Compliance April 4, 2017

Intel Wins Suit Over Use of Alternative Investments

A court found the plaintiff in the case had actual knowledge of the facts comprising his claims more than three years before he filed suit.
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A federal district court judge has found that claims against Intel Corporation’s Investment Policy Committee for its retirement plans is time-barred under the Employee Retirement Income Security Act’s (ERISA)’s three-year statute of limitations.

Christopher M. Sulyma filed a lawsuit on behalf of two proposed classes of participants in the Intel 401(k) Savings Plan and the Intel Retirement Contribution Plan, claiming that the defendants breached their fiduciary duties by investing a significant portion of the plans’ assets in risky and high-cost hedge fund and private equity investments through custom-built target-date funds.           

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The lawsuit says the Intel custom-built funds have underperformed peer funds by approximately 400 basis points annually. The lawsuit claims automatic enrollment and a reenrollment of existing participants resulted in more than two-thirds of participants being allocated to custom-built investments. It goes into great detail about why the plaintiffs believe hedge funds and private equity funds are inappropriate investments for ERISA retirement plans.

Intel defendants moved for summary judgment on all of Sulyma’s claims, arguing that the claims are time-barred under the statute of limitations. U.S. Magistrate Judge Nathanael M. Cousins of the U.S. District Court for the Northern District of California noted that the key issue is whether Sulyma had actual knowledge of the underlying facts constituting his claim within three years of filing his lawsuit.

Sulyma brought six claims: claims I and III allege the Investment Committee defendants breached their fiduciary duties by over-allocating the assets of the 401(k) Plan and Retirement Plan to hedge fund, private equity, and other alternative investments. Claims II and IV allege the Administrative Committee defendants breached their fiduciary duties by failing to disclose required information about the funds. Claim V alleges that the Finance Committee defendants breached their fiduciary duties by failing to monitor the Investment Committee and Administrative Committee. Claim VI alleges that each defendant has derivative liability for the actions of the other defendants.

“Because there is no genuine dispute of material fact that Sulyma had actual knowledge of the facts comprising claims I and III, as well as knowledge of the disclosures he alleges were unlawfully inadequate in claims II and IV, the Court grants defendants’ motion for summary judgment on those claims, finding them time-barred,” Cousins wrote in his opinion. “Without live primary claims, the Court also grants summary judgment on Sulyma’s derivative duty to monitor and co-fiduciary liability claims (claims V and VI).”

NEXT: When Sulyma had actual knowledge

According to the defendants, Sulyma had actual knowledge of the facts constituting the alleged violations of ERISA more than three years before he sued, through “annual notices, quarterly Fund Fact Sheets, targeted emails, and two separate websites.”

Sulyma asserts the financial documents Intel uses to attribute actual knowledge on his part were not easily accessible, and often misleading or inconsistent, though he admits he never looked at those documents to begin with. The documents Sulyma acknowledges receiving and reviewing are the Intel 401(k) and Intel Retirement Contribution Retirement Savings Statements, which “consistently advised him from 2010 to 2013 that he was invested in ‘stock 63%, bonds 16%, short-term 21%.’” The Savings Statements say nothing about investments in private equity or hedge funds.

Cousins noted that actual knowledge exists when a plaintiff knows of the transaction constituting the alleged violation. He rejected Sulyma’s argument that it should adopt a “willful blindness” standard for actual knowledge, saying the cases cited by Sulyma are unpersuasive and do not address ERISA.

Cousins found that Sulyma had actual knowledge of the facts underlying his substantive claims because the financial disclosures provided information about plan asset allocation and an overview of the logic behind investment strategy. According to the opinion, the 2011 Qualified Default Investment Alternatives Notice, 2012 Summary Plan Description, 2012 Annual Disclosures, and targeted emails notified Sulyma of the challenged investment allocations. Taking into consideration the parties’ arguments at the December 14, 2016, hearing, and after review of these documents, Cousins agreed these documents provided Sulyma notice of how his investments were allocated.

Though he does not recall reviewing the Summary Plan Descriptions, each year Sulyma was a plan participant, a Summary Plan Description was made available on the NetBenefits website describing the assets held by the two funds in which he invested—the GDF and TDF, the opinion says. Regarding Sulyma’s holdings in the TDF, for example, the 2012 Summary Plan Description advised Sulyma that “[e]ach fund offers a broadly diversified mix of domestic and international stocks and bonds, and includes investments not typically available to individual investors, such as hedge funds and commodities.” As to the GDF, the same Plan Description advised Sulyma that the asset mix of the GDF included “domestic and international equity, global bond and short-term investments, hedge funds, private equity, and real assets (e.g. commodities, real estate & natural resource-focused private equity).”

“Thus, the Summary Plan Descriptions informed plan participants that the TDF and GDF contained the alternative investments he now alleges were imprudent,” Cousins wrote.

In addition, according to the opinion, Fund Facts Sheets available to Sulyma on the NetBenefits website disclosed the amount in which the TDF and GDF were invested in hedge funds or private equity in narrative and graphic formats, and explanations for the inclusion of those alternative investments. “These June 2012 Fund Fact Sheets demonstrate Sulyma had actual knowledge of the elements of his imprudence claims more than three years before he filed suit regarding the allocations,” Cousins concluded.

Opinions April 4, 2017

Barry’s Pickings Online: Roth-only?

Michael Barry, president of the Plan Advisory Services Group, shares his thoughts about lawmakers’ consideration of making the current pre-tax retirement savings system an after-tax system.
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PS_Barry_JCiardielloArt by J.CardielloThere are widespread reports that House Republicans—in an effort to raise revenues for unrelated purposes—are considering converting the current 401(k) system to Roth-only contributions: requiring that all participant contributions be made on an after tax basis. Those contributions would then—under “Roth treatment”—accumulate and be paid out tax-free (subject, one assumes, to some sort of holding period requirement). Many are reacting (very) negatively to this idea, arguing that it will result in a significant reduction in retirement savings and that, particularly, an all-Roth system will discourage participants from making 401(k) contributions.

