Compliance July 1, 2019

Plaintiffs’ Attorney in Thole v. U.S. Bank Predicts Victory in Supreme Court

The Supreme Court will weigh in on the question of whether an adequately funded pension that is not in immediate danger of insolvency could have wronged participants and breached ERISA in the selection of poorly performing investments offered by an affiliate company.

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The U.S. Supreme Court has agreed to take up Thole v. U.S. Bank, a pension-focused case arising under the Employee Retirement Income Security Act (ERISA). Oral argument is expected to occur in late 2019.

As one of the lead plaintiffs’ attorneys in the case, Karen Handorf, partner at Cohen Milstein and chair of the firm’s employee benefits and ERISA practice group, said she is gratified to see the Supreme Court taking up this matter. Speaking with PLANADVISER about this development, she said she believes the case will help determine whether the millions of Americans whose pensions are held in defined benefit plans have the right to sue the fiduciaries of their plans for mismanaging assets. U.S. Bank declined to comment on the matter, noting it is the firm’s policy not to publicly discuss active litigation.

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Specifically, the Supreme Court will weigh the following questions: “(1) Whether an ERISA plan participant or beneficiary may seek injunctive relief against fiduciary misconduct under 29 U.S.C. § 1132(a)(3) without demonstrating individual financial loss or the imminent risk thereof; and (2) whether an ERISA plan participant or beneficiary may seek restoration of plan losses caused by fiduciary breach under 29 U.S.C. § 1132(a)(2) without demonstrating individual financial loss or the imminent risk thereof.”

By way of background, plaintiffs filed this lawsuit in 2013. In October 2017, the U.S. 8th Circuit Court of Appeals upheld a lower court’s dismissal of the case based on the fact that, despite some significant investment losses suffered by the plan after investments in affiliated investment funds, the Court believed that U.S. Bancorp Pension Plan had enough money left over to keep paying benefits. Thus the participants could not prove, in the Court’s eyes, that they had the sufficient standing to move ahead on fiduciary breach claims.

Handorf suggested the case has far reaching implications for working and retired Americans. She argued that multiple circuit courts, including the 8th Circuit here, have wrongly denied participants in defined benefit plans their right to hold fiduciaries accountable for even the most egregious misconduct.

“Federal courts have taken this matter up in a few different contexts, and at this stage a number of circuit courts have said you don’t, generally speaking, have standing to sue an adequately funded pension plan for harming its participants,” Handorf said. “To me, that’s a really strange and unfortunate stance to take, because it essentially wipes out a big portion of ERISA, which was written to give people the right to sue plan fiduciaries for breaches of their fiduciary duty and to prevent prohibited transactions. The whole idea that the funding level of the plan somehow means fiduciary breaches can’t occur is hard to grasp, because we all know that the funding level of a plan can change quite quickly, depending on the markets and everything else.”

Getting a bit technical, Handorf suggested the case, depending on how the ruling is structured, may help to clarify what she sees as some confusion that exists in terms of how pension plan participants can establish two different types of standing—ERISA statutory standing and Article III standing under the U.S. Constitution. If the Supreme Court were to rule to clarify Article III standing, she said, the case could take on even broader implications well beyond the retirement marketplace. However, she expects the Court can and will rule narrowly to avoid creating sweeping change to the way claims can be brought based on the Constitution.

“I personally think that the Supreme Court will rule in our favor, which won’t surprise you. I think even the conservatives on the Court are going to respond well to our arguments,” Handorf said. “Looking specifically at the 8th Circuit ruling and whether this will be vacated narrowly, we feel confident it will be, because no other court has said that you don’t have statutory standing in a matter like this. It’s an anomaly for them to say that a statute that was specifically put in place to protect people more stringently than trust law doesn’t give you a right to sue when you could have sued under trust law. It makes my head spin, frankly.”

Handorf cited a brief filed by the U.S. Solicitor General following a request for input from the Supreme Court.

“The brief is extremely strong and it asks the same questions we ask. How does it make sense to say that if you are a dollar over-funded, there is no risk of harm to the participants, but if you are a dollar under-funded, there is risk of harm or wrongdoing? It’s an illogical way to analyze this issue,” Handorf said. “Further, what are the funding level formulas we are going to use in this discussion? The statute doesn’t define that. And if you file when the plan was under-funded, like we did, and then it becomes over-funded, does that mean you don’t have standing anymore?”

Handorf said the case also has big implications from a statute of limitations perspective.

“What if a plan becomes under-funded, giving you standing to sue, but the alleged breach of the fiduciary duty happened longer ago that than the relevant statute of limitations? Are you just out of luck in that case?” Handorf asked. “If this is cemented as the standard it will mean that plan fiduciaries can basically get away with anything, so long as they have a well-funded plan during the period that the statute of limitations is running.”

Handorf suggested that a ruling against these arguments would mean it could become impossible to sue pension plans, because no one will have standing to sue until it’s too late.

“Under that sort of standard, it’s not absurd to say that plan fiduciaries could literally steal money from the plan so long as it was adequately funded or more than fully funded,” she said. “Remember, this case also ties back to self-dealing. We believe that the plan fiduciaries made certain investment choices because they wanted to seed the mutual funds of an affiliate. It’s a critically important case in terms of making sure pension plan fiduciaries really pay attention to how they are managing the plan and meeting their duties.”

