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Trust Examination Manual

Advisory Opinion 2001-09A
ERISA Sec. 406(b)

Application of ERISA Sec. 406(b) to certain transactions involving the provision of investment advice and discretionary services with regard to asset allocation for participants in participant-directed defined contribution plans.


December 14, 2001

Mr. William A. Schmidt
Mr. Eric Berger
Kirkpatrick & Lockhart LLP
1800 Massachusetts Avenue, NW, 2nd Floor
Washington, DC 20036-1800


Dear Messrs. Schmidt and Berger:

This is in response to your application, on behalf of SunAmerica Retirement Markets, Inc. (SunAmerica), for an exemption from the prohibited transaction restrictions of section 406 of the Employee Retirement Income Security Act of 1974, as amended (ERISA), with respect to a program (the Program) under which SunAmerica would render certain discretionary and nondiscretionary asset allocation services to participants in ERISA-covered plans (Plans). On the basis of the facts and representations contained in your submission, it is the view of the Department that, for the reasons discussed below, the transactions with respect to which you have requested exemptive relief would not, to the extent executed in a manner consistent with such facts and representations, violate the provisions of section 406(b) of ERISA. Accordingly, we have determined that the appropriate response to your request is an advisory opinion, rather than an exemption under ERISA section 408(a).(1)

Your submission contains the following facts and representations. SunAmerica is an indirectly wholly owned subsidiary of SunAmerica Inc., and is one of a group of companies wholly owned by SunAmerica, Inc. that provide a broad range of financial services. SunAmerica’s affiliate, SunAmerica Asset Management Corp., is a registered investment adviser under the Investment Advisers Act of 1940. SunAmerica intends to offer the Program to individual account plans described in section 3(34) of ERISA. It is anticipated that virtually all of these Plans will be designed or administered in a manner intended to comply with the provisions of section 404(c) of ERISA.(2) Under the Program, asset allocation services may be rendered to Plan participants(3) either through the “Discretionary Asset Allocation Service” or the “Recommended Asset Allocation Service” (collectively, Services; singly, Service). Through the Discretionary Asset Allocation Service, a specific Model Asset Allocation Portfolio will be implemented automatically with respect to a participant’s account (Account). Through the Recommended Asset Allocation Service, a specific Model Asset Allocation Portfolio will be recommended to a participant for investment of his or her Account and the participant then may choose to implement the advice, or to disregard the recommendation and invest in a manner that does not conform to the Model Asset Allocation Portfolios.(4) The Plan fiduciary who causes a Plan to participate in the Program will select the Service (or Services) that will be available to participants and the manner by which participants will authorize such Service (or Services). Model Asset Allocation Portfolios will be based solely on the investment alternatives available under the Plan, which your application refers to as “Core Investments,” but which we refer to herein as “Designated Investments.”(5) In this regard, it is anticipated that the Plans will offer, exclusively or in addition to other vehicles, collective investment vehicles to which SunAmerica or an affiliate of SunAmerica provides investment advisory services (SunAmerica Funds).(6)

According to your submission, while SunAmerica will be making the Program, as well as other services, available to Plans, the Model Asset Allocation Portfolios offered under the Program will, in fact, be the product of a computer program applying a methodology developed, maintained and overseen by a financial expert who is independent of SunAmerica (the Financial Expert). The Model Asset Allocation Portfolio produced under the Program with respect to a particular participant, therefore, will reflect the application of the methodologies developed by the Financial Expert to the Designated Investments, taking into account individual participant data, as provided by the participant, Plan sponsor or recordkeeper.

You represent that, with respect to a Plan’s initial participation in the Program, a Plan fiduciary (i.e., a fiduciary independent of SunAmerica and its affiliates) will be provided detailed information concerning, among other things, the Program and the role of the Financial Expert in the development of the Model Asset Allocation Portfolios under the Program. In addition, the Plan fiduciary will be provided, on an on-going basis, a number of disclosures concerning the Program and Designated Investments under the Plan, including information pertaining to performance and rates of returns on Designated Investments, expenses and fees of SunAmerica Funds that are Designated Investments, and any proposed increases in investment advisory or other fees charged under a SunAmerica Fund.

