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Trust Examination Manual

Advisory Opinion 2003-09A

June 25, 2003
2003-09A
ERISA Sec. 406(b)(1), 406(b)(3)


Gary W. Howell
Gardner, Carton & Douglas
191 North Wacker Drive, Suite 3700
Chicago, IL 60606

Dear Mr. Howell:

This is in response to your request for guidance under the Employee Retirement Income Security Act of 1974 (ERISA). In particular, you ask whether a trust company’s receipt of 12b-1 and subtransfer fees from mutual funds, the investment advisers of which are affiliates of the trust company, for services in connection with investment by employee benefit plans in the mutual funds, would violate section 406(b)(1) and 406(b)(3) of ERISA when the decision to invest in such funds is made by an employee benefit plan fiduciary or participant who is independent of the trust company and its affiliates.

You write on behalf of ABN AMRO Trust Services Company (AATSC), a state-chartered trust company. You represent that AATSC is a wholly owned subsidiary of Alleghany Asset Management Company (Alleghany), which is a wholly owned subsidiary of ABN-AMRO North America Holding Company, a bank holding company (ABN-AMRO).(1)

Alleghany is also the parent organization of several institutional investment advisers (Advisers), including some that have entered into investment advisory contracts with mutual funds registered under the Investment Company Act of 1940. You refer to those mutual funds with which such Advisers have investment advisory contracts as ‘Proprietary Funds.’ All other mutual funds are referred to as ‘Non-Proprietary Funds.’

You represent that AATSC provides directed trustee and ‘non-fiduciary’ services to participant-directed and other defined contribution pension plans (Client Plans) through ‘bundled service’ arrangements. You represent that these services (Plan Services) provided by AATSC through bundled service arrangements include, but are not limited to, custodial trustee services, participant level recordkeeping, participant communications and educational materials and programs, voice response system access to accounts for participants, plan documentation, including prototype plans, summary plan descriptions and annual reports, tax compliance assistance, administrative assistance in processing plan distributions and loans, and a facility for plan investment options.

In connection with the Client Plan-related business, AATSC has entered into shareholder service arrangements with distributors of, or investment advisers to, mutual fund families pursuant to which AATSC will make mutual fund families available for investment by Client Plans. Among the investment advisers with which AATSC enters into such arrangements are those Advisers with investment advisory contracts with Proprietary Funds.

You represent that neither AATSC, nor any other bundled service provider of which AATSC is aware, engages in arrangements where just Plan Services are provided. You represent that, because the true cost of Plan Services would exceed any amount that could be charged in the competitive bundled service market with regard to a Client Plan’s engagement of AATSC as a bundled service provider, all bundled service arrangements between AATSC and a Client Plan are predicated on a Client Plan’s offering of one or more Proprietary Funds as an investment option.

You represent that disclosures with regard to Proprietary Funds will enable the fiduciaries of potential Client Plans to make an informed decision regarding whether to engage AATSC in a bundled service arrangement. Included in every proposal made by AATSC to a potential Client Plan are the following disclosures regarding each Proprietary Fund offered:

the total number of actively-managed mutual funds in the same category as the Proprietary Fund (based on fund classifications by Lipper, Morningstar, or some other generally recognized mutual fund analytical service);

the investment advisory fee, 12b-1 fee (if any) and other fees paid by the Proprietary Fund, as well as the aggregate fees paid by such Proprietary Fund; and

  1. the same fee information described in (b) with respect to the highest-fee, lowest-fee, median-fee, and average-fee fund in the same category as the Proprietary Fund.

    You represent that participant-directed and other defined contribution pension plans become Client Plans through a process of presentation and negotiation. Typically, a plan sponsor, on behalf of a potential Client Plan, either directly, or through a third-party consultant, will ask AATSC to respond to a ‘request for proposal’ to provide a bundle of services for the plan, such as recordkeeping, directed trusteeship, participant investment education, participant loan and distribution processing and investment vehicles. You represent that a potential Client Plan will typically ask other bundled service providers also to respond to a request for proposal.

