California opinion requires collateralization of 457 plan assets.

[Guest RK Matta]

On August 2, 2000, the California Attorney General issued Opinion No. 00-204 to the California Department of Financial Institutions regarding California 457 plans, though it may have implications for 401(a) plans and may serve as a precedent in other states. The conclusion is both puzzling and troubling, and will directly impact any bank or trust company holding custody of California 457 plan assets. Indirectly, it could have a significant (adverse) cost impact on California plans.

The opinion states, in essence, that a bank or trust company holding assets in trust for a 457 plan must pledge collateral against the bank's insolvency, bankruptcy, etc. By way of background, state governments (and, I believe, the Treasury Department) require that state assets placed on deposit with private banking institutions must be protected via a pledge of securities (based on a legal list). In other words, unlike most depositors, a governmental entity becomes a secured creditor of the bank. Banks agree to this b/c of the huge amounts of $$ involved. But, this is usually thought of as applying to commercial accounts, not trust accounts.

In California, it appears that the amount required to be pledged ranges from 105% to 150% of the value of the assets on deposit, depending on the types of assets pledged. Moreover, the pledged assets (1) must be held by a California-based institution and (2) generally are limited to certain low-risk/low return securities. In other words, for every $1 held in trust, the bank may have to have up to $2.50 in assets set aside.

Am I missing something here? Aren't trust assets in effect already fully secured against the bank's general creditors?

Perhaps worse, as the main point of the legislation is to ensure the return of principal, does this in effect turn every California 457 trust into a form of synthetic BIC, with the bank required to guarantee against loss of principal?

Finally, note that logic of the AG's opinion would appear to apply equally to 401(a) and other trusts.

[pjkoehler]

I haven't read the AG's opinion, but I suspect it's focus is on protecting the pension assets of California public agencies, which, of course, aren't protected by ERISA's plan asset requirements. Do you think that the opinion is broad enough to authorize local district attorneys to bring civil actions against banks and trust companies that hold the assets of ERISA plans? Another way of asking this question is: do think that the AG really intends to take on the entire insurance and banking industries that are responsible for managing pension assets of California private sector employers? (For some reason, I doubt the AG intended to embark on such a dubious venture.) But, I can see that he may have a ligitimate public policy concern about protecting the pension assets of California public agencies in view of the recent changes to Code Sec. 457 that mandate that pension assets of governmental plans be held in trust. There has undoubtedly been a tremendous shift of plan assets from the public agencies to the banks and trust companies as a result of this change in federal tax law. I suspect this is really all his opinion is meant to address. Of course, you may be right that the language of the opinion is ambiguous and he should narrow its scope.

[Guest RK Matta]

The law appears to work by prohibiting a governmental entity from contracting with a bank unless the bank by contract agrees to comply with the requirements. But, it is a bit unclear, as some of the statutory provisions are styled as applying directly to the bank. Would they even have jurisdiction over a non-resident bank except via a contract claim?

As for the intent, the opinion itself points to Orange County, etc. But, the point is that common law trust obligations should provide substantially greater protection, without posting collateral, than is the case with a commercial deposit account.

[Carol V. Calhoun]

Thanks for posting this, Rick--and glad to see you found this board!

For anyone interested in reading the California Attorney General's opinion, you can click here to see it. (If you don't already have the Adobe Acrobat reader, a free download, you'll need it to read or print this document.)

[pjkoehler]

As I read this opinion, all the AG is saying is that under prior version of Code Section 457, public agencies were not permitted to hold plan assets in trust. Since the general assets of the public agency in the form cash and other depository accounts at a commercial bank were already covered by the pledged collateral requirement set forth in Cal. Gov. C. Sections 53635 and 53652, this meant that under prior law, these funds had this protection. The opinion merely maintains this protection over these funds by extending the scope of the state law requirement over the assets held in a trust that is maintained in compliance with the new version of Code Sec. 457. This seems perfectly understandable from a public policy perspective. Why should the imposition of the trust requirement for federal tax law purposes, which was meant to enhance the benefit security of public sector plan participants, actually erode those protections? The opinion can be read as merely saying that, for purposes of the pledged collateral requirement, the assets of the trust will be treated as assets of the public agency.