You represent that, with respect to the development of the Model Asset Allocation Portfolios, the Financial Expert, using its own methodologies, will construct strategic “asset class” level portfolios. Using generally accepted principles of Modern Portfolio Theory, the Financial Expert will evaluate and determine its strategic asset class level portfolio recommendations. The Financial Expert then will construct each Model Asset Allocation Portfolio by combining Designated Investments so that the total asset class exposures of those Designated Investments equals the desired strategic asset class portfolio weight.(7) The Model Asset Allocation Portfolios will have different risk and return characteristics. In order for these methodologies to be employed, the Designated Investments of a participating Plan must provide a minimum exposure to a certain number of asset classes. SunAmerica will inform the Plan fiduciary who causes a Plan to participate in the Program of the asset classes that must be available for operation of the Program,(8) and will inform the Plan fiduciary whether this requirement has been satisfied, as solely determined by the Financial Expert, with respect to a particular selection of an investment alternative.

SunAmerica may assist the Financial Expert by providing certain background information for the development of the Model Asset Allocation Portfolios. Specifically, SunAmerica may supply the Financial Expert with algorithms, studies, analytics, research, models, papers and any other relevant materials. The Financial Expert also may seek the assistance of other entities in developing the Model Asset Allocation Portfolios. You represent that in all cases, the Financial Expert retains the sole control and discretion for the development and maintenance of the Model Asset Allocation Portfolios.

With regard to the computer programs utilized by the Financial Expert to select the specific Model Asset Allocation Portfolio provided to a participant, you represent that any programmers who are retained to formulate those programs will have no affiliation with SunAmerica, and that neither SunAmerica nor any of its affiliates will have any discretion regarding the output of such programs. You further represent that these computer programs require an input of minimum participant data that will be determined by the Financial Expert. The Financial Expert also will create a worksheet (the Worksheet) for gathering information from individual participants. The Worksheet will consist of a series of questions designed primarily to assess the participant’s retirement needs, and will provide the participant an opportunity to designate specific investments other than Designated Investments, or to place constraints on investments in and among Designated Investments, if available under the Plan. Also, with respect to the Discretionary Asset Allocation Service, subsequent to initial participation in the Program, at least once each calendar quarter, a “Facilitator” will contact each participant to whom services are provided to obtain any new or different information requested on the Worksheet. This information may lead the Financial Expert to implement a new Model Asset Allocation Portfolio for the participant. The Facilitators will be employees of SunAmerica, independent contractors of SunAmerica’s affiliates, or independent contractors or employees of broker-dealers not affiliated with SunAmerica. Facilitators will not provide services to participants who receive the Recommended Asset Allocation Service, and will not choose or recommend a Model Asset Allocation Portfolio in connection with the Discretionary Asset Allocation Service.

The Model Asset Allocation Portfolios (or any other Asset Allocation Portfolio) implemented will be reviewed regularly and “rebalanced.” You explain that participant Account or Asset Allocation Portfolio rebalancing is the process of moving the assets in an Account or Asset Allocation Portfolio asset class exposures toward its strategic target. This process seeks to reduce the relative performance risk associated with moving the asset class exposures away from what was intended in the strategic asset allocation. You represent that the rebalancing procedures will not involve any discretion on the part of SunAmerica or its affiliates, and that the Financial Expert will develop a mechanical formula to rebalance the relative value of the assets in each Account on a predetermined basis.

With regard to amounts paid by a Plan under the Program, you represent that SunAmerica will receive a fixed percentage of assets of the Plan invested in the Designated Investments up to 100 basis points (the Program Fee). In addition, SunAmerica may receive reimbursements, not to exceed a fixed percentage of Plan assets invested in the Designated Investments up to 25 basis points, for Facilitator fees and “direct expenses” within the meaning of 29 C.F.R. section 2550.408c-2 in connection with the operation of the Program paid by SunAmerica to unaffiliated third persons for goods and services provided to SunAmerica. SunAmerica, or any affiliate, will not be precluded from receiving fees from the SunAmerica Funds.

