Table of Contents
November 8, 2002
The problem of so-called orphan plans, defined contribution plans that have been abandoned by their sponsors and all other fiduciaries authorized to act on their behalf, has recently received increasing attention from retirement plan regulators, service providers, Congress and the retirement plan community. Although orphan plans are estimated to represent only about two percent of all defined contribution plans and less that one percent of total defined contribution plan assets, the problems that orphan plans create for participants, administrators, the government and the courts are substantial.
Plan participants may suffer economic hardship as a result of their inability to obtain a distribution from an orphan plan; plan service providers may be besieged with requests for distributions, although unauthorized to act; and the government may be forced to handle the termination of hundreds or thousands of plans that have been abandoned. The testimony before the working group indicated that the magnitude of the orphan plan problem is likely to grow, as more businesses fail in a difficult economic environment and orphan plans are discovered by service providers in connection with the GUST and EGTRRA document restatement process.
To most effectively deal with the problem of orphan plans, the working group recommended measures that would permit service providers in the private sector to terminate these plans. As the primary concern of such service providers was potential fiduciary liability, the working group recommended the enactment of legislation that would protect service providers from liability in connection with their services relating to the termination of orphan plans. Recognizing, however, that enactment of legislation was not likely in the near term, the group recommended the establishment of a joint EBSA-IRS program to supervise and administer the termination of orphan plans. This program would be directed from the national offices of the DOL and IRS, but administered in the field by the regional EBSA offices.
The working group envisioned a joint EBSA-IRS program that would appoint independent fiduciaries responsible for termination of one or more orphan plans. To the extent possible, these independent fiduciaries would retain the services of the current plan recordkeeper to calculate and effect plan distributions.
The working group recommended a number of regulatory and legislative proposals intended to assist the processing of orphan plan terminations. These recommendations included promulgation of criteria to be used by service providers and trustees to identify and report orphan plans, regulations that would permit an expedited termination of orphan plans by an independent fiduciary and regulations requiring plan documents to include language providing for plan termination in the event of abandonment. Early identification and possible avoidance of plan abandonment was also urged through a proposal to require notice of plan abandonment by the trustee in a bankruptcy proceeding and legislation that would require a bankrupt plan sponsor to terminate the bankrupt entity’s plan or plans as part of the bankruptcy proceeding.
A major concern of the working group was the expense of terminating orphan accounts. Although many plans permit the payment of expenses relating to plan termination out of plan assets, the working group was concerned that such expenses could result in significant erosion of plan account balances. On the other hand, the payment of orphan plan expenses by the government could be an unwelcome addition to an already burdened federal budget. The working group concluded that a streamlined termination process would help reduce termination expenses. The group also urged the adoption of measures intended to penalize plan sponsors abandoning their plans and permitting the payment of plan termination expenses from bankruptcy proceeds.
To prevent undue erosion of participant account balances in plans that permit the payment of termination expenses from plan assets, the working group suggested the imposition of a cap on expenses based on the lesser of a specified percentage of a plan account balance or a fixed dollar amount. In those instances where termination expenses exceeded this cap and in the case of plans that did not provide for the payment of expenses from plan assets, termination expenses would be paid by the joint government program. The working group recommended the creation of a special fund to help pay for such expenses. Such a fund could derive its assets from the penalties paid under various provisions of ERISA and the Internal Revenue Code.
The Definition of an Orphan Plan
For purposes of this report, an orphan plan is a defined contribution plan for which there is no plan sponsor or other plan fiduciary willing to act with respect to the plan. The focus of this report is the process of terminating orphan plans so that distributions may be made to plan participants. The report does not propose solutions for the problem of missing participants, although a recommendation is made with respect to the handling of account balances of participants who cannot be located during the termination process.
A number of witnesses testified that there was a need to define and identify orphan plans more expeditiously. To the extent that these plans can be identified and terminated quickly, there is a greater likelihood that a plan sponsor or other plan fiduciary can be located to terminate the plan and, in some cases, bear some of the expenses of termination. Early discovery also prevents deterioration of plan data that can be expensive to re-construct months or years later. To address this need, some testimony suggested that EBSA develop guidance that would set forth the criteria for determining whether a plan has been abandoned. Trustees and other plan service providers could be required or encouraged to report plans that have met the EBSA criteria for abandonment.
The Scope of the Orphan Plan Problem
The testimony before the working group indicated that the number of orphan plans is not large in an absolute sense. In remarkably consistent testimony, the professional recordkeepers reported that generally about 2% of total plans administered were orphan plans. From a percentage of assets perspective, the testimony indicated that the assets involved were considerably less than 1% of total defined contribution plan assets.
Nevertheless, the problems that orphan plans create for participants, administrators, the government and the courts are substantial. The inability to obtain a distribution from a plan can pose a severe financial hardship for a participant who has also found his or her job eliminated and the plan abandoned. Plan service providers, who are typically authorized to act only upon the direction of a plan fiduciary, are often besieged by requests for distributions by distressed plan participants. In some instances, these service providers are no longer being paid for their services, because the plan sponsor cannot be found or is unwilling or unable to pay. For the government and the courts, handling hundreds, and potentially thousands, of abandoned plans on an ad hoc, plan-by-plan basis is inefficient, expensive and time consuming.
Several witnesses suggested that the number of orphan plans is likely to increase in the coming months because of difficult economic times and the GUST and EGTRRA restatement process. As more businesses fail, the plans of those businesses may be abandoned. The GUST and EGTRRA restatement process may permit service providers to more readily identify plans that previously have been abandoned.
The Causes of the Problem
The testimony before the working group indicated that orphan plans arise for a number of reasons. These include the death of a sole proprietor/plan sponsor, bankruptcy, the removal of plan fiduciaries by the DOL, mergers and acquisitions, and the disappearance or unwillingness of plan fiduciaries to act. As noted above, plan abandonment is often correlated with difficult economic conditions, particularly in the small plan market.
The History of Efforts to Deal with the Problem
The testimony before the working group noted that, to date, orphan plans have been handled through a EBSA national enforcement program established in 1999. This program seeks to identify orphan plans, find a fiduciary willing to act with respect to the plan and appoint an independent fiduciary if a plan fiduciary cannot be found. In most, but not all cases, court orders have been obtained to appoint the independent fiduciary.
