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Advisory Council on Employee Welfare and Pension Benefit Plans

Report of Working Group on Exploring the Utilization of Third-Party Trustees to Protect Plan Participants
November 13, 1996 - Final
Work on Exploring the Utilization of Third Party Trustees to Protect Plan Participants

The Third-Party Trustee Working Group respectfully submits its report and recommendation to the 1996 ERISA Advisory Council session.

The Working Group's Purpose and Scope

In 1993, the ERISA Advisory Council's Defined Contribution Working Group began the first phase of a three-phase study. The third phase, studied during 1995, considered the question whether defined contribution plans provide employees with an adequate source of retirement income. In the course of the Working Group's considerations, we heard testimony relating to protection concerns for defined contribution plans. The Report of the Working Group on Defined Contribution Adequacy contained the following statement:

Defined Contribution plans are not insured by the Pension Benefit Guaranty Corporation (PBGC). Assistant Secretary of Labor Olena Berg has indicated that one of the concerns facing the Department in the defined contribution arena is the failure of employers to make timely remittance of contributions deducted from employees' payroll. The Pension Rights Center advised the Advisory Council that a worker has little or no recourse when an employer embezzles defined contribution funds. The Center noted that the existing statutory protections are inadequate to protect these losses. In their experience, troubled plans have either no fidelity bond or it has lapsed. In many instances, Form 5500's have not been filed for years, with no investigation commenced in response. The Pension Rights Center recommended the defined contribution plans should all be trusteed by independent third-party trustees. Moreover, these trusts should be maintained only by banks, brokerage houses and other financial institutions which are authorized to exercise trust posers over combined capital and surplus in excess of a stated amount by regulations issued by the Secretary of Labor (See section 412 of ERISA as a model).

The Third-Party Trustee Working Group was then formed and charged with taking testimony to determine whether the utilization of independent third-party trustees would further protection of plan assets and/or plan participants.

An initial determination was made to consider the protections that independent third-party trustees could provide to both defined benefit and defined contribution plans.

Working Group Proceedings

Following its initial meeting, the Working Group held three public hearings at which it heard from individuals from a diverse group of organizations whose insights and knowledge of this area were important to the group's deliberations:

Charles Lerner, Esq. (Director of Enforcement for the Pension and Welfare Benefits Administration)

Samuel W. Halpern, Esq. (Executive Vice President and General Counsel, Bear Stearns Fiduciary Services)

Robert Nagle, Esq. (Independent Third-Party Trustee)

Mark E. Freitas (Managing Director, Frank Crystal Financial Services)

Catherine Shavell, Esq. (Counsel for State Street Bank and Trust Company)

Steve Anderson, Esq. (Marsh McClellan)

Ian Dingwall (Chief Accountant, Office of Chief Accountant for the Pension and Welfare Benefits Administration)

Barbara Uberti, Esq. (Vice President, Wilmington Trust Company)

John Barth, (Principal of Institutional Client Services, The Vanguard Group)

R. Gregory Barton, Esq. (Principal Vanguard Institutional Legal Department)

A brief synopsis of the oral testimony is included in this report as Appendix 1.

The Working Group received written testimony from Frederick D. Hunt, Jr. of the Society of Professional Benefit Administrators and supplemental written testimony from Barbara Uberti, Esq. (Wilmington Trust Company) and Charles Lerner (PWBA). We received copies of the following written materials: a copy of Senator Barbara Boxer's 401(k) Pension Protection Act, S. 1837; ERISA Advisory Council member James O. Wood in an article entitled "Why We Need Pension Reform"; an article entitled, "ERISA's Authorization of Unlimited Fiduciary Self- Dealing: Employer Stock Acquisition by Defined Contribution Plan Trustees", by Barry D. Hunter and a March, 1996 article from the American Institute of Certified Public Accountants, Journal of Accountancy entitled "Senate Bill to Crack Down on Fraud Would Change the Way CPAs Do Pension Plan Audits".

The complete record of the Working Group's proceedings, including official transcripts and summaries of oral testimony, the written testimony and materials submitted by witnesses, is available from the office of the ERISA Advisory Council.

A list of the members of the Working Group can be found in Section VI.

Executive Summary

ERISA specifically provides that officers and employees of a corporation and union officials can serve as fiduciaries in employee benefit plans. ERISA section 408(c)(3) states that nothing in ERISA section 406 (prohibited transactions) shall be construed to prohibit any person from serving as a fiduciary in addition to being an officer, employee, agent or other representative of the party in interest.

Our Working Group received testimony from members of the financial services industry, government officials as well as individuals and institutions serving as independent fiduciaries. It was determined that independent third-parties could enhance both protection and performance of qualified plans. The benefits of utilizing independent third-parties include enhanced expertise, independence in decision-making regarding transactions involving plan assets and a party in interest and additional safeguards over the flow of monies in and out of a plan together with cross-checks to ensure accuracy.

Witnesses from the financial services industry informed us that few additional protections would be provided to plan participants by requiring third-party trustees. It was noted that "the critical day-to-day functions that affect the participant's account are really performed by the plan recordkeeper, with the plan trustee having limited oversight responsibility." (Mr. John Barth, Vanguard). There are plan sponsors who keep their own records for defined contribution plans and "those cases"...present "a great potential for abuse"... an independent recordkeeper "could go an awfully long way" to prevent that sort of abuse. (Ms. Barbara Uberti, Wilmington Trust).

Witnesses from insurance institutions indicated that having a single person who is plan administrator, recordkeeper, trustee and investment advisor without any independent advisor, presents an underwriting risk for fidelity and fiduciary insurance because of the absence of checks and balances.

James O. Wood's article "Why We Need Pension Reform" indicated that there is only a 1% chance that a qualified plan will be reviewed by PWBA. The Office of Chief Accountant provided statistical data indicating that they will only be able to examine a fraction of the deficient filings and barely address those who do not file. Each of the current 1993 and 1994 databases include over 16,000 filings with major deficiencies. Data was also provided relating to the level of errors in accountant's reports that were submitted. In a random sample, the Office of the Chief Accountant determined over 19 percent of the accountant's reports were deficient.

Ultimately, however, none of the witnesses recommended mandating an independent third- party recordkeeper. The witnesses did recommend mandating certain changes to ERISA's reporting and disclosure rules which would provide critical and inexpensive safeguards to plan participants.

Testimony from government officials and the financial services industry consistently held that one of the single most effective cross-checks and enforcement mechanisms is letting participants know, by participant statements, the status of retirement benefits. Timely disclosure and confirmation of the recordkeeping activities affecting participants individual benefits is a critical safeguard.

The disclosure provisions in Sections 105(a) and 209(a) (1) of ERISA currently only provide for participant statements, only once a year upon request.

Witnesses also recommended mandating reconciliation of participant records and trust records and requiring a certification by the plan administrator that the reconciliation was done in the summary annual report. The Secretary is specifically empowered under ERISA sections 103(b)(5) and 104(a)(2) to require such a certification.

Finally, the Working Group received written and oral testimony relating to the absence of limitations, under current law, on the amount of employer securities held in defined contribution plans.

Based upon the foregoing, the Working Group has several recommendations, which are described below:

  1. The Secretary should take whatever steps necessary to implement a requirement of automatic issuance of periodic participant statements. This inexpensive, practical step will enable participants to act as a primary level of review of the correct operation of a plan and safety of plan assets. The Working Group believes this action is sufficiently important to warrant an amendment to ERISA, as necessary.

