“Show Time!” for the US Labor Department’s Fiduciary Rule

It may be show time for the U.S. Department of Labor’s (DOL’s) Fiduciary Rule (the “Rule”), but don’t expect an elaborate production.  Think frustrated, reluctant actors on a bare stage with no lights or scenery implementing the previous Administration’s regulatory approach to protecting retirees and retirement savings from conflicted investment advice.

After a long and contentious preview run, the rising curtain reveals that parts of the Rule won’t become effective before January 1, 2018, DOL won’t enforce the rule before that date, and, during this transition period, DOL will continue to consider whether to revise or repeal the rule.  Further, the Securities and Exchange Commission (“SEC”) has shown interest in a major role – or at least an attention-grabbing cameo – that could complicate the production further.

Nonetheless, the show has opened.  Under the Rule, beginning June 9, 2017, those who provide investment advice to retirement savers are fiduciaries and the scope of activity that constitutes investment advice is broader than in the past.   The Best Interest Contract Exemption and the Principal Transactions Exemption will allow financial institutions and advisors to engage in transactions that would otherwise be prohibited under the Employee Retirement Income Security Act and the Internal Revenue Code (the “Code”).  Qualifying for these exemptions, through the end of the year, will require compliance with only “impartial conduct standards” – giving advice in retirement savers’ best interest; charging no more than reasonable compensation; and making no misleading statements about investment transactions, compensation or conflicts of interest. Full compliance, which is set to kick in on January 1, 2018, requires written disclosures, implementation of policies to protect retirees from investment advice that is not in their best interest, new rights and protections for IRA investors, and satisfaction of additional conditions.  Of course, new scenes could be added or the show could close completely before then.

The recent history of this storied rule began with a February 3, 2017 Presidential Memorandum ordering the Secretary of Labor to review the Rule.  In response, DOL requested public comments on the Rule and delayed the April 10 applicability date until June 9 to provide additional time for review.   While on May 22, 2017, DOL Secretary Alexander Acosta announced that the June 9 applicability date would not be further delayed, his agency issued guidance indicating that it would continue its review of the Rule and seek additional public comment on “specific ideas for new exemptions or regulatory changes” and implementation issues.   The guidance also announced a non-enforcement policy stating that DOL will not “pursue claims against fiduciaries who are working diligently and in good faith to comply with the fiduciary rule and exemptions, or treat those fiduciaries as being in violation of the fiduciary duty rule and exemptions” until the January 1, 2018 full compliance date.  The IRS had previously adopted a non-enforcement approach with respect to corresponding provisions in the Code.

Secretary Acosta’s announcement, an opinion piece in the Wall Street Journal, was far from an endorsement of the Rule.  It was, in contrast, a reluctant legal conclusion that the Rule’s implementation must go forward – at least for the time-being. Acosta was clear, however, that the Rule “may not align with the President’s deregulatory goals.”

And there is more.  On June 1, 2017, SEC Chairman Jay Clayton issued a statement recognizing the possible effects that the Fiduciary Rule could have on retail investors and entities regulated by the SEC.  He highlighted the SEC’s mission of (a) protecting investors, (b) maintaining fair, orderly and efficient markets, and (c) facilitating capital formation as part of his request for public comment on the standards of conduct that apply to investment advisers and broker-dealers when they provide investment advice to retail investors.  The Chairman presented 17 areas for public comment to facilitate an updated assessment of the current regulatory framework, the current state of the market for retail investment advice, and market trends.  This is familiar ground for the SEC, which has reviewed these matters a number of times over the last decade or so and received a broad range of recommendations for action in response to their efforts.   While changes in the marketplace may justify a need for updated information, it is worth noting that previous efforts have not produced significant regulatory action in this area.  Whether a new SEC effort to address standards for conduct by investment advisors and broker-dealers in the retail space will be more productive and how it will affect the DOL Fiduciary Rule is not predictable at this point but will certainly provide fodder for a sequel to the current show.

Congress, too, has moved into the Fiduciary Rule spotlight. On June 8, the day before the Rule’s applicability date, the US House of Representatives voted to repeal the Rule until the SEC produced its own fiduciary standard.  The Fiduciary Rule repeal was part of a larger bill repealing the Dodd-Frank Wall Street Reform and Consumer Protection Act.  The same day, Republicans introduced another bill to block the Fiduciary Rule.  This one would establish an alternative, disclosure-based, set of rules to govern fiduciaries and prevent conflicts of interests.  Neither the Fiduciary Rule repeal provision in the House-passed bill nor the newly-introduced bill is likely to progress much further.

