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

Transcription

1 Presenting a live 90 minute webinar with interactive Q&A Collective Investment Trusts in Employee Retirement Plans Navigating SEC and New DOL Regulations and Mitigating Litigation Risks TUESDAY, MAY 31, pm Eastern 12pm Central 11am Mountain 10am Pacific Td 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 The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions ed to registrants for additional information. If you have any questions, please contact Customer Service at ext. 10.

2 Conference Materials If you have not printed the conference materials for this program, please complete the following steps: Click on the + sign next to Conference Materials in the middle of the left- hand column on your screen. Click on the tab labeled Handouts that appears, and there you will see a PDF of the slides for today's program. Double click on the PDF and a separate page will open. Print the slides by clicking on the printer icon.

3 Continuing Education Credits FOR LIVE EVENT ONLY For CLE purposes, please let us know how many people are listening at your location by completing each of the following steps: Close the notification box In the chat box, type (1) your company name and (2) the number of attendees at your location Click the blue icon beside the box to send

4 Tips for Optimal Quality Sound Quality If you are listening via your computer speakers, please note that the quality of your sound will vary depending on the speed and quality of your internet connection. If the sound quality is not satisfactory and you are listening via your computer speakers, you may listen via the phone: dial and enter your PIN when prompted. Otherwise, please send us a chat or sound@straffordpub.com immediately so we can address the problem. If you dialed in and have any difficulties during the call, press *0 for assistance. Viewing Quality To maximize your screen, press the F11 key on your keyboard. To exit full screen, press the F11 key again.

5 Collective Investment Trusts: Legal Context t James O. Fleckner Thomas J. LaFond Scott A. Webster May 31, Goodwin Procter LLP

6 Agenda Regulatory Framework and Compliance Issues Recent ERISA Litigation Goodwin Procter LLP 6

7 Summary A collective investment trust or group trust or collective 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 (as modified by RR & RR ) because all of its assets are derived from: qualified plans certain governmental plans Goodwin Procter LLP 7

8 Summary CITs are generally not subject to oversight by the SEC CITs are regulated by state or federal banking authorities the DOL under ERISA Goodwin Procter LLP 8

9 Summary CITs are widely used as investment vehicles for defined d benefit pension plans participant-directed defined contribution retirement plans self-directed retirement plans (such as 401(k) plans) 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 Goodwin Procter LLP 9

10 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 Goodwin Procter LLP 10

11 CITs vs Mutual Funds Structure, Operation and Regulatory Oversight Structure 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 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 Goodwin Procter LLP 11

12 CITs vs Mutual Funds Structure, Operation and Regulatory Oversight Structure (cont d.) Like mutual funds, CITs may have multiple series or funds with different investment objectives, each of which is essentially treated as a separate CIT Index Fund Value Fund Growth Fund CIT Short-Term Investment Fund Small-Cap Fund International Fund 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 Goodwin Procter LLP 12

13 CITs vs Mutual Funds Structure, Operation and Regulatory Oversight Operation Bank trustee t establishes an agency or similar il 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 Goodwin Procter LLP 13

14 CITs vs Mutual Funds Structure, Operation and Regulatory Oversight Oversight An interest t in a bank-maintained i 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 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 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 Goodwin Procter LLP 14

15 CITs vs Mutual Funds Structure, Operation and Regulatory Oversight Oversight (cont d.) National banks regulated by the OCC required to comply py with the OCC s fiduciary rules (12 CFR 9.18) 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 Goodwin Procter LLP 15

16 CITs vs Mutual Funds Structure, Operation and Regulatory Oversight Oversight (cont d.) As with mutual funds, if the CIT s investment t strategy t 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 Advisor Proposed amendments to CFTC rules Goodwin Procter LLP 16

17 CITs vs Mutual Funds Eligible Participants Virtually any person or entity can invest in a mutual fund Eligible ibl CIT investors include: 401(a) qualified plans most 818 governmental plans (other than 403(b) and 457 plans)) 457(b) governmental plans other group trusts insurance company separate accounts Puerto Rican plans (maybe) Goodwin Procter LLP 17

18 CITs vs Mutual Funds Eligible Participants Eligible CIT investors do not include any other plans or investors Thus, 403(b) plans 457(f) plans and nongovernmental 457(b) plans IRAs VEBAs insurance company general accounts rabbi trusts mutual funds endowments private foundations personal trusts foreign entities are not eligible Goodwin Procter LLP 18

19 CITs vs Mutual Funds Disclosure Advertising of CITs is not restricted under 9.18 as it is for bankmaintained 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 fund for example, daily NAV and liquidity and periodic reporting of investment results 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 Goodwin Procter LLP 19

20 CITs vs Mutual Funds Distribution CITs generally do not need to be marketed through a federally registered broker-dealer 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 CITs If third-party distributors are paid, then some states may regulate them as broker-dealers Goodwin Procter LLP 20

