Jon Chambers

I have to differ. I don't know of any institutional trustees that DON'T use the term "fiduciary", although obviously they will make it clear in what capacity they act as fiduciary, and don't take investment discretion unless they are being paid for it. Some of the trust companies my clients work with include Union Bank of California, Charles Schwab Trust Company, Wells Fargo Bank, CNA Trust, Vanguard Fiduciary Trust Company (note the name), Bank of America and Fidelity. I'd be very interested in hearing what trustees you run into that claim not to be a fiduciary. If you go to the second part of the ERISA fiduciary definition, it continues "...or exercises any authority or control respecting management or disposition of its assets, ..." Obviously, a trustee meets this definition, since they are the only entity that can physically make a disposition. On a separate note, the February 4th issue of Pensions & Investments has an op-ed piece on fiduciaries. They indicate that ERISA has no clear definition of fiduciary, and indicate that it is sometimes unclear as to who is a fiduciary. They cite actuaries and investment consultants as examples, but don't even touch on the issue of trustee.

mjb, let's get back to first principles. Here is a direct copy from ERISA, defining party in interest: "(14) The term ``party in interest'' means, as to an employee benefit plan-- (A) any fiduciary (including, but not limited to, any administrator, officer, trustee, or custodian), counsel, or employee of such employee benefit plan;" Note that the trustee is by definition, a party in interest. Moving to the prohibited transaction issue, we find: "Sec. 1106. Prohibited transactions (a) Transactions between plan and party in interest Except as provided in section 1108 of this title: (1) A fiduciary with respect to a plan shall not cause the plan to engage in a transaction, if he knows or should know that such transaction constitutes a direct or indirect-- (A) sale or exchange, or leasing, of any property between the plan and a party in interest; (B) lending of money or other extension of credit between the plan and a party in interest;" Consequently, it's clear that the trustee, as a party in interest, cannot extend credit to the plan, unless the DOL advisory opinion you referred to above (86-12A) also applies to trustees (I don't have that opinion, and couldn't find it on the Web). Moving to the ERISA definition of "fiduciary", we find, "(21)(A) Except as otherwise provided in subparagraph (B), a person is a fiduciary with respect to a plan to the extent (i) he exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets, ..." I find it hard to believe that even a fully non-discretionary trustee could not be found to have no "authority or control respecting management or disposition of (a plan's) assets". I've never seen a trust agreement claiming a non-discretionary trustee was not a fiduciary at all, although I'm very familiar with agreements that seek to significantly limit the trustee's fiduciary liability. As an advisor to plan sponsors, you may want to review my paper on this topic, at the following link. http://www.advisorsquare.com/advisors/schu...ns/82713136.pdf I think your confusion may stem from the difference between an "investment fiduciary" (I agree a non-discretionary trustee is not an investment fiduciary), and a general fiduciary. I'd be interested in your rationale if you believe that it is possible to be a trustee without being a fiduciary in any sense of the term.

Respectfully, a trustee is always a fiduciary by definition, hence any loan from a trustee is potentially a PT, absent some exemption. Whether or not the trustee has discretion over investments is irrelevant. I agree that it may be possible to trade on margin, when the margin loan comes from a non-fiduciary, but I stand by my earlier comment that the vast majority of broker-dealers that I have experience with don't permit margin loans on qualified plan assets, even when they are not acting as trustee.

mjb-- As I noted in my earlier post, the PT becomes an issue if the loaning party is also the trustee. I concur that it's not a PT if the loan comes from a non-trustee/non-fiduciary brokersgreater than account value as the rationale why most providers don't permit this strategy, not as a legal prohibition. If the stock price declines, the broker/dealer may need to make a margin call, but there may be no way to inject funds into the account. Assuming a 50% margin, if the margined stock drops 50%, the account is wiped out; if it drops more, the account goes negative. For this reason, most brokers don't permit margin trades.

Ability to direct investment is a benefit, right or feature that must pass coverage testing in order for the plan to be qualified. Since a disproportionate number of partners are likely to be HCEs, I'd suggest you have a problem here.

Thanks Barry. That makes lots of sense to me. I'll inform my client.