    Client Plan fiduciaries select the funds in which the Client Plans will invest. AATSC does not restrict the mutual funds that a Client Plan may utilize, beyond requiring, as a condition of engagement, that a Client Plan select at least one Proprietary Fund to offer as an investment option. AATSC will, if requested, provide a list of investment funds for the Client Plan to consider. The Client Plan fiduciaries are free to select funds other than those listed by AATSC. Your representations indicate that AATSC, under the terms of a bundled service arrangement, will not be able to assert any influence with respect to selection of other investment options in which Client Plans will invest or the particular Proprietary Fund in which the Client Plan elects to invest.

    Potential Client Plan fiduciaries are free to accept, reject or further negotiate a bundled service arrangement from AATSC. Based upon such flexibility on the part of a potential Client Plan with respect to negotiation of the terms surrounding engagement of AATSC to provide Plan Services, you represent that engagement of AATSC results from arm’s length negotiations between a potential Client Plan and AATSC.

    You represent that a Client Plan’s choice of investment vehicles affects the cost of engaging AATSC to provide Plan Services. AATSC estimates the amounts that a potential Client Plan would likely invest in Proprietary Funds based on the amount of the Client Plan’s assets and the number of Proprietary Funds selected. This estimate affects the price at which AATSC offers to perform Plan Services. For example, if Client Plan fiduciaries may direct investment into three Proprietary Funds, Plan Services would cost less than if Client Plan fiduciaries may direct investment into two Proprietary Funds. Similarly, Client Plan fiduciaries that may direct investment into only one Proprietary Fund would be quoted a higher price for bundled services, because AATSC would expect to cover less of the cost of providing Plan Services from asset management revenue.

    As a directed trustee, AATSC takes direction from Client Plans regarding their selection of investment options. You assert that, because AATSC does not restrict the mutual funds that a potential Client Plan may utilize, the preparation and furnishing of a list offering an array of mutual fund choices does not constitute discretion to add or delete mutual fund families in which Client Plans may invest.

    You represent that if a Client Plan decides to remove a Proprietary Fund as an investment option, AATSC’s total anticipated revenue from the Client Plan and Proprietary Fund would be affected, leaving less asset management revenue with which to provide Plan Services. In such a situation, you represent that AATSC would invite the Client Plan fiduciaries to consider one or more other Proprietary Funds to replace non-Proprietary Fund investment options. If the plan fiduciaries do not choose to offer another Proprietary Fund as an investment option, AATSC would continue to provide Plan Services pursuant to the bundled services arrangement, but would evaluate such arrangement, as follows.

    If AATSC determines that a bundled service arrangement is no longer profitable, AATSC can withdraw or make an offer to the Client Plan fiduciaries to renegotiate the fees for AATSC’s provision of Plan Services. You represent that AATSC’s bundled service arrangements generally include a provision whereby AATSC may propose a fee adjustment upon sixty days’ written notice. In addition, either party can terminate a bundled service arrangement without cause, upon at least thirty days’ advance written notice. Upon termination of a bundled service arrangement, funds are transferred on the effective date of appointment of a successor trustee.

    You represent that AATSC has the systems and administrative capability to provide investment facilities to a Client Plan for any mutual fund that accepts investments from pension plans. You represent that the majority of mutual funds are traded by AATSC on the National Securities Clearing Corporation (NSCC) ‘platform’ for processing transactions in mutual funds. Mutual fund transactions processed through NSCC’s ‘Fund/SERV’ service are made on its standard, highly automated platform that links approximately 2,000 key providers in the mutual fund industry, including AATSC. For those few funds utilized by Client Plans that do not participate in NSCC, generally because of their small size or low volume of trades, you represent that AATSC processes trades manually, in a manner consistent with industry practice.

    You ask whether AATSC’s receipt of 12b-1 and subtransfer agency fees from mutual funds, including those Proprietary Funds the investment advisers of which are affiliates of AATSC, for services in connection with investment by employee benefit plans in the mutual funds, would violate section 406(b)(1) and 406(b)(3) of ERISA when the decision to invest in such funds is made by an employee benefit plan fiduciary who is independent of AATSC and its affiliates.(2)

    Section 3(14)(A) and (B) of ERISA provides that a party in interest means, as to an employee benefit plan, any fiduciary, including a trustee, of an employee benefit plan or a person providing services to a plan. ERISA section 3(21)(A) provides that a person is a fiduciary with respect to a plan to the extent that it (i) exercises any authority or control respecting management or disposition of its assets, (ii) renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of the plan, or has any authority or responsibility to do so, or (iii) has any discretionary authority or responsibility in the administration of the plan. Accordingly, as directed trustee of Client Plans, AATSC will be a party in interest and a fiduciary.

