Collective Investment Trusts in Employee Retirement Plansmedia.straffordpub.com/products/collective-investment... · 2011. 5. 26. · reqqpy y( )uired to comply with the OCC’s fiduciary

Presenting a live 90‐minute webinar with interactive Q&A

Collective Investment Trusts in Employee Retirement PlansNavigating SEC and New DOL Regulations and Mitigating Litigation Risks

T d ’ f l f

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

TUESDAY, MAY 31, 2011

Today’s faculty features:

James O. Fleckner, Partner, Goodwin Procter, Boston

Thomas J. LaFond, Partner, Goodwin Procter, Boston

Scott A. Webster, Partner, Goodwin Procter, Boston

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Collective Investment Trusts: L l C t t Legal Context

James O FlecknerJames O. FlecknerThomas J. LaFondScott A. Webster

May 31, 2011©2011. Goodwin Procter LLP

Agenda

Regulatory Framework and Compliance Issues

R t ERISA Liti ti Recent ERISA Litigation

Goodwin Procter LLP 6

Summary

A “collective investment trust” or “group trust” or “collective investment fund” is a commingled pool that:investment fund is a commingled pool that:

› is “maintained” by a bank for ERISA and SEC purposes

› qualifies for tax-exempt treatment under IRS Rev Rul 81-100 (as modified by RR 2004-67 & RR 2011-1) because all of its assets are derived from:

qualified plans

certain governmental plans


Summary

CITs are generally not subject to oversight by the SEC

CIT l t d b CITs are regulated by

› state or federal banking authorities

› the DOL under ERISA› the DOL under ERISA


Summary

CITs are widely used as investment vehicles for

› d fi d b fit i l› defined benefit pension plans

› participant-directed defined contribution retirement plans

› self-directed retirement plans (such as 401(k) plans)p ( ( ) p )

› “Rule 180” Keogh plans

CITs may be used as QDIAs

IRAs, 403(b) plans and “unsophisticated” Keogh plans generally may not participate in a CIT for federal securities law reasons


Summary

Banks that maintain a CIT may generally receive non-discretionary investment advice from affiliated or unaffiliated investment advisers

CITs have few restrictions on the types of assets and asset classes in which they can invest

CITs are relatively inexpensive to operate


CITs vs Mutual Funds Structure, Operation and Regulatory Oversight

Structure› A mutual fund is generally a business trust or corporation with› A mutual fund is generally a business trust or corporation with

independent trustees

› An investment in a mutual fund is a share of the trust or corporation

› A CIT is generally› A CIT is generally

▪ a common law trust

▪ with a U.S. bank as trustee

▪ established under a declaration of trust which governs the rights of the participating plans

› The trustee holds title to the assets of the trust as fiduciary for the benefit of interest holders

› An investment in a CIT is an undivided interest in the pool of assets held by the trustee under that trust relationship



Structure (cont’d.)› Like mutual funds CITs may have multiple series or funds with› Like mutual funds, CITs may have multiple series or funds with

different investment objectives, each of which is essentially treated as a separate CIT

CIT

IndexFund

ValueFund

Short-TermInvestment Fund

Small-CapFundFund

GrowthFund

Fund

InternationalFund

› There may be multiple classes of interests in a CIT, similar to share classes of a mutual fund, with differing fees and/or expenses charged to different classes



Operation

› B k t t t bli h i il l ti hi ith› Bank trustee establishes an agency or similar relationship with participating plans (investors)

› Investments may generally be made in cash or in-kind

› The CIT must be “bank-maintained” for SEC purposes if any plan is participant-directed

› “Bank-maintained” means the bank trustee must exercise “substantial investment responsibility” with respect to the CIT

› Banks sometimes utilize affiliated or third-party investment advisers as subadvisors



Oversight

› A i t t i b k i t i d CIT i t it d› An interest in a bank-maintained CIT is an exempt security under Section 3(a)(2) of the Securities Act of 1933

▪ Keogh plan investors must be “sophisticated,” or advised by a “sophisticated” adviser under SEC Rule 180sophisticated adviser, under SEC Rule 180

› Interests in a bank-maintained CIT are generally exempt from the registration requirements of the Securities Exchange Act of 1934, even if there are over 500 participating plansif there are over 500 participating plans

› A bank-maintained CIT is exempt from the Investment Company Act of 1940 under Section 3(c)(11)

› A bank that sponsors CITs is subject to regulation by

▪ federal or state banking authorities

▪ the DOL


the DOL


Oversight (cont’d.)

