ERISA Compliance Handbook for Asset Managers
V. Specific Transactions

A limited category of ordinary‑course securities transactions that may involve parties in interest are not regarded by the DOL as prohibited transactions. Moreover, certain transactions that would otherwise be prohibited can still be covered by one or more readily-available exemptions even if the manager does not have the benefit of the QPAM Exemption or another status-based exemption.

Trades on Exchanges

Transactions executed on a national exchange are generally considered to be blind transactions (as mentioned in Other Key Exemptions), where neither party knows the identity of the other party. Blind transactions are not regarded as prohibited transactions and therefore do not require an exemption, even if it turns out that the other party to the transaction is a party in interest.

Alternative Trading Systems (ERISA Section 408(b)(16))

Furthermore, transactions executed through certain alternative trading systems are designed to be blind transactions. The DOL has stated that blind transactions executed through alternative trading systems are not prohibited transactions.  However, the Department has cautioned that fiduciaries using an alternative trading system for a blind transaction must be careful to make sure that the transaction is truly blind.

There is a statutory exemption at ERISA Section 408(b)(16), which covers transactions placed through an electronic communication network or similar system, even if the transactions are not truly blind.  Transactions may be placed for an ERISA plan through an electronic communication network or similar system if:

• the network or system is subject to federal regulation and oversight;
• the identities of the parties are not taken into account in the execution of trades;
• rules are in place to match purchases and sales at the best price available through the execution system;
• the price and compensation associated with the purchase and sale are at least as favorable to the ERISA plan as in an arm’s length transaction with an unrelated party; and
• a plan fiduciary is provided written or electronic notice of the execution of such transaction at least 30 days in advance of the first use of the network or system.

Under the exemption, electronic networks or similar systems may be used even with a party in interest to the ERISA plan that has an ownership interest in the network or system, as long as the network or system has been authorized for the plan’s use by the plan sponsor or another independent fiduciary.

Principal Transactions (PTE 75-1, Part II)

Even if a manager does not have the benefit of a status‑based exemption such as the QPAM Exemption, PTE 75‑1, Part II permits principal trades of securities to be executed with certain parties in interest. The conditions for using this exemption are as follows:

• the other party to the purchase or sale must be a registered broker that customarily purchases and sells securities for its own account in the ordinary course of business; and
• the other party to the purchase or sale must not have exercised any discretionary authority or control (except as a directed trustee) nor rendered investment advice with respect to the investment of the plan assets involved.

PTE 75-1, Part II is also available for purchases or sales of U.S. government or agency securities with either (a) a reporting dealer who makes primary markets in U.S. government or agency securities and reports daily to the Federal Reserve or (b) a bank supervised by the United States or a state. The dealer or bank must customarily purchase and sell such securities for its own account in the ordinary course of business.

Margin and Short Sales (PTE 75-1, Part V)

Trading on margin and short sales involve an extension of credit by a broker that is a party in interest by reason of providing services to the plan. That extension of credit is a prohibited transaction, which requires an exemption. Typically, coverage would be available under a general purpose exemption such as the QPAM Exemption or the Service Provider Exemption. However, if a general purpose exemption is not available, there is a special purpose exemption in PTE 75‑1, Part V, for extensions of credit in connection with securities transactions. In order for this exemption to apply, the following conditions must be satisfied:

• the extension of credit must be permissible under the securities laws;
• if the party in interest is a fiduciary, the fiduciary must receive no interest or other consideration; and
• the plan must maintain records for six years that are sufficient to demonstrate compliance with the terms of the exemption.

A fiduciary’s selection of itself or an affiliate as a broker to place trades would generally be a prohibited transaction, because the fiduciary would be using its authority to cause an additional fee to be paid to itself or the affiliated broker‑dealer.  However, a commonly-used exemption, PTE 86‑128, provides a conditional exemption covering the use of an affiliated broker, as long as the trades are not excessive in either amount or frequency.