U.S. Supreme Court rules in favor of ERISA exemption for church affiliated organizations

The U.S. Supreme Court has ruled in three cases that pension plans established by church affiliated organizations are “church plans” that are exempt from ERISA (the Employee Retirement Income Security Act of 1974).  The cases are Advocate Health Care Network v. Stapleton, U.S., 6/5/17; Saint Peter’s Healthcare Sys. v. Kaplan, U.S., No. 16-86, 6/5/17; and Dignity Health v. Rollins, U.S., No. 16-258, 6/5/17.

The Supreme Court’s decision overrules contrary decisions by three federal appellate courts.  It thus reinstates longstanding administrative rulings of the Internal Revenue Service, Department of Labor and Pension Benefit Guaranty Corporation (PBGC) that exempted plans established and maintained by church affiliated organizations.

As a result of the Court’s decision, church affiliated organizations that establish and maintain pension plans are not required to comply with ERISA’s pension plan funding requirements or to be part of the PBGC insurance program.  (However, they have always been permitted to elect to do so.)

The Court’s decision also may impact other employee benefit plans established and maintained by church affiliated organizations.  For example, ERISA reporting and disclosure requirements do not apply to any such plans.  Likewise, a self-insured medical plan of a church affiliated organization would not have to comply with certain ERISA rules pertaining to medical plan benefits.

Another impact of the Court’s decision is that plan participants in church plans do not have a right to bring claims for benefits under ERISA.  Presumably, any such actions must be brought under applicable state law.  This may be a two edged sword for church affiliated organizations.  ERISA has an employer-friendly claims procedure that will not apply, and claimants may be able to sue for punitive and other extra-contractual damages that are not available under ERISA.

Finally, it is important to note that the Court’s ruling does not address certain requirements of the law that an affiliated organization be “controlled by or associated with a church or a convention or association of churches”.  Historically, this requirement for church plan status has attracted very little scrutiny.  It would not be surprising to see additional litigation challenging church plan exemptions along those lines.

BA pensions claim failed to fly but appeal to take off

So now we know, BA is not going to let things rest following its defeat in one of the biggest, most high profile and lengthy pensions cases in recent years. It is has been reported that it has sought and been granted leave to appeal. This was yet another case involving questions about indexation of pensions and, of course, was very fact specific.  But there are still things for us all to learn from the judgment.

Pensions lawyers will be comforted to find the judgment breaks no new ground in terms of statements of the law; in fact, the judgment contains useful summaries of the current law on interpretation of pension scheme trust documents, in particular when it comes to understanding the purpose of powers those documents give to trustees, how trustees should proceed when exercising discretions and the Court’s role when supervising the exercise of such discretions. Trustees and those responsible for drawing up their minutes would be well advised to consider the degree of scrutiny to which the trustees in the BA case found their conduct and decision-making put under a microscope. There cannot be many better object lessons as to the importance of clear, timely and careful minute taking.

Pensions & GDPR – the 12 month countdown begins!

The General Data Protection Regulation (GDPR) comes into force on 25 May 2018.  Before that date, trustees of UK occupational pension plans will need to undertake some preparatory work, including:

  • Creating records of all personal data processing activities (or confirming delegation to plan administrators and obtaining confirmation that they will do this) and ensuring administration agreements reflect who is doing what,
  • Reviewing and amending agreements with other third parties,
  • If data is transferred outside of the EEA, putting in place international data transfer mechanisms,
  • Reviewing data security measures (see below),
  • Putting in place procedures for new individual rights,
  • Reviewing and amending privacy notices,
  • Assessing whether there is any ‘high risk’ use of personal data and
  • Formally adopting and rolling out new policies and procedures.

There are some obvious and less obvious pitfalls to consider here.  For example, if a trustee is on holiday outside of the EEA and picks up emails containing personal data whilst away, that will constitute transferring data outside of the EEA.

The recent global cyber attack has thrown into sharp focus the need for trustees to ensure the robustness of cyber security measures put in place by their data processors. As Investment & Pensions Europe report, there has also been a recent instance of a Belgian pension fund being subject to a cyber attack – Ogeo hack.

