Field Assistance Bulletin No. 2002-03
November 5, 2002
Virginia C. Smith
Director of Enforcement, Regional Directors
Robert J. Doyle
Director of Regulations and Interpretations
What does a fiduciary need to consider in evaluating the reasonableness of an agreement under which the service provider will be retaining "float" and what information is a service provider required to disclose to plan fiduciaries with respect to such arrangements in order to avoid engaging in a prohibited transaction?
A number of financial services providers, such as banks and trust companies, acting as non-discretionary directed trustees or custodians maintain general or omnibus accounts to facilitate the transactions of employee benefit plans. The service provider may retain earnings ("float") resulting from the anticipated short-term investment of funds held in such accounts. Typically, these accounts hold contributions and other assets pending investment directions from plan fiduciaries. In addition, fiduciaries transfer funds to a general account of the financial institution in connection with issuance of a check to make a plan distribution or other disbursement. Funds are then held in the account earning interest until checks are presented for payment.
In Advisory Opinion 93-24A, the Department expressed the view that a trustee's exercise of discretion to earn income for its own account from the float attributable to outstanding benefit checks constitutes prohibited fiduciary self-dealing under section 406(b)(1) of ERISA. Advisory Opinion 93-24A dealt with a situation where there was no disclosure of the float to employee benefit plan customers. In a subsequent information letter to the American Bankers Association (August 11, 1994), the Department indicated that ". . . if a bank fiduciary has openly negotiated with an independent plan fiduciary to retain float attributable to outstanding benefit checks as part of its overall compensation, then the bank's use of the float would not be self-dealing because the bank would not be exercising its fiduciary authority or control for its own benefit. Therefore, to avoid problems, banks should, as part of their fee negotiations, provide full and fair disclosure regarding the use of float on outstanding benefit checks." (Emphasis supplied).
In general, the concepts of open negotiation and full and fair disclosure, as used in the 1994 letter, are intended to ensure that service providers provide sufficient information concerning such arrangements so that plan fiduciaries can make informed assessments concerning the prudence of the arrangements. Further, those concepts are intended to ensure that the amount of the service provider's compensation is determined and approved by a fiduciary independent of the service provider so that prohibited self-dealing is avoided.(1) Since the issuance of the letter, Field offices have found, as part of their investigations, a variety of methods by which plan fiduciaries are informed of, and or approve, the practice of plan service providers retaining float as part of their overall compensation. Typically, a service agreement will provide that, in addition to other specifically identified or scheduled fees, the service provider may also receive compensation in the form of earnings on funds awaiting investment or reinvestment or funds pending distribution. According to the investigations, however, there is little or no disclosure of specific information regarding compensation earned in the form of float.
Further guidance, therefore, has been requested concerning the obligations of plan fiduciaries and service providers regarding float arrangements and disclosures.
Obligations of Plan Fiduciary - In selecting a service provider, plan fiduciaries must, consistent with the requirements of section 404(a), act prudently and solely in the interest of the plans participants and beneficiaries and for the exclusive purpose of providing benefits and defraying reasonable expenses of administering the plan. Except as provided in section 408, plan fiduciaries also have an obligation under section 406(a) not to cause the plan to engage in certain transactions, including a direct or indirect furnishing of goods, services or facilities between the plan and a party in interest. Section 408(b)(2) exempts from the prohibitions of section 406(a) any contract or reasonable arrangement with a party in interest, including a fiduciary, for office space, or legal, accounting or other services necessary for the establishment or operation of the plan, if no more than reasonable compensation is paid therefor.(2) In carrying out these responsibilities, the Department has indicated that a plan fiduciary must engage in an objective process designed to elicit information necessary to assess the qualifications of the provider, the quality of services offered, and the reasonableness of the fees charged in light of the services provided. In addition, such process should be designed to avoid self-dealing, conflicts of interest or other improper influence.
In circumstances where a service provider may receive compensation in the form of float, we believe the selection and monitoring process engaged in by the responsible fiduciary should include:
- A review of comparable providers and service arrangements (e.g., quality and costs) to determine whether such providers may credit float to the provider's own account, rather than the plan.
- A review of the circumstances under which float may be earned by the service provider. For example, in the case of float on cash awaiting investment, fiduciaries should ensure that their service agreements include time limits within which the provider will implement investment instructions following receipt of cash from the plan. Fiduciaries also should understand that delays in the plan providing investment instruction or delays in implementing investment direction by the service provider would result in increased compensation in the form of float. In the case of float on funds awaiting disbursement, fiduciaries should ensure that their service agreements specify the time at which assets are transferred from the plan to the general account (e.g., the date the check is requested, the date the check is written, or the date the check is mailed). Inasmuch as timing of mailing or distribution of a check may also affect the amount of float, service agreements should provide, if relevant, an indication as to when checks are mailed following a direction to distribute funds. Fiduciaries also should understand that float will be earned on such disbursements until checks are presented for payment by the payee, the timing of which is beyond the control of the plan and service provider. In this regard, fiduciaries should review periodic statements or reports of distribution checks to determine the extent to which checks tend to remain outstanding for unusually long periods of time (e.g., 90 or more days).