The conditions of the exemption, as applied to separately managed accounts, are as follows:

• a plan fiduciary must provide advance written authorization, which must be terminable at will without penalty;
• the authorizing fiduciary must be provided, within three months before the authorization, with any reasonably available information necessary to determine whether to give the authorization, including, a copy of PTE 86‑128, a form for termination of the authorization and a description of the broker’s placement practices;
• the trading fiduciary must furnish the authorizing fiduciary a confirmation slip within 10 days of each trade; or, alternatively, the trading fiduciary may provide, within 45 days of quarter‑end, a quarterly report describing each trade, the total of all charges paid by the plan and the amount of these charges retained by the fiduciary or affiliate and the amount paid to other persons for execution or other services; and
• the trading fiduciary must provide, within 45 days of each year‑end, a report including the same information a quarterly report would contain, plus a description of any material changes in brokerage practices during the year and the annualized portfolio turnover ratio for the plan.

The exemption is not available if the fiduciary is a plan administrator or an employer whose employees are covered by the plan, unless the fiduciary returns or credits to the plan all profits earned in connection with the trades. In such a case, however, arguably the exemption is not needed because the fiduciary is not using its authority to cause an additional fee to be paid to itself or an affiliate.

The exemption is available for plan asset funds, with some modifications to the conditions.  Specifically, fiduciaries of plans investing in the fund must give advance authorization, and if they do not agree to the arrangement, they must be permitted to terminate their investment in the fund without penalty before an affiliated broker is used.

Special conditions apply if the plan in question covers employees of the fiduciary placing trades.

A manager of ERISA plan assets may seek to purchase publicly offered securities during the existence of an underwriting or selling syndicate that includes the manager or an affiliate of the manager.  The DOL has long considered it a prohibited transaction for a manager to purchase a security in this circumstance either from the manager itself or from its affiliate.  Even a purchase from another member of the selling syndicate might be a prohibited transaction, the Department has stated, because “it is generally in the interests of the members of an underwriting syndicate that all shares being offered by the syndicate are sold.”

However, a class exemption, PTE 75‑1, Part III, is available for purchases from a member of the selling syndicate other than the manager or its affiliate. The exemption has a variety of technical conditions not addressed here, but a key condition is that the exemption is not available if the manager or its affiliate is a manager of the selling syndicate.  For this purpose, a manager is any member of the syndicate who is authorized to act on behalf of the members of the syndicate or who receives compensation from the members of the syndicate for services as a manager of the syndicate.  In some cases, members of a syndicate may be called managers but not possess this authority.  In these cases, the availability of the exemption may be unclear. Over the years, the DOL has issued multiple individual exemptions that cover a broader range of affiliated underwriter transactions than PTE 75‑1.

Some take the view that if the affiliated underwriter does not receive compensation from the members of the syndicate for its services in selling securities, there should be no prohibited transaction. The implication of this view is that if the affiliated underwriter renounces a portion of its selling concession corresponding to the portion of the securities purchased by the manager for its ERISA accounts, the conditions of the exemption should not have to be satisfied.  It is worth noting that renouncing selling concessions in this manner is a condition of certain individual exemptions allowing purchases of this kind on generally more relaxed terms than those of PTE 75-1, Part III. A manager that wants broad flexibility to purchase securities during the existence of an underwriting syndicate that includes an affiliate of the manager might consider applying for an individual exemption of this kind, although this can be a slow and cumbersome process. Some managers simply wait until the securities are available on the public market.

A fiduciary with respect to ERISA plan assets that considers it appropriate to invest those assets in a fund managed by the fiduciary or an affiliate faces the prospect of a prohibited transaction by reason of using its fiduciary authority to cause the plan to pay it or its affiliate an additional fee for services.

Fortunately, one of the earliest prohibited transaction exemptions, PTE 77‑4, provides a roadmap to carry out such investments safely, at least for investments in mutual funds.  Under the exemption:

• no sales commission can be charged;
• no redemption fees can be charged, except fully disclosed redemption fees paid only to the fund;
• the plan cannot be charged double advisory or management fees; either the plan must not pay a plan‑level fee with respect to the assets invested in the mutual fund or the plan must receive a credit against its plan‑level fee for its pro rata share of advisory fees paid by the fund (in either case, the fund may pay its advisory fees to the fund’s adviser);
• a plan fiduciary independent of the manager must be given a prospectus and detailed written disclosure of all fees, stating the reasons why the manager considers the investment appropriate for the plan and whether there are any limitations on the manager with respect to which plan assets may be invested in the mutual fund; and
• the independent plan fiduciary must consent to the investment and to any changes in fees.

