ERISA COMPLIANCE AND ERRORS Top Ten Mistakes

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ERISA COMPLIANCE AND ERRORSTop Ten Mistakes
Marcia S. Wagner, Esq.
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Introduction

• Plan sponsors and financial advisors need to know
  on what to focus when they examine a plan. 
  They need to know the top ten errors, how they
  occur (usually people do not know the terms of
  the plans administration) and how they should be
  rectified.  For each of the top 10 problems, we
  discuss  (i) the issue, (ii) how it arises and
  (iii) how it can be fixed.

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Top Ten Problems

• 1. Automatic Enrollment Automatic Escalation
• 2. 403(b) Plan Universal Availability
• 3. Problem Shared and Leased Employees
• 4. Compensation Done Incorrectly
• 5. Controlled Group Issues
• 6. Bad Plan Documentation
• 7. Prohibited Transactions
• A. Plan Services
• B. Bad 408(b)(2) Disclosure
• 8. Illiquid Plan Assets
• 9. Late Elective Deferrals
• 10. Bad Administration

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• 1. Automatic Enrollment
• Automatic Escalation

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Automatic Enrollment Automatic Escalation

• Applies to any plan allowing elective salary
  deferrals
• Employees enrolled in plan unless elect otherwise
• Plan document specifies percentage
• Employees can opt out or elect different percent
• Default percentage must be uniformly applied
• Qualified Automatic Contribution Arrangement
  (QACA)
• Exemption from nondiscrimination testing
  conditioned on
• Default deferral percentage
• Starts at 3 and increases to 6 maximum 10
• Matching Contribution (100 match up to 1 of
  compensation plus 50 between 1 and 6 of
  compensation) or 3 Nonelective Contribution
• 100 vesting in matching or nonelective
  contribution after 2 YOS
• No hardship distributions for required employer
  contributions

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Automatic Enrollment Automatic Escalation

• Eligible Automatic Contribution Arrangement
  (EACA)
• Withdrawals allowed within 90 days of
  first auto contribution
• Notice Requirements for QACA and EACA
• Written explanation of rights not to
  have auto contributions or to elect
• deferral percentage other than
  default percentage
• Timing reasonable period before beginning of
  each plan year
• Must give reasonable period of time after receipt
  to make alternative election and, in the case of
  a QACA, to make investment elections
• Excess Deferrals
• Participant must notify plan by April 15 of
  following year
• Corrective distributions of excess deferrals to
  be reported on Form 1099
• Potential double tax if excess not withdrawn by
  April 15

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Automatic Enrollment Automatic Escalation

• Failure 1
• Plan sponsor fails to implement plans auto
  enrollment provisions by not deferring salary of
  an employee who did not make an election
• Corrected by providing nonelective employer
  contribution. Missed deferral is the plans auto
  enrollment deferral percentage multiplied by
  employees compensation. Required corrective
  contribution under IRS VCP is 50 of this missed
  deferral
• Failure 2
• Employee never receives enrollment materials
  and is, therefore
• treated as an excluded participant rather
  than a participant whose
• deemed election has not been implemented
• Corrected by making nonelective employer
  contribution equal to 50 of missed deferral
  which is the ADP for the employees group (NHCE
  or HCE) multiplied by employees annual
  compensation

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• 2. 403(b) Plan Universal Availability Problem

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403(b) Plan Universal Availability Problem

• Elective salary deferrals must be available to
  any employee
• Exceptions
• Employee who will contribute 200 or less
  annually
• Employee eligible to make elective deferrals to
  457(b) or 401(k) plan or another 403(b) plan
• Nonresident aliens
• Students performing certain services and certain
  employees not meeting minimum age and service
  requirements
• Employees normally working fewer than 20 hours
  per week
• Exception conditioned on working less than 1,000
  hours in a 12-month period and subsequent
  12-month periods
• No part-time exception
• Universal availability applies separately to each
  501(c)(3) entity even if multiple entities
  participate in same plan

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403(b) Plan Universal Availability Problem

• Universal availability standard met only if at
  least once each plan year plan lets employee make
  or change a cash or deferred election
• Universal availability requires meaningful notice
  of right to defer
• Rule only applies to elective deferrals, not
  employer match or discretionary or mandatory
  employer contributions
• Some plans are drafted so that the eligibility
  standard for these nonelective contributions is
  the same as universal availability. In these
  cases, operational failure occurs if universal
  availability not applied to nonelective
  contributions.

