Prohibited Transactions

[Ron Snyder]

Just got back from attending the Western Pension and Benefits Conference summer meeting in Las Vegas. The final session was about fiduciary duties and was conducted by S. Derrin Watson. In his slide presentation he gave as an example of a PT the case where a qualified plan purchases a piece of real estate at fair market value (as set by independent valuation agreeable to both parties) from the sister of the owner of the Employer corporation. Although he acknowledged that the sister is not a party in interest (or disqualified person), he insisted that the transaction was a PT because the owner of the business certainly would not have had the plan purchase the real estate simply as an investment for the plan, but would only have entered into such a transaction to benefit his sister.

He asserted that the trustee who caused the plan to enter into the transaction would be liable for the excise tax relative to the transaction. (Presumably the transaction would need to be "corrected" as well.)

"I strenuously object." Congress obviously didn't agree with Mr. Watson's view or they would have named siblings of parties in interest or of fiduciaries as parties in interest in their own right. Has anyone run accross an IRS or DOL agent applying such specious logic to commercially reasonable transactions not involving a named party in interest? Does anyone agree with Mr. Watson's specious reasoning?

[Guest Gompers]

Although I don't necessarily agree, 2550.408b-2 (especially the last example) could be read to create a 406(b)(1) PT at any time where a fiduciary enters into a transaction with a party "in whom [the fiduciary] has an interest which may affect the exercise of the fiduicary's best judgment" Pretty broad standard...

[Kirk Maldonado]

DOL Regulation Section 2550.408b-2(f) provides in relevant part as follows:

Example (6). F, a fiduciary of plan P with discretionary authority respecting the management of P, retains S, the son of F, to provide for a fee various kinds of administrative services necessary for the operation of the plan. F has engaged in an act described in section 406(b)(1) of the Act because S is a person in whom F has an interest which may affect the exercise of F's best judgment as a fiduciary. Such act is not exempt under section 408(b)(2) of the Act irrespective of whether the provision of the services by S is exempt.

[Belgarath]

I would tend to disagree if Mr. Watson is asserting that such a transaction is automatically a PT. Does he have a court case or cases to cite as support for his opinion?

I certainly think that there is a POTENTIAL for this to be considered a PT, depending upon facts and circumstances. For example, perhaps if the fiduciary is a beneficiary under the sister's will, or if the sister then helps pay for the college tuition of a child of the fiduciary, etc..

Barring some facts and circumstances evidence of a "benefit" to the fiduciary of some self dealing as a result of this transaction, I'm hard pressed to find a reason that this would be considered a PT.

While I'll leave it to the attorneys to provide a more informed opinion, as a layman, it would at least seem like a possibly increased potential for a successful claim for fiduciary breach IF the investment turns out to go sour. If I were a fiduciary, I'd probably be rather hesitant to engage in such a transaction, but that may be paranoia.

[Locust]

Isn't the identity of the fiduciary an important fact? It's a prohibited transaction for a fiduciary to act when he or she has a conflict.

If the fiduciary is not the business owner and is independent of the business owner, doing business with the owner's relative should not be a problem. If the owner is the fiduciary, he could delegate the decision to an independent fiduciary.

Sometimes you see these deals that a relative can give to a plan that are better than what the plan could do - for example a real estate deal with no commission - and an independent fiduciary could decide that it was OK.

[jpod]

It is probably not correct to say that the transaction described by Mr. Watson would ALWAYS be a 406(b) prohibited transaction. The example in the regs. cited by Kirk is a good example of a fact pattern that will ALWAYS BE A 406(b) pt, because there are plenty of people/firms that can provide the same administrative services that the son would provide. All real estate is unique, however, so I suppose it might be possible to make the argument that the fact that the purchase may incidentally benefit the fiduciary's sister does not necessarily mean that there was self-dealing involved in the transaction. For example, perhaps the plan owns a contiguous piece of real estate.

Nevertheless, if what Mr. Watson was saying is that, absent unusual circumstances, a fiduciary would be a fool to take the risk with the kind of transaction he described, I'd agree with that.

[GBurns]

Did Watson give any further information regarding the need or rationale for the purchase? What was the reason why the purchase is even being made? Speculation, planned development ?

Aside from examples such as the one given by jpod, it could be that Mr. Watson's position is based on the rationale that there is no reason for the Plan to purchase real estate. Additionally, I thought that Real estate investments, per se, are speculations and speculative investment especially those involving a relative or other party in interest seems to fall in line with the concept of PTs.

If such a Real Estate transaction was from "facts and circumstances" a necessary and proper exercise of fiduciary duties, there still should be the issue and example raised by Kirk and Gompers.

