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Lennine Occhino
Mayer, Brown & Platt
190 South La Salle Street
Chicago, Illinois 60603-3441
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1999-16A
ERISA Sec. 406(b)(1)
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Dear Ms. Occhino:
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This is in response to your request for an advisory
opinion concerning whether the payment of certain performance-based
compensation to Mount Lucas Management Corporation (Mount Lucas) by
employee benefit plan clients would violate section 406(b) of the Employee
Retirement Income Security Act of 1974 (ERISA) or section 4975 of the
Internal Revenue Code of 1986 (the Code).(1)
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You represent that Mount Lucas is a registered investment adviser under the
Investment Advisers Act of 1940, a registered commodity trading advisor (CTA),
and a registered commodity pool operator under the Commodity Exchange Act.
Mount Lucas offers investment management services to a wide range of
institutional clients, including pension and profit-sharing plans qualified
under Code section 401(a) and subject to ERISA. Mount Lucas acts as
investment manager for individual plan accounts (Accounts), as the general
partner of a limited partnership available for plan asset investments in
amounts of not less than $2,000,000, and as the manager of a business trust
that is likewise available for plan asset investments.
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By written agreement with client plans, Mount Lucas invests certain plan
assets in commodity futures and forward contracts, and in options on
commodities and commodity futures contracts. For this purpose, Mount Lucas
directs the trading itself and may also employ the services of other CTAs.(2)
Mount Lucas offers both passive and active management of client funds.(3)
For actively managed Accounts of sufficient size (in excess of $6,000,000),
Mount Lucas may recommend to the plan fiduciary that additional, independent
CTAs be retained by Mount Lucas on behalf of the plan to the extent Mount
Lucas determines that such additional services are necessary to satisfy
Mount Lucas' stated diversification policy.(4)
In such situations, Mount Lucas recommends specific CTAs to the plan
fiduciary that it believes are suited to the needs of the Account. All
decisions regarding the appointment of additional CTAs are made by the plan
fiduciary. Mount Lucas and the CTAs make the actual investment decisions on
behalf of the Accounts for which they are retained and have full
discretionary authority over the trading of the plan assets allocated to
their control. Where additional CTAs have been appointed, Mount Lucas
allocates investment authority over the assets in Accounts among the CTAs
and monitors, supervises, and recommends replacement of the CTAs. Mount
Lucas pays the CTAs for their services out of the fees that Mount Lucas
receives from the plans. All brokers utilized by Mount Lucas and the CTAs in
executing trades are independent of Mount Lucas and the CTAs.
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The assets in Accounts for which Mount Lucas has
investment authority consist principally of futures and option contracts
that are traded on recognized futures exchanges regulated by the Commodity
Futures Trading Commission (CFTC), the value of which can be readily
determined by reference to their settlement prices determined at the close
of trading each business day on the particular exchange. You represent
that each exchange or its clearinghouse has established rules regulating
the determination of settlement prices. Settlement prices are thus
objectively determined by third parties independent of Mount Lucas.
Settlement prices are available from many independent, widely available
sources, including the Wall Street Journal and the New York Times, as well
as data services such as CGQ, Quotron and Reuters. You further represent
that, while a small number of futures and options contracts covering the
same or similar commodities are traded on more than one exchange,
contracts from different exchanges are generally not fungible and cannot
be used to offset each other. Therefore, contracts that are traded on one
exchange can only be valued and offset on that exchange.(5)
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You represent that an Account may also include foreign currency forward
contracts that are traded in the interbank market, which is estimated to
have a volume of approximately $300 billion a day. The interbank market is a
24-hour worldwide market with participants including major commercial banks,
investment banks, securities and commodities brokers and dealers, pension
funds, insurance companies, and multinational companies. In addition to
quotations regarding such contracts received directly from market
participants, services such as Reuters and Telerate provide continuous and
reliable market quotations on these foreign currency forward contracts. You
represent that it is Mount Lucas’ intention and understanding that, with
respect to plan Accounts, the plan's custodian (generally, the plan trustee,
who is independent of Mount Lucas and any of its affiliates) can and does
value such contracts on the basis of widely disseminated quotations
available from independent services, such as a particular "page"
offered by Reuters and Telerate that provides bid and ask quotes on a
particular currency by major banks which regularly trade such currencies.
