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Trust Examination Manual

Appendix E — Employee Benefit Law

Advisory Opinion 77-46

Diversification Applicability to Insured and Uninsured Deposits

June 7, 1977

Summary

Indicates a plan may invest in own-bank:

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Insured deposits without violating ERISA diversification requirements.

Uninsured deposits without violating ERISA diversification requirements if the bank's assets are diversified.

U.S. Department of Labor

Pension and Welfare Benefits Programs

Washington, D.C. 20216

June 7, 1977 AO 77-46

Mr. Frederic S. Kramer

Assistant General Counsel

National Association of Mutual Savings Banks

200 Park Avenue

New York, N. Y. 10017

Dear Mr. Kramer:

Thank you for your letter requesting our advice as to whether the diversification rule of the Employee Retirement Income Security Act of 1974 (ERISA) permits savings bank trustees or custodians to invest contributions under self-employed retirement plans and individual retirement account plans (IRAs) in savings accounts and deposits with the trustee or custodian savings bank where the account balance exceeds the $40,000 amount covered by FDIC insurance. With respect to IRAs, we assume your question refers to an IRA which is established by an employer or union (or other employee association), since an IRA established by an individual for himself is not subject to Title I of ERISA. I regret the delay in responding to your letter.

You explain that the National Association of Mutual Savings Banks represents the 475 mutual savings banks in the United States which are authorized under the Internal Revenue Code of 1954 to act as trustees or custodians of self-employed retirement plan funds and IRAs. You advise that many jurisdictions in which savings banks do not enjoy trust powers have enacted legislation permitting savings banks to act as fiduciaries with respect to such plans and that New York law is typical of such legislation. You state that New York law provides that savings banks shall have the power to act as trustees of such plans provided that the provisions of these plans "require the funds of such trust to be invested exclusively in deposits in savings banks" (section 237.7 and 237.8, New York Banking Law). Accordingly, typical provisions in self-employed retirement plans and IRAs in savings banks jurisdictions authorizing savings banks to act as trustees of these accounts provide that the funds of such trusts will be invested exclusively in savings accounts or deposits in the trustee (or custodian) savings bank.

You advise that mutual savings banks are state chartered institutions that derive their powers, including investment powers, from their respective states; as state chartered institutions, mutual savings bank investments are not regulated by federal law.

You have submitted a chart showing the types of legal investments for mutual savings banks, by state, which was most recently compiled as of September 30, 1975. The chart shows that mutual savings banks in Connecticut, Delaware, Maryland, Massachusetts, New Hampshire, Oregon, Pennsylvania, Rhode Island, and Washington are permitted to invest in the following: U.S. Government bonds; state, county, and municipal bonds; railroad bonds; equipment obligations; telephone bonds; electric utility bonds; Canadian bonds; real estate construction loans; conventional mortgage loans; 20 percent mortgage loans; FHA loans; VA loans; large-scale housing; equity securities; bank stock; collateral loans; unsecured notes; acceptances and bills of exchange. The chart also shows that mutual savings banks in Maine, New Jersey, New York, Ohio, and Vermont are permitted to invest in all but one of these types of investments and that Minnesota, Indiana, Alaska, and Wisconsin are somewhat more restrictive in the types of investments permitted for such banks. In all of the above-named states, except Indiana, Vermont, and Wisconsin, mutual savings banks are permitted to invest in equity securities, as well as in debt instruments.

You have also submitted a booklet containing a list of securities considered legal investments for savings banks under section 235 of the New York Banking Law as of July 1, 1975, and financial statements showing the actual investments of three mutual savings banks (a large bank, a small one, and a medium-sized one).

You explain that the investment authority of mutual savings banks differs from that of commercial banks in that while practically all mutual savings banks can invest in equity securities, commercial banks are prohibited, with limited exceptions, from investing in stocks of corporations. Also, while mutual savings banks' authority to invest in equity securities is generally far broader than that of commercial banks, commercial banks have the power to make short term commercial loans at rates which may be tied to the prime rate and further may make such loans to any one issuer or borrower in an amount up to ten percent of the bank's capital stock, paid-in and unimpaired, plus ten percent of its unimpaired surplus fund.

Section 404(a)(1)(C) of ERISA requires a fiduciary to discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries and by diversifying the investments of the plan so as to minimize the risk of large losses, unless under the circumstances it is clearly prudent not to do so. The Conference Report (H. Rep. No. 93-1280, 93rd Congress, 2nd Session) states, on page 305, that the conferees intend that, in general, whether the plan assets are sufficiently diversified is to be determined by examining the ultimate investment of the plan assets. For example, the conferees understand that for efficiency and economy plans may invest all their assets in a single bank or other pooled investment fund, but that the pooled fund itself could have diversified investments. It is intended that, in this case, the diversification rule is to be applied to the plan by examining the diversification of the investments in the pooled fund. The same is true with respect to investments in a mutual fund. Also, generally a plan may be invested wholly in insurance or annuity contracts without violating the diversification rules, since generally an insurance company's assets are to be invested in a diversified manner. The Conference Report also explains, on page 314, that it is expected that the prudent man, diversification, and other rules of section 404(a) of ERISA generally will not be violated if all plan assets in an individual account plan are invested in a federally-insured account, so long as the investments are fully insured. (If an individual's account balance is greater than the amount covered by federal insurance, this will not violate the prudence and diversification requirements if the individual participant or beneficiary has control over his account and determines, for himself, that the assets should be so invested.)

With respect to control, section 404(c) of ERISA states that in the case of a pension plan which provides for individual accounts and permits a participant or beneficiary to exercise control over assets in his account, if a participant or beneficiary exercises control over the assets in his account (as determined under regulations of the Secretary) -- (1) such participant or beneficiary shall not be deemed to be a fiduciary by reason of such exercise and (2) no person who is otherwise a fiduciary shall be liable under Part I of ERISA for any loss, or by reason of any breach, which results from such participant's or beneficiary's exercise of control. However, the Conference Report states, on pages 305-306, that the conferees recognize that there may be difficulties in determining whether the participant in fact exercises independent control over his account. Consequently, whether participants and beneficiaries exercise independent control is to be determined pursuant to regulations prescribed by the Secretary of Labor. The conferees expect that the regulations generally will require that for there to be independent control by participants, a broad range of investments must be available to the individual participants and beneficiaries.

You believe that although the term "control" is not defined by ERISA, the requisite control would exist even though substantial penalties for withdrawal from retirement plan accounts are imposed both by the FDIC and the Internal Revenue Code. A participant can withdraw his funds, which are fully vested at all times, at any time subject to these penalties. A participant's control over his IRA is such that he can, once every three years, withdraw the entire amount of the funds in his account and reinvest the proceeds in another IRA funded through insurance contracts or a mutual fund, or through the deposits of another financial institution.

Alternatively, in the event it is determined that the individual participant or beneficiary does not have control over the account as that term might be defined in regulations, you suggest that recognition of the diversification of insurance company investments, discussed on page 305 of the Conference Report, should apply equally to those of a mutual savings bank. You believe that the investment alternatives of a savings bank are, in much the same way as the investment alternatives of an insurance company, strictly regulated to insure the sound and prudent investment of these kinds of funds.

As noted above, no regulations have yet been issued under section 404(c). In the absence of such regulations, we are unable to respond to the question of control.

[FDIC Note: DOL Regulation 2550.404c-1 was not adopted until 10-13-92.]

With respect to your second question as to whether section 404(a)(1)(C) of ERISA permits investment of all the assets of an individual account plan in savings accounts of mutual savings banks where the account balance exceeds the amount covered by Federal insurance, it is the view of the Department of Labor that such an investment would not, in and of itself, contravene the diversification requirements of section 404(a)(1)(C), assuming that the bank invested its assets in a diversified manner. As noted by the Conference Report at p. 314, to the extent that the investment in the account balance is not in excess of the amount covered by Federal insurance, the diversification standard will not be violated, as there cannot be large losses. However, the individual account plan may invest all its assets in a savings bank even if such amount exceeds the amount covered by Federal insurance, without violating the diversification rules, if the bank's assets are invested in a diversified manner. The fiduciary making such investment would, of course, have to determine whether the bank's assets were diversified so as to minimize the risk of large losses.

We are expressing no opinion as to whether in practice the investments of self-employed retirement plans or IRAs in any specific mutual savings bank or any specific group of mutual savings banks are actually sufficiently diversified to meet the requirements of section 404(a)(1)(C).

Sincerely,

Fred W. Stuckwisch

Director

Office of Regulatory Standards and Exceptions

Advisory Opinion to Bank Plan (79-49)

Payment of Fiduciary Fee to Bank Sponsor of Plan

May 14, 1979

Summary

Indicates a bank plan may provide fiduciary services to its own plan only on a no-fee basis.

U.S. Department of Labor

Labor-Management Services Administration

Washington, D.C. 20216

Washington Service Bureau Reference

May 14, 1979 79-49

Mr. Alfred T. Spada

Hogan and Hartson

815 Connecticut Avenue, N.W.

Washington, D.C. 20006

Re: Riggs National Bank Amended Pension Plan

Dear Mr. Spada:

This is in response to your letter of September 8, 1977, in which you seek our opinion as to whether the appointment and service of the Riggs National Bank (the Bank) as trustee of the Riggs National Bank Amended Pension Plan (the Plan) would constitute a prohibited transaction under section 406 of the Employee Retirement Income Security Act of 1974 (ERISA) or would otherwise be prohibited under ERISA.

In your letter, you represent that the Board of Directors of the Bank adopted the Plan in September 1976 and the related amended trust agreement in May 1977. These documents include an amendment substituting Riggs as trustee of the Plan in place of various individuals currently serving as trustees. You further represent that the Bank will not receive any fee or other compensation from the Plan for its services as trustee.

A number of provisions in Part 4 of Subtitle B of Title I of ERISA seem to imply that an employer of a plan's participants may serve as trustee of the plan.

Section 402(c)(1) states that any employee benefit plan may provide that any person or group of persons may serve in more than one fiduciary capacity with respect to the plan (including service both as trustee and administrator).

Section 408(c)(3) provides that the restrictions of section 406 shall not prohibit a fiduciary from serving as a fiduciary in addition to being an officer, employee, agent, or other representative of a party in interest. Under section 3(14)(C), an employer any of whose employees are covered by a plan is a party in interest with respect to the plan.

Section 408(b)(4)(A) permits the investment of Plan assets in deposits which bear a reasonable interest rate in a bank or similar financial institution supervised by the United States or a State, if such bank or other institution is a fiduciary of the plan and if the plan covers only employees of the bank or other institution and employees of affiliates of such bank or other institution.

Part 4 of Subtitle B of Title I of ERISA contains no provision that prohibits an organization from being both an employer of a plan's participants and a trustee of the plan. We note, however, that the conduct of any organization in its capacity as trustee would be subject to the fiduciary responsibility requirements of Part 4, including section 404 (relating to fiduciary duties) and section 406 (relating to prohibited transactions).

Section 406(a)(1)(C) of ERISA provides generally that a plan fiduciary shall not cause the plan to engage in a transaction, if he knows or should know that such transaction constitutes a direct or indirect furnishing of goods, services, or facilities between the plan and a party in interest.

Section 408(b)(2), however, exempts from the prohibitions of section 406 contracting or making reasonable arrangements with a party in interest for office space, or legal, accounting, or other services necessary for the establishment or operation of a plan, if no more than reasonable compensation is paid therefore.

Regulation 2550.408b-2 explains that the 408(b)(2) exemption applies only to transactions described in section 406(a) of ERISA. If the furnishing of a service involves an act described in section 406(b) (relating to conflicts of interest by fiduciaries), such act constitutes a separate transaction which in not exempt under section 408(b)(2). The prohibitions of section 406(b) are intended to deter fiduciaries from exercising the authority, control, or responsibility which makes them fiduciaries when they have interests which may conflict with the interests of the plans for which they act. Thus, section 406(b) would prohibit a fiduciary from using the authority, control, or responsibility which makes such person a fiduciary to cause a plan to pay an additional fee to such fiduciary (or to a person in which such fiduciary has an interest which may affect the exercise of such fiduciary's best judgment as a fiduciary) to provide a service.

Section 2550.408b-2(c)(3) of the regulation states, however, that if a fiduciary provides services to a plan without the receipt of compensation or other consideration (other than reimbursement of direct expenses properly and actually incurred in the performance of such services), the provision of such services does not, in and of itself, constitute an act described in section 406(b) of ERISA.

We regret the delay in responding to your request, and hope you find this general information helpful.

Sincerely,

Alan D. Lebowitz

Assistant Administrator

Office of Fiduciary Standards

Advisory Opinion to OCC (80-OCC)

Investment in Fiduciary Bank/Holding Company Securities

July 25, 1980

Summary

(1) The discretionary purchase, retention, or sale of a fiduciary bank's own stock, or that of its own holding company, would involve a violation of ERISA's prudence requirement in § 404(a)(1)(B). If the fiduciary had a direct or indirect interest in the transaction, a violation of ERISA § 406(b) would occur.
(2) The non-discretionary purchase, retention, or sale of a fiduciary bank's own stock, or that of its own holding company, would not involve a violation of ERISA.

U.S. Department of Labor

Labor-Management Services Administration

Washington, D.C. 20216

Reply to the Attention of:

Ivan Strasfeld

(202) 523-8971

July 25, 1980

Mr. Dean E. Miller

Deputy Comptroller for Specialized Examinations

Comptroller of the Currency

Administrator of National Banks

Washington, D.C. 20219

Dear Mr. Miller:

By letter dated May 27, 1980, you presented certain issues arising under the prohibited transactions provisions contained in Part 4 of Title I of ERISA that are often discerned by your trust examiners during the course of their inspections.

Accordingly, you have requested guidance with regard to the following questions:

  1. Where a bank has sole investment responsibility with respect to the assets of an employee benefit plan, will the purchase for the plan of the bank's stock or its holding company's stock constitute a prohibited transaction under ERISA? If so, which provisions of section 406 would it violate? (You have asked us to assume that the stock will not be purchased from a party in interest).
  2. Where the bank as trustee is directed by a named fiduciary authorized to direct the investments of a plan, will the directed purchase for the plan of the bank's stock or its holding company's stock constitute a prohibited transaction under ERISA? (Again, you ask us to assume that the stock will not be purchased from a party in interest).
  3. Where an investment manager has been named, will the purchase of the bank trustee's stock or its holding company's stock at the direction of the investment manager constitute a prohibited transaction under ERISA?
  4. Does the retention by a plan of the bank trustee's stock or its holding company's stock constitute a prohibited transaction under ERISA?

The prohibited transactions provisions of ERISA restrict the acquisition and holding by an employee benefit plan of securities issued by an employer-sponsoring company. See section 407 of ERISA. No such explicit proscription or limitation applies to stock of a bank trustee or holding company thereof.

However, section 406(a)(1)(D) of ERISA prohibits a fiduciary with respect to a plan from causing the plan to engage in a transaction if he knows or should know that such transaction constitutes a direct or indirect transfer to, or use by or for the benefit of, a party in interest, of any assets of the plan. The ERISA Conference Report (H.R. Rep. No. 93-1280; 93d Cong., 2d Session 308 (1974)) clarifies this prohibition by stating, among other things, "... securities purchases or sales by a plan to manipulate the price of the security to the advantage of a party in interest constitutes a use by or for the benefit of a party in interest of any assets of the plan."

Sections 406(b)(1) and (2) further prohibit a fiduciary from dealing with the assets of a plan in his own interest or for his own account or acting in any transaction involving the plan on behalf of a party or representing a party whose interests are adverse to the interests of its participants or beneficiaries. The prohibitions of section 406(b) of ERISA impose upon fiduciaries a duty of undivided loyalty to the plans for which they act. Moreover, the codification of the "prudent man rule" contained in section 404(a)(1) of ERISA provides in relevant part:

... a fiduciary shall discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries and ...

(B)   with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like characters and with like aims.

Although a determination of whether a violation of sections 406(b)(1) or (2) and 404(a) has occurred will generally depend on the particular facts and circumstances of each case, it burdens our imagination to envision a situation in which a trustee with investment discretion could make an objective decision, solely on the basis of the prudence standard, regarding the purchase or sale of its own stock [emphasis added]. For example, a trustee may exercise his or her discretion based on inside information regarding the bank's financial condition. Although, in a particular case, it may be in the plan's best interest to sell the bank stock, the sale of such stock might cause a further decline in its market value. In such case, the bank trustee would have an interest in the transaction which would conflict with the interest of the plan for which he acts so as to be in violation of section 406(b)(2) of ERISA.

A bank trustee may avoid engaging in an act described in section 406(b)(1) or (2) of ERISA by not using the authority, control or responsibility which makes it a fiduciary to cause a plan to purchase or sell bank stock. Thus, the purchase or sale of bank stock by a trustee pursuant to the instructions of a named fiduciary or investment manager not affiliated with such trustee will not result in violations of such 406(b) of ERISA.

It should be noted that the inquiry concerning whether a fiduciary has violated section 406(b)(1) and (2) of ERISA is not limited to a decision whether to buy or sell bank stock. At all times that a trustee acts in a fiduciary capacity, he may make no decision on behalf of a plan which would have the effect of benefiting a person in which such fiduciary has an interest. A decision to retain bank stock in the plan portfolio, as well as decisions to buy or sell such stock, may involve acts described in section 406(b) of ERISA. However, to the extent a trustee has no discretion regarding retention of bank stock, (e.g., the decision to retain bank stock is, in fact, made by an independent investment manager), no violation of section 406(b)(1) or (2) will occur.

We hope this information provides adequate guidance to you in the implementation of examination policy. Of course, we would welcome any further inquiries raised under the fiduciary responsibility provisions of ERISA.

Sincerely,

Alan D. Lebowitz

Assistant Administrator for Fiduciary Standards

Pension and Welfare Benefit Programs

Advisory Opinion/Individual Exemption 85-36A

Loans Intended to Benefit Union Members/Employers

October 23, 1985

Summary

[Construction Loan by Construction Union Plan to Provide Employment for Union Members] (1) The loan would probably be a prohibited transaction in violation of ERISA § 406(a)(1)(D) as it would benefit employers contributing to plan, and (2) might violate ERISA § 404 (as imprudent and/or undiversified) and ERISA § 403 (as plan assets benefiting contributing employers).

U.S. Department of Labor

Office of Pension and Welfare Benefit Programs

Washington, D.C. 20210

Ralph P. Katz

Delson & Gordon

230 Park Avenue

New York, NY 10169

RE: Annuity Fund of the Electrical Industry of Long Island

Identification Number: F-2521

Dear Mr. Katz:

This is in response to your letter of September 23, 1982, in which you requested clarification regarding the application of the prohibited transaction provisions of the Employee Retirement Income Security Act of 1974 (ERISA) to a proposed investment by the Annuity Fund of the Electrical Industry of Long Island (the Fund). Specifically, you inquired whether a prohibited transaction would occur if the trustees of the Fund made an investment which was part of an overall agreement obligating an insurance company to invest a specified amount of insurance company assets in construction mortgages within the geographic jurisdiction of the union whose members are participants in the Fund. The agreement would further require the insurance company to make such investments in construction projects employing only labor represented by unions affiliated with the AFL-CIO. You state that the trustees will make the investment after determining that the investment rate of return is equal to or greater than similar investments bearing similar risks.

