For the most part, companies welcomed the Aug. 17 announcement that President Bush had signed into law the Pension Protection Act of 2006 (PPA). Hailed by many as the most sweeping change to the retirement system in more than 20 years, the PPA first and foremost makes it easier for companies to enroll employees automatically in 401(k) plans and provides a safe harbor from discrimination allegations when doing so.
“The new safe harbor is designed to be a strong incentive for employers to offer automatic enrollment,” says Heidi Winzeler, counsel to Osler, Hoskin & Harcourt in New York. “And depending on the design of a particular plan, the PPA structure may be less expensive than existing automatic enrollment requirements.”
Employers also benefit from the substantial tax deferrals associated with 401(k) contributions and avoid the risks that accompany defined benefit arrangements. In addition, the PPA clarifies employers’ default options in the absence of specific investment directions and goes a long way toward shielding employers from fiduciary liability.
But the bill isn’t perfect. It is fraught with tight deadlines, uneven drafting and uncertainties about the timing and scope of clarifying regulations. Accelerated vesting provisions, complicated employee stock diversification rules and heightened notice requirements all make implementation difficult.
“The problem is that there are quick effective dates for a number of the important provisions, and it’s not clear how much guidance the Department of Labor (DOL) and the Treasury Department will be able to offer before those dates,” says Kurt Lawson, an employee benefits partner with Pillsbury Winthrop Shaw Pittman in Washington, D.C.
Timing is particularly critical in the case of employer stock diversification rules.
“From corporate counsel’s perspective, the substantive and notice requirements related to diversification are the issues most deserving of attention,” Lawson says.
Beginning in 2007, where employer stock is an investment option for participants in 401(k) or defined benefit plans, employers must allow participants to diversify their portfolios by choosing from among at least three other investment options. The requirement applies only to publicly traded securities and to employer contributions in cases where an employee has at least three years’ service.
“The diversification provisions are a direct result of the Enron situation where the company could manipulate the stock because so much of it was held in employee plans,” Winzeler points out.
The PPA stipulates that the diversification provisions take effect on Jan. 1, 2007. But the law also provides that employees must be able to diversify their investments quarterly, if not more frequently. Companies must give notice of the diversification option and the importance of exercising that right no more than 30 days before the right becomes available to an employee.
“It’s unclear when the first notice must be given,” Lawson says. “Is it Dec. 1, 2006 or March 1, 2007?”
In either event, employers have very little time to prepare and serve the required notices.
To make matters worse, the Act is generally unclear as to the proper method of giving notice. In the case of electronic notice, for example, the PPA provides a fairly generous but equally vague standard that allows electronic notice to the extent it is “fairly accessible” to employees.
“What if you’re dealing with employees who don’t use computers regularly in their jobs?” Lawson asks. “Can the company simply provide access through a computer located in the HR office or elsewhere? Can companies simply e-mail employees at home?”
Indeed, the uncertainties relating to the method of notice apply not only to the diversification provisions, but to any notice the PPA requires.
This is a major concern for employers because notice requirements pervade the PPA. Commencing in 2007, for example, employers must give participants periodic pension benefits statements–even when employees don’t ask for them.
“There was not previously a requirement for individuals to receive a statement of what was in their accounts–although most employers provided a statement where it was easy to get the information,” Lawson notes.
Similarly, employers wishing to take advantage of the relief from fiduciary liability that accompanies the new “default investment” provisions that apply in the absence of a specific investment direction from a participant will have to provide appropriate notice.
“The plethora of new and more frequent notice provisions means it is essential that companies develop new systems to put them into place,” Lawson says.
But uncertainties in the PPA aren’t confined to notice–they also plague the automatic enrollment provisions, which apply to plans beginning Jan. 1, 2008, and to changes that will allow companies to provide investment advice to their employees, which take effect at the beginning of 2007.
“Under the old regime, employers could provide investment education, but could be liable for giving investment advice if the advice didn’t pan out,” says Martin Tierney, an employee benefits specialist with Michael Best & Friedrich. “Because the line between education and advice is so blurry, employers tended to be very conservative in providing investment education.”
The PPA seeks to remedy this by allowing employers to provide qualified investment advisers to counsel participants who have self-directed investments and to charge a fee for doing so. The PPA shields those who do provide such advice from liability as long as the fees the adviser received do not vary depending on the investment selected, or where the advice is based on a computer investment model.
“No one is even sure that the labor department will be able to come up with a model that satisfies the PPA’s requirements,” Winzeler says. “Until that happens, employers should be nervous about providing investment advice.”
As for automatic enrollment, the statutory scheme is largely dependent for its efficacy on provisions that purport to preempt state laws–such as minimum wage or payroll deduction provisions–that could interfere with automatic contribution arrangements.
ERISA preempts state laws that interfere with the administration of a plan, but it has never been clear whether that provision pre-empts all state laws.
“It’s not clear, for example, whether the preemption applies only to self-directed plans,” Lawson says. “It’s also not clear whether the preemption applies to plans that are not subject to ERISA.”
For all the difficulties, however, there is some light at the end of the tunnel.
On Sept. 27, the Department of Labor surprised everyone with its prompt release–barely a month after President Bush signed the PPA into law–of a proposed regulation outlining permissible “default investments.” The DOL has given stakeholders until Nov. 15 to submit comments.
The early release of the 20-page document has gone a long way to allay the fears expressed by many observers that there would be insufficient guidance from regulatory authorities before many of the PPA’s provisions took effect.
However that may be, the fact remains that time is of the essence.
“There is no question that companies will have to develop new systems very quickly that will ensure that changes are properly in place,” Lawson says. “They must begin acting immediately.”