Compliance July 1, 2019

Simplified Hardship Withdrawal Process Can Still Go Wrong

The IRS is aiming to simplify the hardship withdrawal process, but plan sponsor clients still have to remain mindful of their compliance obligations and safe harbor requirements.

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As explained in a newly published “IRS Snapshot,” a 401(k) plan may permit pre-retirement distributions to be made on account of participants experiencing financial hardships. A hardship is defined as an “immediate and heavy financial need,” and the distribution must be declared by the participant to be necessary to satisfy an immediate financial need.

Generally speaking, employees’ contributions—rather than employer matching dollars—have been drawn upon to meet hardship withdrawal requests. But if the plan sponsor permits, IRS explains, certain employer matching contributions and employer discretionary contributions may also be distributed on account of a hardship, although the standards for distributions may be different.

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For plan years beginning prior to 2019, qualified matching contributions, qualified nonelective matching contributions, and income earned on elective deferrals could not be distributed on account of a hardship. These restrictions were lifted for plan years starting in 2019, however, and more changes are on the horizon due to the requirements of the Bipartisan Budget Act of 2018.

As the IRS explains, the Bipartisan Budget Act of 2018 made several important updates to the requirements for making and monitoring hardship distributions from tax-qualified retirement plans. In particular, the Act provided that a distribution from a 401(k) or similar qualified plan will not fail to be treated as made on account of hardship merely because the employee did not first exhaust any available loan from the plan.

In addition to expanding the types of contributions and earnings a plan may make available for hardship distributions, the law directed the IRS and Treasury Department to eliminate the safe harbor requirement to suspend participant contributions for six months in order for the distribution to be deemed necessary to satisfy an immediate and heavy financial need. Among still other changes, the Act ordered employers and the IRS to allow participants to more easily certify that they are experiencing a financial hardship.

As reviewed in the Snapshot, responding to the Bipartisan Budget Act, the IRS has put forward a proposed regulation to replace the previous requirement for a detailed and document-supported representation of hardship with “a general written statement that the employee has insufficient cash or other liquid assets to satisfy the need,” effective for distributions made on or after January 1, 2020. The IRS Snapshot points out that “whether an employee has an immediate and heavy financial need depends on all relevant facts and circumstances,” and that, broadly speaking, when the proposed rule becomes final, an employer may confidently rely on the employee’s representations unless the employer has actual knowledge that the representations are false.

While the hardship withdrawal rules are, in a sense, becoming more lenient, there are still restrictions. Pursuant to the “safe harbor” provisions most plan sponsors seek to comply with, a distribution is deemed to be on account of an immediate and heavy financial need of the employee if the distribution is for:

  • Generally, expenses for medical care previously incurred by the employee, the employee’s spouse, or any dependents of the employee or necessary for these persons to obtain medical care.
  • Costs directly related to the purchase of a principal residence for the employee (excluding mortgage payments).
  • Payment of tuition, related educational fees, and room and board expenses, for up to the next 12 months of postsecondary education for the employee, or the employee’s spouse, children, or dependents.
  • Payments necessary to prevent the eviction of the employee from the employee’s principal residence or foreclosure on the mortgage on that residence.
  • Burial or funeral expenses for the employee’s deceased parent, spouse, children, or dependents.
  • Certain expenses relating to the repair of damage to the employee’s principal residence that would qualify for the casualty deduction under IRC § 165.
  • The plan may also permit distributions for medical care, tuition, and funeral expenses for certain beneficiaries of the participant, per IRS Notices 2007-7 and 2007-1.

The IRS Snapshot notes that many plans may continue to use more detailed policies and procedures already in place for documenting participants’ requests and receipts of hardships distributions. The recent changes, in other words, allow but do not require plans to be more lenient about the certification and monitoring of declared hardships. And, however a plan sponsor chooses to proceed, it will also be important to ensure the plan remains compliant when it comes to the treatment of records and documents tied to pre-2019 hardships distributions. 

With all this in mind, the IRS Snapshot includes the following audit tips:

  • Review the plan document and stated hardship policies.
  • Examine the hardship distribution form(s) and any written statements provided by the employee for proper signatures, especially spousal consent (if applicable).
  • Make sure that the distribution is limited to the maximum distributable amount related to the source of the funds.
  • Examine the records the employer used to establish whether a hardship exists and the amount of the hardship. Records containing the necessary information may include, but aren’t limited to, medical bills, tuition bills, eviction notices, or closing sheets for the purchase of a principal residence.
  • For elective deferrals, examine the documentation provided by the employee to determine that the employee has no other reasonably available resource to relieve the hardship. This can be limited to an employee representation.
  • For elective deferrals, for plan years beginning prior to January 1, 2019, verify that the employee obtained available distributions and loans and was prohibited from making contributions for six months after the hardship distribution.
  • Examine the returned check(s).  
  • Examine the trust fund statement.
  • Make sure the distribution is properly reported on Form 1099-R.
  • Look for indicators of fraud.

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