GROOM LAW GROUP, CHARTERED

1701 Pennsylvania Ave., N.W. • Washington, D.C. 20006-5811

ERISA FOR SECURITIES PROFESSIONALS

By

Richard K. Matta*

Part or all of this article is 

Copyright © 2009 Emerald Group Publishing Limited

Reprinted with permission

The following is an overview of how the Employee Retirement Income Security Act of 1974, as 

amended (“ERISA”), applies to securities professionals such as registered investment advisers 

(“RIAs”), registered broker-dealers and individual registered representatives and financial 

planners who advise, manage, or trade for investment portfolios of private employee benefit 

plans and individual retirement accounts (“IRAs”). As noted below, ERISA does not apply to 

governmental plans, which are governed by state law; however, many of the ERISA concepts are 

followed by governmental plans.

The principal focus of this article is on investments in securities registered under the Securities 

Act of 1933 (the “1933 Act”) and the Securities Exchange Act of 1934 (the “1934 Act”), and 

securities of investment companies registered under the Investment Company Act of 1940 (the 

“ICA”). Many of these principles also will apply directly to interests in unregistered vehicles, as 

well as to other investments offered by banks, insurance companies, commodity trading advisers 

and real estate advisers, though there may be some variation. 

Key changes resulting from the Pension Protection Act of 2006 (“PPA”) are expressly noted.

SUMMARY

The law broadly known as ERISA comprises a number of provisions of the Internal 

Revenue Code (the “Code”), the Federal labor laws, and other Federal laws. Except for the 

prohibited transaction rules of the Code, which fall mainly under the jurisdiction of the 

Department of Labor (“DOL”) and closely parallel the prohibitions in the labor provisions of 

ERISA, the Code rules mainly deal with the tax-qualification of plans and are beyond the scope 

of this discussion. The provisions of ERISA of greatest concern to securities professionals are 

the labor-law fiduciary requirements contained in Title I of ERISA. These can be broadly divided 

into five major categories:

 Coverage and definitions

 Reporting and disclosure

 General fiduciary obligations, including co-fiduciary principles 

 Prohibited transactions

 Enforcement, including bonding requirements 

Each of these areas is discussed in detail below.
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COVERAGE AND DEFINITIONS

A securities professional will be subject to ERISA only if, and only to the extent, that he 

or she is dealing with ERISA plan assets. For this purpose, there must first be a “plan”; the plan 

must be subject to ERISA; and the assets in question must be “plan assets” of that plan. Once 

this determination is made, the next question usually is whether the professional’s relationship 

to the plan is as an ERISA “fiduciary” or merely as a non-fiduciary service provider.

What Is an ERISA Plan?

The requirements of ERISA Title I only apply to “employee benefit plans,” or simply 

“plans,” which are further subdivided into “pension plans” and “welfare plans.” At minimum, 

every ERISA plan requires:

 A “plan.” Certain ad hoc arrangements covering one or two individual employees 

usually are not plans.

 A plan sponsor. Specifically, there must be more than de minimis involvement of 

an employer or union sponsor.

 Employees. A plan must cover employees; accordingly, a plan covering only selfemployed individuals and their spouses is not subject to ERISA.

 Employee benefits. Although not normally at issue, some common payroll practices 

and employee “perks” are not employee benefits for ERISA purposes.

IRAs and Keoghs. For lack of an employer and/or employees, most individually 

marketed IRAs and many so-called “Keogh” plans (including director plans) are not ERISA plans. 

One major point of confusion, however, relates to the fact that IRAs and Keoghs are benefit 

plans under the Internal Revenue Code, including the prohibited transaction rules; accordingly, 

much of the following discussion is also relevant to IRAs and Keoghs.

403(b) plans. Traditionally, 403(b) tax-sheltered annuities were sold directly to 

employees under the fiction of little or no employer involvement, and thus were not subject to 

ERISA. However – particularly in light of recent IRS rules requiring the adoption of a written 

plan document – more and more 403(b) plans are now subject to ERISA.

For securities professionals, the foregoing is mainly an academic exercise; the types of 

arrangements most frequently encountered, such as traditional tax-qualified pension and 

profit-sharing plans (including 401(k) plans) are almost always ERISA plans when sponsored by 

private, non-governmental employers.

What Plans Does ERISA Govern?

Not all plans are subject to ERISA (and some are partially exempt). Most private 

employer plans are subject to ERISA (both for-profit and not-for-profit). Governmental plans 

generally are exempt, although many are subject to similar state-law requirements. For this 
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reason, many fiduciaries apply their ERISA compliance procedures to governmental plans. 

Church plans also generally are exempt, but often can elect ERISA coverage. Plans maintained 

outside the U.S. are not subject to ERISA, if they primarily cover nonresident aliens.

What Are ERISA “Plan Assets”?

Every security or other asset owned directly by an employee benefit plan or an IRA is a 

“plan asset” subject to ERISA (and/or the Code). The more difficult question is whether an 

asset owned indirectly is also treated as a plan asset. 

In theory, the concept of “plan assets” is simple – an entity that is not itself a “plan” 

subject to ERISA will be treated as holding plan assets if its primary purpose is to invest 

retirement plan assets. In effect, ERISA “looks through” the vehicle, and the persons who 

manage its assets will be treated as directly managing the assets of the plan. In addition, any 

business transactions of the entity must be analyzed in light of ERISA's fiduciary and prohibited 

transaction rules.

In practice, these rules are complex and sometimes counterintuitive. ERISA itself defines 

“plan assets” only in the negative, exempting registered investment companies and insurance 

company guaranteed benefit policies. DOL regulations attempt to provide greater guidance. 

First, they clarify that the concept of “plan assets” only applies to equity investments; there is 

no look-through when a plan invests in any true debt instrument. Second, the regulations start 

with the proposition that you look through every equity investment unless an express exception 

applies. 

The principal exceptions in the regulations (in addition to registered investment 

companies and insurance company guaranteed benefit contracts) are:

 “Publicly offered securities.” Such securities must be 1) freely transferable, 2) 

widely held (more than 100 holders unrelated to management and to each other), 

and 3) registered under the 1934 Act (or scheduled to be registered subsequent to 

an IPO), i.e., most public companies.

 “De minimis” holdings. Any investment in an entity that does not have “significant” 

(25% or more) benefit plan investor participation in any class of equity interests. 

This is the exception typically used by hedge funds. What constitutes a “class” of 

equity interests is not clear, and remains the subject of much debate.

PPA note: Before the Pension Protection Act of 2006, the 25% test was 

applied by treating every retirement plan (and every entity holding plan 

assets) as a “benefit plan investor,” whether or not such plan was otherwise 

subject to ERISA (i.e., including governmental and foreign plans). However, 

the PPA modified this rule so that only plans subject to ERISA or the Code 

(including IRAs) are counted toward the 25% test. Moreover, when an entity 

holding plan assets makes a “downstream” investment in another entity, it is 

treated as holding plan assets only “to the extent” that it has benefit plan 
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investors (e.g., if it is owned 30% by benefit plan investors, 30% of its assets 

are treated as plan assets, not 100%).

 “Operating companies.” Investments in companies that develop or market goods 

and services other than the investment of capital, plus certain “hybrid” entities 

known as “venture capital operating companies” and “real estate operating 

companies.”

Notwithstanding the foregoing, certain entities always are deemed to hold plan assets 

unless registered as investment companies or publicly traded. These include group trusts (e.g., 

bank collective investment funds), most insurance company separate accounts, and any entity 

owned 100% by a single plan or group of related plans (other than an ESOP).

Accordingly, for example, if a plan invests in a mutual fund, the RIA that advises the fund 

as to the investment of its assets will not become an ERISA fiduciary, but any RIA that advises 

the plan as to its investment in the mutual fund will be a fiduciary. However, if the plan invests 

in an unregistered hedge fund, both the RIA that advises the plan and the RIA that advises the 

hedge fund may be fiduciaries.

Ordinarily, interests in securitized vehicles (e.g., mortgage pools) that are treated as 

debt for tax purposes should constitute debt for ERISA purposes. However, the mere 

characterization of an interest as debt is not sufficient; it must be judged on its merits, including 

its credit rating. It should also be noted that holding debt of a “party in interest” raises certain 

prohibited transaction concerns. See below.

Who Is a “Fiduciary” Under ERISA?

ERISA defines three categories of fiduciaries: 1) those who exercise authority or control 

over the management or disposition of plan assets; 2) those who provide investment advice for 

a fee with respect to plan assets, or have authority or responsibility to do so; and 3) those who 

have discretionary responsibility or authority to administer a plan. The Code contains identical 

definitions for IRAs, and they interpreted consistent with the ERISA rules.

RIAs and other money managers typically would fall into one of the first two categories 

(management of plan assets or investment advice). Broker-dealers acting only as such 

generally are not fiduciaries; however, certain traditional broker-dealer activities can, in some 

circumstances, cross the line into investment advice, as discussed below. Financial institutions 

acting as recordkeepers and third-party administrators typically do not have discretionary 

responsibility or authority to administer a plan and are not fiduciaries (this role usually remains 

with the employer); however, having authority to hire or fire other plan service providers may 

cross the line.

The vast majority of questions regarding the fiduciary status of a financial professional 

revolve around the concept of “investment advice.” The term has a different meaning under 

ERISA than under the Investment Advisers Act, as well as different implications:
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What is investment advice under ERISA? The definition of investment advice under 

ERISA is narrower than under the Advisers Act. For investment recommendations to constitute 

ERISA investment advice, generally those recommendations must:

 be rendered on a “regular basis” – this affords something of a “one-bite” exception;

 be rendered for a fee, direct or indirect;1

 be provided pursuant to an agreement, arrangement, or understanding (which may 

be implied by course of dealing and reliance);

 be individualized to the plan’s particular needs; and

 serve as a (not the) primary basis for another plan fiduciary’s investment decisions. 

DOL’s “employee education” Interpretive Bulletin (regulation), discussed below, though not 

directly applicable to relations between an investment adviser and a plan, provides additional 

guidance as to what constitutes “individualized” investment advice.

Securities professionals should note that once the line is crossed under ERISA, for 

purposes of fiduciary liability there is no distinction between “discretionary” and “nondiscretionary” investment advice (provided, of course, that the non-discretionary advice is 

followed by the client).

The law remains unresolved as to whether the “pension consultant” role of 

recommending managers constitutes investment advice under ERISA. In this respect, it can be 

argued that the recommendation of an investment fiduciary is neither a recommendation 

regarding “the value of securities or other property,” nor a recommendation regarding 

“investing, purchasing, or selling securities or other property” under the ERISA regulations. 

However, there is authority for the proposition that DOL reads the statute more broadly. For 

this reason, pension consultants often stop short of recommending specific managers and 

merely offer lists of qualified managers.

When does one cross the line between “education” and “advice”? In 1996 DOL issued 

an interpretive bulletin (“IB 96-1”) indicating what level of investment “education” services may 

be provided to 401(k) plan participants and beneficiaries without crossing the line into fiduciary 

investment advice. IB 96-1 describes four categories of information that may be provided on a 

non-fiduciary basis:

 Plan information. This is basically descriptive information.

 General financial and investment information. This is general advice regarding 

investment “concepts,” terminology, risk assessment, etc.

 

1

 This is one part of the definition that financial professionals always seize upon. However, DOL has interpreted 

the fee requirement very broadly. A financial professional should assume that if he or she is acting under a profit 

motive, there will be a fee somewhere.
December 2008 6

 Asset allocation models. “Generic” models may be provided along with generic 

information regarding the means by which participants may assess which model to 

use. The models may relate to specific plan-designated investment options if certain 

disclosures are made.

 Interactive investment materials. This extends the asset allocation concept through 

the use of “generic” questionnaires, computer programs, and other interactive 

means to allow participants to assess their retirement needs, goals, risk tolerance, 

etc. and to apply those assessments to available investment options.

Although binding on DOL, whether these guidelines would prevent a plan participant or 

beneficiary from challenging the fiduciary nature of an asset allocation program is unclear.

Although IB 96-1, on its face, applies only to participant-directed ERISA plans, it should 

also apply equally to self-directed IRAs. Moreover, although it only purports to cover education 

provided by an employer to employees, the principles that it sets out should apply equally in 

any other context, such as when an adviser helps a plan sponsor determine an appropriate 

asset allocation.

