CM 582, Seattle. P-CM 591, Abilene and Sweetwater. P-CM-SH 72, Spokane. P-CM 396, Amarillo. P-CM 783, Austin. CM 804, Beaumont. P-CM 71, Tacoma. P-CM P-CM 239, Walla Walla. 371, Yakima. P-CM 496, Brownsville and Edinburg P-CM P-CM 506, Corpus Christi. P 61, Dallas. CM 549, Dallas. WEST VIRGINIA P 365, Charleston. 517, Wheeling. STATEMENT OF ROBERT D. CONKEL, LEGAL COUNSEL AND MANAGER, DALLAS OFFICE, AMERICAN ACTUARIES, INC. Initially, I would like to thank the subcommittee for providing the opportunity to comment on the implementation of ERISA. In addition, I believe Congress should be congratulated on the thoroughness of the Act, after painstakingly reviewing the ideas and desires of a multitude of interested persons and organizations. With an Act so voluminous, so technical, and so controversial, there is obviously room for error, misunderstanding and delay in implementation. My remarks shall represent the concern of my company and its clients. American Actuaries, Inc. is a small, closely-held pension consulting firm of 35 employees, which has expanded rapidly in the past five years along with the same rapid expansion of the private pension area. We have approximately 500 corporate clients, each of which are also small closely-held corporations and only a few of which have more than 100 participants in their plan. Although I am speaking for these parties in particular, I believe the same concerns could be expressed by the large segment of the population employed by the small employer. In order to illustrate the numbers of employees we are speaking about, Category III (less than $50 million annual sales and 1,000 employees) under Cost of Living Regulations (Fed. Rel. Vol. 36, No. 220, 11-13-71) was determined by the Pay Board to have 10 million firms with 50 percent of the total U.S. sales and 83 percent of the total U.S. employees. In addition, of the employer reporting units under Social Security in 1967, 98 percent employed 100 or fewer workers constituting about one-half of the reporting working force (Statistical Abstract of the United States, 1969). These particular groups of small employers employ a large segment of the U.S. employees not presently covered by retirement programs. Although the Act has instituted the Individual Retirement Account procedure for those employees to obtain retirement plan coverage, the more significant broad-based coverage by employer plans was not intended to be discouraged. As evidence of this Congressional intent, House Report 93-779 from the Committee on Ways and Means, under Section II, "Reasons for the Bill", reads: "A fundamental aspect of present law, which the committee bill continues, is reliance on voluntary action by employers (and employees under contributory plans) for the establishment of qualified retirement plans. The committee bill also continues the approach in present law of encouraging the establishment of retirement plans which contain socially desirable provisions through the granting of tax inducements. In other words, under the new legislation as under the present law, no one is compelled to establish a retirement plan. However, if a retirement plan is to qualify for the favorable tax treatment, it will be required to comply with specified new requirements which are designed to improve the retirement system. Since the favorable tax treatment is quite substantial, presently involving a revenue loss of over $4 billion a year, it is anticipated that plans will have a strong inducement to comply with the new qualification rules and thereby become more effective in fulfilling their objective of providing retirement income." INCREASED COSTS Notwithstanding this basic intent, the cost of establishing and maintaining the corporate plan in accordance with the Act will have the opposite effect, i.e., discourage the voluntary action of the employer. This "cost" aspect is clearly illustrated by comments at the International Foundation of Employee Benefit Plans meeting on April 6-9, 1975. Manuel Eber, Associate Assistant Regional Director for Technical Assistance, Office of Labor-Management and Welfare-Pension Reports, New York, said, "The law was designed to help participants get the information they need and the last thing the Department wants is fear on the part of administrators. ERISA is not punitive legislation. The pension law is 'consumer legislation' in the sense that participants buy their benefits and when people pay to buy something they 'ought to know what's in the box.' "Language used in plan descriptions for employees should be checked by legal counsel and some disclaimers may be needed to avoid possible misinterpretation." At the same meeting, Carlton Sickles, president of Carday Associates, Inc., Washington, D.C., discussed the utilization and evaluation of professional services. "The functions of a plan administrator include collection of contributions due to the trust, accounting, record keeping, meeting reporting requirements, coordination with trustees and other professionals, and communication with participants and other parties. "The functions of the fund's accountant should be to conduct annual and special audits of the fund's financial operations, review annually and give an opinion on data required to be filed with the Labor Department under ERISA, review internal control