USDOL, PWBA v. George H. Robinson, Administrator Answering Service, Inc. ESOP, 1992-RIS-5 (ALJ Feb. 2, 1993)

U.S. Department of Labor

Office of Administrative Law Judges 101 N.E. Third Avenue, Suite 500 Ft. Lauderdale, FL 22201

DATE: February 2, 1993

CASE NO.: 92-RIS-5

In the Matter of:

U.S. DEPARTMENT OF LABOR,
PENSION AND WELFARE BENEFITS
ADMINISTRATION
    Complainant

    v.

GEORGE H. ROBINSON, ADMINISTRATOR
ANSWERING SERVICE, INC. ESOP
    Respondent

Appearances:

Stevan Durovic,, Esq.
    For Complainant

Robert F. Harrington, Esq.
    For Respondent

BEFORE: ROBERT M. GLENNON
    Administrative Law Judge

   This proceeding involves penalty assessments made against the Respondent, pursuant to the provisions of the Employment Retirement Income Security Act of 1974, as amended, 29 U.S.C. §§ 1001, et seq. ("ERISA"). The implementing regulations particularly in issue in this proceeding are published at 29 CFR Part 2520, the rules for reporting and disclosure, and at 29 CFR Part 2570, the procedures for assessment of civil penalties.

   By a formal Notice of Determination issued on September 24, 1991, the Pension and Welfare Benefits Administration of the U.S. Department of Labor ("PWBA") advised the Respondent, George H. Robinson, Administrator of the Answering Service, Inc., Employee Stock ownership Plan, that Ft/BA had assessed a penalty of $50,000 for failure to file a complete annual report for calendar year 1988. That Notice specified the particular deficiencies found by Ft/BA, and provided references to the specific regulations upon which the Notice was based. Respondent filed a timely "answer" within the meaning of Section 2570.61(c) of the governing procedural regulations on October 9, 1991, requesting waiver of the assessment "for good cause." The filing of that answer initiated the present hearing procedure.

   By a Notice issued January 14, 1992, certain special procedural rules were prescribed for the presentation of evidence and argument by the parties in written form. In accordance with those procedural rules, Respondent's opening statement dated April 2, 1992, with attached Exhibits "A" through "I"; Pt/BA's opening statement dated May 24, 1992, with attached Exhibits Nos. 1 through 17; and Respondent's closing statement dated June 24, 1992, with attached Exhibits "A" through "D" are received into evidence. Upon review of this record, I conclude that there is not raised a genuine issue of material fact so as to require an oral hearing, and that this matter should be resolved on the basis of the arguments and documents submitted under the January 14, 1992 special procedural rules.

   Two general issues are presented: whether Respondent's 1988 annual report was exempt from the ERISA requirement of attaching an audit by an independent qualified public accountant ("IQPA"); and whether there was a rational basis for Ft/BA's imposition of the $50,000 civil penalty.

   1. Factual background. The Respondent, Answering Service, Inc., is a Michigan corporation which maintains an employee stock ownership plan ("ESOP) pursuant to the provisions of the ERISA statute. Respondent's plan is a defined contribution pension benefit plan in which assets are invested by Respondent for eventual distribution to its participants, full time employees of the company, upon termination of their service as employees. According to the audit report presented on February 4, 1991, by Laine, Appold & Co., certified public accountants, for Respondent, the plan uses employer contributions "primarily to purchase common stock of the employer company." The plan's assets are held by a fiduciary, the National Bank of Detroit ("NBD"). Each year the company contributes to the plan an amount determined by the company's board of directors. Employees become vested in allocations of assets of the plan, by increasing percentages, after 2 years of service, and become fully vested after 6 years of service. The account of each participant, or beneficiary, is credited with an allocation of the following factors:

1. the portion of the company's contribution used to acquire the company's common stock;

2. plan earnings;

3. the portion of the company's contribution not used to acquire the company's common stock; and

4. forfeitures of terminated nonvested accounts.

Respondent's 1988 annual report for the ESOP plan showed a total of 190 participants, including 31 retired or separated persons entitled to future benefits; 103 active employees fully vested; 38 employees partially vested; and 18 employees nonvested.

