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Melanie Franco Nussdorf, Esq.
Steptoe & Johnson LLP
1330 Connecticut Avenue, NW
Washington, DC 20036-1795
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2002-05A
PTE 77-4
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Dear Ms. Nussdorf:
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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.
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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.
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Section II(a) of PTE 77-4 provides that the plan must not pay a sales
commission in connection with such purchase or sale.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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)
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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.
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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.
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Sincerely,
Ivan L. Strasfeld
Director, Office of Exemption Determinations
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The Department notes PTE 77-4 would
not apply to the in-kind purchase or sale of ETF creation units by
employee benefit plans.
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