One of my clients has a 401(k) plan which also permits after-tax contributions. Traditionally, participants separating from service and seeking to avoid taxes would elect to roll over 100% of the distribution to an IRA. The plan administrator would segregate the after-tax contributions, roll over the remaining amounts, and issue a check (non-taxable) for the amount of the after-tax contributions only. Great result--some cash for the separating participant, no taxable event. Following the new rollover rules for 2002, the administrator is now rolling over the entire distribution, including the after-tax contributions. The IRA custodian is saying that the 10% penalty tax applies to a pre 59.5 withdrawal of these after-tax contributions. This doesn't seem right to me, but I'll be the first to admit that I don't have a lot of IRA experience. I'd appreciate any insight that could be offered, as well as any cites or links that might be appropriate. Thanks in advance for the help.

You might be interested in the following article on hedge funds that we developed for one of our firm's newsletters.http://raid1.namehub.com/Advisors/schultzc...7%20FF%2014.pdf

I'd suggest that a plan that has a prudently developed investment policy that is actually followed, and an investment monitoring and review process in general holds less liability for the trustee than a plan with an ad hoc set of mutual funds that participants use in a self-directed environment. Remember that the trustee directed structure creates an investment portfolio that is reasonable overall, but probably not optimal for any single plan participant, because the portfolio is managed for the "average" participant, and the average participant doesn't exist. Balance that against the protection afforded under 404©, and the ambiguities in the question become obvious. I'm not sure that your question is an either/or scenario. I'd suggest that trustees bear the least liability under a combination of both approaches--participant self-direction among designated mutual funds, IPS setting standards for selection and review of mutual funds, and periodic monitoring.

Yes. I'm not aware of any class exemptions that relate to hedge funds (there are some for mutual funds).

ERISA prohibits transactions that can result in a loss greater than account value. This is the primary rationale most institutions use to prohibit margin trades. Furthermore, margin interest paid may constitute a PT if the margin lender is also the trustee.

MJB--thanks for the clarifications. I completely agree with you on the IRC not following common sense. Regarding 401(k)/stock bonus/ESOP and Enron, my presumption (based on reports that Enron permitted diversification just for older, long service employees) was that the plan was qualified as an ESOP, and consequently, could follow the ESOP rules for age 55 diversification.

MJB--as you probably know, there is no such thing as a "401(k) plan", there is simply a 401(k) feature of a profit sharing or stock bonus plan. Although I don't have any definitive information regarding the Enron plan, my presumption is that the 401(k) feature was added to a stock bonus plan, since that is the structure typically used when company stock is a primary investment option (e.g., the vehicle for match). In this case, the 401(k) element becomes an element of a stock bonus program, hence the ESOP rules kick in. My point was that the rule requiring ESOP diversification at age 50 is the rule that is exempt from the ADEA. I'm not saying that the whole plan is exempt from ADEA. My point about NUA is really more common sense. How can you have significant NUA if you buy into the stock just prior to it being distributed from the plan? I'm not aware of any IRS cites supporting my position, or any cites disagreeing with it either.

The concentration issue doesn't have a single answer. It varies by individual. Some advisors believe that no retirement assets should be invested in company stock, because the employee's earnings come from the same source that would support retirement assets. If the company goes bankrupt, retirement assets become worthless at the time they are most needed, when the employee is laid off. Personally, I believe that employees should invest in company stock only what they can afford to lose. Further, employees in formulating their retirement plans, employees should expect nothing from company stock. If the stock becomes worthless (like in the Enron case), employees are still ok. If the stock does well, employees have excess assets in retirement--not a problem. Regarding the ADEA, there shouldn't be an issue for Enron, since the ESOP diversification rules (which are driving the age 50 diversification rules) are specifically exempted from ADEA. The Enron case will turn on general prudence rules, potential false or misleading statements made by execs, and the decision to black out trading during a period that execs knew, or should have known, that material information driving down the stock price was likely to come out. Personally, I think that application of insider trading rules should be sufficient to require the senior execs to disgorge their trading profits on Enron stock. The political problem will be what to do with these funds if and when they become available. Should they go to creditors, to employees, to other stockholders? A lot of people got hurt, and I doubt there will be enough money to make everyone whole. Regarding capital gains, the rules that apply to qualified plans are different from the rules that apply to a taxable brokerage account. I don't have time to discuss all the nuances. Suffice it to say that distributions from qualified plans will be 100% ordinary income, unless the distribution is in the form of company stock (ignore A-tax contributions for now). As dmj comments, your trading gains look just like your contributions for tax purposes. And trading gains aren't taxed until they are distributed from the plan. My comment on NUA presumes that funds are distributed from the plan in the form of company stock. Under these rules, you are only taxed on the cost basis of the stock distributed, gains are taxed when the stock is subsequently sold. To clarify for MJB, if you have actively traded your company stock, your cost basis is probably close to the value distributed to you (I'm presuming you bought back in close to current market value), hence the benefit you get from NUA is small.