   The Laine, Appold year-end 1988 audit stated that Respondent's plan had total assets of $620,074, total liabilities of $51,957, and net assets available for plan benefits of $568,117. The assets included $484,723 in common stock of the Respondent, $44,734 in "bank investment funds," and $90,281 in "employer's contribution" as "receivables." The principal liability recorded was $51,603, for "stock acquisition." The significant transaction addendum to the audit showed that the plan recorded the $51,603 as purchasing 12,525 shares of Respondent's common stock.

   The plan's 1988 income statement shows total income, or additions to assets of $164,539. The two significant factors in that income were (1) a $90,281 contribution from Respondent, and (2) a $71,268 unrealized appreciation in the value of Respondent's common stock. On its face, the asserted $71,268 unrealized appreciation in common stock Value would appear to be a 18.7% increase over the asserted value of $381,050 for the stock holding at the beginning of the year.

   The Laine, Appold audit report itself disclaims expression of an opinion on the audited 1988 financial statement as a whole. The audit report notes that Respondent has claimed the Section 2520.103ù8 auditing exemption (the auditing exemption that is in issue in this proceeding) and states:

We have been informed by the plan administrator that National Bank of Detroit holds the plan's investment assets and executes transactions therein. The plan administrator has obtained certifications from the bank that the information provided to the plan administrator by the bank is complete and accurate.

   The record includes a "portfolio summary" presented to Respondent by the Trust Division of the National Bank of Detroit, as of December 31, 1988. That statement shows total assets, both "at cost" and "at market" of $304,839, including (1) "total marketable securities" of $44,734 and (2) "miscellaneous assets" of $260,104. A second schedule of the NBD's "portfolio summary," as of December 31, 1988, categorizes the marketable securities as "demand obligations" with a current yield of 9.5% and estimated cash income of $4,228. That schedule categorizes the ESOP's $206,104 in "miscellaneous assets" as "closely held stocks" with no current yield and no annual cash income.

   2. Respondent's annual report for 1988. Among other requirements imposed upon an employer sponsoring a pension benefit program qualifying for special tax treatment is the requirement for an annual report presented on Form 5500 sponsored jointly by the Internal Revenue Service, the Pension and Welfare Benefits Administration and the Pension Benefits Guaranty Corporation. Respondent filed its Form 5500 for the year 1988 with the Internal Revenue Service on July 21, 1989. The IRS responded with a letter of rejection dated September 27, 1989, asserting that the filing was incomplete, and that, unless the filing was perfected, Respondent would be subject to substantial penalties by the IRS, as well as subsequent enforcement action and penalties imposed by the Department of Labor. The IRS stated:

It appears that your plan is not exempt from the requirement that an accountant's opinion be attached to the report, but no opinion was attached. Consult the instructions for the specific requirement related to audits of plans by independent public accountants.

On October 10, 1989, Respondent replied to the IRS that it adhered to the position that the plan was exempt. In this letter Respondent stated:

Our answer to question 11 and 29 does not change. This plan is a trust and 100% of the assets are controlled by the National Bank of Detroit Trust Dept.

   On November 21, 1989, the IRS sent another rejection letter to Respondent concerning the Form 5500 annual report for 1988, a letter identical with the rejection letter sent on September 27, 1989. Respondent replied to that IRS rejection letter with essentially the same response as its October 10th letter. on February 6, 1990, the IRS again sent to Respondent a rejection letter, also identical with its September 27th letter. This time, Respondent's March 6, 1990 response simply requested a 60day extension "to obtain the necessary information.ö This record does not show whether there was a continuation of this line of communication between IRS and Respondent.

   On September 7, 1990, the Chief Accountant of the Pension and Welfare Benefits Administration sent a letter to Respondent, notifying it that the 1988 annual report was rejected because it was not in compliance with the requirements of ERISA and the implementing regulations. Respondent was advised in this letter that it would be subject to a civil penalty if a satisfactory report were not filed within 45 days. By a letter dated October 15, Respondent replied, adhering to the position that it was exempt from the independent auditor opinion requirement. Respondent stated:

Since 100% of our assets are controlled by National Bank of Detroit Trust Department, we feel we are exempt from having an independent audit.

