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      Resource Center

      For Internal ESOP Trustees: An Overview of Audits, Lawsuits, And Insurance Issues

      ESOP fiduciaries perform their duties with two pairs of eyes looking over their shoulders – the participants and the Department of Labor (DOL).  This article is addressed to trustees and administrators – the two types of fiduciaries that the Employee Retirement Income Security Act of 1974 (ERISA) requires the ESOP to have.  Both trustees and administrators can find themselves the subject of:

      • Department of Labor (DOL) investigations and enforcement actions; and
      • Civil litigation brought by participants and beneficiaries.

      The trustee is the fiduciary responsible for plan assets.  The administrator is responsible for making decisions about the operation of the plan.  The administrator is often referred to as the "plan administrator" and may be an individual or committee appointed by the company board of directors, or may be the board itself if it hasn't appointed anyone to serve in this function.  Our comments below provide insight into how the ESOP's trustee and plan administrator should comport themselves to minimize exposure to DOL action and civil litigation.

      Department of Labor Investigations and Enforcement Actions

      Contrary to common belief, the DOL does not "audit" retirement plans.  The IRS audits plans.  The DOL investigates plans.  DOL conducts investigations through its "subsidiary," the Employee Benefits Security Administration (EBSA).  EBSA maintains regional offices that are the front line for investigating plans to determine whether there are ERISA violations.  In brief, via EBSA, the DOL:

      • Can compel compliance with ERISA by requiring ESOP fiduciaries to correct fiduciary breaches and prohibited transactions or to improve their plan operations to prevent potential problems.
      • Does not unilaterally "impose" penalties for noncompliance, such as the IRS may impose taxes, penalties and interest for Internal Revenue Code violations.
      • Derives its ultimate enforcement ability from litigation it may bring to enforce ERISA provisions.  In these lawsuits, the DOL is represented by the Department of Justice Office of the Solicitor (Solicitor).  If the DOL is unsatisfied with the result when it closes an investigation, it will call on the Solicitor's regional office in the given region to represent the DOL in litigation.

      Although DOL sometimes sues to enforce ERISA, in the overwhelming majority of investigations, it requests (or demands) voluntary compliance.  In fact, only a limited number of cases are referred to the Solicitor's office each year.  However, the DOL may also request assistance from the Solicitor's office where unusual legal issues are involved in an investigation or where the DOL wishes to negotiate forcefully from a posture that suggests litigation may be imminent if it does not achieve the results it seeks.

      Handling DOL Investigations

      DOL investigations are not a certainty.  But trustees and administrators should know that an investigation may result from a complaint filed by a plan participant or from a DOL enforcement initiative.  If DOL does open an investigation of your plan, it is important to understand their "script" for conducting the investigation. The EBSA manual for handling investigations is available online via the DOL's website.  Reviewing the manual will help fiduciaries understand the objectives and tone of investigation as well as the sequence of steps the investigators follow to complete their review and interact with plan representatives. Even though the uncertainty of an investigation can be maddening, it's important for fiduciaries to do what they can to manage the process and provide themselves a feeling of understanding, if not control.  Being proactive and prepared helps plan fiduciaries assume the posture that their performance is and has been up to par.  Fiduciaries are then in a better position to understand the next steps in the investigation, even if they can't predict them.  We advise our clients to push as hard as they can to stay on top of the DOL's process and ensure that the investigation doesn't languish.

      "We're From the Government and We're Here to Help"

      Communications and correspondence with the DOL should be cordial and cooperative.  A confrontational approach to an investigation does not facilitate the process. There are a handful of things that you should keep in mind, however:

