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Trust Examination Manual
Advisory
Opinion 2003-02A
February 10, 2003
Lisa J. Bleier
Senior Counsel
Regulatory and Trust Affairs
American Bankers Association
1120 Connecticut Avenue, NW
Washington, DC 20036
2003-02A
ERISA Sec. 408(b)(2) and 408(b)(6)
Dear Ms. Bleier:
This is in response to your request, on behalf of the American Bankers Association,
regarding the fiduciary responsibility provisions of the Employee Retirement
Income Security Act of 1974, as amended (ERISA). Specifically, you have requested
an opinion clarifying the application of sections 408(b)(2) and 408(b)(6) of
ERISA to the provision of overdraft protection services, including any inherent
extension of credit incident to such services, by banks, whether or not the bank
or other financial institution or affiliate exercises investment discretion over
plan assets.(1)
You represent that banks provide custodial or trust services to institutional
clients, including employee benefit plans. A bank or its affiliate may also serve
as investment manager for plans and other clients or as trustee and investment
manager of collective funds in which plans invest. An essential part of bank
custodial and trust services provided to clients, including employee benefit
plans, is the orderly processing of the client’s securities and other financial
market transactions, generally based on the anticipated receipt of funds to cover
such transactions. In this regard, you indicate that banks have established settlement
policies and procedures to maximize the efficiency of the securities trading
in institutional accounts.
You note that plan investment performance would suffer significantly if a
bank held up settlements to ensure that every sale scheduled to settle (thus
generating
funds necessary to effectuate subsequent transactions) had in fact settled
or that anticipated funds had indeed been received. You represent that, although
most transactions settle on time, settlement problems may arise due to errors,
unexpected delays by a counterparty or its agent, settlement failures by
a counterparty
or its custodian, broker failures or inefficient markets. In the event of
such a failure, banks will generally settle plan transactions without contemporaneous
assurance that the necessary funds have been credited, in the correct currency,
to the plan’s account. You represent that this overdraft protection is provided
as part of a bank’s and its sub-custodians’ “standard operating systems and
practices
maintained routinely for all institutional customers.” Overdraft protection
is necessary to the custody service and is expected and demanded
by plan and non-plan clients.
You explain that unlike a conventional loan between a plan and a bank, overdraft
protection involves no agreement to lend a stated sum for a specified period
of time. Events giving rise to an overdraft are generally inadvertent or
outside the control of the bank or affiliate. A bank or an affiliate makes
no specific
discretionary decision to extend overdraft protection at the time of the
settlement of a transaction and neither the plan nor its investment fiduciary
makes a specific
discretionary decision at that time to accept it. In fact, although the client
is aware that overdraft protection is available, when needed, neither the
client nor the bank is likely to be aware of the existence of any particular
overdraft
or its amount at the time that overdraft protection is actually provided.
Banks recognize the extent to which overdrafts occur only in retrospect upon
reconciliation
of client accounts. Further, you represent that banks have procedures in
place to discourage overdrafts and prevent clients, including
plans, from using the overdraft protection as an intentional line of credit.
Your letter contains the following general information about overdraft protection
procedures. Overdraft protection procedures are designed to ensure that overdraft
protection is consistent with sound banking practice under published positions
of both the Office of the Comptroller of the Currency and the Federal Reserve
Board.(2) According to your letter, bank procedures, as well as agreements
with plan clients, ensure that the terms of overdraft protection are at least
as favorable
to plans as the terms generally available in arm's length transactions between
unrelated parties. After an overdraft is determined, a bank promptly notifies
the appropriate investment manager or other plan fiduciary to determine the
course of action that the fiduciary will take to correct the overdraft. Notice
may be
provided by telephone, facsimile, e-mail, through a bank's secure Web site
or by some alternative method directed by the plan. Banks generally impose
an overdraft
charge and intend that such charge function as a disincentive
for the investment fiduciary to intentionally prolong an overdraft. The overdraft
charge is based on an objective measure that varies depending upon factors such
as the custody location or currency involved. The overdraft charge may be defined
by reference to an identified published rate. The overdraft charge, according
to your letter, does not exceed "reasonable compensation."
