Category: Financial Services Law

Finally the Final … 408(b)(2) Regulation

Recently The National Law Review published an article by Fred Reish and Bruce L. Ashton of Drinker Biddle & Reath LLP regarding The DOL Service Provider Fee Disclosure Regulations:

The Department of Labor (DOL) has issued the long-anticipated final service provider fee disclosure regulation (the “408(b)(2) regulation”). (A complete copy of the final regulation and its preamble is at http://www.drinkerbiddle.com/files/ftpupload/pdf/408b2reg. pdf) In this Alert, we describe what the amendment says; in a subsequent piece, we will explain the impact on various service providers.

>   The extension of the compliance date from April 1, 2012 to July 1, 2012

>   The fact that service providers are not required to provide a summary of the disclosures, though the DOL provided a sample “guide” that is not mandatory

>   The addition of the requirement to describe the arrangement between the service provider and the payer of indirect compensation

>   Limited relief for disclosures for brokerage accounts and similar arrangements

>   Clarification that electronic disclosure of the disclosures is permitted

>   Relief from the disclosure requirements for “frozen” 403(b) contracts

>   The requirement that plan sponsors terminate the relationship with a service provider who fails or refuses to provide information on request

Background

The 408(b)(2) regulation requires most service providers to retirement plans – including pension, profit sharing, 401(k) and 403(b) plans subject to ERISA – to make written disclosure of their services, fiduciary and/or RIA status and total compensation. The regulation was first proposed in 2007, was issued as an “interim final” regulation in July 2010 and has now been finalized with today’s release.

In light of its “interim final” status, it had been widely anticipated that amendments to the regulation would be issued; and the DOL invited comments on several issues in the 2010 release. In August of this year, the DOL publicly announced that it was working on an amendment and as a result extended the compliance date. Now, in issuing the final rule, the compliance date has once again been extended, though for only three months (i.e., July 1, 2012). Given the scope of some of the changes, this may not be sufficient time for covered service providers to develop and disseminate the required information on an orderly basis…which could result in errors.

Because of the delayed compliance date, some service providers have deferred starting the process of preparing the forms and creating the systems needed to comply with the disclosure requirements. Some did so to avoid having to make changes and others may have hoped for a more extended delay. That is not going to happen, and service providers should circle July 1, 2012 (barely five months away) on their calendars to make sure they are in full compliance by that date for existing clients and that they are prepared to comply with advance disclosures for any new clients.

The Final Regulation

The most important changes in the newly released amendment are:

  • Covered Plan – The definition of covered plan now excludes annuity contracts and custodial accounts in 403(b) plans that were issued to employees before January 1, 2009, where no additional contributions have been made and the contract is fully vested and enforceable by the employee.
  • Indirect Compensation – The final regulation has made a fairly significant change in the disclosure of indirect compensation (that is, compensation received from a source other than the plan or plan sponsor). The disclosure must now include both identification of the payer and a description of the arrangement between the payer and the covered service provider, affiliate or subcontractor pursuant to which the indirect compensation is paid. There is limited relief for disclosures related to brokerage accounts and similar arrangements.
  • Investment Information – The regulation modifies the information that must be provided by recordkeepers and others to better track the disclosures required in the participant disclosure regulation. It also adds a requirement to disclose information that is within the control of (or reasonably available to) the covered service provider and that is required for the plan administrator to comply with the participant disclosure regulation.
  • Form of Disclosure – There was speculation that the DOL would require service providers to include a summary of the disclosures and a “roadmap” for finding the disclosures in the documents provided. It did not do so and has indicated that it will be issuing a proposed rule regarding a summary or roadmap (now referred to as a “guide”) requirement in the future. In the meantime, the DOL did provide a sample guide that may, but is not required, to be used. That said, in the preamble, the DOL states, “Similarly, to the extent a responsible plan fiduciary experiences difficulty finding and reviewing the required disclosures in lengthy, technical, or multiple disclosure documents received from a covered service provider pursuant to the requirements of the final rule, the fiduciary should consider requesting assistance from the covered service provider, for example, discussing with the covered service provider the feasibility and cost of using the attached sample guide.”
  • Manner of Delivery – The final regulation clarifies that nothing in the regulation limits the ability to use electronic media.
  • Change Notice – The interim final regulation required that changes in the information previously provided had to be given to the responsible plan fiduciary not later than 60 days after the service provider becomes aware of it. This “update requirement” applied to all disclosures, including investment-related information. The final rule changes this requirement to say that the deadline for disclosure of investment-related information is “at least annually.” In other words, for this type of information, the updating requirement is now annual.
  • Reporting and Disclosure Response – The interim final rule required a service provider to give information necessary for a plan administrator to comply with the plan’s reporting and disclosure requirements under ERISA within 60 days after a written request. This has been changed to say that the information must be provided (in response to a written request) reasonably in advance of when the plan administrator must comply with its reporting obligation.
  • Compensation Definition – The final regulation amends the definition of compensation to permit a service provider to provide a “reasonable and good faith” estimate of compensation if it is not otherwise readily able to describe its compensation, though the covered service provider in this case is also required to explain the methods and assumptions used for the estimate.
  • Plan Fiduciary Relief – The regulation provides an exemption for plan fiduciaries if the service provider fails to provide required disclosures so long as various requirements are met. The exemption originally stated that if the service provider failed to provide the information upon request, the plan fiduciary was required to consider whether to continue the relationship with the service provider. The final rule now requires the plan fiduciary to terminate the relationship if the service provider fails to provide requested information relating to future services.

