The Employee Benefits practice is pleased to present the Benefits Developments Newsletter for the month of August 2018. Click through the links below for more information on each specific development or case.
Dow Chemical Fined $1.75 Million Over Perquisite Disclosures
The Dow Chemical Co., while neither admitting nor denying wrong doing, will pay a $1.75 million fine imposed by the Securities and Exchange Commission (SEC) regarding claims that Dow did not properly disclose approximately $3.0 million of executive compensation in the form of perquisites. While not completely detailed, Dow was claimed to have not disclosed company authorized perquisites including personal use of the Dow aircraft and other expenses. According to the Order of the Securities and Exchange Commission, Dow incorrectly applied a standard whereby a business purpose related to the executive’s job is sufficient to determine that a benefit would not be a perquisite requiring disclosure. That standard had been rejected by the SEC in its rulemaking in 2006. Under the SECs standard, an item is not a perquisite or personal benefit only if it is integrally and directly related to the performance of the executive’s duties. Unless an item is generally available on a non-discriminatory basis to all employees, an item is a perquisite if it confers a direct or indirect benefit that has a personal aspect without regard to whether it may be provided for some business reasons or the convenience of the company,.
Clients should review their internal standards for disclosure of perquisites to be certain that it complies with the standard announced by the SEC. SEC Administrative Proceeding Order, In the Matter of The Dow Chemical Company, 2018.
IRS States Employers Not Exposed to ACA Penalties for Making Cash Payments in Lieu of Health Benefits As Permitted Under the Service Contract Act
In June, the IRS issued an information letter indicating that federal contractors subject to prevailing wage laws will receive credit for making cash payments to employees who opt out of health insurance coverage when determining whether such health coverage is affordable. The IRS provided this clarification in response to an inquiry from a Congressperson on behalf of a constituent who was an applicable large employer for purposes of complying with the Affordable Care Act’s (ACA) employer mandate, but was also subject to a Service Contract Act (SCA) prevailing wage determination.
The SCA requires federal contractors to comply with the terms of a DOL wage determination by providing specified wages and qualifying fringe benefits. The SCA permits federal contractors subject to such fringe benefit obligations to allow employees who opt out of health coverage to receive cash in lieu of health benefits.
The ACA provides that an applicable large employer’s obligation to provide affordable health coverage limits the employer to receiving credit for contributions only if such amounts are exclusively used to pay for medical expenses. Hence, cash offered in lieu of health benefits is generally disregarded in computing the amount of an employer’s contribution that may be included when calculating whether health coverage is affordable. As a result, the amount of cash-out payments to employees who opt out of coverage is added to the total premium price when determining whether the coverage is affordable.
The IRS letter restates the special transition rule from Notice 2015-87 allowing employers subject to the SCA to include employer cash-out payments as part of the employee’s required contribution for purposes of determining the affordability of such coverage under Code Section 4980H(b). Thus, offering the choice of a cash-out payment to employees will not require an SCA employer to pay a greater share of the cost of coverage to avoid affordability penalties.
Although IRS Notice 2015-87 applies this rule for coordinating the ACA and SCA for plan years before January 1, 2017, the IRS letter indicates that the executive order directing agencies to minimize the burden of ACA compliance allows the IRS discretion to continue applying the special treatment of SCA cash-out payments when determining compliance with the ACA’s affordability mandate. IRS Information Letter 2018-0013.
NYU Victorious in Excessive Fee Case
NYU is one of several universities that have been named in ERISA lawsuits that allege breaches of fiduciary duties relating to excessive service provider fees and imprudent investment fund options in a 403(b) plan sponsored by the university. A federal trial court considered the merits of the ERISA claims in a case brought against NYU, and the federal judge ruled in favor of NYU on all claims.
The plaintiffs in the case were NYU employees who alleged that NYU’s Retirement Plan Committee (the “Committee”) failed to fulfill its ERISA fiduciary duties, which resulted in losses of more than $358 million that were suffered in two different 403(b) retirement plans for which the Committee served as an ERISA fiduciary. The plaintiffs’ first claim was that the Committee imprudently managed the selection and monitoring of recordkeeping vendors, which resulted in excessively high fees. The plaintiffs’ second claim was that the Committee imprudently failed to remove two investment fund options which underperformed and resulted in significant plan investment losses.
