November 14, 2000

The Working Group Report, submitted to the ERISA Advisory Council on November 14, 2000, was approved by the full body and subsequently forwarded to the Secretary of Labor. The Advisory Committee on Employee Welfare and Pension Plans, as it is formally known, was established by Section 512(a)(1) of the Employee Retirement Income Security Act of 1974 to advise the Secretary with respect to carrying out his/her duties under ERISA.

Members of the Working Group

  1. Rebecca J. Miller, Chair, McGladrey & Pullen, LLP
  2. Janie Greenwood Harris, Vice Chair, Firstar Corporation
  3. Rose Mary Abelson, Council Vice-Chair, Northrup Grumman Corp.
  4. Evelyn Adams, IBM
  5. Eddie C. Brown, Brown Capital Management
  6. Judith Ann Calder, Abacus Financial Group, Inc.
  7. Michael Gulotta, Council Chair, Actuarial Sciences Associates, Inc.
  8. Catherine L. Heron, Capital Group Companies (CGC) of Los Angeles
  9. Timothy J. Mahota, Integral Development, Inc.
  10. Judith F. Mazo, Segal Company
  11. Patrick N. McTeague, McTeague, Higbee, MacAdam, Case, Watson & Cohen
  12. James S. Ray, The Law Offices of James S. Ray
  13. Michael Stapley, Deseret Mutual Benefit Association
  14. Richard T. Tani, Retired, William M. Mercer

Issue Statement

The last decade has been one of consolidation, outsourcing and reorganization in the entire American economy. Nothing in today’s economy indicates a cessation in this activity. As a result of this activity, employers are confronted with the task of managing different benefit packages. In some situations, sponsors can continue separate benefit structures. In other situations, by choice or by operation of law, one or both plans must change.

The Working Group’s assignment was to identify the challenges to benefit continuity confronting sponsoring organizations and their employees undergoing restructuring. This would be accomplished through a study of the ERISA and Code(1) provisions that are specifically aimed at such sponsor changes and those provisions, though not aimed at such activity, that have been cited as obstacles or impediments in maintaining continuity. Recommendations for change were solicited from the witnesses. The Working Group then reviewed these recommendations in light of the need to balance policy objectives.

Throughout this deliberation, continuity was considered with respect to both the acquired or the acquiring organization’s plans. The fundamental issue is: Does the Act or related regulations inadvertently cause interruptions, and possibly, reductions in participants’ benefits which was not the intent of the particular ERISA or Code provisions? One of the working group members expressed the objective of this study: “ achieve greater flexibility, but ... to do that without undermining the employee protections.”(2)

Expert Witnesses

  • Alan Tawshunsky
    Special Counsel to the Division Counsel/Associate Chief Counsel
    Internal Revenue Service
    Tax Exempt and Government Entities Division
    (May 9, 2000)
  • John Hickey
    Vice President, Human Resources and
    Global Employee Benefits
    Lucent Technologies
    (August 14, 2000)
  • Paul T. Shultz
    Employee Plans Rulings and Agreements
    Tax Exempt/Governmental Entities
    (May 9, 2000)
  • Martha Hutzelman and Janine Bosley, Attorneys
    Bosley & Hutzelman, P.C.
    (August 14, 2000)
  • William Bortz
    Associate Benefits Tax Counsel
    Department of Treasury
    (June 2, 2000)
  • Anthony Rucci
    Executive Vice President
    Cardinal Health
    (August 14, 2000)
  • Louis Campagna
    Chief Division of Fiduciary Interpretations and
    John Canary
    Chief Division of Reporting and Disclosure
    (June 2, 2000)
  • Nelson Phelps, Executive Director and A.J. Jim Norby, President
    Association of U.S. West Retirees
    (September 12, 2000)
  • Peter Tobiason
    Assistant General Counsel for Employee Benefits and OSHA
    ITT Industries, Inc.
    (July 18, 2000)
  • Eli Gottesdiener, Attorney
    Gottesdiener Law Office
    (September 12, 2000)
  • Nell Hennessy
    Senior Vice-President
    Actuarial Sciences Associates, Inc.
    (July 18, 2000)
  • Anonymous Employee
    of acquired company
    Source: Pension Rights Center
    (September 12, 2000)

“We consciously avoided [trying] the best of both worlds.”Pamela Kimmet, Director of Compensation and Benefits for Citigroup commenting on the merger of Citicorp and Travelers Insurance Group reported in the BNA Pension & Benefits Daily 5/15/2000

Executive Summary

Mergers, acquisitions, spin-offs, split-ups, joint ventures, outplacing, outsourcing….the terms available to describe the changes in corporate structure are as diverse as the methods of change. This trend of splitting and reforming has been going on since the 1960’s. There are times when the rate of change slows and times when it seems virtually manic. What seems readily apparent is that this restructuring is unlikely to cease.

Within this context, the benefit plans of both the acquiring and the acquired entity or the divesting and the divested entity become subject to possible change. That change may be triggered by regulatory requirements, industry standards or simply the benefit objectives of either party. From the perspective of the plan sponsor and the participating employees, these changes are not always desired or considered beneficial. The purpose of this working group was to survey what has been happening in this context.

Over a six-month period 15 witnesses from the Departments of Treasury and Labor, Internal Revenue Service, practitioners advising plan sponsors, corporations and participant advocacy groups testified on issues related to the benefit continuity and other consequences arising from the restructuring of the plan sponsor. Their testimony and the accompanying evidence has been subjected to the consideration by the members of this Working Group. Those members are all experts within their respective areas of ERISA and their value in arriving at this report must be recognized. It is the combination of these resources that serve as the backbone for the Working Group’s findings and recommendations.

The testimony and data we collected support the premise that there is often conflict between the policy goals of various aspects of the law. This conflict contributes to the apparent difficulty for either party to any restructuring to maintain absolute continuity in its benefit structure.

The Working Group unanimously makes the following recommendations regarding these challenges:

  • The entities responsible for enforcing all of ERISA (Department of Labor, Department of Treasury, Internal Revenue Service, Pension Benefit Guaranty Corporation, etc.) should create two public service guides in this area. The plan sponsor guide would advise sponsors of the issues that result from a restructuring regarding participant notices, vesting periods, protected benefits, etc. The employee guide would advise employees of their rights, changes that they may expect to see, where they can obtain information or assistance, etc.
  • Disclosure was a consistent theme of the hearings. In this context, the Department of Labor is encouraged to look at the current disclosure provisions of ERISA and consider whether it may be appropriate to revise these rules in light of today’s fast-paced, rapidly changing, electronic workplace.
  • The third category of recommendations deals with transition relief. The Internal Revenue Code contains a transition rule for the participation and coverage test in a retirement plan following an acquisition of divestiture. The recommendation is that comparable transition relief under ERISA and the Internal Revenue Code should be extended to a number of benefit areas and plan types.
  • Finally, although during the hearings a number of technical issues were raised, insufficient data was gathered to make specific recommendations in these highly technical matters. Thus, our recommendations are limited to drawing attention to these issues and encouraging a continued study of the challenges posed.

The remainder of this report highlights pertinent testimony and sets forth in greater detail the Working Group’s findings and Advisory Council recommendations on the challenges to benefit continuity after an organizational restructuring.

Introduction - Laying the Groundwork

According to Thomson Financial Securities Data, mergers worth $1.6 trillion were consummated in 1999. This is nearly triple the value of such activity in 1996. They are currently reporting $2.4 trillion of activity through the middle of October 2000.(3) This is global activity. As such, it may overstate the activity in this country. However, this report highlights only reported mergers or acquisitions. It does not include activity in small, private companies, not-for-profit markets, outsourcing, etc.

The U.S. activity reflected in this report is further amplified by actions of the Federal Trade Commission and the Justice Department. These agencies frequently require that entities wishing to combine divest themselves of segments prior to approving the combination. The following chart illustrates the increase in this activity over the last 5 years.(4)

For example, when 2 large financial institutions desired to combine, they had to agree to divest themselves of 306 branch offices in 4 states. When two large waste collection enterprises combined earlier this year, they had to sell off operations in 15 locations. This phenomena is also supported by a recent study released by The Conference Board. That study highlighted significant downsizing following business combinations.(5) Buyers in successful combinations reported significant downsizing of their workforce 51 percent of the time. Sellers observed downsizing in their workforce in 71 percent of the successful combinations.

All of this activity involves shifting of workers from one employer to another. Some employees may shift through more than one employer within a year. The Conference Board study noted above involved 134 corporations who had participated in at least one combination since 1990. Of these respondents, half had participated in more than 5 mergers or acquisitions between 1990 and 1999. The median number of such events was 3.(6) The importance of employment issues in such activity is demonstrated in the report by the relative participation levels of key executives in the activity. Human resources executives of the acquiring companies were involved 81 percent of the time in the pre-merger negotiations. This rate of participation was exceeded only by the role of the chief executive officer. After acquisition, the human resource executives reported participation 90 percent of the time in the post-merger discussions. This exceeded the participation level of every other executive position in the post-merger integration. This activity highlights the importance of these issues.

Percent Delivering Input Pre-Merger Post-Merger
Buyer Seller Buyer Seller
Rate of Participation by CEOs
CEO 91 79 66 52
Human Resources 81 59 90 58
Communication 54 35 67 34
Operations 67 54 72 61
Legal/Financial 88 71 67 42
Employees 25 25 53 50
Consultants 46 32 28 14

Lest too much emphasis is placed on the place of ERISA plans in this workload, consider that the HR executive’s duties included:

  • Benefits
  • Business Unit Management
  • Change Management
  • Communications
  • Compensation
  • Compliance
  • Contract Review
  • Cultural Integration
  • Downsizing
  • Due Diligence
  • Executive Orientation
  • Integration Team Leadership
  • Labor Relations
  • Merger Negotiations
  • Organizational Development
  • Organizational Structure
  • Outplacement
  • Payroll
  • Pensions
  • Personnel Assessment
  • Planning
  • Purchasing
  • Relocation
  • Resources Review
  • Retention
  • Reward and Recognition
  • Severance
  • Staffing
  • Succession Planning
  • Training
  • Transitioning
  • Work Force Integration

The Conference Board report highlighted some interesting aspects of what the respondents considered to be either successful or unsuccessful merger experiences. There were many troublesome issues presented in such combinations. Apparently the most difficult to resolve were matters such as attitudes towards balancing work and family issues. The following table summarizes the situations encountered relative to ERISA plans.

Issue Companies were Dissimilar Companies Resolved Their Differences
Merger Situations Encountered by ERISA Plans
Retirement Package 67 % 85 %
Health Benefits 57 % 87 %
Employee/Labor Relations 38 % 92 %

It is not surprising to note that the ability to resolve differences in these areas was inversely related to the extent of the differences.

In this background of rapid, complex and increasing activity as plan sponsors go through varying forms of reorganization, ERISA and the Code have to provide a balance of flexibility to sustain this activity and enforcement to protect the employees vested interests in their benefit plans during the course of such changes. This report summarizes the insight the group has gathered from the testimony of expert witnesses called to share their experience and opinions on this important topic.

Chapter One of the report outlines the existing statutory and regulatory framework in which this activity takes place. The Working Group listened to testimony from representatives of the Department of Labor, Internal Revenue Service and Department of Treasury. Each entity outlined the ERISA provisions under its jurisdiction that impact restructuring of the plan sponsors. These provisions included those with direct and indirect implications for continuity.

In Chapter Two the plan sponsors’ side is explored. Testimony was received from senior human resource officers of corporations that had been involved in both sides of a reorganization – the acquirer and the acquired. Testimony was also taken from legal and consulting professionals.

