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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 January 24, 2003, the Department of Labor (the "DOL") issued final regulations implementing the mandates set forth in Section 306(b) (the "Blackout Regulation").[fn1] 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.[fn2] The Blackout Regulation was formulated after discussions with the Securities and Exchange Commission (the "SEC") and is coordinated with the Blackout Trading Restriction ("BTR") rules issued on January 26, 2003 by the SEC under Section 306(a) of the Act.[fn3]

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.[fn4]

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.[fn5] 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.[fn6] 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.[fn7]

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; (3) limited suspensions of account activity in connection with the processing of qualified domestic relations orders ("QDRO") or by reason of a pending determination as to whether a QDRO is qualified;[fn8] and (4) account restrictions that are triggered by the actions of individual participants.[fn9]

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, or the calendar week during which the blackout period is expected to begin and end;[fn10] contact information for participants and beneficiaries who may have questions about the blackout period;[fn11] 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.[fn12] 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, the issuer of equity securities held by a plan will be the plan administrator and/or the plan sponsor. In such situations, if the issuer has designated the plan administrator as its agent for service of legal process, the issuer is deemed to have been furnished notice on the same date as the notice is furnished to affected participants and beneficiaries.[fn13]

Penalties

Under the 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.

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.

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Footnotes

1: See Final Rule Relating to Notice of Blackout Periods to Participants and Beneficiaries, 68 Fed. Reg. 3716 (January 24, 2003). The text of the interim final rule relating to blackout period notice requirements may be found at http://www.dol.gov/ebsa/regs/fedreg/final/2003001430.pdf.

2: See Civil Penalties Under ERISA Section 502(c)(7), 68 Fed. Reg. 3729 (January 24, 2003). The text of the final rule relating to civil penalties relating to the failure to timely provide notices of blackout periods may be found at http://www.dol.gov/ebsa/regs/fedreg/final/2003001431.pdf.

3: See Release Nos. 34-47225; IC-25909; S7-44-02. The text of the BTR rule may be found at http://www.sec.gov/rules/final/34-47225.htm, and our summary of its key provision may be found in our legal update, SEC Issues Final Rules Regarding Insider Trades During Pension Fund Blackout Periods, February 2003.

4: The substantive provisions of the Blackout Regulation are identical to the statutory requirements set out in Section 306(b) of the Act. References to the Blackout Regulation in this update refer to both the regulations themselves as well as the parallel provisions of Section 306(b).

5: Individual account plans are to be distinguished from defined benefit pension plans which typically do not maintain separate participant accounts. Note also that cash-balance pension plans-which are classified as defined benefit plans by ERISA-are not individual account plans for purposes of the Blackout Regulation even though such plans maintain hypothetical accounts for participants.

6: See Release Nos. 34-47225; IC-25909; S7-44-02.

7: In contrast to the BTR rule, a blackout period need not affect more than 50% of the plan sponsor's employees in order to give rise to a notice obligation under the Blackout Regulation.

8: The BTR rule contains a similar exclusion for regularly scheduled blackout periods in a plan or in an amendment to a plan. However, limited suspensions of account activity arising from processing domestic relations orders will generally not constitute a blackout period under the BTR rule, and therefore, no similar exception is set forth in the SEC's rules. In addition, the BTR rule includes an exception for certain blackout periods imposed in connection with merger and divestiture transactions that are imposed in order to enable individuals to become, or to cease to be, plan participants and beneficiaries.

9: The final rule amends the interim final rule by adding this final exclusion. The final rule also expands the QDRO exclusion to include situations in which there is a pending determination as to whether a QDRO is qualified.

10: The final rule provides more flexibility than the interim final rule by allowing plan administrators to give notice of the dates of the expected blackout or the calendar week during which the blackout will occur.

11: The interim final rule mandated that the notice provide the name, address and telephone number of a person responsible for answering questions regarding the blackout period. The final rule provides that the notice provide a contact to answer such questions. This amendment is meant to clarify that a department, rather than an individual, can be listed as the required contact.

12: The statement encouraging evaluations of current investment elections is not required under the BTR rule.

13: This latter provision was added to the final rule.