[jpod]

GBurns: Whether or not an investment is "speculative" in and of itself has absolutely no bearing whatsoever on whether there is self-dealing or a conflict prohibited by 406(b). On the other hand, if there are facts suggesting self-dealing, such as the sister being the seller, the added factor of the investment being "speculative" would increase the likelihood that you have a 406(b) transaction.

[GBurns]

I did not make any connection between "speculative' and 406(b). I made the connection to such investments possibly being PT. 406(b) is not the only section that pertains to PTs nor is it the only section pertinent to the OP.

[jpod]

This is what you said: "Additionally, I thought that Real estate investments, per se, are speculations and speculative investment especially those involving a relative or other party in interest seems to fall in line with the concept of PTs." If you didn't think that a speculative investment would generally "fall in line with the concept of PTs," why did you go on to say "especially . . ."?

The facts as stated indicated that there was no 406(a) pt, only a 406(b). I think everyone would agree that if the sister was a pii it would be a per se pt.

What is "OP?" Did you mean "QP" for "Qualfied Plan(s)"? If so, what's your point? The original post raised a question about pts.

[WDIK]

OP

is sometimes used as shorthand for

original post

[jpod]

Thanks, WDIK.

GBurns, did you mean "Original Post"? If so, what other sections could be pertinent to the original post if the original post concerned 406(b) and only 406(b)? If Mr. Watson was also talking about how real estate could be a bad investment, that would be another story, but evidently he was only talking about the 406(b) implications of the fact pattern described.

[Guest mjb]

If Congress wanted to make siblings parties in interest they would have done so by including siblings as DQ persons or parties in interest. DQ persons are limited to those who are designaed under ERISA/IRC and cannot be extended to other persons by regulatory authorities. A few years ago the IRS was trashed in the Swanson case when lower level personnel attemped to assess the PT tax against an IRA that subscribed to an initial offering of stock which the IRS deemed to be a sale of property between the IRA and the owner. In the ct case the IRS admitted that the was no PT and the tax court awarded $50k in legal fees to the IRA owner to be paid by the govt. The reference to the dol reg is irrevalent because reg 408-2 relates to the performance of services by parties in interest for the plan which was not discussed in the facts of the OP.

I wont even bother reviewing the post that claims that RE investments are speculative since it displays a remarkable lack of understanding of RE as a plan investment. RE is no more speculative than investing in any other class of assets.

[GBurns]

jpod: You are the only person I see who has made this a 406(b) issue. No one else has.

We do not know the context of Mr. Watson's statement. We also do not know the facts and circumstances. So it cannot be determined what applies.

mjb: That RE can be a valid plan investment does not mean that RE cannot also be speculative. It is not whether something is RE that makes it speculative, it is the facts and circumstances of the particular RE transaction. I do not suffer from a lack of understanding of RE as a plan investment and I do have an understanding of plan investments and investments in general. At least enough to know that some RE is speculative and that it depends on the particular transaction. It is much more remarkable that you do not understand that yet are willing to make such a comment.

[Guest mjb]

Additionally, I thought that Real estate investments, per se, are speculations and speculative investment especially those involving a relative or other party in interest seems to fall in line with the concept of PTs.

I dont make this stuff up. Those are your exact words. You also doent seem to know the difference between imprudent investments and PTs.

[Guest P A Weick]

This sounds more like a potential breach of fiduciary duty, by failing to act solely in the best interests of the participants and their beneficairies, than it sounds like a prohibited transaction. And Watson's analysis seems more to the point in the fiduciary breach area than in the PT area.

[Guest Gompers]

As to mjb's statement that the example 6 of the reg is irrelevant outside of an interpretation of the 408(b)(2) statutory exemption, DOL doesn't appear to take that view:

http://www.dol.gov/ebsa/programs/ori/advisory93/93-33a.htm

[Guest mjb]

You want to explain to me what I am missing. The advisory opinon clearly prohibits persons who are parties in interest (daughter and husband) from engaging in a PT which is different from the sister who is not a party in interest. The reference to example 6 in the advisory opinion discusses the performance of services by persons who are a party in interest with an IRA owner whereas in the original post the transaction is an outright sale w/out services to be performed by the related party. I dont see the connection that you are making to the PT rules where the other party is not a party in interest with the IRA owner and is not providing services to the plan. The regulations cannot expand the limitations on who is a party in interest under the IRC.

