Prohibited Transaction Exemption 86-128
Class Exemption for Securities Transactions Involving Employee Benefit Plans and Broker-Dealers
AGENCY: Department of Labor.
ACTION: Grant of class exemption.
SUMMARY: This document contains an exemption which allows persons who serve as fiduciaries for employee benefit plans to effect or execute securities transactions under certain circumstances. The exemption also allows sponsors of pooled separate accounts and other pooled investment funds to use their affiliates to effect or execute securities transactions for such accounts when certain conditions are met. The exemption will replace Prohibited Transaction Exemption 79-1 and Prohibited Transaction Exemption 84-46. It affects participants and beneficiaries of, and fiduciaries with respect to, employee benefit plans which invest in securities, and other persons who engage in the described transactions.
EFFECTIVE DATE: The later of December 18, 1986, or the date on which the Office of Management and Budget approves the information collection requests contained in this exemption under the Paperwork Reduction Act of 1980.
FOR FURTHER INFORMATION CONTACT: Daniel J. Maguire, Esq. Plan Benefits Security Division, Office of the Solicitor, U.S. Department of Labor, Washington, DC 20210, (202) 523-9595 (not a toll-free number) or Mark Greenstein, Office of Regulations and Interpretations, Pension and Welfare Benefits Administration, (202) 523-8671 (not a toll-free number).
SUPPLEMENTARY INFORMATION: On January 24, 1985, notice was published in the Federal Register (50 FR 3427) of the pendency before the Department of Labor (the Department) of a proposed  class exemption to replace PTE 79-1(1) and PTE 84-46(2) which exempted certain transactions from the restrictions of section 406 of the Employee Retirement Income Security Act of 1974 (ERISA or the Act) and from the taxes imposed by section 4975(a) and (b) of the Internal Revenue Code (the Code) by reason of Code section 4975(c)(1)(A) through (F)(3) . Notice was also given of the pendency before the Department of the proposed revocation of PTE 79-1 and PTE 84-46. The proposed class exemption was requested in part in an application filed by the Securities Industry Association (SIA) on behalf of its members, by letters to the Department dated November 29, 1982, April 22, 1983, May 24, 1983 and July 23, 1984. The proposal also contained provisions put forward by the Department on its own motion pursuant to its authority under section 408(a) of the Act and section 4975(c)(2) of the Code. Fifteen comments were received pursuant to those provisions, and in accordance with the procedures set forth in ERISA Procedure 75-1.(4) No requests for a hearing on the proposal were received.
Upon consideration of the entire record in the matter including the comments received, the Department is granting the exemption as proposed but with certain modifications.
Description of the Exemption
This exemption provides relief similar to that provided by Prohibited Transaction Exemption 79-1 (PTE 79-1) and Prohibited Transaction Exemption 84-46 (PTE 84-46), from the restrictions of section 406(b) of the Act and from the taxes imposed by section 4975(a) and (b) of the Code. The exemption conditions the effecting or executing of securities transactions on behalf of a plan by a plan fiduciary upon the fiduciary’s complying with a number of specific requirements designed to protect the interests of plan participants and beneficiaries. The exemption is generally available to fiduciaries with respect to employee benefit plans, except when a person is a fiduciary with respect to a plan by reason of being a plan trustee, plan administrator or sponsoring employer. The exemption is also available to managers of pooled investment funds in which plans invest, with certain restrictions applicable to those funds in which plans covering employees of the manager invest.
The exemption requires that a person engaging in a covered transaction must receive written authorization, executed in advance, from a fiduciary independent of such person. Thereafter, the authorized person must notify the plan at least annually that the authorization is terminable at will and without penalty by the plan. Such notice must include both a statement to the effect that failure to terminate the authorization will result in its continuation and a form on which to effect such a termination.
As in PTE 84-46, the exemption contains special authorization provisions and withdrawal rights for plans participating in pooled arrangements in order to accommodate the needs of funds or accounts in which the assets of many plans are collectively invested.
Persons effecting or executing securities transactions on behalf of plans pursuant to this exemption must disclose periodically certain information to the authorizing plan fiduciary. The exemption provides that a persons engaging in covered transactions must furnish the authorizing fiduciary with either (1) confirmation slips containing the information described in Rule 10b-10 (17 CFR 240.10b-10) under the Securities Exchange Act of 1934 (“1934 Act”), 15 U.S.C. 78a et seq., or (2) quarterly reports. The quarterly reports are compilations of the information that would have been provided by the confirmation slips and, specifically, must disclose the total of all charges incurred by the plan in connection with covered transactions during the reporting period, and the portion thereof that the authorized person has paid to others in connection with covered transactions. Annual reports are required of all persons engaging in covered transactions. The annual reports summarize the information required by the confirmation slips and, in addition, provide information regarding portfolio turnover and the use of brokerage commissions to pay for investment research services.
The exemption continues the recapture provisions of PTE 79-1. Under those provisions, any fiduciary may execute or effect securities transactions for a plan if he or she credits all profits earned in connection with the transaction to the plan. Persons generally excluded from coverage under the remainder of the exemption—that is, plan trustees, plan administrators and sponsoring employers—may engage in covered transactions on behalf of plans in such “recapture” situations.