According to recent testimony of EBSA before Congress, the portion of the EBSA enforcement budget earmarked for handling orphan plans was $500,000 for FY 2002. This amount was allocated to pay the costs associated with hiring independent fiduciaries to terminate orphan plans “where the asset base of the plan was insufficient to bear these expenses without causing substantial reductions in individual account balances.”
To date, major financial service providers generally have not been willing to undertake the termination of orphan plans, because of their concerns about fiduciary liability and, in some cases, charter or legal restrictions prohibiting service in a fiduciary role. Typically, the independent fiduciary terminating an orphan plan at the request of the EBSA is an individual or small firm CPA, actuary or plan consultant willing to take the risk of serving as a plan fiduciary for the limited purpose of terminating the plan under the supervision of the EBSA.
A Possible DOL-IRS “White Knight” Program
The recent congressional testimony described above noted that EBSA is working closely with the IRS to develop a program to identify and terminate orphan plans and, to the extent possible, take regulatory action against plan fiduciaries that do not fulfill their obligations to the plan. This so-called “white knight” program was described in IRS testimony before the working group as an effort to define a class of orphan plans for which streamlined termination procedures could be developed. Under these procedures, a plan could be deemed to be qualified so that there would be no adverse tax consequences for participants. These procedures could also deem the plan to be in compliance with certain requirements of Title I of ERISA.
Who Should be Responsible for Terminating Orphan Plans
The testimony before the working group suggested a number of possible entities that could serve as the supervisory authority for the termination of orphan plans. They included a joint EBSA-IRS program, the PBGC, the bankruptcy trustee for a company in bankruptcy, and one or more designated courts.
Acting under the authority of a government program or a court order, a number of independent fiduciaries, typically not large record keeping institutions, have assumed the responsibility for the termination of orphan plans. These independent fiduciaries testified that they would be willing to direct other plan service providers, such as recordkeepers or TPAs, in the process of plan termination and the distribution of assets.
The independent fiduciaries further requested:
- Protection from enforcement by the DOL,
- Clear guidelines for the process by which a plan could be terminated without causing plan disqualification,
- Relief from certain current law obligations including document amendment, certain plan filings and disclosures and plan audits,
- Development of a process for periodic reports to EBSA,
- The issuance of guidance for distributing the account balances of participants who can not be located, and
- A mechanism to assure payment for their services.
How to Pay for the Termination of Orphan Plans
The testimony before the working group indicated that the estimated costs of terminating an orphan plan could range between a low of $1,000 and a high of $30,000 to $50,000. The size of the plan and the condition of the plan data appear to be major determinants of cost. One independent fiduciary also noted that the greater the potential liability, the greater the fees.
The testimony noted that many plans currently include provisions that permit the payment of plan expenses from plan assets. According to a EBSA advisory opinion, such provisions would not permit the payment from plan assets of settlor plan termination expenses. However, such non-recoverable settlor expenses are generally limited to the cost of analyzing the decision to terminate. Expenses associated with the implementation of the termination decision may be paid from plan assets. Implementation costs that could be paid from plan assets include the cost of any necessary plan amendments or filings, the determination of the correct account balances for distribution, communications with participants and distributions of plan assets. As a practical matter, this advisory opinion will not limit the ability of orphan plans with this plan provision to pay the expenses of termination.
Testimony before the working group noted a concern that the expenses associated with termination of an orphan plan could significantly reduce account balances. For that reason, the working group suggested the imposition of a cap on termination expenses borne by the plan that could be based on the lesser of a specified percentage of an account balance, e.g., 5%, or a fixed dollar amount.
For those plans that do not include a provision permitting the payment of expenses from plan assets, a number of witnesses testified that the plan sponsor should bear the expenses of termination, if the plan sponsor could be located. In the case of a bankrupt plan sponsor, reference was made to the pending bankruptcy legislation. That legislation includes a provision that would require the plan sponsor who files for bankruptcy to continue to serve as fiduciary to the plan or plans of the bankrupt entity. Such a provision should prevent plans of bankrupt entities from becoming orphan plans and thereby eliminate the concern for funding the termination of such plans.
Additional testimony before the working group suggested the imposition of a requirement that a bankruptcy trustee provide notice of a bankruptcy proceeding against a company that maintained one or more plans. Such a notice could permit the filing of a claim against the bankruptcy estate for the administrative expenses of the plan termination. Under current law, administrative expenses of the bankruptcy estate have priority over other creditors. To be effective, the notice would have to be provided to a plan trustee or service provider who could relay the information to the independent fiduciary terminating the plan, if any.
In those cases where 1) the plan terms did not permit the plan to bear the expenses of termination, 2) the expenses of termination exceeded the benchmark for a substantial reduction in account balances, 3) the plan sponsor could not be located or 4) a claim could not be timely filed in a bankruptcy proceeding, the working group concluded that the government (the joint EBSA-IRS program) should bear the costs of plan termination. The group considered the possibility of establishing a special fund for this purpose. The fund could derive its revenue from a variety of sources, including penalties paid to the government under 502 of ERISA, sections 4975 and 3405(d)(10)(B) of the Internal Revenue Code and penalties assessed against plans sponsors seeking to abandon their plans.
How to Protect Independent Fiduciaries from Liability
A major issue for essentially all witnesses testifying before the working group was the concern about the potential liability of a fiduciary willing to undertake the task of terminating an orphan plan. Entities or individuals considering this task expressed concern about potential exposure to an enforcement action by the DOL and lawsuits brought by plan participants or beneficiaries. They noted that a fiduciary terminating an orphan plan could risk litigation relating to both their actions as a fiduciary and the actions of a co-fiduciary of the plan, including a co-fiduciary whose actions preceded their appointment as a fiduciary.
In light of this concern, a number of witnesses suggested the need for a legislative amendment to ERISA protecting from liability, to the extent appropriate, an independent fiduciary terminating an orphan plan. The working group noted that enactment of any such legislation in the near future was not practical and further noted the difficulty of defining those independent fiduciaries whose conduct should be protected from liability.
A number of alternative measures to limit liability were also considered. These included a waiver or release by plan participants upon receipt of a distribution from an orphan plan, a DOL interpretation that the actions of an independent fiduciary terminating a plan were per se non-fiduciary, and a grant of no-enforcement protection for independent fiduciaries terminating orphan plans.
The recommendations of the working group include both legislative and regulatory proposals. The regulatory proposals are described first, because the working group believes that they could be implemented immediately. Recognizing that enactment of the legislative proposals could be a longer-term effort, the group urges the Department to pursue both sets of recommendations simultaneously.
