FLASHPOINT: DOL Embraces Self-Correction … Somewhat, Kind of, Unenthusiastically – The New Proposed VFCP

The Department of Labor (“DOL”) issued a new proposed Voluntary Fiduciary Correction Program (“VFCP”) on November 18, 2022, which should – if finalized – make it easier for fiduciaries to correct certain breaches and errors than under the current VFCP procedure.

VFCP is a program made available by the DOL that permits Plan Officials (i.e., fiduciaries, plan sponsors, prohibited transaction parties-in-interest, and others) to correct violations of Title I of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”) and to avoid civil penalties.  VFCP is coupled with Prohibited Transaction Exemption (“PTE”) 2002-51, which provides relief for those involved in certain prohibited transactions that are resolved under VFCP or that are needed to enable resolution under VFCP. The DOL issuance includes both a proposed update of VFCP (the “Proposal”) and a proposed modification of PTE 2002-51.

As welcome as any simplification or self-correction expansion is, it is clear the DOL has a much harder time letting go of control than its counterparts at the Internal Revenue Service (“IRS”).  The Proposal includes a new Self-Correction Component of VFCP (“SCC”), but it is very limited, and unlike self-correction under the IRS’s procedures (the Employee Plans Compliance Resolution System (“EPCRS”)), it requires that a notice be provided to the DOL for the self-correction to be valid.  Further, the DOL emphasizes repeatedly in its new procedure the ways in which plan sponsors, fiduciaries, and others are not fully protected under VFCP and SCC, telegraphing that the DOL has severe FOMO.

The Proposal and the amended PTE are not effective and cannot be used until approved by the Office of Management and Budget and finalized by the DOL.  The DOL is asking for comments from the public about the Proposal and the PTE by January 17, 2023.

What Is Correctable Under SCC?

Self-correction is available only to fix late deposits of salary deferrals, participant contributions, and loan repayments.  (While the DOL’s obsession with this issue is justified by its importance, it is interesting that the obsession is not abated at all when the amount of dollars involved is small or when the failure is isolated.)  The DOL notes in the Proposal that this is the reason for which the most VFCP filings are made, so it makes sense to reduce the burden for both the plan sponsors making the filings and the DOL representatives who are forced to review them and send out “no action” letters.

SCC is available only when:

• The delinquent amounts (and related lost earnings) are deposited to the plan within 180 days of when they should have gone in; and
• The amount of lost earnings suffered by the plan due to the late deposit of those amounts is not more than $1,000.

The SCC Procedure … and What a Procedure!

If you are familiar with the IRS’s self-correction procedures under EPCRS, you are accustomed to making full correction under those procedures without any government involvement.  Not so in this case.  The Proposal requires that the Plan Official engaging in the corrective process (called the “Self-Corrector”) or its authorized representative file a notice with the DOL online (presumably through EFAST or a similar system), advising the DOL that self-correction has occurred.

But wait, there’s more!

• The Self-Corrector, its authorized representative, and anyone else (such as fiduciaries) who wants to be protected by the VFCP process, must sign a Penalty of Perjury Statement.
• The Self-Corrector must complete and sign the SCC Checklist (available in the procedure).
• The Self-Corrector must put together documentation outlining the deposit failure and its correction. The required documentation mirrors the information required in a formal VFCP application.
• If there is an authorized representative, that individual must obtain and retain a written authorization from the person or organization it represents, attesting to its authority in this matter.
• The Self-Corrector must then send all the above items to the Plan Administrator, who must retain that information for six years.

If the notice is sent to the DOL as required, the DOL will email back an acknowledgement and summary of the SCC notice. It also promises not to initiate a civil investigation into the matter.

SCC mandates that the VFCP calculator be used to determine lost earnings on the delinquent contributions.  It further requires that the lost earnings be determined from the date on which the deferrals were taken from payroll (or the loan payments or employee contributions were received by the employer), with no grace period for the time it takes to actually make the deposit.  This makes the determination of the lost earnings black-and-white, as both the interest rate to be used and the period during which interest is payable are defined.