Section 406(a)(1)(D) of ERISA prohibits a fiduciary with respect to a plan from causing the plan to engage in a transaction which the fiduciary knows or should know constitutes a direct or indirect transfer to, or use by or for the benefit of, a party in interest, of any assets of the plan. Section 406(b)(1) and (2) of ERISA further prohibit a fiduciary with respect to a plan from dealing with the assets of a plan in his or her own interest or for his or her own account, or acting in any transaction on behalf of a party or representing a party whose interests are adverse to the interest of the plan or its participants.

Section 3(14) of ERISA defines the term party in interest to include a fiduciary, an employer any of whose employees are covered by the plan, and any employees of such employer.

We wish to point out, as we have done in prior correspondence regarding this matter, that ERISA's general standards of fiduciary conduct apply to your proposed investment course of action. Sections 403(c) and 404(a)(1) of ERISA require, among other things, that a fiduciary of a plan act prudently, solely in the interest of the plan's participants and beneficiaries, and for the exclusive purpose of providing benefits to participants and beneficiaries. As you know the Department, on a number of occasions, has expressed its views as to the meaning of these requirements in the context of investment decision-making.

We have stated that, to act prudently, a plan fiduciary must consider, among other factors, the availability, riskiness, and potential return of alternative investments for his plan. Because the investment you propose causes the plan to forego other alternative investment opportunities, such an investment would not be prudent if it provided a plan with less return, in comparison to risk, than comparable investments available to the plan, or if it involved a greater risk to the security of plan assets than other investments offering a similar return.

We have construed the requirements that a fiduciary act solely in the interest of, and for the exclusive purpose of providing benefits to, participants and beneficiaries as prohibiting a fiduciary from subordinating the interests of participants and beneficiaries in their requirement income to unrelated objectives. Thus, in deciding whether and to what extent to invest in a particular investment, a fiduciary must ordinarily consider only factors relating to the interests of plan participants and beneficiaries in their retirement income. A decision to make an investment may not be influenced by desire to stimulate the construction industry and generate employment, unless the investment, judged solely on the basis of its economic value to the plan, would be equal or superior to alternative investments available to the plan.

Thus, it would not be inconsistent with the requirements of sections 403(c) or 404 of ERISA for plan fiduciaries to select an investment course of action that reflects non-economic factors, so long as application of such factors follows primary consideration of a broad range of investment opportunities that are, economically advantageous.

Based on the representations made in your letter, it does not appear that the arrangement you describe would involve a prohibited transaction of the kind described in sections 406(a)(1)(A), (B) or (C) of ERISA (relating to sales, leases or other exchanges of property, loans or other extensions of credit and the furnishing of goods, services or facilities). In addition, it does not appear that the arrangement involves a direct transfer of plan assets to, or use of plan assets by or for the benefit of, a party of interest of the kind described in section 406(a)(1)(D) of the Act.

Nonetheless, it is reasonable to infer that the arrangement will result in some benefit to parties in interest with respect to the plan, i.e. contributing employers and their employees. Thus, it is necessary to determine whether the arrangement would involve an indirect use of plan assets for the benefit of a party in interest.

In the circumstances you describe, where the arrangement would be prohibited, if at all, solely as an indirect use of plan assets for the benefit of a party in interest,* the Department believes that it is appropriate to examine the facts and circumstances surrounding the plan's investment to determine whether it is made for the purposes of providing a prohibited benefit. Since this is an inherently factual determination, the Department is not prepared to issue an advisory opinion regarding the specific arrangement described in your letter.

In our view, however, a plan investment which is made subject to a condition which can reasonably be expected to result in a benefit to one or more parties in interest would violate section 406(a)(1)(D) (as well as sections 403 and 404 of the Act) if it involves greater a greater risk or a lesser return to the plan than a comparable transaction that is not subject to such a condition.

This letter constitutes an advisory opinion under ERISA Procedure 76-1. Accordingly, this letter is issued subject to the provisions of that procedure, including section 10 thereof, relating to the effect of advisory opinions.

Sincerely,

Elliot I. Daniel

Assistant Administrator for Regulations and Interpretations

* This kind of arrangement should be distinguished from a plan investment made subject to a condition which in effect makes the transaction an indirect sale or loan.

ERISA Section 403(c)(1)

"Except as provided in paragraph (2) or (3) of subsection (d), or under section 4042 and 4044 (relating to termination of insured plans), the assets of a plan shall never insure to the benefit of an employer and shall be held for the exclusive purposes of providing benefits to participants in the plan and their beneficiaries and defraying reasonable expenses of administering the plan."

Editor Note: - Paras (2) and (3) [of 403(c)] relate to the tax-qualification and tax-deductibility of contributions, and so are not germane to this situation.

- Subsection (d) [of 403] and sections 4042 and 4044 deal with returning excess plan assets to plan sponsors upon termination of plans, and so are not germane to this situation.

Advisory Opinion/Individual Exemption 86-FRB

Sweep Arrangements and Related Sweep Transaction Fees

August 1, 1986

Summary

Covers sweeps from ERISA accounts into own/affiliated-bank deposits and other internal short-term investment vehicles, together with fees that may be charged for such transactions.
Also released is an OCC Trust Interpretive Letter #40 dated August 1, 1986.

U.S. Department of Labor Pension and Welfare Benefits Administration

Washington, D.C. 20210

Mr. Robert S. Plotkin

Assistant Director

Division of Banking Supervision and Regulation

Board of Governors of the Federal Reserve System

Washington, D.C. 20551

Dear Mr. Plotkin:

This is in response to your letter requesting our views regarding the application of the prohibited transaction provisions of the Employee Retirement Income Security Act of 1974 (ERISA) to certain "sweep services" provided to employee benefit plans by banks acting as trustees and/or investment managers. Under such arrangements, banks transfer ("sweep") idle cash balances of customer accounts, including plan accounts, into short term interest bearing investment vehicles such as money market funds or bank-affiliated short-term collective investment funds. You have specifically asked whether such "sweep services" would qualify for the statutory exemptions provided by sections 408(b)(2), 408(b)(6) and/or 408(b)(8) of ERISA.

You indicate that the bank regulatory agencies for many years have been advising the institutions subject to their supervision of their duty to institute cash management procedures and to productively invest trust funds that are temporarily in their custody. Recent technological advances have permitted increased investment returns to trust accounts by the sweeping of once idle cash balances into interest-bearing investment vehicles. You further state that typically, as compensation for its sweep services, a bank retains as its fee a portion of the daily interest generated by the sweep fund, which fee is calculated as a percentage of the daily invested cash balance. In the case of an employee benefit plan, you believe that this compensation retained by a bank may violate the prohibited transaction provisions of ERISA in the absence of an applicable statutory exemption.1

Section 406(a) of ERISA provides, in pertinent part, that a fiduciary of an ERISA plan shall not cause the plan to engage in a transaction which the fiduciary knows or should know constitutes a direct or indirect: (1) sale or exchange, or leasing of any property between the plan and a party in interest; (2) furnishing of goods, services, or facilities between the plan and a party in interest; or (3) transfer to, or use by or for the benefit of a party in interest, of any asset of the plan. Section 3(14) defines the term "party in interest" to include a fiduciary and a person providing services to the plan. In addition, section 406(b) provides that a fiduciary with respect to a plan shall not: (1) deal with the assets of the plan in its own interest or for its own account; (2) act on behalf of or represent a part whose interests are adverse to those of the plan; or (3) receive consideration from a third party in connection with a transaction involving plan assets.

ERISA section 408(b)(2) exempts from the prohibitions of section 406(a) the payment by a plan to a party in interest, including a fiduciary, for a service (or a combination of services if: (1) the service is necessary for the establishment or operation of the plan; (2) the service is furnished under a contract or arrangement which is reasonable; and (3) no more than reasonable compensation is paid for the service. Accordingly, the mere provision of cash sweep services by a bank or similar institution would be exempt from the prohibitions of ERISA section 406(a) if the conditions of the exemption described in section 408(b)(2) were met.2

With respect to the prohibitions in section 406(b), regulation 29 C.F.R. 2550.408b-2(a) indicates that ERISA section 408(b)(2) does not contain an exemption for an act described in ERISA section 406(b) (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 C.F.R. 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) 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).

As a general matter, a bank engages in violations of section 406(b)(1) whenever it uses its fiduciary authority or control with respect to plan funds to increase the amount of its compensation by determining the timing and/or the amount of plan funds to be transferred into the sweep fund.3 Conversely, section 29 C.F.R. 2550.408b-2(e)(3) indicates that if a bank provides sweep services without the receipt of additional compensation or other consideration (other than reimbursement of direct expenses Properly and actually incurred in the performance of such services within the meaning of 29 C.F.R. 2550.408c-2(b)(3)), then the provision of sweep services by the bank would not, in itself, constitute a violation of section 406(b) of ERISA. Moreover, the provision by a bank of investment management services, including sweep services, under a single arrangement which is calculated as a investment management services, including sweep services, of the market value of the total assets under management would not, in itself, constitute an act described in section 406(b)(1) of ERISA because the bank would not be exercising its fiduciary authority or control to cause a plan to pay an additional fee.

The following examples illustrate the application of the of section 408(b)(2) of ERISA to sweep service arrangement. The examples assume that the underlying investment transactions otherwise comply with applicable statutory exemptions.

(1) A plan enters into a standing arrangement with its bank investment manager which authorizes the bank to exercise its discretion to sweep idle cash balances into the bank's money market fund. For this service, the bank will charge the plan a fee calculated as a percentage of the daily invested cash balance in the money market fund. In effect, the bank would be using its fiduciary authority to cause the plan to pay an additional fee for a service performed by the bank in violation of section 406(b)(1) of ERISA. Although there would be initial approval of the arrangement by the plan, thereafter the bank would have total discretion to transfer plan funds into the money market fund and to determine how long the plan funds remain in such fund, thereby increasing its compensation. In this respect, we note that a bank which exercises its fiduciary authority in a manner which contravenes section 406(b)(1) cannot avoid liability simply by obtaining the consent of an independent plan fiduciary after disclosure to that fiduciary. See 29 C.F.R. 2550.408b-2(f), Example (2).

(2) Bank A proposes to provide investment management services, including sweep services, to plans under a single fee arrangement which is calculated as a percentage of the market value of the plan funds under management. There will be no separate charges for the provision of sweep services. Under these circumstances, the provision by Bank A of investment management services, including sweep services, would not, in itself, constitute a violation of section 406(b)(1) because the bank would not be using its fiduciary authority or control to cause a plan to pay additional fees for a service furnished by the Bank. We are assuming for purposes of this example that the total fees to be paid by a plan are reasonable in light of the investment management services received by that plan.

(3) Trustee Bank B proposes to enter into an arrangement with a plan for the provision of sweep services under the following circumstances. The Bank would have a standing authorization whereby, at the close of each business day, the Bank would be required to sweep all uninvested cash in excess of $100 into the Bank's money market fund. For this service, the Bank will charge the plan a fee calculated as a percentage of the daily invested cash balance in the money market fund. Investment Manager C, who is unrelated to the Bank, is the plan's investment manager as described in section 3(38) with the power to acquire or dispose of the plan's assets. C has sole discretion as to when money will be withdrawn from the fund. The plan's arrangement with the Bank is subject to immediate termination without penalty and requires that the Bank notify the plan no less than 30 days prior to any change in the fees to be charged for its provisions of sweep services. This arrangement does not violate section 406(b)(1) because the Bank would not be exercising any of its fiduciary authority or control to cause the plan to pay an additional fee.

You further indicate that some banks have been relying on the exemption provided by section 408(b)(6) of ERISA. Section 408(b)(6) exempts from the prohibitions of section 406 the provision of certain ancillary services by a bank or similar financial institution supervised by the United States or a State to a plan for which it acts as a fiduciary if the conditions of 29 C.F.R. 2550.408b-6(b) are met. Such ancillary services include services which do not meet the requirements of ERISA section 408(b)(2) because the provision of such services involves an act described in section 406(b)(1) or (b)(2) of ERISA, section 2550.408b-6(b) requires that such services must be provided at not more than reasonable compensation; under adequate internal safeguards which assure that the provision of such service is consistent with sound banking and financial practice, as determined by Federal or State supervisory authority; and only to the extent such service is subject to specific guidelines issued by the bank or similar financial institution which meet the requirements of section 2550.408b-6(c). To date, no regulations have been issued clarifying that section. However, the Department has stated that the condition contained in section 408(b)(6)(B) requiring "specific guidelines" is satisfied (in the absence of such regulations) if the ancillary services are provided in accordance with specific guidelines issued by the bank or similar financial institution, and if adherence to the guidelines would reasonably preclude such bank or institution from providing the services in an excessive or unreasonable manner and in a manner that would be inconsistent with the best interests of the participants and beneficiaries. (See 47 FR 14806, April 6, 1982.)

A bank which is a fiduciary to a plan may receive additional fees for additional services rendered only if such services are "ancillary services." In the Department's view, the question of whether short-term cash management services constitute "ancillary services" within the meaning of section 408(b)(6) depends on the expectations of the parties as evidenced by the terms of the governing instrument and applicable Federal banking law. Thus, for example, the Department believes that where a plan appoints a bank trustee or investment manager with complete discretion to manage the assets placed in its control, and no provision for short-term cash management is made under the terms of the governing instrument, the plan does so with the expectation that such person will minimize uninvested cash balances and maximize the plan's rate of return in accordance with evolving technology for short-term cash management. However, where, for example, a plan appoints an independent investment manager to manage plan assets, the provision by a custodial trustee bank of sweep services for any idle cash balances may constitute an "ancillary service" within the meaning of section 408(b)(6). At the present time, the Department is not prepared to conclude that section 408(b)(6) is available in all cases For the arrangements described in your letter.

You further indicate that some banks appear to be relying on the exemption provided by ERISA section 408(b)(8) to invest plan funds in collective trust funds maintained by such banks.

Section 408(b)(8) of ERISA provides an exemption for any transaction between a plan and a common or collective trust fund maintained by a bank or trust company supervised by a State or Federal agency, if (a) the transaction is a sale or purchase of an interest in the fund, (b) the bank or trust company receives not more than reasonable compensation, and (c) the transaction is expressly permitted by the instrument under which the plan is maintained, or by a fiduciary (other than the bank or trust company, or an affiliate thereof) who has authority to manage and control the assets of the plan. The Department has been unwilling to indicate the extent to which section 408(b)(8) provides relief from the prohibitions of section 406(b) of ERISA (See 44 FR 44291 n. 3, July 27, 1979). However, if the bank does not exercise its fiduciary authority to cause a plan to pay an additional fee or other compensation in connection with the acquisition by a plan of an interest in a collective trust fund or for the provisions of services under such fund, the investment would not, in itself, involve acts described in section 406(b)(1) of ERISA.

We hope these comments have been helpful. However, if you should have any further questions or if we can provide any further assistance, please feel free to contact Ivan Strasfeld at (202) 523-8671.

Alan D. Lebowitz

Deputy Administrator for Program Operations

cc: Dean Miller

- Footnotes -

  1. Your request appears to be limited to the situation where the bank fiduciary sweeps idle cash balances into its in-house short-term investment vehicles. Accordingly, our response focuses on that situation and does not address the sweep of cash balances into short-term vehicles maintained by parties unrelated to the bank.
  2. The Department notes that, although section 408(b)(2) of ERISA provides relief for the furnishing of goods in the course of, and incidental to, the furnishing of services to a plan, the statutory exemption for services does not extend to underlying investment transactions, such as sales or extensions of credit otherwise described in section 406 of ERISA. Rather, section 408(b)(2) provides relief from the restrictions of section 406(a) only for those service transactions which satisfy the conditions of section 408(b)(2) and the regulations thereunder. For example, if a bank fiduciary sells repurchase agreements to a plan under a sweep service arrangement, section 408(b)(2) may provide relief for the provision of such sweep service, but does not provide relief for the acquisition of the repurchase agreements from the bank.
  3. In this regard, the Department expresses no opinion as to whether the underlying investment transaction itself is the subject of statutory or administrative relief. See, for example, sections 408(b)(4) and 408(b)(8) of ERISA

Advisory Opinion/Individual Exemption 88-02A

Sweep Arrangements and Related Sweep Transaction Fees

February 2, 1988

Summary

Covers sweeps from non-discretionary ERISA accounts into non-affiliated mutual funds, together with fees that may be charged for such transactions.

U.S. Department of Labor Pension and Welfare Benefits Administration

Washington, D.C. 20210

February 2, 1988 88-02A

Sec. 406(b)(1) & (3), 408(b)(2)

Ms. Charlotte 0. Roederer

Vice President and

Associate General Counsel

Manufacturers and Traders Trust Company

One M&T Plaza

Buffalo, NY 14240

Re: Identification Number: F-3634A

Dear Ms. Roederer;

This is in response to your request for an advisory opinion regarding the application of the Employee Retirement Income Security Act of 1974 (ERISA) to certain "sweep services" provided by Manufacturers and Traders Trust Company (the Bank) to employee benefit plans for which the Bank acts as custodian or directed trustee. You specifically ask whether the transactions would qualify for the statutory exemptions provided by sections 408(b)(2) and/or 408(b)(6) of ERISA.

You represent that the bank offers a daily cash "sweep service" to employee benefit plans for which the Bank acts as custodian or directed trustee. For those plans which elect to utilize the sweep service, some or all of the plans' uninvested cash is swept into one of several money market funds, all of which are sponsored by independent third parties. For each plan to which the Bank offers this service, an independent third party (or the employer, other than the Bank) functions as the sole investment advisor. The investment advisor determines whether and how much uninvested cash will be swept, and chooses which of several money market funds will be utilized. The specified amount of uninvested cash is swept into the selected investment vehicle at the close of each business day.

Each month the plans participating in the sweep service receive a dividend from the money market funds based on the prior month's daily invested cash balance in the funds. The bank periodically calculates a "cash sweep" fee which is a percentage of the dividends received by each plan from the funds. The bank receives no fees or other compensation from the money market funds. Thus, you represent that no part of the dividends received are allocated to the Bank for its own account as compensation for sweep services. The cash sweep fee is recorded separately in the periodic accounting and billing which the Bank sends to the employer. For most plans, the fee is calculated and billed on a quarterly basis, but small plan accounts are billed annually. The cash sweep arrangement is subject to immediate termination without penalty and requires that the Bank notify the plan no less than 30 days prior to any change in the fees to be charged for the service.

The provisions of section 406(a)(1)(C) and (D) of ERISA prohibit a fiduciary with respect to a plan from causing the plan to engage in a transaction if he or she knows or should know that the transaction constitutes a direct or indirect furnishing of goods, services, or facilities between the plan and a party in interest, or transfer to, or use by or for the benefit of, a party in interest, of any assets of the plan. Section 406(b)(1) of ERISA further prohibits a fiduciary with respect to a plan from dealing with the assets of the plan in his or her own interest or for his or her own account. Section 406(b)(2) of ERISA provides that a fiduciary shall not in his or her individual or in any other capacity act in any transaction involving the plan on behalf of a party (or represent a party) whose interests are adverse to the interests of the plan or the interests of its participants or beneficiaries. Section 406(b)(3) of ERISA prohibits a fiduciary from receiving a fee or other consideration for his or her own personal account from a party dealing with a plan in connection with a transaction involving the assets of the plan.

Subject to the limitations of section 408(d), section 408(b)(2) of ERISA exempts from the prohibitions of section 406(a) contracting (or making reasonable arrangements) for services (or a combination of services) with a party in interest if: the service is necessary for the establishment or operation of the plan; (2) the service is furnished under a contract which is reasonable; and no more than reasonable compensation is paid for the service. Regulations issued by the Department clarify the terms "necessary service" (29 C.F.R. 2550.408b-2(b)), "reasonable contract or arrangement" (29 C.F.R. 2550.408b-2(c)), and "reasonable compensation" (29 C.F.R. 2550.408c-2).

