Donald J. Myers, Esq.
Reed Smith LLP
1301 K Street, NW, Suite 1100 East Tower
Washington, DC 20005-3373
Dear Mr. Myers:
This is in response to your request for an advisory opinion on behalf of Vanguard
Fiduciary Trust Company (Vanguard) concerning the application of section 408(b)(8)
of the Employee Retirement Income Security Act of 1974, as amended (ERISA), and
the parallel provisions under section 4975(d)(8) of the Internal Revenue Code
of 1986, as amended (the Code),(1) to an in-kind investment in a bank collective
investment fund, as made under the circumstances described herein.
You represent that Vanguard is a trust company, based in Valley Forge, Pennsylvania,
that is organized under the laws applicable to such entities under the Pennsylvania
Banking Code. Vanguard is supervised by the Pennsylvania Department of Banking.
Vanguard is a wholly-owned subsidiary of The Vanguard Group, Inc. (Vanguard Group).
The Vanguard Group manages assets through registered open-end investment companies,
pursuant to the Investment Company Act of 1940 (i.e., mutual funds). Vanguard
manages assets held in collective trust funds for employee benefit plans covered
by ERISA. You state that many Vanguard Group mutual funds and Vanguard trust
funds serve as investment options for participant-directed individual account
plans, organized to comply with section 401(k) of the Code (“401(k) plans”),
and as investments for other qualified retirement plans.
Vanguard structures stable value investment options, designed to allow investors
to receive current interest income and preserve principal amounts, for many 401(k)
plans either using a commingled trust, or as a separately managed account for
a particular plan. You state that over 900 plans use the commingled trust structure,
and approximately 40 are using the stable value separate account structure (referred
to collectively herein as “stable value portfolios”).
The commingled trust structure uses a collective investment vehicle, the VRST
Master Trust. Plans do not hold interests directly in the VRST Master Trust,
but instead invest in one of seven “feeder” trusts – the Retirement Savings Trusts
– that invest all of their assets in the VRST Master Trust. Investment management
fees are imposed at the “feeder” trust level.
The commingled trusts used by Vanguard take the form of collective investment
funds intended to qualify as group trusts, pursuant to Revenue Ruling 81-100,
1981-1 C.B. 326, and Revenue Ruling 2004-67, 2004-28 I.R.B., that are tax exempt
under section 401 and 501(a) of the Code. Vanguard serves as trustee for such
Plans pay fees to Vanguard only at the level of the stable value investment portfolio
in which the plan directly invests. This is the level of the separately managed
account or, with respect to the VRST Master Trust, the “feeder” trust level.
Vanguard’s stable value portfolios (i.e., the commingled trusts or the separately
managed accounts) currently invest in, among other things, a series of fixed-income
commingled trusts, the Vanguard Targeted Return Trusts (the TRTs). The TRTs were
established quarterly on a rolling basis, each with a 5-year term, and managed
to a constantly decreasing duration to provide liquidity at the end of the 5-year
term. At any one time, there would be 20 TRTs in existence with durations ranging
from one quarter of a year to 5 years. Each quarter, one TRT would expire and
a new one would be created. The stable value portfolios managed by Vanguard,
including the VRST Master Trust, have invested in the various TRTs based on their
available cash, other investments and liquidity needs. The VRST Master Trust
holds the majority of the assets of each TRT.
You state that Vanguard created the TRTs as stable value portfolios with high-quality
fixed income securities with fixed maturity dates. These securities were then
backed by “wrap” contracts with insurance companies or banks to provide for certain
disbursements to be made at the “book” value of the assets, rather than the market
value. This structure is commonly referred to as a “synthetic” guaranteed investment
You represent that for various reasons related to investment management strategies
and cost efficiencies, Vanguard has begun to phase out the TRT program. As the
existing TRTs mature, they are being replaced by investments in two commingled
trusts of comparable aggregate duration – the Vanguard Intermediate-Term Bond
Trust (ITBT), and the Vanguard Short-Term Bond Trust (STBT). These trusts (collectively,
the Bond Trusts), like the TRTs, invest principally in high-quality fixed-income
As a means of transitioning to the new investment management structure, and more
quickly realizing the efficiencies and other benefits of managing assets through
the Bond Trusts rather than the existing TRTs, Vanguard would like to transfer
the assets of the TRTs in-kind to the Bond Trusts as soon as possible, and then
terminate the TRTs.