Chapter Three describes the employees’ perspective on this matter. Testimony was taken from active and retired employees and their advisors. In general, the reported employee attitude towards the impact of restructuring on their benefit programs was negative. The Conference Board Report may give some insight as to why this is true. In reporting what constituencies were involved in the process, it is enlightening to note that employees were only involved 25 percent of the time during the planning and negotiation stage and about half the time during the implementation phase. (See the chart on page 4.) The Conference Board had also studied employee communications in business combinations in 1999. In that report, employees below middle management reported being less committed to any impending merger, receiving less communication or training than any other internal stakeholder group. For example, only 1 percent of the reporting firms gave any training to rank and file employees in contrast to over 50 percent offering such training to upper management.(7)

Chapter Four of the Report provides the Work Group's findings and recommendations arising from this discussion and analysis.

Chapter 1: Statutory Framework

Testimony was solicited from the Internal Revenue Service, Department of Treasury and Department of Labor to establish a general understanding of the attributes of employee benefit plans that are involved when the sponsor undergoes an organizational restructuring. The following table summarizes these provisions and the related policy effect.

Provision Effect Jurisdiction
Attributes of Employee Benefit Plans Whose Sponsors Undergo Organizational Restructuring
Written Plan Participant rights and employer duties fixed and cannot be modified by informal written or oral communications. DOL and Treasury/IRS
Settlor Functions Employer privilege to design plan terms as it sees fit to meet its operational objectives. DOL and Treasury/IRS
Fiduciary Conduct The plan is to be operated for the exclusive benefit of plan participants and their beneficiaries. DOL
Participation/Coverage Tax benefit is conditioned upon covering a fair cross section of the workforce, based on income. Generally such cross section is determined by percentages, but in some cases (such as self- insured health plans), it can be based upon a subjective fair cross section. Treasury/IRS
Nondiscrimination Tax benefit is conditioned upon the plan’s providing substantially similar benefits to highly compensated employees and rank-and-file employees. Treasury/IRS
Anti-cutback rules When included in the written plan, many benefits may not be eliminated or reduced. Included in the list of protected benefits is a participant’s right to already-earned early retirement benefits and subsidies. DOL and Treasury/IRS
Vesting Participant must have a nonforfeitable right to a benefit, once they have satisfied a specific minimum number of years of service with the plan sponsor.


There is a Code section governing the measurement of service in the case of a successor maintaining a plan of a predecessor employer. This has been in the tax code for 25 years with no regulation explaining how and when it applies.

DOL and Treasury/IRS
Aggregation/Affiliation Special definitions of employer, so that the rules for nondiscrimination, coverage, vesting, etc. cannot be avoided by using multiple entities for a unified enterprise. Treasury/IRS
Combined plan limits The amount of benefits that may accrue with full tax protected status is limited. Treasury/IRS
Funding Assets must be set aside to fund retirement benefits, and held solely for that purpose. The laws specify details on the schedule for funding defined benefit plans. DOL and Treasury/IRS
Distribution Restrictions Retirement plans are granted tax benefits for providing retirement income. Thus, the participant’s right to access funds prior to retirement is limited. Treasury/IRS
Tax-Free Rollovers To encourage retention of savings for retirement, participants may transfer funds from one tax- sheltered retirement vehicle to another without current taxation. IRS/Treasury
Health Coverage Continuation (COBRA) Except for those employing very few employees, employees can to continue their employer- provided health coverage at group rates in the event of certain loss of coverage events, including termination of employment. DOL and IRS/Treasury
Pre-existing Medical Conditions A person who had health coverage from a prior employer cannot be excluded from coverage at a new employer due to a pre-existing health problem. DOL and IRS/Treasury

When a plan sponsor goes through a restructuring - merger, acquisition, spin-off, etc. - these statutory provisions frequently create challenges for the entities involved and often have the unintended effect of creating conflict between ERISA’s statutory goals. For example, the anti-cutback provisions require that certain types of benefits be continued if the plan is maintained by a successor employer. One such protected benefit that must be preserved is an early retirement benefit. If the acquired company's plan provides for early retirement distributions upon the attainment on one set of age and service criteria and the successor employer's plan includes no early retirement provision or applies other age and service criteria, the successor’s plan must preserve both options for the benefits that the acquired group had earned by the date of the change. If the successor company does not wish to include this provision for all employees from that point forward, it must account for the two groups separately and test each for nondiscrimination. If it is unwilling to provide for this separate accounting of the participants' interest, then the likely result would be elimination of this option for future benefits earned by the acquired company’s employees or possibly termination of the acquired company’s plan. Thus, this statutory goal of protecting benefits would come into conflict with the fundamental goal of preserving benefits for retirement.

Not all of these provisions create such challenges. The Treasury and IRS have taken great care in drafting the regulations surrounding COBRA (health coverage continuation) to address specific issues and concepts involved in the restructuring of the plan sponsor. The proposed regulations issued in 1999 include detailed guidance in the restructuring of a corporate plan sponsor. In addition, Health Insurance Portability and Accountability Act or HIPAA limited a consequence that could have resulted in loss of coverage during sponsor restructuring. This is the provision that restricts the ability of a successor employer to apply a pre-existing condition clause to the employees coming into its plan.

The regulations for cafeteria plans do not include specific details regarding the implication of the rules in the event of the restructuring of the plan sponsor. Rather, the cafeteria plan rules must be examined from the perspective of the impact of any change upon the participant. Thus, a participant can change its election to make pre-tax contributions towards health coverage under a cafeteria plan, if the successor employer does not maintain a health plan or if it offers different coverage. However, the employee can only replace, not eliminate, the prior coverage with similar coverage. Some cafeteria plans include medical spending accounts, funds that employees set aside from their pay to cover a variety of medical costs with pre-tax dollars. The treatment of such amounts in the context of mergers or divestitures is not discussed in the regulations and it is unclear whether these balances can transfer when the plan sponsor transfers the employees in something other than an equity sale.

The concepts of settlor and fiduciary functions address the balance between the employer’s versus employee’s rights under a benefit plan. Settlor function describes the employer’s right to adopt plan terms that are consistent with its business objectives and are within the limits of the law. The fiduciary function is the obligation of the persons responsible for the plan (Plan Administrator, Trustee, etc.) to operate it, consistent with its written terms, but with consideration of the best interests of the plan participants. Thus within these two basic concept, an employer is permitted to take an action that is within the law, though it could be considered disadvantageous to plan participants.

This can be illustrated by the issues presented to a successor employer with respect to the pre- existing plan of the predecessor.

The plan may be terminated and the balances distributed to the participants.

The plan can be frozen and the balances held in a separate plan until each participant becomes eligible for distribution under the normal plan terms.

The plan can be continued for the existing workforce, subject to the various nondiscrimination and coverage rules.

The plan can be amended to increase or reduce future benefit accruals, to add features or to remove unprotected features.

The plan can be expanded to cover the employees of the buyer’s workforce, if any.

The plan can be merged into the plan of the successor.

All of these choices would be executed under the sponsor’s settlor rights. Once the decision is made, however, the oversight of the operation of the plan including the investment of plan assets, timing of liquidation of assets, efforts to identify the appropriate participants and beneficiaries, etc. would fall within fiduciary conduct.

ERISA does include a requirement that employees be notified of significant plan changes. For a pension plan, notification of any change that reduces the rate of future benefit accruals must be given before such amendment is in effect. For most other changes, such notice is not required until after the end of the year in which such change is effective.

It must be recognized that the statutory framework is constantly being modified. During the seven months that the working group studied this issue, the government issued guidance that provided relief in several areas within the scope of this project. For example, the Pension Benefit Guaranty Corporation issued guidelines to clarify when, under its early warning system, the agency might raise concerns in the event of a spin-off of a segment of the workforce. The IRS provided some relief on the anti-cutback rules and the “same desk” rule. This relief allows a profit sharing or stock bonus plan to eliminate all payment options other than a lump sum and allows for distributions from 401(k) plans within specific fact patterns common in many, but not all restructurings.

See Relevant ERISA Provisions for more information on the specific statutory provisions involved in each policy area.

Chapter 2: The Employer Perspective

“....Even if we are giving them more benefits in total, they take the pluses for granted and look at and magnify what they lose.”

“But even minor benefits lost to seller are perceived by [employees] as big takeaways. Employees who experience the most change are preoccupied by what is being taken away.”

Anonymous respondents to The Conference Board Study(8)

While retirement plan concerns were the most frequently raised by testimony from employers, health plans and cafeteria plans were also mentioned as presenting problems. At least one speaker strongly believed that the laws and regulations could have the “perverse effect of subverting objectives that Congress sought to achieve when it enacted ERISA.”(9) In contrast, another speaker challenged the working group on the implication that benefit continuity was a suitable goal(10). This witness noted that in an efficient market, an employer will seek to provide to employees what benefits they value. The working group does not dispute this position. The focus of this report is not on the employer’s choice of providing or discontinuing benefits but rather on where the provisions of the law or regulations restrict or eliminate the employer’s choice in what benefit package or features to offer following a restructuring.

Retirement Plan Matters

Fiduciary Conduct: Investment issues are increasingly being raised as participants are transferred from the sellers 401(k) plan to the buyers 401(k) plan. The buyers plan and the sellers plan rarely have exactly the same investment options. It is often difficult to obtain new elections in advance of the closing date of the transaction because of the timing of the transaction. Yet it is important to the participants that their salary reductions continue uninterrupted to obtain the tax advantage of the 401(k) plan. Even if the continuing investment options cannot be preserved, continuing participants existing deferral elections is the least disruptive alternative and the most likely to enhance long-term savings. That money then must be invested. Inevitably, some participants do not make timely elections as to how their salary deferrals and matching contributions should be invested.

Employers have two choices: invest the money in comparable funds in the buyer’s plan or put those amounts in a safe investment such a money market fund which protects the principal until the participant makes and investment choice. Either alternative could result in a loss to the participant, either in the form of an actual loss of principal in a higher yielding investment or in a lower return in the safe investment. Yet the alternative, which is to discontinue the salary deferrals for a period, is clearly not the right policy answer.

Automatic Enrollment: The IRS has issued guidance indicating that automatic enrollment (so- called negative elections) for and Internal Revenue Code Section 401(k) plan and Section 403(b) deferrals is permissible under the Code. Fiduciary issues concerning the investment of the funds continue to concern employers, both in on-going plans and in restructuring transactions. Guidance from the Department providing guidance on safe harbor investment options that would not cause the plan to lose its ERISA Section 404(c) protections or that would provide some other sort of comfort for fiduciaries would go a long way toward insuring uninterrupted 401(k) savings. The witnesses suggested that appropriate safeguards could be built in to ensure that funds are indeed comparable and that participants are informed of their right to change investment options.

Employer Stock: Employer stock poses its own problems in restructuring situations. Often employees would like to retain their current investment in the sellers stock. In the buyers plan, however, that stock generally loses its status as employer stock and therefore poses diversification and fiduciary issues. (Certain defined contribution plans are permitted to hold qualifying employer securities without regard to the normal fiduciary conduct consideration of diversification.) Again where the transferred participants have the option to transfer their investment from the sellers stock to other investments in the buyers plan, one witness proposed that the buyers plan should be permitted to treat the seller stock fund as employer securities. The participants would have made the investment choice already in the sellers plan; the transfer to the buyers plan should not cause that investment option to lose its 404(c) protections or subject the new plans fiduciaries to responsibility for offering the other employer stock option to participants. The same issue can arise in a spin-off or a joint venture, where employees want to keep some investment in the former parent company stock.

For a non-traded company, employer stock in a plan can pose an additional problem. If the plan retains the shares of the original sponsor following a restructuring, those shares may lose their status as qualifying employer securities relative to the plan. That means that the plan may be restricted in its ability to divest itself of the shares. The law provides a procedure for the sale of qualifying employer securities to a related party. Such procedure would not apply to a sale of nonqualifying employer securities. But the only market for those non-traded securities may be limited to an entity that is related to the plan or plan sponsor. This leaves the plan in the situation of having to request an individual prohibited transaction exemption. This process is costly and time consuming. Furthermore, during this period, the plan is required to hold such asset, which may be inconsistent with the overall objectives of the plan fiduciary.

