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Lisa J. Bleier
Senior Counsel
Regulatory and Trust Affairs
American Bankers Association
1120 Connecticut Avenue, NW
Washington, DC 20036
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2003-02A
ERISA Sec. 408(b)(2) and 408(b)(6)
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Dear Ms. Bleier:
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This is in response to your request, on behalf of the American Bankers
Association, regarding the fiduciary responsibility provisions of the
Employee Retirement Income Security Act of 1974, as amended (ERISA).
Specifically, you have requested an opinion clarifying the application of
sections 408(b)(2) and 408(b)(6) of ERISA to the provision of overdraft
protection services, including any inherent extension of credit incident to
such services, by banks, whether or not the bank or other financial
institution or affiliate exercises investment discretion over plan assets.(1)
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You represent that banks provide custodial or trust services to
institutional clients, including employee benefit plans. A bank or its
affiliate may also serve as investment manager for plans and other clients
or as trustee and investment manager of collective funds in which plans
invest. An essential part of bank custodial and trust services provided to
clients, including employee benefit plans, is the orderly processing of the
client’s securities and other financial market transactions, generally
based on the anticipated receipt of funds to cover such transactions. In
this regard, you indicate that banks have established settlement policies
and procedures to maximize the efficiency of the securities trading in
institutional accounts.
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You note that plan investment performance would suffer significantly if a
bank held up settlements to ensure that every sale scheduled to settle (thus
generating funds necessary to effectuate subsequent transactions) had in
fact settled or that anticipated funds had indeed been received. You
represent that, although most transactions settle on time, settlement
problems may arise due to errors, unexpected delays by a counterparty or its
agent, settlement failures by a counterparty or its custodian, broker
failures or inefficient markets. In the event of such a failure, banks will
generally settle plan transactions without contemporaneous assurance that
the necessary funds have been credited, in the correct currency, to the plan’s
account. You represent that this overdraft protection is provided as part of
a bank’s and its sub-custodians’ “standard operating systems and
practices maintained routinely for all institutional customers.” Overdraft
protection is necessary to the custody service and is expected and demanded
by plan and non-plan clients.
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You explain that unlike a conventional loan between a plan and a bank,
overdraft protection involves no agreement to lend a stated sum for a
specified period of time. Events giving rise to an overdraft are generally
inadvertent or outside the control of the bank or affiliate. A bank or an
affiliate makes no specific discretionary decision to extend overdraft
protection at the time of the settlement of a transaction and neither the
plan nor its investment fiduciary makes a specific discretionary decision at
that time to accept it. In fact, although the client is aware that overdraft
protection is available, when needed, neither the client nor the bank is
likely to be aware of the existence of any particular overdraft or its
amount at the time that overdraft protection is actually provided. Banks
recognize the extent to which overdrafts occur only in retrospect upon
reconciliation of client accounts. Further, you represent that banks have
procedures in place to discourage overdrafts and prevent clients, including
plans, from using the overdraft protection as an intentional line of credit.
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Your letter contains the following general information about overdraft
protection procedures. Overdraft protection procedures are designed to
ensure that overdraft protection is consistent with sound banking practice
under published positions of both the Office of the Comptroller of the
Currency and the Federal Reserve Board.(2)
According to your letter, bank procedures, as well as agreements with plan
clients, ensure that the terms of overdraft protection are at least as
favorable to plans as the terms generally available in arm's length
transactions between unrelated parties. After an overdraft is determined, a
bank promptly notifies the appropriate investment manager or other plan
fiduciary to determine the course of action that the fiduciary will take to
correct the overdraft. Notice may be provided by telephone, facsimile,
e-mail, through a bank's secure Web site or by some alternative method
directed by the plan. Banks generally impose an overdraft charge and intend
that such charge function as a disincentive for the investment fiduciary to
intentionally prolong an overdraft. The overdraft charge is based on an
objective measure that varies depending upon factors such as the custody
location or currency involved. The overdraft charge may be defined by
reference to an identified published rate. The overdraft charge, according
to your letter, does not exceed "reasonable compensation."
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You represent that banks disclose and obtain the consent of plan clients to
the provision of overdraft protection. Bank disclosures describe the
overdraft protection service and identify the objective basis for the
overdraft charge. Consent may be affirmative if the plan client signs a
trust, custody, or other agreement describing the services. Alternatively,
consent may be deemed given following disclosure of the services.
