Prohibited transaction?

[R. Butler]

Owner of Company A wants to make his brother-in-law the broker for the Plan. Is this a prohibited transaction? The brother-in-law is not a relative under ERISA §3(15), so I don't see that this is necessarily a problem, but just wanted to see if I was missing anything.

[jpod]

While it may not be a per se, "party-in-interest" pt, it certainly could be a self-dealing pt under Section 406(B)(1) of ERISA [ or the Internal Revenue Code equivalent, Section 4975©(1)(E)]. Using plan assets to benefit someone in whom the fiduciary has an interest can be a pt, even if that someone is not a party-in-interest.

[Kirk Maldonado]

I agree with JPOD.

Example 6 of DOL Reg. Section 2550.408b-2(f) says that using your son is a prohibited transaction.

[R. Butler]

What does your son have to do with your brother-in-law?

[mbozek]

Since the brother in law is not a member of family as defined in IRC 4975(e)(6) or under ERISA 3(15) I dont see how any of the pt provisons can apply because of the family relationship. However, the owner could not receive any consideration from the brother in law for making him the broker of record. ERISA 406(B)(1) is not applicable if the commissions are paid to the brother in law because owneris not benefiting from the transaction.

[Kirk Maldonado]

Mbozek:

I think you would reconsider your answer if you read the DOL reg.

[mbozek]

Kirk: Example 6 pertains to a person who is a statutory party in interest under the Dol regs. A brother in law is not a statutory party in interest under ERISA 3(15), therefore there is no basis for a PT. I dont know of any authority for the DOL or IRS to assert a PT based solely on the brother in law relationship. By the way have your read Swanson v. IRS, 106 TC 76. IRS paid $50,000 to Swanson for legal fees incurred after IRS unjustifably assessed PT tax on a transaction that was not a statutory PT under IRC 4975. I am interested in the statutory basis to assert a PT under ERISA/ IRS in this fact pattern (other than the recept of compensation by the owner from b- in law).

Jpod: What is the interest that a fiduciary has in the b in law that would make this arrangement a PT?

[Kirk Maldonado]

MBozek:

You are reading that example excessively narrowly. Paragraph (e) of that regulation is much more broad, specifically stating:

Thus, a fiduciary may not use the authority, control, or responsibility which makes such 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.

I think that a brother-in-law would law within that prohibition.

[R. Butler]

Thank you for your replies. There seems to be an issue as to whether the brother-in-law is a person whom the Owner has an "interest" in. Although I don't agree that this a prohibited transaction, we will still present both views to the client.

Kirk, when I read 2550.408(B)(2)(e), the last sentence states that for examples of parties in which a fiduciary has interest see ERISA §§3(14)(E),(F),(G),(H) & (I). When I review ERISA §3(14) I don't see that brother-in-law fits in those definitions.

[jpod]

For those of you still stuck on the fact that the brother-in-law is not a statutory party-in-interest, you can find several DOL opinion letters indicating that the purpose of 406(B)(1) is to deter fiduciaries from exercising their authority with respect to their plans when they have interests which may conflict with the interests of the plans. These opinion letters address a variety of scenarios analogous to hiring your brother-in-law to be the plan's broker. For example, there is at least one opinion letter suggesting that it could be a self-dealing prohibited transaction to purchase stock of a corporation in which you have an interest through your IRA, even though that corporation is not a statutory party-in-interest.

[R. Butler]

The DOL Opinion letters of which I am aware always focus on the direct or indirect benefit to the fiduciary. The DOL Opinion of which I am aware concerning IRA's is 89-03A. Although I don't have a copy of that ruling, I am fairly certain that the DOL actually allowed the purchase. (Please correct if I am wrong.) The Opinion focused on the degree of company ownership of both the indiviual and the IRA. Clearly the greater the degree of ownership, the more likely there would be a direct or indirect benefit, and thus self dealing.

I would agree that if the owner was getting some kind of kick back from the brother-in-law, there would be a problem. I don't agree that the owner is necessarily receiving a benefit merely because the brother-in-law is the broker.

[jpod]

Doesn't the opinion letter contain the usual caveat that the purchase could be a 406(B) pt depending upon the "facts and circumstances?"