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403(b) Plan Universal Availability Problem

• Failure 1
• Excluding employees based on a job classification
  which is not one of the classes excepted from
  universal availability rule, such as part-time
  workers
• Corrected by making employer contribution under
  IRS VCP program of missed deferral Rev Proc
  2013-12 provides special rule for calculating
  403(b) corrective contribution which will
  generally be 1.5 of employees compensation
  adjusted for lost earnings and any match.
  Mistake may be eligible for self correction if
  error was insignificant and sufficient compliance
  procedures were in place
• Failure 2
• Failure to properly notify a group of employees
  of their right to make deferrals
• Corrected by making employer contribution under
  same methodology as Failure 1.

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• 3. Shared and Leased Employees

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Shared and Leased Employees

• Employee status controls application of plan
  rules
• Control (over when, where and how to perform
  services) is key to determining whether worker is
  common law employee (1992 Supreme Court Darden
  case, Rev Rul 87-41
• Shared employee definition a person working for
  ( and under control of) more than one business at
  a time
• Example staff nurse working for several medical
  practices
• Each practice is the employer simultaneously and
  credits all hours of service for purposes of plan
  eligibility
• Pro rata share of shared employees compensation
  from each employer is allocated to the separate
  plans maintained by each employer
• Failure
• Violation of qualified plan rules to exclude
  nurse from participation in any retirement plans
  maintained by medical practices if nurse has
  1,000 hours of service overall
• Correction require each plan to include nurse
  as participant

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Shared and Leased Employees

• Leased employee definition a person on the
  payroll of one company but working for another
  company
• Example employee on payroll of PEO who actually
  performs services for PEOs client. If client
  controls the leased employees work, however,
  employee will be treated as employed by client,
  not as a shared employee (Rev. Proc. 2002-21)
• For purposes of plan coverage, vesting,
  nondiscrimination and top heavy rules, a leased
  employee is treated as an employee of client
  organization, not PEO (Code 414(n))
• Definition of leased employee
• Full time 1 year
• Contract between client organization and PEO for
  employee services
• Primary control by client organization

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Shared and Leased Employees

• Safe Harbor exception to treatment of leased
  employee as employee of client if employee is
  covered by PEO plan, subject to
• Leased employees no more than 20 of clients
  NHCE workforce
• Money purchase plan
• Minimum contribution(nonintegrated) - 10 of
  compensation
• Full vesting
• Immediate participation by the leased employees
• Failure
• IRS takes position that if leased
  employee is effectively a common law
• employee of client, covering this
  employee under PEO plan violates
• exclusive benefit rule
• Correction Exclude employee from
  PEO plan. Also include leased
• employees as participants in client
  plan unless client plan specifically
• excludes them. If client maintains
  401k) plan, inclusion of leased
• employees may require making
  nonelective contributions that
• compensate leased employee for
  missed deferral. Consider amending
• plan to exclude leased employees

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• 4. Compensation Done Incorrectly

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Compensation Done Incorrectly

• Amount of plan benefits or contributions
  frequently expressed as percent of compensation
• Code 401(a)(17) limits annual compensation that
  can be taken into account
• Limit in 2014 will be 260,000
• Plan definition of compensation must be
  nondiscriminatory under Code 414(s)
• Designed based safe harbors
• Include regular or base salary or wages and
  commissions, tips, overtime, premium pay and
  bonuses
• Exclude reimbursements, expense allowances,
  fringe benefits, moving expenses and deferred
  compensation
• Reasonable formula not favoring HCEs
• Examples Rate of pay vs. actual pay - Pay only
  while plan participant vs. pay for entire plan
  year
• Plan that includes bonuses but excludes overtime
  might be treated as discriminatory
• Test is whether average percentage of total
  compensation included under the definition for
  HCEs exceeds by more than de minimis amount the
  average percentage of total compensation included
  for NHCEs

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Compensation Done Incorrectly

• Failure 1 Plan allocation is based on
  compensation that exceeds the limit
• Correction (two alternative methods)
• Reduce account balance of affected employee by
  improperly allocated amount (adjusted for
  earnings) if excess amount would have been
  allocated to other employees in year of failure,
  it must be reallocated to those employees after
  adjusting it for earnings
• Alternative fix adopt plan amendment increasing
  maximum percentage of compensation and contribute
  additional amount for each other employee who
  received an allocation in failure year
• Example plan contribution rate equals 5 of
  compensation
• 5 applied to Employee Xs 300K comp. In 2012
  when limit was 250,000 - reduce Xs account by
  2,500 excess and reallocate
• Alternatively, retroactively amend plan to raise
  rate to 6

