asking SEC to Withdraw Swing Pricing Rule Proposal

Over thirty (30) fund boards have submitted comment letters to the SEC with respect to the controversial swing pricing rule proposal. Industry participants have noted that this level of direct board participation in the comment process for a rule proposal of this type is unprecedented in recent SEC history. Many of the letters call for a withdrawal of the rule proposal, with some arguing that millions of American investors will not get the best price for their trades. Many letters also stated that requiring swing pricing would burden fund complexes and harm mutual fund investors without solving the liquidity problems that the SEC aimed to resolve. A vast majority of the comment letters indicated that swing pricing is not needed and that current tools for managing liquidity worked well, even during the volatile 2020 markets.

The comment letters also noted that investors who hold fund shares through intermediaries may have to place their orders earlier as a result of the proposed hard close requirement, which would put them at a disadvantage over the investors who buy shares directly from a fund. Several commenters also expressed concern that the hard close could cause intermediaries to drop mutual funds from their offerings in favor of less-regulated investment vehicles, such as collective investment trusts (“CITs”). Some letters pointed out that one of the justifications the SEC raises for the new rule is the market volatility during the early part of the COVID-19 pandemic and its impact on fund liquidity risk management, yet the SEC then goes on to say that it did not have specific data about fund dilution during that period. Letters also alleged that the SEC did not provide an accurate cost benefit analysis, and noted that the SEC states in the rule proposal that it “cannot predict the number of investors that would choose to keep their investments in the mutual fund sector nor the number of investors that would exit mutual funds and instead invest in other fund structures such as ETFs, close-end funds, or CITs.”

SEC Proposes Rule to Prohibit Conflicts of Interest in Certain Securitizations

The SEC issued a proposed rule (the “proposed rule”) to prohibit material conflicts of interest in the sale of asset-backed securities (“ABS”). The proposed rule, Rule 192 under the Securities Act of 1933 (the “Securities Act”), was issued on January 25, 2023, to implement Section 27B of the Securities Act, a provision added by the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”). Specifically, the proposed rule would prohibit securitization participants from engaging in certain transactions that could incentivize a securitization participant to structure an ABS in a way that would put the securitization participant’s interests ahead of those of ABS investors. The SEC originally proposed a rule to implement Section 27B in September 2011. If adopted, the proposed rule would prohibit an underwriter, placement agent, initial purchaser, or sponsor of an ABS, including affiliates or subsidiaries of those entities, from engaging, directly or indirectly, in any transaction that would involve or result in any material conflict of interest between the securitization participant and an investor in such ABS. Under the proposed rule, such transactions would be considered “conflicted transactions” and include, for example, a short sale of the ABS or the purchase of a credit default swap or other credit derivative that entitles the securitization participant to receive payments upon the occurrence of specified credit events in respect of the ABS.

The prohibition on conflicted transactions would commence on the date on which a person has reached, or has taken substantial steps to reach, an agreement that such person will become a securitization participant with respect to an ABS, and it would end one year after the date of the first closing of the sale of the relevant ABS. The proposed rule would provide certain exceptions for risk-mitigating hedging activities, bona fide market-making activities, and certain commitments by a securitization participant to provide liquidity for the relevant ABS. The public comment period will remain open for 60 days following publication of the proposing release on the SEC’s website or 30 days following publication of the proposing release in the Federal Register, whichever period is longer.

Division of Examinations Publishes Risk Alert on Regulation Best Interest

On January 30, 2023, the Division of Examinations published a Risk Alert (the “Risk Alert”) to highlight observations from examinations related to Regulation Best Interest, which had a June 30, 2020, compliance date and to assist broker-dealers in reviewing and enhancing their compliance programs related to Regulation Best Interest. The Risk Alert discusses deficiencies noted during examinations conducted, as well as examples of weak practices that could result in deficiencies. Regulation Best Interest established a new, enhanced standard of conduct under the Securities Exchange Act of 1934 (the “Exchange Act”) for broker-dealers (“broker-dealers” or “firms”) and associated persons that are natural persons (“financial professionals”) of a broker-dealer when making recommendations of securities transactions or investment strategies involving securities (including account recommendations) to retail customers. Regulation Best Interest requires compliance with four component obligations: (1) providing certain prescribed disclosure, before or at the time of the recommendation, about the recommendation and the relationship between the retail customer and the broker-dealer (“Disclosure Obligation”); (2) exercising reasonable diligence, care, and skill in making the recommendation to, among other things, understand the potential risks, rewards, and costs associated with a recommendation, and having a reasonable basis to believe that the recommendation is in the best interest of a retail customer (“Care Obligation”); (3) establishing, maintaining, and enforcing written policies and procedures reasonably designed to identify and address conflicts of interest; and (4) establishing, maintaining, and enforcing written policies and procedures reasonably designed to achieve compliance with Regulation Best Interest. The Risk Alert set out specific examples of practices, policies, and procedures that were deficient in complying with requirements under the Regulation, including:

  • Policies and Procedures Relating to the Disclosure Obligation. Some broker-dealers did not have written policies and procedures reasonably designed to achieve compliance with the Disclosure Obligation. The SEC noted that examples of policies and procedures that may contain deficiencies or weaknesses include policies and procedures that did not specify when or how disclosures should be created or updated.
  • Policies and Procedures Relating to the Care Obligation. Examples of policies and procedures that may contain deficiencies or weaknesses include policies and procedures that directed financial professionals to consider reasonably available alternatives without providing any guidance as to how to do so; directed financial professionals to consider costs without providing any guidance as to how to do so; or created systems that allowed financial professionals to evaluate costs or reasonably available alternatives but did not mandate their use or, in some instances, could not determine whether or not financial professionals used the systems.
  • Conflict of Interest. The SEC observed a number of deficiencies related to the requirement that broker-dealers have written policies and procedures reasonably designed to address conflicts of interest associated with their recommendations to retail customers. For example: some broker-dealers did not have written policies and procedures reasonably designed to specify how conflicts are to be identified or addressed; some broker-dealers limited the identified conflicts to conflicts associated with prohibited activities (e.g., churning) or used high-level, generic language that did not identify the actual conflict (e.g., “we have conflicts related to compensation differences”) and did not reflect all conflicts of interest associated with the recommendations made by the firm or its financial professionals; and some broker-dealers inappropriately relied on disclosure to “mitigate” conflicts that appeared to create an incentive for the financial professional to place its interest ahead of the interest of the retail customer, and did not establish any mitigation measures.

SEC Releases Staff Guidance on Differential Advisory Fee Waivers

The staff of the Division of Investment Management (“Staff”) issued guidance (“Guidance”) on February 2, 2023, to mutual funds, their boards of directors/trustees (“Boards”), and their legal counsel about the implications under the Investment Company Act of 1940, as amended (the “Investment Company Act”), regarding fee waiver and expense reimbursement arrangements that result in different advisory fees being charged to different share classes of the same fund. The Guidance noted that Rule 18f-3 permits fee waivers and expense reimbursements provided that such arrangements do not result in cross-subsidization of fees among classes. The Staff stated that whether a differential advisory fee waiver presents a prohibited means of cross-subsidization between classes is a facts-and-circumstances determination that a mutual fund’s board, in consultation with the investment adviser and legal counsel, should consider making and documenting after considering all relevant factors.

For example, a fund’s Board may be able to conclude that a long-term waiver of an advisory fee for one class of shares, but not other classes of shares, does not provide a means for cross subsidization in contravention of Rule 18f-3 if the Board finds that (1) shareholders in the waived class pay fees to the adviser at the investing fund level in a funds-of-funds structure for advisory services, and (2) that such fees, when added to the advisory fees that are paid by the waived class, after giving effect to the waiver, are at least equal to the amount of advisory fees paid by the other classes, such that the waiver for the waived class is demonstrably not being subsidized by other classes. For a fund that already has such differential advisory fee waivers in place, the Staff said the fund’s board may wish to consider, specifically within the context of Rule 18f-3, whether: (i) such waivers present a means for cross-subsidization, (ii) the steps they are taking to monitor such waivers to guard against cross-subsidization are (and continue to be) effective, and/or (iii) alternative fee arrangements may be appropriate. Relatedly, the Staff suggested that a fund should consider the extent to which the Board’s consideration of these issues under Rule 18f-3 should be disclosed to its shareholders.

SEC Division of Examinations Announces 2023 Priorities

On February 7, 2023, the SEC’s Division of Examinations (the “Division”) announced its 2023 examination priorities. The Division publishes its examination priorities annually to provide insights into its risk-based approach, including the areas it believes present potential risks to investors and the integrity of the U.S. capital markets. The following are a selection of the Division’s 2023 priorities:

  • New Investment Adviser and Investment Company Rules:The Division will focus on the new Marketing Rule (Rule 206(4)-1 under the Investment Advisers Act of 1940, as amended (the “Advisers Act)) and whether registered investment advisers (“RIAs”) have adopted and implemented written policies and procedures that are reasonably designed to prevent violations by the advisers and their supervised persons of the new Marketing Rule and whether RIAs have complied with the substantive requirements.

    The Division will also focus on new rules applicable to investment companies (“funds”), including the Derivatives Rule (Rule 18f-4 under the Investment Company Act) and the Fair Valuation Rule (Investment Company Act Rule 2a-5). If a fund relies on the Derivatives Rule, the Division will, among other things: (1) assess whether registered investment companies, including mutual funds (other than money market funds), exchange-traded funds (“ETFs”) and closed-end funds, as well as business development companies (“BDCs”), have adopted and implemented policies and procedures reasonably designed to manage the funds’ derivatives risks and to prevent violations of the Derivatives Rule pursuant to Investment Company Act Rule 38a-1; and (2) review for compliance with Rule 18f-4, including the adoption and implementation of a derivatives risk management program, board oversight, and whether disclosures concerning the fund’s use of derivatives are incomplete, inaccurate, or potentially misleading.

