Recent litigation and audit activity is focusing on the process undertaken by fiduciaries in connection with a transaction involving an ESOP. Eliot Burriss presented at the 2018 National Center for Employee Ownership Conference summarizing relevant litigation cases, exploring roles and responsibilities, and providing best practices.
Managers of private equity funds who are responsible for investing the assets of a fund that holds plan assets are likely to be considered a fiduciary under the Employee Retirement Income Security Act of 1974, as amended (ERISA). ERISA imposes numerous duties on fiduciaries, and those who fail to meet ERISA’s standards may be personally liable to restore plan losses, disgorge profits made through the use of plan assets, and pay additional statutory penalties imposed by the Department of Labor. The fiduciary may also face criminal penalties if found guilty of wilful failure. It is therefore vitally important that fiduciaries are fully aware of all their duties under ERISA.
In many transactions, particularly those where the buyer is a portfolio company of a private equity fund, the buyer agrees to cause its 401(k) plan to accept a transfer of assets from the seller’s 401(k) plan. The asset transfer from the seller’s plan provides the buyer’s with an asset base with which to negotiate the best possible administrative fee structure, and seamlessly transfers the retirement plan benefits of employees being retained or hired by the buyer. If the seller’s plan contains employer stock as an investment however, the buyer should be aware of fiduciary concerns that may arise under the Employee Retirement Income Security Act of 1974 (ERISA), as amended.
“Stock-drop” litigation is a well-known phenomenon centering on plan fiduciary liability to plan participants when the value of employer stock investments in a retirement plan drops significantly. Less well-known is the fiduciary liability exposure facing new 401(k) plan sponsors and fiduciaries accepting a transfer of assets from the seller’s plan that includes former employer stock. Holding a significant block of a single security that is not company stock implicates ERISA prudence and diversification issues, and must be closely monitored.
Fiduciaries of 401(k) plans considering accepting asset transfers of former employer stock have often been advised to engage counsel to evaluate the prudence of holding the former employer stock in the buyer’s plan as an investment alternative (even if “frozen” to new investment) and establish a timeline for requiring that plan participants divest the former employer stock within one to two years of the asset transfer from the seller’s plan.
In light of the decision in Tatum v RJR Pension Inv. Comm., 2014 U.S. App. LEXIS 14924 (4th Cir. Aug. 4, 2014), buyer 401(k) plan sponsors and plan fiduciaries must now be even more careful to engage in a process that separates fiduciary from non-fiduciary acts and carefully follows established procedures for implementing any required divestitures of former employer stock. In Tatum, the plan was not properly amended to require the divestiture of former employer stock. This failure to properly amend the plan converted a plan design decision, which was a non-fiduciary or “settlor” decision, into a fiduciary act. In Tatum, the plan fiduciaries also failed to follow a prudent process for determining whether or not to eliminate former employer stock and for determining the timeline for implementing such divestitures.
The Tatum decision highlights that, in addition to fiduciary risk in holding former employer stock in the buyer’s 401(k) plan as an investment, there is also fiduciary risk in the process of eliminating former employer stock as an investment in the buyer’s plan.
When establishing a new 401(k) plan, the buyer should consult with legal counsel regarding the risks involved in accepting an asset transfer from a seller’s plan that includes former employer stock. Any new plan sponsors or plan fiduciaries that are contemplating accepting former employer stock as part of an asset transfer should consider whether or not they should engage an independent third party to monitor the former employer [...]
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