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Managing corporate liabilities under ERISA.

WHEN THE PILGFIMS LANDED ON Plymouth Rock in 1620, they came in pursuit of security and a better quality of life. Almost four centuries later, the Employee Retirement Income Security Act of 1974 (ERISA) and related legislation have turned these goals and aspirations into reality.

ERISA was thrust into existence by the 1963 demise of the Studebaker Corp. The failures of the company's pension plan, and the consequent upset of the 6,000 workers who were promised pensions, created a public outcry. The money to provide future retirement payments simply wasn't around. ERISA was intended to prevent a recurrence of this type of monetary disaster.

Although pension plans have existed since the Civil War, their real growth began with the Taft-Hartley Act of 1948, which authorized the organization of multiemployer plans with an equal number of trustees from both management and labor. ERISA was the next great leap forward. Today, there are more than 900,000 singleand multi-employer pension plans, from both the private and public sectors, with combined fund balances in excess of $3 trillion, and there are 4.5 million health plans. About half the funds are invested in equities. Because the market value of New York Stock Exchange securities is approximately $3 trillion, it is clear that pension funds hold a substantial chunk of corporate America. There are about 65 million beneficiaries involved.

Establishing effective labor relations was the incentive for the passage of the Taft-Hartley Act. This act was passed when America's intense experience with labor-management committees during both world wars augmented the government's interest in employment conditions. More than ever, management and labor were concerned with future security, the health and welfare of the labor force and, consequently, pension and welfare benefits.

Fiduciary Responsibility

The increasing size and impact of pension plans has brought tougher enforcement of fiduciary rules relating to plan trustees and all parties-in-interest, which include the officers and directors of plan-sponsors. The "normal" rules governing trusteeship have always been stringent; ERISA trusteeship rules are even more severe.

For many years, plan trustees and corporate officers and directors have operated as though they were exempt from scrutiny by virtue of the interposition of named fiduciaries" to carry out the functions of their plans. However, according to the U.S. Department of Labor, which is responsible for ERISA enforcement, they are not exempt. Since March 1990, the Department of Labor and Pension Benefits Guaranty Corp. (PBGC) has maintained that the purchase of insurance company annuities by employee pension plans ended these agencies' pension responsibilities. However, the recent junk bond-related failure of First Executive Life Insurance Co. has led to Department of Labor lawsuits against two companies whose pension funds bought annuities from Executive Life. "The lawsuits, filed against Maxxam Inc. and Magnetek Inc., were intended as a signal to all companies that they must select the safest available option whenever buying an annuity to finance retirement benefits," according to a June 14 New York Times article. In April, the General Accounting Office reported to Congress that "Millions of former participants in defined benefit plans are now receiving their pensions in the form of insurance annuities. Without any required notification, they have lost the federal guarantee promised by ERISA. Although these annuitants are protected in general by the state guarantee system, some of them could lose part or all their pension benefits should the insurance companies providing their annuities fail."

In the event of an insurer's financial trouble, and the failure of a state guarantee fund to make up pension losses suffered by annuitants, the only recourse of disappointed pension holders is to the company, its plan and the trustees who purchased the annuities. A failure of fiduciary responsibility would certainly have to be demonstrated. The Maxxam and Magnetek cases cited in The New York Times article clearly indicate that the Department of Labor considers all corporate levels to be in its regulatory sphere. Also, as reported on June 17 in The Wall Street Journal, thousands of retirees and employees brought a class-action suit against Unisys Corp. and its officers for investing retirement funds in First Executive Life Insurance Co., an action described as "imprudent" to say the least.

In its April study on private pensions, the GAO estimated that nearly 10 million private pensions are currently being paid, and that approximately 3.5 million retirees and their survivors receive benefits from insurance companies. It is currently impossible to ascertain how many of these annuities might pose problems to those corporations and their plans which purchased them. However, as The New York Times points out in a June 24 article, State guarantee funds, which require surviving life insurance companies to cover the claims of insolvent insurers, are limited in the amount they can assess each year."

Avoiding corporate liability and litigation in connection with pensions rests squarely on good management and fiduciary judgment, careful investment policies and compliance with ERISA. The old adage "If you do nothing wrong, you'll never be arrested" still applies to ERISA.

Problem Sources

There are some areas, including investment policy, which have proven to be sources of problems to corporate officers and directors, plan trustees and administrators. ERISA's prudence rule, which appears in both the act and regulations, outlines the investment duties of a fiduciary of an employee benefit plan. Section 404(a)(1)(b) of the act provides, in part, that "a fiduciary shall discharge his duties with respect to an employee benefit plan with the care, skill, prudence and diligence under the circumstance then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character, with like aims."

