[Federal Register Volume 59, Number 152 (Tuesday, August 9, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-19414]
[[Page Unknown]]
[Federal Register: August 9, 1994]
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DEPARTMENT OF LABOR
Pension and Welfare Benefits Administration
[Application No. D-9679 and D-9680]
Proposed Exemptions; Lake Dallas Telephone Company, Inc. Defined
Benefit Pension Plan
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, NW., Washington, DC
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, NW., Washington, DC 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.
Lake Dallas Telephone Company, Inc. Defined Benefit Pension Plan
(Pension Plan) and Lake Dallas Telephone Company, Inc. 401(k) Profit
Sharing Plan (P/S Plan; Collectively, the Plans) Located in Lake
Dallas, Texas
[Application Nos. D-9679 and D-9680]
Proposed Exemption
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 the proposed sale from the Plans of two
interests (the Interests) in a certain partnership to Lake Cities Land
and Development, Inc. (Lake Cities), an affiliate of the Plans' sponsor
and a party in interest with respect to the Plans, provided that the
following conditions are satisfied:
(1) the sale will be a one-time cash transaction;
(2) no commissions or fees will be paid by the Plans as a result of
the sale; and
(3) the sale price will be the higher of: a) the aggregate fair
market value of the Interests on the date of the sale; or b) the
aggregate investment cost of the Interests to the Plans of $129,146.64.
Summary of Facts and Representations
1. The Plans were established January 1, 1985. The Pension Plan is
a defined benefit plan, and the P/S Plan is a profit sharing plan. The
Plans have approximately 30 participants which participate in both
Plans. As of December 31, 1993, the Pension Plan had $433,943.19 in
total assets, and the P/S Plan had $1,708,137.83 in total assets. Lake
Dallas Telephone Company, Inc. is the sponsor of the Plans (the
Employer). The Employer is a regulated telephone company with $19.5
million in assets incorporated in the State of Texas, and it provides
telephone service to approximately 4,900 subscribers in Denton County,
Texas. The Employer is a wholly-owned subsidiary of Tele-Max, Inc. Lake
Cities is an affiliate of the Employer. The Plans' trustees are Kitna
R. Griggs, President of the Employer, Greg A. Gross, Executive Vice
President of the Employer, and Helen Hutto, Director of Administration
of the Employer (the Trustees).
2. In April and May of 1986, respectively, the Pension Plan
purchased a 4.76% interest (P/P Interest) for $24,500 in cash; and the
P/S Plan purchased a 20.48% interest for $105,350 in cash (P/S
Interest, collectively; the Interests) in CFNVEST Southlake Joint
Venture (the Partnership). The Interests are minority interests and are
not publicly traded. The Plans' Trustees made the decision for the
Plans to invest in the Partnership. At the time of acquisition, the P/P
Interest represented approximately 56% of the Pension Plan's assets and
the P/S Interest represented approximately 39% of the P/S Plan's
assets.1
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\1\The Department notes that the decisions to acquire and hold
the Interests are governed by the fiduciary responsibility
requirements of Part 4, Subtitle B, Title I of the Act. In this
regard, the Department herein is not proposing relief for any
violations of Part 4 which may have arisen as a result of the
acquisition and holding of the Interests by the Plans.
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3. The Partnership is a general partnership joint venture created
in 1986 for the exclusive purpose of purchasing a 3.75 acre tract of
undeveloped land in Southlake, Texas (the Land) and holding it as
investment. It is represented that the Land is the only asset owned by
the Partnership, which holds no investments and conducts no business
other than holding and managing the Land. The Partnership was designed
primarily for investment by tax exempt entities such as employee
retirement plans, although ownership of Partnership interests is not
limited to such entities. The Partnership currently consists of
eighteen partners, fourteen of which are employee retirement plans. The
assets of the Partnership are managed by Robert Cecil, the general
partner and consultant to the Partnership. The Partnership is an
unrelated party to the Plan, the Employer, the holding company and
affiliates of the Employer. At the time the Partnership was formed, the
city of Southlake, Texas was expected to expand rapidly. However, it is
represented that the real estate market has not proven to be as
profitable as originally projected.
4. It is represented that because there is not an established
market for the Interests and because the Land is the only asset owned
by the Partnership, the Interests are valued according to the
proportionate value of the underlying Land. In this regard, the
applicant submitted an affidavit dated April 6, 1994, prepared by Mr.
Cecil (the Affidavit). In the Affidavit, Mr. Cecil stated that he is
independent of the Plans, the Employer and Lake Cities, the proposed
purchaser of the Interests. Mr. Cecil represented that when considering
the book value of the Partnership, its financial condition, lack of
earning capacity, the potential return on the investment, as well as
the history and nature of the Partnership and the lack of a market or
comparable sales for the Interests, it was his opinion that the
Interests have no value in and of themselves. Rather, the only value to
be attributed to the Interests is the proportionate underlying value of
the Land. Each Plan's pro rata ownership Interest in the Land
represents the maximum fair market value of that Interest, before any
discounts for minority interests and lack of marketability.
5. The Land was appraised (the Appraisal) on June 29, 1993, by
Jeffrey A. Walburn (Mr. Walburn), an independent certified real estate
appraiser in the State of Texas. The Land, which is located in the City
of Southlake, Tarrant County, Texas, is vacant and contains 3.75 acres.
Mr. Walburn determined that the fair market value of the Land was
$450,000 as of June 29, 1993. Accordingly, the maximum fair market
value of the P/P Interest was $21,420 and the fair market value of the
P/S Interest was $92,160, for an aggregate fair market value of
$113,580. As such, as of December 31, 1993 the P/P Interest represents
4.94% of the Pension Plan's total assets, and P/S Interest represents
5.4% of the P/S Plan's total assets.
6. Currently, the Plans are receiving no income from their
investment. To date, the P/S Plan and the Pension Plan have received
distributions of $3,845.37 and $894.28, respectively, from their
investment.2 Since the original acquisition of the Interests,
certain additional capital contributions and holding costs have been
paid to the Partnership by the Plans in the aggregate amount of
$4,036.29 (the Holding Costs), with the P/S Plan and the Pension Plan
paying $3,394.76 and $641.53, respectively.
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\2\Proceeds were paid by the State of Texas to the Partnership
as payment for a right of way on the Land. The Partnership in turn
distributed the payments to each partner on a proportionate basis.
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7. The Trustees have made several unsuccessful attempts to sell the
Interests to the other members of the Partnership. In this regard, the
Partnership also has attempted to sell the Land, and a ``for sale''
sign has been posted on the Land for approximately two years. In this
regard, the applicant represents that in rural areas it is the custom
to sell undeveloped lots by posting signs on the property rather than
hiring a real estate broker. The Trustees believe that their inability
to sell the Interests is primarily due to the fact that the Interests
are minority interests and also due to a decline in the real estate
market. It is represented that there is no established market for the
Interests. Moreover, because the Plans hold minority Interests, they
cannot force a sale of the Land.
8. On April 1, 1993, the Employer amended the P/S Plan in order to
provide participant directed investments pursuant to section 404(c) of
the Act and the regulations thereunder. The P/S Plan participants will
be able to invest in mutual funds provided by PaineWebber Trust Company
(Paine Webber). Paine Webber will provide third party administration
and record keeping required to administer the P/S Plan. The applicant
represents that because Paine Webber mutual funds are unable to accept
in-kind transfers of the P/S Plan's assets, all P/S Plan assets must be
liquidated before they can be invested in the mutual fund options and
subject to participant direction. Until that time, the P/S Plan must
incur the added administrative expense of separately trusteeing and
accounting for the P/S Interest.
9. For these reasons, the applicant proposes to sell the Interests
to Lake Cities, a wholly owned subsidiary of Tele-Max, Inc., and
therefore an affiliate of the Employer. Lake Cities desires to purchase
the Interests in a one-time cash transaction. The purchase price will
be the greater of: a) the aggregate fair market value of the Interests
on the date of the sale;3 or b) the aggregate investment cost (the
Aggregate Investment Cost) of the Interests to the Plans of
$129,146.64.4 It is also represented that neither Lake Cities, nor
any of its affiliates own property adjacent to or near the Partnership
Land. Furthermore, no individual owner of the Employer (or any parent
or subsidiary) own any interests in the Partnership, interest in the
underlying Land, or interest in any real property adjacent to or near
the Partnership Land.
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\3\The applicant represents that the fair market value will not
be discounted for the Interests' lack of marketability or the fact
that the Interests are minority interests.
\4\The Aggregate Investment Cost is determined as follows. The
aggregate purchase price to the Plans was $129,850 ($24,500 for the
P/P Interest + $105,350 for the P/S Interest) plus the aggregate
Holding Costs of $4,036.29 ($641.53 for the Pension Plan + $3,394.76
for the P/S Plan) minus the aggregate distributions to the Plans of
$4,739.65 ($894.28 for the P/P Interest + $3,845.37 for the P/S
Interest). Numerically, this is as follows (($129,850 + $4,036.29) -
$4,739.65)) = $129,146.64 for the Aggregate Investment Cost to the
Plans.
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10. It is represented that the proposed transaction is
administratively feasible, in the interest and protection of the Plans'
participants and beneficiaries. The sale would be a one-time cash
transaction and the Plans would incur no expenses or commissions with
respect to the sale. The proposed transaction would enable the Plans to
liquidate its assets and would facilitate restructuring of the P/S
Plan. The proposed sale is protective of the Plans because Lake Cities
will purchase the Interests from the Plans for the greater of: a) the
aggregate fair market value of the Interests on the date of the sale;
or b) the Aggregate Investment Cost of the Interests to the Plans of
$129,146.64. Also, the Plans will be relieved of any liability with
respect to the Partnership. Furthermore, the applicant represents that
any amounts received by the Plans as a result of the proposed
transaction, which are in excess of the fair market value of the
Interests, will be treated as contributions to the Plans, but that
these contributions will not exceed limitations of section 415 of the
Internal Revenue Code.
11. In summary, the applicant represents that the transaction
satisfies the statutory criteria of section 408(a) of the Act and
section 4975(c)(2) of the Code because:
(1) the sale will be a one-time cash transaction;
(2) no commissions or fees will be paid by the Plans as a result of
the sale;
(3) the sale will enable the Plans to liquidate its assets and will
facilitate restructuring of the P/S Plan;
(4) the sale will allow the Plans to divest of non-income producing
Interests that have depreciated in value; and
(5) the sale price will be the higher of: a) the aggregate fair
market value of the Interests on the date of the sale; or b) the
aggregate investment cost of the Interests to the Plans of $129,146.64.
Tax Consequences of Transaction
The Department of Treasury has determined that if a transaction
between a qualified employee benefit plan and its sponsoring employer
(or an affiliate thereof) results in the plan either paying less or
receiving more than fair market value, such excess may be considered to
be a contribution by the sponsoring employer to the plan, and therefore
must be examined under the applicable provisions of the Internal
Revenue Code, including sections 401(a)(4), 404 and 415.
FOR FURTHER INFORMATION CONTACT: Ekaterina A. Uzlyan of the Department,
telephone (202) 219-8883. (This is not a toll-free number.)