Enclosed is a copy of the Port folio Summary from the National Bank of Detroit Trust Department. The summa,ry is recorded on the cash basis, with the stock recorded at cost. The balance sheet on Form 5500, line 34 is recorded on the accrual basis with the stock recorded at market value.

Respondent's October 15 letter to Pt/BA enclosed a copy of the National Bank of Detroit "Portfolio Summary" as of December 31, 1988 that is summarized above.

   By a letter dated January 11, 1991, Ft/BA gave notice to Respondent that it intended to assess a penalty for the continued failure to submit a satisfactory annual report, one which included an independent audit opinion. Respondent replied on February 8, 1991 adhering to its position that the plan was exempt from the independent auditor opinion requirement. on September 24, 1991, PWBA issued its final determination assessing the $50,000 penalty that is the subject of this proceeding.

   3. Arguments of the parties. Respondent contends that its ESOP plan is exempt from the independent auditor opinion requirement, pursuant to the provisions of Sections 103-3 and 103-8 of the 29 CFR Part 2520 regulations. Section 103-8 states:

...the examination and report of an independent qualified public accountant need not extend to any statement or information prepared and certified by a bank or similar institution or insurance carrier. A plan, trust or other entity which meets the requirements of paragraph (b) of this section is not required to have covered by the accountant's examination or report any of the information described in paragraph (c) of this section.

It is not disputed by FWBA that the National Bank of Detroit meets the requirements of paragraph (b), since it is an institution regulated and supervised and subject to periodic examination by a State or Federal agency.

   Paragraph (c) of Section 103-8 provides:

(c) Excluded information. Any statement or information certified to by a bank or similar institution or insurance carrier described in paragraph (b) of this section, provided that the statements or information regarding assets so held are prepared and certified to by the bank or insurance carrier in accordance with § 2520.103-5.

Respondent contends that the plan is exempt from the auditor requirement because "all or part of the ERISA plan assets are maintained in a pooled account at a federally regulated bank (i.e., NBD)." Respondent's Opening Statement, p.4 In this respect, Respondent emphasizes the uncontroverted statements of both the planÆs certified public accountant auditor, Laine, Appold, and the plan's trustee for holding its assets, averring:

. . .100% of the assets of the Answering Service, Inc. ESOP and ERISA Plan are held by the National Bank of Detroit Trust Department as Trustee. Respondent's Opening Statement p.9

Respondent argues that "it is not at all unusual" for a small ERISA plan to rely upon the bank trust exemption afforded by Sections 103-8 and 103-3, asserting:

The underlying reason permitting this very exception is manifest. In a small plan, it would be unduly burdensome and prohibitively expensive to have the IQPA pass an economic opinion upon each and every transaction maintained in a trust department of a federally regulated financial institution. Further, such financial institutions are already extensively regulated by the Internal Revenue Service and the Department of Labor, including the National Bank of Detroit... This exception was specifically created in order to give small plans the economies of scale which come with pooling collective funds, and allowing one large trust department of a bank to handle the administration involved in handling the numerous transactions of several small funds. Respondent's opening Statement, p. 13

   The Pension and Welfare Benefits Administration contends generally that the Respondent's ESOP plan is not exempt from the requirement of furnishing and IQPA audit of its annual report. With respect to the civil penalty imposed, Ft/BA contends that its full penalty amount is appropriate because Respondent "stubbornly" refused to furnish the required IQPA opinion:

. . . in the face of at least four notifications from two different government agencies over fifteen months informing you otherwise...

and because the asserted deficiency in Respondent's reporting of the required data was not ever rectified. Pt/BA Reply Statement, p.17,18

   Discussion and Conclusions. The Part 2520 regulations in issue in this proceeding are not a model of clarity, but I find them sufficiently clear to require rejection of the Respondent's interpretation as highly implausible. A facial reading of Section 103-8 does indeed seem to indicate that an IQPA opinion is not required for a pension plan if "some or all" of the assets are held by a federally regulated bank. But the last sentence of paragraph (a) of Section 103-8 presents an unmistakable limitation of the audit exclusion to "any of the information described in paragraph (c) of this section." Paragraph (c), fairly read, in turn, makes it clear enough that the ESOP assets excluded from an IQPA audit are those subject to a certification by the bank "in accordance with 5 2520.103-5."