You represent that banks disclose and obtain the consent of plan clients to the
provision of overdraft protection. Bank disclosures describe the overdraft protection
service and identify the objective basis for the overdraft charge. Consent may
be affirmative if the plan client signs a trust, custody, or other agreement
describing the services. Alternatively, consent may be deemed given following
disclosure of the services.
As a trustee or custodian, a bank is a party in interest with respect to each
plan. ERISA section 3(14) defines “party in interest” to include, among others,
a fiduciary or person who provides services to a plan. Absent an exemption, a
bank’s provision of overdraft protection, as described herein, to plans would
violate sections 406(a)(1)(C) and (D) of ERISA, which prohibit the provision
of services by a party in interest to a plan and the transfer of assets from
a plan to a party in interest. In addition, absent an exemption, any extension
of credit between the bank and plan that may occur in connection with the overdraft
protection would violate section 406(a)(1)(B) of ERISA. Moreover, if a bank uses
any of the authority, control, or responsibility that makes the bank a fiduciary
to cause a plan to pay to the bank an overdraft charge, the bank may violate
sections 406(b)(1) and (2) of ERISA.
As discussed below, it is the view of the Department that the provision of overdraft
protection services, including any inherent extensions of credit incident to
such services, described in your letter would not constitute a prohibited transaction
under section 406 to the extent that the bank providing such services complies
with the requirements for relief under section 408(b)(2) or section 408(b)(6)
of ERISA, as appropriate, and such provision of services is not otherwise part
of an arrangement to secure credit unrelated to the settlement of securities
or other financial market transactions.
Section 408(b)(2) provides a statutory exemption from the prohibitions of
section 406(a) for contracting or making reasonable arrangements with a party
in interest,
including a fiduciary, for office space, or legal, accounting, or other services
necessary for the establishment or operation of the plan, if no more than
reasonable compensation is paid therefor. 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. §§2550.408b-2(d) and 2550.408c-2) as used
in section 408(b)(2). Thus, overdraft protection services, in the context
described in your letter, appear to be necessary to ensure the orderly processing
of plan
securities and other financial market transactions and, therefore, would
appear to be a “necessary service” for purposes of section 408(b)(2) and
§2550.408b-2(b).
Accordingly, such services would be covered by section 408(b)(2) to the extent
such services are furnished under contracts or arrangements that are reasonable
and no more than reasonable compensation is paid for such services within
the meaning of §2550.408b-2. As explained in §2550.408b-2(a), 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 the provision of services that are exempt under section
408(b)(2).
Section 408(b)(6) of ERISA provides a statutory exemption from the prohibitions
of section 406 for any ancillary services provided to a plan by a bank or similar
financial institution supervised by the United States or a State, if such bank
or financial institution is a fiduciary of such plan and certain conditions are
satisfied. Section 2550.408b-6 further clarifies the application of section 408(b)(6).
Such ancillary services include services that 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.
The Department has indicated that a service is “ancillary” if it aids or is auxiliary
to a primary or principal service. The Department has concluded that the provision
of “sweep services” by a trustee who is subject to direction from an independent
investment manager for the investment of plan assets may constitute an “ancillary
service” within the meaning of section 408(b)(6).(3) The Department also has
indicated that the question of what constitutes an “ancillary service” within
the meaning of section 408(b)(6) depends on the expectations of the parties as
evidenced by the terms of the underlying service agreement and applicable Federal
banking law.(4)
With regard to the expectations of the parties, you represent that plan fiduciaries
are fully informed about, and approve, the terms governing the provision
of overdraft protection services in settling securities and other financial
market transactions
for the plan, including associated charges.(5) Additionally, you represent
that disclosure documents make clear that charges attendant to overdrafts
are in addition
to and separate from fees charged for other services, such as trustee or
investment management services, provided by the bank or an affiliate. Given
the foregoing
and the fact that overdraft protection services appear to be necessary to
ensure the orderly processing of plan securities transactions and other financial
market
transactions, as well as a banking practice recognized and permitted by Federal
banking authorities, it is the view of the Department that the overdraft
protection services described in your letter would constitute an “ancillary
service” and,
therefore, may be exempt from the prohibitions
of section 406 if the conditions of section 408(b)(6) are satisfied. Whether
any given bank satisfies the conditions of section 408(b)(6) is an inherently
factual determination on which the Department generally will not rule.
