[Federal Register Volume 60, Number 115 (Thursday, June 15, 1995)]
[Notices]
[Pages 31501-31520]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-14576]
[[Page 31501]]
DEPARTMENT OF LABOR
[Application No. D-09500, et al.]
Proposed Exemptions; Fidelity Management Trust Company (FMTC) and
its Affiliates, et al
AGENCY: Pension and Welfare Benefits Administration, Labor.
ACTION: Notice of proposed exemptions.
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SUMMARY: This document contains notices of pendency before the
Department of Labor (the Department) of proposed exemptions from
certain of the prohibited transaction restriction of the Employee
Retirement Income Security Act of 1974 (the Act) and/or the Internal
Revenue Code of 1986 (the Code).
Written Comments and Hearing Requests
Unless otherwise stated in the Notice of Proposed Exemption, all
interested persons are invited to submit written comments, and with
respect to exemptions involving the fiduciary prohibitions of section
406(b) of the Act, requests for hearing within 45 days from the date of
publication of this Federal Register Notice. Comments and request for a
hearing should state: (1) The name, address, and telephone number of
the person making the comment or request, and (2) the nature of the
person's interest in the exemption and the manner in which the person
would be adversely affected by the exemption. A request for a hearing
must also state the issues to be addressed and include a general
description of the evidence to be presented at the hearing. A request
for a hearing must also state the issues to be addressed and include a
general description of the evidence to be presented at the hearing.
ADDRESSES: All written comments and request for a hearing (at least
three copies) should be sent to the Pension and Welfare Benefits
Administration, Office of Exemption Determinations, Room N-5649, U.S.
Department of Labor, 200 Constitution Avenue, N.W., Washington, D.C.
20210. Attention: Application No. stated in each Notice of Proposed
Exemption. The applications for exemption and the comments received
will be available for public inspection in the Public Documents Room of
Pension and Welfare Benefits Administration, U.S. Department of Labor,
Room N-5507, 200 Constitution Avenue, N.W., Washington, D.C. 20210.
Notice to Interested Persons
Notice of the proposed exemptions will be provided to all
interested persons in the manner agreed upon by the applicant and the
Department within 15 days of the date of publication in the Federal
Register. Such notice shall include a copy of the notice of proposed
exemption as published in the Federal Register and shall inform
interested persons of their right to comment and to request a hearing
(where appropriate).
SUPPLEMENTARY INFORMATION: The proposed exemptions were requested in
applications filed pursuant to section 408(a) of the Act and/or section
4975(c)(2) of the Code, and in accordance with procedures set forth in
29 CFR Part 2570, Subpart B (55 FR 32836, 32847, August 10, 1990).
Effective December 31, 1978, section 102 of Reorganization Plan No. 4
of 1978 (43 FR 47713, October 17, 1978) transferred the authority of
the Secretary of the Treasury to issue exemptions of the type requested
to the Secretary of Labor. Therefore, these notices of proposed
exemption are issued solely by the Department.
The applications contain representations with regard to the
proposed exemptions which are summarized below. Interested persons are
referred to the applications on file with the Department for a complete
statement of the facts and representations.
Fidelity Management Trust Company (FMTC) and its Affiliates
(collectively, Fidelity) Located in Boston, Massachusetts; Proposed
Exemption
[Application No. D-09500]
The Department is considering granting an exemption under the
authority of section 408(a) of the Act and section 4975(c)(2) of the
Code and in accordance with the procedures set forth in 29 CFR Part
2570, Subpart B (55 FR 32836, 32847, August 10, 1990).
Section I--Exemption for Payment of Certain Fees to Fidelity
The restrictions of section 406(b)(1) and (b)(2) of the Act and the
taxes imposed by section 4975 of the Code, by reason of section
4975(c)(1)(E) of the Code, shall not apply to the payment of certain
performance fees (the Performance Fee) to Fidelity by employee benefit
plans for which Fidelity provides investment management or
discretionary trustee services (the Client Plans) pursuant to an
investment management or trust agreement (the Agreement) entered into
between Fidelity and the Client Plans either individually, through the
establishment of a single client separate account (Single Client
Account), or collectively as participants in a multiple client
commingled account (Multiple Client Account), provided that the
conditions set forth below in Section III are satisfied. (Single Client
Accounts and Multiple Client Accounts are collectively referred to
herein as Accounts.)
Section II--Exemption for Investments in a Multiple Client Account
The restrictions of section 406(a)(1)(A) through (D) of the Act and
the taxes imposed by section 4975 of the Code, by reason of section
4975(c)(1)(A) through (D) of the Code, shall not apply to any
investment by a Client Plan in a Multiple Client Account managed by
Fidelity, provided that the conditions set forth below in Section III
are satisfied.
Section III--General Conditions
(a) The investment of plan assets in a Single or Multiple Client
Account, including the terms and payment of any Performance Fee, shall
be approved in writing by a fiduciary of a Client Plan which is
independent of Fidelity (the Independent Fiduciary). Notwithstanding
the foregoing, Fidelity may authorize the transfer of cash from a
Single Client Account to a Multiple Client Account provided that: (1)
The Multiple Client Account has similar investment objectives and the
identical fee structure as the Single Client Account; (2) the Agreement
governing the Single Client Account authorizes Fidelity to invest in a
Multiple Client Account; (3) Fidelity receives no additional fees from
the Single Client Account for cash invested in the Multiple Client
Account; (4) a binding commitment to make the transfer to the Multiple
Client Account occurs within six months of the Independent Fiduciary's
decision to allocate assets to the Single Client Account or, in the
event Fidelity's binding commitment to make the transfer occurs more
than six months after such fiduciary's decision, Fidelity obtains an
additional authorization from the Independent Fiduciary; and (5) each
transfer of assets from the Single Client Account to the Multiple
Client Account occurs within sixty (60) days of the actual transfer of
such assets to the Single Client Account.
(b) The terms of any investment in an Account and of any
Performance Fee shall be at least as favorable to the Client Plans as
those obtainable in arm's-length transactions between unrelated
parties.
(c) At the time any Account is established and at the time of any
subsequent investment of assets (including the reinvestment of assets)
in such Account: [[Page 31502]]
(1) Each Client Plan shall have total net assets with a value in
excess of $50 million; and
(2) No Client Plan shall invest, in the aggregate, more than five
percent (5%) of its total assets in any Account or more than ten
percent (10%) of its assets in all Accounts established by Fidelity.
(d) Prior to making an investment in any Account, the Independent
Fiduciary of each Client Plan investing in an Account shall receive
offering materials from Fidelity which disclose all material facts
concerning the purpose, structure, and operation of the Account,
including any fee arrangements.
(e) With respect to its ongoing participation in an Account, the
Independent Fiduciary of each Client Plan shall receive the following
written information from Fidelity:
(1) Audited financial statements of the Account prepared by
independent public accountants selected by Fidelity no later than
ninety (90) days after the end of the fiscal year of the Account;
(2) Quarterly and annual reports prepared by Fidelity relating to
the overall financial position of the Account and, in the case of a
Multiple Client Account, the value of such Client Plan's interest in
the Account. Each such report shall include a statement regarding the
amount of fees paid to Fidelity during the period covered by such
report;
(3) Annual reports indicating the fair market value of the
Account's assets determined using market sources and valuation
methodologies acceptable to the Independent Fiduciary of the Client
Plan for a Single Client Account or the responsible independent
fiduciaries of Client Plans and other authorized persons acting for
investors in a Multiple Client Account (the Responsible Independent
Fiduciaries, as defined in Section IV(c) below), or if market sources
are not available, values determined by a qualified appraiser
independent of Fidelity which has been approved by the Independent
Fiduciary or Responsible Independent Fiduciaries. However, no
independent appraisals shall be required for assets acquired for the
Account within the twelve (12) months preceding the end of the period
covered by the report, unless such appraisals are necessary for
purposes of determining any compensation due to Fidelity based on the
value of the assets in the Account for that period; and
(4) In the case of any Multiple Client Account, a list of all other
investors in the Account.
(f) The total fees paid to Fidelity shall constitute no more than
reasonable compensation.
(g) The Performance Fee shall be payable after the Client Plan has
received distributions from the Account in excess of an amount equal to
100% of its invested capital plus a pre-specified annual compounded
cumulative rate of return (the Threshold Amount), except that in the
case of Fidelity's removal or resignation, Fidelity shall be entitled
to receive a Performance Fee payable either at the time of removal, or
in the event of Fidelity's resignation, on the scheduled termination
date of the Account, subject to the requirements of paragraph (j)
below, as determined by a deemed distribution of the assets of the
Account based on an assumed sale of such assets at their fair market
value (in accordance with market sources or independent appraisals as
described in paragraph (k) below), only to the extent that the Client
Plan would receive distributions from the Account in excess of an
amount equal to the Threshold Amount at the time of Fidelity's removal
or resignation. Both the Threshold Amount and the amount of the
Performance Fee, expressed as a percentage of the amount distributed
(or deemed distributed) from the Account in excess of the Threshold
Amount, shall be established by the Agreement and agreed to by the
Independent Fiduciary of the Client Plan.
(h) The Threshold Amount for any Performance Fee shall include at
least a minimum rate of return to the Client Plan, as defined below in
Section IV(d). The Independent Fiduciary acting for a Client Plan shall
specifically agree in writing with Fidelity, prior to any investment in
the Account, that it would be appropriate for the minimum rate of
return applicable to the Account to be based upon the rate of change in
the consumer price index (CPI) during the period specified in the
Agreement, as described in Section IV(d).
(i) For any sale of an asset in an Account which shall give rise to
the payment of a Performance Fee to Fidelity prior to the termination
of the Account, the sale price of the asset shall be at least equal to
a target amount (the Target Amount), as defined in Section IV(e), in
order for Fidelity to sell the asset and receive its Performance Fee
without further approvals. If the proposed sale price of the asset is
less than the Target Amount, the proposed sale shall be disclosed to
and approved by the Independent Fiduciary for a Single Client Account
or the Responsible Independent Fiduciaries for a Multiple Client
Account, in which event Fidelity will be entitled to sell the asset and
receive its Performance Fee. If the proposed sale price is less than
the Target Amount and the Independent Fiduciary's or Responsible
Independent Fiduciaries' approval is not obtained, Fidelity shall still
have the authority to sell the asset, if the Agreement provides
Fidelity with complete investment discretion for the Account, provided
that the Performance Fee that would have been payable to Fidelity by
reason of the sale of the asset is paid only at the termination of the
Account.
(j) In the event Fidelity resigns as investment manager or trustee
of an Account, the Performance Fee shall be calculated at the time of
resignation based upon a deemed distribution of the assets of the
Account at their fair market value (determined using market sources or
independent appraisals as described in paragraph (k) below). The amount
arrived at by this calculation shall be multiplied by a fraction, the
numerator of which shall be the sum of the disposition proceeds of all
assets in the Account received prior to the termination date plus the
fair market value of the assets remaining in the Account on the
termination date and the denominator of which shall be the aggregate
value of the assets in the Account used in determining the amount of
the Performance Fee as of the date of resignation, provided that this
fraction shall never exceed 1.0. The resulting amount shall be the
Performance Fee payable to Fidelity on the scheduled termination date
of the Account.
(k) With respect to the valuation of the assets in an Account for
purposes of determining any Performance Fee based on a deemed
distribution of such assets, Fidelity shall establish the fair market
value for the assets using market sources and valuation methodologies
disclosed to, and approved in writing by, the Independent Fiduciary for
a Single Client Account or the Responsible Independent Fiduciaries for
a Multiple Client Account. In the event market sources are not
available for the valuation of assets in the Account, the fair market
value of such assets shall be determined by an independent qualified
appraiser approved by either the Independent Fiduciary for a Single
Client Account or the Responsible Independent Fiduciaries for a
Multiple Client Account prior to any valuation of the assets. If a new
appraiser for an asset is chosen by Fidelity, the appraiser shall be
approved by such Fiduciaries prior to any valuation of the asset. In
any event, the fair market value of all assets involved in any deemed
distribution shall be based on the current market value of such assets
as of the date of the transactions giving rise to the payment of the
Performance Fee. [[Page 31503]]
(l) Fidelity shall maintain, for a period of six years, the records
necessary to enable the persons described in paragraph (m) of this
Section III to determine whether the conditions of this exemption have
been met, except that: (1) A prohibited transaction will not be
considered to have occurred if, due to circumstances beyond the control
of Fidelity, the records are lost or destroyed prior to the end of the
six year period, and (2) no party in interest, other than Fidelity,
shall be subject to the civil penalty that may be assessed under
section 502(i) of the Act or to the taxes imposed by section 4975(a)
and (b) of the Code if the records are not maintained or are not
available for examination as required by paragraph (m) below.
(m)(1) Except as provided in paragraph (m)(2) and notwithstanding
any provisions of sections 504(a)(2) and (b) of the Act, the records
referred to in paragraph (l) of this Section III shall be
unconditionally available at their customary location for examination
during normal business by:
(i) Any duly authorized employee or representative of the
Department or the Internal Revenue Service;
(ii) Any fiduciary of a Client Plan or any duly authorized employee
or representative of such fiduciary;
(iii) Any contributing employer to any Client Plan or any duly
authorized employee or representative of such employer; and
(iv) Any participant or beneficiary of any Client Plan, or any duly
authorized employee or representative of such participant or
beneficiary.
(2) None of the persons described above in paragraph (m)(1)(ii)-
(iv) shall be authorized to examine the trade secrets of Fidelity or
any commercial or financial information which is privileged or
confidential.
Section IV--Definitions
(a) An ``affiliate'' of a person includes:
(1) Any person directly or indirectly, through one or more
intermediaries, controlling, controlled by, or under common control
with the person;
(2) Any officer, director, employee, relative of, or partner of any
such person; and
(3) Any corporation or partnership of which such person is an
officer, director, partner or employee.
(b) The term ``control'' means the power to exercise a controlling
influence over the management or policies of a person other than an
individual.
(c) The term ``Responsible Independent Fiduciaries'' means with
respect to a Multiple Client Account the Independent Fiduciary of
Client Plans invested in the Account and other authorized persons
acting for investors in the Account which are not employee benefit
plans as defined under section 3(3) of the Act (such as governmental
plans, university endowment funds, etc.) that are independent of
Fidelity and that collectively hold at least 50% of the interests in
the Account.
(d) The term ``Threshold Amount'' means with respect to any
Performance Fee an amount which equals all of a Client Plan's capital
invested in an Account plus a pre-specified annual compounded
cumulative rate of return that is at least a minimum rate of return
determined as follows:
(1) A non-fixed rate which is at least equal to the rate of change
in the CPI during the period from the deposit of the Client Plan's
assets in the Account until distributions of the Client Plan's assets
from the Account equal or exceed the Threshold Amount; or
(2) A fixed rate which is at least equal to the average annual rate
of change in the CPI over some period of time specified in the
Agreement, which shall not exceed 10 years.
