Section 306(b) of the Sarbanes-Oxley Act of 2002 (the "Act") requires retirement plan administrators to provide advance notice of blackout periods to plan participants. The Act contains specific mandates regarding the timing, content, and delivery of blackout notices. On October 21, 2002, the Department of Labor (the "DOL") issued interim final regulations implementing the mandates set forth in Section 306(b) (the "Blackout Regulation"). [1] In addition, the DOL issued regulations under Section 507(c)(7) of the Employee Retirement Income Security Act of 1974, as amended ("ERISA") to impose penalties on plan administrators that fail to comply with the Blackout Regulation. [2] The Blackout Regulation was formulated after discussions with the Securities and Exchange Commission (the "SEC") and is coordinated with the proposed Blackout Trading Restriction ("BTR") rules issued on October 30, 2002 by the SEC under Section 306(a) of the Act. [3]

As with Section 306(a), the notice requirements described in Section 306(b) are applicable with respect to blackout periods that commence on or after January 26, 2003, 180 days after the date of enactment of the Act. This update summarizes the Blackout Regulation and the related provisions of the Act. [4]

Background

In conjunction with Section 306(a) of the Act, the notice requirements imposed by the Blackout Regulation are intended to afford retirement plan participants affected by trading and distribution restrictions implemented as part of a blackout period an opportunity to avoid significant investment losses of the sort sustained by participants in the retirement plans maintained by Enron Corporation among others. Blackout periods are typically associated with changes in the investment alternatives available under a retirement plan or with changes to retirement plan recordkeepers or third-party administrators. During the conversion period from one menu of investment alternatives to another or from one recordkeeper to another, the ability of participants and beneficiaries to make changes to their investment elections or to request distributions from a plan is often restricted. Ideally, these restrictions are imposed for only a few days, although blackout periods can occasionally take several weeks. If a market decline occurs during a blackout period, participants and beneficiaries are usually unable to avoid incurring investment losses. However, with appropriate advance notice of an impending blackout period, participants will be better able to evaluate their retirement plan-based investments and redirect their retirement assets into "safer" alternatives for the duration of the blackout period if they so choose. Consistent with the inclusion of its provisions in the reporting and disclosure requirements of ERISA, Section 306(b) imposes potentially significant penalties on plan administrators who fail to timely provide the required notice to plan participants. These penalties are in addition to potential fiduciary liability for participant investment losses incurred during a blackout period.

Plan Administrators and Plans Subject to the Blackout Regulation

Under the Act, plan administrators are required to provide the requisite blackout notice to participants in their plans. For purposes of the Blackout Regulation, a "plan administrator" is the person or entity designated as such by the plan documents; in the absence of such a designation, the plan administrator is the sponsor of the plan at issue. As is the case for other ERISA-mandated participant notices and communications (such as summary plan descriptions and summary annual reports), it is important for plan sponsors to determine the identity of the "plan administrator" to ensure that such notices and communications are timely distributed to plan participants and beneficiaries.

By its terms, the Blackout Regulation applies to all "individual account plans." In essence, this means that the notice requirements imposed by the Blackout Regulation are applicable to all defined contribution retirement plans. Among the types of plans affected are 401(k) plans, profit-sharing plans, employee stock ownership plans, and money purchase pension plans. The common characteristic of all of these plans is the fact that each participant and beneficiary has one or more separate accounts to which contributions and forfeitures are allocated from time to time. [5] The primary impetus behind this limitation on the scope of the Blackout Regulation appears to be the fact that it is only under individual account plans (and defined contribution plans generally) that participants bear the risk of investment losses.

Although the BTR rule and the Blackout Regulation both refer to individual account plans, the SEC has indicated that non-qualified deferred compensation plans that maintain accounts for participants will also be covered by the trading restrictions imposed by Section 306(a) of the Act. [6] The inclusion of this type of plan in the BTR rule is unlikely to be of major consequence because such plans are rarely if ever subject to "blackout periods" (as defined in the BTR rule).