[Guest Gompers]

The point I am making is that DOL uses the term " any person in whom such fiduciary had an interest that would affect the exercise of his or her best judgement as a fiduciary." They do not limit this to disqualifed persons/parties in interest. In fact they apply it to investment in entities that are not otherwise parties in interest/disqualified persons where the fiduciary has an interest in that entity--for example in 88-18A

http://www.thetaxacademy.com/IRA%20owner%2...wns%2048%25.pdf

They also do not limit this analysis solely to the retention of a service providers, but also apply it to sale lease backs such as in 93-33A or in the case of loans in 88-18A. Now do you understand what you are missing? Of course you can always take comfort in the "DOL is wrong" argument.

[Ron Snyder]

Wow, what a response! I welcome the different views expressed. However, like mjb, I must point out that a purchase of real estate by a qualified plan from the sister of the owner of the business is NOT per se a prohibited transaction (i.e., a direct or indirect transaction between the plan and a party in interest). The citations you have referred to are transactions between IRAs and disqualified persons. Even the example that Kirk Maldonado referred to involved the fiduciary's son, a named party in interest.

Without additional evidence to the contrary, I must presume that Mr. Watson was wrong in his analysis: the plan was able to purchase the real estate from the owner's sister without its being termed a prohibited transaction. However, I will agree with Belgarath that if the facts and circumstances indicate that the transaction was done to benefit the sister, it would likely be deemed to be a PT.

[Guest Gompers]

The citations you have referred to are transactions between IRAs and disqualified persons

Just wondering how this makes a difference to the analysis.

I agree it is not a per se PT, but DOL's test is whether the owner had an interest in his sister that would affect his best judgment. In the reg, DOL presumed that the affection for a son would affect a fiduciary's best judgment. Perhaps that presumption would not apply to a sister.

In 88-18A DOL found it likely that a fiduciary's "affection" for a company in which he had a 48% interest would make a loan to that entity (even though the enitty was not a party in interest/disqualifed person)a prohibited transaction. Congress drew the line at 50% for the designation of a party in interest, but DOL did not draw the line there for a 406(b) PT.

Aguments can be made on both sides--but given DOL's view on this I wold hardly call Derrin's reasoning "specious".

[Guest mjb]

The point I am making is that DOL uses the term " any person in whom such fiduciary had an interest that would affect the exercise of his or her best judgement as a fiduciary." They do not limit this to disqualifed persons/parties in interest. In fact they apply it to investment in entities that are not otherwise parties in interest/disqualified persons where the fiduciary has an interest in that entity--for example in 88-18A

They also do not limit this analysis solely to the retention of a service providers, but also apply it to sale lease backs such as in 93-33A or in the case of loans in 88-18A. Now do you understand what you are missing? Of course you can always take comfort in the "DOL is wrong" argument.

IN Advisory opinion 88-18 that you cite a share holder who owned 46%+ of the interest in a corp wanted to have his IRA loan 500k to the corp.

The dol ruling applied two PT provisions to the transaction as a basis for denial, neither of which are applicable in purchasing RE from the IRA owner's sister:

1. IRC4975©(1)(D) prohibits the direct or indirect transfer to, or use by or for the benefit of a disqualified person of the income or assets of a plan. In 88-18 the IRA owner was the DQ person who was using plan assets for his own benefit as a substantial owner of the corp which would borrow money from his IRA. In effect the owner's IRA was loaning money to the owner's corp which was held to be a loan for the benefit of the owner because of his 46% interest in the corp. Since the sister in this fact pattern is not a DQ person there is no PT If the IRA owner transfers plan assets to her in exchange for her title to the RE since he has no interest in the RE (the purchase of the sister's RE benefits the sister not the owner) unlike the situation in 88-18 where the loan to corp would benefit the IRA owner because of his substantial interest in the corp by increasing the value of his interest in the corp.

2. IRC 4975 ©(1)(E) prohibits a fiduciary (IRA owner) from dealing with the assets of the IRA for his own interest or his own account. The DOL concluded that the IRA owner had an substantial interest in the corp which was held in his own personal account which may effect the judgement of owner as a fiduciary of the IRA who would lend money to the corp. In the case discussed above the IRA owner has no interest in the sister's RE that could affect his judgment as a fiduciary in purchasing the property.

As I stated previously the PT provisions can only be applied to Parties in interest/DQ persons and not to other persons, e.g other family members such as siblings. Opinion 88-18 confirms this conclusion.

