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Cypen & Cypen
MAY 26, 2005

Stephen H. Cypen, Esq., Editor

Never Forget - September 11, 2001


By letter dated May 11, 2005 (released May 23, 2005), the U. S. Department of Labor issued an advisory opinion that banks, brokerage firms and investment firms are prohibited from accepting payments from mutual fund companies in exchange for steering retirement account customers to those funds. The Pension Excise Tax Regulations provide that a fiduciary may not use the authority, control or responsibility that makes such person a fiduciary to cause a plan to pay an additional fee to such fiduciary (or to a person in which such fiduciary has an interest that may affect the exercise of such fiduciary’s best judgment as a fiduciary) to provide a service. A fiduciary may not use the authority, control or responsibility that makes such person a fiduciary to cause a plan to enter into a transaction involving plan assets whereby such fiduciary (or a person in which such fiduciary has an interest that may affect the exercise of such fiduciary’s best judgment as a fiduciary) will receive compensation from a third party in connection with such transaction. Here, the bank that requested the ruling does receive otherwise-prohibited fees, but management fees received by the bank are reduced by an amount equal to such other fees and receipt of such other fees does not cause the bank’s compensation to exceed the amount of management fees agreed to by the individuals who established IRAs or by IRA beneficiaries. This opinion is very significant: it may eliminate some of the conflicts of interest that exist in many IRAs. The bottom line is that a plan participant should only pay the amount of fees designated and not have to worry about recommendations of products that just happen to be most lucrative for the trustee/custodian/investment adviser.


The Federal Financial Institutions Examination Council (FFIEC), on behalf of the Office of Thrift Supervision (OTS), the Board of Governors of the Federal Reserve System (Board), the Federal Deposit Insurance Corporation (FDIC), the National Credit Union Administration (NCUA) and the Office of the Comptroller of the Currency (OCC), is seeking public comment on a proposed Interagency Advisory on the Unsafe and Unsound Use of Limitation of Liability Provisions and Certain Alternative Dispute Resolution Provisions in External Audit Engagement Letters. The proposal advises Financial Institutions’ Board of Directors, Audit Committees and Management that they should ensure that they do not enter into any agreement that contains external auditor limitation liability provisions with respect to financial statement audits. The agencies have observed an increase in the types and frequency of provisions in certain Financial Institutions’ external audit engagement letters that limit the auditors’ liability. While these provisions do not appear in a majority of financial institution engagement letters, they are becoming more prevalent. The agencies believe such provisions may weaken an external auditors’ objectivity, impartiality and performance; therefore, inclusion of these provisions in financial institution engagement letters raises safety and soundness concerns. White these provisions take many forms, they can be generally categorized as an agreement by a financial institution that is a client of an external auditor to:

a. Indemnify the external auditor against claims made by third parties;
b. Hold harmless or release the external auditor from liability for claims or potential claims that might be asserted by the client financial institution; or
c. Limit the remedies available to the client financial institution.

Financial Institutions’ boards of directors, audit committees and management should also be aware that certain financial institution insurance policies (such as error and omissions policies and director and officer liability policies) may not cover the financial institutions’ losses arising from claims that are precluded by the limitation of liability provisions. This advisory, if it becomes final, may not relate directly to pension boards – except to the extent that they might invest in the securities of a financial institution subject to the advisory. However, this advice is well taken in relation to external audits of pension funds themselves, and should be followed regardless of the outcome of the banking regulators’ advisory.


On May 3, 2005, the Deputy Assistant Secretary for Program Operations, Employee Benefits Security Administration, Department of Labor, wrote to General Counsel for the AFL-CIO. He made reference to reports that union officials had suggested fiduciaries of ERISA-covered plans could expend plan assets to inform participants about the current public debate on Social Security, and that plan trustees could make decisions on the hiring and firing of plans’ service providers based upon their opinions on Social Security reform. DOL has grave concerns about these statements, and disagrees with any suggestion that plan assets could be used for any purpose other than to pay benefits defray administrative expenses. In certain very narrow circumstances, such as where a legislative proposal is near enactment and closely tied to plan issues, a fiduciary could decide to spent plan assets to educate participants about the need to take the legislation into account in making particular decisions about their options under the plan. Giving plan participants information directly relevant to particular plan choices, however, is very different from expressing views or providing information concerning issues of public policy like Social Security reform. Under ERISA’s stringent standards of prudence and loyalty, it would be unlawful for a plan fiduciary to review the plan’s service providers based, not upon quality and expense of their services, but rather upon their views on Social Security or any other broad area of public policy. For this reason, DOL reiterates its view that plan fiduciaries may not increase expenses, sacrifice investment returns or reduce the security of any plan benefits in order to promote collateral goals. A fiduciary’s reconsideration of its current service providers based solely upon the service provider’s views on Social Security would raise serious concerns about the prudence and loyalty of the fiduciaries’ actions. Similarly, a fiduciary could not, consistent with the duties of prudence and loyalty, simply exclude qualified service providers from consideration and hiring based solely upon their views on Social Security policy. Could the Administration be pulling out all stops in its quest for substantial Social Security reform?