Specifically, TRT securities would be allocated to the Bond Trusts based on the
TRTs’ average durations. Each TRT would receive in return interests in the applicable
Bond Trust – i.e., the STBT or ITBT – that are equal in value to the value of
the securities it transferred to the respective Bond Trust. The same business
day, the TRT would distribute those Bond Trust interests to each stable value
portfolio that holds interests in the TRT, in proportion to the portfolio’s TRT
interests, and then terminate. At the end of the business day, each stable value
portfolio would hold Bond Trust interests equal in value to its former TRT interests.
The principal advantage of liquidating the TRTs through in-kind exchanges of
securities for interests in the Bond Trusts, as opposed to liquidations for cash
on the open market, would be to avoid transaction costs. The total transaction
cost estimates are in the range of $5.4 million as existing TRTs have securities
with an estimated market value of approximately $3.4 billion. In addition, Vanguard
seeks to avoid the possibility of the Bond Trusts not acquiring the same securities
on the open market that are sold by the TRTs.
You represent that the trust documents for the TRTs and the Bond Trusts provide
the necessary authority for Vanguard to cause the TRTs to make an in-kind investment
in the Bond Trusts. You state that the TRTs, by their terms, permit investment
in a collective investment fund maintained by the trustee of the TRTs (i.e.,
Vanguard), where the fund invests principally in securities of the type in which
the TRT is permitted to invest. Specifically, Article 6.1(a) of each TRT gives
the trustee the authority, in its sole discretion, “to invest and reinvest the
Trust in such investments and other property, without restrictions to investments
authorized for fiduciaries, as the Trustee determines in accordance with the
Trust’s investment objective as set forth in Article 1.2 …, including, without
limitation, (i) any other collective investment trust maintained by the Trustee…”
Your represent further that the trust documents for the Bond Trusts permit investment
by any common, collective or commingled trust fund or group trust that consists
solely of the assets of pension, profit-sharing and other qualified plans, and/or
other types of retirement plans or vehicles holding retirement plan assets. Under
Article 1.02 of the STBT and Article 2.2 of the ITBT, an investment in units
of the respective Trust may be made in the form of cash, or in the form of other
property acceptable to the trustee.
For purposes of the in-kind investments by the TRTs in the Bond Trusts, you state
that the assets being transferred would be valued in a consistent manner by both
the investing and receiving trusts, using independent pricing sources.
Specifically, for valuing fixed-income securities, Vanguard uses the same pricing
services for both the TRTs and the Bond Trusts. Where none of the pricing services
used makes a value available for a particular security, or where there has been
a significant change in value of the security from the previous price used (i.e.,
greater than 1%), Vanguard will obtain quotations from three (3) different independent
brokers, and will use the lowest of the three available quotes. You state that
pricing services and broker quotations are not used for short-term instruments
maturing within 60 days. Thus, pursuant to the trust document’s valuation provisions,
these instruments would be valued at cost (plus or minus any amortized discount
or premium). All valuations would be made as of 3:00 p.m. Eastern Time on the
Vanguard serves as trustee of both the TRTs and the Bond Trusts – all of which,
as bank collective investment funds, are deemed to hold “plan assets” subject
to ERISA pursuant to the Department’s regulations (see 29 CFR §2510.3-101(h)(1)(ii)).
For this reason, you state that Vanguard would find itself acting in a discretionary
role on both sides of any transaction between the TRTs and the Bond Trusts. Thus,
the in-kind investment by the TRTs in the Bond Trusts could be viewed as a sale
by the TRTs of their securities to the Bond Trusts, with Vanguard, in its capacity
as trustee, acting in the role of both the buyer and the seller.
Advisory Opinion Requested
You request an opinion as to whether a purchase of interests in a collective
investment fund through an in-kind investment of securities would be exempt from
the prohibited transaction provisions of section 406 of ERISA by reason of the
statutory exemption contained in section 408(b)(8) of ERISA.