I’m finding the discussion of this a confusing mixture of cynicism and misunderstanding—or at least a lack-of-being-clear—all round. So I’d like to get some things straight about Roth versus non-Roth contributions and then discuss what seem to me to be the obvious problems with it.

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Retirement savings taxation math 

So, first, I want to start with the math. Under the current “non-Roth” system, a participant can make a “pre-tax” contribution—say, the current $18,000 maximum—to a plan, leave it there for 15 years (or one year or 40 years). When this non-Roth saver takes her money out (contributions and earnings), she will pay taxes (at her then income tax rate) on the entire distribution. (That, by the way, will be the first time she has paid any taxes on this money.)

Under the Roth system, an identical participant can take an identical $18,000, pay taxes on it first (at her income tax rate in the year of contribution), then put the (after-tax) balance into the plan. When this Roth saver takes her money out after 15 years, she will take it (contributions and earnings) tax-free.

Can we all agree that—assuming that the tax rate for these savers is same at the time of distribution as it was at the time of contribution, and assuming that they both left the money in for the same period and earnings were identical—these two savers, at distribution, will both have the same amount of money, after taxes. That is, it doesn’t matter if you pay all your taxes at distribution, or you pay all of them at contribution. Your benefit is the same: the non-taxation of trust earnings.

Why do participants dislike Roth? 

Now, I have some significant problems with “Roth only,” which I’m going to get to. But something I find a little puzzling (and in some respects interesting) is that many are saying (and with some evidence) that participants (and particularly low-paid participants) don’t like Roth contributions. And, I thought we just agreed that it doesn’t affect participants.

Here are my thoughts about why that might be—that participants don’t like Roth contributions:

(1) Plans calculate contributions and matching contributions on the basis of gross (that is, pre-tax) pay. So that whole thing about starting with “the identical” $18,000, paying taxes on it, and contributing the balance doesn’t work. OK. But, isn’t there a way to fix that?

(2) Participants don’t understand the math. Maybe. But, again, can’t the math of this be explained?

(3) Most participants expect to be in a lower tax bracket when they take their money out, so that that assumption we made (that tax rates are constant) doesn’t hold. I actually think this may in fact be the case. I would certainly like to see more research on it. If all the talk we hear about how participants are not saving enough is the case, then it seems to me that such a participant expectation may be pretty rational: they will be paying taxes at a lower rate in retirement, because they will have less income in retirement.

Whatever the case, we are going to need to get some clarity on: participant attitudes toward Roth contributions; whether (if they are negative) they can be changed; and whether (if they are negative and can’t be changed) the adverse effect on retirement savings of a Roth-only regime is acceptable.

Those are my thoughts—at this point (and before we’ve seen any actual proposal)—on the effect of Roth-only on participants.

NEXT: Three other problems

But I have three other problems with Roth-only. First, under the current system, taxpayers who believe their current tax rate is lower than it will be in the future can make a Roth contribution and, in effect, shift income from a (future) higher tax year to the (current) low tax year. And taxpayers who believe their current tax rate is higher than it will be in the future can make a non-Roth contribution and shift income from the (current) high tax year to a (future) low tax year.

In other words, the current system allows flexible income smoothing in both directions. That’s not really a retirement policy value—it’s an income tax policy value. And I think it is a really good thing, especially when you have a steeply progressive income tax. Getting rid of it—or, as Roth-only would do, only allowing smoothing in one direction—is in effect an income tax hike. Which (personally), I think is a bad thing.

Second, while (assuming constant tax rates) non-Roth and Roth produce the same result for the participant, switching to Roth-only doesn’t produce anything like the same result for the capital markets. A big chunk of money—10%? 20%?—that used to go straight into the capital markets when a participant made a contribution will now go straight to the federal government. And that is going to have some very negative effects on the economy. I hope the Congressional Budget Office (CBO) is modeling that.

And, finally, and getting to the cynical part—this whole proposal is just a budget gimmick. The CBO “scores” the tax effects of the 401(k) system using a 10-year window. Using that approach, non-Roth contributions front-load tax benefits (because the exclusion is taken in year one and the taxes are only paid at withdrawal, often in years outside the 10-year window). As a result of this scoring approach, the revenue “cost” of the non-Roth system is overstated. Roth contributions flip that treatment—front-loading the tax revenues, pushing the revenue cost (the non-taxation on distribution) outside the window, and thus understating the revenue cost.

Everyone knows this, and everyone knows it’s irrational. But instead of fixing this problem—say, by present-valuing the tax benefit—advocates of Roth-only are just trying to make the irrationality work for them. All in the service of producing more revenues so they can fund income and investment tax rate reductions and a corporate tax fix.

Bottom line 

All of which is to say: lawmakers should be reluctant to radically revise the current system—which, whatever its flaws, is producing meaningful retirement savings—in a way that could significantly compromise its effectiveness and drain assets from the capital markets, all in service of a budgeting artifice. Hopefully they will think twice before pulling the Roth-only trigger.

 

Michael Barry is president of the Plan Advisory Services Group, a consulting group that helps financial services­ corporations with the regulatory issues facing their plan sponsor clients. He has 40 years’ experience in the benefits field, in law and consulting firms, and blogs regularly http://moneyvstime.com/ about retirement plan and policy issues.          

This feature is to provide general information only, does not constitute legal or tax advice, and cannot be used or substituted for legal or tax advice. Any opinions of the author do not necessarily reflect the stance of Asset International or its affiliates.

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