Formalize the ongoing efforts of EBSA and the IRS to establish and maintain a joint program (“the Program”) to supervise and administer the termination of orphan plans.
The working group concluded that the efforts already underway by EBSA and the IRS to develop a joint program would be the most the most effective and immediate means of addressing the problem of orphan plans. Because the tax qualified status of orphan plans must be maintained to protect both participants receiving distributions and fiduciaries responsible for administering plans in the termination process, IRS involvement in the Program is essential.
Provide for the overall administration and supervision of the Program in the EBSA and IRS national offices, with each EBSA regional office empowered to supervise the termination of the orphan plans in its area.
By decentralizing the day-to-day operation of the Program, each EBSA regional office can more effectively supervise the independent fiduciaries terminating plans within their area. It is important, however, that uniform standards for terminating the plans be developed and implemented by the IRS and EBSA national offices. The national offices also can direct the termination of those plans requiring enforcement proceedings and requests for special exemptions from the procedures established for the Program.
Provide that the Program will permit the retention of independent fiduciaries to terminate orphan plans and distribute benefits to participants. Such independent fiduciaries could be retained through a competitive bidding process or some other means.
Through a competitive bidding process, the Program may obtain the services of independent fiduciaries willing to oversee the termination of orphan plans. This process should help ensure that the costs for terminating orphan plans are reasonable.
Require through regulations that plan documents include language directing the Program to take measures necessary to terminate the plan in the event the plan is abandoned. In the alternative, the regulations could permit the plan terms to appoint an independent fiduciary by name, with a default to the Program, in the event the named independent fiduciary is unwilling or unable to act.
Assuming a determination that, as a legal matter, the termination of orphan plans may be directed without a court order, the process of terminating orphan plans should be facilitated. The incorporation of language in a plan document providing for the termination of the plan by either the Program or a designated independent fiduciary in the event of plan abandonment would permit the Program to function without the need for a court order. Such a process would be more efficient for both the Program and the independent fiduciary terminating the plan.
Promulgate regulations setting forth the criteria for determining that a plan has been abandoned and is eligible for the Program. Require or encourage plan service providers and trustees to report plans as abandoned pursuant to the criteria established.
The early identification of orphan plans may reduce the number of plans actually abandoned, make the termination process simpler for those abandoned and assist in funding the expenses necessary to terminate abandoned plans. Early identification will make it more likely to locate a fiduciary for the plan, increase the likelihood that a timely claim for administrative expenses can be filed against the bankruptcy estate and prevent the plan data from becoming further out-of-date.
Guidelines of the Program could establish criteria for determining plan abandonment, such as returned mail for a specified period of time, inability to contact a plan fiduciary, calls from participants stating that a plan has been abandoned or notice from a bankruptcy trustee that a plan sponsor has filed for bankruptcy. Plan trustees and service providers could be required or encouraged to report to the Program plans that meet the established criteria within a specified time frame. In addition, EBSA should consider adopting a policy of inquiring on its own initiative whether a plan that has failed to file a timely 5500 has been abandoned.
Empower the independent fiduciaries selected by the Program to take all necessary steps to efficiently terminate an orphan plan, including, to the extent possible, retention of the current plan recordkeeper or TPA. This recordkeeper or TPA could assist in determining account balances and in making distributions. In effect the termination would be a multi-tiered effort, with the Program serving as the overall supervisor, the independent fiduciary appointed by and reporting to the Program and the current recordkeeper or TPA directed by the independent fiduciary.
In most cases, the current recordkeeper or TPA for the plan can most efficiently and cost-effectively terminate the plan and distribute the assets to participants. Transferring the plan data to the independent fiduciary appointed by the Program would only increase the time and expense of plan termination. Because, however, many current recordkeepers and TPAs cannot or will not assume a fiduciary role, the independent fiduciary could direct the current recordkeeper or TPA with respect to the termination process and distributions. The independent fiduciary could also negotiate the payments required for the services of the current recordkeeper or TPA, consistent with the funding made available to the independent TPA.
Provide for the promulgation of Program guidelines/regulations that provide for:
- expedited plan amendments or a waiver of the requirement to amend plan documents to comply with all requirements of current law, including both IRS amendment requirements and DOL disclosure requirements, such as summaries of material modifications;
- assurance of the qualified status of the plan upon termination without the need for a Form 5310 filing (to protect the tax treatment of participants), if the guidelines have been met;
- relief from any requirement to file missing Forms 5500;
- procedures for filing a final Form 5500 on behalf of the plan;
- relief from the plan audit requirement for those plans for which there is no knowledge of significant errors in account balances;
- establishment of a cap on expenses of plan termination that can be borne by participant accounts. This cap should be based on the lesser of a specified percentage of an account balance or a fixed dollar amount;
- guidance on the allocation of the plan forfeiture account and any other unallocated account, including relief from the limitations of Code 415, to the extent necessary;
- guidance on the extent to which plan data must be fully and completely updated (retroactive recordkeeping) before distributions can be made;
- procedures for distributing the account balances of missing participants, such as the establishment of an IRA without fiduciary liability for selection of the IRA provider and IRA investments and/or a procedure requiring 100% IRS withholding of small distribution amounts. (Such withheld amounts could be transmitted to the IRS and applied as a credit against the participant’s future tax liability);
- a requirement for the independent fiduciary to file with the Program quarterly reports and a final report for the plan; and
- similar to the protection provided through EBSA’s Voluntary Fiduciary Compliance program, an independent fiduciary complying with the guidelines of the Program would not be subject to a DOL enforcement action with respect to activities undertaken in connection with the termination of the plan.
Permit the payment of administrative expenses relating to the termination of orphan plans out of plan assets, to the extent permitted by plan terms, but only to the extent such payment does not cause an excessive reduction in plan account balances. To the extent expenses are not paid out of plan assets, encourage measures designed to recoup such expenses from the plan sponsor or the bankruptcy estate, if any. Remaining expenses of termination would be borne by the Program.
For those plans the terms of which permit the payment of administrative expenses from plan assets, the costs of termination can be allocated among the account balances of the remaining participants. If prior distributions have been made shortly before plan abandonment, the independent fiduciary should seek to recoup from those participants a portion of the termination expenses. The Program should assist the independent fiduciary in these efforts.
