Employee Benefits Bulletin, August 2002
The Sarbanes-Oxley Act of 2002
What Employee Benefits Professionals Need to Know
On July 30th, President Bush signed into law the Sarbanes-Oxley Act of 2002 (H.R. 3763) (the "SOA"). Heated debate over the corporate reform legislation abruptly subsided after WorldCom's accounting scandal was revealed and the stock market began its recent volatile run. This legislation is hoped to restore public confidence in corporate accounting and reporting practices. In addition to the legislation's most prominent feature-a federal accounting oversight board-the legislation also includes the following provisions of interest to employee benefits practitioners:
Notice Requirements for Blackout Periods
In A Nutshell: An explanatory notice must be given to participants and beneficiaries of defined contribution plans (e.g., 401(k) plans) 30 days prior to a blackout period.
Effective Date: January 26, 2003 (180 days after enactment of the SOA).
As stated above, according to the SOA, at least 30 days before the beginning of a blackout period, the plan administrator must notify the plan participants and beneficiaries.
The first step in complying with the requirement is to determine whether the suspension, limitation, or restriction your plan will be experiencing is actually a blackout period. It is important to note that not every interruption in participant control of their individual account qualifies as an SOA "blackout period." The SOA defines a blackout period as a period of more than three consecutive business days during which the participants or beneficiaries in a defined contribution plan (e.g., 401(k) plan) are limited or restricted from their normal right to direct or diversify assets in their accounts or obtain plan loans or distributions. In addition to suspension or limitation periods that do not fit the blackout period definition above (e.g., a two day suspension), there are also specific exceptions listed in the SOA:
regularly scheduled suspensions (e.g., quarterly investment direction) that have been disclosed in writing to participants under the plan (in a summary of material modifications ("SMM") or in the investment literature of the plan),
suspensions required by the SEC, and
suspensions applying pursuant to the receipt of a qualified domestic relations order ("QDRO") are specifically excluded from the SOA definition of "blackout period" and are not subject to the notice requirement.
Once it has been determined that the suspension, limitation, or restriction your plan will be experiencing is, in fact, a blackout period, the next step is to craft a notice to send out to participants and beneficiaries. The notice must be written in a manner that the average plan participant will understand and must include:
the reasons for the blackout period;
an identification of the investments and other rights affected;
the expected beginning date and length of the blackout period;
in the case of investments affected, a statement that the participant or beneficiary should evaluate the appropriateness of their current investment decisions in light of their inability to direct or diversify assets credited to their accounts during the blackout period; and
any other requirements imposed by the regulations the Department of Labor will write to supplement the new SOA provisions of ERISA.
The SOA requires the Department of Labor to flesh out the gaps and questions left by the new ERISA provisions. Interim regulations on the blackout period notice must be issued by October 13, 2002 (75 days after enactment), and initial guidance and a model notice must be released by January 1, 2003.
Stiff penalties result if a plan does not release a blackout period notice. In addition to potential criminal penalties for willful violation of the notice requirement (discussed below), the SOA gives the Department of Labor the power to assess a civil penalty of $100 a day during a violation. Each participant or beneficiary who does not receive a notice is treated as a separate violation. Therefore, the penalties can add up fast. For example, in a plan containing 50 participants, the potential penalty is $5,000 (50 x $100) for each day a notice is late.
Criminal Penalties for ERISA Disclosure Violations Increased
In A Nutshell: The criminal penalties for violations of ERISA's reporting and disclosure rules are significantly increased.
Effective Date: Effective immediately.
The SOA increases the criminal penalties imposed under §501 of ERISA for reporting and disclosure violations, including violations of the new blackout notice requirement. (The ERISA reporting and disclosure rules are found in §101 of ERISA, and the new blackout notice rule of the SOA will become ERISA §101(i).) The maximum penalty that can be imposed on an individual upon conviction increases from $5,000 to $100,000, and the maximum penalty that can be imposed on a non-individual (e.g., corporation) increases from $100,000 to $500,000. The maximum prison term for an individual convicted of a Section 501 violation increases from one year to 10 years.
Insider Trades During Blackout Periods
In A Nutshell: Directors and executives are prohibited from buying, selling, or transferring company stock during a pension fund blackout period.
Effective Date: January 26, 2003 (180 days after enactment of the SOA).
The SOA provides that corporate executive officers and directors are prevented from trading in employer securities acquired in connection with their employment as a director or executive officer during any defined contribution plan blackout period to the extent the plan holds employer securities.
Once again, the first step in compliance is to determine whether the suspension your plan will be experiencing is, in fact, a blackout period. It is important to note that the SOA defines "blackout period" differently for cases of insider trading than it does for the new participant notice requirement. An "insider trading blackout period" is defined as a period of more than 3 consecutive business days during which the ability of at least 50% of participants to direct the investment of employer securities is suspended, limited or restricted. Therefore, if the plan does not hold employer stock, NO blackout period will be an "insider trading blackout period." Additionally, any regularly scheduled suspension, limitation, or restriction (i.e., quarterly investment direction) previously disclosed to participants in writing (through an SMM or plan investment literature) is specifically exempted from the definition of an "insider trading blackout period." An additional exemption is also provided: a suspension, limitation or restriction imposed in connection with persons becoming or ceasing to be participants because of a merger or acquisition involving the plan or plan sponsor is not considered a blackout.
Once it has been determined that the suspension in question is an "insider trading blackout period," the issuing company (usually the plan sponsor) must notify affected corporate officers, directors, and the SEC of the plan blackout period. The SOA requires that the notice be "timely" but does not define the term. The Department of Labor will issue regulations to clarify this and other questions.
Any individual violating this prohibition must forfeit any profit that results from the trading to the issuing company. The company may sue to get these profits, or, if the company fails to file suit, a shareholder may file an action to recover the insider trading profits.
Prohibition on Personal Loans to Executives
In A Nutshell: Companies may no longer make (directly or indirectly) personal loans to executives or directors.
Effective Date: Effective immediately.
The SOA states:
It shall be unlawful for any issuer . . . , directly or indirectly, including through any subsidiary, to extend or maintain credit, to arrange for the extension of credit, or to renew an extension of credit, in the form of a personal loan to or for any director or executive officer (or equivalent thereof) of that issuer.
What should be a fairly simple prohibition has sparked the most questions of the new SOA employee benefits provisions because the SOA does not define the term "personal loan." The SOA does make clear that any loan in existence on July 30, 2002, is grandfathered (not affected by this prohibition), as long as there is no material modification to any term of the loan or any renewal of such loan on or after that date. Additionally, the SOA provides exemptions for loans made by issuers in the ordinary course of the issuer's business (if generally available to the public at the same market rate) and loans made by FDIC-insured institutions.
Beyond these narrow exemptions, there is much speculation as to which common benefits and compensation arrangements could constitute a prohibited "personal loan." Possibilities (beyond outright loans and guarantees) include 401(k) loans, some equity split-dollar life insurance arrangements, and cashless stock option exercises. Clearly, much guidance is needed in this area. Until that guidance is provided, companies should be extremely careful when providing any new benefit to an executive or director that might fall within the prohibition.
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