    Section 406(a)(1)(C) of ERISA proscribes the provision of services to a plan by a party in interest, including a fiduciary, and section 406(a)(1)(D) prohibits the use by or for the benefit of, a party in interest, of the assets of a plan. However, section 408(b)(2) of ERISA provides an exemption from the prohibitions of section 406(a) of ERISA for contracting or making reasonable arrangements with a party in interest, including a fiduciary, for office space, or legal, accounting, or other services necessary for the establishment or operation of the plan, if no more than reasonable compensation is paid.

    29 CFR 2550.408b-2 provides, with respect to a reasonable contract or arrangement, that no contract or arrangement is reasonable within the meaning of section 408(b)(2) and 29 CFR 2550.408b-2(a)(2) if it does not permit termination by the plan without penalty to the plan on reasonably short notice under the circumstances to prevent the plan from becoming locked into an arrangement that has become disadvantageous. Your representations indicate that, pursuant to the Client Plan’s arrangement with AATSC and consistent with 29 CFR 2550.408b-2(c), the Client Plan may terminate a bundled service arrangement without cause and without penalty, upon at least thirty days’ advance written notice.(3)

    Section 406(b)(1) of ERISA prohibits a fiduciary with respect to a plan from dealing with the assets of the plan in its own interest or for its own account. Section 406(b)(3) of ERISA prohibits a fiduciary with respect to a plan from receiving any consideration for its own personal account from any party dealing with the plan in connection with a transaction involving the assets of the plan.

    With respect to the prohibitions in section 406(b), regulation 29 CFR 2550.408b-2(a) indicates that section 408(b)(2) of ERISA does not contain an exemption for an act described in section 406(b) of ERISA (relating to conflicts of interest on the part of fiduciaries) even if such act occurs in connection with a provision of services which is exempt under section 408(b)(2). As explained in regulation 29 CFR 2550.408b-2(e)(1), if a fiduciary uses the authority, control, or responsibility which makes it a fiduciary to cause the plan to enter into a transaction involving the provision of services when such fiduciary has an interest in the transaction which may affect the exercise of its best judgment as a fiduciary, a transaction described in section 406(b)(1) would occur, and that transaction would be deemed to be a separate transaction from the transaction involving the provision of services and would not be exempted by section 408(b)(2). Conversely, the regulation explains that a fiduciary does not engage in an act described in section 406(b)(1) if the fiduciary does not use any of the authority, control, or responsibility which makes such person a fiduciary to cause a plan to pay additional fees for a service furnished by such fiduciary or to pay a fee for a service furnished by a person in which such fiduciary has an interest which may affect the exercise of such fiduciary’s best judgment as a fiduciary.

    You assert that principles previously expressed by the Department in Advisory Opinion 97-15A(4) would apply here. In Advisory Opinion 97-15A, the Department opined that if a trustee acts pursuant to a proper direction in accordance with sections 403(a)(1) or 404(c) of ERISA and does not exercise any authority or control to cause a plan to invest in a mutual fund that pays a fee to the trustee in connection with the plan’s investment, then the trustee would not be dealing with assets of the plan for its own interest or for its own account in violation of section 406(b)(1) of ERISA and the trustee would not be receiving consideration for itself from a third party in connection with a transaction involving plan assets in violation of section 406(b)(3).

    The arrangement about which you request the Department’s guidance differs from the facts of Advisory Opinion 97-15A. In that letter, the trustee had reserved the right to add or remove mutual fund families that it made available to its client plans. The trustee also agreed to apply any fees it received from the mutual funds to the benefit of the plans. You represent that, once a Client Plan enters into a bundled service arrangement with AATSC, the Client Plan fiduciary possesses authority to make decisions regarding investment fund choices and any modifications to the menu of investment fund choices available for investment of plan assets.