This exemption is only available for investments in affiliated mutual funds. Investments in affiliated bank collective trusts can be covered under a statutory exemption at Section 408(b)(8), which actually offers broader relief then PTE 77‑4. However, investments in other types of affiliated funds have no express exemption.

ERISA Section 408(b)(8) grants an exemption for any transaction between a plan and (i) a common or collective trust fund or pooled investment fund maintained by a party in interest that is a bank or trust company or (ii) a pooled investment fund of an insurance company, if:

• the transaction is a sale or purchase of an interest in the fund,
• the bank, trust company or insurance company receives not more than reasonable compensation, and
• such transaction is expressly permitted by the instrument under which the plan is maintained, or by a fiduciary (other than the bank, trust company or insurance company or an affiliate thereof) who has authority to manage and control the assets of the plan.

With respect to investments in other types of affiliated funds, some practitioners take the view that satisfaction of the conditions of PTE 77‑4 should be sufficient to ensure that there is no prohibited transaction in need of exemption. The argument is that if these conditions are satisfied, the fiduciary is not using its authority to cause the plan to pay an additional fee to itself or an affiliate.

The DOL has called attention to the fact that an investment in an affiliated fund could give rise to an independent prohibited transaction, without exemption, if the fiduciary is using the investment to serve its own purposes or those of an affiliate. In particular, the DOL has expressed concerns about the use of ERISA plan assets to seed a new fund. Because such separate issues can easily arise in connection with investments of this kind, it is advisable to consult ERISA counsel before entering into a new arrangement involving investment in an affiliated fund, even one that satisfies the terms of PTE 77‑4.

Because of the conflict of interest restrictions in Section 406(b)(2) of ERISA, the DOL takes the view that a manager can enter into cross‑trades, i.e., trades between an ERISA account and another account managed by the same manager, only if an explicit exemption is available. This is the case notwithstanding such transactions are intended to be beneficial to the ERISA client. Cross‑trades typically must be avoided, because of the difficulty of using available exemptions. Arranging a cross‑trade through a broker, or through two cooperating brokers, is likewise not permitted. As a result, many managers prohibit entering into buy and sell transactions involving the same security on the same day through the same broker where an ERISA account is involved. For certain low‑trading volume securities, certain managers extend this prohibition on trading the same security to a period longer than a single day. In addition, it is important for managers to avoid any prearrangement of buy and sell orders for the same security when an ERISA account is involved.

However, three exemptions are potentially available for cross-trades, each subject to several conditions.  The exemptions require managers to provide fiduciaries of participating ERISA plans with written policies governing the manager’s cross‑trading program. In addition, under the longstanding blind trade doctrine (as discussed in Other Key Exemptions), an ERISA account may generally enter into a securities transaction without concern over potential cross‑trades where the account is not aware of the identity of the counterparty to the transaction.

Cross‑trades may be covered by a statutory exemption at Section 408(b)(19) of ERISA.  The exemption covers only securities for which market quotations are readily available. Generally, the exemption requires the manager:

• to develop policies and procedures to govern cross‑trades;
• to obtain the consent of clients to participate in the cross‑trading program, after providing full disclosure;
• to carry out any cross‑trades in accordance with its policies and procedures; and
• to provide quarterly reports and carry out an annual compliance review.

Certain passive cross‑trades may be carried out under a special‑purpose class exemption (PTE 2002-12) even if the general statutory exemption for cross‑trading is unavailable. PTE 2002‑12 exempts cross‑trades involving index and model‑driven funds or portfolio restructurings for large accounts. However, it covers only trades involving equity securities that are widely held and actively traded and for which market quotations are readily available from independent sources and fixed‑income securities for which market quotations are readily available from independent sources.

Generally, PTE 2002-12 requires the manager:

• to adopt and follow written procedures for its cross‑trading program;
• to provide advance written notice to investors in funds participating in the cross‑trading program;
• to adhere to certain pricing and timing requirements; and
• to satisfy certain recordkeeping and annual notice requirements.

On occasion, a manager may seek specific direction from the ERISA plan client to enter into a given trade at a given price, availing of the argument that in such situations, the manager is not invoking its discretion on both sides of the transaction. Some ERISA clients are comfortable with this approach; others refrain as they do not wish to take on any liability for the trade and price even if it might save the plan some expense.

Note, the prohibition on cross‑trading applies only to plans or accounts subject to ERISA—it does not apply to IRAs or similar plans or accounts that are not subject to ERISA.

