PWBA Office of Exemption Determinations

DEPARTMENT OF LABOR

Pension and Welfare Benefits Administration

[Application Nos. D-5598 and D-5776]

Amendment to Prohibited Transaction Exemption (PTE) 81-6

Involving Lending of Securities by Employee Benefit Plans

Agency: Pension and Welfare Benefits Administration, Department of Labor.

Action: Adoption of amendment to PTE 81-6.

Summary: This document amends PTE 81-6. PTE 81-6 is a class exemption that permits the lending of securities by employee benefit plans to certain broker-dealers and banks which are parties in interest with respect to the plans. The amendment affects participants, beneficiaries and fiduciaries of plans engaging in the described transactions, banks, and certain broker-dealers.

Effective Date: January 23, 1981.

For Further Information Contact: Paul Kelty of the Office of Regulations and Interpretations, Pension and Welfare Benefits Administration, Department of Labor, (202) 523-8196. This is not a toll-free number.

Supplementary Information: On March 21, 1986, notice was published in the Federal Register (51 FR 9900) of the pendency before the Department of two proposed amendments to PTE 81-6. PTE 81-6 provides an exemption from the prohibited transaction restrictions of section 406(a)(1)(A) through (D) of the Employee Retirement Income Security Act of 1974 (ERISA or the Act) and from the taxes imposed by section 4975(a) and (b) of the Internal Revenue Code of 1986 (the Code) by reason of section 4975(c)(1)(A) through (D) of the Code.

Manufacturers Hanover Trust Company (Manufacturers Hanover) requested the first proposed amendment to PTE 81-6 by application dated June 29, 1984 (Application No. D-5598). The second proposed amendment was requested by Merrill Lynch, Pierce, Fenner & Smith (Merrill Lynch) in an application dated September 26, 1984 (Application No. D-5776). Both applications were submitted pursuant to section 408(a) of ERISA and section 4975(c)(2) of the Code¹ and in accordance with ERISA Procedure 75-1 (40 FR 18471, April 28, 1975). The amendment requested by Merrill Lynch was withdrawn by the applicant by letter dated January 9, 1987.

Information collection requirements contained in PTE 81-6 have been approved by the Office of Management and Budget under the provisions of the Paperwork Reduction Act of 1980 (Pub. L. 96-511) and have been assigned OMB $#1210-0065 approved for use through May 31, 1987.

The notice gave interested persons an opportunity to comment on the proposal. Public comments were received pursuant to the provisions of section 408(a) of ERISA and section 4975(c)(2) of the Code and in accordance with the procedures set forth in ERISA Procedure 75-1.

1. Description of the Exemption

PTE 81-6 permits an employee benefit plan to lend securities to a broker-dealer registered under the Securities Exchange Act of 1934 (the 1934 Act) or to a bank, provided certain conditions are met. These conditions include a requirement that the lending plan must receive from the borrower collateral consisting of cash, securities issued or guaranteed by the United States Government or its agencies, or irrevocable bank letters of credit. In the absence of an exemption, securities lending transactions would be prohibited under circumstances where the borrowing broker-dealer or bank is a party in interest or disqualified person with respect to the plan under section 3(14) of ERISA or section 4975(e)(2) of the Code.

The amendment to PTE 81-6 granted pursuant to this notice, requested by Manufactures Hanover, adds broker-dealers which are exempted from registration under section 15(a)(1) of the 1934 Act as dealers in exempted Government securities to the categories of securities borrowers with whom plans may engage in transactions in reliance on the class exemption. The amendment requested by Merrill Lynch would have expended the types of permissible collateral under the exemption to include qualifying irrevocable surety bonds. Since Merrill Lynch no longer contemplates the use of surety bonds as collateral in securities lending transactions and, therefore, has withdrawn its request for exemptive relief, the proposed amendment has not been adopted. For the sake of convenience, the entire text of PTE 81-6, as amended, is reprinted with this notice.