(e) The term ``Target Amount'' means a value assigned to each asset
in the Account established by Fidelity either (1) at the time the asset
is acquired, by mutual agreement between Fidelity and the Independent
Fiduciary for a Single Client Account or the Responsible Independent
Fiduciaries for a Multiple Client Account, or (2) pursuant to an
objective formula approved by such fiduciaries at the time the Account
is established. However, in no event will such value be less than the
acquisition price of the asset.
(f) The term ``Account'' means any Single Client Account or
Multiple Client Account established with Fidelity, under a written
investment management or trust agreement, that is invested primarily
(i.e. more than 50%) in securities or other assets which are not
publicly-traded equity securities or publicly-traded, investment grade
debt securities, pursuant to written instructions and guidelines
established and approved by an Independent Fiduciary for the Client
Plan prior to any investment by the Client Plan in the Account. For
purposes of an ``Account'' meeting the 50% test for assets which are
not ``publicly-traded equity securities'' or ``publicly-traded,
investment grade debt securities'', any private market securities held
by the Account that become publicly-traded securities shall not be
considered as such for a period of thirty (30) months following the
date such securities become publicly-traded so as to allow Fidelity
sufficient time to dispose of such securities in order for the Account
to remain primarily invested in assets which are not publicly-traded
securities, including for such purposes any publicly-traded debt
securities which are not investment grade.1
\1\As noted above in Section III(f), an Independent Fiduciary
must specifically agree in writing with Fidelity that it would be
appropriate for the minimum rate of return applicable to the Account
to be based upon the rate of change in the CPI during the period
specified in the Agreement. However, with respect to any Account
with an investment strategy designed to invest in distressed,
defaulted or other non-performing debt instruments that may be
publicly-traded securities at the time they are acquired by the
Account, the Department encourages Client Plan fiduciaries to
determine whether or not any of the published indices for publicly-
traded debt securities would be a more appropriate performance
benchmark to measure a minimum rate of return for such securities.
The availability of this exemption, if granted, will be subject to
the express condition that the material facts and representations
contained in the application are true and complete, and that the
application accurately describes all material terms of the transactions
which are the subject of this exemption.
Summary of Facts and Representations
1. FMTC is a Massachusetts trust company with its principal office
located in Boston, Massachusetts, and is a ``bank'' as defined under
the Investment Advisers Act of 1940. FMTC manages approximately $24
billion worth of assets for a variety of clients, virtually all of
which are employee benefit plans. FMTC's client accounts consist of
either separate accounts for a single client or commingled accounts for
multiple clients.
2. Fidelity will offer the investment arrangement described below
involving the payment of a Performance Fee to Client Plans that seek to
invest primarily in securities and have aggregate net plan assets with
a fair market value in excess of $50 million.2 Fidelity will serve
such Client Plans as the investment manager or discretionary trustee of
either a Single Client Account or a Multiple Client Account. In
general, Fidelity will have complete discretion for identifying
appropriate investments, making investment decisions, and managing and
disposing of the securities or other assets acquired for the Accounts.
However, with respect to certain Single Client Accounts, Fidelity will
not exercise absolute investment discretion and will be required to
obtain approval for certain investment [[Page 31504]] decisions from
the Independent Fiduciary of the Client Plan. Such approvals will
typically be obtained from the Client Plan sponsor or an investment
committee appointed by the Client Plan sponsor.
\2\In the case of multiple plans maintained by a single employer
or a single controlled group of employers, the assets of which are
invested on a commingled basis (e.g. through a master trust), this
$50 million threshold will be applied to the aggregate assets of all
such plans.
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3. Single Client Accounts will be established pursuant to
Agreements negotiated with the Independent Fiduciaries of the Client
Plans. The terms of Fidelity's compensation will be established in the
Agreements governing the Single Client Account and will be fully
disclosed to the Independent Fiduciary prior to the investment of
assets of the Client Plan in the Single Client Account. If agreed to by
the Independent Fiduciary, the compensation arrangement involving the
payment of the Performance Fee (as described in Item 5 below) will be
included in the Agreement.3 The term of each Account will be
predetermined in the Agreement and approved by the Independent
Fiduciary of the Client Plan (see Item 8 below).
\3\Section 404 of the Act requires, among other things, that a
plan fiduciary act prudently and solely in the interest of the
plan's participants and beneficiaries. Thus, the Department expects
a plan fiduciary, prior to entering into any performance- based
compensation arrangement with an investment manager, to fully
understand the risks and benefits associated with the compensation
formula following disclosure by the investment manager of all
relevant information pertaining to the proposed arrangement. In
addition, a plan fiduciary must be capable of periodically
monitoring the actions taken by the investment manager in the
performance of its duties and must consider, prior to entering into
the arrangement, whether such plan fiduciary is able to provide
oversight of the investment manager during the course of the
arrangement.
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A Multiple Client Account typically will be organized either as a
common law trust or a group trust as defined in IRS Revenue Ruling 81-
100 (as to which Fidelity would serve as discretionary trustee), or as
a limited partnership (as to which Fidelity would be general
partner).4 For any Multiple Client Account, various decisions
regarding the Account other than investment management decisions for
the Account (such as the initial decision to allocate Client Plan
assets to the Account, decisions with respect to the removal of
Fidelity or the termination of the Account) will be made by the
Responsible Independent Fiduciaries. Fidelity represents that in all
instances the Responsible Independent Fiduciaries will be acting for
Account investors that collectively hold at least 50% of the interests
in the Account. The exact percentage required for such decisions will
be specified in the governing documents of the Account.
\4\With respect to any Multiple Client Account organized by
Fidelity as a limited partnership, Fidelity represents that its
interest as a general partner will not exceed 1% of the aggregate
outstanding partnership interests of such limited partnership at any
time.
The decision to invest assets of a Client Plan in any Multiple
Client Account will be made by the Independent Fiduciary of such Client
Plan, based upon full written disclosure of the Performance Fee prior
to such investment. Notwithstanding the foregoing, Fidelity may
authorize the transfer of cash from a Single Client Account to a
Multiple Client Account where: (i) The Multiple Client Account has
similar investment objectives and the identical fee structure as the
Single Client Account; (ii) the Agreement governing the Single Client
Account authorizes Fidelity to invest in a Multiple Client Account;
(iii) Fidelity receives no additional fees from the Single Client
Account for cash invested in the Multiple Client Account; (iv) a
binding commitment to make the transfer to the Multiple Client Account
is made within six months of the Independent Fiduciary's decision to
allocate assets to the Single Client Account or, in the event
Fidelity's binding commitment to make the transfer occurs more than six
months after such fiduciary's decision, Fidelity obtains an additional
authorization from the Independent Fiduciary; and (v) each transfer of
assets from the Single Client Account to the Multiple Client Account
occurs within sixty (60) days of the actual transfer of such assets to
the Single Client Account. Fidelity represents that its commitment to
invest the cash would normally occur within six months of the
Independent Fiduciary's decision to allocate assets to the Single
Client Account. However, if more than six months has transpired since
the Independent Fiduciary's decision to invest the assets in the Single
Client Account, Fidelity will obtain an additional authorization from
such fiduciary. Such authorization will occur following written
disclosure to the Independent Fiduciary of Fidelity's binding
commitment to make a cash transfer to the Multiple Client Account which
will be deemed approved unless such fiduciary objects within a
reasonable time.
After a transfer of cash, the fee structure for the Multiple Client
Account will govern all fees received by Fidelity for such Client Plan
assets. The precise terms of Fidelity's compensation arrangement will
be established as part of the documents pursuant to which the Multiple
Client Account is organized and can be amended only with the
affirmative approval of the Responsible Independent Fiduciaries.
4. The applicant represents that, in general, the investment
objectives of each Account will be to obtain current income and/or
capital appreciation through investments primarily in various types of
private market securities and real estate related investments. Fidelity
represents that it offers a wide range of investment services and
utilizes a wide variety of investment approaches. While the bulk of
Fidelity's business entails investing Client Plan assets in publicly-
traded securities which are readily valued or easily liquidated, other
aspects of its investment business entail, at least in part, investing
Client Plan assets in non-publicly-traded securities and other
property.
Fidelity's objective with respect to the requested exemption is to
achieve sufficient flexibility to respond to client demands and
preferences for utilization of a Performance Fee arrangement of the
type described below. Fidelity believes that such a fee arrangement may
be attractive to Client Plans in situations involving Accounts which
are to be invested primarily (i.e. more than 50%) in certain types of
assets other than publicly-traded equity securities or publicly-traded,
investment grade debt securities. For purposes of an Account meeting
the 50% test for assets which are not ``publicly-traded equity
securities'' or ``publicly-traded, investment grade debt securities'',
any private market securities held by the Account that become publicly-
traded securities shall not be considered as such for a period of
thirty (30) months following the date such securities become publicly-
traded so as to allow Fidelity sufficient time to dispose of such
securities in order for the Account to remain primarily invested in
assets which are not publicly-traded securities, including for such
purposes any publicly-traded debt securities which are not investment
grade.5
\5\The Department notes that a ``publicly-traded security''
would include any security that is a ``publicly-offered security''
as described in the Department's regulations relating to the
definition of ``plan assets'' in the context of certain plan
investments (see 29 CFR 2510.3-101(b) (2)-(4)).
An Account could entail a wide range of types of investments,
including privately placed debt and equity securities, high-yield fixed
income securities, publicly-traded debt securities issued by distressed
companies, partnership interests in venture capital operating
companies, various real estate or real estate-related interests, and
other ``alternative investments'' which have greater risk but
potentially greater returns than traditional classes of equity or debt
[[Page 31505]] securities.6 Fidelity states that it would not
necessarily enter into a Performance Fee arrangement for all Accounts
which are invested in the these types of assets. However, Fidelity
wishes to have the opportunity to do so in circumstances where an
Independent Fiduciary has specifically approved the particular
investment objectives and fee arrangements for the Account, as being
appropriate for the payment of such a Performance Fee. The Accounts may
be designed as either ``blind'' accounts for which Fidelity will select
the investments after the Client Plans have invested therein or ``pre-
identified asset'' accounts for which Fidelity identifies particular
securities or other assets for investment prior to the Client Plans'
investments in the Accounts.
\6\In this regard, Fidelity represents that an Account will not
invest in or use any swap transactions (including caps, floors,
collars, or options relating thereto), forward contracts, exchanged-
traded futures transactions, or options (other than covered call
options). The Department notes that no relief is being provided in
this proposed exemption for any underlying investments made by an
Account which may involve parties in interest with respect to the
Client Plans invested in the Account.
In addition, the Department is expressing no opinion as to
whether the investment of ``plan assets'' by an Account in any
particular type of asset would violate any provision of Part 4 of
Title I of the Act. Thus, the Department is not providing an opinion
regarding whether any particular category of investments or
investment strategy would be considered prudent or in the best
interests of a Client Plan as required by section 404 of the Act.
However, the Department notes that in order to act prudently in
making investment decisions, plan fiduciaries must consider, among
other factors, the availability, risks and potential return of
alternative investments for the plan. A particular investment by a
plan, which is selected in preference to other available
investments, would generally not be prudent if such investment
involves a greater risk to the security of ``plan assets'' than
other comparable investments offering a similar return.
The Department notes further that Client Plan fiduciaries must
thoroughly understand the risks involved with any investment course
of action and must be capable of monitoring at appropriate intervals
the investment course of action taken by Fidelity, particularly with
respect to any period when the payment of a Performance Fee to
Fidelity would be applicable. In this regard, section 405(a) of the
Act states, among other things, that a plan fiduciary shall be
liable for a breach of fiduciary responsibility of another fiduciary
for the same plan if, by his failure to comply with section
404(a)(1) in the administration of his specific duties which give
rise to his status as a fiduciary, he has enabled such other
fiduciary to commit a breach.
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5. Fidelity proposes to have the Client Plans pay for investment
management or discretionary trustee services rendered to the Accounts
based upon a two-part fee structure which will be approved in advance
by the Independent Fiduciaries of the Client Plans. In addition to an
on-going investment management or trustee fee (the Base Fee) paid to
Fidelity by the Client Plan, the fee structure may include the
Performance Fee, a fee payable upon a distribution (or deemed
distribution) of the assets from the Account after the Client Plan has
received (or would receive) a return of all its invested capital plus a
certain pre-specified rate of return on its investments in the Account.
Fidelity requests an exemption for the payment by Client Plans of the
Performance Fee under circumstances described below.
With respect to the Base Fee, such fee will be paid throughout the
term of the Account on a pre-specified periodic basis. The amount of
the Base Fee will be based on either (i) a percentage of the net fair
market value of the Client Plan assets in the Account (i.e. without
regard to any leveraged amounts) as of the last day of each period or
(ii) a percentage of the assets allocated to the Account (i.e. the
invested capital) less any amounts thereof which have been distributed
from the Account. In either event, the Base Fee will be pro-rated for
any partial periods. The exact percentage to be used in determining the
Base Fee will be negotiated between Fidelity and the Independent
Fiduciary of the Client Plan prior to the initial investment of any
Plan assets in the Account.
If the Base Fee is calculated based upon the fair market value of
the assets in the Account as of a specified determination date, the fee
will be based upon values determined using market sources approved in
writing by the Independent Fiduciary of the Client Plan (or specified
in the documents establishing the Account, in the case of a Multiple
Client Account).7 If market sources are not available, the fee
will be based upon values determined immediately prior to the payment
of such fee by an appraiser independent of Fidelity. For any appraisal
used to determine the Base Fee, Fidelity will initially notify in
writing the Independent Fiduciary for a Single Client Account or the
Responsible Independent Fiduciaries for a Multiple Client Account
regarding the identity of the appraiser whom Fidelity proposes to
retain to value the asset. The Independent Fiduciary or the Responsible
Independent Fiduciaries will have an opportunity to approve or
disapprove the suggested appraiser with an approval being deemed to
have occurred unless such fiduciaries object to the appraiser within a
reasonable time. Once approved, the appraiser could perform all future
valuations of the particular asset unless either (i) the Independent
Fiduciary or Responsible Independent Fiduciaries affirmatively withdraw
the prior approval of the appraiser, or (ii) Fidelity suggests a
different appraiser, in which case an approval by such fiduciaries
would again be required.
\7\Fidelity states that in instances where the Base Fee is
determined based on the amount of capital invested in the Account,
rather than on the value of the assets in the Account, no such
market valuations will be utilized to determine the Base Fee. Thus,
the independent valuation requirements discussed herein, including
any independent appraisal of assets in an Account, will be limited
to situations where such valuations are used to calculate either the
Base Fee or the Performance Fee.
