the prohibition on the payment of sales commissions in PTE 77-3 applies
to the payment of 12b-1 Fees by a proprietary mutual fund to an unrelated
Mr. F. Jefferson Bragdon
Two Chatham Center
Pittsburgh, PA 15219
Re: Company A 401(k) and Profit Sharing Plan (the Plan)
is in response to your request for an advisory opinion concerning
Prohibited Transaction Exemption (PTE) 77-3 (42 FR 18734, April 8,
1977).(1) Specifically, you request an opinion on whether the prohibition
on the payment of sales commissions in PTE 77-3 applies to the payment
of distribution-related expenses (12b-1 Fees) by a proprietary mutual
fund (the Mutual Fund) to an unrelated broker. In particular, the
distributor of the Mutual Fund would pay the unrelated broker from
Mutual Fund assets received by the distributor under a Rule 12b-1
plan of distribution (the 12b-1 Plan).(2) The distributor would retain
no portion of the 12b-1 Fees. Due to your uncertainty about the application
of PTE 77-3, you requested that we not identify the relevant parties.
describe the facts as follows. Company A is the sponsor of the Plan.
Company A is an investment adviser to the Z Family of Mutual Funds
(the Funds), and one of four employers of employees covered by the
Plan. The other employers are Company B, the distributor and principal
underwriter of the Funds; Company C, another investment adviser of
the Funds; and Company D, which provides other services to the Funds.
Plan is a defined contribution plan with a section 401(k) cash or
deferred feature permitting employee pre-tax deferrals, which allows
participants to direct the investment of their accounts among the
Funds. The Plan was established by Company A, effective January 1,
1994. The Plan covers only employees of Companies A, B, C, and D (the
Companies). The Plan is intended to comply with section 404(c) of
the Employee Retirement Income Security Act of 1974 (the Act or ERISA).
As of June 30, 2005, the Plan had total assets of approximately $7
million. As of September 9, 2005, the Plan had 260 participants. The
trustee of the Plan is Individual G, a senior executive officer of
the inception of the Plan to September 2005, you explain that participants
have directed the investment of their accounts among the Funds. Beginning
in 1999, you indicate that some of the Funds, in which participants
invested their accounts, adopted 12b-1 Plans in accordance with Rule
12b-1 under the Investment Company Act of 1940 (the ’40 Act), 17 CFR §240.12b-1. You further explain that the 12b-1 Plans permit 0.25 percent of the
Funds’ assets to be used by Company B to pay 12b-1 Fees to promote the sale of shares
of the Funds. No 12b-1 Fees have been paid by Company B in connection
with the acquisition or sale of shares of the Funds by the Plan.
state that Company A has entered into an agreement (the Agreement)
with Company E, an unrelated party to the Funds and the Companies,
to provide administration services for the Plan. In connection therewith,
Company A will (a) adopt the approved prototype plan of Company E,
(b) appoint Bank F as successor trustee, and (c) transfer the assets
of the Plan to Bank F in cash. After the transfer of the Plan assets,
you explain that participants will direct the investment of their
account balances among investment alternatives consisting of mutual
funds that are offered by parties unrelated to the Funds and the Companies,
whose net asset values are listed daily in financial and other news
accommodate a number of participants that want to continue to direct
the investment of their account balances in the Funds after the transfer,
you state that the Agreement with Company E provides for a self-directed
brokerage account (the Self-Directed Brokerage Account) established
with Company H, that will permit participants to direct the investment
of their account balances in the Funds. The Self-Directed Brokerage
Accounts will be available to all participants on an equal basis.
A Plan participant that uses the Self-Directed Brokerage Account option
will pay a $75 annual fee to the Plan recordkeeper.
You represent that Company B will pay a 12b-1 Fee to Company H, the broker, with
respect to amounts invested in the Funds by Plan participants and
that Company B will not retain any portion of such fee. You explain
that Company H provides brokerage services to the Plan participants
and that it is unrelated to the Funds, the Companies, Individual G,
and Bank F. You also state that Company H is not a fiduciary, as defined
in section 3(21) of the Act, with respect to the Plan, because it
does not exercise any discretionary authority or control with respect
to management of the Plan or exercise any authority or control with
respect to management or disposition of assets of the Plan, and does
not render investment advice with respect to any property of the Plan.
