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Trust Examination Manual
Advisory
Opinion 2003-09A
June 25, 2003
2003-09A
ERISA Sec. 406(b)(1), 406(b)(3)
Gary W. Howell
Gardner, Carton & Douglas
191 North Wacker Drive, Suite 3700
Chicago, IL 60606
Dear Mr. Howell:
This is in response to your request for guidance under the Employee Retirement
Income Security Act of 1974 (ERISA). In particular, you ask whether a trust company’s
receipt of 12b-1 and subtransfer fees from mutual funds, the investment advisers
of which are affiliates of the trust company, for services in connection with
investment by employee benefit plans in the mutual funds, would violate section
406(b)(1) and 406(b)(3) of ERISA when the decision to invest in such funds is
made by an employee benefit plan fiduciary or participant who is independent
of the trust company and its affiliates.
You write on behalf of ABN AMRO Trust Services Company (AATSC), a state-chartered
trust company. You represent that AATSC is a wholly owned subsidiary of Alleghany
Asset Management Company (Alleghany), which is a wholly owned subsidiary of ABN-AMRO
North America Holding Company, a bank holding company (ABN-AMRO).(1)
Alleghany is also the parent organization of several institutional investment
advisers (Advisers), including some that have entered into investment advisory
contracts with mutual funds registered under the Investment Company Act of 1940.
You refer to those mutual funds with which such Advisers have investment advisory
contracts as ‘Proprietary Funds.’ All other mutual funds are referred to as ‘Non-Proprietary
Funds.’
You represent that AATSC provides directed trustee and ‘non-fiduciary’ services
to participant-directed and other defined contribution pension plans (Client
Plans) through ‘bundled service’ arrangements. You represent that these services
(Plan Services) provided by AATSC through bundled service arrangements include,
but are not limited to, custodial trustee services, participant level recordkeeping,
participant communications and educational materials and programs, voice response
system access to accounts for participants, plan documentation, including prototype
plans, summary plan descriptions and annual reports, tax compliance assistance,
administrative assistance in processing plan distributions and loans, and a facility
for plan investment options.
In connection with the Client Plan-related business, AATSC has entered into shareholder
service arrangements with distributors of, or investment advisers to, mutual
fund families pursuant to which AATSC will make mutual fund families available
for investment by Client Plans. Among the investment advisers with which AATSC
enters into such arrangements are those Advisers with investment advisory contracts
with Proprietary Funds.
You represent that neither AATSC, nor any other bundled service provider of which
AATSC is aware, engages in arrangements where just Plan Services are provided.
You represent that, because the true cost of Plan Services would exceed any amount
that could be charged in the competitive bundled service market with regard to
a Client Plan’s engagement of AATSC as a bundled service provider, all bundled
service arrangements between AATSC and a Client Plan are predicated on a Client
Plan’s offering of one or more Proprietary Funds as an investment option.
You represent that disclosures with regard to Proprietary Funds will enable the
fiduciaries of potential Client Plans to make an informed decision regarding
whether to engage AATSC in a bundled service arrangement. Included in every proposal
made by AATSC to a potential Client Plan are the following disclosures regarding
each Proprietary Fund offered:
the total number of actively-managed mutual funds in the
same category as the Proprietary Fund (based on fund classifications
by Lipper, Morningstar, or some other generally recognized mutual fund
analytical service);
the investment advisory fee, 12b-1 fee (if any) and other
fees paid by the Proprietary Fund, as well as the aggregate fees paid
by such Proprietary Fund; and
- the same fee information described in (b) with respect to
the highest-fee, lowest-fee, median-fee, and average-fee fund in the
same category as the Proprietary Fund.
You represent that participant-directed and other defined contribution pension
plans become Client Plans through a process of presentation and negotiation.
Typically, a plan sponsor, on behalf of a potential Client Plan, either directly,
or through a third-party consultant, will ask AATSC to respond to a ‘request
for proposal’ to provide a bundle of services for the plan, such as recordkeeping,
directed trusteeship, participant investment education, participant loan and
distribution processing and investment vehicles. You represent that a potential
Client Plan will typically ask other bundled service providers also to respond
to a request for proposal.
Client Plan fiduciaries select the funds in which
the Client Plans will invest. AATSC does not restrict
the mutual funds that a Client Plan may utilize,
beyond
requiring, as a condition of engagement, that a Client Plan select at least
one Proprietary Fund to offer as an investment
option. AATSC will, if requested,
provide a list of investment funds for the Client Plan to consider. The Client
Plan fiduciaries are free to select funds other than those listed by AATSC.
