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2003-09A
ERISA Sec. 406(b)(1), 406(b)(3)
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Gary W. Howell
Gardner, Carton & Douglas
191 North Wacker Drive, Suite 3700
Chicago, IL 60606
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Dear Mr. Howell:
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This is in response to your request for guidance under
the Employee Retirement Income Security Act of 1974 (ERISA). In
particular, you ask whether a trust company’s receipt of 12b-1 and
subtransfer fees from mutual funds, the investment advisers of which are
affiliates of the trust company, for services in connection with
investment by employee benefit plans in the mutual funds, would violate
section 406(b)(1) and 406(b)(3) of ERISA when the decision to invest in
such funds is made by an employee benefit plan fiduciary or participant
who is independent of the trust company and its affiliates.
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You write on behalf of ABN AMRO Trust Services Company (AATSC), a
state-chartered trust company. You represent that AATSC is a wholly owned
subsidiary of Alleghany Asset Management Company (Alleghany), which is a
wholly owned subsidiary of ABN-AMRO North America Holding Company, a bank
holding company (ABN-AMRO).(1)
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Alleghany is also the parent organization of several institutional
investment advisers (Advisers), including some that have entered into
investment advisory contracts with mutual funds registered under the
Investment Company Act of 1940. You refer to those mutual funds with which
such Advisers have investment advisory contracts as ‘Proprietary Funds.’
All other mutual funds are referred to as ‘Non-Proprietary Funds.’
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You represent that AATSC provides directed trustee and ‘non-fiduciary’
services to participant-directed and other defined contribution pension
plans (Client Plans) through ‘bundled service’ arrangements. You
represent that these services (Plan Services) provided by AATSC through
bundled service arrangements include, but are not limited to, custodial
trustee services, participant level recordkeeping, participant
communications and educational materials and programs, voice response system
access to accounts for participants, plan documentation, including prototype
plans, summary plan descriptions and annual reports, tax compliance
assistance, administrative assistance in processing plan distributions and
loans, and a facility for plan investment options.
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In connection with the Client Plan-related business,
AATSC has entered into shareholder service arrangements with distributors
of, or investment advisers to, mutual fund families pursuant to which
AATSC will make mutual fund families available for investment by Client
Plans. Among the investment advisers with which AATSC enters into such
arrangements are those Advisers with investment advisory contracts with
Proprietary Funds.
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You represent that neither AATSC, nor any other bundled service provider of
which AATSC is aware, engages in arrangements where just Plan Services are
provided. You represent that, because the true cost of Plan Services would
exceed any amount that could be charged in the competitive bundled service
market with regard to a Client Plan’s engagement of AATSC as a bundled
service provider, all bundled service arrangements between AATSC and a
Client Plan are predicated on a Client Plan’s offering of one or more
Proprietary Funds as an investment option.
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You represent that disclosures with regard to Proprietary
Funds will enable the fiduciaries of potential Client Plans to make an
informed decision regarding whether to engage AATSC in a bundled service
arrangement. Included in every proposal made by AATSC to a potential Client
Plan are the following disclosures regarding each Proprietary Fund offered:
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the total number of actively-managed
mutual funds in the same category as the Proprietary Fund (based on fund
classifications by Lipper, Morningstar, or some other generally
recognized mutual fund analytical service);
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the investment advisory fee, 12b-1 fee
(if any) and other fees paid by the Proprietary Fund, as well as the
aggregate fees paid by such Proprietary Fund; and
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the same fee information described in
(b) with respect to the highest-fee, lowest-fee, median-fee, and
average-fee fund in the same category as the Proprietary Fund.
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You represent that participant-directed and other
defined contribution pension plans become Client Plans through a process
of presentation and negotiation. Typically, a plan sponsor, on behalf of a
potential Client Plan, either directly, or through a third-party
consultant, will ask AATSC to respond to a ‘request for proposal’ to
provide a bundle of services for the plan, such as recordkeeping, directed
trusteeship, participant investment education, participant loan and
distribution processing and investment vehicles. You represent that a
potential Client Plan will typically ask other bundled service providers
also to respond to a request for proposal.
