DOL update: changes to Voluntary Fiduciary Correction Program expands relief ability.

The Department of Labor issued an updated version of its Voluntary Fiduciary Correction Program in April, adding transactions that can be corrected under the program and expanding the ability to obtain relief from prohibited transactions.

The program's expansion follows the pattern we have seen in the IRS Voluntary Correction Programs for plan qualification defects. Those programs began narrowly, then gradually expanded as the IRS became more comfortable with them. We are now seeing the same type of expansion with the VFC program.

Before getting into the changes, let's look at the background.

Under the VFC program, individuals who could be liable for a fiduciary breach can avoid a DOL civil investigation or other DOL action with respect to that breach if all of the conditions for relief have been satisfied.

In addition, the DOL will waive any penalties under ERISA Sec. 502(1) (which impose a 20 percent penalty on the "applicable recover amount" in a civil action or settlement involving the DOL), and the civil penalties under ERISA Sec. 502(i) for certain prohibited transactions.

Only certain types of fiduciary breaches are eligible for relief under VFC, all of which deal with transactions involving valuation and prohibited transaction issues under Title 1 of ERISA.

The purpose behind the revised VFC program, according to the DOL, is to update, simplify and expand the program. The changes were effective May 19, 2006.

WHAT ARE THE CHANGES?

The 2006 update expands VFC by adding three covered transactions:

1. Participant Loans: Breach of Fiduciary Duty for Failure to Meet the Level Amortization Requirement.

Under ERISA, it is a prohibited transaction for any plan fiduciary to permit a loan by a plan to a participant-in-interest (including plan participants) unless there is an exemption. In addition, prohibited transactions also constitute fiduciary breaches.

Loans to participants are exempt if various conditions are met, including the requirement that the loan be based on a level amortization repayment schedule.

By including this breach in VFC, the DOL has increased the number of covered transactions involving participant loans to four. The others include:

* participant loans that exceed the maximum limit under Internal Revenue Code Sec. 72(p);

* participant loans with repayment terms that exceed the maximum under IRC Sec. 72(p); and

* participant loans that meet the compliance requirements at the time they were made, but those terms were not followed due to a failure of an individual responsible for the administration of participant loans to properly withhold loan repayments from the participant's wages, as required under the terms of the loan.

What is the Correction? This defect must first be corrected under the Voluntary Compliance Program of the Employee Plans Compliance Resolution System (EPCRS; Rev. Proc. 2006-27), since for most plans, the defect results in a failure to follow the terms of the plan and, therefore, subjects the plan to disqualification.

The compliance statement must then be submitted with the VFC application, along with proof of payment of any penalties required under VCP.

This change to VFC addresses a fairly common breach and provides for what comes close to one-stop shopping. That is, with relatively few modifications, a single application can be used to voluntarily correct both the qualification issue and the fiduciary breach, which means a savings in professional fees for the plan sponsor.

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However, by having to wait for the IRS to issue a Compliance Statement, the process of fully protecting the plan and the fiduciaries can take an extended period of time. Hopefully, the DOL will permit simultaneous filing using a single application and expand this type of coordination between EPCRS in subsequent restatements of the VFC program.

We also hope the IRS will take note of the DOL's efforts in this regard, and adopt procedures that deem any prohibited transaction corrected in accordance with VFC to be corrected for IRS purposes.

2. Improper Payment of Expenses From the Plan.

This violation takes place when plan assets are used to pay expenses, including commissions or fees, which should have been paid by the plan sponsor. This breach is also a prohibited transaction.

What is the Correction? The fiduciary must restore the principal amount to the plan, plus the greater of the lost earnings or restoration of profits.

This is another example of a fairly common problem, which had the potential for being particularly expensive to correct due to the applicable excise tax.

Previously, there was no formal mechanism for compromising the excise tax. Over the years, there has been a reduction in the amount of excise tax through the IRS' power to enter into closing agreements.

However, a waiver of the excise tax was not even close to a realistic outcome. As a result of this program change, and a corresponding amendment to a class exemption (discussed below), plan sponsors can now voluntarily correct the fiduciary breach and obtain excise tax relief for prohibited transaction violations involving the use of plan assets to pay expenses to a service provider for services that are characterized as "settlor expenses," so long as such payments are not prohibited in the plan documents.