When do broker-dealer activities become investment advice? The original investment 

advice regulations under ERISA were designed to ensure that traditional investment 

“recommendations” broker-dealers would not, by themselves, be considered investment advice 

for ERISA purposes. In addition, the regulations contain a “safe harbor” under which a brokerdealer may be given a limited range of discretion (as to time frame, price range, etc.) within 

which to execute a trade without becoming a fiduciary. For these reasons, much of the 

discussion that follows relates only to fiduciary RIAs.

However, particularly in the case of smaller plans that come to rely upon the advice of 

their brokers as a primary source of information on which to make investment decisions, in a 

number of individual cases DOL and the courts have found that broker-dealers have crossed the 

line and become ERISA fiduciaries.

In addition, the growing practice of providing “transition brokerage” or “transition 

management” services may cause transition brokers to fall outside of the safe harbor for 

execution to the extent that they are given a greater range of discretion than is permitted 

under the regulations. In order to fit within the safe harbor, trading instructions provided to a 

broker must be given by a fiduciary independent of the broker and must specify all of the 

following:

 Identity of the specific security(ies) to be bought or sold.

 Price range within which the security may be bought or sold.

 A time span for executing the transaction, not to exceed 5 business days.

 The number of shares (or dollar value) to be bought or sold.

PPA note: The PPA added a statutory exemption for the provision of investment advice 

to participants. This exemption is discussed later in this article.
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Who is an “investment manager” under ERISA (and why does it matter)? An RIA who 

has actual authority to acquire, manage, or dispose of plan assets can be appointed as an 

“investment manager” for ERISA purposes. A bank or insurance company may also be an 

investment manager. An investment manager must acknowledge its fiduciary status in writing. 

The appointment of an investment manager under ERISA is not mandatory and is solely 

for the benefit of the appointing fiduciary. A plan fiduciary who properly appoints an 

investment manager (and any trustee who follows the manager’s directions) generally will not 

be liable for investment decisions of the investment manager. The appointing fiduciary must be 

a “named fiduciary” under the plan, and remains liable for prudently selecting the manager and 

monitoring its performance. 

Note: Investment manager status affords no legal benefit for the manager itself.

DOL requires that a state-registered adviser that wishes to be appointed as an 

investment manager must file a copy of its registration electronically with DOL, through the

Investment Adviser Registration Depository (IARD).

“Taft-Hartley” – Where Does it Fit in? 

There is often a great deal of confusion as to whether so-called “Taft-Hartley plans” are 

subject to ERISA. In fact, they are subject to ERISA in the same manner as any other benefit 

plan. The 1947 Labor-Management Relations Act, informally known as the Taft-Hartley Act, is a 

law governing labor relations, not benefit plans as such. It acts as an overlay to the structuring 

of certain collectively bargained plans, in addition to ERISA. 

In general, for securities professionals, the key points to note about Taft-Hartley plans 

or funds are (1) they subject to collective bargaining, usually between a single union and several 

contributing employers in a single trade or business (hence the alternative term 

“multiemployer plan”); and (2) they are trusteed by an equal number of representatives of the 

union (union trustees) and the employers (management trustees). 

This structure has certain practical implications. All costs must be paid from “plan 

assets” as there is no separate pool of employer assets to draw upon; one result is that contract 

indemnities are more limited and often not available. Individual trustees are typically not 

investment professionals and tend to rely to a greater degree on pension consultants as well as 

investment managers to insulate them from fiduciary liability. The trust is a committee that 

must act by majority vote rather than employer fiat. (Note, in particular, that even though the 

union and management appoint equal numbers of trustees, the management trustees 

represent multiple companies and tend to have less continuity, so the union trustees often 

wield disproportionate influence in the decision-making process.)

REPORTING AND DISCLOSURE

ERISA imposes a number of reporting obligations (to DOL and in some cases to the PBGC

or IRS) and disclosure obligations (to plan participants) on plan fiduciaries. These requirements 
December 2008 8

were substantially modified by the PPA and vary depending on the type of plan (defined 

benefit, self-directed defined contribution, fiduciary-directed defined contribution). Disclosure

requirements may include, among other things, summary plan descriptions (“SPDs”), annual 

funding notices, periodic benefits statements, and summary annual reports. The administrator 

of an ERISA plan also must file an annual report with DOL on a 5500-series form. Provided 

certain requirements are met, disclosures to participants under ERISA may now be made 

electronically. 

With limited exceptions, the basic reporting and disclosure requirements of ERISA will 

not apply directly to plan service providers such as an RIA serving as an investment advisory or 

investment management fiduciary. The primary reporting and disclosure obligations of 

securities professionals are those imposed by the securities laws. One exception is that a 

person managing plan assets will be obligated to provide to the plan administrator certain 

financial information necessary for the filing of the plan’s annual reports, and to cooperate as 

reasonably necessary in any required independent annual plan audit. 

Notwithstanding the foregoing, in many cases the service provider may be required by 

contract to fulfill reporting and disclosure obligations otherwise imposed on the plan sponsor or 

other plan fiduciary who has retained the service provider. Reporting and disclosure 

obligations commonly borne by financial institutions include the following:

Form 5500 filing by “DFEs”

In some cases, in lieu of assisting directly in the preparation of each plan’s annual 

report, a financial institution advising a separate (non-registered) commingled investment fund 

holding “plan assets” may elect to prepare a single entity-level annual report as a “direct filing 

entity” or “DFE” pursuant to DOL regulations. These regulations provide that the fund manager 

may, within prescribed time periods, file a single audited financial report for the entity with 

DOL (based on Form 5500). If it does so, the administrator of each investing plan need only 

report the value of the plan’s interest in the entity on the plan’s own annual report; otherwise 

the plan must “look through” the fund and report its proportionate interest in each of the 

fund’s portfolio holdings. Accordingly, this method of compliance is simpler for all parties and 

often is mandated in investment contracts involving unregistered investment vehicles.

ERISA Section 404(c) Disclosures 

A participant-directed plan that is structured to benefit from the fiduciary protections 

afforded by ERISA section 404(c) must comply with certain additional disclosure obligations. 

Typically, plan sponsors look to financial institutions to provide some or all of these disclosures. 

The specific section 404(c) disclosure requirements are discussed in more detail below under 

“GENERAL FIDUCIARY OBLIGATIONS - ERISA Section 404(c) Relief from Fiduciary Liability.”
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GENERAL FIDUCIARY OBLIGATIONS

ERISA imposes certain general obligations on plans and their fiduciaries (generally, these 

rules do not apply to IRAs). Even a non-fiduciary service provider should keep in mind that 

these rules will impact its activities. Briefly, ERISA’s fiduciary obligations (other than the 

prohibited transaction rules, which are discussed separately) include:

Exclusive Purpose/Exclusive Benefit Rule

This is the duty of undivided loyalty to the plan, i.e., a fiduciary must discharge its duties 

solely in the interest of the plan and its participants and beneficiaries, for the exclusive purpose 

of providing plan benefits and defraying reasonable plan expenses. However, leaving aside the 

additional protections of ERISA’s prohibited transaction rules (discussed below), which often 

are considered extensions of the exclusive benefit rule to certain specified fiduciary actions, 

“exclusive” is read to mean “primary,” so that this rule is not necessarily violated if another 

party derives a truly incidental benefit from a plan transaction.

Court cases have made clear that under this rule, fiduciaries have a duty not to mislead 

plan participants when discussing plan-related matters; some courts have begun to expand this 

duty into an obligation not to mislead by omission or even to impose an affirmative duty to 

disclose material information. What if this disclosure obligation conflicts with another duty, 

such as the insider trading rules? In the Enron case, DOL argued, and the court agreed, that 

there is not necessarily a conflict; insider trading rules are not violated by, and indeed 

encourage, public disclosure. The result can be a dilemma for corporate insiders who have 

information that they are not yet ready to release to the public. However, in a 2004 “Field 

Assistance Bulletin” for its field enforcement staff, DOL did provide some additional guidance to 

assist directed trustees and other fiduciaries as to what actions they may be obligated to take if 

anyone within the organization obtains material non-public information regarding a plan 

sponsor.

Prudence Requirement

A fiduciary must act with the care, skill, prudence, and diligence under the

circumstances then prevailing that a reasonably prudent person acting in a like capacity and 

familiar with such matters would use in the conduct of an enterprise of like character and with 

like aims. The highlighted terms distinguish ERISA’s prudence rule, often described as the 

“prudent expert” standard, from traditional common law “good faith” prudence standards 

(though in most states the common law standard has been replaced by the Uniform Prudent 

Investor Act, which follows ERISA’s approach).

The prudent expert standard means, among other things, that the level of care imposed 

on an RIA may vary with the complexity of the investments involved. A 1996 letter from DOL to 

the Comptroller of the Currency, regarding plan fiduciaries’ obligations in connection with 

investments in derivatives, highlights this point.

Note that, in theory at least, DOL has embraced modern portfolio theory in applying the 

fiduciary standards; in practice, however, DOL’s enthusiasm sometimes is not so clear. 
December 2008 10

Moreover, some professionals have questioned whether modern portfolio theory has been 

properly applied in the retirement plan context, particularly when it comes to “frozen” plans, 

i.e., whether “asset based” investing that starts with a 60-40 equity-debt presumption, and that 

looks principally at the plan’s assets and risk tolerance to vary the mix, has been so 

overemphasized that plan liabilities and funding have been overlooked. Thus, the growing 

interest in liability-driven investment (LDI) and commitment-driven investment (CDI) strategies.

Duty to diversify investments

ERISA requires that a fiduciary must diversify a plan’s investments so as to minimize the 

risk of large losses, unless under the circumstances it is clearly prudent not to do so. For 

example, the expense of greatly diversifying a small portfolio may not justify the additional 

protection derived (although there may be other ways of achieving both ends, such as 

commingling the plan’s assets with those of other investors). To the extent that an investment 

manager is responsible only for a portion of a plan’s total assets, its obligation to diversify its 

own portfolio should be clearly spelled out in its investment management agreement; 

generally, however, it would remain responsible for diversifying within its range of discretion 

(e.g., a small cap manager would retain responsibility for maintaining a diversified small cap 

portfolio).

Generally, the duty to diversify does not extend to holdings of employer stock in a 

defined contribution plan. To the extent that ERISA otherwise permits, and to some extent 

even encourages, investment in employer securities through various prohibited-transaction 

exemptions (discussed in more detail below), it also contains an explicit exception to the 

general fiduciary duty to diversify so long as the investment is otherwise prudent, in the 

interests of the plan and its participants, and consistent with the plan’s documents.

Compliance with Plan Documents

Plan fiduciaries are required to act in accordance with the documents governing a plan 

to the extent not inconsistent with the terms of ERISA. For example, if a plan’s trust document 

prohibits certain types of investments, an investment manager who invests in such assets may 

be in violation of ERISA even if such investments do not violate its investment management 

agreement. It should be noted that DOL has used the qualifying language in enforcement 

actions (for example, in the proxy voting context) to challenge fiduciaries who “passively” 

adhere to plan terms when it may not otherwise be prudent to do so. In the face of a potential 

conflict between the terms of a plan and the terms of ERISA, rather than decide which course is 

correct a fiduciary may wish to consider amending the plan.

In the past, RIAs and other service providers have often tried to address the issue of 

complying with plan documents by obtaining representations and warranties from the fiduciary 

who hires them on behalf of the plan (i.e., to the effect that the investment management 

agreement is consistent in all respects with the terms of the plan). However, DOL has indicated 

that a fiduciary may not be able to rely on such representations, but must obtain and review 

applicable plan and trust documents.
December 2008 11

Trust Requirement

ERISA plan assets must be held in trust, with certain limited exceptions (e.g., assets held 

by insurance companies). These rules, however, do not prohibit 1) the holding of securities in

nominee or street name with a custodial bank, insurance company, registered broker-dealer, or 

clearing agency, provided that a trustee is the ultimate beneficial owner of the securities, or 2) 

the creation of certain single-owner or commingled investment vehicles (corporation, 

partnership, LLC, etc.) which hold “plan assets,” if interests in the vehicles are held in trust. A

trustee must be named in the plan or trust documents or be appointed by a “named fiduciary” 

and must have exclusive authority or discretion to manage the assets held by it except to the 

extent that such authority is 1) reserved to a non-trustee named fiduciary or 2) properly 

delegated to an investment manager (but only to the extent that the manager’s directions to 

the trustee do not on their face violate the terms of the plan or the requirements of ERISA).