Defects in the operation of the seller’s plan: Buyers are sometimes reluctant to take transfers from the sellers qualified plans for fear that the receiving plan would be tainted by qualification defects or ERISA violations of those plans. Earlier this year, regulations were issued that protected a receiving plan that accepted a rollover from a defective plan, holding that such a rollover will not jeopardize the receiving plans qualification. The witnesses testified that similar guidance with respect to direct transfers would encourage plan-to-plan transfers allowing the transferred employees entire benefit to be provided from the same plan without the administrative complexity of rollover and the inherent risk of leakage for those employees who do not roll over. Guidance from Treasury extending the same protection to transfers would encourage benefit continuity. The preamble to the regulation indicated that Treasury received a comment urging this result and was considering issuing guidance.

Typically a buyer is unable to identify problems with a plan, particularly operational problems, until after the transaction when the buyer has been administering the plan for some period of time. Currently the IRS and DOL voluntary compliance programs provide no relief for a buyer who finds and corrects defects inherited from a seller, either when an entire plan is transferred or when a portion is transferred. The witnesses offered that both voluntary compliance programs should make it clear that a buyer who corrected defects inherited from the seller’s plan should face reduced penalties if the defects were identified and corrected within a specified period of time after the transaction. Since these defects are often operational in nature, they are often detected only on audit, which takes place after year-end. The speakers encouraged that the transition period chosen should be long enough to complete the first full audit (e.g., until the end of the second year after the transaction). The witnesses offered that if buyers are encouraged to identify and correct these defects without fear of penalties, they might be more likely to continue the seller’s plan.

In addition, the witnesses noted that the current relief programs are limited to retirement plans. They suggested that the DOL and IRS voluntary compliance programs should be expanded to include COBRA, HIPAA, and other health and cafeteria plan issues.

Anti-Cutback and other benefit protection issues: Often concern about preserving benefit distribution forms or other ancillary benefits protected by section 411(d)(6) prevents buyers from accepting a transfer of assets and liabilities from the sellers plan. The Treasury has granted relief to defined contribution plans for changes in distribution options, but the witnesses observed that obstacles remain for defined benefit plans. From the employers perspective, circumstances exist where eliminating options should be permitted, easing the administrative burdens (and attendant cost) on plans without jeopardizing participants. For example, where a frozen option applies to only a small part of the benefit or where an option of equal actuarial value is rarely if ever chosen by participants, the plan should be free to eliminate that option. This would encourage buyers to accept transfers, knowing that over time they could eliminate these vestigial options. The speakers suggested that this change would reduce the number of plan terminations otherwise occurring during restructuring transactions.

One speaker suggested that the right to eliminate the joint and survivor option in profit sharing and stock bonus plans should be extended to money purchase pension plans.

Vesting: Similarly, problems were cited with grandfathering vesting formulas in transfers. Allegedly, companies have refused to accept transfers of assets from the sellers plan because they do not want to be required to administer different vesting schedule for future contributions. However, they are willing to fully vest as to old money. This alternative puts the participant in as good or better situation than they would be if their account were left with the seller, who might or might not have the obligation to vest the transferred participants, depending on whether the transaction resulted in a partial termination.

Nondiscrimination rules: Often the provisions that create the most difficulty for plan sponsors are those aimed at nondiscrimination under the Internal Revenue Code. Designed for a single employers workforce, the rules do not work well for large employers with diverse businesses that are often engaging in mergers, acquisitions and divestitures. These provisions can prevent the employer from continuing the benefits that employees had under the sellers plan because the mathematical tests cannot be met. The successor can encounter the following problems when trying to meet the transferred employees expectations that their benefits will continue unchanged and the problems that can arise under the nondiscrimination rules:

  • Grandfathering the seller’s pension design for transferred employees, which is the option that protects the transferred employees’ expectations without increasing the buyer’s costs for its other employees. This can create discrimination testing problems as the group of transferred employees shrinks over time and becomes more senior (and therefore more highly compensated).
  • If the buyer is willing to continue the existing pension design for the entire acquired business unit on a permanent basis, continuing the benefits often result in expensive discrimination testing. Further, the separate benefit formula may not satisfy the discrimination testing rules if the mix between highly-compensated in the acquired group is significantly different than in the acquiring group.
  • Results of non-discrimination tests are rarely known at the time of the transaction, making buyers reluctant to commit to continuation of the existing benefit structure beyond the transition periods, even though as a business matter they may be willing to make such a commitment. Worse yet, employers who do make extended commitments to their new employees may find themselves flunking the tests as time goes by, particularly as they acquire and sell other businesses.

Same desk rule for 401(k) plans: Based upon the number of comments, the same desk rule that prevents distribution of participants accounts from IRC section 401(k) plans is a frequent source of frustration in transactions. While IRC section 401(k)(10) solves the problem by permitting distributions in certain cases and the IRS has recently issued guidance indicating a narrowing of the same desk rule, certain transactions are still covered by the rule (such as joint ventures and sales of partnership and LLC interests). This rule is cited as being particularly difficult to explain to plan administrators and participants because employees may be permitted to receive distribution of their benefits under the defined benefit plan, to which the Service has said the same desk rule does not apply. On the other hand, these employees may be unable to receive a distribution of their own deferrals under the 401(k) plan due to the same desk rule.

Health Plan Matters

Temporary Sharing of Employees: One of the items raised in the context of health plans is the frequent use of transition employment agreements, where the seller continues to provide health coverage for some brief period for the employees taken over by the successor. A transaction may close when financing is obtained or the Hart-Scott-Rodino antitrust period ends or when regulatory approvals are obtained or simply when the business people iron out all the details. This may not coordinate neatly with the year-end of a benefit plan.

Continued participation in the seller’s health plan, which would create the least disruption, is often precluded by fear that covering these former employees would create an unintended “multiple employer welfare plan” (MEWA) which would be subject to state insurance laws. Earlier this year, the Department responded to this concern in the context of a new MEWA filing requirement created by HIPAA. The Department issued guidance that relieved employers of the obligation to file the Form M-1, at least for this year, if the plan might be a MEWA solely because it provides temporary coverage of former employees in change in control transactions (such as mergers and divestitures). Under the Department’s guidance, the arrangement is considered temporary (and a filing will not be required) if it does not extend beyond the end of the plan year following the year in which the change in control occurs.

Although this guidance deals only with the plan’s reporting obligation on the Form M-1, it does indicate that the DOL is aware of the issues posed in these circumstances. Several witnesses proposed that uninterrupted health benefit coverage would be facilitated if the Department issued permanent guidance that a health plan is not a MEWA where the multiple-employer feature exists solely to facilitate a restructuring.

Cafeteria Plan Matters

Discrimination: Earlier the Code provisions relating to nondiscrimination were discussed for retirement plans. These important protections do contribute to the complexity of managing retirement plans during restructuring, but the Code has relieved this complexity somewhat by providing a transition period. The situation is even worse for cafeteria plans, flexible benefits, and self-funded health plans, where discrimination rules apply, but there is no transition period. While testimony indicated that most IRS offices seem to allow a reasonable transition period, this is by grace of the individual examiner. It would contribute to predictability to have official guidance making it clear that continuation of the sellers benefits for some period of time will not violate the various nondiscrimination rules.

Transfer of Flexible Spending Accounts: Several witnesses testified about the absence of guidance on the right of a successor employer to assume the obligation for pre-existing employee contributions to medical flexible spending accounts. Though the Treasurys perspective on this matter was that these deferrals have the character of insurance, it is not clear that permitting the continuation of these benefits would violate any policy objective and such permission would contribute to continuity. The absence of guidance creates unnecessary confusion and should be corrected.

Chapter 3: The Employee Perspective

"We need legislation to amend ERISA to return it to its original intent, protect the retirees."

A. J. “Jim” Norby, Northwestern Bell retiree

The organizational restructuring of an employer commonly causes uncertainty and anxiety among employees, pensioners, and their families. Among their many concerns are the effects of the restructuring on their health care coverage, expected pension benefits, and other employee benefits, as well as the effects on their jobs, salary and wages, and other terms and conditions of employment. The employer controls the business and the benefit plans (except in the case of multi employer, Taft-Hartley Act plans). Rarely do employees, much less pensioners, have influence over restructuring decisions or the effects of those decisions on terms and conditions of employment, except, perhaps, where the employees are represented by a labor union with collective bargaining and labor law rights. This lack of control and influence exacerbates the concerns of employees and pensioners.

These concerns can often be mitigated through timely, comprehensive, honest communication from the employer to the employees, pensioners and, in a unionized setting, their representatives. In any event, employees and pensioners have a right to know how a restructuring affects their employee benefits and to know as quickly and accurately as possible. Full disclosure was clearly important to the drafters of ERISA; in fact Title I, Part I of ERISA deals with reporting and disclosure. If employees receive full and clear disclosure of what is happening, then they can make informed decisions.

Most benefit plan changes are made by the employer in the exercise of its "plan sponsor" authority to design and amend the plans. In 1974, the authors of ERISA strove to strike a policy balance between protection for plan participants and the voluntary maintenance of pension and health plans by employers -- now Congress should revisit that essential balance. A fiduciary’s duty under ERISA to provide timely, honest, and comprehensive disclosure to plan participants is being expanded by the courts. But, according to employee representatives that gave testimony to this working group that expansion is not moving fast enough, and it is not broad enough to include employers acting in their non-fiduciary roles as plan sponsor. While employers complain that provisions of the law inhibit continuity of benefits in a restructuring, employees and pensioners are concerned that these laws are not sufficiently protective of their vital interests.

Some of this inconsistency is inherent in the law, which is written to grant employers some freedom to make changes as seen necessary to meet business conditions. Some of the inconsistency may, however, be attributed to a simple failure to communicate. This perspective was acknowledged to some extent in the Conference Board’s report:

"Awareness that employees are not fully engaged in the bulk of mergers should act as strong preventive medicine. This means not only ratcheting up customized communications to the rank and file but also developing means for actively involving their input to the merger process and developing the ability to surface and listen to concerns–in decisions from crafting of new values and behaviors in the joint company to downsizing and talent retention. The data on employee distance from merger policy and process are sufficiently clear as to justify a cultural shift by top management as well as by senior HP people. Senior executives often have the right words about employee value, but may lack a supporting body of practices. Many companies report that the disconnect between words and actions in this area has come home to hurt them in retention and ability to fully integrate new teams."

Retirement Plans

Employers often make oral or written representations regarding the maintenance of a certain level of benefits – employees may take these comments as promises. When the successor employer does not maintain such levels, the employees understandably take it as a breach of trust. Employers also make oral representations relative to their relationship with the employees. These may go beyond the literal language of the plan document – and witnesses represented that employees may make employment decisions to take a job or to stay with a job based upon these oral or written representations. Witnesses did not suggest that the employees believe that the successor employers had violated the law – rather witnesses on this point merely wished to point out that they did not believe that the law went far enough to protect employee expectations.

While the employers expressed concerns over the restrictions imposed upon their decision- making under the anti-cutback rules, the employees expressed concerns over the employer’s right to reduce future benefit accruals. Witnesses noted that the marketplace currently provides many opportunities for employees in aggregate but this fails to take into account the circumstances employees face as individuals.

