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Bank Examinations

Appendix E - Employee Benefit Law

Table of Contents

Reference

Interagency Agreement to Refer Violations of ERISA to the Department of Labor

ERISA (Statute)

Section 3    Definitions (Selected)
Section 206    [Excerpt] Pledging by Participant of Vested Interest
Section 401    Coverage
Section 402    Establishment of Plan
Section 403    Establishment of Trust
Section 404    Fiduciary Duties
Section 405    Co-Fiduciary Liability
Section 406    Prohibited Transactions
Section 407    Investment in Sponsor Securities and Real Estate
Section 408    Statutory Exemptions from Prohibited Transactions
Section 409    Liability for Breach of Fiduciary Duty
Section 410    Exculpatory Provisions
Section 411    Prohibition Against Certain Persons Holding Certain Positions
Section 412    Bonding of Fiduciaries
Section 413    Limitation on Actions
Section 502    Civil Money Penalties

Summary of ERISA Regulations, Opinions, and Court Decisions

Section 3    Definitions (Selected)
Section 4    Plans Covered
Section 404    Fiduciary Duties
Section 405    Co-Fiduciary Liability
Section 406    Prohibited Transactions
Section 407    Investment in Sponsor Securities and Real Estate
Section 408    Statutory Exemptions from Prohibited Transactions
Section 410    Exculpatory Provisions
Section 412    Bonding of Fiduciaries

Internal Revenue Code

72(p)    Loans to Plan Participants Treated as Distributions
72(p)-1    Participant Loans Treated as Distributions – IRS Guidelines
408(h)    Custodial Accounts
408(m)    Investment in Collectibles by IRA and Self-Directed Accounts
408(q)    Deemed Individual Retirement Accounts
409(e)    Qualifications for Tax Credit ESOPs – Voting Rights
417    Special Rules for Survivor Annuity Requirements
4975    Tax on Prohibited Transactions

Regulations

54.4975-11    ESOP Requirements
54.4975-12    "Qualified Employer Security" Defined
2510.3-101    Plan Assets (Pension and Welfare Benefits Administration Regulation)
2520.103-5    CIF Reports to Plan Administrators
2550.404a-1    Investment Duties (Prudence Regulation)
2550.404a-2    Safe Harbor for Automatic Rollovers
2550.404b-1    Indicia of Ownership
2550.404c-1    ERISA Section 404(c) Plans
2550.404c-5    Fiduciary Relief for Investments in Qualified Default Investment Alternatives
2550    Default Investment Alternatives Under Participant Directed Individual Account Plans
29 CFR Parts 2550 and 2578 Amendments to Safe Harbor
Cross Trading Statutory Exemption
DOL - Delinquent Filer Voluntary Compliance Program

Employer Securities and Real Property

2550.407a-1    General
2550.407a-2    Employer Securities and Real Property - Acquisition
2550.407d-5    "Qualifying" Employer Security - Defined
2550.407d-6    "Employee Stock Ownership Plan" - Defined
2550.408b-1    Loans to Plan Participants and Beneficiaries
2550.408b-2    Services or Office Space Class Exemption
2550.408b-3    Loans to Employee Stock Ownership Plans
2550.408b-4    Investment in Own-Bank Interest-Bearing Deposits
2550.408b-6    Ancillary Services by Banks or Similar Financial Institutions
2550.408c-2    Compensation for Services
2550.408e    Qualifying Employer Securities and Real Estate
2570.30 - 52    Individual and Class Prohibited Transaction Exemption Requests (Replaces ERISA Procedure 75-1)
Explanatory Preamble

IRS Revenue Rulings

50-60    Valuation of Non-Traded Assets
Revenue Bulletin 2003-37
Revenue Bulletin 2003-13
Roth and Deemed Individual Retirement Account Participation in Group Trusts Described in Revenue Ruling 81-100
IRS Self-Correction Program Frequently Asked Questions
IRS Voluntary Correction Program Frequently Asked Questions
IRS Revenue Ruling Notice 2007-6
IRS Revenue Ruling Notice 2007-7

IRS Interpretive Letter

EP:R:9    IRA Annual Valuations: Partnership Valuations, Inc.

Prohibited Transaction Class Exemptions

75-1    Securities Transactions
77-3    Investment in Mutual Funds by In-House Employee Benefit Plans
77-4    Investment in Advised or Affiliated Mutual Funds
80-26    Interest-Free Loans (Including Overdrafts)
80-50    Collective Investment Funds
80-83    Purchase of Securities Where Issuer May Use Proceeds To Reduce or Retire Indebtedness To Parties in Interest
81-6    Securities Lending
81-8    Short-term Investments & Repurchase Agreements
82-63    Securities Lending Compensation
82-87    Residential Mortgage Loans
84-14    Qualified Professional Asset Managers (QPAMs)
86-128    Securities Transactions Involving Employee Benefit Plans and Broker-Dealers
91-38    Bank Collective Investment Funds
91-55    American Eagle Gold Coins Permitted as IRA Investment
93-33    Receipt of Services by Individuals for Whose Benefit IRAs or Retirement Plans for Self-Employed Individuals are Established
94-20    Foreign Exchange
96-23    In-House Professional Asset Managers
97-11    Relationship Brokerage
97-41    Collective Investment Fund Conversion Transactions
98-54    Foreign Exchange Transactions Executed Pursuant to Standing Instructions
2000-14    Amendment to PTE 80-26 for Certain Interest Free Loans to Employee Benefit Plans
2002-12    Cross-Trading of Securities
2002-13    Amendment to Clarify the Term "Plan"
2002-51    Voluntary Fiduciary Correction Program
2003-39    Release of Claims and Extenstions of Credit in Connection with Litigation
2004-16    Mandatory Distributions (108KB PDF file - PDF Help)
2006-06    Abandoned Individual Account Plans
2006-16    Loans of Securities by Plans

Interpretive Bulletins

75-2    Interpretive Bulletins Relating to the Employee Retirement Income Security Act of 1974
75-3    Interpretive bulletin relating to investments by employee benefit plans in securities of registered investment companies
75-4    Interpretive bulletin relating to indemnification of fiduciaries
75-6    Interpretive bulletin relating to section 408(c)(2) of the Employee Retirement Income Security Act of 1974
75-8    Questions and answers relating to fiduciary responsibility under the Employee Retirement Income Security Act of 1974
94-1    ETIs: Economically Targeted Investments (Social Investing)
94-2    Proxy Voting and Investment Policies
94-3    In-Kind Contributions to Plans
95-1    Interpretive bulletin relating to the fiduciary standard under ERISA when selecting an annuity provider
96-1    Participant Investment Education for 404(c) Individual Account Plans

Technical Bulletins

86-1    Soft Dollars and Directed Commissions for Securities Transactions

Advisory Opinions/Individual Exemptions

77-46    Diversification Applicability to Insured and Uninsured Deposits
79-49    Payment of Fiduciary Fee to Bank Sponsor of Plan
80-OCC    Investment in Fiduciary Bank/Holding Company Securities
85-36A    Loans Intended to Benefit Union Members/Employers
86-FRB    Cash Sweeps and Related Fees ("Plotkin Letter")
88-02A    Cash Sweeps for Non-Discretionary Accounts into Non-Affiliated Mutual Funds
88-09A    Investment in Fiduciary Bank/BHC Treasury Stock
88-18A    Self-Directed IRA Loans to Company Where IRA Grantor/Beneficiary is Insider
88-28    Investment in Fiduciary Bank/BHC Stock in Initial Public Offering
89-03    Self-Directed IRA Purchases of Employer Stock from Employer
92-23A    Investment in Fiduciary Bank/BHC Stock
93-13A    Investment in Affiliated Mutual Funds
93-24A    Float Management
93-26A    Investment in Affiliated Mutual Funds by IRA and Keogh Accounts
94-41A    Escheating
94-OCC    Collective Investment Fund Conversions to Mutual Funds
96-OCC    Investments in Derivatives
97-15A    Acceptance of Mutual Fund 12b-1 Fees; Letter to Frost National Bank; Discretionary and Non-Discretionary Accounts
97-16A    Acceptance of Mutual Fund 12b-1 Fees; Letter to Aetna Life Insurance and Annuity Company; Non-Discretionary Accounts
98-06A    Investment of In-House Employee Benefit Plans into Proprietary Mutual Funds
1999-03A    Purchase of Mortgage-Backed Securities Representing Interests in a Trust Fund for which an Affliate of the Fiduciary Serves as a Sub-Servicer
1999-05A   Application of Plan Assets Regulation to Certain Mortgage Pool Certificates Offered by Freddie Mac
1999-13A    Treatment of QDROs Believed to be Questionable
2000-10A    Whether allowing the owner of an IRA to direct the IRA to invest in a limited partnership, in which relatives and the IRA owner in his individual capacity are partners, will violate section 4975 of the Code
2001-01A    The application of Title I of ERISA to the payment by plans of expenses relating to tax-qualification
2001-09A    How Financial Services Firms Can Provide Asset Allocation Advice
2001-10A    Application of ERISA Secs. 408(b)(2) and 408(b)(6) to the provision of trustee services by Laurel Trust Company
2002-04A    Application of Sec. 408(e) of ERISA to certain transactions between a plan and various personal trusts and estates
2002-05A    Whether the prohibition in PTE 77-4 (42 FR 18732, April 8, 1977) on sales commission payments would apply to commissions paid by a plan to an independent broker
2002-08A    Whether indemnification and limitation of liability provisions in a plan's service provider contract would violate the fiduciary provisions of ERISA
2002-14A    Guidance concerning the selection of annuity providers in connection with distributions
2003-02A    Regarding the application of ERISA to the provision of overdraft protection services
2003-09A    Whether a trust company’s receipt of 12b-1 and subtransfer fees from mutual funds
2003-11A    Whether delivery of a Profile (as described in Rule 498 under the Securities Act of 1933)
2003-15A    Whether a limited partnership in which employee benefit plans invest would be deemed a party in interest with respect to the plans
2004-02A    Time and Order of Issuance of Domestic Relations Orders
2004-05A    Whether the execution of a securities transaction between a plan and party in interest through an alternative trading system
2004-7A    Non-depository, state chartered trust company
2004-09A    Concerning the application of the prohibited transaction provisions under section 4975(c) of the IRC
2005-04A    Whether a plan may invest in a mutual fund
2005-09A    Whether in-kind investments in a bank collective investment fund are covered by ERISA section 408(b)(8)
2006-01A    Whether a lease by a company (LLC) 49% owned by an IRA to a company (S)
2006-06A    Whether the prohibition on the payment of sales commissions in PTE 77-3 applies to the payment of 12b-1 Fees
2006-08A    Whether a fiduciary of a defined benefit plan may, consistent with the requirements of section 404 of ERISA
2006-09A    This advisory opinion concludes that a self-directed IRA‘s investment in notes of a corporation
2007-01A    Whether transactions between a broker-dealer and a separate account managed by a QPAM
2007-02A    Whether the 10% test applicable to pooled investment vehicles

DOL Field Assistance Bulletins

2002-01    ESOP Refinance Transactions
2002-02    Plan Amendments Made by Multiemployer Trustees
2002-03    Disclosure and Other Obligations Relating to "Float"
2003-01    Participant Loans to Corporate Directors and Officers
2003-02    Application of Participant Contribution Requirements to Multiemployer Defined Contribution Pension Plans
2003-03    Allocation of Expenses in a Defined Contribution Plan
2004-01    Health Savings Accounts
2004-02    Fiduciary Duties and Missing Participants in Terminated Defined Contribution Plans
2004-03    Fiduciary Responsibilities of Directed Trustees
2006-01    The Distribution to Plans of Settlement Proceeds Relating to Late Trading and Market Timing
2006-02   Health Savings Accounts - Q&As
2006-03    Periodic Benefit Statements - Pension Protection Act of 2006
2007-01    Statutory Exemption for Investment Advice
2007-02    ERISA Coverage of IRC §403(b) Tax-Sheltered Annuity Programs
2007-03    Periodic Pension Benefit Statements For Non-Participant Directed Individual Account Plans
2007-04    Supplemental health insurance coverage as excepted benefits under HIPAA and related legislation excepted benefits under sections 732(c)(3) and 733(c)(4) of ERISA?
2008-01    Fiduciary Responsibility for Collection of Delinquent Contributions

DOL Interpretive Letter

2002-01    Receipt of Fees from Mutual Fund Distributors and Investment Advisors

ERISA Procedures

76-1    Advisory Opinion Requests: Establishes procedures for requesting ERISA opinions from Labor Department
Voluntary Correction Programs
Voluntary Fiduciary Correction Program FAQs
Participant Notice Voluntary Correction Program
Prohibited Transaction Class Exemption 2002-51

Publications

794    IRS Determination Letters
Example - IRS Determination Letter
US Treasury Notice 2004-8 - Abusive Roth IRA Transaction

Miscellaneous Laws

Pension Protection Act of 2006
Economic Growth and Tax Relief Reconciliation Act of 2001
Tax Relief and Health Care Act of 2006
Medicare Prescription Drug Improvement Act of 2003

Reference

Interagency Agreement to Refer Violations of ERISA to the Department of Labor


Interagency Referral Agreement for ERISA Violations

INTERAGENCY AGREEMENT

Procedures for Cooperation Between the Federal Financial Institution Regulatory Agencies and the Department of Labor in the Enforcement of the Employee Retirement Income Security Act of 1974

The Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, National Credit Union Administration, Office of the Comptroller of the Currency and Office of Thrift Supervision (the federal financial institution regulatory agencies) as part of their supervision of the institutions regulated by them, conduct examinations and perform other functions which occasionally disclose possible violations of the Employee Retirement Income Security Act of 1974 (ERISA). The Department of Labor (DOL) is charged with the administration, interpretation and enforcement of standards of conduct and responsibility of fiduciaries of employee benefit plans under ERISA.

Section 3004(b) of ERISA provides that the Secretary of Labor may utilize the facilities or services of any department, agency, or establishment of the United States, with the lawful consent of such department, agency, or establishment, and each department, agency or establishment of the United States is authorized and directed to cooperate with the Secretary of Labor and, to the extent permitted by law, to provide such information and facilities as the Secretary may request for his assistance in the performance of his functions under ERISA. This agreement is executed pursuant to that authority.

  1. To the maximum extent consistent with law and dependent upon the availability of resources, the federal financial institution regulatory agencies shall provide written notification to the DOL of possible violations of ERISA of a significant nature, which are discovered in the course of their supervision of institutions subject to their respective jurisdiction.
  2. A possible violation shall be considered significant when, in the view of the appropriate federal financial institution regulatory agency, it falls within the following circumstances:
  3. a. Where the financial institution does not serve as plan administrator or plan sponsor, as those terms are defined in ERISA Section 3(16), possible violations of:

    (1) Title I, Part 4, Section 404, relating to fiduciary duties (including transactions directed by named fiduciaries or qualified investment managers), except where the transaction amounts, individually or in combination with other questionable transactions, constitute less than $100,000;

    (2) Title I, Part 4 Section 405, relating to liability for breach of co-fiduciary duties (including transactions directed by named fiduciaries or qualified investment managers), except where the transaction amounts, individually or in combination with other questionable transactions, constitute less than $100,000;

    (3) Title I, Part 4, Sections 406 and 407(a), relating to prohibited transactions, except where the threat of loss to the plan participants is de minimis;

    (4) Title I, Part 4, Section 411, relating to prohibition against certain persons holding certain positions;

    (5) Title I, Part 4, Section 412, relating to the bonding requirements as applicable to the financial institution itself.

    b. Where the financial institution, in respect to a plan, also serves as plan administrator or plan sponsor, the agencies shall provide written notification of possible violations of the ERISA sections enumerated in a. above and, in addition, shall provide written notification of possible violations of Title I, Part 1, of ERISA relating to reporting and disclosure.

  4. The written notification to the DOL shall include the following:
  5. a. The name of the financial institution.

    b. The name of the plan.

    c. A brief description of the nature of the possible violation, and any corrective action requested by the federal financial institution regulatory agency and/or initiated by the federal financial institution regulatory agency.

  6. The DOL agrees that any information received from the federal financial institution regulatory agencies pursuant to this agreement shall, to the extent permissible by law, be held in strict confidence and may be used for investigative purposes only; and that no other use of such information shall be made without the express written authorization of the agency that supplied such information.
  7. The written notification shall be sent to the Director of Enforcement, Employee Benefits Security Administration, U.S. Department of Labor, Washington, D.C. 20210.
ERISA (Statute)

Section 3    Definitions (Selected)

ERISA Section 3
(29 USC 1002)

For purposes of this subchapter:

  1. The terms "employee welfare benefit plan" and "welfare plan" mean any plan, fund, or program which was heretofore or is hereafter established or maintained by an employer or by an employee organization, or by both, to the extent that such plan, fund, or program was established or is maintained for the purpose of providing for its participants or their beneficiaries, through the purchase of insurance or otherwise, (A) medical, surgical, or hospital care or benefits, or benefits in the event of sickness, accident, disability, death or unemployment, or vacation benefits, apprenticeship or other training programs, or day care centers, scholarship funds, or prepaid legal services, or (B) any benefit described in section 186(c) of this title (other than pensions on retirement or death, and insurance to provide such pensions).
  2. Except
    1. as provided in subparagraph (B), the terms "employee pension benefit plan" and "pension plan" mean any plan, fund, or program which was heretofore or is hereafter established or maintained by an employer or by an employee organization, or by both, to the extent that by its express terms or as a result of surrounding circumstances such plan, fund, or program -
      1. Provides retirement income to employees, or
      2. Results in a deferral of income by employees for periods extending to the termination of covered employment or beyond, regardless of the method of calculating the contributions made to the plan, the method of calculating the benefits under the plan or the method of distributing benefits from the plan.
    2. The Secretary may by regulation prescribe rules consistent with the standards and purposes of this chapter providing one or more exempt categories under which -
      1. Severance pay arrangements, and
      2. Supplemental retirement income payments, under which the pension benefits of retirees or their beneficiaries are supplemented to take into account some portion or all of the increases in the cost of living (as determined by the Secretary of Labor) since retirement, shall, for purposes of this subchapter, be treated as welfare plans rather than pension plans. In the case of any arrangement or payment a principal effect of which is the evasion of the standards or purposes of this chapter applicable to pension plans, such arrangement or payment shall be treated as a pension plan.
  3. The term "employee benefit plan" or "plan" means an employee welfare benefit plan or an employee pension benefit plan or a plan which is both an employee welfare benefit plan and an employee pension benefit plan.
  4. The term "employee organization" means any labor union or any organization of any kind, or any agency or employee representation committee, association, group, or plan, in which employees participate and which exists for the purpose, in whole or in part, of dealing with employers concerning an employee benefit plan, or other matters incidental to employment relationships; or any employees' beneficiary association organized for the purpose in whole or in part, of establishing such a plan.
  5. The term "employer" means any person acting directly as an employer, or indirectly in the interest of an employer, in relation to an employee benefit plan; and includes a group or association of employers acting for an employer in such capacity.
  6. The term "employee" means any individual employed by an employer.
  7. The term "participant" means any employee or former employee of an employer, or any member or former member of an employee organization, who is or may become eligible to receive a benefit of any type from an employee benefit plan which covers employees of such employer or members of such organization, or whose beneficiaries may be eligible to receive any such benefit.
  8. The term "beneficiary" means a person designated by a participant, or by the terms of an employee benefit plan, who is or may become entitled to a benefit thereunder.
  9. The term "person" means an individual, partnership, joint venture, corporation, mutual company, joint-stock company, trust, estate, unincorporated organization, association, or employee organization.
  10. The term "State" includes any State of the United States, the District of Columbia, Puerto Rico, the Virgin Islands, American Samoa, Guam, Wake Island, and the Canal Zone. The term "United States" when used in the geographic sense means the States and the Outer Continental Shelf lands defined in the Outer Continental Shelf Lands Act (43 USC 1331-1343).
  11. The term "commerce" means trade, traffic, commerce, transportation, or communication between any State and any place outside thereof.
  12. The term "industry or activity affecting commerce" means any activity, business, or industry in commerce or in which a labor dispute would hinder or obstruct commerce or the free flow of commerce, and includes any activity or industry "affecting commerce" within the meaning of the Labor Management Relations Act, 1947 [29 USCA 141 et seq.] or the Railway Labor Act [45 USCA 151 et seq.]
  13. The term "Secretary" means the Secretary of Labor.
  14. The term "party in interest" means, as to an employee benefit plan -
  15. Editor's Note: Also see "Disqualified Person" definition, Internal Revenue Code § 4975(e)(2).

    1. Any fiduciary (including, but not limited to, any administrator, officer, trustee, or custodian), counsel, or employee of such employee benefit plan;
    2. A person providing services to such plan;
    3. An employer any of whose employees are covered by such plan;
    4. An employee organization any of whose members are covered by such plan;
    5. An owner, direct or indirect, of 50 percent or more of -
      1. The combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock of a corporation.
      2. The capital interest or the profits interest of a partnership, or
      3. The beneficial interest of a trust or unincorporated enterprise, which is an employer or an employee organization described in subparagraph (C) or (D);
    6. A relative (as defined in paragraph (15)) of any individual described in subparagraph (A), (B), (C), or (E);
    7. A corporation, partnership, or trust or estate of which (or in which) 50 percent or more of -
      1. The combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock of such corporation,
      2. The capital interest or profits interest of such partnership, or
      3. The beneficial interest of such trust or estate, is owned directly or indirectly, or held by persons described in subparagraph (A), (B), (C), (D), or (E);
    8. An employee, officer, director (or an individual having powers or responsibilities similar to those of officers or directors), or a 10 percent or more shareholder directly or indirectly, of a person described in subparagraph (B), (C), (D), (E), or (G), or of the employee benefit plan; or
    9. A 10 percent or more (directly or indirectly in capital or profits) partner or joint venture of a person described in subparagraph (B), (C), (D), (E), or (G).

    The Secretary, after consultation and coordination with the Secretary of the Treasury, may by regulation prescribe a percentage lower than 50 percent for subparagraph (E) and (G) and lower than 10 percent for subparagraph (H) or (I). The Secretary may prescribe regulations for determining the ownership (direct or indirect) of profits and beneficial interests, and the manner in which indirect stock holdings are taken into account. Any person who is a party in interest with respect to a plan to which a trust described in section 501(c)(22) of Title 26 is permitted to make payments under section 1403 of this title shall be treated as a party in interest with respect to such trust.

  16. The term "relative" means a spouse, ancestor, lineal descendant, or spouse of a lineal descendant.
  17. Editor's Note: Also see "Family Member" definition, Internal Revenue Code § 4975(e)(6).

  18. The term "administrator" and  "plan sponsor"
    1. The term "administrator" means -
      1. The person specifically so designated by the terms of the instrument under which the plan is operated;
      2. If an administrator is not so designated, the plan sponsor; or
      3. In the case of a plan for which an administrator is not designated and a plan sponsor cannot be identified, such other person as the Secretary may by regulation prescribe.
    2. The term "plan sponsor" means -
      1. The employer in the case of an employee benefit plan established or maintained by a single employer,
      2. The employee organization in the case of a plan established or maintained by an employee organization, or
      3. In the case of a plan established or maintained by two or more employers or jointly by one or more employers and one or more employee organizations, the association, committee, joint board of trustees, or other similar group of representatives of the parties who establish or maintain the plan.
  19. The term "separate account" means an account established or maintained by an insurance company under which income, gains, and losses, whether or not realized, from assets allocated to such account, are, in accordance with the applicable contract, credited to or charged against such account without regard to other income, gains, or losses of the insurance company.
  20. The term "adequate consideration" when used in part 4 of subtitle B of this subchapter means -
    1. In the case of a security for which there is a generally recognized market, either -
      1. The price of the security prevailing on a national securities exchange which is registered under section 78f of Title 15, or
      2. If the security is not traded on such a national securities exchange, a price not less favorable to the plan than the offering price for the security as established by the current bid and asked prices quoted by persons independent of the issuer and of any party in interest; and
    2. In the case of an asset other than a security for which there is a generally recognized market, the fair market value of the asset as determined in good faith by the trustee or named fiduciary pursuant to the terms of the plan and in accordance with regulations promulgated by the Secretary.
  21. The term "nonforfeitable" when used with respect to a pension benefit or right means a claim obtained by a participant or his beneficiary to that part of an immediate or deferred benefit under a pension plan which arises from the participant's service, which is unconditional, and which is legally enforceable against the plan. For purposes of this paragraph, a right to an accrued benefit derived from employer contributions shall not be treated as forfeitable merely because the plan contains a provision described in section 1053(a)(3) of this title.
  22. The term "security" has the same meaning as such term has under section 77b(1) of Title 15.
  23. (A) Except as otherwise provided in subparagraph (B), a person is a fiduciary with respect to a plan to the extent -
  24. Editor's Note: Also see "Fiduciary" definition, Internal Revenue Code § 4975(e)(3).

    1. He exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets,
    2. He renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, or has any authority or responsibility to do so, or
    3. He has any discretionary authority or discretionary responsibility in the administration of such plan. Such term includes any person designated under section 1105(c)(1)(B) of this title.

    (B) If any money or other property of an employee benefit plan is invested in securities issued by an investment company registered under the Investment Company Act of 1940 [15 USCA 80a-1 et seq.], such investment shall not by itself cause such investment company or such investment company's investment adviser or principal underwriter to be deemed to be a fiduciary or a party in interest as those terms are defined in this subchapter, except insofar as such investment company or its investment adviser or principal underwriter acts in connection with an employee benefit plan covering employees of the investment company, the investment adviser, or its principal underwriter. Nothing contained in this subparagraph shall limit the duties imposed on such investment company, investment adviser, or principal underwriter by any other law.

  25. The term "normal retirement benefit" means the greater of the early retirement benefit under the plan, or the benefit under the plan commencing at normal retirement age. The normal retirement benefit shall be determined without regard to -
    1. Medical benefits, and
    2. Disability benefits not in excess of the qualified disability benefit.

    For purposes of this paragraph, a qualified disability benefit is a disability benefit provided by a plan which does not exceed the benefit which would be provided for the participant if he separated from the service at normal retirement age. For purposes of this paragraph, the early retirement benefit under a plan shall be determined without regard to any benefit under the plan which the Secretary of the Treasury finds to be a benefit described in section 1054(b)(1)(G) of this title.

  26. The term "accrued benefit" means -
    1. In the case of a defined benefit plan, the individual's accrued benefit determined under the plan and, except as provided in section 1054(c)(3) of this title, expressed in the form of an annual benefit commencing at normal retirement age, or
    2. In the case of a plan which is an individual account plan, the balance of the individual's account.

    The accrued benefit of an employee shall not be less than the amount determined under section 1054(c)(2)(B) of this title with respect to the employee's accumulated contribution.

  27. The term "normal retirement age" means the earlier of -
    1. The time a plan participant attains normal retirement age under the plan, or
    2. The later of -
      1. The time a plan participant attains age 65, or
      2. The 5th anniversary of the time a plan participant commenced participation in the plan.
  28. The term "vested liabilities" means the present value of the immediate or deferred benefits available at normal retirement age for participants and their beneficiaries which are nonforfeitable.
  29. The term "current value" means fair market value where available and otherwise the fair value as determined in good faith by a trustee or a named fiduciary (as defined in section 1102(a)(2) of this title) pursuant to the terms of the plan and in accordance with regulations of the Secretary, assuming an orderly liquidation at the time of such determination.
  30. The term "present value", with respect to a liability, means the value adjusted to reflect anticipated events. Such adjustments shall conform to such regulations as the Secretary of the Treasury may prescribe.
  31. The term "normal service cost" or "normal cost" means the annual cost of future pension benefits and administrative expenses assigned, under an actuarial cost method, to years subsequent to a particular valuation date of a pension plan. The Secretary of the Treasury may prescribe regulations to carry out this paragraph.
  32. The term "accrued liability" means the excess of the present value, as of a particular valuation date of a pension plan, of the projected future benefit costs and administrative expenses for all plan participants and beneficiaries over the present value of future contributions for the normal cost of all applicable plan participants and beneficiaries. The Secretary of the Treasury may prescribe regulations to carry out this paragraph.
  33. The term "unfunded accrued liability" means the excess of the accrued liability, under an actuarial cost method which so provides, over the present value of the assets of a pension plan. The Secretary of the Treasury may prescribe regulations to carry out this paragraph.
  34. The term "advance funding actuarial cost method" or "actuarial cost method" means a recognized actuarial technique utilized for establishing the amount and incidence of the annual actuarial cost of pension plan benefits and expenses. Acceptable actuarial cost methods shall include the accrued benefit cost method (unit credit method), the entry age normal cost method, the individual level premium cost method, the aggregate cost method, the attained age normal cost method, and the frozen initial liability cost method. The terminal funding cost method and the current funding (pay-as-you-go) cost method are not acceptable actuarial cost methods. The Secretary of the Treasury shall issue regulations to further define acceptable actuarial cost methods.
  35. The term "governmental plan" means a plan established or maintained for its employees by the Government of the United States, by the government of any State or political subdivision thereof, or by any agency or instrumentality of any of the foregoing. The term "governmental plan" also includes any plan to which the Railroad Retirement Act of 1935 or 1937 [45 USCA 231 et seq.] applies, and which is financed by contributions required under that Act and any plan of an international organization which is exempt from taxation under the provisions of the International Organizations Immunities Act [22 USCA 288 et seq.].
  36. (A) The term "church plan" means a plan established and maintained (to the extent required in clause (ii) of subparagraph (B)) for its employees (or their beneficiaries) by a church or by a convention or association of churches which is exempt from tax under section 501 of Title 26.
  37. (B) The term "church plan" does not include a plan -

    1. Which is established and maintained primarily for the benefit of employees (or their beneficiaries) of such church or convention or association of churches who are employed in connection with one or more unrelated trades or businesses (within the meaning of section 513 of Title 26), or
    2. If less than substantially all of the individuals included in the plan are individuals described in subparagraph (A) or in clause (ii) of subparagraph (C) (or their beneficiaries).

    (C) For purposes of this paragraph -

    1. A plan established and maintained for its employees (or their beneficiaries) by a church or by a convention or association of churches includes a plan maintained by an organization, whether a civil law corporation or otherwise, the principal purpose or function of which is the administration or funding of a plan or program for the provision of retirement benefits or welfare benefits, or both, for the employees of a church or a convention or association of churches, if such organization is controlled by or associated with a church or a convention or association of churches.
    2. The term employee of a church or a convention or association of churches includes -
      1. A duly ordained, commissioned, or licensed minister of a church in the exercise of his ministry, regardless of the source of his compensation;
      2. An employee of an organization, whether a civil law corporation or otherwise, which is exempt from tax under section 501 of Title 26 and which is controlled by or associated with a church or a convention or association of churches; and
      3. An individual described in clause (v).
    3. A church or a convention or association of churches which is exempt from tax under section 501 of Title 26 shall be deemed the employer of any individual included as an employee under clause (ii).
    4. An organization, whether a civil law corporation or otherwise, is associated with a church or a convention or association of churches if it shares common religious bonds and convictions with that church or convention or association of churches.
    5. If an employee who is included in a church plan separates from the service of a church or a convention or association of churches or an organization, whether a civil law corporation or otherwise, which is exempt from tax under section 501 of Title 26 and which is controlled by or associated with a church or a convention or association of churches, the church plan shall not fail to meet the requirements of this paragraph merely because the plan -
    1. Retains the employee's accrued benefit or account for the payment of benefits to the employee or his beneficiaries pursuant to the terms of the plan; or
    2. Receives contributions on the employee's behalf after the employee's separation from such service, but only for a period of 5 years after such separation, unless the employee is disabled (within the meaning of the disability provisions of the church plan or, if there are no such provisions in the church plan, within the meaning of section 72(m)(7) of Title 26) at the time of such separation from service.

    (D) (i) If a plan established and maintained for its employees (or their beneficiaries) by a church or by a convention or association of churches which is exempt from tax under section 501 of Title 26 fails to meet one or more of the requirements of this paragraph and corrects its failure to meet such requirements within the correction period, the plan shall be deemed to meet the requirements of this paragraph for the year in which the correction was made and for all prior years.

    (ii) If a correction is not made within the correction period, the plan shall be deemed not to meet the requirements of this paragraph beginning with the date on which the earliest failure to meet one or more of such requirements occurred.

    (iii) For purposes of this subparagraph, the term "correction period" means -

    1. The period ending 270 days after the date of mailing by the Secretary of the Treasury of a notice of default with respect to the plan's failure to meet one or more of the requirements of this paragraph; or
    2. Any period set by a court of competent jurisdiction after a final determination that the plan fails to meet such requirements, or, if the court does not specify such period, any reasonable period determined by the Secretary of the Treasury on the basis of all the facts and circumstances, but in any event not less than 270 days after the determination has become final; or
    3. Any additional period which the Secretary of the Treasury determines is reasonable or necessary for the correction of the default, whichever has the latest ending date.
  38. The term "individual account plan" or "defined contribution plan" means a pension plan which provides for an individual account for each participant and for benefits based solely upon the amount contributed to the participant's account, and any income, expenses, gains and losses, and any forfeitures of accounts of other participants which may be allocated to such participant's account.
  39. The term "defined benefit plan" means a pension plan other than an individual account plan; except that a pension plan which is not an individual account plan and which provides a benefit derived from employer contributions which is based partly on the balance of the separate account of a participant -
    1. For the purposes of section 1052 of this title, shall be treated as an individual account plan, and
    2. For the purposes of paragraph (23) of this section and section 1054 of this title, shall be treated as an individual account plan to the extent benefits are based upon the separate account of a participant and as a defined benefit plan with respect to the remaining portion of benefits under the plan.
  40. The term "excess benefit plan" means a plan maintained by an employer solely for the purpose of providing benefits for certain employees in excess of the limitations on contributions and benefits imposed by section 415 of Title 26 on plans to which that section applies, without regard to whether the plan is funded. To the extent that a separable part of a plan (as determined by the Secretary of Labor) maintained by an employer is maintained for such purpose, that part shall be treated as a separate plan which is an excess benefit plan.
  41. Multiemployer Plan
    1. The term "multiemployer plan" means a plan -
      1. To which more than one employer is required to contribute,
      2. Which is maintained pursuant to one or more collective bargaining agreements between one or more employee organizations and more than one employer, and
      3. Which satisfies such other requirements as the Secretary may prescribe by regulation.
    2. For purposes of this paragraph, all trades or businesses (whether or not incorporated) which are under common control within the meaning of section 1301(b)(1) of this title are considered a single employer.
    3. Notwithstanding subparagraph (A), a plan is a multiemployer plan on and after its termination date if the plan was a multiemployer plan under this paragraph for the plan year preceding its termination date.
    4. For purposes of this subchapter, notwithstanding the preceding provisions of this paragraph, for any plan year which began before September 26, 1980, the term "multiemployer plan" means a plan described in this paragraph (37) as in effect immediately before such date.
    5. Within one year after September 26, 1980, a multiemployer plan may irrevocably elect, pursuant to procedures established by the corporation and subject to the provisions of sections 1453(b) and (c) of this title, that the plan shall not be treated as a multiemployer plan for all purposes under this chapter or Title 26 if for each of the last 3 plan years ending prior to the effective date of the Multiemployer Pension Plan Amendments Act of 1980 -
      1. The plan was not a multiemployer plan because the plan was not a plan described in subparagraph (A)(iii) of this paragraph and section 414(f)(1)(C) of Title 26 (as such provisions were in effect on the day before September 26, 1980); and
      2. The plan had been identified as a plan that was not a multiemployer plan in substantially all its filings with the corporation, the Secretary of Labor and the Secretary of the Treasury.
    6. Qualified Football Coaches Plan
      1. For purposes of this title a qualified football coaches plan -
        1. Shall be treated as a multiemployer plan to the extent not inconsistent with the purposes of this subparagraph; and
        2. Notwithstanding section 401(k)(4)(B) of Title 26, may include a qualified cash and deferred arrangement.
      2. For purposes of this subparagraph, the term "qualified football coaches plan" means any defined contribution plan which is established and maintained by an organization -
        1. Which is described in section 501(c) of Title 26;
        2. The membership of which consists entirely of individuals who primarily coach football as full-time employees of 4-year colleges or universities described in section 170(b)(1)(A)(ii) of Title 26; and
        3. Which was in existence on September 18, 1986.
  42. The term "investment manager" means any fiduciary (other than a trustee or named fiduciary, as defined in section 1102(a)(2) of this title) -
    1. Who has the power to manage, acquire, or dispose of any asset of a plan;
    2. Who is -
      1. Registered as an investment adviser under the Investment Advisers Act of 1940 [15 USCA 80b-1 et seq.];
      2. Is a bank, as defined in that Act; or
      3. Is an insurance company qualified to perform services described in subparagraph (A) under the laws of more than one State; and
    3. Has acknowledged in writing that he is a fiduciary with respect to the plan.
  43. The terms "plan year" and "fiscal year of the plan" mean, with respect to a plan, the calendar, policy, or fiscal year on which the records of the plan are kept.
  44. (A) The term "multiple employer welfare arrangement" means an employee welfare benefit plan, or any other arrangement (other than an employee welfare benefit plan), which is established or maintained for the purpose of offering or providing any benefit described in paragraph (1) to the employees of two or more employers (including one or more self-employed individuals), or to their beneficiaries, except that such term does not include any such plan or other arrangement which is established or maintained -
    1. Under or pursuant to one or more agreements which the Secretary finds to be collective bargaining agreements,
    2. By a rural electric cooperative, or
    3. By a rural telephone cooperative association.

    (B) For purposes of this paragraph -

    1. Two or more trades or businesses, whether or not incorporated, shall be deemed a single employer if such trades or businesses are within the same control group,
    2. The term "control group" means a group of trades or businesses under common control,
    3. The determination of whether a trade or business is under "common control" with another trade or business shall be determined under regulations of the Secretary applying principles similar to the principles applied in determining whether employees of two or more trades or businesses are treated as employed by a single employer under section 1301(b) of this title, except that, for purposes of this paragraph, common control shall not be based on an interest of less than 25 percent,
    4. The term "rural electric cooperative" means -
      1. Any organization which is exempt from tax under section 501(a) of Title 26 and which is engaged primarily in providing electric service on a mutual or cooperative basis, and
      2. Any organization described in paragraph (4) or (6) of section 501(c) of Title 26 which is exempt from tax under section 501(a) of such Title 26 and at least 80 percent of the members of which are organizations described in subclause (I), and
    5. The term "rural telephone cooperative association" means an organization described in paragraph (4) or (6) of section 501(c) of Title 26 which is exempt from tax under section 501(a) of such Title and at least 80 percent of the members of which are organizations engaged primarily in providing telephone service to rural areas of the United States on a mutual, cooperative, or other basis.
  45. Single-employer plan. The term "single-employer plan" means an employee benefit plan other than a multiemployer plan.
  46. The term "single employer plan" means a plan which is not a multiemployer plan.

Section 206    [Excerpt] Pledging by Participant of Vested Interest

ERISA Section 206
(29 USC 1056)

In accordance with section 1056(d)(1)-(2) of this title:

(d) Assignment or alienation of plan benefits

  1. Each pension plan shall provide that benefits provided under the plan may not be assigned or alienated.
  2. For the purposes of paragraph (1) of this subsection, there shall not be taken into account any voluntary and revocable assignment of not to exceed 10 percent of any benefit payment, or of any irrevocable assignment or alienation of benefits executed before September 2, 1974. The preceding sentence shall not apply to any assignment or alienation made for the purposes of defraying plan administration costs. For purposes of this paragraph a loan made to a participant or beneficiary shall not be treated as an assignment or alienation if such loan is secured by the participant's accrued nonforfeitable benefit and is exempt from the tax imposed by section 4975 of Title 26 (relating to tax on prohibited transactions) by reason of section 4975(d)(1) of Title 26.

Section 401    Coverage

ERISA Section 401
(29 USC 1101)

  1. This part shall apply to any employee benefit plan described in section 4(a) (and not exempted under section 4(b)), other than:
    1. A plan which is unfunded and is maintained by an employer primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees; or
    2. Any agreement described in section 736 of Title 26, which provides payments to a retired partner or deceased partner or a deceased partner's successor in interest.
  2. For purposes of this part:
    1. In the case of a plan which invests in any security issued by an investment company registered under the Investment Company Act of 1940 [15 USCA 80a-1 et seq.], the assets of such plan shall be deemed to include such security but shall not, solely by reason of such investment, be deemed to include any assets of such investment company.
    2. In the case of a plan to which a guaranteed benefit policy is issued by an insurer, the assets of such plan shall be deemed to include such policy, but shall not, solely by reason of the issuance of such policy, be deemed to include any assets of such insurer. For purposes of this paragraph:
      1. The term "insurer" means an insurance company, insurance service, or insurance organization, qualified to do business in a State.
      2. The term "guaranteed benefit policy" means an insurance policy or contract to the extent that such policy or contact provides for benefits the amount of which is guaranteed by the insurer. Such term includes any surplus in a separate account, but excludes any other portion of a separate account.

402    Establishment of Plan

ERISA Section 402
(29 USC 1102)

  1. Named fiduciaries
    1. Every employee benefit plan shall be established and maintained pursuant to a written instrument. Such instrument shall provide for one or more named fiduciaries who jointly or severally shall have authority to control and manage the operation and administration of the plan.
    2. For purposes of this subchapter, the term "named fiduciary" means a fiduciary who is named in the plan instrument, or who, pursuant to a procedure specified in the plan, is identified as a fiduciary-
      1. By a person who is an employer or employee organization with respect to the plan or
      2. By such an employer and such an employee organization acting jointly.
  2. Requisite features of plan. Every employee benefit plan shall -
    1. Provide a procedure for establishing and carrying out a funding policy and method consistent with the objectives of the plan and the requirements of this subchapter,
    2. Describe any procedure under the plan for the allocation of responsibilities for the operation and administration of the plan (including any procedure described in section 1105(c)(1) of this title),
    3. Provide a procedure for amending such plan, and for identifying the persons who have authority to amend the plan, and
    4. Specify the basis on which payments are made to and from the plan.
  3. Optional features of plan. Any employee benefit plan may provide -
    1. 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);
    2. That a named fiduciary, or a fiduciary designated by a named fiduciary pursuant to a plan procedure described in section 1105(c)(1) of this title, may employ one or more persons to render advice with regard to any responsibility such fiduciary has under the plan; or
    3. That a person who is a named fiduciary with respect to control or management of the assets of the plan may appoint an investment manager or managers to manage (including the power to acquire and dispose of) any assets of a plan.

403    Establishment of Trust

ERISA Section 403
(29 USC 1103)

  1. Benefit plan assets to be held in trust; authority of trustees.
  2. Except as provided in subsection (b) of this section, all assets of an employee benefit plan shall be held in trust by one or more trustees. Such trustee or trustees shall be either named in the trust instrument or in the plan instrument described in section 1102(a) of this title or appointed by a person who is a named fiduciary, and upon acceptance of being named or appointed, the trustee or trustees 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 trustee or trustees are subject to the direction of a named fiduciary who is not a trustee, in which case the trustees shall be subject to proper directions of such fiduciary which are made in accordance with the terms of the plan and which are not contrary to this chapter, or
    2. Authority to manage, acquire, or dispose of assets of the plan is delegated to one or more investment managers pursuant to section 1102(c)(3) of this title.
  3. Exceptions. The requirements of subsection (a) of this section shall not apply -
    1. To any assets of a plan which consist of insurance contracts or policies issued by an insurance company qualified to do business in a State;
    2. To any assets of such an insurance company or any assets of a plan which are held by such an insurance company;
    3. To a plan -
      1. Some or all of the participants of which are employees described in section 401(c)(1) of Title 26; or
      2. Which consists of one or more individual retirement accounts described in section 408 of Title 26; to the extent that such plan's assets are held in one or more custodial accounts which qualify under section 401(f) or 408(h) of Title 26, whichever is applicable.
    4. To a plan which the Secretary exempts from the requirement of subsection (a) of this section and which is not subject to any of the following provisions of this chapter
      1. Part 2 of this subtitle,
      2. Part 3 of this subtitle, or
      3. Subchapter III of this chapter; or
    5. To a contract established and maintained under section 403(b) of Title 26 to the extent that the assets of the contract are held in one or more custodial accounts pursuant to section 403(b)(7) of Title 26.
    6. Any plan, fund or program under which an employer, all of whose stock is directly or indirectly owned by employees, former employees or their beneficiaries, proposes through an unfunded arrangement to compensate retired employees for benefits which were forfeited by such employees under a pension plan maintained by a former employer prior to the date such pension plan became subject to this chapter.
  4. Assets of plan not to inure to benefit of employer; allowable purposes of holding plan assets
    1. Except as provided in paragraph (2), (3), or (4) or subsection (d) of this section, or under sections 1342 and 1344 of this title (relating to termination of insured plans), or under section 420 of Title 26 as in effect on January 1, 1995) 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 in the plan and their beneficiaries and defraying reasonable expenses of administering the plan.
    2. Contribution
      1. In the case of a contribution, or a payment of withdrawal liability under part 1 of subtitle E of subchapter III of this chapter -
        1. If such contribution or payment is made by an employer to a plan (other than a multiemployer plan) by a mistake of fact, paragraph (1) shall not prohibit the return of such contribution to the employer within one year after the payment of the contribution, and
        2. If such contribution or payment is made by an employer to a multiemployer plan by a mistake of fact or law (other than a mistake relating to whether the plan is described in section 401(a) of Title 26 or the trust which is part of such plan is exempt from taxation under section 501(a) of Title 26), paragraph (1) shall not prohibit the return of such contribution or payment to the employer within 6 months after the plan administrator determines that the contribution was made by such a mistake.
      2. If a contribution is conditioned on initial qualification of the plan under section 401 or 403(a) of Title 26, and if the plan receives an adverse determination with respect to its initial qualification, then paragraph (1) shall not prohibit the return of such contribution to the employer within one year after such determination, but only if the application for the determination is made by the time prescribed by law for filing the employer's return for the taxable year in which such plan was adopted, or such later date as the Secretary of the Treasury may prescribe.
      3. If a contribution is conditioned upon the deductibility of the contribution under section 404 of Title 26, then, to the extent the deduction is disallowed, paragraph (1) shall not prohibit the return to the employer of such contribution (to the extent disallowed) within one year after the disallowance of the deduction.
    3. In the case of a withdrawal liability payment which has been determined to be an overpayment, paragraph (1) shall not prohibit the return of such payment to the employer within 6 months after the date of such determination.
    4. Redesignated (3).
  5. Termination of plan.
    1. Upon termination of a pension plan to which section 1321 of this title does not apply at the time of termination and to which this part applies (other than a plan to which no employer contributions have been made) the assets of the plan shall be allocated in accordance with the provisions of section 1344 of this title, except as otherwise provided in regulations of the Secretary.
    2. The assets of a welfare plan which terminates shall be distributed in accordance with the terms of the plan, except as otherwise provided in regulations of the Secretary.

404    Fiduciary Duties

ERISA Section 404
(29 USC 1104)

  1. Prudent man standard of care.
    1. Subject to sections 1103(c) and (d), 1342, and 1344 of this title, a fiduciary shall discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries and -
      1. For the exclusive purpose of:
        1. Providing benefits to participants and their beneficiaries; and
        2. Defraying reasonable expenses of administering the plan;
      2. 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 character and with like aims;
      3. 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; and
      4. In accordance with the documents and instruments governing the plan insofar as such documents and instruments are consistent with the provisions of this subchapter and subchapter III of this chapter.
    2. In the case of an eligible individual account plan (as defined in section 1107(d)(3) of this title), the diversification requirement of paragraph (1)(C) and the prudence requirement (only to the extent that it requires diversification) of paragraph (1)(B) is not violated by acquisition or holding of qualifying employer real property or qualifying employer securities (as defined in section 1107(d)(4) and (5) of this title).
  2. Indicia of ownership of assets outside jurisdiction of district courts.
  3. Except as authorized by the Secretary by regulation, no fiduciary may maintain the indicia of ownership of any assets of a plan outside the jurisdiction of the district courts of the United States.

  4. Control over assets by participant or beneficiary.
  5. In the case of a pension plan which provides for individual accounts and permits a participant or beneficiary to exercise control over the 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 this part for any loss, or by reason of any breach, which results from such participant's or beneficiary's exercise of control.
  6. Plan terminations.
    1. If, in connection with the termination of a pension plan which is a single-employer plan, there is an election to establish or maintain a qualified replacement plan, or to increase benefits, as provided under section 4980(d) of Title 26, a fiduciary shall discharge the fiduciary's duties under this subchapter and subchapter III of this chapter in accordance with the following requirements:
      1. In the case of a fiduciary of the terminated plan, any requirement -
        1. Under section 4980(d)(2)(B) of Title 26 with respect to the transfer of assets from the terminated plan to a qualified replacement plan, and
        2. Under section 4980(d)(2)(B)(ii) or 4980(d)(3) of Title 26 with respect to any increase in benefits under the terminated plan.
      2. In the case of a fiduciary of a qualified replacement plan, any requirement -
        1. Under section 4980(d)(2)(A) of Title 26 with respect to participation in the qualified replacement plan of active participants in the terminated plan,
        2. Under section 4980(d)(2)(B) of Title 26 with respect to the receipt of assets from the terminated plan, and
        3. Under section 4980(d)(2)(C) of Title 26 with respect to the allocation of assets to participants of the qualified replacement plan.
    2. For purposes of this subsection -
      1. Any term used in this subsection which is also used in section 4980(d) of Title 26 shall have the same meaning as when used in such section, and
      2. Any reference in this subsection to Title 26 shall be a reference to Title 26 as in effect immediately after the enactment of the Omnibus Budget Reconciliation Act of 1990.

405    Co-Fiduciary Liability

ERISA Section 405
(29 USC 1105)

  1. Circumstances giving rise to liability.
  2. In addition to any liability which he may have under any other provision of this part, a fiduciary with respect to a plan shall be liable for a breach of fiduciary responsibility of another fiduciary with respect to the same plan in the following circumstances:

    1. If he participates knowingly in, or knowingly undertakes to conceal, an act or omission of such other fiduciary, knowing such act or omission is a breach;
    2. If, by his failure to comply with section 1104(a)(1) of this title in the administration of his specific responsibilities which give rise to his status as a fiduciary, he has enabled such other fiduciary to commit a breach; or
    3. If he has knowledge of a breach by such other fiduciary, unless he makes reasonable efforts under the circumstances to remedy the breach.
  3. Assets held by two or more trustees.
    1. Except as otherwise provided in subsection (d) of this section and in section 1103(a)(1) and (2) of this title, if the assets of a plan are held by two or more trustees -
      1. Each shall use reasonable care to prevent a co-trustee from committing a breach; and
      2. They shall jointly manage and control the assets of the plan, except that nothing in this subparagraph (B) shall preclude any agreement, authorized by the trust instrument, allocating specific responsibilities, obligations, or duties among trustees, in which event a trustee to whom certain responsibilities, obligations, or duties have not been allocated shall not be liable by reason of this subparagraph (B) either individually or as a trustee for any loss resulting to the plan arising from the acts or omissions on the part of another trustee to whom such responsibilities, obligations, or duties have been allocated.
    2. Nothing in this subsection shall limit any liability that a fiduciary may have under subsection (a) of this section or any other provision of this part.
    3. (A) In the case of a plan the assets of which are held in more than one trust, a trustee shall not be liable under paragraph (1) except with respect to an act or omission of a trustee of a trust of which he is a trustee.
    4. (B) No trustee shall be liable under this subsection for following instructions referred to in section 1103(a)(1) of this title.

  4. Allocation of fiduciary responsibility; designated persons to carry out fiduciary responsibilities.
    1. The instrument under which a plan is maintained may expressly provide for procedures (A) for allocating fiduciary responsibilities (other than trustee responsibilities) among named fiduciaries, and (B) for named fiduciaries to designate persons other than named fiduciaries to carry out fiduciary responsibilities (other than trustee responsibilities) under the plan.
    2. If a plan expressly provides for a procedure described in paragraph (1), and pursuant to such procedure any fiduciary responsibility of a named fiduciary is allocated to any person, or a person is designated to carry out any such responsibility, then such named fiduciary shall not be liable for an act or omission of such person in carrying out such responsibility except to the extent that -
      1. The named fiduciary violated section 1104(a)(1) of this title -
        1. With respect to such allocation or designation,
        2. With respect to the establishment or implementation of the procedure under paragraph (1), or
        3. In continuing the allocation or designation; or
      2. The named fiduciary would otherwise be liable in accordance with subsection (a) of this section.
    3. For purposes of this subsection, the term "trustee responsibility" means any responsibility provided in the plan's trust instrument (if any) to manage or control the assets of the plan, other than a power under the trust instrument of a named fiduciary to appoint an investment manager in accordance with section 1102(c)(3) of this title.
  5. Investment managers.
    1. If an investment manager or managers have been appointed under section 1102(c)(3) of this title, then, notwithstanding subsections (a)(2) and (3) and subsection (b) of this section, no trustee shall be liable for the acts or omissions of such investment manager or managers, or be under an obligation to invest or otherwise manage any asset of the plan which is subject to the management of such investment manager.
    2. Nothing in this subsection shall relieve any trustee of any liability under this part for any act of such trustee.

406    Prohibited Transactions

ERISA Section 406
(29 USC 1106)

Editor's Note: Also see Prohibited Transaction provisions of Internal Revenue Code § 4975(c)(1).

  1. Transactions between plan and party in interest. Except as provided in section 1108 of this title:
    1. A fiduciary with respect to a plan shall not cause the plan to engage in a transaction, if he knows or should know that such transaction constitutes a direct or indirect -
      1. Sale or exchange, or leasing, of any property between the plan and a party in interest;
      2. Lending of money or other extension of credit between the plan and a party in interest;
      3. Furnishing of goods, services, or facilities between the plan and a party in interest;
      4. Transfer to, or use by or for the benefit of, a party in interest, of any assets of the plan; or
      5. Acquisition, on behalf of the plan, of any employer security or employer real property in violation of section 1107(a) of this title.
    2. No fiduciary who has authority or discretion to control or manage the assets of a plan shall permit the plan to hold any employer security or employer real property if he knows or should know that holding such security or real property violates section 1107(a) of this title.
  2. Transactions between plan and fiduciary. A fiduciary with respect to a plan shall not -
    1. Deal with the assets of the plan in his own interest or for his own account,
    2. In his 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, or
    3. 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.
  3. Transfer of real or personal property to plan by party in interest.
  4. A transfer of real or personal property by a party in interest to a plan shall be treated as a sale or exchange if the property is subject to a mortgage or similar lien which the plan assumes or if it is subject to a mortgage or similar lien which a party-in-interest placed on the property within the 10-year period ending on the date of the transfer.

407    10 Percent Limitation on Employer Securities and Employer Real Property

ERISA Section 407
(29 USC 1107)

  1. Percentage limitation. Except as otherwise provided in this section and section 1114 of this title:
    1. A plan may not acquire or hold -
      1. Any employer security which is not a qualifying employer security, or
      2. Any employer real property which is not qualifying employer real property.

      Editor's Note: See DOL ERISA Regulation 2550.408e: Qualifying Employer Securities and Real Estate.

    2. A plan may not acquire any qualifying employer security or qualifying employer real property, if immediately after such acquisition the aggregate fair market value of employer securities and employer real property held by the plan exceeds 10 percent of the fair market value of the assets of the plan.
    3. (A) After December 31, 1984, a plan may not hold any qualifying employer securities or qualifying employer real property (or both) to the extent that the aggregate fair market value of such securities and property determined on December 31, 1984, exceeds 10 percent of the greater of -
      1. The fair market value of the assets of the plan, determined on December 31, 1984, or
      2. The fair market value of the assets of the plan determined on January 1, 1975.

      (B) Subparagraph (A) of this paragraph shall not apply to any plan which on any date after December 31, 1974; and before January 1, 1985, did not hold employer securities or employer real property (or both) the aggregate fair market value of which determined on such date exceeded 10 percent of the greater of -

      1. The fair market value of the assets of the plan, determined on such date, or
      2. The fair market value of the assets of the plan determined on January 1, 1975.
    4. (A) After December 31, 1979, a plan may not hold any employer securities or employer real property in excess of the amount specified in regulations under subparagraph (B). This subparagraph shall not apply to a plan after the earliest date after December 31, 1974, on which it complies with such regulations.
    5. (B) Not later than December 31, 1976, the Secretary shall prescribe regulations which shall have the effect of requiring that a plan divest itself of 50 percent of the holdings of employer securities and employer real property which the plan would be required to divest before January 1, 1985, under paragraph (2) or subsection (c) of this section (whichever is applicable).

  2. Exception
    1. Subsection (a) of this section shall not apply to any acquisition or holding of qualifying employer securities or qualifying employer real property by an eligible individual account plan.
    2. Cross References.
      1. For exemption from diversification requirements for holding of qualifying employer securities and qualifying employer real property by eligible individual account plans, see section 1104(a)(2) of this title.
      2. For exemption from prohibited transactions for certain acquisitions of qualifying employer securities and qualifying employer real property which are not in violation of 10 percent limitation, see section 1108(e) of this title.
      3. For transitional rules respecting securities or real property subject to binding contracts in effect on June 30, 1974, see section 1114(c) of this title.
  3. Election
    1. A plan which makes the election, under paragraph (3) shall be treated as satisfying the requirement of subsection (a)(3) of this section if and only if employer securities held on any date after December 31, 1974 and before January 1, 1985 have a fair market value, determined as of December 31, 1974, not in excess of 10 percent of the lesser of -
      1. The fair market value of the assets of the plan determined on such date (disregarding any portion of the fair market value of employer securities which is attributable to appreciation of such securities after December 31, 1974) but not less than the fair market value of plan assets on January 1, 1975, or
      2. An amount equal to the sum of -
      1. The total amount of the contributions to the plan received after December 31, 1974, and prior to such date, plus
      2. The fair market value of the assets of the plan, determined on January 1, 1975.
    2. For purposes of this subsection, in the case of an employer security held by a plan after January 1, 1975, the ownership of which is derived from ownership of employer securities held by the plan on January 1, 1975, or from the exercise of rights derived from such ownership, the value of such security held after January 1, 1975, shall be based on the value as of January 1, 1975, of the security from which ownership was derived. The Secretary shall prescribe regulations to carry out this paragraph.
    3. An election under this paragraph may not be made after December 31, 1975. Such an election shall be made in accordance with regulations prescribed by the Secretary, and shall be irrevocable. A plan may make an election under this paragraph only if on January 1, 1975, the plan holds no employer real property. After such election and before January 1, 1985 the plan may not acquire any employer real property.
  4. Definitions.
  5. For purposes of this section -

    1. The term "employer security" means a security issued by an employer of employees covered by the plan, or by an affiliate of such employer. A contract to which section 1108(b)(5) of this title applies shall not be treated as a security for purposes of this section.
    2. The term "employer real property" means real property (and related personal property) which is leased to an employer of employees covered by the plan, or to an affiliate of such employer. For purposes of determining the time at which a plan acquires employer real property for purposes of this section, such property shall be deemed to be acquired by the plan on the date on which the plan acquires the property or on the date on which the lease to the employer (or affiliate) is entered into, whichever is later.
    3. (A) The term "eligible individual account plan" means an individual account plan which is -
      1. A profit-sharing, stock bonus, thrift, or savings plan;
      2. An employee stock ownership plan; or
      3. A money purchase plan which was in existence on September 2, 1974, and which on such date invested primarily in qualifying employer securities. Such term excludes an individual retirement account or annuity described in section 408 of Title 26.

      (B) Notwithstanding subparagraph (A), a plan shall be treated as an eligible individual account plan with respect to the acquisition or holding of qualifying employer real property or qualifying employer securities only if such plan explicitly provides for acquisition and holding of qualifying employer securities or qualifying employer real property (as the case may be). In the case of a plan in existence on September 2, 1974, this subparagraph shall not take effect until January 1, 1976.

      (C) The term "eligible individual account plan" does not include any individual account plan the benefits of which are taken into account in determining the benefits payable to a participant under any defined benefit plan.

    4. The term "qualifying employer real property" means parcels of employer real property -
      1. If a substantial number of the parcels are dispersed geographically;
      2. If each parcel of real property and the improvements thereon are suitable (or adaptable without excessive cost) for more than one use;
      3. Even if all of such real property is leased to one lessee (which may be an employer, or an affiliate of an employer); and
      4. If the acquisition and retention of such property comply with the provisions of this part (other than section 1104(a)(1)(B) of this title to the extent it requires diversification, and sections 1104(a)(1)(C), 1106 of this title, and subsection (a) of this section).
    5. The term "qualifying employer security" means an employer security which is -
      1. Stock,
      2. A marketable obligation (as defined in subsection (e)), or
      3. An interest in a publicly traded partnership (as defined in section 7704(b) of Title 26, but only if such partnership is an existing partnership as defined in section 10211(c)(2)(A) of the Revenue Act of 1987 (Public Law 100-203).

      After December 17, 1987, in the case of a plan other than an eligible individual account plan, an employer security described in subparagraph (A) or (C) shall be considered a qualifying employer security only if such employer security satisfies the requirements of subsection (f)(1) of this section.

    6. The term "employee stock ownership plan" means an individual account plan -
    7. Editor's Note: Also see "ESOP" definition, Internal Revenue Code § 4975(e)(7).

      1. Which is a stock bonus plan which is qualified, or a stock bonus plan and money purchase plan both of which are qualified, under section 401 of Title 26, and which is designed to invest primarily in qualifying employer securities, and
      2. Which meets such other requirements as the Secretary of the Treasury may prescribe by regulation.
    8. A corporation is an affiliate of an employer if it is a member of any controlled group of corporations (as defined in section 1563(a) of Title 26, except that "applicable percentage" shall be substituted for "80 percent" wherever the latter percentage appears in such section) of which the employer who maintains the plan is a member. For purposes of the preceding sentence, the term "applicable percentage" means 50 percent, or such lower percentage as the Secretary may prescribe by regulation. A person other than a corporation shall be treated as an affiliate of an employer to the extent provided in regulations of the Secretary. An employer which is a person other than a corporation shall be treated as affiliated with another person to the extent provided by regulations of the Secretary. Regulations under this paragraph shall be prescribed only after consultation and coordination with the Secretary of the Treasury.
    9. The Secretary may prescribe regulations specifying the extent to which conversions, splits, the exercise of rights, and similar transactions are not treated as acquisitions.
    10. For purposes of this section, an arrangement which consists of a defined benefit plan and an individual account plan shall be treated as 1 plan if the benefits of such individual account plan are taken into account in determining the benefits payable under such defined benefit plan.
  6. Marketable obligations. For purposes of subsection (d)(5) of this section, the term "marketable obligation" means a bond, debenture, note, or certificate, or other evidence of indebtedness (hereinafter in this subsection referred to as "obligation") if -
    1. Such obligation is acquired -
      1. On the market, either -
        1. At the price of the obligation prevailing on a national securities exchange which is registered with the Securities and Exchange Commission, or
        2. If the obligation is not traded on such a national securities exchange, at a price not less favorable to the plan than the offering price for the obligation as established by current bid and asked prices quoted by persons independent of the issuer;
      2. From an underwriter, at a price -
        1. Not in excess of the public offering price for the obligation as set forth in a prospectus or offering circular filed with the Securities and Exchange Commission, and
        2. At which a substantial portion of the same issue is acquired by persons independent of the issuer; or
      3. Directly from the issuer, at a price not less favorable to the plan than the price paid currently for a substantial portion of the same issue by persons independent of the issuer;
    2. Immediately following acquisition of such obligation -
      1. Not more than 25 percent of the aggregate amount of obligations issued in such issue and outstanding at the time of acquisition is held by the plan, and
      2. At least 50 percent of the aggregate amount referred to in subparagraph (A) is held by persons independent of the issuer; and
    3. Immediately following acquisition of the obligation, not more than 25 percent of the assets of the plan is invested in obligations of the employer or an affiliate of the employer.
  7. Maximum percentage of stock held by plan; time of holding or acquisition; necessity of legally binding contract
    1. Stock satisfies the requirements of this paragraph if, immediately following the acquisition of such stock -
      1. No more than 25 percent of the aggregate amount of stock of the same class issued and outstanding at the time of acquisition is held by the plan, and
      2. At least 50 percent of the aggregate amount referred to in subparagraph (A) is held by persons independent of the issuer.
    2. Until January 1, 1993, a plan shall not be treated as violating subsection (a) of this section solely by holding stock which fails to satisfy the requirements of paragraph (1) if such stock -
      1. Has been so held since December 17, 1987, or
      2. Was acquired after December 17, 1987, pursuant to a legally binding contract in effect on December 17, 1987, and has been so held at all times after the acquisition.
    3. After December 17, 1987, no plan may acquire stock which does not satisfy the requirements of paragraph (1) unless the acquisition is made pursuant to a legally binding contract in effect on such date.

408    Statutory Exemptions from Prohibited Transactions

ERISA Section 408
(29 USC 1108)

  1. Grant of exemptions.
  2. The Secretary shall establish an exemption procedure for purposes of this subsection. Pursuant to such procedure, he may grant a conditional or unconditional exemption of any fiduciary or transaction, or class of fiduciaries or transactions, from all or part of the restrictions imposed by sections 1106 and 1107(a) of this title. Action under this subsection may be taken only after consultation and coordination with the Secretary of the Treasury. An exemption granted under this section shall not relieve a fiduciary from any other applicable provision of this chapter. The Secretary may not grant an exemption under this subsection unless he finds that such exemption is -

    1. Administratively feasible,
    2. In the interest of the plan and of its participants and beneficiaries, and
    3. Protective of the rights of participants and beneficiaries of such plan.

    Editor's Note: See DOL Regulation 2570.30 through .52, which replaced DOL ERISA Procedure 75-1.

    Before granting an exemption under this subsection from section 1106(a) or 1107(a) of this title, the Secretary shall publish notice in the Federal Register of the pendency of the exemption, shall require that adequate notice be given to interested persons, and shall afford interested persons opportunity to present views. The Secretary may not grant an exemption under this subsection from section 1106(b) of this title unless he affords an opportunity for a hearing and makes a determination on the record with respect to the findings required by paragraphs (1), (2), and (3) of this subsection.

  3. Enumeration of transactions exempted from section 1106 prohibitions. The prohibitions provided in section 1106 of this title shall not apply to any of the following transactions:
    1. Any loans made by the plan to parties in interest who are participants or beneficiaries of the plan if such loans -
    2. Editor's Note: Also see participant loan provisions of Internal Revenue Code § 4975(d)(1) and DOL Regulation 2550.408b-1.

      1. Are available to all such participants and beneficiaries on a reasonably equivalent basis,
      2. Are not made available to highly compensated employees (within the meaning of section 414(q) of Title 26), in an amount greater than the amount made available to other employees,
      3. Are made in accordance with specific provisions regarding such loans set forth in the plan,
      4. Bear a reasonable rate of interest, and
      5. Are adequately secured.
    3. 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 the plan, if no more than reasonable compensation is paid therefore.
    4. Editor's Note: Also see ancillary services provisions of Internal Revenue Code § 4975(d)(2).

    5. A loan to an employee stock ownership plan (as defined in section 1107(d)(6) of this title), if -
    6. Editor's Note: Also see ESOP loan provisions of Internal Revenue Code § 4975(d)(3).

      1. Such loan is primarily for the benefit of participants and beneficiaries of the plan, and
      2. Such loan is at an interest rate which is not in excess of a reasonable rate.

      If the plan gives collateral to a party in interest for such loan, such collateral may consist only of qualifying employer securities (as defined in section 1107(d)(5) of this title).

    7. The investment of all or part of a plan's 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 such plan and if -
    8. Editor's Note: Also see deposit provisions of Internal Revenue Code § 4975(d)(4).

      1. The plan covers only employees of such bank or other institution and employees of affiliates of such bank or other institution, or
      2. Such investment is expressly authorized by a provision of the plan or by a fiduciary (other than such bank or institution or affiliate thereof) who is expressly empowered by the plan to so instruct the trustee with respect to such investment.
    9. Any contract for life insurance, health insurance, or annuities with one or more insurers which are qualified to do business in a State, if the plan pays no more than adequate consideration, and if each such insurer or insurers is -
      1. The employer maintaining the plan, or
      2. A party in interest which is wholly owned (directly or indirectly) by the employer maintaining the plan, or by any person which is a party in interest with respect to the plan, but only if the total premiums and annuity considerations written by such insurers for life insurance, health insurance, or annuities for all plans (and their employers) with respect to which such insurers are parties in interest (not including premiums or annuity considerations written by the employer maintaining the plan) do not exceed 5 percent of the total premiums and annuity considerations written for all lines of insurance in that year by such insurers (not including premiums or annuity considerations written by the employer maintaining the plan).
    10. The providing of an ancillary service by a bank or similar financial institution supervised by the United States or a State, if such bank or other institution is a fiduciary of such plan, and if -
    11. Editor's Note: Also see bank ancillary services provisions of Internal Revenue Code § 4975(d)(6).

      1. Such bank or similar financial institution has adopted adequate internal safeguards which assure that the providing of such ancillary service is consistent with sound banking and financial practice, as determined by Federal or State supervisory authority, and
      2. The extent to which such ancillary service is provided is subject to specific guidelines issued by such bank or similar financial institution (as determined by the Secretary after consultation with Federal and State supervisory authority), and adherence to such guidelines would reasonably preclude such bank or similar financial institution from providing such ancillary service -
        1. In an excessive or unreasonable manner, and
        2. In a manner that would be inconsistent with the best interests of participants and beneficiaries of employee benefit plans.

        Such ancillary services shall not be provided at more than reasonable compensation.

    12. The exercise of a privilege to convert securities, to the extent provided in regulations of the Secretary, but only if the plan receives no less than adequate consideration pursuant to such conversion.
    13. Any transaction between a plan and -
      1. A common or collective trust fund or pooled investment fund maintained by a party in interest which is a bank or trust company supervised by a State or Federal agency or
      2. A pooled investment fund of an insurance company qualified to do business in a State, if -
      3. Editor's Note: Also see collective investment fund provisions of Internal Revenue Code § 4975(d)(8).

        1. The transaction is a sale or purchase of an interest in the fund,
        2. The bank, trust company, or insurance company receives not more than reasonable compensation, and
        3. Such transaction is expressly permitted by the instrument under which the plan is maintained, or by a fiduciary (other than the bank, trust company, or insurance company, or an affiliate thereof) who has authority to manage and control the assets of the plan.
    14. The making by a fiduciary of a distribution of the assets of the plan in accordance with the terms of the plan if such assets are distributed in the same manner as provided under section 1344 of this title (relating to allocation of assets).
    15. Any transaction required or permitted under part 1 of subtitle E of subchapter III of this chapter.
    16. A merger of multiemployer plans, or the transfer of assets or liabilities between multiemployer plans, determined by the Pension Benefit Guaranty Corporation to meet the requirements of section 1411 of this title.
    17. The sale by a plan to a party in interest on or after December 18, 1987, of any stock, if -
      1. The requirements of paragraphs (1) and (2) of subsection (e) of this section are met with respect to such stock,
      2. On the later of the date on which the stock was acquired by the plan, or January 1, 1975, such stock constituted a qualifying employer security (as defined in section 1107(d)(5) of this title as then in effect), and
      3. Such stock does not constitute a qualifying employer security (as defined in section 1107(d)(5) of this title as in effect at the time of the sale).
    18. Any transfer in a taxable year beginning before January 1, 2001, of excess pension assets from a defined benefit plan to a retiree health account in a qualified transfer permitted under section 420 of Title 26 (as in effect on January 1, 1996).
  4. Fiduciary benefits and compensation not prohibited by section 1106. Nothing in section 1106 of this title shall be construed to prohibit any fiduciary from -
    1. Receiving any benefit to which he may be entitled as a participant or beneficiary in the plan, so long as the benefit is computed and paid on a basis which is consistent with the terms of the plan as applied to all other participants and beneficiaries;
    2. Receiving any reasonable compensation for services rendered, or for the reimbursement of expenses properly and actually incurred, in the performance of his duties with the plan; except that no person so serving who already receives full-time pay from an employer or an association of employers, whose employees are participants in the plan, or from an employee organization whose members are participants in such plan shall receive compensation from such plan, except for reimbursement of expenses properly and actually incurred; or
    3. Serving as a fiduciary in addition to being an officer, employee, agent, or other representative of a party in interest.
  5. Owner-employees; family members; shareholder employees. Section 1107(b) of this title and subsections (b), (c), and (e) of this section shall not apply to any transaction in which a plan, directly or indirectly -
    1. Lends any part of the corpus or income of the plan to;
    2. Pays any compensation for personal services rendered to the plan to; or
    3. Acquires for the plan any property from or sells any property to; any person who is with respect to the plan an owner-employee (as defined in section 401(c)(3) of Title 26), a member of the family (as defined in section 267(c)(4) of Title 26) of any such owner-employee, or a corporation controlled by any such owner-employee through the ownership, directly or indirectly, of 50 percent or more of the total combined voting power of all classes of stock entitled to vote or 50 percent or more of the total value of shares of all classes of stock of the corporation. For purposes of this subsection a shareholder employee (as defined in section 1379 of Title 26 as in effect on the day before the date of the enactment of the Subchapter § Revision Act of 1982) and a participant or beneficiary of an individual retirement account or individual retirement annuity described in section 408 of Title 26 or a retirement bond described in section 409 of Title 26 (as effective for obligations issued before January 1, 1984) and an employer or association of employers which establishes such an account or annuity under section 408(c) of Title 26 shall be deemed to be an owner-employee.
  6. Acquisition or sale by plan of qualifying employer securities; acquisition, sale, or lease by plan of qualifying employer real property.
  7. Sections 1106 and 1107 of this title shall not apply to the acquisition or sale by a plan of qualifying employer securities (as defined in section 1107(d)(5) of this title) or acquisition, sale or lease by a plan of qualifying employer real property (as defined in section 1107(d)(4) of this title) -

    1. If such acquisition, sale, or lease is for adequate consideration (or in the case of a marketable obligation, at a price not less favorable to the plan than the price determined under section 1107(e)(1) of this title),
    2. If no commission is charged with respect thereto, and
    3. If -
    1. The plan is an eligible individual account plan (as defined in section 1107(d)(3) of this title), or
    2. In the case of an acquisition or lease of qualifying employer real property by a plan which is not an eligible individual account plan, or of an acquisition of qualifying employer securities by such a plan, the lease or acquisition is not prohibited by section 1107(a) of this title.
  8. Applicability of statutory prohibitions to mergers or transfers. Section 1106(b)(2) of this title shall not apply to any merger or transfer described in subsection (b)(11) of this section.

409    Liability for Breach of Fiduciary Duty

ERISA Section 409
(29 USC 1109)

  1. Any person who is a fiduciary with respect to a plan who breaches any of the responsibilities, obligations, or duties imposed upon fiduciaries by this subchapter shall be personally liable to make good to such plan any losses to the plan resulting from each such breach, and to restore to such plan any profits of such fiduciary which have been made through use of assets of the plan by the fiduciary, and shall be subject to such other equitable or remedial relief as the court may deem appropriate, including removal of such fiduciary. A fiduciary may also be removed for a violation of section 1111 of this title.
  2. No fiduciary shall be liable with respect to a breach of fiduciary duty under this subchapter if such breach was committed before he became a fiduciary or after he ceased to be a fiduciary.

410    Exculpatory Provisions

ERISA Section 410
(29 USC 1110)

  1. Except as provided in sections 1105(b)(1) and 1105(d) of this title, any provision in an agreement or instrument which purports to relieve a fiduciary from responsibility or liability for any responsibility, obligation, or duty under this part shall be void as against public policy.
  2. Nothing in this subpart shall preclude -
    1. A plan from purchasing insurance for its fiduciaries or for itself to cover liability or losses occurring by reason of the act or omission of a fiduciary, if such insurance permits recourse by the insurer against the fiduciary in the case of a breach of a fiduciary obligation by such fiduciary;
    2. A fiduciary from purchasing insurance to cover liability under this part from and for his own account; or
    3. An employer or an employee organization from purchasing insurance to cover potential liability of one or more persons who serve in a fiduciary capacity with regard to an employee benefit plan.

411    Prohibition Against Certain Persons Holding Certain Positions

ERISA Section 411
(29 USC 1111)

  1. Conviction or imprisonment. No person who has been convicted of, or has been imprisoned as a result of his conviction of, robbery, bribery, extortion, embezzlement, fraud, grand larceny, burglary, arson, a felony violation of Federal or State law involving substances defined in section 802(6) of Title 21, murder, rape, kidnapping, perjury, assault with intent to kill, any crime described in section 80a-9(a)(1) of Title 15, a violation of any provision of this chapter, a violation of section 186 of this title, a violation of chapter 63 of Title 18, a violation of section 874, 1027, 1503, 1505, 1506, 1510, 1951, or 1954 of Title 18, a violation of the Labor-Management Reporting and Disclosure Act of 1959 (29 USC 401), any felony involving abuse or misuse of such person's position or employment in a labor organization or employee benefit plan to seek or obtain an illegal gain at the expense of the members of the labor organization or the beneficiaries of the employee benefit plan, or conspiracy to commit any such crimes or attempt to commit any such crimes, or a crime in which any of the foregoing crimes is an element, shall serve or be permitted to serve -
    1. As an administrator, fiduciary, officer, trustee, custodian, counsel, agent, employee, or representative in any capacity of any employee benefit plan,
    2. As a consultant or adviser to an employee benefit plan, including but not limited to any entity whose activities are in whole or substantial part devoted to providing goods or services to any employee benefit plan, or
    3. In any capacity that involves decision making authority or custody or control of the moneys, funds, assets, or property of any employee benefit plan, during or for the period of thirteen years after such conviction or after the end of such imprisonment, whichever is later, unless the sentencing court on the motion of the person convicted sets a lesser period of at least three years after such conviction or after the end of such imprisonment, whichever is later, or unless prior to the end of such period, in the case of a person so convicted or imprisoned -
      1. His citizenship rights, having been revoked as a result of such conviction, have been fully restored, or
      2. If the offense is a Federal offense, the sentencing judge or, if the offense is a State or local offense, the United States district court for the district in which the offense was committed, pursuant to sentencing guidelines and policy statements under section 994(a) of Title 28, determines that such person's service in any capacity referred to in paragraphs (1) through (3) would not be contrary to the purposes of this subchapter. Prior to making any such determination the court shall hold a hearing and shall give notice to such proceeding by certified mail to the Secretary of Labor and to State, county, and Federal prosecuting officials in the jurisdiction or jurisdictions in which such person was convicted. The court's determination in any such proceeding shall be final. No person shall knowingly hire, retain, employ, or otherwise place any other person to serve in any capacity in violation of this subsection.

      Notwithstanding the preceding provisions of this subsection, no corporation or partnership will be precluded from acting as an administrator, fiduciary, officer, trustee, custodian, counsel, agent, or employee of any employee benefit plan or as a consultant to any employee benefit plan without a notice, hearing, and determination by such court that such service would be inconsistent with the intention of this section.

  2. Penalty. Any person who intentionally violates this section shall be fined not more than $10,000 or imprisoned for not more than five years, or both.
  3. Definitions. For the purpose of this section -
    1. A person shall be deemed to have been "convicted" and under the disability of "conviction" from the date of the judgment of the trial court, regardless of whether that judgment remains under appeal.
    2. The term "consultant" means any person who, for compensation, advises, or represents an employee benefit plan or who provides other assistance to such plan, concerning the establishment or operation of such plan.
    3. A period of parole or supervised release shall not be considered as part of a period of imprisonment.
  4. Payment of salary into escrow. Whenever any person -
    1. By operation of this section, has been barred from office or other position in an employee benefit plan as a result of a conviction, and
    2. Has filed an appeal of that conviction, any salary which would be otherwise due such person by virtue of such office or position, shall be placed in escrow by the individual or organization responsible for payment of such salary. Payment of such salary into escrow shall continue for the duration of the appeal or for the period of time during which such salary would be otherwise due, whichever period is shorter. Upon the final reversal of such person's conviction on appeal, the amounts in escrow shall be paid to such person. Upon the final sustaining of that person's conviction on appeal, the amounts in escrow shall be returned to the individual or organization responsible for payments of those amounts. Upon final reversal of such person's conviction, such person shall no longer be barred by this statute from assuming any position from which such person was previously barred.

412    Bonding of Fiduciaries

ERISA Section 412
(29 USC 1112)

  1. Requisite bonding of plan officials. Every fiduciary of an employee benefit plan and every person who handles funds or other property of such a plan (hereafter in this section referred to as "plan official") shall be bonded as provided in this section; except that -
    1. Where such plan is one under which the only assets from which benefits are paid are the general assets of a union or of an employer, the administrator, officers, and employees of such plan shall be exempt from the bonding requirements of this section, and
    2. No bond shall be required of a fiduciary (or of any director, officer, or employee of such fiduciary) if such fiduciary -
      1. Is a corporation organized and doing business under the laws of the United States or of any State;and
      2. Is authorized under such laws to exercise trust powers or to conduct an insurance business;and
      3. Is subject to supervision or examination by Federal or State authority; and
      4. Has at all times a combined capital and surplus in excess of such a minimum amount as may be established by regulations issued by the Secretary, which amount shall be at least $1,000,000. Paragraph (2) shall apply to a bank or other financial institution which is authorized to exercise trust powers and the deposits of which are not insured by the Federal Deposit Insurance Corporation, only if such bank or institution meets bonding or similar requirements under State law which the Secretary determines are at least equivalent to those imposed on banks by Federal law; or
      5. Is registered as a broker or dealer under Section 15(b) of the Securities Exchange Act of 1934 if the broker or dealer is subject to the fidelity bond requirements of a self-regulatory organization.

      The amount of such bond shall be fixed at the beginning of each fiscal year of the plan. Such amount shall be not less than 10 per centum of the amount of funds handled. In no case shall such bond be less than $1,000 nor more than $500,000, except in the case of a plan that holds employer securities, in which case the maximum amount of such bond shall be $1,000,000. The Secretary, however, after due notice and opportunity for hearing to all interested parties, and after consideration of the record, may prescribe an amount in excess of $500,000, subject to the 10 per centum limitation of the preceding sentence. For purposes of fixing the amount of such bond, the amount of funds handled shall be determined by the funds handled by the person, group, or class to be covered by such bond and by their predecessor or predecessors, if any, during the preceding reporting year, or if the plan has no preceding reporting year, the amount of funds to be handled during the current reporting year by such person, group, or class, estimated as provided in regulations of the Secretary. Such bond shall provide protection to the plan against loss by reason of acts of fraud or dishonesty on the part of the plan official, directly or through connivance with others. Any bond shall have as surety thereon a corporate surety company which is an acceptable surety on Federal bonds under authority granted by the Secretary of the Treasury pursuant to sections 9304-9308 of Title 31. Any bond shall be in a form or of a type approved by the Secretary, including individual bonds or schedule of blanket forms of bonds which cover a group or class.

  2. Unlawful acts. It shall be unlawful for any plan official to whom subsection (a) of this section applies, to receive, handle, disburse, or otherwise exercise custody or control of any of the funds or other property of any employee benefit plan, without being bonded as required by subsection (a) of this section and it shall be unlawful for any plan official of such plan, or any other person having authority to direct the performance of such functions, to permit such functions, or any of them, to be performed by any plan official, with respect to whom the requirements of subsection (a) of this section have not been met.
  3. Conflict of interest prohibited in procuring bonds. It shall be unlawful for any person to procure any bond required by subsection (a) of this section from any surety or other company or through any agent or broker in whose business operations such plan or any party in interest in such plan has any control or significant financial interest, direct or indirect.
  4. Exclusiveness of statutory basis for bonding requirement for persons handling funds or other property of employee benefit plans.
  5. Nothing in any other provision of law shall require any person, required to be bonded as provided in subsection (a) of this section because he handles funds or other property of an employee benefit plan, to be bonded insofar as the handling by such person of the funds or other property of such plan is concerned.

  6. Regulations. The Secretary shall prescribe such regulations as may be necessary to carry out the provisions of this section including exempting a plan from the requirements of this section where he finds that -
    1. Other bonding arrangements or
    2. The overall financial condition of the plan would be adequate to protect the interests of the beneficiaries and participants.

    When, in the opinion of the Secretary, the administrator of a plan offers adequate evidence of the financial responsibility of the plan, or that other bonding arrangements would provide adequate protection of the beneficiaries and participants, he may exempt such plan from the requirements of this section.

413    Limitation on Actions

ERISA Section 413
(29 USC 1113)

No action may be commenced under this subchapter with respect to a fiduciary's breach of any responsibility, duty, or obligation under this part, or with respect to a violation of this part, after the earlier of -

  1. Six years after (A) the date of the last action which constituted a part of the breach or violation, or (B) in the case of an omission, the latest date on which the fiduciary could have cured the breach or violation, or
  2. Three years after the earliest date on which the plaintiff had actual knowledge of the breach or violation; except that in the case of fraud or concealment, such action may be commenced not later than six years after the date of discovery of such breach or violation.

502    Civil Money Penalties

ERISA Section 502
(29 USC 1132)

(i) Administrative assessment of civil penalty. In the case of a transaction prohibited by section 406 (29 USC 1106) by a party in interest with respect to a plan to which this part applies, the Secretary may assess a civil penalty against such party in interest. The amount of such penalty may not exceed 10 percent of the amount involved in each such transaction (as defined in section 4975(f)(4) of the Internal Revenue Code, amended as of 1997) for each year or part thereof during which the prohibited transaction continues, except that, if the transaction is not corrected (in such manner as the Secretary shall prescribe in regulations which shall be consistent with section 4975(f)(5) of such Code within 90 days after notice from the Secretary (or such longer period as the Secretary may permit), such penalty may be in an amount not more than 100 percent of the amount involved. This subsection shall not apply to a transaction with respect to a plan described in section 4975(e)(1) of such Code.

  1. Civil penalties on violations by fiduciaries. In the case of -
    1. Any breach of fiduciary responsibility under (or any violation of) part 4 by a fiduciary, or
    2. Any knowing participation in such breach or violation by any other person,

    the Secretary shall assess a civil penalty against such fiduciary or other person in an amount equal to 20 percent of the applicable recovery amount.

  2. For purposes of paragraph (l), the term "applicable recovery amount" means any amount which is recovered from a fiduciary or other person with respect to a breach or violation described in paragraph (1) -
    1. Pursuant to any settlement agreement with the Secretary, or
    2. Ordered by a court to be paid by such fiduciary or other person to a plan or its participants and beneficiaries in a judicial proceeding instituted by the Secretary under subsection (a)(2) or (a)(5).
  3. The Secretary may, in the Secretary's sole discretion, waive or reduce the amount of the penalty under paragraph (l) if the Secretary determines in writing that -
    1. The fiduciary or other person acted reasonably and in good faith, or
    2. It is reasonable to expect that the fiduciary or other person will not be able to restore all losses to the plan without severe financial hardship unless such waiver or reduction is granted.
  4. The penalty imposed on a fiduciary or other person under this subsection with respect to any transaction shall be reduced by the amount of any penalty or tax imposed on such fiduciary or other person with respect to such transaction under subsection (i) of this section and section 4975 of the Internal Revenue Code of 1986.
Cross-References Between ERISA and Equivalent Parts of Internal Revenue Section 4975
Material ERISA Section IRC Section 4975
Definitions:
Employee Stock Ownership Plan (ESOP) 407(d)(6) (e)(7)
Fiduciary 3(21) (e)(3)
Party in Interest/Disqualified Person 3(14) (e)(2)
Relative/Family Member 3(15) (e)(6)
Prohibited Transaction 406 (c)(1)
Statutory Exemptions:
Ancillary Services 408(b)(2) (d)(2)
Bank Ancillary Services 408(b)(6) (d)(6)
Collective Investment Funds 408(b)(8) (d)(8)
Deposits 408(b)(4) (d)(4)
ESOP Loans 408(b)(3) (d)(3)
Summary of ERISA Regulations, Opinions, and Court Decisions

Section 3    Definitions (Selected)

ERISA Section 3

Section-by-Section Interpretations

Regulations, Advisory Opinions, Court Cases, Opinion Letters,and Class Exemptions

Abbreviations Used
AO Advisory Opinion (Department of Labor)
DOL Department of Labor
ERISA Employee Retirement Security Act of 1974
FR Federal Register
PTE Prohibited Transaction Exemption
PLR Private Letter Ruling
WPPDA Welfare and Pension Plans Disclosure Act
WSB

WSB Washington Service Bureau

10-27-94

ERISA Section 3(14)

"Party in Interest"
The term "party in interest" means, as to an employee benefit plan -
(A) Any fiduciary (including, but not limited to, any administrator, officer, trustee, or custodian), counsel, or employee of such employee benefit plan;
(B) A person providing services to such plan;
(C) An employer any of whose employees are covered by such plan;
(D) An employee organization any of whose members are covered by such plan;
(E) An owner, direct or indirect, of 50% 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 a corporation,
  (ii) The capital interest or the profits interest of a partnership, or
  (iii) The beneficial interest of a trust or unincorporated enterprise, which is the employer or an employee organization described in subparagraph (C) or (D);
(F) A relative (as defined in paragraph (15)) of any individual described in subparagraph (A), (B), (C), or (E);
(G) A corporation, partnership, or trust or estate of which (or in which) 50% 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 a corporation,
  (ii) The capital interest or the profits interest of a partnership, or
  (iii) The beneficial interest of a such trust or estate, is owned directly or indirectly, or held by persons described in subparagraph (A), (B), (C) (D), or (E);
(H) An employee, officer, director (or an individual having powers or responsibilities similar to those of officers or directors, or a 10% or more shareholder directly or indirectly, of a person described in subparagraph (B), (C), (D), (E), or (G), or of the employee benefit plan; or
(I) A 10% or more (directly or indirectly in capital or profits) partner or joint venture of a person described in subparagraph (B), (C), (D), (E) or (G). The Secretary, after consultation and coordination with the Secretary of the Treasury, may by regulation prescribe a percentage lower than 50%, for subparagraph (E) and (G) and lower than 10% for subparagraph (H) or (I). The Secretary may prescribe regulations for determining the ownership (direct or indirect) of profits and beneficial interests, and the manner in which indirect stock holdings are taken into account. Any person who is a party in interest with respect to a plan to which a trust described in Section 501(c)(22) of the Internal Revenue Code of 1954 is permitted to make payments under Section 4223 shall be treated as a party in interest with respect to such trust.
  1. Conference Report
  2. See the discussion of the term "party in interest" at page 323 of the Congressional Conference Report.

  3. Prohibited Transaction Class Exemptions (PTE)
  4. [Plans] Two or more multi-employer plans or multiple employer plans are not parties in interest or disqualified persons with respect to each other merely because they are maintained by the same plan sponsors. However, a multi-employer plan or a multiple employer plan may be a party in interest or a disqualified person with respect to another multiemployer plan or multiple employer plan for other reasons (for example, one plan providing services to another). Final PTE 76-1; AO 77-47.

  5. Advisory Opinions
    1. [Affiliates] A corporation 50% or more of which is owned by a more than 50% shareholder of the employer maintaining the plan is a party in interest. Proposed PTE I-492.
    2. [Banks] A savings and loan association is not a party in interest merely because plan assets are held on deposit. AO 77-11; AO 79-10.
    3. [Broker-Dealers] Broker-dealers who execute securities transactions for plans are parties in interest. AO 76-76.
    4. [Custodians] Custodians of plan assets are parties in interest. AO 76-76; PLR 7907091.
    5. [Employer] Employers are parties in interest. WSB 77-14; PLR 7847034. Directors of an employer are parties in interest. WSB 77-14. An employer council is a party in interest because it acts on behalf of employers. AO 76-103.
    6. [Employer] An employer of employees covered by the plan is a party in interest pursuant to ERISA Section 3(14)(C) even if it is merely an affiliate or subsidiary of the employer plan sponsor. Thus, absent a statutory or administrative exemption, the exchange of common stock for preferred stock and the cancellation of a note in connection therewith as a transaction between the affiliate corporation and the plan would constitute a prohibited transaction under Section 406(a)(1)(A). AO 81-34A.
    7. [Insurance Companies] Insurance companies are not parties in interest merely because they issue group insurance policies to plans. AO 76-36.
    8. [Mergers & Acquisitions] A corporation proposes to acquire all of an unrelated third party's assets. In connection therewith, the, acquiring corporation will not assume, adopt or maintain the existing plan of the corporation to be acquired. The acquiring corporation desires to purchase or lease a building owned by the plan. Certain employees of the acquired corporation will become employees of the acquiring corporation. The term party in interest includes in Subsection (c) an employer any of whose employees are covered by the plan. However, the definition of an employer under Section 3(14)(C) must be viewed in light of the overall statutory framework of ERISA, including Section 3(5). That section provides in relevant part that the term "employer" means any person acting directly as an employer or indirectly in the interest of an employer in relation to an employee benefit plan. Since the acquiring corporation had no relationship with the plan in the past and will not assume, maintain or adopt the plan or its accompanying trust after the acquisition, that entity is not a Section 3(14)(C) "party in interest" to the plan upon its acquisition of substantially all of the plan sponsor's assets. Advisory Opinion 81-78A.
    9. [Ownership] A person is not a 50% owner of a corporation or partnership under Section 3(14)(G) if such 50% ownership interest will not be acquired until sometime in the future. AO 75-147; AO 77-83.
    10. [Partners] Section 3(14)(I) applies only to 10% partners in a party in interest, not 10% partners with a party in interest in a partnership that is not itself a party in interest. AO 75-147; AO 77-83.
    11. [Relatives] Relatives are parties in interest. AO 75-137.
    12. [Service Providers] Service providers are parties in interest even if they receive no compensation from the plan. WSB 78-17. However, a person who only provides services to the employer before the plan is established is not a party in interest. AO 76-65.
    13. [Trustees] Trustees of a plan and employees of a trustee are parties in interest. AO 77-84.
    14. [Unions] Unions are parties in interest. AO 76-91; WSB 78-25. Employees of a union are parties in interest. AO 76-91. However, the mere fact that union officers are also directors and employees of a corporation does not make such corporation a party in interest. AO 76-120.
  6. Court Decisions
    1. Trustees of a pension or welfare plan are parties in interest to the plan under Section 3(14)(A). Marshall v. Snyder, 430 F. Supp. 1224 (E.D.N.Y. 1977), aff'd in part, 572 F.2d 894 (2d Cir. 1978).
    2. Trustees and fiduciaries of employee benefit plans are parties in interest within the meaning of ERISA Section 3(14)(A). Donovan v. Bryans, 566 F. Supp. 1258, 4 EBC 1772 (E.D.Pa. 1983). A party in interest as defined by ERISA Section 3(14) includes any fiduciary and any employer of employees covered by an employee benefit plan. Brock v. Gilliken, 677 F. Supp. 398, 9 EBC 1803 (E.D.N.Y. 1987).
    3. In an action by terminated employee claiming applicability of retroactive amendment in employee stock ownership plan, under ERISA Section 3(14) a party in interest includes the employer and its officers, directors and major stockholders. Allen v. The Katz Agency, Inc. Employee Stock Ownership Plan, 677 F.2d 193, 3 EBC 1352 (2d Cir. 1982).
    4. A construction company is deemed a party in interest under Section 3(14)(G) when its sole stock owner and president is the trustee of an employee benefit plan and the company receives loans from such plan. Brock v. Gilliken, 677 F. Supp. 398, 9 EBC 1803 (E.D.N.Y. 1987).
    5. A law firm that receives excessive amounts of money in relationship to services rendered by the firm and benefits received by the members of the represented employee welfare plan is treated as a party in interest in an action alleging the trustees breached their fiduciary duties by overpaying the law firm. Benvenuto v. Schneider 678 F. Supp. 51, 9 EBC 1528 (E.D.N.Y. 1988).
Section 3(15)

"Relative"
The term "relative" means a spouse, ancestor, lineal descendant, or spouse of a lineal descendant.
  1. Conference Report
  2. The Congressional Conference Report does not discuss the term "relative."

  3. Advisory Opinions
  4. The brother of a fiduciary is not a relative under Section 3(15) and, therefore, is not a party in interest under Section 3(14)(F). AO 77-05.

Section 3(18)

"Adequate Consideration"
The term "adequate consideration" when used in part 4 of subtitle B means:
(A) In the case of a security for which there is a generally recognized market, either
(i) The price of the security prevailing on a national securities exchange which is registered under section 6 of the Securities Exchange Act of 1934, or
(ii) If the security is not traded on such a national securities exchange, a price not less favorable to the plan than the offering price for the security as established by the current bid and asked prices quoted by persons independent of the issuer and of any party in interest; and
(B) In the case of an asset other than a security for which there is a generally recognized market, the market value of the asset as determined in good faith by the trustee or named fiduciary, pursuant to the terms of the plan and in accordance with regulations promulgated by the Secretary [of Labor].
  1. Conference Report
  2. The Congressional Conference Report does not discuss the definition of the term "adequate consideration."

  3. Regulations
  4. DOL ERISA Regulation 2510.3-18(b) was proposed in 1988 but has not yet been adopted. It provided guidance on how thinly-traded securities should be valued.

  5. Advisory Opinions
    1. In the absence of regulations under Section 3(18), securities for which there is no generally recognized market should be valued by the trustees or other appropriate plan fiduciary by making a good faith determination of the fair market value of the securities, utilizing recognized methods of determining value. AO 75-141; AO 76-16.
    2. If securities are publicly traded in the over-the-counter market and if there are current bid and asked prices quoted by persons independent of the issuer and of any party in interest, a plan may not purchase a controlling block of stock at a price greater than such current bid and asked prices. AO 76-52.
    3. Reliance by a plan trustee on a ruling received from the IRS that a method of determining the fair market value of book value shares constitutes a reasonable method of determining fair market value for purposes of Treasury Regulation 1.421-7(e)(2) would be considered evidence that the trustee's determination of fair market value was made in good faith for purposes of Section 3(18)(B). AO 77-35.
  6. Court Decisions
    1. [ESOP - Stock Valuation] Where an ESOP purchases securities from a sponsoring company that does not have a generally recognized market, adequate consideration as defined in ERISA requires the trustee to exercise objective good faith by prudently using sound business principles of evaluation for the sole benefit of the employees' plan. Trustees who relied on appraisals that were 13 and 20 months old did not exercise good faith and sound business principles, and the amount paid for the securities purchased by the plan was more than adequate consideration. Donovan v. Cunningham, 716 F.2d 1455, 4 EBC 2329 (5th Cir. 1983).
    2. Adequate consideration is the price for the stock quoted on the American Stock Exchange. The fact that a sale of the stock over a longer period of time might have resulted in a higher return or that a premium might have been obtained for the sale of a large block need not be taken into account. Leonard v. Drug Fair, Inc., No. 78-1335, Fed. Sec. L. Rep. (CCH) 97,144 (D.D.C. 1979).
Section 3(21)

"Fiduciary"
Except as otherwise provided in subparagraph (B), a person is a fiduciary with respect to a plan to the extent
(i) He exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets,
(ii) He renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, or has any authority or responsibility to do so, or
(iii) He has any discretionary authority or discretionary responsibility in the administration of such plan.
Such term includes any person designated under section 405(c)(1)(B).
  1. Conference Report
  2. See the discussion of the term "fiduciary" at page 323 of the Congressional Conference Report.

  3. Regulations
    1. Refer to DOL Regulation 2510.3-21 and IRS Regulation 54.4975-9.
    2. The regulation clarifies the applicability of the definition fiduciary to persons who provide investment advice to plans and to securities brokers and dealers who execute securities transactions for plans. DOL Regulation 2510.3-21(c)-(e).
    3. A person is a fiduciary only to the extent of his or her fiduciary responsibilities to a plan. DOL Regulation 2510.3-21(c)(2), (d)(2).
    4. As a general matter, a person (e.g., a securities broker) is not a fiduciary to a plan if he or she does not know, and has no reason to know, that he or she is acting for a plan. Preamble to DOL Regulation 2510.3-21(c)-(e).
    5. A fee or other compensation, direct or indirect, for the rendering of investment advice to a plan, within the meaning of Section 3(21)(A)(ii), should be deemed to include all fees or other compensation incident to the transaction in which the investment advice to the plan has been rendered or will be rendered. This may include, for example, brokerage commissions, mutual fund sales commissions and insurance sales commissions. Preamble to DOL ERISA Regulation 2510.3-21(c)-(e).
    6. Depending on the facts and circumstances, a sales presentation and recommendations made to a plan fiduciary by an insurance agent or broker, pension consultant or mutual fund principal underwriter in connection with insurance or annuity contracts or mutual funds may constitute investment advice under Section 3(21). Preamble to DOL ERISA Regulation 2510.3-21(c)-(e).
    7. A person who exercises discretion in the administration of a plan by making final decisions on appeals from claim denials is a fiduciary to the plan under Section 3(21)(A)(iii) even if the plan documents fail to state do the person is a named fiduciary or merely a fiduciary. Preamble to DOL ERISA Regulation 2560.503-1 (Claims Procedure).
  4. Interpretive Bulletins
    1. [Trustees] A plan trustee and a plan administrator are plan fiduciaries because of the nature of their functions for a plan. IB 75-8, Question D-3.
    2. People who perform purely ministerial functions for a plan within a framework of policies, interpretations, rules, practices and procedures made by others are not fiduciaries under Section 3(21). IB 75-8, Question D-2. This question contains examples of purely ministerial functions.
    3. An officer, director, or employee of an employer maintaining a plan will not be a fiduciary for the plan, unless he or she has or exercises any of the authority, responsibility or control described in Section 3(21)(A) or provides investment advice to the plan for a fee or other compensation. IB 75-8, Questions D-4 and D-5.
    4. An attorney, accountant, actuary, or consultant for a plan who neither exercises nor has any of the responsibilities, authority or control described in Section 3(21)(A), and who does not provide investment advice to the plan for a fee or other compensation, is not a fiduciary to the plan under Section 3(21). IB 75-5, Question D-1.
    5. A person who merely calculates the amount of benefits to which a participant is entitled in accordance with a formula contained in a plan document is not a fiduciary under Section 3(21). However, a person who has the final authority to authorize or disallow claims for benefits based on an interpretation of plan provisions relating to eligibility for benefits would be a fiduciary under Section 3(21). IB 75-8, Question D-3.
  5. Prohibited Transaction Class Exemptions (PTE)
    1. [Broker-Dealers] Where a broker-dealer acts as an investment adviser in recommending securities transactions and a second fiduciary decides whether each such transaction should be entered into, the broker-dealer may be a fiduciary by reason of providing investment advice within the meaning of ERISA Section 3(21)(A)(ii) and Code Section 4975(e)(3)(B). However, since he or she would not have the power to manage, acquire, or dispose of plan assets without the approval of the second fiduciary, he or she would not be an investment manager as that term is defined in ERISA Section 3(38). Final PTE C 78-10.
    2. [Investment Advisor] A person may be a fiduciary by reason of being an investment adviser even if such person does not exercise investment discretion as that term is defined by the Securities and Exchange Commission under Section 3(a)(35) of the Securities Exchange Act of 1934. Final PTE C 78-10.
  6. Advisory Opinions
    1. The term "investment discretion" is defined in Section 3(a)(35) of the Securities Exchange Act of 1934. In general, a person who exercises investment discretion for a plan under that definition would also be a fiduciary with respect to the plan as defined in Section 3(21) of ERISA and Section 4975(e)(3) of the Code. A person also would also be a fiduciary as the result of rendering investment advice for compensation to a plan. Proposed Extension of Paragraph I(a) of PTE C 75-1.
    2. [Banks] The mere fact that a plan invests in a savings account or certificate of deposit of a savings and loan association does not make the association a plan fiduciary. AO 77-11; AO 79-10.
    3. [Custodians] A custodian of plan assets who has no discretionary authority or control over the management of the plan or the disposition of the assets, and who does not provide investment advice to the plan, is not a fiduciary under Section 3(21)(A). PLR 7907091.
    4. [Insurance Companies] An insurance company maintaining a separate account in which a plan invests is a fiduciary to the plan. Proposed PTE C 78-19.
    5. [Investments] A partnership in which a plan has invested does not become a plan fiduciary merely by reason of such investment. WSB 78-17.
    6. [Plan Committee Members] The individuals serving on one investment committee of a plan with responsibility for managing plan assets and appointing investment managers for the plan are fiduciaries under Section 3(21)(A). AO 76-15.
    7. [Trust Department Staff] A person who merely makes a report to plan fiduciaries on a plan's asset management staff and serves on a committee that advises Plan fiduciaries on plan investment policies and objectives will not be a plan fiduciary under Section 3(21)(A) or ERISA Regulations Section 2510.3-21. AO 77-68.
    8. The advice and recommendations made to plans and plan fiduciaries by insurance agents and brokers, pension consultants and mutual fund principal underwriters (or their employees) regarding plan purchases of insurance contacts or annuities or mutual fund shares constitutes advice as to the value of securities or other property or recommendations as to the advisability of investing in, purchasing or selling securities or other property and could constitute investment advice so as to classify the persons who furnish such advice as fiduciaries if it is rendered under certain circumstances. Proposed PTE C 77-9; WSB 79-99.
  7. Court Decisions
    1. [General] The definition of fiduciary under ERISA Section 3(21) is to be broadly construed. Thus, fiduciary should be defined not only by reference to particular titles, such as trustee, but also by considering the authority that a particular person has or exercises over an employee benefit plan. Donovan v. Mercer, 747 F.2d 304, 5 EBC 2512 (5th Cir. 1984).
    2. [General] ERISA fiduciary status is determined by focusing on the function performed by the individual rather than on the individual's title; an accounting firm was a fiduciary to the extent that it controlled whether or not contributions were returned to plan participants. Blan v. Marshall and Lasserman, 812 F.2d 810, 8 EBC 1495 (2d Cir. 1987).
    3. [General] Because the terms of an employee benefit plan conferred authority on defendants to exercise discretion in the management of the plan and its assets, the defendants were fiduciaries as defined by ERISA Section 3(21). Donovan v. Bryans, 566 F. Supp. 1258, 4 EBC 1772 (E.D.Pa. 1983).
    4. [General] ERISA permits the named plan fiduciary the option of delegating the responsibility of investing plan assets to a professional investment adviser who then might assume the ERISA fiduciary obligations to the plan, including the duties of care and loyalty. Lowen v. Tower Asset Management, Inc., 829 F.2d 1209, 8 EBC 2457 (2d Cir. 987).
    5. [General] A fiduciary continues in his status as such absent any clear resignation or removal under permissible circumstances. Marshall v. Dekeyser, 485 F.Supp. 629, 1 EBC 1898 (W.D.Wis. 1979).
    6. [General] ERISA Section 3(21)(A) limits the scope of both fiduciary status and responsibility; a person is a fiduciary with only for those aspects of the plan over which he or she exercises control or authority, and his or her fiduciary duty extends solely to those functions. Jury instructions should delineate the requisite control necessary to consider a person a fiduciary and warn jurors against drawing inferences of control or authority merely from a person's status, including status as a former employer, an officer, a principal shareholder or a director. Sommers Drug Stores Co. Employee Profit Sharing Trust v. Corrigan Enterprises, Inc., 793 F.2d 1456, 7 EBC 1782 (5th Cir. 1986), cert. denied, 479 U.S. 1089 (1987).
    7. [General] Under ERISA Section 3(21), a person is a fiduciary to a plan to the extent that he or she has any discretionary authority or discretionary responsibility in the administration of such plan. A duty to report "difficulties" concerning borrowers interest payments includes authority, responsibility and discretion to determine what constitutes difficulties. One who is conferred such authority is a fiduciary as defined by ERISA Section 3(21). Davidson v. Cook, 567 F.Supp. 225, 4 EBC 1816 (E.D.Va. 1983), aff'd, 734 F.2d 10 (4th Cir. 1984).
    8. [Attorneys] Attorneys who counsel a plan sponsor, members of a plan investment committee, and stockbrokers or dealers who recommend certain securities and then participate in the purchase or sale of the securities and receive a commission for their services, may be plan fiduciaries by reason of providing investment advice for a fee or other compensation. Eaves v. Penn, 587 F.2d 453 (10th Cir. 1978).
    9. [Broker-Dealer] A stockbroker is a fiduciary as defined by ERISA when, without authorization, he invests the assets of an employee benefit plan in unsuitable, highly speculative securities and disregards the trustee's instructions to liquidate. Metzner v. D. H. Blair & Co., Inc., 663 F. Supp. 716, Fed. Sec. L. Rep. (CCH) 993,306, 8 EBC 2159 (S.D.N.Y. 1987).
    10. [Custodians] A plan custodian can be a fiduciary, but only if the custodian possesses the requisite discretionary authority and discretionary control required by Section 3(21). The parenthetical language after "any fiduciary" in Section 3(14)(A) does not expand upon persons who are fiduciaries. A person is only a fiduciary under Section 3(14)(A) if such person is a fiduciary under Section 3(21). The Hibernia Bank v. International Brotherhood of Teamsters, Chauffeurs, Warehouseman and Helpers of America, 411 F.Supp. 478 (N.D.Cal. 1976).
    11. [Insurance Agent] An insurance agent, who was solely responsible for formulating the specifications of an employee plan, represents himself as the administrator of the plan and subsequently gives investment advice regarding such plan, even though he was never formally appointed as plan administrator nor paid a fee for his services, is deemed a fiduciary as defined by Section 3(21)(A). Applying the agency theory of apparent authority, the insurance company, as the principal of the insurance agent, is designated a fiduciary as well. Miller v. Lay Trucking C&, Inc, 606 F. Supp 1326 (N.D.Ind. 1985).
    12. [Insurance Companies] Congress did not want to make an insurance company that sells a standard annuity contract - one that provides "benefits the amount of which is guaranteed by the insurer" - a fiduciary toward the contract's purchaser. However, where pension trustees did not buy an insurance contract with a fixed payment but turned over the assets of the pension plan to an insurance company to manage with full investment discretion, subject only to a modest income guarantee, that company was a fiduciary as defined in Section 3(21) of ERISA. Amato v. Western Union International, Inc., 596 F. Supp. 963, 5 EBC 2718 (S.D.N.Y. 1984), aff'd in part and rev'd in part, 773 F.2d 1402 (2d Cir. 1985).
    13. [Mergers & Acquisitions] An individual acted as a plan fiduciary when he recommended, designed, and implemented an amendment to a profit-sharing plan that changed the plan to an ESOP and required the plan to invest large sums of money in employer stock so as to enable the individual to acquire control of the employer. Eaves v. Penn, 587 F.2d 453 (10th Cir. 1978).
    14. [Plan Administrator] By the very nature of his position, a plan administrator is a fiduciary to the plan. Marshall v. Dekeyser, 485 F. Supp. 629, 1 EBC 1898 (W.D.Wis. 1979).
    15. [Plan Sponsor] Officers and directors of a plan sponsor are plan fiduciaries if they exercise control through the selection of the investment committee, administrative committee or plan officers or directors. Eaves v. Penn, 587 F.2d 453 (10th Cir. 1978); Marshall v. Dekeyser, 485 F. Supp. 629, 1 EBC 1898 (W.D.Wis. 1979).
    16. [Plan Sponsor] An employer, whose only control over the management of the employee welfare plan is its authority to appoint, retain and remove the plan's administrator, is only a fiduciary for these acts and not for any others. Independent Association of Publishers' Employees, Inc. v. Dow Jones & Co., Inc., 671 F Supp. 1365 (S.D.N.Y. 1987).
    17. [Plan Sponsor] An employer is a fiduciary to a plan only when and to the extent that it engages in activities governed by ERISA, including acing in the capacity of plan administrator. Amato v. Western Union International, Inc., 773 F.2d 1402, 6 EBC 2226 (2d Cir. 1985), cert. dismissed, 474 U.S. 1113 (1986). Contra Ashenbaugh v. Crucible, Inc., 854 F.2d 1516, 9 EBC 2560 (3d Cir. 1988).
    18. [Plan Sponsor] An employer that is also a plan administrator of a plan has assumed two distinct statuses. ERISA's fiduciary duty attaches when the employer/administrator performs the function of a plan administrator but not when it acts in the capacity of an employer. When renegotiating a welfare benefit plan or benefits not vesting under ERISA the employer/administrator is acting in its employer capacity and, thus, can breach no ERISA fiduciary duty, because such fiduciary obligations do not attach to employer functions. United Independent Flight Officers, Inc. v. United Air Lines, Inc., 756 F.2d 1262, 6 EBC 1075, 6 EBC 1291, 118 L.R.R.M. (BNA) 2474,102 Lab. Cas. (CCH) 911,382 (7th Cir. 1985).
    19. [Service Provider] Where a defendant provided claims processing services to a health and welfare fund using adjustment standards established jointly by the fund and the defendant and the fund made final determinations on any contested payments according to the adjustment standards, it was not established that the defendant exercised sufficient discretionary authority or control over the fund or its assets to make it a fiduciary within the meaning of Section 3(21)(A) of ERISA. Donovan v. Robbins, 558 F. Supp. 319 (N.D.Ill. 1983), aff'd, 703 F.2d 570 (7th Cir. 1983).
    20. [Recordkeeping] A company was delegated by a bank trustee or custodian for self-directed IRA accounts the function of maintaining records and preparing appropriate reports required by Section 103 of ERISA. A company maintaining records necessary for the preparation of such reports is a plan fiduciary and must perform these functions with the degree of care set forth in Section 404(a)(1)(B). Redwood Bank v. QTA, Inc., No. C-79-1586, slip op. (N.D.Cal., Oct. 23, 1979).
    21. [Trustees] The trustees of a pension or welfare plan are fiduciaries under Section 3(21)(A). Marshall v. Snyder, 430 F. Supp. 1224 (E.D.N.Y. 1977), aff'd in part, 572 F.2d 894 (2d Cir. 1978); Marshall v. Dekeyser 485 F. Suay (29, I EBC 1898 (W.D.Wis.1979).
    22. [Trustees - Directed] Trustees who merely distribute plan assets upon direction from the plan's administrators in accordance with a court order and with no discretionary authority over the plan assets, do not exercise the required authority over a plan's assets that would impose fiduciary responsibilities. Richardson v. U.S. News & World Report, 623 F. Supp. 350 (D.D.C. 1985).
    23. [Trustees - Directed] Even though a plan trustee has no authority for investment decisions, it cannot disavow itself a responsibility for such decisions, since it is still a fiduciary. However, under the allocation provisions of Section 405(c)(1), the trustee may, in fact, not be liable for such decisions. Leonard v. Drug Fair, Inc., No. 78-1335, Fed. Sec. L. Rep. (CCH) 997,144 (D.D.C. 1979).
Section 3(21)(B)

Investment Company (Mutual Fund) as Fiduciary
If any money or other property of an employee benefit plan is invested in securities issued by an investment company registered under the Investment Company Act of 1940, such investment shall not by itself cause such investment company or such investment company's investment adviser or principal underwriter to be deemed to be a fiduciary or a party in interest as those terms are defined in this title, except insofar as such investment company or its investment adviser or principal underwriter acts in connection with an employee benefit plan covering employees of the investment company, the investment adviser or its principal underwriter. Nothing contained in this subparagraph shall limit the duties imposed on such investment company, investment adviser, or principal underwriter by any other law.
  1. Conference Report
  2. See coverage of this provision on pages 296-297 of the Congressional Conference Report.

  3. Interpretive Bulletinsa
  4. The principles of Section 3(21)(B) are restated in IB 75-3, which also states that if an investment company, its investment adviser or its principal underwriter is a fiduciary or party in interest for a reason other than the investment in the securities of the investment company, such a person remains a fiduciary or party in interest regardless of Section 3(21)(B).

Section 3(38)

"Investment Manager"
The term "investment manager" means any fiduciary (other than a trustee or named fiduciary, as defined in section 402(a)(2)) -
(A) Who has the power to manage, acquire, or dispose of any asset of a plan;
(B) Who is -
(i) Registered as an investment advisor under the Investment Advisers Act of 1940;
(ii) Is a bank, as defined in that Act; or
(iii) Is an insurance company qualified to perform services described in subparagraph (A) under the laws of more than one State; and
(C) Has acknowledged in writing that he is a fiduciary with respect to the plan.
  1. Conference Report
  2. Page 302 of the Congressional Conference Report discusses the term investment manager.

  3. Interpretive Bulletins
    1. A person who is not registered under the Investment Advisers Act of 1940 because of an exemption from registration under that act (and who is not a bank or an insurance company) may not be an investment manager. IB 75-5, Question FR-6.
    2. A person cannot be an investment manager if his or her application for registration under the Investment Advisers Act is still pending. IB 75-5, Question FR-7.
  4. Advisory Opinions
    1. An entity is an investment manager as defined in Section 3(38) of ERISA if it meets the three tests set forth in the statute.
    2. A person can be both a named fiduciary and an investment manager provided that, as named fiduciary, such person does not have the power on behalf of the plan to appoint himself or herself or monitor his or her own performance as investment manager. AO 77-69/70.
    3. A person who is registered only as a broker-dealer under the Securities Exchange Act of 1934 cannot serve as an investment manager. AO 76-20.
  5. Court Decisions
    1. Where an investment management firm had broad powers to manage plan assets, was registered as an investment adviser under the Investment Advisers Act of 1940, and had explicitly acknowledged itself as a fiduciary to the plan in its employment contract, it is considered an investment manager as defined in ERISA, regardless of any oral modifications of the agreement. Lowen v. Tower Asset Management, Inc, 829 F.2d 1209, 8 EBC 2457 (2d Cir. 1987).
    2. Where an investment management company was not registered as an independent adviser under the Investment Advisers Act of 1940, was not a bank or insurance company, and had not acknowledged itself in writing as a fiduciary to the plan, it is not considered an investment manager as defined in ERISA. The trustee of an ESOP may not claim a defense under ERISA Section 405(d)(1). Whitfield v. Cohen, 682 F.Supp. 188, 9 EBC 1739 (S.D.N.Y 1988).

Section 4    Plans Covered

Plans Covered

ERISA Section 4
(a) Except as provided in subsection (b) and in sections 201, 301 and 401, this title shall apply to any employee benefit plan if it is established or maintained:
(1) By any employer engaged in commerce or in any industry or activity affecting commerce; or
(2) By any employee organization or organizations representing employees engaged in commerce or in any industry or activity affecting commerce; or
(3) By both.
(b) The provisions of this title shall not apply to any employee benefit plan if -
(1) Such plan is a governmental plan (as defined in section 3(32));
(2) Such plan is a church plan (as defined in section 3(33)) with respect to which no election has been made under section 410(d) of the Internal Revenue Code of 1954;
(3) Such plan is maintained solely for the purpose of complying with applicable workmen's compensation or unemployment compensation or disability insurance laws;
(4) Such plan is maintained outside of the United States primarily for the benefit of persons substantially all of whom are nonresident aliens; or
(5) Such plan is an excess benefit plan (as defined in section 3(30)) and is unfunded.
  1. Conference Report
  2. These provisions are discussed on pages 255-256 of the Congressional Conference Report.

Section 404   Fiduciary Duties

Section 404(a)(1)
Subject to sections 403(c) and (d), 4042, and 4044, a fiduciary shall discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries and
(A) For the exclusive purpose of:
(i) Providing benefits to participants and their beneficiaries, and
(ii) Defraying reasonable expenses of administering the plan;
(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 character and with like aims;
(C) 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; and
(D) In accordance with the documents and instruments governing the plan insofar as such documents and instruments are consistent with the provisions of this subchapter or subchapter III of this chapter.
  1. Conference Report
  2. All the fiduciary responsibilities imposed by Section 404(a)(1) are discussed at pages 302-305 of the Congressional Conference Report.

  3. Regulations
    1. Plan assets are defined in DOL ERISA Regulation 2510.3-101.
    2. Prudence is covered in DOL ERISA Regulation 2550.404a-1 on "Investment Duties" and the specific coverage of § 404(a)(1)(B), below.
    3. See DOL ERISA Regulation 404c-1, which exempts fiduciaries from certain ERISA liability if plans meet certain conditions and participants direct their own investments.
  4. Interpretive Bulletins
    1. Social Investments ("Economically Targeted Investments") (ETIs). Establishes DOL’s position on permissibility of making investments which achieve a social goal in addition to a financial return. The IB indicates that ETIs are not prohibited by ERISA, and that their choice as an investment must follow DOL ERISA regulation 2550.404a-1 regarding Investment Duties, be prudent, not be a prohibited transaction, and not provide less return to a plan than a normal investment. IB 94-1.
    2. Proxy Voting. Among the fiduciary responsibilities of an investment manager are those to vote proxies for stock owned by ERISA plans. IB 94-2.
    3. Investment Policies. An investment policy designed to further the purposes of a plan and its funding policy is consistent with, but not required by, ERISA 404(a)(1)(A) and (B)IB 94-2.
  5. Advisory Opinions
    1. Pursuant to ERISA Procedure 76-1 and particularly Section 5.02(o), the Department of Labor ordinarily will not issue advisory opinions on ERISA Section 404(a). AO 80-13A.
    2. Service by a bank as trustee of a plan that has a significant portion of its assets invested in employer securities, while the bank is also a substantial secured creditor of the employer, may constitute a violation of Section 404(a)(1) by the bank. AO 76-32.
  6. Court Decisions
    1. [Effective Date] Actions by fiduciaries occurring after 1974 are not insulated from ERISA coverage merely because the roots of such action can be traced to an event prior to the effective date of ERISA. Marshall v. Craft, 463 F. Supp. 493 (N.D.Ga. 1978); Marshall v. Dekeyser, 485 F. Supp. 629, 1 EBC 1898 (W.D.Wis. 1979).
    2. [Exemption Applicability] Exemptions from the prohibited transaction restrictions have no effect on the basic fiduciary responsibility rules of Section 404(a)(1). Marshall v. Dekeyser, 485 F.Supp. 629, 1 EBC 1898 (W.D.Vas. 1979).
    3. [Precedent] Section 404(a)(1) codifies the common law rule that a trustee owes individual loyalty to the beneficiaries. Although trustees should carefully consider all recommendations submitted by the parties who appointed them, trustees are bound to exercise their independent judgment when making decisions in the administration of the trust. Sheet Metal Workers' International Association v. Central Florida Sheetmetal Contractors Association, 234 NLRB (CCH) No. 162 (1978).
    4. [Precedent] ERISA Section 404 essentially codified the strict fiduciary standards that trustees under Section 302 of the Labor-Management Relations Act must meet. The legislative history of ERISA demonstrates that any employee benefit fund trustee is a fiduciary whose duty to the trust beneficiaries must overcome any loyalty to the interest of the plan that appointed him. N.L.R.B. v. Amax Coal Co., 453 U.S. 322,107 L.R.R.M. (BNA) 2769, 91 Lab. Cas. (CCH) Para 12,821, 2 EBC 1489 (1981).
    5. [Bank Stock - Purchase/Retention/Sale of Fiduciary Bank/BHC Stock] The discretionary purchase, retention, or sale of the stock of the fiduciary bank is imprudent. DOL indicates that "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] See 1980 letter from DOL to OCC. Also see AO 88-9 regarding self-directed IRA purchases and AO 88-28 covering self-directed IRA purchases on an initial public offering (IPO) from a mutual-to-stock thrift conversion, and AO 92-23 which permits non-discretionary purchase and retention of holding company stock.
    6. [Exclusive Purpose] The statutory phrase, "solely in the interest" is, at least in part, a codification of the most fundamental duty traditionally owed by a trustee - the duty of loyalty. Accordingly, a fiduciary bears a heavy burden in justifying his conduct in situations where his interests or the interests of others come into conflict with those of plan beneficiaries. Marshall v. Snyder, 430 F. Supp. 1224 (S.D.N.Y. 1977), aff'd in part, rev'd in part, 572 F.2d 894 (2d Cir. 1978).
    7. [Exclusive Purpose] A plan's administrator who is also an officer for the corporate employer, as a fiduciary has a duty to avoid putting himself in a position where he may be forced to compromise his duty of complete loyalty to the plan to act on the employer's behalf. Amato v. Western Union International, Inc., 773 F.2d 1402, 6 EBC 2226 (2d Cir. 1985), cert. dismissed, 474 U.S. 1113 (1986). Contra Ashenbaugh v. Crucible, Inc., 854 F.2d 1516, 9 EBC 2560 (3d Cir. 1988).
    8. [Exclusive Purpose] ERISA Section 404(a)(1) and subsection (a) require a fiduciary to act solely in the interest of the participants and beneficiaries of a plan and for the exclusive purpose of paying plan benefits at a reasonable cost. One who, in his capacity as a trustee, attempts to prevent a trust from suing him for substantial damages cannot reasonably be said to do so solely for the interest or for the exclusive purpose of benefiting others. Iron Workers Local No. 272 v. Bowen, 624 F.2d 1255 (5th Cir. 1980).
    9. [Exclusive Purpose] Preferential effect of trustees' decision alone does not constitute a violation of Section 404(a) of ERISA. Id.
    10. [Exclusive Purpose] Where trustees resolve to extend plan coverage to themselves as trustees and participants in the plan and paid themselves benefits of the plan, such self-dealing conduct was improper and a violation of fiduciary duty under ERISA Section 404(a)(1)(A) and (D). Donovan v. Daugherty, 550 F.Supp. 390, 3 EBC 2079 (S.D.Ala. 1982).
    11. [Exclusive Benefit] An employer that creates a retirement program that encourages early retirement, thereby reducing the workforce at overstaffed facilities, does not violate the exclusive purpose duty because of the consequential benefit of enhanced efficiency to the employer. Trenton v. Scott Paper Co., 832 F.2d 806, 45 Fair Empl. Prac. Case (BNA) 327, 45 Empl. Prac. Dec. (CCH) 137,744, 9 EBC 1075 (3d Cir. 1987), cert. denied, 108 S. Ct. 1576, 9 EBC 1968 (1988).
    12. [Exclusive Benefit] A fiduciary who pays himself a sales commission from plan assets in the sale of plan property despite the lack of any obligation on the part of the plan to pay the commission violates Section 404(a)(1). Marshall v. Kelly, 465 F. Supp. 341, 1 EBC 1850 (W.D.Okla. 1978).
    13. [Exclusive Benefit] Where the sale of ownership of the employer is likely to have an impact on the plan's ability to obtain payment on employer notes held by the plan, which, in turn, is likely to affect the plan's ability to pay benefits under the plan, the plan trustees' duties of loyalty and prudence require them to advise the participants of the full facts concerning the sale. Marshall v. Dekeyser, 485 F. Supp. 629, 1 EBC 1898 (W.D.Wisc. 1979).
    14. [Exclusive Purpose - Arbitrary & Capricious] Because the potential burden of per se personal liability for any violation of ERISA might deter capable persons from serving as trustees of benefit plans, Section 404 of ERISA does not establish a per se rule of fiduciary conduct and a trustee's decision to cancel past service credits will not be overturned unless it is arbitrary and capricious. Fentron Industries, Inc v. Shopmen Pension Fund, 674 F.2d 1300, 34 Fed. R. Serv.2d 281, 94 Lab. Cas. (CCH) Para 113,559, 3 EBC 1323 (9th Cir. 1982).
    15. [Exclusive Purpose - Arbitrary & Capricious] In reviewing the propriety of trustees' action, the judicial standard is whether the trustees acted in an arbitrary and capricious manner or abused their discretion. Robinson v. Central States Pension Fund, 572 F.2d 1208 (8th Cir. 1978). To the same effect: see Robinson v. United Mine Workers, 449 F. Supp. 941 (D.D.C. 1978); Shaw v. Kruidenier, 620 F.2d 307 (8th Cir. 1980); Mosley v. The National Maritime Union Pension and Welfare Plan, 451 F. Supp. 226 (E.D.N.Y. 1978); Taylor v. Bakery and Confectionery Welfare Fund, 455 F. Supp. 816 (E.D.N.C. 1978); Peters v. Operating Engineers Pension Fund, No. CV 76-3747-FW, slip op. (D.C.Cal., April 14, 1979); Bayles v. Central States Pension Fund, 602 F.2d 97 (5th Cir. 1979); Vaughn v. Metal Lathers Local 46 Pension Fund, No. 78 Civ. 2170 (S.D.N.Y. June 14, 1979). To the contrary, see Winpisinger v. Aurora Corporation Illinois, 456 F. Supp. 559 (N.D. Ohio 1978) (standard for judicial review is whether trustees complied with their ERISA fiduciary responsibilities). See also Pierce v. NECA-IBEW Welfare Trust Fund, 488 F. Supp. 559 (E.D.Tenn. 1978), aff'd, 620 F.2d 589 (6th Cir.), cert. denied, 449 U.S. 1015 (1980).
    16. [ESOP] While an ESOP fiduciary may be released from certain per se violations on investments in employer securities under the provisions of ERISA Sections 406 and 407, the structure of ERISA itself requires that in making an investment decision of whether or not a plan's assets should be invested in employer securities, an ESOP fiduciary, just as fiduciaries of other plans, is governed by the solely-in-the-interest and prudence tests of Sections 404(a)(1)(A) and (B). Eaves v. Penn, 587 F.2d 453 (10th Cir. 1978).
    17. [ESOP] Trustee's failure to conform stock ownership plan to Treasury requirements applicable to ESOPs in effect at the time of plaintiff's termination was not a breach of fiduciary duty under Section 404(a)(1) of ERISA for which a beneficiary may sue when defendant's stock ownership plan never functioned as an ESOP within the meaning of ERISA regulations. Allen v. The Katz Agency, Inc. Employee Stock Ownership Plan, 677 F.2d 193, 3 EBC 1352 (2d Cir. 1982).
    18. [Plan Management] Corporate shareholders and directors, who are also pension plan investment managers and custodians violated their fiduciary duties when they refused to attend meetings of the shareholders, board of directors and trustees, thereby preventing any action in favor of the plan while also opposing the sale of shares of preferred hospital stock to the plan. Schoenholtz v. Doniger, 628 F. Supp. 1420, 7 EBC 1501 (S. D. N. Y. 1986).
    19. [Plan Management] An insurance company that possesses the ultimate responsibility to grant or deny claims is a fiduciary under ERISA and must comply with the fiduciary duties enumerated in Section 404. Wickman v. Northwestern National Life Insurance, 9 EBC 1482 (D. Mass. 1987).
    20. [Plan Management] An operator of a corporation's pension plan, who is also controlling the corporation in receivership, does not violate any fiduciary duties by amending the plan, freezing the accrual of benefits, returning excess funds to the corporation, and terminating the plan in accordance with the state court's appointment order and ERISA. Chait v. Bernstein, 645 F. Supp. 1092, 8 EBC 1126 (D.N.J. 1986), aff'd, 835 F.2d 1017, 9 EBC 1257 (3d Cir. 1987).
    21. [Contributions] Corporate president violated his fiduciary duties when he failed to forward employer contributions and employee contributions, although they were deducted from employee paychecks; failed to notify employees that contributions had not been forwarded; allocated the monies to corporate expenses; and assumed conflicting roles of fiduciary and an officer of a struggling corporation. PBGC v. Solmsen, 671 F. Supp. 938, 9 EBC 1391 (E.D.N.Y 1987).
    22. [Loans] Where trustees did not hold the local's proposal for a "loan at arm's length and compare it to other available investments, but instead did their best to accommodate" the local's needs, they violated ERISA Section 404(a)(1)(A)(i). Davidson v. Cook, 567 F. Supp. 225, 4 EBC 1816 (E. D. Va. 1983).
    23. [Loans] A trustee breaches its fiduciary obligations by (1) making loans of plan assets under terms more favorable to the debtor than the plan and then not collecting the balance due; (2) allowing loans of plan assets to a debtor with an unproven business record and unstable financial condition; (3) lending an unreasonably large portion of loan assets to one entity and then concealing the existence of such loans; and (4) failing to adhere to guidelines in plan requiring that loans be at a reasonable rate of interest with adequate collateral. Brock v. Gilliken, 677 F. Supp. 398, 9 EBC 1803 (E.D.N.C. 1987).
    24. [Loans] A fiduciary who makes or renews loans of plan assets based on inadequate security and at a lower interest rate than contemporaneous loans to others, and who fails to pursue timely repayment of principal and interest and to enforce the security agreement violates Section 404(a)(1). Marshall v. Kelly, 465 F. Supp. 341, 1 EBC 1850 (W.D.Okla. 1978); Marshall v. Dekeyser, 485 F. Supp. 629, 1 EBC 1898 (W.D.Wis. 1979).
    25. [Loans/Leases] Pension fund trustees do not breach their fiduciary duties when they approve the construction of an office building after seeking advice from three legal firms, professional engineers, architects, appraisers, contractors and, in addition, eliminate certain aspects or demand cheaper designs when the project appears over budget. Furthermore, a lease agreement with a union that contains certain favorable terms for the union, while also benefiting the plan participants and beneficiaries, does not make the transaction imprudent when the trustees' decisions are calculated to benefit the fund members. Donovan v. Walton, 609 F.Supp. 1221, 6 EBC 1677 (S.D.Fla. 1985), aff'd, Brock v. Walton 794 F.2d 586, 7 EBC 1769, reh'g denied, 802 F.2d 1399 (11th Cir. 1986).
    26. [Mergers & Acquisitions] A corporation which, through its pension board, acts as a fiduciary for the employee pension plan, does not breach its fiduciary duties when a purchase agreement selling a division of the company provides for the transfer of all assets, properly allocable under ERISA, to the trustees of the successor corporation's pension plan, provided the sale was not to avoid any unfunded pension obligations. United Steelworkers 2116 v. Cyclops Corp., 653 F. Supp. 574, 8 EBC 1194 (S.D.Ohio 1987), aff'd in part, vacated in part, 860 F.2d 189, 10 EBC 1345 (6th Cir. 1988).
    27. [Mergers & Acquisitions] Pension plan fiduciary, who liquidated stock of one corporation to buy shares of another corporation to further his own corporate expansion goal without any effort to seek independent analysis to examine further investment opportunities, does not satisfy the prudent person test. Sandoval v. Simmons, 622 F.2d Supp. 1174, 6 EBC 2161 (C.D.Ill. 1985).
    28. [Service in Dual Capacities: Lender and Plan Trustee] Prior to naming a bank as plan trustee, an ERISA plan had invested $796,000 in unsecured notes issued by Supreme Finance (Supreme), a used car finance company. During this time, the bank had extended a $3 million secured line of credit to Supreme. After being named trustee, the bank refused to renew its line of credit because of Supreme's financial difficulties. At the same time, the bank gave notice of resignation as trustee. Supreme subsequently filed for bankruptcy and the only assets remaining were applied to the bank's loan. The federal district court found, and was upheld on appeal, that:
      1. The bank's acceptance of the trusteeship did not violate ERISA because -
        1. nowhere does ERISA explicitly prohibit a trustee from holding positions of dual loyalties, and
        2. the act did not cause the plan's losses.
      2. The bank's decision not to renew Supreme's line of credit did not violate ERISA. The court noted that a fiduciary serving in both corporate and fiduciary capacities may make decisions in its own benefit without violating its fiduciary duty to the plan.
      3. (Friend v. Sanwa Bank California, CA 9, No. 92-55641, 9-13-94).

    29. [Summary Plan Disclosure] ERISA Section 404(a)(1) imposes a duty to provide employees with a comprehensive explanation of the plan. However, it does not impose an affirmative duty to alert an individual participant as to the vesting requirements of the plan once that individual notifies fiduciaries that he was "thinking of retirement." Schlomchik v. Retirement Plan of Amalgamated Insurance Fund, 502 F. Supp. 240 (E.D.Pa. 1980), aff'd, 671 F.2d 496 (3d Cir. 1981).
Section 404(a)(1)(A)
Subject to sections 403(c) and (d), 4042, and 4044, a fiduciary shall discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries and
(A) For the exclusive purpose of-
(i) Providing benefits to participants and their beneficiaries; and
(ii) Defraying reasonable expenses of administering the plan.
  1. Interpretive Bulletins
    1. A vacation plan may pay all or any portion of the benefits to which a plan participant or beneficiary is entitled to a third party without violating Section 404(a)(1)(A) if (a) the plan documents expressly provide for such payments to third parties at the direction of a participant or beneficiary, (b) the participant or beneficiary directs in writing that the plan trustees pay a named third party all or a specified portion of the sum of money that would otherwise be paid to the participant or beneficiary, and (c) payment is made to the third party only when or after the money would otherwise be payable to the participant or beneficiary. IB 78-1.
    2. Social Investments ("Economically Targeted Investments") (ETIs) Establishes DOL position on permissibility of making investments which achieve a social goal in addition to a financial return. Indicates that ETIs are not prohibited by ERISA, and that their choice as an investment must follow DOL ERISA regulation 2550.404a-1 regarding Investment Duties, be prudent, not be a prohibited transaction, and not provide less return to a plan than a normal investment. IB 94-1.
    3. Proxy Voting. Among the fiduciary responsibilities of an investment manager are those to vote proxies for stock owned by ERISA plans. IB 94-2.
    4. Investment Policies. An investment policy designed to further the purposes of a plan and its funding policy is consistent with, but not required by, ERISA 404(a)(1)(A) and (B)IB 94-2.
  2. Advisory Opinions
    1. Payments by a plan for services rendered by a person prohibited from being employed in any capacity by the plan may violate Section 404(a)(1)(A). AO 75-90.
    2. If a participant or beneficiary in Plan A refuses to repay an erroneous overpayment of benefits to Plan A, the fiduciaries of Plan B, a related plan, would fail to be acting solely in the interests of the plan's participants and beneficiaries if they attempted to penalize the participant or beneficiary by delaying or reducing benefits under Plan B. AO 77-07.
    3. A plan provision authorizing reimbursement of legal fees in the event of any legal action that may arise from the performance of a trustee's fiduciary duties is too broad and would be prohibited under Section 404(a)(1)(A). Where a fiduciary is found in a legal proceeding to have violated his fiduciary duties, reimbursement of legal fees by the plan would not be permitted. AO 78-29.
  3. Court Decisions
    1. [Provide Benefits] Dividing pension benefits, once they are being paid out, between a participant and his divorced spouse does not violate Section 404(a)(1)(A). Campa v. Campa, 89 Cal. App.3d 113C (1st Dist. 1979), appeal dismissed, Carpenters Pension Trust Fund for Northern California v. Campa, 444 U. S. 1028 (1980).
    2. [Provide Benefits] The payment of rent on behalf of the widow of a former plan trustee constitutes a violation of Section 404(a)(1)(A) even though the payment was morally commendable and not made for the personal gain of plan fiduciaries. Marshall v. Cuevas, I EBC 1580 (D.P.R. 1979).
    3. [Provide Benefits] Where a plan participant has nonforfeitable vested pension rights under the plan, the plan administrative committee's denial of those rights; based on a retroactive plan amendment adopted by the plan sponsor violated the administrative committee's fiduciary duty to pay benefits when due. Fox v. Abrams, No. CV 77-881-ALS, slip op. (C.D.Cal. 1978).
    4. [Exclusive Purpose] Plan monies, even if they constitute surplus assets, must be applied for the exclusive purpose of plan participants and beneficiaries. Marshall v. Snyder, 430 IF. Supp. 1224 (S.D.N.Y. 1977), aff'd in part, rev'd in part, 572 F.2d 894 (2d Cir. 197abbre8).
    5. [Exclusive Purpose] Where a plan trustee fails to keep adequate records of the plan's financial obligations, questions of whether the plan owes money to the trustee should be resolved in favor of the plan. Marshall v. Kelly, 465 F. Supp. 341, 1 EBC 1850 (W.D.Okla. 1978).
    6. [Exclusive Purpose] Lease by a plan of an aircraft unnecessary for plan operation violates Section 404(a)(1). Usery v. Wilson, 3-76-373 (E.D.Tenn. 1977) (consent order).
    7. [Exclusive Purpose] Purchase by a multiemployer plan of individual automobile insurance policies for plan trustees and employees violates Section 404(a)(1)(A). Usery v. Wilson, 3-76-373 (E.D.Tenn. 1977) (consent order).
    8. [Reasonable Expenses] Payments of in excess of $1 million over a two and one-half year period by a multiemployer plan to an individual for administrative services constitutes excessive compensation in violation of Section 404(a)(1)(A). Marshall v. Snyder, 430 F. Supp. 1224 (S.D.N.Y. 1977), aff'd in part, 572 F.2d 894 (2d Cir. 1978). To the same effect, see Marshall v. Knee, No. C-3-7793 (S.D.Ohio 1977) (complaint).
    9. [Reasonable Expenses] A fiduciary who causes a plan to pay excessive amounts for the construction of a building on plan property violates Section 404(a)(1)(A). Marshall v. Kelly, 465 F. Supp. 341, 1 EBC 1850 (W.D.Okla. 1978).
Section 404(a)(1)(B)

"Prudent Man Rule"
Subject to sections 403(c) and (d), 4042, and 4044, a fiduciary shall discharge his 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 man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character with like aims.
  1. Statute
  2. Investments in collectibles are generally prohibited by Section 408(m) of the Internal Revenue Code and PTE 91-55.

  3. Regulations
    1. Refer to DOL ERISA Regulation 2550.404a-1.
      1. The regulation sets forth guidelines for plan fiduciaries for compliance with the prudence requirement in connection with their investment duties.
      2. As a general rule, a fiduciary, in connection with his or her investment duties, is required to give appropriate consideration to those facts and circumstances that, given the scope of such fiduciary's investment duties, the fiduciary knows or should know are relevant to the particular investment or investment course of action involved. This includes consideration of the role an investment is intended to play in the plan's investment portfolio for which the fiduciary has investment duties.
      3. The regulations also set forth a safe harbor rule. If a fiduciary complies with the safe harbor rule, the Labor Department will presume that the fiduciary has complied with the prudence requirement.

      The safe harbor rule requires a fiduciary in connection with any particular investment or investment course of action -

      1. To determine that the investment is reasonably designed as part of the portfolio (or the portion of the plan's portfolio) for which the fiduciary has investment duties) to further the purposes of the plan, taking into account the investment's risk of loss and opportunity for gain; and
      2. To consider the portfolio's (or portion of the portfolio's) -
      1. Diversification,
      2. Liquidity and current return relative to plan cash flow, needs, and
      3. Projected return relative to plan funding requirements.
    2. For a definition of plan assets, see DOL ERISA Regulation 2510.3-101.
    3. See DOL ERISA Regulation 404c-1, which exempts fiduciaries from certain ERISA liability, including the duty to monitor for prudence, if plans meet certain conditions and participants direct their own investments.
  4. Interpretive Bulletins
    1. A plan fiduciary responsible for appointing trustees or other plan fiduciaries should periodically review the performance of such trustees or other fiduciaries. The procedure for review may vary according to the circumstances. IB 75-8, Question FR-17.
    2. Plan fiduciaries may rely on information and data supplied by non-fiduciaries in discharging their fiduciary duties. IB 75-8, Question FR-11.
    3. Social Investments ("Economically Targeted Investments") (ETIs) Establishes DOL position on permissibility of making investments which achieve a social goal in addition to a financial return. Indicates that ETIs are not prohibited by ERISA, and that their choice as an investment must follow DOL ERISA regulation 2550.404a-1 regarding Investment Duties, be prudent, not be a prohibited transaction, and not provide less return to a plan than a normal investment. IB 94-1.
    4. Proxy Voting. Among the fiduciary responsibilities of an investment manager are those to vote proxies for stock owned by ERISA plans. IB 94-2.
    5. Investment Policies. An investment policy designed to further the purposes of a plan and its funding policy is consistent with, but not required by, ERISA 404(a)(1)(A) and (B)IB 94-2.
  5. Advisory Opinions
    1. [General] Section 404(a)(1)(B) does not absolutely prohibit any general type of investment. Whether an investment is prudent depends on the nature of the investment and the character and aims of the plan. AO 75-83.
    2. [Bank Stock - Purchase/Retention/Sale of Fiduciary Bank/BHC Stock]: The discretionary purchase, retention, or sale of the stock of the fiduciary bank is imprudent. DOL indicates that "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] See 1980 letter from DOL to OCC. Also see AO 88-9 regarding self-directed IRA purchases and AO 88-28 covering self-directed IRA purchases on an initial public offering (IPO) from a mutual-to-stock thrift conversion, and AO 92-23 which permits non-discretionary purchase and retention of holding company stock.
    3. [Mortgage Valuations] Plan fiduciaries will be acting prudently under Section 404(a)(1)(B) if they value plan assets consisting of real estate mortgage loans that the plan has no current intention of selling and that are not financially troubled at the remaining principal balance of the loan. Financially troubled loans should be valued on the basis of any guarantees, security or other factors that a prudent person would deem relevant. AO 77-78; AO 77-81.
    4. [DOL Investigations] Where the Labor Department is already conducting an investigation of plan investments, the new investment managers for the plan will be acting prudently under Section 404(a)(1)(B) if they report any breaches of fiduciary duties by others of which they become aware to the plan trustees and to the Labor Department and make available to the Labor Department all information requested about past transactions. AO 77-60/61; AO 77-79/80.
  6. Court Decisions
    1. [General] ERISA's prudence test is not that of a prudent lay person but, rather, that of a prudent fiduciary with experience dealing with a similar enterprise. Marshall v. Snyder 430 F. Supp. 1224 (S.D.N.Y. 1977), aff'd in part, rev'd in part, 572 F.2d 894 (2d Cir. 1978).
    2. [General] Plan trustees violate their fiduciary obligations if they act arbitrarily or capriciously in light of all of the surrounding circumstances. Reviewing courts are hesitant to second guess the trustees' decisions and will do so only if there is no reasonable justification for the decision. Stewart v. National Shopmen Pension Fund, 795 F.2d 1079, 7 EBC 1917 (D.C.Cir. 1986).
    3. [General] Fiduciaries are not relieved of their fiduciary responsibilities by their lack of involvement in a particular transaction. By failing to monitor the conduct of other trustees, a trustee may violate Section 404(a)(1)(B) and be held liable under Section 405(a)(2). Marshall v. Dekeyser 485 F, Supp. 629, 1 EBC 1898 (W.D.Wisc. 1979).
    4. [General] The prudent person standard found in Section 404 is violated if a trustee who lacks the requisite education, experience and skill to make investment decisions fails to consult independent counsel prior to the making of such decisions. Donovan v. Walton, 609 F. Supp. EM, 6 EBC 1677 (S.D.Fla. 1985), aff'd, Brock c Walton 794 F.2d 586, 7 EBC 1769, reh'g denied, 802 F.2d 1399 (11th Cir. 1986).
    5. [Plan Management] Failure by trustees of a multiemployer plan to maintain full and complete minutes of trustees meetings constitutes a violation of Section 404(a)(1)(B). Usery v. Wilson, et al., No. 3-76-373 (E.D.Tenn., June 6, 1977) (consent order).
    6. [Plan Management] Implicit in ERISA's standard for fiduciary responsibility set forth under Section 404 is fiduciaries' duty to take an initiative to cause reasonably available evidence to be developed and considered in the decision making process. An employer and underwriter breached the duly to develop such evidence by relying upon erroneous, incomplete and sometimes irrelevant information in denying claims and thereby rendered their decisions in an arbitrary and capricious manner. Rosen v. Hotel and Restaurant Employees Union, 637 F.2d 592, 106 L.R.R.M. (BNA) 2745, 90 Lab. Cas. (CCH) Para 912,612, 2 EBC 1054 (3d Cir.), cert. denied, 454 U.S. 898 (1981).
    7. [Arbitrary/Capricious Actions] Pension fiduciaries breach fiduciary duty when they act arbitrarily and capriciously or act with improper discriminatory or bad faith motives. Chambless v. Masters, Mates and Pilots Pension Plan, 571 F. Supp. 1430 (S.D.N.Y. 1983).
    8. [Arbitrary/Capricious Actions] Trustees violated the prudent man standard when they failed to adequately investigate the basis and justification for the payment of over $10 million to a claims processing company as fees for services over a two year period, notwithstanding the court's subsequent finding that the fees were reasonable. Brock v. Robbins 830 F.2d 640, 8 EBC 2489 (7th Cir. 1987).
    9. [ESOP] While an ESOP fiduciary may be released from certain per se violations on investments in employer securities under the provisions of Sections 406 and 407 of ERISA, the structure of ERISA itself requires that in making an investment decision of whether or not a plan's assets should be invested in employer securities, an ESOP fiduciary, just as fiduciaries of other plans, is governed by the solely-in-the-interest and prudence tests of Sections 404(a)(1)(A) and (B). Eaves v. Penn, 587 F.2d 453 (10th Cir. 1978).
    10. [ESOP] United Missouri Bank won a case where it continued to purchase a distressed company's stock for an ESOP, relying on an independent appraiser's valuation. The 10th Circuit Court of Appeals ruled that the bank (1) followed "proper" directions from the ESOP administrator, (2) paid no more than "appropriate consideration" by relying on the appraisals, (3) retained the stock appropriately because it was restricted by the ESOP agreement and to do so "would have run counter to the intended purpose of [the] ESOP," and (4) maintained an effective Chinese Wall within the bank to prevent transmittal of material inside information from the commercial lending to the trust investment areas. Ershick v. United Missouri Bank of Kansas City, N.A., 948 F.2d 660 (10th Cir. 1991).
    11. [ESOP] A Washington bank was found liable for following a similar procedure in Fink v. National Savings & Trust Co., 772 F.2d 951 (D.C. Cir. 1985). The court found the ERISA fiduciary duty of prudence overrides the provisions of plan, such as in ESOPs, which are designed to invest in employer stock.
    12. [ESOP] Banc One Arizona settled for $19 million (plus a $1.15 million DOL penalty) involving the Kroy, Inc., ESOP covering 400 employees. Kroy eventually declared bankruptcy. Banc One continued purchasing stock until Kroy declared bankruptcy. Banc One was criticized for apparently paying too much for the stock. The primary issue of the case dealt with ERISA Section 3(18)(B) regarding "adequate consideration."
    13. [ESOP] The Statewide Bancorp ESOP directed the Plan Committee (who were also directors) to invest "primarily" in Statewide stock. The Committee continued to purchase Statewide stock even as its stock price fell to less than 25 cents a share. Eventually, all remaining assets were placed in money market accounts. Statewide declared bankruptcy. The 3rd Circuit Court of Appeals found that the purchase of Statewide stock was permissive, not mandatory. The court held that two standards apply:
      • If the plan requires investment in employer securities, the trustee must comply unless "compliance would be impossible or illegal" or a court approves a deviation.
      • If investment language is permissive, "the fiduciary must still exercise care, skill, and caution in making decisions to acquire or retain the investment." In such permissive situations, the fiduciary is presumed to have complied with ERISA in purchasing employer securities unless the facts and circumstances would defeat or substantially impair the purposes of the trust. If trustees are also directors or officers of the employer, they must show that they acted impartially in investigating available investment alternatives - particularly if the employer is experiencing financial difficulty.

      The court evaluated the reasonableness of the trustees' actions under the standard set by the U.S. Supreme Court, in the Firestone Tire and Rubber Co. v. Bruch, 489 U.S. 101 (1989) case. Reasonableness is judged by whether:

      • the interpretation is consistent with the goals of the plan;
      • it renders any plan language meaningless or internally inconsistent;
      • it conflicts with the substantive or procedural requirements of ERISA law;
      • the provision has been interpreted consistently; and
      • the interpretation is contrary to the clear language of the plan.

      Moench v. Robertson, 62 F.3d 553 (3d Cir. 1995).

    14. [Investments] Purchase of stock in a financially unstable corporation constitutes a violation of Section 404(a)(1)(B). Usery v. Wilson, et al, No. 3-76-373 (E.D.Tenn., June 6, 1977) (consent order).
    15. [Loans] Evidence that mortgage loans were made at interest rates below the prevailing market rate is insufficient to establish a violation of the prudent investor rule established in ERISA Section 404(a)(1)(A) and (B) where pension fund trustees, in developing a plan participant mortgage loan program, consulted with experts, including accountants and mortgage brokers; examined and considered rates charged on traditional and nontraditional mortgage loans; examined the prospective borrower's employment background; required that the loan be adequately secured; and thereafter set highest rates that not only generated a higher rate of return than any other portfolio asset but exceeded the fund's actuarial and funding requirements. Brock v. Walton, 794 F.2d 586, 7 EBC 1769 (11th Cir.), reh'g denied, 802 F.2d 1399 (11th Cir. 1986) (en banc).
    16. [Loans] Trustees making loans violated the prudence test under ERISA Section 404(a)(1)(B) by failing to properly appraise the proposed building, investigate the borrower's financial resources, evaluate the likely rental income to be derived from the building, take an assignment of rents, require sureties on the loan and require a principal repayment schedule. Davidson v. Cook, 567 F. Supp. 225, 4 EBC 1816 (E.D.Va. 1983), aff'd, 734 F.2d 10 (4th Cir.), cert. denied, 469 U.S. 899 (1984).
    17. [Loans] Where independent investigation based on financial statements would have disclosed imprudence of making loans and where trustees failed to seek outside counsel when "under the circumstances then prevailing ... a prudent man acting in a like capacity and familiar with such matters" would have sought outside counsel, ERISA, Section 404(a)(1)(B) is violated. A trustee's duty to make an independent investigation includes the obligation of not relying on representations, predictions, and hopes of a borrower. Katsaros v. Cody, 503 F. Supp. 360, 4 EBC 1910 (E.D.N.Y 1983).
    18. [Loans] Even assuming the real estate attorney for the pension fund was a fiduciary, the opening bid of $5 million where the property was allegedly worth less, was not a breach of fiduciary duty of care under Section 404 of ERISA when the bid was made in the context of a foreclosure sale, the final judgment against the debtor was $9,615,422.26, and an unrealistically low bid might have precluded a deficiency judgment. Furthermore, although attorney was not instructed to establish $100,000 bid increments, such action was not imprudent where he was instructed to continue bidding the price upwards to $7 million. Donovan v. Nellis, 528 F. Supp. 538, 33 Fed. Rul. Serv. 2d (Cahaghan) 1742, 2 EBC 2209 (N.D.Fla. 1980.
    19. [Loans - Employer] Where plan trustees make loans to employers that lack any security and are at interest rates below those that an arm's length lender would accept under the circumstances the trustees have violated Section 404(a)(1)(B). Marshall v. Dekeyser; 485 F. Supp. 629, 1 EBC 1898 (W.D.Wis. 1979).
    20. [Mergers & Acquisitions] In a contest for corporate control where potential conflicts of interest between plan administrators and beneficiaries existed, administrators who did not conduct independent, "intensive and scrupulous" investigation of plan's investment options violated ERISA Section 404. Leigh v. Engle, 727 F.2d 113, 4 EBC 2702 (7th Cir. 1984).
    21. [Mergers & Acquisitions] Trustees breached ERISA's exclusive purpose and prudent man rules Section 404(a)(1)(A) and (B), by agreeing to the sale of employer securities to the employer's pension plan as part of alleged attempt to maintain corporate control without conducting any investigation as to the proposed transaction. Dimond v. Retirement Plan, 582 F. Supp. 892, 4 EBC 1457 (W.D.Pa. 1983).
    22. [Mergers & Acquisitions] Where sale of ownership of the employer is likely to have an impact on the plan's ability to obtain payment on employer notes held by the plan, which, in turn, is likely to affect the plan's ability to pay benefits under the plan, the plan trustees' duties of loyalty and prudence require them to advise the participants of the full facts concerning the sale. Marshall v. Dekeyser, 485 F. Supp. 629, 1 EBC 1898 (W.D.Wis. 1979).
    23. [Payments, Excessive] Payment of an excessive amount of rent by a plan for the lease of an aircraft violates Section 404(a)(1)(B). Usery v. Wilson, et al., No. 3-76-373 (E. D.Tenn., June 6, 1977) (consent order).
    24. [Payments, Excessive] Trustees of an employee welfare plan breached fiduciary duties when they improperly overpaid a law firm $292,800 for legal services rendered to members of the plan. Law firm that knowingly receives excessive payments from trustees of a plan is held accountable for the breaches committed by the trustees and jointly liable for be overpayment. Benvenuto v. Schneider, 678 F. Supp. 51, 9 EBC 1528 (E.D.N.Y. 1988).
    25. [Recordkeeping] A company was delegated by a bank trustee or custodian for self-directed IRA accounts the function of maintaining records and preparing appropriate reports required by Section 103 of ERISA. A company maintaining records necessary for the preparation of such reports is a plan fiduciary and must perform these functions with the degree of care set forth in Section 404(a)(1)(B). Redwood Bank v. QTA, Inc., No. C-79-1586, slip op. (N.D.Cal., Oct. 23, 1979).
    26. [Self-Dealing] Purchase of automobile insurance covering plan trustees and employees, but which does not protect the plan, constitutes a violation of Section 404(a)(1)(B). Usery v. Wilson, et al., No. 3-76-373 (E.D.Tenn., June 6, 1977) (consent order).
Section 404(a)(1)(C)
Subject to sections 403(c) and (d), 4042, and 4044, a fiduciary shall 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.
  1. Advisory Opinions
    1. [Deposits - Insured/Uninsured] The diversification requirement of Section 404(a)(1)(C) generally will not be violated if all plan assets in an individual account plan are invested in a federally insured savings account, so long as the account is fully insured. Where the account balance exceeds the amount covered by federal insurance, compliance with Section 404(a)(1)(C) is determined by whether the bank invests its assets in a diversified manner. AO 77-46.
    2. [Collective Investment Funds] An investment by an ERISA plan in a single collective investment pool may be deemed to be a properly diversified investment if the pool is itself diversified. In this case, each of the investments of the collective trust is deemed to be an investment of the plan. AO 80-13A.
    3. [Mutual funds/Annuities] A plan may invest all of its assets in insurance or annuity contracts (AO 75-79) or a mutual fund (AO 75-93) without violating Section 404(a)(1)(C) dealing with diversification.
    4. [Real Estate] Where the assets of a plan consist largely of real estate mortgage loans, the new investment managers of the plan will not violate the diversification requirements of Section 404(a)(1)(C) if they follow a policy whereby decisions to retain or dispose of individual loans and properties will be made on the basis of economic and prudent management generally and not on a basis that requires diversification of plan assets in situations in which the principles of economic and prudent management would indicate that such loans and properties should be retained. AO 77-62/63.
    5. [REIT] Proper diversification for plan assets invested in a real estate investment trust (REIT) is determined by considering the assets held by the REIT. AO 78-30.
  2. Court Decisions
    1. [General] Section 404 of ERISA requires that fiduciaries conduct their activities as would a prudent man under similar circumstances. While there is flexibility in the prudence standard, it is not a refuge for fiduciaries who are not equipped to evaluate a complex investment. Glass/Metal Association and Glaziers and Glass Workers Pension Plan, 507 F. Supp. 378, 2 EBC 1006 (D.Hawaii 1980).
    2. [General] Where plan trustees, lacking prior lending experience, fail to follow the procedure that a prudent lender would utilize by failing to consider other real estate investment vehicles that offered greater opportunity for diversification, and by committing plan assets without adequate procedures for evaluation of a risk, the plan trustees violated their duty to act with care, skill, prudence and diligence as required under Section 404(a)(1)(B) of ERISA. Glass/Metal Association and Glaziers and Glass Workers Pension Plan, 507 F. Supp. 378, 2 EBC 1006 (D.Hawaii 1980).
    3. [General] In contrast to traditional trust law, both Congress and the courts have recognized that the diversification requirement of ERISA Section 404(a)(1)(C) imposes a separate duty on plan fiduciaries to spread the risk of loss of the plan. Therefore, if consummated, a commitment of 23% of the pension plan's total assets to a single loan would subject a disproportionate amount of the pension trust's assets to the risk of a large loss and violate the diversification requirement. Glass/Metal Association and Glaziers and Glass Workers Pension Plan, 507 F. Supp. 378, 2 EBC 1006 (D.Hawaii 1980).
    4. [Loans] A loan of 36% of plan assets to finance the expansion of a hotel and gambling casino violates Section 404(a)(1)(C). Marshall v. Teamsters Local 282 Pension Trust Fund, 458 F. Supp. 986 (E.D.N.Y. 1978).
    5. [Loans - Employers] The investment of virtually all of a plan's assets in loans to employers, on its face, represents a complete failure to diversify the investments of the plan so as to minimize the risk of large losses required by Section 404(a)(1)(C). Once a plaintiff proves failure to diversify, the burden shifts to the defendant to demonstrate that nondiversification was prudent under the circumstances. Marshall v. Dekeyser, 485 F. Supp. 629, 1 EBC 1898 (W.D.Wis. 1979).
    6. [Loans] Where trustees failed to collect what defendants owed the pension trust, renewed unfavorable loans and failed to diversity holdings, they violated Section 404(a)(1)(B) and (C). Donovan v. Schmoutey, 592 F. Supp. 1361 (D.Nev. 1984).
    7. [Market Valuation] Pension plan service company that fails to revalue the market value of properties to determine a fair rental value to the lessee, the plan's sponsor, and also fails to advise trustees that the plan assets should be diversified and not concentrated in the buildings leased to the plan's sponsor, breaches its fiduciary duties under ERISA. Brock v. Self, 632 F. Supp. 1509, 7 EBC 1512 (W. D. La. 1986).
Section 404(a)(1)(D)
Subject to sections 403(c) and (d), 4042, and 4044, a fiduciary shall discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries and In accordance with the documents and instruments governing the plan insofar as such documents and instruments are consistent with the provisions of this subchapter or subchapter III of this chapter.
  1. Interpretive Bulletins
    1. A vacation plan may pay all or any portion of the benefits to which a plan participant or beneficiary is entitled to a different party without violating Section 404(a)(1)(D) if (a) the plan documents expressly provide for such payments to third parties at the direction of a participant or beneficiary, (b) the participant or beneficiary directs in writing that the plan trustees pay a named third party all or a specified portion of the sum of money that would otherwise be paid to the participant or beneficiary and (c) payment is made to the third party only when or after the money would otherwise be payable to the participant or beneficiary. IB 78-1.
    2. Investment Policies. An investment policy designed to further the purposes of a plan and its funding policy is consistent with, but not required by, ERISA 404(a)(1)(A) and (B). If one exists, it is considered one of the "documents and instruments governing the plan", and must be followed. IB 94-2.
  2. Advisory Opinions
    1. Within the mandate of Section 404(a)(1)(D) is the rule that plan trustees and fiduciaries must administer the plan in accordance with clear and unambiguous provisions of the plan document and the law. The fact that policy reasons mandate a change in the plan provisions is relevant to a judicial review of the validity of the plan change, but such conditions are not relevant in the interpretation and implementation of such rule. Where, in this case, the plan's rules were clear and unambiguous and were upheld by the courts as valid, the trustees must enforce them as so written. AO 82-IA.
    2. Whether the trustees can accept contributions from employers for certain specific individuals or classes thereof and/or make benefit payments to such individuals is a matter to be determined by the plan document. Section 404(a)(1)(D) requires that the plan be administered in accordance with the plan document to the extent that the plan document is in accordance with the law. AO 81-30A.
  3. Court Decisions
    1. A limitation in the plan instruments on the authority of the trustees to invest plan assets, which is not inconsistent with any provisions of ERISA, is binding on the trustees under Section 404(a)(1)(D). Marshall v. Teamsters Local 282 Pension Trust Fund, 458 F. Supp. 986 (E.D.N.Y. 1978).
    2. Where plan document provided that administrative committee member having interest in transaction shall not participate in transaction and fiduciary acted contrary to plan terms, there was a violation of ERISA Section 404(a)(1)(D). Donovan v. Cunningham, 716 F.2d 1455, 4 EBC 2329 (5th Cir. 1983), cert. denied, 467 U.S. 1251 (1984).
    3. Payment of compensation to plan trustees without express authorization in plan instruments violates Section 404(a)(1)(D). Usery v. Wilson, et al., No. 3-76-373 (E.D.Tenn., June 6, 1977) (consent order).
    4. Payment of benefits to ineligible persons violates Section 404(a)(1)(D). Usery v. Wilson, et al., No. 3-76-373 (E.D.Tenn., June 6, 1977) (consent order).
    5. A trustee's failure to declare his own forfeiture of benefits under a plan by reason of his violation of a 'bad boy' clause does not constitute a breach of fiduciary duty. Fremont v. McGraw-Edison Company, 460 F. Supp. 599 (N.D.Ill. 1978), aff'd in part, rev'd in part, 606 F.2d 752 (7th Cir. 1979), cert. denied, 445 U.S. 951 (1980).
    6. Dividing pension benefits, once they are being paid out, between a participant and his divorced spouse does not violate Section 404(a)(1)(D). Campa v. Campa, 89 Cal. App.3d 113C (1st Dist. 1979), appeal dismissed, Carpenters Pension Trust Fund for Northern California v. Campa, 444 U. S. 1028 (1980).
Section 404(a)(2)
In the case of an eligible individual account plan (as defined in Section 407(d)(3)), the diversification requirement of paragraph (1)(C) and the prudence requirement (only to the extent that it requires diversification) of paragraph (1)(B) is not violated by acquisition or holding of qualifying employer real property or qualifying employer securities (as defined in Section 407(d)(4) and (5)).
  1. Conference Report
  2. This provision is discussed on page 317 of the Congressional Conference Report.

  3. Advisory Opinions

    The purchase of employer securities by a profit-sharing plan is covered by Section 404(a)(2). AO 75-89; WSB 79-86 (thrift plan).

Section 404(b)
Except as authorized by the Secretary by regulation, no fiduciary may maintain the indicia of ownership of any assets of a plan outside the jurisdiction of the district courts of the United States.
  1. Conference Report
  2. Page 306 of the Congressional Conference Report explains this provision.

  3. Regulations
  4.         Refer to DOL ERISA Regulation 2550.404b-1.

    1. Plan assets may be held by persons located outside the United States if the assets are foreign securities and (a) the plan fiduciary, empowered to authorize such holding is a United States regulated bank, insurance company or investment adviser, has its principal place of business in the United States and meets certain minimum financial conditions; or (b) the securities are in the possession of a United States bank, a registered broker or dealer; or an SEC-designated "satisfactory control location" and certain other conditions are met. DOL ERISA Regulation 2550.404b-1.
    2. An ADR (American depository receipt) that enables a person to demand delivery of a foreign security constitutes the "indicia of ownership" of the foreign security for purposes of Section 404(b). Preamble to DOL ERISA Regulation 2550.404b-1.
    3. The indicia of ownership of any plan assets (e.g., foreign securities, United States securities, etc.) attributable to contributions made on behalf of plan participants who are Canadian citizens or residents may be maintained in Canada if required by Canadian tax or other laws. DOL ERISA Regulation 2550.404b-1.
  5. Advisory Opinions
    1. Section 404(b) does not prohibit the investment of plan assets in enterprises located outside the United States provided that the indicia of ownership (e.g., stock certificates) of such assets is maintained in the U.S. (or in accordance with DOL ERISA Regulation 2550.404b-1). AO 75-80.
Section 404(c)
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 the account (as determined under regulations of the Secretary) -
(1) Such participant or beneficiary shall not be deemed to be a fiduciary by reasons of such exercise, and
(2) No person who is otherwise a fiduciary shall be liable under this part for any loss, or by reason of any breach, which results from such participant's, or beneficiary's exercise of control.
  1. Conference Report
  2. This provision is explained on pages 305-306 of the Congressional Conference Report.

  3. Regulations
  4. See DOL ERISA Regulation 404c-1, which exempts fiduciaries from certain ERISA liability if plans meet certain conditions and participants direct their own investments.

  5. Advisory Opinions
    1. Section 404(c) does not exempt transactions covered by Section 404(c) from all provisions of ERISA; it only exempts fiduciaries from liability regarding such transactions and the participant or beneficiary from being a fiduciary by reason of exercising control under Section 404(c). AO 75-81.
    2. The fact that transactions might be exempted from the provisions of Section 406 by reason of Section 404(c) does not affect the application of Section 4975 of the Code. PLR 7821122.
    3. [Individual Account] A person who is a plan fiduciary and who also exercises control over assets in his or her own individual account will not be treated as a fiduciary with respect to such exercise of control. AO 75-24.
  6. Court Decisions
    1. [Fiduciary Liability for Self-Directed Plan Investments] A 401(k) plan offered GICs as one of several investment vehicles for plan participants, who directed their own investments. GICs were issued, in part, by Executive Life Insurance. The trustees relied on ratings of rating services. When Executive Life encountered financial difficulties and was eventually downgraded by the rating services, the plan notified participants that GIC investments were not guaranteed from loss. Unisys negotiated more liberal waiting periods for transfers from the GIC fund to other investment vehicles, but was restricted on what it could tell participants. As a result, it did not tell participants of Executive Life's problems. Unisys did; however, pay for the replacement of an annuity issued to its Chairman by Executive Life with an annuity from another insurer. Executive Life was declared insolvent by state insurance regulators in 1991. Plan participants sued the fiduciaries for breach of fiduciary responsibilities under ERISA Section 404(a). The Unisys trustees' defense was that they were protected from fiduciary responsibility by ERISA Section 404(c).
    2. The courts ruled that (1) the duty of prudent inquiry may have been breached by total reliance on insurance rating services, (2) plan fiduciaries did not release material information to plan participants, (3) the participants' control over their investments may release the fiduciaries from investment liability, and (4) the case was remanded back to the District Court so plan participants may pursue their claims [3rd Circuit Court of Appeals, In Re Unisys Savings Plan Litigation (Meinhardt v. Unisys Corp.), 74 F.3d 420 (3d. Cir. 1996)].

Section 405   Co-Fiduciary Duties

Section 405(a)
In addition to any liability which he may have under any other provision of this part, a fiduciary with respect to a plan shall be liable for a breach of fiduciary responsibility of another fiduciary with respect to the same plan in the following circumstances:
(1) If he participates knowingly in, or knowingly undertakes to conceal, an act or omission of such other fiduciary, knowing such act or omission is a breach;
(2) If, by his failure to comply with section 404(a)(1) in the administration of his specific responsibilities which give rise to his status as a fiduciary, he has enabled such other fiduciary to commit a breach; or
(3) If he had knowledge of a breach by such other fiduciary, unless he makes reasonable efforts under the circumstances to remedy the breach.
  1. Conference Report
  2. Pages 299-300 of the Congressional Conference Report discuss co-fiduciary liability provisions.

  3. Interpretive Bulletins
    1. A plan fiduciary who knows of a breach committed by another fiduciary must take steps to remedy the breach, such as instituting a lawsuit, notifying the Department of Labor or publicizing the breach. Mere resignation by the fiduciary as a protest against the breach is not sufficient. IB 75-5, Question FR-10.
    2. Even though a fiduciary has only limited functions to perform (e.g., because the fiduciaries have properly allocated functions among themselves or delegated them to others), the fiduciary can become liable for breaches in other areas by other plan fiduciaries under Section 405(a). IB 75-8, Questions FR-13, FR-14 and FR-16.
    3. Where the Labor Department is already conducting an investigation of plan investments, the new investment managers for the plan will not be acting in violation of Section 405(a) if they report any breaches of fiduciary duties by others of which they become aware to the plan trustees and to the Labor Department and make available to the Labor Department all information requested about past transactions. AO 77-60/61; AO 77-79/80.
  4. Court Decisions
    1. [General] A fiduciary is liable under ERISA Section 405(a)(1) if he participates knowingly in, or knowingly undertakes to conceal, a co-fiduciary's breach of duty. Davidson v. Cook, 567 F. Supp. 225, 4 EBC 1816 (E.D.Va. 1983), aff'd, 734 F.2d 10 (4th Cir.), cert. denied, 469 U.S. 899 (1984).
    2. [General] ERISA Section 405 does not impose vicarious liability; actual knowledge is required. The fiduciary must know the other person is a fiduciary to the plan, must know that he participated in the act that constituted a breach, and must know that it was a breach. Donovan v. Cunningham, 716 F.2d 1455, 4 EBC 2329 (5th Cir. 1983), cert. denied, 467 U.S. 1251 (1984).
    3. [General] Under Section 405 of ERISA a fiduciary is liable for a co-fiduciary's breach of fiduciary duties if he knowingly participates and/or conceals such breach; furthermore, a fiduciary is required to make reasonable efforts to remedy a known breach by another fiduciary. Davidson v. Cook, 567 F. Supp. 225, 4 EBC 1816 (E.D. Va. 1983), aff'd, 734 F.2d 10 (4th Cir.), cert. denied, 469 U.S. 899 (1984).
    4. [General] Co-fiduciaries each have responsibility for the actions of the others and will be found liable for the others' breach of fiduciary duty if such co-fiduciary participates knowingly in a breach or if, by his failure to comply with Section 404 of ERISA, he enables another fiduciary to commit a breach. LeFebre v. Westinghouse Electrical Corp., 549 F. Supp. 1021, 3 EBC 2353, as amended by 3 EBC 2359 (D.Md. 1982), rev'd, 747 F.2d 197 (4th Cir. 1984).
    5. [General] Relying on the advice or information of a co-trustee alone may subject a trustee to liability. Katsaros v. Cody, 568 F. Supp. 360, 4 EBC 1910 (E.D.N.Y. 1983).
    6. [Omission vs. Commission] Fiduciaries are not relieved of their fiduciary responsibilities by their lack of involvement in a particular transaction. By failing to monitor the conduct of other trustees, a trustee may violate Section 404(a)(1)(B) and be held liable under Section 405(a)(2). Marshall v. Dekeyser, 485 F. Supp. 629, 1 EBC 1898 (W.D.Wis. 1979).
    7. [Successor Trustees] New trustees of a plan are not required to investigate how prudently prior trustees had negotiated a contract. If the contract terms are found reasonable and no other facts indicate the contrary, new trustees are not liable if prior trustees committed a breach of their fiduciary duties by acting imprudently. Brock v. Robbins, 830 F.2d 640, 8 EBC 2489 (7th Cir. 1987).
    8. [Successor Trustees] A successor trustee has a duty to liquidate prior improper investment upon assuming his responsibilities. Marshall v. Craft 463 F. Supp. 493 (N.D.Ga. 1978). See also Morrissey v. Curran, 567 F.2d 546 (2d Cir. 1977).
    9. [Resignation Not a Cure] Resignation by a fiduciary is not sufficient to discharge the fiduciary's duty under Section 405(a)(3) to make reasonable efforts to remedy the breach of another fiduciary. Marshall v. Dekeyser, 485 F. Supp. 629, 1 EBC 1898 (W.D.Wis. 1979).
Section 405(b)
(1) Except as otherwise provided in subsection (d) and in section 403(a)(1) and (2), if the assets of a plan are held by two or more trustees -
(A) Each shall use reasonable care to prevent a co-trustee from committing a breach; and
(B) They shall jointly manage and control the assets of the plan, except that nothing in this subparagraph (B) shall preclude any agreement authorized by the trust instrument, allocating specific responsibilities, obligations, or duties among trustees, in which event a trustee to whom certain responsibilities, obligations, or duties have not been allocated shall not be liable by reason of this subparagraph (B) either individually or as a trustee for any loss resulting to the plan arising from the acts or omissions on the part of another trustee to whom such responsibilities, obligations, or duties have been allocated.
(2) Nothing in this subsection shall limit any liability that a fiduciary may have under subsection (a) or any other provision of this part.
(3) (A) In the case of a plan the assets of which are held in more than one trust, a trustee shall not be liable under paragraph (1) except with respect to an act or omission of a trustee of a trust of which he is a trustee.
(B) No trustee shall be liable under this subsection for following instructions referred to in Section 403(a)(1).
  1. Conference Report
  2. The allocation of trustee duties are discussed on pages 300-301 of the Congressional Conference Report.

  3. Interpretive Bulletins

    A plan fiduciary who knows of a breach committed by another fiduciary must take reasonable steps to remedy the breach, such as instituting a lawsuit, notifying the Department of Labor, or publicizing the breach. Mere resignation by the fiduciary as a protest against the breach is not sufficient. IB 75-5, Question FR-10.

Section 405(c)
(1) The instrument under which a plan is maintained may expressly provide for procedures -
(A) For allocating fiduciary responsibilities (other than trustee responsibilities) among manned fiduciaries, and
(B) For named fiduciaries to designate persons other than named fiduciaries to carry out fiduciary responsibilities (other than trustee responsibilities) under the plan.
(2) If a plan expressly provides for a procedure described in paragraph (1), and pursuant to such procedure any fiduciary responsibility of a named fiduciary is allocated to any person, or a person is designated to carry out any such responsibility, then such named fiduciary shall not be liable for an act or omission of such person in carrying out such responsibility except to the extent that -
(A) The named fiduciary violated section 404(a)(1) -
(i) With respect to such allocation or designation,
(ii) With respect to the establishment or implementation of the procedure under paragraph (1), or
(iii) In continuing the allocation or designation; or
(B) The named fiduciary would otherwise be liable in accordance with subsection (a).
(3) For purposes of this subsection, the term "trustee responsibility" means any responsibility provided in the plan's trust instrument (if any) to manage or control the assets of the plan, other than a power under the trust instrument of a named fiduciary to appoint an investment manager in accordance with Section 402(c)(3).
  1. Conference Report
  2. General fiduciary duty allocation provisions are covered on page 302 of the Congressional Conference Report.

  3. Interpretive Bulletins
    1. [Allocation] Fiduciary responsibilities not involving management or control of plan assets may be allocated among named fiduciaries and may be delegated by named fiduciaries to others if the plan instruments so provide. IB 75-8, Question FR-12.
    2. [Allocation] If directors of an employer are the named fiduciaries of the plan, their liability can be limited by the procedures established in the plan instruments for allocating fiduciary responsibilities among named fiduciaries or for designating others to carry out fiduciary responsibilities. IB 75-8, Question D-4.
    3. [Allocation] Even if named fiduciaries allocate responsibilities or designate others to perform these functions, they are still liable for breaches in the establishment and implementation of the allocation or designation procedure. IB 75-8, Questions FR-13 and FR-14.
    4. [Delegation] Named fiduciaries cannot delegate authority or discretion to manage or control plan assets to anyone other than an investment manager as defined in Section 3(38). IB 75-8, Question FR-15.
  4. Advisory Opinions
    1. A named fiduciary with the duty to appoint, remove and monitor a plan's investment managers is not responsible for the day-to-day management of plan assets by the investment managers but must be prudent in appointing the investment managers and in continuing to retain them. AO 77-69/70.
  5. Court Decisions
    1. [Allocation] Fiduciaries are only liable for imprudent investment decisions made by an investment manager, who has been designated as such by the fiduciaries, if the fiduciaries fail to monitor adequately the performance of the investment manager. Brock v. Berman, 673 F. Supp. 634, 8 EBC 1689 (D.Mass. 1987).
    2. [Allocation] Even though a plan trustee has no authority for investment decisions, it cannot disavow itself of responsibility for such decisions, since it is still a fiduciary. However, under the allocation provisions of Section 405(c)(1), the trustee may, in fact, not be liable for such decisions. Leonard v. Drug Fair, Inc., No. 78-1335, Fed. Sec. L. Rep. (CCH) Para 97,144 (D.D.C. 1979).
    3. [Recordkeeping] A company was delegated by a bank trustee or custodian for self-directed IRA accounts the function of maintaining records and preparing appropriate reports required by Section 103 of ERISA. A company maintaining records necessary for the preparation of such reports is a plan fiduciary and must perform these functions with the degree of care set forth in Section 404(a)(1)(B). Redwood Bank v. QTA, Inc., No. C-79-1586, slip op. (N.D.Cal., Oct. 23, 1979).
Section 405(d)
(1) If an investment manager or managers have been appointed under section 402(c)(3), then, notwithstanding subsections (a)(2) and (3) and subsection (b), no trustee shall be liable for the acts or omissions of such investment manager or managers, or be under an obligation to invest or otherwise manage any assets of the plan which is subject to the management of such investment manager.
(2) Nothing in this subsection shall relieve any trustee of any liability under this part for any act of such trustee.
  1. Conference Report
  2. Investment manager appointment provisions are covered on pages -301-302 of the Congressional Conference Report.

  3. Regulations
   See the DOL plan assets ERISA Regulation 2510.3-101.

Section 406   Prohibited Transactions

Section 406(a)(1)
Except as provided in Section 408 [which contains the exemptions from the prohibited transactions restrictions]:
A fiduciary with respect to a plan shall not cause the plan to engage in a transaction, if he knows or should know that such transaction constitutes a direct or indirect -
(A) Sale or exchange, or leasing, of any property, between the plan and a party in interest;
(B) Lending of money or other extension of credit between the plan and a party in interest;
(C) Furnishing of goods, services or facilities between the plan and a party in interest;
(D) Transfer to, or use by or for the benefit of, a party in interest, of any assets of the plan; or
(E) Acquisition, on behalf of the plan, of any employer security or employer real property in violation of section 407(a) which contains the 10% limitation on the acquisition and holding of qualified employer securities and real property.
  1. Statute
  2. Investments in collectibles are generally prohibited by Section 408(m) of the Internal Revenue Code and PTE 91-55.

  3. Conference Report
  4. These prohibited transaction provisions are discussed on pages 306-309 and 316-320 of the Congressional Conference Report.

  5. Regulations
  6. DOL ERISA Regulation 2510.3-101 defines plan assets.

  7. Prohibited Transaction Class Exemptions (PTE)
    1. [Broker] The provision of brokerage services to IRAs and to Keogh plans to which Title I of ERISA is inapplicable is not subject to the prohibited transaction provisions of Title I of ERISA. However, such IRAs and Keogh plans remain subject to the prohibited transaction provisions of Title I of ERISA. Final PTE C 79-1.
    2. [Coins and Collectibles] PTE 91-55 permits IRA accounts to invest in American Eagle gold coins.
    3. [Broker] Securities broker-dealers regularly provide research, information and advice concerning securities and also effect agency transactions for the purchase or sale of securities in the ordinary course of their business as broker-dealers, and the provision of a combination of such services by a fiduciary with regard to employee benefit plans would constitute prohibited transactions under ERISA and the Code. Proposed Extension of Paragraph 1(a) of PTE C 75-1; Final PTE C 78-10.
    4. [Foreign Exchange] A bank fiduciary may use its own services (or those of an affiliate) to invest, on a non-discretionary basis, in foreign currencies and foreign currency options, subject to a number of conditions. See PTE 94-20.
    5. [Loan by Union Plan to Provide Projects for Union Employers] A loan by a multiemployer plan or a multiple employer plan to an owner of real property who is not a party in interest or a disqualified person to such plan where the loan is for the purpose of enabling such property owner to make construction improvements on such property, and the property owner contracts with an employer participating in the plan to make such construction improvements, is not a prohibited transaction under Section 406(a) of ERISA and Section 4975(c)(1)(A) - (D) of the Code. However, such a loan may give rise to a prohibited transaction if, for example, the loan is made in the context of an arrangement where a specific participating employer is to furnish a portion of the construction, and such employer has a controlling influence over the plan's decision to make the loan. Final PTE C 76-1.
    6. [Office Space] In some instances, a multiemployer plan or a multiple employer plan will secure office space and administrative services jointly with a participating employee organization, employer or employer association, or with another multiemployer plan or multiple employer plan that is a party in interest or disqualified person to the plan and will share the costs of securing such office space or administrative services on a pro-rata basis based on each party's use of such space or services. Such joint use of office space or administrative services does not constitute a prohibited transaction. However, if a multiemployer plan or a multiple employer plan independently secures for its own use office space or administrative services and furnishes part of such office space or administrative services to a party in interest or disqualified person, such transactions are prohibited transactions. Final PTE C 76-1.
    7. [Securities Lending] A securities lending service, pursuant to which a bank-trustee will lend securities of plans for which it serves as trustee to broker-dealers for an additional fee from the plan, may contravene Section 406(b). AO 79-11. But also see PTE 82-63.
    8. [Securities Lending] Payment to a party in interest of any commission, finder's fee or other compensation for services in connection with the effecting of a loan of securities by the plan to a broker-dealer, bank or other person would be a prohibited transaction. Proposed PTE I D-762. But also see PTE 82-63.
  8. Interpretive Bulletins
    1. [Plan Assets] In general, the investment by a plan in securities of a corporation will not be considered to be an investment in the underlying assets of the corporation. The assets of the corporation are not plan assets so subsequent transactions between a party in interest and the corporation will not be prohibited. This general proposition is consistent with Section 401(b)(1). However, this does not mean that such an investment may not sometimes constitute an indirect prohibited transaction. For example, if a plan invests in a corporation pursuant to an arrangement whereunder it is expected that the corporation will engage in a transaction with a party in interest, such arrangement will be a prohibited transaction. IB 75-2 (This IB contains several examples).
    2. [Contributions, In-Kind] Contributions of non-cash ("in-kind") assets to a defined benefit plan is a prohibited transaction. In-kind contributions to a defined contributions or welfare benefit plan may be a prohibited transaction, depending on the facts and circumstances and provisions of the plan. The basic determinant is whether the in-kind contributions represents an attempt to lessen a present or future obligation to make cash contributions to a plan. IB 94-3.
    3. [Bonding of Fiduciaries] The purchase of a bond required under Section 412 is not a prohibited transaction. IB 75-5, FR-9.
    4. [Payment of Benefits] The mere payment of money to which a participant or beneficiary is entitled, at the direction of the participant or beneficiary, to a party in interest does not contravene Section 406(a)(1)(D). IB 78-1.
  9. Advisory Opinions
    1. [Alienation of Benefits] Because Section 406 prohibits both direct and indirect transactions, a trustee to whom the limitation on compensation in Section 408(c)(2) applies could not assign his rights to compensation for services rendered to a plan to a party in interest, such as an employer. Therefore, the trustee could not submit a request for compensation to the fund designating his employer as payee on checks issued. WSB 79-92.
    2. [Alienation of Vested Benefits] Withholding of benefits from a plan participant and transfer of those benefits to a party in interest in satisfaction of a debt owed by the participant to that party in interest is a prohibited transaction. AO 76-99.
    3. [Appointment] The appointment of a bank that is a creditor of the entity maintaining the plan as trustee of the plan assets is not a prohibited transaction. WSB 77-14.
    4. [Appointment] The appointment of a party in interest as trustee, and the transfer of plan assets to the trustee pursuant to such appointment, does not constitute a prohibited transaction under Section 406(a)(1)(D) and does not contravene Sections 406(b)(1) or 406(b)(3). WSB 77-14.
    5. [Bank Servicer] The owner of a trust company that acts as a fiduciary to employee benefit plans that renders certain services for the trust company, but not for the plans, is not subject to the prohibitions of Section 406(a), since the services would not be a transaction between the plan and a party in interest. AO 82-55A.
    6. [Bank Stock - Purchase/Retention/Sale of Fiduciary Bank/BHC Stock]
      • General Discretionary Rule - An ERISA plan may not invest in the stock of a fiduciary bank if the bank has discretion over the transaction. The discretionary retention of such stock would also be prohibited. Non-discretionary purchases, sales, retentions are permitted. See 1980 letter from DOL to OCC.
      • General Non-Discretionary Rule - An ERISA plan may invest in the stock of a fiduciary bank or its bank holding company if the bank has no discretion over the investment. AO 92-23A.
      • Self-Directed Purchases - Permits self-directed accounts to purchase stock (including treasury stock) of the fiduciary bank or its holding company. AO 88-9.
      • Mutual Conversions - Initial Public Offerings - Permits self-directed accounts to purchase stock of the fiduciary bank (or its holding company) in an initial public offering (IPO) or on conversion of a mutual institution to a stock institution. AO 88-28.
    7. [Bonds - Rights] The sale or assignment of rights to debentures by a trust to a party in interest is a prohibited transaction. AO 76-72.
    8. [Collective Funds] The investment of plan assets in a commingled fund (for example, a qualified group trust) maintained by a bank trustee causes the assets of such commingled fund to be treated as assets of the plan. Consequently, a purchase or bolding of a master note (i.e, a nonnegotiable obligation issued by a finance company, the principal amount of which fluctuates on a daily basis depending on how much money the fund desires to loan the issuer) by the commingled fund in which the plan has an interest from a subsidiary of the corporation maintaining the plan constitutes a loan from the plan to the subsidiary in violation of Section 406(a)(1)(B) of ERISA and Section 4975(c)(1)(B) of the Code. PLR 7913114; PLR 7913116; Proposed PTE C 784.
    9. [Collective Funds] The mere transfer of assets between a qualified group trust (CIF) and plans invested therein, and the corresponding increase or decrease in qualified group trust units credited to the plans, are intra plan transactions so long as the group trust is a qualified trust under Section 401(a) of the Code and the transfers are within the terms of the plan. Accordingly, such transactions do not fall within the restrictions of Section 406 of ERISA or Section 4975(c)(1) of the Code. PLR 7913116.
    10. [Collective Funds - Conversion to Mutual Funds] The conversion of an ERISA collective investment fund would be a prohibited transaction in violation of Section 406PTE 77-4 would not provide relief for such a conversion. See the 1994 letter from DOL to OCC.
    11. [Compensation] The receipt of compensation by a fiduciary from a plan is a prohibited transaction if the fiduciary is already receiving full-time compensation from the employer maintaining the plan. AO 78-08.
    12. [Contributions - In-Kind] The contribution to the plan by the employer of a condominium owned by the owner, in lieu of making its contribution to the defined benefit plan, in accordance with the requirements for properly funding the plan, constitutes a prohibited sale or exchange of property between the plan and a party in interest pursuant to Section 406(a)(1)(A).
    13. Section 406 provides that a transfer of real or personal property by a party in interest to a plan shall be treated as a sale or exchange if the property is subject to a mortgage or a lien that the plan assumes or it is subject to a mortgage or similar lien that a party in interest placed on the property within the ten year period ending on the date of the transfer. The transfer of an option to purchase a condominium by a party in interest to the plan followed by the exercise of the option by the plan may also constitute a violation of Section 406(a)(1)(A). AO 81-69A.

    14. [Deposits] The investment of plan assets in credit union share accounts, at the direction of the plan participants and beneficiaries, is not a prohibited transaction. AO 76-38.
    15. [Deposits] The investment of the assets of a noncollectively bargained multiple employer plan covering employees of banks, in savings accounts and certificates of deposit of banks that are contributing employers, constitutes a prohibited transaction under Section 406(a) and may also be prohibited under Section 406(b)(1) and (2), because members of the administrative board of the plan, which directs plan investments, are officers and employees of contributing employer/banks.
    16. However, Section 408(b)(4) provides an exemption from Sections 406(a)406(b)(1), and 406(b)(2) for the investment of plan assets in the deposits of certificates of deposit of a bank that is a plan fiduciary or party in interest, if the requirements of DOL ERISA Regulations Section 2550.408b-4 are met. One requirement of the regulation is that, for investments made after November 1, 1977, the plan specify the name(s) of the banks in which deposits may be made. The specifications may be made in the plan by amendment retroactive to November 1, 1977. AO 79-25.

    17. [Estates] The purchase of real property from the estate of the sole shareholder of a corporation contributing to a plan is not a prohibited transaction even though one of the executors of the estate formerly was a plan trustee. AO 76-420.
    18. [Fees - Own-Bank Plan] A bank is not prohibited from serving as trustee for a plan maintained for the bank's employees where it receives no compensation from the plan for its trustee services [Emphasis added]. AO 79-49.
    19. [Fees] The reimbursement of, or payment to, fiduciaries of expenses properly and actually incurred in settlement of pending or threatened litigation by a plan, pursuant to indemnification provisions that do not contravene ERISA, is not a prohibited transaction. AO 77-66/67.
    20. [Investment Advisor] The provision of investment advisory, services by a corporation to a plan is not a prohibited transaction even though the corporation also provides such services to other clients who may be parties in interest to the plan. AO 77-44.
    21. [Investment Advisor] To the extent that a party renders investment performance measurement services to a plan, providing no more than quantitative measurement and ranking of a plan's investment portfolio and/or management performance based upon objective, reasonable and relevant criteria that are uniformly applied, such service would not constitute the rendering of investment advice. However, where the service provider adopts, applies or modifies performance or portfolio indices in such a way that a plan is furnished with a format for decision making that is designed to influence the plan's continued participation in a particular investment program, the service would constitute investment advice. AO 94-03.
    22. [Leases - Sponsor] The leasing by a plan of improved real property to the employer maintaining the plan is a prohibited transaction pursuant to Sections 406(a)(1)(A), (C), (D) and (E) of ERISA and Sections 4975(c)(a)(1),(C) and (D) of the Code.  In addition, since any property leased to an employer is "employer real property," as defined in Section 407(d)(2) of ERISA, if such property is not "qualifying employer real property" within the meaning of Section 407(d)(4) of ERISA, the holding of such property by the plan is a prohibited transaction pursuant to Sections 406(a)(2) and 407(a)(1) of ERISA. Also, to the extent that the employer may be a fiduciary to the plan, as defined in Section 3(21)(A) of ERISA and Section 4975(e)(3) of the Code, the lease arrangement may be a prohibited transaction pursuant to Section 406(b)(1) and (2) of ERISA and Section 4975(c)(1)(E) of the CodeProposed PTE F 192.
    23. [Loans - Common Borrower] If a loan is made by a plan to a person in order to encourage that person to do business with the employer, the transaction would be prohibited under Sections 406(a)(1)(D) and 406(b). WSB 79-63.
    24. [Loan by Construction Union Plan to Provide Employment for Union Members] Because it will not opine on factual circumstances, the Department will not opine on construction industry trustees' direction to their investment manager to invest a specified amount of plan assets in construction mortgages within the jurisdiction of the union whose members are plan participants. The Department states, however, that it would not be inconsistent with the requirements of Sections 403(c) and 404 for plan fiduciaries to select an investment course of action that reflects non-economic factors so long as application of such factors follows the primary consideration of a broad range of investment opportunities that are economically equally advantageous. Arrangements whereby funds of plans are invested by the fiduciary in transactions that indirectly create employment opportunities and compensation for employee services necessarily require an examination to determine if an indirect use of plan assets for the benefit of a party in interest is involved. AO 85-36A.
    25. [Loan by Union Plan to Provide Projects for Union Employers] If a multiemployer plan acquires unimproved real property and arranges for the construction of building structures on such property for the purpose of providing office space for the plan with building contractors and subcontractors some or all of whose employees are participants or beneficiaries of the plan, the arrangement between the plan and such building contractors and subcontractors would constitute prohibited transactions. Proposed PTE I 76-2.
    26. [Loans - Sponsor] Where a plan has a loan outstanding to X Corp. and the employer with respect to the plan acquires a majority or controlling interest in X Corp., the loan would become a prohibited, indirect extension of credit to the employer, in addition to being a direct prohibited extension of credit to X Corp. However, if the loan transaction is contemplated before the acquisition, the loan would not be a prohibited transaction. AO 79-37.
    27. [Loan Guarantee] A guarantee by a party in interest of a loan by a plan to a third party constitutes an extension of credit between the plan and the party in interest. If such loan was made pursuant to a binding contract in effect on July 1, 1974, it may be exempt under Section 414(c)(1), even if the loan constitutes a nonqualifying security under Section 407. See DOL ERISA Regulation Section 2550.407a-1(b).
    28. [Mutual Fund Conversion from Collective Investment Fund] The conversion of an ERISA collective investment fund would be a prohibited transaction in violation of Section 406PTE 77-4 would not provide relief for such a conversion. See 1994 letter from DOL to OCC.
    29. [Pooled Fund - Seed Money] The transfer by an insurance company of seed money invested by it in separate investment accounts back to the general account of the insurance company would not be treated as assets of a plan that have invested in the separate accounts and, therefore, the insurance company's redemption of its participation units in the separate accounts does not constitute a violation of the provisions of Sections 404(a)(1)(A) and (D). AO 83-38A.
    30. [Sale of Assets to Insider] The sale of certain parcels of real property by a profit-sharing plan to the majority shareholder of the employer maintaining the plan and to a corporation 50% or more of which is owned by such majority shareholder would constitute prohibited transactions pursuant to Section 406(a)(1)(A) and (D) of ERISA and Section 4975(c)(1)(A) and (D) of the Code. In addition, if the majority shareholder has the power to appoint and remove the plan trustee, such sales may be prohibited transactions under Section 406(b)(1) and (2) of ERISA and Section 4975(c)(1)(E) of the CodeProposed PTE I 492.
    31. [Stock - Sponsor] The purchase of common stock of the employer maintaining the plan by the employer from the plan is a prohibited transaction (AO 79-23), even if the purchase is made pursuant to a public tender offer (AO 77-48.)
    32. [Sweep] Scan and sweep services by a bank for plans for which it provides fiduciary services and for which it is paid a separate fee would be exempt from any of the prohibitions of Section 406(a) if the conditions of Section 408(b)(2) are met. The question of what constitutes a reasonable service, a reasonable contract or arrangement, and reasonable compensation is inherently factual in nature, and not subject to opinion.

      Section 408(b) violation would be involved if the bank, as fiduciary, exercised its authority, control or responsibility that 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 that may affect the exercise of its judgment as a fiduciary. Therefore, to the extent the bank would direct the utilization of the scan and sweep services and receive any fee therefore, there would be a per se violation of Section 408(b). However, if the bank does not exercise such authority, but the decision is made by the plan sponsor, no violation would exist. AO 88-02A.

  10. Court Decisions
    1. [General] ERISA Section 406, which prohibits fiduciaries from causing a plan to engage in certain specified transactions, evinced the Congressional desire to prevent transactions that offer a high potential for loss of plan assets and for insider abuse; and to prevent a trustee from being put in a position where he has dual loyalties. McDougall v. Donovan 552 F.Supp. 1206, 3 EBC 2385 (N.D.Ill. 1982).
    2. [General] The question of whether ERISA has been violated does not depend on whether any harm results from the transaction. Congress was concerned in ERISA to prevent transactions that offered a high potential for loss of plan assets or for insider abuse. The fact that a prohibited loan is or may be ultimately repaid does not render the loan lawful. Marshall v. Kelly, F.Supp. 341, 1 EBC 1850 (W.D.Okla. 1978); Cutaiar v. Marshall, 590 F.2d 523 (3d Cir. 1979); Marshall v. Dekeyser, 485 F.Supp. 629, 1, EBC 1898 (W.D.Wis. 1979).
    3. [General] ERISA Section 406(a) prohibits a fiduciary from causing a plan to enter into transactions with parties whom "he knows or should have known" are parties in interest to the plan. A fiduciary must act with prudence in investigating whether a party-in-interest relationship exists. In the case of a significant transaction, generally for the fiduciary to be prudent he must make a thorough investigation of the other party's relationship to the plan to determine if he is a party in interest. In the case of a normal and insubstantial day-to-day transaction, it may be sufficient to check the identity of the other party against a roster of parties in interest that is periodically updated. Marshall v. Kelly, 465 F.Supp. 341, 1 EBC 1850 (W.D.Okla. 1978).
    4. [General] Congress did not intend to exclude from prohibitions under Section 406 transactions that have independent business purposes, just as it did not exclude transactions that are fair under some independent measure. Congressional intent to eliminate all transactions, with even the potential to bias the independent judgment of plan fiduciaries, must be followed. McDougall v. Donovan 552 F.Supp. 1206, 3 EBC 2385 (N.D.Ill. 1982).
    5. [General] Section 406 of ERISA does not create a per se prohibition against plan fiduciaries with dual loyalties acting on behalf of the plan. Donovan v. Bierwirth, 538 F.Supp. 463, 2 EBC 2145 (E.D.N.Y. 1981).
    6. [Effective Date] Actions by fiduciaries occurring after 1974 are not insulated from ERISA coverage merely because their roots can be traced to an event prior to the effective date of ERISA. Marshall v. Craft, 463 F.Supp. 493 (N.D.Ga. 1978).
    7. [Compensation] The critical analysis under Section 406, regarding a transaction with a party in interest that is exempted under Section 408, is whether the party in interest receives more than reasonable compensation. Brock v. Robbins 830 F.2d 640, 8 EBC 2489 (7th Cir. 1987).
    8. [Compensation] The payment by a multiemployer plan of rent for an aircraft leased from a party in interest in an amount in excess of the value received by the multiemployer plan in utilizing the aircraft allegedly constitutes a prohibited transaction under Section 406(a)(1)(D). Usery v. Wilson, et al., No. 3-76-373 (E.D.Tenn., June 6, 1977) (consent order).
    9. [ESOP] Under Section 406(a)(1)(B), one transaction normally prohibited is the lending of money or other extension of credit between the plan and a party in interest; however, loans to employee stock ownership plans are exempt from such prohibitions. Allen v. Katz Agency, Inc. Employee Stock Ownership Plan, 677 F.2d 193, 3 EBC 1352 (2d Cir. 1982).
    10. [Ignorance] Where trustees did not inspect complete agreement as drafted by counsel, and thus were not aware that part of the plan would result in the use of plan assets to benefit a party in interest, they violated ERISA Section 406(a)(1). Dimond v. Retirement Plan, 582 F. Supp. 892, 4 EBC 1457 (W.D. Pa. 1983).
    11. [Leases] The lease of an airplane by a multiemployer plan from a party in interest allegedly constitutes a prohibited transaction under Section 406(a)(1)(A). Usery v. Wilson, et al, No. 3-76-373 (E.D.Tenn., June 6, 1977) (consent order).
    12. [Loans] Fiduciaries cannot act as both borrowers and lenders as these are parties whose interests are adverse; fiduciaries acting on both sides of a loan transaction cannot negotiate the best terms for either party. Davidson v. Cook, 567 F.Supp. 225, 4 EBC 1816 (E.D.Va. 1983), aff'd, 734 F.2d 10 (4th Cir.), cert. denied, 469 U.S. 899 (1984).
    13. [Loans to Plan Sponsor] An employer's borrowing of money from the fund violates the prohibition under ERISA Section 406 regarding the lending of money between a plan and a party in interest. Dependahl v. Falstaff Brewing Corp., 491 F.Supp. 1188, 30 Fed. Rul. Serv.2d(Callahan) 564 (E.D.Miss. 1980), aff'd in part, rev'd in part, 653 F.2d 1208 (8th Cir.), cert.
    14. [Loans] The phrase "reasonable rate of interest" within the meaning of ERISA Section 406(a)(1)(B) does not equate to the term "prevailing or market rate of interest." Thus, if the other requirements of Section 406(a)(1) are met, a pension fund may charge interest rates lower than the prevailing rate on mortgage loans made to plan participants. Evidence that a pension fund had charged a lower interest rate was insufficient to establish that the loans did not "bear a reasonable rate of interest" and were accordingly not exempted from the prohibition of ERISA Section 406(a) against making loans to plan participants. Brock v. Walton, 794 F.2d 586,7 EBC 1769 (11th Cir.), reh'g denied, 802 F.2d 1399 (11th Cir. 1986) (en banc).
    15. [Loans] A loan of money by a multiemployer plan to a party in interest allegedly constitutes a prohibited transaction under Section 406(a)(1)(B). Usery v. Wilson, et al, No. 3-76-373 (E.D.Tenn., June 6, 1977) (consent order).
    16. [Loans] Dissolving the improper party-in-interest relationship prior to the execution of a loan did not preclude the transaction from being violative of ERISA Section 406 when the loan agreement already existed at the time of divestiture. M&R Investment Co., Inc. v. Fitzsimmons, 685 F.2d 283, 3 EBC 1835 (9th Cir. 1982).
    17. [Loans] A loan by a multiemployer plan to a party in interest for the purpose of enabling the party in interest to remove preexisting liens on an aircraft that the party in interest wished to acquire free of encumbrances allegedly constitutes a prohibited transaction under Section 406(a)(1)(D). Usery v. Wilson, et al., No. 3-76-373 (E.D.Tenn., June 6, 1977) (consent order).
    18. [Loans] Profit-sharing plan trustees violated ERISA's prohibited transactions provisions by maintaining pre-ERISA loans to employer-sponsor and to one of the trustees after law's effective date, where one loan was made without security with an oral promise to repay, since loans' terms were not at least as favorable to the plan as arm's length transaction would have been. Donovan v. Bryans, 566 F. Supp. 1258, 4 EBC 1816 (E.D.Pa. 1983).
    19. [Mergers & Acquisitions] Fiduciaries of a trust, containing assets of corporate employee pension benefits plan, violated ERISA's prohibited transactions in Section 406 when they used the assets to finance another corporation's obligation under an acquisition agreement requiring the purchase of shares of stock held by the trust in another corporation. Sandoval v. Simmons 622 F.Supp. 1174, 6 EBC 2161 (D.C. Ill. 1985).
    20. [Mergers & Acquisitions] ERISA Section 406(a)(1)(D) and (b)(1) should be read broadly as a gloss on the duty of loyalty required by Section 404 in light of the Congressional concern with protection of plan beneficiaries and should be read to cover action of trustee who buys shares in target corporation in order to assist either target's management or raider in its quest for corporate control or a control premium. Leigh v. Engle, 727 F.2d 113, 4 EBC 2702 (7th Cir. 1984).
    21. [Provide Benefits] The payment of rent on behalf of the widow of a former plan trustee is a prohibited transaction under Section 406(a)(1)(D) even though the payment was morally commendable and was not made for the personal gain of plan fiduciaries. Marshall v. Cuevas, 1 EBC 1580 (D.P.R. 1979).
    22. [Successor Trustee] ERISA limits a fiduciary's liability for breach of duty to those breaches committed during his tenure; however, under Section 406 of ERISA a successor trustee has a duty to dispose of prior investments violative of ERISA upon assuming his responsibilities. McDougall v. Donovan 552 F.Supp. 1206, 3 EBC 2385 (N.D.Ill. 1982).
    23. [Unions] As Section 406 of ERISA seeks to protect against influences exerted by all parties in interest, Congress intended to prohibit dealings between a plan and any union whose members are among the beneficiaries of the plan. McDougall v. Donovan 552 F.Supp. 1206, 3 EBC 2385 (N.D.Ill. 1982).
Section 406(a)(2)
Except as provided in Section 408 [which contains the exemptions from the prohibited transaction restrictions]:
No fiduciary who has authority or discretion to control or manage the assets of a plan shall permit the plan to hold any employer security or real property if he knows or should know that holding such security or real property violates section 407(a) which contains the 10% limitation on the acquisition and holding of qualifying employer securities and real property.
  1. Conference Report

The prohibited transaction provisions are discussed on pages 306-309 and 316-320 of the Congressional Conference Report.

Section 406(b)(1)
A fiduciary with respect to a plan shall not -
(1) Deal with the assets of the plan in his own interest or for his own account,
  1. Conference Report
  2. This prohibition is covered on page 309 of the Congressional Conference Report.

  3. Regulations
  4. No regulations have been issued yet. However, the regulations under Section 408(b)(2) amplify this prohibition.

    1. This prohibition is imposed to deter fiduciaries from exercising the authority, control or responsibility that makes such persons fiduciaries when they have interests that may conflict with the interests of the plans for which they act. ERISA Regulation 2550.408b-2(e)(1).
    2. 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 that makes such person a fiduciary to cause the plan to pay additional fees for a service furnished by such fiduciary or by a person in which such fiduciary has an interest that may affect the exercise of such fiduciary's best judgment as a fiduciary. DOL ERISA Regulation 2550.408b-2(e)(2).
    3. The regulation cited above contains several important examples. DOL ERISA Regulation 2550.408b-2(f). Some of the examples, however, only deal with Section 406(b)(1) and not with Sections 406(b)(2) and 406(b)(3). Therefore, even if an example indicates that there is no Section 406(b)(1) prohibition, there may be a Section 406(b)(2) or (3) prohibition.
    4. For a definition of plan assets, see DOL ERISA Regulation 2510.3-101.
  5. Advisory Opinions
    1. [General] A fiduciary does not engage in a violation of Section 406(b)(1) unless he uses his fiduciary authority to benefit himself or a related party. WSB 79-20; PLR 7826047; PLR 7826048; PLR 7826049; Proposed PTE I 492; Proposed Extension of Paragraph 1(a) of PTE C 75-1.
    2. [General - Discretion Required] A fiduciary to a plan, by reason of rendering investment advice for a fee or other compensation, shall not be deemed to be a fiduciary regarding any plan assets to which such person does not have discretionary authority, discretionary control or discretionary responsibility, does not exercise any authority or control and does not render investment advice for a fee or other compensation. Thus, a sale of assets by the corporate trustee and investment manager, but of assets not under the control of that fiduciary, does not involve a possible prohibited transaction under Section 406(b). Also, where a factual analysis confirms that at the time of a transaction, the plan, as seller, and the purchaser had no party-in-interest relationship to one another, the sale cannot constitute a violation of Section 406(a)(1)(A) through (D). AO 81-20A.
    3. [General] If a fiduciary uses the authority, control and responsibility that makes him a fiduciary to cause the plan to enter a transaction involving the provision of services when such fiduciary has an interest in the transaction that may affect the exercise of his best judgment as a fiduciary, a transaction described in Section 406(b) would occur. That transaction would be deemed to be a separate transaction from the transaction involving the provision of services and would not be exempted under Section 408(b)(2). Also, questions of what constitutes a necessary service, a reasonable contract or arrangement, and reasonable compensation are inherently factual in nature and will not be the subject of advisory opinions.
    4. Where a firm is an investment manager to individual employee benefit plans, the initial appointment of that firm as investment manager of a master trust and/or trustees of the master trust by independent plan fiduciaries would not cause the investment manager or trustees to violate Section 406(b)(1) or (2) as long as those persons exercise none of the authority, control or responsibility that makes them fiduciaries to cause the plan to make such appointments.

      • [Collective Investment Funds] Also, Section 406(a)(1) does not apply to any transaction between a plan and a common or collective trust fund maintained by a bank or trust company supervised by a state or a federal agency if (a) the transaction is a sale or purchase of an interest in the fund, (b) the bank or trust company receives no more than reasonable compensation, and (c) the transaction is expressly permitted by the instrument under which the plan is maintained or by a fiduciary who has authority to manage and control the assets of the plan.
      • [Deposits] Section 408(b)(4) provides that the prohibitions of Section 406 shall not apply to the investment of all or a part of plan assets and deposits that bear a reasonable rate of interest in a bank or similar financial institution supervised by the United States of America or by a state if such bank or other institution is a fiduciary of the plan and if (a) the plan covers only employees of such bank or other institution or affiliates of such bank or institution or (b) such investment is expressly authorized by a provision of the plan or by a fiduciary who is expressly empowered by the plan to so instruct the trustee regarding such an investment.
      • [Loan to Provide Employment for Union Members] Finally, the Department of Labor, on its own, notes that one of the collective funds that was the subject of the request for opinion is designated as the union construction fund. The Department indicates that a decision to make an investment may not be influenced, for example, by a desire to stimulate the construction industry and generate employment unless the investment, when judged solely on the basis of the economic value to the plan, would be equal to or superior to alternate investments available to the fund. AO 82-51A.
    5. [General] The inquiry concerning whether a fiduciary has violated ERISA Section 406(b)(1) is not limited to the initial decision by the plan regarding retention of the fiduciary to provide additional services. At all times, such fiduciary may make no decision on behalf of the plan (or in any way use his authority or control) to cause the plan to make a decision which would have the effect of personally benefiting himself or any other person in which such fiduciary has an interest.
    6. However, the potential for a prohibited act of self-dealing in violation of ERISA Section 406(b)(1) may be prospectively avoided through the careful application, in effect as well as in form, of Example (7) of ERISA Regulations Section 2550.408(b)-2(f) (for example, the trustee must physically absent himself from all consideration of the matter and cannot any of his authority or control to influence the plan's decision.) WSB 79-20.

    7. [Bank Board Membership] Where an individual is a fiduciary to a plan and where the individual serves as a member of the board of directors of a bank that also serves as a fiduciary to the plan, decisions made by the bank's board of directors regarding plan investments do not necessarily constitute Section 406(b) violations by the individual/director if he absents himself from any arrangements, agreements or understanding; removes himself from all board consideration of these decisions; and does not otherwise exercise any authority, control or responsibility with regard thereto. Provided, however, that if the board itself has an interest in the transaction that could alter or affect its judgment, this would constitute a per se violation under Section 406(b). AO 86-11A.
    8. [Bank Custodian - Board Membership] The investment of plan assets in securities of the bank that is custodian, at the direction of a trustee who is also a director of the bank, may be a prohibited transaction under Section 406(b)(1). AO 76-76.
    9. [Bank Holding Company Affiliate Use] The appointment of a second tier subsidiary and/or a division of a corporation to perform a fiduciary or nonfiduciary service for a plan, for which the second tier subsidiary or division acts as a fiduciary, would not constitute an act of self-dealing by the fiduciary provided that the appointment is made by a fiduciary who is independent of and unrelated to the parent-subsidiary group. PLR 7826047.
    10. [Bank Holding Company Affiliate Use] A second tier subsidiary, acting in its capacity as plan trustee, retained a division of the parent of the first tier subsidiary to provide it with investment advice and related advisory services to the trust for which it was acting as trustee. The services performed by the division were clearly within the existing responsibilities of the second tier subsidiary. The second tier subsidiary did not delegate any of its responsibilities as trustee because it remained fully responsible for managing the plan's investments. The fees charged by the second tier subsidiary included payment for investment advice as well as for custodial services. The second tier subsidiary's fee was not affected by reason of its retaining the division. Rather, at its own expense, the second tier subsidiary compensated the division for the services rendered to it. The second tier subsidiary did not engage in an act of self-dealing under Code Section 4975(c)(1)(E) when it appointed the division to provide investment advice. PLR 7826048.
    11. [Brokerage Services] If a plan fiduciary effects securities transactions on behalf of the plan and performs functions incidental to the effecting of such transactions, such transactions would be prohibited by ERISA and the Code unless, under the particular facts and circumstances surrounding the transactions, they do not constitute acts of self-dealing under ERISA Section 406(b)(1) and Code Section 4975(c)(1)(E)Proposed Extension of Paragraph 1(a) of PTE C 75-1.
    12. [Collective Investment Funds] Also refer to General Advisory Opinions above for AO 82-51A.
    13. [Collective Investment Funds] It is a violation of Section 406(b) when a company maintaining a pension advisory and consulting service, dealing in establishing investment objectives, evaluation, recommending managers, and monitoring performance, makes recommendations with regard to investments in collective trust funds to which said party has a fiduciary role, if the recommendations are a primary basis for plan investments. AO 84-04A.
    14. [Commissions] This advisory opinion involved transactions by a licensed stock brokerage firm, which was the plan sponsor and involved mutual fund investments made by the plan. The documentation between the plan sponsor and the plan provided that the sponsor would agree to receive and hold all commissions as agent for the trustee on behalf of the plan and to pay the commissions to the plan within 30 days after receipt thereof.
    15. The Department of Labor ruled that the receipt of brokerage commissions by a plan fiduciary from a transaction involving assets held by the fiduciary as agent for the plan would not constitute a violation of ERISA if the fiduciary had no right, title or interest in the proceeds passed to the fiduciary, the commissions were returned to the plan in the ordinary course of business, and the fiduciary does not benefit in any manner from the holding of the money. AO 81-90A.

    16. [Compensation] The receipt of compensation by a fiduciary from a plan is a prohibited transaction if the fiduciary is already receiving full-time compensation from the employer maintaining the plan. AO 78-08.
    17. [Compensation] The appointment by a plan trustee of his secretary as plan administrator may violate Section 406(b)(1). Plan fiduciaries are prohibited from dealing with plan assets in their own interest or for their own account. If the compensation paid by the plan for administrative services, in fact, serves to compensate the trustee's secretary for the time spent in the performance of her secretarial duties, a violation of Section 406(b)(1) might occur. AO 77-84.
    18. [Deposits] Also refer to General Advisory Opinions above for AO 82-51A.
    19. [Deposits] The investment of the assets of a plan covering employees of banks, in savings accounts and certificates of deposit of banks that are contributing employers, constitutes a prohibited transaction under Section 406(a) and may also be prohibited under Section 406(b)(1) and (2) because members of the administrative board of the plan, which directs plan investments, are officers and employees of contributing employer/banks.
    20. However, Section 408(b)(4) provides an exemption from Sections 406(a)406(b)(1) and 406(b)(2) for the investment of plan assets in the deposits or certificates of deposit of a bank that is a plan fiduciary or party in interest, if the requirements of ERISA Regulations Section 2550.408b-4 are met. One requirement of the regulation is that, for investments made after November 1, 1977, the plan specify the name(s) of the banks in which deposits may be made. The specifications may be made to the plan by amendment retroactive to November 1, 1977. AO 79-25.

    21. [Fees, Incentive] Payment of an incentive fee pursuant to appropriate contractual relationship between an investment manager (fiduciary) and the plan would not, in and of itself, violate Section 406(b)(1). The amount of compensation that the manager earns depends solely on the changes in value of the securities in the individual accounts and, therefore, the manager would not be exercising any of its fiduciary authority or control to cause the plan to pay an additional fee.
    22. Moreover, it does not appear that the manager would be acting on behalf of or representing a person whose interests are adverse to the plan merely because it enters into an incentive fee arrangement. However, the Department notes that incentive fee arrangements could, under certain facts and circumstances, violate both Sections 406(a) and 406(b), as well as Section 404(a). Thus, the plan fiduciary must act prudently in deciding to enter into an incentive compensation arrangement with an investment manager, as well as the negotiation of the specific formula under which the compensation will be paid. The Department's position is that the fiduciary, prior to a decision to enter into an incentive compensation arrangement, must fully understand the compensation formula and the risks associated with this manner of compensation and have all relevant information pertaining thereto available to it. Further, the plan fiduciary must be capable of periodically monitoring the actions taken by the manager in the performance of its investment duties. AO 86-20A; accord AO 86-21A.

    23. [Float] The ancillary services exemptions (§ 408(b)(2) and 408(b)(6)) do not include the float earned by the fiduciary bank from a demand deposit account to the extent that it is reasonably possible to earn a return on such funds. Retention of float would be permissible if it was a part of the bank's overall compensation from the plan and if the bank had made appropriate disclosures regarding the use of float. Failure to comply would result in a violation of ERISA Section 406(b)(1)AO 93-24A.
    24. [Leases to Sponsor] The leasing by a plan of improved real property to the employer maintaining the plan is a prohibited transaction pursuant to ERISA Section 406(a)(1)(A), (C), (D) and (E) and Code Section 4975(c)(1)(A), (C) and (D). In addition, since any property leased to an employer is employer real property as defined in ERISA Section 407(d)(2), if such property is not qualifying employer real property within the meaning of ERISA Section 407(d)(4), the holding of such property by the plan is a prohibited transaction pursuant to ERISA Sections 406(a)(2) and 407(a)(1). Also, to the extent that the employer may be a fiduciary to the plan as defined in ERISA Section 3(21)(A) and Code Section 4975(e)(3), the lease arrangement may be a prohibited transaction pursuant to ERISA Section 406(b)(1) and (2) and Code Section 4975(c)(1)(E)Proposed PTE I 192.
    25. [Loan by Construction Union Plan to Provide Employment for Union Members] Also refer to General Advisory Opinions above for AO 82-51A.
    26. [Loans] If a loan is made by a plan to a person in order to encourage that person to do business with the employer, the transaction would be prohibited under Section 406(a)(1)(D) and 406(b). WSB 79-63.
    27. [Sale to Insider] The sale of certain parcels of real property by a profit-sharing plan to the majority shareholder of the employer maintaining the plan and to a corporation 50% or more of which is owned by such majority shareholder would constitute prohibited transactions pursuant to Section 406(a)(1)(A) and (D) of ERISA and Section 4975(c)(1)(A) and (D) of the Code. In addition, if the majority shareholder has the power to appoint and remove the plan trustee, such sales may be prohibited transactions under Section 406(b)(1) and (2) of ERISA and Section 4975(c)(1)(E) of the CodeProposed PTE I 492.
    28. [Stock - Exchanges] An exchange of securities held by a stock bonus plan in connection with a reorganization is not a prohibited transaction. WSB 78-29.
  6. Court Decisions
    1. [General] ERISA Section 406(b) codifies the principle that ERISA fiduciaries owe the plan, its participants and its beneficiaries a duty of loyalty and cautions fiduciaries that they must either avoid certain types of transactions or not serve as fiduciaries. Section 406 is violated if fiduciaries invest plan assets in companies in which any fiduciary owns an equity interest or from which any fiduciary receives compensation for the investment. Lowen v. Tower Asset Management, Inc., 829 F.2d 1209, 8 EBC 2457 (2d Cir. 1987).
    2. [General] Based on Congressional concern about protection of plan beneficiaries, ERISA Sections 406(a)(1)(D) and (b)(1)should be read broadly as a gloss on the duty of loyalty required by Section 404 and should be read to cover action of trustee who buys shares in target corporation in order to assist either target's management or raider in its quest for corporate control or a control premium. Leigh v. Engle, 727 F.2d 113, 4 EBC 2702 (7th Cir. 1984).
    3. [Compensation] The prohibition against fiduciaries acting in conflict of interest situations is violated where trustees authorize, for each other, monthly payment from plan's assets as compensation for their services as trustees while they are receiving full-time pay from participating employers or union and further authorize plans to make contributions on their behalf so as to make each other eligible for receipts of benefits from the plans. Donovan v. Daugherty, 550 F.Supp. 390, 3 EBC 2079 (S. D. Ala. 1982).
    4. [Loans] Two trustees of a multiemployer plan who owned a large interest in a corporation and who caused the plan to make a loan commitment to the corporation so that the corporation could remove liens on an aircraft the corporation wished to acquire free of encumbrances allegedly violated Section 406(b)(1). Usery v. Wilson, et al., No. 3-76-373 (E.D.Tenn., June 6, 1977) (consent order). See also Marshall v. Dekeyser, 485 F.Supp. 629, 1 EBC 1898 (W.D.Wis. 1979).
Section 406(b)(2)
A fiduciary with respect to a plan shall not -
(2) In his 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, . . .
  1. Conference Report
  2. Page 309 of the Congressional Conference Report covers the above provision.

  3. Regulations
  4. No regulations have been issued yet. However, the regulations under Section 408(b)(2) and two prohibited transaction class exemptions amplify this prohibition.

    1. This prohibition is imposed to deter fiduciaries from exercising the authority, control or responsibility that makes such persons fiduciaries when they have interests that may conflict with the interests of the plans for which they act. ERISA Regulation § 2550.408b-2(e)(1).
    2. A fiduciary may not use the authority, control or responsibility that makes such a person a fiduciary to cause the plan to pay an additional fee to such fiduciary (or to a person in which such person has an interest that may affect the exercise of such fiduciary's best judgment as a fiduciary). DOL ERISA Regulation 2550.408b-2(e)(1).
    3. The regulation cited above contains several important examples. DOL ERISA Regulation 2550.408b-2(f); however, not all of the examples deal with Section 406(b)(2).
    4. The preambles to PTE C 76-1 and PTE 77-10 amplify the interrelationships between this prohibition and the other prohibitions.
  5. Interpretive Bulletins
    1. If a fiduciary, in addition to his duties for the plan, serves in a decision making capacity with another party, the mere fact that such fiduciary effects payments to such party of money to which a participant is entitled at the direction of the participant and in accordance with specific plan provisions does not contravene Section 406(b)(2). IB 78-1.
  6. Advisory Opinions
    1. [Bank Stock] The investment of plan assets in a bank of which a fiduciary is a director may be a prohibited transaction under Section 406(b)(2). AO 76-62.
    2. [Bank Stock - Purchase/Retention/Sale of Fiduciary Bank/BHC Stock]
    3. General Discretionary Rule - An ERISA plan may not invest in the stock of a fiduciary bank if the bank has discretion over the transaction. The discretionary retention of such stock would also be prohibited. Non-discretionary purchases, sales, and retentions are permitted.

      DOL notes the duty of undivided loyalty owed under § 406(b), but the conflict of interest which may occur if a sale of bank stock would be in the best interests of a plan, but such a sale (or the news of such a sale) might lower the price of the bank's stock.

      See 1980 letter from DOL to OCC.

