What is a "party in interest" ?

[Moe Howard]

An INSURANCE AGENCY partnership (with 3 partners) has a 401(k) plan for its employees.

The same three guys are also the partners of another partnership (INVESTMENT ADVISORY FIRM XX). All three of them are registered investment advisors.

The "Administrator" of the insurance agency's 401(k) is the INSURANCE AGENCY PARTNERSHIP (the employer itself).

The "Administrator" appointed one of the insurance agency partners as the "Trustee" of the insurance agency's 401(k) plan.

The "Trustee" then hired the INVESTMENT ADVISORY FIRM XX, to perform the investment advisory services for the insurance agency's 401(k) plan.

QUESTIONS:

1) Is there a conflict of interest in the above example?

2) If there is a conflict of interest ... then is it a conflict violation under the Internal Revenue Code --or-- a conflict under ERISA ?

3) Who is the "party in interest" in the above example?

[Jon Chambers]

"Party in interest" includes all fiduciaries, anyone providing services to the plan, any employer, direct relatives of anyone named above, several other categories, and all 10% or greater partners in pretty much any organization serving or related to the plan. See ERISA Section 3(14).

The three guys are clearly parties-in-interest, as employer, and in additional roles, such as trustee, investment advisor, etc.

The Internal Revenue Code and ERISA both contain outright prohibitions against direct or indirect economic transactions involving plan assets and parties-in-interest, unless the transaction is covered by an exemption. The Code refers to these individuals as "disqualified persons".

To answer your questions, it appears that there is a conflict of interest under both the Code and ERISA. If anyone is receiving compensation from the Plan, either as a commission, or as fees in the RIA capacity, such compensation is probably a prohibited transaction, and would need to be corrected.

[Moe Howard]

Jon, if "anyone providing services to the plan" is a party in interest .... then that would mean that even the plan's TPA would be a party in interest (because the TPA provides services to the plan).

If the IRS and ERISA say that paying "a party in interest" for any reason is a conflict of interest .... then paying a TPA represents a conflict of interest.

I CAN see how a conflict in interest would exist if the plan pays a service provider "party in interest" (who happens to be one of the plan's fiduciaries) .... but why in the world would a conflict of interest exist simply because a plan pays an independent TPA service provider (a party in interest based on what you claim) for the TPA's administrative services?

I don't kmow of any TPA firms that will work for free.

Are you sure that "anyone providing services to the plan" is a party in interest? Now I'm really confused.

[Guest BenefitsLawyer]

Jon Chambers is correct--the definition of "party in interest" specifically includes "a person providing services to [an employee benefit] plan[.]" 29 USC Section 1002(14)(B). There is a statutory exemption that permits payments to a party in interest for "services necessary for the establishment or operation of the plan, if no more than reasonable compensation is paid therefor." 29 USC Section 1108(B)(2). However, DOL has said that the exemption does not cover transactions with fiduciaries, 29 CFR Section 2550.408b-2©. ERISA says fiduciaries may not deal with plan assets for their own interests, or act on behalf of a party whose interests are adverst to the interests of the plan, or receive any consideration for their own accounts from any party dealing with such plan in connection with a transaction involving plan assets. 29 USC Section 1106(B). So, you have to separate fiduciaries, who have to meet much more stringent requirements, from "mere" parties in interest. The IRC definitions and rules are essentially the same. So, are any of the three being paid for providing services to the plan? If so, there's probably a prohibited transaction. Of course, DOL permits fiduciaries to render services to a plan without compensation other than reimbursement of direct expenses. 29 CFR Section 2550.408b-2(e)(3). And many fiduciaries (especially in situations such as you describe) do, in fact, work "for free."

[Moe Howard]

Benefits Lawyer --- What about if the 401(k) hires a professional outside TRUSTEE ? That person will be a fiduciary.

Based on what you claim, a conflict of interest will exist if the TRUSTEE (a fiduciary " party in interest") is paid by the plan.

I don't know of any professsional trustees that will work for free.

A trustee is not a mere service providor ... a trustee is a fiduciary.

Anyone have any IRC or ERISA sections that can clear this matter up ?

[Jon Chambers]

Thanks BenefitsLawyer, for a good summary of the rules. Moe, back to your point about the TPA, there is no prohibited transaction if the TPA that is engaged and is paid from the plan is otherwise independent from the plan. But consider the scenario where the TPA firm is owned by the spouse of a partner in the company engaging the TPA firm. The partner in the company is clearly a fiduciary, as they are acting as Plan Administrator. The spouse is linked to the hiring fiduciary. Thus, you have self-dealing and consequently a prohibited transaction.