› N ti l b k› National banks

▪ regulated by the OCC

▪ required to comply with the OCC’s fiduciary rules (12 CFR 9.18)q p y y ( )

› State-chartered banks and trust companies

▪ primarily regulated by the applicable state banking department

▪ may also be supervised by the FDIC or the Federal Reserve Board

› Many states apply the OCC’s fiduciary standards in examining bank fiduciary activities



Oversight (cont’d.)

› A ith t l f d if th CIT’ i t t t t i l t di i› As with mutual funds, if the CIT’s investment strategy involves trading in futures, a notice filing with the CFTC is generally necessary to preserve the sponsor’s exemptions from regulation as a Commodity Pool Operator or Commodity Trading Advisorp y g

› Proposed amendments to CFTC rules


CITs vs Mutual Funds Eligible Participants

Virtually any person or entity can invest in a mutual fund

Eli ibl CIT i t i l d Eligible CIT investors include:

› 401(a) qualified plans

› most 818 governmental plans (other than 403(b) and 457 plans))› most 818 governmental plans (other than 403(b) and 457 plans))

› 457(b) governmental plans

› other 81-100 group trusts

› insurance company separate accounts

› Puerto Rican plans (maybe)


CITs vs Mutual Funds Eligible Participants

Eligible CIT investors do not include any other plans or investors

Th Thus,

› 403(b) plans

› 457(f) plans and non

› rabbi trusts

› mutual funds› 457(f) plans and non-governmental 457(b) plans

› IRAs

› mutual funds

› endowments

› private foundations› VEBAs

› insurance company general accounts

› personal trusts

› foreign entities

are not eligible


CITs vs Mutual Funds Disclosure

Advertising of CITs is not restricted under 9.18 as it is for bank-maintained common trust funds

Required disclosure to investors of the CIT’s investments and activities, as well as financial results, is minimal

CITs are not prohibited from conforming their disclosure and reporting schemes to those of mutual funds

Possible for a CIT to have the “look and feel” of a mutual fundPossible for a CIT to have the look and feel of a mutual fund

› for example, daily NAV and liquidity and periodic reporting of investment results

U lik l f d h NAV f CIT i bli h d Unlike mutual funds, the NAV of most CITs is not published, however it can be made available electronically (e.g., via the Internet) to participants


CITs vs Mutual Funds Distribution

CITs generally do not need to be marketed through a federally registered broker-dealerg

Some states continue to regulate the sale of CITs under their broker-dealer securities laws and may also require initial filings for securities offerings by CITssecurities offerings by CITs

If third-party distributors are paid, then some states may regulate them as broker-dealers


CITs vs Mutual Funds Fees and Expenses

Banks typically charge an all-in asset-based fee

F b Fees may be

› internalized (i.e., reflected in NAV), or

› externalized (i.e., paid outside of the CIT, including by redemption of› externalized (i.e., paid outside of the CIT, including by redemption of CIT interests)

Fees charged to participant-directed plans are generally internalized

Many CITs are divided into classes that charge different fee rates

› subject to compliance with applicable banking laws


CITs vs Mutual Funds Compensation and Costs

Banks that sponsor CITs frequently enter into servicing arrangements with plan recordkeepers and other service providersg p p p

› Recordkeepers typically report participant-level trades on an aggregate basis

S i i t ll t b id t fid i Servicing payments generally may not be paid to a fiduciary