Section 2550.408b-6(b) requires that ancillary services described in section
408(b)(6) 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 §2550.408b-6(c). To date, no regulations have been issued
to set specific requirements for such guidelines. 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 the specific guidelines issued by the bank
or similar financial institution, and 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).
In order to reasonably preclude providing services in an excessive or unreasonable
manner or in a manner that would be inconsistent with the best interests
of the participants and beneficiaries, it is the view of the Department that
guidelines
relating to overdraft protection services, at a minimum, would be required
to include measures designed to ensure timely notice to the appropriate plan
fiduciary
of any overdraft and the imposition of charges with respect thereto, to monitor
and limit the duration and usage of overdraft services, and to limit the
ability of a fiduciary to utilize overdraft protection services as a routine
means by
which securities and other financial market transactions are settled. For
example, a pattern or practice of routine use of overdraft protection for
settlement of
securities or other financial market transactions would evidence the providing
of ancillary services in an excessive and unreasonable manner and in a manner
inconsistent with the interests of participants and beneficiaries
in violation of section 408(b)(6).
ERISA’s general standards of fiduciary conduct also apply to the overdraft protection
services. Section 404 requires, among other things, a fiduciary to discharge
his duties respecting a plan solely in the interest of the plan’s participants
and beneficiaries and in a prudent fashion and for the exclusive purpose of providing
benefits and defraying reasonable expenses of administering the plan. Further,
except as provided in section 408, fiduciaries also have an obligation under
section 406 not to engage in self-dealing or to cause the plan to engage in certain
transactions, including a direct or indirect furnishing of goods, services or
facilities between the plan and a party in interest. In this regard, banks or
institutions which act as investment managers to plans and provide through their
affiliates or otherwise overdraft services would need to assure adherence with
the conditions and guidelines specified in section 408(b)(6) of ERISA in the
performance of those services.
As with the selection of any service provider, a plan fiduciary must engage in
an objective process designed to elicit information necessary to assess the qualifications
of the provider, the quality of the services offered, and the reasonableness
of the fees charged in light of the services provided, including overdraft protection
services. As with any compensation arrangement, plan fiduciaries should consider
the circumstances under which services will be rendered and the charges for such
services, the basis for such charges and the ability of the fiduciary to limit
such charges.
This letter constitutes an advisory opinion under ERISA Procedure 76-1. Accordingly,
it is subject to the provisions of the procedure, including section 10 thereof
relating to the effect of advisory opinions.
Sincerely,
Louis Campagna
Chief, Division of Fiduciary Interpretations
Office of Regulations and Interpretations
Footnotes
Under Reorganization Plan No. 4 of 1978, 43 FR 47713 (Oct. 17, 1978), the authority
of the Secretary of the Treasury to issue rulings under section 4975 of the Internal
Revenue Code (Code) has been transferred, with certain exceptions not here relevant,
to the Secretary of Labor. Therefore, the references in this letter to specific
sections of ERISA also refer to the corresponding sections of the Code.
- You represent that the Office of the Comptroller of the
Currency recognizes that overdrafts in fiduciary
accounts are permissible if they are temporary in nature, made only
for proper purposes and appropriately
accounted for in the records of the bank. The Federal
Reserve Board takes a similar position, permitting overdrafts that are
temporary,
corrected as soon as possible, kept to a minimum
and adequately secured. Both agencies permit the imposition of a fee
with respect to the overdraft
if the policy is permitted under local law. See e.g.,
Fed. Res. Interp. Ltr. No. 5-942.22, (March 16, 1993), available at
1993 WL 764576 (F.R.B.).
- See Advisory Opinion No. 2001-10A, December 14, 2001.
- See DOL information letter to Robert Plotkin, August 1,
1986.
- What constitutes an approval by an appropriate plan fiduciary
will depend on the facts and circumstances of each
case. See Advisory Opinions Nos. 97-16A, May 22, 1997 and 2001-01A,
January 18, 2001.
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