The Pension Plan Protection Act of 2006 added a new section 408(b)(19) to ERISA, providing a prohibited transaction exemption for the “cross-trading” of securities between accounts managed by the same investment manager. Congress also directed the U.S. Department of Labor (“DOL”), after consultation with the U.S. Securities and Exchange Commission (the “SEC”), to issue regulations within six months of the date of enactment regarding the content of the written policies and procedures that a manager is required to adopt to qualify for the exemptive relief. On Feb. 12, DOL issued an interim final rule, effective April 13, 2007 (72 Fed. Reg. 6473).
New section 408(b)(19) provides an exemption from sections 406(a)(1)(A) and (b)(2) of ERISA—the prohibitions on purchases and sales with parties in interest and on a fiduciary acting on both sides of a transaction—for the purchase and sale of a security between a plan and any other account managed by the same investment manager. A number of conditions apply, including that the transaction be effected at the independent current market price of the security; that no brokerage commission or other remuneration be paid; that there be advance authorization of cross-trading by an independent plan fiduciary; and that the manager conduct an annual review of the cross-trades documented in a written report. The exemption is only available to plans (or master trusts for related plans) with assets of at least $100 million.
Policies and Procedures Requirement and DOL Regulation
An additional requirement of the exemption is that the manager adopt, and effect the cross-trades in accordance with, written cross-trading policies and procedures that are fair and equitable to all accounts participating in the cross-trading program, and ones that cover pricing and allocation. The DOL interim final rule, which implements this condition, is designed to ensure that the policies and procedures provide sufficient information to enable the plan fiduciary to assess the manager’s cross-trading program, and to enable the manager’s compliance officer to review trades to ensure compliance with the written policies and procedures (with the review to be reflected in the annual report issued to the authorizing plan fiduciaries).
The rule provides that the content of the policies and procedures must be clear and concise, and written in a manner calculated to be understood by the plan fiduciary authorizing the cross-trade. No specific format is required, but the policies and procedures should be sufficiently detailed to facilitate the compliance officer’s periodic review and determination regarding compliance.
Under the interim final rule, the policies and procedures are to include:
- A description of how the manager will determine that the cross-trades are effected at the “independent current market price” of the security within the meaning of SEC Rule 17a-7(b) and the SEC no-action and interpretive letters thereunder, including the identity of sources used to establish such price. The description should contain sufficient detail to enable the compliance officer to independently determine that the cross-trade transaction was effected at the “independent current market price.”
- A statement of policy describing the criteria that will be applied by the manager in determining that execution of a securities transaction as a cross-trade will be beneficial to both parties to the transaction. DOL noted that ERISA’s general standards of fiduciary conduct also would apply to the determination to cross-trade securities on behalf of a plan, specifically to (1) the decision to enter into a cross-trade and (2) the terms of such cross-trade.
- A description of the procedures for ensuring compliance with the $100 million minimum asset size requirement.
- A description of how the manager will mitigate any potentially conflicting division of loyalties and responsibilities to the parties involved in any cross-trade transaction.
- A requirement that the manager allocate cross-trades among participating accounts in an objective and equitable manner, and a description of the allocation method(s) that will be available to and used by the manager. DOL noted its understanding that managers have relied on different systems, such as a pro rata or queue system, to effectuate an objective allocation, and recognized that there may be a number of objective systems that are appropriate for this purpose.
- The identity of the compliance officer responsible for reviewing compliance with the cross-trading policies and procedures, and the officer’s qualifications for this position.
- A statement describing the scope of review conducted by the compliance officer, specifically noting whether the review is limited to compliance with the policies and procedures or extends to overall compliance with the statutory exemption.
- DOL has invited comments on all aspects of the interim final rule. Among other things, DOL has asked whether the compliance officer’s responsibilities should be expanded to encompass all the requirements of the exemption, not just the policies and procedures condition. DOL also expressed an interest in information regarding the current practices of compliance officers in determining compliance with prohibited transaction exemptions. The deadline for comments is April 13.
Managers who intend to rely on this exemption should review this rule and compare the listed requirements to their existing cross-trade policies and procedures. To the extent there are differences, managers should revise their existing policies and procedures to conform to the requirements of the regulation, and may also consider whether it would be desirable to comment to DOL on any aspects of the rule that should be clarified or changed to promote workability and certainty.