Finally, the compliance effective date for the participant disclosures has also been pushed back. For calendar year plans, the initial disclosures of plan and investment information must be provided by August 30, 2012, and the first quarterly expense statement is required by November 14, 2012 (covering the third quarter).

We will be discussing the impact of the changes and the compliance issues in a month or so in another, more detailed bulletin. However, we wanted to get this information to you as quickly as possible.

©2012 Drinker Biddle & Reath LLP

IRS Extends Transition Relief for Puerto Rico Qualified Plans to Participate in U.S. Group Trusts and Deadline to Transfer Assets

Posted in the National Law Review an article by attorney Nancy S. Gerrie and Jeffrey M. Holdvogt of McDermott Will & Emery regarding  U.S. employers with qualified employee retirement plans that cover Puerto Rico:

On December 21, 2011, the U.S. Internal Revenue Service (IRS) issued Notice 2012-6, which provides welcome relief for U.S. employers with qualified employee retirement plans that cover Puerto Rico employees.  Notice 2012-6 provides that the IRS will extend the deadline for employers sponsoring plans that are tax-qualified only in Puerto Rico (ERISA Section 1022(i)(1) Plans) to continue to pool assets with U.S.-qualified plans in group and master trusts described in Revenue Ruling 81-100 (81-100 group trusts) until further notice, provided the plan was participating in the trust as of January 10, 2011, or holds assets that had been held by a qualified plan immediately prior to the transfer of those assets to an ERISA Section 1022(i)(1) Plan pursuant to a spin-off from a U.S.-qualified plan under Revenue Ruling 2008-40.

Notice 2012-6 also extends the deadline for sponsors of retirement plans qualified in both the United States and Puerto Rico (dual-qualified plans) to spin off and transfer assets attributable to Puerto Rico employees to ERISA Section 1022(i)(1) Plans, with the resulting plan assets considered Puerto Rico-source income and not subject to U.S. tax.

There are now two separate deadlines:

    • First, in recognition of the fact that Puerto Rico adopted a new tax code in 2011 with significant changes to the requirements for qualified retirement plans, the IRS has extended the general deadline to December 31, 2012, for dual-qualified plans to make transfers to Puerto Rico-only plans, in order to give plan sponsors time to consider the effect of the changes made by the new tax code.
    • Second, in recognition of the fact that the IRS has not yet issued definitive guidance on the ability of an ERISA Section 1022(i)(1) Plan to participate in 81-100 group trusts, the IRS has extended the deadline for dual-qualified plans that participate in an 81-100 group trust to some future deadline, presumably after the IRS reaches a conclusion on the ability of a dual-qualified plan to participate in an 81-100 group trust, as described in Revenue Ruling 2011-1.

For more information on the issues related to participation of ERISA Section 1022(i)(1) Plans in 80-100 group trusts, see “IRS Permits Puerto Rico-Qualified Plans to Participate in U.S. Group and Master Trusts for Transition Period, Extends Deadline for Puerto Rico Spin-Offs.”

For more information on the issues plan sponsors should consider with respect to a dual-qualified plan spin-off and transfer of assets attributable to Puerto Rico employees to ERISA section 1022(i)(1) plans, see “IRS Sets Deadline for Transfers from Dual-Qualified to Puerto Rico-Only Qualified Plans.”

© 2011 McDermott Will & Emery

The Credit Mark Predicament: A Bank Recapitalization Hurdle

Recently posted in the National Law Review an article by The Financial Institutions Group of Schiff Hardin LLP regarding community banks are searching for capital:

 

 

 

Many community banks are searching for capital either as a cushion to cover credit losses, to meet higher capital standards set by regulatory enforcement actions, or to support balance sheet growth driven by open or closed bank acquisitions, branch purchases or organic expansion.

Any community bank that intends to raise capital has to deal with investor skepticism over the bank’s credit quality. That skepticism gets addressed in most cases by a third-party credit review performed at the direction of the bank, with the results later confirmed by the investor’s own review firm. Because third-party credit reviews have become a gating issue to raising capital, management teams are making decisions about what firm to hire for the work, the scope of the review and how to strategically manage the risks inherent in these reviews.

Many of the risks and strategic approaches for managing third-party credit reviews may not be obvious to bank management, which is for the first time retaining a firm to perform this type of review with the very specific purpose of inducing investors to invest. Likewise, management may not be fully informed as to how the portfolio review will be used by potential investors to evaluate the merits of their investment.

It is hard to over-emphasize the importance of management being careful and strategically thoughtful in: the selection of its third-party credit review firm; the timing of the review in relation to an impending regulatory exam, year-end audit or capital-raising transaction; the scope and methodology of the review; and the use of the results of the review once completed. There are nuances galore in this process and the very survival of the bank can rest in the balance if the process is mishandled.

The attached article surveys the key issues management should consider before retaining a third-party credit review firm, and explains how these reports are used by potential investors in making determinations about investing in a particular bank. In addition, the article reviews common mistakes made in retaining third-party credit review firms.