systems, assist in the design of an accounting system, conduct feasibility studies and assist in the selection of electronic data processing hardware and software, conduct field audits of contributing employers, conduct special audits of benefits payments and investment performance, assist in the resolution of federal income tax questions, and prepare or review government reports. "Attorneys for the fund should prepare legal documents for the trust, review trust publications and benefit booklets, etc., before publication, prepare or review government reports, prepare or review minutes of meetings, negotiate or review contracts of the trust, prepare or review collection procedures and perform legal functions in collection, advise the trustees of the law and the legal effect of their actions, interpret trust documents, and defend legal actions against the trust." The above statements about required plan communication and professional services are "real world" costs to the small employer. These costs, the threat of suit, the severe penalty for inadvertent prohibited transactions, the endless reporting requirements (see Exhibit I illustrating extensive reports required), the cost of PBGC coverage and fiduciary insurance coverage, all represent a discouragement to the small employer to initiate or continue its retirement program. EFFECT ON SMALL EMPLOYER Unless corrective action is taken by Congress or in the promulgation of regulations, the small employer will be effectively excluded from the private retirement system. If he does adopt a plan it will be under the false sanctuary of a bank or insurance company. He will accept the high cost of bank administration (which shall be double the previous cost as estimated by most bank administrators) or the excessive hidden costs of a fully-insured plan. He will adopt a poorly designed contribution plan rather than a carefully designed, properly integrated defined benefit plan-under the false notion that he is saving the cost of an actuary, the premiums of the PBGC, some additional reporting and a potential liability (up to 30% of his corporation's net worth) if he should terminate the plan. The banks must charge greater fees for their administrative duties and liabilities. They are practically forced to recommend defined contribution plans in order to keep the costs down for a potential client. Many insurance companies are taking the position that their agents should only sell defined contribution plans, to the total exclusion of defined benefit plans. For example, here are excerpts of an April, 1975 letter from the home office of a leading carrier in the retirement plan field: "I must say that I read it (a request to change a Defined Contribution Plan to a Defined Benefit Plan) with some degree of concern as the current thinking both here in the Home Office and throughout the pension industry in general is that the implications of the Pension Reform Act on Defined Benefit plans are such that these plans will lose much of their attractiveness (with a few exceptions) to Defined Contribution plans (Money Purchase and Profit-Sharing). That is, it is held that the trend will be towards a decrease in the number of Defined Benefit plans and an increase in the number of Defined Contribution plans. Additionally, it is interesting to note that we have had numerous requests to change existing Defined Benefit plans, i.e., Fixed Benefit plans to Defined Contribution plans, i.e., Money Purchase plans." After a discussion of the benefit limits, minimum funding rules, record-keeping, administrative expense and termination insurance provisions of the Act as they relate to Defined Benefit plans, the writer concludes, "In summary, then, the above depicts something other than a rosy picture for Benefit plans in general, but more particularly, Fixed Benefit plans which are not fully insured as I understand would be this case. It is entirely possible that the additional complexity, administrative involvement and expense on behalf of the Employer will eliminate any reduction in plan contributions by changing from a Defined Contribution to a Defined Benefit plan. We are presently preparing a position paper soon to be released to the Field which will go into the points raised above in far greater detail." Two specific examples of the small employer dilemma have come to my attention recently: (1) "DEAR BOB: I have this day, experienced with a Minneapolis company an example of an owner of a closely-held corporation's reaction to the new law. He stated that 'there is enough government intervention in my business now, that if the government has now determined that my pension plan, which heretofore had flexibility of contributions, must receive a contribution from my corporation every year or else 30% of our assets will be our ultimate liability, I don't want the pension plan.' An attempt to make a technical explanation of when he becomes underfunded and, hence, liable, falls on deaf ears. I have had about four terminations as a direct result of the new law albeit in smaller plans." (2) "DEAR BOB: Throughout the last half of 1974 and early 1975, I have worked very closely on the design and construction of a retirement program for a mercantile corporation in Flint, Michigan. During that time, of course, the Employee Retirement Income Security