Where trustees access emails and documents containing personal data through their own home computers and/or personal mobile devices, there are some key issues about how this is managed:

  • Do all trustees use up to date malware protection?
  • Do the trustees have rules around the encryption of personal data?
  • Do the trustees have a formal policy covering cyber security risks or do they document a policy in a business continuity plan or risk register?
  • Is there a nominated trustee, who is specifically responsible for cyber security?
  • Has the trustee board had any training on cyber security in the past 12 months?
  • Do service level agreements require the trustees’ providers to adhere to specific cyber security standards?
  • Do the trustees have a cyber security incident plan in place?
  • Do the trustees have insurance in place that would cover a cyber security breach or attack?
  • Do the trustees use a segregated wireless network with firewalls?

If you would like any help with preparing for the GDPR, or with your cyber security policies, procedures or arrangements generally please get in touch with your usual Squire Patton Boggs contact.

French social contribution refund for unvested free shares?

In Société Orange (decision QPC 28-4-2017 n°2017-627/628), the French Constitutional Council has ruled that the refusal of the tax authorities to reimburse an employer company’s compulsory social security contributions, made in respect of the grant of conditional bonus (or free) shares where the conditions are not subsequently met (such that the shares never vest), was contrary to the principle of equality as enshrined in Article 13 of the Déclaration des droits de l’homme et du citoyen of 1789.

At the time, the relevant regulations (Article L 137-13 of the French Social Security Code (CSS)) required an employer to make social security contributions on the allocation of ‘free shares’. The contribution was fixed at 10% and due the month following the date of the decision to award the shares. The second chamber of the Cour de Cassation had previously ruled that the employer could not be reimbursed for that contribution, even if the ‘free shares’ never vested.

The company appealed on the basis that linking the employer’s liability to the decision to award the shares (subject to future conditions) infringed the principle of equality when compared to contributions made in respect of remuneration in the form of unconditional bonus shares. The Constitutional Council rejected that argument, confirming that the provisions in the CSS requiring payment of the employer’s contributions before the assignment of the free shares were constitutional. In essence, the CSS did not establish any difference in treatment between the issue of unconditional free shares and conditional shares, merely by reference to the different taxable event dates.

However, the Constitutional Council did identify that the CSS did not prevent the reimbursement of an employer’s contributions in respect of conditional bonus shares where the conditions were subsequently not met and the shares did not therefore vest. In such cases, there was a clear inequality in treatment between, on the one hand, employer contributions made in respect of employees being remunerated by the allocation of bonus shares and, on the other, employer contributions made in respect of employee remuneration that does not ultimately get paid (where the shares do not vest) because certain conditions are not met. In the second scenario, the Council has ruled that the the contributions should be reimbursed to the employer company.

It should be noted, however, that the decision only affects ‘free shares’ granted after 16 October 2007 but before 8 August 2015. This is because the CSS was amended in August 2015 by the so-called ‘Macron law’ which fixed the problem at the heart of the dispute in this case. From that date, employers’ contributions are only due if the employees actually acquire the free shares and are assessed by reference to their market value at vesting. If, therefore, vesting is conditional, the contributions will not be due if the conditions are not met.

The case will be of keen interest to any French employer company that granted, during the relevant period, conditional bonus (or free) shares to incentivise their employees where the conditions were not subsequently met and the shares did not actually vest. Such companies may, if they act quickly enough, be eligible to claim reimbursement of the social security contributions they have made in respect of such grants.

Election 2017: May still right (and a little bit left) on track for victory in June

The Conservative manifesto, ‘Forward, Together’, unveiled late last week by Theresa May, was notable rather less for reiterating commitments to traditional, small government, Conservative principles of ‘low tax’ and ‘better regulation’ and rather more for its embrace of social inclusion, identifying a “need [for] a partnership between the individual and the wider nation, between private sector and public service, and the strong leadership only government can provide”.

Unsurprisingly, perhaps, most of the attention has focused on the proposals to implement “the first ever proper plan to pay for – and provide – social care”, so much so that Mrs May was today forced into a policy u-turn, stepping back from a firm commitment to implement her plan and instead merely promising to consult on the issue.

By contrast, relatively little has been said about the Conservative party’s plans to continue to tinker with the rules regulating corporate governance and employment taxes.