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Client Plan fiduciaries select the funds in which the Client Plans will
invest. AATSC does not restrict the mutual funds that a Client Plan may
utilize, beyond requiring, as a condition of engagement, that a Client Plan
select at least one Proprietary Fund to offer as an investment option. AATSC
will, if requested, provide a list of investment funds for the Client Plan
to consider. The Client Plan fiduciaries are free to select funds other than
those listed by AATSC. Your representations indicate that AATSC, under the
terms of a bundled service arrangement, will not be able to assert any
influence with respect to selection of other investment options in which
Client Plans will invest or the particular Proprietary Fund in which the
Client Plan elects to invest.
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Potential Client Plan fiduciaries are free to accept, reject or further
negotiate a bundled service arrangement from AATSC. Based upon such
flexibility on the part of a potential Client Plan with respect to
negotiation of the terms surrounding engagement of AATSC to provide Plan
Services, you represent that engagement of AATSC results from arm’s length
negotiations between a potential Client Plan and AATSC.
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You represent that a Client Plan’s choice of investment vehicles affects
the cost of engaging AATSC to provide Plan Services. AATSC estimates the
amounts that a potential Client Plan would likely invest in Proprietary
Funds based on the amount of the Client Plan’s assets and the number of
Proprietary Funds selected. This estimate affects the price at which AATSC
offers to perform Plan Services. For example, if Client Plan fiduciaries may
direct investment into three Proprietary Funds, Plan Services would cost
less than if Client Plan fiduciaries may direct investment into two
Proprietary Funds. Similarly, Client Plan fiduciaries that may direct
investment into only one Proprietary Fund would be quoted a higher price for
bundled services, because AATSC would expect to cover less of the cost of
providing Plan Services from asset management revenue.
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As a directed trustee, AATSC takes direction from
Client Plans regarding their selection of investment options. You assert
that, because AATSC does not restrict the mutual funds that a potential
Client Plan may utilize, the preparation and furnishing of a list offering
an array of mutual fund choices does not constitute discretion to add or
delete mutual fund families in which Client Plans may invest.
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You represent that if a Client Plan decides to remove a
Proprietary Fund as an investment option, AATSC’s total anticipated
revenue from the Client Plan and Proprietary Fund would be affected,
leaving less asset management revenue with which to provide Plan Services.
In such a situation, you represent that AATSC would invite the Client Plan
fiduciaries to consider one or more other Proprietary Funds to replace
non-Proprietary Fund investment options. If the plan fiduciaries do not
choose to offer another Proprietary Fund as an investment option, AATSC
would continue to provide Plan Services pursuant to the bundled services
arrangement, but would evaluate such arrangement, as follows.
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If AATSC determines that a bundled service arrangement
is no longer profitable, AATSC can withdraw or make an offer to the Client
Plan fiduciaries to renegotiate the fees for AATSC’s provision of Plan
Services. You represent that AATSC’s bundled service arrangements
generally include a provision whereby AATSC may propose a fee adjustment
upon sixty days’ written notice. In addition, either party can terminate
a bundled service arrangement without cause, upon at least thirty days’
advance written notice. Upon termination of a bundled service arrangement,
funds are transferred on the effective date of appointment of a successor
trustee.
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You represent that AATSC has the systems and
administrative capability to provide investment facilities to a Client
Plan for any mutual fund that accepts investments from pension plans. You
represent that the majority of mutual funds are traded by AATSC on the
National Securities Clearing Corporation (NSCC) ‘platform’ for
processing transactions in mutual funds. Mutual fund transactions
processed through NSCC’s ‘Fund/SERV’ service are made on its
standard, highly automated platform that links approximately 2,000 key
providers in the mutual fund industry, including AATSC. For those few
funds utilized by Client Plans that do not participate in NSCC, generally
because of their small size or low volume of trades, you represent that
AATSC processes trades manually, in a manner consistent with industry
practice.
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You ask whether AATSC’s receipt of 12b-1 and
subtransfer agency fees from mutual funds, including those Proprietary
Funds the investment advisers of which are affiliates of AATSC, for
services in connection with investment by employee benefit plans in the
mutual funds, would violate section 406(b)(1) and 406(b)(3) of ERISA when
the decision to invest in such funds is made by an employee benefit plan
fiduciary who is independent of AATSC and its affiliates.(2)
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Section 3(14)(A) and (B) of ERISA provides that a party
in interest means, as to an employee benefit plan, any fiduciary,
including a trustee, of an employee benefit plan or a person providing
services to a plan. ERISA section 3(21)(A) provides that a person is a
fiduciary with respect to a plan to the extent that it (i) exercises any
authority or control respecting management or disposition of its assets,
(ii) 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) has any discretionary
authority or responsibility in the administration of the plan.