The working group recommends that, when plan participants are bearing the costs of plan termination, such costs should be allocated on the basis of account balances. In addition, the termination costs borne by participants should be capped to prevent any substantial reduction of account balances. The level of the cap should be determined by the Program; however, the members of the working group recommend that the Program adopt a cap that is fixed at the lesser of a specified percentage of an account balance or a fixed dollar amount.
When administrative expenses associated with plan termination cannot be paid from plan assets, the working group recommends that all reasonable efforts be made by the appointed independent fiduciary, with the assistance of the Program, to recoup expenses from the abandoning plan sponsor or the bankruptcy estate of the plan sponsor. Such measures should include the possibility of Program legal action against the sponsor and the filing of a claim with the bankruptcy trustee for administrative expenses. Expenses of termination that cannot be recovered from any of these sources should be borne by the Program.
Seek legislation that would protect plan service providers and independent fiduciaries that terminate orphan plans from fiduciary liability in connection with their services relating to the termination of the plan.
Although the working group concluded that a legislative amendment to ERISA was the most effective manner to assure protection of independent fiduciaries and other plan service providers addressing the problem of orphan plans, the group recognized that enactment of such legislation was not likely in the near-term. The working group also noted the need to carefully draft such legislation to insure that its scope of protection was neither overly broad nor inadequately narrow.
To the extent necessary, introduce legislation providing for the creation of a fund to be established for the purpose of covering Program expenses. The fund could be financed, in part, by penalties assessed under various s of the Code and ERISA, including, but not limited to, section 502(l) of ERISA (fiduciary breaches), section 502(c)(2) of ERISA (5500 report penalties), section 4975 of the Code (prohibited transaction excise taxes), section 3405(d)(10)(B) of the Code (section 402(f) notices), and section 502(c)(7) of ERISA (blackout notices).
In an effort to reduce the budgetary concerns arising from the creation of the proposed Program, the working group recommends the allocation of the income from the various penalty provisions cited above for the Program fund. Currently, these penalties are contributed to the general revenues of the government.
Provide for the imposition of monetary penalties upon plan sponsors and other plan fiduciaries that abandon their fiduciary responsibilities with respect to a plan. These penalties should be substantial enough to deter pan sponsors from abandoning their plans. In the case of a bankrupt plan sponsor, the working group recommends an amendment to proposed bankruptcy legislation that would provide a priority for such a penalty to be paid from the bankruptcy estate. Any such penalties could be contributed to the Program fund established to cover expenses of the Program.
Support the enactment of the provision in proposed bankruptcy legislation that would require a bankrupt plan sponsor to fulfill his fiduciary responsibilities by terminating the company’s retirement plan or plans.
A provision in proposed bankruptcy legislation, S. 420, requires a bankrupt plan sponsor to terminate any plan of the bankrupt company. As noted by the late Senator Wellstone, the sponsor of this provision of the bill, the provision merely enforces the plan fiduciary’s current obligations to the plan or plans. It imposes no new obligations on the plan sponsor. Moreover, such a provision could effectively reduce the number of orphan plans. The bankruptcy trustee could require the sponsor to terminate the plan and thereby avoid the abandonment that might otherwise occur.
Propose inclusion in bankruptcy legislation of a provision that would require trustees in bankruptcy to give notice to plan trustees and other service providers that a company has filed for bankruptcy. In the alternative to legislation requiring notice of the bankruptcy filing to the plan trustee and service providers, propose regulatory guidance that would require such a notice to trustees and service providers.
Once provided, such a notice could serve as one of the criteria for the regulations described in A.5. above that would be applied by a trustee or other service provider in determining that a plan has been or might become abandoned. Such a notice could also facilitate the filing of a claim of process against the bankruptcy estate. The timely filing of this claim may permit expenses of termination to be recovered from the bankruptcy estate as priority administrative expenses.
July 18, 2002
Testimony of Virginia C. Smith
Ms. Smith testified that the Department of Labor (DOL) definition of Orphan Plans is those plans abandoned by the plan sponsor and all other discretionary fiduciaries. The critical issue with orphan plans is the ability of participants and beneficiaries to obtain distributions of their benefits. Orphan plans also raise problems with compliance, amendments, and payments of fees to service providers.
A number of factors lead to the creation of orphan plans. These include DOL enforcement actions (though often removal of a fiduciary is accompanied by appointment of a replacement fiduciary); bankruptcy of the plan sponsor; the death or incarceration of the fiduciary; the flight to avoid extradition of the fiduciary; or an unwillingness by a fiduciary to act.
DOL began to notice the problem in 1997 and 1998 as it received an increasing number of complaints from participants and beneficiaries. EBSA first responded on a case-by-case basis. They followed this with a project in the Philadelphia region to examine the issue and became convinced it is a serious problem and needs national attention.
On October 1, 1999, DOL began a national enforcement project on orphan plans with the objectives of locating orphan plans and trying to locate a fiduciary that they would require to perform the obligatory fiduciary duties. If no fiduciary could be located, EBSA assumed an active role in the appointment of an independent fiduciary.
Between October 1, 1999 and June 30, 2002, DOL brought 464 civil cases involving orphan plans. DOL currently has 274 pending orphan plan cases. More than $111 million has been protected or returned to plans. More than $51 million has been paid to participants and 43 independent fiduciaries have been appointed in 37 cases.
DOL is interested in developing guidelines for a White Knight approach. White Knights are independent fiduciaries who agree to distribute the assets of and terminate orphan plans. This approach would include some type of fiduciary protection for these independent fiduciaries. DOL also supports proposed bankruptcy legislation that would require a bankruptcy trustee to exercise fiduciary control over the company’s benefit plans.
Ms. Smith also testified that DOL is interested in ERISA Advisory Council assistance in:
- Gathering data on the extent of the orphan plan problem, especially from financial service providers
- Determining whether plan assets are being maintained on an individual participant basis with readily ascertainable market balances so that distributions can be made
- Asking whether financial service providers would be willing to file a final Form 5500 on behalf of an orphan plan in order to provide information on the termination of the plan to plan participants
- Ascertaining whether financial service firms would be willing to obtain certifications from participants and beneficiaries prior to making distributions regarding the accuracy of account balances.