Accordingly, the provision of sweep services would be exempt from the prohibitions of section 406(a) of ERISA if the conditions of section 408(b)(2) are met.1 We note, however, that the questions of what constitutes a necessary service, a reasonable contract or arrangement, and reasonable compensation are inherently factual in nature. Section 5.01 of Advisory Opinion Procedure 76-1 (ERISA Proc. 76-1, 41 FR 36281, August 27, 1976) states that the Department generally will not issue opinions on such questions.

With respect to the prohibitions in section 406(b), regulation 29 C.F.R. 2550.408b-2(a) states that section 408(b)(2) of ERISA does not contain an exemption for an act described in section 406(b). As explained in 29 C.F.R. 2550.408b-2(e)(1), if a fiduciary uses the authority, control or responsibility that makes him or her a fiduciary to cause the plan to enter into a transaction involving the provision of services when such a fiduciary has an interest in the transaction that may affect the exercise of his or her best judgment as a fiduciary, a transaction described in section 406(b) of ERISA would occur, and the transaction would be deemed to be a separate transaction from the one involving the provision of services and would not be exempted by ERISA section 408(b)(2).

Your letter of March 31, 1987 states that the bank does not have investment discretion with respect to the plans to which the Bank offers the sweep service, and that the decision to utilize the sweep services and compensate the Bank therefore is made by independent investment advisors. Your submission also explains that the Bank will not receive a fee or other benefit from any of the unrelated money market funds into which uninvested cash is swept and that the Bank will notify a plan no less than 30 days prior to any change in the fees to be charged for the service. Your letter also states that each month, the plan receives from the fund into which the plan's assets are swept a dividend based on the prior month's activity and that the bank's "cash sweep" fee is a percentage of these dividends either paid by the plan sponsor or deducted by the Bank (at the instruction of the sponsor) from the assets of the plan.2

In the circumstances you describe, it appears that the Bank would not be exercising any of the authority, control, or responsibility that makes it a fiduciary to cause a plan to pay an additional fee in connection with the "sweep services". Thus, the provision of sweep services would not, in and of itself, involve acts described in section 406(b)(1) of ERISA. The Bank also would not appear to violate section 406(b)(2) because it would not, solely by reason of the circumstances you describe, be acting on behalf of a party whose interests are adverse to those of the plan.3

With respect to section 406(b)(3), the Department notes that, under the described circumstances, the receipt of fees by the Bank from the assets of a plan for the provision of sweep services would not, in itself, constitute a violation of section 406(b)(3) of ERISA.

You also ask whether the provision of sweep services by the Bank would qualify for the statutory exemption provided by section 408(b)(6) of ERISA. However, to the extent that the arrangement you describe is covered by section 408(b)(2), the Department does not find it necessary to address whether an additional statutory exemption is available.

This letter constitutes an advisory opinion under ERISA Procedure 76-1 and is issued subject to the provisions of that procedure, including section 10, relating to the effect of advisory opinions. We note that pursuant to section 5 of ERISA Procedure 76-1, this advisory opinion relates solely to the arrangement described involving the Bank.

Sincerely,

Robert J. Doyle

Acting Associate Director for Regulations and Interpretations

- Footnotes -

  1. The Department expresses no opinion herein regarding the underlying investment of plan assets in the money market funds. In this regard, the Department notes that the statutory exemption for services does not extend to underlying investment transactions such as sales between a plan and a party in interest described in section 406 of ERISA.
  2. We assume that, where the bank's fee is deducted from the assets of a plan, the obligation to pay such fee is, under the governing plan documents, an obligation of the plan and not of the plan sponsor.
  3. In expressing this opinion, the Department assumes that no arrangement exists between either the Bank and any of the above described mutual funds or the directing plan fiduciary and any of the funds such as described in 29 C.F.R. § 2509.75-2(c).

Advisory Opinion/Individual Exemption 88-09A

Investment in Fiduciary Bank/BHC Treasury Stock

April 15, 1988

Summary

(1) Permits self-directed IRAs to purchase stock of the fiduciary bank's parent holding company if: (1) the fiduciary bank is directed in writing to do so by the participant, who is authorized to direct investments, (2) the seller is not a "disqualified person" (the fiduciary bank or a bank insider), and (3) the participant is not a director or officer of the fiduciary bank.
(2) Such purchases may be made from the holding company's treasury stock if the participant gives specific instructions to do so and the fiduciary bank has no decision authority in deciding the seller.

U.S. Department of Labor

Pension and Welfare Benefits Administration

Washington, D.C. 20210

April 15, 1988 A/Opinion 88-09A

Lloyd V. Crawford

Rushton, Stakely, Johnston & Garrette

184 Commerce Street

Montgomery, AL 36104

Re: Bank of Prattville

Identification Number: F-3677A

Dear Mr. Crawford:

This is in response to your letters of May 29 and June 18, 1987 requesting an advisory opinion regarding the application of the prohibited transaction provisions of section 4975 of the Internal Revenue Code of 1986 (the Code). In particular, your letter concerns purchases of stock of the parent (the Parent) of the Bank of Prattville (the Bank) by various self-directed individual retirement accounts (IRAs) sponsored by the Bank.

You represent that the Bank is a banking corporation organized under the laws of the state of Alabama and is wholly owned by the Parent. The Bank qualifies under section 408(a)(2) and 408(n) of the Code as a trustee of IRAs.

The Bank is considering amending the existing master and prototype IRA for which it serves as custodian to include a self-directed feature which permits the participants to direct the investments of their accounts in securities selected by the participants, including stock of the Parent. Pursuant to these amendments, the participants will have complete and sole discretion over the investments, with the Bank acting only as a nondiscretionary trustee or custodian. The Bank will not make any investments or dispose of any investments for the IRAs except upon the written direction of the participants. Neither the Bank nor the Parent will provide any form of investment advice or make investment recommendations. Purchases and sales of securities will be conducted through brokerage accounts which the IRA participants will establish with the Bank.

Parent stock is not traded on any exchange or on the national over-the-counter market system. In cases where an IRA participant directs that funds in his or her account be invested in Parent stock, the stock would be purchased either from the Parent's treasury or from unrelated third parties.

You ask for an opinion with respect to the following questions:

(1)  Will purchases of Parent stock by the Bank as custodian of its IRAs on behalf of and at the sole direction of participants who are neither executive officers nor directors of the Bank constitute prohibited transactions within the meaning of Code section 4975(c)(1), when the purchase is made directly from the Parent's treasury?

(2)  Will purchases of Parent stock by the Bank as custodian of its IRAs on behalf of and at the sole direction of participants who are executive officers or directors of the Bank constitute prohibited transactions within the meaning of Code section 4975(c)(1), when the purchase is made directly from the Parent's treasury?

(3)  Will purchases of Parent stock by the Bank as custodian of its IRAs on behalf of and at the sole direction of participants who are neither executive officers nor directors of the Bank constitute prohibited transactions within the meaning of Code section 4975(c)(1), when the purchase is made directly from a third party who is neither an executive officer or director of the Bank?

(4)  Will purchases of Parent stock by the Bank as custodian of its IRAs on behalf of and at the sole direction of participants who are executive officers or directors of the Bank constitute prohibited transactions within the meaning of Code section 4975(c)(1), when the purchase is made directly from a third party who is neither an executive officer or director of the Bank?

(5)  Will purchases of Parent stock by IRA custodians other than the Bank on behalf of and at the sole direction of participants who are executive officers or directors of the Bank constitute prohibited transactions within the meaning of Code section 4975(c)(1), whether the purchase is made directly from a third party or from the Parent's treasury?

Pursuant to section 2510.3-2(d) of the Department's regulations, the Department does not have jurisdiction under Title I of the Employee Retirement Income Security Act (ERISA) over those individual retirement accounts described in section 408(2) of the Code which comply with the provisions of that section of the regulation.1 Such IRAs are within the purview of Title II of ERISA, section 4975 of the Code. Under Presidential Reorganization No. 4 of 1978, effective December 31, 1978, the authority of the Secretary of the Treasury to issue interpretations regarding section 4975 of the Code has been transferred, with certain exceptions not here relevant, to the Secretary of Labor and the Secretary of the Treasury is bound by the interpretations of the Secretary of Labor pursuant to such authority. To the extent there is Title I jurisdiction regarding any IRA for which the Bank serves as custodian or trustee, references to specific sections of the Code in this letter shall also refer to the corresponding sections of ERISA.

Section 4975(c)(1) of the Code prohibits, in relevant part, the sale or exchange of property between a plan and a disqualified person (4975(c)(1)(A)), the furnishing of goods or services between a plan and a disqualified person (4975(c)(1)(C)), the use by or for the benefit of a disqualified person of the income or assets of a plan (4975(c)(1)(D)), and an act by a disqualified person who is a fiduciary whereby he or she deals with the income or assets of a plan in his or her own interest or for his or her own account (4975(c)(1)(E)).

Section 4975(e)(2) of the Code defines the term "disqualified person" to include a plan fiduciary and a person providing services to a plan.

Thus, the Bank is a disqualified person with respect to the IRAs. The Parent, however, is not a disqualified person with respect to the IRAs solely by reason of its ownership of the Bank.2 The question of whether the Parent is a disqualified person with respect to the IRAs under any other provision of section 4975(e)(2) of the Code is inherently factual in nature. Section 5.01 of Advisory Opinion Procedure 76-1 (ERISA Proc. 76-1, 41 FR 36281, August 27, 1976) states that the Department generally will not issue opinions on such questions.

Therefore, with respect to questions 1 and 2, to the extent that the Parent is not a disqualified person with respect to the IRAs, purchases of stock from the Parent by the Bank on behalf of and at the direction of the IRA participants would not involve transactions described in section 4975(c)(1)(A) of the Code.

With respect to questions 3 and 4, it is the Department's opinion that if the seller of the Parent stock is not otherwise a disqualified person with respect to an IRA, the purchase by the Bank of Parent stock from unrelated third parties on behalf of the IRA does not constitute a transaction described in section 4975(c)(1)(A) of the Code.

With respect to question 5, regarding purchases of Parent stock by IRA custodians other than the Bank on behalf of and at the sole direction of participants who are officers or directors of the Bank from the Parent or an unrelated third party, it is our view that the purchases of Parent stock do not constitute transactions described in section 4975(c)(i)(A) of the Code to the extent that the seller of Parent stock is not a disqualified person with respect to the IRA.3

However, while the Parent may not be a disqualified person with respect to the IRAs sponsored by the Bank, purchases and holding of Parent stock by the self-directed IRAs of officers and directors of the Bank raise questions under section 4975(c)(1)(D) and (E) of the Code, depending on the degree (if any) of the participant's interest in the transaction. The IRA participants, as officers and directors of the Bank, may have interests in the proposed transactions which may affect their best judgment as fiduciaries of their IRAs. In such circumstances, the transactions may violate section 4975(c)(1)(D) and (E) of the Code.

In addition, although the Bank may have no discretion in selecting the investments to be made by the IRAs, it appears that the Bank may have discretion in determining the seller from which the IRAs will purchase Parent stock. To the extent that it does have such discretion, the Bank would be a plan fiduciary with respect to its exercise of such discretion.

Thus, if the IRA participants do not instruct the Bank with respect to such matters but, rather, rely on it as a fiduciary to select appropriate sellers for the transactions, a selection by the Bank of the Parent as seller would raise questions under section 4975(c)(1)(D) and (E) of the Code. This is because the Bank, as a wholly-owned subsidiary of the Parent, has an interest in the fortunes of the Parent. Therefore, the Bank may be in a position to indirectly use the assets of a plan for its own benefit or to deal with the assets of a plan in its own interest.4

We note that you have not requested and consequently the Department is not offering an opinion regarding the provision of brokerage services by the Bank to the IRAs.

This letter constitutes an advisory opinion under ERISA Procedure 76-1. Section 10 of the procedure describes the effect of advisory opinions.

Sincerely,

Robert J. Doyle

Acting Associate Director for

Regulations and Interpretations

  1. Under the regulation, Title I is inapplicable only if:  (1) no contributions to the plan are made by the employer or employee association; (2) participation is completely voluntary for employees or members; (3) the sole involvement of the employer or employee organization is to permit the sponsor to publicize the program and to collect contributions on behalf of the sponsor through payroll deductions or dues checkoffs; and (4) the employer or employee organization receives no consideration in the form of cash or otherwise, other than reasonable compensation for services actually rendered in connection with payroll deductions or dues checkoffs.
  2. However, the Department notes that the Parent may be a party in interest with respect to any IRAs sponsored by the Bank which are within the jurisdiction of Title I of ERISA. In this regard, contrast section 3(14)(H) of ERISA with section 4975(e)(2)(H) of the Code.
  3. We are assuming for the purposes of this letter that the Bank is not acting as an employer, as defined in section 4975(e)(2)(D) of the Code and section 3(14)(C) of ERISA, with respect to the IRAs of officers and directors of the Bank. See Advisory Opinion 85-26, April 10, 1985.
  4. We assume, for purposes of this ruling, that the Bank does not have any authority or responsibility to vote or otherwise deal with Parent stock held by its self-directed IRAs.

Advisory Opinion/Individual Exemption 88-18A

Self-Directed IRA Loans to Company Where IRA Grantor/Beneficiary is Insider

December 23, 1988

Summary

Covers self-directed IRA account loans to company owned by the IRA's grantor/beneficiary.

U.S. Department of Labor Pension and Welfare Benefits Administration

Washington, D.C. 20210

December 23, 1988

Mr. Joseph E. Hurst, Jr.

Friday, Eldredge & Clark

2000 First Commercial Building

Little Rock, AR 72201

Re: Thomas E. Darragh

Identification Number: F-3819A

Dear Mr. Hurst:

Your letter dated January 22, 1988, to the Internal Revenue Service (the Service) has been forwarded to this office for our consideration and response. Your letter concerns whether a loan from an Individual Retirement Account (IRA) to a corporation would violate section 4975(c)(1)(B) of the Internal Revenue Code of 1986 (the Code).

You represent that Thomas F. Darragh established an IRA described in section 408 of the Code. Mr. Darragh is the only participant in the IRA and has reserved the right to direct the IRA's investments. You further represent that Mr. Darragh is currently an employee, shareholder and member of the Board of Directors of Darragh Company (the Corporation). Your subsequent letter of April 28, 1988, indicates that the Corporation has no involvement whatsoever with the establishment or maintenance of the IRA. The Corporation has two classes of stock, Class A voting and Class B nonvoting. Mr. Darragh owns directly and indirectly (pursuant to section 4975(e)(4) and (6) of the Code) 46.04 percent of the total voting power of the Corporation and 48.14 percent of the total issued and outstanding shares of stock.

Mr. Darragh proposes to direct the IRA Custodian, One National Bank, to lend the Corporation approximately $500,000 pursuant to a promissory note entered into by the Corporation. The Corporation will pay the IRA interest on the note based on the then current prevailing market rate of interest which lenders are currently charging to the Corporation.

You have requested an advisory opinion that the proposed loan will not constitute a prohibited transaction under section 4975(c)(1)(B) of the Code.

Pursuant to section 2510.3-2(d) of the Department of Labor's (the Department) regulations, the Department does not have jurisdiction under Title I of the Employee Retirement Income Security Act of 1974 (ERISA) over those IRAs described in section 408(a) of the Code which comply with the provisions of that section of regulation.* Under Presidential Reorganization Plan No. 4 of 1978, effective December 31, 1978, the authority of the Secretary of the Treasury to issue interpretations regarding section 4975 of the Code has been transferred, with certain exceptions not here relevant, to the Secretary of Labor and the Secretary of the Treasury is bound by such interpretations of the Secretary of Labor pursuant to such authority.

Section 4975(c)(1)(B) of the Code prohibits any direct or indirect sale, lending of money or other extension of credit between a plan and a disqualified person. Section 4975(e)(1) of the Code, in relevant part, defines the term plan to include an IRA described in section 408(a) of the Code. Section 4975(e)(2) of the Code defines "disqualified person" to include a fiduciary, an employer any of whose employees are covered by the plan, and a corporation, partnership, or trust or estate of which (or in which) 50 percent or more of (i) the combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock of the corporation, (ii) the capital interest or profits interest of such partnership, or (iii) the beneficial interest of such trust or estate, is owned directly or indirectly, or held by a fiduciary. Section 4975(e)(3) of the Code defines the term fiduciary, in part, to include any person who exercises any discretionary authority or discretionary control respecting management of the plan, or exercised any authority or control respecting the management or the disposition of its assets.

Mr. Darragh is a fiduciary and, thus, a disqualified person with respect to the IRA because of the authority under the IRA to direct investments. You have stated that Mr. Darragh is employed by the Corporation. Although section 4975 does not define the term "employer", section 3(5) of ERISA provides, in part, that an "employer" is any person acting as an employer in relation to an employee benefit plan. You have stated that the Corporation has no involvement with the establishment or maintenance of the IRA. Therefore, it is the opinion of the Department that the Corporation is not a disqualified person with respect to the IRA under section 4975(e)(2)(C) of the Code. In addition, the Corporation is not a disqualified person with respect to the IRA under section 4975(e)(2)(G) of the Code by reason of Mr. Darragh's stock ownership in the Corporation.

Therefore, to the extent that the Corporation is not a disqualified person with respect to the IRA under any other provision of section 4975(e)(2) of the Code, the loan by the IRA to the Corporation would not violate section 4975(c)(1)(B) of the Code.

We note, however, that this conclusion does not preclude the existence of other prohibited transactions under section 4975 of the Code. Section 4975(c)(1)(D) of the Code prohibits any direct or indirect transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a plan. Section 4975(c)(1)(E) of the Code prohibits a fiduciary from dealing with the income or assets of a plan in his own interest or for his own account. Section 54.4975-6(a)(5) of the Pension Excise Tax Regulations characterizes transactions described in section 4975(c)(1)(E) as involving the use of authority by fiduciaries to cause plans to enter into transactions when those fiduciaries have interests which may affect the exercise of their best judgment as fiduciaries. Mr. Darragh is a fiduciary with respect to the IRA. In addition, he has a substantial interest in the Corporation. Therefore, the Corporation is a party in whom Mr. Darragh has an interest which might affect his best judgment as a fiduciary. Accordingly, a prohibited use of plan assets for the benefit of a disqualified person under section 4975(c)(1)(D) or an act of self-dealing under section 4975(c)(1)(E) is likely to result if Mr. Darragh directs the IRA to loan funds to the Corporation. [Emphasis added]

This letter constitutes an advisory opinion under ERISA Procedure 76-1. Accordingly, this letter is issued subject to the provisions of the procedures, including section 10 thereof, relating to the effect of advisory opinions.

Sincerely,

Robert J. Doyle

Acting Associate Director for Regulations and Interpretations

- Footnote -

* Under the regulations, Title I is inapplicable only if the following conditions are met: (1) no contributions to the plan are made by the employer or employee association; (2) participation is completely voluntary for employees or members; (3) the sole involvement of the employer or employee association is to permit the sponsor to publicize the program and to collect contributions on behalf of the sponsor through payroll deductions or dues checkoffs; and (4) the employer or employee association receives no consideration in the form of cash or otherwise other than reasonable compensation for services actually rendered in connection with such payroll deductions or dues checkoffs.

