ethical issues regarding loans

[K2retire]

I would love to pose this question to the ethics folks on the ASPPA board, but since posting there uses my real name and that would risk disciplinary action from my employer, I'll post it here instead. The company where I work is primarily in the mutual fund record keeping business, but also has a small TPA division. The TPA group is mostly comprised of credentialed ASPPA members, but managed by individuals with mutual fund backgrounds who often don't understand that there are differences between SEC rules and ERISA rules.

A plan sponsor who is both a CPA and a stock broker recently called the record keeping part of the company to inquire about a plan loan. He was told that the plan only allowed one loan to be outstanding, and since he currently had an outstanding loan he would need to pay it off before taking another one. Without consulting his written loan policy or the IRS regs that a CPA should know exist, he sent in a payment of $17,000 or so.

A few days later he sent in a request for a new $60,000 loan. The processor, without looking into the history of the account, informed him that the maximum loan allowed by law was $50,000. The next day a new loan request for $50,000 was received. When attempting to process this request the computer accurately pointed out that the individual's maximum available loan (due to the balance outstanding within the past 12 months) was approximately $2,600. At this point the request was given to the TPA unit to handle.

Although the participant had several valid in-service withdrawal options, he did not want to pay tax on his distribution. After he threatened to withdraw several million dollars of business for his own and his clients' accounts, management decided to reverse the $17,000 loan repayment and return those funds to him.

Those of us with TPA backgrounds are left wondering how this transaction could be justified to an auditor. Suggestions?

[Peter Gulia]

K2retire, perhaps there is no professional-conduct issue.

First, unlike some other professional associations, ASPPA’s Code of Professional Conduct [http://www.asppa.org/pdf_files/mem/code_%20conduct.pdf] doesn’t require a member to report another member’s misconduct. (In my view, ASPPA’s choice makes sense; by contrast, the lawyers’ misconduct-reporting rule has such wide exceptions that it’s worse than useless.)

Even if you felt like reporting something, your description suggests that ASPPA members mostly furnished correct information, and that it’s non-members who decided to accept an instruction to process a transaction that might have been contrary to the plan or relevant law.

Accepting a plan administrator’s instruction - even if it’s contrary to the plan, or contrary to a law that applies to a person other than the person that implements the instruction - is fairly common practice among non-fiduciary recordkeepers. (I’m assuming that the participant you describe as a plan sponsor also acted as the administrator of his employer’s plan.) Further, a recordkeeper that starts to say which instructions it will or won’t follow risks exercising discretionary responsibility that could be argued as making the recordkeeper a plan fiduciary.

Although it’s often unsettling to watch a plan’s administrator make a decision that the observer thinks is “wrong” (especially if the decision-maker has a conflict of interests), we might better understand this frustration as an illustration of why Congress should not permit an employer to serve as the administrator or trustee of the employer’s employee-benefit plan.

[Guest Sieve]

K2 --

You might want to look at the Service Agreement to see if the TPA violated any of its obligations (by knowingly permitting the refund of a loan payment, contrary to the plan's terms).

But I see a more critical issue. Payment of these funds from the plan to the participant would be a prohibited transaction (since the plan had no authority to make that payment), and a non-fiduciary can be liable for knowingly participating in a PT. Don't know who would bring the suit, or why--unless it would be the DOL following an audit--but I don't think this TPA would want to pony up the $17,000 when the particicipant/sponsor doesn't/can't do it. (It's similar to the situation where a TPA knowingly orders a check payable to the Trustee personally, rather than in his/her Trustee capacity, thus enabling the Trustee to abscond with the $$ rather than transferring it to another custodian.)

I don't think it's a fiduciary act for a TPA to refuse to follow instructions which clearly violate ERISA, as suggested by Peter--such as an act contrary to plan terms. In fact, it is possible to make the argument that deciding to act on another's instructions when those instructions are clearly violative of ERISA is, in fact, a discretionary act concerning management of the plan which might cause the TPA to be a fiduciary "to the extent" of that act.