The Program Fee and any reimbursements payable to SunAmerica, and any compensation payable to the Facilitators under the Program, will not vary based on the asset allocations made or recommended by the Financial Expert, except that the Program Fee and any such reimbursements will be based on Designated Investments only and will be reduced if an Account invests in other than the Designated Investments. The compensation of the Financial Expert in connection with the Program will not be affected by the decisions made by the participants regarding investment of the assets of their Accounts in accordance with any Asset Allocation Portfolio.

With regard to the Financial Expert, you represent that the Financial Expert will receive compensation from SunAmerica for its services as the Financial Expert. You represent that fees to be paid by SunAmerica to the Financial Expert will not exceed 5 percent of the Financial Expert’s gross income on an annual basis. In addition you represent that the fees paid to the Financial Expert by SunAmerica will not be affected by investments made in accordance with any Asset Allocation Portfolio under the Program. For example, neither the choice of the Financial Expert by SunAmerica nor any decision to continue or terminate the relationship shall be based on the fee income to SunAmerica that is generated by the Financial Expert’s construction of the Model Asset Allocation Portfolios. You further represent that there have not been, nor will there be, any other relationships between SunAmerica and the Financial Expert that would affect the ability of the Financial Expert to act independent of SunAmerica and its affiliates. Your submission indicates that by providing discretionary asset management services and investment advice to participants, SunAmerica may be acting as a fiduciary with respect to the Plans.

Your submission further indicates that implementation of a Model Asset Allocation Portfolio, whether automatically or at the direction of a participant, may result in the receipt of increased investment advisory fees by SunAmerica or an affiliated entity. At issue, therefore, is whether, under the circumstances described in your submission, the receipt of such fees resulting from the asset allocation services rendered to Plan participants under the Program violates the prohibitions of section 406(b) of ERISA.

Section 3(21)(A) of ERISA defines the term fiduciary as a person with respect to a plan who (i) exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets, (ii) renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, or has any authority or responsibility to do so, or (iii) has any discretionary authority or discretionary responsibility in the administration of such plan. Regulation 29 C.F.R. section 2510.3-21(c)(1) states that, as a general matter, a person will be deemed to be rendering investment advice within the meaning of section 3(21)(A)(ii) if two criteria are met. First, pursuant to regulation section 2510.3-21(c)(1)(i), the person must render advice to the plan with regard to the value of securities or other property, or make recommendations as to the advisability of investing in, purchasing or selling securities or other property. Second, pursuant to regulation section 2510.3-21(c)(1)(ii), a person performing this type of service must either (A) have discretionary authority or control with respect to purchasing or selling securities or other property for the plan, or (B) render such advice on a regular basis pursuant to a mutual agreement, arrangement or understanding, written or otherwise, with the plan that the plan or a fiduciary with respect to the plan will rely on such advice as a primary basis for investment decisions with regard to plan assets. Although the question of whether an entity is a fiduciary by reason of providing services generally depends on the particular facts and circumstances of each case, we are assuming, for purposes of the discussion that follows in this advisory opinion, that the totality of services provided by SunAmerica causes it to be a fiduciary with respect to plans and participants to which it renders services. In this regard, we note that section 404 of ERISA generally provides that fiduciaries shall discharge their duties with respect to a plan prudently and solely in the interest of the participants and beneficiaries.

While section 406(a)(1)(C) of ERISA proscribes the provision of services to a plan by a party in interest, including a fiduciary, and section 406(a)(1)(D) prohibits the use by or for the benefit of, a party in interest, of the assets of a plan, section 408(b)(2) of ERISA provides a statutory exemption from the prohibitions of section 406(a) of ERISA for contracting or making reasonable arrangements 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.