Finally, in the context of a defined contribution/401(k) plan or IRA, there may be additional relief for certain cross-trading transactions involving the fiduciary under PTE 2020-02, discussed at 401(k) Plans.

Other Potential Investment Conflicts

Similar conflicts of interest may arise where a manager is acting on behalf of multiple accounts (one or more of which is an ERISA account) that hold different securities issued by the same company. In these cases, care must be given when exercising any security holder’s rights with respect to one account’s holdings where there may be adversity of interest with another account.  A common example would be where an ERISA account holds senior debt and another account holds junior debt of the same issuer and the ERISA account must determine whether to exercise its rights to preserve the value of its own securities, thereby lowering the value of the junior debt held by the other account.  In these cases, a manager may take steps to insulate the decision‑making process on behalf of the different accounts, including, by potentially hiring an independent fiduciary. These types of conflict situations can be challenging and costly to address when they arise, so managers may want to include formulaic rules for addressing certain conflicts under their formative documents. This approach may also be beneficial for managers of funds of funds or secondaries funds who may face these types of conflicts as the funds they hold interests in wind down.

Co-investment by a manager alongside an ERISA plan client is not per se prohibited under DOL guidance, but the Department cautions that in such situations, an adversity of interests could arise, resulting in the fiduciary facing conflict of interest and/or self-dealing challenges.

Foreign exchange transactions are principal trades with a third party, typically a bank or a broker‑dealer that may well be a party in interest to the ERISA investor engaging in the trade.  Accordingly, an exemption is typically required for such transactions. The QPAM Exemption is the exemption most often used, and it is increasingly expected by counterparties to be the exemption relied upon.  However, the Service Provider Exemption may also be available to cover foreign exchange transactions.

There is also a special‑purpose statutory exemption at ERISA Section 408(b)(18) covering foreign exchange trades. However, the statutory exemption covers only trades in connection with the purchase, holding or sale of securities or other investment assets, and therefore does not cover speculative trades or other trades unrelated to investment holdings. The conditions for the exemption are as follows:

• at the time the transaction is entered into, the terms must be not less favorable to the plan than the terms generally available in comparable arm’s length transactions between unrelated parties, or the terms afforded by the bank or broker dealer;
• the exchange rate must not deviate by more than 3% from the interbank bid and asked rates for transactions of comparable size and maturity as displayed by an independent reporting service; and
• the counterparty must not have investment discretion or provide investment advice with respect to the transaction.

Additional special‑purpose exemptions are available for standing instruction trades and for trades not relating to existing investment holdings.  However, these exemptions are rarely used.

A question that arises with some regularity is whether an asset manager can aggregate and net foreign exchange trades using an internal system or third‑party service, before submitting the net trades to its foreign exchange counterparty. As a general matter, such netting procedures, while attractive economically and generally advantageous for clients, may raise concerns about impermissible cross‑trading. However, the ERISA analysis of such netting procedures is highly fact‑dependent and should be discussed with ERISA counsel.

Dealings in asset-backed securities (“ABS”) and mortgage-backed securities (“MBS”) for ERISA accounts may involve some complexity, depending on the nature of the securities. Generally, offering materials for the securities should be reviewed to determine the nature of the securities, whether ERISA investors are permitted to invest in a specific security, and if so, what exemptions may be needed to acquire and hold the securities.

The simplest case is presented by offerings that are treated as debt instruments with no substantial equity features. As a reminder, the DOL considers the holding of a debt obligation by an ERISA plan to be an extension of credit from the plan to the issuer/borrower. For such securities, the QPAM Exemption (or another status‑based exemption) or the Service Provider Exemption will likely be needed to cover the extension of credit to the issuer (which may be a party in interest) and the purchase of the security from the underwriter (which, likewise, may be a party in interest).

Another straightforward case involves securities that are treated as equity (typically called “certificates”) for purposes of ERISA but are “publicly offered securities” or are issued by an issuer the assets of which are not treated as plan assets because less than 25% of each class of equity interest is held by Benefit Plan Investors. The latter case may be somewhat rare, as it is not typical for the issuer of such securities to monitor Benefit Plan Investor participation. In these cases, again, the QPAM Exemption or the Service Provider Exemption will be needed to cover the purchase of the security from the underwriter, which may be a party in interest.