Advisory Opinion/Individual Exemption 88-28

Investment in Fiduciary Bank/BHC Stock in Initial Public Offering

January 26, 1988 (Exemption Application D-7187)

Summary

Self-directed IRA and Keogh accounts may invest in a new issue ("initial public offering") of own-bank stock or own holding company stock if: (1) the fiduciary bank is directed in writing to do so by the participant, who is authorized to direct investments, (2) other investment vehicles are available to the account, (3) not more than 25% of any account's assets will be invested in the stock issue, (4) no fees or commissions are paid, (5) no more than fair market value is paid, and (6) fair market value is determined by an independent appraiser.

U.S. Department of Labor

Office of Pension and Welfare Benefit Programs

Washington, D.C. 20210

People's Bank (People's) Located In

Bridgeport, Connecticut

(Application No. D-7187)

Proposed Exemption

The Department is considering granting an exemption under the authority of section 408(a) of the Act and section 4975(c)(2) of the Code and in accordance with the procedures set forth in ERISA Procedure 75-1 (40 FR 18471, April 21 1975). If the exemption is granted the restrictions of section 406(a) of the Act and the sanctions resulting from the application of section 4975 of the Code, by reason of section 4975(c)(1)(A) thru (D) of the Code shall not apply to the sale by People's of its subsidiary's stock to the Keogh Plans (the Keoghs) for which People's services [sic] as custodian, as part of an initial issue of such stock, and the sanctions resulting from the application of section 4975 of the Code, by reason of section 4975(c)(1)(A) through (D) of the Code shall not apply to the sale by People's of its subsidiary's stock to the individual retirement accounts (the IRAs) for which People's serves as custodian, as part of an initial issue of such stock, provided the Keoghs and IRAs pay no more than the fair market value of the stock on the date of the sale.1

Summary of Facts and Representations

  1. People's is a mutual savings bank organized under the laws of the State of Connecticut. People's is in the process of reorganizing (the Reorganization) pursuant to Connecticut Public Act 85-330 (the Reorganization Act) from its current form as a mutual savings bank to a mutual holding company with a capital stock subsidiary bank (the Bank) which will assume substantially all of the operations of People's. The majority of the bank's stock will be held by People's in its reorganized form as a mutual holding company.
  2. ln connection with, and as part of the Reorganization, the Bank proposes to offer between 20% and 30% of its stock to the public. The Reorganization Act permits the Bank from selling or offering to sell its common stock or securities convertible into common stock unless it first gives to each "eligible account holder" subscription rights to acquire Bank stock pursuant to a subscription offering. Regulations issued by the Department of Banking of the State of Connecticut clearly establish that the IRAs and the Keoghs, held in time deposits by People's as custodian, are eligible accounts requiring that the holders of those accounts receive subscription rights to purchase Bank stock. Accordingly, People's intends to offer its IRA and Keogh depositors subscription rights to Bank stock in connection with the Reorganization. After the Reorganization, the Bank stock will be traded publicly on the Over-the-Counter market.
  3. People's currently acts as custodian for approximately 64,000 IRA customers and 2,000 participants in custodial Keoghs with assets, in the aggregate, of approximately $500 million. These assets represents approximately 12% of total deposits held by People's. People's as custodian has no discretionary authority with respect to the investment of IRA or Keogh assets. All investments are made at the direction of the account holder within the range of investment choices permitted by the plan documents. The applicants represent that no single IRA or Keogh account will be permitted to invest more than 25% of the assets of such account in stock of the Bank in connection with this initial offering.
  4. In accordance with the provisions of the Reorganization Act, People's must submit to the Connecticut Banking Commissioner (the Commissioner) a plan outlining the terms of the subscription offering. Within 15 days from the date of that submission, People's will be required to mail to each holder, including holders of IRAs and Keoghs, a notice that the Board of Trustees has approved the sale of a certain number of shares of common stock or securities convertible into common stock, a description of the rights of such depositors to subscribe to such stock and various other information concerning rights of stockholders. Subscription rights must be exercised within a period ending no sooner than 60 days from the date the subscription plan is submitted to the Commissioner, or they will expire. Pursuant to the terms of the proposed transaction, the IRA and Keogh customers would notify People's within that subscription period of their intention to invest the assets of their IRA and Keogh accounts in Bank stock. Since the purchase of stock will be made in connection with an initial issue, no broker will be involved and purchases will be made by the IRA or Keogh directly from the Bank. Since no broker is involved in the transaction, no commissions will be paid with respect to the purchase.
  5. As part of the subscription plan submitted to the Commissioner, People's will include an appraisal prepared by an independent firm of the estimated market value of the Bank and the Bank stock to be issued. The valuation will be based on financial information relating People's and the economic environment in which it operates, a comparison of People's with selected publicly held thrift institutions and with other thrift institutions located in Connecticut, and any other factor as the independent appraiser may deem to be appropriate. The valuation will be stated in terms of a subscription price range, the maximum of which will be no more than 25% above the average of the minimum and maximum of such price range, and the minimum of which will be no more than 25% below such average. After the subscription plan is approved by the Commissioner, the independent appraiser will review, prior to the subscription offering, all developments consequent to its initial valuation in order to confirm or amend its determination of the initial subscription price range. The subscription price will be no less than the minimum of the price range, nor any greater than the maximum of the price range.
  6. Concurrently with the subscription offering, People's may offer the opportunity to purchase all shares not subscribed for in the subscription offering to (a) Certain other customers of People's who may not have qualified as eligible account holders; (b) trustees, officers, or employees of People's or its affiliates, and (c) residents of Fairfield, New Haven, Tolland, Hartford and Litchfield Counties, Connecticut (the Community Offering). If all shares of Bank stock are sold through the exercise of subscription rights and through the Community Offering, the independent appraiser will re-examine its estimate of the market value of the Bank and of the shares of Bank stock as of the last day of the subscription offering and the Community Offering. If at that time the independent appraiser's estimate of the value of Bank stock is less than the subscription price (but not less than the minimum of the originally estimated price range), then that estimated value will become the final purchase price for Bank stock and the Bank will refund to all purchasers the difference between the subscription price and the independent appraiser's final estimate of the value of Bank stock. If, however, the independent appraiser's final estimate of the value of Bank stock exceeds the subscription price (or is less than the minimum of the originally estimated price range), then with the approval of the Commissioner, People's will either terminate the subscription plan, establish a new subscription price range, or adjust the total number of shares of the Bank so that the market value per share will be within the subscription price range.
  7. If all the shares of Bank stock to be sold are not sold through the exercise of subscription rights or through the Community Offering, the remaining shares will be sold to the public after approval of a public offering circular by the Commissioner. The independent appraiser will again update its prior appraisal of the estimated market value of Bank stock. If there is any change in that appraisal, the number of shares of the Bank may be adjusted to reflect the increase or decrease of the appraised value of the Bank stock. That number of shares will then be sold to or through the underwriters of the public offering pursuant to terms of an underwriting agreement. In the event the sale price of Bank stock pursuant to the public offering is less than the price paid for exercise of subscription rights or pursuant to the Community Offering the difference will be refunded to those who paid the higher price.
  8. The applicants represent that the entire process is designed to ensure that the price paid for Bank stock is fair market value. In any event, the determination as to the price to be paid for Bank stock will be subject to approval by the Commissioner.
  9. In summary, the applicants represent that the proposed transaction meets the criteria of section 408(a) of the Act and section 4975(c)(2) of the Code because: (1) The decision to purchase the Bank stock will be made by IRA and Keogh customers out of a range of investment choices, and People's has no discretion over such decision; (2) no fees or commissions will be paid with respect to the transaction; (3) no more than 25% of the assets of any IRA or Keogh account will be invested in Bank stock in connection with the initial offering; and (4) the purchase price or the stock will be determined by independent appraisal and must be approved by the Commissioner.

For further information contact: Gary H. Lefkowitz of the Department, telephone (202) 523-8881. (This is not a toll-free number.)

People's Bank (People's) Located

Bridgeport, Connecticut

[Prohibited Transaction Exemption 88-28.

Exemption Application No. D-7187]

Exemption

The restrictions of section 406(a) of the Act and the sanctions resulting from the application of section 4975 of the Code, by reason of section 4975(c)(2)(A) through (D) of the Code, shall not apply to the sale by People's of its subsidiary's stock to the Keogh plans (the Keoghs) for which People's serves as custodian, as part of an initial issue of such stock, and the sanctions resulting from the application of section 4975 of the Code, by reason of section 4975(c)(1)(A) through (D) of the Code shall not apply to the sale by People's of its subsidiary's stock to the individual retirement accounts (the IRAs) for which People's serves as custodian, as part of an initial issue of such stock, provided the Keoghs and the IRAs pay no more than the fair market value of the stock on the date of the sale.1

For a more complete statement of the facts and representations supporting the Department's decision to grant this exemption refer to the notice of proposed exemption published on January 26, 1988 at 53 FR 2106.

For Further Information Contact: Gary Lefkowitz of the Department, telephone (202) 523-8881. (This is not a toll-free number.)

  1. Because the IRAs do not meet the conditions described in 29 C.F.R. 2510.3-2(d), there is no jurisdiction with respect to the IRAs under Title I of the Act. However, there is jurisdiction under Title II of the Act pursuant to section 4975 of the Code.

Advisory Opinion/Individual Exemption 89-03

Self-Directed IRA Purchases of Employer Stock from Employer

March 23, 1989

Summary

Covers self-directed IRA account purchases of stock from the employer of the IRA's grantor/beneficiary.

U.S. Department of Labor Pension and Welfare Benefits Administration

Washington, D.C. 20210

March 23, 1989

Ms. Maria Stefanis

Arthur Young

3000 K Street, N.W.

Washington, D.C. 20007

Re: Individual Retirement Accounts of Edward E. and Frances E. Bowns

Identification Number F-3879A

Dear Ms. Stefanis:

Your letter dated May 19, 1988, to the Internal Revenue Service has been forwarded to this office for our consideration and response. Your letter concerns whether a purchase of stock by an Individual Retirement Account (IRA) from a corporation would violate section 4975(c)(1)(A) of the Internal Revenue Code of 1986 (the Code).

You represent that Edward E. Bowns and his wife, Frances, established IRAs described in section 408 of the Code. Mr. and Mr. Bowns are the only participants in their respective IRAs and have reserved the right to direct their IRA's investments. Mr. Bowns is Executive Vice President and General Manager of the Partition Division of the Rock-Tenn Company. Mr. Bowns owns directly 1,122 shares. Mr. Bowns holds incentive stock options, expiring 1993 through 1998, to acquire an additional 27,020 shares. Assuming all options are exercised and including the 400 shares proposed to be purchased by the IRAs, the Bowns family would own a total of 29,327 shares. There are now approximately 2,500,000 shares of Rock-Tenn common stock outstanding. You further attest that Rock-Tenn has not sponsored, maintained or made any contribution to the IRAs.

Mr. and Mrs. Bowns propose to direct their IRA trustee to purchase Rock-Tenn common stock from Rock-Tenn on behalf of each of their IRAs. The trustee will pay no more than adequate compensation for the Rock-Tenn stock.

You have requested an advisory opinion that the proposed purchase will not constitute a prohibited transaction under section 4975(c)(1)(A) of the Code.

Pursuant to section 2510.3-2(d) of the Department of Labor's (the Department) regulations, the Department does not have jurisdiction under Title I of the Employee Retirement Income Security Act of 1974 (ERISA) over those IRAs described in section 408 of the Code which comply with the provisions of that section of regulation.1 Such IRAs are, however, subject to section 4975 of the Code. Pursuant to Presidential Reorganization Plan No. 4 of 1978, effective December 31, 1978, the authority of the Secretary of the Treasury to issue interpretations regarding section 4975 of the Code, subject to certain exceptions not here relevant, has been transferred to the Secretary of Labor and the Secretary of the Treasury is bound by such interpretations.

Section 4975(c)(1)(A) of the Code prohibits any direct or indirect sale, exchange or leasing of any property between a plan and a disqualified person. Section 4975(e)(1) of the Code, in relevant part, defines the term plan to include an IRA described in section 408(a) of the Code. Section 4975(e)(2) of the Code defines the term disqualified person to include a fiduciary, an employer any of whose employees are covered by the plan, and a corporation of which 50 percent or more of the combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock of the corporation, is owned directly or indirectly, or held by a fiduciary. Section 4975(e)(4) of the Code provides that, for purposes of section 4975(e)(2)(G), there shall be taken into account indirect stock holdings which would be taken into account under section 267(c) of the Code. Section 4975(e)(3) of the Code defines the term fiduciary, in part, to include any person who exercises any discretionary authority or discretionary control respecting management of the plan, or exercised any authority or control respecting the management or the disposition of its assets.

Mr. and Mrs. Bowns are fiduciaries and, thus, disqualified persons with respect to their IRAs because of their authority under the IRAs to direct investments. Although section 4975 does not define the term employer, section 3(5) of ERISA provides, in part, that an employer is any person acting as an employer in relation to an employee benefit plan. You have stated that Rock-Tenn has no involvement with the establishment or maintenance of the IRAs. Therefore, it is the opinion of the Department that Rock-Tenn is not a disqualified person with respect to the IRAs under section 4975(e)(2)(C) of the Code. In addition, Rock-Tenn is not a disqualified person under section 4975(e)(2)(G) of the code by reason of the Bowns' stock ownership in Rock-Tenn.

Therefore, to the extent that Rock-Tenn is not a disqualified person under any other provisions of section 4975(e)(2) of the Code, the purchase of Rock-Tenn would not violate section 4975(c)(1)(A) of the Code.

We note, however, that this conclusion does not preclude the existence of other prohibited transactions under section 4975 of the Code. Section 4975(c)(1)(D) of the Code prohibits any direct or indirect transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a plan. Section 4975(c)(1)(E) of the Code prohibits a fiduciary from dealing with the income or assets of a plan in his own interest or for his own account. The Department will generally not issue advisory opinions with respect to inherently factual matters.2 We note, however, that Mr. and Mrs. Bowns are fiduciaries with respect to their IRAs. In addition, Mr. Bowns is an officer of Rock-Tenn and the Bowns have stock ownership interests in Rock-Tenn. Accordingly, you may wish to consider whether the purchases of stock involve violations of section 4975(c)(1)(D) or (E) of the Code.

This letter constitutes an advisory opinion under ERISA Procedure 76-1. Accordingly, this letter is issued subject to the provisions of the procedures, including section 10 thereof, relating to the effect of advisory opinions.

Sincerely,

Robert J. Doyle

Director of Regulations and Interpretations

- Footnotes -

  1. Under the regulations, Title I is inapplicable only if the following conditions are met: (1) no contributions to the plan are made by the employer or employee association; (2) participation is completely voluntary for employees or members; (3) the sole involvement of the employer or employee association is to permit the sponsor to publicize the program and to collect contributions on behalf of the sponsor through payroll deductions or dues checkoffs; and (4) the employer or employee association receives no consideration in the form of cash or otherwise other than reasonable compensation for services actually rendered in connection with such payroll deductions or dues checkoffs.
  2. See ERISA Proc. 76-1, section 5.01.

Advisory Opinion/Individual Exemption 92-23A

Investment in Fiduciary Bank/BHC Stock

October 27, 1992

Summary

Permits ERISA plans to purchase stock of the fiduciary bank (or its parent holding company) if:

(1) Fiduciary bank is directed in writing to do so by an outside party authorized to direct investments,

(2) Transaction takes place on open market where bank does not know identity of seller,

(3) Plan does not prohibit such investments, and

(4) Fiduciary bank cannot vote the stock.

U.S. Department of Labor

Pension and Welfare Benefits Administration

Washington, D.C. 20210

92-23A

October 27, 1992 ERISA SEC.

403(a)(1),

Mr. John S. Brescher, Jr., Esq. 406(b)(1)

McCarter & English

Four Gateway Center

100 Mulberry Street

P. 0. Box 652

Newark, NJ 07101-0652

Dear Mr. Brescher:

This is in response to your request for an advisory opinion regarding the application of the prohibited transaction provisions of section 406 of the Employee Retirement Income Security Act of 1974 (ERISA) and section 4975 of the Internal Revenue Code (the Code). Your letter concerns purchases of securities issued by the parent company of Citizens First National Bank of New Jersey (the Bank) at the direction of fiduciaries of employee benefit plans for which the Bank serves an trustee.

According to your representations, the Bank is a wholly owned subsidiary of Citizens First Bancorp., Inc. (Bancorp), a bank holding company organized and existing under the laws of the State of New Jersey. Bancorp is a publicly held company; its stock is regularly traded on the American Stock Exchange.

You represent that the Bank, as part of its regular banking services, maintains a Prototype Defined Contribution Plan and Trustee/Custodial Account (the Prototype Plan) for adoption by those of its customers who wish to adopt a qualified retirement program. You state that the Bank may be appointed to serve either as custodian or trustee of an employee benefit plan that adopts the Prototype Plan. You indicate that, in either of these cases, the Bank must invest funds held thereunder in accordance with the requirements of ERISA.

You state that, where the Bank serves as trustee, the Prototype Plan permits investments "in any form of property," expressly including "securities issued by the Trustee and/or affiliates of the Trustee." An adopting employer has the option to direct investments by the trustee, to appoint an investment manager (registered as an investment advisor under the Investment Advisors Act of 1940) to direct investments by the trustee, or to give the trustee sole investment management responsibility. The employer must choose an option in its adoption agreement and the Bank must agree to it. You represent that if the Bank as trustee is subject to the investment direction of the employer or of an investment manager, any investment direction to the Bank must be made in writing by the authorized person.

According to your representations, the Bank, as directed trustee, anticipates receiving directions to purchase Bancorp stock on behalf of a plan. Such stock purchases would be made on the open market on the American Stock Exchange through an unaffiliated national brokerage firm selected by the Bank. No more than fair market value would be paid for the stock and the Bank would receive no commission as a result of any such purchase. The identity of the sellers of any stock so purchased would not be known to the Bank and would, you state, be difficult, if not impossible, to ascertain. You represent that the Bank does not act as market-maker for such stock.

You request an opinion as to whether the Bank would engage in a prohibited transaction within the meaning of section 406 of ERISA or section 4975 of the Code if, in its capacity as directed trustee of an employee benefit plan which adopts the Prototype Plan, it purchased Bancorp stock on the American Stock Exchange on behalf of any such plan, at the proper direction of a named fiduciary having the authority to direct investments by the Bank, or of an investment manager appointed by a named fiduciary.1

Section 403(a) of ERISA provides, in part, that a plan trustee shall have exclusive authority and discretion to manage and control the assets of the plan, except to the extent that: (1) the plan expressly provides that the trustees are subject to the direction of a named fiduciary who is not a trustee, in which case the trustee shall be subject to the proper directions of such fiduciary which are made in accordance with the terms of the plan and which are not contrary to ERISA; or (2) the authority to manage, acquire, or dispose of the assets of the plan is delegated to one or more investment managers pursuant to section 402(c)(3) of ERISA.

Section 406(a)(1)(A) of ERISA prohibits a fiduciary with respect to a plan from causing the plan to engage in a transaction if he or she knows or should know that the transaction constitutes a direct or indirect sale or exchange, or leasing, of any property between the plan and a party in interest. Section 3(14) of ERISA defines the term "party in interest" to include a fiduciary with respect to a plan and a person providing services to a plan, as well as a 10 percent or more shareholder, directly or indirectly, of such a person.2

Section 406(b)(1) of ERISA prohibits a fiduciary with respect to a plan from dealing with the assets of the plan in his or her own interest or for his or her own account.