    Under the new Fair Valuation Rule, the Division will, among other things: (1) assess funds’ and fund boards’ compliance with the new requirements for determining fair value, implementing board oversight duties, setting recordkeeping and reporting requirements, and permitting the funds’ board to designate valuation designees to perform fair value determinations; and (2) review whether adjustments have been made to valuation methodologies, compliance policies and procedures, governance practices, service provider oversight, and/or reporting and recordkeeping.

  • RIAs to Private Funds – Examinations will include a review of issues under the Advisers Act, including an adviser’s fiduciary duty, and will assess risks, focusing on compliance programs, fees and expenses, custody, the new Marketing Rule, conflicts of interest, and the use of alternative data. The Division will also review private fund advisers’ portfolio strategies, risk management, and investment recommendations and allocations, focusing on conflicts and disclosures around these areas. In addition, the Division will focus on RIAs to private funds with specific risk characteristics, including highly leveraged private funds and private funds managed side-by-side with BDCs.
  • Retail Investors and Working Families – Examinations will focus on how registrants are satisfying their obligations under Regulation Best Interest and the Advisers Act fiduciary standard to act in the best interests of retail investors and not to place their own interests ahead of the interests of retail investors.
  • Registered Investment Companies  ̶  The Division will review compliance programs and governance practices, disclosures to investors, and accuracy of reporting to the SEC of the registered investment companies, including ETFs and mutual funds. The Division will also focus on funds with specific characteristics, such as: (1) turnkey funds, to review their operations and assess effectiveness of their compliance programs; (2) mutual funds that converted to ETFs, to assess governance and disclosures associated with the conversion to an ETF; (3) non-transparent ETFs, to assess compliance with the conditions and other material terms of their exemptive relief; (4) loan-focused funds, such as leveraged loan funds and funds focused on collateralized loan obligations, for liquidity concerns and to review whether the funds have been significantly impacted by, and have adapted to, elevated interest rates; and (5) medium and small fund complexes that have experienced excessive staff attrition, to focus on whether such attrition has affected the funds’ controls and operations. The Division will also monitor the proliferation of volatility-linked and single-stock ETFs, and may review such funds’ disclosures, marketing, conflicts, and compliance with portfolio management disclosures, among other things. In addition, the Division will focus on adviser compensation, practices and processes for assessing and approving advisory and other fund fees, the effectiveness of derivatives risk management and liquidity risk management programs.
  • Environmental, Social, and Governance (“ESG”) – The Division will focus on ESG-related advisory services and fund offerings, including whether funds are operating in the manner set forth in their disclosures, whether ESG products are appropriately labeled, and whether recommendations of such products for retail investors are made in the investors’ best interests.
  • Information Security and Operational Resiliency – The Division will review broker-dealers’, RIAs’, and other registrants’ practices to prevent interruptions to mission-critical services and to protect investor information, records, and assets. Reviews of broker-dealers and RIAs will include a focus on the cybersecurity issues associated with the use of third-party vendors, including registrant visibility into the security and integrity of third-party products and services and whether there has been an unauthorized use of third-party providers.
  • Emerging Technologies and Crypto-Assets – The Division will conduct examinations of broker-dealers and RIAs that are using emerging financial technologies or employing new practices, including technological and on-line solutions to meet the demands of compliance and marketing and to service investor accounts. Examinations of registrants will focus on the offer, sale or recommendation of, or advice regarding trading in, crypto or crypto-related assets and include whether the firm (1) met and followed its standard of care when making recommendations, referrals, or providing investment advice; and (2) routinely reviewed, updated, and enhanced its compliance, disclosure, and risk management practices.

As in recent past years, the Division noted that it prioritizes RIAs and investment companies that have never been examined, including recently registered firms or investment companies, and those that have not been examined for a number of years.

“Our priorities reflect the changing landscape and associated risks in the securities market and are the product of a risk-based approach to examination selection that balances our resources across a diverse registrant base. We will emphasize compliance with new SEC rules applicable to investment advisers and investment companies as well as continue our focus on emerging issues and rules aimed at protecting retail investors,” said Division of Examinations’ Director Richard R. Best. “Our examination program continues moving forward and remains committed to furthering investor protection through high-quality examinations and staying abreast of the latest industry trends and emerging risks to investors and the markets.”

SEC Reopens Comment Period for Proposed Cybersecurity Risk Management Rules and Amendments for Registered Investment Advisers and Funds

The SEC reopened the comment period on proposed rules and amendments related to cybersecurity risk management and cybersecurity-related disclosure for registered investment advisers, registered investment companies, and BDCs that were proposed by the SEC on February 9, 2022. The initial comment period ended on April 11, 2022. Per the SEC’s March 15, 2023, announcement, the reopened comment period will allow interested persons additional time to analyze the issues and prepare comments in light of other regulatory developments, including whether there would be any effects of other SEC proposals related to cybersecurity risk management and disclosure that the SEC should consider. The comment period will remain open until 60 days after the date of publication of the reopening release in the Federal Register.

SEC Finalizes Rules to Reduce Broker-Dealer Settlement Cycle from (T+2) to (T+1)

The SEC adopted rule changes to shorten the standard settlement cycle for most broker-dealer transactions in securities from two business days after the trade date (“T+2”) to one (“T+1”). The SEC indicates that the final rules, adopted on February 15, 2023, are designed to reduce the credit, market, and liquidity risks in securities transactions faced by market participants. The final rules will: (i) require a broker-dealer to either enter into written agreements or establish, maintain, and enforce written policies and procedures reasonably designed to ensure the completion of allocations, confirmations, and affirmations as soon as technologically practicable and no later than the end of the trade date; (ii) require registered investment advisers to make and keep records of the allocations, confirmations, and affirmations for certain securities transactions; (iii) add a new requirement to facilitate straight-through processing, which applies to certain types of clearing agencies that provide central matching services; and (iv) require central matching service providers to establish, implement, maintain, and enforce new policies and procedures reasonably designed to facilitate straight-through processing and require them to submit an annual report to the SEC that describes and quantifies progress with respect to straight-through processing. The final rules will become effective 60 days after publication in the Federal Register. The compliance date for the final rules is May 28, 2024.

SEC Proposes Enhanced Custody Rule for Registered Investment Advisers

The SEC proposed rule changes to enhance protections of customer assets managed by registered investment advisers. If adopted, the changes would amend and redesignate rule 206(4)-2, the SEC’s current custody rule (the “custody rule”), as new rule 223-1 under the Advisers Act (the “proposed rule”) and amend certain related recordkeeping and reporting obligations. According to the SEC’s announcement on February 15, 2023, the SEC exercised its authority under the Dodd-Frank Act in broadening the application of the custody rule. The proposed rule would change the current rule’s scope in two important ways. First, it would expand the types of investments covered by the rule. The proposed rule would extend the rule’s coverage beyond client “funds and securities” to client “assets” so as to include additional investments held in a client’s account, e.g. digital assets, including crypto assets. Second, an adviser would be deemed to have “custody” of client assets whenever the adviser has discretionary authority to trade client assets.

The proposed rule would also require qualified custodians to provide certain standard custodial protections when maintaining an advisory client’s assets and additional protections for certain securities and physical assets that cannot be maintained by a qualified custodian. The proposed rule would also provide exceptions to the surprise examination requirement in instances in which the adviser’s sole reason for having custody is because it has discretionary authority or because the adviser is acting according to a standing letter of authorization. In addition, the proposed rule would expand the scope of who can satisfy the custody rule’s surprise examination requirement through financial statement audits. Finally, the proposed rule would update related recordkeeping requirements for advisers and amend Form ADV to align reporting obligations with the proposed rule and to improve the accuracy of custody-related data available to the SEC, its staff, and the public. The comment period on the proposal will remain open for 60 days following publication of the proposing release in the Federal Register.

“I support this proposal because, in using important authorities Congress granted us after the financial crisis, it would help ensure that advisers don’t inappropriately use, lose, or abuse investors’ assets,” said SEC Chair Gary Gensler. “In particular, Congress gave us authority to expand the advisers’ custody rule to apply to all assets, not just funds or securities. Further, investors would benefit from the proposal’s changes to enhance the protections that qualified custodians provide. Thus, through this expanded custody rule, investors working with advisers would receive the time-tested protections that they deserve for all of their assets, including crypto assets, consistent with what Congress envisioned.”

Republican Leaders Request Information from Gensler on Climate Disclosure Proposal

On February 22, 2023, the chairman of the House Financial Services Committee, Patrick McHenry (R-NC); the ranking member of the Senate Committee on Banking, Housing, and Urban Affairs, Tim Scott (R-SC); and the chairman of the Subcommittee on Oversight and Investigations, Bill Huizenga (R-MI), sent a letter to the SEC Chair Gary Gensler demanding records and other information related to the proposed climate disclosure rule, including responses to previous requests by numerous members of both the House and the Senate that Chair Gensler had failed to provide. The Republican leaders argued that the proposed rule exceeds the SEC’s mission, expertise, and authority and—if finalized in any form—will unnecessarily harm consumers, workers, and the U.S. economy. In addition, the Republican members of the House Appropriations subcommittee pushed to cut the agency’s budget and requested that the SEC expand its enforcement efforts, reduce the pace of its rulemaking, and refrain from regulation. According to the opening statement of Steve Womack (R-Ark.), chair of the Financial Services and General Government subcommittee, who opened the March 29, 2023, hearing, the SEC budget is too big, the agency costs too much to run, and it focuses too much on the implementation and enforcement of new regulations rather than on trying to encourage the flow of investment capital into markets.