The Prudential Insurance Company of America Located in New Jersey
[Application No. D-9692]
Proposed Exemption
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, effective December 31, 1991, the restrictions of section
406 (a) and 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 the transfer
by the Prudential Insurance Company of America (Prudential) of certain
assets from its general account (the General Account) into a separate
account (the Separate Account), established and managed by Prudential,
in connection with the conversion of one of Prudential's non-
participating group annuity contracts (the Non-Participating Annuity
Contract) to a participating group annuity contract (the Participating
Annuity Contract), issued by Prudential to the Retirement Program Plan
for Employees of Union Carbide Corporation and its subsidiary companies
(the Plan) and funded through the assets transferred to the Separate
Account; provided that the following conditions are met: (a) Prudential
transferred to the Separate Account sufficient assets to create a
reserve the value of which equaled or exceeded 103% of the value of the
Participating Annuity Contract liabilities, as of December 31, 1991;
(b) an independent qualified appraiser determined the fair market value
of the assets transferred into the Separate Account, as of the date of
such transfer; (c) Prudential irrevocably guarantees the payment of
benefits under the Participating Annuity Contract to the former
participants of the Plan who retired prior to December 31, 1985, (the
Retirees); (d) no additional contribution from the Union Carbide
Corporation (Union Carbide) or its subsidiary companies or the Plan was
or will be required to fund benefits to the Retirees or to any other
participants and beneficiaries of the Plan; (e) prior to the transfer
of assets between the General Account and the Separate Account, Union
Carbide, acting as fiduciary on behalf of the Plan, determined that the
transaction was feasible, in the interest of, and protective of the
Plan and its participants and beneficiaries and would not affect the
payment of benefits to the Retirees; (f) Union Carbide determined that
the terms and conditions of the transaction were at least as favorable
as those negotiated at arm's length in similar transactions with
unrelated third parties; (g) prior to the conversion, Union Carbide
negotiated, reviewed, and approved the transaction, and will monitor
the transaction; (h) Union Carbide reviewed the appraisal and approved
the transfer of each of the assets into the Separate Account prior to
the date the transaction was entered; and (i) the Plan incurred no
fees, commissions, costs, expenses, or other charges associated with
the transaction and will pay no addition compensation as a result of
the conversion of the Non-Participating Annuity Contract to the
Participating Annuity Contract.5
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\5\For purposes of this proposed exemption references to
specific provisions of title I of the Act, unless otherwise
specified, refer also to the corresponding provisions of the Code.
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Effective Date: If granted, this exemption will be effective
December 31, 1991.
Summary of Facts and Representations
1. The Plan is a defined benefit plan that is tax qualified under
section 401(a) of the Code. The Plan is funded by a trust that is
exempt from tax under section 501(a) of the Code. Manufacturers Hanover
Trust Company serves as the trustee for the Plan. The Plan had total
assets of approximately $3.1 billion and $2.58 billion, as of December
31, 1990, and 1991, respectively. It is also represented that there
were approximately 64,000 active individual participants in the Plan,
as of December 31, 1991, and approximately 23,900 Retirees.
2. The sponsor of the Plan is Union Carbide and its subsidiaries.
Union Carbide is a large chemical manufacturer with operations in the
United States and in countries abroad. Union Carbide is a New York
corporation with its principal place of business located in Danbury,
Connecticut. Union Carbide employs approximately 37,756 persons and, as
of December 31, 1990, had total assets of approximately $8.133 billion.
3. Prudential provides a variety of insurance products and
services, including participating and non-participating annuity
contracts, funding, and asset management to pension and profit-sharing
plans subject to the provisions of Title I of the Act. In this regard,
it is represented that Prudential and its affiliates provided insurance
products and services to the Plan prior to the conversion. Accordingly,
Prudential and its affiliates were parties in interest with respect to
the Plan when the transaction was entered.
4. On September 30, 1985, Union Carbide established a plan (the
Spinoff Plan) that was separate from the Plan which is the subject of
this proposed exemption. At that time, the liabilities for the accrued
benefits of former participants who had retired on or before September
30, 1985, and assets in an amount exceeding all such liabilities were
transferred from the Plan to the Spinoff Plan. Union Carbide then,
pursuant to section 4043 of the Act, filed a notice of intent to
terminate the Spinoff Plan under section 4041 of the Act and received a
favorable determination letter from the Internal Revenue Service and
the Pension Benefit Guaranty Corporation. Accordingly, the Spinoff Plan
was then terminated and the excess assets reverted to Union Carbide.
It is represented that Union Carbide purchased irrevocable annuity
contracts from Prudential to cover all vested accrued benefits of the
former participants in the Spinoff Plan at the time it was terminated.
One of the annuity contracts purchased was the Non-Participating
Annuity Contract which is involved in this proposed exemption. However,
because the actual date of Union Carbide's purchase of the Non-
Participating Annuity Contract was subsequent to the effective date of
the termination of the Spinoff Plan, Union Carbide determined that it
would cover certain additional former participants of the Plan who had
retired between September 30, 1985, and December 31, 1985. Accordingly,
under the terms of the Non-Participating Annuity Contract, Prudential
agreed to provide an irrevocable commitment to cover and guarantee the
payment of all benefits for those former participants who retired on or
before December 31, 1985, and their beneficiaries. It is represented
that these Retirees ceased to be participants of the Plan, pursuant to
29 CFR Sec. 2510.3-3(d)(2)(ii) of the Department's regulations, as such
individuals received a certificate describing the benefits to which
they were entitled, the entire benefit rights of such individuals were
fully guaranteed by Prudential, and such rights are enforceable by the
sole choice of such individuals against Prudential. However, because
the Non-Participating Contract covered this additional group of
retirees it is represented that the Non-Participating Contract was
issued by Prudential to the Plan. Further, because the Plan is the
named holder under the provisions of such contract, it is represented
that the Non-Participating Annuity Contract is deemed to be an asset of
the Plan and is subject to the discretion of Union Carbide, acting as
fiduciary for the Plan.
5. Subsequent to the purchase of the Non-Participating Annuity
Contract, the Separate Account was established for the purpose of
converting the Non-Participating Annuity Contract held by the Plan into
a Participating Annuity Contract funded through the Separate Account.
The Separate Account was funded with fixed income investments (the
Fixed Income Assets) transferred from the segment of Prudential's
General Account to which liability for the benefits provided under the
Non-Participating Annuity Contract had been assigned. It is represented
that the in-kind transfer of the Fixed Income Assets avoided
transaction costs in connection with the acquisition by the Separate
Account of a suitable portfolio.
It is represented that the Non-Participating Annuity Contract was
converted to a Participating Annuity Contract funded through the
Separate Account in order for the Plan and the Retirees to take
advantage, in the event of Prudential's insolvency, of the additional
protection from the creditors of the insurer which is typically
available from a separate account structure, and also to obtain for the
Plan the opportunity to participate risk free in any Separate Account
earnings. It is represented that when the transaction was entered, the
terms of the Participating Annuity Contract were at least as favorable
as those provided under the Non-Participating Annuity Contract. Union
Carbide further represents that the Participating Annuity Contract
provides the same level and guarantee of benefit payments to Retirees
as were provided under the terms of the Non-Participating Annuity
Contract. In this regard, it is represented that the contractual
relationship of the Retirees with Prudential was not impacted by the
conversion of the Non-Participating Annuity Contract to the
Participating Annuity Contract, as the individual certificates which
were issued to the Retirees described the benefits which the Retirees
are entitled to receive and provided those Retirees with the right to
enforce the obligation to pay those benefits directly against
Prudential. It is further represented that neither of these factors was
affected by the conversion, because the guarantees provided in the
individual certificates are not dependent on the continuation of the
particular group annuity contract under which the certificates were
issued. No additional contribution of assets was or will be required
from Union Carbide or the Plan to Prudential or the Separate Account in
order to fund benefits guaranted under the terms of the Participating
Annuity Contract. In the event that the Fixed Income Assets transferred
to the Separate Account are insufficient to pay all benefits, it is
represented that Prudential's General Account continues to provide an
irrevocable guarantee for the payment of benefits.
Prudential established the Separate Account, and selected and
transferred the assets into the Separate Account, subject to the
approval of Union Carbide acting as fiduciary on behalf of the Plan.
Once transferred, all of the underlying assets of the Separate Account
were managed by Prudential or its affiliates exclusively. However, it
is represented that Prudential did not provide investment advice to
Union Carbide nor exercise discretionary control with respect to the
decision to convert the Non-Participating Annuity Contract into the
Participating Annuity Contract.
6. The Separate Account was established by Prudential as a separate
account under the definition as set forth in section 3(17) of the Act.
The investment guidelines for the Separate Account (the Investment
Guidelines) imposed certain percentage limitations on the amount that
the Separate Account could invest in each sector of the fixed income
security market and restricted investment to no more than five percent
(5%) of its assets in securities issued by a single issuer. Other
restrictions included that the Separate Account could invest no more
than twenty-five percent (25%) of its assets in securities rated Baa,
and a maximum of seventy-five percent (75%) of its assets in a
combination of securities that have been rated A or Baa by one or more
rating agency selected by the issuer of such securities. These
Investment Guidelines corresponded to the guidelines relating to the
quality of investments held in the segment of Prudential's General
Account to which the Non-Participating Annuity Contract was assigned.
Further, the Separate Account is required to be passively managed by
Prudential in a manner intended to maintain this asset/liability match.
7. Once the Separate Account was established, Prudential
transferred the Fixed Income Assets in-kind from its General Account to
the Separate Account. The Fixed Income Assets consisted entirely of a
dedicated bond portfolio, containing either publicly traded or
privately placed bonds.6 Further, the value of the Fixed Income
Assets transferred from the General Account represented the remaining
liabilities under the Non-Participating Annuity Contract plus an amount
in excess of such liabilities sufficient to establish a reserve as
required by applicable state insurance law. Prudential's intention was
to use the Fixed Income Assets to provide for the payment of benefits
and reasonable expenses related thereto under the terms of the
Participating Annuity Contract maintained by the Separate Account.
However, Prudential has also provided an irrevocable commitment of the
assets of its General Account to pay benefits to the Retirees under the
terms of the Participating Annuity Contract and the Separate Account.
For this reason, it is represented that there was no incentive for
Prudential to have transferred assets other than those of the highest
quality to the Separate Account. Accordingly, on December 31, 1991,
Prudential transferred Fixed Income Assets, valued at approximately $1
billion, from its General Account to the Separate Account.7
Prudential represents that this method of funding the Separate Account
avoided the transaction costs that would have been incurred, had assets
held in Prudential's General Account been liquidated and appropriate
securities been purchased on behalf of the Separate Account with the
proceeds from such a sale.
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\6\It is represented that a portfolio is considered dedicated if
there is a cash-flow match to the liabilities under the contract for
the first twelve months and thereafter a duration match (within one-
half year) on subsequent liabilities.
\7\Prudential represents that the in-kind transfer of the Fixed
Income Assets to the Separate Account also permitted Prudential to
recognize certain statutory gains on its financial statements. It is
represented that at the time of the transfer, the market value of
the transferred assets exceeded the book value at which the assets
had been carried on Prudential's financial statements. Because
assets in a separate account must be reported at market value, the
statutory income statement surplus reflected a gain in the amount of
the difference between book value and market value. As the surplus
of a mutual insurance company is the equivalent of equity capital,
it is represented that the surplus gain reflected on Prudential's
financial schedules reflected a strengthening of its financial
condition.
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8. Prudential is uncertain as to whether the transaction, as
consummated, involved violations of section 406(a) and 406(b) of the
Act. In this regard, the prohibited transaction analysis depends on
whether the Separate Account is deemed to hold ``plan assets'' that are
subject to the fiduciary responsibility provisions of the Act, such
that Prudential's transfer of such assets from the General Account to
the Separate Account may have constituted a direct or indirect transfer
of assets between a plan and a party in interest, described in section
406(a)(1) (A) and (D) of the Act.8
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\8\Section 29 CFR 2510.3-101(h) of the Department's regulations
provides, in part, that a separate account does not hold ``plan
assets'' for purposes of the Act, if it is maintained solely in
connection with fixed contractual obligations of the insurance
company under which the amounts payable to the plan are not affected
in any manner by the investment performance of the separate account.
In the opinion of Prudential, because there is a possibility that
the Plan may participate in the investment performance of the
Separate Account under the terms of the Participating Annuity
Contract, it would appear that the underlying assets of the Separate
Account are not eligible for this exception to the plan assets
regulation and that such assets are ``plan assets.''
