erisa benefit plan investment management agreements...
TRANSCRIPT
The audio portion of the conference may be accessed via the telephone or by using your computer's
speakers. Please refer to the instructions emailed to registrants for additional information. If you
have any questions, please contact Customer Service at 1-800-926-7926 ext. 10.
Presenting a live 90-minute webinar with interactive Q&A
ERISA Benefit Plan Investment Management
Agreements: Selecting 3(38) Investment
Managers, Structuring the IMA Documenting the Relationship to Minimize Risks for Plan Sponsors and Investment Advisers
Today’s faculty features:
1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific
TUESDAY, APRIL 18, 2017
Sharon M. Goodman, Principal, Slevin & Hart, Washington, D.C.
David A. Russell, CFA, Senior Investment Strategist, Senior Consultant,
Investment Performance Services, Newtown, Pa.
Tips for Optimal Quality
Sound Quality
If you are listening via your computer speakers, please note that the quality
of your sound will vary depending on the speed and quality of your internet
connection.
If the sound quality is not satisfactory, you may listen via the phone: dial
1-866-258-2056 and enter your PIN when prompted. Otherwise, please
send us a chat or e-mail [email protected] immediately so we can
address the problem.
If you dialed in and have any difficulties during the call, press *0 for assistance.
Viewing Quality
To maximize your screen, press the F11 key on your keyboard. To exit full screen,
press the F11 key again.
FOR LIVE EVENT ONLY
Continuing Education Credits
In order for us to process your continuing education credit, you must confirm your
participation in this webinar by completing and submitting the Attendance
Affirmation/Evaluation after the webinar.
A link to the Attendance Affirmation/Evaluation will be in the thank you email
that you will receive immediately following the program.
For additional information about continuing education, call us at 1-800-926-7926
ext. 35.
FOR LIVE EVENT ONLY
Program Materials
If you have not printed the conference materials for this program, please
complete the following steps:
• Click on the ^ symbol next to “Conference Materials” in the middle of the left-
hand column on your screen.
• Click on the tab labeled “Handouts” that appears, and there you will see a
PDF of the slides for today's program.
• Double click on the PDF and a separate page will open.
• Print the slides by clicking on the printer icon.
FOR LIVE EVENT ONLY
The opinions expressed in this presentation are those of the speaker. The International Foundation disclaims responsibility for views expressed and statements made by the program speakers.
ERISA Benefit Plan Investment
Management Arrangements
Presented by:
Sharon Goodman, Esq. David A. Russell, CFA Principal Senior Investment Strategist
Slevin & Hart, P.C. Investment Performance Services, LLC
Washington, D.C. Newtown, PA
(202) 797-8700 (215) 867-2330
[email protected] [email protected]
www.slevinhart.com www.ips-net.com
April 18, 2017
Presentation Overview
I. Due Diligence and Selection of ERISA 3(38) Investment
Manager Fiduciaries – David Russell
II. Negotiating and Contracting With ERISA Section 3(38)
Discretionary Investment Managers – Sharon Goodman
III. Monitoring ERISA Section 3(38) Discretionary Managers –
David Russell
IV. Questions
Part I
Due Diligence and
Selection of ERISA 3(38) Investment
Manager Fiduciaries
David Russell
7
What is a Section 3(21) vs. Section 3(38) Fiduciary?
ERISA Section 3(21) provides that any party giving investment advice for a
fee is a plan fiduciary. Investment Consultants traditionally fall into this
category and their contractual duties are to advise, report, monitor and
recommend, but they have no discretion or authority to make decisions or
implement changes to the plan.
ERISA Section 3(28) defines “investment managers” who are also plan
fiduciaries, but they are specifically delegated the discretion, authority and
responsibility for making and implementing investment decisions.
Traditionally, investment manager discretion has been contractually limited to
selecting, buying, holding and selling specific types of securities and are
subject to specific limitations and guidelines as specified in a written
Investment Policy Statement.
The main difference between ERISA Section 3(21) and ERISA Section
3(38) is discretion
8
What is a Section 3(21) vs. Section 3(38) Fiduciary?