Another scenario--the independent TPA also has an investment advisory affiliate. The TPA firm recommends that the plan sponsor hire the investment advisory affiliate. This is probably still ok, since the TPA firm is not a fiduciary, but it's getting grayer. Turn it around, with an investment advisor with a TPA affiliate that is recommended, and it's probably not ok, because the investment advisor is a fiduciary that benefits from the TPA firm being hired.

General rule--don't conduct ERISA plan business with affiliated parties. If you want to break the general rule, be sure to get a legal opinion from a qualified attorney.

[KJohnson]

Moe, for Trustees you go to 408©(2) of ERISA (as opposed to 408(B)(2)) that provides that a trustee can receive reasonable compensation from a plan provided that the trustee is not receiving full time pay from the employer (or union) that sponsors the plan.

[Jon Chambers]

Moe, once again, the trustee can be paid from the plan where they are not a party in interest prior to being hired. They potentially get into trouble where they benefit financially from there role as trustee. This is where you see all the issues relating to trustees collecting 12b-1 fees from mutual funds that they recommend (this is generally not permitted, although may be ok in limited circumstances--see for example the "Frost" opinion letter [DOL ERISA Opinion Letter 97-15A]).

[Moe Howard]

Jon - I would think that somewhere in IRC or ERISA it says that (as you say) ... That "there is no prohibited transaction if the service provider is independent from the plan".

Where might I find that quote ?

Also, Where might I find (in IRC or ERISA) the definition of "independent from the plan" ?

Or are those "comments" simply your good logic ?

[Jon Chambers]

As you may know, ERISA and the IRC are more focused on describing what you can't do, than describing what you can or should do.

The definition of a party in interest is ERISA 3(14). If you don't fit any definition on that list, presumably you are independent from the plan.

For prohibited transaction rules, review ERISA 406. If the transaction is not between the plan and a party in interest, presumably it is not prohibited.

[KJohnson]

Moe,

I think you do have a problem. Why don't you look at the examples that DOL gives in the following regulation regarding 408(B)(2):

http://www.dol.gov/dol/allcfr/PWBA/Title_2...2550.408b-2.htm

[Moe Howard]

All the replys were great.

Thanks.

[Guest BenefitsLawyer]

29 CFR Section 2550.408b-2(e) is the reg that addresses transactions with fiduciaries. The relevant language: "[A] fiduciary may not use the authority, control, or responsibility which makes such a person a fiduciary to cause a plan to pay an additional fee to such fiduciary (or to a person in which such fiduciary has an interest which may affect the exercise of such fiduciary's best judgment as a fiduciary) to provide a service. Nor may a fiduciary use such authority, control, or responsibility to cause a plan to enter into a transaction involving plan assets whereby such fiduciary (or a person in which such fiduciary has an interest which may affect the exercise of such fiduciary's best judgment as a fiduciary) will receive consideration from a third party in connection with such transaction. A person in which a fiduciary has an interest which may affect the exercise of such fiduciary's best judgment as a fiduciary includes, for example, a person who is a party in interest by reason of a relationship with such fiduciary described in section 3(14)(E), (F), (G), (H), or (I)."

A plan's fiduciaries may choose someone else to act as a fiduciary, and pay the fiduciary using plan assets. But then the new fiduciary may not use his/her authority, control, or responsibility as a fiduciary to cause the plan to give the new fiduciary more business. There are several examples at 29 CFR Section 2550.408b-2(f).

Regarding 408©(2), although DOL has not yet staked out its position, there are 2 cases holding that 408©(2) does not apply to 406(B) violations (i.e., fiduciary self-dealing), and a third case that questions whether 408©(2) has any independent exemptive power. I suspect that DOL would agree.

As to independent fiduciaries, the regs address the issue at 29 CFR Section 2550.408b-2(e)(2): "A fiduciary does not engage in an act described in section 406(B)(1) of the Act if the fiduciary does not use any of the suthority, control or responsibility which makes such person a fiduciary to cause a plan to pay additional fees for a service furnished by such fiduciary . . . . This may occur, for example, when one fiduciary is retained on behalf of a plan by a second fiduciary toprovide a service for an additional fee."

In short, a plan may hire a fiduciary and pay the fiduciary. But once s/he is a fiduciary, s/he must be very, very careful about what else s/he does for the plan for additional fees, and what other kinds of transactions s/he enters into that involve plan assets.