Steward H. Diamond and Margaret Kostopulos are partners in the law firm of Ancel, Glink, Diamond, Bush, DiCianni & Krafthefer P.C. in Chicago.

Questions are arising as school districts analyze their changing roles as sponsors of deferred compensation benefits for employees. The changes came from amendments to IRS Regulation 403(b)* that governs these benefit plans.

Does the amended 403(b) create potential liability for school districts where none previously existed? Does additional liability attach to a district if, on behalf of its employees, it contracts for investment program consulting services in order to comply with the amended regulations?

Historically, many school districts offered deferred compensation benefits to their employees pursuant to 403(b), which allows contributions to certain investment programs on a tax-deferred basis. School districts generally offered this benefit by facilitating the pre-tax compensation contribution of employees to investment plans offered by various vendors and chosen by employees. Districts had minimal participation in the process of selecting suitable vendors and undertook no responsibility to analyze the various investment programs available to the district's employees.

Under the new 403(b), which takes effect January 1, 2009, the district's responsibility related to selection of investment programs changes dramatically, requiring that school districts enter into a plan with vendors who provide deferred compensation programs for the district's employees.

The rules make the district the "investment plan sponsor," which creates a new fiduciary relationship, since a "sponsor" assumes certain responsibilities for selecting and monitoring an investment program.

This means liability can arise without any sort of official agreement between the district and the employees. It is generally agreed that such fiduciary duty will extend to the school district's selection of sponsored plans as well as related investments and fees.

The fiduciary duty of investment program sponsors is defined by the Employee Retirement Income Security Act: a fiduciary must act exclusively and loyally for the principal's benefit (in this case, the employee). The fiduciary may not act on behalf of either itself or an adverse party and must act prudently on behalf of the principal. (Chicago Newspaper Publishers Association v. Aetna Casualty 89 Ill. App. 3d 427; 411 N.E. 2d 1054 (1st Dist. 1980), also Neade v. Portes, 193 Ill.2d 433 (2000))

The most likely scenario under which a claim against a school district might arise is the selection of investment programs (or vendors). Claims might arise from what some might see as imprudent selections: plans with high expenses, poor quality investments or those that fail to adhere to other actions regulated by 403(b), like individual loans or transfers.

Based on the presumption that school district administrators are not investment experts, an appropriate discharge of a district's 403(b) fiduciary duties may include contracting for services to analyze and recommend deferred compensation investment programs that most benefit their employees. Relying on analysis and recommendation of appropriate investment programs likely fulfills the duty to "prudently sponsor and administer" these plans.

Any concern that the mere act of contracting for services by a school district to analyze various deferred compensation programs and recommend the programs most advantageous to employees creates a separate 403(b) liability to the district is likely misplaced. The fiduciary duty at issue arises because a school district must act as plan sponsor under the new 403(b) rules.

The contemplated consulting services, and resulting recommendations made, do not create a fiduciary relationship between the consulting service and the district's employees; that fiduciary relationship remains between the district and its employees. Using consulting services to assist a school district in discharging its 403(b) duties evidences its prudent behavior and serves as part of a reasonable defense to a claim of breach of fiduciary duty by a district's employee.

In order to comply with 403(b) regulations, some districts may consolidate their deferred compensation investment programs, resulting in a small number of programs to choose from and elimination of current investment programs.

If so, employees, many of whom are union members, will lose their ability to make new investments in their previously chosen plans. A collective bargaining issue arises as to whether the ability to continue to invest in currently selected deferred compensation programs is a term or condition of employment. If so, what rights remain with a district to change and/or eliminate these investment programs to ensure compliance with the new regulations?

In determining the district's obligation to its union employees, the place to start is the collective bargaining agreement. If the agreement contains a provision describing the rights and duties of the parties concerning changes in the deferred compensation plan, the district is obligated to follow those procedures as it makes changes to investment programs. These contract provisions could range from an agreement to meet and negotiate any changes needed to the plan to one where the ability of a district to make changes depends on employees maintaining a same or similar investment benefit.

