ERISA Compliance Handbook for Asset Managers
II. Documentation

• Individual Clients

It is standard practice to require new clients to complete forms designed to determine their ERISA status and document any particular requirements that may apply to their account, including information necessary to avoid prohibited transactions and/or ensure the availability of needed exemptions. These normally take the form of an IMA between the appointed manager and plan trustee or its delegated authority. In certain situations, the relationship may be structured as a limited partnership with a plan as the sole limited partner – also known as a “fund of one” – in which case there will be a limited partnership agreement and an IMA running from the limited partnership to the investment manager. In these situations, the Benefit Plan Investor will complete a subscription agreement of the type described below. Funds of one often have an incentive fee arrangement that is intended to be treated and taxed as a carried interest for the GP.

• Pooled Fund Investors

It is also standard practice to require all investors in a pooled fund to complete a subscription agreement that includes a questionnaire designed to determine the investor’s Benefit Plan Investor status, which allows the manager/fund sponsor to determine whether the fund will be subject to ERISA under the Plan Asset Rules. Where a fund determines to be structured so as not to be subject to ERISA, the GP/fund sponsor will typically undertake in writing that either the fund will be a VCOC or REOC, or that participation in the fund by Benefit Plan Investors will not be significant (i.e., under 25% of each class of equity). Such undertakings are generally also made in reliance on representations of the investing partners as to whether or not they are Benefit Plan Investors. It then becomes the burden of the general partner/fund sponsor to run the significant participation test and ensure that the fund remains in compliance.

Even if a fund is intended to remain below 25% Benefit Plan Investor ownership, it may rise over and drop below 25% from time to time. ERISA investors will generally also be asked to acknowledge and agree that, for so long as the fund is not deemed to hold plan assets, the GP or managing member will not be a “fiduciary” and that the investor is not relying on the GP or managing member to provide any kind of investment advice with respect to the investor’s purchase of fund interests.

Proper compliance and trading system coding is one of the most important steps in avoiding ERISA compliance problems, including, prohibited transactions and violations of a plan’s investment policy or the IMA itself. Whenever a new ERISA account is established, the manager should ensure that the account is coded as subject to ERISA, and that appropriate restrictions, such as blocks on cross‑trading, limitations on employer securities, and restrictions on trading with client affiliates or parties that have “hire/fire” authority over the account (including their affiliates) have been properly entered into the system. It is also advisable for the manager to verify that all of the restrictions are working properly on a periodic basis, or any time that the trading or compliance systems are updated or changed.

IMAs with ERISA clients generally will contain certain provisions to accommodate the client’s ERISA‑related needs and to avoid imposing unnecessary burdens on the manager. In any given case, the breadth and scope of these representations and undertakings are matters to be negotiated by the parties, with outcomes depending upon evolving market practice and the respective leverage and risk tolerance on the part of the manager and the Benefit Plan Investor. It may be useful for a manager to have its own preferred form; often an investing plan will as well. In the case of a pooled fund intended to be subject to ERISA, these provisions will normally be addressed in the subscription agreement completed by the investor or the IMA between the fund and the manager, as applicable. A summary of relevant provisions to be considered is provided below.

• The appointing fiduciary should expressly appoint the manager as an investment manager, as defined in Section 3(38) of ERISA. The appointing fiduciary should represent that it is a “named fiduciary” under ERISA.
• The manager should acknowledge that it is a “fiduciary” under ERISA with respect to the plan assets that it is managing.

• Note: The above two items are intended to limit the appointing plan fiduciary’s liability to the selection and oversight of the manager with the manager remaining liable for its discretionary actions.