Testimony of Gary Yerke
Mr. Yerke testified that Fidelity Investment’s definition of an orphan plan is a defined contribution plan without a plan sponsor or active fiduciaries. Orphan plans originate when fiduciaries abandon plans, a plan sponsor dissolves, sells assets, goes bankrupt, or a sole proprietor dies. Often Fidelity becomes aware of the issue when its contacts at the plan become unresponsive.
Fidelity dealt with about 100 orphan plans, involving over $40 million in assets and about 2,500 participants. The typical orphan plan has less than 25 participants and less than $1 million in assets. Also, the vast majority of plans that become orphan plans are operating under prototype plan documents.
Fidelity has experienced an increasing number of orphan plans and predicts that the problem will continue to grow because of: more business failures, the adoption of 401(k)s by smaller employers (approximately 20% of small businesses fail during their first two or three years), and the required GUST/EGTRRA amendments may identify more orphan plans because no one will have authority to amend those plans.
Fidelity believes that there are several issues that need resolution. A plan fiduciary must be available to make decisions about plan documents and to administer the plan. It is especially important to Fidelity that someone fills this roll because Fidelity must have direction in order to perform plan-related tasks. Service providers are reluctant to take on many tasks associated with plan administration because of conflicts of interest. Furthermore, service providers may lack necessary information, expertise, etc. in these areas.
Mr. Yerke stated that Fidelity is never willing to make distribution to participants and beneficiaries without the proper authorization of a plan fiduciary. Fidelity is not authorized by plan documents to take such action and often does not have the information required to make those distributions. Fidelity does contact the DOL about those situations.
There needs to be an established procedure for terminating orphan plans and distributing assets. Authorized company signatories may get their own plan assets prior to abandonment, and then they leave the other participants without access to funds.
Qualification issues create problems for participants. During a 1995 audit, the Houston office of the IRS expressed concern about the tax-qualified status of orphan plans and rollovers from those plans. Disqualification would impose an additional hardship on innocent plan participants. As it is, an independent fiduciary may refuse to process distribution requests until plan amendments are finalized and an IRS qualification letter is received. This delays the distribution of funds that participants and beneficiaries may need.
The potential liability of fiduciaries for abandoning plans raises fairness issues. Typically well-meaning fiduciaries may have lost their jobs at a defunct company and then are in a difficult position because they have no access to information, counsel, etc.
Finally, the role of a bankruptcy trustee depends in part on the acquiescence of the bankruptcy trustee. When a bankruptcy trustee does not act voluntarily on behalf of the plan, the DOL’s position seems to differ by region. Sometimes the DOL becomes involved quickly and seeks to get an independent fiduciary appointed, in other cases the regional DOL office is less active.
To address these issues Mr. Yerke outlined a number of items that should be included in comprehensive guidance issued jointly by the DOL and IRS. He suggested administrative relief for service providers; additional guidance using plan assets to pay plan expenses; increasing uniformity of DOL definitions and actions; clarifying the role of the bankruptcy trustee; the qualification of plans without plan sponsors and streamlining tax law compliance.
Mr. Yerke also suggested that legislation might provide relief for former fiduciaries, service providers, and bankruptcy trustees. As an alternative, he suggested that the PBGC might become responsible for the termination of orphan plans.
Testimony of Sanford Koeppel
Mr. Koeppel testified that the most frequent cause of orphan plans is bankruptcy or other termination of the business sponsoring the plan. Trustees in bankruptcy are uncomfortable assuming the role of administrator or successor to the plan administrator, mainly because of liability issues. Other reasons for orphan plans include death of the principal owner of a small business, merger or acquisition of a business, dissolution, liquidation or abandonment of the business by the business owner, or the incarceration of the business owner.
The problems caused by orphan plans are time-consuming and costly. Orphan plans contain, on average, between $100,000 and $500,000. Typically the plans have less than $1 million in assets. The plans include an average of 10 to 20 participants. Average account size is under $10,000. The number of orphan plans is expected to increase in the future.
The major problem presented by orphan plans is finding a way to distribute orphan plan assets to participants. There is usually no plan fiduciary to authorize the distribution; therefore the insurance company is in the awkward position of having to honor a distribution request. Clarifying the role of the bankruptcy trustee would go a long way to resolving many of these problems.
Orphan plans are time consuming and expensive to administer. Terminating an orphan plan can add ten percent to the expenses related to plan administration. These costs include hiring a search firm to locate missing fiduciaries, significant staff time on participant requests, dealing with uncashed checks and returned mail, etc. These situations are lose/lose situations because the higher expenses impact participant’s accounts and participants are frustrated about maintaining a relationship with the service provider because of the situation.
ACLI has convened a task force to address the problem. They will share with the committee their recommendations. However, any solution should be coordinated with the IRS, and any solution should focus on providing a party with requisite authorization and relief from fiduciary liability.
It is important for the IRS and the DOL to coordinate a response, which addresses all the issues and concerns. It is preferable for a solution to be arrived at without legislation. However, if legislation were necessary, that would be appropriate.
Testimony of Joyce Kahn
Ms. Kahn began her testimony by indicating the IRS considers any plan without an employer to be an orphan plan. The IRS position is that the Code presupposes an employer for a plan to exist, therefore any plan without an employer would not be a qualified plan. These plans result from the death of a company owner, to abandonment, etc. The commonalties in these plans are that participants have difficulty getting distributions, distributions may not be eligible for favorable tax treatment, distributions may not be calculated correctly, and that custodial expenses are eating away at assets.
The IRS has established the Employee Plans Compliance Resolution System (EPCRS), which has three components:
- A self-correction component, allowing corrections within a certain amount of time without contacting the IRS,
- A voluntary compliance program (VCR), which allows corrections with IRS approval, and
- An audit program.
There have been submissions from orphan plans in the VCR.
When approached with a problem plan, the IRS determines if relief is appropriate. In certain cases, because of expense, the IRS is working to define a class of plans where disqualification would not be pursued, because of expense. Relief is granted under Title II but exposure may continue under Title I.
Ms. Kahn indicated that the white knight approach would be a good solution. At the same time the IRS does not want to unintentionally encourage employers, under some sort of special guidelines, to abandon plans.
Testimony of Thomas Kim
Mr. Kim defined orphan or abandoned defined contribution plans as plans for which there's no longer an employer or plan fiduciary to maintain, administer, or make distributions under the plan. He said that a plan may become orphaned because the person who served as the sole plan fiduciary has died or because the corporate plan sponsor may have been dissolved as a business entity whether in or outside bankruptcy proceedings. In other situations, the owner may have simply abandoned the business and the retirement plan.