With respect to purchases and sales of Bancorp stock on the open market in the manner described above, we note that the Conference Report accompanying ERISA states that:

In general, it is expected that a transaction will not be a prohibited transaction (under either the labor or tax provisions) if the transaction is an ordinary "blind" transaction purchase or sale of securities through an exchange where neither buyer or seller (nor the agent of either) known the identity of the other party involved. In this case, there is no reason to impose a sanction on a fiduciary (or party-in-interest) merely because, by chance, the other party turns out to be a party-in-interest (or plan). H.R. Rep. 93-1280, 93rd Cong., 2d Sess., 307 (1974).

Based on your representations, it is the opinion of the Department that purchases and sales of Bancorp stock in blind transactions executed by unaffiliated brokers at the proper direction of named fiduciaries of plans of its customers would not constitute transactions described in section 406(a)(1)(A) of ERISA. Moreover, under such circumstances, the Bank would not exercise the authority, control or responsibility to cause the plans for which it serves as directed trustee to engage in purchases and sales of Bancorp stock. Accordingly, it is the Department's view that the Bank, as directed trustee, would not engage in prohibited self-dealing under section 406(b)(1) solely as a result of following the directions of an unaffiliated named fiduciary, made in accordance with section 403(a), to purchase Bancorp stock.3

It should be pointed out, however, that under section 403(a)(1) of ERISA, a trustee that is subject to proper directions from the plan's named fiduciary remains responsible for determining whether following a given direction would result in a violation of ERISA. The directed trustee also has responsibility to exercise discretion where the directed trustee has reason to believe that the named fiduciary's directions are not made in accordance with the terms of the plan or are contrary to ERISA. Furthermore, as with other fiduciary duties, the trustee must ascertain whether existing or potential conflicts of interest may interfere with the proper exercise of this responsibility. Whether, in light of all the facts and circumstances, a trustee is subject to a conflict of interest or has reason to believe that a particular direction is contrary to ERISA are inherently factual questions as to which the Department generally will not opine. See section 5.01 of ERISA Procedure 76-1, 41 Fed. Reg. 36281 (Aug. 27, 1976).

If the named fiduciary has designated an investment manager pursuant to ERISA section 402(c)(3), then pursuant to ERISA section 405(d)(1) the trustee is not liable for the acts and omissions of the investment manager and is under no obligation to invest or otherwise manage any asset of the plan which is subject to the management of such investment manager. Under ERISA section 405(d)(2), however, the trustee would remain liable for any acts of the trustee including knowing participation or knowing concealment of a breach by another fiduciary under ERISA section 405(a)(1).

This letter constitutes an advisory opinion under ERISA Procedure 76-1. Section 10 of the procedure describes the affect of advisory opinions.

Sincerely,

Robert J. Doyle

Director of Regulations and Interpretations

- Footnotes -

  1. Under Reorganization Plan No. 4 of 1978, 43 Fed. Reg 47713 (Oct. 17, 1978), the authority of the Secretary of the Treasury to issue rulings under section 4975 of the Code, with certain exceptions not here relevant has been transferred to the Secretary of Labor. Therefore, the references in this letter to specific sections of ERISA refer also to corresponding sections of the Code.
  2. We note that while Bancorp is thus a party in interest for purposes of Title I of ERISA, it is not a "disqualified person" under the parallel provisions of the Code. In this regard, contrast section 3(14)(H) of ERISA with section 4975(e)(2)(H) of the Code.
  3. We assume, for purposes of this ruling, that the Bank does not have any additional authority to vote or otherwise deal with Bancorp stock held by plans for which it serves as directed trustee.

Advisory Opinion/Individual Exemption 93-13A

Investment in Affiliated Mutual Funds

April 27, 1993

Summary

Provides guidance on the application of PTE 77-4 to the purchase of affiliated mutual funds. Also indicates in footnote 4 that 12b-1 fees may not be paid by a mutual fund on transactions generated by ERISA accounts.

U.S. Department of Labor

Pension and Welfare Benefits Administration

Washington, D.C. 20210

April 27, 1993 AO 93-13A

Fred R. Green, Esq.

Schulte Roth & Zabel

900 Third Avenue

New York, NY 10022

Re: Frank Russell Company

Identification No.: C-9103

Dear Mr. Green:

This is in response to your request for an advisory opinion on behalf of Frank Russell Trust Company and its affiliates regarding the application of Prohibited Transaction Exemption 77-4 (42 FR 18732, April 8, 1977) (PTE 77-4).

You represent that Frank Russell Company (FRC), Frank Russell Trust Company (FRTC), Frank Russell Investment Company (FRIC) and Frank Russell Investment Management Company (FRIMCO) are part of a group of affiliated companies referred to as the Frank Russell Group (hereinafter referred to collectively as FRG).

You further indicate that FRTC serves as trustee, or as investment manager with respect to employee benefit plans (Plans). In addition, FRIMCO serves as investment adviser1 for a family of mutual funds (the Funds) sponsored by FRIC, each of which is an open-end, registered investment company under the Investment Company Act of 1940. FRIMCO develops the investment programs for each of the Funds, selects money managers/investment advisers (Sub-Advisers) within each of the Funds, allocates assets among the Sub-Advisers within each Fund and monitors the Sub-Advisers' investment programs and results.

FRTC proposes to invest plan assets in the Funds. The Plans will continue to pay an investment advisory fee to FRTC with respect to all plan assets for which FRTC is a trustee with investment discretion or investment manager, including plan assets invested in the Funds. The Plans and the Funds will not pay an investment advisory or similar fee to FRIMCO, or any affiliate, with respect to the plan assets invested in the shares of the Funds. However, shareholders of the Funds, other than the Plans, will pay an investment management fee directly to FRIMCO. In turn, FRIMCO is responsible for the payment of investment advisory fees to the Sub-Advisers of the Funds from fees it receives.

In addition, FRC and FRIMCO provide other services (Secondary Services) to the Funds including (i) transfer agent services; (ii) portfolio activity reports; (iii) analysis of international management reports; and (iv) tax record maintenance. FRIMCO and FRC propose to collect all fees for Secondary services provided to the Funds without waiver of, or credit for, the Plans' pro rata share of such fees.

You state that a fiduciary of a Plan who is independent of and unrelated to FRTC or any affiliate will receive a current prospectus provided by FRTC and written disclosure of the investment advisory and other fees, and any change in such fees, to be paid to FRG by the Funds.2 After reviewing the written fee disclosures and the prospectus, the independent fiduciary will provide written approval of a program of investment of Plan assets in the shares of the Funds. The form of the written approval may include, but is not limited to, the execution of modified trust and investment management agreements by the independent fiduciary and FRTC.

You ask whether FRIMCO's waiver of the investment advisory fee, otherwise payable by the Plans to FRG in connection with the investment of plan assets in the Funds, complies with the requirements of paragraph (c) of section II of PTE 77-4.3 Further, you ask whether paragraphs (d), (e) and (f) of section II of PTE 77-4 require written disclosure and approval of fees paid to parties unrelated to FRIMCO, or any affiliate, with respect to the investment of plan assets in the Funds. Finally, you ask whether PTE 77-4 provides relief for the purchase or sale of shares of the Funds subsequent to the approval by a Plan fiduciary, independent of and unrelated to FRTC, of a program for the purchase or sale of shares in the Funds, without prior approval of each such purchase or sale by the independent Plan fiduciary.

PTE 77-4 provides, in part, that:

The restrictions of section 406 of the Act, and the taxes imposed by section 4975(a) and (b) of the Code, by reason of section 4975(c)(1) of the Code, shall not apply to the purchase or sale by an employee benefit plan of shares of an open-end investment company registered under the Investment Company Act of 1940, the investment adviser for which is also a fiduciary with respect to a plan (or an affiliate of such fiduciary) and is not an employer of employees covered by the plan (hereinafter referred to as "fiduciary/investment adviser"), provided that the following conditions are met . . . .

Paragraph (c) of section II of PTE 77-4 states that:

[t]he Plan does not pay an investment advisory or similar fee with respect to the plan assets invested in such shares for the entire period of such investment. This condition does not preclude the payment of investment advisory fees by the investment company under the terms of its investment advisory agreement adopted in accordance with suction 15 of the Investment Company Act of 1940. This condition also does not preclude payment of an investment advisory fee by the plan based on total plan assets from which a credit has been subtracted representing the plan's pro rata share of investment advisory fees paid by the investment company.

The preamble to the proposed class exemption (41 FR 50516, November 16, 1976) explains that:

the proposed exemption would not permit the payment of a "double" investment advisory or investment management fee by the plan with respect to those assets invested in the mutual fund shares (i.e., both the direct fee paid by the plan to its fiduciary with respect to the invested assets and the investment advisory fee paid by the mutual fund to such fiduciary as investment advisor for the fund).

In addition, paragraph (d) of section II of PTE 77-4 provides that:

A second fiduciary with respect to the plan, who is independent of and unrelated to the fiduciary/investment adviser or any affiliate thereof, receives a current prospectus issued by the investment company, and full and detailed written disclosure of the investment advisory and other fees charged to or paid by the plan and the investment company, including the nature and extent of any differential between the rates of such fees, the reasons why the fiduciary/investment adviser may consider such purchases to be appropriate for the plan, and whether there are any limitations on the fiduciary/investment adviser with respect to which plan assets may be invested in shares of the investment company and, if so, the nature of such limitations.

Further, paragraph (e) of section II of PTE 77-4 states that:

On the basis of the prospectus and disclosure referred to in paragraph (d), the second fiduciary approves such purchases consistent with the responsibilities, obligations, and duties imposed on fiduciaries by Part 4 of Title I of the Act. Such approval may be limited solely to the investment advisory and other fees paid by the mutual fund in relation to the fees paid by the plan and need not relate to any other aspects of such investment. In addition, such approval must be either (1) set forth in the plan documents or in the investment management agreement between the plan and the fiduciary/investment adviser, (2) indicated in writing prior to each purchase or sale, or (3) indicated in writing prior to the commencement of a specified purchase or sale program in the shares of such investment company.

In addition, paragraph (f) of section II of PTE 77-4 provides that:

The second fiduciary referred to in paragraph (d), or any successor thereto is notified of any change in the rates of the fees referred to in paragraph (d) and approves in writing the continuation of such purchases or sales and the continued holding of any investment company shares acquired by the plan prior to such change and still held by the plan. Such approval may be limited solely to the investment advisory and other fees paid by the mutual fund in relation to the fees paid by the plan and need not relate to any other aspects of such investment.

It is the opinion of the Department that the arrangement described in your submissions for the payment of investment management fees by the Plans to FRTC and the waiver of investment advisory fees otherwise payable by the Plans to FRIMCO, or any affiliate, with respect to plan assets invested in the Funds will satisfy the conditions of paragraph (c) of section II of PTE 77-4.4 With respect to your second request, the Department is of the view that the conditions of paragraphs (d), (e) and (f) of section II of PTE 77-4 do not apply to fees paid to parties unrelated to FRIMCO, or any affiliate, under the above described arrangement.5 With respect to your last issue, the Department believes that PTE 77-4 provides relief for transactions in which FRTC causes a Plan to purchase or sell shares of the Funds subsequent to written approval by a Plan fiduciary, independent of and unrelated to FRTC, of a program for the purchase or sale of shares in the Funds, without the prior approval of each such purchase or sale by an independent fiduciary, provided all of the other conditions of the exemption are met.

This letter constitutes an advisory opinion under ERISA Procedure 76-1 and is issued subject to the provisions of that procedure, including section 10, relating to the effect of advisory opinions. We note that pursuant to section 5 of ERISA Procedure 76-1 this advisory opinion relates solely to the arrangement described involving FRG.

Sincerely,

Ivan L. Strasfeld

Director

Office of Exemption Determinations

- Footnotes -

  1. The applicant represents that FRIMCO is an investment adviser registered under section 203 of the Investment Advisers Act of 1940. Further, the applicant represents that FRIMCO is an investment adviser with respect to the Funds as defined in section 2(a)(20) of the Investment Company Act of 1940.
  2. We assume, for purposes of this letter, that the fee disclosure includes disclosure of the investment management fees paid directly to FRIMCO by shareholders other than the Plans.
  3. Although you have not requested an opinion regarding the retention of fees for Secondary Services, it is the Department's view that whether a particular service constitutes the provision of investment advisory services or is in fact an additional service depends on the facts and circumstances of each case. Accordingly, the Department is expressing no opinion regarding your characterization of the services for which you propose to collect fees as services other than investment advisory services.
  4. The Department notes that PTE 77-4 would not be available for the purchase or sale of investment company shares if any of the secondary services for which FRIMCO and/or FRC receive compensation involved any function which would be considered to constitute the provision of investment advisory services.
  5. The Department further notes that at the time PTE 77-4 was granted, the use of a portion of the assets of a registered investment company to pay distribution expenses was not generally permitted by the Securities and Exchange Commission. Accordingly, the payment of fees pursuant to a distribution plan adopted in accordance with Rule 12b-1 under the Investment Company Act ("12b-1 fees"), was not specifically considered by the Department as part of its determination to grant PTE 77-4. In any event, the Department does not believe that the payment of a 12b-1 fee by a fund to a plan fiduciary or its affiliate can be functionally distinguished in many instances from the payment of a commission by the plan in connection with the acquisition or sale of shares in a mutual fund. Therefore, the Department is 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 fund's assets attributable to the plan's investment.

  6. The fact that a transaction is the subject of an administrative exemption does not relieve a fiduciary from the general fiduciary responsibility provisions of section 404 of ERISA. In this regard, the Department emphasizes that it expects the plan fiduciary with investment management responsibility to consider the totality of fees to be paid by the plan directly, and/or indirectly through the mutual fund, prior to entering into the arrangement.

Also, the Department is expressing no opinion herein on whether disclosure is required under PTE 77-4 where the fees paid to the sub-advisers are paid out of the investment advisory fees paid to the investment adviser with respect to plan assets invested in the fund.

Advisory Opinion 93-24A

Float Management

September 13, 1993

Summary

Provides guidance on float associated with demand deposits. Also covers certain factors regarding retail repurchase agreements.
Also see interpretive letter to American Bankers Association, immediately following this Advisory Opinion.

U.S. Department of Labor Pension and Welfare Benefits Administration

Washington, D.C. 20210

September 13, 1993 AO 93-24A

ERISA SECTION:

406(b)(1)

406(b)(3)

Roger W. Thomas

Staff Attorney

Department of Financial Institutions

Fourth Floor, The John Sevier Building

500 Charlotte Avenue

Nashville, TN 37243-0705

Dear Mr. Thomas:

This is in response to your inquiry whether certain transactions engaged in by a Tennessee bank are consistent with the Employee Retirement Income Security Act of 1974 (ERISA). In particular, you call attention to an asserted "common industry practice" whereby banks acting as agents or trustees for employee benefit plans earn interest for their own accounts from the "float" when a benefit check is written to a participant until the check is presented for payment.

You indicate that a company (Trust Company), which is chartered under Tennessee law as a non-depository bank limited to trust powers, acts as an agent or trustee for various employee benefit plans. It also offers various collective investment funds in which plans invest. A national bank (National Bank) located in Tennessee serves as custodian for some of these plans.

In connection with the administration of the plans, Trust Company maintains accounts at National Bank, including a "General Account" and a "Disbursement Account." When Trust Company is directed to liquidate pooled fund assets to pay benefits, unless it is specifically directed to wire the funds to the participant, it transfers the funds to the General Account and simultaneously issues a check payable to the participant from the Disbursement Account. When checks are presented for payment, funds are wired from the General to the Disbursement Account. In the interim, Trust Company earns income on such funds

for its own account, pursuant to a retail repurchase agreement with National Bank.

You question whether the payment of this income to Trust Company is a prohibited receipt by a fiduciary of consideration from a party dealing with the plan in connection with a transaction involving the assets of the plan under section 406(b)(3) of ERISA. You also express concern that the Trust Company may be violating ERISA by dealing with National Bank, given National Bank's relationship to the plans.

Trust Company, through its attorney, contends that once a check is written to a participant, corresponding amounts in the General Account cease to be plan assets. In support of this argument Trust Company relies upon the first example of the participant contribution regulation in 29 C.F.R. 2510.3-102, which addresses when amounts that an employer withholds from a participant's pay for contribution to a plan can reasonably be segregated from the employer's general assets, and thus become assets of the plan for certain purposes. These special rules concerning segregation of participant contributions from an employer's general assets, however, have no application to the question of whether a plan has an interest in an administrative account when plan assets are transferred to the account in support of an outstanding benefit check.1

Turning to an analysis of the issues presented, section 406(b)(1) of ERISA states that a fiduciary with respect to a plan shall not deal with the assets of the plan in his or her own interest or for his or her own account. Section 3(21)(A) of ERISA defines a fiduciary, in part, as one who exercises any discretionary authority with respect to the assets of a plan. As explained in 29 C .F.R. 2509.75-8, persons serving as plan trustees (and certain other plan officials) will be fiduciaries due to the very nature of their positions. Other persons will be fiduciaries to the extent that they perform any of the functions described in section 3(21)(A) of ERISA.

Accordingly, it is the view of the Department that, based on the facts described above, where a fiduciary (e.g. Trust Company) exercises discretion with regard to plan assets, its receipt of income from the "float" on benefit checks under a repurchase agreement with a national bank in connection with the investment of such plan assets would result in a transaction described in ERISA section 406(b)(1).2

Moreover, even if all income earned under the repurchase agreements were allocated to the plans, the repurchase agreements themselves may be prohibited where the national bank is a party in interest with respect to the plans. Section 406(a)(1)(A) and (B) of ERISA, in part, prohibit sales or extensions of credit between plans and parties in interest. The term "party in interest" is defined in section 3(14) of ERISA to include a person providing services to a plan. From the information provided, it appears that National Bank, as the custodian of plan assets for some of the plans, is a service provider to such plans.

As we understand it, repurchase agreements essentially involve debt transactions structured as sales of securities. Therefore, absent exemptive relief, it appears that the repurchase agreements in question would involve prohibited extensions of credit, as well as prohibited sales between National Bank and plans that it serves. The Department has issued an administrative exemption, Prohibited Transaction Exemption 81-8 (copy enclosed), which provides conditional relief for investments in repurchase agreements, by or on behalf of an employee benefit plan. Whether this class exemption would grant relief to the parties involved in the subject retail repurchase agreement cannot be determined from the information provided.

This letter constitutes an advisory opinion under ERISA Procedure 76-1. Accordingly, it is issued subject to the provisions of that procedure, including section 10 thereof relating to the effect of advisory opinions.

Sincerely,

Robert J. Doyle

Director of Regulations and Interpretations

- Footnotes -

  1. It is commonly understood that a check does not of itself operate as an assignment of any funds in the hands of the drawee bank available for its payment and the bank is not liable on the instrument until it accepts it. U.C.C. § 3-409(1). A bank which properly pays checks drawn on it extinguishes its liability to the depositor to the extent of the amount so paid, so that it may charge the depositor's account with the amount of such payment. 9 C.J.S. Banks and Banking § 353 (1938).
  2. Although you asked if this arrangement would be prohibited under section 406(b)(3), due to the limited information provided we are unable to conclude that the arrangement described herein gives rise to a violation of this section. Specifically, we are unable to conclude that the bank knew, or should have known, the circumstances under which plan assets were invested pursuant to the repurchase agreements. Thus, we are restricting our analysis to the potential violation of section 406(b)(1).
 