If no existing contract language addresses the rights and duties of the parties to make changes in these investment programs, the district must determine whether it has an independent obligation under the Illinois Educational Labor Relations Act (IELRA). IELRA prohibits an employer from making a unilateral change to a mandatory subject of bargaining. Rather, an employer has the duty to bargain contemplated changes prior to any implementation.

Whether the selection of an individual investment program or vendor within a deferred compensation plan is a mandatory subject of bargaining is determined by applying the test first identified in Central City Education Association IEA/NEA v. Illinois Educational Labor Relations Board (1992). In that case, the court first held that a determination of whether a subject is mandatorily bargainable depends on whether it is one involving wages, hours, and terms and conditions of employment, whether it is one of inherent managerial authority and, if it is both, a balancing of the benefits and burdens of bargaining.

In applying that test, the analysis reveals initially that a deferred compensation plan and its components likely involve wages, terms or conditions of employment, as it relates to a deferred compensation or retirement benefit. The second prong of the test requires an analysis of whether the subject involves inherent managerial authority.

In this regard, it could be argued that selection and/or elimination of investment programs within a 403(b) plan places a burden on the employer to comply with federal regulations and therefore it is an inherent management duty and within management's rights to effectuate. If selection and/or elimination of individual investment programs involve wages, terms or conditions of employment and an inherent managerial authority, the employer must balance the benefits and burdens of bargaining to determine whether the subject is mandatorily bargainable. Generally, the Labor Board favors findings of bargaining obligations.

A review of Illinois court and Labor Board decisions reveals that neither have examined whether the individual investment programs that comprise a deferred compensation plan is a mandatory subject of bargaining. The Labor Board has held, though, that changes in retirement benefits that affect current employees are mandatory subjects of bargaining. Blue Island Professional Firefighters Association v. City of Blue Island (ISLRB 1991)

On the other hand, the Labor Board has also held that a change in insurance carrier is not a mandatory subject of bargaining when that change also involves a material and significant impact on the level of insurance benefits. IUOE Local 399 v. City of Kankakee, et al. (ISLRB 1993)

This finding may be a close analogy. Much like changing insurance carriers without materially or significantly altering the benefit levels, a change in deferred compensation vendors does not necessitate a change in the deferred compensation benefit level.

Nevertheless, even if the actual elimination or change of investment plans is not a mandatory subject of bargaining, the impact of these changes may be. The law provides that an employer is obligated to engage in impact or effects bargaining with a union if it implements a change that is not a mandatory subject of bargaining but has an impact or effect on union members.

In this instance, the impact would be the loss of certain investment programs and the employees' inability to continue investment in them. Hotel Employees and Restaurant Employees Union Local 1 et al. v. Chicago Board of Education (ELRB 2004)

Impact bargaining is limited to negotiation of topics related to diminishing or eliminating the negative impact of the employer's lawful actions, with the union carrying the burden of raising these issues to the employer.

Based on this, it is likely that school districts are not obligated to bargain over the change in investment programs offered as part of their deferred compensation plans, but without reviewing specific contract language or prior analysis a definitive opinion on the subject becomes impossible.

Even though it is likely that a district could prevail in litigation related to the question of whether a bargaining obligation exists regarding the change in investment programs, it is also likely that a district has the obligation to bargain the impact or effects of these changes if such bargaining is requested. Therefore, a practical approach may provide an overall greater benefit.

Prior notification to affected unions of the intended changes along with meetings to explain the changes and the district's changed obligations under new 403(b) regulations may avoid most or all controversy that might otherwise arise. Often, informal discussion and free flow of information on subjects such as benefit levels creates a comfort level with the union representatives to avert escalation of the issue to litigation. Naturally, if impact or effects bargaining is requested, the school district must comply.

The provisions of a school district's collective bargaining agreement may alter its union obligations. School districts should always consult with their school attorneys when analyzing such topics.

Access to a model plan from the Internal Revenue Service can be found at: http://www.irs.gov/pub/irs-drop/rp-07-71.pdf

*26 CFR § 1.403(b)-1 et seq.

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