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Banking & Finance Law Report

Tax Considerations in Settlement Agreements Regarding Cancellation of Debt

Posted in Commercial Law, Tax Law

Although not every settlement agreement has to be reviewed by a tax lawyer if you are representing a creditor or a debtor and the subject matter of the settlement involves the compromise of a debt or a cancellation of an indebtedness, there are some basic tax matters which must be considered.

If you are representing the creditor, you should consider whether the cancellation or compromise of the debt will be deemed income for tax purposes.  This consideration will lead to a determination of whether the creditor must issue a Form 1099-C to the IRS and to the debtor.

If you are representing the debtor, you must consider whether the settlement qualifies as a contested liability dispute.  If the debtor-taxpayer, in good faith, disputes the liability of the obligation, then a subsequent settlement of the disputed debt may not result in income, and thus, the creditor would not have to issue a Form 1099-C.

The recent Sixth Circuit case of McClusky v. Century Bank, FSB, 2015 U.S. App. LEXIS 1419 (2015) concerns the consequences of failing to consider possible tax issues, and provides an excellent summary of the law applicable to the settlement of a dispute involving the cancellation or discharge of an indebtedness.  Although the creditor ultimately won a reversal of the District Court’s summary judgment, each side incurred substantial post-settlement attorneys’ fees which could have been avoided by including a tax-treatment clause in the settlement agreement.

In the McClusky case, the creditor-bank sued the debtors for breach of the promissory note and foreclosure of the mortgage securing the debt.  Ultimately, the property was sold at a sheriff’s sale for $280,000.00.  Three months after the sale, the purchaser flipped the property for $386,550.00.

After the sheriff’s sale, a deficiency judgment was entered against the debtors. Thereafter, the debtors filed a motion to set aside the deficiency judgment based on the failure of a creditor to mitigate its damages.  Specifically, the debtors alleged that the creditor failed to pursue two higher offers on the property prior to the sale.  Thus, the motion was filed to contest liability.

By agreement, the parties reached a settlement whereby the deficiency judgment was released and vacated in exchange for the debtors paying $5,000.  The terms of the compromise were incorporated into a settlement agreement.

After the settlement, the creditor issued a Form 1099-C to the debtors and to the IRS stating that the creditor had cancelled a debt of $159,478.87 arising from the settlement.  The IRS credited this amount as income and the debtors paid $68,660.00 for taxes on the amount forgiven.

Thereafter, the debtors sued the creditor for breach of the settlement agreement by reporting the cancelled debt as income and to recover bad faith attorneys’ fees.

The trial court determined that the creditor had breached the settlement agreement by reporting the cancelled debt as income.  Further, the trial court set the matter for a hearing on the legal fees to be assessed against the creditor for breaching the settlement agreement.

The creditor appealed and was saved by the Sixth Circuit.  The Sixth Circuit held that because the settlement agreement did not address any issues dealing with taxes or reporting the transaction to the IRS, the creditor was free to issue the Form 1099-C to the debtors and to the IRS.

Although the creditor eventually won, it could have avoided the litigation if its legal counsel would have included one simple provision in the settlement.  Further, debtors’ counsel could have protected his clients by negotiating for the inclusion of a contested liability provision.

If you are representing the creditor and wish to guard against a lawsuit alleging that the issuance of the Form 1099-C breached the settlement agreement, consider adding this tax treatment language:

The parties hereby agree that creditor shall report the cancelled indebtedness to the IRS by disclosing the amount on Form 1099-C.

If you are representing a debtor, and you believe the debt was cancelled in good faith and pursuant to a contested liability dispute, consider adding this language:

The parties hereby agree that the settlement of the dispute related to a contest liability and was made in good faith.  As such, the excess of the original debt over the amount of the settlement shall not be considered as income and creditor shall not issue a Form 1099-C.

Under the McClusky decision, if the settlement agreement does not specifically contain language regarding the tax consequences of the cancellation of the debt, then the creditor is free to report the cancelled debt as income.  If you are representing a debtor and recognition of the cancellation of debt as taxable income is not the intent of your client, then you must negotiate a tax-treatment provision in the settlement.  Otherwise, you risk a malpractice claim.