U.S. Department of Labor Pension and Welfare Benefits Administration

Washington, D.C. 20210

AUG 11 1994

Ms. Judith A. McCormick

Federal Counsel

American Bankers Association

1120 Connecticut Avenue, N.W.

Washington, D.C. 20036

Dear Ms. McCormick:

Thank you for the invitation to respond to an editorial entitled "Special Analysis, Perspectives on the 'Float' Issue," which appeared in the American Bankers Association January 1994 edition of the Trust Letter. We appreciate this opportunity to clear up an apparent misunderstanding in the editorial regarding prohibited self-dealing by banks that serve as fiduciaries to employee benefit plans under the Employee Retirement Income Security Act of 1974 (ERISA).

The focus of the editorial is an ERISA advisory opinion, AO 93-24A (Sept. 13, 1993), which concluded that a bank trustee's exercise of discretion to earn income for its own account from the "float" attributable to outstanding benefit checks constitutes prohibited fiduciary self-dealing under ERISA. The editorial questions whether the analysis in AO 93-24A is limited to its facts -- which involved the use of accounts and repurchase agreements with a third-party national bank to earn income for the bank trustee during the period of the float -- or whether the opinion has broader implications for the procedures banks commonly utilize in issuing benefit checks. Although advisory opinions apply only to the specific factual situations that they describe, (ERISA Procedure 76-1, § 10, 41 Fed. Reg. 36281, 36283 (Aug. 27, 1976)), the essential analysis of AO 93-24A is not unique to its facts.

The editorial notes that, in contrast to the facts presented In AO 93-24A, banks commonly issue benefit checks drawn on a disbursement account within the same institution. The editorial points out that, as a technical matter depending upon the type of account used, the actual amounts in such disbursement accounts may no longer be considered plan assets. From this, the editorial concludes, in our view erroneously, that "[i]f these balances are no longer plan assets once transferred to such an account, then no prohibited transaction occurs." This conclusion misses the fundamental principle of AO 93-24A that, without regard to the status of the funds after they are placed in a disbursement or other account, a bank fiduciary's decision to handle plan assets in such a way as to benefit itself constitutes prohibited self-dealing.

We also take issue with the suggestion in the editorial that section 408(b)(6) of ERISA exempts such fiduciary self-dealing. That section affords conditional relief from the prohibitions on self-dealing for the providing of "ancillary" services by a bank to a plan for which it is a fiduciary if, among other requirements, the services are provided for no more than reasonable compensation. The legislative history of this section indicates that "in determining whether a plan pays more than reasonable compensation for its checking account services, the interest available on an alternate use of the funds is to be considered." H.R. Conf. Rept. No. 93-1280, 93d Cong., 2d Sess. (1974) at 315. Given the widespread technological advances in cash management during the twenty years since ERISA was enacted, it is by now generally recognized that banks have the capability of investing daily all but small amounts of cash in trust-quality investment vehicles at competitive market rates. (See Board of Governors of the Federal Reserve System letter to Stephen R. Steinbrink, Deputy Comptroller, Office of Comptroller of the currency, dated May 17, 1991). Accordingly, Section 408(b)(6) does not provide relief for a bank trustee who maintains cash balanced in a zero-interest disbursing account within the same institution to the extent that it is reasonably possible to earn net returns for the plan on those monies. Nor would such an exercise of discretion that is intended to benefit the bank at the expense of the plan's interests comport with the requirements of section 404(a)(1)(A) of ERISA that fiduciaries act prudently and solely in the interest of participants and beneficiaries.

Of course, if a bank fiduciary has openly negotiated with an independent plan fiduciary to retain earnings on the float attributable to outstanding benefit checks as part of its overall compensation, then the bank's use of the float would not be self-dealing because the bank would not be exercising its fiduciary authority or control for its own benefit. Therefore, to avoid, problems, banks should, as part of their fee negotiations, provide full and fair disclosure regarding the use of float an outstanding benefit checks.

Again, thank you for opening a dialogue on this important matter. We hope that this exchange will help to clarify any misunderstanding concerning the "float" issue.

Sincerely,

Robert J. Doyle

Director of Regulations and Interpretations

Advisory Opinion/Individual Exemption 93-26A

Investment in Affiliated Mutual Funds by IRA and Keogh Accounts

September 9, 1993

Summary

Provides guidance on the application of PTE 77-4 to the purchase of affiliated mutual funds by IRA and Keogh (HR-10) accounts.

U.S. Department of Labor Pension and Welfare Benefits Administration

Washington, D.C. 20210

September 9, 1993

Donald S. Kohla, Esq. AO 93-26A

King & Spalding

191 Peachtree Street

Atlanta, Georgia 30303-1763

Re: SunTrust Banks, Inc. (SunTrust)

Exemption Application No. D-9423

Dear Mr. Kohla:

This is in response to the above referenced application requesting an exemption from the prohibitions of section 406 of the Employee Retirement Income Security Act of 1974 (ERISA or the Act) and from the sanctions resulting from the application of Section 4975 of the Internal Revenue Code of 1986 (the Code).

Your application sets forth the following facts and representations. SunTrust proposes to offer shares of the STI Classic Funds (the Funds), a series of open-end investment companies registered under the Investment Company Act of 1940, to individual retirement accounts (IRAs) for which SunTrust acts as a trustee with investment management responsibility. Sun Bank Capital Management and Trustco Capital Management, affiliates of SunTrust, serve as investment advisers for the Funds and receive fees for their services from the Funds. You represent that SunTrust will not charge the IRAs any investment management fees for assets that are invested in the Funds.

At the conference regarding your exemption request on August 19, 1993, you stated that, as an alternative to obtaining an individual exemption for the proposed transactions, SunTrust would be willing to structure the arrangement to comply with Prohibited Transaction Exemption (PTE) 77-4 (42 FR 18732, April 8, 1977) if that exemption is available for IRAs.

Under Reorganization Plan No. 4 of 1978 (43 FR 47713, October 17, 1978) the authority to issue rulings under section 4975 of the Code has been transferred, with certain exceptions, to the Secretary of Labor. Therefore, the references in this letter to specific sections of ERISA refer also to corresponding sections of the Code.

PTE 77-4 provides that the restrictions of section 406 of the Act, and the taxes imposed by section 4975(a) and (b) of the Code, shall not apply to the purchase and sale by an employee benefit plan of shares of an open-end investment company registered under the Investment Company Act of 1940, the investment adviser for which is also a fiduciary with respect to the plan (or an affiliate of such fiduciary), and is not an employer of employees covered by the plan, provided certain conditions are met.

Although PTE 77-4 does not define the term "employee benefit plan", the Department of Labor (the Department) is of the view that the exemption is applicable not only to transactions involving employee benefit plans covered under Title I of ERISA, but also to transactions involving IRAs and HR-10 plans which are not covered by Title I of ERISA but which are subject to the provisions of section 4975 of the Code. We have conferred with representatives of the Internal Revenue Service and they concur in the view that plans described in code section 4975(e)(1) are included within the scope of PTE 77-4.

This letter constitutes an advisory opinion under ERISA Procedure 76-1 and is issued subject to the provisions of that procedure, including section 10, relating to the effect of advisory opinions. This opinion relates only to the specific issue addressed herein. For example, the Department is not providing an opinion as to whether the particular arrangement described in your exemption application would satisfy the conditions imposed by PTE 77-4. Nor is the Department providing an opinion as to the definition of the term "employee benefit plan" in any exemption other than PTE 77-4.

if you have any further questions, please contact Mr. E. F. Williams, Department of Labor, (202) 219-8883.

Sincerely,

Ivan L. Strasfeld

Director

Office of Exemption Determinations

Advisory Opinion to OCC (94-41A)

Escheating

December 7, 1994

U.S. Department of Labor

Pension and Welfare Benefits Administration

Washington, DC 20210

December 7, 1994

Mr. Thomas R. Giltner 94-4lA

Cox & Smith Incorporated ERISA SECTION

112 East Pecan Street, Suite 2000 514(a)

San Antonio, Texas 78205

Dear Mr. Giltner:

This is in reply to your request for an advisory opinion regarding the applicability of Title I of the Employee Retirement Income Security Act of 1974 (ERISA). Specifically, you ask whether section 514(a) of Title I of ERISA preempts the application of the Texas Unclaimed Property Statutes (Tex. Prop. Code Ann. Title 6 (West 1985)), with the result that the State of Texas may not assume custody over unclaimed benefits of those participants in the Luby's Cafeterias, Inc. Employees Profit Sharing and Retirement Trust (the Plan) who cannot be located.

You advise that Luby's Cafeterias, Inc. (the Company) sponsors the Plan for its eligible employees. You further advise that, in the normal operation of the Plan, the plan administrator has occasionally been unable to locate a participant or beneficiary entitled to a distribution of retirement benefits. You interpret Section 7.10 of the plan document, which provides a procedure in the event a participant or beneficiary fails to claim a distribution, to permit or require your current practice in such circumstances, which you describe as follows. If a distributee fails to claim a distribution under the plan, the amount of the unclaimed benefit is transferred to an account styled "Terminated Employees' Account," which is an account segregated from the Plan's other bank accounts, but is an account of the Plan. (l) The Plan maintains records to indicate the amount of each "lost" participant's or beneficiary's interest in the account. If a lost participant or beneficiary is later located, his or her benefits are paid from the Plan's main account, which is then reimbursed from the Terminated Employees' Account. If a lost participant or beneficiary is not located within four years, you represent that his or her share in the Terminated Employees' Account is then transferred to the Plan's main account. If the lost participant or beneficiary is located at any time after this transfer occurs, you represent that his or her benefits are reinstated and paid by the Plan.

(1) You represent that, when a distribution is for benefits valued at less than $3,500, the plan trustee mails a check to the last known address of the unlocated participant. If the check is not cashed after a reasonable period of time (presumably no more than a few months), the trustee cancels the check and transfers the same amount to the Terminated Employees' Account.

In your request, you further assert that Section 7.10 of the Plan, as interpreted above, fully complies with Treasury Regulation section 1.411(a)-4(b)(6), which provides:

(b) Special rules. For purposes of paragraph (a) of this section, a right is- not treated as forfeitable-

6) Lost beneficiary: escheat. In the case of a benefit which is payable, merely because the benefit is forfeitable on account of the inability to find the participant or beneficiary to whom payment is due, provided that the plan provides for reinstatement of the benefit if a claim is made by the participant or beneficiary for the forfeited benefit. In addition, a benefit which is lost by reason of escheat under applicable state law is not treated as a forfeiture.

You further advise that 72.101 of the Texas Unclaimed Property Statutes provides:

72.101. Personal Property Subject to Escheat

Personal property, other than traveler's checks, is presumed abandoned and subject to escheat if, for, longer than seven years:

(1) the existence and location of the owner of the property is unknown to the holder of the property;

(2) according to the knowledge and records of the holder of the property, a claim to the property has not been asserted or an act of ownership of the property has not been exercised; and

(3) a will of the owner of the property has not been recorded or probated in the county in which the property is located.

Section 514(a) of Title I of ERISA provides:

(a) Supersedure; effective date. Except as provided in subsection (b) of this section, the provisions of this title and title IV shall supersede any and all State laws insofar as they may now or hereafter relate to any employee benefit plan described in section 4(a) and not exempt under section 4(b).

Section 514(a) does conflict with Title I of ERISA, not merely preempt state laws that

ERISA, but broadly preempts all state laws related to employee benefit plans. The reasons for the broad preemption of state laws under ERISA were succinctly stated by Senator Javits, a major sponsor and floor manager of the bill that became ERISA, during its final consideration:

Both House and Senate bills provided for preemption of State law but -- with one major exception appearing in the House Bill -- defined the perimeters of preemption in relation to the areas regulated by the bill. Such a formulation raised the possibility of endless litigation over the validity of State action that might impinge on Federal regulation, as well as opening the door to multiple and potentially conflicting State laws hastily contrived to deal with some particular aspect of private welfare or pension plans not clearly connected to the Federal scheme.

Although the desirability of further regulation at either the State or Federal level -- undoubtedly warrants further attention, on balance, the emergence of a comprehensive and pervasive Federal

interest and the interests of uniformity with respect to interstate plans required -- but for certain exceptions -- the displacement of State action in the field of private employee benefit programs. (120 Cong. Rec. S15751 (daily ed. Aug 22, 1974)).

It is the view of the Department of Labor (the Department) that, if the above-quoted section of the Texas Unclaimed Property Statutes were applied to require the Plan to pay to the State amounts held in the Terminated Employees' Account, or in other accounts of the Plan, pursuant to the procedures described above, then such application of the section would be preempted under section 514(a) of ERISA. (2) Such an application of the State escheat law would directly affect the core functions of the Plan by reducing, through the escheat, the amount of plan assets held in trust for the benefit of all participants and beneficiaries of the Plan. (3) Moreover, because the statute at issue is not a law regulating insurance, banking or securities, it is not saved from preemption under section 514(b) (2). (4)

This letter constitutes an advisory opinion under ERISA Procedure 76-1. Accordingly, it is issued subject to the provisions of that procedure, including section 10 thereof relating to the effect of advisory opinions.

Sincerely,

Robert J. Doyle

Director of Regulations and Interpretations

(2) In Opinion 78-32A (December 22, 1978), the Department concluded that a provision of the Illinois Uniform Disposition of Property Act was preempted as applied to employee benefit plans. In Opinion 79-30A (May 14, 1979) the Department reached the same conclusion with respect to a provision of California's Unclaimed Property Law that expressly referred to employee benefit trust dispositions. In Opinion 83-39A (July 29, 1983), the Department found that a section of the New York Abandoned Property Law, which addressed the escheat of "[u]nclaimed insurance proceeds other than life insurance," was saved from preemption under ERISA 514(b)(a)(A) as a law regulating insurance.

(3) In our view, the decision of the United States Court of Appeals for the Second Circuit in Aetna Life Ins. v. gorges, 869 F.2d 142 (2d Cir. 1989), is clearly distinguishable. In that case, the court considered the application of a state escheat law to amounts held in reserve by an insurance company to cover benefit checks issued pursuant to an insurance contract with an employer to provide welfare benefits, which checks were never presented by the participant or beneficiary for payment. The court found that the application of the escheat law in those circumstances would have only an indirect economic and~ administrative impact on the plan that was too remote and tangential to trigger preemption.

(4) We note that Treasury Regulation 1.411(a)-4(b)(6) provides that a benefit "lost by reason of escheat under applicable state law" will not be treated as an impermissible forfeiture under Internal Revenue Code 411(a). This regulation, however, provides no guidance as to whether a particular application of state escheat law is preempted under ERISA Section 514.

Advisory Opinion to OCC (94-OCC)

Collective Investment Fund Conversions to Mutual Funds

(Makes reference to PTE 77-4)

February 14, 1994

 

U.S. Department of Labor Pension and Welfare Benefits Administration

Washington, DC 20210

February 14, 1994

Mr. William Granovsky

National Bank Examiner

Compliance Management

Comptroller of the Currency

Administrator of National Banks

Washington, D.C. 20219

Re: Applicability of Prohibited Transaction Exemption (PTE) 77-4 to the Conversion of Bank Collective Investment Funds.

Dear Mr. Granovsky:

As a follow-up to our meeting on February 1, 1994, I thought it would be helpful if the Department formally provided its views regarding the applicability of Prohibited Transaction Exemption PTE 77-4 to the conversion of bank collective investment funds.

As you know, PTE 77-4 provides conditional relief from ERISA's prohibited transaction provisions for the purchase or sale by a plan of shares of an open-end investment company, the investment adviser for which is also a fiduciary with respect to the plan. Although PTE 77-4 does not specifically address in-kind exchanges, the Department is of the view that the transactions exempted by PTE 77-4 do not include the acquisition or sale of investment company shares for anything other than cash. We believe that if such transactions had been contemplated at the time that the exemption was granted, the exemption would contain additional safeguards designed to address the valuation and other' issues associated with in-kind exchanges. Therefore, the Department is unable to conclude that PTE 77-4 would be available for conversions of bank collective investment funds involving the exchange of securities held by the fund on behalf of plan investors for shares of the bank's affiliated investment company.

If you have any further questions please contact Eric Berger at (202) 219-8971.

Sincerely,

Ivan L. Strasfeld

Director

Office of Exemption Determinations

Pension and Welfare Benefits Administration

Advisory Opinion to OCC (96-OCC)

Investments in Derivatives

March 21, 1996

U.S. Department of Labor

Assistant Secretary for

Pension and Welfare Benefits

Washington, D.C. 20210

March 21, 1996

Honorable Eugene A. Ludwig

Comptroller of the Currency

250 E Street, S.W.

Washington, D.C. 20219

Dear Mr. Ludwig,

At our last meeting we discussed the Department of Labor's views with respect to the utilization of derivatives in the management of a portfolio of assets of a pension plan which is subject to the Employee Retirement Income Security Act of 1974 (ERISA). This letter is to provide you with an update of our views in a format which may be of use to you and your staff.

ERISA governs private-sector sponsored employee welfare and pension benefit plans and provides a general framework within which plan fiduciaries are expected to conduct their investment activities. Under ERISA, a fiduciary includes anyone who exercises discretion in the administration of an employee benefit plan; has authority or control over the plan's assets; or renders investment advice for a fee with respect to any plan assets.2 Thus, any entity, including an institution such as a bank, that meets this functional test with respect to an employee benefit plan sponsored by a private-sector employer, employee organization, or both, would be considered a fiduciary under ERISA.

ERISA establishes comprehensive standards to govern fiduciary conduct. Among other things, fiduciaries with respect to an employee benefit plan must discharge their duties with respect to a plan solely in the interest of the plan's participants and beneficiaries, and with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.3

Investments in derivatives are subject to the fiduciary responsibility rules in the same manner as are any other plan investments. Thus, plan fiduciaries must determine that an investment in derivatives is, among other things, prudent and made solely in the interest of the plan's participants and beneficiaries. In determining whether to invest in a particular derivative, plan fiduciaries are required to engage in the same general procedures and undertake the same type of analysis that they would in making any other investment decision. This would include, but not be limited to, a consideration of how the investment fits within the plan's investment policy, what role the particular derivative plays in the plan's portfolio, and the plan's potential exposure to losses.

While derivatives may be a useful tool for managing a variety of risks and for broadening investment alternatives in a plan's portfolio, investments in certain derivatives, such as structured notes and collateralized mortgage obligations, may require a higher degree of sophistication and understanding on the part of plan fiduciaries than other investments. Characteristics of such derivatives may include extreme price volatility, a high degree of leverage, limited testing by markets, and difficulty in determining the market value of the derivative due to illiquid market conditions.

As with any investment made by a plan, plan fiduciaries with the authority for investing in derivatives are responsible for securing sufficient information to understand the investment prior to making the investment. For example, plan fiduciaries should secure from dealers and other sellers of derivatives, among other things, sufficient information to allow an independent analysis of the credit risk and market risk being undertaken by the plan in making the investment in the particular derivative. The market risks presented by the derivatives purchased by the plan should be understood and evaluated in terms of the effects that they will have on the relevant segments of the plan's portfolio as well as the portfolio's overall risk.

Plan fiduciaries have a duty to determine the appropriate methodology used to evaluate market risk and the information which must be collected to do so. Among other things, this would include, where appropriate, stress simulation models showing the projected performance of the derivatives and of the plan's portfolio under various market conditions. Stress simulations are particularly important because assumptions which may be valid for normal markets may not be valid in abnormal markets, resulting in significant losses. To the extent that there may be little pricing information available with respect to some derivatives, reliable price comparisons may be necessary. After entering into an investment, a plan fiduciary should be able to obtain timely information from the derivatives dealer regarding the plan's credit exposure and the current market value of its derivative positions, and, where appropriate, should obtain such information from third parties to determine the current market value of the plan's derivative positions, with a frequency that is appropriate to the nature and extent of these positions.