    4. [Custodians] The interests of the bank that performs the services of custodial agent for the plan and is a plan fiduciary are or could be deemed to be adverse to the interests of the plan. AO 76-76.
    5. [Deposits] Investment of the assets of a noncollectively bargained multiple employer plan covering employees of banks, in savings accounts and certificates of deposit of banks that are contributing employers, constitutes a prohibited transaction under Section 406(a) and may also be prohibited under Section 406(b)(1) and (2) because members of the administrative board of the plan, which directs plan investments, are officers and employees of contributing employer banks.
    6. However, Section 408(b)(4) provides an exemption from Sections 406(a)406(b)(1) and 406(b)(2) for the investment of plan assets in the deposits or certificates of deposit of a bank that is a plan fiduciary or party in interest if the requirements of ERISA Regulations Section 2550.408b-4 are met. One requirement of the regulation is that, for investments made after November 1, 1977, the plan specify the name(s) of the banks in which deposits may be made. The specifications may be made to the plan by amendment retroactive to November 1, 1977. AO 79-25.

    7. [Investment Manager Appointment] The involvement of a plan fiduciary in the appointment of a corporation of which such fiduciary is a director as an investment manager of the plan's assets may be a prohibited transaction under Section 406(b)(2). AO 76-15.
    8. [Investment Management] The provision of investment management services by the plan manager to a fund would be exempt from Section 406(a) if the conditions of Section 408(b)(2) are met. The question of what constitutes a necessary service, a reasonable contract or arrangement, or reasonable compensation is factual in nature and not subject to advisory opinions.
    9. Further, the mere selection of the manager to provide investment management services to a plan where the payment of compensation for such services is to be made by the plan sponsor receiving such services would not constitute a per se violation of Section 406(b)(1), but such violation could occur in the course of the committee's deliberations to invest in the fund and the concomitant retention of the plan manager. Accordingly, a ruling that the arrangement is exempt from Section 406(b)(1) cannot be made.

      Generally, a fiduciary's decision to retain an affiliate service provider whose fees will be paid by the plan sponsor will not involve an adversity of interest as contemplated by Section 406(b)(2) of the act. If, for example, a fiduciary of the plan, in negotiating a service contract on behalf of the plan, also acts on behalf of a person and causes that person to benefit from such a decision at the expense of any kind to the plan, the decision to retain the service provider would result in a violation of Section 406(b)(2). Accordingly, the decision to retain the manager to service the plan investments in the fund would not, in itself, constitute a violation of Section 406(b)(2); but because it is inherently factual in nature, no opinions can be rendered thereon. AO 83-44A.

    10. [Leases to Sponsor] The leasing by a plan of improved real estate to the employer maintaining the plan is a prohibited transaction pursuant to ERISA Section 406(a)(1)(A), (C), (D) and (E) and Code Section 4975(c)(1)(A), (C) and (D). In addition, since any property leased to an employer is employer real property as defined in ERISA Section 407(d)(2), if such property is not qualifying employer real property within the meaning of ERISA Section 407(d)(4), the holding of such property by the plan is a prohibited transaction pursuant to ERISA Sections 406(a)(2) and 407(a)(1). Also, to the extent that the employer may be a fiduciary to the plan as defined in ERISA Section 3(21)(A) and Code Section 4975(e)(3), the lease arrangement may be a prohibited transaction pursuant to ERISA Section 406(b)(1) and (2) and Code Section 4975(c)(1)(E)Proposed PTE I 192.
    11. [Sale to Insider of Sponsor] The sale of certain parcels of real property by a profit-sharing plan to the majority shareholder of the employer maintaining the plan and to a corporation 50% or more of which is owned by such majority shareholder would constitute prohibited transactions pursuant to ERISA Section 406(a)(1)(A) and (D) and Code Section 4975(c)(1)(A) and (D). In addition, if the majority shareholder has the power to appoint and remove the plan trustee, such sales may be prohibited transactions under ERISA Section 406(b)(1) and (2) and Code Section 4975(c)(1)(E)Proposed PTE I 492.
  7. Court Decisions
    1. [General] ERISA Section 406(b)(2) is to be read as requiring a transaction between the plan and a party having an adverse interest for the prohibition to apply. Donovan v. Bierwirth, 680 F.2d 263, 3 EBC 1417 (2d Cir.), cert. denied, 459 U.S. 1069 (1982).
    2. [General] ERISA Section 406(b)(2) prohibits representation of parties who are adverse in the technical sense. A transaction does not have to exhibit fiduciary misconduct, reflecting harm to the beneficiaries, before ERISA Section 406(b)(2) is violated. When identical trustees of two plans whose participants and beneficiaries are not identical effect a loan between the plans without a statutory or administrative exemption, a per se violation of ERISA exists. ERISA Section 406(b) contains a blanket prohibition of certain transactions, no matter how fair. Cutaiar v. Marshall, 590 F.2d 523 (3d Cir. 1979).
    3. [Loans] A party who is a borrower from a plan or who is claiming payment from a plan will, by definition, have interests adverse to the interests of the plan. Marshall v. Kelly, 465 F.Supp. 341, 1 EBC 1850 (W.D.Okla. 1978); Marshall v. Dekeyser, 485 F.Supp. 629, 1 EBC 1898 (W.D.Wis. 1979).
    4. [Loans] An employer trustee of a Taft-Hartley plan, who was also the director of the employer association, did not violate Section 406(b)(2) by either:
      1. advising employers not to make contributions to the plan and to resist audits by the plan, or
      2. bringing suit to block the plan's collection procedures that the trustee believed to be unauthorized.

      The court noted that under Section 408(c)(3), a plan trustee can also serve as the director of an employer association and perform all of the duties required of a person holding each of these positions. The court also indicated that, where a trustee acts pursuant to Section 405(a)(3) to remedy a breach of fiduciary duty that such trustee believes to have been committed by another plan fiduciary, the trustee is not acting in violation of Section 406(b)(2) regardless of the trustee's motivation. Curren v. Freitag, 432 F.Supp. 668 (S.D.Ill. 1977). See also N.L.R.B. v. Construction and General Laborers Union Local 110, 577 F.2d 16 (8th Cir. 1978), cert. denied, 439 U.S. 1070 (1979) (union trustee and secretary-treasurer of union).

    5. [Loans] The trustees of a multiemployer plan who agreed to cause the plan to: (a) pay rent to a corporation for the joint lease of an airplane (with a union) at a time when the plan held two notes from such corporation that were in default, or (b) make a loan commitment to the corporation so that the corporation could remove liens on an airplane it wished to acquire free of encumbrances, allegedly violated Section 406(b)(2). Usery v. Wilson, et al., No. 3-76-373 (E.D.Tenn., June 6, 1977) (consent order).
Section 406(b)(3)
A fiduciary with respect to a plan shall not -
(3) 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.
  1. Conference Report
  2. The above section is explained on page 309 of the Congressional Conference Report.

  3. Regulations
  4. No regulations have been issued yet. However, the regulations under Section 408(b)(2) amplify this prohibition.

    1. This prohibition is imposed to deter fiduciaries from exercising the authority, control or responsibility that makes such persons fiduciaries when they have interests that may conflict with the interests of the plans for which they act. DOL ERISA Regulation 2550.408b-2(e)(1).
    2. A fiduciary may not use the authority, control or responsibility that makes such a person a fiduciary to cause the plan to enter into a transaction involving plan assets whereby such fiduciary (or a person in which such fiduciary has an interest that may affect the exercise of such fiduciary best judgment as a fiduciary) will receive consideration from a third party in connection with such transaction. DOL ERISA Regulation 2550.408b-2(f).
    3. The regulation cited above contains several important examples. DOL ERISA Regulation 2550.408b-2(f); however, not all of the examples deal with Section 406(b)(3).
    4. For a definition of plan assets, see DOL ERISA Regulation 2510.3-101.
  5. Advisory Opinions
    1. [Compensation] The receipt of compensation by a fiduciary from a plan is a prohibited transaction if the fiduciary is already receiving full-time compensation from the employer maintaining the plan. AO 78-08.
    2. [Estate Legacy] A violation of Section 406(b)(3) would not generally occur from the mere receipt of a distribution from an estate by a plan fiduciary as beneficiary of the estate in a transaction separate and apart from the plan's acquisition of qualifying employer securities from that estate. Under such circumstances, the distribution would not appear to be in connection with the transaction involving plan assets. AO 87-04A.
    3. [Mutual Funds] No Section 406(b)(2) or (3) violations arise, per se, because fiduciaries to certain employee benefit plans are also sponsors of and advisers to certain mutual funds and the employee benefit plans purchase shares therein so long as these fiduciaries exercise none of the authority, control, or responsibility of the plans with regard to causing the plans to purchase units in the mutual funds. AO 82-31A.
  6. Court Decisions
    1. Fiduciary charged with violation of Section 406(b)(3) prohibiting receipt of consideration for fiduciary's own personal account from any party dealing with plan either must prove by a preponderance of evidence that the transaction in question fell within an exception, or must prove by clear and convincing evidence that compensation received was for services other than transactions involving plan assets. Lowen v. Tower Asset Management, Inc., 829 F.2d 1209, 8 EBC 2457 (2d Cir. 1987).
    2. If charged with a violation of Section 406(b)(3) the fiduciary bears the burden of proving that the questionable transaction fell within a Section 408 or regulatory exemption to Section 406(b)(3) or that compensation was for services other than the questionable transaction. For purposes of deciding a motion for summary judgment, if the transaction at issue is not exempted from the prohibitions of Section 406, the evidence before the court must be sufficient to permit a jury to conclude, by clear and convincing evidence, that the compensation received by a fiduciary was not "in connection with" the questionable investment of plan assets. Lowen v. Tower Asset Management, Inc., 829 F.2d 1209, 8 EBC 2457 (2d Cir. 1987).
Section 406(c)
A transfer of real or personal property by a party in interest to a plan shall be treated as a sale or exchange if the property is subject to a mortgage or similar lien which the plan assumes or if it is subject to a mortgage or similar lien which a party-in-interest placed on the property within the 10-year ending on the date of the transfer.
  1. Conference Report
  2. This provision is explained on page 308 of the Congressional Conference Report.

Section 407 Investment in Sponsor Securities and Real Estate

Section 407(a)(1)
Except as otherwise provided in this section and section 414, a plan may not acquire, or hold:
(A) Any employer security which is not a qualifying employer security, or
(B) Any employer real property which is not qualifying employer real property.
  1. Conference Report
  2. Pages 316-320 of the Congressional Conference Report explains the employer security and real property provisions.

  3. Regulations
    1. Refer to DOL ERISA Regulation 2550.407a-1. A plan may hold or acquire only employer securities that are qualifying employer securities and employer real property that is qualifying employer real property. A plan may not hold employer securities and employer real property that are not qualifying employer securities and qualifying employer real property except in certain circumstances.
    2. See DOL ERISA Regulation 404c-1, covering participant-directed plans (such as 401(k) and 403(b)), which contains authorization for investments in employer securities (404c-1(b)(2)(B)(1)(vii)), and special conditions when offering them as an "investment alternative" (see 404c-1(d)(2)(ii)(E)(4)(vii), (viii) and (ix), as well as general 404c-1 requirements). In general, fiduciaries are exempted from certain ERISA fiduciary responsibility liability if plans meet certain conditions and participants direct their own investments.
    3. Also refer to IRS Regulation 54.4975-12, which defines the term "Qualifying Employer Security".
  4. Advisory Opinions
    1. [Concentrations] The only language of ERISA that specifically limits the percentage amount of a particular asset that a plan may hold is found in Section 407, and this limitation refers to the holding or acquisition of qualifying employer securities or real property. Other than Section 407, the amount or percentage of plan assets that may be placed in a particular investment vehicle is governed by the general standards of fiduciary responsibility. AO 76-74.
    2. [Limited Partnerships] Units in a limited partnership are not qualifying employer securities within the definition of ERISA Section 407(d)(5). The continued holding of such units may be a prohibited transaction under ERISA Sections 406(a)(2) and 407(a)(1)Proposed PTE I 038.
    3. [Property - Leased] The leasing by a plan of improved real property to the employer maintaining the plan is a prohibited transaction pursuant to ERISA Section 406(a)(1)(A), (C), (D) and (E) and Code Section 4975(c)(1)(A), (C) and (D). In addition, since any property leased to an employer is "employer real property" as defined in ERISA Section 407(d)(2), if such property is not "qualifying employer real property" within the meaning of ERISA Section 407(d)(4), the holding of such property by the plan is a prohibited transaction pursuant to ERISA Sections 406(a)(2) and 407(a)(1). Also, to the extent that the employer may be a fiduciary to the plan as defined in ERISA Section 3(21)(A) and Code Section 4975(e)(3), the lease arrangement may be a prohibited transaction pursuant to ERISA Section 406(b)(1) and (2) and Code Section 4975(c)(1)(E)Proposed PTE I 192.
    4. [Stock] Stock of the parent in a controlled group corporation held by an employee benefit plan sponsored and maintained by a wholly owned subsidiary constitutes employer qualified securities under Section 407. AO 84-36A.
Section 407(a)(2)
Except as otherwise provided in this section and section 414, a plan may not acquire any qualifying employer security or qualifying employer real property, if immediately after such acquisition the aggregate fair market value of employer securities and employer real property held by the plan exceeds 10% of the fair market value of the assets of the plan.
  1. Conference Report
  2. Pages 316-320 of the Congressional Conference Report explains this employer security and real property provision.

  3. Advisory Opinions
    1. [Stock Exchanges] The exchange of stock between the employer maintaining the plan and the plan pursuant to a re-incorporation of the employer in another state is not an acquisition of employer stock by the plan. AO 75-100.
    2. [Warrants] The acquisition of an employer's common stock by a plan through the exercise of warrants constitutes an acquisition by a plan of qualifying employer securities within the meaning of ERISA Section 407(a)(2). PLR 791005.
Section 407(a)(3)
Except as otherwise provided in this section and section 414:
(A) After December 31, 1984, a plan may not hold any qualifying employer securities or qualifying employer real property (or both) to the extent that the aggregate fair market value of such securities and property determined on December 31, 1984 exceeds 10% or the greater of:
(i) The fair market value of the assets of the plan, determined on December 31, 1984, or
  (ii) The fair market value of the assets of the plan determined on January 1, 1975.
(B) Subparagraph (A) of this paragraph shall not apply to any plan that on any date after December 31, 1974, and before January 1, 1985, did not hold employer securities or employer real property (or both) the aggregate fair market value of which determined on such date exceeded 10% of the greater of -
(i) The fair market value of the assets of the plan, determined on such date, or
(ii) The fair market value of the assets of the plan determined on January 1, 1975.
  1. Conference Report
  2. Pages 316-320 of the Congressional Conference Report explains the employer security and real property provisions.

  3. Advisory Opinions

    A plan will meet the requirements of Section 407(a)(3)(B) if it falls below the 10% limitation on any day prior to December 31, 1984. AO 79-27.

  4. Court Decisions

    Where a trustee invests less than 10% of a pension plan's assets complying with ERISA Section 407(a)(3), a trustee is not relieved of other fiduciary duties contained in ERISA. Donovan v. Bierwirth, 680 F.2d 263, 3 EBC 1417 (2d Cir.), cert. denied, 459 U.S. 1069 (1982).

Section 407(a)(4)
Except as otherwise provided in this section and section 414:
(A) After December 31, 1979, a plan may not hold any employer securities or employer real property in excess of the amount specified in regulations under subparagraph (B). This subparagraph shall not apply to a plan after the earliest date after December 31, 1974, on which it complies with such regulations.
(B) Not later than December 31, 1976, the Secretary shall prescribe regulations which shall have the effect of requiring that a plan divest itself of 50% of the holdings of employer securities and employer real property which the plan would be required to divest before January 1, 1985, under paragraph (2) or subsection (c) (whichever is applicable).
  1. Conference Report
  2. Pages 316-320 of the Congressional Conference Report explain the employer security and real property provisions.

  3. Advisory Opinions
  4. [Bonds] A plan's holding of debentures issued by an employer may constitute a loan or extension of credit to the employer, which, if the conditions of Section 414(c)(1) are met, would be exempt until June 30, 1984 from the restrictions of Section 407(a). WSB 79-69.

Section 407(b)
(1) Subsection (a) of this section shall not apply to any acquisition or holding of qualifying employer securities or qualifying employer real property by an eligible individual account.
(2) Cross References. -
(A) For exemption from diversification requirements for holding of qualifying employer securities and qualifying employer real property by eligible individual account plans, see section 404(a)(2).
(B) For exemption from prohibited transactions for certain acquisitions of qualifying employer securities and qualifying employer real property which are not in violation of the 10% limitation, see section 408(e).
(C) For transitional rules respecting securities or real property subject to binding contracts in effect on June 30, 1974, see section 414(c).
  1. Conference Report
  2. Pages 316-320 of the Congressional Conference Report explains the above employer security and real property provision.

Section 407(c)
(1) A plan which makes the election under paragraph (3) shall be treated as satisfying the requirements of section 407(a)(3) if - and only if - employer securities held on any date after December 31, 1974 and before January 1, 1985 have a fair market value, determined as of December 31, 1974, not in excess of 10% of the lesser of
(A) The fair market value of the assets of the plan determined on such date (disregarding any portion of the fair market value of employer securities which is attributable to appreciation of such securities after December 31, 1974 but not less than the fair market value of plan assets on January 1, 1975), or
(B) An amount equal to the sum of (i) the total amount of the contributions to the plan received after December 31, 1974, and prior to such date, plus (ii) the fair market value of the assets of the plan, determined on January 1, 1975.
(2) For purposes of this subsection, in the case of an employer security held by a plan after January 1, 1975, the ownership of which is derived from ownership of employer securities held by the plan on January 1, 1975, or from the exercise of rights derived from such ownership, the value of such security held after January 1, 1975, shall be based on the value as of January 1, 1975, of the security from which ownership was derived. The Secretary shall prescribe regulations to carry out this paragraph.
(3) An election under this paragraph may not be made after December 31, 1975. Such an election shall be made in accordance with regulations prescribed by the Secretary, and shall be irrevocable. A plan may make an election under this paragraph only if on January 1, 1975, the plan holds no employer real property. After such election and before January 1, 1985, the plan may not acquire any employer real property.
  1. Conference Report
  2. Pages 316-320 of the Congressional Conference Report explain the employer security and real property provisions.

Section 407(d)(1)
For purposes of this section -
The term "employer security" means a security issued by an employer of employees covered by the plan, or by an affiliate of such employer. A contract to which section 408(b)(5) applies shall not be treated as a security for purposes of this section.
  1. Conference Report
  2. Pages 316-320 of the Congressional Conference Report explain the definition of the term employer security.

  3. Advisory Opinions
    1. [Bonds] Rights to certain debentures may be employer securities. AO 76-72.
    2. [Loan Guarantees] The guarantee by an employer of loans made by the plan to a third party constitutes an employer, under Section 407(d)(1) but not a qualifying employer security under Sections 407(d)(5) and 407(e). WSB 79-51.
Section 407(d)(2)
For purposes of this section -
The term "employer real property" means real property (and related personal property) which is leased to an employer of employees covered by the plan, or to an affiliate of such employer. For purposes of determining the time at which a plan acquires employer real property, for purposes of this section, such property shall be deemed to be acquired by the plan on the date on which the plan acquires the property or the date on which the lease to the employer (or affiliate) is entered into, whichever is later.
  1. Conference Report
  2. Pages 316-320 of the Congressional Conference Report explain the definition of the term employer real property.

Section 407(d)(3)
For purposes of this section -
(A) The term "eligible individual account plan" means an individual account plan which is (i) a profit-sharing, stock bonus, thrift or savings plan; (ii) an employee stock ownership plan; or (iii) a money purchase plan which was in existence on the date of enactment of this Act and which on such date invested primarily in qualifying employer securities. Such term excludes an individual retirement account or annuity described in section 408 of the Internal Revenue Code of 1954.
(B) Notwithstanding subparagraph (A) a plan shall be treated as an eligible individual account plan with respect to the acquisition or holding of qualifying employer real property or qualifying employer securities only if such plan explicitly provides for acquisition and holding of qualifying employer securities or qualifying employer real property (as the case may be). In the case of a plan in existence on the date of enactment of this Act, this subparagraph shall not take effect until January 1, 1976.
  1. Conference Report
  2. The term eligible individual account plan is covered at pages 316-320 of the Congressional Conference Report.

  3. Advisory Opinions
    1. [ESOPs] Section 407(b)(1) provides that the limitations on the acquisition and retention of qualifying employer securities and qualifying employer real property as contained in Section 407(a) do not apply to eligible individual account plans. Section 407(d)(3) defines the term eligible individual account plan to include an individual account plan that is an ESOP and that expressly provides for the acquisition and holding of employer securities. AO 81-67A.
    2. An individual account plan is not an eligible individual account plan unless it explicitly provides for the acquisition and holding of qualifying employer securities or qualifying employer real property. AO 78-25; WSB 79-86.
    3. [Profit Sharing Plans] Where a plan is a profit-sharing plan and, therefore, meets the requirements of Section 407(d)(3)(A), it would constitute an eligible individual account plan for purposes of Section 407(d)(3) in connection with the sale of employer stock held by the plan, even though the plan does not expressly provide for the acquisition and holding of employer securities as required by Section 407(d)(3)(B). WSB 79-88.
  4. Court Decisions
    1. [Governing Documents] For purposes of determining whether a plan provides for the purchase of employer securities, both the plan and the trust agreement can be looked to as plan documents. Leonard v. Drug Fair, Inc., Fed. Sec. L. Rep. (CCH) 997,144 (D.D.C. 1979).
    2. [Defined Contribution Plan] Where the board of directors amended a pension plan to allow up to 50% of the plan's assets to be used to purchase the employer's securities, the plan will not violate ERISA Section 407 if the plan is within the definition of an eligible individual account plan. District 65, U.A. W. v. Harper & Row Publishers, Inc., 576 F.Supp. 1468, 4 EBC 2586, F&L S&L L. Rep. (CCH) 999,608 (S.D.N.Y. 1983).
    3. [ESOPs] If a pension plan that allows up to 50% of the plan's assets to be used to purchase the employer's securities is an ESOP, the plan must conform to Code Section 401 in order to be an eligible individual account plan under ERISA Section 407(a). District 65, U.A. W. v. Harper & Row Publishers, Inc., 576 F.Supp. 1468, 4 EBC 2586, F&L S&L L. Rep. (CCH) 999,608 (S.D.N.Y. 1983).
    4. [Bonds] In order for the purchase of debt securities by an eligible individual account plan to be exempt from the Section 407 limitations, the plan must specifically provide for the holding of marketable obligations of the type involved. Marshall v. Dekeyser, 485 F.Supp. 629, 1 EBC 1898 (W.D.Wis. 1979).
Section 407(d)(3)(C)
The term "eligible individual account plan" does not include any individual account plan the benefits of which are taken into account in determining the benefits pursuant to a participant under any defined benefit plan.
Section 407(d)(4)
For purposes of this section -
The term "qualifying employer real property" means parcels of employer real property-
(A) if a substantial number of the parcels are dispersed geographically;
(B) if each parcel of real property and the improvements thereon are suitable (or adaptable without excessive cost) for more than one use;
(C) even if all such real property, is leased to one lessee (which may be an employer, or an affiliate of an employer); and
(D) if the acquisition and retention of such property comply with the provisions of this part (other than section 404(a)(1)(B) to the extent it requires diversification, and sections 404(c)(1)(C)406 and 407(a) of this section).
  1. Conference Report
  2. Pages 316-320 of the Congressional Conference Report explain the definition of the term qualifying employer real property.

  3. Advisory Opinions
    1. To meet the substantial number requirement of Section 407(d)(4)(A), there must be more than one parcel. AO 84-20A.
    2. A single parcel of real property cannot be qualifying employer real property. Qualifying employer real property means parcels (plural) of employer real property. AO 76-14; AO 76-132; AO 77-16; Proposed PTE I 192, PLR 7847043.
    3. Whether a substantial number of parcels of employer real property are geographically dispersed so as to provide protection for a plan in the event of adverse economic conditions in any one area, and whether such parcels are suitable or adaptable without excessive cost for more than one use are both questions that are inherently factual in nature and will not be the subject of advisory opinions. AO 84-20A.
    4. Employer real property, is qualifying employer real property where there are six parcels of real property located in four different states; no two parcels are closer than 80 miles apart; five of the six parcels contain simple one-story structures and the machinery located therein could be removed at minimal costs without affecting the structure; and the sixth parcel contains a building with offices and open space for laboratories and machinery. AO 75-11.
    5. The definition of the term qualifying employer real property requires a determination regarding whether a particular acquisition or retention of employer real property complies with ERISA Section 404. The Department of Labor will not issue an advisory opinion under Section 407(d)(4)(D) as to whether particular employer real property is qualifying employer real property. The Department will; however, issue advisory opinions regarding the other substantive conditions of Section 407(d)(4). AO 77-01.
    6. The geographical dispersion requirement is satisfied where three parcels of property contain three restaurants that serve and draw from different fast food markets. AO 77-01.
Section 407(d)(5)
For purposes of this section -
The term "qualifying employer security" means an employer security which is (1) stock; (2) a marketable obligation (as defined in section (e)), or (3) an interest in a publicly traded partnership (as defined in section 7704(b) of the IRC of 1986), but only if such partnership is an existing partnership as defined in section 10211(c)(2)(A) of the Revenue Act of 1987 (Public Law 100-203). After December 17, 1987, in the case of a plan other than an eligible individual account plan, stock shall be considered a qualifying employer security only if such stock satisfies the requirements of subsection (f)(1).
  1. Conference Report
  2. Pages 316-320 of the Congressional Conference Report explain the definition of the term qualifying employer security.

  3. Regulations
  4. DOL ERISA Regulation 2550.407d-5 merely restates the statutory provisions.

  5. Advisory Opinions
    1. [Affiliate] A plan owns 100% of the stock of a corporation, but employees of that corporation do not participate in the plan. The stock of the corporation is not qualifying employer securities under Section 407(d)(5), since it has not been issued by an employer or an affiliate of an employer. AO 79-27.
    2. [Affiliate] In general, where the employees of two or more employers [whether or not affiliated within the meaning of Section 407(d)(7)] are covered by a single plan, the securities issued by each employer or by an affiliate thereof, as defined in Section 407(d)(7), would ordinarily constitute qualifying employer securities within the meaning of Section 407(d)(5) if the applicable requirements under that section are satisfied. Accordingly, if the plan is, in fact, a single plan and continues to be maintained as one plan by both employers for their respective employees, the common stocks of each and both employers would constitute qualifying employer securities for purposes of applying the provisions of Sections 404(a)(2) and 407. AO 81-5A.
    3. [Affiliate Stock] The common stock of a wholly owned subsidiary would be a qualifying employer security because it is a stock issued by an affiliate of an employer of employees covered by the plan. If the subsidiary has such employees, it would be stock issued by an employer of employees covered by the plan. If the subsidiary has employees covered by the plan, the subsidiary's stock will continue to be a qualifying employer security after the plan owns all of such stock. WSB 78-31. See also AO 77-30; WSB 78-26; WSB 79-86.
    4. [Convertible Bonds] Debentures issued by an employer that are convertible into stock do not constitute stock for Purposes of Section 407(d)(5). AO 79-45.
    5. [Loan Guarantees] The guarantee by an employer of loans made by the plan to a third party constitutes an employer security under Section 407(d)(1) but not a qualifying employer security under Sections 407(d)(5) and 407(e). WSB 79-51.
    6. [Rights] Rights to certain debentures are not qualifying employer securities because they are neither stock nor marketable obligations. AO 76-72.
    7. [Stock] Book value shares are qualifying employer securities. AO 77-35.
    8. [Stock - Preferred] Preferred stock issued by an affiliate of an employer whose employees are covered by a plan is a qualifying employer security. AO 75-89.
Section 407(d)(6)
For purposes of this section -
The term "employee stock ownership plan" means an individual account plan -
(A) Which is a stock bonus plan which is qualified, or a stock bonus plan and money purchase plan both of which are qualified, under section 401 of the Internal Revenue Code of 1954, and which is designed to invest primarily in qualifying employer securities, and
(B) Which meets such other requirements as the Secretary of the Treasury may prescribe by regulation.
  1. Conference Report
  2. The term ESOP is covered at pages 316-320 of the Congressional Conference Report.

  3. Regulations
  4. Refer to DOL ERISA Regulation 2550.407d-6. These regulations contain several requirements relating to ESOPs.

    An ESOP must also meet such other requirements as the Secretary of the Treasury may prescribe by regulation under Section 4975(e)(7) of the Internal Revenue Code.

  5. Advisory Opinions

    [ESOPs] Where a plan is organized and established as an employee stock ownership plan for the purpose of investing primarily in qualifying employer securities but where under the circumstances it would not be prudent or otherwise beneficial to plan participants for the ESOP to invest a large percentage of its assets in qualifying employer securities, even though plan documents generally provide for such investments. In that situation the potential liability for breach of fiduciary duty makes a fiduciary's decision to disregard a plan provision difficult. A plan provision that requires a plan to invest more than 50% of is assets in qualifying employer securities would normally be deemed to satisfy the requirement of Section 407(d)(6) that a plan must satisfy the primary requirement with regard to its primary investment objectives and vehicle. AO 83-6A.

  6. Court Decisions

    [ESOPs] Where a pension plan purchased common stock without voting rights, the plan can still qualify as an ESOP under ERISA Section 407(d)(6), since Code Section 401 does not require stock to have voting rights for tax qualified plans. However, the ESOP must obtain voting power equal to or in excess of the amount of voting power held in said stock by the employer. Schoenholtz v. Doniger 657 F.Supp. 899, 8 EBC 2031 (S.D.N.Y. 1987).

Section 407(d)(7)
For purposes of this section -
A corporation is an affiliate of an employer if it is a member of any controlled group of corporations (as defined in section 1563(a) of the Internal Revenue Code of 1954, except that "applicable percentage" shall be substituted for "80%" whenever the latter percentage appears in such section) of which the employer who maintains the plan is a member. For purposes of the preceding sentence, the term "applicable percentage" means 50%, or such lower percentage as the Secretary may prescribe by regulation. A person other than a corporation shall be treated as an affiliate of an employer to the extent provided in regulations of the Secretary. An employer which is a person other than a corporation shall be treated as affiliated with another person to the extent provided by regulations of the Secretary. Regulations under this paragraph shall be prescribed only after consultation and coordination with the Secretary of the Treasury.
  1. Conference Report
  2. "Affiliate" is discussed on pages 316-320 of the Congressional Conference Report.

  3. Advisory Opinions
    1. A corporation must be an affiliate prior to the sale of its securities for its securities to be either employer securities or qualifying employer securities. AO 77-18.
    2. [Affiliate] Where an employer owns 62% of the outstanding stock of a corporation, such corporation is an "affiliate" of the employer under Section 407(d)(7). AO 79-23.
    3. [Affiliate] A plan owns 100% of the stock of a corporation, but employees of that corporation do not participate in the plan. The stock of the corporation is not qualifying employer securities under Section 407(d)(5), since it has not been issued by an employer or an affiliate of an employer. AO 79-27.
    4. For the exemption provided by Section 408(e) to apply to any sale, the property being sold must be either qualifying employer securities or qualifying employer real property at the time such securities or property, are sold by the plan. If a corporation is not a member of a controlled group prior to the consummation of a sale, the corporation's securities will not be securities of an affiliate prior to the sale. AO 77-18.
Section 407(d)(8)
For purposes of this section -
The Secretary may prescribe regulations specifying the extent to which conversions, splits, the exercise of rights, and similar transactions are not treated as acquisitions.
  1. Conference Report
  2. The above provision is covered at pages 316-320 of the Congressional Conference Report.

Section 407(d)(9)
For purposes of this section, an arrangement which consists of a defined benefit plan and an individual account plan shall be treated as one plan if the benefits of such individual account plan are taken into account in determining the benefits payable under such defined benefit plan.

Section 407(e)
For purposes of subsection (d)(5), the term "marketable obligation" means a bond, debenture, note, or certificate, or other evidence of indebtedness (hereinafter in this subsection referred to as "obligation") if -
(1) Such obligation is acquired -
(A) On the market, either
(i) At the price of the obligation prevailing on a national securities exchange which is registered with the Securities and Exchange Commission, or
(ii) If the obligation is not traded on such a national securities exchange, at a price not less favorable to the plan than the offering price for the obligation as established by current bid and asked prices quoted by persons independent of the issuer;
(B) From an underwriter, at a price
(i) Not in excess of the public offering price for the obligation as set forth in a prospectus or offering circular filed with the Securities and Exchange Commission, and
(ii) At which a substantial portion of the same issue is acquired by persons independent of the issuer; or
(C) Directly from the issuer, at a price not less favorable to the plan than the price paid currently for a substantial portion of the same issue by persons independent of the issuer;
(2)  Immediately following acquisition of such obligation -
(A) Not more than 25% of the aggregate amount of obligations issued in such issue and outstanding at the time of acquisition is held by the plan, and
(B) At least 50% of the aggregate amount referred to in subparagraph (A) is held by persons independent of the issuer; and
(3) Immediately following acquisition of the obligation, not more than 25% of the assets of the plan is invested in obligations of the employer or an affiliate of the employer.
  1. Conference Report
  2. These employer security provisions are discussed at pages 316-320 the Congressional Conference Report.

  3. Regulations
  4. No regulations have been issued under Section 407(e), but regulations have been issued under Section 407(d)(5)ERISA Regulation 2550.407d-5.

  5. Advisory Opinions
    1. ["Independence"] A relative of an officer of the issuer is not "independent of the issuer." WSB 77-13; AO 78-25.
    2. ["Independence"] A private foundation that was created by and may receive contributions from the issuer is not "independent of the issuer." AO 78-25.
    3. [Loan Guarantees] The guarantee by an employer of loans made by the plan to a third party constitutes an employer security under Section 407(d)(1), but not a qualifying employer security under Sections 407(d)(5) and 407(e). WSB 79-51.
    4. ["Marketable"] Debentures issued by a subsidiary of an employer constitute marketable obligations where they are purchased at the closing price on the New York Stock Exchange on the date of purchase, where they represent only 1.14% of the aggregate amount of debentures outstanding, where 50% of such aggregate amount is held by persons independent of the employer, and where the value of the debentures represents 22% of plan assets. AO 79-39.
    5. [Mergers & Acquisitions] A trust will not be considered to have acquired certain debentures if, prior to the corporate merger pursuant to which the trust would have received the debentures, the trust sells or irrevocably assigns the rights to the debentures that it would have received in the merger. AO 76-72.
    6. [Notes] A promissory note issued by an employer to a plan in lieu of a cash contribution to the plan will not constitute a marketable obligation if a substantial portion of the same issue of rates is not acquired by persons independent of the issuer for purposes of Section 407(e)(1) contemporaneously with the acquisition by the plan. PLR 7939009.
Section 407(f)
Stock satisfies the requirements of this subsection if immediately following the acquisition of such stock -
(1) (A) No more than 25% of the aggregate amount of stock of the same class issued and outstanding at the time of acquisition is held by the plan, and
(B) At least 50% of the aggregate amount referred to in subparagraph (A) is held by persons independent of the issuer.
(2) Until January 1, 1993, a plan shall not be treated as violating subsection (A) solely by holding stock which fails to satisfy the requirements of paragraph (1) if such stock -
(A) Has been held since December 17, 1987, or
(B) Was acquired after December 17, 1987 pursuant to a legally binding contract in effect on December 17, 1987, and has been so held at all times after the acquisition.
(3) After December 17, 1987, no plan may acquire stock which does not satisfy the requirements of paragraph (1) unless the acquisition is made pursuant to a legally binding contract in effect on such date.

408   Statutory Exemptions to Prohibited Transactions

Section 408(a)

Exemption Procedures
The Secretary shall establish an exemption procedure for purposes of this subsection. Pursuant to such procedure, he may grant a conditional or unconditional exemption of any fiduciary or transaction, or class of fiduciaries or transactions, from all or part of the restrictions imposed by Sections 406 and 407(a). Action under this subsection shall be taken only after consultation and coordination with the Secretary of the Treasury. An exemption granted under this section shall not relieve a fiduciary from any other applicable provision of this Act. The Secretary may not grant an exemption under this subsection unless he finds that such exemption is -
(1) Administratively feasible,
(2) In the interests of the plan and of its participants and beneficiaries, and
(3) Protective of the rights of participants and beneficiaries of such plan. Before granting an exemption under this subsection from section 406(a) or section 407(a), the Secretary shall publish notice in the Federal Register of the pendency of the exemption, shall require that adequate notice be given to interested persons, and shall afford interested persons an opportunity to present views. The Secretary may not grant an exemption under this subsection from section 406(b) unless he affords an opportunity for a hearing and makes a determination on the record with respect to the findings required by paragraphs (1), (2) and (3) of this subsection.
  1. Conference Report.
  2. The above exemption procedure is discussed on pages 309-311 of the Congressional Conference Report.

  3. Regulations.
  4. See DOL ERISA Regulation 2570.30 through .52. The regulation covers who may file for an exemption, where applications must be filed, the information to be included with an application, rights and procedures to a conference, publication and notification of interested persons, and the effect of an exemption. See also Revenue Procedure 75-26.

  5. Prohibited Transaction Class Exemptions (PTE)
    1. [Annuities] PTE C 77-8 covers the transfer of individual life insurance and annuity contracts from plans to a plan participant, the relative of a participant, the participant's employer or another plan. PTE C 77-7 covers transfers of the same assets to plans from plan participants or employers.
    2. [Brokerage Services] PTE 79-1 granted an exemption for securities transactions for employee benefit plans by broker-dealers who serve as fiduciaries to the plans.
    3. [Brokerage Services] In PTE 78-10, an exemption was granted for provision of securities by broker-dealers to plans for which they are fiduciaries.
    4. [Brokerage Services] Exemption is granted for the execution of certain securities transactions in PTE 86-128.
    5. [Collective Investment Funds] An exemption was granted for transactions between bank collective investment funds and parties in interest. PTE 80-51 (restated to PTE 91-38).
    6. [Court-Authorized Transactions] PTE C 79-15 covers certain transactions authorized or required by judicial order or judicially approved settlement decree.
    7. [Court-Directed Transactions] An exemption was granted for transactions authorized or permitted by a court. PTE 79-15.
    8. [Customer Notes] A class exemption is granted for the purchase of customer notes of a party-in-interest employer by an employee benefit plan in PTE 85-68.
    9. [Debt Retirement] PTE 80-83 provided an exemption for employee plans' purchase of securities used to retire indebtedness owed to parties in interest.
    10. [Interest-Free Loans] PTE 80-26 granted an exemption for certain interest free loans, such as overdrafts, between employee benefit plans and parties in interest.
    11. [Mortgages] An exemption was granted for employee benefit plans to provide mortgage financing to purchasers of certain residential construction in PTE 82-87.
    12. [Mortgage Pools] PTE 81-7 exempted certain transactions between employee benefit plans and parties in interest involving mortgage pool investment trusts.
    13. [Mutual Funds] PTE  77-4 covers the purchase and sale by a plan of mutual fund shares when a fiduciary to the plan is also the investment adviser for the mutual fund. Also see 1994 DOL letter to OCC.
    14. [Mutual Funds - Closed-End] In PTE 79-13, an exemption was granted for acquisitions of shares in closed-end investment companies by employee benefit plans.
    15. [Mutual Funds - Own] PTE  77-3 covers the purchase and sale of in-house mutual fund shares by an employee benefit plan covering employees of the mutual fund, its investment adviser or principal underwriter, or an affiliate thereof.
    16. [Mutual Funds - Own Closed-End] PTE 79-13 covers the acquisition and sale of shares of certain registered closed end investment companies by plans that cover employees of the company, its investment adviser or an affiliate thereof.
    17. [Office Space] PTE 77-10 grants an exemption for sharing and leasing of office space and administrative goods by multiple employer plans.
    18. [Overdrafts] PTE 80-26 granted an exemption for certain interest free loans, such as overdrafts, between employee benefit plans and parties in interest.
    19. [QPAM] PTE 84-14 covers certain prohibited transactions involving plans whose assets are managed by a qualified professional asset manager (QPAM).
    20. [Repurchase Agreements] PTE 81-8 deals with the exemption granted for certain short-term investments (including repurchase agreements) by employee benefit plans.
    21. [Securities Lending] PTE 81-6 granted an exemption for the lending of securities by employee benefit plans to broker-dealers and banks that are parties in interest to the plan.
    22. [Securities Lending - Fees] An exemption was granted for the provision of securities lending services by a fiduciary to an employee benefit plan in PTE 82-63.
    23. [Short-Term Investments] PTE 81-8 deals with the exemption granted for certain short-term investments (including repurchase agreements) by employee benefit plans.
    24. PTE  77-9 covers six classes of transactions involving insurance agents and brokers, pension consultants, insurance companies, investment companies, investment company principal underwriters, and employee benefit plans:
      • The fourth class covers the purchase with plan assets of an insurance or annuity contract from an insurance company.
      • The fifth and sixth classes of transactions cover the purchase with plan assets of insurance or annuity contracts or securities issued by an investment company in situations where the insurance company, investment company, or investment company principal underwriter is a fiduciary or service provider to the plan solely by reason of sponsorship of a master or prototype plan.
    25. Exemptions from prohibitions respecting certain transactions in which multiemployer and multiple employer plans are involved. PTE 76-1 and PTE 77-10. These exemptions cover three classes of transactions: (1) delinquent employer contributions; (2) construction loans; and (3) office space, administrative services and goods.
    26. Exemptions from prohibitions respecting certain classes of transactions involving employee benefit plans and certain broker-dealers, reporting dealers and banks. PTE  75-1, PTE 78-10, and PTE 79-1. These exemptions cover five classes of transactions: (1) agency transactions and services, (2) principal transactions, (3) under writings, (4) market making, and (5) extensions of credit.
  6. Advisory Opinions
    1. [Bonding of Fiduciaries] The bonding provisions of ERISA are contained in Section 412. It is unlawful under Section 412(c) for any Person to procure a required bond through an agent in whose business operation a party in interest has any control or significant financial interest. ERISA's exemption provisions regarding bonding are contained in Section 412(e). Accordingly, it is concluded that Sections 408 and 414(c)(4) are not applicable to transactions that are unlawful under Section 412(c). AO 76-92.
    2. [Relatives] An agent or broker who is a cousin of a plan fiduciary may receive commissions as agent or broker on the sale of insurance to the plan. WSB 79-104.
  7. Court Decisions
  8. Even though the terms of a transaction may be fair to the plan, if it constitutes a prohibited transaction under Section 406, the transaction constitutes a per se violation of ERISA without a Section 408 exemption. Approval of the transaction by a Taft-Hartley umpire is not sufficient. Cutaiar v. Marshall, 590 F.2d 523 (3d Cir. 1979).

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Section 408(b)(1)

Loans to Plan Participants
The prohibitions provided in Section 406 shall not apply to any of the following transactions:
Any loans made by the plan to parties in interest who are participants or beneficiaries of the plan if such loans:
(A) Are available to all such participants and beneficiaries on a reasonably equivalent basis,
(B) Are not made available to highly compensated employees (within the meaning of Section 414(q) of Title 26) in an amount greater than the amount made available to other employees,
(C) Are made in accordance with specific provisions regarding such loans set forth in the plan,
(D) Bear a reasonable rate of interest, and
(E) Are adequately secured.
  1. Conference Report
  2. Participant loans are discussed on pages 311-316 of the Congressional Conference Report.

  3. Statutes
  4. Also refer to Section 72(p) of the Internal Revenue Code, which imposes additional restrictions on loans to plan participants.

  5. Regulations
    1. Refer to DOL ERISA Regulation 2550.408b-1.
    2. If plan makes more than 25 participant loans in a calendar year, it will be need to make the APR and Finance Charge (and other) disclosures required by the Truth in Lending Act and Federal Reserve Regulation Z. Refer to:
      1. Footnote 3 of Regulation Z, concerning who meets the test of being a Creditor under Section 226.2(a)(17) of the Regulation; and
      2. The Federal Reserve Board Official Staff Commentary on Regulation Z explanation of how Creditor applies to -
        • Individual trust accounts instead of the Trust Department as a whole [Item 7], and
        • "Employee savings plans" (401(k) and 403(b)-type plans) [Item 8].
  6. Advisory Opinions
    1. A transaction exempted by Section 408(b) from the prohibitions of Section 406(a) is not exempted for that portion of the transaction which may constitute a violation of Section 406(b). AO 83-45A.
    2. The analysis of a program of investment by an employee benefit plan in residential mortgage loans that may be available to the plan's participants involves consideration of three distinct questions:
      1. Whether the program is prudent within the meaning of Section 404(a)(1)(B),
      2. Whether the loans within such a program are prudent within the meaning of that section, and
      3. Where a loan is to be made to a plan participant, whether the rate of interest charged on the loan is available within the meaning of Section 408(b)(1).

      [Note that the Department of Labor in December 1987 issued regulations under Section 408(b)(1) defining "reasonable rate of interest" consistent with prior decisions under Section 404(a)(2)(B), for example, endorsing the market or prevailing rate of interest.] AO 81-12A.

    3. [ESOPs] Section 408(d) makes Section 408(b)(1) unavailable for transactions that involve a loan of any part of the income or corpus of a plan to a shareholder-employee as defined in Code Section 1379(d) of the employer maintaining the plan. The applicability of Section 408(b)(1) depends, among other things, on whether the proposed recipient is such a shareholder-employee. The trustees of the plan are responsible for determining whether the provisions of Section 408(b)(1), or any other section of ERISA, are applicable to the plan. AO 75-105.
    4. A transaction that constituted a prohibited transaction but that was subject to a statutory exemption under Section 408(b) when the transaction was entered into may, in the future, become prohibited while the transaction continues because of changes in the relationship, causing the loss of the statutory exemption protection for the transaction. Thus, a loan between a plan and a party in interest may be entitled to relief under Section 408(b)(1) when the loan was made. However, if the party in interest later becomes an owner-employee for purposes of Section 408(d), then the loan is a prohibited transaction for which no relief is available under Section 408(b)(1). AO 84-44A.
  7. Court Decisions
    1. If other participants are required to provide greater security for their loans from a plan than the participant was required to provide, the loans to the participant are not made on a reasonably equivalent basis to loans to other participants as required by ERISA Section 408(b)(1)(A). Marshall v. Kelly, 465 F.Supp. 341, 1 EBC 1850 (W.D.Okla. 1978).
    2. If a loan from a plan to a participant exceeds the total of all loans to all other participants, the loan does not meet the criteria of ERISA Section 408(b)(1)(B). Marshall v. Kelly, 465 F.Supp. 341, 1 EBC 1850 (W.D.Okla. 1978).
    3. A loan in an amount that exceeds the limits set forth in the plan document does not satisfy ERISA Section 408(b)(1)(C). Marshall v. Kelly, 465 F.Supp. 341, 1 EBC 1850 (W.D.Okla. 1978).
    4. A participant's vested interest in a plan may not constitute adequate security for a loan from the plan under Section 408(b)(1)(E). Marshall v. Kelly, 465 F.Supp. 341, 1 EBC 1850 (W.D.Okla. 1978).
Section 408(b)(2)

Ancillary Services
The prohibitions provided in Section 406 shall not apply to any of the following transactions:
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 the plan, if no more than reasonable compensation is paid therefore.
  1. Conference Report
  2. General ancillary services are covered on pages 311-316 of the Congressional Conference Report.

  3. Regulations
  4. Refer to DOL ERISA Regulation 2550.408b-2.

    1. Section 408(b)(2) does not contain an exemption from acts described in Section 406(b)(1) through (3). Such acts are separate transactions not described in Section 408(b)(2). DOL ERISA Regulation 2550.408b-2(a).
    2. A service is necessary for the establishment or operation of a plan if the service is appropriate and helpful to the plan obtaining the service in carrying out the purposes for which the plan is established and maintained. DOL ERISA Regulation 2550.408b-2(b).
    3. No contract or arrangement is reasonable 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. DOL ERISA Regulation 2550.408b-2(c).
    4. The prohibitions of Section 406(b) supplement the other provisions of Section 406(a) by imposing on parties in interest who are fiduciaries a duty of undivided loyalty to the plans for which they act. The prohibitions are imposed upon fiduciaries to deter them from exercising the authority, control or responsibility that makes such persons fiduciaries when they have interests that may conflict with the interest of the plans for which they act. A fiduciary may not use the authority, control or responsibility that makes such person a fiduciary to cause a plan to pay an additional fee to a person in which such fiduciary has an interest that may affect the exercise of such fiduciary's best judgment as a fiduciary to provide a service. DOL ERISA Regulation 2550.408b-2(e).
    5. The regulations cited above contain several important examples. DOL ERISA Regulation 2550.408b-2(f). Some of the examples, however, only deal with Section 406(b)(1) and not with Sections 406(b)(2) and 406(b)(3).
    6. The provision of services by a multiemployer plan to a party in interest is the subject of PTE C 76-1 and PTE C 77-10.
  5. Prohibited Transaction Class Exemptions (PTE)
    1. [Bank - Securities Lending] A securities lending service offered by a bank fiduciary to plans would not be exempt under Section 408(b)(2) because the compensation arrangement, which was based on a percentage of the value of the securities loan, might involve self-dealing. AO 79-11. However, see PTE 81-6 and PTE 82-63.
    2. [Brokerage Services] A broker-dealer who provides investment advice to a plan and is therefore a fiduciary may, under certain circumstances, be able to effect brokerage transactions to a plan provided that he obtains prior authorization from another plan fiduciary before effecting any such transaction. Final PTE C 78-10.
    3. [Brokerage Services at Cost or Free] Broker-dealers may perform brokerage services for plans that they sponsor when such services are undertaken to recapture commissions, when such services are provided in accordance with the provisions of Section 408(b)(2), or when such services are performed at no charge to a plan. Final PTE C 79-1.
    4. [Indirect Expenses] Under ERISA Section 408(b)(2) and Code Section 4975(d)(2), a fiduciary may perform services for a plan and be reimbursed for certain direct expenses incurred in connection with those services. However, the allocation of overhead costs to the plan may not be covered by this exemption. Final PTE C 79-1.
    5. [Office Space] The furnishing of office space or administrative services to a plan by a participating employee organization, employer or employee association, or by another multiemployer plan or multiple employer plan that is a party in interest or disqualified person to the plan, will generally be exempt from the prohibited transaction provisions if the conditions of ERISA Section 408(b)(2) and Code Section 4975(d)(2) are met. Final PTE C 76-1.
  6. Advisory Opinions
    1. [General] The Department will not rule on what constitutes a "necessary" service, a "reasonable" contract or arrangement, or what constitutes "reasonable" compensation since each issue is inherently factual in nature. Further, although Section 408(b)(2) generally permits the performance of multiple services for the same plan, it does not exempt an act of self-dealing by a fiduciary under the provisions of Section 406(b)(1). AO 82-26A.
    2. [Administrative Services] A law firm may provide both legal and administrative services to a plan if the arrangement for all such services meets all of the requirements of Section 408(b)(2) and (c)(2) and Regulations Sections 2550.408b-2 and 2550.408c-2 and does not contravene the requirements of Section 406(b). WSB 78-18.
    3. [Administrative Services] A welfare plan may retain a participating union to provide administrative services to the plan for a fee if those plan trustees who are officers of the union physically absent themselves from all consideration of the matter and do not use any of their authority or control to influence the plan's decision to hire the union). See Example 7 of DOL ERISA Regulation 2550.408b-2(f). WSB 79-41.
    4. [Bank - Own-Bank Trustee] A bank is not prohibited from serving as trustee for a plan maintained for the bank's employees where it receives no compensation from the plan for its trustee services (Emphasis added). AO 79-49.
    5. [Bank - Brokerage Service] The provision of brokerage services by a bank to employee benefit plans maintained by it for which the bank also serves as custodian and/or investment manager would be exempt from the prohibitions of Section 406(a) if the conditions of Section 408(b)(2) are met. Whether the conditions are met in each case involves questions that are inherently factual in nature and on which the Department of Labor will issue no rulings. AO 85-15; accord AO 85-16.
    6. [Bank - CIF Investment Manager] The provision of investment management services by a wholly owned bank subsidiary would be exempt from the prohibitions of Section 406(a)(1) of ERISA in connection with the maintenance of a common or collective trust fund if the conditions of Section 408(b)(2) are specifically met. AO 82-22A.
    7. [Bank - CIF Investment Manager] The supplying of investment management and advisory services by a registered advisor/investment manager to a common trust fund of a bank, both of which are part of a single controlled group, would be exempt from the prohibitions of Section 406(a) if the conditions of Section 408(b)(2) are met. The exemption granted by Section 408(b)(2) is limited to Section 406(a) prohibited transactions and does not cover the situations described in Section 406(b). Thus, a decision with regard to the manager's retention by the common trust fiduciaries could constitute a violation of Section 406(b). Further, compensation paid by a service provider to its employees may be a properly reimbursable expense under Regulations Section 2550.408c-2(b)(3) if the expense would not, in fact, have been sustained had the services not been provided and if it can be properly allocated to the particular services provided. What constitutes a direct expense in a particular case; however, is a factual matter to be resolved, taking into account the relevant facts and circumstances, and will not be the subject of an advisory opinion. AO 83-20A.
    8. [Bank - CIF/STIF] The provision of trustee services by a bank to employee benefit plans and the investment of plan funds in the bank's commingled short term investment fund would be exempt from the prohibitions of Section 406(a) if the conditions of Sections 408(b)(2) and 408(b)(8) are met. Also, the mere selection of the bank to provide trustee services to the plans would not in itself constitute a violation of Section 406(b)(1). However, self-dealing in violation of Section 406(b)(1) could occur in the case of a committee's deliberations regarding the retention of the bank as trustee, and no opinion can be rendered on that potential circumstance. AO 82-62A.
    9. [Bank - Loan Participations] Under Section 408(b)(2), a bank trustee for a plan may also provide services to a plan under a loan participation agreement, even if the plan can terminate such services only by selling its participation. WSB 79-48.
    10. [Brokerage/Investment Management at No Cost] A brokerage firm which proposes to provide investment management and brokerage services to employee benefit plans, to be paid for directly by the plan sponsor, would be exempt from the prohibitions of Section 406(a)(1) if the conditions contained in Section 408(b)(2) are met (Emphasis added). AO 82-26A.
    11. [Custodian] Under the facts of the request, where a brokerage firm acts as custodian of custodial accounts established under a prototype plan for self-employed persons (a Keogh plan) or a simplified employee pension plan (SEP) but possesses no discretionary authority over the investments over the accounts nor any other aspect of the business administration of the custodial accounts, the firm would not be treated as a trustee for purposes of PTE 79-4. AO 82-12A.
    12. [Direct Expenses] Where the employer plan sponsor provides administrative services to the plan for charges based upon its actual cost for labor and material in connection therewith, the provision of administrative services would be exempt from the prohibitions of Section 406(a), assuming that, in fact and in operation, the plan service provider has met the conditions of Section 408(b)(2). In addition, it is the Department's view that compensation paid to a service provider to its employees may be a properly reimbursable expense under DOL ERISA Regulation 2550.408c-2(b)(3) if the expense would not have been sustained had the services not been provided, if it can be properly allocated to the particular services provided and the expense does not represent an allocable portion of overhead cost. AO 82-01A.
    13. [Float] The ancillary services exemptions (including 408(b)(6)) do not include the float earned by the fiduciary bank from a demand deposit account to the extent that it is reasonably possible to earn a return on such funds. Retention of float would be permissible if it was a part of the bank's overall compensation from the plan and if the bank had made appropriate disclosures regarding the use of float. Failure to comply would result in a violation of ERISA Section 406(b)(1)AO 93-24A.
    14. [Related Expenses] A plan may reimburse its attorney for expenses incurred in attending an educational seminar if, under the facts and circumstances, attendance at such seminar was deemed to be relevant to the needs of the plan. WSB 79-85.
    15. The provision of services, including construction or repair services, to an apprenticeship plan by a contributing employer or the leasing of office space by an apprenticeship plan from a contributing employer are covered by the statutory exemption under ERISA Section 408(b)(2)Proposed PTE C 78-5. AO 79-72.
  7. Court Decisions
    1. [Written Contract Required] The Section 408(b)(2) exemption is only available where there is a contract or arrangement for services. Marshall v. Kelly, 465 F.Supp. 341, 1 EBC 1850 (W.D.Okla. 1978).
    2. [Partial Exemption Only] ERISA Section 408(b)(2) provides no exemption from the provisions of ERISA Section 406(b). Although the language of ERISA Section 408(b)(2) appears to provide an exemption from all of the prohibitions of Section 406, the court concluded, based on the legislative history of Section 408(b)(2), that it should not be construed to provide an exemption from the prohibitions of ERISA Section 406(b). The decision explicitly supports ERISA Regulations Section 2550.408b-2(a) and (e). Marshall v. Kelly, 465 F.Supp. 341, 1 EBC 1850 (W.D.Okla. 1978).
    3. [Reasonable Compensation] Transactions between trustees of a pension, health and welfare fund and a claims processing company for the rendering of services necessary for the operation of the plan are exempted under Section 408 unless the company receives more than reasonable compensation. Brock v. Robbins 830 F.2d 64, 8 EBC 2489 (7th Cir. 1987).
Section 408(b)(3)

Loans to ESOPs
The prohibitions provided in Section 406 shall not apply to any of the following transactions:
A loan to an employee stock ownership plan (as defined in section 407(d)(6)), if -
(A) Such loan is primarily for the benefit of participants and beneficiaries of the plan, and
(B) Such loan is at an interest rate which is not in excess of a reasonable rate.
If the plan gives collateral to a party in interest for such loan, such collateral may consist only of qualifying employer securities (as defined in Section 407(d)(5)).
  1. Conference Report
  2. ESOP loans are covered in pages 311-316 of the Congressional Conference Report.

  3. Regulations
  4. Regulations have been issued under Section 408(b)(3). See DOL ERISA Regulation 2550.408b-3.

    1. Section 408(b)(3) provides an exemption from the prohibited transaction provisions of Sections 406(a)406(b)(1), and 406(b)(2). Section 408(b)(3) does not provide an exemption from the prohibitions of Section 406(b)(3)DOL ERISA Regulation 2550.408b-3(b)(1).
    2. The exemption under Section 408(b)(3) includes within its scope certain transactions in which the potential for self-dealing by fiduciaries exists and in which the interests of fiduciaries may conflict with the interests of beneficiaries. To guard against these potential abuses, the Department of Labor will subject these transactions to special scrutiny to ensure that they are primarily for the benefit of participants and beneficiaries. DOL ERISA Regulation 2550.408b-3(b)(2).
    3. These regulations contain several requirements relating to these loans. See also Treasury Department Regulation 54.4975-7(b).
Section 408(b)(4) Deposits With Fiduciary Banks and Thrifts
The prohibitions provided in Section 406 shall not apply to any of the following transactions:
The investment of all or part of a plan's 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 such plan and if -
(A) The plan covers only employees of such bank or other institution, and employees of affiliates of such bank or other institution, or
(B) Such investment is expressly authorized by a provision of the plan or by a fiduciary (other than such bank or such institution or affiliate thereof) who is expressly empowered by the plan to so instruct the trustees with respect to such investment.
  1. Conference Report
  2. Deposits with fiduciaries are discussed on pages 311-316 of the Congressional Conference Report.

  3. Regulations
  4. Refer to DOL ERISA Regulation 2550.408b-4.

    1. Section 408(b)(4) provides an exemption from Section 406(b)(1) and 406(b)(2), as well as Section 406(a)(1) because Section 408(b)(4) contemplates a bank or similar financial institution causing a plan for which it acts as a fiduciary to invest plan assets in its own deposits or certificates of deposit, if the requirements of Section 408(b)(4) are met. However, it does not provide an exemption from Section 406(b)(3). The receipt of such consideration is a separate transaction not described in the statutory exemption. DOL ERISA Regulation 2550.408b-4(a).
    2. Such investment may be made if the investment is expressly authorized by a provision of the plan or trust agreement or if the investment is expressly authorized (or made) by a fiduciary of the plan who has authority to make such investments and who has no interest in the transaction that may affect the exercise of such authorizing fiduciary's best judgment as a fiduciary so as to cause such authorization to constitute an act described in Section 406(b)DOL ERISA Regulation 2550.408b-4.
    3. If the requirements of Section 408(b)(4) are met, a defined benefit plan maintained by a bank employer may invest in certificates of deposit issued by the bank in excess of the 10% limitation of Section 407(a) of ERISA. AO 79-76.
  5. Advisory Opinions
    1. [Banks] The investment of plan assets of a noncollectively bargained multiple employer plan covering employees of banks, in savings accounts and certificates of deposit of banks that are contributing employers, constitutes a prohibited transaction under Section 406(a) and may also be prohibited under Section 406(b)(1) and (2) because members of the administrative board of the plan, which directs plan investments, are officers and employees of contributing employer/banks.
    2. However, Section 408(b)(4) provides an exemption from Sections 406(a)406(b)(1) and 406(b)(2) for the investment of plan assets in the deposits or certificates of deposit of a bank that is a plan fiduciary or party in interest, if the requirements of DOL ERISA Regulation 2550.408b-4 are met. One requirement of the regulation is that, for investments made after November 1, 1977, the plan specify the name(s) of the bank(s) in which deposits may be made. The specifications may be made in the plan by amendment retroactive to November 1, 1977. AO 79-25.

    3. [Naming of Depository] A prototype plan used by a bank contained authorization "to invest in any type of deposit of the Trustee." The prototype plan defined the Trustee as the person who executed an adoption agreement. The bank adopted the prototype by executing an adoption agreement. A question arose as to whether such an indirect designation of the fiduciary bank was satisfactory.
    4. In response to an FDIC telephone inquiry, the DOL Office of (ERISA) Regulations and Interpretations staff indicated informally that the arrangement was deemed to comply with Section 408(b)(4) of the Act, DOL ERISA Regulation 2550.408b-4, and AO 79-25. The DOL staff indicated DOL would take a rather liberal view of the various documentation that would constitute the plan document(s). [10-27-94.]

    5. [Substantial Penalty] The payment by an employee benefit plan to an issuer bank of a penalty upon the early redemption of certificates of deposit is subject to the exemption set forth in Section 408(b)(4) to the extent the exemption was available to the certificates of deposit. AO 81-42A.
    6. [Non-bank Bank] A company engaged in the business of issuing face amount certificates for sale to employee benefit plans, among others, is a bank or similar financial institution within the meaning of Section 408(b)(4) based upon the facts set forth in the ruling request. AO 83-18A.
    7. [Non-bank Bank] An industrial loan company may qualify as a bank or similar financial institution for purposes of meeting the conditions of Section 408(b)(4), exempting transactions from the prohibitions of Section 406. Thus, investment of assets of employee benefit plans in the industrial loan entity's saving instruments would be permitted under Section 408(b)(4). AO 82-64A.
    8. [Deposits - Insured/Uninsured] The diversification requirement of Section 404(a)(1)(C) generally will not be violated if all plan assets in an individual account plan are invested in a federally insured savings account, so long as the account is fully insured. Where the account balance exceeds the amount covered by federal insurance, compliance with Section 404(a)(1)(C) is determined by whether the bank invests its assets in a diversified manner. AO 77-46.
Section 408(b)(5)

Insurance Company Fiduciaries
The prohibitions provided in Section 406 shall not apply to any of the following transactions:
Any contract for life insurance, health insurance, or annuities with one or more insurers which are qualified to do business in a State, if the plan pays no more than adequate consideration, and if each such insurer or insurers is -
(A) The employer maintaining the plan, or
(B) A party in interest which is wholly owned (directly or indirectly) by the employer maintaining the plan, or by any person which is a party in interest with respect to the plan, but only if the total premiums and annuity considerations written by such insurers for life insurance, health insurance or annuities for all plans (and their employers) with respect to which such insurers are parties in interest (not including premiums or annuity considerations written by the employer maintaining the plan) do not exceed 5% of the total premiums and annuity considerations written for all lines of insurance in that year by such insurers (not including premiums or annuity considerations written by the employer maintaining the plan).
  1. Conference Report
  2. The Congressional Conference Report explains this statutory exemption at pages 311-316.

  3. Advisory Opinions
    1. [Pooled Fund Use] Where the assets of an insurance company's own plan are maintained in a single customer separate account pursuant to a group annuity contract, the transfer of such assets in kind to a pooled separate account maintained by the company in return for the acquisition of units in such pooled account by the plan, together with a change in the contract to permit plan investment in the pooled account, is exempt under Section 408(b)(5). AO 79-79.
    2. Stop-loss policies of insurance are deemed to be included in the term "life insurance, health insurance and annuity contracts" as that term is used in PTE C 79-41 in connection with sale of stop-loss insurance by an affiliate of a bank holding company to plan sponsor by the holding company for its employees or employees of its affiliates. AO 83-19A.
Section 408(b)(6)

Ancillary Services by Depository Fiduciaries
The prohibitions provided in section 406 shall not apply to any of the following transactions:
the providing of any ancillary service by a bank or similar financial institution supervised by the United States or a State, if such bank or other institution is a fiduciary of such plan, and if:
(A) Such bank or similar financial institution has adopted adequate internal safeguards which assure that the providing of such ancillary service is consistent with sound banking and financial practice, as determined by Federal or State supervisory authority, and
(B) The extent to which such ancillary service is provided is subject to specific guidelines issued by such bank or similar financial institution (as determined by the Secretary after consultation with Federal and State supervisory authority), and adherence to such guidelines would reasonably preclude such bank or similar financial institution from providing such ancillary service -
(i) In an excessive or unreasonable manner, and
(ii) In a manner that would be inconsistent with the best interests of participants and beneficiaries of employee benefit plans.
Such ancillary services shall not be provided at more than reasonable compensation.
  1. Conference Report
  2. Bank ancillary services are discussed on pages 311-316 of the Congressional Conference Report.

  3. Regulations
  4. Regulations have been issued under Section 408(b)(6)DOL ERISA Regulation 2550.408b-6.

    1. The Section 408(b)(6) exemption exempts ancillary services that do not meet the requirements of Section 408(b)(2) because the provision of such services involves self-dealing described in Section 406(b)(1) by the fiduciary bank or similar financial institution or a conflict of interest described in Section 406(b)(2). Section 408(b)(6) provides an exemption from Sections 406(b)(1) and (2) because Section 408(b)(6) contemplates the provision of such ancillary services without the approval of a second fiduciary. DOL ERISA Regulation 2550.408b-6(a).
    2. Plan assets held by a fiduciary bank that are reasonably expected to be needed to satisfy current plan expenses may be placed by the bank in a non-interest bearing checking account in the bank if the conditions of this regulation are met notwithstanding the provisions of Section 408(b)(4), which required the payment of a reasonable rate of interest on bank deposits. DOL ERISA Regulation 2550-408b-4(a).
    3. Section 408(b)(6) does not provide an exemption for the receipt of compensation described in Section 406(b)(3). The receipt of such consideration is a separate transaction not described in Section 408(b)(6). DOL ERISA Regulation 2550.408b-4(a).
  5. Prohibited Transaction Class Exemptions (PTE)

    [Securities Lending] Securities lending is an authorized ancillary service which may be offered by a bank to an ERISA plan. PTE 81-6 permits securities lending and PTE 82-63 permits the bank to receive a fee for providing such services.

  6. Advisory Opinions

    [Bank Loan to Plan] Section 408(b)(6) does not provide an exemption for a loan to a plan by a bank trustee, even if authorized by the plan instruments, in order to aid the plan in paying the purchase price for an asset being purchased by the plan at the direction of the plan's administrative committee. AO 79-73.

Section 408(b)(7)

Conversion of Securities
The prohibitions provided in section 406 shall not apply to any of the following transactions:
The exercise of a privilege to convert securities, to the extent provided in regulations of the Secretary, but only if the plan receives no less than adequate consideration pursuant to such conversion.
  1. Conference Report
  2. The Congressional Conference Report explains this statutory exemption at pages 311-316.

Section 408(b)(8)

Collective Investment Funds
The prohibitions provided in Section 406 shall not apply to any of the following transactions:
Any transaction between a plan and -
(i) A common or collective trust fund or pooled investment fund maintained by a party in interest which is a bank or trust company supervised by a State or Federal agency or
(ii) A pooled investment fund of an insurance company qualified to do business in a State, if:
(A) The transaction is a sale or purchase of an interest in the fund;
(B) The bank, trust company, or insurance company receives not more than reasonable compensation; and
(C) Such transaction is expressly permitted by the instrument under which the plan is maintained, or by a fiduciary (other than the bank, trust company, or insurance company, or an affiliate thereof) who has authority to manage and control the assets of the plan.
  1. Conference Report
  2. The use of a fiduciary's collective investment funds is covered in pages 311-316 of the Congressional Conference Report.

  3. Advisory Opinions
    1. [Annual Reports to Plan Administrators] CIFs are required to provide an annual report, covering certain material, to plan administrators of participating ERISA plans. See DOL ERISA Regulation 2520.103-5.
    2. [CIF Investments in Another CIF] Fund-to-fund investments by affiliates of a multibank holding company, by bank pooled funds in corresponding pooled funds of other affiliates of the holding company, and fund-to-fund investments by a pooled fund of the controlled group in another pooled fund of the controlled group are transactions involving the sale or purchase of all interest in a fund by an employee benefit plan and would be exempt from the prohibitions of Section 406(a)(1) if the conditions of Section 408(b)(8) are met. AO 82-41A.
    3. [Trust Company CIFs] A wholly owned subsidiary corporation of an investment manager established as a trust company and subject to the supervision and examination by the superintendent of banks in the state of its domicile shall be deemed to constitute a bank for purposes of PTE C 80-51, and its common or collective trust fund may be utilized for investment by employee benefit plans managed by the parent-investment manager so long as the conditions of Section 408(b)(8) are satisfied. AO 83-12.
Section 408(b)(9)

Distributions of Plan Assets
The prohibitions provided in section 406 shall not apply to any of the following transactions:
The making by a fiduciary of a distribution of the assets of the plan in accordance with the terms of the plan if such assets are distributed in the same manner as provided under section 4044 of this Act (relating to allocation of assets).
  1. Conference Report
  2. The Congressional Conference Report explains this statutory exemption at pages 311-316.

Section 408(b)(10) and (11)
The prohibitions provided in section 406 shall not apply to any of the following transactions:
(10) Any transaction required or permitted under part 1 of subtitle E of title IV.
(11) A merger of multiemployer plans, or the transfer of assets or liabilities between multiemployer plans, determined by the Pension Benefit Guaranty Corporation to meet the requirements of section 4231.
Section 408(c)(1)
Nothing in section 406 shall be construed to prohibit any fiduciary from receiving any benefit to which he may be entitled as a participant or a beneficiary in the plan, so long as the benefit is computed and paid on a basis which is consistent with the terms of the plan as applied to all other participants and beneficiaries.
  1. Conference Report
  2. The Congressional Conference Report does not explain Section 408(c)(1).

  3. Court Decisions
    1. Profit-sharing plan trustees improperly refused to pay benefits to a former executive on the ground that it would breach his fiduciary duties to receive plan benefits, as he was still a plan trustee when the request was made, since Section 408(c) permits a fiduciary to receive benefits to which he may be entitled as a plan participant so long as benefits are computed and paid in the same manner as they are for other participants. Kann v. Keystone Resources, Inc. Profit Sharing Plan, 575 F.Supp. 1084, 5 EBC 1233 (W.D. Pa. 1983).
    2. Where, as a result of termination of employment, an employee is vested in only a portion of his account balance under a profit-sharing plan, the remaining portion being reallocated under the terms of the plan to other accounts of other participants, the fact that participants who are also plan fiduciaries benefited from such reallocation does not constitute self-dealing by virtue of ERISA Section 408(c)(1). Shaw v. Kruidenier, 470 F.Supp. 1375 (S.D.Iowa 1979), aff'd, 620 F.2d 207 (8th Cir. 1980).
Section 408(c)(2)

Fiduciary Fees and Expenses
Nothing in section 406 shall be construed to prohibit any fiduciary from receiving any reasonable compensation for services rendered, or for the reimbursement of expenses properly and actually incurred, in the performance of his duties with the plan; except that no person so serving who already receives full-time pay from an employer or an association of employers, whose employees are participants in the plan, or from an employee organization whose members are participants in such plan shall receive compensation from such plan, except for reimbursement of expenses properly and actually incurred.
  1. Conference Report
  2. The Congressional Conference Report does not explain this interpretation.

  3. Regulations
  4. Regulations have been issued under Section 408(c)(2)DOL ERISA Regulation 2550.408c-2.

    1. Section 408(b)(2) refers to the payment of reasonable compensation by a plan to a party in interest for services rendered to the plan. Section 408(c)(2) clarifies what constitutes reasonable compensation for such services. DOL ERISA Regulation 2550.408c-2(a).
    2. Generally, whether compensation is reasonable under Sections 408(b)(2) and 408(c)(2) depends on the particular facts and circumstances of each case. DOL ERISA Regulation 2550.408c-2(b)(1).
    3. The term "reasonable compensation" does not include any compensation to a fiduciary who is already receiving full-time pay from an employer or association of employers or from an employer organization, except for the reimbursement of direct expenses properly and actually incurred and not otherwise reimbursed. These restrictions do not apply to a party in interest who is not a fiduciary. DOL ERISA Regulation 2550.408c-2(b)(2).
    4. An expense is not a direct expense to the extent it would have been sustained had the service not been provided or if it represents an applicable portion of overhead costs. DOL ERISA Regulation 2550.408c-2(b)(3).
    5. The term "reasonable compensation", as applied to a fiduciary or an employee of a plan, includes an advance to such a fiduciary or employee by the plan to cover direct expenses to be properly and actually incurred by such person in the performance of such person's duties with the plan if certain conditions are satisfied. DOL ERISA Regulation 2550.408c-2(b)(4).
  5. Interpretive Bulletins
  6. IB 75-6, relating to Section 408(c)(2), has been superseded by the regulation cited above.

  7. Advisory Opinions
    1. [General] Section 408(c)(2) was inserted in ERISA as an exemption from the Section 406 prohibited transaction rules to enable certain services to be provided to a plan. The clause in Section 408(c)(2) relating to full-time employee receiving solely reimbursement for expenses is a limitation within an exemption from Section 406. AO 75-21.
    2. [General] A fiduciary who receives full-time pay from an employer association acting on behalf of a group of employers as a sponsor of an employee benefit plan where employees of the contributing employers are participants in this plan would be precluded under Section 408(b)(2) from receiving compensation from the plan for his services as a trustee. This is consistent with the legislative history of Section 408(c)(2) wherein Congress expressed an intent to prevent double payment when the sponsoring association, which is supported solely by the contributing employers, already pays the trustee full-time pay. AO 85-19A.
    3. [Form of Compensation] Section 408(c)(2) and the regulations thereunder do not proscribe the payment of compensation to fiduciaries in a form other than cash (e.g, purchase of life insurance), provided the amount of total compensation paid in all forms is reasonable. WSB 78-34.
    4. [Compensation] The manner in which a union, an employer, and an employer association characterize the payments that they make to trustees is not dispositive of the issue of whether those payments constitute full-time pay. WSB 78-36.
    5. [Compensation] When two union trustees are full-time paid union officers, no compensation is permissible under Section 408(c)(2). AO 76-57.
    6. [Compensation] The receipt of compensation by a fiduciary from a plan is a prohibited transaction if the fiduciary is already receiving full-time compensation from the employer maintaining the plan. AO 78-08.
    7. [Compensation] A trustee or fiduciary who is paid by his employer on an hourly basis and who loses wages for time spent in connection with his plan duties will not be deemed to be receiving full-time pay from his employer during those periods of time that he is performing his duties as plan trustee or fiduciary; and he may, therefore, receive compensation from the plan for services rendered in the performance of his duties with the plan. AO 76-03; WSB 79-92; WSB 79-97
    8. [Compensation - Owner] A management representative/trustee who is the owner of a business that is an employer whose employees are participants in the plan may not receive compensation from the plan for services rendered in the performance of his duties with the plan. The trustee's regular full-time pay or compensation will not be diminished for his time spent on plan duties. AO 76-03; WSB 79-92; WSB 79-97.
    9. [Indemnification of Trustee] Reimbursement or payment by the fund, pursuant to certain indemnification provisions, of expenses properly and actually incurred (including reimbursement or payment of expenses properly and actually incurred in settlement of pending or threatened litigation) is not a prohibited transaction under Section 406(a)(1)(B) or (D) to the extent the reimbursement or payment does not exceed amounts allowed under Section 408(c)(2). AO 77-66/67.
    10. [Expenses] Section 408(c)(2) expressly does not preclude reimbursement for expenses properly and actually incurred by any plan fiduciary. AO 75-145.
    11. [Legal Expenses] Reimbursement of a legal defense expenses of Taft-Hartley plan trustees is permitted under certain circumstances. However, a plan provision authorizing reimbursement of legal fees in the event of any legal action that may arise from the performance of a trustee's fiduciary duties is too broad and would be prohibited under Section 408(c)(2). Where a fiduciary is found in legal proceedings to have violated his fiduciary duties, reimbursement of legal fees by the plan would not be permitted (Emphasis added). AO 78-29.
  8. Court Decisions
    1. [Legal Expenses] Absent any finding of breach of fiduciary duty, the reimbursement of litigation expenses incurred by a fiduciary defending against allegations of breach of fiduciary duty is not prohibited by Section 410(a) and, by virtue of Section 408(c)(2), is not a prohibited transaction. Central States Pension Fund v. American National Bank & Trust Co. of Chicago, No. 77 C 4335, slip op. (N.D.Ill., Oct. 26, 1979).
    2. [Commissions] The investment of plan assets in companies in exchange for commissions, equity, or other compensation does not qualify as a Section 408 exempted transaction and, as such, is prohibited by Section 406. Lowen v. Tower Asset Management, Inc., 829 F.2d 1209, 8 EBC 2457 (2d Cir. 1987).
    3. [Commissions] The payment of a sales commission to a fiduciary on the sale of plan real property is not exempt under Section 408(c)(2) as the fiduciary received full-time pay from the employer. If the commission is characterized as compensation for "extraordinary services", it is not exempt under Section 408(c)(2), since that section exempts only compensation for the performance of fiduciary duties. Marshall v. Kelly, 465 F.Supp. 341, 1EBC 1850 (W.D.Okla. 1978).
Section 408(c)(3)
Nothing in Section 406 shall be construed to prohibit any fiduciary from serving as a fiduciary in addition to being an officer, employee, agent, or other representative of a party in interest.
  1. Conference Report
  2. The Congressional Conference Report does not explain this interpretation.

  3. Advisory Opinions
    1. [General] Section 408(c)(3) has no bearing on the applicability of the fiduciary duties set forth in Section 404(a)(1). The Section also does not deal with possible prohibited transactions that might occur under Section 406(b), depending on the factual situation, when a fiduciary is a director of an investment manager of the plan's assets. AO 76-15.
    2. [Own-Bank Plans] A bank is not prohibited from serving as trustee for a plan maintained for the bank's employees where it receives no compensation from the plan for its trustee services [Emphasis added]. AO 79-49.
    3. [Bank Director] An individual who is a fiduciary of an employee benefit plan because he has authority to appointment the investment manager is not subject to liability under Section 406 merely because he continues to serve as the director of a trust company that has been appointed as an investment manager to manage assets of such plan. AO 76-15.
    4. [Director] A person serving as a director of a fiduciary or a service provider is a representative of a party in interest. As such, he will not be subject to liability under Section 406 merely because he serves as a trustee of a plan while at the same time serving as a director of a bank service provider. AO 77-45.
  4. Court Decisions

    The appointment of an officer or employee of the plan sponsor as plan trustee is not improper merely because of the trustee's relationship to the sponsor. Blackmar v. Lichtenstein, 468 F.Supp. 370 (E.D.Mo.), aff'd, 603 F.2d 1306, 1 EBC 1679 (8th Cir. 1979).

Section 408(d)
Section 407(b) and subsections (b)(c) and (e) of this section shall not apply to any transaction in which a plan directly or indirectly -
(1) Lends any part of the corpus or income of the plan to;
(2) Pays any compensation for personal services rendered to the plan to; or
(3) Acquires for the plan any property from or sells any property to;
Any person who is with respect to the plan an owner-employee (as defined in section 401(c)(3) of the Internal Revenue Code of 1954), a member of the family (as defined in section 267(c)(4) of such Code) of my such owner-employee, or a corporation controlled by any such owner-employee through the ownership, directly or indirectly, of 50% or more of the combined voting power of all classes of stock entitled to vote or 50% or more of the total value of shares of all classes of stock of the corporation.

For purposes of this subsection a shareholder employee (as defined in section 1379 of the Internal Revenue Code of 1954 as in effect on the day before the date of the enactment of the Subchapter S Revision Act of 1982) and a participant or beneficiary of an individual retirement annuity, or an individual retirement bond (as defined in section 408 or section 409 of the Internal Revenue Code of 1954) and an employer or association of employers which establishes such an account or annuity under section 408(c) of such Code shall be deemed to be an owner-employee.
  1. Conference Report
  2. The Congressional Conference Report does not explain this exception to the scope of the exemptions.

  3. Advisory Opinions

    Section 408(d) makes Section 408(b) unavailable for transactions between a plan and a shareholder-employee (as defined in Section 1379(d) of the Internal Revenue Code of 1954) of the plan. The trustees of the plan are, of course, responsible for determining whether the provisions of Section 408(b), or any other section of ERISA, are applicable to the plan. AO 75-105.

Section 408(e)
Sections 406 and 407 shall not apply to the acquisition or sale by a plan of qualifying employer securities (as defined in Section 407(d)(5)) or acquisition, sale, or lease by a plan of qualifying employer real property (as defined in section 407(d)(4)) -
(1) If such acquisition, sale, or lease is for adequate consideration (or in the case of a marketable obligation, at a price not less favorable to the plan than the price determined under section 407(e)(1)),
(2) If no commission is charged with respect thereto, and
(3) If -
(A) The plan is an eligible individual account plan (as defined in section 407(d)(3)), or
(B) In the case of an acquisition or lease of qualifying employer real property by a plan which is not an eligible individual account plan, or of an acquisition of qualifying employer securities by such a plan, the lease or acquisition is not prohibited by section 407(a).
  1. Conference Report
  2. The Congressional Conference Report explains this employer security and real property exemption at pages 316-320.

  3. Regulations
  4. See DOL ERISA Regulation 2550.408e.

  5. Advisory Opinions
    1. [General] For the exemption provided by Section 408(e) to apply to any sale, the property being sold must be either qualifying employer securities or qualifying employer real property at the time such securities or property are sold by the plan. If a corporation is not a member of a controlled group prior to the consummation of a sale, the corporation's securities will not be securities of an affiliate prior to the sale (Emphasis added). AO 77-18.
    2. [Employer Real Estate] Section 408(e) is not applicable where the property is not "qualifying employer real property" (Emphasis added). AO 76-14.
    3. [Individual Account Plan] An exchange of employer common stock by an eligible individual account plan for stock of a new parent company is covered by Section 408(e). AO 78-22.
    4. [Individual Account Plan] The exemption provided in Section 408(e) is available to an eligible individual account plan only if the conditions set forth in that section are met. AO 79-13 and AO 79-23. The exemption is not affected by the exercise of control by a participant or beneficiary over the assets in his individual account. AO 75-89.
    5. [Employer Securities] The prohibited transaction restrictions of Section 406 of ERISA do not apply to a company's repurchase of its stock from its employee benefit plan, provided that the three conditions of Section 408(e) are met. However, the Department will not opine as to whether a particular transaction is for adequate compensation. AO 81-46A.
    6. [Employer Securities] The acquisition by the plan of preferred stock of the plan sponsor in payment of a debt owned by the plan sponsor corporation to the plan, and the further acquisition by the plan of the plan sponsor's preferred stock in exchange for the plan sponsor's common stock held by the plan, constitute acquisitions within the meaning of Section 408(e). AO 81-33A.
    7. [Valuation - Employer Securities] ERISA Section 3(18) defines the term "adequate consideration", in the case of a security for which there is no generally recognized market, as the fair value of the security determined in good faith by the trustee or named fiduciary to a plan pursuant to the terms of the plan and in accordance with regulations promulgated by the Department of Labor. The Department of Labor has not yet issued such regulations and does not, at the present time, contemplate making advance determinations as to adequate consideration in the case of individual purchases and sales of stock. Guidelines to be issued will be general guidelines in the form of regulations under Section 3(18). In view of the fact that no regulations have been issued under Section 3(18), the plan advisory committee should make a good faith determination of the fair market value of the common stock of the employer maintaining the plan, utilizing recognized methods of determining the value of stock of closely held corporations. AO 75-141.
    8. [Valuation - Employer Securities] In view of the fact that no regulations have been issued under Section 3(18), the trustee should make a good faith determination of the fair market value of the book value shares, utilizing recognized methods of determining the value of such shares. The ruling received by the trustee from the Internal Revenue Service as to where the method of determining fair market value of the book value shares was a reasonable one for purposes of Section 1.421-7(e)(2) of the Income Tax Regulations would be considered as evidence that the trustee determining of fair market value was made in good faith. AO 77-35.
Section 408(f)
Section 406(b)(2) shall not apply to any merger or transfer described in subsection (b)(11).

Section 410   Exculpatory Provisions

Section 410(a)

Exculpatory Provisions
Except as provided in sections 405(b)(1) and 405(d), any provision in an agreement or instrument which purports to relieve a fiduciary from responsibility or liability for any responsibility, obligation, or duty under this part shall be void as against public policy.
  1. Conference Report
  2. The Congressional Conference Report discusses the exculpatory provision proIf an investment manager or managers hibition.

  3. Interpretive Bulletins
  4. Indemnification agreements are not prohibited if the fiduciary who may be indemnified under the agreement remains responsible and liable for his acts or omissions with the indemnifying party merely satisfying the fiduciary liability. For example, an employer or union may agree to indemnity a plan fiduciary under Section 410(a). Also, a fiduciary can agree to indemnity his employees who perform fiduciary functions for a plan. However, a plan cannot agree to indemnify a fiduciary for a breach of fiduciary duty. IB 75-4.

  5. Advisory Opinions
    1. [Exculpatory Clauses] An exculpatory clause that appears in a plan instrument is void even if the plan is not amended to remove the clause. AO 75-122.
    2. [Exculpatory Clauses] Any provision in a plan instrument purporting to relieve the trustees of the duty to collect contributions is void under Section 410(a). AO 78-28.
    3. [Indemnification] Indemnification by a multiemployer plan of an investment manager's defense costs and settlement payment is permitted in a lawsuit alleging a breach of fiduciary duty by the investment manager, provided that (1) no court decision was rendered that the investment manager had breached his fiduciary duties; (2) the defense costs indemnified did not exceed a reasonable amount and (3) an opinion is obtained from independent legal counsel that the acts in question did not involve a breach of fiduciary duty by the investment manager. AO 77-66/67.
    4. [Indemnification] An advance or reimbursement by a plan of expenses incurred by a plan fiduciary in defending a lawsuit alleging a breach of fiduciary duty is not a prohibited transaction, provided (1) no reimbursement is made or any advances repaid if a court rules that a breach has occurred; and (2) the advance or reimbursement is for expenses properly and actually incurred (see DOL ERISA Regulation 2550.408c-2). AO 77-66/67.
    5. [Indemnification] Reimbursement of the legal defense expenses of Taft-Hartley plan trustees is permitted under certain circumstances. However, a plan provision authorizing reimbursement of legal fees in the event of any legal action that may arise from the performance of a trustee's fiduciary duties is too broad and would be prohibited under Section 410(a). Where a fiduciary is found in a legal proceeding to have violated his fiduciary duties, reimbursement of legal fees by the plan would not be permitted. AO 78-29.
  6. Court Decisions
    1. Absent any finding of breach of fiduciary duty, the reimbursement of litigation expenses incurred by a fiduciary in defending against allegations of breach of fiduciary duty is not prohibited by Section 410(a) and, by virtue of Section 408(c)(2), is not a prohibited transaction. Central States Pension Fund v. American National Bank & Trust Co. of Chicago, No. 77 C 4335, slip op. (N.D.Ill., Oct. 26, 1979).
    2. Where a pension plan contains a provision to indemnify members of the board of directors, plan administrative committee, trustee and any other person to whom fiduciary responsibility was allocated from liability for a breach of fiduciary duty, except for liabilities and claims arising from willful misconduct, the indemnity agreement is void under ERISA Section 410(a). Donovan v. Cunningham, 541 F.Supp. 276, 3 EBC 1641 (S.D.Tex. 1982), aff'd in part, rev'd in part, 716 F.2d 1455, 4 EBC 2329 (5th Cir. 1983), cert. denied, 467 U.S. 1251 (1984).
    3. A successor trustee cannot be exonerated by the provisions of a trust agreement from his duty to liquidate prior improper investments upon assuming his responsibilities. Marshall v. Craft, 463 F.Supp. 493 (N.D.Ga. 1978).
    4. Even though a plan trustee has no authority for investment decisions, it cannot disavow itself of a responsibility for such decision since it is still a fiduciary. However, under the allocation provisions of Section 405(c)(1) the trustee may not, in fact, be liable for such decisions. Leonard v. Drug Fair, Inc., Fed. Sec. L. Rep. (CCH) Para 97,144 (D.D.C. 1979).
    5. Where a pension plan was challenged under ERISA Section 410(a) because the summary plan descriptions contained disclaimers, the widow of a deceased employee could not maintain a private action since she was not a beneficiary as defined in ERISA. Trembly v. Marshall, 502 F.Supp. 29, 2 EBC 2500 (D.D.C. 1980).
Section 410(b)

Insurance
Nothing in this subpart shall preclude -
(1) A plan from purchasing insurance for its fiduciaries or for itself to cover liability or losses occurring by reason of the act or omission of a fiduciary, if such insurance permits recourse by the insurer against the fiduciary in the case of a breach of a fiduciary obligation by such fiduciary;
(2) A fiduciary from purchasing insurance to cover liability under this part from and for his own account; or
(3) An employer or an employee organization from purchasing insurance to cover potential liability of one or more persons who serve in a fiduciary capacity with regard to an employee benefit plan.
  1. Conference Report
  2. The Congressional Conference Report discusses the fiduciary insurance provisions of Section 410(b) at pages 320-321.

  3. Regulations
  4. No regulations have been issued interpreting Section 410(b). However, in a news release issued on March 4, 1975, the Department of Labor stated that fiduciary insurance purchased by a plan that provides for recourse by the insurer against the fiduciary but that also permits the fiduciary to pay an additional premium to obtain coverage against the insurer's recourse is not prohibited under Section 410(b).

  5. Advisory Opinions
  6. Section 410(b) does not require plans to maintain fiduciary insurance. AO 76-03.

Section 412   Bonding of Fiduciaries

Section 412
(a) Every fiduciary of an employee benefit plan and every person who handles funds or other property of such plan (hereinafter in this section referred to as "plan official") shall be bonded as provided in this section; except that-
(1) Where such plan is one under which the only assets from which benefits are paid are the general assets of a union or of an employer, the administrator, officers, and employees of such plan shall be exempt from the bonding requirements of this section, and
(2) No bond shall be required of a fiduciary (or of any director, officer, or employee of such fiduciary) if such fiduciary -
(A) Is a corporation organized and doing business under the laws of the United States or any State;
(B) Is authorized under such laws to exercise trust powers or to conduct an insurance business;
(C) Is subject to supervision or examination by Federal or State authority; and
(D) Has at all times a combined capital and surplus in excess of such a minimum amount as may be established by regulations issued by the Secretary, which amount shall be at least $1,000,000. Paragraph (2) shall apply to a bank or other financial institution which is authorized to exercise trust powers and the deposits of which are not insured by the Federal Deposit Insurance Corporation, only if such bank or institution meets bonding or similar requirements under State law which the Secretary determines are at least equivalent to those imposed on banks by Federal law.

The amount of such bond shall be fixed at the beginning of each fiscal year of the plan. Such amount shall not be less than 10 per centum of the amount of funds handled. In no case shall such bond be less than $1,000 nor more than $500,000, except that the Secretary, after due notice and opportunity for hearing to all interested parties, and after consideration of the record, may prescribe an amount in excess of $500,000, subject to the 10 per centum limitation of the preceding sentence.
For purposes of fixing the amount of such bond, the amount of funds handled shall be determined by the funds handled by the person, group, or class to be covered by such bond and by their predecessor or predecessors, if any, during the preceding reporting year, or if the plan has no preceding reporting year, the amount of funds to be handled during the current reporting year by such person, group, or class, estimated as provided in regulations of the Secretary.

Such bond shall provide protection to the plan against loss by reason of acts of fraud or dishonesty on the part of be plan official, directly or through connivance with others. Any bond shall have as surety thereon a corporate surety company which is an acceptable surety on Federal bonds under authority granted by the Secretary of the Treasury pursuant to sections 9304-9308 of title 31. Any bond shall be in a form or of a type approved by the Secretary, including individual bonds or schedule of blanket forms of bonds which cover a group or class.
(b) It shall be unlawful for any plan official to whom subsection (a) applies, to receive, handle, disburse, or otherwise exercise custody of any of the funds or other property of any employees benefit plan, without being bonded as required by subsection (a) and it shall be unlawful for any plan official of such plan, or any other person having authority to direct the performance of such functions, to permit such functions, or any, of them, to be performed by any plan official, with respect to whom the requirements of subsection (a) have not been met.
(c) It shall be unlawful for any person to procure any bond required by subsection (a) from any surety or other company or through any agent or broker in whose business operations such plan or any party in interest in such plan has any control or significant financial interest, direct or indirect.
(d) Nothing in any other provision of law, shall make any person, required to be bonded as provided in subsection (a) because he handles funds or other property of an employee benefit plan, to be bonded insofar as the handling by such person of the funds or other property of such plan is concerned.
(e) The Secretary shall prescribe such regulations as may be necessary to carry out the provisions of this section including exempting a plan from the requirements of this section where he finds that (1) other bonding arrangements or (2) the overall financial condition of the plan would be adequate to protect the interests of the beneficiaries and participants. When, in the opinion of the Secretary, the administrator of a plan offers adequate evidence of the financial responsibility of the plan, or that other bonding arrangements would provide adequate protection of the beneficiaries and participants, he may exempt such plan from the requirements of this section.
  1. Conference Report
  2. The Congressional Conference Report discusses the bonding requirements of ERISA.

  3. Regulations
    1. The temporary regulations generally incorporated by reference the bonding regulations issued under Section 13 of the Welfare and Pension Plans Disclosure Act (WPPDA). ERISA Regs. 2550.412-1. WPPDA Regulation Section 464 (29 C.F.R. 464).
    2. Section 464.5 of the WPPDA regulations provides that the term "funds or other property" [see ERISA 412(a)] includes all property that is to be used by a plan as a source for paying benefits; however, it does not include, among other things, fixed assets used in the operation of a plan (e.g., a building used as office space by a plan).
    3. Section 464.6 of the WPPDA regulations provides that in the case of multiemployer plans, employer contributions become plan funds when they are actually received by the plan.
    4. Section 464.7 of the WPPDA regulations indicates the following regarding persons who handle funds or other property:
      1. Generally, a person handles plan funds or other property, when he has a relationship to funds or property that can rise to risk of loss through fraud or dishonesty. DOL WPPDA Regulation 464.7(a)(1).
      2. However, a person is not deemed to be handling where the risk of loss is negligible (e.g., where the person is handling checks, securities or title papers that he cannot negotiate). DOL WPPDA Regulation 464.7(a)(2).
      3. The power to withdraw funds from a bank account generally constitutes handling, regardless of whether the power is authorized. DOL WPPDA Regulation 464.7(b)(2).
      4. Having the authority to transfer ownership of plan assets to others constitutes handling. DOL WPPDA Regulation 464.7(b)(3).
      5. Persons who disburse plan funds or sign plan checks are handling plan funds. DOL WPPDA Regulation 464.7(b)(4).
      6. In the case of fully insured plans, there is generally no handling of plan funds or other assets, unless benefit payments, dividends, etc., are paid to the plan by the insurance company. DOL WPPDA Regulation 464.7(b)(7).
  4. Interpretive Bulletins
    1. A person who provides investment advice to a plan but does not handle plan funds or other property is not required to be bonded under Section 412. IB 75-5, Question FR-8.
    2. A plan can purchase a bond covering plan officials, but the bond must be solely for the protection of the plan. IB 75-5, Question FR-9.
    3. Even though a person is not a plan fiduciary, he may be subject to the bonding requirements of Section 412 if he handles plan funds or other property. IB 75-8, Question D-2.
  5. Advisory Opinions
    1. The Labor Department cannot postpone the applicability of the bonding requirements to any plan. AO 75-120.
    2. There is no provision in Section 412 exempting plans with a minimum number of participants from the bonding requirements. AO 75-117.
    3. Section 412(a) requires coverage only against fraud or dishonesty; it does not require errors and omissions coverage. AO 75-124.
    4. A plan official is not required to be bonded unless he handles funds or other property. Handling occurs whenever the duties or activities of a plan official are such that there is a risk that such funds or other property could be lost in the event of fraud or dishonesty on the part of such person, acting either alone or in collusion with others. The authorization of disbursements may constitute handling, depending on the facts in a particular case. The factors that are considered include the closeness and continuity of supervision; who is, in fact, charged with or actually exercises final responsibility for determining whether specific disbursements or benefit claims are bona fide, regular and made in accordance with the applicable trust instrument or other documents; and who has the final responsibility for determining the propriety of any specific expenditure. AO 77-84.
    5. An impartial chairman of a joint board of trustees who is only given full trustee voting authority to resolve disputes between trustees is handling plan funds or other property. AO 75-119.
    6. Plan assets deposited in a savings account are not required to be bonded under Section 412. AO 77-11 and AO 79-10.
    7. A person who (a) receives insurance policies from the plan trustees or participants for transmissions to the insurance company and (b) handles premium checks made out to the insurance carrier or receives checks made out to the plan trustees from the insurance company (but has no authority to negotiate these checks) is not handling plan funds or other property. AO 76-47.
    8. The sale of a group insurance policy to an employer to fund a plan does not alone make the insurance company a party in interest to the plan. Therefore, the insurance company is not prohibited under Section 12(c) from selling a bond to the plan. AO 76-36.
    9. The administrator of a plan cannot sell a bond to the plan under Section 412(c). The exemptions provided in Sections 408 and 414(c) apply only to prohibited transactions, not to the bonding restrictions. AO 76-92.
  6. Court Decisions
    1. A fiduciary who is not bonded is legally disqualified from serving as a fiduciary. Lane v. Marshall, Civ. A. No. 79-0868 (N.D.Cal., April 28,1979).
    2. Posting of government obligations in lieu of corporate surety bond does not fulfill ERISA Section 412 bonding requirement. Musso v. Baker, 834 F.2d 78, 9 EBC 1145 (3d Cir. 1987), cert. denied, 101 L.Ed.2d 884, 1988 U.S. LEXIS 2840, 108 S.Ct. 2846, 56 U.S.L.W. 3864, 9 EBC 2304 (U.S. 1988) (where fund trustees deposited fund-owned federal government obligations).
Internal Revenue Code

72(p)    Loans to Plan Participants Treated as Distributions

Section 72(p)
26 USC 72(p)

As Amended through 1988 (P.L. 100-647)

  1. Treatment as Distributions. - For purposes of this section -
    1. Loans. - If during any taxable year a participant or beneficiary receives (directly or indirectly) any amount as a loan from a qualified employer plan, such amount shall be treated as having been received by such individual as a distribution under such plan.
    2. Assignments or pledges. - If during any taxable year a participant or beneficiary assigns (or agrees to assign) or pledges (or agrees to pledge) any portion of his interest in a qualified employer plan, such portion shall be treated as having been received by such individual as a loan from such plan.
  2. Exception of certain loans. -
    1. General rule. - Paragraph (1) shall not apply to any loan to the extent that such loan (when added to the outstanding balance of all other loans from such plan whether made on, before, or after August 13, 1982), does not exceed the lesser of -
      1. $50,000, reduced by the excess (if any) of
        1. The highest outstanding balance of loans from the plan during the 1-year period ending on the day before the date on which such loan was made, over
        2. The outstanding balance of loans from the plan on the date which such loan was more, or
      2. The greater of -
        1. One-half of the present value of the nonforfeitable accrued benefit of the employee under the plan, or
        2. $10,000.

      For purposes of clause (ii) the present value of the nonforfeitable accrued benefit shall be determined without regard to any accumulated deductible employee contributions (as defined in subsection (O)(5)(b)).

    2. Requirement that loan be repayable within 5 years-
      1. In general. - Subparagraph (A) shall not apply to any loan unless such loan, by its terms, is required to be repaid within 5 years.
      2. Exception for home loans. - Clause (i) shall not apply to any loan used to acquire any dwelling unit which within a reasonable time is to be used (determined at the time the loan is made) as a principal residence of the participant.
    3. Requirement of level amortization. -- Except as provided in regulations, this paragraph shall not apply to any loan unless substantially level amortization of such loan (with payments not less frequently than quarterly) is required over the term of the loan.
    4. Related employers and related plans. -- For purposes of this paragraph
      1. The rules of subsections (b), (c), and (m) of section 414 shall apply, and
      2. All plans of an employer (determined after the application of such subsections) shall be treated as 1 plan.
  3. Denial of interest deductions in certain cases. -
    1. In general. No deduction otherwise allowable under this chapter shall be allowed under this chapter for any interest paid or accrued on any loan to which paragraph (1) does not apply by reason of paragraph (2) during the period described in subparagraph (B).
    2. Period to which subparagraph (A) applies. --For purposes of subparagraph (A), the period described in this subparagraph is the period--
      1. On or after the 1st day on which the individual to whom the loan is made is a key employee (as defined in section 416(i)), or
      2. Such loan is secured by amounts attributable to elective deferrals described in subparagraph (A) or (C) of section 402(g)(3). made to a key employee (as defined in section 416(i), or
  4. Qualified employer plan, etc. For purposes of this subsection
    1. Qualified employer plan -
      1. In general. - The term "qualified employer plan" means -
        1. A plan described in section 401(a) which includes a trust exempt from tax under section 501(a).
        2. A annuity plan described in section 403(a), and
        3. A plan under which amounts are contributed by an individual's employer for an annuity contract described in section 403(b).
      2. Special rules. - The term "qualified employer plan" -
        1. Shall include any plan which was (or was determined to be) a qualified employer plan or a government plan, but
        2. Shall not include a plan described in subsection (e)(7).
    2. Government plan. The term "government plan" means any plan, whether or not qualified, established and maintained for its employees by the United States, by a State or political subdivision thereof, or by an agency or instrumentality of any of the foregoing.
  5. Special rules for loans, etc., from certain contracts. For purposes of this subsection, any amount received as a loan under a contract purchased under a qualified employer plan (and any assignment or pledge with respect to such a contract) shall be treated as a loan under such employer plan.

72(p)-1    Participant Loans Treated as Distributions – IRS Guidelines

Section 72(p)-1
26 USC 72(p)-1

Section 72(p) was added by section 236 of the Tax Equity and Fiscal Responsibility Act of 1982 (96 Stat. 324), and amended by the Technical Corrections Act of 1982 (96 Stat. 2365), the Deficit Reduction Act of 1984 (98 Stat. 494), the Tax Reform Act of 1986 (100 Stat. 2085), and the Technical and Miscellaneous Revenue Act of 1988 (102 Stat. 3342).

Section 72(p)-1 was added on July 31, 2000 [Federal Register Volume 65, Number 147].

Statutory effective date: Section 72(p) applies to assignments, pledges, and loans made after August 13, 1982.

Regulatory effective date: Section 72(p)-1 applies to assignments, pledges, and loans made on or after January 1, 2002.

Refer to response to question # 22 (a) through (c)(2) below for applicability dates.

Sec. 1.72(p)-1 Loans treated as distributions.

The questions and answers in this section provide guidance under section 72(p) pertaining to loans from qualified employer plans (including government plans and tax-sheltered annuities and employer plans that were formerly qualified). The examples included in the questions and answers in this section are based on the assumption that a bona fide loan is made to a participant from a qualified defined contribution plan pursuant to an enforceable agreement (in accordance with paragraph (b) of Q&A-3 of this section), with adequate security and with an interest rate and repayment terms that are commercially reasonable. (The particular interest rate used, which is solely for illustration, is 8.75 percent compounded annually.) In addition, unless the contrary is specified, it is assumed in the examples that the amount of the loan does not exceed 50 percent of the participant's nonforfeitable account balance, the participant has no other outstanding loan (and had no prior loan) from the plan or any other plan maintained by the participant's employer or any other person required to be aggregated with the employer under section 414(b), (c) or (m), and the loan is not excluded from section 72(p) as a loan made in the ordinary course of an investment program as described in Q&A-18 of this section. The regulations and examples in this section do not provide guidance on whether a loan from a plan would result in a prohibited transaction under section 4975 of the Internal Revenue Code or on whether a loan from a plan covered by Title I of the Employee Retirement Income Security Act of 1974 (88 Stat. 829) (ERISA) would be consistent with the fiduciary standards of ERISA or would result in a prohibited transaction under section 406 of ERISA. The questions and answers are as follows:

Q-1: In general, what does section 72(p) provide with respect to loans from a qualified employer plan?

A-1: (a) Loans. Under section 72(p), an amount received by a participant or beneficiary as a loan from a qualified employer plan is treated as having been received as a distribution from the plan (a deemed distribution), unless the loan satisfies the requirements of Q&A-3 of this section. For purposes of section 72(p) and this section, a loan made from a contract that has been purchased under a qualified employer plan (including a contract that has been distributed to the participant or beneficiary) is considered a loan made under a qualified employer plan.

(b) Pledges and assignments. Under section 72(p), if a participant or beneficiary assigns or pledges (or agrees to assign or pledge) any portion of his or her interest in a qualified employer plan as security for a loan, the portion of the individual's interest assigned or pledged (or subject to an agreement to assign or pledge) is treated as a loan from the plan to the individual, with the result that such portion is subject to the deemed distribution rule described in paragraph (a) of this Q&A-1. For purposes of section 72(p) and this section, any assignment or pledge of (or agreement to assign or to pledge) any portion of a participant's or beneficiary's interest in a contract that has been purchased under a qualified employer plan (including a contract that has been distributed to the participant or beneficiary) is considered an assignment or pledge of (or agreement to assign or pledge) an interest in a qualified employer plan. However, if all or a portion of a participant's or beneficiary's interest in a qualified employer plan is pledged or assigned as security for a loan from the plan to the participant or the beneficiary, only the amount of the loan received by the participant or the beneficiary, not the amount pledged or assigned, is treated as a loan.

Q-2: What is a qualified employer plan for purposes of section 72(p)?

A-2: For purposes of section 72(p) and this section, a qualified employer plan means-

(a) A plan described in section 401(a) which includes a trust exempt from tax under section 501(a);

(b) An annuity plan described in section 403(a);

(c) A plan under which amounts are contributed by an individual's employer for an annuity contract described in section 403(b);

(d) Any plan, whether or not qualified, established and maintained for its employees by the United States, by a State or political subdivision thereof, or by an agency or instrumentality of the United States, a State or a political subdivision of a State; or

(e) Any plan which was (or was determined to be) described in paragraph (a), (b), (c), or (d) of this Q&A-2.

Q-3: What requirements must be satisfied in order for a loan to a participant or beneficiary from a qualified employer plan not to be a deemed distribution?

A-3: (a) In general. A loan to a participant or beneficiary from a qualified employer plan will not be a deemed distribution to the participant or beneficiary if the loan satisfies the repayment term requirement of section 72(p)(2)(B), the level amortization requirement of section 72(p)(2)(C), and the enforceable agreement requirement of paragraph (b) of this Q&A-3, but only to the extent the loan satisfies the amount limitations of section 72(p)(2)(A).

(b) Enforceable agreement requirement. A loan does not satisfy the requirements of this paragraph unless the loan is evidenced by a legally enforceable agreement (which may include more than one document) and the terms of the agreement demonstrate compliance with the requirements of section 72(p)(2) and this section. Thus, the agreement must specify the amount and date of the loan and the repayment schedule. The agreement does not have to be signed if the agreement is enforceable under applicable law without being signed. The agreement must be set forth either--

(1) In a written paper document;

(2) In an electronic medium that is reasonably accessible to the participant or the beneficiary and that is provided under a system that satisfies the following requirements:

(i) The system must be reasonably designed to preclude any individual other than the participant or the beneficiary from requesting a loan.

(ii) The system must provide the participant or the beneficiary with a reasonable opportunity to review and to confirm, modify, or rescind the terms of the loan before the loan is made.

(iii) The system must provide the participant or the beneficiary, within a reasonable time after the loan is made, a confirmation of the loan terms either through a written paper document or through an electronic medium that is reasonably accessible to the participant or the beneficiary and that is provided under a system that is reasonably designed to provide the confirmation in a manner no less understandable to the participant or beneficiary than a written document and, under which, at the time the confirmation is provided, the participant or the beneficiary is advised that he or she may request and receive a written paper document at no charge, and, upon request, that document is provided to the participant or beneficiary at no charge; or

(3) In such other form as may be approved by the Commissioner.

Q-4: If a loan from a qualified employer plan to a participant or beneficiary fails to satisfy the requirements of Q&A-3 of this section, when does a deemed distribution occur?

A-4: (a) Deemed distribution. For purposes of section 72, a deemed distribution occurs at the first time that the requirements of Q&A-3 of this section are not satisfied, in form or in operation. This may occur at the time the loan is made or at a later date. If the terms of the loan do not require repayments that satisfy the repayment term requirement of section 72(p)(2)(B) or the level amortization requirement of section 72(p)(2)(C), or the loan is not evidenced by an enforceable agreement satisfying the requirements of paragraph (b) of Q&A-3 of this section, the entire amount of the loan is a deemed distribution under section 72(p) at the time the loan is made. If the loan satisfies the requirements of Q&A-3 of this section except that the amount loaned exceeds the limitations of section 72(p)(2)(A), the amount of the loan in excess of the applicable limitation is a deemed distribution under section 72(p) at the time the loan is made. If the loan initially satisfies the requirements of section 72(p)(2)(A), (B) and (C) and the enforceable agreement requirement of paragraph (b) of Q&A-3 of this section, but payments are not made in accordance with the terms applicable to the loan, a deemed distribution occurs as a result of the failure to make such payments. See Q&A-10 of this section regarding when such a deemed distribution occurs and the amount thereof and Q&A-11 of this section regarding the tax treatment of a deemed distribution.

(b) Examples. The following examples illustrate the rules in paragraph (a) of this Q&A-4 and are based upon the assumptions described in the introductory text of this section:

Example 1.
(i) A participant has a nonforfeitable account balance of $200,000 and receives $70,000 as a loan repayable in level quarterly installments over five years.

(ii) Under section 72(p), the participant has a deemed distribution of $20,000 (the excess of $70,000 over $50,000) at the time of the loan, because the loan exceeds the $50,000 limit in section 72(p)(2)(A)(i). The remaining $50,000 is not a deemed distribution.

Example 2.
(i) A participant with a nonforfeitable account balance of $30,000 borrows $20,000 as a loan repayable in level monthly installments over five years.

(ii) Because the amount of the loan is $5,000 more than 50% of the participant's nonforfeitable account balance, the participant has a deemed distribution of $5,000 at the time of the loan. The remaining $15,000 is not a deemed distribution. (Note also that, if the loan is secured solely by the participant's account balance, the loan may be a prohibited transaction under section 4975 because the loan may not satisfy 29 CFR 2550.408b-1(f)(2).)

Example 3.
(i) The nonforfeitable account balance of a participant is $100,000 and a $50,000 loan is made to the participant repayable in level quarterly installments over seven years. The loan is not eligible for the section 72(p)(2)(B)(ii) exception for loans used to acquire certain dwelling units.

(ii) Because the repayment period exceeds the maximum five-year period in section 72(p)(2)(B)(i), the participant has a deemed distribution of $50,000 at the time the loan is made.

Example 4.
(i) On August 1, 2002, a participant has a nonforfeitable account balance of $45,000 and borrows $20,000 from a plan to be repaid over five years in level monthly installments due at the end of each month. After making monthly payments through July 2003, the participant fails to make any of the payments due thereafter.

(ii) As a result of the failure to satisfy the requirement that the loan be repaid in level monthly installments, the participant has a deemed distribution. See paragraph (c) of Q&A-10 of this section regarding when such a deemed distribution occurs and the amount thereof.

Q-5: What is a principal residence for purposes of the exception in section 72(p)(2)(B)(ii) from the requirement that a loan be repaid in five years?

A-5: Section 72(p)(2)(B)(ii) provides that the requirement in section 72(p)(2)(B)(i) that a plan loan be repaid within five years does not apply to a loan used to acquire a dwelling unit which will within a reasonable time be used as the principal residence of the participant (a principal residence plan loan). For this purpose, a principal residence has the same meaning as a principal residence under section 121.

Q-6: In order to satisfy the requirements for a principal residence plan loan, is a loan required to be secured by the dwelling unit that will within a reasonable time be used as the principal residence of the participant?

A-6: A loan is not required to be secured by the dwelling unit that will within a reasonable time be used as the participant's principal residence in order to satisfy the requirements for a principal residence plan loan.

Q-7: What tracing rules apply in determining whether a loan qualifies as a principal residence plan loan?

A-7: The tracing rules established under section 163(h)(3)(B) apply in determining whether a loan is treated as for the acquisition of a principal residence in order to qualify as a principal residence plan loan.

Q-8: Can a refinancing qualify as a principal residence plan loan?

A-8: (a) Refinancings. In general, no, a refinancing cannot qualify as a principal residence plan loan. However, a loan from a qualified employer plan used to repay a loan from a third party will qualify as a principal residence plan loan if the plan loan qualifies as a principal residence plan loan without regard to the loan from the third party.

(b) Example. The following example illustrates the rules in paragraph (a) of this Q&A-8 and is based upon the assumptions described in the introductory text of this section:

Example.
(i) On July 1, 2003, a participant requests a $50,000 plan loan to be repaid in level monthly installments over 15 years. On August 1, 2003, the participant acquires a principal residence and pays a portion of the purchase price with a $50,000 bank loan. On September 1, 2003, the plan loans $50,000 to the participant, which the participant uses to pay the bank loan.

(ii) Because the plan loan satisfies the requirements to qualify as a principal residence plan loan (taking into account the tracing rules of section 163(h)(3)(B)), the plan loan qualifies for the exception in section 72(p)(2)(B)(ii).

Q-9: Does the level amortization requirement of section 72(p)(2)(C) apply when a participant is on a leave of absence without pay?

A-9: (a) Leave of absence. The level amortization requirement of section 72(p)(2)(C)does not apply for a period, not longer than one year (or such longer period as may apply under section 414(u)), that a participant is on a bona fide leave of absence, either without pay from the employer or at a rate of pay (after income and employment tax withholding) that is less than the amount of the installment payments required under the terms of the loan. However, the loan (including interest that accrues during the leave of absence) must be repaid by the latest date permitted under section 72(p)(2)(B) (e.g., the suspension of payments cannot extend the term of the loan beyond 5 years, in the case of a loan that is not a principal residence plan loan) and the amount of the installments due after the leave ends (or, if earlier, after the first year of the leave or such longer period as may apply under section 414(u)) must not be less than the amount required under the terms of the original loan.

(b) Military service. See section 414(u)(4) for special rules relating to military service.

(c) Example. The following example illustrates the rules of paragraph (a) of this Q&A-9 and is based upon the assumptions described in the introductory text of this section:

Example.
(i) On July 1, 2002, a participant with a nonforfeitable account balance of $80,000 borrows $40,000 to be repaid in level monthly installments of $825 each over 5 years. The loan is not a principal residence plan loan. The participant makes 9 monthly payments and commences an unpaid leave of absence that lasts for 12 months. Thereafter, the participant resumes active employment and resumes making repayments on the loan until the loan is repaid in full (including interest that accrued during the leave of absence). The amount of each monthly installment is increased to $1,130 in order to repay the loan by June 30, 2007.

(ii) Because the loan satisfies the requirements of section 72(p)(2), the participant does not have a deemed distribution. Alternatively, section 72(p)(2) would be satisfied if the participant continued the monthly installments of $825 after resuming active employment and on June 30, 2007 repaid the full balance remaining due.

Q-10: If a participant fails to make the installment payments required under the terms of a loan that satisfied the requirements of Q&A-3 of this section when made, when does a deemed distribution occur and what is the amount of the deemed distribution?

A-10: (a) Timing of deemed distribution. Failure to make any installment payment when due in accordance with the terms of the loan violates section 72(p)(2)(C) and, accordingly, results in a deemed distribution at the time of such failure. However, the plan administrator may allow a cure period and section 72(p)(2)(C) will not be considered to have been violated if the installment payment is made not later than the end of the cure period, which period cannot continue beyond the last day of the calendar quarter following the calendar quarter in which the required installment payment was due.

(b) Amount of deemed distribution. If a loan satisfies Q&A-3 of this section when made, but there is a failure to pay the installment payments required under the terms of the loan (taking into account any cure period allowed under paragraph (a) of this Q&A-10), then the amount of the deemed distribution equals the entire outstanding balance of the loan (including accrued interest) at the time of such failure.

(c) Example. The following example illustrates the rules in paragraphs (a) and (b) of this Q&A-10 and is based upon the assumptions described in the introductory text of this section:

Example. (i) On August 1, 2002, a participant has a nonforfeitable account balance of $45,000 and borrows $20,000 from a plan to be repaid over 5 years in level monthly installments due at the end of each month. After making all monthly payments due through July 31, 2003, the participant fails to make the payment due on August 31, 2003 or any other monthly payments due thereafter. The plan administrator allows a three-month cure period.

(ii) As a result of the failure to satisfy the requirement that the loan be repaid in level installments pursuant to section 72(p)(2)(C), the participant has a deemed distribution on November 30, 2003, which is the last day of the three-month cure period for the August 31, 2003 installment. The amount of the deemed distribution is $17,157, which is the outstanding balance on the loan at November 30, 2003. Alternatively, if the plan administrator had allowed a cure period through the end of the next calendar quarter, there would be a deemed distribution on December 31, 2003 equal to $17,282, which is the outstanding balance of the loan at December 31, 2003.

Q-11: Does section 72 apply to a deemed distribution as if it were an actual distribution?

A-11: (a) Tax basis. If the employee's account includes after-tax contributions or other investment in the contract under section 72(e), section 72 applies to a deemed distribution as if it were an actual distribution, with the result that all or a portion of the deemed distribution may not be taxable.

(b) Section 72(t) and (m). Section 72(t) (which imposes a 10 percent tax on certain early distributions) and section 72(m)(5) (which imposes a separate 10 percent tax on certain amounts received by a 5-percent owner) apply to a deemed distribution under section 72(p) in the same manner as if the deemed distribution were an actual distribution.

Q-12: Is a deemed distribution under section 72(p) treated as an actual distribution for purposes of the qualification requirements of section 401, the distribution provisions of section 402, the distribution restrictions of section 401(k)(2)(B) or 403(b)(11), or the vesting requirements of Sec. 1.411(a)-7(d)(5) (which affects the application of a graded vesting schedule in cases involving a prior distribution)?

A-12: No; thus, for example, if a participant in a money purchase plan who is an active employee has a deemed distribution under section 72(p), the plan will not be considered to have made an in-service distribution to the participant in violation of the qualification requirements applicable to money purchase plans. Similarly, the deemed distribution is not eligible to be rolled over to an eligible retirement plan and is not considered an impermissible distribution of an amount attributable to elective contributions in a section 401(k) plan. See also Sec. 1.402(c)-2, Q&A-4(d) and Sec. 1.401(k)-1(d)(6)(ii).

Q-13: How does a reduction (offset) of an account balance in order to repay a plan loan differ from a deemed distribution?

A-13: (a) Difference between deemed distribution and plan loan offset amount.

(1) Loans to a participant from a qualified employer plan can give rise to two types of taxable distributions-

(i) A deemed distribution pursuant to section 72(p); and

(ii) A distribution of an offset amount.

(2) As described in Q&A-4 of this section, a deemed distribution occurs when the requirements of Q&A-3 of this section are not satisfied, either when the loan is made or at a later time. A deemed distribution is treated as a distribution to the participant or beneficiary only for certain tax purposes and is not a distribution of the accrued benefit. A distribution of a plan loan offset amount (as defined in Sec. 1.402(c)-2, Q&A-9(b)) occurs when, under the terms governing a plan loan, the accrued benefit of the participant or beneficiary is reduced (offset) in order to repay the loan (including the enforcement of the plan's security interest in the accrued benefit). A distribution of a plan loan offset amount could occur in a variety of circumstances, such as where the terms governing the plan loan require that, in the event of the participant's request for a distribution, a loan be repaid immediately or treated as in default.

(b) Plan loan offset. In the event of a plan loan offset, the amount of the account balance that is offset against the loan is an actual distribution for purposes of the Internal Revenue Code, not a deemed distribution under section 72(p). Accordingly, a plan may be prohibited from making such an offset under the provisions of section 401(a), 401(k)(2)(B) or 403(b)(11) prohibiting or limiting distributions to an active employee. See Sec. 1.402(c)-2, Q&A-9(c), Example 6. See also Q&A-19 of this section for rules regarding the treatment of a loan after a deemed distribution.

Q-14: How is the amount includible in income as a result of a deemed distribution under section 72(p) required to be reported?

A-14: The amount includible in income as a result of a deemed distribution under section 72(p) is required to be reported on Form 1099-R (or any other form prescribed by the Commissioner).

Q-15: What withholding rules apply to plan loans?

A-15: To the extent that a loan, when made, is a deemed distribution or an account balance is reduced (offset) to repay a loan, the amount includible in income is subject to withholding. If a deemed distribution of a loan or a loan repayment by benefit offset results in income at a date after the date the loan is made, withholding is required only if a transfer of cash or property (excluding employer securities) is made to the participant or beneficiary from the plan at the same time. See Secs. 35.3405-1, f-4, and 31.3405(c)-1, Q&A-9 and Q&A-11, of this chapter for further guidance on withholding rules.

Q-16: If a loan fails to satisfy the requirements of Q&A-3 of this section and is a prohibited transaction under section 4975, is the deemed distribution of the loan under section 72(p) a correction of the prohibited transaction?

A-16: No, a deemed distribution is not a correction of a prohibited transaction under section 4975. See Secs. 141.4975-13 and 53.4941(e)-1(c)(1) of this chapter for guidance concerning correction of a prohibited transaction.

Q-17: What are the income tax consequences if an amount is transferred from a qualified employer plan to a participant or beneficiary as a loan, but there is an express or tacit understanding that the loan will not be repaid?

A-17: If there is an express or tacit understanding that the loan will not be repaid or, for any reason, the transaction does not create a debtor-creditor relationship or is otherwise not a bona fide loan, then the amount transferred is treated as an actual distribution from the plan for purposes of the Internal Revenue Code, and is not treated as a loan or as a deemed distribution under section 72(p).

Q-18: If a qualified employer plan maintains a program to invest in residential mortgages, are loans made pursuant to the investment program subject to section 72(p)?

A-18: (a) Residential mortgage loans made by a plan in the ordinary course of an investment program are not subject to section 72(p) if the property acquired with the loans is the primary security for such loans and the amount loaned does not exceed the fair market value of the property. An investment program exists only if the plan has established, in advance of a specific investment under the program, that a certain percentage or amount of plan assets will be invested in residential mortgages available to persons purchasing the property who satisfy commercially customary financial criteria. A loan will not be considered as made under an investment program if-

(1) Any of the loans made under the program matures upon a participant's termination from employment;

(2) Any of the loans made under the program is an earmarked asset of a participant's or beneficiary's individual account in the plan; or

(3) The loans made under the program are made available only to participants or beneficiaries in the plan.

(b) Paragraph (a)(3) of this Q&A-18 shall not apply to a plan which, on December 20, 1995, and at all times thereafter, has had in effect a loan program under which, but for paragraph (a)(3) of this Q&A-18, the loans comply with the conditions of paragraph (a) of this Q&A-18 to constitute residential mortgage loans in the ordinary course of an investment program.

(c) No loan that benefits an officer, director, or owner of the employer maintaining the plan, or their beneficiaries, will be treated as made under an investment program.

(d) This section does not provide guidance on whether a residential mortgage loan made under a plan's investment program would result in a prohibited transaction under section 4975, or on whether such a loan made by a plan covered by Title I of ERISA would be consistent with the fiduciary standards of ERISA or would result in a prohibited transaction under section 406 of ERISA. See 29 CFR 2550.408b-1.

Q-19: If there is a deemed distribution under section 72(p), is the interest that accrues thereafter on the amount of the deemed distribution an indirect loan for income tax purposes?

A-19: (a) General rule. Except as provided in paragraph (b) of this Q&A-19, a deemed distribution of a loan is treated as a distribution for purposes of section 72. Therefore, a loan that is deemed to be distributed under section 72(p)ceases to be an outstanding loan for purposes of section 72, and the interest that accrues thereafter under the plan on the amount deemed distributed is disregarded in applying section 72 to the participant or beneficiary. Even though interest continues to accrue on the outstanding loan (and is taken into account for purposes of determining the tax treatment of any subsequent loan in accordance with paragraph (b) of this Q&A-19), this additional interest is not treated as an additional loan (and, thus, does not result in an additional deemed distribution) for purposes of section 72(p). However, a loan that is deemed distributed under section 72(p) is not considered distributed for all purposes of the Internal Revenue Code. See Q&A-11 through Q&A-16 of this section.

(b) Exception for purposes of applying section 72(p)(2)(A) to a subsequent loan. In the case of a loan that is deemed distributed under section 72(p) and that has not been repaid (such as by a plan loan offset), the unpaid amount of such loan, including accrued interest, is considered outstanding for purposes of applying section 72(p)(2)(A) to determine the maximum amount of any subsequent loan to the participant or beneficiary.

Q-20: May a participant refinance an outstanding loan or have more than one loan outstanding from a plan?

A-20: [Reserved]

Q-21: Is a participant's tax basis under the plan increased if the participant repays the loan after a deemed distribution?

A-21: (a) Repayments after deemed distribution. Yes, if the participant or beneficiary repays the loan after a deemed distribution of the loan under section 72(p), then, for purposes of section 72(e), the participant's or beneficiary's investment in the contract (tax basis) under the plan increases by the amount of the cash repayments that the participant or beneficiary makes on the loan after the deemed distribution. However, loan repayments are not treated as after-tax contributions for other purposes, including sections 401(m) and 415(c)(2)(B).

(b) Example. The following example illustrates the rules in paragraph (a) of this Q&A-21 and is based on the assumptions described in the introductory text of this section:

Example.
(i) A participant receives a $20,000 loan on January 1, 2003, to be repaid in 20 quarterly installments of $1,245 each. On December 31, 2003, the outstanding loan balance ($19,179) is deemed distributed as a result of a failure to make quarterly installment payments that were due on September 30, 2003 and December 31, 2003. On June 30, 2004, the participant repays $5,147 (which is the sum of the three installment payments that were due on September 30, 2003, December 31, 2003, and March 31, 2004, with interest thereon to June 30, 2004, plus the installment payment due on June 30, 2004). Thereafter, the participant resumes making the installment payments of $1,245 from September 30, 2004 through December 31, 2007. The loan repayments made after December 31, 2003 through December 31, 2007 total $22,577.

(ii) Because the participant repaid $22,577 after the deemed distribution that occurred on December 31, 2003, the participant has investment in the contract (tax basis) equal to $22,577 (14 payments of $1,245 each plus a single payment of $5,147) as of December 31, 2007.

Q-22: When is the effective date of section 72(p) and the regulations in this section?

A-22: (a) Statutory effective date. Section 72(p) generally applies to assignments, pledges, and loans made after August 13, 1982.

(b) Regulatory effective date. This section applies to assignments, pledges, and loans made on or after January 1, 2002.

(c) Loans made before the regulatory effective date-

(1) General rule. A plan is permitted to apply Q&A-19 and Q&A-21 of this section to a loan made before the regulatory effective date in paragraph (b) of this Q&A-22 (and after the statutory effective date in paragraph (a) of this Q&A-22) if there has not been any deemed distribution of the loan before the transition date or if the conditions of paragraph (c)(2) of this Q&A-22 are satisfied with respect to the loan.

(2) Consistency transition rule for certain loans deemed distributed before the regulatory effective date.

(i) The rules in this paragraph (c)(2) of this Q&A-22 apply to a loan made before the regulatory effective date in paragraph (b) of this Q&A-22 (and after the statutory effective date in paragraph (a) of this Q&A-22) if there has been any deemed distribution of the loan before the transition date.

(ii) The plan is permitted to apply Q&A-19 and Q&A-21 of this section to the loan beginning on any January 1, but only if the plan reported, in Box 1 of Form 1099-R, for a taxable year no later than the latest taxable year that would be permitted under this section (if this section had been in effect for all loans made after the statutory effective date in paragraph (a) of this Q&A-22), a gross distribution of an amount at least equal to the initial default amount. For purposes of this section, the initial default amount is the amount that would be reported as a gross distribution under Q&A-4 and Q&A-10 of this section and the transition date is the January 1 on which a plan begins applying Q&A-19 and Q&A-21 of this section to a loan.

(iii) If a plan applies Q&A-19 and Q&A-21 of this section to such a loan, then the plan, in its reporting and withholding on or after the transition date, must not attribute investment in the contract (tax basis) to the participant or beneficiary based upon the initial default amount.

(iv) This paragraph (c)(2)(iv) of this Q&A-22 applies if-

(A) The plan attributed investment in the contract (tax basis) to the participant or beneficiary based on the deemed distribution of the loan;

(B) The plan subsequently made an actual distribution to the participant or beneficiary before the transition date; and

(C) Immediately before the transition date, the initial default amount (or, if less, the amount of the investment in the contract so attributed) exceeds the participant's or beneficiary's investment in the contract (tax basis). If this paragraph (c)(2)(iv) of this Q&A-22 applies, the plan must treat the excess (the loan transition amount) as a loan amount that remains outstanding and must include the excess in the participant's or beneficiary's income at the time of the first actual distribution made on or after the transition date.

(3) Examples. The rules in paragraph (c)(2) of this Q&A-22 are illustrated by the following examples, which are based on the assumptions described in the introductory text of this section (and, except as specifically provided in the examples, also assume that no distributions are made to the participant and that the participant has no investment in the contract with respect to the plan). Example 1, Example 2, and Example 4 of this paragraph (c)(3) of this Q&A-22 illustrate the application of the rules in paragraph (c)(2) of this Q&A-22 to a plan that, before the transition date, did not treat interest accruing after the initial deemed distribution as resulting in additional deemed distributions under section 72(p). Example 3 of this paragraph (c)(3) of this Q&A-22 illustrates the application of the rules in paragraph (c)(2) of this Q&A-22 to a plan that, before the transition date, treated interest accruing after the initial deemed distribution as resulting in additional deemed distributions under section 72(p). The examples are as follows:

Example 1.
(i) In 1998, when a participant's account balance under a plan is $50,000, the participant receives a loan from the plan. The participant makes the required repayments until 1999 when there is a deemed distribution of $20,000 as a result of a failure to repay the loan. For 1999, as a result of the deemed distribution, the plan reports, in Box 1 of Form 1099-R, a gross distribution of $20,000 (which is the initial default amount in accordance with paragraph (c)(2)(ii) of this Q&A-22) and, in Box 2 of Form 1099-R, a taxable amount of $20,000. The plan then records an increase in the participant's tax basis for the same amount ($20,000). Thereafter, the plan disregards, for purposes of section 72, the interest that accrues on the loan after the 1999 deemed distribution. Thus, as of December 31, 2001, the total taxable amount reported by the plan as a result of the deemed distribution is $20,000 and the plan's records show that the participant's tax basis is the same amount ($20,000). As of January 1, 2002, the plan decides to apply Q&A-19 of this section to the loan. Accordingly, it reduces the participant's tax basis by the initial default amount of $20,000, so that the participant's remaining tax basis in the plan is zero. Thereafter, the amount of the outstanding loan is not treated as part of the account balance for purposes of section 72. The participant attains age 59 ½ in the year 2003 and receives a distribution of the full account balance under the plan consisting of $60,000 in cash and the loan receivable. At that time, the plan's records reflect an offset of the loan amount against the loan receivable in the participant's account and a distribution of $60,000 in cash.

(ii) For the year 2003, the plan must report a gross distribution of $60,000 in Box 1 of Form 1099-R and a taxable amount of $60,000 in Box 2 of Form 1099-R.

Example 2.
(i) The facts are the same as in Example 1, except that in 1999, immediately prior to the deemed distribution, the participant's account balance under the plan totals $50,000 and the participant's tax basis is $10,000. For 1999, the plan reports, in Box 1 of Form 1099-R, a gross distribution of $20,000 (which is the initial default amount in accordance with paragraph (c)(2)(ii) of this Q&A-22) and reports, in Box 2 of Form 1099-R, a taxable amount of $16,000 (the $20,000 deemed distribution minus $4,000 of tax basis ($10,000 times ($20,000/$50,000)) allocated to the deemed distribution). The plan then records an increase in tax basis equal to the $20,000 deemed distribution, so that the participant's remaining tax basis as of December 31, 1999, totals $26,000 ($10,000 minus $4,000 plus $20,000). Thereafter, the plan disregards, for purposes of section 72, the interest that accrues on the loan after the 1999 deemed distribution. Thus, as of December 31, 2001, the total taxable amount reported by the plan as a result of the deemed distribution is $16,000 and the plan's records show that the participant's tax basis is $26,000. As of January 1, 2002, the plan decides to apply Q&A-19 of this section to the loan. Accordingly, it reduces the participant's tax basis by the initial default amount of $20,000, so that the participant's remaining tax basis in the plan is $6,000. Thereafter, the amount of the outstanding loan is not treated as part of the account balance for purposes of section 72. The participant attains age 59 ½ in the year 2003 and receives a distribution of the full account balance under the plan consisting of $60,000 in cash and the loan receivable. At that time, the plan's records reflect an offset of the loan amount against the loan receivable in the participant's account and a distribution of $60,000 in cash.

(ii) For the year 2003, the plan must report a gross distribution of $60,000 in Box 1 of Form 1099-R and a taxable amount of $54,000 in Box 2 of Form 1099-R.

Example 3.
(i) In 1993, when a participant's account balance in a plan is $100,000, the participant receives a loan of $50,000 from the plan. The participant makes the required loan repayments until 1995 when there is a deemed distribution of $28,919 as a result of a failure to repay the loan. For 1995, as a result of the deemed distribution, the plan reports, in Box 1 of Form 1099-R, a gross distribution of $28,919 (which is the initial default amount in accordance with paragraph (c)(2)(ii) of this Q&A-22) and, in Box 2 of Form 1099-R, a taxable amount of $28,919. For 1995, the plan also records an increase in the participant's tax basis for the same amount ($28,919). Each year thereafter through 2001, the plan reports a gross distribution equal to the interest accruing that year on the loan balance, reports a taxable amount equal to the interest accruing that year on the loan balance reduced by the participant's tax basis allocated to the gross distribution, and records a net increase in the participant's tax basis equal to that taxable amount. As of December 31, 2001, the taxable amount reported by the plan as a result of the loan totals $44,329 and the plan's records for purposes of section 72 show that the participant's tax basis totals the same amount ($44,329). As of January 1, 2002, the plan decides to apply Q&A-19 of this section. Accordingly, it reduces the participant's tax basis by the initial default amount of $28,919, so that the participant's remaining tax basis in the plan is $15,410 ($44,329 minus $28,919). Thereafter, the amount of the outstanding loan is not treated as part of the account balance for purposes of section 72. The participant attains age 59 ½ in the year 2003 and receives a distribution of the full account balance under the plan consisting of $180,000 in cash and the loan receivable equal to the $28,919 outstanding loan amount in 1995 plus interest accrued thereafter to the payment date in 2003. At that time, the plan's records reflect an offset of the loan amount against the loan receivable in the participant's account and a distribution of $180,000 in cash.

(ii) For the year 2003, the plan must report a gross distribution of $180,000 in Box 1 of Form 1099-R and a taxable amount of $164,590 in Box 2 of Form 1099-R ($180,000 minus the remaining tax basis of $15,410).

Example 4.
(i) The facts are the same as in Example 1, except that in 2000, after the deemed distribution, the participant receives a $10,000 hardship distribution. At the time of the hardship distribution, the participant's account balance under the plan totals $50,000. For 2000, the plan reports, in Box 1 of Form 1099-R, a gross distribution of $10,000 and, in Box 2 of Form 1099-R, a taxable amount of $6,000 (the $10,000 actual distribution minus $4,000 of tax basis ($10,000 times ($20,000/$50,000)) allocated to this actual distribution). The plan then records a decrease in tax basis equal to $4,000, so that the participant's remaining tax basis as of December 31, 2000, totals $16,000 ($20,000 minus $4,000). After 1999, the plan disregards, for purposes of section 72, the interest that accrues on the loan after the 1999 deemed distribution. Thus, as of December 31, 2001, the total taxable amount reported by the plan as a result of the deemed distribution plus the 2000 actual distribution is $26,000 and the plan's records show that the participant's tax basis is $16,000. As of January 1, 2002, the plan decides to apply Q&A-19 of this section to the loan. Accordingly, it reduces the participant's tax basis by the initial default amount of $20,000, so that the participant's remaining tax basis in the plan is reduced from $16,000 to zero. However, because the $20,000 initial default amount exceeds $16,000, the plan records a loan transition amount of $4,000 ($20,000 minus $16,000). Thereafter, the amount of the outstanding loan, other than the $4,000 loan transition amount, is not treated as part of the account balance for purposes of section 72. The participant attains age 59 ½ in the year 2003 and receives a distribution of the full account balance under the plan consisting of $60,000 in cash and the loan receivable. At that time, the plan's records reflect an offset of the loan amount against the loan receivable in the participant's account and a distribution of $60,000 in cash.

(ii) In accordance with paragraph (c)(2)(iv) of this Q&A-22, the plan must report in Box 1 of Form 1099-R a gross distribution of $64,000 and in Box 2 of Form 1099-R a taxable amount for the participant for the year 2003 equal to $64,000 (the sum of the $60,000 paid in the year 2003 plus $4,000 as the loan transition amount).

408(h)    Custodial Accounts

Section 408(h)
26 USC 408(h)

For purposes of this section, a custodial account shall be treated as a trust if the assets of such account are held by a bank (as defined in subsection (n)) or another person who demonstrates, to the satisfaction of the Secretary, that the manner in which he will administer the account will be consistent with the requirements of this section, and if the custodial account would, except for the fact that it is not a trust, constitute an individual retirement account described in subsection (a). For purposes of this title, in the case of a custodial account treated as a trust by reason of the preceding sentence, the custodian of such account shall be treated as the trustee thereof.

408(m)    Investment in Collectibles by IRA and Self-Directed Accounts

Section 408(m)
26 USC 408(m)

As Amended through 1988 (P.L. 100-647)

Editor's Note: Also see PTE 91-55, which permits IRA accounts to hold US American Eagle gold coins.

  • In general. The acquisition by an individual retirement account or by an individually-directed account under a plan described in section 401(a) of any collectible shall be treated (for purposes of this section and section 402) as a distribution from such account in an amount equal to the cost to such account of such collectible.
  • Collectible defined. For purposes of this subsection, the term "collectible" means -
    1. Any work of art,
    2. Any rug or antique,
    3. Any metal or gem,
    4. Any stamp or coin,
    5. Any alcoholic beverage, or
    6. Any other tangible personal property specified by the Secretary for purposes of this subsection.
  • Exception for Certain Coins. In the case of an individual retirement account, paragraph (2) shall not apply to any gold coin described in paragraph (7), (8), (9), or (10) of Section 5112(A) of Title 31 or any silver coin described in Section 5112(e) of Title 31.

408(q)    Deemed Individual Retirement Accounts

Section 408(q)
26 USC 408(q)

"(q) Deemed IRAs under qualified employer plans"

(1) General Rule

If -

(A) a qualified employer plan elects to allow employees to make voluntary employee contributions to a separate account or annuity established under the plan, and

(B) under the terms of the qualified employer plan, such account or annuity meets the applicable requirements of this section or section 408A for an individual retirement account or annuity, then such account or annuity shall be treated for purposes of this title in the same manner as an individual retirement plan and not as a qualified employer plan (and contributions to such account or annuity as contributions to an individual retirement plan and not to the qualified employer plan). For purposes of subparagraph (B), the requirements of subsection (a)(5) shall not apply.

(2) Special rules for qualified employer plans

For purposes of this title, a qualified employer plan shall not fail to meet any requirement of this title solely by reason of establishing and maintaining a program described in paragraph (1).

(3) Definitions

For purposes of this subsection -

(A) Qualified employer plan

The term "qualified employer plan" has the meaning given such term by section 72(p)(4); except such term shall not include a government plan which is not a qualified plan unless the plan is an eligible deferred compensation plan (as defined in section 457(b)).

(B) Voluntary employee contribution

The term "voluntary employee contribution" means any contribution (other than a mandatory contribution within the meaning of section 411(c)(2)(C)) -

(i) which is made by an individual as an employee under a qualified employer plan which allows employees to elect to make contributions described in paragraph (1), and

(ii) with respect to which the individual has designated the contribution as a contribution to which this subsection applies.

409(e)    Qualifications for Tax Credit ESOPs – Voting Rights

Section 409(e)
26 USC 409(e)

As Amended through 1997 (P.L. 105-34)

"(e) Voting Rights"

  1. In general
  2. A plan meets the requirements of this subsection if it meets the requirements of paragraph (2) or (3), whichever is applicable.

  3. Requirements where employer has a registration-type class of securities
  4. If the employer has a registration-type class of securities, the plan meets the requirements of this paragraph only if each participant or beneficiary in the plan is entitled to direct the plan as to the manner in which securities of the employer which are entitled to vote and are allocated to the account of such participant or beneficiary are to be voted.

  5. Requirement for other employers
  6. If the employer does not have a registration-type class of securities, the plan meets the requirements of this paragraph only if each participant or beneficiary in the plan is entitled to direct the plan as to the manner in which voting rights under securities of the employer which are allocated to the account of such participant or beneficiary are to be exercised with respect to any corporate matter which involves the voting of such shares with respect to the approval or disapproval of any corporate merger or consolidation, recapitalization, reclassification, liquidation, dissolution, sale of substantially all assets of a trade or business, or such similar transaction as the Secretary may prescribe in regulations.

  7. Registration-type class of securities defined
  8. For purposes of this subsection, the term, "registration-type class of securities" means -

    1. a class of securities required to be registered under section 12 of the Securities Exchange Act of 1934, and
    2. a class of securities which would be required to be so registered except for the exemption from registration provided in subsection (g)(2)(H) of such section 12.  
  9. 1 Vote per Participant
  10. A plan meets the requirements of paragraph (3) with respect to an issue if -

    1. the plan permits each participant 1 vote with respect to such issue, and
    2. the trustee votes the shares held by the plan in the proportion determined after application of subparagraph (A).

417    Special Rules for Survivor Annuity Requirements

Section 417
26 USC 417

Section. 417. Definitions and special rules for purposes of minimum survivor annuity requirements

(a) Election to waive qualified joint and survivor annuity or qualified preretirement survivor annuity

(1) In general

A plan meets the requirements of section 401(a)(11) only if –

(A) under the plan, each participant -

(i) may elect at any time during the applicable election period to waive the qualified joint and survivor annuity form of benefit or the qualified preretirement survivor annuity form of benefit (or both), and

(ii) may revoke any such election at any time during the applicable election period, and

(B) the plan meets the requirements of paragraphs (2), (3), and (4) of this subsection.

(2) Spouse must consent to election

Each plan shall provide that an election under paragraph (1)(A)(i) shall not take effect unless -

(A) (i) the spouse of the participant consents in writing to such election, (ii) such election designates a beneficiary (or a form of benefits) which may not be changed without spousal consent (or the consent of the spouse expressly permits designations by the participant without any requirement of further consent by the spouse), and (iii) the spouse's consent acknowledges the effect of such election and is witnessed by a plan representative or a notary public, or

(B) it is established to the satisfaction of a plan representative that the consent required under subparagraph (A) may not be obtained because there is no spouse, because the spouse cannot be located, or because of such other circumstances as the Secretary may by regulations prescribe.

Any consent by a spouse (or establishment that the consent of a spouse may not be obtained) under the preceding sentence shall be effective only with respect to such spouse.

(3) Plan to provide written explanations

(A) Explanation of joint and survivor annuity
Each plan shall provide to each participant, within a reasonable period of time before the annuity starting date (and consistent with such regulations as the Secretary may prescribe), a written explanation of -

(i) the terms and conditions of the qualified joint and survivor annuity,

(ii) the participant's right to make, and the effect of, an election under paragraph (1) to waive the joint and survivor annuity form of benefit,

(iii) the rights of the participant's spouse under paragraph (2), and

(iv) the right to make, and the effect of, a revocation of an election under paragraph (1).

(B) Explanation of qualified preretirement survivor annuity

(i) In general
Each plan shall provide to each participant, within the applicable period with respect to such participant (and consistent with such regulations as the Secretary may prescribe), a written explanation with respect to the qualified preretirement survivor annuity comparable to that required under subparagraph (A).

(ii) Applicable period
For purposes of clause (i), the term "applicable period" means, with respect to a participant, whichever of the following periods ends last:

(I) The period beginning with the first day of the plan year in which the participant attains age 32 and ending with the close of the plan year preceding the plan year in which the participant attains age 35.

(II) A reasonable period after the individual becomes a participant.

(III) A reasonable period ending after paragraph (5) ceases to apply to the participant.

(IV) A reasonable period ending after section 401(a)(11) applies to the participant.

In the case of a participant who separates from service before attaining age 35, the applicable period shall be a reasonable period after separation.

(4) Requirement of spousal consent for using plan assets as security for loans

Each plan shall provide that, if section 401(a)(11) applies to a participant when part or all of the participant's accrued benefit is to be used as security for a loan, no portion of the participant's accrued benefit may be used as security for such loan unless -

(A) the spouse of the participant (if any) consents in writing to such use during the 90-day period ending on the date on which the loan is to be so secured, and

(B) requirements comparable to the requirements of paragraph (2) are met with respect to such consent.

(5) Special rules where plan fully subsidizes costs

(A) In general
The requirements of this subsection shall not apply with respect to the qualified joint and survivor annuity form of benefit or the qualified preretirement survivor annuity form of benefit, as the case may be, if such benefit may not be waived (or another beneficiary selected) and if the plan fully subsidizes the costs of such benefit.

(B) Definition
For purposes of subparagraph (A), a plan fully subsidizes the costs of a benefit if under the plan the failure to waive such benefit by a participant would not result in a decrease in any plan benefits with respect to such participant and would not result in increased contributions from such participant.

(6) Applicable election period defined

For purposes of this subsection, the term "applicable election period" means -

(A) in the case of an election to waive the qualified joint and survivor annuity form of benefit, the 90-day period ending on the annuity starting date, or

(B) in the case of an election to waive the qualified preretirement survivor annuity, the period which begins on the first day of the plan year in which the participant attains age 35 and ends on the date of the participant's death.

In the case of a participant who is separated from service, the applicable election period under subparagraph (B) with respect to benefits accrued before the date of such separation from service shall not begin later than such date.

(7) Special rules relating to time for written explanation

Notwithstanding any other provision of this subsection -

(A) Explanation may be provided after annuity starting date

(i) In general
A plan may provide the written explanation described in paragraph (3)(A) after the annuity starting date.  In any case to which this subparagraph applies, the applicable election period under paragraph (6) shall not end before the 30th day after the date on which such explanation is provided.

(ii) Regulatory authority
The Secretary may by regulations limit the application of clause (i), except that such regulations may not limit the period of time by which the annuity starting date precedes the provision of the written explanation other than by providing that the annuity starting date may not be earlier than termination of employment.

(B) Waiver of 30-day period
A plan may permit a participant to elect (with any applicable spousal consent) to waive any requirement that the written explanation be provided at least 30 days before the annuity starting date (or to waive the 30-day requirement under subparagraph (A)) if the distribution commences more than 7 days after such explanation is provided.

(b) Definition of qualified joint and survivor annuity

For purposes of this section and section 401(a)(11), the term "qualified joint and survivor annuity" means an annuity -

(1) for the life of the participant with a survivor annuity for the life of the spouse which is not less than 50 percent of (and is not greater than 100 percent of) the amount of the annuity which is payable during the joint lives of the participant and the spouse, and

(2) which is the actuarial equivalent of a single annuity for the life of the participant.

Such term also includes any annuity in a form having the effect of an annuity described in the preceding sentence.

(c) Definition of qualified preretirement survivor annuity

For purposes of this section and section 401(a)(11) -

(1) In general
Except as provided in paragraph (2), the term "qualified preretirement survivor annuity" means a survivor annuity for the life of the surviving spouse of the participant if -

(A) the payments to the surviving spouse under such annuity are not less than the amounts which would be payable as a survivor annuity under the qualified joint and survivor annuity under the plan (or the actuarial equivalent thereof) if -

(i) in the case of a participant who dies after the date on which the participant attained the earliest retirement age, such participant had retired with an immediate qualified joint and survivor annuity on the day before the participant's date of death, or

(ii) in the case of a participant who dies on or before the date on which the participant would have attained the earliest retirement age, such participant had -

(I) separated from service on the date of death,

(II) survived to the earliest retirement age,

(III) retired with an immediate qualified joint and survivor annuity at the earliest retirement age, and

(IV) died on the day after the day on which such participant would have attained the earliest retirement age, and

(B) under the plan, the earliest period for which the surviving spouse may receive a payment under such annuity is not later than the month in which the participant would have attained the earliest retirement age under the plan.

In the case of an individual who separated from service before the date of such individual's death, subparagraph (A)(ii)(I) shall not apply.

(2) Special rule for defined contribution plans
In the case of any defined contribution plan or participant described in clause (ii) or (iii) of section 401(a)(11)(B), the term "qualified preretirement survivor annuity" means an annuity for the life of the surviving spouse the actuarial equivalent of which is not less than 50 percent of the portion of the account balance of the participant (as of the date of death) to which the participant had a nonforfeitable right (within the meaning of section 411(a)).

(3) Security interests taken into account
For purposes of paragraphs (1) and (2), any security interest held by the plan by reason of a loan outstanding to the participant shall be taken into account in determining the amount of the qualified preretirement survivor annuity.

(d) Survivor annuities need not be provided if participant and spouse married less than 1 year

(1) In general
Except as provided in paragraph (2), a plan shall not be treated as failing to meet the requirements of section 401(a)(11) merely because the plan provides that a qualified joint and survivor annuity (or a qualified preretirement survivor annuity) will not be provided unless the participant and spouse had been married throughout the 1-year period ending on the earlier of -

(A) the participant's annuity starting date, or

(B) the date of the participant's death.

(2) Treatment of certain marriages within 1 year of annuity starting date for purposes of qualified joint and survivor annuities
For purposes of paragraph (1), if -

(A) a participant marries within 1 year before the annuity starting date, and

(B) the participant and the participant's spouse in such marriage have been married for at least a 1-year period ending on or before the date of the participant's death, such participant and such spouse shall be treated as having been married throughout the 1-year period ending on the participant's annuity starting date.

(e) Restrictions on cash-outs

(1) Plan may require distribution if present value not in excess of dollar limit
A plan may provide that the present value of a qualified joint and survivor annuity or a qualified preretirement survivor annuity will be immediately distributed if such value does not exceed the dollar limit under section 411(a)(11)(A). No distribution may be made under the preceding sentence after the annuity starting date unless the participant and the spouse of the participant (or where the participant has died, the surviving spouse) consents in writing to such distribution.

(2) Plan may distribute benefit in excess of dollar limit only with consent If -

(A) the present value of the qualified joint and survivor annuity or the qualified preretirement survivor annuity exceeds the dollar limit under section 411(a)(11)(A), and

(B) the participant and the spouse of the participant (or where the participant has died, the surviving spouse) consent in writing to the distribution, the plan may immediately distribute the present value of such annuity.

(3) Determination of present value

(A) In general

(i) Present value
Except as provided in subparagraph (B), for purposes of paragraphs (1) and (2), the present value shall not be less than the present value calculated by using the applicable mortality table and the applicable interest rate.

(ii) Definitions
For purposes of clause (i) -

(I) Applicable mortality table
The term "applicable mortality table" means the table prescribed by the Secretary. Such table shall be based on the prevailing commissioners' standard table (described in section 807(d)(5)(A)) used to determine reserves for group annuity contracts issued on the date as of which present value is being determined (without regard to any other subparagraph of section 807(d)(5)).

(II) Applicable interest rate
The term "applicable interest rate" means the annual rate of interest on 30-year Treasury securities for the month before the date of distribution or such other time as the Secretary may by regulations prescribe.

(B) Exception
In the case of a distribution from a plan that was adopted and in effect before the date of the enactment of the Retirement Protection Act of 1994, the present value of any distribution made before the earlier of -

(i) the later of the date a plan amendment applying subparagraph (A) is adopted or made effective, or

(ii) the first day of the first plan year beginning after December 31, 1999, shall be calculated, for purposes of paragraphs (1) and (2), using the interest rate determined under the regulations of the Pension Benefit Guaranty Corporation for determining the present value of a lump sum distribution on plan termination that were in effect on September 1, 1993, and using the provisions of the plan as in effect on the day before such date of enactment; but only if such provisions of the plan met the  requirements of section 417(e)(3) as in effect on the day before such date of enactment.

(f) Other definitions and special rules

For purposes of this section and section 401(a)(11) -

(1) Vested participant
The term "vested participant" means any participant who has a nonforfeitable right (within the meaning of section 411(a)) to any portion of such participant's accrued benefit.

(2) Annuity starting date

(A) In general
The term "annuity starting date" means -

(i) the first day of the first period for which an amount is payable as an annuity, or

(ii) in the case of a benefit not payable in the form of an annuity, the first day on which all events have occurred which entitle the participant to such benefit.

(B) Special rule for disability benefits
For purposes of subparagraph (A), the first day of the first period for which a benefit is to be received by reason of disability shall be treated as the annuity starting date only if such benefit is not an auxiliary benefit.

(3) Earliest retirement age
The term "earliest retirement age" means the earliest date on which, under the plan, the participant could elect to receive retirement benefits.

(4) Plan may take into account increased costs
A plan may take into account in any equitable manner (as determined by the Secretary) any increased costs resulting from providing a qualified joint or survivor annuity or a qualified preretirement survivor annuity.

(5) Distributions by reason of security interests
If the use of any participant's accrued benefit (or any portion thereof) as security for a loan meets the requirements of subsection (a)(4), nothing in this section or section 411(a)(11) shall prevent any distribution required by reason of a failure to comply with the terms of such loan.

(6) Requirements for certain spousal consents
No consent of a spouse shall be effective for purposes of subsection (e)(1) or (e)(2) (as the case may be) unless requirements comparable to the requirements for spousal consent to an election under subsection (a)(1)(A) are met.

(7) Consultation with the Secretary of Labor
In prescribing regulations under this section and section 401(a)(11), the Secretary shall consult with the Secretary of Labor.

Source - (Added Pub. L. 98-397, title II, Sec. 203(b), Aug. 23, 1984, 98 Stat. 1441; amended Pub. L. 99-514, title XI, Sec. 1139(b), title XVIII, Sec. 1898(b)(1)(A), (4)(A), (5)(A), (6)(A), (8)(A), (9)(A), (10)(A), (11)(A), (12)(A), (15)(A), (B), Oct. 22, 1986, 100 Stat. 2487, 2944, 2945, 2947-2951; Pub. L. 100-647, title I, Sec. 1018(u)(9), Nov. 10, 1988, 102 Stat. 3590; Pub. L. 101-239, title VII, Sec. 7862(d)(1)(A), Dec. 19, 1989, 103 Stat. 2433; Pub. L. 103-465, title VII, Sec. 767(a)(2), Dec. 8, 1994, 108 Stat. 5038; Pub. L. 104-188, title I, Sec. 1451(a), Aug. 20, 1996, 110 Stat. 1815; Pub. L. 105-34, title X, Sec. 1071(a)(2), Aug. 5, 1997, 111 Stat. 948.)

4975    Tax on Prohibited Transactions

Section 4975
26 USC 4975

As Amended through July 22, 1998 (P.L. 105-206)

(a) Initial taxes on disqualified person

There is hereby imposed a tax on each prohibited transaction.
The rate of tax shall be equal to 15 percent of the amount involved with respect to the prohibited transaction for each year (or part thereof) in the taxable period.  The tax imposed by this subsection shall be paid by any disqualified person who participates in the prohibited transaction (other than a fiduciary acting only as such).

(b) Additional taxes on disqualified person

In any case in which an initial tax is imposed by subsection (a) on a prohibited transaction and the transaction is not corrected within the taxable period, there is hereby imposed a tax equal to 100 percent of the amount involved.  The tax imposed by this subsection shall be paid by any disqualified person who participated in the prohibited transaction (other than a fiduciary acting only as such).

(c) Prohibited Transaction

(1) General rule

For purposes of this section, the term "prohibited transaction" means any direct or indirect -

(A) sale or exchange, or leasing, of any property between a plan and a disqualified person;

(B) lending of money or other extension of credit between a plan and a disqualified person;

(C) furnishing of goods, services, or facilities between a plan and a disqualified person;

(D) transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a plan;

(E) act by a disqualified person who is a fiduciary whereby he deals with the income or assets of a plan in his own interests or for his own account; or

(F) receipt of any consideration for his own personal account by any disqualified person who is a fiduciary from any party dealing with the plan in connection with a transaction involving the income or assets of the plan.

(2) Special exemption

The Secretary shall establish an exemption procedure for purposes of this subsection. Pursuant to such procedure, he may grant a conditional or unconditional exemption of any disqualified person or transaction, orders of disqualified persons or transactions, from all or part of the restrictions imposed by paragraph (1) of this subsection. Action under this subparagraph may be taken only after consultation and coordination with the Secretary of Labor. The Secretary may not grant an exemption under this paragraph unless he finds that such exemption is –

(A) administratively feasible,

(B) in the interests of the plan and of its participants and beneficiaries, and

(C) protective of the rights of participants and beneficiaries of the plan.
Before granting an exemption under this paragraph, the Secretary shall require adequate notice to be given to interested persons and shall publish notice in the Federal Register of the pendency of such exemption and shall afford interested persons an opportunity to present views.  No exemption may be granted under this paragraph with respect to a transaction described in subparagraph (E) or (F) of paragraph (1) unless the Secretary affords an opportunity for a hearing and makes a determination on the record with respect to the findings required under subparagraphs (A), (B), and (C) of this paragraph, except that in lieu of such hearing the Secretary may accept any record made by the Secretary of Labor with respect to an application for exemption under section 408(a) of title I of the Employee Retirement Income Security Act of 1974.

(3) Special rule for individual retirement accounts

An individual for whose benefit an individual retirement account is established and his beneficiaries shall be exempt from the tax imposed by this section with respect to any transaction concerning such account (which would otherwise be taxable under this section) if, with respect to such transaction, the account ceases to be an individual retirement account by reason of the application of section 408(e)(2)(A) or if section 408(e)(4) applies to such account.

(4) Special rule for medical savings accounts

An individual for whose benefit a medical savings account (within the meaning of section 220(d)) is established shall be exempt from the tax imposed by this section with respect to any transaction concerning such account (which would otherwise be taxable under this section) if section 220(e)(2) applies to such transaction.

(5) Special rule for education individual retirement accounts

An individual for whose benefit an education individual retirement account is established and any contributor to such account shall be exempt from the tax imposed by this section with respect to any transaction concerning such account (which would otherwise be taxable under this section) if section 530(d) applies with respect to such transaction.

(d) Exemptions

Except as provided in subsection (f)(6), the prohibitions provided in subsection (c) shall not apply to -

(1) any loan made by the plan to a disqualified person who is a participant or beneficiary of the plan if such loan -

(A) is available to all such participants or beneficiaries on a reasonably equivalent basis,

(B) is not made available to highly compensated employees (within the meaning of section 414(q)) in an amount greater than the amount made available to other employees,

(C) is made in accordance with specific provisions regarding such loans set forth in the plan,

(D) bears a reasonable rate of interest, and

(E) is adequately secured;

(2) any contract, or reasonable arrangement, made with a disqualified person 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 therefore;

(3) any loan to an leveraged employee stock ownership plan (as defined in subsection (e)(7)), if-

(A) such loan is primarily for the benefit of participants and beneficiaries of the plan, and

(B) such loan is at a reasonable rate of interest, and any collateral which is given to a disqualified person by the plan consists only of qualifying employer securities (as defined in subsection (e)(8));

(4) the investment of all or part of a plan's 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 such plan and if -

(A) the plan covers only employees of such bank or other institution and employees of affiliates of such bank or other institution, or

(B) such investment is expressly authorized by a provision of the plan or by a fiduciary (other than such bank or institution or affiliates thereof) who is expressly empowered by the plan to so instruct the trustee with respect to such investment;

(5) any contract for life insurance, health insurance, or annuities with one or more insurers which are qualified to do business in a State if the plan pays no more than adequate consideration, and if each such insurer or insurers is -

(A) he employer maintaining the plan, or

(B) a disqualified person which is wholly owned (directly or indirectly) by the employer establishing the plan, or by any person which is a disqualified person with respect to the plan, but only if the total premiums and annuity considerations written by such insurers for life insurance, health insurance, or annuities for all plans (and their employers) with respect to which such insurers are disqualified persons (not including premiums or annuity considerations written by the employer maintaining the plan) do not exceed 5 percent of the total premiums and annuity considerations written for all lines of insurance in that year by such insurers (not including premiums or annuity considerations written by the employer maintaining the plan);

(6) the provision of any ancillary service by a bank or similar financial institution supervised by the United States or a State, if such service is provided at not more than reasonable compensation, if such bank or other institution is a fiduciary of such plan, and if -

(A) such bank or similar financial institution has adopted adequate internal safeguards which assure that the provision of such ancillary service is consistent with sound banking and financial practice, as determined by Federal or State supervisory authority, and

(B) the extent to which such ancillary service is provided is subject to specific guidelines issued by such bank or similar financial institution (as determined by the Secretary after consultation with Federal and State supervisory authority), and under such guidelines the bank or similar financial institution does not provide such ancillary service -

(i) in an excessive or unreasonable manner, and

(ii) in a manner that would be inconsistent with the best interests of participants and beneficiaries of employee benefit plans;

(7) the exercise of a privilege to convert securities, to the extent provided in regulations of the Secretary but only if the plan receives no less than adequate consideration pursuant to such conversion;

(8) any transaction between a plan and a common or collective trust fund or pooled investment fund maintained by a disqualified person which is a bank or trust company supervised by a State or Federal agency or between a plan and a pooled investment fund of an insurance company qualified to do business in a State if –

(A) the transaction is a sale or purchase of an interest in the fund,

(B) the bank, trust company, or insurance company receives not more than a reasonable compensation, and

(C) such transaction is expressly permitted by the instrument under which the plan is maintained, or by a fiduciary (other than the bank, trust company, or insurance company, or an affiliate thereof) who has authority to manage and control the assets of the plan;

(9) receipt by a disqualified person of any benefit to which he may be entitled as a participant or beneficiary in the plan, so long as the benefit is computed and paid on a basis which is consistent with the terms of the plan as applied to all other participants and beneficiaries; (10) receipt by a disqualified person of any reasonable compensation for services rendered, or for the reimbursement of expenses properly and actually incurred, in the performance of his duties with the plan, but no person so serving who already receives full-time pay from an employer or an association of employers, whose employees are participants in the plan or from an employee organization whose members are participants in such plan shall receive compensation from such fund, except for reimbursement of expenses properly and actually incurred;

(10) service by a disqualified person as a fiduciary in addition to being an officer, employee, agent, or other representative of a disqualified person;

(11) the making by a fiduciary of a distribution of the assets of the trust in accordance with the terms of the plan if such assets are distributed in the same manner as provided under section 4044 of title IV of the Employee Retirement Income Security Act of 1974 (relating to allocation of assets);

(12) any transaction which is exempt from section 406 of such Act by reason of section 408(e) of such Act (or which would be so exempt if such section 406 applied to such transaction) or which is exempt from section 406 of such Act by reason of section 408(b)(12) of such Act;

(13) any transaction required or permitted under part 1 of subtitle E of title IV or section 4223 of the Employee Retirement Income Security Act of 1974, but this paragraph shall not apply with respect to the application of subsection (c)(1) (E) or (F); or

(14) a merger of multiemployer plans, or the transfer of assets or liabilities between multiemployer plans, determined by the Pension Benefit Guaranty Corporation to meet the requirements of section 4231 of such Act, but this paragraph shall not apply with respect to the application of subsection (c)(1) (E) or (F).

(e) Definitions

(1) Plan

For purposes of this section, the term "plan" means -

(A) a trust described in section 401(a) which forms a part of a plan, or a plan described in section 403(a), which trust or plan is exempt from tax under section 501(a),

(B) an individual retirement account described in section 408(a),

(C) an individual retirement annuity described in section 408(b),

(D) a medical savings account described in section 220(d),

(E) an education individual retirement account described in section 530, or

(F) a trust, plan, account, or annuity which, at any time, has been determined by the Secretary to be described in any preceding subparagraph of this paragraph.

(2) Disqualified person

For purposes of this section, the term "disqualified person" means a person who is -

(A) a fiduciary;

(B) a person providing services to the plan;

(C) an employer any of whose employees are covered by the plan;

(D) an employee organization any of whose members are covered by the plan;

(E) an owner, direct or indirect, of 50 percent or more of -

(i) he combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock of a corporation,

(ii) the capital interest or the profits interest of a partnership, or

(iii) the beneficial interest of a trust or unincorporated enterprise, which is an employer or an employee organization described in subparagraph (C) or (D);

(F) a member of the family (as defined in paragraph (6)) of any individual described in subparagraph (A), (B), (C), or (E);

(G) 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 such 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 persons described in subparagraph (A), (B), (C), (D), or (E);

(H) an officer, director (or an individual having powers or responsibilities similar to those of officers or directors), a 10 percent or more shareholder, or a highly compensated employee (earning 10 percent or more of the yearly wages of an employer) of a person described in subparagraph (C), (D), (E), or (G); or

(I) a 10 percent or more (in capital or profits) partner or joint venture of a person described in subparagraph (C), (D), (E), or (G).

The Secretary, after consultation and coordination with the Secretary of Labor or his delegate, may by regulation prescribe a percentage lower than 50 percent for subparagraphs (E) and (G) and lower than 10 percent for subparagraphs (H) and (I).

(3) Fiduciary

For purposes of this section, the term "fiduciary" means any person who -

(A) exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets,

(B) renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, or has any authority or responsibility to do so, or

(C) has any discretionary authority or discretionary responsibility in the administration of such plan. Such term includes any person designated under section 405(c)(1)(B) of the Employee Retirement Income Security Act of 1974.

(4) Stockholdings

For purposes of paragraphs (2)(E)(i) and (G)(i) there shall be taken into account indirect stockholdings which would be taken into account under section 267(c), except that, for purposes of this paragraph, section 267(c)(4) shall be treated as providing that the members of the family of an individual are the members within the meaning of paragraph (6).

(5) Partnerships; Trusts

For purposes of paragraphs (2)(E)(ii) and (iii), (G)(ii) and (iii), and (I) the ownership of profits or beneficial interests shall be determined in accordance with the rules for constructive ownership of stock provided in section 267(c) (other than paragraph (3) thereof), except that section 267(c)(4) shall be treated as providing that the members of the family of an individual are the members within the meaning of paragraph (6).

(6) Member of family

For purposes of paragraph (2)(F), the family of any individual shall include his spouse, ancestor, lineal descendant, and any spouse of a lineal descendant.

(7) Employee stock ownership plan
The term "employee stock ownership plan" means a defined contribution plan -

(A) which is a stock bonus plan which is qualified, or a stock bonus and a money purchase plan both of which are qualified under section 401(a), and which are designed to invest primarily in qualifying employer securities; and

(B) which is otherwise defined in regulations prescribed by the Secretary.

A plan shall not be treated as an employee stock ownership plan unless it meets the requirements of section 409(h), section 409(o), and, if applicable, section 409(n) and section 664(g) and, if the employer has a registration-type class of securities (as defined in section 409(e)(4)), it meets the requirements of section 409(e).

(8) Qualifying employer security
The term "qualifying employer security" means any employer security within the meaning of section 409(l). If any moneys or other property of a plan are invested in shares of an investment company registered under the Investment Company Act of 1940, the investment shall not cause that investment company or that investment company's investment adviser or principal underwriter to be treated as a fiduciary or a disqualified person for purposes of this section, except when an investment company or its investment adviser or principal underwriter acts in connection with a plan covering employees of the investment company, its investment adviser, or its principal underwriter.

(9) Section made applicable to withdrawal liability payment funds

For purposes of this section -

(A) In general

The term "plan" includes a trust described in section 501(c)(22).

(B) Disqualified person In the case of any trust to which this section applies by reason of subparagraph (A), the term "disqualified person" includes any person who is a disqualified person with respect to any plan to which such trust is permitted to make payments under section 4223 of the Employee Retirement Income Security Act of 1974.

(f) Other definitions and special rules

For purposes of this section -

(1) Joint and several liability

If more than one person is liable under subsection (a) or (b) with respect to any one prohibited transaction, all such persons shall be jointly and severally liable under such subsection with respect to such transaction.

(2) Taxable period

The term "taxable period" means, with respect to any prohibited transaction, the period beginning with the date on which the prohibited transaction occurs and ending on the earliest of -

(A) the date of mailing a notice of deficiency with respect to the tax imposed by subsection (a) under section 6212,

(B) the date on which the tax imposed by subsection (a) is assessed, or

(C) the date on which correction of the prohibited transaction is completed.

(3) Sale or exchange; encumbered property

A transfer or real or personal property by a disqualified person to a plan shall be treated as a sale or exchange if the property is subject to a mortgage or similar lien which the plan assumes or if it is subject to a mortgage or similar lien which a disqualified person placed on the property within the 10-year period ending on the date of the transfer.

(4) Amount involved

The term "amount involved" means, with respect to a prohibited transaction, the greater of the amount of money and the fair market value of the other property given or the amount of money and the fair market value of the other property received; except that, in the case of services described in paragraphs (2) and (10) of subsection (d) the amount involved shall be only the excess compensation. For purposes of the preceding sentence, the fair market value -

(A) in the case of the tax imposed by subsection (a), shall be determined as of the date on which the prohibited transaction occurs; and

(B) in the case of the tax imposed by subsection (b), shall be the highest fair market value during the taxable period.

(5) Correction

The terms "correction" and "correct" mean, with respect to a prohibited transaction, undoing the transaction to the extent possible, but in any case placing the plan in a financial position not worse than that in which it would be if the disqualified person were acting under the highest fiduciary standards.

(6) Exemptions not to apply to certain transactions

(A) In general

In the case of a trust described in section 401(a) which is part of a plan providing contributions or benefits for employees some or all of whom are owner-employees (as defined in section 401(c)(3)), the exemptions provided by subsection (d) (other than paragraphs (9) and (12)) shall not apply to a transaction in which the plan directly or indirectly -

(i) lends any part of the corpus or income of the plan to,

(ii) pays any compensation for personal services rendered to the plan to, or

(iii) acquires for the plan any property from, or sells any property to, any such owner-employee, a member of the family (as defined in section 267(c)(4)) of any such owner-employee, or any corporation in which any such owner-employee owns, directly or indirectly, 50 percent or more of the total combined voting power of all classes of stock entitled to vote or 50 percent or more of the total value of shares of all classes of stock of the corporation.

(B) Special rules for shareholder-employees, etc.

(i) In general

For purposes of subparagraph (A), the following shall be treated as owner-employees:

(I) A shareholder-employee.

(II) A participant or beneficiary of an individual retirement plan (as defined in section 7701(a)(37)).

(III) An employer or association of employees which establishes such an individual retirement plan under section 408(c).

(ii) Exception for certain transactions involving shareholder-employees

Subparagraph (A)(iii) shall not apply to a transaction which consists of a sale of employer securities to an employee stock ownership plan (as defined in subsection (e)(7)) by a shareholder-employee, a member of the family (as defined in section 267(c)(4)) of such shareholder-employee, or a corporation in which such a shareholder-employee owns stock representing a 50 percent or greater interest described in subparagraph (A).

(C) Shareholder-employee

For purposes of subparagraph (B), the term "shareholder-employee" means an employee or officer of an S corporation who owns (or is considered as owning within the meaning of section 318(a)(1)) more than 5 percent of the outstanding stock of the corporation on any day during the taxable year of such corporation.

(g) Application of section

This section shall not apply -

(1) in the case of a plan to which a guaranteed benefit policy (as defined in section 401(b)(2)(B) of the Employee Retirement Income Security Act of 1974) is issued, to any assets of the insurance company, insurance service, or insurance organization merely because of its issuance of such policy;

(2) to a governmental plan (within the meaning of section 414(d)); or

(3) to a church plan (within the meaning of section 414(e)) with respect to which the election provided by section 410(d) has not been made.

In the case of a plan which invests in any security issued by an investment company registered under the Investment Company Act of 1940, the assets of such plan shall be deemed to include such security but shall not, by reason of such investment, be deemed to include any assets of such company.

(h) Notification of Secretary of Labor

Before sending a notice of deficiency with respect to the tax imposed by subsection (a) or (b), the Secretary shall notify the Secretary of Labor and provide him a reasonable opportunity to obtain a correction of the prohibited transaction or to comment on the imposition of such tax.

(i) Cross reference

For provisions concerning coordination procedures between Secretary of Labor and Secretary of the Treasury with respect to application of tax imposed by this section and for authority to waive imposition of the tax imposed by subsection (b), see section 3003 of the Employee Retirement Income Security Act of 1974.

Source - (Added Pub. L. 93-406, title II, Sec. 2003(a), Sept. 2, 1974, 88 Stat. 971; amended Pub. L. 94-455, title XIX, Sec. 1906(b)(13)(A), Oct. 4, 1976, 90 Stat. 1834; Pub. L. 95-600, title I, Sec. 141(f)(5), (6), Nov. 6, 1978, 92 Stat. 2795; Pub. L. 96-222, title I, Sec. 101(a)(7)(C), (K), (L)(iv)(III), (v)(XI), Apr. 1, 1980, 94 Stat. 198-201; Pub. L. 96-364, title II, Sec. 208(b), 209(b), Sept. 26, 1980, 94 Stat. 1289, 1290; Pub. L. 96-596, Sec. 2(a)(1)(K),(L), (2)(I), (3)(F), Dec. 24, 1980, 94 Stat. 3469, 3471; Pub. L. 97-448, title III, Sec. 305(d)(5), Jan. 12, 1983, 96 Stat. 2400; Pub. L. 98-369, div. A, title IV, Sec. 491(d)(45), (46), (e)(7), (8), July 18, 1984, 98 Stat. 851-853; Pub. L. 99-514, title XI, Sec. 1114(b)(15)(A), title XVIII, Sec. 1854(f)(3)(A), 1899A(51), Oct. 22, 1986, 100 Stat. 2452, 2882, 2961; Pub. L. 101-508, title XI, Sec. 11701(m), Nov. 5, 1990, 104 Stat. 1388-513; Pub. L. 104-188, title I, Sec. 1453(a), 1702(g)(3), Aug. 20, 1996, 110 Stat. 1817, 1873; Pub. L. 104-191, title III, Sec. 301(f), Aug. 21, 1996, 110 Stat. 2051; Pub. L. 105-34, title II, Sec. 213(b), title X, Sec. 1074(a), title XV, Sec. 1506(b)(1), 1530(c)(10), title XVI, Sec. 1602(a)(5), Aug. 5, 1997, 111 Stat. 816, 949, 1065, 1079, 1094; Pub. L. 105-206, title VI, Sec. 6023(19), July 22, 1998, 112 Stat. 825.)

Regulations

54.4975-11    ESOP Requirements

Internal Revenue Service
Regulation 54.4975-11
26 C.F.R. 54.4975-11

Originally issued September 2, 1977 (42 FR 44393)

As revised through January 9, 1979 (44 FR 1978)

  1. In general -
    1. Type of plan. To be an "ESOP" (employee stock ownership plan), a plan described in section 4975(e)(7)(A) must meet the requirements of this section. See section 4975(e)(7)(B).
    2. Designation as ESOP. To be an ESOP, a plan must be formally designated as such in the plan document.
    3. Continuing loan provisions under plan -
      1. Creation of protections and rights. The terms of an ESOP must formally provide participants with certain protections and rights with respect to plan assets acquired with the proceeds of an exempt loan. These protections and rights are those referred to in the third sentence of  54.4975-7(b)(4), relating to put, call, or other options and to buy-sell or similar arrangements, and in  54.4975-7(b)(10), (11), and (12), relating to put options.
      2. "Nonterminable" protections and rights. The terms of an ESOP must also formally provide that these protections and rights are nonterminable. Thus, if a plan holds or has distributed securities acquired with the proceeds of an exempt loan and either the loan is repaid or the plan ceases to be an ESOP, these protections and rights must continue to exist under the terms of the plan. However, the protections and rights will not fail to be nonterminable merely because they are not exercisable under 54.4975-7(b)(11) and (12)(ii). For example, if, after a plan ceases to be an ESOP, securities acquired with the proceeds of an exempt loan cease to be publicly traded, the 15-month period prescribed by  54.4975-7(b)(11) includes the time when the securities are publicly traded.
      3. No incorporation by reference of protections and rights. The formal requirements of paragraph (a)(3)(i) and (ii) of this section must be set forth in the plan. Mere reference to the third sentence of  54.4975-7(b)(4) and to the provisions of  54.4975-7(b)(10), (11), and (12) is not sufficient.
      4. Certain remedial amendments. Notwithstanding the limits under paragraph (a)(4) and (10) of this section on the retroactive effect of plan amendments, a remedial plan amendment adopted before December 31, 1979, to meet the requirements of paragraph (a)(3)(i) and (ii) of this section is retroactively effective as of the later of the date on which the plan was designated as an ESOP or November 1, 1977.
    4. Retroactive amendment. A plan meets the requirements of this section as of the date that it is designated as an ESOP if it is amended retroactively to meet, and in fact does meet, such requirements at any of the following times:
      1. 12 months after the date on which the plan is designated as an ESOP;
      2. 90 days after a determination letter is issued with respect to the qualification of the plan as an ESOP under this section, but only if the determination is requested by the time in paragraph (a)(4)(i) of this section; or
      3. A later date approved by the district director.
    5. Addition to other plan. An ESOP may form a portion of a plan the balance of which includes a qualified pension, profit-sharing, or stock bonus plan which is not an ESOP. A reference to an ESOP includes an ESOP that forms a portion of another plan.
    6. Conversion of existing plan to an ESOP. If an existing pension, profit-sharing, or stock bonus plan is converted into an ESOP, the requirements of section 404 of the Employee Retirement Income Security Act of 1974 (ERISA) (88 Stat. 877), relating to fiduciary duties, and section 401(a) of the Code, relating to requirements for plans established for the exclusive benefit of employees, apply to such conversion. A conversion may constitute a termination of an existing plan. For definition of a termination, see the regulations under section 411(d)(3) of the Code and section 4041(f) of ERISA.
    7. Certain arrangements barred -
      1. Buy-sell agreements. An arrangement involving an ESOP that creates a put option must not provide for the issuance of put options other than as provided under  54.4975-7 (b)(10), (11), and (12). Also, an ESOP must not otherwise obligate itself to acquire securities from a particular security holder at an indefinite time determined upon the happening of an event such as the death of the holder.
      2. Integrated plans. A plan designated as an ESOP after November 1, 1977, must not be integrated directly or indirectly with contributions or benefits under Title II of the Social Security Act or any other State or Federal law. ESOPs established and integrated before such date may remain integrated. However, such plans must not be amended to increase the integration level or the integration percentage. Such plans may in operation continue to increase the level of integration if under the plan such increase is limited by reference to a criterion existing apart from the plan.
    8. Effect of certain ESOP Provisions on section 401(a) status -
      1. Exempt loan requirements. An ESOP will not fail to meet the requirements of section 401(a)(2) merely because it gives plan assets as collateral for an exempt loan under  54.4975-7(b)(5) or uses plan assets under  54.4975-7(b)(6) to repay an exempt loan in the event of default.
      2. Individual annual contribution limitation. An ESOP will not fail to meet the requirements of section 401(a)(16) merely because annual additions under section 415(c) are calculated with respect to employer contributions used to repay an exempt loan rather than with respect to securities allocated to participants.
      3. Income pass-through. An ESOP will not fail to meet the requirements of section 401(a) merely because it provides for the current payment of income under paragraph (f)(3) of this section.
    9. Transitional rules for ESOPs established before November 1, 1977. A plan established before November 1, 1977, that otherwise satisfies the provisions of this section constitutes an ESOP if it is amended by December 31, 1977, to comply from November 1, 1977, with this section even though before November 1, 1977, the plan did not satisfy paragraphs (c) and (d)(2), (4), and (5) of this section.
    10. Additional transitional rules. Notwithstanding paragraph (a)(9) of this section, a plan established before November 1, 1977, that otherwise satisfies the provisions of this section constitutes an ESOP if by December 31, 1977, it is amended to comply from November 1, 1977, with this section even though before such date the plan did not satisfy the following provisions of this section:
      1. Paragraph (a)(3) and (8)(iii);
      2. The last sentence of paragraph (d)(3), and
      3. Paragraph (f)(3). [Amended by T. D. 7571 on November 16, 1978, 43 FR 53718.]
  2. Plan designed to invest primarily in qualifying employer securities. A plan constitutes an ESOP only if the plan specifically states that it is designed to invest primarily in qualifying employer securities. Thus, a stock bonus plan or a money purchase pension plan constituting an ESOP may invest part of its assets in other than qualifying employer securities. Such plan will be treated the same as other stock bonus plans or money purchase pension plans qualified under section 401(a) with respect to those investments.
  3. Suspense Account. All assets acquired by an ESOP with the proceeds of an exempt loan under section 4975(d)(3) must be added to and maintained in a suspense account. They are to be withdrawn from the suspense account by applying  54.4975-7(b)(8) and (15) as if all securities in the suspense account were encumbered. Such assets acquired before November 1, 1977, must be withdrawn by applying  54.4975-7(b)(8) or the provision of the loan that controls release from encumbrance. Assets in such suspense accounts are assets of the ESOP. Thus, for example, such assets are subject to section 401(a)(2).
  4. Allocations to accounts of participants -
    1. In general. Except as provided in this section, amounts contributed to an ESOP must be allocated as provided under  1.401-1(b)(ii) and (iii) of this chapter, and securities acquired by an ESOP must be accounted for as provided under  1.402(a)-1(b)(2)(ii) of this chapter.
    2. Assets withdrawn from suspense account. As of the end of each plan year, the ESOP must consistently allocate to the participants' accounts non-monetary units representing participants' interests in assets withdrawn from the suspense account.
    3. Income. Income with respect to securities acquired with the proceeds of an exempt loan must be allocated as income of the plan except to the extent that the ESOP provides for the use of income from such securities to repay the loan. Certain income may be distributed currently under paragraph (f)(3) of this section.
    4. Forfeitures. If a portion of a participant's account is forfeited, qualifying employer securities allocated under paragraph (d)(2) of this section must be forfeited only after other assets. If interests in more than one class of qualifying employer securities have been allocated to the participant's account, the participant must be treated as forfeiting the same proportion of each such class.
    5. Valuation. For purposes of  54.4975-7(b)(9) and (12) and this section, valuations must be made in good faith and based on all relevant factors for determining the fair market value of securities. In the case of a transaction between a plan and a disqualified person, value must be determined as of the date of the transaction. For all other purposes under this subparagraph (5), value must be determined as of the most recent valuation date under the plan. An independent appraisal will not in itself be a good faith determination of value in the case of a transaction between a plan and a disqualified person. However, in other cases, a determination of fair market value based on at least an annual appraisal independently arrived at by a person who customarily makes such appraisals and who is independent of any party to a transaction under  54.4975-7(b)(9) and (12) will be deemed to be a good faith determination of value. [Amended by T.D. 7571 on November 16, 1978, 43 FR 53718.]
  5. Multiple plans -
    1. General rule. An ESOP may not be considered together with another plan for purposes of applying section 401(a)(4) and (5) or section 410(b) unless-
      1. The ESOP and such other plan exist on November 1, 1977; or
      2. Paragraph (e)(2) of this section is satisfied.
    2. Special rule for combined ESOPs. Two or more ESOPs, one or more of which does not exist on November 1, 1977, may be considered together for purposes of applying section 401(a)(4) and (5) or section 410(b) only if the proportion of qualifying employer securities to total plan assets is substantially the same for each ESOP and-
      1. The qualifying employer securities held by all ESOPs are all of the same class; or
      2. The ratios of each class held to all such securities held is substantially the same for each plan.
    3. Amended coverage, contribution, or benefit structure. For purposes of paragraph (e)(1)(i) of this section, if the coverage, contribution, or benefit structure of a plan that exists on November 1, 1977, is amended after that date, as of the effective date of the amendment, the plan is no longer considered to be a plan that exists on November 1, 1977. [Amended by T.D. 7571 on November 16, 1978, 43 FR 53718.]
  6. Distribution -
    1. In general. Except as provided in paragraph (f)(2) and (3) of this section, with respect to distributions, a portion of an ESOP consisting of a stock bonus plan or a money purchase pension plan is not to be distinguished from other such plans under section 401(a). Thus, for example, benefits distributable from the portion of an ESOP consisting of a stock bonus plan are distributable only in stock of the employer. Also, benefits distributable from the money-purchase portion of the ESOP may be, but are not required to be, distributable in qualifying employer securities.
    2. Exempt loan proceeds. If securities acquired with the proceeds of an exempt loan available for distribution consist of more than one class, a distributee must receive substantially the same proportion of each such class. However, as indicated in paragraph (f)(1) of this section, benefits distributable from the portion of an ESOP consisting of a stock bonus plan are distributable only in stock of the employer.
    3. Income. Income paid with respect to qualifying employer securities acquired by an ESOP in taxable years beginning after December 31, 1974, may be distributed at any time after receipt by the plan to participants on whose behalf such securities have been allocated. However, under an ESOP that is a stock bonus plan, income held by the plan for a 2-year period or longer must be distributed under the general rules described in paragraph (f)(1) of this section. (See the last sentence of section 803(h), Tax Reform Act of 1976.) [Reg 54.4975-11 added by T. D. 7506 on August 30, 1977; amended by T. D. 7571 on November 16, 1978, 43 FR 53718.]

54.4975-12    "Qualified Employer Security" Defined

Internal Revenue Service
Regulation 54.4975-12
26 C.F.R. 54.4975-12

Originally Issued September 2, 1977 (42 FR 44394)

  1. In general. For purposes of section 4975(e)(8) and this section, the term "qualifying employer security" means an employer security which is -
    1. Stock or otherwise an equity security, or
    2. A bond, debenture, note, or certificate or other evidence of indebtedness which is described in paragraphs (1), (2), and (3) of section 503(e).
  2. Special rule. In determining whether a bond, debenture, note, or certificate or other evidence of indebtedness is described in paragraphs (1), (2), and (3) of section 503(e), any organization described in section 401(a) shall be treated as an organization subject to the provisions of section 503. [Reg.  54.4975-12 added August 30, 1977, by T. D. 7506.]

2510.3-101    "Plan Assets" Defined (Pension and Welfare Benefits Administration Regulation)

Department of Labor
Pension and Welfare Benefits Administration Regulation
Regulation 2510.3-101
29 C.F.R. 2510.3-101

Originally issued November 13, 1986 (51 FR 41280)

Subsection (e) amended for a technical correction December 31, 1986 (51 FR 47226)

  1. In General.
    1. This section describes what constitute assets of a plan with respect to a plan's investment in another entity for purposes of Subtitle A, and Parts 1 and 4 of Subtitle 3, of Title I of the Act and section 4975 of the Internal Revenue Code. Paragraph (a)(2) contains a general rule relating to plan investments. Paragraphs (b) through (f) define certain terms that are used in the application of the general rule. Paragraph (g) describes how the rules in this section are to be applied when a plan owns property jointly with others or where it acquires an equity interest whose value relates solely to identified assets of an issuer. Paragraph (h) contains special rules relating to particular kinds of plan investments. Paragraph (i) describes the assets that a plan acquires when it purchases certain guaranteed mortgage certificates. Paragraph (j) contains examples illustrating the operation of this section. The effective date of this section is set forth in paragraph (k).
    2. Generally, when a plan invests in another entity, the plan's assets include its investment, but do not, solely by reason of such investment, include any of the underlying assets of the entity. However, in the case of a plan's investment in an equity interest of an entity that is neither a publicly-offered security nor a security issued by an investment company registered under the Investment Company Act of 1940 its assets include both the equity interest and an undivided interest in each of the underlying assets of the entity, unless it is established that -
      1. the entity is an operating company, or
      2. equity participation in the entity by benefit plan investors is not significant.

    Therefore, any person who exercises authority or control respecting the management or disposition of such underlying assets, and any person who provides investment advice with respect to such assets for a fee (direct or indirect), is a fiduciary of the investing plan.

  2. "Equity Interests" and "Publicly-Offered Securities".
    1. The term "equity interest" means any interest in an entity other than an instrument that is treated as indebtedness under applicable local law and which has no substantial equity features. A profits interest in a partnership, an undivided ownership interest in property and a beneficial interest in a trust are equity interests.
    2. A "publicly-offered security" is a security that is freely transferable, part of a class of securities that is widely held and either
      1. Part of a class of securities registered under section 12(b) or 12(g) of the Securities Exchange Act of 1934, or
      2. Sold to the plan as part of an offering of securities to the public pursuant to an effective registration statement under the Securities Act of 1933 and the class of securities of which such security is a part is registered under the Securities Exchange Act of 1934 within 120 days (or such later time as may be allowed by the Securities and Exchange Commission) after the end of the fiscal year of the issuer during which the offering of such securities to the public occurred.
    3. For purposes of paragraph (b)(2), a class of securities is "widely-held" only if it is a class of securities that is owned by 100 or more investors independent of the issuer and of one another. A class of securities will not fail to be widely-held solely because subsequent to the initial offering the number of independent investors falls below 100 as a result of events beyond the control of the issuer.
    4. For purposes of paragraph (b)(2), whether a security is "freely transferable" is a factual question to be determined on the basis of all relevant facts and circumstances. If a security is part of an offering in which the minimum investment is $10,000 or less, however, the following factors ordinarily will not, alone or in combination, affect a finding that such securities are freely transferable -
      1. Any requirement that not less than a minimum number of shares or units of such security be transferred or assigned by any investor, provided that such requirement does not prevent transfer of all of the then remaining shares or units held by an investor;
      2. Any prohibition against transfer or assignment of such security or rights in respect thereof to an ineligible or unsuitable investor;
      3. Any restriction on, or prohibition against, any transfer or assignment which would either result in a termination or reclassification of the entity for federal or state tax purposes or which would violate any state or federal statute, regulation, court order, judicial degree, or rule of law;
      4. Any requirement that reasonable transfer or administrative fees be paid in connection with a transfer or assignment;
      5. Any requirement that advance notice of a transfer or assignment be given to the entity and any requirement regarding execution of documentation evidencing such transfer or assignment (including documentation setting forth representations from either or both of the transferor or transferee as to compliance with any restriction or requirement described in this paragraph (b)(4) or requiring compliance with the entity's governing instruments);
      6. Any restriction on substitution of an assignee as a limited partner of a partnership, including a general partner consent requirement, provided that the economic benefits of ownership of the assignor may be transferred or assigned without regard to such restriction or consent (other than compliance with any other restriction described in this paragraph (b)(4));
      7. Any administrative procedure which establishes an effective date, or an event, such as the completion of the offering, prior to which a transfer or assignment will not be effective; and
      8. Any limitation or restriction on transfer or assignment which is not created or imposed by the issuer or any person acting for or on behalf of such issuer.
  3. "Operating Company".
    1. An "operating company" is not an entity that is primarily engaged, directly or through a majority owned subsidiary or subsidiaries, in the production or sale of a product or service other than the investment of capital. The term "operating company" includes an entity which is not described in the preceding sentence, but which is a "venture capital operating company" described in paragraph (d) or a "real estate operating company" described in paragraph (e).
    2. [Editorial Note: There is no subsection (c)(2).]
  4. "Venture Capital Operating Company".
    1. An entity is a "venture capital operating company" for the period beginning on an initial valuation date described in paragraph (d)(5)(i) and ending on the last day of the first "annual valuation period" described in paragraph (d)(5)(ii) (in the case of an entity that is not a venture capital operating company immediately before the determination) or for the 12-month period following the expiration of an "annual valuation period" described in paragraph (d)(5)(ii) (in the case of an entity that is a venture capital operating company immediately before the determination) if -
      1. On such initial valuation date, or at any time within such annual valuation period, at least 50 percent of its assets (other than short-term investments pending long-term commitment or distribution to investors), valued at cost, are invested in venture capital investments described in paragraph (d)(3)(i) or derivative investments described in paragraph (d)(4); and
      2. During such 12-month period (or during the period beginning on the initial valuation date and ending on the last day of the first annual valuation period), the entity, in the ordinary course of its business, actually exercises management rights of the kind described in paragraph (d)(3)(ii) with respect to one or more of the operating companies in which it invests.
    2. Distribution Period
      1. A venture capital operating company described in paragraph (d)(1) shall continue to be treated as a venture capital operating company during the "distribution period" described in paragraph (d)(2)(ii). An entity shall not be treated as a venture capital operating company at any time after the end of the distribution period.The "distribution period" referred to in paragraph (d)(2)(i) begins on a date established by a venture capital operating company that occurs after the first date on which the venture capital operating company has distributed to investors the proceeds of at least 50 percent of the highest amount of its investments (other than short-term investments made pending long-term commitment or distribution to investors) outstanding at any time from the date it commenced business (determined on the basis of the cost of such investments) and ends on the earlier of -
        1. The date on which the company makes a "new portfolio investment", or
        2. The expiration of 10 years from the beginning of the distribution period.
      2. For purposes of paragraph (d)(2)(ii)(A), a "new portfolio investment" is an investment other than -
        1. An investment in an entity in which the venture capital operating company had an outstanding venture capital investment at the beginning of the distribution period which has continued to be outstanding at all times during the distribution period, or
        2. A short-term investment pending long-term commitment or distribution to investors.
    3. Venture Capital Investment
      1. For purposes of this paragraph (d) a "venture capital investment" is an investment in a operating company (other than a venture capital operating company) as to which the investor has or obtains management rights.
      2. The term "management rights" means contractual rights directly between the investor and an operating company to substantially participate in, or substantially influence the conduct of, the management of the operating company.
    4. Derivative Investment
      1. An investment is a "derivative investment" for purposes of this paragraph (d) if it is -
        1. A venture capital investment as to which the investor's management rights have ceased in connection with a public offering of securities of the operating company to which the investment relates, or
        2. An investment that is acquired by a venture capital operating company in the ordinary course of its business in exchange for an existing venture capital investment in connection with:
          1. A public offering of securities of the operating company to which the existing venture capital investment relates, or
          2. A merger or reorganization of the operating company to which the existing venture capital investment relates, provided that such merger or reorganization is made for independent business reasons unrelated to extinguishing management rights.
      2. An investment ceases to be a derivative investment on the later of:
        1. 10 years from the date of the acquisition of the original venture capital investment to which the derivative investment relates, or
        2. 30 months from the date on which the investment becomes a derivative investment.
    5. For purposes of this paragraph (d) and paragraph (e) -
      1. An "initial valuation date" is the later of -
        1. Any date designated by the company within the 12-month period ending with the effective date of this section, or
        2. The first date on which an entity makes an investment that is not a short-term investment of funds pending long-term commitment.
      2. An "annual valuation period" is a pre-established annual period, not exceeding 90 days in duration, which begins no later than the anniversary of an entity's initial valuation date. An annual valuation period, once established may not be changed except for good cause unrelated to a determination under this paragraph (d) or paragraph (e).
  5. "Real Estate Operating Company".
  6. An entity is a "real estate operating company" for the period beginning on an initial valuation date described in paragraph (d)(5)(i) and ending on the last day of the first "annual valuation period" described in paragraph (d)(5)(ii) (in the case of an entity that is not a real estate operating company immediately before the determination) or for the 12-month period following the expiration of an annual valuation period described in paragraph (d)(5)(ii) (in the case of an entity that is a real estate operating company immediately before the determination) if:

    1. On such initial valuation date, or on any date within such annual valuation period, at least 50 percent of its assets, valued at cost (other than short-term investments pending long-term commitment or distribution to investors), are invested in real estate which is managed or developed and with respect to which such entity has the right to substantially participate directly in the management or development activities; and
    2. During such 12-month period (or during the period beginning on the initial valuation date and ending on the last day of the first annual valuation period) such entity in the ordinary course of its business is engaged directly in real estate management or development activities.
  7. Participation by Benefit Plan Investors.
    1. Equity participation in an entity by benefit plan investors is "significant" on any date if, immediately after the most recent acquisition of any equity interest in the entity, 25 percent or more of the value of any class of equity interests in the entity is held by benefit plan investors (as defined in paragraph (f)(2)). For purposes of determinations pursuant to this paragraph (f), the value of any equity interests held by a person (other than a benefit plan investor) who has discretionary authority or control with respect to the assets of the entity or any person who provides investment advice for a fee (direct or indirect) with respect to such assets, or any affiliate of such a person, shall be disregarded.
    2. A "benefit plan investor" is any of the following -
      1. Any employee benefit plan (as defined in section 3(3) of the Act), whether or not it is subject to the provisions of Title I of the Act,
      2. Any plan described in section 4975(e)(1) of the Internal Rev. Code,
      3. Any entity whose underlying assets include plan assets by reason of a plan's investment in the entity.
    3. An "affiliate" of a person includes any person, directly or indirectly, through one or more intermediaries, controlling, controlled by, or under common control with the person. For purposes of this paragraph (f)(3), "control", with respect to a person other than an individual, means the power to exercise a controlling influence over the management or policies of such person.
  8. Joint Ownership. For purposes of this section, where a plan jointly owns property with others, or where the value of a plan's equity interest in an entity relates solely to identified property of the entity, such property shall be treated as the sole property of a separate entity.
  9. Specific Rules Relating to Plan Investment. Notwithstanding any other provision of this section-
    1. Except where the entity is an investment company registered under the Investment Company Act of 1940, when a plan acquires or holds an interest in any of the following entities its assets include its investment and an undivided interest in each of the underlying assets of the entity:
      1. A group trust which is exempt from taxation under section 501(a) of the Internal Revenue Code pursuant to the principles of Rev. Rul. 81-100, 1981-1 C.B. 326,
      2. A common or collective trust fund of a bank,
      3. A separate account of an insurance company, other than a separate account that is maintained solely in connection with fixed contractual obligations of the insurance company under which the amounts payable, or credited, to the plan and to any participant or beneficiary of the plan (including an annuitant) are not affected in any manner by the investment performance of the separate account.
    2. When a plan acquires or holds an interest in any entity (other than an insurance company licensed to do business in a State) which is established or maintained for the purpose of offering or providing any benefit described in section 3(1) or section 3(2) of the Act to participants or beneficiaries of the investing plan, its assets will include its investment and an undivided interest in the underlying assets of that entity.
    3. When a plan or a related group of plans owns all of the outstanding equity interests (other than director's qualifying shares) in an entity, its assets include those equity interests and all of the underlying assets of the entity. This paragraph (h)(3) does not apply, however, where all of the outstanding equity interests in an entity are qualifying employer securities described in section 407(d)(5) of the Act, owned by one or more eligible individual account plan(s) (as defined in section 407(d)(3) of the Act) maintained by the same employer, provided that substantially all of the participants in the plan(s) are, or have been, employed by the issuer of such securities or by members of a group of affiliated corporations (as determined under section 407(d)(7) of the Act) of which the issuer is a member.
    4. For purposes of paragraph (h)(3), a "related group" of employee benefit plans consists of every group of two or more employee benefit plans-
      1. Each of which receives 10 percent or more of its aggregate contributions from the same employer or from members of the same controlled group of corporations (as determined under section 1563(a) of the Internal Revenue Code, without regard to section 1563(a)(4) thereof); or
      2. Each of which is either maintained by, or maintained pursuant to a collective bargaining agreement negotiated by, the same employee organization or affiliated employee organizations. For purposes of this paragraph, an "affiliate" of an employee organization means any person controlling, controlled by, or under common control with such organization, and includes any organization chartered by the same parent body, or governed by the same constitution and bylaws, or having the relation of parent and subordinate.
  10. Governmental Mortgage Pools.
    1. Where a plan acquires a guaranteed governmental mortgage pool certificate, as defined in paragraph (i)(2), the plan's assets include the certificate and all of its rights with respect to such certificate under applicable law, but do not, solely by reason of the plan's holding of such certificate, include any of the mortgages underlying such certificate.
    2. A "guaranteed governmental mortgage pool certificate" is a certificate backed by, or evidencing an interest in, specified mortgages or participation interests therein and with respect to which interest and principal payable pursuant to the certificate is guaranteed by the United States or an agency or instrumentality thereof. The term "guaranteed governmental mortgage pool certificate" includes a mortgage pool certificate with respect to which interest and principal payable pursuant to the certificate is guaranteed by:
      1. The Government National Mortgage Association;
      2. The Federal Home Loan Mortgage Corporation; or
      3. The Federal National Mortgage Association.
  11. Examples. [NOTE: Subsection (j) of the regulation is omitted.]
  12. Effective Date and Transitional Rules.
    1. In general, this section is effective for purposes of identifying the assets of a plan or after March 13, 1987. Except as a defense, this section shall not apply to investments in an entity in existence on March 13, 1987, if no plan subject to Title I of the Act or plan described in section 4975(e)(1) of the Code (other than a plan described in section 4975(g)(2) or 4975(g)(3)) acquires an interest in the entity from an issuer or underwriter at any time on or after March 13, 1987 except pursuant to a contract binding on the plan in effect on March 13, 1987 with an issuer or underwriter to acquire an interest in the entity.
    2. Notwithstanding paragraph (k)(1), this section shall not, except as a defense, apply to a real estate entity described in section 11018(a) of Pub. L. 99-272.

2520.103-5    CIF Reports to Plan Administrators

Department of Labor
Regulation 2520.103-5
29 C.F.R. 2520.103-5

Transmittal and certification of information to plan administrator for annual reporting purposes.

(Collective Investment Fund Reporting to Plan Administrators)

Originally issued September 10, 1978 (43 FR 10140)

  1. General. In accordance with section 103(a)(2) of the Act, an insurance carrier or other organization which provides benefits under the plan or holds plan assets, a bank or similar institution which holds plan assets, or a plan sponsor, shall transmit and certify such information as needed by the administrator to file the annual report under section 104(a)(1)(A) of the Act and  2520.104a-5 or  2520.104a-6:
    1. Within 9 months after the close of the plan year which begins in 1975 or September 30, 1976, whichever is later, and
    2. Within 120 days after the close of any plan year which begins after December 31, 1975.
  2. Application. This requirement applies with respect to -
    1. An insurance carrier or other organization which:
      1. Provides from its general asset accounting funds for the payment of benefits under a plan, or
      2. Holds assets of a plan in a separate account;
    2. A bank, trust company, or similar institution which holds assets of a plan in a common or collective trust, separate trust, or custodial account; and
    3. A plan sponsor as defined in section 3(16)(B) of the Act.
  3. Contents. The information required to be provided to the administrator shall include -
    1. In the case of an insurance carrier or other organization which -
      1. Provides funds from its general asset account for the payment of benefits under a plan, upon request of the plan administrator, such information as is contained within the ordinary business records of the insurance carrier or other organization and is needed by the plan administrator to comply with the requirements of section 104(a)(1)(A) of the Act and 2520.104a-5 or 2520.104a-6;
      2. Holds assets of a plan in a pooled separate account which is exempted from certain reporting requirements under 2520.103-4, a copy of the annual statement of assets and liabilities of the separate account for the fiscal year of such account that ends with or within the plan year for which the annual report is made, and a statement of the value of the plan's units of participation in the separate account;
      3. Holds assets of a plan in a separate account which is not exempted from certain reporting requirements under 2520.103-4, a listing of all transactions of the separate account and, upon request of the plan administrator, such information as is contained within the ordinary business records of the insurance carrier and is needed by the plan administrator to comply with the requirements of section 104(a)(1)(A) of the Act and 2520.104a-5 or 2520.104a-6.
    2. In the case of a bank, trust company, or similar institution holding assets of a plan -
      1. In a common or collective trust which is exempted from certain reporting requirements under 2520.103-3, a copy of the annual statement of assets and liabilities of the common or collective trust for the fiscal year of such trust that ends with or within the plan year for which the annual report is made, and a statement of the value of the plan's units of participation in the common or collective trust.
      2. In a trust which is not exempted from certain reporting requirements under 2520.103-3, a listing of all transactions of the separate trust and, upon request of the plan administrator, such information as is contained within the ordinary business records of the bank, trust company, or similar institution and is needed by the plan administrator to comply with the requirements of section 104(a)(1)(A) of the Act and 2520.104a-5.
      3. In a custodial account, upon request of the plan administrator, such information as is contained within the ordinary business records of the bank, trust company, or similar institution and is needed by the plan administrator to comply with the requirements of section 104(a)(1)(A) of the Act and 2520.104a-5 or 2520.104a-6.
    3. In the case of a plan sponsor, a listing of all transactions directly or indirectly involving plan assets engaged in by the plan sponsor and such information as is needed by the plan administrator to comply with the requirements of section 104(a)(1)(A) of the Act and 2520.104a-5 or 2520.104a-6.
  4. Certification.
    1. An insurance carrier or other organization a bank, trust company, or similar institution, or plan sponsor, as described in paragraph (b) of this section, shall certify to the accuracy and completeness of the information described in paragraph (c) of this section by a written declaration which is signed by a person authorized to represent the insurance carrier, bank, or plan sponsor. Such certification will serve as a written assurance of the truth of the facts stated therein.
    2. Example of Certification. The XYZ Bank (Insurance Carrier) hereby certifies that the foregoing statement furnished pursuant to 20 C.F.R. 2520.103-5(c) is complete and accurate.

2550.404a-1    Investment Duties (Prudence Regulation)

Department of Labor
Regulation 2550.404a-1
C.F.R. 2550.404a-1

Originally issued June 26, 1979 (44 FR 37225)

The technical corrections of 4-4-78 and the amendment of 3-1-89 contained no changes to this regulation.

Recap
Defines and explains the application of the Prudent Man Rule in ERISA Section 404(a)(1)(B).
The Preamble to the Final Regulation is included to assist examiners in interpreting and applying this Rule.

Editor's Note: Also refer to Interpretive Bulletin 94-1, dealing with the prudence of social ("economically targeted" or ETI) investments. Also see DOL ERISA Regulation 404c-1, which exempts fiduciaries from certain ERISA liability if plans meet certain conditions and participants direct their own investments.

Agency: Department of Labor.

Action: Final regulation.

Summary: This document contains a final regulation relating to the investment duties of a fiduciary of an employee benefit plan under the Employee Retirement Income Security Act of 1974 (the Act). The regulation is relevant to the investment of assets of employee benefit plans for which fiduciaries have investment duties, and, therefore, it affects participants, beneficiaries and fiduciaries of all such plans.

Effective Date: July 23, 1979.

Final Regulation

  1. In General. Section 404(a)(1)(B) of the Employee Retirement Income Security Act of 1974 (the Act) provides, in part, that a fiduciary shall discharge his duties with respect to a plan 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 character and with like aims.
  2. Investment Duties.
    1. With regard to an investment or investment course of action taken by a fiduciary of an employee benefit plan pursuant to his investment duties, the requirements of Section 404(a)(1)(B) of the Act set forth in subsection (a) of this section are satisfied if the fiduciary (A) has given appropriate consideration to those facts and circumstances that, given the scope of such fiduciary's investment duties, the fiduciary knows or should know are relevant to the particular investment or investment course of action involved, including the role the investment or investment course of action plays in that portion of the plan's investment portfolio with respect to which the fiduciary has investment duties; and (B) has acted accordingly.
    2. For purpose of paragraph (1) of this subsection, "appropriate consideration" shall include, but is not necessarily limited to:
      1. A determination by the fiduciary that the particular investment course of action is reasonably designed, as part of the portfolio (or, where applicable, that portion of the plan portfolio with respect to which the fiduciary has investment duties), to further the purposes of the plan, taking into consideration the risk of loss and the opportunity for gain (or other return) associated with the investment or investment course of action, and
      2. Consideration of the following factors as they relate to such portion of the portfolio:
        1. The composition of the portfolio with regard to diversification;
        2. The liquidity and current rates of return of the portfolio relative to the anticipated cash flow requirements of the plan, and
        3. The projected return of the portfolio relative to the funding objectives of the plan.
    3. An investment manager appointed, pursuant to the provisions of Section 402(c)(3) of the Act, to manage all or part of the assets of a plan, may, for purposes of compliance with the provisions of paragraphs (1) and (2) of this subsection, rely on, and act upon the basis of, information pertaining to the plan provided by or at the direction of the appointing fiduciary, if -
      1. Such information is provided for the stated purpose of assisting the manager in the performance of his investment duties, and
      2. The manager does not know and has no reason to know that the information is incorrect.
  3. Definitions.
  4. For purposes of this section:

    1. The term "investment duties" means any duties imposed upon, or assumed or undertaken by, a person in connection with the investment of plan assets which make or will make such person a fiduciary of an employee benefit plan or which are performed by such person as a fiduciary of an employee benefit plan as defined in Section 3(21)(A)(i) or (ii) of the Act.
    2. The term "investment course of action" means any series or program of investments or actions related to a fiduciary's performance of his investment duties.
    3. The term "plan" means an employee benefit plan to which Title I of the Act applies.

Explanatory Preamble

For further information contact: Paul R. Antsen, Office of Fiduciary Standards, Pension and Welfare Benefit Programs, U.S. Department of Labor, Washington, D.C. 20216, (202) 522-8971, or Gregor B. McCurdy, Plan Benefits Security Division, Office of the Solicitor, U.S. Department of Labor, Washington, D.C. 20216. (202) 523-9141.

Supplemantary information: On April 25, 1978, notice was published in the Federal Register (43 FR 17480)1 that the Department had under consideration a proposal to adopt a regulation, 29 C.F.R. 2550.404a-1, under section 404(a)(1)(B) of the Act, relating to the investment duties of a fiduciary of an employee benefit plan. Section 404(a)(1)(B) of the Act provides, in part, that a fiduciary shall discharge his duties with respect to an employee benefit plan 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 character and with like aims (the "Prudence" rule).2

Public comments were received, in response to the proposal, that generally supported the tentative views of the Department reflected therein, although many suggestions for specific revisions were offered. A few comments opposed the adoption of the proposed or of any, regulation concerning these matters. Among the reasons given in opposition to the adoption of the proposed regulation were: (1) that the courts, rather than the Department, should determine how the "prudence" rule is to be interpreted, (2) that the Department's views regarding the requirements of the "Prudence" rule, as reflected in the proposed regulation, are incorrect, (3) that it is impractical to attempt to define "prudence" by regulation; and (4) that the proposal did not accomplish its stated objectives. The Department has considered the comments opposing adoption of the regulation, but has not been persuaded that the interpretation of the requirements of the "prudence" rule set forth below is incorrect. It believes, moreover, that adoption of a regulation concerning the investment duties of fiduciaries under the "prudence" rule is appropriate because such a regulation would provide guidance for many plan fiduciaries in an important area of their responsibilities under the Act.

Counsel for one group of interested persons, while supporting the proposed regulation in principle, asked that they be given an opportunity to express their views at a public hearing on the proposed regulation. They also suggested that the regulation should, in any event, be republished to give interested persons additional opportunity for comment. The Department has considered these requests, but has determined that neither a public hearing nor republication of a proposed regulation is necessary or appropriate.

Accordingly, after consideration of all the written comments received, the Department has determined to adopt the proposed regulation as modified and set forth below.

Discussion of the Regulation

The legislative history of the Act indicates that the common law of trusts, which forms the basis for and is federalized and codified in part 4 of Title I of the Act, should, nevertheless, not be mechanically applied to employee benefit plans.3 The "prudence" rule in the Act sets forth a standard built upon, but that should and does depart from, traditional trust law in certain respects.

The Department is of the opinion that (1) generally, the relative riskiness of a specific investment or investment course of action does not render such investment or investment course of action either per se prudent or per se imprudent, and (2) the prudence of an investment decision should not be judged without regard to the role that the proposed investment or investment course of action plays with the overall plan portfolio. Thus, although securities Issued by a small or new company may be a riskier investment than securities issued by a "blue chip" company, the investment in the former company may be entirely proper under the Act's prudence" rule.

Accordingly, paragraph (b)(1) of the regulation, as adopted, provides generally that, with respect to an investment or investment course of action taken pursuant to a fiduciary's investment duties, the requirements of the "prudence" rule have been satisfied if the fiduciary has acted in a manner consistent with appropriate consideration of the facts and circumstances that the fiduciary knows or should know are relevant, including the role that the investment or investment course of action plays in that portion of the plan's investment portfolio with respect to which the fiduciary has investment duties. Paragraph (b), as adopted, has been modified in response to certain comments received on the regulation as originally proposed.

As a general observation, the comments received by the Department indicated that many commentators were uncertain of the scope of the proposed regulation. In particular, some commentators appear to have viewed the various factors and conditions set forth in the proposal as a statement of requirements that must necessarily be met in order to satisfy the requirements of the "Prudence" rule. In this regard, it should be noted that the regulation reflects the views of the Department as to a manner of satisfying the requirements of the "prudence" rule, and does not purport to impose any additional requirements or constraints upon plan fiduciaries. It should also be noted that the Department does not view compliance with the provisions of the regulation as necessarily constituting the exclusive method for satisfying the requirements of the "prudence" rule. Rather, the regulation is in the nature of a "safe harbor" provision; it is the opinion of the Department that fiduciaries who comply with the provisions of the regulation will have satisfied the requirements of the "prudence" rule, but no opinion is expressed in the regulation as to the status of activities undertaken or performed that do not so comply.

With regard to more particular matters, a number of comments suggested that one condition of the proposal - that a fiduciary give appropriate consideration to "all" relevant facts and circumstance - could be read as establishing an impossible standard, especially for fiduciaries of small plans, because (1) no fiduciary has unlimited resources to develop all the information that one might deem to be relevant to a particular investment decision, and (2) no fiduciary can be expected to consider all the relevant facts and circumstances, whether or not of material significance.

Because section 404(a)(1)(B) of the Act provides that it is the fiduciary's duties with respect to the plan which must be discharged in accordance with the "prudence" rule, it appears to the Department that the scope of those duties will determine, in part, the factors which should be considered by a plan fiduciary in a given case. The nature of those duties will, of course, depend on the facts and circumstances of the case, including the nature of the arrangement between the fiduciary and the plan. For that reason, the regulation, as adopted, does not distinguish among classes of fiduciaries with respect to what particular duties may be involved. The Department recognizes, however, that a fiduciary should be required neither to expend unreasonable effort in discharging his duties. nor to consider matters outside the scope of those duties. Accordingly, the regulation has been modified to provide that consideration be given to those facts and circumstances which take into account the scope of his investment duties, the fiduciary knows or should know are relevant to the particular investment decision involved. The scope of the fiduciary's inquiry in this respect, therefore, is limited to those facts and circumstances that a prudent person having similar duties and familiar with such matters would consider relevant.

Several commentators asserted that the regulation, in recognition of the Act's provisions permitting delegation of investment duties to, and allocation among, several fiduciaries, should permit a fiduciary who is responsible for the management of plan assets to rely on information supplied by appropriate other plan fiduciaries, and to act in accordance with policies and instructions supplied by those persons in making decisions on the investment of plan assets. Those comments, generally, addressed the situation where several investment managers are involved in managing the assets of a plan, each being responsible for a portion of the plan's investment portfolio.4 Under those circumstances, it would not, in the view of the commentators, be appropriate to require a fiduciary who is responsible for only a portion of the plan's portfolio to take into consideration facts and circumstances relating to the balance of the portfolio in making an investment decision. The Department agrees, in part, with those comments. Accordingly, paragraph (b)(1) of the regulation as adopted also provides that such a fiduciary need give appropriate consideration to the role the proposed investment or investment course of action plays in that portion only, of the plan's investment portfolio, with respect to which the fiduciary has investment duties.

However, the Department cannot state that, under the foregoing circumstances, a fiduciary is entitled blindly to rely upon instructions or policies established by other plan fiduciaries. Similarly, the regulation does not provide, as requested by one commentator, that the assets of a pooled investment fund may be invested in accordance with its published investment objectives and policies without requiring that consideration be given to the particular needs of any individual plan that has an interest in the fund. It would appear that where authority to manage part (or all) of the assets of a plan has been delegated to one or more investment managers pursuant to section 402(c)(3) of the Act, the primary responsibility for determining that the delegation is appropriate rests with the named fiduciary or fiduciaries effecting the delegation. Nevertheless, the Department considers that each such manager's investment duties, under section 404(a)(1)(B) of the Act, includes (among other things) a duty not to act in accordance with a delegation of plan investment duties to the extent that the manager either knows or should know that the delegation involves a breach of fiduciary responsibility.5 Once the manager has considered factors otherwise necessary to assure himself that the delegation of investment authority and related specific instructions are appropriate, he may, in exercising such authority and carrying out such instructions, rely upon information provided to him in accordance with the provisions of new paragraph (b)(3) of the regulation. That paragraph provides that an investment manager responsible for the management of all or part of a plan's assets pursuant to an appointment described in section 402(c)(3) of the Act may, for purposes o f complying with the provisions of the regulation, rely upon certain information supplied to him by or at the direction of the appointing fiduciary, provided that the manager neither knows or should know that the information is incorrect.

Paragraph (b)(1) of the proposed regulation also been revised in order to make clear that the fiduciary's acts do not satisfy the "prudence" rule solely because the fiduciary had previously given consideration to relevant facts and circumstances. Some comments questioned whether, under the regulation as originally proposed, a fiduciary might be deemed to be "immunized" once he had given such consideration, not withstanding the nature of his subsequent acts. The regulation, as adopted, provides that it is the "investment" or "investment course of action" in question that will satisfy the requirements of the prudence rule if the criteria set forth in the regulation are met.

Paragraph (b)(2) of the regulation sets forth factors that are to be included, to the extent applicable, in an evaluation of an investment or investment course of action if a fiduciary wishes to rely on the provisions of the regulation. They are: (1) the composition of the portfolio with regard to diversification; (2) the liquidity and current return of the portfolio relative to the anticipated cash flow requirements of the plan; and (3) the projected return of the portfolio relative to the objectives of the plan. These factors are adopted substantially as proposed, except that the first factor has been revised, in response to questions raised by some of the comments, to make clear that the word "diversification" is to be given its customary meaning as a mechanism for reducing the risk of large losses; that factor, as originally proposed, referred to "diversification of risk." The second factor has also been modified in order to make clear that its principal subject matter is all anticipated cash requirements of the plan, and not solely those arising by reason of payment of benefits. A fourth factor set forth in the proposal which related to the "volatility" of the portfolio, has been eliminated as a factor specifically to be considered because, although paragraph (b)(2) as adopted sets forth factors which must be considered in all cases in order to comply with the provisions of the regulation6, the reference to volatility may be read, according to some comments, as suggesting that only certain portfolio management techniques are appropriate. Moreover, as discussed more fully below, the subject of risk and opportunity for gain - which subsumes consideration of "volatility" in some respects - is now addressed in subparagraph (A) of paragraph (b)(2). A former fifth factor, which read "the prevailing and projected economic conditions of the entities in which the plan has invested and proposes to invest," is also deal t with in that subparagraph.

Several commentators suggested that inclusion of that fifth factor in the regulation would be contrary to the intent of the proposal because it focuses attention on the individual investment, rather than on the aggregate plan portfolio. Others objected to its inclusion on the ground that it is antithetical to the theory of operation of certain "passive" investment media (such as "index" funds) that acquire portfolios designed to match the performance of various investment indices and that, accordingly, have little or no discretion in altering the composition of their portfolios.7

The regulation, however, is not intended to suggest either that any relevant or material attributes of a contemplated investment may properly be ignored or disregarded, or that a particular plan investment should be deemed to be prudent solely by reason of the propriety of the aggregate risk/return characteristics of the plan's portfolio. Rather, it is the Department's view that an investment reasonably designed - as a part of the portfolio - to further the purposes of the plan, and that is made upon appropriate consideration of the surrounding facts and circumstances, should not be deemed to be imprudent merely because the investment, standing alone, would have, for example, a relatively high degree of risk. The Department also believes that appropriate consideration of an investment to further the purposes of the plan must include consideration of the characteristics of the investment itself. Accordingly, paragraph (b)(2) of the regulation provides that, for purposes of paragraph (b)(1), "appropriate consideration" shall include a determination by the fiduciary that the particular investment or investment course of action is reasonably designed, as part of the portfolio for which the fiduciary is responsible, to further the purposes of the plan, taking into account the risk of loss and the opportunity for gain (or other return) associated with the investment or investment course of action.8

In the case of "passive" investment funds, referred to above, it would seem that, to the extent the fund manager is managing plan assets,9 the investments made by the fund, as well as the plan's investment in the fund, must meet the requirements of the "prudence" rule. However, to the extent that an index fund, including the screen or filter process described above at note 7, is reasonably designed to fulfill the fund manager's fiduciary obligations with respect to a plan whose assets are managed therein, such manager, acting in accordance with the fund's objective and its filter or screen process, generally would be in compliance with the provisions of the "prudence" rule, as described in the regulation, with respect to that plan.

The terms "investment duties" and "investment course of action" are defined in paragraphs (c)(1) and (2) of the regulation. No comments were received regarding these definitions, and they have been adopted substantially in the form proposed. New paragraph (c)(3) has been added, defining the term "plan" to mean an employee benefit plan to which Title I of the Act applies.

Discussion of Certain other Comments

Counsel for one group of commentators characterized the factors set forth in paragraph (b)(2) as relating solely to the "investment merit" of a particular investment or investment course of action. Because, in the view of those commentators, the prudence of the acquisition or retention of a contract Issued by an insurance company may involve factors besides "investment merit", they suggested that the regulation should contain a separate provision that would set forth two factors to be considered by a fiduciary, in evaluating the prudence of the acquisition or retention of such a contract: the risks assumed, and the services provided, by the insurance company. The Department is unable to concur with the commentators' view that the regulation as proposed dealt only with matters of "investment merit" as narrowly perceived in the comment. The Department agrees that such factors as the risk to be assumed and the services to be provided under a contract are pertinent to any investment decision involving such contract. The regulation as adopted specifically provides that, in order to come within the scope of the regulation, a fiduciary shall consider the facts and circumstances the fiduciary knows or should know are relevant to the investment decision, and that the factors set forth in paragraph (b)(2) are not intended to be exclusive. Accordingly, the Department believes that it is unnecessary to set forth additional factors with respect to insurance contracts or other specific types of investment.

Two commentators suggested that the Department clarify that the adoption of the regulation would not result in fiduciaries being required to invest in expensive systems or analyses to make investment decisions. Under the "prudence" rule, the standard to which a fiduciary is held in the proper discharge of his investment duties is defined, in part, by what a prudent person acting in a like capacity and familiar with such matters would do. Thus, for example, it would not seem necessary for a fiduciary of a plan with assets of $50,000 to employ, in all respects, the same investment management techniques as would a fiduciary of a plan with assets of $50,000,000.