Observations about SCC

• If it is not yet obvious, let us say that we are underwhelmed by this Proposal. Seriously, could the DOL have made this self-correction process any more difficult?  And is it really self-correction if you need to provide notice to the DOL?  In fairness, SCC is less work than a full VFCP filing, and you don’t need to wait for a no action letter to feel reassured that the correction is sufficient.  However, it is still crankier than the IRS procedures by a fairly wide margin.
• That said, it is important to keep in mind that the proposed changes to PTE 2002-51 provide forgiveness of the prohibited transaction excise tax. As explained below, the revised PTE would simplify the penalty relief process under SCC. In particular, unlike with full VFCP, the Self-Corrector need not file Form 5330 or pay the excise tax to the IRS. Therefore, it should not be surprising that the process involves more steps than EPCRS self-correction (which does not provide excise tax relief).
• Finding the failure and correcting it within 180 days without engaging in the full SCC process is not sufficient to obtain protection from adverse action by the DOL. Without the DOL notice filing (and presumably the acknowledgement as proof), as well as the other criteria under the Proposal, simply depositing the deferrals plus earnings is not an officially recognized remedy for the failure. Just as today, informal correction that does not comply with DOL procedures can result in DOL involvement (including a possible investigation), requiring the employer to contribute more in lost earnings if actual earnings exceed the DOL calculator amount.
• The DOL openly notes in the preamble that it intends to use the SCC filings to monitor behavior: “[T]he Department will be monitoring for frequent use of the SCC and may communicate with repeat users or open investigations to identify and correct system issues leading to repeated failures to transmit participant contributions in a timely fashion.” This declaration follows a discussion in the preamble of the DOL’s lack of concern that the availability of the procedure will result in a laxity of procedures by employers … but, just in case … the preamble assures us that “the application and reporting requirements under the VFC Program and the SC Component together with the ‘under investigation’ ineligibility condition provide the Department with a system under which it receives notice of repeat usage and a means of protecting against any potentially inappropriate use of the exemption in connection with covered transactions.”  This a very different approach from that of the IRS, which has – at least anecdotally – assured the benefits community that filing under its Voluntary Correction Program (“VCP”) does not expose it to additional IRS scrutiny.
• The Proposal reflects the same lack of coordination of corrective procedures between the IRS and the DOL that we have seen in the past. For example, the required use of the VFCP calculator is not reconciled with the IRS’s negative outlook on the calculator (and marked preference for actual earnings) in EPCRS.  Another example (outside SCC) is that the DOL continues to require an EPCRS VCP filing for a participant loan failure to ensure that the transaction is not a prohibited transaction, even though the IRS has instituted self-correction processes for certain loan failures. The Proposal asks for comments about more closely integrating VFCP with the latest version of EPCRS.
• Sections 2(c) and 2(d) of the Proposal outline the many limitations on the VFCP and SCC, many of which are to be expected: the VFCP resolution is not binding on parties other than the applicants and the DOL, the resolution is void if there are material misrepresentations or omissions.  However, the Proposal also permits the DOL to initiate criminal investigations or make referrals to other agencies, where appropriate, and to take action to remove fiduciaries notwithstanding the VFCP if it believes it to be appropriate.  These sections seem to demonstrate that the DOL remains cynical about parties using correction processes to “get around” liability and is trying to reserve the right to go after bad actors when it sees an opportunity.

Again, SCC is a movement in the right direction for the DOL.  And, we can hope that the DOL is simply hedging its bets and has no intention of being overly punitive to those who do not demonstrate bad motives.  Furthermore, the DOL is clear in the preamble that it is seeking practitioner input on the Proposal, and may be well disposed to hearing from the industry about these issues.

Other VFCP Changes

One of the significant VFCP changes in the Proposal is to permit an innocent Plan Official to apply for VFCP relief even if there was a criminal violation.  For example, if there is a theft of plan assets by a third party, the plan fiduciaries could still correct the theft and apply for VFCP resolution.  To qualify, however, the plan must notify appropriate law enforcement of the crime and advise the DOL whether it made a claim on the plan’s fidelity bond.  Even with this provision, however, the DOL reserves the right to reject the filing if criminal violations are involved.

The Proposal also contains procedures to permit a service provider to make a bulk application covering several plans for the same problematic transaction (similar to the IRS’s Group VCP submissions).  The applicant must be the person or entity that is seeking relief, cannot be under investigation by EBSA, and there must be at least ten named plans.

PTE 2002-51 Changes

The proposed modification to PTE 2002-51 contains a sample notice to participants, which is required to get the waiver of excise taxes on the relevant prohibited transaction.  The DOL expressed concern that notices it had received in VFCP filings over the years contained insufficient language.  The sample, which is not mandatory, may contain more information than some practitioners initially provided, but is very wordy and not likely to be understood by many participants.  This leaves a plan sponsor with a choice:  use a notice that constitutes a “safe harbor” (but is likely to lead to more questions than it answers) or do a custom notice that the DOL may not think is sufficient.

Self-Correctors, however, should not give the notice to participants.  Instead, they compute the amount of the excise tax that would otherwise apply and deposit it in the plan to be allocated to the participants as additional earnings.  Unlike the current version of the PTE, following this approach is permissible regardless of the amount of the penalty, and you need not complete the Form 5330 or send it to the DOL. The interest rate for purposes of the excise tax calculations must be based on the DOL VFCP calculator, and a copy of the calculator’s results must be saved with the internal documentation of the correction.

If VFCP is used (outside of SCC), if excise taxes are less than $100, they can be paid to the plan and reallocated to participants rather than paid to the IRS.  The applicant must complete and file Form 5330 (or written computation of the tax) with the DOL with the VFCP filing.  Under VFCP and PTE 2002-51, outside of SCC, excise taxes of more than $100 may be waived for late deposits but notice of the VFCP filing must be provided to the participants.

Plans are currently prohibited from using the current PTE if they have used it for a similar correction in the last three years.  The Proposal would remove that restriction.  As a result, a plan that had late deposits of deferrals every year during a busy period, for example, could use the PTE repeatedly to avoid paying excise taxes.  But beware:  the DOL notes in the PTE preamble that it intends to use the application filings and reports to monitor repeat usage to avoid abuse.

Conclusion

Even though we are not enthusiastic about this Proposal, it is still a movement in the right direction.  We hope in the future to see more DOL flexibility and leniency towards those who are not evil-doers but simply made human mistakes.