Relevant Provisions of ERISA and Analysis
Section 406(a)(1) of ERISA provides, in part, that a fiduciary with respect to
a plan shall not cause the plan to engage in certain direct or indirect transactions
with a party in interest, including sales or exchanges of property between the
plan and a party in interest (section 406(a)(1)(A)), and transfers to or use
by or for the benefit of a party in interest of any assets of the plan (section
Section 406(b)(1) of ERISA prohibits a fiduciary with respect to a plan from
dealing with the assets of the plan in his or her own interest or for his or
her own account. Section 406(b)(2) of ERISA provides that a fiduciary shall not
in his or her individual or in any other capacity act in any transaction involving
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.
Section 3(21) of ERISA defines a “fiduciary” of a plan to include a person who
exercises any discretionary authority or control respecting management or disposition
of its assets; or who 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.
Section 3(14) of ERISA defines the term “party in interest” to include a fiduciary
and a person providing services to a plan.
The Department’s regulation at 29 CFR §2510.3-101 defines what are considered
to be “plan assets” when a plan invests in another entity. The regulation provides,
at 29 CFR §2510.3-101(h)(1)(ii), that when a plan acquires an interest in a common
or collective trust fund of a bank, its assets include its investment as well
as an undivided interest in each of the fund’s underlying assets.
As you have acknowledged, Vanguard is a fiduciary under section 3(21) of ERISA
with respect to ERISA-covered plans for which it serves as trustee. Pursuant
to the Department’s regulations defining “plan assets” (as noted above), Vanguard
is also a fiduciary for ERISA-covered plans that invest in the TRTs, either through
separately managed accounts or commingled trusts, by reason of its discretionary
authority and control over such assets. You indicate that Vanguard receives investment
management fees from plans that invest in such accounts or trusts invested in
the TRTs, at either the separate account or “feeder” trust level, as applicable.
Therefore, unless an exemption applies, you are concerned that Vanguard would
violate sections 406(a)(1)(A), 406(a)(1)(D), 406(b)(1), and 406(b)(2) of ERISA
if, as a fiduciary of ERISA-covered plans, it caused “plan assets” invested in
the TRTs to be invested in the Bond Trusts.
Section 408(b)(8) of ERISA exempts, in pertinent part, any transaction between
a plan and a common or collective trust fund maintained by a party in interest
which is a bank or trust company supervised by a state or federal agency, if
the following conditions are met:
the transaction is a sale or purchase of an interest in the fund,
the bank or trust company receives not more than reasonable
such transaction is expressly permitted by the instrument
under which the plan is maintained, or by a fiduciary (other than the
bank or trust company or an affiliate) who has authority to manage and
control the assets of the plan.
You represent that the TRTs and Bond Trusts are collective trust funds maintained
by Vanguard, a trust company supervised by the Pennsylvania Department of Banking.
The transactions at issue would be purchases of interests in the Bond Trusts,
and would be authorized by the applicable trust documents relating to each TRT
and Bond Trust. Vanguard would not be paid any separate fees by the Bond Trusts
for the assets invested therein by the TRTs. You state that Vanguard’s existing
fee arrangements with plans would remain unaffected by the proposed transactions
and it would not receive more than reasonable compensation as a result of the
With respect to the conditions of ERISA section 408(b)(8), although the statutory
provisions do not define the term “reasonable compensation” for purposes of the
exemption, the ERISA Conference Committee Report (as issued by Congress in 1974)
“[t]o be allowed, no more than reasonable compensation may be paid by the plan
in the purchase (or sale) and no more than reasonable compensation may be paid
by the plan for investment management by the pooled fund.”
Thus, Congress anticipated that the term “reasonable compensation” would apply
to the purchase or sale of an interest in a collective investment fund by a plan
and to amounts to be paid by the plan for investment management of such assets.