The particular source of the valuation and the timing of the valuation are
expressly agreed upon by a plan trustee and Mount Lucas and set forth in
writing at the time Mount Lucas’ services are obtained for an Account.
Foreign currency forward contracts are thus valued by third parties
independent of Mount Lucas. In no event will Mount Lucas value such
contracts. Mount Lucas does not invest the assets of any Account in any
contracts that are not of sufficient size to be traded on the interbank
market(6) or that are not capable of
being readily and objectively valued by the independent plan fiduciary by
reference to established market settlement prices and quotations.
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You further represent that, for Mount Lucas’ services, a client plan may
be charged, subject to arm’s-length negotiation, the following basic fees:
(1) a monthly or quarterly fixed fee, negotiated at arm's length with each
client plan, that ranges from .50 to 1.50% per annum of the value of the
plan's net assets under management (this fee may decline as a percentage as
the amount of the plan’s assets under Mount Lucas’ management
increases); and (2) the performance fee discussed below. The other expenses
borne by client plans are the actual brokerage costs charged by brokerage
firms not affiliated with Mount Lucas (estimated to range from 2.40% to
3.20% per year of the value of the plan assets under management). You
represent that Mount Lucas believes that its fees are lower than the average
fees charged by other registered commodity trading advisors for the
provision of similar services. Mount Lucas also believes that the total
amount of fees charged to any client plan, including any performance fees,
is not more than reasonable compensation for the services rendered to that
plan by Mount Lucas.
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For some clients and some trading programs, Mount Lucas’ fees include an
annual performance fee. Mount Lucas offers such a performance-based fee
arrangement only to plans with assets of at least $50,000,000, and no such
plan is permitted to place more than ten percent of its total assets under
Mount Lucas' management. You represent that Mount Lucas' performance fee
arrangements comply in all material respects with the requirements of
Investment Advisers Act Rule 205-3 of the Securities and Exchange Commission
(SEC Rule 205-3), governing performance compensation arrangements of
investment advisors, and with all applicable CFTC rules. Client plans must
pay the fixed fee and brokerage costs regardless of whether Mount Lucas
earns a performance fee for any performance period (generally the calendar
year). Any earned performance fee is paid on a pre-specified, agreed-upon
date at the end of the annual performance period, which is generally
December 31 of each year. Where Mount Lucas retains independent CTAs for an
Account, Mount Lucas receives all fees and distributes to the selected CTAs
their earned portions as determined under a preestablished written formula.
That formula provides that performance fees are paid to the CTAs only in the
event that the net performance of the Account results in a performance fee
being paid to Mount Lucas.
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In the case of client plans that choose a performance-fee arrangement, the
performance fee is established, through arms-length negotiation, as a
specified percentage of the amount by which the “cumulative profits”
(Cumulative Profits)(7) of a plan
client’s Account at the end of a performance period exceed the highest
level of Cumulative Profits for that Account as of the end of any prior
performance period. The performance fee will be paid only in the event that
the combined performance of Mount Lucas and any CTAs results in a “new
high level” of Cumulative Profits relative to the Cumulative Profits at
the end of any prior annual performance period.(8)
A "new high level” of Cumulative Profits is reached under the
contract only when the Cumulative Profits for a client's Account for a
performance period are higher than the Cumulative Profits for any previous
performance period. Under this formula, any losses suffered by an Account as
of the end of any prior annual performance period under the particular
investment management agreement with Mount Lucas must be recouped before any
new performance fee may be earned.
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Under the terms of some of its performance-fee arrangements, Mount Lucas is
entitled to a performance fee only if the Cumulative Profits of an Account,
in addition to exceeding the highest level of prior Cumulative Profits for
that Account, also exceeds a preestablished "hurdle rate." The
“hurdle rate” is selected by the plan's independent fiduciary, but in
most cases is the MLM Index Profit (the Index Profit), a figure that is
derived from the MLM Index (the Index).
