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Secretary of Labor Thomas E. Perez
Proposed Class Exemption for Cross-Trades of Securities by Index and Model-Driven Funds [Notices] [12/15/1999]

Proposed Class Exemption for Cross-Trades of Securities by Index and Model-Driven Funds [12/15/1999]

[PDF Version]

Volume 64, Number 240, Page 70057-70070

[[Page 70057]]

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DEPARTMENT OF LABOR

Pension and Welfare Benefits Administration

 
Proposed Class Exemption for Cross-Trades of Securities by Index 
and Model-Driven Funds

AGENCY: Pension and Welfare Benefits Administration, Department of 
Labor.

ACTION: Notice of proposed class exemption.

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SUMMARY: This document contains a notice of pendency before the 
Department of Labor (the Department) of a proposed class exemption from 
certain prohibited transaction restrictions of the Employee Retirement 
Income Security Act of 1974 (the Act or ERISA), the Federal Employees' 
Retirement System Act (FERSA), and from certain taxes imposed by the 
Internal Revenue Code of 1986 (the Code). If granted, the proposed 
exemption would permit cross-trades of securities among Index and 
Model-Driven Funds (Funds) managed by investment managers and among 
such Funds and certain large accounts to which such investment managers 
act as a ``trading adviser'' in connection with a specific portfolio 
restructuring program. The proposed exemption, if granted, would affect 
participants and beneficiaries of employee benefit plans whose assets 
are invested in Index or Model-Driven Funds, large pension plans 
involved in portfolio restructuring programs, as well as the Funds and 
the investment managers.

DATES: Written comments and requests for a public hearing must be 
received by the Department on or before February 14, 2000.

ADDRESSES: All written comments and requests for a public hearing 
(preferably 3 copies) should be sent to: Office of Exemption 
Determinations, Pension and Welfare Benefits Administration, Room N-
5649, 200 Constitution Avenue N.W., Washington, DC 20210, (Attention: 
``Class Exemption for Securities Cross-Traded by Index/Model-Driven 
Funds''). All comments received from interested persons will be 
available for public inspection in the Public Documents Room, Pension 
and Welfare Benefits Administration, U.S. Department of Labor, Room N-
5638, 200 Constitution Avenue N.W., Washington, DC 20210.

FOR FURTHER INFORMATION CONTACT: Mr. Louis J. Campagna, or Mr. E. F. 
Williams, of the Office of Exemption Determinations, Pension and 
Welfare Benefits Administration, U.S. Department of Labor, Washington, 
DC 20210 at (202) 219-8883 or 219-8194, respectively, or Mr. Michael 
Schloss, Plan Benefits Security Division, Office of the Solicitor, U.S. 
Department of Labor, Washington, DC 20210, at (202) 219-4600, ext. 105. 
(These are not toll-free numbers.)

SUPPLEMENTARY INFORMATION: This document contains a notice of pendency 
before the Department of a proposed class exemption from the 
restrictions of sections 406(a)(1)(A) and 406(b)(2) of the Act, section 
8477(c)(2)(B) of FERSA, <SUP>1</SUP> and from the taxes imposed by 
section 4975(a) and (b) of the Code, by reason of section 4975(c)(1)(A) 
of the Code. The Department is proposing the class exemption on its own 
motion pursuant to section 408(a) of the Act and section 4975(c)(2) of 
the Code, and in accordance with the procedures set forth in 29 CFR 
Part 2570, Subpart B (55 FR 32836, August 10, 1990).<SUP>2</SUP>
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    \1\ The Department has responsibility for the administration and 
enforcement of section 8477 of FERSA. Section 8477 establishes the 
standards of fiduciary responsibility and requirements relating to 
the activities of fiduciaries with respect to the Federal Thrift 
Savings Fund. All references herein to the fiduciary responsibility 
provisions of Part 4 of Title I of ERISA also apply to the 
corresponding provisions of FERSA. Accordingly, any relief that 
would be provided under this proposed class exemption, if granted, 
would also apply to cross-trades of securities by the Federal Thrift 
Savings Fund.
    \2\ Section 102 of Reorganization Plan No. 4 of 1978, 5 U.S.C. 
App. 1 (1996) generally transferred the authority of the Secretary 
of the Treasury to issue exemptions under section 4975(c)(2) of the 
Code to the Secretary of Labor.
    In the discussion of the exemption, references to specific 
provisions of the Act should be read to refer as well to the 
corresponding provisions of section 4975 of the Code.
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I. Paperwork Reduction Act Analysis

    The Department, as part of its continuing effort to reduce 
paperwork and respondent burden, conducts a pre-clearance consultation 
program to provide the general public and Federal agencies with an 
opportunity to comment on proposed and continuing collections of 
information in accordance with the Paperwork Reduction Act of 1995 (PRA 
95), 44 U.S.C. 3506(c)(2)(A). This helps to ensure that requested data 
can be provided in the desired format, reporting burden (time and 
financial resources) is minimized, collection instruments are clearly 
understood, and the impact of collection requirements on respondents 
can be properly assessed.
    Currently, the Pension and Welfare Benefits Administration (PWBA) 
is soliciting comments concerning the proposed information collection 
request (ICR) included in the Proposed Class Exemption for Cross-Trades 
of Securities by Index and Model-Driven Funds. A copy of the ICR may be 
obtained by contacting the PWBA official identified below in this 
Notice of Proposed Class Exemption.
    The Department has submitted a copy of the proposed information 
collection to the Office of Management and Budget (OMB) for its review 
in accordance with 44 U.S.C. 3507(d) of PRA 95. The Department and OMB 
are particularly interested in comments that:
    <bullet> Evaluate whether the proposed collection of information is 
necessary for the proper performance of the functions of the agency, 
including whether the information will have practical utility;
    <bullet> Evaluate the accuracy of the agency's estimate of the 
burden of the proposed collection of information, including the 
validity of the methodology and assumptions used;
    <bullet> Enhance the quality, utility, and clarity of the 
information to be collected; and
    <bullet> Minimize the burden of the collection of information on 
those who are to respond, including through the use of appropriate 
automated, electronic, mechanical, or other technological collection 
techniques or other forms of information technology, e.g., permitting 
electronic submission of the responses.
    Dates: Written comments concerning the proposed collection of 
information should be sent to the Office of Information and Regulatory 
Affairs, Office of Management and Budget, Room 10235, New Executive 
Office Building, Washington DC 20503; Attention: Desk Officer for the 
Pension and Welfare Benefits Administration. Although comments may be 
submitted through February 14, 2000, OMB requests the comments be 
received within 30 days of the publication of the Notice of Proposed 
Class Exemption to ensure their consideration.
    Requests for copies of the ICR may be addressed to: Gerald B. 
Lindrew, Office of Policy and Research, U.S. Department of Labor, 
Pension and Welfare Benefits Administration, 200 Constitution Avenue, 
NW, Room N-5647, Washington, D.C. 20210. Telephone: (202) 219-4782 
(this is not a toll-free number); Fax: (202) 219-4745.
    Title: Notice of Proposed Class Exemption for Cross-Trades of 
Securities by Index and Model-Driven Funds.
    Type of Review: New.
    AGENCY: Department of Labor, Pension and Welfare Benefits 
Administration.
    Affected Entities: Business or other for-profit.
    SUMMARY: The proposed class exemption would permit cross-trades by 
Funds in which plans invest and among

[[Page 70058]]

such Funds and Large Accounts pursuant to portfolio restructuring 
programs which, in absence of the exemption, would be prohibited by 
ERISA. The information collection requirements incorporated within the 
proposed class exemption are designed as appropriate safeguards to 
ensure, among other things, prior approval by a plan of its 
participation in a cross-trading program, proper disclosures of 
information about a cross-trading program to plan investors, fair 
pricing procedures for securities cross-traded between the Funds or 
between such Funds and other Large Accounts managed by the investment 
manager, and the absence of a significant degree of investment 
discretion by the investment manager in the selection of particular 
securities for the Funds.
    Needs and Uses: In order for the Department to grant an exemption 
for a transaction that would otherwise be impermissible under ERISA, 
the statute requires that the Department make a finding that the 
proposed exemption meets the statutory requirements of section 408(a). 
Section 408(a) requires a finding that the exemption is 
administratively feasible, in the interest of the plan and its 
participants and beneficiaries, and protective of the rights of the 
participants and beneficiaries. In order to ensure that this exemption 
meets the statutory requirements, the Department finds it necessary 
that certain information be provided to an independent fiduciary of 
each plan that invests in an Index or Model-Driven Fund, and that the 
independent fiduciary approve the plan's participation in a cross-
trading program.
    Respondents and Total Responses: The Department estimates that 
approximately 10 entities will seek to take advantage of the class 
exemption in a given year. The respondents will be banks and other 
investment managers acting as fiduciaries of plans investing in Index 
and Model-Driven Funds managed by such entities. There are expected to 
be 61,800 responses per year or 6,180 responses per entity per year.
    Estimated Annual Burdens: The Department staff estimates the annual 
burden for preparing the materials required under the proposed class 
exemption to be a total of 68,150 hours or 6,815 hours per entity. The 
total annual burden cost (operating/maintenance) is estimated to be 
$116,184 or $11,618 per entity.
    Comments submitted in response to this Notice of Proposed Class 
Exemption will be summarized and/or included in the request for OMB 
approval of the information collection request; they will also become a 
matter of public record.