MJB-- While your observation is correct for plan's using this kind of pricing system, I hardly ever see this approach in the market. Most service providers make specific identification of each trade, so the selling price is what the individual sells for. Another common approach is to take the average price of all trades during the day. Very few plans let you use the prior day's value. Another misconception is that you don't pay trading costs. Many plans net out the brokerage commission when they figure the trading price, but the commissions are paid anyway. While it's possible that the sponsor might absorb the commission, I haven't seen this in practice. Finally, in order to take advantage of the NUA pass through rules, you have to have unrealized appreciation. If you sell the stock, your gains become realized.

Hi Kirk. The SEC did an interesting (but small scope) study of day traders about 18 months ago, and concluded that about 85% of the day trading accounts that they studied would be bankrupt within three years. Between margin loan costs and trading charges, the accounts typically ran up costs equal to 60-80% of invested principal each year. Essentially, the SEC concluded that there was no way that trading profits would be able to overcome costs. According to the SEC study, the only people really profiting from day trading were the brokerage firms supporting the trading. The SEC did say that the remaining 15% of studied accounts had opportunities to be profitable. These accounts: traded more moderately, didn't risk a significant percentage of principal on a single trade or security, and carefully managed trading costs and trade execution. Based on everything I've read about day trading, I think it's awfully difficult to do profitably. If you use the standard definition of day trading (which presumes that all long and short positions are closed before the end of each trading day), you are essentially betting that your individual trading abilities are sufficient to capture enough profits from positions taken for minutes or hours at a time to cover brokerage fees, margin loan costs, and also generate a reasonable profit. Do these strategies generate a broad range of returns, from -100% (losing it all) to +1000%? Yes they do. Do more people lose 100% than gain 1000%? I think they probably do. Do the people who lose 100% talk about it much? Probably not. Do the people who earn 1000% talk about it? I'm sure they do. The net effect is that people perceive day trading to be much more successful than it really is, because we generally only hear the success stories.

dmj, you are correct that this is not a true arbitrage situation, and that was what I was intending to point out. Just because there is a perceived pattern, there is no reason that the stock must continue to follow that pattern. If there were such a reason, it would be an arbitrage opportunity, and the arbs would act in a manner that would destroy the truly predictable pattern. My point is that simbarat's colleagues believe that there is a truly predictable pattern, and they are trying to sell him on the same flawed concept. I'm encouraging him to avoid it. I think you agree with me on that point anyway.

If the stock truly had a predictable pattern that generated the opportunity for "guaranteed, risk free profit", you can be sure that a professional arbiteur will identify the pattern and trade ahead of you and your fellow 401(k) participants, until the profit potential is eliminated. Is there any legal, tax or regulatory reason why you shouldn't try this? No. Are there any practical reasons. Yes. It's stupid. This technique may have worked in the past, but that's probably just a coincidence. Stick with your regular investment strategy. BTW, true "day trading" requires the ability to take margin loans on your account, because of the three day settlement rules. Margin loans are not permitted on 401(k) accounts, making rapid day trading even more difficult than it already is.

Go to the link below and select "Advisory Opinions and Information Letters" Year is 1997 Frost(97-15A):http://benefitsattorney.com/cgibin/framed/...gi?ID=50&id==50 Aetna(97-16A):http://benefitsattorney.com/cgibin/framed/...gi?ID=50&id==50 While I don't claim to be familiar with the Nationwide case, I'm not sure that the Nationwide's plaintiffs claim that all revenue sharing should be reimbursed is inconsistent with the Frost/Aetna opinion letters. In the letters, the DOL appears to indicate that if you don't provide Frost/Aetna type disclosure, you may have a prohibited transaction. If I were arguing for the plaintiff's, I'd assert that Nationwide didn't make required disclosures, hence taking revenue share was a PT, hence, PT must be cured, so they need to give all the money back. Whether or not this flies will be a matter for the courts to decide.