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You represent that use of the Index Profit to establish the “hurdle
rate” that determines, in part, whether a performance fee has been earned
assures objectivity because of the nature of the calculations on which the
Index Profit is based. You explain that the Index is an index of commodities
futures contracts that is designed to reflect the way that commodity
traders, including Mount Lucas, earn profits with respect to a broadly
diversified managed futures portfolio. The Index, which is owned and managed
by Mount Lucas, is based on the daily closing prices of contracts for the 25
largest U.S. futures markets in different commodities.(9)
A determination as to which markets are to be included in the Index is made
in the December preceding the start of each year, and markets are not added
or deleted from the Index during the year. For each market included in the
Index, four delivery months are used for the return calculation. In general,
the delivery months included are "nearby" -- i.e., those due to
expire as of the next, or second next, but are not in, the physical delivery
period, as specified by the sponsoring exchange. Thus, the selection of the
markets to be included in the Index each year is done on a purely objective
basis, and the calculation of the return for each market is a mechanical
operation. You further represent that the Index is published daily by
Bloomberg Financial Services on its financial data service.
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The Index is used, under Mount Lucas’ performance-fee arrangements, to
determine "Index Profit" in the following manner. Each month the
beginning assets of each Account are multiplied by that month's “Index
rate of return,” and the results are summed over the annual performance
period. For this purpose, a month’s “Index rate of return” equals the
“risk-free rate(10) for the assets
under consideration for that month, plus the arithmetic (i.e., non-weighted)
average of the rates of return of the 25 individual markets.(11)
The sum of the twelve monthly results of this computation during the
performance period equals the Index Profit for that Account for that
performance period.
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You have represented that the determination of whether a performance fee has
been earned is made on an agreed-upon specified date at the end of the
annual performance period, which is generally December 31. To make that
determination, the initial Account value for the year, the net trading
income (or loss), and the interest income attributable to that Account are
added together. The fixed management fees charged to that Account are
calculated as a percentage of this total. The fixed fees, interest income,
and other expenses are then subtracted from the net trading income to
determine the net gain on which the performance fee is based. In the event
that a loss due to trading occurs in a particular year, the fixed fees are
charged to the client plan, but no performance fee can be earned for that
year.
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The value of an Account and its daily trading profit (or loss) are
determined each day by totaling the results of all realized futures,
options, and foreign currency forward trades (after commissions), plus the
value of all open positions (determined as described above). You represent
that Mount Lucas, the plan trustee, and the broker each generate information
necessary to calculate the daily trading profits. For the larger Accounts,
the plan trustee provides and maintains the official record of daily trading
profits upon which the performance fee is based. Mount Lucas collects daily
transaction records for each Account and, where required, provides a
consolidated record of the transactions and their prices to the plan
trustee. Mount Lucas also verifies this record with the broker. Also, at the
end of each day, the plan trustee obtains settlement prices for open
positions from independent third-party data services of its choice.(12)
The results of the daily trading for each Account are added together on a
cumulative basis on December 31 of each year to determine whether trading
profits have been earned that year.(13)
The plan trustee then confirms the calculations necessary to determine
whether Mount Lucas has earned a performance fee, using this cumulative
record of trading results to determine whether a new high level of
Cumulative Profits has been achieved and applying the Index Profit figure,
if applicable.
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You represent that a plan’s decision whether to retain Mount Lucas and to
pay a performance-based fee is, in all cases, made by a plan fiduciary who
is independent of Mount Lucas. You further represent that the present and
anticipated future client plans of Mount Lucas generally operate through
investment committees comprised of senior financial officers of the
corporate plan sponsors. These investment committees take an active role in
determining the investment of plan assets.
