Bank Plans/ Fees/ Fiduciary Question

[IRC401]

Suppose that a 401(a) plan of a bank invests the plan's assets through the bank's trust department. The DoL will take the position that the bank may charge "direct expenses" to the trust but not its standard trust fees. (If a customer walked in off the street with a trust account identical in size to the 401(a) plan, the bank may not charge its standard asset based money management fee.)

Why is the result any different for mutual funds? I keep reading articles (For example, see the Reish & Luftman law firm article on the First Union litigation.) That bank's plans invest through the bank's mutual funds and the bank receives asset-based money mangement fees from the plan.

If a bank is not permitted to keep an asset based fee when its trust department manages the money, why is it able to keep the fee when its mutual fund operation manages the money? [Edited by Dave Baker on 08-06-2000 at 10:50 PM]

[Guest Kim C]

I think the difference is the classification of the fee. Banks may charge Investment Mgmt Fees, Investment Advisor fees, etc if they are truly money managing. If they are not, and using the trust account as a vehicle for the purchase of mutual funds, they charge a Trustee/Custodian fee. They cannot keep any 12b1's so they usually pass that onto the trust or current invoices. IMO.

[Kirk Maldonado]

Kim C:

Why would the bank be precluded from keeping any 12b-1 fees?

[Guest Kim C]

In my previous life, I worked at a bank in the Trust division and according to them, keeping 12b1's was not allowed due to licensin issues, NASD, etc. Therefore, they passed on the 12b1's to the clients and offset their fees accordingly. The same rules apply to insurance companies, but the actual legal reason why is not something that stayed in my memory.

[Guest Kim C]

Here's something I found on this site:

Fiduciary Investing Q&A

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Managing 12b-1 Fees

(Posted March 31, 1999)

Question 1: Does an ERISA fiduciary who invests plan assets in mutual funds with 12b-1 fees cause a prohibited transaction? Does the fiduciary's receipt of sub transfer-agent (shareholder services) fees cause a prohibited transaction? Can a fiduciary be paid some or all of the 12b-1 fees to cover its expenses in connection with an investment program?

Answer: There is no prohibition against a fiduciary investing in mutual funds with 12b-1 fees. Indeed, it is done every day by thousands of plans.

Whether or not the decision to use funds with 12b-1 fees instead of ones without this "marketing" expense is prudent is another matter.

What presents a clear problem, however, is the payment to the fiduciary from the plan's trust fund of some or all of the 12b-1 fees or sub transfer-agent fees. Commissions and expenses paid by a plan's trust fund are plan assets and must be handled by the fiduciary in the same fashion as the investments themselves.

The conventional, and we believe proper, way of using 12b-1 fees or sub transfer-agent moneys to cover costs of operating a plan is to have the expenses in question paid by the plan. Then measures can be taken to have a rebate paid to the plan (not to the fiduciaries) which, in turn, can be allocated to offset operational charges.

[IRC401]

I want to clarify my question. I am not asking about fees that banks charge to plans sponsored by unrelated entities. I am inquiring about fees that a bank's plan pays to the bank (via mutual funds owned by the bank).

If the Bank chooses to invest its plan's funds in its own mutual funds and is making a profit off of those funds, it certain appears to be using its fiduciary position to its own advantage, and that looks like a prohibited transaction.

Are banks (such as Bank of America and First Union) hiring independent fiduciaries to make the decision to invest in the bank's mutual funds (or am I missing something)?

[Kirk Maldonado]

IRC401:

I will be the first to admit that I'm not much of an expert on these matters.

Nevertheless, I have had a number of clients over the years whose plans have invested in bank common trust funds. In fact, I seem to recall that an equity fund that Wells Fargo Bank sponsored for qualified plans was one of the biggest funds in the world (at one point in time).

However, these bank-sponsored funds have lost their popularity as mutual funds became more popular. That is sad, because the fees charged on the common trust funds are only a small portion of the fees charged by mutual funds. (The difference, I've been told, is principally because the common trust funds aren't registered with the SEC, like mutual funds, and the bank common trust funds don't pay 12b-1 fees, which function somewhat like commissions.)

If someone else has a more informed opinion on this point, I'd love to hear it.

[pjkoehler]

A plan's purchase or sale of an interest in a collective trust fund maintained by a bank that is a party in interest with respect to the plan is exempt under ERISA Sec. 408(B)(8) if the bank receives no more than "reasonable compensation" and the transaction is expressly permitted by the plan document or approved by an independent fiduciary with the discretionary authority over plan assets. For exemptive relief regarding mutual fund transactions, between plans that cover employees of the mutual fund, its investment advisor or principal underwriter, or an affiliate, and when a plan fiduciary is also the investment advisor, you have to look to PTCE 77-3 and 77-4 respectively. [Edited by PJK on 08-10-2000 at 08:14 PM]

[Jon Chambers]

In addressing why banks face fewer compliance issues when investing their own plan assets in mutual funds, as opposed to investing in separately managed accounts, PJK makes appropriate reference to PTCE 77-3 and 77-4. These exemptions generally permit financial services firms to invest in their own mutual funds, provided that the funds are offered on the best commercially available terms. Kirk, you may be pleased to note that similar exemptions apply to collective trust funds. However, since separately managed accounts typically have negotiated fees, it's impossible to know what the best commercially available terms are, hence the lack of a PT exemption.

PT issues also drive one of the main problems with trustees receiving 12(B)1 fees (other issues have to do with NASD licensing, which aren't relevant to ERISA fiduciary conduct). It only applies when trustees provide investment advice (which they may do indirectly through the range of funds offered). The DOL spells out the issues pretty clearly in the "Frost" Advisory opinion letter 97-15A. Generally, the trustee can't use 12(B)1's to increase revenue, and the arrangement must be fully disclosed to the client.

[Guest Richard Tennenbaum]

I recognize this thread is 10 years old, but I have had this question come up a few times recently. Specifically, the question relates to the collection by a bank of a service fee on assets of its own plan held by the bank's trust company. I don't see any way in which this wouldnt' be a PT under 406 and I don't see an exemption that is on point. For example, Anytown Community Bank also has a trust company and a brokerage service. The trust company holds ACB's 401(k) and provides administrative services to the plan via an internal service agreement. The agreement calls for payment of direct expenses and a "service fee" which is 15 basis pts annually.

I believe under 2550.408b-2, the direct expenses are ok, but the service fee is forbidden (see generally, advisory opinion 79-49).

Am I missing something? I don't believe that 77-3 would apply here.