A third case not raising significant concerns involves certificates issued by Fannie Mae, Freddie Mac or Ginnie Mae. The assets underlying these securities are specifically exempted from being treated as plan assets.

Complexities arise in the case of securities that are treated as equity and that are issued by an issuer the assets of which may be treated as plan assets. One consideration is whether the underlying asset pools will be operated in accordance with the fiduciary requirements of ERISA.  Typically, little or no discretion is exercised at the level of pool operations, so this is often considered not to be a serious concern. A more important consideration is whether the operation of the asset pool could give rise to a prohibited transaction, given that the parties involved are often related to each other and may be parties in interest to investing ERISA plans. However, many ABS and MBS are issued pursuant to so‑called Underwriters Exemptions, which are administrative exemptions with nearly identical terms under which many of the major ABS and MBS sponsors enjoy protection against common prohibited transactions relating to the operation of the underlying asset pool.  A manager that is purchasing ABS and MBS equity securities for an ERISA account should in most cases confirm that an Underwriters Exemption is available, and should make sure that the securities have investment-grade ratings at the time of purchase, as that is a condition for the continued protection of the Underwriters Exemptions.

The structuring and issuance of ABS and MBS are beyond the scope of this Handbook.  Managers seeking to engage in these activities for ERISA accounts should contact their legal advisers.

Certain offerings, by their terms, are prohibited for purchase or holding by or transfer to Benefit Plan Investors, and they are appropriately described as “ERISA‑restricted.”  Such restrictions are often imposed in connection with the issuance of securities by a special purpose vehicle or trust where the security is thought to have significant equity features. Generally, issuers may impose ERISA restrictions out of a concern that the purchase or holding of the security by ERISA plans may subject the issuer and its affiliates to the fiduciary and prohibited transaction requirements of ERISA. Blanket ERISA restrictions are most often seen in fixed‑income securities, particularly, with respect to certain types of loan participation notes.

Risks associated with ERISA‑restricted securities came to the forefront in early 2014, when the DOL and the U.S. Securities and Exchange Commission fined an asset manager $21 million for purchasing and holding ERISA‑restricted securities on behalf of certain ERISA clients. This enforcement action was unprecedented and caused managers to review, and, in certain cases, amend their normal practices for researching and purchasing certain types of securities. Many managers have, with assistance of counsel, developed lists of types of securities that must be reviewed for ERISA restrictions.

Typically, securities that might be ERISA‑restricted are accompanied by offering documents, such as a prospectus or supplemental prospectus, offering memorandum or private placement memorandum. It is typically within these offering documents that one can find provisions restricting the purchase or holding of a security by Benefit Plan Investors.  Offering materials that impose restrictions of this kind may state that purchasers and transferees of the securities are “deemed” to represent that they are not Benefit Plan Investors.  Such materials may also recite remedies that purportedly may be exercised by the issuer in its discretion in the event of a breach of the deemed representation—for example, nullifying the purchase or transfer as “void ab initio” or requiring that the securities be transferred to a transferee of the issuer’s choice within a specified period of time. These provisions can be complicated and are uncertain in their legal effect, and in some cases, may contradict other portions of the offering document.

In an effort to streamline the purchase and sale of these securities on the secondary market, certain financial reporting services (e.g., Bloomberg) provide access to codes designating whether securities are “ERISA eligible”, i.e., whether they are restricted or permitted for purchase by Benefit Plan Investors.  Prior to the SEC’s and DOL’s enforcement action, some managers relied conclusively on these designations in purchasing securities. Unfortunately, the designations are at times incorrect. Accordingly, it is best practice for the manager or its counsel to review the applicable offering documents without relying solely on financial reporting services.

Common ERISA-restricted securities include:

• the equity and lower‑ranked tranches of CLOs;
• debt issued by special purpose vehicles that are not owned by the guarantor;
• UCITS and other non‑U.S. exchange‑traded funds;
• low exercise price warrants; and
• certain non‑U.S. issued debt.

Offering documents should be carefully reviewed prior to purchasing securities of types that are commonly found to be ERISA‑restricted. If after review, it is unclear whether the security is ERISA‑restricted, it is advisable to contact ERISA counsel for assistance.  Counsel should also be contacted if it is discovered that ERISA‑restricted securities are being held or have been held on behalf of an ERISA client.