- A review of sufficient information to enable the plan fiduciary to evaluate the float as part of the total compensation to be paid for the services to be rendered under the agreement. In this regard, fiduciaries should request and review the rates the provider generally expects to earn. For example, the provider might indicate that earnings on uncashed checks are generally at money market interest rates. Given the uncertainties with respect to both actual interest rates and the length of the periods during which any given funds may be pending investment or pending disbursement, it is anticipated that any projections by the fiduciary will result in only a rough approximation of the potential float. However, the information on which the approximation is based (e.g., basis for earnings rates and agreement terms relating to maximum periods within which funds will be invested following investment direction, timing of transfers of cash from the plan to the provider's general account following direction to distribute funds, period for mailing checks, extent to which experience shows that distribution checks remain outstanding for unusually long periods of time, etc.) and the approximation itself, will enable a fiduciary both to compare service provider float practices and assess the extent to which float is a significant component of the overall compensation arrangement.
Additionally, a plan fiduciary must periodically monitor compliance by the service provider with the terms of the agreement and the reasonableness of compensation under the agreement in order to ensure continuation of the agreement meets the requirements of sections 404(a)(1), 406 and 408(b)(2).
Obligations of Service Providers - The primary issue for service providers with float arrangements is whether the provider has disclosed to its employee benefit plan customers sufficient information concerning the administration of its accounts holding float so that the customer can reasonably approve the arrangement based on an understanding of the service provider's compensation. Moreover, the arrangement must not permit the service provider to affect the amount of its compensation in violation of section 406(b)(1) (e.g., by giving the service provider broad discretion over the duration of the float). For example, even where a service provider discloses in its service agreement that additional compensation may be paid to the service provider as a result of float, a prohibited transaction may nonetheless result to the extent that the service provider exercises discretionary authority or control sufficient to cause a plan to pay additional fees to the provider. As noted in Advisory Opinion 93-24A, a fiduciary's decision to handle plan assets in such a way as to benefit itself constitutes prohibited self-dealing, without regard to the status of the funds after they are placed in a disbursement or other account.
It is the view of this Office that, in connection with a service agreement pursuant to which the service provider may be retaining float as part of its compensation, the service provider can avoid self-dealing with respect to such earnings by taking the following steps:
- Disclose the specific circumstances under which float will be earned and retained.
- In the case of float on contributions pending investment direction, establish, disclose and adhere to specific time frames within which cash pending investment direction will be invested following direction from the plan fiduciary, as well as any exceptions that might apply.
- In the case of float on distributions, disclose when the float period commences (e.g., the date check is requested, the date the check is written, the date the check is mailed) and ends (the date on which the check is presented for payment). Also disclose, and adhere to, time frames for mailing and any other administrative practices that might affect the duration of the float period.
- Disclose the rate of the float or the specific manner in which such rate will be determined. For example, earnings on cash pending investment and earnings on uncashed checks are generally at a money market interest rate.
We note that the disclosure of and adherence to the foregoing by service providers will not only reduce the likelihood of prohibited self-dealing, but also will assist plan fiduciaries in discharging their obligations under sections 404(a)(1), 406 and 408(b)(2).
Float should be regarded by plan fiduciaries and service providers as part of the service provider's compensation for services to the plan. As such, the plan fiduciary must have an adequate understanding of how the service provider will earn float, and how it contributes to the service provider's compensation. The service provider must make disclosures sufficient to permit the fiduciary to make an informed decision regarding the proposed float arrangement. In addition, to avoid having the arrangement give rise to self-dealing violations of section 406(b), both parties must avoid giving the service provider discretion to affect the amount of compensation it receives from float.
Questions concerning this matter may be directed to Louis Campagna or Fred Wong, Division of Fiduciary Interpretations at 202.693.8510.
- What constitutes an approval by an appropriate plan fiduciary will depend on the facts and circumstances of each case. See Advisory Opinion Nos. 97-16A and 2001-02A.
- As interpreted by the Department, section 408(b)(2) exempts from the prohibitions of section 406(a) payment by a plan to a party in interest, including a fiduciary, for any service (or combination of services) if (1) such service is necessary for the establishment or operation of the plan; (2) such service is furnished under a contract or arrangement which is reasonable; (3) no more than reasonable compensation is paid for such service. However, section 408(b)(2) does not provide an exemption for an act described in section 406(b) of ERISA, even if such act occurs in connection with a provision of services that is exempt under section 408(b)(2). See 29 C.F.R. § 2550.408b-2.