II. Background

    On March 20, 1998, a Notice was published in the Federal Register 
[63 FR 13696] to announce that the Department has under consideration 
certain applications for exemptions relating to cross-trades of 
securities by investment managers with respect to any account, 
portfolio or fund holding ``plan assets'' <SUP>3</SUP> subject to the 
fiduciary responsibility provisions of Part 4 of Title I of ERISA. The 
Department published the Notice to request information which would 
assist it in determining what standards and safeguards are appropriate 
for future exemptions for cross-trades of securities.
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    \3\ See 29 CFR Part 2510.3-101, Definition of ``plan assets''--
plan investments.
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    The Department understands that securities cross-trading is a 
common practice among investment managers and advisers as a means for 
executing securities transactions for client accounts that are not 
subject to the fiduciary responsibility provisions of 
ERISA.<SUP>4</SUP> Such cross-trades could be either direct cross-
trades or brokered cross-trades.
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    \4\ The Department is expressing no opinion herein as to whether 
such cross-trade practices are in compliance with the relevant 
federal securities laws regulating securities transactions and/or 
the provision of investment advisory or management services by an 
investment manager. For example, cross-trading of securities between 
mutual funds and other accounts that use the same or affiliated 
investment advisers is permitted if the transactions are 
accomplished in accordance with SEC Rule 17a-7, an exemption from 
the prohibited transaction provisions of section 17(a) of the 
Investment Company Act of 1940 (see 17 CFR 270.17a-7). For a 
discussion of the issues relating to the use of SEC Rule 17a-7 for 
ERISA plan accounts, see the Notice published on March 20, 1998 (63 
FR 13696, 13698-13700).
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    Direct cross-trades occur whenever an investment manager causes the 
purchase and sale of a particular security to be made directly between 
two or more accounts under its management without a broker acting as 
intermediary. Under this practice, the manager executes a securities 
transaction between its managed accounts without going into the ``open 
market''--such as a national securities exchange (e.g. the New York 
Stock Exchange--``NYSE'') or an automated broker-dealer quotation 
system (e.g. the National Association of Securities Dealers Automated 
Quotation National Market System--``NASDAQ'').
    Brokered cross-trades occur whenever an investment manager places 
simultaneous purchase and sale orders for the same security with an 
independent broker-dealer under an arrangement whereby such broker-
dealer's normal commission costs are reduced. In such instances, 
brokers are often willing to accept a lower commission because the 
transaction will be easier to execute where there are shares already 
available to complete the order for both the buyer and the seller.
    In the Notice published on March 20, 1998, the Department noted 
that cross-trading transactions could result in violations of one or 
more provisions of Part 4 of Title I of ERISA. For example, section 
406(b)(2) provides that an ERISA fiduciary may not act in any 
transaction involving a plan on behalf of a party (or represent a 
party) whose interests are adverse to the interests of the plan or the 
interests of its participants or beneficiaries. Where an investment 
manager has investment discretion with respect to both sides of a 
cross-trade of securities and at least one side is an employee benefit 
plan account, the Department has previously taken the position that a 
violation of section 406(b)(2) of ERISA would occur.<SUP>5</SUP> The 
Department has taken the position that by representing the buyer on one 
side and the seller on the other in a cross-trade, a fiduciary acts on 
behalf of parties that have adverse interests to each 
other.<SUP>6</SUP> Moreover, the prohibitions embodied in section 
406(b)(2) of ERISA are per se in nature. Merely representing both sides 
of a transaction presents an adversity of interests that violates 
section 406(b)(2) even absent fiduciary misconduct reflecting harm to a 
plan's beneficiaries.<SUP>7</SUP>
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    \5\ Reich v. Strong Capital Management Inc., No. 96-C-0669, USDC 
E.D. Wis. (June 6, 1996).
    \6\ See Strong Capital Management Inc., supra.
    \7\ See, Cutaiar v. Marshall, 590 F.2d 523 (3d Cir. 1979). In 
Cutaiar, the court held that, ``[W]hen identical trustees of two 
employee benefit plans whose participants and beneficiaries are not 
identical effect a loan between the plans without a section 408 
exemption, a per se violation of ERISA exists.'' Cutaiar, 590 F.2d 
at 529.
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    In addition, violations of section 406(b)(1) or (b)(3) of ERISA may 
occur when an investment manager has discretion for both sides of a 
cross-trade. Section 406(b)(1) of ERISA prohibits a plan fiduciary from 
dealing with the assets of the plan in his own interest or for his own 
account. Section 406(b)(3) prohibits a plan fiduciary from receiving 
any consideration for his own personal account from any party dealing 
with such plan in connection with a transaction involving the assets of 
the plan.
    It should also be noted that violations of section 403 and 404 
could arise where the investment manager represents both sides in a 
cross-trade.

[[Page 70059]]

Section 404(a)(1)(A) of ERISA requires, in part, that a plan fiduciary 
must discharge its duties solely in the interests of the participants 
and beneficiaries of that plan and ``for the exclusive purpose'' of 
providing benefits to participants and beneficiaries and defraying 
reasonable plan expenses. Similarly, section 403(c)(1) of ERISA 
requires, in part, that the assets of a plan must be ``[H]eld for the 
exclusive purposes of providing benefits to participants in the plan 
and their beneficiaries and defraying reasonable expenses of 
administering the plan.''
    In the Department's view, conflicts of interest in cross-trading 
occur because a manager is exercising investment and trading discretion 
over both sides to the same transaction and making decisions as to: 
which securities to buy or sell; how much of each security to buy or 
sell; when to execute a sale or purchase of each security; where to 
conduct a trade (i.e., on a market or through a cross-trade); and at 
what price to conduct a trade.
    In the Notice published on March 20, 1998, the Department discussed 
the types of individual exemptions previously granted for cross-trades 
of securities.<SUP>8</SUP> As noted therein, these past exemptions fall 
generally into two categories: (1) Those for Index and Model-Driven 
Funds; and (2) those for actively-managed or discretionary asset 
management arrangements.<SUP>9</SUP>
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    \8\ The individual exemptions generally have focused on direct 
cross-trading transactions. These exemptions have provided relief 
from the prohibitions of section 406(b)(2) of ERISA, but have not 
provided relief for any violations of section 406(b)(1) or (b)(3) of 
ERISA. It should also be noted that the Department does not have 
authority under section 408(a) of ERISA to exempt a plan fiduciary 
from any violations of sections 403 and 404 of ERISA. Thus, even 
when proceeding under an individual exemption, an investment manager 
remains fully liable under sections 403 and 404 of ERISA for the 
investment decisions relating to cross-trades.
    \9\ In this regard, see the following Prohibited Transaction 
Exemptions (PTEs): PTE 95-83, Mercury Asset Management (60 FR 47610, 
September 13, 1995); PTE 95-66, BlackRock Financial Management L.P., 
(60 FR 39012, July 31, 1995); PTE 95-56, Mellon Bank, N.A. (60 FR 
35933, July 12, 1995); PTE 94-61, Batterymarch Financial Management 
(59 FR 42309, August 17, 1994); PTE 94-47, Bank of America National 
Trust and Savings Association (59 FR 32021, June 21, 1994); PTE 94-
43, Fidelity Management Trust Company (59 FR 30041, June 10, 1994); 
PTE 94-36, The Northern Trust Company (59 FR 19249, April 22, 1994); 
PTE 92-11, Wells Fargo Bank, N.A. (57 FR 7801, March 4, 1992)--which 
replaced PTE 87-51 noted below; PTE 89-116, Capital Guardian Trust 
Company (54 FR 53397, December 28, 1989); PTE 89-9, State Street 
Bank and Trust Company (54 FR 8018, February 24, 1989); PTE 87-51, 
Wells Fargo Bank, N.A. (52 FR 22558, June 12, 1987); and PTE 82-133, 
Chase Manhattan Bank, N.A. (47 FR 35375, August 13, 1982).
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    The trading decisions made for the Index and Model-Driven Funds 
involved are ``passive'' or ``process-driven.'' In the case of an Index 
Fund, the investment manager has been hired to invest money according 
to a formula that, for example, tracks the rate of return, risk 
profile, and other characteristics of an independently maintained index 
by either replicating the entire portfolio of the index or by investing 
in a representative sample of such portfolio designed to match the 
projected risk/return profile of that index. Model-Driven Funds are 
based upon formulae by which an ``optimal'' portfolio is created to 
implement some specific investment strategy that is either based upon 
or measured by an independently maintained index of securities. These 
``process driven'' programs are implemented only by investment in an 
index replicating portfolio (in the case of index funds) or a set 
``optimum'' portfolio (in the case of model-driven funds). In granting 
these exemptions, the Department did not believe, based on the 
representations made by the applicants requesting the prior exemptions, 
that the selection of individual securities for Index and Model-Driven 
Funds using such ``process-driven'' strategies would involve any 
significant exercise of investment discretion by the investment manager 
managing the Funds. In actively-managed programs, trading decisions are 
made by individuals hired to select particular securities as 
professional investment managers.
    In the exemption applications, the applicants have represented to 
the Department that cross-trading provides certain benefits to employee 
benefit plans as Fund investors. For example, when one Fund needs to 
sell the same securities that another Fund needs to buy on the same 
day, a cross-trade saves both the selling Fund and the buying Fund the 
transaction costs (e.g., brokerage commissions or the bid-offer spread) 
that would otherwise have been paid to a broker-dealer for executing 
the transaction on the open market.
    While recognizing the advantages of cross-trading to plans, the 
Department has particular concerns where managers have investment 
discretion over both sides of a cross-trade transaction. The conditions 
contained in the Department's prior individual exemptions for cross-
trades by Index and Model-Driven Funds and actively-managed funds were 
intended to address these concerns and to safeguard plans against the 
inherent conflict of interest which exists when there is a common 
investment manager for both sides of a transaction. In this regard, the 
conditions incorporated into these exemptions were designed to protect 
plans against the potential that an investment manager may exercise 
discretion to favor one account over another; e.g., in the pricing of a 
particular cross-trade, in the decision to either buy and/or sell 
particular securities for an ERISA account, or to allocate securities 
among accounts, including ERISA accounts.
    The Department recognizes that its concerns are more apparent in 
situations involving actively-managed accounts or funds, where an 
investment manager has total investment discretion to choose particular 
securities for such accounts or funds at any time, subject only to 
general investment guidelines or objectives established by the client 
plan fiduciaries. As a result, the Department is not proposing relief 
for transactions involving actively-managed cross-trading at this time. 
Information obtained by the Department in response to the Notice with 
respect to cross-trades of securities by actively-managed funds is 
currently under consideration by the Department.<SUP>10</SUP> 
Publication of the proposed exemption does not foreclose future 
consideration of additional exemptive relief for actively-managed 
programs. However, the Department believes that it has developed a 
sufficient record, through consideration of past individual exemptions 
and comments to the Notice, to propose relief for passive and process-
driven cross-trading, subject to certain restrictions and limitations 
regarding the exercise of fiduciary discretion.
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    \10\ In this regard, the Department directs interested persons 
to a notice of public hearing which the Department is also 
publishing in today's Federal Register.
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    With respect to this exemptive relief for cross-trades by Index and 
Model-Driven Funds, it should be noted that, through the development of 
past cross-trading exemptions and enforcement proceedings, the 
Department became aware of issues that have caused it to reexamine its 
exemption policy for such transactions. As a result, certain of the 
conditions and definitions contained in this proposal differ from a 
number of the conditions and definitions developed over time for the 
previously granted passive and process-driven individual exemptions. 
These proposed modifications reflect the importance to the Department 
of retaining flexibility to review its exemption policy in the context 
of changed circumstances or new facts brought to its attention.
    For example, in the ``process-driven'' context, it was represented 
to the Department in past exemption applications that investment 
managers who manage accounts or pooled funds