UPDATE: FDIC joins in on IOLTAs for CRA consideration

Posted in Bank Regulation, Regulation and Compliance

Editor’s Note: This post was prepared by Susan A. Choe, Deputy Director & General Counsel, The Ohio Legal Assistance Foundation.

As an update to our guest blog post of April 10, 2014, the Ohio Legal Assistance Foundation is pleased to report that the Federal Deposit Insurance Corporation (FDIC) will join the Ohio Office of the Comptroller of the Currency and the Federal Reserve Board of Cleveland, in reviewing on a case-by-case basis interest paid above market rates on Ohio IOLTAs (interest on lawyer trust accounts) for potential positive CRA consideration.

Constructively charged with having retroactive actual notice when challenging an improperly recorded defective mortgage…wait, what?

Posted in Commercial Law, Real Estate

Great cases…make bad law” declared Supreme Court Justice Oliver Wendell Holmes Jr. in his dissenting opinion in the Northern Securities antitrust case of 1904. One of the most oft-quoted phrases any aspiring lawyer will hear in law school, this maxim stands for the proposition that decisions in cases of great importance from a public or social perspective make a poor basis upon which to construct a general law. Although an otherwise innocuous adversary bankruptcy proceeding (Daren A. Messer, et al. v. JPMorgan Chase Bank, NA (In re Messer), Adv. Pro. No. 13-2448) can hardly be called a matter of high social importance, it did result in the United States Bankruptcy Court for the Southern District of Ohio certifying two novel questions of state law for consideration by the Ohio Supreme Court that “could potentially affect tens of thousands of [mortgages]” in Ohio. The Ohio Supreme Court has not yet ruled on this matter, but given the implications I felt it worth putting on people’s radar at this time.

In a nutshell, the questions can be summarized as follows: O.R.C. §5301.01 requires that all mortgages be acknowledged in the presence of a notary, and further provides that the recording of said mortgage shall operate as constructive notice of its existence to all persons. In other words, you can’t “avoid” a properly-recorded mortgage – whether as a bankruptcy trustee, as a junior creditor or as a good faith purchaser for value – simply because you did not have actual notice of the existence of that mortgage. This concept forms the foundation upon which the public land records system is constructed. Conversely, documents that are improperly recorded – whether by virtue of a simple defect such as a missing acknowledgement, or if that document was not entitled to be recorded under O.R.C. §317.08 – do not operate as constructive notice, and could be avoided by a person taking an interest in the subject property without actual knowledge of the existence of that instrument.

O.R.C. §1301.401, passed into law in December of 2012, seems to flip this structure on its head by declaring that anyone challenging the validity or effectiveness of a “public record” (such as those documents to which O.R.C. §317.08 refers) shall be “considered to have discovered [i.e., have actual knowledge] of that record as of the time that the record was first…tendered to a county recorder for recording.” Simply put, by challenging the validity of a defectively executed mortgage, the challenging party is then deemed by operation of law to have actual knowledge of the existence of the mortgage and its terms, retroactive to the date upon which that instrument was created. In other words, this statute appears to do away with the question of whether an improperly acknowledged mortgage could provide the basis for constrictive notice, and instead says that the law will assume that a party will be deemed to have had actual knowledge of that instrument, whether or not that was true at the time, should they later dare to challenge its effectiveness under the ordinary constructive notice scheme.

So back to Justice Holmes. Here we have a situation where the Bankruptcy Court declined to make a decision because the conflict between these two statutory schemes was apparently a case of first impression in Ohio, and declining to follow the lender’s interpretation of O.R.C. §1301.401 could negatively affect the noted “tens of thousands” of mortgages in Ohio even if only “1%” of the millions of Ohio mortgages were executed improperly. As someone who routinely practices in the areas of real estate finance and foreclosure, I wouldn’t be surprised to discover that the 1% figure cited by the court is rather conservative. On the other hand, upholding O.R.C. §1301.401 as written would seem to wholly eviscerate O.R.C. §5301.01’s requirement that mortgages be acknowledged, provided the county recorder accepts that instrument for recording. So the Ohio Supreme Court is basically being asked to balance the enforceability of “tens of thousands” of mortgages with the longstanding principle that mortgages must be acknowledged to be recorded and enforceable. Good cases make bad law – indeed.