The Investment Company Institute is a national association of U.S. investment companies. ICI seeks to encourage adherence to high ethical standards, promote public understanding and otherwise advance the interests of funds, their shareholders, directors and advisers. As of April 1, 2005, ICI members included more than 8,000 open-end investment companies (mutual funds), more than 600 closed-end investment companies, 144 exchange-traded funds and 5 sponsors of unit investment trusts. Mutual fund members of ICI have total assets of approximately $8 Trillion (representing more than 95% of all assets of U.S. mutual funds), serving approximately 88 million shareholders in more than 51 million households. ICI has just issued the 45th edition of its annual “Investment Company Fact Book.” ICI reports that of the $13 Trillion U.S. retirement market, approximately $3.1 Trillion is invested in mutual funds ($1.6 Trillion in employer-sponsored accounts and $1.5 Trillion in IRAs). The remaining $9.8 Trillion in retirement assets were in pension funds, insurance companies, banks and brokerage firms. Other data show that 92 million individuals (having a median age of 48) in 54 million U.S. households own mutual funds. Of these individuals, 71% are married, 56% are college graduates, 77% are employed, 49% are Baby Boomers and 24% are members of Generation X. (We know, we know....they’re not supposed to add up to 100%.)


Recent trends in U.S. private pensions are undeniable, according to a Watson Wyatt survey. Over the last twenty-five years, defined benefit plans, once the centerpiece of retirement portfolios, have lost considerable ground to defined contribution plans, which have become the primary vehicle for saving for retirement. Some claim that traditional defined benefit plans are a dying breed (if not already dead). Detractors contend that defined benefit plans are too complicated, too risky for plan sponsors and unappreciated by employees. The Watson Wyatt survey found that most workers value both types of plans very highly. And workers who value their retirement plan are more likely to want to continue working for their current employer than those who do not. As such, design and features of a retirement program can have a very meaningful effect on workers’ behavior, which can deliver favorable economic returns to the organization. The survey asked DB plan participants to indicate their degree of satisfaction with the following eight plan design features (the percentages being “highly satisfied”):

Value of benefits as future income 55.9%
Information about value today 49.9%
Information about projected value 47.4%
How benefits are paid out 54.0%
Age when benefits are available 58.4%
Years of service until vested 67.9%
Ability to access before retirement 35.2%
How plan compares with competitors 40.9%

Overall satisfaction with DB plan 56.4%

The survey also asked employees to indicate their satisfaction with the following plan design features of DC plans:

Match rate 53.3%
Type of matching funds 55.4%
Amount can contribute 79.8%
Investment options 68.7%
Information about balances 74.2%
Education programs 40.7%
Quality of plan administrator services 57.2%
How plan compares with competitors 45.8%

Overall satisfaction with DC plan 68.2%

The conclusion is that most employees appreciate their retirement plans and value them highly. In fact, it appears that a satisfactory plan plays a very significant role in both attracting and retaining employees. Although employee attraction and retention are always important, they are likely to become increasingly so as the Baby Boom generation starts retiring.


In 1999, the taxpayer suffered an injury and applied for Social Security disability benefits. The Social Security Administration resisted the claim, but after many months, the taxpayer prevailed, receiving a lump-sum payment of benefits in 2001 (including $4,000.00 in attorney’s fees). For 2001, the taxpayer received a Form SSA-1099, Social Security Benefit Statement, from the Social Security Administration, showing “benefits for 2001" of $21,656.00. Social Security benefits, including disability benefits, are includable in gross income pursuant to the statutory formula, but the taxpayer included no benefits. Here, application of the formula results in inclusion of benefits of $18,408.00 (85% of $21,656.00). The taxpayer challenged the deficiency for 2001, but the United States Tax Court ruled against her. Even though a significant portion of the Social Security benefits received by the taxpayer was attributable to 1999 and 2000, under income tax accounting principles an item of gross income must be included in income for the taxable year that it is received by a cash basis taxpayer. However, the law recognizes that a taxpayer who receives a lump-sum payment of Social Security benefits attributable in part to prior taxable years may be adversely affected by the “bunching” of income; the statutory formula is designed to provide a measure of relief to such taxpayers. In addition, that portion of the lump-sum payment of Social Security benefits that was paid to the taxpayer’s attorney cannot be disregarded for purposes of application of the statutory formula. Citing a very recent United States Supreme Court decision, the Tax Court held that under the so-called anticipatory assignment of income doctrine, the taxpayer cannot exclude an economic gain from gross income by assigning the gain in advance to another party. (The Court did note that a portion of the attorney’s fees is potentially deductible as an itemized deduction.) Davis v. Commissioner of Internal Revenue, T.C. Summ. Op. 2005-61 (May 19, 2005).


In a rather startling coincidence, on May 19, 1989, the Dow Jones Industrial Average passed 2500 for the first time. In 1993, on the same date, the Dow crossed 3500 for the first time.

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Items in this Newsletter may be excerpts or summaries of original or secondary source material, and may have been reorganized for clarity and brevity. This Newsletter is general in nature and is not intended to provide specific legal or other advice.

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