“The blistering pace of the SEC rulemaking is a cause for concern,” Womack wrote, “especially when the SEC is wading into areas that are not within their expertise and constitutionally questionable, such as requiring public companies to report on greenhouse gas emissions while claiming private enterprises won’t be impacted.”

SEC Fee Rate Advisories

The SEC announced that, starting on February 27, 2023, the fee rates applicable to most securities transactions would be set at $8.00 per million dollars. Per the January 23, 2023, announcement, the then-current rate of $22.90 per million dollars would remain in effect on charge dates through February 26, 2023. The assessment on security futures transactions remained unchanged at $0.0042 for each round-turn transaction. Subsequently, on March 1, 2023, the SEC announced that a mid-year adjustment to the fee rate for fiscal year 2023 was not required. As a result, the fiscal 2023 fee rate will remain at $8.00 per million dollars until September 30, 2023, or 60 days after the enactment of a regular FY 2024 appropriation, whichever occurs later. Similarly, the SEC confirmed that the Section 31 assessment on round-turn transactions in security futures also would remain at $0.0042 per transaction.

SEC Proposes Changes to Reg S-P to Enhance Protection of Customer Information

The SEC proposed amendments to Regulation S-P (“Reg S-P”) that would, among other things, require broker-dealers, investment companies, registered investment advisers, and transfer agents (collectively, “covered institutions”) to provide notice to individuals affected by certain types of data breaches that may put them at risk of identity theft or other harm. Reg S-P currently requires broker-dealers, investment companies, and registered investment advisers to adopt written policies and procedures for the protection of customer records and information (the “safeguards rule”). Reg S-P also requires the proper disposal of consumer report information (the “disposal rule”). If adopted, the SEC’s proposal, which was announced on March 15, 2023, would (i) update current requirements to address the expanded use of technology and corresponding risks since the SEC originally adopted Reg S-P in 2000; (ii) require covered institutions to adopt written policies and procedures for an incident response program to address unauthorized access to or use of customer information; (iii) require, with certain limited exceptions, covered institutions to provide notice to individuals whose sensitive customer information was or is reasonably likely to have been accessed or used without authorization; (iv) require a covered institution to provide such notice as soon as practicable, but not later than 30 days after the covered institution becomes aware that an incident involving unauthorized access to or use of customer information has occurred or is reasonably likely to have occurred; and (v) make a number of additional changes to Reg S-P, including:

(a) broadening and aligning the scope of the safeguards rule and disposal rule to cover “customer information,” a new defined term which would extend the protections of the safeguards and disposal rules to both nonpublic personal information that a covered institution collects about its own customers and nonpublic personal information that a covered institution receives about customers of other financial institutions;

(b) extending the safeguards rule to transfer agents registered with the SEC or another appropriate regulatory agency, and expanding the existing scope of the disposal rule to include transfer agents registered with another appropriate regulatory agency rather than only those registered with the SEC; and

(c) conforming Reg S-P’s existing provisions regarding the delivery of an annual privacy notice with a statutory exception created by the U.S. Congress in 2015.

The public comment period for the proposed amendments will remain open until 60 days after the date of publication of the proposing release in the Federal Register.

SEC Proposes New Requirements to Address Cybersecurity Risks to the U.S. Securities Markets

The SEC proposed requirements (the “proposal”) for broker-dealers, clearing agencies, major security-based swap participants, the Municipal Securities Rulemaking Board, national securities associations, national securities exchanges, security-based swap data repositories, security-based swap dealers, and transfer agents (collectively, “Market Entities”) to address their cybersecurity risks. In its March 15, 2023, announcement of the proposal, the SEC noted that Market Entities increasingly rely on information systems to perform their functions and provide their services and that the interconnectedness of Market Entities increases the risk that a significant cybersecurity incident can simultaneously impact multiple Market Entities causing systemic harm to the U.S. securities markets.

Proposed new Rule 10 under the Exchange Act would require all Market Entities to (i) establish, maintain, and enforce written policies and procedures that are reasonably designed to address their cybersecurity risks, (ii) review and assess, at least annually, the design and effectiveness of their cybersecurity policies and procedures, including whether they reflect changes in cybersecurity risk over the time period covered by the review, and (iii) provide the SEC with immediate written electronic notice of a significant cybersecurity incident upon having a reasonable basis to conclude that the significant cybersecurity incident has occurred or is occurring. The proposal includes additional requirements for Market Entities other than certain types of small broker-dealers (collectively, “Covered Entities”), including the requirement that Covered Entities utilize a proposed new Form SCIR to (a) report and update information about any significant cybersecurity incident and (b) publicly disclose summary descriptions of their cybersecurity risks and the significant cybersecurity incidents they experienced during the current or previous calendar year. The public comment period for the proposal will remain open until 60 days after the date of publication of the proposing release in the Federal Register.

SEC Proposes to Expand and Update Regulation SCI

The SEC proposed amendments to expand and update Regulation Systems Compliance and Integrity (“Regulation SCI”). Regulation SCI requires certain U.S. securities markets entities (“SCI entities”) to take corrective action with respect to systems disruptions, systems compliance issues, and systems intrusions and to notify the SEC of such events. In the SEC’s March 15, 2023, announcement of the proposed amendments, the SEC explained that trading and technology have evolved since Regulation SCI’s adoption in 2014 and that the growth in electronic trading allows ever-increasing volumes of securities transactions in a broader range of asset classes at increasing speed by competing trading platforms, including those offered by broker-dealers that play multiple roles in the markets. The proposed amendments would expand the scope of SCI entities covered by Regulation SCI to include registered security-based swap data repositories, all clearing agencies that are exempt from registration, and certain large broker-dealers (in particular, those that exceed a total assets threshold or a transaction activity threshold in national market system stocks, exchange-listed options contracts, U.S. Treasury Securities, or Agency Securities).

The proposed amendments would require that an SCI entity’s policies and procedures include the maintenance of a written inventory and classification of all SCI systems and a program for life cycle management; a program to prevent unauthorized access to such systems and information therein; and a program to manage and oversee certain third-party providers, including cloud service providers, of covered systems. The proposed amendments would also expand the types of SCI events experienced by an SCI entity that would trigger immediate notification to the SEC, update the rule’s annual SCI review and business continuity and disaster recovery testing requirements, and update certain of the Regulation’s recordkeeping provisions. The public comment period for the proposed amendments will remain open until 60 days after the date of publication of the proposing release in the Federal Register.

The SEC Issues Frequently Asked Questions for Registration of Municipal Advisors

On March 20, 2023, the SEC updated its Registration of Municipal Advisors Frequently Asked Questions (“FAQs”) page which provides general interpretive staff guidance on various aspects of the SEC’s municipal advisor registration rules. The updated page provides answers to questions across several categories, including the following topics: (i) independent registered municipal advisor exemption; (ii) registered investment adviser exclusion; (iii) issuance of municipal securities/post-issuance advice; (iv) completion of Form MA, Form MA-I, and Form MA-NR; (v) withdrawal from municipal advisor registration; and (vi) investment strategies and proceeds of municipal securities.

SEC Issues Statement Regarding Risk Legend Used by Non-Transparent ETFs

Under the terms of the SEC’s exemptive relief granted to actively managed ETFs that do not provide daily portfolio transparency (“non-transparent ETFs”), each non-transparent ETF is required to include in its prospectus, fund website, and any marketing materials a risk legend  highlighting the differences between the non-transparent ETF and fully transparent actively managed ETFs, as well as certain costs and risks unique to non-transparent ETFs. Recognizing that the standardized risk legend required by the exemptive orders may be difficult to place in certain digital advertisements (e.g., banner advertisements) due to space limitations, the SEC issued new disclosure language on March 29, 2023, which may be used in digital advertisements by non-transparent ETFs in place of the standardized risk legend currently provided in the exemptive orders. Requirements relating to placement of the risk legend or new disclosure language in a prominent location remain as prescribed in the exemptive orders.


SEC ENFORCEMENT ACTIONS

SEC Charges Former Investment Adviser Managing Director and Co-Portfolio Manager with Undisclosed Conflict of Interest

The SEC charged a former managing director (the “defendant”) of a New York-based investment adviser (the “Adviser”), with failing to disclose a conflict of interest arising from his relationship with a film distribution company in which the fund he managed for the Adviser invested millions of dollars. The SEC’s order, issued on January 5, 2023, found that, from 2015 to 2019, a closed-end publicly traded fund (the “fund”), invested in Aviron Group, LLC subsidiaries by loaning the subsidiaries, which were in the business of funding advertising budgets of motion pictures, as much as $75 million. The defendant, a co-portfolio manager of the fund, had a significant role in recommending and overseeing the fund’s loans to the Aviron subsidiaries. At the same time, the defendant asked Aviron to help advance his daughter’s acting career. Aviron helped defendant’s daughter obtain a small role in a film produced in 2018. The defendant did not disclose to the fund’s board of trustees or the Adviser’s compliance and legal teams that he asked Aviron to help advance his daughter’s acting career or that Aviron helped his daughter obtain a film role. The defendant consented to the entry of the SEC’s order finding that he violated Section 206(2) of the Advisers Act. Without admitting or denying the SEC’s findings, the defendant agreed to a cease-and-desist order, a censure, and a $250,000 penalty.

