Despite what your financial advisors might tell you, it is difficult to win a lawsuit against one of the large providers. The Western District of New York court recently dismissed a lawsuit brought by the trustee and plan sponsor of a 401(k) plan administered by the payroll company Paychex. The court dismissed the litigation by ruling that Paychex was not a fiduciary as to its actions regarding the plan. Since Paychex was not a fiduciary, the court dismissed the lawsuit in Zang v. Paychex, Inc.

This suit claimed that Paychex has violated ERISA by placing its own financial interests ahead of those of the Plan, and by engaging in transactions prohibited by ERISA. When you read the court’s decision, you might conclude that Paychex’s act made it a fiduciary. The payroll company put together the mutual fund investments that paid revenue sharing to Paychex. The payroll company could also hold plan deposits for up to 5 days before they were invested, using the earnings from the float for their own purposes. Finally, Paychex could add or change funds available to the 401(k) participants in their plans. So why didn’t these actions lead to a determination that Paychex was a fiduciary?

First, the contract between the plan sponsor and Paychex said that while it could collect revenue sharing from plans, make changes in the investment options, and use the float for its own purposes, Paychex was not a plan fiduciary. Specifically the contract said, “… the express intention of the Employer and Paychex that Paychex’ services under this agreement are limited to those of a recordkeeper and provider of non-discretionary administrative services at the direction of the Employer . . . ”

Normally, a contract stating that a party is not a fiduciary is not the controlling factor in determining whether a service provider is a fiduciary, as the courts instead look at actions of the service provider. In this case, however, the agreement notified the employer that Paychex was going to be paid in a number of ways and described them.  While the suit alleged a prohibited transaction relating to the fees, it did not claim that the fees were excessive. 

As to the revenue sharing that was built into the funds being offered by Paychex, the court said that Paychex was free to structure the fund offerings in any way it wanted because that occurred before the plan invested in the funds. The court said: “Ultimately, it remained up to the [plan sponsor] to decide which funds to invest in, and … Paychex did not even provide any investment advice to the [employer].” Even if Paychex had “played a role” in the employer decision to move to its platform, in the end the court stated that it was the employer’s and other fiduciaries’ decision to make.

The court found that Paychex’s ability to make changes in the fund offerings did not lead to Paychex having discretionary authority over the plan because any changes could only be made 60 days after the employer was notified. Then, once notified of an upcoming change, the employer had the choice of rejecting the change or terminating Paychex without penalty. Where a penalty is involved in a change, such as one that could arise with some insurance contracts, the result could be different.

If we had titled this story “State Courts Can Determine If DRO Qualifies As QDRO,” it wouldn’t have been as much fun to read, but it is in fact about QDROs and some important information about state law preemption and the rule of state courts in construing QDROs.

In Mack v. Kuckenmeister, 2010 WL 2853881 (9th Cir.2010), Darren Mack murdered his wife, Charla Mack, and shot the state court judge overseeing their divorce proceedings before a final written divorce decree was filed. Charla's estate, believing that the parties had essentially reached final agreement on the terms of the divorce prior to her death, filed a motion in state court for the divorce decree to be memorialized in an order dated “nunc pro tunc” to a time before her death when the terms were finalized by an oral order of the trial judge.

The Nevada state court granted her estate’s motion and entered a domestic relations order (“order” or “DRO”). The DRO decreed that a QDRO would be issued which would transfer to Mrs. Mack the sum of $500,000 plus any earnings. Darren Mack appealed the order to the Nevada Supreme Court, arguing that the order contravened ERISA. He lost and the Nevada Supreme Court affirmed the retroactive judgment and also determined that it was a QDRO.

On the appeal, the Ninth Circuit determined that state courts have subject matter jurisdiction to decide that a state court domestic relations order is a QDRO. Thus, the Nevada Supreme Court ruling that the order constituted a QDRO was entitled to full faith and credit. The Ninth Circuit observed that ERISA states that “a court of competent jurisdiction” can determine whether a DRO is a QDRO and concluded that a state court is a court of competent jurisdiction.

Additionally, Congress amended ERISA to avoid preemption issues and to permit state court ordered assignments of plan benefits to former spouses and dependents. As amended, ERISA explicitly exempts from its anti-alienation and preemption provisions a subset of DROs. To be exempt, such orders must be judgments, decrees, or orders “made pursuant to State domestic relations law” that “creates or recognizes the existence of an alternate payee's right to, or assigns to an alternate payee the right to receive all or part of the benefits payable with respect to a participant under [an ERISA] plan.”