In addition to special authorization provisions to accommodate the needs of pooled investment funds, the exemption provides, as to such funds in which plans covering employees of the pool manager or its affiliates participate, that the manager may engage in covered transactions on a “recapture” basis or may receive commissions based on the provision of brokerage services to the pool if the participation in the pool of plans covering employees of the pool sponsor is limited to twenty percent of the pool and the commissions received from all pools in which plans covering employees of the pool sponsor participate is limited to five percent of the aggregate amount of brokerage commissions received by the manager from all sources during the calendar year.
The exemption gives the authorizing fiduciary the right to request and receive any reasonably available information necessary for such fiduciary to determine whether the authorization should be made. In addition, the exemption places a corresponding duty on the authorized person to furnish the authorizing fiduciary with any additional information reasonably necessary and available to make this determination.
Finally, certain types of agency cross transactions are permitted under the exemption, under specified conditions.
Discussion of the Comments
A. Replacement of Annual Authorization Requirements
PTE 79-1 requires that persons engaging in a covered transaction on behalf of a plan obtain, at least annually, written authorization to engage in such transactions from an independent fiduciary with respect to that plan. In the interest of eliminating unnecessary costs to the authorized persons and the plans, it was proposed that this requirement be replaced with a provision whereby the independent fiduciary would be sent a form at least annually allowing it to terminate the authorization with respect to the plan; accompanying instructions would notify the plan that failure to return the form would result in continued authorization of the person to engage in covered transactions on behalf of the plan. Comments received on this aspect of the proposed exemption were generally favorable. Most commentators agreed with representations made by the SIA in  its exemption application that such a modification would reduce paperwork as well as other compliance expenses.
One commentator requested that, instead of sending a form, the authorized person be allowed to supply a simple notice containing the name and address of the person to contact if the plan desired to terminate the authorization. The commentator argued that this would reduce costs even further; it was acknowledged, however, that furnishing a form was not a significant burden. Accordingly, the Department believes that requiring the person seeking continued authorization to supply a termination form to the authorizing fiduciary, rather than requiring the authorizing fiduciary to prepare such a termination letter, is a proper allocation of the minimal burden involved.
In the final exemption, section III(g) of the proposed exemption, relating to the termination form, has been incorporated into section III(c) so that all conditions relating to authorization are grouped together.
B. Amendments to the Reporting Requirements
(1) Confirmation Slips and Quarterly Reports
Under PTE 79-1, authorized persons are required to supply the authorizing fiduciary with quarterly reports which disclose certain information related to the total of all transaction-related charges incurred by the plan in connection with covered transactions, the allocation of such charges among various persons, as well as a conspicuous statement about the negotiability of brokerage commissions and an estimate of future commission rates.
Pursuant to representations made by the SIA, the proposed exemption eliminated the requirements of PTE 79-1 as to the statement concerning the negotiability of brokerage commissions and the estimate of future commission rates. Various commentators agreed that the inclusion of these items in the quarterly reports provided little useful information to plan fiduciaries in evaluating the performance or services of the authorized persons.
The proposed exemption also provided that the authorized person was to supply the independent fiduciary with a “confirmation slip” for each securities transaction instead of quarterly reports. It was represented by the SIA that the contents of the confirmation slip would include information sufficient for the authorizing fiduciary to evaluate the execution services provided, and that the combination of confirmation slips and annual summaries would provide the plan fiduciaries with information more useful in monitoring the execution of securities trades than the quarterly reports had provided.
While many commentators agreed that confirmation slips would be as informative to the plans and less costly to the authorized person, several persons requested that the Department retain the quarterly reporting provision, or at least some other alternative, as a means of compliance. One commentator noted, for example, that where an investment adviser is required to maintain a segregated escrow fund (SEF) pursuant to Rule 206(4)-2 (17 CFR 275.206(4)-2), under the Investment Advisers Act of 1940, 15 U.S.C. 80b-1 et seq., confirmation slips for securities transactions are issued only to the adviser and not to the fiduciary of a particular plan client of the adviser. It was argued that issuing confirmation slips to the authorizing fiduciary of each plan participating in the SEF would be much more burdensome than the quarterly reporting requirement of PTE 79-1. In consideration of these comments, the Department has decided to expand the availability of the option, proposed for pooled investment funds, to allow the provision to the authorizing fiduciary of either confirmation slips or quarterly reports.(5)
Those commentators who endorsed the “confirmation slip” aspect of the proposed exemption generally objected to the condition contained in proposed section III(e)(2), that the time of the transaction be included on the confirmation slip. Several commentators noted that Rule 10b-10 under the 1934 Act does not require that the exact time of the trade be included on the slip; rather, under that rule, the slips are to state that the time of the trade will be supplied upon the request of the customer. It was argued that supplying the independent fiduciary with the time of the trade provided no useful information and would entail costly adjustments to computerized reporting systems. Finally, one commentator argued that Rule 10b-10 has been revised and updated in recent years and most likely will continue to be modified in the future.
In consideration of these comments, the Department has modified this aspect of the exemption to state that confirmation slips provided to the authorizing fiduciary must contain the information described in Rule 10b-10 under the 19034 Act. This provision contemplates that, as the Securities and Exchange Commission (SEC) may amend and revise Rule 10b-10, the confirmation slips supplied to the authorizing fiduciaries pursuant to this class exemption will be correspondingly amended and revised, to the extent required by the changes in Rule 10b-10.