Recordkeepers should ensure they are not acting in a fiduciary capacity


CITs vs Mutual Funds Taxes

CITs are not subject to Subchapter M

RR 81 100 d d b RR 2004 67 d RR 2011 1 id RR 81-100, as amended by RR 2004-67 and RR 2011-1, provides that the tax-exempt status of the participating plans is not adversely affected by commingling their assets in a CIT

RR 81-100 requirements:

› Participating trusts adopt the CIT as part of the participating trust’s plan

› Interests in CITs are non assignable› Interests in CITs are non-assignable

› Assets of a CIT must be held for the exclusive benefit of the participating trusts

› CIT trustees must separately account for each participating plan’s interest in the CIT


CITs vs Mutual Funds Taxes

CITs must be created, organized and maintained as domestic trusts in the United States

CITs may accept and distribute appreciated assets in-kind on a tax-free basis

Potential UBTI issues if the CIT leverages its portfolio or engages in certain kinds of transactions


CITs vs Mutual Funds ERISA

Mutual funds are not subject to ERISA, but are subject to self-dealing and other restrictions under the Investment Company Actg p y

CITs that are bank-maintained are always subject to ERISA

The DOL has broad enforcement authority under ERISA


ERISA Fiduciary Duty Rules

The standard of care for CIT trustees is ERISA’s prudent man rule

E l i i t t t l l i i t t f l Exclusive purpose requirement – must act solely in interest of plan

General duty of loyalty

Diversification requirement Diversification requirement

Co-fiduciary liability potential

ERISA prohibits a CIT from indemnifying a fiduciary for a breach ofERISA prohibits a CIT from indemnifying a fiduciary for a breach of its fiduciary duty

A fiduciary can be indemnified by plan sponsors


ERISAProhibited Transaction Rules

PTE 91-38 provides broad relief from ERISA’s prohibited transaction rules for bank-maintained CITs

Need at least two participating plans to be a “collective” investment trust for ERISA purposes and to be able to rely on PTE 91-38

PTE 84-14 (QPAM) and §408(b)(17), as well as other class exemptions are also generally available


ERISA Reporting Requirements

Participant-directed plans that are intended to comply with §404(c) of ERISA may ask the sponsoring trustee for disclosure designed y p g gfor participants

New regulations under §408(b)(2) will require detailed fee disclosure by trusteesby trustees

CITs generally file annual reports with the DOL on Form 5500 as a so-called direct-filing entity, or DFE


ERISAOther Requirements

ERISA’s bonding (although many banks are exempt), custody and indicia of ownership requirements apply to CITsp q pp y


Mutual Fund Fee LitigationJones v. Harris Associates, 130 S.Ct. 1418 (2010), ( )

Interprets Investment Company Act § 36(b), 15 U.S.C. § 80a-35(b):

“th i t t d i f i t d i t t h ll“the investment adviser of a registered investment company . . . shall be deemed to have a fiduciary duty with respect to the . . . receipt of compensation for services . . . ”

§ 36(b) does “not permit a compensation agreement to be reviewed § 36(b) does “not permit a compensation agreement to be reviewed in court for ‘reasonableness’”



“[T]o face liability under § 36(b), an investment adviser must charge a fee that is so disproportionately large that it bears no reasonable p p y grelationship to the services rendered and could not have been the product of arm’s length bargaining” (emphasis added)

“In recognition of the disinterested directors’ role the Act instructs In recognition of the disinterested directors role, the Act instructs courts to give board approval of an adviser’s compensation ‘such consideration . . . as is deemed appropriate under all the circumstances’”circumstances



Court adopts Gartenberg v. Merrill Lynch Asset Management, Inc.,694 F.2d 923 (2d Cir. 1982), and identifies factors: ( ),

› cost of providing services

› economies of scale

› volume of orders

› nature and quality of the services

› profitability› profitability

› fall-out benefits

› comparative fee structurep

› “the independence, expertise, care, and conscientiousness of the board in evaluating adviser compensation”


Recent ERISA Cases Impacting Collective TrustsGeneral ERISA Obligations Bearing on Feesg g