In assessing a particular third-party credit review firm for hire, the following are ten key questions:

  1. Are the bank’s files and documentation in good shape before the third-party credit review begins? If questionable, will several days of advance “triage” of the portfolio be useful in assessing whether the bank will show well based on the order of its documents, all in an effort to avoid judgmental credit downgrades based on file quality?
  2. Does the firm have a senior project manager with strong verbal communication skills that will facilitate discussion of the review results with the board of directors and any potential investors?
  3. Will the firm commit to remaining engaged and active throughout the recapitalization process, to serve in a rebuttal capacity with third-party credit review firms retained by potential investors, and to update its work if necessary as the recapitalization process progresses?
  4. Will the firm provide value to the bank solely by providing a credit valuation, or would the bank benefit from a firm that has not only valuation experience but also skills and capabilities to provide post-valuation loan workout services, including assisting in developing recovery strategies on an individual NPA basis?
  5. Should the firm provide a verbal conclusion on its credit mark before committing its conclusions to writing?
  6. Should the firm be retained by the bank’s legal counsel as opposed to directly by the bank?
  7. Should the firm review and value only the NPA portfolio, or should the review extend to the performing portfolio as well, and, accordingly, assess migration risk of the performing book?
  8. Is the bank seeking capital from institutional investors that will insist on a brand name credit review firm in order to give the review results credibility?
  9. Will the firm review only “paper” in the files or will it spend time with both the bank’s chief credit officer and other credit professionals in reaching valuation determinations?
  10. Finally, will the bank’s personnel have the time and capacity to respond to the document calls by the third-party credit review firm given the other demands on management’s time, recognizing the burden these reviews place on management?

© 2011 Schiff Hardin LLP

OSHA Seeking Comment on SOX Whistleblower Complaint Rules

 

 

 

 

Posted in the National Law Review an article by attorney Virginia E. Robinson of  Greenberg Traurig regarding OSHA  seeking public comment on interim final rules that revise its regulations on the filing and handling of Sarbanes-Oxley Act (SOX) whistleblower complaints

GT Law

The U.S. Department of Labor’s Occupational Safety and Health Administration (OSHA) is seeking public comment on interim final rules that revise its regulations on the filing and handling of Sarbanes-Oxley Act (SOX) whistleblower complaints.

OSHA, the entity charged with receiving and investigating SOX whistleblower complaints, issued the interim rules in part to implement the amendments to SOX’s whistleblower protections that were included in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Those amendments include an extension of the statute of limitations period for filing a complaint from 90 to 180 days. They also clarify that nationally recognized statistical rating organizations and subsidiaries of publicly traded companies are covered employers under SOX.

In addition to implementing the Dodd-Frank amendments, the interim rules also seek to improve OSHA’s handling of SOX whistleblower complaints, and will permit the filing of oral complaints and complaints in any language.

The planned amendments to those regulations were published in the Nov. 3 Federal Register. Comments must be received by Jan. 3, 2012, and may be submitted online, by mail, or by fax. The Depatment of Labor’s recent news release provides additional details.

©2011 Greenberg Traurig, LLP. All rights reserved.

Q&A / Fee Disclosure Requirements Top the List of Issues Facing Retirement Plan Sponsors

 Recently posted in the National Law Review an article by  f Much Shelist Denenberg Ament & Rubenstein P.C.  Much Shelist spoke toNorman D. Schlismann (Senior Managing Director) and David H. Dermenjian (Senior Vice President) in the Retirement Plan Advisory Group about current issues facing 401(k) plan sponsors.

 

In today’s turbulent economy, 401(k) defined-contribution plans are under the microscope. Plan participants and government agencies are scrutinizing every element of retirement plans, paying special attention to the fiduciary responsibilities of plan sponsors and the fees being paid to their service providers. As a diversified financial services firm, Mesirow Financial provides a broad range of asset management, investment advisory, broker-dealer and consulting services to institutions and private clients worldwide. Much Shelist spoke toNorman D. Schlismann (Senior Managing Director) and David H. Dermenjian (Senior Vice President) in the Retirement Plan Advisory Group about current issues facing 401(k) plan sponsors.

Much Shelist: What have been some of the primary effects of the economic crisis on employer-sponsored retirement plans and 401(k) plans in particular?

David Dermenjian: Perhaps the greatest effect of the global economic situation is that everyone—from individual plan participants to plan sponsors, investment fund managers and regulatory officials—is looking more closely at fund performance, employee education and the administrative and other costs associated with these plans. This is quite understandable; over the past several years, virtually every retirement plan has experienced at least a temporary decline in value.

Individual plan participants, including employees and executives, tend to focus on the range of funds available in their plans, as well as fund performance and minimizing costs. Plan sponsors are typically interested in ensuring that they are fulfilling their fiduciary responsibilities and limiting potential liability. Government regulators want to protect individuals against unnecessary losses by stepping up their use of audits and investigations to uncover and correct potential irregularities in financial reporting, self-dealing or the occasional misuse of employee contributions. Ultimately, all of these steps are being taken in pursuit of the same goal: to help employees make wise decisions regarding their retirement assets and preserve value to the maximum extent possible.

Norm Schlismann: Education is the centerpiece of these efforts. By providing in-person counseling and seminars, online webinars and printed materials that clearly describe the various fund options, rules and fees, employers can help employees make more informed decisions, and plan sponsors can be sure they are meeting their fiduciary obligations.

One example of how education can help is in the area of target-date retirement funds. Typically, these funds are built around an estimated retirement year, say 2030. As the target date approaches and participants near their expected retirement, the fund will shift into a more conservative investment mode, often moving assets from stocks into bonds and money market instruments. What many people don’t realize, however, is that target-date funds may appear to be similar but are actually based on different assumptions. A “to-date” fund assumes that participants will withdraw all of their assets upon retirement, whereas a “through-date” fund assumes that smaller withdrawals will occur over time, perhaps on a monthly basis. Since through-date funds assume that assets will remain in the fund even after retirement, they may take a more risky approach to investment allocations.