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In lieu of the Base Fee described above, Fidelity and the
Independent Fiduciaries of the Client Plans may agree to an alternative
fee arrangement for an Account (the Alternative Fee) which is based
upon either a fixed amount or amounts or an objective formula to be
negotiated (in either case) between Fidelity and the Independent
Fiduciary of the Client Plan prior to the initial investment of any
Client Plan assets in the Account. Neither the Base Fee nor any such
Alternative Fees will be covered by the requested exemption.8
\8\Fidelity represents that both the Base Fee and the
Alternative Fee would be covered by section 408(b)(2) of the Act and
the regulations thereunder (see 29 CFR 2550.408b-2). However, the
Department expresses no opinion as to whether the payment of such
fees, as described herein, would meet the conditions of section
408(b)(2) of the Act.
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The Performance Fee will be payable either (i) after the Client
Plan has actually received distributions from the Account, or (ii) in
the case of the removal or resignation of Fidelity, based on deemed
distributions from the Account (as discussed in Item 7 below), which in
each case must be at least equal to such Plan's invested capital plus a
pre-specified annual compounded cumulative rate of return (i.e. the
Threshold Amount). The Performance Fee will be equal to a fixed
percentage (or several fixed percentages) of all amounts distributed
from an Account in excess of the Threshold Amount (or several Threshold
Amounts). In this regard, Fidelity represents that there is a
possibility that several Threshold Amounts may be established with
different percentages being utilized to determine the Performance Fee
depending upon which Threshold Amount has been exceeded.9 Fidelity
states that this structure will allow a Client Plan to negotiate an
arrangement pursuant to which the [[Page 31506]] amount of the
Performance Fee will increase as the level of investment performance
increases. Both the annual rate(s) of return used in determining the
Threshold Amount(s) and the percentage(s) used to determine the amount
of the Performance Fee will be negotiated between, and agreed to by,
Fidelity and the Independent Fiduciary of the Client Plan prior to the
Client Plan's initial investment in the Account.
\9\For example, a Client Plan could negotiate a Performance Fee
whereby Fidelity would receive 10% of all distributions from the
Account once an initial Threshold Amount (e.g. return of all
invested capital plus an 8% annual return) has been achieved and 20%
of all distributions once a second Threshold Amount (e.g. return of
all invested capital plus a 12% annual return) has been achieved.
With respect to the determination of the Threshold Amount, Fidelity
represents that all amounts invested by a Client Plan in an Account
will have to earn a pre-specified rate of return, which is at least
equal to the minimum rate of return specified in Section IV(d)
above,10 for the entire period such assets are in the Account and
must actually be distributed (or deemed distributed) back to the Client
Plan in order for the Threshold Amount to be reached. Fidelity states
that a bookkeeping account will be maintained for each Client Plan
which will show the amount required to be distributed from the Account
to satisfy the Threshold Amount. When a certain amount is invested in
the Account on a particular date, this bookkeeping account will be
reduced by the full amount of the distribution. Thereafter, the
required return will be added to this reduced amount until the next
distribution is made when the bookkeeping account will be reduced to
reflect the amount of that distribution. Only when this bookkeeping
account is reduced to zero will the Threshold Amount be satisfied. At
this time, the Performance Fee will be payable to Fidelity on all
further distributions (or any deemed distribution) from the Account.
\10\Fidelity represents that the Independent Fiduciary acting
for a Client Plan shall specifically agree in writing with Fidelity,
prior to any investment in the Account, that it would be appropriate
for the performance benchmark used to measure the minimum rate of
return applicable to the Account to be based upon the rate of change
in the CPI over the period specified in the Agreement. However, the
Department notes that a Client Plan fiduciary should thoroughly
scrutinize the performance objectives for the Account prior to
agreeing with Fidelity that such a performance benchmark is
appropriate to measure the required minimum rate of return. In this
regard, the Department encourages Client Plan fiduciaries to analyze
whether any performance benchmarks other than a minimum rate of
return based on changes in the CPI, such as an index of publicly-
traded equity or debt securities, would be more appropriate to
measure the Account's performance.
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Fidelity states that for any sale of an asset in an Account which
causes the payment of a Performance Fee and which occurs prior to the
termination of the Account, the sale price for the asset must be at
least equal to a Target Amount (as defined in Section IV(e) above), in
order for Fidelity to be able to sell the asset and receive its
Performance Fee without any further approvals. The Target Amount will
be established by Fidelity either at the time the asset is acquired, by
mutual agreement between Fidelity and the Independent Fiduciary for a
Single Client Account or the Responsible Independent Fiduciaries for a
Multiple Client Account, or pursuant to a formula approved by such
fiduciaries at the time the Account is established. If the proposed
sale price of the asset is less than the Target Amount, the proposed
sale will be disclosed to the Independent Fiduciary or Responsible
Independent Fiduciaries for approval in order for Fidelity to receive
its Performance Fee as a result of the sale. Such approval will be
deemed to have occurred unless the Independent Fiduciary or Responsible
Independent Fiduciaries object to the sale within a reasonable time
after notice of the proposed transaction. If the proposed sale price is
less than the Target Amount and the Independent Fiduciary's or
Responsible Independent Fiduciaries' approval is not obtained, Fidelity
will still have the authority to sell the asset in situations where the
Agreement provides Fidelity with complete investment discretion for the
Account. However, in such instances and in all other circumstances
where the sale price is less than the Target Amount and the Independent
Fiduciary's or Responsible Independent Fiduciaries' approval is not
obtained, the Performance Fee which would have been payable to Fidelity
by reason of the sale of such asset will be paid only at the
termination of the Account. In this regard, Fidelity states that any
Performance Fee which is not paid currently to Fidelity because of the
Target Amount rule will be segregated within the Account and invested
until the termination of the Account with Fidelity to receive any
income (or loss) earned by such investment.
6. All realized income, and proceeds from the sale of the assets of
the Account, net of expenses (including reasonable reserves), will be
either (i) distributed from the Account to the applicable investors in
such Account, including Client Plan(s), or (ii) if the documents
pursuant to which the Account is maintained so provide, reinvested
until a specified date, with any income and proceeds (net of expenses,
including reasonable reserves) of the Account after such date to be
distributed to the applicable investors. All distributions from the
Account shall be included in calculating whether the Threshold Amount
has been reached. Only actual distributions from an Account, and not
any amounts reinvested as described above, will be included in
calculating whether the Threshold Amount has been reached for purposes
of the payment of the Performance Fee.
7. Fidelity may be removed as investment manager or trustee for an
Account at any time, without cause, upon the delivery of a notice of
removal to Fidelity by the Independent Fiduciary for a Single Client
Account or by the Responsible Independent Fiduciaries of a Multiple
Client Account. Fidelity may resign as investment manager or trustee of
an Account at any time, without cause, upon written notice to the
Independent Fiduciary for a Single Client Account or the Responsible
Independent Fiduciaries for a Multiple Client Account.
With respect to a Single Client Account, such removal or
resignation will not become effective until a successor investment
manager or trustee is appointed by the Independent Fiduciary for the
Account.
With respect to a Multiple Client Account, the removal of Fidelity
will become effective when either: (i) A successor investment manager
or trustee is appointed by the Responsible Independent Fiduciaries; or
(ii) sixty (60) days (or such greater number of days as may be
specified by the Responsible Independent Fiduciaries) elapse, whichever
is sooner. Any resignation by Fidelity for a Multiple Client Account
will become effective when either: (i) A successor investment manager
or trustee is appointed by the Responsible Independent Fiduciaries; or
(ii) 180 days elapse, whichever is sooner.
Upon removal of Fidelity as investment manager or trustee, Fidelity
will be entitled to receive a Performance Fee if the Client Plans would
receive distributions from the Account in excess of an amount equal to
the Threshold Amount at the time of Fidelity's removal. Such
Performance Fee will be determined by a deemed distribution of the
assets of the Account based on an assumed sale of such assets at their
fair market value using market sources approved by the Independent
Fiduciary of the Client Plan (or specified in the documents
establishing the Account, in the case of a Multiple Client Account). If
market sources are not available, the fair market value of the assets
will be determined by an independent appraiser mutually agreed upon by
Fidelity and the Independent Fiduciary of each Client Plan in the case
of a Single Client Account or the [[Page 31507]] Responsible
Independent Fiduciaries in the case of a Multiple Client Account. If
Fidelity and such fiduciaries cannot agree on an appraiser, then the
fair market value of such assets will be equal to the average of the
two closest appraisals generated by three independent appraisers--one
selected by Fidelity, one selected by such fiduciaries, and the third
selected by the two appraisers chosen by the parties.
Upon Fidelity's resignation as investment manager or trustee,
Fidelity will not receive a Performance Fee until the scheduled
termination date for the Account. The amount of the Performance Fee
will be based upon a deemed distribution of the assets of the Account
at their fair market value at the time of Fidelity's resignation, as
determined using market sources approved by the Independent Fiduciary
of the Client Plan (or specified in the documents establishing the
Account, in the case of a Multiple Client Account). If such market
sources are not available, the fair market value of the assets will be
determined by an independent appraiser mutually agreed to by Fidelity
and the Independent Fiduciary of the Client Plan in the case of a
Single Client Account or the Responsible Independent Fiduciaries in the
case of a Multiple Client Account. However, if Fidelity and such
fiduciaries cannot agree on an appraiser, the procedure described above
will be followed.
The Performance Fee will be calculated at the time of resignation
based upon the total value of the assets in the Account. The amount of
the Performance Fee for such assets will be multiplied by a fraction,
the numerator of which will be the sum of the disposition proceeds of
all assets in the Account received prior to the termination date plus
the fair market value of the assets remaining in the Account on the
termination date and the denominator of which will be the aggregate
value of the assets in the Account used in determining the amount of
the Performance Fee as of the date of resignation, provided that this
fraction will never exceed 1.0. The resulting amount will be the
Performance Fee payable to Fidelity on the scheduled termination date
of the Account. Thus, even if the value of the assets declines after
Fidelity's resignation, Fidelity will still receive the Performance Fee
for the period of time that it acted as an investment manager or
discretionary trustee for the Account if the Client Plans would have
received distributions from the Account in excess of an amount equal to
the Threshold Amount at the time of Fidelity's resignation, subject to
the operation of the fraction discussed above. The fraction ensures
that an appropriate reduction in the Performance Fee will be made upon
termination of the Account if the value of the assets in the Account
declines after Fidelity resigns as the investment manager or
discretionary trustee of the Account, based on the valuation of such
assets at the time of resignation.
8. A Single Client Account will terminate upon expiration of the
period of years specified as the term for the Account in the Agreement
or upon the removal or resignation of Fidelity. However, the period of
years specified in the Agreement may be extended by the Independent
Fiduciary of the Client Plan. In addition, a Single Client Account may
be terminated at any time by the Independent Fiduciary upon ninety (90)
days written notice to Fidelity.
A Multiple Client Account will terminate upon the occurrence of any
of the following events: (i) The affirmative decision of the
Responsible Independent Fiduciaries; (ii) the failure of the
Responsible Independent Fiduciaries to appoint a successor investment
manager or trustee; (iii) expiration of the period of years specified
as the term of the Account in the Agreement, provided that the period
of years is not extended by the Responsible Independent Fiduciaries;
(iv) the distribution of all assets of the Account; or (v) such other
circumstances as may be specified in the documents governing the
Accounts.
Upon termination of a Single Client Account, the assets in the
Account will be distributed to the Client Plan in cash or in kind as
agreed to by Fidelity and the Independent Fiduciary. In case of a
Multiple Client Account, such distributions (i.e., cash or in-kind)
will be agreed to by Fidelity and the Responsible Independent
Fiduciaries for the Account.
Fidelity will be entitled to the Performance Fee upon termination
of the Account for all remaining distributions made from the Account if
the Threshold Amount has been or would be reached at such time. In the
case of an in kind distribution of assets of the Account, the
Performance Fee will be based on the fair market value of the assets of
the Account as determined using market sources approved by the
Independent Fiduciary of the Client Plan (or specified in the documents
establishing the Account, in the case of a Multiple Client Account). If
market sources are unavailable, the fair market value of the assets
will be determined by an independent appraiser mutually agreed to by
Fidelity and the Independent Fiduciary of the Client Plan in the case
of a Single Client Account or the Responsible Independent Fiduciaries
in the case of a Multiple Client Account. If Fidelity and such
fiduciaries cannot agree on an appraiser, then the same procedure
described in Item 7 above will be followed.
9. Each Client Plan will receive throughout the term of an Account
the following information:
(a) Quarterly and annual reports prepared by Fidelity relating to
the overall financial position of the Account and, in the case of a
Multiple Client Account, the balance of such Client Plan's interest in
the Account. In addition, such reports will include a statement
regarding the amount of all fees paid to Fidelity during the period
covered by the report.
(b) Annual reports indicating the current fair market value of all
assets in the Account as established by using market sources or
independent appraisals (provided that no such appraisals will be
required for assets acquired for the Account within twelve (12) months
preceding the end of the period covered by the report unless such
appraisals are necessary for purposes of determining any compensation
due to Fidelity based on the value of the assets in the Account for
that period).
(c) In the case of a Multiple Client Account, a list of the
investors in the Multiple Client Account.
(d) Audited financial statements prepared by independent public
accountants selected by Fidelity, within ninety (90) days of the end of
the Account fiscal year.
The Independent Fiduciary for the Client Plan, as well as other
authorized persons described above in paragraph (m)(1) of Section III,
will have access during normal business hours to Fidelity's records for
the Accounts in which the Client Plan has an interest.
10. In summary, the applicant represents that the proposed
transactions satisfy the statutory criteria of section 408(a) of the
Act because, among other things:
(a) Each investment in any Account will be authorized in writing by
an Independent Fiduciary of a Client Plan;
(b) No Client Plan may establish a Single Client Account or invest
in a Multiple Client Account unless the Client Plan has total net
assets with a value in excess of $50 million. In addition, a Client
Plan may not invest, in the aggregate, more than five percent (5%) of
its total assets in any one Account or more than ten percent (10%)
[[Page 31508]] of its total assets in all Accounts established by
Fidelity;
(c) Prior to making an investment in any Account, an Independent
Fiduciary for each Client Plan will receive offering materials
disclosing all material facts concerning the purpose, structure and
operation of the Account, including any fee arrangements;
(d) Fidelity will provide each Independent Fiduciary of a Client
Plan with periodic written disclosures with respect to the financial
condition of the Account, the fees paid to Fidelity, the balance of
each Client Plan's interest in the Account, the fair market value of
the Account's assets using market sources or independent appraisals
approved by the Independent Fiduciary where the value of such assets
was used to calculate Fidelity's compensation and, in the case of a
Multiple Client Account, a list of other investors in the Account;
(e) The total fees paid to Fidelity will constitute no more than
reasonable compensation; and
(f) The timing and formula for determining the Performance Fee will
be established and agreed to by the Independent Fiduciary for each
Client Plan prior to the Client Plan's investment in the Account and
will be based on pre-specified percentages of the Client Plan's assets
distributed (or deemed distributed) from the Account in excess of an
agreed upon Threshold Amount.
FOR FURTHER INFORMATION CONTACT: Mr. E.F. Williams of the Department,
telephone (202) 219-8194. (This is not a toll-free number.)