Specifically, these factors were cited as working to disadvantage the employees:

  • The failure to recognize prior service with the predecessor employer when an employee stayed in the same job, but with a new employer.
  • The decision by a successor employer to curtail the prior pattern of providing cost of living adjustments to retirees.
  • One witness, legal counsel to several employee groups, noted that one of the difficulties for employees under ERISA is the access to relief. Too often they must file suit to obtain relief.
  • Notices of change in benefits, other than reductions in future accrual rates, are not required to be communicated until after the end of the plan year.
  • Finally, employees must pay copying fees to obtain something as basic as a copy of the plan document.

The witnesses recognize that these matters may have been permissible under the law, but they still changed the expectations of the affected employees.

Some of the issues raised by employees may go beyond policy conflicts within the law and deal with violations of current law. This working group has studied the existence of conflicting provision or the absence of guidance. To the extent that a fact pattern highlights matters that arose during a restructuring but may have been a violation of the law, they are beyond the scope of this report.

Welfare Plan Concerns

Similar to retirement plans, the primary employee issue with welfare plans is the reduction in expected benefits. The witnesses testified to cases of the reduction or elimination of post- retirement health benefits or the increase in the retirees’ required contribution to such plans. These highlight the lack of clarity for professional advisors in the field of employee benefits, employees and retirees on the rights of the employer to change expected post-retirement welfare benefits.


The witnesses recognized the improvements that ERISA has made. Financial solvency of benefit plans has been substantially improved. The disclosures to employees are more frequent and complete. Employees’ right to obtain access to plan documents has been improved and their ability to seek relief has been enhanced. However, communication problems remain. Notices are frequently too brief and the employee’s right to obtain information is frequently after the fact and, maybe, as much as 19 months after the fact.

Chapter 4: Findings and Recommendations


Over a period of six months, the Working Group heard testimony from the Department of Labor, Department of Treasury, Internal Revenue Service, corporations, employee organizations and advocacy groups and their counsel on issues related to the issues encountered upon the reorganization of a plan sponsor. Based on the testimony heard and the information that was submitted, the Working Group has made the following observations:

  • The level of plan sponsors restructuring is increasing without any indication of slowing.
  • Required notice to plan participants of the benefit plan changes following a restructuring often are made after any changes to the plan have been adopted.
  • The nondiscrimination rules of the Tax Code are indeed a challenge to benefit continuity. While compliance with these rules often requires sponsors to change plans, we are not convinced that the policy goal of nondiscrimination should be overridden by the continuity objective.
  • The notice of the reduction in benefit accruals required by ERISA Section 204(h) is to be issued after the amendment for such reduction has been passed, but at least 15 days before it is effective. As a pension plan may be amended concurrent with the effective date of the merger or other restructuring, this timing is complicated in the event of the confidential negotiation on the restructuring of a sponsor. We cannot see a clear resolution to this matter, as the details involved in such notice cannot easily be reduced to a safe harbor statement.
  • Several speakers noted the problems of complying with ERISA Section 404(c) while changing fund choices due a change in the plan sponsor. One speaker recommended that the Department provide a safe harbor notice or other relief for compliance with ERISA Section 404(c). The working group did not go so far as recommending that such a safe harbor notice be issued, as it was difficult to anticipate what it would entail. However, the difficulty in complying with Section 404(c) where the acquired plan’s portfolio must be conformed to the investment options of the new sponsoring organization should be addressed in the recommended transition relief.
  • The witnesses reported that obtaining relief as a separate line of business under IRC Section 414(r) was difficult. The working group recognizes that this is an extremely complicated area and does represent a compromise between flexibility and the general policy goal of nondiscrimination.
  • The absence of a statute of limitations under ERISA for participant benefit claims and the subsequent default to the various State laws setting limitations was cited as a complexity in reorganizations. The successor employer may continue to be at risk for an uncertain period for unknown defects of its predecessor. The witnesses from the government acknowledged this issue, but advised that any change could have ramifications that go well beyond the scope of this working group. As such, this matter is left as the possible topic for a future working group study.


We unanimously make the following specific recommendations:

The Department should create in conjunction with the IRS and PBGC guides to employee plan issues related to restructuring. We recommend that these agencies solicit input from stakeholders in drafting these guides.

The employer’s guide should be readily available in print and on each agency’s web page. It should include (but not be limited to) reminders of the following technical rules frequently overlooked in such transactions:

  1. The double counting of service credit in the event of a change in year-end,
  2. Partial terminations
  3. Form 5500 reporting periods,
  4. Record retention requirements,
  5. Statute of Limitations, and
  6. Timely employee disclosures, etc.

The employees’ guide should also be made available in print and added to each agency’ web page. It should include, but not be limited to:

  1. Education/communication of employee rights to information.
  2. Common benefit effects in the event of the restructuring
  3. Employee rights to information, documents, etc.
  4. How to access such information; reach the DOL hotline, etc.
  5. Other sources of information and assistance.

Disclosure Issues

The Department should consider developing a legislative package that re-examines the timing of the disclosure requirements, such as the 90-day requirement for the SPD, 210 days for the Statement of Material Modifications, particularly in the context of sponsor restructuring.

In the current debate regarding disclosure of fundamental plan changes, specific consideration should be given to disclosure of changes resulting from a restructuring.

Transition Relief

Each agency responsible for enforcing ERISA has issued policies, rules or regulations that relate to sponsor restructuring. These should be reviewed for the following:

  1. In general, these provisions address the purchase or sale of assets or stock. In today’s marketplace, restructuring takes many forms. These include non- corporate successor employers, partnership joint ventures, the outplacement of a segment of the workforce, etc. Each agency should assess their regulations to determine if they need to be clarified or refined to respond to this change in the marketplace.
  2. In this context it is important to note that the IRS had hoped for insight in this area when they solicited comments on the recent changes to the COBRA regulations. Such input was not forthcoming from the professional community. It remains both prudent and necessary to obtain the guidance, cooperation and assistance of the professional advisors to these sponsors for comprehensive relief to be developed.(11)
  3. The Internal Revenue Code minimum coverage rules include a specific transition provision for retirement plans undergoing a change in sponsors. This is found in Internal Revenue Code Section 410(b)(6)(C). Each of the agencies should be encouraged to review such provision to determine whether such a transition period could be applied to its operations. Such reconsideration should expand to include welfare benefit plans.

The current program for reduced penalty rates in the event of the voluntary filing of late Forms 5500 should be revised to provide for some reduced fees or waivers where a successor employer files the late reports of the predecessor employer.

Both the Department of Labor and the Internal Revenue Service have developed programs that allow plan sponsors to correct plan defects. Specific, discounted relief for corrections made by successor employers should be given.

The Department of Labor should look at the current claims regulation project in the context of what provisions are in place where there has been a change in the plan sponsor from the sponsor who administered the plan at the time the claim arose.

The Department of Labor should consider granting prohibited transaction relief where a plan holds a non-traded security that loses its status as a qualifying employer security due to the restructuring of the plan sponsor. Such relief might involve a prohibited transaction class exemption or a transition period from the date of acquisition in the existing provision for buying, selling or holding qualifying employer securities.

The Department should grant an exemption from MEWA status for situations where 2 or more unrelated employers sponsor a common welfare plan that covers employees who are transitioning from one employer to another consistent with the relief already included from the filing of the Form M-1.

Technical Issues – The Secretary of Labor should consult with the Secretary of Treasury and the Executive Director of the PBGC, as appropriate, on the following matters:

Investigate the policy considerations associated with revising the cafeteria plan regulations to specifically authorize the transfer of flexible spending accounts as part of a restructuring.

Expand the current relief on the same desk rule to include other entities such as partnerships, limited liability companies, etc.

Reconsider the anti-cutback regulations under IRC Section 411(d)(6) in the context of allowing a defined benefit plan sponsor to eliminate certain redundant or de minimis distribution options.

Revise the PBGC premium policies in the event of a spin-off of plan balances. A double payment can arise where a transaction involves a change in plan years -- a premium was due on these participants at the beginning of the predecessor’s plan year and, again, for the successor plan.

Review the procedures for qualifying as a separate line of business (SLOB) when an existing plan sponsor acquires an entity that was a separate business prior to acquisition.

Summary and Testimony of Expert Witnesses

May 9, 2000

Summary of Testimony of Alan Tawshunsky, Special Counsel to the Division Counsel/Associate Chief Counsel, Internal Revenue Service, Tax Exempt and Government Entities Division

Mr. Tawshunsky focused his remarks on two major statutes that deal with provisions that overlap both the Internal Revenue Code and Title I of ERISA -- the Consolidated Omnibus Budget Reconciliation Act of 1985 ("COBRA") and the Health and Insurance Portability and Accountability Act of 1996 ("HIPAA"). It is his opinion that these statutes tend to promote continuity in the event of mergers and acquisitions.


He began his remarks by stating that the set of proposed regulations issued in 1987 provided very little guidance to plan sponsors on how COBRA applied in mergers and acquisitions. This lack of guidance caused uncertainty for the employer because it was not clear as to who had the responsibility to provide COBRA coverage. These uncertainties also caused a number of employees to "fall through the cracks". New proposed regulations were issued in 1999 to address the merger and acquisition situation. The finalization of these regulations is a part of the Treasury Department's business plan for 2000. The new regulations will provide greater certainty for employers as to who is responsible for providing coverage and certainty for employees as to whether a transaction entitles them to coverage.

According to Tawshunsky, there are three groups of potential "qualified beneficiaries", including dependents that must be considered when dealing with COBRA in merger and acquisition situations. First, the participants in a group health plan who have a "qualifying event", i.e. termination of employment before the acquisition; second, participants whose employment is terminated in connection with the transaction; and third, participants who are employed by the buyer after the transaction. He indicated that the new proposed rules address COBRA liabilities in two types of situations: 1) sale of stock and 2) sale of substantial assets. In both stock sales and asset sales, the employees in the first and second groups are entitled to COBRA coverage and the seller has responsibility for providing the coverage if it maintains a group health plan. However, if the seller does not maintain a group health plan after the sale, there is no requirement of the seller to establish a group health plan solely to accommodate the terminated employee. In addressing the third group of employees, he stated that they are entitled to COBRA coverage only if the common law employer has changed, i.e. if a termination of employment has occurred. If the employee remains employed by the same corporation following a stock sale, even if that corporation leaves the seller's controlled group, there has been no "qualifying event". Mr. Tawshunsky pointed out that under the new regulations, the seller can contract with the buyer for the buyer to provide the COBRA coverage. If the buyer fails to perform, the liability comes back to the seller.

He informed the Study Group that the new regulations do not address the sale of ownership interests in non-corporate entities. This area needs to be addressed and will be looked at by the Service in later years.


Mr. Tawshunsky expressed the opinion that some people believe HIPAA does a lot more than it really does. It does not enable employees to take their current plan with them if they change jobs. It mitigates some problems but certainly not all problems connected with a job change. The basic purpose of the statute is to deal with "job lock", i.e. the problem of a preexisting medical condition that will not be covered in a new job.

Specifically HIPAA:

  1. Limits the permissible types of preexisting condition exclusions
  2. Limits the length of preexisting condition exclusions
  3. Requires group plans to give credit for the time an employee has been in another group health plan towards satisfying the preexisting condition exclusion
  4. Requires insurers and employers to give employees certificates of creditable coverage
  5. Provides for special enrollment, in certain situations, e.g. birth, adoption, loss of coverage

In response to the question has HIPAA caused some employers to abandon the preexisting limitations requirements because 90% of the employees get certificates of credible coverage, Mr. Tawshunsky stated that it was his understanding that a fair number of employers feel that preexisting condition exclusions are now more trouble than they are worth.

Prepared by Janie Greenwood Harris

Summary of Testimony of Paul T. Shultz, Director, Employee Plans Rulings and Agreements, Tax Exempt/Governmental Entities

Mr. Shultz's remarks addressed issues that arise under the mirror provisions of the Internal Revenue Code and Title I of ERISA by corporate transactions where retirement plans are involved. He identified five different areas, which overlap and addressed each.