      • Document Requests. Generally, what they want, they get.  The DOL is entitled to get anything they want from plan fiduciaries or other related parties or service providers regarding the plan's operation.  The DOL has the power to issue a "desk subpoena" to compel the production of documents without seeking approval from a court.  It is one of only a few federal agencies with this type of authority.  It is very difficult, if not impossible, to prevent documents from being produced.  We recommend responding to the DOL's document request in a thorough, complete and organized fashion.  Provide everything, if at all possible, all at once.  Index, organize and retain copies of everything you send to the DOL to ensure that there are no allegations of nondisclosure.
      • Fiduciary Communication. Keep in mind that there is generally no attorney/client privilege between an ERISA plan fiduciary and the fiduciary's attorney when a fiduciary is being advised on plan matters.  As a result, all of the correspondence between the plan fiduciaries and their attorney that relates to plan advice must be produced for the DOL if requested.  Advice your attorney may give the corporation or a nonfiduciary regarding plan matters may be protected. Also, advice given to a fiduciary by defense counsel may be privileged.  Talk to your attorney about what advice is provided to which party and for what purpose.  It may be wise for fiduciaries to have separate counsel from the company's counsel or to have your counsel clearly separate their client's files and engagement agreements (including conflict of interest disclosures) to keep fiduciary representation and advice separate from corporate or plan sponsor advice.
      • Past Actions and Transactions. Review these with counsel carefully in preparation for your interview with DOL.  Since the investigation will likely deal with transactions that happened years ago, and may have involved others at the corporation or predecessor trustees, your recollection of the facts and motivations will be hazy and will require re-examination.  It is important to understand what is in the documents that you produce for the DOL, since it will likely be the subject of a fiduciary interview later.  More on this below.
      • Trustee Minutes and Records. The law does not specifically require trustees to keep minutes of meetings; however, they are very useful and desirable.  Trustees will typically adopt resolutions in connection with plan transactions or significant administrative decisions, but perhaps not on a regular year-in and year-out basis.  Don't be surprised if you are asked for such documents in your interview and you are unable to produce them.  Even if you don't have written minutes and records, though, the DOL will still ask you what you did or what you intended in making decisions for the plan.

      When the DOL Comes to Call – The Interview

      In almost every investigation, the DOL will interview the plan fiduciaries.  Expect the interview, be prepared.  Have all of the documents you produced for the DOL present in the interview, organized and indexed.  The DOL will ask open-ended questions seeking a narrative from you.  Make the DOL ask specific questions so you are sure what they are asking.  The purpose of this advice is not to hide anything from the investigator.  Rather, it ensures that the interview stays on track and that your time and effort in the process are focused and potentially minimized.  If necessary, refer to the documents in the interview to see what they say so that your responses aren't based on vague recollections that might conflict with the documents and the written record of your prior decisions.  Bear in mind that the DOL's objective is to protect the best interests of the participants and beneficiaries.  This is your role as fiduciary to the plan as well.  Therefore, it's best to keep in mind that you are on the same team as the DOL in this objective, even though you may not always agree with the details of their positions.  We encourage you to have an attorney present during the interview.  The EBSA manual specifically allows for a fiduciary's attorney to be present.  However, be aware that the investigators are instructed to withdraw from the interview if the attorney attempts to take over or control the interview.

      DOL Voluntary Compliance Letter

      At the close of the investigation, the DOL will issue a "voluntary compliance (VC) letter."  This VC letter contains the results of the investigation and the Regional Director's position and findings.  There should be no surprises as to what the letter contains.  The letter usually asserts one of three conclusions.  It might assert that the investigation is closed and no further action is being taken.  It might assert that the DOL believes you "may" have violated certain provisions of ERISA, but at this time, the DOL is taking no further action.  It might assert that the DOL is of the opinion that you "have" violated certain provisions of ERISA and that certain corrective actions are required.

      You should strive in the investigation not to receive this last form of letter.  If the investigation uncovers issues that are not to the DOL's liking, you should work with them to resolve the problem.  You may not see eye-to-eye with the investigator or the Regional Director, but fiduciaries must work out solutions that are in the best interests of participants.  If such a letter is issued even after discussions, negotiations and attempts to resolve the issues, then you should engage counsel (if you haven't already!) to evaluate whether the DOL is likely to refer the matter to litigation.  It may be possible to resolve the situation without litigation even after receiving this letter, but you should go no further without obtaining the advice of counsel.  We often find that DOL issues these letters because counsel wasn't involved in the investigation and the fiduciaries didn't fully understand the process or what the DOL's objectives and intentions were.  That is why we recommend you involve counsel throughout the investigation process to avoid any allegations of breach of duty.

      Civil Litigation

      There are generally three types of civil litigation that may be brought against you as a plan fiduciary:

      • Benefits claims;
      • Fiduciary breach claims; and
      • Retaliation claims.

      Benefits Claims

      These are the most common forms of confrontation with plan participants.  Participants may file a claim with a plan administrator asserting an entitlement to benefits or requesting a clarification of their employee benefit status.  DOL regulations require detailed benefit claim procedures to be stated in the plan documents and summary plan descriptions.  If a participant files a claim, the plan administrator should follow the plan's claim procedures to the letter.  The plan participant will also be required to follow the procedures to the letter if he wishes to file a claim in court if the dispute is not resolved in his favor. The plan's benefit claim procedures may require a plan participant to file a claim form in order to formally initiate and perfect his benefit claim.  This helps avoid the issue of when and whether a participant has made a claim for benefits and when the timeline for response and appeal begins and ends.

