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Home > Library > Stable Times > Volume 3, Issue 2
The quarterly publication of the Stable Value Investment Association
Second Quarter 1999 • Volume 3 Issue 2
Consolidation of the Financial Services Industry: ERISA Implications
By Donald J. Myers, Partner, Reed Smith Shaw & McClay LLP
The past 10-15 years have witnessed significant consolidation in the financial
services industry. In addition, firms in one segment of the industry that
were once restricted from other segments are now able to branch out into
new areas, due to changes in their governing laws at the legislative or
regulatory levels.
One of the laws that requires attention in connection with these changes
is the Employee Retirement Income Security Act of 1974 (ERISA), the federal
statute governing the management and administration of private employee
benefit plans. The fiduciary responsibility provisions of ERISA include
a series of "prohibited transaction" rules, which restrict the
ability of a plan fiduciary to engage in certain activities.
These rules prohibit two basic types of transactions. First, they prohibit
transactions with persons who have various relationships to the plan,
including plan fiduciaries, other plan service providers, the plan sponsor,
and affiliates of these persons -- so-called "parties in interest."
Second, they prohibit fiduciaries from engaging in self-dealing and conflicts
of interest. Disregarding the prohibited transaction implications in a
merger or consolidation can result in significant liabilities if prohibited
transactions are later discovered. These include liabilities for any losses
suffered by affected plans, liabilities for any benefits to the plan fiduciary
and its affiliates as a result of the transaction, and possible excise
taxes and civil penalties. The U.S. Department of Labor can grant class
and individual exemptions from these restrictions, and a large number
of exemptions have been sought and granted over the past 25 years since
ERISA was enacted.
Some examples of the types of prohibited transaction issues that can arise
are the following:
- An investment management firm
managing an account for a plan, or a commingled fund in which the plan
is an investor (such as an insurance company separate account or bank
collective investment fund), may buy and sell fixed-income securities
with an unaffiliated broker-dealer in principal transactions. The broker-dealer
may provide other services to the plan and thus be a "party in
interest" to that plan. While buying and selling securities with
a party in interest is prohibited under ERISA, the transactions are
covered by a class exemption for principal transactions, PTE 75-1. The
transactions also may be covered by specific exemptions for particular
types of collective pools -- PTE 90-1 for insurance company separate
accounts or PTE 91-38 for bank collective investment funds.
However, if the investment
manager and the broker-dealer become affiliates, these exemptions
will no longer be available, since they do not apply if the party
in interest is related to the manager. As a result, the investment
manager may not be able to conduct principal trades through the now-affiliated
broker-dealer.
- Investment managers often purchase
securities in public offerings. If an affiliate of the investment manager
is a member of the underwriting syndicate, the Department of Labor says
that the purchase from the syndicate could be a prohibited transaction.
PTE 75-1, the class exemption covering principal transactions mentioned
above, also provides relief for purchases from an underwriting syndicate
where a syndicate member is affiliated with the plan's investment manager.
However, PTE 75-1 is not available if the affiliated syndicate member
is a lead or co-"manager" of the syndicate.
The effect of consolidation
and regulatory change is particularly noticeable in this area. Investment
managers are becoming affiliated with broker-dealers who engage in
securities underwriting. This is the result of regulatory changes
that allow securities affiliates of banks to engage in underwritings,
as well as the result of mergers and acquisitions. At the same time,
a smaller number of broker-dealers are involved in underwritings and
those firms increasingly serve as syndicate manager. As a result,
PTE 75-1 may not be available for number of underwritings. The effect
is that investment opportunities can be foreclosed and the risk of
a prohibited transaction is increased.
- Many insurance companies sell
insurance contracts to plans under PTE 84-24. This is a class exemption
from most of the prohibited transaction provisions to cover situations
where the insurance company may be a fiduciary because it provides "investment
advice" to the plan. However, PTE 84-24 is not available for a
sale to a plan if the insurance company is affiliated with a plan trustee
who has investment discretion. If such a relationship comes about through
a merger or acquisition, PTE 84-24 may no longer be available. For future
sales to the plan, the insurance company must either seek an individual
exemption or restructure its operations to avoid potential prohibited
transaction problems.
- A class exemption that many
firms rely upon to avoid party in interest prohibited transactions is
PTE 84-14, the "QPAM" ("qualified professional asset
manager") exemption. It provides general relief for a plan portfolio
managed by a bank, insurance company or registered investment adviser
who meets certain requirements. One of these requirements is that the
QPAM and certain affiliates and owners not have been convicted within
the prior 10 years of certain types of felonies or other crimes.
As companies consolidate,
an investment management firm may become affiliated with a company
convicted of crimes that might appear to have no relevance to the
management firm's retirement plan business. However, those crimes
could result in the QPAM exemption becoming unavailable. Many firms
have had to seek individual exemptions from the Department of Labor
because of such problems.
These ERISA problems could affect the potential benefits of a consolidation
transaction. Companies considering such transactions, and their advisors,
should take potential prohibited transactions into account in evaluating
the consequences of consolidating their businesses, and whether any restructurings
of business operations or Department of Labor exemptions may be necessary.
These steps, taken early, should avoid potentially serious liability problems
(and resulting business relation problems) in the future.
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