ERISA does not mandate the use of corporate trustees, and many plans (including most 

Taft-Hartley plans) have individual trustees. Note, however, that the Code does require that 

IRA assets must be held by a corporate trustee or custodian.

Indicia of Ownership

In conjunction with the trust requirement, ERISA requires that the “indicia of 

ownership” of any plan assets be held within the jurisdiction of the U.S. Federal District courts. 

(What constitutes indicia of ownership of an asset generally will be determined by the 

securities laws or under state/common law.) However, DOL regulations permit the holding of 

certain foreign securities and foreign currency outside the U.S., provided that they are held 1) 

under the management or control of a qualified fiduciary, or 2) in the physical possession or 

control of certain qualifying financial institutions, which fiduciary or custodial institution is a 

U.S. domestic entity whose principal place of business is in the U.S. Although these 

requirements are complicated, generally a qualified fiduciary must be a U.S. bank, insurance 

company, or RIA meeting certain minimum size requirements (in the case of an RIA, $50 million 

in assets under management and $750,000 equity). A qualifying custodial financial institution 

must be a U.S. bank, insurance company, or broker-dealer meeting similar requirements, or 

certain of their foreign agents, provided that certain other requirements are met as to a plan’s 

ability to assert and enforce its ownership rights against the U.S. institution.

In early 2008, DOL issued an advisory opinion to Northern Trust regarding its 

“Multinational Cross-Border Pooling Products.” The opinion addressed the application of the 

indicia of ownership requirements in the context of “global pooling” products. The 

arrangements described in the opinion involve multiple layers of ownership, management, 

custody and sub-custody. A global pooling vehicle would be structured as one of several types, 

typically under the laws of Ireland or Luxembourg. A pooled vehicle may be required to have a 

local custodian regulated under the law of the jurisdiction where the vehicle is formed. 

Northern Trust indicated that this would be either Northern Trust (via a local branch) or a local 

subsidiary of Northern Trust. Where Northern Trust itself is the local custodian, it will also be 

designated as the “global custodian.” Where an affiliate is the local custodian, it will appoint 
December 2008 12

Northern Trust as global custodian (in reality, as a subcustodian). In some jurisdictions, 

Northern Trust may further appoint a local (foreign) entity as its subcustodian. As an 

interesting note, Northern Trust further indicated that uninvested US dollar-denominated cash 

balances would be swept into an Irish sweep vehicle established by Northern Trust, 

notwithstanding the rule that US currency must be held in the US. Northern Trust appears to 

have taken the position, and DOL appears to have agreed, that the indicia of ownership rules 

would be satisfied because the pool would be holding a foreign security (its interest in the 

sweep vehicle), rather than US currency (a fine line, to be sure).

Prohibited Transactions

ERISA’s prohibited transaction rules are discussed separately below. However, it should 

be kept in mind that engaging in or failing to prevent a prohibited transaction may be a 

fiduciary breach separately actionable by DOL or a co-fiduciary (apart from the express 

penalties imposed on the prohibited transaction itself).

Co-Fiduciary Obligations

A plan may have multiple fiduciaries with different responsibilities, e.g., a fixed income 

manager and an equity manager are both fiduciaries, but their responsibilities do not overlap. 

Nonetheless, one ERISA fiduciary may be held liable for a breach of another fiduciary – even if

the breach has nothing to do with the first fiduciary’s responsibilities – if the first fiduciary 1) 

knowingly participates in, or knowingly undertakes to conceal, the other fiduciary’s act or 

omission, provided that he or she knows that the other party’s act or omission is a fiduciary 

breach; 2) in committing his or her own fiduciary breach, allows the second fiduciary also to 

commit a breach; or 3) knows of the second fiduciary’s breach, unless he or she makes a 

reasonable effort, under the circumstances, to remedy it. (For example, the foregoing fixed 

income manager inadvertently discovers that the equity manager has committed a prohibited 

transaction.)

Like regular fiduciary liability, co-fiduciary liability is joint and several; that is, each 

fiduciary can be sued for the full amount of any damages to the plan, regardless of comparative 

liability. The full extent of co-fiduciary liability remains to be tested. What if the co-fiduciary 

obtains its knowledge while acting in a non-fiduciary capacity? What about information 

obtained by non-fiduciary affiliates? 

Note that the term “co-fiduciary” as defined in ERISA has a different (and arguably exact 

opposite) meaning than its use in the common vernacular. The term is often used by money 

managers who agree to accept joint liability with a plan's in-house fiduciary – typically when 

recommending 401(k) plan investment options. In that context, the so-called “co-fiduciary” is 

really a non-discretionary investment adviser and will have direct and primary liability for its 

fiduciary recommendations. 

ERISA Section 404(c) Relief from Fiduciary Liability

General. ERISA section 404(c)(1)(A) provides that if a retirement plan permits 

participants (or beneficiaries) to exercise control over the investment of the assets in their 
December 2008 13

accounts, and a participant actually does exercise control (as determined by DOL regulations), 

then:

 The participant will not be deemed an ERISA fiduciary merely as a result of exercising 

such control; and

 No person who is otherwise a fiduciary shall be liable for any loss or breach of ERISA 

that results from the exercise of control.

PPA note: The PPA amended the foregoing to suspend these protections 

during a “blackout” period (during which the participant is unable to exercise 

control) unless the blackout is authorized and implemented consistent with 

all ERISA requirements.

Although simple in concept, this provision by its terms requires implementing 

regulations. Under the regulations, to qualify for relief, a plan must meet certain requirements, 

which may generally be summarized as follows:

 The plan must offer participants a “broad range of investment alternatives” that 

allow participants the opportunity to materially affect the potential return on the 

portion of their individual account under their control, construct a portfolio with risk 

and return characteristics at any point within a range appropriate for the 

participant; and minimize risk through diversification. 

 Participants must be permitted to give investment instructions with a frequency that 

is appropriate in light of the market volatility of the investment alternatives, but not 

less frequently than once in any three month period, and the plan must comply with 

specific additional trading frequency rules. 

 Participants must receive or have the opportunity to receive specific information 

regarding investment alternatives.

Though these obligations generally are imposed on the plan sponsor or other named 

fiduciary(ies), they often fall on service providers by contract or course of dealing. For example, 

employers often expect that a financial institution offering investment options or investment 

advice to participants will undertake to ensure compliance or, at minimum, will be in a position 

to advise the plan sponsor as to how it may meet its compliance obligation. 

Required disclosures. Information regarding investment options that automatically

must be given to all participants includes:

 An explanation that the plan is intended to constitute a section 404(c) plan and a 

description of the relief afforded to the plan’s fiduciaries by that section.

 A description of the investment alternatives available under the plan and a general 

description of the investment objectives and risk and return characteristics of each 

alternative.
December 2008 14

 If any option involves retaining an RIA to act as investment manager, identification 

of the RIA.

 An explanation of the mechanics of giving investment instructions.

 A description of any fees imposed with respect to an investment option, e.g., fees 

imposed directly (such as sales loads, direct management fees, etc.). Fees imposed 

“inside” a mutual fund are not imposed on plan assets and are indirect for this 

purpose.

 Information identifying a plan fiduciary (usually the plan sponsor, but may be the 

RIA) who will provide the additional “on request” disclosures described below.

 In the case of an investment option that is an employer stock fund, certain 

additional information.

 With respect to any investment option that is registered under the 1933 Act 

(including mutual funds), a copy of the prospectus delivered immediately before or 

immediately following a participant’s initial investment.

 All proxies and voting materials incidental to a participant’s investment choice, and 

information regarding the exercise of voting and similar rights, to the extent that 

those rights are passed through to participants under the terms of the plan.

In addition to the foregoing automatic disclosures, certain additional disclosures must 

be made to participants upon request:

 A description of the annual operating expenses of each investment option, including 

a statement as to the aggregate amount of such expenses expressed as a percentage 

of net asset value.

 Copies of updated prospectuses, financial statements and reports, etc., to the extent 

otherwise provided (i.e., under the securities laws) to the plan.

 In the case of investments in (non-registered) vehicles whose assets are ERISA “plan 

assets,” certain additional information regarding the underlying investments of the 

vehicles.

 Information regarding the value of shares or units in available investment options, 

including past and current performance information (net of expenses). Generally, it 

would appear that this information must follow SEC (and NASD) requirements if 

applicable.

 Information regarding the value of shares or units in the participant’s account.

Affirmative directions. A key drawback of section 404(c) is the need to obtain 

affirmative directions from a participant in order to obtain fiduciary relief. “Negative consent” 

is not sufficient. However, affirmative directions are often difficult to obtain from some 

employees, particularly in the context of automatic enrollment or when plan investment 
December 2008 15

options change. Accordingly, the PPA amended section 404(c) to permit the use of deemed or 

negative consent in two circumstances – when “mapping” from an existing investment option 

to a substitute investment option, and when the employee’s assets are placed into a “default” 

investment option in the absence of an affirmative investment direction. These special cases 

are discussed below:

Qualified mapping. Section 404(c)(4), added by the PPA, provides that if there is a 

“qualified change in investment options” under a plan, and if a participant fails to give 

affirmative investment directions after appropriate notice, then any assets invested in a 

changing (generally, discontinued) investment option may be “mapped” into new options with 

similar risk and return characteristics. If so, the plan’s fiduciaries will not be liable for losses 

that result from the investment of the participant's account balance in the replacement 

option(s).

Mapping under this provision may be an acceptable option in the context of a simple 

substitution of similar funds, but generally raises significant questions in the case of more 

complex plan restructuring transactions. In those cases, plan fiduciaries are more likely to map 

participant balances into QDIAs.

Qualified default investment alternatives (QDIAs). Section 404(c)(5), also added by the 

PPA, provides that if a plan meets certain notice requirements, a participant who fails to give 

directions will be treated as exercising control over the assets of his account which are invested 

by the plan fiduciary in a QDIA in accordance with regulations issued by DOL. DOL issued 

implementing QDIA regulations in late 2007. In early 2008, DOL followed up with certain 

technical amendments as well a “Field Assistance Bulletin” (“FAB”) that attempted to answer 

certain frequently asked questions. 

Fiduciaries who meet the requirements of the regulation are not liable for losses that 

result from the investment of the participant's account balance in a QDIA or for investment 

decisions made by a QDIA investment manager. Nonetheless, like any other investment option, 

fiduciaries remain responsible for prudently selecting and monitoring the default option (and 

any investment manager with respect to that option), and may be liable for any losses that 

result from a failure to do so. Investment managers who manage QDIAs would remain subject 

to applicable fiduciary standards.

Under the regulations, investments eligible for QDIA status generally include balanced 

funds, certain life-cycle or target-date funds, and managed accounts meeting various 

conditions. 

Some plan fiduciaries have begun to look at section 404(c)(5) as a means of periodically 

forcing participants to reevaluate their investment portfolios by requiring them to make new 

affirmative elections from time to time. Those who fail to do so are moved into a QDIA. Such 

an arrangement is sometimes described as a “plan reset” transaction.
December 2008 16

Application of ERISA's Fiduciary Rules to Specific Securities-Related Issues

Proxy voting and corporate governance. Generally, unless the authority to vote has 

been expressly (and properly) reserved or delegated to another fiduciary in accordance with 

ERISA, the fiduciary who is responsible for the management of securities held by a plan also will 

be responsible for voting those securities. DOL regulations recommend that plan fiduciaries 

adopt statements of investment policy and proxy voting guidelines and that those fiduciaries 

expressly require (i.e., in the investment management agreement) that the manager comply 

with those statements. Investment managers likewise are encouraged to adopt their own 

guidelines, particularly with respect to pooled investment vehicles whose investors otherwise 

may have differing priorities. (Generally, investment guidelines are not “plan documents,” so 

that they may be overridden by the management agreement.)

Typically, a broad policy of not voting will not be acceptable, though it may be prudent 

not to vote in certain specific situations, such as where the cost outweighs any potential 

benefit. For example, the preamble to DOL regulations suggests that foreign securities may 

sometimes be costly to vote “due to the variety of regulatory schemes and corporate 

practices.” More generally, voting very small shareholdings may be costly in terms of staff 

time/research costs.

