Identify and Avoid theMost Common Prohibited Transactions

Kevin Walsh, Esq.Associate

Groom Law Groupkwalsh@groom.com

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Goals for Today

Understand the basic fiduciary provisions of ERISA

Identify “prohibited transactions”

Have a framework for researching and evaluating whether a “prohibited transaction exemption” is available

Understand consequences of non-exempt prohibited transactions

Agenda

ERISA overview

The two types of prohibited transactions

Exemption basics

Tools for analyzing exemptions

Examples of using our exemption analysis framework

Consequences of non-exempt prohibited transactions

Questions

ERISA: Background and Purpose

ERISA became the law of the land in 1974

Balances goals of (1) encouraging employers to offer retirement plans, and (2) ensuring that retirement savers are adequately protected

Makes certain entities and individuals “fiduciaries”

Focus of regulators has shifted somewhat over time

• Originally, fear that plan assets would be mismanaged so defined benefit participants would not receive promised benefit

• More and more, fear that plan participants in defined contribution plans disadvantaged by conflicted advice and hidden costs

ERISA Overview

ERISA’s basic structure: everything is prohibited unless an exemption permits otherwise.

But just because something might be a prohibited transaction doesn’t mean you can’t do it---concept of exemptions.

ERISA’s statutory text describes very broad prohibited transaction rules.

ERISA’s statutory text plus administrative guidance from the Department of Labor sets out exemptive relief.

Prohibited Transaction Overview

ERISA’s prohibited transaction rules apply to:

• Any plan covered by ERISA –including welfare plans

• Plan asset “vehicles”

• Code section 4975 at IRAs and HSAs

Two types of prohibited transactions:

• “Party-in-interest” transactions

• “Self-dealing” transactions

406(a) Prohibited Transactions

• Who is a “party in interest”?

• What can’t a plan do with a party in interest?

• Sale or exchange between a plan and a party in interest

• Any loan or extension of credit between a plan and a party in interest

• Any transfer of assets from the plan

• Use of plan assets by or the benefit of a party in interest

“Party-in-interest” transactions

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3(14)(A) - Fiduciary:

•Named Fiduciary

•Plan administrator

•Trustee

•Custodian

•Investment Advisor 3(14)(B)

Service Provider

3(14)(G)

Any entity 50%

owned (directly

or indirectly) by a

Fiduciary

Plan

3(14)(F)

Relative

3(14)(F)

Relative

3(14)(H)

10% owner

(direct or

indirect)

3(14)(H)

Employee

Officer

Director

3(14)(G)

Any entity 50%

owned (directly

or indirectly) by a

Service Provider

3(14)(C)

Employer of

employees covered

by the Plan

3(14)(D) UNION

An employee

organization whose

members are

covered by the Plan

A B

CD

3(14)(H)

Employee

Officer

Director

3(14)(H)

Employee

Officer

Director

3(14)(H)

10% owner

(direct or

indirect)

3(14)(H)

10% owner

(direct or

indirect)

3(14)(H)

Employee

Officer

Director

3(14)(H)

10% owner

(direct or

indirect)

3(14)(H)

Employee

Officer

Director

3(14)(G)

Any entity 50%

owned (directly

or indirectly) by an

Employer or and (E)

3(14)(H)

Employee

Officer

Director

3(14)(H)

10% owner

(direct or

indirect)

3(14)(F)

Relative

3(14)(H)

10% owner

(direct or

indirect)

3(14)(E)

50% owner

(direct or

indirect)

3(14)(H)

Employee

Officer

Director

3(14)(E)

50% owner

(direct or

indirect)

3(14)(G) Any entity

50% owned (directly

or indirectly) by an

Employer organization

or an (E)

3(14)(H)

10% owner

(direct or

indirect)

3(14)(H)

Employee

Officer

Director

3(14)(F)

Relative

3(14)(F)

Relative

“PARTY-IN-INTEREST”

STATUS - § 3(14)

Examples of “Party-in-Interest” Transactions

“Party-in-interest” transactions

The plan sells an investment that it owns to

the plan sponsor

The plan sponsor guarantees a loan to a

plan

406(b) Prohibited Transactions

Self-dealing prohibited transactions.

• Discretion over plan assets

• Provider of investment advice

• Discretion over plan administration

Who is a fiduciary?