3. Illiquid Assets.

If a plan holds an illiquid asset that the plan fiduciary determines is an imprudent investment for the plan (i.e., it would be contrary to the best interests of the plan participants and beneficiaries for the plan to continue to hold the asset), the plan may now divest itself of the asset by selling it to a party-in-interest.

To be eligible for this relief, the illiquid asset must have been acquired under one of the following circumstances:

* the plan purchased the property from a party-in-interest in an acquisition for which relief was available under a statutory or administrative prohibited transaction exemption;

* the plan paid not more than fair market value for the asset, but the transaction was a prohibited transaction because the seller was a party-in-interest;

* the plan purchased the asset from an unrelated third party that is not a party-in-interest, but the fiduciary failed to appropriately discharge his or her duties with respect to the purchase; (for example, by failing to conduct a prudent analysis of the purchase); or

* the plan purchased the asset from an unrelated third party who was not a party-in-interest in an acquisition in which a plan fiduciary appropriately discharged their fiduciary duties.

What is the Correction? To sell the asset to a party-in-interest, provided the plan is made whole by receiving the greater of the fair market value of the asset at the time of resale (without reduction for the cost of sale) or the principal amount, plus lost earnings.

For this purpose, the principal amount is the original purchase price of the asset, plus any transaction costs involved in acquiring the asset. Although not specifically stated in the revised program, the principal amount presumably would include any costs associated with holding the asset.

This is a practical approach to a problem that had been difficult to correct.

Often, the individuals in the best financial position to assist the plan in ridding itself of the imprudent illiquid investment couldn't do so because it would result in a prohibited transaction. Thus, in many cases, this change should facilitate a more timely correction and better ensure the benefits of plan participants and beneficiaries.

ADDITIONAL CORRECTION METHOD

In addition to expanding relief to cover the three transactions discussed above, the 2006 update to the program permits an additional method of correction for a plan's purchase of an asset for cash from a party-in-interest to which no prohibited transaction exemption applies.

Under the revised program, the plan may retain the asset and settle for the correction amount in cash if an independent fiduciary determines that the plan will realize a greater benefit from this correction than it would from selling the asset.

EXPANSION OF EXCISE TAX RELIEF UNDER THE VFC PROGRAM

Along with revising VFC, the DOL also revised Prohibited Transaction Class Exemption 2002-51 to add two of the new covered transactions involving illiquid assets and the impermissible payment of certain expenses from the plan.

Now, PTCE 2002-51 provides a de minimis exception to the notice requirements for transactions involving delinquent participant contributions and/or the failure to transmit participant loan repayments for which the excise tax due under IRC Sec. 4975 is less than or equal to $100.

CONCLUSION

The revisions to VFC and the amendment of PTE 2002-51 are welcome because they:

* expand the program to address additional common problems;

* begin what we hope will be steady progress toward streamlining voluntary compliance through coordination with the IRS under EPCRS; and

* substantially reduce the cost of correcting the pervasive problem of improperly paying expenses from the plan.

The revisions to VFC make voluntary compliance easier and less expensive. Thus, the program continues to provide greater rewards to compliance oriented, proactive plan sponsors and fiduciaries, who establish practices and procedures to identify and correct fiduciary breaches and prohibited transactions when they occur.

This places a high premium on establishing internal systems and procedures designed to comply with ERISA.

Any such systems and procedures should include a self-auditing component to identify errors and, thus, provide those responsible for the plan with an opportunity to correct them quickly and on the most favorable basis.

Plan sponsors and other fiduciaries should keep in mind that correction under VFC is helpful in guarding against adverse DOL action and is extremely valuable in defending against suits by participants, because a "no action" letter would serve as powerful evidence that there are no damages or--at the very least--the damages have been significantly mitigated.

Finally, correction under VFC can be helpful in "grooming" a company for a potential acquisition. That is, to the extent VFC has been used to remediate problems prior to performance of a formal due diligence review, it will reflect positively on the character and stability of a company and, thus, make it more attractive to a potential buyer. And, ultimately, it will facilitate the due diligence process.

BY NICK WHITE, ESQ. AND STEPHANIE BENNETT, ESQ.

Nick White, Esq. is a partner and Stephanie Bennett, Esq. is an associate with Los Angeles-based Reish Luftman Reicher & Cohen. They can be reached at [e-mail] and [e-mail], respectively. Article reprinted with permission from Reish Luftman Reicher & Cohen. This article originally appeared in the firm's Department of Labor Voluntary Compliance Bulletin (June 2006).