Article by Susan G. Curtis and Sergei A. Antonov
On November 5, 2002, the Department of Labor’s Pension and Welfare Benefits Administration released Field Assistance Bulletin 2002-3 (the "Bulletin") which sets forth the disclosure obligations and other conditions under which service providers, such as banks and trust companies, acting as non-discretionary trustees or custodians to employee benefit plans, may retain the earnings ("float") generated by short-term investment of funds held in general or "omnibus" accounts. The Bulletin also details the factors which plan fiduciaries must consider in evaluating the reasonableness of a service agreement containing a float arrangement.
Typically, float is earned when service providers’ general accounts hold contributions pending investment directions from plan fiduciaries or when fiduciaries transfer funds to a general account in connection with issuance of a check relating to a plan distribution or other disbursement. The Bulletin reiterates that retention of float by service providers will not constitute a prohibited transaction under ERISA when it is negotiated as a component of the overall compensation instead of resulting from the exercise of discretion on the part of service providers, as long as adequate disclosures are made by the service providers concerning the float.
The Department’s position in the Bulletin is based on a concern that by using the float without disclosing it, service providers will be able to engage in self-dealing by affecting the amount of compensation they earn. The Department’s position articulated in the Bulletin makes no reference to Section 408(b)(6) of ERISA, the regulations thereunder and the legislative history of ERISA. These authorities state that bank and other financial institution fiduciaries may provide "ancillary services" to plans without violating the prohibited transaction restrictions or the prohibition on self-dealing, if certain conditions are met. The regulations under Section 408(b)(6) and the legislative history give as one example of an acceptable "ancillary service" non-interest bearing checking accounts with respect to plan assets which are reasonably expected to be needed to satisfy current plan expenses.
The Section 408(b)(6) exemption requires banks to establish written policies, and the Bulletin and the exemption, if read to be consistent, would seem to require that bank policies on keeping the float should be in writing and should be disclosed. In order to benefit from the exemption, Section 408(b)(6) requires financial institutions to adopt "adequate internal safeguards" to ensure that the ancillary service is consistent with sound banking and financial practice. Additionally, banks must issue specific guidelines to ensure that ancillary services are not provided in an excessive or unreasonable manner and in a manner inconsistent with the best interests of plan participants and beneficiaries. The Bulletin adds additional disclosures concerning the float for banks and other financial institutions to provide.
Background
In its earlier Advisory Opinion (93-24A) the Department of Labor addressed the situation where a trustee earned income for its own account from float attributable to outstanding benefit checks, without disclosing the float to employee benefit plan customers. The Department found such situations to constitute prohibited fiduciary self-dealing under Section 406(b)(1) of ERISA. In a subsequent information letter to the American Bankers Association (August 11, 1994), the Department indicated that no self-dealing would occur when bank fiduciaries openly negotiate with an independent plan fiduciary to retain float and, as part of fee negotiations, provide full and accurate disclosure regarding the use of float. In such circumstances, service providers would retain float as part of their compensation, and not improperly exercise their fiduciary authority or control for their own benefit.
Investigations conducted by the Department have revealed that service providers have utilized a variety of methods to seek approval of plan fiduciaries to retain float as part of service providers’ overall compensation. Little or no disclosure of specific information was typically made, however, and the Department’s Field offices requested guidance regarding float arrangements and disclosures.
Obligations of Plan Fiduciary
In selecting a service provider, plan fiduciaries must comply with a number of ERISA provisions. Section 404(a) of ERISA directs plan fiduciaries to act solely in the interest of the plan’s participants and beneficiaries and for the exclusive purpose of providing benefits and defraying reasonable expenses of administering the plan. Plan fiduciaries also have an obligation under Section 406(a) not to cause the plan to engage in prohibited transactions, including a direct or indirect furnishing of goods, services or facilities between the plan and a party in interest, such as a service provider. Section 408(b)(2), however, exempts from the prohibitions of Section 406(a) any reasonable arrangement with a party in interest for services that are necessary for the establishment and operation of the plan, if no more than reasonable compensation is paid. To comply with the requirements set forth above, plan fiduciaries must engage in an objective process of selection designed to evaluate the provider’s services and the reasonableness of its fees. In the Bulletin, the Department indicates that the selection process in circumstances where service providers may retain float as part of their compensation should include:
1) An inquiry into whether other service providers of comparable quality and cost may credit float to their own account rather than to the plan.
2) A review of the circumstances under which the service provider may earn float. In particular, the Department indicates that plan fiduciaries should ensure that service agreements, in the case of float on cash awaiting investment, provide for time limits within which service providers must implement investment instructions. In the case of float on cash awaiting investment, service agreements should specify the time at which funds 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), as well as provide a time frame for mailing disbursement checks following a direction to distribute funds. Fiduciaries must also monitor instances when checks issued tend to remain outstanding for unusually long periods of time (e.g., 90 days or more), because in such instances the time frame is beyond control of either plan fiduciaries or service providers.
3) An evaluation of the float as part of total compensation to be earned by the service provider. Plan fiduciaries must be informed of the rates at which float would be earned, as well as of the approximate overall value of potential float, in order to make a useful comparison with other service providers and to assess the extent to which float is a significant component of overall compensation.
Obligations of Service Providers
The primary issue for service providers who retain float as part of their compensation is to make sufficient disclosures to ensure that plan fiduciaries can reasonably approve the compensation arrangement based on an understanding of the service provider’s compensation. Service providers must not be able to affect the amount of their own compensation in violation of Section 406(b)(1) of ERISA, for example, by having broad discretion over the duration of float and, therefore, engage in a prohibited transaction by exercising discretionary control sufficient to cause the plan to pay additional fees to the provider. The Bulletin indicates that, in order to avoid self-dealing under ERISA, service providers must:
1) Disclose specific circumstances under which float will be earned and retained.
2) Establish, disclose and adhere to a specific time frame for retaining float, both with respect to float on contributions and float on distributions. In the case of float on contributions pending investment direction, service providers must invest cash in their general account within that specific time period. In the case of float earned on funds pending disbursement, service providers must disclose when the float period begins (e.g., the date the check is requested, the date the check is written, or the date the check is mailed) and when it ends (e.g., the date the check is presented for payment). Time frames for mailing distribution checks and for any other administrative procedures relating to disbursements must also be disclosed, as they may affect the duration of the float period.
3) Disclose the rate of the float or the specific manner in which float will be determined. For example, earnings on cash pending investment and earnings on uncashed checks are generally at a money market interest rate.
Conclusion
Float must be openly negotiated as part of the overall compensation arrangement of service providers. To avoid violations of their fiduciary duties under ERISA, plan fiduciaries must be informed of how service providers will earn the float and how the float contributes to total compensation. Service providers, in turn, must provide adequate disclosures to enable plan fiduciaries to make an informed decision. In addition, both plan fiduciaries and service providers must ensure that service providers lack the discretion to affect the amount of compensation such service providers receive from float. Finally, the position taken by the Department should be considered in the context of the Section 408(b)(6) exemption for ancillary banking services, which requires banks to regulate the extent of such ancillary service through specific guidelines.
If you have any questions regarding the Bulletin, please contact the authors.
Client Alert is published solely for informational purposes and should in no way be relied upon or construed as legal advice. For specific information on recent developments or particular factual situations, the opinion of legal counsel should be sought. Paul, Hastings, Janofsky & Walker LLP is a limited liability partnership.
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