Numerous comments were received with respect to the factors set forth in paragraph (b)(2). Several persons requested that the Department clarify or define terms such as "diversification of risk". "risk," "volatility" and "liquidity." For example, some persons asked what specific measurements of volatility, risk and liquidity should be utilized by fiduciaries in making investment decisions for a plan. The Department believes that, in view of the modifications (discussed above) made in the regulation as adopted, it is neither necessary nor appropriate for the regulation to contain such definitions. Several commentators asserted that certain specific types of investments such as, for example, investment in small or recently formed companies, or nonincome producing investments that are not securities (such as, for example, certain precious metals and objects of art) have not been viewed with favor, traditionally, as trust investments. Those comments urged that the regulation specify the extent to which such investments are permissible under the "prudence" rule. Other commentators made reference to the traditional principle that trust investments should be income producing, and suggested that the appropriate measure of investment "return" should be defined to mean 'total return" - that is, an aggregate return computed without regard to whether a contributing factor thereto consists of income or capital items. Although the Department considers that defining "return" would be beyond the appropriate scope of this regulation, it believes that the "prudence" rule does not require that every plan investment produce current income under all circumstances. As indicated above and in the preamble to the proposed regulation, the Department believes that the universe of investments permissible under the "prudence" rule is not necessarily limited to those permitted at common law.

However, the Department does not consider it appropriate to include in the regulation any list of investments, classes of investment, or investment techniques that might be permissible under the "prudence" rule. No such list could be complete; moreover, the Department does not intend to create or suggest a "legal list" of investments for plan fiduciaries.

The preamble to the proposed regulation stated (as does this preamble) that the risk level of an investment does not alone make the investment per se prudent or per se imprudent. Comments were received which asserted that such proposition is inappropriate and would promote irresponsibility on the part of plan fiduciaries. Other commentators not only agreed with the proposition, but also suggested that it should be incorporated in the regulation. The Department believes that both of these concerns are addressed by the modifications, discussed above, made to paragraph (b)(2) of the regulation as adopted.

The Department has determined that this regulation is not a "significant regulation" as defined in the Department's guidelines (44 FR 5570, January 26, 1979) implementing Executive Order 12044.

Statutory Authority

The regulation set forth below is adopted pursuant to the authority contained in section 505 of the Act (Pub. L. 93-406, 88 Stat. 894 (29 USC  1135)). Although the regulation is an "interpretative rule" within the meaning of 5 USC  553(d), the effective date of the regulation is July 23, 1979, consistent with the statement of the Department, in connection with the regulation as proposed. that such regulation would be effective 30 days after its adoption.

Final Regulation

Accordingly, Part 2550 of Chapter XXV of Title 29 of the Code of Federal) Regulations is amended by inserting in the appropriate place to read  2550.404a-1.

Signed at Washington, D.C, this 20th day of June 1979.

Ian D. Lanoff, Administrator

Pension and Welfare Benefit Programs

Labor-Management Services Administration

United States Department of Labor

Footnotes

  1. See also 43 FR 27208 (June 23, 1978), in which notice was given of an extension of the original comment period.
  2. The regulation pertains only to the investment duties of a fiduciary of an employee benefit plan. Section 404(a)(1)(B) of the Act, however, requires that a fiduciary discharge all of his duties in accordance with the "prudence" rule.
  3. It should also be noted that although the proposed regulation made reference to an additional requirement of section 404(a)(1) - that the fiduciary discharge his duties solely in the interest of plan participants and beneficiaries - that reference has been deleted from the regulation as adopted. This was done to avoid suggesting that satisfaction of the "prudence" rule with respect to an investment or investment course of action necessarily implies satisfaction of that additional requirement.
  4. See, e.g., H.R. Rep. No. 1280, 93d Cong., 2d Sess. 302 (1974).
  5. See sections 403(a)(2) and 403(c)(3) of the Act.
  6. Further, section 405(a) of the Act provides, in part, that a plan fiduciary shall be liable for a breach of fiduciary liability of another fiduciary with respect to the same plan if, among other things, he has knowledge of such a breach and does not make reasonable efforts to remedy it, or he has enabled such other fiduciary to commit a breach by his failure to comply with the requirements of section 404(a)(1) of the Act in the administration of his specific responsibilities which give rise to his status as a fiduciary.
  7. Paragraph (b)(2) of the regulation, as proposed, stated that the factors which should be considered may include those listed. In order to reduce uncertainty, reflected in the comments, regarding the application of the regulation, and in view of the fact that the regulation is in the nature of a "safe harbor" provision, paragraph (b)(2) has been restructured so as to indicate the factors which should under all circumstances be considered by any fiduciary who wishes to rely on the provisions of the rule.
  8. It should be noted that index funds typically include a screen or filter process by which portfolio investments for any such fund may be changed to reflect significant adverse financial developments affecting any potential or existing portfolio company, notwithstanding the continued inclusion of the company in the index against which the fund is measured.
  9. The term "risk" is used here in its ordinary sense, and refers to any and all types of risk applicable to a particular investment or investment course of action.
  10. See, e.g., section 401(b) of the Act.

2550.404a-2    Safe Harbor for Automatic Rollovers

Department of Labor
Employee Benefits Security Administration
29 CFR Part 2550

Fiduciary Responsibility Under the Employee Retirement Income Security Act of 1974 Automatic Rollover Safe Harbor

SUMMARY: Section 657 of the EGTRRA of 2001 amended IRC Section 401(a)(31)(B) to require qualfied imployer plans to automatically rollover involuntary cash outs of more than $1,000 (but less than $5,000) if the participant failed to affirmatively elect any other plan options. This final regulation will affect employee pension benefit plans, plan sponsors, administrators and fiduciaries, service providers, and plan participants and beneficiaries.

DATES: Effective Date: This final regulation is effective March 28, 2005. Applicability Date: This final regulation shall apply to the rollover of mandatory distributions made on or after March 28, 2005.

Subchapter F—Fiduciary Responsibility Under the Employee Retirement Income Security Act of 1974
PART 2550—RULES AND REGULATIONS FOR FIDUCIARY RESPONSIBILITY

The following new section is added to part 2550 to read as follows:

§ 2550.404a–2 Safe Harbor for Automatic Rollovers to Individual Retirement Plans.

  1. In general.
    1. Pursuant to section 657(c) of the Economic Growth and Tax Relief Reconciliation Act of 2001, Public Law 107–16, June 7, 2001, 115 Stat. 38, this section provides a safe harbor under which a fiduciary of an employee pension benefit plan subject to Title I of the Employee Retirement Income Security Act of 1974, as amended (the Act), 29 U.S.C. 1001 et seq., will be deemed to have satisfied his or her fiduciary duties under section 404(a) of the Act in connection with an automatic rollover of a mandatory distribution described in section 401(a)(31)(B) of the Internal Revenue Code of 1986, as amended (the Code). This section also provides a safe harbor for certain other mandatory distributions not described in section 401(a)(31)(B) of the Code.
    2. The standards set forth in this section apply solely for purposes of determining whether a fiduciary meets the requirements of this safe harbor. Such standards are not intended to be the exclusive means by which a fiduciary might satisfy his or her responsibilities under the Act with respect to rollovers of mandatory distributions described in paragraphs (c) and (d) of this section.
  2. Safe harbor.
  3. A fiduciary that meets the conditions of paragraph (c) or paragraph (d) of this section is deemed to have satisfied his or her duties under section 404(a) of the Act with respect toboth the selection of an individual retirement plan provider and the investment of funds in connection with the rollover of mandatory distributions described in those paragraphs to an individual retirement plan, within the meaning of section 7701(a)(37) of the Code.

  4. Conditions.
  5. With respect to an automatic rollover of a mandatory distribution described in section 401(a)(31)(B) of the Code, a fiduciary shall qualify for the safe harbor described in paragraph (b) of this section if:

    1. The present value of the nonforfeitable accrued benefit, as determined under section 411(a)(11) of the Code, does not exceed the maximum amount under section 401(a)(31)(B) of the Code;
    2. The mandatory distribution is to an individual retirement plan within the meaning of section 7701(a)(37) of the Code;
    3. In connection with the distribution of rolled-over funds to an individual retirement plan, the fiduciary enters into a written agreement with an individual retirement plan provider that provides: (i) The rolled-over funds shall be invested in an investment product designed to preserve principal and provide a reasonable rate of return, whether or not such return is guaranteed, consistent with liquidity; (ii) For purposes of paragraph (c)(3)(i) of this section, the investment product selected for the rolled-over funds shall seek to maintain, over the term of the investment, the dollar value that is equal to the amount invested in the product by the individual retirement plan; (iii) The investment product selected for the rolled-over funds shall be offered by a state or federally regulated financial institution, which shall be: A bank or savings association, the deposits of which are insured by the Federal Deposit Insurance Corporation; a credit union, the member accounts of which are insured within the meaning of section 101(7) of the Federal Credit Union Act; an insurance company, the products of which are protected by State guaranty associations; or an investment company registered under the Investment Company Act of 1940; (iv) All fees and expenses attendant to an individual retirement plan, including investments of such plan, (e.g., establishment charges, maintenance fees, investment expenses, termination costs and surrender charges) shall not exceed the fees and expenses charged by the individual retirement plan provider for comparable individual retirement plans established for reasons other than the receipt of a rollover distribution subject to the provisions of section 401(a)(31)(B) of the Code; and The participant on whose behalf the fiduciary makes an automatic rollover shall have the right to enforce the terms of the contractual agreement establishing the individual retirement plan, with regard to his or her rolledover funds, against the individual retirement plan provider.
    4. Participants have been furnished a summary plan description, or a summary of material modifications, that describes the plan’s automatic rollover provisions effectuating the requirements of section 401(a)(31)(B) of the Code, including an explanation that the mandatory distribution will be invested in an investment product designed to preserve principal and provide a reasonable rate of return and liquidity, a statement indicating how fees and expenses attendant to the individual retirement plan will be allocated (i.e., the extent to which expenses will be borne by the account holder alone or shared with the distributing plan or plan sponsor), and the name, address and phone number of a plan contact (to the extent not otherwise provided in the summary plan description or summary of material modifications) for further information concerning the plan’s automatic rollover provisions, the individual retirement plan provider and the fees and expenses attendant to the individual retirement plan; and
    5. Both the fiduciary’s selection of an individual retirement plan and the investment of funds would not result in a prohibited transaction under section 406 of the Act, unless such actions are exempted from the prohibited transaction provisions by a prohibited transaction exemption issued pursuant to section 408(a) of the Act.
  6. Mandatory distributions of $1,000 or less.
  7. A fiduciary shall qualify for the protection afforded by the safe harbor described in paragraph (b) of this section with respect to a mandatory distribution of one thousand dollars ($1,000) or less described in section 411(a)(11) of the Code, provided there is no affirmative distribution election by the participant and the fiduciary makes a rollover distribution of such amount into an individual retirement plan on behalf of such participant in accordance with the conditions described in paragraph (c) of this section, without regard to the fact that such rollover is not described in section 401(a)(31)(B) of the Code.

  8. Effective date.
  9. This section shall be effective and shall apply to any rollover of a mandatory distribution made on or after March 28, 2005.

    Signed at Washington, DC, this 20th day of September, 2004.
    Ann L. Combs,
    Assistant Secretary, Employee Benefits Security Administration.
    [FR Doc. 04–21591 Filed 9–27–04; 8:45 am]
    BILLING CODE 4150–29–P

2550.404b-1    Indicia of Ownership

Department of Labor
Regulation 2550.404b-1
29 C.F.R. 2550.404b-1

Originally issued October 4, 1977 (42 FR 54124)

Amended January 6, 1981 (46 FR 1267)

ERISA  404(b) requires that plan assets be maintained within the jurisdiction of US District Courts. With the advent of international investments, this is often impractical. This regulation provides a means to keep investments at certain types of non-US custodians. A special provision deals with Canada.

  1. No fiduciary may maintain the indicia of ownership of any assets of a plan outside the jurisdiction of the district courts of the United States, unless:
    1. Such assets are:
      1. Securities issued by a person, as defined in section 3(9) of the Employee Retirement Income Security Act of 1974 (Act) (other than an individual), which is not organized under the laws of the United States or a State and does not have its principal place of business within the United States,
      2. Securities issued by a government other than the government of the United States or of a State, or any political subdivision, agency or instrumentality of such a government,
      3. Securities issued by a person, as defined in section 3(9) of the Act (other than an individual), the principal trading market for which securities is outside the jurisdiction of the district courts of the United States, or
      4. Currency issued by a government other than the government of the United States if such currency is maintained outside the jurisdiction of the district courts of the United States solely as an incident to the purchase, sale or maintenance of securities described in paragraph (a)(1) of this section; and
    2. Such assets are:
      1. Such assets are under the management and control of a fiduciary which is a corporation or partnership organized under the laws of the United States or a State, which fiduciary has its principal place of business within the United States and which is -
        1. A bank as defined in section 202(a)(2) of the Investment Advisors Act of 1940 that has, as of the last day of its most recent fiscal year, equity capital in excess of $1,000,000;
        2. An insurance company which is qualified under the laws of more than one State to manage, acquire, or dispose of any asset of a plan, which company has, as of the last day of its most recent fiscal year, net worth in excess of $1,000,000 and which is subject to supervision and examination by the State authority having supervision over insurance companies; or
        3. An investment adviser registered under the Investment Advisers Act of 1940 that has, as of the last day of its most recent fiscal year, total client assets under its management and control in excess $50,000,000 and either
          1. Shareholders' or partners' equity in excess of $750,000 or
          2. All of its obligations and liabilities assumed or guaranteed by a person described in paragraph (a)(2)(i)(A), (B), or (C)(1) or (a)(2)(ii)(A)(2) of this section; or
      2. Such indicia or ownership are either:
        1. In the physical possession of, or, as a result of normal business operations, are in transit to the physical possession of, a person which is organized under the laws of the United States or a State, which person has its principal place of business in the United States and which is -
          1. A bank as defined in section 202(a)(2) of the Investment Advisers Act of 1940 that has, as of the last day of its most recent fiscal year, equity capital in excess of $1,000,000;
          2. A broker of dealer registered under the Securities Exchange Act of 1934 that has, as of the last day of its most recent fiscal year, net worth in excess of $750,000; or
          3. A broker or dealer registered under the Securities Exchange Act of 1934 that has all of its obligations and liabilities assumed or guaranteed by a person described in paragraph (a)(2)(i)(A), (B), or (C)(1) or (a)(2)(ii)(A)(2) of this section; or
        2. Maintained by a broker or dealer, described in paragraph (a)(2)(ii)(A)(2) or (3) of this section, in the custody of an entity designated by the Securities and Exchange Commission as a "satisfactory control location" with respect to such broker or dealer pursuant to Rule 15c3-3 under the Securities Exchange Act of 1934 provided that:
          1. Such entity holds the indicia of ownership as agent for the broker or dealer, and
          2. Such broker or dealer is liable to the plan to the same extent it would be if it retained the physical possession of the indicia of ownership pursuant to paragraph (a)(2)(ii)(A) of this section.
        3. Maintained by a bank described in paragraph (a)(2)(ii)(A)(1), in the custody of an entity that is a foreign securities depository, foreign clearing agency which acts as a securities depository, or foreign bank which entity is supervised or regulated by a government agency or regulatory authority in the foreign jurisdiction having authority over such depositories, clearing agencies or banks, provided that:
          1. The foreign entity holds the indicia of ownership as agent for the bank;
          2. The bank is liable to the plan to the same extent it would be if it retained the physical possession of the indicia of ownership within the U.S.
          3. The indicia of ownership are not subject to any right, charge, security interest, lien or claim of any kind in favor of the foreign entity except for their safe custody or administration;
          4. Beneficial ownership of the assets represented by the indicia of ownership is freely transferable without the payment of money or value other than for safe custody or administration; and
          5. Upon request by the plan fiduciary who is responsible for the selection and retention of the bank, the bank identifies to such fiduciary the name, address and principal place of business of the foreign entity which acts as custodian for the plan pursuant to this paragraph (a)(2)(ii)(C), and the name and address of the governmental agency or other regulatory authority that supervises or regulates that foreign entity.
  2. Notwithstanding any requirement of paragraph (a) of this section, a fiduciary, with respect to a plan may maintain in Canada the indicia of ownership of plan assets which are attributable to a contribution made on behalf of a plan participant who is a citizen or resident of Canada, if such indicia of ownership must remain in Canada in order for the plan to qualify for and maintain tax exempt status under the laws of Canada or to comply with other applicable laws of Canada or any Province of Canada.
  3. For purposes of this regulation:
    1. The term "management and control" means the power to direct the acquisition or disposition through purchase, sale, pledging, or other means; and
    2. The term "depository" means any company, or agency or instrumentality of government, that acts as a custodian of securities in connection with a system for the central handling of securities whereby all securities of a particular class or series or any issuer deposited within the system are treated as fungible and may be transferred, loaned, or pledged by bookkeeping entry without physical delivery of securities certificates.

2550.404c-1    ERISA Section 404(c) Plans

Department of Labor
Regulation 2550.404c-1
29 C.F.R. 2550.404c-1

Originally issued October 4, 1977 (42 FR 54124)

Amended January 26, 1981 (46 FR 1267)

  1. In General.
    1. Section 404(c) of the Employee Retirement Income Security Act of 1974 (ERISA or the Act) provides that if a pension plan that provides for individual accounts permits a participant or beneficiary to exercise control over assets in his account and that participant or beneficiary in fact exercises control over assets in his account, then the participant or beneficiary shall not be deemed to be a fiduciary by reason of his exercise of control and no person who is otherwise a fiduciary shall be liable for any loss, or by reason of any breach, which results from such exercise of control. This section describes the kinds of plans that are "ERISA section 404(c) plans," the circumstances in which a participant or beneficiary is considered to have exercised independent control over the assets in his account as contemplated by section 404(c), and the consequences of a participant's or beneficiary's exercise of control.
    2. The standards set forth in this section are applicable solely for the purpose of determining whether a plan is an ERISA section 404(c) plan and whether a particular transaction engaged in by a participant or beneficiary of such plan is afforded relief by section 404(c). Such standards, therefore, are not intended to be applied in determining whether, or to what extent, a plan which does not meet the requirements for an ERISA section 404(c) plan or a fiduciary with respect to such a plan satisfies the fiduciary responsibility or other provisions of title I of the Act.
  2. ERISA section 404(c) plans -
    1. In general. An "ERISA section 404(c) plan" is an individual account plan described in section 3(34) of the Act that:
      1. Provides an opportunity for a participant or beneficiary to exercise control over assets in his individual account (see paragraph (b)(2) of this section); and
      2. Provides a participant or beneficiary an opportunity to choose, from a broad range of investment alternatives, the manner in which some or all of the assets in his account are invested (see paragraph (b)(3) of this section).
    2. Opportunity to exercise control.
      1. A plan provides a participant or beneficiary an opportunity to exercise control over assets in his account only if -
        1. Under the terms of the plan, the participant or beneficiary has a reasonable opportunity to give investment instructions (in writing or otherwise, with opportunity to obtain written confirmation of such instructions) to an identified plan fiduciary who is obligated to comply with such instructions except as otherwise provided in paragraph (b)(2)(ii)(B) and (d)(2)(ii) of this section; and
        2. The participant or beneficiary is provided or has the opportunity to obtain sufficient information to make informed decisions with regard to investment alternatives available under the plan, and incidents of ownership appurtenant to such investments. For purposes of this subparagraph, a participant or beneficiary will not be considered to have sufficient investment information unless -
          1. The participant or beneficiary is provided by an identified plan fiduciary (or a person or persons designated by the plan fiduciary to act on his behalf):
            1. An explanation that the plan is intended to constitute a plan described in section 404(c) of the Employee Retirement Income Security Act, and title 29 of the Code of Federal Regulations Section 2550.440c-1, and that the fiduciaries of the plan may be relieved of liability for any losses which are the direct and necessary result of investment instructions given by such participant or beneficiary;
            2. A description of the investment alternatives available under the plan and, with respect to each designated investment alternative, a general description of the investment objectives and risk and return characteristics of each such alternative, including information relating to the type and diversification of assets comprising the portfolio of the designated investment alternative;
            3. Identification of any designated investment managers;
            4. An explanation of the circumstances under which participants and beneficiaries may give investment instructions and explanation of any specified limitations on such instructions under the terms of the plan, including any restrictions on transfer to or from a designated investment alternative and any restrictions on the exercise of voting, tender and similar rights appurtenant to a participant's or beneficiary's investment in an investment alternative;
            5. A description of any transaction fees and expenses which affect the participant's or beneficiary's account balance in connection with purchases or sales of interests in investment alternatives (e.g., commissions, sales load, deferred sales charges, redemption or exchange fees);
            6. The name, address, and phone number of the plan fiduciary (and, if applicable, the person or persons designated by the plan fiduciary to act on his behalf) responsible for providing the information described in paragraph (b)(2)(i)(B)(2) upon request of a participant or beneficiary and a description of the information described in paragraph (b)(2)(i)(B)(2) which may be obtained on request;
            7. In the case of plans which offer an investment alternative which is designed to permit a participant or beneficiary to directly or indirectly acquire or sell any employer security (employer security alternative), a description of the procedures established to provide for the confidentiality of information relating to the purchase, holding and sale of employer securities, and the exercise of voting, tender and similar rights, by participants and beneficiaries, and the name, address and phone number of the plan fiduciary, responsible for monitoring compliance with the procedures (see paragraphs (d)(2)(ii)(E)(4)(vii), (viii) and (ix) of this section); and
            8. In the case of an investment alternative which is subject to the Securities Act of 1933, and in which the participant or beneficiary has no assets invested, immediately following the participant's or beneficiary's initial investment, a copy of the most recent prospectus provided to the plan. This condition will be deemed satisfied if the participant or beneficiary has been provided with a copy of such most recent prospectus immediately prior to the participant's or beneficiary's initial investment in such alternative;
            9. Subsequent to an investment in a investment alternative, any materials provided to the plan relating to the exercise of voting, tender or similar rights which are incidental to the holding in the account of the participant or beneficiary of an ownership interest in such alternative to the extent that such rights are passed through to participants and beneficiaries under the terms of the plan, as well as a description of or reference to plan provisions relating to the exercise of voting, tender or similar rights.
          2. The participants or beneficiary is provided by the identified plan fiduciary (or a person or persons designated by the plan fiduciary to act on his behalf), either directly or upon request, the following information, which shall be based on the latest information available to the plan:
            1. A description of the annual operating expenses of each designated investment alternative (e.g., investment management fees, administrative fees, transaction costs) which reduce the rate of return to participants and beneficiaries, and the aggregate amount of such expenses expressed as a percentage of average net assets of the designated investment alternative;
            2. Copies of any prospectuses, financial statements and reports, and of any other materials relating to the investment alternatives available under the plan, to the extent such information is provided to the plan;
            3. A list of the assets comprising the portfolio of each designated investment alternative which constitute plan assets within the meaning of 29 C.F.R. 2510.3-101, the value of each such asset (or the proportion of the investment alternative which it comprises), and, with respect to each such asset which is a fixed rate investment contract issued by a bank, savings and loan association or insurance company, the name of the issuer of the contract, the term of the contract and the rate of return on the contract;
            4. Information concerning the value of shares or units in designated investment alternatives available to participants and beneficiaries under the plan, as well as the past and current investment performance of such alternatives, determined net of expenses, on a reasonable and consistent basis; and
            5. Information concerning the value of shares or units in designated investment alternatives held in the accounts of the participant or beneficiary.
      2. A plan does not fail to provide an opportunity for a participant or beneficiary to exercise control over his individual account merely because it -
        1. Imposes charges for reasonable expenses. A plan may charge participants' and beneficiaries' accounts for the reasonable expenses of carrying out investment instructions, provided that procedures are established under the plan to periodically inform such participants and beneficiaries of actual expenses incurred with respect to their respective individual accounts;
        2. Permits a fiduciary to decline to implement investment instructions by participants and beneficiaries. A fiduciary may decline to implement participant and beneficiary instructions which are described at paragraph (d)(2)(ii) of this section, as well as instructions specified in the plan, including instructions -
          1. Which would result in a prohibited transaction described in ERISA section  406 or section  4975 of the Internal Revenue Code, and
          2. Which would generate income that would be taxable to the plan;
        3. Imposes reasonable restrictions on frequency of investment instructions. A plan may impose reasonable restrictions on the frequency with which participants and beneficiaries may give investment instructions. In no event however, is such a restriction reasonable unless, with respect to each investment alternative made available by the plan, it permits participants and beneficiaries to give investment instructions with a frequency which is appropriate in light of the market volatility to which the investment alternative may reasonably be expected to be subject, provided that -
          1. At least three of the investment alternatives made available pursuant to the requirements of paragraph (b)(3)(i)(B) of this section, which constitute a broad range of investment alternatives, permit participants and beneficiaries to give investment instructions no less frequently than once within any three month period; and
          2. (i) At least one of the investment alternatives meeting the requirements of paragraph (b)(2)(ii)(C)(1) of this section permits participants and beneficiaries to give investment instructions with regard to transfers into the investment alternative as frequently as participants and beneficiaries are permitted to give investment instructions with respect to any investment alternative made available by the plan which permits participants and beneficiaries to give investment instructions more frequently than once within any three month period; or

            (ii) With respect to each investment alternative which permits participants and beneficiaries to give investment instructions more frequently than once within any three month period, participants and beneficiaries are permitted to direct their investments from such alternative into an income producing, low risk, liquid fund, subfund, or account as frequently as their are permitted to give investment instructions with respect to each such alternative and, with respect to such fund, subfund or account, participants and beneficiaries are permitted to direct investments from the fund, subfund or account to an investment alternative meeting the requirements of paragraph (b)(2)(ii)(C)(1) as frequently as they are permitted to give investment instructions with respect to that investment alternative; and
        4. With respect to transfers from an investment alternative which is designed to permit a participant or beneficiary to directly or indirectly acquire or sell any employer security (employer security alternative) either:
          1. All of the investment alternatives meeting the requirements of paragraph (b)(2)(ii)(C)(1) of this section must permit participants and beneficiaries to give investment instructions with regard to transfers into each of the investment alternatives as frequently as participants and beneficiaries are permitted to give investment instructions with respect to the employer security alternative; or
          2. Participants and beneficiaries are permitted to direct their investments from each employer security alternative into an income producing, low risk, liquid, fund, subfund, or account as frequently as they are permitted to give investment instructions with respect to such employer security alternative and, with respect to such fund, subfund, or account, participants and beneficiaries are permitted to direct investments from the fund, subfund or account to each investment alternative meeting the requirements of paragraph (b)(2)(ii)(C)(1) as frequently as they are permitted to give investment instructions with respect to each such investment alternative.
          3. Paragraph (c) of this section describes the circumstances under which a participant or beneficiary will be considered to have exercised independent control with respect to a particular transaction.
    3. Broad range of investment alternatives.
      1. A plan offers a broad range of investment alternatives only if the available investment alternatives are sufficient to provide the participant or beneficiary with a reasonable opportunity to:
        1. Materially affect the potential return on amounts in his individual account with respect to which he is permitted to exercise control and the degree of risk to which such amounts are subject;
        2. Choose from at least three investment alternatives:
          1. Each of which is diversified;
          2. Each of which has materially different risk and return characteristics;
          3. Which in the aggregate enable the participant or beneficiary by choosing among them to achieve a portfolio with aggregate risk and return characteristics at any point within the range normally appropriate for the participant or beneficiary; and
          4. Each of which when combined with investments in the other alternatives tends to minimize through diversification the overall risk of a participant's or beneficiary's portfolio;
        3. Diversify the investment of that portion of his individual account with respect to which he in permitted to exercise control so as to minimize the risk of large losses, taking into account the nature of the plan and the size of participants' or beneficiaries' accounts. In determining whether a plan provides the participant or beneficiary with a reasonable opportunity to diversify his investments, the nature of the investment alternatives offered by the plan and the size of the portion of the individual's account over which he is permitted to exercise control must be considered. Where such portion of the account of any participant or beneficiary is so limited in size that the opportunity to invest in look-through investment vehicles is the only prudent means to assure an opportunity to achieve appropriate diversification, a plan may satisfy the requirements of this paragraph only by offering look-through investment vehicles.
      2. Diversification and look-through investment vehicles. Where look-through investment vehicles are available as investment alternatives to participants and beneficiaries, the underlying investments of the look-through investment shall be considered in determining whether the plan satisfies the requirements of subparagraphs (b)(3)(i)(B) and (b)(3()i)(C).
  3. Exercise of control.
    1. In general. -
      1. Sections 404(c)(1) and 404(c)(2) of the Act and paragraphs (a) and (d) of this section apply only with respect to a transaction where a participant or beneficiary has exercised independent control in fact with respect to the investment of assets in his individual account under an ERISA section 404(c) plan.
      2. For purposes of sections 404(c)(1) and 4040(c)(2) [sic] of the Act and paragraphs (a) and (d) of this section, a participant or beneficiary will be deemed to have exercised control with respect to the exercise of voting, tender and similar rights appurtenant to the participant's or beneficiary's ownership interest in an investment alternative, provided that the participant's or beneficiary's investment in the investment alternative was itself the result of an exercise of control, the participant or beneficiary was provided a reasonable opportunity to give instruction with respect to such incidents of ownership, including the provision of the information described in paragraph (b)(2)(i)(B)(1)(ix) of this section, and the participant or beneficiary has not failed to exercise control by reason of the circumstances described in Paragraph (c)(2) with respect to such incidents of ownership.
    2. Independent control. Whether a participant or beneficiary has exercised independent control in fact with respect to a transaction depends on the facts and circumstances of the particular case. However, a participant's or beneficiary's exercise of control is not independent in fact if:
      1. The participant or beneficiary is subjected to improper influence by a plan fiduciary or the plan sponsor with respect to the transaction;
      2. A plan fiduciary has concealed material non-public facts regarding the investment from the participant or beneficiary, unless the disclosure of such information by the plan fiduciary to the participant or beneficiary would violate any provision of federal law or any provision of state law which in not preempted by the Act; or
      3. The participant or beneficiary is legally incompetent and the responsible plan fiduciary accepts the instructions of the participant or beneficiary knowing him to be legally incompetent.
    3. Transactions involving a fiduciary. In the case of a sale, exchange or leasing of property (other than a transaction described in paragraph (d)(2)(ii)(E) of this section) between an ERISA section 404(c) plan and a plan fiduciary or an affiliate of such a fiduciary, or a loan to a plan fiduciary or an affiliate of such a fiduciary, the participant or beneficiary will not be deemed to have exercised independent control unless the transaction is fair and reasonable to him. For purposes of this paragraph (c)(3), a transaction will be deemed to be fair and reasonable to a participant or beneficiary if he pays no more than, or receives no less than, adequate consideration (as defined in section 3(18) of the Act) in connection with the transaction.
    4. No obligation to advise. A fiduciary has no obligation under part 4 of Title I of this Act to provide investment advice to a participant or beneficiary under an ERISA section 404(c) plan.
  4. Effect of independent exercise of control.
    1. Participant or beneficiary not a fiduciary. If a participant or beneficiary of an ERISA section 404(c) plan exercises independent control over assets in his individual account in the manner described in paragraph (c), then such participant or beneficiary is not a fiduciary of the plan by reason of such exercise of control.
    2. Limitation on liability of plan fiduciaries -
      1. If a participant or beneficiary of an ERISA section 404(c) plan exercises independent control over assets in his individual account in the manner described in paragraph (c), then no other person who is a fiduciary with respect to such plan shall be liable for any loss, or with respect to any breach of part 4 of Title I of the Act that is the direct and necessary result of that participant's or beneficiary's exercise of control.
      2. Paragraph (d)(2)(i) does not apply with respect to any instruction, which if implemented -
        1. Would not be in accordance with the documents and instruments governing the plan insofar as such documents and instruments are consistent with the provisions of Title I of ERISA;
        2. Would cause a fiduciary to maintain the indicia of ownership of any assets of the plan outside the jurisdiction of the district courts of the United States other than as permitted by section 404(b) of the Act and 29 C.F.R. 2550.404b-1;
        3. Would jeopardize the plan's tax qualified status under the Internal Revenue Code;
        4. Could result in a loss in excess of a participant's or beneficiary's account balance; or
        5. Would result in a direct or indirect:
          1. Sale, exchange or lease of property between a plan sponsor or any affiliate of the sponsor and the plan except for the acquisition or disposition of any interest in a fund, subfund or portfolio managed by a plan sponsor or an affiliate of the sponsor, or the purchase or sale of any qualifying employer security (as defined in Section 407(d)(5) of the Act) which meets the conditions of section 408(e) of ERISA and section (d)(2))(ii)(E)(4) below;
          2. Loan to a plan sponsor or any affiliate of the sponsor;
          3. Acquisition or sale of any employer real property (as defined in section 407(d)(2) of the Act); or
          4. Acquisition or sale of any employer security except to the extent that:
            1. Such securities are qualifying employer securities (as defined in section 407(d)(5) of the Act);
            2. Such securities are stock or an equity interest in a publicly traded partnership (as defined in section 7704(b) of the Internal Revenue Code of 1986), but only if such partnership is an existing partnership as defined in section 10211(c)(2)(A) of the Revenue Act of 1987 (Public Law 100-203);
            3. Such securities are publicly traded on a national exchange or other generally recognized market;
            4. Such securities are traded with sufficient frequency and in sufficient volume to assure that participant and beneficiary directions to buy or sell the security may be acted upon promptly and efficiently;
            5. Information provided to shareholders of such securities is provided to participants and beneficiaries with accounts holding such securities;
            6. Voting, tender and similar rights with respect to such securities are passed through to participants and beneficiaries with accounts holding such securities;
            7. Information relating to the purchase, holding, and sale of securities, and the, exercise of voting, tender, and similar rights with respect to such securities by participants and beneficiaries, is maintained in accordance with procedures which are designed to safeguard the confidentiality of such information, except to the extent necessary to comply with Federal laws or state laws not preempted by the Act;
            8. The plan designates a fiduciary who is responsible for ensuring that: The procedures required under subparagraph (d)(2)(ii)(E)(4)(vii) are sufficient to safeguard the confidentiality of the information described in that subparagraph, such procedures are being followed, and the independent fiduciary required by subparagraph (d)(2)(ii)(E)(4)(ix) is appointed; and
            9. An independent fiduciary is appointed to carry out activities relating to any situations which the fiduciary designated by the plan for purposes of subparagraph (d)(2)(ii)(E)(4)(viii) determines involve a potential for undue employer influence upon participants and beneficiaries, with regard to the direct or indirect exercise of shareholder rights. For purposes of this subparagraph, a fiduciary is not independent if the fiduciary is affiliated with any sponsor of the plan.
      3. The individual investment decisions of an investment manager who is designated directly by a participant or beneficiary or who manages a look-through investment vehicle in which a participant or beneficiary has invested are not direct and necessary results of the designation of the investment manager or of investment in the look-through investment vehicle. However, this paragraph (d)(2)(iii) shall not be construed to result in liability under section 405 of ERISA with respect to a fiduciary (other than the investment manager) who would otherwise be relieved of liability by reason of section 404(c)(2) of the Act and paragraph (d) of this section.
    3. Prohibited Transactions. The relief provided by section 404(c) of the Act and this section applies only to the provisions of part 4 of title I of the Act. Therefore, nothing in this section relieves a disqualified person from the taxes imposed by sections 4975(a) and (b) of the Internal Revenue Code with respect to the transactions prohibited by section 4975(c)(1) of the Code.
  5. Definitions. For purposes of this section:
    1. Look-through investment vehicle means:
      1. An investment company described in section 3(a) of the Investment Company Act of 1940, or a series investment company described in section 18(f) of the 1940 Act or any of the segregated portfolios of such company;
      2. A common or collective trust fund or a pooled investment fund maintained by a bank or similar institution, a deposit in a bank or similar institution, or a fixed rate investment contract of a bank or similar institution;
      3. A pooled separate account or a fixed rate investment contract of an insurance company qualified to do business in a State; or
      4. Any entity whose assets include plan assets by reason of a plan's investment in the entity;
    2. Adequate consideration has the meaning given it in section 3(18) of the Act and in any regulations under this title;
    3. An affiliate of a person includes the following:
      1. Any person directly or indirectly controlling, controlled by, or under common control with the person;
      2. Any officer, director, partner, or employee, an employee of an affiliated employer, relative (as defined in section 3(15) of ERISA), brother, sister, or spouse of a brother or sister, of the person; and
      3. Any corporation or partnership of which the person is an officer director or partner.

      For purposes of this paragraph (e)(3), the term "control" means, with respect to a person other than an individual, the power to exercise a controlling influence over the management or policies of such person.

    4. designated investment alternative is a specific investment identified by a plan fiduciary as an available investment alternative under the plan.
  6. Examples. The provisions of this section are illustrated by the following examples. Examples (5) through (11) assume that the participant has exercised independent control with respect to his individual account under an ERISA section 404(c) plan described in paragraph (b) and has not directed a transaction described in paragraph (d)(2)(ii).
    1. Plan A is an individual account plan described in section 3(34) of the Act. The plan states that a plan participant or beneficiary may direct the plan administrator to invest any portion of his individual account in a particular diversified equity fund managed by an entity which is not affiliated with the plan sponsor, or any other asset administratively feasible for the plan to hold. However, the plan provides that the plan administrator will not implement certain listed instructions for which plan fiduciaries would not be relieved of liability under section 404(c) (see paragraph (d)(2)(ii)).
    2. Plan participants and beneficiaries are permitted to give investment instructions during the first week of each month with respect to the equity fund and at any time with respect to other investments. The plan provides for the pass-through of voting, tender and similar rights incidental to the holding in the account of a participant or beneficiary of an ownership interest in the equity fund or any other investment alternative available under the plan.

      • The plan administrator of plan A provides each participant and beneficiary with the information described in subparagraphs (i), (ii), (iii), (iv), (v), (vi) and (vii) of paragraph (b)(2)(i)(B)(1) upon their entry into the plan, and provides updated information in the event of any material change in the information provided.
      • Immediately following an investment by a participant or beneficiary in the equity fund, the plan administrator provides a copy of the most recent prospectus received from the fund to the investing participant or beneficiary.
      • Immediately following any investment by a participant or beneficiary in any other investment alternative which is subject to the Securities Act of 1933, the plan administrator provides the participant or beneficiary with the most recent prospectus received from that investment alternative (see paragraph (b)(2)(1)(B)(i)(viii)).
      • Finally, subsequent to any investment by a participant or beneficiary, the plan administrator forwards to the investing participant or beneficiary any materials provided to the plan relating to the exercise of voting, tender or similar rights attendant to ownership of an interest in such investment (see paragraph (b)(2)(1)(B)(i)(ix)).
      • Upon request, the plan administrator provides each participant or beneficiary with copies of any prospectuses, financial statements and reports, and any other materials relating to the investment alternatives available under the plan which are received by the plan (see paragraph (b)(2)(i)(B)(2 )(ii)).
      • Also upon request, the plan administrator provides each participant and beneficiary with the other information required by paragraph (b)(2)(i)(B)(2) with respect to the equity fund, which is a designated investment alternative, including information concerning the latest available value of the participant's or beneficiary's interest in the equity fund (see paragraph (b)(2)(i)(B)(2)(v)).

      Plan A meets the requirements of paragraphs (b)(2)(i)(B)(1) and (2) of this section regarding the provision of investment information.

      Note: The regulation imposes no additional obligation on the administrator to furnish or make available materials relating to the companies in which the equity fund invests (e.g., prospectuses, proxies, etc.).

    3. Plan C is an individual account plan described in section 3(34) of the Act under which participants and beneficiaries may choose among three investment alternatives which otherwise meet the requirements of paragraph (b) of this section. The plan permits investment instruction with respect to each investment alternative only on the first 10 days of each calendar quarter, i.e., January 1-10, April 1-10, July 1-10 and October 1-10. Plan C satisfies the condition of paragraph (b)(2)(ii)(C)(1) that instruction be permitted not less frequently than once within any three month period, since there is not any three month period during which control could not be exercised.
    4. Assume the same facts as in paragraph (f)(2), except that investment instruction may only be given on January 1, April 1, July 1 and October 1. Plan C is not an ERISA section 404(c) plan because it does not satisfy the condition of paragraph (b)(2)(ii)(C)(1) that instruction be permitted not less frequently than once within any three month period. Under these facts, there is a three month period, e.g., January 2 through April 1, during which control could not be exercised by participants and beneficiaries.
    5. Plan D is an individual account plan described in section 3(34) of the Act under which participants and beneficiaries may choose among three diversified investment alternatives which constitute a broad range of investment alternatives. The plan also permits investment instruction with respect to an employer securities alternative but provides that a participant or beneficiary can invest no more than 25% of his account balance in this alternative. This restriction does not affect the availability of relief under section 404(c) inasmuch as it does not relate to the three diversified investment alternatives and, therefore, does not cause the plan to fail to provide an opportunity to choose from a broad range of investment alternatives.
    6. A participant, P, independently exercises control over assets in his individual account plan by directing a plan fiduciary, F, to invest 100% of his account balance in a single stock. P is not a fiduciary with respect to the plan by reason of his exercise of control and F will not be liable for any losses that necessarily result from P's investment instruction.
    7. Assume the same facts as in paragraph (f)(5), except that P directs F to purchase the stock from B, who is a party in interest with respect to the plan. Neither P nor F has engaged in a transaction prohibited under section 406 of the Act: P because he is not a fiduciary with respect to the plan by reason of his exercise of control and F because he is not liable for any breach of part 4 of Title I that is the direct and necessary consequence of P's exercise of control. However, a prohibited transaction under section 4975(c) of the Internal Revenue Code may have occurred, and, in the absence of an exemption, tax liability may be imposed pursuant to sections 495(a) and (b) of the Code.
    8. Assume the same facts as in paragraph (f)(5), except that P does not specify that the stock be purchased from B, and F chooses to purchase the stock from B. In the absence of an exemption, F has engaged in a prohibited transaction described in 406(a) of ERISA because the decision to purchase the stock from B is not a direct or necessary result of P's exercise or control.
    9. Pursuant to the terms of the plan, plan fiduciary F designates three reputable investment managers whom participants may appoint to manage assets in their individual accounts. Participant P selects M, one of the designated managers, to manage the assets in his account. M prudently manages P's account for 6 months after which he incurs losses in managing the account through his imprudence. M has engaged in a breach of fiduciary duty because M's imprudent management of P's account is not a direct or necessary result of P's exercise of control (the choice of M as manager). F has no fiduciary liability for M's imprudence because he has no affirmative duty to advise P (see paragraph (c)(4)) and because F is relieved of co-fiduciary liability by reason of section 404(c)(2) (see paragraph (d)(2)(iii)). F does have a duty to monitor M's performance to determine the suitability of continuing M as an investment manager, however, and M's imprudence would be a factor which F must consider in periodically reevaluating its decision to designate M.
    10. Participant P instructs plan fiduciary F to appoint G as his investment manager pursuant to the terms of the plan which provide P total discretion in choosing an investment manager. Through G's imprudence, G incurs losses in managing P's account. G has engaged in a breach of fiduciary duty because G's imprudent management of P's account is not a direct or necessary result of P's exercise of control (the choice of G as manager). Plan fiduciary F has no fiduciary liability for G's imprudence because F has no obligation to advise P (see paragraph (c)(4)) and because F is relieved of co-fiduciary liability for G's actions by reason of section 402(c)(2) (see paragraph (d)(2)(iii)). In addition, F also has no duty to determine the suitability of G as an investment manager because the plan does not designate G as an investment manager.
    11. Participant P directs a plan fiduciary, F, a bank, to invest all of the assets in his individual account in a collective trust fund managed by F that is designed to be invested solely in a diversified portfolio of common stocks. Due to economic conditions, the value of the common stocks in the bank collective trust fund declines while the value of publicly-offered fixed income obligations remains relatively stable. F is not liable for any losses incurred by P solely because his individual account was not diversified to include fixed income obligations. Such losses are the direct result of P's exercise of control; moreover, under paragraph (c)(4) of this section F has no obligation to advise P regarding his investment decisions.
    12. Assume the same facts as in paragraph (f)(10) except that F, in managing the collective trust fund, invests the assets of the fund solely in a few highly speculative stocks. F is liable for losses resulting from its imprudent investment in the speculative stocks and for its failure to diversify the assets of the account. This conduct involves a separate breach of F's fiduciary duty that is not a direct or necessary result of P's exercise of control (see paragraph (d)(2)(iii)).
  7. Effective date.
    1. In general. Except as provided in paragraph (g)(2), this section is effective with respect to transactions occurring on or after the first day of the second plan year beginning on or after October 13, 1992.
    2. This section is effective with respect to transactions occurring under a plan maintained pursuant to one or more collective bargaining agreements between employee representatives and one or more employers ratified before October 13, 1992 after the later of the date determined under paragraph (g)(1) or the date on which the last collective bargaining agreement terminates. For purposes of this paragraph (g)(2), any extension or renegotiation of a collective bargaining agreement which is ratified on or after October 13, 1992 is to be disregarded in determining the date on which the agreement terminates.
    3. Transactions occurring before the date determined under subparagraph (g)(1) or (2) of this section, as applicable, are governed by section 404(c) of, the Act without regard to the regulation.

2550.404c-5    Fiduciary Relief for Investments in Qualified Default Investment Alternatives

Department of Labor
Regulation 2550.404c-5
29 C.F.R. 2550.404c-5

(a) In general.

(1) This section implements the fiduciary relief provided under section 404(c)(5) of the Employee Retirement Income Security Act of 1974, as amended (ERISA or the Act), 29 U.S.C. 1001 et seq., under which a participant or beneficiary in an individual account plan will be treated as exercising control over the assets in his or her account for purposes of ERISA section 404(c)(1) with respect to the amount of contributions and earnings that, in the absence of an investment election by the participant, are invested by the plan in accordance with this regulation. If a participant or beneficiary is treated as exercising control over the assets in his or her account in accordance with ERISA section 404(c)(1) no person who is otherwise a fiduciary shall be liable under part 4 of title I of ERISA for any loss or by reason of any breach which results from such participant's or beneficiary's exercise of control. Except as specifically provided in paragraph (c)(6) of this section, a plan need not meet the requirements for an ERISA section 404(c) plan under 29 CFR 2550.404c–1 in order for a plan fiduciary to obtain the relief under this section.

(2) The standards set forth in this section apply solely for purposes of determining whether a fiduciary meets the requirements of this regulation. Such standards are not intended to be the exclusive means by which a fiduciary might satisfy his or her responsibilities under the Act with respect to the investment of assets in the individual account of a participant or beneficiary.

(b) Fiduciary relief.

(1) Except as provided in paragraphs (b)(2), (3), and (4) of this section, a fiduciary of an individual account plan that permits participants or beneficiaries to direct the investment of assets in their accounts and that meets the conditions of paragraph (c) of this section shall not be liable for any loss, or by reason of any breach under part 4 of title I of ERISA, that is the direct and necessary result of (i) investing all or part of a participant's or beneficiary's account in any qualified default investment alternative within the meaning of paragraph (e) of this section, or (ii) investment decisions made by the entity described in paragraph (e)(3) of this section in connection with the management of a qualified default investment alternative.

(2) Nothing in this section shall relieve a fiduciary from his or her duties under part 4 of title I of ERISA to prudently select and monitor any qualified default investment alternative under the plan or from any liability that results from a failure to satisfy these duties, including liability for any resulting losses.

(3) Nothing in this section shall relieve any fiduciary described in paragraph (e)(3)(i) of this section from its fiduciary duties under part 4 of title I of ERISA or from any liability that results from a failure to satisfy these duties, including liability for any resulting losses.

(4) Nothing in this section shall provide relief from the prohibited transaction provisions of section 406 of ERISA, or from any liability that results from a violation of those provisions, including liability for any resulting losses.

(c) Conditions. With respect to the investment of assets in the individual account of a participant or beneficiary, a fiduciary shall qualify for the relief described in paragraph (b)(1) of this section if:

(1) Assets are invested in a qualified default investment alternative within the meaning of paragraph (e) of this section;

(2) The participant or beneficiary on whose behalf the investment is made had the opportunity to direct the investment of the assets in his or her account but did not direct the investment of the assets;

(3) The participant or beneficiary on whose behalf an investment in a qualified default investment alternative may be made is furnished a notice that meets the requirements of paragraph (d) of this section:

(i) (A) At least 30 days in advance of the date of plan eligibility, or at least 30 days in advance of the date of any first investment in a qualified default investment alternative on behalf of a participant or beneficiary described in paragraph (c)(2) of this section; or (B) On or before the date of plan eligibility provided the participant has the opportunity to make a permissible withdrawal (as determined under section 414(w) of the Internal Revenue Code of 1986, as amended (Code)); and

(ii) Within a reasonable period of time of at least 30 days in advance of each subsequent plan year;

(4) A fiduciary provides to a participant or beneficiary the material set forth in 29 CFR 2550.404c-1(b)(2)(i)(B)(1)(viii) and (ix) and 29 CFR 404c-1(b)(2)(i)(B)(2) relating to a participant's or beneficiary's investment in a qualified default investment alternative;

(5)

(i) Any participant or beneficiary on whose behalf assets are invested in a qualified default investment alternative may transfer, in whole or in part, such assets to any other investment alternative available under the plan with a frequency consistent with that afforded to a participant or beneficiary who elected to invest in the qualified default investment alternative, but not less frequently than once within any three month period;

(ii) (A) Except as provided in paragraph (c)(5)(ii)(B) of this section, any transfer described in paragraph (c)(5)(i), or any permissible withdrawal as determined under section 414(w)(2) of the Code, by a participant or beneficiary of assets invested in a qualified default investment alternative, in whole or in part, resulting from the participant's or beneficiary's election to make such a transfer or withdrawal during the 90-day period beginning on the date of the participant's first elective contribution as determined under section 414(w)(2)(B) of the Code, or other first investment in a qualified default investment alternative on behalf of a participant or beneficiary described in paragraph (c)(2) of this section, shall not be subject to any restrictions, fees or expenses (including surrender charges, liquidation or exchange fees, redemption fees and similar expenses charged in connection with the liquidation of, or transfer from, the investment); (B) Paragraph (c)(5)(ii)(A) of this section shall not apply to fees and expenses that are charged on an ongoing basis for the operation of the investment itself (such as investment management fees, distribution and/or service fees, “12b–1” fees, or legal, accounting, transfer agent and similar administrative expenses), and are not imposed, or do not vary, based on a participant's or beneficiary's decision to withdraw, sell or transfer assets out of the qualified default investment alternative; and

(iii) Following the end of the 90-day period described in paragraph (c)(5)(ii)(A) of this section, any transfer or permissible withdrawal described in this paragraph (c)(5) of this section shall not be subject to any restrictions, fees or expenses not otherwise applicable to a participant or beneficiary who elected to invest in that qualified default investment alternative; and

(6) The plan offers a “broad range of investment alternatives” within the meaning of 29 CFR 2550.404c–1(b)(3).

(d) Notice. The notice required by paragraph (c)(3) of this section shall be written in a manner calculated to be understood by the average plan participant and shall contain the following:

(1) A description of the circumstances under which assets in the individual account of a participant or beneficiary may be invested on behalf of the participant or beneficiary in a qualified default investment alternative; and, if applicable, an explanation of the circumstances under which elective contributions will be made on behalf of a participant, the percentage of such contributions, and the right of the participant to elect not to have such contributions made on the participant's behalf (or to elect to have such contributions made at a different percentage);

(2) An explanation of the right of participants and beneficiaries to direct the investment of assets in their individual accounts;

(3) A description of the qualified default investment alternative, including a description of the investment objectives, risk and return characteristics (if applicable), and fees and expenses attendant to the investment alternative;

(4) A description of the right of the participants and beneficiaries on whose behalf assets are invested in a qualified default investment alternative to direct the investment of those assets to any other investment alternative under the plan, including a description of any applicable restrictions, fees or expenses in connection with such transfer; and

(5) An explanation of where the participants and beneficiaries can obtain investment information concerning the other investment alternatives available under the plan.

(e) Qualified default investment alternative. For purposes of this section, a qualified default investment alternative means an investment alternative available to participants and beneficiaries that:

(1)

(i) Does not hold or permit the acquisition of employer securities, except as provided in paragraph (ii).

(ii) Paragraph (e)(1)(i) of this section shall not apply to:

(A) Employer securities held or acquired by an investment company registered under the Investment Company Act of 1940 or a similar pooled investment vehicle regulated and subject to periodic examination by a State or Federal agency and with respect to which investment in such securities is made in accordance with the stated investment objectives of the investment vehicle and independent of the plan sponsor or an affiliate thereof; or

(B) with respect to a qualified default investment alternative described in paragraph (e)(4)(iii) of this section, employer securities acquired as a matching contribution from the employer/plan sponsor, or employer securities acquired prior to management by the investment management service to the extent the investment management service has discretionary authority over the disposition of such employer securities;

(2) Satisfies the requirements of paragraph (c)(5) of this section regarding the ability of a participant or beneficiary to transfer, in whole or in part, his or her investment from the qualified default investment alternative to any other investment alternative available under the plan;

(3) Is:

(i) Managed by:

(A) an investment manager, within the meaning of section 3(38) of the Act;

(B) a trustee of the plan that meets the requirements of section 3(38)(A), (B) and (C) of the Act; or

(C) the plan sponsor, or a committee comprised primarily of employees of the plan sponsor, which is a named fiduciary within the meaning of section 402(a)(2) of the Act;

(ii) An investment company registered under the Investment Company Act of 1940; or

(iii) An investment product or fund described in paragraph (e)(4)(iv) or (v) of this section; and

(4) Constitutes one of the following:

(i) An investment fund product or model portfolio that applies generally accepted investment theories, is diversified so as to minimize the risk of large losses and that is designed to provide varying degrees of long-term appreciation and capital preservation through a mix of equity and fixed income exposures based on the participant's age, target retirement date (such as normal retirement age under the plan) or life expectancy. Such products and portfolios change their asset allocations and associated risk levels over time with the objective of becoming more conservative (i.e., decreasing risk of losses) with increasing age. For purposes of this paragraph (e)(4)(i), asset allocation decisions for such products and portfolios are not required to take into account risk tolerances, investments or other preferences of an individual participant. An example of such a fund or portfolio may be a “life-cycle” or “targeted-retirement-date” fund or account.

(ii) An investment fund product or model portfolio that applies generally accepted investment theories, is diversified so as to minimize the risk of large losses and that is designed to provide long-term appreciation and capital preservation through a mix of equity and fixed income exposures consistent with a target level of risk appropriate for participants of the plan as a whole. For purposes of this paragraph (e)(4)(ii), asset allocation decisions for such products and portfolios are not required to take into account the age, risk tolerances, investments or other preferences of an individual participant. An example of such a fund or portfolio may be a “balanced” fund.

(iii) An investment management service with respect to which a fiduciary, within the meaning of paragraph (e)(3)(i) of this section, applying generally accepted investment theories, allocates the assets of a participant's individual account to achieve varying degrees of long-term appreciation and capital preservation through a mix of equity and fixed income exposures, offered through investment alternatives available under the plan, based on the participant's age, target retirement date (such as normal retirement age under the plan) or life expectancy. Such portfolios are diversified so as to minimize the risk of large losses and change their asset allocations and associated risk levels for an individual account over time with the objective of becoming more conservative (i.e., decreasing risk of losses) with increasing age. For purposes of this paragraph (e)(4)(iii), asset allocation decisions are not required to take into account risk tolerances, investments or other preferences of an individual participant. An example of such a service may be a “managed account.”

(iv)

(A) Subject to paragraph (e)(4)(iv)(B) of this section, an investment product or fund designed to preserve principal and provide a reasonable rate of return, whether or not such return is guaranteed, consistent with liquidity. Such investment product shall for purposes of this paragraph (e)(4)(iv):

(1) Seek to maintain, over the term of the investment, the dollar value that is equal to the amount invested in the product; and

(2) Be offered by a State or federally regulated financial institution.

(B) An investment product described in this paragraph (e)(4)(iv) shall constitute a qualified default investment alternative for purposes of paragraph (e) of this section for not more than 120 days after the date of the participant's first elective contribution (as determined under section 414(w)(2)(B) of the Code).

(v)

(A) Subject to paragraph (e)(4)(v)(B) of this section, an investment product or fund designed to preserve principal; provide a rate of return generally consistent with that earned on intermediate investment grade bonds; and provide liquidity for withdrawals by participants and beneficiaries, including transfers to other investment alternatives. Such investment product or fund shall, for purposes of this paragraph (e)(4)(v), meet the following requirements:

(1) There are no fees or surrender charges imposed in connection with withdrawals initiated by a participant or beneficiary; and

(2) Such investment product or fund invests primarily in investment products that are backed by State or federally regulated financial institutions.

(B) An investment product or fund described in this paragraph (e)(4)(v) shall constitute a qualified default investment alternative for purposes of paragraph (e) of this section solely for purposes of assets invested in such product or fund before December 24, 2007.

(vi) An investment fund product or model portfolio that otherwise meets the requirements of this section shall not fail to constitute a product or portfolio for purposes of paragraph (e)(4)(i) or (ii) of this section solely because the product or portfolio is offered through variable annuity or similar contracts or through common or collective trust funds or pooled investment funds and without regard to whether such contracts or funds provide annuity purchase rights, investment guarantees, death benefit guarantees or other features ancillary to the investment fund product or model portfolio.

(f) Preemption of State laws.

(1) Section 514(e)(1) of the Act provides that title I of the Act supersedes any State law that would directly or indirectly prohibit or restrict the inclusion in any plan of an automatic contribution arrangement. For purposes of section 514(e) of the Act and this paragraph (f), an automatic contribution arrangement is an arrangement (or the provisions of a plan) under which:

(i) A participant may elect to have the plan sponsor make payments as contributions under the plan on his or her behalf or receive such payments directly in cash;

(ii) A participant is treated as having elected to have the plan sponsor make such contributions in an amount equal to a uniform percentage of compensation provided under the plan until the participant specifically elects not to have such contributions made (or specifically elects to have such contributions made at a different percentage); and

(iii) Contributions are invested in accordance with paragraphs (a) through (e) of this section.

(2) A State law that would directly or indirectly prohibit or restrict the inclusion in any pension plan of an automatic contribution arrangement is superseded as to any pension plan, regardless of whether such plan includes an automatic contribution arrangement as defined in paragraph (f)(1) of this section.

(3) The administrator of an automatic contribution arrangement within the meaning of paragraph (f)(1) of this section shall be considered to have satisfied the notice requirements of section 514(e)(3) of the Act if notices are furnished in accordance with paragraphs (c)(3) and (d) of this section.

(4) Nothing in this paragraph (f) precludes a pension plan from including an automatic contribution arrangement that does not meet the conditions of paragraphs (a) through (e) of this section.

[72 FR 60478, Oct. 24, 2007; 73 FR 23350, Apr. 30, 2008]

2550    Default Investment Alternatives Under Participant Directed Individual Account Plans

29 CFR Parts 2550 and 2578 Amendments to Safe Harbor

US Department of Labor

29 CFR Parts 2550 and 2578 Amendments to Safe Harbor for Distributions From Terminated Individual Account Plans and Termination of Abandoned Individual Account Plans To Require Inherited Individual Retirement Plans for Missing Nonspouse Beneficiaries

Final Rule

Employee Benefits Security Administration

29 CFR Parts 2550 and 2578
RIN 1210–AB16

Amendments to Safe Harbor for Distributions From Terminated Individual Account Plans and Termination of Abandoned Individual Account Plans To Require Inherited Individual Retirement Plans for Missing Nonspouse Beneficiaries

AGENCY: Employee Benefits Security Administration

ACTION: Interim final rule with request for comments.

SUMMARY: This document contains an interim final rule amending regulations under the Employee Retirement Income Security Act of 1974 (ERISA or the Act) that provide guidance and a fiduciary safe harbor for the distribution of benefits on behalf of participants or beneficiaries in terminated and abandoned individual account plans.

The Department is amending these regulations to reflect changes enacted as part of the Pension Protection Act of 2006, Public Law 109–280, to the Internal Revenue Code of 1986 (the Code), under which a distribution of a deceased plan participant’s benefit from an eligible retirement plan may be directly transferred to an individual retirement plan established on behalf of the designated nonspouse beneficiary of such participant. Specifically, the amended regulations require as a condition of relief under the fiduciary safe harbor that benefits for a missing, designated nonspouse beneficiary be directly rolled over to an individual retirement plan that fully complies with Code requirements. This interim final rule will affect fiduciaries, plan service providers, and participants and beneficiaries of individual account pension plans.

DATES: Effective and Applicability Dates: The amendments made by this rule are effective March 19, 2007. This interim final rule is applicable to distributions made on or after March 19, 2007.

Comment Date: Written comments must be received by April 2, 2007.

SUPPLEMENTARY INFORMATION:

A. Background

This interim final rule amends two regulations under ERISA that facilitate the termination of individual account plans, including abandoned individual account plans, and the distribution of benefits from such plans. The first regulation, codified at 29 CFR 2550.404a–3, provides plan fiduciaries of terminated plans and qualified termination administrators (QTAs) of abandoned plans with a fiduciary safe harbor for making distributions on behalf of participants or beneficiaries who fail to make an election regarding a form of benefit distribution, commonly referred to as missing participants or beneficiaries. The second regulation, codified at 29 CFR 2578.1, establishes a procedure for financial institutions holding the assets of an abandoned individual account plan to terminate the plan and distribute benefits to the plan’s participants or beneficiaries, with limited liability.[FN1]

Appendices to these two regulations contain model notices for notifying participants or beneficiaries of the plan’s termination and distribution options. The safe harbor regulation provides that both a fiduciary and a QTA will be deemed to have satisfied ERISA’s prudence requirements under section 404(a) of the Act if the conditions of the safe harbor are met with respect to the distribution of benefits on behalf of missing participants from terminated individual account plans.[FN2]

In general, the regulation provides that a fiduciary or QTA qualifies for the safe harbor if a distribution is made to an individual retirement plan within the meaning of section 7701(a)(37) of the Code. See§ 2550.404a–3(d)(1)(i). However in April 2006, when the Department published this safe harbor regulation, a distribution of benefits from an individual account plan to a nonspouse beneficiary was not considered an eligible rollover distribution under the provisions of section 402(c) of the Code and, therefore, could not be rolled over into an individual retirement plan.[FN3]

As a result, the safe harbor regulation mandated, among other requirements, the distribution of benefits on behalf of a missing nonspouse beneficiary to an account that was not an individual retirement plan. See § 2550.404a– 3(d)(1)(ii). Consequently, such distributions were subject to income tax and mandatory tax withholding in the year distributed into the account.[FN4]

The Pension Protection Act changed the characterization of certain distributions from tax exempt plans and trusts to permit such distributions to qualify for eligible rollover distribution treatment.[FN5]

Section 829 of the Pension Protection Act amended section 402(c) of the Code to permit the direct rollover of a deceased participant’s benefit from an eligible retirement plan to an individual retirement plan established on behalf of a designated nonspouse beneficiary.[FN6]

These rollover distributions would not trigger immediate income tax consequences and mandatory tax withholding for the nonspouse beneficiary. In light of the Pension Protection Act’s changes to the Code allowing a rollover distribution on behalf of a nonspouse beneficiary into an inherited individual retirement plan with the resulting deferral of income tax consequences, the Department is amending the regulatory safe harbor for distributions from a terminated individual account plan, including an abandoned plan, at 29 CFR 2550.404a–3. These amendments require that a deceased participant’s benefit be directly rolled over to an inherited individual retirement plan established to receive the distribution on behalf of a missing, designated nonspouse beneficiary. These amendments eliminate the prior safe harbor condition that required a distribution on behalf of a missing nonspouse beneficiary to be made only to an account other than an individual retirement plan. See§ 2550.404a–3(d)(1)(ii). Therefore, when these amendments become applicable, a distribution on behalf of a missing nonspouse beneficiary would satisfy this condition of the safe harbor only if directly rolled into an individual retirement plan that satisfies the requirements of new section 402(c)(11) of the Code.[FN7]

Conforming changes are made to the content requirements of the mandated participant and beneficiary termination notice and its model notice under the safe harbor. The amendments to 29 CFR 2578.1 also make conforming changes to the content of the required participant and beneficiary termination notice and model notice for abandoned plans. Concurrently with publication of this rule, the Department is publishing proposed amendments to PTE 2006–06,[FN8] which, when finalized, will clarify that the exemption provides relief to a QTA that designates itself or an affiliate as the provider of an inherited individual retirement plan for a missing, designated nonspouse beneficiary pursuant to the exemption’s conditions.As noted in the preamble to the proposed amendments, however, the Department interprets PTE 2006–06 as currently available to the QTA for its self-selection as an inherited individual retirement plan provider subject to the conditions of the exemption.

29 CFR Part 2550
Employee benefit plans, Employee Retirement Income Security Act, Employee stock ownership plans, Exemptions, Fiduciaries, Investments, Investments foreign, Party in interest, Pensions, Pension and Welfare Benefit Programs Office, Prohibited transactions, Real estate, Securities, Surety bonds, Trusts and Trustees.

29 CFR Part 2578
Employee benefit plans, Pensions, Retirement.
For the reasons set forth in the preamble, the Department of Labor amends 29 CFR chapter XXV as follows:

Title 29—Labor
Subchapter F—Fiduciary Responsibility Under the Employee Retirement Income Security Act of 1974

PART 2550—RULES AND REGULATIONS FOR FIDUCIARY RESPONSIBILITY

1. The authority citation for part 2550 continues to read as follows: Authority: 29 U.S.C. 1135; and Secretary of Labor’s Order No. 1–2003, 68 FR 5374 (Feb. 3, 2003). Sec. 2550.401b–1 also issued under sec. 102, Reorganization Plan No. 4 of 1978, 43 FR 47713 (Oct. 17, 1978), 3 CFR, 1978 Comp. 332, effective Dec. 31, 1978, 44 FR 1065 (Jan. 3, 1978), 3 CFR, 1978 Comp. 332. Sec. 2550.401c–1 also issued under 29 U.S.C. 1101. Sec. 2550.404c–1 also issued under 29 U.S.C. 1104. Sec. 2550.407c–3 also issued under 29 U.S.C. 1107. Sec. 2550.404a–2 also issued under 26 U.S.C. 401 note (sec. 657, Pub. L. 107–16, 115 Stat. 38). Sec. 2550.408b–1 also issued under 29 U.S.C. 1108(b)(1) and sec. 102, Reorganization Plan No. 4 of 1978, 3 CFR, 1978 Comp. p. 332, effective Dec. 31, 1978, 44 FR 1065 (Jan. 3, 1978), and 3 CFR, 1978 Comp. 332, Sec. 2550.412–1 also issued under 29 U.S.C. 1112.

2. Amend § 2550.404a–3 by revising (d)(1)(ii), (d)(1)(iii)(C), (d)(2)(ii)(A), (d)(2)(iii), (d)(2)(iv), (d)(3), (e)(1)(iv), (e)(1)(v), (e)(1)(vi) to read as follows:

§ 2550.404a–3 Safe Harbor for Distributions from Terminated Individual Account Plans.
* * * * *
(d) * * *
(1) * * *
(ii) In the case of a distribution on behalf of a designated beneficiary (as defined by section 401(a)(9)(E) of the Code) who is not the surviving spouse of the deceased participant, to an inherited individual retirement plan (within the meaning of section 402(c)(11) of the Code) established to receive the distribution on behalf of the
nonspouse beneficiary; or
(iii) * * *
* * * * *
(C) An individual retirement plan (described in paragraph (d)(1)(i) or (d)(1)(ii) of this section) offered by a financial institution other than the qualified termination administrator to the public at the time of the distribution.
(2) * * *
(ii) * * *
(A) Seek to maintain, over the term of the investment, the dollar value that is equal to the amount invested in the product by the individual retirement plan (described in paragraph (d)(1)(i) or (d)(1)(ii) of this section), and
* * * * *
(iii) All fees and expenses attendant to the transferee plan (described in paragraph (d)(1)(i) or (d)(1)(ii) of this section) or account (described in paragraph (d)(1)(iii)(A) of this section), including investments of such plan, (e.g., establishment charges, maintenance fees, investment expenses, termination costs and surrender charges), shall not exceed the fees and expenses charged by the provider of the plan or account for comparable plans or accounts established for reasons other than the receipt of a distribution under this section; and
(iv) The participant or beneficiary on whose behalf the fiduciary makes a distribution shall have the right to enforce the terms of the contractual agreement establishing the plan (described in paragraph (d)(1)(i) or (d)(1)(ii) of this section) or account (described in paragraph (d)(1)(iii)(A) of this section), with regard to his or her transferred account balance, against the plan or account provider.
(3) Both the fiduciary’s selection of a transferee plan (described in paragraph (d)(1)(i) or (d)(1)(ii) of this section) or account (described in paragraph (d)(1)(iii)(A) of this section) and the investment of funds would not result in a prohibited transaction under section 406 of the Act, unless such actions are exempted from the prohibited transaction provisions by a prohibited transaction exemption issued pursuant to section 408(a) of the Act.
(e) * * *
(1) * * *
(iv) A statement explaining that, if a participant or beneficiary fails to make an election within 30 days from receipt of the notice, the plan will distribute the account balance of the participant or beneficiary to an individual retirement plan (i.e., individual retirement account or annuity described in paragraph (d)(1)(i) or (d)(1)(ii) of this section) and the account balance will be invested in an investment product designed to preserve principal and provide a reasonable rate of return and liquidity;
(v) A statement explaining what fees, if any, will be paid from the participant or beneficiary’s individual retirement plan (described in paragraph (d)(1)(i) or (d)(1)(ii) of this section), if such information is known at the time of the furnishing of this notice;
(vi) The name, address and phone number of the individual retirement plan (described in paragraph (d)(1)(i) or (d)(1)(ii) of this section) provider, if such information is known at the time of the furnishing of this notice; and
* * * * *
BILLING CODE 4510–29–P

Subchapter G—Administration and Enforcement Under the Employee Retirement Income Security Act of 1974

PART 2578—RULES AND REGULATIONS FOR ABANDONED PLANS

3. The authority citation for part 2578.1 continues to read as follows: Authority: 29 U.S.C. 1135; 1104(a); 1103(d)(1).

4. Amend § 2578.1 by revising (d)(2)(vi)(A)(5)(ii), (d)(2)(vi)(A)(5)(iii), (d)(2)(vi)(A)(6), (d)(2)(vi)(A)(7), (d)(2)(vi)(A)(8) to read as follows:

§ 2578.1 Termination of Abandoned Individual Account Plans
* * * * *
(d) * * *
(2) * * *
(vi) * * *
(A) * * *
(5) * * *
(ii) To an inherited individual retirement plan described in§ 2550.404a–3(d)(1)(ii) of this chapter (in the case of a distribution on behalf of a distributee other than a participant or spouse),
(iii) In any case where the amount to be distributed meets the conditions in§ 2550.404a–3(d)(1)(iii), to an interestbearing federally insured bank account, the unclaimed property fund of the State of the last known address of the participant or beneficiary, or an individual retirement plan (described in§ 2550.404a–3(d)(1)(i) or (d)(1)(ii) of this chapter) or
* * * * *
(6) In the case of a distribution to an individual retirement plan (described in§ 2550.404a–3(d)(1)(i) or (d)(1)(ii) of this chapter) a statement explaining that the account balance will be invested in an investment product designed to preserve principal and provide a reasonable rate of return and liquidity;
(7) A statement of the fees, if any, that will be paid from the participant or beneficiary’s individual retirement plan (described in § 2550.404a–3(d)(1)(i) or (d)(1)(ii) of this chapter) or other account (described in § 2550.404a– 3(d)(1)(iii)(A) of this chapter), if such information is known at the time of the furnishing of this notice;
(8) The name, address and phone number of the provider of the individual retirement plan (described in§ 2550.404a7–3(d)(1)(i) or (d)(1)(ii) of this chapter), qualified survivor annuity, or other account (described in§ 2550.404a–3(d)(1)(iii)(A) of this chapter), if such information is known at the time of the furnishing of this notice; and
* * * * *

Footnotes:

[1] Under § 2578.1(d)(2)(vii)(B), a QTA is directed to make distributions in accordance with the safe harbor regulation.

[2] 71 FR 20830 n. 21.

[3] See 26 CFR 1.402(c)–2, Q&A–12.

[4] 71 FR 20828 n.14.

[5] Section 829 of the Pension Protection Act.

[6] Section 829 of the Pension Protection Act requires that the individual retirement plan established on behalf of a nonspouse beneficiary must be treated as an inherited individual retirement plan within the meaning of Code§ 408(d)(3)(C) and must be subject to the applicable mandatory distribution requirements of Code§ 401(a)(9)(B).

[7] See also I.R.S. Notice 2007–07 (January 10, 2007).

[8] 71 FR 20856 (April 21, 2006).

Cross Trading Statutory Exemption

US Department of Labor

29 CFR Parts 2550
RIN 1210–AB17

Statutory Exemption for Cross-Trading of Securities

AGENCY: Employee Benefits Security Administration, Department of Labor

ACTION: Interim final rule with request for comments.

SUMMARY: This document contains an interim final rule that implements the content requirements for the written cross-trading policies and procedures required under section 408(b)(19)(H) of the Employee Retirement Income Security Act of 1974 (ERISA or the Act). Section 611(g) of the Pension Protection Act of 2006, Public Law 109–280, 120 Stat. 780, 972, amended section 408(b) of ERISA by adding a new subsection (19) that exempts the purchase and sale of a security between a plan and any other account managed by the same investment manager if certain conditions are satisfied. Among other requirements, section 408(b)(19)(H) stipulates that the investment manager must adopt, and effect cross-trades in accordance with, written cross-trading policies and procedures that are fair and equitable to all accounts participating in the cross-trading program. This interim final rule would affect employee benefit plans, investment managers, plan fiduciaries and plan participants and
beneficiaries.

DATES: Effective Date: This interim final rule is effective April 13, 2007.

Subchapter F, part 2550 of title 29 of the Code of Federal Regulations is amended as follows:

SUBCHAPTER F—FIDUCIARY RESPONSIBILITY UNDER THE EMPLOYEE RETIREMENT INCOME SECURITY ACT OF 1974

PART 2550—RULES AND REGULATIONS FOR FIDUCIARY RESPONSIBILITY

  1. The authority citation for part 2550 is revised to read as follows: Authority: 29 U.S.C. 1135; sec. 657, Pub. L. 107–16, 115 Stat. 38; sec. 611, Pub. L. 109– 280, 120 Stat. 780; and Secretary of Labor’s Order No. 1–2003, 68 FR 5374 (Feb. 3, 2003). Sec. 2550.401c–1 also issued under 29 U.S.C. 1101. Sec. 2550.404c–1 also issued under 29 U.S.C. 1104. Sec. 2550.407c–3 also issued under 29 U.S.C. 1107. Sec. 2550.408b–1 also issued under 29 U.S.C. 1108(b)(1) and sec. 102, Reorganization Plan No. 4 of 1978, 3 CFR, 1978 Comp., p. 332, effective Dec. 31, 1978, 44 FR 1065 (Jan. 3, 1978), and 3 CFR, 1978 Comp., p. 332. Sec. 2550.408b–19 also issued under sec. 611, Pub. L. 109–280, 120 Stat. 780, 972, and sec. 102, Reorganization Plan No. 4 of 1978, 3 CFR, 1978 Comp., p. 332, effective Dec. 31, 1978, 44 FR 1065 (Jan. 3, 1979), and 3 CFR, 1978 Comp., p. 332. Sec. 2550.412–1 also issued under 29 U.S.C. 1112.
  2. Add § 2550.408b–19 to read as follows:
  3. § 2550.408b–19 Statutory exemption for cross-trading of securities.

    (a) In General.

    (1) Section 408(b)(19) of the Employee Retirement Income Security Act of 1974 (the Act) exempts from the prohibitions of section 406(a)(1)(A) and 406(b)(2) of the Act any cross-trade of securities if certain conditions are satisfied. Among other conditions, the exemption requires that the investment manager adopt, and effect cross-trades in accordance with, written cross-trading policies and procedures that are fair and equitable to all accounts participating in the crosstrading program, and that include:

    (i) A description of the investment manager’s pricing policies and procedures, and
    (ii) The investment manager’s policies and procedures for allocating crosstrades in an objective manner among accounts participating in the crosstrading program.

    (2) Section 4975(d)(22) of the Internal Revenue Code of 1986 (the Code) contains parallel provisions to section 408(b)(19) of the Act. Effective December 31, 1978, section 102 of Reorganization Plan No. 4 of 1978, 5 U.S.C. App. 214 (2000 ed.), transferred the authority of the Secretary of the Treasury to promulgate regulations of the type published herein to the Secretary of Labor. Therefore, all references herein to section 408(b)(19) of the Act should be read to include reference to the parallel provisions of section 4975(d)(22) of the Code.

    (3) Section 408(b)(19)(D) of the Act requires that a plan fiduciary for each plan participating in the cross-trades receive in advance of any cross-trades disclosure regarding the conditions under which the cross-trades may take place. This disclosure must be in a document that is separate from any other agreement or disclosure involving the asset management relationship. The disclosure must contain a statement that any investment manager participating in a cross-trading program will have a potentially conflicting division of loyalties and responsibilities to the parties involved in any cross-trade transaction.

    (4) The standards set forth in this section apply solely for purposes of determining whether an investment manager’s written policies and procedures satisfy the content requirements of section 408(b)(19)(H) of the Act. Accordingly, such standards do not determine whether the investment manager satisfies the other requirements for relief under section 408(b)(19) of the Act.

    (b) Policies and Procedures.

    (1) In General. This paragraph specifies the content of the written policies and procedures required to be adopted by an investment manager and disclosed to the plan fiduciary prior to authorizing cross-trading in order for transactions to qualify for relief under section 408(b)(19) of the Act.

    (2) Style and Format. The content of the policies and procedures required by this paragraph must be clear and concise and written in a manner calculated to be understood by the plan fiduciary authorizing cross-trading. Although no specific format is required for the investment manager’s written policies and procedures, the information contained in the policies and procedures must be sufficiently detailed to facilitate a periodic review by the compliance officer of the crosstrades and a determination by such compliance officer that the cross-trades comply with the investment manager’s written cross-trading policies and procedures.

    (3) Content.

    (i) An investment manager’s policies and procedures must be fair and equitable to all accounts participating in its cross-trading program and reasonably designed to ensure compliance with the requirements of section 408(b)(19)(H) of the Act. Such policies and procedures must include:

    (A) A statement of policy which describes the criteria that will be applied by the investment manager in determining that execution of a securities transaction as a cross-trade will be beneficial to both parties to the transaction;

    (B) A description of how the investment manager will determine that cross-trades are effected at the‘‘ independent current market price’’ of the security (within the meaning of§ 270.17a–7(b) of Title 17, Code of Federal Regulations and SEC no-action and interpretative letters thereunder) as required by section 408(b)(19)(B) of the Act, including the identity of sources used to establish such price;

    (C) A description of the procedures for ensuring compliance with the $100,000,000 minimum asset size requirement of section 408(b)(19). A plan or master trust will satisfy the minimum asset size requirement as to a transaction if it satisfies the requirement upon its initial participation in the cross-trading program and on a
    quarterly basis thereafter;

    (D) A description of how the investment manager will mitigate any potentially conflicting division of loyalties and responsibilities to the parties involved in any cross-trade
    transaction;

    (E) A requirement that the investment manager allocate cross-trades among accounts in an objective and equitable manner and a description of the allocation method(s) available to and used by the investment manager for assuring an objective allocation among accounts participating in the crosstrading program. If more than one allocation methodology may be used by the investment manager, a description of what circumstances will dictate the use of a particular methodology;

    (F) Identification of the compliance officer responsible for periodically reviewing the investment manager’s compliance with section 408(b)(19)(H) of the Act and a statement of the compliance officer’s qualifications for this position; and

    (G) A statement which describes the scope of the review conducted by the compliance officer, specifically noting whether such review is limited to compliance with the policies and procedures required by 408(b)(19)(H), or whether such review extends to any determinations regarding the overall level of compliance with the other requirements of section 408(b)(19) of the Act.

    (ii) Nothing herein is intended to preclude an investment manager from including such other policies and procedures not required by this regulation as the investment manager may determine appropriate to comply with the requirements of section 408(b)(19).

    (c) Definitions. For purposes of this section:

    (1) The term "account" includes any single customer or pooled fund or account.

    (2) The term "compliance officer" means an individual designated by the investment manager who is responsible for periodically reviewing the crosstrades made for the plan to ensure compliance with the investment manager’s written cross-trading policies and procedures and the requirements of section 408(b)(19)(H) of the Act.

    (3) The term "plan fiduciary" means a person described in section 3(21)(A) of the Act with respect to a plan (other than the investment manager engaging in the cross-trades or an affiliate) who has the authority to authorize a plan’s participation in an investment manager’s cross-trading program.

    (4) The term "investment manager" means a person described in section 3(38) of the Act.

    (5) The term "plan" means any employee benefit plan as described in section 3(3) of the Act to which Title I of the Act applies or any plan defined in section 4975(e)(1) of the Code.

    (6) The term "cross-trade" means the purchase and sale of a security between a plan and any other account managed by the same investment manager.

Signed at Washington, DC, this 6th day of February, 2007.
Bradford P. Campbell,
Acting Assistant Secretary, Employee Benefits Security Administration, Department of Labor.

[FR Doc. E7–2290 Filed 2–9–07; 8:45 am]
BILLING CODE 4510–29–P

DOL - Delinquent Filer Voluntary Compliance Program

April 27, 1995 (60 FR 20874)

Recap
Permits delinquent plan administrators to comply with annual reporting obligations under Title I of the ERISA with reduced civil penalties.

Agency: Department of Labor, Employee Benefits Security Administration

Action: Grant of Class Exemption

Effective Date: March 28, 2002

Program

Section 1 - Delinquent Filer Voluntary Compliance (DFVC) Program

The DFVC Program is intended to afford eligible plan administrators (described in Section 2 of this Notice) the opportunity to avoid the assessment of civil penalties otherwise applicable to administrators who fail to file timely annual reports for plan years beginning on or after January 1, 1988. Eligible administrators may avail themselves of the DFVC Program by complying with the filing requirements and paying the civil penalties specified in Section 3 or Section 4, as appropriate, of this Notice.

Section 2 - Scope, Eligibility and Effective Date

Scope. The DFVC Program described in this Notice provides relief from assessment of civil penalties otherwise applicable to plan administrators who fail or refuse to file timely annual reports. Relief under this Program does not extend to penalties that may be assessed for annual reports that are determined by the Department to be incomplete or otherwise deficient.

Eligibility. The DFVC Program is available only to a plan administrator that complies with the requirements of Section 3 or Section 4, as appropriate, of this Notice prior to the date on which the administrator is notified in writing by the Department of a failure to file a timely annual report under Title I of ERISA.

Effective date. The DFVC Program described herein shall be effective March 28, 2002. The Department intends that this DFVC Program to be of indefinite duration; however, the Program may be modified from time to time or terminated in the sole discretion of the Department upon publication of notice in the Federal Register.

Section 3 - Plan Administrators Filing Annual Reports

General. A plan administrator electing to file a late annual report (Form 5500 Series Annual Return/Report) under this DFVC Program must comply with the requirements of this Section 3.

Filing a Complete Annual Report.

(a) The plan administrator must file a complete Form 5500 Series Annual Return/Report, including all required schedules and attachments, for each plan year for which the plan administrator is seeking relief under the Program. This filing shall be sent to PWBA at the appropriate EFAST address listed in the instructions for the most current Form 5500 Annual Return/Report, or electronically in accordance with the EFAST electronic filing requirements. See the EFAST Internet site at www.efast.dol.gov to view forms and instructions.

Note: Do not forward the applicable penalty amount described in Section 3.03 to the EFAST addresses listed above.

(b) For purposes of subparagraph (a), the plan administrator shall file either: (1) The Form 5500 Series Annual Return/Report form (but not a Form 5500-R) issued for each plan year for which the relief is sought, or (2) the most current Form 5500 Annual Return/Report form issued (and, if necessary, indicate in the appropriate space on the first page of the Form 5500 the plan year for which the annual return/report is being filed). Forms may be obtained from the IRS by calling 1-800-TAX-FORM (1-800-829-3676). Forms for certain pre-1999 plan years also are available through the Internet sites for PWBA and the Internal Revenue Service (IRS) (www.dol.gov/dol/pwba, www.irs.gov). For further information on EFAST filing requirements, see the EFAST Internet site (www.efast.dol.gov) and the instructions for the most current Form 5500.

Payment of Applicable Penalty Amount.

(a) The plan administrator shall pay the applicable penalty amount by submitting to the DFVC Program the information described in subparagraph (b) along with a check made payable to the "U.S. Department of Labor" for the applicable penalty amount determined in accordance with subparagraph (c). This separate submission shall be made by mail to: DFVC Program, PWBA, P.O. Box 530292, Atlanta, GA 30353-0292. The annual returns/reports for multiple plans may not be included in a single DFVC Program submission. A separate submission to the DFVC Program (including a separate check for the applicable penalty amount) must be made for each plan.

Note: Personal or private delivery service cannot be made to this address.

(b)

(1) The administrator shall submit to the DFVC Program, with the applicable penalty amount, a paper copy of the Form 5500 Annual Return/Report filed as described in paragraph .02(a), without schedules and attachments. In the event that the plan administrator files as described in paragraph .02(a) using a 1998 or prior plan year form, a paper copy of only the first page of the Form 5500 or Form 5500-C, as applicable, should be submitted to the DFVC Program.

(2) In the case of a plan sponsored by a Code section 501(c)(3) organization described in paragraph .03(c)(4), the administrator shall clearly note "501(c)(3) Plan" in the upper-right hand corner of the first page of the Form 5500 Annual Return/Report submitted to the DFVC Program (in Atlanta, Georgia). This notation should not be included on the annual report filed with PWBA pursuant to paragraph .02 (in Lawrence, Kansas) because it may interfere with the proper processing of the required report.

(c) The applicable penalty amount shall be determined as follows:

(1) In the case of a plan with fewer than 100 participants at the beginning of the plan year (or a plan that would be treated as such a plan under the "80-120" participant rule described in 29 CFR 2520.103-1(d) for the subject plan year) (hereinafter "small plan"), the applicable penalty amount is $10 per day for each day the annual report is filed after the date on which the annual report was due (without regard to any extensions), not to exceed the greater of: $750 per annual report or, in the case of a DFVC submission relating to more than one delinquent annual report filing for the plan, $1,500 per plan.

(2) In the case of a plan with 100 or more participants at the beginning of the plan year (other than a plan that is eligible to use and uses the "80-120" participant rule) (hereinafter "large plan"), the applicable penalty amount is $10 per day for each day the annual report is filed after the date on which the annual report was due (without regard to any extensions), not to exceed the greater of: $2,000 per annual report or, in the case of a DFVC submission relating to more than one delinquent annual report filing for the plan, $4,000 per plan.

(3) In the case of a DFVC submission relating to more than one delinquent annual report filing for a plan, the applicable penalty amount shall be determined by reference to paragraph (c)(2) if for any plan year for which the submission is made the plan was a "large plan."

(4) In the case of a plan administrator filing an annual report for a "small plan" that is sponsored by a Code section 501(c)(3) organization (including a Code section 403(b) plan), the applicable penalty amount is $10 per day for each day the annual report is filed after the date on which the annual report was due (without regard to any extensions), not to exceed $750 per DFVC submission, including DFVC submissions that relate to more than one delinquent annual report filing for the plan. This paragraph (c)(4) shall not apply if, as of the date the plan files pursuant to this DFVC Program, there is a delinquent or late annual report due for a plan year for which the plan was a "large plan." See paragraph .03(b)(2) for special instructions pertaining to small plans sponsored by Code section 501(c)(3) organizations.

Liability for Applicability Amount.

The plan administrator is personally liable for the payment of civil penalties assessed under section 502(c)(2) of ERISA, therefore, civil penalties, including amounts paid under this DFVC Program, shall not be paid from the assets of an employee benefit plan.

Section 4 - Plan Administrators Filing Notices for Apprenticeship and Training Plans and Statements for "Top Hat" Plans

General. Administrators of apprenticeship and training plans, described in 29 CFR 2520.104-22, and administrators of pension plans for a select group of management or highly compensated employees, described in 29 CFR 2520.104-23(a) ("top hat plans"), who elect to file the applicable notice and statement described in sections 2520.104-22 and 2520.104-23, respectively, as a condition of relief from the annual reporting requirements may, in lieu of filing any past due annual report and paying otherwise applicable civil penalties, comply with the requirements of this Section 4. Administrators who have complied with the requirements of this Section 4 shall be considered as having elected compliance with the exemption(s) and/or alternative method of compliance prescribed in Secs. 2520.104-22, or 2520.104-23, as appropriate, for all subsequent plan years.

Filing Applicable Notice or Statement with the U.S. Department of Labor.

The plan administrator must prepare and file a notice or statement meeting the requirements of Secs. 2520.104-22, or 2520.104-23, as appropriate.

The apprenticeship and training plan notice described in Sec. 2520.104-22 shall be sent by mail or by private delivery service to: Apprenticeship and Training Plan Exemption, Pension and Welfare Benefits Administration, Room N-1513, U.S. Department of Labor, 200 Constitution Avenue NW., Washington, DC 20210.

The "top hat" plan statement described in Sec. 2520.104-23 shall be sent by mail or by private delivery service to: Top Hat Plan Exemption, Pension and Welfare Benefits Administration, Room N-1513, U.S. Department of Labor, 200 Constitution Avenue NW., Washington, DC 20210.

Note: A plan sponsor maintaining more than one "top hat" plan is not required to file a separate statement for each such plan. See Sec. 2520.104-23(b).

Payment of Applicable Penalty Amount.

(a) The plan administrator shall pay the applicable penalty amount by submitting to the DFVC Program the information described in subparagraph (b) along with a check made payable to the "U.S. Department of Labor" for the applicable penalty amount determined in accordance with subparagraph (c). This submission shall be made by mail to: DFVC Program, PWBA, P.O. Box 530292, Atlanta, GA 30353-0292.

Note: Personal or private delivery service cannot be made to this address.

(b) The administrator shall submit to the DFVC Program with the applicable penalty amount the most current Form 5500 Annual Return/Report (without schedules and attachments). For purposes of this requirement, the plan administrators must complete Form 5500 line items 1a-1b, 2a-2c, 3a-3c, and use plan number 888 for all "top hat" plans and plan number 999 for all apprenticeship and training plans. In the case of plan sponsors maintaining more than one "top hat" plan and plan sponsors maintaining more than one apprenticeship and training plan described in Sec. 2520.104-22, the plan administrator shall clearly identify each such plan on the Form 5500 filed with the Department of Labor or on an attachment thereto. The plan administrator also must sign and date the Form 5500.

(c) The applicable penalty amount is $750 for each DFVC submission, without regard to the number of plans maintained by the same plan sponsor for which notices and statements are filed pursuant to Section 4 and without regard to the number of plan participants covered under such plan or plans.

Liability for Applicability Amount.

The plan administrator is personally liable for the payment of civil penalties assessed under section 502(c)(2) of ERISA, therefore, civil penalties, including amounts paid under this DFVC Program, shall not be paid from the assets of an employee benefit plan.

Section 5 - Waiver of Right to Notice, Abatement of Assessment and Plan Status

i. Payment of a penalty under the terms of this DFVC Program constitutes, with regard to the filings submitted under the Program, a waiver of an administrator's right both to receive notices of intent to assess a penalty under Sec. 2560.502c-2 from the Department and to contest the Department's assessment of the penalty amount.

ii. Although this Notice does not provide relief from late filing penalties under the Code, the Internal Revenue Service (IRS) has provided the Department with the following information. The Code and the regulations thereunder require information to be filed on the Form 5500 Series Annual Return/Report and provide the IRS with authority to impose or assess penalties for failing to timely file. The IRS has agreed to provide certain penalty relief under the Code for delinquent Form 5500 Annual Returns/Reports filed for Title I plans where the conditions of this DFVC Program have been satisfied. See IRS Notice 2002-23.

iii. Although this Notice does not provide relief from late filing penalties under Title IV of ERISA, the Pension Benefit Guaranty Corporation (PBGC) has provided the Department with the following information. Title IV of ERISA and the regulations thereunder require information to be filed on the Form 5500 Series Annual Return/Report and provide the PBGC with authority to assess penalties against a plan administrator under ERISA Sec. 4071 for late filing of the Form 5500 Series Annual Return/Report. The PBGC has agreed that it will not assess a penalty against a plan administrator under ERISA Sec. 4071 for late filing of a Form 5500 Series Annual Return/Report filed for a Title I plan where the conditions of this DFVC Program have been satisfied.

iv. Acceptance by the Department of a filing and penalty payment made pursuant to this DFVC Program does not represent a determinationby the Department of Labor as to the status of the arrangement as a plan, the particular type of plan under Title I or ERISA, the status of the plan sponsor under the Code, or a determination by the Department of Labor that the provisions of Secs. 2520.104-22 or 2520.104-23 have been satisfied.

Signed at Washington, DC, this 25th day of March, 2002.

Ann L. Combs,
Assistant Secretary,
Pension and Welfare Benefits Administration,
U.S. Department of Labor.

[FR Doc. 02-7514 Filed 3-27-02; 8:45 am]
Billing Code 4510-29-P

Employer Securities and Real Property

2550.407a-1    General

Department of Labor
Regulation 2550.407a-1
29 C.F.R. 2550.407a-1

Originally issued September 20, 1977 (42 FR 47201)

  1. In General. Section 407(a)(1) of the Employee Retirement Income Security Act of 1974 (the Act) states that except as otherwise provided in section 407 and section 414 of the Act, a plan may not acquire or hold any employer security which is not a qualifying employer security or any employer real property which is not qualifying employer real property. Section 406(a)(1)(E) prohibits a fiduciary from knowingly causing a plan to engage in a transaction which constitutes a direct or indirect acquisition, on behalf of a plan, of any employer security or employer real property in violation of section 407(a), and section 406(a)(2) prohibits a fiduciary who has authority or discretion to control or manage assets of a plan to permit the plan to hold any employer security or employer real property if he knows or should know that holding such security or real property violates section 407(a).
  2. Requirements applicable to all plans. A plan may hold or acquire only employer securities which are qualifying employer securities and employer real property which is qualifying employer real property. A plan may not hold employer securities and employer real property which are not qualifying employer securities and qualifying employer real property, except to the extent that:
    1. The employer security is held by a plan which has made an election under section 407(c)(3) of the Act; or
    2. The employer security is a loan or other extension of credit which satisfies the requirements of section 414(c)(1) of the Act or the employer real property is leased to the employer pursuant to a lease which satisfies the requirements of section 414(c)(2) of the Act.

Regulation published in Federal Register September 20, 1977 (42 FR 47201) and amended November 22, 1977 (42 FR 59842).

Codified to 29 C.F.R. 2550.407a-1.

2550.407a-2    Employer Securities and Real Property - Acquisition

Department of Labor
Regulation 2550.407a-2
29 C.F.R. 2550.407a-2

Originally issued September 20, 1977 (42 FR 47201)

  1. In General. Section 407(a)(2) of the Employee Retirement Income Security Act of 1974 (the Act) provides that a plan may not acquire any qualifying employer security or qualifying employer real property, if immediately after such acquisition the aggregate fair market value of qualifying employer securities and qualifying employer real property held by the plan exceeds 10 percent of the fair market value of the assets of the plan.
  2. Acquisitions. For purposes of section 407(a) of the Act, an acquisition by a plan of qualifying employer securities or qualifying employer real property shall include, but not be limited to, an acquisition by purchase, by the exchange of plan assets, by the exercise of warrants or rights, by the conversion of a security (except any acquisition pursuant to a conversion exempt under section 408(b)(7) of the Act), by default of a loan where the qualifying employer security or qualifying employer real property was security for the loan, or by the contribution of such securities or real property to the plan. However, an acquisition of a security shall not be deemed to have occurred if a plan acquires the security as a result of a stock dividend or stock split.
  3. Fair Market Value - Indebtedness incurred in connection with the acquisition of a plan asset. In determining whether a plan is in compliance with the limitation on the acquisition of qualifying employer securities and qualifying employer real property in section 407(a)(2), the limitation on the holding of qualifying employer securities and qualifying employer real property in section 407(a)(3) and the requirement regarding the disposition of employer securities and employer real property in section 407(a)(4) thereunder, the fair market value of total plan assets shall be the fair market value of such assets less the unpaid amount of:
    1. Any indebtedness incurred by the plan in acquiring such assets;
    2. Any indebtedness incurred before the acquisition of such assets if such indebtedness would not have been incurred but for such acquisition; and
    3. Any indebtedness incurred after the acquisition of such assets if such indebtedness would not have been incurred but for such acquisition and the incurrence of such indebtedness was reasonably foreseeable at the time of such acquisition. However, the fair market value of qualifying employer securities and qualifying employer real property shall be the fair market value of such assets without any reduction for the unpaid amount of any indebtedness incurred by the plan in connection with the acquisition of such employer securities and employer real property.
  4. Examples.
    1. Plan assets have a fair market value of $100,000. The plan has no liabilities other than liabilities for vested benefits of participants and does not own any employer securities or employer real property. The plan proposes to acquire qualifying employer securities with a fair market value of $10,000 by paying $1,000 in cash and borrowing $9,000. The fair market value of plan assets would be $100,000 ($100,000 of plan assets less $1,000 cash payment plus $10,000 of employer securities less $9,000 indebtedness), the fair market value of the qualifying employer securities would be $10,000, which is 10 percent of the fair market value of plan assets. Accordingly, the acquisition would not contravene section 407(a).
    2. Plan assets have a fair market value of $100,000. The plan has liabilities of $20,000 which were incurred in connection with the acquisition of those assets, and does not own any employer securities or employer real property. The plan proposes to pay cash for qualifying employer securities with a fair market value of $10,000. The fair market value of plan assets would be $80,000 ($100,000 of plan assets less $10,000 cash payment plus $10,000 of employer securities less $20,000 indebtedness), the fair market value of the qualifying employer securities would be $10,000, which is 12.5 percent of the fair market value of plan assets. Accordingly, the acquisition would contravene section 407(a).

2550.407d-5    "Qualifying" Employer Security - Defined

Department of Labor
Regulation 2550.407d-5
29 C.F.R. 2550.407d-5

Originally issued September 2, 1977 (42 FR 44388)

  1. In General. For purposes of this section and section 407(d)(5) of the Employee Retirement Income Security Act of 1974 (the Act), the term "qualifying employer security" means an employer security which is:
    1. Stock; or
    2. A marketable obligation, as defined in paragraph (b) of this section and section 407(e) of the Act.
  2. For purposes of paragraph (a)(2) of this section and section 407(d)(5) of the Act, the term "marketable obligation" means a bond, debenture, note, or certificate, or other evidence of indebtedness (hereinafter in this paragraph referred to as "obligation") if:
    1. Such obligation is acquired -
      1. On the market, either
        1. At the price of the obligation prevailing on a national securities exchange which is registered with the Securities and Exchange Commission, or
        2. If the obligation is not traded on such a national securities exchange, at a price not less favorable to the plan than the offering price for the obligation as established by current bid and asked prices quoted by persons independent of the issuer;
      2. From an underwriter, at a price -
        1. Not in excess of the public offering price for the obligation as set forth in a prospectus or offering circular filed with the Securities and Exchange Commission, and
        2. At which a substantial portion of the same issue is acquired by persons independent of the issuer; or
      3. Directly from the issuer at a price not less favorable to the plan than the price paid currently for a substantial portion of the same issue by persons independent of the issuer;
    2. Immediately following acquisition of such obligation,
      1. Not more than 25 percent of the aggregate amount of obligations issued in such issue and outstanding at the time of acquisition is held by the plan, and
      2. At least 50 percent of the aggregate amount referred to in paragraph (A) is held by persons independent of the issuer; and
    3. Immediately following acquisition, of the obligation, not more than 25 percent of the assets of the plan is invested in obligations of the employer or an affiliate of the employer.

2550.407d-6    "Employee Stock Ownership Plan" - Defined

Department of Labor
Regulation 2550.407d-6
29 C.F.R. 2550.407d-6

Originally issued September 2, 1977 (42 FR 44388)

  1. In General -
    1. Type of plan. To be an "ESOP" (employee stock ownership plan), a plan described in section 407(d)(6)(A) of the Employee Retirement Income Security Act of 1974 (the Act) must meet the requirements of this section. See section 407(d)(6)(B).
    2. Designation as ESOP. To be an ESOP, plan must be formally designated as such in the plan document.
    3. Retroactive amendment. A plan meets the requirements of this section as of the date that it is designated as an ESOP if it is amended retroactively to meet, and in fact does meet, such requirements at any of the following times:
      1. 12 months after the date on which the plan is designated as an ESOP;
      2. 90 days after a determination letter is issued with respect to the qualification of the plan as an ESOP under this section, but only if the determination is requested by the date in paragraph (a)(3)(i) of this section; or
      3. A later date approved by the Internal Revenue Service district director.
    4. Addition to other plan. An ESOP may form a portion of a plan the balance of which includes a qualified pension, profit-sharing, or stock bonus plan which is not an ESOP. A reference to an ESOP includes an ESOP that forms a portion of another plan.
    5. Conversion of existing plan to an ESOP. If an existing pension, profit-sharing, or stock bonus plan is converted into an ESOP, the requirements of section 404 of the Act, relating to fiduciary duties, and section 401(a) of the Internal Revenue Code (the Code), relating to requirements for plans established for the exclusive benefit of employees, apply to such conversion. A conversion may constitute a termination of an existing plan. For definition of a termination, see the regulations under section 411(d)(3) of the Code and section 4041(f) of the Act.
    6. Certain arrangements barred. (i) buy-sell agreements. An arrangement involving an ESOP that creates a put option must not provide for the issuance of put options other than as provided under Section 2550.408b-3(j), (k) and (l). Also, an ESOP must not otherwise obligate itself to acquire securities from a particular security holder at an indefinite time determined upon the happening of an event such as the death of the holder.
  2. Plan designed to invest primarily in qualifying employer securities. A plan constitutes an ESOP only if the plan specifically states that it is designed to invest primarily in qualifying employer securities. Thus, a stock bonus plan or a money purchase pension plan constituting an ESOP may invest part of its assets in other than qualifying employer securities. Such plan will be treated the same as other stock bonus plans or money purchase pension plans qualified under section 401(a) of the Code with respect to those investments.
  3. Regulations of the secretary of the treasury. A plan constitutes an ESOP for a plan year only if it meets such other requirements as the Secretary of the Treasury may prescribe by regulation under section 4975(e)(7) of the Code. See 26 C.F.R. 54.4975-11.

2550.408b-1    Loans to Plan Participants and Beneficiaries

Department of Labor
Regulation 2550.408b-1
29 C.F.R. 2550.408b-1

Originally issued July 20, 1989 (54 FR 30520)

  1. General Statutory Exemption.
    1. In General. Section 408(b)(1) of the Employee Retirement Income Security Act of 1974 (the Act of ERISA) exempts from the prohibitions of section 406(a)406(b)(1), and 406(b)(2) loans by a plan to parties in interest who are participants or beneficiaries of the plan, provided that such loans:
      1. Are available to all such participants and beneficiaries on a reasonably equivalent basis;
      2. Are not made available to highly compensated employees, officers or shareholders in an amount greater than the amount made available to other employees;
      3. Are made in accordance with specific provisions regarding such loans set forth in the plan;
      4. Bear a reasonable rate of interest; and
      5. Are adequately secured.

      The Internal Revenue Code (the Code) contains parallel provisions to section 408(b)(1) of the Act. Effective, December 31, 1978, section 102 of Reorganization Plan No. 4 of 1978 (43 FR 47713, October 17, 1978) transferred the authority of the Secretary of the Treasury to promulgate regulations of the type published herein to the Secretary of Labor. Therefore, all references herein to section 408(b)(1) of the Act should be read to include reference to the parallel provisions of section 4975(d)(1) of the Code.

      Section 1114(b)(15)(B) of the Tax Reform Act of 1986 amended section 408(b)(1)(B) of ERISA by deleting the phrase "highly compensated employees, officers or shareholders" and substituting the phrase "highly compensated employees (within the meaning of section 414(q) of the Internal Revenue Code of 1986)." Thus, for plans with participant loan programs which are subject to the amended section 408(b)(1)(B), the requirements of this regulation should be read to conform with the amendment.

    2. Scope.
    3. Section 408(b)(1) of the Act does not contain an exemption from acts described in section 406(b)(3) of the Act (prohibiting fiduciaries from receiving consideration for their own personal account from any party dealing with a plan in connection with a transaction involving plan assets). If a loan from a plan to a participant who is a party in interest with respect to that plan involves an act described in section 406(b)(3), such an act constitutes a separate transaction which is not exempt under section 408(b)(1) of the Act. The provisions of section 408(b)(1) are further limited by section 408(d) of the Act (relating to transactions with owner-employees and related persons).

    4. Loans.
      1. Section 408(b)(1) of the Act provides relief from the prohibitions of section 406(a)406(b)(1) and 406(b)(2) for the making of a participant loan. The term "participant loan" refers to a loan which is arranged and approved by the fiduciary administering the loan program primarily in the interest of the participant and which otherwise satisfies the criteria set forth in section 408(b)(1) of the Act. The existence of a participant loan or participant loan program will be determined upon consideration of all relevant facts and circumstances. Thus, for example, the mere presence of a loan document appearing to satisfy the requirements of section 408(b)(1) will not be dispositive of whether a participant loan exists where the subsequent administration of the loan indicates that the parties to the loan agreement did not intent the loan to be repaid. Moreover, a loan program containing a precondition designed to benefit a party in interest (other than the participant) is not afforded relief by section 408(b)(1) or this regulation. In this regard, section 408(b)(1) recognizes that a program of participant loans, like other plans investments, must be prudently established and administered for the exclusive purpose of providing benefits to participants and beneficiaries of the plan.
      2. For the purpose of this regulation, the term "loan" will include any renewal or modification of an existing loan agreement, provided that, at the time of each such renewal or modification, the requirements of section 408(b)(1) and this regulation are met.
    5. Examples. The following examples illustrate the provisions of section 2550.408b-1(a).

      Example (1): T, a trustee of plan P, has exclusive discretion over the management and disposition of plan assets. As a result, T is a fiduciary with respect to P under section 3(21)(A) of the Act and a party in interest with respect to P pursuant to section 3(14)(A) of the Act. T is also a participant in P. Among T's duties as fiduciary is the administration of a participant loan program which meets the requirements of section 408(b)(1) of the Act. Pursuant to strict objective criteria stated under the program, T, who participates in all loan decisions, receives a loan on the same terms as other participants. Although the exercise of T's discretion on behalf of himself may constitute an act of self-dealing described in section 406(b)(1), section 408(b)(1) provides an exemption from section 406(b)(1). As a result, the loan from P to T would be exempt under section 408(b)(1), provided the conditions of that section are otherwise satisfied.

      Example (2): P is a plan covering all the employees of E, the employer who established and maintained P. F is a fiduciary with respect to P and an officer of E. The plan documents governing P give F the authority to establish a participant loan program in accordance with section 408(b)(1) of the Act. Pursuant to an arrangement with E, F establishes such a program but limits the use of loan funds to investments in a limited partnership which is established and maintained by E as general partner. Under these facts, the loan program and any loans made pursuant to this program are outside the scope of relief provided by section 408(b)(1) because the loan program is designed to operate for the benefit of E. Under the circumstance described, the diversion of plan assets for E's benefit would also violate sections 403(c)(1) and 404(a) of the Act.

      Example (3): Assume the same facts as in Example 2, above, except that F does not limit the use of loan funds. However, E pressures his employees to borrow funds under P's participant loan program and then reloan the loan proceeds to E. F, unaware of E's activities, arranges and approves the loans. If the loans meet all the conditions of section 408(b)(1), such loans will be exempt under that section. However, E's activities would cause the entire transaction to be viewed as an indirect transfer of plan assets between P and E, who is a party in interest with respect to P, but not the participant borrowing from P. By coercing the employees to engage in loan transactions for its benefit, E has engaged in separate transactions that are not exempt under section 408(b)(1). Accordingly, E would be liable for the payment of excise taxes under section 4975 of the Code.

      Example (4): Assume the same facts as in Example 2, above, except that, in return for structuring and administering the loan program as indicated, E agrees to pay F an amount equal to 10 percent of the funds loaned under the program. Such a payment would result in a separate transaction not covered by section 408(b)(1). This transaction would be prohibited under section 406(b)(3) since F would be receiving consideration from a party in connection with a transaction involving plan assets.

      Example (5): F is a fiduciary with respect to plan P. D is a party in interest with respect to plan D. Section 406(a)(1)(B) of the Act would prohibit F from causing P to lend money to D. However, F enters into an agreement with Z, a plan participant, whereby F will cause P to make a participant loan to Z with the express understanding that Z will subsequently lend the loan proceeds to D. An examination of Z's credit standing indicates that he is not creditworthy and would not, under normal circumstances, receive a loan under the conditions established by the participant loan program. F's decision to approve the participant loan to Z on the basis of Z's prior agreement to lend the money to D violates the exclusive purposes requirements of sections 403(c) and 404(a). In effect, the entire transaction is viewed as an indirect transfer of plan assets between P and D, and not a loan to a participant exempt under section 408(b)(1). Z's lack of credit standing would also cause the transaction to fail under section 408(b)(1)(A) of the Act.

      Example (6): F is a fiduciary with respect to Plan P. Z is a plan participant. Z and D are both parties in interest with respect to P. F approves a participant loan to Z in accordance with the conditions established under the participant loan program. Upon receipt of the loan, Z intends to lend the money to D. If F has approved this loan solely upon consideration of those factors which would be considered in a normal commercial setting by an entity in the business of making comparable loans, Z's subsequent use of the loan proceeds will not affect the determination of whether loans under P's program satisfy the conditions of section 408(b)(1).

      Example (7): A is the trustee of a small individual account plan. D, the president of the plan sponsor, is also a participant in the plan. Pursuant to a participant loan program meeting the requirements of section 408(b)(1), D applies for a loan to be secured by a parcel of real property. D does not intent to repay the loan; rather, upon eventual default, he will permit the property to be foreclosed upon and transferred to the plan in discharge of his legal obligation to repay the loan. A, aware of D's intention, approves the loan. D fails to make two consecutive quarterly payments of principal and interest under the note evidencing the loan thereby placing the loan in default. The plan then acquires the real property upon foreclosure. Such facts and circumstances indicate that the payment of money from the plan to D was not a participant loan eligible for the relief afforded by section 408(b)(1). In effect, this transaction is a prohibited sale or exchange of property between a plan and a party in interest from the time D receives the money.

      Example (8): Plan P establishes a participant loan program. All loans are subject to the condition that the borrowed funds must be used to finance home purchases. Interest rates on the loans are the same as those charged by a local savings and loan association under similar circumstances. A loan by P to a participant to finance a home purchase would be subject to the relief provided by section 408(b)(1) provided that the conditions of 408(b)(1) are met. A participant loan program which is established to make loans for certain stated purposes (e.g., hardship, college tuition, home purchases, etc.) but which is not otherwise designed to benefit parties in interest (other than plan participants) would not, in itself, cause such program to be ineligible for the relief provided by section 408(b)(1). However, fiduciaries are cautioned that operation of a loan program with limitations may result in loans not being made available to all participants and beneficiaries on a reasonably equivalent basis.

  2. Reasonably Equivalent Basis.
    1. Loans will not be considered to have been made available to participants and beneficiaries on a reasonably equivalent basis unless:
      1. Such loans are available to all plan participants and beneficiaries without regard to any individual's race, color, religion, sex, age or national origin:
      2. In making such loans, consideration has been given only to those factors which would be considered in a normal commercial setting by an entity in the business of making similar types of loans. Such factors may include the applicant's creditworthiness and financial need; and
      3. An evaluation of all relevant facts and circumstances indicates that, in actual practice, loans are not unreasonably withheld from any applicant.
    2. A participant loan program will not fail the requirement of paragraph (b)(1) of this section or section 2550.408b-1(c) if the program establishes a minimum loan amount of up to $1,000, provided that the loans granted meet the requirements of section 2550.408b-1(f).
    3. Examples. The following examples illustrate the provisions of section 2550.408b-1(b)(1):

      Example (1): T, a trustee of plan P, has exclusive discretion over the management and disposition of plan assets. T's duties include the administration of a participant loan program which meets the requirements of section 408(b)(1) of the Act. T receives a participant loan at a lower interest rate than the rate made available to other plan participants of similar financial condition or creditworthiness with similar security. The loan by P to T would not be covered by the relief provided by section 408(b)(1) because loans under P's program are not available to all plan participants on a reasonably equivalent basis.

      Example (2): Same facts as in example 1 except that T is a member of a committee of trustees responsible for approving participant loans. T pressures the committee to refuse loans to other qualified participants in order to assure that the assets allocated to the participants loan program would be available for a loan by P to T. The loan by P to T would not be covered by the relief provided by section 408(b)(1) since participant loans have not been made available to all participants and beneficiaries on a reasonably equivalent basis.

      Example (3): T is the trustee of plan P, which covers the employees of E. A, B and C are employees of E, participants in P, and friends of T. The documents governing P provide that T, in his discretion, may establish a participant loan program meeting certain specified criteria. T institutes such a program and tells A, B and C of his decision. Before T is able to notify P's other participants and beneficiaries of the loan program, A, B, and C file loan applications which, if approved, will use up substantially all of the funds set aside for the loan program. Approval of these applications by T would represent facts and circumstances showing that loans under P's program are not available to all participants and beneficiaries on a reasonably equivalent basis.

  3. Highly Compensated Employees.
    1. Loans will not be considered to be made available to highly compensated employees, officers or shareholders in an amount greater that the amount made available to other employees if, upon consideration of all relevant facts and circumstances, the program does not operate to exclude large numbers of plan participants from receiving loans under the program.
    2. A participant loan program will not fail to meet the requirement in paragraph (c)(1), of this section, merely because the plan documents specifically governing such loans set forth either (i) a maximum dollar limitation, or (ii) a maximum percentage of vested accrued benefit which no loan may exceed.
    3. If the second alternative in paragraph (c)(2) of this section (maximum percentage of vested accrued benefit) is chosen, a loan program will not fail to meet this requirement solely because maximum loan amounts will vary directly with the size of the participant's accrued benefit.
    4. Examples. The following examples illustrate the provisions of section 2550.408b-1(c).

      Example (1): The documents governing plan P provide for the establishment of a participant loan program in which the amount of any loan under the program (when added to the outstanding balance of any other loans under the program to the same participant) does not exceed the lesser of (i) $50,000, or (ii) one-half of the present value of that participant's vested accrued benefit under the plan (but not less than $10,000). P's participant loan program does not fail to meet the requirement in section 408(b)(1)(B) of the Act, and would be covered by the relief provided by section 408(b)(1) if the other conditions of that section are met.

      Example (2): The documents governing plan T provide for the establishment of a participant loan program in which the minimum loan amount would be $25,000. The documents also require that the only security acceptable under the program would be the participant's vested accrued benefit. A, the plan fiduciary administering the loan program, finds that because of the restrictions in the plan documents only 20 percent of the plan participants, all of whom earn in excess of $75,000 a year, would meet the threshold qualifications for a loan. Most of these participants are high-level supervisors or corporate officers. Based on these facts, it appears that loans under the program would be made available to highly compensated employees in an amount greater than the amount made available to other employees. As a result, the loan program would fail to meet the requirements in section 408(b)(1)(B) of the Act and would not be covered by the relief provided in section 408(b)(1).

  4. Specific Plan Provisions. For the purpose of section 408(b)(1) and this regulation, the Department will consider that participant loans granted or renewed at any time prior to the last day of the first plan year beginning on or after January 1, 1989, are made in accordance with specific provisions regarding such loans set forth in the plan if:
    1. The plan provisions regarding such loans contain (at a minimum) an explicit authorization for the plan fiduciary responsible for investing plan assets to establish a participant loan program; and
    2. For participant loans granted or renewed on or after the last day of the first plan year beginning on or after January 1, 1989, the participant loan program which is contained in the plan or in a written document forming part of the plan includes, but need not be limited to, the following:
      1. The identify of the person or positions authorized to administer the participant loan program;
      2. A procedure for applying for loans;
      3. The basis on which loans will be approved or denied;
      4. Limitations (if any) on the types and amount of loans offered;
      5. The procedure under the program for determining a reasonable rate of interest;
      6. The types of collateral which may secure a participant loan; and
      7. The events constituting default and the steps that will be taken to preserve plan assets in the event of such default.

      Example (1): Plan P authorizes the trustee to establish a participant loan program in accordance with section 408(b)1) of the Act. Pursuant to this explicit authority, the trustee establishes a written program which contains all of the information required by section 2550.408b-1(d)(2). Loans made pursuant to this authorization and the written loan program will not fail under section 408(b)(1)(C) of the Act merely because the specific provisions regarding such loans are contained in a separate document forming part of the plan. The specific provisions describing the loan program whether contained in the plan or in a written document forming part of a plan, do affect the rights and obligations of the participants and beneficiaries under the plan and, therefore, must in accordance with section 102(a)(1) of the Act, be disclosed in the plan's summary plan description.

  5. Reasonable Rate of Interest. A loan will be considered to bear a reasonable rate of interest if such loan provides the plan with a return commensurate with the rates of charged by persons in the business of lending money for loans which would be made under similar circumstances.

    Example (1): Plan P makes a participant loan to A at the fixed interest rate of 8% for 5 years. The trustees, prior to making the loan, contacted two local banks to determine under what terms the banks would make a similar loan taking into account A's creditworthiness and the collateral offered. One bank would charge a variable rate of 10% adjusted monthly for a similar loan. The other bank would charge a fixed rate of 12% under similar circumstances. Under these facts, the loan to A would not bear a reasonable rate of interest because the loan did not provide P with a return commensurate with interest rates charged by persons in the business of lending money for loans which would be made under similar circumstances. As a result, the loan would fail to meet the requirement of section 408(b)(1)(D) and would not be covered by the relief provided by section 408(b)(1) if the Act.

    Example (2): Pursuant to the provisions of plan P's participant loan program, T, the trustee of P, approves a loan to M, a participant and party in interest with respect to P. At the time of execution, the loan meets all of the requirements of section 408(b)(1) of the Act. The loan agreement provides that at the end of two years M must pay the remaining balance in full or the parties may renew for an additional two year period. At the end of the initial two year period, the parties agree to renew the loan for an additional two years. At the time of renewal, however, A fails to adjust the interest rate charged on the loan in order to reflect current economic conditions. As a result, the interest rate on the renewal fails to provide a "reasonable rate of interest" as required by section 408(b)(1)(D) of the Act. Under such circumstance, the loan would not be exempt under section 408(b)(1) of the Act from the time of renewal.

    Example (3): The documents governing plan P's participant loan program provide that loans must bear an interest rate no higher than the maximum interest rate permitted under State X's usury law. Pursuant to the loan program, P makes a participant loan to A, a plan participant, at a time when the interest rates charged by financial institutions in the community (not subject to the usury limit) for similar loans are higher than the usury limit. Under these circumstances, the loan would not bear a reasonable rate of interest because the loan does not provide P with a return commensurate with the interest rates charged by persons in the business of lending money under similar circumstances. In addition, participant loans that are artificially limited to the maximum usury ceiling then prevailing call into question the status of such loans under sections 403(c) and 404(a) where higher yielding comparable investment opportunities are available to the plan.

  6. Adequate Security.
    1. A loan will be considered to be adequately secured if the security posed for such loan is something in addition to and supporting a promise to pay, which is so pledged to the plan that it may be sold, foreclosed upon, or otherwise disposed of upon default of repayment of the loan, the value and liquidity of which security is such that it may reasonably be anticipated that loss of principal or interest will not result from the loan. The adequacy of such security will be determined in light of the type and amount of security which would be required in the case of an otherwise identical transaction in a normal commercial setting between unrelated parties on arms'-length terms. A participant's vested accrued benefit under a plan may be used as security for a participant loan to the extent of the plan's ability to satisfy the participant's outstanding obligation in the event of default.
    2. For purposes of this paragraph -
      1. no more than 50% of the present value of a participant's vested accrued benefit may be considered by a plan as security for the outstanding balance of all plan loans made to that participant;
      2. a plan will be in compliance with paragraph (f)(2)(i) of this section if, with respect to any participant, it meets the provisions of paragraph (f)(2)(i) of this section immediately after the origination of each participant loan secured in whole in part by that participant's vested accrued benefit; and
      3. any loan secured in whole or in part by a portion of a participant's vested accrued benefit must also meet the requirements of paragraph (f)(1) of this section.
    3. Effective date. This section is effective for all participant loans granted or renewed after October 18, 1989, except with respect to paragraph (d)(2) of this section relating to specific plan provisions. Paragraph (d)(2) of this section is effective for participant loans granted or renewed on or after the last day of the first plan year beginning on or after January 1, 1989.

2550.408b-2    Services or Office Space Class Exemption

Department of Labor
Regulation 2550.408b-2
29 C.F.R. 2550.408b-2

Originally issued June 24, 1977 (42 FR 32390)

  1. In General. Section 408(b)(2) of the Employee Retirement Income Security Act of 1974 (the Act) exempts from the prohibitions of section 406(a) of the Act payment by a plan to a party in interest, including a fiduciary, for office space or any service (or a combination of services) if (1) such office space or service is necessary for the establishment or operation of the plan (2) such office space or service is furnished under a contract or arrangement which is reasonable and (3) no more than reasonable compensation is paid for such office space or service. However, section 408(b)(2) does not contain an exemption from acts described in section 406(b)(1) of the Act (relating to fiduciaries dealing with the assets of plans in their own interest or for their own account), section 406(b)(2) of the Act (relating to fiduciaries in their individual or in any other capacity acting in any transaction involving the plan on behalf of a party (or representing a party) whose interests are adverse to the interests of the plan or the interests of its participants or beneficiaries) or section 406(b)(3) of the Act (relating to fiduciaries receiving consideration for their own personal account from any party dealing with a plan in connection with a transaction involving the assets of the plan). Such acts are separate transactions not described in section 408(b)(2). See 2550.408b-2(e) and  (f) for guidance as to whether transactions relating to the furnishing of office space or services by fiduciaries to plans involve acts described in section 406(b)(1) of the Act. Section 408(b)(2) of the Act does not contain an exemption from other provisions of the Act, such as section 404, or other provisions of law which may impose requirements or restrictions relating to the transactions which are exempt under section 408(b)(2). See, for example, section 401 of the Internal Revenue Code of 1954. The provisions of section 408(b)(2) of the Act are further limited by section 408(d) of the Act (relating to transactions with owner-employees and related persons).
  2. Necessary service. A service is necessary for the establishment or operation of a plan within the meaning of section 408(b)(2) of the Act and 2550.408b-2(a)(1) if the service is appropriate and helpful to the plan obtaining the service in carrying out the purposes for which the plan is established or maintained. A person providing such a service to a plan (or a person who is a party in interest solely by reason of a relationship to such a service provider described in section 3(14)(F), (G), (H), or (I) of the Act) may furnish goods which are necessary for the establishment or operation of the plan in the course of, and incidental to, the furnishing of such service to the plan.
  3. Reasonable contract or arrangement. No contract or arrangement is reasonable within the meaning of section 408(b)(2) of the Act and 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. A long-term lease which may be terminated prior to its expiration (without penalty to the plan) on reasonably short notice under the circumstances is not generally an unreasonable arrangement merely because of its long term. A provision in a contract or other arrangement which reasonably compensates the service provider or lessor for loss upon early termination of the contract, arrangement or lease is not a penalty. For example, a minimal fee in a service contract which is charged to allow recoupment of reasonable start-up costs is not a penalty. Similarly, a provision in a lease for a termination fee that covers reasonably foreseeable expenses related to the vacancy and reletting of the office space upon early termination of the lease is not a penalty. Such a provision does not reasonably compensate for loss if it provides for payment in excess of actual loss or if it fails to require mitigation of damages.
  4. Reasonable compensation. Section 408(b)(2) of the Act and 2550.408b-2(a)(3) permit a plan to pay a party in interest reasonable compensation for the provision of office space or services described in section 408(b)(2). Section 2550.408c-2 of these regulations contains provisions relating to what constitutes reasonable compensation for the provision of services.
  5. Transactions with fiduciaries.
    1. In General. If the furnishing of office space or a service involves an act described in section 406(b) of the Act (relating to acts involving conflicts of interest by fiduciaries), such an act constitutes a separate transaction which is not exempt under section 408(b)(2) of the Act. The prohibitions of section 406(b) supplement the other prohibitions of section 406(a) of the Act by imposing on parties in interest who are fiduciaries a duty of undivided loyalty to the plans for which they act. These prohibitions are imposed upon fiduciaries to deter them from exercising the authority, control, or responsibility which makes such persons fiduciaries when they have interests which may conflict with the interests of the plans for which they act. In such cases, the fiduciaries have interests in the transactions which may affect the exercise of their best judgment as fiduciaries. Thus, a fiduciary may not use 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. Nor may a fiduciary use such authority, control, or responsibility to cause a plan to enter into a transaction involving plan assets whereby such fiduciary (or a person in which such fiduciary has an interest which may affect the exercise of such fiduciary's best judgment as a fiduciary) will receive consideration from a third party in connection with such transaction. A person in which a fiduciary has an interest which may affect the exercise of such fiduciary's best judgment as a fiduciary includes, for example, a person who is a party in interest by reason of a relationship to such fiduciary described in section 3(14)(E), (F), (G), (H), or (I).
    2. Transactions not described in Section 406(b)(1). A fiduciary does not engage in an act described in section 406(b)(1) of the Act 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. This may occur, for example, when one fiduciary is retained on behalf of a plan by a second fiduciary to provide a service for an additional fee. However, because the authority, control or responsibility which makes a person a fiduciary may be exercised "in effect" as well as in form, mere approval of the transaction by a second fiduciary does not mean that the first fiduciary has not used any of the authority, control or responsibility which makes such person a fiduciary to cause the plan to pay the first fiduciary an additional fee for a service. See paragraph (f) below.
    3. Services without compensation. 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 within the meaning of 2550.408c-2(b)(3)], the provision of such services does not, in and of itself, constitute an act described in section 406(b) of the Act. The allowance of a deduction to an employer under section 162 or 12 of the Code for the expense incurred in furnishing office space or services to a plan established or maintained by such employer does not constitute compensation or other consideration.
  6. Examples. The provisions of 2550.408b-2(e) may be illustrated by the following examples.

    Example (1). E, an employer whose employees are covered by plan P, is a fiduciary of P. I is a professional investment adviser in which E has no interest which may affect the exercise of E's best judgment as a fiduciary. E causes P to retain I to provide certain kinds of investment advisory services of a type which causes I to be a fiduciary of P under section 3(21)(A)(ii) of the Act. Thereafter, I proposes to perform for additional fees portfolio evaluation services in addition to the services currently provided. The provision of such services is arranged by I and approved on behalf of the plan by E. I has not engaged in an act described in section 406(b)(1) of the Act, because I did not use any of the authority, control or responsibility which makes I a fiduciary (the provision of investment advisory services) to cause the plan to pay I additional fees for the provision of the portfolio evaluation services. E has not engaged in an act which is described in section 406(b)(1). E, as the fiduciary who has the responsibility to be prudent in this selection and retention of I and the other investment advisers of the plan, has an interest in the purchase by the plan of portfolio evaluation services. However, such an interest is not an interest which may affect the exercise of E's best judgment as a fiduciary.

    Example (2). D, a trustee of plan P with discretion over the management and disposition of plan assets, relies on the advice of C, a consultant to P, as to the investment of plan assets, thereby making C a fiduciary of the plan. On January 1, 1978, C recommends to D that the plan purchase an insurance policy from U, an insurance company which is not a party in interest with respect to P. C thoroughly explains the reasons for the recommendation and makes a full disclosure concerning the fact that C will receive a commission from U upon the purchase of the policy by P. D considers the recommendation and approves the purchase of the policy by P. C receives a commission. Under such circumstances, C has engaged in an act described in section 406(b)(1) of the Act (as well as sections 406(b)(2) and (3) of the Act) because C is in fact exercising the authority, control or responsibility which makes C a fiduciary to cause the plan to purchase the policy. However, the transaction is exempt from the prohibited transaction provisions of section 406 of the Act, if the requirements of Prohibited Transaction Exemption 77-9 are met.

    Example (3). Assume the same facts as in Example (2) except that the nature of C's relationship with the plan is not such that C is a fiduciary of P. The purchase of the insurance policy does not involve an act described in section 406(b)(1) of the Act (or sections 406(b)(2) or (3) of the Act) because such sections only apply to acts by fiduciaries.

    Example (4). E, an employer whose employees are covered by plan P, is a fiduciary with respect to P. A, who is not a party in interest with respect to P, persuades E that the plan needs the services of a professional investment adviser and that A should be hired to provide the investment advice. Accordingly, E causes P to hire A to provide investment advice of the type which makes A a fiduciary under 2510.3-21(c)(1)(ii)(B). Prior to the expiration of A's first contract with P, A persuades E to cause P to renew A's contract with P to provide the same services for additional fees in view of the increased costs in providing such services. During the period of A's second contract, A provides additional investment advice services for which no additional charge is made. Prior to the expiration of A's second contract, A persuades E to cause P to renew his contract for additional fees in view of the additional services A is providing. A has not engaged in an act described in section 406(b)(1) of the Act, because A has not used any of the authority, control or responsibility which makes A a fiduciary (the provision of investment advice) to cause the plan to pay additional fees for A's services.

    Example (5). F, a trustee of plan P with discretion over the management and disposition of plan assets, retains C to provide administrative services to P of the type which makes C a fiduciary under section 3(21)(A)(iii). Thereafter, C retains F to provide for additional fees actuarial and various kinds of administrative services in addition to the services F is currently providing to P. Both F and C have engaged in an act described in section 406(b)(1) of the Act. F, regardless of any intent which he may have had at the time he retained C, has engaged in such an act because F has, in effect, exercised the authority, control or responsibility which makes F a fiduciary to cause the plan to pay F additional fees for the services. C, whose continued employment by P depends on F, has also engaged in such an act, because C has an interest in the transaction which might affect the exercise of C's best judgment as a fiduciary. As a result, C has dealt with plan assets in his own interest under section 406(b)(1).

    Example (6). F, a fiduciary of plan P with discretionary authority respecting the management of P, retains S, the son of F, to provide for a fee various kinds of administrative services necessary for the operation of the plan. F has engaged in an act described in section 406(b)(1) of the Act because S is a person in whom F has an interest which may affect the exercise of F's best judgment as a fiduciary. Such act is not exempt under section 408(b)(2) of the Act irrespective of whether the provision of the services by S is exempt.

    Example (7). T, one of the trustees of plan P, is president of bank B. The bank proposes to provide administrative services to P for a fee. T physically absents himself from all consideration of B's proposal and does not otherwise exercise any of the authority, control or responsibility which makes T a fiduciary to cause the plan to retain B. The other trustees decide to retain B. T has not engaged in an act described in section 406(b)(1) of the Act. Further, the other trustees have not engaged in an act described in section 406(b)(1) merely because T is on the board of trustees of P. This fact alone would not make them have an interest in the transaction which might affect the exercise of their best judgment as fiduciaries.

2550.408b-3    Loans to Employee Stock Ownership Plans

Department of Labor
Regulation 2550.408b-3
29 C.F.R. 2550.408b-3

Originally issued September 2, 1977 (42 FR 44385)

Technical corrections September 13, 1977 (42 FR 45907)

Amended April 30, 1984 (49 FR 18295)

  1. Definitions. When used in this section, the terms listed below have the following meanings:
    1. ESOP. The term "ESOP" refers to an employee stock ownership plan that meets the requirements of section 407(d)(6) of the Employee Retirement Income Security Act of 1974 (the Act) and 29 C.F.R. 2550.407d-6. It is not synonymous with "stock bonus plan." A stock bonus plan must, however, be an ESOP to engage in an exempt loan. The qualification of an ESOP under section 401(a) of the Internal Revenue Code (the Code) and 26 C.F.R. 54.4975-11 will not be adversely affected merely because it engages in a non-exempt loan.
    2. Loan. The term "loan" refers to a loan made to an ESOP by a party in interest or a loan to an ESOP which is guaranteed by a party in interest. It includes a direct loan of cash, a purchase-money transaction, and an assumption of the obligation of the ESOP. "Guarantee" includes an unsecured guarantee and the use of assets of a party in interest as collateral for a loan, even though the use of assets may not be a guarantee under applicable state law. An amendment of a loan in order to qualify as an exempt loan is not a refinancing of the loan or the making of another loan.
    3. Exempt Loan. The term "exempt loan" refers to a loan that satisfies the provisions of this section. A "non-exempt loan" is one that fails to satisfy such provisions.
    4. Pubicly traded. The term "publicly traded" refers to a security that is listed on a national securities exchange registered under section 6 of the Securities Exchange Act of 1934 (15 U.S.C. 78f) or that is quoted on a system sponsored by a national securities association registered under section 15A(b) of the Securities Exchange Act (15 U.S.C. 78o).
    5. Qualifying Employer Security. The term "qualifying employer security" refers to a security described in 29 C.F.R. 2550.407d-5.
  2. Statutory Exemption.
    1. Scope. Section 408(b)(3) of the Act provides an exemption from the prohibited transaction provisions of sections 406(a) and 406(b)(1) of the Act (relating to fiduciaries dealing with the assets of plans in their own interest or for their own account) and 406(b)(2) of the Act (relating to fiduciaries in their individual or in any other capacity acting in any transaction involving the plan on behalf of a party (or representing a party) whose interests are adverse to the interests of the plan or the interests of its participants or beneficiaries). Section 408(b)(3) does not provide an exemption from the prohibitions of section 406(b)(3) of the Act (relating to fiduciaries receiving consideration for their own personal account from any party dealing with a plan in connection with a transaction involving the income or assets of the plan).
    2. Special scrutiny of transaction. The exemption under section 408(b)(3) includes within its scope certain transactions in which the potential for self-dealing by fiduciaries exists and in which the interests of fiduciaries may conflict with the interests of participants. To guard against these potential abuses, the Department of Labor will subject these transactions to special scrutiny to ensure that they are primarily for the benefit of participants and their beneficiaries. Although the transactions need not be arranged and approved by an independent fiduciary, fiduciaries are cautioned to scrupulously exercise their discretion in approving them. For example, fiduciaries should be prepared to demonstrate compliance with the net effect test and the arm's-length standard under paragraphs (c)(2) and (3) of this section. Also, fiduciaries should determine that the transaction is truly arranged primarily in the interest of participants and their beneficiaries rather than, for example, in the interest of certain selling shareholders.
  3. Primary benefit requirement.
    1. In General. An exempt loan must be primarily for the benefit of the ESOP participants and their beneficiaries. All the surrounding facts and circumstances, including those described in paragraphs (c)(2) and (3) of this section, will be considered in determining whether such loan satisfies this requirement. However, no loan will satisfy such requirement unless it satisfies the requirements of paragraphs (d), (e) and (f) of this section.
    2. Net effect on plan assets. At the time that a loan is made, the interest rate for the loan and the price of securities to be acquired with the loan proceeds should not be such that plan assets might be drained off (Emphasis added).
    3. Arm's-length standard. The terms of a loan, whether or not between independent parties, must, at the time the loan is made, be at least as favorable to the ESOP as the terms of a comparable loan resulting from arm's-length negotiations between independent parties.
  4. Use of loan proceeds. The proceeds of an exempt loan must be used, within a reasonable time after their receipt, by the borrowing ESOP only for any or all of the following purposes:
    1. To acquire qualifying employer securities.
    2. To repay such loan.
    3. To repay a prior exempt loan. A new loan, the proceeds of which are so used, must satisfy the provisions of this section. Except as provided in paragraphs (i) and (j) of this section or as otherwise required by applicable law, no security acquired with the proceeds of an exempt loan may be subject to a put, call, or other option, or buy-sell or similar arrangement while held by and when distributed from a plan, whether or not the plan is then an ESOP.
  5. Liability and collateral of ESOP for loan. An exempt loan must be without recourse against the ESOP. Furthermore, the only assets of the ESOP that may be given as collateral on an exempt loan are qualifying employer securities of two classes: those acquired with the proceeds of the exempt loan and those that were used as collateral on a prior exempt loan repaid with the proceeds of the current exempt loan. No person entitled to payment under the exempt loan shall have any right to assets of the ESOP other than:
    1. Collateral given for the loan,
    2. Contributions (other than contributions of employer securities) that are made under an ESOP to meet its obligations under the loan, and
    3. Earnings attributable to such collateral and the investment of such contributions.

    The payments made with respect to an exempt loan by the ESOP during a plan year must not exceed an amount equal to the sum of such contributions and earnings received during or prior to the year less such payments in prior years. Such contributions and earnings must be accounted for separately in the books of account of the ESOP until the loan is repaid.

  6. Default. In the event of default upon an exempt loan, the value of plan assets transferred in satisfaction of the loan must not exceed the amount of default. If the lender is a party in interest, a loan must provide for a transfer of plan assets upon default only upon and to the extent of the failure of the plan to meet the payment schedule of the loan. For purposes of this paragraph, the making of a guarantee does not make a person a lender.
  7. Reasonable rate of interest. The interest rate of a loan must not be in excess of a reasonable rate of interest. All relevant factors will be considered in determining a reasonable rate of interest, including the amount and duration of the loan, the security and guarantee (if any) involved, the credit standing of the ESOP and the guarantor (if any), and the interest rate prevailing for comparable loans. When these factors are considered, a variable interest rate may be reasonable.
  8. Release from encumbrance.
    1. General rule. In general, an exempt loan must provide for the release from encumbrance of plan assets used as collateral for the loan under this paragraph. For each plan year during the duration of the loan, the number of securities released must equal the number of encumbered securities held immediately before release for the current plan year multiplied by a fraction. The numerator of the fraction is the amount of principal and interest paid for the year. The denominator of the fraction is the sum of the numerator plus the principal and interest to be paid for all future years. See Section 2550.408b-3(h)(4). The number of future years under the loan must be definitely ascertainable and must be determined without taking into account any possible extensions or renewal periods. If the interest rate under the loan is variable, the interest to be paid in future years must be computed by using the interest rate applicable as of the end of the plan year. If collateral includes more than one class of securities, the number of securities of each class to be released for a plan year must be determined by applying the same fraction to each class.
    2. Special rule. A loan will not fail to be exempt merely because the number of securities to be released from encumbrance is determined solely with reference to principal payments. However, if release is determined with reference to principal payments only, the following three additional rules apply. The first rule is that the loan must provide for annual payments of principal and interest at a cumulative rate that is not less rapid at any time than level annual payments of such amounts for 10 years. The second rule is that interest included in any payment is disregarded only to the extent that it would be determined to be interest under standard loan amortization tables. The third rule is that subdivision (2) is not applicable from the time that, by reason of a renewal, extension, or refinancing, the sum of the expired duration of the exempt loan, the renewal period, the extension period, and the duration of a new exempt loan exceeds 10 years.
    3. Caution against plan disqualification. Under an exempt loan, the number of securities released from encumbrance may vary from year to year. The release of securities depends upon certain employer contributions and earnings under the ESOP. Under 26 C.F.R. 54.4975-11(d)(2) actual allocations to participants' accounts are based upon assets withdrawn from the suspense account. Nevertheless, for purposes of applying the limitations under section 415 of the Code to these allocations, under 26 C.F.R. 54.4975-11(a)(8)(ii) contributions used by the ESOP to pay the loan are treated as annual additions to participants' accounts. Therefore, particular caution must be exercised to avoid exceeding the maximum annual additions under section 415 of the Code. At the same time, release from encumbrance in annually varying numbers may reflect a failure on the part of the employer to make substantial and recurring contributions to the ESOP which will lead to loss of qualification under section 401(a) of the Code. The Internal Revenue Service will observe closely the operation of ESOPs that release encumbered securities in varying annual amounts, particularly those that provide for the deferral of loan payments or for balloon payments. See 26 C.F.R. 54.4975-7(b)(8)(iii).
    4. Illustration. The general rule under paragraph (h)(1) of this section operates as illustrated in the following example:

      Example. Corporation X establishes an ESOP that borrows $750,000 from a bank. X guarantees the loan which is for 15 years at 5% interest and is payable in level annual amounts of $72,256.72. Total payments on the loan are $1,083,850.80. The ESOP uses the entire proceeds of the loan to acquire 15,000 shares of X stock which is used as collateral for the loan. The number of securities to be released for the first year is 1,000 shares, i.e., 15,000 shares x $72,256.72/$1,083,850.80 = 15,000 shares x 1/15. The number of securities to be released for the second year is 1,000 shares, i.e., 14,000 shares x $72,256.72/$1,011,594.08 = 14,000 shares x 1/14. If all loan payments are made as originally scheduled, the number of securities released in each succeeding year of the loon will also be 1,000.

  9. Right of first refusal. Qualifying employer securities acquired with proceeds of an exempt loan may, but need not, be subject to a right of first refusal. However, any such right must meet the requirements of this paragraph. Securities subject to such right must be stock or an equity security, or a debt security convertible into stock or an equity security. Also, they must not be publicly traded at the time the right may be exercised. The right of first refusal must be in favor of the employer, the ESOP, or both in any order of priority. The selling price and other terms under the right must not be less favorable to the seller than the greater of the value of the security determined under 26 C.F.R. 54.4975-11(d)(5), or the purchase price and other terms offered by a buyer, other than the employer or the ESOP, making a good faith offer to purchase the security. The right of first refusal must lapse no later than 14 days after the security holder gives written notice to the holder of the right that an offer by a third party to purchase the security has been received.
  10. Put option. A qualifying employer security acquired with the proceeds of an exempt loan by an ESOP after September 30, 1976, must be subject to a put option if it is not publicly traded when distributed or if it is subject to a trading limitation when distributed. For purposes of this paragraph, a "trading limitation" on a security is a restriction under any Federal or State securities law or any regulation thereunder, or an agreement (not prohibited by this section) affecting the security which would make the security not as freely tradable as one not subject to such restriction. The put option must be exercisable only by a participant, by the participant's donee(s), or by a person (including an estate or its distributes) to whom the security passes by reason of a participant's death. (Under this paragraph "participant" means a participant and the beneficiaries of the participant under the ESOP.) The put option must permit a participant to put the security to the employer. Under no circumstances may the put option bind the ESOP. However, it may grant the ESOP an option to assume the rights and obligations of the employer at the time that the put option is exercised. If it is known at the time a loan is made that Federal or state law will be violated by the employer's honoring such option, the put option must permit the security to be put, in a manner consistent with such law, to a third party (e.g., an affiliate of the employer or a shareholder other than the ESOP) that has substantial net worth at the time the loan is made and whose net worth is reasonably expected to remain substantial.
  11. Duration of put option.
    1. General rule. A put option must be exercisable at least during a 15-month period which begins the date the security subject to the put option is distributed by the ESOP.
    2. Special rule. In the case of a security that is publicly traded without restriction when distributed but ceases to be so traded within 15 months after distribution, the employer must notify each security holder in writing on or before the tenth day after the date the security ceases to be so traded that for the remainder of the 15-month period the security is subject to a put option. The number of days between the tenth day and the date on which notice is actually given, if later than the tenth day, must be added to the duration of the put option. The notice must inform distributee(s) of the terms of the put options that they are to hold. The terms must satisfy the requirements of paragraphs (j) through (i) of this section.
  12. Other put option provisions.
    1. Manner of exercise. A put option is exercised by the holder notifying the employer in writing that the put option is being exercised.
    2. Time excluded from duration of put option. The period during which a put option is exercisable does not include any time when a distributee is unable to exercise it because the party bound by the put option is prohibited from honoring it by applicable Federal or state law.
    3. Price. The price at which a put option must be exercisable is the value of the security, determined in accordance with paragraph (d)(5) of 26 C.F.R. 54.4975-11.
    4. Payment terms. The provisions for payment under a put option must be reasonable. The deferral of payment is reasonable if adequate security and a reasonable interest rate are provided for any credit extended and if the cumulative payments at any time are no less than the aggregate of reasonable periodic payments as of such time. Periodic payments are reasonable if annual installments, beginning with 30 days after the date the put option is exercised, are substantially equal. Generally, the payment period may not end more than 5 years after the date the put option is exercised. However, it may be extended to a date no later than the earlier of 10 years from the date the put option is exercised or the date the proceeds of the loan used by the ESOP to acquire the security subject to such put option are entirely repaid.
    5. Payment restrictions. Payment under a put option may be restricted by the terms of a loan, including one used to acquire a security subject to a put option, made before November 1, 1977. Otherwise, payment under a put option must not be restricted by the provisions of a loan or any other arrangement, including the terms of the employer's articles of incorporation, unless so required by applicable state law.
  13. Other terms of loan. An exempt loan must be for a specific term. Such loan may not be payable at the demand of any person, except in the case of default.
  14. Status of paln as ESOP. To be exempt, a loan must be made to a plan that is an ESOP at the time of such loan. However, a loan to a plan formally designated as an ESOP at the time of the loan that fails to be an ESOP because it does not comply with section 401 (a) of the Code or 26 C.F.R. 54.4975-11 will be exempt as of the time of such loan if the plan is amended retroactively under section 401(b) of the Code or 26 C.F.R. 54.4975-11(a)(4).
  15. Special rules for certain loans.
    1. Loans made before January 1, 1976. A loan made before January 1, 1976, or made afterwards under a binding agreement in effect on January 1, 1976 (or under renewals permitted by the terms of such an agreement on that date) is exempt for the entire period of such loan if it otherwise satisfies the provisions of this section for such period, even though it does not satisfy the following provisions of this section:
      1. The last sentence of paragraph (d);
      2. Paragraphs (e), (f), and (h)(1) and (2); and
      3. Paragraphs (i) through (m), inclusive.
    2. Loans made after December 31, 1975, BUT BEFORE November 1, 1977. A loan made after December 31, 1975, but before November 1, 1977, or made afterwards under a binding agreement in effect on November 1, 1977, (or under renewals permitted by the terms of such an agreement on that date) is exempt for the entire period of such loan if it otherwise satisfies the provisions of this section for such period even though it does not satisfy the following provisions of this section:
      1. Paragraph (f);
      2. The three provisions of paragraph (h)(2): and
      3. Paragraph (i).
    3. Release rule. Notwithstanding paragraphs (o)(1) and (2) of this section, if the proceeds of a loan are used to acquire securities after November 1, 1977, the loan must comply by such date with the provisions of paragraph (h) of this section.
    4. Default rule. Notwithstanding paragraphs (o)(1) and (2) of this section, a loan by a party in interest other than a guarantor must satisfy the requirements of paragraph (f) of this section. A loan will satisfy these requirements if it is retroactively amended before November 1, 1977, to satisfy these requirements.
    5. Put option rule. With respect to a security distributed before November 1, 1977, the put option provisions of paragraphs (j), (k), and (l) of this section will be deemed satisfied as of the date the security is distributed if by December 31, 1977, the security is subject to a put option satisfying such provisions. For purposes of satisfying such provisions, the security will be deemed distributed on the date the put option is issued. However, the put option provisions need not be satisfied with respect to a security that is not owned on November 1, 1977, by a person in whose hands a put option must be exercisable.

2550.408b-4    Investment in Own-Bank Interest-Bearing Deposits

Department of Labor
Regulation 2550.408b-4
29 C.F.R. 2550.408b-4

Originally issued June 24, 1977 (42 FR 32392)

  1. In General.
  2. Section 408(b)(4) of the Employee Retirement Income Security Act of 1974 (the Act) exempts from the prohibition of Section 406 of the Act the investment of all or a part of a plan's assets in deposits bearing a reasonable rate of interest in a bank or similar financial institution supervised by the United States or a State, even though such bank or similar financial institution is a fiduciary or other party in interest with respect to the plan, if the conditions of either Part 2550.408b-4(b)(1) or Part 2550.408b-4(b)(2) are met.

    Section 408(b)(4) provides an exemption from Section 406(b)(1) of the Act (relating to fiduciaries dealing with the assets of plans in their own interest or for their own account) and 406(b)(2) of the Act (relating to fiduciaries in their individual or in any other capacity acting in any transaction involving the plan on behalf of a party -- or representing a party -- whose interests are adverse to the interests of the plan or the interests of its participants or beneficiaries), as well as Section 406(a)(1), because Section 408(b)(4) contemplates a bank or similar financial institution causing a plan for which it acts as a fiduciary to invest plan assets in its own deposits if the requirements of Section 408(b)(4) are met.

    However, it does not provide an exemption from Section 406(b)(3) of the Act (relating to fiduciaries receiving consideration for their own personal account from any part dealing with a plan in connection with a transaction involving the assets of the plan). The receipt of such consideration is a separate transaction not described in the statutory exemption. Section 408(b)(4) does not contain an exemption from other provisions of the Act, such as Section 404, or other provisions of law which may impose requirements or restrictions relating to the transactions which are exempt under Section 408(b)(4) of the Act. See, for example, Section 401 of the Internal Revenue Code of 1954 (Code). The provisions of Section 408(b)(4) of the Act are further limited by Section 408(d) of the Act (relating to transactions with owner-employees and related persons).

  3. (1) Plan Covering Own Employees.
  4. Such investment may be made if the plan is one which covers only the employees of the bank or similar financial institution, the employees of any of its affiliates, or the employees of both.

    (2) Other Plans.

    Such investment may be made if -

    • The investment is expressly authorized by a provision of the plan or trust instrument, or
    • The investment is expressly authorized (or made) by a fiduciary of the plan (other than the bank or similar financial institution or any of its affiliates) who has authority to make such investments, or to instruct the trustee or other fiduciary with respect to investments, and who has no interest in the transaction which may affect the exercise of such authorizing fiduciary's best judgment as a fiduciary so as to cause such authorization to constitute an act described in Section 406(b) of the Act.

    Any authorization to make investments contained in a plan or trust instrument will satisfy the requirement of express authorization for investments made prior to November 1, 1977.

    Effective November 1, 1977, in the case of a bank or similar financial institution that invests plan assets in deposits in itself or its affiliates under an authorization contained in a plan or trust instrument, such authorization -

    • Must name such bank or similar financial institution, and
    • Must state that such bank or similar financial institution may make investments in deposits which bear a reasonable rate of interest in itself (or in an affiliate).

    (3) Example.

    B, a bank, is the trustee of plan P's assets. The trust instruments give the trustees the right to invest plan assets in its discretion. B invests in the certificates of deposit of bank C, which is a fiduciary of the plan by virtue of performing certain custodial and administrative services. The authorization is sufficient for the plan to make such an investment under Section 408(b)(4). Further, such authorization would suffice to allow B to make investments in deposits in itself prior to November 1, 1977. However subsequent to October 31, 1977, B may not invest in deposits in itself, unless the plan or trust instrument authorizes it to invest in deposits of B.

  5. Definitions.
    1. The term "bank or similar financial institutions" . . . includes a bank (as defined in Section 581 of the Code), a domestic building and loan association (as defined in Section 7701(a)(19) of the Code).
    2. A person is an "affiliate" of a bank or similar financial institution if such person and such bank or similar financial institution would be treated as members of the same controlled group of corporations or as members of two or more trades or businesses under common control within the meaning of Section 414(b) or (c) of the Code and regulations thereunder.
    3. The term "deposits" includes any account, temporary or otherwise, upon which a reasonable rate of interest is paid, including a certificate of deposit issued by a bank or similar financial institution.

Note: Also refer to ERISA Section 408(b)(4), "Investment in Own-Bank Interest-Bearing Deposits".

2550.408b-6    Ancillary Services by Banks or Similar Financial Institutions

Department of Labor
Regulation 2550.408b-6
29 C.F.R. 2550.408b-6

Originally issued June 24, 1977 (42 FR 32392)

Technical corrections of July 18, 1977 (42 FR 36823) did not contain any changes to this regulation.

  1. In General.
  2. Section 408(b)(6) of the Employee Retirement Income Security Act of 1974 (the Act) exempts from the prohibitions of section 406 of the Act the provision of certain ancillary services by a bank or similar financial institution (as defined in 2550.408b-4(c)(1)) supervised by the United States or a State to a plan for which it acts as a fiduciary if the conditions of 2550.408b-6(b) are met. Such ancillary services include services which do not meet the requirements of section 408(b)(2) of the Act because the provision of such services involves an act described in section 406(b)(1) of the Act (relating to fiduciaries dealing with the assets of plans in their own interest or for their own account) by the fiduciary bank or similar financial institution or an act described in section 406(b)(2) of the Act (relating to fiduciaries in their individual or in any other capacity acting in any transaction involving the plan on behalf of a party (or representing a party) whose interests are adverse to the interests of the plan or the interests of its participants or beneficiaries). Section 408(b)(6) provides an exemption from sections 406(b)(1) and (2) because section 408(b)(6) contemplates the provision of such ancillary services without the approval of a second fiduciary (as described in 2550.408b-2(e)(2)) if the conditions of 2550.408b-6(b) are met. Thus, for example, plan assets held by a fiduciary bank which are reasonably expected to be needed to satisfy current plan expenses may be placed by the bank in a non-interest-bearing checking account in the bank if the conditions of 2550.408b-6(b) are met, notwithstanding the provisions of section 408(b)(4) of the Act (relating to investments in bank deposits). However, section 408(b)(6) does not provide an exemption for an act described in section 406(b)(3) of the Act (relating to fiduciaries receiving consideration for their own personal account from any party dealing with a plan in connection with a transaction involving the assets of the plan). The receipt of such consideration is a separate transaction not described in section 408(b)(6). Section 408(b)(6) does not contain an exemption from other provisions of the Act, such as section 404, or other provisions of law which may impose requirements or restrictions relating to the transactions which are exempt under section 408(b)(6) of the Act. See, for example, section 401 of the Internal Revenue Code of 1954. The provisions of section 408(b)(6) of the Act are further limited by section 408(d) of the Act (relating to transactions with owner-employees and related persons).

  3. Conditions. Such service must be provided -
    1. At not more than reasonable compensation;
    2. 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
    3. Only to the extent that such service is subject to specific guidelines issued by the bank or similar financial institution which meet the requirements of 2550.408b-6(c).
  4. Specific guidelines. (Reserved)

2550.408c-2    Compensation for Services

Department of Labor
Regulation 2550.408c-2
29 C.F.R. 2550.408c-2

Originally issued June 24, 1977 (42 FR 32393)

  1. In General. Section 408(b)(2) of the Employee Retirement Income Security Act of 1974 (the Act) refers to the payment of reasonable compensation by a plan to a party in interest for services rendered to the plan. Section 408(c)(2) of the Act and Section 2550.408c-2(b)(1) through 2550.408c-2(b)(4) clarify what constitutes reasonable compensation for such services.
  2. General Rule. Generally, whether compensation is "reasonable" under sections 408(b)(2) and 408(c)(2) of the Act depends on the particular facts and circumstances of each case.
    1. Payments to certain fiduciaries. Under sections 408(b)(2) and 408(c)(2) of the Act, the term "reasonable compensation" does not include any compensation to a fiduciary who is already receiving full-time pay from an employer or association of employers (any of whose employees are participants in the plan) or from an employee organization (any or whose members are participants in the plan), except for the reimbursement of direct expenses properly and actually incurred and not otherwise reimbursed. The restrictions of this paragraph (b)(2) do not apply to a party in interest who is not a fiduciary.
    2. Certain expenses not direct expenses. An expense is not a direct expense to the extent it would have been sustained had the service not been provided or if it represents an allocable portion of overhead costs.
    3. Expense advances. Under sections 408(b)(2) and 408(c)(2) of the Act, the term "reasonable compensation" , as applied to a fiduciary or an employee of a plan, includes an advance to such a fiduciary or employee by the plan to cover direct expenses to be properly and actually incurred by such person in the performance of such person's duties with the plan if:
    4. The amount of such advance is reasonable with respect to the amount of the direct expense which is likely to be properly and actually incurred in the immediate future (such as during the next month) and
    5. The fiduciary or employee accounts to the plan at the end of the period covered by the advance for the expenses properly and actually incurred.
  3. Excessive compensation. Under sections 408(b)(2) and 408(c)(2) of the Act, any compensation which would be considered excessive under 26 C.F.R. 1.162-7 (Income Tax Regulations relating to compensation for personal services which constitutes an ordinary and necessary trade or business expense) will not be "reasonable compensation". Depending upon the facts and circumstances of the particular situation, compensation which is not excessive under 26 C.F.R. 1.162-7 may, nevertheless, not be "reasonable compensation" within the meaning of sections 408(b)(2) and 408(c)(2) of the Act.

2550.408e    Qualifying Employer Securities and Real Estate

Department of Labor
Regulation 2550.408e
29 C.F.R. 2550.408e

Acquisition or Sale of Qualifying Employer Securities and Acquisition/Sale/Lease of Qualifying Employer Real Estate

Originally issued August 1, 1980 (45 FR 51197)

  1. In General. Section 408(e) of the Employee Retirement Income Security Act of 1974 (the Act) exempts from the prohibitions of section 406(a) and 406(b)(1) and (2) of the Act any acquisition or sale by a plan of qualifying employer securities (as defined in section 407(d)(5) of the Act), or any acquisition, sale or lease by a plan of qualifying employer real property (as defined in section 407(d)(4) of the Ac) if certain conditions are met. The conditions are that:
    1. The acquisition, sale or lease must be for adequate consideration (which is defined in paragraph (d) of this section);
    2. No commission may be charged directly or indirectly to the plan with respect to the transaction; and
    3. In the case of an acquisition or lease of qualifying employer real property, or an acquisition of qualifying the securities, by a plan other than an eligible individual account plan (as defined in section 407(d)(3) of the Act), the acquisition or lease must comply with the requirements of section 407(a) of the Act.
  2. Acquisition. For purposes of section 408(e) and this section, an acquisition by a plan of qualifying employer securities or qualifying employer real property shall include, but not be limited to, an acquisition by purchase, by the exchange of plan assets, by the exercise of warrants or rights, by the conversion of a security, by default of a loan where the qualifying employer security or qualifying employer real property was security for the loan, or in connection with the contribution of such securities or real property to the plan. However, an acquisition of a security shall not be deemed to have occurred if a plan acquires the security as a result of a stock dividend or stock split.
  3. Sale. For purposes of section 408(e) and this section, a sale of qualifying employer real property or qualifying employer securities shall include any disposition for value.
  4. Adequate consideration. For purposes of section 408(e) and this section, adequate consideration means:
    1. In the case of a marketable obligation, a price not less favorable to the plan than the price determined under section 407(e)(1) of the Act and
    2. In all other cases, a price not less favorable to the plan than the price determined under section 3(18) of the Act.
  5. Commission. For purposes of section 408(e) and this section, the term "commission" includes any fee, commission or similar charge paid in connection with a transaction, except that the term "commission" does not include a charge incurred for the purpose of enabling the appropriate plan fiduciaries to evaluate the desirability of entering into a transaction to which this section would apply, such as an appraisal or investment advisory fee.

2570.30 - 52    Individual and Class Prohibited Transaction Exemption Requests (Replaces ERISA Procedure 75-1)

Department of Labor
Regulation 2570.30 through .52
29 C.F.R. 2570.30 through .52

Originally issued August 10, 1990 (55 FR 32847)

§ .35 Amended through April 12, 1991 (56 FR 14861)

Agency: Pension and Welfare Benefits Administration, Labor.

Action: Final regulation and removal of interim final regulation.

Summary: This document contains a final regulation that describes the procedures for filing and processing applications for exemptions from the prohibited transaction provisions of the Employee Retirement Income Security Act of 1974 (ERISA), the Internal Revenue Code of 1986 (the Code), and the Federal Employees' Retirement System Act of 1986 (FERSA). At this time, the Department is also removing an interim regulation which describes the exemption procedures under FERSA because such regulation is superseded by the final regulation contained herein. The Secretary of Labor is authorized to grant exemptions from the prohibited transaction provisions of ERISA, the Code, and FERSA and to establish an exemption procedure to provide for such exemptions. The final regulation updates the description of the Department of Labor's procedures to reflect changes in the Department's exemption authority and to clarify the procedures by providing a more comprehensive description of the prohibited transaction exemption process.

Note: In 1995, the Labor Department also issued a booklet, Exemption Procedures Under Federal Pension Law, explaining how to obtain ERISA exemptions. The text of the exemption request procedure is included in the booklet. The free booklet is available from the Division of Public Affairs; Pension and Welfare Benefits Administration; U.S. Department of Labor; 200 Constitution Avenue, NW; Washington, DC 20210; phone 202/219-8921.

Effective Date: This regulation is effective September 10, 1990, and applies to all exemption applications filed at any time on or after that date.

Explanatory Preamble

(Final Regulation)

For Further Information Contact: Miriam Freund, Office of Exemption Determinations, Pension and Welfare Benefits Administration, U.S. Department of Labor, Washington, DC 20210, (202) 523-8194, or Susan Rees, Plan Benefits Security Division, Office of the Solicitor, U.S. Department of Labor, Washington, DC 20210, (202) 523-9141.

Supplementary Information: Public reporting burden for this collection of information is estimated to average 28.5 hours per response, including the time for reviewing the instructions, searching existing data sources, gathering and maintaining the data needed, and completing and reviewing the collection of information. Send comments regarding this burden estimate or any other aspect of this collection of information, including suggestions for reducing the burden, to Director, Office of Information Management, U.S. Department of Labor, 200 Constitution Avenue NW., Room N-1301, Washington, DC 20210; and to the Office of Information and Regulatory Affairs, Attn: OMB Desk Officer for PWBA, Office of Management and Budget, Room 3001, Washington, DC 20503.

Section 406 of ERISA prohibits certain transactions between employee benefit plans and "Parties in interest" (as defined in section 3(14) of ERISA). In addition, sections 406 and 407(a) of ERISA impose restrictions on plan investments in "employer securities" (as defined in section 407(d)(1) of ERISA) and "employer real property" (as defined in section 407(d)(2) of ERISA). Most of the transactions prohibited by section 406 of ERISA are likewise prohibited by section 4975 of the Code, which imposes an excise tax on those transactions to be paid by each "disqualified person" (defined in section 4975(e)(2) of the Code in virtually the same manner as the term "party in interest") who participates in the transactions.

Both ERISA and the Code contain various statutory exemptions from the. prohibited transaction rules. In addition, section 408(a) of ERISA authorizes the Secretary of Labor to grant administrative exemptions from the restrictions of ERISA sections 406 and 407(a) while section 4975(c)(2) of the Code a authorizes the Secretary of the Treasury or his delegate to grant exemptions from the prohibitions of Code section 4975(c)(1). Sections 408(a) of ERISA and 4975(c)(2) of the Code direct the Secretary of Labor and the Secretary of the Treasury, respectively, to establish procedures to carry out the purposes of these sections.

Under section 3003(b) of ERISA, the Secretary of Labor and the Secretary of the Treasury are directed to consult and coordinate with each other with respect to the establishment of rules applicable to the granting of exemptions from the Prohibited transaction restrictions of ERISA and the Code. Under section 3004 of ERISA, moreover, the Secretaries are authorized to develop jointly rules appropriate for the efficient administration of ERISA. Pursuant to these provisions, the Secretaries jointly issued an exemption procedure on April 28, 1975 (ERISA Proc. 75-1, 40 FR 18471. also issued as Rev. Proc. 75-26, 1975-1 C.B. 722). Under these procedures, a person seeking an exemption under both section 408(a) of ERISA and section 4975(c)(2) of the Code was obliged to file an exemption application with the Rules and Regulations of the Internal Revenue Service as well as with the Department of Labor.

Reorganization Plan No. 4 of 1978 (43 FR 47713, October 17, 1918, effective on December 31, 1978), transferred the authority of the Secretary of the Treasury to issue exemptions under section 4975 of the Code, with certain enumerated exceptions, to the Secretary, of Labor. As a result, the Secretary of Labor now possesses authority under section 4975(c)(2) of the Code, as well as under section 408(a) of ERISA, to issue individual and class exemptions from the prohibited transaction rules of ERISA and the Code. The Secretary has delegated this authority, along with most of his other responsibilities under ERISA, to the Assistant Secretary for Pension and Welfare Benefits. See Secretary of Labor's Order 1-87, 52 FR 13139 (April 21, 1987).

FERSA also contains prohibited transaction rules that are applicable to parties in interest with respect to the Federal Thrift Savings Fund established by ERISA, and the Secretary of Labor is directed to prescribe, by regulation, a procedure for granting administrative exemptions from certain of those prohibited transactions. See 5 USC 8477(c)(3).

On June 28, 1988, the Department published a proposed rule in the Federal Register (53 FR 24422) updating ERISA Procedure 75-1 to reflect the changes made by Reorganization Plan No. 4 and extending the procedure to applications for exemptions from the FERSA prohibited transaction rules. In addition, the proposed regulation codified various procedures developed by PWBA since the adoption of ERISA Proc. 75-1. Formal adoption of those procedures will facilitate review of exemption applications. These new procedures also fill in some of the gaps left in ERISA Proc. 75-1. thereby providing a more detailed description both of the steps to be taken by applicants in applying for exemptions and the steps normally taken by the Department in processing such applications. Finally, the proposed regulation modified some of the procedures described in ERISA Proc. 75-1 to better serve the needs of the administrative exemption program as demonstrated by the Department's experience with the program over the previous fourteen years. These amendments were intended to promote the prompt and fair consideration of all exemption applications.

The notice of proposed rulemaking gave interested persons an opportunity to comment on the proposal. In response, the Department received three letters of comment regarding several aspects of the proposed regulation. The following discussion summarizes the proposed regulation and the issues raised by the commentators and explains the Department's reasons for adopting the provisions of the final regulation.

The Scope of the Regulation

As explained in the notice of proposed rulemaking, the regulation establishes new procedures to replace ERISA Proc. 75-1. These new procedures reflect changes in the Department of Labor's exemption authority effected by Reorganization Plan No. 4 of 1978. Thus, the procedures apply to all applications for exemption which the Department has authority to issue under section 408(a) of ERISA, or, as a result of Reorganization Plan No. 4, under section 4975(c)(2) of the Code. The procedures reflect current practice under which the Department generally treats any exemption application filed solely under section 408(a) of ERISA or solely under section 4275(c)(2) of the Code as an application for exemption filed under both of these sections if the application relates to a transaction prohibited under corresponding provisions of both ERISA and the Code. The grant of an exemption by the Department in such instances protects disqualified persons covered by the exemption from the excise taxes otherwise assessable under section 4975(a) and (b) of the Code.

However, the procedures do not apply to applications for exemption reserved to the jurisdiction of the Secretary of the Treasury by Reorganization Plan No. 4. To ascertain the correct procedures for filing and processing applications for these exemptions, applicants should consult the Internal Revenue Service.

The Department has also concluded that it is appropriate to apply the procedures provided here to exemption applications filed under FERSA, as well as those filed under ERISA or the Code, as provided by proposed § 2570.30, which has been adopted without change in the final regulation. Although the prohibited transaction provisions of FERSA and the scope of the Department's exemptive authority under FERSA differ somewhat from that under ERISA and the Code, administrative exemption matters under FERSA are likely to involve many of the issues as are presented by similar matters involving private plans. Thus, adopting uniform procedures should help assure uniform administration of the exemption programs.

Applications for Exemption under FERSA

On December 29, 1988, the Department published an interim regulation in the Federal Register (29 C.F.R. part 2585, 53 FR 52088) describing the procedures for filing and processing applications for exemptions from the prohibited transaction provisions of FERSA. For such applications, the interim regulation adopted the procedures then currently followed (pursuant to ERISA Proc. 75-1) by applicants for exemptions from the prohibited transaction provisions of ERISA and the Code. The interim final regulation was effective commencing December 29, 1988 until the effective date of the final regulation contained herein for all prohibited transaction exemption applications (under ERISA, the Code and FERSA).1

Section 2585.12 of the interim regulation provides that this regulation shall expire on the effective date of the revised prohibited transaction exemption procedure, published in proposed form on June 28, 1988, 53 FR 24422, and that the Department will publish a document removing these interim regulations when it adopts final regulations based on the published proposal. Accordingly, this notice of final rulemaking removes the interim regulations, as of September 10, 1990, the effective date of the final regulation contained herein.

In regard to FERSA exemption applications, the Department received a comment relating to the adoption of ERISA class exemptions for FERSA purposes. This comment suggested that the final regulation clarify that the Department will follow the procedure authorized under section 8477(c)(3)(E) of FERSA, which permits the Secretary of Labor to determine that an exemption granted for any class of fiduciaries or transactions under section 408(a) of ERISA shall constitute an exemption for FERSA purposes upon publication of notice in the Federal Register without affording interested parties opportunities to present their views (in writing or at a hearing).

The procedures described in the preceding paragraph was not used in conjunction with the Department's adoption for FERSA purposes of a number of specific class exemptions under ERISA (for example, Prohibited Transaction Exemptions (PTE) 75-1, 78-19, 80-26, 80-51, 82-63 and 86-128). In that instance, the Department published in the Federal Register both a notice of proposed adoption of class exemptions under ERISA (53 FR 38105, September 29, 1988), which invited the public to submit written comments or requests for a hearing on the proposed adoption, and also a notice of final adoption of these class exemptions (PTE T88-1, 53 FR 52838, December 29, 1988). In this regard, the Department notes that, with respect to ERISA class exemptions which may be proposed in the future and which may also be relevant under FERSA, the Department will solicit the views of the Executive Director of the Federal Retirement Thrift Investment Board in advance of the publication of the proposed exemption to determine whether such exemption should also be proposed for FERSA purposes.

Also regarding FERSA exemption applications, the Department received another comment requesting clarification that the mere existence of routine audit activity conducted by the Department pursuant to the requirements of section 8477(g) of FERSA2 will not provide a basis for denial of, or failure to consider, an application for exemption under FERSA. It is the view of the Department that those audits conducted by the Department in carrying out its responsibilities in connection with its regular program of compliance audits under FERSA section 8477(g) would not constitute an "investigation" for purposes of § 2570.33(a)(2) and 2570.37(b) of the regulation3 or an "examination" for purposes of § 2570.35(a)(7).4 The Department would not, however, be precluded from denying, or failing to consider, an application based on an investigation prompted by information arising as a result of such a routine audit.

Definitions

Section 2570.31 of the proposed regulation defined the following terms for purposes of the exemption procedures: affiliate, class exemption, Department, exemption transaction, individual exemption, and party in interest. No comments were received regarding these definitions which are adopted in the final regulation as proposed. However, the Department has added to this section a definition of the term "pooled fund" in response to a comment requesting that a special rule be added to the final regulation regarding information to be furnished in exemption applications relating to plans affected by an exemption transaction undertaken by a pooled investment vehicle. (This comment is discussed in more detail below.)

Who May Apply for Exemptions

Section 2570.32(a) of the proposed regulation provided that exemption proceedings may be initiated by the Department either on its own motion or upon the application of: (1) Any party in interest to a plan which is or may be a party to the exemption transaction, (2) any plan which is a party to the exemption transaction, or (3) an association or organization representing parties in interest who may be parties to an exemption transaction covering a class of parties in interest or a class of transactions.

One of the comments received recommended modifying this paragraph of the regulation to permit an exemption application to be filed by any fiduciary or prospective fiduciary with respect to plan assets under such fiduciary's management or control, regardless of whether such fiduciary either represents a specific plan with respect to the exemption application or would be a party to the exemption transaction. The commentator clarified his comment by explaining that he intended this category of applicants to cover prospective fiduciaries, such as persons creating and/or managing a new investment vehicle in which plans are expected to participate if the requested exemption is granted, but in which no plans participate at the time the exemption application is filed. The commentator noted that in the past the Department has granted individual exemptions to institutional investment managers in connection with their investment management of individual plans' investment accounts or pooled investment funds in which several unidentified plans may participate.

In the Department's view, the reference in proposed § 2570.32(a)(1) to "any party in interest to a plan who is or may be a party to the exemption transaction" includes the prospective fiduciaries mentioned by the commentator. Therefore, § 2570.32(a) is adopted in the final regulation without change.

Section 2570.32(b) and (c) of the proposed regulation set forth simplified rules relating to representation of applicants by third parties. No comments were received regarding these paragraphs, which are adopted in the final regulation without change.

Applications the Department Will Not Ordinarily Consider

Section 2570.33(a) of the proposed regulation described the circumstances under which the Department will not ordinarily consider the merits of an exemption application. Thus, this paragraph provided that the Department will not ordinarily consider an incomplete application. In this regard, the Department emphasizes that applicants should not file exemption applications until they have compiled all the information required by § 2570.34 and, if applicable, § 2570.35, and can submit this information in an organized and comprehensive fashion together with all necessary supporting documents and statements. In addition, the proposal made it clear that the Department ordinarily will not consider applications that involve a transaction, or a party in interest with respect to such transaction, that is the subject of an ERISA enforcement action or investigation. In certain cases, however, the Department may exercise its discretion to consider exemption applications in these categories where, for example, deficiencies in the exemption application are merely technical, or where an enforcement matter is clearly unrelated to the exemption transaction.

One comment was received specifically regarding investigations, and it is discussed above under the heading "Applications for Exemption under FERSA." In addition, the Department has amended § 2570.33(a)(2) (relating to certain investigations and enforcement actions) to conform to a similar revision to § 2570.35(a)(7) (discussed below) made in response to two other comments received regarding the proposed requirement to include information in an application concerning certain investigations, examinations, litigation, or continuing controversy involving specified Federal agencies with respect to any plan or party in interest involved in the exemption transaction. The effect of these amendments is to expand the proposed regulation in order to broaden the scope of exemption applications which the Department will ordinarily consider.

No comments were received on paragraphs (b) and (c) of proposed § 2570.33, which are adopted without change in the final regulation. These paragraphs relate to the Department's written explanation to an applicant whose exemption application the Department has decided not to consider, and to applications for individual exemption relating to transaction(s) covered by a class exemption under consideration by the Department.

Exemption Application Contents - General Information

As previously noted in the proposed regulation, the Department's experience to date with the administrative exemption program suggests that the program's efficiency could be increased and applicants can receive more timely treatment of their applications for exemption if the quality of exemption applications filed were improved. In the past, applications have been incomplete, have omitted or misstated facts or legal analyses needed to justify requests for exemptive relief, and in some cases have been so poorly drafted that the details of the transactions for which exemptive relief is sought ("exemption transactions") are unclear. The time and effort required to deal with such deficient applications and to obtain accurate and complete information about exemption transactions have contributed to processing delays. Moreover, in many exemption applications, the discussion of the substantive basis for the exemption does not take adequate account of positions adopted by the Department with respect to other similar applications.

The proposed regulation attempted to address these problems in a number of ways. First, the proposal required that applicants provide more complete information in their applications about exemption transactions and about the plans and the parties in interest involved in those transactions. The Department's experience suggests that this additional information is very helpful, and often essential, for a complete understanding of the exemption transaction and of the context surrounding it, and that the omission of such additional information in exemption applications will delay review of these applications on their merits.

For the same reason the proposed regulation required filing with the exemption copies of the relevant portions of documents. By filing comprehensive applications with necessary supporting documentation, applicants can do much to facilitate the Department's review of requested exemptions and to expedite the exemption process as a whole.

To further expedite the exemption process, the proposed regulation required that an applicant include with his application a statement explaining why the requested exemption satisfies requirements set forth in sections 408(a) of ERISA and 4975(c)(2) of the Code and 5 USC 84711(c)(3)(C) that an exemption be:

  1. Administratively feasible;
  2. In the interests of the plan and of its participants and beneficiaries; and
  3. Protective of the rights of the plan's participants and beneficiaries.

This requirement is not new. Under ERISA Proc. 75-1, applicants have been required to include with their applications statements explaining why a requested exemption satisfies the statutory prerequisites for an exemption. Too often, however, applicants have attempted to satisfy this requirement with generalizations and perfunctory assurances about the benefits to be reaped by plans and their participants and beneficiaries from the proposed exemption.

The Department will not seek out reasons to grant an exemption that has not been adequately justified by an applicant. Indeed, the Department considers that it is the responsibility of applicants to demonstrate clearly that exemptions they are requesting meet statutory criteria. Accordingly, under both the proposed and the final regulation, applicants are expected to review the statutory criteria for granting administrative exemptions and explain with as much specificity as possible why a requested exemption would pose no administrative problems, what benefits affected plans and their participants and beneficiaries can expect to receive from it, and what conditions word be attached to protect the rights of participants and beneficiaries of affected plans.5

Under ERISA Proc. 75-1, applicants have been given the option, but have not been required, to submit a draft of the proposed exemption. Both the proposed and the final regulation preserve this option. However, while not requiring the submission of a draft of the proposed exemption, the Department recommends that applicants include in their exemption applications draft language which defines the scope of the requested exemption, including the specific conditions under which the proposed exemption would apply. A draft which explains the exemption requested in a clear and concise manner and focuses on what the applicant considers to be the essential features of the exemption transaction and the critical safeguards supporting the requested relief is likely to facilitate the process of review. Obviously, the degree of detail necessary to describe the proposed exemption adequately will vary depending on the complexity of the transaction and the kind of relief requested.

Section 2570.34 of the proposed regulation listed the information that is required in every exemption application, whether it be an application for individual or class exemption. In addition, the information specified in § 2570.35 of the regulation must be included in applications for individual exemptions. Some specific items of information are described below.

Shared Representation

Section 2570.34(a)(3) of the proposed regulation required each exemption application to disclose whether the same person will represent both the plan and the parties in interest involved in an exemption transaction in matters relating to the application. The proposal noted that such shared representation may raise questions under the exclusive purpose and prudence requirements of sections 403(b) and 404(a) of ERISA and under the prohibited transaction provisions of section 406 of ERISA and section 4975(c)(1) of the Code. No comments have been received regarding this subparagraph, which is adopted as proposed.

Third-Party Declarations

Section 2570.34(b)[5)(iii) of the proposed regulation required a declaration under penalty of perjury to accompany specialized statements from third-party experts submitted to support an exemption application, such as appraisals, analyses of market conditions, or opinions of independent fiduciaries. Specifically, the proposal required a declaration under penalty of perjury that to the best of the expert's knowledge and belief, the representations made in the specialized statement are true and correct. This declaration was to be dated and signed by the expert who prepared the statement.

One of the commenters urged deletion of this requirement and expressed concern that it would cause additional expense to applicants because new third-party statements would be required once the appraiser, engineer, financial specialist, or other expert became aware of their intended use as part of an exemption application. The commentator advised subsequently that such experts either may be reluctant to provide any sort of attestation because of unknown liabilities which may arise by using the expert's report as part of an exemption application, or may seek an additional, and perhaps substantial, fee for furnishing an attestation due to the unknown liabilities.

In this regard the Department notes that, with respect to any matter within the jurisdiction of any department or agency of the United States, it is a crime, punishable by a fine of up to $10,000 and/or imprisonment of up to five years, for anyone knowingly and willfully to falsify, conceal or cover up by any trick, scheme or device a material fact; to make any false, fictitious, or fraudulent statements or representations; or to make or use any false writing or document knowing the same contains any false, fictitious, or fraudulent statement or entry (18 USC 1001). It is the view of the Department that this provision applies to applicants for exemptions under ERISA, the Code, or FERSA, to fiduciaries (independent or otherwise) representing the plan in an exemption, transaction, and to third-party experts who prepare statements or reports that such experts know will be included in exemption applications.

Nevertheless, the Department recognizes that third-party experts, such as appraisers, bankers, financial analysts, and other specialized consultants usually do not function as fiduciaries with respect to a plan if such experts authority, responsibility, or contact with respect to the plan is limited to providing an opinion which may be included in an exemption application, and which will be considered by plan fiduciaries who will decide what, if any, action they will take on behalf of the plan based upon such opinion. The Department believes that such experts need not be held to the same degree of accountability regarding exemption applications covering transactions where a plan fiduciary has the authority and responsibility to make decisions on behalf of a plan. Thus, the Department has decided to modify proposed § 2570.34(b)(5)(iii) to provide that a statement of consent, rather than a declaration under penalty of perjury, is required from each such expert which acknowledges that his or her statement is being submitted to the Department as part of an exemption application. The Department believes that such a consent statement from a third-party expert will not require an applicant to obtain a new report from the expert because the expert's consent statement may refer to his or her previously issued report. (However, the Department may require an updated report in any case if the substantive information contained in a report submitted with an exemption application is out of date.)

Conversely, where an independent fiduciary represents the plan in an exemption transaction, that fiduciary is subject to all of the responsibilities imposed by part 4 of subtitle B of title A of ERISA. None of the comments received questioned the need for such a fiduciary to provide the declaration under penalty of perjury required under the proposed regulation, and the Department has decided to retain this proposed requirement for such plan fiduciaries in the final regulation. As a result, the Department has modified § 2570.34(b)(5)(ii) and has added § 2570.34(b)(5)(iv) to clarify that a declaration is required for such plan fiduciaries.

Pooled Funds

One comment suggested that § 2570.35 of the proposed regulation be modified to provide a special rule regarding information to be included in an application for an individual exemption involving a pooled investment fund, such as a pooled separate account maintained by an insurance company or a collective investment fund maintained by another financial institution. The commentator pointed out that, as proposed, § 2570.35 would require information to be submitted regarding each plan participating in a pooled investment fund, resulting in the submission of an overwhelming volume of information unrelated to the exemption transaction. However, the commentator recognized that information regarding certain plans may be relevant to the exemption application in view of the potential for conflicts of interest involving such plans. Such plans would include any plan maintained for employees of the sponsor or other fiduciary of the pooled investment fund, and a plan whose participation in the pooled fund exceeded a specified percentage of the total fund assets.

The Department agrees with this comment and, accordingly, has added a new paragraph (c) to § 2570.35, which contains a special rule for applications for individual exemptions involving pooled funds [as defined in § 2570.31(g)]. Subparagraph (1) of § 2570.35(c) excepts such applications from including certain information otherwise required relating to among other things: reportable events under section 4043 of ERISA, notice of intent to terminate a plan (section 4041 of ERISA), the number of participants and beneficiaries of each plan participating in the pooled fund, and the percentage of each such plan's assets involved in the exemption transaction.

Subparagraph (2) of the special rule provides that certain information otherwise required by § 2570.35(a) and (b) of the regulation must be furnished by reference to the pooled fund rather than the plans participating in such fund. This information pertains to: Identifying information; any prior violations of the Code's exclusive benefit rule or of the prohibited transaction provisions of the Code, ERISA or FERSA, any prior applications for exemption from such prohibited transaction provisions; any lawsuits or criminal actions regarding conduct with respect to any employee plan; any criminal convictions described in section 411 of ERISA; any investigation or continuing controversy with specified Federal agencies regarding compliance with ERISA, Code provisions relating to employee plans, or FERSA provisions relating to the Federal Thrift Savings Fund; whether the exemption transaction has been consummated and, if so, certain related information regarding correction of the prohibited transaction and payment of excise taxes; the identification of persons with investment discretion over any assets involved in the exemption transaction and each such person's relationship to the parties in interest involved in the exemption transaction; investments involving certain parties in interest, the fair market value of the pooled fund; the identity of the person who will pay the costs of the exemption application, notifying interested persons, and the fee of any independent fiduciary involved in the exemption transaction; and an analysis of the facts relevant to the exemption transaction as reflected in documents submitted with the application. The pooled fund, rather than participating plans, must also furnish copies of all relevant documents, including, for example, the most recent financial statements of the pooled fund.

Subparagraph (3) of the special rule requires information to be furnished with pooled fund exemption applications with respect to: the aggregate number of plans expected to participate in the pooled fund, and the limits (if any) imposed by the pooled fund on the amount or percentage of each participating plan's assets that may be invested in the pooled fund.

Subparagraph (4) of § 2570.35(c) contains additional requirements for applications for individual exemptions involving pooled funds. These requirements apply to plans whose investments in the pooled fund represent more than 20% of the pooled fund's total assets6 and those plans covering employees of the pooled fund's sponsor, and other fiduciaries with discretion over pooled fund assets. The Department believes that additional information is warranted in those situations where the potential for decision making that may inure to the benefit of a fiduciary or other party in interest is increased. For each of these plans, the additional requirements provide for the furnishing of certain individual plan information described in 2570.35(a), in addition to the information required under § 2570.35(c)(2) and (c)(3). The Department believes this information is necessary for its determination as to whether sufficient protections are incorporated into the exemption transaction.

The Department further notes that the decision by the fiduciaries of certain plans to invest in a pooled fund may involve a separate prohibited transaction, apart from any prohibited transaction which may be entered into by the pooled fund itself In this regard, the Department notes that the information required to be submitted on behalf of such plans is to be provided in accordance with the general rule contained in § 2570.35, rather than the special rule for pooled funds.

Finally, the Department believes that the special rule for pooled funds is less burdensome to applicants than the rules set forth in the proposed regulation. As noted by a commentator, the proposed regulation would have required the submission of voluminous amounts of material, as information would have to be submitted on behalf of each plan investing in a pooled fund. The final regulation limits the amount of material to be submitted since it requires only information relating to the pooled fund and, where applicable, certain plans investing in the pooled fund. In addition, the Department believes that its ability to analyze and process applications for exemption involving pooled funds will be enhanced by this special rule. In this regard, the Department believes that the final regulation eliminates a significant amount of material that otherwise would have been required.

Lawsuits, Certain Criminal Convictions, Investigations, Examinations, Continuing Controversies, etc.

Sections 2570.35(a)(5), (6), and (7) of the proposed regulation required exemption applications to disclose information regarding whether the applicant or any of the parties to the exemption transaction is or has been, within a specified number of years past, a defendant in any lawsuit or criminal action concerning conduct as a fiduciary or other party in interest with respect to any employee benefit plan (§ 2570.35(a)(5)(b) convicted of a crime described in section 411 of ERISA (§ 2570.35(a)(6)), or under investigation or examination or engaged in litigation or a continuing controversy with certain Federal agencies (§ 2570.35(a)(7)). Proposed § 2570.35(a)(7) also required disclosure of whether any plan affected by the exemption transaction has been under such investigation, examination, litigation, or any controversy, and further required the applicant to submit copies of all correspondence with the specified Federal agencies regarding substantive issues involved in such investigation, etc.

Two of the comments urged deletion of the disclosure requirements of proposed § 2570.35(a)(5) and (7) on the basis that such disclosure is difficult, costly, and almost always irrelevant to the exemption transaction.

The Department continues to believe that the proposed disclosure is relevant to the exemption transaction. With regard to § 2570.35(a)(5) (relating to lawsuits or certain criminal actions), the Department views the disclosure required as directly concerning the conduct of the applicant and other parties in interest participating in the exemption transaction. The Department believes that such information is necessary in evaluating the credibility and integrity of such parties, some of whom may possess substantial discretion regarding the exemption transaction or may make representations upon which the Department must rely in determining whether the statutory criteria for an exemption have been satisfied. In addition, the proposed disclosure assists the Department in ensuring that the exemption contains appropriate safeguards.

Further, the Department does not agree that the disclosure required by § 2570.35(a)(5) imposes any "significant" burdens on applicants. The Department believes that prudent fiduciaries would in the normal course of carrying out their responsibilities, ascertain such information about the parties they intend to deal with in investment and other plan transactions. However, the Department has determined that it would be appropriate to modify proposed § 2570.35(a)(5) in the final regulation to limit disclosure to the applicant or any of the parties in interest involved in the exemption transaction.

Regarding the disclosure required by proposed § 2570.35(a)(7) (relating to, investigations, examinations, litigation, and continuing controversy by or with the specified Federal agencies), the Department believes that such information is necessary to ensure that the Department's exemption activities do not compromise its enforcement efforts. Although the Department is most interested in information involving investigations, etc. that are directly related to the subject exemption transactions and the participating parties, the Department believes, nevertheless, that its exemption staff, and not the applicants, should determine which investigations, examinations, etc., are relevant.

One of the comments further suggested that it is inappropriate to require applicants to disclose matters which have resulted in no formal allegations of violations of law. The Department notes, however, that the affected parties may include, as part of their disclosure, any qualification or explanations they deem appropriate for consideration by the Department, including information on the final disposition of any matter;

Another commentator suggested that disclosure under § 2570.35(a)(7) be limited to a reference to the investigation or litigation without requiring submission of copies of "all correspondence" involved in the investigation. In this regard, the Department notes that the proposed regulation did not require submission of copies of all correspondence, but only of correspondence relating to the, substantive issues involved in the investigation, examination, litigation, or controversy. Specifically, the Department intended to require submission of copies of correspondence containing only that information directly relevant to determining whether or not the requested exemption should be granted. After considering the comment, the Department has modified § 2570.35(a)(7) to clarify that the phrase "substantive issues" refers to issues related to compliance with the provisions of parts 1 and 4 of subtitle B of title I of ERISA (reporting and disclosure (part 1) and fiduciary responsibility (part 4)), section 4975 of the Code, or sections 8477 or 8478 of FERSA (fiduciary responsibilities, liability and penalties (section 8477) and bonding (section 8478). Copies of correspondence relating to any of these substantive issues is necessary in order for the Department to determine the effect the requested exemption may have on the Department's enforcement activities in each case under investigation, examination, etc.

One of the comments noted that proposed § 2570.35(a)(5), (6) and (7) required the disclosure of information regarding any parties to the exemption transaction and suggested limiting the disclosure to fiduciaries authorizing the transaction and any parties in interest involved in the exemption transaction. This comment pointed out that investment transactions may involve multiple parties, many of wham are neither plan fiduciaries nor parties in interest. After due consideration, the Department agrees with this suggestion and, accordingly, has modified § 2570.35(a)(5), (6) and (7) to limit the required disclosure to any parties in interest involved in the exemption transaction. The Department rates that this group includes, among others, the fiduciary authorizing the exemption transaction.

See the heading "Applications for Exemption under FERSA," above, regarding modification to proposed § 2570.35(a)(7) as applicable to the Federal Thrift Savings Plan established by FERSA.

Party-in-Interest Investments

Proposed § 2570.35(a)(16) required an application for individual exemption to disclose information regarding any plan investments in loans to, property leased to, or securities issued by, any party in interest involved in the exemption transaction. One of the comments suggested deletion of this requirement due to the difficulty of identifying such investments in view of the "look-through" rule contained in the Department's plan asset regulation (29 C.F.R. 2510.101). This comment suggested that the proposed disclosure may invoke many transactions, by an entity whose underlying assets include "plan assets," which are totally unrelated to the exemption transaction. The comment further indicated that this disclosure would be burdensome for exemption transactions involving numerous parties in interest, such as those involving pooled funds.

The Department agrees that, for exemption applications involving pooled funds, furnishing the proposed disclosure could be burdensome inasmuch as such applications generally do not relate to specific plans. Accordingly, the Department has adopted a special rule for applications for individual exemption involving pooled funds, discussed above (under the heading "Pooled Funds"), which limits this type of disclosure to the pooled fund and to certain plans participating therein.

Regarding exemption applications involving specific individual plans, it appears to the Department that the information to be disclosed under proposed § 2570.35(a)(16) must be maintained, in any event, to satisfy the annual reporting requirements of section 103 of ERISA, as well as the recordkeeping requirements of section 107. Therefore, the Department believes that this disclosure requirement should not impose any additional burdens on the applicant. The information to be disclosed will enable the Department to determine whether the exemption transaction, in conjunction with other plan investments involving parties in interest, would unduly concentrate the plan's assets in such investments so as to raise questions under the fiduciary responsibility provisions of section 404 of ERISA. For these reasons, the Department has decided to adopt § 2570.35(a)(16) as proposed, subject to the special rule for applications for individual exemption involving pooled funds in § 2570.35(c).

Costs Related to the Exemption Application

Proposed § 2570.35(a)(18) and (19) required the exemption application to identify the person who will bear the costs of the exemption application, of notifying interested persons, and of the fee charged by any independent fiduciary involved in the exemption transaction. The preamble to the proposed regulation noted that a plan's payment of the expenses associated with the filing or processing of an exemption application raises questions under the fiduciary responsibility and the prohibited transaction restrictions to the extent that any party in interest benefits from the transaction for which an exemption is sought (see section 406(a)(1)(D) of ERISA).

One of the commentators requested that the Department provide a more specific discussion of when it believes such questions will be raised. The comment states that, in many cases, it is appropriate for the plan to pay the expenses attributable to obtaining an exemption, and that an independent fiduciary's fees are generally paid by the plan receiving such fiduciary's services in order to ensure that such fiduciary conducts its activities in a totally independent manner and without any potential influence from persons other than the plan paying such fees.

The proposed disclosure of who pays the fees for an exemption application is intended to enable the Department to review the appropriateness of such payment by a plan in the context of a specific exemption request. Such disclosure is also intended to aid the exemption staff in evaluating whether the economic merits of the transaction, taking into account the costs attributable to the exemption application, support a finding that the proposed transaction is in the interests of the plan and its participants and beneficiaries. While the Department agrees that there may be certain instances in which it would be appropriate for a plan to pay all or part of the costs attendant with obtaining an exemption, such as where it is necessary to ensure the independence of an independent fiduciary or third-party expert, the Department believes that the propriety of such payments by a plan is an inherently factual determination which can be made only on a case-by-case basis.

In this regard, the Department notes that, when evaluating the propriety of the payment by a plan of certain expenses, plan fiduciaries must first consider the general fiduciary responsibility provisions of sections 403 and 404 of ERISA. Section 403(c)(1) provides, in part, that the assets of an employee benefit plan shall never inure to the benefit of any employer and shall be held for the exclusive purpose of providing benefits to participants and beneficiaries and defraying reasonable expenses of administering the plan. Similarly, section 404(a)(1)(A) requires, in part, that a fiduciary of a plan discharge his duties for the exclusive purpose of providing benefits to participants and their beneficiaries and defraying reasonable expenses of administering the plan. Thus, a payment that is not a distribution of benefits to participants or beneficiaries of a plan would not be consistent with the requirements of sections 403(c)(1) and 404(a)(1)(A) unless it was used to defray a reasonable expense of administering the plan.

In addition, 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. It is the responsibility of appropriate plan fiduciaries to determine whether a particular expense is a reasonable administrative expense under sections 403(c)(1) and 404(a)(1)(A) of ERISA or whether plan payment of an expense would constitute a prohibited use of plan assets for the benefit of a party in interest under section 406(a)(1)(D) of ERISA.

Copies of Documents

Section 2570.35(b)(1) of the proposed regulation required each application for individual exemption to include true copies of all documents bearing on the exemption transaction, such as contracts, deeds, agreements, instruments, and relevant portions of plan documents, including trust agreements.

One comment objected to this requirement on the grounds that having to assemble the required documents is time consuming, costly, and unnecessary if the exemption application properly describes all pertinent plan provisions and other documents in sufficient detail to allow the Department to evaluate the merits of the exemption transaction. In this regard, the Department notes that the documents with respect to which copies are requested are all documents which would be readily available to the parties to the exemption transaction. Accordingly, the Department does not believe that there would be a significant burden in either compiling the documents or in transmitting copies to the Department. Further, the Department notes that it is not uncommon for representations contained in an exemption application to be inconsistent with the provisions of the governing documents or for the latter to contain provisions with respect to which clarifications or other representations are needed in order for the requested exemption to be proposed. On the basis of the Department's experience with exemptions, scrutiny of the relevant documents is, in the large majority of cases, a necessary prerequisite to a complete understanding of the exemption transaction and the implications for affected plans and parties in interest. Moreover, in the Department's experience, the inclusion of copies of the requested documents, as part of the exemption application, has expedited the processing of the requested exemption.

For these reasons, the final regulation adopts proposed § 2570.35(b)(1) without change. However, the Department wishes to clarify three points regarding this requirement. -

  • First, for exemption transactions in which identical documents will be executed by more than one party, the submission of only one specimen document will satisfy the requirements of this paragraph.
  • Second, in the case of exemption transactions which are proposed, copies of the documents relating to the proposed transaction need not be executed or dated when they are submitted with the exemption application if the documents are complete in every other respect. In this regard, the Department strongly encourages requesting an administrative exemption before entering into a prohibited transaction because of the ability to incorporate all of the necessary safeguards into the transaction. By contrast, such safeguards cannot be put into place after a prohibited transaction has occurred.
  • Third, only copies of documents need be submitted. The Department may not be able to return original documents and, therefore, urges that only true copies of documents be submitted.

Where To File an Application

Although no comments were received regarding this section, which is adopted as proposed, the Department wishes to advise applicants that including the room number of the Division of Exemptions in the address will generally expedite its delivery. The current room number of the Division of Exemptions, Room N-5671, is not included in the regulation to avoid the need to amend the regulation every time the room, number of the Division changes.

Duty To Amend and Supplement Information

The proposed regulation contained the requirement established in ERISA Proc. 75-1 that an applicant promptly notify the Division of Exemptions if he discovers that any material fact or representation contained in his application, or in any supporting documents or testimony, was inaccurate or if any such fact or representation changes. However, the proposed regulation added the requirement that an applicant notify the Division of Exemptions when anything occurs that may affect the continuing accuracy of such facts or representations.

Two comments received indicated confusion as to the expiration date of the duty to update information submitted as part of an exemption application. Accordingly, the final Regulation clarifies § 2570.37(a) and (b) to indicate that such duty applies only during the pendency of the exemption application and expires after the exemption is granted. The Department also wishes to clarify that, in § 2570.37(a), the phrase "continuing accuracy of any such fact or representation" refers to future events or changes known before the exemption is granted that will render inaccurate facts stated or representations made before such grant. The Department wishes to note that exemptions are granted only to transactions as described. Therefore, if an exemption is granted and the transaction is not as described in some material aspect, the exemption does not take effect or protect parties in interest from liability for the transaction. See § 2570.49 of the regulation.

Tentative Denial Letters

Although ERISA Proc. 75-1 established no procedures to be followed by the Department in denying exemption applications or by applicants in responding to such denials, the Department has developed procedures over the years to notify applicants first to the tentative and, later, of the final denial of their applications. In large part, the proposed regulation codified these procedures.

Under the proposed regulation, the Department may decide to deny an exemption request at any of a number of stages in the review process. For example, it may decide after its initial review of an application that the requested exemption does not satisfy the statutory criteria set forth in sections 408(a) of ERISA and 4975(c)(2) of the Code. In that event, the Department will send a tentative denial letter to the applicant pursuant to § 2570.38 of the regulation. That letter will inform the applicant of the Department's tentative decision to deny the application and of the reasons therefore. Under § 2570.38, an applicant has 20 days from the date of this letter to request a conference with the Department and/or to notify the Department of his intern to submit additional information in writing to support the application. If the Department receives no request for a conference and no notice of intent to submit additional information within that time, it will send the applicant a final denial letter pursuant to § 2570.41 of the regulation.

One of the comments received suggested that: (1) The final regulation should clarify that the Department's exemption staff may request applicants to provide additional information before a tentative denial letter is issued, and (2) rather than a "short statement" of the reasons for a tentative denial, the tentative denial letter should provide a detailed explanation of the basis for the Department's decision. Regarding the first suggestion, the comment indicates that it is unreasonable to expect an applicant to anticipate, when the exemption application is filed, all of the material which the Department may find pertinent to its consideration of an exemption application.

As stated above (under the heading "Exemption Application Contents - General Information), the Department's view is that the applicant bears the responsibility to demonstrate clearly that the requested exemption meets the statutory criteria. While nothing in the proposed regulation would preclude the Department's exemption staff from exercising its discretion and contacting an applicant for a clarification or additional information, the Department anticipates that such contact will be limited to exemption applications which, upon initial review, meet the essential requirements of the regulation. It is not administratively feasible to expect the Department's exemption staff to solicit information in every case. Moreover, such a procedure would, in effect, shift the burden of developing the exemption application from the applicant to the exemption staff.

Similarly, the imposition of a requirement that tentative denial letters detail all the reasons for the denial would, in effect, shift the analytical burden from the applicant to the Department. As with the circumstances under which additional information is solicited from applicants, the Department believes that the degree of detail required for a tentative denial letter should be left to the discretion of the exemption staff. The Department believes that a general statement of the reasons for a tentative denial is sufficient inasmuch as the issuance of a tentative denial letter does not terminate the exemption proceedings. Rather, the tentative denial letter offers the applicant the opportunity to have a conference and/or to submit additional information for consideration. In addition, a requirement to issuer a comprehensive and detailed tentative denial letter in most cases would significantly increase the time required to conclude a final action.

For these reasons, the Department has decided to adopt proposed § 2570.38 without change.

Opportunities To Submit Additional Information

Section 2570.39 of the proposed regulation provided that if an applicant wishes to submit additional information in support of a tentatively denied exemption application, he may notify the Department of his intention to do so within the prescribed 20-day period either by telephone or by letter. After issuing such a notice, an applicant has 30 days from the date of the notice to furnish additional information to the Department. If an applicant notifies the Department of his intent to submit additional information but requests no conference, and subsequently fails to submit the promised information within the prescribed 30-day period, the Department will issue the applicant a final denial letter pursuant to § 2570.41 of the regulation. However, an applicant who realizes that he will be unable to submit his additional information within the allotted time may avoid receiving a final denial letter by withdrawing his application before the end of the 30-day period pursuant to § 2570.44.

As an alternative to withdrawing his application, an applicant who, for reasons beyond his control, is unable to meet the 30-day deadline may request an extension of time for filing additional information, pursuant to § 2570.39 of the regulation. However, the Department will grant such extensions of time only in unusual circumstances.

No comments were received on this section of the proposed regulation which is adopted without change in the final regulation.

Conferences

Section 2570.40 of the proposed regulation described the procedures regarding conferences on exemption applications which the Department has tentatively decided to deny. Under this proposed section, an applicant is entitled to only one conference with respect to any exemption application, and is also given 20 days after the date of any conference to submit to the Department in writing any additional data or arguments discussed at the conference but not previously or adequately presented in writing. Under the proposal, an applicant is deemed to have waived his right to a conference if he fails, without good cause, to appear for a scheduled conference or to schedule a conference for any of the times proposed by the Department within the 45-day period following the receipt of his request for a conference.

Proposed § 2570.40 is adopted without change in the final regulation. The only comment received regarding this proposed section suggested that the Department continue its practice of informally consulting with applicants on exemption applications in addition to holding conferences. In this regard, the Department will continue to informally contact applicants as it deems appropriate.

Final Denial Letters

Proposed § 2570.41 is adopted without change in the final regulation. No comments were received on this section which specifies the circumstances in which the Department may issue a final denial letter denying a requested exemption. In most cases, the same procedure will also be followed in denying exemptions that the Department has already proposed through publication of a notice of proposed exemption in the Federal Register. However, in cases where the Department holds a hearing on an exemption, § 2570.41(a)(3) of the proposed regulation allowed the Department to issue a final denial letter without first issuing a tentative denial letter and without providing the applicant with the opportunity for a conference. In the Department's view, where a hearing on a proposed exemption is conducted, the applicant and other proponents of the exemption have adequate opportunity to present their views and other evidence in support of the exemption.

Notice of Proposed Exemption

The proposed regulation did not significantly alter the procedures established by ERISA Proc. 75-1 for granting an exemption. Under § 2570.42 of the regulation, the Department will publish a notice of proposed exemption in the Federal Register if, after reviewing an exemption application and any additional information submitted by an applicant, the Department tentatively concludes that the requested exemption satisfies the statutory criteria for the granting of an exemption and that the requested exemption is otherwise appropriate. This proposed section also described the contents of the notice of proposed exemption.

No comments were received on proposed § 2570.42, which is adopted without change in the final regulation.

Notifying Interested Persons

Like ERISA Proc. 75-1, the proposed regulation required applicants to provide notice to interested persons in the event that the Department decides to propose the exemption. Section 2570.34 of the proposal required an applicant to submit with his application a description of the interested persons to whom notice will be provided and a description of the manner in which the applicant proposed to provide notice. That section also required an applicant to provide an estimate of the time he will need to furnish notice to interested persons following publication of a notice of proposed exemption.

Section 2570.43 of the proposed regulation provided guidance on methods an applicant may use to notify interested persons of a proposed exemption and indicated what must be included in the notice. In addition to the Notice of Proposed Exemption published in the Federal Register, the applicant must include in the notification to interested persons a supplemental statement. Section 2570.43 also stated that, once the Department has published a notice of proposed exemption, the applicant must notify the interested persons described in his application in the manner indicated in the application unless the Department has informed the applicant beforehand that it considers the method of notification described in the application to be inadequate. Where the Department has so informed an applicant, it will also secure from the applicant an agreement to provide notice in the time and manner and to the persons designated by the Department. After furnishing notification, an applicant must provide the Department with a declaration under penalty of perjury certifying that notice was given to the persons and in the manner and time specified in his application or the superseding agreement with the Department.

One of the comments received concerning notification requested clarification that, in the case of a pooled fund, the notification requirement would be satisfied if the notice to interested persons is furnished to the appropriate fiduciary of each of the plans participating in the pooled fund, but not to all participants and beneficiaries of such plans.

In the Department's view, the individuals or organizations that will constitute "interested persons" depends on the nature of the exemption being requested. For this reason, the proposed regulation did not attempt to delineate the term "interested persons" for purposes of the notification requirements of § 2570.43. As previously noted, the applicant is required to include, as part of the exemption application, a description of the interested persons to whom the applicant intends to provide notice (§ 2570.34(b)(2)(i)). If the Department finds that either the method of providing notice or the persons to whom the applicant proposes to provide notice is inadequate, the Department will, pursuant to § 2570.43, secure an agreement from the applicant on the appropriate method of providing the notice and/or the scope of the notice to be provided. The Department believes that this approach provides the flexibility necessary to accommodate the varied types of exemption applications, as well as circumstances unique to a particular applicant.7

Accordingly, the Department has decided to adopt § 2570.43 as proposed. However, subparagraph (b)(2) of this section has been modified to insert references to the Code and FERSA and to reflect the current room number of the Division of Exemptions in a footnote to that section. Paragraph (d), of this section has also been modified to clarify that the declaration accompanying the statement to be furnished to the Department regarding the notice to, interested persons must be made under penalty of perjury, as stated in the preamble to the proposed regulation (53 FR 24422, at 24425, June 28,1988).

Withdrawal and Reinstatement of Exemption Applications

Section 2570.44 of the proposed regulation permitted an applicant to withdraw his application at any time and to reinstate the application later. Reinstatement may be requested without resubmitting any information or materials previously furnished if no more than two years has elapsed from the withdrawal date. The request for reinstatement must be accompanied by any additional information that was outstanding at the time of withdrawal.

No comments were received on the proposed section, which is adopted in the final regulation without change.

Requests for Reconsideration of Final Denials

Under § 2570.45 of the proposed regulation, after the Department has issued a final denial letter on an exemption, it will not reconsider an application covering the same transaction unless the applicant presents significant new facts or arguments in support of the exemption which, for good reason, the applicant could not have submitted for consideration during the Department's initial review of the exemption. An applicant must present the significant new facts or arguments in a request for reconsideration within 180 days after the issuance of the final denial letter.

Proposed § 2570.45 also stated that only one request for reconsideration of any finally denied application will be considered by the Department. Although no comments were received on this section of the proposed regulation, the Department has modified this section in the final regulation to clarify that the Department will not limit the number of requests for reconsideration of final denials based solely on the applicant's failure to respond timely to a tentative denial letter or to furnish additional information timely (i.e., within the time frames provided under § 2570.38(b) or 2570.39(e), respectively).

The Department has also clarified in the final regulation that the declaration required under § 2570.45(c) must be made under penalty of perjury. This clarification is consistent with the requirement of § 2570.34(b)(5) that every original exemption application must be accompanied by a similar declaration under penalty of perjury. The Department intends that the same type of declaration should accompany both an original exemption application and request for reconsideration of a final denial based on the merits of such an application.

Hearings

Section 408(a) of ERISA precludes the Department from granting an exemption from the fiduciary self-dealing prohibitions of section 406(b) unless the Department affords an opportunity for a hearing and makes a determination on the record with respect to the three statutory criteria established for granting an exemption.8 Because these provisions specify that an opportunity for a hearing must be given before an exemption from these prohibitions is granted, but not before such an exemption is denied, the Department interprets these provisions to mean that only opponents of such an exemption must be given an opportunity for a hearing. Moreover, the Department has concluded that it must provide a hearing on the record to opponents of such a proposed exemption only where it appears that there are material factual issues relating to the proposed exemption that cannot be fully explored without such a hearing. Indeed, in the Department's experience, such hearings are not useful where the only issues to be decided are matters of law or where material factual issues can be adequately explored by less costly and more expeditious means, such as written submissions. Accordingly, under § 2570.46 of the proposed regulation, the Department requires that persons who may be adversely affected by the grant of an exemption from the fiduciary self-dealing prohibitions offer some evidence of the existence of issues that can be fully examined only at a hearing before it will grant a request for a hearing. Where persuasive evidence of the existence of such issues is offered, however, the Department will grant the requested hearing.

Under § 2570.47 of the proposed regulation, the Department may schedule a hearing on its own motion if it determines that a hearing would be useful in exploring issues relevant to the requested exemption. Under the proposed procedures, if the Department decides to conduct a hearing on an exemption under either § 2570.46 or § 2570.47, the applicant must notify interested persons of the hearing in the manner prescribed by the Department. Ordinarily, such notice may be provided by furnishing interested persons with a copy of the notice of hearing published by the Department in the Federal Register within 10 days of its publication. After furnishing notice, the applicant must submit to the Department a declaration under penalty of perjury certifying that notice has been provided in the manner prescribed.

Any testimony or other evidence offered at a hearing held under either § 2570.46 or § 2570.47 becomes part of the administrative record to be used by the Department in making its final decision on an exemption application.

No comments were received on proposed § 2570.46 and 2570.47, which are adopted without change in the final regulation.

Grant of Exemption

Section 2570.48 of the proposed regulation provided that if, after considering all of an applicant's submissions, together with any comments received from interested persons and the record of any hearing held in connection with a requested exemption, the Department determines that the exemption should be granted, it will publish a notice in the Federal Register granting the exemption. This proposed section also described the contents of the grant notice.

No comments were received on proposed § 2570.48, which is adopted without change in the final regulation.

Limits on the Effect of Exemptions

Notwithstanding the duty to amend and supplement exemption applications provided under § 2570.37, the Department expressly conditions every exemption on the accuracy and completeness of the facts and representations provided by an applicant in support of the exemption. Therefore, as indicated under § 2570.49 of the proposed regulation, an exemption does not take effect or protect parties in interest from liability unless the material facts and representations contained in the application or in any other materials, documents, or testimony submitted by the applicant in support of the application were true and complete Thus, for example, in the case of a continuing exemption transaction such as a loan or a lease, if any of the material facts described in the application were to change after the exemption is granted, the exemption would cease to apply as of the date of such change even though, pursuant to § 2570.37, the applicant would not be obligated to notify the Department of such change. In the event of any such change, the parties in interest involved in the exemption transaction may apply for a new exemption to protect themselves from liability on or after the date of such change. Such an application should be submitted before such change occurs (see the discussion of prospective, versus retroactive, exemptions under the heading "Copies of Documents," above).

No comments were received on proposed § 2570.49, which is adopted without change in the final regulation.

Revocation or Modification of Exemptions

Section 2570.50 of the proposed regulation described the circumstances under which the Department may revoke or modify a previously granted exemption and the rights afforded to the applicant and to other interested persons in the event such revocation or modification is proposed. This section also provided that ordinarily such revocation or modification will be prospective only. Under this proposed section, one of the circumstances permitting the Department to modify or revoke an exemption was a change in policy which calls into question the continuing validity of the Department's original conclusions regarding the granted exemption.

Two of the comments objected to permitting a change in policy as grounds for revoking or modifying a granted exemption. The commentators argued that disturbing transactions already reviewed and approved by the Department would inject an unneeded element of uncertainty into the exemption process. Moreover, concern was expressed that the revocation of an exemption could severely disrupt an applicant's business and impose great financial hardship. A commentator suggested that the final regulation include a prohibition against revocation of an exemption until the affected party in interest is given both written notice of the facts or conduct which may warrant the revocation and an opportunity to demonstrate compliance with the requirements of the exemption.9

Proposed § 2570.50 is intended to provide the Department with the flexibility to undertake appropriate action in those cases where, subsequent to the grant of an exemption, potentially abusive practices or changes in the regulatory environment of an industry are identified which would cause the Department to reconsider its policy with respect to whether the exemption transactions continue to satisfy the statutory criteria under section 408(a) of ERISA.

With regard to the procedural issues raised by one of the comments, the Department notes that paragraph (b) of proposed § 2570.50 provides for notice to interested persons by publication in the Federal Register, notice to the applicant of the proposed revocation or modification, and an opportunity for the interested persons and the applicant to submit comments on the proposed revocation or modification.

After careful consideration of the comments, the Department has decided to adopt § 2570.50 as proposed. However the Department has clarified paragraph (b) to provide that the notice of proposed revocation or modification given to the applicant must be in writing.

Public Inspection and Copies

Section 2570.51 of the proposed regulation provided that the public may examine and copy any exemption application and all correspondence and documents submitted in regard thereto and may receive photocopies of all or any portion of such administrative record for a specified charge per page. For this reason, the Department cannot honor requests to keep confidential any information submitted regarding an exemption application. Therefore, none of the information submitted in regard to a requested exemption should be material that the applicant or other sender does not wish to disclose to the public.

No comments were received on proposed § 2570.51, which is adopted without change in the final regulation.

Executive Order 12291 Statement

The Department has determined that this regulatory action would not constitute a "major rule" as that term is used in Executive Order 12291 because the action would not result in: an annual effect on the economy of $100 million; a major increase in costs or prices for consumers, individual industries, government agencies, or geographical regions; or significant adverse effects on competition, employment, investment, productivity, innovation, or on the ability of United States-based enterprises to compete with foreign-based enterprises in the domestic or export markets.

Regulatory Flexibility Act Statement

The Department has determined that this regulation would not have a significant economic impact on small plans or other small entities. As stated previously, this regulation would do little more than describe procedures that reflect practices already in place for filing and processing applications for exemptions from the prohibited transaction provisions of the Employee Retirement Income Security Act of 1974. the Internal Revenue Code of 1986, and the Federal Employee Retirement System Act of 1986.

Paperwork Reduction Act

This regulation modifies current collection of information requirements. It does so largely by codifying requests for facts and opinions that are routinely addressed to applicants for exemptions under current procedures. Accordingly, the regulation will not increase the paperwork burden for applicants. The regulation has been approved by the Office of Management and Budget under the provisions of the Paperwork Reduction Act of 1980 (Pub. L. 96-511). The final regulation is assigned control number 1210-0060.

Authority

The final regulation set forth herein is issued pursuant to the authority granted in sections 408(a) (Pub. L. 93-406, 88 Stat. 883, 29 USC 1108(a)) and 505 (Pub. L. 93-406, 88 Stat. 894, 29 USC 1135) of ERISA, under Reorganization Plan No. 4 of 1978 (43 FR 47713, October 17, 1978), under 5 USC 8477(c)(3), and under Secretary of Labor's Order No. 187 (52 FR 13139, April 21, 1987).

List of Subjects in 29 C.F.R. Part 2570

Administrative practice and procedure, Employee benefit plans, Employee Retirement Income Security Act, Federal Employees' Retirement System Act, Party in interest, Pensions, Prohibited transactions.

Final Regulation

For the reasons set out in the preamble, parts 2570 and 2585 of chapter XXV of title 29 of the Code of Federal Regulations are amended as follows:

Part 2570 - [Amended]

  1. The authority for part 2570 is revised to read as follows:
  2. Authority: 29 USC 1108(a), 1135; Reorganization Plan No. 4 of 1978; 5 USC 8477(c)(3); Secretary of Labor's Order No. 187.

    Subpart A is also issued under 29 USC 1132(i).

  3. By adding in the appropriate place the following new subpart B to part 2570.

Subpart B - Procedures for Filing and Processing Prohibited Transaction Exemption Applications

Sections.

2570.30 Scope of rules.

2570.31 Definitions.

2570.32 Persons who may apply for exemptions.

2570.33 Applications the Department will not ordinarily consider.

2570.34 Information to be included in every exemption application.

2570.35 Information to be included in applications for individual exemptions only.

2570.36 Where to file an application.

2570.37 Duty to amend and supplement exemption applications.

2570.38 Tentative denial letters.

2570.39 Opportunities to submit additional information.

2570.40 Conferences.

2570.41 Final denial letters.

2570.42 Notice of proposed exemption.

2570.43 Notification of interested persons by applicant.

2570.44 Withdrawal of exemption applications.

2570.45 Requests for reconsideration.

2570.46 Hearings in opposition to exemptions from restrictions on fiduciary self-dealing.

2570.47 Other hearings.

2570.46 Decision to grant exemptions.

2570.49 Limits on the effect of exemptions.

2570.50 Revocation or modification of exemptions.

2570.51 Public inspection and copies.

2570.52 Effective date.

Subpart B - Procedures for Filing and Processing Prohibited Transaction Exemption Applications

§ 2570.30 Scope of rules.

  1. (1) The rules of procedure set forth in this subpart apply to all applications for exemption which the Department has authority to issue under:
    1. Section 408(a) of the Employee Retirement Income Security Act of 1974 (ERISA);
    2. Section 4975(c)(2) of the Internal Revenue Code of 1986 (the Code) (see Reorganization Plan No. 4 of 1978); or
    3. The Federal Employees' Retirement System Act of 1986 (FERSA) (5 USC 8477(c)(3)).
  2. The Department will generally treat any exemption application which is filed solely under section 408(a) of ERISA or solely under section 4975(c)(2) of the Code as an exemption filed under both section 408(a) and section 4975(c)(2) if it relates to a transaction that would be prohibited by ERISA and by the corresponding provisions of the Code.
  3. The procedures set forth in this subpart represent the exclusive means by which the Department will issue administrative exemptions. The Department will not issue exemptions upon oral request alone. Likewise, the Department will not grant exemptions orally. An applicant for an administrative exemption may request and receive oral advice from Department employees in preparing an exemption application. However, such advice does not constitute part of the administrative record and is not binding on the Department in its processing of an exemption application or in its examination or audit of a plan.

§ 2570.31 Definitions.

For purposes of these procedures, the following definitions apply:

  1. An affiliate of a person means -
    1. Any person directly or indirectly through one or more intermediaries, controlling, controlled by, or under common control with the person;
    2. Any director of, relative of, or partner in, any such person;
    3. Any corporation, partnership, trust, or unincorporated enterprise of which such person is an officer, director, or a 5 percent or more partner or owner; and
    4. Any employee or officer of the person who -
      1. Is highly compensated (as defined in section 4975(e)(2)(H) of the Code), or
      2. Has direct or indirect authority, responsibility, or control regarding the custody, management, or disposition of plan assets.
  2. A class exemption is an administrative exemption, granted under section 408(a) of ERISA, section 4975(c)(2) of the Code, and/or 5 USC 8477(c)(3), which applies to any parties in interest within the class of parties in interest specified in the exemption who meet the conditions of the exemption.
  3. Department means the U.S. Department of Labor and includes the Secretary of Labor or his delegate exercising authority with respect to prohibited transaction exemptions to which this subpart applies.
  4. Exemption transaction means the transaction or transactions for which an exemption is requested.
  5. An individual exemption is an administrative exemption, granted under section 408(a) of ERISA, section 4975(c)(2) of the Code, and/or 5 USC 8477(c)(3), which applies only to the specific parties in interest named or otherwise defined in the exemption.
  6. A party in interest means a person described in section 3(14) of ERISA or 5 USC 8477(a)(4) and includes a disqualified person, as defined in section 4975(e)(2) of the Code.
  7. Pooled fund means an account or fund for the collective investment of the assets of two or more unrelated plans, including (but not limited to) a pooled separate account maintained by an insurance company and a common or collective trust fund maintained by a bank or similar financial institution.

§ 2570.32 Persons who may apply for exemptions.

  1. The Department may initiate exemption proceedings on its own motion. In addition, the Department will initiate exemption proceedings upon the application of -
    1. Any party in interest to a plan who is or may be a party to the exemption transaction;
    2. Any plan which is a party to the exemption transaction; or
    3. In the case of an application for an exemption covering a class of parties in interest or a class of transactions, in addition to any person described in paragraphs (a)(1) and (a)(2) of this section, an association or organization representing parties in interest who may be parties to the exemption transaction.
  2. An application by or for a person described in paragraph (a) of this section, may be submitted by the applicant or by his authorized representatives. If the application is submitted by a representative of the applicant, the representative must submit proof of his authority in the form of
    1. A power of attorney; or
    2. A written certification from the applicant that the representation is authorized.
  3. If the authorized representative of an applicant submits an application for an exemption to the Department together with proof of his authority for file the application as required by paragraph (b) of this section, the Department will direct all correspondence and inquiries concerning the application to the representative unless requested to do otherwise by the applicant.

§ 2570.33 Applications the Department will not ordinarily consider.

  1. The Department will not ordinarily consider:
    1. An application that fails to include all the information required by § 2570.34 and 2570.35, or otherwise fails to conform to the requirements of these procedures; or
    2. An application for exemption involving a transaction or transactions which are the subject of an investigation for possible violations of part 1 or 4 of subtitle B of title I of ERISA or section 8477 or 8478 of FERSA or an application for an exemption involving a party in interest who is the subject of such an investigation or who is a defendant in an action by the Department or the Internal Revenue Service to enforce the above-mentioned provisions of ERISA or FERSA.
  2. If for any reason the Department decides not to consider an exemption application, it will inform the applicant of that decision in writing and of the reasons therefore.
  3. An application for an individual exemption relating to a specific transaction or transactions will ordinarily not be considered separately if the Department is considering a class exemption relating to the same type of transaction or transactions.

§ 2570.34 Information to be included in every exemption application.

  1. All applications for exemptions must contain the following information:
    1. The name(s) of the applicant(s);
    2. A detailed description of the exemption transaction and the parties in interest for whom an exemption is requested, including a description of any larger integrated transaction of which the exemption transaction is a part;
    3. Whether the affected plan(s) and any parties in interest will be represented by the same person with regard to the exemption application;
    4. Reasons a plan would have for entering into the exemption transaction;
    5. The prohibited transaction provisions from which exemptive relief is requested and the reason why the transaction would violate each such provision;
    6. Whether the exemption transaction is customary for the industry or class involved;
    7. Whether the exemption transaction is or has been the subject of an investigation or enforcement action by the Department or by the Internal Revenue Service; and
    8. The hardship or economic loss, if any, which would result to the person or persons on behalf of whom the exemption is sought, to affected plans and to their participants and beneficiaries from denial of the exemption.
  2. All applications for exemption must also contain the following:
    1. A statement explaining why the requested exemption would be -
      1. Administratively feasible;
      2. In the interests of affected plans and their participants and beneficiaries; and
      3. Protective of the rights of participants and beneficiaries of affected plans.
    2. With respect to the notification of interested persons required by § 2570.43:
      1. A description of the interested person(s) to whom the applicant intends to provide notice;
      2. The manner in which the applicant will provide such notice; and
      3. An estimate of the time the applicant will need to furnish notice to all interested persons following publication of a notice of the proposed exemption in the Federal Register.
    3. If an advisory opinion has been requested with respect to any issue relating to the exemption transaction -
      1. A copy of the letter concluding the Department's action on the advisory opinion request; or
      2. If the Department has not yet concluded its action on the request:
        1. A copy of the request or the date on which it was submitted together with the Department’s correspondence control number as indicated in the acknowledgment letter; and
        2. An explanation of the effect of a favorable advisory opinion upon the exemption transaction.
    4. If the application is to be signed by anyone other than an individual party in interest seeking exemptive relief on his own behalf, a statement which -
      1. Identifies the individual, who will be signing the application and his position with the applicant; and
      2. Explain briefly the basis of his familiarity with the matters discussed in the application.
    5. (i) A declaration in the following form: Under penalty of perjury, I declare that I am familiar with the matters discussed in this application and to the best of my knowledge and belief, the representations made in this application are true and correct.

    (ii) This declaration must be dated and signed by:

    1. The applicant himself in the case of an individual party in interest seeking exemptive relief on his own behalf;
    2. A corporate officer or partner where the applicant is a corporation or partnership;
    3. A designated officer or official where the applicant is an association, organization or other unincorporated enterprise;
    4. The plan fiduciary who has the authority, responsibility, and control with respect to the exemption transaction where the applicant is a plan.

    (iii) Specialized statements from third party experts, such as appraisals or analyses of market conditions, submitted to support an application for exemption must also be accompanied by a statement of consent from such expert acknowledging that he or she knows that his or her statement is being submitted to the Department as part of an application for exemption.