(2) Annual Reporting Requirements
(a) Allocation of transaction related charges. PTE 79-1 requires that the reports furnished to the authorizing fiduciary disclose both the total charges relating to covered transactions incurred by the plan during the period to which the report relates, as well as the amount of the transaction-related charges retained by the authorized person and the amount of such charges paid to other persons for execution or other services. The proposed exemption retained the requirement that this information be disclosed, either annually (for those issuing confirmation slips) or in quarterly reports otherwise. Some commentators stated that they had no objection to this requirement. A few commentators, however, objected to its inclusion. It was argued that the requirement provides the independent plan fiduciary with no useful information, as his or her concern should be with the aggregate charges and not with any additional breakdown. Another commentator analogized to the statutory reporting requirement under ERISA; it was noted that whereas section 103(e)(2) of ERISA requires a breakdown of how an insurance company disposes of premiums received from a plan, Congress imposed no such reporting requirements on broker-dealers.(6)
The Department is not persuaded by these arguments. While it agrees that this is information not required under ERISA’s annual reporting requirements, the Department believes that it is entirely appropriate, in the context of this class exemption, to require disclosure of certain information by the exempted person so as to reduce the need for the independent fiduciary to make independent inquiry into the actions of that person. In this case, the breakdown of remuneration charges enables the authorizing fiduciary to ascertain whether, and if so, to what  extent the authorized person is the one actually performing the services for which the plan has contracted.(7) It appears to the Department that such information would be helpful to independent fiduciaries generally in their evaluation of the management and brokerage services provided. Accordingly, the Department has decided to retain this requirement.(8)
(b) Disclosure of charges for research and other services. The proposed exemption contained a provision requiring annual disclosure of whether any transaction-related charges were attributable to consideration for research, other non-brokerage services or goods and, if so, a detailed description of such services or goods. Many commentators objected to this section of the proposal. Some commentators argued that the Department lacks the legal authority to require such disclosure and that only the SEC has jurisdiction over such matters. Others interpreted this section as inhibiting the payment of monies for research services in contravention of section 28(e) of the 1934 Act. Several commentators represented that compliance with the proposed requirement was impracticable because research and other services may not be directly attributable to specific trades for specific accounts.
In adopting amendments to several forms and a proxy rule under the Investment Company Act, the SEC addressed similar concerns(9) while still reflecting its longstanding position that “such brokerage placement practices, although permissible, should be disclosed to investors.”(10) Amendments were adopted which required disclosure of whether persons acting on behalf of an investment company are authorized to pay a broker a brokerage commission in excess of that which another broker might have charged for effecting the same transaction, in recognition of the value of brokerage or research services provided by the broker.(11)
In addition, amendments to the “brochure rule” under the Investment Advisers Act of 1940 required certain investment advisers to provide a narrative description about their brokerage placement practices.(12)
Several commentators responding to the proposed exemption recommended that the Department rely on the disclosures required by the SEC in the rules discussed above.
In consideration of the comments, the Department has decided to modify the reporting provisions relating to charges that are attributable in part to consideration for goods or nonbrokerage services.
Rather than impose an annual reporting requirement, the final exemption requires that, as part of the initial authorization, the person requesting authorization provide the authorizing fiduciary with a description of the person’s brokerage placement practices. Compliance with the brokerage placement practice disclosures required by Form ADV of the Advisers Act will satisfy this requirement of section III(d) of this exemption.(13) Subsequent to this initial disclosure, additional information regarding the person’s brokerage placement practices need only be supplied in the summary provided pursuant to section III(f)(3) of the exemption when there is a material change in those practices.
As to pooled accounts, the final exemption has been amended to include a parallel reporting provision in section IV(d)(1(B). Under this provision, the person requesting authorization must provide the authorizing fiduciary with a description of the person’s brokerage placement practices along with other information necessary to determine whether the authorization should be made. Material changes in such brokerage placement practices must be disclosed to authorizing fiduciaries in the summaries provided pursuant to section III(f) of the exemption.
The Department notes that sections III(d) and IV(d)(1)(B) of the exemption continue the requirements of PTE 79-1 and PTE 84-46 that the authorized person is required to furnish the authorizing fiduciary with any reasonably available information necessary to determine whether the authorization should be made or continued. The Department further notes that, under ERISA section 404(a)(1)(B), the authorizing fiduciary has an obligation to be prudent in the selection, and in monitoring the performance of, the investment manager authorized to provide services under the exemption.(14) In this regard, the authorizing fiduciary may wish to request more information from the person concerning brokerage placement practices than is supplied with the initial authorization materials in order to satisfy his or her duties as the authorizing fiduciary.
With respect to the comments questioning the Department’s authority to impose these disclosure requirements, the Department notes that the transactions covered by the exemption would, but for the exemption, be proscribed by ERISA’s prohibited transaction provisions, for reasons that are unrelated to section 28(e). In the Department’s view, the authority to grant exemptions from those provisions carries with it the authority to grant exemptions subject to conditions that the Department determines to be appropriate.
(c) Disclosure of portfolio turnover. Section III(f)(4) of the proposed exemption provided that the annual summary furnished to the authorizing fiduciary contain a calculation of the annualized portfolio turnover ratio as a percentage of the plan assets consisting of securities or cash for which the authorized person had investment discretion. That section provided a formula by which to make this calculation.