2. Discussion of Comments Received

The Department received three letters commenting on various aspects of the proposed amendments to PTE 81-6. Both the American Bankers Association (ABA) and the California Bankers Association expressed support for the proposal. A letter from the ABA noted that under the existing class exemption, a bank trustee of an employee benefit plan would be hesitant to lend securities to a dealer in Government securities if the dealer is not registered under the 1934 Act unless it can clearly be demonstrated that the dealer is not a party in interest with respect to the plan. According to the ABA, the burden of proving that a dealer is not a party in interest may be a deterrent to making the securities loan. However, Government securities dealers are major market participants and plans should not be precluded from lending securities to them. The ABA stated that, if the proposed amendments were adopted, employee benefit plans would benefit from the additional income resulting from the wider universe of eligible borrowers.

A letter submitted on behalf of the Committee on Securities Lending of the Robert Morris Associates, a trade group of over 35 banks representing securities lenders, asserted that the availability of surety bonds as acceptable collateral under PTE 81-6 would diminish the level of protection for employee benefit plans lending securities. In view of Merrill Lynch's decision to withdraw its request for amendment of PTE 81-6, it is unnecessary for the Department to respond to this comment.

3. Miscellaneous

Paragraph 2 of PTE 81-6 states that "securities issued or guaranteed by the United States Government or its agencies" are acceptable collateral to secure loans of securities made in reliance on the class exemption. The Department was asked by a fourth commentator to clarify the scope of the phrase "securities issued or guaranteed by the United States Government or its agencies." In this respect, the Department has concluded that obligations of instrumentalities of the United States Government are sufficiently similar to U.S. Government obligations that they are appropriate collateral for securities lending transactions. Thus, the Department has modified paragraph 2 of the final exemption to clearly indicate that securities issued or guaranteed by instrumentalities of the U.S. Government are acceptable collateral.²

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 ERISA does not relieve a fiduciary or other party in interest or disqualified person from certain other provisions of ERISA 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 ERISA which require, among other things, that a fiduciary discharge his or her duties respecting the plan solely in the interests of the participants and beneficiaries of the plan; 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 ERISA, the Department makes the following determinations:

(i) The amendment set forth herein is administratively feasible,

(ii) It is in the interests of plans and of their participants and beneficiaries, and

(iii) It is protective of the rights of the participants and beneficiaries of plans;

(3) The class exemption is applicable to a particular transaction only if the transaction satisfies the conditions specified in the exemption; and

(4) The amendment is supplemental to, and not in derogation of, any other provisions of ERISA 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.

;Exemption;

Accordingly, PTE 81-6 amended under the authority of section 408(a) of ERISA and section 4975(c)(2) of the Code and in accordance with ERISA Procedure 75-1 [40 FR 18471, April 28, 1975].

Effective January 23, 1981, the restrictions of section 408(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)(1) 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 CFR 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 instrumentalities, 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 or, in the case of letters of credit a stated amount, equal to not less than 100 percent of the then 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;

(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;

6. 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.

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.

7. 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

8. 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.

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: (i) Any person directly or indirectly, through one or more intermediaries, controlling, controlled by, or under common control with such other person; (ii) any officer, director, or partner, employee or relative (as defined in section 3(15) of the Act) of such other person; and (iii) 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.

Signed at Washington, D.C., this 13th day of May, 1987.

David M. Walker
Deputy Assistant Secretary
Pension and Welfare Benefits
Administration
U.S. Department of Labor

¹Section 102 of Reorganization Plan No. 4 of 1978 (43 FR 47713, October 17, 1978), effective December 31, 1978 (44 FR 1065, January 3, 1979), transferred the authority of the Secretary of the Treasury to issue exemptions of this type to the Secretary of Labor.

²In the Department's view, it would not be proper for a plan fiduciary to accept U.S. Government or Governmental instrumentality securities as collateral in a securities lending transaction unless the securities are sufficiently liquid to be readily marketable in the event of default. U.S. Government securities were included within the categories of permissible collateral under the original exemption because such securities are essentially treated by investors as being equivalent to cash.

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