Examining the Enforceability of Prepetition Waivers of the Automatic Stay

Posted in Bankruptcy

Recently, a bankruptcy court for the district of Puerto Rico held that a debtor’s waiver of the automatic stay contained in a pre-petition forbearance agreement was enforceable. In re Triple A & R Capital Inv., Inc., 519 B.R. 581 (Bankr. D.P.R. 2014). Unfortunately, the case adds little to the debate over the enforceability of pre-petition agreements impacting bankruptcy rights for one simple reason — the court’s holding was premised on the fact that the pre-petition forbearance agreement waiving the automatic stay was enforceable because the debtor, as part of a post-petition stipulation permitting the use of cash collateral, had ratified and agreed to be bound by the forbearance agreement.

Nonetheless, the court did briefly look at the treatment of pre-petition waivers of the automatic stay lacking post-petition ratification. Its examination provides a good opportunity to review the state of the law on this issue.

Before deciding the issue on its ratification grounds, the court noted that bankruptcy courts that have examined the enforceability of pre-petition waivers of the automatic stay:

[H]ave used different approaches with conflicting results. Three basic approaches have emerged: (1) uphold the stay waiver in broad unqualified terms on the basis of freedom of contract; (2) reject the stay waiver as unenforceable per se as against public policy; and (3) treat the waiver as a factor in deciding whether “cause” exists to lift the stay.

Id. at 584. The court further noted that “[a] review of the cases nationwide that addressed this issue indicate a trend that appears toward the enforcement of stay waivers.” Id.

Both of these observations oversimplify the issue.

Courts have refused to enforce prepetition stay waivers on a number of grounds, including: (1) a pre-petition debtor’s lack of “capacity to waive the rights bestowed by the Bankruptcy Code upon a Chapter 11 debtor in possession,” e.g., In re Pease, 195 B.R. 431, 433 (Bankr. D. Neb. 1996); (2) as a disguised ipso facto clause, e.g. id.; (3) as depriving third-party creditors of the protections of the bankruptcy code, e.g., In re South East Fin. Assocs., 212 B.R. 1003, 1005 (Bankr. M.D. Fla. 1997); and (4) as a violation of public policy, which, especially in the case of a single asset case, is said to closely approximate an unenforceable agreement not to file bankruptcy. In re DB Capital Holdings, LLC, 454 B.R. 804 (Bankr.D.Colo. 2011); In re Jenkins Court Assocs. Ltd. Partnership, 181 B.R. 33, 37 (Bankr. E.D. Pa. 1995).

Nonetheless, for those courts considering the issue, the modern trend appears to be to find “cause” to modify the automatic stay, based at least in part on a debtor’s prepetition agreement to waive the benefits of the automatic stay. However, typically a pre-petition stay wavier is not held to be per se enforceable. E.g., In re Frye, 320 B.R. 786, 787 (Bankr. D. Vt. 2005) Indeed, most courts will consider a stay waiver appearing only in a forbearance agreement or loan modification, and not in the original loan documents. E.g., Wells Fargo Bank, N.A. v. Kobernick, 2009 U.S. Dist. LEXIS 126723, 20-22 (S.D. Tex. May 28, 2009). Courts often consider the circumstances in which the stay waiver was agreed upon and changes in circumstances following such agreement, including:

  1. the sophistication of the party making the waiver;
  2. the consideration for the waiver, including the creditor’s risk and the length of time the waiver covers;
  3. whether other parties are affected including unsecured creditors and junior lienholders;
  4. the feasibility of the debtor’s plan.