As a general matter, there is a burden on an ERISA fiduciary to correct nonexempt prohibited transactions and restore any losses to the plan caused by the transaction or any other breach of duty. A manager may also be liable to a counterparty (e.g., in the case of a swap or brokerage agreement) for reimbursement of excise taxes due as a result of a prohibited transaction depending upon the representations and indemnities given to the counterparty by the manager on behalf of the plan. As noted in Prohibited Transactions, there is an excise tax owed by the party in interest equal to 15% of the amount involved for each year in which the prohibited transaction is not corrected. This amount can increase to 100% of the amount involved if not corrected before the IRS issues a notice of deficiency or assessment.

In the context of third-party managers of ERISA plans, when nonexempt prohibited transactions occur, they generally happen due to mistaken or misunderstood reliance on a statutory, class or individual exemption. For example, a manager may overlook that the QPAM Exemption is not available for plans comprising more than 20% of its assets under management after the loss of an unrelated large client, or the manager may not realize that a party in interest is a manager in an underwriting. In more extreme cases, a manager may discover that a pooled fund client actually holds plan assets upon proper application of the significant participation test when it had been operating the fund on the assumption that it did not hold plan assets.

ERISA counsel should be consulted upon suspicion or recognition by the asset manager that a prohibited transaction or other breach of duty may have occurred.

Correction of a prohibited transaction involves putting the plan in the place it would have been had the transaction not occurred – this often means reversing or rescinding the transaction where possible. Situations where the plan would be harmed by a reversal should in particular be discussed with ERISA counsel.

If there are losses involved due to the transaction or other breaches of duty, those must be restored to the plan by the fiduciary causing the loss. Any profits or enrichment inured to the benefit of the fiduciary must also be disgorged in favor of the plan. Any excise taxes are filed by the party in interest on IRS Form 5330. The transaction, including the name of the parties involved, must be reported by the plan on its Form 5500, Schedule G Part III.

There are two potential avenues for avoiding excise taxes and the associated reporting requirements. One is to avail of a 14-day correction period set forth under the statute; the other is to participate in the DOL’s “Voluntary Fiduciary Correction Program.”  This chapter explains which transactions may be corrected by these means and how to correct those transactions.

Correcting a Prohibited Transaction (ERISA Section 408(b)(20))

Pursuant to ERISA Section 408(b)(20), an otherwise prohibited transaction becomes exempt if:

• the transaction involves the acquisition, holding or disposition of any security or commodity (each as defined below), other than transactions between a plan and a plan sponsor or its affiliates that involve the acquisition or sale of an employer security, or employer real property (this would include, for example, the purchase of an asset from or the lending of money to a party in interest);
• the transaction is corrected within 14 days of the date on which it is discovered, or reasonably should have been discovered that the transaction was prohibited under ERISA. To avail itself of this relief, the fiduciary must:
  
  
  
  • undo the transaction to the extent possible;
  • make good to the plan any losses resulting from the transaction; and
  • restore to the plan any profits made through the use of assets of the plan.

Of note, the 14‑day correction period is not available if, at the time the transaction occurred, the fiduciary “knew (or reasonably should have known)”, that the transaction was prohibited under ERISA. This undefined standard, together with the language that the 14-day period begins when the applicable person “reasonably should have discovered” the transaction if earlier than actual discovery, often results in uncertainty as to whether the relief is available in any particular case. Because there is no filing due or taxes paid, and no sign-off from the DOL (in contrast to the VFCP program discussed below), managers, plan sponsors and their counsel are in effect making a judgment call and risk management decision with respect to reliance.

For purposes of this relief, a “security” means any (i) share of stock in a corporation; (ii) partnership or beneficial ownership interest in a widely held or publicly traded partnership or trust; (iii) note, bond, debenture or other evidence of indebtedness; (iv) interest rate, currency or equity notional principal contract; (v) evidence of an interest in, or a derivative financial instrument in, any security described above, or any currency, including any option, forward contract, short position, and any similar financial instrument in such a security or currency; and any position not described above, or hedge, with respect to such a security.

Furthermore, a “commodity” means any: (i) commodity that is actively traded; (ii) notional principal contract with respect to any actively traded commodity; (iii) evidence of an interest in, or a derivative instrument in, any commodity described in (i) or (ii), including any option, forward contract, futures contract, short position and any similar instrument in such a commodity; and (iv) position or hedge with respect to such a commodity.