Economically targeted investments. DOL also has issued various pronouncements with 

respect to the issue of “economically targeted investments,” or “ETIs” and other “social 

investing” issues, including most recently in 2008 regarding the use of Taft-Hartley plan assets 

to promote union organizing and collective bargaining campaigns. These transactions, in effect, 

take into account non-economic “social” investment considerations. DOL’s position, which 

remains controversial, is that it is permissible to take non-economic considerations into account 

only if an investment otherwise satisfies all fiduciary considerations and otherwise is expected 

to provide no less a return than other investments with similar risk and return characteristics.

Employer securities. Even before the Enron and WorldCom cases, it was obvious that 

holding employer securities in a plan could raise significant ERISA concerns both for employers 

as well as financial institutions administering plans. Particularly in the case of a troubled 

company, a key source of concern has been the conflict between following plan terms that 

mandate investment in employer securities and general fiduciary duties of loyalty and 

prudence, which may suggest ignoring those terms. Although the law remains unsettled, to 

date several courts have suggested that there exists a presumption that it is prudent to follow 

plan terms; in other words, the burden of proof may be on participants to show otherwise. 

However, this remains a very complicated and volatile area, and more litigation may be 

anticipated in light of the current economic downturn.

The acquisition, holding and disposition of employer securities also raises various 

prohibited transaction considerations, see below.

Late trading and market timing. Generally, many of the issues surrounding the late 

trading and market timing scandals have been addressed both by plans and by mutual funds 
December 2008 17

and their advisers. If nothing else, these issues served as a wake-up call to plan fiduciaries to 

ensure that they are adequately performing their due diligence and monitoring functions.

PROHIBITED TRANSACTIONS

As an extension of ERISA’s fiduciary duties, and in deviation from common-law fiduciary 

principles, ERISA and the Code incorporate very broad prohibitions against a wide range of 

activities. These prohibitions extend to a broad group of fiduciary and non-fiduciary parties, 

and roughly fall into three categories: 1) prohibited transactions between a plan and any “party 

in interest” (“disqualified person” under the Code), which party need not be a fiduciary; 2) the 

acquisition or holding by a plan of certain “employer securities” or “employer real property”; 

and 3) fiduciary conflicts, including “self-dealing,” direct conflicts (representing a plan and an 

“adverse party” in the same transaction), or accepting compensation from a third party dealing 

with the plan (“kickbacks”). As noted above, these rules also apply to IRAs, with some minor 

differences.

Particularly for securities professionals, it is important to keep in mind that one 

overriding principle of ERISA’s prohibited transaction rules is that they were designed to avoid 

subjective determinations of violations, even if that result seems harsh. That is – at least until 

the PPA added a “service provider” exemption, see below – there were no broad exceptions for 

transactions that are reasonable, “arm’s-length,” or based on disclosure and informed consent; 

however, some or all of these factors may be necessary, but usually not sufficient, steps in 

complying with certain administrative exemptions.

Typically, two of the three broad categories of prohibited transactions are relevant to 

securities professionals: 1) transactions between a plan and certain “parties in interest,” 

sometimes regarded as per se or “objective” prohibitions because they look only to result; and 

2) fiduciary conflicts/self-dealing transactions, which often involve a subjective “intent” of the

fiduciary.

Party-in-Interest Transactions

Absent an exemption, ERISA prohibits certain direct or indirect transactions between a 

plan (including a vehicle holding plan assets) and a party in interest to that plan.

Who is a “party in interest”? Parties in interest with respect to a plan include, among 

others: 1) all fiduciaries of the plan; 2) any person providing services (fiduciary or non-fiduciary) 

to the plan; 3) any employer or union whose employees are covered by the plan; and 4)

numerous parties affiliated with the foregoing in various direct or indirect ways. For a large 

plan, not even counting employees, there can be hundreds if not thousands of parties in 

interest.

What transactions are prohibited? By definition, virtually any direct or indirect

transaction between a party in interest and a plan is prohibited in the first instance, including 

sales, exchanges, or leasing of property; lending of money or other extensions of credit (by a 
December 2008 18

plan or to a plan); furnishing of goods or services; and transfers of assets to or for the benefit of 

a party in interest.

Note: In general, when a plan holds an equity interest in a vehicle that does not hold 

“plan assets”, it is not a prohibited transaction for the vehicle to engage in a transaction 

with a person who is a party in interest to the investing plan. However, DOL regulations 

state that if the plan invests in the vehicle intending or knowing that the vehicle will 

transact business with a party in interest, the investment may be prohibited.

What exceptions apply? Notwithstanding the foregoing, ERISA also recognizes plans’ 

needs to engage in certain otherwise prohibited transactions, and so incorporates various 

statutory exemptions and provides that DOL also may promulgate administrative exemptions. 

In this respect, certain statutory exemptions relevant to securities professionals include:

 Reasonable services. Perhaps the most important exemption is the one permitting 

a party in interest to contract with a plan for services “necessary” for the 

establishment or operation of the plan – ERISA section 408(b)(2). Regulations 

indicate that a service is necessary if it is “appropriate” and “helpful” to the plan in 

carrying out its functions. However, the exemption only applies if the arrangement 

and the compensation are “reasonable.” The arrangement is reasonable only if it is 

terminable by the plan without penalty, upon reasonably short notice “under the 

circumstances.”

It is important to note that this exemption has been interpreted as not extending to 

any fiduciary conflict (the so-called “multiple services” issue). For example, unless 

another exemption applies, an investment adviser would engage in a separate act of 

“self-dealing” if it caused a plan to retain its affiliated broker-dealer to execute 

trades for additional compensation, regardless of whether the arrangement is 

reasonable. Self-dealing is discussed separately below.

Note: In December, 2007, DOL published proposed revisions to its 

regulations under section 408(b)(2) to incorporate significant new fee 

disclosure requirements for ERISA plans. The proposal is discussed in more 

detail below under “Hot Topics.”

 Blind transactions. Although not incorporated into the statute per se, ERISA’s 

legislative history indicates that a purchase or sale of securities between a plan and 

a party in interest would not be prohibited if the transaction is an ordinary “blind” 

transaction on a traditional securities exchange (including OTC) where neither party 

(nor their broker agents) knows the identity of the other. DOL recently issued an 

advisory opinion extended this concept to an “alternative trading system” that 

facilitates block trading (Liquidnet ATS) even though it is possible that the parties’ 

identities “could” become known, provided they take steps to remain anonymous.

PPA note: the PPA added a new statutory exemption to ERISA that exempts 

trades carried out on certain electronic communications networks (ECNs), 
December 2008 19

even if not technically “blind” (and even if the RIA or broker has an 

ownership interest in the ECN), if certain conditions are satisfied with respect 

to execution mechanics, valuation, and disclosure and consent.

 Transactions with service providers. Not to be confused with the above exemption 

for the provision of reasonable services to a plan, ERISA section 408(b)(17) – added 

by the PPA – permits a plan to engage in other types of transactions (purchases and 

sales, loans, leases, etc.) with service providers. It requires that the service provider 

not have fiduciary authority over the assets in question, and that the plan pay no 

more than, or receive no less than, “adequate consideration.” This is a major 

development, as the original drafters of ERISA expressly rejected the idea of a broad 

“arm’s-length” exception to the party-in-interest prohibitions.

DOL has also promulgated a number of generic or “class” prohibited transaction 

exemptions (“PTEs”), which are broadly available to any party in interest who satisfies their 

conditions. (DOL also issues individual PTEs, applicable only to the identified parties.) Many of 

these class exemptions apply to party-in-interest transactions involving securities, including:

 Broker-dealer transactions. The very first exemption, PTE 75-1, broadly exempts 

certain principal transactions, underwriting, and extensions of credit by nonfiduciary broker-dealers, as well as certain market-making transactions by parties in

interest who may or may not be fiduciaries.

Generally, the exemption for principal transactions does not apply if the dealer (or 

its affiliate) is a fiduciary with respect to the assets involved in the transaction. 

However, there is a specific exception in PTE 75-1 for a broker-dealer who as a 

fiduciary (directly or in conjunction with its affiliates) receives a fee for causing a 

client plan to invest in unaffiliated mutual funds. Although styled as an exemption 

for principal transactions, it is clear that it was intended to cover typical mutual fund 

distribution (dealer) agreements. 

The exemption for underwriting (traditional IPOs) should not be confused with the 

so-called “underwriters exemptions,” which relate to the underwriting of assetbacked investment pools (see below with respect to mortgage pool investment 

trusts).

 Certain IPOs. PTE 80-83 exempts certain purchases of securities in an IPO where the 

issuer may use the proceeds to reduce or retire an indebtedness to a party in 

interest.

 Securities lending. PTE 2006-16 permits plans to engage in securities lending 

transactions with counterparties who may be parties in interest. Compared to its 

predecessor (PTE 81-6), the exemption expands the types of collateral that a plan 

may accept and enables plans to loan securities to certain foreign banks and brokerdealers. The exemption also clarifies that “fee-for-hold” arrangements, as well as 

loans structured as repurchase agreements can qualify for relief. 
December 2008 20

 Short-term investments. PTE 81-8 permits a plan to enter into certain short-term 

investment transactions with parties in interest, including certain: 1) bankers’ 

acceptances; 2) commercial paper; and 3) repurchase agreements (but not reverse 

repos). Similar individual relief was granted in 1996 to Lehman Brothers in 

connection with the marketing of “synthetic” or “collateralized” GICs (“guaranteed 

investment contracts”).

 Mortgage pool investment trusts. PTE 83-1, as amended several times, grants 

broad relief for a variety of potential prohibited transactions involving plan 

purchases of interests in certain securitized residential mortgage pools. Numerous 

individual “underwriter exemptions” have been granted to almost all financial 

institutions that participate in the offering of asset-backed investments, and 

extending this relief to other types of asset-backed pools.

 QPAM. Traditionally one of the most important exemptions, PTE 84-14, as amended 

in 2005, broadly exempts transactions effected by a plan at the direction of a 

“qualified professional asset manager,” or “QPAM.” I.e., PTE 84-14 permits a plan to 

engage in transactions with third parties, without needing to conduct due diligence 

to determine whether such third parties may be parties in interest to the plan.

A QPAM must be an independent fiduciary and, if an RIA, must have total client 

assets under its discretionary management of $85 million and shareholders’ or 

partners’ equity of $1 million. The exemption is available with respect to any plan 

whose assets (combined with those of any affiliated plan) represent no more than 

20% of the QPAM’s discretionary client assets. The exemption does not cover a 

party in interest who, at the time of the transaction, has the power to appoint the 

QPAM as the manager of the plan assets that are involved in the transaction for 

which relief is sought (subject to an exception for certain smaller investors in a 

pooled fund).

With limited exceptions, the PTE does not apply to transactions with persons related 

to the QPAM or the plan sponsor.

DOL currently is considering an amendment to the exemption that would generally 

allow a QPAM to provide management services to its own (in-house) plans if certain 

conditions are met.

PPA note: the new statutory exemption for transactions with service 

providers, discussed above, ultimately may largely replace the QPAM 

exemption, and DOL already is considering whether QPAM will continue to 

have any utility in the future.

 Foreign exchange transactions. PTE 94-20 permits a bank or broker-dealer, or their 

affiliates, who may be parties in interest with respect to a plan, to act as principal in 

a foreign exchange transaction with the plan, provided that the transaction is done 

at the direction of a fiduciary independent of the bank or broker-dealer. PTE 98-54 
December 2008 21

similarly covers certain foreign exchange transactions that are pursuant to standing 

instructions.

PPA note: the PPA added a new and expanded foreign exchange exemption 

that may largely replace these class exemptions.

 INHAM. Because many larger plans manage their assets in-house and cannot rely 

upon the QPAM PTE, DOL issued PTE 96-23 to permit certain transactions directed 

by such in-house asset managers (“INHAMS”). Among other things, an INHAM must 

be a separately incorporated RIA subsidiary of the plan’s sponsor, or a nonprofit RIA 

controlled by the sponsor, with at least $50 million under management. It is 

available only for larger plans ($250 million in assets). The INHAM must obtain an 

annual audit; largely because of this audit requirement, it is estimated that only 15 

to 20 large plans utilize this exemption.

PPA note: as with QPAM, the new statutory exemption for transactions with 

service providers ultimately may replace the INHAM exemption.

Note that these exemptions contain various conditions and limitations and do not necessarily 

exempt fiduciary conflicts, which are separately discussed below.