If the plan is investing in a pooled fund which is managed by a party other than the plan fiduciary who has chosen the fund, then that plan fiduciary should obtain, among other things, sufficient information to determine the pooled fund's strategy with respect to use of derivatives in its portfolio, the extent of investment by the fund in derivatives, and such other information as would be appropriate under the circumstances.

As part of its evaluation of the investment, a fiduciary must analyze the operational risks being undertaken in making the investment. Among other things, the fiduciary should determine whether it possesses the requisite expertise, knowledge, and information to understand and analyze the nature of the risks and potential returns involved in a particular derivative investment. In particular, the fiduciary must determine whether the plan has adequate information and risk management systems in place given the nature, size and complexity of the plan's derivatives activity, and whether the plan fiduciary has personnel who are competent to manage these systems. If the investments are made by outside investment managers hired by the plan fiduciary, that fiduciary should consider whether the investment managers have such personnel and controls and whether the plan fiduciary has personnel who are competent to monitor the derivatives activities of the investment managers.

Plan fiduciaries have a duty to evaluate the legal risk related to the investment. This would include assuring proper documentation of the derivative transaction and, where the transaction is pursuant to a contract, assuring written documentation of the contract before entering into the contract.

Also, as with any other investment, plan fiduciaries have a duty to properly monitor their investments in derivatives to determine whether they are still appropriately fulfilling their role in the portfolio. The frequency and degree of the monitoring will, of course, depend on the nature of such investments and their role in the plan's portfolio.

We hope these comments have been helpful. However, if you should have any further questions or if we can provide any further assistance, please feel free to contact Morton Klevan at (202) 219-9044 or Louis Campagna at (202) 219-8883.

Sincerely,

Olana Berg

- Footnotes -

  1. We refer to derivatives in this letter as financial instruments whose performance is derived in whole or in part from the performance of an underlying asset (such as a security or index of securities). Some examples of these financial instruments include futures, options, options on futures, forward contracts, swaps, structured notes and collateralized mortgage obligations.
  2. See ERISA section 3(21).
  3. See ERISA section 404(a).

Advisory Opinion 97-15A to Frost National Bank

Acceptance of Mutual Fund 12b-1 Fees; Letter to Frost National Bank; Discretionary and Non-Discretionary Accounts

May 22, 1997

Summary

Guidance on the purchase of mutual funds which pay 12b-1 fees to fiduciaries.

U.S. Department of Labor Pension and Welfare Benefits Administration

Washington, DC 20210

May 22 1997

Mark S. Miller 97-15A

Fulbright & Jaworski, LLP

1301 McKinney, Suite 5100

Houston, Texas 77010-3095

Dear Mr. Miller:

This is in response to your request for an advisory opinion regarding the prohibited transaction provisions of the Employee Retirement Income Security Act of 1974 (ERISA). In particular, you ask whether the payment of certain fees by a mutual fund in which an employee pension benefit plan has invested to a bank serving as the plan's trustee would violate sections 406(b)(1) and 406(b)(3) of ERISA.

You represent that Frost National Bank (Frost) serves as trustee to various employee pension benefit plans (the Plans). As trustee of the Plans, Frost's duties may include one or more of the following functions, pursuant to instructions from the Plan sponsor or participants: opening and maintaining individual participant accounts; receiving contributions from the Plan sponsor and crediting them to individual participant accounts; investing contributions in shares of a mutual fund and reinvesting dividends and other distributions; redeeming, transferring, or exchanging mutual fund shares; providing or maintaining various administrative forms in making distributions from the Plan to participants or beneficiaries; keeping custody of the Plan's assets; withholding amounts on Plan distributions; making sure all Plan loan payments are collected and properly credited; conducting Plan enrollment meetings; and preparing newsletters and videos relating to the administration of the Plan.

In connection with its Plan-related business, Frost has entered into arrangements with one or more distributors of, or investment advisors to, mutual fund families pursuant to which Frost will make the mutual fund families available for investment by the Plans. Frost will periodically review each such mutual fund family to determine whether to continue the arrangement, and will reserve the right to add or remove mutual fund families that it makes available to the Plans.

As part of Frost's arrangements with the mutual fund families, Frost may provide shareholder services to, and receive fees from, some of the Individual mutual funds in which Plan assets are invested. The shareholder services may include, e.g., providing mutual fund recordkeeping and accounting services in connection with the Plans' purchase or sale of shares, processing mutual fund sales and redemption transactions involving the Plans, and providing mutual fund enrollment material (including prospectuses) to Plan participants. The fees paid by the mutual funds to Frost will generally be based on a percentage of Plan assets invested in each mutual fund, and will be paid pursuant to either a distribution plan described in Securities and Exchange Commission (SEC) Rule 12b-1, 17 C.F.R. 270.12b-I (a 12b-1 plan), or a "subtransfer agency arrangement."1

You further represent that, with respect to some of the Plans, Frost will recommend to the Plan fiduciary the advisability of investing in particular mutual funds offered pursuant to Frost's arrangements with the mutual fund families. In addition, Frost will monitor the performance of the individual mutual funds selected by the Plan fiduciary and, as it deems appropriate, will make further recommendations regarding additional or substitute mutual funds for the investment of Plan assets.

With respect to other Plans, Frost will not make any recommendations concerning the selection of, or continued investment in, particular mutual funds. Rather, the responsible Plan fiduciary will independently select, from the mutual fund families made available by Frost, particular mutual funds for the investment of Plan assets, or for designation as investment alternatives offered to participants under the Plan.

In both instances, whether or not Frost makes specific investment recommendations, you represent that, before a Plan enters into the arrangement, the terms of Frost's fee arrangements with the mutual fund families will be fully disclosed to the Plans. In addition, Frost's trustee agreement with a Plan will be structured so that any 12b-1 or subtransfer agent fees received by Frost that are attributable to the Plan's investment in a mutual fund will be used to benefit the Plan. Pursuant to the particular agreement with each Plan, Frost will offset such fees, on a dollar-for-dollar basis, against the trustee fee that the Plan is obligated to pay Frost or against the recordkeeping fee that the Plan is obligated to pay to a third-party recordkeeper; or Frost will credit the Plan directly with the fees it receives based on the investment of Plan assets in the mutual fund.2 The trustee agreement will provide that, to the extent that Frost receives fees from mutual funds in connection with the Plan's investments that are in excess of the fee that the Plan owes to Frost, the Plan will be entitled to the excess amount.

You request an opinion that Frost's receipt of fees from the mutual funds under the circumstances described would not constitute a violation of ERISA section 406(b)(1) or (b)(3).3

You have asked us to assume for the purpose of your request that the arrangements between Frost and the Plans satisfy the conditions of ERISA section 408(b)(2).4

Section 406(b)(1) of ERISA prohibits a fiduciary with respect to a plan from dealing with the assets of the plan in his or her own interest or for his or her own account. Section 406(b)(3) prohibits a fiduciary with respect to a plan from receiving any consideration for his or her personal account from any party dealing with the plan in connection with a transaction involving the assets of the plan.5

Under section 3(21)(A) of ERISA, a person is a "fiduciary" with respect to a plan to the extent that the person (i) exercises any discretionary authority or control respecting management of the plan or 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.

Frost, as trustee, is a fiduciary with respect to the Plans under section 3(21)(A) of ERISA. See 29 C.F.R. 2509.75-8, D-3 (the position of trustee of a plan, by its very nature, requires the person who holds it to perform one or more of the functions described in ERISA section 3(21)(A))6

When the Trustee Advises

You have indicated that, with respect to some of the Plans, Frost will advise the Plan fiduciary regarding particular mutual funds in which to invest Plan assets.7 It also appears from your submission that, under Frost's arrangements with various mutual fund families, Frost may receive fees from some of the mutual funds as a result of a Plan's investment in the mutual funds recommended by Frost. In the view of the Department, advising that plan assets be invested in mutual funds that pay additional fees to the advising fiduciary generally would violate the prohibitions of ERISA section 406(b)(1).

You represent, however, that before entering into an arrangement with a Plan, or recommending any particular mutual fund investments, Frost will disclose to the Plan fiduciary the extent to which it may receive fees from the mutual fund(s). Furthermore, you represent that the trustee agreement between Frost and the Plan will expressly provide that any fees received by Frost as a result of the Plan's investment in such a mutual fund will be used to pay all or a portion of the compensation that the Plan is obligated to pay to Frost, and that the Plan will be entitled to any such fees that exceed the Plan's liability to Frost.8 To the extent the Plan's legal obligation to Frost is extinguished by the amount of the offset, it is the opinion of the Department that Frost would not be dealing with the assets of the Plan in its own interest or for its own account in violation of section 406(b)(1).

With respect to the prohibition of section 406(b)(3), Frost's contract with a Plan, as described above, will provide that Frost's receipt of fees from one or more mutual funds in connection with the Plan's investment in such funds will be used to reduce the Plan's obligation to Frost, will in no circumstances increase Frost's compensation, and thus will benefit the Plan rather than Frost. Accordingly, it is the opinion of the Department that in these circumstances Frost would not be deemed to receive such payments for its own personal account in violation of section 406(b)(3).

When the Trustee is Directed

With respect to Plans for which Frost does not provide any investment advice, it appears that the Plan fiduciary, and in some instances the Plan participants, will select the mutual funds in which to invest Plan assets from among those made available by Frost. Generally speaking, if a trustee acts pursuant to a direction in accordance with section 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, the trustee would not be dealing with the assets of the plan for its own interest or for its own account in violation of section 406(b)(1).

Similarly, it is generally the view of the Department that if a trustee acts pursuant to a direction in accordance with section 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, the mere receipt by the trustee of a fee or other compensation from the mutual fund in connection with such investment would not in and of itself violate section 406(b)(3). Your submission indicates, however, that Frost reserves the right to add or remove mutual fund families that it makes available to Plans. Under these circumstances, we are unable to conclude that Frost would not exercise any discretionary authority or control to cause the Plans to invest in mutual funds that pay a fee or other compensation to Frost.9

However, because Frost's trustee agreements with the Plans are structured so that any 12b-1 or subtransfer agent fees attributable to the Plans' investments in mutual funds are used to benefit the Plans, either as a dollar-for-dollar offset against the fees the Plans would be obligated to pay to Frost for its services or as amounts credited directly to the Plans, it is the view of the Department that Frost would not be dealing with the assets of the Plans in its own interest or for its own account, or receiving payments for its own personal account in violation of section 406(b)(1) or (b)(3).

Finally, it should be noted that ERISA's general standards of fiduciary conduct also would apply to the proposed arrangement. 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, the above-described arrangement and trustee agreement with Frost, and in determining which investment options to utilize or make available to Plan participants or beneficiaries. In this regard, the responsible Plan fiduciaries must assure that the compensation paid directly or indirectly by the Plan to Frost is reasonable, taking into account the trustee services provided to the Plan as well as any other fees or compensation received by Frost in connection with the investment of Plan assets. In this connection, it is the view of the Department that the responsible Plan fiduciaries must obtain sufficient information regarding any fees or other compensation that Frost receives with respect to the Plan's investments in each mutual fund to make an informed decision whether Frost's compensation for services is no more than reasonable. The Plan fiduciaries also must periodically monitor the actions taken by Frost in the performance of its duties, to assure, among other things, that any fee offsets to which the Plan is entitled are correctly calculated and applied.

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

Sincerely,

Bette J. Briggs

Chief, Division of Fiduciary Interpretations .

Office of Regulations and Interpretations

- Footnotes -

  1. A "subtransfer agency fee" is typically a fee paid for recordkeeping services provided to the mutual fund transfer agent with respect to bank customers.
  2. We assume for purposes of this opinion that each Plan's governing documents provide that the Plan will pay costs and expenses for trustee services necessary to the operation and administration of the Plan.
  3. For a discussion of related issues involving receipt of fees by a record-keeper offering a program of investment options and services to plans, see also Advisory Opinion 97-16A, May 22, 1997.
  4. We offer no opinion herein as to whether such conditions have been satisfied; nor does this opinion address the application of any other provisions of ERISA.
  5. Under Reorganization Plan No. 4 of 1978, effective December 31, 1978, the authority of the Secretary of the Treasury to issue interpretations regarding section 4975 of the Internal Revenue Code of 1986 (the Code) has been transferred, with certain exceptions not here relevant, to the Secretary of Labor, and the Secretary of the Treasury is bound by interpretations of the Secretary of Labor pursuant to such authority. Therefore, references in this letter to specific sections of ERISA should be read to refer also to the corresponding sections of the Code.
  6. Section 403(a) of ERISA establishes that, in general, a trustee of a plan must have exclusive authority and discretion to manage and control the plan's assets. Under section 403(a)(1), when the plan expressly so provides, the trustee may be subject to the proper directions of a named fiduciary which are made in accordance with the terms of the plan and not contrary to ERISA. Nevertheless, a directed trustee has residual fiduciary responsibility for determining whether a given direction is proper and whether following the direction would result in a violation of ERISA. Accordingly, it is the view of the Department that a directed trustee necessarily will perform fiduciary functions.
  7. We assume for the purposes of your request that Frost will provide investment advice within the meaning of ERISA section 3(21)(A)(ii) and 29 C.F.R. 2510.3-21(c)(1)(i) and (ii)(B) with respect to these Plans.
  8. We express no opinion herein as to the propriety of such a pass-through of fees under Federal securities laws. Questions concerning the application of the Federal securities laws are within the jurisdiction of the SEC.
  9. See, in this regard, the Department's position as expressed in the preamble to the final regulation regarding participant-directed individual account plans (ERISA section 404(c) plans), 57 Fed. Reg. 46906, 46924 n. 27 (Oct. 13, 1992):

In this regard [a fiduciary is relieved of responsibility only for the direct and necessary consequences of a participant's exercise of control], the Department points out that the act of limiting or designating investment options which are intended to constitute all or part of the investment universe of an ERISA 404(c) plan is a fiduciary function which, whether achieved through fiduciary designation or express plan language, is not a direct or necessary result of any participant direction of such plan.

Advisory Opinion 97-16A to Aetna Life Insurance and Annuity Company

Acceptance of Mutual Fund 12b-1 Fees; Letter to Aetna Life Insurance and Annuity Company; Non-Discretionary Accounts

May 22, 1997

Summary

Guidance on the purchase of mutual funds which pay 12b-1 fees to Non-Discretionary Administrative and Record Keeping Service Providers

U.S. Department of Labor Pension and Welfare Benefits Administration

Washington, D.C. 20210

May 22 1997

Stephen M. Saxon 97-16A

Groom & Nordberg

1701 Pennsylvania Avenue, N.W.

Suite 1200

Washington, DC 20006

Dear Mr. Saxon:

This is in response to your request for an advisory opinion concerning the application of section 406(b)(3) of the Employee Retirement Income Security Act (ERISA ) to the receipt of certain fees by the Aetna Life Insurance and Annuity Company (ALIAC), an indirect subsidiary of Aetna Insurance Company, Inc. (Aetna). In particular, you request an opinion that ALIAC's receipt of fees from mutual funds that are unrelated to Aetna for recordkeeping and other services in connection with investments by employee benefit plans in the unrelated funds does not violate section 406(b)(3) under the circumstances described in your request.

ALIAC is a life insurance company domiciled in Connecticut, as well as a registered broker-dealer and a registered investment adviser. You represent that ALIAC sponsors and manages the Aetna Mutual Funds 401(k) Program (the 401(k) Program), which offers sponsors (other than Aetna) of participant-directed defined contribution plans (Plans): a) a volume submitter plan document; b) recordkeeping and related administrative services through Aetna 401 Retirement Plan Services (ARPS), ALIAC's business unit; c) investment options selected by ALIAC consisting of no-load or low load mutual funds from various fund families that are unrelated to Aetna (Unrelated Funds), Aetna Series Funds (a series of mutual funds within a diversified open-ended investment company registered under the Investment Company Act of 1940 (ICA)), and group annuity contracts (GACS) issued by Aetna Life Insurance Company (ALIC), an affiliate of ALIAC;1 and d) directed trustee or custodial services provided by a bank that is unrelated to Aetna (the Bank). You represent that Unrelated Funds from three different mutual fund families are currently available and that additional families may be added in the future. You further represent that, in the future, Unrelated Funds may also pay fees to ALIAC for "marketing services."2

Plan fiduciaries who are independent of and unrelated to ALIAC, ALIC, and their affiliates are responsible for selecting the investment options to be offered to Plan participants from among the Unrelated Funds, Aetna Series Funds, and several options under the GACS. You further represent that neither ALIAC, ALIC, nor any other affiliate of Aetna (or any of its employees) provides investment advice or recommendations, within the meaning of ERISA section 3(21)(A)(ii), to Plan fiduciaries or participants regarding the advisability of either selecting any of the investment options for the Plans, or investing in any of the investment options that are available under the Plans.

ARPS, ALIAC's business unit, will, pursuant to a plan services agreement, provide some or all of the following services to Plans:

1) one-time installation services, which may include assistance in preparation of Plan documents, participant communication materials, and government filings, and installation of Plan and participant level records into the ARPS recordkeeping systems;

2) basic non-discretionary administrative and recordkeeping services, e.g. (a) enrolling participants, (b) maintaining participant and Plan-level account records, (c) balancing and allocating contributions, loan repayments, and forfeitures among accounts, (d) processing distributions and withdrawals, (e) reconciling Plan and participant activity on a daily basis, (f) preparing periodic account activity statements for participants and Plan fiduciaries, (g) providing participant communication materials, (h) providing toll-free telephone access permitting participants to obtain current balance and investment information, change investment elections, and initiate loans, withdrawals and terminations, (i) performing certain tax qualification testing on a semi-annual basis, and (j) preparation of certain tax reporting forms;

3) recordkeeping and administrative support services for an employer stock fund, or for existing non-convertible GICs held by a Plan pending maturity (which are not associated with the GACS); and

4) optional services, e.g., (a) processing of participant loans, rollovers, lump sum and installment distributions, and qualified domestic relations orders, (b) additional tax qualification testing, (c) assistance in preparation of Plan-level government filings, and (d) recordkeeping and administrative support services for an employer stock fund and/or non-convertible GICS.

You represent that ARPS is not a "plan administrator" as defined in ERISA section 3(16)(A).

You indicate that the 401(k) Program service charges are fully disclosed in the marketing materials describing the 401(k) Program that are provided to Plan fiduciaries. Plans entering into the 401(k) Program pay ARPS a one-time charge for installation services, and annual charges for standard administrative and recordkeeping services, based on the number of participants.