• Using assets for his or her own interest for his or her own account

• Representing an adverse party in a transaction involving a plan (can’t represent both sides of a transaction)

• Receiving consideration for a personal account from any party dealing with a plan transaction involving plan assets

Fiduciaries are prohibited from:

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Prohibited Transactions “Real” Conflicts by Fiduciaries

• Self-Dealing

– Fiduciary deals with plan assets “in own interest”

– Intent not relevant

– Example: Plan’s purchase of bond from investment manager’s affiliate even if fair price

– Example: Fiduciary consultant recommends own service or product

• Representing Both Sides

– Fiduciary represents both plan and counterparty in transaction between them

– Example: A trade between two accounts managed by the same manager (or affiliated managers)

• “Kickbacks”

– Fiduciary receives “consideration” from party involved in plan transaction

– Example: Fiduciary consultant receives a commission from insurer in connection with policy recommended by consultant

Examples of Self-DealingProhibited Transactions

Fiduciary-prohibited transactions

A fiduciary hires his son to provide services to a plan

A fiduciary invests in a fund that will pay fees to

an affiliate of the fiduciary

Exemption Basics

What are exemptions?

• Statutory Exemptions

• Administrative Class Exemptions

• Administrative Individual Exemptions

• Other Guidance

Where would I find an exemption?

Statutory Exemptions

Commonly used statutory exemptions

ERISA section 408(b)(2): reasonable

compensation/services

ERISA section 408(b)(8): collective investment

trusts

ERISA section 408(b)(17): transactions with plan

service providers

Administrative Class Exemptions

Commonly used class exemptions

PTEs 77-3 and 77-4: mutual fund exemptions

PTE 84-14: qualified professional asset managers

PTE 91-38 and PTE 90-1: bank collective trusts and insurance

pooled separate accounts

Individual Exemptions

Individual prohibited transaction exemptions

• Exemption needs to be:

• Administratively feasible

• In the interests of the plan, its participants, and beneficiaries

• Protective of the rights of participants and beneficiaries

• Individual exemptions and EXPRO (PTE 96-62)

• A “fast track” procedure to obtain an individual exemption

• However, only available if you can point to “substantially similar” exemptive relief already granted by the DOL

Other Guidance

Non-Exemptions

• Occasionally DOL provides relief through temporary enforcement policies or other guidance

Tools for Analyzing an Exemption

Regulatory Class Exemption Key Questions

Key Questions

Which transactions do

the guidance apply to?

What type of relief does the

exemption provide?

Can I meet the conditions?

Statutory Class Exemption Key Questions

Key Questions

What is the text of the statute?

Has DOL interpreted the

exemption?

Which transactions do

the guidance apply to?

What type of relief does the

exemption provide?

Can I meet the conditions?

Non-Exemption Key Questions

Key Questions

Which transactions do

the guidance apply to?

What type of relief does the

guidance provide?

Can I meet the conditions?

How is this different than an exemption?

Regulatory Example

PTE 77-4, Section II

Which transactions do the exemption

apply to?

• The purchase or sale of an open-ended investment company, 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

PTE 77-4, Section II

What type of relief does the exemption

provide?

• 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

PTE 77-4, Section II

Can I meet the conditions?

• The Plan does not pay a sales commission in connection with such purchase or sale

• The Plan does not pay a redemption fee unless the redemption fee is only paid to the investment company and the existence of the fee is disclosed in the prospectus at the time of purchase and at the time of the sale

• The Plan does not pay an investment management, investment advisory fee, or similar fee with respect to the plan assets invested in such shares for the entire period of the investment. The investment company is permitted to pay investment advisory fees.

• A second Plan fiduciary, who is independent, receives a current prospectus, full and detailed disclosure of fees charged to or paid by the plan, the reasons why the first fiduciary considers the purchase to be appropriate for the Plan, and any limitations on the first fiduciary with respect to the assets that would be invested in the investment company.

• On the basis of the disclosure, the second fiduciary approves of the fees to be paid by the investment company in writing

• The disclosure and approval is updated should there be a change in fees

Statutory Example with Minimal Guidance

408(b)(8)

What is the text of the statute?

• The prohibitions provided in section 406 shall not apply to ... any transaction between a plan and ... a ... 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 transaction is a sale or purchase of an interest in the fund,

• The bank, trust company ... receives no more than reasonable compensation, and

• 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 thereof) who has authority to manage and control the assets of the plan

408(b)(8)

Has DOL interpreted the

statute?

• In Advisory Opinion 96-15A, DOL interpreted 408(b)(8) to clarify that:

• The exemption provides relief from sections 406(a)(1), 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 its funds

408(b)(8)

Which transactions do the exemption

apply to?