Your representations indicate that AATSC, under
the terms of a bundled service arrangement,
will not be able to assert any influence with respect to selection of other
investment options in which Client Plans will invest
or the particular Proprietary Fund in which the Client Plan elects to invest.
Potential Client Plan fiduciaries are free to accept, reject or further negotiate
a bundled service arrangement from AATSC. Based upon such flexibility on the
part of a potential Client Plan with respect to negotiation of the terms surrounding
engagement of AATSC to provide Plan Services, you represent that engagement of
AATSC results from arm’s length negotiations between a potential Client Plan
and AATSC.
You represent that a Client Plan’s choice of investment
vehicles affects the cost of engaging AATSC to
provide Plan Services. AATSC estimates the amounts
that a potential Client Plan would likely invest in Proprietary Funds based
on the amount of the Client Plan’s assets and the
number of Proprietary Funds selected.
This estimate affects the price at which AATSC offers to perform Plan Services.
For example, if Client Plan fiduciaries may direct investment into three
Proprietary
Funds, Plan Services would cost less than if Client Plan fiduciaries may
direct investment into two Proprietary Funds. Similarly,
Client Plan fiduciaries that
may direct investment into only one Proprietary
Fund would be quoted a higher price for bundled services, because AATSC would
expect to cover less of the cost of providing Plan Services from asset management
revenue.
As a directed trustee, AATSC takes direction from Client Plans regarding their
selection of investment options. You assert that, because AATSC does not restrict
the mutual funds that a potential Client Plan may utilize, the preparation and
furnishing of a list offering an array of mutual fund choices does not constitute
discretion to add or delete mutual fund families in which Client Plans may invest.
You represent that if a Client Plan decides to
remove a Proprietary Fund as an investment option,
AATSC’s
total anticipated revenue from the Client Plan
and Proprietary Fund would be affected, leaving
less asset management revenue with
which to provide Plan Services. In such a situation, you represent that AATSC
would invite the Client Plan fiduciaries to consider one or more other Proprietary
Funds to replace non-Proprietary Fund investment options. If the plan fiduciaries
do not choose to offer another Proprietary Fund as an investment option,
AATSC would continue to provide Plan Services pursuant
to the bundled services arrangement,
but would evaluate such arrangement, as follows.
If AATSC determines that a bundled service arrangement is no longer profitable,
AATSC can withdraw or make an offer to the Client Plan fiduciaries to renegotiate
the fees for AATSC’s provision of Plan Services. You represent that AATSC’s bundled
service arrangements generally include a provision whereby AATSC may propose
a fee adjustment upon sixty days’ written notice. In addition, either party can
terminate a bundled service arrangement without cause, upon at least thirty days’
advance written notice. Upon termination of a bundled service arrangement, funds
are transferred on the effective date of appointment of a successor trustee.
You represent that AATSC has the systems and administrative
capability to provide investment facilities to
a Client Plan for any mutual fund that accepts
investments
from pension plans. You represent that the majority of mutual funds are traded
by AATSC on the National Securities Clearing Corporation (NSCC) ‘platform’
for
processing transactions in mutual funds. Mutual fund transactions processed
through NSCC’s ‘Fund/SERV’ service are made on
its standard, highly automated platform
that links approximately 2,000 key providers in the mutual fund industry,
including AATSC. For those few funds utilized by
Client Plans that do not participate
in NSCC, generally because of their small
size or low volume of trades, you represent that AATSC processes trades manually,
in a manner consistent with industry practice.
You ask whether AATSC’s receipt of 12b-1 and subtransfer agency fees from mutual
funds, including those Proprietary Funds the investment advisers of which are
affiliates of AATSC, for services in connection with investment by employee benefit
plans in the mutual funds, would violate section 406(b)(1) and 406(b)(3) of ERISA
when the decision to invest in such funds is made by an employee benefit plan
fiduciary who is independent of AATSC and its affiliates.(2)
Section 3(14)(A) and (B) of ERISA provides that
a party in interest means, as to an employee benefit
plan, any fiduciary, including a trustee, of an
employee
benefit plan or a person providing services to a plan. ERISA section 3(21)(A)
provides that a person is a fiduciary with respect to a plan to the extent
that
it (i) exercises any authority or control respecting management or disposition
of its assets, (ii) renders investment advice for a fee or other compensation,
direct or indirect, with respect to any moneys or other property of the plan,
or has any authority or responsibility to do so, or (iii) has any discretionary
authority or responsibility in the administration of the
plan. Accordingly, as directed trustee of Client Plans, AATSC will be a party
in interest and a fiduciary.