Further, Prudential believes that the Separate Account could be
deemed to hold ``plan assets'' for purposes of the Act, because the
assets of the Separate Account do not appear to be held in
connection with a ``guaranteed benefit policy,'' as defined in
section 401(b)(2)(B) of the Act. Section 401(b)(2)(B), defines the
term ``guaranteed benefit policy'' to mean an insurance policy or
contract to the extent that such policy or contract provides for
benefits the amount of which is guaranteed by the insurer. Such term
includes any surplus in a separate account, but excludes any other
portion of a separate account. Under section 401(b)(2), the assets
of a plan are deemed to include such ``guaranteed benefit policy''
but are not, solely by reason of the issuance of such policy deemed
to include the assets of the insurer.
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If the Separate Account contained Plan assets, the question becomes
whether Prudential acted as a fiduciary with respect to the Separate
Account at the time the Fixed Income Assets were transferred. In
Prudential's view, exemptive relief from section 406(b) may be
necessary, because Prudential approved the assets transferred to the
Separate Account from the segment of Prudential's General Account that
formerly backed the Non-Participating Annuity Contract, or because
Prudential is the manager of the Separate Account, even though the
Separate Account did not hold any cash or other assets until after the
transfer took place. In this regard, however, Prudential represents
that Union Carbide acted as fiduciary with respect to the Plan, as
discussed more fully in paragraph number eleven below. Accordingly,
Prudential has requested exemptive relief from section 406(a) and
406(b) for the transaction described herein.
9. It is represented that all of the assets in the Separate Account
are and will be managed exclusively by Prudential or its affiliates and
that Prudential receives from the Separate Account certain customary
fees and charges to compensate for services performed and risks assumed
by Prudential. In this regard, Prudential receives an annual
administrative charge equal to .05% of the outstanding liabilities
under the terms of the Participating Annuity Contract and an annual
investment management and custodial fee equal to .45% of the value of
the Separate Account. Prudential also receives risk charges fixed at
.90% of the Participating Annuity Contract liability amount which
accrues daily beginning January 1, 1992. In this regard, it is
represented that such risk charges are deducted from the Separate
Account on a quarterly basis and that withdrawal of risk charges from
the Separate Account is permitted only to the extent that the assets in
the Separate Account exceed 107% of the contract liability amount of
the Participating Annuity Contract which is equivalent to 110% of the
actual benefit liabilities then remaining under the Participating
Annuity Contract. It is further represented that other than the fees
and charges described in this paragraph, Prudential does not receive
any part of the earnings in the Separate Account, and that the Plan
receives the entire benefit of favorable investment experience, if any,
in the Separate Account.
With respect to the fees Prudential receives from the Separate
Account, Prudential represents that for two reasons it cannot under any
circumstances receive more compensation in connection with the
provision of services to the Separate Account under the terms of the
Participating Annuity Contract than it was entitled to receive through
the single premium for the Non-Participating Annuity Contract when
initially purchased by Union Carbide. First, Prudential represents that
generally it charges higher premiums for a participating annuity
contract than for a non-participating annuity contract. However, with
respect to conversion of the Non-Participating Annuity Contract to the
Participating Annuity Contract that is the subject of this proposed
exemption, no additional premiums or other consideration, beyond the
single premium already paid by Union Carbide for the Non-Participating
Annuity Contract, were or will be charged by Prudential to Union
Carbide or the Plan in connection with the Participating Annuity
Contract.
Second, with regard to the fees and charges received by Prudential
under the terms of the Participating Annuity Contract, it is
represented that generally the same types of costs are taken into
account for purposes of calculating the premium required for a non-
participating annuity contract. It is further represented that because
such fees and charges are not the continuing obligation of the holder
of a non-participating annuity contract, they are not set forth in a
fee schedule but are primarily a matter of internal record keeping.
According to Prudential, similar fees and charges were built into the
single sum premium under the terms of the Non-Participating Annuity
Contract and were pro-rated for the purpose of the conversion to the
Participating Annuity Contract. It is represented that in accordance
with the terms of the Participating Annuity Contract, Prudential
transferred to the Separate Account assets attributable to the pro-
rated value of those internal fees and risk charges which had not yet
accrued under the Non-Participating Annuity Contract at the time of the
transfer. According to Prudential, it is entitled to reimbursement for
the amount of such internal fees and risk charges over the life of the
Participating Annuity Contract, and that such reimbursement does not
constitute additional compensation.9
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\9\Prudential has not requested relief for the institution of
the fee schedule nor the receipt of fees from the Separate Account
in accordance with the terms of the Participating Annuity Contract.
The Department is expressing no opinion as to whether the change in
the manner in which fees were and are charged to the Plans by
Prudential as a result of the conversion from the Non-Participating
Annuity Contract to a Participating Annuity Contract constituted a
violation of section 406 of the Act. Accordingly, no relief is
proposed, herein, beyond that covered by section 408(b)(2) of the
Act for the provision of services by Prudential to the Separate
Account or the receipt of fees for services rendered in connection
with the transaction described in this proposed exemption.
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10. Prior to the transfer of the Fixed Income Assets between the
General Account and Separate Account, Prudential hired an independent
accounting firm, Deloitte & Touche, to perform an independent appraisal
of each of the Fixed Income Assets. In preparing this appraisal,
Deloitte & Touche was provided with and reviewed information on: (a)
the historical and prospective financial credit risk of the issuers;
(b) the terms of the Fixed Income Assets; and (c) credit market data.
Deloitte & Touche represents that it has extensive experience in the
valuation of securities and that it receives less than one percent of
its income from Prudential. Further, Deloitte & Touche represents that
it had no present or contemplated future interest in the assets which
were the subject of the appraisal and had no personal interest or bias
with respect to the Fixed Income Assets or the parties involved.
Deloitte & Touche also represents that the compensation it received in
connection with preparation of the appraisal report was in no way
contingent on the conclusions drawn therein.
As described in paragraph number seven above, the Fixed Income
Assets initially transferred to the Separate Account were publicly and
privately placed debt instruments. In determining the fair market value
of privately placed Fixed Income Assets, Deloitte & Touche read and
analyzed summaries of pertinent provisions of the loan agreements,
including interest rates, collateral provisions, call provisions,
sinking fund provisions, and other terms having a material influence on
value. With respect to the publicly traded Fixed Income Assets,
Deloitte & Touche determined their value by applying the trading price
on the date of transfer to the number of securities transferred into
the Separate Account. Deloitte & Touche concluded that the publicly
traded Fixed Income Assets and the privately placed Fixed Income Assets
were valued, respectively, at $609,715,883 and $474,251,095, as of
December 31, 1991. Accordingly, the total fair market value of the
Fixed Income Assets was approximately $1.083 billion dollars, as of the
same date.
Initially due to delays in the availability of trade pricing
information, it is represented that the fair market value of the Fixed
Income Assets transferred into the Separate Account on December 31,
1991, was based on fair market value of such assets, as of December 27,
1991. This date was chosen for valuation purposes to insure that a
consistent valuation date could be applied to each of the Fixed Income
Assets. Once valuation information became available, Prudential,
complying with state insurance law, provided for the transfer to the
Separate Account of sufficient assets to create a reserve10 which
equaled or exceeded 103% of the value of the Participating Annuity
Contract liabilities on December 31, 1991.
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\1\0Prudential maintains that funds of the General Account
contributed in order to establish a reserve amount in the Separate
Account, as required under state insurance law, are equivalent to
``seed money,'' and should not be treated as ``plan assets'' for
purposes of the Act. In this regard, Prudential cites to the
analysis contained in Advisory Opinion 83-38A (July 22, 1983), for
the proposition that ``seed money'' allocated by an insurer to its
pooled separate accounts would not be treated as ``plan assets'' for
purposes of the Act and that the redemption of the units of
participation in these separate accounts by the insurer, according
to the rules governing the redemption rights of those participating
units, would not, solely by reason of the redemption, constitute a
violation of section 406(a)(1) (A) and (D) and 406 (b)(1) and (b)(2)
of the Act. Accordingly, Prudential has not requested exemptive
relief from section 406(a)(1) (A) and (D) and 406 (b)(1) and (b)(2)
of the Act with respect to the contribution to or with respect to
the withdrawal from the Separate Account of such reserve amounts. In
this regard, the Department, herein, is expressing no opinion
whether any such transactions would violate section 406 of the Act
and is offering no relief for such contribution or withdrawal of
``seed money.''
However, as the bulk of the assets in the Separate Account would
not constitute ``seed money'' under Prudential's analysis,
Prudential requests and the Department, herein, is proposing relief
for the transfer of assets from the General Account to the Separate
Account to the extent that such transaction may have constituted a
prohibited sale or exchange, or use of plan assets for the benefit
of a party in interest in violation of section 406(a)(1) (A) and (D)
of the Act.
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Following the transfer, the valuation of the assets in the Separate
Account and the calculation of the liabilities under the Participating
Annuity Contract were reconciled. This reconciliation of assets and
liabilities resulted in Prudential's transfer of two additional assets
(the Additional Assets) to the Separate Account on January 10, 1992, in
connection with three minor adjustments to the valuations. The transfer
of these Additional Assets was approved by Union Carbide. The three
adjustments are described in the three paragraphs immediately below.
First, the valuation, as of December 27, 1991, assumed all coupons
attached to the securities would be transferred to the Separate Account
on December 31, 1991. However, a $920,000 coupon payment was due and
paid to Prudential's General Account on December 30, 1991. Thus, the
value of the Additional Assets which were transferred to the Separate
Account equaled or exceeded the value of the coupon.
Second, the option pricing model utilized in the December 27th
appraisal overestimated the duration of some publicly traded bonds
which resulted in a $530,000 overstatement in the initial valuations of
these securities. It is represented that because these bonds were
actually subject to a high call probability, the model should have
assigned a duration of zero, instead of the three or four year duration
actually assumed.
Finally, the decline in interest rates between December 27, 1991,
and December 31, 1991, resulted in an increased market value for the
Separate Account, which caused the value of certain securities
tentatively transferred to the Separate Account to exceed the dollar
limitations established for the Separate Account by the Investment
Guidelines. The securities that exceeded these limitations were valued
at $900,000. Accordingly, they were replaced by portions of the
Additional Assets described in the paragraph below.
The Additional Assets transferred to the Separate Account in
connection with the reconciliation were valued at $3,576,650, as of
December 31, 1991. Although the value of these Additional Assets
exceeded the amount required to be transferred by approximately $1.2
million, these Additional Assets were selected, because they were the
smallest available denominations that met the Investment Guidelines.
11. It is represented that Union Carbide exercised fiduciary
discretion with respect to this proposed transaction. In this regard,
it is represented that Union Carbide is independent of Prudential in
that it is not affiliated with Prudential and receives less than one
percent of its annual income from Prudential.
Before reaching its conclusions on the proposed transaction, Union
Carbide, was provided with and reviewed the following information: (a)
the appraisals of the value of the Fixed Income Assets prepared by
Deloitte & Touche; (b) the terms of the Participating Annuity Contract,
including the compensation to be retained by Prudential pursuant to
such contract; (c) the calculation of the current value of the
liabilities under the Participating Annuity Contract performed by
Prudential using the methodology and assumptions, as set forth in the
Participating Annuity Contract; (d) the list of the Fixed Income Assets
selected by Prudential for transfer into the Separate Account; (e) a
copy of the Investment Guidelines for the portfolio of the Separate
Account; and (f) all additional information provided by Prudential or
requested by Union Carbide.
