2022 Retirement Policy – Year in Review
In this review of retirement policy developments in 2022, we discuss major retirement-related legislative and regulatory initiatives and significant developments in retirement plan litigation.
Bipartisan retirement policy reform: The end-of-year spending bill passed by Congress on December 23, 2022, included a “Division T SECURE 2.0 Act of 2022” (SECURE 2.0). Key elements of the new law include:
- Improved student loan repayment/401(k) match rules.
- Establishment of a Retirement Savings Lost and Found database, that individuals can use to locate “lost” benefits.
- Gradual increase in the required minimum distribution (RMD) required beginning date from age 72 to age 75.
- Limit on catch-up contributions to Roth only and an increase in the catch-up contribution limit to $10,000.
- Instructions to DOL to review its annuity provider selection guidance in pension risk transfer transactions.
- Replace the Saver’s Credit with a Saver’s “Match” – in effect a federally- (tax credit-) funded match sent to a low-income individual’s retirement plan/IRA.
- Increase the cap on mandatory distributions (currently $5,000) to $7,000.
- Allow sponsors to establish “pension-linked emergency savings accounts.”
- Require enhanced participant disclosure for lump sum windows.
- Require (subject to certain exceptions) that participants receive at least one paper benefit statement a year (for DC plans) or every three years (for DB plans).
- Discontinue inflation indexing of PBGC variable-rate premium; the VRP rate will be fixed at 5.2% of UVBs (subject to the headcount cap) beginning in 2023.
- Clarify that, for purposes of the Internal Revenue Code’s DB plan anti-backloading rules, the projected interest crediting rate for a cash balance plan that uses a variable interest crediting rate (e.g., a market return cash balance plan), shall be “a reasonable projection of such variable interest crediting rate, not to exceed 6 percent.” (See our article Congress Opens the Door for the Retirement Program of the Future.)
Many separate 2022 retirement policy legislative initiatives were wrapped into SECURE 2.0. Two that did not make it in, but address issues of ongoing concern, were (1) the LIFE Act, which would explicitly authorize “covered annuity contracts” as (effectively) a qualified default investment alternative (QDIA) in participant directed defined contribution plans, and (2) the Financial Freedom Act, which would (among other things) prohibit DOL from issuing any guidance “constraining or prohibiting the range or type of investments that may be offered through [a self-directed] brokerage window” and provide that ERISA’s diversification and prudence rules are not violated by the inclusion of a self-directed brokerage window as an investment alternative or a participant’s control over assets in a self-directed brokerage window. The latter proposal was directed at DOL’s threats to investigate DC plans that offer crypto investments (see below).
Agencies – DOL
ESG/Proxy voting: On November 22, 2022, DOL released its revised amendments to its ESG/proxy voting rules.
Changes from the (Trump) DOL 2020 ESG rule include:
- Replacing “pecuniary/non-pecuniary” terminology with “risk-return” terminology.
- Stating that prudent investment “may include the economic effects of climate change and other [ESG] factors.”
- Eliminating the 2020 rule’s prohibition of ESG funds in qualified default investment alternatives (QDIAs) (e.g., a 401(k) plan’s default target date fund).
- Providing a more flexible tie-breaker rule and eliminating the 2020 rule’s elaborate documentation and disclosure requirements for tie-breaker decisions.
- Clarifying that fiduciaries may take into account participant preferences (including, e.g., demand for an ESG fund) in constructing a participant-directed DC plan fund menu.
Changes from the (Trump) DOL 2020 proxy voting rule include:
- Eliminating language in the 2020 rule stating that ERISA’s fiduciary rule “does not require the voting of every proxy or the exercise of every shareholder right.”
- Eliminating the two “proxy non-voting” safe harbors
- Eliminating the 2020 rule’s special monitoring obligations with respect to investment managers and proxy voting firms and specific records requirements with respect to proxy voting/exercises of shareholder rights.
