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Guest Article


(From the May 1, 2006 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

DOL Offers Guidance on Fiduciary Duties Regarding Proceeds from Late-Trading and Market Timing Settlements

Now that the Securities and Exchange Commission (SEC) has stripped many gains from those engaged in mutual fund late-trading and market timing, 401(k) plan fiduciaries must determine how to allocate the settlement proceeds employee benefit plans may receive in compliance with ERISA's fiduciary requirements. In response to a flood of questions on these issues, the Department of Labor's Employee Benefits Services Administration (EBSA) has provided guidance to its regional offices with respect to the specific ERISA roles and duties of the "independent distribution consultants," "intermediaries," and plan fiduciaries who will be involved in this distribution. Field Assistance Bulletin No. 2006-01, April 19, 2006 (FAB No. 2006-01).


The SEC, in its roles as a protector of investors and a market regulator, determined several entities had violated SEC rules by permitting trading in mutual funds after the markets had closed ("late trading") and other "market timing" activities. As part of the resolution of these violations, the SEC required restitution to the mutual fund holders and appointed an "independent distribution consultant" -- IDC -- for each mutual fund involved. These IDCs are responsible for developing and implementing the settlement funds' distribution among affected parties.

In many cases the holders of record will be ERISA-protected plans. Unlike individual fund holders, determining exactly how to allocate the settlement funds among the plan participants could become extremely complex, and in many cases sufficient records to determine precise allocations are not available or the cost of calculating precise allocations to individual accounts could exceed the amount provided by the settlement. The DOL acknowledges that in most cases the settlements will not include sufficient funds to pay for the administrative costs of the repayment process.

IDCs' Allocations Among Shareholders

The SEC-created IDCs are not designed to be an agent of the employee benefit plans or to act on behalf of plans. The IDCs' role is to develop plans to distribute the settlement fund money to affected shareholders (including employee plans). These distribution settlements must be approved by the SEC. In the SEC's view no mutual fund investor, including an employee benefit plan, has an interest in or claims against settlement fund proceeds prior to their distribution.

Based on these SEC positions, the FAB concludes the settlement fund proceeds "would not constitute plan assets prior to their distribution by an IDC to affected plan shareholders or intermediaries acting on their behalf." Accordingly, the IDC would not be exercising any authority or control over plan assets that would cause an IDC to become a fiduciary under ERISA. The FAB concludes this finding would control even if the IDC applied a de minimis threshold for deciding which entities, including employer plans, would receive distributions, or imposed conditions on receiving the funds, such as requiring the plan to use a particular allocation methodology at the participant-level or to report to the IDC on how the distributed funds were allocated among participants.

Intermediaries -- Allocations Among Omnibus Account Clients

Unlike IDCs, "intermediaries" will receive settlement funds on behalf of omnibus account clients (e.g. shareholders of record, such as a broker-dealer, underwriter or recordkeeper). These omnibus account clients will have a beneficial interest in the funds, even if the precise amount of that interest remains to be calculated. Consequently, the FAB concludes:

Accordingly, applying ordinary notions of property rights, settlement fund proceeds received by intermediaries on behalf of employee benefit plan clients will constitute plan assets and, as such, will be required to be held in trust and managed in accordance with the fiduciary responsibility provisions of Part 4 of Title I of ERISA.

This fiduciary status with respect to these settlement funds will apply to the intermediary regardless of whether the intermediary was a fiduciary prior to receiving the settlement funds. This new status requires the same ERISA standards of prudence and management for the exclusive benefit of the plan participants. As a practical matter, in some situations these duties may require investing the funds while the plan sponsor and/or the intermediary determine how to allocate the funds among the plan participants.

If the IDC has a SEC-approved distribution plan that requires a specific fund allocation methodology, the DOL in considering enforcement issues will treat such allocations among individual omnibus account clients as satisfying the requirements of ERISA ? 404(a) with respect to employee benefit plans. But the FAB cautions that fiduciaries also will need to ensure that implementation of the methodology is carried out in a prudent manner.

