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Posts Tagged ‘Internal Revenue Code’

Not Just for Trust Fund Babies Anymore

Posted on: May 3rd, 2018

By: Bryce M. Van De Moere

Even with the existence of the Affordable Care Act, the preferred way to get health benefits is still through your employer.  Health insurance packages have become an integral part of employee compensation.  As employers continue to offer health benefits to their employees, liability for employers has also increased exponentially; not only in terms of how to shoulder the premium increases brought on by the utilization of an aging workforce but also exposure to legal action brought on by perceived deficiencies in the quality of the benefits.

Welfare Benefit Plans are described in Title 1 of the Employee Retirement Income Security Act of 1974 (ERISA) which governs any plan, fund or program that provides (among other things), “medical, dental, prescription drugs, vision, psychiatric, long term health care, life insurance or accidental death or dismemberment benefits.” Regulation of these plans is federally governed and penalties for violation of the regulations can be severe. Further complicating an already difficult area, many employers are approaching health insurance carriers and contracting with them directly.  They are a signatory to a contract to offer benefits to an employee group and as such can be liable for claims made by their employees.   As such, when representing employers, especially those in the public sector, such as Municipalities and School Districts who have a unionized employee base with whom they are required to collectively bargain, it is of vital importance that those employers be shielded from liability, not only from their own employees but also from the penalties associated with failure to comply with state and federal laws that govern those benefit plans and the agencies that enforce those penalties.

One option employers should consider is banding together and pooling their employees by forming or joining a VEBA, or Voluntary Employee Benefit Association. A VEBA is an Internal Revenue Code Section 501(c)(7) Trust that is generally tax exempt and defined as “a mutual association of employees providing certain specified benefits to its members or their designated beneficiaries which may be funded by the employees or their employer.”  VEBA’s are legal entities that take the place of the individual employer.  Much like incorporation protects your personal assets, a VEBA can protect the employer’s business.

A VEBA is guided by a Board of Trustees made up of the member employers (and sometimes union representatives.)  The Trust is now the signatory to the contract.  The employer and their employees become a part of a much larger group or “pool” buying benefits in bulk which helps promote price stabilization and increases negotiation power. The Board of Trustees is also allowed to delegate the responsibilities of the Trust, which means they can hire a Trust ERISA counsel and Trust auditor to ensure regulatory compliance and a Trust Benefit Administrator to manage the claims of the benefit plan members.  This further shield’s the employer from responsibility and liability.

This is just one of the vehicles available for the management of employee benefit plans. If you have questions about this or other options available under the Internal Revenue Code, feel free to contact me at [email protected].

Has Fiduciary Rule Suffered a Fatal Blow?

Posted on: April 4th, 2018

By: Theodore C. Peters

The Employee Retirement Income Security Act of 1974 (“ERISA”) defined a “fiduciary” as someone who provides investment advice for a fee.  The following year, the U.S. Department of Labor (“DOL”) promulgated regulations that provided a five-part test for assessing whether someone was a fiduciary as defined by ERISA.  Seeking to implement a uniform fiduciary rule for all retail investment accounts, the DOL issued the Fiduciary Rule on April 6, 2016.  The Fiduciary Rule re-defined who is an “investment advice fiduciary” under ERISA and heightened the fiduciary duty to a “best interest” standard for those clients with ERISA plans and IRAs.  Previously, brokers were bound only to make “suitable” recommendations.  The Fiduciary Rule also created a “Best Interest Contract Exemption” that permitted financial advisors to avoid penalties stemming from prohibited transactions so long as they contractually affirmed their fiduciary status.

Several industry groups brought suit against the DOL, opposing implementation of the Fiduciary Rule.  In 2017, the United States District Court for the Northern District of Texas, in an 81-page ruling, ruled in favor of the DOL.  Chief Judge Barbara M.G. Lynn concluded that the DOL had not exceeded its authority and had not created a private right of action for clients. On March 15, 2018, in Chamber of Commerce v. United States Department of Labor, the Court of Appeals for the Fifth Circuit invalidated the Fiduciary Rule in a 2-1 decision.

In reversing the lower court, the Court addressed a simple but critical issue: whether the DOL exceeded its rulemaking authority by expanding the definition of “investment advice fiduciary.” The Court concluded that the new definition was in conflict with ERISA and the Internal Revenue Code because it was inconsistent with the common meaning of “fiduciary.”  The Court noted that the DOL arbitrarily and improperly sought to broaden the scope of its authority through the concept of investment “advice,” that included products sold by financial salespersons and even insurance agents. Further, the Court criticized the best interest contract exemption, which permitted brokers to receive compensation for investment products they recommend (thereby creating potential conflicts), provided they agree by contract to act in the investor’s “best interests.”

By vacating the Fiduciary Rule under the Administrative Procedures Act, the Fifth Circuit effectively voided the entire rule nationwide.  The DOL could possibly request a hearing en banc before the entire Fifth Circuit, or alternatively, petition for a writ of certiorari to the United State Supreme Court.  Or perhaps, the DOL will take no action at all, in which case the Fiduciary Rule will presumably die on the vine, and the five-step test enunciated in 1975 would be resurrected. Of note, however, mere days before the Fifth Circuit’s decision, the Tenth Circuit ruled in favor of the DOL in the context of a more limited challenge to the Fiduciary Rule highlighting a split between federal circuits – which may in turn spur the DOL to seek Supreme Court review.