No further guidance on retirement income disclosure prior to 2nd quarter 2022 due date:On July 26, 2021, DOL issued four “Temporary Implementing FAQs” on its September 2020 interim final rule (IFR) on lifetime income illustrations. While DOL had promised “permanent” rules prior to the June 30, 2022, date for the first lifetime income illustration, it did not provide further guidance in 2022, critically with respect to its decision not to credit earnings from the current date to a participant’s projected retirement date. The latter treatment was criticized by, among others, Ways and Means Committee Chairman Neal (D-MA)).
DOL crypto letter and reaction: On March 10, 2022, the Department of Labor released Compliance Assistance Release No. 2022-01 401(k) “Plan Investments in ‘Cryptocurrencies.’” The CAR generally cautioned against 401(k) plans including “cryptocurrencies” (and other “digital assets” including “tokens,” “coins,” “crypto assets,” and “derivatives thereof”) in a fund menu or brokerage window. The CAR raised several issues with respect to crypto investments, especially where they are made available in participant directed defined contribution plans, including: their speculative and volatile nature; the lack of participant expertise with respect to them; difficulties with respect to custody and recordkeeping; issues with respect to valuation; and the lack of a regulatory framework.
The CAR was controversial, especially for its concluding statement that “plan fiduciaries … allowing [crypto] investments through brokerage windows should expect to be questioned about how they can square their actions with their duties of prudence and loyalty in light of the risks described [in the CAR].” We note the following subsequent developments: (1) introduction of Financial Freedom Act legislation (discussed above); (2) a letter from Ways and Means Committee Chairman Neal to the Government Accountability Office asking GAO to look into the scope of the crypto/DC investment issue; (3) a lawsuit against DOL, by the 401(k) provider ForUsAll, claiming that DOL’s action in the CAR was “arbitrary and capricious.”
DOL issues RFI on disclosure and fiduciary issues with respect to “climate-related financial risks”: On February 14, 2022, the Department of Labor published a “Request for Information on Possible Agency Actions to Protect Life Savings and Pensions from Threats of Climate-Related Financial Risk.” Among other things, the RFI solicited comments on whether DOL should collect data on climate-related financial risk (CRFR) for retirement plans, whether certain guaranteed lifetime investment products (e.g., annuities) may mitigate/hedge CRFR and whether DOL should facilitate their inclusion in DC plans, and whether there is a need to educate participants (e.g., in participant directed DC plans) about CRFR.
Agencies – IRS
Temporary relief from spousal consent “physical presence” requirement expires: On May 13, 2022, IRS issued Notice 2022-27, further extending, through the end of 2022, Covid-related temporary relief from the requirement that a spousal consent to a plan distribution be witnessed in the “physical presence” of a notary or plan representative. On November 30, 2022, a broad-based group of industry representatives and service providers sent a letter to IRS requesting that it make this relief permanent or, in the alternative, extend it into 2023. IRS has not extended this temporary relief, and sponsors will therefore have to go back to the old physical presence rules beginning January 1, 2023. There remains a possibility, however, that Treasury/IRS will at some point in the reasonably near future (e.g., at some point in 2023) amend the physical presence rules to allow “virtual” procedures under the Covid-related temporary relief, perhaps through a notice-and-comment rulemaking.
IRS proposes new regulations/mortality tables for DB valuations:On April 28, 2022, the IRS published proposed regulations/mortality tables for determining the present value of benefits under defined benefit plans for purposes of determining the plan’s ERISA minimum funding requirements, Pension Benefit Guaranty Corporation variable-rate premiums, and lump sum valuations. The proposed new mortality tables changed the calculation of plan liabilities for those purposes – depending on plan demographics, they may marginally decrease or increase liabilities (relative to a liability determination under current rules). On this issue, note also that SECURE 2.0 (discussed above) includes a provision instructing IRS to, within 18 months, further amend this regulation to provide that “for valuation dates occurring during or after 2024, [applicable] mortality improvement rates shall not assume for years beyond the valuation date future mortality improvements at any age which are greater than .78 percent.” The IRS may modify that .78 percent figure “as necessary to reflect material changes in the overall rate of improvement projected by the Social Security Administration.”