Bankers Trust Company (Bankers Trust) Located in New York, NY; Proposed
Exemption
[Application No. D-09869]
The Department is considering granting an exemption under the
authority of section 408(a) of the Act and section 4975(c)(2) of the
Code and in accordance with the procedures set forth in 29 CFR Part
2570, Subpart B (55 FR 32836, 32847, August 10, 1990). If the exemption
is granted, the restrictions of sections 406(a), 406(b)(1) and
406(b)(2) of the Act and the sanctions resulting from the application
of section 4975 of the Code, by reason of section 4975(c) (1)(A)
through (E) of the Code, shall not apply as of October 28, 1994, to the
cash sale of certain structured notes (the Notes) for $432,131,250 by
three collective investment funds for which Bankers Trust acts as
trustee (the Funds) to Bankers Trust New York Corporation (BTNY), a
party in interest with respect to employee benefit plans invested in
the Funds, provided that the following conditions were met:
(a) Each sale was a one-time transaction for cash;
(b) Each Fund received an amount which was equal to the greater of
either (i) the par value of the Notes owned by the Fund at the time of
sale, (ii) the purchase price paid by the Fund for its interest in each
of the Notes, or (iii) the fair market value of the Notes owned by the
Fund, as determined by bid quotations for the Notes obtained from
independent broker-dealers at the time of sale;
(c) The Funds did not pay any commissions or other expenses with
respect to the sale;
(d) Bankers Trust, as trustee of the Funds, determined that the
sale of the Notes was in the best interests of each Fund, and the
employee benefit plans invested in the Fund, at the time of the
transactions;
(e) Bankers Trust took all appropriate actions necessary to
safeguard the interests of the Funds, and the employee benefit plans
invested in the Funds, in connection with the transactions; and
(f) The Funds received a reasonable rate of return during the
period of time that the Funds held the Notes.
EFFECTIVE DATE: The proposed exemption, if granted, will be effective
as of October 28, 1994.
Summary of Facts and Representations
1. Bankers Trust, a New York banking corporation, is a leading
commercial bank which provides a wide range of banking, fiduciary,
recordkeeping, custodial and investment services to corporations,
institutions, governments, employee benefit plans, governmental
retirement plans and private investors worldwide. Bankers Trust is
wholly owned by BTNY, which is a bank holding company established in
1965 under the laws of the State of New York. As of December 31, 1993,
BTNY and its affiliates had consolidated assets in excess of $92
billion and capital of approximately $4.5 billion.
2. Bankers Trust is one of the largest providers of trust and other
services to employee benefit plans. Many of these plans also engage
BTNY or an affiliate to provide investment advice or to be the plan's
investment manager, within the meaning of the Act. Bankers Trust
maintains more than 80 collective investment funds for employee benefit
plan investment.
3. The Funds are the Bankers Trust Pyramid Aggressive Cash Fund
(the BT Aggressive STIF), the Bankers Trust Pyramid Cash Plus Fund (the
BT Cash Plus Fund), and the Bankers Trust Pyramid Super Cash Fund (the
BT Super Cash Fund).
These three Funds are actively managed, market valued money market
vehicles which endeavor to provide a rate of return in excess of
traditional par valued short-term money market funds by extending
eligible maturities, modifying credit restrictions, and taking
advantage of trading opportunities in the money markets. The applicant
represents that there are certain differences in the investment
strategies used by each Fund, including the duration of average
maturities and, in the case of the BT Aggressive STIF, the permitted
use of equities and equity equivalents. Bankers Trust states that the
Notes were permissible investments under the investment guidelines for
each Fund and initially paid above market returns. However, unexpected
increases in interest rates during 1994 adversely affected the market
value of the Notes. Therefore, the Funds sold the Notes to BTNY on
October 28, 1994, for an amount equal to the par value of the Notes
owned by each Fund. The Funds had purchased the Notes for an amount
which equalled the par value of the Notes, except for Note #2 which was
purchased at a slight discount (see Paragraph 5 below).
4. The Notes consisted of U.S. Government Constant Maturity
Treasury (CMT) Notes issued by various U.S. Government agencies, and
Index Amortizing Notes (IANs) issued by various private sector
corporations (as described in Paragraph 5 below). All of the issuers
were parties unrelated to the Funds and employee benefit plans invested
in the Funds (the Plans) as well as BTNY or any affiliate. In addition,
the Notes were purchased by the Funds from broker-dealers that were
independent of the Funds, the Plans, BTNY and its affiliates.
The CMT Notes were debt instruments which initially paid a premium
rate of interest monthly based on changes in a specified index, such as
the London Interbank Offered Rate (LIBOR), the U.S. Treasury Bill Rate
or the U.S. Federal Reserve's Cost of Funds Index (COFI). However,
under the terms of CMT Notes at the time of issuance, the formula for
interest rate payments, and the index upon which such payments were
based, was scheduled to change on a specified future date to a
different formula based on the U.S. Treasury CMT Rate. Bankers Trust
states that the formulas for the interest rate payments made the market
value of CMT Notes particularly sensitive to certain changes in the
U.S. Treasury CMT Rate. In this regard, Bankers Trust represents that
the CMT Notes paid a [[Page 31509]] rate of return that was higher than
the existing rates for U.S. Treasury securities of comparable maturity
as long as the yield curve for such securities was ``steep''--with
interest rates falling based on the specified index. However, Bankers
Trust states that once the yield curve became ``flat'' (i.e. with
short-term interest rates rising faster than long-term interest rates)
or ``climbed'' (i.e. with a general rise in both short-term and long-
term rates), the relative yield on the CMT Notes fell and their market
value was below par.
The IANs were debt instruments which initially paid a premium rate
of interest monthly based on LIBOR, pursuant to certain formulas used
to calculate such rates at various specified times. However, the IANs
risked a maturity extension if short-term interest rates, as measured
by LIBOR, rose above a certain level. Under such circumstances, once
the maturity on the IANs was extended, the IANs would stop paying
interest and the outstanding principal balance would be paid down over
the remaining term pursuant to certain specified schedules.
5. The terms of the Notes, and the circumstances relating to their
yield as investments for the Funds, are described as follows:
Note #1 was a five-year CMT note issued by the Federal National
Mortgage Association (FNMA or ``Fannie Mae''), which was purchased by
the Funds on February 15, 1994 from McDonald & Company for $95 million,
with final maturity on March 2, 1999. Note #1 paid interest monthly at
a rate equal to one-month LIBOR plus 20 basis points for the first and
second years, .65 times the two-year CMT rate plus 129 basis points for
the third through fifth years. At the time of the sale of Note #1 by
the Funds to BTNY, the note was paying a coupon of LIBOR plus 20 basis
points. Bankers Trust states that at the time of sale, the forward
curve (i.e. a measurement of future interest rates based on yields for
U.S. Treasury securities of comparable duration) suggested that the
performance of Note #1 would be significantly impaired once the LIBOR-
based coupon payment period ended. According to the forward curve
determined by Bankers Trust on October 28, 1994, the comparable
investment rate for the time horizon of February 15, 1996 through March
15, 1999 was 7.55%. Bankers Trust represents that Note #1 would have
had a market value greater than par if the ``time weighted average'' of
the expected coupons had been greater than or equal to 7.55%. However,
at the time of sale, Bankers Trust did not expect that the coupons to
be received on Note #1 would be greater than the comparable investment
rate for the duration of Note #1. Therefore, Bankers Trust determined
that it was appropriate to sell the security.
Note #2 was a three-year CMT note issued by the Federal Home Loan
Bank (FHLB), which was purchased by the BT Cash Plus Fund on October
27, 1993 from McDonald & Company for $26,831,250, with a final maturity
on November 12, 1996. The par value of Note #2 was $27 million. Thus,
the BT Cash Plus Fund purchased Note #2 at a discounted price. Note #2
paid interest quarterly at a rate equal to the three-month U.S.
Treasury Bill Rate plus 25 basis points for the first year and .4 times
the two-year CMT rate plus 205 basis points for the second and third
years. At the time of the sale of Note #2 by the BT Cash Plus Fund to
BTNY, the period for the note to pay the three-month U.S. Treasury Bill
Rate plus 25 basis points had ended. Bankers Trust states that once
this payment period ended, the forward curve suggested that the
performance of Note #2 would be significantly impaired. According to
the forward curve determined by Bankers Trust on October 28, 1994,
since the remaining life of Note #2 was two years, the comparable
investment rate was equal to the then current two-year CMT rate which
was 6.82%. Bankers Trust represents that Note #2 would have had a
market value greater than par if the ``time weighted average'' of the
expected coupons had been greater than 6.82%. However, at the time of
sale, Bankers Trust did not expect that the coupons to be received on
Note #2 would be greater than the comparable investment rate for the
duration of Note #2. Therefore, Bankers Trust determined that it was
appropriate to sell the security.
Note #3 was a five-year CMT note issued by Fannie Mae, which was
purchased by the BT Cash Plus Fund on February 7, 1994 from McDonald &
Company for $95 million, with final maturity on February 17, 1999. Note
#3 paid interest monthly at a rate equal to the COFI rate plus 10 basis
points for the first and second years, .4 times the two-year CMT rate
plus 245 basis points for the third through fifth years. At the time of
the sale of Note #3 by the BT Cash Plus Fund to BTNY, the note was
paying the COFI rate plus 10 basis points. However, Bankers Trust
states that once this COFI-based coupon payment ended, the forward
curve suggested that the performance of the note would be significantly
impaired. According to the forward curve determined by Bankers Trust on
October 28, 1994, the comparable investment rate for the period
February 17, 1996 to February 1, 1999 was 7.53%. Bankers Trust
represents that Note #3 would have had a market value greater than par
if the ``time weighted average'' of the expected coupons had been
greater than 7.53%. At the time of sale, Bankers Trust did not expect
that the coupons to be received on Note #3 would be greater than the
comparable investment rate for the duration of Note #3. Therefore,
Bankers Trust determined that it was appropriate to sell the security.
Note #4 was a five-year CMT note issued by the Federal Home Loan
Mortgage Corporation (FHLMC or ``Freddie Mac''), which was purchased by
the BT Cash Plus Fund and the BT Super Cash Fund on February 16, 1994
from Nikko Securities for $71 million, with final maturity on March 2,
1999. Note #4 paid interest monthly at a rate equal to .5 times the
two-year CMT rate plus 209 basis points. According to the forward curve
determined by Bankers Trust on October 28, 1994, the comparable
investment rate for the period October 28, 1994 through March 2, 1999
was 7.4%. Bankers Trust represents that Note #4 would have had a market
value greater than par if the ``time weighted average'' of the expected
coupons had been greater than 7.4%. However, at the time of sale,
Bankers Trust did not expect that the coupons to be received on Note #4
would be greater than the comparable investment rate for the duration
of Note #4. Therefore, Bankers Trust determined that it was appropriate
to sell the security.
Note #5 was a three-year CMT note issued by the Student Loan
Marketing Association (SLMA or ``Sallie Mae''), which was purchased on
February 10, 1994 from Nikko Securities for $95 million, with final
maturity on February 24, 1997. Note #5 paid interest monthly at a rate
equal to one-month LIBOR plus 20 basis points for the first year and
.65 times the two-year CMT rate plus 75 basis points for the second and
third years. At the time of the sale of Note #5 by the Funds to BTNY,
the note was paying LIBOR plus 20 basis points. However, Bankers Trust
states that once this LIBOR-based coupon payment ended, the forward
curve suggested that the performance of the note would be significantly
impaired. According to the forward curve determined by Bankers Trust on
October 28, 1994, the comparable investment rate was equal to the then
current two-year CMT rate which was 6.82%. Bankers Trust represents
that Note #5 would have had a market value greater than par if the
``time weighted average'' of the expected coupons had been greater than
6.82%. At the time of sale, Bankers Trust did not expect that the
coupons to be received on Note #5 would be greater [[Page 31510]] than
the comparable investment rate for the duration of Note #5. Therefore,
Bankers Trust determined that it was appropriate to sell the security.
Note #6 was an IAN issued by Rabobank, which was purchased by the
Funds on November 9, 1993 from Lehman Brothers for $14 million, with
initial maturity on November 17, 1994. Note #6 paid interest quarterly
at a rate equal to three-month LIBOR plus 50 basis points until
November 17, 1994 and paid 4.33% thereafter. Bankers Trust states that
Note #6 was subject to the risk of a maturity extension if short-term
rates rose above a certain level on a specified date. Under the terms
of Note #6, if three-month LIBOR was less than 4.9% on November 15,
1994, the note would mature and the principal would be repaid in full
on November 17, 1994. However, if three-month LIBOR was above 4.9% on
November 15, 1994, the term of Note #6 would be extended for three
years with a fixed coupon rate of 4.33% and principal would be repaid
according to a pre-set amortization schedule. On October 28, 1994,
three-month LIBOR was 5.69%, approximately 79 basis points above Note
#6's trigger rate of 4.9%. Thus, it appeared highly probable that the
note's maturity would be extended until November 1997. Bankers Trust
considered the fixed coupon rate of 4.33% on Note #6 to be
significantly below the comparable investment rate for the duration of
the note, which was calculated to be 7.14%. Therefore, Bankers Trust
determined that the security should be sold.
Note #7 was an IAN issued by Prudential Funding, which was
purchased by the Funds on September 24, 1993 from Lehman Brothers for
$34 million, with initial maturity on October 18, 1994. Note #7 paid
interest quarterly at a fixed rate of 4.75% until October 18, 1994.
Like Note #6 described above, Bankers Trust states that Note #7 was
subject to the risk of a maturity extension if short-term rates rose
above a certain level on a specified date. Under the terms of Note #7,
if three-month LIBOR was above 5.04% on October 16, 1994, the maturity
of the note extended for three years at a 0% coupon rate with quarterly
payments of principal in amounts based on a pre-set amortization
schedule. If three-month LIBOR was below 5.04% on October 16, 1994,
Note #7 would mature in full on that date. However, Bankers Trust
states that three-month LIBOR was above 5.04% on October 16, 1994. At
the time of sale, Note #7 was scheduled to pay a 0% coupon and its
maturity had been extended. Thus, Bankers Trust determined that the
security should be sold.
Note #8 was an IAN issued by E.I. du Pont, which was purchased by
the BT Super Cash Fund on September 24, 1993 from Morgan Stanley for
$1.3 million, with initial maturity on October 14, 1994. Note #8 paid
interest quarterly at a fixed rate of 4.75%. Like Note #7 described
above, Bankers Trust states that Note #8 was subject to the risk of a
maturity extension if short-term rates rose above a certain level on a
specified date. Under the terms of Note #8, if three-month LIBOR was
above 5.04% on October 12, 1994, the maturity of the note extended for
three years at a 0% coupon rate with quarterly payments of principal in
amounts based on a pre-set amortization schedule. If three-month LIBOR
was below 5.04% on October 12, 1994, Note #8 would mature in full on
October 14, 1994. Since three-month LIBOR was above 5.04% on October
12, 1994, the maturity of Note #8 extended for three years paying a 0%
coupon. Thus, Bankers Trust determined that the security should be
sold.