As fiduciary with respect to this transaction, Union Carbide
represents that it: (a) reviewed the general investment strategy
regarding the assets that were assigned to meet the liabilities under
the Non-Participating Annuity Contract; (b) reviewed the Investment
Guidelines of the Separate Account, and determined that such were
appropriate, and that the transfer of the Fixed Income Assets was
consistent with the Investment Guidelines; (c) reviewed the quality and
diversification of the Fixed Income Assets transferred to the Separate
Account and found such assets to be of high investment quality and
sufficiently diverse to protect the interests of the Plan; (d) approved
each of the Fixed Income Assets selected by Prudential from its General
Account before such assets were transferred into the Separate Account;
(e) reviewed the appraisal report prepared by Deloitte & Touche and
determined that such report was reliable and complete, notwithstanding
the fact that Deloitte & Touche relied on certain information provided
by Prudential; (f) reviewed and approved the methodology for valuing
the liabilities and the assumptions with respect to interest rates,
mortality, and expenses that are set forth in the Participating Annuity
Contract; (g) based on its review of the Deloitte & Touche appraisal
report and on Prudential's calculations of the current value of
contract liabilities, determined that the Fixed Income Assets were
transferred to the Separate Account at fair market value and were
sufficient to meet the liabilities due under the terms of the
Participating Annuity Contract, as of the date of the transfer; (h)
reviewed and approved the reconciliation as described more fully in
paragraph number ten above; (i) reviewed and analyzed the terms of the
Participating Annuity Contract, including the compensation Prudential
receives thereunder, and determined that such terms were at least as
favorable as those which could have been obtain in arm's length
negotiations with unrelated third parties; (j) determined that the
conversion was in the best interest of the Retirees, because it did not
affect Prudential's irrevocable commitment to use the assets in its
General Account to provide payment for benefits under the certificates
issued to the Retirees and because in the event Prudential becomes
insolvent, the assets in the Separate Account will be protected from
the claims of Prudential's general creditors; and (k) gave due
consideration to the cash flow of the liabilities under the terms of
the Participating Annuity Contract.
Accordingly, prior to the transfer of the Fixed Income Assets
between the General Account and the Separate Account, Union Carbide,
determined that the transaction was in the best interest of the Plan
and that adequate safeguards were adopted to protect the interest of
the Retirees and of the Plan and its participants and beneficiaries. In
addition, Union Carbide, acting as fiduciary, reviewed and approved the
risk charges described in paragraph nine above.\11\
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\1\1In this regard, the Department expects that Union Carbide,
acting as fiduciary to the Plan, prudently considered the
relationship of fees for services and risk charges paid by the Plan
to the level of services provided by Prudential to the Separate
Account and the risks assumed by Prudential in connection with the
Participating Annuity Contract.
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Five officers either of Union Carbide or Benefit Capital Management
Corporation (BCMC), a wholly-owned subsidiary of Union Carbide that
manages the investment portfolio of the Plan, were responsible for
carrying out Union Carbide's functions as a fiduciary with respect to
the transaction. As a group, it is represented that these individuals
were qualified in that they had extensive experience with sophisticated
investment analysis techniques, in-depth expertise relating to
investments suitable to the Plan, and skill in negotiating terms and
conditions of investments. These individuals had at their disposal
various outside experts and in-house professionals to advise them in
areas where more specialized expertise is required. It is represented
that these individuals were responsible, either directly or through
oversight of outside managers, for approximately $3.8 billion in assets
of plans sponsored by Union Carbide.
These individuals were employed by Union Carbide to perform the
analysis and evaluation of the transaction and to issue a fiduciary
report. Such a fiduciary report (the Original Report), as summarized
above in this paragraph eleven, was issued in March of 1992.
Subsequently, on February 3, 1993, one of the preparers of the Original
Report, a Senior Vice President of BCMC and the investment manager of
the Plan's fixed income portfolio, was arrested and incarcerated for
tax fraud. As a result of this event, on April 27, 1993, Union Carbide
terminated the employment of this individual (the Former Employee),
effective August 17, 1992. Thereafter, this Former Employee on August
31, 1993, was indicted for mail fraud, securities fraud, kickbacks with
respect to an employee benefit plan, and on February 2, 1994, pled
guilty in connection with these activities.
BCMC and Union Carbide are cooperating with the U.S. Attorney's
office in the investigation and prosecution of the matters described in
the paragraph above. In this regard, an investigation was conducted
under the direction of the law department of Union Carbide which found
no indication that anyone else was implicated or was aware of the
illegal activities of the Former Employee. It is represented that BCMC
had preventative practices and procedures in place at the time and has
enhanced such procedures, since the discovery of the wrongdoing on the
part of the Former Employee.
Union Carbide estimates that the loss to the Plan from the illegal
activities of the Former Employee totaled approximately $3.5 million.
In this regard, Union Carbide has made a claim against the insurer
which provides fraud and dishonesty coverage to BCMC and the Plans. In
addition, Union Carbide anticipates filing suit against various parties
seeking satisfactory recovery of the loss to the Plan.
Subsequently, three of the individuals who signed the Original
Report, plus a fourth individual, issued a supplemental fiduciary
report (the Supplemental Report), dated September 2, 1993. It is
represented that the Former Employee did not participate in the
preparation of the Supplemental Report. It is represented that the
Supplemental Report confirmed that the conversion of the Non-
Participating Annuity Contract to the Participating Annuity Contract
was in the best interest of the Retirees, because (1) such action does
not affect Prudential's irrevocable commitment to use its General
Account assets to provide payment for all benefits provided under the
certificates issued to Retirees, and (2) the assets in the Separate
Account should be protected from the claims of Prudential's general
creditors in the event of insolvency.
Subsequently, on March 28, 1994, the four individuals who signed
the Supplemental Report, plus the fixed income investment manager who
replaced the Former Employee, issued another report (the Restated
Report) which reached the identical conclusions in support of the
transaction which were issued in the Original Report. In this regard,
the Restated Report contained the following conclusions: (1) Any
earnings from the Separate Account that are not required to reimburse
certain risk charges, management fees and administrative fees will be
used to meet Plan liabilities; (2) in the event that the assets in the
Separate Account are insufficient to cover all Participating Annuity
Contract liabilities, Prudential will continue to provide the same
irrevocable commitment to use its general assets to provide payment of
all benefits provided under the Participating Annuity Contract; (3)
under no circumstances will Union Carbide or the Plan be required to
contribute additional assets to fund benefits under the Participating
Annuity Contract; (4) in the event of Prudential's insolvency, the
assets of the Separate Account should not be reached by Prudential's
creditors; (5) the transfer of assets permits the Separate Account to
avoid transaction costs in connection with the acquisition of a
suitable portfolio; (6) the type and quality of the assets transferred
to the Separate Account are consistent with the Separate Account's
investment guidelines; (7) based on a review of the Deloitte & Touche
appraisal report, the assets transferred to the Separate Account were
transferred at fair market value and were sufficient to meet the
liabilities due under the Non-Participating Annuity Contract as of the
date of the transfer; and (8) the transaction is at least as favorable
to current and former Plan participants and beneficiaries as an arm's
length transaction with an unrelated third party. Further the Restated
Report confirmed that Union Carbide would have performed the same
analysis and reached the same conclusions set forth in Original Report,
if the Former Employee had not participated in the original review of
the transaction.
The applicant maintains that exemption should be granted on the
basis of Union Carbide's Restated Report for the following reasons: (1)
Union Carbide, not the Former Employee individually, acted as the
fiduciary on behalf of the Plan; (2) the Former Employee was only one
of several persons assigned to carry out Union Carbide's duties as
fiduciary; (3) Union Carbide has reconfirmed each of its determinations
in the Original Report; (4) the securities transferred from the General
Account of Prudential into the Separate Account were in no way involved
with the Former Employee's improper activities; and (5) the indictment
of the Former Employee did not affect whether the transaction was in
the best interest of the Plan.
12. In addition to the responsibilities described above, as named
fiduciary on behalf of the Plan, Union Carbide is also responsible for
monitoring the performance of any investment manager that it appoints
on behalf of the Plan. Because the Separate Account is structured with
a ``buy and hold'' strategy, it is represented that relatively little
oversight should be required. As the transaction did not involve any
ongoing prohibited transaction, no specialized continuing oversight is
anticipated by Union Carbide. However, it is represented that Union
Carbide will yearly arrange for an independent audit of the Separate
Account for the purpose of reconciling the benefit payments made out of
the Separate Account, determining the remaining contract liability, and
calculating whether additional reserves are necessary, as the reserve
amount that is required to be maintained in the Separate Account may
vary with time and quality of the assets held in such Separate Account.
13. It is represented that Union Carbide received no payments or
other compensation in connection with the transaction, except to the
extent that Union Carbide received reimbursement for the ``direct
expenses'' of providing services to the Plan, pursuant to sections
408(b)(2) and 408(c)(2) of the Act.\12\ In addition, Prudential will
indemnify Union Carbide with respect to any action or threatened action
to which Union Carbide is made a party by reason of Union Carbide's
services as fiduciary.\13\
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\1\2 The Department expresses no opinion, herein, as to whether
the provision of services by Union Carbide and the compensation
received therefor satisfy the terms and conditions as set forth in
section 408(b)(2) of the Act.
\1\3The Department does not hereby construe any exculpatory
clauses agreed to between Union Carbide and Prudential, nor do such
agreements in any way modify the fiduciary duties and
responsibilities of either Union Carbide or Prudential with respect
to the Plan, as imposed by reason of part 4, title I, of the Act.
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14. In summary, Prudential, as applicant, represents that the
transaction met the statutory criteria for an exemption under section
408(a) of the Act because:
(a) Prudential transferred to the Separate Account sufficient
assets to create a reserve the value of which equaled or exceeded 103%
of value of the Participating Annuity Contract liabilities, as of
December 31, 1991;
(b) the fair market value of the Fixed Income Assets transferred
into the Separate Account was determined by an independent qualified
appraiser, as of the date the transaction was entered;
(c) Prudential irrevocably guarantees the payment of benefits to
the Retirees;
(d) no additional contribution from Union Carbide or the Plan was
or will be required to fund benefits to the Retirees;
(e) the Plan avoided transaction costs inherent in liquidating
assets of the General Account in order to initially fund the Separate
Account;
(f) funding the Participating Annuity Contract through the Separate
Account protects the Plan and the Retirees from the general creditors
of Prudential;
(g) prior to entering the transaction, Union Carbide, acting as
fiduciary on behalf of the Plan, determined that the transaction was
feasible, was in the interest of, and was protective of the Plan and
its participants and beneficiaries and would not affect the payment of
benefits to the Retirees;
(h) after full disclosure, including the provisions regarding the
compensation to be paid to Prudential, Union Carbide determined that
the terms of the transaction were at least as favorable as those
negotiated at arm's length with unrelated third parties in similar
transactions;
(i) prior to the conversion, Union Carbide negotiated, reviewed,
and approved the transaction, and will monitor the transaction;
(j) Union Carbide reviewed the appraisal and the transfer of each
of the assets into the Separate Account prior to entering into the
transaction; and
(k) according to Prudential, the Plan incurred no fees,
commissions, costs, expenses, or other charges associated with the
transaction and will pay no additional compensation as a result of the
conversion of the Non-Participating Annuity Contract to the
Participating Annuity Contract.
FOR FURTHER INFORMATION CONTACT: Angelena C. Le Blanc of the
Department, telephone (202) 219-8883. (This is not a toll-free number.)
Berean Capital, Inc. (Berean) Located in Chicago, Illinois
[Application No. D-9745]
Proposed Exemption
I. Transactions
A. Effective June 27, 1994, the restrictions of sections 406(a) and
407(a) of the Act and the taxes imposed by section 4975 (a) and (b) of
the Code by reason of section 4975(c)(1) (A) through (D) of the Code
shall not apply to the following transactions involving trusts and
certificates evidencing interests therein:
(1) The direct or indirect sale, exchange or transfer of
certificates in the initial issuance of certificates between the
sponsor or underwriter and an employee benefit plan when the sponsor,
servicer, trustee or insurer of a trust, the underwriter of the
certificates representing an interest in the trust, or an obligor is a
party in interest with respect to such plan;
(2) The direct or indirect acquisition or disposition of
certificates by a plan in the secondary market for such certificates;
and
(3) The continued holding of certificates acquired by a plan
pursuant to subsection I.A. (1) or (2).