Several persons commented on this aspect of the proposed exemption. Some argued that the formula was so simple that the information it provided would be at best meaningless, and at worst  misleading, to the authorizing fiduciary. Others stated that the calculation was so complex as to be burdensome for the authorized person. One commentator suggested that the final exemption contain a definition of “portfolio turnover” consistent with that contained in Form N-SAR pursuant to the Investment Company Act of 1940.(15)
In consideration of these comments, the Department has decided to eliminate the requirement that the specific formula as set forth in this exemption must be used in computing the portfolio turnover ratio. Instead, the Department has determined that the authorizing fiduciary and the manager should be permitted to agree on a different method of computation that is reasonably designed to provide the authorizing fiduciary with the information needed to assist in discharging its duty of prudence. However, the formula as proposed, with certain technical modifications described below in response to the comments received, remains as a “safe harbor” method of satisfying the requirement of section III(f)(4).
The Department has modified the formula to eliminate from the computation the effects of short-term cash management—that is, management of debt securities with maturity at acquisition of one year or less. This was done to eliminate a “masking” effect that might otherwise result from high portfolio turnover ratios that can be the result of short-term cash management. In addition, explicit instructions for computing the “monthly average of the market value of the portfolio” have been provided. Both of these modifications were made to conform the method of computation to the method set forth in Form N-SAR, cited above. The formula does depart from that set forth in Form N-SAR, however, in that it adds an annualizing factor to account for the possibility that managers may serve for periods of varying durations.
As adopted, the “safe harbor” formula provides that a non-annualized portfolio turnover ratio is first calculated, by dividing the lesser of the aggregate dollar amounts of purchases or sales of portfolio securities during the relevant periods by the monthly average of the market value of the portfolio securities during such periods. The monthly average is obtained by totaling the market values of the portfolio securities as of the beginning and end of each period and as of the end of each month that ends within such periods, and dividing the sum by the number of valuation dates so used. As is noted above, all debt securities whose maturities at the time of acquisition were one year or less are excluded from both the numerator and the denominator. The annualized portfolio turnover ratio is then obtained by multiplying the portfolio turnover ratio described above by an annualizing factor. The annualizing factor is obtained by dividing the number twelve by the aggregate duration of the relevant management periods expressed in months (and fractions thereof).
The Department has added a section to the final exemption, (section V), containing examples which illustrate the use of this formula. The Department believes that, with the adoption of the formula as a “safe harbor”, affected parties are provided with both the certainty and the flexibility necessary to comply with this condition of the class exemption.
In response to another comment, the Department has eliminated the requirement to supply the computation in cases where the authorized person has not, during the period covered by the report, exercised any discretionary authority over trading in the account. In those cases, the Department has concluded that the potential for self-dealing by means of causing the plan involved to engage in excessive trading, thereby generating un-warranted brokerage commissions, is substantially reduced if not eliminated. In other cases, however, the Department has decided to retain the requirement. The commentators who generally objected to the requirement argued that many factors, such as the types of securities contained in the portfolio and a given plan’s investment objectives, would substantially affect the degree of portfolio turnover. The Department believes that a plan’s authorizing fiduciary should be aware of these factors and, therefore, will be able to evaluate the portfolio turnover computation in light of them. Authorized persons may provide whatever supplemental explanatory material they believe to be necessary to make the calculation more meaningful and not misleading to the authorizing fiduciary in the annual report.
C. Clarification of the Scope of the Exemption
PTE 79-1 provides an exemption from both section 406(a) and 406(b) of ERISA. The proposed exemption provided relief only from the restrictions of section 406(b). The reason for this modification is that the Department believes that any relief from section 406(a) that may be necessary in connection with transactions covered by this exemption is provided by the statutory exemption for the provision of services to a plan by a party in interest contained in section 408(b)(2) of ERISA.
Several commentators objected to this aspect of the proposed exemption. Some of these commentators included an argument that section 408(b)(2) provides an exemption from all of section 406, not just 406(a). The Department does not share this view of the scope of section 408(b)(2).(16)
Neither this class exemption, nor PTE 79-1 or PTE 84-46, provides relief for direct or indirect sales, or other underlying transactions, described in section 406, in which a plan and a party in interest participate. Rather, this exemption provides relief from the restrictions of section 406(b) only for those service transactions that are covered by section II of the exemption and receipt of compensation therefore by a plan fiduciary. For example, if a plan fiduciary purchases securities from a person he knows to be a party in interest for the plan in an agency cross transaction, and receives a commission from the party-in-interest for effecting that transaction, this exemption provides relief from section 406(b)(3) for the receipt of the commission by such fiduciary (provided that the conditions of the exemption are met) but does not provide relief from section 406(a)(1)(A), which generally prohibits a fiduciary with respect to a plan from causing the  plan to engage in a transaction that constitutes a direct or indirect sale or exchange of any property between a plan and a party in interest. In the absence of other exemptive relief, this latter transaction would be prohibited.
This exemption specifically excludes relief for acts of “churning.” In this regard, section II(a) of the proposed exemption stated that relief was provided for the described transactions, “but only to the extent that such transactions are not excessive, under the circumstances, in either amount or frequency.”