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Compensation Done Incorrectly

• Failure 2 improper exclusion of bonuses,
  overtime, commissions or another element of
  compensation from base on which employees may
  make elective deferrals
• Correction employer contribution equal to 50
  of missed deferral opportunity which would be the
  employees elected percentage of compensation
  that would have been deferred from the excluded
  compensation element. Also contribute any
  applicable match and lost earnings
• Failure 3 Improper deferral on items not
  included in plan definition of compensation
• Correction Distribute excess elective
  deferrals plus earnings to participant. Forfeit
  match related to excess deferrals and either
  reallocate or use to offset future employer
  contributions

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• 5. Controlled Group Issues

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Controlled Group Issues

• Rules apply as if all controlled group employees
  worked for employer adopting the plan
• Applies to eligibility, vesting, minimum
  participation, determining contributions and
  benefits, nondiscrimination, compensation limits,
  top heavy rules and simplified employee pension
  and simple retirement accounts
• Minimum Participation Example
• Failure Company A maintains a qualified plan
  with a one year service requirement only for its
  employees but is a member of a controlled group
  of corporations that includes Company B.
  Employee X completes 3 years of service with
  Company B and then transfers to Company A.
• Correction The plan must recognize Xs service
  with Company B and admit her as a participant
  immediately.
• Highly Compensated Employee Example
• Failure Company C and Company D are controlled
  group members each of which pay Employee Y a
  salary of 60,000 for 2013.
• Correction For purposes of nondiscrimination
  testing, Employee Y will be considered highly
  compensated, since the HCE limit for 2013 is
  115,000 and Employee Ys aggregate compensation
  is 120,000.

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Controlled Group Issues

• Discrimination Testing Example
• Failure Company E maintains a 401(k) plan for
  its employees that has never been extended to its
  wholly-owned subsidiary F Company. When the
  minimum coverage test is run, including the
  employees of F Company, the 401(k) plan fails to
  satisfy Code 410(b) and, as a result ceases to
  be tax-qualified.
• Correction NHCEs of Company F must be included
  as participants on a retroactive basis and
  receive a QNEC sufficient to pass ADP/ACP test
• SIMPLE IRA Example
• Failure SIMPLE IRAs can be established only by
  an employer which had no more than 100 employees
  who made at least 5,000 for the preceding year.
  Company G maintains a SIMPLE IRA for its 80
  employees (all whom made more than 5,000 last
  year). Company G has a brother/sister affiliate,
  Company H, which is a member of the same
  controlled group as Company G and has 40
  employees who made over 5,000. Because
  Companies G and H must be treated as a single
  employer, Company G is ineligible to maintain the
  SIMPLE plan.
• Correction Stop employer and employee
  contributions. File VCP application requesting
  that contributions made for previous years remain
  in the employees SIMPLE IRAs.

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• 6. Bad Plan Documentation

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Bad Plan Documentation

• IRS definition of plan document failure
• A plan provision (or absence of a plan provision)
  that violates Code qualification requirements
• Arises under 2 scenarios
• New law passes or regulations issued and plan not
  timely amended to meet new rules
• Plan not timely amended during remedial amendment
  period for adopting good faith or interim
  amendments
• Interim amendments are required to keep a plan up
  to date between remedial amendment cycles
• Examples of recent law changes with expired
  deadline
• Conversion of 401(k) accounts to Roth without
  distribution
• Allowing nonspouse beneficiary distributions via
  rollover
• Allowing suspension of required distributions for
  2009
• Special benefits for participants w/qualified
  military service
• Faster vesting of employer contributions under
  PPA 2006

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Bad Plan Documentation

• Correcting Amendment Failures
• Adopt amendments for missed tax law changes
• Look for IRS sample language in model amendments
  and List of Required Modifications
• Effective date of amendment should be retroactive
  to conform plan terms to legislative requirement
• File VCP submission with IRS
• Submission is expected to include the executed
  amendments that will correct the failure
• Issuance of compliance statement by IRS results
  in amendments being treated as if they had been
  adopted timely
• Avoiding Future Failures
• Do annual review of plan document
• Designate person responsible for identifying
  time-sensitive amendments
• Use annual cumulative list published by IRS
  (e.g., see Notice 2012-76)

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• 7. Prohibited Transactions
• A. Plan Services B. Bad 408(b)(2)
  Disclosure

