Plan Funding & Fiduciary Responsibilities January 14, 2014 Stuart Hack, JD, CLU Sunlin Consulting LLP shack@sunlin.biz 949-770-7322

Funded vs. Unfunded Plans Assets placed in a trust To fund retirement plan benefits Solely for the benefit of plan participants Unfunded (in general) Benefits are a bare promise of the employer Assets may be designated to specifically fund the benefits, but remain subject to creditors of employer

Funded Plans All IRS Qualified Plans must be funded. Funding Vehicles Defined Benefit, 401(k), 403(b), Money Purchase, Profit Sharing, Cash Balance, Target Benefit, ESOP Funding Vehicles Trust Discretionary Trustee – full fiduciary responsibility, including selection and monitoring of plan investments Directed Trustee – liability limited to specific activities, usually to hold assets, transmit transactions, and maintain record of plan assets Custodial Account – similar to Directed Trustee Annuity Contract – insurance contract with underlying assets held by insurance company; insurance company is the custodian of the assets

Unfunded Plans Non-qualified Deferred Compensation Plans 457 Plans Can accumulate assets in a Rabbi Trust to add some protection to covered employees 457 Plans For certain tax exempt and governmental organizations only 457(b) Plans for both HCE and NHCE Statutory contribution limits Statutory distribution requirements

Unfunded Plans (continued) 457 (f) Plans for HCE only Limit is “reasonable” compensation Must have risk of forfeiture Statutory distribution requirements Governmental plans may be funded Can accumulate assets in a Rabbi Trust

Types of Asset Classes Equities Foreign Domestic Large Cap Medium Cap Small Cap Value Growth Blend Special asset classes, such as Real Estate

Types of Asset Classes (cont.) Bonds U.S. Treasury Other Governmental Corporate Foreign Emerging Hi Yield Money Market Guaranteed / Stable Value

Types of Plan Assets Mutual Funds - registered securities Separately Managed Accounts Insurance Company Products Stable Value Funds Individual securities “Strange assets”

Mutual Funds Registered with the SEC Various share classes, designed for specific product distribution streams Registered Investment Advisors Brokers Broker dealers Record keepers

Separately Managed Accounts Not registered with the SEC Offered by Bank/Trust Company Insurance Company Investment Managers Pool of assets or individual account managed in specified investment style Typically institutional / lower cost internal charges

Insurance Company Products Guaranteed Accounts Insurance company guarantees fixed rate of return and principal Subject to withdrawal rules similar to Stable Value funds Annuity wrapped accounts Insurance company wraps services, annuity rate guarantees and fees/commissions around the mutual fund or separately managed account Provides a method of flexible compensation for distribution systems

Insurance Company Products (cont.) Fixed Annuities Insurance company guarantees income stream for specified period, including for life Variable Annuities – stream of income based on underlying asset performance Hybrid Annuities – variable returns with guaranteed minimums

Stable Value Funds Guaranteed yield, usually annually adjusted Market value adjustments, usually made if plan terminates the contract and surrenders it Benefit payments usually exempted from market value adjustments Participant direction sensitive, i.e., no market value adjustments for participant direction into or out of stable value accounts Restrictions usually apply to transfers to a “competing” fixed income investment option Underlying assets include bonds, BICs, GICs, and insurance company general accounts Similar to mutual funds

Internal Fees/Charges/Expenses Mutual Funds Disclosed in prospectus Investment management fee 12b-1 fee Transfer agency fee Administration and record keeping fee Commissions Contingent deferred sales charges Undisclosed expenses/costs Trading expenses Trading efficiencies/inefficiencies

Internal Fees/Charges/Expenses (cont.) Separately Managed Accounts Disclosed in contract with plan sponsor Includes Investment management fees Custodian fees Insurance Company Products Investment management fee Annuity/insurance charges Compensation to distribution channels Revenue to pay plan expenses