    In Advisory Opinion 97-16A,(5) the Department expressed the view that a person would not be exercising discretionary authority or control over the management of a plan or its assets solely as a result of deleting or substituting a fund from a program of investment options and services offered to plans, provided that the appropriate plan fiduciary in fact makes the decision to accept or reject the change. In this regard, the Department went on to opine that the plan fiduciary must be provided advance notice of the change, including disclosure of record-keeper fee information and must be afforded a reasonable amount of time in which to accept or reject the change. Such advance notice ensured that the fiduciary would maintain independence with respect to selection of investment options offered. Similar to the arrangement described in Advisory Opinion 97-16A, here a Client Plan sponsor or other fiduciary shall, independent of AATSC, maintain complete control with respect to the selection of funds in which the Client Plan will invest. AATSC itself has no role with respect to selection of investment options beyond requiring, as a condition of initial engagement of AATSC as a bundled service provider, that at least one Proprietary Fund is offered by a Client Plan for investment.

    You represent that when a Client Plan engages AATSC to provide bundled services, a Client Plan fiduciary, independent of AATSC or its affiliates, will select the Client Plan’s investment options. We note, however, that if, with respect to a particular Client Plan, AATSC provides ‘investment advice’ within the meaning of regulation 29 CFR 2510.3-21(c), AATSC would engage in a violation of section 406(b)(1) of ERISA in causing the Client Plan to invest in a Proprietary Fund (or any mutual fund that pays a fee to AATSC or its affiliates).

    It is the view of the Department that AATSC’s receipt of 12b-1 or subtransfer fees from mutual funds, including those Proprietary Funds the investment advisers of which are affiliates of AATSC, for services in connection with investment by employee benefit plans in the mutual funds, under the circumstances described above, would not violate section 406(b)(1) or 406(b)(3) of ERISA when the decision to invest in such funds is made by a fiduciary who is independent of AATSC and its affiliates, or by participants of such employee benefit plans.

    Finally, it should be noted that ERISA’s general standards of fiduciary conduct also would apply to the proposed arrangement. Section 403(c)(1) of ERISA provides that the assets of a plan shall never inure to the benefit of any employer and shall be held for the exclusive purposes of providing benefits to participants and beneficiaries and defraying reasonable expenses of administering the plan. Under section 404(a)(1) of ERISA, the responsible plan fiduciaries must act prudently and solely in the interest of the plan participants and beneficiaries both in deciding whether to enter into, or continue, arrangements with AATSC and in determining the investment options in which to invest or make available to plan participants and beneficiaries in self-directed plans.

    This letter constitutes an advisory opinion under ERISA Procedure 76-1, 41 Fed. Reg. 36281 (Aug. 27, 1976). Accordingly, it is issued subject to the provisions of that procedure, including section 10 thereof relating to the effect of advisory opinions.

    Sincerely,
    Louis Campagna
    Chief, Division of Fiduciary Interpretations
    Office of Regulations and Interpretations



    Footnotes

    In your initial submission, you wrote on behalf of The Chicago Trust Company (TCTC). Since the date of submission, TCTC has been renamed AATSC, effective January 1, 2002. This change is in name only and was effected without any legal change in the individual corporate status of TCTC. AATSC continues as a state-chartered trust company under the original charter and corporate status granted by the state to the former TCTC, and remains in the same legal relationship, by way of ownership, to Alleghany and ABN-AMRO.
  2. Consistent with Prohibited Transaction Exemption 96-74, granted to TCTC, TCTC will never receive any 12b-1 or subtransfer agency fees from its Proprietary Funds in connection with the conversion of certain collective investment fund units into shares of Proprietary Funds. Furthermore, you represent that AATSC relies upon Prohibited Transaction Class Exemption 77-4 to cover situations where AATSC may serve as a fiduciary to a Client Plan with authority to select investments, including Proprietary Funds. In Advisory Opinions 93-12A and 93-13A, the Department expressed the view that it was unable to conclude that PTE 77-4 would be available for plan purchases and sales of mutual fund shares if a 12b-1 fee is paid to the fiduciary or its affiliate with regard to that portion of the mutual fund’s assets attributable to the plan’s investment.
  3. The Department expresses no view as to whether the conditions contained in section 408(b)(2) of ERISA would be satisfied with respect to any arrangement between AATSC and a Client Plan.

Issued on May 22, 1997.

Issued on May 22, 1997.



 
Last Updated 04/02/2008

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