    (iv) For those applications requiring an independent fiduciary to represent the plan in the exemption transaction, each statement submitted by said independent fiduciary must contain a signed and dated declaration under penalty of perjury that, to the best of said fiduciary's knowledge and belief the representations made in such statement are true and correct.

  3. An application for exemption may also include a draft of the requested exemption which defines the transaction and parties in interest for which exemptive relief is sought and the specific conditions under which the exemption would apply.

§ 2570.35 Information to be included in applications for Individual exemptions only.

  1. Except as provided in paragraph (c) of this section, every application for an individual exemption must include, in addition to the information specified in § 2570.34, the following information:
    1. The name, address, telephone number, and type of plan or plans to which the requested exemption applies;
    2. The Employer Identification Number (EIN) and the plan number (PN) used by such plan or plans in all reporting and disclosure required by the Department;
    3. Whether any plan or trust affected by the requested exemption has ever been found by the Department, the Internal Revenue Service, or by a court to have violated the exclusive benefit rule of section 401(a) of the Code, or to have engaged in a prohibited transaction under section 503(b) of the Code or corresponding provisions of prior law, section 4975(c)(1) of the Code, section 406 or 407(a) of ERISA, or 5 USC 8477(c)(3);
    4. Whether any relief under section 408(a) of ERISA, section 4975(c)(2) of the Code, or 5 USC 8477(c)(3) has been requested by, or provided to, the applicant or any of the parties on behalf of whom the exemption is sought and, if so, the exemption application number or the prohibited transaction exemption number;
    5. Whether the applicant or any of the parties in interest involved in the exemption transaction is currently, or has been within the last five years, a defendant in any lawsuit or criminal action concerning such person's conduct as a fiduciary or party in interest with respect to any plan;
    6. Whether the applicant or any of the parties in interest involved in the exemption transaction has within the last 13 years, been convicted of any crime described in section 411 of ERISA.
    7. Whether, within the last five years, any plan affected by the exemption transaction or any party in interest involved in the exemption transaction has been under investigation or examination by, or has been engaged in litigation or a continuing controversy with, the Department, the Internal Revenue Service, the Justice Department, the Pension Benefit Guaranty Corporation, or the Federal Retirement Thrift Investment Board involving compliance with provisions of FERSA, provisions of the Code relating to employee benefit plans, or provisions of FERSA relating to the Federal Thrift Savings Fund. If so, the applicant must submit copies of all correspondence with the Department, the Internal Revenue Service, the Justice Department, the Pension Benefit Guaranty Corporation, or the Federal Retirement Thrift Investment Board regarding the substantive issues involved in the investigation, examination, litigation, or controversy which relate to compliance with the provisions of part 1 or 4 of subtitle B of title I of ERISA, section 4975 of the Code, or section 8477 or 8478 of FERSA. For this purpose, the term "examination" does not include routine audits conducted by the Department pursuant to section 8477(g) of FERSA;
    8. Whether any plan affected by the requested exemption has experienced a reportable event under section 4043 of ERISA;
    9. Whether a notice of intent to terminate has been filed under section 4041 of ERISA respecting any plan affected by the requested exemption;
    10. Names, addresses, and taxpayer identifying numbers of all parties in interest involved in the subject transaction;
    11. The estimated number of participants and beneficiaries in each plan affected by the requested exemption as of the date of the application;
    12. The percentage of the fair market value of the total assets of each affected plan that is involved in the exemption transaction;
    13. Whether the exemption transaction has been consummated or will be consummated only if the exemption is granted;
    14. If the exemption transaction has already been consummated:
      1. The circumstances which resulted in plan fiduciaries causing the plan to engage in the subject transaction before obtaining an exemption from the Department;
      2. Whether the transaction has been terminated;
      3. Whether the transaction has been corrected as defined in Code section 4975(f)(5);
      4. Whether Form 5330, Return of Excise Taxes Related to Employee Benefit Plans, has been filed with the Internal Revenue Service with respect to the transaction; and
      5. Whether any excise taxes due under section 4975(a) and (b) of the Code by reason of the transaction have been paid.
    15. The name of every person who has investment discretion over any assets involved in the exemption transaction and the relationship of each such person to the parties in interest involved in the exemption transaction and the affiliates of such parties in interest;
    16. Whether or not the assets of the affected plan(s) are invested in loans to any party in interest involved in the exemption transaction, in property leased to any such party in interest, or in securities issued by any such party in interest, and, if such investments exist, a statement for each of these three types of investments which indicates:
      1. The type of investment to which the statement pertains;
      2. The aggregate fair market value of all investments of this type as reflected in the plan's most recent annual report;
      3. The approximate percentage of the fair market value of the plan's total assets as shown in such annual report that is represented by all investments of this type; and
      4. The statutory or administrative exemption covering these investments, if any.
    17. The approximate aggregate fair market value of the total assets of each affected plan;
    18. The person(s) who will bear the costs of the exemption application and of notifying interested persons; and
    19. Whether an independent fiduciary is or will be involved in the exemption transaction and, if so, the names of the persons who will bear the cost of the fee payable to such fiduciary.
  2. Each application for an individual exemption must also include:
    1. True copies of all contracts, deeds, agreements, and instruments, as well as relevant portions of plan documents, trust agreements, and any other documents bearing on the exemption transaction;
    2. A discussion of the facts relevant to the exemption transaction that are reflected in these documents and an analysis of their bearing on the requested exemption; and
    3. A copy of the most recent financial statements of each plan affected by the requested exemption.
  3. Special rule for applications for individual exemption involving pooled funds:
    1. The information required by paragraphs (a)(8) through (12) of this section is not required to be furnished in an application for individual exemption involving one or more pooled funds;
    2. The information required by paragraphs (a)(1) through (7) and (a)(13) through (19) of this section and by paragraphs (b)(1) through (3) of this section must be furnished by reference to the pooled fund, rather than to the plans participating therein. (For purposes of this paragraph, the information required by paragraph (a)(16) of this section relates solely to other pooled fund transactions with, and investments in, parties in interest involved in the exemption transaction which are also sponsors of plans which invest in the pooled fund.);
    3. The following information must also be furnished -
      1. The estimated number of plans that are participating (or will participate) in the pooled fund; and
      2. The minimum and maximum limits imposed by the pooled fund (if any) on the portion of the total assets of each Plan that may be invested in the pooled fund.
    4. Additional requirements for applications for individual exemption involving pooled funds in which certain plans participate.
      1. This paragraph applies to any application for individual exemption involving one or more pooled funds in which any plan participating therein -
        1. Invests an amount which exceeds 20% of the total assets of the pooled fund, or
        2. Covers employees of -
          1. The party sponsoring or maintaining the pooled fund, or any affiliate of such party, or
          2. Any fiduciary with investment discretion over the pooled fund's assets, or any affiliate of such fiduciary.
      2. The exemption application must include, with respect to each plan described in paragraph (c)(4)(i) of this section, the information required by paragraphs (a)(1) through (3), (a)(5) through (7), (a)(10), (a)(12) through (16), and (a)(18) and (19) of this section. The information required by this paragraph must be furnished by reference to the plan's investment in the pooled fund (e.g., the names, addresses and taxpayer identifying numbers of all fiduciaries responsible for the plan's investment in the pooled fund (§ 2570.35(a)(10), the percentage of the assets of the plan invested in the pooled fund [§ 2570.35(a)(12)], whether the plan's investment in the pooled fund has been consummated or will be consummated only if the exemption is granted [§ 2570.35(a)(13), etc.).
      3. The information required by paragraph (c)(4) of this section is in addition to the information required by paragraphs (c)(2) and (3) of this section relating to information furnished by reference to the pooled fund.
    5. The special rule and the additional requirements described in paragraphs (c)(1) through (4) of this section do not apply to an individual exemption request solely for the investment by a plan in a pooled fund. Such an application must provide the information required by paragraphs (a) and (b) of this section.

§ 2570.36 Where to file an application.

The Department's prohibited transaction exemption program is administered by the Pension and Welfare Benefits Administration (PWBA). Any exemption application governed by these procedures should be mailed or otherwise delivered to: Exemption Application, PWBA, Office of Exemption Determinations, Division of Exemptions, US Department of Labor, 200 Constitution Avenue, NW, Washington, DC 20210.

§ 2570.37 Duty to amend and supplement exemption applications.

  1. During the pendency of his exemption application, an applicant must promptly notify the Division of Exemptions in writing, if he discovers that any material fact or representation contained in his application or any documents or testimony provided in support of the application is inaccurate, if any such fact or representation changes during this period, or if, during the pendency of the application, anything occurs that may affect the continuing accuracy of any such fact or representation.
  2. If, at any time during the pendency of his exemption application, an applicant or any other party in interest who would participate in the exemption transaction becomes the subject of an investigation or enforcement action by the Department, the Internal Revenue Service, the Justice Department, the Pension Benefit Guaranty Corporation, or the Federal Retirement Thrift Investment Board involving compliance with provisions of ERISA, provisions of the Code relating to employee benefit plans, or provisions of FERSA relating to the Federal Thrift Savings Fund, the applicant must promptly notify the Division of Exemptions.
  3. The Department may require an applicant provide documentation it considers necessary to verify any statements contained in the application or in supporting materials or documents.

§ 2570.38 Tentative denial letters.

  1. If, after reviewing an exemption file, the Department concludes that it will not grant the exemption. it will notify the applicant in writing of its tentative denial of the exemption application. At the same time, the Department will provide a short statement of the reasons for its tentative denial.
  2. An applicant will have 20 days from the date of a tentative denial letter to request a conference under § 2570.40 of these procedures and/or to notify the Department of its intent to submit additional information in writing, under § 2570.39 of these procedures. If the Department does not receive a request for a conference or a notification of intent to submit additional information within that time, it will issue a final denial letter pursuant to § 2570.41.
  3. The Department need not issue a tentative denial letter to an applicant before issuing a final denial letter where the Department has conducted a hearing on the exemption pursuant to either § 2570.46 or § 2570.47 of these procedures.

§ 2570.39 Opportunities to submit additional information.

  1. An applicant may notify the Department of its intent to submit additional information supporting an exemption application either by telephone or by letter sent to the address, furnished in, the applicant's tentative denial letter. At the same time, the applicant should indicate generally the type of information that he will submit.
  2. An applicant will have 30 days from the date of the notification discussed in paragraph (a) of this section to submit in writing all of the additional information he intends to provide in support of his application. All such information must be accompanied by a declaration under penalty of perjury attesting to the truth and correctness of the information provided, which is dated and signed by a person qualified under § 2570.34(b)(5) of these procedures to sign such a declaration.
  3. If, for reasons beyond his control, an applicant is unable to submit in writing all the additional information he intends to provide in support of his application within the 30-day period described in paragraph (b) of this section, he may request an extension of time to furnish the information. Such requests must be made before the expiration of the 30-day period and will be granted only in unusual circumstances and for limited periods of time.
  4. If an applicant is unable to submit all of the additional information he intends to provide in support of his exemption application within the 30-day period specified in paragraph (b) of this section or within any additional period of time granted to him pursuant to paragraph (c) of this section, the applicant may withdraw the exemption application before expiration of the applicable time period and reinstate it later pursuant to § 2570.44 of these procedures.
  5. The Department will issue without further notice the final denial letter, denying the requested exemption pursuant to § 2570.41 of these procedures where -
    1. The Department has not received the additional information that the applicant indicated he would submit within the 30-day period described in paragraph (b) of this section, or within any additional period of time granted pursuant to paragraph (c) of this section;
    2. The applicant did not request a conference pursuant to § 2570.38(b) of these procedures; and
    3. The applicant has not withdrawn his application as permitted by paragraph (d) of this section.

§ 2570.40 Conferences.

  1. Any conference between the Department and an applicant pertaining to a requested exemption will be held in Washington, DC, except that a telephone conference will be held at the applicant's request.
  2. An applicant is entitled to only one conference with respect to any exemption application. An applicant will not be entitled to a conference, however, where the Department has held a hearing on the exemption under either § 2570.46 or § 2570.47 of these procedures.
  3. Insofar as possible, conferences will be scheduled as joint conferences with all applicants present where:
    1. More than one applicant has requested an exemption with respect to the same or similar types of transactions;
    2. The Department is considering the applications together as a request for a class exemption;
    3. The Department contemplates not granting the exemption; and
    4. More than one applicant has requested a conference.
  4. The Department will attempt to schedule a conference under this section for a mutually convenient time during the 45-day period following the later of -
    1. The date the Department receives the applicant's request for a conference, or
    2. The date the Department notifies the applicant, after reviewing additional information submitted pursuant to § 2570.39, that it is still not prepared to propose the requested exemption. If the applicant is unable to attend a conference at any of the times proposed by the Department during this 45-day period or if the applicant fails to appear for a scheduled conference, he will be deemed to have waived his right to a conference unless circumstances beyond his control prevent him from scheduling a conference or attending a scheduled conference within this period.
  5. Within 20 days after the date of any conference held under this section, the applicant may submit to the Department a written record of any additional data, arguments, or precedents discussed at the conference but not previously or adequately presented in writing.

§ 2570.41 Final denial letters.

  1. The Department will issue a final denial letter denying a requested exemption where:
    1. The conditions for issuing a final denial letter specified in § 2570.38(b) or § 2570.39(e) of these procedures are satisfied;
    2. After issuing a tentative denial letter under § 2570.38 of this part and considering the entire record in the case, including all written information submitted pursuant to § 2570.39 and § 2570.40(e) of these procedures, the Department decides not to propose an exemption or to withdraw an exemption already proposed; or
    3. After proposing an exemption and conducting a hearing on the exemption under either § 2570.46 or § 2570.47 of this part and after considering the entire record in the case, including the record of the hearing, the Department decides to withdraw the proposed exemption.

§ 2570.42 Notice of proposed exemption.

If the Department tentatively decides, based on all the information submitted by an applicant, that the exemption should be granted, it will publish a notice of proposed exemption in the Federal Register. The notice will:

  1. Explain the exemption transaction and summarize the information received by the Department in support of the exemption;
  2. Specify any conditions under, which the exemption is proposed;
  3. Inform interested persons of their right to submit comments in writing to the Department relating to the proposed exemption and establish a deadline for receipt of such comments;
  4. If the proposed exemption includes relief from the prohibitions of section 406(b) of ERISA, section 4975(c)(1)(E) or (F) of the Code, or section 8477(c)(2) of FERSA, inform interested persons of their right to request a hearing under § 2570.46 of this part and establish a deadline for receipt of requests for such hearings.

§ 2570.43 Notification of Interested persons by applicant.

  1. If, as set forth in the exemption application, the notification that an applicant intends to provide to interested persons upon publication of a notice of proposed exemption in the Federal Register is inadequate, the Department will so inform the applicant and will secure the applicant's written agreement to provide what it considers to be adequate notice under the circumstances.
  2. If a notice of proposed exemption is published in the Federal Register in accordance with § 2570.42 of this part, the applicant must notify interested persons of the pendency of the exemption in the manner and time period specified in the application or in any superseding agreement with the Department. Any such notification must include:
    1. A copy of the notice of proposed exemption; and
    2. A supplemental statement in the following form:
      • You are hereby notified that the United States Department of Labor is considering granting an exemption from the prohibited transaction restrictions of the Employee Retirement Income Security Act of 1974, the Internal Revenue Code of 1986, or the Federal Employees' Retirement System Act of 1986. The exemption under consideration is explained in the enclosed Notice of Proposed Exemption. As a person who may be affected by this exemption, you have the right to comment on the proposed exemption by [date].
      • [If you may be adversely affected by the grant of the exemption, you also have the right to request a hearing on the exemption by [date].]
      • Comments or requests for a hearing should be addressed to: Office of Exemption Determinations, Pension and Welfare Benefits Administration, Room ---,
      • US Department of Labor, 200 Constitution Avenue, NW, Washington, DC 20210, Attention:  Application No. ---,
      • The Department will make no final decision on the proposed exemption until it reviews all comments received in response to the enclosed notice. If the Department decides to hold a hearing on the exemption before making its final decision, you will be notified of the time and place of the hearing.
  3. The method used to furnish notice to interested persons must be reasonably calculated to ensure that interested persons actually receive the notice. In all cases, personal delivery and delivery by first-class mail will be considered reasonable methods of furnishing notice.
  4. After furnishing the notice required by this section, an applicant must provide the Department with a statement confirming that notice was furnished to the persons and in the manner and time designated in its exemption application or in any superseding agreement with the Department. This statement must be accompanied by a declaration under penalty of perjury attesting to the truth of the information provided in the statement and signed by a person qualified under § 2570.34(b)(5) of these procedures to sign such a declaration. No exemption will be granted until such a statement and its accompanying declaration have been furnished to the Department.

§ 2570.44 Withdrawal of exemption applications.

  1. An applicant may withdraw his application for an exemption at any time by informing the Department, either orally or in writing, of his intent to withdraw.
  2. Upon receiving an applicant's notice of intent to withdraw an application for an individual exemption, the Department will confirm by letter the applicant's withdrawal of the application and will terminate all proceedings relating to the application. If a notice of proposed exemption has been published in the Federal Register, the Department will publish a notice withdrawing the proposed exemption.
  3. Upon receiving an applicant's notice of intent to withdraw an application for a class exemption or for an individual exemption that is being considered with other applications as a request for a class exemption, the Department will inform any other applicants for the exemption of the withdrawal. The Department will continue to process other applications for the same exemption. If all applicants for a particular class exemption withdraw their applications, the Department may either terminate all proceedings relating to the exemption or propose the exemption on its own motion.
  4. If, following the withdrawal of an exemption application, an applicant decides to reapply for the same exemption, he may submit a letter to the Department requesting that the application be reinstated and referring to the application number assigned to the original application. If, at the time the original application was withdrawn, any additional information to be submitted to the Department under § 2570.39 of these procedures was outstanding, that information must accompany the letter requesting reinstatement of the application. However, the applicant need not resubmit information previously furnished to the Department in connection with a withdrawn application unless reinstatement of the application is requested more than two years after the date of its withdrawal.
  5. Any request for reinstatement of a withdrawn application submitted in accordance with paragraph (d) of this section, will be granted by the Department, and the Department will take whatever steps remained at the time the application was withdrawn to process the application.

§ 2570.45 Requests for reconsideration.

  1. The Department will entertain one request for reconsideration of an exemption application that has been finally denied pursuant to § 2570.41(a)(2) or (a)(3) of this part if the applicant presents in support of the application significant new facts or arguments which for good reason could not have been submitted for the Department's consideration during its initial review of the exemption application.
  2. A request for reconsideration of a previously denied application must be made within 180 days after the issuance of the final denial letter and must be accompanied by a copy of the Department's final letter denying the exemption and a statement setting forth the new information and/or arguments that provide the basis for reconsideration.
  3. A request for reconsideration must also be accompanied by a declaration under penalty of perjury attesting to the truth of the new information provided, which is signed by a person qualified under § 2570.34(b)(5) of these procedures to sign such a declaration.
  4. If, after reviewing a request for reconsideration, the Department decides that the facts and arguments presented do not warrant reversal of its original decision to deny the exemption, it will send a letter to the applicant reaffirming that decision.
  5. If, after reviewing a request for reconsideration, the Department decides, based on the new facts and arguments submitted, to reconsider its denial letter, it will notify the applicant of its intent to reconsider the application in light of the new information provided. The Department will then take wherever steps remained at the time it issued its final denial letter to process the exemption application
  6. If, at any point during its subsequent processing of the application, the Department decides again that the exemption is unwarranted, it will issue a letter affirming its final denial.

§ 2570.46 Hearings in opposition to exemptions from restrictions on fiduciary self-dealing.

  1. Any interested person who may be adversely affected by an exemption which the Department proposes to grant from the restrictions of section 406(b) of ERISA, section 4975(c)(1)(E) or (F) of the Code, or section 8477(c)(2) of FERSA may request a hearing before the Department within the period of time specified in the Federal Register notice of the proposed exemption Any such request must state:
    1. The name, address, and telephone number of the person making the, request;
    2. The nature of the person's interest in the exemption and the manner in which the person would be adversely affected by the exemption; and
    3. A statement of the issues to be addressed and a general description of the evidence to be presented at the hearing.
  2. The Department will grant a request for a hearing made in accordance with paragraph (a) of this section where a hearing is necessary to fully explore material factual issues identified by the person requesting the hearing. However, the Department may decline to hold a hearing where:
    1. The request for the hearing does not meet the requirements of paragraph (a);
    2. The only issues identified for exploration at the hearing are matters of law; or
    3. The factual issues identified can be fully explored through the submission of evidence in written form.
  3. An applicant for an exemption must notify interested persons in the event that the Department schedules a hearing on the exemption. Such notification must be given in the form, time, and manner prescribed by the Department. Ordinarily, however, adequate notification can be given by providing to interested persons a copy of the notice of hearing published by the Department in the Federal Register within 10 days of its publication, using any of the methods approved in § 2570.43(c) of this part.
  4. After furnishing the notice required by paragraph (c) of this section, an applicant must submit a statement confirming that notice was given in the form, manner, and time prescribed. This statement must be accompanied by a declaration under penalty of perjury attesting to the truth of the information provided in the statement, which is signed by a person qualified under § 2570.34(b)(5) of these procedures to sign such a declaration.

§ 2570.47 Other hearings.

  1. In its discretion, the Department may schedule a hearing on its own motion where it determines that issues relevant to the exemption can be most fully or expeditiously explored at a hearing.
  2. An applicant for an exemption must notify interested persons of any hearing on an exemption scheduled by the Department in the manner described in § 2570.46(c). In addition, the applicant must submit a statement subscribed as true under penalty of perjury like that required in § 2570.46(d).

§ 2570.48 Decision to grant exemptions.

  1. If, after considering all the facts and representations submitted by an applicant in support of an exemption application, all the comments received in response to a notice of proposed exemption, and the record of any hearing held in connection with the proposed exemption, the Department determines that the exemption should be granted, it will publish a notice in the Federal Register granting the exemption.
  2. A Federal Register notice granting an exemption will summarize the transaction or transactions for which exemptive relief has been granted and will specify the conditions under which such exemptive relief is available.

§ 2570.49 Limits on the effect of exemptions.

  1. An exemption does not take effect or protect parties in interest from liability with respect to the exemption transaction unless the material facts and representations contained in the application and in any materials and documents submitted in support of the application were true and complete.
  2. An exemption is effective only for the period of time specified and only under the conditions set forth in the exemption.
  3. Only the specific parties to whom an exemption grants relief may rely on the exemption. If the notice granting an exemption does not limit exemptive relief to specific parties, all parties to the exemption transaction may rely on the exemption.

§ 2570.50 Revocation or modification of exemptions.

  1. If, after an exemption takes effect, changes in circumstances, including changes in law or policy, occur which call into question the continuing validity of the Department's original conclusions concerning the exemption, the Department may take steps to revoke or modify the exemption.
  2. Before revoking or modifying an exemption, the Department will publish a notice of its proposed action in the Federal Register and provide interested persons with an opportunity to comment on the proposed revocation or modification. In addition, the Department will give the applicant at least 30 days notice in writing of the proposed revocation or modification and the reasons therefore and will provide the applicant with the opportunity to comment on the revocation or modification.
  3. Ordinarily the revocation modification of an exemption will have prospective effect only.

§ 2570.51 Public Inspection and copies.

  1. The administrative record of each exemption application will be open to public inspection and copying at the Public Disclosure Branch, PWBA, U.S. Department of Labor, 200 Constitution Avenue, NW, Washington, DC 20210.
  2. Upon request, the staff of the Public Disclosure Branch will furnish photocopies of an administrative record, or any specified portion of that record, for a specified charge per page.

§ 2570.52 Effective Date.

This regulation is effective with respect to all applications for exemptions filed with the Department under section 408(a) of ERISA, section 4975(c)(2) of the Code, or 5 USC 8477(c)(3) at any time on or after September 10, 1990. Applications for exemptions under section 408(a) of ERISA and/or section 4975 of the Code filed before September 10, 1990, are governed by ERISA Procedure 75-1. Applications for exemption under 5 USC 8477(c)(3) filed before September 10, 1990, but after December 29, 1988 are governed by part 2585 of chapter XXV of title 29 of the Code of Federal Regulations, (section 29 C.F.R. part 2585 as revised July 1, 1990). Applications under 5 USC 8477(c)(3) filed before December 29, 1988 are governed by ERISA Procedure 75-1.

Part 2585 [Removed)

3. The regulations in part 2585 of chapter XXV of title 29 of the Code of Federal Regulations are removed.

Signed at Washington, DC, this 27th day of July, 1990.

David G. Ball, Assistant Secretary for Pension and Welfare Benefits

U.S. Department of Labor.

Footnotes to Preamble:

  1. Under section 111 of the FERSA Technical Corrections Act of 1986 (Pub.L. 99-566, October 27, 1986), the Department's existing exemption procedures were made applicable to exemption applications under FERSA until the earlier of the date of publication of final regulations adopting an exemption procedure or December 31, 1988.
  2. Section 8477(g) of FERSA requires the Secretary of Labor to establish a program to carry out audits to determine the level of compliance with the requirements of this section relating to fiduciary responsibilities and prohibited activities of fiduciaries with respect to the Thrift Savings Fund of the Federal Employees' Retirement System. The Department has interpreted section 8477(g) to mean that the Department has a continuing responsibility to audit the Thrift Savings Fund established by FERSA.
  3. These sections, relate, in pertinent part, to the Department's nonconsideration of exemption applications which are the subject of an investigation for possible violations of FERSA or which involve a party in interest who is the subject of such an investigation (§ 2570.33(a)(2)); and to the notification of the Division of Exemptions of certain investigations initiated after the filing of an exemption application (§ 2570.37(b)).
  4. This section of the regulation requires certain exemption applications to include copies of correspondence relating to investigations, examinations, litigation, and continuing controversies with specified Federal agencies.
  5. The Department must find that the statutory criteria are satisfied before granting a prohibited transaction exemption. The legislative history of ERISA makes it clear, however, that the Department has broad discretion in determining whether or not to grant an exemption. H.R. Rep. 1280, 93 Cong., 2d Sess. 311 (1974).
  6. See section 1(e) of PTE 84-14 (49 FR 9494, March 13, 1984) the class exemption involving qualified professional asset managers [QPAM] (See page 5-).
  7. The Department notes that the form of the notice is prescribed under § 2570.43(b) of the regulation.
  8. Section 4975(c)(2) of the Code and 5 USC 8477(c)(3)(D) (added by FERSA) contain similar hearing requirements. The following discussion of the hearing requirements of section 408(a) of ERISA is equally applicable to those statutory provisions.
  9. This comment compares the revocation of an exemption to the revocation of a license granted by an agency of the United States Government pursuant to 5 USC 558(c). The Department is expressing no opinion herein as to the applicability of 5 USC 558(c) to the revocation of prohibited transaction exemptions under ERISA, the Code, or FERSA.

Footnotes to Regulation:

  1. The applicant will write in this space the date of the last day of the time period specified in the notice of proposed exemption.
  2. To be added in the case of an exemption that provides relief from section 406(b) of ERISA or corresponding sections of the Code or FERSA.
  3. The applicant will fill in the room number of the Division of Exemptions. As of the date of this final regulation, the room number of the Division of Exemptions was N-5671.
  4. The applicant will fill in the exemption application number, which is stated in the notice of proposed exemption, as well as in all correspondence from the Department to the applicant regarding the application.
IRS Revenue Rulings

50-60    Valuation of Non-Traded Assets

Internal Revenue Code
Revenue Ruling 59-60

As Modified by 65-193

In valuing the stock of closely held corporations, or the stock of corporations where market quotations are not available, all other available financial data, as well as all relevant factors affecting the fair market value must be considered for estate tax and gift tax purposes. No general formula may be given that is applicable to the many different valuation situations arising in the valuation of such stock. However, the general approach, methods, and factors which must be considered in valuing such securities are outlined.

Revenue Ruling 54-77, C.B. 1954-1, 187, superseded.

Section 1. Purpose.

The purpose of this Revenue Ruling is to outline and review in general the approach, methods and factors to be considered in valuing shares of the capital stock of closely held corporations for estate tax and gift tax purposes. The methods discussed herein will apply likewise to the valuation of corporate stocks on which market quotations are either unavailable or are of such scarcity that they do not reflect the fair market value.

Sec. 2. Background and Dfinitions

  1. All valuations must be made in accordance with the applicable provisions of the Internal Revenue Code of 1954 and the Federal Estate Tax and Gift Tax Regulations. Sections 2031(a), 2032 and 2512(a) of the 1954 Code (sections 811 and 1005 of the 1939 Code) require that the property to be included in the gross estate, or made the subject of a gift, shall be taxed on the basis of the value of the property at the time of death of the decedent, the alternate date if so elected, or the date of gift.
  2. Section 20.2031-1(b) of the Estate Tax Regulations (section 81.10 of the Estate Tax Regulations 105) and section 25.2512-1 of the Gift Tax Regulations (section 86.19 of Gift Tax Regulations 108) define fair market value, in effect, as the price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts. Court decisions frequently state in addition that the hypothetical buyer and seller are assumed to be able, as well as willing, to trade and to be well informed about the property and concerning the market for such property.
  3. Closely held corporations are those corporations the shares of which are owned by a relatively limited number of stockholders. Often the entire stock issue is held by one family. The result of this situation is that little, if any, trading is the shares takes place. There is, therefore, no established market for the stock and such sales as occur at irregular intervals seldom reflect all of the elements of a representative transaction as defined by the term "fair market value."

Sec. 3. Approach to Valuation

  1. A determination of fair market value, being a question of fact, will depend upon the circumstances in each case. No formula can be devised that will be generally applicable to the multitude of different valuation issues arising in estate and gift tax cases. Often, an appraiser will find wide differences of opinion as to the fair market value of a particular stock. In resolving such differences, he should maintain a reasonable attitude in recognition of the fact that valuation is not an exact science. A sound valuation will be based upon all the-relevant facts, but the elements of common sense, informed judgment and reasonableness must enter into the process of weighing those facts and determining their aggregate significance.
  2. The fair market value of specific shares of stock will vary as general economic conditions change from "normal" to "boom" or "depression," that is, according to the degree of optimism or pessimism with which the investing public regards the future at the required date of appraisal. Uncertainty as to the stability or continuity of the future income from a property decreases its value by increasing the risk of loss of earnings and value in the future. The value of shares of stock of a company with very uncertain future prospects is highly speculative. The appraiser must exercise his judgment as to the degree of risk attaching to the business of the corporation which issued the stock, but that judgment must be related to all of the other factors affecting value.
  3. Valuation of securities is, in essence, a prophesy as to the future and must be based on facts available at the required date of appraisal. As a generalization, the prices of stocks which are traded in volume in a free and active market by informed persons best reflect the consensus of the investing public as to what the future holds for the corporations and industries represented. When a stock is closely held, is traded infrequently, or is traded in an erratic market, some other measure of value must be used. In many instances, the next best measure may be found in the prices at which the stocks of companies engaged in the same or a similar line of business are selling in a free and open market.

Sec. 4. Factors to Consider

  1. It is advisable to emphasize that in the valuation of the stock of closely held corporations or the stock of corporations where market quotations are either lacking or too scarce to be recognized, all available financial data, as well as all relevant factors affecting the fair market value, should be considered. The following factors, although not all-inclusive are fundamental and require careful analysis in each case:
    1. The economic outlook in general and the condition and outlook of the specific industry in particular.
    2. The book value of the stock and the financial condition of the business.
    3. The earning capacity of the company.
    4. The dividend-paying capacity.
    5. Whether or not the enterprise has goodwill or other intangible value.
    6. Sales of the stock and the size of the block of stock to be valued.
    7. The market price of stocks of corporations engaged in the same or a similar line of business having their stocks actively traded in a free and open market, either on an exchange or over-the-counter.
  2. The following is a brief discussion of each of the foregoing factors:
    1. The history of a corporate enterprise will show its past stability or instability, its growth or lack of growth, the diversity or lack of diversity of its operations, and other facts needed to form an opinion of the degree of risk involved in the business. For an enterprise which changed its form of organization but carried on the same or closely similar operations of its predecessor, the history of the former enterprise should be considered. The detail to be considered should increase with approach to the required date of appraisal, since recent events are of greatest help in predicting the future; but a study of gross and net income, and of dividends covering a long prior period, is highly desirable. The history to be studied should include, but need not be limited to, the nature of the business, its products or services, its operating and investment assets, capital structure, plant facilities, sales records and management, all of which should be considered as of the date of the appraisal, with due regard for recent significant changes. Events of the past that are unlikely to recur in the future should be discounted, since value has a close relation to future expectancy.
    2. A sound appraisal of a closely held stock must consider current and prospective economic conditions as of the date of appraisal, both in the national economy and in the industry or industries with which the corporation is allied. It is important to know that the company is more or less successful than its competitors in the same industry, or that it is maintaining a stable position with respect to competitors. Equal or even greater significance may attach to the ability of the industry with which the company is allied to compete with other industries. Prospective competition which has not been a factor in prior years should be given careful attention. For example, high profits due to the novelty of its product and the lack of competition often lead to increasing competition. The public's appraisal of the future prospects of competitive industries or of competitors within an industry may be indicated by price trends in the markets for commodities and for securities. The loss of the manager of a so-called "one-man" business may have a depressing effect upon the value of the stock of such business, particularly if there is a lack of trained personnel capable of succeeding to the management of the enterprise. In valuing the stock of this type of business, therefore, the effect of the loss of the manager on the future expectancy of the business, and the absence of management- succession potentialities are pertinent factors to be taken into consideration. On the other hand, there may be factors which offset, in whole or in part, the loss of the manager's services. For instance, the nature of the business and of its assets may be such that they will not be impaired by the loss of the manager. Furthermore, the loss may be adequately covered by life insurance, or competent management might be employed on the basis of the consideration paid for the former manager's services. These, or other offsetting factors, if found to exist, should be carefully weighed against the loss of the manager's services in valuing the stock of the enterprise.
    3. Balance sheets should be obtained, preferably in the form of comparative annual statements for two or more years immediately preceding the date of appraisal, together with a balance sheet at the end of the month preceding that date, if corporate accounting will permit. Any balance sheet descriptions that are not self-explanatory, and balance sheet items comprehending diverse assets or liabilities, should be clarified in essential detail by supporting supplemental schedules. These statements usually will disclose to the appraiser (1) liquid position (ratio of current assets to current liabilities); (2) gross and net book value of principal classes of fixed assets; (3) working capital; (4) long-term indebtedness; (5) capital structure; and (6) net worth. Consideration also should be given to any assets not essential to the operation of the business, such as investments in securities, real estate, etc. In general, such nonoperating assets will command a lower rate of return than do the operating assets, although in exceptional cases the reverse may be true. In computing the book value per share of stock, assets of the investment type should be revalued on the basis of their market price and the book value adjusted accordingly. Comparison of the company's balance sheets over several years may reveal, among other facts, such developments as the acquisition of additional production facilities or subsidiary companies, improvement in financial position, and details as to recapitalizations and other changes in the capital structure of the corporation. If the corporation has more than one class of stock outstanding, the charter or certificate of incorporation should be examined to ascertain the explicit rights and privileges of the various stock issues including: (1) voting powers, (2) preference as to dividends, and (3) preference as to assets in the event of liquidation.
    4. Detailed profit-and-loss statements should be obtained and considered for a representative period immediately prior to the required date of appraisal, preferably five or more years. Such statements should show:
      1. Gross income by principal items;
      2. Principal deductions from gross income including major prior items of operating expenses, interest and other expense on each item of long-term debt, depreciation and depletion if such deductions are made, officers' salaries, in total if they appear to be reasonable or in detail if they seem to be excessive, contributions (whether or not deductible for tax purposes) that the nature of its business and its community position require the corporation to make, and taxes by principal items, including income and excess profits taxes;
      3. Net income available for dividends;
      4. Rates and amounts of dividends paid on each class of stock;
      5. Remaining amount carried to surplus; and
      6. Adjustments to, and reconciliation with, surplus as stated on the balance sheet.

      With profit and loss statements of this character available, the appraiser should be able to separate recurrent from nonrecurrent items of income and expense, to distinguish between operating income and investment income, and to ascertain whether or not any line of business in which the company is engaged is operated consistently at a loss and might be abandoned with benefit to the company. The percentage of earnings retained for business expansion should be noted when dividend-paying capacity is considered. Potential future income is a major factor in many valuations of closely-held stocks, and all information concerning past income which will be helpful in predicting the future should be secured. Prior earnings records usually are the most reliable guide as to the future expectancy, but resort to arbitrary five-or-ten-year averages without regard to current trends or future prospects will not produce a realistic valuation. If, for instance, a record of progressively increasing or decreasing net income is found, then greater weight may be accorded the most recent years' profits in estimating earning power. It will be helpful, in judging risk and the extent to which a business is a marginal operator, to consider deductions from income and net income in terms of percentage of sales. Major categories of cost and expense to be so analyzed include the consumption of raw materials and supplies in the case of manufacturers, processors and fabricators; the cost of purchased merchandise in the case of merchants; utility services; insurance; taxes; depletion or depreciation; and interest.

    5. Primary consideration should be given to the dividend-paying capacity of the company rather than to dividends actually paid in the past. Recognition must be given to the necessity of retaining a reasonable portion of profits in a company to meet competition. Dividend-paying capacity is a factor that must be considered in an appraisal, but dividends actually paid in the past may not have any relation to dividend-paying capacity. Specifically, the dividends paid by a closely held family company may be measured by the income needs of the stockholders or by their desire to avoid taxes on dividend receipts, instead of by the ability of the company to pay dividends. Where an actual or effective controlling interest in a corporation is to be valued, the dividend factor is not a material element, since the payment of such dividends is discretionary with the controlling stockholders. The individual or group in control can substitute salaries and bonuses for dividends, thus reducing net income and understating the dividend-paying capacity of the company. It follows, therefore, that dividends are less reliable criteria of fair market value than other applicable factors.
    6. In the final analysis, goodwill is based upon earning capacity. The presence of goodwill and its value, therefore, rests upon the excess of net earnings over and above a fair return on the net tangible assets. While the element of goodwill may be based primarily on earnings, such factors as the prestige and renown of the business, the ownership of a trade or brand name, and a record of successful operation over a prolonged period in a particular locality, also may furnish support for the inclusion of intangible value. In some instances it may not be possible to make a separate appraisal of the tangible and intangible assets of the business. The enterprise has a value as an entity. Whatever intangible value there is, which is supportable by the facts, may be measured by the amount by which the appraised value of the tangible assets exceeds the net book value of such assets.
    7. Sales of stock of a closely held corporation should be carefully investigated to determine whether they represent transactions at arm's length. Forced or distress sales do not ordinarily reflect fair market value nor do isolated sales in small amounts necessarily control as the measure of value. This is especially true in the valuation of a controlling interest in a corporation. Since, in the case of closely held stocks, no prevailing market prices are available, there is no basis for making an adjustment for blockage. It follows, therefore, that such stocks should be valued upon a consideration of all the evidence affecting the fair market value. The size of the block of stock itself is a relevant factor to be considered. Although it is true that a minority interest in an unlisted corporation's stock is more difficult to sell than a similar block of listed stock, it is equally true that control of a corporation, either actual or in effect, representing as it does an added element of value, may justify a higher value for a specific block of stock.
    8. Section 2031(b) of the Code states, in effect, that in valuing unlisted securities the value of stock or securities of corporations engaged in the same or a similar line of business which are listed on an exchange should be taken into consideration along with all other factors. An important consideration is that the corporations to be used for comparisons have capital stocks which are actively traded by the public. In accordance with section 2031(b) of the Code, stocks listed on an exchange are to be considered first. However, if sufficient comparable companies whose stocks are listed on an exchange cannot be found, other comparable companies which have stocks actively traded in on the over-the-counter market also may be used. The essential factor is that whether the stocks are sold on an exchange or over-the-counter there is evidence of an active, free public market for the stock as of the valuation date. In selecting corporations for comparative purposes, care should be taken to use only comparable companies. Although the only restrictive requirement as to comparable corporations specified in the statute is that their lines of business be the same or similar, yet it is obvious that consideration must be given to other relevant factors in order that the most valid comparison possible will be obtained. For illustration, a corporation having one or more issues of preferred stock, bonds or debentures in addition to its common stock should not be considered to be directly comparable to one having only common stock outstanding. In like manner, a company with a declining business and decreasing markets is not comparable to one with a record of current progress and market expansion.

Sec. 5. Weight to be Accorded Various Factors

The valuation of closely held corporate stock entails the consideration of all relevant factors as stated in section 4. Depending upon the circumstances in each case, certain factors may carry more weight than others because of the nature of the company's business. To illustrate:

  1. Earnings may be the most important criterion of value in some cases whereas asset value will receive primary consideration in others. In general, the appraiser will accord primary consideration to earnings when valuing stocks of companies which sell products or services to the public; conversely, in the investment or holding type of company, the appraiser may accord the greatest weight to the assets underlying the security to be valued.
  2. The value of the stock of a closely held investment or real estate holding company, whether or not family owned, is closely related to the value of the assets underlying the stock. For companies of this type the appraiser should determine the fair market values of the assets of the company. Operating expenses of such a company and the cost of liquidating it, if any, merit consideration when appraising the relative values of the stock and the underlying assets. The market values of the underlying assets give due weight to potential earnings and dividends of the particular items of property underlying the stock, capitalized at rates deemed proper by the investing public at the date of appraisal. A current appraisal by the investing public should be superior to the retrospective opinion of an individual. For these reasons, adjusted net worth should be accorded greater weight in valuing the stock of a closely held investment or real estate holding company, whether or not family owned, than any of the other customary yardsticks of appraisal, such as earnings and dividend paying capacity.

Sec. 6. Capitalization Rates

In the application of certain fundamental valuation factors, such as earnings and dividends, it is necessary to capitalize the average or current results at some appropriate rate. A determination of the proper capitalization rate presents one of the most difficult problems in valuation. That there is no ready or simple solution will become apparent by a cursory check of the rates of return and dividend yields in terms of the selling prices of corporate shares listed on the major exchanges of the country. Wide variations will be found even for companies in the same industry. Moreover, the ratio will fluctuate from year to year depending upon economic conditions. Thus, no standard tables of capitalization rates applicable to closely held corporations can be formulated. Among the more important factors to be taken into consideration in deciding upon a capitalization rate in a particular case are: (1) the nature of the business; (2) the risk involved; and (3) the stability or irregularity of earnings.

Sec. 7. Average of Factors

Because valuations cannot be made on the basis of a prescribed formula, there is no means whereby the various applicable factors in a particular case can be assigned mathematical weights in deriving the fair market value. For this reason, no useful purpose is served by taking an average of several factors (for example, book value, capitalized earnings and capitalized dividends) and basing the valuation on the result. Such a process excludes active consideration of other pertinent factors, and the end result cannot be supported by a realistic application of the significant facts in the case except by mere chance.

Sec. 8. Restrictive Agreements

Frequently, in the valuation of closely held stock for estate and gift tax purposes, it will be found that the stock is subject to an agreement restricting its sale or transfer. Where shares of stock were acquired by a decedent subject to an option reserved by the issuing corporation to repurchase at a certain price, the option price is usually accepted as the fair market value for estate tax purposes. See Rev. Rul. 54-76, C.B. 1954-1, 194. However, in such case the option price is not determinative of fair market value for gift tax purposes. Where the option, or buy and sell agreement, is the result of voluntary action by the stockholders and is binding during the life as well as at the death of the stockholders, such agreement may or may not, depending upon the circumstances of each case, fix the value for estate tax purposes. However, such agreement is a factor to be considered, with other relevant factors, in determining fair market value. Where the stockholder is free to dispose of his shares during life and the option is to become effective only upon his death, the fair market value is not limited to the option price. It is always necessary to consider the relationship of the parties, the relative number of shares held by the decedent, and other material facts, to determine whether the agreement represents a bona fide business arrangement or is a device to pass the decedent's shares to the natural objects of his bounty for less than an adequate and full consideration in money or money's worth. In this connection see Rev. Rul. 157 C.B. 1953-2, 255, and Rev. Rul. 189, C.B. 1953-2, 294.

Sec. 9. Effect on Other Documents

Revenue Ruling 54-77, C.B. 1954-1, 187, is hereby superseded.

Revenue Bulletin 2003-37

Internal Revenue Bulletin: 2003-37

Catch-Up Contributions for Individuals Age 50 or Older

Final regulations implementing "Catch-Up" contribution provisions for Section 401(k) plans, Section 408(p) Simple IRA plans, Section 408(k) Simplified Employee Pensions (SEPs), Section 403(b) tax-sheltered annuity contracts, and Section 457 governmental plans.

September 15, 2003

T. D. 9072
Catch-Up Contributions for Individuals Age 50 or Older
Department of the Treasury
Internal Revenue Service (IRS)

26 CFR Part 1

Agency: Internal Revenue Service (IRS), Treasury

Action: Final regulations

Summary:

This document contains final regulations that provide guidance concerning the requirements for retirement plans providing catch-up contributions to individuals age 50 or older pursuant to the provisions of section 414(v). These final regulations affect section 401(k) plans, section 408(p) SIMPLE IRA plans, section 408(k) simplified employee pensions, section 403(b) tax-sheltered annuity contracts, and section 457 eligible governmental plans, and affect participants eligible to make elective deferrals under these plans or contracts.

Dates:

Effective Date: These final regulations are effective on July 8, 2003.

Applicability Date: These final regulations are applicable to contributions in taxable years beginning on or after January 1, 2004.

Supplementary information:

Background

This document contains amendments to the Income Tax Regulations (26 CFR Part 1) under sections 402(g) and 414(v) of the Internal Revenue Code (Code). Section 414(v), added by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) (Public Law 107-16; 115 Stat. 38), effective for years beginning after December 31, 2001, permits an individual age 50 or older to make additional elective deferrals each year, up to a dollar limit, if certain requirements provided under that section are satisfied. Under section 414(v)(3), these additional elective deferrals are not subject to certain otherwise applicable limitations on elective deferrals and are excluded from consideration for certain nondiscrimination tests. Under section 414(v)(4), catch-up contributions generally must be made available to all catch-up eligible individuals who participate under any plan maintained by the employer that provides for elective deferrals.

Adoption of Amendments to the Regulations

26 CFR part 1 is amended as follows:

Part 1-Income Taxes

Paragraph 1. The authority citation for part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805

Par. 2. Section 1.402(g)-2 is added to read as follows:

§1.402(g)-2 Increased limit for catch-up contributions.

(a) General rule. Under section 402(g)(1)(C), in determining the amount of elective deferrals that are includible in gross income under section 402(g) for a catch-up eligible participant (within the meaning of §1.414(v)-1(g)), the otherwise applicable dollar limit under section 402(g)(1)(B) (as increased under section 402(g)(7), to the extent applicable) shall be further increased by the applicable dollar catch-up limit as set forth under §1.414(v)-1(c)(2).

(b) Participants in multiple plans. Paragraph (a) of this section applies without regard to whether the applicable employer plans (within the meaning of section 414(v)(6)) treat the elective deferrals as catch-up contributions. Thus, a catch-up eligible participant who makes elective deferrals under applicable employer plans of two or more employers that in total exceed the applicable dollar amount under section 402(g)(1) by an amount that does not exceed the applicable dollar catch-up limit under either plan may exclude the elective deferrals from gross income, even if neither applicable employer plan treats those elective deferrals as catch-up contributions.

(c) Effective date-

(1) Statutory effective date. Section 402(g)(1)(C) applies to contributions in taxable years beginning on or after January 1, 2002.

(2) Regulatory effective date. Paragraphs (a) and (b) of this section apply to contributions in taxable years beginning on or after January 1, 2004.

Par. 3. Section 1.414(v)-1 is added to read as follows:

§1.414(v)-1 Catch-up contributions.

(a) Catch-up contributions.

(1) General rule. An applicable employer plan shall not be treated as failing to meet any requirement of the Internal Revenue Code solely because the plan permits a catch-up eligible participant to make catch-up contributions in accordance with section 414(v) and this section. With respect to an applicable employer plan, catch-up contributions are elective deferrals made by a catch-up eligible participant that exceed any of the applicable limits set forth in paragraph (b) of this section and that are treated under the applicable employer plan as catch-up contributions, but only to the extent they do not exceed the catch-up contribution limit described in paragraph (c) of this section (determined in accordance with the special rules for employers that maintain multiple applicable employer plans in paragraph (f) of this section, if applicable). To the extent provided under paragraph (d) of this section, catch-up contributions are disregarded for purposes of various statutory limits. In addition, unless otherwise provided in paragraph (e) of this section, all catch-up eligible participants of the employer must be provided the opportunity to make catch-up contributions in order for an applicable employer plan to comply with the universal availability requirement of section 414(v)(4). The definitions in paragraph (g) of this section apply for purposes of this section and §1.402(g)-2.

(2) Treatment as elective deferrals. Except as specifically provided in this section, elective deferrals treated as catch-up contributions remain subject to statutory and regulatory rules otherwise applicable to elective deferrals. For example, catch-up contributions under an applicable employer plan that is a section 401(k) plan are subject to the distribution and vesting restrictions of section 401(k)(2)(B) and (C). In addition, the plan is permitted to provide a single election for catch-up eligible participants, with the determination of whether elective deferrals are catch-up contributions being made under the terms of the plan.

(3) Coordination with section 457(b)(3). In the case of an applicable employer plan that is a section 457 eligible governmental plan, the catch-up contributions permitted under this section shall not apply to a catch-up eligible participant for any taxable year for which a higher limitation applies to such participant under section 457(b)(3). For additional guidance, see regulations under section 457.

(b) Elective deferrals that exceed an applicable limit.

(1) Applicable limits. An applicable limit for purposes of determining catch-up contributions for a catch-up eligible participant is any of the following:

(i) Statutory limit. A statutory limit is a limit on elective deferrals or annual additions permitted to be made (without regard to section 414(v) and this section) with respect to an employee for a year provided in section 401(a)(30), 402(h), 403(b), 408, 415(c), or 457(b)(2) (without regard to section 457(b)(3)), as applicable.

(ii) Employer-provided limit. An employer-provided limit is any limit on the elective deferrals an employee is permitted to make (without regard to section 414(v) and this section) that is contained in the terms of the plan, but which is not required under the Internal Revenue Code. Thus, for example, if, in accordance with the terms of the plan, highly compensated employees are limited to a deferral percentage of 10% of compensation, this limit is an employer-provided limit that is an applicable limit with respect to the highly compensated employees.

(iii) Actual deferral percentage (ADP) limit. In the case of a section 401(k) plan that would fail the ADP test of section 401(k)(3) if it did not correct under section 401(k)(8), the ADP limit is the highest amount of elective deferrals that can be retained in the plan by any highly compensated employee under the rules of section 401(k)(8)(C) (without regard to paragraph (d)(2)(iii) of this section). In the case of a simplified employee pension (SEP) with a salary reduction arrangement (within the meaning of section 408(k)(6)) that would fail the requirements of section 408(k)(6)(A)(iii) if it did not correct in accordance with section 408(k)(6)(C), the ADP limit is the highest amount of elective deferrals that can be made by any highly compensated employee under the rules of section 408(k)(6) (without regard to paragraph (d)(2)(iii) of this section).

(2) Contributions in excess of applicable limit.

(i) Plan year limits.

(A) General rule. Except as provided in paragraph (b)(2)(ii) of this section, the amount of elective deferrals in excess of an applicable limit is determined as of the end of the plan year by comparing the total elective deferrals for the plan year with the applicable limit for the plan year. In addition, except as provided in paragraph (b)(2)(i)(B) of this section, in the case of a plan that provides for separate employer-provided limits on elective deferrals for separate portions of plan compensation within the plan year, the applicable limit for the plan year is the sum of the dollar amounts of the limits for the separate portions. For example, if a plan sets a deferral percentage limit for each payroll period, the applicable limit for the plan year is the sum of the dollar amounts of the limits for the payroll periods.

(B) Alternative method for determining employer-provided limit.

(1) General rule. If the plan limits elective deferrals for separate portions of the plan year, then, solely for purposes of determining the amount that is in excess of an employer-provided limit, the plan is permitted to provide that the applicable limit for the plan year is the product of the employee's plan year compensation and the time-weighted average of the deferral percentage limits, rather than determining the employer-provided limit as the sum of the limits for the separate portions of the year. Thus, for example, if, in accordance with the terms of the plan, highly compensated employees are limited to 8% of compensation during the first half of the plan year and 10% of compensation for the second half of the plan year, the plan is permitted to provide that the applicable limit for a highly compensated employee is 9% of the employee's plan year compensation.

(2) Alternative definition of compensation permitted. A plan using the alternative method in this paragraph (b)(2)(i)(B) is permitted to provide that the applicable limit for the plan year is determined as the product of the catch-up eligible participant's compensation used for purposes of the ADP test and the time-weighted average of the deferral percentage limits. The alternative calculation in this paragraph (b)(2)(i)(B)(2) is available regardless of whether the deferral percentage limits change during the plan year.

(ii) Other year limit. In the case of an applicable limit that is applied on the basis of a year other than the plan year (e.g., the calendar-year limit on elective deferrals under section 401(a)(30)), the determination of whether elective deferrals are in excess of the applicable limit is made on the basis of such other year.

(c) Catch-up contribution limit-

(1) General rule. Elective deferrals with respect to a catch-up eligible participant in excess of an applicable limit under paragraph (b) of this section are treated as catch-up contributions under this section as of a date within a taxable year only to the extent that such elective deferrals do not exceed the catch-up contribution limit described in paragraphs (c)(1) and (2) of this section, reduced by elective deferrals previously treated as catch-up contributions for the taxable year, determined in accordance with paragraph (c)(3) of this section. The catch-up contribution limit for a taxable year is generally the applicable dollar catch-up limit for such taxable year, as set forth in paragraph (c)(2) of this section. However, an elective deferral is not treated as a catch-up contribution to the extent that the elective deferral, when added to all other elective deferrals for the taxable year under any applicable employer plan of the employer, exceeds the participant's compensation (determined in accordance with section 415(c)(3)) for the taxable year. See also paragraph (f) of this section for special rules for employees who participate in more than one applicable employer plan maintained by the employer.

(2) Applicable dollar catch-up limit.

(i) In general. The applicable dollar catch-up limit for an applicable employer plan, other than a plan described in section 401(k)(11) or 408(p), is determined under the following table:

For Taxable Years Beginning in

Applicable Dollar Catch-up Limit

2002 $1,000
2003 $2,000
2004 $3,000
2005 $4,000
2006 $5,000

(ii) Simple plans. The applicable dollar catch-up limit for a SIMPLE 401(k) plan described in section 401(k)(11) or a Simple IRA plan as described in section 408(p) is determined under the following table:

For Taxable Years Beginning in

Applicable Dollar Catch-up Limit

2002 $500
2003 $1,000
2004 $1,500
2005 $2,000
2006 $2,500

(iii) Cost of living adjustments. For taxable years beginning after 2006, the applicable dollar catch-up limit is the applicable dollar catch-up limit for 2006 described in paragraph (c)(2)(i) or (ii) of this section increased at the same time and in the same manner as adjustments under section 415(d), except that the base period shall be the calendar quarter beginning July 1, 2005, and any increase that is not a multiple of $500 shall be rounded to the next lower multiple of $500.

(3) Timing rules. For purposes of determining the maximum amount of permitted catch-up contributions for a catch-up eligible participant, the determination of whether an elective deferral is a catch-up contribution is made as of the last day of the plan year (or in the case of section 415, as of the last day of the limitation year), except that, with respect to elective deferrals in excess of an applicable limit that is tested on the basis of the taxable year or calendar year (e.g., the section 401(a)(30) limit on elective deferrals), the determination of whether such elective deferrals are treated as catch-up contributions is made at the time they are deferred.

(d) Treatment of catch-up contributions.

(1) Contributions not taken into account for certain limits. Catch-up contributions are not taken into account in applying the limits of section 401(a)(30), 402(h), 403(b), 408, 415(c), or 457(b)(2) (determined without regard to section 457(b)(3)) to other contributions or benefits under an applicable employer plan or any other plan of the employer.

(2) Contributions not taken into account in application of ADP test.

(i) Calculation of ADR. Elective deferrals that are treated as catch-up contributions pursuant to paragraph (c) of this section with respect to a section 401(k) plan because they exceed a statutory or employer-provided limit described in paragraph (b)(1)(i) or (ii) of this section, respectively, are subtracted from the catch-up eligible participant's elective deferrals for the plan year for purposes of determining the actual deferral ratio (ADR) (as defined in regulations under section 401(k)) of a catch-up eligible participant. Similarly, elective deferrals that are treated as catch-up contributions pursuant to paragraph (c) of this section with respect to a SEP because they exceed a statutory or employer-provided limit described in paragraph (b)(1)(i) or (ii) of this section, respectively, are subtracted from the catch-up eligible participant's elective deferrals for the plan year for purposes of determining the deferral percentage under section 408(k)(6)(D) of a catch-up eligible participant.

(ii) Adjustment of elective deferrals for correction purposes. For purposes of the correction of excess contributions in accordance with section 401(k)(8)(C), elective deferrals under the plan treated as catch-up contributions for the plan year and not taken into account in the ADP test under paragraph (d)(2)(i) of this section are subtracted from the catch-up eligible participant's elective deferrals under the plan for the plan year.

(iii) Excess contributions treated as catch-up contributions. A section 401(k) plan that satisfies the ADP test of section 401(k)(3) through correction under section 401(k)(8) must retain any elective deferrals that are treated as catch-up contributions pursuant to paragraph (c) of this section because they exceed the ADP limit in paragraph (b)(1)(iii) of this section. In addition, a section 401(k) plan is not treated as failing to satisfy section 401(k)(8) merely because elective deferrals described in the preceding sentence are not distributed or recharacterized as employee contributions. Similarly, a SEP is not treated as failing to satisfy section 408(k)(6)(A)(iii) merely because catch-up contributions are not treated as excess contributions with respect to a catch-up eligible participant under the rules of section 408(k)(6)(C). Notwithstanding the fact that elective deferrals described in this paragraph (d)(2)(iii) are not distributed, such elective deferrals are still considered to be excess contributions under section 401(k)(8), and accordingly, matching contributions with respect to such elective deferrals are permitted to be forfeited under the rules of section 411(a)(3)(G).

(3) Contributions not taken into account for other nondiscrimination purposes.

(i) Application for top-heavy. Catch-up contributions with respect to the current plan year are not taken into account for purposes of section 416. However, catch-up contributions for prior years are taken into account for purposes of section 416. Thus, catch-up contributions for prior years are included in the account balances that are used in determining whether the plan is top-heavy under section 416(g).

(ii) Application for section 410(b). Catch-up contributions with respect to the current plan year are not taken into account for purposes of section 410(b). Thus, catch-up contributions are not taken into account in determining the average benefit percentage under §1.410(b)-5 for the year if benefit percentages are determined based on current year contributions. However, catch-up contributions for prior years are taken into account for purposes of section 410(b). Thus, catch-up contributions for prior years would be included in the account balances that are used in determining the average benefit percentage if allocations for prior years are taken into account.

(4) Availability of catch-up contributions. An applicable employer plan does not violate §1.401(a)(4)-4 merely because the group of employees for whom catch-up contributions are currently available (i.e., the catch-up eligible participants) is not a group of employees that would satisfy section 410(b) (without regard to §1.410(b)-5). In addition, a catch-up eligible participant is not treated as having a right to a different rate of allocation of matching contributions merely because an otherwise nondiscriminatory schedule of matching rates is applied to elective deferrals that include catch-up contributions. The rules in this paragraph (d)(4) also apply for purposes of satisfying the requirements of section 403(b)(12).

(e) Universal availability requirement.

(1) General rule.

(i) Effective opportunity. An applicable employer plan that offers catch-up contributions and that is otherwise subject to section 401(a)(4) (including a plan that is subject to section 401(a)(4) pursuant to section 403(b)(12)) will not satisfy the requirements of section 401(a)(4) unless all catch-up eligible participants who participate under any applicable employer plan maintained by the employer are provided with an effective opportunity to make the same dollar amount of catch-up contributions. A plan fails to provide an effective opportunity to make catch-up contributions if it has an applicable limit (e.g., an employer-provided limit) that applies to a catch-up eligible participant and does not permit the participant to make elective deferrals in excess of that limit. An applicable employer plan does not fail to satisfy the universal availability requirement of this paragraph (e) solely because an employer-provided limit does not apply to all employees or different limits apply to different groups of employees under paragraph (b)(2)(i) of this section. However, a plan may not provide lower employer-provided limits for catch-up eligible participants.

(ii) Certain practices permitted.

(A) Proration of limit. A applicable employer plan does not fail to satisfy the universal availability requirement of this paragraph (e) merely because the plan allows participants to defer an amount equal to a specified percentage of compensation for each payroll period and for each payroll period permits each catch-up eligible participant to defer a pro-rata share of the applicable dollar catch-up limit in addition to that amount.

(B) Cash availability. An applicable employer plan does not fail to satisfy the universal availability requirement of this paragraph (e) merely because it restricts the elective deferrals of any employee (including a catch-up eligible participant) to amounts available after other withholding from the employee's pay (e.g., after deduction of all applicable income and employment taxes). For this purpose, an employer limit of 75% of compensation or higher will be treated as limiting employees to amounts available after other withholdings.

(2) Certain employees disregarded. An applicable employer plan does not fail to satisfy the universal availability requirement of this paragraph (e) merely because employees described in section 410(b)(3) (e.g., collectively bargained employees) are not provided the opportunity to make catch-up contributions.

(3) Exception for certain plans. An applicable employer plan does not fail to satisfy the universal availability requirement of this paragraph (e) merely because another applicable employer plan that is a section 457 eligible governmental plan does not provide for catch-up contributions to the extent set forth in section 414(v)(6)(C) and paragraph (a)(3) of this section.

(4) Exception for section 410(b)(6)(C)(ii) period. If an applicable employer plan satisfies the universal availability requirement of this paragraph (e) before an acquisition or disposition described in §1.410(b)-2(f) and would fail to satisfy the universal availability requirement of this paragraph (e) merely because of such event, then the applicable employer plan shall continue to be treated as satisfying this paragraph (e) through the end of the period determined under section 410(b)(6)(C)(ii).

(f) Special rules for an employer that sponsors multiple plans.

(1) General rule. For purposes of paragraph (c) of this section, all applicable employer plans, other than section 457 eligible governmental plans, maintained by the same employer are treated as one plan and all section 457 eligible governmental plans maintained by the same employer are treated as one plan. Thus, the total amount of catch-up contributions under all applicable employer plans of an employer (other than section 457 eligible governmental plans) is limited to the applicable dollar catch-up limit for the taxable year, and the total amount of catch-up contributions for all section 457 eligible governmental plans of an employer is limited to the applicable dollar catch-up limit for the taxable year.

(2) Coordination of employer-provided limits. An applicable employer plan is permitted to allow a catch-up eligible participant to defer amounts in excess of an employer-provided limit under that plan without regard to whether elective deferrals made by the participant have been treated as catch-up contributions for the taxable year under another applicable employer plan aggregated with such plan under this paragraph (f). However, to the extent elective deferrals under another plan maintained by the employer have already been treated as catch-up contributions during the taxable year, the elective deferrals under the plan may be treated as catch-up contributions only up to the amount remaining under the catch-up limit for the year. Any other elective deferrals that exceed the employer-provided limit may not be treated as catch-up contributions and must satisfy the otherwise applicable nondiscrimination rules. For example, the right to make contributions in excess of the employer-provided limit is an other right or feature which must satisfy §1.401(a)(4)-4 to the extent that the contributions are not catch-up contributions. Also, contributions in excess of the employer provided limit are taken into account under the ADP test to the extent they are not catch-up contributions.

(3) Allocation rules. If a catch-up eligible participant makes additional elective deferrals in excess of an applicable limit under paragraph (b)(1) of this section under more than one applicable employer plan that is aggregated under the rules of this paragraph (f), the applicable employer plan under which elective deferrals in excess of an applicable limit are treated as catch-up contributions is permitted to be determined in any manner that is not inconsistent with the manner in which such amounts were actually deferred under the plan.

(g) Definitions.

(1) Applicable employer plan. The term applicable employer plan means a section 401(k) plan, a SIMPLE IRA plan as defined in section 408(p), a simplified employee pension plan as defined in section 408(k) (SEP), a plan or contract that satisfies the requirements of section 403(b), or a section 457 eligible governmental plan.

(2) Elective deferral. The term elective deferral means an elective deferral within the meaning of section 402(g)(3) or any contribution to a section 457 eligible governmental plan.

(3) Catch-up eligible participant. An employee is a catch-up eligible participant for a taxable year if-

(i) The employee is eligible to make elective deferrals under an applicable employer plan (without regard to section 414(v) or this section); and

(ii) The employee's 50th or higher birthday would occur before the end of the employee's taxable year.

(4) Other definitions.

(i) The terms employer, employee, section 401(k) plan, and highly compensated employee have the meanings provided in §1.410(b)-9.

(ii) The term section 457 eligible governmental plan means an eligible deferred compensation plan described in section 457(b) that is established and maintained by an eligible employer described in section 457(e)(1)(A).

(h) Examples.

The following examples illustrate the application of this section. For purposes of these examples, the limit under section 401(a)(30) is $15,000 and the applicable dollar catch-up limit is $5,000 and, except as specifically provided, the plan year is the calendar year. In addition, it is assumed that the participant's elective deferrals under all plans of the employer do not exceed the participant's section 415(c)(3) compensation, that the taxable year of the participant is the calendar year and that any correction pursuant to section 401(k)(8) is made through distribution of excess contributions. The examples are as follows:

Example 1.

(i) Participant A is eligible to make elective deferrals under a section 401(k) plan, Plan P. Plan P does not limit elective deferrals except as necessary to comply with sections 401(a)(30) and 415. In 2006, Participant A is 55 years old. Plan P also provides that a catch-up eligible participant is permitted to defer amounts in excess of the section 401(a)(30) limit up to the applicable dollar catch-up limit for the year. Participant A defers $18,000 during 2006.

(ii) Participant A's elective deferrals in excess of the section 401(a)(30) limit ($3,000) do not exceed the applicable dollar catch-up limit for 2006 ($5,000). Under paragraph (a)(1) of this section, the $3,000 is a catch-up contribution and, pursuant to paragraph (d)(2)(i) of this section, it is not taken into account in determining Participant A's ADR for purposes of section 401(k)(3).

Example 2.

(i) Participants B and C, who are highly compensated employees each earning $120,000, are eligible to make elective deferrals under a section 401(k) plan, Plan Q. Plan Q limits elective deferrals as necessary to comply with section 401(a)(30) and 415, and also provides that no highly compensated employee may make an elective deferral at a rate that exceeds 10% of compensation. However, Plan Q also provides that a catch-up eligible participant is permitted to defer amounts in excess of 10% during the plan year up to the applicable dollar catch-up limit for the year. In 2006, Participants B and C are both 55 years old and, pursuant to the catch-up provision in Plan Q, both elect to defer 10% of compensation plus a pro-rata portion of the $5,000 applicable dollar catch-up limit for 2006. Participant B continues this election in effect for the entire year, for a total elective contribution for the year of $17,000. However, in July 2006, after deferring $8,500, Participant C discontinues making elective deferrals.

(ii) Once Participant B's elective deferrals for the year exceed the section 401(a)(30) limit ($15,000), subsequent elective deferrals are treated as catch-up contributions as they are deferred, provided that such elective deferrals do not exceed the catch-up contribution limit for the taxable year. Since the $2,000 in elective deferrals made after Participant B reaches the section 402(g) limit for the calendar year does not exceed the applicable dollar catch-up limit for 2006, the entire $2,000 is treated as a catch-up contribution.

(iii) As of the last day of the plan year, Participant B has exceeded the employer-provided limit of 10% (10% of $120,000 or $12,000 for Participant B) by an additional $3,000. Since the additional $3,000 in elective deferrals does not exceed the $5,000 applicable dollar catch-up limit for 2006, reduced by the $2,000 in elective deferrals previously treated as catch-up contributions, the entire $3,000 of elective deferrals is treated as a catch-up contribution.

(iv) In determining Participant B's ADR, the $5,000 of catch-up contributions are subtracted from Participant B's elective deferrals for the plan year under paragraph (d)(2)(i) of this section. Accordingly, Participant B's ADR is 10% ($12,000 / $120,000). In addition, for purposes of applying the rules of section 401(k)(8), Participant B is treated as having elective deferrals of $12,000.

(v) Participant C's elective deferrals for the year do not exceed an applicable limit for the plan year. Accordingly, Participant C's $8,500 of elective deferrals must be taken into account in determining Participant C's ADR for purposes of section 401(k)(3).

Example 3.

(i) The facts are the same as in Example 2, except that Plan Q is amended to change the maximum permitted deferral percentage for highly compensated employees to 7%, effective for deferrals after April 1, 2006. Participant B, who has earned $40,000 in the first 3 months of the year and has been deferring at a rate of 10% of compensation plus a pro-rata portion of the $5,000 applicable dollar catch-up limit for 2006, reduces the 10% of pay deferral rate to 7% for the remaining 9 months of the year (while continuing to defer a pro-rata portion of the $5,000 applicable dollar catch-up limit for 2006). During those 9 months, Participant B earns $80,000. Thus, Participant B's total elective deferrals for the year are $14,600 ($4,000 for the first 3 months of the year plus $5,600 for the last 9 months of the year plus an additional $5,000 throughout the year).

(ii) The employer-provided limit for Participant B for the plan year is $9,600 ($4,000 for the first 3 months of the year, plus $5,600 for the last 9 months of the year). Accordingly, Participant B's elective deferrals for the year that are in excess of the employer-provided limit are $5,000 (the excess of $14,600 over $9,600), which does not exceed the applicable dollar catch-up limit of $5,000.

(iii) Alternatively, Plan Q may provide that the employer-provided limit is determined as the time-weighted average of the different deferral percentage limits over the course of the year. In this case, the time-weighted average limit is 7.75% for all participants, and the applicable limit for Participant B is 7.75% of $120,000, or $9,300. Accordingly, Participant B's elective deferrals for the year that are in excess of the employer-provided limit are $5,300 (the excess of $14,600 over $9,300). Since the amount of Participant B's elective deferrals in excess of the employer-provided limit ($5,300) exceeds the applicable dollar catch-up limit for the taxable year, only $5,000 of Participant B's elective deferrals may be treated as catch-up contributions. In determining Participant B's actual deferral ratio, the $5,000 of catch-up contributions are subtracted from Participant B's elective deferrals for the plan year under paragraph (d)(2)(i) of this section. Accordingly, Participant B's actual deferral ratio is 8% ($9,600 / $120,000). In addition, for purposes of applying the rules of section 401(k)(8), Participant B is treated as having elective deferrals of $9,600.

Example 4.

(i) The facts are the same as in Example 1. In addition to Participant A, Participant D is a highly compensated employee who is eligible to make elective deferrals under Plan P. During 2006, Participant D, who is 60 years old, elects to defer $14,000.

(ii) The ADP test is run for Plan P (after excluding the $3,000 in catch-up contributions from Participant A's elective deferrals), but Plan P needs to take corrective action in order to pass the ADP test. After applying the rules of section 401(k)(8)(C) to allocate the total excess contributions determined under section 401(k)(8)(B), the maximum deferrals which may be retained by any highly compensated employee in Plan P is $12,500.

(iii) Pursuant to paragraph (b)(1)(iii) of this section, the ADP limit under Plan P of $12,500 is an applicable limit. Accordingly, $1,500 of Participant D's elective deferrals exceed the applicable limit. Similarly, $2,500 of Participant A's elective deferrals (other than the $3,000 of elective deferrals treated as catch-up contributions because they exceed the section 401(a)(30) limit) exceed the applicable limit.

(iv) The $1,500 of Participant D's elective deferrals that exceed the applicable limit are less than the applicable dollar catch-up limit and are treated as catch-up contributions. Pursuant to paragraph (d)(2)(iii) of this section, Plan P must retain Participant D's $1,500 in elective deferrals and Plan P is not treated as failing to satisfy section 401(k)(8) merely because the elective deferrals are not distributed to Participant D.

(v) The $2,500 of Participant A's elective deferrals that exceed the applicable limit are greater than the portion of the applicable dollar catch-up limit ($2,000) that remains after treating the $3,000 of elective deferrals in excess of the section 401(a)(30) limit as catch-up contributions. Accordingly, $2,000 of Participant A's elective deferrals are treated as catch-up contributions. Pursuant to paragraph (d)(2)(iii) of this section, Plan P must retain Participant A's $2,000 in elective deferrals and Plan P is not treated as failing to satisfy section 401(k)(8) merely because the elective deferrals are not distributed to Participant A. However, $500 of Participant A's elective deferrals can not be treated as catch-up contributions and must be distributed to Participant A in order to satisfy section 401(k)(8).

Example 5.

(i) Participant E is a highly compensated employee who is a catch-up eligible participant under a section 401(k) plan, Plan R, with a plan year ending October 31, 2006. Plan R does not limit elective deferrals except as necessary to comply with section 401(a)(30) and section 415. Plan R permits all catch-up eligible participants to defer an additional amount equal to the applicable dollar catch-up limit for the year ($5,000) in excess of the section 401(a)(30) limit. Participant E did not exceed the section 401(a)(30) limit in 2005 and did not exceed the ADP limit for the plan year ending October 31, 2005. Participant E made $3,200 of deferrals in the period November 1, 2005, through December 31, 2005, and an additional $16,000 of deferrals in the first 10 months of 2006, for a total of $19,200 in elective deferrals for the plan year.

(ii) Once Participant E's elective deferrals for the calendar year 2006 exceed $15,000, subsequent elective deferrals are treated as catch-up contributions at the time they are deferred, provided that such elective deferrals do not exceed the applicable dollar catch-up limit for the taxable year. Since the $1,000 in elective deferrals made after Participant E reaches the section 402(g) limit for the calendar year does not exceed the applicable dollar catch-up limit for 2006, the entire $1,000 is a catch-up contribution. Pursuant to paragraph (d)(2)(i) of this section, $1,000 is subtracted from Participant E's $19,200 in elective deferrals for the plan year ending October 31, 2006, in determining Participant E's ADR for that plan year.

(iii) The ADP test is run for Plan R (after excluding the $1,000 in elective deferrals in excess of the section 401(a)(30) limit), but Plan R needs to take corrective action in order to pass the ADP test. After applying the rules of section 401(k)(8)(C) to allocate the total excess contributions determined under section 401(k)(8)(C), the maximum deferrals that may be retained by any highly compensated employee under Plan R for the plan year ending October 31, 2006, (the ADP limit) is $14,800.

(iv) Under paragraph (d)(2)(ii) of this section, elective deferrals that exceed the section 401(a)(30) limit under Plan R are also subtracted from Participant E's elective deferrals under Plan R for purposes of applying the rules of section 401(k)(8). Accordingly, for purposes of correcting the failed ADP test, Participant E is treated as having contributed $18,200 of elective deferrals in Plan R. The amount of elective deferrals that would have to be distributed to Participant E in order to satisfy section 401(k)(8)(C) is $3,400 ($18,200 minus $14,800), which is less than the excess of the applicable dollar catch-up limit ($5,000) over the elective deferrals previously treated as catch-up contributions under Plan R for the taxable year ($1,000). Under paragraph (d)(2)(iii) of this section, Plan R must retain Participant E's $3,400 in elective deferrals and is not treated as failing to satisfy section 401(k)(8) merely because the elective deferrals are not distributed to Participant E.

(v) Even though Participant E's elective deferrals for the calendar year 2006 have exceeded the section 401(a)(30) limit, Participant E can continue to make elective deferrals during the last 2 months of the calendar year, since Participant E's catch-up contributions for the taxable year are not taken into account in applying the section 401(a)(30) limit for 2006. Thus, Participant E can make an additional contribution of $3,400 ($15,000 minus ($16,000 minus $4,400)) without exceeding the section 401(a)(30) for the calendar year and without regard to any additional catch-up contributions. In addition, Participant E may make additional catch-up contributions of $600 (the $5,000 applicable dollar catch-up limit for 2006, reduced by the $4,400 ($1,000 plus $3,400) of elective deferrals previously treated as catch-up contributions during the taxable year). The $600 of catch-up contributions will not be taken into account in the ADP test for the plan year ending October 31, 2007.

Example 6.

(i) The facts are the same as in Example 5, except that Participant E exceeded the section 401(a)(30) limit for 2005 by $1,300 prior to October 31, 2005, and made $600 of elective deferrals in the period November 1, 2005, through December 31, 2005 (which were catch-up contributions for 2005). Thus, Participant E made $16,600 of elective deferrals for the plan year ending October 31, 2006.

(ii) Once Participant E's elective deferrals for the calendar year 2006 exceed $15,000, subsequent elective deferrals are treated as catch-up contributions as they are deferred, provided that such elective deferrals do not exceed the applicable dollar catch-up limit for the taxable year. Since the $1,000 in elective deferrals made after Participant E reaches the section 402(g) limit for calendar year 2006 does not exceed the applicable dollar catch-up limit for 2006, the entire $1,000 is a catch-up contribution.  Pursuant to paragraph (d)(2)(i) of this section, $1,000 is subtracted from Participant E's elective deferrals in determining Participant E's ADR for the plan year ending October 31, 2006. In addition, the $600 of catch-up contributions from the period November 1, 2005, to December 31, 2005, are subtracted from Participant E's elective deferrals in determining Participant E's ADR. Thus, the total elective deferrals taken into account in determining Participant E's ADR for the plan year ending October 31, 2006, is $15,000 ($16,600 in elective deferrals for the current plan year, less $1,600 in catch-up contributions).

(iii) The ADP test is run for Plan R (after excluding the $1,600 in elective deferrals in excess of the section 401(a)(30) limit), but Plan R needs to take corrective action in order to pass the ADP test. After applying the rules of section 401(k)(8)(C) to allocate the total excess contributions determined under section 401(k)(8)(C), the maximum deferrals that may be retained by any highly compensated employee under Plan R (the ADP limit) is $14,800.

(iv) Under paragraph (d)(2)(ii) of this section, elective deferrals that exceed the section 401(a)(30) limit under Plan R are also subtracted from Participant E's elective deferrals under Plan R for purposes of applying the rules of section 401(k)(8). Accordingly, for purposes of correcting the failed ADP test, Participant E is treated as having contributed $15,000 of elective deferrals in Plan R. The amount of elective deferrals that would have to be distributed to Participant E in order to satisfy section 401(k)(8)(C) is $200 ($15,000 minus $14,800), which is less than the excess of the applicable dollar catch-up limit ($5,000) over the elective deferrals previously treated as catch-up contributions under Plan R for the taxable year ($1,000). Under paragraph (d)(2)(iii) of this section, Plan R must retain Participant E's $200 in elective deferrals and is not treated as failing to satisfy section 401(k)(8) merely because the elective deferrals are not distributed to Participant E.

(v) Even though Participant E's elective deferrals for calendar year 2006 have exceeded the section 401(a)(30) limit, Participant E can continue to make elective deferrals during the last 2 months of the calendar year, since Participant E's catch-up contributions for the taxable year are not taken into account in applying the section 401(a)(30) limit for 2006. Thus Participant E can make an additional contribution of $200 ($15,000 minus ($16,000 minus $1,200)) without exceeding the section 401(a)(30) for the calendar year and without regard to any additional catch-up contributions. In addition, Participant E may make additional catch-up contributions of $3,800 (the $5,000 applicable dollar catch-up limit for 2006, reduced by the $1,200 ($1,000 plus $200) of elective deferrals previously treated as catch-up contributions during the taxable year). The $3,800 of catch-up contributions will not be taken into account in the ADP test for the plan year ending October 31, 2007.

Example 7.

(i) Participant F, who is 58 years old, is a highly compensated employee who earns $100,000 per year. Participant F participates in a section 401(k) plan, Plan S, for the first 6 months of the year and then transfers to another section 401(k) plan, Plan T, sponsored by the same employer, for the second 6 months of the year. Plan S limits highly compensated employees' elective deferrals to 6% of compensation for the period of participation, but permits catch-up eligible participants to defer amounts in excess of 6% during the plan year, up to the applicable dollar catch-up limit for the year. Plan T limits highly compensated employees' elective deferrals to 8% of compensation for the period of participation, but permits catch-up eligible participants to defer amounts in excess of 8% during the plan year, up to the applicable dollar catch-up limit for the year.  Participant F earned $50,000 in the first 6 months of the year and deferred $6,000 under Plan S. Participant F also deferred $6,500 under Plan T.

(ii) As of the last day of the plan year, Participant F has $3,000 in elective deferrals under Plan S that exceed the employer-provided limit of $3,000. Under Plan T, Participant F has $2,500 in elective deferrals that exceed the employer-provided limit of $4,000. The total amount of elective deferrals in excess of employer-provided limits, $5,500, exceeds the applicable dollar catch-up limit by $500. Accordingly, $500 of the elective deferrals in excess of the employer-provided limits are not catch-up contributions and are treated as regular elective deferrals (and are taken into account in the ADP test). The determination of which elective deferrals in excess of an applicable limit are treated as catch-up contributions is permitted to be made in any manner that is not inconsistent with the manner in which such amounts were actually deferred under Plan S and Plan T.

Example 8.

(i) Employer X sponsors Plan P, which provides for matching contributions equal to 50% of elective deferrals that do not exceed 10% of compensation. Elective deferrals for highly compensated employees are limited, on a payroll-by-payroll basis, to 10% of compensation. Employer X pays employees on a monthly basis. Plan P also provides that elective contributions are limited in accordance with section 401(a)(30) and other applicable statutory limits. Plan P also provides for catch-up contributions. Under Plan P, for purposes of calculating the amount to be treated as catch-up contributions (and to be excluded from the ADP test), amounts in excess of the 10% limit for highly compensated employees are determined at the end of the plan year based on compensation used for purposes of ADP testing (testing compensation), a definition of compensation that is different from the definition used under the plan for purposes of calculating elective deferrals and matching contributions during the plan year (deferral compensation).

(ii) Participant A, a highly compensated employee, is a catch-up eligible participant under Plan P with deferral compensation of $10,000 per monthly payroll period. Participant A defers 10% per payroll period for the first 10 months of the year, and is allocated a matching contribution each payroll period of $500. In addition, Participant A defers an additional $4,000 during the first 10 months of the year. Participant A then reduces deferrals during the last 2 months of the year to 5% of compensation. Participant A is allocated a matching contribution of $250 for each of the last 2 months of the plan year. For the plan year, Participant A has $15,000 in elective deferrals and $5,500 in matching contributions.

(iii) A's testing compensation is $118,000. At the end of the plan year, based on 10% of testing compensation, or $11,800, Plan P determines that A has $3,200 in deferrals that exceed the 10% employer provided limit. Plan P excludes $3,200 from ADP testing and calculates A's ADR as $11,800 divided by $118,000, or 10%. Although A has not been allocated a matching contribution equal to 50% of $11,800, because Plan P provides that matching contributions are calculated based on elective deferrals during a payroll period as a percentage of deferral compensation, Plan P is not required to allocate an additional $400 of matching contributions to A.

(i) Effective date.

(1) Statutory effective date. Section 414(v) applies to contributions in taxable years beginning on or after January 1, 2002.

(2) Regulatory effective date. Paragraphs (a) through (h) of this section apply to contributions in taxable years beginning on or after January 1, 2004.

Robert E. Wenzel,
Deputy Commissioner for
Services and Enforcement.

Approved June 27, 2003.

Pamela F. Olson,
Assistant Secretary (Tax Policy).

Note:

(Filed by the Office of the Federal Register on July 7, 2003, 8:45 a.m., and published in the issue of the Federal Register for July 8, 2003, 68 F.R. 40510)

Revenue Bulletin 2003-13


Deemed Individual Retirement Accounts

"Deemed IRAs" were created under the Economic Growth and Tax Relief Reconciliation Act of 2001 when it added Section 408(q) to the Internal Revenue Code.  Section 408q permits employees to make either regular IRA and/or Roth IRA contributions to an individual retirement account (IRA) within a qualified employer plan.

Part III. Administrative, Procedural, and Miscellaneous
26 CFR 601.201: Rulings and determination letters
Revenue Procedure 2003-13

Section 1. Purpose

This revenue procedure provides guidance for employers that want to amend their plans qualified under § 401(a) of the Internal Revenue Code to include "deemed IRAs" described in § 408(q). The revenue procedure also provides a sample plan amendment that may be used, in conjunction with IRA language, to amend a qualified plan to provide for deemed IRAs.

Section 2. Background

  1. Section 408(q) was added to the Code by section 602 of the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA"), Pub. L. 107-16, effective for plan years beginning after December 31, 2002. Section 408(q) provides that if a qualified employer plan elects to allow employees to make voluntary employee contributions to a separate account or annuity established under the plan, and under the terms of the qualified employer plan such account or annuity meets the applicable requirements of § 408 or 408A for an individual retirement account or annuity, then such account or annuity shall be treated under the Code in the same manner as an IRA and not as a qualified employer plan. The Internal Revenue Service and Treasury expect to issue regulations under Code § 408(q) in the near future.
  2. Notice 2001-42, 2001-2 C.B. 70, provides a remedial amendment period under § 401(b), ending no earlier than the end of the first plan year beginning on or after January 1, 2005, in which any needed retroactive EGTRRA plan amendment may be adopted (the "EGTRRA remedial amendment period"). The availability of the EGTRRA remedial amendment period is conditioned on the timely adoption of a good faith EGTRRA plan amendment.
  3. Notice 2001-57, 2001-2 C.B. 279, provides sample plan amendments that satisfy, in form, the "good faith EGTRRA plan amendment" requirement described in the preceding paragraph. Although not containing a sample plan amendment for deemed IRAs under Code § 408(q), the notice provides that the good faith plan amendment requirement applies to § 408(q). The notice also provides that, until further notice, the Service will not consider EGTRRA in issuing determination, opinion or advisory letters.
  4. Rev. Proc. 2002-10, 2002-4 I.R.B. 401, requires all prototype sponsors with currently approved IRAs, SEPs, and SIMPLE IRA plans to amend these documents and submit applications for opinion letters on the amended documents by December 31, 2002.

Section 3. Required language for deemed IRAs

  1. Plan sponsors that want to provide for deemed IRAs must have such provisions in their plan documents and must have deemed IRAs in effect for employees no later than the date deemed IRA contributions are accepted from such employees. Notwithstanding the preceding sentence, plan sponsors that want to provide for deemed IRAs for plan years beginning before January 1, 2004, (but after December 31, 2002) are not required to have such provisions in their plan documents before the end of such plan years. Plan sponsors must otherwise comply with the rules in Notice 2001-57. To satisfy the requirements for the EGTRRA remedial amendment period, the provisions must reflect a reasonable, good-faith interpretation of the statute. The sample plan amendment contained in the appendix to this revenue procedure, when used in conjunction with IRA language described in section 3.02 below, is a reasonable, good-faith interpretation of the statute.
  2. In addition to the sample plan amendment in the Appendix, a plan that intends to comply with Code § 408(q) must also contain language that satisfies § 408 or 408A, relating to traditional and Roth IRAs, respectively. The Service provides sample language (a "Listing of Required Modifications," or "LRMs") that satisfies §§ 408 and 408A on the Service's Web Site at www.irs.gov/ep. A plan will satisfy the "reasonable, good-faith interpretation of the statute" requirement with respect to IRA language if the language addresses every applicable point in the IRA LRMs.

Drafting Information

The principal author of this revenue procedure is Roger Kuehnle of the Employee Plans, Tax Exempt and Government Entities Division. For further information regarding this revenue procedure, please contact Employee Plans' taxpayer assistance telephone service at 1-877-829-5500 (a toll-free number), between the hours of 8:00 a.m. and 6:30 p.m. Eastern Time, Monday through Friday. Mr. Kuehnle can be reached at 202-283-9888 (not a toll-free number).

Appendix

Sample Plan Amendment

(The following sample plan amendment may be adopted only by plans trusteed by a person eligible to act as a trustee of an IRA under § 408(a)(2) and plans that designate an insurance company to issue annuity contracts under § 408(b). Additional language that satisfies § 408 or 408A must also be added to the plan.)

Section - Deemed IRAs

1. Applicability and effective date. This section shall apply if elected by the employer in the adoption agreement and shall be effective for plan years beginning after the date specified in the adoption agreement.

2. Deemed IRAs. Each participant may make voluntary employee contributions to the participant's ---------------- [insert "traditional" or "Roth"] IRA under the plan. The plan shall establish a separate -------------- [insert "account" or "annuity"] for the designated IRA contributions of each participant and any earnings properly allocable to the contributions, and maintain separate recordkeeping with respect to each such IRA.

3. Reporting duties. The ----------- [insert "trustee" or "issuer"] shall be subject to the reporting requirements of section 408(i) of the Internal Revenue Code with respect to all IRAs that are established and maintained under the plan.

4. Voluntary employee contributions. For purposes of this section, a voluntary employee contribution means any contribution (other than a mandatory contribution within the meaning of section 411(c)(2) of the Code) that is made by the participant and which the participant has designated, at or prior to the time of making the contribution, as a contribution to which this section applies.

5. IRAs established pursuant to this section shall be held in ----------- [insert "a trust" or "an annuity"] separate from the trust established under the plan to hold contributions other than deemed IRA contributions and shall satisfy the applicable requirements of sections 408 and 408A of the Code, which requirements are set forth in section ---------- [insert the section of the plan that contains the IRA requirements].

(Adoption agreement provisions)

Section of the plan, Deemed IRAs: (check one)

  • shall be effective for plan years beginning after December 31, (enter a year later than 2001).
  • shall not apply.

Roth and Deemed Individual Retirement Account Participation in Group Trusts Described in Revenue Ruling 81-100

Internal Revenue Code
2004-67

Part I

Section 501 - Exemption From Tax on Corporations, Certain Trusts, Etc.
26 CFR 1.501(a)(1): Exemption from taxation.
(Also, §§ 457; 1.457-8.)
Revenue Ruling 2004-67

Purpose

This revenue ruling extends the ability to participate in group trusts described in Revenue Ruling 81-100, 1981-1 C.B. 326, to eligible governmental plans under § 457(b) of the Internal Revenue Code and clarifies the ability of Roth individual retirement accounts described in § 408A and deemed individual retirement accounts described in § 408(q) to participate in these group trusts. In addition, this revenue ruling provides related model language for eligible governmental plans under § 457(b).

Issue

Whether the assets of eligible governmental plan trusts described in § 457(b) may be pooled with the assets of a group trust described in Revenue Ruling 81-100, without affecting the tax status of the eligible governmental plan trust or the group trust (including its current participants).

Law and analysis

Section 501(a) provides, in part, that a trust described in § 401(a) is exempt from income tax. Section 401(a)(1) provides that a trust or trusts created or organized in the United States and forming a part of a stock bonus, pension, or profit-sharing plan of an employer for the exclusive benefit of its employees or their beneficiaries is qualified under § 401(a) if contributions are made to the trust or trusts by the applicable employer, or employees, or both for the purpose of distributing to such employees or their beneficiaries the corpus and income of the fund accumulated in accordance with such plan. Section 401(a)(2) provides, in part, that under each trust instrument it must be impossible, at any time prior to the satisfaction of all liabilities with respect to employees and their beneficiaries under the plan and the trust or trusts, for any part of the corpus or income of the trust, to be used for or diverted to purposes other than for the exclusive benefit of the employees or their beneficiaries.

Section 401(a)(24) provides that any group trust that otherwise meets the requirements of § 401(a) will not fail to satisfy such requirements due to the participation or inclusion of a plan or governmental unit described in § 818(a)(6) in the group trust. Section 818(a)(6) provides, in part, that for these purposes the trust of a pension plan contract includes a governmental plan within the meaning of § 414(d) and an eligible deferred compensation plan within the meaning of § 457(b).

Section 401(f) provides that a custodial account, an annuity contract and certain other contracts issued by an insurance company will be treated as a qualified trust if the custodial account or contract would, except for the fact that it is not a trust, constitute a qualified trust under § 401, and, if the assets in any such custodial account are held by a bank or another person who demonstrates that he will hold the assets in a manner consistent with the requirements of § 401.

Section 408(e) provides for the exemption from taxation of an individual retirement account that meets the requirements of § 408. Section 408(a)(5) provides that the assets of an individual retirement account may not be commingled with other property except in a common trust fund or common investment fund.

Section 408A provides that, except as otherwise provided in § 408A, a Roth IRA is treated for purposes of the Code as an individual retirement plan, which includes an individual retirement account that meets the requirement of § 408. Consequently, a Roth IRA that is an individual retirement account is exempt from tax under § 408(e). Section 408(q) provides, in part, that if a qualified employer plan, as defined in § 408(q)(3)(A), elects to allow employees to make voluntary employee contributions to a separate account established under the plan and, under the terms of the qualified employer plan, the account meets the requirements of § 408 or 408A for an individual retirement account, then that account is treated as an individual retirement account (deemed individual retirement account), and not as a qualified employer plan. An individual retirement account described in § 408(q) is exempt from taxation under § 408(e).

Rev. Rule. 81-100 holds that if certain requirements are satisfied, a group trust is exempt from taxation under § 501(a) with respect to its funds that equitably belong to participating trusts described in § 401(a) and also is exempt from taxation under § 408(e) with respect to its funds that equitably belong to individual retirement accounts that satisfy the requirements of § 408. Also, the status of individual trusts as qualified under § 401(a), or as meeting the requirements of § 408 and as being exempt from tax under § 501(a) or § 408(e), are not affected by the pooling of their funds in a group trust.

Section 457 provides that compensation deferred under an eligible deferred compensation plan of an eligible employer that is a State or political subdivision, agency, or instrumentality thereof (an eligible governmental plan) and any income attributable to the amounts deferred, is includible in gross income only in the taxable year in which it is paid to the plan participant or beneficiary.

Section 457(g)(1) requires an eligible governmental plan under § 457(b) to hold all assets and income of the plan in a trust for the exclusive benefit of participants and their beneficiaries.

Section 457(g)(2) provides, in part, that a trust described in § 457(g)(1) is treated as an organization exempt from federal income tax under § 501(a).

Section 457(g)(3) provides that custodial account and contracts described in § 401(f) are treated as trusts under rules similar to the rules under § 401(f).

This revenue ruling extends the holding of Revenue Ruling 81-100 to eligible governmental plans described in § 457(b). Therefore, if the requirements below are satisfied, the funds from qualified plan trusts, individual retirement accounts (including a Roth individual retirement account described in § 408A and a deemed individual retirement account described in § 408(q)) that are tax-exempt under § 408(e), and eligible governmental plan trusts described in § 457(b) and § 457(g) may be pooled without adversely affecting the tax status of the group trust or the tax status of the separate trusts.

Holding

The assets of eligible governmental plan trusts described in § 457(b) may be pooled with the assets of a group trust described in Revenue Ruling 81-100 without affecting the tax status of the eligible governmental plan trust or the group trust (including its current participants). Accordingly, under Revenue Ruling 81-100 and this revenue ruling, if the five criteria below are satisfied, a trust that is part of a qualified retirement plan, an individual retirement account (including a Roth individual retirement account described in § 408A and a deemed individual retirement account described in § 408(q)) that is exempt from taxation under § 408(e), or an eligible governmental plan under § 457(b) may pool its assets in a group trust without adversely affecting the tax status of any of the separate trusts or the group trust. For this purpose, a trust includes a custodial account that is treated as a trust under § 401(f), under § 408(h), or under § 457(g)(3).

(1) The group trust is adopted as a part of each adopting employer's plan or each adopting individual retirement account.

(2) The group trust instrument expressly limits participation to pension, profit sharing, and stock bonus trusts or custodial accounts qualifying under § 401(a) that are exempt under § 501(a); individual retirement accounts that are exempt under § 408(e); and eligible governmental plan trusts or custodial accounts under § 457(b) that are exempt under § 457(g) (adopting entities).

(3) The group trust instrument prohibits any part of its corpus or income that equitably belongs to any adopting entity from being used for or diverted to any purpose other than for the exclusive benefit of the employees (and the individual for whom an individual retirement account is maintained) and their beneficiaries who are entitled to benefits under such adopting entity.

(4) The group trust instrument prohibits assignment by an adopting entity of any part of its equity or interest in the group trust.

(5) The group trust is created or organized in the United States and is maintained at all times as a domestic trust in the United States.

Model Amendments

There are two model amendments set forth below. One is for those group trusts that have received favorable determination letters from the Service that the group trust satisfies Revenue Ruling 81-100. The other is for those trusts of eligible governmental plans under § 457(b) that have received a letter ruling from the Service (in each instance issued prior to July 12, 2004).

Ammendment 1 - For group Trust

A sponsor of a group trust that satisfies Revenue Ruling 81-100 may amend its group trust to include the model language below to reflect this revenue ruling: This group trust is operated or maintained exclusively for the commingling and collective investment of funds from other trusts that it holds. Notwithstanding any contrary provision in this group trust, the trustee of this group trust is permitted, unless restricted in writing by the named fiduciary, to hold in this group trust funds that consist exclusively of trust assets held under plans qualified under Code section 401(a), individual retirement accounts that are exempt under Code section 408(e), and eligible governmental plans that meet the requirements of Code section 457(b). For this purpose, a trust includes a custodial account that is treated as a trust under Code section 401(f) or under Code section 457(g)(3).

"For purposes of valuation, the value of the interest maintained by the fund with respect to any plan or account in such group trust shall be the fair market value of the portion of the fund held for that plan or account, determined in accordance with generally recognized valuation procedures."

Reliance by trustees with prior determination letter

A trustee entitled to rely on a favorable determination letter issued to it prior to July 12, 2004, regarding eligibility of its group trust under Revenue Ruling 81-100 will not lose its right to rely on its determination letter merely because it adopts Model Amendment 1 set forth above in this revenue ruling on a word-for-word basis (or adopts an amendment that is substantially similar in all material respects). The group trust sponsor may adopt Model Amendment 1 on a word-for-word basis (or adopt an amendment that is substantially similar in all material respects) and continue to rely on the previously issued determination letter regarding its group trust without filing another request with the Service for a new determination letter.

A sponsor that satisfies the above requirements and amends its group trust to include Model Amendment 1 on a word-for-word basis (or adopts an amendment that is substantially similar in all material respects) will also not lose its right to rely on its prior determination letter merely because it becomes necessary, as a result of the adoption of such model amendment (or an amendment that is substantially similar in all material respects), to delete a prior provision that is inconsistent with the model amendment so adopted (or an amendment that is substantially similar in all material respects that is so adopted).

Generally, the group trust instrument will provide that amendments to the group trust will automatically pass through to the trusts of qualified plans under § 401(a); individual retirement accounts that are exempt under § 408(e); and trusts of eligible governmental plans under § 457(b). However, a group trust that has received a favorable determination letter under Rev. Proc. 2004-6, 2004-1 Internal Revenue Bulletin 204, (or its predecessors) that does not contain such a pass-through provision may not adopt Model Amendment 1 and automatically continue to rely on its determination letter. In addition, further guidance will be issued to address the transition necessary to bring into compliance a group trust that has received a favorable determination letter under Rev. Proc. 2004-6, 2004-1 Internal Revenue Bulletin 204, (or its predecessors) that does not comply with this revenue ruling.

Amendment 2 - For eligible governmental plan under § 457(b)

A plan sponsor of a trust that funds an eligible governmental plan under § 457(b) may amend the trust agreement to include the model language below to reflect this revenue ruling:

"Notwithstanding any contrary provision in the instrument governing the [Name of eligible governmental plan under § 457(b)], the plan trustee may, unless restricted in writing by the named fiduciary, transfer assets of the plan to a group trust that is operated or maintained exclusively for the commingling and collective investment of monies provided that the funds in the group trust consist exclusively of trust assets held under plans qualified under Code section 401(a), individual retirement accounts that are exempt under Code section 408(e), and eligible governmental plans that meets the requirements of Code section 457(b)".

For this purpose, a trust includes a custodial account that is treated as a trust under Code section 401(f) or under Code section 457(g)(3).

"For purposes of valuation, the value of the interest maintained by the [Name of eligible governmental plan under §457] in such group trust shall be the fair market value of the portion of the group trust held for the [Name of eligible governmental plan under § 457(b)], determined in accordance with generally recognized valuation procedures."

Reliance by employer on prior § 457(b) ruling

An employer described in section 457(e)(1)(A) entitled to rely on a favorable private letter ruling issued to it prior to July 12, 2004 regarding the eligibility of its plan under § 457(b) will not lose its right to rely on its letter ruling merely because it adopts Model Amendment 2 set forth above on a word-for-word basis (or adopts an amendment that is substantially similar in all material respects). Such an employer may adopt Model Amendment 2 on a word-for-word basis (or adopt an amendment that is substantially similar in all material respects) and continue to rely on the previously issued letter ruling regarding its § 457(b) plan without filing another request with the Service for a new letter ruling.

An employer described in § 457(e)(1)(A) that satisfies the above requirements and amends the trust of its eligible governmental plan under § 457(b) to include Model Amendment 2 on a word-for-word basis (or adopts an amendment that is substantially similar in all material respects) will not lose its right to rely on its prior letter ruling merely because it becomes necessary as a result of the adoption of such model amendment (or an amendment that is substantially similar in all material respects), to delete a prior provision that is inconsistent with the model amendment so adopted.

Effect on other Documents

Revenue Ruling 81-100 is clarified and modified.

Drafting Information

The principal author of this revenue ruling is Dana A. Barry of the Employee Plans, Tax Exempt and Government Entities Division. For further information regarding this revenue ruling, please contact the Employee Plans' taxpayer assistance telephone service at 1-877-829-5500 (a toll-free number) between the hours of 8:00 a.m. and 6:30 p.m. Eastern Time, Monday through Friday (a toll free call). Ms. Barry may be reached at (202) 283-9888 (not a toll-free call).

IRS Self-Correction Program Frequently Asked Questions


Summary
IRS published guidance regarding the Self-Correction Program

Agency: Internal Revenue Service

IRS Self-Correction Program Frequently Asked Questions Guidance.

These frequently asked questions and answers are provided for general information only and should not be cited as any type of legal authority. They are designed to provide the user with information required to respond to general inquiries. Due to the uniqueness and complexities of Federal tax law, it is imperative to ensure a full understanding of the specific question presented, and to perform the requisite research to ensure a correct response is provided.

Is there a way to attain IRS approval prior to audit regarding the appropriate way to correct a failure under the SCP?

The SCP is a voluntary employer-initiated program that does not involve IRS approval; therefore, the IRS will not approve a Plan Sponsor's method of correction prior to audit. However, Rev. Proc. 2003-44 sets forth General Correction Principles designed to assist a plan sponsor in determining the appropriate method of correction for a failure. In addition, Appendix A and Appendix B of Rev. Proc. 2003-44 provide plan sponsors with sample correction methods for certain failures. To the extent the plan sponsor applies the applicable correction method set forth in either of these appendices, the correction is deemed to be reasonable and appropriate correction for the failure. Upon examination, the IRS has the right to review whether the taxpayer made the correct determination that such failure(s) were eligible under the SCP as well as whether the correction method is acceptable.

What practices and procedures are required to be in place in order for a plan to be eligible for relief under the SCP?

The IRS is concerned that the practices and procedures of a plan foster compliance with the requirements of the Code.

  • Practices and procedures may be formal or informal.
  • Practices and procedures must be routinely followed.
  • Practices and procedures need not be in place for a specific failure (as long as practices and procedures exist that evidence an overall effort on the part of the Plan Sponsor to maintain the plan in compliance with the Code requirements).
  • A plan document alone is not sufficient to establish evidence of good practices and procedures.
  • An example of an acceptable practice or procedure outside of the plan document is a checksheet routinely followed for determining whether an employee is a key employee for purposes of meeting the top heavy requirements.

If a plan sponsor discovers a failure of the Actual Deferral Percentage (ADP), Actual Deferral Percentage (ACP), or Multiple Use tests in the plan sponsor's profit-sharing plan, may the failures be corrected under the SCP?

Yes. A failure of the ADP, ACP or Multiple Use Tests is treated as an Operational Failure for purposes of EPCRS. Under Code section 401(k) and (m), a Plan Sponsor has until the end of the plan year following the plan year in which an excess contribution or excess aggregate contribution was made to correct the failure; under the SCP, the two-year correction period applicable to Significant Operational Failures does not begin under the expiration of the statutory correction period. (Note that the Multiple Use Test has been repealed for plan years beginning after 12/31/01.)

Example - In 2004, a Plan Sponsor discovers that in 2003, when testing the contributions made in its section 401(k) plan during 2003 for the ADP test, mistakes were made in determining the correct amount of compensation that should have been taken into account under the test. When the ADP test was rerun with the correct data, the plan sponsor discovers that the ADP test was failed. Assuming the other eligibility requirements of Self-Correction Program are satisfied, if the ADP failure is a Significant Operation Failure, the plan sponsor may correct the failure to satisfy the ADP test by the end of the 2006 plan year. If the ADP failure is an Insignificant Operational Failure, the plan sponsor has even longer to correct the failure, and may correct even upon audit of the plan.

What are Insignificant Operational Failures under the SCP?

The SCP permits Plan Sponsors to correct significant Operational Failures within two years of the year in which the failure occurred, provided the other requirements of the SCP are satisfied. A number of factors are considered in determining whether Operational Failures are insignificant. These include, but are not limited to:

  • whether other failures occurred during the period being examined (for this purpose, a failure is not considered to have occurred more than once merely because more than one participant is affected by the failure);
  • the percentage of plan assets and contributions involved in the failure;
  • the number of years the failure occurred;
  • the number of participants affected relative to the total number of participants in the plan;
  • the number of participants affected as a result of the failure relative to the number of participants who could have been affected by the failure;
  • whether correction was made within a reasonable time after discovery of the failure; and
  • the reason for the failure (for example, data errors such as errors in the transcription of data, the transposition of numbers, or minor arithmetic errors).

This is not an exclusive list and no single factor is determinative. Failures will not be considered significant merely because they occur in more than one year. In addition, the IRS will apply these factors in a way so as to not preclude small businesses from being eligible for the SCP merely because of their size.

When correcting Significant Operational Failures, what actions must be taken by a plan sponsor by the end of the two-year correction period in order to be entitled to relief under the SCP?

In general, correction must be completed by the end of the two-year correction period in order for a plan to be entitled to relief under the SCP. However, where a Plan Sponsor substantially completes correction within the correction period, the plan sponsor will not lose the relief provided under the SCP merely because correction wasn't completed during the correction period. There are two circumstances under which correction is considered to have been substantially completed:

First, where,

  • during the correction period, the Plan Sponsor is reasonably prompt in identifying the  Operational Failure , formulating a correction method, and initiating correction in a manner that demonstrates a commitment to completing correction of the Operational Failure as expeditiously as practicable, and
  • within 90 days after the last day of the correction period, the Plan Sponsor completes correction of the Operational Failure; and

Second, where,

  • during the correction period, correction is completed with respect to 85% of all participants affected by the Operational Failure, and
  • thereafter, the Plan Sponsor completes correction of the Operational Failure with respect to the remaining affected participants in a diligent manner.

In addition, a Plan Sponsor will not be considered to have failed to fully correct within the correction period where a plan sponsor takes reasonable action to find but has not located all current and former participants and beneficiaries to whom additional benefits are due. Reasonable action includes the use of the Internal Revenue Service Letter Forwarding Program (see Rev. Proc. 94-22, 1994-1 C.B. 608) or the Social Security Administration Reporting Service. If an individual is later located, the additional benefits must be provided to the individual at that time.

If correction of an Operational Failure is being implemented through adoption of a plan amendment, the required application for a determination letter must be submitted within the two-year correction period in order for correction to be considered to have been timely implemented.

Assume a plan sponsor discovers a vesting problem in which the plan terms were not followed, should the plan sponsor use SCP or the Voluntary Correction Program to correct the problem?

The decision of whether to use the SCP or Voluntary Correction Program to correct an Operational Failure depends on a number of factors, including: (1) the type of failure involved, (2) the practices and procedures under the plan, (3) whether, if the failure is an Operational Failure, it would be considered to be a Significant Operational Failure, (4) whether a Favorable Letter has been issued with respect to the plan, (5) whether the failure is an Egregious Failure, (6) when the failure is discovered, and (7) the amount of comfort the Plan Sponsor has with respect to the method used to correct the failure.

Although the SCP does not require the payment of a fee or notification to the IRS, it is limited to correcting Operational Failures that are not egregious. In addition, if the failure is a Significant Operational Failure, the Plan Sponsor must complete correction of the failure within two years of the year in which the failure occurred. Although a plan sponsor does not necessarily get assurance that the correction method employed under the SCP is acceptable to the IRS, the IRS has provided several examples of failures and acceptable correction methods under Appendix A and Appendix B in Rev. Proc. 2003-44. If a plan sponsor corrects a failure listed in Appendix A or Appendix B in accordance with the method of correction method set forth in the appendix, the plan sponsor may be assured that the IRS will find that correction method to be acceptable.

In this example, an Operational Failure, a vesting failure, has occurred. Appendix B, section 2.03 provides examples of acceptable correction methods for a vesting failure. Therefore, if there are acceptable practices and procedures under the plan (see Q&A 2 above), and the failure is an Insignificant Operational Failure, the Plan Sponsor may use the SCP to correct the failure at any time, even if the plan is Under Examination. Further, if the plan sponsor uses one of the correction methods under Appendix B of the revenue procedure, it will have assurance that the plan would be entitled to relief under the SCP with respect to its correction method. If, however, the failure is a Significant Operational Failure, the plan would be entitled to relief under the SCP only if the failure is identified and corrected within the two-year correction period under the SCP. Also, if the failure is a Significant Operational Failure, the plan would be eligible for relief under the SCP only if a Favorable Letter has been issued with respect to the plan. If the failure would be considered an Egregious Failure, it would be eligible for correction under the Voluntary Correction Program but not under the SCP.

IRS Voluntary Correction Program Frequently Asked Questions


Summary
IRS published guidance regarding the Voluntary Correction Program

Agency: Internal Revenue Service

IRS Voluntary Compliance Program Frequently Asked Questions Guidance.

The frequently asked questions and answers provided below are for general information only and should not be cited as any type of legal authority. They are designed to provide the user with information required to respond to general inquiries. Due to the uniqueness and complexities of Federal tax law, it is imperative to ensure a full understanding of the specific question presented, and to perform the requisite research to ensure a correct response is provided.

Is there an application form that plan sponsors must use to apply under the VCP?

There is no application form applicable to the VCP; however, the IRS provides Sample Submission Formats in Appendix D of Rev. Proc. 2003-44, which facilitate the submission process. The IRS also provides a Checklist designed to assist the Plan Sponsor and their representatives in preparing a submission that contains the information and documents required under each of those programs. The checklist must be completed, signed, and dated by the employer, plan sponsor, or the plan sponsor's representative, and should be placed on top of the submission.

What is the mailing address for applications submitted under the VCP?

All VCP submissions and accompanying determination letter applications (if applicable) should be mailed to the following address:

Internal Revenue Service
Attention: T:EP:RA:VC
P.O. Box 27063
McPherson Station
Washington, D.C. 20038

Some employers have very little involvement in their employees' 403(b) plans. Who should file a VCP application in these cases?

The employer is the only one who can submit an application to correct failures under the VCP. Although insurers and custodians may have some liability to the employer, they have no liability under the VCP. The employer is responsible for identifying the failures, correcting the failures, and insuring that necessary changes are made to administrative procedures for operating the 403(b) plan. When necessary for correction, the employer must secure the cooperation of the providers prior to submitting an application under the VCP.

For a VCP submission, what information must the plan sponsor supply with respect to correction of the failures?

The letter from the Plan Sponsor or the plan sponsor's representative must contain a detailed description of the method for correcting the failures that the plan sponsor has implemented or proposes to implement. 

  • Each step of the correction method must be described in narrative form. 
  • The description must include the specific information needed to support the suggested correction method, including:
    • the number of employees affected;
    • the expected cost of correction;
    • the years involved, and
    • calculations or assumptions the Plan Sponsor used to determine the amounts needed for correction. 
  • The number of employees affected and the expected cost of correction may be approximated if the exact number cannot be determined at the time of the request.
  • A description of the methodology that will be used to calculate earnings or actuarial adjustments on any corrective contributions or distributions (indicating the computation periods and the basis for determining earnings or actuarial adjustments.
  • Specific calculations for each affected employee or a representative sample of affected employees. 
  • The sample calculations must be sufficient to demonstrate each aspect of the correction method proposed. For example, if a Plan Sponsor requests a compliance statement with respect to a failure to satisfy the contribution limits of § 415(c) and proposes a correction method that involves elective contributions (both matched and unmatched) and matching contributions, the plan sponsor must submit calculations illustrating the correction method proposed with respect to each type of contribution.  As another example, with respect to a failure to satisfy the actual deferral percentage (ADP) test in § 401(k)(3), the plan sponsor must submit the ADP test results both before the correction and after the correction.
  • The method that will be used to locate and notify former employees and beneficiaries, or an affirmative statement that no former employees or beneficiaries were affected by the failures.
  • A description of the measures that have been or will be implemented to ensure that the same failures will not recur.

If a plan with a Plan Document Failure is submitted under the VCP, is the plan sponsor required to concurrently submit an application for a determination letter?

"Yes. Anytime a Plan Sponsor is required to file for a determination letter in association with a VCP application, whether it be for the correction of a Plan Document Failure, Demographic Failure, or correction of an Operational Failure by plan amendment, if the amendment is other than the adoption of an amendment designated by the IRS as a model amendment or the adoption of a prototype or volume submitter plan for which the Plan Sponsor has reliance on the plan's opinion or advisory letter (see Rev. Proc. 2003-6, 2003-1 I.R.B. 191), the plan sponsor is required to submit a determination letter application with the appropriate user fee at the same time and to the same address that the VCP submission is sent.

Is there an avenue for plan sponsors to negotiate correction under the VCP on an anonymous basis?

Yes. Rev. Proc. 2003-44, section 10.11 sets forth the provisions of the Anonymous Submission procedure. The Anonymous Submission procedure permits Plan Sponsors to submit Qualified Plans, 403(b) Plans, SEPs, and Simple IRA Plans under VCP without initially identifying the applicable plan(s) or applicant. The submission requirements relating to VCP apply to anonymous submissions on the same terms they apply to submissions in which the plan and plan sponsor are identified. However, information identifying the plan or the Plan Sponsor may be excluded from the submission until the IRS and the plan representative reach agreement with respect to all aspects of the submission. 

Until the plan(s) and Plan Sponsor are identified to the IRS, an anonymous submission does not preclude an examination of the Plan Sponsor or its plan(s). Thus, a plan submitted under the Anonymous Submission procedure that comes Under Examination prior to the date the plan(s) and Plan Sponsor(s) identifying materials are received by the IRS will no longer be eligible under VCP.

Should a plan sponsor that discovers a Plan Document Failure in a plan that has been submitted for a determination letter raise the issue to the Employee Plans agent working the determination letter application?

If the Plan Sponsor knows about the failure prior to submitting a determination letter application, the plan sponsor should submit under the VCP and include the determination letter application with the VCP submission. If the failure is identified and voluntarily raised by the taxpayer to the Employee Plans Agent or Specialist assigned to the determination letter application, the taxpayer will be given an opportunity to perfect a VCP submission and have the issue resolved under the VCP.

What happens if the IRS and plan sponsor fail to reach resolution regarding the appropriate correction of a failure?

Under the VCP, if resolution cannot be reached (for example, where information is not timely provided to the IRS or because agreement cannot be reached on correction or a change in administrative procedures), the compliance fee will not be returned, and the case may be referred to the appropriate EP office for examination consideration.

May a plan sponsor receive an extension of the 150-day correction period under the VCP?

In appropriate circumstances, a Plan Sponsor will be granted an extension of the 150-day correction period under VCP. The plan sponsor should submit a written request explaining the reason for the request to the agent working the case. The request must be made prior to the expiration of the 150-day correction period.

Can trust assets be used for the payment of the fee or sanction under the VCP?

As a rule, fees or sanctions should be paid by parties other than the trust. Exceptions are allowed only in very narrow circumstances.

Has the IRS established a program to verify that plan sponsors are correcting failures in accordance with Compliance Statements that have been issued under the VCP?

Yes, the IRS has established a verification program. The program is not an examination of the Plan Sponsor books and records. The IRS checks available information from the plan sponsor to insure that all corrections were made in accordance with the terms of the compliance statement. If necessary corrections or administrative changes were not timely made, the plan may be referred to EP Examinations.

Are matters relating to excise taxes resolved under the EPCRS?

The correction programs are not available for events for which the Code provides tax consequences other than plan disqualification (such as the imposition of an excise tax or additional income tax). For example, funding deficiencies (failures to make the required contributions to a plan subject to § 412), prohibited transactions, and failures to file the Form 5500 cannot be corrected under the correction programs.

However, it should be noted that excise taxes and additional taxes, to the extent applicable, are not waived merely because the underlying failure has been corrected or because the taxes result from the correction. Thus, for example, the excise tax on certain excess contributions under § 4979 is not waived under these correction programs, even though the underlying Qualification Failure is corrected under the EPCRS.

Under Audit CAP, excise taxes that are reportable on the Form 5330 (e.g., prohibited transactions) may be resolved by the agent securing a Form 5330 providing for 100% of the tax and interest outstanding.  The agent may, in his or her discretion, recommend to the Service Center waiver of the failure to file and/or failure to pay penalty, under IRC §6651.

Section 4974(d) provides for waiver of the minimum distribution excise tax under certain circumstances. As part of VCP, if the failure involves the failure to satisfy the minimum required distribution requirements of § 401(a)(9), in appropriate cases, the IRS will waive the excise tax under § 4974 applicable to plan participants. The waiver will be included in the compliance statement issued by the IRS. The Plan Sponsor, as part of the submission, must request the waiver and in cases where the participant subject to the excise tax is an owner-employee as defined in § 401(c)(3), or a 10 percent owner of a corporation, the Plan Sponsor must also provide an explanation supporting the request for the waiver.

Assume a plan sponsor discovers a vesting problem in which the plan terms were not followed, should the plan sponsor use the Self-Correction Program or the VCP to correct the problem?

The decision of whether to use the SCP or Voluntary Correction Program to correct an Operational Failure depends on a number of factors, including: (1) the type of failure involved, (2) the practices and procedures under the plan, (3) whether, if the failure is an Operational Failure, it would be considered to be a Significant Operational Failure, (4) whether a Favorable Letter has been issued with respect to the plan, (5) whether the failure is an Egregious Failure, (6) when the failure is discovered, and (7) the amount of comfort the Plan Sponsor has with respect to the method used to correct the failure.

Although the SCP does not require the payment of a fee or notification to the IRS, it is limited to correcting Operational Failures that are not egregious. In addition, if the failure is a Significant Operational Failure, the Plan Sponsor must complete correction of the failure within two years of the year in which the failure occurred. Although a plan sponsor does not necessarily get assurance that the correction method employed under the SCP is acceptable to the IRS, the IRS has provided several examples of failures and acceptable correction methods under Appendix A and Appendix B in Rev. Proc. 2003-44. If a plan sponsor corrects a failure listed in Appendix A or Appendix B in accordance with the method of correction method set forth in the appendix, the plan sponsor may be assured that the IRS will find that correction method to be acceptable.

In this example, an Operational Failure, a vesting failure, has occurred. Appendix B, section 2.03 provides examples of acceptable correction methods for a vesting failure. Therefore, if there are acceptable practices and procedures under the plan, and the failure is an Insignificant Operational Failure, the Plan Sponsor may use the SCP to correct the failure at any time, even if the plan is Under Examination. Further, if the plan sponsor uses one of the correction methods under Appendix B of the revenue procedure, it will have assurance that the plan would be entitled to relief under the SCP with respect to its correction method. If, however, the failure is a Significant Operational Failure, the plan would be entitled to relief under the SCP only if the failure is identified and corrected within the two-year correction period under the SCP. Also, if the failure is a Significant Operational Failure, the plan would be eligible for relief under the SCP only if a Favorable Letter has been issued with respect to the plan. If the failure would be considered an Egregious Failure, it would be eligible for correction under the Voluntary Correction Program but not under the SCP.

IRS Revenue Ruling Notice 2007-6

IRS Revenue Ruling Notice 2007-6

Cash Balance and Other Hybrid Defined Benefit Pension Plans

Notice 2007-6

  1. PURPOSE
  2. This notice announces that the Service is beginning to process determination letter and examination cases in which an application for a determination letter or a plan under examination involves an amendment to change a traditional defined benefit plan into a cash balance plan and provides related guidance. This notice also provides transitional guidance on the requirements of §§ 411(a)(13) and 411(b)(5) of the Internal Revenue Code (Code), as added by section 701(b) of the Pension Protection Act of 2006, Public Law 109–280 (PPA 2006), which was enacted on August 17, 2006. This guidance generally relates to cash balance plans and other hybrid defined benefit pension plans and to amendments that convert defined benefit pension plans to hybrid defined benefit pension plans. This notice also requests comments on certain issues raised by §§ 411(a)(13) and 411(b)(5).

  3. BACKGROUND
  4. A defined benefit pension plan generally must satisfy the minimum vesting standards of § 411(a) and the accrual requirements of § 411(b) in order to be qualified under § 401(a). Both sections have been modified by section 701(b) of PPA 2006, which added §§ 411(a)(13) and 411(b)(5) to the Code. Section 411(a)(13)(A) provides that a plan described in § 411(a)(13)(C) is not treated as failing to meet either (i) the requirements of § 411(a)(2) (subject to a special vesting rule in § 411(a)(13)(B) with respect to benefits derived from employer contributions), or (ii) the requirements of§ 411(c) or § 417(e) with respect to benefits derived from employer contributions, solely because the present value of the accrued benefit (or any portion thereof) of any participant is, under the terms of the plan, equal to the amount expressed as the balance in a hypothetical account or as an accumulated percentage of the participant’s final average compensation. A plan is described in§ 411(a)(13)(C)(i) if the plan is a defined benefit plan under which the accrued benefit (or any portion thereof) of a participant is calculated as the balance of a hypothetical account maintained for the participant or as an accumulated percentage of the participant’s final average compensation. Under § 411(a)(13)(C)(ii), the Secretary is to issue regulations that treat any defined benefit plan (or any portion of such a plan) that has an effect similar to a plan described in§ 411(a)(13)(C)(i) as if it were described in § 411(a)(13)(C)(i). For purposes of this notice, a plan described either in § 411(a)(13)(C)(i) or in regulations or other guidance issued pursuant to§ 411(a)(13)(C)(ii) is referred to as a statutory hybrid plan. Section 411(b)(1)(H)(i) provides that a defined benefit plan fails to comply with § 411(b) if, under the plan, an employee’s benefit accrual is ceased, or the employee’s rate of benefit accrual is reduced, because of the attainment of any age. Section 411(b)(5)(A), as added by section 701(b)(1) of PPA 2006, generally provides that a plan will not be treated as failing to meet the requirements of§ 411(b)(1)(H)(i) if a participant’s benefit accrued to date, as determined as of any date under the terms of the plan, would be equal to or greater than that of any similarly situated, younger individual who is or could be a participant. For purposes of this notice, a participant’s benefit accrued to date is referred to as the participant’s accumulated benefit. Under§ 411(b)(5)(A)(iv), for purposes of the safe harbor standard of § 411(b)(5)(A), a participant’s accumulated benefit may, under the terms of the plan, be expressed as an annuity payable at normal retirement age, the balance of a hypothetical account, or the current value of the accumulated percentage of the employee’s final average compensation. Section 411(b)(5)(B) imposes several requirements on a statutory hybrid plan as a condition of satisfying § 411(b)(1)(H). First, § 411(b)(5)(B)(i) provides that a statutory hybrid plan is treated as failing to meet the requirements of § 411(b)(1)(H) if the terms of the plan provide for an interest credit (or an equivalent amount) for any plan year at a rate that is greater than a market rate of return. Second,§ 411(b)(5)(B)(ii) and (iii) contain minimum benefit rules that apply if, after June 29, 2005, an amendment is adopted that converts a defined benefit plan to a statutory hybrid plan. For purposes of this notice, such an amendment is referred to as a conversion amendment. Third,§ 411(b)(5)(B)(vi) provides a special rule for projecting variable interest crediting rates in the case of a terminating statutory hybrid plan. In addition, § 411(a)(13)(B) requires a statutory hybrid plan to provide that an employee who has completed at least 3 years of service has a nonforfeitable right to 100 percent of the employee’s accrued benefit derived from employer contributions. Section 411(b)(5)(E) provides that a plan is not treated as failing to meet the requirements of § 411(b)(1)(H) solely because the plan provides for indexing of accrued benefits under the plan. Under§ 411(b)(5)(E)(iii), indexing means, in connection with an accrued benefit, the periodic adjustment of the accrued benefit by means of the application of a recognized investment index or methodology. Section 701(a) of PPA 2006 added provisions to the Employee Retirement Income Security Act of 1974, Public Law 93–406 (ERISA) that are parallel to the above described sections of the Code that were added by section 701(b) of PPA 2006. The guidance provided in this notice with respect to the Code also applies for purposes of the parallel amendments to ERISA made by PPA 2006.1 Section 701(c) of PPA 2006 added provisions to the Age Discrimination in Employment Act of 1967, Public Law 90–202 (ADEA), that are parallel to § 411(b)(5) of the Code. Executive Order 12067 requires all Federal departments and agencies to advise and offer to consult with the Equal Employment Opportunity Commission (EEOC) during the development of any proposed rules, regulations, policies, procedures or orders oncerning equal employment opportunity. Treasury and the Service have consulted with the EEOC prior to the issuance of this notice. The amendments made by section 701 of PPA 2006 are generally effective for periods beginning on or after June 29, 2005. There are a number of special effective date rules, some of which are described in this notice. Section 701(d) of PPA 2006 provides that nothing in the amendments made by section 701 should be construed to create an inference concerning the treatment of statutory hybrid plans or conversions of plans into such plans under§ 411(b)(1)(H), or concerning the determination of whether a statutory hybrid plan fails to meet the requirements of§ 411(a)(2), 411(c), or 417(e) as in effect before such amendments solely because the present value of the accrued benefit (or any portion thereof) of any participant is equal to the amount expressed as the balance in a hypothetical account or as an accumulated percentage of the participant’s final average compensation. Section 702 of PPA 2006 requires the Secretary to prescribe regulations for the application of the provisions of section 701 of PPA 2006 in cases where the conversion of a plan to a statutory hybrid plan is made with respect to a group of employees who become employees by reason of a merger, acquisition, or similar transaction. Proposed regulations (EE–184–86, 1988–1 C.B. 881) under §§ 411(b)(1)(H) and 411(b)(2) were published by Treasury and the Service in the Federal Register on April 11, 1988 (53 F.R. 11876), as part of a package of regulations that also included proposed regulations under §§ 410(a), 411(a)(2), 411(a)(8), and 411(c) (relating to the maximum age for participation, vesting, normal retirement age, and actuarial adjustments after normal retirement age, respectively).2 Notice 96–8, 1996–1 C.B. 359, described the application of §§ 411 and 417(e), prior to the enactment of PPA 2006, to a single-sum distribution under a cash balance plan where interest credits under the plan are frontloaded (i.e., where future interest credits to an employee’s hypothetical account balance are not conditioned upon future service and thus accrue at the same time that the benefits attributable to a hypothetical allocation to the account accrue). Under the analysis set forth in Notice 96–8, in order to comply with §§ 411(a) and 417(e) in calculating the amount of a single-sum distribution under a cash balance plan, the balance of an employee’s hypothetical account must be projected to normal retirement age and converted to an annuity under the terms of the plan, and then the employee must be paid at least the present value of the projected annuity, determined in accordance with § 417(e). Under that analysis, where a cash balance plan provides frontloaded interest credits using an interest rate that is higher than the § 417(e) applicable interest rate, payment of a single-sum distribution equal to the current hypothetical account balance as a complete distribution of the employee’s accrued benefit may result in a violation of § 417(e) or a forfeiture in violation of § 411(a). In addition, Notice 96–8 proposed a safe harbor that provided that, if frontloaded interest credits are provided under a plan at a rate no greater than the sum of identified standard indices and associated margins, no violation of § 411(a) or 417(e) would result if the employee’s entire accrued benefit is distributed in the form of a single-sum distribution equal to the employee’s hypothetical account balance, provided the plan uses appropriate annuity conversion factors. On September 15, 1999, the Service’s Director, Employee Plans, issued a field directive requiring that open determination letter applications and examination cases that involved the conversion of a defined benefit plan formula into a benefit formula commonly known as a cash balance formula be submitted for technical advice with respect to the conversion’s effect on the qualified status of the plan (referred to in this notice as the 1999 Field Directive). The 1999 Field Directive identified as a cash balance formula a benefit formula in a defined benefit plan by whatever name (e.g., personal account plan, pension equity plan, life cycle plan, cash account plan, etc.) that, rather than expressing the accrued benefit as a life annuity commencing at normal retirement age, defines benefits for each employee by reference to a single-sum distribution amount. In Announcement 2003–1, 2003–1 C.B. 281, the Service announced that the cases that were the subject of the 1999 Field Directive would not be processed pending issuance of regulations addressing age discrimination.

  5. TRANSITIONAL GUIDANCE
  6. This part III provides transitional guidance with respect to rules in §§ 411(a)(13) and 411(b)(5) that relate to statutory hybrid plans and the conversion of a defined benefit plan into a statutory hybrid plan. The transitional guidance provided in this part III applies pending the issuance of further guidance.

    1. Section 411(a)(13)(C): Definition of statutory hybrid plan.
      1. In general. A statutory hybrid plan described in § 411(a)(13)(C)(i) and (ii) is a plan that is either a lump sum based plan or a plan that has a similar effect to a lump sum based plan. For purposes of this notice, the term lump sum based plan means a defined benefit plan under the terms of which the accumulated benefit of a participant is expressed as the balance of a hypothetical account maintained for the participant or as the current value of the accumulated percentage of the participant’s final average compensation, and includes a plan under which the accrued benefit under the terms of the plan is calculated as the actuarial equivalent of such a hypothetical account balance or accumulated percentage. Whether a plan is a lump sum based plan is determined based on how the accumulated benefit of a participant is expressed under the terms of the plan, and does not depend on whether the plan provides for an optional form of benefit in the form of a lump sum payment.
      2. Similar effect to a lump sum based plan.
      3. (i) Treated as having a similar effect. Except as provided below in part IIIA(2)(ii) of this notice, a plan that is not a lump sum based plan is treated as having a similar effect to a lump sum based plan if the plan provides that a participant’s accrued benefit (payable at normal retirement age) is expressed as a benefit that includes automatic periodic increases through normal retirement age that results in the payment of a larger amount at normal retirement age to a similarly situated participant who is younger. This includes a plan that provides for indexing of accrued benefits within the meaning of§ 411(b)(5)(E)(iii), such as a plan that expresses the accrued benefit as an indexed annuity.
        (ii) Not treated as having a similar effect.

        (I) Plan with post-retirement adjustment. A plan described in § 411(b)(5)(E) that solely provides for post-retirement adjustment of the amounts payable to a participant is not treated as having a similar effect to a lump sum based plan.
        (II) Variable annuity plan. A variable annuity plan is not treated as having a similar effect to a lump sum based plan if it has an assumed interest rate used for purposes of adjustment of amounts payable to a participant that is at least five percent. For this purpose, a variable annuity plan includes any plan which provides that the amount payable is periodically adjusted by reference to the difference between the rate of return of plan assets (or specified market indices) and the assumed interest rate.

    2. Section 411(a)(13): Special rules for the application of §§ 411(a)(2), 411(c), and 417(e).
      1. In general. Section 411(a)(13)(A) provides special rules with respect to§§ 411(a)(2), 411(c), and 417(e) for benefits expressed as the balance of a hypothetical account maintained for a participant or as the current value of the accumulated percentage of a participant’s final average compensation under a lump sum based plan. Specifically, with respect to such benefits, a lump sum based plan is not treated as failing to meet the requirements of § 411(a)(2), or the requirements of§§ 411(c) and 417(e) with respect to such benefits derived from employer contributions, solely because the present value of such benefits of any participant is, under the terms of the plan, equal to the amount expressed as the balance in the hypothetical account or as the accumulated percentage of the participant’s final average compensation. Section 411(a)(13)(A) does not apply to benefits under a statutory hybrid plan that are expressed neither as the balance of a hypothetical account maintained for a participant nor as the current value of the accumulated percentage of a participant’s final average compensation.
      2. Effective date. Section 411(a) (13)(A) is effective for distributions made after August 17, 2006. The Service expects to issue regulations shortly interpreting the effective date of § 411(a)(13)(A).
      3. Section 411(d)(6) relief. In the case of a lump sum based plan that provides for a single-sum distribution to a participant that exceeds the participant’s hypothetical account balance or accumulated percentage of final average compensation, the plan may be amended to eliminate the excess for distributions made after August 17, 2006, under the rules of section 1107 of PPA 2006. Because such an amendment is made pursuant to section 701 of PPA 2006, section 1107 of PPA 2006 applies to the amendment if the amendment satisfies the requirements specified in section 1107. Thus, if the amendment is adopted on or before the last day of the first plan year beginning on or after January 1, 2009 (January 1, 2011, for a governmental plan), and the plan is operated as if such amendment were in effect as of the first date the amendment is effective, then the amendment does not violate section 411(d)(6) with respect to distributions made after the later of August 17, 2006, or the effective date of the amendment.
      4. Section 4980F. Pursuant to this notice, in the case of an amendment described in section B(3) of this part III, a notice required under § 4980F (and the parallel provision at section 204(h) of ERISA)must be provided at least 30 days before the date the amendment is first effective. Thus, if an amendment described in section B(3) of this part III that significantly reduces the rate of future benefit accrual for purposes of § 4980F is adopted retroactively (i.e., is adopted after the effective date of the amendment) as an amendment under the rules of section 1107 of PPA 2006, then the notice required under § 4980F must be provided at least 30 days before the earliest date on which the plan is operated in accordance with the amendment.
      5. Vesting. See § 411(a)(13)(B) for a special 3-year vesting schedule for statutory hybrid plans.
    3. Section 411(b)(5)(A)(iv): Scope of rule.
    4. In applying the age discrimination test set forth in § 411(b)(5)(A)(i), a lump sum based plan may under§ 411(b)(5)(A)(iv) determine the accumulated benefit of a participant as the balance of a hypothetical account or the current value of the accumulated percentage of the employee’s final average compensation even if the plan defines the
      participant’s accrued benefit as an annuity at normal retirement age that is actuarially equivalent to such balance or value.

    5. Section 411(b)(5)(B)(i): Market rate of return.
      1. Future guidance on market rate of return. During 2007, Treasury and the Service expect to issue guidance that addresses the market rate of return rules at
        § 411(b)(5)(B)(i), including the special rule regarding preservation of capital under§ 411(b)(5)(B)(i)(II) and the minimum rate of return rules in the second sentence of § 411(b)(5)(B)(i)(I). The guidance is also expected to address the extent to which § 411(d)(6) relief provided under section 1107 of PPA 2006 applies to an amendment to a statutory hybrid plan that changes the plan’s interest crediting rate where such amendment is adopted after August 17, 2006.
      2. Safe harbor. Pending further guidance, a market rate of return for purposes of § 411(b)(5)(B)(i) includes the rate of interest on long-term investment grade corporate bonds (as described in§ 412(b)(5)(B)(ii)(II) prior to amendment by PPA 2006 for plan years beginning prior to January 1, 2008, and the third segment rate described in § 430(h)(2)(C)(iii) for subsequent plan years) or the rate of interest on 30-year Treasury securities (as described in § 417(e)(3) prior to amendment by PPA 2006). In addition, a market rate of return for purposes of § 411(b)(5)(B)(i) includes the sum of any of the standard indices and the associated margin for that index as described in part IV of Notice 96–8.
      3. Certain plan termination requirements. See § 411(b)(5)(B)(vi) for required plan terms related to termination of a statutory hybrid plan.
    6. Section 411(b)(5)(B)(ii)—(iv): Special rules for conversion amendments.
      1. In general. Section 411(b)(5)(B)(ii) provides that if a conversion amendment is adopted with respect to a plan after June 29, 2005, the plan is treated as failing to meet the requirements of§ 411(b)(1)(H) unless the requirements of§ 411(b)(5)(B)(iii) are met with respect to each individual who was a participant in the plan immediately before the adoption of the conversion amendment.
      2. Requirements of § 411(b)(5)(B)(iii). Subject to § 411(b)(5)(B)(iv), § 411(b)(5) (B)(iii) is satisfied with respect to any participant if the accrued benefit of the participant under the terms of the plan as in effect after the conversion amendment is not less than the sum of—
      3. (i) the participant’s accrued benefit for years of service before the effective date of the conversion amendment, determined under the terms of the plan as in effect before the amendment, and
        (ii) the participant’s accrued benefit for years of service after the effective date of the amendment, determined under the terms of the plan as in effect after the amendment.

      4. Requirements of § 411(b)(5)(B)(iv). Under § 411(b)(5)(B)(iv), a plan must credit the accumulation account or similar account for purposes of the accrued benefit described in part IIIE(2)(ii) of this notice with the amount of any early retirement benefit or retirement-type subsidy for the plan year in which the participant retires if, as of such time, the participant has met the age, years of service, and other requirements under the plan for entitlement to such benefit or subsidy. For this purpose, the date on which a participant retires means the annuity starting date for the participant’s benefit.
      5. Effective date. Section 411(b)(5) (B)(ii) applies to a conversion amendment that is adopted after, and takes effect after, June 29, 2005. See section 701(e)(5) of PPA 2006 for a special election with respect to § 411(b)(5)(B)(ii).
    7. Safe harbor for conversions related to mergers and acquisitions.
      1. Future guidance on conversions related to mergers and acquisitions. In accordance with section 702 of PPA 2006, the Service expects to issue regulations not later than August 17, 2007, regarding an amendment to convert a defined benefit plan into a hybrid defined benefit plan with respect to a group of employees who become employees by reason of amerger, acquisition, or similar transaction.
      2. Safe harbor. Pending further guidance, a plan amendment described in part IIIE that is also described in part IIIF(1) of this notice is not treated as failing to meet the requirements of § 411(b)(1)(H) if the benefit of each participant under the plan as amended is not less than the sum of:
      3. (A) the participant’s section 411(d)(6) protected benefit (as defined in§ 1.411(d)–3(g)(14)) with respect to service before the effective date of the conversion amendment, determined under the terms of the plan as in effect before the amendment, and
        (B) the participant’s section 411(d)(6) protected benefit with respect to service on and after the effective date of the conversion amendment, determined under the terms of the plan as in effect after the amendment.

      For purposes of this paragraph F(2), the benefits under clause (A) and the benefits under clause (B) of this paragraph F(2) must each be determined in the same manner
      as if they were provided under separate plans that are independent of each other (e.g., without any benefit offsets).

  7. DETERMINATION LETTERS
  8. In light of the enactment of section 701 of PPA 2006, the Service is no longer applying the 1999 Field Directive and Announcement 2003–1 and is beginning to process the determination letters and examination cases that were the subject of such field directive and announcement (referred to as moratorium plans in this notice). This part IV describes certain rules that will be applied for purposes of processing moratorium plans. Qualification requirements that are not described in this part IV (e.g., the backloading rules of§ 411(b)(1)(A), (B), and (C)) continue to apply.

    1. Age discrimination.
      1. In general. Except as provided in part IVA(2) of this notice, a moratorium plan will be reviewed as to whether accruals under the plan that relate to service performed by the participant after the conversion violate § 411(b)(1)(H). For this purpose, a moratorium plan will not be treated as failing to satisfy the requirements of § 411(b)(1)(H) merely because a moratorium plan that is frontloaded provides that interest credits through normal retirement age are accrued in the year of the related hypothetical allocation.
      2. Pre-6/30/05 conversions. For purposes of processing a determination letter application for a moratorium plan, the plan will not be reviewed as to whether the conversion of the plan satisfies the requirements of § 411(b)(1)(H) if the amendment that results in the conversion was adopted prior to June 30, 2005. Therefore, determination letters issued to moratorium planswill not consider, andmay not be relied on with respect to, whether such a conversion satisfies the requirements of§ 411(b)(1)(H), as in effect prior to the addition of § 411(b)(5) by PPA 2006, including the effect of any wearaway.
      3. Post-6/29/05 conversions. In the case of a moratorium plan that involves a conversion of the plan to a statutory hybrid plan pursuant to an amendment that is adopted after June 29, 2005, the conversion must satisfy the requirements of § 411(b)(5)(B)(ii) (described in part IIIE of this notice).
    2. Distributions before August 18, 2006.
    3. The Service expects to issue regulations interpreting the effective date of§ 411(a)(13)(A) (described in part IIIB(2) of this notice). Until this guidance is issued, the Service will not process a moratorium plan that does not satisfy the requirements of Notice 96–8 with respect to distributions made before August 18, 2006.

    4. Terminating plans.
    5. Under Title IV of ERISA, a standard termination may only occur if, when the final distribution of assets occurs, the plan is sufficient for benefit liabilities determined as of the termination date. See § 4041(b)(1)(D) of ERISA; 29 C.F.R. § 4041.8(a). The Pension Benefit Guaranty Corporation (PBGC) has informed the Service that, for purposes of Title IV of ERISA, a terminating plan with a termination date that is prior to August 18, 2006, cannot apply § 411(a)(13)(A) in determining its benefit liabilities with respect to any distributions made by the terminating plan.

  9. COMMENTS REQUESTED AND FUTURE REGULATIONS
  10. Treasury and the Service expect to issue regulations with respect to the transitional guidance provided in this notice and the issues described in part IIIB(2) of this
    notice. These initial regulations may address some additional issues, but will not address all of the outstanding issues relating to §§ 411(a)(13) and 411(b)(5).
    Comments are requested on the following additional issues. These comments will be considered in conjunction with the comments received in response to the initial
    regulations in developing additional guidance.

    • Identification of when two or more amendments, or the coordination of two or more defined benefit plans, have the effect of a conversion into a statutory hybrid plan.
    • The definition of market rate of return for purposes of § 411(b)(5)(B)(i), including the following related issues:
      • The impact of the minimum rate of return rules in the second sentence of § 411(b)(5)(B)(i)(I) on the definition of market rate of return.
      • The impact of the preservation of capital rule in § 411(b)(5)(B)(i)(II) on the definition of market rate of return.
      • The application of § 411(d)(6) to an amendment to the interest crediting rate specified in a statutory hybrid plan, and the circumstances under which the § 411(d)(6) relief provided under section 1107 of PPA 2006 should apply to such an amendment.
      • Application of the special rules for hybrid plans in the case of a plan in which only certain participants’ accrued benefits, or only a portion of a participant’s accrued benefit, is determined by reference to a hypothetical account balance or an accumulated percentage of final average compensation, including plans in which the benefit payable under one plan is offset by the benefit provided under another plan.
      • The application of qualification requirements other than §§ 411(b)(1)(H) and 417(e) to a defined benefit plan under which the accrued benefit is calculated as an accumulated percentage of the participant’s final average compensation (commonly referred to as a pension equity plan or PEP), including the treatment of interest credited with respect to terminated vested participants.
      • The definition of a recognized index or methodology for purposes of § 411(b)(5)(E) and whether there are any types of indexed plans that should not be treated as statutory hybrid plans other than those described in part IIIA(2)(i) above.

    Written comments should be submitted by April 16, 2007. Send submissions to CC:PA:LPD:DRU (Notice 2007–6), Room 5203, Internal Revenue Service, POB 7604 Ben Franklin Station, Washington, D.C. 20044. Comments may be hand delivered to CC:PA:LPD:DRU (Notice 2007–6), Room 5203, Internal Revenue Service, 1111 Constitution Avenue, NW,Washington, DC. Alternatively, comments may be submitted via the Internet at notice.comments@irscounsel.treas.gov (Notice 2007–6). All comments will be available for public inspection.

  11. DRAFTING INFORMATION
  12. The principal authors of this notice are Kathleen J. Herrmann of the Employee Plans, Tax Exempt and Government Entities Division and Christopher A. Crouch, Lauson C. Green, and Linda S. F.Marshall of the Office of the Division Counsel/Associate Chief Counsel (Tax Exempt and Government Entities). For further information regarding this notice, contact Ms. Herrmann at (202) 283–9888 and Mr. Crouch, Mr. Green, and Ms. Marshall at (202) 622–6090 (not toll-free numbers).

Footnotes

  1. Under section 101 of Reorganization Plan No. 4 of 1978 (43 F.R. 47713), the Secretary has interpretive jurisdiction over the subject matter addressed by this notice for purposes of ERISA.
  2. On December 11, 2002, Treasury and the Service issued proposed regulations (REG–209500–86; REG–164464–02, 2003–1 C.B. 262) regarding the age discrimination requirements of§ 411(b)(1)(H) that specifically addressed cash balance plans as part of a package of regulations that also addressed § 401(a)(4) nondiscrimination cross-testing rules applicable to cash balance plans (67 F.R. 76123). The 2002 proposal was intended to replace the 1988 proposal. In Announcement 2003–22, 2003–1 C.B. 847, Treasury and the Service announced the withdrawal of the 2002 proposed regulations under § 401(a)(4), and in Announcement 2004–57, 2004–2 C.B. 15, Treasury and the Service announced the withdrawal of the 2002 proposed regulations relating to age discrimination.

IRS Revenue Ruling Notice 2007-7

Internal Revenue Service 2007-7

Part III. Administrative, Procedural, and Miscellaneous

Miscellaneous Pension Protection Act Changes

  1. PURPOSE
  2. This notice provides guidance in the form of questions and answers with respect to certain provisions of the Pension Protection Act of 2006, P.L. 109-280 ("PPA 2006"), that are effective in 2007 or earlier. The sections of PPA 2006 addressed in this notice, which are primarily related to distributions, are § 303 (relating to interest rate assumptions for lump sum distributions), § 826 (relating to hardship distributions), § 828 (relating to early distributions to public safety employees), § 829 (relating to rollovers for nonspouse beneficiaries), § 845 (relating to distributions to pay for accident or health insurance for public safety officers), § 904 (relating to vesting of nonelective contributions), §1102 (relating to the notice and consent period for distributions), and §1201 (relating to distributions from IRAs to charitable organizations).

  3. Section 303 of Pension Protection Act of 2006
  4. Section 415(b) of the Code provides limitations on annual benefits under a defined benefit plan. Under § 415(b)(2)(B), if a benefit is payable in a form other than a straight life annuity, the benefit is adjusted to an actuarially equivalent straight life annuity for purposes of determining whether the limitations of § 415(b) have been satisfied. Section 415(b)(2)(E) provides limitations on the actuarial assumptions that can be used in making the adjustment under § 415(b)(2)(B). Prior to the enactment of PPA 2006, for purposes of adjusting a benefit payable in a form that is subject to the minimum present value requirements of § 417(e)(3), § 415(b)(2)(E)(ii) provided that the interest rate assumption must not be less than the greater of the applicable interest rate as defined in § 417(e)(3) or the rate specified in the plan. However, § 101(b)(4) of the Pension Funding Equity Act of 2004, P.L. 108-218, amended § 415(b)(2)(E)(ii) to provide that, for plan years beginning in 2004 and 2005, 5.5% must be used in lieu of the applicable interest rate (as defined in § 417(e)(3)) for purposes of adjusting the benefit. Section 303(a) of PPA 2006 amended § 415(b)(2)(E)(ii) to provide that the interest rate assumption for purposes of adjusting a benefit payable in a form that is subject to the minimum present value requirements of § 417(e)(3) must not be less than the greatest of (i) 5.5%, (ii) the rate that provides a benefit of not more than 105% of the benefit that would be provided if the applicable interest rate (as defined in § 417(e)(3)) were the interest rate assumption, or (iii) the rate specified under the plan.

    Q-1. What is the effective date of the changes made to § 415 of the Code by§ 303(a) of PPA 2006?

    A-1. The changes to § 415 of the Code made by § 303(a) of PPA 2006 apply to distributions made in plan years beginning after December 31, 2005. However, the changes do not apply to a plan with a termination date that is on or before August 17, 2006, the date of enactment of PPA 2006.

    Q-2. May a plan be amended retroactively to comply with the requirements of§ 303(a) of PPA 2006 without violating the anti-cutback rules provided in § 411(d)(6) of the Code?

    A-2. Yes. Under § 1107 of PPA 2006, a plan does not violate the anti-cutback rules of § 411(d)(6) of the Code if it is amended retroactively to comply with § 303(a) of PPA 2006, provided the amendment is adopted on or before the last day of the first plan year beginning on or after January 1, 2009 (2011 in the case of a governmental plan), and the plan is operated as if such amendment were in effect as of the first date the amendment is effective.

    Q-3. If a plan made a distribution in a plan year beginning in 2006 that satisfied the limitations of § 415(b) prior to the enactment of PPA 2006 but which is in excess of the limitations of § 415(b) taking into account the amendments to § 415 made by § 303(a) of PPA 2006 (a "§ 303 excess distribution"), does the distribution violate the requirements of § 415(b)?

    A-3. Yes. However, three methods are available for correcting a § 303 excess distribution. First, Q&A-4 of this notice sets forth a special correction method that is available for a § 303 excess distribution made prior to September 1, 2006, provided that the correction is completed by March 15, 2007. Second, if correction is completed by December 31, 2007 (even if the § 303 excess distribution occurs after September 1, 2006), a plan may correct a § 303 excess distribution by using the correction method for a § 415(b) excess distribution described in the Employee Plans Compliance Resolution System ("EPCRS") (see section 2.04(1) in Appendix B in Rev. Proc. 2006-27, 2006-22 IRB 945) even if the plan does not meet the requirements specified in Rev. Proc. 2006- 27, including the special requirements for self correction under Part IV of Rev. Proc. 2006-27. Finally, a plan that meets the requirements of Rev. Proc. 2006-27 may correct § 303 excess distributions by using the correction method for § 415(b) excess distributions under EPCRS even after December 31, 2007. A plan that is amended retroactively to comply with § 303(a) of PPA 2006 will not fail to satisfy the requirement in§ 1107(b)(2)(A) of PPA 2006 (that the plan be operated in accordance with the terms of the amendment) merely because it made a § 303 excess distribution, provided the§ 303 excess distribution is corrected using one of these three correction methods.

    Q-4. What special correction method is available to correct a § 303 excess distribution made prior to September 1, 2006?

    A-4. A special correction method is available for a § 303 excess distribution made prior to September 1, 2006, provided the correction is completed by March 15, 2007. Under the special correction method, a plan may use the EPCRS correction method for a § 415(b) excess distribution (as described in section 2.04(1) in Appendix B in Rev. Proc. 2006-27, even if the plan does not otherwise meet the requirements of Rev. Proc. 2006-27, including the special requirements for self correction) with the following modifications. The excess amount (i.e., the amount by which the distribution actually made exceeds the distribution permitted using the interest assumption specified in § 415(b) as amended by PPA 2006) is not required to be returned to the plan (as otherwise required under the EPCRS correction method). Instead, a plan must issue two Forms 1099-R (Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.) to a participant who has received a § 303 excess distribution. The first Form 1099-R should include only the amount that would have been distributed had the benefit payable been adjusted using the interest assumptions specified in § 415(b) as amended by PPA 2006. The second Form 1099-R should include only the excess amount that was distributed, and should include code" E" in box 7 to identify the amount as an excess distribution. As provided in the EPCRS correction, this excess amount is not an eligible rollover distribution, and therefore must be included in gross income in the year distributed from the plan.

  5. Section 826 of Pension Protection Act of 2006
  6. An employee’s elective contributions under a cash or deferred arrangement can only be distributed upon the occurrence of certain events, one of which is the employee’s hardship. A distribution is made on account of hardship only if the distribution both is made on account of an immediate and heavy financial need of the employee and is necessary to satisfy the financial need. A distribution made for any of the expenses listed in Regulation § 1.401(k)-1(d)(3)(iii)(B) is deemed to be on account of an immediate and heavy financial need of the employee. Several of these listed expenses can be expenses of the employee’s spouse or dependents. Section 826 of PPA 2006 directs the Secretary of the Treasury to modify the rules relating to distributions from § 401(k), § 403(b), § 409A, and § 457(b) plans on account of a participant’s hardship or unforeseeable financial emergency to permit such plans to treat a participant’s beneficiary under the plan the same as the participant’s spouse or dependent in determining whether the participant has incurred a hardship or unforeseeable financial emergency.

    Q-5. What changes are being made pursuant to § 826 of PPA 2006 in the rules relating to hardship distributions from § 401(k) plans and § 403(b) plans and relating to distributions on account of an unforeseeable financial emergency from a plan described in § 457(b) or § 409A?

    A-5. (a) Hardship distributions from § 401(k) plans and § 403(b) plans. A § 401(k) plan that permits hardship distributions of elective contributions to a participant only for expenses described in § 1.401(k)-1(d)(3)(iii)(B) may, beginning August 17, 2006, permit distributions for expenses described in § 1.401(k)-1(d)(3)(iii)(B)(1), (3), or (5) (relating to medical, tuition, and funeral expenses, respectively) for a primary beneficiary under the plan. For this purpose, a "primary beneficiary under the plan" is an individual who is named as a beneficiary under the plan and has an unconditional right to all or a portion of the participant’s account balance under the plan upon the death of the participant. A plan that adopts these expanded hardship provisions must still satisfy all the other requirements applicable to hardship distributions, such as the requirement that the distribution be necessary to satisfy the financial need. These rules also apply to § 403(b) plans.

    (b) Distributions on account of an unforeseeable financial emergency from a plan described in § 457(b) or § 409A. In applying § 457(d)(1)(A)(iii), § 1.457-6(c)(2)(i), § 409A(a)(2)(A)(vi), and Proposed Regulation § 1.409A-3(g)(3)(i), a plan described in § 457(b) or § 409A may treat a participant’s beneficiary under the plan the same as the participant’s spouse or dependent in determining whether the participant has incurred an unforeseeable financial emergency. This will be reflected in the upcoming final regulations under § 409A.

  7. Section 828 of Pension Protection Act of 2006
  8. Section 72(t)(1) of the Code provides for a 10% additional tax on an early distribution from a qualified retirement plan (as defined in § 4974(c)), unless the early distribution qualifies for one of the exceptions listed in § 72(t)(2). For example,§ 72(t)(2)(A)(v) provides an exception to the 10% additional tax for distributions made to an employee who separates from service after attainment of age 55. Under§ 72(t)(3)(A), § 72(t)(2)(A)(v) does not apply to individual retirement plans. Section 828 of PPA 2006 amended § 72 of the Code by adding § 72(t)(10), which provides that in the case of a distribution to a qualified public safety employee from a governmental defined benefit plan, § 72(t)(2)(A)(v) is applied by substituting age 50 for age 55. Thus, the 10% additional tax on early distributions under § 72(t)(1) does not apply to a distribution from a governmental defined benefit plan made to a qualified public safety employee who separates from service after attainment of age 50. This exception to the 10% additional tax applies to distributions made after August 17, 2006 (the date of enactment of PPA 2006.

    Q-6. Who is a qualified public safety employee?

    A-6. For purposes of § 72(t)(10), the term "qualified public safety employee" means an employee of a State or of a political subdivision of a State (such as a county or city) whose principal duties include services requiring specialized training in the area of police protection, firefighting services, or emergency medical services for any area within the jurisdiction of the State or the political subdivision of the State.

    Q-7. How does a qualified public safety employee qualify for the exception to the 10% additional tax under § 72(t)(10)?

    A-7. In order to qualify for the exception to the 10% additional tax under§ 72(t)(10), a qualified public safety employee (i) must have received the distribution from a governmental defined benefit plan after separating from service with the employer maintaining the plan and (ii) the separation from service must have occurred during or after the calendar year in which the qualified public safety employee attained age 50. For example, a qualified public safety employee who separated from service on June 30, 2006, and attained age 50 on December 12, 2006, is eligible for the exception under § 72(t)(10) with respect to distributions made after August 17, 2006.

    Q-8. What are the consequences if, before August 18, 2006, a qualified public safety employee began receiving substantially equal periodic payments that qualify for the exception to the 10% additional tax described in § 72(t)(2)(A)(iv) and then modified the periodic payments after August 17, 2006?

    A-8. If the payments satisfy the requirements in Q&A-7 of this notice, payments received by the qualified public safety employee after August 17, 2006, would qualify for the exception to the 10% additional tax under § 72(t)(10). However, if the modification would result in the imposition of the recapture tax under the rules of § 72(t)(4), then the recapture tax applies to the payments made before August 18, 2006.

    Q-9. Does the exception to the 10% additional tax under § 72(t)(10) apply if the qualified public safety employee rolls over distributions from a governmental defined benefit plan into an IRA or a defined contribution plan and subsequently takes an early distribution from the IRA or defined contribution plan?

    A-9. No. The exception to the 10% additional tax under § 72(t)(10) applies only to amounts distributed from a governmental defined benefit plan and does not apply to distributions from a defined contribution plan or an individual retirement plan.

    Q-10. How does a payer report distributions that qualify for the exception to the 10% additional tax under § 72(t)(10) on Form 1099-R?

    A-10. A payer is permitted to use distribution code 2 (early distribution, exception applies) in box 7 of Form 1099-R. However, a payer is also permitted to use distribution code 1 (early distribution, no known exception) in box 7 of Form 1099-R, if the payer does not know whether the exception under § 72(t)(10) applies. For further information on reporting, see Instructions for Forms 1099-R and 5498.

  9. Section 829 of Pension Protection Act of 2006
  10. Under § 402(c)(11) of the Code, which was added by § 829 of PPA 2006, if a direct trustee-to-trustee transfer of any portion of a distribution from an eligible retirement plan is made to an individual retirement plan described in § 408(a) or (b) (an "IRA") that is established for the purpose of receiving the distribution on behalf of a designated beneficiary who is a nonspouse beneficiary, the transfer is treated as a direct rollover of an eligible rollover distribution for purposes of § 402(c). The IRA of the nonspouse beneficiary is treated as an inherited IRA within the meaning of § 408(d)(3)(C). Section 402(c)(11) applies to distributions made after December 31, 2006.

    Q-11. Can a qualified plan described in § 401(a) offer a direct rollover of a distribution to a nonspouse beneficiary?

    A-11. Yes. Under § 402(c)(11), a qualified plan described in § 401(a) can offer a direct rollover of a distribution to a nonspouse beneficiary who is a designated beneficiary within the meaning of § 401(a)(9)(E), provided that the distributed amount satisfies all the requirements to be an eligible rollover distribution other than the requirement that the distribution be made to the participant or the participant’s spouse. (See § 1.401(a)(9)-4 for rules regarding designated beneficiaries.) The direct rollover must be made to an IRA established on behalf of the designated beneficiary that will be treated as an inherited IRA pursuant to the provisions of § 402(c)(11). If a nonspouse beneficiary elects a direct rollover, the amount directly rolled over is not includible in gross income in the year of the distribution. See § 1.401(a)(31)-1, Q&A-3 and-4, for procedures for making a direct rollover.

    Q-12. Can other types of plans offer a direct rollover of a distribution to a nonspouse beneficiary?

    A-12. Yes. Section 402(c)(11) also applies to annuity plans described in§ 403(a) or (b) and to eligible governmental plans under § 457(b).

    Q-13. How must the IRA be established and titled?

    A-13. The IRA must be established in a manner that identifies it as an IRA with respect to a deceased individual and also identifies the deceased individual and the beneficiary, for example, "Tom Smith as beneficiary of John Smith."

    Q-14. Is a plan required to offer a direct rollover of a distribution to a nonspouse beneficiary pursuant to § 402(c)(11)?

    A-14. No. A plan is not required to offer a direct rollover of a distribution to a nonspouse beneficiary. If a plan does offer direct rollovers to nonspouse beneficiaries of some, but not all, participants, such rollovers must be offered on a nondiscriminatory basis because the opportunity to make a direct rollover is a benefit, right, or feature that is subject to § 401(a)(4). In the case of distributions from a terminated defined contribution plan pursuant to 29 C.F.R. § 2550.404a-3(d)(1)(ii), the plan will be considered to offer direct rollovers pursuant to § 402(c)(11) with respect to such distributions without regard to plan terms.

    Q-15. For what purposes is the direct rollover of a distribution by a nonspouse beneficiary treated as a rollover of an eligible rollover distribution?

    A-15. Section 402(c)(11) provides that a direct rollover of a distribution by a nonspouse beneficiary is a rollover of an eligible rollover distribution only for purposes of § 402(c). Accordingly, the distribution is not subject to the direct rollover requirements of § 401(a)(31), the notice requirements of § 402(f), or the mandatory withholding requirements of § 3405(c). If an amount distributed from a plan is received by a nonspouse beneficiary, the distribution is not eligible for rollover.

    Q-16. If the named beneficiary of a decedent is a trust, is a plan permitted to make a direct rollover to an IRA established with the trust as beneficiary?

    A-16. Yes. A plan may make a direct rollover to an IRA on behalf of a trust where the trust is the named beneficiary of a decedent, provided the beneficiaries of the trust meet the requirements to be designated beneficiaries within the meaning of§ 401(a)(9)(E). The IRA must be established in accordance with the rules in Q&A-13 of this notice, with the trust identified as the beneficiary. In such a case, the beneficiaries of the trust are treated as having been designated as beneficiaries of the decedent for purposes of determining the distribution period under § 401(a)(9), if the trust meets the requirements set forth in § 1.401(a)(9)-4, Q&A-5, with respect to the IRA.

    Q-17. How is the required minimum distribution (an amount not eligible for rollover) determined with respect to a nonspouse beneficiary if the employee dies before his or her required beginning date within the meaning of § 401(a)(9)(C)?

    A-17. (a) General rule. If the employee dies before his or her required beginning date, the required minimum distributions for purposes of determining the amount eligible for rollover with respect to a nonspouse beneficiary are determined under either the 5-year rule described in § 401(a)(9)(B)(ii) or the life expectancy rule described in § 401(a)(9)(B)(iii). See Q&A-4 of § 1.401(a)(9)-3 to determine which rule applies to a particular designated beneficiary. Under either rule, no amount is a required minimum distribution for the year in which the employee dies. The rule in Q&A-7(b) of§ 1.402(c)-2 (relating to distributions before an employee has attained age 70½) does not apply to nonspouse beneficiaries.

    (b) Five-year rule. Under the 5-year rule described in § 401(a)(9)(B)(ii), no amount is required to be distributed until the fifth calendar year following the year of the employee’s death. In that year, the entire amount to which the beneficiary is entitled under the plan must be distributed. Thus, if the 5-year rule applies with respect to a nonspouse beneficiary who is a designated beneficiary within the meaning of§ 401(a)(9)(E), for the first 4 years after the year the employee dies, no amount payable to the beneficiary is ineligible for direct rollover as a required minimum distribution. Accordingly, the beneficiary is permitted to directly roll over the beneficiary’s entire benefit until the end of the fourth year (but, as described in Q&A-19 of this notice, the 5-year rule must also apply to the IRA to which the rollover contribution is made). On or after January 1 of the fifth year following the year in which the employee died, no amount payable to the beneficiary is eligible for rollover.

    (c) Life expectancy rule.

    (1) General rule. If the life expectancy rule described in§ 401(a)(9)(B)(iii) applies, in the year following the year of death and each subsequent year, there is a required minimum distribution. See Q&A-5(c)(1) of § 1.401(a)(9)-5 to determine the applicable distribution period for the nonspouse beneficiary. The amount not eligible for rollover includes all undistributed required minimum distributions for the year in which the direct rollover occurs and any prior year (even if the excise tax under§ 4974 has been paid with respect to the failure in the prior years). See the last sentence of § 1.402(c)-2, Q&A-7(a).

    (2) Special rule. If, under paragraph (b) or (c) of Q&A-4 of § 1.401(a)(9)-3, the 5-year rule applies, the nonspouse designated beneficiary may determine the required minimum distribution under the plan using the life expectancy rule in the case of a distribution made prior to the end of the year following the year of death. However, in order to use this rule, the required minimum distributions under the IRA to which the direct rollover is made must be determined under the life expectancy rule using the same designated beneficiary.

    Q-18. How is the required minimum distribution with respect to a nonspouse beneficiary determined if the employee dies on or after his or her required beginning date?

    A-18. If an employee dies on or after his or her required beginning date, within the meaning of § 401(a)(9)(C), for the year of the employee’s death, the required minimum distribution not eligible for rollover is the same as the amount that would have applied if the employee were still alive and elected the direct rollover. For the year after the year of the employee’s death and subsequent years, see Q&A-5 of § 1.401(a)(9)-5 to determine the applicable distribution period to use in calculating the required minimum distribution. As in the case of death before the employee’s required beginning date, the amount not eligible for rollover includes all undistributed required minimum distributions for the year in which the direct rollover occurs and any prior year, including years before the employee’s death.

    Q-19. After a direct rollover by a nonspouse designated beneficiary, how is the required minimum distribution determined with respect to the IRA to which the rollover contribution is made?

    A-19. Under § 402(c)(11), an IRA established to receive a direct rollover on behalf of a nonspouse designated beneficiary is treated as an inherited IRA within the meaning of § 408(d)(3)(C). The required minimum distribution requirements set forth in§ 401(a)(9)(B) and the regulations thereunder apply to the inherited IRA. The rules for determining the required minimum distributions under the plan with respect to the nonspouse beneficiary also apply under the IRA. Thus, if the employee dies before his or her required beginning date and the 5-year rule in § 401(a)(9)(B)(ii) applied to the nonspouse designated beneficiary under the plan making the direct rollover, the 5-year rule applies for purposes of determining required minimum distributions under the IRA. If the life expectancy rule applied to the nonspouse designated beneficiary under the plan, the required minimum distribution under the IRA must be determined using the same applicable distribution period as would have been used under the plan if the direct rollover had not occurred. Similarly, if the employee dies on or after his or her required beginning date, the required minimum distribution under the IRA for any year after the year of death must be determined using the same applicable distribution period as would have been used under the plan if the direct rollover had not occurred.

  11. Section 845 of Pension Protection Act of 2006
  12. Code § 402(l), which was added by § 845(a) of PPA 2006, provides for an exclusion from gross income for distributions from certain retirement plans (referred to in this notice as "Eligible Government Plans") used to pay qualified health insurance premiums of an eligible retired public safety officer. The exclusion applies with respect to an eligible retired public safety officer who elects to have qualified health insurance premiums deducted from amounts distributed from an Eligible Government Plan and paid directly to the insurer. Qualified health insurance premiums include premiums for accident and health insurance or qualified long-term care insurance contracts for the eligible retired public safety officer and his or her spouse and dependents. The distribution is excluded from gross income to the extent that the aggregate amount of the distributions does not exceed the amount used to pay the qualified health insurance premiums of the eligible retired public safety officer and his or her spouse and dependents. An "Eligible Government Plan" is a governmental plan described in§ 414(d) that is either: a § 401(a), § 403(a), or § 403(b) plan; or an eligible governmental plan under § 457(b). Section 402(l) applies to distributions in taxable years beginning after December 31, 2006.

    Q-20. Who is an eligible retired public safety officer for purposes of the exclusion under § 402(l)?

    A-20. An employee is an eligible retired public safety officer for purposes of the exclusion under § 402(l) only if the employee is an individual who separated from service, either by reason of disability or after attainment of normal retirement age, as a public safety officer with the employer who maintains the Eligible Government Plan from which the distributions to pay qualified health insurance premiums are made. Thus, a public safety officer who retires before attainment of normal retirement age is not an eligible retired public safety officer unless the public safety officer retires by reason of disability. The terms of the Eligible Government Plan from which the participant will be receiving the distributions apply in determining whether a public safety officer has separated from service by reason of disability or after attainment of normal retirement age.

    Q-21. Who is a public safety officer?

    A-21. For purposes of § 402(l), the term "public safety officer" means an individual serving a public agency in an official capacity, with or without compensation, as a law enforcement officer, a firefighter, a chaplain, or as a member of a rescue squad or ambulance crew. See § 1204(9)(A) of the Omnibus Crime Control and Safe Streets Act of 1968 (42 U.S.C. 3796b(9)(A)).

    Q-22. Under what circumstances are the provisions of § 402(l) available for eligible retired public safety officers?

    A-22. The favorable tax treatment under § 402(l) is available only when an eligible retired public safety officer elects to have an amount subtracted from his or her distributions from an Eligible Government Plan and such amount is used to pay qualified health insurance premiums. The employer sponsoring the Eligible Government Plan is not required to offer such an election.

    Q-23. Can the accident or health plan receiving the payments of qualified health insurance premiums be a self-insured plan?

    A-23. No. The accident or health plan must be an accident or health insurance plan. Thus, the plan must be providing insurance issued by an insurance company regulated by a State (including a managed care organization that is treated as issuing insurance).

    Q-24. Will an eligible retired public safety officer be entitled to favorable tax treatment under § 402(l) with respect to benefits attributable to service other than as a public safety officer?

    A-24. Yes. Benefits attributable to service other than as a public safety officer are eligible for favorable tax treatment under § 402(l), as long as the individual separates from service as a public safety officer, by reason of disability or after attainment of normal retirement age, with the employer maintaining the Eligible Government Plan.

    Q-25. If an eligible retired public safety officer dies, are amounts subtracted from distributions made to the decedent’s surviving spouse or dependents eligible for favorable tax treatment under § 402(l)?

    A-25. No. Section 402(l) provides that the distribution is not includible in the gross income of an employee who is an eligible retired public safety officer. Thus, the exclusion would not extend to amounts subtracted from distributions to other distributees.

    Q-26. Is an eligible retired public safety officer limited in the amount that the officer can exclude from gross income for distributions from an Eligible Government Plan used to pay qualified health insurance premiums?

    A-26. Yes. The aggregate amount that is permitted to be excluded, with respect to any taxable year, from an eligible retired public safety officer’s gross income by reason of § 402(l) is limited to $3,000. For purposes of applying this $3,000 limitation, distributions with respect to the eligible retired public safety officer that are used to pay for qualified health insurance premiums from all Eligible Government Plans are aggregated.

    Q-27. Are amounts used to pay qualified health insurance premiums that are excluded from gross income under § 402(l) taken into account for purposes of determining the itemized deduction for medical care expenses under § 213?

    A-27. No. Amounts used to pay qualified health insurance premiums that are excluded from gross income under § 402(l) are not taken into account in determining the itemized deduction for medical care expenses under § 213.

  13. Section 904 of Pension Protection Act 2006
  14. Prior to the effective date of PPA 2006 § 904, a defined contribution plan satisfied the minimum vesting requirements of Code § 411(a) with respect to employer nonelective contributions if it maintained a 5-year vesting schedule or a 3 to 7 year vesting schedule. Section 904 of PPA 2006 amended the minimum vesting requirements to require faster vesting of employer nonelective contributions to a defined contribution plan. Under Code § 411(a)(2)(B) as amended by § 904 of PPA 2006, a defined contribution plan satisfies the minimum vesting requirements with respect to employer nonelective contributions if it has a 3-year vesting schedule or a 2 to 6 year vesting schedule. Code § 411(a)(2)(B) as amended by § 904 of PPA 2006 generally applies to contributions for plan years beginning after December 31, 2006.

    Q-28. If a plan amendment changes the plan’s vesting schedule to satisfy Code § 411(a)(2)(B) as amended by § 904 of PPA 2006, is the plan amendment required to satisfy § 411(a)(10).?

    A-28. Yes. A plan amendment that changes the vesting schedule must satisfy Code § 411(a)(10). Although § 411(a)(10)(B) would require a participant with at least 3 years of service to elect to have the nonforfeitable percentage of his accrued benefit determined without regard to the amendment, the plan must ensure that any such election satisfies the vesting requirements of § 411(a)(2)(B), as amended by § 904 of PPA 2006. Thus, such a participant must be provided, at all times, a vesting percentage that is no less than the minimum under a vesting schedule that satisfies § 904 and the vesting percentage determined under the plan without regard to the amendment. Under Temporary Regulation § 1.411(a)-8T, no election need be provided for any participant whose nonforfeitable percentage under the plan, as amended, at any time cannot be less than such percentage determined without regard to such amendment.

    Q-29. Can a plan have separate vesting schedules for employer nonelective contributions that are and are not subject to Code § 411(a)(2)(B), as amended by § 904 of PPA 2006?

    A-29. Yes. A plan can have a vesting schedule for employer nonelective contributions for plan years beginning after December 31, 2006, and another vesting schedule for other employer nonelective contributions under the plan, provided that the plan separately accounts for the contributions made under the vesting schedule in effect prior to the first day of the first plan year beginning after December 31, 2006, and the vesting schedule for employer nonelective contributions for plan years beginning after December 31, 2006, satisfies Code § 411(a)(2)(B), as amended by § 904 of PPA 2006.

    Q-30. If a plan maintains a bifurcated vesting schedule, how is it determined whether a contribution is for a plan year beginning before January 1, 2007?

    A-30. A contribution is for a plan year that begins before January 1, 2007, if it is allocated under the terms of the plan as of a date in that plan year and is not subject to any conditions that have not been satisfied by the end of that plan year. This applies even if the contribution is not made until the next plan year. Thus, for example, if a plan with a calendar-year plan year makes a contribution as of December 31, 2006, based on compensation and service in 2006, and the contribution is not contingent on the occurrence of an event after 2006, then the contribution is treated as made for the 2006 plan year and is not subject to Code § 411(a)(2)(B), as amended by § 904 of PPA 2006, even if it is not contributed until 2007. Forfeitures and ESOP allocations from a suspense account are treated in the same manner for this purpose.

  15. Section 1102 of Pension Protection Act of 2006
  16. Section 1102 of PPA 2006 makes certain changes to the notice requirements related to distributions. Section 1102(a) provides that a notice required to be provided under § 402(f), § 411(a)(11), or § 417 may be provided to a participant as much as 180 days before the annuity starting date. Section 1102(b) directs the Secretary to modify the regulations under § 411(a)(11) of the Code and § 205 of ERISA to provide that the description of a participant's right to defer a distribution must also include a description of the consequences of failing to defer receipt of a distribution. The modifications made by § 1102 apply to years beginning after December 31, 2006. However, § 1102(b)(2)(B) provides that a plan will not be treated as failing to meet the new requirements under § 1102(b) if the plan administrator makes a reasonable attempt to comply with the new requirements under that section during the period that is within 90 days of the issuance of regulations required by § 1102(b).

    Q-31. How does the effective date of § 1102 operate?

    A-31. The provisions of § 1102 apply to plan years that begin after December 31, 2006. This means that the new rules relating to the content of the notices apply only to notices issued in those plan years, without regard to the annuity starting date for the distributions. Similarly, the 180-day period for distributing notices applies to notices distributed in a plan year that begins after December 31, 2006. This change to the 180-day period also modifies the definition of the maximum QJSA explanation period under § 1.411(d)-3(g), which is used in applying the timing rules for the effective date of a plan amendment under the rules of § 1.411(d)-3(c) and (f) in the case of an amendment that is adopted in a plan year that begins after December 31, 2006.

    Q-32. Is a plan required to revise the notice under § 411 pursuant to the modifications made by § 1102(b) before the regulations are amended to reflect the requirement?

    A-32. Yes. A plan administrator is required to revise the notice under § 411 to reflect the modifications to the requirements made by § 1102(b) for notices provided in plan years beginning after December 31, 2006. However, pursuant to § 1102(b)(2)(B) of PPA 2006, a plan will not be treated as failing to meet the new requirements under § 1102(b) if the plan administrator makes a reasonable attempt to comply with the new requirements under that section in the case of a notice that is provided prior to the 90th day after the issuance of regulations reflecting the modifications required by § 1102(b).

    Q-33. Is there a safe harbor available to a plan administrator that would be considered a reasonable attempt to comply with the requirement in § 1102(b)(1) that a description of a participant’s right to defer receipt of a distribution include a description of the consequences of failing to defer?

    A-33. Yes. A description that is written in a manner reasonably calculated to be understood by the average participant and that includes the following information is a reasonable attempt to comply with the requirements of § 1102(b)(2)(B): (a) in the case of a defined benefit plan, a description of how much larger benefits will be if the commencement of distributions is deferred; (b) in the case of a defined contribution plan, a description indicating the investment options available under the plan (including fees) that will be available if distributions are deferred; and (c) the portion of the summary plan description that contains any special rules that might materially affect a participant’s decision to defer. For purposes of clause (a), a plan administrator can use a description that includes the financial effect of deferring distributions, as described in§ 1.417(a)(3)-1(d)(2)(i), based solely on the normal form of benefit.

  17. Section 1201 of Pension Protection Act of 2006
  18. Section 1201(a) of PPA 2006 adds § 408(d)(8) to the Code, which is applicable to distributions made in taxable years 2006 and 2007. Under § 408(d)(8), generally, if a distribution from an IRA owned by an individual after the individual has attained age 70½ is made directly by the trustee to certain organizations described in § 170(b)(1)(A), the distribution is excluded from gross income. The exclusion is only available to the extent that the distribution would otherwise have been includible in gross income, and§ 408(d)(8)(D) provides a special rule for determining the amount that would otherwise be includible in gross income. In addition, the exclusion applies only if the contribution would otherwise qualify for a charitable contribution deduction under § 170 (without regard to the percentage limitations of § 170(b)). A distribution that is eligible for this exclusion is called a qualified charitable distribution.

    Q-34. Is there an overall limit on the amount that may be excluded from gross income for qualified charitable distributions that are made in a year?

    A-34. Yes. The income exclusion for qualified charitable distributions only applies to the extent that the aggregate amount of qualified charitable distributions made during any taxable year with respect to an IRA owner does not exceed $100,000. Thus, if an IRA owner maintains multiple IRAs in a taxable year, and qualified charitable distributions are made from more than one of these IRAs, the maximum total amount that may be excluded for that year by the IRA owner is $100,000. For married individuals filing a joint return, the limit is $100,000 per individual IRA owner.

    Q-35. Is the exclusion for qualified charitable distributions available for a distribution made to any organization eligible to receive charitable contributions that are deductible by the donor for income tax purposes?

    A-35. No. Qualified charitable distributions may be made to an organization described in § 170(b)(1)(A), other than supporting organizations described in § 509(a)(3) or donor advised funds that are described in § 4966(d)(2).

    Q-36. Is the exclusion for qualified charitable distributions available for distributions from any type of IRA?

    A-36. Generally, the exclusion for qualified charitable distributions is available for distributions from any type of IRA (including a Roth IRA described in § 408A and a deemed IRA described in § 408(q)) that is neither an ongoing SEP IRA described in § 408(k) nor an ongoing SIMPLE IRA described in § 408(p). For this purpose, a SEP IRA or a SIMPLE IRA is treated as ongoing if it is maintained under an employer arrangement under which an employer contribution is made for the plan year ending with or within the IRA owner’s taxable year in which the charitable contributions would be made.

    Q-37. Is the exclusion for qualified charitable distributions available for distributions from an IRA maintained for a beneficiary if the beneficiary has attained age 70½ before the distribution is made?

    A-37. Yes. The exclusion from gross income for qualified charitable distributions is available for distributions from an IRA maintained for the benefit of a beneficiary after the death of the IRA owner if the beneficiary has attained age 70½ before the distribution is made.

    Q-38. If a 2006 distribution satisfies all the requirements under § 408(d)(8), but it was made before August 17, 2006 (the date PPA 2006 was enacted), is the amount distributed excludable as a qualified charitable distribution?

    A-38. Yes. Section 408(d)(8) is applicable to distributions made at any time in 2006. Thus, a distribution made in 2006 that satisfies the requirements under § 408(d)(8) is a qualified charitable distribution even if it was made before August 17, 2006.

    Q-39. Is the amount of a qualified charitable distribution deductible as a charitable contribution under § 170?

    A-39. No. For purposes of determining the amount of charitable contributions that may be deducted under § 170, qualified charitable distributions which are excluded from income under § 408(d)(8) are not taken into account. However, qualified charitable distributions must still satisfy the requirements to be deductible charitable contributions under § 170 (other than the percentage limits of § 170(b)), including the substantiation requirements under § 170(f)(8).

    Q-40. Is a qualified charitable distribution subject to withholding under § 3405?

    A-40. No. A qualified charitable distribution is not subject to withholding under§ 3405 because an IRA owner that requests such a distribution is deemed to have elected out of withholding under § 3405(a)(2). For purposes of determining whether a distribution requested by an IRA satisfies the requirements under § 408(d)(8), the IRA trustee, custodian, or issuer may rely upon reasonable representations made by the IRA owner.

    Q-41. Is a check from an IRA made payable to a charitable organization described in § 408(d)(8) and delivered by the IRA owner to the charitable organization a direct payment to such organization?

    A-41. Yes. If a check from an IRA is made payable to a charitable organization described in § 408(d)(8) and delivered by the IRA owner to the charitable organization, the payment to the charitable organization will be considered a direct payment by the IRA trustee to the charitable organization for purposes of § 408(d)(8)(B)(i).

    Q-42. Will a qualified charitable distribution be taken into account in determining whether the required minimum distribution requirements of §§ 408(a)(6), 408(b)(3), and 408A(c)(5) have been satisfied?

    A-42. Yes. The amount distributed in a qualified charitable distribution is an amount distributed from the IRA for purposes of §§ 408(a)(6), 408(b)(3), and 408A(c)(5).

    Q-43. What are the tax consequences of a direct payment of an amount from a IRA to a charity where the transaction is intended to satisfy the requirements of § 408(d)(8) but fails to do so?

    A-43. If an amount intended to be a qualified charitable distribution is paid to a charitable organization but fails to satisfy the requirements of § 408(d)(8), the amount paid is treated as (1) a distribution from the IRA to the IRA owner that is includible in gross income under the rules of § 408 or § 408A, as applicable; and (2) a contribution from the IRA owner to the charitable organization that is subject to the rules under § 170 (including the percentage limits of § 170(b)).

    Q-44. Will a distribution made directly by the trustee to a § 170(b)(1)(A) organization (as permitted by § 408(d)(8)(B)(i)) be treated as a receipt by the IRA owner under § 4975(d)(9)?

    A-44. Yes. The Department of Labor, which has interpretive jurisdiction with respect to § 4975(d), has advised Treasury and the IRS that a distribution made by an IRA trustee directly to a § 170(b)(1)(A) organization (as permitted by § 408(d)(8)(B)(i)) will be treated as a receipt by the IRA owner under § 4975(d)(9), and thus would not constitute a prohibited transaction. This would be true even if the individual for whose benefit the IRA is maintained had an outstanding pledge to the receiving charitable organization.

  19. DRAFTING INFORMATION
  20. The principal author of this notice is Angelique V. Carrington of the Employee Plans, Tax Exempt and Government Entities Division. For further information regarding this notice, please contact the Employee Plans taxpayer assistance telephone service at (877) 829-5500 (a toll-free number) between the hours of 8:30 am and 4:30 pm Eastern Time, Monday through Friday. Ms. Carrington may be reached at (202) 283-9888 (not a toll-free number).

IRS Interpretive Letter

EP:R:9    IRA Annual Valuations: Partnership Valuations, Inc.

February 24, 1993

Internal Revenue Service Department of the Treasury
Washington, D.C. 20224

Person to Contact:
Laura B. Warshawsky, Esq.

Mr.

Partnership Valuations, Inc. Telephone Number:
(202) 622-8400
Annapolis, Maryland 21404

Refer Reply to:
E:EP:R:9

Date: February 24, 1993

Dear Mr.

This is in response to your letter to Martin Slate , Director of the Employee Plans Technical and Actuarial Division, dated December 24, 1992, in which you requested general information regarding valuation of assets in Individual Retirement Accounts and Individual Retirement Annuities ("IRAs"). In your letter, you posed the following questions: (1) Is an IRA required to value its assets on an annual basis? (2) Is an IRA required to value "hard to value" assets (e.g. partnerships, closely-held stock, collectibles, etc.) as well as exchange-traded securities? (3) Are non-traded asset value standards the same for IRAs as for defined benefit ("DB") plans and defined contribution ("DC") plans? (4) Who is responsible for insuring an IRA’s assets are properly valued? (5) Can a fiduciary evade its valuation responsibilities by having the client sign a release, indemnification or other instrument?

Section 408(i) of the Internal Revenue Code of 1986 (the "Code") requires the trustee of an individual retirement account and the issuer of an endowment contract or an individual retirement annuity to make certain reports regarding such account, contract, or annuity to the Secretary of the Treasury and to the individual for whom such account, contract or annuity is maintained. Section 408(i) of the Code gives the Secretary authority to prescribe the manner of providing such reports and to determine the information required to be provided.

Section 1.408-5 of the Income Tax Regulations provides that the trustee of an individual retirement account or the issuer of an individual retirement annuity shall make annual calendar year reports concerning the status of the account or the annuity. The information required in the annual reports by the trustees and issuers of IRAs includes: the amount of contributions, the amount of distributions, the amount of the premium paid for an endowment contract allocable to the cost of life insurance, the name and address of the trustee or issuer, and such other information as the Commissioner of Internal Revenue may require.

Internal Revenue Service Form 5498, Individual Retirement Arrangement Information, is the prescribed form for satisfying the annual reporting requirements of section 408(i) of the Code and the regulations thereunder. The instructions to Form 5498 require the trustee or issuer to report the fair market value of the IRA account as of December 31 of each year.

In response to your questions, first, based on the fact that the Internal Revenue Service (the "Service) requires that the fair market value of the assets as of December 31 be reported on Form 5498, an IRA is required to value its assets on an annual basis. Similarly, the requirement that fair market value be determined annually for purposes of Form 5498 necessitates the valuation of all IRA assets, including "hard to value" assets.

With respect to your third question, Revenue Ruling 59-60, 1959-1 C.B. 237, as modified by Revenue Ruling 65-193, 1965-2 C.B. 370, sets forth the proper approach to use to value corporate stock for estate and gift tax purposes. Revenue Ruling 68-609, 1968-2 C.B. 327, states that the general approach, methods and factors outlined in Revenue Ruling 59-60 are equally applicable to valuations of corporate stock for income and other tax purposes. The general approach, methods and factors also apply to valuations of corporate stock in IRAs.

With respect to your fourth question, the person responsible for insuring that an IRA’s assets are properly valued is the IRA trustee or issuer, because under the Service’s reporting requirements that person is responsible for reporting the correct fair market value of the assets.

Finally, the IRA trustee or issuer cannot evade valuation responsibility by having the participant sign a release, indemnification or other instrument, because the trustee’s or issuer’s responsibility for valuation derives from the Service’s reporting requirements, which cannot be waived by participant action.

We believe this information will be of assistance to you. This is not a ruling, however, and may not be relied upon with respect to any specific transaction.

Sincerely,

John G. Riddle, Jr.
Acting Chief, Employee Plans
Rulings Branch

Prohibited Transaction Class Exemptions

75-1    Securities Transactions

Securities Transactions (67KB PDF file - PDF Help)

Also See 86-128.

77-3    Investment in Mutual Funds by In-House Employee Benefit Plans

Class Exemption Involving Mutual Fund In-House Plans Requested by the Investment Company Institute
April 8, 1977 (42 FR 18743)

Recap
Permits an employee benefit plan which covers only employees of a mutual fund, the fund’s investment adviser, the principal underwriter, or an affiliate of such persons, to "acquire" or sell shares of a registered open-end investment company .

Class Exemption

Agency: Department of Labor, Labor-Management Services Administration

Action: Grant of Class Exemption Effective Date: December 31, 1974

Exemption

Effective for transactions occurring after December 31, 1974, the restrictions of sections 406 and 407(a) 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 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 (as defined in section 2(a)(3) of the Investment Company Act of 1940) of such investment adviser or principal underwriter, provided that the following conditions are met (whether or not such investment company, investment adviser, principal underwriter or any affiliated person thereof is a fiduciary with respect to the plan):

  1. The plan does not pay any investment management, investment advisory or similar fee to such investment adviser, principal underwriter or affiliated person. 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 section 15 of the Investment Company Act of 1940.
  2. The plan does not pay a redemption fee in connection with the sale by the plan to the investment company of such shares unless (1) such redemption fee is paid only to the investment company, and (2) the existence of such redemption fee is disclosed in the investment company prospectus in effect both at the time of the acquisition of such shares and at the time of such sale.
  3. In the case of transactions occurring more than 60 days after the granting of this exemption, the plan does not pay a sales commission in connection with such acquisition or sale.
  4. 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.

Signed at Washington, D.C., this 31st day of March, 1977.

J. Vernon Ballard,
Acting Administrator of Pension and Welfare Benefit Programs, Department of Labor.

and

William E. Williams,
Acting Commissioner of Internal Revenue

[FR Doc. 77-10157 Filed 4-1-77; 11:44 AM]

77-4    Investment in Advised or Affiliated Mutual Funds

Prohibited Transaction Class Exemption 77-4
March 31, 1977

Recap
Permits investment in mutual funds advised by or affiliated with a fiduciary if: (1) approved by a second, independent, fiduciary, (2) no front-end load is imposed, (3) redemption fees meet certain conditions, and (4) conditions on mutual fund fees are met.
Cross reference: See Advisory Opinion 93-13 regarding application of PTE 77-4 to purchase of affiliated mutual funds. Also see 1994 DOL letter to OCC regarding conversions of collective investment funds into mutual funds.

Class Exemption

To Invest in Mutual Funds Affiliated With or Advised By a Fiduciary

Agency: Department of Labor and Internal Revenue Service.

Action: Grant of class exemption.

Effective Date: Certain retroactive exemption is given for transactions between January 1, 1975 and ninety days after the exemption is granted. Prospective exemption is granted for transactions occurring ninety days after the exemption is granted. [Since the exemption was signed 3-31-77, the prospective exemption should be effective 7-1-77.]

Exemption

Section I - Retroactive.

The Retroactive portion of this Exemption covers transactions between 1-1-75 and 7-1-77. As such, it is not reprinted here.

Section II - Prospective.  Effective 90 days after the date of granting of this exemption, 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 the 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:

  1. The plan does not pay a sales commission in connection with such purchase or sale.
  2. The plan does not pay a redemption fee in connection with the sale by the plan to the investment company of such shares, unless:
    1. Such redemption fee is paid only to the investment company, and
    2. The existence of such redemption fee is disclosed in the investment company prospectus in effect both at the time of the purchase of such shares and at the time of such sale.
  3. The plan does not pay an investment management, 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 section 15 of the Investment Company Act of 1940.
    • This condition also does not preclude the 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.
    • If, during any fee period for which the plan prepaid its investment management, investment advisory or similar fee, the plan purchases shares of the investment company, the requirements of this paragraph (c) shall be deemed met with respect to such prepaid fee if, by a method reasonable designed to accomplish the same, the amount of the prepaid fee that constitutes the fee with respect to the plan assets invested in the investment company shares:
      1. Is anticipated and subtracted from the prepaid fee at the time of payment of such fee,
      2. Is returned to the plan no later than during the immediately following fee period, or
      3. Is offset against the prepaid fee for the immediately following fee period or for the fee period immediately following thereafter.

      For purposes of this paragraph, a fee shall be deemed to be prepaid for any fee period if the amount of such fee is calculated as of a date not later than the first day of such period.

  4. 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.

    For purposes of this exemption, such second fiduciary will not be deemed to be independent of and unrelated to the fiduciary/investment adviser or any affiliate thereof if:

    1. Such second fiduciary directly or indirectly controls, is controlled by, or under common control with the fiduciary/investment adviser or any affiliate thereof;
    2. Such second fiduciary or any officer, director, partner, employee or relative of such second fiduciary is an officer, director, partner, employee or relative of such fiduciary/investment adviser or any affiliate thereof; or
    3. Such second fiduciary directly or indirectly receives any compensation or other consideration for his or his own personal account in connection with any transaction described in this exemption.

    If an officer, director, partner, employee or relative of such fiduciary/investment adviser or any affiliate thereof is a director of such second fiduciary, and if he or she abstains from participation in

    1. The choice of the plan's investment adviser,
    2. The approval of any such purchase or sale between the plan and the investment company and
    3. The approval of any change of fees charged to or paid by the plan, then paragraph (d)(2) of this section shall not apply.

    For purposes of this exemption, the term "control" means the power to exercise a controlling influence over the management or policies of a person other than an individual, and the term "relative" means a "relative" as that term is defined in section 3(15) of the Act (or a "member of the family" as that term is defined in section 4975(e)(6) of the Code), or a brother, a sister, or a spouse of a brother or a sister.

  5. On the basis of the prospectus and disclosure referred to in paragraph (d), the second fiduciary referred to in paragraph (d) approves such purchases and sales 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 plain and need not relate to any other aspects of such investments. 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.
  6. The second fiduciary referred to in paragraph (d), or any successor thereto, is notified of any change in any of the rates of 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 change. 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.

Signed at Washington, D. C. this 31st day of March 1977.

J. Vernon Ballard,
Acting Administrator of Pension and Welfare Benefit Programs

Department of Labor.

William E. Williams
Acting Commissioner of Internal Revenue.

80-26    Interest-Free Loans (Including Overdrafts)

Prohibited Transaction Class Exemption 80-26
April 29, 1980 (45 FR 28545)

Recap
Interest-free loans. Permits interest-free loans (including overdrafts) between plans and parties in interest provided certain conditions are met.

Class Exemption for Certain Interest Free Loans to Employee Benefit Plans

Agency: Department of Labor.

Action: Grant of class exemption.

Summary: This class exemption permits parties in interest with respect to employee benefit plans to make interest free loans to such plans. Such loans would be prohibited by the Employee Retirement Income Security Act of 1974 (the Act) and the Internal Revenue Code of 1964 (the Code). The exemption affects all employee benefit plans, their participants and beneficiaries, and parties in interest with respect to those plans.

Effective Date: January 1, 1975.

Exemption

Effective January 1, 1975, the restrictions of section 406(a)(1)(B) and (D) and section 406(b)(2) of the Act, and the taxes imposed by section 4975(a) and (b) of the Code by reason of section 4975(c)(1)(B) and (D) of the Code, shall not apply to the lending of money or other extension of credit from party in interest or disqualified person to an employee benefit plan, nor to the repayment of such loan or other extension of credit in accordance with its terms or written modifications thereof, if:

  1. No interest or other fee is charged to the plan, and no discount for payment in cash is relinquished by the plan in connection with the loan or extension of credit;
  2. The proceeds of the loan or extension of credit are used only:
    1. For the payment of ordinary operating expenses of the plan, including the payment of benefits in accordance with the terms of the plan and periodic premiums under an insurance or annuity contract; or
    2. For a period of not more than three days, for a purpose incidental to the ordinary operation of the plan;
  3. The loan or extension of credit is unsecured; and
  4. The loan or extension of credit is not directly or indirectly made by an employee benefit plan.

80-50    Collective Investment Funds

Prohibited Transaction Class Exemption 80-51
June 25, 1980 (45 FR 49709)

Recap
Collective Investment Funds. ERISA plans are permitted to invest in collective investment funds operated by bank fiduciaries, subject to certain limitations and conditions.

Class Exemption Covering Collective Investment Funds

Agency: Department of Labor.

Action: Grant of class exemption.

Summary: This exemption allows collective investment funds that are maintained by banks and in which employee benefit plans participate to engage in certain transactions provided that specified conditions are met. In the absence of this exemption, these transactions might be prohibited by the Employee Retirement Income Security Act of 1974 (the Act) and the Internal Revenue Code of 1954 (the Code).

Effective Date: January 1, 1975.

Exemption

Note: This exemption has been replaced by PTE 91-38.

80-83    Purchase of Securities Where Issuer May Use Proceeds To Reduce or Retire Indebtedness To Parties in Interest

Prohibited Transaction Class Exemption 80-83
November 4, 1980 (45 FR 73189)

Recap
Permits ERISA plans to invest in securities issued by plan sponsors, when proceeds are used to reduce debt at the fiduciary bank or its affiliates (even if fiduciary personnel know how proceeds will be used) subject to conditions:

(1) Issuer has been in business for 3 or more years, or securities are not convertible and are rated in the highest 4 ratings by a nationally-recognized firm; (2) No more than 10% of the offering is subscribed to by the bank as fiduciary; (3) No more than 3% of the offering is subscribed to by an individual ERISA plan; (4) Consideration paid by the plan to acquire the securities does not exceed 3% of an ERISA plan's market value.

Note: Covers discretionary, non-discretionary and custodial accounts.

Class Exemption for Certain Transactions Involving Purchase of Securities

Where Issuer May Use Proceeds To Reduce or Retire Indebtedness

To Parties in Interest

Agency: Department of Labor.

Action: Grant of Class Exemption.

Summary: This class exemption permits, under certain conditions, purchases of securities by employee benefit plans when the proceeds from the sale of such securities may be used by the issuer to reduce or retire indebtedness to persons who are parties in interest with respect to such plans. In the absence of the retroactive and prospective relief provided by this exemption, these transactions might be prohibited by the Employee Retirement Income Security Act of 1974 (the Act) and the Internal Revenue Code of 1954 (the Code).

Effective Date: Section I(B) of this exemption is effective December 1, 1980. The remainder of this exemption is effective January 1, 1975.

Exemption

  1. Transactions
    1. Effective January 1, 1975 the restrictions of section 406(a)(1)(A) through (D) of the Act and the taxes imposed by reason of section 4975(c)(1)(A) through (D) of the Code shall not apply to the purchase or other acquisition prior to December 1, 1980 in a public offering (defined in Section II(B)) of securities by a fiduciary on behalf of an employee benefit plan solely because the proceeds from the sale were or were to be used by the issuer of the securities to retire or reduce indebtedness owed to a party in interest with respect to the plan other than the fiduciary, provided that the price paid by the plan for the securities does not exceed adequate consideration as defined in section 3(18) of the Act.
    2. Subject to the conditions described in section II(A), effective December 1, 1980, the restrictions of section 406(a)(1)(A) through (D) of the Act and the taxes imposed by reason of section 4975(c)(1)(A) through (D) of the Code shall not apply to the purchase or other acquisition in a public offering (defined in section II(B)) of securities by a fiduciary on behalf of an employee benefit plan solely because the proceeds from the sale may be used by the issuer of the securities to retire or reduce indebtedness owed to a party in interest of the plan other than the fiduciary.
    3. Subject to the conditions described in section II(A), effective January 1, 1975, the restrictions of sections 406(a)(1)(A) through (D) and 406(b)(1) and (2) of the Act and the taxes imposed by reason of section 4975(c)(I)(A) through (E) of the Code shall not apply to the purchase or other acquisition in a public offering (defined in section II(B)) of securities by a fiduciary, which is a bank or an affiliate thereof, on behalf of an employee benefit plan solely because the proceeds from the sale may be used by the issuer of the securities to retire or reduce indebtedness owed to such fiduciary or any affiliate thereof provided that, if such fiduciary of the plan knows (as defined in paragraph (7) that the proceeds of this issue will be used in whole or in part by the issuer of the securities to reduce or retire indebtedness owed to such fiduciary or affiliate thereof the transaction shall have complied with the conditions set forth in paragraph 1 through 6 below:
      1. Such securities are purchased prior to the end of the first full business day after the securities have been offered to the public, except that -
        1. If such securities are offered for subscription upon exercise of rights, they may be purchased on or before the fourth day preceding the day on which the rights offering terminates; or
        2. If such securities are debt securities, they may be purchased on a day subsequent to the end of such first full business day, if the effective interest rates on comparable debt securities offered to the public subsequent to such first full business day and prior to the purchase are less than effective interest rate of the debt securities being purchased;
      2. Such securities are offered by the issuer pursuant to an underwriting agreement under which the members of the underwriting syndicate are committed to purchase all of the securities being offered, except if the securities
        1. Are purchased by others pursuant to a rights offering, or
        2. Are offered pursuant to an over allotment option;
      3. The issuer of such securities has been in continuous operation for not less than three years, including the operations of any predecessors, unless such securities are nonconvertible debt securities rated in one of the four highest rating categories by at least one nationally recognized statistical rating organization;
      4. The amount of securities purchased or otherwise acquired on behalf of the plan by the fiduciary does not exceed three percent of the total amount of the securities being offered;
      5. The consideration to be paid by any plan in purchasing or otherwise acquiring such securities does not exceed three percent of the fair market value, as of the most recent valuation date of the plan prior to such transaction of the plan assets which are subject to the management and control of such fiduciary;
      6. The total amount of securities in any single offering purchased by the fiduciary of behalf of the plan together with the total amount of such securities purchased by such fiduciary acting as a fiduciary on behalf of any other employee benefit plan subject to Title I of the Act does not exceed 10 percent of the amount of the offering;
      7. As used in this section I(C), a fiduciary will be deemed to know that the proceeds of an issuance of securities will be used in whole or in part by the issuer of the securities to reduce or retire indebtedness owned [owed] to such fiduciary or an affiliate thereof, if
        1. Such knowledge is actually communicated to, or
        2. Information reasonably sufficient to cause belief that the proceeds will be used in whole or in part by the issuer of the securities to reduce or retire indebtedness owned [owed] to the fiduciary, or an affiliate thereof, is possessed by, the officers or employees of the fiduciary, who are authorized to be involved in carrying out the investment responsibilities, obligations, or duties of the fiduciary, or who in fact are involved in carrying out such responsibilities, obligations, or duties, regarding the purchase or other acquisition.
    4. Effective January 1, 1975, the restrictions of sections 406(a)(I)(A) through (D) and 406(b)(1) and (2) of the Act and the taxes imposed by reason of section 4975(c)(I)(A) through (E) of the Code shall not apply to the receipt by a party in interest of any of the proceeds resulting from the issuance, in a public offering (as defined in section II(B)), of securities merely because such proceeds are used by the issuer of the securities to retire or reduce indebtedness owed to the party in interest provided that, when such party in interest is a fiduciary acquiring such securities on behalf of a plan, such fiduciary is a bank or an affiliate thereof (as defined in section II(B)) which meets the provisions of section I(C) of this exemption.
  2. General Conditions
    1. The following conditions apply to the transactions described in section I(B) and (C) above:
      1. The price paid by the plan fiduciary for the securities shall not be in excess of the offering price described in an effective registration statement under the Securities Act of 1933 covering such securities or in the case of securities described in section II(B)(I)(b), in the offering circular required under applicable federal law;
      2. (a) The fiduciary, on behalf of the plan, maintains for a period of six years from the date of the transaction the records necessary to enable the persons described in section II(A)(2)(b) below to determine whether the conditions of this exemption have been met, except that a prohibited transaction will not be deemed to have occurred if, due to circumstances beyond the control of the fiduciary, the records are lost or destroyed prior to the end of the six-year period;
      3. (b) Notwithstanding any provisions of subsections (a)(2) and (b) of section 504 of the Act, the records referred to in section II(A)(2)(a) above are unconditionally available at their customary location for examination during normal business hours by:

        1. Any duly authorized employee or representative of the Department of Labor or the Internal Revenue Service,
        2. Any fiduciary of a plan who has authority to manage and control the assets of the plan, or to allocate to another fiduciary the authority to manage and control the assets of the plan, or any duly authorized employee or representative of such fiduciary,
        3. Any contributing employer to the plan or representative of such employer,
        4. Any participant or beneficiary of the plan or any duly-authorized employee or representative of such participant or beneficiary,
        5. None of the persons described in subparagraph (ii) through (iv) of this paragraph shall be authorized to examine any fiduciary's trade secrets or required to be kept commercial [sic] or financial information which is privileged or required to be kept confidential.
    2. For the purposes of the exemptions contained in Part I,
      1. The term "public offering" means -
      2. The offering of securities registered under the Securities Act of 1933 (Securities Act), or
      3. The offering of securities exempt from registration under the Securities Act which are -
        1. Issued by a bank.
        2. Issued by a motor carrier if such issuance is subject to the provisions of section 214 of the Interstate Commerce Act, as amended,
        3. Exempt from the registration requirements of the Securities Act pursuant to a federal statute other than the Securities Act, or
        4. The subject of a distribution and of a class which is required to be registered under section 12 of the Securities Exchange Act of 1934 (15 USC 781), and the issuer of which has been subject to the reporting requirements of section 13 of that Act (15 USC 78m) for a period of at least 90 days immediately preceding the sale of securities and has filed all reports required to be filed thereunder with the Securities and Exchange Commission during the preceding 12 months.
      4. An "affiliate" of a bank means any entity directly or indirectly, through one or more intermediaries, controlling, controlled by, or under common control with such bank.
      5. For the purposes of this paragraph, the term "control" means the power to exercise a controlling influence over the management or policies of a person other than an individual.

      6. Each plan participating in a collective or commingled fund shall be considered to own the same proportionate undivided interest in each asset of the collective investment fund as its proportionate interest in the total assets of the collective investment fund as calculated on the most recent preceding valuation date of the fund.

81-6    Securities Lending

Prohibited Transaction Class Exemption 81-6
[Amended on May 19, 1987 (52 FR 18754)]

Recap
Securities Lending: Loans by plans to banks and broker-dealers. - The lending of securities by employee benefit plans to broker-dealers and banks who are parties in interest is permitted under this class exemption. In order for such loans to be exempt from ERISA's prohibited transaction provisions, neither the borrower nor an affiliate may have discretionary authority with respect to the investment of the plan assets involved in the transaction.

A 1987 amendment, which expanded the exemption to government securities dealers, is included in the Amended Exemption.
Also See: PTE 82-63 permits payment of compensation to a fiduciary for securities lending services.

Class Exemption To Permit Certain Loans of Securities by Employee Benefit Plans

Agency: Department of Labor.

Action: Grant of class exemption.

Summary: This exemption will allow the lending of securities by employee benefit plans to banks and broker-dealers who are parties in interest with respect to such plans, if the conditions specified in the exemption are met. The exemption affects participants and beneficiaries of employee benefit plans, persons who manage the assets of such plans, and parties in interest who might engage in securities lending transactions with such plans. In the absence of this exemption, securities lending transactions between a plan and a party in interest would be prohibited by the Employee Retirement Income Security Act of 1974 (the Act) and the Internal Revenue Code of 1954 (the Code).

Effective Date: January 23, 1981. For purposes solely of Prohibited Transaction Exemption 79-23 (the Grumman Corp. Pension Trust, 44 FR 31750, June 1, 1979). The final disposition of this class exemption will be deemed to occur on February 23, 1981.

Amended Exemption

Effective January 23, 1981, the restrictions of section 406(a)(1)(A) through (D) of the Act and the taxes imposed by section 4975(a) and (b) of the Code by reason of section 4975(c)(1)(A) through (D) of the Code shall not apply to the lending of securities that are assets of an employee benefit plan to a broker-dealer registered under the Securities Exchange Act of 1934 (the 1934 Act) or exempted from registration under section 15(a)(I) of the 1934 Act as a dealer in exempted Government securities (as defined in section 3(a)(12) of the 1934 Act) or to a bank, if:

  1. Neither the borrower nor an affiliate of the borrower has discretionary authority or control with respect to the investment of the plan assets involved in the transaction, or renders investment advice (within the meaning of 29 C.F.R. 2510.3-21(c)) with respect to those assets;
  2. The plan receives from the borrower (either by physical delivery or by, book entry in a securities depository) by the close of the lending fiduciary's business on the day in which the securities lent are delivered to the borrower, collateral consisting of cash, securities issued or guaranteed by the United States Government or its agencies, or irrevocable bank letters of credit issued by a person other than the borrower or an affiliate thereof, or any combination thereof, having, as of the close of business on the preceding business day, a market value equal to not less than 100 percent of the market value of the securities lent;
  3. Prior to the making of any such loan, the borrower shall have furnished the lending fiduciary with (1) the most recent available audited statement of the borrower's financial condition, (2) the most recent available unaudited statement of its financial condition (if more recent than such audited statement), and (3) a representation that, at the time the loan is negotiated, there has been no material adverse change in its financial condition since the date of the most recent financial statement furnished to the plan that has not been disclosed to the lending fiduciary. Such representation may be made by the borrower's agreeing that each such loan shall constitute a representation by the borrower that there has been no such material adverse change;
  4. The loan is made pursuant to a written loan agreement, the terms of which are at least as favorable to the plan as an arm's length transaction with an unrelated party, would be. Such agreement may be in the form of a master agreement covering a series of securities lending transactions;
  5. (a) The plan (1) receives a reasonable fee that is related to the value of the borrowed securities and the duration of the loan, or (2) has the opportunity to derive compensation through the investment of cash collateral. Where the plan has that opportunity, the plan may pay a loan rebate or similar fee to the borrower, if such fee is not greater than the plan would pay in a comparable transaction with an unrelated party;
  6. (b) The plan receives the equivalent of all distributions made to holders of the borrowed securities during the term of the loan, including, but not limited to, cash dividends, interest payments, shares of stock as a result of stock splits and rights to purchase additional securities;

  7. If the market value of the collateral at the close of trading on a business day is less than 100 percent of the market value of the borrowed securities at the close of trading on that day, the borrower shall deliver, by the close of business on the following business day, an additional amount of collateral (as described in paragraph 2) the market value of which, together with the market value of all previously delivered collateral, equals at least 100 percent of the market value of all the borrowed securities as of such preceding day.
  8. Notwithstanding the foregoing, part of the collateral may be returned to the borrower if the market value of the collateral exceeds 100 percent of the market value of the borrowed securities, as long as the market value of the remaining collateral equals at least 100 percent of the market value of the borrowed securities;

  9. The loan may be terminated by the plan at any time, whereupon the borrower shall deliver certificates for securities identical to the borrowed securities (or the equivalent thereof in the event of reorganization, recapitalization or merger of the issuer of the borrowed securities) to the plan within (1) the customary delivery period for such securities, (2) five business days, or (3) the time negotiated for such delivery by the plan and the borrower, whichever is lesser; and
  10. In the event the loan is terminated, and the borrower fails to return the borrowed securities or the equivalent thereof within the time described in paragraph 7 above, (i) the plan may, under the terms of the loan agreement, purchase securities, identical to the borrowed securities (or their equivalent as described above) and may apply, the collateral to the payment of the purchase price, any other obligations of the borrower under the agreement, and any expenses associated with the sale and/or purchase, and (ii) the borrower is obligated, under the terms of the loan agreement, to pay, and does pay to the plan the amount of any remaining obligations and expenses not covered by the collateral plus interest at a reasonable rate.
  11. Notwithstanding the foregoing, the borrower may, in the event the borrower fails to return borrowed securities as described above, replace non-cash collateral with an amount of cash not less than the then current market value of the collateral, provided such replacement is approved by the lending fiduciary.

    If the borrower fails to comply with any condition of this exemption in the course of engaging in a securities lending transaction, the plan fiduciary who caused the plan to engage in such transaction shall not be deemed to have caused the plan to engage in a transaction prohibited by section 406(a)(1)(A) through (D) of the Act solely by reason of the borrower's failure to comply with the conditions of the exemption.

    For purposes of this class exemption the term "affiliate" of another person shall include:

    1. Any person directly or indirectly, through one or more intermediaries, controlling, controlled by, or under common control with such other person;
    2. Any officer, director, or partner, employee or relative (as defined in section 3(15) of the Act) of such other person; and
    3. Any corporation or partnership of which such other person is an officer, director or partner.

    For purposes of this definition the term "control" means the power to exercise a controlling influence over the management or policies of a person other than an individual.

81-8    Short-term Investments & Repurchase Agreements

Prohibited Transaction Class Exemption 81-8
January 23, 1981 (46 FR 7511)

[Amended on April 9, 1985 (50 FR 14043)]

Recap
Employee benefit plans: Short-term investments. Employee benefit plans are permitted to engage in transactions involving certain short-term investments, notwithstanding the prohibited transaction provisions of ERISA. The class exemption allows four types of short-term investments: banker's acceptances, commercial paper, repurchase agreements, and certificates of deposit.

Class Exemption Covering Certain Short-Term Investments

Agency: Department of Labor.

Action: Grant of class exemption.

Summary: This exemption permits employee benefit plans to engage in transactions involving certain short-term investments notwithstanding the prohibited transaction restrictions of the Employee Retirement Income Security Act of 1974 (ERISA or the Act). The exemption will affect participants and beneficiaries of employee benefit plans, persons who manage the assets of such plans, and other persons who provide services to such plans.

Effective Date: January 1, 1975. (Certain conditions to the availability of the exemption are effective April 23, 1981).

Amended Exemption

Effective January 1, 1975, the restrictions of sections 408(a)(1)(A) (B) and (D) of the Act, and the taxes imposed by reason of section 4975(c)(1)(A), (B) and (D) of the Code shall not apply to an investment of employee benefit plan assets which involves the purchase or other acquisition, holding, sale, exchange or redemption by or on behalf of an employee benefit plan of the following:

  1. Banker's Acceptances. A banker's acceptance that is issued by a bank if:
    1. The banker's acceptance has a stated maturity date of one year or less from date of issue or has a maturity date of one year or less from the date of purchase on behalf of the plan;
    2. Neither the bank nor any affiliate of the bank has discretionary authority or control with respect to the investment of the plan assets involved in the transaction or renders investment advice (within the meaning of 29 C.F.R. 2510.3-21(c)) with respect to those assets;
    3. The terms of the transaction are at least as favorable to the plan as those of an arm's length transaction with an unrelated party would be; and,
    4. With respect to transactions occurring on or after April 23, 1981 the bank issuing the banker's acceptance is supervised by the United States or a State.
  2. Commercial Paper. Commercial paper if:
    1. It is not issued by an employer any of whose employees are covered by the plan or by an affiliate of such employer;
    2. It has a stated maturity date of nine months or less from the date of issue, exclusive of days of grace, or is a renewal of an issue of commercial paper the maturity of which is likewise limited;
    3. Neither the issuer of the commercial paper, any guarantor of the commercial paper, nor an affiliate of such issuer or guarantor, has discretionary authority or control with respect to the investment of the plan assets involved in the transaction or renders investment advice (within the meaning of 29 C.F.R. 2510.3-21(c)) with respect to those assets;
    4. With respect to an acquisition or holding of commercial paper (including an acquisition by exchange) occurring on or after April 23, 1981, at the time it is acquired, the commercial paper is ranked in one of the three highest rating categories by at least one nationally recognized statistical rating services.
  3. Repurchase Agreement.
  4. A repurchase agreement (or securities or other instruments under cover of a repurchase agreement) in which the seller of the underlying securities or other instruments is a bank which is supervised by the United States or a State; a broker-dealer registered under the Securities Exchange Act of 1934; or a dealer who makes primary markets in securities of the United States government or any agency thereof or in bankers acceptances and reports daily to the Federal Reserve Bank of New York its position with respect to these obligations, if each of the following conditions are satisfied.

    1. The repurchase agreement is embodied in, or is entered into pursuant to a written agreement the terms of which are at least as favorable to the plan as an arm's length transaction with an unrelated party would be. For transactions occurring before April 23, 1981 a written confirmation of a repurchase agreement whose terms were at least as favorable to the plan as an arm's length transaction with an unrelated party would have been will be deemed to satisfy this condition.
    2. The plan receives interest at a rate no less than that which it would receive in a comparable transaction with an unrelated party.
    3. The repurchase agreement has a duration of one year or less.
    4. The plan receives securities, banker's acceptances, commercial paper, or certificates of deposit having a market value equal to not less than 100 percent of the purchase price paid by the plan.
    5. Upon expiration of the repurchase agreement and return of the securities or other instruments to the bank, broker-dealer or dealer (seller), the seller transfers to the plan an amount equal to the purchase price plus the appropriate interest.
    6. Neither the seller nor an affiliate of the seller has discretionary authority or control with respect to the investment of the plan assets involved in the transaction or render investment advice (within the meaning of 29 C.F.R. 2510.3-21(c)) with respect to those assets.
    7. The securities, banker's acceptances, commercial paper or certificates of deposit received by the plan:
      1. Could be acquired directly by the plan in a transaction not covered by this section III without violating sections 406(a)(1)(E)406(a)(2) or 407(a) of the Act; and,
      2. If the securities are subject to the provisions of the Securities Act of 1933, they are obligations that are not "restricted securities" within the meaning of Rule 144 under that act.
    8. With respect to transactions occurring on or after April 23, 1981:
      1. If the market value of the underlying securities or other instruments falls below the purchase price at any time during the term of the agreement, the plan may, under the written agreement required by paragraph A of this section, require the seller to deliver, by the close of business on the following business day, additional securities or other instruments the market value of which, together with the market value of securities previously delivered or sold to the plan under the repurchase agreement, equals at least 100 percent of the purchase price paid by the plan;
      2. If the seller does not deliver additional securities or other instruments as required above, the plan may terminate the agreement, and, if upon termination or expiration of the agreement, the amount owing is not paid to the plan, the plan may sell the securities or other instruments and apply the proceeds against the obligations of the seller under the agreement, and against any expenses associated with the sale; and,
      3. The seller agrees to furnish the plan with the most recent available audited statement of its financial condition as well as its most recent available unaudited statement, agrees to furnish additional audited and unaudited statements of its financial condition as they are issued and either:
        1. Agrees that each repurchase agreement transaction pursuant to the agreement shall constitute a representation by the seller that there has been no material adverse change in its financial condition since the date of the last statement furnished that has not been disclosed to the plan fiduciary with whom such written agreement is made; or
        2. Prior to each repurchase agreement transaction, the seller represents that, as of the time the transaction is negotiated, there has been no material adverse change in its financial condition since the date of the last statement furnished that has not been disclosed to the plan fiduciary with whom such written agreement is made.
      4. In the event of termination and sale as described in (2) above, the seller pays to the plan the amount of any remaining obligations and expenses not covered by the sale of the securities or other instruments, plus interest at a reasonable rate.

    If a seller involved in a repurchase agreement covered by this exemption fails to comply with any condition of this exemption in the course of engaging in the repurchase agreement, the plan fiduciary who caused the plan to engage in such repurchase agreement shall not be deemed to have caused the plan to engage in a transaction prohibited by section 406(a)(1)(A) through (D) of the Act solely by reason of the seller's failure to comply with the conditions of the exemption.

  5. Certificates of Deposit.
  6. A certificate of deposit that is issued by a bank which is supervised by the United States or a State if neither the bank nor any affiliate of the bank has discretionary authority or control with respect to the investment of the plan assets involved in the transaction or renders investment advice (within the meaning of 29 C.F.R. 2510.3-21(c)) with respect to those assets.

    For purposes of this exemption the term affiliate is defined in 29 C.F.R. 2510.3-21(e).

  7. Securities of Banks.
  8. A security issued by a bank or an affiliate of the bank if:

    1. The bank is supervised by the United States or a State;
    2. The bank is a party in interest or disqualified person with respect to the plan solely by reason of the furnishing of checking account or related services to the plan
    3. The terms of the transaction are at least as favorable to the plan as those of an arm's-length transaction with an unrelated party would be; and
    4. The investment is not part of an arrangement under which the bank causes a transaction to be made with or for the benefit of a party in interest or disqualified person.

82-63    Securities Lending Compensation

Prohibited Transaction Class Exemption 82-63
April 6, 1982 (47 FR 14804)

Recap
Payment of compensation to a fiduciary for securities lending services. This class exemption allows certain compensation arrangements to be made for the provision by a fiduciary of securities lending services to an employee benefit plan, if the conditions specified in the exemption are met.
Also see: PTE 81-6 permits plans to engage in securities lending with banks, broker-dealers, and government securities dealers.

Class Exemption to Permit Payment of Compensation to Plan Fiduciaries for the Provision of Securities Lending Services

Agency: Office of Pension and Welfare Benefit Programs, Labor.

Action: Grant of class exemption.

Summary: This exemption will allow certain compensation arrangements to be made for the provision by a fiduciary of securities lending services to an employee benefit plan, if the conditions specified in the exemption are met. The exemption affects participants and beneficiaries of employee benefit plans and fiduciaries who provide securities lending services to such plans. In the absence of this exemption, certain compensation arrangements for the provision of securities lending services by a plan fiduciary to an employee benefit plan would be subject to the prohibitions of section 406(b)(1) of the Employee Retirement Income Security Act of 1974 (the Act) and the taxes imposed by section 4975(a) and (b) of the Internal Revenue Code of 1954 (the Code) by reason of section 4975(c)(1)(E) of the Code.

Effective Date: April 6, 1982.

The Explanatory Preamble, together with the full Exemption, are available in the PREAMBLE document.

Exemption

  1. Transactions
  2. Effective April 6, 1982, the restrictions of section 406(b)(1) of the Employee Retirement Income Security Act of 1974 (the Act) and the taxes imposed by section 4975(a) and (b) of the Internal Revenue Code of 1954 (the Code) by reason of section 4975(c)(1)(E) of the Code shall not apply to the payment to a fiduciary (the "lending fiduciary") of compensation for services rendered in connection with loans of plan assets that are securities, provided that:

    1. The loan of securities is not prohibited by section 406(a) of the Act;
    2. The lending fiduciary is authorized to engage in securities lending transactions on behalf of the plan;
    3. The compensation is reasonable and is paid in accordance with the terms of a written instrument, which may be in the form of a master agreement covering a series of securities lending transactions;
    4. Except as otherwise provided in paragraph (f), the arrangement under which the compensation is paid (1) is subject to the prior written authorization of a plan fiduciary (the "authorizing fiduciary"), who is (other than in the case of a plan covering only employees of the lending fiduciary or affiliates of such fiduciary) independent of the lending fiduciary and of any affiliate thereof, and (2) may be terminated by the authorizing fiduciary within (i) the time negotiated for such notice of termination by the plan and the lending fiduciary, or (ii) five business days, whichever is lesser, in either case without penalty to the plan;
    5. No such authorization is made or renewed unless the lending fiduciary shall have furnished the authorizing fiduciary with any reasonably available information which the lending fiduciary reasonably believes to be necessary to determine whether such authorization should be made or renewed, and any other reasonably available information regarding the matter that the authorizing fiduciary may reasonably request; and
    6. (Special Rule for Commingled Investment Funds) In the case of a pooled separate account maintained by an insurance company qualified to do business in a state or, a common or collective trust fund maintained by a bank or trust company supervised by a state or federal agency, the requirements of paragraph (d) of this exemption shall not apply: Provided, that -
      1. The information described in paragraph (e) (including information with respect to any material change in the arrangement) shall be furnished by the lending fiduciary to the authorizing fiduciary described in paragraph (d) with respect to each plan whose assets are invested in the account or fund, not less than 30 days prior to implementation of the arrangement or material change thereto, and, where requested, upon the reasonable request of the authorizing fiduciary;
      2. In the event any such authorizing fiduciary submits a notice in writing to the lending fiduciary objecting to the implementation of, material change in, or continuation of the arrangement, the plan on whose behalf the objection was tendered is given the opportunity to terminate its investment in the account or fund, without penalty to the plan, within such time as may he necessary to effect such withdrawal in an orderly manner that is equitable to all withdrawing plans and to the nonwithdrawing plans. In the case of a plan that elects to withdraw pursuant to the foregoing, such withdrawal shall be effected prior to the implementation of, or material change in, the arrangement, but an existing arrangement need not be discontinued by reason of a plan electing to withdraw; and
      3. In the case of a plan whose assets are proposed to be invested in the account or fund subsequent to the implementation of the compensation arrangement and which has not authorized the arrangement in the manner described in paragraphs (f)(1) and (f)(2), the plan's investment in the account or fund shall be authorized in the manner described in paragraph (d)(1).
  3. Definitions
  4. For purposes of this exemption, the term, "affiliate" of another person means:

    1. Any person directly or indirectly, through one or more intermediaries, controlling, controlled by, or under common control with such other person;
    2. Any officer, director, partner, employee, relative (as defined in section 3(15) of the Act) of such other person, and
    3. Any corporation or partnership of which such other person is an officer, director or partner.

    For purposes of this paragraph, the term "control" means the power to exercise a controlling influence over the management or policies of a person other than an individual.

82-87    Residential Mortgage Loans

Prohibited Transaction Class Exemption 82-87
May 18, 1982 (47 FR 21331)

Recap
Residential Mortgages. ERISA plans are permitted to invest in 1-to-4 family mortgages and mortgage participations, collect origination fees, and use affiliates to service the mortgages, subject to certain limitations and conditions. The PTE covers first and second liens on homes, townhouses, condominiums, cooperative apartments, and "manufactured housing". Rental housing is not covered.