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You further represent that an independent plan
fiduciary may include in the investment management agreement a provision
that requires Mount Lucas to notify the fiduciary and stop trading if
losses in an Account reach a certain, pre-determined level. Furthermore,
the level of portfolio margin(14) in
the Account (which appears in monthly statements that are provided by the
independent broker to the plan) discloses the degree of risk to which an
Account is currently exposed. An independent plan fiduciary is able
therefore to monitor whether Mount Lucas or a CTA has altered the degree
of risk to which an Account is exposed by reviewing the monthly statements
for changes in the level of margin. Finally, you represent that Mount
Lucas has in place procedures to prevent Mount Lucas or the CTAs from
taking a “straddle position(15) with
respect to two or more clients for the purpose of ensuring themselves a
performance fee.
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You represent that either party to a performance-fee
arrangement may terminate the arrangement upon thirty to forty-five days'
notice, or such shorter period as the parties may agree upon. In the event
that either Mount Lucas or a plan terminates the arrangement on other than
an annual valuation date, a determination of whether a performance fee has
been earned will be made through the effective date of termination.
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You request an advisory opinion that client plans’
payment of a performance-based fee to Mount Lucas under the conditions and
circumstances described above will not constitute a violation of section
406(b) of ERISA.
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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 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 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 provides that a fiduciary with respect to a
plan shall not 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 and beneficiaries.
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Section 3(14) of ERISA defines the term "party in
interest" to include a fiduciary and a person providing services to a
plan.
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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 therefor.
Regulations issued by the Department of Labor (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). In this regard, you have not
requested an opinion that the proposed provision of services by Mount
Lucas complies with the requirements of section 408(b)(2) of ERISA. 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.
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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).
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As explained in regulation 29 CFR §2550.408b-2(e), 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.
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Based on the representations contained in your
submission, it is the Department's view that the payment of a performance
fee pursuant to the specific arrangement described above would not, in
itself, constitute a violation of section 406(b)(1) of ERISA. It appears
that the amount of compensation that Mount Lucas would earn depends solely
on the changes in value of the contracts in the individual Account as
compared to the performance of the Account at the end of prior calendar
years, and, in some cases, to the Index, as determined by readily
available market quotations or independent valuations. Therefore, in the
situation you describe, it appears that Mount Lucas would not be
exercising any of its fiduciary authority or control to cause a plan to
pay an additional fee. Moreover, it does not appear that Mount Lucas would
be acting on behalf of, or representing, a person whose interests are
adverse to the plan merely because it enters into an agreement to provide
investment management services pursuant to the arrangement described
above. Accordingly, based on your representations, it is the Department's
view that payment of a performance fee pursuant to such arrangement would
not, in itself, constitute a violation of section 406(b)(2) of ERISA.
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However, if, in operation, the provision of services by
Mount Lucas pursuant to the described arrangement results in a divergence
of interests between a plan and Mount Lucas, violations of sections
406(b)(1) and 406(b)(2) could occur. Accordingly, the Department is unable
to rule that the described arrangement, in operation, would not violate
those sections. For instance, results of trading activity in an Account
(e.g., substantial losses in a short period of time) could cause the
interests of the plan (to minimize losses) and Mount Lucas (to earn a
performance fee) to diverge with respect to the acceptable degree of
investment risk in the plan's Account, causing Mount Lucas to invest plan
assets, in violation of section 406(b)(1) and 406(b)(2), in contracts with
a higher degree of risk than is appropriate for or acceptable to the plan.
