Replacing market value adjustment on conversion

[Guest Sieve]

Plan changes providers. Old provider hits outgoing plan with a market value adjustment under its contract with the employer. Different employees are hit differently, depending on their account balance in the investment with respect to which the adjustment is made. The Employer, feeling guilty, decides it wants to replace the $40K market value adjustment, allocating the appropriate amount to each participant suffering a loss. How do you do this?

I think the employer $$ will be a non-elective contribution, requiring a Plan amendment in order to permit the allocation in a manner that would replace the individual account losses (rather than being allocated according to the comp-to-comp PS allocation formula)--watching out, of course, for discrimination issues in the allocation. Or, is this just an investment return (rather than an e'er contribution), allocated directly to those suffering a loss and thus not needing a plan amendment? (Bonusing is a possibility, but the employer would rather keep the $$ in the plan.) Any thoughts?

[jpod]

There was a Rev. Rul. published within the last 10 years which sort of outlined circumstances in which an employer payment to a plan can be characterized as "damages" (e.g., for breach of a fiduciary duty under ERISA), and allocated as earnings, rather than as a contribution.

While your situation, which I have seen a couple of times in the past, may not satisfy the criteria of the Rev. Rul., I don't think the Rev. Rul. says that any payment that does not satisfy those criteria will necessarily be treated as a contribution. I've seen cases where the new vendor put up the money to cover the market value adjustment (because it was worth it to get the business), and I don't think anybody would ever question that this would be a deemed contribution by the employer. So, why should the result be different just because the enmployer puts up the money rather than the new vendor. I think in your scenario allocating the payment as earnings - and not as a contribution - would be reasonable and defensible (unless you next tell us that most of the money would be allocated to the owner(s), in which case I'd be concerned).

[Medusa]

The Rev. Ruling jpod refers to is 2002-45.

Your circumstances seems to dictate that the restoration will be treated as a nonelective contribution, and in order to allocate it in the same manner in which it was assessed as a "market value" adjustment, yes you will need a plan amendment authorizing a special contribution that will be allocated in a manner that will restore the losses incurred by the plan participants due to the surrender of the contract. Such contribution will need to satisfy 401(a)(4).

jpod suggests the possibility of treating as investment earnings - I wouldn't go that route without getting a PLR.

[Guest Sieve]

jpod -- Thanks for your thoughts. I like your solution, but it still causes me concern--unfortunately, the skeptic in me reamins unconvinced. The Rev. Rul. you refer to relates to restorative payments and describes whether they are or are not plan contributions. It concludes they are not. If you don't fit into that fact pattern, however, I believe you may have issues because the employer $$ are considered a plan contribution. The Rev. Rul. is now part of the new Section 415 regs which say, among other things, that "[p]ayments made to a plan to make up for losses due merely to market fluctuations and other payments that are made not made on account of a reasonable risk of liability for breach of a fiduciary duty . . . are not restorative payments and generally constitute contributions that give rise to annual additions . . ." (Treas. Reg. Section 415©-1(b)(2)(ii)©.) If those payments are contributions subject to Section 415 (and, yes, I know the reg says such payments "generally" are contributions), then it only makes sense (if any of the Code makes sense!) that they are contributions for other purposes, as well. To me, if the employer makes the contribution, it's much different from a third party doing it and is subject to the rules surrounding employer contributions (including deduction limitations and plan allocation provisions, among others).

It is very telling, I believe, that you mention your concern about the HCE issue. If this payment truly represented earnings, based on account values and market adjustments, then neither you nor I would be concerned about discrimination. Since it bothers both of us, however, it leads me to believe that the payment would, in fact, be an employer contribution--at least that's how we perceive it--and therefore there must be an allocation formula in place with regard to this one-time employer contribution.

Med -- It's not that the restoration will be treated as a nonelective contribution. It's just that I think it probably is required to be so treated under the circumstances. And therein lies the rub. Is it a non-elective? Is it earnings? Toss a coin, ehh? I lean towards your advice, but don't know if it's because it's the right answer or becasue I'm just conservative by nature in these areas.

[Bird]

Market value adjustments, surrender charges, and the like are a reflection of the assets' true values. "Making them up," while well-intentioned, is indeed simply a non-elective contribution as you suggested originally, and yes, you'd need a special amendment. It's subject to non-discrimination, document considerations, etc. etc. It often is do-able.

If the trustee is liable for some sort of mismanagement and caused a loss, then that kind of loss can be "made up" as earnings. But a MVA doesn't fall under that category.

[jpod]

Getting out at a time that will result in a substantial MVA may be a breach of fiduciary duty, or getting into a product in the first place that may result in a substantial MVA on the back end may be a breach of fiduciary duty. Then again, it may not. My position is based to a great extent on practicalities and the notion that if it doesn't "smell" (i.e., the owners are not getting the lion share of the MVA), it is not likely to be challenged for hyper-technical reasons.

Nevertheless, if you intend to treat it as a non-elective contribution, obviously you need an amendment, and to keep things simple you can draft the amendment to say that no HCE will receive an allocation that is a greater percentage of his or her compensation than the lowest percentage of compensation allocated to any NHCE. Any HCE who gets shortchanged due to this limitation can be made "whole" via cash.

I would be surprised if you have any 415 problems, but if you do then that would be a further limitation in your amendment.

[SRP]

What about a different situation where it wasn't a restoration as a result of liquidating a specific asset but rather a loss because of a recordkeeper's mistake.

For instance, what if the recordkeeper was obligated to liquidate plan assets (on a predefined date) to transfer the plan to a new recordkeeper but made a mistake and liquidated on day later. Let's say because of a market value decrease the total plan assets value is $50,000 less than it would have been if the liquidation had been completed on the proper date.

Is a payment by the recordkeeper a permitted restorative payment due to a trustee breach OR what is the appropriate method to recognize this $50,000 adjustment/corrective deposit and allocation to the participant accounts?

[Guest Sieve]

Do you think a recordkeeper is a fiduciary under ERISA? Generally, the answer is No--but, to the extent the recordkeeper is liquidating plan assets (which makes that recordkeeper something more than a recorkeeper, right?) and can control the timing of the liquidation of those assets, it is a fiduciary because it "exercises authority or control respecting . . . disposition of [plan] assets . . ." (ERISA Section 3(21)(A)(i).)

So, if a trade which is a day late is considered to be a breach of duty, then it would be a fiduciary breach, and any repayment of the loss by the "recordkeeper" would, in fact, be a restorative payment.