  2. Consistent with the first recommendation, the Working Group heard testimony that there is no current requirement that there be a reconciliation of participant records and trust records in defined contribution plans and this fundamental step is a cornerstone of prudent recordkeeping. The Secretary should amend Department of Labor regulations to provide for mandatory reconciliation of participant records and trust records in defined contribution plans and a certification to that effect in summary annual reports.

  3. Participants rely on timely and accurate reporting by Plan Sponsors to the Department of Labor. Testimony was received that there is a large scale failure to file, failure to file financial statements or financial statements that are filed are materially deficient. The Secretary should assure, that where legally required financial statements are not filed or are deficient, that the Department has sufficient resources available to investigate and remedy the noncompliance.

  4. The Secretary should have a study conducted regarding special issues and concerns in reporting/administration of under 100 lives plans. The Secretary has, by regulation, eliminated the audit requirement for all under 100 lives plans. We have heard testimony regarding risks associated with having a plan where a single person acts as plan administrator, record-keeper, trustee and investment advisor, and no fiduciary insurance has been purchased. We have heard further testimony that this is substantially more likely to occur in under 100 lives plans. The Working Group is concerned about the cost/benefit tradeoffs here but has been presented evidence that plans fitting the foregoing profile lack cross-checks, safeguards and controls which financial institutions deem essential and the insurance industry require for the underwriting of fiduciary/fidelity insurance.

  5. The Secretary should continue support of the Pension Audit Improvement Bill (S 1490) to require specific training for auditors of qualified plans.

  6. The Secretary should have a study conducted on the advisability of limiting the amount of employer securities held in defined contribution plans.

Findings and Recommendations

I. Defining Terms

One of the first challenges faced by the Working Group was a determination of what was meant by the term "Independent Trustee". An initial inquiry was whether an Independent Trustee was an independent party who had been delegated fiduciary duties? Apart from the named fiduciary of section 402(a) of ERISA, a person is a plan fiduciary "to the extent" he (i) exercises discretionary authority or control over plan management or any authority or control over management or disposition of plan assets, (ii) renders investment advice regarding plan assets for a fee or other compensation or has authority or responsibility to do so, or (iii) has any discretionary authority or responsibility in plan administration. ERISA section 3(21)(A). Early Department of Labor regulations state that certain positions, such as plan trustee or plan administrator, "by their very nature" carry fiduciary status. 29 C.F.R. § 2509.75-8 at D-3.

However, it was not determined to be critical to our function to make a determination as to whether a particular party was or was not a fiduciary. Rather the essential focus was the service that individual or institution provided to the plan and what way, if any, would an independent party providing that service provide extra protections to the participants or plan assets.

One service would be the Trustee/Asset Custodian. If the institution that served as custodian for plan assets did not also have responsibility for investment management of plan assets, it would be called the Directed Trustee. The Trustee/Asset Custodian safeguards trusteed assets, pays benefits upon instruction from Plan Administrator and executes and records investment transactions. Trust Agreements uniformly provide that the Trustee is responsible only the funds it actually receives and to pay benefits and bills as directed by authorized parties.

The Investment Advisor/Manager advises regarding overall investment policy and investments, selects and evaluates investments and invests plan assets subject to certain guidelines.

The Recordkeeper maintains the participant and beneficiary information provided by the plan sponsor as to age, service, compensation, entry date, termination date and marital status, to the extent applicable. The Recordkeeper also maintains election forms for each participant and beneficiary. Additionally, the Recordkeeper allocates contributions, distributions, loans distributions and repayments and withdrawals to each participant's account as provided by the plan sponsor. This core function of maintaining records of the entitlements of the participants and beneficiaries and for monies that go in and out of the plan, may be performed by the Plan Administrator alone or in conjunction with a Third-Party Administrator. In the defined benefit context, the Actuary has the task of calculating funding requirements and limitations, accumulated benefit obligations and individual benefit amounts.

The appointment of certain advisors, whether or not they are fiduciaries, may be on an ongoing basis or for purposes of a particular transaction.

II. Existing Legal Framework

A. Statutory

ERISA section 408(c)(3) states that nothing in ERISA section 406 (prohibited transactions) shall be construed to prohibit any person from serving as a fiduciary in addition to being an officer, employee, agent or other representative of the party in interest. Consequently, ERISA specifically provides that officers and employees of a corporation and union officials can serve as fiduciaries in employee benefit plans.

B. Case Law

There is case law holding that the failure, in certain situations of divided loyalties with clear potential for conflicts of interest, to seek independent, disinterested advice, amounted to a breach of fiduciary duty. In Donovan v. Bierwith, 680 F.2d 263 (2nd Cir. 1982), cert denied, 459 U.S. 1069 (1982) the Court addressed a situation where the Trustees of a stock option plan, in the midst of a takeover attempt, decided to purchase securities in the marketplace and not to tender the shares already held by the Plan. The Court plainly felt that the trustees' sole purpose was to block the buy-out offer without consideration of the best interests of the plan participants. Section 404(a)(1)(4) of ERISA imposes a basic duty on plan participants to act "solely in the interest" of plan participants and beneficiaries. The Court held:

Although officers of a corporation who are trustees of its pension plan do not violate their duties as trustees by taking action which, after careful and impartial investigation, they reasonably conclude best to promote the interests of participants and beneficiaries simply because it incidentally benefits the corporation or, indeed themselves, their decisions must be made with an eye single to the interests of the participants and beneficiaries. Restatement of Trusts 2d § 170 (1959); II Scott on Trusts §170, at 1297-99 (1967) (citing cases and authorities); Bogert, The Law of Trusts and Trustees §543 (2d ed. 1978). This, in turn, imposes a duty on the trustees to avoid placing themselves in a position where their acts as officers or directors of the corporation will prevent their functioning with the complete loyalty to participants demanded of them as trustees of a pension plan. Id. at 271.

The Second Circuit, in Donovan v. Bierwith, held that the activities of two of the Trustees "in opposing the offer precluded their exercising the detached judgment required of them as trustees of the Plan, and that the only proper course was for the trustees immediately to resign so that a neutral trustee or trustees could be swiftly appointed to serve for the duration of the tender offer." Id. at 271-72.

The necessity for fiduciaries to find independent, neutral substitutes is emphasized even more clearly in Leigh v. Engle, 727 F.2d 113 (7th Cir. 1984). It was held that profit-sharing Trustees breached ERISA's exclusive purpose rule when they failed "to make intensive and independent investigation of available options to ensure that they acted in the best interest of plan beneficiaries in the midst of a corporate control contest in which they were actively involved and had substantial interests. The Seventh Circuit states that it views "favorably the suggestion of the Secretary of Labor...that the preferred course of action for a fiduciary of a plan holding or acquiring stock...who is also an officer, director or employee of a party-in-interest seeking to acquire or retain control, is to resign and clear the way for the appointment of a genuinely neutral trustee to manage the assets involved in the control contest." Id. at 132.

Danaher Corp. v. Chicago Pneumatic Tool Co., 7 E.B.C. 1616 (S.D.N.Y. 1986), involved another takeover of an ESOP. The court held that it was inappropriate for the corporation president to serve as ESOP trustee during the tender offer, since his personal interests in continued employment conflicted with his duty to act in the interests of plan beneficiaries in deciding whether to tender plan shares. In Danaher, the court appointed a neutral trustee to replace the corporation president.

The Department of Labor has sought, in appropriate cases, to have trustees removed and for new trustees to be selected or to have an independent fiduciary operate the plan either entirely for in certain transaction(s). Such a result may be achieved by court order or settlement.