Several commentators objected to this language. Some commentators noted that whether an account is in fact “churned” depends on all the facts and circumstances, not merely the amount or frequency of securities trades. Others stated they feared that the Department would be developing or imposing a set of standards regarding what constitutes “churning” that differs from standards that would apply under the federal securities laws.
Upon consideration of the comments, the Department has decided to adopt the provision as proposed. The conduct of a plan fiduciary in managing a securities account must be measured according to ERISA’s fiduciary responsibility standards; excessive trading in the account is one respect in which the fiduciary might breach the general fiduciary responsibilities, including that of prudence, imposed on him or her by section 404(a)(1) of ERISA. While the Department does not consider it appropriate to condition the availability of the exemption on adherence by the fiduciary to all facets of these fiduciary duties (including those related to the merits of the underlying transaction), the generation of excessive fees through inappropriately high portfolio turnover rates is an abuse with which the Department is concerned in implementing this class exemption. Thus, the Department could conclude that a fiduciary had violated ERISA’s prudence requirement where an account had been “churned”, despite the fact that the resulting composition of the plan’s portfolio, viewed by itself without regard to the impact of excessive transaction costs, was beyond challenge. The Department does not wish to suggest that the exemption in any way relieves fiduciaries of the obligation not to cause the plan to pay excessive transaction costs.(17)
D. Agency Cross Transactions
The proposed exemption contained specific provisions relating to the conditions under which an authorized person could affect or execute agency cross transactions on behalf of its plan clients. Generally, an agency cross transaction is a transaction in which both the buyer and the seller of a security use the same broker. It was represented by the applicant that such transactions would save plans money and that SEC regulations are sufficient to protect plans from any potential abuse. The proposed conditions were derived from two SEC rules: (1) Rule 206(3)-2 under the Investment Advisers Act of 1940 (17 CFR 275.206(3)-2), and (2) Rule 17a-7 under the Investment Company Act of 1940 (17 CFR 270.17a-7).
As a general matter, the Department received no comments objecting to the inclusion in the exemption of the section on agency cross transactions. Rather, comments were addressed to particular aspects of that section of the proposed exemption; these comments are discussed below.
Section III(h)(5) of the proposed exemption required that agency cross transactions be effected at a price “no less favorable to any plan involved in the transaction than the ‘current market price’ of the security, as … defined in Rule 17a-7(b).” That subsection of Rule 17a-7 contains four possible means of determining “current market price” depending on such factors as whether the security is a reported security and whether its principal market is an exchange.
Four commentators objected to this subsection of the proposed exemption. It was argued that the condition in the proposed exemption would operate so as to require a broker-dealer to execute such transactions at the last sale price for certain reported securities, unless there were no reported transactions on that day, which could result in a transaction taking place at a price either higher or lower than the current market price for those securities. The commentators suggested that this condition be revised to require that agency cross transactions be effected or executed at any price at or between the current bid and current ask quotations. The commentators represented that their proposed condition, in conjunction with section III(h)(4) of the proposed exemption (which limits agency cross transactions to situations where market quotations for a security are readily available), would be sufficiently protective of the interests of the plan.
The Department agrees with the commentators’ concerns. The Department has, therefore, adopted the suggested revision to the price condition, with the additional condition that the bid and ask quotations be independent.
(2) Transactions Where Discretion Exists on Both Sides
The preamble to the proposed exemption stated that relief was neither requested nor proposed by the Department to extend to agency cross transactions where a broker-dealer has discretionary authority or renders investment advice with respect to both sides of the transaction, in view of the additional potential for abuse that exists in such situations.
In response to this aspect of the proposed exemption, the Department received two comments. Specifically, it was requested that the proposed exemption be revised to permit agency cross transactions between two employee benefit plans, or between a plan and a mutual fund, when the transaction is recommended or effected by a person who serves as an adviser or fiduciary to both parties to the transaction. It was argued that normal portfolio adjustments necessary for liquidity needs as well as individual and overall investment strategies may result in the not unusual situation where an adviser/fiduciary has one client account for which he wishes to sell a particular security at the same time that he has another client account for which he wishes to buy that same security. It was represented that extending relief under the proposed exemption to allow the  authorized person to effect the transaction for both sides would be beneficial to plans, both because, under the commentators’ proposals, only limited fees would be charged and because the buyer and seller may obtain a better, less distorted price than that otherwise available on the open market.
Both commentators suggested that exemptive relief modeled after Rule 17a-7 of the Investment Company Act of 1940 would safeguard plans involved in such transactions against potential abuse. As to mutual funds, that rule provides an exemption for certain purchase or sale transactions between a mutual fund and certain “affiliated persons” thereof under specified conditions. Those conditions include quarterly determinations by the mutual fund’s board of directors (including a majority of the directors who are not “interested persons” of the fund) that all purchases or sales made during the quarter pursuant to the Rule were in compliance with procedures reasonably designed to provide that the requirements of the Rule are met. Further, subsection (d) of the Rule provides, that “no brokerage commission, fee (except for customary transfer fees), or other remuneration [may be] paid in connection with the transaction.” One commentator noted, however, that “customary transfer fees” may be indicated as “commissions” on the brokerage confirmation. This commentator further advised that “broker-dealers may charge what is termed ‘commissions’ for an agency cross transaction since broker-dealers’ costs and risks associated with such transactions may fluctuate with the amount of securities involved.”