Fiduciary Conflicts

As noted above, ERISA separately prohibits fiduciaries from engaging in certain 

transactions that may be viewed as resulting in conflicts of interest. These include 1) dealing 

with the assets of a plan for the fiduciary’s own interest or own account (“self-dealing”); 2) 

acting on behalf of, or representing (in any capacity), a party in a transaction if that party’s 

interests are adverse to the interests of the plan or its participants and beneficiaries (direct 

conflict of interest); or 3) receiving any consideration for the fiduciary’s personal account, from 

a third party, in connection with a transaction involving plan assets (a “kickback”). Such 

violations also may, but need not, separately constitute violations of the party-in-interest 

prohibitions. (Kickbacks may also result in criminal violations.) Types of transactions that may 

be prohibited by these rules include:

Performance of additional services/hiring of affiliates. Although a fiduciary is not 

prohibited from being retained on behalf of a plan to provide one or more services for a 

negotiated fee, a fiduciary cannot use its authority to hire itself or any affiliate to perform 

additional services for additional fees (“multiple services”). Conversely, there generally is no 

prohibited act of self-dealing if 1) neither the fiduciary nor any of its affiliates is exercising 

fiduciary authority but are acting solely at the direction of another, unaffiliated fiduciary 

(including the provision of “bundled” services) or 2) the additional services are provided for no 

additional consideration other than reimbursement of direct (out-of-pocket) expenses. Limited 

exemptions to this prohibition have been granted in connection with:

 Securities lending services. PTE 2006-16 permits a fiduciary to receive additional 

compensation in connection with the provision of securities lending services to a plan, 
December 2008 22

subject to prior authorization and certain other conditions. (This had been previously 

allowed by PTE 82-63; PTE 2006-16 consolidated PTE 86-1, above, and PTE 82-63).

 Brokerage services. PTE 86-128 permits the receipt of fees (brokerage commissions) 

by a plan fiduciary or its affiliate for “effecting or executing” securities transactions as 

agent for the plan, but only if trading is not excessive in amount or frequency (i.e., no 

“churning”). Very old DOL guidance suggests that the exemption may cover mutual 

fund front-end sales loads, even though such fees technically are paid by the fund 

rather than directly by the plan; however, more recently DOL argued, and a court 

agreed, that it does not exempt the receipt of 12b-1 fees. “Effecting or executing” is 

used in normal securities law sense, and includes ancillary services such as clearance, 

settlement, custodial, or other functions (but not margin lending). If the fiduciary 

serves as more than an RIA or directed trustee (e.g., as discretionary trustee, plan 

administrator, or plan sponsor), the exemption only applies if all profits earned on the 

trades are disgorged and paid to the plan. See also the discussion of PTE 84-24, 

below.

PTE 86-128 also extends to agency cross transactions, but only if the broker-dealer is 

acting solely as agent for the non-plan counterparty (i.e., is not exercising discretion or 

rendering investment advice).

All of the conditions of PTE 86-128 are waived with for IRAs, making it a key 

exemption for broker-sponsored IRAs.

Keep in mind that the PTE applies to trades that are executed on the advice or at the 

discretion of a fiduciary adviser; no exemption is required for trades that are fully 

directed by the client.

The exception to the above rules permitting reimbursement of a fiduciary for its direct 

expenses must be applied with caution. An expense is “direct” only if it does not represent 

overhead and only if it would not have been incurred “but for” the provision of services to the 

plan. In effect, the expense normally must be traceable to a specific plan, not merely allocable 

among a number of plans. For example, computer software normally would be considered 

overhead and/or would be usable for the benefit of more than one client; however, software 

purchased to implement a unique investment program of a single plan client might satisfy the 

rules for reimbursement.

Investing plan assets in proprietary mutual funds. To the extent that a plan fiduciary also 

serves as investment adviser to a registered, open-end investment company, the fiduciary’s 

investment of plan assets in the mutual fund may involve one or more fiduciary conflicts. PTE 77-

4 (for client plans) and PTE 77-3 (for the fiduciary’s own, in-house, plans) provide relief for such 

investments provided that certain conditions are satisfied, including disclosure and consent, and 

taking steps to avoid double fees. Similar relief is granted under PTE 79-13 for in-house plans of 

closed-end investment companies (but not for client plans, which effectively prevents most 

registered hedge fund managers from relying on these exemptions).
December 2008 23

PTE 84-24 also exempts, among other things, a plan’s investment in a mutual fund where 

the fund’s adviser or principal underwriter is also a directed trustee, prototype plan sponsor, or 

other service provider with respect to a plan (but not an investment manager or trustee having 

discretionary authority or control over the plan assets involved in the transaction, nor the plan 

sponsor), where an affiliate of the fund’s adviser or principal underwriter will receive a sales 

commission with respect to the transaction. For this purpose, sales commissions generally include 

12b-1 distribution fees. The PTE does not explicitly authorize the receipt of fund-level advisory 

and other fees (in contrast to PTEs 77-3 and 77-4), though it appears to do so implicitly. (Note 

that PTE 84-24 is not limited to the marketing of proprietary funds, though it is often used for that 

purpose.)

Investing plan assets in third-party mutual funds. To the extent that a plan fiduciary 

directs (or recommends) the investment of plan assets into a third-party mutual fund or other 

investment vehicle from which the fiduciary or any of its affiliates may receive compensation 

(12b-1, transfer agency, subadministration, referral, custody, etc. fees), retention of such fees 

would be prohibited. DOL’s 1997 “Frost” advisory opinion indicates, however, that such fees may 

be received if they are fully applied, on a dollar-for-dollar basis, to offset plan-level fees or 

otherwise are credited back to the plan. (Based on the Frost and “Aetna” letters, a follow-up 

DOL information letter to the American Bankers Association confirms that a fully directed 

trustee/fiduciary generally may retain such fees with the knowledge and consent of the plan.) 

Generally, an RIA or broker-dealer acting only in a non-fiduciary capacity would not be subject to 

these concerns. However, it is important to bear in mind that if an affiliate is a fiduciary, the 

activities of the RIA or broker-dealer may be attributed to the affiliate.

As noted in the previous sub-section, PTE 84-24 may cover the receipt of sales loads and 

12b-1 fees by a party providing (fiduciary) investment advice with regard to the investment of 

plan assets into a non-proprietary fund. However, DOL has suggested that the relief afforded by 

PTE 84-24 would not extend to separate charges for the investment advice over and above the 

sales commissions themselves.

See also the discussion above regarding relief to broker-dealers engaging in principal 

transactions (PTE 75-1), which covers certain transactions involving the investment of client plan 

assets in third-party mutual funds, where the fiduciary may receive certain types of revenue 

sharing payments.

Investing plan assets in collective investment trusts and insurance company pooled 

separate accounts. Section 408(b)(8) of ERISA is a statutory exemption for the investment of 

plan assets in certain pooled investment vehicles not registered under the Investment Company 

Act. It provides that “the prohibitions of section 406” of ERISA shall not apply to any 

transaction between a plan and a bank-maintained common or collective trust fund or an 

insurance company pooled separate account, where the transaction involves a sale or purchase 

of an interest in the fund and the transaction is expressly permitted either directly in plan 

documents or by an independent fiduciary.
December 2008 24

DOL has indicated that the exemption permits a money manager or its affiliate to invest 

plan assets on a discretionary basis into a proprietary collective investment trust or insurance 

company pooled separate account, and to collect additional fees for managing the trust or 

account. Unlike PTE 77-4, there is no requirement to waive or offset fees (assuming that the fees 

at the plan level and the fund level are for separate fiduciary services, e.g., asset allocation and 

portfolio management).

 DOL has questioned whether the exemption covers non-discretionary advice, though 

logically it should.

 The authorities are less clear whether the exemption permits a fiduciary to receive 

compensation when investing in an unaffiliated collective trust, though there is nothing 

on the face of the exemption to suggest that it does not.

Investing plan assets in other unregistered, affiliated vehicles. RIAs and other 

fiduciaries often seek to invest client plan assets in various types of unregistered proprietary or 

affiliated investment funds, such as hedge funds or private equity. Generally, there is no 

exemption available comparable to that afforded by PTE 77-4 for investing in proprietary 

mutual funds. Accordingly, an RIA cannot as an ERISA fiduciary cause or recommend that a 

client plan invest in such unregistered vehicles unless it waives or credits back all additional 

compensation earned at the fund level. 

Note: Bank-maintained collective trusts and insurance company pooled separate 

accounts sometimes are used as “wrappers” around proprietary alternative investments 

(i.e., as a form of feeder fund). Under this approach, a management fee is charged at 

the trust or separate account level (pursuant to ERISA section 408(b)(8), see above) at 

least equal to the fee that is otherwise charged by the alternative investment vehicle. 

The fees at the vehicle level are then waived or credited back against the trust/separate 

account fees. In this way, it is sometimes possible indirectly to invest in affiliated hedge, 

private equity or other unregistered vehicles.

Participant investment advice. As a general proposition, there are five ways that which 

a financial institution and its representatives may provide investment advice to individual plan 

participants and be compensated for their services without violating ERISA:

 Non-fiduciary advice. As noted above, the definition of “investment advice” for 

ERISA is narrower than for securities law purposes, so it is possible to stay on the 

“safe” side of the line. Two specific examples are: 

o Employee “education” – under IB 96-1, discussed above, a professional 

provide certain information, modeling, etc., without crossing the line into 

individualized advice.

o IRA rollovers – DOL recently opined that an adviser who is not otherwise a 

plan fiduciary, who recommends that participant roll over his or her plan 

account balance to an IRA that invests in the adviser’s proprietary products, 

would not be engaged in the provision of “fiduciary investment advice” 
December 2008 25

either as it relates to taking the assets out of the plan or investing them via 

the IRA. 

 “Fee leveling.” As discussed above, to the extent that an adviser does not use its 

authority as a fiduciary to “cause” the receipt of additional compensation (amount 

or timing) by the adviser or its affiliates, it does not engage in a prohibited 

transaction. This is the basis for many so-called “wrap fee” arrangements. In 

addition, DOL has provided guidance to the effect that if a fiduciary adviser receives 

compensation from a third party, it does not engage in a prohibited transaction if it 

applies that compensation – on a dollar-for-dollar basis – to offset fees that the plan 

otherwise is obligated to pay and/or to pay or reimburse third-party expenses (such 

as the fees of a third-party recordkeeper).

 Prohibited transaction exemptions. Many fiduciaries rely on a combination of 

various statutory and class exemptions as discussed above, e.g., PTEs 75-1, 77-4, 84-

24 and 86-128; ERISA section 408(b)(8).

 “SunAmerica” Advisory Opinion. DOL’s letter to SunAmerica, Advisory Opinion 

2001-09A, is an important step in clarifying application of the prohibited transaction 

rules to a common form of asset allocation program, where the service provider 

offers its own funds as a package in partnership with an independent investment 

adviser or through a computer model, which makes recommendations to plan 

participants as to how their plan assets should be invested. Importantly, this advice 

may include recommendations that the participant invest in affiliated mutual funds 

or other affiliated investments, from which the bundled service provider or its 

affiliates may earn fees. The key to this opinion is that, although SunAmerica 

presumably accepted “ownership” of (and liability for) the investment advice 

provided by a third-party (Ibbotson, in SunAmerica’s case), it had no influence over 

the advice given and could not modify it.

 New PPA “Investment Advice” exemption. The PPA added an exemption to the 

prohibited transaction rules whereby a plan fiduciary may provide investment advice 

to a participant or beneficiary under an “eligible investment advice arrangement.” 

Such “arrangement” is one requiring that the fiduciary's compensation for providing 

investment advice not be dependent on the selection of investments by the 

participant (“level fees”) or an arrangement requiring that the investment advice be 

provided pursuant to a computer model. The computer model must meet certain 

certification requirements. 

DOL has clarified that – in contrast to the fee-leveling discussed above – the level fee

requirement under the statute only applies to the person or entity actually giving 

the advice, not to affiliates. Thus, for example, a broker and its registered 

representatives might advise a participant to invest in a mutual fund advised by a 

separate RIA affiliate of the broker.