Internal Fees/Charges/Expenses (cont.) Annuity wrapped accounts Disclosed in contract with plan sponsor Includes Expenses charged by underlying mutual funds Annuity/insurance fees Commissions Revenue to pay plan expenses Stable Value Funds Provided in Contract or Trust Agreement Not always disclosed Investment management fee Distribution fee/commissions

ERISA 404 (a) Prior to ERISA is was like the “wild West” Imposes a “prudent man standard of care” for qualified plan fiduciaries For the exclusive purpose of providing benefits to participants and their beneficiaries; and defraying reasonable expenses of administering the plan

ERISA 404 (a) (continued) With the care, skill, prudence, and diligence that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims By diversifying the investments of the plan so as to minimize the risk of large losses unless under the circumstances it is clearly prudent not to do so; and …

Plan Fiduciaries Anyone who: Exercises control or authority over the management of the plan or the plan’s assets; Provides investment advice for a fee; or Has discretionary authority over the plan’s administration Is responsible for actions of the other plan fiduciaries, unless Fiduciary duties are specified and limited Reasonably not aware of actions taken by other ficuciaries

Most Common Fiduciaries Plan sponsor Plan Administrator – named in plan document Administrative and investment committees named individual members Named Plan Trustee Compensation committees and board members on the committees, individually Members of the Board who appoint committee members Functional Fiduciaries

Other Types of Plan Fiduciaries Co-fiduciary – accepts limited fiduciary duties 3(21) investment advisor co-fiduciary – helps the plan sponsor decide 3(38) investment manager fiduciary – decides for the plan sponsor

Common Fiduciary Liability Lawsuit Allegations Excessive investment fees Unreasonable expenses charged to participant accounts Failure to monitor investments, resulting in lost investment earnings Failure to document decisions Improper investments Failing to include eligible participants

How to Manage Exposure (Best Practices) Allocate plan responsibilities and document accountability Outsource duties that exceed expertise of committees Document, Document, Document

Specific Investment Fiduciary Responsibilities & Attributes Defined Benefit Plans Create asset allocation appropriate for funding guaranteed, pre- determined pension benefits Maintain appropriate liquidity to pay benefits as they become due Investment gains/losses Affect amount of employer contributions Do not affect amount of benefits to participants Can put plan/plan sponsor in jeopardy

Specific Investment Fiduciary Responsibilities & Attributes (cont.) Participant-Directed Defined Contribution Plans Investment fiduciaries responsible for Providing investment alternatives with sufficient range of risk for participants to create asset allocations responsive to their risk tolerance and length of their accumulation period Selection and monitoring of investment alternatives provided by the plan Changing investment managers and investment alternatives, when appropriate to do so Investment gains/losses Affect amount of benefit participants have at retirement Do not affect amount of employer contribution

Best Practices to Manage Investment Fiduciary Responsibilities Written Investment Policy Documented periodic investment monitoring Documented investment committee decisions

404(a)(5) Disclosure Requirements Summary Disclosure of plan investment-related information Disclosure of expenses charged to participant-directed accounts Purpose To ensure that all participants and beneficiaries have the information they need to make informed decisions about the management of their individual accounts, and are aware of what expenses are charged to their accounts and why the expenses are charged to their accounts

404(a)(5) General Requirements Annual notice in general, once every 12 months Quarterly notice – via participant statements Interim information changes Any change in information, except investment- related information Provided at least 30 days, but no later than 90 days, prior to date of change Specific additional information must be provided upon request

404(a)(5) General Requirements (cont.) Notice content falls into 4 categories General operational and identification information Information on administrative expenses Information on individual expenses Investment-related information Identifying information Performance data Benchmark information Fee and expense information DOL suggests that the bulk of the investment-related information be provided using a “Model Chart.”