[[Page 70060]]

often attempt to track the rate of return, risk profile and other 
characteristics of an independently maintained third party index (e.g., 
the Standard & Poors 500 Composite Stock Price Index a/k/a the S&P 500 
Index, the Wilshire 5000 Index, the Russell 2000 Index). These pooled 
funds are usually collective investment funds established and trusteed 
by large banks that manage money for institutional investors, including 
employee benefit plans. Under the Department's past exemptions, such 
funds may cross-trade pursuant to certain narrowly-defined ``triggering 
events'' which involve little, if any, discretion on the part of the 
investment manager.
    In the past, various applicants represented to the Department that 
the investment strategy of most Index Funds merely involved replicating 
the capitalization-weighted composition of a particular index. In this 
regard, FERSA itself requires that the Common Stock Index Investment 
Fund (an S&P 500 Fund) be invested in a portfolio that is ``* * * 
designed such that, to the extent practicable, the percentage of the 
Common Stock Index Investment Fund that is invested in each stock is 
the same as the percentage determined by dividing the aggregate market 
value of all shares of that stock by the aggregate market value of all 
shares of all stocks included in such index.'' 5 U.S.C. 
Sec. 8438(b)(2)(B).<SUP>11</SUP> Consequently, in the past, the 
Department generally focused on issues relating to Index Funds which 
simply replicated the capitalization-weighted composition of a 
particular index.
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    \11\ In addition, section 8438 (b)(3)(B) and (b)(4)(B) of FERSA 
contain similar requirements for the Small Capitalization Stock 
Index Investment Fund and International Stock Index Investment Fund.
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    However, the Department now understands that the process that Index 
Funds use to replicate the returns of an index may not be limited to 
replicating the exact composition of the index and that many, if not 
most, Index Funds do not totally replicate the exact composition of the 
index that is being tracked. In many instances, the manager maintains 
some discretion to select particular securities to track the rate of 
return, risk profile and other characteristics of the overall index 
without actually holding all of the securities included in the index. 
Some Index Funds are designed to exceed the rate of return and/or 
deviate from the risk profile of the index by altering the composition 
or weighting of securities within the index as designated by the 
organization that maintains the index. These ``enhanced'' Index Funds 
often have strategies that resemble actively-managed accounts. 
Therefore, the Department believes that the definition of an ``Index 
Fund'' that is permitted to cross-trade pursuant to certain narrowly-
defined ``triggering events'' needs to be modified under the proposal 
from that contained in prior individual exemptions.
    In addition, Model-Driven Funds are portfolios that apply specific 
investment philosophies and criteria in formulaic fashion to create a 
specialized portfolio. Model-Driven Funds may come in many different 
forms. Some Model-Driven Funds seek to transform the capitalization-
weighted or other specified composition of an index in order to 
accomplish certain goals. Such goals may include client-initiated 
instructions to delete certain stocks from an index that is otherwise 
being tracked, or investment management styles which incorporate 
mathematical formulae designed to focus on certain investment criteria 
(e.g., price-earnings ratios) at certain times in order to achieve a 
rate of return for the model-driven portfolio that exceeds that of the 
underlying index. Thus, some Model-Driven Funds appear to be a more 
sophisticated type of ``enhanced'' Index Fund.
    The Department notes that the proposed exemption would not be 
available to a Fund if the manager has modified the index or design of 
the model to produce cross-trade opportunities. For example, the 
exemption would not be available to a Fund if the manager has modified 
the index or design of the model to generate buy or sell orders based 
on the availability of a security within the control of the manager. 
Such a modification or design would cause a Fund to engage in cross-
trades solely for the purpose of providing matching trades suited to 
another Fund's needs rather than for the investment purposes of the 
Fund whose trading criteria have been modified.
    The Department believes that the definition of a ``Model-Driven 
Fund'' that cross-trades pursuant to ``triggering events'' also needs 
to be modified from that contained in prior exemptions. Further, the 
Department is of the view that the definition of a ``triggering event'' 
should be modified to reduce the amount of discretion that an 
investment manager may exercise in connection with a cross-trading 
decision on behalf of a Model-Driven Fund.

III. Discussion of the Comments on the Notice

    The Department received a total of twenty-nine (29) comment letters 
on the Notice, approximately half of which addressed cross-trades by 
Index and Model-Driven Funds. Some of these comments were from major 
industry groups, such as associations representing investment managers 
that act as fiduciaries for employee benefit plans.
    Many of these comments responded directly to the specific questions 
posed by the Department in the Notice. These comments, as they relate 
to cross-trades by Index and Model-Driven Funds, are summarized below.
    The comments almost universally endorsed the idea of the Department 
proposing additional exemptive relief for cross-trades of securities by 
Index and Model-Driven Funds. All of the comments noted that, under 
appropriate conditions, cross-trading can provide numerous benefits to 
client accounts and funds, including the avoidance of brokerage 
commissions and bid-offer spreads that would otherwise be incurred, and 
the avoidance of adverse market impact costs if such trades were 
transacted on the open market. In addition, many of the commenters 
noted that in international markets there are benefits from cross-
trading associated with avoiding other related transaction costs, such 
as settlement charges, registration fees, and certain taxes. As noted 
above, the Department questions whether avoiding adverse market impact 
costs is favorable to the party that would have received a better price 
had the market price moved in its favor prior to engaging in the 
transaction. The Department invites comments regarding this concern.
    A commenter stated that the advantages provided by cross-trading 
securities are magnified in the case of ``passively'' managed accounts 
or funds, primarily because of the relatively large account sizes and 
overlap in portfolio composition. For example, because Index and Model-
Driven Funds must maintain certain weighting and parameters, cash 
inflows into one Fund essentially mandate the acquisition of an array 
of securities, while cash outflows in another Fund may require the 
simultaneous disposition of many of the same securities.
    With respect to the size of the market attributable to assets of 
employee benefit plans that cross-trade, one comment from a large 
investment manager estimated that over $700 billion of pension and 
retirement funds are invested in ``passive'' strategies (e.g., Index 
and Model-Driven Funds) which rely heavily on cross-trading to minimize 
transaction costs. Another comment from a major bank that manages Index 
and Model-Driven Funds

[[Page 70061]]

stated that the bank estimates that cross-trading saves its clients 
hundreds of millions of dollars each year by substantially reducing 
transaction costs. Other comments from major corporations with large 
pension plans that invest in Index and Model-Driven Funds also noted 
transaction cost savings of over $1,000,000 for each of their plans 
over a two-year period. Similar comments were made by other 
institutional investors, such as governmental plans.
    The Department is concerned that the savings mentioned by the 
commenters may not only be reflective of transaction cost savings, but 
may also reflect ``savings'' attributable to the avoidance of market 
impact by cross-trading securities rather than engaging in open market 
transactions. The Department seeks further comments and data regarding 
the savings which may be expected from cross-trades and the basis for 
such savings.
    Some commenters further asserted that clients demand cross-trading 
capabilities as a condition for the investment manager to handle their 
accounts. With ``passive'' investment management strategies that seek 
to replicate the rate of return, risk profile and other characteristics 
of a designated index (e.g., the S&P 500 Index), the success of an 
investment manager is often measured by the tracking error of the 
managed portfolio vis-a-vis the index. Cross-trades of securities help 
reduce an investment manager's overall transaction costs, which are 
otherwise a major source of tracking error in relation to the index 
because the index is valued without taking into consideration 
transaction costs. Thus, it is virtually impossible for an investment 
manager to replicate the rate of return, risk profile and other 
characteristics of an index, or to accurately track the designated 
composition and weighting of the securities contained therein, when the 
organization maintaining such index establishes the value of the index 
exclusive of such transaction costs. In addition, the comments note 
that every dollar a portfolio spends on transaction costs (either as 
spreads or commissions) detracts from the investment strategy guideline 
that has been mandated by the independent plan fiduciary--i.e., to come 
as close as possible to the rate of return, risk profile and other 
characteristics of the designated index.
    Moreover, cross-trades of securities by Model-Driven Funds that are 
designed to exceed the rate of return of a designated index also 
achieve better results by reducing transaction costs. A commenter noted 
that the computer models, which create the portfolios for a Model-
Driven Fund by transforming an index, dictate the securities to be 
purchased and sold in precise quantities. Thus, the commenter stated 
that the types of passive strategies used by these Funds do not work as 
effectively if an investment manager must make decisions with respect 
to purchases or sales of individual securities which override the 
selections made by the computer model.
    In this regard, one commenter asserted that cross-trading enables 
an investment manager to obtain, or dispose of, the necessary amounts 
of such securities without having to alter a model's investment 
strategy because of transaction costs associated with achieving the 
desired goal. Other comments asserted that cross-trading is merely 
another method of executing the purchase or sale of a security that has 
already been included on the trade list of a Model-Driven Fund for a 
particular day. Thus, the decision to buy or sell a security through 
cross-trades, rather than on the open market, is made after the trade 
list for the purchase or sale of that security has been prepared. Such 
trade lists are developed by computer models which use prescribed 
objective factors and external data to automatically generate a model-
prescribed portfolio, or use a client's instructions to buy or sell 
particular securities to facilitate a client-initiated portfolio 
restructuring.
    Still other commenters noted that the computer models or 
optimization programs that drive a Model-Driven Fund are designed to 
keep the Fund's portfolio of securities balanced with the projected 
return, risk profile and other characteristics of the appropriate model 
or index. One major bank that manages such Funds commented that these 
models are not designed to increase the frequency of cross-trades, but 
rather to apply quantitative techniques to achieve a predetermined 
investment strategy. This comment stated that investment managers do 
not let the ``tail wag the dog'' by weighting or manipulating the 
investment models to produce more cross-trades.
    With respect to the degree of investment discretion exercised by an 
investment manager in creating and operating a Model-Driven Fund, one 
comment asserted that, while the creation of a computer model may 
require human intervention, the operation of a Model-Driven Fund in 
accordance with the dictates of the model involves the same type of 
``passive'' investment strategy and human intervention as an Index 
Fund. In addition, the comments state that these computer models are 
rarely changed and their operations are free of any overt or subtle 
discretion exercised by the investment manager. When such models are 
changed, clients are often provided with prior notice of the change and 
objective criteria are used to design the new ``passive'' investment 
strategy. The comments maintain that the mere ability to change the 
model, exercised infrequently, does not change a strategy from passive 
to active. In this regard, some of the comments state that an 
investment manager for an Index or Model-Driven Fund is not hired by 
its clients to subjectively analyze individual securities or a range of 
securities, and that the compensation paid to the investment manager 
for implementing a ``passive'' investment strategy is much less than 
that required for active management. Thus, these comments note that the 
level of compensation paid to a ``passive'' investment manager reflects 
the role that such manager has in operating a Model-Driven Fund.
    In any event, all of the comments state that the benefits of cross-
trading override any concerns the Department may have regarding the 
degree of discretion a particular investment manager may exercise in 
the design and implementation of a computer model used for a Model-
Driven Fund. The comments assert that these concerns are further 
mitigated by the conditions of the Department's past exemptions which 
require, among other things, that: (1) cross-trades by the Funds can 
occur only in response to various ``triggering events'' which are not 
within the manager's control or discretion; (2) a large plan or other 
large account can only engage in cross-trades with an Index or Model-
Driven Fund where the investment decisions relating to a particular 
portfolio restructuring program for the large plan/account are made by 
a fiduciary or other appropriate decision-maker who is independent of 
the investment manager; (3) all cross-trade transactions will occur 
within three business days of the ``triggering event'' necessitating 
the purchase or sale; (4) all cross-traded securities must be 
securities for which there is a generally recognized market; (5) the 
price for all securities involved in the cross-trade will be the 
current market value for the securities on the close of the trading day 
in which the transaction occurs; and (6) the investment manager may not 
receive additional compensation as a result of the cross-trade.
    After consideration of the information contained in the comments 
relating to cross-trades of securities by Index and Model-Driven Funds 
and the current