Additional services are available on a fee-for-service basis, at the election of the Plan fiduciary. Either party may terminate the arrangement without penalty on 60 days written notice. ALIC receives fees for administration and management of the GACS, including the separate accounts maintained in connection with the GACS. ALIAC receives advisory and administrative fees for investment management and related services provided to the Aetna Series Funds, pursuant to agreements between the Aetna Series Funds and ALIAC, which you represent are standard in the mutual fund industry.3

ALIAC has entered into various contracts with the Unrelated Funds (or their advisers or distributors) pursuant to which shares issued by the Unrelated Funds are purchased on behalf of Plans from the distributors of the Unrelated Funds or directly from the Unrelated Funds. Pursuant to these agreements, ALIAC receives from the Unrelated Funds (or their advisers or distributors) payments in consideration of (1) ARPS's provision of shareholder services (including participant-level recordkeeping) and other administrative services in connection with Plan investments in the Unrelated Funds, and (2) reductions in the Unrelated Funds' shareholder servicing and other administrative expenses (e.g., transfer agency fees) made possible by ARPS's provision of such services. These payments are based on a percentage of Plan assets invested in each Unrelated Fund through the 401(k) Program, and are paid either as administrative expenses by an Unrelated Fund (or by a servicing agent, adviser, or distributor from which the Unrelated Fund obtains its administrative services), or pursuant to a written plan described in Securities and Exchange Commission (SEC) Rule 12b-1, 17 C.F.R. 270.12b-1 (a 12b-1 Plan). The total administrative expenses paid by Unrelated Funds, including fees paid pursuant to 12b-1 Plans, are described to shareholders in prospectus materials. ALIAC discloses its receipt of fees from the Unrelated Funds (or their investment managers or other affiliates) in marketing and other disclosure materials provided to Plan fiduciaries. In particular, ALIAC will provide existing and prospective Plan customers a statement disclosing that ALIAC receives, or may receive, fees from many, but not all, of the Unrelated Funds, their managers or other affiliates (described as a percentage of assets under management with the Unrelated Funds). The statement will enumerate the services that ALIAC provides to the mutual funds and the rate of fees paid. The statement will also provide a toll-free telephone number to request more detailed information concerning which funds pay fees and an estimate of how much ALIAC may receive or has received during a particular time period. ALIAC will update the disclosure whenever there is any material change.

ALIAC reserves the right to modify the agreement with the Plan, including the list of Unrelated Funds available for investment, by giving 60 days written notice to the Plan's named fiduciary. If ALIAC decides to delete or replace an Unrelated Fund, ALIAC will notify the fiduciary of each Plan affected by the change. This notice would generally be sent by first class mail or fax. The notice would: (1) explain the proposed modification to the Unrelated Funds menu; (2) fully disclose any resulting chances in the fees paid to ALIAC by the Plan, or by any other entity with respect to Plan assets invested in the affected Funds; (3) identify the effective date of the change; (4) explain the Plan fiduciary's right to reject the change or terminate the agreement; and (5) reiterate that, pursuant to the contract provisions agreed to by the Plan fiduciary, failure to object will be treated as consent to the proposed change.

In addition, ALIAC may, depending on the facts and circumstances, send the notice by certified mail, include additional information and notice of the proposed deletion or substitution in other mailings to the Plan fiduciary (e.g., in periodic newsletters, in materials provided to assist the Plan fiduciary in notifying participants of the change, or in an invoice), or follow up its notice of a Fund deletion or substitution by telephone or other contact with the Plan fiduciary. Any or all of these procedures might be taken with respect to a particular Plan or implemented for all Plans affected by a deletion or substitution of a Fund.

You represent that if a Plan fiduciary rejects the proposed deletion or substitution, ALIAC would not be authorized to make the proposed deletion or substitution effective with respect to that particular Plan. In such circumstances, upon written notice of termination, the Plan fiduciary is afforded an additional 60 days to convert the Plan to another service provider. You represent, however, that in most cases ALIAC would seek to avoid terminating the agreement and losing a customer by negotiating to address the concerns of a Plan fiduciary that has rejected a proposed modification to the Unrelated Funds menu.

You also represent that ALIAC may determine, based on the particular facts and circumstances, to provide more than the minimum 60 days notice of the proposed change, waive some or all of the agreement's 60-day period for notice of termination by a Plan, and/or, if administratively feasible, agree to continue to provide services to a particular Plan beyond the 60-day termination period without deleting or substituting any Unrelated Funds pending the Plan's conversion to a new service provider if additional time is required to complete a conversion. Any of these or other measures might be taken with respect to particular Plans, or implemented for all Plans affected by a deletion or substitution of an Unrelated Fund. You thus represent that a Plan fiduciary will have a reasonable period of time within which to convert to a new service provider.

You have requested an opinion that the receipt of fees by ALIAC from the Unrelated Funds would not violate ERISA section 406(b)(3). Section 406(b)(3) provides that:

A fiduciary with respect to a plan shall not receive any consideration for his own personal account from any party dealing with such plan in connection with a transaction involving the assets of the plan.

The Department has taken the position that if a fiduciary does not exercise any authority or control to cause a plan to invest in a mutual fund, the mere receipt by the fiduciary of a fee or other compensation from the mutual fund in connection with the plan's investment would not in and of itself violate section ERISA 406(b)(3) (See, Advisory Opinion 97-15A, May 22, 1997).

Whether the receipt of such fees by ALIAC involves violations of section 406(b)(3) turns first on whether ALIAC is a fiduciary with respect to the investing Plans. ALIAC receives fees from an Unrelated Fund for its own account that are based on a percentage of the Plan assets invested in the Unrelated Fund. Such fees are paid to ALIAC by the Unrelated Fund or a related party in connection with a transaction (the purchase and sale of securities issued by the Unrelated Fund) involving the assets of the Plans.

The circumstances under which ALIAC provides recordkeeping and administrative services to Plans, you believe, would not cause ALIAC to be considered a fiduciary. You seek assurance, however, that ALIAC will not be deemed to be a fiduciary with respect to a Plan merely because ALIC, an affiliate under common control with ALIAC, may be considered a fiduciary of the Plan by virtue of providing investment management services for Plan assets invested in an ALIC separate account.

ERISA section 3(21)(A) provides that a person is a fiduciary with respect to a plan to the extent that he/she (i) exercises any discretionary authority or control respecting management of the plan or 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. Section 3(21)(B) provides that neither an investment company registered under the ICA, nor its investment adviser or principal underwriter shall be deemed to be fiduciaries or parties in interest with respect to a plan solely by reason of the plan's investment in securities issued by the investment company, unless the plan covers employees of the investment company, investment adviser or principal underwriter.

Interpretive Bulletin 75-8 (IB 75-8, 29 C.F.R. 2509-75-8) provides additional guidance concerning what types of functions will make a person a fiduciary with respect to a plan. In particular, question-and-answer D-2 states that a person who performs purely ministerial functions, such as preparation of employee communications material, preparation of government reports, and preparation of reports concerning participants' benefits, among others, within a framework of policies, interpretations, rules, practices and procedures made by other persons is not a fiduciary because such person does not have or exercise any discretionary authority or control regarding the management of the plan or its assets.

Pursuant to these provisions, a determination of whether a person is a fiduciary with respect to a plan requires an analysis of the types of functions performed and actions taken by the person on behalf of the plan to determine whether particular functions or actions are fiduciary in nature and therefore subject to ERISA's fiduciary responsibility provisions. As a result, the question of whether ALIAC is a "fiduciary" within the meaning of section 3(21)(A) of ERISA is inherently factual and will depend on the particular actions or functions ALIAC performs on behalf of the Plans.

You represent that ALIAC is not a trustee or administrator of the Plans, and provides only non-discretionary administrative and recordkeeping services pursuant to detailed administrative guidelines described in the Plan services agreement. Based on this representation, it would appear that, in most respects, ALIAC would not be a fiduciary with respect to Plans that are a party to such service agreements. ALIAC, however, retains some authority over the investment options selected by the Plans under the 401(k) Program in that it may, in its discretion, delete or substitute Unrelated Funds. In such instances, you represent that, before implementing a change in Funds with respect to any given Plan, ALIAC will provide advance notice to the appropriate Plan fiduciary regarding the change, including any changes in the fees to be received by ALIAC. If the Plan is permitted to maintain its investments in a deleted or replaced Fund, the advance notice will disclose any increased charges attributable to the retention by the Plan of the deleted or replaced Fund. In connection with this notice, you represent that Plan fiduciaries are afforded up to120 days, or more, to reject the change and terminate ALIAC's services without penalty.

It is the view of the Department 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 fiduciary must be provided advance notice of the change, including any changes in the fees received, and afforded a reasonable period of time within which to decide whether to accept or reject the change and, in the event of a rejection, secure a new service provider. On the basis of your representations that ALIAC provides the appropriate Plan fiduciary advance notice of the deletion or substitution of Funds and a reasonable period of time following receipt of the notice (here, at least 120 days) within which to reject the change in Funds and secure a new service provider,5 as described in your letter, it is the view of the Department that ALIAC would not become a fiduciary solely as a result of deleting or substituting an Unrelated Fund under such circumstances, provided that the actual decision to accept or reject the change in Funds is made by the Plan fiduciary.

You have assumed that ALIC, an affiliate under common control with ALIAC, is a fiduciary with respect to the Plans by virtue of exercising authority or control over Plan assets invested in separate accounts maintained by ALIC. There is nothing, however, in your submission to indicate that ALIAC is in a position to (or in fact does) exercise any authority or control over those assets. Accordingly it does not appear that ALIAC would be considered a fiduciary merely as a result of its affiliation with ALIC.

Finally, it should be noted that ERISA's general standards of fiduciary conduct also would apply to the proposed arrangement. 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, the above-described arrangement with ALIAC, and in determining which investment options to utilize or make available to Plan participants and beneficiaries. In this regard, the responsible Plan fiduciaries must assure that the compensation paid directly or indirectly by the Plan to ALIAC is reasonable, taking into account the services provided to the Plan as well as any other fees or compensation received by ALIAC in connection with the investment of Plan assets. The responsible Plan fiduciaries therefore must obtain sufficient information regarding any fees or other compensation that ALIAC receives with respect to the Plan's investments in each Unrelated Fund to make an informed decision whether ALIAC's compensation for services is no more than reasonable.

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

Sincerely,

Bette J. Briggs

Chief, Division of Fiduciary Interpretations

Office of Regulations and Interpretations

- Footnotes -

  1. You represent that ALIC utilizes several separate accounts in connection with the GACS, and have assumed for purposes of the advisory opinion request that the assets of these separate accounts would be deemed to be plan assets pursuant to the Department's regulation at 29 CFR 2510.3-101.
  2. The Department does not express any opinion concerning the effect, if any, of the receipt by ALIAC of fees for marketing services that may be added in the future.
  3. In this letter the Department expresses no opinion regarding the fees paid by the Aetna Series Funds to ALIAC.
  4. Under Reorganization Plan No. 4 of 1978, effective December 31, 1978, the authority of the Secretary of the Treasury to issue interpretations regarding section 4975 of the Internal Revenue Code of 1986 (the Code) has been transferred, with certain exceptions not here relevant, to the Secretary of Labor, and the Secretary of the Treasury is bound by interpretations of the Secretary of Labor pursuant to such authority. Therefore, references in this letter to specific sections of ERISA should be read to refer also to the corresponding sections of the Code.
  5. What constitutes a "reasonable period" within which to terminate an arrangement and change service providers will depend on the particular facts and circumstances of each case. There may be situations in which a time period shorter than 120 days may constitute a "reasonable period."

Advisory Opinion (98-06A)

Investment of In-House Employee Benefit Plans into Proprietary Mutual Funds

July 30, 1998

Summary

Clarification of Applicability of PTE 97-4 and PTE 77-3 to Investment of In-House Bank Employee Benefit Plans into Proprietary Mutual Funds

U.S. Department of Labor

Washington, D.C. 20216

July 30, 1998

Mr. Donald J. Myers

Reed Smith Shaw & McClay LLP

1301 K Street, N.W.

Suite 1100 - East Tower

Washington, D.C. 20005-3317

Re: Federated Investors

Identification Number C-9171

Dear Mr. Myers:

This is in response to your request on behalf of Federated Investors ("Federated") for guidance concerning whether Prohibited Transaction Class Exemption 77-3, 42 Fed. Reg. 18734 (April 8, 1977) (PTE 77-3) provides relief for the investment by a bank’s in-house plan in a mutual fund advised by the bank through an in-kind exchange of assets for mutual fund shares, assuming the conditions of the exemption have been satisfied.

You represent that Federated advises, administers and distributes its own mutual funds, and also administers, distributes and provides related services to funds that are advised by other financial institutions, including many banks. Federated has assisted its client banks in establishing "proprietary" mutual funds, i.e., open-end investment companies registered under the Investment Company Act of 1940 as to which the bank serves as investment adviser. These funds often come to serve as the investment vehicles for in-house bank plans through the conversion or partial conversion of the collective investment funds (the "CIFs") maintained by the bank. Federated assists these banks in the conversion process, and may serve as administrator and distributor, as well as in other capacities (such as transfer agent and portfolio recordkeeper) with respect to the proprietary mutual funds.

You state that on the date of a CIF conversion, assets representing the interests of investing plans in the converting CIFs are transferred to the mutual funds, in exchange for which the plans receive shares of the mutual funds of equal value to the assets transferred. These assets are valued for purposes of the transfer in a consistent and objective manner as of the close of business on the day of the transfer in accordance with the valuation conditions of Rule 17a-7 under the Investment Company Act of 1940 at 17 C.F.R. section 270.17a-7. Rule 17a-7 was adopted by the Securities and Exchange Commission as an exemption to permit, among other things, direct portfolio transactions between funds using the same investment adviser subject to specific conditions. That rule, at subsection 270.17a-7(b), requires that each security be valued at its "independent current market price" and stipulates the methods for determining price based on independent sources, as follows:

(1) If the security is a `reported security’ as that term is defined in rule 11Aa3-1 under the Securities Exchange Act of 1934, the last sale price with respect to such security reported in the consolidated transaction reporting system ('consolidated system') or the average of the highest current independent bid and lowest current independent offer for such security (reported pursuant to rule 11Ac1-1 under the Securities Exchange Act of 1934) if there are no reported transactions in the consolidated system that day; or

(2) If the security is not a reported security, and the principal market for such security is an exchange, then the last sale on such exchange or the average of the highest current independent bid and lowest current independent offer on such exchange if there are no reported transactions on such exchange that day; or

(3) If the security is not a reported security and is quoted in the NASDAQ system, then the average of the highest current independent bid and lowest current independent offer reported on Level 1 of NASDAQ; or

(4) For all other securities, the average of the highest current independent bid and lowest current independent offer determined on the basis of reasonable inquiry.

You also represent that all plans involved in these transactions, both the in-house plans of the bank and the outside client plans of the bank, are treated in the same manner in these transactions and on a basis no less favorable than such dealings would be with other shareholders of the mutual funds. No brokerage commissions or other transaction costs are charged to the CIFs, the investing plans or the mutual funds in the exchange transaction.

PTE 77-3 provides that the restrictions of sections 406 and 407(a) of the Employee Retirement Income Security Act of 1974 ("ERISA") and the taxes imposed by section 4975 (a) and (b) of the Internal Revenue Code (the "Code"), by reason of section 4975(c)(1) of the Code, shall not apply to the acquisition or sale of shares of an open-end investment company registered under the Investment Company Act of 1940 by an employee benefit plan covering only employees of such investment company, employees of the investment adviser or principal underwriter for such investment company, or employees of any affiliated person of such investment adviser or principal underwriter; provided that the conditions of the class exemption are met. The term "acquisition" is not defined in PTE 77-3.

In support of your argument that PTE 77-3 extends to the in-kind exchange of assets for mutual fund shares, you note that the regulation at 29 C.F.R. 2550.407a-2(b) defines the term "acquisition" for purposes of section 407(a) of ERISA to include both an acquisition "by purchase" and "by the exchange of plan assets." You assert that by distinguishing a "purchase" from an "exchange," the regulation makes clear that, compared to a "purchase," an "acquisition" is a broader term that includes both cash "purchases" and in-kind "exchanges." In this regard, you argue that the meaning of the term "acquisition" in both the regulation and PTE 77-3 should be interpreted in a similar manner. However, the Department notes that the definition of the term "acquisition" in 29 CFR 2550.407a-2(b) does not control the meaning of that term in PTE 77-3, since the application of that definition is expressly limited to the implementation of section 407(a) of ERISA.

Nevertheless, it is the view of the Department of Labor (the "Department") that relief under PTE 77-3 is available not only for cash purchases of investment company shares, but also for transactions involving the exchange of securities held on behalf of a plan for shares of the investment company. In this regard, the Department notes that section (d) of PTE 77-3 requires that all other dealings between the plan and the investment company, the investment adviser or principal underwriter for the investment company, or any affiliated person of such investment adviser or principal underwriter, are on a basis no less favorable to the plan than such dealings are with other shareholders of the investment company. The Department further notes that Prohibited Transaction Exemption 97-41 (62 FR 42830, August 8, 1997) permits a plan to purchase shares of an open-end mutual fund, the investment adviser for which is a bank that also serves as a fiduciary of a non-affiliated client plan, in exchange for plan assets transferred in-kind to the fund from a collective investment fund maintained by the bank. To the extent that the transactions described in your request involve both the conversion of CIF assets owned by outside client plans, which is within the scope of PTE 97-41, and the conversion of CIF assets owned by in-house plans, which is not, the Department interprets section (d) of PTE 77-3 to require that the methodology used to value the assets of the in-house plan transferred to the mutual fund and to determine the number of shares of the mutual fund received by the in-house plan, be the same as is applicable to the conversion of outside client plan assets under PTE 97-41. 

Moreover, section 406(b)(1) of ERISA prohibits a fiduciary from dealing with the plan’s assets in his or her own interest or for his or her own account. In addition, section 406(b)(2) of ERISA prohibits a plan fiduciary from acting on behalf of a party whose interests are adverse to the interests of the plan or the plan’s participants or beneficiaries. Accordingly, a plan fiduciary considering the in-kind acquisition of shares of a mutual fund advised by the bank in exchange for assets of the bank’s in-house plan must ensure that the fiduciary’s or the bank’s interest in attracting and retaining investors in the mutual fund does not conflict with the interests of the plan or its participants and beneficiaries in the selection of appropriate investment vehicles.

In addition, it is the Department’s view that the class exemption prescribed in PTE 77-3 would not provide relief for any prohibited transaction that may arise in connection with terminating a CIF, permitting certain plans to withdraw from a CIF that is not terminating, or transferring any plan assets held by a CIF. PTE 77-3 only provides relief for the acquisition of a proprietary mutual fund’s shares by an in-house plan in exchange for assets that were transferred from a CIF.

The Department cautions that ERISA’s general standards of fiduciary conduct would apply to the plan’s acquisition of mutual fund shares in exchange for plan assets transferred in-kind to the mutual fund from a CIF maintained by the plan’s sponsor. Section 404(a)(1)(B) of ERISA requires that a fiduciary discharge his or her duties with respect to a plan solely in the interest of the participants and beneficiaries and with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims. Accordingly, the plan fiduciary must act "prudently" and "solely in the interest" of the plan’s participants and beneficiaries with respect to the decision regarding the in-kind acquisition of mutual fund shares by the plan.

The Department further emphasizes that it expects a plan fiduciary, prior to entering into the transaction, to fully understand the mechanics of the transaction and to evaluate the risks associated with this type of investment, following disclosure of all relevant information pertaining to the transaction, including the valuation methodology applicable to the transferred securities and the mutual fund shares received in exchange. If the decision by the plan fiduciary to enter into the transaction is not "solely in the interest" of the plan’s participants and beneficiaries, e.g., if the decision is motivated by the intent to generate seed money that facilitates the marketing of the mutual fund, then the plan fiduciary would be liable for any loss resulting from such breach of fiduciary responsibility, even if the acquisition of mutual fund shares was exempt by reason of PTE 77-3.

This letter constitutes an advisory opinion under ERISA Procedure 76-1. Accordingly, it is issued subject to the provisions of the procedure, including section 10 thereof, relating to the effect of advisory opinions.

Sincerely,

Ivan Strasfeld

Director

Office of Exemption Determinations

 
Last Updated 04/02/2008

supervision@fdic.gov