Class Exemption for Transactions Involving

Certain Residential Mortgage Financing Arrangements

Agency: Department of Labor.

Action: Grant of class exemption.

Summary: This document contains a final exemption from certain of the prohibited transactions provisions of the Employee Retirement Security Income Act of 1974 (the Act) and the Internal Revenue Code of 1954 (the Code). The exemption involves the issuance of commitments for the provision of mortgage financing to purchasers of residential dwelling units, the receipt of a fee in exchange for the issuance of such commitment, the making or purchase of loans or participation interests therein pursuant to such commitments, and the direct making, purchase, sale, exchange or transfer of mortgage loans or participation interests therein by employee benefit plans, if the conditions specified in the exemption are met. The exemption affects participants and beneficiaries of employee benefit plans involved in such transactions, certain employers who contribute to such plans and other persons who engage in the described transactions. In the absence of this exemption, certain purchase and sale transactions between the plan and parties in interest and certain extensions of credit transactions between the plan and other parties in interest would be prohibited by the Act and the Code.

Effective Date: January 1, 1975. [Certain conditions, as specified herein, are applicable effective June 17, 1982.]

Exemption

  1. Transactions
  2. Accordingly, the following exemption is hereby granted under the authority of section 408(a) of the Act and section 4975(c)(2) of the Code and in accordance with the procedure set forth in ERISA Procedure 75-1.

    Effective January 1, 1975, the restrictions of section 406(a) of the Employee Retirement Income Security Act of 1974 (the Act) and the taxes imposed by section 4975(a) and (b) of the Internal Revenue Code of 1954 (Code) by reason of section 4975(c)(1)(A) through (D) of the Code shall not apply to the following transactions if the conditions set forth in Part II below are met:

    1. The issuance of a commitment by one or more employee benefit plans to provide mortgage financing to purchasers of residential dwelling units, either by making or participating in loans directly to purchasers or by purchasing mortgage loans or participation interests in mortgage loans originated by a third party;
    2. The receipt by the plan of a fee in exchange for issuing such commitment;
    3. The actual making or purchase of a mortgage loan or participation interest therein pursuant to such commitment;
    4. The direct making or purchase by one or more employee benefit plans of a mortgage loan or a participation interest therein other than where a commitment has been issued; and
    5. The sale, exchange or transfer of a mortgage loan or participation interest therein by an employee benefit plan prior to the maturity date of such instrument whether or not acquired pursuant to this exemption, provided that the ownership interest sold, exchanged or transferred represents the plan's entire interest in such investment.
  3. Conditions
    1. Effective January 1, 1975, the exemption provided for transactions described in Part I is available only if each of the following conditions, as applicable, is met:
      1. General Conditions
        1. Any mortgage loan to be acquired must be a "recognized mortgage loan" (as defined in Section D of Part III) or a participation interest in such loan for the purchase of a "residential dwelling unit" (as defined in Section E of Part III)
        2. Any mortgage loan must be originated (either directly for the plan or by the origination-purchase process) by an "established mortgage lender" (as defined in Section B of Part III) -
          1. Who qualifies the recipient, and
          2. As to which neither the plan, nor an employer or group of employers contributing to the plan, nor an employee organization any of whose members are covered by the plan, has the power to exercise a controlling influence over the management or policies of such "established mortgage lender";
        3. The price paid or received by the plan must be at least as favorable to the plan as a similar transaction involving unrelated parties; and
        4. No person who is a developer or a builder involved in the development or construction of the units, or a lender who is associated with the construction financing arrangement for the units, or who, at the time the decision to purchase is made by the plan (whether directly or pursuant to a commitment) is the owner of a mortgage or a participation interest therein which is subsequently sold to the plan, shall have exercised any discretionary authority or control or rendered any investment advice that would make that person a fiduciary with respect to the plan's decision to purchase, or to commit to purchase, a mortgage loan or a participation interest therein or setting the terms thereof.
      2. Specific Conditions Applicable to Commitments. Where the decision by the plan involves a commitment to purchase either a mortgage loan or participation interest therein:
        1. The commitment must be in writing and must be at least as favorable to the plan as a commitment involving unrelated parties and consistent with customary practices in the residential finance industry; and
        2. The commitment must provide for the use of underwriting guidelines and mortgage instruments which will ensure that all mortgage loans originated pursuant to such commitment will result in a "recognized mortgage loan";
      3. Specific Conditions Applicable to Participations Where the acquisition by the plan involves a participation interest in a mortgage loan(s) (whether directly or pursuant to a commitment):
        1. the participation agreement governing such transaction must provide that:
          1. The rights and interests evidenced by such participation interest not be subordinated to the rights and interests of other holders of the same participation agreement,
          2. The majority interest in the participation agreement must be owned by parties independent of and not controlled by the person selling the participation interest and servicing the underlying mortgage(s), and
          3. In the event of an inability to obtain collections on any mortgage loan(s) underlying the participation agreement, decisions regarding foreclosure options must be directed by persons other than the seller/service; and
        2. Such participation agreement must be in writing and must be at least as favorable to the plan as a participation agreement involving unrelated parties and consistent with customary practices in the residential finance industry.
    2. Effective 30 days after date of publication of this notice in the Federal Register the exemption provided for transactions described in Part I is available only if each of the following conditions is satisfied in addition to each of the applicable conditions described in Section A of this Part II:
      1. The decision to purchase or sell the mortgage loan or participation interest therein, or to issue a commitment to do so, must be made on behalf of the plan by a "qualified real estate manager" (as defined in Section C of Part III) as to which neither the plan, nor an employer or group of employers contributing to the plan, nor an employee organization any of whose members are covered by the plan, has the power to exercise a controlling influence over the management or policies of such "qualified real estate manager."
      2. (a) The plan shall maintain for the duration of any loan made pursuant to this exemption records necessary to enable the persons described in paragraph (b) of this subsection to determine whether the conditions of this exemption have been met, except that,
        1. A prohibited transaction will not be deemed to have occurred, if due to circumstances beyond the control of the fiduciaries of the plan, records are lost or destroyed prior to the termination of the loan and,
        2. No party in interest shall be subject to the civil penalty which may be assessed under section 502(i) of ERISA, or to the taxes imposed by section 4975(a) and (b) of the Code, if the records are not maintained or are not available for examination as required by sub-paragraph (b) below.

        (b) Notwithstanding any provisions of subsection (a)(2) and (b) of section 504 of the Act, the records referred to in sub-paragraph (a) of this paragraph must be unconditionally available at their customary location for examination during normal business hours by: any trustee, investment manager, participant or beneficiary of the plan, or any duly authorized employee or representative of such person or of the Department or the Internal Revenue Service.

  4. Definitions.
  5. For purposes of this exemption:

    1. References to persons described in this exemption includes their affiliates. An affiliate is defined as:
      1. Any person directly or indirectly, through one or more intermediaries, controlling, controlled by, or under common control with such person;
      2. Any officer, director, partner, employee or relative (as defined in section 3(15) of the Act) of such person; and
      3. Any corporation or partnership of which such person is an officer, director or partner.
    2. An "established mortgage lender" means an organized business enterprise which has as one of its principal purposes in the normal course of business the origination of loans secured by real estate mortgages or deeds of trust and which has satisfied the qualification requirements of one of the following categories:
      1. Approval by the Secretary of the Department of Housing and Urban Development for participation in any mortgage insurance program under the National Housing Act;
      2. Approval by the Federal National Mortgage Association or the Federal Home Loan Mortgage Corporation as a qualified Seller/Servicer; or
      3. A State agency or independent State authority empowered by State law to raise capital to provide financing for residential dwelling units.
    3. A "qualified real estate manager" means a fiduciary as defined in section 3(21) of the Act who:
      1. Is a financial institution or business organization, which in the normal course of business advises institutional investors regarding investments similar to those in which the plan desires to engage and which are described in Part I of this exemption; and
      2. Acknowledges in writing to the plan that it will make decisions regarding plan investments in mortgage loans or participation interests therein in its capacity as a fiduciary of such plan.
    4. A "recognized mortgage loan" is any mortgage loan on a "residential dwelling unit" which, at the time of its origination, was eligible, through an established program, for purchase by the Federal National Mortgage Association, the Government National Mortgage Association or the Federal Home Loan Mortgage Corporation;
    5. A "residential dwelling unit" or "unit" means:
      1. Owner occupied non-farm property comprising one to four dwelling units, including detached houses, townhouses, manufactured housing, condominiums, units in a housing cooperative, or a unit in a multi unit subdivision (planned unit development) restricted by recorded documents which limit the use of the unit to residential purposes and provide for maintenance of common facilities; or
      2. Certain non-owner occupied units where such unit complies with the uniform underwriting standards required for investor loans to qualify as a "recognized mortgage loan" under this exemption.

    Signed at Washington, D.C. this 13th day of May 1982.

84-14    Qualified Professional Asset Managers (QPAMs)

Prohibited Transaction Class Exemption 84-14
March 13, 1984 (49 FR 9494)

Amendment to PTE-84-14 (80KB PDF file - PDF Help)

[Amended on October 10, 1985 (50 FR 41430)]

Summary
Permits various parties who are related to employee benefit plans to engage in transactions involving plan assets if, among other conditions, the assets are managed by "qualified professional asset managers" (QPAMs), who are independent of the parties in interest and meet specified financial standards.

Additional exemptive relief is provided for: (1) employers to furnish limited amounts of goods and services in the ordinary course of business, and (2) leases of office or commercial space between managed funds and QPAMs or contributing employers.

Includes 1985 Amendment which clarified the term "Affiliate".

Class Exemption 84-14

for Plan Asset Transactions Determined by

Independent Qualified Professional Asset Managers

Agency: Department of Labor

Action: Grant of Class Exemption.

Summary: This document contains a final exemption from certain prohibited transactions restrictions of the Employee Retirement Income Security Act of 1974 (ERISA) and from certain taxes imposed by the Internal Revenue Code of 1954 (the Code). The exemption permits various parties who are related to employee benefit plans to engage in transactions involving plan assets if, among other conditions, the assets are managed by persons, defined for purposes of this exemption as "qualified professional asset managers" (QPAMs), which are independent of the parties in interest and which meet specified financial standards. Additional exemptive relief is provided for employers to furnish limited amounts of goods and services in the ordinary course of business. Limited relief is also provided for leases of office or commercial space between managed funds and QPAMs or contributing employers. The exemption will affect participants and beneficiaries of employee benefit plans, the sponsoring employers of such plans, QPAMs and other persons engaging in the described transactions.

Effective Date: December 21, 1982.

The Explanatory Preamble for the original PTE 84-14, together with the full Amended Exemption, are available in the PREAMBLE document. The Preamble for the Amendment appears in the PREAMBLE documents, immediately following the Amended Exemption.

Amended Exemption

Part I. General Exemption.

Effective December 21, 1982, the restrictions of ERISA section 406(a)(1)(A) through (D) and the taxes imposed by Code section 4975(a) and (b), by reason of Code section 4975(c)(I)(A) through (D), shall not apply to a transaction between a party in interest with respect to an employee benefit plan and an investment fund (as defined in section V(b)) in which the plan has an interest, and which is managed by a qualified professional asset manager (QPAM) (as defined in section V(a)), if the following conditions are satisfied:

  1. At the time of the transaction (as defined in section V(i)) the party in interest, or its affiliate (as defined in section V(c)), does not have, and during the immediately preceding one year has not exercised, the authority to -
    1. Appoint or terminate the QPAM as a manager of any of the plan's assets or
    2. Negotiate the terms of the management agreement with the QPAM (including renewals or modifications thereof) on behalf of the plan;
  2. The transaction is not described in -
    1. Prohibited Transaction Exemption 81-6 (46 FR 7527; January 23, 1981) (relating to securities lending arrangements),
    2. Prohibited Transaction Exemption 83-1 (28 FR 895; January 7, 1983) (relating to acquisitions by plans of interests in mortgage pools), or
    3. Prohibited Transaction Exemption 82-87 (47 FR 21331; May 18,1982) (relating to certain mortgage financing arrangements);
  3. The terms of the transaction are negotiated on behalf of the investment fund by, or under the authority and general direction of, the QPAM, and either the QPAM, or (so long as the QPAM retains full fiduciary responsibility with respect to the transaction) a property manager acting in accordance with written guidelines established and administered by the QPAM, makes the decision on behalf of the investment fund to enter into the transaction, provided that the transaction is not part of an agreement, arrangement or understanding designed to benefit a party in interest;
  4. The party in interest dealing with the investment fund is neither the QPAM nor a person related to the QPAM (within the meaning of section V(h));
  5. The transaction is not entered into with a party in interest with respect to any plan whose assets managed by the QPAM, when combined with the assets of other plans established or maintained by the same employer (or affiliate thereof described in section V(c)(1) of this exemption) or by the same employee organization, and managed by the QPAM, represent more than 20 percent of the total client assets managed by the QPAM at the time of the transaction;
  6. At the time the transaction is entered into, and at the time of any subsequent renewal or modification thereof that requires the consent of the QPAM, the terms of the transaction are at least as favorable to the investment fund as the terms generally available in arm's length transactions between unrelated parties;
  7. Neither the QPAM nor any affiliate thereof (as defined in section V(d)), nor any owner, direct or indirect, of a 5 percent or more interest in the QPAM is a person who within the 10 years immediately preceding the transaction has been either convicted or released from imprisonment, whichever is later, as a result of any felony involving abuse or misuse of such person's employee benefit plan position or employment, or position or employment with a labor organization; any felony arising out of the conduct of the business of a broker, dealer, investment adviser, bank, insurance company or fiduciary; income tax evasion; any felony involving the larceny, theft, robbery, extortion, forgery, counterfeiting, fraudulent concealment, embezzlement, fraudulent conversion, or misappropriation of funds or securities; conspiracy or attempt to commit any such crimes or a crime in which any of the foregoing crimes is an element; or any other crime described in section 411 of ERISA. For purposes of this section (g), a person shall be deemed to have been "convicted" from the date of the judgment of the trial court, regardless of whether that judgment remains under appeal.

Part II. Specific Exemptions for Employers.

Effective December 21, 1982, the restrictions of sections 406(a)406(b)(1) and 407(a) of ERISA and the taxes imposed by section 4975(a) and (b) of the Code, by reason of Code section 4975(e)(1)(A) through (E), shall not apply to:

  1. The sale, leasing, or servicing of goods (as defined in section V(j)), or to the furnishing of services, to an investment fund managed by a QPAM by a party in interest with respect to a plan having an interest in the fund, if -
    1. The party in interest is an employer any of whose employees are covered by the plan or is a person who is a party in interest by virtue of a relationship to such an employer described in section V(c),
    2. The transaction is necessary for the administration or management of the investment fund,
    3. The transaction takes place in the ordinary course of a business engaged in by the party in interest with the general public,
    4. Effective for taxable years of the party in interest furnishing goods and services after the date this exemption is granted, the amount attributable in any taxable year of the party in interest to transactions engaged in with an investment fund pursuant to section II(a) of this exemption does not exceed one (1) percent of the gross receipts derived from all sources for the prior taxable year of the party in interest, and
    5. The requirements of sections I(c) through (g) are satisfied with respect to the transaction;
  2. The leasing of office or commercial space by an investment fund managed by a QPAM to a party in interest with respect to a plan having an interest in the investment fund, if -
    1. The party in interest is an employer any of whose employees are covered by the plan or is a person who is a party in interest by virtue of a relationship to such an employer described in section V(c),
    2. No commission or other fee is paid by the investment fund to the QPAM or to the employer, or to an affiliate of the QPAM or employer (as defined in section V(c)), in connection with the transaction,
    3. Any unit of space leased to the party in interest by the investment fund is suitable (or adaptable without excessive cost) for use by different tenants,
    4. The amount of space covered by the lease does not exceed fifteen (15) percent of the rentable space of the office building, integrated office park, or of the commercial center (if the lease does not pertain to office space),
    5. In the case of a plan that is not an eligible individual account plan (as defined in section 407(d)(3) of ERISA), immediately after the transaction is entered into, the aggregate fair market value of employer real property and employer securities held by investment funds of the QPAM in which the plan has an interest does not exceed 10 percent of the fair market value of the assets of the plan held in those investment funds. In determining the aggregate fair market value of employer real property and employer securities as described herein, a plan shall be considered to own the same proportionate undivided interest in each asset of the investment fund or funds as its proportionate interest in the total assets of the investment fund(s). For purposes of this requirement, the term "employer real property" means real property leased to, and the term "employer securities" means securities issued by, an employer any of whose employees are covered by the plan or a party in interest of the plan by reason of a relationship to the employer described in subparagraphs (E) or (G) of ERISA section 3(14), and
    6. The requirements of sections I(c) through (g) are satisfied with respect to the transaction.

Part III. Specific Lease Exemption for QPAMs.

Effective December 21, 1982, the restrictions of section 406(a)(1)(A) through (D) and 406(b)(1) and (2) of ERISA and the taxes imposed by Code section 4975(a) and (b), by reason of Code section 4975(c)(1)(A) through (E), shall not apply to the leasing of office or commercial space by an investment fund managed by a QPAM to the QPAM, a person who is a party in interest of a plan by virtue of a relationship to such QPAM described in subparagraphs (G), (H), or (I) of ERISA section 3(14) or a person not eligible for the General Exemption of Part I by reason of section I(a), if -

  1. The amount of space covered by the lease does not exceed the greater of 7500 square feet or one (1) percent of the rentable space of the office building, integrated office park or of the commercial center in which the investment fund has the investment,
  2. The unit of space subject to the lease is suitable (or adaptable without excessive cost) for use by different tenants,
  3. At the time the transaction is entered into, and at the time of any subsequent renewal or modification thereof that requires the consent of the QPAM, the terms of the transaction are not more favorable to the lessee than the terms generally available in arm's length transactions between unrelated parties, and
  4. No commission or other fee is paid by the investment fund to the QPAM, any person possessing the disqualifying, powers described in section I(a), or any affiliate of such persons (as defined in section V(c)), in connection with the transaction.

Part IV. Transactions Involving Places of Public Accommodation.

Effective December 21, 1982, the restrictions of section 406(a)(1)(A) through (D) and 406(b)(1) and (2) of ERISA and the taxes imposed by Code section 4975(a) and (b), by reason of Code section 4975(c)(1)(A) through (E), shall not apply to the furnishing of services and facilities (and goods incidental thereto) by a place of public accommodation owned by an investment fund managed by a QPAM to a party in interest with respect to a plan having an interest in the investment fund, if the services and facilities (and incidental goods) are furnished on a comparable basis to the general public.

Part V. Definitions and General Rules.

For the purposes of this exemption:

  1. The term "qualified professional asset manager" or "QPAM" means -
    1. A bank, as described in section 202(a)(2) of the Investment Advisers Act of 1940 that has the power to manage, acquire or dispose of assets of a plan, which bank has, as of the last day of its most recent fiscal year, equity capital (as defined in section V(k)) in excess of $1,000,000, or
    2. A savings and loan association, the accounts of which are insured by the Federal Savings and Loan Insurance Corporation, that has made application for and been granted trust powers to manage, acquire or dispose of assets of a plan by a State or Federal authority having supervision over savings and loan associations, which savings and loan association has, as of the last day of its most recent fiscal year, equity capital (as defined in section V(k)) or net worth (as defined in section V(I)) in excess of $1,000,000, or
    3. An insurance company which is qualified under the laws of more than one State to manage, acquire, or dispose of any assets of a plan, which company has, as of the last day of its most recent fiscal year, net worth (as defined in section V(I)) in excess of $1,000,000 and which is subject to supervision and examination by a State authority having supervision over insurance companies, or
    4. An investment adviser registered under the Investment Advisers Act of 1940 that has, as of the last day of its most recent fiscal year, total client assets under its management and control in excess of $50,000,000, and either (A) shareholders' or partners' equity (as defined in section V(m)) in excess of $750,000, or (B) payment of all of its liabilities including any liabilities that may arise by reason of a breach or violation of a duty described in sections 404 or 406 of ERISA is unconditionally guaranteed by -
      1. A person with a relationship to such investment adviser described in section V(c)(l) if the investment adviser and such affiliate have, as of the last day of their most recent fiscal year, shareholders' or partners' equity, in the aggregate, in excess of $750,000, or
      2. A person described in (a)(1), (a)(2) or (a)(3) of section V above, or
      3. A broker-dealer registered under the Securities Exchange Act of 1934 that has, as of the last day of its most recent fiscal year, net worth in excess of $750,000;

    Provided that such bank, savings and loan association, insurance company or investment adviser has acknowledged in a written management agreement that it is a fiduciary with respect to each plan that has retained the QPAM.

  2. An "investment fund" includes single customer and pooled separate accounts maintained by an insurance company, individual trusts and common, collective or group trusts maintained by a bank, and any other account or fund to the extent that the disposition of its assets (whether or not in the custody of the QPAM) is subject to the discretionary authority of the QPAM.
  3. For purposes of section I(a) and Part II, and "affiliate" of a person means -
    1. Any person directly or indirectly, through one or more intermediaries, controlling, controlled by, or under common control with the person,
    2. Any corporation, partnership, trust or unincorporated enterprise of which such person is an officer, director, 5 percent or more partner, or employee (but only if the employer of such employee is the plan sponsor), and
    3. Any director of the person or any employee of the person who is a highly compensated employee, as defined in section 4975(e)(2)(H) of the Code, or who has direct or indirect authority, responsibility or control regarding the custody, management or disposition of plan assets. A named fiduciary (within the meaning of section 402(a)(2) of ERISA) of a plan and an employer any of whose employees are covered by the plan will also be considered affiliates with respect to each other for purposes of section I(a) if such employer or an affiliate of such employer has the authority, alone or shared with others, to appoint or terminate the named fiduciary or otherwise negotiate the terms of the named fiduciary's employment agreement.
  4. For purposes of section I(g) an "affiliate" of a person means -
    1. Any person directly or indirectly through one or more intermediaries, controlling, controlled by, or under common control with the person,
    2. Any director of, relative of, or partner in, any such person,
    3. Any corporation, partnership, trust or unincorporated enterprise of which such person is an officer, director, or a 5 percent or more partner or owner, and
    4. Any employee or officer of the person who -
      1. Is a highly compensated employee (as defined in section 4975(e)(2)(H) of the Code) or officer (earning 10 percent or more of the yearly wages of such person), or
      2. Has direct or indirect authority, responsibility or control regarding the custody, management or disposition of plan assets.
  5. The term "control" means the power to exercise a controlling influence over the management or policies of a person other than an individual.
  6. The term "party in interest" means a person described in ERISA section 3(14) and includes a "disqualified person," as defined in Code section 4975(e)(2).
  7. The term "relative" means a relative as that term is defined in ERISA section 3(15), or a brother, a sister, or a spouse of a brother or sister.
  8. A QPAM is "related" to a party in interest for purposes of section I(d) of this exemption if the party in interest (or a person controlling, or controlled by, the party in interest) owns a five percent or more interest in the QPAM or if the QPAM (or a person controlling, or controlled by, the QPAM) owns a five percent or more interest in the party in interest. For purposes of this definition:
    1. The term "interest" means with respect to ownership of an entity -
      1. The combined voting power of all classes of stock entitled to vote or the total value of the shares of all classes of stock of the entity if the entity is a corporation,
      2. The capital interest or the profits interest of the entity if the entity is a partnership, or
      3. The beneficial interest of the entity if the entity is a trust or unincorporated enterprise; and
    2. A person is considered to own an interest held in any capacity if the person has or shares the authority -
      1. To exercise any voting rights or to direct some other person to exercise the voting rights relating to such interest, or
      2. To dispose or to direct the disposition of such interest.
    3. The time as of which any transaction occurs is the date upon which the transaction is entered into. In addition, in the case of a transaction that is continuing, the transaction shall be deemed to occur until it is terminated. If any transaction is entered into on or after December 21, 1982, or a renewal that requires the consent of the QPAM occurs on or after December 21, 1982 and the requirements of this exemption are satisfied at the time the transaction is entered into or renewed, respectively, the requirements will continue to be satisfied thereafter with respect to the transaction. Notwithstanding the foregoing, this exemption shall cease to apply to a transaction exempt by virtue of Part I or Part II at such time as the percentage requirement contained in section I(e) is exceeded, unless no portion of such excess results from an increase in the assets transferred for discretionary management to a QPAM. For this purpose, assets transferred do not include the reinvestment of earnings attributable to those plan assets already under the discretionary management of the QPAM. Nothing in this paragraph shall be construed as exempting a transaction entered into by an investment fund which becomes a transaction described in section 406 of ERISA or section 4975 of the Code while the transaction is continuing, unless the conditions of this exemption were met either at the time the transaction was entered into or at the time the transaction would have become prohibited but for this exemption.
    4. The term "goods" includes all things which are movable or which are fixtures used by an investment fund but does not include securities, commodities, commodities futures, money, documents, instruments, accounts, chattel paper, contract rights and any other property, tangible or intangible, which, under the relevant facts and circumstances, is held primarily for investment.
    5. For purposes of section V(a)(1) and (2), the term "equity capital" means stock (common and preferred), surplus, undivided profits, contingency reserves and o her capital reserves.
    6. For purposes of section V(a)(3), the term "net worth" means capital, paid-in and contributed surplus, unassigned surplus, contingency reserves, group contingency reserves, and special reserves.
    7. For purposes of section V(a)(4), the term "shareholders' or partners' equity" means the equity shown in the most recent balance sheet prepared within the two years immediately preceding a transaction undertaken pursuant to this exemption, in accordance with generally accepted accounting principles.

86-128    Securities Transactions Involving Employee Benefit Plans and Broker-Dealers

Prohibited Transaction Class Exemption 86-128
November 18, 1986 (51 FR 41686)

Replaces Temporary PTE 79-9, March 23, 1979 (44 FR 17819)

Recap
Securities Transactions with Brokers. Permits use of affiliated brokerage services under certain conditions. Also covers collective investment fund transactions.

Class Exemption Covering Securities Transactions with Brokers

Explanatory Preamble to PTE 86-128 (Excerpt)

Agency: Department of Labor.

Action: Grant of class exemption.

Summary: This document contains an exemption which allows persons who serve as fiduciaries for employee benefit plans to effect or execute securities transactions under certain circumstances. The exemption also allows sponsors of pooled separate accounts and other pooled investment funds to use their affiliates to effect or execute securities transactions for such accounts when certain conditions are met. The exemption will replace Prohibited Transaction Exemption 79-1 and Prohibited Transaction Exemption 84-46. It affects participants and beneficiaries of, and fiduciaries with respect to, employee benefit plans which invest in securities, and other persons who engage in the described transactions.

Effective Date: The later of December 18, 1986, or the date on which the Office of Management and Budget approves the information collection requests contained in this exemption under the Paperwork Reduction Act of 1980.

Exemption

In accordance with section 408(a) of the Act and section 4975(c)(2) of the Code, and based upon the entire record including the written comments submitted in response to the notice of January 24, 1985, the Department makes the following determinations:

  1. The class exemption set forth herein is administratively feasible;
  2. It is in the interests of plans and of their participants and beneficiaries; and
  3. It is protective of the rights of participants and beneficiaries of plans.

Accordingly, the following exemption is hereby granted 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.

Section I - Definitions and Special Rules

The following definitions and special rules apply to this exemption:

  1. The term "person" includes the person and affiliates of the person.
  2. An "affiliate" of a person includes the following:
    1. Any person directly or indirectly controlling, controlled by, or under common control with, the person
    2. Any officer, director, partner, employee, relative (as defined in section 3(15) of ERISA), brother, sister, or spouse of a brother or sister, of the person;
    3. Any corporation or partnership of which the person is an officer, director or partner.

    A person is not an affiliate of another person solely because one of them has investment discretion over the other's assets. The term "control" means the power to exercise a controlling influence over the management or policies of a person other than an individual.

  3. An "agency cross transaction" is a securities transaction in which the same person acts as agent for both any seller and any buyer for the purchase or sale of a security.
  4. The term "covered transaction" means an action described in section II(a), (b) or (c) of this exemption.
  5. The term "effecting or executing a securities transaction" means the execution of a securities transaction as agent for another person and/or the performance of clearance, settlement, custodial or other functions ancillary thereto.
  6. A plan fiduciary is independent of a person only if the fiduciary has no relationship to or interest in such person that might affect the exercise of such fiduciary's best judgment as a fiduciary.
  7. The term "profit" includes all charges relating to effecting or executing securities transactions, less reasonable and necessary expenses including reasonable indirect expenses (such as overhead costs) properly allocated to the performance of these transactions under generally accepted accounting principles.
  8. The term "securities transaction" means the purchase or sale of securities.
  9. The term "nondiscretionary trustee" of a plan means a trustee or custodian whose powers and duties with respect to any assets of the plan are limited to -
    1. The provision of nondiscretionary trust services to the plan, and
    2. Duties imposed on the trustee by any provision or provisions of the Act or the Code.

    The term "nondiscretionary trust services" means custodial services and services ancillary to custodial services, none of which services are discretionary. For purposes of this exemption, a person does not fail to be a nondiscretionary trustee solely by reason of having been delegated, by the sponsor of a master or prototype plan, the power to amend such plan.

Section II - Covered Transactions

Effective the later of December 18, 1986, or the date on which the Office of Management and Budget approves the information collection requests contained in this exemption under the Paperwork Reduction Act of 1980, if each condition of section III of this exemption is either satisfied or not applicable under section IV, the restrictions of section 406(b) of ERISA and the taxes imposed by sections 4975(a) and (b) of the Code by reason of section 4975(c)(1)(E) or (F) of the Code shall not apply to:

  1. A plan fiduciary's using its authority to cause a plan to pay a fee for effecting or executing securities transactions to that person as agent for the plan, but only to the extent that such transactions are not excessive, under the circumstances, in either amount or frequency;
  2. A plan fiduciary's acting as the agent in an agency cross transaction for both the plan and one or more other parties to the transaction; or
  3. The receipt by a plan fiduciary of reasonable compensation for effecting or executing an agency cross transaction to which a plan is a party from one or more other parties to the transaction.

Section III - Conditions

Except to the extent otherwise provided in section IV of this exemption, section II of this exemption applies only if the following conditions are satisfied:

  1. The person engaging in the covered transaction is not a trustee (other than a nondiscretionary trustee) or an administrator of the plan, or an employer any of whose employees are covered by the plan.
  2. The covered transaction is performed under a written authorization executed in advance by a fiduciary of each plan whose assets are involved in the transaction, which plan fiduciary is independent of the person engaging in the covered transaction.
  3. The authorization referred to in paragraph (b) of this section is terminable at will by the plan, without penalty to the plan, upon receipt by the authorized person of written notice of termination. A form expressly providing an election to terminate the authorization described in paragraph (b) of this section with instructions on the use of the form must be supplied to the authorizing fiduciary no less than annually. The instructions for such form must include the following information:
    1. The authorization is terminable at will by the plan, without penalty to the plan, upon receipt by the authorized person of written notice from the authorizing fiduciary or other plan official having authority to terminate the authorization; and
    2. Failure to return the form will result in the continued authorization of the authorized person to engage in the covered transactions on behalf of the plan.
  4. Within three months before an authorization is made, the authorizing fiduciary is furnished with any reasonably available information that the person seeking authorization reasonably believes to be necessary for the authorizing fiduciary to determine whether the authorization should be made, including (but not limited to) a copy of this exemption, the form for termination of authorization described in section III(c), a description of the person's brokerage placement practices, and any other reasonably available information regarding the matter that the authorizing fiduciary requests.
  5. The person engaging in a covered transaction furnishes the authorizing fiduciary with either:
    1. A confirmation slip for each securities transaction underlying a covered transaction within ten business days of the securities transaction containing the information described in Rule 10b-10(a)(1-7) under Securities Exchange Act of 1934, 17 C.F.R. 240.10b-10; or
    2. At least once every three months and not later than 45 days following the period to which it relates, a report disclosing:
      1. A compilation of the information that would be provided to the plan pursuant to subparagraph (e)(1) of this section during the three-month period covered by the report;
      2. The total of all securities transaction-related charges incurred by the plan during such period in connection with such covered transactions; and
      3. The amount of the securities transaction-related charges retained by such person and the amount of such charges paid to other persons for execution or other services.

    For purposes of this paragraph (e), the words "incurred by the plan" shall be construed to mean "incurred by the pooled fund" when such person engages in covered transactions on behalf of a pooled fund in which the plan participates.

  6. The authorizing fiduciary is furnished with a summary of the information required under paragraph (e)(1) of this section at least once per year. The summary must be furnished within 45 days after the end of the period to which it relates, and must contain the following:
    1. The total of all securities transaction-related charges incurred by the plan during the period in connection with covered securities transactions.
    2. The amount of the securities transaction-related charges retained by the authorized person and the amount of these charges paid to other persons for execution or other services.
    3. A description of the person's brokerage placement practices, if such practices have materially changed during the period covered by the summary.
    4. A portfolio turnover ratio, calculated in a manner which is reasonably designed to provide the authorizing fiduciary with the information needed to assist in discharging its duty of prudence. The requirements of this paragraph (f)(4)(i) will be met if the "annualized portfolio turnover ratio", calculated in the manner described in paragraph (f)(4)(ii), is contained in the summary.
      1. The "annualized portfolio turnover ratio" shall be calculated as a percentage of the plan assets consisting of securities or cash over which the authorized person had discretionary investment authority, or with respect to which such person rendered, or had any responsibility to render, investment advice (the "portfolio") at any time or times ("management period(s)") during the period covered by the report. First, the "portfolio turnover ratio" (not annualized) is obtained by dividing (A) the lesser of the aggregate dollar amounts of purchases or sales of portfolio securities during the management period(s) by (B) the monthly average of the market value of the portfolio securities during all management period(s). Such monthly average is calculated by totaling the market values of the portfolio securities as of the beginning and end of each management period and as of the end of each month that ends within such period(s), and dividing the sum by the number of valuation dates so used. For purposes of this calculation, all debt securities whose maturities at the time of acquisition were one year or less are excluded from both the numerator and the denominator.
      2. The "annualized portfolio turnover ratio" is then derived by multiplying the "portfolio turnover ratio" by an annualizing factor. The annualizing factor is obtained by dividing (C) the number twelve by (D) the aggregate duration of the management period(s) expressed in months (and fractions thereof).

        Examples of the use of this formula are provided in section V of this exemption.

      3. The information described in this paragraph (f)(4) is not required to be furnished in any case where the authorized person has not exercised discretionary authority over trading in the plan's account during the period covered by the report.

    For purposes of this paragraph (f), the words "incurred by the plan" shall be construed to mean "incurred by the pooled fund" when such person engages in covered transactions on behalf of a pooled fund in which the plan participates.

  7. If an agency cross transaction to which section IV(b) does not apply is involved, the following conditions must also be satisfied:
    1. The information required under section III(d) or IV(d)(1)(B) of this exemption includes a statement to the effect that with respect to agency cross transactions the person effecting or executing the transactions will have a potentially conflicting division of loyalties and responsibilities regarding the parties to the transactions;
    2. The summary required under section III(f) of this exemption includes a statement identifying the total number of agency cross transactions during the period covered by the summary and the total amount of all commissions or other remuneration received or to be received from all sources by the person engaging in the transactions in connection with those transactions during the period;
    3. The person effecting or executing the agency cross transaction has the discretionary authority to act on behalf of, and/or provide investment advice to, either (A) one or more sellers or (B) one or more buyers with respect to the transaction, but not both.
    4. The agency cross transaction is a purchase or sale, for no consideration other than cash payment against prompt delivery of a security for which market quotations are readily available; and
    5. The agency cross transaction is executed or effected at a price that is at or between the independent bid and independent ask prices for the security prevailing at the time of the transaction.

Section IV - Exceptions from conditions

  1. Certain plans not covering employees. Section III of this exemption does not apply to covered transactions to the extent they are engaged in on behalf of individual retirement accounts meeting the conditions of 29 C.F.R. 2510.3-2(d), or plans, other than training programs, that cover no employees within the meaning of 29 C.F.R. 2510.3-3.
  2. Certain agency cross transactions. Section III of this exemption does not apply in the case of an agency cross transaction, provided that the person effecting or executing the transaction:
    1. Does not render investment advice to any plan for a fee within the meaning of section 3(21)(A)(ii) of ERISA with respect to the transaction;
    2. Is not otherwise a fiduciary who has investment discretion with respect to any plan assets involved in the transaction, see 29 C.F.R. 2510.3-21(d); and
    3. Does not have the authority to engage, retain or discharge any person who is or is proposed to be a fiduciary regarding any such plan assets.
  3. Recapture of profits. Section III(a) of this exemption does not apply in any case where the person engaging in a covered transaction returns or credits to the plan all profits earned by that person in connection with the securities transactions associated with the covered transaction.
  4. Special rules for pooled funds. In the case of a person engaging in a covered transaction on behalf of an account or fund for the collective investment of the assets of more than one plan (pooled fund):
    1. Sections III(b), (c) and (d) of this exemption do not apply if -
      1. The arrangement under which the covered transaction is performed is subject to the prior and continuing authorization, in the manner described in this paragraph (d)(1), of a plan fiduciary with respect to each plan whose assets are invested in the pooled fund who is independent of the person. The requirement that the authorizing fiduciary be independent of the person shall not apply in the case of a plan covering only employees of the person, if the requirements of section IV(d)(2)(A) and (B) are met.
      2. The authorizing fiduciary is furnished with any reasonably available information that the person engaging or proposing to engage in the covered transactions reasonably believes to be necessary to determine whether the authorization should be given or continued, not less than 30 days prior to implementation of the arrangement or material change thereto, including (but not limited to) a description of the person's brokerage placement practices, and, where requested, any reasonably available information regarding the matter upon the reasonable request of the authorizing fiduciary at any time.
      3. In the event an authorizing fiduciary submits a notice in writing to the person engaging in or proposing to engage in the covered transaction objecting to the implementation of, material change in, or continuation of, the arrangement, the plan on whose behalf the objection was tendered is given the opportunity to terminate its investment in the pooled fund, without penalty to the plan, within such time as may be necessary to effect the withdrawal in an orderly manner that is equitable to all withdrawing plans and to the nonwithdrawing plans. In the case of a plan that elects to withdraw under this subparagraph (d)(1)(C), the withdrawal shall be effected prior to the implementation of, or material change in, the arrangement; but an existing arrangement need not be discontinued by reason of a plan electing to withdraw.
      4. In the case of a plan whose assets are proposed to be invested in the pooled fund subsequent to the implementation of the arrangement and that has not authorized the arrangement in the manner described in subparagraphs (d)(1)(B) and (C) of this section, the plan's investment in the pooled fund is subject to the prior written authorization of an authorizing fiduciary who satisfies the requirements of subparagraph (d)(1)(A).
  5. Section III(a) of this exemption, to the extent that it prohibits the person from being the employer of employees covered by a plan investing in a pool managed by the person does not apply if -
    1. The person is an "investment manager" as defined in section 3(38) of ERISA, and
    2. Either (i) the person returns or credits to the pooled fund all profits earned by the person in connection with all covered transactions engaged in by the person on behalf of the fund, or (ii) the pooled fund satisfies the requirements of paragraph IV(d)(3).
  6. A pooled fund satisfies the requirements of this paragraph for a fiscal year of the fund if -
    1. On the first day of such fiscal year, and immediately following each acquisition of an interest in the pooled fund during the fiscal year by any plan covering employees of the person, the aggregate fair market value of the interests in such fund of all plans covering employees of the person does not exceed twenty percent of the fair market value of the total assets of the fund; and
    2. The aggregate brokerage commissions received by the person, in connection with covered transactions engaged in by the person on behalf of all pooled funds in which a plan covering employees of the person participates, do not exceed five percent of the total brokerage commissions received by the person from all sources in such fiscal year.

Section V - Examples illustrating the use of the annualized portfolio turnover ratio described in Section III(F)(4)(ii)

(Note: This section containing examples has been omitted.)

Section VI - Effective dates and Transitional Rule

  1. This exemption will be effective on the later of December 18, 1986, or the date on which the Office of Management and Budget approves the information collection requests contained in this exemption under the Paperwork Reduction Act of 1980.
  2. PTE 79-1 and PTE 84-46 are revoked effective April 1, 1987.

91-38    Bank Collective Investment Funds

Prohibited Transaction Class Exemption 91-38
July 12, 1991 (56 FR 31966)

Summary
Replaces PTE 80-51. Permits investment in collective investment funds operated by bank fiduciaries, subject to certain limitations and conditions. 5% limitations of PTE 80-51 replaced by 10%.

Class Exemption

Amendment to Prohibited Transaction Exemption (PTE) 80-51

Involving Bank Collective Investment Funds

Agency: Pension and Welfare Benefits Administration, Labor Department.

Internal Revenue Service.

Action: Adoption of amendment to PTE 80-51, and redesignation as PTE 91-38.

Summary: This document amends PTE 80-51, a class exemption that permits Bank Collective Investment Funds, in which employee benefit plans have an interest, to engage in certain transactions, provided specified conditions are met. The amendment affects, among others, participants, beneficiaries and fiduciaries of plans that invest in the collective investment funds, banks, and other persons engaging in the described transactions.

Effective Date: The amendment to section I(a)(1)(A) of PTE 80-51 is effective as of July 1, 1990.

Exemption

For the sake of convenience, the entire text of PTE 80-51, as amended, has been reprinted with this notice. The Department has redesignated the exemption as PTE 91-38.

Section I - Exemption for Certain Transactions Involving Bank Collective Investment Funds

  1. Effective January 1, 1975, the restrictions of sections 406(a)406(b)(2) and 407(a) of the Act and the taxes imposed by section 4975(a) and (b) of the Code by reason of section 4975(c)(1)(A), (B), (C) or (D) of the Code, shall not apply to the transactions described below if the applicable conditions set forth in section III are met.
    1. Transactions between parties in interest and bank collective investment funds: General. Any transaction between a party in interest with respect to a plan and a collective investment fund that is maintained by a bank and in which the plan has an interest, or any acquisition or holding by the collective investment fund of employer securities or employer real property, if the party in interest is not the bank that maintains the collective investment fund, any other collective fund maintained by the bank or any affiliate of the bank, and if, at the time of the transaction, acquisition or holding, either -
      1. The interest of the plan together with the interests of any other plans maintained by the same employer or employee organization in the collective investment fund does not exceed -
        1. 10 percent of the total of all interests in the collective investment fund, if the transaction occurs prior to October 23, 1980; or
        2. 5 percent of the total of all assets in the collective investment fund, if the transaction occurs on or after October 23, 1980, and on or before June 30, 1990; or
        3. 10 percent of the total of all assets in the collective investment fund, if the transaction occurs on or after July 1, 1990; or
      2. The collective investment fund is a specialized fund that has a policy of investing, and invests, substantially all of its assets in short-term obligations (having a stated maturity date of one year or less or having a maturity date of one year or less from the date of acquisition by such specialized fund), including but not necessarily limited to --
        1. Corporate or governmental obligations or related repurchase agreements;
        2. Certificates of deposit;
        3. Bankers' acceptances; or
        4. Variable amount notes of borrowers of prime credit.
    2. Special transactions not meeting the criteria of section I(a)(1)(A) between employers of employees covered by a multiple employer plan and collective investment funds. Any transaction between an employer (or an affiliate of an employer) of employees covered by a multiple employer plan and a collective investment fund maintained by a bank in which the plan has an interest, or any acquisition or holding by the collective investment fund of employer securities or employer real property, if at the time of the transaction, acquisition or holding --
      1. In the case of a transaction occurring prior to October 23, 1980, the employer is not a "substantial employer" with respect to the plan (within the meaning of section 4001(a)(2) of the Act); or
      2. In the case of a transaction occurring on or after October 23, 1980:
        1. The interest of the multiple employer plan in the collective investment fund does not exceed 10 percent of the total assets in the collective investment fund, and the employer is not a "substantial employer" with respect to the plan (within the meaning of section 4001(a)(2) of the Act); or
        2. The interest of the multiple employer plan in the collective investment fund exceeds 10 percent of the total assets in the collective investment fund, but the employer is not a "substantial employer" with respect to the plan and would not be a "substantial employer" within the meaning of section 4001(a)(2) of the Act if "5 percent" were substituted for "10 percent" in that definition.
    3. Acquisition, sale or holding of employer securities and employer real property.
      1. Except as provided in subsection (B) of this section (3), any acquisition, sale or holding of employer securities and any acquisition, sale or holding of employer real property by a collective investment fund in which a plan has an interest and which does not meet the requirements of paragraphs (a)(1) and (a)(2) of this section, if no commission is paid to the bank or to the employer or any affiliate of the bank or the employer in connection with the acquisition or sale of employer securities or the acquisition, sale or lease of employer real property; and
        1. In the case of employer real property -
        2. (aa) Each parcel of employer real property and the improvements thereon held by the collective investment fund are suitable (or adaptable without excessive cost) for use by different tenants, and

          (bb) The property of the collective investment fund that is leased or held for lease to others, in the aggregate, is dispersed geographically.

        3. In the case of employer securities -
        4. (aa) The bank in whose collective investment fund the security is held is not an affiliate of the issuer of the security, and

          (bb) If the security is an obligation of the issuer, either

      2. In the case of a plan that is not an eligible individual account plan (as defined in section 407(d)(3) of the Act), the exemption provided in subsection (A) of this paragraph (3) shall be available only if, immediately after the acquisition of the securities or real property, the aggregate fair market value of employer securities and employer real property with respect to which the bank has investment discretion does not exceed 10 percent of the fair market value of all the assets of the plan with respect to which the bank has such investment discretion.
      3. For the purposes of the exemption contained in subsection (A) of this section (3), the term "employer securities" shall include securities issued by, and the term "employer real property" shall include real property leased to, a person who is a party in interest with respect to a plan (participating in the collective investment fund) by reason of a relationship to the employer described in section 3(14) (E), (G), (H) or (I) of the Act.
    4. The collective investment fund owns the obligation at the time the plan acquires an interest in the collective investment fund, and interests in the collective fund are offered and redeemed in accordance with valuation procedures of the collective investment fund applied on a uniform or consistent basis, or
    5. Immediately after acquisition of the obligation: (a) Not more than 25 percent of the aggregate amount of obligations issued in the issue and outstanding at the time of acquisition is held by such plan, and (b) in the case of an obligation that is a restricted security within the meaning of rule 144 under the Securities Act of 1933, at least 50 percent of the aggregate amount of obligations issued in the issue and outstanding at the time of acquisition is held by persons independent of the issuer. The bank, its affiliates and any collective investment fund maintained by the bank shall be considered to be persons independent of the issuer if the bank is not an affiliate of the issuer.
  2. Effective January 1, 1975, the restrictions of section 406(a)(1) (A), (B), (C) and (D) and section 406(b) (1) and (2) of the Act and the taxes imposed by section 4975 (a) and (b) of the Code by reason of section 4975(c)(1) (A), (B), (C), (D) or (E) of the Code, shall not apply to the transactions described below, if the conditions of section III are met.
    1. Transactions with persons who are parties in interest with respect to the plan solely by virtue of being certain service providers or certain affiliates of service providers. Any transaction between a collective investment fund and a person who is a party in interest with respect to a plan that has an interest in the collective investment fund, if --
      1. The person is a party in interest (including a fiduciary) solely by reason of providing services to the plan, or solely by reason of a relationship to a service provider described in section 3(14) (F), (G), (H) or (I) of the Act, or both and the person neither exercised nor has any discretionary authority, control, responsibility or influence with respect to the investment of plan assets in, or held by, the collective investment fund, and
      2. The person is not an affiliate of the bank maintaining the collective investment fund.
    2. Certain leases and goods. The furnishing of goods to a collective investment fund by a party in interest with respect to a plan participating in the collective investment fund, or the leasing of real property owned by the collective investment fund to such party in interest and the incidental furnishing of goods to such party in interest by the collective investment fund, if--
      1. In the case of goods, they are furnished to or by the collective investment fund in connection with real property owned by the collective investment fund;
      2. The party in interest is not the bank maintaining the collective investment fund, or any affiliate of the bank, or any other collective investment fund maintained by the bank; and
      3. The amount involved in the furnishing of goods or leasing of real property in any calendar year (including the amount under any other lease or arrangement for the furnishing of goods in connection with the real property investments of the collective investment fund with the same party in interest or any affiliate thereof) does not exceed the greater of $25,000 or 0.5 percent of the fair market value of the assets of the collective investment fund on the most recent valuation date of the fund prior to the transaction.
    3. Management of real property. Any services provided to a collective investment fund in which a plan has an interest by the bank maintaining that fund or by an affiliate of that bank in connection with the management of the real property owned by the collective investment fund, if the compensation paid to the bank or its affiliate does not exceed the cost of the services to the bank or its affiliate.
    4. Transactions involving places of public accommodation. The furnishing of services, facilities and any goods incidental to such services and facilities by a place of public accommodation owned by a bank collective investment fund, to a party in interest with respect to a plan, which plan has an interest in the collective investment fund, if the services, facilities and incidental goods are furnished on a comparable basis to the general public.

Section II - Excess Holdings Exemption for Employee Benefit Plans

  1. Effective January 1, 1975, the restrictions of sections 406(a)406(b)(2) and 407(a) of the Act and the taxes imposed by section 4975(a) and (b) of the Code by reason of section 4975(c)(1)(A), (B), (C) or (D) of the Code shall not apply to any acquisition or holding of qualifying employer securities or qualifying employer real property (other than through a collective investment fund), if -
    1. The acquisition or holding contravenes the restrictions of sections 406(a)(1)(E)406(a)(2) and 407(a) of the Act solely by reason of being aggregated with employer securities or employer real property held by a collective investment fund in which the plan has an interest;
    2. The requirements of either paragraph (a)(1) or paragraph (a)(2) of section I of this exemption are met; and
    3. The applicable conditions set forth in section III of this exemption are met.

Section III - General conditions

  1. At the time the transaction is entered into, and at the time of any subsequent renewal thereof that requires the consent of the bank, the terms of the transaction are not less favorable to the collective investment fund than the terms generally available in arm's-length transactions between unrelated parties.
  2. The bank maintains for a period of six years from the date of the transaction, the records necessary to enable the persons described in paragraph (c) of this section to determine whether the conditions of this exemption have been met, except that -
    1. a prohibited transaction will not be considered to have occurred if, due to circumstances beyond the bank's control, the records are lost or destroyed prior to the end of the six-year period; and
    2. no party in interest other than the bank shall be subject to the civil penalty that may be assessed under 502(i) of the Act, or to the taxes imposed by section 4975(a) and (b) of the Code, if the records are not maintained, or are not available for examination as required by paragraph (c) below.
  3. (1) Except as provided in subsection 2 of this paragraph and notwithstanding any provisions of subsections (a)(2) and (b) of section 504 of the Act, the records referred to in paragraph (b) of this section are unconditionally available at their customary location for examination during normal business hours by:
    1. Any duly authorized employee or representative of the Department of Labor or the Internal Revenue Service,
    2. Any fiduciary of a plan who has authority to acquire or dispose of the interests of the plan in the collective investment fund, or any duly authorized employee or representative of such fiduciary.
    3. Any contributing employer to any plan that has an interest in the collective investment fund or any duly authorized employee or representative of such employer.
    4. Any participant or beneficiary of any plan that has an interest in the collective investment fund, or any duly authorized employee or representative of such participant or beneficiary.

(2) None of the persons described in subparagraphs (B) through (D) of this paragraph shall be authorized to examine a bank's trade secrets or commercial or financial information which is privileged or confidential.

Section IV - Definitions and General Rules

For the purposes of this exemption,

  1. An "affiliate" of a person includes -
    1. Any person directly or indirectly through one or more intermediaries, controlling, controlled by, or under common control with the person;
    2. Any officer, director, employee, relative of, or partner in any such person; and
    3. Any corporation or partnership of which such person is an officer, director, partner or employee.
  2. The term "control" means the power to exercise a controlling influence over the management or policies of a person other than an individual.
  3. The term "party in interest" includes a "disqualified person" as defined in section 4975(e)(2) of the Code.
  4. The term "relative" means a "relative" as that term is defined in section 3(15) of the Act (or a "member of the family" as that term is defined in section 4975(e)(6) of the Code), or a brother, a sister, or a spouse of a brother or sister.
  5. (1) Except as provided in subparagraph (2) of this paragraph, the term "collective investment fund" means a common or collective trust fund or pooled investment fund maintained by a bank or a trust company.
  6. (2) In the case of a common or collective trust fund or pooled investment fund maintained by a bank or trust company that consists of separate investment accounts, each separate investment account of that fund, rather than the entire fund, shall be considered to be a separate "collective investment fund" for purposes of this exemption.

  7. The term "multiple employer plan" means an employee benefit plan that satisfies at least the requirements of section 3(37)(A)(i), (ii) and (v) of the Act and section 414(f)(1)(A), (B) and (E) of the Code.
  8. The term "obligation" means a bond, debenture, note, certificate, or other evidence of indebtedness.
  9. The time as of which any transaction, acquisition or holding occurs is the date upon which the transaction is entered into, the acquisition is made or the holding commences. In addition, in the case of a transaction that is continuing, the transaction shall be deemed to occur until it is terminated. If any transaction is entered into, or an acquisition is made, on or after January 1, 1975, or a renewal that requires the consent of the bank occurs on or after January 1, 1975, and the requirements of this exemption are satisfied at the time the transaction is entered into or renewed, respectively, or at the time the acquisition is made, the requirements will continue to be satisfied thereafter with respect to the transaction or acquisition and the exemption shall apply thereafter to the continued holding of the securities or property so acquired. This exemption also applies to any transaction or acquisition entered into, or holding commencing prior to January 1, 1975, if either the requirements of this exemption would have been satisfied on the date the transaction was entered into or acquisition was made (or on which the holding commenced), or the requirements would have been satisfied on January 1, 1975, if the transaction had been entered into, the acquisition was made, or the holding had commenced, on January 1, 1975. Notwithstanding the foregoing, this exemption shall cease to apply to a holding exempt by virtue of section I(a)(1) at such time as the interest of the plan in the collective investment fund exceeds the percentage interest limitation of section I(a)(1), unless no portion of such excess results from an increase in the assets allocated to the collective investment fund by the plan. For this purpose, assets allocated do not include the reinvestment of fund earnings. Nothing in this paragraph shall be construed as exempting a transaction entered into by a collective investment fund which becomes a transaction described in section 406 of the Act or section 4975 of the Code while the transaction is continuing, unless the conditions of the exemption were met either at the time the transaction was entered into or at the time the transaction would have become prohibited but for this exemption.
  10. Each plan participating in a collective investment fund shall be considered to own the same proportionate undivided interest in each asset of the collective investment fund as its proportionate interest in the total assets of the collective investment fund as calculated on the most recent preceding valuation date of the fund.
  11. Where any of the assets of a collective investment fund are invested in another collective investment fund, the interest of the plan in the second fund arising from its investment in the first fund shall be established by multiplying the percentage interest of the plan in the first fund by the percentage interest of the first fund in the second fund, such computation to be continued similarly in the event that further investments are made by the second investment fund in one or more other collective investment funds.

91-55    American Eagle Gold Coins Permitted as IRA Investment

Prohibited Transaction Class Exemption 91-55
September 27, 1991 (56 FR 49209)

Summary
Permits IRA accounts to invest in American Eagle. Other gold coins and "collectibles" still prohibited as investment vehicles.

Class Exemption

Transactions Between Individual Retirement Accounts

and Authorized Purchasers of American Eagle Coins

Agency: Pension and Welfare Benefits Administration, Labor Department.

Internal Revenue Service.

Action: Grant of class exemption.

Summary: This document contains a final class exemption from certain taxes imposed by the Internal Revenue Code of 1986 (the Code). The exemption permits purchases and sales by certain "individual retirement accounts," as defined in Code section 408 ("IRAs"), of American Eagle bullion coins ("Coins") in principal transactions from or to broker-dealers in Coins which are "authorized purchasers" of Coins in bulk quantities from the United States Mint (the "Mint") and which are also "disqualified persons," within the meaning of Code section 4975(e)(2), with respect to the IRAs. The exemption would also permit the interest-free extension of credit in connection with such purchases and sales. The exemption affects persons with an interest in the investments of IRAs, including IRA depositors and their beneficiaries, as well as persons who provide custodial services to IRAs.

Effective Date: January 1, 1987.

The Explanatory Preamble, together with the full Exemption, are available in the PREAMBLE document.

Exemption

Section I: Definitions and Special Rules

The following definitions apply to this exemption:

  1. "Authorized purchasers" are banks or other persons referenced in section 408(a)(2) or (h) of the Internal Revenue Code of 1986 (Code) that are approved by the United States Mint (the Mint), for eligibility to purchase the American Eagle U.S. gold or silver bullion coins which are described in section 5112(a)(7), (8), (9), and (10) or section (e) of Title 31 of the United States Code (Coins), directly from the Mint in bulk quantities.
  2. The term "covered transaction" means a transaction described in section II of this exemption.
  3. "IRA" means an individual retirement account described in Code section 408 with respect to which the authorized purchaser is a disqualified person.
  4. An "affiliate" of a person includes the following:
    1. Any person directly or indirectly controlling, controlled by, or under common control with, the person;
    2. Any officer, director, partner, employee, member of the family (as defined in Code section 4975(e)(6)), brother, sister, or spouse of a brother or sister, of the person;
    3. Any corporation or partnership of which the person is an officer, director or partner.

    The term "control" means the power to exercise a controlling influence over the management or policies of a person other than an individual.

  5. The term "execution" means the acceptance of an offer to purchase or sell a Coin in a covered transaction such that both the IRA and the authorized purchaser are legally obligated to complete the transaction as directed.
  6. The term "accredited person" means any duly authorized employee of the Department of Labor or the Internal Revenue Service or the person directing the investments of an IRA.
  7. The term "independent third party" excludes the authorized purchaser and any person affiliated therewith.

Section II. Covered Transactions

Effective January 1, 1987, if each condition of section III of this exemption is satisfied, the taxes imposed by section 4975(a) and (b) of the Code by reason of section 4975(c)(1)(A), (B) or (D) of the Code shall not apply to -

  1. The purchase of Coins by an IRA from an authorized purchaser; or
  2. The sale by an IRA of Coins to be authorized purchaser;
  3. The extension of credit in connection with the settlement of transactions described in (a) or (b).

Section III. Conditions

  1. In the case of an IRA with is an employee benefit plan covered by Title I of the Employee Retirement Income Security Act of 1974 (ERISA), the covered transaction is the type of transaction described in section 404(c) of ERISA.
  2. The transaction is directed either by the individual for whose benefit the IRA is maintained or by an independent third party appointed by such individual.
  3. Neither the authorized purchaser nor any affiliate thereof has any discretionary authority or control respecting the management or disposition of the IRA assets involved in the transaction, or renders investment advice (within the meaning of 26 C.F.R. 54.4975-9(c)) respecting those assets.
  4. Each denomination of Coins offered to IRAs pursuant to this exemption is purchased and sold by the authorized purchaser in transactions with unrelated parties in the ordinary course of its business with customers other than IRAs.
  5. At the time the transaction is executed, the terms of the transaction must be not less favorable to the IRA than the terms afforded by the disqualified person or any affiliate thereof in comparable Coin transactions involving unrelated parties.
  6. Payment for, and delivery of, Coins in settlement of a covered transaction is made simultaneously and in no event more than 10 business days after execution of the transaction involved, and no interest is charged for the period of time between execution and settlement.
  7. The disqualified person provides current price quotations to the person directing the investments of the IRA immediately prior to the time a covered transaction is executed so that such person will know the exact price at which the purchase or sale will occur.
  8. A separate written confirmation statement is issued with respect to each covered transaction to the person who directs the transaction for the IRA. The confirmation shall disclose the date, quantity, and price of the Coins bought or sold as well as the fact that the disqualified person acted as a principal in the transaction. The confirmation shall be issued in no event more than 10 business days after the execution of the transaction.
  9. With regard to transactions entered into subsequent to (enter date 90 days after grant of the final exemption), prior to its engaging in covered transactions the disqualified person prepares and provides to the person directing the investments of the IRA material information regarding transactions in Coins, and furnishes supplemental information to the person directing the investments of IRAs which have invested in Coins if material changes occur. This information must include:
    1. A general description of the manner in which Coins are priced in the market.
    2. Disclosure of any fees for services or special or minimum transaction costs that will be incurred as the result of the purchase or sale of Coins by an IRA.
    3. Any minimum quantity of Coins which must be brought or sold.
    4. Disclosure of the role of the disqualified person as a principal in the transaction.
    5. An explanation that the purchase or sale of Coins between the IRA and the authorized purchaser would be prohibited in the absence of an exemption, a discussion of the arm's-length pricing standard of this exemption and disclosure that records are accessible which would enable the person directing investments of the IRA to determine whether the conditions of this exemption have been met.
  10. The disqualified person maintains or causes to be maintained for a period of at least six years from the date of settlement of a covered transaction such records as are necessary to allow accredited persons to determine whether the conditions of the exemption have been met. The records shall include daily information indicating each customer (including each IRA and each other client) with whom a transaction involving Coins was consummated, the price and number of Coins involved, and the date and the time at which the transaction was executed. The persons directing the investments of an IRA are not authorized to examine a disqualified person's trade secrets or financial information which is privileged or confidential. The records must be reasonably accessible and must be available for examination during normal business hours. Notwithstanding these recordkeeping requirements, a prohibited transaction will not be deemed to have occurred if, due to circumstances beyond the control of the disqualified person, such records are lost or destroyed prior to the end of the six year period.

93-33    Receipt of Services by Individuals for Whose Benefit IRAs or Retirement Plans for Self-Employed Individuals are Established

Amendment to Prohibited Transaction Class Exemption 93-33 [Formerly PTE 93-2]
May 11, 1993

Recap
Permits the receipt of services from a bank at reduced or no cost by an IRA or Keogh Plan beneficiary under certain conditions.

Class Exemption

Receipt of Services by an IRA or Keogh Plan from a Bank

Agency: Pension and Welfare Benefits Administration, U.S. Department of Labor.

Action: Adoption of Amendment to PTE 93-33.

Effective Date: The amendment is effective January 1, 1998.

Exemption

Accordingly, PTE 93-33 is amended under the authority of section 408(a) of ERISA and section 4975(c)(2) of the Code and in accordance with the procedures set forth in 29 CFR Part 2570, Subpart B (55 FR 32836, August 10, 1990).

Section I: Covered Transactions

Effective January 1, 1998, the restrictions of sections 406(a)(1)(D) and 406(b) of ERISA and the sanctions resulting from the application of section 4975 of the Code, including the loss of exemption of an individual retirement account (IRA) pursuant to section 408(e)(2)(A) of the Code, by reason of section 4975(c)(1)(D), (E) and (F) of the Code, shall not apply to the receipt of services at reduced or no cost by an individual for whose benefit an IRA, or, if self-employed, a Keogh Plan, is established or maintained, or by members of his or her family, from a bank pursuant to an arrangement in which the account balance in the IRA or Keogh Plan is taken into account for purposes of determining eligibility to receive such services, provided that each condition of Section II of this exemption is satisfied.

Section II: Conditions

(a) The IRA or Keogh Plan, the balance of which is taken into account for purposes of determining eligibility to receive services at reduced or no cost, is established and maintained for the exclusive benefit of the participant covered under the IRA or Keogh Plan, his or her spouse or their beneficiaries.

(b) The services must be of the type that the bank itself could offer consistent with applicable federal and state banking law.

(c) The services are provided by the bank (or an affiliate of the bank) in the ordinary course of the bank's business to customers who qualify for reduced or no cost banking services but do not maintain IRAs or Keogh Plans with the bank.

(d) For the purpose of determining eligibility to receive services at reduced or no cost, the account balance required by the bank for the IRA or Keogh Plan is equal to the lowest balance required for any other type of account which the bank includes to determine eligibility to receive reduced or no cost services.

(e) The rate of return on the IRA or Keogh Plan investment is no less favorable than the rate of return on an identical investment that could have been made at the same time at the same branch of the bank by a customer of the bank who is not eligible for (or who does not receive) reduced or no cost services.

Section III: Definitions

The following definitions apply to this exemption:

(a) The term bank means a bank described in section 408(n) of the Code.

(b) The term IRA means an individual retirement account described in Code section 408(a) or an education individual retirement account described in section 530 of the Code. For purposes of this exemption, the term IRA shall not include an IRA which is an employee benefit plan covered by Title I of ERISA, except for a Simplified Employee Pension (SEP) described in section 408(k) of the Code or a Simple Retirement Account described in section 408(p) of the Code which provides participants with the unrestricted authority to transfer their balances to IRAs or Simple Retirement Accounts sponsored by different financial institutions.

(c) The term Keogh Plan means a pension, profit sharing, or stock bonus plan qualified under Code section 401(a) and exempt from taxation under Code section 501(a) under which some or all of the participants are employees described in section 401(c) of the Code. For purposes of this exemption, the term Keogh Plan shall not include a Keogh Plan which is an employee benefit plan covered by title I of ERISA.

(d) The term account balance means deposits as that term is defined under 29 CFR 2550.408b-4(c)(3), or investments in securities for which market quotations are readily available. For purposes of this exemption, the term account balance shall not include investments in securities offered by the bank (or its affiliate) exclusively to IRAs and Keogh Plans.

(e) An affiliate of a bank includes any person directly or indirectly controlling, controlled by, or under common control with a bank. The term control means the power to exercise a controlling influence over the management or policies of a person other than an individual.

(f) The term members of his or her family refers to beneficiaries of the individual for whose benefit the IRA or Keogh Plan is established or maintained, who would be members of the family as that term is defined in Code section 4975(e)(6), or a brother, a sister, or spouse of a brother or a sister.

(g) The term service includes incidental products of a de minimis value provided by third persons pursuant to an arrangement with the bank, which are directly related to the provision of banking services covered by the exemption.

Signed at Washington, DC this 26th day of February 1999.

Alan D. Lebowitz,
Deputy Assistant Secretary for Program Operations,
Pension and Welfare Benefits Administration,
U.S. Department of Labor.

[FR Doc. 99-5572 Filed 3-5-99]

94-20    Foreign Exchange

Prohibited Transaction Class Exemption 94-20
February 10, 1994

Summary
Permits ERISA plans to use fiduciary banks and broker-dealers, and their affiliates, to invest in foreign currency and options on foreign currencies, subject to conditions: (1) the fiduciary bank has no discretion to make the investment on its own authority, (2) the transaction is done on an arms-length basis, (3) written policies are maintained to ensure any third party knows an ERISA account is involved, (4) written confirmations, with specified contents, are provided the independent fiduciary authorizing the transaction within 5 business days, and (5) records are maintained for 6 years on territory in the jurisdiction of US courts.

Class Exemption

Agency: Pension and Welfare Benefits Administration, Labor Department.

Action: Grant of Class Exemption.

Summary: This document contains a final exemption from certain prohibited transaction restrictions of the Employee Retirement Income Security Act of 1974 (the Act) and from certain taxes imposed by the Internal Revenue Code of 1986 (the Code). The class exemption permits the purchase and sale of foreign currencies between an employee benefit plan and a bank or a broker-dealer or an affiliate thereof which is a party in interest with respect to such plan.

The exemption affects participants and beneficiaries of employee benefit plans involved in such transactions, as well as banks and broker-dealers and their affiliates which act as dealers in foreign exchange.

Effective Date: Section I(a) of PTE 94-20 is effective for transactions occurring from January 1, 1975 to June 18, 1991. Section I(b) of PTE 94-20 is effective for transactions occurring on or after June 18, 1991.

The Explanatory Preamble, together with the full Exemption, are available in the PREAMBLE document.

Exemption

Section I. Transactions

  1. For the period from January 1, 1975 to June 18, 1991, the restrictions of section 406(a)(1)(A) through (D) of the Employee Retirement Income Security Act of 1974 (the Act) and the taxes imposed by section 4975(a) and (b) of the Internal Revenue Code of 1986 (the Code) by reason of Code section 4975(c)(1)(A) through (D) shall not apply to any foreign exchange transaction between a bank or broker-dealer or an affiliate thereof and an employee benefit plan with respect to which the bank or broker-dealer or affiliate thereof is a trustee, custodian, fiduciary or other party in interest, provided that (i) the transaction is directed (within the meaning of section IV(e)) on behalf of the plan by a fiduciary which is independent of the bank, the broker-dealer, and any affiliate thereof, and (ii) the conditions set forth in section II are met.
  2. Effective June 18, 1991, the restrictions of section 406(a)(1)(A) through (D) of the Act and the taxes imposed by section 4975(a) and (b) of the Code by reason of Code section 4975(c)(1)(A) through (D) shall not apply to any foreign exchange transaction between a bank or broker-dealer or an affiliate thereof and an employee benefit plan with respect to which the bank or broker-dealer or an affiliate thereof is a trustee, custodian, fiduciary, or other party in interest, provided that (i) the transaction is directed (within the meaning of section IV(e)) on behalf of the plan by a fiduciary which is independent of the bank, the broker-dealer, and any affiliate thereof, and (ii) all of the conditions set forth in sections II and III are met.

Section II. General Conditions

Section I of this exemption applies only if the following conditions of this section II are satisfied. In the case of transactions described in section I(b), all of the conditions specified in section III below must also be satisfied.

  1. At the time the transaction is entered into, the terms of the transaction are not less favorable to the plan than the terms generally available in comparable arm's length foreign exchange transactions between unrelated parties.
  2. Neither the bank, the broker-dealer, nor any affiliate thereof has any discretionary authority or control with respect to the investment of the plan, assets involved in the transaction or renders investment advice (within the meaning of 29 C.F.R. 2510.3-21(c)) with respect to the investments of those assets.

Section III. Specific Conditions

Section I(b) of this exemption applies only if the conditions specified in section II above and the following conditions are satisfied:

  1. At the time the transaction is entered into, the terms of the transaction are not less favorable to the plan than the terms afforded by the bank, the broker-dealer, or any affiliate thereof in comparable arm's length foreign exchange transactions involving unrelated parties.
  2. The bank, or broker-dealer, maintains at all times written policies and procedures regarding the handling of foreign exchange transactions with plans with respect to which the bank or broker-dealer is a trustee, custodian, fiduciary or other party in interest or disqualified person which assure that the person acting for the bank or broker-dealer knows that he or she is dealing with a plan.
  3. A written confirmation statement is issued with respect to each covered transaction to the independent plan fiduciary who directs the transaction for the plan.
  4. The confirmation shall disclose the following information:

    1. Account name;
    2. Transaction date;
    3. Exchange rates;
    4. Settlement date;
    5. Currencies exchanged:
      1. Identity of the currency sold,
      2. The amount sold;
      3. Identity of the currency purchased;
      4. The amount purchased.

    The confirmation shall be issued in no event more than 5 business days after execution of the transaction.

  5. The bank or broker-dealer, or affiliate thereof, maintains within territories under the jurisdiction of the United States Government, for a period of six years from the date of the transaction, the records necessary to enable the persons described in paragraph (e) of this section to determine whether the applicable conditions of this exemption have been met. Notwithstanding these recordkeeping requirements, a prohibited transaction will not be considered to have occurred if, due to circumstances beyond the bank's or broker-dealer's control, the records are lost or destroyed prior to the end of the six-year period, and no fiduciary of a plan who is independent of the bank or broker-dealer or any affiliate thereof, which engages in a transaction covered by the exemption, shall be subject to the civil penalty that may be assessed under 502(i) of the Act, or to the taxes imposed by section 4975(a) and (b) of the Code solely because the records are not maintained by the bank, the broker-dealer, or its affiliate, or are not made available for examination by the bank or broker-dealer or affiliate as required by paragraph (e) below.
  6. (i) Except as provided in subparagraph (ii) of this paragraph and notwithstanding any provisions of subsection (a)(2) and (b) of section 504 of the Act, the records referred to in paragraph (d) of this Section are available at their customary location for examination, upon reasonable notice, during normal business hours by:
    1. Any duly authorized employee or representative of the Department of Labor or the Internal Revenue Service.
    2. Any fiduciary of a plan who has authority to acquire or dispose, of the assets of the plan involved in the foreign exchange transaction or any duly authorized employee and representative of such fiduciary.
    3. Any contributing employer to the plan involved in the foreign exchange transaction or any duly authorized employee or representative of such employer.

    (ii) None of the persons described in subparagraphs (B) and (C) shall be authorized to examine a bank's or broker-dealer's trade secrets or commercial or financial information of a bank or broker-dealer or an affiliate thereof which is privileged or confidential.

Section IV. Definitions and General Rules

For purposes of this exemption.

  1. A "foreign exchange transaction" means the exchange of the currency of one nation for the currency of another nation, or a contract for such an exchange. The term foreign exchange transaction includes options contracts on foreign exchange transactions.
  2. A "bank" means a bank which is supervised by the United States or a State thereof, or any affiliate thereof.
  3. A "broker-dealer" means a broker-dealer registered under the Securities Exchange Act of 1934, or any affiliate thereof.
  4. An "affiliate" of a bank or broker-dealer means any entity directly or indirectly, through one or more intermediaries, controlling, controlled by, or under common control with such bank or broker-dealer.
  5. The term "control" means the power to exercise a controlling influence over the management or policies of a person other than an individual.
  6. A foreign exchange transaction involving assets of an employee benefit plan shall be considered "directed" only where the independent plan fiduciary who has not been appointed by the bank or broker-dealer or affiliate dealer or affiliate thereof, directs such bank or broker-dealer or affiliate thereof to effect the purchase or sale of a specific amount of currency at a specific exchange rate.
  7. For purposes of this exemption, the term "employee benefit plan" refers to a pension plan described in 29 C.F.R. 2510.3-2 and/or a welfare benefit plan described In 29 C.F.R. 2510.3-1.

96-23    In-House Professional Asset Managers

Department of Labor
Pension and Welfare Benefits Administration

[Prohibited Transaction Exemption 96-23; Application Number D-09602]

Class Exemption for Plan Asset Transactions Determined by In-House Asset Managers

Agency: Pension and Welfare Benefits Administration, Labor.

Action: Grant of class exemption.

Summary: This document contains a final exemption from certain prohibited transaction restrictions of the Employee Retirement Income Security Act of 1974 (ERISA or the Act) and from certain taxes imposed by the Internal Revenue Code of 1986 (the Code). The exemption permits various transactions involving employee benefit plans whose assets are managed by in-house managers (INHAMS), provided that the conditions of the exemption are met. The exemption affects participants and beneficiaries of employee benefit plans, the sponsoring employers of such plans, INHAMS, and other persons engaging in the described transactions.

EFFECTIVE DATE: The effective date of the exemption is April 10, 1996.

FOR FURTHER INFORMATION CONTACT: Lyssa Hall or Virginia J. Miller, Pension and Welfare Benefits Administration, Office of Exemption Determinations, U.S. Department of Labor, Washington, DC 20210, (202) 219-8971 (not a toll-free number) or Paul D. Mannina, Plan Benefits Security Division, Office of the Solicitor, (202) 219-9141 (not a toll-free number).

Supplementary Information: Exemptive relief for the transactions described herein was requested in an application dated December 16, 1993 submitted by the Committee on Investment of Employee Benefit Assets (CIEBA), pursuant to section 408(a) of ERISA and section 4975(c)(2) of the Code, and in accordance with the procedures set forth in 29 CFR section 2570 subpart B (55 FR 32836 August 10, 1990).

On March 24, 1995, the Department published a notice in the Federal Register (60 FR 15597) of the pendency of a proposed class exemption from certain of the restrictions of sections 406 and 407(a) of ERISA and from certain taxes imposed by section 4975(a) and (b) of the Code, by reason of section 4975(c)(1) of the Code.1

The notice gave interested persons an opportunity to submit written comments or requests for a hearing on the proposed class exemption to the Department. The Department received fourteen written comments and no requests for a public hearing. Upon consideration of all of the comments received, the Department has determined to grant the proposed class exemption, subject to certain modifications. These modifications and the major comments are discussed below.

Discussion of the Comments:

  1. Basic Exemption
    1. INHAM as Decision Maker (Section I(a)). The proposed general exemption, set forth in Part I, permitted that portion of a plan that is managed by an INHAM to engage in all transactions described in section 406(a)(1)(A) through (D) with virtually all party in interest service providers except the INHAM or a person related to the INHAM. Under section I(a) of the proposed exemption, the INHAM must function as the decision maker for the plan in all covered transactions. Specifically, section I(a) requires that the terms of the transaction be negotiated by, or under the authority and general direction of, the INHAM and that the INHAM make the decision to enter into the transaction.
    2. Under section I(a) of the proposal, the exemption would be available for a transaction involving an amount in excess of $5,000,000 notwithstanding the fact that the transaction that had been negotiated by the INHAM was subject to a veto or approval by the plan sponsor. A commenter suggested that section I(a) should be modified to permit the plan sponsor or its designee to retain the right to veto or approve any transaction, regardless of the size of the transaction. Although the exemption permits the retention of a veto power for large transactions, the exemption was developed based on the premise that independent decisionmaking was more likely to be assured if day to day transactions are negotiated and approved by an INHAM. Therefore, the Department has determined not to adopt the commenter's suggestion.

      A commenter is concerned that the requirement under section I(a) of the proposal that the INHAM negotiate and make the decision on behalf of the plan to enter into the transaction may foreclose a transaction where an INHAM retains a QPAM to locate and negotiate the terms of a possible plan investment. According to the commenter, it is frequently advantageous for a plan to retain a QPAM to identify investment opportunities and to negotiate the terms of these types of investments, while permitting the INHAM to perform its own "due diligence" review of each investment opportunity presented and evaluate the appropriateness of the investment for the plan's particular investment needs. The Department does not believe that it would be appropriate in the context of this exemption proceeding to modify the INHAM exemption to, in effect, permit a transaction that was previously rejected by the Department during its consideration of the final QPAM class exemption.2

      A commenter questioned whether Part I of the exemption would apply to "drag along" and similar transactions that are not actually negotiated by the INHAM. According to the commenter, when a plan makes an investment in a non-publicly traded entity, both the plan and other investors want to be able to dispose of their investment at a favorable price. In order to accomplish this objective, plans and other investors may negotiate certain rights at the time they make their initial investments. One such right would be the ability of the plan to "tag along" and sell out its interest at the same price as the majority investors if the majority investors sell their interests to a third party. The converse of this right would be the ability of the majority investors to "drag along" the plan if they sell their interest to a third party. When these rights are exercised, it may turn out that the party to whom the interests are sold is a party in interest. The commenter argues that the "drag along" or similar transactions should be treated as subordinate to the initial investment transaction and, therefore, subject to the authority or general direction of the INHAM for purposes of section I(a) of the exemption. The commenter represents that, while the INHAM is not involved in selecting the party to whom the plan's interest is sold, the transaction is determined by an independent party pursuant to rights negotiated by the INHAM at arm's- length at the outset of the investment transaction. The commenter further represents that these rights would be taken into account by the INHAM in determining whether the initial investment would be prudent. It is the view of the Department that section I(a) of the exemption will be deemed satisfied in the case of "drag along" or similar transactions that are entered into pursuant to rights that were negotiated by the INHAM as part of the primary investment transaction. The Department notes, however, that it does not interpret section I(a) as exempting a "drag along" or similar transaction unless such transaction is itself subject to relief under the exemption and the applicable conditions are otherwise met. In this regard, the Department expects that any determination regarding the appropriate price to be paid for the investment would reflect the effect on the value of such investment of rights which may be exercised in the future at the discretion of unrelated third persons.

      One commenter requested that the Department clarify that the requirements of section I(a) would be met if an officer of the INHAM also serves as a member of the employer's investment committee or other named fiduciary under the plan. Nothing contained in section I(a) would preclude an officer of the INHAM from also serving as a member of the employer's investment committee or other named fiduciary under the plan, provided that the INHAM otherwise meets the definition set forth in section IV(a), including the requirement that the INHAM must be a separate entity that is registered as an investment adviser.

      A commenter requested that the Department clarify that the requirements of section I(a) will be satisfied notwithstanding the fact that the INHAM also manages assets of outside clients.

      In the Department's view, nothing contained in the exemption would preclude the INHAM from providing services to outside clients who have no affiliation with the INHAM.

      In response to a comment regarding typical investment increments used in financial transactions, the Department has revised section I(a) by replacing "an amount in excess of $5,000,000" to "$5,000,000 or more" in connection with the plan sponsor's right to veto or approve such transactions.

    3. Transactions Involving Arrangements Designed to Benefit Parties in Interest (Section I(c)). Section I(c) of the proposal requires that the transaction not be part of an agreement, arrangement or understanding designed to benefit a party in interest. A commenter suggested that the Department clarify that to the extent that the INHAM's purpose in entering into a transaction is not to benefit a party in interest, so that any benefit to the party in interest is incidental to the purpose of the transaction, the transaction should not give rise to an agreement, arrangement or understanding designed to benefit a party in interest which is described in section I(c). The Department concurs with the commenter and notes that the intent of the condition in section I(c) was not to deny direct benefits to other parties to a transaction but, rather, to exclude relief for transactions that are part of a broader overall agreement, arrangement or understanding designed to benefit parties in interest.
    4. Transactions with Service Providers (Section I(e)). Under section I(e) of the proposed exemption, relief was limited to transactions with party in interest service providers who do not have discretionary authority or control with respect to the assets involved in the transaction or otherwise render investment advice with respect to such assets. A commenter urged the Department to expand the scope of the final exemption to include relief for all parties in interest. The Department does not believe that a sufficient showing has been made that the safeguards contained in the proposed exemption would adequately discourage the exercise of undue influence upon the INHAM if the final exemption were expanded as requested by the commenter. Accordingly, the Department cannot conclude that further relief is warranted.
    5. Several commenters suggested that the Department clarify that section I(e) of the proposal would not preclude a directed trustee of a plan or a trustee with discretionary authority over plan assets not involved in the transaction from engaging in transactions with the plan. In the Department's view, a nondiscretionary trustee subject to the direction of an INHAM, and that does not otherwise render investment advice with respect to the plan assets involved in the transaction may carry out proper directions that are not contrary to ERISA with respect to the transactions covered by the class exemption. Similarly, the exemption would be available for transactions with a trustee that exercises investment discretion with respect to a portion of plan assets not involved in the transaction.

      Another commenter objected to the requirement in section I(e)(2) that the party in interest dealing with the plan not have discretionary authority or control with respect to the investment of the plan assets involved in the transaction and not render investment advice (within the meaning of 29 CFR 2510.3-21(c)) with respect to those assets. According to the commenter, the first part of this condition regarding discretionary authority or control is unnecessary in view of the requirement under section I(a) that the terms of the transaction must be negotiated by the INHAM, and that the INHAM make the decision on behalf of the plan to enter into the transaction. The commenter further believed that the requirement contained in section I(e)(2) that the party in interest dealing with the plan not render "investment advice" would create uncertainty and is unnecessary in view of the limited scope of relief provided. Accordingly, the commenter requests that the Department eliminate this requirement from the final exemption.

      This class exemption was developed, and is being granted by the Department, based on the essential premise that broad exemptive relief from the prohibitions of section 406(a) of ERISA can be afforded for all types of service provider transactions in which a plan engages only if the INHAM independently negotiates the transaction and makes the decision on behalf of the plan to enter into the transaction. The limitations contained in section I(e)(2) were included in the proposal in order to further emphasize that the INHAM must be the decision-maker in order for transactions to be covered by the class exemption. In addition, the Department believes that, if exemptive relief were to be provided where the party in interest renders investment advice to the plan, with respect to the transaction at issue, the potential for decision making with regard to the plan assets that would inure to the benefit of a party in interest would be increased. For these reasons, the Department believes that a separate condition is warranted and has determined not to revise the exemption as requested by the commenter.

    6. Fiduciary Audit (Section I(g)). Section I(g) of the proposed exemption required that an independent auditor conduct an annual fiduciary audit to determine whether the written procedures adopted by the INHAM are designed to assure compliance with the conditions of the exemption. Section IV(f) defined fiduciary audit as including: (1) a determination by the auditor as to whether or not the plan has developed adequate internal policies and procedures designed to assure compliance with the terms of the exemption; (2) a test of a representative sample of the plan's transactions to determine operational compliance with such policies and procedures; (3) a determination as to whether the INHAM meets the definition of INHAM set forth in the exemption; and (4) a written report describing the steps performed by the auditor during the course of its review and the auditor's findings and recommendations.
    7. Several commenters requested that the Department clarify the types of "policies and procedures" that the INHAM is required to adopt for purposes of sections I(g) and IV(f) of the proposal, and the criteria the independent auditor should apply in conducting the audit. Another commenter recommended that the audit be conducted in accordance with standards established by the American Institute of Certified Public Accountants (AICPA), and that the Department establish criteria against which the independent auditor can make a determination that the procedures are designed to operate in the manner contemplated by the exemption. In this regard, a commenter raised a related question concerning whether the proposed audit condition would require that the policies and procedures include substantive criteria regarding expected risk, gross return and expenses of a proposed transaction that the INHAM should consider. One commenter suggested that the scope of the audit should be expanded to include a determination by the auditor regarding compliance with section 404(a) of ERISA. Lastly, a commenter urged the Department to delete this requirement entirely.

      As noted in the preamble to the proposed exemption, the Department proposed the audit requirement in order to address the lack of independence of the INHAM. The Department continues to believe that an annual fiduciary audit is necessary to address this lack of independence and, accordingly, has determined not to delete this requirement. In this regard, it was the Department's intent that the role of the auditor would be limited to determining whether the written procedures adopted by the INHAM are designed to assure compliance with the conditions of the exemption. Since the sole purpose of the audit requirement is to assure compliance with the exemption, the Department does not believe that it would be appropriate to expand the scope of this requirement to include either determinations under section 404 of the Act or determinations regarding the appropriateness of investments entered into under the exemption. In response to the comment concerning the adoption of AICPA standards as part of the audit requirement, the Department does not believe that it would be appropriate to adopt a definition that would require compliance with standards developed by certain professional organizations. However, in consideration of the concerns expressed by the commenters, the Department has adopted a new section I(g) which specifically requires that the INHAM adopt written policies and procedures designed to assure compliance with the conditions of the exemption. (The fiduciary audit requirement, set forth in section I(g) of the proposal, has been renumbered as section I(h) under the final exemption.) The Department has also adopted a new definition, under section IV(g), that contains a list of the objective requirements of the exemption that must be described in the written policies and procedures and that must be reviewed by the auditor.3 In addition, the Department notes that, although the exemption provides flexibility with respect to the specific procedures adopted by the INHAM, it expects such procedures to be designed in a manner that assures that the INHAM's operations are consistent with the requirements of the exemption.

      On a related issue, another commenter noted that the role of the auditor under the exemption should be limited to determining compliance with policies and procedures designed by the INHAM and should not include a determination by the auditor as to whether the plan has developed adequate policies and procedures as required under section IV(f) of the proposal. According to the commenter, having the auditor review the adequacy of the procedures would expand the auditor's role beyond the typical role of an independent auditor. In response to the commenter, the Department has determined to modify section IV(f) to delete the requirement that the auditor make a determination regarding the adequacy of the policies and procedures adopted by the INHAM. Under the revised section IV(f)(1), the auditor would be required to review the policies and procedures for consistency with the objective requirements of the exemption. In light of the decision to revise section (IV)(f)(1), the Department has also determined to expand section IV(f)(2) to require the auditor to test for compliance with both the written policies and procedures adopted by the INHAM and the objective requirements of the exemption. In the Department's view, this revised condition will help to assure that the INHAM properly carries out its responsibilities under the exemption.

      A commenter noted that the proposal did not make clear the consequences on existing transactions of an unsatisfactory audit. In response to the comment, the Department notes that an adverse finding in the auditor's report would not, in itself, render the exemption unavailable for any transaction engaged in by the INHAM on behalf of the plan.4 However, if a transaction did not meet a condition of the exemption (e.g., because relief was not available for transactions with the party with whom the INHAM dealt), the exemption would not be available for that transaction, but the exemption would continue to be available for those transactions that did satisfy its conditions. Conversely, a failure to comply with the general terms of the exemption applicable to all transactions would render the exemption unavailable, regardless of whether the failure is identified in the audit. Thus, if the INHAM failed to adopt policies and procedures that complied with the requirements of section I(g) or if no audit were conducted, the exemption would not cover transactions engaged in on behalf of the plan by the INHAM.

      Several commenters were concerned that the exemption could be interpreted to mean that only financial accounting firms or auditing firms could conduct the fiduciary audit required under section I(g) of the proposal. According to the commenters, other types of financial service organizations may well be capable of conducting a fiduciary audit. The Department did not intend to limit eligibility to serve as independent auditors under the exemption solely to accounting or auditing firms. Accordingly, any person who otherwise possesses the requisite technical training and proficiency with ERISA's fiduciary responsibility provisions may conduct a fiduciary audit.

      A number of commenters also requested that we clarify the requirement that the person performing the fiduciary audit must be "independent". In the Department's view, whether an auditor is independent for purposes of the exemption would depend on the particular facts and circumstances of each case. However, the Department would not view an auditor as independent under circumstances where the auditor has a financial interest, including an ownership interest, in the INHAM , the employer, any parties dealing with the plan under the exemption, or any affiliates thereof, or otherwise receives more than a de minimis amount of its compensation from the INHAM, the employer, its affiliates, or the plan.

      One commenter questioned whether the auditor performing the fiduciary audit can be an entity or individual who provides other services to the plan, e.g., the firm that audits the plan in connection with preparation of the plan's annual report (Form 5500). In the Department's view, the provision of other services would not, in itself, preclude a firm from meeting the requirement under the exemption that the person performing the fiduciary audit must be independent. However, the Department notes that the provision of other services could raise questions regarding the independence of the auditor if the aggregate services result in the auditor deriving more than a de minimis amount of its compensation from the INHAM, the employer, its affiliates, or the plan.

      One of the commenters expressed concern about how the audit requirement would apply to the condition, contained in section I(b), that the transaction not be described in certain specified class exemptions. The commenter suggested that the auditor's role regarding this condition should be limited to a finding as to whether the transaction is of the type described in the specified class exemptions, rather than a finding regarding compliance with the terms and conditions of such class exemptions. The Department concurs with this comment. The Department believes, however, that it is the ongoing responsibility of the INHAM to determine whether a transaction is covered by one of the specified class exemptions or the INHAM exemption.

      A commenter suggested that the Department revise the requirement under section I(g) of the proposal that the independent auditor must have appropriate technical training and proficiency with ERISA's fiduciary responsibility provisions. According to the commenter, the most likely candidates to conduct an audit are people who have experience with ERISA's fiduciary responsibility provisions rather than technical training. On the basis of this comment, the Department has determined to modify section I(g) to provide that the independent auditor must have appropriate technical training or experience, and proficiency with ERISA's fiduciary responsibility provisions. Another commenter urged the Department to delete this requirement entirely. In response to this comment, the Department believes that the requirement that the auditor be familiar with ERISA's fiduciary responsibility provisions provides an additional protection under the class exemption. Therefore, the Department has determined not to further revise this condition.

      According to a commenter, the language in section IV(f)(4) of the proposal, which provides that the auditor must make recommendations in its written report, would require the auditor to go beyond its auditing role of providing findings regarding compliance. The Department concurs with this comment and, accordingly, has deleted the words "and recommendations" from section IV(f). In response to a related comment, the Department has deleted the words "among other things" from the definition of fiduciary audit in order to clarify that the definition sets out the specific steps for a fiduciary audit. The Department cautions that the auditor would be responsible for taking any actions necessary to adequately perform the steps described in the definition of fiduciary audit.

      A commenter suggested that the Department modify sections I(g) and IV(f) by deleting the word "fiduciary" from "fiduciary audit" wherever it appears in those sections and substituting the word "exemption" to reflect the fact that the auditor's role is to assure compliance with the policies and procedures established for purposes of the exemption and does not otherwise involve examining for compliance with ERISA's fiduciary responsibility provisions. The Department concurs with the commenter's suggestion and has modified the exemption accordingly.

      The following examples illustrate the types of transactions which would be covered by Part I of the exemption:

      (1) Corporation C designates INHAM X to manage a portion of Plan P's assets. Assume that X meets the criteria for an INHAM under the exemption. X uses Plan P assets to purchase a building from Y, a wholly-owned subsidiary of a broker-dealer that provides services to the Plan. Absent this exemption, the purchase of the building from Y, a party in interest described in ERISA section 3(14)(G), would violate the restrictions contained in section 406(a)(1)(A), and the transaction could not proceed until exempted by the Department. The general exemption set forth in Part I would allow such transaction if the conditions contained therein are met.

      (2) INHAM X invests part of a pension fund's assets to acquire a parcel of unimproved real property from the president of the employer sponsoring the Plan. Part I does not provide an exemption for the purchase of the property since relief is limited under that Part to transactions with service providers and their affiliates. In addition, no relief would be provided under the exemption for the act of self-dealing described in section 406(b)(1) arising in connection with X's use of the fund's assets in a transaction that benefits a person in whom X has an interest that may affect the exercise of its best judgement as a fiduciary.

      (3) Corporation C is the named fiduciary of Plan P. C chooses INHAM X to manage the portion of P's assets allocated for real estate investments. X, using its discretionary authority, locates and negotiates the purchase for $6 million of a commercial building in New York that is being offered for sale by Corporation Z. Z provides accounting services to Plan P. Pursuant to its arrangement with C, X is required to seek the approval of C for all real estate transactions involving amounts of $5 million or more. On the basis of X's recommendation, C approves the transaction. Despite the retention of approval power by C, Part I of the exemption would be available for the purchase of the building provided there is no arrangement with C that requires X to buy the building from Z and the conditions of Part I are otherwise met.

      (4) Corporation C allocates part of the assets of its Plan P to a master trust managed by INHAM X. X uses master trust assets to purchase an office building that is subsequently leased to M. M provides administrative services to Plan P. During the term of the lease, M becomes a wholly-owned subsidiary of Corporation C. Although M is no longer a party in interest with respect to Plan P solely by reason of providing services to such Plan, Part I will continue to be available for the entire lease term since, at the time the transaction was entered into (as defined in section IV(e)), M was not affiliated with the plan sponsor and its relationship to Plan P was solely that of a service provider.

      (5) INHAM X retains Broker-Dealer B to provide brokerage services to Plan P. In a separate transaction, X uses Plan P assets to purchase corporate bonds directly from B. The bonds were originally issued by Corporation Z, an investment manager for a portion of the Plan's assets that are not controlled by INHAM X. Since the Department expects that, as part of its fiduciary responsibilities, the INHAM would have analyzed the terms of the bonds prior to purchase, the relief provided by Part I could extend to both the acquisition of the bonds and the underlying extension of credit. Thus, Part I could cover a subsidiary transaction with a party in interest if such transaction is itself subject to relief under the exemption and the applicable conditions are otherwise met.

      (6) Corporation C designates INHAM X to manage a portion of Plan P's assets. X uses plan assets to purchase an office building that is subsequently leased to Broker-Dealer BD, a non-party in interest with respect to Plan P. During the term of the lease, BD becomes a service provider to Plan P. Although BD was not a party in interest service provider at the time the lease was executed, section IV(e) provides that Part I of the exemption would be available for the entire lease term provided that the remaining conditions of the exemption were met at the time the transaction was entered into. Alternatively, section IV(e) provides that Part I of the exemption would be available to exempt the transaction if the conditions of the exemption were met as of the time the transaction would have become prohibited.

  2. Specific Exemptions for Employers
  3. A commenter urged the Department to expand the relief provided under Part II of the proposal to permit an INHAM to select an affiliate to provide telecommunications related goods and services to any real property that may be considered an asset of the plan or to an entity in which the plan owns a controlling interest and that is managed by an INHAM. While the commenter has identified the need for exemptive relief, the Department does not believe that it has sufficient information on the record at this time to provide additional relief for a class of transactions that would otherwise violate section 406(b) of ERISA. Finally, the Department believes that adoption of the commenter's suggestion would arbitrarily favor one specific industry over another under similar circumstances.

  4. Definitions
    1. INHAM (Section IV(a)). A commenter requested that the definition of an INHAM be revised to include a division or group within the employer's management structure. The Department believes that an INHAM that is organized as a separate legal entity, is separately managed, and is subject to oversight by the Securities and Exchange Commission as a result of registration as an investment adviser under the Investment Advisers Act of 1940 provides an important safeguard under the exemption. Therefore, the Department cannot conclude that further relief is warranted.
    2. Another commenter suggested that the Department modify the definition of INHAM to permit a majority-owned subsidiary of an employer, or a direct or indirect majority-owned subsidiary of a parent organization of such an employer to serve as an INHAM. The Department does not believe that a sufficient showing has been made that the requirement that the INHAM be wholly-owned under the proposal would raise compliance problems for those persons intending to use the exemption. Accordingly, the Department has determined not to revise the final exemption as requested.

      Several commenters urged the Department to expand the definition of an INHAM to include an entity established by a multiemployer plan or its plan sponsor. A commenter further noted that the definition of an affiliate of the INHAM contained in sections IV(a) and IV(b) of the proposal should be broadened to include families of multiemployer plans. The Department notes that the exemption application requested relief for transactions involving the assets of single employer plans managed by in-house managers. Accordingly, the Department does not believe that it has sufficient information regarding the operation and management of multiemployer plans to make the findings necessary to grant exemptive relief. Moreover, the Department does not believe that a sufficient showing has been made by the commenters that the conditions contained in the exemption would adequately protect the interests of participants and beneficiaries of internally managed multiemployer plans. Of course, the Department would be prepared to consider additional relief upon proper demonstration that the findings can be made under section 408(a) of ERISA with respect to such plans.

      A commenter requested that the Department clarify that the relief provided for employee benefit plans whose assets are managed by INHAMs extends, not only to plans sponsored by affiliates of the INHAM, but also includes plans sponsored by the INHAM itself. According to the commenter, the INHAM may establish a stand-alone plan to cover its employees, or its employees may participate in a plan established and maintained by an affiliate of the INHAM. Therefore, the commenter urged that the Department adopt a definition of "plan", which would include plans maintained by the INHAM or an affiliate of the INHAM. In consideration of the concerns raised by the commenter, the Department has determined to adopt a definition of plan under section IV(h) that includes plans maintained by the INHAM and affiliates of the INHAM. The commenter further requested that the requirements under section IV(a) that the INHAM have $50 million of plan assets under management and control, and that plans maintained by affiliates of the INHAM have $250 million of aggregate plan assets also should be modified to clarify that these requirements are not intended to exclude any plan maintained by the INHAM. The requirement that the INHAM be affiliated with a plan sponsor (or group of related plan sponsors) whose plan(s) hold in the aggregate assets of at least $250 million, $50 million of which is under the direct management and control of the INHAM was imposed because the Department believes that INHAMs of large plans are more likely to have an appropriate level of expertise in financial and business matters. In this regard, the Department believes that the requirement that the INHAM have a significant dollar amount of assets under its management and control attributable to plans maintained by affiliates which are separately accountable for the operation of their respective plans provides an additional safeguard under the exemption. Accordingly, the Department has determined not to revise the $50 million requirement. However, the Department has determined that it would be appropriate to include the assets of plans maintained by the INHAM in determining compliance with the $250 million standard.

      Finally, a commenter requested that the $50 million requirement be revised to permit the $50 million threshold to be met during the INHAM's first fiscal year as a separate legal entity. According to the commenter, the requirement that the INHAM have in excess of $50 million of plan assets under its management and control as of the last day of its most recent fiscal year could unintentionally prevent the exemption from being immediately available for an employer's in-house management group in its first year as a separate wholly-owned subsidiary of the employer. In response to this comment, the Department has revised section IV(a)(2) to specify that an existing asset management group that is newly-incorporated as a separate subsidiary of the employer may satisfy the $50 million requirement in its initial fiscal year if the requirement is met as of the date during its initial fiscal year as a separate legal entity that responsibility for the management of such assets in excess of $50 million was transferred to it from the employer.

    3. Continuing Transactions (Section IV(e)). A commenter asserted that the last sentence of section IV(e), which deals with transactions which are continuing in nature, is unclear. This sentence addresses the issue of whether a continuing transaction that is not prohibited and, therefore, not subject to the exemption at the outset, may become covered by the exemption during the course of the transaction if it later becomes prohibited. According to the commenter, certain of the conditions of the exemption can be met only at the time the transaction is entered into, such as the condition in section I(d) dealing with arms-length terms. Conversely, the requirements of section I(e)(1) dealing with the party in interest relationships permitted under the exemption can only be determined at the time the transaction would have become prohibited. It is the view of the Department that section I(d) will be deemed satisfied in the case of a continuing transaction that later becomes prohibited if the transaction negotiated by the INHAM satisfied such section at the time the transaction was entered into. The Department notes that it does not interpret section IV(e) as exempting a continuing transaction that becomes prohibited subsequent to a renewal or modification that required the consent of the INHAM, unless the renewal or modification otherwise met the arm's-length requirement of section I(d). Lastly, the Department has modified section IV(e) to clarify that in determining compliance with the conditions of the exemption at the time that the transaction was entered into, section I(e) will be deemed satisfied if the transaction was entered into between a plan and a person who was not then a party in interest.
  5. Miscellaneous
  6. In response to a comment, the Department has added section IV(d)(3) to the exemption in order to define "control" for purposes of determining whether or not an INHAM is "related" to a party in interest under section IV(d).

    General Information

    The attention of interested persons is directed to the following:

    (1) The fact that a transaction is the subject of an exemption under section 408(a) of the Act and section 4975(c)(2) of the Code does not relieve a fiduciary or other party in interest or disqualified person from certain other provisions of the Act and the Code, including any prohibited transaction provisions to which the exemption does not apply and the general fiduciary responsibility provisions of section 404 of the Act which require, among other things, that a fiduciary discharge his duties respecting the plan solely in the interests of the participants and beneficiaries of the plan and in a prudent fashion in accordance with section 404(a)(1)(B) of the Act; nor does it affect the requirement of section 401(a) of the Code that the plan must operate for the exclusive benefit of the employees of the employer maintaining the plan and their beneficiaries;

    (2) In accordance with section 408(a) of the Act and section 4975(c)(2) of the Code, and based upon the entire record, the Department finds that the exemption is administratively feasible, in the interests of plans and of their participants and beneficiaries and protective of the rights of participants and beneficiaries;

    (3) The exemption is supplemental to, and not in derogation of, any other provisions of the Act and the Code, including statutory or administrative exemptions and transitional rules. Furthermore, the fact that a transaction is subject to an administrative or statutory exemption is not dispositive of whether the transaction is in fact a prohibited transaction; and

    (4) The exemption is applicable to a particular transaction only if the transaction satisfies the conditions specified in the class exemption.

    Exemption

    Accordingly, the following exemption is granted 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 29 CFR part 2570, subpart B (55 FR 32836, August 10, 1990).

    Part I - Basic Exemption

    Effective April 10, 1996, the restrictions of section 406(a)(1) (A) through (D) of the Act and the taxes imposed by Code section 4975 (a) and (b) of the Code, by reason of 4975(c)(1) (A) through (D), shall not apply to a transaction between a party in interest with respect to a plan (as defined in section IV(h)) and such plan, provided that an in- house asset manager (INHAM) (as defined in section IV(a)) has discretionary authority or control with respect to the plan assets involved in the transaction and the following conditions are satisfied:

    (a) The terms of the transaction are negotiated on behalf of the plan by, or under the authority and general direction of, the INHAM, and either the INHAM, or (so long as the INHAM retains full fiduciary responsibility with respect to the transaction) a property manager acting in accordance with written guidelines established and administered by the INHAM, makes the decision on behalf of the plan to enter into the transaction. Notwithstanding the foregoing, a transaction involving an amount of $5,000,000 or more, which has been negotiated on behalf of the plan by the INHAM will not fail to meet the requirements of this section I(a) solely because the plan sponsor or its designee retains the right to veto or approve such transaction;

    (b) The transaction is not described in-

    (1) Prohibited Transaction Exemption 81-6 (46 FR 7527; January 23, 1981) (relating to securities lending arrangements),

    (2) Prohibited Transaction Exemption 83-1 (48 FR 895; January 7, 1983) (relating to acquisitions by plans of interests in mortgage pools), or

    (3) Prohibited Transaction Exemption 88-59 (53 FR 24811; June 30, 1988) (relating to certain mortgage financing arrangements);

    (c) The transaction is not part of an agreement, arrangement or understanding designed to benefit a party in interest;

    (d) At the time the transaction is entered into, and at the time of any subsequent renewal or modification thereof that requires the consent of the INHAM, the terms of the transaction are at least as favorable to the plan as the terms generally available in arm's length transactions between unrelated parties;

    (e) The party in interest dealing with the plan: (1) is a party in interest with respect to the plan (including a fiduciary) solely by reason of providing services to the plan, or solely by reason of a relationship to a service provider described in section 3(14) (F), (G), (H), or (I) of ERISA; and (2) does not have discretionary authority or control with respect to the investment of the plan assets involved in the transaction and does not render investment advice (within the meaning of 29 CFR 2510.3-21(c)) with respect to those assets;

    (f) The party in interest dealing with the plan is neither the INHAM nor a person related to the INHAM (within the meaning of section IV(d));

    (g) The INHAM adopts written policies and procedures that are designed to assure compliance with the conditions of the exemption; and

    (h) An independent auditor, who has appropriate technical training or experience and proficiency with ERISA's fiduciary responsibility provisions and so represents in writing, conducts an exemption audit (as defined in section IV(f)) on an annual basis. Following completion of the exemption audit, the auditor shall issue a written report to the plan presenting its specific findings regarding the level of compliance with the policies and procedure adopted by the INHAM in accordance with section I(g).

    Part II - Specific Exemptions

    Effective April 10, 1996, the restrictions of sections 406(a), 406(b)(1), 406(b)(2) and 407(a) of the Act and the taxes imposed by section 4975 (a) and (b) of the Code, by reason of Code section 4975(c)(1) (A) through (E), shall not apply to:

    (a) The leasing of office or commercial space owned by a plan managed by an INHAM to an employer any of whose employees are covered by the plan or an affiliate of such an employer (as defined in section 407(d)(7) of the Act), if-

    (1) The plan acquires the office or commercial space subject to an existing lease with an employer, or its affiliate as a result of foreclosure on a mortgage or deed of trust;

    (2) The INHAM makes the decision on behalf of the plan to foreclose on the mortgage or deed of trust as part of the exercise of its discretionary authority;

    (3) The exemption provided for transactions engaged in with a plan pursuant to section II(a) is effective until the later of the expiration of the lease term or any renewal thereof which does not require the consent of the plan lessor;

    (4) The amount of space covered by the lease does not exceed fifteen (15) percent of the rentable space of the office building or the commercial center; and

    (5) The requirements of sections I(c), I(g) and I(h) are satisfied with respect to the transaction.

    (b) The leasing of residential space by a plan to a party in interest if--

    (1) The party in interest leasing space from the plan is an employee of an employer any of whose employees are covered by the plan or an employee of an affiliate of such employer (as defined in section 407(d)(7) of the Act);

    (2) The employee who is leasing space does not have any discretionary authority or control with respect to the investment of the assets involved in the lease transaction and does not render investment advice (within the meaning of 29 CFR 2510.3-21(c)) with respect to those assets;

    (3) The employee who is leasing space is not an officer, director, or a 10% or more shareholder of the employer or an affiliate of such employer;

    (4) At the time the transaction is entered into, and at the time of any subsequent renewal or modification thereof that requires the consent of the INHAM, the terms of the transaction are not less favorable to the plan than the terms afforded by the plan to other, unrelated lessees in comparable arm's length transactions;

    (5) The amount of space covered by the lease does not exceed five percent (5%) of the rentable space of the apartment building or multi- unit residential subdivision [townhouses or garden apartments], and the aggregate amount of space leased to all employees of the employer or an affiliate of such employer does not exceed ten percent (10%) of such rentable space; and

    (6) The requirements of sections I(a), I(c), I(d), I(g) and I(h) are satisfied with respect to the transaction.

    Part III - Places of Public Accommodation

    Effective April 10, 1996, the restrictions of sections 406(a)(1) (A) through (D) and 406(b) (1) and (2) of ERISA and the taxes imposed by Code section 4975 (a) and (b), by reason of Code section 4975(c)(1) (A) through (E), shall not apply to the furnishing of services and facilities (and goods incidental thereto) by a place of public accommodation owned by a plan and managed by an INHAM to a party in interest with respect to the plan, if the services and facilities (and incidental goods) are furnished on a comparable basis to the general public.

    Part IV - Definitions

    For the purposes of this exemption:

    (a) The term "in-house asset manager" or "INHAM" means an organization which is-

    (1) either (A) a direct or indirect wholly-owned subsidiary of an employer, or a direct or indirect wholly-owned subsidiary of a parent organization of such an employer, or (B) a membership nonprofit corporation a majority of whose members are officers or directors of such an employer or parent organization; and

    (2) an investment adviser registered under the Investment Advisers Act of 1940 that, as of the last day of its most recent fiscal year, has under its management and control total assets attributable to plans maintained by affiliates of the INHAM (as defined in section IV(b)) in excess of $50 million; provided that if it has no prior fiscal year as a separate legal entity as a result of it constituting a division or group within the employer's organizational structure, then this requirement will be deemed met as of the date during its initial fiscal year as a separate legal entity that responsibility for the management of such assets in excess of $50 million was transferred to it from the employer.

    In addition, plans maintained by affiliates of the INHAM and/or the INHAM, must have, as of the last day of each plan's reporting year, aggregate assets of at least $250 million.

    (b) For purposes of sections IV(a) and IV(h), an "affiliate" of an INHAM means a member of either (1) a controlled group of corporations (as defined in section 414(b) of the Code) of which the INHAM is a member, or (2) a group of trades or businesses under common control (as defined in section 414(c) of the Code) of which the INHAM is a member; provided that "50 percent" shall be substituted for "80 percent" wherever "80 percent" appears in section 414(b) or 414(c) or the rules thereunder.

    (c) The term "party in interest" means a person described in Act section 3(14) and includes a "disqualified person" as defined in Code section 4975(e)(2).

    (d) An INHAM is "related" to a party in interest for purposes of section I(f) of this exemption if the party in interest (or a person controlling, or controlled by, the party in interest) owns a five percent or more interest in the INHAM or if the INHAM (or a person controlling, or controlled by, the INHAM) owns a five percent or more interest in the party in interest. For purposes of this definition:

    (1) The term "interest" means with respect to ownership of an entity-

    (A) The combined voting power of all classes of stock entitled to vote or the total value of the shares of all classes of stock of the entity if the entity is a corporation.

    (B) The capital interest or the profits interest of the entity if the entity is a partnership, or

    (C) The beneficial interest of the entity if the entity is a trust or unincorporated enterprise;

    (2) A person is considered to own an interest held in any capacity if the person has or shares the authority--

    (A) To exercise any voting rights or to direct some other person to exercise the voting rights relating to such interest, or

    (B) To dispose or to direct the disposition of such interest; and

    (3) The term "control" means the power to exercise a controlling influence over the management or policies of a person other than an individual.

    (e) For purposes of this exemption, the time as of which any transaction occurs is the date upon which the transaction is entered into. In addition, in the case of a transaction that is continuing, the transaction shall be deemed to occur until it is terminated. If any transaction is entered into on or after April 10, 1996, or any renewal that requires the consent of the INHAM occurs on or after April 10, 1996, and the requirements of this exemption are satisfied at the time the transaction is entered into or renewed, respectively, the requirements will continue to be satisfied thereafter with respect to the transaction. Nothing in this paragraph shall be construed as exempting a transaction entered into by a plan which becomes a transaction described in section 406 of the Act or section 4975 of the Code while the transaction is continuing, unless the conditions of the exemption were met either at the time the transaction was entered into or at the time the transaction would have become prohibited but for this exemption. In determining compliance with the conditions of the exemption at the time that the transaction was entered into for purposes of the preceding sentence, section I(e) will be deemed satisfied if the transaction was entered into between a plan and a person who was not then a party in interest.

    (f) Exemption Audit. An "exemption audit" of a plan must consist of the following:

    (1) A review of the written policies and procedures adopted by the INHAM pursuant to section I(g) for consistency with each of the objective requirements of this exemption (as described in section IV(g)).

    (2) A test of a representative sample of the plan's transactions in order to make findings regarding whether the INHAM is in compliance with (i) the written policies and procedures adopted by the INHAM pursuant to section I(g) of the exemption and (ii) the objective requirements of the exemption.

    (3) A determination as to whether the INHAM has satisfied the definition of an INHAM under the exemption; and

    (4) Issuance of a written report describing the steps performed by the auditor during the course of its review and the auditor's findings.

    (g) For purposes of section IV(f), the written policies and procedures must describe the following objective requirements of the exemption and the steps adopted by the INHAM to assure compliance with each of these requirements:

    (1) The definition of an INHAM in section IV(a).

    (2) The requirements of Part I and section I(a) regarding the discretionary authority or control of the INHAM with respect to the plan assets involved in the transaction, in negotiating the terms of the transaction, and with regard to the decision on behalf of the plan to enter into the transaction.

    (3) That any procedure for approval or veto of the transaction meets the requirements of section I(a).

    (4) For a transaction described in Part I:

    (A) that the transaction is not entered into with any person who is excluded from relief under section I(e)(1), section I(e)(2), to the extent such person has discretionary authority or control over the plan assets involved in the transaction, or section I(f), and

    (B) that the transaction is not described in any of the class exemptions listed in section I(b).

    (5) For a transaction described in Part II:

    (A) If the transaction is described in section II(a),

    (i) that the transaction is with a party described in section II(a);

    (ii) that the transaction occurs under the circumstances described in section II(a) (1) and (2);

    (iii) that the transaction does not extend beyond the period of time described in section II(a)(3); and

    (iv) that the percentage test in section II(a)(4) has been satisfied or

    (B) If the transaction is described in section II(b),

    (i) that the transaction is with a party described in sections II(b)(1);

    (ii) that the transaction is not entered into with any person excluded from relief under section II(b)(2) to the extent such person has discretionary authority or control over the plan assets involved in the lease transaction or section II(b)(3); and

    (iii) that the percentage test in section II(b)(5) has been satisfied.

    (h) The term "plan" means a plan maintained by the INHAM or an affiliate of the INHAM.

Signed at Washington,DC, 4th day of April 1996.

ALAN D. LEBOWITZ
Deputy Assistant Secretary of
Program Operations
Pension and Welfare Benefits Administration

U.S. Department of Labor

  1. Section 102 of Reorganization Plan No. 4 of 1978 (43 FR 47713, October 17, 1978), effective December 31, 1978 (44 F.R. 1063, January 3, 1978), generally transferred the authority of the Secretary of the Treasury to issue exemptions under section 4975(c)(2) of the Code to the Secretary of Labor. In the discussion of the exemption, references to sections 406 and 408 of the Act should be read to refer as well to the corresponding provisions of section 4975 of the Code.
  2. In this regard, see PTE 84-14, 49 FR 9497 (March 13, 1984).
  3. Although the Department has limited the auditor's responsibilities under the final exemption to making findings on the INHAM's compliance with the objective requirements of the exemption, the INHAM remains responsible for assuring compliance with all of the conditions of the exemption. Accordingly, the failure of the INHAM to comply with a condition of the exemption not described in section IV(g) would render the exemption unavailable.
  4. The Department cautions that the failure of the INHAM to take appropriate steps to address any adverse findings in an unsatisfactory audit would raise issues under ERISA's fiduciary responsibility provisions.

97-11    Relationship Brokerage

Relationship Brokerage (25KB PDF file - PDF Help)

Amendment #1 and Amendment #2 (28KB and 44KB PDF files - PDF Help)

97-41    Collective Investment Fund Conversion Transactions

Prohibited Transaction Class Exemption 97-41
August 8, 1997 (62 FR 42830)

Recap
Permits an employee benefit plan (Plan) to purchase shares of a mutual fund, advised by a bank or investment adviser which is also a fiduciary to the Plan, in exchange for assets transferred in-kind from a collective investment fund (CIF), when the Plan’s assets are completely withdrawn from the CIF.

Class Exemption

Conversion of Collective Investment Funds into a Registered Investment Company (Mutual Fund)

Agency: Department of Labor, Pension and Welfare Benefits Administration

Action: Grant of Class Exemption

Effective Date: Section I of this exemption is effective for transactions occurring from October 1, 1988 until August 8, 1997. Section II of the exemption is effective for transactions occurring after August 8, 1997.

Exemption

Section I.

Retroactive Exemption for the Purchase of Fund Shares With Assets Transferred In-Kind From a CIFF or the period from October 1, 1988 to August 8, 1997, the restrictions of sections 406(a) and 406 (b)(1) and (b)(2) of the Act and the taxes imposed by section 4975 of the Code, by reason of section 4975(c)(1) (A) through (E), shall not apply to the purchase by an employee benefit plan (the Client Plan) of shares of one or more open-end management investment companies (the Fund or Funds) registered under the Investment Company Act of 1940, in exchange for assets of the Client Plan transferred in-kind to the Fund from a collective investment fund (the CIF) maintained by a bank (the Bank) or a plan adviser (the Plan Adviser), where the Bank or Plan Adviser is the investment adviser to the Fund and also a fiduciary of the Client Plan. The transfer and purchase must be in connection with a complete withdrawal of the Client Plan's assets from the CIF, and the following conditions must be met:

(a) No sales commissions or other fees are paid by the Client Plan in connection with the purchase of Fund shares.

(b) All transferred assets are securities for which market quotations are readily available, or cash.

(c) The transferred assets constitute the Client Plan's pro rata portion of all assets that were held by the CIF immediately prior to the transfer.

(d) The Client Plan receives Fund shares that have a total net asset value equal to the value of the Client Plan's transferred assets on the date of the transfer, as determined with respect to securities, in a single valuation for each asset, with all valuations performed in the same manner, at the close of the same business day, in accordance with Securities and Exchange Commission Rule 17a-7 (using sources independent of the Bank or Plan Adviser and the Fund) and the procedures established by the Funds pursuant to Rule 17a-7.

(e) An independent fiduciary with respect to the Client Plan (the Independent Fiduciary) receives advance written notice of an in-kind transfer and purchase of assets and full written disclosure of information concerning the Fund which includes the following:

(1) A current prospectus for each Fund to which the CIF assets may be transferred;

(2) A statement describing the fees to be charged to, or paid by, a Client Plan and the Funds to the Bank or Plan Adviser, including the nature and extent of any differential between the rates of the fees;

(3) A statement of the reasons why the Bank or Plan Adviser may consider the transfer and purchase to be appropriate for the Client Plan; and

(4) A statement of whether there are any limitations on the Bank or Plan Adviser with respect to which plan assets may be invested in shares of the Funds, and, if so, the nature of such limitations.

(f) On the basis of the foregoing information, the Independent Fiduciary gives prior approval, in writing, for each purchase of Fund shares in exchange for the Client Plan's assets transferred from the CIF, consistent with the responsibilities, obligations and duties imposed on fiduciaries by Part 4 of Title I of the Act.

(g) The Bank or Plan Adviser sends by regular mail or personal delivery to the Independent Fiduciary of each Client Plan that purchases Fund shares in connection with the in-kind transfer, no later than 105 days after completion of each purchase, a written confirmation of the transaction containing--(1) The number of CIF units held by the Client Plan immediately before the in-kind transfer, the related per unit value and the total dollar amount of such CIF units; and (2) The number of shares in the Funds that are held by the Client Plan immediately following the purchase, the related per share net asset value and the total dollar amount of such shares.

(h) As to each Client Plan, the combined total of all fees received by the Bank or Plan Adviser for the provision of services to the Client Plan, and in connection with the provision of services to a Fund in which a Client Plan holds shares purchased in connection with the in-kind transfer, is not in excess of "reasonable compensation" within the meaning of section 408(b)(2) of the Act.

(i) All dealings in connection with the in-kind transfer and purchase between the Client Plan and a Fund are on a basis no less favorable to the Client Plan than dealings between the Fund and other shareholders.

Section II.

Prospective Exemption for the Purchase of Fund Shares With Assets Transferred In-Kind From a CIF Effective after August 8, 1997, the restrictions of sections 406(a) and 406 (b)(1) and (b)(2) of the Act and the taxes imposed by section 4975 of the Code, by reason of section 4975(c)(1) (A) through (E) of the Code, shall not apply to the purchase by an employee benefit plan (the Client Plan) of shares of one or more open-end management investment companies (the Fund or Funds) registered under the Investment Company Act of 1940, in exchange for assets of the Client Plan transferred in-kind to the Fund from a collective investment fund (the CIF) maintained by a bank (the Bank) or a plan adviser (the Plan Adviser), where the Bank or Plan Adviser is the investment adviser to the Fund and also a fiduciary of the Client Plan. The transfer and purchase must be in connection with a complete withdrawal of the Client Plan's assets from the CIF, and the following conditions must be met:

(a) No sales commissions or other fees are paid by the Client Plan in connection with the purchase of Fund shares.

(b) All transferred assets are securities for which market quotations are readily available, or cash.

(c) The transferred assets constitute the Client Plan's pro rata portion of all assets that were held by the CIF immediately prior to the transfer. Notwithstanding the foregoing, the allocation of fixed-income securities held by a CIF among Client Plans on the basis of each Client Plan's pro rata share of the aggregate value of such securities will not fail to meet the requirements of this subsection if: (1) The aggregate value of such securities does not exceed one (1) percent of the total value of the assets held by the CIF immediately prior to the transfer; and (2) Such securities have the same coupon rate and maturity, and at the time of the transfer, the same credit ratings from nationally recognized statistical rating agencies.

(d) The Client Plan receives Fund shares that have a total net asset value equal to the value of the Client Plan's transferred assets on the date of the transfer, as determined with respect to securities, in a single valuation for each asset, with all valuations performed in the same manner, at the close of the same business day, in accordance with Securities and Exchange Commission Rule 17a-7 (using sources independent of the Bank or Plan Adviser and the Fund) and the procedures established by the Funds pursuant to Rule 17a-7.

(e) An independent fiduciary with respect to the Client Plan (the Independent Fiduciary) receives advance written notice of the in-kind transfer and purchase of assets and full written disclosure of information concerning the Funds which includes the following:

  1. A current prospectus for each Fund to which the CIF assets may be transferred;
  2. A statement describing the fees to be charged to, or paid by, a Client Plan and the Funds to the Bank or Plan Adviser, including the nature and extent of any differential between the rates of the fees paid by the Fund and the rates of the fees paid by the Client Plan in connection with the Client Plan's investment in the CIF;
  3. A statement of the reasons why the Bank or Plan Adviser may consider the transfer and purchase to be appropriate for the Client Plan;
  4. A statement of whether there are any limitations on the Bank or Plan Adviser with respect to which plan assets may be invested in shares of the Funds, and, if so, the nature of such limitations;
  5. The identity of all securities that will be valued in accordance with Rule 17a-7(b)(4) and allocated on the basis of the Client Plan's pro rata portion under section II(c); and
  6. The identity of any fixed-income securities that will be allocated on the basis of each Client Plan's pro rata share of the aggregate value of such securities pursuant to section II(c).

(f) On the basis of the foregoing information, the Independent Fiduciary gives prior approval, in writing, for each purchase of Fund shares in exchange for the Client Plan's assets transferred from the CIF, consistent with the responsibilities, obligations and duties imposed on fiduciaries by Part 4 of Title I of the Act. In addition, the Independent Fiduciary must give prior approval, in writing, for the receipt of confirmation statements described below in paragraph (g)(1) and (g)(2) by facsimile or electronic mail if the Independent Fiduciary elects to receive such statements in that form.

(g) The Bank or Plan Adviser sends by regular mail or personal delivery or, if applicable, by facsimile or electronic mail to the Independent Fiduciary of each Client Plan that purchases Fund shares in connection with the in-kind transfer, the following information:

  1. No later than 30 days after the completion of the purchase, a written confirmation which contains--(i) The identity of each transferred security that was valued for purposes of the purchase of Fund shares in accordance with Rule 17a-7(b)(4); (ii) The current market price, as of the date of the in-kind transfer, of each such security involved in the purchase of Fund shares; and (iii) The identity of each pricing service or market-maker consulted in determining the current market price of such securities.
  2. No later than 105 days after the completion of each purchase, a written confirmation which contains-
  3. (i) The number of CIF units held by the Client Plan immediately before the in-kind transfer, the related per unit value and the total dollar amount of such CIF units; and (ii) The number of shares in the Funds that are held by the Client Plan immediately following the purchase, the related per share net asset value and the total dollar amount of such shares.

(h) With respect to each of the Funds in which the Client Plan continues to hold shares acquired in connection with the in-kind transfer, the Bank or Plan Adviser provides the Independent Fiduciary of the Client Plan with--(1) A copy of an updated prospectus of such Fund, at least annually; and (2) Upon request of the Independent Fiduciary, a report or statement (which may take the form of the most recent financial report, the current Statement of Additional Information, or some other written statement) containing a description of all fees paid by the Fund to the Bank or Plan Adviser.

(i) As to each Client Plan, the combined total of all fees received by the Bank or Plan Adviser for the provision of services to the Client Plan, and in connection with the provision of services to a Fund in which a Client Plan holds shares acquired in connection with the in-kind transfer, is not in excess of "reasonable compensation" within the meaning of section 408(b)(2) of the Act.

(j) All dealings in connection with the in-kind transfer and purchase between the Client Plan and a Fund are on a basis no less favorable to the Client Plan than dealings between the Fund and other shareholders.

Section III.

Availability of Prohibited Transaction Exemption (PTE) 77-4

Any purchase of Fund shares that complies with the conditions of either Section I or Section II of this class exemption shall be treated as a "purchase or sale" of shares of an open-end investment company for purposes of PTE 77-4 and shall be deemed to have satisfied paragraphs (a), (d) and (e) of section II of that exemption. 42 FR 18732 (April 8, 1977).

Section IV. Definitions For purposes of this exemption:

(a) The term "Bank" means a bank or trust company, and any affiliate thereof [as defined below in paragraph (b)(1)], which is supervised by a state or federal agency.

(b) An "affiliate" of a person includes--(1) Any person directly or indirectly through one or more intermediaries, controlling, controlled by, or under common control with the person. (2) Any officer, director, employee or relative of such person, or partner in any such person; and (3) Any corporation or partnership of which such person is an officer, director, partner or employee.

(c) The term "control" means the power to exercise a controlling influence over the management or policies of a person other than an individual.

(d) The term "collective investment fund" or "CIF" means a common or collective trust fund or pooled investment fund maintained by a "Bank" as defined in paragraph (a) of this Section IV or by a "Plan Adviser" as defined in paragraph (m) of this Section IV for the collective investment of the assets attributable to two or more plans maintained by unrelated employers.

(e) The term "Fund" or "Funds" means any open-end management investment company or companies registered under the 1940 Act for which the Bank or Plan Adviser serves as an investment adviser, and may also serve as a custodian, shareholder servicing agent, transfer agent or provide some other secondary service (as defined below in paragraph (i) of this section).

(f) The term "net asset value" means the amount calculated by dividing the value of all securities, determined by a method as set forth in a Fund's prospectus and Statement of Additional Information, and other assets belonging to each of the portfolios in such Fund, less the liabilities chargeable to each portfolio, by the number of outstanding shares.

(g) The term "relative" means a "relative" as that term is defined in section 3(15) of the Act (or a "member of the family" as that term is defined in section 4975(e)(6) of the Code), or a brother, a sister, or a spouse of a brother or a sister.

(h) The term "Independent Fiduciary" means a fiduciary of a Client Plan who is independent of and unrelated to the Bank or Plan Adviser. For purposes of this exemption, the Independent Fiduciary will not be deemed to be independent of and unrelated to the Bank or Plan Adviser if: (1) Such fiduciary directly or indirectly controls, is controlled by, or is under common control with the Bank or Plan Adviser; (2) Such fiduciary, or any officer, director, partner, employee, or relative of such fiduciary, is an officer, director, partner, employee of the Bank or Plan Adviser (or is a relative of such persons); (3) Such fiduciary, directly or indirectly receives any compensation or other consideration for his or her own personal account in connection with any transaction described in this exemption.

If an officer, director, partner, employee of the Bank or Plan Adviser (or relative of such persons), is a director of such Independent Fiduciary, and if he or she abstains from participation in (i) the choice of the Client Plan's investment adviser, and (ii) the approval of any purchase or sale between the Client Plan and the Funds, as well as any transaction described in Sections I and II above, then paragraph (h)(2) of this Section IV shall not apply.

(i) The term "secondary service" means a service provided by a Bank or Plan Adviser to a Fund other than investment management, investment advisory or similar services.

(j) The term "fixed-income security" means any interest-bearing or discounted government or corporate security with a face amount of $1,000 or more that obligates the issues to pay the holder a specified sum of money, at specific intervals, and to repay the principal amount of the loan at maturity.

(k) The term "Client Plan" means a pension plan described in 29 CFR 2510.3-2, a welfare benefit plan described in 29 CFR 2510.3-1, and a plan described in section 4975(e)(1) of the Code, but does not include an employee benefit plan established or maintained by the Bank or a Plan Adviser for its own employees.

(l) The term "security" shall have the same meaning as defined in section 2(36) of the 1940 Act, as amended, 15 U.S.C. 80a-2(36) (1996).

(m) The term "Plan Adviser" means an investment adviser registered under the Investment Advisers Act of 1940, and any "affiliate" thereof [as defined above in paragraph (b)(1)].

(n) The term "business day" means a banking day as defined by federal or state banking regulations.

(o) The term "unrelated employers" means persons which are not, directly or indirectly, affiliates, as defined above in paragraph (b)(1).

(p) The term "personal delivery" means delivery of the information described in sections I(g) and II(g) above to an individual or individuals designated by the Client Plan to act on behalf of the Independent Fiduciary.

Signed at Washington, D.C., this 1st day of August, 1997.

Alan D. Lebowitz,
Deputy Assistant Secretary for Program Operations, Pension and Welfare
Benefits Administration, Department of Labor.

[FR Doc. 97-21003 Filed 8-7-97; 8:45 AM]

98-54    Foreign Exchange Transactions Executed Pursuant to Standing Instructions

Prohibited Transaction Class Exemption 98-54
November 12, 1998 (FR Doc 98-30291)

Recap
Permits foreign exchange transactions between employee benefit plans and banks and broker-dealers, which are parties in interest with respect to such plans, pursuant to standing instructions.

Class Exemption

Foreign Exchange Transactions Executed Pursuant to Standing Instructions

Agency: Department of Labor, Pension and Welfare Benefits Administration

Action: Grant of Class Exemption

Effective Dates: Section II is effective for transactions occurring from June 18, 1991 to January 12, 999. Section III is effective for transactions occurring after January 12, 1999.

Exemption

Effective Dates: Section II is effective for transactions occurring from June 18, 1991 to January 12, 1999. Section III is effective for transactions occurring after January 12, 1999.

Exemption

Accordingly, the following exemption is granted 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 29 ERISA Procedure 75-1 (40 FR 18471, April 28, 1975).

Section I Covered Transactions

  1. For the period from June 18, 1991 to January 12, 1999, the restrictions of sections 406(a)(1)(A) through (D) and 406(b)(1) and (b)(2) of the Employee Retirement Security Act of 1974 (ERISA or the Act) and the taxes imposed by section 4975(a) and (b) of the Internal Revenue Code of 1986 (the Code), by reason of Code section 4975(c)(1)(A) through (E), shall not apply to the following foreign exchange transactions, between a bank or broker-dealer and an employee benefit plan with respect to which the bank or broker-dealer is a trustee, custodian, fiduciary or other party in interest, pursuant to a standing instruction, if the conditions set forth in section II below are met:
    1. An income item conversion; or
    2. A de minimis purchase or sale transaction.
  2. Effective after January 12, 1999, the restrictions of sections 406(a)(1)(A) through (D) and 406(b)(1) and (b)(2) of the Act and the taxes imposed by section 4975(a) and (b) of Code, by reason of Code section 4975(c)(1)(A) through (E), shall not apply to the following foreign exchange transactions, between a bank or broker-dealer, and an employee benefit plan with respect to which the bank or broker-dealer is a trustee, custodian, fiduciary or other party in interest, pursuant to a standing instruction, if the conditions set forth in section III below are met:
    1. An income item conversion; or
    2. A de minimis purchase or sale transaction.

Section II Retroactive Conditions

  1. At the time the foreign exchange transaction is entered into, the terms of the transaction are not less favorable to the plan than the terms generally available in comparable arm's length foreign exchange transactions between unrelated parties.
  2. At the time the foreign exchange transaction is entered into, the terms of the transaction are not less favorable to the plan than the terms afforded by the bank or the broker-dealer in comparable arm's length foreign exchange transactions involving unrelated parties.
  3. Neither the bank, the broker-dealer nor any foreign affiliate thereof, has any discretionary authority or control with respect to the investment of the plan assets involved in the transaction or renders investment advice (within the meaning of 29 CFR 2510.3-21(c)) with respect to the investment of those assets.
  4. The bank or broker-dealer maintains at all times written policies and procedures regarding the handling of foreign exchange transactions for plans with respect to which the bank or broker-dealer is a trustee, custodian, fiduciary or other party in interest or disqualified person which assure that the person acting for the bank or broker-dealer knows that he or she is dealing with a plan.
  5. The exchange rate used by the bank or broker-dealer for a particular foreign exchange transaction did not deviate by more than 10% (above or below) the interbank bid and asked rates at the time of the transaction as displayed on Reuters or another independent service in the foreign currency market for such currency; provided, however, that a prohibited transaction shall not be deemed to have occurred solely because records demonstrating compliance with this section with respect to specific transactions have been lost, destroyed or are not available to the bank or broker-dealer. Nothing in this section shall be deemed to relieve the bank or broker-dealer of its responsibility to demonstrate compliance with the conditions of this exemption.
  6. A written confirmation statement is furnished with respect to each covered transaction to the independent plan fiduciary that authorized the standing instruction. The confirmation statement shall include:
    1. Account name;
    2. Transaction date;
    3. Exchange rates;
    4. Settlement date;
    5. Currencies exchanged;
      1. Identity of foreign currency sold;
      2. Amount sold;
      3. Identity of currency purchased; and
      4. Amount purchased.

    The confirmation shall be issued in no event more than 5 business days after execution of the transaction.

Section III Prospective Conditions

  1. At the time the foreign exchange transaction is entered into, the terms of the transaction are not less favorable to the plan than the terms generally available in comparable arm's-length foreign exchange transactions between unrelated parties.
  2. At the time the foreign exchange transaction is entered into, the terms of the transaction are not less favorable to the plan than the terms afforded by the bank or broker-dealer in comparable arm's-length foreign exchange transactions involving unrelated parties.
  3. Neither the bank, the broker-dealer, nor any foreign affiliate thereof has any discretionary authority or control with respect to the investment of the plan assets involved in the transaction or renders investment advice (within the meaning of 29 CFR 2510.3-21(c)) with respect to the investment of those assets.
  4. The bank or broker-dealer maintains at all times written policies and procedures regarding the handling of foreign exchange transactions for plans with respect to which the bank or broker-dealer is a trustee, custodian, fiduciary or other party in interest or disqualified person which assure that the person acting for the bank or broker-dealer knows that he or she is dealing with a plan.
  5. The covered transaction is performed under a written authorization executed in advance by a fiduciary of the plan whose assets are involved in the transaction, which plan fiduciary is independent of the bank or broker-dealer engaging in the covered transaction or any foreign affiliate thereof. The written authorization must specify: (1) The identities of the currencies in which covered transactions may be executed; and (2) That the authorization may be terminated by either party without penalty on no more than ten days notice.
  6. (1) Income item conversions are executed within no more than one business day from the date of receipt of notice by the bank or broker-dealer that such items are good funds, and a foreign custodian which is an affiliate of the bank or broker-dealer, provides such notice to the bank or broker-dealer within "one business day" of its receipt of good funds;
  7. (2) De minimis purchase and sale transactions are executed within no more than one business day from the date that either the bank or broker-dealer receives notice from a foreign custodian that the proceeds of a sale of foreign securities denominated in foreign currency are good funds, or the direction to acquire foreign currency was received by the bank or broker-dealer, and a foreign custodian which is an affiliate of the bank or broker-dealer, provides such notice to the bank or broker-dealer within one business day of its receipt of good funds from a sale.

  8. (1) At least once each day, at the time(s) specified in its written policies and procedures, the bank or broker-dealer establishes either a rate of exchange or a range of rates to be used for income item conversions and de minimis purchase and sale transactions covered by this exemption.
  9. (2) Income item conversions are executed at the next scheduled time for conversions following receipt of notice by the bank or broker-dealer from the foreign custodian that such funds are good funds. If it is the policy of the bank or broker-dealer to aggregate small amounts of foreign currency until a specified minimum threshold amount is received, then the conversion may take place at a later time but in no event more than 24 hours after receipt of notice.

    (3) De minimis purchase and sale transactions are executed at the next scheduled time for such transactions following receipt of either notice that the sales proceeds denominated in foreign currency are good funds, or a direction to acquire foreign currency. If it is the policy of the bank or broker-dealer to aggregate small transactions until a specified threshold amount is received, then the execution may take place at a later time but in no event more than 24 hours after receipt of either notice that the sales proceeds have been received by the foreign custodian as good funds, or a direction to acquire foreign currency. For purposes of this paragraph (g), the range of exchange rates established by the bank or broker-dealer for a particular foreign currency cannot deviate by more than three percent [above or below] the interbank bid and asked rates as displayed on Reuters or another nationally recognized independent service in the foreign exchange market, for such currency at the time such range of rates is established by the bank or broker-dealer.

  10. Prior to the execution of the authorization referred to in paragraph (e), the bank or broker-dealer provides the independent fiduciary with a copy of the bank's or broker-dealer's written policies and procedures regarding the handling of foreign exchange transactions involving income item conversions and de minimis purchase and sale transactions. The policies and procedures must, at a minimum, contain the following information:
    1. Disclosure of the time(s) each day that the bank or broker-dealer will establish the specific rate of exchange or the range of exchange rates for the covered transactions to be executed and the time(s) that such covered transactions will take place. The bank or broker-dealer shall include a description of the methodology that the bank or broker-dealer uses to determine the specific exchange rate or range of exchange rates;
    2. Disclosure that income item conversions and de minimis purchase and sale transactions will be executed at the first scheduled transaction time after notice that good funds from an income item conversion or a sale have been received, or a direction to purchase foreign currency has been received. To the extent that the bank or broker-dealer aggregates small amounts of foreign currency until a specified minimum threshold amount is met, a description of this practice and disclosure of the threshold amount; and
    3. A description of the process by which the bank's or broker-dealer's foreign exchange policies and procedures for income item conversions and de minimis purchase and sale transactions may be amended and disclosed to plans.
  11. The bank or broker-dealer engaging in the covered transaction furnishes to the independent fiduciary a written confirmation statement with respect to each covered transaction not more than five business days after execution of the transaction.
    1. With respect to income item conversions, the confirmation shall disclose the following information:
      1. Account name;
      2. Date of notice that good funds were received;
      3. Transaction date;
      4. Exchange rate;
      5. Settlement date;
      6. Identity of foreign currency;
      7. Amount of foreign currency sold;
      8. Amount of U.S. dollars or other currency credited to the plan; and
    2. With respect to de minimis purchase and sale transactions, the confirmation shall disclose the following information:
      1. Account name;
      2. Date of notice that sales proceeds denominated in foreign currency are received as good funds or direction to acquire foreign currency was received;
      3. Transaction date;
      4. Exchange rates;
      5. Settlement date;
      6. Currencies exchanged:
        1. Identity of the currency sold;
        2. The amount sold;
        3. Identity of the currency purchased; and
        4. The amount purchased;
    3. The bank or broker-dealer, maintains, within territories under the jurisdiction of the United States Government, for a period of six years from the date of the transaction, the records necessary to enable the persons described in paragraph (l) of this section to determine whether the applicable conditions of this exemption have been met, including a record of the specific exchange rate or range of exchange rates the bank or broker-dealer established each day for foreign exchange transactions effected under standing instructions for income item conversions and de minimis purchase and sale transactions. However, a prohibited transaction will not be considered to have occurred if, due to circumstances beyond the bank's or broker-dealer's control, the records are lost or destroyed prior to the end of the six-year period, and no party in interest other than the bank or broker-dealer shall be subject to the civil penalty that may be assessed under section 502(i) of the Act, or the taxes imposed by section 4975(a) and (b) of the Code, if the records are not maintained by the bank or broker-dealer, or are not made available for examination by the bank or broker-dealer, or its affiliate as required by paragraph (k) of this section.
    4. (1) Except as provided in subparagraph (2) of this paragraph and notwithstanding any provisions of subsection (a)(2) and (b) of section 504 of the Act, the records referred to in paragraph (j) of this Section are available at their customary location for examination, upon reasonable notice, during normal business hours by:
      1. Any duly authorized employee or representative of the Department of Labor or the Internal Revenue Service.
      2. Any fiduciary of a plan who has authority to acquire or dispose of the assets of the plan involved in the foreign exchange transaction or any duly authorized employee or representative of such fiduciary.
      3. Any contributing employer to the plan involved in the foreign exchange transaction or any duly authorized employee or representative of such employer.

      (2) None of the persons described in subparagraphs (B) and (C) shall be authorized to examine a bank's or broker-dealer's trade secrets or commercial or financial information of a bank or broker-dealer, which is privileged or confidential.

Section IV Definitions and General Rules

For purposes of this exemption,

  1. A foreign exchange transaction means the exchange of the currency of one nation for the currency of another nation.
  2. The term standing instruction means a written authorization from a plan fiduciary, who is independent of the bank or broker-dealer engaging in the foreign exchange transaction and any foreign affiliate thereof, to the bank or broker-dealer to effect the transactions specified therein pursuant to the instructions provided in such authorization.
  3. A bank means a bank which is supervised by the United States or a State thereof, or any domestic affiliate thereof.
  4. A broker-dealer means a broker-dealer registered under the Securities Exchange Act of 1934, or any domestic affiliate thereof.
  5. A domestic affiliate of a bank or broker-dealer means any entity which is supervised by the United States or a State thereof and which is directly or indirectly, through one or more intermediaries, controlling, controlled by, or under common control with such bank or broker-dealer.
  6. The term control means the power to exercise a controlling influence over the management or policies of a person other than an individual.
  7. An income item conversion means: (1) The conversion into U.S. dollars of an amount which is the equivalent of no more than 300,000 U.S. dollars of interest, dividends or other distributions or payments with respect to a security, tax reclaims, proceeds from dispositions of rights, fractional shares or other similar items denominated in the currency of another nation that are received by the bank or broker-dealer on behalf of the plan from the plan's foreign investment portfolio; or (2) the conversion into any currency as required and specified by the standing instruction of an amount which is the equivalent of no more than 300,000 U.S. dollars of interest, dividends, or other distributions or payments with respect to a security, tax reclaims, proceeds from dispositions of rights, fractional shares or other similar items denominated in the currency of another nation that are received by the bank or broker-dealer on behalf of the plan from the plan's foreign investment portfolio, provided that the converted funds are either transferred to an interest bearing account which provides a reasonable rate of interest within 24 hours of the conversion and held therein pending reinvestment by the plan or the bank reinvests such proceeds within 24 hours of the conversion at the direction of the plan.
  8. A de minimis purchase or sale transaction means the purchase or sale of foreign currencies in an amount of no more than 300,000 U.S. dollars or the equivalent thereof in connection with the purchase or sale of foreign securities by a plan.
  9. For purposes of this exemption the term employee benefit plan refers to a pension plan described in 29 CFR Sec. 2510.3-2 and/or a welfare benefit plan described in 29 CFR Sec. 2510.3-1.
  10. For purposes of this exemption, the term good funds means funds immediately available in cash with no sovereign or other governmental impediments or restrictions to the exchange or transfer of such funds.
  11. For purposes of this exemption, the term business day means a banking day as defined by federal or state banking regulations.
  12. For purposes of this exemption, the term foreign affiliate of a bank or broker-dealer means any non-U.S. entity which is directly or indirectly, through one or more intermediaries, controlling, controlled by, or under common control with such bank or broker-dealer.

Signed at Washington, DC this 6th day of November 1998.

Alan D. Lebowitz,
Deputy Assistant Secretary for Program Operations, Pension and Welfare
Benefits Administration, Department of Labor.

[FR Doc. 98-30291 Filed 11-12-98; 8:45 am]

Billing Code 4510-29-P

2000-14    Amendment to PTE 80-26 for Certain Interest Free Loans to Employee Benefit Plans

Prohibited Transaction Class Exemption 2000-14
April 3, 2000 (65 FR 17540)

Recap
Provides a temporary amendment to PTE 80-26, permitting parties-in-interest to make interest free loans to a plan to continue the plan’s ordinary operation, in the event it experiences an inability to liquidate or access assets, or to access data as a result of a Y2K problem, but permits the loans to be repaid no later than December 31, 2000.

Class Exemption

Amendment to PTE 80-26 for Certain Interest Free Loans to Employee Benefit Plans

Agency: Department of Labor, Pension and Welfare Benefits Administration

Action: Grant of Class Exemption

Effective Date: The amendment to PTE 80-26 is effective from November 1, 1999 until December 31, 2000.

Exemption

Section I: General Exemption

Effective January 1, 1975, the restrictions of section 406(a)(1)(B) and (D) and section 406(b)(2) of the Act, and the taxes imposed by section 4975(a) and (b) of the Code, by reason of section 4975(c)(1)(B) and (D) of the Code, shall not apply to the lending of money or other extension of credit from a party in interest or disqualified person to an employee benefit plan, nor to the repayment of such loan or other extension of credit in accordance with its terms or written modifications thereof, if:

  1. No interest or other fee is charged to the plan, and no discount for payment in cash is relinquished by the plan, in connection with the loan or extension of credit;
  2. The proceeds of the loan or extension of credit are used only:
    1. For the payment of ordinary operating expenses of the plan, including the payment of benefits in accordance with the terms of the plan and periodic premiums under an insurance or annuity contract; or
    2. For a period of no more than three business days, for a purpose incidental to the ordinary operation of the plan;
  3. The loan or extension of credit is unsecured; and
  4. The loan or extension of credit is not directly or indirectly made by an employee benefit plan.

Section II: Temporary Exemption

Effective November 1, 1999 through December 31, 2000, the restrictions of section 406(a)(1)(B) and (D) and section 406(b)(2) of the Act, and the taxes imposed by section 4975(a) and (b) of the Code, by reason of section 4975(c)(1)(B) and (D) of the Code, shall not apply to the lending of money or other extension of credit from a party in interest or disqualified person to an employee benefit plan, nor to the repayment of such loan or other extension of credit in accordance with its terms or written modifications thereof, if:

  1. No interest or other fee is charged to the plan, and no discount for payment in cash is relinquished by the plan, in connection with the loan or extension of credit;
  2. The proceeds of the loan or extension of credit are used only for a purpose incidental to the ordinary operation of the plan which arises in connection with the plan’s inability to liquidate, or otherwise access its assets or access data as a result of a Y2K problem.
  3. The loan or extension of credit is unsecured;
  4. The loan or extension of credit is not directly or indirectly made by an employee benefit plan;
  5. The loan or extension of credit begins on or after November 1, 1999 and is repaid or terminated no later than December 31, 2000.

For the purposes of section II, a Y2K problem is a disruption of computer operations resulting from a computer system’s inability to process data because such system recognizes years only by the last two digits, causing a "00" entry to be read as the year "1900" rather than the year "2000."

Signed at Washington, D.C., this 28th day of March, 2000.

Ivan L. Strasfeld,
Director of Exemption Determinations, Pension and Welfare Benefits Administration, U.S. Department of Labor.

[FR Doc. 00-8057 Filed 3-31-00; 8:45 AM]

2002-12    Cross-Trading of Securities

Cross-Trading of Securities (201KB PDF file - PDF Help)

2002-13    Amendment to Clarify the Term "Plan"

Amendment to Clarify the Term "Plan" (42KB PDF file - PDF Help)

2002-51    Voluntary Fiduciary Correction Program

Voluntary Fiduciary Correction Program (58KB PDF file - PDF Help)

Amendment to 2002-51 (66KB PDF file - PDF Help)

2003-39    Release of Claims and Extenstions of Credit in Connection with Litigation

Release of Claims and Extenstions of Credit in Connection with Litigation (72KB PDF file - PDF Help)

2004-16    Mandatory Distributions (108KB PDF file - PDF Help)

Mandatory Distributions (108KB PDF file - PDF Help)

2006-06    Abandoned Individual Account Plans

Abandoned Individual Account Plans (116KB PDF file - PDF Help)

2006-16    Loans of Securities by Plans

Loans of Securities by Plans (108KB PDF file - PDF Help)

Interpretive Bulletins

75-2    Interpretive Bulletins Relating to the Employee Retirement Income Security Act of 1974

29 CFR 2509.75-2
Section Number: 2509.75-2
Section Name: Interpretive bulletin relating to prohibited transactions.

On February 6, 1975, the Department of Labor issued an interpretive bulletin, ERISA IB 75-2, with respect to whether a party in interest has engaged in a prohibited transaction with an employee benefit plan where the party in interest has engaged in a transaction with a corporation or partnership (withinthe meaning of section 7701 of the Internal Revenue Code of 1954) in which the plan has invested.On November 13, 1986 the Department published a final regulation dealing with the definition of "plan assets". See Sec. 2510.3-101 of this title. Under that regulation,theassets of certain entities in which plans invest would include "plan assets" for purposes of the fiduciary responsibility provisions of the Act. Section 2510.3-101 applies only for purposes of identifying plan assets on or after the effective date of that section, however, and Sec. 2510.3-101 does not apply to plan investments in certain entities that qualify for the transitional relief provided for in paragraph (k) of that section.

The principles discussed in paragraph (a) of this Interpretive Bulletin continue to be applicable for purposes of identifying assets of a plan for periods prior to the effective date of Sec. 2510.3-101 and for investments that are subject to the transitional rule in Sec. 2510.3-101(k). Paragraphs (b) and (c) of this Interpretive Bulletin, however, relate to matters outside the scope of Sec. 2510.3-101, and nothing in that section affects the continuing application of the principles discussed in those parts.

(a) Principles applicable to plan investments to which Sec. 2510.3-101 does not apply. Generally, investment by a plan in securities (within the meaning of section 3(20) of the Employee Retirement Income Security Act of 1974) of a corporation or partnership will not, solely by reason of such investment, be considered to be an investment in the underlying assets of such corporation or partnership so as to make such assets of the entity "plan assets" and thereby make a subsequent transaction between the party in interest and the corporation or partnership a prohibited transaction under section 406 of the Act. For example, where a plan acquires a security of a corporation or a limited partnership interest in a partnership, a subsequent lease or sale of property between such corporation or partnership and a party in interest will not be a prohibited transaction solely by reason of the plan's investment in the corporation or partnership. This general proposition, as applied to corporations and partnerships, is consistent with section 401(b)(1) of the Act, relating to plan investments in investment companies registered under the Investment Company Act of 1940. Under section 401(b)(1), an investment by a plan in securities of such an investment company may be made without causing, solely by reason of such investment, any of the assets of the investment company to be considered to be assets of the plan.

(b) [Reserved]

(c) Applications of the fiduciary responsibility rules. The preceding paragraphs do not mean that an investment of plan assets in a security of a corporation or partnership may not be a prohibited transaction. For example, section 406(a)(1)(D) prohibits the direct or indirect transfer to, or use by or for the benefit of, a party in interest of any assets of the plan and section 406(b)(1) prohibits a fiduciary from dealing with the assets of the plan in his own interest or for his own account. Thus, for example, if there is an arrangement under which a plan invests in, or retains its investment in, an investment company and as part of the arrangement it is expected that the investment company will purchase securities from a party in interest, such arrangement is a prohibited transaction. Similarly, the purchase by a plan of an insurance policy pursuant to an arrangement under which it is expected that the insurance company will make a loan to a party in interest is a prohibited transaction.

Moreover, notwithstanding the foregoing, if a transaction between a party in interest and a plan would be a prohibited transaction, then such a transaction between a party in interest and such corporation or partnership will ordinarily be a prohibited transaction if the plan may, by itself, require the corporation or partnership to engage in such transaction. Similarly, if a transaction between a party in interest and a plan would be a prohibited transaction, then such a transaction between a party in interest and such corporation or partnership will ordinarily be a prohibited transaction if such party in interest, together with one or more persons who are parties in interest by reason of such persons' relationship (within the meaning of section 3(14)(E) through (I)) to such party in interest may, with the aid of the plan but without the aid of any other persons, require the corporation or partnership to engage in such a transaction. However, the preceding sentence does not apply if the parties in interest engaging in the transaction, together with one or more persons who are parties in interest by reason of such persons' relationship (within the meaning of section 3(14)(E) through (I)) to such party in interest, may, by themselves, require the corporation or partnership to engage in the transaction. Further, the Department of Labor emphasizes that it would consider a fiduciary who makes or retains an investment in a corporation or partnership for the purpose of avoiding the application of the fiduciary responsibility provisions of the Act to be in contravention of the provisions of section 404(a) of the Act.

[51 FR 41280, Nov. 13, 1986, as amended at 61 FR 33849, July 1, 1996]

75-3    Interpretive bulletin relating to investments by employee benefit plans in securities of registered investment companies

29 CFR 2509.75-3
Section Number: 2509.75-3
Section Name: Interpretive bulletin relating to investments by employee benefit plans in securities of registered investment companies.

On March 12, 1975, the Department of Labor issued an interpretive bulletin, ERISA IB 75-3, with regard to its interpretation of section 3(21)(B) of the Employee Retirement Income Security Act of 1974. That section provides that an investment by an employee benefit plan in securities issued by an investment company registered under the Investment Company Act of 1940 shall not by itself cause the investment company, its investment adviser or principal underwriter to be deemed to be a fiduciary or party in interest "except insofar as such investment company or its investment adviser or principal underwriter acts in connection with an employee benefit plan covering employees of the investment company, the investment adviser, or its principal underwriter."

The Department of Labor interprets this section as an elaboration of the principle set forth in section 401(b)(1) of the Act and ERISA IB 75-2 (issued February 6, 1975) that the assets of an investment company shall not be deemed to be assets of a plan solely by reason of an investment by such plan in the shares of such investment company. Consistent with this principle, the Department of Labor interprets this section to mean that a person who is connected with an investment company, such as the investment company itself, its investment adviser or its principal underwriter, is not to be deemed to be a fiduciary of or party in interest with respect to a plan solely because the plan has invested in the investment company's shares. This principle applies, for example, to a plan covering employees of an investment adviser to an investment company where the plan invests in the securities of the investment company. In such a case the investment company or its principal underwriter is not to be deemed to be a fiduciary of or party in interest with respect to the plan solely because of such investment.On the other hand, the exception clause in section 3(21) emphasizes that if an investment company, its investment adviser or its principal underwriter is a fiduciary or party in interest for a reason other than the investment in the securities of the investment company, such a person remains a party in interest or fiduciary. Thus, in the preceding example, since an employer is a party in interest, the investment adviser remains a party in interest with respect to a plan covering its employees.

The Department of Labor emphasized that an investment adviser, principal underwriter or investment company which is a fiduciary by virtue of section 3(21)(A) of the Act is subject to the fiduciary responsibility provisions of part 4 of title I of the Act, including those relating to fiduciary duties under section 404.

[40 FR 31599, July 28, 1975. Redesignated at 41 FR 1906, Jan. 13, 1976]

75-4    Interpretive bulletin relating to indemnification of fiduciaries

29 CFR 2509.75-4
Section Number: 2509.75-4
Section Name: Interpretive bulletin relating to indemnification of fiduciaries.

On June 4, 1975, the Department of Labor issued an interpretive bulletin, ERISA IB 75-4, announcing the Department's interpretation of section 410(a) of the Employee Retirement Income Security Act of 1974, insofar as that section relates to indemnification of fiduciaries.

Section 410(a) states, in relevant part, that "any provision in an agreement or instrument which purports to relieve a fiduciary from responsibility or liability for any responsibility, obligation, or duty under this part shall be void as against public policy." The Department of Labor interprets this section to permit indemnification agreements which do not relieve a fiduciary of responsibility or liability under part 4 of title I. Indemnification provisions which leave the fiduciary fully responsible and liable, but merely permit another party to satisfy any liability incurred by the fiduciary in the same manner as insurance purchased under section 410(b)(3), are therefore not void under section 410(a).

Examples of such indemnification provisions are:

(1) Indemnification of a plan fiduciary by (a) an employer, any of whose employees are covered by the plan, or an affiliate (as defined in section 407(d)(7) of the Act) of such employer, or (b) an employee organization, any of whose members are covered by the plan; and

(2) Indemnification by a plan fiduciary of the fiduciary's employees who actually perform the fiduciary services.

The Department of Labor interprets section 410(a) as rendering void any arrangement for indemnification of a fiduciary of an employee benefit plan by the plan. Such an arrangement would have the same result as an exculpatory clause, in that it would, in effect, relieve the fiduciary of responsibility and liability to the plan by abrogating the plan's right to recovery from the fiduciary for breaches of fiduciary obligations. While indemnification arrangements do not contravene the provisions of section 410(a), parties entering into an indemnification agreement should consider whether the agreement complies with the other provisions of part 4 of title I of the Act and with other applicable laws.

[40 FR 31599, July 28, 1975. Redesignated at 41 FR 1906, Jan. 13, 1976]

75-6    Interpretive bulletin relating to section 408(c)(2) of the Employee Retirement Income Security Act of 1974.

29 CFR 2509.75-6
Section Number: 2509.75-6
Section Name: Interpretive bulletin relating to section 408(c)(2) of the Employee Retirement Income Security Act of 1974.

The Department of Labor today announced guidelines for determining when a party in interest with respect to an employee benefit plan may receive an advance for expenses to be incurred on behalf of the plan without engaging in a transaction prohibited by section 406 of the Employee Retirement Income Security Act of 1974. That section prohibits, among other things, any lending of money from a plan to 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, as well as any act whereby a fiduciary deals with the assets of a plan in his own interest or for his own account. However, section 408(c)(2) of the Act provides that nothing in section 406 of the Act shall be construed to prohibit the reimbursement by a plan of expenses properly and actually incurred by a fiduciary in the performance of his duties with the plan. Questions have arisen under section 408(c)(2) of the Act as to whether a plan may reimburse a party in interest in the performance of his duties with the plan and as to whether a plan might make an advance to a fiduciary or other party in interest for expenses to be incurred in the future.

The Department of Labor views the relevant provisions of section 408(c)(2) as clarifying the scope of section 406 so as to permit reimbursement of fiduciaries for expenses incurred in the performance of their duties with a plan. Similarly, consistent with section 408(c)(2), section 406 is construed to permit the reimbursement by the plan of expenses properly and actually incurred by a party in interest in the performance of his duties with the plan. If a plan makes an advance to a fiduciary or other party in interest to cover expenses to be properly and actually incurred by such person in the performance of his duties with the plan, a prohibited transaction within the meaning of section 406 shall not occur when the plan makes the advance if-

(a) The amount of such advance is reasonable with respect to the amount of the expense which is likely to be properly and actually incurred in the immediate future (such as during the next month), and

(b) The party in interest accounts to the plan at the end of the period covered by the advance for the expenses actually incurred (whether computed on the basis of actual expenses incurred or on the basis of actual transportation costs plus a reasonable per diem allowance, where appropriate).

It should be noted, however, that despite the reasonableness of the amount of the advance and of the expenses underlying it, the question of whether incurring such expenses was prudent, and thus whether the advance was for reasonable expenses, is to be judged pursuant to section 404 of the Act (relating to fiduciary responsibilities).

[40 FR 31755, July 29, 1975. Redesignated at 41 FR 1906, Jan. 13, 1976]

75-8    Questions and answers relating to fiduciary responsibility under the Employee Retirement Income Security Act of 1974

29 CFR 2509.75-8
Section Number: 2509.75-8
Section Name: Questions and answers relating to fiduciary responsibility under the Employee Retirement Income Security Act of 1974.

The Department of Labor today issued questions and answers relating to certain aspects of fiduciary responsibility under the Act, thereby supplementing ERISA IB 75-5 (29 CFR 2555.75-5) which was issued on June 24, 1975, and published in the Federal Register on July 28, 1975 (40 FR 31598). Pending the issuance of regulations or other guidelines, persons may rely on the answers to these questions in order to resolve the issues that are specifically considered. No inferences should be drawn regarding issues not raised which may be suggested by a particular question and answer or as to why certain questions, and not others, are included. Furthermore, in applying the questions and answers, the effect of subsequent legislation, regulations, court decisions, and interpretive bulletins must be considered. To the extent that plans utilize or rely on these answers and the requirements of regulations subsequently adopted vary from the answers relied on, such plans may have to be amended. An index of the questions and answers, relating them to the appropriate sections of the Act, is also provided.

Index

Key to question prefixes: D - refers to definitions; FR - refers to fiduciary responsibility.

------------------------------------------------------------------------
Section No. Question No.
------------------------------------------------------------------------
3(21)(A).................................. D-2, D-3, D-4, D-5.
3(38)..................................... FR-15.
402(c)(1)................................. FR-12.
402(c)(2)................................. FR-15.
402(c)(3)................................. FR-15.
403(a)(2)................................. FR-15.
404(a)(1)(B).............................. FR-11, FR-17.
405(a).................................... FR-13, FR-14, FR-16.
405(c)(1)................................. FR-12, FR-15.
405(c)(2)................................. D-4, FR-13, FR-14, FR-16.
412....................................... D-2.
------------------------------------------------------------------------

Note: Questions D-2, D-3, D-4, and D-5 relate to not only section 3(21)(A) of title I of the Act, but also section 4975(e)(3) of the Internal Revenue Code (section 2003 of the Act). The Internal Revenue Service has indicated its concurrence with the answers to these questions.

D-2 Q: Are persons who have no power to make any decisions as to plan policy, interpretations, practices or procedures, but who perform the following administrative functions for an employee benefit plan, within a framework of policies, interpretations, rules, practices and procedures made by other persons, fiduciaries with respect to the plan:

(1) Application of rules determining eligibility for participation
or benefits;
(2) Calculation of services and compensation credits for benefits;
(3) Preparation of employee communications material;
(4) Maintenance of participants' service and employment records;
(5) Preparation of reports required by government agencies;
(6) Calculation of benefits;
(7) Orientation of new participants and advising participants of
their rights and options under the plan;
(8) Collection of contributions and application of contributions as
provided in the plan;
(9) Preparation of reports concerning participants' benefits;
(10) Processing of claims; and
(11) Making recommendations to others for decisions with respect to
plan administration?

A: No. Only persons who perform one or more of the functions described in section 3(21)(A) of the Act with respect to an employee benefit plan are fiduciaries. Therefore, a person who performs purely ministerial functions such as the types described above for an employee benefit plan within a framework of policies, interpretations, rules, practices and procedures made by other persons is not a fiduciary because such person does not have discretionary authority or discretionary control respecting management of the plan, does not exercise any authority or control respecting management or disposition of the assets of the plan, and does not render investment advice with respect to any money or other property of the plan and has no authority or responsibility to do so. However, although such a person may not be a plan fiduciary, he may be subject to the bonding requirements contained in section 412 of the Act if he handles funds or other property of the plan within the meaning of applicable regulations. The Internal Revenue Service notes that such persons would not be considered plan fiduciaries within the meaning of section 4975(e)(3) of the Internal Revenue Code of 1954.

D-3 Q: Does a person automatically become a fiduciary with respect to a plan by reason of holding certain positions in the administration of such plan?

A: Some offices or positions of an employee benefit plan by their very nature require persons who hold them to perform one or more of the functions described in section 3(21)(A) of the Act. For example, a plan administrator or a trustee of a plan must, be the very nature of his position, have "discretionary authority or discretionary responsibility in the administration" of the plan within the meaning of section 3(21)(A)(iii) of the Act. Persons who hold such positions will therefore be fiduciaries. Other offices and positions should be examined to determine whether they involve the performance of any of the functions described in section 3(21)(A) of the Act. For example, a plan might designate as a "benefit supervisor" a plan employee whose sole function is to calculate the amount of benefits to which each plan participant is entitled in accordance with a mathematical formula contained in the written instrument pursuant to which the plan is maintained. The benefit supervisor, after calculating the benefits, would then inform the plan administrator of the results of his calculations, and the plan administrator would authorize the payment of benefits to a particular plan participant. The benefit supervisor does not perform any of the functions described in section 3(21)(A) of the Act and is not, therefore, a plan fiduciary. However, the plan might designate as a "benefit supervisor" a plan employee who has the final authority to authorize or disallow benefit payments in cases where a dispute exists as to the interpretation of plan provisions relating to eligibility for benefits. Under these circumstances, the benefit supervisor would be a fiduciary within the meaning of section 3(21)(A) of the Act. The Internal Revenue Service notes that it would reach the same answer to this question under section 4975(e)(3) of the Internal Revenue Code of 1954.

D-4 Q: In the case of a plan established and maintained by an employer, are members of the board of directors of the employer fiduciaries with respect to the plan?

A: Members of the board of directors of an employer which maintains an employee benefit plan will be fiduciaries only to the extent that they have responsibility for the functions described in section 3(21)(A) of the Act. For example, the board of directors may be responsible for the selection and retention of plan fiduciaries. In such a case, members of the board of directors exercise "discretionary authority or discretionary control respecting management of such plan" and are, therefore, fiduciaries with respect to the plan. However, their responsibility, and, consequently, their liability, is limited to the selection and retention of fiduciaries (apart from co-fiduciary liability arising under circumstances described in section 405(a) of the Act). In addition, if the directors are made named fiduciaries of the plan, their liability may be limited pursuant to a procedure provided for in the plan instrument for the allocation of fiduciary responsibilities among named fiduciaries or for the designation of persons other than named fiduciaries to carry out fiduciary responsibilities, as provided in section 405(c)(2).The Internal Revenue Service notes that it would reach the same answer to this question under section 4975(e)(3) of the Internal Revenue
Code of 1954.

D-5 Q: Is an officer or employee of an employer or employee organization which sponsors an employee benefit plan a fiduciary with respect to the plan solely by reason of holding such office or
employment if he or she performs none of the functions described in section 3(21)(A) of the Act?

A: No, for the reasons stated in response to question D-2. The Internal Revenue Service notes that it would reach the same answer to this question under section 4975(e)(3) of the Internal Revenue
Code of 1954.

FR-11 Q: In discharging fiduciary responsibilities, may a fiduciary with respect to a plan rely on information, data, statistics or analyses provided by other persons who perform purely ministerial functions for such plan, such as those persons described in D-2 above?

A: A plan fiduciary may rely on information, data, statistics or analyses furnished by persons performing ministerial functions for the plan, provided that he has exercised prudence in the selection and retention of such persons. The plan fiduciary will be deemed to have acted prudently in such selection and retention if, in the exercise of ordinary care in such situation, he has no reason to doubt the competence, integrity or responsibility of such persons.

FR-12 Q: How many fiduciaries must an employee benefit plan have?

A: There is no required number of fiduciaries that a plan must have. Each plan must, of course, have at least one named fiduciary who serves as plan administrator and, if plan assets are held in trust, the plan
must have at least one trustee. If these requirements are met, there is no limit on the number of fiduciaries a plan may have. A plan may have as few or as many fiduciaries as are necessary for its operation and administration. Under section 402(c)(1) of the Act, if the plan so provides, any person or group of persons may serve in more than one fiduciary capacity, including serving both as trustee and administrator. Conversely, fiduciary responsibilities not involving management and control of plan assets may, under section 405(c)(1) of the Act, be allocated among named fiduciaries and named fiduciaries may designate persons other than named fiduciaries to carry out such fiduciary responsibilities, if the plan instrument expressly provides procedures for such allocation or designation.

FR-13 Q: If the named fiduciaries of an employee benefit plan allocate their fiduciary responsibilities among themselves in accordance with a procedure set forth in the plan for the allocation of responsibilities for operation and administration of the plan, to what extent will a named fiduciary be relieved of liability for acts and omissions of other named fiduciaries in carrying out fiduciary
responsibilities allocated to them?

A: If named fiduciaries of a plan allocate responsibilities in accordance with a procedure for such allocation set forth in the plan, a named fiduciary will not be liable for acts and omissions of other named fiduciaries in carrying out fiduciary responsibilities which have been allocated to them, except as provided in section 405(a) of the Act, relating to the general rules of co-fiduciary responsibility, and section 405(c)(2)(A) of the Act, relating in relevant part to standards for establishment and implementation of allocation procedures. However, if the instrument under which the plan is maintained does not provide for a procedure for the allocation of fiduciary responsibilities among named fiduciaries, any allocation which the named fiduciaries may make among themselves will be ineffective to relieve a named fiduciary from responsibility or liability for the performance of fiduciary responsibilities allocated to other named fiduciaries.

FR-14 Q: If the named fiduciaries of an employee benefit plan designate a person who is not a named fiduciary to carry out fiduciary responsibilities, to what extent will the named fiduciaries be relieved of liability for the acts and omissions of such person in the
performance of his duties?

A: If the instrument under which the plan is maintained provides for a procedure under which a named fiduciary may designate persons who are not named fiduciaries to carry out fiduciary responsibilities, named fiduciaries of the plan will not be liable for acts and omissions of a person who is not a named fiduciary in carrying out the fiduciary responsibilities which such person has been designated to carry out, except as provided in section 405(a) of the Act, relating to the general rules of co-fiduciary liability, and section 405(c)(2)(A) of the Act, relating in relevant part to the designation of persons to carry out fiduciary responsibilities. However, if the instrument under which the plan is maintained does not provide for a procedure for the designation of persons who are not named fiduciaries to carry out fiduciary responsibilities, then any such designation which the named fiduciaries may make will not relieve the named fiduciaries from responsibility or liability for the acts and omissions of the persons so designated.

FR-15 Q: May a named fiduciary delegate responsibility for management and control of plan assets to anyone other than a person who is an investment manager as defined in section 3(38) of the Act so as to be relieved of liability for the acts and omissions of the person to whom such responsibility is delegated?

A: No. Section 405(c)(1) does not allow named fiduciaries to delegate to others authority ordiscretion to manage or control plan assets. However, under the terms of sections 403(a)(2) and 402(c)(3) of
the Act, such authority and discretion may be delegated to persons who are investment managers as defined in section 3(38) of the Act. Further, under section 402(c)(2) of the Act, if the plan so provides, a named fiduciary may employ other persons to render advice to the named fiduciary to assist the named fiduciary in carrying out his investment responsibilities under the plan.

FR-16 Q: Is a fiduciary who is not a named fiduciary with respect to an employee benefit plan personally liable for all phases of the management and administration of the plan?

A: A fiduciary with respect to the plan who is not a named fiduciary is a fiduciary only to the extent that he or she performs one or more of the functions described in section 3(21)(A) of the Act. The personal liability of a fiduciary who is not a named fiduciary is generally limited to the fiduciary functions, which he or she performs with respect to the plan. With respect to the extent of liability of a named fiduciary of a plan where duties are properly allocated among named fiduciaries or where named fiduciaries properly designate other persons to carry out certain fiduciary duties, see question FR-13 and FR-14. In addition, any fiduciary may become liable for breaches of fiduciary responsibility committed by another fiduciary of the same plan under circumstances giving rise to co fiduciary liability, as provided in section 405(a) of the Act.

FR-17 Q: What are the ongoing responsibilities of a fiduciary who has appointed trustees or other fiduciaries with respect to these appointments?

A: At reasonable intervals the performance of trustees and other fiduciaries should be reviewed by the appointing fiduciary in such manner as may be reasonably expected to ensure that their performance has been in compliance with the terms of the plan and statutory standards, and satisfies the needs ofthe plan. No single procedure will be appropriate in all cases; the procedure adopted may vary in accordance with the nature of the plan and other facts and circumstances relevant to the choice of the procedure.

[40 FR 47491, Oct. 9, 1975. Redesignated at 41 FR 1906, Jan. 13, 1976]

94-1    Economically Targeted Investments (Social Investing)

Interpretive Bulletin 94-1
Economically Targeted Investments (Social Investing)

June 23, 1994 (59 FR 32606)

Summary
Establishes DOL position on permissibility of making investments which achieve a social goal in addition to a financial return. Indicates that ETIs are not prohibited by ERISA, and that their choice as an investment must follow DOL ERISA regulation 2550.404a-1 (Investment Duties), be prudent, not be a prohibited transaction, and not provide less return to a plan than a normal investment.

Interpretive Bulletin

Agency: Pension and Welfare Benefits Administration, Labor Department

Action: Interpretive Bulletin

Summary: This document sets forth the view of the Department of Labor (the Department) concerning the legal standard imposed by sections 403 and 404 of Part 4 of Title I of the Employee Retirement Income Security Act of 1974 (ERISA) with respect to a plan fiduciary's decision to invest plan assets in "economically targeted investments" (ETIs). ETIs are generally defined as investments that are selected for the economic benefits they create in addition to the investment return to the employee benefit plan investor. In this document, the Department states that the requirements of sections 403 and 404 do not prevent plan fiduciaries from deciding to invest plan assets in an ETI if the ETI has an expected rate of return that is commensurate to rates of return of alternative investments with similar risk characteristics that are available to the plan, and if the ETI is otherwise an appropriate investment for the plan in terms of such factors as diversification and the investment policy of the plan.

Effective Date: January 1, 1975

Interpretive Bulletin

Section 2509.94-1

Interpretive Bulletin Relating to the fiduciary standard under ERISA in considering economically targeted investments.

This Interpretive Bulletin sets forth the Department of Labor's interpretation of sections 403 and 404 of the Employee Retirement Income Security Act of 1974 (ERISA), as applied to employee benefit plan investments in "economically targeted investments" (ETIs), that is, investments selected for the economic benefits they create apart from their investment return to the employee benefit plan. Sections 403 and 404, in part, require that a fiduciary of a plan act prudently, and to diversify plan investments so as to minimize the risk of large losses, unless under the circumstances, it is clearly prudent not to do so. In addition, these sections require that a fiduciary act solely in the interest of the plan's participants and beneficiaries and for the exclusive purpose of providing benefits to their participants and beneficiaries. The Department has 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 retirement income to unrelated objectives.

With regard to investing plan assets, the Department has issued a regulation, at 29 C.F.R. 2550.404a-1, interpreting the prudence requirements of ERISA as they apply to the investment duties of fiduciaries of employee benefit plans. The regulation provides that the prudence requirements of section 404(a)(1)(B) are satisfied if -

  1. The fiduciary making an investment or engaging in an investment course of action has given appropriate consideration to those facts and circumstances that, given the scope of the fiduciary's investment duties, the fiduciary knows or should know are relevant, and
  2. The fiduciary acts accordingly.

This includes giving appropriate consideration to the role that the investment or investment course of action plays (in terms or such factors as diversification, liquidity and risk/return characteristics) with respect to that portion of the plan's investment portfolio within the scope of the fiduciary's responsibility.

Other facts and circumstances relevant to an investment or investment course of action would, in the view of the Department, include consideration of the expected return on alternative investments with similar risks available to the plan. It follows that, because every investment necessarily causes a plan to forgo other investment opportunities, an investment will not be prudent if it would be expected to provide a plan with a lower rate of return than available alternative investments with commensurate degrees of risk or is riskier than alternative available investments with commensurate rates of return.

The fiduciary standards applicable to ETIs are no different than the standards applicable to plan investments generally. Therefore, if the above requirements are met, the selection of an ETI, or the engaging in an investment course of action intended to result in the selection of ETIs, will not violate section 404(a)(1)(A) and (B) and the exclusive purpose requirements of section 403.

94-2    Voting of Proxies and Investment Policies

Interpretive Bulletin 94-2
Voting of Proxies and Investment Policies

July 29, 1994 (59 FR 38860)

Summary
Establishes DOL position on (1) the desirability of plan investment policies, and when such policies must be followed as a "plan document" under ERISA 404(a)(1)(D); and (2) responsibilities by trustees, named fiduciaries, and investment managers (including collective investment funds) to vote proxies.

Interpretive Bulletin

Agency: Department of Labor.

Action: Interpretive Bulletin.

Summary: This document summarizes the Department of Labor's (the Department) statements with respect to the duty of employee benefit plan fiduciaries to vote proxies appurtenant to shares of corporate stock held by their plans. In these statements, the Department has explained, among other things, that the voting of proxies is a fiduciary act of plan asset management This document also describes the Department's view of the legal standards imposed by sections 402(c)(3)403(a) and 404(a)(1)(B) of part 4 of title I of the Employee Retirement Income Security Act of 1974 (ERISA) on the use of written statements of investment policy, including statements of proxy voting policy or guidelines. The bulletin makes clear that a named fiduciary who appoints an investment manager may, consistent with its fiduciary obligations, issue written statements of investment policy, including guidelines as to the voting of proxies by the investment manager. Moreover, an investment manager may be required to comply with such investment policies to the extent that any given investment decision (including a proxy voting decision) is consistent with the provisions of title I or title IV of ERISA. Finally, this document provides guidance concerning the appropriateness under ERISA of more active monitoring of corporate management by fiduciaries of plans that own corporate securities.

Effective Date: January 1, 1975

Interpretive Bulletin

This interpretive bulletin sets forth the Department of Labor's (the Department) interpretation of sections 402403 and 404 of the Employee Retirement Income Security Act of 1974 (ERISA) as those sections apply to voting of proxies on securities held in employee benefit plan investment portfolios and the maintenance of and compliance with statements of investment policy, including proxy voting policy. In addition, this interpretive bulletin provides guidance on the appropriateness under ERISA of active monitoring of corporate management by plan fiduciaries.

  1. Proxy Voting
  2. The fiduciary act of managing plan assets that are shares of corporate stock includes the voting of proxies appurtenant to those shares of stock. As a result, the responsibility for voting proxies lies exclusively with the plan trustee except to the extent that either (1) the trustee is subject to the directions of a named fiduciary pursuant to ERISA § 403(a)(1); or (2) the power to manage, acquire or dispose of the relevant assets has been delegated by a named fiduciary to one or more investment managers pursuant to ERISA § 403(a)(2). Where the authority to manage plan assets has been delegated to an investment manager pursuant to § 403(a)(2), no person other than the investment manager has authority to vote proxies appurtenant to such plan assets except to the extent that the named fiduciary has reserved to itself (or to another named fiduciary so authorized by the plan document) the right to direct a plan trustee regarding the voting of proxies. In this regard, a named fiduciary, in delegating investment management authority to an investment manager, could reserve to itself the right to direct a trustee with respect to the voting of all proxies or reserve to itself the right to direct a trustee as to the voting of only those proxies relating to specified assets or issues.

    If the plan document or investment management agreement provides that the investment manager is not required to vote proxies, but does not expressly preclude the investment manager from voting proxies, the investment manager would have exclusive responsibility for voting proxies. Moreover, an investment manager would not be relieved of its own fiduciary responsibilities by following directions of some other person regarding the voting of proxies, or by delegating such responsibility to another person. If, however, the plan document or the investment management contract expressly precludes the investment manager from voting proxies, the responsibility for voting proxies would lie exclusively with the trustee. The trustee, however, consistent with the requirements of ERISA § 403(a)(1), may be subject to the directions of a named fiduciary if the plan so provides.

    The fiduciary duties described at ERISA § 404(a)(1)(A) and (B), require that, in voting proxies, the responsible fiduciary consider those factors that may affect the value of the plan's investment and not subordinate the interests of the participants and beneficiaries in their retirement income to unrelated objectives. These duties also require that the named fiduciary appointing an investment manager periodically monitor the activities of the investment manager with respect to the management of plan assets, including decisions made and actions taken by the investment manager with regard to proxy voting decisions. The named fiduciary must carry out this responsibility solely in the interest of the participants and beneficiaries and without regard to its relationship to the plan sponsor.

    It is the view of the Department that compliance with the duty to monitor necessitates proper documentation of the activities that are subject to monitoring. Thus, the investment manager or other responsible fiduciary would be required to maintain accurate records as to proxy voting. Moreover, if the named fiduciary is to be able to carry out its responsibilities under ERISA § 404(a) in determining whether the investment manager is fulfilling its fiduciary obligations in investing plans assets in a manner that justifies the continuation of the management appointment, the proxy voting records must enable the named fiduciary to review not only the investment manager's voting procedure with respect to plan-owned stock, but also to review the actions taken in individual proxy voting situations.

    The fiduciary obligations of prudence and loyalty to plan participants and beneficiaries require the responsible fiduciary to vote proxies on issues that may affect the value of the plan's investment. Although the same principles apply for proxies appurtenant to shares of foreign corporations, the Department recognizes that in voting such proxies, plans may, in some cases, incur additional costs. Thus, a fiduciary should consider whether the plan's vote, either by itself or together with the votes of other shareholders, is expected to have an effect on the value of the plan's investment that will outweigh the cost of voting. Moreover, a fiduciary, in deciding whether to purchase shares of a foreign corporation, should consider whether the difficulty and expense in voting the shares is reflected in their market price.

  3. Statements of Investment Policy
  4. The maintenance by an employee benefit plan of a statement of investment policy designed to further the purposes of the plan and its funding policy is consistent with the fiduciary obligations set forth in ERISA § 404(a)(1)(A) and (B). Since the fiduciary act of managing plan assets that are shares of corporate stock includes the voting of proxies appurtenant to those shares of stock, a statement of proxy voting policy would be an important part of any comprehensive statement of investment policy. For purposes of this document, the term "statement of investment policy" means a written statement that provides the fiduciaries who are responsible for plan investments with guidelines or general instructions concerning various types or categories of investment management decisions, which may include proxy voting decisions. A statement of investment policy is distinguished from directions as to the purchase or sale of a specific investment at a specific time or as to voting specific plan proxies.

    In plans where investment management responsibility is delegated to one or more investment managers appointed by the named fiduciary pursuant to ERISA § 402(c)(3), inherent in the authority to appoint an investment manager, the named fiduciary responsible for appointment of investment managers has the authority to condition the appointment on acceptance of a statement of investment policy. Thus, such a named fiduciary may expressly require, as a condition of the investment management agreement, that an investment manager comply with the terms of a statement of investment policy which sets forth guidelines concerning investments and investment courses of action which the investment manager is authorized or is not authorized to make. Such investment policy may include a policy or guidelines on the voting of proxies on shares of stock for which the investment manager is responsible. In the absence of such an express requirement to comply with an investment policy, the authority to manage the plan assets placed under the control of the investment manager would lie exclusively with the investment manager. Although a trustee may be subject to the directions of a named fiduciary pursuant to ERISA § 403(a)(1), an investment manager who has authority to make investment decisions, including proxy voting decisions, would never be relieved of its fiduciary responsibility if it followed directions as to specific investment decisions from the named fiduciary or any other person.

    Statements of investment policy issued by a named fiduciary authorized to appoint investment managers would be part of the "documents and instruments governing the plan" within the meaning of ERISA § 404(a)(1)(D). An investment manager to whom such investment policy applies would be required to comply with such policy, pursuant to ERISA § 404(a)(1)(D) insofar as the policy directives or guidelines are consistent with titles I and IV of ERISA. Therefore, if, for example, compliance with the guidelines in a given instance would be imprudent then the investment manager's failure to follow the guidelines would not violate ERISA § 404(a)(1)(D). Moreover, ERISA § 404(a)(1)(D) does not shield the investment manager from liability for imprudent actions taken in compliance with a statement of investment policy.

    The plan document or trust agreement may expressly provide a statement of investment policy to guide the trustee or may authorize a named fiduciary to issue a statement of investment policy applicable to a trustee. Where a plan trustee is subject to an investment policy, the trustee's duty to comply with such investment policy would also be analyzed under ERISA § 404(a)(1)(D). Thus, the trustee would be required to comply with the statement of investment policy unless, for example, it would be imprudent to do so in a given instance.

    Maintenance of a statement of investment policy by a named fiduciary does not relieve the named fiduciary of its obligations under ERISA § 404(a) with respect to the appointment and monitoring of an investment manager or trustee. In this regard, the named fiduciary appointing an investment manager must periodically monitor the investment manager's activities with respect to management of the plan assets. Moreover, compliance with ERISA § 404(a)(1)(B) would require maintenance of proper documentation of the activities of the investment manager and of the named fiduciary of the plan in monitoring the activities of the investment manager. In addition, in the view of the Department, a named fiduciary's determination of the terms of a statement of investment policy is an exercise of fiduciary responsibility and, as such, statements may need to take into account factors such as the plan's funding policy and its liquidity needs as well as issues of prudence, diversification and other fiduciary requirements of ERISA.

    An investment manager of a pooled investment vehicle that holds assets of more than one employee benefit plan may be subject to a proxy voting policy of one plan that conflicts with the proxy voting policy of another plan. Compliance with ERISA § 404(a)(1)(D) would require such investment manager to reconcile, insofar as possible, the conflicting policies (assuming compliance with each policy would be consistent with ERISA § 404(a)(1)(D)) and, if necessary and to the extent permitted by applicable law, vote the relevant proxies to reflect such policies in proportion to each plan's interest in the pooled investment vehicle. If, however, the investment manager determines that compliance with conflicting voting policies would violate ERISA § 404(a)(1)(D) in a particular instance, for example, by being imprudent or not solely in the interest of plan participants, the investment manager would be required to ignore the voting policy that would violate ERISA § 404(a)(1)(D) in that instance. Such an investment manager may, however, require participating investors to accept the investment manager's own investment policy statement, including any statement of proxy voting policy, before they are allowed to invest. As with investment policies originating from named fiduciaries, a policy initiated by an investment manager and adopted by the participating plans would be regarded as an instrument governing the participating plans, and the investment manager's compliance with such a policy would be governed by ERISA § 404(a)(1)(D).

  5. Shareholder Activism

An investment policy that contemplates activities intended to monitor or influence the management of corporations in which the plan owns stock is consistent with a fiduciary's obligations under ERISA where the responsible fiduciary concludes that there is a reasonable expectation that such monitoring or communication with management, by the plan alone or together with other shareholders, is likely to enhance the value of the plan's investment in the corporation, after taking into account the costs involved. Such a reasonable expectation may exist in various circumstances, for example, where plan investments in corporate stock are held as long-term investments or where a plan may not be able to easily dispose such an investment. Active monitoring and communication activities would generally concern such issues as the independence and expertise of candidates for the corporation's board of directors and assuring that the board has sufficient information to carry out its responsibility to monitor management. Other issues may include such matters as consideration of the appropriateness of executive compensation, the corporation's policy regarding mergers and acquisitions, the extent of debt financing and capitalization, the nature of long-term business plans, the corporation's investment in training to develop its work force, other workplace practices and financial and nonfinancial measures of corporate performance. Active monitoring and communication may be carried out through a variety of methods including by means of correspondence and meetings with corporate management as well as by exercising the legal rights of a shareholder.

94-3    In-Kind Contributions to Employee Benefit Plans

Interpretive Bulletin 94-3
In-Kind Contributions to Employee Benefit Plans

December 28, 1994 (59 FR 66735)

Summary
Covers non-cash ("in-kind") contributions to ERISA plans. Establishes DOL positions on whether the contributions constitute a prohibited transaction and what a fiduciary must consider before accepting them.
l For defined benefit plans, indicates that an in-kind contribution is a prohibited transaction.
l For defined contribution plans, in-kind contributions may be acceptable, depending on the circumstances and provisions of the plan document. For these plans, a fiduciary must consider the fiduciary responsibility factors in ERISA § 404 in weighing whether to accept an in-kind contribution.

Interpretive Bulletin

Agency: Pension and Welfare Benefits Administration, Department of Labor

Action: Interpretive Bulletin.

Summary: This document provides guidance on in-kind contributions to employee benefit plans under the Employee Retirement Income Security Act of 1974 (ERISA) and plans under section 4975 of the Internal Revenue Code (the Code). The Supreme Court addressed certain in-kind contributions to defined benefit pensions plans in Commissioner of Internal Revenue v. Keystone Consolidated Industries, Inc., U.S.  113 S. Ct. 2006 (1993). The Court in Keystone held that an employer's contribution of unencumbered real properties to a tax-qualified defined benefit pension plan in satisfaction of the employer's funding obligation is a "sale or exchange" prohibited by section 4975(c)(1)(A) of the CodeSection 406(a)(1)(A) of ERISA is a parallel provision to section 4975(c)(1)(A) of the Code but applies to a different group of plans. This document sets forth the Department's view that in-kind contributions (for example, contributions of any property other than cash) that reduce an obligation to the plan constitute prohibited transactions under section 4975(c)(1)(A) of the Code and section 406(a)(1)(A) of ERISA.

Effective Date: The guidance announced in this bulletin is effective January 1, 1975.

Interpretive Bulletin

Part 2509
Interpretive Bulletin
Relating to In-Kind Contributions to Employee Benefit Plans.

  1. General. This bulletin sets forth the views of the Department of Labor (the Department) concerning in-kind contributions (for example, contributions of property other than cash) in satisfaction of an obligation to contribute to an employee benefit plan to which part 4 of Title I of the Employee Retirement income Security Act of 1974 (ERISA) or a plan to which section 4975 of the Internal Revenue Code (the Code) applies. (For purposes of this document the term "plan" shall refer to either or both types of such entities as appropriate). Section 406(a)(1)(A) of ERISA provider that a fiduciary with respect to a plan shall not cause the plan to engage in a transaction if the fiduciary knows or should know that the transaction constitutes a direct or indirect sale or exchange of any property between a plan and a party in interest" as defined in section 3(14) of ERISA. The Code imposes a two-tier excise tax under section 4975(c)(1)(A) an any direct or indirect sale or exchange of any property between a plan and a "disqualified person" as defined in section 4975(e)(2) of the Code. An employer or employee organization that maintains a plan is included within the definitions of "party in interest" and "disqualified person."1
  2. In Commissioner of Internal Revenue v. Keystone Consolidated Industries, Inc.,  U.S. , 113 S. Ct. 2006 (1993), the Supreme Court held that an employer's contribution of unencumbered real property to a tax-qualified defined benefit pension plan was a sale or exchange prohibited under section 4975 of the Code where the stated fair market value of the property was credited against the employer's obligation to the defined benefit pension plan. The parties stipulated that the property was contributed to the plan free of encumbrances and the stated fair market value of the property was not challenged. 113 S. Ct. at 2009. In reaching its holding the Court construed section 4975(f)(3) of the Code (and therefore section 406(c) of ERISA), regarding transfers of encumbered property, not as a limitation but rather as extending the reach of section 4975(c)(1)(A) of the Code (and thus section 406(a)(1)(A) of ERISA) to include contributions of encumbered property that do not satisfy funding obligations. Id. at 2013. Accordingly, the Court concluded that the contribution of unencumbered property was prohibited under section 4975(c)(1)(A) of the Code (and thus section 406(a)(1)(A) of ERISA) as "at least both an indirect type of sale and a form of exchange, since the property is exchanged for diminution of the employer's funding obligation." 113 S. Ct. at 2012.

  3. Defined benefit plans. Consistent with the reasoning of the Supreme Court in Keystone, because an employer's or plan sponsor's in-kind contribution to a defined benefit pension plan is credited to the plan's funding standard account it would constitute a transfer to reduce an obligation of the sponsor or employer to the plan. Therefore, in the absence of an applicable exemption, such a contribution would be prohibited under section 406(a)(1)(A) of ERISA and section 4975(c)(1)(A) of the Code. Such an in-kind contribution would constitute a prohibited transaction even if the value of the contribution is in excess of the sponsor's or employer's funding obligation for the plan year in which the contribution is made and thus is not used to reduce the plan's accumulated funding deficiency for that plan year because the contribution would result in a credit against funding obligations which might arise in the future.
  4. Defined contribution and welfare plans. In the context of defined contribution pension plans and welfare plans, it is the view of the Department that an in-kind contribution to a plan that reduces an obligation of a plan sponsor or employer to make a contribution measured in terms of cash amounts would constitute a prohibited transaction under section 406(a)(1)(A) of ERISA (and section 4975(c)(1)(A) of the Code) unless a statutory or administrative exemption under section 408 of ERISA (or sections 4975(c)(2) or (d) of the Code) applies. For example, if a profit sharing plan required the employer to make annual contributions "in cash or in kind" equal to a given percentage of the employer's net profits for the year, an in-kind contribution used to reduce this obligation would constitute a prohibited transaction in the absence of an exemption because the amount of the contribution obligation is measured in terms of cash amounts (a percentage of profits) even though the terms of the plan purport to permit in-kind contributions.
  5. Conversely, a transfer of unencumbered property to a welfare benefit plan that does not relieve the sponsor or employer of any present or future obligation to make a contribution that is measured in terms of cash amounts would not constitute a prohibited transaction under section 406(a)(1)(A) of ERISA or section 4975(c)(1)(A) of the Code. The same principles apply to defined contribution plans that are not subject to the minimum funding requirements of section 302 of ERISA or section 412 of the Code. For example, where a profit sharing or stock bonus plan, by its terms, is funded solely at the discretion of the sponsoring employer, and the employer is not otherwise obligated to make a contribution measured in terms of cash amounts, a contribution of unencumbered real property would not be a prohibited sale or exchange between the plan and the employer. If, however, the same employer had made an enforceable promise to make a contribution measured in terms of cash amounts to the plan, a subsequent contribution of unencumbered real property made to offset such an obligation would be a prohibited sale or exchange.

  6. Fiduciary standards. Independent of the application of the prohibited transaction provisions, fiduciaries of plans covered by part 4 of Title I of ERISA must determine that acceptance of an in-kind contribution is consistent with ERISA's general standards of fiduciary conduct. It is the view of the Department that acceptance of an in-kind contribution is a fiduciary act subject to section 404 of ERISA. In this regard, Sections 406(a)(1)(A), and (B) of ERISA require that fiduciaries discharge their duties to a plan solely in the interests of the participants and beneficiaries, for the exclusive purpose of providing benefits and defraying reasonable administrative expenses, 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. In addition, section 404(a)(1)(C) requires generally that fiduciaries diversify plan assets so as to minimize the risk of large losses. Accordingly, the fiduciaries of a plan must act "prudently," "solely in the interest" of the plan's participants and beneficiaries and with view to the need to diversify plan assets when deciding whether to accept in-kind contributions. If accepting an in-kind contribution is not "prudent," not "solely in the interest" of the participants and beneficiaries of the plan, or would result in an improper lack of diversification of plan assets, the responsible fiduciaries of the plan would be liable for any losses resulting from such a breach of fiduciary responsibility, even if a contribution in kind does not constitute a prohibited transaction under section 406 of ERISA. In this regard a fiduciary, should consider any liabilities appurtenant to the in-kind contribution to which the plan would be exposed as a result of acceptance of the contribution.

Footnote

  1. Under Reorganization Plan No. 4 of 1978 (43 FR 47713, October 17, 1978), the authority of the Secretary of the Treasury to issue rulings under the prohibited transactions provisions of section 4975 of the Code has been transferred, with certain exceptions not here relevant, to the Secretary of Labor. Except with respect to the types of plans covered, the prohibited transaction provisions of section 406 of ERISA generally parallel the prohibited transaction provisions of section 4975 of the Code.

95-1    Interpretive bulletin relating to the fiduciary standard under ERISA when selecting an annuity provider

Interpretive Bulletin 95-1
2
9 CFR 2509.95-1

(a) Scope. This Interpretive Bulletin provides guidance concerning certain fiduciary standards under part 4 of title I of the Employee Retirement Income Security Act of 1974 (ERISA), 29 U.S.C. 1104-1114, applicable to the selection of annuity providers for the purpose of pension plan benefit distributions where the plan intends to transfer liability for benefits to the annuity provider.

(b) In General. Generally, when a pension plan purchases an annuity from an insurer as a distribution of benefits, it is intended that the plan's liability for such benefits is transferred to the annuity provider. The Department's regulation defining the term ``participant covered under the plan'' for certain purposes under title I of ERISA recognizes that such a transfer occurs when the annuity is issued by an insurance company licensed to do business in a State. 29 CFR 2510.3- 3(d)(2)(ii). Although the regulation does not define the term ``participant'' or "beneficiary'' for purposes of standing to bring an action under ERISA Sec. 502(a), 29 U.S.C. 1132(a), it makes clear that the purpose of a benefit distribution annuity is to transfer the plan's liability with respect to the individual's benefits to the annuity provider. Pursuant to ERISA section 404(a)(1), 29 U.S.C. 1104(a)(1), fiduciaries must discharge their duties with respect to the plan solely in the interest of the participants and beneficiaries. Section 404(a)(1)(A), 29 U.S.C. 1104(a)(1)(A), states that the fiduciary must act for the exclusive purpose of providing benefits to the participants and beneficiaries and defraying reasonable plan administration expenses. In addition, section 404(a)(1)(B), 29 U.S.C. 1104(a)(1)(B), requires a fiduciary to act with the care, skill, prudence and diligence under the prevailing circumstances that a prudent person acting in a like capacity and familiar with such matters would use.

(c) Selection of Annuity Providers. The selection of an annuity provider for purposes of a pension benefit distribution, whether upon separation or retirement of a participant or upon the termination of a plan, is a fiduciary decision governed by the provisions of part 4 of title I of ERISA. In discharging their obligations under section 404(a)(1), 29 U.S.C. 1104(a)(1), to act solely in the interest of participants and beneficiaries and for the exclusive purpose of providing benefits to the participants and beneficiaries as well as defraying reasonable expenses of administering the plan, fiduciaries choosing an annuity provider for the purpose of making a benefit distribution must take steps calculated to obtain the safest annuity available, unless under the circumstances it would be in the interests of participants and beneficiaries to do otherwise. In addition, the fiduciary obligation of prudence, described at section 404(a)(1)(B), 29 U.S.C. 1104(a)(1)(B), requires, at a minimum, that plan fiduciaries conduct an objective, thorough and analytical search for the purpose of identifying and selecting providers from which to purchase annuities. In conducting such a search, a fiduciary must evaluate a number of factors relating to a potential annuity provider's claims paying ability and creditworthiness. Reliance solely on ratings provided by insurance rating services would not be sufficient to meet this requirement. In this regard, the types of factors a fiduciary should consider would include, among other things:

(1) The quality and diversification of the annuity provider's investment portfolio;

(2) The size of the insurer relative to the proposed contract;

(3) The level of the insurer's capital and surplus;

(4) The lines of business of the annuity provider and other indications of an insurer's exposure to liability;

(5) The structure of the annuity contract and guarantees supporting the annuities, such as the use of separate accounts;

(6) The availability of additional protection through state guaranty associations and the extent of their guarantees. Unless they possess the necessary expertise to evaluate such factors, fiduciaries would need to obtain the advice of a qualified, independent expert. A fiduciary may conclude, after conducting an appropriate search, that more than one annuity provider is able to offer the safest annuity available.

(d) Costs and Other Considerations. The Department recognizes that there are situations where it may be in the interest of the participants and beneficiaries to purchase other than the safest available annuity. Such situations may occur where the safest available annuity is only marginally safer, but disproportionately more expensive than competing annuities, and the participants and beneficiaries are likely to bear a significant portion of that increased cost. For example, where the participants in a terminating pension plan are likely to receive, in the form of increased benefits, a substantial share of the cost savings that would result from choosing a competing annuity, it may be in the interest of the participants to choose the competing annuity. It may also be in the interest of the participants and beneficiaries to choose a competing annuity of the annuity provider offering the safest available annuity is unable to demonstrate the ability to administer the payment of benefits to the participants and beneficiaries. The Department notes, however, that increased cost or other considerations could never justify putting the benefits of annuitized participants and beneficiaries at risk by purchasing an unsafe annuity. In contrast to the above, a fiduciary's decision to purchase more risky, lower-priced annuities in order to ensure or maximize a reversion of excess assets that will be paid solely to the employer-sponsor in connection with the termination of an over-funded pension plan would violate the fiduciary's duties under ERISA to act solely in the interest of the plan participants and beneficiaries. In such circumstances, the interests of those participants and beneficiaries who will receive annuities lies in receiving the safest annuity available and other participants and beneficiaries have no countervailing interests. The fiduciary in such circumstances must make diligent efforts to assure that the safest available annuity is purchased. Similarly, a fiduciary may not purchase a riskier annuity solely because there are insufficient assets in a defined benefit plan to purchase a safer annuity. The fiduciary may have to condition the purchase of annuities on additional employer contributions sufficient to purchase the safest available annuity.

(e) Conflicts of Interest. Special care should be taken in reversion situations where fiduciaries selecting the annuity provider have an interest in the sponsoring employer which might affect their judgment and therefore create the potential for a violation of ERISA Sec. 406(b)(1). As a practical matter, many fiduciaries have this conflict of interest and therefore will need to obtain and follow independent expert advice calculated to identify those insurers with the highest claims-paying ability willing to write the business. [60 FR 12329, Mar. 6, 1995]

96-1    Participant Investment Education for Individual Account [404(c)] Plans

Interpretive Bulletin 96-1
29 C.F.R. Part 2509.96-1

June 11, 1996 (61 FR 29586)

Summary
Applicable to "individual account plans" (employer-sponsored plans which provide for self-directed investments), such as 401(k) plans. Provides information on the requirement to provide participants with sufficient information to make informed decisions about the investment vehicles available under the plan.
Cross Reference: See Section (b)(2)(B)(1) of DOL ERISA Regulation 2550.404c-1.

Interpretive Bulletin

Agency: Pension and Welfare Benefits Administration, Labor.

Action: Interpretive bulletin.

Summary: This interpretive bulletin sets forth the views of the Department of Labor (the Department) concerning the circumstances under which the provision of investment-related information to participants and beneficiaries in participant-directed individual account pension plans will not constitute the rendering of "investment advice" under the Employee Retirement Income Security Act of 1974, as amended (ERISA). This guidance is intended to assist plan sponsors, service providers, participants and beneficiaries in determining when activities designed to educate and assist participants and beneficiaries in making informed investment decisions will not cause persons engaged in such activities to become fiduciaries with respect to a plan by virtue of providing "investment advice" to plan participants and beneficiaries for a fee or other compensation.

Effective Date: January 1, 1975.

Explanatory Preamble to PTE 86-128 (Excerpt)

Text of Interpretive Bulletin

For further information contact:

Bette J. Briggs or Teresa L. Turyn, Pension and Welfare Benefits Administration, U.S. Department of Labor, 200 Constitution Ave. N.W. Room N-5669, Washington, DC 20210, telephone (202) 219-8671, or Paul D. Mannina, Plan Benefits Security Division, Office of the Solicitor, U.S. Department of Labor, Washington, DC 20210, telephone (202) 219-4592. These are not toll-free numbers.

Supplementary Information: In order to provide a concise and ready reference to its interpretations of ERISA, the Department publishes its interpretive bulletins in the Rules and Regulations section of the Federal Register. Published in this issue of the Federal Register is ERISA Interpretive Bulletin 96-1, which interprets section 3(21)(A)(ii), 29 USC 1002(21)(A)(ii), and the Department's regulation issued thereunder at 29 C.F.R. 2510.3-21(c). The Department is publishing this interpretive bulletin because it believes there is a need to clarify the circumstances under which the provision of investment-related information to participants and beneficiaries will not give rise to fiduciary status under ERISA section 3(21)(A)(ii). (Sec. 505, Pub. L. 93-406, 88 Stat. 894 (29 USC 1135).)

Background:

With the growth of participant-directed individual account pension plans, more employees are directing the investment of their pension plan assets and, thereby, assuming more responsibility for ensuring the adequacy of their retirement income.* At the same time, there has been an increasing concern on the part of the Department, employers and others that many participants may not have a sufficient understanding of investment principles and strategies to make their own informed investment decisions. It has been represented to the Department that, while a number of employers sponsoring participant-directed individual account pension plans have instituted programs intended to educate their employees about investment principles, financial planning and retirement, many employers have not offered programs or offered only limited programs due to uncertainty regarding the extent to which the provision of investment-related information may be considered the rendering of "investment advice" under section 3(21)(A)(ii) of ERISA, resulting in fiduciary responsibility and potential liability in connection with participant-directed investments. Although section 404(c) of ERISA, 29 USC 1104(c), and the Department's regulations, at 29 C.F.R. 2550.404c-1, provide limited relief from liability for fiduciaries of pension plans that permit a participant or beneficiary to exercise control over the assets in his or her individual account, there remains a need for employers and others who provide investment information with respect to pension plan assets to know what standards apply in determining whether an education activity may give rise to fiduciary status.

In view of the important role that investment education can play in assisting participants and beneficiaries in making informed investment and retirement-related decisions and the uncertainty relating to the fiduciary implications of providing investment-related information to participants and beneficiaries, the Department is clarifying, herein, the application of ERISA's definition of the term "fiduciary with respect to a plan" in section 3(21)(A)(ii) to the provision of investment-related information to participants and beneficiaries.

Interpretive Bulletin 96-1 identifies categories of information and materials regarding participant-directed individual account pension plans that do not, in the view of the Department, constitute "investment advice" under the definition of "fiduciary" in ERISA section 3(21)(A)(ii) and the corresponding regulation at 29 C.F.R. 2510.3-21(c)(1). The interpretive bulletin points out, in effect, a series of graduated safe harbors under ERISA for plan sponsors and service providers who provide participants and beneficiaries with four increasingly specific categories of investment information and materials -- plan information, general financial and investment information, asset allocation models and interactive investment materials -- as described in paragraph (d) of IB 96-1.

Comments on the Interpretive Bulletin

Interpretive Bulletin 96-1 was developed following extensive review of educational materials currently being provided by plan sponsors and service providers to participants. To further ensure that the guidance provided would be helpful, and would promote increased and improved participant education efforts, the Department also released an exposure draft of the interpretive bulletin for public comment. The response to the exposure draft was overwhelmingly positive. Both plan sponsor and service provider representatives unequivocally agreed that the guidance as drafted would strengthen participant investment education, and urged the Department to proceed as expeditiously as possible to adopt the interpretive bulletin. The commenters also suggested various technical and clarifying changes which, as discussed below, have been included in the interpretive bulletin.

Identifying Specific Investment Alternatives in Model Asset Allocations

The most frequent comment on the exposure draft concerned the safe harbor provision in paragraphs (d)(3) (asset allocation models) and (d)(4) (interactive investment materials) that if a model asset allocation identifies or matches any specific investment alternative available under the plan with a generic asset class, then all investment alternatives under the plan with similar risk and return characteristics must be similarly identified or matched. The commenters were concerned that in plans with investment alternatives offered by multiple service providers it would be difficult, and possibly inappropriate, for one service provider to identify and describe a competitor's products.

The requirement to identify other investment alternatives within an asset class was intended to address the concern that a service provider could effectively steer participants to a specific investment alternative by identifying only one particular fund in connection with an asset allocation model. Where it is possible to identify other investment alternatives within an asset class, the Department encourages service providers to do so. In response to the comments, however, safe harbors (d)(3) and (d)(4) have been revised to provide that, where an asset allocation model identifies any specific investment alternative available under the plan, an accompanying statement must indicate that other investment alternatives having similar risk and return characteristics may be available under the plan, and must identify where information on those investment alternatives may be obtained.

The Fiduciary Safe Harbors and Section 404(c)

Several commenters requested clarification of the statement in the exposure draft that issues relating to the circumstances under which information provided to participants and beneficiaries may affect their ability to exercise independent control for purposes of 404(c) are outside the scope of the IB. The commenters were concerned that activities which come within one of the safe harbors for participant education may nevertheless be viewed by the Department as compromising a participant's or beneficiary's ability to exercise independent control under section 404(c).

Whether a participant or beneficiary has exercised independent control over the assets in his or her individual account pursuant to section 404(c) is necessarily a factual inquiry. In general, however, the types of educational programs described in the safe harbors do not, in the view of the Department, raise issues under section 404(c). Accordingly, footnote 2 of IB 96-1 makes clear that the provision of investment-related information and materials to participants and beneficiaries in accordance with paragraph (d) of the IB will not, in and of itself, affect the availability of relief from the fiduciary responsibility provisions of ERISA that is provided by section 404(c).

Applying Asset Allocations to Individual Participants and Beneficiaries

A number of commenters asked the Department to clarify the requirement to provide a statement that individual participants and beneficiaries should consider their other assets, income or investments (outside of the plan) when applying an asset allocation model or using interactive investment materials. The commenters pointed out that, in many instances, interactive models or materials already take into account an individual's other assets. Accordingly, they requested clarification that such models or materials come within the safe harbor in paragraph (d)(4). Commenters were also concerned that given the rationale for the safe harbor in paragraph (d)(4) -- i.e. that interactive investment models or materials enable participants and beneficiaries independently to design and assess multiple asset allocation models -- the Department may have intended to exclude from the safe harbors situations in which service providers assist individual participants or beneficiaries to develop possible asset allocation models based upon their personal financial information.

The provisions of the safe harbors are designed to ensure that participants and beneficiaries will have adequate information to enable them to make their own, informed asset allocation decisions. The Department has clarified that the safe harbor in paragraph (d)(4) for interactive investment materials would not be unavailable merely because the asset allocation models generated by the materials take into account a participant's or beneficiary's non-plan assets, income and investments. Nor does the Department consider that the safe harbor would be unavailable merely because participants and beneficiaries receive personal assistance in developing model asset allocations. In this regard, paragraph (d) of the IB states that providing the categories of information identified in paragraph (d) will not in and of itself constitute the rendering of "investment advice" irrespective of the form in which the materials are provided (e.g.,  whether on an individual or group basis, in writing or orally, or via video or computer software). The interpretive bulletin also makes clear that information and materials within each category may be furnished alone or combined with information and materials from other categories. For example, general financial and investment information on estimating future retirement income needs, determining investment time horizons and assessing risk tolerance, as described in paragraph (d)(2), may be combined with interactive investment materials described in paragraph (d)(4) in order to assist participants and beneficiaries to relate basic retirement planning concepts to their individual situations.

Generally Accepted Investment Theories

Several commenters requested clarification of the requirement that asset allocation models and interactive investment materials must be based on "generally accepted investment theories that take into account the historic returns of different asset classes (e.g.,  equities, bonds, or cash) over defined periods of time." The Department included this requirement to assure that, for purposes of the safe harbors, any models or materials presented to participants or beneficiaries will be consistent with widely accepted principles of modern portfolio theory, recognizing the relationship between risk and return, the historic returns of different asset classes, and the importance of diversification.

Plan Sponsor or Fiduciary Endorsements of Service Providers

The commenters also requested clarification regarding the circumstances in which a plan sponsor or fiduciary may be viewed as having fiduciary responsibility by virtue of endorsing a third party who has been selected by a participant or beneficiary to provide participant education or investment advice. Commenters noted, for example, that a plan sponsor may wish merely to provide office space or make computer terminals available for use by a service provider that has been selected by a participant or beneficiary to provide investment education using interactive materials. Whether a plan sponsor or fiduciary has effectively endorsed or made an arrangement with a particular service provider is an inherently factual inquiry which depends upon all the relevant facts and circumstances. It is the Department's view, however, that a uniformly applied policy of providing office space or computer terminals for use by participants or beneficiaries who have independently selected a service provider to provide investment education would not, in and of itself, constitute an endorsement of or arrangement with the service provider for purposes of the IB.

Participation Rates, Contribution Levels and Pre-retirement Withdrawals

With the objective of distinguishing between investment education and investment advice, IB 96-1 focuses primarily on educational activities relating to investment decision-making. However, as suggested in a recent study by the Employee Benefits Research Institute (EBRI), which was commissioned by the Department of Labor, plan participants also need to be informed about the impact on retirement savings of pre-retirement withdrawals and other fundamental principles regarding plan participation and contribution levels. According to the EBRI study, the impact of pre-retirement withdrawals on retirement income is one of the least often provided topics and could have serious consequences for the adequacy of employees' retirement income. The Department, therefore, encourages educational service providers to emphasize that participants should: (1) participate in available plans as soon as they are eligible; (2) make the maximum contribution possible to the plan; and(3) if they change employment, refrain from withdrawing their retirement savings, and opt instead to directly transfer or roll over their plan account into an IRA or other retirement vehicle. Such information relating to plan participation is specifically encompassed within the safe harbor in paragraph (d)(1) of IB 96-1.

Application of the Investment Advisers Act of 1940

Employer sponsors of participant-directed individual account pension plans that provide investment-related information to employees who are participants in those plans have also raised questions regarding their status under the Investment Advisers Act of 1940, 15 USC 80b-1 et  seq., ("Advisers Act"). In this regard, the staff of the Division of Investment Management of the Securities and Exchange Commission (SEC) has advised the Department of Labor that, generally, employers who provide their employees with investment information including, but not limited to, the type described in paragraph (d) of IB 96-1 would not be subject to registration or regulation under the Advisers Act. This position applies only to employers who provide such information, and not to third-party service providers, whose status under the Adviser's Act must be determined independently. See Letters from Jack W. Murphy, Associate Director (Chief Counsel), Division of Investment Management, SEC, to Olena Berg, Assistant Secretary, Pension and Welfare Benefit Administration, U.S. Department of Labor, dated February 22, 1996, and December 5, 1995. Persons who have questions regarding this issue are directed to contact the Office of the Chief Counsel, Division of Investment Management, at (202) 942-0660. This is not a toll free number.

Interpretive Bulletin

For the reasons set forth above, Part 2509 of Title 29 of The Code of Federal Regulations is amended as follows:

  1. Scope. This interpretive bulletin sets forth the Department of Labor's interpretation of section 3(21)(A)(ii) of the Employee Retirement Income Security Act of 1974, as amended (ERISA), and 29 C.F.R. 2510.3-21(c) as applied to the provision of investment-related educational information to participants and beneficiaries in participant-directed individual account pension plans (i.e., pension plans that permit participants and beneficiaries to direct the investment of assets in their individual accounts, including plans that meet the requirements of the Department's regulations at 29 C.F.R. 2550.404c-1).
  2. General. Fiduciaries of an employee benefit plan are charged with carrying out their duties prudently and solely in the interest of participants and beneficiaries of the plan, and are subject to personal liability to, among other things, make good any losses to the plan resulting from a breach of their fiduciary duties. ERISA sections 403404 and 409, 29 USC 1103, 1104, and 1109. Section 404(c) of ERISA provides a limited exception to these rules for a pension plan that permits a participant or beneficiary to exercise control over the assets in his or her individual account. The Department of Labor's regulation, at 29 C.F.R. 2550.404c-1, describes the kinds of plans to which section 404(c) applies, the circumstances under which a participant or beneficiary will be considered to have exercised independent control over the assets in his or her account, and the consequences of a participant's or beneficiary's exercise of such control.[FN 1]
  3. With both an increase in the number of participant-directed individual account plans and the number of investment options available to participants and beneficiaries under such plans, there has been an increasing recognition of the importance of providing participants and beneficiaries, whose investment decisions will directly affect their income at retirement, with information designed to assist them in making investment and retirement-related decisions appropriate to their particular situations. Concerns have been raised, however, that the provision of such information may in some situations be viewed as rendering "investment advice for a fee or other compensation," within the meaning of ERISA section 3(21)(A)(ii), thereby giving rise to fiduciary status and potential liability under ERISA for investment decisions of plan participants and beneficiaries.

    In response to these concerns, the Department of Labor is clarifying herein the applicability of ERISA section 3(21)(A)(ii) and 29 C.F.R. 2510.3-21(c) to the provision of investment-related educational information to participants and beneficiaries in participant directed individual account plans.[FN 2] In providing this clarification, the Department does not address the "fee or other compensation, direct or indirect," which is a necessary element of fiduciary status under ERISA section 3(21)(A)(ii).[FN 3]

  4. Investment Advice. Under ERISA section 3(21)(A)(ii), a person is considered a fiduciary with respect to an employee benefit plan to the extent that person "renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, or has any authority to do so * * *." The Department issued a regulation, at 29 C.F.R. 2510.3-21(c), describing the circumstances under which a person will be considered to be rendering "investment advice" within the meaning of section 3(21)(A)(ii). Because section 3(21)(A)(ii) applies to advice with respect to "any moneys or other property" of a plan and 29 C.F.R. 2510.3-21(c) is intended to clarify the application of that section, it is the view of the Department of Labor that the criteria set forth in the regulation apply to determine whether a person renders "investment advice" to a pension plan participant or beneficiary who is permitted to direct the investment of assets in his or her individual account.
  5. Applying 29 C.F.R. 2510.3-21(c) in the context of providing investment- related information to participants and beneficiaries of participant-directed individual account pension plans, a person will be considered to be rendering "investment advice," within the meaning of ERISA section 3(21)(A)(ii), to a participant or beneficiary only if: (i) the person renders advice to the participant or beneficiary as to the value of securities or other property, or makes recommendations as to the advisability of investing in, purchasing, or selling securities or other property (2510.3-21(c)(1)(i); and (ii) the person, either directly or indirectly, (A) has discretionary authority or control with respect to purchasing or selling securities or other property for the participant or beneficiary (2510.3-21(c)(1)(ii)(A)), or (B) renders the advice on a regular basis to the participant or beneficiary, pursuant to a mutual agreement, arrangement or understanding (written or otherwise) with the participant or beneficiary that the advice will serve as a primary basis for the participant's or beneficiary's investment decisions with respect to plan assets and that such person will render individualized advice based on the particular needs of the participant or beneficiary (2510.3-21(c)(1)(ii)(B)).[FN 4]

    Whether the provision of particular investment-related information or materials to a participant or beneficiary constitutes the rendering of "investment advice," within the meaning of 29 C.F.R. 2510.3-21(c)(1), generally can be determined only by reference to the facts and circumstances of the particular case with respect to the individual plan participant or beneficiary. To facilitate such determinations, however, the Department of Labor has identified, in paragraph (d), below, examples of investment-related information and materials which if provided to plan participants and beneficiaries would not, in the view of the Department, result in the rendering of "investment advice" under ERISA section 3(21)(A)(ii) and 29 C.F.R. 2510.3- 21(c).

  6. Investment Education. For purposes of ERISA section 3(21)(A)(ii) and 29 C.F.R. 2510.3-21(c), the Department of Labor has determined that the furnishing of the following categories of information and materials to a participant or beneficiary in a participant-directed individual account pension plan will not constitute the rendering of "investment advice," irrespective of who provides the information (e.g., plan sponsor, fiduciary or service provider), the frequency with which the information is shared, the form in which the information and materials are provided (e.g.,  on an individual or group basis, in writing or orally, or via video or computer software), or whether an identified category of information and materials is furnished alone or in combination with other identified categories of information and materials.
    1. Plan Information.
      1. Information and materials that inform a participant or beneficiary about the benefits of plan participation, the benefits of increasing plan contributions, the impact of pre-retirement withdrawals on retirement income, the terms of the plan, or the operation of the plan; or
      2. Information such as that described in 29 C.F.R. 2550.404c-1(b)(2)(i) on investment alternatives under the plan (e.g., descriptions of investment objectives and philosophies, risk and return characteristics, historical return information, or related prospectuses).[FN 5]

      The information and materials described above relate to the plan and plan participation, without reference to the appropriateness of any individual investment option for a particular participant or beneficiary under the plan. The information, therefore, does not contain either "advice" or "recommendations" within the meaning of 29 C.F.R. 2510.3-21(c)(1)(i). Accordingly, the furnishing of such information would not constitute the rendering of "investment advice" for purposes of section 3(21)(A)(ii) of ERISA.

    2. General Financial and Investment Information. Information and materials that inform a participant or beneficiary about: (i) General financial and investment concepts, such as risk and return, diversification, dollar cost averaging, compounded return, and tax deferred investment; (ii) historic differences in rates of return between different asset classes (e.g., equities, bonds, or cash) based on standard market indices; (iii) effects of inflation; (iv) estimating future retirement income needs; (v) determining investment time horizons; and (vi) assessing risk tolerance.
    3. The information and materials described above are general financial and investment information that have no direct relationship to investment alternatives available to participants and beneficiaries under a plan or to individual participants or beneficiaries. The furnishing of such information, therefore, would not constitute rendering "advice" or making "recommendations" to a participant or beneficiary within the meaning of 29 C.F.R. 2510.3-21(c)(1)(i). Accordingly, the furnishing of such information would not constitute the rendering of "investment advice" for purposes of section 3(21)(A)(ii) of ERISA.

    4. Asset Allocation Models. Information and materials (e.g., pie charts, graphs, or case studies) that provide a participant or beneficiary with models, available to all plan participants and beneficiaries, of asset allocation portfolios of hypothetical individuals with different time horizons and risk profiles, where: (i) Such models are based on generally accepted investments theories that take into account the historic returns of different asset classes (e.g., equities, bonds, or cash) over define periods of time; (ii) all material facts and assumptions on which such models are based (e.g., retirement ages, life expectancies, income levels, financial resources, replacement income ratios, inflation rates, and rates of return) accompany the models; (iii) to the extent that an asset allocation model identifies any specific investment alternative available under the plan, the model is accompanied by a statement indicating that other investment alternatives having similar risk and return characteristics may be available under the plan and identifying where information on those investment alternatives may be obtained; and (iv) the asset allocation models are accompanied by a statement indicating that, in applying particular asset allocation models to their individual situations, participants or beneficiaries should consider their other assets, income, and investments (e.g., equity in a home, IRA investments, savings accounts, and interests in other qualified and non-qualified plans) in addition to their interests in the plan.
    5. Because the information and materials described above would enable a participant or beneficiary to assess the relevance of an asset allocation model to his or her individual situation, the furnishing of such information would not constitute a "recommendation" within the meaning of 29 C.F.R. 2510.3-21(c)(1)(i) and, accordingly, would not constitute "investment advice" for purposes of section 3(21)(A)(ii) of ERISA. This result would not, in the view of the Department, be affected by the fact that a plan offers only one investment alternative in a particular asset class identified in an asset allocation model.

    6. Interactive Investment Materials. Questionnaires, worksheets, software, and similar materials which provide a participant or beneficiary the means to estimate future retirement income needs and assess the impact of different asset allocations on retirement income, where: (i) Such materials are based on generally accepted investment theories that take into account the historic returns of different asset classes (e.g., equities, bonds, or cash) over defined periods of time; (ii) there is an objective correlation between the asset allocations generated by the materials and the information and data supplied by the participant or beneficiary; (iii) all material facts and assumptions (e.g., retirement ages, life expectancies, income levels, financial resources, replacement income ratios, inflation rates, and rates of return) which may affect a participant's or beneficiary's assessment of the different asset allocations accompany the materials or are specified by the participant or beneficiary; (iv) to the extent that an asset allocation generated by the materials identifies any specific investment alternative available under the plan, the asset allocation is accompanied by a statement indicating that other investment alternatives having similar risk and return characteristics may be available under the plan and identifying where information on those investment alternatives may be obtained; and (v) the materials either take into account or are accompanied by a statement indicating that, in applying particular asset allocations to their individual situations, participants or beneficiaries should consider their other assets, income, and investments (e.g., equity in a home, IRA investments, savings accounts, and interests in other qualified and non-qualified plans) in addition to their interests in the plan.

    The information provided through the use of the above-described materials enables participants and beneficiaries independently to design and assess multiple asset allocation models, but otherwise these materials do not differ from asset allocation models based on hypothetical assumptions. Such information would not constitute a "recommendation" within the meaning of 29 C.F.R. 2510.3-21(c)(1)(i) and , accordingly, would not constitute "investment advice" for purposes of section 3(21)(A)(ii) of ERISA.

    The Department notes that the information and materials described in subparagraphs (1)-(4) above merely represent examples of the type of information and materials which may be furnished to participants and beneficiaries without such information and materials constituting "investment advice." In this regard, the Department recognizes that there may be many other examples of information, materials, and educational services which, if furnished to participants and beneficiaries, would not constitute "investment advice." Accordingly, no inferences should be drawn from subparagraphs (1)-(4), above, with respect to whether the furnishing of any information, materials or educational services not described therein may constitute "investment advice." Determinations as to whether the provision of any information, materials or educational services not described herein constitutes the rendering of "investment advice" must be made by reference to the criteria set forth in 29 C.F.R. 2510.3-21(c)(1).