[[Page 70062]]

cross-trade practices utilized by investment managers that manage such 
Funds, the Department has determined to propose this class exemption. 
As discussed in further detail below, this proposed class exemption for 
cross-trades of securities by Index and Model-Driven Funds contains 
many of the same conditions that appear in the individual exemptions 
previously granted by the Department, with certain modifications. In 
addition, the proposal contains a number of new conditions and 
definitions which attempt to address concerns that have been raised 
since those exemptions were granted.

IV. Description of the Proposed Exemption

A. Scope and General Rule

    The proposed exemption consists of four parts. Section I sets forth 
the general exemption and describes the transactions covered by the 
exemption. Sections II and III contain specific and general conditions 
applicable to transactions described in section I. Section IV contains 
definitions for certain terms used in the proposed exemption.
    The exemption set forth in section I would provide relief from the 
restrictions of sections 406(a)(1)(A) and 406(b)(2) of ERISA and 
section 8477(c)(2)(B) of FERSA for: (a) the purchase and sale of 
securities between an Index or Model-Driven Fund and another such Fund, 
at least one of which holds ``plan assets'' subject to the Act; and (b) 
the purchase and sale of securities between such Funds and certain 
large accounts (Large Accounts) pursuant to portfolio restructuring 
programs of the Large Accounts.
    The proposed exemption under section I(a) applies to cross-trades 
of securities among Index or Model-Driven Funds managed by the same 
investment manager where both Funds contain plan assets. However, as 
stated above, a violation of section 406(b)(2) occurs when an 
investment manager has investment discretion with respect to both sides 
of a cross-trade of securities and at least one side is an entity which 
contains plan assets. As a result, the proposed exemption is also 
applicable to situations where the investment manager has investment 
discretion for both Funds involved in a cross-trade but one Fund does 
not contain plan assets because, for example, it is registered as an 
investment company under the Investment Company Act of 1940 (e.g., a 
mutual fund). Any mutual fund or other institutional investor covered 
by the proposed exemption under section I(a) must meet the definition 
of an Index Fund or a Model-Driven Fund, contained in section IV(a) and 
(b). Institutional investors which meet the definition contained in 
section IV(a) and (b) may include, but are not limited to, entities 
such as insurance company separate accounts or general accounts, 
governmental plans, university endowment funds, charitable foundation 
funds, trusts or other funds exempt from taxation under section 501(a) 
of the Code.
    The proposed exemption under section I(b) would apply to the 
purchase and sale of securities between a Fund and a Large Account, at 
least one of which holds ``plan assets'' subject to ERISA or FERSA, 
pursuant to portfolio restructuring programs initiated on behalf of 
certain Large Accounts. The term ``Large Accounts'' is defined in 
section IV(e) as certain large employee benefit plans or other large 
institutional investors with at least $50 million in total assets, 
including certain insurance company separate and general accounts and 
registered investment companies. A portfolio restructuring program, as 
defined in section IV(f), involves the buying and selling of securities 
on behalf of a Large Account in order to produce a portfolio of 
securities which either becomes an Index Fund or a Model-Driven Fund or 
resembles such a Fund, or to carry out a liquidation of a specified 
portfolio of securities for a Large Account. The definition of a Large 
Account requires that an independent fiduciary authorize an investment 
manager (i.e., a Manager, as defined in section IV(i)) to restructure 
all or part of the portfolio or to act as a ``trading adviser'' as 
defined in section IV(g) with respect to the restructuring of such 
portfolio. The trading adviser's role is limited under the proposed 
exemption to the disposition within a stated period of time of a 
securities portfolio of a Large Account and the creation of the 
required portfolio. Under this definition, the manager may not have any 
discretionary authority for any asset allocation, security selection, 
restructuring or liquidation decisions or otherwise provide investment 
advice with respect to such transactions. It has been represented to 
the Department that, in such restructuring transactions, commissions 
and other costs are saved by not having to liquidate all of the 
securities contained in the Large Account's portfolio on the open 
market. In this regard, the Department notes that it expects the 
investment manager to comply with the applicable securities laws in 
connection with any portfolio restructuring program.
    Section IV(a) and (b) require that the Index or Model-Driven Fund 
be based upon an index which represents the investment performance of a 
specific segment of the public market for equity or debt securities. 
Section IV(c) requires that the index be established and maintained by 
an independent organization which is: in the business of providing 
financial information or brokerage services to institutional clients; a 
publisher of financial news or information; or a public stock exchange 
or association of securities dealers. The index must be a standardized 
index of securities which is not specifically tailored for the use of 
the manager. The Department seeks comments directed to the proposed 
definition of an index.
    Section IV(a) and (b) specifically define Index and Model-Driven 
Funds for purposes of the proposed exemption. These definitions are 
designed to limit the amount of discretion the manager can exercise to 
affect the identity or amount of securities to be purchased or sold and 
to assure that the purchase or sale of any security is not part of an 
arrangement, agreement or understanding designed to benefit the 
manager. Under the definition of ``Index Fund'' contained in section 
IV(a), the investment manager must track the rate of return of an 
independently maintained securities index by either replicating the 
same combination of securities which compose such index or by investing 
in a representative sample of such portfolio based on objective 
criteria and data designed to recreate the projected return, risk 
profile and other characteristics of the index. Under the definition of 
``Model-Driven Fund'' contained in section IV(b), trading decisions are 
passive or process-driven since the identity and the amount of the 
securities contained in the Fund must be selected by a computer model. 
Although the manager can use its discretion to design the computer 
model, the model must be based on prescribed objective criteria using 
third party data, not within the control of the manager, to transform 
an independently maintained index. Thus, for example, no exemptive 
relief would be available if the manager designed the computer model to 
consider the liquidity or the availability of a security based on 
information that was solely within the control of the manager. In such 
instances, the computer model would be considering data that was not 
from a third party source, and that was within the control of the 
manager.

B. Price and Securities

    Section II(a) requires that the cross-trade must be executed at the 
closing price for that security. ``Closing price'' is defined in 
section IV(h) as the price

[[Page 70063]]

for the security on the date of the transaction, as determined by 
objective procedures disclosed to Fund investors in advance and 
consistently applied with respect to securities traded in the same 
market. The procedures shall indicate the independent pricing source 
(and alternates, if the designated pricing source is unavailable) used 
to establish the closing price and the time frame after the close of 
the market in which the closing price will be determined. The pricing 
source must be independent of the manager and must be engaged in the 
ordinary course of business of providing financial news and pricing 
information to institutional investors and/or the general public, and 
must be widely recognized as an accurate and reliable source for such 
information. In this regard, some managers use one pricing service for 
pricing domestic securities and another pricing service for pricing 
foreign securities. With respect to foreign securities, the applicable 
independent pricing source should provide the price in local currency 
rates and, if that currency is other than U.S. dollars, also provide 
the U.S. dollar exchange rate. Thus, securities would be cross-traded 
in all cases at the closing prices received by the manager from the 
relevant independent pricing source.
    The Department has adopted this definition in an effort to be 
consistent with the methods for determining the price of cross-traded 
securities currently utilized by Index and Model-Driven Fund investment 
managers, according to the comments to the Notice published on March 
20, 1998. In addition, the Department believes that this pricing 
approach will ensure that the pricing procedures utilized are objective 
and not subject to the discretion or manipulation of any of the 
involved parties. The comments received indicated that passive managers 
generally utilize independent pricing services which collect 
information on closing prices of securities. However, the Department 
realizes that passive fund managers have an ever present need to retain 
the flexibility to consider advanced trading or pricing techniques 
which could reduce costs that generate tracking error or which reflect 
a more refined view of the market behavior of a specific security. 
Comments are invited as to whether the definition of the price for a 
cross-traded security contained in this proposal is responsive to that 
need.
    Section II(f) requires that the cross-trades of either equity 
securities or fixed income securities involve only securities for which 
market quotations are readily available from independent sources that 
are engaged in the ordinary course of business of providing financial 
news and pricing information to institutional investors and/or the 
general public, and are widely recognized as accurate and reliable 
sources for such information. Section II(f)(1) further requires that 
cross-trades of equity securities only involve securities which are 
widely-held and actively-traded. In this regard, the Department notes 
that equity securities will be deemed to be ``widely-held'' and 
``actively-traded'' under this proposed exemption if such securities 
are included in an independently maintained index, as defined in 
section IV(c) herein. The Department invites comments from interested 
persons regarding the definitions of the types of allowable securities 
permitted to be cross-traded under the exemption. The Department's 
intent is to exclude those securities which are thinly-traded. This 
intent is based upon the underlying notion that the cross-trading of a 
security may avoid the market impact on the price of the security that 
a similar trade on the market would produce. This avoidance of market 
impact through cross-trading would be more dramatic with thinly-traded 
securities. The Department expects that managers, in making their 
determinations regarding the types of securities included within the 
scope of this condition, would consider information about the average 
daily trading volume for U.S. equities traded on a nationally 
recognized securities exchange or NASDAQ which would be readily 
available from independent pricing sources or other independent sources 
which publish financial news and information.
    The Department also invites comments from interested persons as to 
whether Index Funds and Model-Driven Funds may hold significant amounts 
of the outstanding shares of a particular security which is included in 
an index used by a manager to design and operate a portfolio for its 
Funds. In addition, the Department invites comments as to whether 
cross-trades of securities by a manager's Funds, which may represent a 
high percentage of the average daily trading volume for the securities 
on the open market, avoids the market impact that the same trades would 
have if executed on the open market.