      Handling the Benefit Claim

      Plan administrators should provide claim forms and promptly respond to all document requests from the plan participant.  If documents are not provided within 30 days, penalties may be assessed against the plan administrator in the context of litigation.  ERISA lists the documents that must be made available to plan participants. These include the plan document, summary plan description, annual report and any other instruments under which the plan is administered.  You should seek advice from counsel as to whether the ESOP's appraisal report must be provided at the participant's request as this varies among the geographic federal judicial circuits.

      All responses to benefit claims should be in writing.  The plan administrator should cite the time frame for its reply.  If an extension of the response time is required, the plan administrator should notify the participant of the need for an extension of time.  If the benefit is denied and the participant appeals, the plan administrator must engage in a "full and fair investigation" of the appeal.  At the conclusion of this investigation, the plan administrator should issue a detailed appeal decision which includes the relevant law and facts and terms of the plan under which the appeal is decided.

      Legal v. Administrative Decisions

      If the benefit claim goes to court, the court will view the plan administrator's decision differently depending upon whether it is a plan interpretation or a legal decision that the court is reviewing.  Plan interpretations are viewed by the courts as presumptively correct, unless the plan administrator made an "arbitrary and capricious" decision to deny the benefit or committed an "abuse of discretion."  This presumption applies as long as the plan specifies that the administrator has the absolute discretion to interpret the plan.  Benefit decisions that are legal decisions will be reviewed "de novo" by the courts, meaning that no presumption of correctness is given to the plan administrator's legal decisions and the court is free to look at the smallest of legal errors in the decision.  Note that some benefit claims will involve both decisions of law and interpretive decisions. Be clear in your appeal decisions and consult with counsel regarding the basis for the determination and the conclusions in the appeal.

      What Is an Abuse of Discretion?

      Courts look at a number of factors when deciding whether a fiduciary has committed an "abuse of discretion."  It is important for the plan administrator to demonstrate that their decisions were consistent with:

      • The terms of the plan;
      • The past precedent of dealing with benefits for participants that are similarly situated; and
      • Applicable statutes and regulations.

      The plan administrator's thoroughness in the decision and appeal processes is critical.  It is also important that there is no evidence of bias or conflict of interest in the decision.

      Fiduciary Breach Claims

      Both the DOL and plan participants may file suits alleging fiduciary breaches.  Unlike benefits claims, there is no need for a plan participant to follow an administrative claims procedure prior to filing a lawsuit for fiduciary breach.  However, as a practical matter, these claims are typically coupled with a benefit claim because a benefit denial is often alleged to be a fiduciary breach.  Historically, participants were required to file a suit for fiduciary breach on behalf of the entire plan, not just to recover the benefits in their individual accounts.  However, with the 2008 U.S. Supreme Court decision in LaRue v. DeWolff, Boberg & Associates, it is now possible for a participant to bring a suit, individually, to recover losses to his individual account.

      Retaliation Claims

      Participants bring these claims alleging interference with the exercise of their rights under ERISA.  Retaliation claims are typically coupled with a wrongful termination suit because the participant is alleging that he was terminated because he complained about a fiduciary's behavior, his rights under the plan or his entitlement to benefits.  These claims are very similar to wrongful termination claims from the perspective of which party carries the burden of proof and what facts will be looked at to determine whether the discharge was wrongful or was related to the participant's ERISA rights.

      Attorney's Fees

      The ability to recover attorney's fees in ERISA litigation is important to plaintiffs and defendant fiduciaries.  For fiduciaries defending a lawsuit, it is important because courts are very hesitant to award attorney's fees to the defense, even if the defense is successful on the merits of the case.  So, even if the defendant fiduciaries win, they will likely not recover their attorney's fees.  For plaintiffs, it is important because very few attorneys will take an ERISA case on a contingency basis for the simple reason that the damages sought are the participant's benefits in his account.  Punitive damages and other consequential damages are not available.  