This divergence of interests could occur at a level of loss that is short
of the level of loss that would trigger an agreement to halt trading by
Mount Lucas. Monthly disclosure of changes in the level of portfolio
margin in an Account may not be sufficiently timely to inform the plan's
independent fiduciary of a divergence of interests. In addition, the
Department is not addressing issues relating to a fiduciary's allocation
of investment opportunities among other Accounts over which he has
discretion.(16)
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ERISA's general standards of fiduciary conduct also
would apply to the proposed arrangement. Section 404 requires a fiduciary,
among other things, to discharge his duties respecting a plan solely in
the interest of the plan's participants and beneficiaries and in a prudent
fashion. Accordingly, the plan fiduciary must act prudently with respect
to the decision to invest in futures contracts and related investment
vehicles, and to enter into a performance-based compensation arrangement
with an investment manager, as well as the negotiation of the specific
formula under which compensation will be paid. It is the Department’s
view that in these circumstances a fiduciary could not act prudently in
making decisions respecting such performance-based compensation
arrangements unless the fiduciary had obtained all relevant information
pertaining to the proposed arrangement with the investment manager and
fully understood the compensation formula and the risks associated with
this manner of compensation. A fiduciary making such decisions should also
fully understand the risks involved in the particular types of investments
being made by the manager. The fiduciary should understand, for example,
that futures markets may be more volatile than securities markets, and
that there is a potential for a performance-based compensation formula to
induce the investment manager to make riskier investments than he would
make in the absence of such a formula.
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In addition, the plan fiduciary must be able to, and
must in fact, periodically monitor the actions taken by the manager in the
performance of its investment duties, with a frequency appropriate to the
nature of the investment(s), and must be able to, and must in fact, take
appropriate action when necessary. For example, if, during the course of a
plan's relationship with Mount Lucas, a divergence of interests develops
between the plan and Mount Lucas, the plan fiduciary must be able to
detect the divergence and take steps to eliminate the conflict of interest
in order to avoid a possible fiduciary breach and prohibited transaction.
Accordingly, in considering whether to enter into an arrangement of the
kind described in your letter, a fiduciary should take into account its
ability to provide adequate oversight of the investment manager. Finally,
we also note that, under section 405(a) of ERISA, any plan fiduciary
(including an investment manager) will have co-fiduciary liability for any
breach of fiduciary responsibility of another plan fiduciary: (1) if he
knowingly participates in or conceals such breach; (2) if by his failure
to comply with section 404(a)(1), he enables another fiduciary to commit
such a breach; or (3) if he has knowledge of the breach of another
fiduciary and he fails to make a reasonable effort to remedy the breach.
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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. This opinion
relates only to the specific issues raised by your request. For example,
the Department is expressing no opinion with respect to the selection and
retention of trading advisors, or the allocation of plan assets among such
advisors.
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Sincerely,
Susan G. Lahne
Chief, Division of Fiduciary Interpretations
Office of Regulations and Interpretations
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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.
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You have acknowledged that Mount
Lucas and any other trading advisors are all fiduciaries with respect
to investing plans, as defined in section 3(21) of ERISA.
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Passively managed accounts are
invested in a portfolio of futures contracts that replicates the MLM
Index, an index of commodities futures contracts. Such accounts are
not the subject of this opinion.
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Mount Lucas decides whether to
recommend the retention of independent CTAs for an Account based on an
analysis of each CTA's stated trading methods and the relationship of
those methods to the other trading programs selected for that Account.
Each CTA generally must disclose its past and present trading programs
in the Disclosure Document the CTA is required to file with the
Commodity Futures Trading Commission and to provide to prospective
investors.
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You represent that there are two
limited exceptions to this general rule. The Chicago Mercantile
Exchange (CME) and the Singapore International Monetary Exchange (SIME)
have established an inter-exchange linkage pursuant to which a trader
on the CME can establish or close out contract positions when the CME
is closed by entering an order through its CME clearing member for
execution on the SIME floor or through SIME’s electronic order and
execution and trading facility. If a contract position is closed out
on the SIME, the price (and any gain or loss) is determined at the
time the transaction is executed on the SIME. If a contract position
is established on the SIME, the price is determined at the time the
transaction is executed and any gain or loss on the position will be
determined by reference to the settlement price established by the CME
as of the close of trading on the next business day. After the order
is executed, it is automatically transferred back to the CME as of the
close of trading on the SIME (prior to the commencement of trading the
next day on the CME) and is treated in all respects as any other CME
contract, including margin and settlement price determinations. The
Comex Division of the New York Mercantile Exchange and the Sydney
(Australia) Futures Exchange have established a similar linkage.