SEC Charges Former SPAC CFO for Orchestrating Fraud Scheme

The SEC announced fraud charges against Cooper J. Morgenthau, the former CFO of African Gold Acquisition Corp. (“African Gold”), a special purpose acquisition company (“SPAC”), alleging that he stole more than $5 million from African Gold and from investors in two other SPACs that he incorporated. The SEC’s January 3, 2023, complaint alleged that from June 2021 through July 2022, Morgenthau embezzled money from African Gold and stole funds from another SPAC series to pay for his personal expenses and to trade in crypto assets and other securities; concealed unauthorized withdrawals by falsifying African Gold’s bank account statements; and raised money from the other SPAC’s investors based on misrepresentations. The SEC’s complaint alleged that Morgenthau violated antifraud provisions of the federal securities laws, lied to African Gold’s auditor and accountants in violation of the Exchange Act, knowingly falsified African Gold’s books and records, and filed false certifications with the SEC. Morgenthau consented to a judgment enjoining him from further federal securities laws violations and barring him from serving as an officer or director of a publicly traded company, with monetary remedies to be determined at a later date. In a parallel action, the U.S. Attorney’s Office for the Southern District of New York, on the same day the SEC issued its complaint, announced criminal charges against Morgenthau.

In a related matter, on February 22, 2023, the SEC announced that it settled charges against African Gold for internal controls, reporting, and recordkeeping violations. Per the SEC, it was due to these failures that Morgenthau was able to embezzle money from the company’s operating bank account as discussed in the above complaint. The SEC noted that African Gold made materially false filings with the SEC and maintained inaccurate books and records. According to the SEC’s order, African Gold’s only liquid asset was the money held in its operating bank account, and thus potential fraud by management posed one of the company’s most significant risks of material misstatements in its financial statements. The SEC’s order alleged that, despite this risk, African Gold gave Morgenthau control over nearly all aspects of its operating bank account and financial reporting process with little to no oversight. The SEC’s order found that African Gold violated Exchange Act provisions relating to internal controls, reporting, and recordkeeping. Without admitting or denying the SEC’s findings, African Gold agreed to a cease-and-desist order and to pay a $103,591 civil monetary penalty.

SEC Settles Charges Against Investment Adviser for Alleged Conflicts of Interest Arising Out of Revenue Sharing and Incentive Arrangements

The SEC issued an order instituting and settling administrative and cease-and-desist proceedings against Moors & Cabot, Inc. (“Moors & Cabot”), a registered investment adviser and broker-dealer. Per the January 19, 2023, order, between at least February 2017 and September 2021, Moors & Cabot failed to fully and fairly disclose material facts and conflicts of interest associated with certain revenue-sharing payments and financial incentives that Moors & Cabot received from two unaffiliated clearing brokers. According to the order, Moors & Cabot also failed to implement written compliance policies and procedures reasonably designed to prevent violations of the Advisers Act in connection with the disclosure of revenue sharing, fee markups, financial incentives, and associated conflicts of interest, as well as disciplinary histories. Moors & Cabot is charged with willfully violating Sections 206(2) and 206(4) of the Advisers Act and Rule 206(4)-7 thereunder.

Company to Pay $5 Million for Misleading Disclosures About Its Valuation Methodologies for Fixed Income Securities

The SEC announced settled charges against a privately held financial, software, data and media company headquartered in New York (the “Company”) for misleading disclosures relating to its paid subscription service, which provides daily price valuations for fixed income securities to financial services entities. The SEC’s January 23, 2023, order found that from at least 2016 through October 2022, the Company failed to disclose to its subscription service customers that the valuations for certain fixed income securities could be based on a single data input, such as a broker quote, which did not adhere to methodologies it had previously disclosed. The order found that the Company was aware that its customers, including mutual funds, may utilize subscription service prices to determine fund asset valuations, including for valuing fund investments in government, supranational, agency, and corporate bonds, municipal bonds, and securitized products, and that subscription service prices, therefore, can have an impact on the price at which securities are offered or traded. The SEC’s order found that the Company violated section 17(a)(2) of the Securities Act. Without admitting or denying the findings, the Company agreed to cease and desist from future violations and to pay a $5 million penalty. The SEC’s order noted that the Company voluntarily engaged in remedial efforts to improve its subscription service line of business.

Twenty-five States File Lawsuit to Block DOL’s ESG Rule

Twenty-five states are suing the Biden Administration in an attempt to block the Department of Labor (“DOL”) rule that allows fiduciaries to consider ESG factors when choosing retirement investments (“DOL ESG Rule”). According to the lawsuit filed in Texas federal court on January 26, 2023, the attorneys general claim that the DOL ESG Rule violates Employment Retirement Income Security Act (“ERISA”), which requires that retirement plans invest solely for financial gain, and runs afoul of the Administrative Procedure Act (“APA”) as arbitrary and capricious because the DOL failed to assess either the harm it poses for plan participants and beneficiaries or the advantage of superseding the 2020 DOL rule effectively banning ESG considerations in plan investment selections. Among the twenty-five states are Alabama, Alaska, Arkansas, Florida, Georgia, Indiana, Idaho, and Iowa. In addition to the states, listed plaintiffs include two energy companies, an energy industry trade group, and an individual participant in an unnamed workplace plan.

The claimants argue that the DOL is deviating from prior policy because its 2020 DOL rule still required that financial factors take precedence. It is argued in the complaint that the DOL justified the 2022 rule by noting that it would cure a “chill” or “confusion” allegedly caused by the 2020 rule. Per the claimants, the DOL never identified who was confused, what the source of confusion was, or whether the alleged confusion caused a reduction in the financial returns for plan participants. Claimants further allege that the DOL did not consider alternatives and failed to consider that the solution to the purported concerns caused by the 2020 rules would be to issue clarifying sub-regulatory guidance. The claimants request the court to postpone the DOL ESG Rule’s effective date and to impose a preliminary injunction and declare the DOL ESG Rule in violation of the APA and ERISA.

SEC Charges Options Clearing Corporation with Rule Failures

The SEC announced that The Options Clearing Corporation (“OCC”) will undertake remedial efforts and pay $17 million in penalties to settle charges that it failed to comply with its own SEC-approved stress testing and clearing fund methodology rule during certain times between October 2019 and May 2021. According to the SEC’s February 16, 2023, order, Chicago-based OCC’s failure to implement and comply with its own rule was the result of its failure to properly establish, implement, and enforce written policies and procedures reasonably designed to manage certain operational risks. The SEC’s order further found that OCC failed to modify its comprehensive stress testing system and did not provide timely notification to the SEC of this failure as required by Regulation SCI. The SEC also found that OCC failed to comply with its margin methodology, margin policy, and stress testing and clearing fund methodology relating to specific wrong way risk and holiday margin.

According to the SEC, in addition to the $17 million penalty, OCC has undertaken several remedial measures, including revising its model validation policies and procedures; enhancing its approach to risk data governance; implementing changes to elements of its control environment, including processes, procedures, and controls; and conducting appropriate training on the changes. This is the SEC’s second enforcement action against OCC. In a September 2019 settled action, the SEC charged OCC with failure to establish and enforce policies and procedures involving financial risk management, operational requirements, and information-systems security, and imposed remedial measures and a $15 million penalty.

Republican Attorney-Generals Ask Court to Set Aside SEC Proxy Voting Disclosure Rules

Texas Attorney General Ken Paxton and three other Republican attorneys general filed a petition on February 21, 2023, against the SEC in the federal appeals court opposing the new proxy voting disclosure rules. Among other changes, the new rules amend Form N-PX by expanding the number of voting categories to include information about votes in certain standardized categories, including various ESG-related topics such as environment or climate, and diversity, equity and inclusion. Though the petition does not detail the states’ legal arguments against the proxy voting disclosure rules, Attorney General Paxton claimed in a statement that the rules are politically motivated. According to the office of Utah’s attorney general, the rules “will put shareholders at increased risk of loss, encouraging political activism and raising administrative costs.” The SEC’s two Republican commissioners, Hester Peirce and Mark Uyeda, both voted against adopting the rules, which the SEC’s three Democrats supported.

SEC Charges a Church and Its Investment Management Company for Disclosure Failures and Misstated Filings

The SEC announced charges against an exempt investment adviser (the “Adviser”), a non-profit entity operated by a religious organization (the “Church”) to manage the Church’s investments, for failing to file forms that would have disclosed the Church’s equity investments, and for instead filing forms for shell companies that obscured the Church’s portfolio and misstated the Adviser’s control over the Church’s investment decisions. The SEC also announced charges against the Church for causing these violations. To settle the charges, the Adviser agreed to pay a $4 million penalty and the Church agreed to pay a $1 million penalty. The SEC’s order, issued on February 21, 2023, found that from 1997 through 2019, the Adviser failed to file Forms 13F. According to the SEC’s order, the Church was concerned that disclosure of its portfolio, which by 2018 had grown to approximately $32 billion, would lead to negative consequences and in order to obscure the amount of the Church’s portfolio, and with the Church’s knowledge and approval, the Adviser filed Forms 13F in the names of shell LLCs which it had created rather than in the Adviser’s name.