MS: Fee disclosures have received significant attention of late. Briefly, what are they?

DD: The concept of fee disclosures has been floating around for a while, but the final rule—described under ERISA Section 408(b)2—will go into full effect April 2012. Under the rule, retirement plan fiduciaries must ensure that “reasonable fees” are being paid to providers for “reasonable services.” Fiduciaries must also obtain information sufficient to enable them to make informed decisions about the costs associated with these providers and must disclose this information to plan participants.

Typical information contained in a disclosure includes benchmarking data (comparing the fees associated with a particular fund or retirement plan to other, similar funds or plans) and fee structures. It’s important to note that higher fees are not necessarily unreasonable. Some providers offer a higher level of service—one-on-one employee counseling, real-time access to complete fund reports, etc.—which can justify the higher costs to participants.

NS: Clarity and transparency are the watchwords of disclosures. For this reason, disclosures should often include information beyond simple fee information. For example, disclosures should also include an assessment of the independence of—and potential conflicts between—service providers, as well as possible conflicts between service providers and fiduciaries. Revenue sharing and finders fees are typical areas of concern.

MS: To that point, what is the difference between a plan fiduciary and a service provider?

NS: Plan fiduciaries are individuals or groups of individuals who use their own judgment in administering and managing the plan or who have the power to actually control the plan’s assets. Service providers, on the other hand, execute the instructions of plan fiduciaries; they may include plan recordkeepers, administrators, custodians, advisors and other financial or investment professionals engaged to operate retirement plans or provide guidance with respect to the plans.

In some cases, a service provider may also act in the role of a fiduciary. For example, a broker-dealer, whose responsibility to the client for suitability and appropriateness of a recommendation ends the moment a sale is made, could be considered a service provider but not a fiduciary. A registered investment advisor, who may be involved in the recommendation of a particular investment option to the plan and who may continue to provide guidance over the life of an investment, is considered both a service provider and a fiduciary.

MS: Where can plan sponsors find the information they need to make proper disclosures?

DD: That’s the $64,000 question! While it is getting easier to obtain this information, plans and their cost structures have grown more complex over the years. Understanding exactly what the data is telling you, vis-à-vis your own plans, can be difficult. This is where the assistance of experienced financial professionals is critical.

In terms of accessing information, the trend today is toward a more open plan architecture, which makes it easier to find the required data. Similarly, a number of third-party providers offer benchmarking data and analytics. Other companies, such as Fi360, offer a more comprehensive range of resources, tools and training to help fiduciaries fulfill their duties.

However, as we’ve already noted, it is often in the best interests of fiduciaries to obtain the services of an experienced investment advisor and fiduciary consultant. In doing so, independence is probably the most important consideration. Consultants should also have proven tools and procedures that enable them to conduct a fiduciary audit (including a detailed analysis) and provide evidentiary documentation in the process.

MS: How do I know if I need this type of fiduciary audit?

NS: The easy answer is that all plan sponsors need information, and they need to fully understand how that information applies to their unique combination of employer-sponsored retirement plans and services. That said, a number of companies—especially small and mid-sized businesses—have let their plans go “dormant” over the years, acting as if nothing has changed. If you can’t clearly articulate your fiduciary process, then you probably don’t have one! And, you are probably at greater risk of failing a Department of Labor audit of your plan.

Plan sponsors may also be concerned about the cost of a consultant. However, the money spent on the services of an experienced consultant is often considerably less than the savings recouped once the plan sponsor has actionable information. The likelihood increases over time that your retirement plan is spending too much on administrative and management fees. We advise plan sponsors to benchmark their plans against comparable averages annually and benchmark against other providers in the market every few years.

The bottom line? Plan sponsors are in a better position to fulfill their fiduciary responsibilities, and lower costs mean that more money is preserved in participants’ accounts—which can result in improved returns over time.

For more information on this topic, contact Norm Schlismann (nds@mesirowfinancial.com) or Dave Dermenjian (dhd@mesirowfinancial.com).

This article contains material of general interest and should not be construed as legal advice or a legal opinion on any specific facts or circumstances. Under professional rules, this content may be regarded as attorney advertising.

© 2011 Much Shelist Denenberg Ament & Rubenstein, P.C.

How Lessors and Lenders Can Audit the Eurocontrol Accounts of Lessees

Recently posted in the National Law Review an article by attorney John I. Karesh of Vedder Price P.C. regarding  lessors will no longer receive an aircraft operator’s statement of account from Eurocontrol via e-mail.

Eurocontrol has implemented a change to the way lessors, lenders and security trustees can audit the Eurocontrol accounts of lessees. Effective September 1, 2011, lessors will no longer receive an aircraft operator’s statement of account from Eurocontrol via e-mail. In an attempt to provide better security, Eurocontrol will now provide such statements only upon the lessor’s request via a secured extranet system called CEFA (Central Route Charges Office Extranet for Airspace Users). We have been advised by Eurocontrol that lenders and security trustees also will be granted access to CEFA under the same protocol. In order to gain access, the requesting party needs to complete an Agreement (available on Eurocontrol’s website). Once the Agreement is completed and received by Eurocontrol, the requesting party can view an operator’s statement of account online 24/7. Access is free. However, requesting parties must obtain approval from each operator whose statement of account they wish to view by having the operator sign an Authorization Letter in the prescribed form.