Agencies – PBGC
PBGC premiums – measuring UVBs for variable-rate premiums – the alternative vs. standard method election: We note a tactical issue that has been a focus of a number of DB sponsors – the possibility of using spot rates to value UVBs for purposes of determining PBGC variable-rate premiums. Briefly:
- Variable-rate premiums are a percentage (4.8% for 2022 and increasing to 5.2% for 2023 and thereafter) of a plan’s unfunded vested benefits (UVBs).
- UVBs = the present value of plan liabilities (for vested participants) minus the fair market value of plan assets.
- Liabilities may be measured under the standard (spot rate) or alternative (24-month average) method, subject to a 5-year lockup.
- During a period (like the current one) of increasing interest rates, switching from the alternative method to the standard method (if possible) may significantly reduce PBGC variable-rate premiums. The deadline for 2022 for this election was October 15, 2022 (see our article Measuring UVBs for variable-rate premiums – the alternative vs. standard method election due October 15, 2022).
- Sponsors that were subject to the lockup (that is, had elected the alternative method in the last 5 years) have been looking at alternative strategies to take advantage of the 2021-2022 rate rise. Two that have been considered are (1) switching to a full yield curve for liability valuation/funding generally and (2) risk transfer/annuitization of liabilities (at current, more favorable rates), to get them off the books. Both of these options involve a number of variables/decision issues – sponsors considering them should consult with their actuaries and with counsel.
The Supreme Court sends Hughes v. Northwestern back to the Seventh Circuit: On January 24, 2022, in a unanimous decision, the Supreme Court vacated the Seventh Circuit’s decision in Hughes v. Northwestern (an ERISA prudence case implicating a number of issues that have been raised in 401(k) fee litigation). The Court rejected the Seventh Circuit’s reliance on the availability of lower cost alternatives as a defense to claims that the cost of certain funds and of plan recordkeeping was unreasonably high. In characterizing the analysis the Seventh Circuit should engage in on remand, the Supreme Court stated:
“Because the content of the duty of prudence turns on ‘the circumstances . . . prevailing’ at the time the fiduciary acts, … the appropriate inquiry will necessarily be context specific.” [Citing Fifth Third Bancorp v. Dudenhoeffer] At times, the circumstances facing an ERISA fiduciary will implicate difficult tradeoffs, and courts must give due regard to the range of reasonable judgments a fiduciary may make based on her experience and expertise.
Post-Hughes v. Northwestern fee/prudence litigation:
The Supreme Court’s decision left critical issues in ERISA prudence litigation unclear. Below we review 2022 decisions in different Appellate Circuits applying the decision. We begin with a discussion of the critical procedural issue – the standard to be applied on a motion to dismiss, the “bar” a plaintiff must clear to get to discovery.
The significance of the motion to dismiss: The Supreme Court has observed (in Fifth Third Bancorp v. Dudenhoeffer) that the motion to dismiss is an “important mechanism for weeding out meritless claims.” A frustrating element of 401(k) fee/prudence litigation is that most cases in which plaintiffs’ claims are not dismissed on motion, and therefore proceed to (often expensive) discovery, are settled, without any decision on the merits.
The threshold issue in a motion to dismiss “for failure to state a claim” is: what standard of review should the court apply? In this regard, and as a general matter in federal court: (1) the plaintiffs’ factual allegations are accepted as true but (2) “the complaint must lay out enough facts for a court to reasonably infer that the defendant wronged the plaintiff.”
Process vs. circumstantial allegations:ERISA prudence is about process, and a challenge to fiduciary conduct must ultimately focus on the process the fiduciary used to arrive at the allegedly imprudent action. Thus, ordinarily, in ERISA prudence litigation, the plaintiff must show that, e.g., the defendant did not employ “the appropriate methods to investigate the merits of the investment.”