Protected Benefits under Section 411(d)(6)

The rule affects business transactions because it requires optional forms of benefits and protected benefits to be preserved after a transaction, if the plan is continued. It is Mr. Shultz's opinion that this anti-cutback rule may encourage employers to terminate plans instead of retaining them. He informed the study group that the proposed regulations would 1) allow some optional forms of benefits to be eliminated; 2) liberalize the existing elective transfer rules; 3) apply the elective transfer rules to amounts that are not eligible rollover distributions and 4) revise the rules for in-kind distributions.

Continuation of benefits on a termination basis, Section 401(e)(12) and 414(l)

These provisions provide that in the case of a merger or consolidation, or a transfer of assets or liabilities from one plan to another, each participant must receive benefits equal to or greater than the benefits the participant would have received before the merger, consolidation, or transfer on a termination basis. In Mr. Shultz's opinion, a buyer may be discouraged from continuing the seller's plan because it could be responsible for any operational deficiencies in the seller's plan.

Common Control Rules under Section 414(b), 414(c) and 414(m)

The rules governing common control effect the business transactions because after the transaction has occurred, the group of employees and the newly formed group of companies will change also. Mr. Shultz noted that the rules are complex and business people are looking for more guidance on how they apply in specific scenarios.

Vesting and eligibility under Section 414(a)(1) and 414(a)(2)

Section 414(a)(1) provides that service for a predecessor employer must be counted in any case in which the employer maintains a plan of a predecessor employer. Section 414(a)(2) provides that where an employer maintains a plan of a predecessor employer, service for the predecessor is treated as service for the successor employer "to the extent provided in regulations". Mr. Shultz stated many people have not counted such service since there were no regulations. He is not sure that that is the right position to take. He indicated that this is an issue that the service needs to look at.

Joint and Survivor Rules under Section 401(a)(11) and Section 417

These provisions require the qualified joint and survivor annuity and the qualified pre-retirement survivor annuity be provided to participants and spouses. Mr. Shultz stated that a buyer may not wish to continue a seller's plan subject to these provisions and may elect to terminate the plan. The final regulation may ease these provisions, although they will not be completely eliminated.

When asked how the partial termination rules might apply in the case of a spin-off, it was his opinion that the rules don't apply very often because a substantial decrease in employment, at least 20%, is needed and generally that level is not reached.

In response to a comment concerning the continuity of benefits in outsourcing business functions, Mr. Shultz stated that outsourcing situations generally raise a lot of questions that need to be thought about and addressed.

Prepared by Janie Greenwood Harris

June 2, 2000

Summary of the Testimony of Bill Bortz, Associate Benefits Tax Counsel, Department of Treasury

Mr. Bortz appeared at the recommendation of Mr. Paul Schultz and Alan Tawshunsky to address questions that the working group had in the area of cafeteria plans. He emphasized that cafeteria plans must be analyzed in the context of their origin. Their specific purpose was to lessen the cost to employees where the employer required an increase in the employee’s contribution to their health care coverage. The program involves salary reduction elections where the employee agrees to give up cash wages in exchange for health coverage or some other tax-advantaged benefit. The key to these arrangements is that when the rules are satisfied, the general tax principal of “constructive receipt” does not apply and the employee does not pay tax on the benefit, even though he or she had the unrestricted right to the cash.

Mr. Bortz’s comments then shifted to the specific issues of medical flexible spending accounts. He emphasized that such arrangements must be viewed as insurance. The decision to enter into the arrangement must be made before any expenses are incurred and will be fixed for a year. Changes in coverage can be made during the year in the event of changes in circumstances that are of independent significance. He emphasized that the typical FSA involves a benefit that is equal to one times cost the employee sets aside $500 and can receive up to $500 of benefit. Such plans, however, cannot have design features that insure that benefits equal cost. Coverage must be fairly uniform throughout the year. For example, an employee may defer $50 per month, but incur a cost early in the year and request a reimbursement of up to their total annual payment, even though their cumulative deposits to date do not cover the amount of the benefit. If the employee incurs no medical costs during the year and thus, submits no claims, the benefit is not refunded.

The discussion then shifted to whether or not the requirements for operating a cafeteria plan provide sufficient flexibility in the event of a reorganization of the plan sponsor. The concept of a reorganization of the plan sponsor is not an event that is listed as a basis for an employee making a change in their election. A change in election can be made if there is a change in coverage. Thus, a change in sponsor that involves a simultaneous change in coverage would trigger the right to change certain elections. Such changes, however, must be consistent with the change in coverage.

A specific question was what would happen to the amounts that the employee has deferred from wages for future medical or dependent care costs, but were not used as of the date of the transfer to the successor employer. Mr. Bortz noted that there was no specific provision in the law covering this matter and that it is a matter of plan design. Mr. Bortz emphasized that if such employees lost these deferrals during the course of such transaction; they should not be looked upon as forfeitures. This is the point of emphasizing the insurance nature of these deferrals. Mr. Bortz stated that these periodic deferrals are similar to periodic premium payments for insurance. If the policy period ends for any reason, the right to coverage ceases with no right to refund for previously paid premiums.

Prepared by Rebecca J. Miller

Testimony of Louis Campagna, Chief of the Division of Fiduciary Interpretations, Office of Regulations and Interpretations, Pension and Welfare Benefits Administration accompanied by John Canary, Division of Disclosure

Mr. Campagna emphasized that the bulk of the specific guidance covering the reorganization of the plan sponsor lies within the Internal Revenue Code provisions of ERISA. Mr. Campagna covered the fiduciary conduct provisions that each employer must demonstrate with respect to the plan.

Fiduciary Conduct Matters

In general, the decisions of a plan sponsor to merge, terminate or amend a plan following a merger, acquisition, outsourcing or other restructuring event would not be considered a fiduciary action. These are settlor functions. However, the actions taken to implement these decisions can involve fiduciary standards.

Mr. Campagna emphasized that there is very little guidance on this matter in ERISA. The general rules of fiduciary conduct apply. Fiduciaries must act solely in the interest of the plan participants and beneficiaries and for the exclusive purpose of providing benefits to participants.

The following items are subject to scrutiny for fiduciary conduct:

  • Merger of defined contribution plans must protect the participants’ accrued benefit, as they existed prior to the merger. This ties into the anti-cutback provisions of the Code. A plan is merged, not when assets are commingled, but when the assets of one plan can be used to pay benefits of the other plan.
  • Participant rights to direct their investments. The right itself is not protected. The plan sponsor can eliminate this right. But, once granted, how such right operates does trigger fiduciary conduct concerns.
  • The change in investment funds offered to participants as a result of a merger including the costs associated with the wholesale liquidation of one portfolio and investment into a new portfolio, if any. (There was significant discussion on this point by members of the working group.)
  • Offering proprietary funds of the plan sponsor, subject to the class exemption from prohibited transaction.
  • Black out periods during the investment transfer.
  • The fees associated with different investment choices.
  • Payment of expenses by the plan.
  • Notices and disclosures to participants. There was significant discussion on this point also highlighting the timing and limited number of notices required to participants in the event of a reorganization of a sponsor of a defined contribution plan.
  • Actions with respect to employer securities held in a plan including tender offers.

During the question and answer session of Mr. Campagna’s presentation there was significant discussion about the transition of early retirement subsidies, etc. in the case of a restructuring. The consensus was that the accrued benefits to the date of transfer must remain, but there is no fiduciary conduct matter regarding the continuation of future accruals following the change. That becomes a settlor function of the successor employer.

At that point the discussion switched to the matter of welfare plans. Much of the focus was on retiree benefits. There is no vesting concept in ERISA for welfare plans, but frequently the participants in these plans have received written and oral representations that the benefits would be available for life. Mr. Campagna agreed that this was an area of uncertainty under the law.

Mr. Campagna then discussed the statute of limitations concept under ERISA. Section 413 of ERISA contains the sole reference to a statute of limitations and it applies to fiduciary breaches and prohibited transactions. This period goes for the later of 6 years from the date of the last action which constituted a breach or violation or the last date on which the fiduciary could have cured the breach or violation or three years after the earliest date on which the fiduciary actually had knowledge of the breach or violation, except in the cases of fraud or concealment, which is then extended to six years.

There is no reference to a statute of limitations for reporting or disclosure matters or participant claims. Participant claims are subject to state law where they may be treated as a contract claim or a claim for lost wages. ERISA does, however, have specific claims procedures for employees who believe they have been denied benefits to which they are entitled. The regulations are in the process of being revised.

This triggered a discussion among the group members of the diversity of caseloads between state and federal courts.

On the question of participant deferrals through a cafeteria plan, Mr. Campagna and Mr. Canary noted that they were not aware of any enforcement actions in this regard but that this was not their specific field of influence.

Mr. Canary discussed the penalties associated with late filings of Form 5500. He mentioned that many persons had discussed the issue of the absence of a statute of limitations and the size of the penalty in the context of an innocent successor sponsor. The DOL is looking at these penalties as part of the revised Form 5500 reporting system, but no specific statement was made relative to relief in this area.

Prepared by Rebecca J. Miller

July 18, 2000

Summary of Testimony of Peter J. Tobiason, Assistant General Counsel for Employee Benefits and OSHA on behalf of the ERISA Industry Committee

The ERISA Industry Committee (*ERIC*) represents major employers with over 25 million ERISA plan participants to whom its members directly provide retirement, health and other benefits.

Although technology, increased global and domestic competition, and new markets are driving an increase in mergers and acquisitions, employees are still recognized as the most important asset to a business. Employers want to retain employees during and after M&A transactions.

Five problems exist in connection with benefit continuity in organizational restructuring:

  1. PBGC intervention in M&A transactions with no regulatory guidance or limits. The result is that sellers, in order to avoid PBGC intervention, are not transferring plans to buyers. As a result, many employees end up without a plan or have their benefits split between two plans, which may mean less in the way of overall benefits. Also, many employers are simply staying away from DB plans in M&A transactions. [NOTE: the PBGC, subsequent to this testimony and in response to ERIC’s concerns, addressed this issue in Technical Update 00-3.]
  2. Anti-Cutback Rule: Having to maintain all forms of distribution options under the old plan effectively discourages combining the seller’s plan with the buyer’s plan in order to provide employees with seamless coverage.
  3. Nondiscrimination rules can prevent the buyer from providing the seller’s employees with the same benefits previously provided by the seller or from tailoring benefits to address employee needs and competitive conditions in a new line of business. The grace period to continue the seller’s plan is ineffective. QSLOB provisions in the Code are so narrowly interpreted as to be ineffective.
  4. IRS Audit CAP program is unpredictable and exposes a buyer to substantial penalties if it maintains the seller’s plan.
  5. Cafeteria Plans: Unknown whether a seller can transfer the plan to a buyer.

Substantial uncertainty as to a MEWA (multiple employer welfare arrangement) is created when the buyer temporarily continues the seller’s welfare arrangement or when an employee work’s for a joint venture (with less than 80% ownership of employer) and continues to maintain that employee on its welfare arrangement.

Portability inhibitors: The same desk rule is a major inhibition to portability for which the only meaningful solution is repeal of the rule. Also, the anti-cutback rule inhibits portability due to the administrative burden discussed above. The current IRS proposal would provide relief in some situations.

Current cash-balance plan legislative proposals would also substantially inhibit continuity of benefits, for example:

  1. Pension Reduction Disclosure Act: Requires four kinds of disclosure: 1) basic written notice, 2) hypothetical examples protecting benefits under the new and old plans, 3) at participants’ requests, information sufficient to confirm calculations in the hypotheticals, and 4) at the participant’s request, individual benefit projections. This amount of disclosure is overkill and impossible to comply with in the context of business transactions.
  2. Older Workers Pension Protection Act of 1999, which requires "sum of" approach whenever the plan’s benefit formula is amended (i.e. benefit=accrued benefit under plan’s old benefit formula at date of amendment + benefit accrued after amendment under plan’s new benefit formula). This imposes a substantial burden because it requires every participant’s benefit formula to be bifurcated every time plan is amended. This will force more buyers to reject any seller DB plan.