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Prohibited Transaction and Plan Services

• Furnishing goods, services or facilities to plan
  is a prohibited transaction unless arrangement
  qualifies for exemption
• Violation results in 15 excise tax and100 tax
  if not corrected
• Four requirements for exemption
• Service must be necessary to establish or operate
  plan
• Necessary means appropriate or helpful
• Service contract must be reasonable
• Plan must be able to terminate contract without
  penalty on short notice
• Plan should not be locked into an arrangement
  that becomes unfavorable
• Long-term lease is acceptable only if it can be
  terminated before expiration
• Minimal early termination fee to allow recoupment
  of start-up costs is acceptable
• Plan should pay no more than reasonable
  compensation
• Management Evaluates reasonableness of fees by
  market rate for comparable services
• Disclosure by service provider

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Bad 408(b)(2) Disclosure

• Regulation effective in 2012 requires plan
  service provider to make written disclosures to
  plan
• Description of services
• Whether services to be performed as fiduciary
• Compensation to be received from plan and from
  third parties
• Bad disclosure makes service arrangement a
  prohibited transaction by plan fiduciary and
  service provider
• Failures can be cured
• Plan must make written request for information
  and provider must respond within 90 days
• Service provider refusal or inability to comply
  with request for information requires plan
  fiduciary to notify DOL
• Plan fiduciary must decide whether to terminate
  services
• Presumption is termination
• Services to be continued only if prudent
• Good faith mistakes must be corrected no more
  than 30 days after provider knows of error or
  omission

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• 8. Illiquid Plan Assets

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Illiquid Assets

• Holding illiquid assets is problematic for an
  ERISA plan if
• Purchased in non-exempt prohibited transaction
  involving party in interest
• Purchase was an imprudent decision or
• It is imprudent for plan to continue to hold the
  asset
• Examples of illiquid assets
• Restricted and thinly traded stock
• Limited partnership interest
• Real estate
• Collectibles
• Plan fiduciary must determine that asset is
  illiquid because
• Asset failed to appreciate, provide reasonable
  rate of return or caused loss
• Sale is in plans best interest
• Asset cannot be sold for its original purchase
  price or FMV (if greater) to a person other than
  person who is a party in interest to the plan
• May correct by selling to related party subject
  to conditions

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Illiquid Assets

• Conditions of correction by selling to party in
  interest
• Purchase price on sale to party in interest must
  be greater of
• FMV of asset at time of resale (unreduced by sale
  costs)
• Original purchase price plus lost earnings under
  DOL calculator
• Qualified independent appraiser must report on
  Assets FMV
• Application to DOL
• Documentation of original purchase price to be
  included in submission
• DOL no action letter
• Allows correction or assets original acquisition
• Permits sale of asset in transaction that
  otherwise might be prohibited
• Example
• Plan buys real property from party in interest in
  1999 for 60,000. Plan official makes illiquid
  asset determination in 2004. In 2004, appraiser
  values property at 20,000. Plan sponsor pays
  plan 60,000 plus lost earnings and plan
  transfers real estate to plan sponsor.

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• 9. Late Elective Deferrals

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Late Elective Deferrals

• When participant funds become plan assets
• Amounts that a participant pays to an employer or
  amounts that a participant has withheld from
  wages must be paid to the plan trust on earliest
  date they can be segregated from employers
  general assets
• Safe harbor for plans with fewer than 100
  participants deadline for remittance to trust is
  7th business day following day on which the
  amount is received by the employer or would have
  been payable to the participant in cash
• IRS Failure
• Employer fails to remit participant elective
  deferrals by the earliest date employer can
  reasonably segregate deferral deposits from
  general assets. This will not be an operational
  failure for VCP purposes if plan does not have
  language relating to time contributions are
  deposited. If plan has timing language, there
  will be a qualification failure for failing to
  follow plan terms.
• Correction Employer makes contributions with
  earnings up to date of correction. VCP
  submission should describe new procedural
  safeguards adopted to ensure that deposits will
  be timely made.