Courts generally recognize, however, that (quoting the court in Forman v. TriHealth (2021)):
[G]iven the early stage of a motion to dismiss, and a plaintiff’s general lack of inside information as to a defendant’s decision-making processes without the benefit of discovery, “[e]ven when the alleged facts do not directly address the process by which the Plan was managed, a claim alleging a breach of fiduciary duty may still survive a motion to dismiss if the court, based on circumstantial factual allegations, may reasonably infer from what is alleged that the process was flawed.”
This structure of the motion-to-dismiss jurisprudence explains why, typically, plaintiffs make “circumstantial factual allegations” involving comparison with other plans’ administrative costs and with the fees on “identical” lower cost investment alternatives. And it is the adequacy of those sorts of allegations to “state a claim” that have been at the heart of most post-Northwestern 2022 litigation, summarized below:
In Goodman v. Columbus Regional Healthcare System, on January 25, 2022, the United States District Court for the Middle District of Georgia denied defendant fiduciaries’ motion to dismiss, finding that “a defined contribution plan participant may state a claim for breach of ERISA’s duty of prudence by alleging that the plan fiduciary offered higher priced retail-class mutual funds instead of available identical lower priced institutional-class funds. [Citing Hughes v. Northwestern.] And the Court is satisfied that Plaintiffs state a plausible claim that continuing to offer underperforming mutual funds with excessive expense ratios despite a consistent history of underperformance would violate ERISA’s duty of prudence.” (We note that in many 401(k) prudence cases the issue of fees is combined with a fund “underperformance” claim.) With respect to recordkeeping fees, the court found (similarly) that plaintiffs’ allegations – that the fees “were nearly double what a reasonable recordkeeping fee would have been for a similarly sized ERISA plan” – were adequate to survive a motion to dismiss.
In two unpublished Ninth Circuit decisions, in Davis v. Salesforce (April 8, 2022) and Kong v. Trader Joe’s (April 15, 2022), the court found that allegations – that (e.g., in Trader Joe’s) plan fiduciaries failed “to monitor and control the offering of a number of mutual funds in the form of ‘retail’ share classes that carried higher fees than those charged by otherwise identical ‘institutional’ share classes of the same investments” – were sufficient to survive a motion to dismiss. Critically (and this issue will come up in other litigation) the court held that defendants’ explanation – that the decision to include retail funds was justified by related revenue sharing agreements – was “unavailing” at the stage of a motion to dismiss. In effect, the prudence of the retail fee + revenue sharing arrangement would have to await a trial on the facts.
The Sixth Circuit, on June 8, 2022, affirmed the dismissal of plaintiff’s claim, in Smith v. CommonSpirit Health, et al., that the fiduciary of the CommonSpirit Health 401(k) plan “breached its duty of prudence by offering several actively managed investment funds when index funds available on the market offered higher returns and lower fees.” In reaching this conclusion, the court found: there is nothing imprudent about actively managed funds per se; simply pointing (retrospectively) to underperformance is not enough to state a claim; it is generally not appropriate (in attempting to show imprudence) to compare the performance of actively managed funds to index funds, because they have different goals and strategies.
The “Red Flags issue” – the possible existence of “red flags” has been a feature of underperformance cases, and a critical issue has been what is a sufficient “red flag” – a negative mention in the financial press or something more serious? In this regard, the Sixth Circuit stated “Nothing in [the submitted] reports suggests that the Freedom Funds’ reputation was bad enough when viewed in the market as a whole that a prudent plan administrator should never have included them in the offerings or should have precipitously dumped them. We would need significantly more serious signs of distress to allow an imprudence claim to proceed.” That is a relatively high bar.