The Second Circuit's decision in Marshall v. Snyder, 572 F.2d 894 (2nd Cir. 1978), outlines the legislative history and statutory authority for removal of trustees and appointment of a temporary receiver. The Secretary of Labor, in the interest of the beneficiaries of certain union employee benefit plans, sought to remove the trustees of these plans, and to void certain transactions undertaken by said trustees. It was alleged that the trustees misused funds for various reasons including what the trustees claimed was for compensation and office refurbishing. p. 896. The plaintiff requested the District Court to appoint a temporary receiver to assume the trustees' duties. The defendants argued inter alia, that a receiver appointed to take over their duties was not only not warranted, but not explicitly provided for in ERISA. The Second Circuit relied upon ERISA 409(a), 29 U.S.C. §1109(a), that provides that "any person who is a fiduciary with respect to a plan who breaches any of the duties imposed on fiduciaries by the statute not only is personally liable to make good to the plan any losses resulting from the breach, but also is subject to such other equitable or remedial relief as the court may deem appropriate, including removal of such fiduciary." (emphasis added). ERISA section 502(a)(5), 29 U.S.C. §1132(a)(5) "empowers the Secretary to bring a civil action: (A) to enjoin any act or practice which violates any provision...or (B) to obtain other appropriate equitable relief: (i) to redress such violation or (ii) to enforce any provision...." . The Second Circuit cited legislative history of ERISA, including Senate Report #93-383. The report, appearing in U.S.Code Cong. & Admin.News, at p. 4989, stated in relevant part that "It is expected that a fiduciary...may be removed for repeated or substantial violation of his responsibilities, and that upon removal the court may, in its discretion, appoint someone to serve until a fiduciary is properly chosen in accordance with the plan." (emphasis added).

In Katsaros v. Cody, 744 F.2d 270 (2nd Cir. 1984), the defendant trustees were found to have violated their fiduciary duties under ERISA for making an unauthorized loan and failing to collect on an aborted loan. The District Court, among other relief, appointed a "fund manager to oversee the operation of the fund" for a fixed amount of time. The Second Circuit affirmed, modifying only by saying the manager should perform until "successor trustees are appointed by the union and employer association who meet with court's approval" Id. at 282. The Court relied upon the same legislative history and statutory authority as in Snyder.

The Second Circuit found that any amendment of the trust agreement which made the trustees immune from removal, even in the event of their malfeasance...." to be a violation of ERISA section 401(a)(1), 29 U.S.C. 1101(a). Levy v. Local Union Number 810, 20 F.3d 516, 519 (2nd Cir. 1994). Moreover, the Court noted a Department of Labor opinion letter which considered the question whether the appointment of benefit fund trustees for life, in the absence of fiduciary misfeasance was compatible with fiduciary responsibilities imposed by ERISA. Department of Labor, Pension & Benefit Welfare Programs, Opinion 85-41 A, December, 1985 (1985) ERISA LEXIS 3) (hereinafter "DOL Opinion"). The Department reasoned that the congressional mandate of "high standards of loyalty and prudence," Id. at *2, implied a requirement "that the conduct of [the fund trustee] should be subject to effective oversight on behalf of plan participants and beneficiaries." Id. at *2-*3. This goal required that arrangements with fiduciaries be subject to termination "on reasonably short notice under the circumstances so the plan would not become locked into an arrangement that may become disadvantageous." Id. at *3. The Department observed that these "principles ... may be frustrated where a plan sponsor ... can [remove a trustee and appoint a successor] only upon successfully bringing such charges as misfeasance or incapacity ..." Id. The Department concluded that, notwithstanding removability for misfeasance, "a lifetime term of appointment ... would be inconsistent with ERISA's fiduciary responsibility provisions." Id. at *2.

The Southern District of New York, in International Brotherhood of Teamsters v. Garage Employees Local Union Number 272, 1992 WL 235173 (S.D.N.Y. 1992), ruled that an International Union acted properly under the "emergency situation" provision of its own constitution by appointing a temporary trustee; the defendant union was found to have "been 'advised of the reason for the appointment' of the temporary trustee...", even though the IBT Constitution does not mandate advisement. Thus, the defendant was issued a mandatory injunction requiring them to recognize the temporary trustee and to allow him access to the union's records, etc.

III. Evidence of Need for Further Protections

The Working Group heard testimony from Mr. Ian Dingwall, the chief accountant from PWBA's Office of Chief Accountant. One of the office's essential functions is to oversee the Form 5500 reporting system. In 1992, there were about 708,000 private pension plans and about six million health and welfare plans. Only funded welfare benefit plans are required to file a Annual Report Form 5500. In 1996, the Office of Chief Accountant will oversee over 1 million annual reports with a staff of 19 which includes both accountants and reporting compliance specialists.

The Form 5500 filings are first keypunched into a database at the Internal Revenue Service and are subjected to about one hundred edit tests. A letter is sent in order to perfect the filing. There were 438,000 edit test failures on the 1989 returns. The number of edit test failures has decreased progressively over the years. The latest figures show that in 1992 there were 264,465 edit test failures.

The most egregious deficiencies selected for review are: (1) where the accountant's report is missing, (2) the accountant's report contains a material qualification and (3) schedules are missing. Mr. Dingwall testified that in 1993 database, there are 21,663 deficient filings; 2,924 without accountant's opinions. In the database in April of 1996 for the 1994 plan year (two year lag), there are 16,863 filings that have a major deficiency, 2,109 missing an accountant's report. Due to the present size of the staff at the Office of Chief Accountant, they can only examine approximately 1,700 filings per year.

There is also an enforcement effort with respect to plans which have stopped filing without filing a terminal report, or simply failed to file one or more reports. In the last four years there have been 77,000 filers who just stopped filing or did not file one or more years. There is but one individual in the Office of Chief Accountant who reviews the non-filer cases. He can examine only about 240 cases a year. Mr. Dingwall expressed the opinion that the failure to file an accountant's report, particularly after a history of compliance, is some indication that "there's a problem with the plan." Similarly, the failure to file an accountant's report is also an indication that of underlying problems.

Mr. Dingwall also testified to the adequacy of the audits that performed in plans that submitted an accountant's report. In 1992, the Office of Chief Accountant pulled a sample of 276 audit engagements and went on site, pulled the work papers, looked at the results of the review and concluded that 19% of the audits were deficient. Another 33% of the audit reports failed one or more of the ERISA reporting disclosure requirements. If this average of deficiency is projected over the population of audits, then approximately 6,000 and 12,000 audits would not be done in accordance with general accounting standards and the assets involved would be between $44 billion and $214 billion.

Mr. Dingwall noted that while the office budget is approximately $1.5 million, it collects over $12 million in penalties a year. The office collected over $46 million in the delinquent filer program.

The Working Group also received materials from the Department of Labor relating to its pension payback program and 401(k) enforcement results. It was noted that in 1993 there were over 170,000 401(k) plans nationwide covering 23.4 million people with combined assets totalling $613 billion.

In 1995, after DOL's Pension and Welfare Benefits Administration (PWBA) began registering an increase in the number of complaints about 401(k) plans, the agency launched an enforcement program aimed at increasing protection of employees' 401(k) contributions.

As part of the overall 401(k) enforcement initiative, Secretary of Labor Robert B. Reich initiated the Pension Payback Program on March 6, 1996. This voluntary compliance enforcement program allowed employers to restore delinquent contributions plus lost earnings to their plans without penalty. Eligible employers who participated in the program could avoid civil and criminal sanctions, including civil injunctions, criminal prosecutions or criminal fines, excise taxes, and civil money penalties.

