HUMAN RESOURCES ALERT

Warner Norcross & Judd LLP900 Fifth Third Center111 Lyon Street NWGrand Rapids, Michigan 49503-2487

ADDRESS SERVICE REQUESTED

INSIDENew Shift in Attitude

at the IRS May Impact401(K) and Other Retirement Plans

Participant-Directed Investments:

A New Exception to Fiduciary Liability for Plan

Losses

Medicare Part D Benefit and Cost Increases Could

Affect Your Notice of Creditable Coverage

Court of Appeals Clarifies Enforcement of Noncompete Agreements

An Ounce of Prevention: Check Your Employment

and Severance Agreements for Compliance With New

IRC Section 409A.

WNJ LOCATIONS:

Grand Rapids 900 Fifth Third Center111 Lyon Street, N.W. Grand Rapids, MI 49503-2487 Telephone: 616.752.2000Fax: 616.752.2500

Holland85 East Eighth St., Suite 310Holland, MI 49423-3528Telephone: 616.396.9800Fax: 616.396.3656

Metro Detroit2000 Town Center, Suite 2700Southfield, MI 48075-1318Telephone: 248.784.5000Fax: 248.784.5005

Muskegon400 Terrace PlazaP.O. Box 900Muskegon, MI 49443-0900Telephone: 231.727.2600Fax: 231.727.2699

Visit us at www.wnj.com

401(k) and other retirement plans are the best thing since sliced bread. They provide tax advantages for employers and employees and, in today’s economy, they are vital to personal planning for retirement.

We closely monitor how Congress and the IRS treat 401(k) and other retirement plans, applauding when they are made easier and more effective and expressing concern when the government moves in the direction of making plans more burdensome for business to maintain.

We are watching with a cautious eye as the IRS unveils changes in its 401(k) and other retirement plan audit program. The new IRS commissioner feels - across the board - that the “kinder and gentler” IRS of the last decade or so actually became too kind. He feels some took advantage of perceived lax enforcement. As a result, all IRS enforcement activity, including that relating to employee plans, is being stepped up.

In the 401(k) and other retirement plan area, we will likely see:

• More audits • More focused audits in which the IRS visits, checks

something and then - if nothing is found - moves on to the next audit relatively quickly

• More emphasis on assuring that the employer has appropriate plan processes in place and good help in running its plan

• A strong desire to visit the workplace and talk to Jane in accounting to make sure Jane understands the plan and how to run it

So, we will likely see more frequent, but less detailed, 401(k) and retirement plan audits. Hopefully, this system will be more efficient, less time-consuming and less disruptive.

The time to plan for an audit is before you are contacted by the IRS. There is actually a two-or three-year lag in the IRS’s audit cycle for 401(k) and other retirement plans. So, today’s audits are looking at how you ran your plan in 2003 or 2004. Conversely, what we do today to improve your plan will pay dividends in plan audits occurring in 2008 and 2009. The point is, being attentive to plan process and the audit cycle should be a continuing process. In that regard, part of the good news is that we still have excellent IRS (and Department of Labor) voluntary correction programs, many of which do not even require contact with the government when a problem is found. The best approach by far is still to self-audit and correct problems voluntarily, long before an IRS or DOL audit is on the horizon. But, if you are contacted regarding an audit, bear in mind it is not a do-it-yourself project.

Here at WNJ, we have worked long and hard to develop and maintain a strong, mutually respectful relationship with the IRS in connection with plan audits. We would like to think that our best work is done in helping you run your plans as efficiently and effectively as possible long before the prospect of an audit appears on the horizon. Our help early on - with a self-audit or at the time of audit to interface with the IRS on your behalf - can save you significant time and money in the long run.

NO MORE MR. NICE GUY:NEW SHIFT IN ATTITUDE AT THE IRS MAY IMPACT 401(K) AND OTHER RETIREMENT PLANSby Anthony J. Kolenic, Jr.