6. Bankers Trust had the Funds sell their respective interests in
the Notes to BTNY on October 28, 1994, for the par value of the Notes,
which in each case was greater than the fair market value of the Notes
owned by the Fund (see table below). At the time of the transaction,
the par value of the Notes was equal in each case to the outstanding
principal balance of the Notes because no principal payments had been
made on any of the Notes (see charts in Paragraph 7 below). In
addition, Bankers Trust states that the par value of the Notes was
either greater than or equal to the initial purchase price paid by the
Fund for its interest in the Notes.
Bankers Trust obtained bids from independent broker-dealers to
establish the fair market value of the Notes at the time of the
transaction. The most recent bids obtained by Bankers Trust prior to
the sale of the Notes were as of October 21, 1994. Bankers Trust states
that bids for the Notes obtained on October 31, 1994 showed no
significant change had occurred over the ten-day period, thereby
confirming that the fair market value of the Notes was significantly
less than the par value of the Notes on the transaction date of October
28, 1994. Bankers Trust represents that on both October 21, 1994 and
October 31, 1994, the bids for Note #1 through Note #5 were quoted by
Nikko Securities, for Note #6 and Note #7 by Lehman Brothers, and for
Note #8 by Morgan Stanley. The bids for the Notes were quoted by the
broker-dealers as a percentage of the outstanding principal balance of
each Note. These bids, in comparison with the par value of the Notes,
were as follows:
------------------------------------------------------------------------
Price quoted
Note -------------------------- Price received (par
10/21/94 10/31/94 value)
------------------------------------------------------------------------
#1................... 1196.06 96.00 100 ($95,000,000)
#2................... 96.10 96.05 100 (27,000,000)
#3................... 91.15 91.08 100 (95,000,000)
#4................... 94.08 94.00 100 (71,000,000)
#5................... 96.00 95.27 100 (95,000,000)
#6................... 90.29 90.25 100 (14,000,000)
#7................... 79.25 80.21 100 (34,000,000)
#8................... 80.38 80.50 100 (1,300,000)
------------------------------------------------------------------------
11Bankers Trust states that the prices quoted are per $100 of principal.
To determine the total price quoted, the face value of each Note is
multiplied by the quote, expressed as a percentage of 100. Thus, for
example, since the par value of Note #1 is $95,000,000, the quoted
price on October 21, 1994 would have been $91,257,000 since
$95,000,000 x .9606 = $91,257,000.
In addition, Duff & Phelps Capital Markets Co. (D&P) in Chicago,
Illinois, provided an opinion letter to Bankers Trust on October 27,
1994, which stated that the fair market value of each Note was less
than its par value at that time. In providing this opinion, D&P used a
valuation methodology which was based on a predicted stream of cash
flows for each Note, discounted at a rate that reflected each Note's
credit risk and average life. D&P established the predicted stream of
cash flows based on implied forward interest rates for each Note
adjusted according to the terms of the Note. In doing this analysis,
D&P states that it attempted to apply conservative assumptions whenever
possible such that the analysis would tend to overvalue rather than
undervalue the Notes. Bankers Trust states that D&P's opinion letter
helped confirm that the market value of the Notes was less than par at
the time of sale because D&P's conclusions were consistent with the bid
quotations received by Bankers Trust for each Note as well as Bankers
Trust's own analysis of the Notes.
7. The Funds' holdings regarding each Note, including the
percentage of the Fund that the Note represented and the interest
earnings on the Note as of October 28, 1994, are shown on the tables
below:12 [[Page 31511]]
\12\With respect to the figures shown for each Note in the
tables, if a Fund did not own an interest in the particular Note a
zero dollar amount is shown.
BT Aggressive STIF
----------------------------------------------------------------------------------------------------------------
Purchase price/ Outstanding Approx. % of Interest
Note basis balance fund earnings
----------------------------------------------------------------------------------------------------------------
#1.............................................. $10,000,000 $10,000,000 19.95 $295,965
#2.............................................. 0 0 0.00 0
#3.............................................. 0 0 0.00 0
#4.............................................. 0 0 0.00 0
#5.............................................. 5,000,000 5,000,000 9.97 120,617
#6.............................................. 2,500,000 2,500,000 4.99 162,556
#7.............................................. 3,000,000 3,000,000 5.98 146,458
#8.............................................. 0 0 0.00 0
---------------------------------------------------------------
20,500,000 20,500,000 40.89 725,596
----------------------------------------------------------------------------------------------------------------
BT Cash Plus Fund
----------------------------------------------------------------------------------------------------------------
Purchase price/ Outstanding Approx. % of Interest
Note basis balance fund earnings
----------------------------------------------------------------------------------------------------------------
#1.............................................. $70,000,000 $70,000,000 5.44 $2,071,758
#2.............................................. 26,831,250 27,000,000 2.08 383,229
#3.............................................. 95,000,000 95,000,000 7.38 2,572,424
#4.............................................. 55,000,000 55,000,000 4.27 1,803,636
#5.............................................. 70,000,000 70,000,000 5.44 1,688,635
#6.............................................. 5,500,000 5,500,000 0.43 939,705
#7.............................................. 26,000,000 26,000,000 2.02 960,555
#8.............................................. 0 0 0.00 0
---------------------------------------------------------------
348,331,250 348,500,000 27.06 10,419,942
----------------------------------------------------------------------------------------------------------------
BT Super Cash Fund
----------------------------------------------------------------------------------------------------------------
Purchase price/ Outstanding Approx. % of Interest
Note basis balance fund earnings
----------------------------------------------------------------------------------------------------------------
#1.............................................. $15,000,000 $15,000,000 5.32 $295,376
#2.............................................. 0 0 0.00 0
#3.............................................. 0 0 0.00 0
#4.............................................. 16,000,000 16,000,000 5.67 524,694
#5.............................................. 20,000,000 20,000,000 7.09 482,467
#6.............................................. 6,000,000 6,000,000 2.13 369,828
#7.............................................. 5,000,000 5,000,000 1.77 244,097
#8.............................................. 1,300,000 1,300,000 0.46 46,313
---------------------------------------------------------------
63,300,000 63,300,000 22.43 1,962,775
----------------------------------------------------------------------------------------------------------------
Bankers Trust represents that the Notes paid the Funds a reasonable
rate of interest during the period of time that the Funds held the
Notes. For example, Bankers Trust states that the annualized rate of
interest for each Note at the time of the transaction was as follows:
(i) 5.2% for Note #1; (ii) 5.34% for Note #2; (iii) 4.05% for Note #3;
(iv) 5.39% for Note #4; (v) 5.26% for Note #5; (vi) 5.44% for Note #6;
(vii) 4.75% for Note #7; and (viii) 4.75% for Note #8.
8. Bankers Trust, as trustee of the Funds, believed that the sale
of the Notes to BTNY was in the best interests of each Fund, and the
employee benefit plans invested in the Fund, at the time of the
transaction. Bankers Trust states [[Page 31512]] that any sale of the
Notes on the open market would have produced significant losses for the
Funds and for the individual employee benefit plan investors
involved.13
13The Department is expressing no opinion in this proposed
exemption regarding whether the acquisition and holding of the Notes
by the Funds violated any of the fiduciary responsibility provisions
of Part 4 of Title I of the Act.
The Department notes that section 404(a) of the Act requires,
among other things, that a fiduciary of a plan act prudently, solely
in the interest of the plan's participants and beneficiaries, and
for the exclusive purpose of providing benefits to participants and
beneficiaries when making investment decisions on behalf of a plan.
Section 404(a) of the Act also states that a plan fiduciary should
diversify the investments of a plan so as to minimize the risk of
large losses, unless under the circumstances it is clearly prudent
not to do so.
In this regard, the Department is not providing any opinion as
to whether a particular category of investments or investment
strategy would be considered prudent or in the best interests of a
plan as required by section 404 of the Act. The determination of the
prudence of a particular investment or investment course of action
must be made by a plan fiduciary after appropriate consideration to
those facts and circumstances that, given the scope of such
fiduciary's investment duties, the fiduciary knows or should know
are relevant to the particular investment or investment course of
action involved, including a plan's potential exposure to losses and
the role the investment or investment course of action plays in that
portion of the plan's portfolio with respect to which the fiduciary
has investment duties (see 29 CFR 2550.404a-1). The Department also
notes that in order to act prudently in making investment decisions,
a plan fiduciary must consider, among other factors, the
availability, risks and potential return of alternative investments
for the plan. Thus, a particular investment by a plan, which is
selected in preference to other alternative investments, would
generally not be prudent if such investment involves a greater risk
to the security of a plan's assets than other comparable investments
offering a similar return or result.
---------------------------------------------------------------------------
9. Bankers Trust represents that it took all appropriate actions
necessary to safeguard the interests of the Funds, and the employee
benefit plans invested therein, in connection with the transactions.
Bankers Trust ensured that each Fund received the appropriate amount of
cash from BTNY in exchange for such Fund's interests in the Notes at
the time of the transactions. Bankers Trust reviewed the latest
information regarding the fair market value of the Notes, based on bid
quotations received from independent broker-dealers. Bankers Trust also
ensured that the Funds did not pay any commissions or other expenses
for the sale of the Notes to BTNY.
10. In summary, the applicant represents that the transactions
satisfied the statutory criteria of section 408(a) of the Act and
section 4975 of the Code because: (a) Each sale of the Notes by the
Funds was a one-time transaction for cash; (b) each Fund received an
amount which was equal to the greater of either (i) the par value of
the Notes owned by the Fund at the time of sale, (ii) the purchase
price paid by the Fund for its interest in each of the Notes, or (iii)
the fair market value of the Notes owned by the Fund as determined by
bid quotations for the Notes obtained by Bankers Trust from independent
broker-dealers at the time of sale; (c) the Funds did not pay any
commissions or other expenses with respect to the sale; (d) Bankers
Trust, as trustee of the Funds, determined that the sale of the Notes
was in the best interests of each Fund, and the employee benefit plans
invested in the Fund, at the time of the transaction; (e) Bankers Trust
took all appropriate actions necessary to safeguard the interests of
the Funds in connection with the transactions; and (f) the Funds
received a reasonable rate of return during the period of time that the
Funds held the Notes.
Notice to Interested Persons
The applicant states that notice of the proposed exemption shall be
made by first class mail to the appropriate Plan fiduciaries for each
employee benefit plan participating in the Funds at the time of the
transactions. Notice to the plan fiduciaries shall be made within
fifteen (15) days following the publication of the proposed exemption
in the Federal Register. This notice shall include a copy of the notice
of proposed exemption as published in the Federal Register and a
supplemental statement (see 29 CFR 2570.43(b)(2)) which informs
interested persons of their right to comment on and/or request a
hearing with respect to the proposed exemption. Comments and requests
for a public hearing are due within forty-five (45) days following the
publication of the proposed exemption in the Federal Register.
FOR FURTHER INFORMATION CONTACT: Mr. E.F. Williams of the Department,
telephone (202) 219-8194. (This is not a toll-free number.)
General Electric Pension Trust (the Trust) Located in Fairfield,
Connecticut; Proposed Exemption
[Application No. D-09880]
The Department is considering granting an exemption under the
authority of section 408(a) of the Act and section 4975(c)(2) of the
Code and in accordance with the procedures set forth in 29 CFR Part
2570, Subpart B (55 FR 32836, 32847, August 10, 1990). If the exemption
is granted, the restrictions of sections 406(a), 406(b)(1) and
406(b)(2) of the Act and the sanctions resulting from the application
of section 4975 of the Code, by reason of section 4975(c)(1) (A)
through (E) of the Code, shall not apply effective August 3, 1994, to
the past and continued lease (the Lease) by the Trust of office space
in a commercial office building located at 201 Mission Street in San
Francisco, California (the Property), to GE Capital Aviation Services,
Inc. (GE Aviation), a party in interest with respect to employee
benefit plans participating in the Trust, provided the following
conditions are met:
(a) All terms and conditions of the Lease are at least as favorable
to the Trust as those which the Trust could have obtained in an arm's-
length transaction with an unrelated party at the time the Lease was
executed;
(b) The rent paid by GE Aviation to the Trust under the Lease is
not less than the fair market rental value of the office space, as
established by an independent qualified real estate appraiser;
(c) David P. Rhoades (Mr. Rhoades), acting as a qualified,
independent fiduciary for the Trust reviewed all terms and conditions
of the Lease prior to the transaction, as well as any subsequent
modifications to the Lease, and determined that such terms and
conditions would be in the best interests of the Trust at the time of
the transaction; and
(d) Mr. Rhoades represents the interests of the Trust for all
purposes under the Lease as a qualified, independent fiduciary for the
Trust, monitors the performance of the parties under the terms and
conditions of the Lease and the exemption, and takes whatever action is
necessary to safeguard the interests of the Trust throughout the
duration of the Lease.
EFFECTIVE DATE: This proposed exemption, if granted, will be effective
for the period from August 3, 1994, until the scheduled termination
date of the Lease (i.e. September 16, 1999) or, if earlier, the date
the Lease is actually terminated by the parties.
Summary of Facts and Representations
1. The Trust holds assets of the General Electric Company Pension
Plan (the GE Pension Plan), the Knolls Atomic Laboratories Pension
Plan, ERC Retirement Plan, GE Components Pension Plan For Puerto Rico,
and Neutron Devices Department Pension Plan (collectively, the Plans).
The Plans are all defined benefit plans that cover employees of General
Electric Company (GE) and various GE subsidiaries. There are a total of
over 488,000 participants and beneficiaries under the Plans. As of
December 31, 1993, the Trust held approximately $27.3 billion in
assets.
The trustees of the Trust are five individuals (the Trustees) who
are [[Page 31513]] officers of GE and its subsidiaries. The Trustees
are appointed by the GE Benefit Plans Investment Committee, an
oversight committee that determines the investment policies of the
Trust. The Trustees maintain overall responsibility for investment of
the Trust's assets. The Trustees have delegated specific responsibility
for investment management of most of the Trust's assets to the General
Electric Investment Corporation (GEIC).
GEIC, a Delaware corporation and a wholly-owned subsidiary of GE,
is a registered investment adviser under the Investment Advisers Act of
1940. GEIC provides investment management services to a variety of GE-
affiliated entities. As of January 1, 1994, GEIC managed approximately
$40.4 billion in assets.
2. GE Aviation, a Delaware corporation formerly known as the
Polaris Corporation, is a wholly-owned subsidiary of General Electric
Capital Corporation. The primary business of GE Aviation is airplane
equipment leasing. GE Aviation's employees are participants in the GE
Pension Plan.
3. The transaction for which an exemption is requested involves the
leasing of office space between the Trust, as landlord, and GE
Aviation, as tenant, in the office building located at 201 Mission
Street in San Francisco, California (the Property).