But a claim based on retail vs. institutional fund classes survives a motion to dismiss: Notwithstanding the defendant-friendly approach taken by the Sixth Circuit in CommonSpirit, the same court found, in Forman v. Tri-Health (2022), that a claim based on the use of a retail share class, rather than a less-expensive institutional share class, was sufficient to survive a motion to dismiss.
On August 29, 2022, in Albert v. Oshkosh Corporation, the Seventh Circuit Court of Appeals affirmed the dismissal of an ERSIA fee-related prudence claim against fiduciaries of Oshkosh’s defined contribution plan. This case is especially interesting because it was a Seventh Circuit decision in the Northwestern ERSIA fee-related prudence litigation that the Supreme Court vacated and remanded in January. In Oshkosh, the Seventh Circuit, in its first post-Northwestern decision on these issues, held:
- Plaintiff must allege facts showing that comparators are in fact comparable.The Seventh Circuit set a relatively high standard for comparability: with respect to recordkeeping services, there must be pleading showing not just that the comparator plans (with lower priced recordkeeping costs) are demographically similar, but that the quality of services provided are in fact similar; and, with respect to fund fees, that the comparator funds (with lower priced fees) have similar or identical investment objectives.
- A simple comparison of “net fees” (expense ratio minus revenue sharing) is not, without more, adequate to state a claim. The Seventh Circuit rejected plaintiff’s (novel) theory that sticker price (i.e., expense ratio) minus revenue sharing is an appropriate “metric” for comparing fund/share class costs.
- The Supreme Court’s decision in Northwestern is limited.The Seventh Circuit is prepared to limit the Supreme Court’s decision in Northwestern to the issue of its (now repudiated) “categorical rule” that “the inclusion of low-cost investment options in the plan mitigated concerns that other investment options were imprudent.”
Non-Hughes related litigation
Court grants Intel’s motion to dismiss in litigation challenging the use of “non-traditional assets” in a TDF: On January 8, 2022, the United States District Court for the Northern District of California granted defendant plan fiduciaries’ motion to dismiss in Anderson v. Intel, a case involving a challenge to Intel’s inclusion of non-traditional assets (including hedge funds, private equity, and commodities) in Intel’s 401(k) plan default target date fund (TDF). Plaintiffs argued that the inclusion of non-traditional assets in the TDF resulted in the TDF’s “underperformance” and was therefore imprudent. The case was interesting in (at least) two respects. First, in rejecting plaintiffs’ underperformance argument, the Intel court held that “[a] fund that is a ‘meaningful benchmark’ must … have similar aims, risks, and potential rewards to a challenged fund.” (The court in CommonSpirit (above) reached a similar conclusion.) And, second, in view of the Department of Labor’s (2021) “Supplemental Statement” on the inclusion of private equity investments as a “component” of, e.g., a target date fund, the case presented a real world test of the prudence, under ERISA, of that strategy, which the plan fiduciaries won.
Law firm files a series of complaints targeting use of BlackRock TDF:In the second half of 2022, participants and former participants in some of the largest 401(k) plans in the US sued plan fiduciaries claiming that the use of one of the largest target date funds, the BlackRock LifePath Funds, was imprudent, because those funds “underperformed” alleged “comparators.” These sorts of fiduciary imprudence/TDF underperformance claims have emerged as a second major line of attack (after the attack on fund and recordkeeping fees that began in the early 2000s) by plaintiffs’ lawyers on 401(k) plan fiduciaries. These lawsuits, in which plaintiffs are all represented by the same law firm, include claims against the plans of Black & Decker, Cisco Systems, Citigroup, Marsh & McLennan, and Microsoft. The complaints are very similar (and in large parts identical) and generally focus on the imprudence of investing in the BlackRock TDF, which uses a “through” glidepath, based on a comparison with other major TDF fund operators that use a “to” glidepath.
