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COLLECTIVE INVESTMENT FUNDS AND ERISA

Learn about the advantages of CIFs and how they are regulated under ERISA. Get tips for selecting Target Date Funds (TDFs) and evaluating their performance.

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COLLECTIVE INVESTMENT FUNDS AND ERISA

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  1. COLLECTIVE INVESTMENTFUNDS AND ERISA Marcia S. Wagner, Esq.

  2. 1. CIFs and ERISA2. DOL Tips for Selecting TDFs3. CIF Advantages

  3. What Is A CollectiveInvestment Fund (“CIF”) • Created by declaration of trust. • Corporate trustee (bank or trust company). • “Maintained” by the bank trustee. • Adviser can partner with bank to create customized investment vehicles. • Bank must be in overall control. • Limited to holding assets of tax-qualified plan. • Trust exempt from entity level taxation. • Trust instrument restricts use of assets to exclusive benefit of plan participants.

  4. Application of ERISA to CIF’s • ERISA look-through rule means plan assets include interest in every underlying CIF asset. • CIF trustee and investment adviser treated as ERISA fiduciaries. • CIF subject to ERISA reporting and disclosure (e.g., Form 5500). • CIF transactions subject to ERISA prohibited transaction rules unless exemption applies. • Investing in proprietary products could be prohibited. • Investing in securities of plan sponsor could be prohibited.

  5. Prohibited Transaction Exemptions • ERISA Section 408(b)(8) exempts a plan’s purchase of a CIF interest from the bank. • Allows trustee to charge additional fees for asset management with no offset. • Exemption conditioned on approval of affiliated fiduciary or approval written into plan documents. • Favorable result compared to mutual funds.

  6. ERISA Fiduciary Responsibilityand Protection from Liability for Investment Losses • CIFs same as any other investment with respect to qualifying for ERISA 404(c) protection. • Conditioned on plan qualifying as 404(c) plan. • Protection is against liability for losses due to participant’s selection of CIF from plan menu. • Plan sponsor responsible for selecting CIF as plan investment alternative. • CIF investment adviser responsible for prudently investing CIF assets. • Bank trustee has co-fiduciary responsibility with plan sponsor and adviser.

  7. Example of How FiduciaryResponsibility Allocated • Plan sponsor adds 3 risk-based CIFs to plan menu: aggressive, moderate, conservative. • Participant alone responsible for picking appropriate fund based on participant’s risk profile. • No fiduciary liability if risk averse participant picks aggressive CIF. • CIF adviser liable for imprudent investment of CIF’s underlying assets. • Bank also liable for CIF adviser’s imprudent investment decisions. • Plan sponsor only responsible if failed to prudently monitor CIF.

  8. Participant-Level Disclosuresfor CIFs • Each CIF treated as designated investment alternative. • Each CIF to be included on comparative chart furnished to participants. • Standardized performance information for each CIF required, including benchmarking. • Total annual operating expenses (including investment fees) to be disclosed. • CIF’s investment strategy would need to be discussed in required website posting.

  9. Participant-Level Disclosuresfor CIFs (cont’d) • Bank trustees have recordkeeping and disclosure systems comparable to mutual funds. • CIF providers can reduce disclosure compliance burden. • Performance calculations. • Unitized accounting.

  10. Qualification of CIFs as QDIA • QDIA rules provide relief from liability when participant defaults into investment. • Product investment strategy must be either: • Target date, or • Balanced. • CIF fiduciary must have discretion over CIF’s underlying assets under QDIA rules.

  11. 1. CIFs and ERISA2. DOL Tips for Selecting TDFs3. CIF Advantages

  12. DOL’s Tips for Choosing TDFs - Background • TDFs often used as QDIA, relieving plan fiduciaries of liability for default investment losses. • ERISA prudence requires objective process. • CIFs with TDF strategy can also qualify as QDIA. • Obtain information about TDF. • Use information to evaluate TDF. • Periodically review decision. • Document how decision made. • Proposed TDF regulations focusing on disclosure issued November 2010. • DOL tips on choosing TDFs issued February 28, 2013.

  13. Comparison, Evaluation& Review of TDFs • Get information from prospectus: • investment performance • fees and expenses • target date • glidepath • landing point. • Obtain additional information (e.g., salary levels, turnover). • Ensure TDF characteristics match needs of participants.

  14. Comparison, Evaluation& Review of TDFs (cont’d) • Glidepath considerations. • Landing point may be reached at or after target date. • Periodically review TDF characteristics and plan objectives for changes. • TDF management team or strategy. • Plan demographics.

  15. Role of TDF’s UnderlyingInvestments • Understand TDFs underlying investments. • Determine appropriate glidepath construction for plan. • “To” retirement. • “Through” retirement. • Measure TDF fees and expenses against investment performance and service. • Determine expense ratios of underlying funds. • Consider relevant services: • Special asset allocation. • Access to special investments.

  16. Employee Communications Regarding TDFs • Information DOL thinks should be provided to participants: • General information regarding TDFs (e.g., explanation of nature of glidepath). • Info about plan’s specific TDFs (e.g., actual glidepath, historical performance and fees). • DOL tips include its proposed regulatory disclosures. • TDF not guaranteed. • Participant may lose money before, at and after target date.

  17. Use of Consultantsin Evaluating TDFs • DOL recognizes plan fiduciaries’ lack of expertise to evaluate TDFs which are a new and complex product. • DOL endorses use of “commercially available sources for information and services”. • DOL presumably means to include advisers with expertise to evaluate TDFs. • Unquestioning reliance on consultant’s recommendations not viewed as prudent.

  18. 1. CIFs and ERISA2. DOL Tips for Selecting TDFs3. CIF Advantages

  19. Mutual Fund TDFs vs. CIF TDFs • Mutual Fund TDFs typically invest in affiliated funds. • Conflicts within Mutual Fund TDFs may hurt performance and increase fees. • DOL recommends inquiring about customized TDFs consisting of plan’s core funds. • CIF’s underlying investments would be unaffiliated, resulting in greater diversification. • Potential disadvantage is higher cost and administrative complexity. ◦ Better fiduciary result.

  20. Summing Up CIF Advantagesfrom ERISA Perspective • More flexibility than mutual funds. • 404(c) Protection for CIF advisers. • CIF qualification as QDIA. • Responds to DOL suggestion to consider customized target date funds.

  21. COLLECTIVE INVESTMENT FUNDS AND ERISA Marcia S. Wagner, Esq. 99 Summer Street, 13th Floor Boston, MA 02110 Tel: (617) 357-5200 Fax: (617) 357-5250 Website: www.wagnerlawgroup.com marcia@wagnerlawgroup.com A0095235

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