VFCP - Correcting a Breach of Fiduciary Duty

A fiduciary that has caused a loss to a plan due to a breach of fiduciary duty may, in certain specified cases, voluntarily correct the transaction with DOL approval through the Department’s Voluntary Fiduciary Correction Program (“VFCP”) and potentially avoid excise taxes. The VFCP is primarily aimed at breaches committed by a plan sponsor in the administration of its plan(s), and so as a practical matter, it is not often utilized by a third-party asset manager in the context of its discretionary authority over the investment of plan assets.

Generally, the program requires the fiduciary to:

• identify any violations and determine whether they are covered by the VFCP;
• undo the transaction, if possible;
• calculate and restore any losses, profits, or supplemental benefits to the plan and participants; and
• submit an application to the DOL.

Once the fiduciary satisfies the terms of the program, the DOL will issue a no‑action letter for the transaction in question. Pursuant to the no‑action letter, the Department will not initiate a civil investigation regarding the fiduciary’s responsibility for the transaction or assess civil penalties on the correction amount paid to the plan or its participants. However, the Department may investigate to verify the facts set forth in the application and to confirm that the transaction was corrected. The relevant parties may then apply to the IRS for a waiver of any excise taxes otherwise due.

In the context of asset management by a third-party fiduciary, the following transactions may be corrected through the VFCP. Note, the statutory exemption discussed above (ERISA Section 408(b)(20)) would be preferable as it avoids DOL filings and automatically eliminates the excise taxes. However, the VFCP may be the only path available for a DOL-approved outcome where there is doubt that the parties meet the “should have discovered” and “should have known” requirements of the statute:

• Purchase of an asset by a plan from a party in interest ‑ Correction is available if a plan purchased an asset with cash from a party in interest, in a transaction to which no prohibited transaction exemption applies.
• Sale of an asset by a plan to a party in interest – Correction is available if a plan sold an asset for cash to a party in interest, in a transaction to which no prohibited transaction exemption applies
• Purchase of an asset by a plan at a price more than fair market value – Correction is available if a plan acquired an asset from a person who is not a party in interest without determining the asset’s fair market value, and as a result, the plan paid more than it should have for the asset.
• Sale of an asset by a plan at a price less than fair market value - Correction is available if a plan sold an asset to a person who is not a party in interest without determining the asset’s fair market value, and as a result the plan received less than it should have from the sale.

A fiduciary cannot participate in the VFCP if the fiduciary or the plan is “under investigation,” unless the plan notifies the DOL.  A fiduciary or plan is under investigation if it has received a notice that (i) the DOL is conducting an investigation of the fiduciary in connection with an act or transaction directly related to the plan; (ii) any governmental agency is conducting a criminal investigation of the fiduciary in connection with an act or transaction directly related to the plan; (iii) the Pension Benefit Guaranty Corporation, any state attorney general, or any state insurance commissioner is conducting an investigation or examination of the fiduciary in connection with an act or transaction directly related to the plan; (iv) the DOL is conducting an investigation of the plan; or (v) the IRS is conducting an Employee Plans examination of the plan.  The VFCP also cannot be used if the DOL has conducted an investigation that resulted in the transaction’s referral to the IRS. Finally, the VFCP is not available if the application contains evidence of potential criminal violations.

After identifying and correcting a breach, the fiduciary must file an application with the DOL. If the fiduciary has a representative submit the application, the application must include a signed statement that the representative is authorized to represent the fiduciary. Plan assets may not be used for any fees paid to a representative for preparing and submitting the application. The application must include specified documentation relevant to the breach. The Department may request additional documentation in writing from the fiduciary or authorized representative. The fiduciary must maintain copies of the application and any subsequent correspondence with the Department for six years after the filing date. The transaction must still be reported on the plan’s Form 5500.

The DOL will maintain the confidentiality of any documents submitted under the VFCP, to the extent permitted by law. However, it has an obligation to make certain referrals to the IRS, and to refer to other agencies, evidence of criminality and other information for law enforcement purposes.

Where it is determined that the correction exemption is not available and the parties decline to use VFCP, fiduciaries including, asset managers, should consult with ERISA counsel and generally follow the principles outlined above in a manner judged to be prudent and beneficial to the plan.