Summer 2006

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AN OUNCE OF PREVENTION: CHECK YOUR EMPLOYMENT AND SEVERANCE AGREEMENTS FOR COMPLIANCE WITH NEW IRC SECTION 409A.by Robert J. Chovanec

Internal Revenue Code Section 409A imposes strict new requirements for “deferred compensation.” It is written so broadly that a lot of things that you wouldn’t think of as “deferred compensation” are covered. The penalties for

violating the new law are severe. Any amount classified as noncompliant deferred compensation is currently taxable to the employee, even though it hasn’t been paid or may never be paid. In addition, the law imposes a penalty tax on the employee equal to 20% of the non-compliant deferred compensation.

This reminder is not to give you the details, but rather to urge you to pay particular attention to your employment and severance agreements and arrangements. The new law covers many different forms of compensation. These include not only traditional “deferred compensation plans” but also bonus plans and arrangements, supplemental retirement programs, equity compensation programs, and a host of other

compensation arrangements, such as employment contracts and severance programs and agreements. Arrangements that provide for long-term severance pay, benefit continuation, or severance pay triggered by an employee’s resignation for “good reason” are particularly at risk, but the new law is so broad that all employment and severance pay agreements, and all severance pay programs, should be reviewed. In many cases, coverage and compliance will depend on the exact terms of the arrangement. There are also special restrictions on severance payments to managers of corporations whose stock is publicly traded.

This law is in effect now, and payments that violate the law are subject to the penalties described above. However, the law allows a grace period through December 31, 2006, to bring documentation into compliance. You should check with the WNJ business, employment or employee benefits lawyer with whom you work. We can give you a quick review of the issues and, if necessary, refer you to a member of our “Section 409A Task Force” for further review of your agreements.

In our Summer 2005 Human Resources Alert, we informed you about a bill that had been introduced that would place limits on an employer’s ability to regulate the off-duty conduct of its employees “Proposed Law

Would Require Employers to ‘Butt Out’ of Employee’s Nonwork Activities.” That proposed legislation was a reaction to the highly publicized resignation of several employees from Weyco after the company implemented a tobacco-free workforce policy. Dubbed the “Employee Privacy Protection Act,” the bill would prohibit an employer, except in certain very limited circumstances, from refusing to hire, discharging, or otherwise discriminating against an employee in any term or condition of employment because the employee engaged in a lawful activity off work premises and during non-working time. At last report, that bill was still pending in committee.

A recent package of bills introduced in the Michigan Senate suggests that at least some legislators are still concerned about employer regulation of off-duty employee conduct. One bill, which if enacted would be called the “Employee Dietary and Smoking Rights Protection Act,” would prohibit an employer from making employment decisions or discriminating in employment because the applicant or employee smokes, drinks or consumes certain foods. Yet another bill would prohibit employer discrimination based on an individual’s body type, degree of physical fitness or other physical characteristic. Two other bills would prohibit discrimination in employment because the applicant or employee engaged in or was regarded as having engaged in lawful political activity or because of an individual’s (real, potential or perceived) membership in a lawful organization or advocacy group. Finally, one of the bills would amend the Elliott-Larsen Civil Rights Act to prohibit employment decisions based on an employee’s or applicant’s familial status. All of these bills contain limited exceptions which would allow employers to refuse to hire,

discharge or take some employment action where the characteristic or off-duty activity at issue was a bona fide occupational qualification or where it interfered with some bona fide occupational requirement.

Although the prohibitions contained in some of these bills might not seem all that significant to you in your workplace, consider the impact that such a law might have on your employee benefit or wellness plans. Many employers provide incentives in their health insurance plans to employees who don’t smoke, who have a body-mass index within certain parameters, or who regularly exercise. Would those types of incentives be unlawful if these bills became law? Also, would antinepotism policies be outlawed if Elliott-Larsen were amended to prohibit employment decisions based on familial status?

These bills were only recently introduced and were promptly referred to the appropriate committee for consideration. Whether they will ever see the light of day is uncertain, but we will continue to monitor them and alert you if they move toward becoming law.