Fund companies may discover that a plan has been orphaned under a variety of circumstances. For example, a plan participant or beneficiary may contact the service provider seeking a distribution from the plan and representing the plan sponsor is no longer available or has simply died. Other ways a defined contribution service provider may learn that a plan has been abandoned are that the service provider may receive a bankruptcy filing notice; a financial advisor or broker serving as an intermediary between the plan and the service provider may inform a service provider that the plan sponsor is no longer operating; or, statements or other plan related mailings that are sent to plan fiduciaries are returned as undeliverable by the post office. Moreover, as prototype plans are being amended for GUST, it is likely that additional orphan plans will be discovered.
While ICI members observe that there do not appear to be a large number of orphan plans at their respective firms, many report that they're dealing with such plans and that the issues raised by them cause significant legal and practical difficulties. Generally most plans are known to be relatively small, having less than 25 participants. Often they're plans maintained by sole proprietorships with few participants holding less than half a million dollars in total assets. At the same time ICI members have occasionally found that a large client plans with hundreds or thousands of participants and millions of dollars in assets has become an orphan.
ICI members do not act in a fiduciary capacity with respect to retirement plans. To the extent that they serve as trustees, they function as directed trustees. In other words, in the absence of affirmative direction from a plan fiduciary, they're not authorized to make plan distributions or make other discretionary decisions. Thus, fund companies generally are unable to make distributions to orphan plan participants.
Also, a mutual fund company may often lack the necessary plan and participant information to even ascertain whether a participant is eligible for distribution. In many cases, the plan sponsor may have been the only party with plan-related documents, including the plan document itself.
Finally, many orphan plans have qualification defects because no plan sponsor has been available to maintain the plan. Plans, for instance, that may not have been updated for new tax law changes, indeed, a plan that's been orphaned for an extended period is probably unlikely to satisfy the numerous requirements of Code Section 401(a) or may be delinquent in submitting regulatory filings, such as the Form 5500.
Mr. Kim suggested that the Department of Labor and the IRS jointly develop a program offering two approaches. First, service providers could voluntarily make distributions to orphan plan participants to the extent that they have sufficient information concerning the plan participant's benefits and other relevant information. And importantly, by following the program's specified guidelines, the service provider's actions would not be viewed as discretionary in nature and, therefore, would not give rise to fiduciary status under Title I of ERISA. And, of course, a program would also have to clarify when a plan is considered orphaned.
Alternatively, a plan service provider could submit the available information relating to an orphan plan to a government-established clearinghouse. The government entity could then bundle such plans and seek appointment of an independent fiduciary to authorize distributions. The bundling of these plans could provide greater efficiencies and economies of scale.
To the extent that any program builds upon the department's current efforts, ICI recommends that the department develop uniform publicly available guidelines that will facilitate the referral of orphan plans by service providers to the department. It should do so without imposing burdensome requirements on such providers and also expedite the delivery of distributions to participants.
Additionally, the program should address the plan's potential qualification deficiencies under the Internal Revenue Code because participants under such plans are not responsible for the dissolution or absence of the employer. Distributions should be made as if the plan were qualified, notwithstanding the existence of qualification defects. This should include allowing distributees to preserve the assets in a retirement solution by allowing them to roll over assets into another retirement savings vehicle subject, of course, to otherwise applicable rules.
In sum, Mr. Kim testified that ICI believes that the program should emphasize the efficient delivery of distributions to orphan plan participants, given that many plan participants may not have alternative sources of retirement incomes. To the extent that service providers are permitted to deliver distributions under such a program, program rules should reduce potential liability for such activities, refrain from imposing requirements that fall outside the scope of the duties of service providers and account for the diverse factual situations encountered by service provider. This would include the varying degrees to which they would have plan and participant information. The program should minimize the administrative costs of the program, particularly because participant accounts may be the only available source of funds.
Finally, the plan may become orphaned due to a plan sponsor's liquidation and bankruptcy proceedings. While in bankruptcy, the party in the best position to authorize distributions from defined contribution plan is the bankruptcy trustee. The bankruptcy code, however, doesn't currently clearly assign this responsibility to the trustee, and although the duties of the bankruptcy trustee as a representative of the bankruptcy estate include the resolution of pension issues. Many bankruptcy trustees are reticent or reluctant to assume such duties. A legislative clarification of the bankruptcy trustee's responsibility with regard to pension plans would be helpful. The proposal, for instance, could clarify that a trustee steps into the shoes of the plan sponsor in bankruptcy to authorize distributions to participants and otherwise wipe out the plan. Passage of the legislative provision that's currently pending before Congress would certainly be a step in the right direction.
Testimony of James A. Boyd
Mr. Boyd testified that while the problem with orphan plans is almost minuscule in numbers, it is gigantic in impact. He indicated that while he had administered approximately 1,500 plans, only nine had become orphan plans. In each case, the situation was the result of the company filing for bankruptcy dissolution. It was not the result of a reorganization. In addition, the bankruptcy trustee either forgot to do something with the plan or did not know what needed to be done.
He testified that participant balances in these plans, however small, sometimes meant survival to people who are scared, angry, and confused. As an example he related his experience with a 70-employee plan that became orphaned in early 1990’s. He indicated that he was able to provide the participants with their money only after a difficult and time-consuming process supported by a very sympathetic and non-bureaucratic agent at the Department of Labor. His company was also required to write-off any outstanding fees owed.
Mr. Boyd recommended that an amendment be made to ERISA that would grant the trustee of a plan that has been orphaned the authority to terminate the plan; make distribution of assets to participants; or rollover plan balances into an IRA in the name of a participant. The change should also allow the trustee to initiate the action, sign the necessary documentation, and allow reasonable expenses to be charged against participant balances on a pro rata basis if there is no provision already existing in the document.
Also, as the trustee for many small plans is an officer of the company as well as the plan administrator, he suggested the same right to terminate should also be extended to the participants as a group, not to exceed ten percent of the participants. This approach should be established with an understanding that if such authority is granted to the participants of a plan, care must be taken not to impose burdensome requirements beyond the basics.
Mr. Boyd suggested that if after 180 days there have been no contributions, no contact with the employer, no activity in the plan, then the plan trustee should give a certification that it has become an orphan plan. If the company were in bankruptcy, this certification would be coupled with the bankruptcy filing that this is a dissolution and not a reorganization. This certification would also serve notice that the trustee intends to terminate the plan and distribute the balances unless some other fiduciary steps in with an alternative solution.