While the court acknowledged that there were deficiencies in the Committee’s processes, including Committee members who “displayed a concerning lack of knowledge relevant to the Committee’s mandate,” the court still found that the plaintiffs had not adequately proven that the Committee acted imprudently or that the losses were the result of any such deficiencies. Significant findings by the court in this case include the following:
Certain Committee members were under-prepared or relied too heavily on the Committee-appointed investment advisor, but there were other more well-equipped Committee members who, together the investment adviser, allowed the Committee to perform its duties adequately.
The evidence presented supported a finding that the Committee prudently managed its recordkeepers by running prudent RFP processes, by obtaining lower fees for one of the 403(b) plans when plan consolidation was impractical, and by consolidating recordkeepers for the other 403(b) plan.
Plaintiffs did not meet their burden of proof as to the damages (i.e., plan losses) for excessive recordkeeping fees because the plaintiffs failed to demonstrate by a preponderance of the evidence that the recordkeeping fee ranges asserted by the plaintiffs’ to be prudent were the only plausible or prudent ones – “or, indeed, that any comparable Plan has ever charged within that range.”
The evidence also demonstrated that the Committee closely monitored the performance of the investment fund options; that evidence included testimony that the Committee:
Received and reviewed detailed reports analyzing the investment options;
Discussed investment performance at numerous Committee meetings, and asked questions of the investment advisor regarding his analysis; and
Compiled a watch list to monitor certain funds.
The plaintiffs did not demonstrate that the real estate fund and the stock fund, which the plaintiffs alleged to be imprudent, did not underperform significantly enough to find the Committee breached its duties by failing to remove the funds, or that the plans suffered losses due to their inclusion.
This case reminds us of the importance of having a prudent process for selecting and monitoring service providers and plan investments, and then documenting that process. Even in the face of potentially damaging gaps in the composition and involvement of the Committee members, the judge in this case found sufficient documentation of a fiduciary process that ultimately worked in favor of NYU. Sacerdote v. New York University S.D.N.Y 2018.
Final Regulations on Short-Term, Limited-Duration Insurance Issued
The Internal Revenue Service, Department of Labor, and Department of Health and Human Services (Departments) jointly issued final regulations for amending the definition of short-term, limited-duration insurance (STLDI).
These final regulations are consistent with the proposed regulations issued last February and the Executive Order from October 2017. Under the final regulations, the maximum length of STLDI coverage would increase from a maximum period of three months to a maximum period of just under twelve months. STLDI is a type of health insurance coverage designed to fill temporary gaps in coverage that may occur when an individual transitions from one plan or coverage to another.
Although STLDI coverage is not an excepted benefit, it is exempt from certain individual-market requirements, such as annual or lifetime limits on essential health benefits, or the prohibition on pre-existing condition exclusions. These final regulations undo the 2016 regulations that limited the duration of STLDI coverage to no more than three months. Also under these final regulations, issuers of STLDI insurance would need to include a notice in the insurance contract.
The notice will inform individuals purchasing the STLDI contract that the coverage is not required to comply with federal requirements under the Affordable Care Act. For policies having an effective date prior to January 1, 2019, the notice will also include a statement that the coverage does not qualify as “minimum essential coverage” and that you may be subject to a penalty if you do not have minimum essential coverage for any month in 2018.
The final regulations will become effective 60 days after they are published in the federal register. Final Regulations https://www.cms.gov/CCIIO/Resources/Files/Downloads/dwnlds/CMS-9924-F-STLDI-Final-Rule.pdf
IRS Provides Guidance on Amended 162(m)
On August 21, 2018, the IRS issued guidance regarding changes to Section 162(m) of the Internal Revenue Code made by the Tax Cuts and Jobs Act (“TCJA”). In particular, IRS Notice 2018-68 provides guidance regarding the determination of covered employees and what arrangements may qualify for grandfathered status under new Section 162(m).
Under new Section 162(m), a covered employee includes any employee who serves as the CEO or CFO of a publicly held corporation at any time during a year. A covered employee also includes any employee whose total compensation for the taxable year is required to be reported to shareholders under the Securities Exchange Act of 1934 by reason of the employee being among the three highest compensated officers for the taxable year (other than the CEO or CFO). Further, any employee who was a covered employee in any preceding taxable year beginning after December 31, 2016 is a covered employee in any future taxable year.
The Notice addresses two aspects of covered employee status under new Section 162(m):
Certain commentators had asserted that an end-of-the-year requirement should apply to executive officers because SEC rules relating to executive compensation generally apply to the three most highly compensated executive officers (other than the CEO or CFO) who were serving as executive officers at the end of the fiscal year. The IRS responded that SEC rules can also require disclosure for individuals who were not serving as executive officers at the end of the fiscal year. For this purpose, the IRS specifically cited SEC rules requiring disclosure of the compensation of up to two additional individuals for whom disclosure would have been required but for the fact they were not executive officers on the last day of the fiscal year. As a result, the IRS concluded that there is no end of year requirement in order for an executive officer to be considered a covered employee.