The term "blackout period" for purposes of Section 306(b) is defined somewhat differently than for Section 306(a). A blackout period is any period of time during which the ability of participants or beneficiaries to direct the investment of their interests in the plan, to obtain loans from the plan, or to obtain distributions from the plan is temporarily suspended, limited, or restricted for 3 or more consecutive business days. [7]

Excluded from this definition are a number of situations that might otherwise be considered to be blackout periods. These include (1) regularly scheduled "blackout periods" adopted by many publicly-traded companies as a safeguard against violations of the prohibition of "insider trading" prior to the time that their quarterly results of operations; (2) regularly-scheduled suspensions, limitations, or restrictions that are disclosed to participants and beneficiaries in a "summary of material modifications" distributed under Section 104(b)(1) of ERISA; and (3) limited suspensions of account activity in connection with the processing of qualified domestic relations orders. [8]

Advance Notice of Blackout Period

In general, the Blackout Regulation requires a plan administrator to provide at least 30 days' prior notice of a blackout period to all participants and beneficiaries in the affected plan. However, in certain circumstances, a shorter notice period is permitted. If the plan administrator makes a written determination that delaying the commencement of a blackout period in order to provide 30 days' prior notice is likely to result in a breach of its fiduciary duties under ERISA or that it is impossible to provide such notice due to unforeseen circumstances, the notice must be distributed to participants and beneficiaries as soon as reasonably possible.

In addition, the Blackout Regulation indicates that where a blackout period affects one or more participants in connection with a merger, acquisition, or similar transaction, and occurs in connection with the commencement or cessation of participation in a plan, the plan administrator is not required to provide 30 day's prior notice but must instead provide notice as soon as reasonably possible.

Content of Blackout Notice

Under the Blackout Regulation, the advance notice of a blackout period provided by a plan administrator must be in written in easily-understood language and must contain information regarding the reasons for the blackout period, the investments or other rights affected during the blackout period, the expected beginning and ending date of the blackout period, contact information for the person responsible for answering questions about the blackout period, and a statement encouraging participants to evaluate the appropriateness of their current investment elections in light of the trading or other restrictions that will be imposed during the blackout period. [9] Notices must be provided in writing, but electronic distribution of a notice (e.g., via email or intranet posting) is permissible as long as the intended recipients have reasonable access to the electronic version of the notice. If, after the distribution of a blackout period notice, either the beginning or ending date of the period changes, the plan administrator must provide a supplemental notice to affected plan participants and beneficiaries as soon as reasonably possible to advise them of the revised dates.

In addition to notifying plan participants and beneficiaries of an impending blackout period, the Blackout Regulation obligates the plan administrator to notify the issuer of any equity securities subject to the blackout period. In most instances, this notice will be a formality because the issuer of equity securities held by a plan will be the plan administrator and/or the plan sponsor.

Penalties

Under the interim final regulations issued in conjunction with the Blackout Regulation, civil penalties of up to $100 per participant per day for untimely blackout period notices can be imposed by the DOL. In the event penalties are assessed for violations of the Blackout Regulation, the plan administrator is entitled to review of the assessment in a hearing before a DOL administrative law judge.

Finalization of Blackout Regulation

The Blackout Regulation is applicable for any blackout period that commences on or after January 26, 2003. The DOL may revise the Blackout Regulation in response to comments received prior to November 20, 2002.

Impact of the Blackout Regulation

For the most part, Section 306(b) and the Blackout Regulation codify the "best practices" approach to implementing retirement plan blackout periods. As has been demonstrated in the on-going litigation involving the Enron 401(k) plan, plan administrators and other fiduciaries bear a heavy responsibility for safeguarding the retirement assets of participants in the plans they administer. Even in the absence of the Blackout Regulation, prudent plan administrators would provide ample advance notice of blackout periods to participants and beneficiaries and take all reasonable actions to minimize the duration and frequency of blackout periods. With the enactment of the Act and the adoption of the Blackout Regulation, plan administrators now have a further incentive to carefully evaluate proposed changes to investment alternatives and plan service providers and an additional compliance obligation in the event such changes are implemented.