  7. Selection and Monitoring of Educators and Advisors. As with any designation of a service provider to a plan, the designation of a person(s) to provide investment educational services or investment advice to plan participants and beneficiaries is an exercise of discretionary authority or control with respect to management of the plan; therefore, persons making the designation must act prudently and solely in the interest of the plan participants and beneficiaries, both in making the designation(s) and in continuing such designation(s). See ERISA sections 3(21)(A)(i) and 404(a), 29 USC 1002 (21)(A)(i) and 1104(a). In addition, the designation of an investment advisor to serve as a fiduciary may give rise to co-fiduciary liability if the person making and continuing such designation in doing so fails to act prudently and solely in the interest of plan participants and beneficiaries; or knowingly participates in, conceals or fails to make reasonable efforts to correct a known breach by the investment advisor. See ERISA section 405(a), 29 USC 1105(a). The Department notes, however, that, in the context of an ERISA section 404(c) plan, neither the designation of a person to provide education nor the designation of a fiduciary to provide investment advice to participants and beneficiaries would, in itself, give rise to fiduciary liability for loss, or with respect to any breach of part 4 of title I of ERISA, that is the direct and necessary result of a participant's or beneficiary's exercise of independent control. 29 C.F.R. 2550.404c-1(d). The Department  also notes that a plan sponsor or fiduciary would have no fiduciary responsibility or liability with respect to the actions of a third party selected by a participant or beneficiary to provide education or investment advice where the plan sponsor or fiduciary neither selects nor endorses the educator or advisor, nor otherwise makes arrangements with the educator or advisor to provide such services.

Signed at Washington, DC, this 30th day of May, 1996.

Olena Berg,
Assistant Secretary
Pension and Welfare, Benefits Administration
U.S. Department of Labor.

Footnotes

* Under section 3(2) of ERISA, 29 USC 1002(2), the term "pension plan" encompasses any plan, fund or program established or maintained by an employer or employee organization, or by both, to the extent that by its express terms or as a result of surrounding circumstances, it provides retirement income to employees or results in a deferral of income by employees for periods extending to the termination of covered employment or beyond. The Department notes that, for purposes of Title I of ERISA, an employer-sponsored individual retirement account (IRA) is considered to be an individual account pension plan. See 29 C.F.R. 2510.3-2(d).

  1. The section 404(c) regulation conditions relief from fiduciary liability on, among other things, the participant or beneficiary being provided or having the opportunity to obtain sufficient investment information regarding the investment alternatives available under the plan in order to make informed investment decisions. Compliance with this condition, however, does not require that participants and beneficiaries be offered or provided either investment advice or investment education, e.g.  regarding general investment principles and strategies, to assist them in making investment decisions. 29 C.F.R. 2550.404c-1(c)(4).
  2. Issues relating to the circumstances under which information provided to participants and beneficiaries may affect a participant's or beneficiary's ability to exercise independent control over the assets in his or her account for purposes of relief from fiduciary liability under ERISA section 404(c) are beyond the scope of this interpretive bulletin. Accordingly, no inferences should be drawn regarding such issues. See 29 C.F.R. 2550.404c-1(c)(2). It is the view of the Department, however, that the provision of investment-related information and material to participants and beneficiaries in accordance with paragraph (d) of this interpretive bulletin will not, in and of itself, affect the availability of relief under section 404(c).
  3. The Department has expressed the view that, for purposes of section 3(21)(A)(ii), such fees or other compensation need not come from the plan and should be deemed to include all fees or other compensation incident to the transaction in which the investment advise has been or will be rendered. See A.O. 83-60A (Nov. 21, 1983); Reich v. McManus, 883 F. Supp. 1144 (N.D. Ill. 1995).
  4. This IB does not address the application of 29 C.F.R. 2510.3-21(c) to communications with fiduciaries of participant-directed individual account pension plan plans.
  5. Descriptions of investment alternatives under the plan may include information relating to the generic asset class (e,g,, equities, bonds, or cash) of the investment alternatives. 29 C.F.R. 2550.404c-1(b)(2)(i)(B)(1)(ii).
Technical Bulletins

86-1    Soft Dollars and Directed Commissions for Securities Transactions

Technical Bulletin 86-1
Soft Dollars and Directed Commission Arrangements

May 22, 1986

Summary
Establishes DOL positions on how (1) the "soft dollar" safe harbor of Section 28(e) of the Securities Exchange Act and (2) the directed commission arrangements on securities transactions apply to ERISA accounts and fiduciaries.

Technical Bulletin

This statement reflects the views of the Pension and Welfare Benefits Administration (PWBA) with regard, to "soft dollar" and directed commission arrangements pursuant to its responsibility to administer and enforce the provisions of Title I of the Employee Retirement Income Security Act of 1974 (ERISA). Investment managers, plan sponsors and other members of the pension community which provide services to employee plans have expressed a great deal of interest in the application of the fiduciary responsibility provisions of ERISA to these arrangements.

"Soft dollar" and directed commission arrangements typically involve situations in which an investment manager of an employee benefit plan or other plan fiduciary purchases goods or services with a portion of the brokerage commission paid by a plan to a broker for executing a securities transaction. Prior to the elimination of fixed commission rates on stock exchange transactions, investment managers often purchased additional services with commission dollars beyond simple execution, clearance and settlement of securities transactions. After the elimination of fixed commission rates in May 1975, Congress, as part of the Securities Acts Amendments of 1975, added Section 28(e) to the Securities Exchange Act of 1934 (the 1934 Act) to address the practice whereby brokers provided investment managers with brokerage and research services. The Securities and Exchange Commission (the Commission) administers the 1934 Act and has exclusive authority to interpret the scope of Section 28(e) and the terms used therein.

Section 28(e) of the 1934 Act provides generally that no person who exercises investment discretion with respect to securities transactions will be deemed to have acted unlawfully or to have breached a fiduciary duty solely by reason of paying brokerage commissions for effecting a securities transaction in excess of the amount of commission another broker-dealer would have charged, if such person determined in good faith that the commission was reasonable in relation to the value of brokerage and research services provided by the broker-dealer. The limited safe harbor provided by Section 28(e) is available only for the provision of brokerage and research services to persons who exercise investment discretion with respect to an account as that term is defined in Section 3(a)(35) of the 1934 Act. The Commission has indicated that if a plan fiduciary does not exercise investment discretion with respect to the securities transaction or uses "soft dollars" to pay for non-research related services, the transaction falls outside the protection afforded by Section 28(e) of the 1934 Act and may be in violation of the securities laws and the fiduciary responsibility provisions of ERISA.

It has come to the attention of PWBA that ERISA fiduciaries may be involved in several types of "soft dollar" and directed commission arrangements which do not qualify for the "safe harbor" provided by Section 28(e) of the 1934 Act. In some instances, investment managers direct a portion of a plan's securities trades through specific broker-dealers, who then apply a percentage of the brokerage commissions to pay for travel, hotel rooms and other goods and services for such investment managers which do not qualify as research within the meaning of Section 28(e).1 In other instances, plan sponsors who do not exercise investment discretion with respect to a plan direct the plan's securities trades to one or more broker-dealers in return for research, performance evaluation, other administrative services or discounted commissions. The Commission has indicated that the safe harbor of Section 28(e) is not available for directed brokerage transactions.2

A fiduciary for an ERISA plan, such as a trustee or investment manager, must meet the fiduciary responsibility standards set forth in part 4 of Title I of ERISA. These standards are designed to help ensure that the fiduciary's decisions are made in the best interests of the plan and are not colored by self-interest.

Section 403(c)(1) provides, in part, that the assets of a plan shall be held for the exclusive purpose of providing benefits to the plan's participants and their beneficiaries and defraying reasonable expenses of administering the plan. Section 404(a)(1) sets forth a similar requirement on how a plan fiduciary must discharge his duties with respect to the plan, and provides further that such fiduciary must act prudently and solely in the interest of the participants and beneficiaries. Those basic provisions are supplemented by the per se prohibitions of certain classes of transactions set forth in section 406 of ERISA.

Section 406(a)(1)(D) of ERISA prohibits a fiduciary of an ERISA plan from causing that plan to engage in a transaction if he knows or should know that the transaction would constitute a direct or indirect transfer to, or use by or for the benefit of, a party in interest, of any assets of that plan. Section 3(14) includes, within the definition of "party in interest" with respect to a plan, any fiduciary with respect to that plan. Thus, section 406(a)(1)(D) would not only prohibit a fiduciary from causing the plan to engage in a transaction which would benefit a third person who is a party in interest, but it also would prohibit the fiduciary from similarly benefiting himself. In addition, section 406(b)(1) specifically prohibits a fiduciary with respect to a plan from dealing with the assets of that plan in his own interest or for his own account. Section 406(b)(3) supplements these provisions by prohibiting a plan fiduciary from receiving any consideration for his own personal account from any party dealing with the plan in connection with a transaction involving the assets of the plan.

When investment management responsibility has been properly delegated to an investment manager, the manager is responsible for all aspects of the investment process.3 The manager, in those cases, is required to act prudently with respect to a decision to buy or sell securities as well as with respect to the decision concerning who will execute the transaction. If such a delegation has occurred, the named fiduciary of the plan is not liable for the particular acts or omissions of the manager but has oversight responsibility to periodically review the investment manager's performance.

Where an investment manager has entered into a "soft dollar" arrangement, Section 28(e) of the 1934 Act does not relieve anyone other than the person who exercises investment discretion from the applicability of the fiduciary provisions of ERISA. Therefore, the fiduciary who appoints the investment manager is not relieved of his ongoing duty to monitor the investment manager to assure that the manager has secured best execution of the plan's brokerage transactions and to assure that the commissions paid on such transactions are reasonable in relation to the value of the brokerage and research services provided to the plan.4

It is PWBA's understanding that where a plan sponsor or other plan fiduciary directs the investment manager to execute securities trades for the plan through one or more specified broker-dealers, the direction generally requires the investment manager to execute a specified percentage of the plan's trades or a specified amount of the plan's commission business through the particular broker-dealers, consistent with the manager's duty to secure best execution for the transactions.

A plan sponsor's decision to direct brokerage transactions must be made prudently and solely in the interest of the participants and beneficiaries. In directing a plan's brokerage transactions, the sponsor has an initial responsibility to determine that the broker-dealer is capable of providing best execution for the plan's brokerage transactions. In addition, the sponsor has an ongoing responsibility to monitor the services provided by the broker-dealer so as to assure that the manager has secured best execution of the plan's brokerage transactions and that the commissions paid are reasonable in relation to the value of the brokerage and other services received by the plan.

In considering "soft dollar" and directed commission arrangements, ERISA's prohibited transaction provisions also must be taken into account. A fiduciary with respect to an ERISA plan is generally prohibited, by section 406(b)(1), from causing the plan to engage in a transaction if the fiduciary has an interest in the matter which may affect the fiduciary's best judgment as a fiduciary. For example, an employer which is the named fiduciary for its plan and which does not exercise investment discretion would, normally be prohibited from directing the plan's brokerage transactions through a designated broker-dealer who agrees to utilize a portion of the brokerage commissions received from the plan to procure goods or services for the benefit of the employer. (As previously noted, Section 28(e) is unavailable for such brokerage transactions.) Each use of the broker-dealer that results in the receipt of goods and services by the employer following that designation would create an additional violation of sections 406(a)(1)(D) and 406(b)(1) of ERISA. In addition, where the relief provided by Section 28(e) is unavailable, the receipt by a fiduciary (i.e., the employer) of goods or services for its own personal account from a party (i.e., the broker-dealer) dealing with a plan in connection with a transaction involving the assets of the plan would, in the opinion of PWBA, constitute a violation of section 406(b)(3). Such an arrangement would also violate sections 403(c)(1) and 404(a)(1) to the extent that the employer is benefiting from its use of its position.

However, where an investment manager directs brokerage transactions through a designated broker-dealer to procure goods and services on behalf of the plan, and for which the plan would be otherwise obligated to pay, such use of brokerage commissions ordinarily would not violate the fiduciary provisions of ERISA, provided that the amount paid for the brokerage and other goods and services is reasonable, and the investment manager has fulfilled its fiduciary duty to obtain best execution for the plan's securities transactions. This result does not depend on the availability of the "safe harbor" under Section 28(e) for these transactions.

In applying the fiduciary responsibility provisions of ERISA to the various "soft dollar" and directed commission arrangements that fall outside of the protection of Section 28(e), it is apparent to PWBA that issues are raised under section 406 of ERISA whenever there is an inducement for the investment manager or other plan fiduciary to direct plan brokerage transactions through particular broker-dealers. The following examples illustrate the application of the fiduciary responsibility provisions of ERISA to "soft dollar" and directed commission arrangements:

  1. Employer X instructs the master trustee of its plan to direct all plan brokerage transactions through Broker-Dealer B. Part of the commissions are rebated to the master trustee, to reduce its fees. The plan provides that administrative costs, including the fees of the master trustee, are to be paid by the plan. Under these circumstances, this transaction would not, in itself, constitute a violation of the prohibited transaction provisions of ERISA since the "soft dollars" are being used for the exclusive benefit of the plan which generated the commissions. However, in order to act prudently under section 404(a)(1) of ERISA, Employer X would be obligated to initially determine that Broker-Dealer D is capable of providing best execution of the plan's brokerage transactions. In addition, Employer X must also periodically monitor the execution of the plan's brokerage transactions and evaluate whether the brokerage commissions paid by the plan are reasonable in light of the total services received by the plan. Moreover, Employer X would be obligated to assure that the arrangement does not result in the payment of unreasonable compensation to the master trustee.
  2. Money Manager A enters into an arrangement with Broker-Dealer B whereby Money Manager A would direct brokerage on behalf of its managed plan accounts which would generate fees of $500,000 per year to Broker-Dealer B. In return, Broker-Dealer P would provide bookkeeping services that do not constitute research under Section 28(e) for the general corporate purposes of Money Manager A. Money Manager A has engaged in an act prohibited by sections 406(a)(1)(D)406(b)(1) and 406(b)(3) of ERISA since Money Manager A has exercised its fiduciary authority over plan assets to benefit itself. Such a transaction would also violate the exclusive purpose provisions of sections 403(c)(1) and 404(a)(1) of ERISA. In these circumstances, the relief provided by Section 28(e) would not be available because the "soft dollars" are paid for services other than research.
  3. The named fiduciaries of Plan P retain Money Manager C to manage part of the assets of Plan P. Money Manager C directs the plan's brokerage transactions through Broker-Dealer D. In return, Broker-Dealer D will provide research on tax-exempt securities to Money Manager C. Although tax-exempt securities would not be a suitable investment for Plan P, Money Manager C has, determined that this research would be useful to his managed accounts as a whole. Money Manager C's arrangement with Broker-Dealer P is therefore encompassed by Section 28(e) of the 1934 Act. However, in retaining Money Manager C, the named fiduciaries of Plan P are required under section 404(a)(1) of ERISA to periodically review the execution secured by Money Manager C and ensure that the brokerage commissions paid by Plan P to Broker-Dealer D are reasonable.

The foregoing discussion is intended to provide general guidance as to the nature of the analysis applicable to these situations. The discussion should not be viewed as expressing an opinion with respect to any specific case.

Footnotes

  1. See Securities Exchange Act Release No. 34-23170 (April 23, 1986).
  2. See Section VI of Securities Exchange Act Release No. 34-23170 (April 23, 1986).
  3. Section 405 of ERISA limits the liability of certain plan fiduciaries if management of plan assets has been properly delegated to an investment manager.
  4. In PWBA's view, an investment manager's responsibility to seek best execution under the circumstances requires the manager to consider not only the cost of the commissions for the transaction but the quality and reliability of the execution.
Advisory Opinions/Individual Exemptions

77-46    Diversification Applicability to Insured and Uninsured Deposits

Advisory Opinion 77-46
Diversification Applicability to Insured and Uninsured Deposits

June 7, 1977

Summary
Indicates a plan may invest in own-bank:
I Insured deposits without violating ERISA diversification requirements.
I 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

79-49    Payment of Fiduciary Fee to Bank Sponsor of Plan

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

80-OCC    Investment in Fiduciary Bank/Holding Company Securities

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

85-36A    Loans Intended to Benefit Union Members/Employers

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.

86-FRB    Sweep Arrangements and Related Sweep Transaction Fees

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.

88-02A    Sweep Arrangements and Related Sweep Transaction Fees

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).

88-09A    Investment in Fiduciary Bank/BHC Treasury Stock

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.

88-18A    Self-Directed IRA Loans to Company Where IRA Grantor/Beneficiary is Insider

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.1 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 CodeSection 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

  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.

88-28    Investment in Fiduciary Bank/BHC Stock in Initial Public Offering

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.

89-03    Self-Directed IRA Purchases of Employer Stock from Employer

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 CodeSection 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.

92-23A    Investment in Fiduciary Bank/BHC Stock

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

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.

93-13A    Investment in Affiliated Mutual Funds

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.

93-24A    Float Management

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

93-26A    Investment in Affiliated Mutual Funds by IRA and Keogh Accounts

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

94-41A    Escheating

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.

94-OCC    Collective Investment Fund Conversions to Mutual Funds

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

96-OCC    Investments in Derivatives

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 derivatives1 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).

97-15A    Acceptance of Mutual Fund 12b-1 Fees; Letter to Frost National Bank; Discretionary and Non-Discretionary Accounts

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.

97-16A    Acceptance of Mutual Fund 12b-1 Fees; Letter to Aetna Life Insurance and Annuity Company; Non-Discretionary Accounts

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."

98-06A    Investment of In-House Employee Benefit Plans into Proprietary Mutual Funds

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

1999-03A    Purchase of Mortgage-Backed Securities Representing Interests in a Trust Fund for which an Affliate of the Fiduciary Serves as a Sub-Servicer

1999-03A
ERISA Sec. 406(b)

January 25, 1999

Michael A. Lawson
Skadden, Arps, Slate, Meagher, & Flom, LLP
300 South Grand Avenue
Los Angeles, California 90071-3144

Dear Mr. Lawson:

This is in response to your request for an advisory opinion concerning the application of section 406(b) of the Employee Retirement Income Security Act of 1974 (ERISA) and section 4975(c)(1)(D), (E), and (F) of the Internal Revenue Code of 1986 (the Code).(1) In particular, you request guidance with respect to a plan fiduciary’s decision to purchase on the secondary market, with plan assets, non-subordinated mortgage-backed pass-through certificates (Certificates) representing interests in a trust fund for which an affiliate of the fiduciary serves as a sub-servicer.(2)

You represent that BlackRock Financial Management, Inc. (BlackRock), is an investment advisor that is registered under the Investment Advisors Act of 1940 and is a wholly-owned second-tier subsidiary of PNC Bank, a national banking association (PNC). BlackRock has over $45 billion in assets under management, including assets of a number of employee benefit plans (Plans) subject to Title I of ERISA and/or section 4975 of the Internal Revenue Code of 1986 (the Code).

The Certificates represent interests in trust funds (Trusts), each of which consists of a segregated pool primarily of conventional, fixed-rate, multifamily or commercial mortgage loans (Mortgage Loans). A portion of the Mortgage Loans in each pool have been originated by PNC (PNC Loans). PNC also acts, pursuant to the pooling and servicing agreement that establishes each Trust, as a sub-servicer for the PNC Loans held in each Trust. The services provided by PNC typically include, among other things, notifying borrowers of amounts due on receivables, maintaining records of payments received, and instituting foreclosure or similar proceedings in the event of default with respect to the PNC Loans. Such services do not include any investment management or investment advisory services. As the subservicer of PNC Loans in a Trust, PNC receives a monthly fee in an amount equal to a fixed percentage of the outstanding principal balance of each Loan. This amount is collected from interest actually paid with respect to each Loan. In addition, under certain Trusts, PNC is entitled to retain certain ancillary fees that may be collected with respect to the Loan, including assumption fees, modification fees, insufficient funds fees and similar charges. You represent that PNC has no discretion with respect to the assets or management of the Trust. You further represent that neither PNC nor BlackRock is affiliated with any other entity that is a party to any of the Trusts, including the underwriter, master servicer, trustee, insurer, or obligor to or of the Trusts.

The sponsor of a Trust, through one or more underwriters or placement agents, makes an initial public or private offering of Certificates to investors. After the initial offering, Certificates are traded on the secondary market. The price of Certificates, both in the initial offering and in the secondary market, is affected by market forces, including investor demand, the pass-through interest rate on the Certificates in relation to the rate payable on investments of similar types and quality, expectations as to the effect on yield resulting from the prepayment of underlying mortgages, and expectations as to the likelihood of timely payment.(3)

The pass-through rate for holders of Certificates is equal to the interest rate on mortgages included in the Trust minus a specified servicing fee. You represent that all fees and other consideration payable by the Trust to PNC and other service providers to the Trust are determined and fixed as of the closing of the initial offering of the Certificates.

You state that BlackRock will cause Plans to purchase Certificates only on the secondary market.(4) You assert that any fees payable to PNC in accordance with the applicable pooling and servicing agreement between PNC and the Trust will be unaffected by BlackRock’s causing Plans to purchase Certificates on the secondary market. Neither PNC nor BlackRock, you state, would have any interest in, or receive any additional consideration from, any source by reason of, or in connection with, such secondary market transactions.

You are seeking guidance that BlackRock would not violate ERISA section 406(b) by causing Plans over which it has fiduciary authority to purchase, on the secondary market, Certificates of Trusts containing PNC Loans merely because its affiliate, PNC, acts as sub- servicer for such Loans and receives compensation, pursuant to its subservicing agreements, from the Trusts for the provision of such services.

Section 406(b)(1) of ERISA prohibits a fiduciary with respect to a plan from dealing with the assets of the plan in his own interest or for his own account. Section 406(b)(2) prohibits a fiduciary, in his individual or any other capacity, from acting in any transaction involving the plan on behalf of a party (or representing a party) whose interests are adverse to the interests of the plan or the interests of its participants or beneficiaries. Section 406(b)(3) prohibits a fiduciary from receiving 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.

You have represented that PNC’s compensation from the Trusts is determined and fixed as of the close of the initial offering of Certificates in each Trust and is not affected by whether or not BlackRock invests plan assets in the Certificates in the secondary market. Regulation section 29 C.F.R. 2550.408b-2(e)(2) states that a fiduciary does not engage in an act described in section 406(b)(1) of ERISA if the fiduciary does not use any of the authority, control, or responsibility that makes such person a fiduciary to cause a plan to pay additional fees for a service provided by such fiduciary or by a person in whom such fiduciary has an interest that may affect the exercise of such fiduciary’s best judgment as a fiduciary. Similarly, it is the view of the Department that a fiduciary does not engage in an act described in section 406(b)(3) of ERISA if the fiduciary does not use any of its authority, control, or responsibility to cause a third party to pay to the fiduciary any compensation in connection with a transaction involving the assets of the plan.(5) Accordingly, it is the opinion of the Department that BlackRock would not violate section 406(b)(1) or (b)(3) of ERISA by causing Plans over which it has fiduciary authority to purchase Certificates of the Trusts on the secondary market merely because its affiliate, PNC, acts as a sub-servicer of the Trusts, as long as the compensation that BlackRock and PNC receives is not affected by such investment. Moreover, because PNC’s relationship to the Trusts remains wholly unaffected by BlackRock’s investment of Plan assets in the Certificates, such investment would not be considered to involve BlackRock’s acting on behalf of PNC in violation of section 406(b)(2) of ERISA merely because of PNC’s role as sub-servicer of the Trusts.(6)

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 10 relating to the effect of advisory opinions.

Sincerely,

Susan G. Lahne
Acting Chief, Division of Fiduciary Interpretations
Office of Regulations and Interpretations

Footnotes

  1. Under Reorganization Plan No. 4 of 1978 (43 FR 47713, October 17, 1978), the authority of the Secretary of the Treasury to issue rulings under section 4975 of the 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 refer also to the corresponding sections of the Code.
  2. You represent that, although BlackRock Financial Management, Inc., a plan fiduciary that is an affiliate of a sub-servicer of the issuing trust, is the entity that would cause a plan to purchase the Certificates, the purchase of such Certificates would otherwise conform to the conditions set forth in a series of individual prohibited transaction exemptions (PTEs) issued by the Department of Labor for plan investments in securities issued by trusts that hold multifamily and commercial mortgages (generally referred to as the Underwriter Exemptions). See, e.g., PTEs 97-5 (SouthTrust Securities, Inc. (62 FR 1926, January 14, 1997), 96-94 (First Chicago, NBD, 61 FR 68787, December 30, 1996), and 96-92 (BA Securities, Inc., 61 FR 66333, December 17, 1996). See also, class PTE 97-34 (62 FR 39021, July 21, 1997), which amended the individual PTEs involving such trusts, primarily to permit pre-funding of the tru sts, and making related changes.
  3. In this connection, we note that the Underwriter Exemptions referred to in fn. 2, above, require that, at the time of acquisition by a plan, certificates must have received one of the three highest ratings available from one of four specified rating services.
  4. Under the facts detailed in the Underwriter Exemptions, the underwriter of certificates normally attempts to make a market for securities (including certificates) for which it is the lead or co-managing underwriter. At times, an underwriter will facilitate sales by investors who purchase certificates if the underwriter has acted as agent or principal in the original private placement of the certificates and if such investors request the underwriter’s assistance.
  5. See, in this regard, Advisory Opinion 97-15A (May 22, 1997).
  6. This opinion does not address, however, the question of whether, in actual operation, BlackRock’s decisions to invest plan assets are designed to benefit PNC. For example, this opinion would not apply if BlackRock conditioned investment in any Certificate of a Trust on whether the Trust includes mortgages that are serviced by PNC.

1999-05A   Application of Plan Assets Regulation to Certain Mortgage Pool Certificates Offered by Freddie Mac

1999-05A
ERISA Sec. 401(b)

February 22, 1999

Laraine S. Rothenberg, Esq.
Fried, Frank, Harris, Shriver & Jacobson
One New York Plaza
New York, New York 10004

Dear Ms. Rothenberg:

This is in response to your request on behalf of the Federal Agricultural Mortgage Corporation (“Farmer Mac”) for an advisory opinion regarding the application of the “plan assets” regulation issued by the Department of Labor (the Department) under the Employee Retirement Income Security Act of 1974 (“ERISA”) to certain mortgage pool certificates offered by Farmer Mac. Specifically, you request an advisory opinion that guaranteed mortgage-backed certificates issued by Farmer Mac are “guaranteed governmental mortgage pool certificates” within the meaning of 29 C.F.R. 2510.3-101(i)(2). You also request an advisory opinion as to whether certain parties performing various services with respect to the assets underlying the mortgage-backed certificates would be parties in interest under section 3(14) of ERISA or disqualified persons under section 4975(e)(2) of the Internal Revenue Code of 1986 (the Code) with respect to investing employee benefit plans.(1) In addition, you ask for an advisory opinion that the certificates would be deemed to meet a particular condition of a group of prohibited transaction exemptions (“the Underwriter Exemptions”),(2) granted to provide relief for the origination and operation of certain asset pool investment trusts, including guaranteed governmental mortgage pool certificate investment trusts, and for the acquisition, holding and disposition of asset backed pass-through certificates representing undivided interests in those trusts.

You represent that Farmer Mac is a federally chartered corporate instrumentality of the United States established in 1987 for the purpose of promoting a secondary market for agricultural mortgage loans, similar to the secondary markets in residential mortgage loans established by the Federal National Mortgage Association (“Fannie Mae”) and Federal Home Loan Mortgage Corporation (“Freddie Mac”).(3) The Board of Directors of Farmer Mac consists of fifteen members, five of whom are elected by holders of common stock of Farmer Mac that are banks, insurance companies, or other financial institutions or entities; five of whom are elected by holders of common stock of Farmer Mac that are Farm Credit System institutions; and five of whom, including the Chairman of the Board, are appointed by the President of the United States and confirmed by the Senate.

Farmer Mac is authorized under the Farm Credit Act to purchase several different types of agricultural and real estate mortgages, mortgage pass-through certificates and other mortgage- backed securities evidencing interests in or secured by agricultural real estate mortgages, and to resell them, primarily in the form of mortgage-backed certificates (“Certificates”) representing undivided interests in pools of mortgages purchased by Farmer Mac.(4) You state that while Farmer Mac Certificates are not guaranteed directly by the United States, Farmer Mac guarantees the timely payment of principal and interest on such investments to all Certificate holders. Farmer Mac Certificates provide for periodic (monthly, quarterly, semi-annual or annual) payment of interest and the pass-through of principal based on collections with respect to the underlying mortgages.

You state further that Farmer Mac Certificates are offered from time to time in one or more series. Each series of Certificates represents, in the aggregate, the entire beneficial ownership interest in a segregated pool of mortgages held in a trust fund managed by Farmer Mac Securities Corporation (“Depositor”), a wholly-owned subsidiary of Farmer Mac. The Certificates are purchased from the Depositor by an underwriter or placement agent that offers the Certificates from time to time in public offerings registered under the Securities Act of 1933, and in private placements. The Certificates may be sold in negotiated transactions, at varying prices determined at the time of sale.

The trustee of the trust funds managed by the Depositor is currently U.S. Bank Trust National Association.(5) The assets of the trust funds consist of segregated pools of fixed rate or adjustable rate agricultural real estate mortgage loans (“Qualified Loans”); portions of loans that are guaranteed by the United States Secretary of Agriculture (“Guaranteed Portions”); mortgage pass-through certificates or other mortgage-backed securities evidencing interests in or secured by Qualified Loans or Guaranteed Portions; or any combination thereof (collectively, “Qualified Assets”).(6) Qualified Loans are secured by parcels of land, which may be improved by buildings or other structures permanently affixed to the parcels, that are used for the production of one or more agricultural commodities and consist of a minimum of five acres or are used in producing minimum annual receipts of at least $5,000; or by a mortgage on a principal residence that is a single-family moderately priced residential dwelling located in a rural area.(7)

You represent further that the sellers of Qualified Assets (“Sellers”) are banks and other financial institutions, including member institutions of the Farm Credit System and insurance companies. The Sellers may be the financial institutions that originally made the Qualified Loans (“Originators”) or they may be purchasers of the Qualified Loans from one or more Originators. Farmer Mac selects the Qualified Assets that it wishes to purchase from a Seller, after determining that the Qualified Assets meet Farmer Mac’s underwriting standards. The Depositor then purchases the Qualified Assets from the Seller, assigns the Qualified Assets transferred to it by the Seller to a segregated pool in a trust fund,(8) causes the trust fund to issue one or more series of Certificates, and receives the proceeds of the sale of the Certificates. Farmer Mac guarantees the timely payment of principal and interest on the Certificates upon their issuance by the Depositor. To assure its ability to fulfill its guarantee obligations, Farmer Mac is required to establish reserves upon issuance of a guarantee. Farmer Mac’s charter provides that, in the event that Farmer Mac’s own reserves and capital are insufficient to enable it to meet its guarantee obligations, the Treasury will purchase up to $1.5 billion of Farmer Mac’s obligations.(9)

You state that Farmer Mac acts as Master Servicer of the Qualified Loans in each loan pool and is ultimately responsible for the servicing of the Qualified Loans, though it has contracted with banks and other financial institutions (collectively, “Central Servicers”) to perform the servicing functions on its behalf, including the distribution of principal and interest payments on the Qualified Loans in each pool and the distribution of any yield maintenance charge (the amount payable by a borrower under a loan in connection with a principal prepayment or acceleration by the lender) to the Trust Fund, on behalf of the holders of Certificates.(10) Pursuant to the contracts, Central Servicers establish and maintain separate accounts on behalf of the Trust Fund for the collection of payments on Qualified Assets and foreclose upon or comparably convert the ownership of properties of any Qualified Loans that continue in default.(11) The Central Servicers are compensated for their services out of the interest payments received on each Qualified Loan and also retain certain late fees, servicing charges assessed against borrowers, and other fees. Central Servicers may subcontract their servicing functions with respect to the Qualified Loans to qualified agricultural mortgage servicers (“Field Servicers”), some of whom may be Sellers or Originators.

The Farm Credit Administration (FCA), acting through the Office of Secondary Market Oversight (OSMO), has general regulatory and enforcement authority over Farmer Mac, including the authority to promulgate rules and regulations governing the activities of Farmer Mac and to apply its general enforcement power to Farmer Mac and its activities. In accordance with its statutory mandate, Farmer Mac’s loan standards were submitted to Congress for approval before they were adopted in 1990. The Director of OMSO, who is selected by and reports to the FCA Board, is responsible for the examination of Farmer Mac and the general supervision of the safe and sound performance by Farmer Mac of the powers and duties vested in it by Title VIII of the Farm Credit Act of 1971, as amended.(12)

The Farm Credit Act requires the FCA to examine and audit Farmer Mac’s books and financial transactions and to perform an evaluation of the safety and soundness of Farmer Mac’s operations at least annually. Farmer Mac is required to file quarterly reports of condition with the FCA, as well as copies of all documents filed with the Securities Exchange Commission under the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934. While the FCA is not required to approve the payment of dividends on Farmer Mac common stock, the Farm Credit Act provides that no dividend may be declared or paid unless the Farmer Mac Board determines that adequate provision has been made for the corporation’s reserve against guarantee losses and that no obligation issued by Farmer Mac to the Secretary of the Treasury remains outstanding.(13) Under its general regulatory and supervisory authority, the FCA regularly reviews new programs and activities of Farmer Mac involving the purchase, sale, servicing of, lending on the security of, or otherwise dealing in conventional agricultural mortgages. In addition, the Farm Credit Act requires the Comptroller General of the United States to perform an annual review of the actuarial soundness and reasonableness of the guarantee fees established by Farmer Mac.

It is expected by the Board of Directors and management of Farmer Mac that the Depositor will not have any relationships to investing employee benefit plans, other than through their transactions with respect to the Certificates. However, you state that obligors with respect to Qualified Assets Collateralizing the Certificates (“Borrowers”) may be related to sponsors of investing employee benefit plans. For example, a Borrower may also be the plan sponsor of an investing employee benefit plan. You state that it is also possible that a Central Servicer, Field Servicer, Seller, or trustee of a trust fund managed by the Depositor may be related to investing employee benefit plans and may therefore be a party in interest or fiduciary with respect to such plans.

The Department’s plan asset regulation at 29 C.F.R. 2510.3-101 describes the circumstances under which the assets of an entity in which a plan invests will be considered to include assets of the plan for purposes of ERISA’s reporting and disclosure and fiduciary responsibility provisions and the related prohibited transaction provisions of the Internal Revenue Code. Section 2510.3-101(i)(2) defines a “guaranteed governmental mortgage pool certificate” as “a certificate backed by, or evidencing an interest in, specified mortgages or participation interests therein and with respect to which interest and principal payable pursuant to the certificate are guaranteed by the United States or an agency or instrumentality thereof.” The regulation specifically refers to mortgage pool certificates guaranteed by Ginnie Mae, Freddie Mac, or Fannie Mae,(14) but makes clear that the exception may also apply to similar governmental mortgage pool investments. As explained in the preamble to the final regulation, the regulation provides in section 2510.3-101(i)(l) that, when a plan invests in a guaranteed governmental mortgage pool, its assets include its investment, but do not, solely by reason of such investment, include any of the underlying mortgages. Thus, the sponsor or manager of a governmental mortgage pool would not be a fiduciary of a plan solely by reason of the plan’s investment in the pool. The regulation specifically states that interests in Freddie Mac, Ginnie Mae and Fannie Mae are among the investments to which the regulation’s general rule applies.(15) Accordingly, the term “guaranteed governmental mortgage pool certificate” in section 2510.3-101(i)(2) is not limited to securities of the three entities specifically listed, but encompasses any certificates backed by, or evidencing an interest in, specified mortgages or participation interests therein and with respect to which interest and principal payable pursuant to the certificate are guaranteed by the United States or an agency or instrumentality thereof.

It appears to the Department from your representations that, for purposes of the definition of plan assets, Farmer Mac was established and is operated in a manner substantially similar to that of Fannie Mae and Freddie Mac. Like those entities, Farmer Mac is a Federally chartered instrumentality of the United States that issues guarantees on pools of mortgage loans in order to increase the availability of mortgage credit. Although Farmer Mac Certificates are not guaranteed by the United States, in light of the significant Federal involvement in the management of the Farmer Mac, it is our view that investments in Certificates issued by Farmer Mac should be treated in the same way as investments in certificates issued by Fannie Mae and Freddie Mac. Based on your representations and in view of the foregoing, it is the view of the Department that the mortgage pool Certificates guaranteed and issued by Farmer Mac meet the definition of a “guaranteed governmental mortgage pool certificate,” as defined in 29 C.F.R. 2510.3-101(i)(2).

The Department notes that ERISA’s general standards of fiduciary liability apply to any investment by a plan covered by Title I, including an investment in a guaranteed governmental mortgage certificate as defined in 29 C.F.R. 2510.3-101(i)(2). Section 404(a)(1)(B) of ERISA requires that a fiduciary discharge his duties to a plan solely in the interests of the plan participants and beneficiaries, and with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent man would use in the conduct of an enterprise of like character and with like aims. Accordingly, the fiduciaries of an investing plan must act “prudently” and “solely in the interest” of the plan’s participants and beneficiaries when deciding whether or not to invest in a Certificate.

You also requested an opinion as to whether trustees of a trust fund managed by the Depositor, Central Servicers, Field Servicers or Borrowers would be parties in interest under section 3(14) of ERISA or disqualified persons under section 4975(e)(2) of the Code. In this regard, we note that the mere investment of plan assets in the Certificates issued by Farmer Mac would not, by itself, make those entities parties in interest or disqualified persons, since it is our view that it is only the Certificates, and not the assets underlying the Certificates, that are plan assets. However, to the extent any of these entities have other relationships to the investing plans that are described in ERISA section 3(14) or Code section 4975(e)(2), such entities may be parties in interest or disqualified persons with respect to such plans.

Further, because it is our view that the Certificates are “guaranteed governmental mortgage certificates” within the meaning of that term as defined at 29 C.F.R. 2510.3-101(i)(2), transactions between these parties and a Farmer Mac trust fund that relate only to the assets underlying the Certificates, and that do not involve the Certificates themselves, would not constitute prohibited transactions under sections 406 or 407 of ERISA or section 4975(c)(1) of the Code.

We are unable to provide you guidance on your final question regarding the Underwriter Exemptions. Specifically, you asked for an opinion that the Certificates are deemed to meet the condition that “the certificates acquired by the plan have received a rating at the time of such acquisition that is in one of the three highest generic rating categories from either Standard & Poor’s Structured Rating Group, Moodys Investors Service, Inc., Duff & Phelps Credit Rating Co. or Fitch Investors Service, L.P.” We do not have authority to deem that a transaction satisfies a condition set forth in an individual exemption. To the extent that the prohibited transactions provisions of ERISA or the Code are implicated by transactions involving the Certificates, we suggest that you discuss this matter with the Office of Exemption Determinations of this agency.

This letter constitutes an advisory opinion under ERISA Procedure 76-1 (41 Fed. Reg. 36281, August 27, 1976). Section 10 of the Procedure describes the effect of advisory opinions.

Sincerely,

Susan G. Lahne
Acting Chief, Division of Fiduciary Interpretations
Office of Regulations and Interpretations

Footnotes

  1. Under Presidential 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 has been, with certain exceptions not here relevant, transferred 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.
  2. Such exemptions include, for example, Banc One Capital Corporation, 60 Fed. Reg. 49011 (Sept. 21, 1995); ContiFinancial Services Corporation, 61 Fed. Reg. 3490 (Jan 31, 1996); and SouthTrust Securities, 62 Fed. Reg. 1926 (Jan. 14, 1997).
  3. Farmer Mac was created by the Agricultural Credit Act of 1987 (12 U.S.C. §§ 2279aa et seq.), which amended the Farm Credit Act of 1971. The Farm Credit System Reform Act of 1996 (Pub. L. 104-105 (1996)) (the 1996 Act) amended the Farm Credit Act and expanded Farmer Mac’s secondary market authority. Among other things, the 1996 Act authorized Farmer Mac to purchase and pool eligible loans to serve as collateral for securities guaranteed by Farmer Mac; eliminated a requirement to create a subordinated interest or reserve of at least 10% of the initial principal balance of pooled loans; and included requirements that Federal Reserve banks act as depositories for and fiscal agents of Farmer Mac and that Farmer Mac have access to the Federal Reserve System’s book-entry system, thereby permitting Farmer Mac securities to be traded in the same manner as those issued by Fannie Mae, Freddie Mac and the Government National Mortgage Association (“Ginnie Mae”). The latter three entities are also sometimes referred to as FNMA, FHLMC, and GNMA, respectively.
  4. Public offerings of Farmer Mac guaranteed mortgage-backed Certificates are required to be registered under the Securities Act of 1933.
  5. Under the Farm Credit Act, Farmer Mac may select itself, or banks or other financial institutions not affiliated with Farmer Mac, to serve as trustee of a trust fund. While U.S. Bank Trust Corporation is currently the trustee of all the trust funds managed by the Depositor, it is possible that at some point different trusts might have different trustees.
  6. The Trust Fund may also include a de minimus amount of real estate owned by the Trust Fund following a foreclosure and proceeds received by the Trust Fund with respect to Qualified Loans prior to such proceeds being distributed.
  7. You represent that Farmer Mac does not currently secure Qualified Loans solely by mortgages on primary residences located in rural areas, but, under the Farm Credit Act, is permitted to do so.
  8. The segregated pool may also contain Qualified Assets transferred to the Depositor by other Sellers.
  9. The Farm Credit Act also permits Farmer Mac and its affiliates to issue debt obligations for the purpose of obtaining amounts for the re-purchase of any securities previously issued and guaranteed by Farmer Mac that represent interests in, or obligations backed by, pools of Qualified Loans; for the purchase of Qualified Loans; and for obtaining reasonable amounts for business operations, including adequate liquidity, subject to minimum capital requirements imposed by Farmer Mac’s charter.
  10. As Master Servicer, Farmer Mac has the right to purchase from the Trust Fund delinquent Qualified Loans and property acquired by the Trust Fund upon foreclosure or comparable conversion of a Qualified Loan.
  11. Central Servicers are selected by Farmer Mac based on their experience, general reputation and financial strength. Current Central Servicers are Lend Lease Business, Inc.; AgFirst Farm Credit Bank; and GMAC Commercial Mortgage Corporation.
  12. 12 U.S.C. § 2279aa et seq.
  13. “Guarantee losses” refer to payments by Farmer Mac of principal and interest on guaranteed securities in excess of the liquidation proceeds of the collateral securing the Qualified Loans in the pool that backs such securities.
  14. Farmer Mac was created subsequent to the promulgation of both the Department’s 1982 final regulation on government mortgage pools (the 1982 Regulation), 47 Fed. Reg. 21241 (May 18, 1982), and the Department’s 1986 final regulation on the definition of plan assets. (See 29 CFR 2510.3-101, 51 Fed. Reg. 41262, 41278 (Nov. 13, 1986)). The 1986 final regulation on the definition of plan assets incorporated the guaranteed governmental mortgage pool exception established in the 1982 Regulation and redesignated it to appear at 29 C.F.R. 2510.3-101(i).
  15. Preamble to the Final Regulation on Trust Requirement and Definition of Plan Assets - Governmental Mortgage Pools, 47 Fed. Reg. 21241 (May 18, 1982), at 21243-44.

1999-13A    Treatment of QDROs Believed to be Questionable

1999-13A
ERISA Sec. 206(d)(3)

September 29, 1999

Brian G. Belisle
Oppenheimer Wolff & Donnelly LLP
Plaza VII
45 South Seventh Street, Suite 3400
Minneapolis, Minnesota 55402-1609

Dear Mr. Belisle:

This is in response to your request on behalf of the UAL Corporation (UAL) and United Air Lines, Inc. (United) for an advisory opinion. Specifically, you ask how a plan administrator should treat domestic relations orders the plan administrator has reason to believe are “sham” or “questionable” in nature.(1)

UAL is a holding company. Its major wholly-owned subsidiary is United. You represent that employees of United participate in three pension plans – an employee stock ownership plan (the ESOP); a 401(k) plan that is a profit sharing plan qualified under section 401(a) of the Code (the 401(k) Plan); and a defined benefit pension plan. The ESOP is a combination leveraged ESOP and non-leveraged stock bonus plan that is qualified under section 401(a) of the Code. Substantially all of the assets in the ESOP are invested in UAL stock.

You represent that the named plan administrator of the ESOP is UAL. UAL has assigned many of its administrative duties under the ESOP, including the duty to establish procedures for determining whether a domestic relations order constitutes a “qualified domestic relations order” (QDRO), to an ESOP Committee consisting of employees of United. The ESOP Committee has delegated to United’s Pension Programs Department (Pension Programs) the responsibility of reviewing and determining whether a domestic relations order received by the ESOP Committee is a QDRO within the meaning of section 206(d)(3) of ERISA. Appeals of QDRO determinations are made to the ESOP Committee.

You further represent that the ESOP permits an alternate payee to request the immediate lump sum distribution of any benefits under the plan that are assigned pursuant to the terms of any domestic relations order that the ESOP Committee determines is a QDRO. The ESOP otherwise permits lump sum distributions only following a participant’s termination of employment (including by way of the participant’s death).

The named plan administrator of the 401(k) Plan is United. United has delegated the authority to control and manage the administration of the 401(k) Plan, including the duty to establish procedures for determining whether a domestic relations order constitutes a QDRO, to a Pension and Welfare Plans Administration Committee (PAWPAC) consisting of employees of United. PAWPAC in turn has delegated to Pension Programs the responsibility for reviewing and determining whether a domestic relations order applying to the 401(k) Plan is a QDRO. Appeals of a QDRO determination are made to PAWPAC. As with the ESOP, the 401(k) Plan permits the immediate distribution of benefits under the plan that are assigned pursuant to the terms of a QDRO. Although an alternate payee may thus receive an immediate lump sum distribution from the 401(k) Plan, participants or beneficiaries are entitled to distributions from the 401(k) plan only following termination of employment (including by way of the participant’s death) or upon financial hardship.

You represent that Pension Programs currently has under review 16 domestic relations orders concerning benefits under the ESOP and the 401(k) Plan that Pension Programs believes may be “questionable” or “sham” in nature.(2)

You detail the grounds for Pension Programs’ suspicions as to the nature of these domestic relations orders as follows. Pension Programs received within a very short period of time five domestic relations orders from the same lawyer (two of the orders were mailed in the same envelope). Each order related to participants working in United’s maintenance facility located in Indianapolis, Indiana. Each of the five orders identically provided for an assignment of 100 percent of the participant’s benefit in the ESOP and the 401(k) Plan to an alternate payee. Each order made no provision for any assignment of these participants’ benefits in United’s defined benefit pension plan. In each of the orders, the alternate payee and participant were shown as having the same address. Despite its suspicions, Pension Programs determined that each of the five orders was qualified because they satisfied the requirements of section 206(d)(3) of ERISA. In Pension Programs’ view, these orders differed from other domestic relations orders processed by Pension Programs in that they dealt only with the ESOP and the 401(k) Plan; they provided for assignment of 100 percent of the participant’s benefit; and they showed the participant and alternate payee as having the same address.

After its determination that these five domestic relations orders were QDROs, Pension Programs received and reviewed 16 other orders that had unusual characteristics similar to those of the original five orders. These 16 orders similarly provided for a 100 percent assignment of benefits payable under the ESOP and/or the 401(k) Plan, made no mention of the defined benefit pension plan, and specified in most cases that the alternate payee and participant shared the same address. You represent that Pension Programs performed additional investigation in its review of these 16 domestic relations orders to determine whether they were qualified.(3) While these orders were pending review with Pension Programs, two participants from the Indiana facility called at different times to determine the status of the review of their orders. You indicate that, during those conversations, each participant asserted that his order was not one of the “fraudulent QDROs.” You represent that these statements led Pension Programs to heighten its scrutiny of the 16 orders assigning 100 percent of the participant’s right to the ESOP and 401(k) benefits.

You further represent that, after beginning its investigation of the 16 domestic relations orders in question, Pension Programs learned of a pamphlet entitled “Retirement Liberation Handbook” that was being distributed by at least one United employee in the Indianapolis, Indiana area.(4) The pamphlet advocated, as a method of acquiring a distribution of pension plan benefits before reaching retirement age, that participants and their spouses obtain a divorce for the sole purpose of securing a court order assigning pension plan benefits and then remarry. Such a sham divorce, according to the Liberation Handbook, would enable the participant to obtain direct control over the investment of the participant’s pension benefit. The Liberation Handbook also suggested that single employees could go through a sham marriage and subsequent divorce, by paying an individual a percentage of the anticipated pension distribution as compensation for acting as spouse, or could instead quit employment in order to obtain a similar early distribution and later get rehired. The Handbook described in some detail how distributions from pension plans are handled for tax purposes and discussed various options for distributions and investments of the distributions.

After reviewing the Liberation Handbook, Pension Programs determined that all of the 16 orders in question, as well as the original five orders it had previously deemed qualified, had significant similarities to the specific format promoted by the Liberation Handbook. For example, two of the initial five orders requested that distribution be made to an inappropriate account named in the Liberation Handbook.

In addition, all of the orders identified by Pension Programs as questionable relate to the ESOP and 401(k) benefits of employees who, at the time of the order, resided in the Indianapolis area and were in related work groups, and all had a number of common characteristics not typically seen in Pension Programs’ review of domestic relations orders. Included in these were rapid remarriage and continued use by the putative alternate payee of United’s no-cost travel for spouses.

You represent that Pension Programs engaged local counsel in Indiana to determine whether and to what extent the questionable domestic relations orders might be valid under Indiana law. Indiana counsel opined that, if the orders had been obtained as promoted by the Liberation Handbook, (i) the participant and alternate payee would have committed perjury; (ii) the parties would be in contempt of court; (iii) the order would have been fraudulently obtained; and (iv) if the foregoing could be established to the satisfaction of a judge, the order likely would be vacated by the court.

You have asked for an advisory opinion as to whether, and if so when, a plan administrator may investigate or question a domestic relations order submitted for review to determine whether it is a valid “domestic relations order” under State law for purposes of section 206(d)(3)(B) of ERISA.

Section 206(d)(1) of ERISA generally requires pension plans covered by Title I of ERISA to provide that plan benefits may not be assigned or alienated. Section 206(d)(3)(A) of ERISA states that section 206(d)(1) applies to an assignment or alienation of benefits pursuant to a “domestic relations order” unless the order is determined to be a “qualified domestic relations order” (QDRO). Section 206(d)(3)(A) further provides that pension plans must provide for payment of benefits in accordance with the applicable requirements of any QDRO.

Section 206(d)(3)(B) of ERISA defines the terms “qualified domestic relations order” and “domestic relations order” for purposes of section 206(d)(3) as follows:

(B) For purposes of [section 206(d)(3)] –

(i) the term “qualified domestic relations order” means a domestic relations order –

(I) which creates or recognizes the existence of an alternate payee’s right to, or assigns to an alternate payee the right to, receive all or a portion of the benefits payable with respect to a participant under a plan, and

(II) with respect to which the requirements of subparagraphs (C) and (D) are met, and

(ii) the term “domestic relations order” means any judgment, decree, or order (including approval of a property settlement agreement) which –

(I) relates to the provision of child support, alimony payments, or marital property rights to a spouse, former spouse, child, or other dependent of a participant, and

(II) is made pursuant to a State domestic relations law (including a community property law).

Section 206(d)(3)(C) requires that in order for a domestic relations order to be qualified such order must clearly specify (i) the name and the last known mailing address (if any) of the participant and the name and mailing address of each alternate payee covered by the order; (ii) the amount or percentage of the participant’s benefits to be paid by the plan to each such alternate payee, or the manner in which such amount or percentage is to be determined; (iii) the number of payments or period to which such order applies; and (iv) each plan to which the order applies.

Section 206(d)(3)(D) specifies that a domestic relations order is qualified only if such order does not require (i) the plan to provide any type of benefit, or any option, not otherwise provided by the plan; (ii) the plan to provide increased benefits (determined on the basis of actuarial value); and (iii) the payment of benefits to an alternate payee that are required to be paid to another alternate payee under another order previously determined to be a qualified domestic relations order.

Section 206(d)(3)(G) of ERISA requires the plan administrator to determine the qualified status of domestic relations orders received by the plan and to administer distributions under such qualified orders, pursuant to reasonable procedures established by the plan. In administering QDROs, plan administrators must follow the plan’s reasonable procedures, as required under section 206(d)(3)(G), and must assure that the plan pays only reasonable expenses of administering the plan, as required by sections 403(c)(1) and 404(a)(1)(A) of ERISA. In this regard, plan fiduciaries must take appropriate steps to ensure that plan procedures are designed to be cost effective and to minimize expenses associated with the administration of domestic relations orders. See Advisory Opinion 94-32A (Aug. 4, 1994).

When a pension plan receives an order requiring that all or a part of the benefits payable with respect to a participant be paid to an alternate payee, the plan administrator must determine that the judgment, decree or order is a “domestic relations order” within the meaning of section 206(d)(3)(B)(ii) of ERISA – i.e., that it relates to the provision of child support, alimony payments, or marital property rights to a spouse, former spouse, child or other dependent of the participant and that it is made pursuant to State domestic relations law by a State authority with jurisdiction over such matters. Additionally, the plan administrator must determine that the order is qualified under the requirements of section 206(d)(3) of ERISA. It is the view of the Department that the plan administrator is not required by section 206(d)(3) or any other provision of Title I to review the correctness of a determination by a competent State authority pursuant to State domestic relations law that the parties are entitled to a judgment of divorce. See Advisory Opinion 92-17A (Aug. 21, 1992). Nevertheless, a plan administrator who has received a document purporting to be a domestic relations order must carry out his or her responsibilities under section 206(d)(3) in a manner consistent with the general fiduciary duties in part 4 of title I of ERISA.

For example, if the plan administrator has received evidence calling into question the validity of an order relating to marital property rights under State domestic relations law, the plan administrator is not free to ignore that information. Information indicating that an order was fraudulently obtained calls into question whether the order was issued pursuant to State domestic relations law, and therefore whether the order is a “domestic relations order” under section 206(d)(3)(C). When made aware of such evidence, the administrator must take reasonable steps to determine its credibility. If the administrator determines that the evidence is credible, the administrator must decide how best to resolve the question of the validity of the order without inappropriately spending plan assets or inappropriately involving the plan in the State domestic relations proceeding. The appropriate course of action will depend on the actual facts and circumstances of the particular case and may vary depending on the fiduciary’s exercise of discretion. However, in these circumstances, we note that appropriate action could include relaying the evidence of invalidity to the State court or agency that issued the order and informing the court or agency that its resolution of the matter may affect the administrator’s determination of whether the order is a QDRO under ERISA.(5) The plan administrator’s ultimate treatment of the order could then be guided by the State court or agency’s response as to the validity of the order under State law. If, however, the administrator is unable to obtain a response from the court or agency within a reasonable time, the administrator may not independently determine that the order is not valid under State law and therefore is not a “domestic relations order” under section 206(d)(3)(C), but should rather proceed with the determination of whether the order is a QDRO.

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

Sincerely,

Susan G. Lahne
Acting Chief, Division of Fiduciary Interpretations
Office of Regulations and Interpretations

Footnotes

  1. You do not ask and we do not opine as to whether any of the individual domestic relations orders at issue is “qualified” pursuant to section 206(d)(3) of the Employee Retirement Income Security Act of 1974, as amended (ERISA) and section 414(p) of the Internal Revenue Code (Code).
  2. Pension Programs processes between approximately 200 and 300 domestic relations orders per year for all of its qualified retirement plans.
  3. You represent that United pays all expenses related to the administration of domestic relations orders and QDROs, including all of the investigative efforts relating to any questionable QDROs and all legal expenses. You state that no plan assets of either the ESOP or the 401(k) Plan have been used directly or indirectly to pay for the expenses of investigating the QDROs at issue here.
  4. The Liberation Handbook apparently first appeared in the classified section of a local advertising exchange.
  5. Appropriate action could take other forms, depending on the circumstances and the fiduciary’s assessment of the relative costs and benefits, including actual intervention in or initiation of legal proceedings in State court.

2000-10A    Whether allowing the owner of an IRA to direct the IRA to invest in a limited partnership, in which relatives and the IRA owner in his individual capacity are partners, will violate section 4975 of the Code

2000-10A
ERISA Sec. 4975(c)(1)

July 27, 2000

Hugh Janow
Janow & Meyer, LLC
One Blue Hill Plaza
P.O. Box 1606 Suite 1006
Pearl River, New York 10965-8606

Dear Mr. Janow:

This is in response to your request for an advisory opinion under section 4975 of the Internal Revenue Code (Code). Specifically, you ask whether allowing the owner of an IRA to direct the IRA to invest in a limited partnership, in which relatives and the IRA owner in his individual capacity are partners, will violate section 4975 of the Code.(1)

You represent that the Fetner Family Partnership is a New York general partnership that is an investment club (the Partnership), in which Mr. Adler, through a general partnership known as Esponda Associates (Esponda), and various relatives of Mr. Adler invest. Through his investment in Esponda, which is a pass-through partnership, Mr. Adler owns a 12.11 percent interest in the Partnership. Mr. Adler presently owns a 30.38 percent interest in Esponda. The only other partner in Esponda is David Geiger, who is unrelated to Mr. Adler. Esponda currently owns a 39.85 percent interest in the Partnership.

The other current partners of the Partnership are as follows: Steven Adler (Mr. Adler’s son) – 5.25%; Jack Fetner (Mr. Adler’s father-in-law) – 13.44%; Adam Nadel (Mr. Adler’s son’s brother-in-law); Fay Nadel (Mr. Adler’s mother-in-law) – 25.55%; Andrea Raskin (Mr. Adler’s daughter) – 5.33%; Lois Zoldon (Mr. Adler’s sister-in-law) – 7.57%.

The Partnership’s assets are managed by Bernard L. Madoff Investment Securities (Madoff), which is unrelated to Mr. Adler. Madoff requires entities to maintain a minimum capital account. You represent that the Partnership currently has an account with Madoff and has not received any notice that its does not meet minimum capital requirements for investment management by Madoff. The IRA’s assets are not necessary for the Partnership to continue its account with Madoff.

You represent that Leonard Adler intends to open a self-directed individual retirement account (IRA) in the amount of approximately five hundred thousand ($500,000.00) dollars through Retirement Accounts, Inc. of Denver, Colorado. At the time Mr. Adler directs the IRA investment, the Partnership will become a limited Partnership. Mr. Adler will be the only general partner in the Partnership and will own 6.52%. Mr. Adler will not have any investment management functions with respect to the assets of the Partnership.

The limited partners and their percentage ownership interests will be as follows: Andrea Raskin – 1.35%; Steven Adler – 3.07%; Jack Fetner – 3.94%; Fay Nadel – 18.1%; Adam Nadel – 1.77%; Lois Zoldon – 5.55%; David Geiger – 20.31%; IRA of Leonard Adler – 39.38%. Messrs. Adler and Geiger will invest directly in the Partnership in the same percentages as they would have invested through Esponda, instead of investing through Esponda. Esponda will no longer invest in the Partnership.

You further represent that Mr. Adler believes that Madoff would effectively manage assets for the IRA, but that Mr. Adler’s IRA does not meet the minimum capital requirements (currently $1 million) for investment management by Madoff. You represent, however, that Madoff will manage the IRA’s assets if it invests with Madoff through the Partnership, even though the IRA by itself otherwise would not meet the minimum capital requirements. You further represent that all of the assets of the Partnership are liquid marketable securities. You also represent that none of the funds contributed by the IRA is required to be used, or will be used, to liquidate or redeem any other partner’s interest in the Partnership.

Finally, you represent that Mr. Adler does not and will not receive any compensation from the Partnership. He likewise will not receive any compensation as a result of the acquisition by the IRA of its limited partnership interest.

You ask whether the investment by the IRA in the Partnership will give rise to a prohibited transaction under section 4975 of the Code. 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,” in relevant part, to include a fiduciary, a relative, and a partnership, of which (or in which) 50 percent or more of the capital interest or profits interest of such partnership 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 such plan or exercises any authority or control regarding management or disposition of its assets. In order for a prohibited transaction to occur under section 4975 of the Code, there must be a transaction involving a disqualified person with respect to a plan. Where none of the relationships described in section 4975(e)(2) of the Code are found to exist, an entity would not be a disqualified person with respect to a plan.

Section 4975(c)(1)(A) of the Code prohibits any direct or indirect sale or exchange or leasing, of any property between a plan and a disqualified person. 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 or her own interest or for his or her 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.

As a trustee with investment discretion over the assets of his IRA, Mr. Adler is a fiduciary, and therefore, a disqualified person under section 4975(e)(2) of the Code. Mr. Adler is also a disqualified person in his capacity as the general partner of the Partnership to the extent he exercises discretionary authority over the administration or management of the IRA assets invested in the Partnership. In addition, although Mr. Adler, his son and his daughter are disqualified persons, you represent that the investment transaction is between the Partnership itself and the IRA, and not with Mr. Adler and his family, except as fellow investors in the Partnership. Mr. Adler owns only 6.5 percent of the Partnership, and therefore the Partnership itself is not a disqualified person under section 4975(e)(2)(G) of the Code which defines a disqualified person to include a corporation, partnership or trust or estate of which 50 percent or more of the capital interest is owned directly or indirectly, or held by persons described as fiduciaries.

Based solely on the facts and representations contained in your submissions, it is the opinion of the Department that the IRA’s purchase of an interest in the Partnership would not constitute a transaction described in section 4975(c)(1)(A) of the Code (prohibiting any direct or indirect sale or exchange or leasing of any property between a plan and a disqualified person).

Whether the proposed transaction would violate sections 4975(c)(1)(D) and (E) of the Code raises questions of a factual nature upon which the Department will not issue an opinion. A violation of section 4975(c)(1)(D) and (E) would occur if the transaction was part of an agreement, arrangement or understanding in which the fiduciary caused plan assets to be used in a manner designed to benefit such fiduciary (or any person which such fiduciary had an interest which would affect the exercise of his best judgment as a fiduciary).

In this regard, the Department notes Mr. Adler does not and will not receive any compensation from the Partnership and will not receive any compensation by virtue of the IRA’s investment in the Partnership. However, the Department further notes that if an IRA fiduciary causes the IRA to enter into a transaction where, by the terms or nature of that transaction, a conflict of interest between the IRA and the fiduciary (or persons in which the fiduciary has an interest) exists or will arise in the future, that transaction would violate either 4975(c)(1)(D) or (E) of the Code. Moreover, the fiduciary must not rely upon and cannot be otherwise dependent upon the participation of the IRA in order for the fiduciary (or persons in which the fiduciary has an interest) to undertake or to continue his or her share of the investment. Furthermore, even if at its inception the transaction did not involve a violation, if a divergence of interests develops between the IRA and the fiduciary (or persons in which the fiduciary has an interest), the fiduciary must take steps to eliminate the conflict of interest in order to avoid engaging in a prohibited transaction. Nonetheless, a violation of section 4975(c)(1)(D) or (E) will not occur merely because the fiduciary derives some incidental benefit from a transaction involving IRA assets.

Moreover, the Department notes that by virtue of the contemplated investment by the IRA in the Partnership, there will be significant investment in the Partnership by benefit plan investors. See 29 CFR § 2510.3-101(f). Accordingly, the Partnership will hold “plan assets” within the meaning of that term in the Department’s regulations at 29 CFR § 2510.3-101. As a result, any person who exercises discretionary authority or control with respect to assets of the Partnership will be fiduciary of the IRA and subject to the restrictions of section 4975(c)(1) of the Code, except to the extent a statutory or administrative exemption applies.

This letter constitutes an advisory opinion under ERISA Procedure 76-1, 41 Fed. Reg. 36281 (1976). Accordingly, this letter 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

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 the interpretations of the Secretary of Labor pursuant to such authority.

2001-01A    The application of Title I of ERISA to the payment by plans of expenses relating to tax-qualification

2001-01A
ERISA Sec. 403 - 404

January 18, 2001

Mr. Carl J. Stoney, Jr.
Crosby, Heafey, Roach & May
Two Embarcadero Center, Suite 2000
San Francisco, California 94111-4106

Dear Mr. Stoney:

This is in response to your recent correspondence in which you request confirmation of the continued viability of the Department of Labor’s views expressed in Advisory Opinion 97-03A (January 23, 1997), discussing the application of the Employee Retirement Income Security Act (ERISA) to the payment of certain plan termination expenses by tax-qualified plans administered by the Insurance Commissioner of the State of California in its capacity as liquidator of the companies which sponsored the plans. Further, you request any other guidance that the department may be able to provide on the issue of permissible plan expenses. In this regard, you indicate that you represent the Conservation and Liquidation Office of the State of California Department of Insurance in connection with the termination of, and attendant distribution of assets from, tax-qualified retirement plans sponsored by now-insolvent insurance companies.

Since the issuance of Advisory Opinion 97-03A, questions have been raised concerning the extent to which an employee benefit plan may pay the costs attendant to maintaining tax- qualified status, without regard to the fact that tax qualification confers a benefit on the plan sponsor. The following is intended to clarify the views of the Department of Labor on this issue.

As discussed in Advisory Opinion 97-03A, a determination as to whether to pay a particular expense out of plan assets is a fiduciary act governed by ERISA’s fiduciary responsibility provisions. ERISA provides that, subject to certain exceptions, the assets of an employee benefit plan shall never inure to the benefit of any employer and shall be held for the exclusive purpose of providing benefits to participants and beneficiaries and defraying reasonable expenses of administering the plan. In discharging their duties under ERISA, fiduciaries must act prudently and solely in the interest of the plan participants and beneficiaries, and in accordance with the documents and instruments governing the plan insofar as they are consistent with the provisions of ERISA. See ERISA sections 403(c)(1), 404(a)(1)(A), (B), and (D).

With regard to sections 403 and 404 of ERISA, we noted that, as a general rule, reasonable expenses of administering a plan include direct expenses properly and actually incurred in the performance of a fiduciary’s duties to the plan. We also noted, however, that the department has long taken the position that there is a class of discretionary activities which relate to the formation, rather than the management, of plans, explaining that these so-called settlor functions include decisions relating to the establishment, design and termination of plans and, except in the context of multi-employer plans, generally are not fiduciary activities governed by ERISA. Expenses incurred in connection with the performance of settlor functions would not be reasonable expenses of a plan as they would be incurred for the benefit of the employer and would involve services for which an employer could reasonably be expected to bear the cost in the normal course of its business operations. However, reasonable expenses incurred in connection with the implementation of a settlor decision would generally be payable by the plan.

In Advisory Opinion 97-03A, the department expressed the view that the tax-qualified status of a plan confers benefits upon both the plan sponsor and the plan and, therefore, in the case of a plan that is intended to be tax-qualified and that otherwise permits expenses to be paid from plan assets, a portion of the expenses attendant to tax-qualification activities may be reasonable plan expenses. This view has been construed to require an apportionment of all tax qualification- related expenses between the plan and plan sponsor. The department does not agree with this reading of the opinion. The opinion recognizes that, in the context of tax-qualification activities, fiduciaries must consider, consistent with the principles articulated in earlier letters,(1) whether the activities are settlor in nature for purposes of determining whether the expenses attendant thereto may be reasonable expenses of the plan. However, in making this determination, the department does not believe that a fiduciary must take into account the benefit a plan’s tax-qualified status confers on the employer. Any such benefit, in the opinion of the department, should be viewed as an integral component of the incidental benefits that flow to plan sponsors generally by virtue of offering a plan.(2)

In the context of tax-qualification activities, it is the view of the department that the formation of a plan as a tax-qualified plan is a settlor activity for which a plan may not pay. Where a plan is intended to be a tax-qualified plan, however, implementation of this settlor decision may require plan fiduciaries to undertake activities relating to maintaining the plan’s tax-qualified status for which a plan may pay reasonable expenses (i.e., reasonable in light of the services rendered). Implementation activities might include drafting plan amendments required by changes in the tax law, nondiscrimination testing, and requesting IRS determination letters. If, on the other hand, maintaining the plan’s tax-qualified status involves analysis of options for amending the plan from which the plan sponsor makes a choice, the expenses incurred in analyzing the options would be settlor expenses.

The foregoing views are intended to clarify, rather than supersede, the views of the department set forth in Advisory Opinion 97-03A. We hope the information provided is of assistance to you.

This letter constitutes an advisory opinion under ERISA Procedure 76-1 (41 Fed. Reg. 36281, August 27, 1976).

Sincerely,

Robert J. Doyle
Director of Regulations and Interpretations

Footnotes

  1. See letter to John N. Ernlenborn from Dennis M. Kass (March 13, 1986); letter to Kirk F. Maldonado from Elliot I. Daniel (March 2, 1987).
  2. The Supreme Court has recognized that plan sponsors receive a number of incidental benefits by virtue of offering an employee benefit plan, such as attracting and retaining employees, providing increased compensation without increasing wages, and reducing the likelihood of lawsuits by encouraging employees who would otherwise be laid off to depart voluntarily. It is the view of the department that the mere receipt of such benefits by plan sponsors does not convert a settlor activity into a fiduciary activity or convert an otherwise permissible plan expense into a settlor expense. See Lockheed Corp. v. Spink, 517 U.S. 882 (1996); Hughes Aircraft Company v. Jacobson, 525 U.S. 432 (1999).

2001-09A    How Financial Services Firms Can Provide Asset Allocation Advice

Advisory Opinion 2001-09A
ERISA Sec. 406(b)

Application of ERISA Sec. 406(b) to certain transactions involving the provision of investment advice and discretionary services with regard to asset allocation for participants in participant-directed defined contribution plans.

December 14, 2001

Mr. William A. Schmidt
Mr. Eric Berger
Kirkpatrick & Lockhart LLP
1800 Massachusetts Avenue, NW, 2nd Floor
Washington, DC 20036-1800

Dear Messrs. Schmidt and Berger:

This is in response to your application, on behalf of SunAmerica Retirement Markets, Inc. (SunAmerica), for an exemption from the prohibited transaction restrictions of section 406 of the Employee Retirement Income Security Act of 1974, as amended (ERISA), with respect to a program (the Program) under which SunAmerica would render certain discretionary and nondiscretionary asset allocation services to participants in ERISA-covered plans (Plans). On the basis of the facts and representations contained in your submission, it is the view of the Department that, for the reasons discussed below, the transactions with respect to which you have requested exemptive relief would not, to the extent executed in a manner consistent with such facts and representations, violate the provisions of section 406(b) of ERISA. Accordingly, we have determined that the appropriate response to your request is an advisory opinion, rather than an exemption under ERISA section 408(a).1

Your submission contains the following facts and representations. SunAmerica is an indirectly wholly owned subsidiary of SunAmerica Inc., and is one of a group of companies wholly owned by SunAmerica, Inc. that provide a broad range of financial services. SunAmerica’s affiliate, SunAmerica Asset Management Corp., is a registered investment adviser under the Investment Advisers Act of 1940. SunAmerica intends to offer the Program to individual account plans described in section 3(34) of ERISA. It is anticipated that virtually all of these Plans will be designed or administered in a manner intended to comply with the provisions of section 404(c) of ERISA.2 Under the Program, asset allocation services may be rendered to Plan participants3 either through the "Discretionary Asset Allocation Service” or the "Recommended Asset Allocation Service” (collectively, Services; singly, Service). Through the Discretionary Asset Allocation Service, a specific Model Asset Allocation Portfolio will be implemented automatically with respect to a participant’s account (Account). Through the Recommended Asset Allocation Service, a specific Model Asset Allocation Portfolio will be recommended to a participant for investment of his or her Account and the participant then may choose to implement the advice, or to disregard the recommendation and invest in a manner that does not conform to the Model Asset Allocation Portfolios.4 The Plan fiduciary who causes a Plan to participate in the Program will select the Service (or Services) that will be available to participants and the manner by which participants will authorize such Service (or Services). Model Asset Allocation Portfolios will be based solely on the investment alternatives available under the Plan, which your application refers to as "Core Investments,” but which we refer to herein as "Designated Investments.”5 In this regard, it is anticipated that the Plans will offer, exclusively or in addition to other vehicles, collective investment vehicles to which SunAmerica or an affiliate of SunAmerica provides investment advisory services (SunAmerica Funds).6

According to your submission, while SunAmerica will be making the Program, as well as other services, available to Plans, the Model Asset Allocation Portfolios offered under the Program will, in fact, be the product of a computer program applying a methodology developed, maintained and overseen by a financial expert who is independent of SunAmerica (the Financial Expert). The Model Asset Allocation Portfolio produced under the Program with respect to a particular participant, therefore, will reflect the application of the methodologies developed by the Financial Expert to the Designated Investments, taking into account individual participant data, as provided by the participant, Plan sponsor or recordkeeper.

You represent that, with respect to a Plan’s initial participation in the Program, a Plan fiduciary (i.e., a fiduciary independent of SunAmerica and its affiliates) will be provided detailed information concerning, among other things, the Program and the role of the Financial Expert in the development of the Model Asset Allocation Portfolios under the Program. In addition, the Plan fiduciary will be provided, on an on-going basis, a number of disclosures concerning the Program and Designated Investments under the Plan, including information pertaining to performance and rates of returns on Designated Investments, expenses and fees of SunAmerica Funds that are Designated Investments, and any proposed increases in investment advisory or other fees charged under a SunAmerica Fund.

You represent that, with respect to the development of the Model Asset Allocation Portfolios, the Financial Expert, using its own methodologies, will construct strategic "asset class” level portfolios. Using generally accepted principles of Modern Portfolio Theory, the Financial Expert will evaluate and determine its strategic asset class level portfolio recommendations. The Financial Expert then will construct each Model Asset Allocation Portfolio by combining Designated Investments so that the total asset class exposures of those Designated Investments equals the desired strategic asset class portfolio weight.7 The Model Asset Allocation Portfolios will have different risk and return characteristics. In order for these methodologies to be employed, the Designated Investments of a participating Plan must provide a minimum exposure to a certain number of asset classes. SunAmerica will inform the Plan fiduciary who causes a Plan to participate in the Program of the asset classes that must be available for operation of the Program,(8) and will inform the Plan fiduciary whether this requirement has been satisfied, as solely determined by the Financial Expert, with respect to a particular selection of an investment alternative.8

SunAmerica may assist the Financial Expert by providing certain background information for the development of the Model Asset Allocation Portfolios. Specifically, SunAmerica may supply the Financial Expert with algorithms, studies, analytics, research, models, papers and any other relevant materials. The Financial Expert also may seek the assistance of other entities in developing the Model Asset Allocation Portfolios. You represent that in all cases, the Financial Expert retains the sole control and discretion for the development and maintenance of the Model Asset Allocation Portfolios.

With regard to the computer programs utilized by the Financial Expert to select the specific Model Asset Allocation Portfolio provided to a participant, you represent that any programmers who are retained to formulate those programs will have no affiliation with SunAmerica, and that neither SunAmerica nor any of its affiliates will have any discretion regarding the output of such programs. You further represent that these computer programs require an input of minimum participant data that will be determined by the Financial Expert. The Financial Expert also will create a worksheet (the Worksheet) for gathering information from individual participants. The Worksheet will consist of a series of questions designed primarily to assess the participant’s retirement needs, and will provide the participant an opportunity to designate specific investments other than Designated Investments, or to place constraints on investments in and among Designated Investments, if available under the Plan. Also, with respect to the Discretionary Asset Allocation Service, subsequent to initial participation in the Program, at least once each calendar quarter, a "Facilitator” will contact each participant to whom services are provided to obtain any new or different information requested on the Worksheet. This information may lead the Financial Expert to implement a new Model Asset Allocation Portfolio for the participant. The Facilitators will be employees of SunAmerica, independent contractors of SunAmerica’s affiliates, or independent contractors or employees of broker-dealers not affiliated with SunAmerica. Facilitators will not provide services to participants who receive the Recommended Asset Allocation Service, and will not choose or recommend a Model Asset Allocation Portfolio in connection with the Discretionary Asset Allocation Service.

The Model Asset Allocation Portfolios (or any other Asset Allocation Portfolio) implemented will be reviewed regularly and "rebalanced.” You explain that participant Account or Asset Allocation Portfolio rebalancing is the process of moving the assets in an Account or Asset Allocation Portfolio asset class exposures toward its strategic target. This process seeks to reduce the relative performance risk associated with moving the asset class exposures away from what was intended in the strategic asset allocation. You represent that the rebalancing procedures will not involve any discretion on the part of SunAmerica or its affiliates, and that the Financial Expert will develop a mechanical formula to rebalance the relative value of the assets in each Account on a predetermined basis.

With regard to amounts paid by a Plan under the Program, you represent that SunAmerica will receive a fixed percentage of assets of the Plan invested in the Designated Investments up to 100 basis points (the Program Fee). In addition, SunAmerica may receive reimbursements, not to exceed a fixed percentage of Plan assets invested in the Designated Investments up to 25 basis points, for Facilitator fees and "direct expenses” within the meaning of 29 C.F.R. section 2550.408c-2 in connection with the operation of the Program paid by SunAmerica to unaffiliated third persons for goods and services provided to SunAmerica. SunAmerica, or any affiliate, will not be precluded from receiving fees from the SunAmerica Funds.

The Program Fee and any reimbursements payable to SunAmerica, and any compensation payable to the Facilitators under the Program, will not vary based on the asset allocations made or recommended by the Financial Expert, except that the Program Fee and any such reimbursements will be based on Designated Investments only and will be reduced if an Account invests in other than the Designated Investments. The compensation of the Financial Expert in connection with the Program will not be affected by the decisions made by the participants regarding investment of the assets of their Accounts in accordance with any Asset Allocation Portfolio.

With regard to the Financial Expert, you represent that the Financial Expert will receive compensation from SunAmerica for its services as the Financial Expert. You represent that fees to be paid by SunAmerica to the Financial Expert will not exceed 5 percent of the Financial Expert’s gross income on an annual basis. In addition you represent that the fees paid to the Financial Expert by SunAmerica will not be affected by investments made in accordance with any Asset Allocation Portfolio under the Program. For example, neither the choice of the Financial Expert by SunAmerica nor any decision to continue or terminate the relationship shall be based on the fee income to SunAmerica that is generated by the Financial Expert’s construction of the Model Asset Allocation Portfolios. You further represent that there have not been, nor will there be, any other relationships between SunAmerica and the Financial Expert that would affect the ability of the Financial Expert to act independent of SunAmerica and its affiliates. Your submission indicates that by providing discretionary asset management services and investment advice to participants, SunAmerica may be acting as a fiduciary with respect to the Plans.

Your submission further indicates that implementation of a Model Asset Allocation Portfolio, whether automatically or at the direction of a participant, may result in the receipt of increased investment advisory fees by SunAmerica or an affiliated entity. At issue, therefore, is whether, under the circumstances described in your submission, the receipt of such fees resulting from the asset allocation services rendered to Plan participants under the Program violates the prohibitions of section 406(b) of ERISA.

Section 3(21)(A) of ERISA defines the term fiduciary as a person with respect to a plan who (i) exercises any discretionary authority or discretionary control respecting management of such 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 such plan, or has any authority or responsibility to do so, or (iii) has any discretionary authority or discretionary responsibility in the administration of such plan. Regulation 29 C.F.R. section 2510.3-21(c)(1) states that, as a general matter, a person will be deemed to be rendering investment advice within the meaning of section 3(21)(A)(ii) if two criteria are met. First, pursuant to regulation section 2510.3-21(c)(1)(i), the person must render advice to the plan with regard to the value of securities or other property, or make recommendations as to the advisability of investing in, purchasing or selling securities or other property. Second, pursuant to regulation section 2510.3-21(c)(1)(ii), a person performing this type of service must either (A) have discretionary authority or control with respect to purchasing or selling securities or other property for the plan, or (B) render such advice on a regular basis pursuant to a mutual agreement, arrangement or understanding, written or otherwise, with the plan that the plan or a fiduciary with respect to the plan will rely on such advice as a primary basis for investment decisions with regard to plan assets. Although the question of whether an entity is a fiduciary by reason of providing services generally depends on the particular facts and circumstances of each case, we are assuming, for purposes of the discussion that follows in this advisory opinion, that the totality of services provided by SunAmerica causes it to be a fiduciary with respect to plans and participants to which it renders services. In this regard, we note that section 404 of ERISA generally provides that fiduciaries shall discharge their duties with respect to a plan prudently and solely in the interest of the participants and beneficiaries.

While 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, section 408(b)(2) of ERISA provides a statutory 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.

Section 406(b)(1) of ERISA provides that a fiduciary with respect to a plan shall not deal with plan assets in his or her own interests or for his or her own account. Section 406(b)(3) provides that a fiduciary with respect to a plan shall not receive any consideration for his or her own personal account from any party dealing with such plan in connection with a transaction involving the assets of the plan.

With respect to the prohibitions in section 406(b), regulation 29 C.F.R. section 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).9 As explained in regulation 29 C.F.R. section 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.

In general, the provision of investment advice for a fee is a fiduciary act. On the basis of the foregoing, it is the view of the Department that SunAmerica would be acting as a fiduciary with respect to both the discretionary and nondiscretionary asset allocation services provided to plans and plan participants and, as such, would be subject to the fiduciary responsibility provisions of ERISA, including sections 404 and 406. In this regard, SunAmerica would be responsible for the prudent selection and periodic monitoring of its investment advisory services consistent with the requirements of ERISA section 404.10

With respect to the prohibitions in section 406(b) of ERISA, it is the view of the Department that, based on the facts and representations contained in your submission, the individual investment decisions or recommendations (i.e., Asset Allocation Portfolios) provided or implemented under the Program would not be the result of SunAmerica’s exercise of authority, control, or responsibility for purposes of section 406(b) and the applicable regulations. This conclusion is premised on the following facts. First, Plan fiduciaries responsible for selecting the Program are fully informed about, and approve, the Program and the nature of the services provided thereunder, including the role of the Financial Expert. Second, the investment recommendations provided to, or implemented on behalf of, participants are the result of methodologies developed, maintained and overseen by a party (the Financial Expert) that is independent of SunAmerica and any of its affiliates.(11) The Financial Expert (an independent party) retains sole control and discretion over the development and maintenance of the methodologies. Any computer programmers engaged to formulate the computer programs used by the Financial Expert will have no affiliation with SunAmerica. Recommendations provided to, or implemented on behalf of, participants by SunAmerica will be based solely on input of participant information into computer programs utilizing methodologies and parameters provided by the Financial Expert and neither SunAmerica, nor its affiliates, will be able to change or affect the output of the computer programs. SunAmerica will exercise no discretion over the communication to, or implementation of, investment recommendations provided under the Program. Third, the arrangement between SunAmerica and the Financial Expert preserves the Financial Expert’s ability to develop Model Asset Allocation Portfolios solely in the interests of the plan participants and beneficiaries. Neither the Financial Expert’s compensation from SunAmerica, nor any other aspect of the arrangement between the Financial Expert and SunAmerica, is related to the fee income that SunAmerica or its affiliates will receive from investments made pursuant to the Portfolios.

It is the view of the Department, therefore, that, to the extent that SunAmerica follows the Program as structured in relation to an investment of Plan assets in SunAmerica Funds, there would not be a per se violation of section 406(b)(1) or (3) of ERISA solely as a result of SunAmerica’s, or any affiliate’s, receipt of increased investment advisory fees resulting from such investments.

In view of this letter, the Department believes that no further action is necessary with respect to your exemption application. Accordingly, your exemption application is closed without further action. This letter constitutes an advisory opinion under ERISA Procedure 76-1, 41 Fed. Reg. 36281 (Aug. 27, 1976). Accordingly, this letter 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

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 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.

2 The Department expresses no views herein, and no views should be implied, concerning the application of ERISA section 404(c) to the Program or any participating Plan or participant.

3 The asset allocation services under the Program also may be available to beneficiaries who, under the terms of their Plan, have the power to direct the investments in their account balances. For purposes of convenience, we refer only to participants.

4 You represent that the Program and Services will impose no limit on the frequency with which a participant may change his or her investment election. However, there may be limits concerning such frequency under the terms of a participating Plan.

5 You explain that, with respect to the Recommended Asset Allocation Services, under circumstances where a participating Plan permits participant input such as direction to invest in assets other than Designated Investments or to place ceilings or floors on the percentages, or amounts, of Designated or non-Designated Investments, the methodologies followed by the Financial Expert, as described below, may result in a portfolio, other than a Model Asset Allocation Portfolio, that includes non-Designated Investments. You refer to such portfolios, along with the Model Asset Allocation Portfolios, generally as "Asset Allocation Portfolios.”

6 As described below, an independent Plan fiduciary will determine the investments that will be available under the Plan.

7 You explain that the assets underlying the Designated Investments may fall into more than one asset class, and that in constructing a Model Asset Allocation Portfolio, the Financial Expert will employ a statistical method to determine the asset class exposure to a participant of a Designated Investment’s investment approach.

8 You note that this process may be completed in a summary manner where SunAmerica offers the Program along with a range of SunAmerica Funds that will constitute the Designated Investments. You also represent that under no circumstances, except for Plans maintained by SunAmerica and its affiliates, will SunAmerica select investment alternatives to be made available under a Plan. This letter addresses only participation by Plans that are not maintained by SunAmerica and/or its affiliates.

9 We express no opinion as to whether the requirements of section 408(b)(2) of ERISA would be satisfied with respect to the Program.

10 The Department notes that, with regard to the selection and monitoring of the Financial Expert and SunAmerica’s investment advisory services, any consideration of the effect of investment recommendations, or methodologies upon which such recommendations are based, on the fees or other compensation of SunAmerica or any of its affiliates, would, in the view of the Department, be inconsistent with a fiduciary’s obligations under section 404 of ERISA.

11 Whether a party is "independent" for purposes of the subject analysis will generally involve a determination as to whether there exists a financial interest (e.g., compensation, fees, etc.), ownership interest, or other relationship, agreement or understanding that would limit the ability of the party to carry out its responsibility beyond the control, direction or influence of the fiduciary. In this regard, we note there have been other contexts in which the Department dealt with this issue. Under Prohibited Transaction Class Exemption 84-14, relief from section 406(a) of ERISA was provided for transactions between plans and parties in interest if approved by a qualified professional asset manager (QPAM). The party in interest could not be "related” to the QPAM - meaning such party in interest (or person controlling, or controlled by, the party in interest) could not own a five percent or more interest in the QPAM; or the QPAM (or person controlling, or controlled by, the QPAM) could not own a five percent or more interest in the party in interest. Further, the plan with respect to which the person was a party in interest could not represent more than 20% of the assets that the QPAM had under management at the time of the transaction.

2001-10A    Application of ERISA Secs. 408(b)(2) and 408(b)(6) to the provision of trustee services by Laurel Trust Company

2001-10A
ERISA Sec. 408(b)(2) & 408(b)(6)

December 14, 2001

Mr. James M. Winn
Smith & Downey
1110 Vermont Ave., NW, Suite 400
Washington, DC 20005

Dear Mr. Winn:

This is in response to your letter requesting an advisory opinion under the Employee Retirement Income Security Act of 1974, as amended (ERISA). In particular, you request an opinion that the provision of trustee services by Laurel Trust Company (Laurel) to two defined benefit pension plans sponsored by Laurel (the Plans), and the payment by the Plans of Laurel’s standard trustee fees would be exempt from ERISA’s prohibited transaction provisions by reason of section 408(b)(6) of ERISA.(1)

Your letter contains the following representations. Laurel provided trustee services to the Plans and charged its customary trustee fees for such services. Laurel assumed that the provision of such services and the receipt of the fees was exempted from the prohibited transactions provisions of section 406 of ERISA by reason of section 408(b)(6). You represent that in 1996, the Department of Labor (the Department) determined that this arrangement constituted a violation of section 406 of ERISA and imposed on Laurel (then known as BT Management Trust Company) a civil penalty under section 502(l) of ERISA. Laurel petitioned the Department for a waiver or reduction of the civil penalty, which was denied. Laurel paid the civil penalty and ceased charging its customary fees to the Plans. Citing a 1993 IRS Field Service Advice Memorandum, which you believe takes a view contrary to that of the Department, you have requested that the Department reconsider its position with respect to section 408(b)(6) of ERISA.

Laurel contends that section 406 of ERISA does not prohibit the Plans from paying Laurel its customary trustee fees, which are the same fees paid by plans sponsored by parties unrelated to Laurel. You represent that such fees represent reasonable compensation for services, which plans are permitted to pay, even if those fees include a profit component. You recognize that ERISA section 406 would otherwise prohibit the payment of such fees, but claim that the statutory exemption provided by section 408(b)(6) permits the payment of the fees by the Plans to Laurel.

Section 406(a)(1)(C) and (D) of ERISA provides that a fiduciary with respect to a plan shall not cause the plan to engage in a transaction, if the fiduciary 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 or a 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 provides that a fiduciary with respect to a plan shall not deal with plan assets in his own interest or for his own account. Section 406(b)(2) of ERISA prohibits a fiduciary with respect to a plan from acting 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 of its participants and beneficiaries.

Section 408(b)(6) of ERISA provides that the prohibitions of section 406 shall not apply to the provision of any ancillary service 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, provided that certain conditions are satisfied.

You represent that Laurel, as a Pennsylvania state-chartered trust company, is a “bank or similar financial institution” that is supervised by a State. You further represent that the provision of services to and payment of fees by the Plans satisfies the other conditions of ERISA section 408(b)(6).

You claim that the Department has previously concluded that a plan’s payment of fees that include a profit component is not “reasonable compensation,” as that term is used in both section 408(b)(2) and 408(b)(6) of ERISA. You further claim that the Internal Revenue Service (IRS) has taken a contrary position with respect to section 4975(d)(6) of the Internal Revenue Code of 1986 (the Code), a parallel provision to ERISA section 408(b)(6), in a 1993 Field Service Advice Memorandum (Memorandum), a copy of which you included with your letter. Pursuant to section 102 of Reorganization Plan No. 4 of 1978 (see, footnote 1, above), all authority to issue regulations, rulings, interpretations, and exemptions under section 4975(d) of the Code, with exceptions not here relevant, was transferred to the Department. The Department, therefore, has sole authority and responsibility to interpret section 4975(d)(6) of the Code.

Section 408(b)(6) of ERISA (and by reference, section 4975(d)(6) of the Code, see, footnote 1, above) exempts from the prohibited transaction provisions of ERISA the provision of “ancillary” services to a plan by a fiduciary that is a bank or similar financial institution supervised by the United States or a State and the payment of no more than “reasonable compensation” by the plan. It is the opinion of the Department that trustee services are not ancillary services.

Trustee services are necessary and essential to the establishment, maintenance, and operation of a pension plan that is subject to ERISA. Section 403(a) of ERISA requires that, subject to several exceptions not relevant here, all assets of an employee benefit plan shall be held in trust by one or more trustees. The trustee or trustees shall have exclusive authority and discretion to manage and control the assets of the plan, except to the extent that the plan expressly provides that the trustee or trustees are subject to the direction of a named fiduciary who is not a trustee, in which case the trustees shall be subject to proper directions of such fiduciary which are made in accordance with the terms of the plan and which are not contrary to ERISA, or to the extent that authority to manage, acquire, or dispose of assets of the plan is delegated to one or more investment managers. In the Department’s view a service is “ancillary” if it aids or is auxiliary to a primary or principal service. For instance, the Department has stated 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).(2) Given the central role that the establishment of a trust and the naming of a trustee plays in the establishment, maintenance, and operation of an employee benefit plan, the Department concludes that trustee services cannot be “ancillary services” within the meaning of ERISA section 408(b)(6).

Section 408(b)(2) of ERISA exempts from the prohibitions of section 406(a) any contract or reasonable arrangement 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 therefore. Regulations issued by the Department clarify the terms "necessary service" (29 CFR §2550.408b-2(b)), "reasonable contract or arrangement" (29 CFR §2550.408b-2(c)) and "reasonable compensation" (29 CFR §2550.408b-2(d) and 2550.408c-2) as used in section 408(b)(2). As a general matter, whether the requirements of that section are met in each case involves questions which are inherently factual in nature. Pursuant to section 5.01 of ERISA Procedure 76-1, the Department ordinarily does not issue opinions on such matters. The Department has not concluded, however, that fees including a profit component necessarily exceed reasonable compensation.

With respect to the prohibitions in section 406(b), the regulation under section 408(b)(2) of ERISA (29 CFR §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) even if such act occurs in connection with a provision of services that is exempt under section 408(b)(2).

As explained in regulation 29 CFR §2550.408b-2(e)(1), the prohibitions of section 406(b) are imposed upon fiduciaries to deter them from exercising the authority, control, or responsibility that makes them fiduciaries when they have interests that may conflict with the interests of the plans for which they act. Thus, a fiduciary may not use the authority, control, or responsibility that makes him a fiduciary to cause a plan to pay an additional fee to such fiduciary, or to a person in which he has an interest that may affect the exercise of his best judgment as a fiduciary, to provide a service. However, regulation 29 CFR §2550.408b-2(e)(2) provides that a fiduciary does not engage in an act described in section 406(b)(1) of ERISA if the fiduciary does not use any of the authority, control, or responsibility that makes him 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 the fiduciary has an interest that may affect the exercise of his judgment as a fiduciary. Furthermore, regulation section 2550.408b-2(e)(3) explains that if a fiduciary provides services to a plan without the receipt of compensation or other consideration other than the 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. Regulation section 2550.408c-2(b)(3) provides that an expense is not a direct expense to the extent that it would have been sustained had the service not been provided or if it represents an allocable portion of overhead.

Accordingly, it is the opinion of the Department that if Laurel provides trustee services to the Plans and charges the Plans a fee that exceeds the direct expenses that Laurel incurs in the provision of trustee services to the Plans, it would engage in violations of ERISA section 406(b)(1) and (2), which would not be exempted by ERISA section 408(b)(2) or (6).

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 10 relating to the effect of advisory opinions.

Sincerely,

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

Footnotes

  1. Under Reorganization Plan No. 4 of 1978 (43 FR 47713, October 17, 1978), 5 U.S.C. App.1, 92 Stat. 3790, the authority of the Secretary of the Treasury to issue rulings under section 4975 of the 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 should be taken as referring also to the corresponding sections of the Code.
  2. See, letter from Alan D. Lebowitz to Robert S. Plotkin, Assistant Director, Division of Banking Supervision and Regulation, Board of Governors of the Federal Reserve System, August 1, 1986.

2002-04A    Application of Sec. 408(e) of ERISA to certain transactions between a plan and various personal trusts and estates

2002-04A
ERISA Sec. 408(e)

June 7, 2002

Wallace M. Starke, Esq.
Troutman, Sanders, Mays & Valentine, L.L.P.
P.O. Box 1122
Richmond, VA 23218-1122

Dear Mr. Starke:

This is in response to your request for an advisory opinion regarding the application of section 408(e) of the Employee Retirement Income Security Act of 1974, as amended (ERISA) to certain transactions between a plan and various personal trusts and estates sharing a common trustee with the plan.

You represent that National Bankshares, Inc. (NBI) is a bank holding company which owns all the issued and outstanding stock of the National Bank of Blacksburg (the Bank). The Bank is a national banking association subject to the supervision of the Office of the Comptroller of the Currency (OCC).

You further represent that NBI acts as plan sponsor of the National Bankshares, Inc. Employee Stock Ownership Plan (the ESOP) and the Bank is a participating employer with respect to the ESOP. You state that the Bank serves as trustee of the ESOP and also serves as trustee of various inter vivos and executorial trusts and estates (referred to hereafter as personal trusts). You state that to the best of your knowledge, none of the personal trusts are ERISA plans, parties in interest with respect to the ESOP as defined in section 3(14) of ERISA, or disqualified persons within the meaning of section 4975(e) of the Internal Revenue Code (the Code).

You state that the ESOP is an employee stock ownership plan within the meaning of 4975(e)(7) of the Code and section 407(d)(6) of ERISA. It is intended to be qualified under section 401(a) of the Code and last received a favorable determination letter from the Internal Revenue Service to that effect on June 1, 1995. The ESOP, by its terms, is designed to invest primarily in the stock of NBI. NBI's outstanding stock consists of one class of common stock which is readily traded on the NASDAQ small cap market.

You request an advisory opinion regarding several transactions involving the purchase by the ESOP of NBI stock from several personal trusts for which the Bank also serves as trustee. No broker was used for the sales. You represent that the Bank as trustee for the ESOP initiated such purchases of NBI stock for the ESOP. You state that the Bank has an established procedure to obtain, prior to executing any acquisition of NBI stock by the ESOP from a personal trust, written consent from the primary beneficiary or any co-fiduciary of the personal trust to sell NBI stock owned by the personal trust to the ESOP.

You state that no commission was charged to the ESOP or the personal trusts in connection with the NBI stock purchases in question. The consideration paid by the ESOP for the NBI stock was cash equal to the bid price for such shares as quoted by the online service MSN Money Central, a price which was not more than the fair market value of such shares at the time of their purchase. The trustee did not receive any consideration for its personal account in connection with any of the NBI stock purchases in question.

You state that MSN Money Central is an online pricing service that obtains its stock quotes from Standard and Poor's ComStock, Inc., the same service used by a number of other pricing services. You state that there is a 15-minute delay when a stock quote is obtained from MSN Money Central, and that in each of the purchases at issue the transaction was executed within 15 minutes of the time that a price quote was obtained. You state that effecting the trade at the bid price, rather than the asked price, benefitted the plan in that the bid price in most, if not all, cases is lower than the asked price.

A total of ten such transactions occurred between June of 2000 and April of 2001 representing a total of 7,646 shares of NBI stock and a total sale price of $163,301. During an examination by the OCC of the operations of the trust department of the Bank, the OCC examiner questioned whether these transactions were prohibited by ERISA and the Code.

You request the Department's view as to whether the described transactions are exempt from the prohibited transaction restrictions of ERISA and the Code by virtue of sections 408(e) of ERISA and 4975(d)(13) of the Code.

Section 406(a)(1)(A) and (D) of ERISA prohibit a fiduciary with respect to a plan from causing a plan to engage in a transaction if s/he knows or should know that such transaction constitutes a direct or indirect sale or exchange, or leasing of any property between a plan and a party in interest; or a transfer to, or use for the benefit of, a party in interest, of any assets of the plan. Section 3(14)(A) and (C) of ERISA define a party in interest with respect to a plan to include a fiduciary of the plan and an employer any of whose employees are covered by such plan.

Section 406(a)(1)(E) of ERISA prohibits a fiduciary with respect to a plan from causing the plan to engage in a transaction if s/he knows or should know that such transaction constitutes a direct or indirect acquisition, on behalf of the plan, of any employer security in violation of section 407(a). In addition section 406(a)(2) prohibits certain fiduciaries from permitting a plan to hold any employer security if s/he knows or should know that holding such security violates section 407(a).

Section 407(a) of ERISA provides, in part, that a plan may not acquire or hold any employer security which is not a qualifying employer security.

Section 406(b)(1) and (2) of ERISA 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 own account, or from acting in his or her individual or in any other capacity in any transaction involving the plan on behalf of a party (or representing a party) whose interests are adverse to the interests of the plan or the interests of its participants or beneficiaries. Section 406(b)(3) prohibits a fiduciary with respect to a plan from receiving any consideration for his own personal account from any party dealing with such plan in connection with a transaction involving the assets of a plan.

However, section 408(e) of ERISA provides, in part, that sections 406(a) and 406(b)(1) and (2) shall not apply to the acquisition or sale by a plan of qualifying employer securities (as defined in section 407(d)(5)) if the following conditions are met: (1) the acquisition or sale is for adequate consideration; (2) no commission is charged with respect to the acquisition or sale; and (3) the plan is an eligible individual account plan (as defined in section 407(d)(3))… 2.

Section 407(d)(1) of ERISA defines the term employer security in part to mean a security issued by an employer of employees covered by the plan or by an affiliate of such employer. With respect to eligible individual account plans, section 407(d)(5) of ERISA defines the term qualifying employer security to include an employer security which is a stock.

Section 3(18) of ERISA defines the term adequate consideration to include, in the case of a security for which there is a generally recognized market and if the security is not traded on a national securities exchange which is registered under section 6 of the Securities Exchange Act of 1934, a price not less favorable to the plan than the offering price for the security as established by the current bid and asked prices quoted by persons independent of the issuer and of any party in interest.

The term eligible individual account plan is defined under section 407(d)(3) as including employee stock ownership plans which explicitly provide for the acquisition and holding of qualifying employer securities.

Based on the representations described in your request, it is the opinion of the Department that the ESOP constitutes an eligible individual account plan inasmuch as the plan is an employee stock ownership plan within the meaning of 4975(e)(7) of the Code and 407(d)(6) of ERISA and is designed, by its terms, to invest primarily in the common stock of NBI.

You have represented that the transactions involve the purchase of NBI common stock by the ESOP. You state that the ESOP is maintained for the benefit of the employees of NBI, the Bank, and any other NBI affiliate which adopts the ESOP as a participating employer. The Bank, as a wholly owned subsidiary of NBI, constitutes an affiliate of NBI on the basis of the facts you describe. Based on your representations, it is the Department's view that common stock of NBI will constitute qualifying employer securities with respect to the ESOP.

You represent that none of these trusts are parties in interest as defined under section 3(14). As a result, a violation of section 406(a) would not have occurred with respect to the transactions. You have also represented that the transactions involve the purchase of NBI common stock by the ESOP from several personal trusts for which the Bank also serves as the trustee. Such transactions would involve violations of section 406(b)(2).

Further, the Department has stated that to the extent that an investment manager exercises discretion over both sides of a transaction in a cross-trade transaction, there is potential for the investment manager to use its discretion to favor one account over another, for example, in the pricing or timing of the trade or in the decision to buy or sell securities for an ERISA account. Such acts could result in one or more violations of the fiduciary provisions of Title I of ERISA in addition to those described in section 406(b)(2).

Regulations issued by the Department clarify that section 408(e), by its terms, exempts certain transactions from the prohibitions of section 406(a) and 406(b)(1) and (2). Accordingly, it is the view of the Department that the acquisitions of NBI stock by the ESOP under the circumstances described would be exempt from the prohibitions of 406(a), and 406(b)(1) and (2) by virtue of section 408(e) provided that the transactions are for adequate consideration and that no commission is charged with respect to the transactions.

Whether the terms of section 408(e) have been met with respect to a transaction is an inherently factual question which may only be answered by the appropriate plan fiduciaries based on all of the relevant facts and circumstances. The Department generally will not opine as to whether a particular transaction is for adequate consideration. Rather, the Department believes that such determinations should be made by appropriate plan fiduciaries on the basis of all relevant facts and circumstances.

We would note, however, that the fact that a transaction is exempt under section 408(e) is not determinative of whether a fiduciary has met its fiduciary obligations under ERISA. Section 404(a)(1)(A) of ERISA requires plan fiduciaries to discharge their duties with respect to a plan solely in the interest of plan participants and beneficiaries and for the exclusive purpose of providing benefits to participants and beneficiaries and defraying the reasonable expenses of administering the plan. Section 404(a)(1)(B) requires plan fiduciaries to act 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 character with like aims. Section 403(c)(1) provides that the assets of a plan shall never inure to the benefit of an employer and shall be held for the exclusive purposes of providing benefits to participants and beneficiaries and defraying reasonable expenses of administering the plan.

The general standards of fiduciary conduct contained in sections 404(a)(1) and 403(c) apply to the described purchases of NBI stock by the ESOP. Accordingly, fiduciaries of the ESOP must act prudently, solely in the interest of the plan's participants and beneficiaries, and for the exclusive purpose of providing benefits and defraying reasonable plan administrative costs when deciding whether to acquire NBI stock for the ESOP. Therefore, if plan fiduciaries failed to act in compliance with these general fiduciary standards in the acquisition of the NBI stock for the ESOP, they would be liable for losses resulting from such breaches of fiduciary responsibility regardless of whether the acquisition may be exempt from certain prohibited transaction restrictions by virtue of section 408(e).

If, under the facts and circumstances of any transaction, the Bank uses the authority which makes it a fiduciary with respect to the transaction to benefit personal trust clients at the expense of the ESOP, or otherwise fails to act solely in the interest of plan participants and beneficiaries in deciding to purchase NBI stock for the ESOP, violations of sections 404(a)(1) and 403(c) could occur.

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 J. Campagna
Chief, Division of Fiduciary Interpretations
Office of Regulations and Interpretations

2002-05A    Whether the prohibition in PTE 77-4 (42 FR 18732, April 8, 1977) on sales commission payments would apply to commissions paid by a plan to an independent broker

2002-05A
PTE 77-4

June 7, 2002

Melanie Franco Nussdorf, Esq.
Steptoe & Johnson LLP
1330 Connecticut Avenue, NW
Washington, DC 20036-1795

Dear Ms. Nussdorf:

This is in response to your request for an advisory opinion concerning Prohibited Transaction Exemption 77-4 (42 FR 18732, April 8, 1977) (PTE 77-4). Specifically, you request an opinion as to whether the prohibition on sales commission payments in PTE 77-4 would apply to commissions paid by a plan to an independent broker who executes the plan’s purchase or sale of shares of open-end investment companies registered under the Investment Company Act of 1940 through a securities exchange.

As you know, PTE 77-4 provides an exemption from the restrictions of section 406 of the Employee Retirement Income Security Act (the Act), as amended, and the taxes imposed by section 4975(a) and (b) of the Internal Revenue Code of 1986, as amended (the Code), by reason of section 4975(c)(1) of the Code, for 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, where the investment adviser for the investment company 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.

Section II(a) of PTE 77-4 provides that the plan must not pay a sales commission in connection with such purchase or sale.

You represent that your inquiry concerns an investment vehicle known as an Exchange Traded Fund or ETF which is similar to a mutual fund. You have explained that an ETF is legally classified as a registered open-end investment company. Like other open-end investment companies, an ETF issues shares representing an undivided interest in a managed portfolio of securities. Additionally, ETF shares are offered continuously and may be purchased and redeemed directly through the ETF on a daily basis, at the net asset value (NAV) per share, with or without a fixed transaction fee.

You represent that direct purchases and redemptions occur, however, only in large blocks (generally called creation units) and generally are effected through an in-kind tender of a specified basket of securities, and not cash. You note that this tends to reduce portfolio turnover and attendant transactional expenses by minimizing the liquidations and acquisitions of portfolio securities required with respect to purchases and redemptions in ETF shares.

You state that individual ETF shares trade on the exchanges at market prices, which may differ from NAV. Trades of ETF shares in the secondary market incur brokerage commissions, like common stocks.

You have requested an advisory opinion confirming that the sales commissions precluded under section II(a) of PTE 77-4 do not include commissions paid to brokers provided that: (1) the sale of shares of open-end investment companies registered under the Investment Company Act of 1940 are executed through a securities exchange; and (2) the brokers are unrelated to the investment company’s principal underwriter or investment adviser (or their affiliates). You note that where the broker is not affiliated with the investment adviser for the fund and the fund’s principal underwriter, neither the adviser, the principal underwriter, nor any of their affiliates, derives any additional benefit from initiating a transaction which causes the broker to receive a commission.

ETFs did not exist in 1977 at the time PTE 77-4 was granted by the Department of Labor (the Department). At that time open-end investment company shares were purchased from the fund itself (or through a broker affiliated with the fund). The prohibition in PTE 77-4 on the payment of sales commissions by a plan was intended to avoid potential abuses that could arise if a mutual fund, its investment adviser or an affiliate thereof were to receive a commission or load in connection with the transaction. The Department explained in the preamble to the proposed class exemption relating to PTE 77-4 that the requirement that the plan not pay commissions would apply ...whether the transaction is between the plan and the mutual fund directly or is executed by the mutual fund’s principal underwriter or transfer agent as an intermediary. (See 41 FR 50516, November 16, 1976). Each of these types of transactions would involve payment of a commission to someone associated with the mutual fund.

The Department’s views regarding fees paid to parties with respect to transactions described in PTE 77-4 were also discussed in Advisory Opinion 93-13A, in which a company, serving as investment manager or trustee to employee benefit plans, proposed to invest the plans’ assets in affiliated mutual funds. The Department stated that conditions (d), (e) and (f) of PTE 77-4, relating to required disclosures and approval by an independent fiduciary, would not apply to fees paid to parties unrelated to the mutual funds’ adviser, or any affiliate, under the arrangement described in the advisory opinion.

As noted above, ETFs are a more recent development in the securities market and their trading procedures differ from those of traditional open-end investment companies. In this regard, creation units are traded directly with the fund in like-kind exchanges while individual shares are traded between investors on securities exchanges and result in brokerage commissions being paid to brokers who may or may not be related to the fund, investment adviser or any affiliates thereof.

Based on the above facts and representations, the Department is of the view that the term sales commission as used in section II(a) of PTE 77-4 does not include brokerage commissions paid to a broker in connection with purchases or sales of shares of registered open-end investment companies on an exchange if the broker is unaffiliated with the fund, its principal underwriter, investment adviser or any affiliate thereof.(1)

The Department cautions, however, that where a plan fiduciary, who is an investment adviser to a fund, causes the plan to pay commissions to a broker-dealer who is an affiliate of such adviser or of the fund, such commission payments would be separate prohibited transactions under section 406(b) of the Act for which no relief is available under PTE 77-4. Section 406(b) prohibits a plan fiduciary from dealing with the assets of the plan in his own interest or for his own account, acting in his individual or in any other capacity in any transaction involving the plan on behalf of a party (or representing a party) whose interests are adverse to the interests of the plan or the interests of its participants and beneficiaries, or receiving 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.

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.

Sincerely,

Ivan L. Strasfeld
Director, Office of Exemption Determinations

Footnotes

The Department notes PTE 77-4 would not apply to the in-kind purchase or sale of ETF creation units by employee benefit plans.

2002-08A    Whether indemnification and limitation of liability provisions in a plan's service provider contract would violate the fiduciary provisions of ERISA

2002-08A
ERISA Sec. 404(a) & 408(b)(2)

August 20, 2002

Michael A. Crabtree, Esq.
Central Pension Fund of the International Union of
Operating Engineers and Participating Employers
4115 Chesapeake Street, NW
Washington, DC 20016-4665

Dear Mr. Crabtree:

This is in response to your request for an advisory opinion on behalf of the Central Pension Fund of the International Union of Operating Engineers and Participating Employers (the “Fund”) concerning the application of the provisions of the Employee Retirement Income Security Act of 1974, as amended (ERISA). Specifically, you have requested the views of the Department as to whether inclusion of certain indemnification and hold-harmless provisions in a plan’s service provider contract would violate the fiduciary provisions of ERISA.

You represent that an actuarial firm, in connection with discussions relating to the renewal of its contract to provide actuarial services to the Fund, advised that it was requiring all new engagement letters to contain, among other things, “limitation of liability” and “indemnification” provisions. These provisions, in effect, would require the Fund to agree not to recover from the actuarial firm an amount in excess of the greater of $250,000 or one year’s fee for any damage caused to the Fund “regardless of the cause of action,” and to indemnify and hold the actuarial firm harmless for any amount exceeding the same limits “from any third party claim or liability” arising from, or in connection with, the firm’s services to the Fund. The Fund’s insurer has informed the Fund that its fiduciary liability policy would not cover the Fund’s losses if the Fund suffered losses in excess of $250,000 as a result of the actuarial firm’s actions that were not recovered because of the proposed limitation of liability and indemnification provisions. The insurer explained that the policy is not designed to cover professional liability exposures normally associated with Actuarial Errors and Omissions coverage.

Although the Fund has decided not to retain the actuarial firm, opting instead for a firm that required no specific limitation of liability or indemnification provision, limitation of liability and indemnification provisions may be becoming increasingly popular with actuarial firms according to press and other reports. Given the current and future issues presented to fiduciaries with respect to the engagement of service providers with contractual limitations of liability or indemnification provisions, you have requested guidance from the Department concerning the permissibility of such provisions under ERISA.

Section 404(a)(1) of ERISA requires, among other things, 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 like character with like aims. The prohibited transaction provisions state, in section 406(a)(1)(C) and (D) of ERISA, that a fiduciary with respect to an employee benefit plan shall not cause the plan to engage in a transaction if he or she knows or should know that such transaction constitutes a direct or indirect furnishing of services between the plan and a party in interest with respect to the plan, or transfer to, or use by or for the benefit of, a party in interest, of any assets of the plan. Section 408(b)(2) of ERISA 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 for such services.

With regard to the selection of service providers under ERISA, the Department has previously indicated that the responsible plan fiduciary must engage in an objective process designed to elicit information necessary to assess the qualifications of the provider, the quality of services offered, and the reasonableness of the fees charged in light of the services provided. In addition, such process should be designed to avoid self-dealing, conflicts of interest or other improper influence. What constitutes an appropriate method of selecting a service provider, however, will depend upon the particular facts and circumstances. Soliciting bids among service providers is a means by which a fiduciary can obtain the necessary information relevant to the decision-making process, including information about contractual provisions such as those identified in your letter relating to limitations of liability and indemnification.

The Department does not believe that, in and of themselves, most limitation of liability and indemnification provisions in a service provider contract are either per se imprudent under ERISA section 404(a)(1)(B) or per se unreasonable under ERISA section 408(b)(2). The Department believes, however, that provisions that purport to apply to fraud or willful misconduct by the service provider are void as against public policy and that it would not be prudent or reasonable to agree to such provisions. Other limitations of liability and indemnification provisions, applying to negligence and unintentional malpractice, may be consistent with sections 404(a)(1) and 408(b)(2) of ERISA when considered in connection with the reasonableness of the arrangement as a whole and the potential risks to participants and beneficiaries. At a minimum, compliance with these standards would require that a fiduciary assess the plan’s ability to obtain comparable services at comparable costs either from service providers without having to agree to such provisions, or from service providers who have provisions that provide greater protection to the plan.

In the Department’s view, compliance with ERISA’s fiduciary provisions, including section 408(b)(2), also would require that a fiduciary assess the potential risk of loss and costs to the plan that might result from a service provider’s act or omission subject to a proposed limitation of liability or indemnification provision. In making such an assessment, a fiduciary should consider the potential for, and outside limits of, such a loss, as well as any additional actions that may be available to the plan to minimize such a loss.

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

Sincerely,

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

2002-14A    Guidance concerning the selection of annuity providers in connection with distributions

2002-14A
29 CFR 2509.95-1

December 18, 2002

Leonard A. Davis, Chief Counsel – Benefits
Sharon W. Vaino, Assistant Tax Counsel
Tax Department
Metropolitan Life Insurance Company
One MetLife Plaza
Long Island City, NY 11101-4015

Dear Mr. Davis and Ms. Vaino:

This is in response to your request for guidance concerning the selection of annuity providers, pursuant to Interpretive Bulletin 95-1 (29 C.F.R. § 2509.95-1), in connection with distributions from defined contribution plans. Specifically, you have requested the Department to address the application of specific requirements of Interpretive Bulletin 95-1 to defined contribution plans.

Interpretive Bulletin 95-1 (the IB) provides guidance concerning the fiduciary standards under Part 4 of Title I of the Employee Retirement Income Security Act (ERISA) applicable to the selection of annuity providers for purposes of pension plan benefit distributions. In general, the IB makes clear that the selection of an annuity provider in connection with benefit distributions is a fiduciary act governed by the fiduciary standards of section 404(a)(1), including the duty to act prudently and solely in the interest of the plan’s participants and beneficiaries. In this regard, the IB provides that plan fiduciaries must take steps calculated to obtain the safest annuity available, unless under the circumstances it would be in the interest of the participants and beneficiaries to do otherwise. The IB also provides that fiduciaries must conduct an objective, thorough and analytical search for purposes of identifying providers from which to purchase annuities and sets forth six factors that should be considered by fiduciaries in evaluating a provider’s claims paying ability and creditworthiness. (§ 2509.95-1(c)). Further, the IB recognizes that there may be situations where it may be in the interest of participants and beneficiaries to purchase other than the safest available annuity, such as when an annuity is only marginally safer, but disproportionately more expensive than a competing annuity. However, the IB notes that increased costs or other considerations could never justify putting the benefits of participants and beneficiaries at risk by purchasing an unsafe annuity. (§ 2509.95-1(d)).

The following information is provided in response to the specific issues raised by your request.

The general fiduciary principles set forth in the IB with regard to the selection of annuity providers are equally applicable to defined benefit and defined contribution plans. Accordingly, the selection of annuity provider by the fiduciary of a defined contribution plan would be governed by section 404(a)(1) and, therefore, such fiduciary, in evaluating claims paying ability and creditworthiness of an annuity provider, should take into account the six factors set forth in § 2509.95-1(c).

With regard to factor six (§ 2509.95-1(c)(6)) relating to state guarantees, you requested a clarification as to the scope of a fiduciary’s consideration. Factor six indicates that fiduciaries should consider “the availability of additional protection through state guaranty associations and the extent of their guarantees.” For purposes of factor six, fiduciaries should determine whether the provider and annuity product are covered by state guarantees and the extent of those guarantees, in terms of amounts (e.g., percentage limits on guarantees) and individuals covered (e.g., residents, as opposed to non-residents, of a state). Such information should be available to the public and easily accessible through state guaranty associations and state insurance departments. Of course, if there were facts known to the fiduciary calling into question the ability of a state association offering guarantees to meet its obligations under the guarantee, it would be incumbent on the fiduciary to weigh that information when selecting an annuity provider.

In evaluating the six factors, the IB indicates that, “[u]nless they possess the necessary expertise to evaluate such factors, fiduciaries would need to obtain the advice of a qualified, independent expert.” With regard to this provision, you express concern that fiduciaries should be able to make evaluations of annuity providers without becoming or hiring an expert in annuity matters. The standard set forth in the IB follows from the prudence standard of section 404(a)(1)(B). That section provides that a fiduciary shall discharge its duties “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 character and with like aims.” (Emphasis supplied). Accordingly, in those instances where the fiduciary responsible for the selection of an annuity provider has, at the time of the selection, a sufficient level of expertise or knowledge to meaningfully evaluate the claims paying ability and creditworthiness of an annuity provider, including the factors set forth in the IB, the fiduciary would not be required to engage a qualified, independent expert to evaluate such factors. For purposes of the IB, “independent” means independent of the annuity provider.

With regard to paragraph (d) of § 2509.95-1, relating to costs and other considerations, you request confirmation that, in evaluating competing products, cost is an appropriate consideration for the fiduciary of a defined contribution plan when the participant receives an increased benefit as a result of reduced costs. It is the view of the Department that it is appropriate for the fiduciary of a defined contribution plan in selecting an annuity provider to take into account the costs and benefits to the participant or beneficiary of competing annuity products. Consistent with the IB, however, a lower cost cannot justify the purchase of an unsafe annuity even when the annuity would pay a higher benefit amount to the participant or beneficiary.

Lastly, you raise a question concerning the applicability of paragraph (e) of § 2509.95-1 to defined contribution plans. Paragraph (e) requires that special care be taken in reversion situations where fiduciaries selecting annuity providers have an interest in the sponsoring employer that may affect their judgment. In such situations, the IB advises that the fiduciary will need to obtain and follow independent expert advice calculated to identify those insurers with the highest claims-paying ability willing to write the business. In the absence of any possibility of funds reverting to a plan sponsor in connection with the termination of a defined contribution plan, it is the view of the Department that paragraph (e) would not apply to such plan.

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

Sincerely,

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

2003-02A    Regarding the application of ERISA to the provision of overdraft protection services

2003-02A
ERISA Sec. 408(b)(2) and 408(b)(6)

February 10, 2003

Lisa J. Bleier
Senior Counsel
Regulatory and Trust Affairs
American Bankers Association
1120 Connecticut Avenue, NW
Washington, DC 20036

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

  1. 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.
  2. 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.).
  3. See Advisory Opinion No. 2001-10A, December 14, 2001.
  4. See DOL information letter to Robert Plotkin, August 1, 1986.
  5. 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.

2003-09A    Whether a trust company’s receipt of 12b-1 and subtransfer fees from mutual funds

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

June 25, 2003

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

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

Issued on May 22, 1997.

2003-11A    Whether delivery of a Profile (as described in Rule 498 under the Securities Act of 1933)

2003-11A
ERISA Sec. 404(c)

September 8, 2003

Stephen M. Saxon
Groom Law Group, Chartered
1701 Pennsylvania Ave., NW
Washington, DC 20006-5893

Dear Mr. Saxon:

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 participant-directed individual account plan’s delivery of a mutual fund Profile, as described below, to participants and beneficiaries immediately before or immediately after their investment in the mutual fund would satisfy regulations issued by the Department of Labor (Department) pursuant to section 404(c) of ERISA.

You represent that the Principal Financial Group (Principal) provides investment products and administrative services to tax-qualified defined contribution plans established pursuant to section 401(a) of the Internal Revenue Code of 1986 (the Code), including plans that permit employee elective deferrals under section 401(k) of the Code (401(k) plans). Many of these 401(k) plans permit participants to direct the investments of the amounts in their individual accounts. These 401(k) plans are typically designed and administered by Principal to comply with regulations issued by the Department pursuant to section 404(c) of ERISA (404(c) regulations).(1)

Section 404(c) of ERISA provides that, in the case of an individual account plan that permits participants or beneficiaries to exercise control over assets in their accounts, no person who is otherwise a fiduciary shall be liable under part 4 of Title I of ERISA for any loss, or by reason of any breach, which results from such participant’s or beneficiary’s exercise of control. The 404(c) regulations require, among other things, that a participant or beneficiary shall be provided or have the opportunity to obtain sufficient information to make informed decisions with regard to investment alternatives available under the plan.(2) In the case of an investment alternative subject to the registration requirements of the Securities Act of 1933 (Securities Act) such as a mutual fund, the 404(c) regulations provide that a participant or beneficiary shall be provided by the identified plan fiduciary (or a person or persons designated by the plan fiduciary to act on his behalf), a copy of the most recent prospectus that was provided to the plan, either immediately before the participant’s or beneficiary’s initial investment in such investment alternative, or immediately following the participant’s or beneficiary’s initial investment.(3) The 404(c) regulations also provide that a participant or beneficiary shall be provided, either directly or upon request, the following information, which shall be based on the latest information available to the plan: copies of any prospectuses, financial statements and reports, and of any other materials relating to the investment alternatives available under the plan, to the extent such information is provided to the plan.(4)

Section 2(a)(10) of the Securities Act generally defines the term “prospectus” to include any notice, circular, advertisement, letter, or communication that offers any security for sale or confirms the sale of any security.(5) Section 10(a) of the Securities Act generally provides that a prospectus relating to a security (10(a) prospectus) shall contain much of the same information that is contained in the registration statement of the security.(6) Section 10(a) of the Securities Act specifies the information that a prospectus must contain and the information that a prospectus may omit.(7) Section 10(b) of the Securities Act provides that the Securities and Exchange Commission (SEC) shall, by rules or regulations deemed necessary or appropriate in the public interest or for the protection of investors, permit the use of a summary document (10(b) prospectus) which omits in part or summarizes information provided in a 10(a) prospectus.

Under section 5(b)(1) of the Securities Act, a 10(b) prospectus may be provided to an investor in connection with an offer to sell a registered security.(8) Under section 5(b)(2) of the Securities Act, however, a 10(a) prospectus must be provided to an investor at or before any sale of a registered security.(9) Thus, under the federal securities laws, while a summary document under section 10(b) of the Securities Act may be delivered for purposes of an offer, a 10(a) prospectus would, in any event, also be required to be delivered in order to sell a registered security.

On March 13, 1998, the SEC adopted Rule 498 under the Securities Act (Securities Act Rule 498). Under Securities Act Rule 498, a summary prospectus, or a Profile, designed to comply with section 10(b) of the Securities Act, may be delivered to investors in connection with an offer to purchase or sell mutual fund shares.(10) Paragraph (b) of Securities Act Rule 498 provides that a Profile is intended to be a standardized summary of key information contained in a 10(a) prospectus. Securities Act Rule 498 requires a Profile to provide clear and concise information in a format designed to communicate information effectively, while avoiding excessive detail, technical or legal terms, and long sentences and paragraphs.(11) A Profile is specifically required to include, among other things: identifying information; an explanation that the Profile summarizes key information included in the prospectus; information regarding how investors can obtain the prospectus; investment objectives, strategies, and risks; fees and expenses; identities of investment advisers and managers; information regarding purchase and sale of shares; investment requirements; distributions and tax information; and other services available.

In adopting Securities Act Rule 498, the SEC stated its belief that investors in participant-directed defined contribution plans may find a Profile helpful in evaluating and comparing funds offered as investment alternatives in a plan.(12) Paragraph (d)(1) of Securities Act Rule 498 provides that, in a Profile intended for use with respect to a 401(k) plan, a mutual fund may modify or omit certain information which may not be relevant to participants and beneficiaries of a plan, such as information about requirements for purchasing and selling shares, fund distributions, tax consequences with regard to distributions, and other fund services that are not applicable to plan participants and beneficiaries. The SEC did not, however, authorize the use of the Profile for purposes of a sale under section 5(b)(2) of the Securities Act.

You represent that, because Principal’s 401(k) plan clients typically design and administer their plans to comply with the 404(c) regulations, administrative services provided by Principal include assistance in meeting the disclosure and other requirements of the 404(c) regulations. With regard to mutual funds, Principal proposes to deliver Profiles of mutual funds, including its proprietary funds, to participants of 401(k) plans designed to comply with the 404(c) regulations. You represent that Principal believes that delivery of a mutual fund Profile to a participant of a 401(k) plan designed to comply with the 404(c) regulations will satisfy the requirement under the 404(c) regulations that a prospectus be delivered to each participant either immediately before or immediately after the participant’s initial investment in the mutual fund.(13) You assert that automatic delivery of a Profile would permit plans to avoid the additional expense of automatically providing a lengthy 10(a) prospectus. In addition, you represent that, with regard to delivery of a 10(a) prospectus, Principal will send a 10(a) prospectus to any requesting participant or beneficiary within three days of receipt of such request.(14)

You assert that, consistent with the Department’s reasoning in the preamble to the 404(c) regulations with regard to delivery of a prospectus, the delivery of a Profile, as a concise summary of a mutual fund’s investment objectives, risk and return characteristics, and type and diversification of assets, will provide participants and beneficiaries with the information necessary for them to make informed investment decisions with respect to investment in mutual funds. You assert that the required delivery of a prospectus under section 404(c) is intended to ensure that participants and beneficiaries are provided with sufficient information in order to be able to make informed decisions with respect to investment alternatives under the plan. In this regard, you represent that a Profile conveys all the information about a mutual fund that the 404(c) regulations require to be delivered automatically to participants in connection with each designated investment option (i.e., the description of investment objectives, risk and return characteristics, type and diversification of assets, and identification of investment manager, required by 29 CFR section 2550.404c-1(b)(2)(i)(B)(1)(ii) and (iii)).

You specifically ask whether delivery of a Profile would satisfy a participant-directed individual account plan’s obligation under the 404(c) regulations to deliver a copy of the most recent prospectus to plan participants and beneficiaries immediately before or immediately after such individuals initially invest in mutual funds.

The Department has not defined the term “prospectus” in the 404(c) regulations, or elsewhere. In the preamble to the 404(c) regulations, the Department states that the prospectus delivery requirement is intended to ensure that, immediately before or immediately after a participant’s or beneficiary’s initial investment in an investment alternative, such as a mutual fund, that is required to deliver a prospectus to investors under the federal securities laws, participants and beneficiaries must be afforded the opportunity to review the prospectus in connection with an initial investment in such investment alternative.(15)

The Department takes no position with respect to the application of the federal securities laws to your question. However, it is the view of the Department that, under the 404(c) regulations, the term “prospectus” includes a Profile. The Department believes that the delivery of a Profile by an identified plan fiduciary or designee to plan participants or beneficiaries satisfies the requirements of the 404(c) regulations because it provides a clear summary of key information about a mutual fund that is useful to such participants and/or beneficiaries.

A Profile, designed to comply with section 10(b) of the Securities Act, provides participants with information of the sort that the Department intended a participant in a section 404(c) plan to receive both automatically and upon request with respect to a relevant investment. Moreover, if a participant wishes to obtain additional information, the cover page of the Profile shows how to obtain a 10(a) prospectus from the offeror.

Where the most recent prospectus in the plan’s possession is a Profile, then delivering the Profile to plan participants and beneficiaries, immediately before or immediately after such individuals’ initial investment in a mutual fund, would satisfy a participant-directed individual account plan’s prospectus delivery obligation under 29 CFR section 2550.404c-1(b)(2)(i)(B)(1)(viii). Where the most recent prospectus is a 10(a) prospectus, 29 CFR section 2550.404c-1(b)(2)(i)(B)(1)(viii) would require the delivery of a 10(a) prospectus.

Separately, under 29 CFR section 2550.404c-1(b)(2)(i)(B)(2), the identified plan fiduciary or designee must provide, either directly or upon request, copies of prospectuses (among other things) based on the latest information available to the plan. Where a participant requests a prospectus, and the most recent prospectus is a Profile, then providing the Profile will comply with this requirement. If, however, the participant specifically requests a 10(a) prospectus, the most recent 10(a) prospectus must be provided.

This letter constitutes an advisory opinion under ERISA Procedure 76-1. Accordingly, it is 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

  1. 29 CFR 2550.404c-1.
  2. 29 CFR 2550.404c-1(b)(2)(i)(B).
  3. 29 CFR 2550.404c-1(b)(2)(i)(B)(1)(viii).
  4. 29 CFR 2550.404c-1(b)(2)(i)(B)(2)(ii).
  5. See 15 USC 77b(a)(10).
  6. On March 13, 1998, the SEC adopted amendments to Form N-1A, the registration form used by mutual funds. Pursuant to the amendments, a mutual fund prospectus must provide investors with essential information about the mutual fund, including: risk/return summaries; investment strategies; mutual fund performance; management, organization, and capital structure; shareholder information; and distribution arrangements. A mutual fund prospectus should avoid: lengthy legal and technical discussions; a restatement of legal or regulatory requirements to which mutual funds generally are subject; and disproportionate emphasis on possible investments or activities of the mutual fund that are not a significant part of the mutual fund’s investment operations. In addition, a mutual fund prospectus may modify or omit certain items when mutual funds are investment options for 401(k) plans, including: procedures for purchasing and redeeming mutual fund shares if such procedures are inapplicable; dividend and distribution policies if such policies are inapplicable; and tax consequences to shareholders with respect to buying, holding, exchanging, and selling mutual fund shares if such consequences are inapplicable. See Registration Form Used by Open-End Management Investment Companies, Securities Act Release No. 7512 (March 13, 1998).
  7. See 15 USC 77j(a).
  8. See 15 USC 77j(b).
  9. See 15 USC 77e(b)
  10. See New Disclosure Option for Open-End Management Investment Companies, Securities Act Release No. 7513 (March 13, 1998) (Securities Act Rule 498 Adopting Release). In adopting Securities Act Rule 498 which permits the use of a Profile, the SEC stated that the “profile of a fund will be a summary prospectus under section 10(b) of the Securities Act, but the fund’s section 10(a) prospectus will remain the primary disclosure document under the federal securities laws.” Securities Act Rule 498 Adopting Release. Accordingly, paragraph (c)(1)(v) of Securities Act Rule 498 requires that a Profile shall provide a toll-free (or collect) telephone number that investors can use to obtain the prospectus and a mutual fund may indicate, as applicable, that the prospectus and other information is available on the mutual fund’s internet site or by e-mail request, or that the prospectus is available through a financial intermediary.
  11. See 17 CFR 230.498.
  12. Securities Act Rule 498 Adopting Release, text accompanying note 124.
  13. See 29 CFR 2550.404c-1(b)(2)(i)(B)(1)(viii).
  14. We note that the Instruction to Paragraph (c)(1)(v) of Securities Act Rule 498 provides that when a mutual fund (or financial intermediary through which shares of the mutual fund may be purchased or sold) receives a request for a 10(a) prospectus, the mutual fund (or financial intermediary) must send the 10(a) prospectus within three business days.
  15. See 57 Fed. Reg. 46906, 46911 (October 13, 1992).

2003-15A    Whether a limited partnership in which employee benefit plans invest would be deemed a party in interest with respect to the plans

2003-15A
ERISA Sec. 3(14)(G) and 406(a)

November 17, 2003

William A. Schmidt
Kirkpatrick & Lockhart LLP
1800 Massachusetts Avenue, NW
Second Floor
Washington, DC 20036-1800

Jacob I. Friedman
Proskauer Rose LLP
1585 Broadway
New York, NY 10036-8299

Dear Messrs. Schmidt and Friedman:

This is in response to your request for an advisory opinion on behalf of Verizon Investment Management Corp. as to whether certain transactions between employee benefit plans sponsored by Verizon Communications, Inc. (Verizon) and a limited partnership in which those plans invest would constitute prohibited transactions under the Employee Retirement Income Security Act of 1974 (ERISA).

You represent that Verizon sponsors welfare benefit plans that qualify as voluntary employees’ beneficiary associations (VEBAs) and defined benefit plans (DB Plans), collectively the Verizon Plans.(1) The Bell Atlantic Master Trust (Master Trust) holds the assets of the Verizon DB Plans. Mellon Bank, N.A. (Mellon) serves as the directed trustee of the Master Trust. Each VEBA is held in trust by Mellon.

Verizon Investment Management Corp. (VIMCO), a wholly-owned subsidiary of Verizon, serves as investment manager of the Verizon Plans. You represent that VIMCO is an in-house asset manager (INHAM) within the meaning of Part IV(a) of Prohibited Transaction Exemption 96-23 with respect to the Verizon Plans.

You represent that Verizon intends to create an investment vehicle for the Verizon Plans, employee benefit plans maintained and sponsored by third parties unrelated to Verizon or Mellon (Third Party Plans), and other institutional investors. To accomplish this, VIMCO, in concert with Mellon, would establish and operate a limited partnership, which is a collective investment vehicle (CIV) organized under the laws of Delaware.(2) The CIV will be managed by a joint venture between VIMCO and Mellon (Joint Venture).

You represent that Delaware law requires that, among other things, the CIV have one or more general partners and one or more limited partners. You represent that, pursuant to Delaware law, the general partner is not required to make contributions to the CIV nor acquire a partnership interest in the CIV. You further represent that the general partner will not make a contribution to, nor acquire a partnership interest in, the CIV unless required to do so pursuant to the law of jurisdictions, other than Delaware, in which the CIV may be doing business.(3) A wholly-owned subsidiary of VIMCO will be the general partner of the CIV. You represent that the Verizon Plans will contribute assets to the CIV and become limited partners of the CIV at the time the CIV is organized. You represent that Mellon will have no responsibility or authority with respect to the Verizon Plans’ decisions to invest in the CIV. The Third Party Plans and other third party institutional investors will become limited partners at future dates upon contribution to the CIV. Mellon or a third party will be the trustee for the Third Party Plans. The Third Party Plans will not have any relationship with VIMCO prior to making a contribution to the CIV. You represent that, assuming that state law requirements are fulfilled, the liability of each limited partner for the CIV’s debts or obligations will be limited to the extent of the capital that the limited partner has contributed or has agreed to contribute to the CIV, undistributed profits and, under certain circumstances, the return of certain distributions from the CIV. You represent that the CIV will not be designated as a named fiduciary of, nor perform fiduciary functions for, the Verizon Plans or the Third Party Plans.

With respect to a Third Party Plan’s participation in the CIV, an independent fiduciary (i.e., independent of VIMCO and Mellon) will make a determination whether to make initial or subsequent contributions into the CIV based upon detailed information provided by VIMCO concerning the available investment pools and other relevant information. The independent fiduciary must approve each Third Party Plan’s program of purchases and redemptions of interests in the CIV.

Mellon will be the custodian of the assets of the CIV. You represent that Mellon, as trustee of the Master Trust, will hold at least fifty percent of the interests of the CIV, on behalf of the Verizon DB Plans, for the foreseeable future.

The CIV will be composed of multiple investment pools with varying investment risks. The Joint Venture will be the investment manager of the CIV, and as such, will direct the allocation of each limited partner’s interests in the CIV among the various investment pools. The Joint Venture will enter into a contract with VIMCO under which VIMCO will discharge substantially all of the Joint Venture’s investment management responsibilities with respect to the CIV. You further represent that each limited partner will have an undivided interest in the assets of each underlying investment pool in which it invests. The various investment pools will be either (i) invested in common investment funds or mutual funds, or (ii) managed by the Joint Venture or other investment advisers designated by the Joint Venture (Third Party Investment Advisers), which will act as investment managers and which are registered under the Investment Advisers Act of 1940 or which are banks or insurance companies.

You represent that the Joint Venture and the Third Party Investment Advisers will receive reasonable fees from the Third Party Plans and other institutional investors for their services. In addition, while the Third Party Investment Advisers will receive reasonable fees from the Verizon Plans for their services, the Joint Venture, VIMCO and Mellon will not receive any fees or other compensation (directly or indirectly) for investment management services to the Verizon Plans, but will be reimbursed for expenses directly and properly incurred for performing services for the Verizon Plans.

You have asked for an advisory opinion to the effect that, where fifty percent or more of the interests in the CIV are legally held by Mellon, as fiduciary for the benefit of the Verizon Plans, the CIV is not itself a party in interest with respect to the Verizon Plans invested in the CIV, and therefore, contributions to and distributions from the CIV would not constitute prohibited transactions under ERISA. You are specifically concerned that the CIV may be deemed a party in interest with respect to the Verizon Plans under section 3(14)(G) of ERISA because Mellon would hold more than fifty percent of the interests in the CIV on behalf of the Verizon Plans as trustee of those Plans.

Section 406(a)(1)(A) and (D) prohibits, in relevant part, the exchange of any property between a plan and party in interest and the transfer to, or use by or for the benefit of, a party in interest, of any assets of the plan. Section 3(14)(G) of ERISA defines a party in interest to include a corporation, partnership or trust or estate of which (or in which) fifty 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 such 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, among others, a fiduciary of a plan. (Emphasis added.)

Mellon, as trustee of the Verizon Plans, is a fiduciary with respect to the Verizon Plans under section 3(21) of ERISA. The Verizon Plans’ contributions to the CIV would be directed by VIMCO. The ownership interests in the CIV would be held by Mellon on behalf of the Verizon Plans. Similarly, distributions from the CIV to the Verizon Plans would be made to Mellon and held on behalf of the Verizon Plans.

Consistent with section 3(14) of ERISA, a plan’s ownership of fifty percent or more of a partnership entity will not cause that partnership to become a party in interest with respect to that investing plan.(4) In our view, the application of section 3(14)(G) should not change that result merely because a plan’s interests in a partnership are held by a fiduciary on behalf of the plan. Although Mellon would hold more than fifty percent of the value of the CIV interests, it would hold such interests on behalf of the Verizon Plans, not on behalf of itself or a third party. As a result, it is the view of the Department that the CIV will not be a party in interest with respect to the Verizon Plans.(5) Therefore, transactions between the Verizon Plans and the CIV, including initial and subsequent contributions to the CIV by the Verizon Plans and distributions from the CIV to the Verizon Plans, would not be prohibited under section 406(a) of ERISA.

Section 406(b)(1) of ERISA prohibits a fiduciary from dealing with plan assets in his or her own interests or for his or her own account. ERISA section 406(b)(2) specifically prohibits fiduciaries in their individual or in any other capacity from acting in any transaction involving the plan on behalf of a party (or representing a party) whose interests are adverse to the interests of the plan or the interests of its participants or beneficiaries. Accordingly, VIMCO and Mellon must ensure that they can act on behalf of the CIV without compromising their positions as fiduciaries of the Verizon Plans. Further, while the Department recognizes that determining whether violations of the prohibited transaction provisions of section 406(b) of ERISA would occur are inherently factual questions, it is the view of the Department that if, in operation, VIMCO’s provision of investment management services to the Verizon Plans or Mellon’s provision of trustee services to the Verizon Plans results in a divergence of interests between VIMCO and the Verizon Plans or Mellon and the Verizon Plans, violations of sections 406(b) of ERISA could occur.

The Department cautions that ERISA’s general standards of fiduciary conduct would apply to the Verizon Plans’ investment in the CIV. Section 404(a)(1) of ERISA requires, among other things, 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 like character and with like aims. Accordingly, the appropriate plan fiduciaries must act “prudently” and “solely in the interests” of the plan participants and beneficiaries with respect to the decision to acquire or dispose of the Verizon Plans’ interests in the CIV.

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

Sincerely,

Louis J. Campagna
Chief, Division of Fiduciary Interpretations
Office 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 Internal Revenue Code (the Code) has been transferred to the Secretary of Labor, with certain exceptions not here relevant. 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.
  2. You represent that the CIV will be treated as a partnership for tax purposes pursuant to Treasury Regulation 26 CFR 301.7701-3(b).
  3. You represent that if the general partner must make a contribution to, or acquire a partnership interest in, the CIV pursuant to state law requirements, the general partner’s interest in the CIV will be limited to the extent necessary to comply with such requirements.
  4. Under the plan assets regulation, 29 CFR 2510.3-101, the extent of a plan’s equity ownership interest in an entity may cause that entity to be deemed to hold plan assets.
  5. See Advisory Opinion 80-67A (Nov. 30, 1980).

2004-02A    Time and Order of Issuance of Domestic Relations Orders

2004-02A
ERISA Sec. 206(d)(3)

Whether a domestic relations order that changes a prior assignment of benefits to an alternate payee to reduce the amount assigned to the alternate payee may be a qualified domestic relations order within the meaning of section 206(d)(3) of ERISA.

Terry-Lynne Lastovich
Dorsey & Whitney LLP
50 South Sixth Street, Suite 1500
Minneapolis, MN 55402-1498

Dear Ms. Lastovich:

This is in response to your request on behalf of Northwest Airlines, Inc. Retirement Plan for Pilot Employees (the Plan) for an advisory opinion under section 206(d) of Title I of the Employee Retirement Income Security Act of 1974 (ERISA). Specifically, you ask whether a domestic relations order that changes a prior assignment of benefits to an alternate payee to reduce the amount assigned to the alternate payee may be a "qualified domestic relations order" (QDRO) within the meaning of section 206(d)(3) of ERISA.

You represent that this question arises out of a divorce and property settlement involving a now-retired employee of Northwest Airlines, Inc. (the participant) and his former spouse (the alternate payee). The participant has earned a vested pension benefit under the Plan, which is a defined benefit pension plan. Northwest Airlines, Inc. (Northwest) sponsors and is the administrator of the Plan.

In 1997, while the participant was still actively employed, the Plan received a domestic relations order, dated April 3, 1997, that assigned to the alternate payee a percentage of the participant's pension benefits (the 1997 Order). The 1997 Order was issued by the District Court of the First Judicial District, Family Court Division, County of Dakota, State of Minnesota. In accordance with its procedures, the Plan reviewed the order, determined it to be a QDRO, and so informed both the participant and the alternate payee on August 27, 1997.

In November 2000, while the participant was still actively employed, the participant notified the Plan that both he and the alternate payee desired to modify the assignment reflected in the QDRO to reduce the portion of the participant's benefits that would be paid in the future to the alternate payee. The participant sought the Plan's advice on how to make such a change. The Plan advised the alternate payee and the participant that it would not consider an order that purported to reduce the assignment already made under a previously recognized QDRO to be permissible.

Nonetheless, on June 6, 2002, the participant submitted to the Plan a second domestic relations order, dated June 4, 2002 (the 2002 Order). The 2002 Order was also issued by the District Court of the First Judicial District, Family Division, County of Dakota, State of Minnesota. This order stated that the parties to the divorce were "in agreement" that the QDRO provisions of the 1997 Order should be altered and therefore ordered that those 1997 QDRO provisions were "deleted." The 2002 Order set forth new provisions for a different (and smaller) assignment to the alternate payee.

During the course of its review of the 2002 Order, the Plan expressed its doubts as to whether such a reduction in the amount assigned could be effected by a QDRO and requested both participant and alternate payee to provide "a written explanation of why this amended order should or should not be reviewed as a qualified domestic relations order." These parties declined to offer argument on this issue and continued to assert that the 2002 Order expressed their consensus on how the participant's benefits should be divided between them.

In September 2002, before the Plan had issued a determination on the qualified status of the 2002 Order, the participant retired, and Northwest began paying benefits to both the participant and the alternate payee under the terms of the 1997 Order.

On November 15, 2002, the Plan sent a letter to the participant, setting forth its "decision” that the 2002 Order was not qualified, based upon its view that a subsequent order cannot reduce the benefits awarded to an alternate payee under a previous domestic relations order recognized by the Plan as a QDRO. This letter set forth the following additional determinations: (1) the 2002 Order is "provisionally" determined not to be a QDRO; (2) the 1997 Order continues in full force and effect; (3) the Plan has requested an advisory opinion from the Department of Labor (the Department) on whether an order that "takes away" benefits previously assigned to an alternate payee can be a QDRO; and (4) pending issuance of the advisory opinion, the Plan will continue to pay out benefits in accordance with the 1997 Order. The letter further advised the participant that, if the Department opined that the 2002 Order cannot be a QDRO, the Plan's determination would become "final." The letter further stated that if the Department opined that the 2002 Order could be a QDRO "even though it 'takes away' a benefit previously awarded" to the alternate payee, it would then seek reimbursement of any "overpayments" made to the alternate payee based on the 1997 Order. If the alternate payee did not return the "overpayments" the Plan would withhold future payments to the alternate payee until the "overpayments" were recovered.

This request for an advisory opinion ensued. In the context of these facts, you seek guidance on whether the 2002 Order, which purported to reduce the amount of the participant's benefits that are assigned to the alternate payee, could qualify as a QDRO within the meaning of section 206(d)(3) of ERISA.

Under section 206(d)(3) of ERISA, the plan administrator is the party to whom an initial determination of the qualified status of an order is entrusted. The Department generally does not provide advisory opinions addressing this question because making such a determination necessarily requires an interpretation of the specific provisions of a plan and application of those provisions to specific facts, including the nature and amount of a participant's pension benefits. Nonetheless, the Department believes it is appropriate to provide guidance under section 206(d)(3) on the narrow issue you have presented of whether a subsequent domestic relations order that alters or modifies a qualified domestic relations order involving the same participant and alternate payee may itself be qualified and therefore supercede the previous order. In providing this guidance, however, the Department takes no position on whether any particular order described in this letter is or is not a "qualified domestic relations order" within the meaning of section 206(d)(3) of ERISA.

Section 206(d)(1) of ERISA generally requires pension plans covered by Title I of ERISA to provide that plan benefits may not be assigned or alienated. Section 206(d)(3)(A) of ERISA states that section 206(d)(1) applies to any assignment or alienation of benefits made pursuant to a "domestic relations order," unless the order is determined to be a “qualified domestic relations order.” Section 206(d)(3)(A) further provides that pension plans must provide for the payment of benefits in accordance with the applicable requirements of any order that is determined to be a “qualified domestic relations order.” The grounds on which the plan administrator must judge the status of an order that purports to assign benefits are set forth in the specific subparagraphs of section 206(d)(3).

Subparagraph (B) of section 206(d)(3) of ERISA defines the terms "qualified domestic relations order" and "domestic relations order" for purposes of section 206(d)(3) as follows:

(B) For purposes of [section 206(d)(3)] –

(i) the term "qualified domestic relations order" means a domestic relations order –

(I) which creates or recognizes the existence of an alternate payee’s right to, or assigns to an alternate payee the right to, receive all or a portion of the benefits payable with respect to a participant under a plan, and

(II) with respect to which the requirements of subparagraphs (C) and (D) are met, and

(ii) the term "domestic relations order" means any judgment, decree, or order (including approval of a property settlement agreement) which –

(I) relates to the provision of child support, alimony payments, or marital property rights to a spouse, former spouse, child, or other dependent of a participant, and

(II) is made pursuant to a State domestic relations law (including a community property law).

Subparagraphs (C) and (D) of section 206(d)(3) of ERISA contain both positive and negative requirements for qualification of a domestic relations order. Subparagraph (C) specifies that, in order for a domestic relations order to be qualified, such order must clearly specify (i) the name and the last known mailing address (if any) of the participant and the name and mailing address of each alternate payee covered by the order; (ii) the amount or percentage of the participant's benefits to be paid by the plan to each such alternate payee, or the manner in which such amount or percentage is to be determined; (iii) the number of payments or period to which such order applies; and (iv) each plan to which the order applies.

Subparagraph (D) provides that an order cannot be qualified if it either (i) requires the plan to provide any type of benefit, or any option, not otherwise provided by the plan; (ii) requires the plan to provide increased benefits (determined on the basis of actuarial value); or (iii) requires the plan to pay benefits to an alternate payee that are required to be paid to another alternate payee under another order previously determined to be a qualified domestic relations order.

A plan administrator may determine that an order is not qualified only on the basis of the requirements set forth in section 206(d)(3) of ERISA. In our view, nothing in section 206(d)(3) suggests that a State court (or other appropriate State agency or instrumentality) may not alter or modify a previous domestic relations order involving the same participant and alternate payee, as long as the new domestic relations order itself meets the statutory requirements. Indeed, the purpose of section 206(d)(3) is to permit the division of marital property on divorce in accordance with the directions of the State authority with jurisdiction to achieve the appropriate disposition of property upon the dissolution of a marriage. Where a State authority reasserts jurisdiction over a marital dissolution and issues an order changing a previously established property allocation, it would appear contrary to this purpose to create additional requirements, beyond what is specified in section 206(d)(3) of ERISA, that would thwart the exercise of that authority. Accordingly, provided that a domestic relations order otherwise meets the requirements of section 206(d)(3) of ERISA, a plan administrator may not fail to qualify the domestic relations order merely because the order changes a prior assignment to the same alternate payee.(1) Thus, it is the Department's view that a plan administrator may determine, consistent with the requirements of section 206(d)(3), that a domestic relations order is qualified even if it would supersede or amend a pre-existing QDRO assigning the same participant's benefits to the same alternate payee.

The plan administrator in this case has made apparent its intention to seek repayments from, or to withhold future payments to, the alternate payee of amounts paid out in accordance with the 1997 Order. We do not believe that, under these facts, the plan administrator would have the authority to do so. As a general matter, a plan administrator making QDRO determinations has fiduciary duties applicable to the determination process. The administrator has a duty under section 206(d)(3)(G) of ERISA to determine whether a domestic relations order is a QDRO within a reasonable time after receipt and to promptly notify the participant and each alternate payee of the determination. The administrator has a duty under section 404(a)(1) of ERISA to act prudently and solely in the interests of the plan's participants and beneficiaries, and to follow the plan's QDRO procedures unless they conflict with the provisions of ERISA.

Because, in this case, the plan administrator had previously determined the 1997 Order to be a QDRO, the plan was required to make benefit payments in accordance with the 1997 Order. The plan administrator took no steps to preserve the amounts that would be affected by the 2002 Order during its consideration of that order's qualified status, but continued to make the payments required by the 1997 Order. Subparagraph (I) of section 206(d)(3) of ERISA provides that, if a plan fiduciary, acting in accordance with its fiduciary duties, treats a domestic relations order as being qualified, and pays out benefits in accordance with its determination and the 18-month segregation rules of subparagraph (H), the plan's obligations to the participant and any alternate payee are discharged with respect to such payments.(2) Accordingly, under these circumstances it is appropriate to treat the 2002 Order as prospective only. There does not appear to be grounds on which the plan could seek repayment from the alternate payee of the benefits paid out in accordance with the 1997 Order.(3)

This letter constitutes an advisory opinion under ERISA Procedure 76-1, 41 Fed. Reg. 36281 (1976). Accordingly, this letter 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

  1. Section 206(d)(3)(D)(iii), which provides that a domestic relations order may be qualified only if it does not require the payment of benefits to an alternate payee that are required to be paid to another alternate payee under a pre-existing QDRO, does not apply here, where there is only one alternate payee.
  2. Although § 206(d)(3)(H) requires an administrator to segregate amounts that would be payable to an alternate payee under an order for 18 months pending determination of the order's qualified status, that section does not require segregation of amounts that would be transferred from the alternate payee (per a previously recognized QDRO) to the participant. Nonetheless, the administrator may have been able, under these facts, to arrange a voluntary escrow of the amounts in question, since both the participant and the alternate payee apparently sought the change in assignment.
  3. Nothing in this letter is intended to alter or have any effect on the federal tax consequences under the Internal Revenue Code (the Code) to the participant and alternative payee of distributions under either the 1997 Order or the 2002 Order.

2004-05A    Whether the execution of a securities transaction between a plan and party in interest through an alternative trading system

2004-05A
ERISA Sec. 406(a)(1)(A),(D)
406(b)(1),(2)

May 24, 2004

Mr. William R. Charyk
Arent Fox Kintner Plotkin & Kahn, PLLC
1050 Connecticut Avenue, NW
Washington, DC 20036-5339

Dear Mr. Charyk:

This is in response to your request for guidance under section 406 of the Employee Retirement Income Security Act of 1974 (ERISA) and section 4975 of the Internal Revenue Code of 1986, as amended (the Code).(1) In particular, you ask whether the execution of a securities transaction between a plan and a party in interest with respect to such plan as defined in ERISA through an alternative trading system (ATS) maintained by Liquidnet, Inc. (Liquidnet) constitutes a prohibited transaction under section 406(a)(1)(A) and (D) of ERISA. In addition, you inquire whether the execution of a securities transaction through the Liquidnet ATS (the Liquidnet System) between a plan and a counterparty that is an affiliate of the fiduciary directing such trade on behalf of the plan also violates section 406(b) of ERISA.

You write on behalf of Liquidnet, a registered broker/dealer that maintains the Liquidnet System. The Liquidnet System is an "alternative trading system," as defined in Rule 300(a) of Regulation ATS under the Securities Exchange Act of 1934, as amended. You also represent that all of Liquidnet’s approximately 200 subscribers are large institutional investors that individually manage, on average, approximately $31 billion of equity assets. You note that these subscribers, none of which are affiliated with Liquidnet, often act as named fiduciaries, investment managers, or provide other services to employee benefit plans.

You state that Liquidnet was created to facilitate the trading of “blocks” of equity securities. In this regard, since its inception in 2001, more than three billion shares of equity securities have been traded over the Liquidnet System pursuant to trade sizes that have averaged approximately 44,000 shares. You state that the total value of the shares traded through the Liquidnet System approximated $61 billion as of August 29, 2003.

You state that subscribers to Liquidnet may trade U.S., U.K., French, German, Netherlands, and Swiss equity securities through the Liquidnet System. In this regard, you state that the Liquidnet System: (1) interfaces with the order management systems of Liquidnet’s subscribers; and (2) identifies, with respect to a particular security, each Liquidnet subscriber that has an interest in buying the security and each Liquidnet subscriber that contemporaneously has an interest in selling the security. You state that each Liquidnet subscriber indicates to the Liquidnet System its interest in buying or selling various securities. If one subscriber indicates to the Liquidnet System an interest in buying a certain security that a different subscriber has independently indicated to the Liquidnet System an interest in selling, the Liquidnet System notifies both subscribers that a transaction opportunity exists.(2) You note that the Liquidnet System does not disclose the identity of either subscriber to the other. The two subscribers may then negotiate; through their respective computer systems; both the price and the quantity of the security. Accordingly, you state that the Liquidnet System enables subscribers to engage in an anonymous, no obligation, one-on-one, real-time negotiation (a subscriber must terminate its current negotiation with another subscriber before engaging in a new negotiation with a different subscriber).

You state that multiple Liquidnet subscribers may have an interest in buying (or selling) a security that a different Liquidnet subscriber has an interest in selling (or buying). Where, for example, the Liquidnet System identifies that multiple subscribers have an interest in buying a security that a different subscriber has an interest in selling, the Liquidnet System provides the selling subscriber with an electronic listing of the anonymous subscribers interested in buying. You note that once a subscriber is provided with such a listing, the subscriber may thereafter negotiate with any or all of the subscribers on the list. You state that the Liquidnet System currently determines the order of a multiple subscriber listing by comparing the quantities they have posted to the quantity posted by the single contra-side subscriber. The subscriber posting a quantity that is nearest to the quantity posted by the single contra-side subscriber is placed first on the list. The remaining order is determined in the same fashion.(3) You state that the Liquidnet System's trading rules, which are distributed to all subscribers, contains a disclosure that describes how multiple potential negotiating subscribers will be ordered.

You represent that trades entered into pursuant to the Liquidnet System are executed on a “blind” basis. In this regard, you state that, during the entire execution and settlement processes, subscribers interact with each other pursuant to policies and rules designed to ensure anonymity. You represent that the Liquidnet System, never discloses the identity of a subscriber to any other. In addition, all physical transfers of equity securities and cash are made between an independent clearing firm, Bear, Stearns Securities Corp. and the buyer’s and seller’s respective custodians. Therefore, the identities of the parties to a trade will not be revealed to the parties during the clearing process.

You state that: given the number and type of Liquidnet subscribers; the large number of trades executed on Liquidnet on a daily basis; and the fact that such trades are executed and settled pursuant to rules, procedures and software designed to ensure anonymity; it is expected that the parties to a transaction engaged in through the Liquidnet System will not know, at any time, the identity of each other.(4) Accordingly, it is possible for a subscriber, in its capacity as a fiduciary with respect to a plan, to unknowingly buy/sell a security on behalf of the plan through the Liquidnet System from/to a Liquidnet subscriber that is a party in interest to the plan.

Further, you note that although a subscriber cannot execute a securities transaction with itself through the Liquidnet System (i.e., as both the buyer and seller), it is possible for a plan fiduciary to direct a trade through the Liquidnet System whereby the Liquidnet subscriber that is the counterparty to the plan is an affiliate of such fiduciary. You state that two affiliates may request that Liquidnet "block" negotiations between the two entities. However, you note that a Liquidnet subscriber may not be aware that an affiliate thereof is also a Liquidnet subscriber.

Section 3(14)(A) and (B) of ERISA defines the term “party in interest” as meaning, as to an employee benefit plan, any fiduciary (including, among others, a trustee) of an employee benefit plan; and a person providing services to such plan. ERISA section 3(21)(A) provides that a person is a fiduciary with respect to a plan to the extent that (i) he exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets, (ii) he 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) he has any discretionary authority or responsibility in the administration of such plan.

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 406(a)(1)(D) of ERISA provides that a fiduciary with respect to a plan shall not cause the plan to engage in a transaction, if he or she 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. Section 406(b)(1) of ERISA provides 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 406(b)(2) provides that a fiduciary with respect to a plan 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.

With respect to purchases and sales of equity securities, 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” purchase or sale of securities through an exchange where neither buyer nor seller (nor the agent of either) knows 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).

As you noted, Liquidnet matches purchase and sell orders from its clients and gives purchasers and sellers the opportunity to negotiate a trade based on price and volume. The number of subscribers and the trading procedures assure a party’s anonymity, unless the party wishes to identify itself to the counter-party. In our view, transactions executed through Liquidnet’s trading procedures for the execution of transactions, that are designed to permit anonymous negotiations without identifying the parties, function in a manner similar to the operation of an exchange. Accordingly, based on your representations, it is our further view that “blind” transactions executed pursuant to such procedures would not, in themselves, constitute prohibited transactions under section 406(a)(1)(A), 406(a)(1)(D), 406(b)(1) or 406(b)(2) of ERISA.

The Department notes, however, that a transaction effectuated through the Liquidnet System will not be considered "blind” if, prior to the execution of such transaction, the plan fiduciary responsible for the plan's engagement in the transaction knew, or had reason to know, the identity of the counterparty to such transaction. Given the ability of parties to a transaction to disclose their identities to each other, persons trading on behalf of employee benefit plans should be particularly careful to make sure the transaction is truly blind. Moreover, these determinations assume that such purchase and sale transactions did not arise in connection with any arrangement, agreement, or understanding designed to benefit the fiduciary (including an affiliate thereof) or any other party in interest to the plan.

In addition, with respect to the arrangement and transactions described above, ERISA's general standards of fiduciary conduct apply to: (i) the determination to buy or sell a particular equity security (and, in addition, the determination as to the appropriate purchase or sale price for such security); and (ii) the determination as to which trading system should be used to assist with the purchase or sale of equity securities.(5) In this regard, as noted above, section 404 of ERISA requires a fiduciary to discharge his duties respecting a plan solely in the interest of the plan's participants and beneficiaries. This section also requires that a plan fiduciary act prudently and for the exclusive purpose of: providing benefits to plan participants and their beneficiaries; and defraying reasonable expenses of administering the plan. Accordingly, plan fiduciaries that subscribe to Liquidnet must consider the costs associated with the use of alternative trading systems as well as the potential revenue returns, discounts, and other benefits that result from the continuing use of particular alternative trading systems over other similar services.

Further, prior to a plan fiduciary’s decision to execute a securities transaction through Liquidnet, the plan fiduciary (as a subscriber or an affiliate of a subscriber) should determine whether any existing or potential conflicts of interest or prohibited transactions under ERISA would interfere with the proper exercise of any of the fiduciary’s responsibilities under section 404 of ERISA, including the duty to act solely on behalf of the plan.

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 10 relating to the effect of advisory opinions. The opinion only relates to the specific issues raised by your request. For example, you have not asked and the Department is expressing no opinion with respect to the fees and other compensation received by persons engaging in transactions on the Liquidnet System on behalf of plans.

Sincerely,

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

Footnotes

  1. Under Reorganization Plan No. 4 of 1978, 43 FR 47713 (5 U.S.C. App. 1 [1996]), the authority of the Secretary of the Treasury to issue rulings under section 4975 of the Code has been transferred, with certain exceptions not here relevant, to the Secretary of Labor. 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.
  2. Accordingly, you state that Liquidnet does not "solicit" subscriber interest with respect to the buying or selling of securities (i.e., once a subscriber notifies Liquidnet that it has an interest in buying or selling a security, the Liquidnet System does not thereafter broadcast that interest to all of the other Liquidnet subscribers).
  3. You state that in the future, the percentage of successful negotiations attributable to each respective subscriber may also affect the ordering of a multiple subscriber list.
  4. You note, however, that subscribers using the system to negotiate a securities transaction may "chat" with each other. In this regard, you state that although the Liquidnet System does not disclose the identities of negotiating subscribers to each other, two such subscribers may electronically correspond to each other, without restriction as to content, through the Liquidnet System as part of the negotiation. You note that this type of correspondence is reviewed and retained by Liquidnet.
  5. Whether, in light of all the facts and circumstances, a purchase or sale of securities or the use of a particular service provider satisfies the fiduciary responsibility provisions of ERISA is an inherently factual question 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).

2004-7A    Non-depository, state chartered trust company

2004-07A
ERISA Sec. 412

July 1, 2004

William A. Mrozowski
President and Chief Executive Officer
First Commonwealth Trust Company
614 Philadelphia Street
Indiana, PA 15701-0400

Dear Mr. Mrozowski:

This is in response to your request for an advisory opinion regarding the application of section 412 of Title I of the Employee Retirement Income Security Act of 1974 (ERISA). Specifically, you ask whether the First Commonwealth Trust Company (FCTC) is exempt from ERISA’s fidelity bonding requirement pursuant to the statutory exemption in section 412(a)(2) of ERISA with respect to plans for which FCTC acts in a fiduciary capacity. You also ask whether FCTC would be covered by the regulatory exemption in 29 C.F.R. §§ 2580.412-27 and 412-28 applicable to certain banking institutions and trust companies subject to federal regulation.

The correspondence and materials you forwarded contain the following facts and representations. FCTC is a corporation that has operated as a trust company in the State of Pennsylvania since 1991, and it is authorized to exercise trust powers under a non-deposit trust bank charter from Pennsylvania. Although FCTC is not itself a member of the Federal Reserve System, it is a wholly owned subsidiary of First Commonwealth Financial Corporation (“First Commonwealth”), a bank holding company. Further, an affiliate of FCTC, another wholly owned subsidiary of First Commonwealth, is a state-chartered member bank of the Federal Reserve System. First Commonwealth is subject to supervision and examination by the Federal Reserve System pursuant to the Bank Holding Company Act. You represent that FCTC is subject to examination and supervision by Pennsylvania banking regulators under state law and by the Federal Reserve System pursuant to section 5 of the Bank Holding Company Act, 12 U.S.C. § 1844, which provides the Federal Reserve System with the authority to supervise and examine subsidiaries of bank holding companies.(1) You represent that the Federal Reserve Bank of Cleveland in fact periodically examines FCTC. You further represent that FCTC has over $1 million in capital and surplus, and has fidelity bonding coverage that would satisfy the bonding coverage required for First Commonwealth under federal banking law.

Section 412 of ERISA, subject to certain exceptions, requires that every fiduciary of an employee benefit plan and every person who handles funds or other property of such a plan shall be covered by a fidelity bond that meets the requirements of section 412 of ERISA and the Department of Labor’s implementing regulations. Section 412(a)(2) provides, in relevant part, that no bond shall be required of a fiduciary (or of any director, officer, or employee of such fiduciary) if such fiduciary – (A) is a corporation organized and doing business under the laws of the United States or of any State; (B) is authorized under such laws to exercise trust powers or to conduct an insurance business; (C) is subject to supervision or examination by Federal or State authority; and (D) has at all times a combined capital and surplus in excess of such a minimum amount as may be established by regulations issued by the Secretary, which amount shall be at least $1,000,000.(2)

Section 412(a)(2) of ERISA further provides that the exemption for such fiduciaries shall apply to a bank or other financial institution which is authorized to exercise trust powers and the deposits of which are not insured by the Federal Deposit Insurance Corporation (FDIC), “only if such bank or institution meets bonding or similar requirements under State law which the Secretary [of Labor] determines are at least equivalent to those imposed on banks by Federal law.” The Secretary has not made any determinations as to whether any state bonding or similar requirements are at least equivalent to those imposed on banks by federal law. The statutory exemption in section 412(a)(2) thus is not available to any bank or other financial institution authorized to exercise trust powers that has deposits that are not insured by the FDIC. It is the view of the Department, however, that banks and other financial institutions that have no deposits, such as FCTC, are not subject to this additional condition. Accordingly, based on your representations that FCTC satisfies all of the other conditions in section 412(a)(2), FCTC would satisfy the conditions for the exemption in section 412(a)(2) of ERISA with respect to the ERISA-covered plans for which FCTC acts in a fiduciary capacity.

The Department has also promulgated regulations under section 412 of ERISA. The regulation at 29 C.F.R. § 2550.412-1 provides, in relevant part, that any plan official, as defined in section 412(a), shall be deemed to be in compliance with the bonding requirements of ERISA if he or she is exempt from such bonding requirements under an exemption in Part 2580 of Title 29 of the Code of Federal Regulations.(3) The regulations at 29 C.F.R. §§ 2580.412-27 and 412-28 provide “banking institutions and trust companies subject to regulation and examination by the Comptroller of the Currency or the Board of Governors of the Federal Reserve System, or the Federal Deposit Insurance Corporation” with an “exemption from the bonding requirements” in sections 412(a) and (b) of ERISA.(4)

In the view of the Department, the authority of the Federal Reserve System over FCTC as a subsidiary of a bank holding company pursuant to the Bank Holding Company Act constitutes regulation and examination by the Board of Governors of the Federal Reserve System within the meaning of 29 C.F.R. §§ 2580.412-27 and 412-28.(5) Accordingly, based on the facts and representations you supplied, it is the opinion of the Department that FCTC would also be exempt under 29 C.F.R. §§ 2580.412-27 and 412-28 from being bonded under Title I in connection with its handling of plan funds or other property of ERISA-covered welfare and pension plans.

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

Sincerely,

John J. Canary
Chief, Division of Coverage, Reporting and Disclosure
Office of Regulations and Interpretations

Footnotes

  1. 12 U.S.C. § 1844(c) provides in relevant part: “(1) Reports (A) In general – The Board, from time to time, may require a bank holding company and any subsidiary of such company to submit reports under oath to keep the Board informed as to – (i) its financial condition, systems for monitoring and controlling financial and operating risks, and transactions with depository institution subsidiaries of the bank holding company; and (ii) compliance by the company or subsidiary with applicable provisions of this chapter or any other Federal law that the Board has specific jurisdiction to enforce against such company or subsidiary. . . . (2) Examinations (A) Examination authority for bank holding companies and subsidiaries – Subject to subparagraph (B), the Board may make examinations of each bank holding company and each subsidiary of such holding company in order – (i) to inform the Board of the nature of the operations and financial condition of the holding company and such subsidiaries; (ii) to inform the Board of – (I) the financial and operational risks within the holding company system that may pose a threat to the safety and soundness of any depository institution subsidiary of such holding company; and (II) the systems for monitoring and controlling such risks; and (iii) to monitor compliance with the provisions of this chapter or any other Federal law that the Board has specific jurisdiction to enforce against such company or subsidiary and those governing transactions and relationships between any depository institution subsidiary and its affiliates.”
  2. In the absence of regulations setting higher capital and surplus requirements under section 412(a)(2) of ERISA, the requisite amount to be eligible for the exemption is the $1,000,000 minimum provided in the statute.
  3. 29 C.F.R. §2550.412-1, pending issuance of permanent bonding regulations implementing section 412 of ERISA, incorporates by reference most of the bonding regulations issued under the predecessor statute, the Welfare and Pension Plans Disclosure Act (the WPPDA) and makes them applicable to plan officials under ERISA.
  4. Sections 2580.412-27 and 412-28 provide an exemption from the “bonding requirements” in section 412(a) and (b) of ERISA, but not from the section 412(b) prohibition on any plan official, or any other person having the authority to direct the receipt, handling, disbursement, or other exercise of custody or control of any of the funds or other property of any employee benefit plan, from directing that such functions be performed by any plan official with respect to whom the requirements of subsection 412(a) have not been met.
  5. You represent that FCTC is neither a registered investment advisor nor a broker-dealer that would be a “functionally regulated subsidiary” of a bank holding company within the meaning of the Bank Holding Company Act. We express no opinion in this letter regarding the applicability of the bonding exemption in 29 C.F.R. §§ 2580.412-27 and 412-28 to entities that are “functionally regulated subsidiaries” within the meaning of the Bank Holding Company Act.

2004-09A    Concerning the application of the prohibited transaction provisions under section 4975(c) of the IRC

2004-09A
Code Sec. 4975(c)

December 22, 2004

Thomas G. Schendt, Esq.
Alston & Bird LLP
601 Pennsylvania Avenue, N.W.
North Building, 10th Floor
Washington, DC 20004-2601

Dear Mr. Schendt:

This is in response to your request for an advisory opinion from the U.S. Department of Labor (the Department) concerning the application of the prohibited transaction provisions under section 4975(c) of the Internal Revenue Code of 1986, as amended (the Code), to certain contributions to health savings accounts (HSAs), as described below.(1)

You represent that your client, an insurer (the Company) and its affiliates, offers various health benefit plans in the individual market, including high deductible health plans (HDHPs), as that term is defined in section 223(c)(2) of the Code. In addition, the Company either offers HSAs, as defined in section 223(d) of the Code, to individuals covered by HDHPs issued by the Company, or enters into a contractual arrangement with a specified bank that will offer HSAs to such individuals, as described below.

Your letter contains the following facts and representations.

Factual Scenario I

Under Factual Scenario I, only persons insured under HDHPs issued by the Company in the individual market are able to establish HSAs with the Company. However, a person does not have to establish an HSA with the Company to participate in an individual HDHP with the Company. If a person establishes an HSA with the Company, the Company will serve as both the trustee or custodian and the record-keeper of the HSA. The Company does not provide HSA custodial services in the employer group market.

To encourage participation in the Company’s HSA program, the Company will offer an incentive to a person who establishes an HSA with the Company when he or she first enters into an individual HDHP with the Company. This incentive will be in the form of a $100 cash credit by the Company, as trustee or custodian, directly to the individual’s HSA. This credit to the HSA will be automatic. The account holder will not be required to make any contribution to his or her HSA to receive the credit to his or her HSA. The credit is dependent on the establishment of an HSA with the Company. The account holder will not be able to divert the money to himself or herself before it is credited to the HSA.

If the person does not establish an HSA with the Company, he or she will not receive any incentive from the Company under this incentive program. Thus, for example, the individual will not receive any incentive from the Company in the form of a credit to an HSA not provided by the Company or in the form of money paid to him or her outside of the HSA. The credit to the account holder’s HSA with the Company will be subject to the statutory requirements for HSAs set forth in section 223 of the Code, and the tax treatment of any distributions from the HSA attributable to this credit will be governed by the provisions of section 223(f) of the Code.

With respect to each HSA established with the Company pursuant to this incentive program, the Company represents that any arrangement for services by the Company to the HSA (e.g., as trustee or custodian and/or record-keeper of the HSA) will meet the requirements of section 4975(d)(2) of the Code and the Treasury’s regulations at 26 CFR §54.4975-6.

The Company represents that the premiums payable under the HDHP will not vary based on the individual’s choice of HSA custodian or trustee. Thus, the individual’s insurance premiums will not be higher or lower as a result of his or her decision to establish an HSA either with the Company or with some other custodian or trustee. The Company also represents that any administrative fees the Company may charge the account holder with respect to his or her HSA will not change (i.e., will not increase or decrease) as a result of the credit to his or her HSA.

The Company states that although the duration of this incentive program has not been determined, it envisions that the incentive program could be used at various times for specified periods of time. The Company also anticipates that the amount of the incentive could change from time to time. However, for purposes of this request, the Company represents that the amount of the incentive will not exceed $100 per person.

Factual Scenario II

Under Factual Scenario II, the Company and its affiliates offer various health benefit plans in the group market, including HDHPs as defined under the Code.

The Company enters into a contractual relationship with a specified bank (the Bank) to provide HSAs for individuals covered by HDHPs issued by the Company. However, an individual does not have to establish an HSA with the Bank to participate in a group HDHP issued by the Company. The Bank serves as the trustee or custodian and the record-keeper of those HSAs and receives remuneration from the Company for its services in that regard. The Company also enters into a contractual relationship with a specified entity (the Vendor) to provide various services in relation to these HSAs, for which the Company compensates the Vendor. Neither the Bank nor the Vendor is a member of the Company’s controlled group under sections 414(b), (c) and (m) of the Code.

To encourage the establishment of HSAs with the Bank in connection with group HDHPs issued by the Company, the Bank will offer an incentive to a person who establishes an HSA with the Bank when the Company first covers such person under a group HDHP. This incentive will be in the form of a $100 cash credit from the Bank directly to the individual’s HSA. This credit to the HSA will be automatic. The account holder will not be required to make any contribution to his or her HSA to receive the credit to his or her HSA. The credit will be dependent on the establishment of an HSA with the Bank. The account holder will not be able to divert the money to himself or herself before it is credited to the HSA.

If the person does not establish an HSA with the Bank, he or she will not receive any incentive from the Bank under this incentive program. For example, the individual will not receive any incentive from the Company or the Bank in the form of a credit to an HSA not provided by the Bank or in the form of money paid to him or her outside of his or her HSA. The credit to the account holder’s HSA with the Bank will be subject to the statutory requirements for HSAs set forth in section 223 of the Code, and the tax treatment of any distributions from the HSA attributable to this credit will be governed by the provisions of section 223(f) of the Code.

With respect to the HSAs established with the Bank pursuant to this incentive program, the Company, the Bank and the Vendor intend that any arrangements for services by the Bank or the Vendor to the HSA (e.g., as the trustee or custodian and/or record-keeper of the HSA) will meet the requirements of section 4975(d)(2) of the Code and the Treasury’s regulations at 26 CFR §54.4975-6.(2)

The Company represents that the premiums charged for the individual’s coverage under the group HDHP will not vary based on the individual’s choice of HSA custodian or trustee. Thus, the premiums charged by the Company for the individual’s coverage under the group HDHP will not be higher or lower as a result of his or her decision to establish an HSA either with the Bank or with some other custodian or trustee. In addition, any administrative fees the Bank or the Vendor may charge the account holder with respect to his or her HSA will not change (i.e., will not increase or decrease) as a result of this credit to his or her HSA.

The Company states that although the duration of this incentive program has not been determined, it envisions that the incentive program could be used at various times for specified periods of time. The Company also anticipates that the amount of the incentive could change from time to time. However, for purposes of this request, the Company represents that the amount of the incentive will not exceed $100 per person.

Advisory Opinions Requested

With respect to Factual Scenario I, you have requested an advisory opinion that the credit to an account holder’s HSA will not constitute a prohibited transaction under section 4975(c) of the Code for either the account holder or the Company.

In addition, with respect to Factual Scenario II, you have requested an advisory opinion that the credit to an account holder’s HSA will not constitute a prohibited transaction under section 4975(c) of the Code or section 406 of the Employee Retirement Income Security Act of 1974, as amended (ERISA).

Prohibited Transactions under the Internal Revenue Code

Section 4975(e)(1)(E) of the Code defines the term “plan” to include “…a health savings account described in section 223(d)” of the Code.

A “prohibited transaction” under section 4975(c)(1) of the Code includes, among other things, any direct or indirect:

(A) sale or exchange, or leasing, of any property between a plan and a disqualified person;

(C) furnishing of goods, services, or facilities between a plan and a disqualified person;

(D) transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a plan;

(E) act by a disqualified person who is a fiduciary whereby he deals with the income or assets of a plan in his own interest or for his own account; or

(F) receipt of any consideration for his own personal account by any disqualified person who is a fiduciary from any party dealing with the plan in connection with a transaction involving the income or assets of the plan.

A “disqualified person” is defined under section 4975(e)(2) of the Code, in pertinent part, to include a person who is a fiduciary or a person providing services to the plan.

Analysis of Factual Scenarios I and II

Under Factual Scenario I, the Company will be a trustee or custodian of the HSA. As such, the Company would be a disqualified person with respect to the HSA.

Under Factual Scenario II, the Bank will be a trustee or custodian of the HSA. As such, the Bank is a disqualified person with respect to the HSA. However, as we understand the facts, the Company would not be a disqualified person with respect to the HSA. In both scenarios, the account holder is a fiduciary and disqualified person with respect to the HSA.

Under both Factual Scenarios, the $100 credit proposed by either the Company or the Bank, respectively, would be a cash contribution to the account holder’s HSA. The Department notes that in accordance with IRS Notice 2004-50, Q&A 28, wherein it states that "any person . . . may make contributions to an HSA on behalf of an eligible individual," Code section 223 does not prohibit the Company or the Bank from making such contributions to its customers’ HSAs. A cash contribution to a plan is not generally a sale or exchange of property prohibited by section 4975(c)(1)(A) of the Code. Additionally, the cash contribution would not be a transfer of an asset of a plan for the benefit of a disqualified person or an act of self-dealing by either the Company or the Bank under section 4975(c)(1)(D) or (E) of the Code involving the assets of a plan. Therefore, neither the Company’s nor the Bank’s contribution of a cash credit to the account holder’s HSA, as described herein, would be a prohibited transaction under section 4975(c)(1) of the Code.(3)

Similarly, the HSA's receipt of the Company’s or the Bank’s contribution of a cash credit, under the facts described above, would not be an act of self-dealing on the part of the account holder nor a receipt by the account holder in his or her individual capacity of any consideration from a party dealing with the HSA in connection with a transaction involving assets of the HSA. Even though the Company or the Bank, respectively, would make the contribution as an incentive to encourage the account holder's participation in the Company’s or the Bank’s HSA program, the contribution goes to the HSA and not to the account holder.(4) Therefore, the receipt by the HSA of such cash contributions would not be a prohibited transaction under section 4975(c)(1) of the Code.(5)

Since the Company is not a disqualified person with respect the HSA under Factual Scenario II, the Bank’s contribution of the credit to the account holder’s HSA would not be a prohibited transaction under section 4975(c) of the Code with respect to the Company.

Finally, with respect to the contribution of any cash credits by the Bank to an account holder’s HSA under the facts described above, the same analysis and conclusions would apply, for purposes of the prohibited transaction provisions contained in section 406(a) and (b) of ERISA, to an HSA that would be an “employee benefit plan” covered under Title I of ERISA(6) under the principles discussed in the Department’s Field Assistance Bulletin (FAB) 2004-01 (April 7, 2004). Further, in such instances, the fiduciary responsibility provisions of Title I would apply to the selection of service providers to the HSA.

In discussing whether, and under what circumstances, HSAs established in connection with employment-based group health plans would be subject to the provisions of Title I of ERISA, FAB 2004-01 states that generally such HSAs would not constitute an “employee welfare benefit plan” as defined under section 3(1) of ERISA, if employer involvement with the HSA is limited. Specifically, HSAs meeting the conditions of the safe harbor for group or group-type insurance programs at 29 CFR §2510.3-1(j)(1)-(4) are not considered employee welfare benefit plans within the meaning of section 3(1) of ERISA. However, a finding that an HSA established by an employee is not covered by ERISA does not affect whether an HDHP sponsored by the employer is itself a group health plan subject to Title I. In fact, FAB 2004-01 states that unless otherwise exempt from Title I (e.g., governmental plans, church plans), employer-sponsored HDHPs will be “employee welfare benefit plans” within the meaning of section 3(1) of ERISA and, thus, subject to the fiduciary responsibility provisions of Title I.

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

Sincerely,

Louis J. Campagna
Chief, Division of Fiduciary Interpretations
Office 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 has been transferred, with certain exceptions not here relevant, to the Secretary of Labor. See 5 USC App. at 214 (2000 ed.).
  2. The Company is not requesting, and the Department is not providing, an opinion as to whether any arrangement for services by the Company, the Bank or the Vendor to an HSA will satisfy the requirements necessary for relief under section 4975(d)(2) of the Code and the regulations relating thereto. In this regard, the Department ordinarily does not issue advisory opinions on questions that are inherently factual in nature.
  3. With respect to contributions or transfers of property to a plan that are considered to be an “exchange,” see Adv. Op. 81-69A (July 28, 1981) and the Department’s Interpretative Bulletin at 29 CFR 2509.94-3, relating to in-kind contributions to employee benefit plans.
  4. This distinguishes the arrangement from others that have been found to involve prohibited transactions. See Adv. Op. 89-12A (July 14, 1989)(personal receipt of “free checking” account services by a customer from a bank in connection with the investment of assets of the customer’s individual retirement account (IRA) in the bank’s financial products would constitute a violation of section 4975(c)(1) of the Code.) See also PTE 93-33, 58 Fed. Reg. 31053 (May 28, 1993) (exempting certain arrangements benefiting an IRA account holder).
  5. This advisory opinion does not address payments to the individual account of any person who is a disqualified person for reasons other than as the account holder of an HSA.
  6. Section 3(3) of ERISA defines the term “employee benefit plan” or “plan” as an employee welfare benefit plan (see section 3(1) of ERISA) or an employee pension benefit plan (see section 3(2) of ERISA) or a plan which is both an employee welfare benefit plan and an employee pension benefit plan.

2005-04A    Whether a plan may invest in a mutual fund

2005-04A
ERISA Sec. 406(b)

March 25, 2005

Ms. Norma M. Sharara
Buchanan Ingersoll, PC
1776 K Street, NW, Suite 800
Washington, DC 20006-2365

Dear Ms. Sharara:

This is in response to your request for guidance under the Employee Retirement Income Security Act of 1974 (ERISA). In particular, you request an advisory opinion that the proposed investment of assets of an employee retirement plan (the Plan) in a mutual fund (the Fund) will not constitute a per se prohibited transaction under section 406 of ERISA.(1) The Plan is sponsored by a foundation (the Foundation) and the Fund is a registered open-ended investment company that is advised and distributed by an investment advisor (the Advisor).

You represent that the Foundation is a tax-exempt organization described in Code section 501(c)(3). The Foundation was organized under Ohio law as a non-profit corporation, and its principal place of business is currently located in New York City. The Foundation has functioned as a private foundation whose principal purpose is to support other operating charitable organizations. It is exempt from federal income taxation and has been classified by the Internal Revenue Service (IRS) as a private foundation under Code section 509. As of December 31, 2002, the Foundation had approximately $305,000,000 in assets. The Foundation, in keeping with the wishes of its founder is time-limited, and expects to disburse substantially all of its assets by 2010.

Because the Foundation expects to bring its operations to a close by 2010, the level of grant-making will accelerate significantly in the coming years. Prior to 2002, the Foundation did not have any paid staff. The Foundation hired nine individuals in 2002 essentially to prepare for and carry out the increased grant-making activities that the Foundation expects to occur between 2002 and 2010 as the Foundation winds down its activities and operations. The Plan was established in 2002 on behalf of these nine employees.

The Foundation is governed by a three-person board of trustees (the Board), none of whom are currently employees of the Foundation or participants in the Plan. One trustee also serves as the chief executive officer of the Foundation, and will soon become an employee of the Foundation. Another trustee serves as a vice-president of the Foundation.

The Plan is a defined contribution plan covering nine participants and is intended to qualify under Code section 401(a). As of December 31, 2002, the Plan had net assets of $163,652. Investment decisions for the plan are made by the Foundation. The Foundation is also the plan administrator and named fiduciary of the Plan. The Board, as the decision-maker for the Foundation, carries out the Foundation’s fiduciary responsibilities on behalf of the Plan. The Board also serves as the Plan’s trustee, in which capacity it is subject to direction by the Foundation. The Board has determined to allocate the Plan’s investments equally between equity and interest-bearing securities.

The Fund invests primarily in common stocks and is managed using a “value” strategy. The Fund has consistently outperformed its benchmark, the S&P 500 Index, over the last 10 years. A trustee and member of the Board is the President and Chief Executive Officer of the Advisor. He also holds a 22.9% ownership interest in the Advisor. Neither the Foundation nor any of the other trustees holds any ownership interest in, or has any other relationship with, the Advisor. The Board proposes to invest up to 25% of the Plan’s assets in the Fund. The remaining allocation to equity securities will be invested in other mutual funds that are unrelated to the Advisor. The Board has determined that this allocation would be consistent with the Plan’s investment policy.

This trustee is also one of three Advisor portfolio managers charged with day-to-day management of the Fund’s assets. The Fund pays the Advisor an annual investment advisory fee of 1% of the Fund’s net asset value, reduced by certain expenses that the Advisor reimburses to the Fund. The Fund’s independent Board of Directors is responsible for approving the investment advisory agreement between the Fund and the Advisor. The Fund imposes no sales charges, exchange fees, or redemption fees.

You represent that the trustee’s compensation for his services on behalf of the Advisor is not affected by the total amount of assets under management by the Fund. As of December 31, 2002, the Fund held net assets of approximately $3.9 billion.

You request an opinion that the Plan’s investment of up to 25% of its assets in the Fund will not result in a prohibited transaction under section 406 of ERISA.

Section 3(21) of ERISA provides that a person is a fiduciary with respect to a plan to the extent he exercises any discretionary authority or control respecting the management of the plan or the management or disposition of the assets of the plan. A plan’s administrator and named fiduciary by virtue of having those positions, must have or exercise discretionary authority or control respecting the management of the plan or the management or disposition of its assets.(2) The Foundation is the Plan’s administrator and named fiduciary. The Board exercises the Foundation’s fiduciary responsibilities on behalf of the plan. Accordingly, all trustees and members of the Board are fiduciaries with respect to the Plan.

Section 406(b)(1) of ERISA prohibits a fiduciary from dealing with the assets of the plan in his own interest or for his own account. Section 406(b)(2) of ERISA prohibits a fiduciary with respect to a plan from acting 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 of its participants and beneficiaries.

The Department has explained in regulation 29 CFR §2550.408b-2(e) that the prohibitions of section 406(b) are imposed upon fiduciaries to deter them from exercising the authority, control, or responsibility that makes them fiduciaries when they have interests that may conflict with the interests of the plans for which they act. Thus, a fiduciary may not use the authority, control, or responsibility that makes him a fiduciary to cause a plan to pay an additional fee to such fiduciary, or to a person in which he has an interest that may affect the exercise of his best judgment as a fiduciary, to provide a service. However, regulation 29 CFR §2550.408b-2(e)(2) provides that a fiduciary does not engage in an act described in section 406(b)(1) of ERISA if the fiduciary does not use any of the authority, control, or responsibility that makes him 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 the fiduciary has an interest that may affect the exercise of his judgment as a fiduciary.

One member of the Board and trustee of the Plan is a significant owner and the President and Chief Executive Officer of the Advisor, the investment advisor for the Fund. In addition, he is one of the portfolio managers of the Fund, involved in the day-to-day operation of the Fund. It is the opinion of the Department that based on these factors, taken together, this trustee has an interest in the Fund that may affect his best judgment as a fiduciary of the Plan regarding the decision whether to invest Plan assets in the Fund. Accordingly, if that trustee uses any of the authority, control, or responsibility that makes him a fiduciary to cause the Plan to invest in the Fund, the trustee will engage in a violation of section 406(b)(1) and 406(b)(2).

The Department has stated in other situations involving a fiduciary who has this type of conflict of interest that the fiduciary can avoid engaging in a transaction described in section 406(b)(1) and 406(b)(2) of ERISA by removing himself from all consideration of the transaction in question, and not exercising any of the authority, control, or discretion that makes him a fiduciary to cause the plan to enter into the transaction, as long as there is no arrangement, agreement, or understanding regarding the proposed transaction.(3) We note, however, that if a fiduciary has or obtains material information, including information regarding plan investments, that would be necessary in order for other plan fiduciaries to make an appropriate and prudent decision with respect to the purchase, holding, or disposition of a particular investment, we believe the fiduciary’s duties under section 404 of ERISA would require informing the deciding fiduciaries of that information.(4)

ERISA's general standards of fiduciary conduct also would apply to the proposed investment. Under section 404(a)(1), the responsible Plan fiduciaries must act prudently and solely in the interest of the Plan participants and beneficiaries in deciding whether to make an investment of Plan assets in the Fund.

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 10 relating to the effect of advisory opinions.

Sincerely,

Louis J. Campagna
Chief, Division of Fiduciary Interpretations
Office of Regulations and Interpretations

Footnotes

  1. Under Reorganization Plan No. 4 of 1978 (43 FR 47713, October 17, 1978), the authority of the Secretary of the Treasury to issue rulings under section 4975 of the Internal Revenue Code (the 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 should be taken as referring also to the corresponding sections of the Code.
  2. See, Interpretive Bulletin 75-8, D-3 (29 CFR 2509.75-8, D-3)
  3. See, Advisory Opinion 99-09A (May 21, 1999) and Advisory Opinion 79-72A (October 10, 1979)
  4. We offer no opinion on the impact that insider-trading rules under the Federal securities laws may have on the dissemination of such information to other fiduciaries. Such rules are under the jurisdiction of the Securities and Exchange Commission.

2005-09A    Whether in-kind investments in a bank collective investment fund are covered by ERISA section 408(b)(8)

2005-09A
ERISA Sec. 408(b)(8)

May 11, 2005

Donald J. Myers, Esq.
Reed Smith LLP
1301 K Street, NW, Suite 1100 East Tower
Washington, DC 20005-3373

Dear Mr. Myers:

This is in response to your request for an advisory opinion on behalf of Vanguard Fiduciary Trust Company (Vanguard) concerning the application of section 408(b)(8) of the Employee Retirement Income Security Act of 1974, as amended (ERISA), and the parallel provisions under section 4975(d)(8) of the Internal Revenue Code of 1986, as amended (the Code),(1) to an in-kind investment in a bank collective investment fund, as made under the circumstances described herein.

Background

You represent that Vanguard is a trust company, based in Valley Forge, Pennsylvania, that is organized under the laws applicable to such entities under the Pennsylvania Banking Code. Vanguard is supervised by the Pennsylvania Department of Banking. Vanguard is a wholly-owned subsidiary of The Vanguard Group, Inc. (Vanguard Group).

The Vanguard Group manages assets through registered open-end investment companies, pursuant to the Investment Company Act of 1940 (i.e., mutual funds). Vanguard manages assets held in collective trust funds for employee benefit plans covered by ERISA. You state that many Vanguard Group mutual funds and Vanguard trust funds serve as investment options for participant-directed individual account plans, organized to comply with section 401(k) of the Code (“401(k) plans”), and as investments for other qualified retirement plans.

Vanguard structures stable value investment options, designed to allow investors to receive current interest income and preserve principal amounts, for many 401(k) plans either using a commingled trust, or as a separately managed account for a particular plan. You state that over 900 plans use the commingled trust structure, and approximately 40 are using the stable value separate account structure (referred to collectively herein as “stable value portfolios”).

The commingled trust structure uses a collective investment vehicle, the VRST Master Trust. Plans do not hold interests directly in the VRST Master Trust, but instead invest in one of seven “feeder” trusts – the Retirement Savings Trusts – that invest all of their assets in the VRST Master Trust. Investment management fees are imposed at the “feeder” trust level.

The commingled trusts used by Vanguard take the form of collective investment funds intended to qualify as group trusts, pursuant to Revenue Ruling 81-100, 1981-1 C.B. 326, and Revenue Ruling 2004-67, 2004-28 I.R.B., that are tax exempt under section 401 and 501(a) of the Code. Vanguard serves as trustee for such commingled trusts.

Plans pay fees to Vanguard only at the level of the stable value investment portfolio in which the plan directly invests. This is the level of the separately managed account or, with respect to the VRST Master Trust, the “feeder” trust level.

Vanguard’s stable value portfolios (i.e., the commingled trusts or the separately managed accounts) currently invest in, among other things, a series of fixed-income commingled trusts, the Vanguard Targeted Return Trusts (the TRTs). The TRTs were established quarterly on a rolling basis, each with a 5-year term, and managed to a constantly decreasing duration to provide liquidity at the end of the 5-year term. At any one time, there would be 20 TRTs in existence with durations ranging from one quarter of a year to 5 years. Each quarter, one TRT would expire and a new one would be created. The stable value portfolios managed by Vanguard, including the VRST Master Trust, have invested in the various TRTs based on their available cash, other investments and liquidity needs. The VRST Master Trust holds the majority of the assets of each TRT.

You state that Vanguard created the TRTs as stable value portfolios with high-quality fixed income securities with fixed maturity dates. These securities were then backed by “wrap” contracts with insurance companies or banks to provide for certain disbursements to be made at the “book” value of the assets, rather than the market value. This structure is commonly referred to as a “synthetic” guaranteed investment contract arrangement.

You represent that for various reasons related to investment management strategies and cost efficiencies, Vanguard has begun to phase out the TRT program. As the existing TRTs mature, they are being replaced by investments in two commingled trusts of comparable aggregate duration – the Vanguard Intermediate-Term Bond Trust (ITBT), and the Vanguard Short-Term Bond Trust (STBT). These trusts (collectively, the Bond Trusts), like the TRTs, invest principally in high-quality fixed-income securities.

As a means of transitioning to the new investment management structure, and more quickly realizing the efficiencies and other benefits of managing assets through the Bond Trusts rather than the existing TRTs, Vanguard would like to transfer the assets of the TRTs in-kind to the Bond Trusts as soon as possible, and then terminate the TRTs.

Specifically, TRT securities would be allocated to the Bond Trusts based on the TRTs’ average durations. Each TRT would receive in return interests in the applicable Bond Trust – i.e., the STBT or ITBT – that are equal in value to the value of the securities it transferred to the respective Bond Trust. The same business day, the TRT would distribute those Bond Trust interests to each stable value portfolio that holds interests in the TRT, in proportion to the portfolio’s TRT interests, and then terminate. At the end of the business day, each stable value portfolio would hold Bond Trust interests equal in value to its former TRT interests.

The principal advantage of liquidating the TRTs through in-kind exchanges of securities for interests in the Bond Trusts, as opposed to liquidations for cash on the open market, would be to avoid transaction costs. The total transaction cost estimates are in the range of $5.4 million as existing TRTs have securities with an estimated market value of approximately $3.4 billion. In addition, Vanguard seeks to avoid the possibility of the Bond Trusts not acquiring the same securities on the open market that are sold by the TRTs.

You represent that the trust documents for the TRTs and the Bond Trusts provide the necessary authority for Vanguard to cause the TRTs to make an in-kind investment in the Bond Trusts. You state that the TRTs, by their terms, permit investment in a collective investment fund maintained by the trustee of the TRTs (i.e., Vanguard), where the fund invests principally in securities of the type in which the TRT is permitted to invest. Specifically, Article 6.1(a) of each TRT gives the trustee the authority, in its sole discretion, “to invest and reinvest the Trust in such investments and other property, without restrictions to investments authorized for fiduciaries, as the Trustee determines in accordance with the Trust’s investment objective as set forth in Article 1.2 …, including, without limitation, (i) any other collective investment trust maintained by the Trustee…”

Your represent further that the trust documents for the Bond Trusts permit investment by any common, collective or commingled trust fund or group trust that consists solely of the assets of pension, profit-sharing and other qualified plans, and/or other types of retirement plans or vehicles holding retirement plan assets. Under Article 1.02 of the STBT and Article 2.2 of the ITBT, an investment in units of the respective Trust may be made in the form of cash, or in the form of other property acceptable to the trustee.

For purposes of the in-kind investments by the TRTs in the Bond Trusts, you state that the assets being transferred would be valued in a consistent manner by both the investing and receiving trusts, using independent pricing sources.

Specifically, for valuing fixed-income securities, Vanguard uses the same pricing services for both the TRTs and the Bond Trusts. Where none of the pricing services used makes a value available for a particular security, or where there has been a significant change in value of the security from the previous price used (i.e., greater than 1%), Vanguard will obtain quotations from three (3) different independent brokers, and will use the lowest of the three available quotes. You state that pricing services and broker quotations are not used for short-term instruments maturing within 60 days. Thus, pursuant to the trust document’s valuation provisions, these instruments would be valued at cost (plus or minus any amortized discount or premium). All valuations would be made as of 3:00 p.m. Eastern Time on the valuation date.

Vanguard serves as trustee of both the TRTs and the Bond Trusts – all of which, as bank collective investment funds, are deemed to hold “plan assets” subject to ERISA pursuant to the Department’s regulations (see 29 CFR §2510.3-101(h)(1)(ii)). For this reason, you state that Vanguard would find itself acting in a discretionary role on both sides of any transaction between the TRTs and the Bond Trusts. Thus, the in-kind investment by the TRTs in the Bond Trusts could be viewed as a sale by the TRTs of their securities to the Bond Trusts, with Vanguard, in its capacity as trustee, acting in the role of both the buyer and the seller.

Advisory Opinion Requested

You request an opinion as to whether a purchase of interests in a collective investment fund through an in-kind investment of securities would be exempt from the prohibited transaction provisions of section 406 of ERISA by reason of the statutory exemption contained in section 408(b)(8) of ERISA.

Relevant Provisions of ERISA and Analysis

Section 406(a)(1) of ERISA provides, in part, that a fiduciary with respect to a plan shall not cause the plan to engage in certain direct or indirect transactions with a party in interest, including sales or exchanges of property between the plan and a party in interest (section 406(a)(1)(A)), and transfers to or use by or for the benefit of a party in interest of any assets of the plan (section 406(a)(1)(D)).

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)(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 3(21) of ERISA defines a “fiduciary” of a plan to include a person who exercises any discretionary authority or control respecting management or disposition of its assets; or who 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.

Section 3(14) of ERISA defines the term “party in interest” to include a fiduciary and a person providing services to a plan.

The Department’s regulation at 29 CFR §2510.3-101 defines what are considered to be “plan assets” when a plan invests in another entity. The regulation provides, at 29 CFR §2510.3-101(h)(1)(ii), that when a plan acquires an interest in a common or collective trust fund of a bank, its assets include its investment as well as an undivided interest in each of the fund’s underlying assets.

As you have acknowledged, Vanguard is a fiduciary under section 3(21) of ERISA with respect to ERISA-covered plans for which it serves as trustee. Pursuant to the Department’s regulations defining “plan assets” (as noted above), Vanguard is also a fiduciary for ERISA-covered plans that invest in the TRTs, either through separately managed accounts or commingled trusts, by reason of its discretionary authority and control over such assets. You indicate that Vanguard receives investment management fees from plans that invest in such accounts or trusts invested in the TRTs, at either the separate account or “feeder” trust level, as applicable.

Therefore, unless an exemption applies, you are concerned that Vanguard would violate sections 406(a)(1)(A), 406(a)(1)(D), 406(b)(1), and 406(b)(2) of ERISA if, as a fiduciary of ERISA-covered plans, it caused “plan assets” invested in the TRTs to be invested in the Bond Trusts.

Section 408(b)(8) of ERISA exempts, in pertinent part, any transaction between a plan and a common or collective trust fund maintained by a party in interest which is a bank or trust company supervised by a state or federal agency, if the following conditions are met:

  1. the transaction is a sale or purchase of an interest in the fund,
  2. the bank or trust company receives not more than reasonable compensation, and
  3. such 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) who has authority to manage and control the assets of the plan.

You represent that the TRTs and Bond Trusts are collective trust funds maintained by Vanguard, a trust company supervised by the Pennsylvania Department of Banking. The transactions at issue would be purchases of interests in the Bond Trusts, and would be authorized by the applicable trust documents relating to each TRT and Bond Trust. Vanguard would not be paid any separate fees by the Bond Trusts for the assets invested therein by the TRTs. You state that Vanguard’s existing fee arrangements with plans would remain unaffected by the proposed transactions and it would not receive more than reasonable compensation as a result of the transactions.

With respect to the conditions of ERISA section 408(b)(8), although the statutory provisions do not define the term “reasonable compensation” for purposes of the exemption, the ERISA Conference Committee Report (as issued by Congress in 1974) provides that:

“[t]o be allowed, no more than reasonable compensation may be paid by the plan in the purchase (or sale) and no more than reasonable compensation may be paid by the plan for investment management by the pooled fund.”

[See H.R. Rep. No. 93-1280, 93rd Cong., 2nd Sess., at 316 (1974)]

Thus, Congress anticipated that the term “reasonable compensation” would apply to the purchase or sale of an interest in a collective investment fund by a plan and to amounts to be paid by the plan for investment management of such assets.

In addition, with respect to covered transactions, the ERISA Conference Committee Report does not appear to distinguish cash from in-kind assets, nor does it specify a particular form of investment, with regard to any purchase or sale of interests or units in a common or collective investment trust fund, or pooled investment fund, maintained by a party in interest which is a bank or trust company. Furthermore, at the end of the relevant section discussing the provisions of ERISA section 408(b)(8), Congress expressed the view that, under the general fiduciary rules of ERISA, a bank “…cannot use pooled funds as a place to dump unwanted investments which were initially made on its own (or another’s behalf).” Id.

In this regard, by noting the possibility of a bank placing investments it previously had made into a collective investment fund, Congress appears to have anticipated in-kind investments being made into such a fund as a “purchase” covered by the statutory exemption.

Accordingly, it is the opinion of the Department that the statutory exemption provided under section 408(b)(8) of ERISA would permit an in-kind exchange of securities owned by a plan or fund holding “plan assets” for units or interests in a collective investment fund maintained by a bank or trust company, provided that the conditions necessary for relief as stated therein are met.(2) However, please note that the issue of whether all of the conditions of section 408(b)(8) will be met is a factual determination upon which the Department cannot opine. Therefore, the appropriate plan fiduciaries, including Vanguard, must determine, based on the particular facts and circumstances, whether the conditions of section 408(b)(8) will be met for the proposed in-kind exchanges.

In particular, the Department notes that the exemption provided in section 408(b)(8) is available for the proposed in-kind exchanges only if the valuation method used by Vanguard in connection with each transaction results in a plan paying no more than reasonable compensation for its investment. In our view, a plan would pay more than reasonable compensation in any in-kind exchange in which the value of assets transferred to a fund would be more than the value of the fund units or interests the plan received.

Therefore, the Department cautions Vanguard to ensure that appropriate procedures and safeguards are in place to guarantee uniform pricing of both the relevant “plan assets” in each TRT to be transferred to each Bond Trust and the Bond Trust’s units to be received by each plan’s stable value portfolio investment. As described herein, such investments would include the Retirement Savings Trusts that are “feeder” trusts for the VRST Master Trust, as managed by Vanguard on the date of the transactions.

Finally, the Department is providing no opinion herein as to Vanguard’s current or future stable value investment strategies, or courses of action to implement to such strategies (including methods for saving transaction costs or avoiding market impact).

Section 404(a)(1) of ERISA provides, in pertinent part, that fiduciaries shall discharge their duties with respect to a plan 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. Among other things, a fiduciary must give appropriate consideration to those facts and circumstances that, given the scope of such fiduciary’s investment duties, the fiduciary knows or should know are relevant to the particular investment or investment course of action involved, including the role the investment or investment course of action plays in that portion of the plan’s investment portfolio with respect to which the fiduciary has investment duties.(3)

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

Sincerely,

Louis J. Campagna
Chief, Division of Fiduciary Interpretations
Office of Regulations and Interpretations

Footnotes

  1. Under Reorganization Plan No. 4 of 1978, effective December 31, 1978 [5 USC App. at 214 (2000 ed.)], 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 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.
  2. See Adv. Op. 96-15A (Aug. 7, 1996), wherein the Department took the position that section 408(b)(8) of ERISA provides relief from sections 406(a)(1)(A), 406(a)(1)(D), 406(b)(1) and 406(b)(2) for the purchase or sale by a bank or trust company, as fiduciary of ERISA-covered plans, of interests in a collective fund so long as the conditions of the statutory exemption are met, including that the transaction be expressly permitted by the plan or an authorized independent fiduciary.
  3. The Department notes that regulation §2550.404a-1 defines appropriate considerations for an investment course of action by fiduciaries in such matters.

2006-01A    Whether a lease by a company (LLC) 49% owned by an IRA to a company (S)

2006-01A
ERISA Sec. 29 CFR 2509.75-2

Whether a lease by a company (LLC) 49% owned by an IRA to a company (S) which is a disqualified person with respect to that IRA is a prohibited transaction where the manager of the LLC is an officer of S. Whether 29 CFR 2509.75-2 makes the transaction an indirect prohibited transaction and whether it makes the transaction a violation of the Internal Revenue Code's exclusive benefit rule.

January 6, 2006
Debra C. Buchanan, Esq.
Guidant Legal Group, PLLC
225 Commerce Street, Suite 450
Tacoma, WA 98402

Dear Ms. Buchanan,

This is in response to your request for an advisory opinion as to whether the following proposed transaction would be prohibited under section 4975 of the Internal Revenue Code (the “Code”), 26 U.S.C. § 4975.(1)

You represent that Salon Services and Supplies, Inc. is a Washington state “S” Corporation (“S Company”) which is 68% owned by Miles and Sydney Berry, a marital community (M). The other 32% is owned by a third-party, George Learned (“G”). Miles Berry (Berry) proposes to create a limited liability corporation (“LLC”) that will purchase land, build a warehouse and lease the property to S Company. The investors in the LLC would be Berry’s individual retirement account (“IRA”) (49%), Robert Payne’s (“R”) IRA (31%) and G (20%). R is the comptroller of S Company. R and G will manage the LLC. You represent that S Company is a disqualified person with respect to Berry’s IRA under section 4975(e)(2) of the Code. You represent that R and G are independent of Berry. You also represent that the LLC does not contain plan assets because it is a “real estate operating company” (REOC) as defined by 29 C.F.R. § 2510.3-101(e).

You state that an independent qualified commercial real estate appraiser has appraised the rental value of the lease and has found that the terms of the lease are not less favorable to the LLC and its IRA investors than those obtainable in an arm’s length transaction between unrelated parties. Finally, the custodian for Berry’s and R’s IRAs has reviewed the LLC operating agreement and has approved the investment for those two self-directed IRAs.

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(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. A “disqualified person” is defined under section 4975(e)(2)(A) of the Code to include a person who is a fiduciary. Code section 4975(e)(3) defines the term “fiduciary” to include, in pertinent part, any person who exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets. Section 4975(c)(1)(E) prohibits a fiduciary from dealing with the income or assets of a plan in the fiduciary’s own interest or for his or her own account. Section 4975(e)(1)(B) of the Code defines the term “plan” to include an individual retirement account described in Code section 408(a).

We first address the proposed lease as it relates to Berry’s IRA. Berry is a fiduciary to his own IRA because he exercises authority or control over its assets and management. 26 U.S.C. § 4975(e)(3). As a fiduciary, Berry is a disqualified person under section 4975(e)(2)(A) of the Code. You represent that S Company is a disqualified person under section 4975(e)(2) of the Code. R, the comptroller of S Company, is a disqualified person with respect to Berry’s IRA under section 4975(e)(2)(H) as an officer of S Company. R, as an employee of S Company, a company 68% owned by M, cannot be considered independent of Berry.

Based upon your representations, it is the opinion of the Department that a lease of property between the LLC and S Company would be a prohibited transaction under Code section 4975, at least as to Berry’s IRA. The lease constitutes a prohibited transaction regardless of whether the LLC qualifies as a REOC under the Department’s plan assets regulation. 29 C.F.R. § 2510.3-101.

The Department’s regulation at 29 C.F.R. § 2509.75-2(a) (Interpretative Bulletin 75-2), explains that a transaction between a party in interest under ERISA(2) (or disqualified person under the Code, in this case S Company) and a corporation in which a plan has invested (i.e., the LLC) does not generally give rise to a prohibited transaction. However, in some cases it can give rise to a prohibited transaction. Regulation section 2509.75-2(c) and Department opinions interpreting it have made clear that a prohibited transaction occurs when a plan invests in a corporation as part of an arrangement or understanding under which it is expected that the corporation will engage in a transaction with a party in interest (or disqualified person).(3)

According to your representations, it appears that Berry’s IRA will invest in the LLC under an arrangement or understanding that anticipates that the LLC will engage in a lease with S Company, a disqualified person. Therefore, the lease would amount to a transaction between Berry’s IRA and S Company that Code section 4975(c)(1)(A) and (D) prohibits. Additionally, the proposed lease, if consummated, may also constitute a violation by Berry, a fiduciary, of Code section 4975(c)(1)(D) and (E).

Finally, we note the express emphasis in 29 C.F.R. § 2509.75-2(c) that the Department considers “a fiduciary who makes or retains an investment in a corporation or partnership for the purpose of avoiding the application of the fiduciary responsibility provisions of the Act to be in contravention of the provisions of section 404(a) of the Act.”

Thus, the proposed lease, which would violate section 4975(c)(1) of the Code, would also have to be referred to the Internal Revenue Service for a determination as to whether it would consider the transaction a violation of the exclusive benefit rule of section 401(a)(2) of the Code, which is the Code’s analogue to the fiduciary responsibility provisions of section 404(a) of ERISA.

Because we have concluded that the proposed lease would constitute a prohibited transaction with respect to Berry’s IRA, the issue of whether the Code prohibits the lease as it relates to R’s IRA is moot, and does not need to be addressed.

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

Sincerely,

Louis J. Campagna
Chief, Division of Fiduciary Interpretations
Office of Regulations and Interpretations

Footnotes

  1. Under Reorganization Plan No. 4 of 1978, effective December 31, 1978 [5 U.S.C. App. at 214 (2000 ed.)], the authority of the Secretary of the Treasury to issue interpretations regarding section 4975 of the Code was transferred, with certain exceptions not here relevant, to the Secretary of Labor. As a result, citations to section 406 of the Employee Retirement Income Security Act (ERISA), 29 U.S.C. § 1001 et seq. and applicable regulations also refer to the parallel citations of section 4975 of the Code.
  2. Section 3(14) of ERISA defines the term “party in interest” for purposes of Title I of ERISA, including the prohibited transaction provisions of ERISA section 406.
  3. See 29 C.F.R. § 2509.75-2(c); Opinion No. 75-103 (Oct. 22, 1975); 1978 WL 170764 (June 13, 1978). Further, prior to the promulgation of the Department’s plan assets regulation, 29 C.F.R. § 2510.3-101, the Department had issued Interpretive Bulletin 75-2 which discusses certain prohibited transactions under section 406 of ERISA or section 4975 or the Code. As indicated in the preamble to the plan assets regulation, part of Interpretive Bulletin 75-2 was revised to coordinate it with the final regulation (51 Fed. Reg. 41278). The remainder of the Interpretive Bulletin 75-2, published at 29 C.F.R. § 2509.75-2(c), remains in force and was not affected by the plan assets regulation. Regulation section 2509.75-2(c) sets forth that a transaction between a party in interest and a corporation in which a plan has invested may constitute a prohibited transaction under certain circumstances. Such transactions are prohibited regardless of whether or not they meet the plan assets regulation

2006-06A    Whether the prohibition on the payment of sales commissions in PTE 77-3 applies to the payment of 12b-1 Fees

2006-06A
PTE 77-3

Whether the prohibition on the payment of sales commissions in PTE 77-3 applies to the payment of 12b-1 Fees by a proprietary mutual fund to an unrelated broker.

July 26, 2006
Mr. F. Jefferson Bragdon
Williams Coulson
15th Floor
Two Chatham Center
Pittsburgh, PA 15219

Re: Company A 401(k) and Profit Sharing Plan (the Plan)

Identification Number C-09259

Dear Mr. Bragdon:

This is in response to your request for an advisory opinion concerning Prohibited Transaction Exemption (PTE) 77-3 (42 FR 18734, April 8, 1977).(1) Specifically, you request an opinion on whether the prohibition on the payment of sales commissions in PTE 77-3 applies to the payment of distribution-related expenses (12b-1 Fees) by a proprietary mutual fund (the Mutual Fund) to an unrelated broker. In particular, the distributor of the Mutual Fund would pay the unrelated broker from Mutual Fund assets received by the distributor under a Rule 12b-1 plan of distribution (the 12b-1 Plan).(2) The distributor would retain no portion of the 12b-1 Fees. Due to your uncertainty about the application of PTE 77-3, you requested that we not identify the relevant parties.

You describe the facts as follows. Company A is the sponsor of the Plan. Company A is an investment adviser to the Z Family of Mutual Funds (the Funds), and one of four employers of employees covered by the Plan. The other employers are Company B, the distributor and principal underwriter of the Funds; Company C, another investment adviser of the Funds; and Company D, which provides other services to the Funds.

The Plan is a defined contribution plan with a section 401(k) cash or deferred feature permitting employee pre-tax deferrals, which allows participants to direct the investment of their accounts among the Funds. The Plan was established by Company A, effective January 1, 1994. The Plan covers only employees of Companies A, B, C, and D (the Companies). The Plan is intended to comply with section 404(c) of the Employee Retirement Income Security Act of 1974 (the Act or ERISA). As of June 30, 2005, the Plan had total assets of approximately $7 million. As of September 9, 2005, the Plan had 260 participants. The trustee of the Plan is Individual G, a senior executive officer of the Companies.

From the inception of the Plan to September 2005, you explain that participants have directed the investment of their accounts among the Funds. Beginning in 1999, you indicate that some of the Funds, in which participants invested their accounts, adopted 12b-1 Plans in accordance with Rule 12b-1 under the Investment Company Act of 1940 (the ’40 Act), 17 CFR §240.12b-1. You further explain that the 12b-1 Plans permit 0.25 percent of the Funds’ assets to be used by Company B to pay 12b-1 Fees to promote the sale of shares of the Funds. No 12b-1 Fees have been paid by Company B in connection with the acquisition or sale of shares of the Funds by the Plan.

You state that Company A has entered into an agreement (the Agreement) with Company E, an unrelated party to the Funds and the Companies, to provide administration services for the Plan. In connection therewith, Company A will (a) adopt the approved prototype plan of Company E, (b) appoint Bank F as successor trustee, and (c) transfer the assets of the Plan to Bank F in cash. After the transfer of the Plan assets, you explain that participants will direct the investment of their account balances among investment alternatives consisting of mutual funds that are offered by parties unrelated to the Funds and the Companies, whose net asset values are listed daily in financial and other news publications.

To accommodate a number of participants that want to continue to direct the investment of their account balances in the Funds after the transfer, you state that the Agreement with Company E provides for a self-directed brokerage account (the Self-Directed Brokerage Account) established with Company H, that will permit participants to direct the investment of their account balances in the Funds. The Self-Directed Brokerage Accounts will be available to all participants on an equal basis. A Plan participant that uses the Self-Directed Brokerage Account option will pay a $75 annual fee to the Plan recordkeeper.

You represent that Company B will pay a 12b-1 Fee to Company H, the broker, with respect to amounts invested in the Funds by Plan participants and that Company B will not retain any portion of such fee. You explain that Company H provides brokerage services to the Plan participants and that it is unrelated to the Funds, the Companies, Individual G, and Bank F. You also state that Company H is not a fiduciary, as defined in section 3(21) of the Act, with respect to the Plan, because it does not exercise any discretionary authority or control with respect to management of the Plan or exercise any authority or control with respect to management or disposition of assets of the Plan, and does not render investment advice with respect to any property of the Plan. You further represent that no fiduciary of the Plan, or affiliate of any fiduciary, will benefit from any part of the 12b-1 Fee.

You represent that the Plan’s investment in the Funds has met and will continue to meet the conditions stated in PTE 77-3. Therefore, you explain that the only issue with respect to the continued availability of PTE 77-3 is the possibility that the payment of 12b-1 Fees to Company H may not be permissible under PTE 77-3.

PTE 77-3 provides relief from the restrictions of sections 406 and 407(a) of the Act 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, with respect to the acquisition or sale of shares of an open-end investment company registered under the ’40 Act 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. Among its requirements, section (c) of PTE 77-3 provides that the plan must not pay a sales commission in connection with such acquisition or sale.

As you have noted, the Department’s concern with respect to 12b-1 Fees was expressed in ERISA Advisory Opinion 93-12A (April 27, 1993) in the context of a transaction otherwise covered by PTE 77-4 (42 FR 18732, April 8, 1977). PTE 77-4 permits the purchase or sale by a plan of shares of a registered open-end investment company where an investment adviser to the mutual fund is also a fiduciary with respect to the plan. In ERISA Advisory Opinion 93-12A, a company serving as investment manager or trustee to employee benefit plans invested plan assets in affiliated mutual funds. The company credited the plan for investment advisory fees that the company received from the mutual fund, but did not credit the plan for fees that it received for secondary services provided to that fund. The Department stated that PTE 77-4 would be available if the secondary services were not investment advisory services and the conditions of this class exemption were otherwise met.

The Department also noted in ERISA Advisory Opinion 93-12A 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-related expenses was not generally permitted by the Securities and Exchange Commission. Accordingly, the Department stated that the payment of 12b-1 Fees was not specifically considered as part of its determination to grant PTE 77-4. In any event, the Department was of the view that the payment of a 12b-1 Fee by a mutual fund to a plan fiduciary or its affiliate could not 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 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 was paid to the fiduciary or its affiliate with regard to that portion of the fund’s assets attributable to the plan’s investment.

In ERISA Advisory Opinion 2002-05A (June 7, 2002) involving “exchange-traded funds,” the Department expressed the view that the term “sales commission,” as used in section II(a) of PTE 77-4, would not include brokerage commissions paid to a broker in connection with purchases or sales of shares of registered open-end investment companies listed on an exchange if the broker is unaffiliated with the fund, its principal underwriter, investment adviser or any affiliate thereof.

Similarly in the case under consideration, the broker (Company H) is unaffiliated with the Mutual Fund, its principal underwriter/distributor (Company B), any investment advisers (Companies A and C) or any affiliate thereof (Company D), and any other fiduciary of the Plan (Bank F and Company E). In addition, neither the Companies nor their affiliates would receive any part of the 12b-1 Fees, nor would any fiduciary with respect to the Plan or affiliate of such fiduciary receive such fees. Finally, no commissions would be paid from the Plan participants’ accounts other than 12b-1 Fees out of Fund assets. Accordingly, it is the Department’s view that the term “sales commission,” as used in section (c) of PTE 77-3, would not include 12b-1 Fees that are paid to Company H, by Company B, from Mutual Fund assets, where Company H is an unrelated party and Company B keeps no part of the 12b-1 Fees.

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 and is consistent with ERISA Advisory Opinion 2002-05A.

Sincerely,

Ivan L. Strasfeld
Director, Office of Exemption Determinations

Footnotes

  1. The Department received your submission as a request for an administrative exemption. However, due to the nature of the issue involved, the Department has decided, with your concurrence, to process this submission as an advisory opinion request.
  2. Although you have also requested information concerning excise taxes and the correction of inadvertent prohibited transactions related to the 12b-1 Fees, this opinion letter does not address these issues. The Department believes that the appropriate forum to resolve these matters is the Internal Revenue Service.

2006-08A    Whether a fiduciary of a defined benefit plan may, consistent with the requirements of section 404 of ERISA

2006-08A
ERISA Sec. 404(a)

Whether a fiduciary of a defined benefit plan may, consistent with the requirements of section 404 of ERISA, consider the liability obligations of the plan and the risks associated with such liability obligations in determining a prudent investment strategy for the plan.

October 3, 2006
Donald J. Myers, Esq.
Reed Smith LLP
1301 K Street, N.W.
Suite 1100-East Tower
Washington, D.C. 20005-3373

Dear Mr. Myers:

This is in response to your request for an advisory opinion on behalf of JPMorgan Chase Bank, N.A. (JPMorgan) regarding the application of the fiduciary responsibility provisions of Title I of the Employee Retirement Income Security Act of 1974, as amended (ERISA). Specifically you have inquired whether a fiduciary of a defined benefit plan may, consistent with the requirements of section 404 of ERISA, consider the liability obligations of the plan and the risks associated with such liability obligations in determining a prudent investment strategy for the plan.

You represent that JPMorgan, as a plan fiduciary, proposes to “risk manage” the assets of defined benefit plans by better matching the risks of a plan’s investment portfolio assets with the risks associated with its benefit liabilities, with a goal toward reducing the likelihood that liabilities will rise at a time when the assets decline. Defined benefit plan liabilities are determined by a number of factors, most significantly the demography of the participant population (participants’ number of years of service and/or expected length of time for payment of retirement benefits) and the interest rates used to calculate the present value of the plan’s obligations for funding and accounting purposes.

According to your letter, these liabilities most closely correlate with fixed-income assets, so that one approach for risk managing assets would be to invest directly in a portfolio of fixed-income securities with a duration of the plan’s benefit obligations. However, you note that there may be aspects of a plan’s obligations that correlate more closely with other types of investments, and it may not be possible to match liabilities precisely with fixed-income securities due to limitations in the fixed-income market. As a result, you indicate that a variety of approaches may be used in practice, depending on the facts and circumstances of the particular plan.

In developing an asset allocation that better matches the risk and duration characteristics of a plan’s benefit liabilities, you explain that the focus of JPMorgan’s services would be on reducing the risk of underfunding to the plan and its participants and beneficiaries by reducing volatility in funding levels. In this regard, you note that there may be incidental benefits to the plan sponsor from maintaining more consistent funding levels, such as reduced volatility on the sponsor’s financial statements and reduced minimum contribution obligations. However, you also note that the principal benefit of decreased volatility would be the reduced need for the plan to rely on the plan sponsor to meet its funding obligations, protecting the plan participants and beneficiaries in the event of the sponsor’s insolvency.

Taking into account the foregoing, you have requested the views of the Department on whether a fiduciary of a defined benefit plan may, consistent with the requirements of section 404 of ERISA, consider the liability obligations of the plan and the risks associated with such liability obligations in determining a prudent investment strategy for the plan.

Sections 403(c) and 404(a)(1)(A) of ERISA require plan fiduciaries to discharge their duties with respect to a plan solely in the interest of plan participants and beneficiaries and for the exclusive purpose of providing benefits to participants and beneficiaries and defraying the reasonable expenses of administering the plan. Section 404(a)(1)(B) of ERISA requires plan fiduciaries to act 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 character with like aims. These fiduciary standards apply to the selection and monitoring of plan investments, including plan investments made pursuant to a particular investment strategy. The frequency and degree of monitoring, will, of course, depend on the nature of such investments and their role in the plan’s portfolio.

The general standards of fiduciary conduct contained in sections 404(a)(1) apply to any investment by a plan covered by Title I, including investments made pursuant to the described risk management investment strategy. Accordingly, fiduciaries of the plan must act prudently, solely in the interest of the plan’s participants and beneficiaries, and for the exclusive purpose of providing benefits and defraying reasonable plan administrative costs when deciding whether to invest in a particular investment or use a particular investment strategy.

With regard to investing plan assets, the Department has issued a regulation, at 29 CFR 2550.404a-1, interpreting the prudence requirements of ERISA as they apply to the investment duties of fiduciaries of employee benefit plans. The regulation provides that the prudence requirements of section 404(a)(1)(B) are satisfied if (1) the fiduciary making an investment or engaging in an investment course of action has given appropriate consideration to those facts and circumstances that, given the scope of the fiduciary's investment duties, the fiduciary knows or should know are relevant, and (2) the fiduciary acts accordingly. This includes giving appropriate consideration to the role that the investment or investment course of action plays with respect to that portion of the plan's investment portfolio within the scope of the fiduciary's responsibility.

