Guest Article

(From the February 17, 2003 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits. Hyperlinks within the article have been added by BenefitsLink.)

DOL Proposes Prohibited Transaction Exemption to Help Plans Settle Lawsuits

When an ERISA plan has been wronged, the plan's fiduciaries must take steps to ensure the plan is made whole. This sometimes involves threatening and eventually initiating legal action against other plan fiduciaries or parties in interest. Even though it often may be in the plan's best interest to settle these claims, certain settlement agreements may violate ERISA's and the IRC's prohibited transaction rules. In order to facilitate settlements, the Department of Labor is proposing a prohibited transaction class exemption that would provide relief in narrowly defined circumstances. 68 FR 6953 (February 11, 2003).

Reason for the Proposed PTE

According to the preamble to the proposed PTE, the Labor Department has been receiving informal inquiries from plan fiduciaries involved in class action securities fraud cases. The defendants in these cases often are parties in interest with respect to the plan. (A "party in interest" with respect to a plan generally includes the plan sponsor and its majority shareholders, any plan fiduciary, counsel, or employee, and the plan's service providers, among others.)

Depending on the circumstances, the ERISA plan fiduciaries may decide it is best for the plan's participants and beneficiaries to forego expensive and unpredictable litigation in favor of settling these (and other) types of lawsuits. The plan usually will be asked to release its claim(s) against the defendant/party in interest as part of any potential settlement agreement. But such a release may create problems under the prohibited transaction rules because the plan's legal claim arguably is its "property" (i.e., a "plan asset"). ERISA plan fiduciaries cannot cause the plan to engage in any transactions that constitute a direct or indirect--

Additionally, these types of cases often involve large sums of money and the defendant/party in interest may want to pay what it owes the plan in installments rather than a lump sum. But these arrangements also raise prohibited transaction issues because ERISA plan fiduciaries cannot cause the plan to lend money or extend credit to a party in interest. [ERISA section 406(a)(1)(B) and IRC section 4975(c)(1)(B).]

How the Proposed PTE Would Work

The proposed PTE would be retroactive and prospective, and would apply to the following transactions:

The proposed PTE would apply only if the plan's attorney determines a genuine controversy between the plan and party in interest exists, and only if an "independent" plan fiduciary negotiates the settlement terms and conditions. (In order to be "independent," the fiduciary may not have any relationship to or interest in the parties involved in the litigation-- other than the plan-- that might affect its best judgment as a fiduciary.) Also, the proposed PTE would not apply if the settlement were part of an agreement, arrangement, or understanding designed to benefit a party in interest.

Additional conditions would apply based on whether the transaction occurred before or after the final PTE is published in the Federal Register. Transactions that occur before the final PTE is published will be subject to the retroactive exemption; all others will be subject to the prospective exemption.

In order for the retroactive exemption for extensions of credit to apply, the extension of credit would have to bear a reasonable interest rate. The same reasonable interest rate condition would apply to the prospective exemption for extensions of credit, but the rate also would be subject to a floor based on the IRC section 6621(a)(2) underpayment rate (i.e., the federal short-term rate plus 3 percentage points).

The other special conditions that would apply only to the prospective exemption are as follows.

• The settlement terms must be specifically described in a written agreement or consent decree.

• The plan must participate in the settlement on at least as favorable a basis as similarly situated non-plans.

• The settlement must be reasonable, given the likelihood of full recovery and the risk of litigation.

• The settlement must be in the best interests of the plan's participants and beneficiaries.

If the transaction is covered by the exemption and if the appropriate conditions are satisfied, the proposed PTE would allow the plan fiduciary to go forward without being subjected to prohibited transaction-related civil penalties or excise taxes.

DOL Accepting Comments on Proposed PTE

Written comments on the proposed PTE should be submitted to the Department of Labor before March 28, 2003, at the following address:

U.S. Department of Labor
Employee Benefits Security Administration
Room N-5649
200 Constitution Ave., N.W.
Washington, D.C. 20210
Attention: Plan Settlement Class Exemption Proposal

Comments also may be sent by fax (202-219-0204) or e-mail (moffittb@pwba.dol.gov).

The information in this Washington Bulletin is general information only and not intended to provide advice or guidance for specific situations. Contact your Deloitte advisor for information regarding your specific circumstances. If you have questions or need additional information about this article and you do not have a Deloitte advisor, please contact Martha Priddy Patterson (202.879.5634) or Robert B. Davis (202.879.3094). Human Capital Advisory Services, Deloitte LLP, 555 12th Street NW, Suite 500, Washington, DC 20004-1207. Copyright 2003, Deloitte.