RECENT BILLS INDICATE THAT LEGISLATURE STILL WANTS EMPLOYERS TO MIND THEIR OWN BUSINESS WHEN IT COMES TO OFF-DUTY EMPLOYEE ACTIVITIESby Robert A. Dubault

Human Resources Alert is published by Warner Norcross & Judd LLP to inform clients and friends of new developments. It is not intended as legal advice. If you need additional information on the topics in this issue, please contact your Warner Norcross & Judd attorney or any member of the firm’s HR Group.

The members of the Human Resources Group are:

Edward Bardelli 616.752.2165 Andrea Bernard 616.752.2199Michael Brady 248.784.5032Scott Carvo 616.752.2759Robert Chovanec 616.752.2120Jack Combs 616.752.2112Sue Conway 616.752.2153Amber DeLong 231.727.2630Kevin Dougherty 616.752.2175Gerardyne Drozdowski 616.752.2110Robert Dubault 231.727.2638Carl Dufendach 616.752.2136Daniel Ettinger 616.752.2168Kathleen Hanenburg 616.752.2151Angela Jenkins 616.752.2480Gregory Kilby 616.752.2181Jonathan Kok 616.752.2487Anthony Kolenic, Jr. 616.752.2412Norbert Kugele 616.752.2186Joseph Martin 616.752.2113John McKendry, Jr. 231.727.2637Yvette Moody 616.752.2739Jeffrey Nelson 616.752.2453Jeffrey Ott 616.752.2170Dean Pacific 616.752.2424Christopher Predko 616.752.2190Louis Rabaut 616.752.2147Janet Ramsey 616.752.2736Vernon Saper 616.752.2116Valerie Simmons 616.752.2163Paul Sorensen 616.752.2135Justin Stemple 616.752.2375Karen VanderWerff 616.752.2183Donald Veldman 231.727.2603George Whitfield 616.752.2102Kathryn Wood 616.752.2782

32596WNJ6.06

PARTICIPANT-DIRECTED INVESTMENTS: A NEW EXCEPTION TO FIDUCIARY LIABILITY FOR PLAN LOSSESby Amber R. DeLong

MEDICARE PART D BENEFIT AND COST INCREASES COULD AFFECT YOUR NOTICE OF CREDITABLE COVERAGEby Norbert F. Kugele

COURT OF APPEALS CLARIFIES ENFORCEMENT OF NONCOMPETE AGREEMENTSby Edward J. Bardelli

HUMAN RESOURCES ALERT

In St. Clair Medical, P.C. v Borgiel, the Michigan Court of Appeals recently provided some needed clarity in the area of non-competition agreements. The case was approved for publication on March 14, 2006, which means that all lower

Michigan courts will be bound by it. Although Borgiel involved a noncompete between a doctor/employee and a medical practice/employer, the decision has broader implications for all employers who use or who are thinking about using a noncompete agreement.

In Borgiel, a doctor signed an employment agreement that contained a noncompete clause. The noncompete prohibited him from working for another medical practice within seven miles of two offices where he had worked, for a period of one year from the termination of his employment. The agreement also provided that the doctor would pay his former employer $40,000 if he breached the noncompete. You can guess what happened next: The doctor quit and went to work for a medical practice within seven miles of an office where he had worked. His employer sued to enforce the noncompete and the trial court granted the employer’s motion for summary disposition.

On appeal, the Court of Appeals also ruled in the employer’s favor. In doing so, it set forth the way in which most noncompete cases should be analyzed. First, the court looked to the agreement itself to determine whether it was unambiguous and if so, whether the doctor had breached it. This was an important step. If the agreement’s language was unclear, creating a question as to its meaning, the employer would not have been able to file a motion with the trial court seeking to enforce the agreement as written. Rather, the trial court or a jury would have had to determine which party’s interpretation was correct. Because the court found the noncompete capable of only one meaning, it easily found that the doctor had breached it.