ERISA § 404(a)(1)(A):

› D t f l lt i l d “d f i bl f› Duty of loyalty includes “defraying reasonable expenses of administering the plan” (emphasis added)

Prohibited transaction exemptions:

› “The prohibitions provided in [ERISA § 406] shall not apply to . . . [c]ontracting or making reasonable arrangements with a party in interest for . . . services necessary for the establishment or operation of the

l if th bl ti i id th f ”plan, if no more than reasonable compensation is paid therefor” ERISA § 408(b)(2) (emphasis added)

› “Nothing in [ERISA § 406] shall be construed to prohibit any fiduciary from receiving any reasonable compensation for servicesfrom . . . receiving any reasonable compensation for services rendered . . . .” ERISA § 408(c)(2) (emphasis added)


Recent ERISA Cases Impacting Collective TrustsGeorge v. Kraft Foods Global, Inc., __ F.3d __, 2011 WL 1345463 (7th Cir. Apr. 11, 2011)2011 WL 1345463 (7th Cir. Apr. 11, 2011)

Reverses summary judgment on two substantive issues:

› Fid i th t ll d t k f d t b iti d th th› Fiduciary that allowed company stock fund to be unitized, rather than share accounted, is not entitled to deference in absence of evidence showing that decision was intentional

› Plaintiff established a triable fact where his expert opined that it was› Plaintiff established a triable fact where his expert opined that it was imprudent not to get market prices every three years, and that the plan paid approximately twice as much as it should have for recordkeeping services

Petition for rehearing en banc filed May 9, 2011


District Court Cases Addressing Subprime Investmentsp

Saint Vincent Catholic Medical Centers, et al. v. Morgan Stanley Investment Management, Inc., No. 09-9730, 2010 WL 4007224 g , , ,(S.D.N.Y. Oct. 4, 2010)

› Defined benefit (DB) plan investment manager did not violate ERISA by investing 9% - 12% of plan assets in mortgage-backed securities eveninvesting 9% 12% of plan assets in mortgage backed securities, even where written investment guidelines specified that the portfolio’s primary investment objective was preservation of principal and long-term growth

› Dismissal appealed to the Second CircuitDismissal appealed to the Second Circuit

In Re Regions Morgan Keegan ERISA Litigation, 692 F. Supp. 2d 944 (W.D. Tenn. 2010)

› Dismissal of prudence claim denied because “Defendants knew or should have known that the Bond Funds violated their own investment guidelines when they assumed high levels of risk by investing primarily and imprudently in the subprime sector”


and imprudently in the subprime sector

Securities Lending Cases

Fishman Haygood Phelps Walmsley Willis & Swanson, L.L.P. v. State Street Corp., 2010 WL 1223777, 48 Employee Benefits Cas. p , , p y2488 (D. Mass. March 25, 2010)

› Dismisses action where expert discovery showed that plaintiff suffered no cognizable harm from unrealized securities lending lossesno cognizable harm from unrealized securities lending losses

Diebold v. Northern Trust Investments, N.A., No. 09 C 1934, 2010 WL 3700387, 50 Employee Benefits Cas. 1508 (N. D. Ill. Sept. 7, 2010)2010)

› Denies motion to dismiss where “Plaintiffs have alleged that, given the information the Defendants had about the economy, a prudent fiduciary would have altered the way in which the assets of the collateral poolwould have altered the way in which the assets of the collateral pool were managed”


James O. Fleckner(617) 570-1153jfleckner@goodwinprocter com [email protected]

Thomas J. LaFond(617) 570-1990tlafond@goodwinprocter [email protected]

Scott A. Webster(617) 570-8229swebster@goodwinprocter [email protected]

©2011. Goodwin Procter LLPLIBC/4091293

Documents

Collective Investment Trusts in Employee Retirement Plansmedia.straffordpub.com/products/collective-investment... · 2011. 5. 26. · reqqpy y( )uired to comply with the OCC’s fiduciary