It seems so long ago, but April 30, 2010 marked the end of the two-year period for a plan sponsor using a pre-approved defined contribution plan document for its 401(k) plan to restate the plan to a so-called “EGTRRA” pre-approved document.  Unfortunately, despite all efforts of plan advisors to address this matter, there are undoubtedly plan sponsors out there who failed to meet this deadline.  That essentially means that qualified status of the plan is in serious jeopardy, and there would be significant consequences if an IRS or DOL audit uncovered the restatement failure.  The IRS discussed this problem in the Summer issue of its Retirement News for Employers.  It already maintains a “Voluntary Correction Program” (VCP) as part of its Employee Plans Compliance Resolution System that provides plan sponsors with a process to resolve plan qualification issues and other matters.  The IRS has added a “Voluntary Correction Program Submission Kit” that provides detailed instructions for plan sponsors who wish to make a VCP submission to resolve the failure to adopt a timely EGTRRA restatement.  Among other things, the Kit lists the materials that the sponsor must include in its application, line-by-line instructions for key parts of the application, and a guidance to determine the relevant application fee.  The Kit also has links to other IRS guidance on aspects of the correction program.  You can access the Kit at the IRS website, www.irs.gov.

Meanwhile, the folks at Sungard Relius have posted a Technical Update on their website explaining that at least some plans still have time to restate their plan, even after passage of the April 30th deadline, which was part of a 6-year remedial amendment cycle for prototype and volume submitter plans.  The Update points out that this cycle “is effectively an exception” to the 5-year remedial amendment cycle that people generally assume applies to individually designed plans.  That assumption is incorrect, however; any plan can use the 5-year cycle, including plans using prototype or volume submitter plan documents.  Under the 5-year cycle, the restatement deadline is generally determined by the last digit of the plan sponsor’s EIN, and plan sponsors with an EIN ending in either 5 or 0 (known as Cycle E), have until January 31, 2011 to complete their EGTRRA restatement.  According to the Update, a plan sponsor qualifying for the Cycle E deadline that adopts a prototype or volume submitter plan document by that deadline can rely on the IRS approval letter issued to the pre-approved plan sponsor, is entitled to extended reliance back to the beginning of the 2002 plan year, and does not need to file its own application for a determination letter.  If the employer does file for its own determination letter, it can use Form 5307, which has a lower user fee than Form 5300, which is used for individually designed plans.  In effect, Cycle E plan sponsors have a second kick at the can for their EGTRRA restatement.

Most not-for-profits with 403(b) plans found getting their plans into compliance with the final 403(b) regulations to be a huge headache. Those problems haven’t lessened much. A problem with a high potential impact on plan sponsors is keeping a non-ERISA 403(b) plan from becoming an ERISA plan because, when there are more than 100 eligible employees, making a misstep can lead to a big financial mistake. Large non-ERISA 403(b) plans don’t need a CPA’s audit, but large ERISA 403(b)s do. Large here means more than 100 eligible participants.

When the employer participates in approving a plan loan or a hardship distribution to a participant, this causes the 403(b) plan to be subject to ERISA. A non-ERISA 403(b) plan does not have any employer contributions, and the employer is not involved in the plan’s administration. When the employer is “involved” in the administration, the ERISA exemption is lost. Preparing the Form 5500, transferring employee deposits to a provider, and amending the plan document is about all the employer can do without having its actions trigger ERISA coverage.

When a 403(b) provider (e.g. recordkeeper, broker, etc.) asks the employer to approve a loan or a hardship distribution that is requested by a participant, many employers are unaware that doing so will cause their ERISA exemption to be lost. In part the employer’s approval is being required by the provider in order to prevent the service provider from being seen as having discretionary control over the plan. If the recordkeeper has that control or authority, then it becomes a fiduciary, and providers do not want that extra liability.

It may seem obvious that before a recordkeeper would make a hardship payment, it would ask the employer to confirm that an individual requesting a loan is still employed or that some aspect of the hardship, such as confirmation that a dependent exists, before the recordkeeper would make the distribution to pay a dependent’s health expenses. Confirming that someone has a dependent, or that the participant is or is not employed, causes the plan sponsor to be involved in plan administration. The only way to address this issue to meet the provider’s and plan sponsor’s needs is to amend the plan to prohibit loans and hardship distributions.

Another issue that is causing some not-for-profit 403(b) plans with employee-only money to be subject to ERISA is the new plan document adopted to get into compliance with the final regulations. One 403(b) document we saw that had been offered by an insurance company to its non-profit, non-ERISA 403(b) plan contained ERISA provisions. It also contained a statement in the opening paragraph to the effect that the ERISA provision of the document applied if the plan is an ERISA plan. Similar wording was in the Summary Plan Description, which would not be the case if the plan weren’t an ERISA plan.