Steering safely through the ERISA minefield

Beware of “accidents” that occur in benefit plans when insufficient attention is paid to the rules.

BY ANN LONGMORE

T0 BE COMPETITIVE with bigger firms, to attract and keep qualified employees, family companies have to offer some kind of benefits. The rules, however, often seem calculated to make it more difficult for family companies to offer and maintain retirement plans, profit sharing plans, stock bonus plans, health and disability insurance, and other programs.

With fewer employees and assets to invest, the smaller family owned businesses often lack clout with plan service providers and therefore tend to pay more — and get less — for both the company and the plan participants. Just as important, it often seems that these companies have a harder time steering a safe course through the minefield of rules governing pension and welfare plans under ERlSA (the Employee Retirement Income Security Act of 1974, as amended). With smaller staffs and more limited access to expert advice, these companies are more exposed to liability lawsuits.

To appreciate the cost of such plans to smaller companies, take the popular 401(k), today the retirement plan of choice for many companies, regardless of size or industry. The costs of small 401(k) plans averages $91 per employee, as against $17 per participant for the plans of larger companies. In addition to paying over 500 percent more for basically the same services, the smaller plan sponsors may not be able to offer the same range of services as larger companies. Typically, their plans contain fewer investment choices than those of larger companies — which tends to make the small employers less attractive in the job market. That undermines one of the very reasons that small firms want such plans in the first place, which is to attract top talent in today's competitive marketplace.

The same lack of clout can translate into greater potential liability for the family owned business. One section of the ERISA code, for example, provides safe harbor protection for employers if their plans offer participants at least three diverse investment options with varying characteristics and allow them to make their own investment decisions. When those conditions are met, it is the plan participants who by law bear the risk of the investments and not the plan sponsor or fiduciaries. But many family companies unable to offer three investment options do not qualify for safe harbor protection.

Smaller firms are particularly vulnerable because of their reliance on outside professionals for advice and guidance. While few things in this life are as complicated as brain surgery, compliance with the complex federal rules for benefit plans comes close. Even large companies with their own legal and finance departments as well as benefits staffs sometimes get caught with their ERISA slips showing. A few years back, for example, Weyerhaeuser, the privately owned forest products company, was forced to agree to a $20-30 million settlement after entrusting its pension fund assets to a money manager who lost $100 million in risky trades.

When it comes to ERISA rules, no one is perfect. Family companies are probably far less perfect because they generally lack people qualified to check up on the professionals and ensure that their actions are prudent and legal. The owners of such firms are likely to have little or no training on pension or benefits issues. The managers in charge of overseeing the plans probably do not have benefits programs as their primary area of responsibility. Nor are family companies likely to have independent trustees or fiduciaries for their benefit plans, or boards with outside directors who might supply the needed backup expertise.

The lean management structure of family owned companies permits faster decision making, but may also mean less attention is paid to pension and other benefits matters. A surprising number of management decisions involve ERISA requirements. One recent high-profile case involving a public company went all the way to the U.S. Supreme Court. The Massey Ferguson Co. was planning to spin off one of its unprofitable units, Variety Corporation, and in its deliberations, the board of directors had discussed how employee benefits would be handled and how to explain what would happen to the plan in the divestiture. Afterwards, the parent company reassured employees that their benefits were not in jeopardy and would be continued by the spunoff company. While the parent company had a healthy balance sheet, however, the subsidiary was losing $30 million to $40 million a year. Ultimately the nation's highest court ruled the board had made decisions relating to an ERISA plan and the company had breached its fiduciary duty to plan participants when it "sugarcoated" the facts about the financial health of the spunoff company. The lawyers are still trying to figure out how this case will affect future litigation on pensions and benefits.

In a very similar recent case, USX needed to close down one of its plants in a cost-cutting campaign. The plant selected was chosen because it was antiquated and relatively less productive but also because it had a lot of employees receiving a big benefits package. The minutes of board meetings quickly established that the benefits package weighed heavily in the decision. The decision was viewed as an interference with the rights of plan beneficiaries. USX was ordered to pay $47 million in damages to the plant participants and has not appealed the verdict.

If big companies such as USX and Massey Ferguson seem unaware of all the pitfalls, how can smaller companies avoid getting caught in ERISA's trammels? Benefits programs are likely to represent a sizable portion of company expenditures in a small or midsized family firm. Decisions on the plans are also more likely to have a significant impact on the decision makers, who are often owners of the company. This presents potential conflict-of-interest issues (especially when combined with fewer outside fiduciaries to act as independent oversight). ERISA has a strict "exclusive benefit rule," which holds that pension and welfare benefit plans must be managed and all duties discharged "solely in the interest of the [plan] participants and beneficiaries ... for the exclusive purpose of: (i) providing benefits to participants and beneficiaries...." The strong impact that pension and benefit decisions can have on the corporate bottom line makes it especially difficult to separate what is in the best interests of the company and the family owners from what is in the best interests of the plan and its beneficiaries.

Although many experts have acknowledged the potential conflicts of interest involved in corporate-sponsored ERISA benefit plans, few can give a practical road map on how to consistently avoid what I call accidents. A common "accident," for example, occurs when a company goes to a loan officer at the bank that serves as trustee for its ERISA plan and tries to get favorable terms for a loan. Under ordinary circumstances, an executive seeking a loan is likely to invoke "our long and fruitful relationship" when asking for an interest rate lower than prime or for a longer payback period. People in business use that kind of leverage every day. Under ERISA, however, a company is prohibited from profiting in any way from its plan. To benefit from its association with the bank trustee is to profit from the plan — and to violate the rules.

The standard of care demanded by law of ERISA plan trustees is significantly higher than ordinarily required of directors and officers in managing the company. To satisfy ERISA's prudent-expert standard, company executives and decision makers must negotiate the best possible deals for their plans with service providers.

When relying on professionals, they must be keenly aware of the exclusive loyalty that they owe the plans under ERISA law. They are obliged to monitor the experts and second-guess them when necessary, to act as "inquiring minds" to avoid conflicts of interest and other violations of the rules. Aware of the limitations on corporate indemnification, prudent fiduciaries may also want to carry ERISA fiduciary liability insurance to fill any remaining gaps. (American International Group, Chubb, and Aetna are the biggest carriers of this type of insurance.)

I pray almost daily for some form of pension simplification to be enacted by Congress. It is not that the smaller businesses cannot understand the benefit rules (although at times I defy any rational person to explain those rules) but rather that in practice, the rules seem to come down harder on the smaller firms. That is why owners of family companies should at least be aware of the pitfalls and do whatever they can to establish checks and balances against mismanagement of their plans.

 

Ann Longmore is an ERISA fiduciary specialist with Willis Corroon Corporation Management Liability in New York.


How to avoid a misstep