Notwithstanding the foregoing, section I.A. does not provide an
exemption from the restrictions of sections 406(a)(1)(E), 406(a)(2) and
407 for the acquisition or holding of a certificate on behalf of an
Excluded Plan by any person who has discretionary authority or renders
investment advice with respect to the assets of that Excluded
Plan.14
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\1\4Section I.A. provides no relief from sections 406(a)(1)(E),
406(a)(2) and 407 for any person rendering investment advice to an
Excluded Plan within the meaning of section 3(21)(A)(ii) and
regulation 29 CFR 2510.3-21(c).
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B. Effective June 27, 1994, the restrictions of sections 406(b)(1)
and 406(b)(2) of the Act and the taxes imposed by section 4975 (a) and
(b) of the Code by reason of section 4975(c)(1)(E) of the Code shall
not apply to:
(1) The direct or indirect sale, exchange or transfer of
certificates in the initial issuance of certificates between the
sponsor or underwriter and a plan when the person who has discretionary
authority or renders investment advice with respect to the investment
of plan assets in the certificates is (a) an obligor with respect to 5
percent or less of the fair market value of obligations or receivables
contained in the trust, or (b) an affiliate of a person described in
(a); if:
(i) the plan is not an Excluded Plan;
(ii) solely in the case of an acquisition of certificates in
connection with the initial issuance of the certificates, at least 50
percent of each class of certificates in which plans have invested is
acquired by persons independent of the members of the Restricted Group
and at least 50 percent of the aggregate interest in the trust is
acquired by persons independent of the Restricted Group;
(iii) a plan's investment in each class of certificates does not
exceed 25 percent of all of the certificates of that class outstanding
at the time of the acquisition; and
(iv) immediately after the acquisition of the certificates, no more
than 25 percent of the assets of a plan with respect to which the
person has discretionary authority or renders investment advice are
invested in certificates representing an interest in a trust containing
assets sold or serviced by the same entity.15 For purposes of this
paragraph B.(1)(iv) only, an entity will not be considered to service
assets contained in a trust if it is merely a subservicer of that
trust;
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\1\5 For purposes of this exemption, each plan participating in
a commingled fund (such as a bank collective trust fund or insurance
company pooled separate account) shall be considered to own the same
proportionate undivided interest in each asset of the commingled
fund as its proportionate interest in the total assets of the
commingled fund as calculated on the most recent preceding valuation
date of the fund.
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(2) The direct or indirect acquisition or disposition of
certificates by a plan in the secondary market for such certificates,
provided that the conditions set forth in paragraphs B.(1) (i), (iii)
and (iv) are met; and
(3) The continued holding of certificates acquired by a plan
pursuant to subsection I.B. (1) or (2).
C. Effective June 27, 1994, the restrictions of sections 406(a),
406(b) and 407(a) of the Act, and the taxes imposed by section 4975(a)
and (b) of the Code by reason of section 4975(c) of the Code, shall not
apply to transactions in connection with the servicing, management and
operation of a trust, provided:
(1) such transactions are carried out in accordance with the terms
of a binding pooling and servicing arrangement; and
(2) the pooling and servicing agreement is provided to, or
described in all material respects in the prospectus or private
placement memorandum provided to, investing plans before they purchase
certificates issued by the trust.16
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\1\6In the case of a private placement memorandum, such
memorandum must contain substantially the same information that
would be disclosed in a prospectus if the offering of the
certificates were made in a registered public offering under the
Securities Act of 1933. In the Department's view, the private
placement memorandum must contain sufficient information to permit
plan fiduciaries to make informed investment decisions.
Notwithstanding the foregoing, section I.C. does not provide an
exemption from the restrictions of section 406(b) of the Act or from
the taxes imposed by reason of section 4975(c) of the Code for the
receipt of a fee by a servicer of the trust from a person other than
the trustee or sponsor, unless such fee constitutes a ``qualified
administrative fee'' as defined in section III.S.
D. Effective June 27, 1994, the restrictions of sections 406(a) and
407(a) of the Act, and the taxes imposed by sections 4975(a) and (b) of
the Code by reason of sections 4975(c)(1)(A) through (D) of the Code,
shall not apply to any transactions to which those restrictions or
taxes would otherwise apply merely because a person is deemed to be a
party in interest or disqualified person (including a fiduciary) with
respect to a plan by virtue of providing services to the plan (or by
virtue of having a relationship to such service provider described in
section 3(14)(F), (G), (H) or (I) of the Act or section 4975(e)(2)(F),
(G), (H) or (I) of the Code), solely because of the plan's ownership of
certificates.
II. General Conditions
A. The relief provided under Part I is available only if the
following conditions are met:
(1) The acquisition of certificates by a plan is on terms
(including the certificate price) that are at least as favorable to the
plan as they would be in an arm's-length transaction with an unrelated
party;
(2) The rights and interests evidenced by the certificates are not
subordinated to the rights and interests evidenced by other
certificates of the same trust;
(3) The certificates acquired by the plan have received a rating at
the time of such acquisition that is in one of the three highest
generic rating categories from either Standard & Poor's Corporation
(S&P's), Moody's Investors Service, Inc. (Moody's), Duff & Phelps Inc.
(D & P) or Fitch Investors Service, Inc. (Fitch);
(4) The trustee is not an affiliate of any member of the Restricted
Group. However, the trustee shall not be considered to be an affiliate
of a servicer solely because the trustee has succeeded to the rights
and responsibilities of the servicer pursuant to the terms of a pooling
and servicing agreement providing for such succession upon the
occurrence of one or more events of default by the servicer;
(5) The sum of all payments made to and retained by the
underwriters in connection with the distribution or placement of
certificates represents not more than reasonable compensation for
underwriting or placing the certificates; the sum of all payments made
to and retained by the sponsor pursuant to the assignment of
obligations (or interests therein) to the trust represents not more
than the fair market value of such obligations (or interests); and the
sum of all payments made to and retained by the servicer represents not
more than reasonable compensation for the servicer's services under the
pooling and servicing agreement and reimbursement of the servicer's
reasonable expenses in connection therewith; and
(6) The plan investing in such certificates is an ``accredited
investor'' as defined in Rule 501(a)(1) of Regulation D of the
Securities and Exchange Commission under the Securities Act of 1933.
B. Neither any underwriter, sponsor, trustee, servicer, insurer, or
any obligor, unless it or any of its affiliates has discretionary
authority or renders investment advice with respect to the plan assets
used by a plan to acquire certificates, shall be denied the relief
provided under Part I, if the provision of subsection II.A.(6) above is
not satisfied with respect to acquisition or holding by a plan of such
certificates, provided that (1) such condition is disclosed in the
prospectus or private placement memorandum; and (2) in the case of a
private placement of certificates, the trustee obtains a representation
from each initial purchaser which is a plan that it is in compliance
with such condition, and obtains a covenant from each initial purchaser
to the effect that, so long as such initial purchaser (or any
transferee of such initial purchaser's certificates) is required to
obtain from its transferee a representation regarding compliance with
the Securities Act of 1933, any such transferees will be required to
make a written representation regarding compliance with the condition
set forth in subsection II.A.(6) above.
III. Definitions
For purposes of this exemption:
A. Certificate means:
(1) a certificate--
(a) that represents a beneficial ownership interest in the assets
of a trust; and
(b) that entitles the holder to pass-through payments of principal,
interest, and/or other payments made with respect to the assets of such
trust; or
(2) a certificate denominated as a debt instrument--
(a) that represents an interest in a Real Estate Mortgage
Investment Conduit (REMIC) within the meaning of section 860D(a) of the
Internal Revenue Code of 1986; and
(b) that is issued by and is an obligation of a trust;
with respect to certificates defined in (1) and (2) above for which
Berean or any of its affiliates is either (i) the sole underwriter or
the manager or co-manager of the underwriting syndicate, or (ii) a
selling or placement agent.
For purposes of this exemption, references to ``certificates
representing an interest in a trust'' include certificates denominated
as debt which are issued by a trust.
B. Trust means an investment pool, the corpus of which is held in
trust and consists solely of:
(1) either
(a) secured consumer receivables that bear interest or are
purchased at a discount (including, but not limited to, home equity
loans and obligations secured by shares issued by a cooperative housing
association);
(b) secured credit instruments that bear interest or are purchased
at a discount in transactions by or between business entities
(including, but not limited to, qualified equipment notes secured by
leases, as defined in section III.T);
(c) obligations that bear interest or are purchased at a discount
and which are secured by single-family residential, multi-family
residential and commercial real property (including obligations secured
by leasehold interests on commercial real property);
(d) obligations that bear interest or are purchased at a discount
and which are secured by motor vehicles or equipment, or qualified
motor vehicle leases (as defined in section III.U);
(e) ``guaranteed governmental mortgage pool certificates,'' as
defined in 29 CFR 2510.3-101(i)(2);
(f) fractional undivided interests in any of the obligations
described in clauses (a)-(e) of this section B.(1);
(2) property which had secured any of the obligations described in
subsection B.(1);
(3) undistributed cash or temporary investments made therewith
maturing no later than the next date on which distributions are to made
to certificateholders; and
(4) rights of the trustee under the pooling and servicing
agreement, and rights under any insurance policies, third-party
guarantees, contracts of suretyship and other credit support
arrangements with respect to any obligations described in subsection
B.(1).
Notwithstanding the foregoing, the term ``trust'' does not include any
investment pool unless: (i) the investment pool consists only of assets
of the type which have been included in other investment pools, (ii)
certificates evidencing interests in such other investment pools have
been rated in one of the three highest generic rating categories by
S&P's, Moody's, D & P, or Fitch for at least one year prior to the
plan's acquisition of certificates pursuant to this exemption, and
(iii) certificates evidencing interests in such other investment pools
have been purchased by investors other than plans for at least one year
prior to the plan's acquisition of certificates pursuant to this
exemption.
C. Underwriter means:
(1) Berean;
(2) any person directly or indirectly, through one or more
intermediaries, controlling, controlled by or under common control with
Berean; or
(3) any member of an underwriting syndicate or selling group of
which Berean or a person described in (2) is a manager or co-manager
with respect to the certificates.
D. Sponsor means the entity that organizes a trust by depositing
obligations therein in exchange for certificates.
E. Master Servicer means the entity that is a party to the pooling
and servicing agreement relating to trust assets and is fully
responsible for servicing, directly or through subservicers, the assets
of the trust.
F. Subservicer means an entity which, under the supervision of and
on behalf of the master servicer, services loans contained in the
trust, but is not a party to the pooling and servicing agreement.
G. Servicer means any entity which services loans contained in the
trust, including the master servicer and any subservicer.
H. Trustee means the trustee of the trust, and in the case of
certificates which are denominated as debt instruments, also means the
trustee of the indenture trust.
I. Insurer means the insurer or guarantor of, or provider of other
credit support for, a trust. Notwithstanding the foregoing, a person is
not an insurer solely because it holds securities representing an
interest in a trust which are of a class subordinated to certificates
representing an interest in the same trust.
J. Obligor means any person, other than the insurer, that is
obligated to make payments with respect to any obligation or receivable
included in the trust. Where a trust contains qualified motor vehicle
leases or qualified equipment notes secured by leases, ``obligor''
shall also include any owner of property subject to any lease included
in the trust, or subject to any lease securing an obligation included
in the trust.
K. Excluded Plan means any plan with respect to which any member of
the Restricted Group is a ``plan sponsor'' within the meaning of
section 3(16)(B) of the Act.
L. Restricted Group with respect to a class of certificates means:
(1) each underwriter;
(2) each insurer;
(3) the sponsor;
(4) the trustee;
(5) each servicer;
(6) any obligor with respect to obligations or receivables included
in the trust constituting more than 5 percent of the aggregate
unamortized principal balance of the assets in the trust, determined on
the date of the initial issuance of certificates by the trust; or
(7) any affiliate of a person described in (1)-(6) above.