      Federal courts apply a "five factor" test to determine whether to award attorney's fees.  The presumption is that a prevailing plaintiff should be awarded his attorney's costs and fees.  However, it is not absolutely necessary for a plaintiff to win to have his attorney's fees awarded – federal courts do not want to discourage plan participants from asserting their ERISA rights.  Even though relatively few attorneys spend a significant amount of time litigating benefit claims or fiduciary breach actions against retirement plans and ESOPs, the attorneys who do take these cases understand the likelihood of being awarded attorney's fees, or not, in connection with a particular case.


      Indemnification is the payment of a party's costs or damages by another party who assumes the responsibility by the terms of its contract or agreement.  Plan fiduciaries are typically indemnified by the plan or by the employer under the terms of the plan document.  The plan or the corporation may fund the indemnification by purchasing director's and officer's insurance (D&O), or fiduciary insurance.  It also is possible to simply fund the indemnification out of corporate assets.  Note that there generally is a limit on indemnification in ESOP cases where funding the indemnity would damage the stock price of the corporation sponsoring the ESOP.  Also keep in mind that if fiduciary insurance is purchased by the plan out of plan assets, the law requires that the insurance company have recourse against the fiduciary to recover damages resulting from the breach.  Therefore, it is advantageous to have the corporation purchase the insurance coverage rather than the plan.

      Fiduciary insurance coverage and D&O policies should be carefully reviewed.  Some D&O policies have gaps or "carve outs" that specifically exclude coverage for matters relating to an ERISA employee benefit plan.  For these policies, a specific "rider" or additional policy must be purchased to provide the ERISA fiduciary coverage.  This leads to the question of how much insurance coverage you should purchase to protect your plan fiduciaries.  Also, when should you consider buying fiduciary coverage for your ESOP fiduciaries?  Since coverage is typically most valued for covering the cost of the defense and not always for potential penalties resulting from the litigation, the amount of coverage may be a fraction of the ESOP's overall stock value.  However, the more complex the plan or transaction, the greater the policy limit that is desirable.  Note that some policies will not pay for the actual plan losses or benefits that are payable to the plan participant.

      An Ounce of Prevention Is Worth…

      Consider the following suggestions for proactive risk management:

      • Get It in Writing. Get answers to your technical questions or advice from your advisors in writing.  Seek planning memos and written analyses of fiduciary responsibility issues and liability for plan decisions and transaction decisions.  Try to have your advisors and attorneys make clear:  the unique situation, who bears the burden of the decisions, what the legal standards are for making the decisions, and what the process should be for reaching conclusions.  Written guidance will help you better document the actions that you are taking.
      • Cross-Communications. Are your advisors, including your third party administrator (TPA), certified public account (CPA), corporate counsel, and ESOP counsel communicating with one another?  In ESOP planning and transactions, it is absolutely critical for all of your advisors to be in the loop on the advice being given.  It must be clear which advisors are assuming responsibility for which issues. With specific acknowledgements among the advisors, a fiduciary client can help ensure that he is getting the right advice from the right professional.  It is not unusual for a specific advisor to disclaim responsibility for advice as long as another advisor is reaching the conclusion and making the appropriate recommendations.  Team communication will avoid gaps in your advice.
      • Documentation on Calculations. It is important that the advisor responsible for the issue provide documentation of the rationale and conclusions being reached. The same is true for calculations that affect the administration of the plan.  The CPA and the TPA should be in close communication so that the tax returns and the plan's administration agree and are completely accurate.  Finally, if there are tax positions that are being taken which may affect the plan's tax return, be sure that your attorney and CPA are identifying who is the "preparer" for purposes of that issue on the return.  It is possible for your attorney to be considered a return preparer if the attorney's advice is being relied upon for a reporting position on the return.

      What to Do?

      It can be a challenge for plan fiduciaries to understand and minimize their risk from the government regulators and from conflicts that could result in civil litigation.  The appropriate starting point is understanding the different categories and types of conflict situations and what issues are typically in dispute.  Most importantly, fiduciaries should confirm that their risks are insured and that their process for reaching conclusions is well thought out, well advised, and well documented.  Some level of exposure exists in all of these areas.  You can't eliminate the risk, but we advise that you be aware of the important elements of exposure in advance and be prepared.

      This topic was presented originally at the National Center for Employee Ownership (NCEO) two-day conference for ESOP fiduciaries in 2009.

      Editor's Note: We did the best we could to make sure the information and advice in this article were current as of the date of posting to the web site. Because the laws and the government's rules are changing all the time, you should check with us if you are unsure whether this material is still current. Of course, none of our articles are meant to serve as specific legal advice to you. If you would like that, please call us at (916) 357-5660.