PPA note: See below under “HOT TOPICS” for 2008 developments.
December 2008 26

Note re: private wealth management. Securities professionals who are retained 

directly by plan participants and IRA accountholders to help manage their retirement assets 

should keep in mind that they may be advising with respect to “plan assets” and thus may be 

fiduciaries subject to all of ERISA's fiduciary and/or prohibited transaction rules. It is irrelevant 

that the RIA may not otherwise have any contract directly with the ERISA plan or plan sponsor, 

so long as the RIA’s advice extends to the investment of plan assets.2

Relief for specific types of fees and other compensation. DOL has interpreted the 

fiduciary prohibitions to extend to a fiduciary’s receipt of any compensation to the extent that the 

fiduciary’s own actions can affect either the amount or timing of such compensation. 

Accordingly, flat or asset-based fees are normally permissible. Transaction-based fees, such as 

acquisition or disposition fees, sales commissions and certain performance or incentive fees, 

including cash flow fees, normally are prohibited. However, there are certain exceptions 

including:

 Brokerage commissions. See above regarding PTE 86-128.

 Performance fees. In the case of performance fees payable to securities and 

commodities (but not real estate) managers for transactions involving generally 

marketable securities, DOL has issued several advisory opinion letters that approve 

the use of such fees if certain conditions are satisfied. The specific types of fees 

approved in these letters involved fees calculated 1) as a percentage of portfolio 

appreciation; 2) as a base fee plus a percentage of appreciation; and/or 3) in the form 

of a “fulcrum fee,” i.e., a fee that goes up or down as determined by the manager’s 

performance relative to an agreed-upon index. Among the various factors on which 

DOL based its approval was the sophistication of the clients, the marketability of the 

securities and availability of market valuations (factors that are often glossed over), 

fixed performance measurement periods and preestablished valuation dates, 

inclusion of unrealized losses if unrealized gains were included in the calculation, use 

of standardized indices for base-plus or fulcrum fee calculations, ability of the plan to 

terminate the arrangement on reasonably short notice (60 days was noted), and 

compliance with SEC Rule 205-3. (Note that these letters have not been updated to 

reflect subsequent SEC revisions to Rule 205-3.) DOL has also granted exemptive relief 

on a case-by-case basis for certain real estate managers (true market values are 

difficult to obtain for real estate). 

Securities professionals dealing with alternative investment vehicles, particularly 

those involving private equity and funds of funds, should keep in mind that many 

performance fee arrangements deviate significantly from those addressed in DOL's 

 

2

 RIAs in the wealth management area often take the position that any advice they give relates to the individual or 

family portfolio holdings as a whole, and are not specific to any IRA, 401(k) or other plan assets, such that it does 

not constitute “investment advice” for ERISA or Code purposes. However, this argument has yet to be tested, and 

is often inconsistent with the actual facts.
December 2008 27

advisory opinions. General partners of partnerships holding ERISA plan assets who 

style their performance fees as “carried interests” in order to obtain favorable (capital 

gains) tax treatment should also consider whether such a position is fundamentally 

inconsistent with ERISA. (That is, in order to argue for capital gains treatment, the 

manager must take the position that it has an equity interest in the partnership, which 

in effect is “leveraged” by the partnership or its investors, rather than a fee interest. 

Simultaneously, to avoid an ERISA prohibited transaction, the general partner 

generally must argue that its carried interest is really a fee for performing 

management services.)

 Soft Dollars and Directed Brokerage. Generally, the payment of soft dollars would 

be prohibited if the services provided by the paying broker benefited the fiduciary 

manager or any of its affiliates. However, the safe harbor afforded by section 28(e) 

under the 1934 Act generally preempts ERISA. It provides that a discretionary 

fiduciary who causes a client (plan) to pay brokerage commissions for effecting a 

securities transaction, in excess of the commissions another broker would have 

charged for the same transaction, will not be deemed to have breached its fiduciary 

duty under any law if the commissions paid are reasonable in relation to the value of 

the brokerage and research services provided by the broker. Section 28(e) only 

covers agency transactions, and only the receipt of soft dollars in the form of

research services. For other types of services and goods, DOL has indicated that a 

manager can direct a plan to a specific broker to procure goods and services for the 

benefit of the plan that is paying the commissions (subject, of course, to the 

manager’s overall fiduciary obligations to the plan and the overall reasonableness of 

the commissions). These exceptions do not relieve plan fiduciaries of their general 

fiduciary obligation to seek best execution of trades.

Allocation of investment opportunities among client accounts. To the extent that an 

investment manager represents multiple clients, it may be presented with investment 

opportunities that are appropriate for more than one client but which cannot be acquired in

sufficient quantities to meet all such clients’ needs. In order to avoid an assertion of a conflict

of interest in allocating such investments among clients, the manager should have in place an 

allocation procedure that is incorporated by reference into each investment management 

agreement. ERISA does not dictate any particular procedure, as long as it is applied fairly and 

consistently so as to avoid favoring one client over another. This could include, for example, 

allocating investment opportunities pro rata among all similarly situated clients or allocating 

them to certain clients first based on a rotational basis.

Execution of client trades. Similarly, to avoid potential conflicts, a manager or brokerdealer should have in place procedures for the ordering of securities trades for its clients.

Cross-trading between client accounts. It is not unusual for a manager who manages 

multiple client accounts to buy securities for certain accounts at the same time it is selling the 

same securities for another account. “Crossing” the securities between the accounts on a prearranged basis may save transaction costs and may have other potential benefits. Nonetheless, 
December 2008 28

if the manager has investment discretion with respect to both accounts, engaging in such crosstrading generally raises an ERISA conflict issue, as the manager is “representing” both parties. 

(To the extent that the manager is directed as to one side of the transaction, it should not have 

a conflict or the conflict may be exempted pursuant to PTE 86-128, discussed above.)

Some managers have attempted to avoid the conflict by running simultaneous trades 

through an unrelated broker. DOL’s position is that the use of an unaffiliated broker is 

insufficient, at least if it is understood that the trades will be matched and are not truly “blind.” 

A few financial institutions have obtained individual exemptions to permit cross-trading, but 

these exemptions are limited in scope and apply only to the institutions which obtained them.

DOL issued class PTE 2002-12 to permit certain “passive” cross-trading similar to the 

relief granted in various individual exemptions; it is a key exemption used by large banks 

performing transition management services. In addition, at DOL’s invitation, an industry group 

representing INHAMs has requested relief for trading between affiliated plans, including trades 

carried out by outside managers.

PPA note: the PPA added a new statutory exemption – ERISA section 408(b)(19) – to 

facilitate certain “active” cross trading. Under this exemption, the purchase and sale of 

a security between a plan and any account managed by the same investment manager is 

exempt from ERISA's prohibited transaction rules if specified conditions are met. For 

example, the plan must have at least $100 million in assets and a fiduciary independent 

of the manager must approve the manager's cross-trading program. In addition, the 

manager must adopt and provide to clients written cross-trading policies and 

procedures. 

Prohibitions Relating to Employer Securities and Employer Real Property

ERISA also generally prohibits a plan from acquiring and holding securities issued by the 

employer (even if acquired on the open market in a “blind” transaction), or real property leased 

to the employer, unless certain conditions are satisfied. To the extent permitted under the 

terms of the plan, and provided that the general fiduciary requirements are satisfied, a defined 

benefit pension plan (traditional plan paying fixed retirement benefits) may acquire qualifying 

employer securities and qualifying employer real property provided that, in the aggregate, such 

assets do not exceed 10% of the plan’s total assets.

Although certain recent legislative attempts have been made to change the 

requirements, generally the 10% limitation does not extend to “defined contribution” plans, 

including 401(k) plans, if the plan terms expressly authorize such investments. In addition, such 

plans are relieved of the diversification requirements of ERISA to the extent they invest in such 

assets. For this purpose, “qualifying employer securities” are stock or marketable debt 

instruments if certain requirements are met to ensure that such instruments were not issued 

primarily to be acquired by the plan, and if certain other conditions are met regarding price, 

etc.
December 2008 29

In the case of a participant-directed plan, the regulations under section 404(c) impose 

various additional requirements on the offering of employer securities to participants in order 

to utilize the fiduciary relief afforded by that section.

In light of the various considerations surrounding the acquisition and holding of

employer securities – and because there is often little financial incentive for financial 

institutions to deal with employer securities – many securities professionals simply adopt 

procedures designed to avoid acquisition of any employer securities on behalf of a plan, except 

through a separate employer stock fund established for that purpose or as otherwise 

individually agreed upon by the manager and the employer.

Special Considerations for IRAs

As noted, most of the prohibited transaction rules and the exemptions discussed above 

apply equally to IRAs, although there may be certain differences (e.g., PTE 86-128). However, 

there are certain rules and exemptions unique to IRAs, some of which are noted below:

 Disqualification as a penalty for certain prohibited transactions. Where an IRA 

accountholder “engages in” a prohibited transaction with his or her IRA, the 15% 

prohibited transaction excise tax does not apply; rather, the IRA is “disqualified” and 

all of its assets are treated as having been distributed to the accountholder (and 

thus immediately subject to income tax in the case of a regular IRA). Originally 

designed to “benefit” IRA accountholders by allowing them to avoid the extra 

burden of the 15% penalty, this provision now raises serious concerns in the context 

of very small prohibited transactions that occur within very large (rollover) IRAs. 

There is surprisingly little guidance as to what it means to “engage in” a prohibited 

transaction with one's own IRA. Many practitioners believe that it may refer to any 

“self-directed” transaction. However, there is reason to believe that disqualification 

should apply only where the accountholder is an actual party to a transaction with 

the IRA (such as buying, selling or leasing assets; borrowing money; or receiving 

compensation for services). In all other cases, the excise tax should remain the

proper penalty.

 Brokerage commissions of managed accounts. As noted above, PTE 86-128 permits 

a fiduciary to receive sales commissions for “effecting or executing” securities 

transactions (i.e., as a discretionary or non-discretionary fiduciary), if various 

conditions are satisfied. All of these conditions are waived in the case of IRAs.

 Prohibited investments. IRAs may not invest in life insurance or certain 

“collectibles.”

 Pledging IRA assets – brokerage accounts. An IRA accountholder may not pledge 

his or her IRA assets as security for a loan “outside” the IRA (some practitioners even 

question whether IRA assets can be pledged to support a loan “inside” the IRA). 

Brokers should note that most brokerage account agreements contain explicit terms 

permitting the broker to use assets in any brokerage account maintained by an 
December 2008 30

individual to satisfy margin calls and delivery failures in other accounts of the same 

individual. However, if one of those accounts is an IRA, such a provision may 

constitute a prohibited “pledge” of the IRA assets. (Conversely, to the extent such a 

provision may allow the broker to reach non-IRA assets to settle a debt of the IRA, 

the accountholder may be engaged in a prohibited extension of credit to his/her 

IRA.)

 “Householding.” Many financial institutions offer fee discounts and other benefits 

based on the overall volume of assets a client brings to the table, regardless of the 

source. This is particularly common in the IRA context where an individual 

accountholder may have several personal, trust and other “family” accounts. 

Householding raises potential prohibited transaction considerations to the extent 

that the accountholder may derive a personal benefit (lower fees in his/her 

individual accounts) from the investment of IRA assets. Often, the issues can be 

resolved by ensuring that the benefit runs proportionately across all accounts, but 

this may not always be feasible. (Giving a greater discount to the IRA may resolve 

the prohibited transaction issues, but could raise additional tax considerations.) In 

some cases, the relationship services exemptions discussed in the next bullet point 

may offer relief as well.

Note: A recent individual exemption to broadly permitted Fidelity to offer 

special financial benefits to IRA accountholders and family members, taking 

into account IRA assets.