M. Affiliate of another person includes:
(1) Any person directly or indirectly, through one or more
intermediaries, controlling, controlled by, or under common control
with such other person;
(2) Any officer, director, partner, employee, relative (as defined
in section 3(15) of the Act), a brother, a sister, or a spouse of a
brother or sister of such other person; and
(3) Any corporation or partnership of which such other person is an
officer, director or partner.
N. Control means the power to exercise a controlling influence over
the management or policies of a person other than an individual.
O. A person will be independent of another person only if:
(1) such person is not an affiliate of that other person; and
(2) the other person, or an affiliate thereof, is not a fiduciary
who has investment management authority or renders investment advice
with respect to any assets of such person.
P. Sale includes the entrance into a forward delivery commitment
(as defined in section Q below), provided:
(1) The terms of the forward delivery commitment (including any fee
paid to the investing plan) are no less favorable to the plan than they
would be in an arm's length transaction with an unrelated party;
(2) The prospectus or private placement memorandum is provided to
an investing plan prior to the time the plan enters into the forward
delivery commitment; and
(3) At the time of the delivery, all conditions of this exemption
applicable to sales are met.
Q. Forward delivery commitment means a contract for the purchase or
sale of one or more certificates to be delivered at an agreed future
settlement date. The term includes both mandatory contracts (which
contemplate obligatory delivery and acceptance of the certificates) and
optional contracts (which give one party the right but not the
obligation to deliver certificates to, or demand delivery of
certificates from, the other party).
R. Reasonable compensation has the same meaning as that term is
defined in 29 CFR 2550.408c-2.
S. Qualified Administrative Fee means a fee which meets the
following criteria:
(1) the fee is triggered by an act or failure to act by the obligor
other than the normal timely payment of amounts owing in respect of the
obligations;
(2) the servicer may not charge the fee absent the act or failure
to act referred to in (1);
(3) the ability to charge the fee, the circumstances in which the
fee may be charged, and an explanation of how the fee is calculated are
set forth in the pooling and servicing agreement; and
(4) the amount paid to investors in the trust will not be reduced
by the amount of any such fee waived by the servicer.
T. Qualified Equipment Note Secured By A Lease means an equipment
note:
(a) which is secured by equipment which is leased;
(b) which is secured by the obligation of the lessee to pay rent
under the equipment lease; and
(c) with respect to which the trust's security interest in the
equipment is at least as protective of the rights of the trust as the
trust would have if the equipment note were secured only by the
equipment and not the lease.
U. Qualified Motor Vehicle Lease means a lease of a motor vehicle
where:
(a) the trust holds a security interest in the lease;
(b) the trust holds a security interest in the leased motor
vehicle; and
(c) the trust's security interest in the leased motor vehicle is at
least as protective of the trust's rights as the trust would receive
under a motor vehicle installment loan contract.
V. Pooling and Servicing Agreement means the agreement or
agreements among a sponsor, a servicer and the trustee establishing a
trust. In the case of certificates which are denominated as debt
instruments, ``Pooling and Servicing Agreement'' also includes the
indenture entered into by the trustee of the trust issuing such
certificates and the indenture trustee.
Effective Date: This exemption, if granted, will be effective
for transactions occurring on or after June 27, 1994.
Summary of Facts and Representations
1. Berean is a financial services company involved in securities
brokerage. It is registered as a broker-dealer with the Securities and
Exchange Commission under the Securities Exchange Act of 1934, and with
the National Association of Securities Dealers. Berean is incorporated
in the State of Delaware and is owned by two individual shareholders.
The applicant represents that Berean has extensive experience in
underwriting and trading of mortgage-backed and other asset-backed,
pass-through securities.
Trust Assets
2. Berean seeks exemptive relief to permit plans to invest in pass-
through certificates representing undivided interests in the following
categories of trusts: (1) single and multi-family residential or
commercial mortgage investment trusts;17 (2) motor vehicle
receivable investment trusts; (3) consumer or commercial receivables
investment trusts; and (4) guaranteed governmental mortgage pool
certificate investment trusts.18
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\1\7The Department notes that PTE 83-1 [48 FR 895, January 7,
1983], a class exemption for mortgage pool investment trusts, would
generally apply to trusts containing single-family residential
mortgages, provided that the applicable conditions of PTE 83-1 are
met. Berean requests relief for single-family residential mortgages
in this exemption because it would prefer one exemption for all
trusts of similar structure. However, Berean has stated that it may
still avail itself of the exemptive relief provided by PTE 83-1.
\1\8Guaranteed governmental mortgage pool certificates are
mortgage-backed securities with respect to which interest and
principal payable is guaranteed by the Government National Mortgage
Association (GNMA), the Federal Home Loan Mortgage Corporation
(FHLMC), or the Federal National Mortgage Association (FNMA). The
Department's regulation relating to the definition of plan assets
(29 CFR 2510.3-101(i)) provides that where a plan acquires a
guaranteed governmental mortgage pool certificate, the plan's assets
include the certificate and all of its rights with respect to such
certificate under applicable law, but do not, solely by reason of
the plan's holding of such certificate, include any of the mortgages
underlying such certificate. The applicant is requesting exemptive
relief for trusts containing guaranteed governmental mortgage pool
certificates because the certificates in the trusts may be plan
assets.
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3. Commercial mortgage investment trusts may include mortgages on
ground leases of real property. Commercial mortgages are frequently
secured by ground leases on the underlying property, rather than by fee
simple interests. The separation of the fee simple interest and the
ground lease interest is generally done for tax reasons. Properly
structured, the pledge of the ground lease to secure a mortgage
provides a lender with the same level of security as would be provided
by a pledge of the related fee simple interest. The terms of the ground
leases pledged to secure leasehold mortgages will in all cases be at
least ten years longer than the term of such mortgages.19
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\1\9Trust assets may also include obligations that are secured
by leasehold interests on residential real property. See PTE 90-32
involving Prudential-Bache Securities, Inc. (55 FR 23147, June 6,
1990 at 23150).
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Trust Structure
4. Each trust is established under a pooling and servicing
agreement between a sponsor, a servicer and a trustee. The sponsor or
servicer of a trust selects assets to be included in the trust. These
assets are receivables which may have been originated by a sponsor or
servicer of the trust, an affiliate of the sponsor or servicer, or by
an unrelated lender and subsequently acquired by the trust sponsor or
servicer.
On or prior to the closing date, the sponsor acquires legal title
to all assets selected for the trust, establishes the trust and
designates an independent entity as trustee. On the closing date, the
sponsor conveys to the trust legal title to the assets, and the trustee
issues certificates representing fractional undivided interests in the
trust assets. Berean, alone or together with other broker-dealers, acts
as underwriter or placement agent with respect to the sale of the
certificates. All of the public offerings of certificates made to date
and all of the public offerings of certificates presently contemplated
have been or are to be underwritten on a firm commitment basis. In
addition, Berean has privately placed certificates on both a firm
commitment and an agency basis. Berean may also act as the lead
underwriter for a syndicate of securities underwriters.
Certificateholders are entitled to receive monthly, quarterly or
semi-annually installments of principal and/or interest, or lease
payments due on the receivables, adjusted, in the case of payments of
interest, to a specified rate--the pass-through rate--which may be
fixed or variable.
When installments or payments are made on a semi-annual basis,
funds are not permitted to be commingled with the servicer's assets for
longer than would be permitted for a monthly-pay security. A segregated
account is established in the name of the trustee (on behalf of
certificateholders) to hold funds received between distribution dates.
The account is under the sole control of the trustee, who invests the
account's assets in short-term securities which have received a rating
comparable to the rating assigned to the certificates. In some cases,
the servicer may be permitted to make a single deposit into the account
once a month. When the servicer makes such monthly deposits, payments
received from obligors by the servicer may be commingled with the
servicer's assets during the month prior to deposit. In no event will
the period of time between receipt of funds by the servicer and deposit
of these funds in a segregated account exceed 45 days. Furthermore, in
those cases where distributions are made semi-annually, the servicer
will furnish a report on the operation of the trust to the trustee on a
monthly basis. At or about the time this report is delivered to the
trustee, it will be made available to certificateholders and delivered
to or made available to each rating agency that has rated the
certificates.
5. Some of the certificates will be multi-class certificates.
Berean requests exemptive relief for two types of multi-class
certificates: ``strip'' certificates and ``fast-pay/slow-pay''
certificates. Strip certificates are a type of security in which the
stream of interest payments on receivables is split from the flow of
principal payments and separate classes of certificates are
established, each representing rights to disproportionate payments of
principal and interest.\20\
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\20\It is the Department's understanding that where a plan
invests in REMIC ``residual'' interest certificates to which this
exemption applies, some of the income received by the plan as a
result of such investment may be considered unrelated business
taxable income to the plan, which is subject to income tax under the
Code. The Department emphasizes that the prudence requirement of
section 404(a)(1)(B) of the Act would require plan fiduciaries to
carefully consider this and other tax consequences prior to causing
plan assets to be invested in certificates pursuant to this
exemption.
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Fast-pay/slow-pay certificates involve the issuance of classes of
certificates having different stated maturities or the same maturities
with different payment schedules. In certain transactions of this type,
interest and/or principal payments received on the underlying
receivables are distributed first to the class of certificates having
the earliest stated maturity of principal, and/or earlier payment
schedule, and only when that class of certificates have been paid in
full (or has received a specified amount) will distributions be made
with respect to the second class of certificates. Distributions on
certificates having later stated maturities will proceed in like manner
until all the certificateholders have been paid in full. The only
difference between this multi-class pass-through arrangement and a
single-class pass-through arrangement is the order in which
distributions are made to certificateholders. In each case,
certificateholders will have a beneficial ownership interest in the
underlying assets. In neither case will the rights of a plan purchasing
a certificate be subordinated to the rights of another
certificateholder in the event of default on any of the underlying
obligations. In particular, if the amount available for distribution to
certificateholders is less than the amount required to be so
distributed, all senior certificateholders then entitled to receive
distributions will share in the amount distributed on a pro rata
basis.\21\
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\21\If a trust issues subordinated certificates, holders of such
subordinated certificates may not share in the amount distributed on
a pro rata basis with the senior certificateholders. The Department
notes that the exemption does not provide relief for plan investment
in such subordinated certificates.
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6. For tax reasons, the trust must be maintained as an essentially
passive entity. Therefore, both the sponsor's discretion and the
servicer's discretion with respect to assets included in a trust are
severely limited. Pooling and servicing agreements provide for the
substitution of receivables by the sponsor only in the event of defects
in documentation discovered within a short time after the issuance of
trust certificates. Any receivable so substituted is required to have
characteristics substantially similar to the replaced receivable and
will be at least as creditworthy as the replaced receivable.
In some cases, the affected receivable would be repurchased, with
the purchase price applied as a payment on the affected receivable and
passed through to certificateholders.
Parties to Transactions
7. The originator of a receivable is the entity that initially
lends money to a borrower (obligor), such as a homeowner or automobile
purchaser, or leases property to the lessee. The originator may either
retain a receivable in its portfolio or sell it to a purchaser, such as
a trust sponsor.
Originators of receivables included in the trusts will be entities
that originate receivables in the ordinary course of their business,
including finance companies for whom such origination constitutes the
bulk of their operations, financial institutions for whom such
origination constitutes a substantial part of their operations, and any
kind of manufacturer, merchant, or service enterprise for whom such
origination is an incidental part of its operations. Each trust may
contain assets of one or more originators. The originator of the
receivables may also function as the trust sponsor or servicer.
8. The sponsor will be one of three entities: (i) a special-purpose
corporation unaffiliated with the servicer, (ii) a special-purpose or
other corporation affiliated with the servicer, or (iii) the servicer
itself. Where the sponsor is not also the servicer, the sponsor's role
will generally be limited to acquiring the receivables to be included
in the trust, establishing the trust, designating the trustee, and
assigning the receivables to the trust.