SouthWest Ga. Bank v. Desai (In re Desai), 282 B.R. 527, 532 (Bankr. M.D. Ga. 2002);

  1. whether there is evidence that the waiver was obtained by coercion, fraud or mutual mistake of material facts;
  2. whether enforcing the agreement will further the legitimate public policy of encouraging out of court restructurings and settlements;
  3. whether there appears to be a likelihood of reorganization;
  4. the extent to which the creditor would be otherwise prejudiced if the waiver is not enforced;
  5. the proximity in time between the date of the waiver and the date of the bankruptcy filing and whether there was a compelling change in circumstances during that time; and
  6. whether the debtor has equity in the property and the creditor is otherwise entitled to relief from stay under § 362(d).

In re Frye, 320 B.R. 786, 791 (Bankr. D. Vt. 2005).

Importantly, courts hold that such stay waivers are not self-executing, such that the stay is not automatically lifted and a motion to lift stay is still required. Id. at 790. Furthermore, such stay waivers are typically considered alongside other legitimate grounds for stay relief. And, in most cases, a stay waiver will not prevent a court from considering an objection from a third-party creditor. E.g., In re Atrium High Point Ltd. Partnership, 189 B.R. 599, 607 (Bankr. M.D.N.C. 1995).

Finally, it should be noted that the modern trend does not include any circuit court opinions, and in fact includes only a handful of cases in total. Furthermore, the modern trend appears inconsistent with the dicta of several circuit courts, including the Second Circuit, Commerzanstalt v. Telewide Sys., 790 F.2d 206, 207 (2d Cir. N.Y. 1986) (considering a post-petition waiver and stating, “[s]ince the purpose of the stay is to protect creditors as well as the debtor, the debtor may not waive the automatic stay.”), the Third Circuit, Constitution Bank v. Tubbs, 68 F.3d 685, 691 (3d Cir. Pa. 1995) (considering a post-petition wavier and stating, “[t]he automatic stay cannot be waived.”); Maritime Electric Co. v. United Jersey Bank, 959 F.2d 1194, 1204 (3d Cir. 1991 (considering a post-petition waiver and stating, “[b]ecause the automatic stay serves the interests of both debtors and creditors, it may not be waived and its scope may not be limited by a debtor.”); Ass’n of St. Croix Condominium Owners v. St. Croix Hotel Corp., 682 F.2d 446, 448 (3d Cir. 1982), and the Ninth Circuit, Continental Ins. Co. v. Thorpe Insulation Co. (In re Thorpe Insulation Co.), 671 F.3d 1011, 1026 (9th Cir. Cal. 2012) (citing In re Pease approvingly and invalidating pre-petition waiver of Bankruptcy Code provisions invalidating prepetition anti-assignment clauses.); Bank of China v. Huang (In re Huang), 275 F.3d 1173, 1177 (9th Cir. Cal. 2002) (considering pre-petition waiver of dischargability and stating, “[i]t is against public policy for a debtor to waive the prepetition protection of the Bankruptcy Code.”). But see, In re Wheaton Oaks Office Partners, 1992 U.S. Dist. LEXIS 18781 (N.D. Ill. Dec. 9, 1992) (considering and rejecting applicability of Commerzanstalt and Ass’n of St. Croix Condominium Owners to pre-petition waivers, explaining “[n]either case stands for the proposition that a bankruptcy court can never find such a waiver to constitute cause to grant relief from the automatic stay.”).

Given the uncertain state of the law, lenders would be wise to (1) exclude such stay waivers from their original loan documents, (2) consider including stay waivers in their forbearance agreements, and (3) not rely exclusively on such waivers in their motions to lift stay.