In any event, the potential self-dealing involved in hiring the brother-in-law is the desire to benefit the brother-in-law because he is the fiduciary's brother-in-law. Substitute "significant other" for "brother-in-law" and maybe the point becomes clearer.

[E as in ERISA]

If there is no per se prohibition against hiring the brother-in-law as a service provider for the plan, the owner should still the same due diligence that he would in hiring any service provider (e.g., obtain info on several different providers; analyze the information -- including services, fees, etc.; make an informed decision; and document how he decided that was the best service provider).

[jpod]

Katherine makes an excellent point.

However, I would also advise the fiduciary of the obvious:

1. The choice of a broker for the plan is a fiduciary act.

2. A fiduciary can be held personally liable for any losses of the plan due to the fiduciary's breach of fiduciary duties.

3. Therefore, no matter how thorough the due diligence, and no matter how competent the brother-in-law, if something goes wrong down the road involving the performance of the brother-in-law the fiduciary will be at much greater risk than if he had hired an unrelated broker. As the saying goes, no good deed goes unpunished.

[KJohnson]

I'm with JPOD and Kirk. My recollection of Swanson was that the IRS failed to allege that the fiduciary dealt with the assets of the plan for his own benefit under the 406(B)/4975©(1)(E) "self-dealing" aspects of the pt provisions (and there was also a quesiton regarding "when" various assets became plan assets).

406(B) can be a tricky thing because if a self-dealing is established, then there is a per-se prohibitied transaciton no matter how "good" a job the brother-in-law broker does. This is not like a fiduciary breach where there is a general no-harm no-foul rule (other than the possible removal of the fiduciaries). The trnasactions will have to be "unwound" to the extent possible.

JPOD is correct I think there are at least three examples where DOL raised the 406(B) flag where there was not a 406(a) technical prohibited transaction. One involved an IRA owner who wanted to lend IRA assets to a corporation of which he owned approximately 1% and was an office. The DOL raised, but did not rule on the self-dealing issues. (Of course there was no 406(a) prohibited transaction because the IRA owner did not own 50% of the corporation). Under a similar fact scenario where the IRA owner also owned 48% of the corporation, the DOL found that a 406(B) self-dealing prohibited transaction was "likely " although, once again there was no 406(a)l prohibited transaction. In a third situation, DOL found that there was a probable self-dealing prohibited transaction where an IRA owner wanted to use IRA assets for a sale/lease-back of school property where the IRA owner's children were the founders and employees of the school (but did not have an ownership interest).

In short, I think it is a bad idea. However, you do get beyond the technical 406(a) problems. And, if you have "comparison shopped" with a number of other brokers and found (and documented) that the brother-in-law is more experienced with better execution, performance and cheaper fees--then you might be able to argue that these "objective" critieria were the sole reason for the decision rather than the "influence" of the family relationship.

[mbozek]

My reason for citing Swanson was to note that regulatory agencies can't enlarge the boundaries of the laws that they enforce without a statutory basis. In Swanson the IRA owner directed the custodian of his IRA to subscribe to 100% of a new issue of stock of a company in which he was the sole director and an officer. The IRS disqualifed the IRA on the grounds that the stock subscription by the IRA was a prohibited sale or exchange under 4975©(1)(A) among other PT violations. Before trial the IRS agreed that the subscription to an original issue is not a sale or exchange. I see a similar analogy in this case because a brother in law is not a family member who is a disqualified person / party in interest. The scope of my comments is limited to the opinion that a b -in-law can execute trades on behalf of the plan without violating the pt rules- but with the caveat that the fiduciary cannot violate any other rules under ERISA 406,eg. broker cant take owner and spouse on all expense paid vacation to Hawaii, trading costs must be reasonable, etc. There is one other issue lurking which needs to be addressed . If the b - in law is the broker for the owner's personal accounts is there a potential confilict of interest under ERISA or can broker give impartial advice to both types of accounts??. What if the b in - law is the broker for his sister's accounts?

[Kirk Maldonado]

R. Butler:

The answer to your question is contained in your posting. The regulation says that the list is illustrative, not exclusive. In other words, it is just one way that there could be a problem, not the only way.