Section 406(a)(1)(C) of ERISA proscribes the provision of services to a plan
by a party in interest, including a fiduciary, and section 406(a)(1)(D) prohibits
the use by or for the benefit of, a party in interest, of the assets of a plan.
However, section 408(b)(2) of ERISA provides an exemption from the prohibitions
of section 406(a) of ERISA for contracting or making reasonable arrangements
with a party in interest, including a fiduciary, for office space, or legal,
accounting, or other services necessary for the establishment or operation of
the plan, if no more than reasonable compensation is paid.
29 CFR 2550.408b-2 provides, with respect to a
reasonable contract or arrangement, that no contract
or arrangement
is reasonable within the meaning of section 408(b)(2)
and 29 CFR 2550.408b-2(a)(2) if it does not permit termination by the plan
without
penalty to the plan on reasonably short notice under the circumstances to
prevent the plan from becoming locked into an arrangement
that has become disadvantageous.
Your representations indicate that, pursuant to the Client Plan’s arrangement
with AATSC and consistent with 29 CFR 2550.408b-2(c), the Client Plan may
terminate a bundled service arrangement without
cause and without penalty, upon at least
thirty days’ advance written
notice.(3)
Section 406(b)(1) of ERISA prohibits a fiduciary with respect to a plan from
dealing with the assets of the plan in its own interest or for its own account.
Section 406(b)(3) of ERISA prohibits a fiduciary with respect to a plan from
receiving any consideration for its own personal account from any party dealing
with the plan in connection with a transaction involving the assets of the plan.
With respect to the prohibitions in section 406(b),
regulation 29 CFR 2550.408b-2(a) indicates that
section 408(b)(2) of ERISA does not contain an
exemption
for an
act described in section 406(b) of ERISA (relating to conflicts of interest
on the part of fiduciaries) even if such act occurs
in connection with a provision
of services which is exempt under section 408(b)(2). As explained in regulation
29 CFR 2550.408b-2(e)(1), if a fiduciary uses the authority, control, or
responsibility which makes it a fiduciary to cause
the plan to enter into a transaction involving
the provision of services when such fiduciary has an interest in the transaction
which may affect the exercise of
its best judgment as a fiduciary, a transaction described in section 406(b)(1)
would occur, and that transaction would be deemed to be a separate transaction
from the transaction involving the provision of services and would not be
exempted by section 408(b)(2). Conversely, the regulation explains that a
fiduciary
does not engage in an act described in section 406(b)(1) if the fiduciary
does not
use any of the authority, control, or responsibility which makes such person
a fiduciary to cause a plan to pay additional fees for a service furnished
by such fiduciary or to pay a fee for a service furnished by a person in
which such
fiduciary has an interest which may affect the exercise of such fiduciary’s best judgment as a fiduciary.
You assert that principles previously expressed
by the Department in Advisory Opinion 97-15A(4)
would
apply here. In Advisory Opinion 97-15A, the Department
opined that if a trustee acts pursuant to a proper direction in accordance
with
sections 403(a)(1) or 404(c) of ERISA and does not exercise any authority
or control to cause a plan to invest in a mutual
fund that pays a fee to the trustee
in connection with the plan’s investment, then the trustee would not be dealing
with assets of the plan for its own interest or for its own account in violation
of section 406(b)(1) of ERISA and the trustee would not be receiving consideration
for itself from a third party in connection with
a transaction involving plan assets in violation of section 406(b)(3).
The arrangement about which you request the Department’s guidance differs from
the facts of Advisory Opinion 97-15A. In that letter, the trustee had reserved
the right to add or remove mutual fund families that it made available to its
client plans. The trustee also agreed to apply any fees it received from the
mutual funds to the benefit of the plans. You represent that, once a Client Plan
enters into a bundled service arrangement with AATSC, the Client Plan fiduciary
possesses authority to make decisions regarding investment fund choices and any
modifications to the menu of investment fund choices available for investment
of plan assets.