C. Triggering Events

    Section II(b) of the proposed exemption requires that any purchase 
or sale of securities by a Fund in a cross-trade with another Fund or 
with a Large Account occur as a direct result of a ``triggering 
event,'' as defined in section IV(d), and that such cross-trade be 
executed no later than the close of the second business day following 
such ``triggering event.'' The Department believes that trading 
pursuant to triggering events limits the discretion of the manager to 
affect the identity or amount of securities to be purchased or sold. 
Triggering events, as defined in section IV(d), are outside the control 
of the manager and will ``automatically'' cause the buy or sell 
decision to occur.
    Triggering events are defined in section IV(d) as:
    (1) a change in the composition or weighting of the index 
underlying the Fund by the independent organization creating and 
maintaining the index;
    (2) A specific amount of net change in the overall level of assets 
in a Fund, as a result of investments in and withdrawals from the Fund, 
provided that: (A) Such specified amount has been disclosed in writing 
as a ``triggering event'' to an independent fiduciary of each plan 
having assets held in the Fund prior to, or within ten (10) days after, 
its inclusion as a ``triggering event'' for such Fund; and (B) 
investments or withdrawals as a result of the manager's discretion to 
invest or withdraw assets of an employee benefit plan maintained by the 
manager for its own employees (a Manager Plan), other than a Manager 
Plan which is a defined contribution plan under which participants 
direct the investment of their accounts among various investment 
options, including such Fund, will not be taken into account in 
determining the specified amount of net change;
    (3) An accumulation in the Fund of a specified amount of either: 
(A) Cash which is attributable to interest or dividends on, and/or 
tender offers for, portfolio securities; or (B) stock attributable to 
dividends on portfolio securities; provided that such specified amount 
has been disclosed in writing as a ``triggering event'' to an 
independent fiduciary of each plan having assets held in the Fund prior 
to, or within ten (10) days after, its inclusion as a ``triggering 
event'' for such Fund; or
    (4) A change in the composition of the portfolio of a Model-Driven 
Fund mandated solely by operation of the formulae contained in the 
computer model underlying the Fund where the basic factors for making 
such changes (and any fixed frequency for operating the formulae 
contained in the model) have been disclosed in writing to an 
independent fiduciary of each plan having assets held in the Fund prior 
to, or within ten (10) days after, its inclusion as a ``triggering 
event'' for such Fund.

[[Page 70064]]

    The first three triggering events have largely been adopted based 
upon those triggering events utilized in prior individual exemptions, 
with an additional requirement in the second and third triggering 
events for the amounts involved to be specified and disclosed to 
independent fiduciaries of plans investing in the Funds. In addition, 
the last triggering event has been added to the proposal in order to 
clarify that a triggering event also occurs as a result of a change in 
the composition of a Fund's portfolio mandated solely by operation of 
the computer model underlying the Fund. For example, if a model 
contained a formula for a Fund requiring only stocks with a certain 
price/earnings ratio and some of the originally prescribed stocks now 
were above the specified tolerances of the formula relating to that 
model, a triggering event would occur requiring that those stocks be 
sold by the Fund. The Department has added this triggering event under 
this proposed exemption in order to clarify that certain Model-Driven 
Funds may need to buy or sell securities to conform to changes to the 
portfolio prescribed by the model that differ from changes to a 
portfolio necessitated as a result of changes to the underlying index. 
The proposed exemption does not require that a computer model be 
operated according to any fixed frequency, but, the Department is of 
the view that the proposed exemption would not be available unless the 
formulae contained in the computer model underlying a Fund are operated 
by the manager on an objective basis rather than being used for the 
purpose of creating cross-trade opportunities in response to the needs 
of other Funds or certain Large Accounts.
    The Department further notes that under section II(l), disclosures 
must be made to independent plan fiduciaries regarding the triggering 
events that would create cross-trading opportunities for Funds under 
the manager's cross-trading program. Under the model-driven triggering 
event contained in the proposal, the basic factors for making changes 
in the composition of the portfolio of a Model-Driven Fund mandated 
solely by operation of the formulae contained in the computer model 
must be included in these disclosures.
    Finally, the Department notes that if a computer model used to 
create a portfolio for a Model-Driven Fund is designed to exclude 
particular stocks for reasons specified by the plan client or the 
plan's investment guidelines, such exclusions would not be considered a 
separate triggering event.

D. Modifications to the Computer Model

    Section II(c) requires that, if the model or the computer program 
used to generate the model underlying the Fund is changed by the 
manager, no cross-trades of any securities can be engaged in pursuant 
to the proposed exemption for ten (10) business days following the 
change. This restriction recognizes the authority of the manager to 
change assumptions involving computer models after the model's 
activation.
    The Department notes that the proposed ten (10) business day 
``blackout'' period for cross-trades by a Fund after any change made by 
the manager to the model underlying the Fund is intended to prevent 
model changes which might be made by managers, in part, to deliberately 
create additional cross-trading activity. The 10-day period is based on 
a condition contained in a prior individual exemption for cross-trading 
by Index and Model-Driven Funds (e.g., Section I(d) of PTE 95-56, 
regarding Mellon Bank, 60 FR 35933, July 12, 1995) as well as 
representations made by applicants in a number of exemption 
applications currently under consideration.<SUP>12</SUP>
---------------------------------------------------------------------------

    \12\ These exemption applications are: D-9584, Wells Fargo Bank, 
N.A.; D-10107, Bankers Trust Company of New York; D-10188, Barclays 
Bank PLC and Affiliates; and D-10507, ANB Investment Management and 
Trust Company.
---------------------------------------------------------------------------

    However, the Department now understands that, in order to keep pace 
with the demands of investors in Model-Driven Funds, the industry 
changed many of its past practices which may now make a ``10-day 
blackout period'' for cross-trades problematic for certain Fund 
managers. For example, many Model-Driven Funds have more frequent 
opening dates for accepting new contributions from investors than in 
the past. In some cases, a Model-Driven Fund may be open for new 
contributions every day. In such instances, decisions regarding the 
implementation of a model change which would require the 10-day 
blackout period for cross-trades may place the manager in a situation 
of conflict between investors who wish to make contributions at 
different times.
    Therefore, the Department specifically requests comments from 
interested persons as to whether the proposed 10-day blackout period 
for cross-trades would be an acceptable approach to address our 
concerns regarding model changes that may be timed to create additional 
cross-trading opportunities or whether there are other approaches which 
would be equally effective, but less burdensome, to the manager's 
operation of the Fund. The Department also requests specific comments 
as to how frequently changes to a model are made.
    In addition, under section IV(b), a computer model for a Model-
Driven Fund must use independent third party data, not within the 
control of the manager, to transform an index.

E. Allocation of Cross-Trade Opportunities

    The Department notes that frequently the amount of a security which 
all of the Funds need to buy may be less than the amount of such 
security which all of the Funds will need to sell, or vice versa. Thus, 
section II(d) of the proposed exemption requires that all cross-trade 
opportunities be allocated by the manager among potential buyers, or 
sellers, on an objective basis. Under section II(d), this basis for 
allocation must have been previously disclosed to independent 
fiduciaries on behalf of each plan investor, and must not permit the 
exercise of any discretion by the manager. In previous individual 
exemptions, applicants have relied on different systems (e.g. pro rata 
or queue) to objectively allocate cross-trade opportunities. While it 
appears to the Department that a pro rata basis of allocation would be 
the method least subject to scrutiny, the Department recognizes the 
validity of other workable objective systems. However, the Department 
cautions that such systems may not permit the exercise of discretion by 
the manager.

F. Disclosures and Authorizations

    Section II(i) of the proposed exemption requires that a plan's 
participation in a cross-trade program of a manager will be subject to 
the prior written authorization of a plan fiduciary who is independent 
of the manager. This authorization, once given, would apply to all 
Funds that comprise the manager's cross-trading program at the time of 
the authorization. Thus, a new authorization by an independent plan 
fiduciary for investment in a different Fund, in which the plan did not 
invest at the time of its initial written authorization, would not be 
necessary to the extent that such Funds were part of the program at the 
time of the original authorization. However, where a manager makes new 
Funds available for plan investors or changes triggering events 
relating to Funds subject to the initial authorization, and such Funds 
or triggering events were not previously disclosed as being part of the 
manager's cross-trading program, section II(l) of the proposal requires 
that in such instances the manager furnish

[[Page 70065]]