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In this respect, you represent that
interbank trades will occur in large denominations in units of
$5,000,000 (or its foreign currency equivalent).
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Cumulative Profit is defined in
these performance-fee arrangements to mean the aggregate of total
profit (or loss) earned by the Account during each annual performance
period, calculated on the basis of all realized and unrealized gains
and losses, since the inception of the plan's relationship with Mount
Lucas. Interest earned on the assets in the Account is not included in
profits for purposes of the performance fee calculation. For purposes
of the performance fee, Cumulative Profits of an Account are
calculated solely on the combined results from the trading of futures,
forward, and option contracts by Mount Lucas, all of the CTAs
servicing that Account, or both, net of the fixed fee, all brokerage
commissions, transaction fees, and all other expenses borne by the
Account, excepting previously paid performance fees. All gains and
losses, both realized and unrealized, during the performance period
are included in computing Cumulative Profits.
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In those cases when Mount Lucas has
retained independent CTAs for an Account, a CTA's share of an earned
performance fee is proportionate to that advisor's contribution to the
Cumulative Profit of an Account.
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The size of the individual futures
markets is measured by the dollar value of open interests in each
market. If two markets for the same commodity are found to be among
the 25 largest markets, only the larger of the two is included in the
Index, and the next largest market in a commodity not represented in
the Index is included. You represent that six of the 25 markets
currently included in the Index are foreign currencies.
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The "risk-free rate" is an
objective measure of what the same assets could earn for the monthly
period if they were invested in Treasury Bills of comparable duration.
You represent that an investment in futures or options is not
considered to generate a "real" return until it has exceeded
the “risk-free rate.”
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The rate of return for each
individual market depends on whether the market position is long or
short. The market position is long during a particular month if the
unit asset value of the commodity for the prior month is above the
market's 12-month moving average; otherwise the market position is
short. The determination of market position is made on the
next-to-last trading day of the month, the market position is
established on the last trading day of the month, and that position is
held throughout the coming month. If the market position is long, the
market monthly rate of return equals the percentage change in the
market price during the month. If the market position is short, the
market monthly rate of return equals -1 (negative one) times the
percentage change in the market price during the month. You represent
that this calculation ensures that the movement of the market in
relative terms during a particular month, rather than the direction
that it moves, is the most relevant factor in determining if a
commodity trader has earned an above- market profit.
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Mount Lucas also obtains settlement
prices for open positions from a third-party data service and
determines the realized and unrealized trading results. However, in
the event that the figures obtained and generated by Mount Lucas
differ from those of the plan trustee, those of the plan trustee are
utilized.
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In determining whether a performance
fee has been earned with respect to the first annual performance
period of an Account (for which there is no prior annual performance
period and, hence, no Cumulative Profit), a determination is made
whether any trading profits were earned for the first performance
period and, if applicable, whether that profit exceeded the Index
Profit. The performance fee is then calculated as the agreed-upon
percentage of any such profit.
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"Margin" is a small
percentage of a futures contract face amount that a customer is
required to post with the relevant exchange or its clearinghouse. This
margin is in the nature of a performance bond or good faith deposit on
the contract. The amount of margin required with respect to a
particular contract is related to the volatility of the contract and
is established by the exchange on which the relevant contract is
traded. In addition, the amount of margin that a customer needs to
maintain with respect to a particular contract will fluctuate as the
value of the contract fluctuates. Thus, it differs in nature from
margin as used in securities transactions, where margin is money
borrowed by the customer to finance a transaction.
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A straddle position involves taking
offsetting positions with respect to the same futures or options
contract. Taking a straddle position on a contract with respect to two
or more clients would ensure that at least one of them would earn a
profit on the particular contract, while the other client(s) would be
ensured of a loss.
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We note, moreover, that to the
extent that Mount Lucas or a CTA takes a “straddle position” (see,
fn. 15, above) with respect to one or more plan clients, for the
purpose of assuring itself a performance fee from one or the other of
its clients, Mount Lucas or such CTA would violate sections 406(b)(1)
and 406(b)(2).
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