“P” is for Prohibited Transaction, “S” is for Self-Dealing: How Not to Administer a Retirement Plan

The Employee Retirement Income Security Act of 1974, 29 U.S.C. § 1001, et seq. (“ERISA”), is the federal law that governs most employee benefit plans in the United States.  As its name implies, this includes retirement plans…

By Adam Garner

The Employee Retirement Income Security Act of 1974, 29 U.S.C. § 1001, et seq. (“ERISA”), is the federal law that governs most employee benefit plans in the United States.  As its name implies, this includes retirement plans like pension plans and 401(k) plans.  The law is complicated, comprehensive, and imposes a variety of regulations and obligations on the individuals and entities that administer and service the plans.  These regulations and obligations exist for good reason: to prevent corruption and self-dealing; protect the plan’s assets for the benefit for all participants; and to ensure the prudent and impartial administration of covered plans.

On Thursday, November 10, 2016, the United States District Court for the Middle District of Tennessee issued an opinion in Perez v. Eye Centers of Tennessee, Case No. 2:14-cv-0115, 2016 U.S. Dist. LEXIS 156248 (M.D. Tenn. November 10, 2016), a case brought by the Secretary of Labor, against the sponsor and several fiduciaries of a profit-sharing plan.  (A copy of the opinion may be downloaded by clicking here.)   The Defendants’ conduct, as described the court, illustrates the sort of self-dealing and imprudent behavior that ERISA was designed to prevent.

Eye Centers of Tennessee (“ECOTN”) is an ophthalmology practice with multiple offices.  ECOTN sponsored a retirement plan (“the Plan”) for the benefit of its employees.  The Plan is a contribution based retirement plan that permits discretionary profit sharing contributions to be made by ECOTN.  The Plan also allowed participants, through payroll deductions, to contribute a portion of their paycheck to the Plan.  ECOTN, its principal owner, and its office manager were the Plan’s named fiduciaries.

The individual Defendants in Eye Centers were all “parties in interest” of the Eye Centers of Tennessee 401(k) Profit Sharing Plan (“the Plan”).  A party in interest includes:

  • any fiduciary or employee of an employee benefit plan;
  • a benefit plan’s service provider;
  • an employer whose employees are covered by the plan;
  • an owner, direct or indirect, of 50 percent or more of an employer whose employees are covered by the plan; and
  • certain relatives of a party in interest.

29 U.S.C. §1002(14).    Section 406 of ERISA, 29 U.S.C. § 1106, prohibits certain transactions involving “parties in interest.”  In addition, some Defendants were also Plan fiduciaries. Section 404 of ERISA, 29 U.S.C. § 1104, requires plan fiduciaries to, among other things, discharge their fiduciary duties solely in the interest of the participants and beneficiaries for the sole purpose of providing plan benefits to participants and their beneficiaries and defraying reasonable administrative expenses of the plan.  Fiduciaries are also required to discharge their duties “with the care, skill, prudence, and diligence” of a prudent person acting under the same or similar circumstances.  29 U.S.C. § 1104.

The Eye Centers Defendants engaged in many prohibited transactions and breaches of their fiduciary duties.  They included:

  • transferring over $782,000 in Plan assets to Maple Leaf Developments, LLC (“MLD”), which was owned by ECOTN’s owner and office manager, without documenting the Plan’s ownership interest in property owned by MLD;
  • transferring assets worth $50,000 from the Plan back to ECOTN, without documenting a loan, securing a promissory note, or otherwise requiring any form of collateral or repayment to pay for the company’s operations.
  • Making $344,225.39 in payments from the Plan to Park Street Properties, LLC, another “party in interest,” which the office manager owned.
  • Having the Plan pay $17,077.24 to a company owned by the office manager’s brother (who was also a ECOTN employee) for undocumented “services;” and
  • Having the Plan purchase a commercial property for $285,000, leasing it to a business owned by the office manager’s family for $5,000 a year (only 16% of the Plan’s annual mortgage payment), and failing to collect the rent owed.

The Court held that each of the above-transactions was a per se prohibited transaction in violation of ERISA Section 406(a).  Likewise, Defendants engaged in self-dealing in violation of ERISA Section 406(b).  The Court further found that no prohibited transaction exemption was applicable to Defendants.  Although ERISA Section 408(b)(2), 29 U.S.C. § 1108(b)(2), allows for an exemption for “contracting or making reasonable arrangements with a party in interest for office space, or legal, accounting, or other services necessary for the establishment or the operation of the plan, if no more than reasonable compensation is paid therefor,” it does not exempt violations of self-dealing under ERISA Section 406(b)(1) or (2).  29 C.F.R. § 2550.408b-2.  Likewise, any compensation made to other parties in interest must be reasonable to qualify for exemption.  The Eye Centers Defendants did not show that they met this reasonableness requirement.  Finally, Defendants did not dispute that the fiduciary defendants failed to discharge their fiduciary duty in accordance with ERISA Section 404.

The Defendants were barred from ever administering another employee benefit plan, and the case will proceed to trial to determine the damages owed to the plan due to Defendants’ misconduct.

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