Prepared by Tim Mahota

Summary of Testimony of Nell Hennessy, President ASA Fiduciary Councilors, Inc.

Ms. Hennessy indicated that the subject matter was important because laws intended to protect participants should not impede seamless continuation of benefits where both buyer and seller have an interest in maintaining the status quo. She then summarized issues in the following areas:

Health Plans

Ms. Hennessy emphasized that continuity in health plan coverage is very important and that continued participation in the seller’s plan would create the least disruption, but there is concern that such an arrangement would create an unintended “multi-employer welfare plan” (MEWA) which would be subject to state insurance laws. She further stated that the department in July responded to this concern by issuing guidance in the form of Q&A-20, which relieves the employer of the obligation to file the form M1 in three circumstances. Ms. Hennessy suggested that it would greatly facilitate uninterrupted health benefit coverage if the Department would issue permanent guidance that a health plan is not an MEWA in circumstances outlined in the Q&A-20, both for the M1 reporting obligation and for the underlying MEWA status.

Joint Ventures

Ms. Hennessy indicated that a rule that would allow employees to participate in the plan of any company that owned 25 percent or more of the venture would be helpful in providing benefit continuity, particularly for participants transferred to the joint venture.

Fiduciary Issues

Ms. Hennessy discussed fiduciary issues related to investment related concerns that are raised when participants are transferred from the seller’s 401(k) plan to the buyer’s 401(k) plan. These issues relate to investment options, new elections, salary reduction agreements, and what the employer can and cannot do. She indicated that guidance from the Department of Labor providing direction on Safe Harbor investment options that would not cause the plan to lose its 404(c) protections would go a long way towards insuring uninterrupted 401(k) savings. Ms. Hennessy further discussed the problems related to employer stock in an organizational change. She indicated that the buyer’s plan should be permitted to treat the seller’s stock as employer securities. This is because the participants have already made the investment choice in the seller’s plan and the transfer to the buyer’s plan shouldn’t cause that investment option to lose its 404(c) protection.

Defects in the Operation of the Seller’s Plan

Ms. Hennessy then discussed several issues related to defects in the seller’s plan that may or may not be inherited by the buyer and the impact that this situation may have on benefit continuity. She recommended that the accepting plan be protected from defects in the sending plan in the case of transfers which are simpler than rollovers and do not have the risk of leakage inherent in rollovers. Ms. Hennessy then recommended that the IRS and DOL Voluntary Compliance Program provide relief for buyers who find and correct defects inherited from a seller when such defects are corrected within a reasonable period of time. This will encourage them to continue the seller’s plan and provide better benefit continuity.

Other Transfer Issues

Ms. Hennessy discussed concerns relating to benefit distribution forms protected by Section 411(d)(6) that make buyers unwilling to accept transfers of assets and liabilities in the seller’s plan. She suggested that whereas the Treasury has indicated a willingness to grant release to defined contribution plans this has not been the case with defined benefit plans and that there are clearly circumstances where eliminating options could be permitted easing administrative burdens and attended costs in plans without jeopardizing participants. She also raised concerns with respect to grandfathering investing formulas in transfers. Such grandfathering have caused companies to refuse to accept transfer of assets from seller’s plan because they do not want to have to administer vesting schedules separately.

Nondiscrimination Rules

Ms. Hennessy indicated that some of the most difficult problems in benefit continuity in business restructuring are related to the nondiscrimination rules under the Internal Revenue Code. She indicated these were designed for a single work force and do not work well for large employers with diverse businesses. She indicated that grandfathering the seller’s pension design for transferred employees can create discrimination testing problems over time. That even when the buyer’s want to continue the existing pension design, to continue the seller’s benefits often will create expensive discrimination testing. Also, the rigidity of the coverage rules and separate lines of business rules make it so that the former facts and circumstances test no longer apply which in turn makes it so that buyers are reluctant to commit to continuation of the existing benefit structure. This situation is even worse in cafeteria plans, flexible benefits, and self funded health plans where the rules provide no transition period.

PBGC Issues

Ms. Hennessy raised concerns about duplicative PBGC premiums where even a portion of the plan is transferred from the seller’s plan and the need for written guidance regarding circumstances in which PBGC won’t intervene in corporate transactions.

Same Desk Rule for 401(k) Plans

Ms. Hennessy indicated that the same desk rule that prevents distribution of participant accounts in 401(k) plans is an endless source of frustration in transactions and should be eliminated. She suggested that a good solution would be a rule that would allow employees to receive a distribution from their 401(k) plan if they transfer from the controlled group, which maintains the plan to another controlled group that does not participate in the plans.

Prepared by Michael Stapley

August 14, 2000

Summary of Testimony of John Hickey, Vice President, Global Benefits, Lucent Technologies Inc.

Mr. Hickey testified regarding his experience with respect to over 100 different deals involving Lucent. These deals typically involved the acquisition by Lucent of start-up companies with defined contribution plans.

He identified three areas of the law where relief is needed to smooth the transition of employees involved in an organizational restructuring: the anti-cut back rule, the tainting of a plan by a predecessor plan and the same desk rule.

With respect to the anti-cut back rule, Mr. Hickey described the problem created by existing law, which requires that the plan of the acquiring organization maintain all of the optional benefit forms offered under the acquired plan. He noted that the recently-proposed IRS regulations would be a step in the right direction, but would not entirely solve this problem. He suggested that the regulations be expanded to cover survivors as well as participants. In addition, he suggested that a defined benefit plan should be permitted to eliminate all other optional benefit forms, provided that the plan offers a 50% joint and survivor annuity.

With respect to the potential for the tainting of one plan by another plan when the plans are merged, Mr. Hickey suggested that any IRS penalties arising from an operational defect in one of the plans being merged be limited to the closed group merged into the plan rather than the entire post-merger plan. This solution would prevent a windfall to the IRS when a small plan with a potential operational defect is merged into a larger plan. Currently, the need for an audit of the acquired plan typically costs between $10,000 and $50,000 and results in an average delay of six months for assets to be transferred. Prior to the transfer, both plans must be separately administered.

Mr. Hickey urged the need for further relief from the application of the same desk rule to a 401(k) plan. Although Rev. Ruling 2000-27 provided some relief, that relief is limited to situations where the seller sells less than 85% of the assets of a trade or business. It does not appear to apply to spin-offs or the sale of a business by a partnership. He urged the complete repeal of the same desk rule for defined contribution plans.

In additional testimony, Mr. Hickey noted the need for clear guidance regarding the use of Transition Service Agreements when a sale of part of a business results in certain employees changing employers. In the absence of clear IRS guidance, such agreements, which provide a smooth benefits transition for employees, can result in the unintentional creation of a MEWA. He further noted need for relaxation of the non-discrimination rules to provide more flexibility to employers and the need for guidance under the PBGC’s Early Warning Program. Although this Program has been disruptive in the past, Technical Update 00-3 appears to grant the necessary relief.

When asked to identify his top two recommendations, Mr. Hickey cited the need for relief from tainting of a plan when two plans are merged and relief from the anti-cut back rule.

Prepared by Catherine Heron

Summary of Testimony of Martha Hutzelman and Janine Bosley, attorneys, Bosley & Hutzelman, P.C.

Attorneys Bosley and Hutzelman made the following significant points in their written statement and oral testimony:

  1. They are attorneys who represent businesses that engage in mergers and acquisitions. Their joint testimony focused on the obstacles to maintaining benefit continuity after corporate restructurings, especially mergers and acquisitions.
  2. The general problem with the current regulatory scheme is that the statutory and regulatory rules applicable to mergers and acquisitions were developed piecemeal in response to particular issues or situations. Piecemeal solutions sometimes create new problems and leave other questions unanswered.
  3. Particular obstacles relating to defined contribution plans include the following:
    1. Protected plan benefits. Internal Revenue Code (IRC) Section 411(d)(6), the so-called "anti-cutback rule," protects all optional forms of benefit payments under both plans when plans are consolidated. For a large employer involved in multiple acquisitions, the employer’s surviving plan may have a proliferation of benefit options. Small and mid-sized employers may have prototype and master plans that cannot be easily amended to include non-standard benefit options included in the acquired companies’ plans. These employers may have to incur the cost of designing a custom plan or finding a plan administrator who is willing to administer additional benefit options.
      Recently proposed IRS regulations would provide some relief by allowing some defined contribution plans (e.g. 401(k) plans) to be amended to eliminate nearly all existing benefit options so long as the participants distribution choices include payment in the form of a single lump sum and an extended distribution form (e.g. life annuity) that is otherwise identical to the replaced optional form of benefit. However, this relief is not available for consolidation of a money purchase pension plan with another defined contribution plan. Under the regulations, employers will never be able to eliminate the costs and burdens associated with the joint and survivor annuity option that must be offered under any plan that contains money purchase pension plan assets.
    2. Same Desk Rule. This rule prevents a buyer from making distributions from the seller’s plan to participants who are employed by the buyer in essentially the same occupation as they previously held with the seller. The employee is treated as though his employment was not severed. The IRS provided narrow relief in Revenue Ruling 2000-27, but it is of limited use. Accordingly, if the seller’s plan is not terminated before the acquisition, the buyer must either continue the seller’s plan or consolidate the two plans; in either event, the buyer assumes responsibility for the protected benefits of the seller’s plan and any defects in the plan.
    3. Plan Defect-Short Year Vesting. If the plan year is changed as part of an organizational restructuring, there may be a short year (less than 12 months). Participants who have 1,000 hours of service in the short year and 1,000 hours in the new plan year are entitled to two years of vesting credit under Labor Department regulations. But, this rule is commonly overlooked. The employer would have to resort to the IRS’ voluntary correction programs to correct the defect and avoid possible disqualification.
  4. Issues for defined benefit plans include a situation where the seller’s plan was terminated before the acquisition, but the final distribution has not been made until after the acquisition and there is an unfunded benefit liability to the PBGC. The buyer could be held responsible for the liability to the PBGC.
  5. Following an acquisition, the Code Section 125 cafeteria plans of the buyer and the seller must be consolidated for purposes of complying with the nondiscrimination rules. If there is a nondiscrimination problem, the employer must correct it prospectively. But, there is no IRS voluntary correction program under which Section 125 plan problems can be corrected retroactively to avoid adverse consequences.
  6. Issues for health plans affected by mergers and acquisitions include the following:
    1. COBRA: Following an acquisition there may be an issue as to whether the buyer or the seller is responsible for providing COBRA notices to former employees of the seller. IRS proposed regulations adequately address this issue in the context of asset sales, stock sales, and other transactions. But, the regulations do not address limited liability partnerships and limited liability companies.
    2. HIPAA: Extensive regulations issued by the Labor Department and the IRS address the applicability of the HIPAA portability and notice requirements in business reorganizations. However, the regulations do not address whether there is a break in creditable coverage at the time a participant leaves a health plan of the seller and enters a health plan of the buyer.
  7. Recommendations include the following:
    1. There should be a comprehensive, long-range regulatory structure for benefits issues in mergers and acquisitions that is based on general principles rather than piecemeal solutions to specific situations.
    2. There should be a nationwide network of IRS and Labor Department personnel dedicated to dealing with issues raised by mergers and acquisitions to foster consistency and clarity of interpretation and application of the law and regulations.
    3. The Labor Department and the IRS should publish an informational booklet on benefits issues in mergers and acquisitions. The agencies should also conduct education programs. With this information, employers involved in mergers and acquisitions could better identify and assess the risks of regulatory problems and adjust the price of the acquisition to account for the risk.