The program's grace period ended Sept. 7, 1996. The following results were achieved:

  • The Department received 170 notifications; notifications were received from employers located in 38 states.

  • $4.8 million in delinquent contributions and lost earnings were reported returned to plans during the grace period.

  • Contributions repaid to plans ranged from $43.07 to over $200,000.

  • 16,800 participants were included in affected plans.

Since the initiation of the increased 401(k) enforcement efforts, 1,178 investigations have been opened, including 434 that have been closed (744 remain open), and $9.8 million has been returned to 401(k) plans.

  • $5.7 million from 87 different companies of the 434 closed cases.

  • approximately $4.1 million by voluntary compliance from companies among the 744 open investigations.

Of the $9.8 million, $8.7 million is employee contributions and $1.1 million is employer contributions.

Since the beginning of the project, there have been 59 criminal cases opened - 46 are still pending. Six cases have resulted in guilty pleas. Criminal court-ordered restitution totalling $99,804 has been made.

Charles Lerner, Esq., Director of Enforcement for Pension and Welfare Benefits Administration indicated that the 401(k) enforcement effort is not based upon a random selection of 401(k) plans but rather in response to participant complaints based upon their participant statements. Both Mr. Lerner and Mr. Robert Nagle discussed various cases regarding improper loans and imprudent investment activity that culminated in the appointment of an independent third-party trustee.

A number of witnesses commented that curbing abuses was a more pressing concern for defined contribution plans than defined benefit plans, as defined benefit plans have most of their benefits insured by the PBGC. In addition, one witness commented that defined benefit plans would require the services of an actuary who would serve as an independent recordkeeper and thus a cross-check for any questionable distributions. (Testimony of Barbara Uberti, Wilmington Trust Company).

IV. Enhancement to Protection and Performance Provided by Independent Third-Parties

Witnesses before the Working Group described a variety of (roles in which independent third-parties could enhance both protection and performance to qualified plans. The roles ranged from enhanced expertise and independence, curing and replacing trustees in breach, providing safeguards and cross-checks to the flow of monies in and out of a plan and to provide cross- checks to ensure accuracy. The witnesses outlined a series of "best practices" provided by the financial services industry to provide accuracy and prevent pension abuse.

The Working Group heard testimony from Samuel W. Halpern, Bear Stearns that the general benefits of an independent fiduciary included: (1) Enhanced expertise; (2) Enhanced independence and (3) Reducing/spreading the plan's fiduciary risk.

He noted that an independent fiduciary could provide invaluable expertise in structuring and supervising a plan's investment activities in areas of complexity beyond the expertise of the named fiduciaries; i.e. structuring and monitoring brokerage activities such as soft dollar arrangements or commission recapture programs, developing and adjusting asset allocations, due diligence etc.

There is also a need for enhanced independence when a particular transaction requires an independent advisor or decision maker regarding a proposed transaction involving plan assets and a party in interest. (See Section II B.) Such transactions could include tender, proxy voting or work-out situations regarding employer securities or sale or in-kind contributions of non-qualifying employer securities or real estate or qualifying employer securities or real estate beyond statutory limits.

Finally, to the extent that the independent party is truly a fiduciary, then the independent party is taking on liability and fiduciary exposure for whatever the decision making process is involved.

Barbara Ann Uberti, Esq. (Wilmington Trust Company) described the three major movements of money through a employee benefit plan; plan contributions; plan investing and plan distributions.

Ms. Uberti noted that plan contributions can be misappropriated if they are not remitted to the trust. Under standard trust agreements, the trustee is only responsible for monies that it actually receives. All aspects of the appropriate plan contribution, whether or not discretionary, are not generally known to the trustee/custodian. The amount and timing of the contribution is known to the recordkeeper and plan administrator in a defined contribution plan and the actuary/recordkeeper and plan administrator in a defined benefit plan. These parties should already have a complete audit of payroll, list of participants, an analysis of the plan and other factors affecting contributions. Ms. Uberti noted there are plan sponsors who keep their own records for defined contribution plans and "those cases"...present "a great potential for abuse". She indicated that an independent recordkeeper "could go an awfully long way" to prevent that sort of abuse.

Requiring participant statements that set forth the amount of the employer and employee contribution, "would align everyone's interest"..."let the people who really care about it"..."have the ability to look at the flow of money and make sure it is right". Barbara Uberti recommended a requirement for automatic participant statements, at least annually.

Another area of control recommended by Barbara Uberti was mandatory reconciliation of participant records and trust records.

Employee benefit assets can also be diluted by improper investments. Ms. Uberti noted that, under current law, a defined contribution plan can invest all of its assets in employer securities. If a substantial amount of plan assets are invested in employer securities and "the company goes downhill, you can lose your job and your retirement benefits at the same time". Barbara Uberti recommended limiting the amount of employer securities that can be held by defined contribution plans (except ESOPS) and prohibit the requirement that matching contributions be invested in employer securities.

The Working Group received a copy of Senator Barbara Boxer's proposed 401(k) Pension Protection Act, S. 1837. The Bill notes that defined benefit pension plans are prohibited by ERISA from investing more than 10% of their assets in securities and real estate of the company sponsoring the pension plan, but not defined contribution plans. The Bill would amend ERISA to provide the same limitation to defined contribution plans and provides a grandfather rule to existing holdings in excess of this limit.

Barbara Uberti noted that plan distributions were "the simplest way to steal from a plan". The plan sponsor simply directs a payment of a benefit, a loan or a bill from trust assets. The trustee/custodian is not well-suited to prevent this abuse as a standard trust agreement requires them to pay benefits as directed and expenses as directed, as long a the person who directed the payment was authorized to do so. Again, Barbara Uberti noted that an independent recordkeeper could curb this form of abuse, as a cross-check to payments not authorized by the plan records and/or plan document. Another control possibility would be third-party authorizations for distributions that are unlikely to be a big expense.

It was noted that plan distributions is another place where the reconciliation of participant records and trust records would help.

John Barth (Vanguard) also emphasized that few protections would really be provided to plan participants by requiring third-party trustees. He noted that "the critical day-to-day functions that affect the participant's account are really performed by the plan recordkeeper, with the plan trustee having limited oversight responsibility".

John Barth emphasized that one of the most important protections provided to defined contribution participants was timely disclosure and confirmation of recordkeeping activities affecting their individual accounts. The information included on the statement should include, at a minimum, a summary of each of the investments that the participant is investing in, starting with a beginning balance which should agree with the ending balance of the previous period. It should include activity for the period which would be contribution activity, any withdrawals, distributions or loans, repayment of loans, transfer or exchange activity, unrealized gain or loss and a demonstration of market value at the end of the statement. Mr. Barth testified that cost of quarterly statements per year, per participant is approximately $5.00 to $10.00 per year. Their firm only charges $5.00. With new technology, many financial services institutions perform daily valuations and provide access to account information by voice network or through the internet.

The types of risks that adequate controls and cross-checks safeguard against include errors or mistakes in plan administration, mistakes in participant's deferral calculations, contribution allocations, investment exchanges, distribution payouts, loans and loan repayments.

Mr. Barth also agreed that reconciliation of participant records and trust records was an essential control and cross-check. Rather than mandate that this be done by a third-party he suggested that in the summary annual report, the plan administrator would have to certify, under penalty of perjury, that trust records were reconciled to the participant records. Mr. Barth indicated he could not go so far as to mandate the use of third-party recordkeeper due to the cost factor and the potential for discouraging small employers to start plans.