The other commentator stated that it was unable to define the term “customary transfer fee”. It did state that such fees were understood to include such things as custodial transaction fees, out-of-pocket expenses, transfer agent transaction fees, and charges incurred pursuant to governmental reporting requirements. This commentator advised, however, that the Department should not attempt to define or limit the type of fees that may be charged in such transactions in order not to restrict unnecessarily the flexibility of investment advisers. The commentator also argued against restriction of the expanded relief it requested to transactions involving reported securities or securities principally marketed on an exchange.
After consideration of these comments, the Department has decided not to extend relief in the final exemption to agency cross transactions where the authorized person has discretionary authority with respect to both sides of the transaction.
In addition to uncertainty regarding both the fees that would be charged for such transactions and the bases for those fees, the comments received indicate that strict application of Rule 17a-7’s pricing provisions may not be appropriate in all cases. The requested augmentation of the exemption, even if modified to allow the pricing flexibility that appears to be necessary or at least desirable, as is discussed above, would provide no assurance that plans that are parties to the transaction—possibly on both sides—would be obtaining a price commensurate with what arm’s-length bargaining would have produced. Accordingly, the Department has not been persuaded that, on balance, the potential benefits that may inure to plans outweigh the possibility of abuse that exists when a plan fiduciary acts on behalf of both the plan and a party whose interests are adverse to those of the plan.
E. Recapture Provision
Section IV(c) of the proposed exemption continued the provision from PTE 79-1 which allows a fiduciary to effect securities transactions for a plan with respect to which the fiduciary is a plan trustee, plan administrator or employer of employees covered by the plan, provided that all profits resulting from the brokerage function are recaptured on behalf of the plan. The Department received two comments requesting modification of section III(a) and IV(c) of the proposal so as to allow plan trustees to engage in covered transactions on a non-recapture basis.
The Department received one comment requesting that all trustees, including those with discretion with respect to plan investments, be allowed to engage in covered transactions. It was argued that PTE 79-1 and the exemption as proposed placed banks at a competitive disadvantage, “for no apparent reason”, in relation to both insurance companies and investment advisory affiliates of broker-dealers, where a plan sponsor has “elected the stability, experience, and security offered…by a bank trustee.”
The Department has previously expressed concern that, as a general matter, the position of a plan trustee may carry with it so great an influence over the general operation of the plan that an independent fiduciary may not be effective in examining critically and objectively multiple service arrangements.(18)
Although that comment did not address the Department’s previously expressed concern, another commentator requested that the Department clarify the definition of trustee by explicitly excluding custodial or “non-discretionary” trustees who possess no investment discretion with respect to any assets of the plan. Custodial functions were described as including the provision of plan documents and necessary amendments to comply with applicable law, the safekeeping of securities, the disbursement of benefits, and the reporting of information required by the Internal Revenue Service. This commentator noted that the Department’s Advisory Opinion #82-12A discussed the situation where, by operation of Code sections 401(f) or 408(h), a custodial account may be treated as a qualified trust, and as a result, the custodian is treated as the trustee of such account. On the basis of the representations made in that opinion request, the Department concluded that the custodian of the participant-directed plans would not be treated as a trustee for purposes of PTE 79-1.
This commentator also noted that the Comptroller of the Currency allows banks without fiduciary powers to “combine the functions of custodian and the purchasing of securities upon the direction of the principal.”(19) In addition, the Federal Deposit Insurance Corporation recently amended its rules to permit certain banks that do not exercise trust powers to act as trustee or custodian of Individual Retirement Accounts and Simplified Employer Pensions under certain condition; these conditions include: (1) the bank’s duties as trustee or custodian must be essentially custodial in nature, (2) the bank must invest the funds from such plans only in its own time or savings deposits or in any other assets at the direction of the customer, (3) the bank may not exercise any investment discretion or provide any investment advice with respect to such accounts, and (4) the bank’s acceptances of such accounts without trust powers must not be contrary to state law.(20)
In addition, this commentator argued that the Department’s rationale for excluding trustees from those persons eligible to engage in transactions under  this exemption—that is, that such persons may have so great an influence over the operation of the plan that adequate independent examinations of any multiple service arrangement involving the trustee may not exist—was not applicable in situations where a trustee has very little or no discretion respecting the investment of the assets of the plan. On the basis of these comments, the Department has concluded that persons who are trustees, but whose duties are limited in a manner similar to those of the non-trustee custodians discussed above, should be excepted from the condition that the person engaging in the covered transaction must not be a plan trustee.(21) Section III(a) of the exemption, as adopted, excludes “nondiscretionary trustees” from that condition, and new section I(i) defines the term “nondiscretionary trustee” in the same manner as that term is defined in PTE 77-9 as amended.(22) In other respects, the Department has decided to retain the condition of PTE 79-1 that trustees may provide brokerage services under this exemption only in recapture situations.(23)
F. Special Rule for Pooled Funds
PTE 84-46 allows an affiliate of an insurance company maintaining a pooled separate account to provide brokerage services for that account. The authorization provisions of that exemption are designed to accommodate the needs of funds or accounts in which the assets of many plans are collectively invested. The proposed exemption made these alternative methods of authorization available to any account or fund for the collective investment of the assets of more than one plan without requiring the recapture of brokerage profits on behalf of that account or fund. The Department received no criticism of this provision and thus has retained it in the final.