Because lenders and lessors must execute the Agreement, they should take note that the Agreement contains various noteworthy provisions including the following: Article 4 provides that to the extent permitted by national law, in the event of a dispute, Eurocontrol’s data, including metadata, shall be admissible in court and shall constitute evidence of the facts contained therein unless contrary evidence is adduced. Section 9.2 provides that once a statement of account becomes available on CEFA, it shall be deemed received by the “Leasing Company,” which agrees to proactively and regularly check the CEFA site. Article 13 contains various provisions concerning confidentiality and protection of data. Section 14.2 requires the Leasing Company to indemnify Eurocontrol against any claims for damages made by third parties where the claims or damages are due to a fault of the Leasing Company. Article 15 provides that without prejudice to any mandatory national law, the transmission of electronic data under the Agreement shall be governed by Belgian law. Article 16 provides that any dispute arising out of or in connection with the Agreement shall be referred to the Brussels Court of First Instance (Belgium), which shall have sole jurisdiction.

Also, Section 17.3 provides that the Agreement is for an indefinite period, but either party may terminate it on not less than three months’ written notice, and that Eurocontrol is entitled to terminate or suspend the Agreement in a case foreseen under the confidentiality and protection of data provisions (Section 13.1) or if all authorizations to release Statements of Account to the lessor have been withdrawn. Section 17.4 provides that access to the Statements of Account of an Aircraft Operator will be terminated without notice in case of the withdrawal of the authorization to release such Statements of Account. However, the prescribed form of Authorization Letter provides that it may only be revoked or amended by written instructions from the operator and lessor.

The foregoing is merely a summary of a few of the provisions of the Agreement. All provisions should carefully be reviewed before signing. However, it appears the only way lessors, lenders and security trustees can obtain the statement of an operator’s account is by means of the Authorization Letter and signed Agreement.

© 2011 Vedder Price P.C.

Second Circuit's Citigroup Decision Endorses Presumption of Prudence, Upholds Dismissal of Disclosure Claims

Posted this week at the National Law Review by Morgan, Lewis & Bockius LLP regarding the decision that employer stock in a 401(k) plan is subject to a “presumption of prudence” that a plaintiff alleging fiduciary breach:

 

 

 

In a much-anticipated decision, the U.S. Court of Appeals for the Second Circuit joined five other circuits in ruling that employer stock in a 401(k) plan is subject to a “presumption of prudence” that a plaintiff alleging fiduciary breach can overcome only upon a showing that the employer was facing a “dire situation” that was objectively unforeseeable by the plan sponsor. In re Citigroup ERISA Litigation, No. 09-3804, 2011 WL 4950368 (2d Cir. Oct. 19, 2011). The appellate court found the plaintiffs had not rebutted the presumption of prudence and so upheld the dismissal of their “stock drop” claims.

BACKGROUND

The Citigroup plaintiffs were participants in two 401(k) plans that specifically required the offering of Citigroup stock as an investment option. The plaintiffs alleged that Citigroup’s large subprime mortgage exposure caused the share price of Citigroup stock to decline sharply between January 2007 and January 2008, and that plan fiduciaries breached their duties of prudence and loyalty by not divesting the plans of the stock in the face of the declines. The plaintiffs further alleged that the defendants breached their duty of disclosure by not providing complete and accurate information to plan participants regarding the risks associated with investing in Citigroup stock in light of the company’s exposure to the subprime market. On a motion to dismiss, the district court found no fiduciary breach because the defendants had “no discretion whatsoever” to eliminate Citigroup stock as an investment option (sometimes referred to as “hardwiring”). Alternatively, the lower court ruled that Citigroup stock was a presumptively prudent investment and the plaintiffs had not alleged sufficient facts to overcome the presumption.

SECOND CIRCUIT DECISION

Oral argument in the Citigroup case occurred nearly a year ago, and legal observers have been anxiously awaiting the court’s ruling. In a 2-1 decision, with Judge Chester J. Straub issuing a lengthy dissent, the Second Circuit rejected the “hardwiring” rationale but confirmed the application of the presumption of prudence, which was first articulated by the Third Circuit in Moench v. Robertson, 62 F.3d 553 (3d Cir. 1995). The court also rejected claims that the defendants violated ERISA’s disclosure obligations by failing to provide plan participants with information about the expected future performance of Citigroup stock.

Prudence

Joining the Third, Fifth, Sixth, Seventh, and Ninth Circuits,[1] the court adopted the presumption of prudence as the “best accommodation between the competing ERISA values of protecting retirement assets and encouraging investment in employer stock.” Under the presumption of prudence, a fiduciary’s decision to continue to offer participants the opportunity to invest in employer stock is reviewed under an abuse of discretion standard of review, which provides that a fiduciary’s conduct will not be second-guessed so long as it is reasonable. The court also ruled that the presumption of prudence applies at the earliest stages of the litigation and is relevant to all defined contribution plans that offer employer stock (not just ESOPs, which are designed to invest primarily in employer securities).

Having announced the relevant legal standard, the court of appeals dispatched the plaintiffs’ prudence claim in relatively short order. The plaintiffs alleged that Citigroup made ill-advised investments in the subprime market and hid the extent of its exposure from plan participants and the public; consequently, Citigroup’s stock price was artificially inflated. These facts alone, the court held, were not enough to plead a breach of fiduciary duty: “[T]hat Citigroup made a bad business decision is insufficient to show that the company was in a ‘dire situation,’ much less that the Investment Committee or the Administrative Committee knew or should have known that the situation was dire.” Nor could the plaintiffs carry their burden by alleging in conclusory fashion that individual fiduciaries “knew or should have known” about Citigroup’s subprime exposure but failed to act. Relying on the Supreme Court’s decision in Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007), the court of appeals held these bald assertions were insufficient at the pleadings stage to suggest knowledge of imprudence or to support the inference that the fiduciaries could have foreseen Citigroup’s subprime losses.

