Prohibited Transactions Under ERISA
By Jeff Aga, QKA
Last month, Jeff discussed prohibited transactions under the Internal Revenue Code (IRC). The other governing authority over prohibited transactions is the Employee Retirement Income Security Act (ERISA), which has rules very similar to the IRC.
What is a prohibited transaction under ERISA?
Section 406(a) of ERISA prohibits fiduciaries of ERISA plans from entering into certain transactions with parties in interest. Parties in interest include any plan fiduciary (e.g., plan administrator, officer, trustee or custodian), the employer that sponsors the plan or any affiliate, any employee of the employer, and any service provider to the plan (e.g., attorney, auditor, etc.)
ERISA Section 406(a) states that a fiduciary with respect to a plan shall not cause the plan to engage in a transaction if he knows or should know that such transaction constitutes a direct or indirect
sale or exchange, or leasing, of property between the plan and a party in interest;
lending of money or other extension of credit between the plan and a party in interest;
furnishing goods, services, or facilities between the plan and a party in interest;
transfer to, or use by or for the benefit of, a party in interest of any assets of the plan; or
acquisition, on behalf of the plan, of any employer security or employer real property in violation of ERISA Section 407(a).
No fiduciary that has authority or discretion to control or manage the assets of a plan may permit the plan to hold any employer security or employer real property if he knows or should know that holding such security or real property violates ERISA Section 407(a).
ERISA Section 406(b) prohibits fiduciaries from self-dealing in three areas. A fiduciary shall not
deal with plan assets in his own interest or for his account;
in any capacity act in any transaction involving the plan on behalf of a party (or represent a party) whose interests are adverse to the interests of the plan or the interests of its participants or beneficiaries; or
receive any consideration for his own personal account from any party dealing with such plan in connection with a transaction involving plan assets.
Examples of prohibited transactions under ERISA are similar to those that would occur under the Internal Revenue Code.
What penalties are imposed under ERISA involving prohibited transactions?
The Department of Labor (DOL), the agency responsible for enforcing the prohibited transaction rules under ERISA, can impose against the parties to the transaction a five percent civil penalty under ERISA Sec. 502(i) on the total dollar amount involved in the prohibited transaction. But if the prohibited transaction is not corrected during the correction period, the civil penalty will be 100 percent of the amount involved, unless a lesser amount is agreed to by the DOL and those being assessed.
Are there any exceptions to the prohibited transaction rules?
There are three types of exceptions, officially known as exemptions: statutory exemptions; class exemptions; and individual exemptions. Statutory exemptions are created by Congress and apply to anyone who meets the statute’s requirements. The most common statutory exemption involves the ability of participants to take loans from their qualified retirement plans, the statutory provision being found in IRC Sec. 4975(d)(1). Another statutory exemption allows a plan to hire service providers as long as the services are necessary to operate the plan and the arrangement under which the services provided and compensation paid are reasonable.
The DOL can create exemptions on an industry-wide basis, called prohibited transaction class exemptions, or PTEs. This is an administrative exemption that applies to any party in interest within the class who meets conditions set forth in the exemption. An example is recently issued PTE 2020-02, which provided industry-wide guidance on factors that determine whether financial professionals will be considered fiduciaries when providing investment advice.
Another class exemption permits certain organizations serving as “qualified termination administrators” to step in and terminate abandoned retirement plans and pay out benefits to participants, under rules found in the exemption.
The DOL can also issue exemptions on an individual basis, granted and applying only to the individual or firm requesting the exemption. These involve a narrow set of circumstances where the DOL can be satisfied that a potential conflict of interest can be avoided, or a proposed relationship shown not to be conflicted.