It was noted that Vanguard always sends confirmations to participants and he recommended "requiring confirmation checks". He noted that when Vanguard receives a notification of change of address from a participant, a confirmation is sent to the old and new address.

V. Existing Gaps in Protection

No mandatory issuance of periodic participant statements

Charles Lerner (PWBA), Barbara Uberti (Wilmington Trust), John Barth (Vanguard) and Ian Dingwall (PWBA) all indicated that one of the single most effective cross-checks and enforcement mechanisms is letting participants know, by participant statements, the status of retirement benefits.

Section 105(a) of ERISA generally requires an administrator of an employee pension benefit plan to furnish to any participant or beneficiary who so requests in writing, a statement indicating, on the basis of the latest available information, the total benefits accrued and the nonforfeitable pension benefits, if any, which have accrued, or the earliest date on which such benefits will become nonforfeitable.

Similarly, section 209(a)(1) of ERISA generally requires the plan administrator of a pension plan subject to Part 2 of title of the Act to make a report, in accordance with regulations of the Secretary of Labor, to each employee who is a participant under the Plan and who requests such report, terminates service with the employer, or has a one year break in service. The report required under ERISA section 209(1) must be sufficient to inform the employee of his or her accrued benefits which are nonforfeitable.

Under both sections, ERISA section 105(a) and ERISA section 209(a)(1), no participant is entitled to more than one report during any single 12-month period.

Consequently, in order to require automatic issuance of periodic participant statements, sections 105(a) and 209(a)(1) of ERISA would have to be amended. Although there are proposed regulations at 2520.105-1 and a Request For Information was issued in the Federal Register, Volume 58, No. 246 on December 27, 1993, neither seeks to require automatic issuance of periodic participant statements.

It was noted by the witnesses that most of the financial services institutions that serve as trustee/custodian and recordkeeper issue these statements automatically. The cost is relatively minor; between $5.00 and $10.00 per year per participant. A requirement that the annual statements now required by request, be issued automatically, would be a vast improvement. It is contemplated that regulations would take advantage of existing advances in technology.

It was unanimously agreed by the witnesses that timely disclosure and confirmation of the activities in a participant's retirement account is the key to protecting the assets and ensuring against errors. No one of us would consider depositing our monies in a bank or a brokerage house which only provided annual statements upon request. We should ask our pensioners to a practice which is inexpensive to implement and essential to the safety and accuracy of their retirement benefit.

Consequently, it is our recommendation to mandate automatic disclosure of periodic participant statements.

No mandatory reconciliation of participant records and trust records

There is no current requirement that there be a reconciliation of participant records and trust records. Over 100 lives plans must file audits with their Form 5500, but under 100 lives plans do not have be audited. Barbara Uberti (Wilmington Trust) noted ..."if the bank account and book got reconciled every month, you would know if something were missing". Arguably, it would be the essence of imprudence for someone to never balance one's checkbook, yet qualified plans are not required to do so. Advisory Council Member Marilee P. Lau, a member of the Advisory Council and an Assurance Officer with KPMG Peat Marwick LLP, stated at a full Board Meeting that such reconciliation should be done monthly, otherwise it would be, "like reconciling your bank account once a year. You've got to close the bank account in order to be able to do that."

Subsequent to the hearing, Barbara Uberti supplemented her testimony with a letter summarizing information received from recordkeeping and accounting firms to determine the cost of reconciling participant records. From these discussions, she recommended reconciling small- to medium-size plans on an annual basis and larger plans on a quarterly basis. For both large and small plans, the number of transactions and the number of investment funds determines the cost of reconciliation. Large firms estimate that it takes two hours per fund per plan per period for reconciliation of a large plan done on a quarterly basis, charging $100 per hour. For example, if a plan has five investment options, the annual reconciliation cost would be $4,000. It would cost $500-$1,000 to reconcile a small plan with five investment funds on an annual basis. These estimates apply to ongoing reconciliation.

John Barth (Vanguard) noted that, with the technology available today, "it would not be that complicated to do a reconciliation". Mr. Greg Barton, who also appeared for Vanguard, said that "What you'd really be looking at for the small mom-and-pop, 20-employee [establishment], is a requirement to provide an annual statement, and at the bottom of that statement would be certification under penalty of perjury by the plan administrator that the assets were reconciled". Ian Dingwall (PWBA) also suggested improving the summary annual report, "the things that they actually get in their hands".

ERISA sections 103 and 104 provide for the publication and filing of annual reports with participants and the Secretary of Labor, respectively. Section 103(b) provides that the financial statement in the annual report shall contain certain specified information and under Section 103(b)(5):

Such financial and actuarial information including but not limited to the material described in subsections (b) and (d) of this section as the Secretary may find necessary or appropriate.

ERISA section 104(a)(2)(A)&(B) provides:

(2)(A) With respect to annual reports required to be filed with the Secretary under this part, he may by regulation prescribe simplified annual reports for any pension plan which covers less than 100 participants.

(B) Nothing contained in this paragraph shall preclude the Secretary from requiring any information or data from any such plan to which this part applies where he find such data or information is necessary to carry out the purposes of this title nor shall the Secretary be precluded from revoking provisions for simplified reports for any such plan if he finds it necessary to do so in order to carry out the objectives of this title.

Consequently, it is our recommendation to mandate reconciliation of participant records and trust records and require a certification by the plan administrator that the reconciliation was done in the summary annual report. We submit that the Secretary is specifically empowered under ERISA sections 103(b)(5) and 104(a)(2) to require such a certification.

Failure to consider risk factors in reporting/administration of under 100 lives plans

Charles Lerner, Esq. (PWBA) testified to a number of cases which the Department of Labor, though settlement or court order, had an independent trustee appointed due to malfeasance on the part of the existing trustees. The cases involved improper "loans" or failure to remit contributions. He noted:

"In the settlement of our cases, our civil cases, typically we are talking about obtaining money from a fiduciary insurance policy. The losses are often in the hundreds of thousands and millions of dollars, which are often beyond the means or availability of the trustees themselves, and thus you're looking at the fiduciary insurance policy as the major source of funds that are being put back into the plan."

As a consequence of Mr. Lerner's remarks, we heard testimony from two individuals representing fidelity and fiduciary insurance carriers. We heard from Mark E. Freitas (Frank Crystal Financial Services) and Steve Anderson, Esq. (Marsh McClellan). Fidelity insurance is required by Section 412 of ERISA, which requires that every fiduciary of an employee benefit plan and every plan who handles funds or other property of the plan shall be bonded. Both Mr. Freitas and Mr. Anderson indicated that fidelity insurance was first-party coverage that provides protection to the named insured against losses sustained by fraudulent or dishonest acts. Each individual must be bonded for at least 10 percent of the amount of plan funds he handles and in no case for less than $1,000. No individual need be bonded for more than $500,000 with respect to a single plan unless the Secretary of Labor (after a hearing) requires a larger bond. The cost of fidelity insurance is relatively inexpensive with respect to the ERISA section 412 and the minimum requirements. Mr. Freitas indicated it was approximately a few hundred dollars per bond. One reason for the low cost was the fact that there are relatively few claims made against fidelity bonds. Coverage becomes expensive with respect to the large investment advisors who, for example, have 500 plans. They have to purchase a limit per plan. Both Mr. Freitas and Mr. Anderson could recommend increasing the 10% limitation under section 412 of ERISA, as long as this increase did not apply to investment advisors.