He also recommended the creation of an office within DOL to assist in the termination of the plans. This office would assist trustees or participants with the plan termination protect the rights of the participants and carry out the original intent of the plan.
Testimony of David L. Heald
Mr. Heald testified that the current process provides little relief and is not cost effective for orphan plan resolution. This comes at a time when there is growing concern about and a growing number of inquiries regarding orphan plans. There will be a growth in these plans due the current adverse economic situation. Most orphans are small plans containing small assets.
Most orphan plans are caused when plan sponsors going out of business. Typically, parties involved with the plan do not understand what the appropriate procedures are for orphan plan termination. There is no one authority or party assigned to act on behalf of a plan when it is orphaned. There is no empowered fiduciary or decision-maker. Custodians may exist but custodians cannot make fiduciary decisions. Custodians will only react to direction for a fiduciary. Often those attempting to terminate an orphan plan must get court authorization. This wastes time and reduces assets.
A fiduciary is needed to make decisions, arrange for termination, pay out balances and search for lost participants. The fiduciary assumes liability exposure but who will pay expenses? There will be higher expenses due to higher risk exposure. If the risk is eliminated the expenses could be reduced. It is estimated to cost between $10,000 and $30,000 to wind down an orphan plan.
Standard procedures should be an established. A fiduciary should be appointed automatically without court involvement as the result of coordination and agreement between the DOL and the IRS. The IRS should require a provision in plan that triggers a DOL appointed fiduciary if the plan is orphaned. If orphaned plan or a service provider with an orphan plan contacts DOL, a fiduciary should be automatically appointed. DOL should take a supervisory role in this process.
This approach does not require legislation. No new agencies are required to be formed. No other agencies need be involved.
Testimony of Regina Pizzonia
The T.Rowe Price definition of an orphan plan is a plan with which there has not been contact or transactions for two years. Most of its orphan plans were sole proprietorships not subject to ERISA. T.Rowe Price has experienced 15-18 orphan plans in the midsize and larger plan market. Some have been the result of a plan sponsor bankruptcy. In some the employer could not be found. The average assets of a T.Rowe Price were about $50,000 but two were $1,000,000. DOL is involved with two of these plans.
Although there are not many orphan plans, dealing with such plans is time consuming and costly. Costs are especially high relative to assets involved. Also, participants must wait months for benefits. Further, there is no one to approve loans, Qualified Domestic Relations Orders (QDROs) or other participant transactions. This in itself could cause qualification issues.
T. Rowe Price believes that DOL should not to get involved in each orphan plan. DOL involvement is too time-consuming. Further, lawsuits brought by DOL to appoint fiduciaries are only a partial solution.
T. Rowe Price recommends that DOL follow the existing structure of the PBGC program. That is a small group of employees within EBSA should be identified to handle these plans as a routine matter. Such a centralized solution would 1) create consistency 2) be efficient 3) be cost effective.
An alternative would be to have DOL create a similar structure as the PBGC and/or to contract with PBGC to locate participants to pay out benefits. DOL also could contract with various third party administrators (TPAs) to wind down the plans.
DOL and IRS need to work together with service providers on this problem. The IRS should provide some type of summary termination procedures. A clearinghouse created as part of the DOL or private agency would also be useful. No legislation is warranted due to the small number of plans and the small amounts involved.
September 18, 2002
Testimony of David M. Lipkin
Mr. Lipkin believes that the number of orphan plans is likely to increase in the future because they constitute some percentage of all plans and poor economic periods may increase the numbers of orphan plans.
The major problems Metro Benefits has experienced in working with orphan plans are:
- Getting accurate financial data
- Locating plan participants
- The need to spend plan assets on fees
- Distrust of plan participants who already may feel mistreated by their employer
- The lack of insurance protection for trustees.
Metro Benefits recommends that DOL:
- Provide assistance in locating participants
- Continue its new program of paying trustee fees for termination services
- Increase and formalize the reporting relationship from trustee of an orphan plan to the DOL
- Build inter-agency cooperation with the IRS particularly regarding qualification issues and the need to file past due 5500 forms
- Increase penalties for plan sponsors who abandon their retirement plans.
Testimony of James Lang
Principal Life Insurance Company currently has about 1,000 orphan plans, or about two percent of the plans the company services. The plans tend to have between 10 and 20 participants and approximately $100,000 in assets. As an insurance company, subject to state law and obligated to remain in compliance with its representations to the state, Principal cannot provide trustee services to these plans.
Principal has identified the following risks and problems associated with orphan plans. First, because fiduciary responsibility is based upon function, anyone who acts as a fiduciary with respect to an orphan plan assumes potential liability. This includes service providers who would act on their own to terminate an orphan plan.
Second, documents and records of some orphan plans are in often incomplete and out of date. This includes issues with late or unmade contributions, delinquent Form 5500s, and the absence of any company official to assume plan duties.
Third, like any other plan, orphan plans require ongoing fiduciary decision making for issues such as plan distributions, domestic relations orders, and governmental reporting.
To address the orphan plan problem Principal made the following suggestions:
- DOL should provide procedures for winding down orphan plans.
- Those who engage in the termination of orphan plans should be protected from liability. This would include protection for financial institutions and for those preparing government filings.
- DOL should provide standards for determining when a plan is orphaned.
Principal is not in favor of requiring that participants certify that their account balances are accurate because of delays, lack of participant knowledge, and potential for abuse.
On a related topic Principal suggests that DOL should provide standards for dealing with missing participants. The company recommends that for amounts less than $1,000 the amount be transferred to the IRS as withholding, and that amounts over $1,000 be automatically rolled over into an IRA. Appropriate guidance would need to be issued regarding these automatic rollovers.
Testimony of M. Larry Lefoldt
Mr. Lefoldt testified that his firm has terminated 45 or 46 orphan plans. It started working with the DOL on orphan plan terminations in May 1999. Since 1999 the firm’s work with orphan plans has increased substantially. Currently the firm is trustee for 40 orphan plans. This includes orphaned medical reimbursement plans. The plan assets in plans it has trusteed have ranged from $5,000 to $8,000,000.