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As a trustee or custodian, a bank is a party in interest with respect to
each plan. ERISA section 3(14) defines “party in interest” to include,
among others, a fiduciary or person who provides services to a plan. Absent
an exemption, a bank’s provision of overdraft protection, as described
herein, to plans would violate sections 406(a)(1)(C) and (D) of ERISA, which
prohibit the provision of services by a party in interest to a plan and the
transfer of assets from a plan to a party in interest. In addition, absent
an exemption, any extension of credit between the bank and plan that may
occur in connection with the overdraft protection would violate section
406(a)(1)(B) of ERISA. Moreover, if a bank uses any of the authority,
control, or responsibility that makes the bank a fiduciary to cause a plan
to pay to the bank an overdraft charge, the bank may violate sections
406(b)(1) and (2) of ERISA.
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As discussed below, it is the view of the Department that the provision of
overdraft protection services, including any inherent extensions of credit
incident to such services, described in your letter would not constitute a
prohibited transaction under section 406 to the extent that the bank
providing such services complies with the requirements for relief under
section 408(b)(2) or section 408(b)(6) of ERISA, as appropriate, and such
provision of services is not otherwise part of an arrangement to secure
credit unrelated to the settlement of securities or other financial market
transactions.
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Section 408(b)(2) provides a statutory exemption from the prohibitions of
section 406(a) 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 therefor.
Regulations issued by the Department clarify the terms "necessary
service" (29 C.F.R. §2550.408b-2(b)), "reasonable contract or
arrangement" (29 C.F.R. §2550.408b-2(c)), and "reasonable
compensation” (29 C.F.R. §§2550.408b-2(d) and 2550.408c-2) as used in
section 408(b)(2). Thus, overdraft protection services, in the context
described in your letter, appear to be necessary to ensure the orderly
processing of plan securities and other financial market transactions and,
therefore, would appear to be a “necessary service” for purposes of
section 408(b)(2) and §2550.408b-2(b). Accordingly, such services would be
covered by section 408(b)(2) to the extent such services are furnished under
contracts or arrangements that are reasonable and no more than reasonable
compensation is paid for such services within the meaning of §2550.408b-2.
As explained in §2550.408b-2(a), section 408(b)(2) does not contain an
exemption for an act described in ERISA section 406(b) (relating to
conflicts of interest on the part of fiduciaries) even if such act occurs in
connection with the provision of services that are exempt under section
408(b)(2).
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Section 408(b)(6) of ERISA provides a statutory exemption from the
prohibitions of section 406 for any ancillary services provided to a plan by
a bank or similar financial institution supervised by the United States or a
State, if such bank or financial institution is a fiduciary of such plan and
certain conditions are satisfied. Section 2550.408b-6 further clarifies the
application of section 408(b)(6). Such ancillary services include services
that do not meet the requirements of ERISA section 408(b)(2) because the
provision of such services involves an act described in section 406(b)(1) or
(b)(2) of ERISA.
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The Department has indicated that a service is “ancillary” if it aids or
is auxiliary to a primary or principal service. The Department has concluded
that the provision of “sweep services” by a trustee who is subject to
direction from an independent investment manager for the investment of plan
assets may constitute an “ancillary service” within the meaning of
section 408(b)(6).(3) The
Department also has indicated that the question of what constitutes an “ancillary
service” within the meaning of section 408(b)(6) depends on the
expectations of the parties as evidenced by the terms of the underlying
service agreement and applicable Federal banking law.(4)
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With regard to the expectations of the parties, you represent that plan
fiduciaries are fully informed about, and approve, the terms governing the
provision of overdraft protection services in settling securities and other
financial market transactions for the plan, including associated charges.(5)
Additionally, you represent that disclosure documents make clear that
charges attendant to overdrafts are in addition to and separate from fees
charged for other services, such as trustee or investment management
services, provided by the bank or an affiliate. Given the foregoing and the
fact that overdraft protection services appear to be necessary to ensure the
orderly processing of plan securities transactions and other financial
market transactions, as well as a banking practice recognized and permitted
by Federal banking authorities, it is the view of the Department that the
overdraft protection services described in your letter would constitute an
“ancillary service” and, therefore, may be exempt from the prohibitions
of section 406 if the conditions of section 408(b)(6) are satisfied. Whether
any given bank satisfies the conditions of section 408(b)(6) is an
inherently factual determination on which the Department generally will not
rule.