Fiduciary liability insurance, by contrast, is a third-party coverage providing protection for the named insured for claims made against it by parties who allege damage as a result of a breach of fiduciary duty under ERISA or other negligence on the part of the named insured in managing or administering plan assets. Fiduciary insurance is not required by law. Typically, the claim is in the form of an actual lawsuit seeking recovery for the damage that has allegedly been caused by the named insured. When fiduciary liability insurance is for trustees, it is basically a directors and officers liability policy and is relatively inexpensive. It is approximately a few thousand dollars. When fiduciary liability insurance is for investment advisory liability or professional liability, is substantially more in cost, at a minimum of ten thousand dollars.

Both Mr. Freitas and Mr. Anderson indicated that, if you have a single person who is plan administrator, recordkeeper, trustee and investment advisor, that situation presents an underwriting risk, because "you don't have checks and balances, the insurance companies feel that there is a greater temptation" (Freitas); underwriters get "very concerned where you have a company that may be dominated by a sole owner or an owner that is a controlling owner, shareholder, where that individual is functioning in a position where he or she is making a majority of the decisions in-house for the plan".(Anderson)

Barbara Uberti (Wilmington Trust) noted there are plan sponsors who keep their own records for defined contribution plans and "those cases"...present "a great potential for abuse". She indicated that an independent recordkeeper "could go an awfully long way" to prevent that sort of abuse.

Under ERISA section 104(a)(2)(A), the Secretary of Labor may prescribe simplified annual reports for pension plans with fewer than 100 participants. The Secretary issued regulations permitting plans with fewer than 100 participants to file an annual report without the accountant's report. See Labor Reg. §2520.103-1(c).

The foregoing illustrates that the financial services institutions that service employee benefit plans consider plans were no independent party participates as recordkeeper, investment advisor, plan administrator or trustee as an underwriting risk. There are no checks and balances, no sign offs, no independent controls and thus, such a plan presents an underwriting risk. Mr. Dingwall, when asked about the 100 life rule said ..."audits are expensive, no doubt about it. This is the balancing act that we all try to do. But it should be balanced in relation to the risk that's associated with the plan, I think, not the number of participants".

Mark Freitas (Frank Crystal), Steve Anderson (Marsh McClellan), Barbara Uberti (Wilmington Trust Company) and John Barth (Vanguard) all conceded the foregoing scenario of a plan sponsor assuming all the roles of a plan without the use of any independent advisors is likely only to occur in the under 100 lives plan.

As a consequence, we deem it advisable for the Secretary to consider, in the reporting requirements of the under 100 lives plans, what plans present "underwriting risk factors" and what additional protections might those plans be required to meet; including, but not limited to, one or more of the following: independent recordkeeper; fiduciary insurance; auditors report every three years etc.

Failure to provide sufficient staffing to resolve deficiencies in annual reporting

James O. Wood's article "Why We Need Pension Reform" indicates that there is only a 1% chance that a qualified plan will be reviewed by PWBA. Ian Dingwall (PWBA) dramatically illustrated that his office can only perform 1,700 per year while in the 1993 database, there are 21,663 deficient filings, 2,924 without accountant's opinions. In the database in April of 1996 for the 1994 plan year (two year lag), there are 16,863 filings that have a major deficiency, 2,109 missing an accountant's report. In the last four years there are 77,000 filers who just stopped filing or did not file one or more years. There is one individual in the Office of Chief Accountant who reviews the non-filer cases. He can examine only about 240 cases a year. Ian Dingwall expressed the opinion that the failure to file, particularly after a history of compliance, is some indication that "there's a problem with the plan". The failure to file an accountant's report is a "tip off" that there is a problem with the plan.

Moreover, the efforts of the Office of Chief Accountant actually generates revenue for the United States Treasury. Mr. Dingwall noted that while their budget is approximately $1.5 million they collect over $12 million in penalties a year. They collected over $46 million in the delinquent filer program.

The written commentary from the Society of Professional Benefit Administrators recommended a central phone number for reporting real or suspected problems in plans (a 911 for benefits). They indicated that "[t]he current reporting system is dysfunctional. You need to call a regional office who may or may not follow up".

The obligation to report to the Secretary serious violations that auditors discover, specified in the Pension Audit Improvement Bill (S 1490), will have little impact if there is not the staff in the Department of Labor to respond to these reports.

It is recommended, at a minimum, that the Secretary seek additional staffing to enable it to have sufficient resources available to investigate and remedy noncompliance. Members of the Working Group suggested that advances in technology and interagency dialogue with the IRS might be the source of other innovative solutions.

Failure to require specific training for auditors

In 1992, the Office of Chief Accountant pulled a sample of 276 audit engagements and went on site, pulled the work papers, looked at the results of the review and concluded that 19% of the audits were deficient. Another 33% of the audit reports failed one or more of the ERISA reporting disclosure requirements.

Mr. Dingwall noted that the Pension Audit Improvement Bill (S 1490) created a continuing professional education requirement for plan auditors. One can not even audit an employee benefit plan unless you had 16 hours of continuing professional education. The bill also requires that the auditor be subject to peer review every three years.

It was noted in an article entitled "Senate Bill to Crack Down on Fraud Would Change the Way CPAs Do Pension Audits", American Institute of Certified Public Accountants, Journal of Accountancy, March, 1996, that the AICPA supports the bill and has worked closely with the Department of Labor to strengthen ERISA audits.

Employer securities held in defined contribution plans

We received oral testimony and written materials which noted that under current law, a defined contribution plan can invest all of its assets in employer securities. Pursuant to ERISA sections 407(d) and 408(e)(3)(A), eligible individual account plans are specifically authorized to invest up to 100 percent of plan assets in employer securities. The duties of diversification imposed under ERISA's fiduciary duty Section 404(a)(1) are specifically lifted in cases where the eligible individual account plan undertakes self-dealing transactions in employer stock (ERISA Section 404(a)(2)), although arguably the prudent man standard remains applicable.

Barry Hunter describes the failure to limit the amount of employer securities that can be held by a defined contribution plans together with ERISA's authorization to allow plan sponsors to act as investment managers as an "authorization of unlimited fiduciary self-dealing". Moreover, he states these rules conflict with overlapping trading rules adopted by the Securities and Exchange commission, were a corporate insider is prohibited from either purchasing or selecting stock without first disclosing all material, nonpublic information in his or her possession.

If a substantial amount of plan assets are invested in employer securities and "the company goes downhill, you can lose your job and your retirement benefits at the same time". (Barbara Uberti, Wilmington Trust). She recommended limiting the amount of employer securities that can be held by defined contribution plans (except ESOPS) and prohibit the requirement that matching contributions be invested in employer securities.

The Working Group received a copy of Senator Barbara Boxer's proposed 401(k) Pension Protection Act, S. 1837. The Bill notes that defined benefit pension plans are prohibited by ERISA from investing more than 10% of their assets in securities and real estate of the company sponsoring the pension plan but not defined contribution plans. The Bill would amend ERISA to provide the same limitation to defined contribution plans and provides a grandfather rule to existing holdings in excess of this limit.

The issue relating to limiting employer securities defined contribution plans was raised at our last hearing without an opportunity for opponents of the idea to be given an opportunity to present their views. A member of our Working Group indicated that there are many companies that have savings, plus stock savings plans which are designed to create an identity of interest between employees and their Company. It was noted that if they were prohibited from offering the stock, it doesn't mean that they take the dollars and put it into other benefits. The benefits may just disappear.