The order found that the Adviser maintained investment discretion over all relevant securities, that it controlled the shell LLCs, and that it directed nominee “business managers,” most of whom were employed by the Church, to sign the SEC filings. The SEC found that the shell LLCs’ Forms 13F misstated, among other things, that the LLCs had sole investment and voting discretion over the securities, when in reality the Adviser retained control over all investment and voting decisions. The Adviser agreed to settle the SEC’s allegation that it violated Section 13(f) of the Exchange Act and Rule 13f-1 thereunder by failing to file Forms 13F and by misstating information in these forms. The Church also agreed to settle the SEC’s allegation that it caused the Adviser’s violations through its knowledge and approval of the Adviser’s use of the shell LLCs.

SEC Charges Private Fund Auditor and Audit Engagement Partner with Improper Professional Conduct

The SEC announced settled charges against Spicer Jeffries LLP, an audit firm based in Denver, and an audit engagement partner Sean P. Tafaro, for their improper professional conduct in connection with audits of two private funds. According to the SEC’s March 29, 2023, order, during the audit planning stages, Spicer Jeffries and Tafaro assessed that valuation of investments was a significant fraud risk but did not implement the planned audit approach to respond to the risk. The order further finds that Spicer Jeffries and Tafaro failed to obtain sufficient audit evidence about the method of measuring fair value, the valuation models, and whether alternative valuation assumptions were considered. According to the order, due to these failures and others, Spicer Jeffries and Tafaro did not exercise due care, including professional skepticism. The order also found that Spicer Jeffries’ deficient system of quality control led to failures to adhere to professional auditing standards. Without admitting or denying the findings, Spicer Jeffries and Tafaro consented to the SEC’s order finding that they engaged in improper professional conduct. Spicer Jeffries agreed to be censured and to implement undertakings to retain an independent consultant to review and evaluate certain of its audit, review, and quality control policies and procedures. Tafaro agreed to be suspended from appearing and practicing before the SEC as an accountant. The SEC’s order permits Tafaro to apply for reinstatement after one year.

Cyber Fraud and Crypto Asset Enforcement Actions

The SEC brought charges against various individuals and entities relating to cyber fraud and crypto assets, including blockchain and lending programs. For example, these include:

  1. The SEC charged five individuals and three entities for their involvement in a fraudulent investment scheme named CoinDeal that raised more than $45 million from sales of unregistered securities to tens of thousands of investors worldwide. According to the SEC’s complaint filed on January 4, 2023, the five individuals allegedly disseminated false and misleading statements to investors about extravagant returns from investing in a blockchain technology called CoinDeal; the purported value of CoinDeal; the parties involved in the supposed sale of CoinDeal; and the use of investment proceeds. The complaint further alleged that no sale of CoinDeal ever occurred and no distributions were made to CoinDeal investors, and that the defendants collectively misappropriated millions of dollars of investor funds for personal use. In June 2022, the U.S. Department of Justice indicted one of the individuals on three counts of wire fraud and two counts of monetary transaction in unlawful proceeds for his involvement in CoinDeal. The SEC’s complaint charged each party with different violations of the antifraud and registration provisions of the Securities Act and Exchange Act; and aiding and abetting under the antifraud provisions of the Exchange Act; and under the antifraud and registration provisions of the Securities Act and Exchange Act.
  2. The SEC charged a crypto asset-related financial products and services corporation (the “Corporation”), with failing to register the offer and sale of its retail crypto asset lending product. To settle the SEC’s charges, the Corporation agreed to pay a $22.5 million penalty and cease its unregistered offer and sale of its product to U.S. investors. In parallel actions announced the same day, the Corporation agreed to pay an additional $22.5 million in fines to settle similar charges by state regulatory authorities. The SEC’s January 19, 2023, order found that the Corporation marketed its product as a means for investors to earn interest on their crypto assets, and that the Corporation exercised its discretion to use investors’ crypto assets in various ways to generate income for its own business and to fund interest payments to investors. The order also found that the Corporation’s product is a security and that the offer and sale of the Corporation’s product did not qualify for an exemption from SEC registration. Without admitting or denying the SEC’s findings, the Corporation agreed to a cease-and-desist order prohibiting it from violating the registration provisions of the Securities Act.
  3. The SEC charged Avraham Eisenberg with orchestrating an attack on a crypto asset trading platform, Mango Markets, by manipulating the MNGO token, a so-called governance token that was offered and sold as a security. Eisenberg is facing parallel criminal and civil charges in the Southern District of New York brought by the U.S. Department of Justice and the Commodities Futures Trading Commission (“CFTC”). The SEC’s complaint alleged that beginning on October 11, 2022, Eisenberg engaged in a scheme to steal approximately $116 million worth of crypto assets from the Mango Markets platform. The SEC’s complaint, filed in federal district court in Manhattan, charged Eisenberg with violating antifraud and market manipulation provisions of the securities laws and sought permanent injunctive relief, a conduct-based injunction, disgorgement with prejudgment interest, and civil penalties.
  4. The SEC charged Singapore-based Terraform Labs PTE Ltd and Do Hyeong Kwon with orchestrating a multibillion-dollar crypto asset securities fraud involving an algorithmic stablecoin and other crypto asset securities. According to the SEC’s complaint filed on February 16, 2023, from April 2018 until the scheme’s collapse in May 2022, Terraform and Kwon raised billions of dollars from investors by offering and selling an inter-connected suite of crypto asset securities, many in unregistered transactions. The complaint charged the defendants with violating the registration and antifraud provisions of the Securities Act and the Exchange Act.
  5. The SEC announced charges against former NBA player Paul Pierce for touting EMAX tokens, crypto asset securities offered and sold by EthereumMax, on social media without disclosing the payment he received for the promotion and for making false and misleading promotional statements about the same crypto asset. The SEC’s February 17, 2023, order found that Pierce violated the anti-touting and antifraud provisions of the federal securities laws. Without admitting or denying the SEC’s findings, Pierce agreed to settle the charges and pay over $1.4 million in penalties, disgorgement, and interest. Pierce also agreed not to promote any crypto asset securities for three years.
  6. The SEC charged the former co-lead engineer (the “defendant”) of an Antigua- and Barbuda-based company that operated a global crypto asset trading platform (the “Company”), for his role in a multiyear scheme to defraud equity investors. According to the SEC’s complaint, issued on February 28, 2023, the defendant created software code that allowed Company customer funds to be diverted to a quantitative trading firm specializing in crypto assets (a “crypto hedge fund”) owned by co-founders and officers of the Company, despite false assurances to investors that the Company was a safe crypto asset trading platform with sophisticated risk mitigation measures to protect customer assets and that the crypto hedge fund was just another customer with no special privileges. The complaint alleged that the defendant knew or should have known that such statements were false and misleading, and that the defendant actively participated in the scheme to deceive the Company’s investors
    The SEC’s complaint charged the defendant with violating the antifraud provisions of the Securities Act and the Exchange Act. The defendant consented to a bifurcated settlement, subject to court approval, which would permanently enjoin him from violating the federal securities laws, a conduct-based injunction, and an officer and director bar. In a parallel action, the U.S. Attorney’s Office for the Southern District of New York and the Commodity Futures Trading Commission (“CFTC”) announced charges against the defendant on the same day the SEC’s complaint was filed.
  7. The SEC charged the crypto asset trading platform beaxy.com (the “Beaxy Platform”) and its executives for failing to register as a national securities exchange, broker, and clearing agency. The SEC also charged the founder of the platform, Artak Hamazaspyan, and a company he controlled, Beaxy Digital, Ltd., with raising $8 million in an unregistered offering of the Beaxy token (“BXY”) and alleged that Hamazaspyan misappropriated at least $900,000 for personal use, including gambling. Finally, the SEC charged market makers operating on the Beaxy Platform as unregistered dealers. Pursuant to the Consents filed on March 29, 2023, the charged market makers have agreed to perform certain undertakings, including ceasing all activities as an unregistered exchange, clearing agency, broker, and dealer; shutting down the Beaxy Platform; providing an accounting of assets and funds for the benefit of customers; transferring all customer assets and funds to each respective customer; and destroying any and all BXY in possession.

Thomas R. Westle and Stacy H. Louizos would like to thank Margaret M. Murphy and Hiba Hassan for their contributions to this update.

© 2023 Blank Rome LLP
For more Financial and Securities legal news, click here to visit the National Law Review

Biden Administration Sets New Course on ESG Investing in Retirement Plans

In late 2022, the Department of Labor finalized a new rule titled “Prudence in Selecting Plan Investments and Exercising Shareholder Rights,” largely reversing Trump-era guidance that had strictly limited the ability of plan fiduciaries to consider “environmental, social, and governance” (ESG) factors in selecting retirement plan investments and generally discouraged the exercise of proxy voting. In short, the new rule allows a fiduciary to consider ESG factors in selecting investment options, provided that the selection serves the financial interests of the plan and its participants over an appropriate time horizon, and encourages fiduciaries to engage in proxy voting.

The final rule moves away from 2020 Trump-era rulemaking by allowing more leeway for fiduciaries to consider ESG factors in selecting investment options. Specifically, the rule states that a “fiduciary’s duty of prudence must be based on factors that the fiduciary reasonably determines are relevant to a risk and return analysis and that such factors may include the economic effects of climate change and other ESG considerations on the particular investment or investment course of action.” The rule makes clear, however, that there is no requirement to affirmatively consider ESG factors, effectively limiting its scope and effect and putting the onus on fiduciaries to determine whether they want to incorporate ESG factors into their assessments of competing investments.