Act of 1974 was finalized and put into law. After the severity of the act became evident, the owners of the corporation, it appears, have all but decided not to ever set up a retirement program. The reporting requirements particularly concerned these people and with the knowledge that, not only the Internal Revenue Service, but the Labor Department and the Treasury Department will be formulating new reporting documents, it seemed to be the final blow to the establishment of the plan. Further, they had planned on being their own trustees and the fiduciary responsibility and severity of prohibitive transactions soured them even further on the plan.' The outcome is that 17 employees of this company will probably never have a retirement program, and a projected annual deposit of $63,374.17 will never be made on their behalf. It seems tragic to me that the side effects of the Employee Retirement Income Security Act of 1974 have resulted in this situation. RECOMMENDATIONS As a consequence of these valid experiences after six months of the Act's existence, I am compelled to recommend the following, as a minimum, in order to alleviate the problems enumerated above: 1. Small plans (fewer than 100 participants) should have reporting and disclosure exemptions from the plan description, summary plan description and annual report requirements. 2. The remaining reports, including the annual summary report to the participants, the report to a terminating employee, the report of employee termination to the IRS, the plan termination report to the IRS, Labor Department and PBGC, and the annual IRS reports should be simplified and consolidated. For example, the PBGC requires the same basic information as the IRS whenever a plan terminates. Surely, this data can be consolidated so that only one report could satisfy both agencies. Portions of the annual IRS reports should be acceptable as a summary annual report to the participants. There is excessive waste of time and money in the repetitious reporting of plan provisions which remain unchanged from year to year. Certainly, this reporting can be simplified by accepting the data furnished upon request for approval from IRS, with only additional data furnished in later years if and when a change occurs. This could be implemented by properly_drafted regulations as permitted by the Act and suggested by the Conference Report. This type of consolidation and simplification should be made available for all plans, regardless of size. 3. Recognizing that enrollment of actuaries is currently being considered by the Joint Board, we believe it is imperative that a prompt decision be made as to who is and who is not an "enrolled actuary". Mr. Howard Johnson, President of the American Society of Pension Actuaries, in recent testimony before the Joint Board, stated the situation for the small employer very accurately when he said: "We feel that the Joint Board must take into consideration the fact that it is inevitable, now that there will be such a thing as an enrolled actuary, that the public will look to the enrolled actuary for more than just mathematical services. We feel that he will be the focal point in the formation and administration of most retirement plans. We feel it is essential that there be enough enrolled actuaries in order that the private pension system can grow in an economically viable way. "What we are most concerned with today is the protection of the public. We have to ensure there will be sufficient numbers of qualified people so that the price does not go out of sight for actuarial services." If the "enrolled actuary" is restricted to a few technically skilled professionals the cost of the defined benefit plan for the small employer will be outlandish. Alternatively, he will have only the fully insured defined benefit plan available to him, with all its inherent expense and inflexibility. 4. The prohibited transactions provisions of the Act must be clarified soon. Plan advisors cannot advise, except to resolve against the transaction. The Act raises questions as to perfectly legitimate, arms-length transactions between the corporation and the plan which are significantly beneficial to the plan and its participants. For example, plant and property ownership by the plans squarely falls into a "prohibited transaction," notwithstanding yields well in excess of 8% to the plan and without endangering the liquidity or safety of the fund. Another example is the formerly popular loan by the trust to the corporation again, with proper security and handsome yield to the trust. These types of transactions are not necessarily essential to the small corporation but offer it tremendous flexibility in its financing arrangements. We understand the dangers of "everything going down the drain," but certainly proper safeguards can be enacted to again make available some of these arrangements. (See Exhibit II citing four sample cases of a Dallas CPA illustrating the advantageous yields provided by investments which might now be classified as "prohibited transactions.") The dual jurisdiction of the IRS and the Labor Department in this area of prohibited transactions has created a nightmare of untangling for the plan administrator. The IRS calls certain individuals "disqualified persons," which is similar to, but not exactly the same