[Guest Gompers]

The following is from Natalie Choate--I think she has made the same point in ALI-ABA and other materials at her seminars:

http://advisor.morningstar.com/articles/do...4123&pgNo=1

Some advisors believe prohibited transactions can be avoided by dealing only with relatives who are not "disqualified persons" in the code, such as siblings, or with entities where the IRA owner's ownership is below the statutory percentage that would make the entity a disqualified person. That belief is mistaken. The category of prohibited transaction the IRS usually attacks with is the fiduciary's "indirect benefit" or "conflict of interest," for which they do not need to find a "disqualified person" on the other side of the transaction.

In a recent case, a pension plan had done business with some entities in which the business owner (plan fiduciary) owned minority interests. These entities were not "disqualified persons" because the fiduciary's ownership was less than 50%. Thus, he thought that what he was doing was legal, but the court ruled for the IRS: These were prohibited transactions because of the conflict of interest and possible indirect benefit to the fiduciary.

You can get the first 6 pages of Choate's more in depth analysis here:

https://d2d.ali-aba.org/index.cfm?fuseActio...;NAVSUBMODE=928

Unfortunatley you will have to pay ALI-ABA $29 to see the rest where she addresses buying real estate from an IRA owner's sister.

[Guest mjb]

The authority you cite is still discussing hypothetical cases regarding the PT rules when non Party in interest family members are involved. The uncited case she mentions (I would like to see what the facts are) states that the fiduciary had a minority ownership in the business that the plan is dealing with which is different than purchasing property outright from a sibling who is not a DQ person since there is no conflict on behalf of the IRA owner. I would be suprised if there is a case or ruling where the IRS applied the PT rules to an arms length transaction between an IRA and a sibling of the IRA owner because there is no statutory basis for such a holding under the PT rules. The IRS paid the taxpayer's legal fees in the Swanson case because agents improperly applied the rules prohibiting a sale of security between the plan and the fiduciary to a subscription by the IRA to an initial offering which under IRS rules did not constitute a sale of a security.

I also find the statement claiming that an indirect benefit /conflict of interest results from transactions with a sibling which can be attacked by the IRS to be an over the top application of the PT rules in the absence of any tangible benefit to the IRA owner resulting from the purchase of the RE by the IRA from the sibling.

[Ron Snyder]

There is a difference in dealings with a disqualified person (or party in interest) and others under the law. The facts and circumstances would have to be examined to determine that an actual conflict of interest is involved; with a person other than a party in interest, no such conflict can be presumed.

Ms. Choate gives no citation to any DoL Regs or rulings, other than to Temporary IRS Regs entitled: "Statutory exemptions for office space or services and certain transactions involving financial institutions."

The actual quotation from the Temp Regs is: "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. 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."

Both you and Ms. Choate leave out the most important elements of the Reg: (1) it is limited to the cases cited, (2) no service is being provided and (3) no third party consideration is involved.

[Guest Gompers]

Both you and Ms. Choate leave out the most important elements of the Reg: (1) it is limited to the cases cited, (2) no service is being provided and (3) no third party consideration is involved.

What makes you think that these are important factors? What do you mean to the case cited? I think the factors are largely irrelevant.

The "per se" rules with parties in interest are set forth in 406(a). Whether someone is a party in interest is irrelevant to a 406(b) analysis. In fact the words "party in interest" are nowhere in 406(b).

The upshot of DOL's view is that under 406(b) you cannot enter into an arrangement or a contract with someone-- whether it be for services or real estate-- where that individual is a person in which the fiduciary has an interest which may affect the exercise of such fiduciary's best judgment as a fiduciary. Of course the DOL has said that entering into a contract where the fiduciary's son would benefit would violate this rule even if that transaction was exempt under 406(a) (because of a statutory 408(b)(2) exemption). They have said that entering into a contract with a company where the fiduciary has a minority ownership would likely violate 406(b) even though it would not be prohibited under 406(a).

I guess I would say that if a fiduciary wanted to buy real estate from his sister, the fidicuary better be in a position to establish that he neither loved her nor hated her because it would appear that either of these emotions "may" affect his best judgment as a fiduciary.

[Mike Preston]

Derrin's right, unless you want to fight.

That, in itself, should be a fiduciary breach.

I know, I know. We are talking about PT's.

Wouldn't it be icing on the proverbial cake if the DOL marched in and demanded both excise taxes for a PT and removal of the fiduciary due to the breach?

The DOL believes in the domino theory. They feel they can string a series of questionable acts together and paint the principals as rogues. Unless you want to expend that 50k in legal fees (or more and rely on a 50k reimbursement to partially soothe the sting), it makes absolutely no sense for a fiduciary to buy and/or sell from/to a sibling.

Any other advice, without strong cautionary caveats, is malpractice, plain and simple.

Strong letter to follow.

