The Department of Labor’s Employee Benefits Security Administration in late July announced a proposed amendment to the Class Prohibited Transaction Exemption 84-14.
The PTE is commonly known as the “qualified professional asset manager exemption,” and its basic purpose is to permit various parties who are related to retirement plans covered by the Employee Retirement Income Security Act’s fiduciary provisions to engage in otherwise-barred transactions involving retirement plans and individual retirement account assets. To satisfy the QPAM exemption, the assets in question must be managed by QPAMs that are “independent of the parties in interest” to the plan and that meet specified financial standards, among other conditions.
The proposed amendment includes a number of important changes. As summarized in an EBSA press release, the amendment would better protect plans and their participants and beneficiaries by, among other changes, addressing what EBSA calls “perceived ambiguity” as to whether foreign criminal convictions are included in the scope of the exemption’s ineligibility provision. The amendment further expands the ineligibility provision to include additional types of serious misconduct. Other provisions focus on mitigating potential costs and disruptions to plans and IRAs when a QPAM becomes ineligible due to a conviction or other serious misconduct.
Other changes the amendments would make include an update of the asset management and equity thresholds in the actual definition of “qualified professional asset manager” and the addition of a standard recordkeeping requirement that the exemption currently lacks. Finally, the amendment seeks to clarify the requisite independence and control that a QPAM must have with respect to investment decisions and transactions.
A Surprise Proposal
Speaking with PLANSPONSOR about the implications of the amendment, Carol McClarnon, a partner on the tax group of Eversheds Sutherland, calls it “unexpected and worrying.”
“In its press release announcing the proposal, the DOL named six objectives of the proposed changes,” McClarnon says. “On their face, these objectives would appear to be sensible clarifications. However, the actual conditions being proposed to attain these objectives reveal that the proposal would add significant costs and liability exposure to managers, perhaps even limiting the QPAM exemption as a viable solution.”
As McClarnon observes, before the proposal’s publication last week, the common perception among regulatory experts in the retirement plan industry was that the DOL was unlikely to direct EBSA to take an action like this, as the DOL’s key sub-agency is still operating without a Senate-confirmed head.
“The perception has been that EBSA has put a lot on hold,” McClarnon says. “We did know that the QPAM issue was on EBSA’s radar, but I think it is fair to say that few people expected to see a proposal as ambitious as this to come out right now. Frankly, I was pretty amazed to see this proposal come out.”
A Fundamental Exemption
McClarnon says the QPAM exemption is of fundamental importance to the operation of the modern retirement plan system. This is because so many plans invest in pooled funds and group-style investments with other plans and third parties, and because of the way ERISA defines and treats “parties in interest” to retirement plans or other institutional investors subject to ERISA’s fiduciary provisions. Any party in interest to a given retirement plan may be prohibited from entering into certain transactions with that plan if the transaction will result in additional compensation going to the party in interest, McClarnon notes.
Parties in interest may include, among others, fiduciaries or employees of the plan, any person who provides services to the plan, an employer whose employees are covered by the plan, an employee organization whose members are covered by the plan, a person who owns 50% or more of such an employer or employee organization, or relatives of such persons.
McClarnon explains that certain plan transactions with parties in interest are prohibited under ERISA and are required, without regard to their materiality, to be disclosed in the plan’s annual report to the DOL.
“In practice, the QPAM exemption is used very commonly and for a variety of different purposes,” McClarnon says. “Just imagine if you had, say, 1,000 ERISA-covered retirement plans invested in a given fund. Each of those plans will have a ton of parties in interest. In the most basic terms, what the QPAM exemption does is state that, if you as the asset manager meet the regulatory qualifications, most transactions with these parties of interest in the plan are OK. The new proposal addresses the qualifications in a meaningful way.”
A Burdensome Proposal
Based on her initial reading and discussions with colleagues, McClarnon says the proposal appears to be “so burdensome that it could almost be said to essentially change the availability of the QPAM exemption.” She points out that, in the nearly four decades since the QPAM exemption framework was first established, the financial services world has become far more interconnected.
“In today’s industry, you just have a lot more complexity, with larger conglomerates and highly sophisticated international entities that do business with U.S. retirement plans,” McClarnon says. “The proposed framework, if it is not adjusted after the comment period, will make it very difficult for these types of entities to reliably and efficiently use the QPAM exemption, in my opinion.”
As an example, McClarnon points to the provision in the proposal that declares that the entrance of a QPAM-affiliated person into a non-prosecution agreement will trigger the ineligibility restrictions.
“To me, that’s concerning, because you do not generally speaking admit criminal wrongdoing when entering into such an agreement,” McClarnon says. “There is also a new concept and condition that they have called ‘integrity.’ The proposal says that the DOL can disqualify an entity from using the QPAM exemption based on their own internal examination process and the determination that a QPAM exemption user has not acted with integrity, which they define in the proposal by using various examples and stipulations. In my opinion, there is very little due process recourse for an entity that finds itself in this situation.”
McClarnon says she is perhaps most troubled by the provision in the proposal that seeks to isolate retirement plans from harm if a service provider they work with has its QPAM exemption revoked by EBSA. One must consider the potential consequences of such a framework, she says.
“They don’t want to cause hardships on the plans in cases of disqualification, which makes sense,” McClarnon says. “However, the proposal seems to require that the investment manager sign a written agreement where they declare that, if there is a criminal finding or the ineligibility provision is triggered for some other reason, the QPAM itself has to pick up the full cost of helping the plan make a transition to a new investment. Just imagine the potential cost of this if we are taking about a mega-sized retirement plan or group of plans.”
What Comes Next
McClarnon emphasizes that she understands the DOL and EBSA have a critical job to do in protecting retirement plans and their participants. However, she expects the investment community to respond forcefully to this proposal, and that the comment period could help EBSA constructively refine the proposal.
“The potential for unintended consequences here is so significant,” McClarnon says. “The exemption serves a critical purpose in the current retirement plan system. It is meant to allow plans to be able to invest in things that would otherwise have technical prohibited transaction restrictions on them that do not actually relate to potential operational conflicts of interest. If the proposal is not refined, you could see investment providers not wanting to take on this type of exposure.”
The one element of the proposal she would most want to see changed, McClarnon says, is the contractual requirement related to the QPAM covering the full expense of a fund transition on behalf of a plan.
“I really don’t like the forced contractual requirement,” McClarnon says. “I don’t think EBSA should be telling people these contracts have to be set. I also want to point out that, yes, a giant financial services company may be able to figure out how to make this new framework work, and they may even have the scale and resources to meet the hold-harmless provisions. But a lot of small advisers use this exemption all the time, and in fact it is baked into many standard operating agreements used by all different parties in the industry. It is very common in all kinds of collective investment trust agreements, for example, and we know these investments are becoming more popular. There are just so many traps for the unwitting and the unwary in all this.”
« Helping Employees Prepare for Current and Future Health Care Costs