United States: Final Amendments to U.S. Department of Labor Exemption (PTE 84-14) from Prohibited Transaction Rules of the Employee Retirement Income Security Act of 1974 ("ERISA")

On August 23, 2005, the U.S. Department of Labor (the "DOL") published in final form important amendments to Prohibited Transaction Exemption ("PTE") 84-14 (the "QPAM Exemption"), dealing with transactions entered into by qualified professional asset managers ("QPAMs") on behalf of benefit plans regulated under ERISA. The amendments, as finalized, make compliance with the QPAM Exemption less onerous. These amendments were originally proposed on September 3, 2003.

Specifically, the amendments:

• remove the one year look-back rule with respect to the exercise of a power of appointment;

• clarify that the disqualifying power of appointment relates only to management of the assets involved in the transaction intended to be covered by the exemption (and not all of the plan’s assets);

• negate the power of appointment issue with respect to a plan’s investment in a commingled fund in cases where the plan’s investment represents less than ten percent of the fund’s total assets;

• modify the definition of affiliates, with respect to a party in interest, with respect to part 5(c)(2), eliminating: 1) partnerships in which an entity has less than a ten percent interest, and 2) employees of the plan sponsor other than "highly compensated employees";

• narrow the definition of "related" with respect to a QPAM and a party in interest;

• in passing, clarify the relationship of the QPAM Exemption and PTEs 81-6, 83-1 and 82-87;

• in passing, make clarifications regarding the role of a QPAM in continuing transactions;

• increase the required dollar amount of client assets under management from $50 million to $85 million and the dollar amount of required shareholder or partner equity from $750,000 to $1 million; and

• clarify that a QPAM must be independent of an employer with respect to a plan whose assets are managed by such QPAM and provide limited and retroactive relief to financial services entities that have been acting as QPAMs for their own plans.

The QPAM Exemption permits an "investment fund" (a plan trust, a commingled vehicle, etc.) managed by a QPAM to engage in a number of transactions otherwise prohibited under section 406(a) of ERISA with parties in interest other than the parties with a presumed ability to influence the QPAM’s decisions. In this regard, the QPAM Exemption is unavailable if a party in interest or its "affiliate" has, at the time of the transaction, the power to appoint or terminate the QPAM as an asset manager to the plan, or is authorized to negotiate the management agreement between the QPAM and the plan. In addition, the QPAM may not engage in a transaction on behalf of a plan with itself or a "related" party.

The QPAM Exemption formerly contained a restriction providing that if the party in interest or its affiliate had exercised the powers described above in the year immediately preceding the proposed transaction, the QPAM Exemption would be unavailable. This one year look-back rule has been eliminated. Additionally, the DOL has provided clarification that the power of appointment is only with respect to assets involved in the transaction, not any other of the plan’s assets.

The DOL has also amended the QPAM Exemption to be available to parties in interest with respect to a plan investing in a commingled investment fund, if the plan’s interest in the fund represents less than ten percent of the investment fund’s total assets (a change from the former rule, where the exemption could not be used in connection with any transaction between a manager of a commingled fund and a party in interest who caused a plan (regardless of its size) to invest in the commingled fund).

In addition, the definition of "affiliate" with respect to a party in interest and the power of appointment test has been modified under the amendments. Under the amendments, affiliates do not include (a) partnerships in which the party in interest held a less than 10% interest (the former rule was less than 5%) or (b) employees of a plan sponsor other than highly compensated employees (as defined in Section 4975(e)(2)(H) of the Internal Revenue Code) (a change from the former inclusion of all employees).

With regard to whether a QPAM and a party in interest are related, the amendments also alter the definition of "related" in several respects. First, under the amendments, a QPAM and a party in interest are related if (a) the QPAM owns a ten percent or greater interest in the party in interest or vice versa; (b) a person controlling or controlled by the QPAM or party in interest owns a twenty percent or greater interest in the other entity; (c) the party in interest owns a ten percent or greater interest in the QPAM; or (d) a person controlling or controlled by the party in interest owns a twenty percent or greater interest in the QPAM. Notwithstanding the foregoing, if a controlling or controlled person owns less than a twenty percent but greater than ten percent interest in the other entity and nonetheless exercises control over the other entity, the entities will be related. The former QPAM Exemption set the limitations at five percent. In addition, the testing of the relationship may only be made as of the end of the preceding calendar quarter. Finally, and importantly, for purposes of determining the percentage of ownership, equity interests held in a fiduciary capacity need not be counted.