District Court finds for defendant plan sponsor in BlackRock Target Date Fund suit: On September 30, 2022, in Pizarro v. The Home Depot, the United States District Court for the Northern District of Georgia found for defendant plan sponsor/sponsor fiduciaries on cross-motions for summary judgment in a suit claiming that Home Depot and plan fiduciaries violated ERISA prudence requirements. The case involves a number of important issues, including what sorts of procedural standards are appropriate for a fiduciary monitoring fees for investment advice and for monitoring fund performance. Most significantly, however, the court found that the plan’s investment BlackRock TDF was “substantively prudent” – that even if the fiduciaries’ procedures were inadequate, the investment itself was “objectively” prudent, given that: (1) the BlackRock TDFs tracked their custom benchmark; (2) BlackRock charged among the lowest fees of TDF providers; (3) the BlackRock TDFs are presently a popular target date fund suite; and (4) the fiduciaries’ investment consultant “consistently rated the funds as a ‘Buy.’”
Seventh Circuit upholds DOL cybersecurity subpoena against Alight requiring disclosure of client/plan names: On August 12, 2022, the Seventh Circuit Court of Appeals upheld a decision by a lower court in Walsh v. Alight Solutions LLC enforcing (with modifications) an administrative subpoena by the Department of Labor against Alight. The subpoena requires Alight to produce documents, including “client identifying information,” in connection with alleged cybersecurity breaches at Alight with respect to the retirement and health plans for which it provides recordkeeping services. The decision makes clear that plan sponsors are at least one potential target of this investigation.
New York District Court offers an interpretation of ERISA’s advice fiduciary rule that is at odds with DOL’s:On September 27, 2022, United States District Court for the Southern District of New York, in Carfora et al. v. Teachers Insurance Annuity Association of America and TIAA-CREF Individual & Institutional Services, found (among other things) that “advice” that defendants gave plaintiffs with respect to rollovers did not make them “advice fiduciaries” under ERISA. Carfora provides a judicial interpretation both of ERISA’s fiduciary definition and of the Department of Labor’s (regulatory) “five-part test” for fiduciary status in the critical context of plan rollovers. And in that regard, the court’s interpretation differs substantively from DOL’s own recent re-interpretation of the five-part test (in the preamble to Prohibited Transaction Exemption 2020-02). As such, the court’s decision is unique and offers a counter-interpretation to DOL’s new rule that may affect ongoing litigation over it.
On July 8, 2022, a three-judge panel of the DC Circuit Court of Appeals reversed the decision of a lower court in United Mine Workers of America 1974 Pension Plan v. Energy West Mining Company, ordering that the discount rate used to calculate multiemployer pension plan withdrawal liability must be similar to the discount rate the Enrolled Actuary uses in performing funding calculations for the plan. In doing so, the DC Circuit joins the Sixth Circuit in coming to this conclusion.
The issue of what discount rate may be used on withdrawal from a multiemployer plan has been a matter of ongoing dispute, with withdrawing employers arguing that it should be the same rate as used for plan valuations and plans (and plan trustees) arguing that a lower rate may be used.
In mid-October 2022, PBGC (finally, after 40 years) proposed regulations specifying actuarial assumptions for this purpose. Paraphrasing and oversimplifying, the proposed regulation provides that the actuarial assumptions other than the valuation interest/discount rate used to determine withdrawal liability must be reasonable and, in combination, offer the actuary’s best estimate of anticipated experience under the plan. For the interest/discount rate assumption, however, the actuary may use any rate in the range from the plan funding rate to the (significantly lower) PBGC rates, even if, e.g., using PBGC rates would render the assumptions to be “unreasonable” in the aggregate.
Following the publication of PBGC’s proposal, the Ninth Circuit, in GCIU – Employer Retirement Fund; Board of Trustees of the GCIU – Employer Retirement Fund v MNG Enterprises, Inc., ruled in favor of a withdrawing employer on this issue, rejecting the application of the terms of the proposed regulation to the withdrawal transaction under consideration (which occurred prior to any finalization of that regulation).
* * *
We will continue to follow these issues.