Disclosure

The court’s treatment of the disclosure claims was equally instructive. Plaintiffs’ allegations rested on two theories of liability under ERISA: (1) failing to provide complete and accurate information to participants (the “nondisclosure” theory), and (2) conveying materially inaccurate information about Citigroup stock to participants (the “misrepresentation” theory).

As to the nondisclosure theory, the court found that Citigroup adequately disclosed in plan documents made available to participants the risks of investing in Citigroup stock, including the undiversified nature of the investment, its volatility, and the importance of diversification. The court also emphasized that ERISA does not impose an obligation on employers to disclose nonpublic information to participants regarding a specific plan investment option.

Turning to the misrepresentation theory, the court found plaintiffs’ allegations that the fiduciaries “knew or should have known” about Citigroup’s subprime losses, or that they failed to investigate the prudence of the stock, were too threadbare to support a claim for relief. Though plaintiffs claimed that false statements in SEC filings were incorporated by reference into summary plan descriptions (SPDs), the court found no basis to infer that the individual defendants knew the statements were false. It also concluded there were no facts which, if proved, would show (without the benefit of hindsight) that an investigation of Citigroup’s financial condition would have revealed the stock was no longer a prudent investment.

IMPLICATIONS

Coming from the influential Second Circuit, the Citigroup decision represents something of a tipping point in stock-drop jurisprudence, especially with respect to the dozens of companies (including many financial services companies) that have been sued in stock-drop cases based on events surrounding the 2007-08 global financial crisis. The Second Circuit opinion gives the presumption of prudence critical mass among appellate courts and signals a potential shift in how stock-drop claims will be evaluated, including at the motion to dismiss stage.[2]

Under the Citigroup analysis, fiduciaries should not override the plan terms regarding employer stock unless maintaining the stock investment would frustrate the purpose of the plan, such as when the company is facing imminent collapse or some other “dire situation” that threatens its viability. Like other circuits that have adopted the prudence presumption, the Citigroup court emphasized the long-term nature of retirement investing and the need to refrain from acting in response to “mere stock fluctuations, even those that trend downhill significantly.” It also sided with other courts in holding that the presumption of prudence should be applied at the motion to dismiss stage (i.e., not allowing plaintiffs to gather evidence through discovery to show the imprudence of the stock). Taken together, these rulings may make it harder for plaintiffs to survive a motion to dismiss, especially where their allegations of imprudence are based on relatively short-lived declines in stock price.

Some had predicted the Second Circuit would endorse the “hardwiring” argument and allow employers to remove fiduciary discretion by designating stock as a mandatory investment in the plan document. The Citigroup court was unwilling to go that far, but it did adopt a “sliding scale” under which judicial scrutiny will increase with the degree of discretion a plan gives its fiduciaries to offer company stock as an investment. This is similar to the approach taken by the Ninth Circuit inQuan and consistent with the heightened deference that courts generally give to fiduciaries when employer stock is hardwired into the plan. Thus, through careful plan drafting, employers should be able to secure the desired standard of review. Language in the plan document and trust agreement (as well as other documents) confirming that employer stock is a required investment option should result in the most deferential standard and provide fiduciaries the greatest protection.

Also noteworthy was the court’s treatment of the disclosure claims. Many stock-drop complaints piggyback on allegations of securities fraud, creating an inevitable tension between disclosure obligations under the federal securities laws and disclosure obligations under ERISA. The Second Circuit did not resolve this tension, but it construed ERISA fiduciary disclosure requirements narrowly and rejected the notion that fiduciaries have a general duty to tell participants about adverse corporate developments. The court made this ruling in the context of SPD disclosures under the 401(k) plan that identified specific risks of investing in Citigroup stock. Plan sponsors should review their SPDs and other participant communications to make sure company stock descriptions are sufficiently explicit about issues such as the volatility of a single-stock investment and the importance of diversification. These disclosures may go beyond what is already required under Department of Labor regulations.

[1]. See Howell v. Motorola, Inc., 633 F.3d 552, 568 (7th Cir.), cert.denied, ­­­2011 WL 4530151 (2011); Quan v. Computer Sciences Corp., 623 F.3d 870, 881 (9th Cir. 2010); Kirschbaum v. Reliant Energy, Inc., 526 F.3d 243, 254 (5th Cir. 2008); Kuper v. Iovenko, 66 F.3d 1447, 1459-60 (6th Cir. 1995).

[2]. That said, plan sponsors and fiduciaries should continue to monitor future developments in Citigroup in light of Judge Straub’s dissenting opinion and the likelihood of a petition for rehearing (or rehearing en banc), which the Citigroup plaintiffs have indicated they intend to seek. In his dissent, Judge Straub rejected the Moench presumption in favor of plenary review of fiduciary decisions regarding employer stock. He also disagreed with the majority’s interpretation of ERISA disclosure duties.

Copyright © 2011 by Morgan, Lewis & Bockius LLP. All Rights Reserved.