The regulation further specifies the facts and circumstances that must be given appropriate consideration to include, but not be limited to, (A) a determination by the fiduciary that the particular investment or investment course of action is reasonably designed, as part of the portfolio (or, where applicable, that portion of the plan portfolio with respect to which the fiduciary has investment duties) to further the purposes of the plan, taking into consideration the risk of loss and the opportunity for gain (or other return) associated with the investment or investment course of action and (B) consideration of the following factors as they relate to such portion of the portfolio: (i) the composition of the portfolio with regard to diversification; (ii) the liquidity and current return of the portfolio relative to the anticipated cash flow requirement of the plan; and (iii) the projected return of the portfolio relative to the funding objectives of the plan.

Within the framework of ERISA’s prudence, exclusive purpose and diversification requirements, the Department believes that plan fiduciaries have broad discretion in defining investment strategies appropriate to their plans. In this regard, the Department does not believe that there is anything in the statute or the regulations that would limit a plan fiduciary’s ability to take into account the risks associated with benefit liabilities or how those risks relate to the portfolio management in designing an investment strategy.

For these reasons, a fiduciary would not, in the view of the Department, violate their duties under sections 403 and 404 solely because the fiduciary implements an investment strategy for a plan that takes into account the liability obligations of the plan and the risks associated with such liabilities and results in reduced volatility in the plan’s funding requirements. Whether any particular investment strategy is prudent with respect to a particular plan will depend on all the facts and circumstances involved.

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,

Louis J. Campagna
Chief, Division of Fiduciary Interpretations
Office of Regulations and Interpretations

2006-09A    This advisory opinion concludes that a self-directed IRA‘s investment in notes of a corporation

2006-09A
IRC Section 4975 (c)(1)(A) & (B)

This advisory opinion concludes that a self-directed IRA‘s investment in notes of a corporation, a majority of whose stock is owned by the son-in-law of the IRA owner, would be a prohibited transaction under the Internal Revenue Code.

December 19, 2006
Edward A. Appelt
24 Winslow Drive
Pittsburg, PA 15229

Dear Mr. Appelt:

This is in response to your request for an advisory opinion under section 4975 of the Internal Revenue Code (Code). Specifically, you ask whether allowing the owner of an individual retirement account (IRA) to direct the IRA to invest in notes being offered by a corporation, in which a relative of the IRA owner is the majority owner and stockholder, would give rise to a prohibited transaction under Code section 4975.(1)

You represent that as the owner of an IRA for which you have retained investment discretion, you would like to direct the investment of these IRA funds into notes (Notes) that are being offered by STARR Life Sciences Corporation (STARR). STARR is currently owned by the founders of the Company who are: Eric (your son-in-law) - 87.5%; Erika (an unrelated party) - 7.5%; and Dr. Strolh (an unrelated party) - 5.0%.

You represent that these Notes are being offered and sold exclusively to persons who qualify as "accredited investors" under rule 501(a) of Regulation D promulgated under the Securities Act of 1933. You represent that you qualify as an accredited investor.

You ask whether the IRA’s investment in the Notes would give rise to a prohibited transaction under section 4975 of the Code. Section 4975(c)(1)(A) and (B) of the Code defines a prohibited transaction to include any direct or indirect sale or exchange of property and lending of money or other extension of credit between a plan and a disqualified person.

Section 4975(e)(1) of the Code defines, in relevant part, the term "plan" to include an IRA described in Code section 408(a). Section 4975(e)(3) of the Code defines the term "fiduciary," in relevant part, to include any person who exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets. Because you retain investment discretion over the IRA, you are a fiduciary. Section 4975(e)(2) of the Code defines "disqualified person," in relevant part, to include a fiduciary and certain members of the family of a fiduciary. Consequently, you are also classified as a disqualified person under Code section 4975(e)(2)(A). Sections 4975(e)(2)(F) and 4975(e)(6) of the Code state, in relevant part, that the family of a fiduciary shall include his spouse, ancestor, lineal descendant, and any spouse of a lineal descendant. Consequently, your son-in-law is also classified as a disqualified person because he is a member of the family of a fiduciary.

The IRA’s purchase of the Notes would be a transaction between STARR and the IRA. Code section 4975(e)(2)(G)(i) defines "disqualified person," in relevant part, to include a corporation of which (or in 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 such corporation is owned indirectly by a fiduciary.

In determining indirect stockholdings, Code section 4975(e)(4) requires that for purposes of Code section 4975(e)(2)(G)(i), indirect stockholdings include those which would be taken into account under Code section 267(c), except that members of a family of a fiduciary are members within the meaning of Code section 4975(e)(6). The application of this rule attributes to you the majority stockholdings of your son-in-law. Consequently, STARR is also classified as a disqualified person.

The IRA is a plan and STARR is a disqualified person. Based on the facts and representations in your submissions, it is the opinion of the Department of Labor that the IRA's purchase of the Notes from STARR at your direction would be a transaction described in section 4975(c)(1)(A) and (B) of the Code which prohibit a direct or indirect sale or exchange of property and lending of money or other extension of credit between a plan and a disqualified person.

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

Sincerely,

Louis J. Campagna
Chief, Division of Fiduciary Interpretations
Office of Regulations and Interpretations

Footnotes

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 the interpretations of the Secretary of Labor pursuant to such authority.

2007-01A    Whether transactions between a broker-dealer and a separate account managed by a QPAM

2007-01A
PTE 84-14

Whether transactions between a broker-dealer and a separate account managed by a QPAM under a 401(k) plan fail to satisfy section I(a) of PTE 84-14 where plan participants investing in such account receive investment allocation advice from a subsidiary of the broker-dealer.

January 22, 2007
Melanie Franco Nussdorf, Esq.
Steptoe & Johnson LLP
1330 Connecticut Ave NW
Washington DC 20036

Dear Ms. Nussdorf:

This is in response to your request for guidance concerning the application of section I(a) of Prohibited Transaction Exemption (PTE) 84-14 (49 FR 9494, March 13, 1984, as corrected at 50 FR 41430, October 10, 1985, as amended at 70 FR 49305, August 23, 2005).(1) PTE 84-14 permits certain transactions between a party in interest with respect to an employee benefit plan and an investment fund (as defined in section V(b) of PTE 84-14) in which the plan has an interest and which is managed by a qualified professional asset manager (QPAM), if the conditions of the exemption are satisfied.

You write on behalf of an investment banking, securities and investment management firm (Firm A). You represent that Firm A is a broker-dealer which is a frequent counterparty to plans and vehicles that hold plan assets. A subsidiary of Firm A (Subsidiary B) provides investment advice for a fee to participants in self-directed individual account plans.

You request our views on a scenario under which a participant-directed individual account plan offers a separate account that is managed by a QPAM as one of its investment options. The QPAM is not related to either Firm A or Subsidiary B. You represent that Subsidiary B’s services to the plan are limited to advising participants with respect to allocation of their investments in the plan. Subsidiary B does not have authority or control over any participant accounts and does not participate in the selection or oversight by the plan sponsor of investment options available under the plan. The plan sponsor (or a named fiduciary unrelated to Firm A and Subsidiary B) would possess and exercise the authority to appoint and terminate the QPAM for the plan. Neither Firm A nor Subsidiary B would participate in the negotiation of the terms of the management agreement with the QPAM. You note that, under certain circumstances, a fiduciary who provides investment advice to a plan for a fee may exert so much influence over the plan sponsor (or named fiduciary) so as to have effectively “exercised” authority or control over the operation of the plan or its assets. You ask, however, that the Department assume, for purposes of this opinion, the absence of such influence, control or authority over the plan sponsor (or named fiduciary).

You have requested guidance as to whether transactions between Firm A and the investment fund managed by the QPAM as an option under the plan would fail to satisfy the condition in section I(a) of the exemption if plan participants investing in such fund receive investment allocation recommendations from Subsidiary B. You state that, since the plan sponsor (or named fiduciary) of each plan, as opposed to Firm A or Subsidiary B, is the party that possesses and exercises the power to select the investment vehicles that may be managed by a QPAM, and since plan participants, as opposed to Firm A or Subsidiary B, have the power to select investment options under the plan in which to invest, such transactions should fall within the relief provided by PTE 84-14.

Section I(a) of PTE 84-14 provides that, at the time of the transaction, the party in interest, or its affiliate (as defined in section V(c)), does not have the authority to appoint or terminate the QPAM as a manager of the plan assets involved in the transaction, or negotiate on behalf of the plan the terms of the management agreement with the QPAM (including renewals or modifications thereof) with respect to the plan assets involved in the transaction.

Section V(c) of the exemption defines an affiliate of a person as:

[a]ny person directly or indirectly, through one or more intermediaries, controlling, controlled by, or under common control with the person,

[a]ny corporation, partnership, trust or unincorporated enterprise of which such person is an officer, director, 10 percent or more partner ... or highly compensated employee as defined in section 4975(e)(2)(H) of the Code (but only if the employer of such employee is the plan sponsor), and

[a]ny director of the person or any employee of the person who is a highly compensated employee, as defined in section 4975(e)(2)(H) of the Code, or who has direct or indirect authority, responsibility or control regarding the custody, management or disposition of plan assets involved in the transaction. A named fiduciary (within the meaning of section 402(a)(2) of ERISA) of a plan with respect to the plan assets involved in the transaction and an employer any of whose employees are covered by the plan will also be considered affiliates with respect to each other for purposes of section I(a) if such an employer or an affiliate of such employer has the authority, alone or shared with others, to appoint or terminate the named fiduciary or otherwise negotiate the terms of the named fiduciary’s employment agreement.

It is the Department’s view that, based upon the circumstances you have described, neither Firm A nor Subsidiary B has the authority to appoint or terminate the QPAM as a manager of plan assets involved in the transaction, or to negotiate the terms of the QPAM’s management agreement. The fact that Subsidiary B provides investment advice for a fee to participants in a plan who invest in a separate account under the plan managed by such QPAM would not cause a transaction between the separate account and Firm A to fail section I(a) of the QPAM class exemption solely by reason of the provision of such participant advice.

The Department notes that Part I of PTE 84-14 provides no relief for transactions described in section 406(b) of ERISA. If Subsidiary B is a fiduciary by virtue of rendering investment advice within the meaning of 29 CFR 2510.3-21(c), the provision of such investment advice involving self-dealing will subject the fiduciary adviser to liability under section 406(b) of ERISA. Thus, for example, a violation of section 406(b) would occur if Subsidiary B advised plan participants to invest in a QPAM-managed fund pursuant to an arrangement or understanding with the QPAM which would result in a benefit being conferred upon Firm A or Subsidiary B as a result of such investment.

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.

Sincerely,

Ivan L. Strasfeld
Director, Office of Exemption Determinations

Footnotes

See also Proposed Amendment to Prohibited Transaction Exemption (PTE) 84-14 for Plan Asset Transactions Determined by Independent Qualified Professional Asset Managers, 70 FR 49312 (August 23, 2005).

2007-02A    Whether the 10% test applicable to pooled investment vehicles

Whether the 10% test applicable to pooled investment vehicles under the QPAM class exemption (84-14) does not require consideration of any underlying plan investors in a pooled fund investing in another pooled fund (47KB PDF file - PDF Help)

DOL Field Assistance Bulletins

2002-01    ESOP Refinance Transactions

Department of Labor - Employee Benefits Security Administration
Field Assistance Bulletin 2002-1

September 26, 2002

Memorandum for:
Virginia C. Smith
Director of Enforcement, Regional Directors

From:
Robert J. Doyle
Director of Regulations and Interpretations

Subject: ESOP Refinancing Transactions

Issue: What are the obligations of a fiduciary under sections 404(a) and 408(b)(3) of ERISA in connection with the refinancing of an exempt ESOP loan?

Background

An ESOP is a defined contribution pension plan designed to invest primarily in stock of the sponsoring employer or an affiliate. A leveraged ESOP is an ESOP that finances its purchase of such stock through securities acquisition debt obtained from, or guaranteed by, the sponsoring employer. A leveraged ESOP, operated in accordance with applicable regulations, holds the shares purchased with the proceeds of such a loan in a “suspense account,” and releases them from the suspense account as the loan is repaid according to a set formula that is expressed in terms of number of shares.(1) This release formula requires that in a given year, the number of shares released from the suspense account will be determined by multiplying the number of shares in the suspense account by a fraction. The numerator of that fraction is the amount of principal and interest paid for the year, and the denominator is the sum of the numerator plus the amount of principal and interest to be paid for all future years on the loan.(2) After the shares of stock are released from the suspense account, they are allocated to participants’ accounts.

Loan repayment schedules typically are designed to provide for the release of stock from the ESOP suspense account consistent with a specific projected level of benefits or participant contributions. Loan repayment schedules, therefore, are often formulated based on projections as to the future value of shares, the number of participants and, if relevant, levels of participant contributions over the term of the loan. Accordingly, where there are significant deviations from the projections – such as significant increases in the value of the stock held in the ESOP suspense account or significant decreases in the number of participating employees – the release of stock in accordance with original loan terms will result in a level of benefits greater than originally intended by the plan sponsor. Refinancing of the underlying loans is a means by which some plan sponsors have sought to bring future allocations closer to the amounts they originally intended. In general, an ESOP refinancing involves entering into a new loan that extends the repayment schedule and, therefore, the period over which stock will be allocated from the suspense account to individual participants. Typically, the ESOP uses the loan proceeds to retire the original loan and release suspense account shares to the accounts of the participants only as the new, extended, loan is repaid. While all of the shares acquired in the original stock purchase are ultimately released under the extended terms of the new loan, fewer shares are released from the suspense account during the period of the original underlying loan and fewer shares are allocated to participants’ accounts during that same period.

Analysis

Section 404(a)(1)(A) of ERISA requires, among other things, that a fiduciary of a plan discharge its duties with respect to the plan solely in the interest of the plan’s participants and beneficiaries and for the exclusive purpose of providing benefits to participants and their beneficiaries and defraying reasonable expenses of administering the plan. Section 404(a)(1)(B) requires that a fiduciary of a plan discharge its duties with respect to the 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. Section 403(c)(1) requires, in part, and subject to certain exceptions, that the assets of a plan shall never inure to the benefit of any employer and shall be held for the exclusive purpose of providing benefits to participants and beneficiaries and defraying reasonable expenses of administering the plan.

Section 406(a)(1)(B) provides, in pertinent part, that a fiduciary with respect to a plan shall not cause the plan to engage in a transaction, if he or she knows or should know that such transaction constitutes a direct or indirect “lending of money or other extension of credit between the plan and a party in interest.” ERISA section 3(14) defines a “party in interest” to include an employer. Section 408(b)(3) provides that a loan to an ESOP is exempt from section 406 (except section 406(b)(3)(3)) if such loan is “primarily for the benefit of participants and beneficiaries of the plan, and . . . such loan is at an interest rate which is not in excess of a reasonable rate.” It is the view of the Department that the requirements of section 408(b)(3) apply to the refinancing of an ESOP loan, as well as to the original loan. Accordingly, an ESOP fiduciary, in order to avoid engaging in a prohibited transaction, must take steps to ensure that a refinancing transaction comports with the requirements of section 408(b)(3) and 29 C.F.R. § 2550.408b-3.

§ 2550.408b-3(c) addresses the application of the “primary benefit” requirement of section 408(b)(3). In applying the “primary benefit” requirement, paragraph (c)(1) of § 2550.408b-3 provides, among other things, that a fiduciary must consider “[a]ll the surrounding circumstances, including those described in paragraphs (c)(2) and (3) of this section.”(4) Paragraph (c)(2) of that section provides that “[a]t the time that a loan is made, the interest rate for the loan and the price of securities to be acquired with the loan proceeds should not be such that plan assets might be drained off.” Paragraph (c)(3) of that section provides that “[t]he terms of a loan, whether or not between independent parties, must, at the time the loan is made, be at least as favorable to the ESOP as the terms of a comparable loan resulting from arm’s-length negotiations between independent parties.” The preamble to the final regulation explains that the tests encompassed in paragraphs (c)(2) and (3) of § 2550.408b-3 were added to the regulation to illustrate how a determination can be made with respect to whether a transaction meets the primary benefit requirement.(5) The regulation additionally states that the Department will give “special scrutiny” to ESOP loans and that fiduciaries have an obligation to ensure that such loans are “truly arranged primarily in the interest of participants and beneficiaries.” 29 C.F.R. § 2550.408b-3(b)(2).

Whether a fiduciary acts in accordance with its responsibilities under sections 404(a)(1)(A) and (B) and 403(c) of ERISA, and whether a particular loan satisfies the requirements of section 408(b)(3) of ERISA, are inherently factual determinations that must be made by the appropriate plan fiduciary based on all relevant facts and circumstances. In determining whether a refinancing is consistent with the fiduciary provisions of Title I of ERISA, the burden is on the fiduciary to establish compliance. However, we note that certain procedures and factors considered by a fiduciary may be appropriate in determining whether to cause an ESOP to engage in a refinancing.

Conclusion

At a minimum, in determining whether to cause an ESOP to engage in a refinancing, a fiduciary must make a careful assessment of the costs and benefits conferred upon the ESOP and the likely consequences of a failure to refinance, and ensure that the transaction is “arranged primarily in the interest of participants and beneficiaries.” 29 C.F.R. § 2550.408b-3(b)(2). It is the view of the Department that, consistent with the obligation to consider “all the surrounding circumstances” pursuant to § 2550.408b-3(c)(1), an ESOP fiduciary must, in considering any refinancing of an ESOP loan that results in an extension of the period over which stock will be allocated to participant accounts, assess the extent to which the refinancing is consistent with the documents and instruments governing the plan, including loan and related agreements.(6) An ESOP fiduciary, in our view, also should assess the extent to which such an extension is consistent with the reasonable expectations of the plan’s participants and beneficiaries, as might be determined by reference to the plan’s summary plan description or other disclosures describing the funding and benefits of the plan.

Although a refinancing may also benefit the employer (for example, by reducing the employer’s cost of providing future pension benefits), the fiduciary must act with undivided loyalty to the participants and beneficiaries of the plan if it is to satisfy the requirements of sections 404(a)(1)(A) and 408(b)(3) of ERISA. The “primary benefit” test set forth in section 408(b)(3) of ERISA and the regulations thereunder require the fiduciary to focus on the benefits of the refinancing transaction to the plan’s participants and beneficiaries. Accordingly, a refinancing would satisfy the primary benefit test if the fiduciary reasonably concludes that the transaction is advantageous to the plan’s participants and beneficiaries after a careful assessment of the costs and benefits of the transaction, and if the terms related to the refinancing are at least as favorable as the terms that would have resulted from an arm’s-length negotiation between independent parties.

Often, employers offer a number of inducements for the plan to engage in the refinancing which could support a fiduciary’s conclusion that the transaction is primarily for the benefit of participants and beneficiaries, such as a commitment that shares held in the suspense account will not be applied to repayment of the outstanding portion of the refinanced loan if the ESOP is terminated (often referred to as “event protection”); additional diversification rights for participants; an increase in the amount of the employer’s matching contribution; the payment of a “dividend make-whole” to compensate participants and beneficiaries for the increased use of dividends for loan repayment; and other such inducements. Whether some or all of such inducements are sufficient to satisfy the primary benefit test is highly dependent on the particular facts and circumstances surrounding the transaction.

One circumstance of particular importance is whether the sponsoring employer has made an enforceable commitment to make all of the contributions necessary to retire the loan. In such a case, the ESOP may have an unqualified right to receive contributions and to release stock in accordance with the original amortization schedule. As a result, the negative consequences to the ESOP of rejecting a proposed refinancing could be minimal, and the economic value transferred to a sponsoring employer may be substantial, unless the ESOP receives substantial additional consideration for entering into the transaction.

Further, we note that the fiduciary has a duty of impartiality to all of the plan’s participants, and may appropriately balance the interests of different classes of participants in evaluating a proposed refinancing, including the potentially varying interests of present and future participants. See Varity Corp. v. Howe, 516 U.S. 489, 514 (1996); Restatement (Second) of Trusts § 183. In our view, however, the fiduciary cannot satisfy the duty of impartiality solely by considering the asserted benefits of the refinancing to future participants (e.g., more generous benefits in later years than the employer would otherwise provide), but must also consider the interests of current participants and beneficiaries. Although a refinancing does not remove shares from the ESOP, those current participants who terminate employment before the full repayment of a refinanced loan may receive fewer shares of stock than they would have received absent the refinancing, and current participants who remain employed by the sponsor must work more years to receive the same number of shares that they would have received absent the refinancing. Accordingly, a fiduciary cannot reasonably assess the costs and benefits conferred upon an ESOP without giving due consideration to the interests of current participants.

With respect to the obligations of an ESOP fiduciary under section 404(a)(1), it is the view of the Department that satisfaction of the “primary benefit” requirement of section 408(b)(3) and the regulation with respect to the refinancing of an ESOP loan also typically would serve to satisfy a fiduciary’s obligations to act prudently and solely in the interest of plan participants and beneficiaries under section 404(a)(1). Conversely, a failure to satisfy the “primary benefit” requirement of section 408(b)(3) would also result in a violation of section 404(a)(1).

Any questions concerning this matter may be directed to Louis Campagna or Fred Wong, Division of Fiduciary Interpretations at 202.693.8510.

Footnotes

  1. 29 C.F.R. § 2550.408b-3(h); 26 C.F.R. § 54.4975-11(c).
  2. 29 C.F.R. § 2550.408b-3(h)(1). Also note that § 2550.408b-3(h)(2) permits a release formula that is determined solely with reference to principal payments.
  3. In adopting § 2550.408b-3, the Department expressed its view that the only prohibited transactions to which the exemption under section 408(b)(3) does not apply are those arising under section 406(b)(3), relating to the receipt by a fiduciary of any consideration for his own personal account from a party dealing with the plan. 42 Fed. Reg. 44384 (September 2, 1977).
  4. Paragraph (c) of § 2550.408b-3 also provides that no loan will satisfy the primary benefit requirement unless it also satisfies the requirements of paragraphs (d) [relating to use of loan proceeds], (e) [relating to liability and collateral for an ESOP loan] and (f) [relating to defaults].
  5. 42 Fed. Reg. 44384 (September 2, 1977).
  6. For purposes of this discussion, it is assumed that there are no provisions in documents or instruments governing the plan, including loan and related agreements, that specifically preclude the refinancing of an ESOP loan.

2002-02    Plan Amendments Made by Multiemployer Trustees

Department of Labor - Employee Benefits Security Administration
Field Assistance Bulletin 2002-2

November 4, 2002

Memorandum for:
Virginia C. Smith
Director of Enforcement, Regional Directors

From:
Robert J. Doyle
Director of Regulations and Interpretations

Subject: Plan Amendments Made by Multiemployer Plan Trustees

Issue: Were the trustees of two related multiemployer plans subject to ERISA's fiduciary standards when they amended the plans' trust agreement?

Background

Employer Association X and Labor Union Y established a defined benefit plan (DB plan) in 1955 and, in 1987, a defined contribution plan (DC Plan). Employer contributions to Fund Z fund both plans. Although some DC Plan participants also participate in the DB plan, most do not. In 1989, the DB plan was frozen. No new employees became participants of the DB plan and the existing participants accrued no further benefits. At that time, the trustees believed that the DB plan needed no further contributions. All future contributions were allocated to the DC Plan.

By 1999, the DB plan’s funding situation had apparently changed. That year, Employer Association X and Labor Union Y amended the trust agreement to allocate employer contributions to the DB plan in an amount equivalent to the forfeitures in the DC Plan. The collective bargaining agreement under which the plans are maintained only sets a formula for employer contributions to Fund Z; the trust agreement specifies the allocation of contributions among the plans. The trust agreement provides that either Employer Association X and Labor Union Y, or Fund Z’s board of trustees may make amendments.

The 1999 reallocation did not prove sufficient to make the DB Plan solvent. In 2002, the trustees voted to amend the trust agreement, this time diverting an additional 20% of the employer contributions to the DB plan. The amendment resolution states that the trustees were acting "in their Settlor capacity."

Analysis

Section 3(21) of ERISA defines a fiduciary as one who has or exercises discretionary authority or control in the administration or management of an employee benefit plan or its assets. Part 4 of Title I of ERISA establishes the standards pursuant to which any fiduciary is to act, including the duty to act solely in the interests of the participants and beneficiaries of the plan, to be prudent in carrying out her responsibilities, and to avoid engaging in prohibited transactions. Section 3(16) of ERISA, in relevant part, defines the term "plan sponsor" of a plan established or maintained jointly by one or more employers and one or more employee organizations, as the joint board trustees who establish or maintain the plan.

In analyzing the extent to which assets of an employee benefit plan may properly be applied toward the payment of certain expenses, the Department has distinguished between activities that are “settlor” in nature (i.e., activities that relate to the establishment, design, and termination of plans) and activities that are fiduciary in nature (i.e., activities involving management of the plan). As indicated in various pronouncements, expenses incurred in connection with the performance of settlor functions would not be reasonable plan expenses as they would be incurred for the benefit of the employer and would involve services for which an employer could reasonably be expected to bear the cost in the normal course of its business or operations.(1) In applying these distinctions, the Department has generally recognized that certain activities that would be settlor activities in the context of a single employer plan might be fiduciary activities in the context of a multiemployer plan.(2) This view was consistent with earlier case law, such as NLRB v. Amax Coal Co., 453 U.S. 322 (1981) which held that employer appointed trustees of a multiemployer plan do not represent the interests of the contributing employers, but act as fiduciaries of the plan. 453 U.S. at 331-334. More recent Supreme Court pronouncements on settlor functions, however, have led several courts to conclude that multiemployer plan trustees may act in a settlor capacity without regard to ERISA's fiduciary standards.(3)

For example, the Third Circuit Court of Appeals, in Walling v. Brady(4) and the Sixth Circuit Court of Appeals, in Gard v. Blankenburg,(5) have taken the position that boards of trustees may act as settlors when they amend plans, and that such amendments are not subject to ERISA’s fiduciary responsibility provisions. As the Third Circuit noted in the Walling case, the Supreme Court, in both Lockheed Corp. v. Spink and Wright Corp. v. Schoonejongen,(6) recognized that the use of the term “plan sponsor” is significant. Under ERISA section 3(16), the sponsor of a multiemployer plan is the joint board of trustees that is directed, pursuant to a collective bargaining agreement, to establish one or more employee benefit plans. While the Walling court noted that, notwithstanding Lockheed, there may be situations in which single employer and multiemployer plans should be treated differently, they opined that under the facts of that case, involving the amendment of a multiemployer plan, ERISA’s fiduciary rules did not apply.

The facts in Walling are very similar to those in the present case. In Walling, the board of trustees of a multiemployer defined benefit pension plan and group health plan amended the health plan (pursuant to authority granted under the collective bargaining agreement and the plan document) to require that participants pay $100 per month in order to receive benefits and amended the pension plan (also pursuant to authority granted under the collective bargaining agreement and the plan document) to provide an additional $100 benefit to those participants who were also participants in the health plan. The court in Walling, in concluding that the trustees’ amendment of the pension plan fell outside of the scope of ERISA’s fiduciary responsibility provisions, noted that imposing fiduciary duties on a sponsor’s decision to amend a plan, whether the employer in the case of a single-employer plan, or the trustees in the case of a multiemployer plan, would divide the sponsor’s loyalties and make amendment of a plan impossible.

In Advisory Opinion 80-8A,(7) we considered the issue of whether trustees who allocate employer contributions to related multiemployer plans established and maintained under the same collective bargaining agreements engage in a fiduciary act in making such allocations. In that opinion, we concluded that where allocations are made pursuant to a fixed formula established in the collective bargaining agreement, which formula is binding on the trustees, the trustees are not, solely by reason of such allocation, engaged in an act described in section 406(b)(2). However, the opinion noted that if the trustees exercise discretion in determining how to allocate employer contributions among the related plans, the trustees were engaging in a transaction involving the plans to which contributions were allocated, or withheld, and that such transactions could violate section 406(b)(2) since the plans may have competing interests as to the fixed pool of money. We note, however, that the opinion expressly reserved the question of whether the trustees would be engaged in a fiduciary violation where the collective bargaining agreement gives the trustees the authority to make prospective changes in the formula under which contributions are allocated among related plans.

In the case at hand, the collective bargaining agreements vested broad authority in the trustees to act establish the Fund, as well as the DB Plan and the DC Plan. The trustees also had the authority to amend the Fund and the plans. Pursuant to this authority, the trustees have amended the trust agreement and the plans to provide for the allocation of a portion of the employer contributions to the DB Plan, based on a fixed formula contained in the trust agreement. Once the amendment was properly adopted, the formula became binding on the trustees.

Conclusion

In our view, where relevant documents (e.g., collective bargaining agreements, trust documents, and plan documents) contemplate that the board of trustees of a multi-employer plan will act as fiduciaries in carrying out activities which would otherwise be settlor in nature, such activities would be governed by the fiduciary provisions of ERISA. In our view, such designation by the plan would result in the board of trustees exercising discretion as fiduciaries in the management or administration of a plan or its assets when undertaking the activities. However, where, as here, the relevant plan documents are silent, then the activities of the board of trustees which are settlor in nature generally will be viewed as carried out by the board of trustees in a settlor capacity, and such activities would not be fiduciary activities subject to Title I of ERISA. Accordingly, it is the view of this Office that the Trustees of the Fund did not violate their fiduciary duties under ERISA in amending the Fund, the DB Plan, and the DC Plan to provide for an allocation of employer contributions to the DB Plan.

It is also the view of this Office that, consistent with the plan expense guidance discussed above, it would not be appropriate for a multiemployer plan to pay for expenses attendant to activities that a multiemployer plan trustee carries out in a settlor capacity.

Any questions concerning this matter may be directed to Louis Campagna or David Lurie, Division of Fiduciary Interpretations at 202.693.8510.

Footnotes

  1. See, Advisory Opinion Nos. 97-03A and 2001-01A. Also see letter to Kirk F. Maldonado from Elliot I. Daniel (March 2, 1987).
  2. Advisory Opinions 97-03A and 2001-01A both indicate “these so-called ‘settlor’ functions include decisions relating to the establishment, design, and termination of plans, and except in the context of multiemployer plans, generally are not fiduciary activities.” (Emphasis added)
  3. E.g., Walling v. Brady, 125 F.3d 114 (3rd Cir. 1997); Gard v. Blackenburg, No. 00-1234 (6th Cir. 2002) Hartline v. Sheetmetal Workers' National Pension Fund, 134 F. Supp. 2d 1 (D.D.C. 2000), citing Lockheed Corp. v. Spink, 517 U.S. 882 (1996); Wright Corp. v. Schoonejongen, 514 U.S. 73 (1995). See also Pope v. Central States, Southeast and Southwest Areas Health and Welfare Fund, 27 F.3d 211 (6th Cir. 1994).
  4. 125 F.3d 114 (3d Cir., 1997)
  5. No. 00-1234 (6th Cir., 2002)
  6. 517 U.S. 882 (1996); 514 U.S. 73 (1995)

2002-03    Disclosure and Other Obligations Relating to "Float"

Department of Labor - Employee Benefits Security Administration
Field Assistance Bulletin 2002-3

November 5, 2002

Memorandum for:
Virginia C. Smith
Director of Enforcement, Regional Directors

From:
Robert J. Doyle
Director of Regulations and Interpretations

Subject: Disclosure and other Obligations Relating to “Float”

Issue: What does a fiduciary need to consider in evaluating the reasonableness of an agreement under which the service provider will be retaining “float” and what information is a service provider required to disclose to plan fiduciaries with respect to such arrangements in order to avoid engaging in a prohibited transaction?

Background

A number of financial services providers, such as banks and trust companies, acting as non-discretionary directed trustees or custodians maintain general or “omnibus” accounts to facilitate the transactions of employee benefit plans. The service provider may retain earnings (“float”) resulting from the anticipated short-term investment of funds held in such accounts. Typically, these accounts hold contributions and other assets pending investment directions from plan fiduciaries. In addition, fiduciaries transfer funds to a general account of the financial institution in connection with issuance of a check to make a plan distribution or other disbursement. Funds are then held in the account earning interest until checks are presented for payment.

In Advisory Opinion 93-24A, the Department expressed the view that a 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 section 406(b)(1) of ERISA. Advisory Opinion 93-24A dealt with a situation where there was no disclosure of the float to employee benefit plan customers. In a subsequent information letter to the American Bankers Association (August 11, 1994), the Department indicated that “ . . . if a bank fiduciary has openly negotiated with an independent plan fiduciary to retain 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 on outstanding benefit checks.” (Emphasis supplied).

In general, the concepts of open negotiation and full and fair disclosure, as used in the 1994 letter, are intended to ensure that service providers provide sufficient information concerning such arrangements so that plan fiduciaries can make informed assessments concerning the prudence of the arrangements. Further, those concepts are intended to ensure that the amount of the service provider's compensation is determined and approved by a fiduciary independent of the service provider so that prohibited self-dealing is avoided.(1) Since the issuance of the letter, Field offices have found, as part of their investigations, a variety of methods by which plan fiduciaries are informed of, and or approve, the practice of plan service providers retaining float as part of their overall compensation. Typically, a service agreement will provide that, in addition to other specifically identified or scheduled fees, the service provider may also receive compensation in the form of earnings on funds awaiting investment or reinvestment or funds pending distribution. According to the investigations, however, there is little or no disclosure of specific information regarding compensation earned in the form of float.

Further guidance, therefore, has been requested concerning the obligations of plan fiduciaries and service providers regarding float arrangements and disclosures.

Analysis

Obligations of Plan Fiduciary - In selecting a service provider, plan fiduciaries must, consistent with the requirements of section 404(a), act prudently and solely in the interest of the plan’s participants and beneficiaries and for the exclusive purpose of providing benefits and defraying reasonable expenses of administering the plan. Except as provided in section 408, plan fiduciaries also have an obligation under section 406(a) not 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. Section 408(b)(2) exempts from the prohibitions of section 406(a) any contract or reasonable arrangement 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.(2) In carrying out these responsibilities, the Department has indicated that a plan fiduciary must engage in an objective process designed to elicit information necessary to assess the qualifications of the provider, the quality of services offered, and the reasonableness of the fees charged in light of the services provided. In addition, such process should be designed to avoid self-dealing, conflicts of interest or other improper influence.

In circumstances where a service provider may receive compensation in the form of float, we believe the selection and monitoring process engaged in by the responsible fiduciary should include:

A review of comparable providers and service arrangements (e.g., quality and costs) to determine whether such providers may credit float to the provider’s own account, rather than the plan.

A review of the circumstances under which float may be earned by the service provider. For example, in the case of float on cash awaiting investment, fiduciaries should ensure that their service agreements include time limits within which the provider will implement investment instructions following receipt of cash from the plan. Fiduciaries also should understand that delays in the plan providing investment instruction or delays in implementing investment direction by the service provider would result in increased compensation in the form of float. In the case of float on funds awaiting disbursement, fiduciaries should ensure that their service agreements specify the time at which assets are transferred from the plan to the general account (e.g., the date the check is requested, the date the check is written, or the date the check is mailed). Inasmuch as timing of mailing or distribution of a check may also affect the amount of float, service agreements should provide, if relevant, an indication as to when checks are mailed following a direction to distribute funds. Fiduciaries also should understand that float will be earned on such disbursements until checks are presented for payment by the payee, the timing of which is beyond the control of the plan and service provider. In this regard, fiduciaries should review periodic statements or reports of distribution checks to determine the extent to which checks tend to remain outstanding for unusually long periods of time (e.g., 90 or more days).

A review of sufficient information to enable the plan fiduciary to evaluate the float as part of the total compensation to be paid for the services to be rendered under the agreement. In this regard, fiduciaries should request and review the rates the provider generally expects to earn. For example, the provider might indicate that earnings on uncashed checks are generally at money market interest rates. Given the uncertainties with respect to both actual interest rates and the length of the periods during which any given funds may be pending investment or pending disbursement, it is anticipated that any projections by the fiduciary will result in only a rough approximation of the potential float. However, the information on which the approximation is based (e.g., basis for earnings rates and agreement terms relating to maximum periods within which funds will be invested following investment direction, timing of transfers of cash from the plan to the provider's general account following direction to distribute funds, period for mailing checks, extent to which experience shows that distribution checks remain outstanding for unusually long periods of time, etc.) and the approximation itself, will enable a fiduciary both to compare service provider float practices and assess the extent to which float is a significant component of the overall compensation arrangement.

Additionally, a plan fiduciary must periodically monitor compliance by the service provider with the terms of the agreement and the reasonableness of compensation under the agreement in order to ensure continuation of the agreement meets the requirements of sections 404(a)(1), 406 and 408(b)(2).

Obligations of Service Providers - The primary issue for service providers with float arrangements is whether the provider has disclosed to its employee benefit plan customers sufficient information concerning the administration of its accounts holding float so that the customer can reasonably approve the arrangement based on an understanding of the service provider's compensation. Moreover, the arrangement must not permit the service provider to affect the amount of its compensation in violation of section 406(b)(1) (e.g., by giving the service provider broad discretion over the duration of the float). For example, even where a service provider discloses in its service agreement that additional compensation may be paid to the service provider as a result of float, a prohibited transaction may nonetheless result to the extent that the service provider exercises discretionary authority or control sufficient to cause a plan to pay additional fees to the provider. As noted in Advisory Opinion 93-24A, a fiduciary’s decision to handle plan assets in such a way as to benefit itself constitutes prohibited self-dealing, without regard to the status of the funds after they are placed in a disbursement or other account.

It is the view of this Office that, in connection with a service agreement pursuant to which the service provider may be retaining float as part of its compensation, the service provider can avoid self-dealing with respect to such earnings by taking the following steps:

Disclose the specific circumstances under which float will be earned and retained.

In the case of float on contributions pending investment direction, establish, disclose and adhere to specific time frames within which cash pending investment direction will be invested following direction from the plan fiduciary, as well as any exceptions that might apply.

In the case of float on distributions, disclose when the float period commences (e.g., the date check is requested, the date the check is written, the date the check is mailed) and ends (the date on which the check is presented for payment). Also disclose, and adhere to, time frames for mailing and any other administrative practices that might affect the duration of the float period.

Disclose the rate of the float or the specific manner in which such rate will be determined. For example, earnings on cash pending investment and earnings on uncashed checks are generally at a money market interest rate.

We note that the disclosure of and adherence to the foregoing by service providers will not only reduce the likelihood of prohibited self-dealing, but also will assist plan fiduciaries in discharging their obligations under sections 404(a)(1), 406 and 408(b)(2).

Conclusion

Float should be regarded by plan fiduciaries and service providers as part of the service provider’s compensation for services to the plan. As such, the plan fiduciary must have an adequate understanding of how the service provider will earn float, and how it contributes to the service provider’s compensation. The service provider must make disclosures sufficient to permit the fiduciary to make an informed decision regarding the proposed float arrangement. In addition, to avoid having the arrangement give rise to self-dealing violations of section 406(b), both parties must avoid giving the service provider discretion to affect the amount of compensation it receives from float.

Questions concerning this matter may be directed to Louis Campagna or Fred Wong, Division of Fiduciary Interpretations at 202.693.8510.

Footnotes

  1. What constitutes an approval by an appropriate plan fiduciary will depend on the facts and circumstances of each case. See Advisory Opinion Nos. 97-16A and 2001-02A.
  2. As interpreted by the Department, section 408(b)(2) exempts from the prohibitions of section 406(a) payment by a plan to a party in interest, including a fiduciary, for any service (or combination of services) if (1) such service is necessary for the establishment or operation of the plan; (2) such service is furnished under a contract or arrangement which is reasonable; (3) no more than reasonable compensation is paid for such service. However, section 408(b)(2) does not provide an exemption for an act described in section 406(b) of ERISA, even if such act occurs in connection with a provision of services that is exempt under section 408(b)(2). See 29 C.F.R. § 2550.408b-2.

2003-01    Participant Loans to Corporate Directors and Officers

Department of Labor - Employee Benefits Security Administration
Field Assistance Bulletin 2003-1

April 15, 2003

Memorandum for:
Virginia C. Smith
Director of Enforcement, Regional Directors

From:
Robert J. Doyle
Director of Regulations and Interpretations

Subject: Participant Loans to Corporate Directors and Officers

Issue: May a plan administrator deny participant loans to directors and executive officers of the sponsoring employer of the plan on the basis that such loans may violate Section 13(k) of the Securities Exchange Act of 1934 without contravening the requirement of section 408(b)(1) of ERISA that loans be made available to all participants on a reasonably equivalent basis?

Law And Analysis

Section 402 of the Sarbanes-Oxley Act of 2002 added a new subsection (k) to Section 13 of the Securities Exchange Act of 1934 (the “1934 Act”). Section 13(k) makes it unlawful for any issuer (as defined in Section 2(a)(7) of the Sarbanes-Oxley Act of 2002)(1), directly or indirectly, including through any subsidiary, to extend or maintain credit, to arrange for the extension of credit, or to modify or renew an extension of credit maintained by the issuer on the date of enactment,(2) in the form of a personal loan to or for any director or executive officer (or equivalent thereof). The Department of Labor does not have interpretative authority with respect to the 1934 Act.

Section 404 of ERISA requires, among other things, that fiduciaries of employee benefit plans discharge their duties prudently and solely in the interest of the plan’s participants and beneficiaries. Section 404(a)(1)(D) requires that fiduciaries discharge their duties in accordance with the documents and instruments governing the plan insofar as such documents and instruments are consistent with the provisions of title I of ERISA. Section 406(a)(1)(B) prohibits a fiduciary from causing an employee benefit plan to engage in a loan between the plan and a party in interest. Parties in interest include employees, officers and directors of an employer sponsoring the plan.

Section 408(b)(1) exempts from the prohibited transactions provisions of section 406 the making of a loan by an employee benefit plan to a party in interest who is a participant or beneficiary of the plan, provided that certain conditions are satisfied. Among other things, section 408(b)(1)(A) and the Department’s regulations issued thereunder, at 29 CFR § 2550.408b-1, provide that such loans must be made available to all participants and beneficiaries of the plan on a reasonably equivalent basis.

Section 514(d) of ERISA provides that nothing in Title I of ERISA shall be construed to alter, amend, modify, invalidate, impair, or supersede any other Federal law.

We understand that ERISA practitioners have raised the question of whether section 13(k) of the 1934 Act prohibits directors and executive officers of an employer from taking loans from employee pension benefit plans. It has long been the view of the Department that fiduciaries are responsible for administering their plans to assure compliance with both ERISA and other applicable Federal laws, in recognition of the fact that such other Federal laws are not preempted by ERISA.

In our view, a decision to disallow a participant loan based on a reasonable question concerning the legality of the loan would not be a failure to provide loans to all participants on a reasonably equivalent basis and would not affect the plan's compliance with section 408(b)(1) or 29 C.F.R. § 2550.408b-1.

Conclusion

It is the view of this Office that, in view of the uncertainty concerning the scope of section 13(k) of the 1934 Act, plan fiduciaries of public companies may deny participant loans to officers and directors (or the equivalent thereof) without violating the requirements of section 404(a)(1) or the requirement of section 408(b)(1)(A) and the regulation issued thereunder that loans be available to all participants and beneficiaries on a reasonably equivalent basis. In stating this view, the Department takes no position on the application of section 13(k) of the 1934 Act to participant loans.

Any questions concerning this matter may be directed to Louis Campagna or David Lurie, Division of Fiduciary Interpretations, 202.693.8510.

Footnotes

  1. Section 2(a)(7) of the Sarbanes-Oxley Act of 2002 defines “issuer” as “an issuer (as defined in section 3 of the Securities Exchange Act of 1934 (15 U.S.C. 78c)), the securities of which are registered under section 12 of the Act (15 U.S.C. 78l), or that is required to file reports under section 15(d) (15 U.S.C. 78o(d)), or that files or has filed a registration statement that has not yet become effective under the Securities Act of 1933 (15 U.S.C. 77a et seq.), and that it has not withdrawn.”

2003-02    Application of Participant Contribution Requirements to Multiemployer Defined Contribution Pension Plans

Department of Labor - Employee Benefits Security Administration
Field Assistance Bulletin 2003-2

May 7, 2003

Memorandum for:
Virginia C. Smith
Director of Enforcement, Regional Directors

From:
Robert J. Doyle
Director of Regulations and Interpretations

Subject: Application of Participant Contribution Requirements to Multiemployer Defined Contribution Pension Plans

Issue: In the context of a multiemployer defined contribution pension plan, to what extent may collective bargaining, employer participation and similar agreements be taken into account in determining when participant contributions can reasonably be segregated from the general assets of participating employers?

Background

In 1996, the Department adopted final rules defining when amounts that a participant pays to, or has withheld by, an employer for contribution to an employee benefit plan are “plan assets” for purposes of Title I of ERISA. These rules are set forth at 29 CFR § 2510.3-102 (“Definition of plan assets – participant contributions”). In general, the rules provide that the assets of a plan include amounts that a participant or beneficiary pays to, or amounts that a participant has withheld from his wages by an employer, for contribution to the plan as of the earliest date on which such contributions can reasonably be segregated from the employer’s general assets.(1) With respect to pension plans, the rules also provide that in no event shall such date be later than the 15th business day of the month following the month in which the amounts were received by the employer (in the case of amounts paid to the employers) or in which the amounts would otherwise have been payable to the participant (in the case of amounts withheld by the employer from a participant’s wages).(2)

On the basis of information obtained by, and furnished to, the Department, many multiemployer defined contribution pension plans establish through collective bargaining, employer participation and similar agreements, the form, manner and timing of amounts for contributions to employee benefit plans, including participant contributions to defined contribution pension plans. Frequently, such agreements provide for contributions to be remitted to the plan at specific times, without regard to when any given participating employer might be able to mechanically segregate monies from its general assets. Such practices, therefore, have raised questions concerning the extent to which multiemployer defined contribution pension plan trustees and participating employers must disregard the terms of collective bargaining and employer participation agreements in order to ensure compliance with the terms of the plan assets - participant contribution regulation. Determining when participant contributions to a multiemployer, defined contribution plan become plan assets is critical to understanding the fiduciary obligations of plan trustees and participating employers in handling participant contributions.(3)

Analysis

In adopting changes to the plan assets – participant contribution rules in 1996, the Department recognized that plan sponsors and fiduciaries must weigh the costs and benefits, as well as risks presented to participants, of processes established for the transmittal and receipt of participant contributions.(4) In this regard, many commenters on the proposed rules, while acknowledging that participant contributions could be segregated quickly and frequently into a trust established to temporarily hold such contributions until they could be reconciled, represented that the costs of establishing and administering such a trust would be considerable, outweighing any additional benefits to participants.(5) Taking such comments into consideration, the Department indicated that, while the final rule significantly reduces the maximum period during which participant contributions may be treated as other than plan assets, the final rule “accommodates employers who are unable reasonably to segregate participant contributions from their general assets more frequently than in what appears to be a fairly standard monthly processing cycle for participant contributions to pension plans.”(6)

With regard to multiemployer plans specifically, several commenters on the proposed rules argued that, given the unique nature of such plans, multiemployer plans with participant contributions should either be exempt from the plan asset – participant contribution rules altogether or exempt from the maximum period within which contributions must be made. While the Department did not adopt either of these suggestions, the Department did determine that “the maximum time period for pension plans in the final rule was sufficient to accommodate multiemployer plans." The Department also recognized that transmission of participant contributions may be controlled by pre-existing collective bargaining agreements and, therefore, postponed the application of the final rule’s new maximum period (within which participant contributions must be transmitted to a plan) for collectively bargained pension plans.(7)

It is the view of this Office that the provisions of the participant contribution regulation apply in the same way to multiemployer plans that the provisions apply to single employer plans. That is, participant contributions deducted by or paid to an employer become plan assets as soon as they can reasonably be segregated from the employer's general assets. As is the case with single employer plans, if a multiemployer plan maintains a reasonable process for the expeditious and cost-effective receipt of contributions, this process may be taken into account in determining when participant contributions can reasonably be segregated from the employer's general assets. To the extent that a collective bargaining agreement, for example, describes such a process, then the collective bargaining agreement should be considered in determining when participant contributions become plan assets.

To be reasonable, a plan's process for receiving participant contributions should take into account how quickly the participating employers can reasonably segregate and forward contributions. The plan fiduciaries should also consider how costly to the plan a more expeditious process would be. These costs should be balanced against any additional income and security the plan and plan participants would realize from a faster system.

No matter how reasonable a pension plan's process, however, participants contributions become plan assets no later than the 15th business day of the month following the month in which the amounts were received by the employer (in the case of amounts paid to the employers) or in which the amounts would otherwise have been payable to the participant (in the case of amounts withheld by the employer from a participant’s wages). Thus neither a collective bargaining agreement, nor any other agreement between the plan and an employer, can justify a failure to comply with the maximum periods in the regulation.

Conclusion

In determining when participant contributions can reasonably be segregated from the general assets of any given contributing employer to a multiemployer defined contribution plan, it is the view of this Office that the time frames established in collective bargaining, employer participation and similar agreements must be taken into account to the extent such agreements represent the considered judgment of the plan’s trustees that such time frames reflect the appropriate balancing of the costs of transmitting, receiving and processing such contributions relative to the protections provided to participants and beneficiaries, provided that any such time frames do not extend beyond the maximum period prescribed in § 2510.3-102(b). As with other fiduciary duties, plan trustees must make such determinations prudently and solely in the interest of plans’ participants and beneficiaries.(8)

Questions concerning the information contained in this Bulletin may be directed to Louis Campagna or David Lurie, at 202.693.8510.

Footnotes

  1. See paragraph (a) of § 2510.3-102.
  2. See paragraph (b) of § 2510.3-102. Also note that paragraph (d) of § 2510.3-102 describes the circumstances under which the maximum time period may be extended.
  3. The obligation of a fiduciary to collect participant contributions from an employer is similar to the obligations of a fiduciary to collect contributions payable by an employer on its own behalf. In this respect, the Department has indicated that if a multiple employer trustee does not establish and implement collection procedures which are reasonable, diligent and systematic, it may be found to be engaging in prohibited transactions for failing to collect delinquent contributions. See section 406(a)(1)(B). Cf. Central States Pension Fund v. Central Transport, Inc., 472 U.S. 559, 574 (1985) where the Court interpreted 406(a)(1)(B) as creating a requirement that the plan trustee assure full and prompt collection of all contributions owed to the plan.
  4. See 61 Fed. Reg. at 41226.
  5. See 61 Fed. Reg. at 41222.
  6. See 61 Fed. Reg. at 41223.
  7. See 61 Fed. Reg. at 41228.
  8. The mere fact that plan settlors via collective bargaining establish specific dates for the transmittal of participant contributions does not relieve plan trustees from their fiduciary responsibility to determine that the established time frames reflect the appropriate balancing of costs and protections. If the trustees determine that time frames established in collective bargaining agreements fail to reflect the appropriate balance and, therefore, would result in an unreasonable delay in transmittal of participant contributions, the trustees must take steps to collect participant contributions from employers consistent with their fiduciary obligations.

2003-03    Allocation of Expenses in a Defined Contribution Plan

Department of Labor - Employee Benefits Security Administration
Field Assistance Bulletin 2003-3

May 19, 2003

Memorandum for:
Virginia C. Smith
Director of Enforcement, Regional Directors

From:
Robert J. Doyle
Director of Regulations and Interpretations

Subject: Allocation of Expenses in a Defined Contribution Plan

Issue: What rules apply to how expenses are allocated among plan participants in a defined contribution pension plan?

Background

A number of questions have been raised in the course of investigations and otherwise concerning the propriety of certain expense allocation practices in defined contribution plans. This memorandum is intended to respond to the various requests for guidance from the National and Regional Offices on these issues.(1)

The two principal issues raised with respect to the allocation of plan expenses in defined contribution plans involve the extent to which plan expenses are required to be allocated on a pro rata, rather than per capita, basis and the extent to which plan expenses may properly be charged to an individual participant, rather than plan participants as a whole. For purposes of discussing these issues, we assume first that the expenses at issue are proper plan expenses(2) and second that, with respect to the plan as a whole, the amount of the expenses at issue are reasonable with respect to the services to which they relate.

Analysis

ERISA contains no provisions specifically addressing how plan expenses may be allocated among participants and beneficiaries. The Act and implementing regulations, however, do address certain instances in which a plan may impose charges on particular participants and beneficiaries. For example, section 104(b)(4) provides that the plan administrator may impose a reasonable charge to cover the cost of furnishing copies of plan documents and instruments upon request of a participant or beneficiary.(3) Also, section 602 permits group health plans, subject to certain conditions, to require the payment of 102% of the applicable premium for any period of continuation coverage elected by an eligible participant or beneficiary. Further, the Department’s regulations under sections 404(c) and 408(b)(1) provide that reasonable expenses associated with a participant’s exercise of an option under the plan to direct investments or to take a participant loan may be separately charged to the account of the individual participant.(4) By contrast, regulations may limit the ability of a plan to charge a particular participant or beneficiary by requiring that information be furnished free of charge upon request of a participant or beneficiary.(5)

Section 404(a)(1) generally provides, in relevant part, that fiduciaries shall discharge their duties with respect to a plan “solely in the interest of the participants and beneficiaries,” prudently (404(a)(1)(B)), and “in accordance with the documents and instruments governing the plan insofar as such documents and instruments are consistent with the provisions of [Title I] . . . ” (404(a)(1)(D)). Plan fiduciaries, therefore, would be required to implement allocation of expense provisions set forth in the plan, unless such provisions otherwise violate Title I.

Accordingly, plan sponsors and fiduciaries have considerable discretion in determining, as a matter of plan design or a matter of plan administration, how plan expenses will be allocated among participants and beneficiaries.

Allocating Expenses Among All Participants - Pro rata v. Per capita

In analyzing formulas for allocating expenses among all plan participants, the starting point is a review of the instruments governing the plan. Inasmuch as ERISA does not specifically address the allocation of expenses in defined contribution plans, a plan sponsor, as noted above, has considerable discretion in determining the method of expense allocation. Where the method of allocating expenses is determined by the plan sponsor (i.e., set forth in the plan documents), fiduciaries, consistent with section 404(a)(1)(D), will be required to follow the prescribed method of allocation. The fiduciary’s obligation in this regard does not change merely because the allocation method favors a class (or classes) of participants. When set forth in plan documents, the method of allocating expenses, in effect, becomes part of defining the benefit entitlements under the plan.(6)

When the plan documents are silent or ambiguous on this issue, fiduciaries must select the method or methods for allocating plan expenses. A plan fiduciary must be prudent in the selection of the method of allocation. Prudence in such instances would, at a minimum, require a process by which the fiduciary weighs the competing interests of various classes of the plan’s participants and the effects of various allocation methods on those interests. In addition to a deliberative process, a fiduciary’s decision must satisfy the “solely in the interest of participants” standard. In this regard, a method of allocating expenses would not fail to be “solely in the interest of participants” merely because the selected method disfavors one class of participants, provided that a rational basis exists for the selected method.(7) On the other hand, if a method of allocation has no reasonable relationship to the services furnished or available to an individual account, a case might be made that the fiduciary breached his fiduciary duties to act prudently and “solely in the interest of participants” in selecting the allocation method. Further, in the case where the fiduciary is also a plan participant, the selection of the method of allocation may raise issues under the prohibited transaction provisions of section 406 of ERISA where the benefit to the fiduciary is more than merely incidental.(8) For example, if in anticipation of the plan fiduciary’s own divorce, the fiduciary who is also a plan participant decides to change the allocation of expenses related to a determination of whether a domestic relations order constitutes a “qualified” order from the account incurring the expense to the plan as a whole, such change in allocation by the fiduciary could constitute an act of self-dealing under section 406 of ERISA.

While a pro rata method of allocating expenses among individual accounts (i.e., allocations made on the basis of assets in the individual account) would appear in most cases to be an equitable method of allocation of expenses among participants, it is not the only permissible method. A per capita method of allocating expenses among individual accounts (i.e., expenses charged equally to each account, without regard to assets in the individual account) may also provide a reasonable method of allocating certain fixed administrative expenses of the plan, such as recordkeeping, legal, auditing, annual reporting, claims processing and similar administrative expenses. On the other hand, where fees or charges to the plan are determined on the basis of account balances, such as investment management fees, a per capita method of allocating such expenses among all participants would appear arbitrary. With regard to services which provide investment advice to individual participants, a fiduciary may be able to justify the allocation of such expenses on either a pro rata or per capita basis and without regard to actual utilization of the services by particular individual accounts. Investment advice services might also be charged on a utilization basis, as discussed below, whereby the expense will be allocated to an individual account solely on the basis of a participant’s utilization of the service.

Allocating Expenses to an Individual v. General Plan Expense

In contrast to the preceding discussion, which focused on methods of allocating plan expenses among all participants, the following discussion focuses on the extent to which an expense may be allocated (or charged) solely to a particular participant’s individual account, rather than allocated among the accounts of all participants (e.g., on a pro rata or per capita basis). The Department provided some guidance on this issue in Advisory Opinion No. 94-32A. In analyzing the extent to which a plan may charge a participant (or alternate payee) for a determination as to whether a domestic relations order constitutes a “qualified” order, the Department concluded in AO 94-32A that imposing the costs of a QDRO determination solely on the participant (or alternate payee) seeking the QDRO, rather than the plan as a whole, would violate ERISA.

Since the issuance of AO 94-32A, the Department has had an opportunity to review the Act and the opinion in the context of a broader array of plan expense allocation issues raised in the course of investigations. On the basis of this review, the Department has determined that neither the analyses or conclusions set forth in that opinion are legally compelled by the language of the statute. Except for the few instances in which ERISA specifically addresses the imposition of expenses on individual participants, the statute places few constraints on how expenses are allocated among plan participants. In this regard, the same principles applicable to determining the method of allocating expenses among all participants, as discussed above, apply to determining the permissibility of allocating specific expenses to the account of an individual participant, rather than the plan as a whole (i.e., among all participants).(9)

Examples of Specific Plan Expenses

Hardship Withdrawals. Some plans may provide for the allocation of administrative expenses attendant to hardship withdrawal distributions to the participant who seeks the withdrawal. ERISA does not specifically preclude the allocation of reasonable expenses attendant to hardship withdrawals to the account of the participant or beneficiary seeking the withdrawal.

Calculation of Benefits Payable under Different Plan Distribution Options. Some defined contribution plans may charge participants for a calculation of the benefits payable under the different distribution options available under the plan (e.g., joint and survivor annuity, lump sum, single life annuity, etc.). ERISA does not specifically preclude the allocation of reasonable expenses attendant to the calculation of benefits payable under different distribution options available under the plan to the account of the participant or beneficiary seeking the information.

Benefit Distributions. Some plans provide for the imposition of benefit distribution charges on the participant to whom the distribution is being made. These charges may be assessed for benefit distributions paid on a periodic basis (e.g., monthly check writing expenses). ERISA does not specifically preclude the allocation of reasonable expenses attendant to the distribution of benefits to the account of the participant or beneficiary seeking the distribution.

Accounts of Separated Vested Participants. Some plans, with respect to which the plan sponsor generally pays the administrative expenses of the plan, provide for the assessment of administrative expenses against participants who have separated from employment. In general, it is permissible to charge the reasonable expenses of administering a plan to the individual accounts of the plan’s participants and beneficiaries. Nothing in Title I of ERISA limits the ability of a plan sponsor to pay only certain plan expenses or only expenses on behalf of certain plan participants. In the latter case, such payments by a plan sponsor on behalf of certain plan participants are equivalent to the plan sponsor providing an increased benefit to those employees on whose behalf the expenses are paid. Therefore, plans may charge vested separated participant accounts the account’s share (e.g., pro rata or per capita) of reasonable plan expenses, without regard to whether the accounts of active participants are charged such expenses and without regard to whether the vested separated participant was afforded the option of withdrawing the funds from his or her account or the option to roll the funds over to another plan or individual retirement account.

Qualified Domestic Relations Orders (QDROs) and Qualified Medical Child Support Order (QMCSOs) Determinations. ERISA does not, in our view, preclude the allocation of reasonable expenses attendant to QDRO or QMCSO determinations to the account of the participant or beneficiary seeking the determination.(10)

It should be noted that, pursuant to 29 CFR § 2520.102-3(l), plans are required to include in the Summary Plan Description a summary of any provisions that may result in the imposition of a fee or charge on a participant or beneficiary, or the individual account thereof, the payment of which is a condition to the receipt of benefits under the plan. In addition, § 2520.102-3(l) provides that Summary Plan Descriptions must include a statement identifying the circumstances that may result in the “ . . . offset, [or] reduction . . . of any benefits that a participant or beneficiary might otherwise reasonably expect the plan to provide on the basis of the description of benefits . . .” These requirements are intended to ensure that participants and beneficiaries are apprised of fees and charges that may affect their benefit entitlements.

Questions concerning the information contained in this Bulletin may be directed to the Division of Fiduciary Interpretations, Office of Regulations and Interpretations, 202.693.8510.

Footnotes

  1. The views set forth herein relate solely to the application of Title I of ERISA. We express no view as to whether any particular allocation of expenses might violate the Internal Revenue Code or any other Federal statute.
  2. See Advisory Opinion No. 2001-01A and related hypotheticals for discussion of the principles applicable to distinguishing settlor from plan expenses.
  3. See § 29 CFR 2520.104b-30. See also § 2520.104-4(b)(2)(ii).
  4. See § 2550.404c-1(b)(2)(ii)(A) and 54 FR 30520, 30522 (July 20, 1989)(preamble to 29 CFR § 2550.408b-1).
  5. See §§ 2520.104-46(b)(1)(i)(C), 2520.104b-1(c)(1)(iii) and (iv), 2520.104b-30.
  6. If a plan is intended to be a tax qualified plan, the fiduciary would have a duty to assure that the allocation method does not negatively affect the tax qualified status of the plan.
  7. In reviewing the propriety of such fiduciary actions, the judicial standard is whether the fiduciary acted in an arbitrary or capricious manner. In meeting this standard, the fiduciary has a duty of impartiality to all the plan’s participants and may appropriately balance the interests of different classes of participants in evaluating a proposed method of expense allocation. See Varity Corp. v. Howe, 516 U.S. 489, 514 (1996); Restatement (Second) of Trusts §183.
  8. See Advisory Opinion No. 2000-10A.
  9. The views expressed herein supersede the views expressed in AO 94-32A.
  10. See footnote 9.

2004-01    Health Savings Accounts

Department of Labor - Employee Benefits Security Administration
Field Assistance Bulletin 2004-1

April 7, 2004

Memorandum for:
Virginia C. Smith
Director of Enforcement, Regional Directors

From:
Robert J. Doyle
Director of Regulations and Interpretations

Subject: Health Saving Accounts

Issue: Whether Health Savings Accounts established in connection with employment-based group health plans constitute "employee welfare benefit plans" for purposes of Title I of ERISA?

Background

Section 3(1) of the Employee Retirement Income Security Act of 1974 (ERISA) defines the term "employee welfare benefit plan" in relevant part to mean "any plan, fund, or program . . . established or maintained by an employer . . . to the extent that such plan, fund, or program was established or is maintained for the purpose of providing for its participants or their beneficiaries, through the purchase of insurance or otherwise, (A) medical, surgical, or hospital care or benefits, or benefits in the event of sickness . . . ."

Section 1201 of the Medicare Prescription Drug, Improvement, and Modernization Act of 2003, Pub. L. No. 108-173 (the Medicare Modernization Act), added section 223 to the Internal Revenue Code (Code) to permit eligible individuals to establish Health Savings Accounts (HSAs).(1) In general, HSAs are established to receive tax-favored contributions by or on behalf of eligible individuals, and amounts in an HSA may be accumulated over the years or distributed on a tax-free basis to pay or reimburse "qualified medical expenses." In order to establish an HSA, an eligible individual, among other conditions, must be covered under a High Deductible Health Plan (HDHP).(2) Contributions to an HSA established by an eligible individual who is an employee may be made by the employee, the employee's employer or both in a given year.(3) Amounts in an HSA may be rolled over to another HSA.(4) If an employer makes contributions to HSAs, the employer must make available a comparable contribution on behalf of all eligible employees with comparable coverage during the same period.(5) However, employers that make contributions to an employee's HSA are not responsible for determining whether HSAs are used for qualified medical expenses or for investing or managing amounts contributed to an employee's HSA.(6)

It is our understanding that a number of employers that currently sponsor ERISA-covered group health plans may wish to add an HDHP option and offer programs designed to enable employees to establish HSAs to pay for medical expenses not covered by the HDHP. Questions have been raised about whether, and under what circumstances, HSAs established in connection with employment-based programs would constitute "employee welfare benefit plans" within the meaning of section 3(1) of ERISA.

Analysis

Congress, in enacting the Medicare Modernization Act, recognized that HSAs would be established in conjunction with employment-based health plans and specifically provided for employer contributions. However, neither the Medicare Modernization Act nor section 223 of the Code specifically address the application of Title I of ERISA to HSAs. Based on our review of Title I, and taking into account the provisions of the Code as amended by the Medicare Modernization Act, we believe that HSAs generally will not constitute employee welfare benefit plans established or maintained by an employer where employer involvement with the HSA is limited, whether or not the employee's HDHP is sponsored by an employer or obtained as individual coverage.

Specifically, HSAs meeting the conditions of the safe harbor for group or group-type insurance programs at 29 C.F.R. § 2510.3-1(j)(1)-(4) would not be employee welfare benefit plans within the meaning of section 3(1) of ERISA.(7) Moreover, although contributions or payment of group insurance premiums by an employer would be a significant consideration in determining whether a group or group-type insurance arrangement is an employee welfare benefit plan under section 3(1), such contributions or payments are not necessarily significant in analyzing the status of HSAs under ERISA. As noted above, HSAs are personal health care savings vehicles rather than a form of group health insurance. For example, funds deposited in an HSA generally may not be used to pay health insurance premiums,(8) and the beneficiaries of the account have sole control and are exclusively responsible for expending the funds in compliance with the requirements of the Code. Because of these differences, we regard court precedent on the significance of employer contributions to group or group-type insurance arrangements as inapposite to HSAs. In the group health insurance context, the employer, whether by choosing an insurance policy or creating a self-funded program, typically establishes the type of benefits provided, the conditions for their receipt, and the manner in which claims will be adjudicated. In the context of HSAs, however, the employer may be doing little more than contributing funds to an account controlled solely by the employee.

Accordingly, we would not find that employer contributions to HSAs give rise to an ERISA-covered plan where the establishment of the HSAs is completely voluntary on the part of the employees and the employer does not: (i) limit the ability of eligible individuals to move their funds to another HSA beyond restrictions imposed by the Code; (ii) impose conditions on utilization of HSA funds beyond those permitted under the Code; (iii) make or influence the investment decisions with respect to funds contributed to an HSA; (iv) represent that the HSAs are an employee welfare benefit plan established or maintained by the employer; or (v) receive any payment or compensation in connection with an HSA.

The mere fact that an employer imposes terms and conditions on contributions that would be required to satisfy tax requirements under the Code or limits the forwarding of contributions through its payroll system to a single HSA provider (or permits only a limited number of HSA providers to advertise or market their HSA products in the workplace) would not affect the above conclusions regarding HSAs funded with employer or employee contributions, unless the employer or the HSA provider restricts the ability of the employee to move funds to another HSA beyond those restrictions imposed by the Code.

Conclusion

HSAs generally will not constitute "employee welfare benefit plans" for purposes of the provisions of Title I of ERISA. Employer contributions to the HSA of an eligible individual will not result in Title I coverage where, as discussed above, employer involvement with the HSA is limited. Finding that an HSA established by an employee is not covered by ERISA does not, however, affect whether an HDHP sponsored by the employer is itself a group health plan subject to Title I. In fact, unless otherwise exempt from Title I (e.g., governmental plans, church plans) employer-sponsored HDHPs will be employee welfare benefit plans within the meaning of ERISA section 3(1) subject to Title I.

Questions concerning this matter may be directed to Suzanne Adelman, Division of Coverage, Reporting and Disclosure at 202.693.8523.

Footnotes

  1. The U.S. Department of the Treasury and the Internal Revenue Service (IRS), which have interpretive and regulatory authority over HSAs under section 223 of the Code, issued general guidance concerning HSAs on December 22, 2003, in I.R.S. Notice 2004-2, and issued additional guidance on March 30, 2004, in I.R.S. Notice 2004-23, I.R.S. Notice 2004-25, Revenue Ruling 2004-38, and Revenue Procedure 2004-22. The Treasury/IRS guidance is available on the Internet at www.treas.gov/offices/public-affairs/hsa.
  2. See I.R.S. Notice 2004-2, Q&A Nos. 1 and 2.
  3. Id. Q&A No. 11.
  4. Id. Q&A No. 23.
  5. Id. Q&A No. 32.
  6. Id. Q&A No. 30.
  7. Regulation section 2510.3-1(j) excludes from Title I coverage certain group or group-type insurance programs. In general, such programs are excluded from coverage where there are no employer contributions, employee participation is voluntary, the employer does not endorse the program, and the employer receives no consideration in connection with the program, other than reasonable compensation for administrative services actually rendered in connection with payroll deductions. See also 29 C.F.R. § 2509.99-1 relating to payroll deduction IRAs.
  8. Although the Medicare Modernization Act excludes health insurance from the qualified medical expenses that may be paid from an HSA, there are exceptions for the payment of COBRA premiums, certain insurance for individuals over 65, long-term care insurance premiums and health insurance during periods of unemployment. Code section 223(d)(2).

2004-02    Fiduciary Duties and Missing Participants in Terminated Defined Contribution Plans

Department of Labor - Employee Benefits Security Administration
Field Assistance Bulletin 2004-02

September 30, 2004

Memorandum For:
Virginia C. Smith
Director of Enforcement, Regional Directors

From:
Robert J. Doyle
Director of Regulations and Interpretations

Subject: Fiduciary Duties and Missing Participants in Terminated Defined Contribution Plans

Issue: What does a plan fiduciary need to do in order to fulfill its fiduciary obligations under ERISA with respect to: (1) locating a missing participant of a terminated defined contribution plan; and (2) distributing an account balance when efforts to communicate with a missing participant fail to secure a distribution election?

Background

All plan assets must be distributed as soon as administratively feasible after the date of a plan termination in order to effectively complete a plan termination under Internal Revenue Code requirements.(1) Prior to any distribution, the Code requires a plan administrator to contact all participants for affirmative directions regarding distribution of their account balances.(2) This notice requirement extends to all participants, regardless of their length of service or the size of their account balances, because all participants vest in their account balances upon termination of the plan.(3)

In the context of terminated defined contribution plans, some participants may be unresponsive to written notices from plan administrators asking for direction regarding the distribution of their account balances: these participants are commonly referred to as missing participants.(4) As a result of participants’ unresponsiveness, plan administrators often are unable to effectively wind–up the plans’ financial affairs and are confronted with an array of issues related to their duties under the fiduciary responsibility provisions of ERISA to search for missing participants and distribute their benefits.

The Department has previously issued guidance to fiduciaries of terminated defined contribution plans on the handling of certain missing participant issues. However, Field Offices have, in the course of their investigations, found that plan fiduciaries use a variety of methods in searching for missing participants and distributing account balances when a search proves unsuccessful. Additional guidance, therefore, has been requested concerning the obligations of plan fiduciaries that are confronted with missing participant issues in terminated defined contribution plans.(5)

Analysis

Consistent with the requirements of section 404(a) of ERISA, a fiduciary must act prudently and solely in the interest of the plan’s participants and beneficiaries and for the exclusive purpose of providing benefits and defraying reasonable expenses of administering the plan. Also, under section 404(a)(1)(D) of ERISA, fiduciaries are required to act in accordance with the documents and instruments governing the plan insofar as such documents and instruments are consistent with the provisions of Title I and IV. Section 402(b)(4) of ERISA provides that every employee benefit plan shall specify the basis on which payments are made to and from the plan. Section 403(a) of ERISA generally requires that the assets of a plan be held in trust by a trustee. In the case of plan terminations, fiduciaries must also ensure that the allocation of any previously unallocated funds is made in accordance with the provisions of section 403(d) of ERISA.

Under Title I of ERISA, the decision to terminate a plan is generally viewed as a “settlor” decision rather than a fiduciary decision relating to the administration of the plan. However, the steps taken to implement this decision, including steps to locate missing participants, are governed by the fiduciary responsibility provisions of ERISA.(6) Further, in our view, while the distribution of the entire benefit to which a participant is entitled ends his or her status as a plan participant and the distributed assets cease to be plan assets under ERISA, a plan fiduciary’s choice of a distribution option is a fiduciary decision subject to the general fiduciary responsibility provisions of ERISA.(7)

It is our view that a plan fiduciary must take certain steps in an effort to locate a missing participant or beneficiary before the plan fiduciary determines that the participant cannot be found and distributes his or her benefits in accordance with this Bulletin. These steps are identified below under the heading “Search Methods.” It also is our view that, in determining any additional steps that may be appropriate with regard to a particular participant, a plan fiduciary must consider the size of the participant’s account balance and the expenses involved in attempting to locate the missing participant. Accordingly, the specific steps that a plan fiduciary takes to locate a missing participant may vary depending on the facts and circumstances. This consideration of additional steps is discussed below under the heading “Other Search Options.” Reasonable expenses attendant to locating a missing participant may be charged to a participant’s account, provided that the amount of the expenses allocated to the participant’s account is reasonable and the method of allocation is consistent with the terms of the plan and the plan fiduciary’s duties under ERISA.(8) Whatever decisions are made in connection with locating of missing participants or the distribution of assets on their behalf, plan fiduciaries must be able to demonstrate compliance with ERISA’s fiduciary standards.

Search Methods

In the context of a defined contribution plan termination, one of the most important functions of the plan’s fiduciaries is to notify participants of the termination and of the plan’s intention to distribute benefits. In most instances, routine methods of delivering notice to participants, such as first class mail or electronic notification, will be adequate. In the event that such methods fail to obtain from the participant the information necessary for the distribution, or the plan fiduciary has reason to believe that a participant has failed to inform the plan of a change in address, plan fiduciaries need to take other steps to locate the participant or a beneficiary. In our view, some search methods involve such nominal expense and such potential for effectiveness that a plan fiduciary must always use them, regardless of the size of the participant’s account balance. A plan fiduciary cannot distribute a missing participant’s benefits in accordance with the distribution options discussed below unless each of these methods proves ineffective in locating the missing participant. However, a plan fiduciary is not obligated to take each of these steps if one or more of them are successful in locating the missing participant. These methods are:

Use Certified Mail. Certified mail can be used to easily ascertain, at little cost, whether the participant can be located in order to distribute benefits.

Check Related Plan Records. While the records of the terminated plan may not have current address information, it is possible that the employer or another plan of the employer, such as a group health plan, may have more up-to-date information with respect to a given participant or beneficiary. For this reason, plan fiduciaries of the terminated plan must ask both the employer and administrator(s) of related plans to search their records for a more current address for the missing participant. If there are privacy concerns, the plan fiduciary that is engaged in the search can request the employer or other plan fiduciary to contact or forward a letter on behalf of the terminated plan to the participant or beneficiary, requesting the participant or beneficiary to contact the plan fiduciary.

Check With Designated Plan Beneficiary. In connection with a search of the terminated plan’s records or the records of related plans, plan fiduciaries must attempt to identify and contact any individual that the missing participant has designated as a beneficiary (e.g., spouse, children, etc.) for updated information concerning the location of the missing participant. Again, if there are privacy concerns, the plan fiduciary can request the designated beneficiary to contact or forward a letter on behalf of the terminated plan to the participant, requesting the participant or beneficiary to contact the plan fiduciary.

Use A Letter-Forwarding Service. Both the Internal Revenue Service (IRS) and the Social Security Administration (SSA) offer letter-forwarding services. Plan fiduciaries must choose one service and use it in attempting to locate a missing participant or beneficiary. The IRS has published guidelines under which it will forward letters for third parties for certain “humane purposes,” including a qualified plan administrator’s attempt to locate and pay a benefit to a plan participant.(9) The SSA’s letter forwarding service may be used for similar purposes, and is described on the SSA’s Web site.(10) It is our understanding that to use either the IRS or SSA program, the plan fiduciary/requestor must submit a written request for letter forwarding to the agency, and must provide the missing participant’s social security number or certain other identifying information. Both the IRS and SSA will search their records for the most recent address of the missing participant and will forward a letter from the plan fiduciary/requestor to the missing participant if appropriate. In using these letter-forwarding services to notify a missing participant that he or she is entitled to a benefit, the plan fiduciary’s letter should provide contact information for claiming the benefit. This notice may also suggest a date by which the participant must respond, as neither the IRS nor the SSA will notify the plan fiduciary as to whether the participant was located.

Other Search Options

In addition to using the search methods discussed above, a plan fiduciary should consider the use of Internet search tools, commercial locator services, and credit reporting agencies to locate a missing participant. Depending on the facts and circumstances concerning a particular missing participant, it may be prudent for the plan fiduciary to use one or more of these other search options. If the cost of using these services will be charged to the missing participant’s account, plan fiduciaries will need to consider the size of the participant’s account balance in relation to the cost of the services when deciding whether the use of such services is appropriate.

Distribution Options

There will be circumstances when, despite their use of the search methods described above, plan fiduciaries will be unable to locate participants or otherwise obtain directions concerning the distribution of their benefits from terminated defined contribution plans. In these circumstances, plan fiduciaries will nonetheless have to consider distribution options in order to effectuate the termination of the plan.(11) We have set forth below the fiduciary considerations that are relevant to the various options available to plan fiduciaries in the context of missing participants of terminated defined contribution plans.

Individual Retirement Plan Rollovers - In our view, plan fiduciaries must always consider distributing missing participant benefits into individual retirement plans (i.e., an individual retirement account or annuity).(12) Establishing an individual retirement plan is the preferred distribution option because it is more likely to preserve assets for retirement purposes than any of the other identified options.

Distribution to an individual retirement plan preserves retirement assets because it results in a deferral of income tax consequences for missing participants. A distribution that qualifies as an eligible rollover distribution(13) from a qualified plan, which is handled by a trustee to trustee transfer into an individual retirement plan, will not be subject to immediate income taxation, the 20 percent mandatory income tax withholding requirement, or the 10 percent additional tax for premature distributions that may be required based on the participant’s age and related facts.(14)

As we have noted in other contexts, the choice of an individual retirement plan also raises fiduciary issues as to the particular choice of an individual retirement plan trustee, custodian or issuer as well as the selection of an initial individual retirement plan investment to receive the distribution.(15) By regulation, the Department established a safe harbor for plan fiduciaries to satisfy their fiduciary responsibility under section 404(a) of ERISA when selecting individual retirement plan providers and initial investments in connection with the rollover of certain mandatory distributions to individual retirement plans.(16) In general, this regulation applies to distributions of $5,000 or less for separating participants who leave an employer's workforce without making an election to either receive a taxable cash distribution or directly roll over assets into an individual retirement plan or another qualified plan.

In our view, the circumstances giving rise to relief under this safe harbor regulation are similar to those confronting fiduciaries of terminated defined contribution plans. Therefore, in the context of making distributions from terminated defined contribution plans on behalf of participants who are determined to be missing or otherwise fail to elect a method of distribution in connection with the termination, fiduciaries who choose investment products that are designed to preserve principal should, as an enforcement matter, be treated as satisfying their fiduciary duties in connection with such distributions, when the fiduciary complies with the relevant requirements of the automatic rollover safe harbor regulation, without regard to the amount involved in the rollover distribution.(17)

Alternative Arrangements - If a plan fiduciary is unable to locate an individual retirement plan provider that is willing to accept a rollover distribution on behalf of a missing participant, plan fiduciaries may consider either establishing an interest-bearing federally insured bank account in the name of a missing participant or transferring missing participants’ account balances to state unclaimed property funds. In this regard, fiduciaries should be aware that transferring a participant’s benefits to either a bank account or state unclaimed property fund will subject the deposited amounts to income taxation, mandatory income tax withholding and a possible additional tax for premature distributions. Moreover, interest accrued would also be subject to income taxation. Plan fiduciaries should not use 100% income tax withholding as a means to distribute plan benefits to missing participants.

Federally Insured Bank Accounts - Plan fiduciaries may consider establishing an interest bearing federally insured bank account in the name of a missing participant, provided the participant would have an unconditional right to withdraw funds from the account. In selecting a bank and accepting an initial interest rate, with or without a guarantee period, a plan fiduciary must give appropriate consideration to all available information relevant to such selection and interest rate, including associated bank charges.

Escheat To State Unclaimed Property Funds - As an alternative, plan fiduciaries may also consider transferring missing participants’ account balances to state unclaimed property funds in the state of each participant’s last known residence or work location. We understand that some states accept such distributions on behalf of missing participants. We also understand that states often provide searchable Internet databases that list the names of property owners and, in some instances, award minimal interest on unclaimed property funds.

In prior guidance, the Department concluded that, if a state unclaimed property statute were applied to require an ongoing plan to pay to the state amounts held by the plan on behalf of terminated employees, the application of that statute would be preempted by section 514(a) of ERISA.(18) However, we do not believe that the principles set forth in Advisory Opinion 94-41A, which dealt with a plan fiduciary’s duty to preserve plan assets held in trust for an ongoing plan, prevent a plan fiduciary from voluntarily deciding to escheat missing participants’ account balances under a state’s unclaimed property statute in order to complete the plan termination process.

Additionally, we believe that a plan fiduciary’s transfer of a missing participant’s account balance from a terminated defined contribution plan to a state’s unclaimed property fund would constitute a plan distribution, which ends both the property owner’s status as a plan participant and the property’s status as plan assets under ERISA.(19)

In deciding between distribution into a state unclaimed property fund and distribution into a federally insured bank account, we believe that a plan fiduciary should evaluate any interest accrual and fees associated with a bank account against the availability of the state unclaimed property fund’s searchable database that may facilitate the potential for recovery. In any event, transfer to state unclaimed property funds must comply with state law requirements.

100% Income Tax Withholding - We are aware that some plan fiduciaries believe that imposing 100% income tax withholding on missing participant benefits, in effect transferring the benefits to the IRS, is an acceptable means by which to deal with the benefits of missing participants. After reviewing this option with the staff of the Internal Revenue Service, we have concluded that the use of this option would not be in the interest of participants and beneficiaries and, therefore, would violate ERISA’s fiduciary requirements. Based on discussions with the IRS staff and our understanding of the IRS’s current data processing, the 100% withholding distribution option would not necessarily result in the withheld amounts being matched or applied to the missing participants’/taxpayers’ income tax liabilities resulting in a refund of the amount in excess of such tax liabilities.(20) This option, therefore, should not be used by plan fiduciaries as a means to distribute benefits to plan participants and beneficiaries.

Miscellaneous Issues

Fiduciaries have expressed concerns about legal impediments that might hinder the establishment of individual retirement plans or bank accounts on behalf of missing participants. These impediments include perceived conflicts with the customer identification and verification provisions of the USA PATRIOT Act (Act).(21) With regard to this problem, we note that Treasury staff, along with the staff of the other Federal functional regulators,(22) has issued helpful guidance for fiduciaries that are establishing an individual retirement plan or federally insured bank account in the name of a missing participant. This guidance was published in a set of questions and answers on the customer identification and verification provision (CIP) of the Act, “FAQs: Final CIP Rule,” on the regulators’ Web sites.(23)

The Federal functional regulators advised the Department that they interpret the CIP requirements of section 326 of the Act and implementing regulations to require that banks and other financial institutions implement their CIP compliance program with respect to an account (including an individual retirement plan or federally insured bank account) established by an employee benefit plan in the name of a former participant (or beneficiary) of such plan, only at the time the former participant or beneficiary first contacts such institution to assert ownership or exercise control over the account. CIP compliance will not be required at the time an employee benefit plan establishes an account and transfers the funds to a bank or other financial institution for purposes of a distribution of benefits from the plan to a separated employee.

With regard to the application of state laws, including those governing signature requirements and escheat, we note that such issues are beyond the Department’s jurisdiction.

Conclusion

Actions taken to implement the decision to terminate a plan, including the search for missing participants, and if search efforts fail, the selection of a distribution option for the benefits of missing participants, are governed by the fiduciary responsibility provisions of ERISA. In fulfilling their duties of prudence and loyalty to missing participants, we believe there are certain search methods which involve such nominal expense and potential for effectiveness that fiduciaries must always use them, regardless of the size of the account balance, as discussed in detail above.

We also believe that these duties require that fiduciaries consider establishing individual retirement plans as the preferred method of distribution for the benefits of missing participants. In this regard, the selection of an individual retirement plan provider and the initial investment for an individual retirement plan also constitute fiduciary decisions. If plan fiduciaries are unable to locate an individual retirement plan provider that is willing to accept a rollover distribution, fiduciaries may consider distributing a missing participant’s benefits into a federally insured bank account or transferring a missing participant’s benefit to a state unclaimed property fund; the factors to be considered in choosing between these options are discussed more fully above.

Questions concerning the information contained in this Bulletin may be directed to the Division of Fiduciary Interpretations, Office of Regulations and Interpretations, 202.693.8510.

Footnotes

  1. See Rev. Rul. 89-87, 1989-2 C.B. 81.
  2. Under Internal Revenue Code (Code) §402(f), a plan administrator is required, prior to making an eligible rollover distribution, to provide the participant with a written explanation of the Code provisions under which the participant may elect to have the distribution transferred directly to an IRA or another qualified plan, the provision requiring tax withholding if the distribution is not directly transferred and the provisions under which the distribution will not be taxed if the participant transfers the distribution to an IRA or another qualified plan within 60 days of receipt.
  3. Under Code §411(d)(3), a plan must provide that, upon its termination or complete discontinuance of contributions, benefits accrued to the date of termination or discontinuance of contributions become vested to the extent funded on such date.
  4. The Department notes that this guidance applies only in the context of terminated defined contribution plans. For rules governing the Pension Benefit Guaranty Corporation's missing participants program, which applies to terminated defined benefit plans covered by Title IV of ERISA, see ERISA § 4050 and 29 CFR § 4050.
  5. This guidance assumes that the terminated plan does not provide an annuity option and that no other appropriate defined contribution plans are maintained within the sponsoring employer’s corporate group to which account balances from the terminated plan could be transferred..
  6. See Advisory Opinion 2001-01A (Jan. 18, 2001); see also Letter to John N. Erlenborn from Dennis M. Kass (Mar. 13, 1986).
  7. See Rev. Rul. 2000-36 where the Department stated that the selection of an IRA trustee, custodian or issuer and of an IRA investment for purposes of a default rollover pursuant to a plan provision would constitute a fiduciary act under ERISA.
  8. See generally Field Assistance Bulletin 2003-3 (May 19, 2003) for the Department’s views with respect to expense allocations in defined contribution plans. See also Rev. Rul. 2004-10, 2004-7 I.R.B. (Jan. 29, 2004).
  9. See Rev. Proc. 94-22, 1994-1 C.B. 608; IRS Policy Statement P-1-187.
  10. The Social Security Administration’s Web site is found at www.ssa.gov.
  11. See supra footnote 1.
  12. Code §7701(a)(37) defines an "individual retirement plan" to mean an individual retirement account described in Code §408(a) and an individual retirement annuity described in Code §408(b).
  13. An "eligible rollover distribution" is, subject to certain limited exceptions, any distribution to an employee of all or any portion of the balance to the credit of the employee in a qualified trust. See Code §402(c) and (f)(2)(A).
  14. Code §402(a), §3405(c), and §72(t).
  15. See supra footnote 6.
  16. See 29 C.F.R. §2550.404a-2.
  17. It should be noted that Class Exemption (PTE No. 2004-16) generally provides relief from ERISA’s prohibited transaction provisions for a plan fiduciary’s selection of itself as the provider of an individual retirement plan and/or issuer of an investment in connection with rollovers of missing participant accounts for amounts up to $5,000.
  18. Advisory Opinion 94-41A (Dec. 7, 1994).
  19. Prior Departmental Advisory Opinions addressed distributions from ongoing plans. See, e.g., Advisory Opinion 94-41A (Dec. 7, 1994); Advisory Opinion 79-30A (May 14, 1979); Advisory Opinion 78-32A (Dec. 22, 1978). We note, however, that this memorandum addresses only distributions that complete the termination of defined contribution plans.
  20. See, e.g., Code section 6511 (regarding the time limitations for taxpayer refunds).
  21. Pub. L. No. 107-56, Oct. 26, 2001, 115 Stat. 272.
  22. The term “other Federal functional regulators” refers to the other agencies responsible for administration and regulations under the Act.
  23. See “FAQs: Final CIP Rule” at:
    https://www.occ.gov/news-issuances/news-releases/2005/nr-occ-2005-42a.pdf
    https://www.occ.gov/news-issuances/news-releases/2009/nr-ia-2009-65a.pdf
    https://www.fdic.gov/news/financial-institution-letters/2004/FIL0404a.html

2004-03    Fiduciary Responsibilities of Directed Trustees

Department of Labor - Employee Benefits Security Administration
Field Assistance Bulletin 2004-03

December 17, 2004

Memorandum For:
Virginia C. Smith
Director of Enforcement, Regional Directors

From:
Robert J. Doyle
Director of Regulations and Interpretations

Subject: Fiduciary Responsibilities Of Directed Trustees

Issue: In the context of publicly traded securities, what are the fiduciary responsibilities of a directed trustee?

Background

Many employee pension plans use directed trustees to carry out transactions according to instructions from a named fiduciary of the plan. During investigations of such transactions by the Department, difficult questions may arise regarding the scope of the directed trustee’s fiduciary duties. Recent court decisions, addressing this issue in the context of purchases and holdings of publicly traded employer securities in particular, have focused attention on the nature and scope of a directed trustee’s fiduciary duties. This bulletin provides general guidance to EBSA regional offices regarding the Department’s views on the responsibilities of directed trustees under ERISA, particularly with respect to directions involving employer securities.

Fiduciary Status Of Directed Trustee

Section 403(a) provides that a plan trustee “shall have exclusive authority and discretion to manage and control the assets of the plan.” Section 3(21)(A) provides that a person is a fiduciary with respect to a plan “to the extent . . . he . . . exercises any authority or control respecting management or disposition of its assets.” A plan trustee, therefore, will, by definition, always be a “fiduciary” under ERISA as result of its authority or control over plan assets. Not all trustees, however, have the same authority or discretion to manage or control the assets of a plan. In this regard, section 403(a) specifically recognizes that a trustee or trustees will have limited authority or discretion when:

(1) the plan expressly provides that the trustee or trustees are subject to the direction of a named fiduciary who is not a trustee, in which case the trustees shall be subject to proper directions of such fiduciary which are made in accordance with the terms of the plan and which are not contrary to this Act.

While section 403(a)(1) does not remove a directed trustee from section 3(21)’s purview, it significantly limits such a trustee’s responsibilities as a plan fiduciary. As the district court in In re Enron Corp. Securities, Derivative & ERISA Litig., 284 F. Supp. 2d 511, 601 (S.D. Tex. 2003), recognized:

At least some fiduciary status and duties of a directed trustee are preserved, even though the scope of its exclusive authority and discretion to manage and control the assets of the plan’ has been substantially constricted by the directing named fiduciary’s correspondingly broadened role . . . .

The court in In re WorldCom, Inc. ERISA Litig., 263 F. Supp. 2d 745, 762 (S.D.N.Y. 2003) also noted that, while the directed trustee provision serves as a limiting principle, “section 403(a) does not . . . eliminate the fiduciary status or duties that normally adhere to a trustee with responsibility over ERISA assets.” See also FirsTier Bank, N.A. v. Zeller, 16 F.3d 907, 9110 (8th Cir.), cert. denied sub nom, Vercoe v. FirsTier Bank, N.A., 513 U.S. 871 (1994); Herman v. NationsBank Trust Co., 126 F.3d 1354, 1361-62, 1370 (11th Cir. 1997).

The duties of a directed trustee under section 403(a)(1) are therefore significantly narrower than the duties generally ascribed to a discretionary trustee under common law trust principles.(1)

Determining Whether A Direction Is "Proper"

Under section 403(a)(1), a directed trustee is subject to proper directions of a named fiduciary. For purposes of section 403(a)(1), a direction is proper only if the direction is “made in accordance with the terms of the plan” and “not contrary to the Act [ERISA].” Accordingly, when a directed trustee knows or should know that a direction from a named fiduciary is not made in accordance with the terms of the plan or is contrary to ERISA, the directed trustee may not, consistent with its fiduciary responsibilities, follow the direction.

In accordance with plan terms

Under section 403(a)(1), a directed trustee may not follow a direction that the trustee knows or should know is inconsistent with the terms of the plan. In order to make such determinations, directed trustees necessarily have a duty to request and review all the documents and instruments governing the plan that are relevant to its duties as directed trustee. Accordingly, if a directed trustee either fails to request such documents or fails to review the documents furnished in response to its request and, as a result of such failure, follows a direction contrary to the terms of the plan, the directed trustee may be liable for following such direction because the directed trustee had a duty to request and review pertinent plan documents and, therefore, should have known that the direction was not in accordance with the terms of the plan. If a directed trustee follows an improper direction, as would be the case where the purchase of a particular stock at the direction of the plan’s named fiduciary is contrary to the plan’s investment policy, the directed trustee may be liable for a breach of its fiduciary duty to follow only proper directions.

It is the view of the Department that a direction is consistent with the terms of a plan if the documents pursuant to which the plan is established and operated do not prohibit the direction. It is also the view of the Department that if, in the course of reviewing the propriety of a particular direction, a directed trustee determines that the terms of the relevant documents are ambiguous with respect to the permissibility of the direction, the directed trustee should obtain a clarification of the plan terms from the fiduciary responsible for interpreting such terms in order to ensure that the direction is proper. In this regard, the directed trustee may rely on the interpretation of such fiduciary.

Not contrary to ERISA

Even when a direction is consistent with the terms of the plan, the direction may nonetheless fail to be a proper direction because it is contrary to ERISA. Under section 403(a)(1), a directed trustee may not follow a direction that the trustee knows or should know is contrary to ERISA. For example, the directed trustee cannot follow a direction that the directed trustee knows or should know would require the trustee to engage in a transaction prohibited under section 406 or violate the prudence requirement of section 404(a)(1). The following discussion further clarifies the duties of a directed trustee in this area.

Prohibited transaction determinations

A directed trustee must follow processes that are designed to avoid prohibited transactions. A directed trustee could satisfy its obligation by obtaining appropriate written representations from the directing fiduciary that the plan maintains and follows procedures for identifying prohibited transactions and, if prohibited, identifying the individual or class exemption applicable to the transaction. A directed trustee may rely on the representations of the directing fiduciary unless the directed trustee knows that the representations are false.

Prudence determinations

The named fiduciary has primary responsibility for determining the prudence of a particular transaction, whether the transaction involves buying, selling or holding particular assets. Accordingly, as the courts and the Department have long recognized, the scope of a directed trustee’s responsibility is significantly limited. A directed trustee does not, in the view of the Department, have an independent obligation to determine the prudence of every transaction. The directed trustee does not have an obligation to duplicate or second-guess the work of the plan fiduciaries that have discretionary authority over the management of plan assets and does not have a direct obligation to determine the prudence of a transaction. See In re WorldCom ERISA Litig., 263 F. Supp. 2d at 761; Herman v. NationsBank Trust Co., 126 F.3d at 1361-62, 1371 (directed trustee does not have a direct obligation of prudence under ERISA section 404; its obligation is simply “to make sure” the “directions were proper, in accordance with the terms of the plan, and not contrary to ERISA”).

Duty to act on non-public information

The directed trustee’s obligation to question market transactions involving publicly traded stock on prudence grounds is quite limited. The primary circumstance in which such an obligation could arise is when the directed trustee possesses material non-public information regarding a security. If a directed trustee has material non-public information that is necessary for a prudent decision, the directed trustee, prior to following a direction that would be affected by such information, has a duty to inquire about the named fiduciary’s knowledge and consideration of the information with respect to the direction. For example, if a directed trustee has non-public information indicating that a company’s public financial statements contain material misrepresentations that significantly inflate the company’s earnings, the trustee could not simply follow a direction to purchase that company’s stock at an artificially inflated price.

Generally, the possession of non-public information by one part of an organization will not be imputed to the organization as a whole (including personnel providing directed trustee services) where the organization maintains procedures designed to prevent the illegal disclosure of such information under securities, banking or other laws.(2) If, despite such procedures, the individuals responsible for the directed trustee services have actual knowledge of material non-public information, the directed trustee, prior to following a direction that would be affected by such information, has a duty, as indicated above, to inquire about the named fiduciary’s knowledge and consideration of the information with respect to the direction. Similarly, if the directed trustee performs an internal analysis in which it concludes that the company’s current financial statements are materially inaccurate, the directed trustee would have an obligation to disclose this analysis to the named fiduciary before making a determination whether to follow a direction to purchase the company’s security. The directed trustee would not have an obligation to disclose reports and analyses that are available to the public.

Duty to act on public information

Absent material non-public information, a directed trustee, given its limited fiduciary duties as determined by statute, will rarely have an obligation under ERISA to question the prudence of a direction to purchase publicly traded securities at the market price solely on the basis of publicly available information. Three considerations counsel in favor of this view: (1) markets generally are assumed to be efficient so that stock prices reflect publicly available information and known risks; (2) in the case of employer securities, the securities laws impose substantial obligations on the company, its officers, and its accountants to state their financial records accurately; and (3) ERISA section 404 requires the instructing fiduciary to adhere to a stringent standard of care.(3) Furthermore, because stock prices fluctuate as a matter of course, even a steep drop in a stock’s price would not, in and of itself, indicate that a named fiduciary’s direction to purchase or hold such stock is imprudent and, therefore, not a proper direction.

In limited, extraordinary circumstances, where there are clear and compelling public indicators, as evidenced by an 8-K filing with the Securities and Exchange Commission (SEC), a bankruptcy filing or similar public indicator, that call into serious question a company’s viability as a going concern,(4) the directed trustee may have a duty not to follow the named fiduciary’s instruction without further inquiry.(5) For example, if a company filed for bankruptcy under circumstances which make it unlikely that there would be any distribution to equity-holders, or otherwise publicly stated that it was unlikely to survive the bankruptcy proceedings in a manner that would leave current equity-holders with any value, the directed trustee would have an obligation to question whether the named fiduciary has considered the prudence of the direction.(6) It also is the view of the Department that, in situations where a fiduciary who is a corporate employee gives an instruction to buy or hold stock of his or her company subsequent to the company, its officers or directors, being formally charged by state or Federal regulators with financial irregularities, the directed trustee, taking such facts into account, may need to decline to follow the direction or may need to conduct an independent assessment of the transaction in order to assure itself that the instruction is consistent with ERISA.(7) If, however, an independent fiduciary was appointed to manage the plan’s investment in company stock, a directed trustee could follow the proper directions of the independent fiduciary without having to conduct its own independent assessment of the transaction.

Effect Of Questioning Directions On Fiduciary Status

It is the view of the Department that the nature and scope of a directed trustee’s fiduciary responsibility, as discussed herein, does not change merely because the directed trustee, in carrying out its duties, raises questions concerning whether a direction is “proper” or declines to follow a direction that the directed trustee does not believe is a proper direction within the meaning of section 403(a)(1). For example, information provided to a named fiduciary concerning the prudence of a direction is not investment advice for purposes of ERISA §3(21)(A)(ii). Similarly, if a named fiduciary changes a direction in response to a directed trustee’s inquiries or information, the directed trustee’s fiduciary responsibility with respect to the changed direction remains governed by section 403(a)(1). The directed trustee does not become primarily responsible for the prudence of the direction.

Co-Fiduciary Duties

Under ERISA section 405(a)(1), a fiduciary is liable for the breach of another fiduciary if the fiduciary “participates knowingly” in the breach of the other fiduciary. Accordingly, if a directed trustee has knowledge of a fiduciary breach, the directed trustee may be liable as a co-fiduciary unless the directed trustee takes reasonable steps to remedy the breach. Thus, if the directed trustee knew that the named fiduciary was failing to discharge its obligations in accordance with ERISA’s requirements, it could not simply follow directions from the breaching fiduciary. Efforts to remedy a breach (or to prevent an imminent breach) may include reporting the breach to other fiduciaries of the plan or the Department of Labor.

Conclusion

Although its responsibilities are significantly limited under the statute, a directed trustee is a fiduciary under ERISA and must exercise its duties prudently and solely in the interest of the plan participants and beneficiaries. Particularly in the context of purchasing, selling or holding publicly traded securities on a generally recognized market, the trustee may follow the named fiduciary’s directions absent extraordinary circumstance as discussed above.

Footnotes

  1. It is assumed for purposes of this guidance that discretionary authority or control over plan assets, beyond that discussed herein as applicable to a person serving as a directed trustee under section 403(a)(1), has not been conferred upon a directed trustee under the terms of the plan, including trust and service provider agreements.
  2. The Department expresses no view as to whether, or under what circumstances, other procedures established by an organization to limit the disclosure of information will serve to avoid the imputation of information to a directed trustee.
  3. It should be noted that, in the case of an individual account plan, the diversification requirements of section 404(a)(1)(C) do not apply to the acquisition or holding of qualifying employer securities within the meaning of section 407(d)(5).
  4. We note that section 409 of the Sarbanes-Oxley Act of 2002, 15 U.S.C. 78(m)(l), requires public companies to disclose “on a rapid and current basis” material information regarding changes in the company’s financial condition or operations as the SEC by rule determines to be necessary or useful for the protection of investors or in the public interest. The SEC has recently updated its disclosure requirements related to Form 8-K, expanding the number of reportable events and shortening the filing deadline for most items to four business days after the occurrence of the event triggering the disclosure requirements of the form. 69 FR. 15594 (Mar. 25, 2004). Not all 8-K filings regarding a company would trigger a duty on the part of a directed trustee to question a direction to purchase or hold securities of that company. Only those relatively few 8-Ks that call into serious question a company’s ongoing viability may trigger a duty on the part of the directed trustee to take some action.
  5. A directed trustee’s actual knowledge of media or other public reports or analyses that merely speculate on the continued viability of a company does not, in and of itself, constitute knowledge of clear and compelling evidence concerning the company sufficient to give rise to a directed trustee’s duty to act.
  6. Even under such circumstances, it might not be imprudent to purchase or hold stock in a distressed company in bankruptcy. There may be situations in which the plan’s fiduciaries could reasonably conclude that the stock investment makes sense, even for a long-term investor, in light of the proposed restructuring of the company’s debts or other factors.
  7. Nothing in the text should be read to suggest that a directed trustee would have a heightened duty whenever a regulatory body opens an investigation of a company whose securities are the subject of a direction, merely based on the bare fact of the investigation.

2006-01    The Distribution to Plans of Settlement Proceeds Relating to Late Trading and Market Timing

Department of Labor - Employee Benefits Security Administration
Field Assistance Bulletin No. 2006-01

Date: April 19, 2006

Memorandum For:
Virginia C. Smith
Director of Enforcement, Regional Directors

From:
Robert J. Doyle
Director of Regulations and Interpretations

Subject: The Distribution To Plans Of Settlement Proceeds Relating To Late Trading And Market-Timing

Issue: What are the duties and responsibilities under ERISA of independent distribution consultants (IDCs), plan service-providers and fiduciaries with respect to the allocation and distribution of mutual fund settlement proceeds to plans and plan participants?

Background

Pursuant to Orders entered by the Securities and Exchange Commission (SEC) in several SEC enforcement matters alleging late trading and market timing activities, SEC distribution funds have been created for the purpose of making distributions to investors who suffered losses as a result of the conduct alleged in the matters. For each relevant mutual fund or series of funds, an independent distribution consultant (IDC) has been or will be appointed pursuant to SEC Orders to establish a plan to distribute the monies from the settlement fund to appropriate fund shareholders, subject to the SEC’s approval.

A number of ERISA-covered plans will be entitled to settlement proceeds by virtue of their mutual fund investments. In some cases, plans will be the shareholder of record and receive their settlement distribution directly from the settlement fund. In other cases, an intermediary, e.g., a broker-dealer, underwriter, and/or record-keeper, will be the shareholder of record and plans, as well as non-plan investors, will receive their settlement distribution based on their interest in an “omnibus account” operated by the intermediary. When an intermediary is involved, we understand that distribution plans may provide an intermediary with the option of either receiving the settlement proceeds in a lump sum and making the requisite distribution of proceeds to the individual investors in its omnibus account or providing the IDC the necessary client and transaction records, based on which the IDC will make distributions to the individual investors. In other instances, we understand that distribution plans will provide that the IDC will allocate and distribute settlement proceeds directly to all beneficial shareholders, including plans.

Under certain settlement agreements, mutual fund companies or settling parties may agree to pay the costs associated with allocations and distributions made by the IDCs with respect to omnibus account clients of intermediaries. However, in most instances it is anticipated that settlements will not provide for the costs associated with allocations among plans or, at the plan level, among plan participants and beneficiaries.

A number of issues have been raised by IDCs, intermediaries, plan sponsors, plan-level fiduciaries, and others regarding the application of ERISA’s fiduciary responsibility rules to the distribution and allocation of these settlement proceeds. Among the issues raised are questions about whether and/or when settlement proceeds will become “plan assets” under ERISA and when an intermediary or other plan service-provider may become a “fiduciary” by virtue of its receipt and investment of such proceeds. Other issues concern the duties of a plan fiduciary with respect to the allocation of such proceeds among plans and participants and beneficiaries.

This bulletin provides general guidance to EBSA regional offices regarding the Department’s views on the application of ERISA’s fiduciary rules to parties involved in the distribution and allocation of mutual fund settlement proceeds to employee benefit plans and among the participants and beneficiaries of such plans.

Analysis

Independent Distribution Consultants (IDCs) – Allocation among shareholders

In light of the fact that some ERISA-covered employee benefit plans, as investors in the relevant mutual funds, will be entitled to a portion of the mutual fund settlement proceeds, questions have been raised as to whether an IDC, in developing and implementing a distribution plan, is subject to ERISA’s fiduciary rules. It is the view of the Department that the development and implementation of settlement fund distribution plans will not, in and of itself, cause an IDC to become a fiduciary under ERISA.

Section 3(21) of ERISA defines a fiduciary as one who has or exercises discretionary authority or control in the administration or management of an employee benefit plan or exercises any authority or control respecting management or disposition of its assets. In determining whether particular funds constitute plan assets, the Department has issued regulations describing what constitutes plan assets with respect to a plan’s investment in other entities and with respect to participant contributions. See 29 C.F.R. § § 2510.3-101 and 2510.3-102. The Department also has indicated that the assets of an employee benefit plan generally are to be identified in other situations on the basis of “ordinary notions of property rights.”

As discussed above, IDCs are appointed pursuant to SEC Orders to establish a plan to distribute the monies from the settlement fund to affected shareholders, and prior to implementation, distribution plans must be approved by the SEC. The IDC, in this capacity, has not been engaged to act on behalf of an employee benefit plan or plans and is not an agent of the plans. Moreover, we have been informed by the SEC that no mutual fund investor, including employee benefit plan investors, has an interest in or claims against settlement fund proceeds prior to their distribution to the affected shareholders. For these reasons, in our view, under the regulations and applying ordinary notions of property rights, settlement fund proceeds, in whole or in part, would not constitute plan assets prior to their distribution by an IDC to affected plan shareholders or intermediaries acting on their behalf. Accordingly, an IDC, in developing and implementing a distribution plan, would not be exercising any authority or control in the administration or management of an employee benefit plan or its assets. Therefore, the development and implementation of settlement fund distribution plans will not, in and of itself, cause an IDC to become a fiduciary under ERISA.

This conclusion would not be affected by the fact that the IDC, as part of its distribution plan, applied a de minimis threshold for determining which shareholders, including plans, received distributions, or imposed conditions on the receipt of a distribution, such as conditioning receipt on the use of a particular allocation methodology at the participant-level or furnishing a report to the IDC on how the distributed funds were allocated among participants.

Intermediaries – Allocation among omnibus account clients

Unlike IDCs acting under the auspices of the SEC, intermediaries, in receiving settlement fund proceeds, will be acting on behalf of their omnibus account clients, including employee benefit plan clients. The omnibus account clients, therefore, will have a beneficial interest in the settlement fund proceeds received by the intermediary, without regard to whether determinations have been made as to the specific entitlement of each omnibus account client. Accordingly, applying ordinary notions of property rights, settlement fund proceeds received by intermediaries on behalf of employee benefit plan clients will constitute plan assets and, as such, will be required to be held in trust and managed in accordance with the fiduciary responsibility provisions of Part 4 of Title I of ERISA.

Without regard to whether an intermediary was a fiduciary with respect to an employee benefit plan prior to receiving a distribution of settlement proceeds, an intermediary receiving proceeds on behalf of an employee benefit plan would, in the view of the Department, be assuming fiduciary responsibilities upon receipt of such proceeds as a result of having discretionary authority or control respecting administration or management of an ERISA plan or exercising any authority or control respecting management or disposition of plan assets. The Department notes that the decision by an intermediary, who is not otherwise a fiduciary, to decline to receive a settlement fund distribution on behalf of its omnibus account clients would not, in and of itself, be viewed as a fiduciary decision. The intermediary’s decision or related actions, however, may nonetheless give rise to fiduciary liability if such actions adversely affect the plan’s right to receive proceeds in accordance with the IDC’s plan of distribution.

As noted above, an intermediary in receipt of settlement fund proceeds will be required to hold the proceeds in trust and manage those proceeds in accordance with the fiduciary responsibility provisions of Part 4 of Title I. Among other things, an intermediary in discharging its responsibilities to act prudently and solely in the interest of plan participants and beneficiaries, in accordance with section 404(a) of ERISA, may have to invest the proceeds pending the development and/or implementation of a plan for distributing the proceeds to individual omnibus account clients. In such instances, the intermediary may also be responsible for developing and/or implementing a plan for allocating settlement proceeds among individual omnibus account clients.

If an IDC, as part of its distribution plan approved by the SEC, makes available to an intermediary or requires, as a condition to the distribution, that the intermediary utilize a particular methodology for allocating settlement fund proceeds among individual omnibus account clients, the Department will, as an enforcement matter, view the application of such methodology to the allocation of settlement fund proceeds among individual omnibus account clients as satisfying the requirements of section 404(a) with respect to the methodology for allocating assets to employee benefit plans. We note that while the use of a particular allocation methodology may be considered prudent, fiduciaries also need to ensure that implementation of the methodology (e.g., making allocations and distributions in accordance with such methodology) is carried out in a prudent manner.

In some instances, the intermediary will be responsible both for developing and implementing the plan for allocating proceeds among its omnibus account clients. As fiduciaries, intermediaries must be prudent in the selection of the method of allocating the proceeds among its clients in an omnibus account, including plans. Prudence in such instances would, at a minimum, require a process by which the fiduciary chooses a methodology where the proceeds of the settlement would be allocated, where possible, to the affected clients in relation to the impact the late trading and market timing activities may have had on the particular plan. However, prudence would also require a process by which the fiduciary weighs the costs and ultimate benefit to the clients associated with achieving that goal. For example, there may be instances where the cost of allocating an amount to a particular plan may exceed the projected amount of the proceeds with respect to which the plan might be entitled under a prudent methodology. In such instances (i.e., where the cost to the plan is projected to exceed the benefit to the plan), an allocation plan would not be considered imprudent merely because it included an objective formula pursuant to which amounts otherwise allocable to a plan are forfeited and reallocated among other omnibus account clients, provided that any such formula applies to all omnibus account clients, not just employee benefit plans, and does not permit the exercise of discretion by the intermediary.

Further, it is our view that an allocation plan would not fail to be “solely in the interest of participants,” for purposes of section 404(a)(1), merely because the allocation methodology does not result in an exact reflection of transactional activity of the clients, provided such method is reasonable, fair and objective. For example, if a fiduciary determines that it would be more cost-effective to do so, it may allocate the proceeds among clients in an omnibus account according to the average share or dollar balance of the clients’ investment in the mutual fund during the relevant period.

In some instances, the services rendered by intermediaries in connection with the receipt, allocation and/or distribution of settlement fund proceeds may involve services or compensation not contemplated in the service provider agreement between the employee benefit plan(s) and the intermediary. While an intermediary may charge plans for any direct expenses incurred in connection with receipt, allocation and/or distribution of settlement fund proceeds, an intermediary, as a plan fiduciary, cannot compensate itself from plan assets beyond direct expenses without violating the prohibited transaction rule of section 406 of ERISA.

If the receipt, allocation and/or distribution services of the intermediary, and compensation for such services, are carried out in accordance with the directions and approval of appropriate plan fiduciaries, the intermediary may be able to avoid fiduciary status and issues relating to self-dealing under ERISA. However, determinations as to whether approval by a plan fiduciary has occurred would be factual in nature and would involve considerations such as language in relevant service contracts or whether the intermediary has disclosed to its employee benefit plan clients sufficient information concerning its proposed administration of the settlement proceeds so that the plan client reasonably can approve the arrangement based upon its understanding of the arrangement and related expenses.

In some instances, an intermediary may receive settlement proceeds with respect to plans that have, since the event leading to the settlement, hired a new record keeper or intermediary for investments made by the plan. In such instances, the intermediary in receipt of the proceeds would still be considered a fiduciary with respect to plan assets in its possession and would be expected to transfer the assets to the plan’s new record keeper or to an appropriate fiduciary of the plan.

An intermediary may also receive proceeds on behalf of plans that have terminated. In such instances, an intermediary should make reasonable efforts to deliver such assets to a responsible plan fiduciary (most likely, the plan sponsor) for distribution to plan participants or other appropriate disposition. If the intermediary is unable to locate a responsible plan fiduciary after a reasonable and diligent search, the intermediary may reallocate such proceeds among its other clients. Under no circumstances may an intermediary retain such assets for its own use.

Plan Fiduciary – Allocation among participants and beneficiaries

The following discussion focuses on the obligations of the plan fiduciary in allocating settlement fund proceeds among the plan’s participants and beneficiaries. For purposes of this discussion, the fiduciary might be the plan sponsor, intermediary or other person charged with allocating the proceeds among participants and beneficiaries.

Similar to the allocation of settlement fund proceeds among plans, if an IDC, as part of its distribution plan approved by the SEC, requires, as a condition to the distribution, that the fiduciary utilize a particular methodology for allocating settlement fund proceeds among plan participants and beneficiaries, the Department will, as an enforcement matter, view the application of such methodology to the allocation of proceeds among participants and beneficiaries as satisfying the requirements of section 404(a) with respect to the methodology for allocating assets to participants and beneficiaries.

If an IDC’s distribution plan provides, but does not require the use of, a methodology for allocating proceeds among plan participants and beneficiaries, the Department also will, as an enforcement matter, view the use of such methodology as satisfying the requirements of section 404(a)(1)(A) and (B) of ERISA with respect to a methodology for allocating assets to participants and beneficiaries. As noted above, while the use of a particular allocation methodology may be treated as prudent, fiduciaries also need to ensure that implementation of the IDC allocation methodology (e.g., making allocations to participants and beneficiaries in accordance with the methodology) is carried out in a prudent manner.

In the absence of guidance in the IDC’s distribution plan with respect to allocations to a plan’s participants and beneficiaries, fiduciaries must select a method or methods for allocating proceeds. In this regard, a plan fiduciary must be prudent in the selection of a method of allocating settlement proceeds among plan participants. Prudence in such instances, at a minimum, would require a process by which the fiduciary chooses a methodology where the proceeds of the settlement would be allocated, where possible, to the affected participants in relation to the impact the market timing and late trading activities may have had on the particular account. However, prudence would also require a process by which the fiduciary weighs the costs to the plan or the participant accounts and ultimate benefit to the plan or the participants associated with achieving that goal.

In addition, a fiduciary’s decision must satisfy the “solely in the interest of participants” standard of section 404(a)(1) of ERISA. In this regard, a method of allocation would not fail to be “solely in the interest of participants” merely because the selected method may be seen as disadvantaging some affected participants or groups of participants. In deciding on an allocation method, the plan fiduciary may properly weigh the competing interests of various participants or classes of plan participants (e.g., affected versus current participants) and the effects of the allocation method on those participants provided a rational basis exists for the selected method and such method is reasonable, fair and objective. For example, if a fiduciary determines that plan records are insufficient to reasonably determine the extent to which participants invested in mutual funds during the relevant period should be compensated, the fiduciary may properly decide to allocate the proceeds to current participants invested in the mutual fund based upon a reasonable, fair and objective allocation method. Similarly, if a plan fiduciary determines that the cost to allocate the proceeds among participants whose accounts were invested in the mutual fund during the entirety of the relevant period approximates the amount of the proceeds, the fiduciary may properly decide to allocate the proceeds to current participants invested in the mutual fund based upon a reasonable, fair and objective allocation method.

As plan assets, the proceeds of the settlement may not be used to benefit employers, fiduciaries or other parties in interest with respect to the plan. Sections 403(c) and 406 of ERISA. Such proceeds should not be used to offset an employer’s future contributions to the plan, unless such use is permissible under the terms of the plan and would not violate applicable provisions of the Internal Revenue Code (e.g., such as when amounts involved would be considered “forfeitures” under the terms of the plan). However, we believe that a plan fiduciary, consistent with its obligations under sections 404 and 406, may reasonably conclude that certain participant-level allocations that are not “cost-effective” (e.g., allocations to participant accounts of de minimis amounts) may instead be used for other permissible plan purposes, such as the payment of reasonable expenses of administering the plan.

It is the view of the Department that compliance with ERISA’s fiduciary rules generally will require that a fiduciary accept a distribution of settlement proceeds. The Department recognizes, however, that in rare instances the cost attendant to the receipt and distribution of such proceeds may exceed the value of such proceeds to the plan’s participants. In such instances, and provided that there is no other permissible use for such proceeds by the plan (e.g., payment of plan administrative expenses), it might be appropriate for a plan fiduciary to not accept the settlement distribution.

Conclusion

SEC settlement fund proceeds resulting from market timing and late trading activities will not be considered “plan assets” until distributed from the settlement fund. A party will be a fiduciary to the extent it exercises any authority or control over such plan assets following distribution by an IDC.

Settlement fund proceeds will upon distribution to a plan or an intermediary constitute plan assets and, therefore, will be required to be held in trust and managed in accordance with ERISA’s fiduciary responsibility rules. In general, as an enforcement matter, plan fiduciaries and intermediaries will be considered to satisfy their fiduciary duty to prudently select a method for allocating settlement proceeds if they utilize an allocation methodology provided or required by an IDC in a distribution plan approved by the SEC.

While plan fiduciaries generally have flexibility in designing a methodology for allocating settlement fund proceeds among the plan’s participants and beneficiaries, plan fiduciaries must ensure that the selected methodology does not otherwise violate the prudence and “solely in the interest” requirements of section 404(a).

Finally, plan fiduciaries should document appropriately the plan’s receipt and use of such settlement proceeds and work closely with their record-keepers and other service-providers in completing the process.

Questions concerning the information contained in this Bulletin may be directed to the Division of Fiduciary Interpretations, Office of Regulations and Interpretations, 202.693.8510.

Footnotes

  1. See Advisory Opinion 2005-08A (May 11, 2005) and Advisory Opinion 92-24A (November 11, 1992).
  2. See generally 17 C.F.R. § 201.1100, et. seq. (SEC Rules on Fair Fund and Disgorgement Plans).
  3. Among other things, an allocation methodology might include the use of a particular algorithm or a restriction on the depositing of proceeds in the forfeiture account of a plan.
  4. Some IDC plans may include ERISA plans within the definition of “intermediaries.” This discussion of intermediaries is intended to include only those intermediaries that are not ERISA plans. Where ERISA plans are themselves shareholders of record, the fiduciaries of such plans are generally acting in a fiduciary capacity with respect to the settlements.
  5. For example, any deposit of proceeds in funds managed by an intermediary or affiliate would be a transaction prohibited by section 406 of ERISA unless a relevant statutory or administrative exemption applies.
  6. For example, if an intermediary elects not to receive settlement fund proceeds on behalf of its employee benefit plan clients and also refuses to provide client records and other information necessary for an IDC to make the required distributions, the intermediary would be considered to be effectively exercising discretion or control over plan assets and, thereby, subject to ERISA’s fiduciary standards because its actions will have prevented the plan from receiving a share of the settlement.
  7. Advisory Opinion Nos. 2001-10A (December 14, 2001), 93-06A (March 11, 1993).
  8. See Field Assistance Bulletin 2002-3 (November 5, 2002). See also Advisory Opinion 2001-02A (February 15, 2001). In this advisory opinion involving demutualization proceeds distribution, Prudential provided the policyholder advance notice of the allocation options and a reasonable period of time (here at least 60 days) to select an option. As long as the plan fiduciary actually chose the default allocation, its failure affirmatively to communicate that decision to Prudential did not cause Prudential to become a fiduciary by implementing that option.
  9. A violation of section 406 would arise, for example, if the plan document provides that the employer would pay plan expenses.

2006-02   Health Savings Accounts - Q&As

Department of Labor - Employee Benefits Security Administration
Field Assistance Bulletin No. 2006-02

Date: October 27, 2006

Memorandum For:
Virginia C. Smith
Director of Enforcement, Regional Directors

From:
Robert J. Doyle
Director of Regulations and Interpretations

Subject: Health Savings Accounts - ERISA Q&As

Background

In general, a Health Savings Account (HSA) is an account established pursuant to section 223 of the Internal Revenue Code (Code) to pay or reimburse the qualified medical expenses of eligible individuals. Although the requirements for tax qualified HSAs are found in the Code, questions regarding the application of the Employee Retirement Income Security Act of 1974 (ERISA) to HSAs arise because employers may establish and contribute to an employee's HSA. On April 7, 2004, the Department of Labor's Employee Benefits Security Administration issued Field Assistance Bulletin (FAB) 2004-01 addressing the status of HSAs under ERISA. That guidance explained that HSAs generally will not constitute "employee welfare benefit plans" covered by Title I of ERISA where employer involvement with the HSA is limited.

In FAB 2004-01, the Department specifically indicated that employer contributions to HSAs would not give rise to an ERISA-covered plan where the establishment of the HSA is completely voluntary on the part of the employees and the employer does not: limit the ability of eligible individuals to move their funds to another HSA or impose conditions on utilization of HSA funds beyond those permitted under the Code; make or influence the investment decisions with respect to funds contributed to an HSA; represent that the HSA is an employee welfare benefit plan established or maintained by the employer; or receive any payment or compensation in connection with an HSA.

Since the issuance of FAB 2004-01, the Department has received a number of recurring questions about the guidance and the evolving practices regarding the offering of HSAs. The following provides further guidance on many of the frequently asked questions raised with the Department.

Questions And Answers

In the absence of an employee's affirmative consent, may an employer open an HSA for an employee and deposit employer funds into the HSA without violating the condition in the FAB that requires that the establishment of an HSA by an employee be "completely voluntary"?

Yes. The intended purpose of the "completely voluntary" condition in FAB 2004-01 is to ensure that any contributions an employee makes to an HSA, including salary reduction amounts, will be voluntary. HSA accountholders have sole control and are exclusively responsible for expending HSA funds and generally may move the funds to another HSA or otherwise withdraw the funds. The fact that an employer unilaterally opens an HSA for an employee and deposits employer funds into the HSA does not divest the HSA accountholder of this control and responsibility and, therefore, would not give rise to an ERISA-covered plan so long as the conditions described in FAB 2004-01 are met.

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If an employer maintains a high deductible health plan (HDHP) for its employees, can the employer limit the HSA providers that it allows to market their HSA products in the workplace or select a single HSA provider to which it will forward contributions without making the HSA part of the employer's ERISA-covered group health plan?

Yes. As stated in FAB 2004-01, an employer may offer an HSA to its employees without establishing an ERISA-covered plan in one of two ways. The employer may rely on the group-type insurance safe harbor in 29 C.F.R. § 2510.3-1(j), in which case the employer cannot make contributions to the HSA, or it may rely on the separate conditions outlined in FAB 2004-01, in which case the employer may or may not elect to make employer contributions to the HSA.

If the employer relies on the group-type insurance safe harbor in 29 C.F.R. § 2510.3-1(j), it cannot "endorse" the HSA provider. In the Department's view, an employer would not be considered to "endorse" an HSA within the meaning of the regulation merely by limiting the HSA providers that it allows to market their HSA products in the workplace or selecting a single HSA provider to which it will forward contributions. Employers may also provide employees general information on the advisability of using an HSA in conjunction with the HDHP without "endorsing" the program. See generally Interpretive Bulletin 99-1, 29 C.F.R. § 2509.99-1.

The separate conditions in FAB 2004-01, though including completely voluntary employee participation and employer neutrality in not representing that the HSA is an employee welfare benefit plan established or maintained by the employer, do not include the group-type insurance safe harbor's prohibition on employer "endorsement." As explained in FAB 2004-01, an employer could limit the HSA providers that it allows to market their HSA products in the workplace or select a single HSA provider to which it will forward contributions and still satisfy the conditions outlined in the FAB without converting the HSA into an ERISA-covered plan.

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Would an employer be viewed as "making or influencing" the HSA investment decisions of employees, within the meaning of the FAB, merely because the employer selects an HSA provider that offers some or all of the investment options made available to the employees in their 401(k) plan?

No. The mere fact that an employer selects an HSA provider to which it will forward contributions that offers a limited selection of investment options or investment options that replicate the investment options available to employees under their 401(k) plan would not, in the view of the Department, constitute the making or influencing of an employee's investment decisions giving rise to an ERISA-covered plan, so long as employees are afforded a reasonable choice of investment options and employees are not limited in moving their funds to another HSA. The selection of a single HSA provider that offers a single investment option would not, in the view the Department, afford employees a reasonable choice of investment options.

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If contributions to an HSA are made through a cafeteria plan, would the savings that benefit the employer from non-payment of FICA and FUTA taxes on those contributions be considered "payment or compensation received in connection with an HSA" that would subject the HSA to Title I coverage?

No. The Department does not view an employer's non-payment of FICA and FUTA taxes on amounts contributed to an HSA as "payment or compensation" for purposes of the guidance issued in FAB 2004-01.

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Can an employer pay the fees associated with the HSA that the employee would normally be expected or required to pay without causing the HSA to become an ERISA-covered plan?

Yes. As stated in the FAB, the mere fact that an employer contributes to an HSA does not result in the HSA being an ERISA-covered plan. Therefore, the Department does not believe that an employer paying fees associated with an HSA that the employee would otherwise be required to pay would make that HSA an ERISA-covered plan.

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May an HSA vendor offer an HSA product it offers to the public to its own employees without the HSAs being considered employee benefit plans covered by ERISA?

Yes. Offering HSA products that the employer offers to the public in the regular course of business would not mean the HSA provider established or is maintaining the HSA as an employer to provide benefits to its employees.

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If the employer limits the number of HSA vendors to which it will forward contributions, may the employer receive a discount on another product from one of the selected HSA vendors?

No. In the Department's view, receiving a discount on another product from an HSA vendor selected by the employer would constitute the employer receiving a "payment" or "compensation" in connection with an HSA. In the Department's view, the arrangement would also give rise to fiduciary and prohibited transaction issues.

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Are HSAs subject to the prohibited transaction provisions of section 4975 of the Internal Revenue Code?

Yes. Although the Department believes that HSAs meeting the conditions of FAB 2004-01 generally will not be ERISA-covered plans, the Medicare Modernization Act specifically provided that HSAs will be subject to the prohibited transaction provisions in section 4975 of the Code. In that regard, the Department's plan asset regulation at 29 C.F.R. § 2510.3-102 states, in relevant part, that "[f]or purposes of [certain specified provisions of ERISA] and section 4975 of the Internal Revenue Code only . . . the assets of the plan include amounts . . . that a participant or beneficiary pays to an employer, or amounts that a participant has withheld from his wages by an employer, for contribution to the plan as of the earliest date on which such contributions can reasonably be segregated from the employer's general assets." (Emphasis added). As a result, employers who fail to transmit promptly participants' HSA contributions may violate the prohibited transaction provisions of section 4975 of the Code. See Code § 4975(c)(1)(D) (prohibited transactions include the "transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a plan").

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Do the class prohibited transaction exemptions for owners of individual retirement accounts (IRAs) apply to accountholders of HSAs?

No. The class exemptions issued by the Department for products and services offered owners of IRAs, PTE 97-11, PTE 93-33, PTE 93-1, do not apply to HSA accountholders.

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Is it a prohibited transaction for an HSA provider to offer a cash incentive for establishing an HSA with that provider?

No, if the provider deposits the incentive into the HSA. The Department stated in Advisory Opinion 2004-09A that, in certain situations, an HSA provider would not violate the prohibited transaction provisions under Code section 4975(c) or ERISA section 406 where the HSA provider offers an incentive to individuals for establishing an HSA with that provider by depositing cash directly into the individual's HSA. A cash contribution to an HSA generally would not be considered a "sale or exchange of property" or "a transfer of plan assets" for purposes of the prohibited transaction provisions of the Code. Because the cash contribution goes to the HSA and not the HSA account holder, the HSA's receipt of the cash contribution also would not be considered an act of self dealing on the part of the HSA account holder nor a receipt by the HSA account holder in his or her individual capacity of any consideration from a party dealing with the HSA.

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May an HSA vendor provide a line of credit for HSA expenses to an HSA accountholder choosing its HSA?

The Internal Revenue Service has issued guidance permitting eligible individuals to use debit, credit, or stored-value cards to receive distributions from an HSA for qualified medical expenses. See IRS Notice 2004-2, Q&A 37. Subsequent guidance by the Service explains that, under section 223(e)(2) of the Code, account beneficiaries, HSA trustees, and HSA custodians may not enter into certain "prohibited transactions" with an HSA. See IRS Notice 2004-50, Q&A 67, 68. For example, an account beneficiary may not borrow or pledge the assets of the HSA or receive a benefit in his or her own individual capacity as a result of opening or maintaining an HSA because such a transaction would constitute a prohibited transfer to or use of the HSA assets by or for the benefit of the account beneficiary. See Advisory Opinion 89-12A. Whether a credit card arrangement between a vendor and owner of an HSA results in a prohibited transaction would depend on specific facts and circumstances. A prohibited transaction would not result merely from an HSA accountholder directing the payment of HSA funds to the credit line vendor to reimburse the vendor for HSA expenses paid with a credit card.

2006-03    Periodic Benefit Statements - Pension Protection Act of 2006

Department of Labor - Employee Benefits Security Administration
Field Assistance Bulletin No. 2006-03

Date: December 20, 2006

Memorandum For:
Virginia C. Smith
Director of Enforcement, Regional Directors

From:
Robert J. Doyle
Director of Regulations and Interpretations

Subject: Periodic Pension Benefit Statements - Pension Protection Act of 2006

Background

Section 105 of the Employee Retirement Income Security Act (ERISA) sets forth the requirements applicable to the furnishing of pension benefit statements to plan participants and beneficiaries. Section 508(a) of the Pension Protection Act of 2006 (PPA)(1) amended section 105, making a number of significant changes to the pension benefit statement requirements for both individual account plans and defined benefit plans. Among other things, the amendments to section 105 establish an affirmative obligation to automatically furnish pension benefit statements – at least once each quarter, in the case of individual account plans that permit participants to direct their investments; at least once each year, in the case of individual account plans that do not permit participants to direct their investments; and at least once every three years in the case of defined benefit plans. The amendments also increase the amount of information required to be contained in pension benefit statements for both individual account and defined benefit plans.

The amendments to section 105 are generally applicable to plan years beginning after December 31, 2006, with special rules for plans maintained pursuant to collective bargaining agreements.(2) Section 508(b) of the PPA requires the Department to develop one or more model pension benefit statements within one year of the date of enactment of the PPA (i.e., by August 18, 2007).

Since the enactment of the PPA, representatives of plan sponsors, service providers and others in the employee benefits community have raised a number of interpretive and compliance issues concerning the new pension benefit statement provisions. In particular, concerns have been expressed about the imminent effective date, the absence of guidance, and the cost and burdens attendant to pension benefit statement compliance efforts prior to the adoption of pension benefit statement regulations and the issuance of model pension benefit statements by the Department.

In recognition of the foregoing concerns, including the fact that major changes in what, how, and when pension benefit statement information is furnished to participants and beneficiaries may, in the absence of regulatory guidance from the Department, result in plan sponsors, plans, or participants and beneficiaries (in the case of individual account plans) incurring excessive or unnecessary compliance costs, the Department is providing general guidance in this Bulletin for EBSA’s national and regional offices, as well as plan sponsors and administrators, concerning good faith compliance with the pension benefit statement provisions pending the issuance of regulations.

Good Faith Compliance

The Department has not yet issued regulations or other guidance concerning compliance with the pension benefit statement provisions of section 105 of ERISA, as amended by section 508(a) of the PPA. Until such regulations or guidance is issued, the Department will, as an enforcement matter, treat a plan administrator as satisfying the requirements of section 105 if the administrator has acted in good faith with a reasonable interpretation of those requirements. This Bulletin provides the Department’s views as to what constitutes good faith compliance with certain requirements of section 105.

Issues

1. Form of furnishing statements. In the case of individual account plans that provide for participant direction of investments, to what extent can the benefit statement requirements be satisfied by using multiple documents or sources for the required information?

It appears that, in the case of individual account plans that provide for participant direction, the information required to be included in pension benefit statements will, in many instances, involve multiple service providers, each of whom is a source for some, but not all, of the required information. For example, the plan administrator may be the source for information on vesting, whereas the plan’s recordkeeper or brokerage firm may be the source for investment-related account information. We understand that, in the short term, compiling all the required information for disclosure in a single document may be impractical for plans.

Pending the issuance of further guidance, it is the view of the Department that good faith compliance with the pension benefit statement provisions does not preclude the use of multiple documents or sources for benefit statement information, provided that participants and beneficiaries have been furnished notification that explains how and when the information required by section 105 will be furnished or made available to participants and beneficiaries. Such notification should be written in a manner calculated to be understood by the average plan participant, furnished in any manner that a pension benefit statement could be furnished under this Bulletin (see issue two, below), and furnished in advance of the date on which a plan is required to furnish the first pension benefit statement pursuant to section 105(a)(1)(A)(i) of ERISA.

2. Manner of furnishing statements. To what extent can the pension benefit statement requirements be satisfied using electronic media?

Section 105(a)(2)(A)(iv) provides that a pension benefit statement may be delivered in written, electronic, or other appropriate form to the extent such form is reasonably accessible to the participant or beneficiary. In the Technical Explanation of the PPA, prepared by the staff of the Joint Committee on Taxation, the Committee explains, by way of example, that regulations relating to the furnishing of pension benefit statements, “could permit current benefit statements to be provided on a continuous basis through a secure plan web site for a participant or beneficiary who has access to the web site.”(3)

With regard to the use of electronic media generally, the Department has issued a regulation, at 29 C.F.R. § 2520.104b-1(c), setting forth conditions under which a plan administrator will be deemed to satisfy the requirement, in section 2520.104b-1(b), that certain disclosures be furnished using “measures reasonably calculated to ensure actual receipt of the material.” While the furnishing of the required pension benefit statement information in accordance with the safe harbor prescribed in paragraph (c) of section 2520.104b-1 would constitute good faith compliance with section 105, the Department notes that such manner of furnishing is not the exclusive means by which plan administrators could, in the absence of guidance to the contrary, satisfy their obligation to furnish pension benefit statement information. In this regard, we note that the Department of the Treasury and Internal Revenue Service recently issued guidance, at 26 C.F.R. § 1.401(a)-21,(4) relating to the use of electronic media to provide certain notices and documents required to be furnished to participants by retirement plans under the Internal Revenue Code. For purposes of section 105 of ERISA, the Department, pending further guidance and a review of the provisions of section 2520.104b-1(c), will view the furnishing of pension benefit statements in accordance with the provisions of section 1.401(a)-21, as good faith compliance with the requirement to furnish pension benefit statements to participants and beneficiaries.

With regard to pension plans that provide participants continuous access to benefit statement information through one or more secure web sites, the Department will view the availability of pension benefit statement information through such media as good faith compliance with the requirement to furnish benefit statement information, provided that participants and beneficiaries have been furnished notification that explains the availability of the required pension benefit statement information and how such information can be accessed by the participants and beneficiaries In addition, the notification must apprise participants and beneficiaries of their right to request and obtain, free of charge, a paper version of the pension benefit statement information required under section 105. Such notification should be written in a manner calculated to be understood by the average plan participant, furnished in any manner that a pension benefit statement could be furnished under this Bulletin, and furnished both in advance of the date on which a plan is required to furnish the first pension benefit statement pursuant to section 105(a)(1)(A)(i) and (ii) of ERISA and annually thereafter.

3. Dates for furnishing statements. Because the new pension benefit statement provisions are applicable as of the first plan year beginning after December 31, 2006, what is the earliest date on which non-collectively bargained pension plans will be required to automatically furnish benefit statements that comply with the new provisions?

With regard to individual account plans that permit participants and beneficiaries to direct the investment of assets in their account, section 105(a)(1)(A)(i) requires that a pension benefit statement be furnished at least once each calendar quarter. For calendar year plans subject to this provision, the first pension benefit statement would be required for the quarter ending March 31, 2007. If a plan operated on a fiscal year basis, with the first plan year (after December 31, 2006) beginning on July 1, 2007, the first pension benefit statement required to comply with the new requirements would be required to be furnished for the quarter ending September 30, 2007.

Plans that do not provide participants or beneficiaries a right to direct their investments are required, pursuant to section 105(a)(1)(A)(ii), to furnish pension benefit statements at least once each calendar year. Whether on a calendar year or fiscal year basis, the first pension benefit statement for such plans that is required to comply with the new requirements would be required to be furnished for the calendar year ending December 31, 2007.

Pending the issuance of further guidance, it is the view of the Department that the furnishing of pension benefit statement information not later than 45 days following the end of the period (calendar quarter or calendar year) will constitute good faith compliance with the requirement to furnish a pension benefit statements in accordance with section 105(a)(1)(A)(i) and (ii).

Defined benefit plans generally are required, pursuant to section 105(a)(1)(B)(i), to furnish participants a pension benefit statement at least once every three years. The first pension benefit statement complying with the new requirements, therefore, would be due for the 2009 plan year, provided that the plan does not elect to comply with the alternative notice requirement in section 105(a)(3)(A). The alternative notice requirement for defined benefit plans provides that the requirements of section 105(a)(1)(B)(i) shall be treated as met with respect to a participant if at least once each year the administrator provides the participant notice of the availability of the pension benefit statement and the ways in which the participant may obtain such statement. If a plan elects to take advantage of the alternative notice provision in section 105(a)(3)(A), the required notification must be furnished not later than December 31, 2007.

It is the view of the Department that, in the absence of guidance to the contrary, similar principles would apply in determining good faith compliance by plans maintained pursuant to one or more collective bargaining agreements, with respect to which PPA section 508(c)(2) provides special rules for determining the date on which the provisions of section 105 are effective.

4. Right to direct investments. Will an individual account plan that does not otherwise provide participants the right to direct the investment of assets in their accounts be subject to the requirement to furnish statements quarterly (section 105(a)(1)(A)(i)) merely because the plan permits participants to take participant loans from the plan?

Pending issuance of further guidance, a reasonable interpretation of section 105(a)(1)(A)(i) would be that a participant loan feature does not, standing alone, cause a plan to be a plan that provides participants the right to direct the investment of assets in their accounts.

5. Limitations or restrictions on right to direct investments. Section 105(a)(2)(B)(ii)(I) requires that the pension benefit statement of an individual account plan that permits participant investment direction include “an explanation of any limitations or restrictions on any right of the participant or beneficiary under the plan to direct an investment.” What types of limitations and restrictions, if any, need not be included in benefit statements?

In the absence of guidance to the contrary, a reasonable interpretation of section 105(a)(2)(B)(ii)(I) would be that benefits statements must include limitations and restrictions on participants' or beneficiaries' rights imposed "under the plan," but need not include limitations and restrictions imposed by investment funds, other investment vehicles, or by state or federal securities laws.

6. Investment principles. Section 105(a)(2)(B)(ii)(II) requires that the pension benefit statement of an individual account plan that permits participant investment direction include “an explanation . . . of the importance, for the long-term retirement security of participants and beneficiaries, of a well-balanced and diversified investment portfolio, including a statement of the risk that holding more than 20 percent of a portfolio in the security of one entity (such as employer securities) may not be adequately diversified[.]” In the absence of a model benefit statement, is there language that a plan might use to satisfy this requirement?

It is the view of the Department that, in the absence of guidance to the contrary, the use of the following language will constitute good faith compliance with the requirements of section 105(a)(2)(B)(ii)(II):

To help achieve long-term retirement security, you should give careful consideration to the benefits of a well-balanced and diversified investment portfolio. Spreading your assets among different types of investments can help you achieve a favorable rate of return, while minimizing your overall risk of losing money. This is because market or other economic conditions that cause one category of assets, or one particular security, to perform very well often cause another asset category, or another particular security, to perform poorly. If you invest more than 20% of your retirement savings in any one company or industry, your savings may not be properly diversified. Although diversification is not a guarantee against loss, it is an effective strategy to help you manage investment risk.

In deciding how to invest your retirement savings, you should take into account all of your assets, including any retirement savings outside of the Plan. No single approach is right for everyone because, among other factors, individuals have different financial goals, different time horizons for meeting their goals, and different tolerances for risk.

It is also important to periodically review your investment portfolio, your investment objectives, and the investment options under the Plan to help ensure that your retirement savings will meet your retirement goals.

7. Notification of diversification rights. May an individual account plan that, prior to January 1, 2007, provides participants and beneficiaries diversification rights at least equal to the new rights conferred under section 204(j), satisfy the notice obligations under section 101(m) of ERISA by providing information concerning the importance of a diversified portfolio in connection with the furnishing of the first quarterly pension benefit statement information required by section 105(a)(1)(A)(i)?

Yes. The Department believes that the information required to be disclosed to participants and beneficiaries pursuant to section 101(m) is most significant for those participants and beneficiaries acquiring new diversification rights under section 204(j). For this reason the Department continues to believe that participants and beneficiaries in plans conferring new diversification rights as of January 1, 2007, should be furnished information concerning such rights and the importance of maintaining a diversified portfolio as soon as possible following January 1, 2007.(5)

With regard to individual account plans that, prior to January 1, 2007, provide participants and beneficiaries diversification rights at least equal to those conferred under section 204(j), the Department is persuaded that the furnishing of the 101(m) notice as a stand-alone disclosure may result both in confusion to participants and beneficiaries and distribution costs that, in many instances, will be passed on to the plan’s participants and beneficiaries. In view of the fact that the periodic pension benefit statement required to be furnished pursuant to section 105(a)(1)(A)(i) is required, pursuant to section 105(a)(2)(B)(ii)(II), to contain information similar to that required by section 101(m)(2) concerning the importance of maintaining a diversified portfolio, and the fact that the pension benefit statement required to be furnished pursuant to section 105(a)(1)(A)(i) is required to be furnished within a few months of the furnishing of the 101(m) notice, the Department will treat a plan administrator’s compliance with the periodic benefit statement requirements of section 105(a)(1)(A)(i) as satisfying the notice requirements of section 101(m) if, prior to January 1, 2007, the individual account plan provided participants and beneficiaries diversification rights at least equal to those conferred under section 204(j).

8. Department of Labor Web site. Section 105(a)(2)(B)(ii)(III) requires that the pension benefit statement of an individual account plan that permits participant direction of investment include a notice directing participants and beneficiaries to the Internet web site of the Department of Labor for sources of information on individual investing and diversification. What Internet address should plan administrators use for this requirement?

For purposes of section 105(a)(2)(B)(ii)(III), plan administrators may use the following Internet address for pension benefit statements: www.dol.gov/ebsa/investing.html.

Questions concerning this matter may be directed to Jeff Turner or Suzanne Adelman, at 202.693.8523.

Footnotes

  1. Pub. L. No. 109-280, 120 Stat. 780 (2006).
  2. See § 508(c) of the Pension Protection Act of 2006.
  3. See Joint Committee on Taxation, Technical Explanation of H.R. 4, the “Pension Protection Act of 2006,” as Passed by the House on July 28, 2006, and as Considered by the Senate on August 3, 2006 (JCX-38-06), August 3, 2006.
  4. 71 FR 61877 (Oct. 20, 2006).
  5. I.R.S. Notice 2006-107.

2007-01    Statutory Exemption for Investment Advice

Department of Labor - Employee Benefits Security Administration
Field Assistance Bulletin No. 2007-01

Date: February 2, 2007

Memorandum For:
Virginia C. Smith
Director of Enforcement, Regional Directors

From:
Robert J. Doyle
Director of Regulations and Interpretations

Subject: Statutory Exemption For Investment Advice

Background

Section 3(21)(A)(ii) includes within the definition of “fiduciary” a person that renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of a plan, or has any authority or responsibility to do so.(1) The prohibited transaction provisions of ERISA and the Internal Revenue Code (Code) prohibit an investment advice fiduciary from using the authority, control or responsibility which makes it a fiduciary to cause itself, or a party in which it has an interest that may affect its best judgment as a fiduciary, to receive additional fees. As a result, in the absence of a statutory or administrative exemption, fiduciaries are prohibited from rendering investment advice to plan participants regarding investments that result in the payment of additional advisory and other fees to the fiduciaries or their affiliates.

The growth of participant directed individual account plans has increased recognition of the importance of investment advice to participants in such plans. Accordingly, employers and other fiduciaries have raised questions concerning their responsibilities in connection with offering investment advice programs. In response to these questions, the Department has issued various forms of guidance concerning when a person would be a fiduciary by reason of rendering investment advice and when the provision of investment advice may result in prohibited transactions.(2)

The Pension Protection Act of 2006 (PPA)(3) amended both ERISA and the Code to add a statutory exemption relating to the provision of investment advice. Specifically, section 601 of the PPA added a statutory exemption under section 408(b)(14) of ERISA (and section 4975(d)(17) of the Code(4)). Section 408(b)(14) applies to the provision of investment advice under an “eligible investment advice arrangement, “ as defined in paragraph (2) of section 408(g) (also added by the PPA), to participants and beneficiaries of a defined contribution plan that permits them to direct the investment of their accounts in the plan. If the conditions of section 408(g) are met, section 408(b)(14) exempts from the prohibited transaction rules the provision of investment advice, the investment transaction entered into pursuant to the advice, and the direct or indirect receipt of fees or other compensation by the fiduciary adviser or an affiliate in connection with the provision of advice or the transaction pursuant to the advice. An “eligible investment advice arrangement” is an arrangement that either provides that any fees (including any commission or other compensation) received by the fiduciary adviser for investment advice or with respect to the investment of plan assets do not vary depending on the basis of any investment option selected, or uses a computer model under an investment advice program that meets the requirements set forth in section 408(g)(3).

Paragraph (10) of section 408(g) addresses the responsibility and liability of plan sponsors and other fiduciaries in the context of investment advice provided pursuant to the statutory exemption. Subject to certain requirements, section 408(g)(10) provides that a plan sponsor or other person who is a plan fiduciary, other than a fiduciary adviser, is not treated as failing to meet the fiduciary requirements of ERISA solely by reason of the provision of investment advice as permitted by the statutory exemption. This provision does not exempt a plan sponsor or a plan fiduciary from fiduciary responsibility under ERISA for the prudent selection and periodic review of the selected fiduciary adviser. The provision does make clear, however, that plan sponsors and other persons who are fiduciaries do not have a duty under ERISA to monitor the specific investment advice given by a fiduciary adviser to any particular recipient of the advice.

Since the enactment of section 408(b)(14) and 408(g) of ERISA, the Department has received a number of inquiries concerning the status of its prior guidance on investment advice and the scope of the statutory exemption for investment advice. This Bulletin provides guidance to EBSA’s national and regional offices on the following specific issues.

Issues

  1. Did enactment of the investment advice provisions of the Pension Protection Act of 2006 invalidate or otherwise affect prior guidance issued by the Department concerning investment advice?
  2. No. It is the view of the Department that enactment of section 408(b)(14) and 408(g) allows the provision of investment advice to plan participants under circumstances that would, in the absence of an exemption, have constituted a prohibited transaction prior to the enactment of the PPA. Except for providing that persons who develop or market computer models described in section 408(g)(3) or who market investment advice programs using such models are fiduciaries, and requiring advisers to expressly acknowledge their fiduciary status,(5) sections 408(b)(14) and 408(g) do not alter ERISA’s framework for determining fiduciary status or recast otherwise permissible forms of investment advice as prohibited for purposes of section 406. For this reason, it is the view of the Department that the new provisions do not invalidate or otherwise affect prior guidance of the Department relating to investment advice and that such guidance continues to represent the views of the Department.(6)

    Guidance of particular note in this regard includes: Interpretive Bulletin 96-1 (29 CFR § 2509.96-1), in which the Department identified categories of investment-related information and materials that do not constitute investment advice; Advisory Opinion Nos. 97-15A and 2005-10A, in which the Department explained that a fiduciary investment adviser could provide investment advice with respect to investment funds that pay it or an affiliate additional fees without engaging in a prohibited transaction if those fees are offset against fees that the plan otherwise is obligated to pay to the fiduciary; and Advisory Opinion 2001-09A in which the Department concluded that the provision of fiduciary investment advice, under circumstances where the advice provided by the fiduciary with respect to investment funds that pay additional fees to the fiduciary is the result of the application of methodologies developed, maintained and overseen by a party independent of the fiduciary, would not result in prohibited transactions.

  3. To what extent are the standards for selecting and monitoring a fiduciary adviser described in section 408(g)(10) different from the standards applicable to plan fiduciaries who offer an investment advice program with respect to which relief under the statutory exemption for investment advice (section 408(b)(14)) is not required?
  4. It is the view of the Department that, with the exception of certain requirements in subparagraph (A)(i) – (iii) of section 408(g)(10) regarding compliance with the conditions of the statutory exemption, the same fiduciary duties and responsibilities apply to the selection and monitoring of an investment adviser for participants and beneficiaries in a participant directed individual account plan, regardless of whether the program of investment advice services is one to which the statutory exemption applies.

    Subparagraph (A) of section 408(g)(10) provides that a plan fiduciary shall not be treated as failing to meet the requirements of Part 4 of title I of ERISA solely by reason of the provision of investment advice within the meaning of section 3(21)(A)(ii) or solely by reason of contracting or arranging for the provision of investment advice pursuant to an “eligible investment advice arrangement” but subject to subparagraph (B), which addresses a fiduciary’s duty to select and review the investment advice provider prudently. This principle is consistent with the Department’s guidance provided in Interpretive Bulletin 96-1 regarding the provision of investment advice generally. See 29 CFR § 2509.96-1(e). Accordingly, it is the view of the Department that a plan sponsor or other fiduciary will not fail to meet the requirements of Part 4 of title I of ERISA solely by reason of offering a program of investment advice services to participants or beneficiaries that is not an “eligible investment advice arrangement.”

    Subparagraph (B) of section 408(g)(10), however, makes clear that, without regard to subparagraph (A), plan fiduciaries have a duty to prudently select and periodically monitor the advisory program. Subparagraph (B) of section 408(g)(10) further clarifies that fiduciaries have no duty to monitor the specific investment advice given by the fiduciary adviser to any particular recipient of advice. As with subparagraph (A), it is the view of the Department that the principles described in subparagraph (B) of section 408(g)(10) are consistent with those set forth in § 2509.96-1(e) and, therefore, equally applicable to plan fiduciaries who select a program of investment advice services with respect to which relief under the investment advice statutory exemption is not required.

    Thus, it is the view of the Department that a plan sponsor or other fiduciary that prudently selects and monitors an investment advice provider will not be liable for the advice furnished by such provider to the plan’s participants and beneficiaries, whether or not that advice is provided pursuant to the statutory exemption under section 408(b)(14).(7)

    Although the Interpretive Bulletin does not address the monitoring of specific investment advice provided to a particular plan participant or beneficiary, the Department believes that fiduciaries selecting advisory programs are subject to the same fiduciary duty to prudently select and monitor investment advisers regardless of whether the advice arrangement was established under the section 408(b)(14) exemption. Accordingly, it is the view of the Department that, like fiduciaries offering exempted advice arrangements, fiduciaries offering programs of investment advice services with respect to which exemptive relief is not required have no duty to monitor the specific investment advice given by the investment advice provider to any particular recipient of the advice.

    With regard to the prudent selection of service providers generally, the Department has indicated that a fiduciary should engage in an objective process that is designed to elicit information necessary to assess the provider’s qualifications, quality of services offered and reasonableness of fees charged for the service. The process also must avoid self dealing, conflicts of interest or other improper influence. In applying these standards to the selection of investment advisers for plan participants, we anticipate that the process utilized by the responsible fiduciary will take into account the experience and qualifications of the investment adviser, including the adviser’s registration in accordance with applicable federal and/or state securities law, the willingness of the adviser to assume fiduciary status and responsibility under ERISA with respect to the advice provided to participants, and the extent to which advice to be furnished to participants and beneficiaries will be based upon generally accepted investment theories.

    In monitoring investment advisers, we anticipate that fiduciaries will periodically review, among other things, the extent to which there have been any changes in the information that served as the basis for the initial selection of the investment adviser, including whether the adviser continues to meet applicable federal and state securities law requirements, and whether the advice being furnished to participants and beneficiaries was based upon generally accepted investment theories. Fiduciaries also should take into account whether the investment advice provider is complying with the contractual provisions of the engagement; utilization of the investment advice services by the participants in relation to the cost of the services to the plan; and participant comments and complaints about the quality of the furnished advice. With regard to comments and complaints, we note that to the extent that a complaint or complaints raise questions concerning the quality of advice being provided to participants, a fiduciary may have to review the specific advice at issue with the investment adviser.

    Subparagraph (C) of section 408(g)(10) makes clear that plan assets can be used to pay reasonable expenses in providing investment advice to participants and beneficiaries. Again, this provision is consistent with the long held view of the Department, as set forth in § 2509.96-1(e), provided that the service provider rendering investment advice is selected and monitored prudently. Consistent with this guidance, fiduciaries selecting programs of investment advice services with respect to which exemptive relief is not required may use plan assets to pay reasonable expenses in providing investment advice (and/or investment education) to plan participants and beneficiaries.

  5. For purposes of an “eligible investment advice arrangement” within the meaning of section 408(g)(2)(A)(i), is an affiliate of a fiduciary adviser subject to the level fee requirement?
  6. The investment advice exemption provided by section 408(b)(14) applies only to investment advice provided by a “fiduciary adviser” under an “eligible investment advice arrangement.” Section 408(g)(2)(A)(i) includes within the meaning of “eligible investment advice arrangement” an arrangement that, among other things, provides that any fees (including any commission or other compensation) received by the fiduciary adviser for investment advice or with respect to the sale, holding, or acquisition of any security or other property for purposes of investment of plan assets do not vary depending on the basis of any investment option selected.

    The term “fiduciary adviser” is defined in section 408(g)(11)(A) to mean a person who is a fiduciary of the plan by reason of providing investment advice and who is a registered investment adviser, a bank or similar financial institution, an insurance company, or a registered broker dealer; an affiliate(8) of such registered investment adviser, bank, insurance company, or broker dealer; or an employee, agent or registered representative of any such entity.

    It is clear from section 408(g)(2)(A)(i) that only the fees or other compensation of the fiduciary adviser may not vary. In this regard we note that, in contrast to other provisions of section 408(b)(14) and section 408(g), section 408(g)(2)(A)(i) references only the fiduciary adviser, not the fiduciary adviser or an affiliate. Inasmuch as a person, pursuant to section 408(g)(11)(A), can be a fiduciary adviser only if that person is a fiduciary of the plan by virtue of providing investment advice, an affiliate of a registered investment adviser, a bank or similar financial institution, an insurance company, or a registered broker dealer will be subject to the varying fee limitation only if that affiliate is providing investment advice to plan participants and beneficiaries.

    Also, consistent with past Departmental guidance (see discussion of issue 1), if the fees and compensation received by an affiliate of a fiduciary that provides investment advice do not vary or are offset against those received by the fiduciary for the provision of investment advice, no prohibited transaction would result solely by reason of providing investment advice and thus there would be no need for a prohibited transaction exemption.(9) It is the view of the Department, therefore, that, for purposes of section 408(g)(2)(A)(i), Congress did not intend for the requirement that fees not vary depending on the basis of any investment options selected to extend to affiliates of the fiduciary adviser, unless, of course, the affiliate is also a provider of investment advice to a plan.

    We further note that although section 408(g)(11)(A) generally limits ”fiduciary advisers” to certain types of entities, it also permits employees, agents, or registered representatives of those entities to also qualify as fiduciary advisers if they satisfy the requirements of applicable insurance, banking, and securities laws relating to the provision of the advice. See section 408(g)(11)(A)(vi). As with affiliates, such an individual must, for purposes of section 408(g)(11)(A), not only be an employee, agent, or registered representative of one of those entities, but also must provide investment advice in his or her capacity as employee, agent, or registered representative. It is the view of the Department that when an individual acts as an employee, agent or registered representative on behalf of an entity engaged to provide investment advice to a plan, that individual, as well as the entity, must be treated as the fiduciary adviser for purposes of section 408(g)(11)(A).(10) In such instances, therefore, both the individual and the entity would be treated as fiduciary advisers and subject to the limitations of section 408(g)(2)(A)(i).(11)

    In general, a party seeking to avail itself of a statutory or administrative exemption from the prohibited transaction provisions bears the burden of establishing compliance with the conditions of the exemption. With regard to the exemptive relief accorded an “eligible investment advice arrangement” within the meaning of section 408(g)(2)(A)(i), it is the expectation of the Department that parties offering investment advisory services will maintain, and be able to demonstrate compliance with, policies and procedures designed to ensure that fees and compensation paid to fiduciary advisers, at both the entity and individual level, do not vary on the basis of any investment option selected. Moreover, it is anticipated that compliance with such policies and procedures will be reviewed as part of the annual audit required by section 408(g)(5)(A) and addressed in the report referred to in section 408(g)(5)(B).

    Questions concerning the information contained in this Bulletin may be directed to the Division of Fiduciary Interpretations, Office of Regulations and Interpretations, 202.693.8510.

Footnotes

  1. See also 29 CFR § 2510.3-21(c).
  2. See Interpretative Bulletin relating to participant investment education, 29 CFR § 2509.96-1 (Interpretive Bulletin 96-1), AO 97-15A (May 22, 1997), AO 2001-09A (December 14, 2001), and AO 2005-10A (May 11, 2005).
  3. Pub. L. 109-280, 120 Stat. 780 (Aug. 17, 2006).
  4. Under Reorganization Plan No. 4 of 1978 (43 FR 47713, October 17, 1978), 5 U.S.C. App.1, 92 Stat. 3790, the authority of the Secretary of the Treasury to issue rulings under section 4975 of the Code has been transferred, with certain exceptions not here relevant, to the Secretary of Labor. Therefore, the references in this Bulletin to specific sections of ERISA should be taken as referring also to the corresponding sections of the Code.
  5. ERISA section 408(g)(11)(A)(flush language), 408(g)(10)(A), 408(g)(6)(A)(vii).
  6. See also August 3, 2006 Floor Statement of Senate Health, Education, Labor and Pensions Committee Chairman Enzi (who chaired the Conference Committee drafting legislation forming the basis of H.R. 4), regarding investment advice to participants in which he states, “It was the goal and objective of the Members of the Conference to keep this advisory opinion [AO 2001-09A, SunAmerica Advisory Opinion] intact as well as other pre-existing advisory opinions granted by the Department. This legislation does not alter the current or future status of the plans and their many participants operating under these advisory opinions. Rather, the legislation builds upon these advisory opinions and provides alternative means for providing investment advice which is protective of the interests of plan participants and IRA owners.” 152 Cong. Rec. S8, 752 (daily ed. Aug. 3, 2006) (statement of Sen. Enzi).
  7. We note, however, that a fiduciary may have co-fiduciary liability under ERISA section 405(a) if, for example, it knowingly participates in a breach committed by another fiduciary.
  8. Under section 408(g)(11)(B) the term affiliate of another entity means an affiliated person of the entity (as defined in section 2(a)(3) of the Investment Company Act of 1940 (15 U.S.C. 80a-2(a)(3))).
  9. See AO 97-15A and AO 2005-10A.
  10. No inferences should be drawn regarding the extent to which such an entity is responsible as principal for the acts of the individual fiduciary adviser providing the investment advice.
  11. For purposes of section 408(g)(2)(A)(i), the Department interprets the requirement that fees received by a fiduciary adviser not vary on the basis of any investment option selected as meaning that the fees or other compensation (including salary, bonuses, awards, promotions or any other thing of value) received, directly or indirectly from an employer, affiliate or other party, by a fiduciary adviser (or used for the adviser’s benefit) may not be based, in whole or part, on the investment options selected by participants or beneficiaries.

2007-02    ERISA Coverage of IRC§403(b) Tax-Sheltered Annuity Programs

Department of Labor - Employee Benefits Security Administration
Field Assistance Bulletin No. 2007-02

Date: July 24, 2007

Memorandum For:
Virginia C. Smith, Director of Enforcement
Regional Directors

From:
Robert J. Doyle
Director of Regulations and Interpretations

Subject:
ERISA Coverage Of IRC § 403(b) Tax-Sheltered Annuity Programs

Issue: How do the Department of the Treasury/Internal Revenue Service regulations governing Internal Revenue Code § 403(b) tax-sheltered annuity programs affect the status of such programs under the Department of Labor's safe harbor regulation at 29 C.F.R. § 2510.3-2(f)?

Background

A tax-sheltered annuity (TSA) program under section 403(b) of the Internal Revenue Code (Code), also known as a “403(b) plan,” is a retirement plan for employees of public schools, employees of certain tax-exempt organizations, and certain ministers. Under a 403(b) plan, employers may purchase for their eligible employees annuity contracts or establish custodial accounts invested only in mutual funds for the purpose of providing retirement income. Annuity contracts must be purchased from a state licensed insurance company, and the custodial accounts must be held by a custodian bank or IRS approved non-bank trustee/custodian. The annuity contracts and custodial accounts may be funded by employee salary deferrals, employer contributions, or both. Although not subject to the qualification requirements of section 401 of the Code, some of the requirements that apply to qualified plans also apply, with modifications, to 403(b) plans.

These TSA programs, if established or maintained by an employer engaged in commerce or in any industry or activity affecting commerce, generally are “pension plans” within the meaning of section 3(2) of ERISA and covered by Title I pursuant to section 4(a) of ERISA.(1) The terms “establish” or “maintain” are not defined in ERISA, and uncertainty as to the application of ERISA to TSA programs funded entirely with employee contributions prompted the Department of Labor in 1979 to issue a “safe harbor” regulation at 29 C.F.R. § 2510.3-2(f).

The safe harbor at § 2510.3-2(f) states that a program for the purchase of annuity contracts or custodial accounts in accordance with provisions set forth in section 403(b) of the Code and funded solely through salary reduction agreements or agreements to forego an increase in salary, are not “established or maintained” by an employer under section 3(2) of the Act, and, therefore, are not employee pension benefit plans subject to Title I, provided that certain factors are present. These factors are: (1) that participation of employees is completely voluntary, (2) that all rights under the annuity contract or custodial account are enforceable solely by the employee or beneficiary of such employee, or by an authorized representative of such employee or beneficiary, (3) that the involvement of the employer is limited to certain optional specified activities, and (4) that the employer receive no direct or indirect consideration or compensation in cash or otherwise other than reasonable reimbursement to cover expenses properly and actually incurred in performing the employer's duties pursuant to the salary reduction agreements. In this latter regard, if an employer, or a person acting in the interest of an employer, receives, for example, other consideration from an annuity contractor, the employer could be deemed to have “established or maintained” a plan.

The safe harbor allows the employer to engage in a range of activities to facilitate the operation of the program. The employer may permit annuity contractors–including agents or brokers who offer annuity contracts or make available custodial accounts–to publicize their products, may request information concerning proposed funding media, products, or annuity contractors, and may compile such information to facilitate review and analysis by the employees. The employer may enter into salary reduction agreements and collect annuity or custodial account considerations required by the agreements, remit them to annuity contractors, and maintain records of such collections. The employer may hold one or more group annuity contracts in the employer’s name covering its employees and exercise rights as representative of its employees under the contract, at least with respect to amendments of the contract. The employer may also limit funding media or products available to employees, or annuity contractors who may approach the employees, to a number and selection designed to afford employees a reasonable choice in light of all relevant circumstances.(2)

The Department of the Treasury/Internal Revenue Service has issued final regulations at 26 C.F.R. 1.403(b)-0 et seq. (July 2007) reflecting legislative changes made to § 403(b) since the existing regulations were adopted in 1964. The § 403(b) regulations also incorporate interpretive positions that the Department of the Treasury/Internal Revenue Service have taken in other guidance on § 403(b). This Bulletin is intended to provide guidance to EBSA’s national and regional offices concerning the extent to which compliance with the updated regulations would cause employers to exceed the limitations on employer involvement permitted under the Department of Labor’s safe harbor for tax-sheltered annuity programs at 29 C.F.R. § 2510.3-2(f).

Analysis

The new § 403(b) regulations have not led the Department of Labor to change its view on the principles that apply in determining whether any given TSA program is covered by Title I of ERISA. Even though the differences between the tax rules for TSA programs and those governing other ERISA-covered pension plans may have diminished, the Department's safe harbor regulation at 29 C.F.R. § 2510.3-2(f) remains operative. The new § 403(b) regulations allow significant flexibility regarding the employer's functions in the structure and operation of the arrangement. Thus, compliance with the new § 403(b) regulations will not necessarily cause a TSA program to become covered by Title I of ERISA.

The Department has acknowledged that employers have an interest separate from acting as their employees’ authorized representatives in ensuring that the annuity contracts and custodial accounts in TSA programs are tax compliant. The Code’s qualification requirements impose obligations directly on employers in connection with the employees’ annuity contracts and custodial accounts. If individual contracts or accounts fail to satisfy the tax qualification requirements, even if due to actions or errors of an employee or annuity contractor, the employer can be liable to the IRS for potentially substantial penalty taxes, correction fees, and employment taxes on employee salary deferrals. Accordingly, in the Department’s view, the safe harbor at section 2510.3-2(f) subsumes certain employer activities designed to ensure that a TSA program continues to be tax compliant under section 403(b) of the Code.

The Department of Labor has issued advisory opinions and other guidance on whether specific employer functions are compatible with the safe harbor. The Department believes that the safe harbor allows an employer to conduct administrative reviews of the program structure and operation for tax compliance defects. Such reviews may include discrimination testing and compliance with maximum contribution limitations under the Treasury regulations. As noted in previous guidance issued by the Department, the employer may also fashion and propose corrections; develop improvements to the plan's administrative processes that will obviate the recurrence of tax defects; obtain the cooperation of independent entities involved in the program needed to correct tax defects; and keep records of its activities.(3)

A program could fit within the section 2510.3-2(f) safe harbor and include terms that require employers to certify to an annuity provider a state of facts within the employer's knowledge as employer, such as employee addresses, attendance records or compensation levels. The employer may also transmit to the annuity provider another party's certification as to other facts, such as a doctor's certification of the employee's physical condition. The employer could not, however, consistent with the safe harbor, have responsibility for, or make, discretionary determinations in administering the program. Examples of such discretionary determinations are authorizing plan-to-plan transfers, processing distributions, satisfying applicable qualified joint and survivor annuity requirements, and making determinations regarding hardship distributions, qualified domestic relations orders (QDROs), and eligibility for or enforcement of loans.(4)

An important requirement in the Treasury regulations is that a TSA program must be maintained pursuant to a “written defined contribution plan” that satisfies the Code’s regulatory requirements and contains all the material terms and conditions for benefits under the plan. An employer, by adopting such a written plan, does not automatically establish a Title I plan. Compiling the benefit terms of the contracts and the responsibilities of the employer, annuity providers and participants is a function similar to the information collection and compilation activities expressly permitted under the Department’s TSA safe harbor. Indeed, the preamble to the final Treasury regulations makes clear that the “plan” required to satisfy the Code does not have to be a single document, but may incorporate by reference other documents, including insurance policies and custodial account agreements and other documents governing the contracts and accounts prepared by the annuity providers. 26 C.F.R. § 1.403(b)-3(b)(3).

The Department of Labor expects that the written plan for a TSA program that complies with the safe harbor would consist largely of the separate contracts and related documents supplied by the annuity providers and account trustees or custodians. An employer’s development and adoption of a single document to coordinate administration among different issuers, and to address tax matters that apply, such as the universal availability requirement in Code section 403(b)(12)(A)(ii), without reference to a particular contract or account, would not put the TSA program out of compliance with the safe harbor.

Because the Treasury regulations allow a plan to allocate responsibility for performing administrative functions to persons other than the employer, the relevant documents should identify the parties that are responsible for administrative functions, including those related to tax compliance. The documents should correctly describe the employer’s limited role and allocate discretionary determinations to the annuity provider or participant or other third party selected by the provider or participant.

In addition, an employer seeking to take advantage of the safe harbor may periodically review the documents making up the plan for conflicting provisions and for compliance with the Code and the Treasury regulations. Negotiating with annuity providers or account custodians to change the terms of their products for other purposes, such as setting conditions for hardship withdrawals, would be a form of employer involvement outside the safe harbor.

A tax-sheltered annuity program will not, in the Department’s view, become covered by Title I of ERISA merely because the written plan conforms to the new § 403(b) regulations by limiting employees to exchanges of contract funds only among providers who have adopted the written plan, or transfers from the program of a former employer to that of the current employer. Under the safe harbor, the employer may limit funding media or products available to employees, or annuity providers who may approach the employee, to a number designed to afford employees a reasonable choice in light of all relevant circumstances. The Code-mandated restrictions on transfers of funds may, however, require the employer to allow providers to offer a wider variety of products in order to afford employees a reasonable choice in light of all relevant circumstances for purposes of the safe harbor. Alternately, an employer may limit the number of providers to which it will forward salary reduction contributions as long as employees may transfer all or a part of their funds to any provider whose annuity contract or custodial account complies with the Code requirements and who agrees to the plan's division of tax compliance responsibilities among the employer, provider and participant.

Finally, in the event an employer decides that it does not want to continue to perform the ministerial and administrative functions required under the § 403(b) regulations, the Department does not believe that the employer's determination to terminate a TSA program in compliance with the Treasury regulations will cause a program not otherwise covered by Title I of ERISA to become covered.

Conclusion

The Department is of the view that tax-exempt employers will be able to comply with the requirements in the new § 403(b) regulations and remain within the Department’s safe harbor for TSA programs funded solely by salary deferrals. We note, however, that the new § 403(b) regulations offer employers considerable flexibility in shaping the extent and nature of their involvement under a tax-sheltered annuity program. The question of whether any particular employer, in complying with the § 403(b) regulations, has established or maintained a plan covered under Title I of ERISA must be analyzed on a case-by-case basis applying the criteria set forth in 29 C.F.R. § 2510.3-2(f) and section 3(2) of ERISA.

Questions concerning the information contained in this Bulletin may be directed to the Division of Coverage, Reporting and Disclosure, Office of Regulations and Interpretations, 202.693.8523.

Footnotes

  1. Under ERISA § 4(b) (1) and (2), “governmental plans” and “church plans” generally are excluded from coverage under Title I of ERISA. Therefore, § 403(b) contracts and custodial accounts purchased or provided under a program that is either a “governmental plan” under § 3(32) of ERISA or a non-electing “church plan” under § 3(33) of ERISA are not subject to Title I.
  2. The regulation at 29 C.F.R. § 2510.3-2(f) provides a “safe harbor” for TSA programs that conform to its provisions. The safe harbor does not preclude the possibility that programs that do not fully conform with the regulation may nevertheless not be “established or maintained” by an employer for purposes of Title I of ERISA.
  3. See DOL Information Letter to Siegel Benefit Consultants (Feb. 27, 1996).
  4. See Advisory Opinion Nos. 94-30A, 83-23A, and 80-11A.

2007-03    Periodic Pension Benefit Statements For Non-Participant Directed Individual Account Plans

Field Assistance Bulletin No. 2007-03

Date: October 12, 2007

Memorandum For:
Virginia C. Smith, Director of Enforcement
Regional Directors

From:
Robert J. Doyle
Director of Regulations and Interpretations

Subject: Periodic Pension Benefit Statements for Non-Participant Directed Individual Account Plans

On December 20, 2006, the Department of Labor issued Field Assistance Bulletin (FAB) 2006-03 providing guidance for the Employee Benefits Security Administration’s national and regional offices concerning good faith compliance with the pension benefit statement provisions of section 105 of ERISA, as amended by the Pension Protection Act of 2006. In FAB 2006-03, the Department indicated, among other things, that, pending the issuance of further guidance, the furnishing of pension benefit statement information not later than 45 days following the end of the relevant period (calendar quarter or calendar year) will constitute good faith compliance with the requirement to automatically furnish pension benefit statements by individual account plans.

Since the issuance of FAB 2006-03, it has come to the attention of the Department that many individual account plans that do not permit participants and beneficiaries to direct the investment of assets in their individual accounts may not be able to comply within the 45-day period set forth in the FAB. It is represented that many of these plans are profit sharing plans and the sponsors of those plans do not determine or contribute profit sharing contributions until after the sponsor’s business tax return is completed. Similarly, non-participant directed individual account plans sponsored by partnerships cannot make contribution determinations until completion of the partnership tax return. It also is represented that many such plans are dependent on securing third-party valuations for those assets that do not have a readily ascertainable value. Compliance with the 45-day good faith period, therefore, would appear to be impossible or very expensive for many of these plans unless the benefit statements were based on data from the end of the prior plan year. It is further represented that much of the required information is compiled in connection with the preparation of the plan’s Form 5500 Annual Return/Report and, accordingly, the time frame for furnishing benefit statements should correspond to the required filing of the plan’s Form 5500.

In view of the foregoing, and pending the issuance of further guidance, the Department is providing the following additional guidance. Plan administrators of individual account plans that do not provide for participant direction of investments will be treated as acting in good faith compliance with a reasonable interpretation of section 105(a)(1)(A)(ii) of ERISA when statements are furnished to participants and beneficiaries on or before the date on which the Form 5500 Annual Return/Report is filed by the plan (but in no event later than the date, including extensions, on which the Annual Return/Report is required to be filed by the plan) for the plan year to which the statement relates.

This guidance supersedes the guidance provided in FAB 2006-03 as it relates to the dates for furnishing pension benefit statements to participants and beneficiaries of individual account plans that do not permit participants and beneficiaries to direct the investment of assets in their individual accounts.

Questions concerning this matter may be directed to Jeff Turner or Suzanne Adelman, at 202.693.8523.

2007-04    Supplemental health insurance coverage as excepted benefits under HIPAA and related legislation excepted benefits under sections 732(c)(3) and 733(c)(4) of ERISA?

Field Assistance Bulletin No. 2007-04

December 7, 2007

Memorandum For:
Virginia C. Smith, Director of Enforcement
Regional Directors

From:
Daniel J. Maguire
Director of Health Plan Standards and Compliance Assistance

Subject: Supplemental health insurance coverage as excepted benefits under HIPAA and related legislation

Issue: What are the circumstances under which supplemental health insurance coverage satisfies the requirements for excepted benefits under sections 732(c)(3) and 733(c)(4) of ERISA?

Background:

HIPAA Health Reform and Related Legislation

Titles I and IV of the Health Insurance Portability and Accountability Act of 1996, Pub. L. 104-191, 110 Stat. 1936 (HIPAA) amended the Employee Retirement Income Security Act (ERISA), the Internal Revenue Code (Code), and the Public Health Service Act (PHS Act) to improve portability, access, and continuity with respect to group health plan coverage provided in connection with employment. These laws include limitations on preexisting condition exclusions, require issuance of certificates of creditable coverage, provide special enrollment rights, and prohibit discrimination on the basis of any health factor. Later amendments to these laws provide protections relating to mental health parity, hospital lengths of stay following childbirth, and post-mastectomy coverage. Regulations issued by the Departments of Labor, the Treasury, and Health and Human Services (the Departments) on these group market provisions are contained in 29 CFR Part 2590, 26 CFR Part 54, and 45 CFR Parts 144 and 146. Additional reforms were provided in the PHS Act for health coverage in the individual market and are contained in 45 CFR Parts 144 and 148.

In general, these health reform provisions apply to group health plans (generally plans established or maintained by employers or employee organizations, or both) and health insurance issuers in the group or individual market. However, these provisions do not apply to certain excepted benefits. In general, if all benefits under a plan or coverage are excepted benefits, then the plan and any health insurance coverage under the plan does not have to comply with the health reform requirements, and the coverage may not qualify as creditable coverage.

Supplemental Health Insurance Coverage

One category of excepted benefits is supplemental excepted benefits. Benefits are supplemental excepted benefits only if they are provided under a separate policy, certificate, or contract of insurance and are either Medicare supplemental health insurance, TRICARE supplemental programs, or similar supplemental coverage provided to coverage under a group health plan. The phrase “similar supplemental coverage provided to coverage under a group health plan” is not defined in the statute or regulations. However, the regulations clarify that one requirement to be similar supplemental coverage is that the coverage must be specifically designed to fill gaps in primary coverage, such as coinsurance or deductibles (but similar supplemental coverage does not include coverage that becomes secondary or supplemental only under a coordination-of-benefits provision). 29 CFR 2590.732 (c)(5)(i)(C), 26 CFR 54.9831-1(c)(5 )(i)(C), and 45 CFR 146.145(c)(5)(i)(C).

Coordination of Administration

Various situations have come to the attention of the Departments that raise concerns about whether all of the coverage that is being marketed as similar supplemental coverage actually qualifies as such.

Section 104 of HIPAA requires the Secretaries of Labor, the Treasury, and Health and Human Services to ensure that guidance under HIPAA issued by the Departments that relates to the same matter be administered so as to have the same effect at all times. In accordance with section 104 of HIPAA, each of the Departments is issuing guidance concerning the requirements for “similar supplemental coverage” that qualifies as benefits excepted from the requirements of HIPAA. The guidance being issued has been developed on a coordinated basis by the Departments. HHS is also issuing guidance on similar supplemental coverage for the individual market.

Discussion

In order to prevent issuers from avoiding compliance with ERISA’s health reform provisions by issuing multiple insurance contracts in connection with a plan, this bulletin establishes an enforcement safe harbor under which supplemental health insurance will be considered excepted benefits for purposes of Part 7 of ERISA. Similar supplemental coverage that does not meet the standards for this safe harbor may be subject to enforcement actions by the Department.

To fall within the safe harbor, a policy, certificate, or contract of insurance must be issued by an entity that does not provide the primary coverage under the plan and must be specifically designed to fill gaps in primary coverage.

In addition, the Department believes that the value of the supplemental coverage must be significantly less than the value of the primary coverage that it supplements. To fall within the enforcement safe harbor, the cost of supplemental coverage may not exceed 15 percent of the cost of the plan’s primary coverage. The Department will determine cost in the same manner as the “applicable premium” is calculated under a COBRA continuation provision.(1) Some plans subject to HIPAA titles I or IV are not subject to the COBRA continuation coverage requirements, such as plans maintained by an employer with 20 or fewer employees. For these plans, the Department will compute cost as if they were subject to COBRA. (For insured coverage – all supplemental coverage and primary coverage to the extent insured – the COBRA cost is, for purposes of this bulletin, the cost of the insurance coverage.)

Issuers of Medicare supplemental health insurance (commonly referred to as “Medigap”) generally are subject to prohibitions against discrimination based on enrollees’ or potential enrollees’ health status. Accordingly, to fall within the enforcement safe harbor, the coverage may not differentiate among individuals in eligibility, benefits, or premiums based upon any health factor of the individual.

Conclusion

For purposes of enforcing ERISA’s health reform provisions, the Department will treat coverage as “similar supplemental coverage provided to coverage under a group health plan” under 29 CFR 2590.732(c)(5)(i)(C), within the enforcement safe harbor, if it is a separate policy, certificate, or contract of insurance and if it satisfies all of the following requirements:

Independent of Primary Coverage. The supplemental policy, certificate, or contract of insurance must be issued by an entity that does not provide the primary coverage under the plan. For this purpose, entities that are part of the same controlled group of corporations or part of the same group of trades or businesses under common control, within the meaning of section 52(a) or (b) of the Code, are considered a single entity.

Supplemental for Gaps in Primary Coverage. The supplemental policy, certificate, or contract of insurance must be specifically designed to fill gaps in primary coverage, such as coinsurance or deductibles, but does not include a policy, certificate, or contract of insurance that becomes secondary or supplemental only under a coordination-of-benefits provision.

Supplemental in Value of Coverage. The cost of coverage under the supplemental policy, certificate, or contract of insurance must not exceed 15 percent of the cost of primary coverage. Cost is determined in the same manner as the applicable premium is calculated under a COBRA continuation provision.

Similar to Medicare Supplemental Coverage. The supplemental policy, certificate, or contract of insurance that is group health insurance coverage must not differentiate among individuals in eligibility, benefits, or premiums based on any health factor of an individual (or any dependent of the individual).

Questions concerning the information contained in this Bulletin may be directed to the Office of Health Plan Standards and Compliance Assistance at 202.693.8335.

Footnotes

Under the COBRA rules, plans are generally permitted to charge up to 102 percent of the applicable premium. Thus, COBRA cost for purposes of this bulletin is 100 percent of the applicable premium, not 102 percent of the applicable premium that the plan is generally permitted to charge under the COBRA rules.

2008-01    Fiduciary Responsibility for Collection of Delinquent Contributions

Field Assistance Bulletin No. 2008-01

February 1, 2008

Memorandum For:
Virginia C. Smith, Director of Enforcement
Regional Directors

From:
Robert J. Doyle
Director of Regulations and Interpretations

Subject: Fiduciary Responsibility for Collection of Delinquent Contributions

Issue: What are the responsibilities of named fiduciaries and trustees of ERISA-covered plans for the collection of delinquent employer and employee contributions?

Background

A number of pension plan investigations have revealed agreements that purport to relieve the financial institutions serving as plan trustees of any responsibility to monitor and collect delinquent contributions. The investigations have revealed circumstances where no other trust agreement or plan document assigns those obligations to another trustee or imposes the obligations on a named fiduciary with the authority to direct a trustee. In other cases, the plan documents and trust agreements are silent or ambiguous on the matter. Questions have been raised as to whether, and if so, to what extent, trust agreements and other instruments may define the scope of trustee undertakings and exclude responsibilities for monitoring the plan’s receipt of contributions, determining when they are delinquent and taking appropriate steps for collection.

Employer contributions are delinquent when they are due and owing to the plan under the documents and instruments governing the plan but have not been transmitted to the plan in a timely manner.1 The Department has taken the position that employer contributions become an asset of the plan only when the contribution has been made.2 However, when an employer fails to make a required contribution to a plan in accordance with the plan documents, the plan has a claim against the employer for the contribution, and that claim is an asset of the plan. Participant contributions that are withheld from wages or paid to the employer are delinquent if they become plan assets while still in the hands of the employer. Under the Department’s regulations, participant contributions become plan assets in the hands of the employer on the earliest date that the amount withheld from the participant’s pay or paid to the employer reasonably can be segregated from the employer’s general assets. With respect to an employee pension benefit plan, this date can be no later than the 15th business day of the month following the month in which participant contribution amounts were withheld from the employee’s paychecks or paid to the employer.3

Analysis

The duty to enforce valid claims held by a trust has long been considered a trustee responsibility under common law. IIA Austin W. Scott & William E. Fratcher, The Law of Trusts § 177 (4th ed. 1989); Restatement (Third) of Trusts, § 76 (2007). See also George G. Bogert & George T. Bogert, The Law of Trusts and Trustees § 583 at p.355 (2d rev. ed. 1980) (where the settlor retains possession of trust assets, “the trustee must hold the settlor to [his] obligation”); Scott 175, at 1415 (“trustee is under a duty to take such steps as are reasonable to secure control of the trust property and to keep control of it”). The Supreme Court affirmed that the collection of contributions is a trustee responsibility under ERISA in Central States, Southeast and Southwest Areas Pension Fund v. Central Transport, 472 U.S. 559, 571 (1985). The Court noted that:

One of the fundamental common-law duties of a trustee is to preserve and maintain trust assets, and this encompasses “determin[ing] exactly what property forms the subject-matter of the trust [and] who are the beneficiaries.” The trustee is thus expected to “use reasonable diligence to discover the location of the trust property and to take control of it without unnecessary delay.” A trustee is similarly expected to “investigate the identity of the beneficiary when the trust documents do not clearly fix such party” and to “notify the beneficiaries under the trust of the gifts made to them” (citations omitted).

Section 404(a) of ERISA requires that a fiduciary discharge his duties prudently and solely in the interests of the participants and beneficiaries of the plan. The steps necessary to discharge a duty to collect contributions will depend on the facts of each case. In determining what collection actions to take, a fiduciary should weigh the value of the plan assets involved, the likelihood of a successful recovery, and the expenses expected to be incurred. Among other factors, the fiduciary may take into account the employer’s solvency in deciding whether to expend plan assets to pursue a claim. Diduck v. Kaszycki & Sons Contractors, 874 F. 2d 912 (2nd Cir. 1989). The Department of Labor has also long held the view that if the plan is not making systematic, reasonable and diligent efforts to collect delinquent employer contributions, or the failure to collect delinquent contributions is the result of an arrangement, agreement or understanding, express or implied, between the plan and a delinquent employer, such failure to collect delinquent contributions may be deemed to be a prohibited transactions under section 406 of ERISA.4

Section 402(a)(1) provides that every employee benefit plan shall be established and maintained pursuant to a written instrument, and that the instrument “shall provide for one or more named fiduciaries who jointly or severally shall have authority to control and manage the operation and administration of the plan.”5 Section 403(a) of ERISA provides, with certain exceptions, that all assets of an employee benefit plan must be held in trust by one or more trustees, who are to be named in the plan or trust instrument or appointed by a person who is a named fiduciary. Section 403(a) further provides that “upon acceptance of being named or appointed, the trustee or trustees shall have exclusive authority and discretion to manage and control the assets of the plan . . . .” A plan trustee, therefore, will, by definition, always be a “fiduciary” under ERISA as a result of its authority or control over plan assets and, accordingly, is required to discharge its trustee responsibilities prudently and solely in the interest of the plan’s participants and beneficiaries. Although trust documents cannot excuse trustees from their duties under ERISA, ERISA clearly gives named fiduciaries the authority to appoint multiple trustees and to allocate trustee responsibilities among those trustees (including directed trustees).

Section 403(a) recognizes two exceptions to the general rule that exclusive authority and discretion to manage and control the assets of a plan must be vested in one or more plan trustees. The first exception, at section 403(a)(1), applies when “the plan expressly provides that the trustee or trustees are subject to the direction of a named fiduciary who is not a trustee.” In such instances, the trustee, commonly referred to as a “directed trustee,” is subject to the proper directions of the named fiduciary. As the Department noted in Field Assistance Bulletin No. 2004-03 (Dec. 17, 2004), directed trustees are fiduciaries, and as such, are subject to ERISA’s fiduciary rules, but the scope of their duties is “significantly narrower than the duties generally ascribed to a discretionary trustee under common law trust principles.” The second exception to the “exclusive authority” provision in section 403(a)(1) applies when the authority to manage, acquire or dispose of plan assets is delegated to one or more investment managers pursuant to section 402(c)(3).

Additionally, section 405(b)(1)(B) provides, in relevant part, that, except as set forth in section 403(a)(1), if the assets of a plan are held by two or more trustees they shall jointly manage and control the assets of a plan except that nothing shall preclude any agreement, authorized by the trust instrument, allocating specific responsibilities, obligations, or duties among trustees, in which event a trustee to whom certain responsibilities, obligations, or duties have not been allocated shall not be liable either individually or as a trustee for any loss resulting to the plan arising from the acts or omissions on the part of another trustee to whom such responsibilities, obligations or duties have been assigned. Similarly, in those cases where the assets of a plan are held in more than one trust, a trustee is responsible only for those acts or omissions of the trustees of the trust for which it is trustee.6

Thus, in accordance with the statutory framework described above, authority over a plan’s assets subject to the trust requirement of section 403(a) of ERISA, including a plan’s legal claim for delinquent contributions, must be assigned to i) a plan trustee with discretionary authority over the assets, ii) a directed trustee subject to the proper and lawful directions of a named fiduciary, or iii) an investment manager.

Accordingly, it is the view of the Department that a named or functional fiduciary who has authority to appoint the plan’s trustee(s) must ensure that the obligation to collect contributions is appropriately assigned to a trustee, unless the plan expressly provides that the trustee will be a directed trustee with respect to contributions pursuant to section 403(a)(1) or the authority to collect contributions is delegated to an investment manager pursuant to section 403(a)(2).

Thus, although a fiduciary may enter into a trust agreement under which a particular trustee is not responsible for monitoring and collecting contributions, if no trustee or investment manager has this responsibility, the fiduciary with authority to hire the trustees may be liable for plan losses due to a failure to collect contributions because the fiduciary failed to specifically allocate this responsibility.7

These situations should be evaluated on the basis of all the facts and circumstances. Where the provisions in trust instruments and plan documents are ambiguous, they should generally be interpreted in a manner that corresponds to the statutory scheme, rather than in a manner that relieves all of the trustees and investment managers from responsibility.8 Reliance on plan, trust and other governing documents to define the responsibilities of plan fiduciaries, however, may not be completely determinative if the provisions in the documents are inconsistent with the actions of the parties. For example, if a nominally directed trustee routinely assumes discretionary responsibility, the trustee cannot seek to limit its liability with respect to the exercise of that discretion on the basis that it is a directed trustee. Similarly, a trustee cannot alter its status as fiduciary through a contractual provision that defines its trustee duties as non-fiduciary in nature.

If a particular trustee is not responsible for monitoring and collecting contributions under the terms of the trust instrument, that trustee (including a directed trustee) nonetheless would have an obligation under sections 404 and 405(a) to take appropriate steps to remedy a situation where the trustee knows that no party has assumed responsibility for the collection and monitoring of contributions and that delinquent contributions are going uncollected. As explained in Field Assistance Bulletin No. 2004-03, a fiduciary, pursuant to section 405(a)(1), is liable for the breach of another fiduciary if the fiduciary “participates knowingly” in the breach of the other fiduciary. In addition, under section 405(a)(2), a fiduciary is liable for a breach of another fiduciary if the fiduciary’s failure to comply with section 404(a)(1) in the administration of his specific fiduciary responsibilities enables the other fiduciary to commit a breach. Under section 405(a)(3), a fiduciary is liable for a breach of another fiduciary if the fiduciary has knowledge of the breach of the other fiduciary, unless the fiduciary takes reasonable efforts under the circumstances to remedy the breach. Efforts to remedy may, depending on the circumstances, include advising the named fiduciary or the Department of Labor of the breach, reporting the breach to other fiduciaries of the plan, directly taking actions to enforce the contribution obligation on behalf of the plan, seeking an amendment of the relevant plan and trust documents, or seeking a court order mandating a proper allocation of fiduciary responsibility over contributions. The documents and instruments governing a plan cannot serve to absolve a co-fiduciary from liability for failing to take steps to remedy a known breach of another fiduciary.9 Whether and to what extent information concerning the failure of an employer to forward contributions to a plan constitutes knowledge of a breach that would give rise to co-fiduciary liability will depend upon the facts and circumstances of each case.

Conclusion

The responsibility for collecting contributions is a trustee responsibility. If a plan has two or more trustees, the duty may be allocated to a single trustee. A plan may also provide that a named fiduciary may direct a trustee as to this responsibility or may appoint an investment manager to take on this duty. To the extent the nature and scope of the trustee’s responsibilities are specifically limited in the plan documents or trust agreement, it is generally the responsibility of the named fiduciary with the authority to hire and monitor trustees to assure that all trustee responsibilities with respect to the management and control of the plan’s assets (including collecting delinquent contributions) have been properly assigned to a trustee or investment manager.

Footnotes

  1. In the event that those instruments are ambiguous, promised employer contributions are delinquent if not transmitted to the plan within a reasonable time after the legally enforceable obligation to make the contribution arises.
  2. See Advisory Opinion 93-14; Preamble to Prohibited Transaction Exemption 76-1, 41 FR 12740 at 12741 (Mar. 26, 1976).
  3. See 29 CFR 2510.3-102. An employer continuing to hold participant contribution commingled with its general assets after the participant contributions reasonably could have been segregated will have engaged in a prohibited transaction in violation of ERISA section 406. This memorandum is not intended to address any civil or criminal liability that may attach to an employer as a result of such a prohibited transaction.
  4. See the preamble to Prohibited Transaction Exemption 76-1, 41 FR 12740, 12741 (Mar. 26, 1976).
  5. Section 402(a)(2) of ERISA defines the term “named fiduciary” to mean “a fiduciary who is named in the plan instrument, or who, pursuant to a procedure specified in the plan, is identified as a fiduciary (A) by a person who is an employer or employee organization with respect to the plan or (B) by such an employer and such an employee organization acting jointly.”
  6. See discussion below on co-fiduciary liability under section 405(a).
  7. Under ERISA section 403(b), employee benefit plans are not subject to section 403(a)’s trust requirement if the plan’s assets consist entirely of insurance contracts or policies issued by an insurance company qualified to do business in a State, or individual retirement accounts, such as SIMPLE-IRA plans and SEPS, with assets held in custodial accounts under Code section 408(h), or contracts established and maintained under Code section 403(b) with assets held in custodial accounts under Code section 403(b)(7). In such cases, the duty to use reasonable diligence to discover the location of the plan’s property (such as delinquent contributions) and to take control of it without unnecessary delay is, in the view of the Department, part of the named fiduciary’s duties under ERISA section 402(a)(1) to control and manage the operation and administration of the plan. In the case of SIMPLE-IRAs and SEPS, the plan sponsor generally will be a named fiduciary because the documents establishing the plan typically provide the employer with authority with respect to management and administration of the plan notwithstanding that the plan documents may fail to state expressly that the plan sponsor is a “named fiduciary.”
  8. See Best v. Cyrus, 310 F.3d 932, 935 (6th Cir. 2002)
  9. See ERISA section 410 (which provides, subject to certain exceptions, that “any provision in an agreement or instrument which purports to relieve a fiduciary from responsibility or liability for any responsibility, obligation, or duty under this part shall be void as against public policy.”). See also 29 CFR § 2509.75-4.
DOL Interpretive Letter

Receipt of Fees from Mutual Fund Distributors and Investment Advisors

U.S. Department of Labor
Pension and Welfare Benefits Administration
Washington, D.C. 20210

August 20, 1997

Judith A. McCormick
Senior Trust Counsel
American Bankers Association
1120 Connecticut Avenue, N.W.
Washington, D.C. 20036

Dear Ms. McCormick:

This is in response to your request for an information letter on behalf of the American Bankers Association (ABA), confirming that the principles enunciated in Advisory Opinions 97-15A and 97-16A (May 22, 1997) would apply in the case of a bank that acts as a directed trustee of an employee benefit plan. A.O. 97-15A concerned a bank that served both as a directed trustee and as a trustee with investment discretion. A.O. 97-16A involved a plan recordkeeper. Both opinions addressed the receipt of fees by the trustee or recordkeeper from mutual funds (or their distributors or investment advisors) in connection with the investment of plan assets in the mutual funds as part of a combined program of investment options and services offered to plans, commonly referred to as a "bundled services" product.

In general, you have described a typical "bundled services" product as a comprehensive program of administrative, custodial, and investment services offered by affiliated and non-affiliated entities to pension plans, most typically participant-directed defined contribution plans. Such a program may be offered by a single financial institution or through an arrangement in which multiple vendors contract with each other to offer a bundle of plan services. The plan services typically include, but are not limited to, custodial trustee services, participant level record-keeping, 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 menu of investment options, typically consisting of mutual funds from one or more mutual fund families.

You described typical situations in which a financial institution (the bank) may offer to plans a bundled services product in which it acts as a directed trustee and which includes as investment options mutual funds from one or more mutual fund families. Pursuant to the bank’s contracts with the mutual funds (or their distributors or investment advisors), the bank may provide subtransfer agent, administrative and/or shareholder services to or on behalf of the mutual funds in connection with the purchase of mutual fund shares by the plans. In return for these services, the mutual fund (or its distributor or investment advisor) pays a fee to the bank (frequently pursuant to a plan adopted under Securities and Exchange Commission Rule 12b-1) based on percentage of the mutual fund’s assets attributable to plan investments in the fund. Generally, the bank reserves the right to add, delete, or substitute individual mutual funds or mutual fund families to or from the investment menu, but otherwise has and exercises no investment discretion.

In A.O. 97-15A, the Department explained that, although a directed trustee is necessarily a fiduciary, if the 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 sections 406(b)(1) or (b)(3). The Department indicated, however, that because the trustee in that case had reserved the right to add or remove mutual fund families that it made available to the plans, the Department could not conclude that the trustee 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 the trustee. The Department further noted that the trustee in that case fully disclosed to the plans its fee arrangements with the mutual fund families, and agreed to apply any fees it received from the mutual funds to the benefit of the plans, either as a dollar-for-dollar offset against the fees the plans were obligated to pay for trustee or recordkeeping services, or as amounts credited directly to the plans. Under these circumstances, the Department concluded that the trustee would not violate sections 406(b)(1) or (b)(3) because it would not be dealing with plan assets in its own interest or for its own account, or receiving the payments from the mutual funds for it s own personal account.

In A.O. 97-16A, the Department opined that a recordkeeper that offered plans a bundled services product would not exercise discretionary authority or control over the management of a plan or its assets solely as a result of deleting or substituting a mutual fund from its program of investment options and services it offered to the plans, provided that the appropriate plan fiduciary in fact makes the decision to accept or reject the change. The Department emphasized that, in order to be able to make that decision, the plan fiduciary must be provided advance notice of the change, including any changes in the fees received by the recordkeeper, 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. In that case, the recordkeeper provided at least 120 days following notice of a proposed change in funds within which to reject the change and secure a new service provider. The Department noted, however, that what constitutes a reasonable period of time within which to terminate a bundled services arrangement and change service providers is inherently a factual question which must be determined by the appropriate plan fiduciary in light of the particular facts and circumstances in each case.

The opinions expressed in A.O. 97-15A and A.O. 97-16A are limited to the facts presented and may be relied upon only by the parties to whom they were issued. See Advisory Opinion Procedure 76-1, Section 10, 41 Fed. Reg. 36281 (Aug. 27, 1976). Nevertheless, it is the view of the Department that the foregoing legal principles, as expressed in A.O. 97-15A and A.O. 97-16A, would apply in the case of a bank that serves as a directed trustee for employee benefit plans in the context of a bundled services product as described above.

We hope that this information is helpful to you.

Sincerely,

Bette J. Briggs Chief,
Division of Fiduciary Interpretations
Office of Regulations and Interpretations

ERISA Procedures

76-1    Advisory Opinion Requests: Establishes procedures for requesting ERISA opinions from Labor Department

Department of Labor - Advisory Opinion Procedure
ERISA Procedure 76-1

August 27, 1976

41 FR 36281

It is the practice of the Department of Labor (the Department) to answer inquiries of individuals or organizations affected, directly or indirectly, by the Employee Retirement Income Security Act of 1974 (Pub. L. 93-406, hereinafter "the Act") as to their status under the Act and as to the effect of certain acts and transactions. The answers to such inquiries are categorized as "information letters" and "advisory opinions." This "ERISA Procedure" (ERISA Proc. 76-1) describes the general procedures of the Department in issuing Information letters and advisory opinions under the Act, and is designed to promote efficient handling of inquiries and to facilitate prompt responses.

Section 7 of this Procedure (instructions to individuals and organizations requesting advisory opinions relating to prohibited transactions and common definitions) is reserved. This section will set forth the procedures to be followed to obtain an advisory opinion relating to prohibited transactions and common definitions, such as whether a person is a party in interest and a disqualified person. In general, this section will incorporate a revenue Procedure to be published by the Internal Revenue Service.

This advisory opinion procedure consists of rules of agency procedure and practice, and is therefore excepted under 5 USC 552(b)(3)(A) of the Administrative Procedure Act from the ordinary notice and comment provisions for agency rulemaking. Accordingly, the Procedure is effective August 27, 1976.

Sec. 1. Purpose.

The purpose of this ERISA Procedure is to describe the general Procedures of the Department of Labor (the Department) in issuing information letters and advisory opinions to individuals and organizations under the Employee Retirement Income Security Act of 1974 (Pub. L. 93-406), hereinafter referred to as "the Act." This ERISA Procedure also informs individuals and organizations, and their authorized representatives, where they may direct requests for information letters and advisory opinions, and outline procedures to be followed in order to promote efficient handling of their inquiries.

Sec. 2. General practice.

It is the practice of the Department to answer inquiries of individuals and organizations, whenever appropriate, and in the interest of sound administration of the Act, as to their status under the Act and as to the effects of their acts or transactions. One of the functions of the Department is to issue information letters and advisory opinions in such matters.

Sec. 3. Definitions.

  1. An "information letter" is a written statement issued either by the Pension and Welfare Benefit Programs (Office of Employee Benefits Security), U.S. Department of Labor, Washington, D.C. or a Regional Office or an Area Office of the Labor-Management Services Administration, U.S. Department of Labor, that does no more than call attention to a well established interpretation or principle of the Act without applying it to a specific factual situation. An information letter may be issued to any individual or organization when the nature of the request from the individual or the organization suggests that it is seeking general information or where the request does not meet all the requirements of section 6 or 7 of this procedure, and it is believed that such general information will aid the individual or organization.
  2. An "advisory opinion" is a written statement issued to an individual or organization, or to the authorized representative of such individual or organization, by the Administrator of Pension and Welfare Benefit Programs or his delegate, that interprets and applies the Act to a specific factual situation. Advisory opinions are issued only by the Administrator of Pension and Welfare Benefit programs or his delegate.
  3. Individuals and organizations are those persons described in section 4 of this procedure.

Sec. 4. Individuals and organizations who may request advisory opinions or information letters.

  1. Any individual or organization affected directly or indirectly by the Act may request an information or an advisory opinion from the Department.
  2. A request by or for an individual or organization must be signed by the individual or organization, or by the authorized representative of such individual or organization. See section 7.03 of this procedure.

Sec. 5. Discretionary Authority to Render Advisory Opinions.

  1. The Department will issue advisory opinions involving the interpretation of the application of one or more sections of the Act, regulations promulgated under the Act, interpretive bulletins or exemptions issued by the Department to a specific factual situation. Generally, advisory opinions will be issued by the Department only with respect to prospective transactions (i.e., a transaction which will be entered into). Moreover, there are certain areas where, because of the inherently factual nature of the problem involved, or because the subject of the request for opinion is under investigation for a violation of the Act, the Department will ordinarily not issue advisory opinions. Generally, an advisory opinion will not be issued on alternative courses of proposed transactions, or on hypothetical situations or where all parties involved are not sufficiently identified and described, or where material facts or details of the transaction are omitted.
  2. The Department ordinarily will not issue advisory opinions relating to the following sections of the Act:
    1. Section 3(18), relating to whether certain consideration constitutes adequate consideration;
    2. Section 3(26), relating to whether the valuation of any asset is at current value;
    3. Section 3(27), relating to whether the valuation of any asset is at present value;
    4. Section 102(a)(1), relating to whether a summary plan description is written in a manner calculated to be understood by the average participant;
    5. Section 103(a)(3)(A), relating to whether the financial statements and schedules required to be included in the Annual Report are presented fairly in conformity with generally accepted accounting principles applied on a consistent basis;
    6. Section 103(b)(1), relating to whether a matter must be included in a financial statement in order to fully and fairly present the financial statement of the plan;
    7. Section 202 (other than section 202(a)(3) and (b)(1)), relating to minimum participation standards;
    8. Section 203 (other than sections 202(a)(3)(B), (b)(1) (flush language), (b)(2), (b)(3)(A);
    9. Section 204 of the Act (other than sections 204(b)(1)(B), (b)(1)(A), (C), (D), (E)), relating to benefit accrual requirements;
    10. Section 205(e), relating to the period during which a participant may elect in writing not to receive a joint and survivor annuity;
    11. Section 208, relating to mergers and consolidation of plans or transfer of plan assets;
    12. Section 209(a)(1), relating to whether the report required by section 209(a)(1) is sufficient to inform the employee of his accrued benefits under the plan, etc.;
    13. Sections 302 through 305, relating to minimum funding standards;
    14. Section 403(c)(1), relating to the purposes for which plan assets must be held;
    15. Section 404(a), relating to fiduciary duties as applied to particular conduct; and
    16. Section 407(a)(2) and (3) and (c)(1), relating to fair market value, as applied to whether the value of any particular security or real property constitutes fair market value.

    This list is not all inclusive and the department may decline to issue advisory opinions relating to other sections of the Act whenever warranted by the facts and circumstances of a particular case. The Department may, when it is deemed appropriate and in the best interest of sound administration of the Act, issue information letters calling attention to established principles under the Act, even though the request that was submitted was for an advisory opinion.

  3. Pending the adoption of regulations (either temporary or final) involving the interpretation of the application of a provision of the Act, consideration will be given to the issuance of advisory opinions relating to such provisions of the Act only under the following conditions:
    1. If an inquiry presents an issue on which the answer seems to be clear from the application of the provisions of the Act to the facts described, the advisory opinion will be issued in accordance with the procedures contained herein.
    2. If an inquiry presents an issue on which the answer seems reasonably certain but not entirely free from doubt, an advisory opinion will be issued only it is established to the satisfaction of the Department that a business emergency requires an advisory opinion or that unusual hardship to the plan or its participants and beneficiaries will result from failure to obtain an advisory opinion. In any case in which the individual or organization believes that a business emergency exists or that an unusual hardship to the plan or its participants and beneficiaries will result from the failure to obtain an advisory opinion, the individual or organization should submit with the request a separate letter setting forth the facts necessary for the Department to make a determination in this regard. In this connection, the Department will not deem a "business emergency" to result from circumstances within the control of the individual or organization such as, for example, scheduling within an inordinately short time the closing date of a transaction or a meeting of the Board of Directors or the shareholders of a corporation.
    3. If an inquiry presents an issue that cannot be reasonably resolved prior to the issuance of a regulation, an advisory opinion will not be issued.
  4. The Department ordinarily will not issue advisory opinions on the form or effect in operation of a Plan, fund, or program (or a particular provision or provisions thereof) subject to Title I of the Act. For example, the Department will not issue an advisory opinion on whether a plan satisfies the requirements of Parts 2 and  3 of Title I of the Act.

Sec. 6. Instructions to individuals and organizations requesting advisory opinions from the Department.

  1. If an advisory opinion is desired, a request should be submitted to: Advisory Opinion, Office of Regulatory Standards and Exceptions, Pension and Welfare Benefit Programs, U.S. Department of Labor, Washington, D.C. 20216.
  2. A request for an advisory opinion must contain the following information:
    1. The name and type of plan or plans (e.g., pension, profit-sharing, or welfare plan); the Employer Identification Number (EIN); the Plan Number (PN) used by the plan in reporting to the Department of Labor on Form EBS-1; or a copy of the first two pages of the most recent Form EBS-1 filed with the Department.
    2. A detailed description of the act or acts or transaction or transactions with respect to which an advisory opinion is requested. Where the request pertains to only one step of a larger integrated act or transaction, the facts, circumstances, etc. must be submitted with respect to the entire transaction. In addition, a copy of all documents submitted must be included in the individual's or organization's statement and not merely incorporated by reference, and must be accompanied by an analysis of their bearing on the issue or issues, specifying the pertinent Provisions.
    3. A discussion of the issue or issues presented by the act or acts or transaction or transactions which should be addressed in the advisory opinion.
    4. If the individual or organization is requesting a particular advisory opinion, the requesting party must furnish an explanation of the grounds for the request, together with a statement of relevant supporting authority. Even though the individual or organization is urging no particular determination with regard to a proposed or prospective act or acts or transaction or transactions, the party requesting the ruling must state such party's views as to the results of the proposed act or acts or transaction or transactions and furnish a statement of relevant authority to support such views.
  3. A request for an advisory opinion by or for an individual or organization must be signed by the individual or organization or by the individual's or organization's authorized representative. If the request is signed by a representative of an individual or organization, or the representative may appear before the Department in connection with the request, the request must include a statement that the representative is authorized to represent the individual or organization.
  4. A request for an advisory opinion that does not comply with all the provisions of this procedure will be acknowledged, and the requirements that have not been met will be noted. Alternatively, at the discretion of the Department, the Department will issue an information letter to the individual or organization.
  5. If the individual or organization, or the authorized representative, desires a conference in the event the Department contemplates issuing an adverse advisory opinion, such desire should be stated in writing when filing the request or soon thereafter in order that the Department may evaluate whether in the sole discretion of the Department, a conference should be arranged and at what stage of the consideration a conference would be most helpful.
  6. It is the practice of the Department to process requests for information letters and advisory opinions in regular order and as expeditiously as possible. Compliance with a request for consideration of a matter ahead of its regular order, or by a specified time, tends to delay the disposition of other matters. Requests for processing ahead of the regular order, made in writing (submitted with the request or subsequent thereto) and showing clear need for such treatment will be given consideration as the particular circumstances warrant. However, no assurance can be that any letter will be processed by the time requested. The Department will not consider a need for expedited handling to arise if the request shows such need has resulted from circumstances within the control of the person making the request.
  7. An individual or organization, or the authorized representative desiring to obtain information relating to the status of his or her request for an advisory opinion may do so by contacting the Office of Regulatory Standards and Exemptions, Pension and Welfare Benefit Programs, U.S. Department of Labor, Washington,  D.C.

Sec. 7. Instructions to individuals and organizations requesting advisory opinions relating to prohibited transactions and common definitions.

  1. [Reserved]
  2. [Reserved]
  3. [Reserved]

Sec. 8. Conferences at the Department of Labor.

If a conference has been requested, and the Department determines that a conference is necessary or appropriate, the individual or organization or the authorized representative will be notified of the time and place of the conference. A conference will normally be scheduled only when the Department in its sole discretion deems it will be necessary or appropriate in deciding the case. If conferences are being arranged with respect to more than one request for an opinion letter involving the same individual or organization, they will be so scheduled as to cause the least inconvenience to the individual or organization.

Sec. 9. Withdrawal of requests.

The individual or organization's request for an advisory opinion may be withdrawn at any time prior to receipt of notice that the Department intends to issue an adverse opinion. Even though a request is withdrawn, all correspondence and exhibits will be retained by the Department and will not be returned to the individual or organization.

Sec. 10. Effect of Advisory Opinion.

An advisory opinion is an opinion of the Department as to the application of one or more sections of the Act, regulations promulgated under the Act, interpretive bulletins, or exemptions. The opinion assumes that all material facts and representations set forth in the request are accurate, and applies only to the situation described therein. Only the parties described in the request for opinion may rely on the opinion, and they may rely on the opinion only to the extent that the request fully and accurately contains all the material facts and representations necessary to issuance of the opinion and the situation conforms to the situation described in the request for opinion.

Sec. 11. Effect of Information Letters.

An information letter issued by the Department is informational only and is not binding on the Department with respect to any particular factual situation.

Sec. 12. Public inspection.

  1. Advisory opinions shall be open to public inspection at the Public Disclosure Room, U.S. Department of labor, 200 Constitution Avenue, N.W., Washington, D.C. 20216.
  2. Background files (including the request for an advisory opinion, correspondence between the Department and the individual or organization requesting the advisory opinion) shall be available upon written request. Background files may be destroyed after three years from the date of issuance.
  3. Advisory opinions will be modified to delete references to proprietary information prior to disclosure. Any information considered to be proprietary should be so specified in a separate letter at the time of request. Other than proprietary information, all materials contained in the public files shall be available for inspection pursuant to section 12.02.
  4. The cost of search, copying and deletion of any references to proprietary information will be borne by the person requesting the advisory opinion or the background file.

Sec. 13. Effective date.

This procedure is effective August 27, 1976, the date of its publication in the Federal Register.

Signed at Washington, D.C. this 24 day of August 1976.

James D. Hutchinson
Administrator of Pension and Welfare Benefit Programs,
U.S. Department of Labor.

Voluntary Correction Programs

Employee Benefit Plan Voluntary Correction Programs

The Internal Revenue Service, US Department of Labor, and Pension Benefit Guaranty Corporation have adopted voluntary correction programs which permit employee benefit plan sponsors and other plan officials to correct certain categories of errors and misfilings with either no, or reduced, penalties, while preserving the plan's tax qualification.

  1. Internal Revenue Service
  2. The IRS retirement plan correction program (Employee Plans Compliance Resolution System, covered under Revenue Procedure 2003-44), helps employer sponsors protect participant benefits and keep their plans within the requirements of the Internal Revenue Code.  This revenue procedure combined and revised a series of previous IRS remedial programs for correcting plan qualification defects.  The program covers qualified retirement plans, Section 403(b) arrangements, SEPs, and SIMPLE IRAs, for a variety of plan qualification failures and violations, including:  operational failures, for failure to comply with terms of plan documents; plan document failures, in which retirement plan provisions violate IRS qualification requirements; demographic failures, in which IRS nondiscrimination requirements are not met in the plan document; and the diversion or misuse of plan assets.

    Self Correction Program
    Under the Self Correction Program certain plan errors can be corrected without IRS involvement.  No notification of IRS is required, no fees or penalties are assessed, and the plan and its participants retain tax benefits.

    Voluntary Correction Program
    The Voluntary Correction Program may be used for plan errors which not eligible for self‑correction.  Errors are corrected and the tax benefits of the plan are preserved for plan participants with IRS assistance.

    IRS Plan Audits
    Errors corrected under either the Self Correction or Voluntary Correction programs are not treated as errors when the IRS audits these plans.  For other errors found during IRS examinations, the Audit Closing Agreement Program permits their correction and tax benefit preservation at fees which are lower than would be incurred if the plan had not a participated in the Voluntary Correction Programs.

  3. U.S. Department of Labor
  4. The Employee Benefits Security Administration has two voluntary self-correction programs for plan administrators who need help in meeting ERISA requirements: the Delinquent Filer Voluntary Compliance Program promotes, through the assessment of reduced civil penalties, plan administrator compliance with annual reporting obligations under Title I of the Employee Retirement Income Security Act of 1974; the Voluntary Fiduciary Compliance Program allows plan participants and beneficiaries and certain other persons engaging prohibited transactions under the Employee Retirement Income Security Act of 1974 to self‑correct the violations, and avoid potential civil actions by the DOL.

    Delinquent Filer Voluntary Compliance Program
    The Delinquent Filer Voluntary Compliance Program assists plan administrators who have filed Form 5500 late, or not filed it at all, to comply with the filing requirements and pay reduced civil penalties.  The IRS has agreed to provide penalty relief under the Code for delinquent Form 5500 Annual Returns/Reports filed for Title I plans where the conditions of this program have been satisfied.

    Voluntary Fiduciary Correction Program
    The Voluntary Fiduciary Correction Program (PTE 2002-51) affords plan sponsors and officials the opportunity to self-correct 15 specific transactions, involving delinquent participant contributions and other violations, prohibited under ERISA.  The DOL also relieves these individuals from the payment of excise taxes associated with the transactions covered under the class exemption.  It has released a VFC Program FAQ bulletin outlining specific issues and qualifications for participating in the program.

  5. Pension Benefit Guaranty Corporation
  6. PBGC provides incentives to self-correct late filings, or other errors involving missed premium deadlines and underpaid premiums.

    Underpaid Premium Correction Program
    Voluntarily self-corrected underpayments made before PBGC sends a notice of premium delinquency or a premium audit, reduces the monthly penalty rate by 80 percent (from 5 percent to 1 percent of the unpaid premium).  Premium penalties may be waived for reasonable cause or in other appropriate circumstances.

    Participant Notice Voluntary Correction Program
    Missed or improperly prepared reports or notices are assessed lower penalties where the failure is quickly corrected or involves a small plan.  Information penalties are waived for reasonable cause or in other appropriate circumstances. Self‑correction is considered a mitigating factor for plans participating in this program.

Voluntary Fiduciary Correction Program FAQs

Voluntary Fiduciary Correction Program (VFCP)

March 28, 2002 (67 FR 15062)

Summary
Allows voluntary correction of some breaches to allow plan officials to avoid potential civil actions initiated by the DOL and civil penalties under ERISA.

Agency: Pension and Welfare Benefits Administration, Labor Department.

Action: Permanent adoption of the VFCP.

Frequently Asked Questions about the Voluntary Fiduciary Correction Program

What is the Voluntary Fiduciary Correction Program (VFCP)?

The VFCP is a voluntary enforcement program that encourages the correction of possible violations of Title I of ERISA. The program allows plan officials to identify and fully correct certain transactions such as prohibited purchases, sales and exchanges, improper loans, delinquent participant contributions, and improper plan expenses. The program includes 15 specific transactions and their acceptable means of correction, eligibility requirements, and application procedures. If an eligible party documents the acceptable correction of a specified transaction, the U.S. Department of Labor Employee Benefits Security Administration (EBSA) will issue a no-action letter.

Why did the U.S. Department of Labor create the VFCP?

In part, the U.S. Department of Labor developed the VFCP in response to requests from the employee benefits community for a formal program that would reduce the risk of enforcement action and the imposition of the Section 502(l) penalty. Most of EBSA's investigations are resolved by fiduciaries taking corrective action after EBSA identifies violations. The U.S. Department of Labor recognized that as the private benefit system evolves, there is a need for innovation in voluntary compliance. Publication of the VFCP provides an opportunity to inform plan fiduciaries of their obligations so that complete and fully acceptable corrections may be made without discussion or negotiation with the U.S. Department of Labor.

Who is eligible to participate in the program?

The U.S. Department of Labor will consider an application if neither the plan nor the applicant is under investigation and if the application contains no evidence of potential criminal violations as determined by EBSA.

How long will the U.S. Department of Labor operate the program?

The U.S. Department of Labor expects to operate the program indefinitely.

What if the U.S. Department of Labor receives an application from a plan sponsor that has not adequately corrected a violation?

The U.S. Department of Labor may need to negotiate with the sponsor for full correction. In that case, the Section 502(l) penalty may apply to amounts restored pursuant to the negotiation. Depending on the facts, EBSA may also need to conduct a civil or criminal investigation or take other action, such as seeking removal of persons from positions of authority with respect to a plan.

Are there any civil penalties involved in the program?

If the applicant complies with the conditions of the program, no Section 502(l) penalty would apply to correction amounts paid to the plan or to participants. However, the U.S. Department of Labor is not precluded from referring information regarding the transaction to the IRS as required by Section 3003(c) of ERISA, or from imposing civil penalties under Section 502(c)(2) of ERISA based on the failure or refusal to file a timely, complete and accurate annual report Form 5500.

Will the new program provide any certainty to the applicant if he or she complies with the conditions?

Yes. The U.S. Department of Labor acknowledged the need for plan sponsors and their service providers to know that the U.S. Department of Labor would take no further action if the applicant satisfied the terms of the program. Under those circumstances, the U.S. Department of Labor will issue a no-action letter to the applicant. The no-action letter states that the U.S. Department of Labor will not initiate a civil investigation under Title I of ERISA regarding the applicant's responsibility for any transaction described in the no-action letter, nor assess a Section 502(l) penalty. However, the issuance of a no-action letter does not affect the ability of any other government agency, or any other person, to enforce their rights.

How do I apply for relief?

The program includes application procedures. Briefly, one must submit a written narrative and supporting documents describing the transaction and its correction, proof of restoration of losses,  and an executed penalty of perjury statement.

Where do I apply?

Applications should be mailed to the appropriate EBSA regional office.

How can I find out more about the program?

Interested parties may contact the appropriate EBSA regional office.  Regional coordinator's assigned to the program will assist you with your questions. Information about the VFCP can also be obtained by calling EBSA's Toll-Free number at 1.866.444.EBSA (3272)

How can I comment on the program?

Comments may be addressed in writing to:

U.S. Department of Labor
Employee Benefits Security Administration
Office of Enforcement - VFCP
200 Constitution Avenue, NW, Suite N-5702
Washington, DC 20210

How do I determine when participant contributions to pension plans are late?

The Department's regulation relating to the definition of Plan Assets - Participant Contributions (29 CFR 2510.3-102) describes a general rule and a maximum time period for pension benefit plans. The general rule provides that the assets of a plan include amounts (other than union dues) that a participant or beneficiary pays to an employer, or amounts that a participant has withheld from his wages by an employer, for contribution to the plan as of the earliest date on which such contributions can reasonably be segregated from the employer's general assets.

The maximum time period for pension benefit plans for transmitting participant contributions shall in no event be later than the 15th business day of the month following the month in which the participant contribution amounts are received by the employer (in the case of amounts that a participant or beneficiary pays to an employer) or the 15th business day of the month following the month in which such amounts would otherwise have been payable to the participant in cash (in the case of amounts withheld by an employer from a participant's wages).

The date when participant contributions reasonably can be segregated from the employer's general assets usually will be earlier than the maximum time period for pension plans in the regulation. Thus, when contributions reasonably can be segregated from the employer's general assets in a shorter time period, delay in forwarding the contributions, even a delay that does not exceed the maximum time period under the regulation, may cause a breach of fiduciary duty under Title I of ERISA that may be corrected under the Voluntary Fiduciary Correction Program (VFCP). Moreover, where the contributions have been delinquent longer than the maximum time period and the contributions could have been segregated earlier than the maximum time period, the loss date (as defined in the program), for purposes of calculating lost earnings (as defined in the program), is the date on which the contributions reasonably could have been segregated and not the maximum time period.

How do I show the earliest date contributions can be segregated for purposes of preparing a VFCP application?

Program applicants are reminded that the program requires that the applicant document, under its particular circumstances, the earliest date on which the contributions reasonably could have been segregated from the employer's general assets. This documentation may consist of the plan sponsor's past withholding and remittance history, the sponsor's withholding and remittance process, and the minimum period between withholding and remittance.

Participant contributions to the plan were delinquent, but the dollar amount to correct is very small. Do I have to participate in the VFCP?

If participant contributions are delinquent, plan officials must take appropriate action to correct the violation. Although plan officials are not required to file an application with the Department under the VFCP to correct a violation, the VFCP is available to correct a loss of any amount resulting from a transaction covered by the program. Participation in the VFCP is voluntary. However, if you do not file an application with the Department, you cannot obtain the relief available under the program. Moreover, if the Department discovers the violation on audit, and the correction was not complete for purposes of the program, a civil penalty may be assessed on any additional amount required by the Department to fully correct the violation following the Department's audit of the plan.

Can I use the VFCP to correct a failure to forward participant loan repayments to a plan in a timely fashion?

Yes. In Advisory Opinion 2002-02A, the Department concluded that, while not subject to the participant contribution regulation (29 C.F.R. § 2510.3-102), participant loan repayments paid to or withheld by an employer for purposes of transmittal to an employee benefit plan are sufficiently similar to participant contributions to justify, in the absence of regulations providing otherwise, the application of principles similar to those underlying the final participant contribution regulation for purposes of determining when such repayments become assets of the plan. Specifically, the Advisory Opinion concluded that participant loan repayments paid to or withheld by an employer for purposes of transmittal to the plan become plan assets as of the earliest date on which such repayments can reasonably be segregated from the employer's general assets. Given the similar treatment of participant contributions and loan repayments, the Department has determined that it is appropriate to permit delinquent participant loan repayments to be corrected under the VFCP in the same manner as delinquent participant contributions.

I have determined that participant contributions to the pension plan were delinquent and I want to correct under the program. How do I determine what rate of return to use for calculating earnings on the delinquent contributions?

In order to correct under the program, you will need to calculate the lost earnings on the delinquent contributions. For purposes of correction under the program, the rate of return to use is the highest of:

  • The rate of return of the plan for non-participant directed plans or of individual participant accounts
  • Restoration of profits (as defined under the program)
  • The Internal Revenue Code §6621 rate. How to calculate each of those amounts is demonstrated in the questions and answers below

The plan investments are selected by the plan fiduciaries. How do I calculate the overall rate of return for the plan?