additional disclosures to an independent plan fiduciary. The Manager 
shall provide a notice to each relevant independent plan fiduciary 
prior to, or within ten (10) days following, such addition of Funds or 
change to, or addition of, triggering events, which contains a 
description of such Fund(s) or triggering event(s). Such notice will 
also include a statement that the plan has the right to terminate its 
participation in the cross-trading program and its investment in any 
Index Fund or Model-Driven Fund without penalty at any time, as soon as 
is necessary to effectuate the withdrawal in an orderly manner.
    As noted below, section II(m) also requires that disclosures 
regarding any new Funds or triggering events be made as part of the 
notice required for a plan's annual re-authorization of its 
participation in the manager's cross-trading program, even though the 
plan receiving such notice has not invested in such new Funds.
    Section II(j) clarifies the meaning of Section II(i) with respect 
to existing plan investors in any of the Funds prior to a manager's 
implementation of a cross-trading program. Under section II(j), the 
authorizing independent fiduciary must be furnished notice and an 
opportunity to object to that plan's participation in the program not 
less than forty-five (45) days prior to the implementation of the 
cross-trade program. Section II(j) further states that the failure of 
the authorizing fiduciary to return a special termination form provided 
in the notice within thirty (30) days of receipt shall be deemed to be 
approval of the plan's participation in the program. If the authorizing 
plan fiduciary objects to the plan's inclusion in the program, the plan 
will be given the opportunity to withdraw without penalty prior to the 
program's implementation.
    Sections II(k) and II(l) describe the type of information that is 
required to be disclosed to a plan fiduciary prior to the authorization 
defined in sections II(i) and II(j). Important among these disclosures 
is a statement describing the conflicts that will exist as a result of 
the manager's cross-trading activities. This statement must also detail 
and explain how the manager's practices and procedures will mitigate 
such conflicts. Such writing must include a statement that:
    Investment decisions will not be based in whole or in part by the 
manager on the availability of cross-trade opportunities. These 
investment decisions include:
    <bullet> Which securities to buy or sell;
    <bullet> How much of each security to buy or sell; and,
    <bullet> When to execute a sale or purchase of each security.
    Investment decisions will be made prior to the identification and 
determination of any cross-trade opportunities. In addition, all cross-
trades by a Fund will be based solely upon triggering events set forth 
in the exemption. Records documenting each cross-trade transaction will 
be retained by the manager.
    Section II(m) further requires that notice be provided to the 
authorizing plan fiduciary at least annually of the plan's right to 
terminate its participation in the cross-trading program and its 
investment in any of the Funds without penalty. Such notice must be 
accompanied by a special termination form. Failure to return the form 
(within at least thirty (30) days of the receipt) will be deemed 
approval of the plan's continued participation in the cross-trading 
program. Such annual re-authorization will contain disclosures 
regarding any new Funds that are added to the cross-trading program or 
any new ``triggering events'' (as defined in Section IV(d) below) that 
may have been added to existing Funds since the time of the initial 
authorization described in Section II(i), or the time of the notice 
described in Section II(j).
    Section II(n) of the proposed exemption details specific 
requirements for cross-trades of securities which will occur in 
connection with a Large Account restructuring. In particular, section 
II(n)(2) requires that the authorization for such cross-trades must be 
made in writing prior to the cross-trade transactions by fiduciaries of 
the Large Account who are independent of the manager. Such 
authorization must follow full written disclosure of information 
regarding the cross-trading program. Such authorization may be 
terminated at will upon receipt by the manager of written notice of 
termination. A termination form must be supplied to the Large Account 
fiduciary concurrent with the written description of the cross-trading 
program. Under section II(n)(3), the portfolio restructuring program 
must be completed within thirty (30) days of the initial authorization 
made by the Large Account's fiduciary (or initial receipt of assets 
associated with the restructuring, if later), unless the Large 
Account's fiduciary agrees in writing to extend this period for another 
thirty (30) days. Large Account fiduciaries may utilize the termination 
form or any other written instrument at any time within this 30-day 
period to terminate their prior written authorization for cross-trading 
related to the portfolio restructuring program. Under section II(n)(4), 
within thirty (30) days of the completion of the restructuring program, 
the Large Account fiduciary must be fully apprised in writing of the 
results of the transactions. Such writing may include, upon request by 
the Large Account fiduciary, additional information sufficient to allow 
the independent fiduciary for the Large Account to verify the need for 
each cross-trade and the determination of the above decisions. However, 
the manager may refuse to disclose to a Large Account fiduciary or 
other person any such information which is deemed confidential or 
privileged if the manager is otherwise permitted by law to withhold 
such information from such person and, by the close of the thirtieth 
(30th) day following the request, the manager gives a written notice to 
such person advising that person both the reasons for the refusal and 
that the Department may request such information.

G. Recordkeeping

    Section III(a) requires that the manager maintain records necessary 
to allow a determination of whether the conditions of the proposed 
exemption have been met. These records must be maintained for a period 
of six (6) years from the date of the transactions. These records must 
include records which identify the following:
    (1) On a Fund by Fund basis, the specific triggering events which 
result in the creation of the model prescribed output or trade list of 
specific securities to be cross-traded;
    (2) On a Fund by Fund basis, the model prescribed output or trade 
list which describes: (A) Which securities to buy or sell; (B) how much 
of each security to buy or sell in detail sufficient to allow an 
independent plan fiduciary to verify that each of the above decisions 
for the Fund was made in response to specific triggering events; and
    (3) On a Fund by Fund basis, the actual trades executed by the Fund 
on a particular day and which of those trades were associated with 
triggering events.
    As explained to the Department, the triggering event relating to 
net investments in, or withdrawals from, a Fund results in new cash to 
invest in the Fund or the need to liquidate securities from a Fund. The 
model or index underlying the Fund determines which securities to 
purchase or sell based on the amount of net investments or withdrawals. 
This process results in the creation of a trade list or a model 
prescribed output of securities to be

[[Page 70066]]

purchased or sold. The manager then applies its objective allocation 
system to the trade lists or model prescribed outputs used for other 
Funds participating in the cross-trade program to determine which 
particular cross-trades will occur between Funds. For those securities 
which cannot be cross-traded after application of the manager's 
allocation system, the necessary purchases and sales are made through 
other means.
    In the view of the Department, records must be maintained of this 
cross-trading activity with enough specificity to allow an independent 
plan fiduciary to verify whether the safeguards of this exemption have 
been met. Section II(b) requires that any cross-trade of securities by 
a Fund occur as a direct result of a ``triggering event'' as defined in 
section IV(d) and is executed no later than the close of the second 
business day following such ``triggering event.'' Among the records 
needed to verify that this condition has been satisfied, section 
III(a)(1) requires that, on a Fund by Fund basis, the manager maintain 
a record of the specific triggering events which result in the creation 
of the list of specific securities for the manager's cross-trading 
system. Section III(a)(2) further requires that, on a Fund by Fund 
basis, the manager maintain records of the model prescribed output or 
trade list, as well as the procedures utilized by the manager to 
determine which securities to buy or sell and how much of each security 
to buy or sell, in detail sufficient to allow an independent plan 
fiduciary to verify that each of the above decisions for the Fund was 
made in response to specific triggering events. As provided by section 
III(b)(2), if such material is viewed as a trade secret, or privileged 
or confidential, the manager may refuse to disclose such information if 
reasons for the refusal are given and the person is also notified that 
the Department of Labor may request such information.
    This recordkeeping requirement is intended to assure that 
independent plan fiduciaries will be able to determine whether Funds 
and their underlying models or indexes operate consistently in 
following the input of triggering event information. The Department 
does not intend to prescribe a detailed list of records that are 
necessary to enable a determination of compliance with the exemption 
because the necessary records will depend on the nature of the Index or 
Model-Driven Funds involved and other factors. This information, 
however, should be kept in sufficient detail to enable a replication of 
specific historical events in order to satisfy an inquiry by persons 
identified in section III(b)(1)(A). Section III(a)(3) requires that, on 
a Fund by Fund basis, records be maintained of the actual trades 
executed by the Fund on a particular day and which of those trades 
resulted from triggering events.
    The Department recognizes that these requirements may require 
adjustments to a manager's record-keeping systems. Therefore, the 
Department seeks specific comments on these record-keeping requirements 
and any additional burdens that they may impose on Fund managers.
    Further, Section III(a) requires that the records must be readily 
available to assure accessibility and maintained so that an independent 
fiduciary, or other persons identified in section III(b)(1)(A), may 
obtain them within a reasonable time. This requirement should permit 
the records to be retrieved and assembled quickly, regardless of the 
location in which they are maintained. For those records which are not 
maintained electronically, the records should be maintained in a 
central location to facilitate assembly and examination.
    All records must be unconditionally available at their customary 
location for examination during normal business hours by the persons 
described in section III(b)(1). However, as noted with respect to 
information which may be disclosed to a Large Account fiduciary or 
other person, the manager may refuse to disclose to a person, other 
than a duly authorized employee or representative of the Department or 
the Internal Revenue Service, any such information which is deemed 
confidential or privileged if the manager is otherwise permitted by law 
to withhold such information from such person. In such instances, the 
manager shall provide, by the close of the thirtieth (30th) day 
following the request, a written notice to such person advising that 
person of the reasons for the refusal and that the Department may 
request such information.

H. Effect on Existing Exemptions

    The proposed exemption is generally similar to a number of 
individual exemptions that previously have been granted by the 
Department for such transactions.<SUP>13</SUP> However, the operative 
language of the proposal differs from that of the individual exemptions 
in a number of respects. For example, the proposal under section II(h) 
prohibits the cross-trade of any securities issued by the manager, 
unless the manager has obtained a separate prohibited transaction 
exemption for the acquisition of such securities by its Index and 
Model-Driven Funds. A number of prior individual exemptions allow such 
transactions in order to eliminate potential tracking error of the Fund 
associated with replicating the rate of return, risk profile and other 
characteristics of the index containing the manager's securities. The 
Department invites comments as to the effect that the continuation of 
current Index and Model-Driven Fund individual exemptions would have in 
offering an advantage to those investment managers granted such relief 
compared to those managers which would utilize this exemption, if 
granted. Finally, the Department is aware that a number of individuals 
have expressed concern regarding whether the Department would revoke 
past individual exemptions involving Index and Model-Driven Fund cross-
trading programs in connection with the granting of this class 
exemption. The Department notes that under the Prohibited Transaction 
Exemption Procedures, 29 CFR Section 2570.50(b), before revoking or 
modifying an exemption, the Department must publish a notice of its 
proposed action in the Federal Register and provide interested persons 
with an opportunity to comment on the proposed revocation or 
modification.
---------------------------------------------------------------------------

    \13\ The following individual exemptions involve cross-trades of 
securities by Index and Model-Driven Funds: PTE 95-56, Mellon Bank, 
N.A. (60 FR 35933, July 12, 1995); PTE 94-47, Bank of America 
National Trust and Savings Association (59 FR 32021, June 21, 1994); 
PTE 94-43, Fidelity Management Trust Company (59 FR 30041, June 10, 
1994); PTE 94-36, The Northern Trust Company (59 FR 19249, April 22, 
1994); PTE 92-11, Wells Fargo Bank, N.A. (57 FR 7801, March 4, 
1992)--which replaced PTE 87-51 noted below; PTE 89-9, State Street 
Bank and Trust Company (54 FR 8018, February 24, 1989); and PTE 87-
51, Wells Fargo Bank, N.A. (52 FR 22558, June 12, 1987).
---------------------------------------------------------------------------

General Information

    The attention of interested persons is directed to the following:
    (1) The fact that a transaction is the subject of an exemption 
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 or disqualified 
person 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 which require, among other things, that a fiduciary 
discharge his duties with respect to the plan solely in the interests 
of the participants and beneficiaries of the plan and in a prudent 
fashion in accordance with section 404(a)(1)(B) of the Act; nor does it 
affect the

[[Page 70067]]

requirement of section 401(a) of the Code that the plan must operate 
for the exclusive benefit of the employees of the employer maintaining 
the plan and their beneficiaries;
    (2) Before an exemption may be granted under section 408(a) of the 
Act and section 4975(c)(2) of the Code, the Department must find that 
the exemption is administratively feasible, in the interests of the 
plans and their participants and beneficiaries and protective of the 
rights of participants and beneficiaries of such plans;
    (3) If granted, the proposed exemption will be applicable to a 
transaction only if the conditions specified in the exemption are met; 
and
    (4) The proposed exemption, if granted, will be supplemental to, 
and not in derogation of, any other provisions of the Act and the Code, 
including statutory or administrative 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.