Time to dig out the horror stories, isn't it? Each and every one supports Derrin's position, unless somebody is itching for a fight. Now I know that mjb isn't taking the other side to drum up potential business, although if you find yourself in this sort of predicament he sounds like he would be a fine advocate for your cause, and instead is doing so on a theoretical basis. To h*** with theory, this is the DOL we are talking about.

Recall that just recently, right here on BenefitsLink, an admitted ex-DOL field investigator made it clear that his advice to all of us is to ignore things like the literal wording of both the law and the regulations. Instead, he "knows" (divine intervention?) what the "intent" of the law and the regulations is and, as a field investigator, he was taught to apply that "intent".

This is the mentality you are dealing with when facing the DOL and therefore, unless you want a fight, Derrin is right.

[Ron Snyder]

I don't enjoy disagreeing with Darren Watson or Mike Preston. But I still don't see it your way.

More facts of the case: The fiduciary is one of the investment managers of CALPERS, charged with managing a $2.5 billion real estate portfolio. He locates a a shopping mall for sale through a licensed real estate broker for $6.5 million. On behalf of CALPERS he tenders an offer to S/M Mall, LLC for an amount close to the listing price, which is accepted by S/M. His sister is the manager and controlling owner of S/M Mall, LLC.

Your analysis suggests that this is a PT simply because the plan purchases property from the sister. No showing of any of the elements referred to in the IRS temporary regs. (back-door compensation, leasing between the plan and a disqualified person, ongoing service arrangement, etc.), or any other detriment to the plan or benefit to the LLC.

If you don't claim the foregoing to be a PT, then it is a facts and circumstances test, which I earlier suggested, and we're not really disagreeing at all.

[Guest mjb]

Derrin's right, unless you want to fight.

That, in itself, should be a fiduciary breach.

I know, I know. We are talking about PT's.

Wouldn't it be icing on the proverbial cake if the DOL marched in and demanded both excise taxes for a PT and removal of the fiduciary due to the breach?

The DOL believes in the domino theory. They feel they can string a series of questionable acts together and paint the principals as rogues. Unless you want to expend that 50k in legal fees (or more and rely on a 50k reimbursement to partially soothe the sting), it makes absolutely no sense for a fiduciary to buy and/or sell from/to a sibling.

Any other advice, without strong cautionary caveats, is malpractice, plain and simple.

Strong letter to follow.

Time to dig out the horror stories, isn't it? Each and every one supports Derrin's position, unless somebody is itching for a fight. Now I know that mjb isn't taking the other side to drum up potential business, although if you find yourself in this sort of predicament he sounds like he would be a fine advocate for your cause, and instead is doing so on a theoretical basis. To h*** with theory, this is the DOL we are talking about.

Recall that just recently, right here on BenefitsLink, an admitted ex-DOL field investigator made it clear that his advice to all of us is to ignore things like the literal wording of both the law and the regulations. Instead, he "knows" (divine intervention?) what the "intent" of the law and the regulations is and, as a field investigator, he was taught to apply that "intent".

This is the mentality you are dealing with when facing the DOL and therefore, unless you want a fight, Derrin is right.

MIke:

DOL does not collect tax on PT - IRS asseses tax under the IRC rules which after Swanson IRS is not going to aggressively pursue PT violations which are not clearly defined in 4975 (IRS mistake in Swanson was treating a subscription for an initial offering of stock as a sale which it was not).

Fiduciary breach is DOL responsibilty but only results in liabilty if there is a loss to plan which would not result if plan does not pay more than FMV.

Despite your belief the the DOL is exempt from the laws that apply to other persons, Govt agencies need to folow the rules. Please provide any rulings or cases that have applied PT rules to family members who are not parties in interest such as siblings, inlaws, cousins, step children, etc. How many degrees of sepraation are required?

Finally if these transactions are not reported as PTs on the 5500s, because they do not fall under the definition of a PT how will there be any discovery other than by audit?

[Mike Preston]

veba, the facts you posit would, in my mind, be highly suspect. My guess is that CALPERS has rules that would preclude such transactions. At least they should. That is the classic circumstance where there should be concern. At the least, the CALPERS individual should engage an independent fiduciary to analyze the transaction.

Assuming the transaction went forward as indicated, I would expect the DOL, should it end up running into the issue, to object and demand it be "fixed". That means an independent analysis with any loss to the plan being restored or undoing the entire transaction.

At the least I would think it shows bad business judgement to have gone down that road without appropriate fiduciary protection.

[Mike Preston]

mjb, I don't disagree with anything that you have said. Except that on a practical level, the DOL makes life hell for those it investigates and people should be told that fact before they decide on a course of action.