Prepared by James Ray

Summary of Testimony of Anthony J. Rucci, Executive Vice President and Chief Administrative Officer, Cardinal Health, Inc.

Mr. Rucci began his remarks by posing a hypothetical question - Should benefits "continuity" be a goal in corporate restructurings? He asked the Council to at least entertain the possibility that benefits continuity during periods of organizational change may not be the most desirable outcome.

He addressed the issue of benefits continuity post-restructuring from three perspectives:

  1. The "health of the enterprise" perspective. Any decisions about continuity and levels of employee benefits must consider the competitive positioning of the organization.
  2. The "fairness to employees" perspective. Fairness to prior, current and future employees must be considered.
  3. The "compliance" perspective. Laws and policy, which are appropriately intended to protect individual rights, if too complex or administratively burdensome, can slow down business and thus work against the long-term best interests of the US and its workforce.

In discussing the "health of the enterprise" perspective, Mr. Rucci concluded that the primary consideration in benefits continuity situations should be the long-term competitive health of the organization. Ultimately, that is the best decision for employees. To illustrate his position, he cited four different strategies that had been employed by companies with which he has been involved:

  1. "best of both worlds strategy" - best benefits of both companies were retained. (Baxter-Travenol acquisition of American Hospital Supply Corporation in 1985)
  2. "protect the level of benefits strategy" - the more liberal benefits were retained (Casemark spinoff from Baxter International in 1992)
  3. "what will it take to be competitive" strategy - benefits for all employees were reduced to be competitive (Allegiance spin-off from Baxter in 1996)
  4. "challenge the legacy" strategy - benefits were changed (Sears transformation)

Which employees benefitted the most? It was Mr. Rucci's conclusion that the Allegiance employees benefitted the most in the long run, even though there were short-term give-ups in benefits.

In discussing the "fairness to employees" perspective, he emphasized that the interests of all groups of employees - past, current and future - must be balanced. As an example he cited the Sears decision to reduce over a ten-year period the retiree life insurance benefit, an unpopular and difficult decision, but a decision that benefitted current and future employees and better-positioned Sears for the future.

As to the "compliance" perspective, Mr. Rucci stated that he supports any efforts to protect funded and vested benefits. However, he encourages greater regulatory flexibility. Compliance adjudication that jeopardizes the future competitiveness and career and earnings opportunities for employees is dysfunctional.

He summarized his three perspectives by recounting a personal anecdote involving his family, who were employed by the steel industry. It was his opinion that US steelworkers may have been better served if the unions and steel companies had not "bargained" themselves out of competitiveness versus global competition. In the long run, employees are not benefitted if, in the interest of benefits continuity, we contribute to an organization's competitive decline.

Prepared by Janie Greenwood Harris

September 12, 2000

Summary of Testimony of A. J. “Jim” Norby, President and Nelson Phelps, Executive Director of U. S. WEST Retirees Association

Mr. Norby, who is a Northwestern Bell retiree, informed the Working Group that the association, which was formed in 1992, has a membership of approximately 19,000 members and represents 45,000 individuals. The membership consists of retirees and active employees including employees who are union represented. The pension plan is a combined plan, which covers both vocational workers and management. The organization became very active at the time QWEST announced its intention to acquire U.S. WEST.

He stated that the association’s relationship with their former employer is adversarial for the following reasons:

Inequities in the administration of the health benefit plan. There has been a constant erosion of health benefits. The retirees were promised the same level of benefits in retirement as they received as active employees. This promise was made in written documents and was part of the bargaining agreement. The retirees now must use HMO’s and make co-payments – contrary to the promises made to them.

Misuse of the pension trust fund. The Company rewrote the plan to provide that the substantial surplus – approximately 6 billion – would revert to the company. In the last 11 years, there has been no increase in benefits to the retirees except a 2.9 percent average raise given in January 1996. Mr. Norby also indicated that there were some irregularities in regards to expenses that were charged to the administrative costs of the plan.

Mr. Phelps discussed the three lawsuits that the Association has been a party to. The first case – the Unger Case – alleged that the plan sponsor charged improper administrative expenses to the defined benefit plan. The company agreed to restore 8 million dollars to the pension fund and the case was settled out of court. In the second suit, the plaintiffs alleged that the company was denying the health benefits promised to the retirees at the time of their retirement. The Company agreed to retain the promised level of benefits and the case was settled. The final case charged a violation of ERISA when the plan sponsor amended the plan in 1994 to change the benefits. This case was decided against the retirees on the basis of the Hughes case.

He further commented on the Association’s efforts to oppose the merger of QWEST and U. S. WEST because of the effect the merger would have on retiree benefits. They were thwarted in this effort at the state regulatory level because of the preemptive provisions of ERISA. Mr. Phelps stated that what was being sought at the state level was the protection of what had been promised by the employer and not a cost of living increase.

Mr. Norby and Mr. Phelps both think that the preemptive provisions of ERISA do not protect the interests of plan participants. They also feel that case law, particularly the Hughes case, does not adequately protect the normal retirement benefits of employees. In their opinion, “ERISA has become a law for corporations.” They urged the Council to recommend legislation that will amend ERISA, enforce vesting and reverse the Hughes case.

Prepared by Janie Greenwood Harris

Summary of Testimony of Eli Gottesdiener, Esq., Gottesdiener Law Office, Washington, D.C.

Mr. Gottesdiener discussed four class action suits that he has filed within the past two years against First Union Corporation, SBC Communications, Inc. and New York Life Insurance Company arising out of these companies’ handling of their of in-house 401(k) and defined benefit plans. He said that broadly stated, the common theme of the suits is that the companies, acting as fiduciaries, engaged in self- dealing and breach of fiduciary duty with respect to the investment of the plans’ assets.

The First Union Cases

Mr. Gottesdiener explained that there are two First Union cases. The first, known as Franklin I or the Signet case, arises out of First Unions takeover of Signet Bank in Richmond, Virginia in 1997. The suit challenges First Unions unilateral liquidation of the non-proprietary investment options in the Signet 401(k) plan and reinvestment of the proceeds in the exclusively First Union proprietary options offered under the First Union 401(k). The First Union options have under performed the Signet options by some $100 million. The case was filed with nine plaintiffs on behalf of some 5,000 Signet 401(k) Plan participants. The case was filed in May 1999 in the Eastern District of Virginia in Richmond. It asserts a variety of claims under ERISA.

The second First Union case, closely related to the first, and known as Franklin II or the First Union Case was filed in September 1999 by eighteen plaintiffs on behalf of some 100,000 First Union 401(k) participants and challenges, among other things, First Unions practice of offering only First Union proprietary investment options to its employees. The suit contends that had participants been offered non-proprietary options -- such as the ones that First Union is required by market forces to offer third- party client plans - participants accounts would be worth some $300 million more than they are today. The suit also alleges that First Union improperly assesses the Plans participant fees for record keeping and administrative services that First Union waives for much smaller clients. It alleges claims under ERISA, RICO and the Bank Holding Company Act.

New York Life Case

Mr. Gottesdiener explained that the New York Life case was filed on June 14, 2000 in the Eastern District of Pennsylvania (Philadelphia division) on behalf of tens of thousands of New York Life employees and agents. It focuses on the investment of the company’s in-house large pension plans’ assets in proprietary mutual funds. The suit accuses the company of using the assets of the employees’ and agents’ defined benefit plans to seed, sustain and subsidize a new line of institutional mutual funds. In the early 1990’s, New York Life took hundreds of millions of dollars of pension plan assets and used them to create the new funds. Since then, the company has invested hundreds of millions of dollars more in plan assets into the funds. For some years, the pension plans’ investment in the funds constituted 70%, 80% and even 90% or more of some individual funds, leaving little doubt as to the funds’ dependence on the pension plans’ assets for their continued survival and profitability. Indeed, since the funds’ inception, they have consistently had, in the aggregate, half of all their assets come from the plans.

Mr. Gottesdiener explained that ERISA obviously forbids the use of plan assets for any purpose other than the exclusive interest of plan participants and thus the suit accused New York Life of self-dealing and breach of the duty of loyalty (as well as racketeering under RICO). But, he said, more simply, the suit contends that the investment of the pension plans’ assets in the MainStay funds was imprudent because it forced the pension plans to pay tens of millions of dollars in unnecessary mutual fund fees and expenses. He said that mutual funds may be appropriate investment vehicles for small or relatively small investors but it is an entirely inappropriate form of investment for a large pension plan, such as the multi-billion dollar New York Life Plans, which can obtain expert, individualized investment management outside the mutual fund form for a fraction of the cost of even the least expensive mutual fund.

Mr. Gottesdiener said the suit also contends that as part of New York Life’s scheme to use its in-house employee benefit plans to jump start the company’s entry in the institutional mutual fund business, the company similarly abused its stewardship over its 401(k) plans. The 401(k) plans had been invested in New York Life separate accounts. In the mid-1990’s, New York Life converted those investments into its news proprietary mutual funds -- to grow the size of those funds, according to the suit. In addition to alleging that this was a prohibited act of self-dealing and breach of the fiduciary duty of loyalty, the suit questions whether it was prudent for New York Life to use mutual funds for the 401(k) plans at all or at least without exploring the use of less expensive individually managed or pooled accounts. Assuming the use of mutual forms was not imprudent under the circumstances, the New York Life plaintiffs still claim that New York Life violated ERISA (and RICO) by never considering offering its employees anything other than New York Life mutual funds, much the same as First Union does. Indeed, New York Life, like First Union, is a bundled provider in the highly competitive 401(k) marketplace and, like First Union, is forced to offer its third-party clients and prospective clients better performing non- proprietary mutual funds, and not just its own, in order to attract and retain business.

The SBC Case

Mr. Gottesdiener said the SBC case was filed in April 2000 in the Central District of California (Los Angeles division) on behalf of approximately 40,000 401(k) plan participants. It challenges SBC’s decision to liquidate participants’ investment in the stock of a rival company, AirTouch (now Vodafone AirTouch), which they held in the 401(k) plan of a company SBC acquired (Pacific Telesis Group or “PTG”), and SBC’s mapping of the proceeds into SBC stock. The suit also challenges SBC’s failure to give clear and timely notice to the many thousands of participants who had the right before the liquidation to withdraw or rollout their shares of AirTouch that they had the right to do so. The suit contends that SBC’s motive to get their new employees (those acquired in the PTG) out of AirTouch, a key SBC rival, drove the decision to provide participants with notice of the liquidation that all but said participants had no means of avoiding the liquidation of their shares. However, under the terms of the PTG 401(k) plan, many thousands of participants had the right to withdraw or roll out their AirTouch shares at any time. According to the suit, the notice SBC sent out to participants concerning the liquidation of the AirTouch stock fund misled participants into believing that there was nothing they could do to save their AirTouch holdings. Mr. Gottesdiener said that a favorable ruling from the First Union-Signet case on the notice issue should help establish that SBC breached its fiduciary duties with respect to this subclass of participants.

Prepared by Janie Greenwood Harris

Summary of Testimony of Anonymous Employee Witness, arranged by the Pension Rights Center

The witness began his testimony by stating that he thought his story represented a good example of what employees go through with regard to their retirement benefits in a corporate restructuring. He is a 50- year old senior programmer analyst for an insurance company with 23 years of service, nine with his present employer and the remainder with a company acquired by his present employer.

He stated that many of his estimated retirement benefits have fluctuated wildly, mostly downward. This fluctuation was due to three factors:

  1. freezing of the benefit in the predecessor company’s defined benefit plan
  2. no credit in the present pension plan for service with the predecessor employer
  3. conversion of the employer’s defined benefit pension plan to an age weighted cash balance plan.