[J Simmons]

k2retire,

Peter pointed out in another thread a couple of days ago the following:

If an employer’s plan is stated using a master, prototype, or volume-submitter document that permits practitioner amendment, a sponsor or practitioner that “reasonably concludes” that an employer’s plan “may [sic] no longer be a qualified plan” must (if the sponsor or practitioner doesn’t submit an EPCRS request) “notify the employer that plan may no longer be qualified, advise the employer that adverse tax consequences may result from loss of the plan’s qualified status, and inform the employer about the availability of EPCRS.” Rev. Proc. 2005-16 at § 8.05 and § 15.07.

If your mutual fund record keeping business w/ small TPA division is the sponsor of such a lead document that is being used by the plan sponsor, your company may need to send such a notice to the plan sponsor.

[K2retire]

In this case the participant, trustee and owner of the plan sponsor are the same individual.

My employer is the sponsor of the prototype document. But since the same managers who made the decision to refund the loan repayment don't think there is anything inappropriate about it, nothing further will be done.

Some of us have pointed out that we create liability for the company by preparing the 5500 without reporting a prohibited transaction, but we have not succeeded in persuading them that this refund might be an inappropriate solution.

My employer's position certainly agrees with Peter that the company has no choice but to honor the direction of the trustee/plan sponsor. They also believe that our service agreement (that purports to limit our liability to one year's annual administration fee) will protect us from any financial losses. My concern is not necessarily any sort of whistle blowing disclosure, but rather self preservation and determination of what sort of personal risk there might be to those of us who recognize that this solution creates a bigger problem, but were unable to do anything about it.

[Peter Gulia]

Just an observation: I don't think that a recordkeeper has no choice but to implement the administrator/trustee's instruction; rather, it's that ordinarily a non-fiduciary recordkeeper has no duty or obligation to question an instruction. Nonetheless, there are some recordkeepers that prefer to question, and even refuse, troublesome instructions. That too is a business choice.

[BG5150]

Does your company have a legal department? Bringing up potential legal matters to management sometimes gets them moving.

You may want to point out that not only was this a prohibited transaction, but one involving an HCE and a fiduciary, which the DOL and/or IRS would consider way more egregious if it were an NHCE (I would think).

[K2retire]

That's a good idea, except that to get to the legal department, we have to go through the individuals who approved this "fix" in the first place. Since they think it is OK, they are not likely to want to check with legal after the fact.

[Guest Sieve]

As Peter pointed out, it's not clear there has been an error or breach here. Nevertheless, I hope your E&O is paid up!

[K2retire]

The mutual fund folks among us believe that the client made the loan payment relying on inaccurate or incomplete information that we supplied, therefore the proper correction is to reverse the loan payment.

The pension folks among us think that reversing the loan payment looks suspiciously like making a new loan in that amount, which is clearly over the maximum available at the time it was made.

I expect that the only way to resolve that disagreement would be to consult the very regulatory agencies that we all hope will never notice it.

Thanks for all your feedback.

[J Simmons]

The correction resolution system of the SEC must be more user friendly than EPCRS. Sounds like the SEC one has a 'Mulligan' concept, like lax golfers. It would be nice if the IRS gave pension practitioners a 'do over'.

On second thought, Madoff slipped under the SEC radar. Maybe it is better that we have to deal with EPCRS.

[Mike Preston]

Getting back to the issue, I'm not sure there is a problem. I seem to recall there was a PLR that took the position that a "repayment and a new loan" was NOT a "repayment and a new loan" in certain circumstances. My memory bone tingles when I think that the relevant circumstances revolved around repayment terms. First, it is clear that the intent of this individual was to increase the single allowable loan, not to terminate the existing loan and establish a brand new one.

My memory bone is tingling again.... this time the examples in the loan regulations are coming to mind.

Assuming you can find the justification for establishing the loan as a replacement loan rather than a new loan, I seem to have yet more tingling that gets stronger when I think about establishing an amortization schedule for the new loan which provides for payoff of the first loan within a five year period measured from the date it was established and payoff of the increased amount within a five year period from the date of the "new loan."

So, you might have the power to right this ship merely by having the repayment schedule adhere to the regulations.

I think I'm done tingling.

[K2retire]

Mike,

Thanks for those helpful thoughts. Since what was done on our system was to reverse the payoff and make it appear as though it had never happened, the payment schedule is unchanged from the original loan payment schedule.

[Mike Preston]

That sounds like there was no increase in lending. You might find that after reading the regs you can offer more to your client than the $2,600 previously mentioned, as long as the repayment schedule is appropriate.