The Property is a 30-story office building located in the southern
financial district of San Francisco. The Property is part of a series
of high-rise buildings developed during the 1980s on the fringes of the
city's traditional financial district. The ground floor is leased to
retail businesses and the other floors are leased as office space. The
rentable area of the Property is approximately 475,675 square feet. The
current value of the Property is approximately $40 million.
Construction of the Property was completed in 1981. The Trust
financed the acquisition of the Property by an unrelated party that
subsequently went into receivership. The Trust acquired the Property by
deed in lieu of foreclosure in April 1993. The Trust currently owns the
Property through a real estate title holding company, Pacific Gateway
Realty Corporation.
Most of the office space in the Property was originally rented by
Bank of America. Bank of America subsequently decided to relocate and
consolidate its offices, and vacated one-half of the office space it
occupied in the Property in 1991. At that time, the vacated area was
leased on a short-term basis to Pacific Gas & Electric (PG&E), which
was making repairs to its existing offices as a consequence of
earthquake damage. While there were negotiations in 1993 for PG&E to
extend its existing lease and to lease additional space, PG&E's board
of directors ultimately decided against remaining in the Property. PG&E
intends to vacate the Property in January 1996, when the repairs to its
original offices are expected to be completed.
Bank of America vacated the other half of the office space it
occupied in the Property in late 1993 upon completing its relocation.
As a result, about 34 percent (i.e. 160,014 square feet) of the
rentable area in the Property was vacant as of early 1994, compared to
a general vacancy rate in San Francisco-area office buildings of around
12 percent at that time.
In the months after Bank of America vacated, the managers of the
Property actively searched for tenants, in an effort to lease the
vacant space as quickly as possible before PG&E leaves. As of June
1994, tenants had been found for approximately 77,000 square feet of
space, or about 16 percent of rentable area, leaving around 18 percent
of the Property vacant. One of the tenants was GE Aviation.
4. The applicant represents that in early 1994 GE Aviation had its
offices at Four Embarcadero Center in San Francisco's main business
district. However, GE Aviation was in the process of downsizing its
operations and was looking for smaller space in a less expensive part
of San Francisco. In the course of its search for office space, GE
Aviation contacted Sentre Partners (Sentre), the independent property
manager retained by the Trust to manage the Property. GE Aviation
decided that it was interested in leasing space in the Property and
entered into negotiations with Sentre.
The Lease was executed by GE Aviation in July 1994, after which the
documents were sent to Sentre. The Lease was executed by Pacific
Gateway Realty Corporation as landlord on August 3, 1994, following
receipt of the report by Mr. Rhoades, the independent fiduciary acting
for the Trust in connection with the subject transaction. The applicant
states that once the Lease was signed by all of the parties, the
landlord began making extensive improvements to the space in order to
accommodate a planned occupancy date for GE Aviation of September 1,
1994.
5. Under the Lease, GE Aviation has leased approximately 9,376
square feet of space located on the eastern and southern portions of
the 27th floor of the Property. This space constitutes approximately
two percent of the rentable square footage in the Property. The term of
the Lease is five years, which commenced on September 16, 1994, the
date that work on the premises was substantially completed. The annual
rent is $20 per square foot of rentable area, or $187,520, for the
first three years of the Lease, and $21 per square foot of rentable
area, or $196,896, for the fourth and fifth years, payable monthly. The
Lease requires that GE Aviation pay its proportionate share of the
Trust's real estate taxes and expenses relating to the Property for
years after 1995, to the extent these taxes and expenses exceed those
for 1995 (the ``base'' year) or to the extent any additional taxes or
expenses are properly chargeable solely to GE Aviation in connection
with its activities with the leased space.
Late payments are subject to a 5% late payment charge after written
notice is given. If the late payment becomes an event of default, or in
the event of any failure by GE Aviation to perform its obligations
under the Lease, GE Aviation will be obligated for interest charges and
other amounts necessary to compensate the Trust for damages caused by
GE Aviations' failure to perform.
GE Aviation does not have any options or rights to expand or extend
the Lease, nor has it received any period of free rent. Any assignments
or subleases by GE Aviation are void unless the Trust has provided
prior written consent and, if consented to, are subject to additional
charges.
6. The Trust has provided agreed-upon improvements to the space
which, prior to the Lease, contained only nominal improvements. The
total cost of the improvements shall not exceed $42.50 per rentable
square foot ($398,480), with any additional costs to be paid by GE
Aviation.14 The Trust is responsible to repair any defects in this
work of which it is notified by GE Aviation within one year, other than
defects resulting from compliance with the specifications provided by
GE Aviation's architect or engineer. GE Aviation is responsible at its
expense for any additional work it needs or desires that is not part of
the agreed-upon [[Page 31514]] improvements. Any alterations to be made
during the term of the Lease are subject to the Trust's written
consent. Alterations generally become the property of the Trust and
remain at the expiration of the Lease, except that the Trust may
require the alterations to be removed at GE Aviation's expense.
\14\The Department expresses no opinion in this proposed
exemption as to whether the expenses incurred by the Trust relating
to the tenant improvements provided for GE Aviation would violate
any provision of Part 4 of Title I of the Act. In this regard, the
Department notes that section 404(a) of the Act requires, among
other things, that plan fiduciaries act prudently and solely in the
interest of the plan's participants and beneficiaries when making
investment decisions on behalf of a plan. In addition, section
404(a) of the Act requires that plan fiduciaries act for the
exclusive purpose of providing benefits to participants and
beneficiaries and to defray reasonable expenses of administering the
plan.
---------------------------------------------------------------------------
7. Mr. Rhoades was retained by GEIC to act as an independent
fiduciary for the Trust in connection with the Lease. Mr. Rhoades is
president of the real estate appraisal and consulting firm of David P.
Rhoades & Associates, Inc., of San Francisco, California. Mr. Rhoades
represents that he and his firm are independent of, and unrelated to,
GE and its affiliates. Mr. Rhoades states that he is a Member of the
Appraisal Institute (MAI) and has 22 years experience as a real estate
appraiser dealing with the valuation and analysis of all types of
property, including urban office buildings similar to the Property. Mr.
Rhoades has acknowledged in writing that he is a fiduciary for the
Trust and that he understands his duties, responsibilities, and
liabilities as a fiduciary under the Act.
8. Mr. Rhoades reviewed the Lease and inspected the Property prior
to the transaction. In an appraisal dated July 6, 1994, Mr. Rhoades
concluded that the market rent for the space covered by the Lease would
be in the range of $19.00 to $21.00 per square foot. Thus, Mr. Rhoades
determined that the proposed average rental rate under the Lease of
$20.22 per square foot would be at the upper end of the range of rents
for comparable leases in the San Francisco area and would not be less
than the fair market rental value for the space. Mr. Rhoades states
that the terms of the Lease are comparable to the terms that would have
been negotiated in arm's-length transactions between unrelated parties.
Mr. Rhoades concluded that the Lease would be in the best interest of
the Trust because it would yield the Trust a market rate of return,
would avoid additional leasing efforts, and would avoid the lost
revenue and associated costs of having the space remain vacant.
Mr. Rhoades represents that the tenant improvement allowance for
the Lease of $42.50 per square foot was necessary because of the
unimproved condition of the particular space. Mr. Rhoades states that
the space on the 27th floor leased by GE Aviation was previously
demolished in connection with work that was done for another tenant,
who currently occupies part of the 27th floor and the two floors above
the 27th floor. In this regard, the applicant represents that the 27th
floor space previously was occupied by Bank of America, which had been
a major tenant in the Building from 1981 through 1991. The entire 27th
floor, when occupied by the Bank of America, was primarily open space
with movable partitions. At the time the Bank of America vacated the
27th floor space, substantial work on the space was needed to satisfy
applicable legal requirements, such as current fire and safety codes.
In addition, the Bank of America's use of the space was not readily
adaptable to a new tenant desiring up-to-date conventional office space
and was functionally obsolete. Consequently, the applicant states that
it was cost effective to demolish the entire floor when work was being
done for a new tenant that would occupy half of the 27th floor and to
re-build sufficiently to meet the minimum requirements for the entire
floor, including the part that was not yet being leased. As a result,
when the other half of the floor was leased to GE Aviation, it was in
unimproved condition. Thus, prior to the Lease, the space was
effectively ``first generation'' or unimproved space which required
relatively high outlays for tenant improvements.
Mr. Rhoades states that the improvements made to the space leased
by GE Aviation are functional and reusable by a wide range of tenants
without major costs, and are typical of the types of improvements
landlords usually build for such tenants. Mr. Rhoades maintains that
the residual value of the tenant improvements at the end of the Lease
(i.e. 5 years) will be about 50 percent of the original cost of the
tenant improvements, or approximately $21.25 per square foot.
9. With respect to the overall rate of return to the Trust under
the terms of the Lease, Mr. Rhoades conducted an analysis of both the
``internal rate of return'' (IRR) and the ``net present value'' (NPV)
to the Trust from the Lease.
Mr. Rhoades represents that the ``rate of return'' on a real estate
investment is the ratio of income to the original investment and the
``IRR'' is the annualized rate of return on capital that is generated
within an investment over a period of ownership.15 Thus, the IRR
measures the returns from an investment in relation to the original
capital outlay. In this case, Mr. Rhoades states that the ``returns''
consist of the rental income over the Lease term and the pass-through
of certain expenses after the first year, as well as the residual value
of the tenant improvements at the end of the Lease. The ``original
capital outlay'' consists of expenses relating to the leased space,
including the tenant improvements, operating expenses, brokerage fees,
parking, and taxes. This ``original capital outlay'' was approximately
$421,920.
15Mr. Rhoades cites The Dictionary of Real Estate
Appraisal (3rd edition) as his source for the definition of these
terms.
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In addition, Mr. Rhoades states that the ``NPV'' is the difference
between the present value of all expected investment benefits, or
positive cash flows, and the present value of capital outlays, or
negative cash flows, over the entire period of the investment. The
present value calculation involved in determining NPV requires the use
of a specific discount rate, which operates as the annual rate of
return objective. In this regard, Mr. Rhoades used the standard real
estate industry rate of 9 percent for the NPV calculation, which
provided a basis for comparing the rate of return on the Lease to
different leasing arrangements in the Property.
Mr. Rhoades states that his approach to evaluating leases and
leasing costs is customary in the real estate industry. Mr. Rhoades
states further that he was consistent in using this approach to
evaluate the comparable leases in the Building and other comparable
properties for purposes of determining the fair market rental value of
the space under the Lease as well as the IRR and NPV of the Lease to
the Trust. However, Mr. Rhoades notes that his approach did not
consider the original cost or value of the Building in evaluating the
specific leases. In this regard, Mr. Rhoades has confirmed that it is
not customary to consider the cost or value of a building for this
purpose because the focus in valuing a lease is on the incremental
costs and income of the lease and the ongoing costs relating to the
space.
Based on an extensive analysis and comparison of the terms of the
Lease to all other leases in the Property at the time of the
transaction, Mr. Rhoades concluded that the Lease had a greater NPV and
would yield a higher IRR than any other lease of a comparable term in
the Property. Mr. Rhoades represents that the Lease will yield an IRR
to the Trust of approximately 10.83 percent on an annual basis and has
a NPV of $4.87 per square foot based on a discount rate of 9 percent,
when taking into account the residual value of the tenant improvements.
Therefore, Mr. Rhoades states that it is unlikely that the Trust would
have obtained a lease for the space on more favorable terms from
[[Page 31515]] other tenants in the market at the time of the
transaction.16
\16\Mr. Rhoades states in his letter dated August 12, 1994, that
the NPV of leaving the space vacant for the five year term of the
Lease would have been a negative $19.45 per square foot due to the
operational and tax expenses related to the space. Mr. Rhoades notes
that while it is unlikely that the space would have remained vacant
for the entire five year period, it would have taken about six
months for the Trust to have obtained a lease on terms at least as
favorable to the Trust, with the same IRR and NPV values, as the
terms of the Lease.
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10. Mr. Rhoades, as independent fiduciary for the Trust, will
monitor the Lease on an ongoing basis. Mr. Rhoades will determine GE
Aviation's compliance with the terms of the Lease and has the authority
to take any action necessary to enforce the rights of the Trust under
the Lease, including the termination of the Lease. Any renewals of the
Lease will be subject to the oversight, review and approval of Mr.
Rhoades. Such a renewal will not be executed in the absence of Mr.
Rhoades' opinion that the proposed renewal would be in the best
interests of the Trust.
11. In summary, the applicant states that the transaction meets the
statutory criteria of section 408(a) of the Act and section 4975(c)(2)
of the Code because: (a) the terms of the Lease are at least as
favorable to the Trust as the terms which would exist in an arm's-
length transaction with an unrelated party; (b) the Trust will receive
rental amounts under the Lease equal to the fair market rental value
for the space, as determined by a qualified, independent appraiser; (c)
an independent fiduciary (i.e. Mr. Rhoades) acting for the Trust
reviewed the terms and conditions of the Lease and determined that the
transaction would be in the best interests of the Trust; (d) Mr.
Rhoades, as the independent fiduciary, will monitor the Lease on behalf
of the Trust and take whatever actions are necessary to protect the
interests of the Trust; and (e) the Lease only involves a small
percentage of the Trust's total assets.
FOR FURTHER INFORMATION CONTACT: Mr. E.F. Williams of the Department,
telephone (202) 219-8194. (This is not a toll-free number.)
The Amended and Restated Profit Sharing Retirement Plan for Employees
of 84 Lumber Company (the Profit Sharing Plan) and The Amended and
Restated Savings Fund Plan for Employees of 84 Lumber Company (the
Savings Plan; together, the Plans) Located in Eighty Four,
Pennsylvania; Proposed Exemption
[Application Nos. D-09945 and D-09946]
The Department is considering granting an exemption under the
authority of section 408(a) of the Act and section 4975(c)(2) of the
Code and in accordance with the procedures set forth in 29 CFR Part
2570, Subpart B (55 FR 32836, 32847, August 10, 1990). If the exemption
is granted, the restrictions of sections 406(a), 406(b)(1) and (b)(2)
of the Act and the sanctions resulting from the application of section
4975 of the Code, by reason of section 4975(c)(1)(A) through (E) of the
Code, shall not apply to (1) The proposed extension of credit by 84
Lumber Company (Lumber) to the Plans in the form of loans (the Loans)
with respect to Guaranteed Investment Contract, Number CG0124601A
issued by Executive Life Insurance Company (ELIC) to the Profit Sharing
Plan and Guaranteed Investment Contract No. CG0124701A (both Contracts
together, the GICs) issued by ELIC to the Savings Plan; and (2) the
Plans' potential repayment of the Loans (the Repayments), provided: (a)
all terms of such transactions are no less favorable to the Plans than
those which the Plans could obtain in arm's-length transactions with an
unrelated party; (b) no interest and/or expenses are paid by the Plans;
(c) the Loans are made with respect to amounts invested by the Plans in
the GICs; (d) the Repayments are restricted to the amounts, if any,
paid to the Plans after the date of the Loans by ELIC or other
responsible third parties with respect to the GICs (the GIC Proceeds);
(e) the Repayments under each Loan will not exceed the total amount of
the Loan; and (f) the Repayments are waived with respect to the amount
by which any Loan exceeds the GIC Proceeds.