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Late Elective Deferrals

• DOL Failure
• Regardless of plan language, failure to make
  timely remittance will be a prohibited
  transaction for DOL purposes.
• Correction employer required to make delinquent
  contributions plus greater of
• Lost earnings or
• Restoration of profits resulting from employers
  use of the delinquent funds prior to making
  contribution
• DOL Voluntary Fiduciary Correction Program
  requires extensive documentation
• Narrative of remittance practices and
  certification by plan official of earliest date
  when remittance possible
• Copy of payroll documents showing date / amount
  of each withholding
• Relief from submission of documentary evidence if
  amount is below 50,000 or delinquency is less
  than 180 days

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• 10. Bad Administration

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Bad Administration - Loans

• Loans - In order for a plan loan to not be
  considered a taxable distribution, it must meet
  certain IRC requirements
• Maximum amount of loan
• Repayable within 5 years with exception for
  certain home loans
• Level amortization and not less than quarterly
  payments
• Failure 1 - Plan sponsor permits loan in excess
  of Code limit
• Failure - Loan is more than lesser of (a) 50 of
  vested account balance (but not less than
  10,000) or (b) 50,000 reduced by highest amount
  owed on other loans by the participant during
  prior one-year period
• Correction Participant repays excess amount to
  plan. Principal balance of loan reamortized over
  5 years from date of original loan
• Failure 2 Loan repayment period more than 5
  years
• Failure Loan provides 6-year term
• Correction Plan sponsor can avoid treating loan
  as taxable distribution by filing VCP
  application. Remaining balance of loan at time
  of submission would be reamortized so that loan
  is fully paid by end of 5 years measured from
  loan date.

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Bad Administration Loans Hardship Withdrawals

• Loan Failure 3 Repayment Failure
• Failure Employee fails to make loan repayments
  according to repayment schedule (e.g., employees
  loan information not forwarded to payroll dept.
  which would have implemented repayment by payroll
  deductions.
• Correction - Two alternatives under VCP provide
  relief from reporting loan as distribution
• Participant to repay missed payments plus accrued
  interest in lump sum and repay loan balance over
  remaining loan term or
• Loan may be reamortized over remaining term
• If plan provides that a loan does not become
  deemed distribution until end of calendar quarter
  following quarter in which payment was missed,
  the cure period may allow administrator to fix
  problem without VCP or other negative
  consequences
• Failure 1 Due to Financial Hardship Withdrawal
• Failure - Elective deferrals not suspended for
  6-month period following financial hardship
  withdrawal, as required by the Code and plan
  terms
• Correction 6 months of improper deferrals
  treated as current taxable distribution. File
  VCP application and distribute deferrals plus
  earnings.

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Bad Administration Hardship Withdrawals
Eligibility

• Failure 2 Due to Financial Hardship Withdrawal
• Failure Employer permits participant to take
  hardship withdrawal from a 401(k) plan that does
  not provide for such withdrawals
• Correction File VCP application requesting
  authorization to amend plan retroactively to
  permit hardship distributions
• Eligibility Failures
• In general, employees must be allowed to
  participate in a qualified plan if
• They have attained age 21 and
• They have at least 1 year of service
• Failure - Employer permits employees who have not
  met its 401(k) plans eligibility conditions to
  become participants
• Correction Two alternatives
• If prematurely included employees are primarily
  NHCE, employer may file VCP submission requesting
  that plan be retroactively amended to permit
  their participation. Impact of amendment must
  not be discriminatory
• Distribute improper employee deferrals and notify
  them of their taxability

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Speaker Biography Marcia S. Wagner
Marcia is a specialist in pension and employee
benefits law, and she is the principal of The
Wagner Law Group, one of the nations largest
boutique law firms, specializing in ERISA,
employee benefits and executive compensation,
which she founded over 18 years ago. A summa cum
laude and Phi Beta Kappa graduate of Cornell
University and a graduate of Harvard Law School,
she has practiced law for over twenty-seven
years. Ms. Wagner was appointed to the IRS Tax
Exempt Government Entities Advisory Committee
and ended her three-year term as the Chair of its
Employee Plans subcommittee, and received the
IRS Commissioners Award. Ms. Wagner has also
been inducted as a Fellow of the American College
of Employee Benefits Counsel. For the past six
years, 401k Wire has listed Ms. Wagner as one of
its 100 Most Influential Persons in the 401(k)
industry, and she has received the Top Women of
Law Award in Massachusetts and is listed among
the Top 25 Attorneys in New England by Boston
Business Journal.

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ERISA COMPLIANCE AND ERRORSTop Ten Mistakes

• Marcia S. Wagner, Esq.
• 99 Summer Street, 13th FloorBoston, MA
  02110Tel [phone] Fax [phone]
  Website www.wagnerlawgroup.commarcia_at_wagnerlawgr
  oup.com
• A118399.pptx