Mr. Lefoldt observed that orphan plans raise a number of issues, especially compliance issues. As an example, he indicated that his firm has been getting exemptions from the need to file retroactive Form 5500s and, instead, files one catch up Form 5500. He observed that there is a need to weigh costs and benefits in compliance considerations with orphan plans.
He also pointed out that orphan plan data in incomplete and inaccurate and that it is often difficult to locate some participants. There are also issues with the payment of fees to the plan’s TPA. This can be compounded by the time lag between a bankruptcy filing and appointment of an independent fiduciary, which can create additional financial costs for orphan plans. In fact, some TPAs have failed file claims with the bankruptcy court for their fees.
Pooled income plans pose particular risks because there is no one to make ongoing decisions regarding investments and reporting. This lack of a fiduciary can sometimes create significant delays in evaluating the investments.
Mr. Lefoldt had a number of suggestions for dealing with orphan plans. He suggested that specific procedures be formulated for dealing with the compliance issues, such as Form 5500 filings. Orphan plans should not be required to file 5310s and updating amendments with the IRS.
Mr. Lefoldt felt that most communications should continue to be between the trustee and the regional DOL office responsible for the orphan plan. He felt that centralized administration of some orphan plan matters might decrease the specific plan knowledge on the part of the DOL contact. He has had good results in working with the regional offices.
He recommended that a procedure be established for the trustee to follow in dealing with the account balances of lost participants. He specifically suggested forwarding them to the IRS as tax payments.
He indicated that determination of orphan plan status should be made as quickly as possible. The more time that passes, the more problems occur with respect to plan data, bankruptcy issues, and locating participants. TPAs should be asked or required to report potential orphan plans to the DOL as early as possible, perhaps even at the point that potential trouble is observed. Similarly, company fiduciaries of the plan should be required to notify the DOL of any bankruptcy filing.
Finally, he recommended that fiduciaries working on the termination of orphan plans should be granted liability protection, particularly in the case of pooled income plans.
September 25, 2002
Testimony of Nicholas L. Saakvitne
Mr. Saakvitne recommended the following solutions for consideration by the ERISA Advisory Council. First, the DOL should be given the authority to appoint fiduciaries for orphan plans. He suggested that language could be included in the plan document that would give DOL this authority.
Second, the requirement of an independent audit of the plan should be waived for orphan plans. Auditing an orphan plan is expensive. Such an audit can cost between $10,000 and $25,000. At the same time, DOL should establish a procedure to be followed by fiduciaries in establishing the benefit levels of orphan plan participants.
Third, all discrimination testing for orphan plans should be waived. He pointed out that it often impossible to obtain the data necessary to perform these tests appropriately.
Fourth, a de minimis balance standard should be set for orphan plans. If an account balance were lower than the standard the fiduciary would be authorized to forfeit that amount upon plan termination. The expense of communicating with participants with very small balances often exceeds the value of those balances.
Fifth, there should be 100 percent federal income tax withholding of the benefits of lost participants with small balances. This is the most efficient and fair method of dealing with this issue.
Sixth, personal responsibility by the plan administrator/fiduciary appointed by the DOL for the Form 5500 filings should be waived. It is unfair to hold those appointed to deal with orphan plans responsible for missing or incomplete 5500s that were to be filed prior to the date of their appointment.
- 2002 Index for the Working Group on Orphan Plans
- Advisory Council on Employee Benefit and Pension Plans
- Actual Transcripts/Executive Summaries for the Council's full meetings and working group sessions are available - at a cost - through the Department of Labor's contracted court reporting service, which is Neal R. Gross and Co., Inc. 1323 Rhode Island Avenue, NW, Washington, DC 20005-3701 at (202) 234-4433 or nealgross.com.
July 18, 2002: Working Group on Orphan Plans
- Official Transcript
- Questions Posed to Witnesses by Chairs
- “EBSA Developing ‘White Knight’ Guidelines to Assist Fiduciaries; Asks for Information” by Michael Wyand, July 19, 2002 BNA Pensions & Benefits Reporter.
- Written Statement of Virginia Smith, Director of Enforcement, Employee Benefits Security Administration, on Orphan Plan Project.
- Statement on Behalf of the Investment Company Institute by Thomas Kim, Associate Counsel.
- Written Testimony of Sanford E. Koeppel, Vice President, Legislative and Regulatory Affairs, Prudential Financial, Inc.
- Outline of Comments made by Gary L. Yerke, Associate General Counsel, Fidelity Investments.
- Written Testimony of Reginia Pizzonia, Vice President and Associate Counsel, T.Rowe Price Associates.
- Written Testimony of David L. Heald, Principal, Consulting Fiduciaries, Inc.
- Packet of Pension and Welfare Benefits Administration news releases about orphan plan cases being litigated by the agency.
September 18, 2002: Working Group on Orphan Plans
- Official Transcript
- Outline of testimony provided by David M. Lipkin, F.S.A., Metro Benefits Inc.
- Outline of testimony provided by M. Larry Lefoldt, CPA
- Section on Orphan Plans from Testimony presented by Assistant Secretary of the Pension and Welfare Benefits Administration Ann Combs before the House Committee on Education and the Workforce, Subcommittee on Employer-Employee Relations on September 10, 2002.
- Written testimony of Jim Lang, Compliance Officer, Principal Life Insurance Company.
- A recent news release issued by EBSA regarding the naming of Larry Lefoldt as the independent fiduciary of Sun Country Airline’s Pension Plan.
- “Protection for Orphan Plan Service Providers Requires Legislative Solution, Speaker Says,” article in the September 19, 2002 issue of BNA’s Pension & Benefits Reporter.
- Copy of letter received from Nicholas L. Saakvitne, an ERISA attorney, who opined on the topic.
- Summary of issues for the working group to consider as it begins its deliberations, prepared by the chair Catherine Heron.
- American Council of Life Insurers (ACLI) Recommendations to the Working Group on Orphan Plan regarding the Department of Labor’s “White Knight” Fiduciary Program.
October 15, 2002: Working Group on Orphan Plans
- Official Transcript
- Rough Draft of the Final Report and Recommendations for the Secretary of Labor.
- Catherine Heron, Chair
- David Wray, Vice Chair
- James S. Ray, Chair of the ERISA Advisory Council and Ex-Officio Member of All Working Groups
- Ronnie S. Thierman, Vice Chair of the Council and Ex-Officio Member of All Working Groups
- Michele Weldon
- John Szczur
- Norman Stein
- Dana Muir
- Robert Patrician