An Ohio Alternative – Foreclosure Sales Conducted by a Special Master

Posted in Collection and Foreclosure, Commercial Lending

Lenders can typically credit bid at sheriff’s sales in an amount well in excess of the minimum bid requirements, as a result of which some real estate investors shy away from attending and bidding at sheriff’s sales because they feel like they won’t necessarily get a “bargain”.  Accordingly, lenders are typically the successful purchaser at sheriff’s sales.  However, the epic credit meltdown that began in 2008 resulted in lenders’ REO (real estate owned by the lender) spiking to the point where, beginning in 2009 or 2010, lenders—especially on the residential real estate side–no longer wanted to be the purchaser at foreclosure sale.   This caused them to consider—particularly after being bombarded with pitches from real estate auction houses–using a “special master” instead of the sheriff to conduct foreclosure sales, with the thought that the sales would be well attended by buyers not concerned with being outbid by the first mortgagee.

Pursuant to Revised Code § 2329.34, a master commissioner may be appointed by the court to sell real property. Such sales often work more like a private auction than a public sale, with specialized brokers performing targeted advertising prior to the sale.  Although auction companies usually don’t mention this when marketing their services to lenders, the scenarios under which a court may appoint such a special master are limited, however, to those situations where “there exists some special reason why the sale should not be made by the sheriff of the county where the decree or order was made, which reason, if the court finds any to exist, shall be embodied in and made part of the judgment, order or decree for such sale.”  See Huntington National Bank v. Conservatory Associates, LLC, 2011-Ohio-3249 (order for master commissioner sale overturned because trial court did not specifically incorporate special reasons for the sale into the final judgment, but rather glossed over the issue by indicating that the plaintiff’s motion was “well taken” and “granted”). Examples of possible “special reasons” may include:

1.         An inordinate length of time in a particular county between the date foreclosure decree is entered and the date of the foreclosure sale;

2.         The property was previously offered at sheriff’s sale but resulted in a “no bid no sale”; and

3.         The nature of the property is such that it would be best for all parties that it be sold by a master commissioner instead of the sheriff.

It is important for lenders to make sure they support any motion for sale by special master with appropriate reasons why the particular property ought to be sold by a special master instead of the sheriff, and for the court order granting that motion to contain specific findings with respect to those reasons.  Otherwise, the sale could be attacked by the borrower after the fact, or a title company might refuse to insure the buyer’s title.


Does your construction mortgage really protect you from mechanic’s liens?

Posted in Bank Lending, Lien Perfection, Other Articles, Real Estate

If you are a lender/mortgagee and your borrower/mortgagor is adding more real property collateral to the mortgage (in Ohio), how do you retain your first priority position in all mortgaged property while adding that property to the mortgage? This question is especially relevant when the borrower is assembling property as part of a development. The answer may not be as simple as you think.

You could do an amended and restated mortgage, but that could be construed as replacing the original mortgage, which would cause the priority of the mortgage to be changed from the recording date of the original mortgage to the recording date the amended and restated mortgage. So, instead you could record an amendment or modification which adds property to the mortgage. Naturally you would include a provision that states that all of the original mortgage provisions continue in full force and effect. That should do it, right? Well, recently one Ohio Court said “no.”

In 2003, Bridgeview Crossing LLC (“BC”) began assembling properties for a commercial development. In 2006 BC signed a $24,000,000 Cognovit Note and granted an open-end construction mortgage (the “Original Mortgage”) in favor of its lender (the “Mortgagee”). There was evidence that Panzica Construction Company (“Panzica”) had done some work before the mortgage was recorded (and before the Notice of Commencement was recorded).

Normally, a subsequently filed mechanics lien for work done before the Original Mortgage was filed would have priority over the mortgage. (See Ohio Revised Code § 1311.13.) However, the Original Mortgage contained the standard construction mortgage provision contained in Ohio Rev. Code 1311.14, which, if the requirements are satisfied, gives a construction mortgage “super-priority” over mechanic’s liens which are later filed for work done prior to the filing of the mortgage.

After the Original Mortgage was filed, BC continued to acquire more properties. The Mortgagee wanted to add those properties to the Original Mortgage and maintain the same “super-priority” over subsequently-filed mechanics liens. This was done by recording a series of Mortgage Modifications (individually a “Modification” and collectively, the “Modifications”) adding more property to the lien of the Original Mortgage, which were recorded from December 22, 2006 through May 13, 2008. Each Modification included the following language (the “Reaffirmation Clause”): “Except as amended and modified hereby, the provisions of the Loan Documents remain in full force and effect and are binding upon and shall inure to the benefit of the parties hereto and their respective heirs, personal representatives, successors and assigns.”

