Amend plan document to prohibit direct rollovers?

[Guest RBeck]

Company X took over Company Y. Both have 401(k) plans. As part of the takeover, Company Y's plan terminated. The current service provider for Company Y's plan has been cold calling employees to get them to roll their assets into IRAs with the current provider. Company X wants employees to roll their assets into its 401(k) plan. Company X suggested to Company Y that the Company Y plan be amended to bar direct rollovers to the current service provider. Is this allowed?

[pjkoehler]

The simple answer to you questions is: NO.

Code Sec. 401(a)(31) requires a qualified plan to permit a participant to elect a direct transfer of an eligible rollover distribution to an eligible retirement plan, including an IRA. Reg. Sec. 1.402©-2, Q&A-2. (There is a de minimis exception, under which the plan is not required to permit a direct rollover of $200 or less per year. Reg. Sec. 1.401(a)(31)-1., Q&A-11.)

Even if this wasn't a basic qualification requirement, the amendment would probably violate the anti-cutback rule set forth under Code Sec. 411(d)(6), as a prohibited elimination of an optional form of distribution. Anyway, an amendment theoretically adopted after the board of directors formally terminated the plan (other than to bring the language of the plan into formal compliance pursuant to a determination letter request), is probably inconsistent with the other terms of the plan and, hence, subject to challenge.

You probably know that Code Sec. 402(f) requires the employer to distribute written notice of the participant's distribution options, including direct rollover. The employer should avoid the temptation to impose any procedures for processing direct rollover elections that effectively eliminates or substantially impairs the distributee's ability to elect a direct rollover. See Reg. Sec. 1.401(a)(31)-1, Q&A-6(B).

The right approach would have been to merge Plan Y into Plan X, transferring the Plan Y assets to the Plan X trustee. This would have been a plan level transaction, rather than a distribution event, so individual participant consent would have been unnecessary. 20-20 hindsight is great!

[This message has been edited by PJK (edited 06-26-2000).]

[MoJo]

What about 401(k)(10)? We don't know if this is an asset purchase or stock purchase, when (and who) terminated the plan. Distributions may be prohibited under the successor plan rules... More details, please....

[Guest RBeck]

In response to PJK, I know the rules, I hear you, but the regs say ANY, not ALL, and this is truly an aggressive approach, I know. They don't want to prohibit direct rollovers entirely. They just want to prohibit direct rollovers to the current service provider. Any OTHER service provider would be fine. Especially if the participants decide to roll their assets into Company X's plan, because it's more convenient than having to find an IRA provider. That's the issue. And as I said, it's aggressive. But the bottom line is, who is going to complain? the service provider may want to complain, but may risk being hit with "broker misconduct" - soliciting existing clients for fee based products or some other issues.

In response to MoJo - the plan terminated before the merger occurred, therefore, there isn't a successor plan issue. Although, if the bulk of the participants in Company Y DO transfer their assets to the Company X plan, it's quite possible that IRS could call it a successor plan. But that would require the plan being audited to be determined, and a 5310 wasn't filed.

[This message has been edited by RBeck (edited 06-27-2000).]

[MoJo]

Was it an asset purchase or a stock purchase? If the two companies merged (stock purchase/merger) then the surviving company is the successor of the merged company, and there could still be a successor plan issue....

[Alonzo]

Read 401(a)(31)(A) and Q & A 1 of the 401(a)(31) regs. The plan is not qualified if its terms do not permit a distributee to make a direct rollover to the eligible retirement plan specified by the distributee.

As PJK indicates, this is a basic qualification requirement that is not to be evaded.

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[Guest RBeck]

again, I say, the regs say ANY, not ALL. The essential rights of the participant are not being denied. Company X just doesn't want Company Y's current service provider to harrass its new employees, and feels that it is necessary to amend Company Y's plan to disallow rollovers to that particular service provider. The successor plan issue I think is moot because the plan terminated prior to the merger, and the sales agreement specifically states that the purchaser will not continue the purchasee's plan.

[Alonzo]

From A-1, 1.401(a)(31)-1

"To satisfy section 401(a)(31), a plan must provide that if the distributee of any eligible rollover distribution elects to have the distribution paid directly to an eligible retirement plan, then the distribution shall be paid to THAT eligible retirement plan in a direct rollover."

All Q&A 2 is meant to do is say that you are not required to make a direct rollover to a defined benefit plan. The "although" sentence you are getting the word "any" out of has to be read in harmony with Q&A 1. The purpose of the sentence you are quoting is to say that your plan can permit direct rollovers to a defined benefit plan.

Your client is going to get itself into trouble if it attempts to prevent a participant from exercising his right to make a direct rollover into scamco's IRAs.

[pjkoehler]

RBeck, I wouldn't get hung-up on the "any" vs. "all" issue. Any meaning that you discern is a very slender reed on which to base a blatant evasion of a basic qualification requirement. When read in the light of Code 401(a)(31) (the committee minutes) and the regs, it's a distinction without a difference.

Take a look at Reg. Sec. 1.401(a)(31)-1, Q&A-6(B). It flatly says that a plan fails Sec. 401(a)(31) "if the plan administrator prescribes any unreasonable procedure, or requires information or documentation, that effectively eliminates or substantially impairs the distributee's ability of elect a direct rollover." Now, if I'm a participant in Plan Y and I elect a direct rollover to the Company Y service provider, I don't think it's too much of a stretch to infer that the plan administrator has "effectively eliminated" my ability to elect that direct rollover. Take a look at the examples of the "impermissible procedures." They are all much more benign, than a procedure that flatly bars a direct rollover to a particular IRA custodian or trustee.

