United States: DOL Finalizes Regulations for Automatic Rollovers of Plan Distributions
(Financial Services Alert - Developments of Note)

Originally published October 12, 2004

The Department of Labor (the "DOL") finalized regulations (the "Final Regulations") under the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), that establish a safe harbor for ERISA plan fiduciaries in connection with the automatic rollover of mandatory distributions from ERISA plans to an individual retirement account (an "IRA"). When a participant in an ERISA plan, including a 401(k) plan, terminates his employment, the terms of the plan will generally require that the participant’s vested account balance be automatically distributed to the participant if the account balance is less than $5,000 (a "Mandatory Distribution"). Beginning March 28, 2005, ERISA plans will be required to automatically roll over Mandatory Distributions of more than $1,000 into an IRA designated by the plan, unless the participant affirmatively elects to receive the distribution directly or to have it rolled over to a different IRA or plan. The Final Regulations create a safe harbor under which a plan fiduciary will be deemed to have satisfied his general ERISA fiduciary duties in connection with the automatic rollover of a Mandatory Distribution.

Among other things, the Final Regulations require that the distribution be rolled into an IRA maintained by a state or federally regulated financial institution that is a bank or savings association (the deposits of which are insured by the Federal Deposit Insurance Corporation), a credit union (the member accounts of which are insured within the meaning of Section 101(7) of the Federal Credit Union Act), an insurance company (the products of which are protected by state guaranty associations) or an investment company registered under the Investment Company Act of 1940 (each a "Financial Institution"); that the IRA be invested in a product designed to preserve principal and provide a reasonable rate of return (e.g., a money market fund or certificate of deposit); and that the IRA’s fees and expenses (including the fees associated with establishing the IRA) be comparable to the fees and expenses charged to IRAs that are not subject to the automatic rollover provisions. The Final Regulations eliminate the requirement that was contained in the proposed regulations that fees and expenses (other than the fees associated with establishing the IRA) be charged only against the income earned by the IRA. In addition, the Final Regulations require that the plan’s automatic rollover provisions be described in a summary plan description provided to participants.

The DOL also finalized Prohibited Transaction Class Exemption 2004-16 (the "Final Exemption") under ERISA to enable plan fiduciaries of plans maintained by a Financial Institution (or its affiliate) to establish an IRA for Mandatory Distributions at such Financial Institution, subject to a number of requirements. In addition, subject to certain conditions, the Final Exemption permits a fiduciary of a plan maintained by a Financial Institution to select a proprietary product for the initial investment of the IRA and to receive certain fees in connection with the establishment or maintenance of the IRA and the initial investment of a Mandatory Distribution. However, unlike under the Final Regulations, the fees and expenses (other than the fee associated with establishing the IRA) related to the IRA and the proprietary product may be charged only against the income earned by the IRA.

The Final Regulations and Final Exemption are effective for Mandatory Distributions made on or after March 28, 2005; however, the safe harbor set forth in the Final Regulations may be relied upon before such effective date.

The FRB, FDIC and OCC (the "Banking Agencies") filed a joint comment letter objecting to the SEC’s Proposed Regulation B, which interprets the bank activity exemptions in the Gramm-Leach-Bliley Act of 1999 (the "GLB Act," see Alert of June 3, 2004 – to view this article please click on ‘Next Page’ link at bottom of page). The GLB Act provided for SEC functional regulation of bank brokerage activity, subject to 11 exemptions designed to preserve traditional bank activity, including trust and fiduciary services, custody and safekeeping and sweep activity. The SEC proposed Regulation B in June 2004 as an alternative to heavily criticized interim final rules issued in May 2001. Seeing little, if any, improvement, the Banking Agencies commented that the proposed rules "reflect a profound misinterpretation" of the GLB Act. Far from implementing the exemptions, they stated, "the Proposed Rules would insert the [SEC] to an unprecedented and unforeseen degree in the management of banks’ internal operations." In their view, Regulation B would impose a new regime of "extraordinarily complex" requirements that "no question…would significantly disrupt" longstanding bank activities. They called on the SEC to "take the time necessary" and "follow a fundamentally different approach" to make the rules comport with the language and purposes of the GLB Act exemptions.

The 40 page comment letter and appendix address many specific provisions, strongly objecting to the interpretation of the "chiefly compensated" test under the trust and fiduciary exemption and the "push out" of activities under the custody exemption. The Banking Agencies charged that in implementing these "critically important" exemptions the SEC "has not faithfully interpreted" the GLB Act. The comment letter also objected to unclear or restrictive interactions among exemptions and to undue restrictions on sweeps and networking referral fees. The Banking Agencies supported the SEC’s withdrawal of earlier language defining "trustee" and its decision to rely on the Banking Agencies regarding examination requirements. The Banking Agencies requested that the SEC delay the effectiveness of the GLB Act’s "broker" exemptions in order to continue working on the regulation. They requested a one-year or longer transition period for compliance after the regulation becomes final. They also stated it is important for the SEC and the NASD to clarify before a regulation is final that NASD Rule 3040 concerning broker supervision of "associated persons" does not apply to bank employees when they conduct permissible activities in their role as bank employees.

FRB Governor Bernanke spoke recently regarding anticipated Basel II concerns regarding (1) home-host country supervision of international banks, and (2) the application of Basel II in the US.