Section 406(b)(1) of ERISA provides that a fiduciary with respect to a plan shall not deal with plan assets in his or her own interests or for his or her own account. Section 406(b)(3) provides that a fiduciary with respect to a plan shall not receive any consideration for his or her own personal account from any party dealing with such plan in connection with a transaction involving the assets of the plan.

With respect to the prohibitions in section 406(b), regulation 29 C.F.R. section 2550.408b-2(a) indicates that section 408(b)(2) of ERISA does not contain an exemption for an act described in section 406(b) of ERISA (relating to conflicts of interest on the part of fiduciaries) even if such act occurs in connection with a provision of services which is exempt under section 408(b)(2).(9) As explained in regulation 29 C.F.R. section 2550.408b-2(e)(1), if a fiduciary uses the authority, control, or responsibility which makes it a fiduciary to cause the plan to enter into a transaction involving the provision of services when such fiduciary has an interest in the transaction which may affect the exercise of its best judgment as a fiduciary, a transaction described in section 406(b)(1) would occur, and that transaction would be deemed to be a separate transaction from the transaction involving the provision of services and would not be exempted by section 408(b)(2). Conversely, the regulation explains that a fiduciary does not engage in an act described in section 406(b)(1) if the fiduciary does not use any of the authority, control, or responsibility which makes such person a fiduciary to cause a plan to pay additional fees for a service furnished by such fiduciary or to pay a fee for a service furnished by a person in which such fiduciary has an interest which may affect the exercise of such fiduciary’s best judgment as a fiduciary.

In general, the provision of investment advice for a fee is a fiduciary act. On the basis of the foregoing, it is the view of the Department that SunAmerica would be acting as a fiduciary with respect to both the discretionary and nondiscretionary asset allocation services provided to plans and plan participants and, as such, would be subject to the fiduciary responsibility provisions of ERISA, including sections 404 and 406. In this regard, SunAmerica would be responsible for the prudent selection and periodic monitoring of its investment advisory services consistent with the requirements of ERISA section 404.(10)

With respect to the prohibitions in section 406(b) of ERISA, it is the view of the Department that, based on the facts and representations contained in your submission, the individual investment decisions or recommendations (i.e., Asset Allocation Portfolios) provided or implemented under the Program would not be the result of SunAmerica’s exercise of authority, control, or responsibility for purposes of section 406(b) and the applicable regulations. This conclusion is premised on the following facts. First, Plan fiduciaries responsible for selecting the Program are fully informed about, and approve, the Program and the nature of the services provided thereunder, including the role of the Financial Expert. Second, the investment recommendations provided to, or implemented on behalf of, participants are the result of methodologies developed, maintained and overseen by a party (the Financial Expert) that is independent of SunAmerica and any of its affiliates.(11) The Financial Expert (an independent party) retains sole control and discretion over the development and maintenance of the methodologies. Any computer programmers engaged to formulate the computer programs used by the Financial Expert will have no affiliation with SunAmerica. Recommendations provided to, or implemented on behalf of, participants by SunAmerica will be based solely on input of participant information into computer programs utilizing methodologies and parameters provided by the Financial Expert and neither SunAmerica, nor its affiliates, will be able to change or affect the output of the computer programs. SunAmerica will exercise no discretion over the communication to, or implementation of, investment recommendations provided under the Program. Third, the arrangement between SunAmerica and the Financial Expert preserves the Financial Expert’s ability to develop Model Asset Allocation Portfolios solely in the interests of the plan participants and beneficiaries. Neither the Financial Expert’s compensation from SunAmerica, nor any other aspect of the arrangement between the Financial Expert and SunAmerica, is related to the fee income that SunAmerica or its affiliates will receive from investments made pursuant to the Portfolios.

It is the view of the Department, therefore, that, to the extent that SunAmerica follows the Program as structured in relation to an investment of Plan assets in SunAmerica Funds, there would not be a per se violation of section 406(b)(1) or (3) of ERISA solely as a result of SunAmerica’s, or any affiliate’s, receipt of increased investment advisory fees resulting from such investments.