You further represent that no fiduciary of the Plan, or affiliate
of any fiduciary, will benefit from any part of the 12b-1 Fee.
represent that the Plan’s investment in the Funds has met and will continue to meet the conditions stated
in PTE 77-3. Therefore, you explain that the only issue with respect
to the continued availability of PTE 77-3 is the possibility that
the payment of 12b-1 Fees to Company H may not be permissible under
77-3 provides relief from the restrictions of sections 406 and 407(a)
of the Act and the taxes imposed by section 4975 (a) and (b) of the
Internal Revenue Code (the Code), by reason of section 4975(c)(1)
of the Code, with respect to the acquisition or sale of shares of
an open-end investment company registered under the ’40 Act by an employee benefit plan covering only employees of such investment
company, employees of the investment adviser or principal underwriter
for such investment company, or employees of any affiliated person
of such investment adviser or principal underwriter; provided that
the conditions of the class exemption are met. Among its requirements,
section (c) of PTE 77-3 provides that the plan must not pay a sales
commission in connection with such acquisition or sale.
As you have noted, the Department’s concern with respect to 12b-1 Fees was expressed in ERISA Advisory Opinion
93-12A (April 27, 1993) in the context of a transaction otherwise
covered by PTE 77-4 (42 FR 18732, April 8, 1977). PTE 77-4 permits
the purchase or sale by a plan of shares of a registered open-end
investment company where an investment adviser to the mutual fund
is also a fiduciary with respect to the plan. In ERISA Advisory Opinion
93-12A, a company serving as investment manager or trustee to employee
benefit plans invested plan assets in affiliated mutual funds. The
company credited the plan for investment advisory fees that the company
received from the mutual fund, but did not credit the plan for fees
that it received for secondary services provided to that fund. The
Department stated that PTE 77-4 would be available if the secondary
services were not investment advisory services and the conditions of this class exemption were otherwise met.
Department also noted in ERISA Advisory Opinion 93-12A that at the
time PTE 77-4 was granted, the use of a portion of the assets of a
registered investment company to pay distribution-related expenses
was not generally permitted by the Securities and Exchange Commission.
Accordingly, the Department stated that the payment of 12b-1 Fees
was not specifically considered as part of its determination to grant
PTE 77-4. In any event, the Department was of the view that the payment
of a 12b-1 Fee by a mutual fund to a plan fiduciary or its affiliate
could not be “functionally distinguished” in many instances from the payment of a commission by the plan in connection
with the acquisition or sale of shares in a mutual fund. Therefore,
the Department was unable to conclude that PTE 77-4 would be available
for plan purchases and sales of mutual fund shares if a 12b-1 Fee
was paid to the fiduciary or its affiliate with regard to that portion
of the fund’s assets attributable to the plan’s investment.
ERISA Advisory Opinion 2002-05A (June 7, 2002) involving “exchange-traded funds,” the Department expressed the view that the term “sales commission,” as used in section II(a) of PTE 77-4, would not include brokerage commissions
paid to a broker in connection with purchases or sales of shares of
registered open-end investment companies listed on an exchange if
the broker is unaffiliated with the fund, its principal underwriter,
investment adviser or any affiliate thereof.
in the case under consideration, the broker (Company H) is unaffiliated
with the Mutual Fund, its principal underwriter/distributor (Company
B), any investment advisers (Companies A and C) or any affiliate thereof
(Company D), and any other fiduciary of the Plan (Bank F and Company
E). In addition, neither the Companies nor their affiliates would
receive any part of the 12b-1 Fees, nor would any fiduciary with respect
to the Plan or affiliate of such fiduciary receive such fees. Finally,
no commissions would be paid from the Plan participants’ accounts other than 12b-1 Fees out of Fund assets. Accordingly, it is the Department’s view that the term “sales commission,” as used in section (c) of PTE 77-3, would not include 12b-1 Fees that are paid
to Company H, by Company B, from Mutual Fund assets, where Company
H is an unrelated party and Company B keeps no part of the 12b-1 Fees.
letter constitutes an advisory opinion under ERISA Procedure 76-1
and is issued subject to the provisions of that procedure, including
section 10, relating to the effect of advisory opinions. This opinion
relates only to the specific issue addressed herein and is consistent
with ERISA Advisory Opinion 2002-05A.
Ivan L. Strasfeld
Director, Office of Exemption Determinations
Department received your submission as a request
for an administrative exemption. However, due to
the nature of the issue involved, the Department
has decided, with your concurrence, to process this
submission as an advisory opinion request.
you have also requested information concerning excise
taxes and the correction of inadvertent prohibited
transactions related to the 12b-1 Fees, this opinion
letter does not address these issues. The Department
believes that the appropriate forum to resolve these
matters is the Internal Revenue Service.