Delegation of fiduciary control from Trustees to investment manager
only occurs if manager is ERISA Section 3(38) fiduciary.
Plan sponsors are increasingly considering delegating much or all of the
investment decision making to consultants and/or investment managers.
This concept has been referred to by several terms, including:
• Discretionary Consulting
• Discretionary Management
• Outsourced Chief Investment Officer (OCIO)
Regardless of the term used, or the type of organization providing the service,
they are plan fiduciaries that have discretion over plan assets and have the
authority to make decisions. They therefore fall under ERISA Section 3(38)
definition of an “investment manager.”
That also means they have legal responsibility and liability for their decisions.
9
10
Selecting ERISA 3(38) Fiduciaries
Potential Vendors:
ERISA Section 3(38) Investment Manager Fiduciaries providing OCIO or
Discretionary services can be:
• Investment Managers
• Investment Consultants
• Financial Planners
• Banks
• Insurance Companies
• Mutual Fund Companies
• Other Financial Institutions
Due Diligence Process:
• Trustees should document their due diligence process in selecting a 3(38)
fiduciary.
• The process should be comprehensive and thorough - Trust but verify!
• Trustees still have a duty to monitor the fiduciary!
11
The Due Diligence Process
Using a written Request For Proposal (RFP) process is typical:
• Provides written documentation of the process;
• Comprehensive information is obtained;
• Questions cover all relevant services and standards of performance;
• Structures information in a common format, which makes it easier to rate
and rank vendors;
• Provides competitive market data for services and fees.
12
The Due Diligence Process
1. Firm Data
2. Legal and Regulatory
3. Business Continuity, Disaster Recovery, Data Integrity
4. Operations and Trading
5. Investment Philosophy and Strategy
6. Track Record
7. Fees
13
The Due Diligence Process
Request For Proposal (RFP) questions typically cover:
1) Firm Data:
• Location, legal structure, ownership, history, revenue, assets managed,
management, organizational structure, number of employees, staff
turnover.
• Range and number of firm-wide products and services offered,
• Types and longevity of clients.
• Experience and staffing of 3(38) Discretionary/OCIO services:
• Number, nature, longevity and size of current 3(38) clients;
• Number, background, experience and history of staff;
• References
• Personnel Policies and Practices: Diversity, non-discrimination,
compensation structure and incentives.
14
The Due Diligence Process
Request For Proposal (RFP) questions typically cover:
2) Legal and Regulatory:
• SEC, FINRA or other registrations (Form ADV Parts I and II)
• Regulatory investigations, complaints or disciplinary actions (Edgar.com)
• Qualified Professional Asset Manager (QPAM) status
• Date and outcome of any regulatory reviews
• Litigation history
• Insurance Coverage: Professional Liability, E&O, D&O, ERISA Fiduciary
Liability and Bonding
• Code of Ethics
• Personnel Compliance – Policies, staffing, monitoring process, reporting
exceptions
15
The Due Diligence Process
Request For Proposal (RFP) questions typically cover:
3) Business Continuity, Disaster Recovery, Data Integrity
• Information technology and software systems used
• Data back up plan and testing
• Remote site for operations, trading and data access
• Firewalls, breach protection, denial of service protection
• Natural disaster and pandemic plans and testing.
16
The Due Diligence Process
Request For Proposal (RFP) questions typically cover:
4) Operations and Trading:
• Account setup (onboarding) process
• Compliance with Investment Policy and Guidelines
• Account monitoring and exception reporting process
• Compliance software and staff training
• Trading policies and practices
• Trading systems and custodian/counter-party reconciliation process.