Whether the risk is limited to disclosure upon audit or not is beside the point. If you end up in their cross-hairs it matters not how you got there.

[Ron Snyder]

Your analysis seems to have morphed from PT to breach of fiduciary duty and violation of Calpers rules, irrelevant to the PT issue. Certainly a breach of fiduciary duty or actual conflict of interest could give rise to fiduciary liability. But a non-PT doesn't become a PT automatically simply a related non-disqualified person is involved. The IRS Temporary Regs give examples of what additional facts and circumstance would give rise to PT treatment.

[Mike Preston]

No argument there.

I agree that a transaction as you describe is potentially not a problem (or, as you put it, not automatically a problem merely because of the familial relationship). However, the likelihood of it being a problem seems greater to me than the likelihood of it not being a problem.

Yes, I have roped into my argument in favor of advising against the course of action the issues that I think are relevant and have not limited myself to just the PT issue.

[Guest Gompers]

Sounds like a PT to me if we were dealing with a plan governed by ERISA. The fact that a deal is fair, reasonable, and entered into in perfectly good faith does not prevent a 406(b) PT from arising. The fact that the fiduciary's interest is non-financial does not prevent a 406(b) PT from arising. The standard applied by DOL, IRS and the Courts is whether you are entering into a transaction with a person that "may affect the exercise of the best judgment of the fiduciary." I think you are taking a MIGHTY big chance in arguing that a sister does not fall under this category. Although I have not cite checked these cases, you might want to look at.....

330 F.Supp.2d 236, LaScala v. Scrufari, (W.D.N.Y. 2004)

------------ Excerpt from pages 330 F.Supp.2d 253-330 F.Supp.2d 254

As set forth above, section 406(b)(1) prohibits fiduciaries from "deal [ing] with the assets of the plan in [their] own interest or for [their] own account." > 29 U.S.C. § 1106(b)(1). This prohibition imposes on fiduciaries "a duty of undivided loyalty to the plans for which they act ...," so as to deter them from using their authority to engage in transactions "which may affect the exercise of their best judgment as fiduciaries." > Gilliam v. Edwards, 492 F.Supp. at 1262-63 (quoting > 29 C.F.R. § 2550.408b-2(e)(1)). Section 406(b)(1) "creates a per se ERISA violation; even in the absence of bad faith, or in the presence of a fair and reasonable transaction,

816 F.Supp. 138, New York State Teamsters Council Health and Hosp. Fund v. Estate of DePerno, (N.D.N.Y. 1993)

------------ Excerpt from page 816 F.Supp. 147

> [4] Therefore, a violation of ERISA § 406(b)(1) (29 U.S.C. § 1106(b)(1)) occurs whenever a fiduciary deals with the assets of a plan in his own interest, Id., and a financial loss to the fund is not required. > Brock v. Hendershott, 840 F.2d 339 (6th Cir.1988). In addition, in > Leigh v. Engle, 727 F.2d 113, 126 (7th Cir.1984), the court stated that "n light of ERISA's broad language and protective provisions, ... we should read broadly the term 'interest' in Section 406(b)(1)." > 727 F.2d at 127 (cited in > Lowen, 829 F.2d at 1213). The court quoted with approval the following law review commentary:

The absence of a direct financial interest in the transaction, however, should not preclude the application of this section to officer-trustees, as the prohibited transaction rules are designed to prevent the use of plan assets for any interest, financial or nonfinancial, other than an interest of the plan and its beneficiaries.

Id.; quoting Note, The Duties of Employee Benefit Plan Trustees Under ERISA in Hostile Tender Offers, 82 Colum.L.Rev. 1692, 1703 n. 51 (1982).

[Guest mjb]

Sounds like a PT to me if we were dealing with a plan governed by ERISA. The fact that a deal is fair, reasonable, and entered into in perfectly good faith does not prevent a 406(b) PT from arising. The fact that the fiduciary's interest is non-financial does not prevent a 406(b) PT from arising. The standard applied by DOL, IRS and the Courts is whether you are entering into a transaction with a person that "may affect the exercise of the best judgment of the fiduciary." I think you are taking a MIGHTY big chance in arguing that a sister does not fall under this category. Although I have not cite checked these cases, you might want to look at.....

