Trust Examination Manual
May 24, 2004
ERISA Sec. 406(a)(1)(A),(D)
Mr. William R. Charyk
Arent Fox Kintner Plotkin & Kahn,
1050 Connecticut Avenue, NW
Washington, DC 20036-5339
Dear Mr. Charyk:
This is in response to your request for guidance under section 406 of the Employee
Retirement Income Security Act of 1974 (ERISA) and section 4975 of the Internal
Revenue Code of 1986, as amended (the Code).(1) In particular, you ask whether
the execution of a securities transaction between a plan and a party in interest
with respect to such plan as defined in ERISA through an alternative trading
system (ATS) maintained by Liquidnet, Inc. (Liquidnet) constitutes a prohibited
transaction under section 406(a)(1)(A) and (D) of ERISA. In addition, you inquire
whether the execution of a securities transaction through the Liquidnet ATS (the
Liquidnet System) between a plan and a counterparty that is an affiliate of the
fiduciary directing such trade on behalf of the plan also violates section 406(b)
You write on behalf of Liquidnet, a registered broker/dealer that maintains
the Liquidnet System. The Liquidnet System is an "alternative
trading system," as defined in Rule 300(a) of Regulation ATS under the Securities Exchange Act
of 1934, as amended. You also represent that all of Liquidnet’s approximately
200 subscribers are large institutional investors that individually manage,
on average, approximately $31 billion of equity assets. You note that these
none of which are affiliated with Liquidnet, often act as named fiduciaries,
investment managers, or provide other services to employee benefit plans.
You state that Liquidnet was created to facilitate the trading of “blocks” of
equity securities. In this regard, since its inception in 2001, more than three
billion shares of equity securities have been traded over the Liquidnet System
pursuant to trade sizes that have averaged approximately 44,000 shares. You state
that the total value of the shares traded through the Liquidnet System approximated
$61 billion as of August 29, 2003.
You state that subscribers to Liquidnet may trade U.S., U.K., French, German,
Netherlands, and Swiss equity securities through the Liquidnet System. In
this regard, you state that the Liquidnet System: (1) interfaces with the
systems of Liquidnet’s subscribers; and (2) identifies, with respect to a
particular security, each Liquidnet subscriber that has an interest in buying
and each Liquidnet subscriber that contemporaneously has an interest in selling
the security. You state that each Liquidnet subscriber indicates to the Liquidnet
System its interest in buying or selling various securities. If one subscriber
indicates to the Liquidnet System an interest in buying a certain security
that a different subscriber has independently indicated to the Liquidnet
interest in selling, the Liquidnet System notifies both subscribers that
a transaction opportunity exists.(2) You note that the Liquidnet System does
not disclose the
identity of either subscriber to the other. The two
subscribers may then negotiate; through their respective computer systems;
both the price and the quantity of the security. Accordingly, you state that
System enables subscribers to engage in an anonymous, no obligation, one-on-one,
real-time negotiation (a subscriber must terminate its current negotiation
with another subscriber before engaging in a new negotiation with a different
You state that multiple Liquidnet subscribers may have an interest in buying
(or selling) a security that a different Liquidnet subscriber has an interest
in selling (or buying). Where, for example, the Liquidnet System identifies
that multiple subscribers have an interest in buying a security that a different
has an interest in selling, the Liquidnet System provides the selling subscriber
with an electronic listing of the anonymous subscribers interested in buying.
You note that once a subscriber is provided with such a listing, the subscriber
may thereafter negotiate with any or all of the subscribers on the list.
You state that the Liquidnet System currently determines the order of a multiple
subscriber listing by comparing the quantities they have posted to the quantity
posted by the single contra-side subscriber. The subscriber posting a quantity
that is nearest to the quantity posted by the single contra-side subscriber
placed first on the list. The remaining order is determined in the same
fashion.(3) You state that the Liquidnet System's trading rules, which are
distributed to all subscribers, contains a disclosure that describes how
negotiating subscribers will be ordered.