• Derivatives practices, counter-party exposures, collateral/cash
management (ISDA terms)
• Process for measuring and monitoring trading costs and “best execution”
• Soft dollar practices, services and budget
• Flow of transactions from investment team – traders – middle office- back
office – compliance – accounting
• Independent audits of fund and firms
• Proxy voting policy and reporting
17
The Due Diligence Process
Request For Proposal (RFP) questions typically cover:
5) Investment Philosophy and Strategy
• Overall investment philosophy
• Beliefs regarding: fundamental vs. quantitative, active vs. passive,
• liquid vs. illiquid, allocations to alternatives, complex strategies,
derivatives, leverage, asset classes and strategies used vs. avoided
• Investment vehicles used: legal structure, open architecture vs. proprietary
products.
• Custody of assets – Independent custodian or internal/proprietary custody.
• Development of investment policy and guidelines
• Experience and software for asset and liability modeling
• Single allocation model vs. client customization
• Risk management, measurement and monitoring methodologies (Std Dev,
VaR, down-side, factor-based, risk budgeting, etc.)
• Performance reporting systems
• Research and investment information resources
18
The Due Diligence Process
Request For Proposal (RFP) questions typically cover:
6) Track record
• Return history (monthly data with Quarterly, Annual and Cumulative
results)
• Benchmarks used and how selected?
• Universe rankings
• Monthly/quarterly data volatility
• How are composites constructed?
• How difference risk levels handled?
• What other composites are there?
• Are any client portfolios not included in composites and why?
• Are composites compliant with Investment Performance Reporting
Standards (GIPS)? Provide GIPS independent audits.
19
The Due Diligence Process
Request For Proposal (RFP) questions typically cover:
7) Fees
• Fee Structure: Flat fees, % of assets or a combination
• Incentive fees – high water marks, claw-backs, catch-ups
• Fee sharing from underlying investments -12(b)(1) fees or rebates/offsets
• Fund operating expenses and/or management fees for proprietary funds
• Frequency of billing and transparency of fees
20
The Due Diligence Process
Some plans use a
Rating Matrix
to compare and
rank vendor
responses to the
RFP
21
Part II
Negotiating and Contracting
With ERISA Section 3(38)
Discretionary Investment Managers
Sharon Goodman
22
Plan Document Considerations
• ERISA Section 404(a) requires Trustees to discharge their duties in
accordance with document governing the Plan.
• Do your Plan governing documents allow for this investment?
– Trust Agreement
– Investment Policy
• So Trustees decision to invest in private equity is breach of fiduciary duty
under ERISA Section 404(a) if Plan’s investment policy prohibits private
securities.
• Avoid unnecessary ERISA fiduciary breach issue
23
Who is the Fiduciary For the Investment?
HAVE TRUSTEES DELEGATED THEIR FIDUCIARY CONTROL TO MANAGER?
• Who is ERISA fiduciary for ongoing investment decisions – Trustees or investment manager?
• Does Investment Hold Any ERISA Plan Assets?
• If NO, Trustees remain fiduciary for ongoing investment decisions by manager.
• If YES, is Participation By ERISA Benefit Plan Investors 25% or more of Investors?
• If ERISA Plan Assets less than 25%, Manager does not control plan assets so cannot be ERISA fiduciary or Section 3(38) manager.
• If YES, manager is ERISA fiduciary so can be ERISA Section 3(38) manager for ongoing investment decisions if acknowledges that status in writing.
• Trustees’ decision – will you pick a manager/investment that is not an ERISA fiduciary?
24
The Plan Asset Rule Under ERISA
• BASICS: When ERISA plan invests in equity of any entity, both equity
interest and proportionate interest in that entity’s assets treated as assets
of ERISA plan, unless exception applies.
• MOST COMMON EXCEPTIONS:
– Investment in publicly offered security
– Investment issued by investment company registered under 1940 Act
– Investment by benefit plan investors not significant
– Investment in venture capital operating company
– Investment in real estate operating company
• If exception applies, Trustees have not delegated fiduciary control to Manager.
• Trustees remain fiduciary in control of those plan assets.
25
Public Securities
• ERISA plan buys publicly offered securities.
• Publicly offered security is security that is:
– Freely transferable;
– Widely held (at least 100 independent investors on issue date);
– SEC registered.
• Example: ERISA Trustees use plan assets to buy Facebook stock.