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Section 2550.408b-6(b) requires that ancillary services described in section
408(b)(6) must be provided at not more than reasonable compensation; under
adequate internal safeguards which assure that the provision of such service
is consistent with sound banking and financial practice, as determined by
Federal or State supervisory authority; and only to the extent such service
is subject to specific guidelines issued by the bank or similar financial
institution which meet the requirements of §2550.408b-6(c). To date, no
regulations have been issued to set specific requirements for such
guidelines. However, the Department has stated that the condition contained
in section 408(b)(6)(B) requiring "specific guidelines" is
satisfied (in the absence of such regulations) if the ancillary services are
provided in accordance with the specific guidelines issued by the bank or
similar financial institution, and adherence to the guidelines would
reasonably preclude such bank or institution from providing the services in
an excessive or unreasonable manner and in a manner that would be
inconsistent with the best interests of the participants and beneficiaries
(See 47 FR 14806, April 6, 1982).
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In order to reasonably preclude providing services in an excessive or
unreasonable manner or in a manner that would be inconsistent with the best
interests of the participants and beneficiaries, it is the view of the
Department that guidelines relating to overdraft protection services, at a
minimum, would be required to include measures designed to ensure timely
notice to the appropriate plan fiduciary of any overdraft and the imposition
of charges with respect thereto, to monitor and limit the duration and usage
of overdraft services, and to limit the ability of a fiduciary to utilize
overdraft protection services as a routine means by which securities and
other financial market transactions are settled. For example, a pattern or
practice of routine use of overdraft protection for settlement of securities
or other financial market transactions would evidence the providing of
ancillary services in an excessive and unreasonable manner and in a manner
inconsistent with the interests of participants and beneficiaries in
violation of section 408(b)(6).
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ERISA’s general standards of fiduciary conduct also
apply to the overdraft protection services. Section 404 requires, among
other things, a fiduciary to discharge his duties respecting a plan solely
in the interest of the plan’s participants and beneficiaries and in a
prudent fashion and for the exclusive purpose of providing benefits and
defraying reasonable expenses of administering the plan. Further, except
as provided in section 408, fiduciaries also have an obligation under
section 406 not to engage in self-dealing or to cause the plan to engage
in certain transactions, including a direct or indirect furnishing of
goods, services or facilities between the plan and a party in interest. In
this regard, banks or institutions which act as investment managers to
plans and provide through their affiliates or otherwise overdraft services
would need to assure adherence with the conditions and guidelines
specified in section 408(b)(6) of ERISA in the performance of those
services.
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As with the selection of any service provider, a plan
fiduciary must engage in an objective process designed to elicit
information necessary to assess the qualifications of the provider, the
quality of the services offered, and the reasonableness of the fees
charged in light of the services provided, including overdraft protection
services. As with any compensation arrangement, plan fiduciaries should
consider the circumstances under which services will be rendered and the
charges for such services, the basis for such charges and the ability of
the fiduciary to limit such charges.
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This letter constitutes an advisory opinion under ERISA
Procedure 76-1. Accordingly, it is subject to the provisions of the
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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Under Reorganization Plan No. 4 of
1978, 43 FR 47713 (Oct. 17, 1978), the authority of the Secretary of
the Treasury to issue rulings under section 4975 of the Internal
Revenue Code (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 also refer to the
corresponding sections of the Code.
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You represent that the Office of the
Comptroller of the Currency recognizes that overdrafts in fiduciary
accounts are permissible if they are temporary in nature, made only
for proper purposes and appropriately accounted for in the records of
the bank. The Federal Reserve Board takes a similar position,
permitting overdrafts that are temporary, corrected as soon as
possible, kept to a minimum and adequately secured. Both agencies
permit the imposition of a fee with respect to the overdraft if the
policy is permitted under local law. See e.g., Fed. Res. Interp. Ltr.
No. 5-942.22, (March 16, 1993), available at 1993 WL 764576 (F.R.B.).
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See Advisory Opinion No. 2001-10A,
December 14, 2001.
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See DOL information letter to Robert
Plotkin, August 1, 1986.
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What constitutes an approval by an
appropriate plan fiduciary will depend on the facts and circumstances
of each case. See Advisory Opinions Nos. 97-16A, May 22, 1997 and
2001-01A, January 18, 2001.
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