Finding a breach of a noncompete, however, is only the first step. The next step is to determine whether it is enforceable under Michigan law. Even an unambiguous noncompete will fail if it runs afoul of the Michigan Antitrust Reform Act (“MARA”). MARA provides that an employer may obtain from an employee an agreement that protects the employer’s reasonable competitive business interest and expressly prohibits an employee from engaging in employment or a line of business after termination of employment if the agreement is reasonable as to its duration, geographic area and type of employment or line of business.

In assessing what is a reasonable competitive business interest, the court reaffirmed that the employer’s interest must be more than simply preventing competition. In the medical setting at issue in Borgiel, the court recognized that a noncompete could protect against unfair competition by: (1) protecting an employer’s confidential business information or

patient lists; (2) protecting an employer’s investment in specialized training of a physician; or (3) preventing a loss of patients.

Because the employer did not present any evidence that it provided specialized training and because there was a disputed issue as to whether the doctor had access to confidential business information or patient lists, the court did not rule on the first two interests. The fact that it discussed them will be important in future cases, however. Although the court found that there was a question as to whether the doctor had access to confidential business information or patient lists, it signaled that had there not been a question on this issue, the employer would have been able to enforce the noncompete without further factual findings. In addition, the court indicated that an employer seeking to enforce a noncompete because it provided specialized training to the employee will have to offer evidence in support of that position. General training that the employee could get anywhere will not do. This is important because the Borgiel court reaffirmed the long-standing principle in Michigan that general knowledge or skill obtained through training or experience acquired during employment does not, by itself, give the employer a sufficient interest to support a noncompete.

Even though the employer in Borgiel couldn’t or didn’t show specialized training or access to confidential information, the court still upheld the noncompete because it sought to legitimately protect the employer’s interest in preventing a loss of patients. The court reasoned that the employer had invested in advertising and goodwill and the noncompete provided it with a reasonable period of time to regain goodwill with its patients after the doctor left. In other words, the noncompete prevented the doctor from using patient contacts gained during the course of his employment to unfair advantage in competition with the employer. The court specifically stated, “A physician who establishes patient contacts and relationships as the result of the goodwill of his employer’s medical practice is in a position to unfairly appropriate that goodwill and thus unfairly compete with a former employer upon departure.” The court recognized that the doctor could unfairly take advantage of the employer’s investments in advertising and goodwill when competing with his former employer to retain patients.

Finally, the court found the one-year time period and seven-mile geographic restrictions reasonable. The court also held that the $40,000 damage provision was reasonable since actual damages for a breach of the agreement were uncertain and difficult to ascertain

and because it did not appear excessive in relation to patient loss. Accordingly, the court held that the doctor could either choose not to practice within seven miles of his former offices for a year, or pay his former employer $40,000 to do so.

So what does Borgiel mean outside of the doctor/medical practice context? A lot. Borgiel’s implications will reach many employment situations. It has also helped clarify just what a “reasonable competitive business interest” is by delineating at least three areas. Those areas could just as easily apply to the loss of customers and customer lists, instead of patients and patient lists. Moreover, the court recognized that protecting confidential information is a legitimate interest – without resort to determining whether that information must reach trade secret status to be protected.

Perhaps the most important part of this ruling, however, was the court’s recognition of an employer’s goodwill as a legitimate competitive business interest to be protected. Outside the context of a doctor/patient relationship, this issue will likely come up most often in the salesperson/customer relationship. We all too often see a salesperson leave an employer and attempt to contact customers, or use a customer list, in violation of a noncompete. The court’s decision in Borgiel certainly indicates that the employer’s interest in keeping the customer is legitimate, and not simply a way to prevent competition. And even where there may be a dispute about whether a customer list has been taken or confidential information has been used, a noncompete should be enforced on the basis that a salesperson cannot use the goodwill of the employer to unfairly compete to retain a customer. As with the doctor in Borgiel , a salesperson benefits from advertising, the relationship with the customer that is facilitated by the employer (at the employer’s expense), and the employer’s goodwill.

Noncompetition agreements are often the last line of defense in protecting your investment in confidential information, advertising, customer relationships, and preventing unfair competition by a former employee. Borgiel provides the perfect opportunity for you to review your current noncompetition agreements to ensure their enforceability. It also provides a road map if you are thinking about entering into noncompetition agreements with certain employees. Should you choose to revise your current agreements or enter into new ones, you should contact your human resources counsel to assist with this process.