• Mark Zuckerberg is not fiduciary to ERISA plan – does not control plan assets.
• ERISA plan does not negotiate with Facebook on terms of purchase
• No investment management agreement with Facebook
• Trustees have not delegated fiduciary control to manager of operating company.
• Trustees remain fiduciary in control of those plan assets.
26
Investment In Registered Investment Company
• ERISA plan buys securities issued by investment company registered under Investment Company Act of 1940.
• Example: ERISA plan buys shares of Vanguard mutual funds.
• Vanguard mutual fund manager not fiduciary to ERISA plan – does not control plan assets.
• ERISA plan (usually) does not negotiate with Vanguard on terms of purchase.
• No investment management agreement with Vanguard-usually just application to buy shares.
• Trustees have not delegated fiduciary control to manager of operating company.
• Trustees remain fiduciary in control of those plan assets.
27
Investment by Benefit Plans Not Significant
• Benefit plan investment “significant” if benefit plan investors hold 25% or more of any class of equity interests by value.
• Pension Protection Act: Foreign plans and other non-ERISA plans no longer count toward 25% limit.
• 25% excludes entity controlling investment and its affiliates (example: general partner of partnership) or rendering investment advice for fee excluded in applying 25% limit.
• Trustees have not delegated fiduciary control to manager of operating company.
• Trustees remain fiduciary in control of those plan assets.
28
Investment by Benefit Plans Not Significant
• Example: ERISA plan buys shares of Great Dane Opportunities Fund, Ltd.,
limited liability corporation formed to invest in privately held companies.
• Great Dane Opportunities Fund, Ltd. managed by Slobber Management,
L.P.
• Dubai Sovereign Pension Plan owns 10% of equity interest in Great Dane
Opportunities Fund.
• ERISA benefit plan investments own 15% of equity interest in Great Dane
Opportunities Fund.
• Slobber owns 8% of equity invest in Great Dane Opportunities Fund.
• Slobber not fiduciary to ERISA plan – does not control plan assets because
ERISA plan investors hold less than 25%.
• BUT ERISA plan (usually) does negotiate with Slobber over side letter to modify terms to buy equity interest in Great Dane Opportunities Fund.
29
Investment In Operating Company
• Operating company = entity primarily engaged, either directly or through
majority owned subsidiaries, in production or sale of product or service.
• Most common encountered by ERISA plans
– venture capital operating company
– real estate operating company
• Manager of operating company does not control ERISA plan assets of plan investors in company.
• Trustees have not delegated fiduciary control to manager of operating company.
• Trustees remain fiduciary in control of those plan assets.
30
Venture Capital Operating Company
• ERISA plan investment in Venture Capital Operating Company (VCOC) Not Plan Assets Subject to ERISA
• Common in private equity strategies.
• VCOC is entity with at least 50% of its assets invested in “venture capital investments” in which it has “management rights.”
• Management rights = rights to substantially influence management of the operating company. • Must be “direct” rights that VCOC can exercise.
• Asset/management tests done annually.
• Under exception, manager of VCOC does not control ERISA plan assets of plan investors in VCOC
• BUT ERISA plan (usually) does negotiate with VCOC on terms of side letter to buy equity interest in VCOC
31
Real Estate Operating Company
• REOC is entity with 50% or more of its assets invested in qualifying real
estate and directly engaged in real estate management or development
activities.
• Tested with first investment and annually thereafter.
• Under exception, manager of REOC does not control ERISA plan assets of
plan investors in REOC
• BUT ERISA plan (usually) does negotiate with REOC on terms of side
letter to buy equity interest in VCOC
32
Issues Under Investment Contract
Type of Investment Drives Contract Terms
• Is this a separate account or a commingled/collective trust or
something else?
• Separate Account
• Commingled/Collective Trust
• Or does an exception to Plan asset rules apply?
33
Separate Account Investment
• Direct investment management agreement between ERISA plan and
investment manager
• Investment manager is ERISA Section 3(38) fiduciary for investment
because it controls plan assets if it acknowledges that status in writing
• Trustees delegate fiduciary duty for those plan assets to manager.