The former QPAM Exemption provided that it was not available for transactions described in PTE 81-6 (relating to securities lending arrangements), PTE 83-1 (relating to plans’ acquisitions of interests in residential mortgage pools) or PTE 82-87 (relating to certain mortgage financing arrangements). The preamble to the proposed amendments clarified that such transactions are eligible for exemption under the QPAM Exemption if (a) the transaction met all of the requirements of the QPAM Exemption and (b) the transaction was not structured to fail one or more requirements of the other applicable exemption solely in order to benefit from the QPAM Exemption. In effect, the QPAM Exemption now can apply to transactions that are similar to those described in these three class exemptions but that do not meet all of the requirements for exemption under the otherwise appropriate exemption.

In response to questions regarding uncertainty of a QPAM’s role in continuing transactions (e.g., a loan, a swap, or a lease), the DOL has provided some clarification. The preamble to the proposed amendments expressed the DOL’s view that the QPAM Exemption is available for a continuing transaction provided that (a) all conditions for the exemption to apply are met on the date on which the transaction is entered into (or on the date of a renewal that requires consent of the QPAM) and (b) at all times Section I(e) of the exemption is met, which provision specifies that the transaction is not with a party in interest with respect to any plan (including related plans) whose assets represent more than 20 percent of the total client assets managed by the QPAM. The DOL notes that although general relief under Part I of the QPAM Exemption would be available through the course of the transaction, relief for an act of self dealing (a so-called "(b) violation", referring to the prohibited transactions described in section 406(b) of ERISA) would not be available.

Further, the DOL notes its view that, should a QPAM be terminated or otherwise become unable to continue in its role, the QPAM Exemption would continue to be available in the interim period until a replacement QPAM is appointed, provided that there is no need to make material decisions with respect to the transaction in the interim period.

Unfortunately, the entire concept of the continuing application of the QPAM Exemption to an ongoing transaction, such as a swap, continues to be very muddled and every effort should be made to ensure to the extent possible that all conditions of the QPAM Exemption are met throughout the term of such a transaction, and that a QPAM is in place representing the interests of the ERISA plans.

Under the original QPAM Exemption, an investment advisor was required to have total client assets in excess of $50 million and shareholder or partner equity in excess of $750,000. The DOL noted that those amounts had not been increased since 1984. Under the amendments, the dollar amounts are increased to $85 million and $1 million, respectively. There is a transition rule.

In the proposed amendments, the DOL clarified that the word "independent" used to describe a QPAM meant that the QPAM had to be independent of an employer with respect to a plan whose assets are managed by the QPAM, as well as the party in interest. However, according to comments received by the DOL, many employers in the financial services industry believed, based on the advice of counsel, that they were eligible to serve as QPAMs for their own plans.

In the final amendments, the DOL decided not to freely permit financial services entities to serve as QPAMs for their own plans. Instead, the DOL is providing limited retroactive and transitional relief for such entities that currently serve as QPAMs for their own plans. The DOL is also proposing an amendment to the QPAM exemption that would permit financial services entities to serve as QPAMs for their own plans going forward, provided that certain conditions are satisfied. These conditions include establishment by the QPAM of written policies and procedures designed to ensure compliance with the proposed amendment and a required audit by an independent auditor to review the policies and procedures of the QPAM and to determine whether the QPAM is in operational compliance with such policies and procedures. The limited and retroactive relief provides that the "independent fiduciary" requirement of the QPAM exemption will not apply from December 21, 1982 until the DOL finalizes its amendment that would permit financial services entities to serve as QPAMs for their own plans.

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