 Bonuses and relationship services. Financial institutions sometimes offer gifts or 

bonuses for opening an account. Generally, a cash bonus paid directly into the IRA 

should not raise a prohibited transaction issue (nor, in most cases, a tax issue), 

though any “giveback” requirement (e.g., if the account is not kept open for some 

minimum time period) may be problematic. However, anything of value given 

“outside” the IRA raises a potential prohibited transaction concern. DOL has issued 

three class exemptions for these types of arrangements. 

o PTE 93-1 (the “toaster” exemption) permits a financial institution to make 

nominal payments of cash or gifts to an individual for opening or contributing 

to an IRA.

o PTE 93-33 permits the receipt of certain reduced or no-cost services from a 

bank (e.g., free checking).

o PTE 97-11 provides a similar exemption for free or discounted brokerage 

services.
December 2008 31

ENFORCEMENT

Potential Consequences of Violating ERISA

General equitable and civil remedies. ERISA provides that enforcement actions for 

fiduciary violations generally can be brought by DOL or by other plan fiduciaries and, in some 

cases, by plan participants and beneficiaries. Remedies generally include the obligation to 

restore a plan’s losses incurred as a result of a fiduciary breach (“make-whole” relief) and to 

disgorge any profits made as a result of the breach, as well as any other “equitable or remedial” 

relief, including injunctive relief, that a court deems necessary and appropriate. In some cases, 

DOL has obtained injunctive relief to prevent a fiduciary from engaging in further violations (for 

the purpose of using contempt procedures if further violations occur) or even to prevent a 

person from acting as an ERISA fiduciary with respect to any plan (which could, for instance, 

effectively put an RIA out of business). In the event of any monetary settlement or courtordered monetary relief, DOL will also impose a civil penalty of 20% of the applicable recovery 

amount.

ERISA’s fiduciary liabilities are personal. This means that, in general, individuals who 

exercise fiduciary powers will not be insulated from liability by acting through a corporate form, 

though some protection may exist within the jurisdiction of the 3

rd Circuit Court of Appeals 

(Pennsylvania, New Jersey, Delaware).

ERISA’s fiduciary liabilities are also joint and several. Thus, if a trustee acts imprudently 

on the advice of a non-discretionary investment adviser, either may be sued for the entire

amount of any resulting loss, regardless of comparative fault. Moreover, the majority position 

of the courts appears to be that the fiduciary who is held liable has no implied right to seek 

contribution from the second fiduciary. In other words, the foregoing trustee may have no 

recourse against the investment adviser in the absence of an express indemnity in the adviser’s 

contract; indeed, one or two courts have gone so far as to hold that ERISA preempts even an 

express agreement between fiduciaries for contribution or indemnification. 

Criminal penalties. “Willful” breaches of ERISA reporting and disclosure obligations are 

potentially subject to criminal penalties, increased under the Sarbanes-Oxley Act of 2002 to 

include imprisonment for up to 10 years and fines of up to $100,000 ($500,000 for nonindividuals) per violation. Other non-ERISA federal criminal statutes may also apply to ERISA 

violations and are sometimes enforced, e.g., in connection with kickbacks from pension funds.

Penalties on prohibited transactions. Violations of the prohibited transaction rules are 

subject to a two-tiered schedule of excise tax or civil penalties. The initial penalty is 15% of the 

“amount involved” in the transaction (IRS rules defining the “amount involved” pre-date ERISA 

and often difficult to apply). In addition, if the transaction is not “corrected” by the parties 

after notice by the IRS, an additional 100% penalty is imposed. (Correction is not mandatory for 

non-fiduciary parties, in the sense that they can elect to pay the 100% penalty – for instance, if 

the cost of correcting is higher than the penalty.) Correction usually involves undoing the 

transaction (rescission), to the extent possible, or such other action as will put the plan in at 

least as favorable a position as it would have been in had the transaction not occurred. In the 
December 2008 32

case of a party-in-interest transaction, the primary burden of the penalty will fall on the party in 

interest that engages in the transaction, although under ERISA (but not the Code) the 

authorizing fiduciary is also liable. In the case of a prohibited fiduciary conflict, the penalty will 

fall on the fiduciary. The annual report, Form 5500, requires that any known non-exempt 

prohibited transactions be reported under penalties of perjury.

PPA note: ERISA section 408(b)(20) provides a limited exemption for certain 

inadvertent prohibited transactions involving securities or commodities, if corrected 

within 14 days of “discovery”. While styled as new relief, it can be argued that the new 

provision forecloses a previously common argument that any transaction entered on 

the basis of a mistake in fact (as opposed to a mistake of law), and unwound as soon as 

such facts were discovered, could be treated as an inadvertent error rather than a 

prohibited transaction.

As noted above, in some cases the penalty for engaging in a prohibited transaction with 

an IRA may be tax disqualification.

Claims against non-fiduciary parties. Breaking from common law principles, the courts 

have held that persons who are not fiduciaries (such as recordkeepers, brokers, custodians) are 

not subject generally to liability for “aiding and abetting” a fiduciary’s breach of its duties. 

However, at least to the extent that it can be shown that the non-fiduciary has itself breached 

some ill-defined ERISA “duty” (such as a duty of a party-in-interest not to engage in a prohibited 

transaction), more recently the courts have found that non-fiduciaries themselves may be 

subject to claims for “equitable” relief under ERISA, including, for example, disgorgement of

fees.

Limitations on Liability and Indemnities

ERISA voids any arrangement in a plan or agreement that purports to relieve a fiduciary 

of liability for its wrongdoing. This has been interpreted to include any indemnification paid out

of plan assets involving an ERISA violation. However, ERISA does not preclude a fiduciary from 

contracting with another fiduciary or the plan sponsor for indemnification, or from obtaining 

(or requiring another party to obtain for its benefit) fiduciary insurance to cover its financial 

losses. The cost of fiduciary insurance may be borne by the plan, so long as the insurer has 

recourse against the fiduciary in the event a fiduciary breach is found to have occurred.

ERISA’s Bonding Requirements

Every ERISA fiduciary and any other person who “handles” employee benefit plan assets 

must be covered under a fidelity bond, which relates to fraud, theft, embezzlement, etc., and 

not to breaches of fiduciary duty. Regulated banks and other entities with trust powers under 

local law are exempted if they have capital of at least $1 million; note however, that an 

exemption may not be available to a state-chartered trust company acting only as a nonfiduciary custodian. The PPA further exempted broker-dealers who are subject to the bonding 

requirement of a self-regulatory organization (e.g., FINRA). There is no exemption available for 

RIAs who are not also banks, insurance companies or broker-dealers.
December 2008 33

The amount of the bond must be not less than 10% of the funds handled as of the 

beginning of the fiscal year, with a minimum of $1,000 and a maximum of $500,000 per plan, 

increased to $1 million for a plan holding employer securities. The cost of bonding may be 

borne by the plan.

Some plans maintain blanket bonds covering all persons who handle assets of the plan, 

or purchase riders covering agents. However, some sureties no longer provide coverage that 

extends to parties other than the purchaser and its affiliated persons. Thus, an RIA generally 

would have to obtain its own individual coverage covering its employees and agents, naming 

each client plan as the insured party.

In late November, 2008, DOL issued additional bonding guidance by way of a Field 

Assistance Bulletin.

ERISA Preemption

ERISA broadly preempts “any” state law that “relates to” an ERISA-governed plan. The 

preemption provision is limited by a “savings clause,” which leaves in place state insurance, 

banking, and securities laws. The savings clause itself is limited by the so-called “deemer 

clause,” which provides that a state may not circumvent preemption by “deeming” a benefit 

plan or benefit plan trust to be an insurance company, bank, trust company or investment 

company or to be engaged in the business of insurance or banking. Generally, these rules mean 

that a state may not regulate investment activities of plans, but may continue to regulate the 

activities of securities professionals who market products or services to plans.

The interplay between ERISA's preemption and state laws governing normal commercial 

activities – such corporate/partnership laws, laws governing contracts, and tax laws – is highly 

complex and not well settled. Although it is clear that ERISA plans can enter into contracts, 

under some circumstances ERISA may impact the interpretation or enforcement of contract 

terms. For instance, if a contract results in a prohibited transaction, a plan may have a right to 

rescind or void part or all of the contract terms.

ERISA does not preempt other federal laws, nor does it preempt state laws as they apply 

to non-ERISA plans such as IRAs.

DOL’s Audit and Enforcement Role

DOL has broad audit, subpoena, and enforcement powers and generally may review any 

books and records of any party that contain information relating to the filing of any return or 

report required under ERISA. Investigations may be initiated by DOL on its own initiative or at 

the request of plan fiduciaries. For certain industries, DOL auditors may target specific issues, 

and auditors from the SEC, the OCC, the Federal Reserve, and other Federal agencies may 

request information regarding ERISA compliance and refer questionable cases to DOL for 

further investigation. Audit and enforcement actions generally originate from local and 

regional DOL offices, but may be coordinated with the National Office staff. Securities 

professionals who are asked to produce books and records should consult with counsel familiar 

with such matters; too often, audit targets react improperly to such requests – either by failing 
December 2008 34

to cooperate fully or, at the opposite extreme, by producing far more information than is 

necessary.

In July 2008, DOL and the SEC entered into a Memorandum of Understanding (“MOU”) 

regarding consultation and sharing of information between the two agencies. Among other 

things, the SEC granted DOL access to SEC examination information. In theory, the MOU merely 

formalized arrangements that several DOL field offices already had in place with their SEC 

counterparts, but the formality also appears to signal greater mutual enforcement efforts.

HOT TOPICS

The employee benefits field has seen an incredible number of changes in recent years. 

The Pension Protection Act of 1986 (PPA), whose principal focus was pension plan funding, 

included the most sweeping changes to ERISA's prohibited transaction rules since ERISA was 

enacted. There have been other significant legislative, regulatory, enforcement and litigation 

developments. Some of the more significant recent developments affecting RIAs, brokerdealers and other financial service providers to retirement plans are summarized below.

DOL Fee Reporting and Disclosure Initiatives

Reacting to various pressures, in recent years DOL has taken various steps to increase 

reporting and disclosure of fees and other compensation. The first steps involved the reporting 

of gratuities to (and by) union members. 

In 2007 and 2008, DOL announced three major fee disclosure initiatives. The first 

involved significant changes to the reporting of payments to service providers on the Form

5500 annual report for ERISA plans (Schedule C). The second involved a proposed revision to 

the regulations under ERISA's “service provider” regulations under section 408(b)(2), to 

incorporate new fee disclosure obligations on service providers to plans. The proposed 

regulations were accompanied by a proposed class exemption. The third prong involved new 

disclosure regulations with respect to self-directed account plan fees. These fee disclosure 

requirements will have an enormous impact on financial institutions providing services to 

plans.

Reporting meals and entertainment/“gratuities”. Although not strictly an ERISA issue, 

the reporting requirements applicable with respect to payments made to union trustees of 

Taft-Hartley plans became a significant issue in 2005. Generally speaking, for securities 

professionals, payments commonly associated with business development and client relations 

activities – such as meals, golf, travel, seminars, etc. – may be reportable on a Form LM-10 

which must be filed by the RIA/broker-dealer or other service provider. Conversely, the union 

official or employee (including his spouse or minor children) who receives the benefit of such 

payments may be required to report the amounts on a Form LM-30 that he is required to file 

with DOL. 
December 2008 35

The statutory basis for Form LM-10 and Form LM-30 reporting is found in the Labor 

Management Reporting and Disclosure Act of 1959 (the “LMRDA”) or Landrum-Griffin Act. In 

general, the Form LM-30 must be used by a union official or union employee to report anything 

of value he, his spouse, or his minor children directly or indirectly receive from any employer or 

business dealing with a union or (pension) trust in which a union is interested. Although these 

rules have been in existence for decades, only recently has DOL focused on enforcing them.

Reporting does not necessarily mean that such payments are improper or illegal 

kickbacks (thought they may be under ERISA or other laws), but in and of itself reporting is 

meant to have a deterrent effect as the information is publicly available on the Internet. 

However, DOL also began to focus on whether meals and entertainment may constitute 

prohibited “kickbacks” under ERISA when the recipient is a plan fiduciary (in particular, union 

trustees). 

In 2008, DOL announced that it would be revising its Enforcement Manual to address 

certain permissible expense items. First, the Manual instructs investigators to "ignore" 

entertainment provided to plan fiduciaries where the cost of the entertainment is $250 or less 

per person, per year (informally, DOL staff have indicated that this $250 is a “safe harbor”, not 

a bright line, though it is not clear that this will be reflected in any writing). Second, in the case 

of educational conferences, investigators are instructed to ignore a plan fiduciary's participation 

at a conference regardless of cost, where such participation is permitted by the plan's policies 

and procedures and where the cost of participation otherwise could have been paid by the 

plan. In all cases, the decision to authorize the plan fiduciary’s attendance should be welldocumented.