9. The trustee of a trust is the legal owner of the obligations in
the trust. The trustee is also a party to or beneficiary of all the
documents and instruments deposited in the trust, and as such is
responsible for enforcing all the rights created thereby in favor of
certificateholders.
The trustee will be an independent entity, and therefore will be
unrelated to Berean, the trust sponsor or the servicer. Berean
represents that the trustee will be a substantial financial institution
or trust company experienced in trust activities. The trustee receives
a fee for its services, which will be paid by the servicer, sponsor or
the trust as specified in the pooling and servicing agreement. The
method of compensating the trustee which is specified in the pooling
and servicing agreement will be disclosed in the prospectus or private
placement memorandum relating to the offering of the certificates.
10. The servicer of a trust administers the receivables on behalf
of the certificateholders. The servicer's functions typically involve,
among other things, notifying borrowers of amounts due on receivables,
maintaining records of payments received on receivables and instituting
foreclosure or similar proceedings in the event of default. In cases
where a pool of receivables has been purchased from a number of
different originators and deposited in a trust, it is common for the
receivables to be ``subserviced'' by their respective originators and
for a single entity to ``master service'' the pool of receivables on
behalf of the owners of the related series of certificates. Where this
arrangement is adopted, a receivable continues to be serviced from the
perspective of the borrower by the local subservicer, while the
investor's perspective is that the entire pool of receivables is
serviced by a single, central master servicer who collects payments
from the local subservicers and passes them through to
certificateholders.
In some cases, the originator and servicer of receivables to be
included in a trust and the sponsor of the trust (though they
themselves may be related) will be unrelated to Berean. In other cases,
however, affiliates of Berean may originate or service receivables
included in a trust, or may sponsor a trust.
Certificate Price, Pass-Through Rate and Fees
11. Where the sponsor of a trust is not the originator of
receivables included in a trust, the sponsor generally purchases the
receivables in the secondary market, either directly from the
originator or from another secondary market participant. The price the
sponsor pays for a receivable is determined by competitive market
forces, taking into account payment terms, interest rate, quality, and
forecasts as to future interest rates.
As compensation for the receivables transferred to the trust, the
sponsor receives certificates representing the entire beneficial
interest in the trust, or the cash proceeds of the sale of such
certificates. If the sponsor receives certificates from the trust, the
sponsor sells all or a portion of these certificates for cash to
investors or securities underwriters. In some transactions, the sponsor
or an affiliate may retain a portion of the certificates for its own
account. In addition, in some transactions the originator may sell
receivables to a trust for cash. At the time of the sale, the trustee
would sell certificates to the public or to underwriters and use the
cash proceeds of the sale to pay the originator for receivables sold to
the trust. The transfer of the receivables to the trust by the sponsor,
the sale of certificates to investors, and the receipt of the cash
proceeds by the sponsor generally take place simultaneously.
12. The price of the certificates, both in the initial offering and
in the secondary market, is affected by market forces, including
investor demand, the pass-through interest rate on the certificates in
relation to the rate payable on investments of similar types and
quality, expectations as to the effect on yield resulting from
prepayment of underlying receivables, and expectations as to the
likelihood of timely payment.
The pass-through rate for certificates is equal to the interest
rate on receivables included in the trust minus a specified servicing
fee.22 This rate is generally determined by the same market forces
that determine the price of a certificate. The price of a certificate
and its pass-through, or coupon, rate together determine the yield to
investors. If an investor purchases a certificate at less than par,
that discount augments the stated pass-through rate; conversely, a
certificate purchased at a premium yields less than the stated coupon.
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\2\2The pass-through rate on certificates representing interests
in trusts holding leases is determined by breaking down lease
payments into ``principal'' and ``interest'' components based on an
implicit interest rate.
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13. As compensation for performing its servicing duties, the
servicer (who may also be the sponsor, and receive fees for acting in
that capacity) will retain the difference between payments received on
the receivables in the trust and payments payable (at the pass-through
rate) to certificateholders, except that in some cases a portion of the
payments on receivables may be paid to a third party, such as a fee
paid to a provider of credit support or deposited into a reserve fund.
Any funds on deposit in a reserve fund after the certificateholders
(and the credit enhancement provider, if any) have been paid in full
are generally paid to the sponsor or the servicer. The servicer may
receive additional compensation by having the use of the amounts paid
on the receivables between the time they are received by the servicer
and the time they are due to the trust (which time is set forth in the
pooling and servicing agreement). The servicer will be required to pay
the administrative expenses of servicing the trust, including, in some
cases, the trustee's fee, out of its servicing compensation.
The servicer is also compensated to the extent it may provide
credit enhancement to the trust or otherwise arrange to obtain credit
support from another party. This ``credit support fee'' may be
aggregated with other servicing fees, and is either paid out of the
interest income received on the receivables in excess of the pass-
through rate or paid in a lump sum at the time the trust is
established.
14. The servicer may be entitled to retain certain administrative
fees paid by a third party, usually the obligor. These administrative
fees fall into three categories: (a) prepayment fees; (b) late payment
and payment extension fees and fees related to the modification of the
terms of an obligation as permitted by the provisions of the pooling
and servicing agreement (including the partial release of collateral to
the extent provided therein); and (c) fees and charges associated with
foreclosure or repossession, or other conversion of a secured position
into cash proceeds, upon default of an obligation.
Compensation payable to the servicer will be set forth or referred
to in the pooling and servicing agreement and described in reasonable
detail in the prospectus or private placement memorandum relating to
the certificates.
15. Payments on receivables may be made by obligors to the servicer
at various times during the period preceding any date on which pass-
through payments to the trust are due. In some cases, the pooling and
servicing agreement may permit the servicer to place these payments in
non-interest bearing accounts in itself or to commingle such payments
with its own funds prior to the distribution dates. In these cases, the
servicer would be entitled to the benefit derived from the use of the
funds between the date of payment on a receivable and the pass-through
date. Commingled payments may not be protected from the creditors of
the servicer in the event of the servicer's bankruptcy or receivership.
In those instances when payments on receivables are held in non-
interest bearing accounts or are commingled with the servicer's own
funds, the servicer is required to deposit these payments by a date
specified in the pooling and servicing agreement into an account from
which the trustee makes payments to certificateholders.
16. Berean will receive a fee in connection with the securities
underwriting or private placement of certificates. In a securities
underwriting, this fee would normally consist of the difference between
what Berean receives for the certificates that it distributes and what
it pays the sponsor for those certificates. In some public offerings,
however, Berean may sell certificates on an agency basis in a best
efforts underwriting. In those cases, Berean would receive an agency
commission paid by the sponsor plus reimbursement for out-of-pocket
expenses. In a private placement, the fee normally takes the form of an
agency commission paid by the sponsor.
Purchase of Receivables by the Servicer
17. The applicant represents that as the principal amount of the
receivables in a trust is reduced by payment, the cost of administering
the trust generally increases, making the servicing of the trust
prohibitively expensive at some point. Consequently, the pooling and
servicing agreement generally provides that the servicer may purchase
the receivables remaining in the trust when the aggregate unpaid
balance payable on the receivables is reduced to a specified percentage
(usually 5 to 10 percent) of the initial aggregate unpaid balance.
The purchase price of a receivable is specified in the pooling and
servicing agreement and will be at least equal to: (1) the unpaid
principal balance on the receivable plus accrued interest, less any
unreimbursed advances of principal made by the servicer; or (2) the
greater of (a) the amount in (1) or (b) the fair market value of such
obligations in the case of a REMIC, or the fair market value of the
certificates in the case of a trust that is not a REMIC.
Certificate Ratings
18. The certificates will have received one of the three highest
ratings available from either S&P's, Moody's, D&P or Fitch. Insurance
or other credit support (such as surety bonds, letters of credit,
guarantees, or the creation of a class of certificates with
subordinated cash flow) will be obtained by the trust sponsor to the
extent necessary for the certificates to attain the desired rating. The
amount of this credit support is set by the rating agencies at a level
that is a multiple of the worst historical net credit loss experience
for the type of obligations included in the issuing trust.
Provision of Credit Support
19. In some cases, the master servicer, or an affiliate of the
master servicer, may provide credit support to the trust (i.e. act as
an insurer). In these cases, the master servicer, in its capacity as
servicer, will first advance funds to the full extent that it
determines that such advances will be recoverable (a) out of late
payments by the obligors, (b) from the credit support provider (which
may be itself) or, (c) in the case of a trust that issues subordinated
certificates, from amounts otherwise distributable to holders of
subordinated certificates, and the master servicer will advance such
funds in a timely manner. When the servicer is the provider of the
credit support and provides its own funds to cover defaulted payments,
it will do so either on the initiative of the trustee, or on its own
initiative on behalf of the trustee, but in either event it will
provide such funds to cover payments to the full extent of its
obligations under the credit support mechanism. In some cases, however,
the master servicer may not be obligated to advance funds but instead
would be called upon to provide funds to cover defaulted payments to
the full extent of its obligations as insurer. However, a master
servicer typically can recover advances either from the provider of
credit support or from future payments on the affected assets.
If the master servicer fails to advance funds, fails to call upon
the credit support mechanism to provide funds to cover delinquent
payments, or otherwise fails in its duties, the trustee would be
required and would be able to enforce the certificateholders' rights,
as both a party to the pooling and servicing agreement and the owner of
the trust estate, including rights under the credit support mechanism.
Therefore, the trustee, who is independent of the servicer, will have
the ultimate right to enforce the credit support arrangement.
When a master servicer advances funds, the amount so advanced is
recoverable by the servicer out of future payments on receivables held
by the trust to the extent not covered by credit support. However,
where the master servicer provides credit support to the trust, there
are protections in place to guard against a delay in calling upon the
credit support to take advantage of the fact that the credit support
declines proportionally with the decrease in the principal amount of
the obligations in the trust as payments on receivables are passed
through to investors. These safeguards include:
(a) There is often a disincentive to postponing credit losses
because the sooner repossession or foreclosure activities are
commenced, the more value that can be realized on the security for the
obligation;
(b) The master servicer has servicing guidelines which include a
general policy as to the allowable delinquency period after which an
obligation ordinarily will be deemed uncollectible. The pooling and
servicing agreement will require the master servicer to follow its
normal servicing guidelines and will set forth the master servicer's
general policy as to the period of time after which delinquent
obligations ordinarily will be considered uncollectible;
(c) As frequently as payments are due on the receivables included
in the trust (monthly, quarterly or semi-annually as set forth in the
pooling and servicing agreement), the master servicer is required to
report to the independent trustee the amount of all past-due payments
and the amount of all servicer advances, along with other current
information as to collections on the receivables and draws upon the
credit support. Further, the master servicer is required to deliver to
the trustee annually a certificate of an executive officer of the
master servicer stating that a review of the servicing activities has
been made under such officer's supervision, and either stating that the
master servicer has fulfilled all of its obligations under the pooling
and servicing agreement or, if the master servicer has defaulted under
any of its obligations, specifying any such default. The master
servicer's reports are reviewed at least annually by independent
accountants to ensure that the master servicer is following its normal
servicing standards and that the master servicer's reports conform to
the master servicer's internal accounting records. The results of the
independent accountants' review are delivered to the trustee; and
(d) The credit support has a ``floor'' dollar amount that protects
investors against the possibility that a large number of credit losses
might occur towards the end of the life of the trust, whether due to
servicer advances or any other cause. Once the floor amount has been
reached, the servicer lacks an incentive to postpone the recognition of
credit losses because the credit support amount becomes a fixed dollar
amount, subject to reduction only for actual draws. From the time that
the floor amount is effective until the end of the life of the trust,
there are no proportionate reductions in the credit support amount
caused by reductions in the pool principal balance. Indeed, since the
floor is a fixed dollar amount, the amount of credit support ordinarily
increases as a percentage of the pool principal balance during the
period that the floor is in effect.
