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2004-05A
ERISA Sec. 406(a)(1)(A),(D)
406(b)(1),(2)
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Mr. William R. Charyk
Arent Fox Kintner Plotkin & Kahn, PLLC
1050 Connecticut Avenue, NW
Washington, DC 20036-5339
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Dear Mr. Charyk:
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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.
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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.
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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.
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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).
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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.
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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.
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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.
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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.
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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.
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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.
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With respect to purchases and sales of equity securities, we note that the
Conference Report accompanying ERISA states that:
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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).
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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.
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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.
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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.
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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.
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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. 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.
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Sincerely,
Louis Campagna
Chief, Division of Fiduciary Interpretations
Office of Regulations and Interpretations
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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.
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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).
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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.
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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.
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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).
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