Dodd-Frank Update — Several Regulatory and Legislative Proposals of Note

Recently posted in the National Law Review an article by attorneys  Sylvie A. Durham, Genna Garver and Dmitry G. Ivanov of Greenberg Traurig, LLP regarding  the OCC, FDIC and SEC’s proposed a joint rule implementing theVolcker Rule:

GT Law

REGULATORS PROPOSE VOLCKER RULE:

On October 11, 2011, the Office of the Comptroller of the Currency, Treasury (OCC), Board of Governors of the Federal Reserve System (Board), Federal Deposit Insurance Corporation (FDIC), and Securities and Exchange Commission (SEC) issued a joint proposed rule implementing the long awaited Volcker Rule. This proposal establishes exemptions from the prohibition on proprietary trading and restrictions on covered fund activities and investments as well as limitations on those exemptions. In addition, the proposal requires certain banking entities to report quantitative measurements with respect to their trading activities and to establish enhanced compliance programs regarding the Volcker Rule, including adopting written policies and procedures. Appendices to the proposal provide the quantitative measurements to be used to report trading activities, commentary regarding the factors the agencies propose to use to distinguish permitted market making-related activities from prohibited proprietary trading and the minimum requirements and standards for compliance programs. Comments should be received on or before January 13, 2012. A copy of the proposed rule is available here.

FSOC PROPOSES RULE TO SUPERVISE AND REGULATE CERTAIN NON-BANK FINANCIAL COMPANIES:

On October 11, 2011, the Financial Stability Oversight Council (FSOC) issued its second proposed rule and interpretive guidance to provide additional details regarding the framework that FSOC intends to use in the process of assessing whether a nonbank financial company could pose a threat to U.S. financial stability, and further opportunity for public comment on FSOC’s approach to making determinations to require supervision and regulation of certain nonbank financial companies in accordance with Title I of Dodd-Frank, previously proposed on January 26, 2011. The proposed rule, previously proposed on January 26, 2011, has been modified to provide additional details about the processes and procedures through which FSOC may make this determination under Dodd-Frank, and the manner in which a nonbank financial company may respond to and contest a proposed determination. Importantly, the interpretive guidance sets out a three-stage process of increasingly in-depth evaluation and analysis leading up to a proposed determination that a nonbank financial company could pose a threat to the financial stability of the United States. The first stage would involve a quantitative analysis by applying thresholds that related to the framework categories of size, interconnectedness, leverage and liquidity risk and maturity mismatch. A company will be evaluated further in stage 2 only if it both meets the total consolidated assets threshold ($50 billion in global consolidated assets for U.S. global financial companies or $50 billion in U.S. total consolidated assets for foreign nonbank financial companies) and any one of the other enumerated metrics. Stage 2 would involve a wide range of quantitative and qualitative industry-specific and company-specific factors. Stage 3 would focus on the company’s potential to pose a threat to the U.S. financial system. Comments are due by December 19, 2011. A copy of the proposed rule is available here.

PROPOSED LEGISLATION ON TO EXTEND DEADLINE FOR DERIVATIVES RULEMAKING:

A bill was introduced in the Senate to extend the deadline for rulemaking on derivatives to July 16, 2012. The Dodd-Frank Improvement Act of 2011 (S. 1650) would require the SEC, the CFTC and other relevant regulators to jointly adopt an implementation schedule for derivatives regulations by December 31, 2011, which would, among other things, specify schedules for publication of final rules and for the effective dates for provisions in Dodd-Frank on derivatives. The proposed bill would also allow the regulators to issue exemptions with respect to swap transactions, activities or persons from the Dodd-Frank Act derivatives provisions, would exempt end-users of swaps from margin requirements, would revise the definition of major swap participants to “prevent Main Street businesses that are using derivatives to hedge business risks from being regulated like swap dealers,” and would exempt inter-affiliate transactions from the definition of “swaps.” The bill would also create the Office of Derivatives within the SEC to “administer rules, coordinate oversight and monitor the developments in the market.” The text of the bill is available by clicking here.

PROPOSED LEGISLATION TO FREEZE REGULATORY RULEMAKING:

Two bills were introduced in the House of Representatives to freeze regulatory rulemaking actions during a “moratorium period” and to repeal certain existing regulations. The Job Creation and Regulatory Freeze Act of 2011 (H.R. 3194)would establish a moratorium period until January 20, 2013, prohibiting regulators from adopting any “covered regulations,” which would include final regulations that, among other things, would have an adverse effect on employment, economy or public health or are likely to “have an annual effect on the economy of $100,000,000 or more.” At the same time, the bill would allow rulemaking, to the extent necessary “due to an imminent threat to human health or safety, or any other emergency” or if it promotes “private sector job creation,” encourages economic growth or reduces “regulatory burdens.” The Stop the Regulation Invasion Please Act of 2011, or STRIP Act of 2011 (H.R. 3181) would also establish a two-year moratorium period for all new rulemaking, except in certain limited circumstances. In addition, that bill would repeal, with certain exceptions, all rules that became effective after October 1, 1991. The existing rules that would continue in effect would need to be justified before the Congress based on cost-benefit analysis. The H.R. 3194 is available by clicking here; and the H.R. 3181 is available by clicking here.

©2011 Greenberg Traurig, LLP. All rights reserved.

Anti-Money Laundering Compliance Costs

Recently posted in the National Law Review an article by Emily Holbrook of Risk and Insurance Management Society, Inc. (RIMS) regarding anti-money laundering  initiatives take more precedence in the corporate world:

 

Each year, anti-money laundering (AML) initiatives take more precedence in the corporate world, particularly within the financial industry. According to Celent, global spending on AML compliance, including operations and technology, will reach a staggering $5.8 billion within the financial sector by 2013.