No matter what you think of 401(a)(31), you still have to address 411(d)(6). Under the terms of the plan document when it was terminated, a distributee had the right to make a direct rollover to the Plan Y service provider. Do you think that amending the plan to eliminate this right would survive a Sec. 411(d)(6) analysis under IRS audit?

What about ERISA litigation. Many distributees may want to make these direct rollovers if they're being solicited by the Plan Y service provider. What if the fee structure and investment options are superior to Plan X or any other IRA custodian or trustee? It may be argued that an amendment after plan termination is without effect as a legal matter (either because the plan is meant to be construed in a manner that preserves its qualified status and Sec. 401(a)(31) and Sec. 411(d)(6) invalidate any such amendment or simply because the plan terms do not allow amendments after the plan has been terminated). If the amendment is without effect, do you think the plan administrator is exposed to an ERISA breach of fiduciary duty claim on the basis that any post-termination imposition of the restriction falls below the ERISA fiduciary standard that requires all fiduciaries to act in accordance with the governing instruments of the plan?

[Guest RBeck]

hey, I agree with you - this is a very tenuous position indeed, but the attorney for Company X is adamant that Company Y's employees should be barred from making direct rollovers to the service provider for the Company Y plan. The attorney is splitting hairs, to be sure - "any" versus 'all", etc. And, no, PJK, I don't think this position will stand upon audit. But, as the attorney said, who's going to complain? And what are the chances of the plan being audited? I'm not advocating what's being done here. I'm trying to prepare for the eventual and inevitable fallout.

[pjkoehler]

RBeck, isn't Plan Y requesting a determination letter on plan termination? If so, doesn't that put the plan amendment on top of the IRS radar screen? So, let's see, the possible complaining parties include: (1) the IRS, who bestowed qualified status on the plan in part based on the plan's compliance with little things like Code Section 401(a)(31) and 411(d)(6), (2) disappointed plan participants who want to elect a direct rollover to the Plan Y service provider (I assume the Plan Y's Sec. 402(f) notice will contain this bizarre restriction)and who think the plan administrator breached its fiduciary responsibility in enforcing the restriction, (3) the Plan Y service provider, who may well be of some assistance to the participants in educating them about their ERISA rights, and (4) the Department of Labor, who may choose seek civil penalties against the plan admininstrator. Oh yes. there's also the shareholders of the acquiring company, who may well object to the Plan Y plan admininstrator engaging in actions that expose the assets of the acquired company to substantial financial losses. You may want to take a quick look at the acquisition agreement to determine if the former Company Y shareholders indemnify Company X for any losses, damages, etc. that result from these kinds of actions by the plan administrator. In fact, I've drafted many acquisition agreements that include a covenant by the acquired company and its shareholders that expressly prohibits them from allowing the plan administrator to terminate the plan in a manner that would expose the acquiring company to liability.

Is it really worth all this exposure to exact some retribution on the Plan Y Service provider?

[Guest RBeck]

PJK - no, there won't be a determination letter request upon termination of the plan, and there's indemnification language in the sales agreement, (but I don't think it's as extensive as you suggest) - which may be why the attorney has been saying who's going to know, who's going to complain - I don't think the attorney sees any long term consequences, or maybe feels that the consequences are minimal. I personally agree with you - it's a long way to go to exact retribution on a service provider. I think it's pushing the envelope too far. But, if the plan terminated before the merger, can the acquiring company be held responsible for the sold company's actions? Seems to me like the attorney is playing the audit lottery

[pjkoehler]

Terminating a plan without requesting a determination letter is letting the Plan Y participants and the Company X shareholders fly blind. It's commonly believed to be an audit flag, but who knows, maybe Company X and the Company Y plan administrator are just plain lucky in the IRS plan audit and ERISA litigation lottery.

Have you explored the idea of having the board revoke its resolution terminating the plan and recasting this as a plan merger transaction, or is it too late for that? Keep in mind that "plan termination" for Code purposes doesn't mean the mere adoption of resolutions by the board. The IRS has long taken the position that for its purposes "plan termination" doesn't occur until all of the plan assets have been distributed, i.e. as long as the terminated plan's trust holds plan assets, the plan is still in existence. It is typical for the corporate transaction to close before the all plan assets can be distributed, which, in a stock deal, typically leaves the acquiring company exposed to the risk of loss for any post-closing noncompliance of the plan (which is one reason why the acquisition agreement almost always includes a post-closing covenant by the acquired company to obtain a favorable letter of determination on the plan termination). The acquiring company is usually indemnified by the shareholders of the acquired company for losses incurred as a result of the plan's noncompliance, but if all the consideration has changed hands, that indemnification may not be worth much in relation to the size of the potential liabilities to which Company X may be exposed.

[This message has been edited by PJK (edited 06-27-2000).]

[Guest RBeck]

PJK - unfortunately, it's too late to undo the transaction and recast it as what it should have been. The problem was that the buyer didn't want the potential liability of the buyee's plans. you make a good point in that a termination doesn't occur just because a resolution has been signed. I'm hopeful that Company Y will not amend its plan as suggested by Company X.

[Guest JAREL]

I think any attorney who suggests this type of amendment is putting his client at great risk. All it takes is a market correction after a rollover of accounts to the new plan for the lawsuits to start flying. Also, what about the fiduciary responsibility to operate the plan solely for the benefit of the plan participants, which in my opinion extends to the decision to preclude these rollovers. Amendment in this manner just provides a roadmap to the DoL of a potential breach.

[Guest RBeck]

JAREL, you make an excellent point about plan operation and the exclusive benefit rule. I don't see how this kind of amendment can fly in the face of all the problems it raises.

[Alf]

I'm with PJK.

If no determination letter is received, I wouldn't want the rollovers in my plan. I would let the former TPA have ALL of the accounts.