330 F.Supp.2d 236, LaScala v. Scrufari, (W.D.N.Y. 2004)

------------ Excerpt from pages 330 F.Supp.2d 253-330 F.Supp.2d 254

As set forth above, section 406(b)(1) prohibits fiduciaries from "deal [ing] with the assets of the plan in [their] own interest or for [their] own account." > 29 U.S.C. § 1106(b)(1). This prohibition imposes on fiduciaries "a duty of undivided loyalty to the plans for which they act ...," so as to deter them from using their authority to engage in transactions "which may affect the exercise of their best judgment as fiduciaries." > Gilliam v. Edwards, 492 F.Supp. at 1262-63 (quoting > 29 C.F.R. § 2550.408b-2(e)(1)). Section 406(b)(1) "creates a per se ERISA violation; even in the absence of bad faith, or in the presence of a fair and reasonable transaction,

816 F.Supp. 138, New York State Teamsters Council Health and Hosp. Fund v. Estate of DePerno, (N.D.N.Y. 1993)

------------ Excerpt from page 816 F.Supp. 147

> [4] Therefore, a violation of ERISA § 406(b)(1) (29 U.S.C. § 1106(b)(1)) occurs whenever a fiduciary deals with the assets of a plan in his own interest, Id., and a financial loss to the fund is not required. > Brock v. Hendershott, 840 F.2d 339 (6th Cir.1988). In addition, in > Leigh v. Engle, 727 F.2d 113, 126 (7th Cir.1984), the court stated that "n light of ERISA's broad language and protective provisions, ... we should read broadly the term 'interest' in Section 406(b)(1)." > 727 F.2d at 127 (cited in > Lowen, 829 F.2d at 1213). The court quoted with approval the following law review commentary:

The absence of a direct financial interest in the transaction, however, should not preclude the application of this section to officer-trustees, as the prohibited transaction rules are designed to prevent the use of plan assets for any interest, financial or nonfinancial, other than an interest of the plan and its beneficiaries.

Id.; quoting Note, The Duties of Employee Benefit Plan Trustees Under ERISA in Hostile Tender Offers, 82 Colum.L.Rev. 1692, 1703 n. 51 (1982).

How do any of the previous quotes address the three main issues that have been discussed:

1. the sister is not a party in interest who triggers a PT if the plan purchases property from her.

2. the fiduciary is not dealing with plan assets for his own interest as defined in ERISA 406(b)(1) since the fid does not have any interest in the RE owned by his sister and only the sister's interest benefits from the purchase of the property (which is different from a fid who loans IRA assets to a corp in which he has an interest of 46%).

3. the plan pays no more than reasonable comp and (thus no loss is incurred by the plan in acquiring the assets,) since the purchase of the property at FMV is in the interest of the plan and not another party

[Mike Preston]

Time to step back and evaluate.

I think the fact that we are dealing with a "sister" here is a red herring. We could be dealing with a 3rd cousin twice removed. The issue would still be the same. If the fiduciary is perceived to have dealt with the assets in a way that could potentially benefit the fiduciary, then a violation has taken place. Actually, quoting the law is really a good thing here (which I didn't do above), and I won't do here because it has already been cited by others. If it can be claimed that the fiduciary's judgement MIGHT have been impacted by the "benefits" the fiduciary MIGHT receive, that is all that is really necessary for the DOL or IRS to prevail, IMO. In the case of a sister, it is very difficult to argue that some benefit would not inure to the fiduciary by causing the transaction to consummate. In the case of a 3rd cousin twice removed quite a bit more difficult. The key here is that the standard is "who will convince the judge or jury when all is said and done". mjb has quoted one case where the fiduciary was successful, one might say spectacularly successful, in convincing the court that there was no PT. The question is, with respect to any transaction not yet entered into: do you feel lucky?

[Guest mjb]

The client prevailed in swanson not because he was lucky but because there was no statutory basis for a PT, which is the same reason as there is no statutory basis to hold that a transaction with a sibling is a PT. In order to prevail on other grounds the regulator would have to demonstrate what benefit the plan fid would receive from the sale of the land for his own account, (outside of the plan). By the way the taxpayer in swanson did not have to convince the ct that there was no PT- The IRS admitted there was no PT before the judge decided the case. The Judge's only role was to impose the 50k award against the IRS. I am still waiting for a case or ruling that determined a PT /fid breach occurred because the plan fid purchased a plan asset from a sibling other family member who was not a party in interest.

[rcline46]

Why is everyone running around grasping at straws? It would be a much simpler solution to directly ask Ms. Choate or Mr. Watson what their reasoning is for making such statement!

Ms. Choate? Mr. Watson? Any pearls of wisdom you can impart unto us?

[Guest Gompers]

1

. the sister is not a party in interest who triggers a PT if the plan purchases property from her.

Whether the sister is a party in interest is irrelevant to a 406(b) analysis. Party in interest is not a term used used in 406(b).