• In order to address the requirements that fiduciaries act in accordance with the plan’s governing documents (insofar as they themselves are consistent with ERISA) the investor will generally be asked to represent that the appointment of the manager and all actions contemplated under the IMA are consistent with the plan’s documents and that the investor will notify the manager if any plan provision changes in a way that would make that representation untrue. The manager may agree to act in accordance with the plan documents as represented. Some managers may require internal review of the trust agreement as a matter of diligence.
• The manager may represent that it is qualified to act as a QPAM (discussed at QPAM Exemption).The QPAM Exemption does not require a manager to agree that it will act in accordance with the requirements of the exemption or that each transaction will be exempt by application of the exemption, but managers commonly do so agree. Along these lines, the investing plan may provide a schedule of persons who have the authority to appoint or terminate the QPAM on behalf of the plan.
• The exercise (or deliberate nonexercise) of shareholder rights such as proxy voting and other rights appurtenant to ownership is considered by the DOL to be part of a fiduciary’s duties to the plan. The IMA should clearly address who will be responsible for proxy voting and approval of other corporate actions, as well as any procedures for determining other appurtenant shareholder rights (e.g., joining class action suits). See Proxy Voting for ERISA Plans.
• To avoid self-dealing and conflict of interest challenges, the manager generally should avoid having discretionary authority to value assets on which a management fee or performance fee is based. The manager also generally should not have the ability to increase its fees by allocating assets to a particular investment strategy.
• In connection with ERISA’s diversification requirements, the manager may agree to diversify the account in accordance with ERISA, but the manager would normally not make any commitment with respect to the overall investment strategy of the plan. Some managers seek to disclaim the duty of diversification, particularly with very targeted investment strategies.
• A U.S.‑based manager may agree to comply with the “indicia of ownership” requirements under ERISA. A non‑U.S. manager generally should consult with ERISA counsel with regard to these requirements and any related contractual undertakings.
• With respect to any client‑directed brokerage arrangement, the investor generally will be required to represent that the direction of its account to a specified broker and the brokerage commission rate (i) are in the best interest of the account; (ii) are for the exclusive purpose of providing benefits to participants and beneficiaries of the plan; and (iii) are not, and will not cause the account to be engaged in, a prohibited transaction. The investor will generally also represent that it has determined, and will monitor the account to ensure, that the directed broker is capable of providing best execution for the account’s brokerage transactions and that the commission rates that have been negotiated are reasonable in relation to the value of the brokerage and other services received.
• If relevant to the IMA, any “soft dollars” arrangement must comply with the safe harbor standards under Section 28(e) of the Exchange Act.
• The manager generally will agree to be bonded against theft or fraud as required under ERISA, unless the investor agrees to cover this obligation. See Fidelity Bonds. Investors often also seek evidence or a representation of ERISA fiduciary liability insurance coverage.
• In general, plan assets may not be used to indemnify the manager for any breach of its fiduciary duties. Therefore, the indemnification provisions of the IMA should permit indemnification only to the extent permitted by applicable law, including ERISA. Likewise, a manager cannot shield itself from potential liability by contractually altering the prudent expert and related fiduciary duties under ERISA statutory law. 
• The manager generally will not agree to avoid or monitor transactions in employer securities unless the investor provides a list of such employer securities and/or guidelines for handling such securities.
• In connection with the DOL’s cybersecurity guidance, appointing fiduciaries may ask for language addressing ongoing compliance with cybersecurity and information security standards (See Cybersecurity).
• Investors will often ask the investment manager to provide assurances that it will provide any information necessary for the plan to satisfy its own disclosure obligations and Form 5500 filing requirements on a timely basis (See Reporting and Disclosure).
• In addition, as a matter of risk management, managers typically ask an ERISA investor to represent that (i) it is aware of and has taken into consideration its fiduciary duties, including, the diversification requirements of Section 404(a)(1)(C) of ERISA; (ii) it has concluded that the proposed arrangement or investment in the fund is a prudent one; and (iii) it has concluded that the contemplated compensation arrangement is reasonable and consistent with ERISA’s standards.

Managers of plan asset funds often will enter into so‑called prime brokerage arrangements that cover a suite of services in addition to execution of trades. Other services may include: margin loans, foreign exchange transactions and securities lending, and the prime broker may in some cases act as a counterparty in swap transactions.

Special considerations arise from the prime broker’s holding and use of assets pledged as collateral in connection with certain transactions.  Similar considerations arise in connection with ISDA agreements governing swap transactions and GMRAs governing repurchase transactions. Two recurrent questions that arise in connection with these arrangements are whether the collateral held by the broker or counterparty remains subject to ERISA in the hands of the broker or counterparty and what permits the broker or counterparty to exercise certain agreed rights over assets in the account, such as offset and closeout rights.

The DOL has addressed these issues in limited contexts in a manner that has given practitioners comfort that assets pledged as collateral do not retain their plan asset character in the hands of the counterparty. Specifically, the Department has stated that when assets are held by a futures commission merchant (“FCM”) to fund a plan’s margin account, the assets in the account are not plan assets; rather, when a plan engages in a futures transaction, “its assets are the rights embodied in the futures contract as evidenced by a written confirmation and outlined in its agreement with its FCM…” Similarly, the Department has stated that when assets being used for cleared swaps are held in a margin account, the assets in the account are not plan assets; rather, when a plan engages in cleared swaps, “its assets are the rights embodied in the swap contract as evidenced by the written agreement” between the plan and its clearing member.

The DOL has also opined that the exercise of closeout rights over amounts in an ERISA account can be treated as exempt under the QPAM Exemption, if the rights have been spelled out in detail in the agreement. Specifically, the Department has stated in the cleared swaps context that the QPAM Exemption provides relief for such transactions as “subsidiary transactions” if the agreement governing the swap clearing services contains enough specifics of such subsidiary transactions that the potential outcomes are reasonably foreseeable by the QPAM when negotiating and entering into the agreement.

Given the foregoing considerations, managers that are entering into prime brokerage and derivatives agreements on behalf of ERISA accounts will typically need to consider the following:

• The agreement will usually require that the manager represent that it is a QPAM and that the QPAM Exemption is available for transactions under the agreement (See QPAM Exemption). Sometimes, this representation is made on the basis of assumed conditions agreed to by the parties.
• In the case of a prime brokerage agreement, the prime broker is a service provider to the ERISA customer, so its selection must be prudent, its compensation must be reasonable and it needs to give the customer a full fee disclosure to satisfy the exemption under ERISA for reasonable compensation paid for necessary services.

Generally, a prime broker will ask for assurances that the ERISA customer does not and will not treat any assets pledged as collateral as “plan assets.” The DOL guidance on analogous situations described above has generally been sufficient for managers to be comfortable operating in this way; however, it is also not uncommon to word this provision as an agreement or acknowledgment between the parties rather than as a representation regarding the legal status of the assets. These assurances are also often made by the prime broker to the ERISA customer.

A prime broker may also ask for assurances that certain uses of the ERISA customer’s assets are exempt from the prohibited transaction restrictions. Again, the DOL guidance on analogous situations described above is often sufficient for managers to get comfortable with using the QPAM Exemption to cover such transactions as subsidiary transactions.

It is common for ISDAs to specify ERISA‑related termination events, disclosure obligations and representations. It is generally advisable for a manager to have ERISA counsel review these sections, perhaps after discussing what an appropriate “standard” set of ERISA provisions should include and exclude. Attention should also be paid to the form of derivative documentation being used and whether all requirements of any applicable exemptions have been met.