Several years ago, in the Aetna and Frost opinion letters, the DOL listed disclosure requirements needed to avoid prohibited transaction concerns when administrative service providers receive and retain revenue sharing from mutual funds (Aetna was just a recordkeeper, Frost also acted as trustee, and in some cases, investment advisor). In my experience, very few administrative service providers satisfy the disclosure standards listed in the Aetna and Frost letters. Among other things, the standards require that the fund revenue sharing structure be fullly disclosed, that fees be offset dollar for dollar for revenue sharing received, and that the offset procedure be fully accounted for in written form to the plan sponsor. My guess is that Nationwide did not meet these standards. Consequently, the case may turn on whether or not the Aetna and Frost letters represent the "law", or whether they are simply a recommended approach. Incidentally, following the filing of the Nationwide suit, I'm starting to see other providers improve their disclosure relating to their revenue sharing procedures. I'd suggest that in light of the Nationwide case, all TPAs and administrative service providers that accept mutual fund revenue sharing should review the Aetna and Frost opinion letters to determine whether their disclosures meet the standards described by the DOL.

Just a couple of quick thoughts: 1) Most of the time, in a bundled service environment using publicly traded mutual funds (which is used by most but not all larger plan sponsors) 404© compliance is not that hard. 2) I agree with IRC401 that 404© is becoming a de facto standard of fiduciary conduct. 3) I agree with Pete Swisher that cases we have seen so far are claiming fiduciary breaches that 404© doesn't cover. But I disagree that 404© is necessarily a "shallow shield". Consider potential claims from participants that invested 100% of their accounts in large growth funds last year that lost 50%, when the average stock was up 28% in 2001 (yes, that is accurate, check the performance of the equally weighted Wilshire 5000). Losses are primarily attributable to a participant's bad asset allocation decision, exactly what 404© is intended to protect against.

AndyH, you make a reasonable point, and I'm probably not going to be able to come up with a clear cite. So let me give you my logic instead. 1) If the matching contribution is fully discretionary, the 204(h) notice clearly doesn't apply. But as a practical matter, it's impossible to pre-fund a fully discretionary match, so my presumption is that the match was contributed and funded according to some definable formula (e.g., 50% of the first 6% of pay deferred). My presumption is that this formula is written into the plan document. 2) Adding a last day requirement would reduce the rate of benefit accrual under a definitely determinable formula written into the plan. Does 204(h) apply? You could argue no, since the plan isn't a "pension plan". You could argue yes, since the employer has a legal obligation to fund in accordance with plan terms, that makes the matching obligation look like pension obligation. I guess I took a shortcut, and cited what I see as typical practice, even if there is no clearly applicable legal requirement. BTW, if anyone out there can bail me out by providing AndyH with an applicable cite, I'd appreciate it.

Coming back to the original question, I think it really depends on whether the pre-funding was a matter of policy or a plan requirement. First, based on Karla's clarification, it appears the question relates to a 401(k) match. We all know the funding rules. The match needs to be funded before the employer's tax filing deadline. Nothing in the funding rules prevents the employer from funding earlier. And I'm not aware of any rule that requires an employer that was electively funding early to provide notice of a change to a later funding that is within the required timeframe. The second element of the question has to do with participant accrual of the matching contribution. It appears that the employer is now imposing a last day requirement. This probably does require notice, unless (as I've seen relatively frequently), the plan previously had a last day requirement that the employer ignored (since they were funding on a payroll frequency, and would have had a big problem with unallocable contributions that were already in the plan--I'm not even going to begin getting into the problems with this). Thus, the requirement for notice turns on whether the last day requirement is a new rule, in which case notice is required, or simply the appropriate application of an existing rule, in which case notice is not required. As earlier posters have noted, a quick review of the SPD should answer this question. Finally, Karla raises the question of large layoffs on 12/30 to avoid the requirement to make a contribution for the year. Under ERISA, it is not permissible to terminate a participant's employment to prevent them from accruing a benefit under a qualified plan. Whether this rule would be triggered depends on the size and scope of the layoff--eliminating one or two positions from a large employer typically doesn't trigger it, eliminating 50% of the workforce almost certainly would. Most companies I work with are sensitive to this issue, and provide employees with the benefit of the doubt, either deferring the layoff date until after the last day requirement is met, or otherwise bridging service such that laid off employees that worked the bulk of the year receive a contribution for their final year. A layoff that is clearly designed to eliminate an otherwise required contribution to an ERISA plan is a relatively easy target for litigation claiming wrongful termination. Hope this helps,

I don't know. I always figured it was a funding issue, because if the account lost more than 100%, the participant (or somebody) would need to make up the difference, with no practical way to allocate, account for or otherwise fund the dollars contributed to the plan to make up for the loss. Anyone else have an idea or experience with this?

ERISA prohibits transactions that could result in a loss greater than the account balance (I'm paraphrasing here). As a practical matter, that precludes almost all margin and naked option investments. Short sales are similarly questionable, unless the strategy is clearly defensive.