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Election 2017: Labour to raise income tax to 67.5%

Alongside the almost complete reversal of recent cuts in the main rate of corporation tax (returning it to 26% by 2020-21 – a rate not seen since 2011 or, rather, the time of the last Labour government), the proposal to introduce a so-called ‘Robin Hood’ tax on financial derivatives (a proposal mired by its own complexity in Europe and described in the past by the Labour Mayor of London, Sadiq Khan, as “madness”), and promises to explore new revenue raising options (such as a possible tax on land values), it is the proposals in the Labour Party Manifesto 2017 for income and employment taxes that are most eye-wateringcatching.

Income tax will not, Messrs Corbyn and McDonnell promise, rise for 95% of taxpayers. In addition, there will be no rise in personal National Insurance Contributions (NICs). So, in England and Wales at least, it will be the top 5% of taxpaying adults (i.e. the roughly 1.5m individuals who already contribute something approaching almost half of the current UK’s income tax takings) who will be asked to ‘contribute a little more’. In the main, that contribution will come from dropping the threshold for the additional rate of income tax (45%) from £150,000 to £80,000 while those with earnings over (a very precise) £123,000 paying tax at a [re-introduced] 50% rate.

These provisions alone will (it is hoped at least, assuming a certain degree of stability in any behavioural reaction) raise some £6.4bn per year by 2021-22. In addition, employer’s paying ‘excessive’ salaries will face the ‘Excessive Pay Levy’ (or, if you prefer, ‘Fat Cat Tax’), initially set at 2.5% of (as yet undefined) ‘total compensation’ in excess of £330,000 but rising to 5% of ‘total compensation’ over £500,000, and all of which will add another £1.3bn to the Treasury’s coffers.

Such proposals have, perhaps predictably (and/or understandably), set alarm bells ringing in business circles, already concerned by the uncertainty caused by Brexit and desperately desiring stability in the tax system in a fluid economic environment, because of the possible adverse impact they might have on the ability of UK firms to attract and retain talent.

But, from a pure tax policy perspective, the problems run even deeper.

On the one hand, the reaction of the highest earners is unclear but it is conceivable that directly increasing the headline rates of tax on those best placed to plan and structure around, or simply move out of, the reach of the increased charges, could prove to be counter-productive. This makes Labour’s calculations unstable, could result in the need for additional anti-tax-avoidance measures (and so more complexity in the UK’s tax code) and leave a Labour government disappointed by the tax revenue it actually collects.

On the other, the Labour Party have missed a golden opportunity to address one of the UK tax system’s most bizarre features: the arbitrary 60% effective rate (the highest rate borne by any group of earners in the UK) levied on those earning between £100,000 and, Labour’s specifically chosen, £123,000 figure which is caused by the manner in which the personal allowance is withdrawn. By leaving the mechanism for withdrawing the personal allowance in place, Labour’s policy would not only see the effective rate of income tax between £100,000 and £123,000 actually rise to a massive 67.5% but also, perhaps more fundamentally, entrench an element of illogical income tax unfairness… an open-goal, astonishing missed when included as part of a Manifesto apparently built on the principle of fairness in the interests of the many and not the few.

If Labour had sought establish a highest marginal income tax rate of 50% while abolishing the current Government’s effective 60% top rate they just might have won a few more friends.

Pension funds to benefit from further three year mandatory clearing exemption

Last week (4 May 2017), the European Commission published a legislative proposal to amend various provisions of the European Market Infrastructure Regulation (Regulation 648/2012) (EMIR).

The proposal was adopted following a general report on EMIR published by the Commission in November 2016. Although the report indicated that “no fundamental change should be made to the nature of the core requirements of EMIR”, there was the possibility to “eliminate disproportionate costs and burdens on certain derivatives counterparties”. Among other things, the proposal extends the transitional clearing exemption available to Pension Scheme Arrangements (PSAs), previously due to expire in August 2018, for a further three years on the grounds that no viable technical clearing solution for the transfer of non-cash collateral as variation margins currently exists. This is because Central Counterparties (CCPs) tend to only accept cash from their clients to meet variation margin calls, whereas PSAs typically limit their cash positions in order to yield higher returns for their policy holders. As a result, PSAs have to convert part of their assets into cash in order to centrally clear. This poses structural issues, results in significant additional costs and negatively impacts the retirement income of pensioners.

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