In Advisory Opinion 97-16A,(5) the Department expressed
the view that a person would not be exercising
discretionary authority or control over the management
of a plan or its assets solely as a result of deleting or substituting a
fund
from a program of investment options and services offered to plans, provided
that the appropriate plan fiduciary in fact makes the decision to accept
or reject the change. In this regard, the Department
went on to opine that the plan fiduciary
must be provided advance notice of the change, including disclosure of record-keeper
fee information and must be afforded a reasonable amount of time in which
to
accept or reject the change. Such advance notice
ensured that the fiduciary would maintain independence with respect to selection
of investment options offered. Similar to the arrangement described in Advisory
Opinion 97-16A, here a Client Plan sponsor or other fiduciary shall, independent
of AATSC, maintain complete control with respect to the selection of funds
in which the Client Plan will invest. AATSC itself has no role with respect
to selection
of investment options beyond requiring, as a condition of initial engagement
of AATSC as a bundled service provider, that at least one Proprietary Fund
is offered by a Client Plan for investment.
You represent that when a Client Plan engages AATSC to provide bundled services,
a Client Plan fiduciary, independent of AATSC or its affiliates, will select
the Client Plan’s investment options. We note, however, that if, with respect
to a particular Client Plan, AATSC provides ‘investment advice’ within the meaning
of regulation 29 CFR 2510.3-21(c), AATSC would engage in a violation of section
406(b)(1) of ERISA in causing the Client Plan to invest in a Proprietary Fund
(or any mutual fund that pays a fee to AATSC or its affiliates).
It is the view of the Department that AATSC’s receipt of 12b-1 or subtransfer
fees from mutual funds, including those Proprietary Funds the investment advisers
of which are affiliates of AATSC, for services in connection with investment
by employee benefit plans in the mutual funds, under the circumstances described
above, would not violate section 406(b)(1) or 406(b)(3) of ERISA when the decision
to invest in such funds is made by a fiduciary who is independent of AATSC and
its affiliates, or by participants of such employee benefit plans.
Finally, it should be noted that ERISA’s general
standards of fiduciary conduct also would apply
to the proposed arrangement. Section 403(c)(1)
of ERISA
provides
that the assets of a plan shall never inure to the benefit of any employer
and shall be held for the exclusive purposes of
providing benefits to participants
and beneficiaries and defraying reasonable expenses of administering the
plan. Under section 404(a)(1) of ERISA, the responsible
plan fiduciaries must act
prudently and solely in the interest of the plan
participants and beneficiaries both in
deciding whether to enter into, or continue, arrangements with AATSC and
in determining the investment options in which
to invest
or make available to plan participants and beneficiaries in self-directed
plans.
This letter constitutes an advisory opinion under ERISA Procedure 76-1, 41 Fed.
Reg. 36281 (Aug. 27, 1976). Accordingly, it is issued subject to the provisions
of that procedure, including section 10 thereof relating to the effect of advisory
opinions.
Sincerely,
Louis Campagna
Chief, Division of Fiduciary Interpretations
Office of Regulations and Interpretations
Footnotes
In your initial submission, you wrote on behalf of
The Chicago Trust Company (TCTC). Since the date
of submission, TCTC has been renamed AATSC, effective
January 1, 2002. This change is in name only and
was effected without any legal change in the individual
corporate status of TCTC. AATSC continues as a
state-chartered trust company under the original charter and corporate
status granted by the state to the former TCTC,
and remains in the same legal relationship, by way of
ownership, to Alleghany and ABN-AMRO.
- Consistent with Prohibited Transaction Exemption 96-74,
granted to TCTC, TCTC will never receive any
12b-1 or subtransfer agency fees from its Proprietary Funds in connection
with the conversion of
certain collective investment fund units into
shares
of Proprietary Funds. Furthermore, you represent
that AATSC relies upon Prohibited
Transaction Class Exemption 77-4 to cover situations
where AATSC may serve as a fiduciary to a Client
Plan with authority to select investments,
including Proprietary Funds. In Advisory Opinions
93-12A and 93-13A, the Department expressed the
view that it was unable to conclude that
PTE 77-4 would be available for plan purchases
and sales of mutual fund shares if a 12b-1 fee is paid to the fiduciary
or its affiliate with
regard to that portion of the mutual fund’s assets
attributable to the plan’s investment.
- The Department expresses no view as to whether the
conditions contained in section 408(b)(2) of ERISA
would be satisfied with respect
to any arrangement between AATSC and a Client
Plan.
Issued on May 22, 1997.
Issued on May 22, 1997.
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