In those cases in which the intermediary is responsible both for developing and implementing the allocation of plan proceeds among its omnibus account clients, the intermediaries are considered fiduciaries. As such, these intermediaries must be prudent in the selection of the method of allocating the proceeds among its clients in an omnibus account, including employer plans. To state what should be obvious, the FAB notes, "Prudence in such instances would, at a minimum, require a process by which the fiduciary chooses a methodology where the proceeds of the settlement would be allocated, where possible, to the affected clients in relation to the impact the late trading and market timing activities may have had on the particular plan."

Fortunately, the FAB also recognizes the fiduciary must weigh the costs and ultimate benefit to the clients associated with achieving that goal. The FAB specifically addresses situations in which costs to implement the allocations may exceed the benefit to the plan. The FAB concludes in these cases "an allocation plan would not be considered imprudent" merely because it uses an objective formula "pursuant to which amounts otherwise allocable to a plan are forfeited and reallocated among other omnibus account clients, provided that any such formula applies to all omnibus account clients, not just employee benefit plans, and does not permit the exercise of discretion by the intermediary." But the FAB cautions that an intermediary may never retain these assets for its own use.

Plan Fiduciary Allocation Among Participants and Beneficiaries

Recognizing that for purposes of allocations among participants and beneficiaries, fiduciaries include plan sponsors, intermediaries, or other entities, the FAB restates many of the allocation rules discussed for intermediaries. In the absence of an IDC's distribution plan, the plan fiduciaries essentially must follow the same guidelines on prudence, using methods that seek to match allocations of the settlement in proportion to losses. But the plan fiduciary is not required to use an allocation methodology that would cost more to implement than the plan participants would receive.

In addition the FAB includes the following points governing plan fiduciaries:

  • A fiduciary's decision must satisfy the ERISA standard of being " 'solely in the interest of participants', but a method of allocation would not fail that standard merely because the selected method may be seen as disadvantaging some affected participants or groups of participants."
  • In deciding on an allocation method, the plan fiduciary may properly weigh the competing interests of various participants or classes of plan participants (such as those affected versus current participants) and the effects of the allocation method on those participants, provided a rational basis exists for the selected method that meets standards of reason, fairness, and objectivity.
  • If a plan fiduciary determines that the cost to allocate the proceeds among participants whose accounts were invested in the mutual fund during the entirety of the relevant period approximates the amount of the proceeds, the fiduciary may properly decide to allocate the proceeds to current participants invested in the mutual fund based upon a reasonable, fair, and objective allocation method.
  • As plan assets, the proceeds of the settlement may not be used to benefit employers, fiduciaries, or other parties in interest with respect to the plan, unless the plan by its terms permits the use of such proceeds (for example plan terms permitting the use of forfeitures).
  • A plan fiduciary could reasonably conclude that certain participant-level allocations that are not "cost-effective" (allocations of de minimis amounts) may instead be used for other plan purposes, such as the payment of reasonable expenses of administering the plan.

The FAB also notes the importance of fiduciaries documenting the receipt and uses of the settlement proceeds and working closely with recordkeepers and other plan service providers. This will be especially important in documenting the source, amounts, and accuracy of records for the plan and its participants.

Questions about the FAB should be posed to the Division of Fiduciary Interpretations, Office of Regulations and Interpretations, 202.693.8510.

DeloitteThe information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations.

If you have questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Taina Edlund 202.879.4956, Laura Edwards 202.879.4981, Mike Haberman 202.879.4963, Stephen LaGarde 202.879-5608, Bart Massey 202.220.2104, Martha Priddy Patterson 202.879.5634, Tom Pevarnik 202.879.5314, Carlisle Toppin 202.220.2067, Tom Veal 312.946.2595, Deborah Walker 202.879.4955.

Copyright 2006, Deloitte.

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