PLANADVISER - July/August 2017 - 51

fiduciary fitness
Proprietary Funds
Mixed results when plans that offer such funds rely on PTEs
BESIDES the claims of breach of fiduciary duty made of late
against plan sponsors that offer proprietary funds, there
have been claims of prohibited transactions. With respect
to the latter, plan sponsors have sought to rely on both
statutory and administrative exemptions, but with only
limited success.
Employee Retirement Income Security Act (ERISA)
Section 408(b)(8) provides that the prohibitions of ERISA
Section 406 do not apply to a transaction between a plan
and a pooled investment fund maintained by a bank, trust
company or insurance company if: 1) the transaction is
a sale or purchase of an interest in the fund; 2) the bank,
trust company or insurance company receives no more
than reasonable compensation; and 3) such transaction is
expressly authorized by the plan or a fiduciary other than
one of those three institutions or an affiliate thereof.
The problem for defendants is that this exemption
applies only to a sale or purchase of an interest in the funds,
but the alleged prohibited transactions are generally the
payment of fees from plan assets. As a California district
court made clear last year in Santomenno v. Transamerica Life
Insurance Co., Section 408(b)(8) is " not about fees or how fees
are properly collected. "
The administrative exemption that plan sponsors of
proprietary funds rely upon is prohibited transaction class
exemption (PTE) 77-3, which permits employers to offer
their own proprietary funds to employees. PTE 77-3 applies
so long as the plan satisfies four conditions: 1) it pays no fees
to the investment adviser except via the investment company's
payment of its standard advisory and other fees; 2) it
pays no redemption fee to any party other than the investment
company itself; 3) it pays no sales commission; and
4) " all other dealings between the plan and the investment
company, the investment adviser or principal underwriter
are on a basis as favorable to the plan [as are those] with
other shareholders of the investment company. "
The meaning of this last condition, 77-3(d), was addressed
in Brotherston v. Putnam. Plaintiff's allegation was that
Putnam provided revenue-sharing rebates to third-party
providers that, in some instances, passed on those rebates
to participants in other plans. Despite the fact that PTE 77-3
had existed for approximately 40 years before Brotherston,
only one reported case had interpreted this clause-Krueger
v. Ameriprise. This 2012 Minnesota District Court case read
into the exemption a reasonable compensation component
and did not address the scope of the fourth condition.
Putnam argued that the revenue-sharing payments
were not " dealings " within the meaning of PTE 77-3(d), and,
alternatively, even if they were dealings, the fourth condition
was satisfied because of discretionary contributions to
plan participants by Putnam. In effect, Putnam argued that
the relevant issue was the net position of its plan participants,
not the individual rebate transactions. The District
Court rejected Putnam's argument that, because the firm
did not negotiate the amount of the rebate between the
recordkeeper and third-party plans, there were no dealings
for purposes of PTE 77-3(d).
However, the court accepted Putnam's other argument,
stating, " Allowing plan participants to recover for the lack of
revenue-sharing payments when they already profited from
Putnam's discretionary contributions to the plan would
allow the participants to be unjustly enriched. "
Aside from this victory, however, PTE 77-3 has been of
limited utility to defendants. While there is case law to the
effect that a breach of loyalty cannot be presumed merely
because a defendant needed to rely upon PTE 77-3 to avoid
a prohibited transaction,
it is also true that, even if the
conditions of PTE 77-3 are satisfied, a fiduciary still must
discharge his other duties to the plan solely in the interest
of the participants and beneficiaries, and prudently. Therefore,
PTE 77-3 is inapplicable to a fiduciary's duties under
Section 404.
More importantly, in many instances, PTE 77-3 will
not allow a prohibited transaction claim to be dismissed
for failure to state a claim. For example, in Wildman v.
American Century Services, plaintiffs alleged that American
Century introduced a lower-class share class for several
of its funds, and that share class was available to other
employer-sponsored plans, but the defendant had failed to
convert to this new class in time for its own plan to benefit.
The complaint also alleged that defendants directed the
plan trustees to delay conversion to the lower-cost share
classes, in order to collect additional fees, which caused a
loss to plan participants.
The bottom line: Plan sponsors that offer proprietary
funds now face the prospect of extensive and expensive
discovery, which frequently results in settlements to avoid
the hazards of litigation.
Marcia Wagner is an expert on a variety of employee benefits
and executive compensation issues, including qualified and
nonqualified retirement plans, and welfare benefit arrangements.
She is a summa cum laude graduate of Cornell University and
Harvard Law School and has practiced law for 30 years. She is a
frequent lecturer and has authored numerous books and articles.
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PLANADVISER - July/August 2017

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