On October 15, 2008 Panzica filed a mechanics lien affidavit (amended December 12, 2008), claiming that it had started construction work prior to the date of filing of the Original Mortgage. In late 2008 BC defaulted on the loan and the Mortgagee took judgment on the Cognovit Note, but did not foreclose.

In August 2009 Panzica filed a foreclosure action (Cuyahoga County Common Pleas Court Case No. 09 CV 700759) and subsequently claimed that it had priority over the Mortgagee’s interest in the collateral. In late 2012, the Mortgagee and the Panzica both filed motions for summary judgment. The facts were complicated and many legal issues were raised. On September 24, 2014, the Court issued its ruling.

The Court held that since the Modifications did not include a recitation of the 1311.14 statutory construction loan language, that the “super-priority” law did not apply to the property added to the Original Mortgage. The Court then ruled that Panzica’s mechanics lien had priority over the Original Mortgage with respect to the properties added via the Modifications. The Mortgagee’s priority over the various property parcels would be based on the date the respective Modifications were recorded. The Court did not address the efficacy of the Reaffirmation Clauses in the Modifications or any of the other issues raised in the summary judgment motions. On October 22, 2014, the Mortgagee filed a notice of appeal, which appeal remains pending.

You may scoff at this ruling, assured that it does not apply to you because if you were going to add additional land to your mortgage, you would get a lien waiver and title insurance. Well, the Mortgagee here did those things, but Panzica argued that the lien waivers were ineffective. Furthermore, the Mortgagee obtained title insurance guarantying the Modifications were first priority. Unfortunately the ruling did not discuss the lien waiver issue or any other issues raised in the motions. Moreover, the title insurance covers any eventually proved loss, but it does not speed up the foreclosure process itself. This foreclosure has been pending for five years and the appeals are likely to last for years longer. As a result, the property will remain in limbo and remain undeveloped for a long time without generating any income and without any productive use.

So, faced with this ruling, what should mortgagees do to protect themselves in these situations? Of course, there is no definitive answer. It appears that the Panzica case judge wants you to specifically include in your amendment or modification, the 1311.14 construction mortgage language. But if you do that and do not include other provisions of the original mortgage, you might be faced with the claim that the amendment did not include all other terms of the original mortgage and therefore those provisions do not apply to any property or debt added to the original mortgage with the amendment. Finally, as stated above, if you do an amended and restated mortgage you could lose your original priority date.

Perhaps for now, until the Court of Appeals sorts this out, the best compromise is to add the following clause to any amendment: “All of the terms of the Original Mortgage remain in place and are incorporated hereat by reference, including but not limited to the provision in the Original Mortgage that states that it is a Construction Mortgage pursuant to Ohio Revised Code Section 1311.14.” Additionally it would be prudent for all original mortgages to include a provision that states that any and all future amendments or modifications to the mortgage shall be governed by the provisions of said mortgage, except as otherwise set forth in such amendments or modifications.

Just when you thought you had enough belt and suspenders language, you find out that you need to think again.

Texas Federal Court decision illustrates need for BYOD policies

Posted in Labor Law, Other Articles

EDITOR’S NOTE:  This recent post from the PWMA Employer Law Report on the importance a BYOD policy highlights an area of current concern for bankers and other employers.

Saman Rajaee was a salesman for Design Tech Homes. He used his personal iPhone to connect to his employer’s Microsoft Exchange Server, which allowed him to access his work-related email, contacts and calendar from his phone. Design Tech did not have a BYOD policy. When Rajaee’s employment terminated, Design Tech remotely wiped his phone, which deleted all of his data, including personal emails, texts, photos, personal contacts, etc.