Where there are no distributions or expense disbursements during the period of delinquency, the overall rate of return for the plan is calculated by subtracting the amount of plan assets on the date contributions were due under the Department's regulation from the amount of plan assets on the date the delinquent contributions are repaid to the plan, but not including the addition of the delinquent contributions, divided by the amount of assets on the date the contributions were due.

Where there have been distributions or expense disbursements during the period of delinquency, applicants may demonstrate the actual average rate of return of all the investments of the plan where they have evidence to show such rate of return. In the alternative, applicants may, for administrative convenience, calculate the overall rate of return by using a fraction where the numerator is the amount of plan assets on the date the contributions are repaid minus the amount of plan assets on the date contributions were due, but not including the addition of the delinquent contributions, plus any distributions and expense disbursements made between the date the contributions were repaid and the date the contributions were due, and the denominator is the amount of assets on the date the contributions were due.

The plan investments are participant directed. How do I calculate the rate of return for purposes of determining lost earnings on delinquent contributions?

When calculating the rate of return for participant-directed plans, it is necessary to calculate the rate of return for each individual participant account. The same method used for calculating the overall plan rate of return for a plan where the investments are selected by the plan fiduciaries is used for each participant account. For administrative convenience, the applicant may use the highest rate of return of any plan investment option as the rate of return for each individual participant account.

If the plan investments are participant directed and certain participants have not designated any investment options, what rate of return do I use for those participants for purposes of determining earnings on delinquent contributions?

For those participants in a participant-directed plan who have not designated any investment options, the applicant may use the plan's overall rate of return for those participants during the period of the delinquency.

How do I determine what is the restoration of profits amount for purposes of determining earnings on delinquent contributions?

The restoration of profits amount is the amount earned by the fiduciary or party in interest on the use of the monies that should have been forwarded to the plan for the duration of the delinquency. If the purpose for which the monies were used and the earnings thereon are ascertainable, then those actual earnings are the amount of the restoration of profits.

What is the IRC §6621 rate and how do I find out what the rate was for the applicable time period?

Section 6621 of the Internal Revenue Code establishes the rates for interest on tax overpayments and underpayments. The VFCP uses the underpayment rate as the rate of return that must be examined for determining lost earnings where it is not possible to ascertain the restoration of profits amount. The Internal Revenue Service publishes the §6621(a)(2) rate quarterly. The rate announcements can be found on the internet.

Participant Notice Voluntary Correction Program

Pension Benefit Guaranty Corporation
Participant Notice Voluntary Correction Program

May 3, 2004 (FR 04-10406)

Recap
Permits plan administrators to correct Participant Notice compliance failures for 2002 and 2003 without penalty.

Voluntary Correction Program

RIN 1212-AB00

Agency: Pension Benefit Guaranty Corporation

Action: Notice

Effective Date: May 3, 20024

Summary

The Pension Benefit Guaranty Corporation ("PBGC") is announcing a Participant Notice Voluntary Correction Program ("VCP"). This program, which generally covers Participant Notices for the 2002 or 2003 plan year that were not issued as required, is designed to encourage plan administrators to correct recent compliance failures without penalty and to facilitate plan administrators' future compliance. The PBGC will not pursue any failure to provide a pre-2002 Participant Notice unless there is a 2002 or 2003 participant Notice failure that is covered by the VCP but that does not meet the requirements for penalty relief under the VCP. Elsewhere in today's Federal Register, the PBGC is proposing a new Participant Notice penalty policy.

Dates

To meet the requirements for penalty relief under the Participant Notice Voluntary Correction Program with respect to a Participant Notice failure for the 2002 or 2003 plan year, the plan administrator must: (1) Issue a VCP corrective notice by the 2004 Participant Notice due date (for calendar year plans, generally October 4, 2004, November 15, 2004, or December 15, 2004); and (2) notify the PBGC within 30 days after the 2004 Participant Notice due date.

For further information contact: Harold J. Ashner, Assistant General Counsel, or Catherine B. Klion, Attorney, Office of the General Counsel, Pension Benefit Guaranty Corporation, 1200 K Street, NW., Washington, DC 20005-4026; 202-326-4024 (TTY/TDD users may call the Federal relay service toll-free at 1-800-877-8339 and ask to be connected to 202-326-4024.)

Supplementary information

Overview of Participant Notice Requirements Section 4011 of the Employee Retirement Income Security Act of 1974 ("ERISA") requires certain underfunded plans to issue a notice to participants of the plan's funding status and the limits on the PBGC's guarantee ("Participant Notice"). The Participant Notice helps to ensure that participants better understand the financial status of their plans and the consequences that plan underfunding may have on their promised benefits. The PBGC's implementing regulations are at 29 CFR part 4011. In general, a plan administrator must issue a Participant Notice for a plan year if a variable rate premium (which is tied to plan underfunding) is payable for that plan year, unless the plan meets the "DRC Exception Test" for that plan year or for the prior plan year. However, the Job Creation and Worker Assistance Act of 2002 (JCWAA) made a temporary change to the premium interest rate that did not apply for purposes of determining whether a Participant Notice was required. Therefore, a plan administrator may be required to provide a Participant Notice for the 2002 or 2003 plan year even if a variable rate premium is not payable for that plan year. The Pension Funding Equity Act of 2004 (PFEA), which was signed into law by the President on April 10, 2004, changes the rules for determining the required interest rate for premium payment years beginning in 2004 or 2005. Under PFEA, plan administrators may use the premium interest rate for purposes of determining whether a Participant Notice is required. Thus, a plan administrator may be required to issue a Participant Notice for the 2004 or 2005 plan year only if a variable rate premium is payable for that plan year. A Participant Notice for a plan year is due in that plan year-"two months after the due date (with extensions) for the plan's Form 5500 for the prior plan year. (The due date for a plan's Participant Notice for a plan year is keyed to the due date for the plan's Summary Annual Report for the prior plan year so that the two documents may be issued together.) For calendar year plans, common due dates for the 2004 Participant Notice are therefore October 4, 2004, November 15, 2004, and December 15, 2004. There are a variety of rules governing who is entitled to receive the Participant Notice and the form, content, and manner of issuance of the Participant Notice. Plan administrators are required to certify on the annual PBGC premium filing (Form 1 or Form 1-EZ) that, for the prior plan year: (1) A Participant Notice was not required to be issued; (2) a Participant Notice was issued as required; or (3) an explanation is attached (e.g., because a required Participant Notice was issued late). See appendix A for a detailed explanation of the requirements governing Participant Notices.

Compliance and Enforcement Background

The Participant Notice requirement went into effect in the 1995 plan year for large plans (generally plans with more than 100 participants) and in the 1996 plan year for small plans (generally plans with 100 or fewer participants). In the first few years after the requirement went into effect, plan administrators of only a relatively small number of defined benefit plans had to provide a Participant Notice, reflecting the fact that plans were better funded at that time. The PBGC conducted compliance surveys and found that both large plan and small plan compliance was high for those plan years. In the last several years, however, because of low interest rates and poor investment returns, more plans have become underfunded and, therefore, many plan administrators have been required to issue a Participant Notice for the first time. Recent PBGC audits have found higher rates of noncompliance with the Participant Notice requirement than in prior years. Much of the noncompliance appears to have resulted from a lack of awareness or understanding of the applicable requirements rather than from an attempt to avoid disclosure. Nonetheless, plan participants deserve to know if their plans are underfunded. As a result, the PBGC is expanding its Participant Notice enforcement program with a view toward more actively auditing compliance and assessing penalties for noncompliance.

Overview of Voluntary Correction Program

As a transition to this expanded enforcement program, the PBGC is launching a Participant Notice Voluntary Correction Program ("VCP") designed to encourage plan administrators to correct past compliance failures and to facilitate their future compliance with Participant Notice requirements. The VCP generally covers Participant Notice failures for the 2002 and 2003 plan years. Under this program, the PBGC will not assess penalties for failure to provide a 2002 or 2003 Participant Notice as required if the failure is corrected in accordance with the guidelines in this notice. (The VCP focuses on the 2002 and 2003 plan years in part because the PBGC is concerned that some plan administrators may have misunderstood the effect of JCWAA on their Participant Notice obligations for those plan years.) The PBGC will not pursue failures to provide a pre-2002 Participant Notice unless there is a 2002 or 2003 by the VCP but that does not meet the requirements for penalty relief under the VCP. Focusing the PBGC's enforcement resources primarily on 2002 and later Participant Notice failures will concentrate those resources effectively and limit disclosures to plan years that are most relevant to participants. The PBGC anticipates that many plan administrators will want to participate in the VCP as a precaution, even in the absence of a known Participant Notice failure. Participation in the VCP will not affect the likelihood that a plan will be selected for audit of compliance with the requirement to issue a post-VCP Participant Notice (see "Participant Notices Covered by VCP"), with the PBGC premium requirement, or with any other PBGC requirement.

Participant Notices Covered by VCP

The VCP covers any Participant Notice for a plan's 2002 or 2003 plan year: (1) That is due before May 7, 2004; and (2) that is not, as of May 7, 2004, the subject of a PBGC audit proceeding. For purposes of determining whether the VCP covers a plan's Participant Notice, the date the Participant Notice is due is determined without regard to any deadline extension resulting from a disaster relief notice. For example, if a calendar year plan's 2003 Participant Notice was originally due on December 15, 2003, but as a result of a disaster relief notice the due date was extended to May 14, 2004, the VCP would cover the plan's 2003 Participant Notice because the extension to May 14, 2004, would be disregarded.

Requirements for VCP Penalty Relief

For any Participant Notice that is covered by the VCP, the PBGC will not assess a penalty if the plan administrator, in accordance with the guidelines in this notice: (1) Issues a VCP corrective notice; and (2) notifies the PBGC that it is participating in the VCP. (If the only failure was a late issuance corrected before May 7, 2004, see "Special rule for late 2002/2003 notices already corrected.")  VCPCorrective Notice The PBGC believes that many of the plans that will participate in the VCP to correct a Participant Notice failure for 2002 or 2003 will also be required to issue a Participant Notice for 2004. Accordingly, the PBGC has structured the VCP corrective notice requirements to enable such plans to issue a single notice that meets the requirements for a VCP corrective notice and for the 2004 Participant Notice. This approach will minimize the confusion for participants that could result from the issuance of multiple notices at or about the same time. The VCP corrective notice must meet all of the requirements that apply to the 2004 Participant Notice (or, if the plan is not required to issue a 2004 Participant Notice, all of the requirements that would apply if it were required), except as otherwise provided in the guidelines in this notice. Normally the 2004 Participant Notice would have to include the "funded current liability percentage" for the 2003 plan year or for the 2004 plan year. Under the VCP, whether the plan administrator is correcting only a 2002 failure, only a 2003 failure, or both a 2002 and a 2003 failure, the VCP corrective notice: (1) Must include the funded current liability percentage for the 2002 plan year and for the 2003 plan year, and (2) may include as well the funded current liability percentage for the 2004 plan year. In all other respects, the VCP corrective notice must contain the information required in a 2004 Participant Notice (e.g., current information on funding waivers, missed contributions, and limitations on the PBGC's guarantee). Although the plan administrator is not required to inform participants that it had a Participant Notice failure for the 2002 or 2003 plan year (or for both), or that it is participating in a "voluntary correction program," a plan administrator may choose to include that information in the VCP corrective notice. Appendix B contains a model VCP corrective notice that plan administrators may use to meet VCP requirements. The PBGC will treat a VCP corrective notice that is issued in accordance with the guidelines in this notice as meeting the requirements for the 2004 Participant Notice. Plan administrators should take special note that because the VCP corrective notice is tied to the requirements for the 2004 Participant Notice rather than to the requirements for the 2002 or 2003 Participant Notice that was not issued as required, the VCP corrective notice is required to be issued only to those persons entitled to receive the plan's 2004 Participant Notice (or that would be entitled to receive the plan's 2004 Participant Notice if it were required). Thus, there is no need to issue the VCP corrective notice to those persons who were entitled to receive the 2002 or 2003 Participant Notice that was not issued as required but who are not entitled to receive the 2004 Participant Notice (e.g., a participant whose entire benefit has been annuitized or paid out in a lump sum). Notice to PBGC The plan administrator must notify the PBGC that it is participating in the VCP no later than the 30th day after the due date for issuing the VCP corrective notice. The notification must include a copy of the VCP corrective notice and the name and telephone number of a person for the PBGC to contact with any questions. Plan administrators may notify the PBGC electronically through the PBGC's Web site at http:// www.pbgc.gov/participantnotice, by fax at 202-336-4197, or by mail, commercial delivery service, or hand at Contracts and Control Review Department, Pension Benefit Guaranty Corporation, 1200 K Street, NW., Suite 580, Washington, DC 20005-4026. The PBGC will promptly issue a written acknowledgment of the notification. Plan administrators should keep the acknowledgment as proof of meeting the VCP requirement of notifying the PBGC.

Special Rule for Late 2002/2003 Notices Already Corrected

If a plan administrator's only failure with respect to a 2002 or 2003 Participant Notice was late issuance and the failure has been corrected before May 7, 2004, the PBGC will treat the plan administrator as having participated in the VCP and will assess no penalty for that 2002 or 2003 failure (and will not pursue any pre-2002 Participant Notice failure) without requiring that the plan administrator issue a VCP corrective notice or notify the PBGC of the plan's participation in the VCP.

Effect of VCP on Certification Requirements Ordinarily, a plan administrator that filed an erroneous certification on the annual PBGC premium filing as to whether a Participant Notice was required for the prior plan year and, if so, whether it was issued as required would have to file an amended certification. However, if the plan administrator notifies the PBGC of the plan's participation in the VCP, the PBGC will treat the notification as effectively amending any erroneous certification filed on or before May 7, 2004, with respect to a 2002 or 2003 Participant Notice. The PBGC will take no enforcement action based on the erroneous prior certification if the plan administrator of a plan that meets the requirements for penalty relief under the VCP amends (or effectively amends) the erroneous prior certification. meet the requirements for VCP penalty relief will be required to check a box on the 2005 PBGC premium filing notifying the PBGC of the plan's participation in the VCP. This requirement is in addition to the Notice to PBGC requirement described above that must be met to qualify for VCP penalty relief, except under "Special rule for late 2002/2003 notices already corrected."

Compliance Assistance

The PBGC has developed written guidance on the requirements of the VCP, including a Fact Sheet and Frequently Asked Questions. All information related to the VCP and to Participant Notice requirements generally is available on the PBGC's Web site at http://www.pbgc.gov/ participantnotice. In addition, plan administrators seeking guidance on Participant Notice compliance questions, including questions about the VCP, may submit questions electronically through that Web site or call the toll-free telephone number at the PBGC's Practitioner Customer Service Center (1-800-736-2444). Plan administrators may also contact the PBGC to request appropriate modifications to the VCP requirements on a case-by-case basis. For example, in the case of a 2002 or 2003 "partial" failure such as a failure to provide the notice to some of the participants or a failure to include in the notice some required information, the PBGC will work with the plan administrator to determine what type of correction, if any, would be needed to address the partial failure in order to qualify for penalty relief under the VCP.

Future Participant Notice Penalties Elsewhere in today's Federal Register, the PBGC is proposing a new Participant Notice penalty policy. The PBGC intends to publish its final Participant Notice penalty policy as soon as practicable after considering public comments.

Compliance With Rulemaking Guidelines

The PBGC has determined, in consultation with the Office of Management and Budget, that this Notice is a "significant regulatory action" under Executive Order. The Office of Management and Budget has therefore reviewed this notice under Executive Order 12866. The collection of information requirements under the VCP have been approved by the Office of Management and Budget under control numbers 1212-0009 (expires December 31, 2006) and 1212-0050 (expires November 30, 2004). An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a currently valid OMB control number. Because this action deals only with a general statement of PBGC enforcement policy, it is not subject to the notice and comment rulemaking requirements or delayed effective date requirements under section 553 of the Administrative Procedure Act. Because no general notice of proposed rulemaking is required, the Regulatory Flexibility Act does not apply. See 5 U.S.C. 601(2), 603, 604. Issued in Washington, DC, this 3rd day of May, 2004.

Bradley D. Belt
Executive Director,
Pension Benefit Guaranty Corporation.

Appendix A

Summary of Participant Notice
Requirements Statutory and Regulatory Framework Section 4011 of ERISA and 29 CFR part 4011 require certain underfunded plans to issue an annual notice to participants (a "Participant Notice") that discloses the plan's funding status and the limits of the PBGC's guarantee.

When Requirement Applies
In general, a plan administrator is required to provide a Participant Notice for a plan year if a variable rate premium (which is tied to plan underfunding) is payable for that plan year, unless the plan meets a funding-related test tied to the "deficit reduction contribution" rules-the "Deficit Reduction Contribution ("DRC") Exception Test"-for that plan year or for the prior plan year. See § 4011.3. However, as discussed below under Effect of JCWAA on Requirements, a plan administrator may be required to provide a Participant Notice for the 2002 or 2003 plan year even if a variable rate premium is not payable for that plan year. In general, the DRC Exception Test requires a plan to be at least 90 percent funded, although a plan that is at least 80 percent funded meets the test if it was at least 90 percent funded for two consecutive plan years out of the last three. There are special rules under the DRC Exception Test that allow small plans to avoid doing additional calculations by using numbers they already reported on the Schedule B to their Form 5500. See § 4011.4. Most new and newly covered plans are exempt from the Participant Notice requirement. See § 4011.5. Due Dates A participant notice for a plan year is due in that plan year. The due date for issuing a Participant Notice for a plan year is two months after the plan's due date, with extensions, if any, for filing the Form 5500 for the prior plan year. (The due date for a plan's Participant Notice for a plan year is keyed to the due date for the plan's Summary Annual Report for the prior plan year so that the two documents may be issued together.) The plan administrator may change the date of issuance from one plan year to the next, provided that the effect of any change is not to avoid disclosing a minimum funding waiver or a missed contribution. See § 4011.8.

Persons Entitled To Receive Notice
A plan administrator must provide a Participant Notice to participants, beneficiaries of deceased participants, alternate payees, and unions. To determine who is a person entitled to receive a Participant Notice, the plan administrator may select any date during the period beginning with the last day of the prior plan year and ending with the date on which the Participant Notice is due, provided that a change in the date from one plan year to another does not exclude a substantial number of participants and beneficiaries. See § 4011.7.

Manner of Issuance
The plan administrator must issue a Participant Notice using measures reasonably calculated to ensure actual receipt by the persons entitled to receive it. A Participant Notice may be issued together with another document, such as the Summary Annual Report (which is due at the same time as the Participant Notice), as long as it is in a separate document. See § 4011.9, as amended by the PBGC's final rule published October 28, 2003 (68 FR 61344, 61353).

Form of Notice
A Participant Notice must contain the plan's "Notice Funding Percentage" the plan's "funded current liability percentage" as defined in section 302(d)(9)(C) of ERISA- for the current plan year or the prior plan year, along with the date as of which that percentage is determined. The Participant Notice also must contain information on minimum funding waivers and missed contributions, a summary of plan benefits guaranteed by the PBGC with an explanation of the limitations on the guarantee, and other information specified in the regulation. See § 4011.10(b) and (c). Additional information must be in a separate document. See § 4011.10(d). A Participant Notice must be readable and written in a manner calculated to be understood by the average plan participant and not to mislead recipients. See § 4011.10(a). Plan administrators of plans with specified numbers or percentages of participants literate only in the same non-English language must provide either an English-language Participant Notice with a prominent legend in the common non-English language offering assistance in that language or a Participant Notice in the common non-English language. See § 4011.10(e). The Participant Notice regulation contains a Model Participant Notice as an example of a Participant Notice that meets the requirements of § 4011.10. Each year the PBGC issues a Technical Update that provides specific information relating to that year's Participant Notice and updates the Model Notice. Effect of JCWAA on Requirements Section 405 of the Job Creation and Worker Assistance Act of 2002 ("JCWAA") increased the required interest rate for calculating vested benefits for the PBGC variable rate premium under section 4006(a)(3)(E)(iii) of ERISA from 85 percent to 100 percent of the yield on 30-year Treasury securities. The statutory change applies only to plan years beginning in 2002 or 2003. However, JCWAA does not allow use of 100 percent of the Treasury yield to determine whether a PBGC variable rate premium is payable for purposes of determining whether a Participant Notice is required. Thus, plan administrators must continue to use 85 percent of the Treasury yield for this purpose. Section 405 of JCWAA also increased, for plan years beginning in 2002 or 2003, the maximum interest rate (from 105 percent to 120 percent of the four-year weighted average of the yield on 30-year Treasury securities) that may be used to calculate current liability for purposes of the DRC funding requirement. The change in the maximum interest rate used to calculate current liability for DRC funding purposes can affect, for the 2002, 2003, and certain future plan years: (1) Whether a plan administrator is required to issue a Participant Notice; and (2) the plan funding information required to be disclosed in a Participant Notice. The effect of JWCAA on Participant Notice requirements is fully discussed in PBGC Technical Updates 02-2 and 03-17, both available on the PBGC's Web site, http:// https://www.pbgc.gov/prac/other-guidance/tu.

Certification
The plan administrator is required to certify on the annual PBGC premium filing (Form 1 or Form 1-EZ) that, for the prior plan year: (1) A Participant Notice was not required to be issued; (2) a Participant Notice was issued as required; or (3) an explanation is attached (e.g., because a required Participant Notice was issued late).

Penalties
If a Participant Notice is not issued as required, the PBGC may assess penalties under section 4071 of ERISA and 29 CFR part 4071. For more information on Participant Notice penalties, see the PBGC's proposal on such penalties published elsewhere in today's Federal Register.

Appendix B

Model VCP Corrective Notice
The following is an example of a corrective notice that satisfies the requirements of the Participant Notice Voluntary Correction Program when the required information is filled in (subject to § 4011.10(d)-(e), as applicable). It also satisfies the requirements of § 4011.10 for the 2004 Participant Notice.

Notice to Participants of [Plan Name]
The law requires that you receive information on the funding level of your defined benefit pension plan and the benefits guaranteed by the Pension Benefit Guaranty Corporation (PBGC), a federal insurance agency. [You may include a statement to the effect that the plan had a prarticipant notice failure for the 2002 plan year or for the 2003 plan year (or for both). You may also include a statement to the effect that the plan is participating the PBGC'S Participants Notice Voluntary Correction Program.] Your Plan's Funding As of [Applicable date], your plan had [Insert plan's funded current liability percentage (as defined in section 302(d)(9)(C) of ERISA) for the 2002 plan year] percent of the money needed to pay benefits promised to employees and retirees. As of [Applicable date], your plan had [Insert plan's funded current liability percentage (as defined in section 302(d)(9)(C) of ERISA) for the 2003 plan year] percent of the money needed to pay benefits promised to employees and retirees. [You may also include the following statement: As of [Applicable date], your plan had [Insert plan's funded current liability percentage (as defined in section 302(d)(9)(C) of ERISA) for the 2004 plan year] percent of the money needed to pay benefits promised to employees and retirees.]

[SEE § 4011.10(c)(2) For special rules small plans may use to determine the plan's funded current liability percentage.] To pay pension benefits, your employer is required to contribute money to the pension plan over a period of years. A plan's funding percentage does not take into consideration the financial strength of the employer. Your employer, by law, must pay for all pension benefits, but your benefits may be at risk if your employer faces a severe financial crisis or is in bankruptcy. [include the following paragraph only if, for any of the previous five plan years, the paln has been granted and has not fully repaid a funding waiver.]

Your plan received a funding waiver for [List any of the five previous plan years for which a funding waiver was granted and has not been fully repaid]. If a company is experiencing temporary financial hardship, the Internal Revenue Service may grant a funding waiver that permits the company to delay contributions that fund the pension plan. [Include the following with respect to any unpaid or late payment that must be disclosed under section 4011.10(b)(6):] Your plan was required to receive a payment from the employer on [List applicable due date(s)]. That payment [has not been made] [was made on [List applicable payment date(s)]].

PBGC Guarantees When a pension plan terminates without enough money to pay all benefits, the PBGC steps in to pay pension benefits. The PBGC pays most people all pension benefits, but some people may lose certain benefits that are not guaranteed. The PBGC pays pension benefits up to certain maximum limits.

The maximum guaranteed benefit is $3,698.86 per month or $44,386.32 per year for a 65-year-old person in a plan that terminates in 2004. [If you issue this notice after the maximum guaranteed benefit information for plans that terminate in 2005 is announced, you may add or substitute that information in order to provide participants with more current information. The PBGC expects to make that information available on its website at www.PBGC.gov in early November 2004.]

The maximum benefit may be reduced for an individual who is younger than age 65. For example, it is $1,664.49 per month or $19,973.88 per year for an individual who starts receiving benefits at age 55. [In Lieu of age 55, you may add or substitute any age(s) relevant under the plan. For example, you may add or substitute the maximum benefit for ages 62 or 60. The maximum benefit is $2,922.10 per month or $35,065.20 per year at age 62; It is $2,404.26 per month or $28,851.12 per year at age 60. If the plan provides for normal retirement before AGE 65, you must include the normal retirement age.] [If you issue this notice after the maximum guaranteed benefit information for plans that terminate in 2005 is announced, you may add or substitute that information in order to provide participants with more current inforamtion. The PBGC expects to make that information available on its web site at www.PBGC.gov in early November 2004.] [If the plan does not provide for commencement of benefits before age 65, you may omit this paragraph.]

The maximum benefit will also be reduced when a benefit is provided for a survivor. The PBGC does not guarantee certain types of benefits. [Include the following guarantee limits that apply to the benefits available under your plan.] The PBGC does not guarantee benefits for which you do not have a vested right when a plan terminates, usually because you have not worked enough years for the company.

The PBGC does not guarantee benefits for which you have not met all age, service, or other requirements at the time the plan terminates.

Benefit increases and new benefits that have been in place for less than a year are not guaranteed. Those that have been in place for less than 5 years are only partly guaranteed.

Early retirement payments that are greater than payments at normal retirement age may not be guaranteed. For example, a supplemental benefit that stops when you become eligible for Social Security may not be guaranteed.   Benefits other than pension benefits, such as health insurance, life insurance, death benefits, vacation pay, or severance pay, are not guaranteed.

The PBGC generally does not pay lump sums exceeding $5,000. Where To Get More Information Your plan, [EIN-PN], is sponsored by [Contributing sponsor(s)]. If you would like more information about the funding of your plan, contact [Insert Name, title, business address and phone number of individual or entity]. For more information about the PBGC and the benefits it guarantees, you may request a free copy of Your Guaranteed Pension by writing to Consumer Information Center, Dept. YGP, Pueblo, Colorado 81009. [The following sentence may be included:] "Your Guaranteed Pension" is also available on the PBGC's Web site at www.pbgc.gov.

Issued

[Insert at least month and year] [FR Doc. 04-10406 Filed 5-6-04; 8:45 am] Billing Code 7708-01-P.

Prohibited Transaction Class Exemption 2002-51

Department of Labor
Class Exemption to Permit Certain Transactions Identified in the Voluntary Fiduciary Correction Program

March 28, 2002 (67 FR 15083)

Recap
Permits sponsors and officials to self-correct 15 specific transactions, involving delinquent participant contributions and other violations, and provides relief from penalties and excise taxes otherwise associated with the transactions.

Class Exemption

Agency: Department of Labor, Employee Benefits Security Administration

Action: Grant of Class Exemption

Effective Date: November 25, 2002

Exemption

Section I: Eligible Transactions

The sanctions resulting from the application of section 4975(a) and (b) of the Code, by reason of section 4975(c)(1)(A) through (E) of the Code, shall not apply to the following eligible transactions described in section 7 of the Voluntary Fiduciary Correction (VFC) Program (67 FR 15061, March 28, 2002), provided that the applicable conditions set forth in Sections II, III and IV are met:

  1. Failure to transmit participant contributions to a pension plan within the time frames described in the Department's regulation at 29 CFR section 2510.3-102, (see VFC Program, section 7.A.1.), and/or the failure to transmit participant loan repayments to a pension plan within a reasonable time after withholding or receipt by the employer.
  2. Loan at a fair market interest rate to a party in interest with respect to a plan. (See VFC Program, section 7.B.1.).
  3. Purchase or sale of an asset (including real property) between a plan and a party in interest at fair market value. (See VFC Program, sections 7.C.1. and 7.C.2.).
  4. Sale of real property to a plan by the employer and the leaseback of the property to the employer, at fair market value and fair market rental value, respectively. (See VFC Program, section 7.C.3.).

Section II: Conditions

  1. With respect to a transaction involving participant contributions or loan repayments to pension plans described in Section I.A., the contributions or repayments were transmitted to the pension plan not more than 180 calendar days from the date the amounts were received by the employer (in the case of amounts that a participant or beneficiary pays to an employer) or the date the amounts otherwise would have been payable to the participant in cash (in the case of amounts withheld by an employer from a participant's wages).
  2. With respect to the transactions described in Sections I.B., I.C., or I.D., the plan assets involved in the transaction, or series of related transactions, did not, in the aggregate, exceed 10 percent of the fair market value of all the assets of the plan at the time of the transaction.
  3. The fair market value of any plan asset involved in a transaction described in Sections I.C. or I.D. was determined in accordance with section 5 of the VFC Program.
  4. The terms of a transaction described in Sections I.B., I.C., or I.D. were at least as favorable to the plan as the terms generally available in arm's-length transactions between unrelated parties.
  5. With respect to any transaction described in Section I, the transaction was not part of an agreement, arrangement or understanding designed to benefit a party in interest.
  6. (1) With respect to any transaction described in Section I, the applicant has not taken advantage of the relief provided by the VFC Program and this exemption for a similar type of transaction(s) identified in the current application during the period which is three years prior to submission of the current application.
  7. (2) Notwithstanding the foregoing, Section II.F.(1) shall not apply to an applicant provided that:

    (a) The applicant was a broker-dealer registered under the Securities Exchange Act of 1934, a bank supervised by the United States or a State thereof, a broker-dealer or bank subject to foreign government regulation, an insurance company qualified to do business in a State, or an affiliate thereof;

    (b) The applicant was a party in interest (including a fiduciary) solely by reason of providing services to the plan or solely by reason of a relationship to such service provider described in section 3(14)(F), (G), (H) or (I) (and/or the corresponding provisions of section 4975 of the Code);

    (c) Neither the applicant nor any affiliate (i) was a fiduciary (within the meaning of section 3(21)(A) of ERISA) with respect to the assets of the plan involved in the transaction and (ii) used its discretion to cause the plan to engage in the transaction;

    (d) Individuals acting on behalf of the applicant had no actual knowledge or reason to know that the transaction was not exempt pursuant to a statutory or administrative exemption under ERISA and/or the Code; and

    (e) Prior to the transaction, the applicant established written policies and procedures that were reasonably designed to ensure compliance with the prohibited transaction rules and the applicant engaged in periodic monitoring for compliance.

Section III: Compliance with VFC Program

  1. The applicant has met all of the applicable requirements of the VFC Program.
  2. PWBA has issued a no action letter to the applicant pursuant to the VFC Program with respect to a transaction described in Section I.

Section IV: Notice

  1. Written notice of the transaction(s) for which the applicant is seeking relief pursuant to the VFC Program and this exemption, and the method of correcting the transaction, was provided to interested persons within 60 calendar days following the date of the submission of an application under the VFC Program. A copy of the notice was provided to the appropriate Regional Office of the United States Department of Labor, Pension and Welfare Benefits Administration within the same 60-day period, and the applicant indicated the date upon which notice was distributed to interested persons. Plan assets were not used to pay for the notice. The notice included an objective description of the transaction and the steps taken to correct it, written in a manner reasonably calculated to be understood by the average plan participant or beneficiary. The notice provided for a period of 30 calendar days, beginning on the date the notice was distributed, for interested persons to provide comments to the appropriate Regional Office. The notice included the address and telephone number of such Regional Office.
  2. Notice was given in a manner that was reasonably calculated, taking into consideration the particular circumstances of the plan, to result in the receipt of such notice by interested persons, including but not limited to posting, regular mail, or electronic mail, or any combination thereof. The notice informed interested persons of the applicant's participation in the VFC Program and intention of availing itself of relief under the exemption.

Signed at Washington, DC, this 11th day of November, 2002.

Ivan L. Strasfeld,
Director of Exemption Determinations, Pension and Welfare Benefits
Administration, U.S. Department of Labor.

[FR Doc. 02-29799 Filed 11-22-02; 8:45 am]

Publications

794    IRS Determination Letters

Department of Labor - Advisory Opinion Procedure

Department of the Treasury
Internal Revenue Service
Publication 794

(Rev. April 1994)

Favorable Determination Letter

Introduction

This publication explains the significance of your favorable determination letter, points out some features that may affect the qualified status of your employee retirement plan and nullify your determination letter without specific notice from us, and provides general information on the reporting requirements for your plan. An example of a determination letter is included.

Significance of a Favorable Determination Letter

An employee retirement plan qualified under Internal Revenue Code section 401(a) (qualified plan) is entitled to favorable tax treatment. For example, contributions made in accordance with the plan document are generally currently deductible. However, participants will not include these contributions into income until the time they receive a distribution from the plan, at which time special income averaging rates for lump sum distributions may serve to reduce the tax liability. In some cases, taxation may be further deferred by rollover to another qualified plan or individual retirement arrangement. (See Publication 575, Pension and Annuity Income, for further details.) Finally, plan earnings may accumulate free of tax.

Employee retirement plans that fail to satisfy the requirements under Code section 401(a) are not entitled to favorable tax treatment. Therefore, many employers desire advance assurance that the terms of their plans satisfy the qualification requirements. The Internal Revenue Service provides such advance assurance by means of the determination letter program. A favorable determination letter indicates that, in the opinion of the Service, the terms of the plan conform to the requirements of Internal Revenue Code section 401(a). In addition, a favorable determination letter may indicate that, on the basis of other information provided in your application, it has been demonstrated that the plan satisfies certain nondiscrimination requirements of Code section 401(a). See the following topic, Limitations of a Favorable Determination Letter, for more details.

Limitations of a Favorable Determination Letter

A favorable determination letter is limited in scope and may also have a limited useful life. A determination letter generally applies to qualification requirements regarding the form of the plan. A determination letter may also apply to other qualification requirements pertaining to the prohibition against discrimination in favor of highly compensated employees. These requirements are generally referred to as the coverage and nondiscrimination requirements. They include the nondiscrimination requirements of section 401(a)(4) of the Code, the minimum coverage requirements of section 410(b), and certain related requirements.

The extent to which a determination letter applies to the coverage and nondiscrimination requirements depends on the terms of the plan, the scope of the determination you requested, and the additional information you supplied with your application. Your determination letter will contain specific statements that will describe the scope of reliance represented by the letter.

In addition, the following apply generally to all determination letters:

The determination letter may not include a statement regarding the minimum coverage requirements of Code section 410(b); this means that you have demonstrated that the plan satisfies these requirements by satisfying the ratio-percentage test.

  • A favorable determination letter means that you have demonstrated that the plan satisfies the minimum participation requirements of Code section 401(a)(26). (Letters for certain governmental plans may also include a statement regarding a special effective date rule.)
  • If you maintain two or more retirement plans some of which were either not submitted to the Service for determination or not disclosed on each application, certain limitations and requirements will not have been considered on an aggregate basis. Therefore, you may not rely on the determination letter regarding the plans when considered as a total package.
  • A determination letter does not consider the special requirements relating to affiliated service groups or leased employees unless the letter includes a statement that the requirements of Internal Revenue Code section 414(m) (affiliated service groups), or 414(n) (leased employees) have been considered.
  • For plans that are not amended to comply with the final nondiscrimination regulations retroactively to the 1989 plan year, a determination letter may not be relied upon as to whether plan provisions satisfy a good faith interpretation of the requirements of section 401(a)(4) and related sections of the Code.
  • No determination letter may be relied on with respect to the effective availability of benefits, rights, or features under the plan. (See section 1.401(a)(4)-4(c) of the Income Tax Regulations.) Reliance on whether benefits, rights, or features are currently available to a non-discriminatory group of employees is provided to the extent specified in the letter.
  • A determination letter does not consider whether actuarial assumptions are reasonable for funding or deduction purposes or whether a specific contribution is deductible.
  • A determination letter does not consider and may not be relied on with respect to certain other matters described in section 4.08 of Rev. Proc. 93-39, 199331 I.R.B. 7 (i.e., whether a plan amendment is part of a pattern of amendments that significantly discriminates in favor of highly compensated employees; the use of the substantiation guidelines contained in Rev. Proc. 93-42, 1993-31 I.R.B. 32; and certain qualified separate lines of business requirements of section 414(r) of the Code).
  • The determination letter applies only to the employer and its participants on whose behalf the determination letter was issued.

Become familiar with the terms of the determination letter. Please call the contact person listed on the determination letter if you do not understand any terms in your determination letter.

Retention of Information. Whether a plan qualifies is determined from the information in the written plan document and the supporting information submitted by the employer. Therefore, you must retain copies of any demonstrations or other information submitted with your application. Such demonstrations determine the extent of reliance provided by your determination letter. Failure to retain such Information may limit the scope of reliance on issues for which demonstrations were provided. The determination letter will not provide reliance if:

  1. there has been a misstatement or omission of material facts,
  2. the facts subsequently developed are materially different than the facts on which the determination was made, or
  3. there is a change in applicable law.

Law changes affecting the plan. In general, a determination letter is issued based on the law in effect at the time the application is received. However, your letter may include a statement indicating any exception to this rule.

Amendments to the plan. A favorable determination letter may no longer apply if there is a change in a statute, regulation, or revenue ruling applicable to the qualification of the plan. However, the determination letter will continue to apply for years before the effective date of the statute, regulation, or revenue ruling. If the letter no longer applies to the plan, the plan must be amended to comply with the new requirements to maintain its qualified status.

Generally, if a regulation changes, the amendment must be adopted by the end of the first plan year beginning after the adoption date of the regulation. Generally, if a revenue ruling changes, the amendment must be adopted by the end of the first plan year beginning after the publication date of the revenue ruling. Generally the amendment must be effective not later than the first day of such plan year.

Amendments required by Internal Revenue Code sections 401(a)(17) and 401(a)(31). If the plan is a master or prototype or regional prototype plan, the determination letter may be relied on with respect to the direct rollover requirements of Internal Revenue Code section 401(a)(31) and the $150,000 compensation limitation of Internal Revenue Code section 401(a)(17), only if the sponsor amends the master or prototype or regional prototype plan on behalf of all adopting employers to satisfy these requirements by December 31, 1994. In the case of individually designed plans, letters issued under Rev. Proc. 93-39 consider these requirements.

Extended Reliance. In general, individually designed plans (not master or prototype, or regional prototype plans) submitted for a determination letter before July 1, 1994 need not be amended for, or comply in operation with subsequent Treasury regulations or other guidance (for example, revenue rulings, notices, etc.) issued by the Service after the date of the plan determination letter until the last day of the last plan year commencing prior to January 1, 1999, unless specifically stated otherwise.

However, plans must be amended by any date(s) established for plan amendment by subsequent legislation. If the determination letter is dated after June 30, 1994, this extended reliance will apply only d so stated in the determination letter. Similar reliance applies to master and prototype or regional prototype plans if the plan sponsor requested a notification or opinion letter before April 1, 1991.

Plan Must Qualify in Operation

Generally, a plan qualifies in operation if it continues to satisfy the coverage and nondiscrimination requirements and is maintained according to the terms on which the favorable determination letter was issued. Changes in facts and other bases on which the determination letter was issued may mean that the determination letter may no longer be relied upon.

Some examples of the effect of a plan's operation on a favorable determination are:

Not meeting nondiscrimination in amount requirement. If the determination letter states that the plan satisfies the nondiscrimination in amount requirement of section 1.401(a)(4)-1(b)(2) of the regulations on the basis of a design-based safe harbor, the plan will generally continue to satisfy this requirement in operation n the plan is maintained according to its terms. If the determination letter states that the plan satisfies the nondiscrimination in amount requirement on the basis of a nondesign-based safe harbor or a general test, and the plan subsequently fails to meet this requirement in operation, the letter may no longer be relied upon with respect to this requirement.

Not meeting minimum coverage requirements. If the determination letter does not include a statement regarding the minimum coverage requirements of Code section 410(b), this means that the plan satisfies these requirements by satisfying the ratio-percentage test. However, if the plan subsequently fails to satisfy the ratio-percentage test in operation, the letter may no longer be relied upon with respect to the coverage requirements. Likewise, if the determination letter states the plan satisfies the average benefit test, the letter may no longer be relied on with respect to the coverage requirements once the plan fails to satisfy the average benefit test in operation.

Changes in testing methods. If the determination letter is based in part on a demonstration that a coverage or nondiscrimination requirement is satisfied, and, in the operation of the plan, the method used to test that this requirement continues to be satisfied is changed (or is required to be changed because the facts have changed) from the method employed in the demonstration, the letter may no longer be relied upon with respect to this requirement.

Contributions or benefits in excess of the limitations under Code section 415. A retirement plan may not provide retirement benefits or, in the case of a defined contribution plan, contributions and other additions, that exceed the limitations specified in Internal Revenue Code section 415. Your plan contains provisions designed to provide benefits within these limitations. Please become familiar with these limitations for your plan will be disqualified if these limitations are exceeded.

Top heavy minimums. If this plan primarily benefits employees who are highly compensated, it may be a top heavy plan and must provide certain minimum benefits and vesting for lower compensated employees. If your plan provides the accelerated benefits and vesting only for years during which the plan is top heavy, failure to identify such years and to provide the accelerated vesting and benefits will disqualify the plan.

Actual deferral percentage or contribution percentage tests. If this plan provides for cash or deferred arrangements, employer matching contributions, or employee contributions, the determination letter

does not consider whether special discrimination tests described in Code section 401(k)(3) or 401(m)(2) have been satisfied in operation.

Reporting Requirements

Most plan administrators or employers who maintain an employee benefit plan must file an annual return/report with the Internal Revenue Service. The following is a general discussion of the forms to be used for this purpose. See the instructions to each form for specific information:

Form 5500-EZ, Annual Return of One Participant (Owners and their Spouses) Pension Benefit Plans - generally for a "One-participant Plan', which is a plan that covers only:

  1. an individual, or an individual and his or her spouse who wholly own a business whether incorporated or not; or
  2. partner(s) in a partnership or the partner(s) and the partner's spouse.

If Form 5500-EZ cannot be used, the one-participant plan should use Form 5500-C/R, Return/Report of Employee Benefit Plan.

Note. A "one-participant" plan that has no more than $100,000 in assets at the end of the plan year is not required to file a return. However, Form 5500-EZ must be filed for any subsequent year in which plan assets exceed $100,000. If two or more one-participant plans have more than $100,000 in assets, a separate Form 5500-EZ must be filed for each plan.

A "Final" Form 5500-EZ must be filed if the plan is terminated or if assets drop below $100,000 and you wish to stop filing Form 5500-EZ.

Form 5500, Annual Return/Report Of Employee Benefit Plan - for a pension benefit plan with 100 or more participants at the beginning of the plan year.

Form 5500-C/R, Return/Report of Employee Benefit Plan - for each pension benefit plan with more than one but fewer than 100 participants at the beginning of the plan year. Form 5500-C/R takes the place of separate Forms 5500-C and 5500-R. Filing only the first two pages of Form 5500-C/R constitutes the filing of Form 5500-R for plan years for which Form 5500-C is not filed.

Note. Keogh (HR-10) plans having over $100,000 in assets are required to file an annual return even if the only participants are owner-employees. The term "owner-employee' includes a partner who owns more than 10% interest in either the capital or profits of the partnership. This applies to both defined contribution and defined benefit plans.

When to file. Forms 5500 and 5500-EZ must be filed annually. Form 5500-C must be filed for (i) the initial plan year, (ii) the year a final return/report would be filed, and (iii) at three-year intervals.

Form 5500-R pages 1 and 2 of Form 5500-C/R) must be filed in the years when 5500-C is not filed. However, 5500-C will be accepted in place of 5500-R.

Form 5330 for prohibited transactions - Transactions between a plan and someone having a relationship to the plan (disqualified person) are prohibited, unless specifically exempted from this requirement. A few examples are loans, sales and exchanges of property, leasing of property, furnishing goods or services, and use of plan assets by the disqualified person. Disqualified persons

who engage in a prohibited transaction for which there is no exception must file Form 5330 by the last day of the seventh month after the end of the tax year of the disqualified person.

Form 5330 for tax on nondeductible employer contributions to qualified plans - If contributions are made to this plan in excess of the amount deductible, a tax is imposed upon the excess contribution. Form 5330 must be filed by the last day of the seventh month after the end of the employer's tax year.

Form 5330 for tax on excess contributions to cash or deferred arrangements or excess employee contributions or employer matching contributions - If a plan includes a cash or deferred arrangement (Code section 401(k)) or provides for employee contributions or employer matching contributions (Code section 401(m)), then excess contributions that would cause the plan to fail the actual deferral percentage or the actual contribution percentage test are subject to a tax unless the excess is eliminated within 2 1/2 months after the end of the plan year. Form 5330 must be filed by the due date of the employer's tax return for the plan year in which the tax was incurred.

Form 5330 for tax on reversions of plan assets - Under Code section 4980, a tax is payable on the amount of any employer reversion of plan assets. Form 5330 must be filed by the last day of the month following the month in which the reversion occurred.

Form 5310-A for certain transactions - Under Code section 6058(b), an actuarial statement is required at least 30 days before a merger, consolidation, or transfers (including spin-offs) of assets to another plan. This statement is required for all plans. However, penalties for non-filing will not apply to defined contribution plans for which:

  1. The sum of the account balances in each plan equals the fair market value of all plan assets,
  2. The assets of each plan are combined to form the assets of the plan as merged,
  3. Immediately after a merger, the account balance of each participant is equal to the sum of the account balances of the participant immediately before the merger, and
  4. The plans must not have an unamortized waiver or unallocated suspense account.

Penalties will also not apply if the assets transferred are less than three percent of the assets of the plan involved in the transfer (spin-off), and the transaction is not one of a series of two or more transfers (spin-off transactions) that are, in substance, one transaction.

The purpose of the above discussions is to illustrate some of the principal filing requirements that apply to pension plans. This listing is not an exclusive listing of all returns and schedules that must be filed.

Disclosure. The Internal Revenue Service will process the returns and provide the Department of Labor and the Pension Benefit Guaranty Corporation with the necessary information and copies of the returns on microfilm for disclosure purposes.

Example - IRS Determination Letter

Example - IRS Determination Letter

Department of the Treasury
Internal Revenue Service
1100 Commerce St. Code 431

In reply refer to: 75260006 Springfield

AS 99001 Dec. 04, 1987 LTR 835AU

73-0793565P 0000 74 001

Input 0p: 75018508 00016

Flimflam & Jones, P.C.

1000 Ajax Life Bldg

PLANO AS 99103

District Office Code and

Case Serial Number: 73737028 EP

Name of Plan: Flimflam & Jones Profit Sharing Plan

Application Form: 5301

Date Amended: 030386

Employer Identification Number: 73-0793565

Plan Number: 001

File Number: 730000488

Dear Applicant:

Based on the information supplied, we have made a favorable determination on your application identified above. Please keep this letter in your permanent records.

Continued qualification of the plan will depend on its effect in operation under its present form. (See Section 1.401-1(b)(3) of the Income Tax Regulations.) The status of the plan in operation will be reviewed periodically.

The enclosed document describes some events that could occur after you receive this letter that would automatically nullify it without specific notice from us. The document also explains how operation of the plan may affect a favorable determination letter, and contains information about filing requirements.

This letter relates only to the status of your plan under the Internal Revenue Code. It is not a determination regarding the effect of other federal or local statutes.

This determination is not a ruling on the effect of reclamination on the deferred percentage test.

If you have any questions, please contact E P Tech Assistor at 703-754-1234.

Sincerely your,

James P. Huttonski
District Director

Enclosures:
Publication 794

US Treasury Notice 2004-8 - Abusive Roth IRA Transaction

U.S. Treasury Notice 2004-8
Abusive Roth IRA Transactions

December 31, 2003

Summary
Identifies specific transactions used to avoid Roth IRA contribution limitations, and substantially similar transactions, as listed transactions for purposes of § 1.6011-4(b)(2) of Income Tax Regulations and §§ 301.6111-2(b)(2) and 301.6112-1(b)(2) of Procedure and Administration Regulations.

Notice 2004-8

Part III - Administrative, Procedural and Miscellaneous

December 31, 2003

U.S. Treasury Notice

Abusive Roth IRA Transactions

Notice 2004-8

The Internal Revenue Service and the Treasury Department are aware of a type of transaction, described below, that taxpayers are using to avoid the limitations on contributions to Roth IRAs. This notice alerts taxpayers and their representatives that these transactions are tax avoidance transactions and identifies these transactions, as well as substantially similar transactions, as listed transactions for purposes of § 1.6011-4(b)(2) of the Income Tax Regulations and §§ 301.6111-2(b)(2) and 301.6112-1(b)(2) of the Procedure and Administration Regulations. This notice also alerts parties involved with these transactions of certain responsibilities that may arise from their involvement with these transactions.

Background

Section 408A was added to the Internal Revenue Code by section 302 of the Taxpayer Relief Act of 1997, Pub. L. 105-34, 105th Cong., 1st Sess. 40 (1997). This section created Roth IRAs as a new type of nondeductible individual retirement arrangement (IRA). The maximum annual contribution to Roth IRAs is the same maximum amount that would be allowable as a deduction under § 219 with respect to the individual for the taxable year over the aggregate amount of contributions for that taxable year to all other IRAs. Neither the contributions to a Roth IRA nor the earnings on those contributions are subject to tax on distribution, if distributed as a qualified distribution described in § 408A(d)(2).

A contribution to a Roth IRA above the statutory limits generates a 6 - percent excise tax described in § 4973The excise tax is imposed each year until the excess contribution is eliminated.

Facts

In general, these transactions involve the following parties: (1) an individual (the Taxpayer) who owns a pre-existing business such as a corporation or a sole proprietorship (the Business), (2) a Roth IRA within the meaning of § 408A that is maintained for the Taxpayer, and (3) a corporation (the Roth IRA Corporation), substantially all the shares of which are owned or acquired by the Roth IRA. The Business and the Roth IRA Corporation enter into transactions as described below. The acquisition of shares, the transactions or both are not fairly valued and thus have the effect of shifting value into the Roth IRA.

Examples include transactions in which the Roth IRA Corporation acquires property, such as accounts receivable, from the Business for less than fair market value, contributions of property, including intangible property, by a person other than the Roth IRA, without a commensurate receipt of stock ownership, or any other arrangement between the Roth IRA Corporation and the Taxpayer, a related party described in § 267(b) or 707(b), or the Business that has the effect of transferring value to the Roth IRA Corporation comparable to a contribution to the Roth IRA.

Analysis

The transactions described in this notice have been designed to avoid the statutory limits on contributions to a Roth IRA contained in § 408A. Because the Taxpayer controls the Business and is the beneficial owner of substantially all of the Roth IRA Corporation, the Taxpayer is in the position to shift value from the Business to the Roth IRA Corporation. The Service intends to challenge the purported tax benefits claimed for these arrangements on a number of grounds.

In challenging the purported tax benefits, the Service will, in appropriate cases, assert that the substance of the transaction is that the amount of the value shifted from the Business to the Roth IRA Corporation is a payment to the Taxpayer, followed by a contribution by the Taxpayer to the Roth IRA and a contribution by the Roth IRA to the Roth IRA Corporation. In such cases, the Service will deny or reduce the deduction to the Business; may require the Business, if the Business is a corporation, to recognize gain on the transfer under § 311(b); and may require inclusion of the payment in the income of the Taxpayer (for example, as a taxable dividend if the Business is a C corporation). See Sammons v. United States, 433 F.2d 728 (5th Cir. 1970); Worcester v. Commissioner, 370 F.2d 713 (1st Cir. 1966).

Depending on the facts of the specific case, the Service may apply § 482 to allocate income from the Roth IRA Corporation to the Taxpayer, Business, or other entities under the control of the Taxpayer. Section 482 provides the Secretary with authority to allocate gross income, deductions, credits or allowances among persons owned or controlled directly or indirectly by the same interests, if such allocation is necessary to prevent evasion of taxes or clearly to reflect income. The § 482 regulations provide that the standard to be applied is that of a person dealing at arm's length with an uncontrolled person. See generally § 1.482-1(b) of the Income Tax Regulations. To the extent that the consideration paid or received in transactions between the Business and the Roth IRA Corporation is not in accordance with the arm's length standard, the Service may apply § 482 as necessary to prevent evasion of taxes or clearly to reflect income. In the event of a § 482 allocation between the Roth IRA Corporation and the Business or other parties, correlative allocations and other conforming adjustments would be made pursuant to § 1.482-1(g). Also see, Rev. Rul. 78-83, 1978-1 C.B. 79.

In addition to any other tax consequences that may be present, the amount treated as a contribution as described above is subject to the excise tax described in § 4973 to the extent that it is an excess contribution within the meaning of § 4973(f). This is an annual tax that is imposed until the excess amount is eliminated.

Moreover, under § 408(e)(2)(A), the Service may take the position in appropriate cases that the transaction gives rise to one or more prohibited transactions between a Roth IRA and a disqualified person described in § 4975(e)(2). For example, the Department of Labor has advised the Service that, to the extent that the Roth IRA Corporation constitutes a plan asset under the Department of Labor's plan asset regulation (29 C.F.R. § 2510.3-101), the provision of services by the Roth IRA Corporation to the Taxpayer's Business (which is a disqualified person with respect to the Roth IRA under § 4975(e)(2)) would constitute a prohibited transaction under § 4975(c)(1)(C). Further, the Department of Labor has advised the Service that, if a transaction between a disqualified person and the Roth IRA would be a prohibited transaction, then a transaction between that disqualified person and the Roth IRA Corporation would be a prohibited transaction if the Roth IRA may, by itself, require the Roth IRA Corporation to enter into the transaction.

Listed Transactions

The following transactions are identified as "listed transactions" for purposes of §§ 1.6011-4(b)(2), 301.6111-2(b)(2) and 301.6112-1(b)(2) effective December 31, 2003, the date this document is released to the public: arrangements in which an individual, related persons described in § 267(b) or 707(b), or a business controlled by such individual or related persons, engage in one or more transactions with a corporation, including contributions of property to such corporation, substantially all the shares of which are owned by one or more Roth IRAs maintained for the benefit of the individual, related persons described in § 267(b)(1), or both. The transactions are listed transactions with respect to the individuals for whom the Roth IRAs are maintained, the business (if not a sole proprietorship) that is a party to the transaction, and the corporation substantially all the shares of which are owned by the Roth IRAs. Independent of their classification as "listed transactions," these transactions may already be subject to the disclosure requirements of § 6011 (§ 1.6011-4), the tax shelter registration requirements of § 6111 (§§ 301.6111-1T and 301.6111-2), or the list maintenance requirements of § 6112 (§ 301.6112-1).

Substantially similar transactions include transactions that attempt to use a single structure with the intent of achieving the same or substantially same tax effect for multiple taxpayers. For example, if the Roth IRA Corporation is owned by multiple taxpayers' Roth IRAs, a substantially similar transaction occurs whenever that Roth IRA Corporation enters into a transaction with a business of any of the taxpayers if distributions from the Roth IRA Corporation are made to that taxpayer's Roth IRA based on the purported business transactions done with that taxpayer's business or otherwise based on the value shifted from that taxpayer's business to the Roth IRA Corporation.

Persons required to register these tax shelters under § 6111 who have failed to do so may be subject to the penalty under § 6707(a). Persons required to maintain lists of investors under § 6112 who have fail to do so (or who fail to provide such lists when requested by the Service) may be subject to the penalty under § 6708(a). In addition, the Service may impose penalties on participants in this transaction or substantially similar transactions, including the accuracy related penalty under § 6662, and as applicable, persons who participate in the reporting of this transaction or substantially similar transactions, including the return preparer penalty under § 6694, the promoter penalty under § 6700, and the aiding and abetting penalty under § 6701.

The Service and the Treasury recognize that some taxpayers may have filed tax returns taking the position that they were entitled to the purported tax benefits of the type of transaction described in this notice. These taxpayers should consult with a tax advisor to ensure that their transactions are disclosed properly and to take appropriate corrective action.

Drafting Information

The principal author of this notice is Michael Rubin of the Employee Plans, Tax Exempt and Government Entities Division. However, other personnel from the Service and Treasury participated in its development. Mr. Rubin may be reached at (202) 283-9888 (not a toll-free call).

Footnotes
  1. Under section 102 of Reorganization Plan No. 4 of 1978 (43 FR 47713), the Secretary of Labor has interpretive jurisdiction over § 4975 of the Internal Revenue Code.
  2. For the Roth IRA Corporation to be considered as holding plan assets under the Department of Labor's plan asset regulation, the Roth IRA's investment in the Roth IRA Corporation must be an equity interest, the Roth IRA Corporation's securities must not be publicly-offered securities, and the Roth IRA's investment in the Roth IRA Corporation must be significant. 29 C.F.R. §§ 2510.3-101(a)(2), 2510.3-101(b)(1), 2510.3-101(b)(2), and 2510.3-101(f). Although the Roth IRA Corporation would not be treated as holding plan assets if the Roth IRA Corporation constituted an operating company within the meaning of 29 C.F.R. § 2510.3-101(c), given the context of the examples described in this notice, it is unlikely that the Roth IRA Corporation would qualify as an operating company.
  3. See 29 C.F.R. § 2509.75-2(c).
Miscellaneous Laws

Pension Protection Act of 2006

  1. Pension Protection Act of 2006 (PDF)
  2. Pension Protection Act of 2006 (Revised)

Economic Growth and Tax Relief Reconciliation Act of 2001

(Sections Made Permanent by Section 811 of the Pension Protection Act of 2006)

TITLE VI - Pension and Individual Retirement Arrangement Provisions

Subtitle A - Individual Retirement Accounts

Sec. 601. Modification of IRA contribution limits.
Sec. 602. Deemed IRAs under employer plans.

Subtitle B - Expanding Coverage

Sec. 611. Increase in benefit and contribution limits.
Sec. 612. Plan loans for subchapter S owners, partners, and sole proprietors.
Sec. 613. Modification of top-heavy rules.
Sec. 614. Elective deferrals not taken into account for purposes of deduction limits.
Sec. 615. Repeal of coordination requirements for deferred compensation plans of State and local governments and tax-exempt organizations.
Sec. 616. Deduction limits.
Sec. 617. Option to treat elective deferrals as after-tax Roth contributions.
Sec. 618. Nonrefundable credit to certain individuals for elective deferrals and IRA contributions.
Sec. 619. Credit for pension plan startup costs of small employers.
Sec. 620. Elimination of user fee for requests to IRS regarding pension plans.
Sec. 621. Treatment of nonresident aliens engaged in international transportation services.

Subtitle C - Enhancing Fairness for Women

Sec. 631. Catch-up contributions for individuals age 50 or over.
Sec. 632. Equitable treatment for contributions of employees to defined contribution plans.
Sec. 633. Faster vesting of certain employer matching contributions.
Sec. 634. Modification to minimum distribution rules.
Sec. 635. Clarification of tax treatment of division of section 457 plan benefits upon divorce.
Sec. 636. Provisions relating to hardship distributions.
Sec. 637. Waiver of tax on nondeductible contributions for domestic or similar workers.

Subtitle D - Increasing Portability for Participants

Sec. 641. Rollovers allowed among various types of plans.
Sec. 642. Rollovers of IRAs into workplace retirement plans.
Sec. 643. Rollovers of after-tax contributions.
Sec. 644. Hardship exception to 60-day rule.
Sec. 645. Treatment of forms of distribution.
Sec. 646. Rationalization of restrictions on distributions.
Sec. 647. Purchase of service credit in governmental defined benefit plans.
Sec. 648. Employers may disregard rollovers for purposes of cash-out amounts.
Sec. 649. Minimum distribution and inclusion requirements for section 457 plans.

Subtitle E - Strengthening Pension Security and Enforcement

PART I - GENERAL PROVISIONS

Sec. 651. Repeal of 160 percent of current liability funding limit.
Sec. 652. Maximum contribution deduction rules modified and applied to all defined benefit plans.
Sec. 653. Excise tax relief for sound pension funding.
Sec. 654. Treatment of multi-employer plans under section 415.
Sec. 655. Protection of investment of employee contributions to 401(k) plans.
Sec. 656. Prohibited allocations of stock in S corporation ESOP.
Sec. 657. Automatic rollovers of certain mandatory distributions.
Sec. 658. Clarification of treatment of contributions to multi-employer plan.

PART II–TREATMENT OF PLAN AMENDMENTS REDUCING FUTURE BENEFIT ACCRUALS

Sec. 659. Excise tax on failure to provide notice by defined benefit plans significantly reducing future benefit accruals.

Subtitle F - Reducing Regulatory Burdens

Sec. 661. Modification of timing of plan valuations.
Sec. 662. ESOP dividends may be reinvested without loss of dividend deduction.
Sec. 663. Repeal of transition rule relating to certain highly compensated employees.
Sec. 664. Employees of tax-exempt entities.
Sec. 665. Clarification of treatment of employer-provided retirement advice.
Sec. 666. Repeal of the multiple use test.

Subtitle A – Individual Retirement Accounts

Sec. 601. Modification Of IRA Contribution Limits.

(a) INCREASE IN CONTRIBUTION LIMIT -

(1) IN GENERAL - Paragraph (1)(A) of section 219(b) (relating to maximum amount of deduction) is amended by striking "$2,000" and inserting "the deductible amount".
(2) DEDUCTIBLE AMOUNT - Section 219(b) is amended by adding at the end the following new paragraph:
(5) DEDUCTIBLE AMOUNT - For purposes of paragraph (1)(A)–

(A) IN GENERAL - The deductible amount shall be
determined in accordance with the following table:

For taxable years The deductible beginning in: amount is:
2002 through 2004 ..................................................................... $3,000
2005 through 2007 ..................................................................... $4,000
2008 and thereafter .................................................................... $5,000.

(B) CATCH-UP CONTRIBUTIONS FOR INDIVIDUALS 50 OR OLDER -

(i) IN GENERAL - In the case of an individual who has attained the age of 50 before the close of the taxable year, the deductible amount for such taxable year shall be increased by the applicable amount.
(ii) APPLICABLE AMOUNT - For purposes of clause (i), the applicable amount shall be the amount determined in accordance with the following table:

For taxable years The applicable beginning in: amount is:
2002 through 2005 ....................................................................... $500
2006 and thereafter ................................................................... $1,000.

(C) COST-OF-LIVING ADJUSTMENT -

(i) IN GENERAL - In the case of any taxable year beginning in a calendar year after 2008, the $5,000 amount under subparagraph (A) shall be increased by an amount equal to–

(I) such dollar amount, multiplied by
(II) the cost-of-living adjustment determined under section 1(f )(3) for the calendar year in which
the taxable year begins, determined by substituting ‘calendar year 2007’ for ‘calendar year 1992’ in subparagraph (B) thereof.

(ii) ROUNDING RULES - If any amount after adjustment under clause (i) is not a multiple of $500, such
amount shall be rounded to the next lower multiple of $500.".

(b) CONFORMING AMENDMENTS.

(1) Section 408(a)(1) is amended by striking "in excess of $2,000 on behalf of any individual" and inserting "on behalf of any individual in excess of the amount in effect for such taxable year under section 219(b)(1)(A)".

(2) Section 408(b)(2)(B) is amended by striking "$2,000" and inserting "the dollar amount in effect under section 219(b)(1)(A)".

(3) Section 408(b) is amended by striking "$2,000" in the matter following paragraph (4) and inserting "the dollar amount in effect under section 219(b)(1)(A)".

(4) Section 408( j) is amended by striking "$2,000".

(5) Section 408(p)(8) is amended by striking "$2,000" and inserting "the dollar amount in effect under section
219(b)(1)(A)".

(c) EFFECTIVE DATE. The amendments made by this section shall apply to taxable years beginning after December 31, 2001.

Sec. 602. Deemed IRAs Under Employer Plans.

(a) IN GENERAL - Section 408 (relating to individual retirement accounts) is amended by redesignating subsection (q) as subsection (r) and by inserting after subsection (p) the following new subsection:

"(q) DEEMED IRAS UNDER QUALIFIED EMPLOYER PLANS -

"(1) GENERAL RULE - If

"(A) a qualified employer plan elects to allow employees to make voluntary employee contributions to a separate account or annuity established under the plan, and

"(B) under the terms of the qualified employer plan, such account or annuity meets the applicable requirements of this section or section 408A for an individual retirement account or annuity, then such account or annuity shall be treated for purposes of this title in the same manner as an individual retirement plan and not as a qualified employer plan (and contributions to such account or annuity as contributions to an individual retirement plan and not to the qualified employer plan). For purposes of subparagraph (B), the requirements of subsection (a)(5) shall not apply.

"(2) SPECIAL RULES FOR QUALIFIED EMPLOYER PLANS - For purposes of this title, a qualified employer plan shall not fail to meet any requirement of this title solely by reason of establishing and maintaining a program described in paragraph (1).

"(3) DEFINITIONS - For purposes of this subsection -

"(A) QUALIFIED EMPLOYER PLAN - The term ‘qualified employer plan’ has the meaning given such term by section 72(p)(4); except such term shall not include a government plan which is not a qualified plan unless the plan is an eligible deferred compensation plan (as defined in section 457(b)).

"(B) VOLUNTARY EMPLOYEE CONTRIBUTION - The term ‘voluntary employee contribution’ means any contribution (other than a mandatory contribution within the meaning of section 411(c)(2)(C)) -

"(i) which is made by an individual as an employee under a qualified employer plan which allows employees to elect to make contributions described in paragraph (1), and "(ii) with respect to which the individual has designated the contribution as a contribution to which this subsection applies.".

(b) AMENDMENT OF ERISA -

(1) IN GENERAL - Section 4 of the Employee Retirement Income Security Act of 1974 (29 U.S.C. 1003) is amended by adding at the end the following new subsection:

"(c) If a pension plan allows an employee to elect to make voluntary employee contributions to accounts and annuities as provided in section 408(q) of the Internal Revenue Code of 1986, such accounts and annuities (and contributions thereto) shall not be treated as part of such plan (or as a separate pension plan) for purposes of any provision of this title other than section 403(c), 404, or 405 (relating to exclusive benefit, and fiduciary and cofiduciary responsibilities).".

(2) CONFORMING AMENDMENT - Section 4(a) of such Act (29 U.S.C. 1003(a)) is amended by inserting "or (c)" after "subsection (b)".

(c) EFFECTIVE DATE - The amendments made by this section shall apply to plan years beginning after December 31, 2002.

Subtitle B – Expanding Coverage

Sec. 611. Increase In Benefit And Contribution Limits.

(a) DEFINED BENEFIT PLANS -

(1) DOLLAR LIMIT -

(A) Subparagraph (A) of section 415(b)(1) (relating to limitation for defined benefit plans) is amended by striking "$90,000" and inserting "$160,000".

(B) Subparagraphs (C) and (D) of section 415(b)(2) are each amended in the headings and the text, by striking "$90,000" and inserting "$160,000",

(C) Paragraph (7) of section 415(b) (relating to benefits under certain collectively bargained plans) is amended by striking "the greater of $68,212 or one-half the amount otherwise applicable for such year under paragraph (1)(A) for ‘$90,000’ " and inserting "one-half the amount otherwise applicable for such year under paragraph (1)(A) for ‘$160,000’ ".

(2) LIMIT REDUCED WHEN BENEFIT BEGINS BEFORE AGE 62 -

Subparagraph (C) of section 415(b)(2) is amended by striking "the social security retirement age" each place it appears in the heading and text and inserting "age 62" and by striking the second sentence.

(3) LIMIT INCREASED WHEN BENEFIT BEGINS AFTER AGE 65 -

Subparagraph (D) of section 415(b)(2) is amended by striking "the social security retirement age" each place it appears in the heading and text and inserting "age 65".

(4) COST-OF-LIVING ADJUSTMENTS - Subsection (d) of section 415 (related to cost-of-living adjustments) is amended–

(A) by striking "$90,000" in paragraph (1)(A) and inserting "$160,000"; and

(B) in paragraph (3)(A)– (i) by striking "$90,000" in the heading and inserting "$160,000"; and (ii) by striking "October 1, 1986" and inserting "July 1, 2001".

(5) CONFORMING AMENDMENTS -

(A) Section 415(b)(2) is amended by striking subparagraph (F).

(B) Section 415(b)(9) is amended to read as follows:

"(9) SPECIAL RULE FOR COMMERCIAL AIRLINE PILOTS -

"(A) IN GENERAL - Except as provided in subparagraph (B), in the case of any participant who is a commercial airline pilot, if, as of the time of the participant’s retirement, regulations prescribed by the Federal Aviation Administration require an individual to separate from service as a commercial airline pilot after attaining any age occurring on or after age 60 and before age 62, paragraph (2)(C) shall be applied by substituting such age for age 62.

"(B) INDIVIDUALS WHO SEPARATE FROM SERVICE BEFORE AGE 60 - If a participant described in subparagraph (A) separates from service before age 60, the rules of paragraph (2)(C) shall apply.".

(C) Section 415(b)(10)(C)(i) is amended by striking "applied without regard to paragraph (2)(F)".

(b) DEFINED CONTRIBUTION PLANS -

(1) DOLLAR LIMIT - Subparagraph (A) of section 415(c)(1) (relating to limitation for defined contribution plans) is amended by striking "$30,000" and inserting "$40,000".

(2) COST-OF-LIVING ADJUSTMENTS - Subsection (d) of section 415 (related to cost-of-living adjustments) is amended–

(A) by striking "$30,000" in paragraph (1)(C) and inserting "$40,000"; and

(B) in paragraph (3)(D)– (i) by striking "$30,000" in the heading and inserting "$40,000"; and (ii) by striking "October 1, 1993" and inserting "July 1, 2001".

(c) QUALIFIED TRUSTS -

(1) COMPENSATION LIMIT - Sections 401(a)(17), 404(l), 408(k), and 505(b)(7) are each amended by striking "$150,000" each place it appears and inserting "$200,000".

(2) BASE PERIOD AND ROUNDING OF COST-OF-LIVING ADJUSTMENT -

Subparagraph (B) of section 401(a)(17) is amended–

(A) by striking "October 1, 1993" and inserting "July 1, 2001"; and

(B) by striking "$10,000" both places it appears and inserting "$5,000".

(d) ELECTIVE DEFERRALS -

(1) IN GENERAL - Paragraph (1) of section 402(g) (relating to limitation on exclusion for elective deferrals) is amended to read as follows:

"(1) IN GENERAL -

"(A) LIMITATION - Notwithstanding subsections (e)(3) and (h)(1)(B), the elective deferrals of any individual for any taxable year shall be included in such individual’s gross income to the extent the amount of such deferrals for the taxable year exceeds the applicable dollar amount.

"(B) APPLICABLE DOLLAR AMOUNT - For purposes of subparagraph (A), the applicable dollar amount shall be the amount determined in accordance with the following table:

"For taxable years The applicable beginning in dollar amount:

Calendar Year:
2002 ............................................................................................. $11,000
2003 ............................................................................................. $12,000
2004 ............................................................................................. $13,000
2005 ............................................................................................. $14,000
2006 or thereafter ........................................................................... $15,000.".

(2) COST-OF-LIVING ADJUSTMENT - Paragraph (5) of section 402(g) is amended to read as follows:

"(5) COST-OF-LIVING ADJUSTMENT - In the case of taxable years beginning after December 31, 2006, the Secretary shall adjust the $15,000 amount under paragraph (1)(B) at the same time and in the same manner as under section 415(d), except that the base period shall be the calendar quarter beginning July 1, 2005, and any increase under this paragraph which is not a multiple of $500 shall be rounded to the next lowest multiple of $500.".

(3) CONFORMING AMENDMENTS -

(A) Section 402(g) (relating to limitation on exclusion for elective deferrals), as amended by paragraphs (1) and (2), is further amended by striking paragraph (4) and redesignating paragraphs (5), (6), (7), (8), and (9) as paragraphs (4), (5), (6), (7), and (8), respectively.

(B) Paragraph (2) of section 457(c) is amended by striking "402(g)(8)(A)(iii)" and inserting "402(g)(7)(A)(iii)".

(C) Clause (iii) of section 501(c)(18)(D) is amended by striking "(other than paragraph (4) thereof )".

(e) DEFERRED COMPENSATION PLANS OF STATE AND LOCAL GOVERNMENTS AND TAX-EXEMPT ORGANIZATIONS -

(1) IN GENERAL - Section 457 (relating to deferred compensation plans of State and local governments and tax-exempt organizations) is amended–

(A) in subsections (b)(2)(A) and (c)(1) by striking "$7,500" each place it appears and inserting "the applicable dollar amount"; and

(B) in subsection (b)(3)(A) by striking "$15,000" and inserting "twice the dollar amount in effect under subsection (b)(2)(A)".

(2) APPLICABLE DOLLAR AMOUNT; COST-OF-LIVING ADJUSTMENT -

Paragraph (15) of section 457(e) is amended to read as follows:

"(15) APPLICABLE DOLLAR AMOUNT -

"(A) IN GENERAL - The applicable dollar amount shall be the amount determined in accordance with the following table:

"For taxable years. The applicable beginning in dollar amount:

Calendar year:
2002 ............................................................................................. $11,000
2003 ............................................................................................. $12,000
2004 ............................................................................................. $13,000
2005 ............................................................................................. $14,000
2006 or thereafter ........................................................................... $15,000.

"(B) COST-OF-LIVING ADJUSTMENTS - In the case of taxable years beginning after December 31, 2006, the Secretary shall adjust the $15,000 amount under subparagraph (A) at the same time and in the same manner as under section 415(d), except that the base period shall be the calendar quarter beginning July 1, 2005, and any increase under this paragraph which is not a multiple of $500 shall be rounded to the next lowest multiple of $500.".

(f ) SIMPLE RETIREMENT ACCOUNTS -

(1) LIMITATION - Clause (ii) of section 408(p)(2)(A) (relating to general rule for qualified salary reduction arrangement) is amended by striking "$6,000" and inserting "the applicable dollar amount".

(2) APPLICABLE DOLLAR AMOUNT - Subparagraph (E) of 408(p)(2) is amended to read as follows:

"(E) APPLICABLE DOLLAR AMOUNT; COST-OF-LIVING ADJUSTMENT -

"(i) IN GENERAL - For purposes of subparagraph (A)(ii), the applicable dollar amount shall be the amount determined in accordance with the following table:

"For years The applicable beginning in dollar amount:

Calendar year:
2002 ...................................................................................... $7,000
2003 ...................................................................................... $8,000
2004 ...................................................................................... $9,000
2005 or thereafter .................................................................. $10,000.

"(ii) COST-OF-LIVING ADJUSTMENT - In the case of a year beginning after December 31, 2005, the Secretary shall adjust the $10,000 amount under clause (i) at the same time and in the same manner as under section 415(d), except that the base period taken into account shall be the calendar quarter beginning July 1, 2004, and any increase under this subparagraph which is not a multiple of $500 shall be rounded to the next lower multiple of $500.".

(3) CONFORMING AMENDMENTS -

(A) Subclause (I) of section 401(k)(11)(B)(i) is amended by striking "$6,000" and inserting "the amount in effect under section 408(p)(2)(A)(ii)".

(B) Section 401(k)(11) is amended by striking subparagraph (E).

(g) CERTAIN COMPENSATION LIMITS -

(1) IN GENERAL - Subparagraph (A) of section 401(c)(2) (defining earned income) is amended by adding at the end thereof the following new sentence: "For purposes of this part only (other than sections 419 and 419A), this subparagraph shall be applied as if the term ‘trade or business’ for purposes of section 1402 included service described in section 1402(c)(6).".

(2) SIMPLE RETIREMENT ACCOUNTS - Clause (ii) of section 408(p)(6)(A) (defining self-employed) is amended by adding at the end the following new sentence: "The preceding sentence shall be applied as if the term ‘trade or business’ for purposes of section 1402 included service described in section 1402(c)(6).".

(h) ROUNDING RULE RELATING TO DEFINED BENEFIT PLANS AND DEFINED CONTRIBUTION PLANS - Paragraph (4) of section 415(d) is amended to read as follows:

"(4) ROUNDING -

"(A) $160,000 AMOUNT - Any increase under subparagraph (A) of paragraph (1) which is not a multiple of $5,000 shall be rounded to the next lowest multiple of $5,000.

"(B) $40,000 AMOUNT - Any increase under subparagraph (C) of paragraph (1) which is not a multiple of $1,000 shall be rounded to the next lowest multiple of $1,000.".

(i) EFFECTIVE DATES -

(1) IN GENERAL - The amendments made by this section shall apply to years beginning after December 31, 2001.

(2) DEFINED BENEFIT PLANS - The amendments made by subsection (a) shall apply to years ending after December 31, 2001.

Sec. 612. Plan Loans For Subchapter S Owners, Partners, And Sole Proprietors.

(a) IN GENERAL - Subparagraph (B) of section 4975(f )(6) (relating to exemptions not to apply to certain transactions) is amended by adding at the end the following new clause:

"(iii) LOAN EXCEPTION - For purposes of subparagraph (A)(i), the term ‘owner-employee’ shall only include a person described in subclause (II) or (III) of clause (i).".

(b) AMENDMENT OF ERISA - Section 408(d)(2) of the Employee Retirement Income Security Act of 1974 (29 U.S.C. 1108(d)(2)) is amended by adding at the end the following new subparagraph:

"(C) For purposes of paragraph (1)(A), the term ‘owner employee’ shall only include a person described in clause (ii) or (iii) of subparagraph (A).".

(c) EFFECTIVE DATE - The amendment made by this section shall apply to years beginning after December 31, 2001.

Sec. 613. Modification Of Top-Heavy Rules.

(a) SIMPLIFICATION OF DEFINITION OF KEY EMPLOYEE -

(1) IN GENERAL - Section 416(i)(1)(A) (defining key employee) is amended -

(A) by striking "or any of the 4 preceding plan years" in the matter preceding clause (i);

(B) by striking clause (i) and inserting the following: "(i) an officer of the employer having an annual compensation greater than $130,000,";

(C) by striking clause (ii) and redesignating clauses (iii) and (iv) as clauses (ii) and (iii), respectively; and

(D) by striking the second sentence in the matter following clause (iii), as redesignated by subparagraph (C), and by inserting the following: "in the case of plan years beginning after December 31, 2002, the $130,000 amount in clause (i) shall be adjusted at the same time and in the same manner as under section 415(d), except that the base period shall be the calendar quarter beginning July 1, 2001, and any increase under this sentence which is not a multiple of $5,000 shall be rounded to the next lower multiple of $5,000.".

(2) CONFORMING AMENDMENT - Section 416(i)(1)(B)(iii) is amended by striking "and subparagraph (A)(ii)".

(b) MATCHING CONTRIBUTIONS TAKEN INTO ACCOUNT FOR MINIMUM CONTRIBUTION REQUIREMENTS - Section 416(c)(2)(A) (relating to defined contribution plans) is amended by adding at the end the following: "Employer matching contributions (as defined in section 401(m)(4)(A)) shall be taken into account for purposes of this subparagraph (and any reduction under this sentence shall not be taken into account in determining whether section 401(k)(4)(A) applies).".

(c) DISTRIBUTIONS DURING LAST YEAR BEFORE DETERMINATION DATE TAKEN INTO ACCOUNT -

(1) IN GENERAL - Paragraph (3) of section 416(g) is amended to read as follows:

"(3) DISTRIBUTIONS DURING LAST YEAR BEFORE DETERMINATION DATE TAKEN INTO ACCOUNT -

"(A) IN GENERAL - For purposes of determining -

"(i) the present value of the cumulative accrued benefit for any employee, or "(ii) the amount of the account of any employee, such present value or amount shall be increased by the aggregate distributions made with respect to such employee under the plan during the 1-year period ending on the determination date. The preceding sentence shall also apply to distributions under a terminated plan which if it had not been terminated would have been required to be included in an aggregation group.

"(B) 5-YEAR PERIOD IN CASE OF IN-SERVICE DISTRIBUTION -

In the case of any distribution made for a reason other than separation from service, death, or disability, subparagraph (A) shall be applied by substituting ‘5-year period’ for ‘1-year period’.".

(2) BENEFITS NOT TAKEN INTO ACCOUNT - Subparagraph (E) of section 416(g)(4) is amended -

(A) by striking "LAST 5 YEARS" in the heading and inserting "LAST YEAR BEFORE DETERMINATION DATE"; and

(B) by striking "5-year period" and inserting "1-year period".

(d) DEFINITION OF TOP-HEAVY PLANS - Paragraph (4) of section 416(g) (relating to other special rules for top-heavy plans) is amended by adding at the end the following new subparagraph:

"(H) CASH OR DEFERRED ARRANGEMENTS USING ALTERNATIVE METHODS OF MEETING NONDISCRIMINATION REQUIREMENTS -

The term ‘top-heavy plan’ shall not include a plan which consists solely of–

"(i) a cash or deferred arrangement which meets the requirements of section 401(k)(12), and

"(ii) matching contributions with respect to which the requirements of section 401(m)(11) are met. If, but for this subparagraph, a plan would be treated as a top-heavy plan because it is a member of an aggregation group which is a top-heavy group, contributions under the plan may be taken into account in determining whether any other plan in the group meets the requirements of subsection (c)(2).".

(e) FROZEN PLAN EXEMPT FROM MINIMUM BENEFIT REQUIREMENT -

Subparagraph (C) of section 416(c)(1) (relating to defined benefit plans) is amended–

(A) by striking "clause (ii)" in clause (i) and inserting "clause (ii) or (iii)"; and

(B) by adding at the end the following:

"(iii) EXCEPTION FOR FROZEN PLAN - For purposes of determining an employee’s years of service with the employer, any service with the employer shall be disregarded to the extent that such service occurs during a plan year when the plan benefits (within the meaning of section 410(b)) no key employee or former key employee.".

(f ) EFFECTIVE DATE - The amendments made by this section shall apply to years beginning after December 31, 2001.

Sec. 614. Elective Deferrals Not Taken Into Account For Purposes Of Deduction Limits.

(a) IN GENERAL - Section 404 (relating to deduction for contributions of an employer to an employees’ trust or annuity plan and compensation under a deferred payment plan) is amended by adding at the end the following new subsection:

"(n) ELECTIVE DEFERRALS NOT TAKEN INTO ACCOUNT FOR PURPOSES OF DEDUCTION LIMITS - Elective deferrals (as defined in section 402(g)(3)) shall not be subject to any limitation contained in paragraph (3), (7), or (9) of subsection (a), and such elective deferrals shall not be taken into account in applying any such limitation to any other contributions.".

(b) EFFECTIVE DATE - The amendment made by this section shall apply to years beginning after December 31, 2001.

Sec. 615. Repeal Of Coordination Requirements For Deferred Compensation Plans Of State And Local Governments And Tax-Exempt Organizations.

(a) IN GENERAL - Subsection (c) of section 457 (relating to deferred compensation plans of State and local governments and tax-exempt organizations), as amended by section 611, is amended to read as follows:

"(c) LIMITATION - The maximum amount of the compensation of any one individual which may be deferred under subsection (a) during any taxable year shall not exceed the amount in effect under subsection (b)(2)(A) (as modified by any adjustment provided under subsection (b)(3)).".

(b) EFFECTIVE DATE - The amendment made by subsection (a) shall apply to years beginning after December 31, 2001.

Sec. 616. Deduction Limits.

(a) MODIFICATION OF LIMITS -

(1) STOCK BONUS AND PROFIT SHARING TRUSTS -

(A) IN GENERAL - Subclause (I) of section 404(a)(3)(A)(i) (relating to stock bonus and profit sharing trusts) is amended by striking "15 percent" and inserting "25 percent".

(B) CONFORMING AMENDMENT - Subparagraph (C) of section 404(h)(1) is amended by striking "15 percent" each place it appears and inserting "25 percent".

(2) DEFINED CONTRIBUTION PLANS -

(A) IN GENERAL - Clause (v) of section 404(a)(3)(A) (relating to stock bonus and profit sharing trusts) is amended to read as follows:

"(v) DEFINED CONTRIBUTION PLANS SUBJECT TO THE FUNDING STANDARDS - Except as provided by the Secretary, a defined contribution plan which is subject to the funding standards of section 412 shall be treated in the same manner as a stock bonus or profit-sharing plan for purposes of this subparagraph.".

(B) CONFORMING AMENDMENTS -

(i) Section 404(a)(1)(A) is amended by inserting "(other than a trust to which paragraph (3) applies)" after "pension trust".

(ii) Section 404(h)(2) is amended by striking "stock bonus or profit-sharing trust" and inserting "trust subject to subsection (a)(3)(A)".

(iii) The heading of section 404(h)(2) is amended by striking "STOCK BONUS AND PROFIT-SHARING TRUST" and inserting "CERTAIN TRUSTS".

(b) COMPENSATION -

(1) IN GENERAL - Section 404(a) (relating to general rule) is amended by adding at the end the following:

"(12) DEFINITION OF COMPENSATION - For purposes of paragraphs (3), (7), (8), and (9), the term ‘compensation’ shall include amounts treated as ‘participant’s compensation’ under subparagraph (C) or (D) of section 415(c)(3).".

(2) CONFORMING AMENDMENTS -

(A) Subparagraph (B) of section 404(a)(3) is amended by striking the last sentence thereof.

(B) Clause (i) of section 4972(c)(6)(B) is amended by striking "(within the meaning of section 404(a))" and inserting "(within the meaning of section 404(a) and as adjusted under section 404(a)(12))".

(c) EFFECTIVE DATE - The amendments made by this section shall apply to years beginning after December 31, 2001.

Sec. 617. Option To Treat Elective Deferrals As After-Tax Roth Contributions.

(a) IN GENERAL - Subpart A of part I of subchapter D of chapter 1 (relating to deferred compensation, etc.) is amended by inserting after section 402 the following new section:

SEC. 402A. OPTIONAL TREATMENT OF ELECTIVE DEFERRALS AS ROTH CONTRIBUTIONS.

"(a) GENERAL RULE - If an applicable retirement plan includes a qualified Roth contribution program–

"(1) any designated Roth contribution made by an employee pursuant to the program shall be treated as an elective deferral for purposes of this chapter, except that such contribution shall not be excludable from gross income, and

"(2) such plan (and any arrangement which is part of such plan) shall not be treated as failing to meet any requirement of this chapter solely by reason of including such program.

"(b) QUALIFIED ROTH CONTRIBUTION PROGRAM - For purposes of this section–

"(1) IN GENERAL - The term ‘qualified Roth contribution program’ means a program under which an employee may elect to make designated Roth contributions in lieu of all or a portion of elective deferrals the employee is otherwise eligible to make under the applicable retirement plan.

"(2) SEPARATE ACCOUNTING REQUIRED - A program shall not be treated as a qualified Roth contribution program unless the applicable retirement plan–

"(A) establishes separate accounts (‘designated Roth accounts’) for the designated Roth contributions of each employee and any earnings properly allocable to the contributions, and

"(B) maintains separate recordkeeping with respect to each account.

"(c) DEFINITIONS AND RULES RELATING TO DESIGNATED ROTH CONTRIBUTIONS - For purposes of this section–

"(1) DESIGNATED ROTH CONTRIBUTION - The term ‘designated Roth contribution’ means any elective deferral which–

"(A) is excludable from gross income of an employee without regard to this section, and

"(B) the employee designates (at such time and in such manner as the Secretary may prescribe) as not being so excludable.

"(2) DESIGNATION LIMITS - The amount of elective deferrals which an employee may designate under paragraph (1) shall not exceed the excess (if any) of–

"(A) the maximum amount of elective deferrals excludable from gross income of the employee for the taxable year (without regard to this section), over "(B) the aggregate amount of elective deferrals of the employee for the taxable year which the employee does not designate under paragraph (1).

"(3) ROLLOVER CONTRIBUTIONS -

"(A) IN GENERAL - A rollover contribution of any payment or distribution from a designated Roth account which is otherwise allowable under this chapter may be made only if the contribution is to–

"(i) another designated Roth account of the individual from whose account the payment or distribution was made, or

"(ii) a Roth IRA of such individual.

"(B) COORDINATION WITH LIMIT - Any rollover contribution to a designated Roth account under subparagraph (A) shall not be taken into account for purposes of paragraph (1).

"(d) DISTRIBUTION RULES - For purposes of this title–

"(1) EXCLUSION - Any qualified distribution from a designated Roth account shall not be includible in gross income.

"(2) QUALIFIED DISTRIBUTION - For purposes of this subsection–

"(A) IN GENERAL - The term ‘qualified distribution’ has the meaning given such term by section 408A(d)(2)(A) (without regard to clause (iv) thereof).

"(B) DISTRIBUTIONS WITHIN NONEXCLUSION PERIOD -

A payment or distribution from a designated Roth account shall not be treated as a qualified distribution if such payment or distribution is made within the 5-taxable-year period beginning with the earlier of–

"(i) the first taxable year for which the individual made a designated Roth contribution to any designated Roth account established for such individual under the same applicable retirement plan, or

"(ii) if a rollover contribution was made to such designated Roth account from a designated Roth account previously established for such individual under another applicable retirement plan, the first taxable year for which the individual made a designated Roth contribution to such previously established account.

"(C) DISTRIBUTIONS OF EXCESS DEFERRALS AND CONTRIBUTIONS

AND EARNINGS THEREON - The term ‘qualified distribution’ shall not include any distribution of any excess deferral under section 402(g)(2) or any excess contribution under section 401(k)(8), and any income on the excess deferral or contribution.

"(3) TREATMENT OF DISTRIBUTIONS OF CERTAIN EXCESS DEFERRALS - Notwithstanding section 72, if any excess deferral under section 402(g)(2) attributable to a designated Roth contribution is not distributed on or before the 1st April 15 following the close of the taxable year in which such excess deferral is made, the amount of such excess deferral shall–

"(A) not be treated as investment in the contract, and

"(B) be included in gross income for the taxable year in which such excess is distributed.

"(4) AGGREGATION RULES - Section 72 shall be applied separately with respect to distributions and payments from a designated Roth account and other distributions and payments from the plan.

"(e) OTHER DEFINITIONS - For purposes of this section–

"(1) APPLICABLE RETIREMENT PLAN - The term ‘applicable retirement plan’ means–

"(A) an employees’ trust described in section 401(a) which is exempt from tax under section 501(a), and

"(B) a plan under which amounts are contributed by an individual’s employer for an annuity contract described in section 403(b).

"(2) ELECTIVE DEFERRAL - The term ‘elective deferral’ means any elective deferral described in subparagraph (A) or (C) of section 402(g)(3).".

(b) EXCESS DEFERRALS - Section 402(g) (relating to limitation on exclusion for elective deferrals) is amended–

(1) by adding at the end of paragraph (1)(A) (as added by section 201(c)(1)) the following new sentence: "The preceding sentence shall not apply the portion of such excess as does not exceed the designated Roth contributions of the individual for the taxable year."; and

(2) by inserting "(or would be included but for the last sentence thereof )" after "paragraph (1)" in paragraph (2)(A).

(c) ROLLOVERS - Subparagraph (B) of section 402(c)(8) is amended by adding at the end the following:

"If any portion of an eligible rollover distribution is attributable to payments or distributions from a designated Roth account (as defined in section 402A), an eligible retirement plan with respect to such portion shall include only another designated Roth account and a Roth IRA.".

(d) REPORTING REQUIREMENTS -

(1) W–2 INFORMATION - Section 6051(a)(8) is amended by inserting, "including the amount of designated Roth contributions (as defined in section 402A)" before the comma at the end.

(2) INFORMATION - Section 6047 is amended by redesignating subsection (f ) as subsection (g) and by inserting after subsection (e) the following new subsection:

"(f ) DESIGNATED ROTH CONTRIBUTIONS - The Secretary shall require the plan administrator of each applicable retirement plan (as defined in section 402A) to make such returns and reports regarding designated Roth contributions (as defined in section 402A) to the Secretary, participants and beneficiaries of the plan, and such other persons as the Secretary may prescribe.".

(e) CONFORMING AMENDMENTS -

(1) Section 408A(e) is amended by adding after the first sentence the following new sentence: "Such term includes a rollover contribution described in section 402A(c)(3)(A).".

(2) The table of sections for subpart A of part I of subchapter D of chapter 1 is amended by inserting after the item relating to section 402 the following new item: "Sec. 402A. Optional treatment of elective deferrals as Roth contributions.".

(f ) EFFECTIVE DATE - The amendments made by this section shall apply to taxable years beginning after December 31, 2005.

Sec. 618. Nonrefundable Credit To Certain Individuals For Elective Deferrals And IRA Contributions.

(a) IN GENERAL - Subpart A of part IV of subchapter A of chapter 1 (relating to nonrefundable personal credits) is amended by inserting after section 25A the following new section:

"SEC. 25B. ELECTIVE DEFERRALS AND IRA CONTRIBUTIONS BY CERTAIN INDIVIDUALS.

"(a) ALLOWANCE OF CREDIT - In the case of an eligible individual, there shall be allowed as a credit against the tax imposed by this subtitle for the taxable year an amount equal to the applicable percentage of so much of the qualified retirement savings contributions of the eligible individual for the taxable year as do not exceed $2,000.

"(b) APPLICABLE PERCENTAGE - For purposes of this section, the applicable percentage is the percentage determined in accordance with the following table:

………………………………………Adjusted Gross Income
.....Joint return…………Head of a household……..All other cases………..Applicable percentage
Over…….….Not over……Over……...Not over……...Over…....….Not over
………….. ..$30,000…………..….…$22,500….......…………….$15,000…..…..50
$30,000……$32,500…..$22,500…...$24,375……..$15,000…....$16,250…..…..20
$32,500……$50,000…..$24,375…...$37,500……..$16,250…….$25,000……...10
$50,000……….…..…….$37,500……………….......$25,000…………………..…..0

"(c) ELIGIBLE INDIVIDUAL - For purposes of this section–

"(1) IN GENERAL - The term ‘eligible individual’ means any individual if such individual has attained the age of 18 as of the close of the taxable year.

"(2) DEPENDENTS AND FULL-TIME STUDENTS NOT ELIGIBLE -

The term ‘eligible individual’ shall not include–

"(A) any individual with respect to whom a deduction under section 151 is allowed to another taxpayer for a taxable year beginning in the calendar year in which such individual’s taxable year begins, and "(B) any individual who is a student (as defined in section 151(c)(4)).

"(d) QUALIFIED RETIREMENT SAVINGS CONTRIBUTIONS - For purposes of this section–

"(1) IN GENERAL - The term ‘qualified retirement savings contributions’ means, with respect to any taxable year, the sum of–

"(A) the amount of the qualified retirement contributions (as defined in section 219(e)) made by the eligible individual,

"(B) the amount of– "(i) any elective deferrals (as defined in section 402(g)(3)) of such individual, and "(ii) any elective deferral of compensation by such individual under an eligible deferred compensation plan (as defined in section 457(b)) of an eligible employer described in section 457(e)(1)(A), and "(C) the amount of voluntary employee contributions by such individual to any qualified retirement plan (as defined in section 4974(c)).

"(2) REDUCTION FOR CERTAIN DISTRIBUTIONS -

"(A) IN GENERAL - The qualified retirement savings contributions determined under paragraph (1) shall be reduced (but not below zero) by the sum of– "(i) any distribution from a qualified retirement plan (as defined in section 4974(c)), or from an eligible deferred compensation plan (as defined in section 457(b)), received by the individual during the testing period which is includible in gross income, and "(ii) any distribution from a Roth IRA or a Roth account received by the individual during the testing period which is not a qualified rollover contribution (as defined in section 408A(e)) to a Roth IRA or a rollover under section 402(c)(8)(B) to a Roth account.

"(B) TESTING PERIOD - For purposes of subparagraph (A), the testing period, with respect to a taxable year, is the period which includes–

"(i) such taxable year, "(ii) the 2 preceding taxable years, and "(iii) the period after such taxable year and before the due date (including extensions) for filing the return of tax for such taxable year.

"(C) EXCEPTED DISTRIBUTIONS - There shall not be taken into account under subparagraph (A)–

"(i) any distribution referred to in section 72(p), 401(k)(8), 401(m)(6), 402(g)(2), 404(k), or 408(d)(4), and

"(ii) any distribution to which section 408A(d)(3) applies.

"(D) TREATMENT OF DISTRIBUTIONS RECEIVED BY SPOUSE OF INDIVIDUAL - For purposes of determining distributions received by an individual under subparagraph (A) for any taxable year, any distribution received by the spouse of such individual shall be treated as received by such individual if such individual and spouse file a joint return for such taxable year and for the taxable year during which the spouse receives the distribution.

"(e) ADJUSTED GROSS INCOME - For purposes of this section, adjusted gross income shall be determined without regard to sections 911, 931, and 933.

"(f) INVESTMENT IN THE CONTRACT - Notwithstanding any other provision of law, a qualified retirement savings contribution shall not fail to be included in determining the investment in the contract for purposes of section 72 by reason of the credit under this section.

"(g) TERMINATION - This section shall not apply to taxable years beginning after December 31, 2006.".

(b) CREDIT ALLOWED AGAINST REGULAR TAX AND ALTERNATIVE MINIMUM TAX -

(1) IN GENERAL - Section 25B, as added by subsection (a), is amended by inserting after subsection (f ) the following new subsection:

"(g) LIMITATION BASED ON AMOUNT OF TAX - The credit allowed under subsection (a) for the taxable year shall not exceed the excess of–

"(1) the sum of the regular tax liability (as defined in section 26(b)) plus the tax imposed by section 55, over

"(2) the sum of the credits allowable under this subpart (other than this section and section 23) and section 27 for the taxable year.".

(2) CONFORMING AMENDMENTS -

(A) Section 24(b)(3)(B), as amended by sections 201(b) and 203(d), is amended by striking "section 23" and inserting "sections 23 and 25B".

(B) Section 25(e)(1)(C), as amended by section 201(b), is amended by inserting "25B," after "24,".

(C) Section 26(a)(1), as amended by sections 201(b) and 203, is amended by striking "and 24" and inserting" , 24, and 25B".

(D) Section 904(h), as amended by sections 201(b) and 203, is amended by striking "and 24" and inserting ", 24, and 25B".

(E) Section 1400C(d), as amended by sections 201(b) and 203, is amended by striking "and 24" and inserting ", 24, and 25B".

(c) CONFORMING AMENDMENT - The table of sections for subpart A of part IV of subchapter A of chapter 1, as amended by section 432, is amended by inserting after the item relating to section 25A the following new item:" Sec. 25B. Elective deferrals and IRA contributions by certain individuals.".

(d) EFFECTIVE DATE - The amendments made by this section shall apply to taxable years beginning after December 31, 2001.

Sec. 619. Credit For Pension Plan Startup Costs Of Small Employers.

(a) IN GENERAL - Subpart D of part IV of subchapter A of chapter 1 (relating to business related credits) is amended by adding at the end the following new section:

"SEC. 45E. SMALL EMPLOYER PENSION PLAN STARTUP COSTS.

"(a) GENERAL RULE - For purposes of section 38, in the case of an eligible employer, the small employer pension plan startup cost credit determined under this section for any taxable year is an amount equal to 50 percent of the qualified startup costs paid or incurred by the taxpayer during the taxable year.

"(b) DOLLAR LIMITATION - The amount of the credit determined under this section for any taxable year shall not exceed–

"(1) $500 for the first credit year and each of the 2 taxable years immediately following the first credit year, and

"(2) zero for any other taxable year.

"(c) ELIGIBLE EMPLOYER - For purposes of this section–

"(1) IN GENERAL - The term ‘eligible employer’ has the meaning given such term by section 408(p)(2)(C)(i).

"(2) REQUIREMENT FOR NEW QUALIFIED EMPLOYER PLANS -

Such term shall not include an employer if, during the 3-taxable year period immediately preceding the 1st taxable year for which the credit under this section is otherwise allowable for a qualified employer plan of the employer, the employer or any member of any controlled group including the employer (or any predecessor of either) established or maintained a qualified employer plan with respect to which contributions were made, or benefits were accrued, for substantially the same employees as are in the qualified employer plan.

"(d) OTHER DEFINITIONS - For purposes of this section–

"(1) QUALIFIED STARTUP COSTS -

"(A) IN GENERAL - The term ‘qualified startup costs’ means any ordinary and necessary expenses of an eligible employer which are paid or incurred in connection with–

"(i) the establishment or administration of an eligible employer plan, or

"(ii) the retirement-related education of employees with respect to such plan.

"(B) PLAN MUST HAVE AT LEAST 1 PARTICIPANT - Such term shall not include any expense in connection with a plan that does not have at least 1 employee eligible to participate who is not a highly compensated employee.

"(2) ELIGIBLE EMPLOYER PLAN - The term ‘eligible employer plan’ means a qualified employer plan within the meaning of section 4972(d).

"(3) FIRST CREDIT YEAR - The term ‘first credit year’ means–

"(A) the taxable year which includes the date that the eligible employer plan to which such costs relate becomes effective, or

"(B) at the election of the eligible employer, the taxable year preceding the taxable year referred to in subparagraph (A).

"(e) SPECIAL RULES - For purposes of this section–

"(1) AGGREGATION RULES - All persons treated as a single employer under subsection (a) or (b) of section 52, or subsection (n) or (o) of section 414, shall be treated as one person. All eligible employer plans shall be treated as 1 eligible employer plan.

"(2) DISALLOWANCE OF DEDUCTION - No deduction shall be allowed for that portion of the qualified startup costs paid or incurred for the taxable year which is equal to the credit determined under subsection (a).

"(3) ELECTION NOT TO CLAIM CREDIT - This section shall not apply to a taxpayer for any taxable year if such taxpayer elects to have this section not apply for such taxable year.".
(b) CREDIT ALLOWED AS PART OF GENERAL BUSINESS CREDIT -

Section 38(b) (defining current year business credit) is amended by striking "plus" at the end of paragraph (12), by striking the period at the end of paragraph (13) and inserting ", plus", and by adding at the end the following new paragraph: "(14) in the case of an eligible employer (as defined in section 45E(c)), the small employer pension plan startup cost credit determined under section 45E(a).".

(c) CONFORMING AMENDMENTS -

(1) Section 39(d) is amended by adding at the end the following new paragraph:

"(10) NO CARRYBACK OF SMALL EMPLOYER PENSION PLAN STARTUP COST CREDIT BEFORE JANUARY 1, 2002 - No portion of the unused business credit for any taxable year which is attributable to the small employer pension plan startup cost credit determined under section 45E may be carried back to a taxable year beginning before January 1, 2002.".

(2) Subsection (c) of section 196 is amended by striking "and" at the end of paragraph (8), by striking the period at the end of paragraph (9) and inserting ", and", and by adding at the end the following new paragraph:"(10) the small employer pension plan startup cost credit determined under section 45E(a).".

(3) The table of sections for subpart D of part IV of subchapter A of chapter 1 is amended by adding at the end the following new item:" Sec. 45E. Small employer pension plan startup costs.".

(d) EFFECTIVE DATE - The amendments made by this section shall apply to costs paid or incurred in taxable years beginning after December 31, 2001, with respect to qualified employer plans established after such date.

Sec. 620. Elimination Of User Fee For Requests To IRS Regarding Pension Plans.

(a) ELIMINATION OF CERTAIN USER FEES - The Secretary of the Treasury or the Secretary’s delegate shall not require payment of user fees under the program established under section 10511 of the Revenue Act of 1987 for requests to the Internal Revenue Service for determination letters with respect to the qualified status of a pension benefit plan maintained solely by one or more eligible employers or any trust which is part of the plan. The preceding sentence shall not apply to any request–

(1) made after the later of–

(A) the fifth plan year the pension benefit plan is in existence; or

(B) the end of any remedial amendment period with respect to the plan beginning within the first 5 plan years; or

(2) made by the sponsor of any prototype or similar plan which the sponsor intends to market to participating employers.

(b) PENSION BENEFIT PLAN - For purposes of this section, the term "pension benefit plan" means a pension, profit-sharing, stock bonus, annuity, or employee stock ownership plan.

(c) ELIGIBLE EMPLOYER - For purposes of this section, the term "eligible employer" means an eligible employer (as defined in section 408(p)(2)(C)(i)(I) of the Internal Revenue Code of 1986) which has at least one employee who is not a highly compensated employee (as defined in section 414(q)) and is participating in the plan. The determination of whether an employer is an eligible employer under this section shall be made as of the date of the request described in subsection (a).

(d) DETERMINATION OF AVERAGE FEES CHARGED - For purposes of any determination of average fees charged, any request to which subsection (a) applies shall not be taken into account.

(e) EFFECTIVE DATE - The provisions of this section shall apply with respect to requests made after December 31, 2001.

Sec. 621. Treatment Of Nonresident Aliens Engaged In International Transportation Services.

(a) EXCLUSION FROM INCOME SOURCING RULES - The second sentence of section 861(a)(3) (relating to gross income from sources within the United States) is amended by striking "except for purposes of sections 79 and 105 and subchapter D,".

(b) EFFECTIVE DATE - The amendment made by subsection (a) shall apply to remuneration for services performed in plan years beginning after December 31, 2001.

Subtitle C – Enhancing Fairness for Women

Sec. 631. Catch-Up Contributions For Individuals Age 50 Or Over.

(a) IN GENERAL - Section 414 (relating to definitions and special rules) is amended by adding at the end the following new subsection:

"(v) CATCH-UP CONTRIBUTIONS FOR INDIVIDUALS AGE 50 OR OVER -

"(1) IN GENERAL - An applicable employer plan shall not be treated as failing to meet any requirement of this title solely because the plan permits an eligible participant to make additional elective deferrals in any plan year.

"(2) LIMITATION ON AMOUNT OF ADDITIONAL DEFERRALS -

"(A) IN GENERAL - A plan shall not permit additional elective deferrals under paragraph (1) for any year in an amount greater than the lesser of–

"(i) the applicable dollar amount, or

"(ii) the excess (if any) of– "(I) the participant’s compensation (as defined in section 415(c)(3)) for the year, over "(II) any other elective deferrals of the participant for such year which are made without regard to this subsection.

"(B) APPLICABLE DOLLAR AMOUNT - For purposes of this paragraph–

"(i) In the case of an applicable employer plan other than a plan described in section 401(k)(11) or 408(p), the applicable dollar amount shall be determined in accordance with the following table:

"For taxable years beginning in: The applicable dollar amount is:

2002 ................................................................................................... $1,000
2003 ................................................................................................... $2,000
2004 ................................................................................................... $3,000
2005 ................................................................................................... $4,000
2006 and thereafter .......................................................................... $5,000.

"(ii) In the case of an applicable employer plan described in section 401(k)(11) or 408(p), the applicable dollar amount shall be determined in accordance with the following table:

"For taxable years beginning in: The applicable dollar amount is:

2002 ................................................................................................... $500
2003 ................................................................................................... $1,000
2004 ................................................................................................... $1,500
2005 ................................................................................................... $2,000
2006 and thereafter .......................................................................... $2,500.

"(C) COST-OF-LIVING ADJUSTMENT - In the case of a year beginning after December 31, 2006, the Secretary shall adjust annually the $5,000 amount in subparagraph (B)(i) and the $2,500 amount in subparagraph (B)(ii) for increases in the cost-of-living at the same time and in the same manner as adjustments under section 415(d); except that the base period taken into account shall be the calendar quarter beginning July 1, 2005, and any increase under this subparagraph which is not a multiple of $500 shall be rounded to the next lower multiple of $500.".

"(3) TREATMENT OF CONTRIBUTIONS - In the case of any contribution to a plan under paragraph (1) -

"(A) such contribution shall not, with respect to the year in which the contribution is made -

"(i) be subject to any otherwise applicable limitation contained in section 402(g), 402(h), 403(b), 404(a), 404(h), 408(k), 408(p), 415, or 457, or "(ii) be taken into account in applying such limitations to other contributions or benefits under such plan or any other such plan, and

"(B) except as provided in paragraph (4), such plan shall not be treated as failing to meet the requirements of section 401(a)(4), 401(a)(26), 401(k)(3), 401(k)(11), 401(k)(12), 403(b)(12), 408(k), 408(p), 408B, 410(b), or 416 by reason of the making of (or the right to make) such contribution.

"(4) APPLICATION OF NONDISCRIMINATION RULES -

"(A) IN GENERAL - An applicable employer plan shall be treated as failing to meet the nondiscrimination requirements under section 401(a)(4) with respect to benefits, rights, and features unless the plan allows all eligible participants to make the same election with respect to the additional elective deferrals under this subsection.

"(B) AGGREGATION - For purposes of subparagraph (A), all plans maintained by employers who are treated as a single employer under subsection (b), (c), (m), or (o) of section 414 shall be treated as 1 plan.

"(5) ELIGIBLE PARTICIPANT - For purposes of this subsection, the term ‘eligible participant’ means, with respect to any plan year, a participant in a plan -

"(A) who has attained the age of 50 before the close of the plan year, and

"(B) with respect to whom no other elective deferrals may (without regard to this subsection) be made to the plan for the plan year by reason of the application of any limitation or other restriction described in paragraph (3) or comparable limitation or restriction contained in the terms of the plan.

"(6) OTHER DEFINITIONS AND RULES - For purposes of this subsection -

"(A) APPLICABLE EMPLOYER PLAN - The term ‘applicable employer plan’ means -

"(i) an employees’ trust described in section 401(a) which is exempt from tax under section 501(a),

"(ii) a plan under which amounts are contributed by an individual’s employer for an annuity contract described in section 403(b), "(iii) an eligible deferred compensation plan under section 457 of an eligible employer described in section 457(e)(1)(A), and "(iv) an arrangement meeting the requirements of section 408 (k) or (p).

"(B) ELECTIVE DEFERRAL - The term ‘elective deferral’ has the meaning given such term by subsection (u)(2)(C).

"(C) EXCEPTION FOR SECTION 457 PLANS - This subsection shall not apply to an applicable employer plan described in subparagraph (A)(iii) for any year to which section 457(b)(3) applies.".

(b) EFFECTIVE DATE - The amendment made by this section shall apply to contributions in taxable years beginning after December 31, 2001.

Sec. 632. Equitable Treatment For Contributions Of Employees To Defined Contribution Plans.

(a) EQUITABLE TREATMENT -

(1) IN GENERAL - Subparagraph (B) of section 415(c)(1) (relating to limitation for defined contribution plans) is amended by striking "25 percent" and inserting "100 percent".

(2) APPLICATION TO SECTION 403(b) - Section 403(b) is amended–

(A) by striking "the exclusion allowance for such taxable year" in paragraph (1) and inserting "the applicable limit under section 415",

(B) by striking paragraph (2), and

(C) by inserting "or any amount received by a former employee after the fifth taxable year following the taxable year in which such employee was terminated" before the period at the end of the second sentence of paragraph (3).

(3) CONFORMING AMENDMENTS -

(A) Subsection (f ) of section 72 is amended by striking "section 403(b)(2)(D)(iii))" and inserting "section 403(b)(2)(D)(iii), as in effect before the enactment of the Economic Growth and Tax Relief Reconciliation Act of 2001".

(B) Section 404(a)(10)(B) is amended by striking ", the exclusion allowance under section 403(b)(2),".

(C) Section 415(a)(2) is amended by striking ", and the amount of the contribution for such portion shall reduce the exclusion allowance as provided in section 403(b)(2)".

(D) Section 415(c)(3) is amended by adding at the end the following new subparagraph:"(E) ANNUITY CONTRACTS - In the case of an annuity contract described in section 403(b), the term ‘participant’s compensation’ means the participant’s includible compensation determined under section 403(b)(3).".

(E) Section 415(c) is amended by striking paragraph (4).

(F) Section 415(c)(7) is amended to read as follows: "(7) CERTAIN CONTRIBUTIONS BY CHURCH PLANS NOT TREATED AS EXCEEDING LIMIT -

"(A) IN GENERAL - Notwithstanding any other provision of this subsection, at the election of a participant who is an employee of a church or a convention or association of churches, including an organization described in section 414(e)(3)(B)(ii), contributions and other additions for an annuity contract or retirement income account described in section 403(b) with respect to such participant, when expressed as an annual addition to such participant’s account, shall be treated as not exceeding the limitation of paragraph (1) if such annual addition is not in excess of $10,000.

"(B) $40,000 AGGREGATE LIMITATION - The total amount of additions with respect to any participant which may be taken into account for purposes of this subparagraph for all years may not exceed $40,000.

"(C) ANNUAL ADDITION - For purposes of this paragraph, the term ‘annual addition’ has the meaning given such term by paragraph (2).".

(G) Subparagraph (B) of section 402(g)(7) (as redesignated by section 611(c)(3)) is amended by inserting before the period at the end the following: "(as in effect before the enactment of the Economic Growth and Tax Relief Reconciliation Act of 2001".

(H) Section 664(g) is amended–

(i) in paragraph (3)(E) by striking "limitations under section 415(c)" and inserting "applicable limitation under paragraph (7)", and

(ii) by adding at the end the following new paragraph:

"(7) APPLICABLE LIMITATION -

"(A) IN GENERAL - For purposes of paragraph (3)(E), the applicable limitation under this paragraph with respect to a participant is an amount equal to the lesser of–"(i) $30,000, or "(ii) 25 percent of the participant’s compensation (as defined in section 415(c)(3)).

"(B) COST-OF-LIVING ADJUSTMENT - The Secretary shall adjust annually the $30,000 amount under subparagraph (A)(i) at the same time and in the same manner as under section 415(d), except that the base period shall be the calendar quarter beginning October 1, 1993, and any increase under this subparagraph which is not a multiple of $5,000 shall be rounded to the next lowest multiple of $5,000.".

(4) EFFECTIVE DATE - The amendments made by this subsection shall apply to years beginning after December 31, 2001.

(b) SPECIAL RULES FOR SECTIONS 403(b) AND 408 -

(1) IN GENERAL - Subsection (k) of section 415 is amended by adding at the end the following new paragraph:

"(4) SPECIAL RULES FOR SECTIONS 403(b) AND 408 - For purposes of this section, any annuity contract described in section 403(b) for the benefit of a participant shall be treated as a defined contribution plan maintained by each employer with respect to which the participant has the control required under subsection (b) or (c) of section 414 (as modified by subsection (h)). For purposes of this section, any contribution by an employer to a simplified employee pension plan for an individual for a taxable year shall be treated as an employer contribution to a defined contribution plan for such individual for such year.".

(2) EFFECTIVE DATE -

(A) IN GENERAL - The amendment made by paragraph (1) shall apply to limitation years beginning after December 31, 1999.

(B) EXCLUSION ALLOWANCE - Effective for limitation years beginning in 2000, in the case of any annuity contract described in section 403(b) of the Internal Revenue Code of 1986, the amount of the contribution disqualified by reason of section 415(g) of such Code shall reduce the exclusion allowance as provided in section 403(b)(2) of such Code.

(3) ELECTION TO MODIFY SECTION 403(b) EXCLUSION ALLOWANCE TO CONFORM TO SECTION 415 MODIFICATION - In the case of taxable years beginning after December 31, 1999, and before January 1, 2002, a plan may disregard the requirement in the regulations regarding the exclusion allowance under section 403(b)(2) of the Internal Revenue Code of 1986 that contributions to a defined benefit pension plan be treated as previously excluded amounts for purposes of the exclusion allowance.

(c) DEFERRED COMPENSATION PLANS OF STATE AND LOCAL GOVERNMENTS AND TAX-EXEMPT ORGANIZATIONS -

(1) IN GENERAL - Subparagraph (B) of section 457(b)(2) (relating to salary limitation on eligible deferred compensation plans) is amended by striking "331/3 percent" and inserting "100 percent".

(2) EFFECTIVE DATE - The amendment made by this subsection shall apply to years beginning after December 31, 2001.

Sec. 633. Faster Vesting Of Certain Employer Matching Contributions.

(a) IN GENERAL - Section 411(a) (relating to minimum vesting standards) is amended -

(1) in paragraph (2), by striking "A plan" and inserting "Except as provided in paragraph (12), a plan"; and

(2) by adding at the end the following:

"(12) FASTER VESTING FOR MATCHING CONTRIBUTIONS - In the case of matching contributions (as defined in section 401(m)(4)(A)), paragraph (2) shall be applied–"(A) by substituting ‘3 years’ for ‘5 years’ in subparagraph (A), and "(B) by substituting the following table for the table contained in subparagraph (B):

The nonforfeitable "Years of service: .........................................percentage is:

2 ................................................................................................... 20
3 ................................................................................................... 40
4 ................................................................................................... 60
5 ................................................................................................... 80
6 ................................................................................................... 100.".

(b) AMENDMENT OF ERISA - Section 203(a) of the Employee Retirement Income Security Act of 1974 (29 U.S.C. 1053(a)) is amended–

(1) in paragraph (2), by striking "A plan" and inserting "Except as provided in paragraph (4), a plan", and

(2) by adding at the end the following:

"(4) In the case of matching contributions (as defined in section 401(m)(4)(A) of the Internal Revenue Code of 1986), paragraph (2) shall be applied–

"(A) by substituting ‘3 years’ for ‘5 years’ in subparagraph (A), and "(B) by substituting the following table for the table contained in subparagraph (B):

The nonforfeitable"Years of service: ..........................................percentage is:

2 ................................................................................................... 20
3 ................................................................................................... 40
4 ................................................................................................... 60
5 ................................................................................................... 80
6 ................................................................................................... 100.".

(c) EFFECTIVE DATES -

(1) IN GENERAL - Except as provided in paragraph (2), the amendments made by this section shall apply to contributions for plan years beginning after December 31, 2001.

(2) COLLECTIVE BARGAINING AGREEMENTS - In the case of a plan maintained pursuant to one or more collective bargaining agreements between employee representatives and one or more employers ratified by the date of the enactment of this Act, the amendments made by this section shall not apply to contributions
on behalf of employees covered by any such agreement for plan years beginning before the earlier of -

(A) the later of -

(i) the date on which the last of such collective bargaining agreements terminates (determined without regard to any extension thereof on or after such date of the enactment); or (ii) January 1, 2002; or

(B) January 1, 2006.

(3) SERVICE REQUIRED - With respect to any plan, the amendments made by this section shall not apply to any employee before the date that such employee has 1 hour of service under such plan in any plan year to which the amendments made by this section apply.

Sec. 634. Modification To Minimum Distribution Rules.

The Secretary of the Treasury shall modify the life expectancy tables under the regulations relating to minimum distribution requirements under sections 401(a)(9), 408(a)(6) and (b)(3), 403(b)(10), and 457(d)(2) of the Internal Revenue Code to reflect current life expectancy.

Sec. 635. Clarification Of Tax Treatment Of Division Of Section 457 Plan Benefits Upon Divorce.

(a) IN GENERAL - Section 414(p)(11) (relating to application of rules to governmental and church plans) is amended–

(1) by inserting "or an eligible deferred compensation plan (within the meaning of section 457(b))" after "subsection (e))"; and

(2) in the heading, by striking "GOVERNMENTAL AND CHURCH PLANS" and inserting "CERTAIN OTHER PLANS".

(b) WAIVER OF CERTAIN DISTRIBUTION REQUIREMENTS - Paragraph (10) of section 414(p) is amended by striking "and section 409(d)" and inserting "section 409(d), and section 457(d)".

(c) TAX TREATMENT OF PAYMENTS FROM A SECTION 457 PLAN - Subsection (p) of section 414 is amended by redesignating paragraph (12) as paragraph (13) and inserting after paragraph (11) the following new paragraph:

"(12) TAX TREATMENT OF PAYMENTS FROM A SECTION 457 PLAN - If a distribution or payment from an eligible deferred compensation plan described in section 457(b) is made pursuant to a qualified domestic relations order, rules similar to the rules of section 402(e)(1)(A) shall apply to such distribution or payment."

(d) EFFECTIVE DATE - The amendment made by this section shall apply to transfers, distributions, and payments made after December 31, 2001.

Sec. 636. Provisions Relating To Hardship Distributions.

(a) SAFE HARBOR RELIEF -

(1) IN GENERAL - The Secretary of the Treasury shall revise the regulations relating to hardship distributions under section 401(k)(2)(B)(i)(IV) of the Internal Revenue Code of 1986 to provide that the period an employee is prohibited from making elective and employee contributions in order for a distribution to be deemed necessary to satisfy financial need shall be equal to 6 months.

(2) EFFECTIVE DATE - The revised regulations under this subsection shall apply to years beginning after December 31, 2001.

(b) HARDSHIP DISTRIBUTIONS NOT TREATED AS ELIGIBLE ROLLOVER DISTRIBUTIONS -

(1) MODIFICATION OF DEFINITION OF ELIGIBLE ROLLOVER -
Subparagraph (C) of section 402(c)(4) (relating to eligible rollover distribution) is amended to read as follows:"(C) any distribution which is made upon hardship of the employee.".

(2) EFFECTIVE DATE - The amendment made by this subsection shall apply to distributions made after December 31, 2001.

Sec. 637. Waiver Of Tax On Nondeductible Contributions For Domestic Or Similar Workers.

(a) IN GENERAL - Section 4972(c)(6) (relating to exceptions to nondeductible contributions), as amended by section 616, is amended by striking "and" at the end of subparagraph (A), by striking the period and inserting ", or" at the end of subparagraph (B), and by inserting after subparagraph (B) the following new
subparagraph:59 ½

"(C) so much of the contributions to a simple retirement account (within the meaning of section 408(p)) or a simple plan (within the meaning of section 401(k)(11)) which are not deductible when contributed solely because such contributions are not made in connection with a trade or business of the employer.".

(b) EXCLUSION OF CERTAIN CONTRIBUTIONS - Section 4972(c)(6), as amended by subsection (a), is amended by adding at the end the following new sentence: "Subparagraph (C) shall not apply to contributions made on behalf of the employer or a member of the employer’s family (as defined in section 447(e)(1)).".

(c) NO INFERENCE - Nothing in the amendments made by this section shall be construed to infer the proper treatment of nondeductible contributions under the laws in effect before such amendments.

(d) EFFECTIVE DATE - The amendments made by this section shall apply to taxable years beginning after December 31, 2001.

Subtitle D – Increasing Portability for Participants

Sec. 641. Rollovers Allowed Among Various Types Of Plans.

(a) ROLLOVERS FROM AND TO SECTION 457 PLANS -

(1) ROLLOVERS FROM SECTION 457 PLANS -

(A) IN GENERAL - Section 457(e) (relating to other definitions and special rules) is amended by adding at the end the following:

"(16) ROLLOVER AMOUNTS -

"(A) GENERAL RULE - In the case of an eligible deferred compensation plan established and maintained by an employer described in subsection (e)(1)(A), if -

"(i) any portion of the balance to the credit of an employee in such plan is paid to such employee in an eligible rollover distribution (within the meaning of section 402(c)(4)), "(ii) the employee transfers any portion of the property such employee receives in such distribution to an eligible retirement plan described in section 402(c)(8)(B), and "(iii) in the case of a distribution of property other than money, the amount so transferred consists of the property distributed, then such distribution (to the extent so transferred) shall not be includible in gross income for the taxable year in which paid."

"(B) CERTAIN RULES MADE APPLICABLE - The rules of paragraphs (2) through (7) and (9) of section 402(c) and section 402(f ) shall apply for purposes of subparagraph (A).

"(C) REPORTING - Rollovers under this paragraph shall be reported to the Secretary in the same manner as rollovers from qualified retirement plans (as defined in section 4974(c)).".

(B) DEFERRAL LIMIT DETERMINED WITHOUT REGARD TO ROLLOVER AMOUNTS - Section 457(b)(2) (defining eligible deferred compensation plan) is amended by inserting "(other than rollover amounts)" after "taxable year".

(C) DIRECT ROLLOVER - Paragraph (1) of section 457(d) is amended by striking "and" at the end of subparagraph (A), by striking the period at the end of subparagraph (B) and inserting ", and", and by inserting after subparagraph (B) the following: "(C) in the case of a plan maintained by an employer described in subsection (e)(1)(A), the plan meets requirements similar to the requirements of section 401(a)(31). Any amount transferred in a direct trustee-to-trustee transfer in accordance with section 401(a)(31) shall not be includible in gross income for the taxable year of transfer.".

(D) WITHHOLDING -

(i) Paragraph (12) of section 3401(a) is amended by adding at the end the following:"(E) under or to an eligible deferred compensation plan which, at the time of such payment, is a plan described in section 457(b) which is maintained by an eligible employer described in section 457(e)(1)(A), or".

(ii) Paragraph (3) of section 3405(c) is amended to read as follows: "(3) ELIGIBLE ROLLOVER DISTRIBUTION - For purposes of this subsection, the term ‘eligible rollover distribution’ has the meaning given such term by section 402(f )(2)(A).".

(iii) LIABILITY FOR WITHHOLDING - Subparagraph (B) of section 3405(d)(2) is amended by striking "or" at the end of clause (ii), by striking the period at the end of clause (iii) and inserting ", or", and by adding at the end the following: "(iv) section 457(b) and which is maintained by an eligible employer described in section 457(e)(1)(A).".

(2) ROLLOVERS TO SECTION 457 PLANS -

(A) IN GENERAL - Section 402(c)(8)(B) (defining eligible retirement plan) is amended by striking "and" at the end of clause (iii), by striking the period at the end of clause (iv) and inserting ", and", and by inserting after clause (iv) the following new clause: "(v) an eligible deferred compensation plan described in section 457(b) which is maintained by an eligible employer described in section 457(e)(1)(A).".

(B) SEPARATE ACCOUNTING - Section 402(c) is amended by adding at the end the following new paragraph:"(10) SEPARATE ACCOUNTING - Unless a plan described in clause (v) of paragraph (8)(B) agrees to separately account for amounts rolled into such plan from eligible retirement plans not described in such clause, the plan described in such clause may not accept transfers or rollovers from such retirement plans.".

(C) 10 PERCENT ADDITIONAL TAX - Subsection (t) of section 72 (relating to 10-percent additional tax on early distributions from qualified retirement plans) is amended by adding at the end the following new paragraph:"(9) SPECIAL RULE FOR ROLLOVERS TO SECTION 457 PLANS -

For purposes of this subsection, a distribution from an eligible deferred compensation plan (as defined in section 457(b)) of an eligible employer described in section 457(e)(1)(A) shall be treated as a distribution from a qualified retirement plan described in 4974(c)(1) to the extent that such distribution is attributable to an amount transferred to an eligible deferred compensation plan from a qualified retirement plan (as defined in section 4974(c)).".

(b) ALLOWANCE OF ROLLOVERS FROM AND TO 403(b) PLANS -

(1) ROLLOVERS FROM SECTION 403(b) PLANS - Section 403(b)(8)(A)(ii) (relating to rollover amounts) is amended by striking "such distribution" and all that follows and inserting "such distribution to an eligible retirement plan described in section 402(c)(8)(B), and".

(2) ROLLOVERS TO SECTION 403(b) PLANS - Section 402(c)(8)(B) (defining eligible retirement plan), as amended by subsection (a), is amended by striking "and" at the end of clause (iv), by striking the period at the end of clause (v) and inserting ", and", and by inserting after clause (v) the following new clause:"(vi) an annuity contract described in section 403(b).".

(c) EXPANDED EXPLANATION TO RECIPIENTS OF ROLLOVER DISTRIBUTIONS -

Paragraph (1) of section 402(f ) (relating to written explanation to recipients of distributions eligible for rollover treatment) is amended by striking "and" at the end of subparagraph (C), by striking the period at the end of subparagraph (D) and inserting ", and", and by adding at the end the following new subparagraph:

"(E) of the provisions under which distributions from the eligible retirement plan receiving the distribution may be subject to restrictions and tax consequences which are different from those applicable to distributions from the plan making such distribution.".

(d) SPOUSAL ROLLOVERS - Section 402(c)(9) (relating to rollover where spouse receives distribution after death of employee) is amended by striking "; except that" and all that follows up to the end period.

(e) CONFORMING AMENDMENTS -

(1) Section 72(o)(4) is amended by striking "and 408(d)(3)" and inserting "403(b)(8), 408(d)(3), and 457(e)(16)".

(2) Section 219(d)(2) is amended by striking "or 408(d)(3)" and inserting "408(d)(3), or 457(e)(16)".

(3) Section 401(a)(31)(B) is amended by striking "and 403(a)(4)" and inserting ", 403(a)(4), 403(b)(8), and 457(e)(16)".

(4) Subparagraph (A) of section 402(f )(2) is amended by striking "or paragraph (4) of section 403(a)" and inserting ", paragraph (4) of section 403(a), subparagraph (A) of section 403(b)(8), or subparagraph (A) of section 457(e)(16)".

(5) Paragraph (1) of section 402(f ) is amended by striking "from an eligible retirement plan".

(6) Subparagraphs (A) and (B) of section 402(f )(1) are amended by striking "another eligible retirement plan" and inserting "an eligible retirement plan".

(7) Subparagraph (B) of section 403(b)(8) is amended to read as follows:"(B) CERTAIN RULES MADE APPLICABLE - The rules of paragraphs (2) through (7) and (9) of section 402(c) and section 402(f ) shall apply for purposes of subparagraph (A), except that section 402(f ) shall be applied to the payor in lieu of the plan administrator.".

(8) Section 408(a)(1) is amended by striking "or 403(b)(8)," and inserting "403(b)(8), or 457(e)(16)".

(9) Subparagraphs (A) and (B) of section 415(b)(2) are each amended by striking "and 408(d)(3)" and inserting "403(b)(8), 408(d)(3), and 457(e)(16)".

(10) Section 415(c)(2) is amended by striking "and 408(d)(3)" and inserting "408(d)(3), and 457(e)(16)".

(11) Section 4973(b)(1)(A) is amended by striking "or 408(d)(3)" and inserting "408(d)(3), or 457(e)(16)".

(f ) EFFECTIVE DATE; SPECIAL RULE -

(1) EFFECTIVE DATE - The amendments made by this section shall apply to distributions after December 31, 2001.

(2) REASONABLE NOTICE - No penalty shall be imposed on a plan for the failure to provide the information required by the amendment made by subsection (c) with respect to any distribution made before the date that is 90 days after the date on which the Secretary of the Treasury issues a safe harbor rollover notice after the date of the enactment of this Act, if the administrator of such plan makes a reasonable attempt to comply with such requirement.

(3) SPECIAL RULE - Notwithstanding any other provision of law, subsections (h)(3) and (h)(5) of section 1122 of the Tax Reform Act of 1986 shall not apply to any distribution from an eligible retirement plan (as defined in clause (iii) or (iv) of section 402(c)(8)(B) of the Internal Revenue Code of 1986) on behalf of an individual if there was a rollover to such plan on behalf of such individual which is permitted solely by reason of any amendment made by this section.

Sec. 642. Rollovers Of IRAs Into Workplace Retirement Plans.

(a) IN GENERAL - Subparagraph (A) of section 408(d)(3) (relating to rollover amounts) is amended by adding "or" at the end of clause (i), by striking clauses (ii) and (iii), and by adding at the end the following:

"(ii) the entire amount received (including money and any other property) is paid into an eligible retirement plan for the benefit of such individual not later than the 60th day after the date on which the payment or distribution is received, except that the maximum amount which may be paid into such plan may not exceed the portion of the amount received which is includible in gross income (determined without regard to this paragraph).

For purposes of clause (ii), the term ‘eligible retirement plan’ means an eligible retirement plan described in clause (iii), (iv), (v), or (vi) of section 402(c)(8)(B).".

(b) CONFORMING AMENDMENTS -

(1) Paragraph (1) of section 403(b) is amended by striking "section 408(d)(3)(A)(iii)" and inserting "section 408(d)(3)(A)(ii)".

(2) Clause (i) of section 408(d)(3)(D) is amended by striking "(i), (ii), or (iii)" and inserting "(i) or (ii)".

(3) Subparagraph (G) of section 408(d)(3) is amended to read as follows:"(G) SIMPLE RETIREMENT ACCOUNTS - In the case of any payment or distribution out of a simple retirement account (as defined in subsection (p)) to which section 72(t)(6) applies, this paragraph shall not apply unless such payment or distribution is paid into another simple retirement account.".

(c) EFFECTIVE DATE; SPECIAL RULE -

(1) EFFECTIVE DATE - The amendments made by this section shall apply to distributions after December 31, 2001.

(2) SPECIAL RULE - Notwithstanding any other provision of law, subsections (h)(3) and (h)(5) of section 1122 of the Tax Reform Act of 1986 shall not apply to any distribution from an eligible retirement plan (as defined in clause (iii) or (iv) of section 402(c)(8)(B) of the Internal Revenue Code of 1986) on behalf of an individual if there was a rollover to such plan on behalf of such individual which is permitted solely by reason of the amendments made by this section.

Sec. 643. Rollovers Of After-Tax Contributions.

(a) ROLLOVERS FROM EXEMPT TRUSTS - Paragraph (2) of section 402(c) (relating to maximum amount which may be rolled over) is amended by adding at the end the following:

"The preceding sentence shall not apply to such distribution to the extent–"(A) such portion is transferred in a direct trustee-to-trustee transfer to a qualified trust which is part of a plan which is a defined contribution plan and which agrees to separately account for amounts so transferred, including separately accounting for the portion of such distribution which is includible in gross income and the portion of such distribution which is not so includible, or"(B) such portion is transferred to an eligible retirement plan described in clause (i) or (ii) of paragraph (8)(B).".

(b) OPTIONAL DIRECT TRANSFER OF ELIGIBLE ROLLOVER DISTRIBUTIONS - Subparagraph (B) of section 401(a)(31) (relating to limitation) is amended by adding at the end the following:

"The preceding sentence shall not apply to such distribution if the plan to which such distribution is transferred– "(i) agrees to separately account for amounts so transferred, including separately accounting for the portion of such distribution which is includible in gross income and the portion of such distribution which is not so includible, or "(ii) is an eligible retirement plan described in clause (i) or (ii) of section 402(c)(8)(B).".

(c) RULES FOR APPLYING SECTION 72 TO IRAS - Paragraph (3) of section 408(d) (relating to special rules for applying section 72) is amended by inserting at the end the following:

"(H) APPLICATION OF SECTION 72 -

"(i) IN GENERAL - If–"(I) a distribution is made from an individual retirement plan, and "(II) a rollover contribution is made to an eligible retirement plan described in section 402(c)(8)(B)(iii), (iv), (v), or (vi) with respect to all or part of such distribution, then, notwithstanding paragraph (2), the rules of clause (ii) shall apply for purposes of applying section 72.

"(ii) APPLICABLE RULES - In the case of a distribution described in clause (i)–

"(I) section 72 shall be applied separately to such distribution,

"(II) notwithstanding the pro rata allocation of income on, and investment in, the contract to distributions under section 72, the portion of such distribution rolled over to an eligible retirement plan described in clause (i) shall be treated as from income on the contract (to the extent of the aggregate income on the contract from all individual retirement plans of the distributee), and

(III) appropriate adjustments shall be made in applying section 72 to other distributions in such taxable year and subsequent taxable years.".

(d) EFFECTIVE DATE - The amendments made by this section shall apply to distributions made after December 31, 2001.

Sec. 644. Hardship Exception To 60-Day Rule.

(a) EXEMPT TRUSTS - Paragraph (3) of section 402(c) (relating to transfer must be made within 60 days of receipt) is amended to read as follows:

"(3) TRANSFER MUST BE MADE WITHIN 60 DAYS OF RECEIPT -

"(A) IN GENERAL - Except as provided in subparagraph (B), paragraph (1) shall not apply to any transfer of a distribution made after the 60th day following the day on which the distributee received the property distributed.

"(B) HARDSHIP EXCEPTION - The Secretary may waive the 60-day requirement under subparagraph (A) where the failure to waive such requirement would be against equity or good conscience, including casualty, disaster, or other events beyond the reasonable control of the individual subject to such requirement.".

(b) IRAS - Paragraph (3) of section 408(d) (relating to rollover contributions), as amended by section 643, is amended by adding after subparagraph (H) the following new subparagraph:

"(I) WAIVER OF 60-DAY REQUIREMENT - The Secretary may waive the 60-day requirement under subparagraphs (A) and (D) where the failure to waive such requirement would be against equity or good conscience, including casualty, disaster, or other events beyond the reasonable control of the individual subject to such requirement.".

(c) EFFECTIVE DATE - The amendments made by this section shall apply to distributions after December 31, 2001.

Sec. 645. Treatment Of Forms Of Distribution.

(a) PLAN TRANSFERS -

(1) AMENDMENT OF INTERNAL REVENUE CODE - Paragraph (6) of section 411(d) (relating to accrued benefit not to be decreased by amendment) is amended by adding at the end the following:

"(D) PLAN TRANSFERS -

"(i) IN GENERAL - A defined contribution plan (in this subparagraph referred to as the ‘transferee plan’) shall not be treated as failing to meet the requirements of this subsection merely because the transferee plan does not provide some or all of the forms of distribution previously available under another defined contribution plan (in this subparagraph referred to as the ‘transferor plan’) to the extent that–

"(I) the forms of distribution previously available under the transferor plan applied to the account of a participant or beneficiary under the transferor plan that was transferred from the transferor plan to the transferee plan pursuant to a direct transfer rather than pursuant to a distribution from the transferor plan,

"(II) the terms of both the transferor plan and the transferee plan authorize the transfer described in subclause (I),

"(III) the transfer described in subclause (I) was made pursuant to a voluntary election by the participant or beneficiary whose account was transferred to the transferee plan,

"(IV) the election described in subclause (III) was made after the participant or beneficiary received a notice describing the consequences of making the election, and "(V) the transferee plan allows the participant or beneficiary described in subclause (III) to receive any distribution to which the participant or beneficiary is entitled under the transferee plan in the form of a single sum distribution.

"(ii) SPECIAL RULE FOR MERGERS, ETC - Clause (i) shall apply to plan mergers and other transactions having the effect of a direct transfer, including consolidations of benefits attributable to different employers within a multiple employer plan.

"(E) ELIMINATION OF FORM OF DISTRIBUTION - Except to the extent provided in regulations, a defined contribution plan shall not be treated as failing to meet the requirements of this section merely because of the elimination of a form of distribution previously available thereunder. This subparagraph shall not apply to the elimination of a form of distribution with respect to any participant unless–

"(i) a single sum payment is available to such participant at the same time or times as the form of distribution being eliminated, and

"(ii) such single sum payment is based on the same or greater portion of the participant’s account as the form of distribution being eliminated.".

(2) AMENDMENT OF ERISA - Section 204(g) of the Employee Retirement Income Security Act of 1974 (29 U.S.C. 1054(g)) is amended by adding at the end the following: "(4)(A) A defined contribution plan (in this subparagraph referred to as the ‘transferee plan’) shall not be treated as failing to meet the requirements of this subsection merely because the transferee plan does not provide some or all of the forms of distribution previously available under another defined contribution plan (in this subparagraph referred to as the ‘transferor plan’) to the extent that–

"(i) the forms of distribution previously available under the transferor plan applied to the account of a participant or beneficiary under the transferor plan that was transferred from the transferor plan to the transferee plan pursuant to a direct transfer rather than pursuant to a distribution from the transferor plan;

"(ii) the terms of both the transferor plan and the transferee plan authorize the transfer described in clause (i);

"(iii) the transfer described in clause (i) was made pursuant to a voluntary election by the participant or beneficiary whose account was transferred to the transferee plan;

"(iv) the election described in clause (iii) was made after the participant or beneficiary received a notice describing the consequences of making the election; and

"(v) the transferee plan allows the participant or beneficiary described in clause (iii) to receive any distribution to which the participant or beneficiary is entitled under the transferee plan in the form of a single sum distribution.

"(B) Subparagraph (A) shall apply to plan mergers and other transactions having the effect of a direct transfer, including consolidations of benefits attributable to different employers within a multiple employer plan. "(5) Except to the extent provided in regulations promulgated by the Secretary of the Treasury, a defined contribution plan shall not be treated as failing to meet the requirements of this subsection merely because of the elimination of a form of distribution previously available thereunder. This paragraph shall not apply to the elimination of a form of distribution with respect to any participant unless–"(A) a single sum payment is available to such participant at the same time or times as the form of distribution being eliminated; and "(B) such single sum payment is based on the same or greater portion of the participant’s account as the form of distribution being eliminated.".

(3) EFFECTIVE DATE - The amendments made by this subsection shall apply to years beginning after December 31, 2001.

(b) REGULATIONS -

(1) AMENDMENT OF INTERNAL REVENUE CODE - Paragraph (6)(B) of section 411(d) (relating to accrued benefit not to be decreased by amendment) is amended by inserting after the second sentence the following: "The Secretary shall by regulations provide that this subparagraph shall not apply to any plan amendment which reduces or eliminates benefits or subsidies which create significant burdens or complexities for the plan and plan participants, unless such amendment adversely affects the rights of any participant in a more than de minimis manner.".

(2) AMENDMENT OF ERISA - Section 204(g)(2) of the Employee Retirement Income Security Act of 1974 (29 U.S.C. 1054(g)(2)) is amended by inserting after the second sentence the following: "The Secretary of the Treasury shall by regulations provide that this paragraph shall not apply to any plan amendment which reduces or eliminates benefits or subsidies which create significant burdens or complexities for the plan and plan participants, unless such amendment adversely affects the rights of any participant in a more than de minimis manner.".

(3) SECRETARY DIRECTED - Not later than December 31, 2003, the Secretary of the Treasury is directed to issue regulations under section 411(d)(6) of the Internal Revenue Code of 1986 and section 204(g) of the Employee Retirement Income Security Act of 1974, including the regulations required by the amendment made by this subsection. Such regulations shall apply to plan years beginning after December 31, 2003, or such earlier date as is specified by the Secretary of the Treasury.

Sec. 646. Rationalization Of Restrictions On Distributions.

(a) MODIFICATION OF SAME DESK EXCEPTION -

(1) SECTION 401(k) -

(A) Section 401(k)(2)(B)(i)(I) (relating to qualified cash or deferred arrangements) is amended by striking "separation from service" and inserting "severance from employment".

(B) Subparagraph (A) of section 401(k)(10) (relating to distributions upon termination of plan or disposition of assets or subsidiary) is amended to read as follows: "(A) IN GENERAL - An event described in this subparagraph is the termination of the plan without establishment or maintenance of another defined contribution plan (other than an employee stock ownership plan as defined in section 4975(e)(7)).".

(C) Section 401(k)(10) is amended– (i) in subparagraph (B)– (I) by striking "An event" in clause (i) and inserting "A termination"; and (II) by striking "the event" in clause (i) and inserting "the termination"; (ii) by striking subparagraph (C); and (iii) by striking "OR DISPOSITION OF ASSETS OR SUBSIDIARY" in the heading.

(2) SECTION 403(b) -

(A) Paragraphs (7)(A)(ii) and (11)(A) of section 403(b) are each amended by striking "separates from service" and inserting "has a severance from employment".

(B) The heading for paragraph (11) of section 403(b) is amended by striking "SEPARATION FROM SERVICE" and inserting "SEVERANCE FROM EMPLOYMENT".

(3) SECTION 457 - Clause (ii) of section 457(d)(1)(A) is amended by striking "is separated from service" and inserting "has a severance from employment".

(b) EFFECTIVE DATE - The amendments made by this section shall apply to distributions after December 31, 2001.

Sec. 647. Purchase Of Service Credit In Governmental Defined Benefit Plans.

(a) SECTION 403(b) PLANS - Subsection (b) of section 403 is amended by adding at the end the following new paragraph: "(13) TRUSTEE-TO-TRUSTEE TRANSFERS TO PURCHASE PERMISSIVE SERVICE CREDIT - No amount shall be includible in gross income by reason of a direct trustee-to-trustee transfer to a defined benefit governmental plan (as defined in section 414(d)) if such transfer is– "(A) for the purchase of permissive service credit (as defined in section 415(n)(3)(A)) under such plan, or "(B) a repayment to which section 415 does not apply by reason of subsection (k)(3) thereof.".

(b) SECTION 457 PLANS - Subsection (e) of section 457, as amended by section 641, is amended by adding after paragraph (16) the following new paragraph: "(17) TRUSTEE-TO-TRUSTEE TRANSFERS TO PURCHASE PERMISSIVE SERVICE CREDIT - No amount shall be includible in gross income by reason of a direct trustee-to-trustee transfer to a defined benefit governmental plan (as defined in section 414(d)) if such transfer is– "(A) for the purchase of permissive service credit (as defined in section 415(n)(3)(A)) under such plan, or "(B) a repayment to which section 415 does not apply by reason of subsection (k)(3) thereof.".

(c) EFFECTIVE DATE - The amendments made by this section shall apply to trustee-to-trustee transfers after December 31, 2001.

Sec. 648. Employers May Disregard Rollovers For Purposes Of Cash-Out Amounts.

(a) QUALIFIED PLANS -

(1) AMENDMENT OF INTERNAL REVENUE CODE - Section 411(a)(11) (relating to restrictions on certain mandatory distributions) is amended by adding at the end the following: "(D) SPECIAL RULE FOR ROLLOVER CONTRIBUTIONS - A plan shall not fail to meet the requirements of this paragraph if, under the terms of the plan, the present value of the nonforfeitable accrued benefit is determined without regard to that portion of such benefit which is attributable to rollover contributions (and earnings allocable thereto). For purposes of this subparagraph, the term ‘rollover contributions’ means any rollover contribution under sections 402(c), 403(a)(4), 403(b)(8), 408(d)(3)(A)(ii), and 457(e)(16).".

(2) AMENDMENT OF ERISA - Section 203(e) of the Employee Retirement Income Security Act of 1974 (29 U.S.C. 1053(c)) is amended by adding at the end the following: "(4) A plan shall not fail to meet the requirements of this subsection if, under the terms of the plan, the present value of the nonforfeitable accrued benefit is determined without regard to that portion of such benefit which is attributable to rollover contributions (and earnings allocable thereto). For purposes of this subparagraph, the term ‘rollover contributions’ means any rollover contribution under sections 402(c), 403(a)(4), 403(b)(8), 408(d)(3)(A)(ii), and 457(e)(16) of the Internal Revenue Code of 1986.".

(b) ELIGIBLE DEFERRED COMPENSATION PLANS - Clause (i) of section 457(e)(9)(A) is amended by striking "such amount" and inserting "the portion of such amount which is not attributable to rollover contributions (as defined in section 411(a)(11)(D))".

(c) EFFECTIVE DATE - The amendments made by this section shall apply to distributions after December 31, 2001.

Sec. 649. Minimum Distribution And Inclusion Requirements For Section 457 Plans.

(a) MINIMUM DISTRIBUTION REQUIREMENTS - Paragraph (2) of section 457(d) (relating to distribution requirements) is amended to read as follows:

"(2) MINIMUM DISTRIBUTION REQUIREMENTS - A plan meets the minimum distribution requirements of this paragraph if such plan meets the requirements of section 401(a)(9).".

(b) INCLUSION IN GROSS INCOME -

(1) YEAR OF INCLUSION - Subsection (a) of section 457 (relating to year of inclusion in gross income) is amended to read as follows:

"(a) YEAR OF INCLUSION IN GROSS INCOME -

"(1) IN GENERAL - Any amount of compensation deferred under an eligible deferred compensation plan, and any income attributable to the amounts so deferred, shall be includible in gross income only for the taxable year in which such compensation or other income–

"(A) is paid to the participant or other beneficiary, in the case of a plan of an eligible employer described in subsection (e)(1)(A), and "(B) is paid or otherwise made available to the participant or other beneficiary, in the case of a plan of an eligible employer described in subsection (e)(1)(B).

"(2) SPECIAL RULE FOR ROLLOVER AMOUNTS - To the extent provided in section 72(t)(9), section 72(t) shall apply to any amount includible in gross income under this subsection.".

(2) CONFORMING AMENDMENTS -

(A) So much of paragraph (9) of section 457(e) as precedes subparagraph (A) is amended to read as follows: "(9) BENEFITS OF TAX EXEMPT ORGANIZATION PLANS NOT TREATED AS MADE AVAILABLE BY REASON OF CERTAIN ELECTIONS, ETC - In the case of an eligible deferred compensation plan of an employer described in subsection (e)(1)(B)–".

(B) Section 457(d) is amended by adding at the end the following new paragraph:

"(3) SPECIAL RULE FOR GOVERNMENT PLAN - An eligible deferred compensation plan of an employer described in subsection (e)(1)(A) shall not be treated as failing to meet the requirements of this subsection solely by reason of making a distribution described in subsection (e)(9)(A).".

(c) EFFECTIVE DATE - The amendments made by subsections (a) and (b) shall apply to distributions after December 31, 2001.

Subtitle E – Strengthening Pension Security and Enforcement

Part I – General Provisions

Sec. 651. Repeal Of 160 Percent Of Current Liability Funding Limit.

(a) AMENDMENTS TO INTERNAL REVENUE CODE - Section 412(c)(7) (relating to full-funding limitation) is amended–

(1) by striking "the applicable percentage" in subparagraph (A)(i)(I) and inserting "in the case of plan years beginning before January 1, 2004, the applicable percentage"; and

(2) by amending subparagraph (F) to read as follows: "(F) APPLICABLE PERCENTAGE - For purposes of subparagraph (A)(i)(I), the applicable percentage shall be determined in accordance with the following table:

"In the case of any plan year ..................................................The applicable
beginning in– .........................................................................percentage is–
2002 ............................................................................................. 165
2003 ............................................................................................. 170.".

(b) AMENDMENT OF ERISA - Section 302(c)(7) of the Employee Retirement Income Security Act of 1974 (29 U.S.C. 1082(c)(7)) is amended–

(1) by striking "the applicable percentage" in subparagraph (A)(i)(I) and inserting "in the case of plan years beginning before January 1, 2004, the applicable percentage", and (2) by amending subparagraph (F) to read as follows:

"(F) APPLICABLE PERCENTAGE - For purposes of subparagraph (A)(i)(I), the applicable percentage shall be determined in accordance with the following table:

"In the case of any plan year ..................................................The applicable
beginning in calendar year– .....................................................percentage is–
2002 ............................................................................................. 165
2003 ............................................................................................. 170.".

(c) EFFECTIVE DATE - The amendments made by this section shall apply to plan years beginning after December 31, 2001.

Sec. 652. Maximum Contribution Deduction Rules Modified And Applied To All Defined Benefit Plans.

(a) IN GENERAL - Subparagraph (D) of section 404(a)(1) (relating to special rule in case of certain plans) is amended to read as follows:

"(D) SPECIAL RULE IN CASE OF CERTAIN PLANS -

"(i) IN GENERAL - In the case of any defined benefit plan, except as provided in regulations, the maximum amount deductible under the limitations of this paragraph shall not be less than the unfunded current liability determined under section 412(l).

"(ii) PLANS WITH 100 OR LESS PARTICIPANTS - For purposes of this subparagraph, in the case of a plan which has 100 or less participants for the plan year, unfunded current liability shall not include the liability attributable to benefit increases for highly compensated employees (as defined in section 414(q)) resulting from a plan amendment which is made or becomes effective, whichever is later, within the last 2 years.

"(iii) RULE FOR DETERMINING NUMBER OF PARTICIPANTS - For purposes of determining the number of plan participants, all defined benefit plans maintained by the same employer (or any member of such employer’s controlled group (within the meaning of section 412(l)(8)(C))) shall be treated as one plan, but only employees of such member or employer shall be taken into account.

"(iv) PLANS MAINTAINED BY PROFESSIONAL SERVICE EMPLOYERS - In the case of a plan which, subject to section 4041 of the Employee Retirement Income Security Act of 1974, terminates during the plan year, clause (i) shall be applied by substituting for unfunded current liability the amount required to make the plan sufficient for benefit liabilities (within the meaning of section 4041(d) of such Act).".

(b) CONFORMING AMENDMENT - Paragraph (6) of section 4972(c), as amended by sections 616 and 637, is amended–

(1) by striking subparagraph (A) and redesignating subparagraphs (B) and (C) as subparagraphs (A) and (B), respectively,

(2) by striking the first sentence following subparagraph (B) (as so redesignated),

(3) by striking "subparagraph (B)" in the next to last sentence and inserting "subparagraph (A)", and

(4) by striking "Subparagraph (C)" in the last sentence and inserting "Subparagraph (B)".

(c) EFFECTIVE DATE - The amendments made by this section shall apply to plan years beginning after December 31, 2001.

Sec. 653. Excise Tax Relief For Sound Pension Funding.

(a) IN GENERAL - Subsection (c) of section 4972 (relating to nondeductible contributions) is amended by adding at the end the following new paragraph:

"(7) DEFINED BENEFIT PLAN EXCEPTION - In determining the amount of nondeductible contributions for any taxable year, an employer may elect for such year not to take into account any contributions to a defined benefit plan except to the extent that such contributions exceed the full-funding limitation (as defined in section 412(c)(7), determined without regard to subparagraph (A)(i)(I) thereof ). For purposes of this paragraph, the deductible limits under section 404(a)(7) shall first be applied to amounts contributed to defined contribution plans and then to amounts described in this paragraph. If an employer makes an election under this paragraph for a taxable year, paragraph (6) shall not apply to such employer for such taxable year.".

(b) EFFECTIVE DATE - The amendment made by this section shall apply to years beginning after December 31, 2001.

Sec. 654. Treatment Of Multi-employer Plans Under Section 415.

(a) COMPENSATION LIMIT -

(1) IN GENERAL - Paragraph (11) of section 415(b) (relating to limitation for defined benefit plans) is amended to read as follows:

"(11) SPECIAL LIMITATION RULE FOR GOVERNMENTAL AND MULTIEMPLOYER PLANS - In the case of a governmental plan (as defined in section 414(d)) or a multi-employer plan (as defined in section 414(f )), subparagraph (B) of paragraph (1) shall not apply.".

(2) CONFORMING AMENDMENT - Section 415(b)(7) (relating to benefits under certain collectively bargained plans) is amended by inserting "(other than a multi-employer plan)" after "defined benefit plan" in the matter preceding subparagraph (A).

(b) COMBINING AND AGGREGATION OF PLANS -

(1) COMBINING OF PLANS - Subsection (f ) of section 415 (relating to combining of plans) is amended by adding at the end the following:

"(3) EXCEPTION FOR MULTIEMPLOYER PLANS - Notwithstanding paragraph (1) and subsection (g), a multi-employer plan (as defined in section 414(f)) shall not be combined or aggregated–

"(A) with any other plan which is not a multi-employer plan for purposes of applying subsection (b)(1)(B) to such other plan, or

"(B) with any other multi-employer plan for purposes of applying the limitations established in this section.".

(2) CONFORMING AMENDMENT FOR AGGREGATION OF PLANS - Subsection (g) of section 415 (relating to aggregation of plans) is amended by striking "The Secretary" and inserting "Except as provided in subsection (f )(3), the Secretary".

(c) EFFECTIVE DATE - The amendments made by this section shall apply to years beginning after December 31, 2001.

Sec. 655. Protection Of Investment Of Employee Contributions To 401(K) Plans.

(a) IN GENERAL - Section 1524(b) of the Taxpayer Relief Act of 1997 is amended to read as follows:

"(b) EFFECTIVE DATE -

"(1) IN GENERAL - Except as provided in paragraph (2), the amendments made by this section shall apply to elective deferrals for plan years beginning after December 31, 1998.

"(2) NONAPPLICATION TO PREVIOUSLY ACQUIRED PROPERTY - The amendments made by this section shall not apply to any elective deferral which is invested in assets consisting of qualifying employer securities, qualifying employer real property, or both, if such assets were acquired before January 1, 1999.".

(b) EFFECTIVE DATE - The amendment made by this section shall apply as if included in the provision of the Taxpayer Relief Act of 1997 to which it relates.

Sec. 656. Prohibited Allocations Of Stock In S Corporation ESOP.

(a) IN GENERAL - Section 409 (relating to qualifications for tax credit employee stock ownership plans) is amended by redesignating subsection (p) as subsection (q) and by inserting after subsection (o) the following new subsection:

"(p) PROHIBITED ALLOCATIONS OF SECURITIES IN AN S CORPORATION -

"(1) IN GENERAL - An employee stock ownership plan holding employer securities consisting of stock in an S corporation shall provide that no portion of the assets of the plan attributable to (or allocable in lieu of ) such employer securities may, during a nonallocation year, accrue (or be allocated directly or indirectly under any plan of the employer meeting the requirements of section 401(a)) for the benefit of any disqualified person.

"(2) FAILURE TO MEET REQUIREMENTS -

"(A) IN GENERAL - If a plan fails to meet the requirements of paragraph (1), the plan shall be treated as having distributed to any disqualified person the amount allocated to the account of such person in violation of paragraph (1) at the time of such allocation.

"(B) CROSS REFERENCE -

"For excise tax relating to violations of paragraph (1) and ownership of synthetic equity, see section 4979A.

"(3) NONALLOCATION YEAR - For purposes of this subsection–

"(A) IN GENERAL - The term ‘nonallocation year’ means any plan year of an employee stock ownership plan if, at any time during such plan year– "(i) such plan holds employer securities consisting of stock in an S corporation, and "(ii) disqualified persons own at least 50 percent of the number of shares of stock in the S corporation.

"(B) ATTRIBUTION RULES - For purposes of subparagraph (A)–

"(i) IN GENERAL - The rules of section 318(a) shall apply for purposes of determining ownership, except that– "(I) in applying paragraph (1) thereof, the members of an individual’s family shall include members of the family described in paragraph (4)(D), and "(II) paragraph (4) thereof shall not apply.

"(ii) DEEMED-OWNED SHARES - Notwithstanding the employee trust exception in section 318(a)(2)(B)(i), an individual shall be treated as owning deemed-owned shares of the individual. Solely for purposes of applying paragraph (5), this subparagraph shall be applied after the attribution rules of paragraph (5) have been applied.

"(4) DISQUALIFIED PERSON - For purposes of this subsection–

"(A) IN GENERAL - The term ‘disqualified person’ means any person if– "(i) the aggregate number of deemed-owned shares of such person and the members of such person’s family is at least 20 percent of the number of deemed-owned shares of stock in the S corporation, or "(ii) in the case of a person not described in clause (i), the number of deemed-owned shares of such person is at least 10 percent of the number of deemed-owned shares of stock in such corporation.

"(B) TREATMENT OF FAMILY MEMBERS - In the case of a disqualified person described in subparagraph (A)(i), any member of such person’s family with deemed-owned shares shall be treated as a disqualified person if not otherwise treated as a disqualified person under subparagraph (A).

"(C) DEEMED-OWNED SHARES -

"(i) IN GENERAL - The term ‘deemed-owned shares’ means, with respect to any person– "(I) the stock in the S corporation constituting employer securities of an employee stock ownership plan which is allocated to such person under the plan, and "(II) such person’s share of the stock in such corporation which is held by such plan but which is not allocated under the plan to participants.

"(ii) PERSON’S SHARE OF UNALLOCATED STOCK - For purposes of clause (i)(II), a person’s share of unallocated S corporation stock held by such plan is the amount of the unallocated stock which would be allocated to such person if the unallocated stock were allocated to all participants in the same proportions as the most recent stock allocation under the plan.

"(D) MEMBER OF FAMILY - For purposes of this paragraph, the term ‘member of the family’ means, with respect to any individual– "(i) the spouse of the individual, "(ii) an ancestor or lineal descendant of the individual or the individual’s spouse, "(iii) a brother or sister of the individual or the individual’s spouse and any lineal descendant of the brother or sister, and "(iv) the spouse of any individual described in clause (ii) or (iii). A spouse of an individual who is legally separated from such individual under a decree of divorce or separate maintenance shall not be treated as such individual’s spouse for purposes of this subparagraph.

"(5) TREATMENT OF SYNTHETIC EQUITY - For purposes of paragraphs (3) and (4), in the case of a person who owns synthetic equity in the S corporation, except to the extent provided in regulations, the shares of stock in such corporation on which such synthetic equity is based shall be treated as outstanding stock in such corporation and deemed-owned shares of such person if such treatment of synthetic equity of 1 or more such persons results in– "(A) the treatment of any person as a disqualified person, or "(B) the treatment of any year as a nonallocation year. For purposes of this paragraph, synthetic equity shall be treated as owned by a person in the same manner as stock is treated as owned by a person under the rules of paragraphs (2) and (3) of section 318(a). If, without regard to this paragraph, a person is treated as a disqualified person or a year is treated as a nonallocation year, this paragraph shall not be construed to result in the person or year not being so treated.

"(6) DEFINITIONS - For purposes of this subsection–

"(A) EMPLOYEE STOCK OWNERSHIP PLAN - The term ‘employee stock ownership plan’ has the meaning given such term by section 4975(e)(7).

"(B) EMPLOYER SECURITIES - The term ‘employer security’ has the meaning given such term by section 409(l).

"(C) SYNTHETIC EQUITY - The term ‘synthetic equity’ means any stock option, warrant, restricted stock, deferred issuance stock right, or similar interest or right that gives the holder the right to acquire or receive stock of the S corporation in the future. Except to the extent provided in regulations, synthetic equity also includes a stock appreciation right, phantom stock unit, or similar right to a future cash payment based on the value of such stock or appreciation in such value.

"(7) REGULATIONS AND GUIDANCE -

"(A) IN GENERAL - The Secretary shall prescribe such regulations as may be necessary to carry out the purposes of this subsection.

"(B) AVOIDANCE OR EVASION - The Secretary may, by regulation or other guidance of general applicability, provide that a nonallocation year occurs in any case in which the principal purpose of the ownership structure of an S corporation constitutes an avoidance or evasion of this subsection.".

(b) COORDINATION WITH SECTION 4975(e)(7) - The last sentence of section 4975(e)(7) (defining employee stock ownership plan) is amended by inserting ", section 409(p)," after "409(n)".

(c) EXCISE TAX -

(1) APPLICATION OF TAX - Subsection (a) of section 4979A (relating to tax on certain prohibited allocations of employer securities) is amended–

(A) by striking "or" at the end of paragraph (1), and (B) by striking all that follows paragraph (2) and inserting the following:

"(3) there is any allocation of employer securities which violates the provisions of section 409(p), or a nonallocation year described in subsection (e)(2)(C) with respect to an employee stock ownership plan, or "(4) any synthetic equity is owned by a disqualified person in any nonallocation year, there is hereby imposed a tax on such allocation or ownership equal to 50 percent of the amount involved.".

(2) LIABILITY - Section 4979A(c) (defining liability for tax) is amended to read as follows:

"(c) LIABILITY FOR TAX - The tax imposed by this section shall be paid–"(1) in the case of an allocation referred to in paragraph (1) or (2) of subsection (a), by– "(A) the employer sponsoring such plan, or "(B) the eligible worker-owned cooperative, which made the written statement described in section 664(g)(1)(E) or in section 1042(b)(3)(B) (as the case may be), and"(2) in the case of an allocation or ownership referred to in paragraph (3) or (4) of subsection (a), by the S corporation the stock in which was so allocated or owned.".

(3) DEFINITIONS - Section 4979A(e) (relating to definitions) is amended to read as follows:

"(e) DEFINITIONS AND SPECIAL RULES - For purposes of this section–

"(1) DEFINITIONS - Except as provided in paragraph (2), terms used in this section have the same respective meanings as when used in sections 409 and 4978.

"(2) SPECIAL RULES RELATING TO TAX IMPOSED BY REASON OF PARAGRAPH (3) OR (4) OF SUBSECTION (a) -

"(A) PROHIBITED ALLOCATIONS - The amount involved with respect to any tax imposed by reason of subsection (a)(3) is the amount allocated to the account of any person in violation of section 409(p)(1).

"(B) SYNTHETIC EQUITY - The amount involved with respect to any tax imposed by reason of subsection (a)(4) is the value of the shares on which the synthetic equity is based.

"(C) SPECIAL RULE DURING FIRST NONALLOCATION YEAR - For purposes of subparagraph (A), the amount involved for the first nonallocation year of any employee stock ownership plan shall be determined by taking into account the total value of all the deemed-owned shares of all disqualified persons with respect to such plan.

"(D) STATUTE OF LIMITATIONS - The statutory period for the assessment of any tax imposed by this section by reason of paragraph (3) or (4) of subsection (a) shall not expire before the date which is 3 years from the later of–"(i) the allocation or ownership referred to in such paragraph giving rise to such tax, or "(ii) the date on which the Secretary is notified of such allocation or ownership.".

(d) EFFECTIVE DATES -

(1) IN GENERAL - The amendments made by this section shall apply to plan years beginning after December 31, 2004.

(2) EXCEPTION FOR CERTAIN PLANS - In the case of any– (A) employee stock ownership plan established after March 14, 2001, or (B) employee stock ownership plan established on or before such date if employer securities held by the plan consist of stock in a corporation with respect to which an election under section 1362(a) of the Internal Revenue Code of 1986 is not in effect on such date, the amendments made by this section shall apply to plan years ending after March 14, 2001.

Sec. 657. Automatic Rollovers Of Certain Mandatory Distributions.

(a) DIRECT TRANSFERS OF MANDATORY DISTRIBUTIONS -

(1) IN GENERAL - Section 401(a)(31) (relating to optional direct transfer of eligible rollover distributions), as amended by section 643, is amended by redesignating subparagraphs (B), (C), and (D) as subparagraphs (C), (D), and (E), respectively, and by inserting after subparagraph (A) the following new subparagraph:

"(B) CERTAIN MANDATORY DISTRIBUTIONS -

"(i) IN GENERAL - In case of a trust which is part of an eligible plan, such trust shall not constitute a qualified trust under this section unless the plan of which such trust is a part provides that if– "(I) a distribution described in clause (ii) in excess of $1,000 is made, and "(II) the distributee does not make an election under subparagraph (A) and does not elect to receive the distribution directly, the plan administrator shall make such transfer to an individual retirement plan of a designated trustee or issuer and shall notify the distributee in writing (either separately or as part of the notice under section 402(f )) that the distribution may be transferred to another individual retirement plan.

"(ii) ELIGIBLE PLAN - For purposes of clause (i), the term ‘eligible plan’ means a plan which provides that any nonforfeitable accrued benefit for which the present value (as determined under section 411(a)(11)) does not exceed $5,000 shall be immediately distributed to the participant.".

(2) CONFORMING AMENDMENTS -

(A) The heading of section 401(a)(31) is amended by striking "OPTIONAL DIRECT" and inserting "DIRECT".

(B) Section 401(a)(31)(C), as redesignated by paragraph (1), is amended by striking "Subparagraph (A)" and inserting "Subparagraphs (A) and (B)".

(b) NOTICE REQUIREMENT - Subparagraph (A) of section 402(f )(1) is amended by inserting before the comma at the end the following: "and that the automatic distribution by direct transfer applies to certain distributions in accordance with section 401(a)(31)(B)".

(c) FIDUCIARY RULES -

(1) IN GENERAL - Section 404(c) of the Employee Retirement Income Security Act of 1974 (29 U.S.C. 1104(c)) is amended by adding at the end the following new paragraph: "(3) In the case of a pension plan which makes a transfer to an individual retirement account or annuity of a designated trustee or issuer under section 401(a)(31)(B) of the Internal Revenue Code of 1986, the participant or beneficiary shall, for purposes of paragraph (1), be treated as exercising control over the assets in the account or annuity upon– "(A) the earlier of the earlier of– "(i) a rollover of all or a portion of the amount to another individual retirement account or annuity; or "(ii) one year after the transfer is made; or "(B) if the transfer is made in a manner consistent with guidance provided by the Secretary.".

(2) REGULATIONS -

(A) AUTOMATIC ROLLOVER SAFE HARBOR - Not later than 3 years after the date of enactment of this Act, the Secretary of Labor shall prescribe regulations providing for safe harbors under which the designation of an institution and investment of funds in accordance with section 401(a)(31)(B) of the Internal Revenue Code of 1986 is deemed to satisfy the fiduciary requirements of section 404(a) of the Employee Retirement Income Security Act of 1974 (29 U.S.C. 1104(a)).

(B) USE OF LOW-COST INDIVIDUAL RETIREMENT PLANS - The Secretary of the Treasury and the Secretary of Labor may provide, and shall give consideration to providing, special relief with respect to the use of low-cost individual retirement plans for purposes of transfers under section 401(a)(31)(B) of the Internal Revenue Code of 1986 and for other uses that promote the preservation of assets for retirement income purposes.

(d) EFFECTIVE DATE - The amendments made by this section shall apply to distributions made after final regulations implementing subsection (c)(2)(A) are prescribed.

Sec. 658. Clarification Of Treatment Of Contributions To Multi-employer Plan.

(a) NOT CONSIDERED METHOD OF ACCOUNTING - For purposes of section 446 of the Internal Revenue Code of 1986, a determination under section 404(a)(6) of such Code regarding the taxable year with respect to which a contribution to a multi-employer pension plan is deemed made shall not be treated as a method of accounting of the taxpayer. No deduction shall be allowed for any taxable year for any contribution to a multi-employer pension plan with respect to which a deduction was previously allowed.

(b) REGULATIONS - The Secretary of the Treasury shall promulgate such regulations as necessary to clarify that a taxpayer shall not be allowed an aggregate amount of deductions for contributions to a multi-employer pension plan which exceeds the amount of such contributions made or deemed made under section 404(a)(6) of the Internal Revenue Code of 1986 to such plan.

(c) EFFECTIVE DATE - Subsection (a), and any regulations promulgated under subsection (b), shall be effective for years ending after the date of the enactment of this Act.

PART II – TREATMENT OF PLAN AMENDMENTS REDUCING FUTURE BENEFIT ACCRUALS

Sec. 659. Excise Tax On Failure To Provide Notice By Defined Benefit Plans Significantly Reducing Future Benefit Accruals.

(a) AMENDMENT OF INTERNAL REVENUE CODE -

(1) IN GENERAL - Chapter 43 (relating to qualified pension, etc., plans) is amended by adding at the end the following new section:

"SEC. 4980F. FAILURE OF APPLICABLE PLANS REDUCING BENEFIT ACCRUALS TO SATISFY NOTICE REQUIREMENTS.

"(a) IMPOSITION OF TAX - There is hereby imposed a tax on the failure of any applicable pension plan to meet the requirements of subsection (e) with respect to any applicable individual.

"(b) AMOUNT OF TAX -

"(1) IN GENERAL - The amount of the tax imposed by subsection (a) on any failure with respect to any applicable individual shall be $100 for each day in the noncompliance period with respect to such failure.

"(2) NONCOMPLIANCE PERIOD - For purposes of this section, the term ‘noncompliance period’ means, with respect to any failure, the period beginning on the date the failure first occurs and ending on the date the notice to which the failure relates is provided or the failure is otherwise corrected.

"(c) LIMITATIONS ON AMOUNT OF TAX -

"(1) TAX NOT TO APPLY WHERE FAILURE NOT DISCOVERED AND REASONABLE DILIGENCE EXERCISED - No tax shall be imposed by subsection (a) on any failure during any period for which it is established to the satisfaction of the Secretary that any person subject to liability for the tax under subsection (d) did not know that the failure existed and exercised reasonable diligence to meet the requirements of subsection (e).

"(2) TAX NOT TO APPLY TO FAILURES CORRECTED WITHIN 30 DAYS - No tax shall be imposed by subsection (a) on any failure if– "(A) any person subject to liability for the tax under subsection (d) exercised reasonable diligence to meet the requirements of subsection (e), and "(B) such person provides the notice described in subsection (e) during the 30-day period beginning on the first date such person knew, or exercising reasonable diligence would have known, that such failure existed.

"(3) OVERALL LIMITATION FOR UNINTENTIONAL FAILURES -

"(A) IN GENERAL - If the person subject to liability for tax under subsection (d) exercised reasonable diligence to meet the requirements of subsection (e), the tax imposed by subsection (a) for failures during the taxable year of the employer (or, in the case of a multi-employer plan, the taxable year of the trust forming part of the plan) shall not exceed $500,000. For purposes of the preceding sentence, all multi-employer plans of which the same trust forms a part shall be treated as 1 plan.

"(B) TAXABLE YEARS IN THE CASE OF CERTAIN CONTROLLED GROUPS - For purposes of this paragraph, if all persons who are treated as a single employer for purposes of this section do not have the same taxable year, the taxable years taken into account shall be determined under principles similar to the principles of section 1561.

"(4) WAIVER BY SECRETARY - In the case of a failure which is due to reasonable cause and not to willful neglect, the Secretary may waive part or all of the tax imposed by subsection (a) to the extent that the payment of such tax would be excessive or otherwise inequitable relative to the failure involved.

"(d) LIABILITY FOR TAX - The following shall be liable for the tax imposed by subsection (a):

"(1) In the case of a plan other than a multi-employer plan, the employer. "(2) In the case of a multi-employer plan, the plan.

"(e) NOTICE REQUIREMENTS FOR PLANS SIGNIFICANTLY REDUCING BENEFIT ACCRUALS -

"(1) IN GENERAL - If an applicable pension plan is amended to provide for a significant reduction in the rate of future benefit accrual, the plan administrator shall provide written notice to each applicable individual (and to each employee organization representing applicable individuals).

"(2) NOTICE - The notice required by paragraph (1) shall be written in a manner calculated to be understood by the average plan participant and shall provide sufficient information (as determined in accordance with regulations prescribed by the Secretary) to allow applicable individuals to understand the effect of the plan amendment. The Secretary may provide a simplified form of notice for, or exempt from any notice requirement, a plan–

"(A) which has fewer than 100 participants who have accrued a benefit under the plan, or "(B) which offers participants the option to choose between the new benefit formula and the old benefit formula.

"(3) TIMING OF NOTICE - Except as provided in regulations, the notice required by paragraph (1) shall be provided within a reasonable time before the effective date of the plan amendment.

"(4) DESIGNEES - Any notice under paragraph (1) may be provided to a person designated, in writing, by the person to which it would otherwise be provided.

"(5) NOTICE BEFORE ADOPTION OF AMENDMENT - A plan shall not be treated as failing to meet the requirements of paragraph (1) merely because notice is provided before the adoption of the plan amendment if no material modification of the amendment occurs before the amendment is adopted.

(f) DEFINITIONS AND SPECIAL RULES - For purposes of this section–

"(1) APPLICABLE INDIVIDUAL - The term ‘applicable individual’ means, with respect to any plan amendment–"(A) each participant in the plan, and "(B) any beneficiary who is an alternate payee (within the meaning of section 414(p)(8)) under an applicable qualified domestic relations order (within the meaning of section 414(p)(1)(A)), whose rate of future benefit accrual under the plan may reasonably be expected to be significantly reduced by such plan amendment.

"(2) APPLICABLE PENSION PLAN - The term ‘applicable pension plan’ means–

"(A) any defined benefit plan, or "(B) an individual account plan which is subject to the funding standards of section 412. Such term shall not include a governmental plan (within the meaning of section 414(d)) or a church plan (within the meaning of section 414(e)) with respect to which the election provided by section 410(d) has not been made.

"(3) EARLY RETIREMENT - A plan amendment which eliminates or significantly reduces any early retirement benefit or retirement-type subsidy (within the meaning of section 411(d)(6)(B)(i)) shall be treated as having the effect of significantly reducing the rate of future benefit accrual.

"(g) NEW TECHNOLOGIES - The Secretary may by regulations allow any notice under subsection (e) to be provided by using new technologies.".

(2) CLERICAL AMENDMENT - The table of sections for chapter 43 is amended by adding at the end the following new item:

"Sec. 4980F. Failure of applicable plans reducing benefit accruals to satisfy notice requirements.".

(b) AMENDMENT OF ERISA - Subsection (h) of section 204 of the Employee Retirement Income Security Act of 1974 (29 U.S.C. 1054) is amended to read as follows:

"(h)(1) An applicable pension plan may not be amended so as to provide for a significant reduction in the rate of future benefit accrual unless the plan administrator provides the notice described in paragraph (2) to each applicable individual (and to each employee organization representing applicable individuals).

"(2) The notice required by paragraph (1) shall be written in a manner calculated to be understood by the average plan participant and shall provide sufficient information (as determined in accordance with regulations prescribed by the Secretary of the Treasury) to allow applicable individuals to understand the effect of the plan amendment. The Secretary of the Treasury may provide a simplified form of notice for, or exempt from any notice requirement, a plan–"(A) which has fewer than 100 participants who have accrued a benefit under the plan, or "(B) which offers participants the option to choose between the new benefit formula and the old benefit formula.

"(3) Except as provided in regulations prescribed by the Secretary of the Treasury, the notice required by paragraph (1) shall be provided within a reasonable time before the effective date of the plan amendment. "(4) Any notice under paragraph (1) may be provided to a person designated, in writing, by the person to which it would otherwise be provided.

"(5) A plan shall not be treated as failing to meet the requirements of paragraph (1) merely because notice is provided before the adoption of the plan amendment if no material modification of the amendment occurs before the amendment is adopted.

"(6)(A) In the case of any egregious failure to meet any requirement of this subsection with respect to any plan amendment, the provisions of the applicable pension plan shall be applied as if such plan amendment entitled all applicable individuals to the greater of–"(i) the benefits to which they would have been entitled without regard to such amendment, or "(ii) the benefits under the plan with regard to such amendment.

"(B) For purposes of subparagraph (A), there is an egregious failure to meet the requirements of this subsection if such failure is within the control of the plan sponsor and is–"(i) an intentional failure (including any failure to promptly provide the required notice or information after the plan administrator discovers an unintentional failure to meet the requirements of this subsection),"(ii) a failure to provide most of the individuals with most of the information they are entitled to receive under this subsection, or"(iii) a failure which is determined to be egregious under regulations prescribed by the Secretary of the Treasury.

"(7) The Secretary of the Treasury may by regulations allow any notice under this subsection to be provided by using new technologies.

"(8) For purposes of this subsection–

"(A) The term ‘applicable individual’ means, with respect to any plan amendment–"(i) each participant in the plan; and"(ii) any beneficiary who is an alternate payee (within the meaning of section 206(d)(3)(K)) under an applicable qualified domestic relations order (within the meaning of section 206(d)(3)(B)(i)), whose rate of future benefit accrual under the plan may reasonably be expected to be significantly reduced by such plan amendment.

"(B) The term ‘applicable pension plan’ means–"(i) any defined benefit plan; or"(ii) an individual account plan which is subject to the funding standards of section 412 of the Internal Revenue Code of 1986.

"(9) For purposes of this subsection, a plan amendment which eliminates or significantly reduces any early retirement benefit or retirement-type subsidy (within the meaning of subsection (g)(2)(A)) shall be treated as having the effect of significantly reducing the rate of future benefit accrual.".

(c) EFFECTIVE DATES -

(1) IN GENERAL - The amendments made by this section shall apply to plan amendments taking effect on or after the date of the enactment of this Act.

(2) TRANSITION - Until such time as the Secretary of the Treasury issues regulations under sections 4980F(e)(2) and (3) of the Internal Revenue Code of 1986, and section 204(h) of the Employee Retirement Income Security Act of 1974, as added by the amendments made by this section, a plan shall be treated as meeting the requirements of such sections if it makes a good faith effort to comply with such requirements.

(3) SPECIAL NOTICE RULE -

(A) IN GENERAL - The period for providing any notice required by the amendments made by this section shall not end before the date which is 3 months after the date of the enactment of this Act.

(B) REASONABLE NOTICE - The amendments made by this section shall not apply to any plan amendment taking effect on or after the date of the enactment of this Act if, before April 25, 2001, notice was provided to participants and beneficiaries adversely affected by the plan amendment (or their representatives) which was reasonably expected to notify them of the nature and effective date of the
plan amendment.

Subtitle F – Reducing Regulatory Burdens

Sec. 661. Modification Of Timing Of Plan Valuations.

(a) IN GENERAL - Paragraph (9) of section 412(c) (relating to annual valuation) is amended to read as follows:

"(9) ANNUAL VALUATION -

"(A) IN GENERAL - For purposes of this section, a determination of experience gains and losses and a valuation of the plan’s liability shall be made not less frequently than once every year, except that such determination shall be made more frequently to the extent required in particular cases under regulations prescribed by the Secretary.

"(B) VALUATION DATE -

"(i) CURRENT YEAR - Except as provided in clause (ii), the valuation referred to in subparagraph (A) shall be made as of a date within the plan year to which the valuation refers or within one month prior to the beginning of such year.

"(ii) USE OF PRIOR YEAR VALUATION - The valuation referred to in subparagraph (A) may be made as of a date within the plan year prior to the year to which the valuation refers if, as of such date, the value of the assets of the plan are not less than 125 percent of the plan’s current liability (as defined in paragraph (7)(B)).

"(iii) ADJUSTMENTS - Information under clause (ii) shall, in accordance with regulations, be actuarially adjusted to reflect significant differences in participants.".

(b) AMENDMENT OF ERISA - Paragraph (9) of section 302(c) of the Employee Retirement Income Security Act of 1974 (29 U.S.C. 1053(c)) is amended–

(1) by inserting "(A)" after "(9)", and

(2) by adding at the end the following:

"(B)(i) Except as provided in clause (ii), the valuation referred to in subparagraph (A) shall be made as of a date within the plan year to which the valuation refers or within one month prior to the beginning of such year."(ii) The valuation referred to in subparagraph (A) may be made as of a date within the plan year prior to the year to which the valuation refers if, as of such date, the value of the assets of the plan are not less than 125 percent of the plan’s current liability (as defined in paragraph (7)(B))."(iii) Information under clause (ii) shall, in accordance with regulations, be actuarially adjusted to reflect significant differences in participants.".

(c) EFFECTIVE DATE - The amendments made by this section shall apply to plan years beginning after December 31, 2001.

Sec. 662. ESOP Dividends May Be Reinvested Without Loss Of Dividend Deduction.

(a) IN GENERAL - Section 404(k)(2)(A) (defining applicable dividends) is amended by striking "or" at the end of clause (ii), by redesignating clause (iii) as clause (iv), and by inserting after clause (ii) the following new clause: "(iii) is, at the election of such participants or their beneficiaries– "(I) payable as provided in clause (i) or (ii), or "(II) paid to the plan and reinvested in qualifying employer securities, or".

(b) STANDARDS FOR DISALLOWANCE - Section 404(k)(5)(A) (relating to disallowance of deduction) is amended by inserting "avoidance or" before "evasion".

(c) EFFECTIVE DATE - The amendments made by this section shall apply to taxable years beginning after December 31, 2001.

Sec. 663. Repeal Of Transition Rule Relating To Certain Highly Compensated Employees.

(a) IN GENERAL - Paragraph (4) of section 1114(c) of the Tax Reform Act of 1986 is hereby repealed.

(b) EFFECTIVE DATE - The repeal made by subsection (a) shall apply to plan years beginning after December 31, 2001.

Sec. 664. Employees Of Tax-Exempt Entities.

(a) IN GENERAL - The Secretary of the Treasury shall modify Treasury Regulations section 1.410(b)–6(g) to provide that employees of an organization described in section 403(b)(1)(A)(i) of the Internal Revenue Code of 1986 who are eligible to make contributions under section 403(b) of such Code pursuant to a salary reduction agreement may be treated as excludable with respect to a plan under section 401(k) or (m) of such Code that is provided under the same general arrangement as a plan under such section 401(k), if– (1) no employee of an organization described in section 403(b)(1)(A)(i) of such Code is eligible to participate in such section 401(k) plan or section 401(m) plan; and (2) 95 percent of the employees who are not employees of an organization described in section 403(b)(1)(A)(i) of such Code are eligible to participate in such plan under such section 401(k) or (m).

(b) EFFECTIVE DATE - The modification required by subsection (a) shall apply as of the same date set forth in section 1426(b) of the Small Business Job Protection Act of 1996.

Sec. 665. Clarification Of Treatment Of Employer-Provided Retirement Advice.

(a) IN GENERAL - Subsection (a) of section 132 (relating to exclusion from gross income) is amended by striking "or" at the end of paragraph (5), by striking the period at the end of paragraph (6) and inserting ", or", and by adding at the end the following new paragraph:

"(7) qualified retirement planning services.".

(b) QUALIFIED RETIREMENT PLANNING SERVICES DEFINED - Section 132 is amended by redesignating subsection (m) as subsection (n) and by inserting after subsection (l) the following:

"(m) QUALIFIED RETIREMENT PLANNING SERVICES -

"(1) IN GENERAL - For purposes of this section, the term ‘qualified retirement planning services’ means any retirement planning advice or information provided to an employee and his spouse by an employer maintaining a qualified employer plan.

"(2) NONDISCRIMINATION RULE - Subsection (a)(7) shall apply in the case of highly compensated employees only if such services are available on substantially the same terms to each member of the group of employees normally provided education and information regarding the employer’s qualified employer plan.

"(3) QUALIFIED EMPLOYER PLAN - For purposes of this subsection, the term ‘qualified employer plan’ means a plan, contract, pension, or account described in section 219(g)(5).".

(c) EFFECTIVE DATE - The amendments made by this section shall apply to years beginning after December 31, 2001.

Sec. 666. Repeal Of The Multiple Use Test.

(a) IN GENERAL - Paragraph (9) of section 401(m) is amended to read as follows:

"(9) REGULATIONS - The Secretary shall prescribe such regulations as may be necessary to carry out the purposes of this subsection and subsection (k), including regulations permitting appropriate aggregation of plans and contributions.".

(b) EFFECTIVE DATE - The amendment made by this section shall apply to years beginning after December 31, 2001.

Tax Relief and Health Care Act of 2006

Title III: Health Savings Accounts
Health Opportunity Patient Empowerment Act of 2006

SEC. 301. SHORT TITLE.

This title may be cited as the "Health Opportunity Patient Empowerment Act of 2006".

SEC. 302. FSA AND HRA TERMINATIONS TO FUND HSAs.

(a) In General - Section 106 (relating to contributions by employer to accident and health plans) is amended by adding at the end the following new subsection:

"(e) FSA and HRA Terminations to Fund HSAs"-

(1) IN GENERAL - A plan shall not fail to be treated as a health flexible spending arrangement or health reimbursement arrangement under this section or section 105 merely because such plan provides for a qualified HSA distribution.

(2) QUALIFIED HSA DISTRIBUTION - The term `qualified HSA distribution' means a distribution from a health flexible spending arrangement or health reimbursement arrangement to the extent that such distribution-

(A) does not exceed the lesser of the balance in such arrangement on September 21, 2006, or as of the date of such distribution, and

(B) is contributed by the employer directly to the health savings account of the employee before January 1, 2012. Such term shall not include more than 1 distribution with respect to any arrangement.

(3) ADDITIONAL TAX FOR FAILURE TO MAINTAIN HIGH DEDUCTIBLE HEALTH PLAN COVERAGE-

(A) IN GENERAL - If, at any time during the testing period, the employee is not an eligible individual, then the amount of the qualified HSA distribution-

(i) shall be includible in the gross income of the employee for the taxable year in which occurs the first month in the testing period for which such employee is not an eligible individual, and

(ii) the tax imposed by this chapter for such taxable year on the employee shall be increased by 10 percent of the amount which is so includible.

(B) EXCEPTION FOR DISABILITY OR DEATH- Clauses (i) and (ii) of subparagraph (A) shall not apply if the employee ceases to be an eligible individual by reason of the death of the employee or the employee becoming disabled (within the meaning of section 72(m)(7)).

(4) DEFINITIONS AND SPECIAL RULES- For purposes of this subsection-

(A) TESTING PERIOD- The term `testing period' means the period beginning with the month in which the qualified HSA distribution is contributed to the health savings account and ending on the last day of the 12th month following such month.

(B) ELIGIBLE INDIVIDUAL- The term `eligible individual' has the meaning given such term by section 223(c)(1).

(C) TREATMENT AS ROLLOVER CONTRIBUTION- A qualified HSA distribution shall be treated as a rollover contribution described in section 223(f)(5).

(5) TAX TREATMENT RELATING TO DISTRIBUTIONS- For purposes of this title-

(A) IN GENERAL- A qualified HSA distribution shall be treated as a payment described in subsection (d).

(B) COMPARABILITY EXCISE TAX -

(i) IN GENERAL - Except as provided in clause (ii), section 4980G shall not apply to qualified HSA distributions.

(ii) FAILURE TO OFFER TO ALL EMPLOYEES - In the case of a qualified HSA distribution to any employee, the failure to offer such distribution to any eligible individual covered under a high deductible health plan of the employer shall (notwithstanding section 4980G(d)) be treated for purposes of section 4980G as a failure to meet the requirements of section 4980G(b).

(b) Certain FSA Coverage Disregarded Coverage - Subparagraph (B) of section 223(c)(1) (relating to certain coverage disregarded) is amended by striking `and' at the end of clause (i), by striking the period at the end of clause (ii) and inserting `, and', and by inserting after clause (ii) the following new clause:

"(iii) for taxable years beginning after December 31, 2006, coverage under a health flexible spending arrangement during any period immediately following the end of a plan year of such arrangement during which unused benefits or contributions remaining at the end of such plan year may be paid or reimbursed to plan participants for qualified benefit expenses incurred during such period if -

(I) the balance in such arrangement at the end of such plan year is zero, or

(II) the individual is making a qualified HSA distribution (as defined in section 106(e)) in an amount equal to the remaining balance in such arrangement as of the end of such plan year, in accordance with rules prescribed by the Secretary.

(c) Application of Section -

(1) SUBSECTION (a) - The amendment made by subsection (a) shall apply to distributions on or after the date of the enactment of this Act.

(2) SUBSECTION (b) - The amendment made by subsection (b) shall take effect on the date of the enactment of this Act.

SEC. 303. REPEAL OF ANNUAL DEDUCTIBLE LIMITATION ON HSA CONTRIBUTIONS.

(a) IN GENERAL - Paragraph (2) of section 223(b) (relating to monthly limitation) is amended-

(1) in subparagraph (A) by striking "the lesser of–" and all that follows and inserting "$2,250.", and (2) in subparagraph (B) by striking "the lesser of–" and all that follows and inserting "$4,500.".

(b) CONFORMING AMENDMENT - Section 223(d)(1)(A)(ii)(I) is amended by striking "subsection (b)(2)(B)(ii)" and inserting "subsection (b)(2)(B)".

(c) EFFECTIVE DATE - The amendments made by this section shall apply to taxable years beginning after December 31, 2006.

SEC. 304. MODIFICATION OF COST-OF-LIVING ADJUSTMENT.

Paragraph (1) of section 223(g) (relating to cost-of living adjustment) is amended by adding at the end the following new flush sentence:

"In the case of adjustments made for any taxable year beginning after 2007, section 1(f)(4) shall be applied for purposes of this paragraph by substituting ‘March 31’ for ‘August 31’, and the Secretary shall publish the adjusted amounts under subsections (b)(2) and (c)(2)(A) for taxable years beginning in any calendar year no later than June 1 of the preceding calendar year.".

SEC. 305. CONTRIBUTION LIMITATION NOT REDUCED FOR PART - YEAR COVERAGE.

(a) INCREASE IN LIMIT FOR INDIVIDUALS BECOMING ELIGIBLE INDIVIDUALS AFTER BEGINNING OF THE YEAR - Subsection (b) of section 223 (relating to limitations) is amended by adding at the end the following new paragraph:

"(8) INCREASE IN LIMIT FOR INDIVIDUALS BECOMING ELIGIBLE INDIVIDUALS AFTER THE BEGINNING OF THE YEAR -

"(A) IN GENERAL - For purposes of computing the limitation under paragraph (1) for any taxable year, an individual who is an eligible individual during the last month of such taxable year shall be treated -

"(i) as having been an eligible individual during each of the months in such taxable year, and

"(ii) as having been enrolled, during each of the months such individual is treated as an eligible individual solely by reason of clause (i), in the same high deductible health plan in which the individual was enrolled for the last month of such taxable year.

"(B) FAILURE TO MAINTAIN HIGH DEDUCTIBLE HEALTH PLAN COVERAGE -

"(i) IN GENERAL - If, at any time during the testing period, the individual is not an eligible individual, then–‘

"(I) gross income of the individual for the taxable year in which occurs the first month in the testing period for which such individual is not an eligible individual is increased by the aggregate amount of all contributions to the health savings account of the individual which could not have been made but for subparagraph (A), and

"(II) the tax imposed by this chapter for any taxable year on the individual shall be increased by 10 percent of the amount of such in crease.

"(ii) EXCEPTION FOR DISABILITY OR DEATH - Subclauses (I) and (II) of clause (i) shall not apply if the individual ceased to be an eligible individual by reason of the
death of the individual or the individual becoming disabled (within the meaning of section 72(m)(7)).

"(iii) TESTING PERIOD - The term‘testing period’ means the period beginning with the last month of the taxable year referred to in subparagraph (A) and ending
on the last day of the 12th month following such month.".

(b) EFFECTIVE DATE - The amendments made by this section shall apply to taxable years beginning after December 31, 2006.

SEC. 306. EXCEPTION TO REQUIREMENT FOR EMPLOYERS TO MAKE COMPARABLE HEALTH SAVINGS ACCOUNT CONTRIBUTIONS.

(a) IN GENERAL - Section 4980G (relating to failure of employer to make comparable health savings account contributions) is amended by adding at the end the following new subsection:

"(d) EXCEPTION - For purposes of applying section 4980E to a contribution to a health savings account of an employee who is not a highly compensated employee
(as defined in section 414(q)), highly compensated employees shall not be treated as comparable participating employees.".

(b) EFFECTIVE DATE - The amendment made by this section shall apply to taxable years beginning after December 31, 2006.

SEC. 307. ONE-TIME DISTRIBUTION FROM INDIVIDUAL RETIREMENT PLANS TO FUND HSAs.

(a) IN GENERAL - Subsection (d) of section 408 (relating to taxability of beneficiary of employees’ trust) is amended by adding at the end the following new para
graph:

"(9) DISTRIBUTION FOR HEALTH SAVINGS ACCOUNT FUNDING -

"(A) IN GENERAL - In the case of an individual who is an eligible individual (as defined in section 223(c)) and who elects the application of this paragraph for a taxable year, gross income of the individual for the taxable year does not include a qualified HSA funding distribution to the extent such distribution is otherwise includible in gross income.

"(B) QUALIFIED HSA FUNDING DISTRIBUTION - For purposes of this paragraph, the term ‘qualified HSA funding distribution’ means a distribution from an individual retirement plan (other than a plan described in subsection (k) or (p)) of the employee to the extent that such distribution is contributed to the health savings account of the individual in a direct trustee-to-trustee transfer.

"(C) LIMITATIONS -

"(i) MAXIMUM DOLLAR LIMITATION. The amount excluded from gross income by subparagraph (A) shall not exceed the excess of–

"(I) the annual limitation under section 223(b) computed on the basis of the type of coverage under the high deductible health plan covering the individual at the time of the qualified HSA funding distribution, over

"(II) in the case of a distribution described in clause (ii)(II), the amount of the earlier qualified HSA funding distribution.

"(ii) ONE-TIME TRANSFER -

"(I) IN GENERAL - Except as provided in subclause (II), an individual may make an election under subparagraph (A) only for one qualified HSA funding distribution during
the lifetime of the individual. Such an election, once made, shall be irrevocable.

"(II) CONVERSION FROM SELF ONLY TO FAMILY COVERAGE - If a qualified HSA funding distribution is made during a month in a taxable year during which an individual has self-only coverage under a high deductible health plan as of the first day of the month, the individual may elect to make an additional qualified HSA funding distribution during a subsequent month in such taxable year during which the individual has family coverage under a high deductible health plan as of the first day of the subsequent month.

"(D) FAILURE TO MAINTAIN HIGH DEDUCTIBLE HEALTH PLAN COVERAGE -

"(i) IN GENERAL - If, at any time during the testing period, the individual is not an eligible individual, then the aggregate amount of all contributions to the health savings account of the individual made under subparagraph (A)–

"(I) shall be includible in the gross income of the individual for the taxable year in which occurs the first month in the testing period for which such individual is not an eligible individual, and

"(II) the tax imposed by this chapter for any taxable year on the individual shall be increased by 10 percent of the amount which is so includible.

"(ii) EXCEPTION FOR DISABILITY OR DEATH - Subclauses (I) and (II) of clause (i) shall not apply if the individual ceased to be an eligible individual by reason of the
death of the individual or the individual becoming disabled (within the meaning of section 72(m)(7)).

"(iii) TESTING PERIOD - The term‘testing period’ means the period beginning with the month in which the qualified HSA funding distribution is contributed to a
health savings account and ending on the last day of the 12th month following such month.

"(E) APPLICATION OF SECTION 72 - Not withstanding section 72, in determining the extent to which an amount is treated as otherwise includible in gross income for purposes of sub-paragraph (A), the aggregate amount distributed from an individual retirement plan shall be treated as includible in gross income to the extent that such amount does not exceed the aggregate amount which would have been so includible if all amounts from all individual retirement plans were distributed. Proper adjustments shall be made in applying section 72 to other distributions in such taxable year and subsequent taxable years.".

(b) COORDINATION WITH LIMITATION ON CONTRIBUTIONS TO HSAS - Section 223(b)(4) (relating to coordination with other contributions) is amended by striking "and" at the end of subparagraph (A), by striking the period at the end of subparagraph (B) and inserting", and", and by inserting after subparagraph (B) the following new subparagraph:

"(C) the aggregate amount contributed to health savings accounts of such individual for such taxable year under section 408(d)(9) (and such amount shall not be allowed as a deduction under subsection (a)).".

(c) EFFECTIVE DATE. The amendments made by this section shall apply to taxable years beginning after December 31, 2006.

Medicare Prescription Drug Improvement Act of 2003

TITLE XII - TAX INCENTIVES FOR HEALTH AND RETIREMENT SECURITY

SEC. 1201. HEALTH SAVINGS ACCOUNTS.

(a) IN GENERAL. Part VII of subchapter B of chapter 1 of the Internal Revenue Code of 1986 (relating to additional itemized deductions for individuals) is amended by redesignating section 223 as section 224 and by inserting after section 222 the following new section:

"SEC. 223. HEALTH SAVINGS ACCOUNTS.

(a) DEDUCTION ALLOWED. In the case of an individual who is an eligible individual for any month during the taxable year, there shall be allowed as a deduction for the taxable year an amount equal to the aggregate amount paid in cash during such taxable year by or on behalf of such individual to a health savings account of such individual.

(b) LIMITATIONS.

"(1) IN GENERAL. The amount allowable as a deduction under subsection (a) to an individual for the taxable year shall not exceed the sum of the monthly limitations for months during such taxable year that the individual is an eligible individual.

"(2) MONTHLY LIMITATION. The monthly limitation for any month is 1/12 of-

"(A) in the case of an eligible individual who has self only coverage under a high deductible health plan as of the first day of such month, the lesser of–

"(i) the annual deductible under such coverage, or

"(ii) $2,250, or

"(B) in the case of an eligible individual who has family coverage under a high deductible health plan as of the first day of such month, the lesser of-

"(i) the annual deductible under such coverage, or

"(ii) $4,500.

"(3) ADDITIONAL CONTRIBUTIONS FOR INDIVIDUALS 55 OR OLDER -

"(A) IN GENERAL - In the case of an individual who has attained age 55 before the close of the taxable year, the applicable limitation under subparagraphs (A) and (B) of paragraph (2) shall be increased by the additional contribution amount.

"(B) ADDITIONAL CONTRIBUTION AMOUNT - For purposes of this section, the additional contribution amount is the amount determined in accordance with the following table:

"For taxable years beginning in: .............. The additional contribution amount is:

2004 ................................................................................................... $500
2005 ................................................................................................... $600
2006 ................................................................................................... $700
2007 ................................................................................................... $800
2008 ................................................................................................... $900
2009 and thereafter ............................................................................ $1,000.

"(4) COORDINATION WITH OTHER CONTRIBUTIONS. The limitation which would (but for this paragraph) apply under this subsection to an individual for any taxable year shall be reduced (but not below zero) by the sum of-

"(A) the aggregate amount paid for such taxable year to Archer MSAs of such individual, and

"(B) the aggregate amount contributed to health savings accounts of such individual which is excludable from the taxpayer’s gross income for such taxable year
under section 106(d) (and such amount shall not be allowed as a deduction under subsection (a)). Subparagraph (A) shall not apply with respect to any individual
to whom paragraph (5) applies.

"(5) SPECIAL RULE FOR MARRIED INDIVIDUALS. In the case of individuals who are married to each other, if either spouse has family coverage-

"(A) both spouses shall be treated as having only such family coverage (and if such spouses each have family coverage under different plans, as having the family coverage with the lowest annual deductible), and

"(B) the limitation under paragraph (1) (after the application of subparagraph (A) and without regard to any additional contribution amount under paragraph (3))-

"(i) shall be reduced by the aggregate amount paid to Archer MSAs of such spouses for the taxable year, and

"(ii) after such reduction, shall be divided equally between them unless they agree on a different division.

"(6) DENIAL OF DEDUCTION TO DEPENDENTS - No deduction shall be allowed under this section to any individual with respect to whom a deduction under section 151 is allowable to another taxpayer for a taxable year beginning in the calendar year in which such individual’s taxable year begins.

"(7) MEDICARE ELIGIBLE INDIVIDUALS - The limitation under this subsection for any month with respect to an individual shall be zero for the first month such individual is entitled to benefits under title XVIII of the Social Security Act and for each month thereafter.

"(c) DEFINITIONS AND SPECIAL RULES - For purposes of this section–

"(1) ELIGIBLE INDIVIDUAL -

"(A) IN GENERAL - The term "eligible individual" means, with respect to any month, any individual if–

"(i) such individual is covered under a high deductible health plan as of the 1st day of such month, and

"(ii) such individual is not, while covered under a high deductible health plan, covered under any health plan–

"(I) which is not a high deductible health plan, and

"(II) which provides coverage for any benefit which is covered under the high deductible health plan.

"(B) CERTAIN COVERAGE DISREGARDED - Subparagraph (A)(ii) shall be applied without regard to–

"(i) coverage for any benefit provided by permitted insurance, and

"(ii) coverage (whether through insurance or otherwise) for accidents, disability, dental care, vision care, or long-term care.

"(2) HIGH DEDUCTIBLE HEALTH PLAN -

"(A) IN GENERAL - The term ‘high deductible health plan’ means a health plan–

"(i) which has an annual deductible which is not less than–

"(I) $1,000 for self-only coverage, and

"(II) twice the dollar amount in subclause (I) for family coverage, and

"(ii) the sum of the annual deductible and the other annual out-of-pocket expenses required to be paid under the plan (other than for premiums) for covered
benefits does not exceed–

"(I) $5,000 for self-only coverage, and

"(II) twice the dollar amount in subclause (I) for family coverage.

"(B) EXCLUSION OF CERTAIN PLANS - Such term does not include a health plan if substantially all of its coverage is coverage described in paragraph (1)(B).

"(C) SAFE HARBOR FOR ABSENCE OF PREVENTIVE CARE DEDUCTIBLE - A plan shall not fail to be treated as a high deductible health plan by reason of failing to have a deductible for preventive care (within the meaning of section 1871 of the Social Security Act, except as otherwise provided
by the Secretary).

"(D) SPECIAL RULES FOR NETWORK PLANS - In the case of a plan using a network of providers–

"(i) ANNUAL OUT-OF-POCKET LIMITATION - Such plan shall not fail to be treated as a high deductible health plan by reason of having an out-of-pocket limitation for services provided outside of such network which exceeds the applicable limitation under subparagraph (A)(ii).

"(ii) ANNUAL DEDUCTIBLE - Such plan’s annual deductible for services provided outside of such network shall not be taken into account for purposes of subsection (b)(2).

"(3) PERMITTED INSURANCE - The term "permitted insurance" means–

"(A) insurance if substantially all of the coverage provided under such insurance relates to–

"(i) liabilities incurred under workers’ compensation laws,

"(ii) tort liabilities,

"(iii) liabilities relating to ownership or use of property, or

"(iv) such other similar liabilities as the Secretary may specify by regulations,

"(B) insurance for a specified disease or illness, and"(C) insurance paying a fixed amount per day (or other period) of hospitalization.

"(4) FAMILY COVERAGE - The term ‘family coverage’ means any coverage other than self-only coverage.

"(5) ARCHER MSA - The term ‘Archer MSA’ has the meaning given such term in section 220(d).

"(d) HEALTH SAVINGS ACCOUNT - For purposes of this section–

"(1) IN GENERAL - The term health savings account means a trust created or organized in the United States as a health savings account exclusively for the purpose of paying the qualified medical expenses of the account beneficiary, but only if the written governing instrument creating the trust meets the following requirements:

"(A) Except in the case of a rollover contribution described in subsection (f)(5) or section 220(f)(5), no contribution will be accepted–

"(i) unless it is in cash, or

"(ii) to the extent such contribution, when added to previous contributions to the trust for the calendar year, exceeds the sum of–

"(I) the dollar amount in effect under subsection (b)(2)(B)(ii), and

"(II) the dollar amount in effect under subsection (b)(3)(B).

"(B) The trustee is a bank (as defined in section 408(n)), an insurance company (as defined in section 816), or another person who demonstrates to the satisfaction of the Secretary that the manner in which such person will administer the trust will be consistent with the requirements of this section.

"(C) No part of the trust assets will be invested in life insurance contracts.

"(D) The assets of the trust will not be commingled with other property except in a common trust fund or common investment fund.

"(E) The interest of an individual in the balance in his account is nonforfeitable.

"(2) QUALIFIED MEDICAL EXPENSES -

"(A) IN GENERAL - The term ‘qualified medical expenses’ means, with respect to an account beneficiary, amounts paid by such beneficiary for medical care (as defined in section 213(d) for such individual, the spouse of such individual, and any dependent (as defined in section 152) of such individual, but only to the extent such amounts are not compensated for by insurance or otherwise.

"(B) HEALTH INSURANCE MAY NOT BE PURCHASED FROM ACCOUNT - Subparagraph (A) shall not apply to any payment
for insurance.

"(C) EXCEPTIONS - Subparagraph (B) shall not apply to any expense for coverage under–

"(i) a health plan during any period of continuation coverage required under any Federal law,

"(ii) a qualified long-term care insurance contract (as defined in section 7702B(b)),

"(iii) a health plan during a period in which the individual is receiving unemployment compensation under any Federal or State law, or

"(iv) in the case of an account beneficiary who has attained the age specified in section 1811 of the Social Security Act, any health insurance other than a medicare supplemental policy (as defined in section 1882 of the Social Security Act).

"(3) ACCOUNT BENEFICIARY - The term ‘account beneficiary’ means the individual on whose behalf the health savings account was established.

"(4) CERTAIN RULES TO APPLY - Rules similar to the following rules shall apply for purposes of this section:

"(A) Section 219(d)(2) (relating to no deduction for rollovers).

"(B) Section 219(f)(3) (relating to time when contributions deemed made).

"(C) Except as provided in section 106(d), section 219(f)(5) (relating to employer payments).

"(D) Section 408(g) (relating to community property laws).

"(E) Section 408(h) (relating to custodial accounts).

"(e) TAX TREATMENT OF ACCOUNTS -

"(1) IN GENERAL - A health savings account is exempt from taxation under this subtitle unless such account has ceased to be a health savings account. Notwithstanding the preceding sentence, any such account is subject to the taxes imposed by section 511 (relating to imposition of tax on unrelated business
income of charitable, etc. organizations).

"(2) ACCOUNT TERMINATIONS - Rules similar to the rules of paragraphs (2) and (4) of section 408(e) shall apply to health savings accounts, and any amount treated as distributed under such rules shall be treated as not used to pay qualified medical expenses.

"(f) TAX TREATMENT OF DISTRIBUTIONS -

"(1) AMOUNTS USED FOR QUALIFIED MEDICAL EXPENSES -
Any amount paid or distributed out of a health savings account which is used exclusively to pay qualified medical expenses of any account beneficiary shall not be includible in gross income.

"(2) INCLUSION OF AMOUNTS NOT USED FOR QUALIFIED MEDICAL EXPENSES - Any amount paid or distributed out of a health savings account which is not used exclusively to pay the qualified medical expenses of the account beneficiary shall be included in the gross income of such beneficiary.

"(3) EXCESS CONTRIBUTIONS RETURNED BEFORE DUE DATE OF RETURN -

"(A) IN GENERAL - If any excess contribution is contributed for a taxable year to any health savings account of an individual, paragraph (2) shall not apply to distributions from the health savings accounts of such individual (to the extent such distributions do not exceed the aggregate excess contributions to all such accounts of such individual for such year) if–

"(i) such distribution is received by the individual on or before the last day prescribed by law (including extensions of time) for filing such individual’s return for such taxable year, and

"(ii) such distribution is accompanied by the amount of net income attributable to such excess contribution. Any net income described in clause (ii) shall be included in the gross income of the individual for the taxable year in which it is received.

"(B) EXCESS CONTRIBUTION - For purposes of subparagraph (A), the term ‘excess contribution’ means any contribution (other than a rollover contribution described in paragraph (5) or section 220(f)(5)) which is neither excludable from gross income under section 106(d) nor deductible under this section.

"(4) ADDITIONAL TAX ON DISTRIBUTIONS NOT USED FOR QUALIFIED MEDICAL EXPENSES -

"(A) IN GENERAL. The tax imposed by this chapter on the account beneficiary for any taxable year in which there is a payment or distribution from a health savings account of such beneficiary which is includible in gross income under paragraph (2) shall be increased by 10 percent of the amount which is so includible. "(B) EXCEPTION FOR DISABILITY OR DEATH - Subparagraph (A) shall not apply if the payment or distribution is made after the account beneficiary becomes disabled within the meaning of section 72(m)(7) or dies.

"(C) EXCEPTION FOR DISTRIBUTIONS AFTER MEDICARE ELIGIBILITY - Subparagraph (A) shall not apply to any payment or distribution after the date on which the account beneficiary attains the age specified in section 1811 of the Social Security Act.

"(5) ROLLOVER CONTRIBUTION - An amount is described in this paragraph as a rollover contribution if it meets the requirements of subparagraphs (A) and (B).

"(A) IN GENERAL - Paragraph (2) shall not apply to any amount paid or distributed from a health savings account to the account beneficiary to the extent the amount received is paid into a health savings account for the benefit of such beneficiary not later than the 60th day after the day on which the beneficiary receives the payment or distribution.

"(B) LIMITATION - This paragraph shall not apply to any amount described in subparagraph (A) received by an individual from a health savings account if, at any time during the 1-year period ending on the day of such receipt, such individual received any other amount described in subparagraph (A) from a health savings account which was not includible in the individual’s gross income because of the application of this paragraph.

"(6) COORDINATION WITH MEDICAL EXPENSE DEDUCTION -

For purposes of determining the amount of the deduction under section 213, any payment or distribution out of a health savings account for qualified medical expenses shall not be treated as an expense paid for medical care.

"(7) TRANSFER OF ACCOUNT INCIDENT TO DIVORCE - The transfer of an individual’s interest in a health savings account to an individual’s spouse or former spouse under a divorce or separation instrument described in subparagraph (A) of section 71(b)(2) shall not be considered a taxable transfer made by such individual notwithstanding any other provision of this subtitle, and such interest shall, after such transfer, be treated as a health savings account with respect to which such spouse is the account beneficiary.

"(8) TREATMENT AFTER DEATH OF ACCOUNT BENEFICIARY -

"(A) TREATMENT IF DESIGNATED BENEFICIARY IS SPOUSE - If the account beneficiary’s surviving spouse acquires such beneficiary’s interest in a health savings account by reason of being the designated beneficiary of such account at the death of the account beneficiary, such health savings account shall be treated as if the spouse were the account beneficiary.

"(B) OTHER CASES -

"(i) IN GENERAL - If, by reason of the death of the account beneficiary, any person acquires the account beneficiary’s interest in a health savings account in a case to which subparagraph (A) does not apply–

"(I) such account shall cease to be a health savings account as of the date of death, and

"(II) an amount equal to the fair market value of the assets in such account on such date shall be includible if such person is not the estate of such beneficiary, in such person’s gross income for the taxable year which includes such date, or if such person is the estate of such beneficiary, in such beneficiary’s gross income for the last taxable year of such beneficiary.

"(ii) SPECIAL RULES -

"(I) REDUCTION OF INCLUSION FOR PREDEATH EXPENSES - The amount includible in gross income under clause (i) by any person (other than the estate) shall be reduced by the amount of qualified medical expenses which were incurred by the decedent before the date of the decedent’s death and paid by such person within 1 year after such date.

"(II) DEDUCTION FOR ESTATE TAXES - An appropriate deduction shall be allowed under section 691(c) to any person (other than the decedent
or the decedent’s spouse) with respect to amounts included in gross income under clause (i) by such person.

"(g) COST-OF-LIVING ADJUSTMENT -

"(1) IN GENERAL. Each dollar amount in subsections (b)(2) and (c)(2)(A) shall be increased by an amount equal to–

"(A) such dollar amount, multiplied by

"(B) the cost-of-living adjustment determined under section 1(f)(3) for the calendar year in which such taxable year begins determined by substituting for ‘calendar year 1992’ in subparagraph (B) thereof–

"(i) except as provided in clause (ii), ‘calendar year 1997’, and

"(ii) in the case of each dollar amount in subsection (c)(2)(A), ‘calendar year 2003’.

"(2) ROUNDING - If any increase under paragraph (1) is not a multiple of $50, such increase shall be rounded to the nearest multiple of $50.

"(h) REPORTS - The Secretary may require–

"(1) the trustee of a health savings account to make such reports regarding such account to the Secretary and to the account beneficiary with respect to contributions, distributions, the return of excess contributions, and such other matters as the Secretary determines appropriate, and

"(2) any person who provides an individual with a high deductible health plan to make such reports to the Secretary and to the account beneficiary with respect to such plan as the Secretary determines appropriate. The reports required by this subsection shall be filed at such time and in such manner and furnished to such individuals at such time and in such manner as may be required by the Secretary.".

(b) DEDUCTION ALLOWED WHETHER OR NOT INDIVIDUAL ITEMIZES OTHER DEDUCTIONS - Subsection (a) of section 62 of such Code is amended by inserting after paragraph (18) the following new paragraph:

"(19) HEALTH SAVINGS ACCOUNTS - The deduction allowed by section 223.".

(c) ROLLOVERS FROM ARCHER MSAS PERMITTED - Subparagraph (A) of section 220(f)(5) of such Code (relating to rollover contribution) is amended by inserting "or a health savings account (as defined in section 223(d))" after "paid into an Archer MSA".

(d) EXCLUSIONS FOR EMPLOYER CONTRIBUTIONS TO HEALTH SAVINGS ACCOUNTS -

(1) EXCLUSION FROM INCOME TAX - Section 106 of such Code (relating to contributions by employer to accident and health plans) is amended by adding at the end the following new subsection:

"(d) CONTRIBUTIONS TO HEALTH SAVINGS ACCOUNTS -

"(1) IN GENERAL - In the case of an employee who is an eligible individual (as defined in section 223(c)(1)), amounts contributed by such employee’s employer to any health savings account (as defined in section 223(d)) of such employee shall be treated as employer-provided coverage for medical expenses
under an accident or health plan to the extent such amounts do not exceed the limitation under section 223(b) (determined without regard to this subsection) which is applicable to such employee for such taxable year.

"(2) SPECIAL RULES - Rules similar to the rules of paragraphs (2), (3), (4), and (5) of subsection (b) shall apply for purposes of this subsection.

"(3) CROSS REFERENCE -

"For penalty on failure by employer to make comparable contributions to the health savings accounts of comparable employees, see section 4980G.".

(2) EXCLUSION FROM EMPLOYMENT TAXES -

(A) RAILROAD RETIREMENT TAX - Subsection (e) of section 3231 of such Code is amended by adding at the end the following new paragraph:

"(11) HEALTH SAVINGS ACCOUNT CONTRIBUTIONS - The term ‘ compensation’ shall not include any payment made to or for the benefit of an employee if at the time of such payment it is reasonable to believe that the employee will be able to exclude such payment from income under section 106(d).".

(B) UNEMPLOYMENT TAX - Subsection (b) of section 3306 of such Code is amended by striking "or" at the end of paragraph (16), by striking the period at the end of paragraph (17) and inserting "; or", and by inserting after paragraph (17) the following new paragraph:

"(18) any payment made to or for the benefit of an employee if at the time of such payment it is reasonable to believe that the employee will be able to exclude such payment from income under section 106(d).".

(C) WITHHOLDING TAX - Subsection (a) of section 3401 of such Code is amended by striking "or" at the end of paragraph (20), by striking the period at the end of paragraph (21) and inserting "; or", and by inserting after paragraph (21) the following new paragraph:

"(22) any payment made to or for the benefit of an employee if at the time of such payment it is reasonable to believe that the employee will be able to exclude such payment from income under section 106(d).".

(3) EMPLOYER CONTRIBUTIONS REQUIRED TO BE SHOWN ON W-2 - Subsection (a) of section 6051 of such Code is amended by striking "and" at the end of paragraph (10), by striking the period at the end of paragraph (11) and inserting ", and", and by inserting after paragraph (11) the following new paragraph:

"(12) the amount contributed to any health savings account (as defined in section 223(d)) of such employee or such employee’s spouse.".

(4) PENALTY FOR FAILURE OF EMPLOYER TO MAKE COMPARABLE HEALTH SAVINGS ACCOUNT CONTRIBUTIONS -

(A) IN GENERAL - Chapter 43 of such Code is amended by adding after section 4980F the following new section:

" SEC. 4980G. FAILURE OF EMPLOYER TO MAKE COMPARABLE HEALTH SAVINGS ACCOUNT CONTRIBUTIONS.

"(a) GENERAL RULE - In the case of an employer who makes a contribution to the health savings account of any employee during a calendar year, there is hereby imposed a tax on the failure of such employer to meet the requirements of subsection (b) for such calendar year.

"(b) RULES AND REQUIREMENTS - Rules and requirements similar to the rules and requirements of section 4980E shall apply for purposes of this section.

"(c) REGULATIONS - The Secretary shall issue regulations to carry out the purposes of this section, including regulations providing special rules for employers who make contributions to Archer MSAs and health savings accounts during the calendar year.". (B) CLERICAL AMENDMENT - The table of sections for chapter 43 of such Code is amended by adding after the item relating to section 4980F the following new item:

"Sec. 4980G. Failure of employer to make comparable health savings account contributions.".

(e) TAX ON EXCESS CONTRIBUTIONS - Section 4973 of such Code (relating to tax on excess contributions to certain tax-favored accounts and annuities) is amended-

(1) by striking "or" at the end of subsection (a)(3), by inserting "or" at the end of subsection (a)(4), and by inserting after subsection (a)(4) the following new paragraph:

"(5) a health savings account (within the meaning of section 223(d)),", and

(2) by adding at the end the following new subsection:

"(g) EXCESS CONTRIBUTIONS TO HEALTH SAVINGS ACCOUNTS - For purposes of this section, in the case of health savings accounts (within the meaning of section 223(d)), the term ‘excess contributions’ means the sum of -

"(1) the aggregate amount contributed for the taxable year to the accounts (other than a rollover contribution described in section 220(f)(5) or 223(f)(5)) which is neither excludable from gross income under section 106(d) nor allowable as a deduction under section 223 for such year, and

"(2) the amount determined under this subsection for the preceding taxable year, reduced by the sum of -

"(A) the distributions out of the accounts which were included in gross income under section 223(f)(2), and

"(B) the excess (if any) of -

"(i) the maximum amount allowable as a deduction under section 223(b) (determined without regard to section 106(d)) for the taxable year, over

"(ii) the amount contributed to the accounts for the taxable year.For purposes of this subsection, any contribution which is distributed out of the health savings account in a distribution to which section 223(f)(3) applies shall be treated as an amount not contributed.".

(f) TAX ON PROHIBITED TRANSACTIONS -

(1) Section 4975 of such Code (relating to tax on prohibited transactions) is amended by adding at the end of subsection (c) the following new paragraph:

"(6) SPECIAL RULE FOR HEALTH SAVINGS ACCOUNTS - An individual for whose benefit a health savings account (within the meaning of section 223(d)) is established shall be exempt from the tax imposed by this section with respect to any transaction concerning such account (which would otherwise be taxable under this section) if, with respect to such transaction, the account ceases to be a health savings account by reason of the application of section 223(e)(2) to such account.".

(2) Paragraph (1) of section 4975(e) of such Code is amended by redesignating subparagraphs (E) and (F) as subparagraphs (F) and (G), respectively, and by inserting after subparagraph (D) the following new subparagraph:

"(E) a health savings account described in section 223(d),".

(g) FAILURE TO PROVIDE REPORTS ON HEALTH SAVINGS ACCOUNTS - Paragraph (2) of section 6693(a) of such Code (relating to reports) is amended by redesignating subparagraphs (C) and (D) as subparagraphs (D) and (E), respectively, and by inserting after subparagraph (B) the following new subparagraph:"(C) section 223(h) (relating to health savings accounts),".

(h) EXCEPTION FROM CAPITALIZATION OF POLICY ACQUISITION EXPENSES - Subparagraph (B) of section 848(e)(1) of such Code (defining specified insurance contract) is amended by striking "and" at the end of clause (iii), by striking the period at the end of clause (iv) and inserting ", and", and by adding at the end the following new clause:

"(v) any contract which is a health savings account (as defined in section 223(d)).".

(i) HEALTH SAVINGS ACCOUNTS MAY BE OFFERED UNDER CAFETERIA PLANS - Paragraph (2) of section 125(d) (relating to cafeteria
plan defined) is amended by adding at the end the following new subparagraph:

"(D) EXCEPTION FOR HEALTH SAVINGS ACCOUNTS - Subparagraph (A) shall not apply to a plan to the extent of amounts which a covered employee may elect to have the employer pay as contributions to a health savings account established on behalf of the employee.".

(j) CLERICAL AMENDMENT - The table of sections for part VII of subchapter B of chapter 1 of such Code is amended by striking the last item and inserting the following:

"Sec. 223. Health savings accounts.".

"Sec. 224. Cross reference.".

(k) EFFECTIVE DATE - The amendments made by this section shall apply to taxable years beginning after December 31, 2003.

SEC. 1202. EXCLUSION FROM GROSS INCOME OF CERTAIN FEDERAL SUBSIDIES FOR PRESCRIPTION DRUG PLANS.

(a) IN GENERAL. Part III of subchapter B of chapter 1 of the Internal Revenue Code of 1986 is amended by inserting after section 139 the following new section:

"SEC. 139A. FEDERAL SUBSIDIES FOR PRESCRIPTION DRUG PLANS.

"Gross income shall not include any special subsidy payment received under section 1860D–22 of the Social Security Act. This section shall not be taken into account for purposes of determining whether any deduction is allowable with respect to any cost taken into account in determining such payment.".

(b) ALTERNATIVE MINIMUM TAX RELIEF. Section 56(g)(4)(B) of such Code is amended by inserting "or 139A" after "section 114".

(c) CONFORMING AMENDMENT. The table of sections for part III of subchapter B of chapter 1 of such Code is amended by inserting after the item relating to section 139 the following new item:

"Sec. 139A. Federal subsidies for prescription drug plans".

(d) EFFECTIVE DATE. The amendments made by this section shall apply to taxable years ending after the date of the enactment of this Act.

SEC. 1203. EXCEPTION TO INFORMATION REPORTING REQUIREMENTS RELATED TO CERTAIN HEALTH ARRANGEMENTS.

(a) IN GENERAL. Section 6041 of the Internal Revenue Code of 1986 (relating to information at source) is amended by adding at the end the following new subsection:

"(f) SECTION DOES NOT APPLY TO CERTAIN HEALTH ARRANGEMENTS.

This section shall not apply to any payment for medical care (as defined in section 213(d)) made under -

"(1) a flexible spending arrangement (as defined in section 106(c)(2)), or

"(2) a health reimbursement arrangement which is treated as employer provided coverage under an accident or health plan for purposes of section 106.".

(b) EFFECTIVE DATE. The amendment made by this section shall apply to payments made after December 31, 2002.

Approved December 8, 2003.

Last Updated: May 10, 2024