21 CITs vs Mutual Funds Fees and Expenses Banks typically charge an all-in asset-based fee Fees may be internalized (i.e., reflected in NAV), or 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 Goodwin Procter LLP 21

22 CITs vs Mutual Funds Compensation and Costs Banks that sponsor CITs frequently enter into servicing arrangements with plan recordkeepers and other service providers Recordkeepers typically report participant-level trades on an aggregate basis Servicing i payments generally may not be paid to a fiduciaryi Recordkeepers should ensure they are not acting in a fiduciary capacity Goodwin Procter LLP 22

23 CITs vs Mutual Funds Taxes CITs are not subject to Subchapter M RR , 100 as amended d by RR and RR , 1 provides that the tax-exempt status of the participating plans is not adversely affected by commingling their assets in a CIT RR requirements: Participating trusts adopt the CIT as part of the participating trust s plan 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 Goodwin Procter LLP 23

24 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 taxfree basis Potential UBTI issues if the CIT leverages its portfolio or engages in certain kinds of transactions Goodwin Procter LLP 24

25 CITs vs Mutual Funds ERISA Mutual funds are not subject to ERISA, but are subject to selfdealing and other restrictions under the Investment Company Act CITs that are bank-maintained are always subject to ERISA The DOL has broad enforcement authority under ERISA Goodwin Procter LLP 25

26 ERISA Fiduciary Duty Rules The standard of care for CIT trustees is ERISA s prudent man rule Exclusive purpose requirement must act solely l in interest t of plan General duty of loyalty Diversification requirement Co-fiduciary liability potential ERISA prohibits a CIT from indemnifying a fiduciary for a breach of its fiduciary duty A fiduciary can be indemnified by plan sponsors Goodwin Procter LLP 26

27 ERISA Prohibited Transaction Rules PTE 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 PTE (QPAM) and 408(b)(17), as well as other class exemptions are also generally available Goodwin Procter LLP 27

28 ERISA Reporting Requirements Participant-directed plans that are intended to comply with 404(c) of ERISA may ask the sponsoring trustee for disclosure designed for participants New regulations under 408(b)(2) will require detailed fee disclosure by trustees CITs generally file annual reports with the DOL on Form 5500 as a so-called direct-filing entity, or DFE Goodwin Procter LLP 28

29 ERISA Other Requirements ERISA s bonding (although many banks are exempt), custody and indicia of ownership requirements apply ppy to CITs Goodwin Procter LLP 29

30 Mutual Fund Fee Litigation Jones v. Harris Associates,, 130 S.Ct (2010) Interprets Investment Company Act 36(b), 15 U.S.C. 80a-35(b): the investment t adviser of a registered investment t 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 in court for reasonableness Goodwin Procter LLP 30

31 Mutual Fund Fee Litigation Jones v. Harris Associates,, 130 S.Ct (2010) [T]o face liability under 36(b), an investment adviser must charge a fee that is so disproportionately p large that it bears no reasonable relationship 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 courts to give board approval of an adviser s compensation such consideration... as is deemed appropriate under all the circumstances Goodwin Procter LLP 31

32 Mutual Fund Fee Litigation Jones v. Harris Associates,, 130 S.Ct (2010) 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 fall-out benefits comparative fee structure the independence, expertise, care, and conscientiousness of the board in evaluating adviser compensation Goodwin Procter LLP 32

33 Recent ERISA Cases Impacting Collective Trusts General ERISA Obligations Bearing on Fees ERISA 404(a)(1)(A): Duty of loyalty lt 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 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 services rendered.... ERISA 408(c)(2) (emphasis added) Goodwin Procter LLP 33

34 Recent ERISA Cases Impacting Collective Trusts George v. Kraft Foods Global, Inc., F.3d, 2011 WL (7th Cir. Apr. 11, 2011) Reverses summary judgment on two substantive issues: Fiduciary i that t 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 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 Goodwin Procter LLP 34

35 District Court Cases Addressing Subprime Investments Saint Vincent Catholic Medical Centers, et al. v. Morgan Stanley Investment Management, Inc.,, No , 2010 WL (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, 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 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 Goodwin Procter LLP 35

36 Securities Lending Cases Fishman Haygood Phelps Walmsley Willis & Swanson, L.L.P. v. State Street Corp., p, 2010 WL , 48 Employee Benefits Cas (D. Mass. March 25, 2010) Dismisses action where expert discovery showed that plaintiff suffered no cognizable harm from unrealized securities lending losses Diebold v. Northern Trust Investments, N.A., No. 09 C 1934, 2010 WL , 50 Employee Benefits Cas (N. D. Ill. Sept. 7, 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 pool were managed Goodwin Procter LLP 36

37 James O. Fleckner (617) com Thomas J. LaFond (617) Scott A. Webster (617) LIBC/ Goodwin Procter LLP