Summary of Facts and Representations
1. Lumber is a Pennsylvania general partnership engaged in the
retail lumber and building products business. As of January 1, 1995,
Lumber operated 374 individual store locations in 31 states. The
headquarters of Lumber are in Eighty Four, Pennsylvania. The managing
general partner of Lumber is Pierce-Hardy Real Estate, Inc., a
Pennsylvania business trust. Lumber is the sponsor of both Plans, each
of which covers the employees of Lumber. The Profit Sharing Plan also
covers employees of the Trusty Building Components Company, an
affiliate of Lumber.
2. Each of the Plans is a defined contribution plan that is
qualified under section 401(a) of the Code. The Savings Plan is
intended to constitute a qualified cash or deferred arrangement in
accordance with section 401(k) of the Code. The Savings Plan is a
participant-directed individual account plan under which the
participants may direct the investment of their accounts in one or more
investment funds. As of December 31, 1994, (i) the Profit Sharing Plan
had 3,018 active and terminated vested participants and total assets of
approximately $24,718,415; and (ii) the Savings Plan had 2,080 active
and terminated vested participants and total assets of approximately
$17,187,503.
3. On September 25, 1987, ELIC issued the GICs to the Plans. The
Profit Sharing Plan's GIC was in the principal amount of $2 million,
and the Savings Plan's GIC was in the principal amount of $1 million.
Each GIC guaranteed an annual interest rate of 9.92% from the issue
date to the September 25, 1992 maturity date. Interest accrued under
the GICs was payable yearly, and each Plan received interest payments
for 1988, 1989 and 1990. The final interest payments made by ELIC were
received by the Plans on September 25, 1990. No interest accrued under
the GICs was paid in 1991.
4. On April 11, 1991 (the Conservation Date), ELIC was placed in
conservatorship by the Commissioner of Insurance for the State of
California. As of that date, payments under the GICs were suspended,
and no payments were made to the Plans.17 As of the Conservation
Date, the accumulated book values of the GICs (Accumulated Book Value),
defined as the amount of deposits, plus interest at the contract rate,
less interest paid, were $2,051,440 for the Profit Sharing Plan and
$1,049,923 for the Savings Plan. Effective June 30, 1991, the Plans'
Administrative Committees (the Committees) froze the GICs and a
proportionate share of the accounts of participants with account
balances invested in the GICs. The Plans have not permitted
distributions or withdrawals from the respective plans with respect to
the frozen portion of a participant's account. Moreover, the Savings
Plan has not allowed participants to receive a loan from or reallocate
the frozen portion of their accounts to any other investment option
under the Savings Plan.
\17\The Department notes that the decisions to acquire and hold
the GICs are governed by the fiduciary responsibility provisions of
Part 4, Subtitle B, of Title I of the Act. In this regard, the
Department is not herein proposing relief for any violations of Part
4 which may have arisen as a result of the acquisition and holding
of the GICs by the Plans.
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5. On August 13, 1993, the Los Angeles Superior Court approved the
terms of the Rehabilitation/Liquidation Plan for ELIC effective
September 3, [[Page 31516]] 1993 (the Rehab Plan). On or about December
1, 1993, each ELIC contract holder was provided with an election form
and a summary of the Rehab Plan. Under the Rehab Plan, ELIC guaranteed
investment contracts were reduced in value to approximately 79% of the
Accumulated Book Value as of the Conservation Date and each holder of
such contracts was paid an amount for accumulated interest and fees for
the period between the Conservation Date and September 3, 1993 (the
Interim Payments). Each contract holder, including the Plans, was
informed that it could elect by February 12, 1994 to ``opt in'' or
``opt out'' of the Rehab Plan. By opting in, a contract holder would
have been issued a new 5-year guaranteed investment contract issued by
Aurora National Life Assurance Company (Aurora), the successor to ELIC,
in an amount equal to the restructured percentage of the Accumulated
Book Value as of the Conservation Date, plus the right to receive
possible distributions from certain trusts and settlements that may
occur in the liquidation of ELIC. Opting out of the Rehab Plan would
have resulted in a cash settlement, payment of which would be made by
immediate payments and future payments from an Allocation Holdback
Trust, plus the right to receive possible distributions from certain
trusts and settlements that may occur in the liquidation of ELIC.
6. After reviewing the Rehab Plan materials supplied by ELIC,
Lumber elected to ``opt in'' with respect to the GICs. As a result, the
Plans' GICs were replaced, effective February 27, 1994, with the Aurora
GICs in accordance with the approved Rehab Plan. A comparison of the
terms of the ELIC GICs and the Aurora GICs is set forth below:
------------------------------------------------------------------------
ELIC GIC Aurora GIC
------------------------------------------------------------------------
1. Profit sharing plan:
Contract number................. CG0214601A CG01246A1A
Maturity date................... 9/25/92 9/3/98
Account value................... $2,000,000 $1,280,487
Guaranteed interest rate........ 9.92% 5.61%
2. Savings Plan:
Contract number................. CG0214701A CG01247A1A
Maturity date................... 9/25/92 9/3/98
Account value................... $1,000,000 $640,243
Guaranteed interest rate........ 19.92% 5.61%
------------------------------------------------------------------------
7. As the chart indicates, the present account value of the Aurora
GICs is substantially less than the pre- conservatorship book values of
the ELIC GICs. In addition, the interest rate on the Aurora GICs is
substantially less than the stated interest under the ELIC GICs.
Interest received by the Plans during ELIC's conservatorship and prior
to the consummation of the Rehab Plan was also substantially less than
the ELIC contract rate. The foregoing factors have resulted in a
significant reduction in value and yield of the contracts held by the
Plans.
8. The extended maturity date of the Aurora GICs has also had a
significant impact on participants in the Plans and their
beneficiaries. Under the terms of the Aurora GICs, the only payments
that may be made prior to maturity are semi-annual interest payments.
The only other benefit withdrawals permitted are the annuitization of
benefits under the contract, which is not permitted under the Plans
(which provide only a lump sum form of benefit).18 As a result,
participants who terminate their employment with Lumber are not able to
have their lump sum distributions paid out of the respective Aurora
GICs at this time.
18The applicant represents that pursuant to section
401(a)(11) of the Code, the Plans are not required to provide joint
and survivor annuities. The Department expresses no opinion with
respect to the applicant's representation.
9. In order to permit the Plans to resume full funding of all Plan
events, including distributions, withdrawals, loans, interfund
transfers and fund investments, Lumber proposes to make the Loans to
each of the Plans and has requested an exemption to permit the Loans
under the terms and conditions described herein. The Loans will be made
(i) pursuant to written agreements and (ii) as a single lump sum cash
payment to each Plan (the Loan Amount).19 It is contemplated that
the Loan Amount to the Profit Sharing Plan will be $1,378,000,
representing the original $2,000,000 principal amount of that Plan's
ELIC GIC, less an Interim Payment received by the Profit Sharing Plan
of $405,852, and less payments of $93,416 under the Aurora Replacement
GIC characterized as return of principal, and certain Rehab Plan
adjustments attributable to distributions from various trusts (see rep.
5, above) in the amount of $123,033. It is contemplated that the Loan
Amount to the Savings Plan will be $689,000, representing the original
principal amount of that Plan's ELIC GIC, less an Interim Payment
received by the Savings Plan of $202,925, and less payments of $46,708
under the Aurora Replacement GIC characterized as return of principal,
and certain Rehab Plan adjustments attributable to distributions from
various trusts (see rep. 5, above) in the amount of $61,516.20 The
Loans will be made as soon as practicable after the granting of the
exemption proposed herein, and a closing agreement with respect thereto
has been entered into between Lumber and the Internal Revenue Service.
The Repayments will be limited to the cash proceeds of any payments
received by the respective Plans as GIC Proceeds after the date of the
Loans. Repayments are due only when GIC Proceeds are received by the
Plans. No interest will be paid on the Loans. Under no circumstances
will Repayments exceed the Loan Amounts, even if GIC Proceeds should
exceed such amounts. At such time that Lumber learns that no further
GIC Proceeds will be received, Repayments of any outstanding Loan
Amounts will be waived by Lumber.
19The Department notes that this exemption, if granted,
will not affect the rights of any participant or beneficiary with
respect to any civil action against Plan fiduciaries for breaches of
section 404 of the Act in connection with any aspect of the GIC
transactions.
20The Loan Amounts have been rounded to $1,378,000 and
$689,000 for the Profit Sharing Plan and the Savings Plan,
respectively.
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10. If the exemption proposed herein is granted, the Committees
intend to value the Aurora GICs at the original principal amount of the
ELIC GICs. Each frozen account would then be adjusted to reflect this
new value, and the freeze placed on each participant's account would be
removed. The Plans would then resume distributions and withdrawals
under the Plans with [[Page 31517]] respect to frozen account balances.
Loans and interfund transfers under the Savings Plan would also resume
with respect to amounts that had been frozen.
11. In summary, the applicant represents that the proposed
transactions satisfy the criteria contained in section 408(a) of the
Act because: (a) All terms of the transactions will be no less
favorable to the Plans than those obtainable in arm's-length
transactions with unrelated parties; (b) the Loans will enable the
Plans to resume normal operations with respect to distributions,
withdrawals, loans, interfund transfers and fund investments; (c) the
Plans will pay no interest or other expenses in connection with the
Loans; (d) Repayments will be made only out of any cash proceeds of any
amounts received by the Plans as GIC Proceeds after the date of the
Loans; (e) the Repayments will not exceed the principal amount of the
Loans; and (f) the Repayments will be waived to the extent the Loan
Amounts exceed the GIC Proceeds.
FOR FURTHER INFORMATION CONTACT: Gary H. Lefkowitz of the Department,
telephone (202) 219-8881. (This is not a toll-free number.)
Warburg Investment Management International Ltd. (Warburg
International) Located in London, England; Proposed Exemption
[Application No. D-09998]
The Department is considering granting an exemption under the
authority of section 408(a) of the Act and section 4975(c)(2) of the
Code and in accordance with the procedures set forth in 29 CFR Part
2570, Subpart B (55 FR 32836, 32847, August 10, 1990). If the exemption
is granted, the restrictions of sections 406(a)(1)(A) and 406(b)(2) of
the Act and the sanctions resulting from the application of section
4975 of the Code, by reason of section 4975(c)(1)(A) of the Code, shall
not apply to the proposed cross-trading of securities between various
accounts managed by Warburg International or its Affiliates (the
Accounts) where at least one Account involved in any cross-trade is an
employee benefit plan account (Plan Account) for which Warburg
International acts as a fiduciary; provided that both the General
Conditions of Section I and the Specific Conditions of Section II below
are met.
Section I--General Conditions
(a) Each employee benefit plan comprising a Plan Account
participating in Warburg International's cross-trading program has
total assets equal to at least $25 million. In the case of multiple
employee benefit plans maintained by a single employer or controlled
group of employers, the $25 million requirement may be met by
aggregating the assets of such plans if the assets are commingled for
investment purposes in a single master trust.
(b) A Plan's participation in the cross-trade program is subject to
a written authorization executed in advance by a qualified Plan
Fiduciary which is independent of Warburg International and its
Affiliates (the Independent Fiduciary).
(c) The authorization referred to in paragraph (b) above is
terminable at will without penalty to the Plan Account, upon receipt by
Warburg International of written notice of termination.
(d) Before an authorization is made for any Plan Account, the
Independent Fiduciary is furnished with any reasonably available
information necessary for the Independent Fiduciary to determine
whether the authorization should be made, including (but not limited
to) a copy of the final exemption (if granted), an explanation of how
the authorization may be terminated, a description of Warburg
International's cross-trade practices, and any other reasonably
available information regarding the matter that the Independent
Fiduciary requests.
(e) Each cross-trade transaction involves only equity or debt
securities for which there is a generally recognized market. With
respect to any non-U.S. securities, only those securities traded on a
recognized foreign securities exchange for which market quotations are
readily available shall be covered by the exemption.21
\21\With respect to all non-U.S. securities that are ``plan
assets'' managed by Warburg or an Affiliate, the applicant
represents that the requirements of section 404(b) of the Act and
the regulations thereunder will be met (see 29 CFR 2550.404b-1). In
this regard, section 404(b) of the Act states that no fiduciary may
maintain the indicia of ownership of any assets of a plan outside
the jurisdiction of the district courts of the United States, except
as authorized by regulation by the Secretary of Labor. The
Department is providing no opinion herein as to whether such
requirements will be met.
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(f) Each cross-trade transaction is effected at the current market
value for the security on the date of the transactions. For equity
securities, this shall be the closing price for the security on the
date of the transaction. The ``closing price'' shall be the last trade
price on exchanges where dealing is order-driven and the closing mid-
market price (i.e. the average of the closing bid and offer prices)
where dealing is quote-driven. For debt securities, the current market
value shall be the fair market value determined in accordance with
paragraph (b) of Rule 17a-7 issued by the Securities and Exchange
Commission (SEC) under the Investment Company Act of 1940.
(g) Neither Warburg International nor its Affiliates charges a Plan
Account affected by a cross-trade transaction any fee or commission for
such transaction.
(h) At least every three months, and not later than 45 days
following the period to which it relates, Warburg International
furnishes the Independent Fiduciary with a report disclosing: (1) a
list of all cross-trade transactions engaged in on behalf of the Plan
Account, and (2) with respect to each cross-trade transaction, the
prices at which the securities involved in the transaction were traded
on the date of such transaction.
(i) The Independent Fiduciary is furnished with a summary of
certain additional information at least once per year. The summary must
be furnished within 45 days after the end of the period to which it
relates, and must contain the following: (1) A description of the total
amount of the Plan Account's assets involved in cross-trade
transactions during the period, (2) a description of Warburg
International's cross-trade practices, if such practices have changed
materially during the period covered by the summary, (3) a statement
that the Independent Fiduciary's authorization of cross-trade
transactions may be terminated upon receipt by Warburg International of
written notice to that effect, and (4) a statement that the Independent
Fiduciary's authorization of the Plan Account's participation in the
cross-trade program will continue in effect unless it is terminated.
(j) For all Accounts participating in the cross-trading program, if
the number of shares of a particular security which any Accounts need
to sell on a given day is less than the number of shares of such
security which any Accounts need to buy, or vice versa, the direct
cross-trade opportunity is allocated among the buying or selling
Accounts on a pro rata basis.
(k) The Accounts involved in cross-trade transactions do not
include assets of any Plan established or maintained by Warburg
International or its Affiliates.