As many employers are aware, ERISA § 404(c) generally provides an optional retirement plan feature that may shield fiduciaries from liability associated with participant-directed accounts. If a retirement plan is set up

according to 404(c) and the associated regulations, the plan’s fiduciary would not be responsible for losses from investment decisions made by a participant. Recently, a Seventh Circuit Court of Appeals decision, Jenkins v. Yager (Case no. 04-4258, April 14, 2006, available at http://www.ca7.uscourts.gov) held that 404(c) is not the exclusive exception to fiduciary liability for participant-directed investments.

ERISA requires a plan’s investment fiduciary to manage and invest plan assets according to a prescribed standard of care. Many plans permit individual participants to control the investment of their own accounts. By complying with the requirements of 404(c), which include disclosure requirements and standards applicable to the selection of investments made available to participants, the fiduciaries of these plans are excepted from liability for losses attributable to a participant’s investment directions. Until now it had never been definitively stated whether this relief might be available for plans that offer participant-directed accounts but are not in compliance with 404(c). In Jenkins, the Seventh Circuit has determined that there is an implied

exception to fiduciary liability for participant-directed account investments.

The plan at issue in Jenkins was a 401(k) plan that allowed participant-directed accounts, but did not comply with 404(c) requirements. However, the court determined that even though the plan did not meet these requirements, Department of Labor regulations and prior guidance did not require 404(c) compliance to be the exclusive authority for permitting the delegation of investment responsibility to participants, and that 404(c) should be seen merely as a safe harbor. The court found that the plan trustee was not liable for the losses sustained in the plaintiff ’s self-directed 401(k) account, and did not breach any fiduciary in selecting and monitoring the funds available, allowing participant-directed accounts, or in providing adequate information about the available investments to participants. The trustee made four funds available, chosen as part of a prudent long-term investment strategy, and gave participants regular information on the investment funds. Once the court determined that the trustee had properly performed these set up and monitoring functions for the investment funds, it found that an implied exception to fiduciary liability permitted the delegation of investment control to the participants and removed the trustee’s responsibility for the plan’s losses.

In Jenkins, the court seemed to treat this implied exception as a blanket exception protecting plan fiduciaries from liability with respect to participant-

directed investments. Until other authority addresses this issue it will remain unclear as to exactly what circumstances may remove the availability of this fiduciary protection. Section 404(c), as a safe harbor, continues to remain the best option available under which fiduciaries may properly delegate investment responsibility to participants, but this implied exception may provide relief to plans that are intended and designed to comply with 404(c) but unintentionally fail to meet some of its technical requirements.

If you would like further information on 404(c), or would like help designing your plan to meet this section’s safe harbor requirements, please contact a member of the Employee Benefits Practice Group.

The prescription drug program under Medicare Part D is tied to an inflation index. For 2007, the deductibles, benefits and cost-sharing provisions for the standard Medicare Part D prescription drug benefit will increase as follows:

2006 2007

Deductible: $250 $265

Initial Coverage Limit: $2,250 $2,400

Out-of-Pocket Threshold: $3,600 $3,850

True Out-of-Pocket Amount: $5,100 $5,451.25

Although these changes primarily impact participants in the Medicare Part D program, they could also have an impact on the notice of creditable coverage status that your health plan is required to provide at least annually to all employees and covered family members who are eligible for Medicare Part D benefits. Because the actuarial value of the Medicare Part D program is increasing for 2007, you may have to reevaluate whether your plan will still provide actuarially equivalent prescription drug coverage. If it does not, you will need to revise your notice to reflect the status of the plan. The updated notice should be distributed with your annual open enrollment materials.

If you have any questions about Medicare Part D, please talk to a member of the Employee Benefits Practice Group.

By complying with the requirements of 404(c)... the fiduciaries of these plans are excepted from liability for losses attributable to a participant’s investment directions.