In addition, with respect to covered transactions,
the ERISA Conference Committee Report does not appear
to distinguish cash from in-kind assets, nor does
a particular form of investment, with regard to any purchase or sale of interests
or units in a common or collective investment trust fund, or pooled investment
fund, maintained by a party in interest which is a bank or trust company. Furthermore,
at the end of the relevant section discussing the provisions of ERISA section
408(b)(8), Congress expressed the view that, under the general fiduciary rules
of ERISA, a bank “…cannot use pooled funds as a place to dump unwanted investments
which were initially made on its
own (or another’s behalf).” Id.
In this regard, by noting the possibility of a bank placing investments it previously
had made into a collective investment fund, Congress appears to have anticipated
in-kind investments being made into such a fund as a “purchase” covered by the
Accordingly, it is the opinion of the Department
that the statutory exemption provided under section
408(b)(8) of ERISA would permit an in-kind exchange
securities owned by a plan or fund holding “plan assets” for units or interests
in a collective investment fund maintained by a bank or trust company, provided
that the conditions necessary for relief as stated therein are met.(2) However,
please note that the issue of whether all of the conditions of section 408(b)(8)
will be met is a factual determination upon which the Department cannot opine.
Therefore, the appropriate plan fiduciaries, including Vanguard, must determine,
based on the particular facts and circumstances, whether
the conditions of section 408(b)(8) will be met for the proposed in-kind exchanges.
In particular, the Department notes that the exemption provided in section 408(b)(8)
is available for the proposed in-kind exchanges only if the valuation method
used by Vanguard in connection with each transaction results in a plan paying
no more than reasonable compensation for its investment. In our view, a plan
would pay more than reasonable compensation in any in-kind exchange in which
the value of assets transferred to a fund would be more than the value of the
fund units or interests the plan received.
Therefore, the Department cautions Vanguard to ensure that appropriate procedures
and safeguards are in place to guarantee uniform pricing of both the relevant
“plan assets” in each TRT to be transferred to each Bond Trust and the Bond Trust’s
units to be received by each plan’s stable value portfolio investment. As described
herein, such investments would include the Retirement Savings Trusts that are
“feeder” trusts for the VRST Master Trust, as managed by Vanguard on the date
of the transactions.
Finally, the Department is providing no opinion herein as to Vanguard’s current
or future stable value investment strategies, or courses of action to implement
to such strategies (including methods for saving transaction costs or avoiding
Section 404(a)(1) of ERISA provides, in pertinent
part, that fiduciaries shall discharge their duties
with respect to a plan with the care, skill, prudence,
and diligence under the circumstances then prevailing that a prudent person
in a like capacity and familiar with such matters would use in the conduct
of an enterprise of a like character and with like
aims. Among other things, a fiduciary
must give appropriate consideration to those facts and circumstances that,
given the scope of such fiduciary’s investment duties,
the fiduciary knows or should
know are relevant to the particular investment or investment course of action
involved, including the role the investment or
investment course of action plays in that portion of the plan’s investment
portfolio with respect to which the fiduciary has investment duties.(3)
This letter constitutes an advisory opinion under ERISA Procedure 76-1, 41 Fed.
Reg. 36281 (1976). Accordingly, this letter is issued subject to the provisions
of that procedure, including section 10 thereof, relating to the effect of advisory
Louis J. Campagna
Chief, Division of Fiduciary Interpretations
Office of Regulations and Interpretations
Under Reorganization Plan No. 4 of 1978, effective
December 31, 1978 [5 USC App. at 214 (2000 ed.)],
the authority of the Secretary of the Treasury to issue
interpretations regarding section 4975 of the Code
has been transferred, with certain exceptions not
here relevant, to the Secretary of Labor and 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.
See Adv. Op. 96-15A (Aug. 7, 1996), wherein the Department
took the position that section 408(b)(8) of ERISA
provides relief from sections 406(a)(1)(A), 406(a)(1)(D), 406(b)(1)
and 406(b)(2) for the
purchase or sale by a bank or trust company, as fiduciary
of ERISA-covered plans, of interests in a collective fund so long
as the conditions of
the statutory exemption are met, including that the
transaction be expressly permitted by the plan or an authorized independent
The Department notes that regulation §2550.404a-1
defines appropriate considerations for an investment course of action
in such matters.