Section II--Specific Conditions
(a) An Independent Fiduciary of each Plan specifically authorizes
each cross-trade transaction in accordance with the following
procedure:
(1) No more than three business days prior to the execution of any
cross-trade transaction, Warburg International shall inform an
Independent Fiduciary of each Plan Account involved in the
[[Page 31518]] cross-trade transaction that Warburg International
proposes to buy or sell specified securities in a cross-trade
transaction if an appropriate opportunity is available, the current
trading price for such securities, and the total number of shares to be
acquired or sold by each such Plan Account;
(2) Prior to each cross-trade transaction, the transaction shall be
authorized either orally or in writing by the Independent Fiduciary of
each Plan Account involved in the cross-trade transaction;
(3) If a cross-trade transaction is authorized orally by an
Independent Fiduciary, Warburg International shall provide written
confirmation of such authorization in a manner reasonably calculated to
be received by such Independent Fiduciary within one business day from
the date of such authorization;
(4) The authorization referred to in this Section II shall be
effective for a period of three business days; and
(5) No more than ten days after the completion of a cross-trade
transaction, the Independent Fiduciary shall be provided with a written
confirmation of the transaction and the price at which the transaction
was executed.
(b) A cross-trade transaction is effected only where the
transaction involves less than five (5) percent of the aggregate
average daily trading volume for the securities involved in the
transaction for the week immediately preceding the authorization of the
transaction. A cross-trade transaction may exceed this limit only by
express authorization of Independent Fiduciaries on behalf of Plan
Accounts affected by the transaction, prior to the execution of the
cross-trade.
(c) The cross-trade transaction is effected at a price which is
within ten (10) percent of the closing price of the security on the day
before the date on which Warburg International received authorization
by the Independent Fiduciary to engage in the cross-trade transaction.
Section III--Definitions
For purposes of this proposed exemption:
(a) ``Account'' means a Plan Account or Non-Plan Account;
(b) ``Affiliate'' means any person directly or indirectly through
one or more intermediaries, controlling, controlled by, or under common
control with Warburg International;
(c) ``Buying Account'' means the Account which seeks to purchase
securities in a cross-trade transaction;
(d) ``Cross-trade transaction'' means a purchase and sale of
securities between Accounts for which Warburg International or an
Affiliate is acting as investment manager;
(e) ``Plan Account'' means an Account managed by Warburg
International consisting of assets of one or more employee benefit
plans which are subject to the Act;
(f) ``Non-Plan Account'' means an Account managed by Warburg
International consisting of assets of clients which are not employee
benefit plans subject to the Act; and
(g) ``Selling Account'' means the Account which seeks to sell its
securities in a cross-trade transaction.
Summary of Facts and Representations
1. Warburg International is a wholly-owned subsidiary of Mercury
Asset Management plc (MAM), a public limited company organized under
the laws of the United Kingdom. As of September 30, 1994, MAM and its
subsidiaries had over $90 billion of assets under management. Warburg
International is registered as an investment adviser under the U.S.
Investment Advisers Act of 1940 (the 1940 Act) and is a member of the
Investment Management Regulatory Organization Limited (IMRO) in the
United Kingdom. Warburg International's clients are primarily U.S.
institutional investors, such as qualified pension funds and registered
investment companies. As of December 31, 1994, Warburg International
had more than $3 billion in assets under management, of which
approximately $2 billion consisted of assets of Plan Accounts and
governmental plan accounts for which it had agreed to act as a
fiduciary.
2. The Accounts for which an exemption is requested are those Plan
Accounts for which Warburg International provides active portfolio
management. Investment decisions are generally subject to the
investment manager's discretion, subject to general written guidelines
as to which types of securities to acquire or sell for the Accounts.
For some Accounts, investment selections are based in part on the
corresponding decisions made for registered investment companies or
other institutional accounts for which Warburg International or an
Affiliate serves as the investment adviser. Thus, Accounts with the
same or similar investment guidelines or objectives often will be
acquiring or selling the same securities on the same day.
3. Warburg International states that the acquisition or disposition
of any particular security for an Account would be unrelated to the
fact that an opportunity for a cross-trade transaction may be
available. Under the cross-trade program, if Warburg International or
an Affiliate sells securities to another Account it manages, or
acquires such securities from another Account it manages, it would have
an opportunity to save commissions for both the selling or acquiring
Account. Under current procedures, all securities transactions are
effected by an independent broker which may be dealing with a second
broker acting for the party on the other side of the transaction. If
Warburg International effects a transaction through a broker on the
open market, the client would ordinarily be charged a commission at the
market rate (normally about 0.2 percent, but commissions vary according
to the country where the transaction is effected). However, under the
cross-trade program, Warburg International states that no commission
would be charged where the transaction is effected by Warburg
International or an Affiliate, and in certain markets, transfer or
registration taxes would also not be charged. Warburg International
states that even if a broker is involved, matching the buy and sell
orders for a particular day through a single broker in an off-market
transaction would still result in lower commission charges for the
Accounts.
4. Warburg International represents that the Plan Accounts would
also benefit under the cross-trade program by not incurring the cost
(in terms of price) of dealing with a person or a firm acting as
``market-maker'' for the specific security involved in the transaction.
This cost is generally measured by the spread between the asking and
the bidding price for the securities. In normal trading by Warburg
International, the Selling Account receives a lower ``bid'' price,
while the Buying Account pays a higher ``ask'' price. By contrast, in a
direct cross-trade, the price received by the Selling Account would be
the same as the price paid by the Buying Account, based on an average
of the ``bid'' and ``ask'' prices, without any dealer mark-ups. In
addition, if permitted to direct a cross-trading of securities from one
Account to another, Warburg International would be able to implement
its investment strategies at the earliest possible point in time.
Finally, the trading of some securities may be ``thin'', that is there
are limited numbers of shares available. In such cases, the spread may
be particularly wide. Matched sales would essentially provide the
Accounts with early opportunities to acquire or sell such thinly-traded
securities without paying the spread.
[[Page 31519]]
5. Participation by Plan Accounts in Warburg International's cross-
trade program will be subject to several conditions. Each cross-trade
transaction will involve only securities for which there is a generally
recognized market. With respect to any non-U.S. securities, only those
securities traded on a recognized foreign securities exchange for which
market quotations are readily available will be involved in the cross-
trade program. Each cross-trade transaction will be effected at the
current market value for the security on the date of the direct cross-
trade. For equity securities, the current market value will be the
closing price for the security on the date of the transaction. The
``closing price'' will be the last trade price on exchanges where
dealing is order-driven and the closing mid-market price (i.e. the
average of the closing bid and offer prices) where dealing is quote-
driven. For all domestic or foreign debt securities, the current market
value will be the fair market value of the security as determined
pursuant to paragraph (b) of SEC Rule 17a-7 under the 1940 Act. In this
regard, SEC Rule 17a-7(b) contains four possible means of determining
``current market value'' depending on such factors as whether the
security is a reported security and whether its principal market is an
exchange. This Rule is also applicable to registered investment
companies for which Warburg International or an Affiliate acts as an
investment advisor.
Warburg International will receive no fees or other incremental
compensation (other than its previously agreed upon investment
management fee) with respect to any direct cross-trade transaction.
6. A fiduciary of a Plan Account independent of Warburg
International and its Affiliates (i.e. the Independent Fiduciary) will
provide written authorization allowing for the Plan Account's
participation in Warburg International's cross-trading program, before
any specific cross-trades for such Account are effected. This
authorization will be terminable at will without penalty to the Plan
Account upon written notice to Warburg International of such
termination. In addition, before any such general authorization is
granted, Warburg International will provide the Independent Fiduciary
with all materials necessary to permit an evaluation of the cross-trade
program. These materials will include (but not be limited to) a copy of
the proposed and final exemptions, an explanation of how the
authorization may be terminated, a description of Warburg
International's cross-trade practices, and any other reasonably
available information regarding the matter which the Independent
Fiduciary may request.
7. After a Plan Account's participation in Warburg International's
cross-trading program is authorized, Warburg International will furnish
periodic reports to the Independent Fiduciary, at least once every
three months, and no later than 45 days following the period to which
it relates, disclosing: (a) A list of all cross-trade transactions
engaged in on behalf of the Plan Account; and (b) with respect to each
cross-trade transaction, the prices at which the securities involved in
the transaction were traded on the date of such transaction. The
Independent Fiduciary will also be furnished with a summary of certain
additional information at least once per year. The summary will be
furnished within 45 days after the end of the period to which it
relates, and will contain the following: (a) A description of the total
amount of the Plan Account's assets involved in cross-trade
transactions during the period, (b) a description of Warburg
International's cross-trade practices, if such practices have changed
materially during the period covered by the summary, (c) a statement
that the Independent Fiduciary's authorization of cross-trade
transactions may be terminated upon receipt by Warburg International of
written notice to that effect, and (d) a statement that the Independent
Fiduciary's authorization of the Plan Account's participation in the
cross-trade program will continue in effect unless it is terminated.
8. The Accounts involved in cross-trade transactions will not
include assets of any Plan established or maintained by Warburg
International or its Affiliates to provide income to its employees or
to result in a deferral of income by employees for periods extending to
the termination of covered employment or beyond.
Each employee benefit plan comprising a Plan Account participating
in Warburg International's cross-trading program will have total assets
equal to at least $25 million. In the case of multiple employee benefit
plans maintained by a single employer or controlled group of employers,
the $25 million requirement may be met by aggregating the assets of
such plans if the assets are commingled for investment purposes in a
single master trust.
9. Warburg International states that a Plan Account's participation
in its cross-trade program will also be subject to certain special
conditions. In addition to requiring a general authorization of a Plan
Account's participation in the cross-trade program, an Independent
Fiduciary will specifically authorize each cross-trade transaction. Any
such authorization will be effective only for a period of three
business days and will be subject to certain pricing and volume
limitations (as discussed in Paragraph 10 below). The authorization to
proceed with the cross-trade transaction will be either oral or
written. If a cross-trade transaction is authorized orally by an
Independent Fiduciary, Warburg International will provide a written
confirmation of the authorization in a manner reasonably calculated to
be received by the Independent Fiduciary within one business day from
the date of such authorization. The Independent Fiduciary will be sent
a written confirmation of the cross-trade transaction, including the
price at which it was executed, within ten days of the completion of
the transaction.
10. Warburg International states that a cross-trade transaction
will be effected only where the trade involves less than five (5)
percent of the aggregate average daily trading volume for the
securities involved in the transaction for the week immediately
preceding the authorization of the transaction. A cross-trade will
exceed this limit only by express written or oral authorization of an
Independent Fiduciary for each Plan Account involved, prior to the
execution of the cross-trade. With respect to pricing, a cross-trade
transaction will not be made at a price which differs by more than ten
(10) percent from the price at the close on the day before specific
authorization was provided by the Independent Fiduciary.
11. Warburg International represents that it is conceivable that
situations will arise in which it will be necessary to allocate cross-
trade opportunities among several Accounts. Warburg International will
make these decisions pursuant to a non-discretionary pro-rata
allocation system. For example, in the event that the number of shares
of a particular security which a Selling Account needs to sell on a
given day is less than the number of shares of such security which
other Buying Accounts need to buy on that date, the cross-trade
opportunity will be allocated among potential Buying Accounts on a pro-
rata basis. A similar procedure would apply where the number of shares
of a particular security to be sold by Selling Accounts is more than
the number of such shares which any Buying Accounts need to buy on that
date. Thus, the Accounts participating in Warburg International's
cross-trade program will have the opportunity to participate on a
proportional basis in cross-trade [[Page 31520]] transactions during
the operation of the program. Warburg International states that this
aspect of the cross-trading program will be part of the information
disclosed in writing to the fiduciaries of the Plan Accounts prior to
their authorization for participation in the program.
12. In summary, Warburg International represents that the proposed
transactions will satisfy the statutory criteria of section 408(a) of
the Act because, among other things: (a) An Independent Fiduciary will
provide written authorization, which will be terminable at will, to
Warburg International to permit the Plan Account to participate in the
cross-trading program; (b) cross-trades will always be executed at the
current market price of the security on the date of the transaction, as
determined by an independent, third party source; (c) specific oral or
written authorization will be provided by the Independent Fiduciary to
Warburg International prior to each cross-trade transaction; (d) all
securities involved in cross-trades will be securities for which there
is a generally recognized market; (e) Warburg International will
provide periodic reporting of the cross-trade transactions to the
Independent Fiduciary; (f) the Plan Accounts will realize significant
cost savings due to reduced brokerage commissions and avoidance of the
bid and offer spread and will benefit from more efficient
implementation of investment strategies; (g) each employee benefit plan
comprising a Plan Account participating in the cross-trade will have
total assets of at least $25 million or must be part of a master trust
of plans maintained by a single employer or controlled group of
employers which has at least $25 million in assets; (h) the cross-trade
transactions will not include any assets of a Plan established or
maintained by Warburg International or its Affiliates; and (i) neither
Warburg International nor its Affiliates will receive any additional
fees or other compensation as a result of the proposed cross-trade
transactions.
FOR FURTHER INFORMATION CONTACT: Mr. E.F. Williams of the Department,
telephone (202) 219-8194. (This is not a toll-free number.)
General Information
The attention of interested persons is directed to the following:
(1) The fact that a transaction is the subject of an exemption
under section 408(a) of the Act and/or section 4975(c)(2) of the Code
does not relieve a fiduciary or other party in interest of disqualified
person from certain other provisions of the Act and/or the Code,
including any prohibited transaction provisions to which the exemption
does not apply and the general fiduciary responsibility provisions of
section 404 of the Act, which among other things require a fiduciary to
discharge his duties respecting the plan solely in the interest of the
participants and beneficiaries of the plan and in a prudent fashion in
accordance with section 404(a)(1)(b) of the act; nor does it affect the
requirement of section 401(a) of the Code that the plan must operate
for the exclusive benefit of the employees of the employer maintaining
the plan and their beneficiaries;
(2) Before an exemption may be granted under section 408(a) of the
Act and/or section 4975(c)(2) of the Code, the Department must find
that the exemption is administratively feasible, in the interests of
the plan and of its participants and beneficiaries and protective of
the rights of participants and beneficiaries of the plan;
(3) The proposed exemptions, if granted, will be supplemental to,
and not in derogation of, any other provisions of the Act and/or the
Code, including statutory or administrative exemptions and transitional
rules. Furthermore, the fact that a transaction is subject to an
administrative or statutory exemption is not dispositive of whether the
transaction is in fact a prohibited transaction; and
(4) The proposed exemptions, if granted, will be subject to the
express condition that the material facts and representations contained
in each application are true and complete and accurately describe all
material terms of the transaction which is the subject of the
exemption. In the case of continuing exemption transactions, if any of
the material facts or representations described in the application
change after the exemption is granted, the exemption will cease to
apply as of the date of such change. In the event of any such change,
application for a new exemption may be made to the Department.
Signed at Washington, DC, this 9th day of June, 1995.
Ivan Strasfeld,
Director of Exemption Determinations, Pension and Welfare Benefits
Administration, U.S. Department of Labor.
[FR Doc. 95-14576 Filed 6-14-95; 8:45 am]
BILLING CODE 4510-29-P