Rajaee sued under the federal Stored Communications (“SCA”) and Computer Fraud and Abuse Acts (“CFAA”) as well as raising various state law claims. Design Tech moved for summary judgment on the federal claims. On the SCA claim, the court held, based on Fifth Circuit precedent, that information an individual stores to his hard drive or cell phone is not in electronic storage within the meaning of the statute.

Design Tech was successful on the CFAA claim as well, but was forced to take a much riskier path than would have been necessary had it simply had a BYOD policy. Generally speaking, the CFAA prohibits accessing a protected computer without authority or in excess of authority, but requires a showing that the computer owner sustained at least $5000 in losses specifically due to either the cost of investigating and responding to an offense or the costs incurred because of a “service interruption.” In Rajaee, the court held that the value of the data wiped from Rajaee’s phone was not the type of loss or cost contemplated as being recoverable under the CFAA. In addition, the court held that the deletion of Rajaee’s data did not constitute a “service interruption.” As a result, his claim under the CFAA failed.

Takeaway for Employers:

Employers using a BYOD environment really need to put a BYOD policy in place. Had Design Tech had such a policy, it could have – and indeed, should have told its employees, including Rajaee, that upon separation of employment (or, for instance, also if the device is lost or stolen), any device used to access the employer’s network would be wiped. This would enable the employees to preserve any important personal data on their devices. In addition, using containerization software would permit the employer to segregate business data from personal data on the phone, which also would permit the employer to wipe only the business data upon separation from employment.


Here we go again: Does the DOL’s request for information regarding self-directed brokerage accounts mean new fee disclosure requirements are coming soon?

Posted in ERISA

If you’re a fan of the tv show “The Simpsons,” you might remember an early episode where Homer Simpson launched a crusade against every public safety issue in the city. The result was practically every square inch of the town contained signs alerting people to every dip, pothole, and other nuisance on the roads. After watching that episode again recently (we won’t admit which one of us got sucked into the tv marathon), we were reminded of a first year torts class in law school that discussed the efficacy of public safety notices. The professor made the comment, “A wealth of information leads to a poverty of attention.”

That comment is especially fitting with respect to ERISA fee disclosures, particularly regarding defined contribution plans. Recently, the DOL requested information and comments about self-directed brokerage accounts (“SDBAs”). The DOL’s history with trying to provide guidance on SDBAs provides a great illustration of the difficulty of determining how much information is too much. On one hand, the DOL has been concerned that defined contribution plan participants will be unable to navigate the wide universe of investment options available under SDBAs unless strict procedural rules are in place. On the other hand, the plan sponsor community has tried to make clear that rank-and-file employees typically are not interested in SDBAs. Instead, more sophisticated investors request this feature, and they do not need a detailed protective regime. The DOL, to its credit, has recognized the different points of view on this issue and has sought input to help develop a balanced approach to regulating SDBAs.

DOL’s Early Attempts to Regulation SDBAs

As background, ERISA’s fiduciary duties require plan sponsors to offer a diverse menu of investment options to participants in defined contribution plans. Plans typically contain a packaged menu of options that are called Designated Investment Alternatives (“DIAs”). With DIAs, the plan sponsor compiles a list of funds, from which the plan participants can select for investment of their plan contributions. As with any benefit plan governed by ERISA, plan fiduciaries are required to act prudently for the exclusive benefit of plan participants. As such, plan sponsors must monitor the DIAs to ensure they remain prudent investments and make certain the funds continue charging reasonable fees for their services. Further, participants must have enough information to make an educated decision as to which fund to direct investment, a responsibility that additionally falls to the plan fiduciary. Required disclosures include information regarding the prior performance of the fund, comparative benchmarks, and fee amounts.

In addition to DIAs, plans may offer participants the option to look outside the plan for alternative funds in which to invest. When participants elect this method, it is referred to as a Self-Directed Brokerage Account (“SDBA”). SDBAs place the burden of making investment decisions on the participant, giving control over where their money will go. SDBAs actually originated to meet the demands of more sophisticated employees who (in theory) are sophisticated enough to analyze a wide range of investment options on their own. They thought that they could make better investment decisions than their employers and wanted their employers out of their investment decisions and financial planning. The people who demanded SDBAs in many ways were similar to the types of participants who would fall into a top-hat plan select group eligible to participate in nonqualified deferred compensation plans.