Written Comments and Hearing Requests

    All interested persons are invited to submit written comments or 
requests for a public hearing on the proposed exemption to the address 
and within the time period set forth above. All comments will be made a 
part of the record. Comments and requests for a hearing should state 
the reasons for the writer's interest in the proposed exemption. 
Comments received will be available for public inspection with the 
referenced application at the above address.

Proposed Exemption

    The Department has under consideration the grant of the following 
class exemption under the authority of section 408(a) of the Act and 
section 4975(c)(2) of the Code, and in accordance with the procedures 
set forth in 29 CFR Part 2570, Subpart B (55 FR 32836, 32847, August 
10, 1990).

Section I--Exemption for Cross-Trading of Securities by Index and/or 
Model-Driven Funds

    Effective [date of publication of final class exemption], the 
restrictions of sections 406(a)(1)(A) and 406(b)(2) of the Act, section 
8477(c)(2)(B) of FERSA, and the sanctions resulting from the 
application of section 4975 of the Code, by reason of section 
4975(c)(1)(A) of the Code, shall not apply to:
    (a) The purchase and sale of securities between an Index Fund or a 
Model-Driven Fund (a ``Fund''), as defined in Sections IV(a) and (b) 
below, and another Fund, at least one of which holds ``plan assets'' 
subject to the Act or FERSA; or
    (b) The purchase and sale of securities between a Fund and a Large 
Account, as defined in Section IV(e) below, at least one of which holds 
``plan assets'' subject to the Act or FERSA, pursuant to a portfolio 
restructuring program, as defined in Section IV(f) below, of the Large 
Account;
provided that, with respect to all such purchases and sales (referred 
to herein as ``cross-trades''), the conditions set forth in Sections II 
and III below are met.

Section II--Specific Conditions

    (a) The cross-trade is executed at the closing price, as defined in 
Section IV(h) below.
    (b) Any cross-trade of securities by a Fund occurs as a direct 
result of a ``triggering event,'' as defined in Section IV(d) below, 
and is executed no later than the close of the second business day 
following such ``triggering event.''
    (c) If the cross-trade involves a Model-Driven Fund, the cross-
trade does not take place within ten (10) business days following any 
change made by the Manager to the model underlying the Fund.
    (d) The Manager has allocated the opportunity for all Funds or 
Large Accounts to engage in the cross-trade on an objective basis which 
has been previously disclosed to the authorizing fiduciaries of plan 
investors, and which does not permit the exercise of discretion by the 
Manager (e.g., a pro rata allocation system).
    (e) No more than ten (10) percent of the assets of the Fund or 
Large Account at the time of the cross-trade are comprised of assets of 
employee benefit plans maintained by the Manager for its own employees 
(Manager Plans) for which the Manager exercises investment discretion.
    (f)(1) Cross-trades of equity securities involve only securities 
that are widely-held, actively-traded, and for which market quotations 
are readily available from independent sources that are engaged in the 
ordinary course of business of providing financial news and pricing 
information to institutional investors and/or the general public, and 
are widely recognized as accurate and reliable sources for such 
information. For purposes of this requirement, the terms ``widely-
held'' and ``actively-traded'' shall be deemed to include any security 
listed in an Index, as defined in Section IV(c) below; and
    (2) Cross-trades of fixed-income securities involve only securities 
for which market quotations are readily available from independent 
sources that are engaged in the ordinary course of business of 
providing financial news and pricing information to institutional 
investors and/or the general public, and are widely recognized as 
accurate and reliable sources for such information.
    (g) The Manager receives no brokerage fees or commissions as a 
result of the cross-trade.
    (h) The cross-trade does not involve any security issued by the 
Manager unless the Manager has obtained a separate prohibited 
transaction exemption for the acquisition of such security.
    (i) As of the date the proposed exemption is granted, a plan's 
participation in the Manager's cross-trading program as a result of 
investments made in any Index or Model-Driven Fund that holds plan 
assets is subject to a written authorization executed in advance of 
such investment by a fiduciary of the plan which is independent of the 
Manager engaging in the cross-trade transactions.
    (j) With respect to existing plan investors in any Index or Model-
Driven Fund as of the date the proposed exemption is granted, the 
independent fiduciary is furnished with a written notice, not less than 
forty-five (45) days prior to the implementation of the cross-trading 
program, that describes the Fund's participation in the Manager's 
cross-trading program, provided that:
    (1) Such notice allows each plan an opportunity to object to the 
plan's participation in the cross-trading program as a Fund investor by 
providing the plan with a special termination form;
    (2) The notice instructs the independent plan fiduciary that 
failure to return the termination form to the Manager by a specified 
date (which shall be at least 30 days following the plan's receipt of 
the form) shall be deemed to be an approval by the plan of its 
participation in the Manager's cross-trading program as a Fund 
investor; and
    (3) If the independent plan fiduciary objects to the plan's 
participation in the cross-trading program as a Fund investor by 
returning the termination form to the Manager by the specified date, 
the plan is given the opportunity to withdraw from each Index or Model-
Driven Fund without penalty prior to the implementation of the cross-
trading program, within such time as may be reasonably necessary to 
effectuate the withdrawal in an orderly manner.

[[Page 70068]]

    (k) Prior to obtaining the authorization described in Section 
II(i), and in the notice described in Section II(j), the following 
statement must be provided by the Manager to the independent plan 
fiduciary:
    Investment decisions for the Fund (including decisions regarding 
which securities to buy or sell, how much of a security to buy or sell, 
and when to execute a sale or purchase of securities for the Fund) will 
not be based in whole or in part by the Manager on the availability of 
cross-trade opportunities and will be made prior to the identification 
and determination of any cross-trade opportunities. In addition, all 
cross-trades by a Fund will be based solely upon a ``triggering event'' 
set forth in this exemption. Records documenting each cross-trade 
transaction will be retained by the Manager.
    (l) Prior to any authorization set forth in Section II(i), and at 
the time of any notice described in Section II(j) above, the 
independent plan fiduciary must be furnished with any reasonably 
available information necessary for the fiduciary to determine whether 
the authorization should be given, including (but not limited to) a 
copy of this exemption, an explanation of how the authorization may be 
terminated, detailed disclosure of the procedures to be implemented 
under the Manager's cross-trading practices (including the ``triggering 
events'' that will create the cross-trading opportunities, the 
independent pricing services that will be used by the manager to price 
the cross-traded securities, and the methods that will be used for 
determining closing price), and any other reasonably available 
information regarding the matter that the authorizing fiduciary 
requests. The independent plan fiduciary must also be provided with a 
statement that the Manager will have a potentially conflicting division 
of loyalties and responsibilities to the parties to any cross-trade 
transaction and must explain how the Manager's cross-trading practices 
and procedures will mitigate such conflicts.
    With respect to Funds that are added to the Manager's cross-trading 
program or changes to, or additions of, triggering events regarding 
Funds, following the authorizations described in section II(i) or 
section II(j), the Manager shall provide a notice to each relevant 
independent plan fiduciary prior to, or within ten (10) days following 
such addition of Funds or change to, or addition of, triggering events, 
which contains a description of such Fund(s) or triggering event(s). 
Such notice will also include a statement that the plan has the right 
to terminate its participation in the cross-trading program and its 
investment in any Index Fund or Model-Driven Fund without penalty at 
any time, as soon as is necessary to effectuate the withdrawal in an 
orderly manner.
    (m) At least annually, the Manager notifies the independent 
fiduciary for each plan that has previously authorized participation in 
the Manager's cross-trading program as a Fund investor, that the plan 
has the right to terminate its participation in the cross-trading 
program and its investment in any Index Fund or Model-Driven Fund 
without penalty at any time, as soon as is necessary to effectuate the 
withdrawal in an orderly manner. This notice shall also provide each 
independent plan fiduciary with a special termination form and instruct 
the fiduciary that failure to return the form to the Manager by a 
specified date (which shall be at least thirty (30) days following the 
plan's receipt of the form) shall be deemed an approval of the subject 
plan's continued participation in the cross-trading program as a Fund 
investor. Such annual re-authorization must contain disclosures 
regarding any new Funds that are added to the cross-trading program or 
any new triggering events (as defined in Section IV(d) below) that may 
have been added to existing Funds since the time of the initial 
authorization described in Section II(i), or the time of the notice 
described in Section II(j).
    (n) With respect to a cross-trade involving a Large Account:
    (1) The cross-trade is executed in connection with a portfolio 
restructuring program, as defined in Section IV(f) below, with respect 
to all or a portion of the Large Account's investments which an 
independent fiduciary of the Large Account has authorized the Manager 
to carry out or to act as a ``trading adviser,'' as defined in Section 
IV(g) below, in carrying out a Large Account-initiated liquidation or 
restructuring of its portfolio;
    (2) Prior to the cross-trade, a fiduciary of the Large Account who 
is independent of the Manager has been fully informed of the Manager's 
cross-trading program, has been provided with the information required 
in Section II(l), and has provided the Manager with advance written 
authorization to engage in cross-trading in connection with the 
restructuring, provided that--
    (A) Such authorization may be terminated at will by the Large 
Account upon receipt by the Manager of written notice of termination.
    (B) A form expressly providing an election to terminate the 
authorization, with instructions on the use of the form, is supplied to 
the authorizing Large Account fiduciary concurrent with the receipt of 
the written information describing the cross-trading program. The 
instructions for such form must specify that the authorization may be 
terminated at will by the Large Account, without penalty to the Large 
Account, upon receipt by the Manager of written notice from the 
authorizing Large Account fiduciary;
    (3) The portfolio restructuring program must be completed by the 
Manager within thirty (30) days of the initial authorization (or 
initial receipt of assets associated with the restructuring, if later) 
to engage in such restructuring by the Large Account's independent 
fiduciary, unless such fiduciary agrees in writing to extend this 
period for another thirty (30) days; and,
    (4) No later than thirty (30) days following the completion of the 
Large Account's portfolio restructuring program, the Large Account's 
independent fiduciary must be fully apprised in writing of all cross-
trades executed in connection with the restructuring. Such writing 
shall include a notice that the Large Account's independent fiduciary 
may obtain, upon request, the information described in Section III(a), 
subject to the limitations described in Section III(b). However, if the 
program takes longer than thirty (30) days to complete, interim reports 
containing the transaction results must be provided to the Large 
Account fiduciary no later than fifteen (15) days following the end of 
each thirty (30) day period.