as the Labor Department's "party in interest." The penalties for certain transactions are different in Title I from that in Title II. (See "Overlap of IRS and Labor in regulating compensation plans can create problems." Journal of Taxation, January, 1975.) It is absolutely essential that these two agencies resolve these differences as soon as is feasible so that the employer and his advisors can take action on certain available transactions. The defined benefit plan was singled out in the prohibited transactions and fiduciary provisions of the Act so as to limit their investment flexibility. With only 10% of the plan assets available for investment in employer stock or real property, significant curtailment of pre-existing investment flexibility will result. Realizing that variances may be acceptable, it is most important that relaxed guidelines and streamlined procedures for seeking these variances be adopted as soon as feasible. The specific exemption for ESOP plans is understandable; however, with this distinct exception, the severe prohibited transactions and investment limitations on defined benefit plans becomes incongruous. Is there such a significant difference between raising capital for an employer through an ESOP plan and raising capital for an employer by borrowing from the trust for a reasonable rate of interest and adequate security? 5. Clarification by regulation is needed now for certain definitions, such as (1) who is or is not a "fiduciary," (2) what is an "indirect" sale, lease or exchange by and between a plan and party in interest, (3) what are "multiple services" of a consultant or insurance salesman, (4) is an enrolled actuary of an insurance company an "independent actuary"? Answers to these questions are needed today in order to prepare for tomorrow. Although a consultant can receive commissions and fees now (and until June 30, 1977), if he cannot do so after June 30, 1977, he probably should establish new accounts which will require revision of duties and responsibilities later. What does he tell his clients today? If he says your plan will require new advisors in two years, he won't sell the client today. Therefore, he is forced to not tell the whole story so that he can continue his livelihood this year. PROTECTION FOR SMALL EMPLOYER It is our opinion that a lot of good has been accomplished by the Act. The private pension system, in order to be sound, requires there be protection to the participant and the Congress was right in "stepping in" to prevent abusive situations. Nevertheless, the system must not be so strangled by regulation as to prevent flexible employer and personal investment. Without the need of forced government stipulation which might develop another social security system (as has been proffered by some), there is a great need to extend certain fiduciary duties to professionals or self-styled "experts" in the private pension system. The employer needs protection, especially the small employer, from the complexity of retirement plans, so that in the decision-making process of establishing a plan he will be able to make an "informed decision." This protection should be provided through legislation (or an interpretation of the present fiduciary provisions), similar to the "truth in lending" legislation. That is, there should be full disclosure of the types of plans, provisions of plans, investments, costs, etc. available thereto. The employer could signify receipt of this data and guidelines for the salesman and professional could be established. To keep this system strong, fair, and responsible we need to eliminate shoddy explanations, unqualified advice and unfair presentations of fact as is so prevalent in our industry today. No finger is pointed at any industry or profession. All, in some measure, have been guilty. If those selecting plans are given minimum explanations and illustrations, then stronger, more lasting programs will be established. Fewer amended plans will occur, there will be less anguish between parties, with fewer accusations and suits being the result. This is good for the salesman, professionals, advisors, the employers, the investment mediums, and most importantly, the participants. (See "Fiduciary Duties-For Whom and When", Pension and Profit Sharing Tax Journal, (Spring) March, 1975) HR-10 RECOMMENDATIONS Certain provisions affecting self-employed retirement plans need clarification or revision as follows: (a) The contributions for employees of an owner-employee who contributes under the minimum ($750) provision is not clear. A regulation should have been provided already inasmuch as this was effective for 1974 tax years. (b) The provision for "no contributions by an owner-employee for five years" was eliminated due to the enactment of an excise tax on excess contributions. However, the "no contribution for five years" provision still applies for premature distributions. This provision should be changed so that the employer and his employees can continue to enjoy plan coverage. (c) The excise tax provision on excess contributions is effective for taxable years beginning after 1975. This should be changed to be effective for taxable years beginning after 1974, so we do not have revised plans containing a provision for only one year that will require amendment the following year. |