In terms of fiduciary standards, however, allowing participants the freedom to fail may not be either prudent or in their best interest. The DOL’s concern initially appears to have been that plan fiduciaries use SDBAs to shirk some of the more onerous fiduciary duties by placing these kinds of investment decisions in the hands of participants.

To address those potential concerns, the DOL issued FAB 2012-02 in May of 2012. The question-and-answer-styled bulletin explained that where high volumes of SDBA participants began investing in the same fund, compliance with fiduciary duties would require monitoring and disclosure similar to that associated with DIAs. The guidance failed to provide any definitive threshold, beyond which the additional disclosures would be required. In the midst of this uncertainty, sponsors and brokers feared the heightened duties would apply to nearly every fund in which SDBA investors participated. Given that the entire universe of investment funds is open to these participants, the list could have been extensive. As a result, plan sponsors and brokers expressed widespread alarm over the content of the guidance.

Because of their concern, a mere month later, the DOL issued a revision removing all of the offending requirements, but maintaining a tone that suggested a general distrust of self-directed brokerage accounts. The revision additionally explained that the DOL would keep the topic open, returning to it later for further discussion.

Recent Request for Additional Information

That time is upon us. In the DOL’s recent request for information regarding SDBAs, the DOL has included questions concerning the following:

  • The number of plan participants who opt for an SDBA;
  • Demographic information about those participants;
  • Comparative analysis of outcomes and costs for SDBAs and DIAs;
  • The fiduciary to participant and the fiduciary to broker relationships;
  • The amount of information available to participants;
  • Fiduciary knowledge of their duties with respect to SDBA participants.

In the introductory portion of its information request, the DOL cites the debate regarding the overall merits of allowing SDBAs in defined contribution plans. On one hand, the DOL cited articles that indicated the need for fiduciaries to analyze thoroughly the different investment options available in an SDBA before making them available to participants, essentially to protect participants from themselves. In essence, the DOL provided support for its initial position on the topic. On the other hand, the DOL acknowledged commentary that explained that brokerage windows actually benefit both sophisticated and unsophisticated participants. The reason is that SDBAs reduce the need for a plan to provide a large number of DIAs in order to satisfy specific investment option demands by more sophisticated participants.

What the Future May Hold

It is unclear where the DOL will go from here. In the past, the DOL showed clear apprehension with respect to the use of SDBAs, and it appears that the DOL still has some of those concerns. The DOL should be applauded, however, for understanding the counterargument and reaching out to the industry to assist with determining the extent of new procedural requirements for SDBAs. As of now, the DOL is only requesting information. While the future remains uncertain, it appears that additional guidance will be coming soon.


“The Bandits’ Club” gets its due

Posted in Bank Litigation, Regulation and Compliance

Our colleagues at Antitrust Law Source posted an interesting update about probable charges alleging that traders at approximately a dozen global banks – including Deutsche Bank, JPMorgan Chase, Barclays, and USB – fixed the foreign exchange market, or “forex,” market. The U.S. Department of Justice may bring charges by the end of the year. Read the complete article on Antitrust Law Source.

Porter Wright Announces New Antitrust Law Site

Posted in Other Articles, PWMA News, PWMA Practice

We wanted to take a moment to announce our newest endeavor, Antitrust Law Source. Antitrust Law Source is a new site designed for visitors to quickly and easily learn about developments in this growing arena. The site primarily will focus on providing news and legal updates in the antitrust arena in a podcasting format. The podcasts will feature a variety of insights, educational offerings, discussions and interviews with thought leaders across a variety of industries.

The site is prepared by members of our firm’s Antitrust Practice Group and will feature news and information on a wide range of areas, including:

  • Agriculture
  • Civil litigation
  • Compliance programs/audits
  • Consumer protection
  • Criminal and civil government enforcement
  • Distribution, pricing and promotional allowance programs
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