Under PTE 79-1 and the exemption as proposed, persons who are plan trustees, plan administrators, or employers of employees covered by a plan, are generally prohibited from engaging in covered transactions on behalf of such plans other than in recapture situations. In response to that proposal, the Department received one comment requesting that the sponsors of pooled accounts or their affiliates be allowed, under certain conditions, to engage in covered transactions on a non-recapture basis where plans covering employees of the pool sponsors or their affiliates (in-house plans) participate in the pool. The suggested conditions included that the participation of in-house plans in a pool be limited to a certain percentage of the fair market value of the total assets of the pool. Furthermore, the commentator noted that limits could be placed on the total commissions received from all such pooled funds in which in-house plans participate. It was asserted that the interests of the in-house plans would be adequately protected because independent investors representing a substantial portion of the assets of a pooled fund would be scrutinizing the provision of brokerage services by the affiliated broker-dealer. In addition, the commentator noted that a limitation on commissions receivable with respect to pools in which in-house plans participate, similar to that contained in, for example, ERISA section 408(b)(5), would provide additional protection to such plans.
It was argued that the Department has granted similar exemptive relief in the past. In PTE 77-3, the Department exempted from the prohibited transaction provisions of the Act and the Code the acquisition and sale of shares of a mutual fund by the fund’s in-house plan. This relief, in turn, was modeled on the statutory exemptions for banks and insurance companies contained in ERISA sections 408(b)(4) and (5). As the Conference Report explains in relation to those statutory exemptions, it would be contrary to normal business practice for a bank to invest the assets of its in-house plan in another bank, or for a plan covering employees of an insurance company to purchase its insurance from another company.(25)
Based on these comments, the Department has decided to modify the exemption in the manner requested so as to allow in-house plans to participate in such pools subject to certain protective conditions. Upon consideration, the Department has determined that a five percent limitation on the total commissions received with respect to those pooled funds in which in-house plans participate is an appropriate limitation.(26) In addition, the Department believes that further protection would be provided to such in-house plans where the value of their investment is limited to twenty percent of the fair market value of the pool, as determined on the first day of each fiscal year of the pool. The twenty percent figure is consistent with a similar condition in PTE 84-14, Class Exemption for Plan Asset Transactions Determined by Independent Qualified Professional Asset Managers (49 FR 9494, March 13, 1984), and adequately addresses the concerns expressed by the commentator. A determination of whether a pooled fund meets the twenty percent limit during the course of the pool’s fiscal year must be made in a manner similar to that by which the percentage of a plan’s holding of employer securities is made under the Department’s regulations at 29 CFR 2550.407a-2 and 2550.407a-3; that is, (1) an in-house plan may not acquire any additional interests in a pool if, immediately after such acquisition, the fair market value of all in-house plans’ interests would exceed 20% of the fair market value of the total assets of the pool; and (2) such pool fund will be in initial compliance with the 20% requirement for a fiscal year if it satisfies the requirement on the first day of that fiscal year notwithstanding any subsequent increase in such percentage limitation which occurs merely as a result of the withdrawal of other participants in the pool.
G. Transitional Rule and Effective Date
The proposed exemption provided that the replacement exemption would become effective thirty days after its publication in the Federal Register. Further, the proposal indicated that the  Department intended to revoke PTE 79-1 and PTE 84-46 at the same time. The Department received several comments requesting clarification of the effective date provisions, as well as comments requesting an additional period of time before the revocation of the existing class exemptions.
Two commentators requested that the annual fiduciary authorizations obtained pursuant to PTE 79-1 be allowed to satisfy the initial authorization requirement of the new exemption without any further action by the authorized person. It was suggested that at the expiration of this annual authorization, the authorized person would then be required to include as part of the next annual report to the independent plan fiduciary all the information that would be required under the new exemption.
Another commentator requested that PTE 79-1 not be revoked for at least six months so as to allow time for agreements and contracts executed pursuant to that exemption to be modified in order to comply with the new exemption.
In consideration of these comments, the Department has made the following determinations: An authorized person may continue to rely on authorizations obtained pursuant to PTE 79-1 for PTE 84-46 to engage in covered transactions under the new exemption, provided that: (1) The authorization complies with the applicable authorization requirements of the new exemption, and (2) before the authorized person begins operating under the new exemption, the authorizing fiduciary is provided with the information required by section III(d) or IV(d)(1)(B), whichever is applicable (including a copy of this exemption) and the form for terminating the authorization. In addition, PTE 79-1 and PTE 84-46 will not be revoked until April 1, 1987, so as to allow authorized persons and authorizing fiduciaries ample time in which to adjust their authorization and reporting procedures. It should be noted, however, that this provision does not operate so as to relieve persons who continue to act pursuant to the “old” exemptions from any of the conditions imposed thereunder, including the reporting provisions. Authorized persons are reminded that they are required, under PTE 79-1 and PTE 84-46, to supply reports with respect to any three-month period in which they engaged in any covered transactions; upon availing themselves of the new exemption, therefore, such persons must still send the authorizing fiduciary any reports required under the old exemptions.