Disclosure
20. In connection with the original issuance of certificates, the
prospectus or private placement memorandum will be furnished to
investing plans. The prospectus or private placement memorandum will
contain information material to a fiduciary's decision to invest in the
certificates, including:
(a) Information concerning the payment terms of the certificates,
the rating of the certificates, and any material risk factors with
respect to the certificates;
(b) A description of the trust as a legal entity and a description
of how the trust was formed by the seller/servicer or other sponsor of
the transaction;
(c) Identification of the independent trustee for the trust;
(d) A description of the receivables contained in the trust,
including the types of receivables, the diversification of the
receivables, their principal terms, and their material legal aspects;
(e) A description of the sponsor and servicer;
(f) A description of the pooling and servicing agreement, including
a description of the seller's principal representations and warranties
as to the trust assets and the trustee's remedy for any breach thereof;
a description of the procedures for collection of payments on
receivables and for making distributions to investors, and a
description of the accounts into which such payments are deposited and
from which such distributions are made; identification of the servicing
compensation and any fees for credit enhancement that are deducted from
payments on receivables before distributions are made to investors; a
description of periodic statements provided to the trustee, and
provided to or made available to investors by the trustee; and a
description of the events that constitute events of default under the
pooling and servicing contract and a description of the trustee's and
the investors' remedies incident thereto;
(g) A description of the credit support;
(h) A general discussion of the principal federal income tax
consequences of the purchase, ownership and disposition of the pass-
through securities by a typical investor;
(i) A description of the underwriters' plan for distributing the
pass-through securities to investors; and
(j) Information about the scope and nature of the secondary market,
if any, for the certificates.
21. Reports indicating the amount of payments of principal and
interest are provided to certificateholders at least as frequently as
distributions are made to certificateholders. Certificateholders will
also be provided with periodic information statements setting forth
material information concerning the underlying assets, including, where
applicable, information as to the amount and number of delinquent and
defaulted loans or receivables.
22. In the case of a trust that offers and sells certificates in a
registered public offering, the trustee, the servicer or the sponsor
will file such periodic reports as may be required to be filed under
the Securities Exchange Act of 1934. Although some trusts that offer
certificates in a public offering will file quarterly reports on Form
10-Q and Annual Reports on Form 10-K, many trusts obtain, by
application to the Securities and Exchange Commission, a complete
exemption from the requirement to file quarterly reports on Form 10-Q
and a modification of the disclosure requirements for annual reports on
Form 10-K. If such an exemption is obtained, these trusts normally
would continue to have the obligation to file current reports on Form
8-K to report material developments concerning the trust and the
certificates. While the Securities and Exchange Commission's
interpretation of the periodic reporting requirements is subject to
change, periodic reports concerning a trust will be filed to the extent
required under the Securities Exchange Act of 1934.
23. At or about the time distributions are made to
certificateholders, a report will be delivered to the trustee as to the
status of the trust and its assets, including underlying obligations.
Such report will typically contain information regarding the trust's
assets, payments received or collected by the servicer, the amount of
prepayments, delinquencies, servicer advances, defaults and
foreclosures, the amount of any payments made pursuant to any credit
support, and the amount of compensation payable to the servicer. Such
report also will be delivered to or made available to the rating agency
or agencies that have rated the trust's certificates.
In addition, promptly after each distribution date,
certificateholders will receive a statement prepared by the trustee
summarizing information regarding the trust and its assets. Such
statement will include information regarding the trust and its assets,
including underlying receivables. Such statement will typically contain
information regarding payments and prepayments, delinquencies, the
remaining amount of the guaranty or other credit support and a
breakdown of payments between principal and interest.
Secondary Market Transactions
24. It is Berean's normal policy to attempt to make a market for
securities for which it is lead or co-managing underwriter, and it is
Berean's intention to attempt to make a market for any certificates for
which Berean is lead or co-managing underwriter.
Retroactive Relief
25. Berean represents that it has engaged in transactions related
to mortgage-backed and asset-backed securities based on the assumption
that retroactive relief would not be granted. However, it is possible
that some transactions may have occurred that would be prohibited. For
example, because many certificates are held in street or nominee name,
it is not always possible to identify whether the percentage interest
of plans in a trust is or is not ``significant'' for purposes of the
Department's regulation relating to the definition of plan assets (29
CFR 2510.3-101(f)). These problems are compounded as transactions occur
in the secondary market. In addition, with respect to the ``publicly-
offered security'' exception contained in that regulation (29 CFR
2510.3-101(b)), it is difficult to determine whether each purchaser of
a certificate is independent of all other purchasers.
Therefore, Berean requests relief retroactive for transactions
which have occurred on or after June 27, 1994, the date Berean
originally filed its exemption application with the Department.
Summary
26. In summary, the applicant represents that the transactions for
which exemptive relief is requested satisfy the statutory criteria of
section 408(a) of the Act due to the following:
(a) The trusts contain ``fixed pools'' of assets. There is little
discretion on the part of the trust sponsor to substitute receivables
contained in the trust once the trust has been formed;
(b) Certificates in which plans invest will have been rated in one
of the three highest rating categories by S&P's, Moody's, D&P or Fitch.
Credit support will be obtained to the extent necessary to attain the
desired rating;
(c) All transactions for which Berean seeks exemptive relief will
be governed by the pooling and servicing agreement, which is made
available to plan fiduciaries for their review prior to the plan's
investment in certificates;
(d) Exemptive relief from sections 406(b) and 407 for sales to
plans is substantially limited; and
(e) Berean has made, and anticipates that it will continue to make,
a secondary market in certificates.
Discussion of Proposed Exemption
I. Differences between Proposed Exemption and Class Exemption PTE 83-1
The exemptive relief proposed herein is similar to that provided in
PTE 81-7 [46 FR 7520, January 23, 1981], Class Exemption for Certain
Transactions Involving Mortgage Pool Investment Trusts, amended and
restated as PTE 83-1 [48 FR 895, January 7, 1983].
PTE 83-1 applies to mortgage pool investment trusts consisting of
interest-bearing obligations secured by first or second mortgages or
deeds of trust on single-family residential property. The exemption
provides relief from sections 406(a) and 407 for the sale, exchange or
transfer in the initial issuance of mortgage pool certificates between
the trust sponsor and a plan, when the sponsor, trustee or insurer of
the trust is a party-in-interest with respect to the plan, and the
continued holding of such certificates, provided that the conditions
set forth in the exemption are met. PTE 83-1 also provides exemptive
relief from section 406(b)(1) and (b)(2) of the Act for the above-
described transactions when the sponsor, trustee or insurer of the
trust is a fiduciary with respect to the plan assets invested in such
certificates, provided that additional conditions set forth in the
exemption are met. In particular, section 406(b) relief is conditioned
upon the approval of the transaction by an independent fiduciary.
Moreover, the total value of certificates purchased by a plan must not
exceed 25 percent of the amount of the issue, and at least 50 percent
of the aggregate amount of the issue must be acquired by persons
independent of the trust sponsor, trustee or insurer. Finally, PTE 83-1
provides conditional exemptive relief from section 406(a) and (b) of
the Act for transactions in connection with the servicing and operation
of the mortgage trust.
Under PTE 83-1, exemptive relief for the above transactions is
conditioned upon the sponsor and the trustee of the mortgage trust
maintaining a system for insuring or otherwise protecting the pooled
mortgage loans and the property securing such loans, and for
indemnifying certificateholders against reductions in pass-through
payments due to defaults in loan payments or property damage. This
system must provide such protection and indemnification up to an amount
not less than the greater of one percent of the aggregate principal
balance of all trust mortgages or the principal balance of the largest
mortgage.
The exemptive relief proposed herein differs from that provided by
PTE 83-1 in the following major respects: (1) The proposed exemption
provides individual exemptive relief rather than class relief; (2) The
proposed exemption covers transactions involving trusts containing a
broader range of assets than single-family residential mortgages; (3)
Instead of requiring a system for insuring the pooled receivables, the
proposed exemption conditions relief upon the certificates having
received one of the three highest ratings available from S&P's,
Moody's, D&P or Fitch (insurance or other credit support would be
obtained only to the extent necessary for the certificates to attain
the desired rating); and (4) The proposed exemption provides more
limited section 406(b) and section 407 relief for sales transactions.
II. Ratings of Certificates
After consideration of the representations of the applicant and
information provided by S&P's, Moody's, D&P and Fitch, the Department
has decided to condition exemptive relief upon the certificates having
attained a rating in one of the three highest generic rating categories
from S&P's, Moody's, D&P or Fitch. The Department believes that the
rating condition will permit the applicant flexibility in structuring
trusts containing a variety of mortgages and other receivables while
ensuring that the interests of plans investing in certificates are
protected. The Department also believes that the ratings are indicative
of the relative safety of investments in trusts containing secured
receivables. The Department is conditioning the proposed exemptive
relief upon each particular type of asset-backed security having been
rated in one of the three highest rating categories for at least one
year and having been sold to investors other than plans for at least
one year.\23\
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\23\In referring to different ``types'' of asset-backed
securities, the Department means certificates representing interests
in trusts containing different ``types'' of receivables, such as
single family residential mortgages, multi-family residential
mortgages, commercial mortgages, home equity loans, auto loan
receivables, installment obligations for consumer durables secured
by purchase money security interests, etc. The Department intends
this condition to require that certificates in which a plan invests
are of the type that have been rated (in one of the three highest
generic rating categories by S&P's, D&P, Fitch or Moody's) and
purchased by investors other than plans for at least one year prior
to the plan's investment pursuant to the proposed exemption. In this
regard, the Department does not intend to require that the
particular assets contained in a trust must have been ``seasoned''
(e.g., originated at least one year prior to the plan's investment
in the trust).
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III. Limited Section 406(b) and Section 407(a) Relief for Sales
Berean represents that in some cases a trust sponsor, trustee,
servicer, insurer, and obligor with respect to receivables contained in
a trust, or an underwriter of certificates may be a pre-existing party
in interest with respect to an investing plan.\24\ In these cases, a
direct or indirect sale of certificates by that party in interest to
the plan would be a prohibited sale or exchange of property under
section 406(a)(1)(A) of the Act.\25\ Likewise, issues are raised under
section 406(a)(1)(D) of the Act where a plan fiduciary causes a plan to
purchase certificates where trust funds will be used to benefit a party
in interest.
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\24\In this regard, we note that the exemptive relief proposed
herein is limited to certificates with respect to which Berean or
any of its affiliates is either (a) the sole underwriter or manager
or co-manager of the underwriting syndicate, or (b) a selling or
placement agent.
\25\The applicant represents that where a trust sponsor is an
affiliate of Berean, sales to plans by the sponsor may be exempt
under PTE 75-1, Part II (relating to purchases and sales of
securities by broker-dealers and their affiliates), if Berean is not
a fiduciary with respect to plan assets to be invested in
certificates.
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Additionally, Berean represents that a trust sponsor, servicer,
trustee, insurer, and obligor with respect to receivables contained in
a trust, or an underwriter of certificates representing an interest in
a trust may be a fiduciary with respect to an investing plan. Berean
represents that the exercise of fiduciary authority by any of these
parties to cause the plan to invest in certificates representing an
interest in the trust would violate section 406(b)(1), and in some
cases section 406(b)(2), of the Act.
Moreover, Berean represents that to the extent there is a plan
asset ``look through'' to the underlying assets of a trust, the
investment in certificates by a plan covering employees of an obligor
under receivables contained in a trust may be prohibited by sections
406(a) and 407(a) of the Act.
After consideration of the issues involved, the Department has
determined to provide the limited sections 406(b) and 407(a) relief as
specified in the proposed exemption.
FOR FURTHER INFORMATION CONTACT: Gary Lefkowitz of the Department,
telephone (202) 219-8881. (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 4th day of August, 1994.
Ivan Strasfeld,
Director of Exemption Determinations, Pension and Welfare Benefits
Administration,U.S. Department of Labor.
[FR Doc. 94-19414 Filed 8-8-94; 8:45 am]
BILLING CODE 4510-29-P