The Working Group found that this is a complex issue which warrants further study and we recommend a study of the advisability of limiting the amount of employer securities in defined contribution plans.

The Working Group recommends implementation of these proposals.

VI. Members of the Working Group

Victoria Quesada, Working Group Chair
Law Office of Victoria Quesada

Vivian L. Hobbs, Working Group Vice-Chair
Arnold and Porter

Joyce Mader
O'Donoghue & O'Donoghue

Jim Hill
State of Oregon

Thomas J. Healey
Goldman, Sachs and Company

David Hirschland
International Union, United Automobile, Aerospace
and Agricultural Implement Workers of America, United Auto Workers

Zenaida Samaniego
Equitable Life Assurance Society of the United States

Judith Mares, Chair of the Advisory Council
Mares Financial Consulting, Inc.

Appendix 1

Summary of Oral Testimony

The testimony presented to the Working Group is recorded in the verbatim transcripts of the Council. It is further summarized in the Executive Summary prepared of each Working Group meeting. Therefore, the following constitutes a brief summary of the oral testimony of each witness who testified before the Working Group on Exploring the Utilization of Third-Party Trustees to Protect Plan Participants.

May 7, 1996 Meeting

Charles Lerner, Director of Enforcement for the DOL Pension Welfare Benefits Administration ("PWBA")

Charles L. Lerner described his responsibilities as the oversight and conduct of PWBA's enforcement program, which is in the national office, but is administered primarily through its 15 field offices.

Mr. Lerner reminded the Council that the idea of mandating third-party trustees is not a new one. In 1990, Congress proposed legislation (H.R. 2664) that would have amended ERISA to require that the assets of all single employer pension and welfare plans be held in trust by joint trusteeship. Then Assistant Secretary of Labor David George Ball testified against H.R. 2664, noting that joint trusteeship would increase both the cost and administrative burden of providing benefits.

Mr. Lerner discussed some of the cases in which the enforcement office has been involved where it has appointed an independent trustee to resolve the dispute. In Leigh v. Engle, 727 F.2d 113 (7th Cir. 1983) beneficiaries of employee benefit plan brought action against plan administrators and others for alleged violations of fiduciary duties under ERISA. In Danaher Corp. v. Chicago Pneumatic Tool Co., 635 F. Supp. 236 (S.D.N.Y. 1986) the court found it improper for president of the company to act as a trustee of an ESOP where company was subject to takeover bid. Two union representatives violated ERISA's exclusive purpose rules, in Brock v. Hendershot, 840 F.2d 339 (6th Cir. 1988), where one fiduciary was held liable for influencing local unions to choose specific dental program and other representative negotiated agreements resulting in new members to dental program. Trustee and other defendants were ordered to pay $1 million to an independent trustee for losses caused when they loaned plan money to company and plan participants in Reich v. Hosking, 20 EBC March 7, 1996.

The enforcement office has also been engaged in a number of investigations dealing with 401(k) plans and failure of employers to forward employee contributions.

June 18, 1996 Meeting

Samuel W. Halpern, Executive Vice President and General Counsel, Bear Stearns Fiduciary Services

Mr. Halpern discussed the varying roles of the Independent Fiduciary. An Independent Fiduciary may or may not be a trustee as technically defined by ERISA. Independent fiduciaries may serve (1) on an ongoing basis, for example acting as an investment manager or rendering "investment advice" or (2) for a specific transaction. The benefits which an Independent Fiduciary could provide include special expertise, enhanced independence, and a reduction of the plan's fiduciary risk. Some ongoing functions falling within the scope of an Independent Fiduciary's responsibility could include development and adjustment of asset allocation, selection of investment managers, implementation of controls over risk and expense, evaluation of investment performance, and structuring and monitoring of brokerage activities. Some examples of specific transactions which may call for an Independent Fiduciary include: the sole or in-kind contribution of employer securities or employer real estate between a sponsor and its plan, a merger of bank collective trusts or mutual funds sponsored by affiliated financial institutions which are themselves ERISA fiduciaries, or tender-offer or work-out situations regarding the securities of a party in interest (such as a plan sponsor) which the plan owns.

The type and level of Independent Fiduciary fees would depend on the precise nature and scope of the functions required, the liability to be faced by the Fiduciary, including the extent of pending or threatened litigation, and the extent to which the benefits to the client were quantifiable.

Robert Nagle, Independent Third-Party Trustee

Mr. Nagle described his experience as a court appointed trustee for several pension plans and as a neutral trustee for several multi-employer benefit plans. He pointed out that the mandating of third-party trustees would require a change in the law. It is his opinion that the extent there are abuses in pension plan administration, they are more of a problem for defined contribution plans than defined benefit plans since the latter have most of their benefits insured by the PBGC. Mr. Nagle pointed out that smaller plans seem to be more prone to abuse because (1) audited financial statements were not required for those with under 100 participants and (2) there is often only one person running the plan without oversight from an independent trustee or an auditor. The only negative to a broader audit requirement or mandating a third party trustee would be that of cost.

Mark Freitas, Managing Director, Frank Crystal Financial Services

Mr. Freitas discussed fidelity and fiduciary insurance coverage, their costs and market capacities. He defined fidelity insurance as a first-party contract which protects the funds of the plan from theft and fraudulent acts of employees or other parties, whereas fiduciary liability insurance is a third-party contract which is used to protect the trustee for administering the plan and investment advisors for giving investment advise. Costs range from $200-$500 per fidelity/bond plan (maximum liability is $500,000) to a few thousand dollars for a plan trustee and at least $10,000 for investment advisors. There are about 7-8 insurers who write fidelity bonds (capacity ranges from $25-100 million), fewer who carry fiduciary liability coverage. Custodians, either bank or brokerage house, typically have fidelity bonds, while bout 50% of registered investment advisors carry fiduciary insurance.

Catherine Shavell, Counsel for State Street Bank and Trust Company

Ms. Shavell opened her testimony by stating that there are significant custodian and trustee of ERISA funds in the market and that State Street's experience is mainly in the large plan area. She said that their world is trying to respond to the needs of plans and plan sponsors to do what is necessary for them to establish their plans.

Ms. Shavell stated that she had picked up the chart of key providers from the morning session and that she wanted to make a few amendments to the chart. She said that she thought that there were many more fiduciaries involved in the plans than the group might have contemplated. Trusteeship involves a spectrum of services from custodial service to full investment control, providing reporting services not just to the Department of Labor, but also to the plan sponsor and plan participants. Additional regulation will result in additional cost.

When asked by Ms. Quesada about what would be ways to improve protections for plan participants that would be unobtrusive and not add layers of regulation, Ms. Shavell stated that for protection to plans from a custodial and banking perspective, it is important to establish the authenticity of trading instructions in order to know that authorized transactions are being performed without the presence of a rogue trader or an invasion. Ms. Shavell wants to be sure that she is paying benefits to the right people.

In response to a question from Ms. Mares regarding responsibilities for setting accounting policy or evaluation policy, Ms. Shavell said that they have to follow the generally accepted accounting principles and produce a report that reflects correct values of assets and transactions. Ms. Shavell was unable to quantify the cost difference to a plan sponsor between a custodial arrangement and full investment control. She explained that costs depend on investments chosen, volume and the investment management mandates active separately managed accounts cost more than an index strategy.