Accordingly, as directed trustee of Client Plans, AATSC will be a party in
interest and a fiduciary.
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Section 406(a)(1)(C) of ERISA proscribes the provision
of services to a plan by a party in interest, including a fiduciary, and
section 406(a)(1)(D) prohibits the use by or for the benefit of, a party
in interest, of the assets of a plan. However, section 408(b)(2) of ERISA
provides an exemption from the prohibitions of section 406(a) of ERISA for
contracting or making reasonable arrangements 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.
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29 CFR 2550.408b-2 provides, with respect to a
reasonable contract or arrangement, that no contract or arrangement is
reasonable within the meaning of section 408(b)(2) and 29 CFR
2550.408b-2(a)(2) if it does not permit termination by the plan without
penalty to the plan on reasonably short notice under the circumstances to
prevent the plan from becoming locked into an arrangement that has become
disadvantageous. Your representations indicate that, pursuant to the
Client Plan’s arrangement with AATSC and consistent with 29 CFR
2550.408b-2(c), the Client Plan may terminate a bundled service
arrangement without cause and without penalty, upon at least thirty days’
advance written notice.(3)
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Section 406(b)(1) of ERISA prohibits a fiduciary with
respect to a plan from dealing with the assets of the plan in its own
interest or for its own account. Section 406(b)(3) of ERISA prohibits a
fiduciary with respect to a plan from receiving any consideration for its
own personal account from any party dealing with the plan in connection
with a transaction involving the assets of the plan.
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With respect to the prohibitions in section 406(b),
regulation 29 CFR 2550.408b-2(a) indicates that section 408(b)(2) of ERISA
does not contain an exemption for an act described in section 406(b) of
ERISA (relating to conflicts of interest on the part of fiduciaries) even
if such act occurs in connection with a provision of services which is
exempt under section 408(b)(2). As explained in regulation 29 CFR
2550.408b-2(e)(1), if a fiduciary uses the authority, control, or
responsibility which makes it a fiduciary to cause the plan to enter into
a transaction involving the provision of services when such fiduciary has
an interest in the transaction which may affect the exercise of its best
judgment as a fiduciary, a transaction described in section 406(b)(1)
would occur, and that transaction would be deemed to be a separate
transaction from the transaction involving the provision of services and
would not be exempted by section 408(b)(2). Conversely, the regulation
explains that a fiduciary does not engage in an act described in section
406(b)(1) if the fiduciary does not use any of the authority, control, or
responsibility which makes such person 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 such fiduciary has an
interest which may affect the exercise of such fiduciary’s best judgment
as a fiduciary.
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You assert that principles previously expressed by the
Department in Advisory Opinion 97-15A(4)
would apply here. In Advisory Opinion 97-15A, the Department opined that
if a trustee acts pursuant to a proper direction in accordance with
sections 403(a)(1) or 404(c) of ERISA and does not exercise any authority
or control to cause a plan to invest in a mutual fund that pays a fee to
the trustee in connection with the plan’s investment, then the trustee
would not be dealing with assets of the plan for its own interest or for
its own account in violation of section 406(b)(1) of ERISA and the trustee
would not be receiving consideration for itself from a third party in
connection with a transaction involving plan assets in violation of
section 406(b)(3).
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The arrangement about which you request the Department’s
guidance differs from the facts of Advisory Opinion 97-15A. In that
letter, the trustee had reserved the right to add or remove mutual fund
families that it made available to its client plans. The trustee also
agreed to apply any fees it received from the mutual funds to the benefit
of the plans. You represent that, once a Client Plan enters into a bundled
service arrangement with AATSC, the Client Plan fiduciary possesses
authority to make decisions regarding investment fund choices and any
modifications to the menu of investment fund choices available for
investment of plan assets.