Commentators also questioned whether an individual for whom a publicly held corporation is not required to disclose compensation to shareholders under SEC rules could nevertheless be a covered employee. The IRS responded by pointing to the language in new Section 162(m) that a covered employee includes an employee who would otherwise be an executive officer (other than the CEO or CFO) for whom disclosure of compensation would be required if such disclosure was required (e.g., executive officers of a corporation that does not file a proxy statement because the corporation becomes delisted). As a result, the IRS concluded that executive officers of a publicly held corporation can be covered employees even when disclosure of their compensation is not required under SEC rules.
The Notice includes an example where a publicly held corporation’s three most highly compensated executive officers during a year (other than the CEO and CFO) each retire before the end of the fiscal year. Of these three retired executive officers, the corporation disclosed to shareholders the compensation of the two highest paid retired executive officers. The example concludes that all three retired executive officers are covered employees for the taxable year. The IRS’ conclusion that the lowest paid retired executive officer is a covered employee for the taxable year appears to be at odds with the flush language of the statute, given the executive officer’s compensation was not required to be reported to shareholders. However, the IRS position set forth in the Notice appears to be that any individual who is among the three highest compensated executive officers for a taxable year (other than the CEO or CFO) is a covered employee, even if such individual is not serving as an executive officer at the end of the fiscal year or even if such individual’s compensation is not required to be disclosed to shareholders.
New Section 162(m) provides that its provisions will not apply to compensation that is provided pursuant to a written binding contract in effect on November 2, 2017, unless the contract is materially modified. The Notice provides guidance on what constitutes a written binding contract and a material modification.
Written Binding Contracts
The Notice clarifies that compensation is considered payable pursuant to a written binding contract only to the extent the corporation is obligated under applicable law (e.g., state contract law) to pay the compensation if the employee performs the requisite services or satisfies the applicable vesting conditions.
Many pre-TCJA arrangements permitted a corporation’s compensation committee to exercise negative discretion to reduce the amount of compensation payable under an arrangement. The Notice suggests that arrangements permitting negative discretion will not qualify for grandfathered status because the arrangement may not constitute a written binding contract.
Similarly, many deferred compensation plans provide that the corporation may amend or terminate the plan at any time, but in doing so may not reduce any benefits already earned under the plan. For plans including this type of language, an example in the Notice suggests that only amounts accrued under the plan as of November 2, 2017 may be viewed as being grandfathered under the same rationale that applies in the case of arrangements providing for negative discretion.
In general, an arrangement that is renewed after November 2, 2017 will be viewed as a new written binding contract subject to new Section 162(m) as of the date the contract becomes terminable. Thus, for example, an employment agreement that is treated as being renewed unless either the corporation or the employee provides the other party with a non-renewal notice at least 60 days before the end of the current term of the agreement would be treated as a new written binding contract as of the renewal date. The Notice provides clarification on two additional points: (i) an arrangement is not treated as being terminable if it may only be terminated by terminating the employee’s employment, and (ii) an arrangement that will be renewed unless the employee (but not the employer) decides to terminate the contract is not treated as being terminable.
In general, a material modification will be considered to occur if an arrangement is amended to increase the amount of compensation payable to the employee. If an arrangement is materially modified, it is treated as a new contract as of the date of the material modification.
If an arrangement is modified to accelerate the time of payment, the amendment constitutes a material modification unless there is reasonable adjustment to the amount of compensation payable to reflect the time value of money.
If an arrangement is modified to defer the time of payment, the modification will not result in the loss of grandfathered status if any amounts payable under the modified arrangement that are in excess of the original amount payable are based on a reasonable rate of interest or a predetermined actual investment (whether or not any assets are actually being invested).
Supplemental contracts that provide increased or additional compensation that, in substance, is based on the same elements or conditions as compensation that is otherwise payable under a grandfathered arrangement will be treated as resulting in a material modification. However, a modification of an arrangement to provide a reasonable cost of living adjustment will not be treated as a material modification.
The failure to exercise negative discretion under a contract does not result in a material modification.
In view of the IRS’ guidance, publicly held corporations are encouraged to examine (or re-examine) their current compensation arrangements to determine whether those arrangements may be grandfathered under new Section 162(m). In particular, an analysis may be necessary to determine whether a particular arrangement represents a written binding contract.