Steve Andersen, Marsh McClellan

Mr. Andersen discussed fidelity and fiduciary insurance, particularly as they pertain to companies who buy within their insurance portfolio coverage for plans within their organizations. Fidelity claims require proof of dishonesty or fraud and cannot be based on negligence. Loss experience has been very small. On the other hand, fiduciary claims are typically in the form of actual lawsuit seeking recovery for alleged damage resulting from breach of fiduciary duty or other negligence on part of named insurance in administering or managing plan assets. It covers defense costs of named insurance in addition to settlement amount or adverse judgement. Underwriting considerations include internal audits and controls, independent trustees, claim experience, employee communications, plan size and controlling owner (as in small plans).

Ian Dingwall, Chief Accountant of the DOL Office of the Chief Accountant, Pension and Welfare Benefits Administration ("PWBA")

Ian Dingwall explained that, in his capacity as chief accountant, he heads three programs. These three programs are designed to (1) improve the quality of audits, (2) oversee the reporting compliance program, and (3) audit the Thrift Savings Plan for all government employees.

Mr. Dingwall explained that, with respect to reporting and compliance, his office looks at three things: (1) whether required annual reports are filed; (2) whether they are filed timely; and (3) whether the reports meet the filing requirements.

Mr. Dingwall pointed out that in the 1993 database, there were 21,663 deficient filings, 2,924 without accountant's opinions. In the database in April of 1996 for the 1994 plan year, there were 16,863 filings that have a major deficiency, 2,109 missing an accountant's report. In the 1994 plan year, there were 107 annual reports that are greater than 100 million that have these kinds of deficiencies. He stated that there have been 77,000 non-filers over the last four years, all of which have been notified by the IRS.

Mr. Dingwall testified that he believes his office is a revenue maker for the federal government, collecting at least $1 million per month in penalties. All revenue collected goes directly to the U.S. Treasury, not the PWBA.

Mr. Dingwall's department recently surveyed its 1992 audits. Of the 276 audits tested, 19% failed to meet one or more of the ten professional auditing standards. In addition, another 33% failed one or more of the ERISA reporting and disclosure requirements. Mr. Dingwall acknowledged, that, for the approximately 20,000 deficient cases received in any given year, his office has only the capacity to review 1700.

September 10, 1996 Meeting

Barbara Ann Uberti, Vice President, Wilmington Trust Company

Barbara Ann Uberti presented testimony on behalf of the American Banker's Association. First, Ms. Uberti explained the traditional role of bank trustees for employee benefit plans. In that role, banks have the following basic duties: (1) custody of assets; (2) benefit payments; (3) investment management; (4) participant recordkeeping and (5) plan reporting.

Second, Ms. Uberti advised the Council to focus on how money moves in and out of plans. Money moves through plans in three ways: (1) money comes into the plan -- plan contributions; (2) money is invested by the bank -- plan investments; and (3) money is paid out of the plan, e.g., benefit payments, plan loans and payments to outside providers -- plan distributions.

By tracking money movement, she said, you can track the ways of misappropriating plan assets. First, employee benefit assets can be misappropriated before they go to the trust where an employer fails to remit a contribution. Second, employee benefit assets can be improperly invested, which would result in a diminution of employee benefit funds. Third, employee benefit assets can be distributed inappropriately, either as a benefit payment to a nonparticipant or to a subterfuge for the plan sponsor or service provider.

Next, Ms. Uberti outlined controls that exist for each of the ways money moves. Controls in place today for plan contributions include ERISA obligations, bank regulators who perform audits such as the Comptroller of the Currency, Federal Reserve, OTS, OCC, DOL and IRS, and bank practices and procedures, involving assurance of deposit authorization and internal reporting. She suggested additional controls to ensure that plan contributions get to the bank. Key among her recommendations is requiring participant statements setting forth the amount of the employer and employee contributions.

Controls for plan investments are ERISA obligations and diversification rules, competent investment managers, limited holdings of employer securities and bank procedures and practices, among others. Additional control possibilities could include limiting holdings of employer securities, affirmative reporting obligations on the trustee and trustee inquiry and follow-through on unusual investments.

With respect to plan distributions, a major concern is stopping both fraudulent benefit payments and payment of fraudulent bills initiated by plan sponsors. Present controls insuring proper plan distributions include, again, ERISA standards, bank regulators, practices and procedures. Two additional solutions to control distribution problems are third-party authorization and mandatory reconciliation of participant and trust records.

The major hurdle in implementing additional controls in each of these three areas is the cost of compliance, she said. Uberti emphasized that third-party authorization for distributions is unlikely to be a big expense, but that the reconciliation process could be costly. She was unable to quantify these costs at the time of the hearing.

Subsequent to the hearing, Ms. Uberti supplemented her testimony with a letter to Ms. Quesada summarizing information she got from calling several recordkeeping and accounting firms to determine the cost of reconciling participant records. From these discussions, she recommended reconciling small to medium size plans on an annual basis and larger plans on a quarterly basis. For both large and small plans, the number of transactions and the number of investment funds determines the cost of reconciliation. Large firms estimate that it takes two hours per fund per plan per period for reconciliation of a large plan done on a quarterly basis, charging $100 per hour. For example, if a plan has five investment options, the annual reconciliation cost would be $4,000. It would cost $500-$1,000 to reconcile a small plan with five investment funds on an annual basis. These estimates apply to ongoing reconciliation.

John E. Barth, Principal of Institutional Client Services, The Vanguard Group R. Gregory Barton, Principal Vanguard Institutional Legal Department

John E. Barth and R. Gregory Barton, testifying on behalf of Vanguard Institutional Client Services and Vanguard Institutional Legal Department, told the Council that few protections would be provided to plan participants by requiring third party trustees, because plan trustees generally have limited oversight and reporting responsibilities. In most plans, the critical day-to-day functions affecting participants' accounts are performed by the plan's recordkeepers.

They recommended that ERISA mandate that defined contribution plans be required to provide participants with comprehensive account statements summarizing all recent contribution, investment and distribution activity occurring within their individual plan accounts on a regular, e.g., semiannual or quarterly basis. They estimated that the cost of these statements would be nominal -- $5-$10 per participant per year.

Frederick Hunt, Jr., President of the Society of Professional Benefit Administrators ("SPBA")

Written testimony was submitted by Frederick D. Hunt, Jr. Mr. Hunt's testimony first spelled out the common misconception that a Third-Party Administrator might be a third-party trustee. By definition, a Third-Party Administrator ("TPA") is just a contracted entity hired to carry out some delegated functions. Plan sponsor/trustees, on the other hand, are the official plan administrator and fiduciary referenced in ERISA. Hunt further advised the Council to use the term "Outside Trustees" instead of third-party Trustees.

Mr. Hunt testified that he did not think it is appropriate to require "independent custodians" to submit annual statements to plan participants. He stated that this requirement would be costly and duplicative. He also reiterated that TPAs are hired for specific functions -- they do not have access to the financial and personnel data needed to compile participant reports. ERISA places this responsibility where it belongs -- with the plan trustees.

Appendix 2

Selected Bibliography

Articles

  • James O. Wood, "Why We Need Pension Reform", Benefits Quarterly, Third Quarter 1995.

  • * Barry D. Hunter, "ERISA's Authorization of Unlimited Fiduciary Self-Dealing: Employer Stock Acquisition by Defined Contribution Plan Trustees", Journal of Pension Planning and Compliance, Fall, 1994.

* "Senate Bill to Crack Down on Fraud Would Change the Way CPAs Do Pension Audits", American Institute of Certified Public Accountants, Journal of Accountancy, March, 1996.

Legislation

* Senator Barbara Boxer's 401(k) Pension Protection Act, S. 1837

If you have questions, please call the Council's Executive Secretary at 202-219-8753.