You represent that trades entered into pursuant to the Liquidnet System are executed
on a “blind” basis. In this regard, you state that, during the entire execution
and settlement processes, subscribers interact with each other pursuant to policies
and rules designed to ensure anonymity. You represent that the Liquidnet System,
never discloses the identity of a subscriber to any other. In addition, all physical
transfers of equity securities and cash are made between an independent clearing
firm, Bear, Stearns Securities Corp. and the buyer’s and seller’s respective
custodians. Therefore, the identities of the parties to a trade will not be revealed
to the parties during the clearing process.
You state that: given the number and type of Liquidnet subscribers; the large
number of trades executed on Liquidnet on a daily basis; and the fact that such
trades are executed and settled pursuant to rules, procedures and software designed
to ensure anonymity; it is expected that the parties to a transaction engaged
in through the Liquidnet System will not know, at any time, the identity of each
other.(4) Accordingly, it is possible for a subscriber, in its capacity as a
fiduciary with respect to a plan, to unknowingly buy/sell a security on behalf
of the plan through the Liquidnet System from/to a Liquidnet subscriber that
is a party in interest to the plan.
Further, you note that although a subscriber cannot execute a securities
transaction with itself through the Liquidnet System (i.e., as both the buyer
it is possible for a plan fiduciary to direct a trade through the Liquidnet
System whereby the Liquidnet subscriber that is the counterparty to the plan
is an affiliate
of such fiduciary. You state that two affiliates may request that Liquidnet "block" negotiations
between the two entities. However, you note that a Liquidnet subscriber may
not be aware that an affiliate thereof is also a Liquidnet subscriber.
Section 3(14)(A) and (B) of ERISA defines the term “party in interest” as meaning,
as to an employee benefit plan, any fiduciary (including, among others, a trustee)
of an employee benefit plan; and a person providing services to such plan. ERISA
section 3(21)(A) provides that a person is a fiduciary with respect to a plan
to the extent that (i) he 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) he renders investment
advice for a fee or other compensation, direct or indirect, with respect to any
moneys or other property of the plan, or has any authority or responsibility
to do so, or (iii) he has any discretionary authority or responsibility in the
administration of such plan.
Section 406(a)(1)(A) of ERISA prohibits a fiduciary with respect to a plan
from causing the plan to engage in a transaction if he or she knows or should
that the transaction constitutes a direct or indirect sale or exchange, or
leasing, of any property between the plan and a party in interest. Section
of ERISA provides that a fiduciary with respect to a plan shall not cause
the plan to engage in a transaction, if he or she knows or should know that
transaction constitutes a direct or indirect transfer to, or use by or for
the benefit of, a party in interest, of any assets of the plan. Section 406(b)(1)
of ERISA provides that a fiduciary with respect to a plan shall not deal
the assets of the plan in his or her own interest or for his or her own account.
Section 406(b)(2) provides that a fiduciary with respect to a plan shall
not in his or her individual or in any other capacity act in any transaction
the 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.
With respect to purchases and sales of equity securities, we note that the Conference
Report accompanying ERISA states that:
In general, it is expected that a transaction will not be a prohibited transaction
(under either the labor or tax provisions) if the transaction is an ordinary
“blind” purchase or sale of securities through an exchange where neither buyer
nor seller (nor the agent of either) knows the identity of the other party involved.
In this case, there is no reason to impose a sanction on a fiduciary (or party-in-interest)
merely because, by chance, the other party turns out to be a party-in-interest
(or plan). H.R. Rep. 93-1280, 93rd Cong., 2d Sess., 307 (1974).
As you noted, Liquidnet matches purchase and sell orders from its clients and
gives purchasers and sellers the opportunity to negotiate a trade based on price
and volume. The number of subscribers and the trading procedures assure a party’s
anonymity, unless the party wishes to identify itself to the counter-party. In
our view, transactions executed through Liquidnet’s trading procedures for the
execution of transactions, that are designed to permit anonymous negotiations
without identifying the parties, function in a manner similar to the operation
of an exchange. Accordingly, based on your representations, it is our further
view that “blind” transactions executed pursuant to such procedures would not,
in themselves, constitute prohibited transactions under section 406(a)(1)(A),
406(a)(1)(D), 406(b)(1) or 406(b)(2) of ERISA.