   A fair reading, in turn, of Section 2520.103-5 shows that its provisions must be read in context with Section 103-3, which provides the basic reporting exemption itself. Section 103-3 (a) extends the exemption to

. . . a plan whose assets are held in whole or in part in a common or collective trust maintained by a bank, trust company, or similar institution....

but the last two sentences of Section 103-3 (a) state a clear demarcation of that exemption as follows:

Such plan is not required to include in the annual report any information concerning the individual transactions of the common or collective trust. This exemption has no application to assets not held in such trusts.

   Both Section 103-3 and 103-8 refer to the specific statutory authority under which they are promulgated. The statutory exemption underlying both Section 103-3 and 103-8 is provided in subsection l03(b)(3)(G) of the ERISA statute. That provision states:

(G) if some or all of the assets of a plan or plans are held in a common or collective trust maintained by a bank or similar institution or in a separate account maintained by an insurance company or a separate trust maintained by a bank as trustee, the report shall include the most recent annual statement of assets and liabilities of such common or collective trust, and in the case of a separate account or a separate trust, such other information as is required by the administrator in order to comply with this subsection. 29 U.S.C.A. § l023(b)(3)(G)

Thus, it can be seen that the regulatory scheme is a simple one, although its regulatory description is cumbersome: if a bank is managing assets of a pension plan in a financial pool with other assets being managed by the bank, no IQPA annual audit of those assets is required of the pension plan administrator. No other assets are excluded from the reach of the annual reporting obligations imposed upon the pension plan administrator by ERISA and the Part 2520 regulations.

   Both the statute and the regulations provide specially for simplified reports for pension plans when the assets are managed by a bank. In its implementation of Section 103(b)(4) of the ERISA statute, Section 103-9 of the Part 2520 regulations allows the pension plan administrator to file a simple certification identifying the institution managing those assets. The assets eligible for such simplified treatment, and therefore excluded from the reach of the independent audit obligation of the pension plan administrator, are only those "assets and liabilities of the common or collective trust. . .if the bank. . .which maintains such trust. . .files such statement of assets and liabilities directly with the Secretary." 29 CFR 2520.103-9(a) [The ellipses relate to a comparable reporting exclusion for "pooled separate accounts" managed by insurance carriers, as contrasted with trust accounts managed by banks. Compare 29 U.S.C.A. § 1023(a)(2)(A) and (B).]

   Notably among the statements to be included in any annual report of an employee pension benefit plan filed in accordance with the ERISA statute are, among other things:

• a description of agreements and transactions with persons known to be parties in interest;

• any other matters necessary to fully and fairly present the financial statements of such pension plan; and

• a statement of the assets "valued at their current value." 29 U.S.C.A. º 1023 (b) (2) and (3)

The term "current value" is defined specifically in the ERISA statute to mean either the "fair market value", when available, or "the fair value as determined in good faith by a trustee or a named fiduciary .. assuming an orderly liquidation at the time of such determination." 29 U.S.C.A. § 1002 (26)

   In summary, although there is a degree of circumlocution in the regulatory articulation of the ERISA bank trust account reporting exemption, a fair reading of the regulations in their own context , and in context with the underlying ERISA statute, demonstrates that the trust account exemption is limited to assets actually controlled and invested by a regulated banking institution. In concept, such a bank's certification as to the current value of assets it manages in a trust account presents a high degree of credibility. But a bank obviously has little ability to certify the value of assets it simply holds on instructions but does not actively manage, particularly where, as here, the assets are closely held common stocks, with no current yield but a claimed 18.7% unrealized annual appreciation.