Overall, the AML compliance burden is expected to expand at a rate of 7.8% annually while global spending on AML software is projected to expand at a rate of 10.4% per year. But what is the motivation behind such a drive? The research firm found that 42% of respondents cited regulatory requirements, and 25% pointed to reputational risk and brand protection as the main driver for AML compliance spending. And in further findings, financial institutions cited the integration of their AML and anti-fraud operations and technologies as a long-term goal.

“Although intuitively attractive, many institutions may find it difficult to build a business case for integrating AML with anti-fraud,” said Neil Katkov, senior vice president for Celent. “Fortunately, the compliance-driven development of modern AML software, analytics and case management has created a new generation technology that can often deliver better results than legacy anti-fraud systems.”

It seems it’s out with the old and in with the new — and expensive — AML

Risk Management Magazine and Risk Management Monitor. Copyright 2011 Risk and Insurance Management Society, Inc. All rights reserved.

Mortgage Industry to Face Centralized Repository for State Regulatory Enforcement Actions – Deadline for Comments is September 20, 2011

Posted in the National Law Review an article by attorney  Thomas J. McKee, Jr., Gil Rudolph and Michael R. Sklaire of Greenberg Traurig, LLP regarding State Regulatory Registry LLC (SRR);

 

 

Deadline for Comments is September 20, 2011

On July 22, 2011, the State Regulatory Registry LLC (SRR) issued a Request for Public Comments on a proposal to collect, centralize and publish all state regulatory enforcement information concerning mortgage loan originators. By creating a central source of investigation information, the SRR aims to provide a repository of background information for both consumers and other state and federal regulators. Before implementing, the SRR has asked for public comments to be submitted by September 20, 2011.

In 2008, the Nationwide Mortgage Licensing System & Registry (NMLS) was created under the federal Secure and Fair Enforcement for Mortgage Licensing Act (“SAFE Act”), with the purpose of “provid[ing] consumers with accessible information . . . regarding the employment history of, and publicly adjudicated disciplinary and enforcement actions against loan originators.” 12 U.S.C.A. § 5101(7). As part of implementing this purpose, the NMLS intended to use the SRR as the vehicle through which to include all regulatory actions taken by state regulators against companies and individuals that could be gathered and published. Previously, actions by state regulators could only be found, if at all, through a search of the individual state regulators’ websites.

The proposal to incorporate state regulatory reporting into the NMLS, which would take effect in Spring of 2012, consists of twelve major policies and processes, which include, among others:

  1. The state agency that took the action will be responsible for inputting such information into the NMLS. The SRR will not verify, validate, or amend any of the enforcement actions, as such information can only be changed by the inputting agency.
  2. Whether an action will actually be included in the NMLS can vary from state to state, depending on state-specific statutes and regulations. Further, each state will determine which actions will be shared only with other regulators, and those that will be made available to the general public.
  3. Reported actions will not be limited to those actions that are public. Instead, a regulator will have the ability, at their discretion, to include information that is to be shared only among regulators or among agency employees.
  4. A recommendation that any postings be made within five (5) days of receipt of a state agency’s final order.
  5. Provide a standardized set of information to be posted, including, for example, (a) the enforcing agency, (b) a description of the Order, and (c) the amount of any fine or other penalty.
  6. The SRR recommends that actions taken against companies should be posted on a prospective basis, while actions taken against loan originators should be posted as of the date each state’s SAFE Act became effective.
  7. All respondents named in an action will be included in any reporting, and the action will be tied to the records of both the named company and/or individuals.
  8. A company or individual will be notified of any posting in the system and will be able to view any publicly posted actions against it in the NMLS. The SRR proposal does not, however, contain a mechanism for a company or individual to learn of the non-public postings against it.
  9. State regulators will have the ability to post multi-state actions through NMLS. Each state involved in such an action is responsible for posting the action pursuant to its own reporting policies.

At first glance, the proposed registry presents a number of benefits to companies. For example, by having a central repository for all state regulatory actions, companies will have easy, up-to-date, access to the types of enforcement actions being pursued across the country, including the resulting fines and penalties assessed. Such information can be invaluable when defending an enforcement action and evaluating settlement proposals with state agencies. Companies will be able to see enforcement trends and use such information to modify their practices. The new system will greatly simplify a company’s ability to learn from the conduct of others.

Such benefits, however, do not come without a host of potential drawbacks. Specifically, while the system seeks to compile standard information regarding enforcement actions, it does not set forth a standard for reporting. Instead, its reliance upon individual state standards for reporting could lead to competitive disadvantages where, despite identical conduct, one company is tagged with a report while another is not solely due to a difference in state reporting standards.

The discretion given to regulators under the system could have similar effects. Giving regulators the discretion to input information (including non-adjudicated information) that will only be shared among regulators or agency employees could result in information being shared without verification, accountability, or opportunity to cure. Successfully defending an enforcement action would not necessarily preclude the sharing of negative comments about a company on the system. Companies will not be privy to such secret, albeit formalized, statements that could be prejudicial to how such entities are viewed and/or treated by other regulatory agencies. Nevertheless, the repository could be a potential treasure trove of information for future plaintiffs and will certainly be a frequent target of discovery in lawsuits.

Companies should carefully examine the potential ramifications each of the proposed policies may have on their business.

©2011 Greenberg Traurig, LLP. All rights reserved.