Overview

  • Similar to the Trump-era guidance, there is no definition of “ESG” or an “ESG”-style fund. Debate continues over what kinds of funds can be considered ESG investments, especially in light of the fact that some companies in industries traditionally thought to be inconsistent with ESG conscious investing are now trying to attract ESG investors (e.g. industrials, energy).
  • Fiduciaries are not required to consider ESG factors in selecting investment options. However, the consideration of such factors is not a presumed violation of a fiduciary’s duty of loyalty or prudence. Unlike the prior rule, which suggested that consideration of ESG factors could only be considered if all other pecuniary factors between competing investments were equal (the “tiebreaker” approach), the new rule allows a fiduciary to consider potential financial benefits of ESG investing in all circumstances.
  • Plan fiduciaries may take into account participant preferences in constructing a fund lineup. Therefore, if participants express a desire for ESG investment options, then it may be reasonable for plan fiduciaries to add ESG funds or to consider ESG factors in crafting the fund lineup.
  • ESG-centric funds may be used as qualified default investments (QDIAs) within retirement plans, reversing the prior outright prohibition on use of such funds as QDIAs.
  • In some situations, fiduciaries may be required to exercise shareholder rights when required to protect participant interests. It is unclear whether the exercise of such rights is only limited to situations that have an economic impact on the plan, or applies to additional situations. The clarification suggests that the exercise of proxy voting is not disfavored as an inefficient use of fiduciaries’ time and resources, as the prior iteration of the rule suggested.

Effective Date and Challenges to the Regulation

The new rule became effective in January 2023, except for delayed applicability of proxy voting provisions. However, twenty five state attorneys general have joined a lawsuit in federal court in Texas that seeks to overturn the regulation. The court is in the Fifth Circuit, which historically has been hostile to past Department of Labor regulations (including Obama-era fiduciary rules overturned in 2018, though the ESG rule is less far-reaching than the fiduciary rule and may survive a challenge even in the Fifth Circuit). Congressional Republicans have also introduced a Congressional Review Act (CRA) review proposal to repeal the regulation that has gained the support of Joe Manchin (D-WV). Although CRA actions are not subject to Senate filibuster rules, they are subject to presidential veto, which President Biden is sure to do if the repeal reaches his desk.

Action Steps

Employers should assume that the ESG rules will remain in effect and engage with plan fiduciaries, advisors, and employees and determine the extent to which ESG considerations should (or should not) enter into fiduciary deliberations when considering plan investment alternatives. Some investment advisors have already begun to include separate ESG scorecards for mutual funds and other investments in their regular plan investment reviews. Fiduciaries should also consider whether and how the approach that is ultimately taken should be reflected in the plan’s investment policy statement. Plans that delegate full control over investments to an independent fiduciary (an ERISA 3(38) advisor) should engage with their advisor to determine whether and the extent to which ESG considerations will be part of that fiduciary’s process, and whether that is consistent with the desires of the plan fiduciaries and participants.

© 2023 Jones Walker LLP

Many New Jersey Employers Must Soon Offer Employee Retirement Savings Plans

The New Jersey Secure Choice Savings Program Act (the “Act”) is set to take effect on March 28, 2022 and will require many employers to offer their own retirement plan or provide access to a State-sponsored program.

This Act impacts all New Jersey businesses that:

  1. have employed at least 25 employees in the State during the previous calendar year;
  2. have been in business at least two years; and
  3. do not already offer a qualified retirement plan.

The Act mandates employers to offer their full and part-time employees a retirement savings in either the form of either a qualified retirement plan (e.g., a 401(k) or 403(b)), or through the New Jersey Secure Choice Savings Program (the “Program”). The State-sponsored Program is an individual retirement account (IRA) where employees contribute a portion of their pretax earnings via automatic payroll deductions.

Employers must first decide whether they want to sponsor a qualified retirement plan or opt for the State-sponsored Program. Those who fail to comply will be subject to penalties ranging from a written warning to a $500 fine per employee. Employers have nine months from the implementation date to comply with the Act. While the anticipated implementation date is March 28, 2022, the Treasury Department website dedicated to the program notes that implementation is not yet operational.

We suggest intermittently checking in on the website.

© 2022 Giordano, Halleran & Ciesla, P.C. All Rights Reserved
For more articles about employment law, visit the NLR Labor & Employment section.

CMS Removes All Nursing Home Visitation Restrictions as COVID-19 Cases Decrease

In order to continue addressing the impacts of COVID-19 on nursing home residents, the Centers for Medicare & Medicaid Services (CMS) recently issued a memo updating guidance for nursing home visitation. You can read the full memo here.

Early in the pandemic, CMS implemented visitation restrictions to mitigate the risk of visitors introducing COVID-19 to nursing homes. Now, CMS is updating its guidance and allowing visitation for residents at all times. CMS explained its decision to allow visitation is based upon data which shows approximately 86% of residents and 74% of staff are fully vaccinated, and the number of new COVID-19 cases each week in nursing homes has dramatically decreased.

Under the new guidance, nursing homes cannot limit the frequency and length of visits for residents, the number of visitors, or require advance scheduling of visits as mandated under the previous guidance. However, CMS is still directing nursing homes to follow infection-control policies and procedures. Visitors who have tested positive for COVID-19, have symptoms of COVID-19, or currently meet the criteria for quarantine, should not enter the facility. Nursing homes should still screen all visitors before entry.

Although not required, CMS is encouraging nursing homes in counties with substantial or high levels of community transmission to offer testing to visitors, if feasible. Nursing homes should also educate and encourage visitors to become vaccinated. Visitors should still wear face coverings and social distance at all times while in the nursing home. Nursing homes should stay diligent in their infection-control efforts.

© 2021 Dinsmore & Shohl LLP. All rights reserved.

SECURE Act Brings About Significant Changes to IRAs

As we reach the end of 2019 and prepare to flip the calendar to 2020, Congress and the president have finally passed the SECURE (Setting Every Community Up for Retirement Enhancement) Act. The act brings about significant changes to federal tax law impacting individuals and business owners alike. Here are some of the law’s most significant provisions:

Removes Some Stretch Distributions for Inherited IRAs

This is a long-expected change that significantly impacts what an IRA beneficiary receives upon the death of the account owner. Under current law, any traditional IRA account owner must begin taking required minimum distributions (RMDs) from the IRA upon reaching age 70½. If the account owner dies after that age, any funds remaining in the IRA at the owner’s death may be inherited, with the RMDs being paid out to the heir over his or her life expectancy in most cases. This stretch enabled a younger beneficiary to grow the inherited IRA substantially (and tax-free), sometimes over many decades.

As a result of the SECURE Act, most beneficiaries will be required to distribute the entirety of an inherited IRA over a 10-year period. The writing has been on the wall since 2014 when the Supreme Court declared that an inherited IRA in the hands a non-spouse beneficiary was not a retirement account in the bankruptcy context (Clark v. Rameker). However, RMDs payable to the following persons still qualify for the stretch:

  • Surviving spouse of an account owner
  • Person who is not more than 10 years younger than the account owner
  • Minor child of the account owner
  • Disabled person
  • Chronically ill person

These new RMD rules apply to retirement accounts whose owners die after December 31, 2019.

Increases RMD Ages

As noted above, under current law, any traditional IRA owner must begin taking RMDs upon reaching age 70½. Under the SECURE Act, this age has been raised to 72, providing for a slightly increased period of tax deferral as well as greater clarity given the lack of half-birthday celebrations.

Removes Age Limitations on Traditional IRA Contributions

Under current law, while an individual could contribute to a Roth IRA without any age restriction, contributions to a traditional IRA were disallowed upon attaining age 70½. As a result of the SECURE Act, any individual may continue contributing to a traditional IRA throughout his/her lifetime with no age restriction.

The benefit of the removal of the contribution age restriction is significantly muted when read in conjunction with the removal of the stretch distributions for non-spousal beneficiaries above. Nevertheless, the removal of age restrictions on contributions presents an attractive tax deferral opportunity for the septuagenarian wage earner with a younger spouse who is named as the IRA’s beneficiary.

Adds Penalty-Free Distributions for Birth of Child or Adoption

As a default rule, withdrawals from retirement accounts prior to age 59 1/2 are subject to income tax on the withdrawn amount plus a 10 percent penalty. The SECURE Act provides a specific carve-out from the penalty if the funds – up to $5,000 – are withdrawn in order to pay expenses associated with a qualified birth or adoption. You’ll still pay income tax on the funds withdrawn but only if they aren’t repaid.

Adds Qualified 529 Plan Expenditures

The Tax Cuts and Jobs Act signed into law back in December 2017 permitted 529 account funds to be used for the payment of K-12 education expenses on behalf of the account beneficiary. The SECURE Act further expands the list of permissible uses of 529 funds to include costs associated with registered apprenticeships and student loan repayments.

Unfortunately, Michigan residents are still in a strange limbo with regard to using 529 account funds to pay K-12 education expenses as Michigan has not amended state law in coordination with the change in federal law. As a result, while withdrawals from 529 accounts for K-12 education expenses are explicitly qualified withdrawals under federal tax law, they may or may not be qualified expenses under Michigan state law. This position is further complicated by the presence of the Blaine amendment in Michigan’s constitution requiring that no money be appropriated from the state treasury for the benefit of any religious sect. If the Michigan Department of Revenue determined that withdrawals for the payment of K-12 education expenses were not qualified, any income withdrawn from the 529 account would be subject to income tax as ordinary income along with a 10 percent penalty.