404(a)(5) Plan Sponsor Responsibility Provide all of the 404(a)(5) required information to plan participants May reasonably rely upon information provided by service providers Failure to provide all information in timely fashion may result in liability exposure for breach of fiduciary duty

408(b)(2) Disclosure Requirements Purpose is to require service providers to inform the plan sponsor about: fees being charged services provided potential conflicts of interest Applies to all types of plans Must be in writing Any changes in provisions of service agreements must be provided within 60 days prior to the change

408(b)(2) General Requirements Responsibility of service provider to disclose to appropriate plan fiduciaries Expenses charged (direct and indirect) Revenues received (direct and indirect) Sub-contractors and relationships Potential conflicts of interest

408(b)(2) General Requirements (cont.) Responsibility of plan sponsor to: Make sure all of required disclosures are received Evaluate whether disclosures are reasonably accurate Obtain expert help in understanding disclosures, if needed Notify DOL if service provider fails to provide timely disclosure Decide whether fees charged are reasonable for services provided Determine whether potential exists for service provider conflict of interest Replace service provider if it refuses to provide required information

408(b)(2)Disclosure Requirements Liability Exposure No contract between a service provider and a plan sponsor is “reasonable” if the contract fails to meet 408(b)(2) disclosure requirements. The furnishing of goods, services, or facilities between a plan and a party in interest to the plan generally is prohibited under section 406(a)(1)(C) of ERISA. This Prohibited Transaction Exemption is lost if requirements of 408(b) are not fulfilled. The contract becomes a Prohibited Transaction. Each fiduciary is potentially personally liable for any losses caused to plan or participants. Potential penalties to plan sponsor and service provider for Prohibited Transaction

ERISA 404(c) Provides fiduciary exemption for investment return results experienced by participants due to their asset allocation directions Does not exempt fiduciary for responsibility to select and monitor investment options ERISA §404(a)(5) largely replaces 404(c) However, 404(c) compliance specifically depends upon compliance with 404(a)(5).

ERISA 404(c) (cont.) 404(a)(5) compliance does not provide fiduciary liability exemption for the investment results attributable to Participant’s investment allocation decisions Plan’s default investment Blackout period Qualified change in investment

ERISA 404(c) (cont.) To have 404(c) protection, a plan must Formally provide participants written notice that it elects to be a 404(c) plan Provide a “broad range” of investment alternatives Allow participants to have independent control Fulfill certain requirements for plans that have employer stock as an investment option Fulfill QDIA selection and notice rules Prudently select and monitor service providers and plan investment alternatives

Employee Plan Compliance Resolution System Revenue Procedure 2008-50 Plan Sponsors have the option to correct qualification problems through Employee Plans Compliance Resolution System (EPCRS) Purpose is to provide incentive for corrections by minimizing cost of compliance

Employee Plan Compliance Resolution System (continued) The components of EPCRS are: Self-Correction Program (SCP) Corrective action taken without requesting IRS approval Voluntary Correction Program (VCP) Process to request IRS approval of corrective action Fee to apply Usually requires employer contributions to the plan to make the corrections Some correction coasts are very predictable; some have to be negotiated Alternative of waiting until issues raised on audit can be very expensive

Fiduciary Liability Management Fiduciary failure lawsuits are EXPENSIVE Legal defense costs Company resources diverted from production, sales, etc. Ultimate judgment results Fiduciary liability insurance only covers defense and settlement Best insurance is: documented fiduciary compliance procedures documented fiduciary decisions and actions documented allocation of fiduciary responsibilities

Typical Corrections Needed Foot-faults Discrimination test failures Failure to include all eligible employees Failure to follow plan document provisions Failure to make required document updates by deadlines

U.S. Department of Labor (DOL) Correction Programs Correct fiduciary problems through Employee Benefits Security Administration (EBSA)  The components are Delinquent Filer Voluntary Compliance Program (DFVC) Provides plan administrators with a way to comply with the annual reporting requirements by coming up to date with corrected filings of 5500 Forms Voluntary Fiduciary Correction Program (VFCP) Gives plan sponsors and service providers the opportunity to self- correct fifteen specific financial transactions that violate ERISA, such as delinquent participant contributions

Q & A