The application of the prudence rule is quite broad; it allows for the engagement of advisory counsel and fund managers. Past practice makes it clear that while a fiduciary need not be the sole criterion for a plan's investments, he or she-must be certain that fund managers are following the investment objectives approved by the plan's board of trustees. He or she cannot rely on them blindly, but should ensure that principles of diversification, safety and sound judgment are followed. Losses traceable to a lack of fiduciary prudence may well be chargeable to the fiduciary and other parties-in-interest.

Excessive investment in high-yield bonds appears to be the reason why state regulators seize several major insurance companies. Pension plan investments in junk bonds must be governed by the same standards of prudence that apply to all other investments. The anticipated high yields, on which the sale of low-priced annuities by insurers was premised, have not developed. This was a major factor in capital as well as in income losses.

Unless so-called "social investments" are made within the parameters of reasonable returns and with strict safety standards, they are not acceptable to the Department of Labor. The concept of "survival investment,' by which low-yield loans were made to or for related borrowers with the hope they would create employment in a fund-related industry, a source of employment-based fund contributions or a physical benefit such as a resort facility for beneficiaries, has not survived. The yield on "social investments" should never be less than the yield on other available investments.

ERISA, and all related pronouncements by the Department of Labor, PBGC and the Internal Revenue Service, makes it clear that plan fiduciaries shall act solely in the interest of the participants and beneficiaries. This rule extends to the voting of stock proxies. If a fiduciary names an investment fund manager to acquire and dispose of plan assets, the fund manager has the responsibility for voting the shares unless that right is reserved by the trustees. Several years ago, the Department of Labor stressed that investment policies and the voting of stock proxies should not be totally based on management recommendations, but that proxy voting must primarily support the interests of the plan's participants and beneficiaries and be done by or under the direction of plan trustees and in accordance with a documented investment policy that conforms to Department of Labor rules. Conceptually, prohibited transactions, detailed in Section 406 of ERISA, are those between a party-in-interest or a plan fiduciary and the plan. Deviations from the rule must be supported by a formal Department of Labor exemption. The statutory definitions and examples are broad enough to cover every conceivable type of transaction. Restrictions also exist on plan investments in "employer securities." Similarly, the concept of "party-in-interest" relates to all individuals and their relatives associated with a plan by ownership, discretionary power and management or advisory functions. Because corporate directors appoint and/or approve plan trustees, they appear to have an implicit responsibility in monitoring the trustees' activities.

Exemptions should be obtained from the secretary of labor before entering into prohibited transactions. The exemption proceedings may be initiated by any party involved in the transaction. The adjustment sometimes returned by money managers to employee benefit plans, in the form of free analytical services or perks to plan administrators, can provide a basis for serious criticism. These adjustments can be direct fee reductions and can serve to reduce the base cost of plan investments.


ERISA requires that an annual examination of a plan's financial activities be conducted by an independent, qualified public accountant so that an opinion on the financial statements may be submitted. Limited-scope audits are still permitted under ERISA by excluding from the examinations assets held by banks and insurers if they vouch for the assets for which they are responsible. However, because additional costs would not be material and the fact that auditors will not express a clean" opinion if they are not permitted to perform a full-scope audit, parties-in-interest should assure greater protection to their plans with full-scope audits.

A requirement for full-scope audits of employee benefit plans, approved by the Department of Labor, is undergoing congressional review. Compliance and internal control reviews by independent professionals will assure compliance with ERISA regulations. Actuarial reviews should be thorough and aimed at establishing yields on a pragmatic basis.

The serious approach to ERISA enforcement taken by the Department of Labor is emphasized by the drive in Congress for several hundred additional investigators. The parties concerned want to insure that pension funds will not be tainted by the fraud and other bad practices which were prevalent in the savings and loan industry.

Additional penalties are now assessable by the secretary of labor for fiduciary violations. The final responsibility for the sound administration of employee benefits is in the hands of corporate directors and officers, trustees and administrators. With the cooperation of management and labor, they can be safely managed.

Kermit J. Berylson is vice president and Jules Zimmerman is president and CEO of Hickok Associates in New York.
COPYRIGHT 1991 Risk Management Society Publishing, Inc.
No portion of this article can be reproduced without the express written permission from the copyright holder.
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Title Annotation:Employee Retirement Income Security Act
Author:Berylson, Kermit J.; Zimmerman, Jules
Publication:Risk Management
Date:Dec 1, 1991
Previous Article:Uncovering the hidden costs of long-term disability.
Next Article:A perspective on health care and the employer.

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