• The purchase or sale by a bank or trust company, as fiduciary of ERISA-covered plans, of interests in its funds

408(b)(8)

What type of relief does the exemption

provide?

• Sections 406(a)(1), 406(a)(1)(D), 406(b)(1) and 406(b)(2)

• Does not cover the receipt of consideration for a personal account from any party dealing with a plan transaction involving plan assets

408(b)(8)

Can I meet the conditions?

• Is it a sale or purchase of an interest in a CIT?

• Am I a bank or trust company?

• Am I receiving no more than reasonable compensation?

• Is the transaction expressly permitted by an instrument of the plan or has it been approved by an independent discretionary fiduciary?

Statutory Example with Formal Regulation

408(b)(2)

What is the text of the statute?

• The prohibitions provided in section 406 shall not apply to ... 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 therefor

408(b)(2)

Has DOL interpreted the

statute?

• Yes, it has issued a regulation

• DOL’s regulations clarify that acts described in ERISA section 406(b) are “separate transactions” not exempted by ERISA section 408(b)(2)

• The implementing regulations under ERISA section 408(b)(2) provide that a contract will not be a reasonable contract unless the service provider discloses, among other things, all compensation it will receive (directly or indirectly) in connection with its services to the plan

408(b)(2)

Which transactions do the exemption

apply to?

• The payment of fees to and the provision of reasonable and necessary services by a party in interest to a plan pursuant to a contract for reasonable fees

408(b)(2)

What type of relief does the exemption

provide?

•Relief from 406(a)’s “party-in-interest” prohibited transaction provisions

408(b)(2)

Can I meet the conditions?

• Are the services necessary for the establishment or operation of the plan?

• Are the services to be furnished under a contract or arrangement that is reasonable?

• Will no more than reasonable compensation be paid for such services?

• Has all compensation to be received (directly or indirectly) in connection with the services been disclosed in writing to the plan?

Non-Exemption Example

Field Assistance Bulletin 2018-02

Which transactions do the guidance

apply to?

• Transactions that would have been exempted had the Best Interest Contract Exemption and Principal Transactions Exemption not been vacated

Field Assistance Bulletin 2018-02

What type of relief does the guidance

provide?

•The Department will not pursue prohibited transaction claims

Field Assistance Bulletin 2018-02

Can I meet the conditions?

• Would the transaction have been exempt under the Best Interest Contract Exemption or the Principal Transactions Exemption?

• Am I working diligently and in good faith to comply with the impartial conduct standards?

• What are the impartial conduct standards?

• Provide advice that reflects 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 like aims, based on the investment objectives, risk tolerance, financial circumstances, and needs of the retirement investor, without regard to the financial or other interest of the advisor, financial institution or any affiliate, related entity or other party

• Receive no more than reasonable compensation

• Avoid materially misleading statements

Field Assistance Bulletin 2018-02

How is this different than an

exemption?

• Guidance is easier to revoke without notice

• Possibly leaves third-parties able to assert prohibited transaction claims

Consequences

PERSONAL LIABILITY – A fiduciary is liable for: – Losses to plan arising from his or her violation– Profit earned by fiduciary in connection with violation

EXCISE TAXES – Owed to IRS under the Code on prohibited transactions – By counterparty (party in interest) if violation of 406(a)– By fiduciary, if violation of fiduciary conflict rules

CO-FIDUCIARY LIABILITY – A fiduciary may be liable for the actions of another fiduciary if:– It knowingly participates in another fiduciary’s breach– In committing his or her own breach, he or she allows another fiduciary to

commit a breach, or– It has knowledge of a breach by another fiduciary and fails to take reasonable

steps to remedy it

Consequences of Engaging in a Non-Exempt Prohibited Transaction

ERISA section 409 imposes personal liability for breaches of fiduciary responsibilities

Such liability includes personal liability to :

• Make good any losses to the plan

• Restore any profits earned by the fiduciary through the use of plan assets

• Other equitable or remedial relief as a “court may deem appropriate, including removal of such fiduciary”

Prohibited transactions are also required to be reported on Form 5500 (Schedule H), which may result in collateral consequences

Consequences of Engaging in a Non-Exempt Prohibited Transaction

Tax of 15 percent of the “amount involved” per calendar year until correction

Potential tax to 100 percent of the “amount involved” if the prohibited transaction is not corrected

Increased private litigation risk

Enforcement and Litigation

Department of Labor enforcement

• Role in investigations

• Voluntary compliance letters

• Settlement and litigation

Private litigation

• Common claims

• How prohibited transactions play out in litigation

Questions?

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