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In Advisory Opinion 97-16A,(5)
the Department expressed the view that a person would not be exercising
discretionary authority or control over the management of a plan or its
assets solely as a result of deleting or substituting a fund from a
program of investment options and services offered to plans, provided that
the appropriate plan fiduciary in fact makes the decision to accept or
reject the change. In this regard, the Department went on to opine that
the plan fiduciary must be provided advance notice of the change,
including disclosure of record-keeper fee information and must be afforded
a reasonable amount of time in which to accept or reject the change. Such
advance notice ensured that the fiduciary would maintain independence with
respect to selection of investment options offered. Similar to the
arrangement described in Advisory Opinion 97-16A, here a Client Plan
sponsor or other fiduciary shall, independent of AATSC, maintain complete
control with respect to the selection of funds in which the Client Plan
will invest. AATSC itself has no role with respect to selection of
investment options beyond requiring, as a condition of initial engagement
of AATSC as a bundled service provider, that at least one Proprietary Fund
is offered by a Client Plan for investment.
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You represent that when a Client Plan engages AATSC to
provide bundled services, a Client Plan fiduciary, independent of AATSC or
its affiliates, will select the Client Plan’s investment options. We
note, however, that if, with respect to a particular Client Plan, AATSC
provides ‘investment advice’ within the meaning of regulation 29 CFR
2510.3-21(c), AATSC would engage in a violation of section 406(b)(1) of
ERISA in causing the Client Plan to invest in a Proprietary Fund (or any
mutual fund that pays a fee to AATSC or its affiliates).
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It is the view of the Department that AATSC’s receipt
of 12b-1 or subtransfer fees from mutual funds, including those
Proprietary Funds the investment advisers of which are affiliates of AATSC,
for services in connection with investment by employee benefit plans in
the mutual funds, under the circumstances described above, would not
violate section 406(b)(1) or 406(b)(3) of ERISA when the decision to
invest in such funds is made by a fiduciary who is independent of AATSC
and its affiliates, or by participants of such employee benefit plans.
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Finally, it should be noted that ERISA’s general
standards of fiduciary conduct also would apply to the proposed
arrangement. Section 403(c)(1) of ERISA provides that the assets of a plan
shall never inure to the benefit of any employer and shall be held for the
exclusive purposes of providing benefits to participants and beneficiaries
and defraying reasonable expenses of administering the plan. Under section
404(a)(1) of ERISA, the responsible plan fiduciaries must act prudently
and solely in the interest of the plan participants and beneficiaries both
in deciding whether to enter into, or continue, arrangements with AATSC
and in determining the investment options in which to invest or make
available to plan participants and beneficiaries in self-directed plans.
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This letter constitutes an advisory opinion under ERISA
Procedure 76-1, 41 Fed. Reg. 36281 (Aug. 27, 1976). Accordingly, it is
issued subject to the provisions of that procedure, including section 10
thereof relating to the effect of advisory opinions.
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Sincerely,
Louis Campagna
Chief, Division of Fiduciary Interpretations
Office of Regulations and Interpretations
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In your initial submission, you
wrote on behalf of The Chicago Trust Company (TCTC). Since the date of
submission, TCTC has been renamed AATSC, effective January 1, 2002.
This change is in name only and was effected without any legal change
in the individual corporate status of TCTC. AATSC continues as a
state-chartered trust company under the original charter and corporate
status granted by the state to the former TCTC, and remains in the
same legal relationship, by way of ownership, to Alleghany and
ABN-AMRO.
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Consistent with Prohibited
Transaction Exemption 96-74, granted to TCTC, TCTC will never receive
any 12b-1 or subtransfer agency fees from its Proprietary Funds in
connection with the conversion of certain collective investment fund
units into shares of Proprietary Funds. Furthermore, you represent
that AATSC relies upon Prohibited Transaction Class Exemption 77-4 to
cover situations where AATSC may serve as a fiduciary to a Client Plan
with authority to select investments, including Proprietary Funds. In
Advisory Opinions 93-12A and 93-13A, the Department expressed the view
that it was unable to conclude that PTE 77-4 would be available for
plan purchases and sales of mutual fund shares if a 12b-1 fee is paid
to the fiduciary or its affiliate with regard to that portion of the
mutual fund’s assets attributable to the plan’s investment.
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The Department expresses no view as
to whether the conditions contained in section 408(b)(2) of ERISA
would be satisfied with respect to any arrangement between AATSC and a
Client Plan.
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Issued on May 22, 1997.
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Issued on May 22, 1997.
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