Enhances Small Employer Access to Retirement Plans

Congress previously authorized the creation of the SIMPLE (1996) and SEP (1978) IRAs in an effort to improve access to retirement accounts for small employers. In the SECURE Act, Congress acknowledged that those previous efforts produced some success but left room for improvement. The new law should increase the willingness of small employers to participate in pooled retirement plans by softening the impact for an employer when another employer in a pooled plan fails.

The act also increases the credit for plan start-up costs, which will make it more affordable for small businesses to set up retirement plans. The existing $500 credit is increased by changing its calculation from a flat dollar amount to the greater of (1) $500 or (2) the lesser of (a) $250 multiplied by the number of nonhighly compensated employees of the eligible employer who are eligible to participate in the plan or (b) $5,000.

The SECURE Act will bring about both opportunities and complications for individuals planning their own financial futures as well as employers seeking to maximize their attractiveness to potential employees.


© 2019 Varnum LLP

For more on retirement regulation, see the National Law Review Labor & Employment law page.

Congress (Finally) Passes the SECURE Act

After a delay of several months, Congress passed the Setting Every Community Up for Retirement Enhancement (SECURE) Act, clearing the way for one of the most substantial pieces of retirement plan legislation in years to become law.

The House of Representatives initially passed the SECURE Act in May by an overwhelming 417−3 vote. Although the Act was set for easy bipartisan passage, it foundered in the Senate. The bill found new life at the eleventh hour of the 2019 legislative session as an attachment to the must-pass $1.4 trillion spending bill, which passed by significant margins.

The SECURE Act brings quite a few changes that will affect both plan sponsors and participants. It is intended to incentivize employers (particularly small businesses) to offer retirement plans, promote additional retirement savings, and enhance retiree financial security, including several provisions that will impact current plan administration. The changes brought by the Act are generally positive in our view, but certain ones will create some new administrative challenges and questions.

Key changes include:

Open Multiple Employer Plans (MEPs)

Among several other MEP-related provisions, the Act provides for the establishment of defined contribution Open MEPs – referred to as “Pooled Plans” – which will be treated as single ERISA plans. Under current law, where a plan is sponsored by a group of employers that are not under common control, the employers must have certain “commonality” of interests, or the arrangement may be treated as multiple component plans for ERISA purposes. Even though the recent Department of Labor regulation on “Association Retirement Plans” relaxed the commonality requirement significantly, a limited commonality requirement nonetheless remained. As a result, Open MEPs (which are generally offered by service providers and open to any employer who wishes to adopt them) remained subject to potential treatment as multiple ERISA plans. In a move largely cheered by the industry, the SECURE Act goes further by abolishing the commonality requirement entirely.

Part-Time Employee Eligibility for 401(k) Plans

Sponsors of 401(k) plans will be required to allow employees who work at least 500 hours during each of three consecutive 12-month periods to make deferral contributions ─ in addition to employees who have satisfied the general “one year of service” requirement by working at least 1,000 hours during one 12-month period. Long-term part-time employees eligible under this provision may be excluded from eligibility for employer contributions, and the Act provides very significant nondiscrimination testing relief with respect to this group. Nonetheless, this is an example of a provision that – while positive in the sense of encouraging additional retirement plan coverage – will nonetheless create new recordkeeping and administrative challenges.

Required Minimum Distributions (RMDs)

The age at which required minimum distributions must commence will be increased to 72 from 70 1/2. This is another example of a helpful change that will nonetheless lead to additional compliance questions.

Increased Tax Credits

The cap on start-up tax credits for establishing a retirement plan will increase to up to $5,000 (depending on certain factors) from $500. Small employers who add automatic enrollment to their plans also may be eligible for an additional $500 tax credit per year for up to three years.

Safe Harbor 401(k) Enhancements

Employers will have more flexibility to add non-elective safe harbor contributions mid-year. Additionally, the Act eliminates the notice requirement for safe harbor plans that make non-elective contributions to employees. The automatic deferral cap for plans that rely on the automatic enrollment safe harbor model (known as the “qualified automatic contribution arrangement” or “QACA” safe harbor) also will increase to 15% from 10%.

Other Retirement Plan Highlights

  • Penalty-free (but of course, not tax-free) retirement plan withdrawals for a birth or adoption.
  • An objective fiduciary safe harbor for the selection of a lifetime income provider is being added to encourage employers to offer in-plan annuity options. The Act also provides for tax-advantaged portability for a lifetime income product from one plan to another or between plans and IRAs to help avoid surrender charges and penalties where the lifetime income product is removed from a particular plan.
  • A separate provision also requires participant lifetime income disclosures illustrating the monthly payments if the participant’s account balance was used to provide lifetime income in an annuity.
  • Nondiscrimination testing relief for some closed defined benefit plans.
  • Certain clarifications relating to the termination of 403(b) custodial accounts and 403(b) retirement income accounts within church-sponsored plans.
  • Increase in penalties for failing to file plan returns on time.

While it is not related directly to employer-sponsored plans, readers may be interested to know that the Act also repeals the maximum age for IRA contributions and eliminates the stretch IRA. As to the latter, non-spouse beneficiaries of inherited IRAs will be required to take their benefits in income on an accelerated basis (as compared with current law) – this will have estate planning implications for individuals and families that should be understood and reviewed.

The SECURE Act is one of the most comprehensive retirement plan reforms in a decade and brings many changes for consideration. Plan sponsors should consider how the SECURE Act will impact the administration of their plans. Employers that do not currently sponsor retirement plans may wish to consider (or reconsider) doing so given the Act’s additional incentives ─ or may consider joining a MEP.

Most provisions of the Act will go into effect on January 1, 2020. In the coming months, it will be necessary to consider its practical effects on plan design and administration, including the interplay between certain of the Act’s provisions and existing regulatory guidance where there is subject-matter overlap.


©2019 Drinker Biddle & Reath LLP. All Rights Reserved

More on retirement regulation on the National Law Review Labor & Employment law page.

U.S. tax reform – retirement plan provisions finalized

The tax reform bill is done.  President Trump signed the bill on December 22, meeting his deadline for completion by Christmas.

While there is much to be said about the Tax Cuts and Jobs Act (the “Act”), the update on the retirement plan provisions is relatively unexciting.  Recall that when the tax reform process started, there was a lot of buzz about “Rothification” and other reductions to the tax advantages of retirement savings plans.  For now, that pot of potential tax savings remains untapped (perhaps to pay for tax cuts in the future).  Nonetheless, the Act that emerged from the Conference Committee reconciliation continues to include a section entitled “Simplification and Reform of Savings, Pensions, Retirement”. The provisions that remain are effective on December 31, 2017.

Recharacterization of Roth IRA Contributions.

Current law allows contributions to a Roth or Traditional IRA (individual retirement account) to be recharacterized as a contribution to the other type of IRA using a trust-to-trust transfer prior to the IRA-owner’s income tax deadline for the year.

Under the Act, taxpayers can no longer unwind Roth IRA contributions that had previously been converted from a Traditional IRA.  In other words, if a taxpayer converts a Traditional IRA contribution to a Roth contribution, it cannot later be recharacterized back to a Traditional IRA.  Other types of recharacterizations between Roth and Traditional IRAs are still permitted.

Plan Loans. 

The Act gives qualified plan participants with outstanding plan loans more time to repay the loans when they terminate employment or the plan terminates.  In these situations, current law generally deems a taxable distribution of the outstanding loan amount to have occurred unless the loan is repaid within 60 days.  The Act gives plan participants until their deadline for filing their Federal income tax returns to repay their loans.

Length of Service Awards for Public Safety Volunteers. 

Under current law these awards are not treated as deferred compensation (and, thus, are not subject to the rules under Section 409A of the Internal Revenue Code) if the amount of the award does not exceed $3,000.  The Act increases that limit to $6,000 in 2018 and allows for cost-of-living adjustments in the future.

That’s all folks!  Happy Holidays!

© Copyright 2017 Squire Patton Boggs (US) LLP

The Malta Pension Plan – A Supercharged, Cross-Border Roth IRA

Relevant US Tax Principles

In the cross border setting, two of the principal goals in international tax planning are (i) deferral of income earned offshore and (ii) the tax efficient repatriation of foreign profits at low or zero tax rates in the United States. For U.S. taxpayers investing through foreign corporations, planning around the controlled foreign corporation (CFC) rules typically achieves the first goal of deferral, and utilizing holding companies resident in treaty jurisdictions generally accomplishes the second goal of minimizing U.S. federal income tax on the eventual repatriation of profits (for U.S. corporate taxpayers, the use of foreign tax credits may be used to achieve this latter goal).

In a purely domestic setting, limited opportunities exist to defer paying U.S. federal income tax on income or gain realized through any type of entity, and fewer opportunities, if any, exist for the beneficial owners of such entities to receive tax-free distributions of the accumulated profits earned by these entities. A Roth IRA may be the best vehicle available to achieve these goals.

Roth IRA (hereafter, “Roth”) is a type of tax-favored retirement account, under which contributions to the Roth are not tax deductible (like contributions to a traditional IRA would be), but all earnings of the Roth accumulate free of U.S. tax. In addition, qualified distributions from a Roth are not subject to U.S. federal income tax. In other words, once after-tax funds are placed in a Roth, those funds generally are not taxed again. As with traditional IRAs, however, the tax benefits of Roth IRAs are restricted to certain taxpayers who fall below certain modified adjusted gross income thresholds, and even then, such persons are limited in the amounts that can be contributed each year. Additionally, those who are eligible to contribute to such Roth accounts are limited to a maximum contribution of $5,500 per year ($6,500 for taxpayers age 50+). Any “excess contributions” beyond the stated limitations trigger an annual 6 percent excise tax until the excess contributions are eliminated. Finally, because of the “prohibited transaction” provisions, it is not possible for U.S. taxpayers to transfer property (whether appreciated or not) to a Roth without triggering certain taxes (i.e., excise tax as well as income tax on any built-in gain). Therefore, while the benefits of Roths are significant, they are not widely available, particularly to high-income taxpayers.