The Department notes, however, that a transaction effectuated through the
Liquidnet System will not be considered "blind”
if, prior to the execution of such transaction, the plan fiduciary responsible
for the plan's engagement in the transaction knew, or had reason to know,
the identity of the counterparty to such transaction. Given the ability of
to a transaction to disclose their identities to each other, persons trading
on behalf of employee benefit plans should be particularly careful to make
sure the transaction is truly blind. Moreover, these determinations assume
purchase and sale transactions did not arise in connection with any arrangement,
agreement, or understanding designed to benefit the fiduciary (including
an affiliate thereof) or any other party in interest to the plan.
In addition, with respect to the arrangement and transactions described above,
ERISA's general standards of fiduciary conduct apply to: (i) the determination
to buy or sell a particular equity security (and, in addition, the determination
as to the appropriate purchase or sale price for such security); and (ii)
the determination as to which trading system should be used to assist with
or sale of equity securities.(5) In this regard, as noted above, section
404 of ERISA requires a fiduciary to discharge his duties respecting a plan
in the interest of the plan's participants and beneficiaries. This section
also requires that a plan fiduciary act prudently and for the exclusive purpose
providing benefits to plan participants and their beneficiaries; and defraying
reasonable expenses of administering the plan. Accordingly, plan fiduciaries
that subscribe to Liquidnet must consider the costs associated with the use
of alternative trading systems as well as the potential revenue returns,
and other benefits that result from the continuing use of particular alternative
trading systems over other similar services.
Further, prior to a plan fiduciary’s decision to execute a securities transaction
through Liquidnet, the plan fiduciary (as a subscriber or an affiliate of a subscriber)
should determine whether any existing or potential conflicts of interest or prohibited
transactions under ERISA would interfere with the proper exercise of any of the
fiduciary’s responsibilities under section 404 of ERISA, including the duty to
act solely on behalf of the plan.
This letter constitutes an advisory opinion under ERISA Procedure 76-1 (41 Fed.
Reg. 36281, August 27, 1976). Accordingly, this letter is issued subject to the
provisions of the procedure, including section 10 relating to the effect of advisory
opinions. The opinion only relates to the specific issues raised by your request.
For example, you have not asked and the Department is expressing no opinion with
respect to the fees and other compensation received by persons engaging in transactions
on the Liquidnet System on behalf of plans.
Chief, Division of Fiduciary Interpretations
Office of Regulations and Interpretations
Under Reorganization Plan No. 4 of 1978, 43 FR 47713 (5 U.S.C. App. 1 ),
the authority of the Secretary of the Treasury to issue rulings under section
4975 of the Code has been transferred, with certain exceptions not here relevant,
to the Secretary of Labor. The Secretary of the Treasury is bound by interpretations
of the Secretary of Labor pursuant to such authority. Therefore, references in
this letter to specific sections of ERISA should be read to refer also to the
corresponding sections of the Code.
- Accordingly, you state that Liquidnet does not "solicit" subscriber
interest with respect to the buying or selling of securities
(i.e., once a subscriber notifies Liquidnet that it has an interest
or selling a security, the Liquidnet System does not
thereafter broadcast that interest to all of the other Liquidnet subscribers).
- You state that in the future, the percentage of successful
negotiations attributable to each respective subscriber
may also affect the ordering of a multiple subscriber list.
- You note, however, that subscribers using the system to
negotiate a securities transaction may "chat" with each other. In this regard, you state that although the Liquidnet System
does not disclose the identities of negotiating subscribers
to each other, two such subscribers may electronically correspond
to each other,
without restriction as to content, through the Liquidnet
System as part of the negotiation. You note that this type of correspondence
and retained by Liquidnet.
- Whether, in light of all the facts and circumstances,
a purchase or sale of securities or the use of a particular service
satisfies the fiduciary responsibility provisions
of ERISA is an inherently factual question as to which the Department
generally will not opine.
See section 5.01 of ERISA Procedure 76-1, 41 Fed.
Reg. 36281 (Aug. 27, 1976).