Guest Article

(From the December 2, 2002 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits. Hyperlinks within the article have been added by BenefitsLink.)

DOL Issues Fiduciary Guidance Relating to 'Floats'

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The Department of Labor on November 5 issued Field Assistance Bulletin 2002-3 to provide additional guidance on the obligations of ERISA plan fiduciaries with respect to "float" arrangements in which financial service providers are permitted to retain earnings on plan assets temporarily held in general accounts to facilitate certain transactions. The FAB is available on the Pension and Welfare Benefits Administration's Web site, at www.dol.gov/pwba.

The FAB addresses the following issues: What does a fiduciary need to consider in evaluating the reasonableness of an agreement under which the service provider will be retaining "float" earnings and what information is a service provider required to disclose to plan fiduciaries with respect to such arrangements in order to avoid engaging in a prohibited transaction?

Background

Financial service providers (e.g., banks and trust companies) sometimes place ERISA plan assets in a general account for short periods of time in order to facilitate certain transactions. Specifically, a financial service provider might hold plan assets in a general account while awaiting investment instructions from the plan's fiduciaries. Also, a financial service provider might transfer plan assets to a general account in order to make a distribution or other disbursement.

The period that begins when the plan money is deposited in the financial service provider's general account, and ends when the investment instructions are executed or the disbursement check clears, is known as the "float." During this float period, the money often is invested in conservative, short-term investments. In some cases, the ERISA plan is credited with the earnings on these investments. In others, the financial service provider keeps the earnings as part of its compensation.

During the early 1990s, the Department of Labor provided guidance on float arrangements. In Advisory Opinion 93-24A, DOL indicated a trustee violated the ERISA prohibition of fiduciary self-dealing when it exercised discretion to earn income for its own account from a float attributable to outstanding benefit checks. [ERISA section 406(b)(1) prohibits ERISA plan fiduciaries from dealing with plan assets in their own interest or for their own account.] The trustee had not disclosed the float arrangement to its employee benefit plan customers.

The DOL expanded on its advisory opinion in an information letter to the American Bankers Association (August 11, 1994). According to the information letter, "... if a bank fiduciary has openly negotiated with an independent plan fiduciary to retain float attributable to outstanding benefit checks as part of its overall compensation, then the bank's use of the float would not be self-dealing because the bank would not be exercising its fiduciary authority or control for its own benefit." In order to avoid ERISA section 406(b)(1) problems, the information letter advised, "... banks should, as part of their fee negotiations, provide full and fair disclosure regarding the use of float on outstanding benefit checks."

Need for Additional Guidance

The DOL decided to issue additional guidance on this issue in response to problems identified during Field office investigations. According to DOL, even though financial service provider agreements often disclose the provider's intentions to retain float earnings, there is little or no specific information about how much these earnings will be. DOL is concerned that plan fiduciaries are agreeing to these float arrangements without the benefit of "open negotiation and full and fair disclosure." As a result, the fiduciaries that agree to these arrangements may not be satisfying their basic ERISA fiduciary duties to act prudently and solely in the interest of the plan's participants and beneficiaries and for the exclusive purpose of providing benefits and defraying reasonable plan administration expenses. ERISA sec. 404(a)(1). Additionally, by retaining float earnings pursuant to such agreements, the financial services providers may risk violating the prohibition of fiduciary self-dealing under ERISA sec. 406(b)(1).

Obligations of the Plan Fiduciary

According to FAB 2002-3, when selecting a service provider a plan fiduciary generally must "engage in an objective process designed to elicit information necessary to assess the qualifications of the provider, the quality of services offered, and the reasonableness of the fees charged in light of the services provided. In addition, such process should be designed to avoid self-dealing, conflicts of interest or other improper influence."

If the financial service provider may receive compensation in the form of float earnings, the FAB further advises the "responsible" fiduciary's selection and monitoring process should include:

1. A review of comparable providers and service arrangements (e.g., quality and costs) to determine whether such providers may credit float to the provider's own account, rather than the plan.

2. A review of the circumstances under which the service provider may receive float earnings. For example, with respect to floats that may occur when the financial service provider is awaiting investment instructions, the service agreement should include time limits within which the provider will implement investment instructions once received. This is to ensure the financial service provider does not have discretion to maximize float earnings by delaying implementation of investment instructions. (Note also that ERISA plan fiduciaries may violate sec. 404(a) if they do not provide investment instructions in a timely manner.) With respect to floats relating to uncashed disbursement or distribution checks, the service agreements should specify when money should be transferred to the general account (e.g., the date the check is requested, the date the check is written, or the date the check is mailed). The service agreement also may need to specify how quickly checks should be mailed after the financial service provider is directed to distribute funds. Again, the key is to ensure that the financial service provider does not have discretion to affect the amount of float earnings.

3. A review of sufficient information to enable the plan fiduciary to evaluate the float earnings as part of the total compensation to be paid for the services to be rendered under the agreement. Specifically, fiduciaries should request and review the rates the provider generally expects to earn on floats. This information should help the fiduciary compare service provider practices and assess the extent to which float is a significant component of the overall compensation arrangement.

In addition, the FAB advises fiduciaries must periodically monitor the service provider's compliance with the terms of the agreement and the reasonableness of the service provider's compensation, including float earnings.

Obligations of Service Providers

In addition to disclosing enough information to enable the fiduciary to reasonably approve the float arrangement, the FAB indicates the arrangement must not give the service provider discretion to affect the amount of its float earnings. Such discretion could cause the financial service provider to violate the sec. 406(b)(1) fiduciary self-dealing prohibition.

In order to avoid self-dealing, the FAB suggests the service provider take the following steps in connection with float arrangements:

1. Disclose the specific circumstances under which float will be earned and retained.

2. In the case of float on contributions pending investment direction, establish, disclose and adhere to specific time frames within which cash pending investment direction will be invested following direction from the plan fiduciary, as well as any exceptions that might apply.

3. In the case of float on distributions, disclose when the float period commences (e.g., the date the check is requested, the date the check is written, the date the check is mailed) and ends (the date on which the check is presented for payment). Also disclose, and adhere to, time frames for mailing and any other administrative practices that might affect the duration of the float period.

4. Disclose the rate of the float or the specific manner in which such rate will be determined. For example, earnings on cash pending investment and earnings on uncashed checks are generally at a money market interest rate.

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The information in this Washington Bulletin is general information only and not intended to provide advice or guidance for specific situations. Contact your Deloitte advisor for information regarding your specific circumstances. If you have questions or need additional information about this article and you do not have a Deloitte advisor, please contact Martha Priddy Patterson (202.879.5634) or Robert B. Davis (202.879.3094). Human Capital Advisory Services, Deloitte LLP, 555 12th Street NW, Suite 500, Washington, DC 20004-1207. Copyright 2002, Deloitte.

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