Section III--General Conditions

    (a) The Manager maintains or causes to be maintained for a period 
of six (6) years from the date of each cross-trade the records 
necessary to enable the persons described in paragraph (b) of this 
Section to determine whether the conditions of the exemption have been 
met, including records which identify:
    (1) On a Fund by Fund basis, the specific triggering events which 
result in the creation of the model prescribed output or trade list of 
specific securities to be cross-traded;
    (2) On a Fund by Fund basis, the model prescribed output or trade 
list which describes: (A) which securities to buy or sell; and (B) how 
much of each security to buy or sell; in detail sufficient to allow an 
independent plan fiduciary to verify that each of the above decisions 
for the Fund was made in response to specific triggering events; and
    (3) On a Fund by Fund basis, the actual trades executed by the Fund 
on

[[Page 70069]]

a particular day and which of those trades resulted from triggering 
events.
    Such records must be readily available to assure accessibility and 
maintained so that an independent fiduciary, or other persons 
identified below in paragraph (b) of this Section, may obtain them 
within a reasonable period of time. However, a prohibited transaction 
will not be considered to have occurred if, due to circumstances beyond 
the control of the Manager, the records are lost or destroyed prior to 
the end of the six-year period, and no party in interest other than the 
Manager shall be subject to the civil penalty that may be assessed 
under section 502(i) of the Act or to the taxes imposed by sections 
4975(a) and (b) of the Code if the records are not maintained or are 
not available for examination as required by paragraph (b) below.
    (b)(1) Except as provided in paragraph (b)(2) and notwithstanding 
any provisions of sections 504(a)(2) and (b) of the Act, the records 
referred to in paragraph (a) of this Section are unconditionally 
available at their customary location for examination during normal 
business hours by--
    (A) Any duly authorized employee or representative of the 
Department of Labor or the Internal Revenue Service,
    (B) Any fiduciary of a Plan participating in a cross-trading 
program who has the authority to acquire or dispose of the assets of 
the Plan, or any duly authorized employee or representative of such 
fiduciary,
    (C) Any contributing employer with respect to any Plan 
participating in a cross-trading program or any duly authorized 
employee or representative of such employer, and
    (D) Any participant or beneficiary of any Plan participating in a 
cross-trading program, or any duly authorized employee or 
representative of such participant or beneficiary.
    (2) If in the course of seeking to inspect records maintained by a 
Manager pursuant to this exemption, any person described in paragraph 
(b)(1)(B) through (D) seeks to examine trade secrets, or commercial or 
financial information of the Manager that is privileged or 
confidential, and the Manager is otherwise permitted by law to withhold 
such information from such person, the Manager may refuse to disclose 
such information provided that, by the close of the thirtieth (30th) 
day following the request, the Manager gives a written notice to such 
person advising the person of the reasons for the refusal and that the 
Department of Labor may request such information.
    (3) The information required to be disclosed to persons described 
in paragraph (b)(1)(B) through (D) shall be limited to information that 
pertains to cross-trades involving a Fund or Large Account in which 
they have an interest.

Section IV--Definitions

    The following definitions apply for purposes of this proposed 
exemption:
    (a) Index Fund--Any investment fund, account or portfolio 
sponsored, maintained, trusteed, or managed by the Manager or an 
Affiliate, in which one or more investors invest, and--
    (1) Which is designed to track the rate of return, risk profile and 
other characteristics of an independently maintained securities index, 
as defined in Section IV(c) below, by either (i) replicating the same 
combination of securities which compose such index or (ii) sampling the 
securities which compose such index based on objective criteria and 
data;
    (2) For which the Manager does not use its discretion, or data 
within its control, to affect the identity or amount of securities to 
be purchased or sold;
    (3) That either contains ``plan assets'' subject to the Act, is an 
investment company registered under the Investment Company Act of 1940, 
or is an institutional investor, which may include, but not be limited 
to, such entities as an insurance company separate account or general 
account, a governmental plan, a university endowment fund, a charitable 
foundation fund, a trust or other fund which is exempt from taxation 
under section 501(a) of the Code; and
    (4) That involves no agreement, arrangement, or understanding 
regarding the design or operation of the Fund which is intended to 
benefit the Manager, its Affiliates, or any party in which the Manager 
or an Affiliate may have an interest.
    (b) Model-Driven Fund--Any investment fund, account or portfolio 
sponsored, maintained, trusteed, or managed by the Manager or an 
Affiliate, in which one or more investors invest, and--
    (1) Which is composed of securities the identity of which and the 
amount of which are selected by a computer model that is based on 
prescribed objective criteria using independent third party data, not 
within the control of the Manager, to transform an Index, as defined in 
Section IV(c) below;
    (2) Which either contains ``plan assets'' subject to the Act, is an 
investment company registered under the Investment Company Act of 1940, 
or is an institutional investor, which may include, but not be limited 
to, such entities as an insurance company separate account or general 
account, a governmental plan, a university endowment fund, a charitable 
foundation fund, a trust or other fund which is exempt from taxation 
under section 501(a) of the Code; and
    (3) That involves no agreement, arrangement, or understanding 
regarding the design or operation of the Fund or the utilization of any 
specific objective criteria which is intended to benefit the Manager, 
its Affiliates, or any party in which the Manager or an Affiliate may 
have an interest.
    (c) Index--A securities index that represents the investment 
performance of a specific segment of the public market for equity or 
debt securities in the United States and/or foreign countries, but only 
if--
    (1) The organization creating and maintaining the index is--
    (A) Engaged in the business of providing financial information, 
evaluation, advice or securities brokerage services to institutional 
clients,
    (B) A publisher of financial news or information, or
    (C) A public stock exchange or association of securities dealers; 
and,
    (2) The index is created and maintained by an organization 
independent of the Manager, as defined in Section IV(i) below; and,
    (3) The index is a generally accepted standardized index of 
securities which is not specifically tailored for the use of the 
Manager.
    (d) Triggering Event:
    (1) A change in the composition or weighting of the Index 
underlying a Fund by the independent organization creating and 
maintaining the Index;
    (2) A specific amount of net change in the overall level of assets 
in a Fund, as a result of investments in and withdrawals from the Fund, 
provided that: (A) Such specified amount has been disclosed in writing 
as a ``triggering event'' to an independent fiduciary of each plan 
having assets held in the Fund prior to, or within ten (10) days 
following, its inclusion as a ``triggering event'' for such Fund; and 
(B) investments or withdrawals as a result of the manager's discretion 
to invest or withdraw assets of a Manager Plan, other than a Manager 
Plan which is a defined contribution plan under which participants 
direct the investment of their accounts among various investment 
options, including such Fund, will not be taken into account in 
determining the specified amount of net change;
    (3) An accumulation in the Fund of a specified amount of either:

[[Page 70070]]

    (A) cash which is attributable to interest or dividends on, and/or 
tender offers for, portfolio securities; or
    (B) Stock attributable to dividends on portfolio securities;

provided that such specified amount has been disclosed in writing as a 
``triggering event'' to an independent fiduciary of each plan having 
assets held in the Fund prior to, or within ten (10) days after, its 
inclusion as a ``triggering event'' for such Fund; or
    (4) A change in the composition of the portfolio of a Model-Driven 
Fund mandated solely by operation of the formulae contained in the 
computer model underlying the Fund where the basic factors for making 
such changes (and any fixed frequency for operating the computer model) 
have been disclosed in writing to an independent fiduciary of each plan 
having assets held in the Fund prior to, or within ten (10) days after, 
its inclusion as a ``triggering event'' for such Fund.
    (e) Large Account--Any investment fund, account or portfolio that 
is not an Index Fund or a Model-Driven Fund sponsored, maintained, 
trusteed or managed by the Manager, which holds assets of either:
    (1) An employee benefit plan within the meaning of section 3(3) of 
the Act that has $50 million or more in total assets;
    (2) An institutional investor that has total assets in excess of 
$50 million, such as an insurance company separate account or general 
account, a governmental plan, a university endowment fund, a charitable 
foundation fund, a trust or other fund which is exempt from taxation 
under section 501(a) of the Code; or
    (3) An investment company registered under the Investment Company 
Act of 1940 (e.g., a mutual fund) other than an investment company 
advised or sponsored by the Manager;

provided that the Manager has been authorized to restructure all or a 
portion of the portfolio for such Large Account or to act as a 
``trading adviser'' (as defined in Section IV(g) below) in connection 
with a specific liquidation or restructuring program for the Large 
Account.
    (f) Portfolio restructuring program--Buying and selling the 
securities on behalf of a Large Account in order to produce a portfolio 
of securities which will be an Index Fund or a Model-Driven Fund 
managed by the Manager, without regard to the requirements of Section 
IV(a)(3) or (b)(2), or to carry out a liquidation of a specified 
portfolio of securities for the Large Account.
    (g) Trading adviser--A person whose role is limited with respect to 
a Large Account to the disposition of a securities portfolio in 
connection with a Large Account-initiated liquidation or restructuring 
within a stated period of time in order to minimize transaction costs. 
The person does not have discretionary authority or control with 
respect to any underlying asset allocation, restructuring or 
liquidation decisions for the account in connection with such 
transactions and does not render investment advice [within the meaning 
of 29 CFR Sec. 2510.3-21(c)] with respect to such transactions.
    (h) Closing price--The price for a security on the date of the 
transaction, as determined by objective procedures disclosed to Fund 
investors in advance and consistently applied with respect to 
securities traded in the same market, which procedures shall indicate 
the independent pricing source (and alternates, if the designated 
pricing source is unavailable) used to establish the closing price and 
the time frame after the close of the market in which the closing price 
will be determined.
    (i) Manager--A person who is:
    (1) A bank or trust company, or any Affiliate thereof, as defined 
in Section IV(j) below, which is supervised by a state or federal 
agency; or
    (2) An investment adviser or any Affiliate thereof, as defined in 
Section IV(j) below, which is registered under the Investment Advisers 
Act of 1940.
    (j) Affiliate--An ``affiliate'' of a Manager includes:
    (1) Any person, directly or indirectly, through one or more 
intermediaries, controlling, controlled by or under common control with 
the person;
    (2) Any officer, director, employee or relative of such person, or 
partner of any such person; and
    (3) Any corporation or partnership of which such person is an 
officer, director, partner or employee.
    (k) Control--The power to exercise a controlling influence over the 
management or policies of a person other than an individual.
    (l) Relative--A ``relative'' is a person that is defined in section 
3(15) of the Act (or a ``member of the family'' as that term is defined 
in section 4975(e)(6) of the Code), or a brother, a sister, or a spouse 
of a brother or a sister.

    Signed at Washington, D.C., this 9th day of December, 1999.
Alan D. Lebowitz,
Deputy Assistant Secretary for Program Operations, Pension and Welfare 
Benefits Administration, U.S. Department of Labor.
[FR Doc. 99-32404 Filed 12-14-99; 8:45 am]
BILLING CODE 4510-29-P