Cross-Border Issues. As to home-host country supervision, the concern is that each national supervisor may ask for different data, and apply different rules, to operations of the same institution in different countries. Governor Bernanke noted that international supervisory cooperation issues have predated Basel II, but recognizes that "concerns are quite understandable." To mitigate these concerns, Governor Bernanke highlights that, in addition to the efforts by the Accord Implementation Group to address cross-border issues, a series of case studies currently are proceeding to uncover implementation issues. Governor Bernanke also highlights that operational risk charges raise particular cross-border issues because host countries will not be required to recognize the group-wide diversification benefits that Basel II proposes in this area. Moreover, the Basel Committee has proposed that "significant" subsidiaries not get the benefit of group-wide diversification in any event when calculating operational risk capital. Accordingly, Mr. Bernanke concedes that "both the proposal for significant subsidiaries and the possible host-supervisor response for other subsidiaries may well result in the sum of individual legal-entity capital requirements being greater than the consolidated entity requirements."

US Basel II Application. As to US Basel II application, the principal issue is that US regulators only will allow implementation of the most advanced version of Basel II in the US. For foreign banks, the concern arises if they have chosen to operate under the foundation approach abroad, but need to operate under the advanced approach in the US. The foreign bank would then have to gather two additional inputs in the US, loss given default ("LGD"), and exposure at default ("EAD"). Governor Bernanke stated that a possible solution is for US regulators to permit a conservative approach to LGD and EAD, and perhaps even operational risk, for a transitional period. He highlights, however, that full adoption will be expected in a relatively short period. For US banks, the principal concern is that some foreign banks may gain a competitive capital edge, given that the foundation and standardized approach will start in 2007, but the advanced approach (which US banks must use) will not begin until 2008. Governor Bernanke stated that the staggered start dates were a difficult decision, but US banks should not expect to be able to start using Basel II before 2008, "regardless of any individual bank's ability and readiness to do so."

The DOL issued Field Assistance Bulletin 2004-02 (the "Bulletin") under the ERISA. The Bulletin addresses what steps a fiduciary of a terminating defined contribution plan must take in order to locate missing participants and how a plan fiduciary should proceed if missing participants cannot be located. The Bulletin states that in locating missing participants of a terminating defined contribution plan a fiduciary must (i) use certified mail; (ii) check the records of the employer’s other plans for more up-to-date information; (iii) contact any designated beneficiaries to obtain updated information; and (iv) use the letter forwarding service of either the Internal Revenue Service (the "IRS") or the Social Security Administration. Further, if the missing participant cannot be located after the plan fiduciary has followed these four required steps, the plan fiduciary should consider use of additional methods, such as Internet search tools, commercial locator services and credit reporting agencies. The Bulletin also states, as a general matter, that the reasonable expenses of locating a missing participant may be charged to the participant’s account if permitted by the plan document, and that the size of the account balance relative to the cost of any additional methods should beconsidered when considering whether to use any of the additional methods after the required steps have failed to locate the missing participant. In the event a plan fiduciary is unable to locate a missing participant after following the DOL’s guidance, the Bulletin provides additional guidance as to how the plan fiduciary may process distributions in order to complete the plan termination process. Specifically, the Bulletin provides that an automatic rollover to an IRA is the preferred distribution option. If a willing IRA provider cannot be located, a plan fiduciary may consider establishing an interest-bearing federally insured bank account in the name of the missing participant or escheating the missing participant’s account balance to the unclaimed property fund of the state of the missing participant’s last known address. The Bulletin notes that the alternatives to an IRA rollover are subject to mandatory tax withholding; but cautions that a plan fiduciary may not transfer the missing participant’s account balance to the IRS by imposing 100% tax withholding. The Bulletin is effective with respect to account balances that have not yet been distributed from terminating defined contribution plans.

The Basel Committee on Banking Supervision (the "Basel Committee") issued guidelines (the "2004 Guidelines") entitled "Consolidated KYC Risk Management" that supplement and update prior guidance on know your customer ("KYC") issues disseminated by the Basel Committee in 2001 and 2003. The 2004 Guidelines focus upon the special KYC challenges faced by banking organizations that conduct business in multiple jurisdictions ("Multinational Groups"). The 2004 Guidelines state that Multinational Groups should establish centralized KYC policies and procedures, coordinate worldwide KYC risk management efforts, broadly share information within the Multinational Group and actively "identify, monitor and mitigate reputational, operational, legal and concentration risks." The Basel Committee notes that, for reasons of protecting customer privacy, some jurisdictions limit banks’ ability "to transmit names and balances as regards customer liabilities," but the 2004 Guidelines stress the importance of countries’ allowing information for KYC risk management purposes to be provided to a bank’s head office and bank regulatory supervisor. The 2004 Guidelines suggest principles that should be used by a Multinational Group in adopting its customer acceptance and identification policy and in monitoring accounts and transactions on a coordinated, group wide basis. It is also important, states the Basel Committee, that a Multinational Group’s head office auditors, compliance officers, and home country supervisors have freedom to conduct unrestricted reviews of the Multinational Group’s KYC risk management through unfettered on-site visits and unrestricted access to a local branch or subsidiary’s customer names, addresses and other pertinent records. The 2004 Guidance also notes that Multinational Groups that engage in securities and insurance activities as well as banking face additional customer due diligence issues and must be alert to customer activity in each of the business sectors to which they provide services.

The OTS executed an information sharing agreement with the European Union ("EU") which is an addendum to the agreement the EU formerly executed with the OCC and FRB. The agreement will permit the OTS to be deemed a consolidated supervisor of institutions operating in the US and the EU.

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