By Stephen M. Saxon and George M. Sepsakos
Over the last few months, service providers to ERISA covered plans have been following developments in “error correction” practices and the troubling assertions made by DOL investigators throughout the country. DOL investigators are asserting that not only may record keepers inadvertently become ERISA fiduciaries due to their record keeping practices, but also that they may breach fiduciary duties under ERISA by following long-standing error correction policies and provisions.
All of this came to a head recently when DOL announced a settlement with ING Life Insurance and Annuity Company regarding the company’s error correction policies. Let’s take a close look at the ramifications of the settlement.
Correcting by Reprocessing
When a plan investment transaction is processed erroneously (for example, is entered too late, or is for the wrong amount or the wrong security) and subsequently detected, typically it is corrected by “reprocessing” the same transaction. Reprocessing usually involves reversing the erroneous transaction and putting the participant or plan account in the same position it would have been had the error not occurred. Depending on whether securities prices rose or fell between the date the original transaction occurred (or should have occurred) and the date it was corrected, the reprocessing event will result in either a financial gain or a loss.
By reprocessing the erroneous transaction, the record keeper is seeking to put plan participants in the same position they would have been had the error not occurred. The financial consequences of the reprocessing (that is, whether the event will generate a gain or a loss) cannot be known at the time the error is corrected. What the record keeper does know is that over time, some corrections will generate a gain and some will generate a loss. And if gains are not used to offset erroneous losses, a firm’s operating expenses will rise.
Error Correction and ERISA
From an ERISA perspective, error correction practices present several issues. The first and most fundamental legal question involves the plan asset status of the erroneous gains under ERISA. Assuming that erroneous gains are characterized as plan assets, several additional issues arise. For instance, it is arguable that by using its discretion to retain gains without the consent of the plan sponsor, the record keeper will become a fiduciary under ERISA. Additionally, because it could be viewed as setting its own compensation, the record keeper could be held in violation of ERISA’s prohibited transaction rules.
Are Gains Plan Assets?
In the ING settlement, the DOL seems to confirm that erroneous gains retained by the record keeper are assets of the plan. To the extent that this view prevails, and gains retained by the record keeper as a result of error correction are therefore “plan assets,” a fundamental question arises to what basis there is for the record keeper to retain the gains, and whether there is a basis to support the netting of gains and losses across multiple accounts when trading through an omnibus account.
The ING settlement permits ING’s retention of the gains associated with error correction practices as record keeping compensation, subject to the condition that the company's error correction policy is disclosed and agreed to by its clients. This is similar to the position taken by the DOL a decade ago in its Field Assistance Bulletin regarding the retention of “float” income — that is, a service provider will not be deemed to exercise discretion over the amount and timing of its compensation if it discloses the source of the income to an independent plan fiduciary and the fiduciary authorizes the retention of that income as compensation.
Disclosure Problem
Under the ING settlement, it appears that on a prospective basis ING will report gains it receives as compensation under the DOL’s ERISA section 408(b)(2) regulations. However, it is not clear how this would be accomplished, since ING appears to be obligated to track “the effect of the corrections for each affected plan on an annual basis and will make that information available under ERISA section 408(b)(2).” This is a significant problem.
The problem may be able to be resolved if 408(b)(2) disclosures can be made without an estimate, range or cap regarding error correction compensation. The DOL needs to recognize that it is extremely difficult to quantify random events for any client or client group.
Other Issues Facing Record Keepers
While the ING settlement appears to illuminate DOL’s views on many issues surrounding error correction, it also creates numerous questions that record keepers and other service providers will need to untangle in the coming months. For example, it appears that the settlement requires ING to track gains received on a plan-by-plan basis and report the total gains received annually as compensation. However, when errors occur on an omnibus account level, it is unlikely that record keepers maintain the capability to allocate the gain among the plans involved on this basis.
Also, plan fiduciaries receiving 408(b)(2) disclosures reporting erroneous gains will be required to review and analyze the information received for “reasonableness.” However, it is difficult to ascertain how responsible plan fiduciaries are to determine the reasonableness of compensation that is created through the correction of an inadvertent error and is dependent upon unpredictable fluctuations in the price of securities.
Stephen M. Saxon is the chairman of the Groom Law Group in Washington, DC.
George M. Sepsakos is an associate in firm’s fiduciary responsibility group.