In addition, the effective date of the exemption has been changed to the later of thirty days after publication in the Federal Register or the date on which the Office of Management and Budget approves the information collection requests contained in the exemption under the Paperwork Reduction Act of 1980. When the exemption is effective, the Department will publish a notice in the Federal Register notifying interested persons of that fact.
H. Paperwork Reduction Act
In accordance with the Paperwork Reduction Act of 1980 (Pub. L. 96-511), the disclosure provisions that are included in this exemption have been submitted to the Office of Management and Budget.
The attention of interested persons is directed to the following:
(1) The fact that a transaction is the subject of an exemption granted under section 408(a) of the Act and section 4975(c)(2) of the Code does not relieve a fiduciary or other party in interest with respect to a plan to which the exemption is applicable from certain other provisions of the Act and the Code, including any prohibited transaction provisions to which the exemption does not apply and the general fiduciary responsibility provisions of section 404 of the Act. That section requires, among other things, that a fiduciary discharge his or her duties respecting the plan solely in the interest of the plan’s participants and beneficiaries and in a prudent fashion in accordance with section 404(a)(1)(B) of the Act. This exemption also does not affect the requirement of section 401(a) of the Code that a plan must operate for the exclusive benefit of participants and beneficiaries.
(2) This exemption is supplemental to, and not in derogation of, any other provision of the Act and the Code, including statutory exemptions and transitional rules. Furthermore, the fact that a transaction is subject to an administrative or statutory exemption is not dispositive of whether the transaction is in fact a prohibited transaction.
(3) The class exemption is applicable to a particular transaction only if the transaction satisfies the conditions specified in the class exemption.
In accordance with section 408(a) of the Act and section 4975(c)(2) of the Code, and based upon the entire record including the written comments submitted in response to the notice of January 24, 1985, the Department makes the following determinations:
(a) The class exemption set forth herein is administratively feasible;
(b) It is in the interests of plans and of their participants and beneficiaries; and
(c) It is protective of the rights of participants and beneficiaries of plans.
Accordingly, the following exemption is hereby granted under the authority of section 408(a) of the Act and section 4975(c)(2) of the Code and in accordance with ERISA procedure 75-1.
Section I. Definitions and Special Rules
The following definitions and special rules apply to this exemption:
A person is not an affiliate of another person solely because one of them has investment discretion over the other’s assets. The term “control” means the power to exercise a controlling influence over the management or policies of a person other than an individual.
Section II. Covered Transactions
Effective the later of December 18, 1986, or the date on which the Office of Management and Budget approves the information collection requests contained in this exemption under the Paperwork Reduction Act of 1980, if each condition of section III of this exemption is either satisfied or not applicable under section IV, the restrictions of section 406(b) of ERISA and the taxes imposed by sections 4975(a) and (b) of the Code, by reason of section 4975(c)(1)(E) or (F) of the Code shall not apply to –
Section III: Conditions
Except to the extent otherwise provided in section IV of this exemption, section II of this exemption applies only if the following conditions are satisfied:
Section IV. Exceptions from Conditions
Section V. Examples Illustrating the Use of the Annualized Portfolio Turnover Ratio Described in Section III(f)(4)(ii)
(a) A, an investment manager affiliated with a broker dealer that A uses to effect securities transactions for the accounts that it manages, exercises investment discretion over the account of plan P for the period January 1, 1987, though June 30, 1987, after which the relationship between A and P ceases. The market values of P’s account with A at the relevant times (excluding debt securities having a maturity of one year or less at the time of acquisition) are:
Aggregate purchases during the 6-month period were $850,000; aggregate sales were $1,000,000, excluding in each case debt securities having a maturity of one year or less at the time of acquisition.
For purposes of section III(f)(4) of this exemption, A computes the annualized portfolio turnover as follows:
A=$850,000 (lesser of purchases or sales)
B=$10,657,143 ($74.6 million divided by 7, i.e, number of valuation dates)
Annualizing factor = C/D = 12/6 = 2
Annualized portfolio turnover ratio = 2X(850,000/10,657,143)=0.160=16.0 percent
(b) Same facts as (a), except that A manages the portfolio through July 15, 1987 and, in addition, resumes management of the portfolio on November 10, 1987 through the end of the year. The additional relevant valuation dates and portfolio values are:
During the periods July 1, 1987 through July 15, 1987, and November 10, 1987 through December 31, 1987, there were an additional $650,000 of purchases and $400,000 of sales. Thus, total purchases were $1,500,000 (i.e., $850,000 + $650,000) and total sales were $1,400,000 (i.e., $1,000,000 + $400,000) for the management periods.
A now computes the annualized portfolio turnover as follows:
A=$1,400,000 (lesser of aggregate purchases or sales)
B=$10,509,091 ($115.6 million divided by 11)
Annualizing factor = C/D = 12/(6.5+1.67)=1.47
Annualized portfolio turnover ratio=1.47X(1,400,000/10509,091)=0.196=19.6 percent
Section VI. Effective Dates and Transitional Rule
(a) This exemption is effective on February 12, 1987 or the date on which the Office of Management and Budget approves the information collection requests contained in this exemption under the Paperwork Reduction Act of 1980.
(b) PTE 79-1 and PTE 84-46 are revoked effective June 1, 1987.
Signed at Washington, DC, this 5th day of November, 1986.