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Failed Top Hat Plan

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I feel like I should know the answer to this but not sure I've ever seen discussed.  Am curious for thoughts or any insight from actual experiences with similar situations.

Employer established non-qualified deferred compensation plan to permit deferrals of substantial bonus amounts for a wide range of employees.  All amounts in the plan were fully vested at all times and generally designed to provide for distribution upon separation from service.  No employee salary deferrals ever went into the plan.   Of course, there was no trust for the plan.

After several years in existence, former executive with various axes to grind surfaces and says the Top Hat Plan is not really a Top Hat Plan because it includes non-management and non-HCEs.  (Let's assume for this thread that the plan clearly would not qualify as top hat plan and company readily admits this after looking at general guidance.)  Former executive threatens to report the company / plan to the regulators if he doesn't get his way on severance and other points.

The Plan has had a few participants retire and get benefits under the plan after termination but not a lot.  Most of the participants in the plan are still working and have large accrued balances.  While there are definitely some non-Top Hat participants in the Plan, there are not a lot of those and their balances relatively small.  The company feels it could kick them out and deal with them and their accrued benefits outside the plan easily enough if possible.

Does the company have any corrective options?  Could it somehow kick out the non-top hat folks and deal with them outside the plan and continue on even though it was presumably operating without complying with all applicable ERISA retirement plan protections in place?  Does the employer face potential exposure for the fact it was operating such a plan for years without any general attention to minimum coverage and participation rules--i.e, do non-participants have any potential claim they should have been covered by plan?


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The employer is exposed to potential liabilities, civil penalties, and expenses for:

failures to tax-report wages;

failures to withhold Federal, States’, and municipalities’ income taxes;

failures to file Form 5500 reports;

failures to deliver summary annual reports;

failures to deliver other ERISA title I disclosures;

deception under Federal and States’ securities laws;

negligent misrepresentations under States’ common law of torts; and

more problems an incautious employer faces.

The employer should lawyer-up.  Managing the situation calls for complete control of all communications.

Even if some communications with a certified public accountant or other “Federally authorized tax practitioner” advising only within her proper scope might get a limited evidence-law privilege under Internal Revenue Code § 7525, that’s not good enough.  That privilege never applies for anything about a State’s law, including a State or local tax law.  For Federal law, it can apply only about tax law (and only civil, not criminal); not ERISA’s title I, and not securities law.

Seeking a lawyer’s advice, the employer might protect information using evidence-law privileges for attorney-client communications, and for attorney work product, including fact work product and opinion work product.

How to deal with the former executive might turn on discerning how much he knows about the employer’s weaknesses, and how skillfully or ineptly he might try to exploit them.  One might consider also whether he is complicit in any of the failures, and how recognizing that the plan did not result in a deferral of compensation could affect his personal tax situation.

There are opportunities to use a severance negotiation and, perhaps a settlement agreement with confidentiality provisions, to buy time and breathing room for an easier clean-up project.

Peter Gulia PC

Fiduciary Guidance Counsel

Philadelphia, Pennsylvania



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"But only if the problems are uncovered before the employer gets rid of them."

I don't understand what this means.  Do you mean that the employer can avoid the consequences of the presumed law violations by simple prospective correction of the ongoing violations -  the "them" of "get rid of "them"?  Or is the "them" any employee who is a subject of, or would have leverage because of, the violations?  "Fixing" the past violations is going to hurt, although not as much as if first caught by the authorities either by routine investigation/audit or by being turned in by someone who is aware of the violations.  


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With due respect to Peter's answer, a lot of the potential problems (ERISA-related--numbers 2,3 and 4 on his list) go away if the Company timely filed an ERISA exemption certificate as provided by the regulations the way we do for all of our NQDC plans. While a "select group of management or highly-compensated" as the DOL qualifier language from the statute has been open to interpretation over the years by various experts, it would be important to get experienced ERISA counsel involved as Peter also recommends.  I'd also be interested in an IRS practice and procedure (periods and methods we used to call it) expert perhaps filing a catch-up for back salaries and taxes to make this right going forward--from a large CPA firm perspective, we had specialists who would handle problems like this fairly often with their good network of contacts at the regulatory agencies---but I'm also not so sure about any securities law violations. I also agree with Peter that undoing this in the right way as quickly as possible reduces the disgruntled ex-executive's leverage, if any. 

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I had a situation like this years ago.  I told them to put the non-top hat participants' benefits in a qualified plan (where they belonged in the first place).  In that case, it was easy--the qualified plan was a cash balance DB plan.  But you could probably put them into a DC plan employer contribution account (may require amendment of the DC plan to reflect full vesting).  Does that solve everything?  No, but it did make sure the non-top hat employees' benefits complied with ERISA's trust requirements and the problem went away (no unhappy employee was going to report, in that case.)

The problem with a non-top hat top hat plan is that under ERISA, all employees who are non-top hat employees and who weren't in the plan have a cause of action to enforce benefits in a non-discriminatory way.  In other words, if the top hat plan paid 5% of pay, all employees should have gotten 5% of pay (or some percent that complied with non-discrimination rules).  Plus, the benefits in the plan should have been in an irrevocable trust.

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