In view of this letter, the Department believes that no further action is necessary with respect to your exemption application. Accordingly, your exemption application is closed without further action. This letter constitutes an advisory opinion under ERISA Procedure 76-1, 41 Fed. Reg. 36281 (Aug. 27, 1976). Accordingly, this letter is issued subject to the provisions of that procedure, including section 10 thereof, relating to the effect of advisory opinions.

Sincerely,
Louis Campagna
Chief, Division of Fiduciary Interpretations
Office of Regulations and Interpretations

 

Footnotes:

  1. Under Reorganization Plan No. 4 of 1978, 43 Fed. Reg. 47713 (Oct. 17, 1978), the authority of the Secretary of the Treasury to issue rulings under section 4975 of the Internal Revenue Code (Code) has been transferred, with certain exceptions not here relevant, to the Secretary of Labor. Therefore, the references in this letter to specific sections of ERISA also refer to the corresponding sections of the Code.
  2. The Department expresses no views herein, and no views should be implied, concerning the application of ERISA section 404(c) to the Program or any participating Plan or participant.
  3. The asset allocation services under the Program also may be available to beneficiaries who, under the terms of their Plan, have the power to direct the investments in their account balances. For purposes of convenience, we refer only to participants.
  4. You represent that the Program and Services will impose no limit on the frequency with which a participant may change his or her investment election. However, there may be limits concerning such frequency under the terms of a participating Plan.
  5. You explain that, with respect to the Recommended Asset Allocation Services, under circumstances where a participating Plan permits participant input such as direction to invest in assets other than Designated Investments or to place ceilings or floors on the percentages, or amounts, of Designated or non-Designated Investments, the methodologies followed by the Financial Expert, as described below, may result in a portfolio, other than a Model Asset Allocation Portfolio, that includes non-Designated Investments. You refer to such portfolios, along with the Model Asset Allocation Portfolios, generally as “Asset Allocation Portfolios.”
  6. As described below, an independent Plan fiduciary will determine the investments that will be available under the Plan.
  7. You explain that the assets underlying the Designated Investments may fall into more than one asset class, and that in constructing a Model Asset Allocation Portfolio, the Financial Expert will employ a statistical method to determine the asset class exposure to a participant of a Designated Investment’s investment approach.
  8. You note that this process may be completed in a summary manner where SunAmerica offers the Program along with a range of SunAmerica Funds that will constitute the Designated Investments. You also represent that under no circumstances, except for Plans maintained by SunAmerica and its affiliates, will SunAmerica select investment alternatives to be made available under a Plan. This letter addresses only participation by Plans that are not maintained by SunAmerica and/or its affiliates.
  9. We express no opinion as to whether the requirements of section 408(b)(2) of ERISA would be satisfied with respect to the Program.
  10. The Department notes that, with regard to the selection and monitoring of the Financial Expert and SunAmerica’s investment advisory services, any consideration of the effect of investment recommendations, or methodologies upon which such recommendations are based, on the fees or other compensation of SunAmerica or any of its affiliates, would, in the view of the Department, be inconsistent with a fiduciary’s obligations under section 404 of ERISA.
  11. Whether a party is “independent” for purposes of the subject analysis will generally involve a determination as to whether there exists a financial interest (e.g., compensation, fees, etc.), ownership interest, or other relationship, agreement or understanding that would limit the ability of the party to carry out its responsibility beyond the control, direction or influence of the fiduciary. In this regard, we note there have been other contexts in which the Department dealt with this issue. Under Prohibited Transaction Class Exemption 84-14, relief from section 406(a) of ERISA was provided for transactions between plans and parties in interest if approved by a qualified professional asset manager (QPAM). The party in interest could not be “related” to the QPAM - meaning such party in interest (or person controlling, or controlled by, the party in interest) could not own a five percent or more interest in the QPAM; or the QPAM (or person controlling, or controlled by, the QPAM) could not own a five percent or more interest in the party in interest. Further, the plan with respect to which the person was a party in interest could not represent more than 20% of the assets that the QPAM had under management at the time of the transaction.



 
Last Updated 04/02/2008

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