The witness informed the Working Group that he will suffer a loss of more than a quarter of a million dollars in projected age 65 retirement benefits. This amounts to more than a 45 percent reduction of his projected benefit.

He stated that improving the notice requirements when an employee’s benefits change would do little to help employees whose benefits have been reduced. Something more substantial must be done to eliminate the employer’s ability to break their promises of retirement benefits. The employees should be informed of what the old benefits were, what the new benefits are and given the opportunity to choose between the two.

In conclusion, the witness urged the Council to recommend changes to current laws that will protect the benefits of plan participants from corporate actions that reduce their anticipated pensions.

Prepared by Janie Greenwood Harris

Index of Sources

Index for Benefit Continuity After Organizational Restructuring - 2000

May 9, 2000: Benefit Continuity After Organizational Restructuring

Chair: Rebecca Miller, Vice Chair: Janie Greenwood Harris

  1. Agenda
  2. Official Transcript
  3. Executive Summary of Transcript
  4. Overview of Study Scope
  5. Number of News Releases About the Topic including "SBC Communications Sued by Workers on Stock Sale: Dispute Centers on Employee 401(k) Plan by David Cay Johnston, New York Times; "Employees Sue SBC Over Stock in 401(k) by Albert B. Crenshaw, Washington Post; "Workers Sue SBC over 401(k) by Christine Dugas, USA Today;"SBC Faces Suit Over Retirement Plans: Pacific Telesis Employees Allege That Investments Were Improperly Sold" by Jeff D. Opdyke and Ellen E. Schultz, Wall Street Journal, all on April 19, 2000, and
    "Sprenger & Lang, PLC Announces Employee Class Action Lawsuit Against SBC Communications Inc., in Billion Dollar 401(k) Suit, Business Wire, April 18, 2000.

June 2, 2000:Benefit Continuity After Organizational Restructuring

  1. Agenda
  2. Official Transcript
  3. Executive Summary of Transcript
  4. ERISA Industry Committee submission to the Internal Revenue Service and Department of Treasury on Application of the Plan Qualification Requirements in Connection with Mergers, Acquisitions, Dispositions and Other Transactions and on the Multiple Use Rules, March 22, 2000.
  5. "Advisory Council: Officials Discuss Benefit Issues Under Mergers, Acquisitions, Spin-Offs," May 10, 2000 BNA Pension and Benefits Daily.
  6. Harry Bellas, Appellee, v. CBS, Inc. Westinghouse Pension Plan, Partial Settlement Granted June 29, 1999, Civil Action #98-1455, and Appeal November 22, 1999. (Amicus Curiae of the Association of Private Pension and Welfare Plans in support of appellants urging reversal.
  7. "Officials Discuss Benefit Issues under Mergers, Acquisitions, Spinoffs" by Colleen T. Congel, May 10, 2000 BNA Pension and Benefits Daily

July 18, 2000: Benefit Continuity After Organizational Restructuring

  1. Agenda
  2. Official Transcript
  3. Executive Summary of Transcript
  4. Written Testimony by Peter J. Tobiason, Assistant General Counsel for Employee Benefits and OSHA, ITT Industries, Inc., on behalf of the ERISA Industry Committee, as well as the news release issued by ERIC on his appearance before the working group.
  5. Written Testimony by Nell Hennessy, President, ASA Fiduciary Counselors, Inc.
  6. Several news stories including:
    1. "US West Retirees Threaten to Block Merger" by Andrew Backover, Knight Ridder Syndicate, June 28, 2000;
    2. "No Constructive Discharge in Requiring Choice Between Pension and Employment" in BNA Pensions and Benefits, June 5, 2000; "Employ Caution With Company Stock," a column by Jane Bryant Quinn, Washington Post, July 2, 2000; "Participants Waived Right to Escrow Following Merger and Plan Termination," BNA, June 12, 2000.
  7. A comment letter from the Investment Company Institute to the Internal Revenue Service, June 27, 2000, on proposed special rules regarding optional forms of benefit under qualified retirement plans.

August 14, 2000: Benefit Continuity After Organizational Restructuring

  1. Agenda
  2. Official Transcript
  3. Executive Summary of Transcript
  4. Written Testimony on Problematic Issues Commonly Found in Mergers and Acquisitions by Janine H. Bosley and Martha L. Hutzelman, Bosley & Hutzelman, P.C.
  5. Written Statement of John G. Hickey, Vice President of Global Benefits, Lucent Technologies, Inc.
  6. Written Testimony of Anthony J. Rucci, Cardinal Health, Inc.
  7. IRS Private Letter Rulings on Distributions, Exclusion of Compensation for Sickness or Inquiry, Qualification, Minimum Funding Standard, Deferred Compensation, GCMs, TAMs & PLRs, Section 401 PLR 200030031, BNA Pensions & Benefits, August 8, 2000.
  8. ERIC Applauds PBGC Guidance on Operation of Early Warning Program
  9. ALJ Reduces Labor Department Penalty Where Plan Merger Led to Reporting Error, BNA Pensions & Benefits, July 13, 2000
  10. ERISA Does Not Authorize Recovery of Fees for Administrative Appeal Work, Court Rules.
  11. TEI Supports Anti-Cutback Exceptions, Latitude in Transferring Plan Benefits, BNA Pensions & Benefits, August 8, 2000.
  12. PLR 200027059, Same desk rule applies to prevent contract for outsourcing of information services from causing separation from service.
  13. Court Says Participant May Sue Employer for Failing to Provide Insurer’s Claim Form?
  14. Welsch v. Empire Plastics, Inc., May 19, 2000
  15. Section 401 PLR 200024056, Same desk rule does not apply to distributions to terminated employees hired by new primary government contractor.
  16. "Cleaning up ?same desk’ IRS Rule," August 1, 2000, Providence Journal.
  17. Merger Found Not ?Change in Control’ Under Terms of Executive’s Agreement, And Trucking Company Did Not Violate ERISA During Subsidiary Spin-Off, Court Rules, both in BNA Pension & Benefits, August 7, 2000.
  18. No Constructive Discharge in Requiring Choice Between Pension or Employment, BNA, June 5, 2000.
  19. Your Portfolio: Is Your Boss Raiding the 401(k) Till? Individual Investor Magazine, July 20, 2000.
  20. PBGC Technical Update 00-3 on Early Warning Program, June 24, 2000.

September 12, 2000: Benefit Continuity After Organizational Restructuring

  1. Agenda
  2. Official Transcript
  3. Executive Summary of Transcript
  4. ABA Net story on Comments Regarding the Internal Revenue Service and Treasury Department Proposal on the Application of Section 4119d)(6) to Defined Contribution Plans
  5. Copy of Larry F. Gottlieb, et al vs. SBC Communications and Pacific Telesis and their related savings and pension plans, U.S. District Court for the Central District of California - A class action lawsuit.
  6. The Retiree Guardian, newsletter of the U S West Retiree Association, as well as Highlights of the Pay and Benefits Changes for Classic U S West Employees with 20 or more years of service, series of letters from association president James Norby to various personages (Witnesses also provided copy September 2000 issue of the AARP Bulletin, featuring an article "Pension revolt catches fire: Longtime employees say they want their ?just due’ by Trish Nicholson.
  7. An Employee’s Testimony before the Working Group on September 12. Provided by the Pension Rights Center after principals arranged for anonymous caller to talk about his own situation regarding a corporate acquisition.

October 13, 2000: Benefit Continuity After Organizational Restructuring

  1. Agenda
  2. Executive Summary
  3. Official Transcript
  4. Conference Board’s "Post-Merger Integration" A Human Resources Perspective", a Research Report 1278-00-RR.
  5. Merge & Purge by Daniel Gross, CFO Magazine, October 2000.
  6. U.S. Court of Appeals for the Third Circuit, March 7, 1985 in Merle R. Edwards, James Bridgland, William Fisher, Edward J. Schrode, John T. Tredinnick and Richard L. Zath, Appellants v. Wilkes-Barre Publishing Co. Pension Trust and Wilkes-Barre Publishing Co., Appellees

Relevant ERISA Provisions

The following lists the statutory provisions that correspond to the policy considerations in Chapter One.

Requirement: Written Plan
Citations: ERISA Section 402(a)(1), Treasury Regulation Section 1.401-1(a)(2) for a retirement plan; IRC Sections 125, 127, 129, 137 for assorted welfare benefit programs.

Requirement: Settlor Functions
Citations: Various, see, e.g., Lockheed Corp. v. Spink, 517 U.S. 882 (1996)

Requirement: Fiduciary Conduct
Citations: IRC Section 401(a)(2) for retirement plans. Treasury Regulation Section 1.501(c)(9)-4 for certain funded welfare plans.
ERISA Section 403 – 405 for all plans subject to ERISA.
ERISA Sections 406 through 408 on prohibited transactions. Similar standards are found in IRC Section 4975; see also, IRC Section 503
Statute of limitations is found in ERISA Section 413, enforcement provisions in ERISA Section 502.

Requirement: Broad – based Participation/Coverage
Citations: IRC Sections 401(a)(26) and 410

Requirement: Nondiscrimination in Benefits
Citations: IRC Sections 401(a)(4), 401(k), 401(m), 401(l), 403(b)(12), 414(q), 414(r) and 416
Treasury Regulation Section 1.401(a)(4) for retirement plans
Sections 79, 105(h), 125, 127, 129, 137, 501(c)(17) and 505, e.g., for various welfare plans (these include coverage nondiscrimination standards, as well)

Requirement: Anti-cutback Rules
Citations: IRC Sections 411(d)(6) and 414(l) and ERISA Sections 204(g), 208 and 4231(b)(2), 4232(b)

Requirement: Vesting
Citations: IRC Sections 411 and 414(a), ERISA Section 203

Requirement: Aggregation/Affiliation
Citations: IRC Sections 414(b), (c), (m), (n) and (o) with an exception in IRC Section 414(r); ERISA sections 210(c), (d), 4001(b)(1)
IRC Section 414(t) extends these considerations to certain welfare plans

Requirement: Combined retirement plan benefit limits
Citations: IRC Sections 401(a)(17) and 415

Requirement: Minimum Funding
Citations: IRC Sections 412, 418 – 418E and ERISA Sections 302 – 307, 4062- 69, 4201-25 - minimum funding and employer liability for pension plans

Requirement: Distribution Restrictions
Citations: IRC Sections 401(a) various, 401(k), 411(a)(11) and 417

Requirement: Tax-Free Rollovers
Citations: IRC Sections 401(a)(31), 402(c) and 408

Requirement: Health Coverage Continuation (COBRA)
Citations:IRC Section 4980B, ERISA Sections 601 through 608

Requirement: Pre-existing Medical Conditions
Citations: IRC Sections 4980D, 9801 and ERISA Section 701


  1. For purposes of this report ERISA refers to the Title I provisions of the Employee Retirement Income Security Act of 1974. The term “Code” will be used when referring to the Tax Code provisions of ERISA or other relevant Tax Code provisions.
  2. Patrick McTeague – Working Group meeting October 13. Page 18, line 7 of transcript.
  3. Year to date market totals, reported on October 11, 2000 on the Thomson Financial Securities Data web page at
  4. FTC Annual Reports
  5. The Conference Board, Post-Merger Integration: A Human Resources Perspective, R-1278, September 2000. Page 14
  6. The Conference Board, ibid. 4
  7. The Conference Board, ibid. page 15
  8. The Conference Board ibid. page 18
  9. Peter Tobiason, Assistant General Counsel for Employee Benefits and OSHA, ITT Industries, Inc. testimony on July 18, 2000, page 7 of transcript.
  10. Anthony Rucci, Executive Vice President and Chief Administrative Office, Cardinal Health, testimony on August 14, 2000
  11. Testimony of Alan Tawshunsky, May 9, 2000, page 40.