Regardless of what action the DOL takes, the Securities Exchange Commission (“SEC”) is likely to seek to implement its own rules.  Commencing in October 2017, the SEC began reviewing the DOL’s Fiduciary Rule with a goal of introducing its own new rule governing investment advice.   SEC Chairman Jay Clayton testified before the Senate Banking Committee that the drafting of an SEC rule that harmonizes with the DOL’s Fiduciary Rule was a priority.  Despite the Fifth Circuit ruling, the SEC’s resolve appears to remain steadfast.  During a Q&A session at the SIFMA compliance conference just days after the ruling, Jay Clayton said “I’m not sitting on this… [and] as far as I’m concerned, we’re moving forward.”

If you have questions or would like more information, please contact Ted Peters at [email protected].

Continuing Fiduciary Relationship Does Not Always Toll the Statute of Limitations in California

Posted on: March 5th, 2018

By: Brett C. Safford

In Choi v. Sagemark Consulting, 18 Cal. App. 5th 308 (2017) (“Choi”), plaintiffs, husband and wife, filed a lawsuit in November 2010 alleging that defendants, their former financial advisors, offered negligent and fraudulent financial planning advice with respect a complex investment program involving life insurance and annuities under former section 412(i) of the Internal Revenue Code (“IRC section 412(i) Plan”).  Audited by the IRS in 2006, Plaintiffs alleged that defendants misrepresented the IRC section 412(i) Plan’s promised benefits as well as its risk of adverse IRS action and tax consequences.  The audit concluded in 2009, and plaintiffs were subject to significant penalties and tax liabilities caused by the IRC section 412(i) Plan.

Defendants moved for summary judgment, arguing that plaintiffs’ causes of action were barred by the applicable statutes of limitation.  Defendants introduced two communications to show that plaintiffs were aware the IRS had identified defects in the IRC section 412(i) Plan as of November 2006, and IRS penalties and damages would be accruing as of September 2007. Trial court granted summary judgment, finding that plaintiffs were on notice of the IRS penalties as of September 2007, and therefore, the two-year and three-year statutes of limitations applicable to plaintiffs’ causes of action expired prior to filing of the complaint in November 2010.

The Court of Appeal affirmed, rejecting plaintiffs’ arguments that (1) the September 2007 e-mail only put plaintiffs on notice that damages might occur in the future, and (2) the fiduciary or confidential relationship between plaintiffs and defendants, as their financial advisors, tolled the statute of limitations.  Applying the general “discovery rule,” the court concluded that the plaintiffs discovered or should have discovered defendants’ negligent advice as of the September 2007 e-mail because that e-mail indicated “‘legally cognizable damage’ in the form of IRS penalties.” Choi, 18 Cal. App. 5th at 330.  Despite uncertainty as to the monetary amount of the penalties, “‘the existence of appreciable actual injury does not depend on the plaintiff’s ability to attribute a qualifiable sum of money to consequential damages.’” Id. at 331.  The court further held that tolling did not apply, even though the fiduciary relationship between plaintiffs and defendants continued while they collectively challenged the IRS assessment, because “[d]elayed accrual due to the fiduciary relationship does not extend beyond the bounds of the discovery rule.” Id. at 334.  Therefore, the court “decline[d] to apply the tolling principles to a scenario in which the defendants had disclosed the facts necessary to support’ the plaintiff’s cause of action.” Id.

The Court of Appeal’s analysis in Choi is significant in the professional liability context for two reasons.  First, the court reaffirmed that the general “discovery rule,” i.e., the statute of limitations period begins to run when a plaintiff discovers or should have discovered the cause of action, is the default rule for when causes of action accrue in professional liability cases.  The Court rejected plaintiffs’ attempt to apply a differing accrual rule applicable only to accounting malpractice actions arising from negligent preparation of tax returns.  The court explained, “It may be that actual injury results from an accountant’s allegedly negligent preparation of tax returns only as determined by an IRS audit, but the same cannot be said for more wide-ranging categories of negligent tax-related or investment advice.” Choi, 18 Cal. App. 5th at 328.

Second, and more importantly, the appellate court declined to toll the statute of limitations even though plaintiffs and defendants maintained a fiduciary relationship while challenging the audit.  California recognizes that certain cases involving a fiduciary obligation will toll the statute of limitations.  For example, the statute of limitations in a legal malpractice action is tolled while “[t]he attorney continues to represent the plaintiff regarding the specific subject matter in which the alleged wrongful act or omission occurred.” Cal. Civ. Proc. Code, § 340.6, subd. (a)(2).  However, in Choi, the court held that the discovery rule is not displaced by delayed accrual due to a fiduciary relationship—at least in the financial advisor-client context.  The court reasoned that Plaintiffs were on inquiry notice of the facts constituting their injury as of September 2007, and their continuing relationship with defendants “did not prevent or delay [them] from discovering the wrongdoing beyond September 2007.” Choi, 18 Cal. App. 5th at 335.

The Court of Appeal’s decision in Choi undermines the commonly asserted proposition that a continuing fiduciary relationship will toll the statute of limitations and reaffirms the importance of the “discovery rule.”  At least in professional liability cases involving financial advisors, plaintiffs cannot hide behind their fiduciary relationship with defendants to avoid a statute of limitations defense.  Rather, the central inquiry is when did plaintiffs discover their causes of action—regardless of whether the discovery occurred before or after the termination of the fiduciary relationship.  As such, the Choi decision provides valuable authority for professional liability defense attorneys, especially those representing financial advisors, in cases where the statute of limitations may offer a defense.

If you have any questions or would like more information, please contact Brett Safford at [email protected].