Form 5500 Schedule C changes. In late 2007, DOL made various changes to the ERISA 

Annual Report (Form 5500) that must be filed by plan administrators. For securities 

professionals, the most notable changes were to Schedule C, with respect to the reporting of 

“indirect” service provider compensation (previously, the Schedule covered only direct 

compensation) beginning in 2009. For this purpose, indirect compensation includes a broad 

range of fees and expense reimbursements, including third-party payments (revenue sharing, 

12b-1 fees, etc.), float, brokerage commissions, soft dollars, and even “non-monetary” 

compensation such as meals and entertainment. Some relief is granted for “eligible indirect 

compensation” if certain disclosures are made regarding the nature of the compensation, and 

when payments are made to a “bundled services” provider who then further allocates such 

payments among subcontractors and affiliates. The new requirements raised innumerable 

questions. In July, 2008, DOL attempted to address some of these questions by publishing on 

its website guidance in the form of 40 questions and answers, or “FAQs” . Nonetheless, many 

questions remained unanswered.
December 2008 36

Proposed section 408(b)(2) fee disclosure regulations. As noted above, the mere 

provision of services to a plan for a fee can be a prohibited transaction under ERISA. A key 

provision of ERISA, section 408(b)(2), provides broad relief from the prohibited transaction 

rules for service contracts or arrangements if:

 the arrangements are reasonable;

 the services are necessary for the establishment or operation of the plan; and

 the plan pays no more than reasonable compensation for the services.

The proposed changes to the regulations would add a number of disclosure

requirements in order for a contract or arrangement to qualify as a “reasonable arrangement.” 

DOL has taken the position that it is the responsibility of plan fiduciaries who hire service 

providers to evaluate the compensation and potential conflicts of interest of those service 

providers. The disclosure requirements in the proposed regulation thus focus on service 

provider compensation and conflicts of interest. The disclosure requirements would apply to 

three categories of service providers:

 fiduciaries (either under ERISA section 3(21) or under the Investment Advisers Act of 

1940);

 service providers who provide or may provide banking, consulting, custodial, 

insurance, investment advisory, investment management, recordkeeping, securities 

or other investment brokerage or other third-party administration services; and

 service providers who receive or may receive indirect compensation or fees in 

connection with providing accounting, actuarial, appraisal, auditing, legal or 

valuation services to a plan pursuant to a contract or arrangement.

The proposed regulations require that service arrangements be in writing and impose an 

affirmative obligation on service providers to disclose certain information, including:

 the services to be provided;

 the compensation or fees received by the service provider with respect to each 

service; and

 the manner of receipt (e.g., direct or indirect) of compensation or fees.

The proposed regulations define “compensation or fees” as money or any other thing of 

monetary value. Gifts, awards, and trips received by a service provider are considered to be 

compensation for services provided to the plan and must be disclosed. 

Under the proposal, a bundled service provider must disclose how it allocates 

compensation or fees that are either separately charged directly against the plan's investment 

and reflected in the net value of the investment or that are charged on a transaction basis (such 

as finder's fees, brokerage commissions, and soft dollars). Compensation under a bundled 

arrangement that does not fit into these two categories does not have to be unbundled or 

allocated among the service providers in the bundle.
December 2008 37

The proposed rule also requires disclosures focused on potential conflicts of interest, 

including:

 whether the service provider will – or will not – be a fiduciary in providing services (a 

highly significant development in and of itself);

 any participation or interest the service provider may have in plan transactions;

 any material financial, referral or other relationship that creates or may create a 

conflict of interest for the service provider;

 whether the service provider will be able to affect its own compensation or fees 

without prior approval of an independent plan fiduciary; and

 any policies or procedures in place to address potential conflicts of interest.

These disclosures would have to be made prior to entering into a contract or arrangement, 

under a written contract that includes a representation from the service provider that the 

required information was in fact disclosed before the parties entered into the agreement.

As currently proposed, the new disclosure obligations would not apply to non-ERISA 

plans, such as IRAs and HSAs, but this may change.

Proposed prohibited transaction class exemption for hiring fiduciaries. The proposed 

section 408(b)(2) regulations were accompanied by a proposed exemption that would relieve a 

plan fiduciary from liability if the fiduciary hires a service provider with a reasonable belief that 

the arrangement met the disclosure requirements and did not know or have reason to know of 

the failure to disclose at the time it occurred. After discovering the failure, the fiduciary must 

request the missing information in writing. The plan fiduciary is also required to determine 

whether to terminate or continue the arrangement with the service provider. This 

determination must be made based on the facts and circumstances and consistent with the 

fiduciary's duties under ERISA. In addition, if the service provider refuses to disclose the 

requested information or fails to provide the requested information within 90 days, the 

fiduciary must notify DOL of the service provider's failure to disclose. DOL staff have suggested 

that this “whistleblower” requirement puts the real “teeth” in the new disclosure rules.

Proposed disclosure requirements for participant-directed individual account plans. In 

July, 2008, DOL proposed new regulations adding extensive new disclosure rules with respect to 

plans – such as 401(k) plans – that permit such participants to direct the investment of their 

account balances. The proposed regulations come in two parts. The first part is styled as a new 

interpretation of ERISA’s fiduciary rules. As such, it would apply to all plans that permit 

participant directions. Specifically, DOL stated that plan fiduciaries: 

must take steps to ensure that [] participants and beneficiaries, on a regular and periodic basis, 

are made aware of their rights and responsibilities with respect to the investment of assets held 

in, or contributed to, their accounts and are provided sufficient information regarding the plan, 

including plan fees and expenses, and regarding designated investment alternatives available 

under the plan, including fees and expenses attendant thereto, to make informed decisions with 

regard to the management of their individual accounts.
December 2008 38

The second part would amend the regulations that apply to plans “electing” ERISA section 

404(c) status.

Among other things, the proposal would impose new annual disclosure obligations for 

each “designated investment alternative” under a plan, including 1-year, 5-year and 10-year 

comparative return information similar in format to what is provided by mutual funds; 

quarterly disclosure requirements; fee and expense disclosures; and other information 

regarding specific types of investments. DOL prescribed a specific model chart format for 

investment performance disclosure. The requirements would not apply to investments 

available under a brokerage window.

Participant Investment Advice

In August 2008, DOL published proposed regulations and a proposed class exemption 

that would expand upon the statutory exemption for investment advice to individual plan 

participants and IRA accountholders. The PTE would expand the relief in three major ways: 1) 

for IRAs, it would permit in many cases the substitution of "educational" materials in place of

computer modeling; 2) it would permit an adviser to provide "individualized" or "off-model"

advice after the computer model or educational materials have been provided, and to receive 

higher compensation as a result (i.e., fee leveling would not be required, even for the individual 

employee/agent/rep); and 3) in the case of advisers using fee leveling instead of computer 

modeling/educational materials, it would apply the "fee leveling" requirement only to 

compensation received by the individual employee, agent or registered representative, rather 

than at the level of the financial institution (fiduciary adviser). This proposal is highly 

controversial, and Democrat lawmakers might seek to kill or roll back this broader relief in 

2009, and might even seek to reverse the PPA exemption.

Litigation

401(k) plan fees. The last several years have seen significant action in the area of fees 

typically associated with 401(k) plans, most importantly targeting revenue-sharing 

arrangements between plans, mutual funds (and other investment providers), and plan service 

providers such as recordkeepers, trustees and third-party administrators. Class-action lawsuits 

have been filed against plan sponsors, and their officers and directors attacking investment 

related fees paid to plan service providers andchallenging the use of more expensive fund 

options (e.g., actively managed versus index funds). Lawsuits have also been filed against 

insurance companies providing plan administration and recordkeeping services to plans. 

In June 2007, a Federal district court dismissed all claims asserted in a suit involving 

Deere & Co., one of the many lawsuits filed over allegedly excessive and undisclosed 401(k) 

fees. Deere is significant in that the court's opinion endorsed many of the legal concepts used 

to defend challenges to 401(k) fee and revenue sharing arrangements, and some hope it may 

serve as a check on similar suits. Among other things, the court ruled that “[n]othing in the 

[ERISA] statute or regulation directly requires such a disclosure” and that the mutual fund 

prospectuses admittedly given to the plan participants “accurately reflect the expenses paid to 

the fund manager.” The court expressed skepticism that participants would gain any practical 
December 2008 39

benefit by knowing the precise details about how the manager subdivided that total fee among 

profits, revenue sharing and other expenses. Additionally, the court cited DOL's proposal 

(above) to amend existing regulations possibly to require further fee disclosures as further 

proof that such disclosures are not required under current law. Finally, the court ruled that

ERISA section 404(c) shielded the defendants from any liability arising from the allegedly 

excessive fees. Citing the fee disclosures provided by the mutual fund prospectuses, and the 

plan's brokerage window, the court held that “[t]he only possible conclusion is that to the 

extent participants incurred excessive expenses, those losses were the result of the participants 

exercising control over their investments within the meaning of [ERISA section 404(c)'s] safe 

harbor provision.”

Investing “in-House” plans in proprietary mutual funds. Five or six years ago, actions 

were filed by plan participants against several financial institutions that invested benefit plan 

assets in the institutions’ proprietary funds. Although these actions were limited to the 

financial institutions’ own, in-house plans, in theory the allegations could apply to client plans 

as well. Several new actions were filed in 2007. Plaintiffs alleged, among other things, that the 

institutions caused plans to pay excessive fees and used the plan assets to “seed” new funds, 

thereby breaching their fiduciary duties and committing prohibited transactions.

Investment Valuation

ERISA plans. Plan assets must be valued for various purposes under ERISA, including for 

annual reporting purposes, to ensure proper valuation of participant accounts under individual 

account plans, for funding purposes, etc. Specifically for annual reporting on Form 5500, ERISA 

requires that all plan assets be valued at their “current value”, which in turn is defined as fair 

market value where available; otherwise, fair value determined by a fiduciary in good faith.

These requirements themselves are nothing new, but valuation recently became a hot 

topic for several reasons, including:

 New FAS 157 and FAS 132 “fair value” reporting requirements for plan sponsors 

and audited plans.

 Increased plan investment in alternative investments and resistance by fund 

sponsors to provide market valuations.

 DOL Boston regional office 2008 “Benages letter” asserting that plan fiduciaries 

may have violated ERISA fiduciary rules by failing to adopt and implement 

appropriate valuation procedures – may not accurately reflect DOL National 

Office position.

 Current economic crisis and resulting bailout/TARP.

IRAs. As more and more IRAs invest in alternative investments and other hard-to-value

assets, valuation also has become a significant issue, but under the Code rather than ERISA. 

Under the Code, the (corporate) trustee or custodian of an IRA must report annually the “fair 

market value” of the IRA on Form 5498. This obligation cannot be delegated to the 
December 2008 40

accountholder or any other person. The penalty for non-compliance is only $50 per account, 

but in theory a non-bank custodian with a pattern of non-compliance could face revocation of

its authority to hold IRA assets, and a pattern of non-compliance by a bank custodian/trustee 

could be reported to its primary regulator. In addition, if an IRA is required to make annual 

distributions, failure to establish proper value could result in under-withholding.

Pension “Defeasement”

Over the past several years, as a result of changes in accounting rules, weak investment 

performance, and competitive issues, there has been a lot of interest in some quarters in 

finding ways to remove defined benefit plan liabilities from corporations’ books without 

terminating the plan and purchasing annuities. One key proposal (greatly oversimplified here) 

would have involved transferring “sponsorship” of a frozen, underfunded plan (plus some cash 

“outside” the plan) to a newly formed corporate subsidiary, then selling the stock of the 

subsidiary to an entity outside of the seller’s controlled group (generally for a nominal sum plus 

assumption of liabilities). The buyer would be managed by financial professionals and owned 

or funded by a financial institution or institutional investors. The institution could retain fees 

for managing the assets and, in theory, good management would permit the investors 

eventually to recover the “outside” assets in lieu of an otherwise taxable “reversion” of excess 

plan assets.

In 2008, the Internal Revenue Service issued a Revenue Ruling that effectively would 

prevent the most likely form of such a transaction, by concluding that the transfer of plan 

sponsorship other than in connection with the transfer of significant business operations, assets 

or employees, violates the Code’s “exclusive benefit” rule because the plan is no longer 

maintained by an “employer” for the benefit of its “employees”. 

*Richard K. Matta is an attorney with Groom Law Group, Chtd., in Washington, DC.

He may be contacted at (202) 861-5431 or by e-mail at rmatta@groom.com

This memorandum is a general overview and should not be construed as imparting legal advice on 

any specific matter, including tax advice within the meaning of Treasury Circular 230.