   The evidence in this case shows that the National Bank of Detroit holds Respondent's assets in two entirely different categories, as described in Exhibit B to Respondent's Opening Statement. The far larger component ($484,723) of these assets is the holding of a "substantial investment in the shares of Answering Services, Inc. common stock," in accordance with the company's instructions, Only a relatively small component ($44,734) of Respondent's assets are invested by NBD in a common trust fund operated, as NBD states it: "under the regulations of the Office of the Comptroller of the Currency (0CC) and Internal Revenue Service." Although Respondent's 1988 year end annual report states $484,723 as the "fair value" for the company's common stock held by NBD, the bank itself states the value of that stock as $260,104, with no characterization as either "fair value" or "market value." Respondent's annual report to Ft/BA provides no reasonable method of assessing the reliability of Respondent's assertion in its annual report that the plan had $568,107 in net assets available for plan benefits as of December 31, 1988. No independent qualified public accountant opinion or regulated bank trustee opinion certifies to that assertion of the Respondent. The Ft/BA was correct in determining that Respondent's annual report for 1988 was not in conformity with the 29 CFR Part 2520 regulations implementing ERISA.

   Respondent also argues that the Pt/BA has presented no rational basis for imposing the $50,000 civil penalty, emphasizing in particular that no beneficiary of the employee benefit plan has been prejudiced, or deprived of "even one penny in their ERISA benefits." Respondent asserts:

Similarly, there have been absolutely no allegations of insider dealing, imprudent investments, or indifference to request for distributions by participants or request for information by participants. Indeed, it is difficult to imagine how there could be any prejudice to the participants in the case at bar since it is undisputed that 100% of the assets of the Respondent's ERISA Plan are maintained within the Trust Department of the National Bank of Detroit. Respondent's Opening Statement, p.17

In reality, however, there is no way of knowing from Respondent's annual report the "fair value" or the "market value" of the bulk of the assets assigned to this plan, the Company's common stock, nor of the unrealized appreciation imbedded in the total value claimed. It may be noted, incidentally, that the 1988 annual report of the plan administrator does affirm (at Items 24a and 24b of Form 5500) that a "current appraisal" of the value of the company's stock had been made before its contribution or purchase for 1988, with the appraisal being made by "an unrelated third party," but that appraisal is not provided, nor otherwise referred to by Respondent in the course of this proceeding. Since neither Laine, Appold nor NBD expresses an opinion as to whether the ESOP assets are accounted for fairly and in accordance with generally accepted accounting principles, Respondent's assertion of the Section 103-3 exemption effectively erects a stone wall precluding the reasonable disclosures mandated by ERISA.

   In face of repeated efforts by the IRS and the Ft/BA to obtain a complete annual report for 1988, and despite warnings about potential penalties, Respondent adamantly refused to furnish the IQPA audit opinion both agencies required. From the outset, Respondent's reactions to the government agencies was misleading. On October 10 and again on December 29, 1989, Respondent stated to the IRS that 100% of the plan's assets "are controlled by the National Bank of Detroit Trust Department." Complainant's Exhibits 3,5 Respondent repeated that misleading assertion to the Ft/BA on October 15, 1990 and February 8, 1991. Complainant's Exhibits 9,11 Following the institution of this formal proceeding, Respondent changed the phrase describing the bank's handling of the plan's funds. Respondent does not now assert that NBD "controls" the ESOP's funds, but rather that those assets are "maintained" or "retained" by NBD. From these facts I conclude that Respondent knowingly filed an obscuring and incomplete annual report for 1988, contrary to the fair disclosure mandate of ERISA, and that PWBA's assessment of a substantial civil penalty was justified. Ft/BA's January 11, 1991 and September 24, 1991 letters clearly stated the basis of the amount of penalty asserted, and Ft/BA's Statement of May 24, 1992 provides a further rationalization for that penalty and its amount. I find no good reason to order a reduction in the penalty assessed in this case by Ft/BA.

   It is hereby ORDERED that George H. Robinson, plan administrator for the Answering Service, Inc., Employee Stock ownership Plan and Trust, shall pay the civil penalty, in the amount of $50,000, as assessed and directed in the Notice of Determination issued by the Department of Labor of September 24, 1991.

       ROBERT M. GLENNON
       Administrative Law Judge