Relevant Maltese Principles Relating to Malta Pensions

Since 2002, Maltese legislation has been in existence which allows for the creation of cross-border pension funds (although these pension funds have become more relevant to U.S. taxpayers since the effective date of the U.S.-Malta income tax treaty (the “Treaty”) in November of 2010). In contrast to the stringent limitations imposed on contributions to Roths under U.S. law, unlimited contributions may be made to a Malta pension plan. This is true also for U.S. citizens and tax residents, regardless of whether such persons are resident in or have any connection at all to Malta (though no U.S. deduction is permitted for contributions to such Maltese plans). A Maltese pension plan generally is classified as a foreign grantor trust from a U.S. federal income tax perspective because of the retained interest of the grantor/member in the pension fund. Thus, contributions to such a pension fund (including contributions of appreciated property) generally are ignored from the U.S. income tax perspective and should not trigger any adverse U.S. tax consequences.[1]

There also appears to be almost no limitation on what types of assets can be contributed tax-free to a Malta pension, including, for example, stock in private or publicly-traded companies (including PFICs), partnership and LLC interests (including so-called “carried interests”), and interests in U.S. or non-U.S. real estate. While the specific terms of each pension plan vary, Malta law generally permits distributions to be made from such plans beginning at age 50.

The relevant Maltese pension rules allow an initial lump sum payment of up to 30% of the value of the member’s pension fund to be made free of Maltese tax. This initial payment must be made within the first year of the retirement date chosen by that member. Additional periodic payments generally must then be made from the pension at least annually thereafter, and while such payments may be taxable to the recipient, they are usually significantly limited in amount (generally being tied to applicable minimum wage standards in the recipient’s home jurisdiction). Beyond those minimum wage amounts, excess lump sum distributions of up to 50 percent of the balance of the plan generally can be made free of Malta tax.

U.S.-Malta Income Tax Treaty Provisions

As noted above, when the Treaty became effective in late 2010, Maltese pension plans became more attractive to U.S. taxpayers. The Treaty contains very favorable provisions that can result in significant tax benefits to U.S. members of a Maltese pension. In order for such U.S. members to take advantage of these benefits, the pension must qualify as a resident of Malta under the Treaty and also satisfy the limitation on benefits (LOB) article of the Treaty.

Article 4, paragraph 2 of the Treaty provides that a pension fund established in either the United States or Malta is a “resident” for purposes of the Treaty, despite that all or part of the income or gains of such a pension may be exempt from tax under the domestic laws of the relevant country. Under Article 22(2)(e) of the Treaty, a pension plan that is resident in one of the treaty countries satisfies the LOB provision as long as more than 75% of the beneficiaries, members, or participants of the pension fund are individuals who are residents of either the Unites States or Malta.[2]

Thus, as long as a Maltese pension is formed pursuant to relevant Maltese law and more than 75% of its members are U.S. and/or Maltese residents, the pension plan should be eligible for Treaty benefits.

Pursuant to Article 18 of the Treaty, income earned by a Maltese pension fund cannot be taxed by the United States until a distribution is made from that fund to a U.S. resident. This article of the Treaty contains no restrictions on the types of income that are covered, and thus is generally believed to apply broadly to all income (including, for example, income arising in connection with interests in U.S. real estate, PFIC stock, and assets connected to a U.S. trade or business).[3]

Article 17(1)(b) of the Treaty further provides that distributions from a pension arising in one country, and which would be exempt from tax in that country if paid to a resident of that country, must also be exempt from tax in the other country when paid to a  resident of the latter country.  The U.S. Treasury’s Technical Explanation to the Treaty further clarifies that, for example, “a distribution from a U.S. Roth IRA to a resident of Malta would be exempt from tax in Malta to the same extent the distribution would be exempt from tax in the United States if it were distributed to a U.S. resident.”[4]

As mentioned above, pursuant to Maltese law, the initial lump sum payment from a Maltese pension (up to 30% of the value of the relevant pension fund) generally is not taxable in Malta. Thus, based on Article 17(1)(b) of the Treaty, such amounts likewise must not be taxed in the United States when made to a U.S. resident beneficiary. Additionally, this same Maltese exemption generally applies to further lump sum payments received by Maltese resident beneficiaries in certain subsequent years (generally, such distributions may be made tax-free beginning three years after the initial lump sum distribution is received). Notably, any required annual (or more frequent) periodic payments would be taxable in Malta if made to a Maltese resident, and therefore also are taxable in the United States under Section 72 when received by a U.S. resident member of the pension fund.[5]

Finally, while under the so-called “savings clause” the United States generally reserves the right under its income tax treaties to tax its citizens and “residents” as though the treaty did not exist, this savings clause contains certain exceptions. Under the Treaty, Article 1(5) provides that Articles 17(1)(b) and 18 are excepted from the savings clause (found at Article 1(4)). Consequently, the savings clause of the Treaty should not prevent a U.S. citizen or resident member of a Maltese pension from qualifying for Treaty benefits under relevant provisions of Articles 17 and 18.

Example

Assume a U.S. resident individual 49-years of age owns both highly-appreciated U.S. real estate and founders’ shares of a technology start-up that is about to go public. In combination, the interests are worth approximately $100 million, and the aggregate tax basis of the assets is $10 million. As part of her retirement planning, this U.S. individual decides to contribute these assets to a Maltese pension fund.[6] During this same tax year, the real estate is sold for fair market value and the technology company goes public, though she is required to hold the shares for at least six months before disposing of them.  During the following tax year, after her lockup period expires, she sells her shares for fair market value, leaving her portion of the pension plan holding proceeds of $100 million. Since at this time she is at least 50 years of age, assuming the terms of the pension plan permit her to begin withdrawing assets at age 50, the U.S. individual can cause the pension plan to distribute to her during that tax year $30 million of the pension plan funds without the imposition of any tax, either in Malta or the United States.

At this point, the pensioner would need to wait until year 4 to be able to extract additional profits tax-free (pursuant to Maltese law, three years must pass after the initial lump sum distribution before additional lump sum distributions could be made to a resident of Malta tax-free). Thus, in year 4, additional assets can be distributed to the member without triggering tax liability. To calculate how much can be distributed free of tax, it is necessary to first determine the pension holds “sufficient retirement income.” This amount in turn is based, pursuant to Maltese law, on the “annual national minimum wage” in the jurisdiction where the member is resident. To the extent the pension plan balance exceeds the member’s “sufficient retirement income” (on a lifetime basis), 50% of the excess can be withdrawn tax-free each year. Assuming the $70 million remaining assets (after accounting for the initial lump sum distribution) had increased in value to $85 million by year 4, and further assuming it was determined that the individual needed $1 million as her sufficient retirement income, 50% of the $84 million excess, or $42 million, could be distributed to her that year free of tax. Such calculations could likewise be performed in each succeeding tax year, with 50% of the excess being available for tax-free receipt by the beneficiary each year. Consequently, while it is not possible to distribute 100% of the proceeds of such a pension tax-free, a substantial portion of any income generated in the pension (including gains realized with respect to appreciation accrued prior to contribution of assets to the pension fund) may be distributed without any Maltese or U.S. tax liability.

Conclusion

Some commentators have suggested that the purported benefits of Maltese pensions in this context were not intended by Treasury in negotiating the Treaty and that therefore the use of such pensions in this manner is “too good to be true.” The underlying legal principles, however, are not so different from those that apply to Roths in the United States. Like participants in Roths, participants in Maltese pensions can contribute after-tax dollars to the plan and never pay future tax on profits realized with respect to assets held in the plan. Admittedly, the biggest differences relate to the unlimited amounts that may be contributed to Maltese pensions and the fact that prior appreciation in assets that are contributed to the plan also may avoid being subjected to any U.S. tax. Regardless, these distinctions result from features of domestic Maltese law (not U.S. law), and make the use of such pension plans by U.S. residents so potentially attractive.

[1] Note, however, that U.S. information filing obligations may be triggered to the U.S. transferor member pursuant to Section 6048. Unless otherwise noted, all Section references are to the Internal Revenue Code of 1986, as amended (the “Code”), and the Treasury regulations promulgated under the Code.

[2] For this purpose, the term resident includes a U.S. citizen.  Article 4(1) of the Treaty.

[3] It should be noted that the FIRPTA provisions of Section 897 and Section 1445 should not be applicable because the pension plan is treated as a foreign grantor trust for U.S. federal income tax purposes.

[4] Treasury Technical Explanation of the U.S.-Malta Income Tax Treaty, signed 8/8/2008, Article 17, paragraph 1.

[5] Under Section 72, a portion of each payment represents tax-free return of basis.

[6] Note that, as discussed above, there should be no U.S. tax implications on contribution of the assets (for example, under Section 684), as the pension plan should be classified as a grantor trust for U.S. federal income tax purposes.

This post was written by  Jeffrey L. Rubinger and Summer Ayers LePree of  Bilzin Sumberg Baena Price & Axelrod LLP.
Read more on the National Law Review.