2

. the fiduciary is not dealing with plan assets for his own interest as defined in ERISA 406(b)(1) since the fid does not have any interest in the RE owned by his sister and only the sister's interest benefits from the purchase of the property (which is different from a fid who loans IRA assets to a corp in which he has an interest of 46%).

The issue is whether he has an interest in his sister that would affect his judgment, not whether he has an existing interest in the asset being purchased. In the DOL reg quoted very early in this thread DOL made it clear that entering into a transaction where a fiduciary's son stood to benefit would be a 406(b) PT. This is not becasue the son is a party in interest--as noted above party in interest is not mentioned in 406(b). It is because the fact that the individual is the fiduciary's son may affect the fiduciary's best judgment as a fiduciary. As one of the cases above notes, the absence of a finanical interest by the fiduciary does not preclude a 406(b) PT. Any competing interest, financial or non-financial is sufficient to create the PT. As DOL notes in 2550.408b-2(e):

The prohibitions of section 406(b) supplement the other prohibitions of section 406(a) of the Act by imposing on parties in interest who are fiduciaries a duty of undivided loyalty to the plans for which they act. These prohibitions are imposed upon fiduciaries to deter them from exercising the authority, control, or responsibility which makes such persons fiduciaries when they have interests which may conflict with the interests of the plans for which they act. In such cases, the fiduciaries have interests in the transactions which may affect the exercise of their best judgment as fiduciaries

3. the plan pays no more than reasonable comp and (thus no loss is incurred by the plan in acquiring the assets,) since the purchase of the property at FMV is in the interest of the plan and not another party

As the cases above note, whether a transaction is made in good faith or is a good deal is irrelevant to a 406(b) PT.

I agree with Mike Preston's point. You are looking at a question of degree. But, I would think sister is far too close for any well advised fiduciary. The solution, if there are other fiduciaries, is for them to cause the Plan to enter into the transaction with the conflicted fiduciary abstaining and not participating or influencing the process in any way.

[Ron Snyder]

Good point, Mike. We're not so far apart after all, especially compared to mjb and Gompers (Bonkers).

rcline - Ms. Choate doesn't post here. I believe that Darrin Watson comes on the board from time to time, but he keeps plenty busy with his work.

[Guest Gompers]

No, not so far apart at all...

Vebaguru:

Does anyone agree with Mr. Watson's specious reasoning?

Mike Preston:

Derrin's right, unless you want to fight.

[Guest Derrin Watson]

Good point, Mike. We're not so far apart after all, especially compared to mjb and Gompers (Bonkers).

rcline - Ms. Choate doesn't post here. I believe that Darrin Watson comes on the board from time to time, but he keeps plenty busy with his work.

Yes, but at the request of two friends I will drop in to comment. I do generally limit my comments to my Who's the Employer column.

Context: The presentation was not a technical presentation designed for industry professionals. That is not how it was described, not what I was asked to give, and not how it was prepared. This was designed as a presentation of fiduciary basics for employers. In that context, I gave the example of Joe acting as president of his company and trustee of its plan. His sister, Suzy, is eager to sell a piece of property. Therefore, Joe has it appraised and has the plan buy it for FMV. In my mind, the driving factor for the transaction is helping the Trustee's sister, and I have no hesitation in saying that certainly looks like dealing "with the assets of the plan in his own interest or for his own account."

These are powerpoint slides in a brief presentation for nonprofessionals. I chose not to go into the details of ERISA 406(b), although that's what the slide concerns. Here's the first bullet on the slide: "A fiduciary may not cause a plan to engage in a transaction which causes the fiduciary to receive additional consideration or where the fiduciary deals with plan assets in his/her own interest." That's a pretty clear reference to 406(b). I never made the "specious" argument that the sister is a party in interest.

If an employer really wants to engage in such a transaction, I think virtually everyone here would hope that they would consult with a professional first. Perhaps, viewing the facts of the actual situation, rather than a cooked up quickie hypothetical, the professional may find that it is not a prohibited transaction or a fiduciary breach. Wonderful. Hopefully that conclusion will be in writing and backed up with malpractice insurance. But my purpose was to stop employers from rushing ahead into ill advised transactions simply because one of the parties may not be a party-in-interest.

[rcline46]

Thank you Derrin.

[KJohnson]

See pages 8-9 of this article from Groom that talks about transations with non-disqualified persons (such as brothers or sisters) where the fiduciary may still have a personal interest and the PT implications (in the IRA context).

http://www.groom.com/documents/IRAMythArticle5.12.09_000.pdf