Construction Employee Relations and Benefits
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Latest Spitzer Investigations Raise ERISA Issues
By:Gregory L. Ash

Practice Group(s):Employee Benefits

The most recent in a series of investigations and lawsuits brought by New York State Attorney General Eliot Spitzer may cause ERISA fiduciaries to ask additional questions of their brokers and consultants. Mr. Spitzer’s current investigations, which have been widely reported in the press, are aimed at certain practices in the insurance and brokerage industries. Although initially focused on the property and casualty insurance market, the investigations are quickly spreading to health, disability, and other insurance products that are often part of employer-sponsored ERISA plans.

Mr. Spitzer and his staff are challenging two separate but related insurance industry practices. The first, which is clearly illegal, involves an insurance carrier’s artificially inflating its bid at the request of a broker, in exchange for the broker’s assurance that it will “steer” other business to the carrier. The broker’s alleged purpose in facilitating these arrangements is essentially to “fix” the bid, such that another carrier favored by the broker will be selected. In exchange, the carrier rewards the broker in some way, in some cases by engaging in the second practice under scrutiny by Mr. Spitzer. That practice occurs when a carrier pays a bonus to a broker for placing a predetermined volume or type of business with the carrier. Those rewards are known in the industry by various terms, including “contingent commissions,” “override commissions,” and “market service agreements.” These payments are over and above the ordinary commissions that the broker receives from the carrier, and often are not disclosed to the purchaser.

The alleged losers in these arrangements are the employer that is purchasing the insurance policy – because it is being duped into buying a product that may not be the best suited for its needs – and employees whose benefits are governed by the policy, and who may be paying a portion of the premium. If the policy is being used to fund an ERISA welfare or pension plan, these bid-rigging and contingent commission practices directly implicate ERISA’s fiduciary duty rules. Consequently, the ERISA fiduciaries who choose a plan’s broker and insurance carrier now will need to ask a number of questions, both of the carrier and the broker.

The Department of Labor is just beginning to flesh out the ERISA issues that may be implicated by this latest scandal. Sure to be among those issues, however, is whether a broker’s failure to disclose the full extent of its fees – that is, any contingent commissions it receives – to plan fiduciaries vitiates exemptions to ERISA’s prohibited transaction rules that would otherwise be available. Those rules forbid certain transactions between a plan and individuals or entities that have a close relationship to the plan. They also prohibit self dealing on the part of such individuals and entities, if those individuals and entities are considered fiduciaries of the plan.

For example, if a consultant exercises enough influence over a plan that it would itself be considered a fiduciary of the plan, and if the consultant uses this influence to cause the plan to purchase an insurance policy pursuant to which the consultant will receive a commission, the consultant has engaged in prohibited self dealing. That prohibited transaction can be cured, however, if the consultant complies with the terms of a special exemption to these rules.

Prohibited transaction class exemption 84-24 excuses violations of the type described above as long as the consultant fully discloses to other plan fiduciaries the fees and commissions that it will receive as a result of the plan’s purchase. It is unlikely, however, that the kind of contingent commission payments being challenged by Mr. Spitzer would have been disclosed in the manner required by this class exemption. Thus, to the extent that a broker could be considered a plan fiduciary, the broker’s receipt of contingent commissions could cause the insurance purchase to be considered a prohibited transaction. Significant penalties or excise taxes could be imposed on the broker or any other plan fiduciary as a result.

Most insurance brokers are more likely to be considered mere service providers, and not fiduciaries of a plan. ERISA’s self-dealing restrictions therefore would not apply to them. Nevertheless, other prohibited transactions might arise if the remuneration a broker receives is not fully and accurately disclosed.

Moreover, the selection of a service provider, such as an insurance carrier or broker, is a fiduciary act, as is the decision to retain that service provider. Plan fiduciaries have an obligation under ERISA to conduct a prudent evaluation of such service providers. Following Mr. Spitzer’s earlier investigation into the practices of mutual fund providers, the Department of Labor issued specific instructions to fiduciaries, directing them to inquire about the involvement of their own plan’s mutual fund providers in the challenged practices. In light of the current investigation into the brokerage and insurance industry, part of a fiduciary’s evaluation of a plan’s broker and insurance carrier now should include specific inquiries about the participation of the provider in the practices that are being challenged by Mr. Spitzer. Because the decision to retain a current service provider also is a fiduciary act, these inquiries should be addressed both to existing service providers and those a plan or employer may be thinking of engaging. For example, an employer or plan fiduciary may wish to ask the following questions of the current broker, and of any potential new broker:

• Has the broker received a subpoena from the New York Attorney General’s office?

• Does the broker solicit or receive “contingent commissions” (or other amounts in excess of regular commissions) from insurers?

• If so, will the broker provide a complete accounting of all such amounts it received?

• Has the broker ever asked an insurance company to submit an artificially high bid in an effort to establish a false appearance of a competitive bidding process?

Asking these questions should accomplish two objectives. First, it will help illuminate whether the broker has any perverse incentives that might affect the broker’s recommendations. And second, it will help establish a record of procedural prudence in the selection and retention of the service provider. Similar questions should be asked of potential and existing insurance carriers.