• Plan’s investment policy governs manager’s strategy.
34
Separate Account Investment
Example: ERISA plan hires PIMCO to manage fixed income strategy in
separate account
• Assets held at plan’s custodial bank
• PIMCO controls purchase and sale of bonds held in account
• PIMCO is fiduciary and ERISA Section 3(38) to ERISA plan because it
controls plan assets and acknowledges it in contract.
• ERISA plan negotiates with PIMCO over investment management agreement
35
If Commingled/Collective Trust Investment
• Direct agreement between ERISA plan and collective trust that investment
manager controls.
• Investment manager is ERISA fiduciary and Section 3(38) manager for
investment because it controls plan assets and acknowledges it in contract.
• Trustees delegate fiduciary duty for those plan assets to manager.
• Manager’s investment policy governs trust’s strategy.
36
If Commingled/Collective Trust Investment
• Example: ERISA plan participates in Amalgamated Bank S&P 500 Index
Fund.
• Assets held at Amalgamated Bank custody account.
• Amalgamated Bank controls purchase and sale of stocks held in account.
• Amalgamated Bank is fiduciary to ERISA plan – directly controls plan
assets.
• ERISA plan (maybe) negotiates with Amalgamated Bank PIMCO over participation agreement.
37
Special Delegation Issues
• Named Fiduciary = only fiduciary with ability to delegate its ERISA fiduciary
duty to another fiduciary
• Must be identified in Plan Document (Trust Agreement)
• Board of Trustees/Retirement Committee usually Named Fiduciary
• “Master manager” of hedge fund of funds
– Does master manager also want to be a named fiduciary to delegate
ERISA fiduciary duty to sub-managers/underlying investment funds?
– Does Trust Agreement allow designation of master manager as named
fiduciary?
– If not, does master manager acknowledge that it is liable for sub-
manager’s actions?
38
Issues For Negotiation Under Investment Contract
Negotiations Over Investment Management Agreement or Side Letter To
Commingled/Collective Investment Documents
• Separate account – negotiating terms of direct investment management
agreement
• Commingled fund – negotiating terms of plan’s side letter to “clarify” fund
documents that apply to all investors
• Non-Plan asset investment – negotiating side letter (usually) to “clarify”
fund documents that apply to all investors
39
Issues For Negotiation Under Investment Contract
Standard of Care
– For ERISA fiduciary manager = ERISA fiduciary standard
– If not ERISA fiduciary manager (because one of the exceptions applies)
= negotiate whether ERISA-like contractual standard or ERISA-light
contractual standard (prudence standard only)
40
Issues For Negotiation Under Investment Contract
Indemnification
• Relevant whether ERISA fiduciary manager or not
• Investment documents should (try) to:
– Require manager to indemnify Plan and Trustees
– Often mutual/parallel indemnification by plan of manager and manager
of plan
– If so, make clear that ERISA plan – AND NOT TRUSTEES—liable for
any indemnification
– Beware of “signatory below shall indemnify......”
41
Issues For Negotiation Under Investment Contract
Fees
• Most Favored Nations (“MFN”) Treatment on Fees, Rights and Features
– All investors?
– Similar sized investors?
– Count affiliated investor plans?
• Incentive Fees
– Warrant under DOL guidance?
– Valuation of Portfolio and Potential Conflicts
• Claw back If Incentive Fees
– Avoid heads manager wins, tails fund loses
– How is high-water mark for payment of incentive fees set and reset?
42
Issues For Negotiation Under Investment Contract
• More Fees -- Unrelated Business Taxable Income
– Effort to avoid?
– Protections if taxable income is earned?
– Impact of tax on net return/incentive fee?
• Key Man Provisions – If strategy depends on superstar/few key people, what happens if they are unwilling or unable to continue to manage investment?
43
Issues For Negotiation Under Investment Contract
Confidentiality
• When can manager release ERISA plan’s information?
– What notice is required to plan?
– Disclose to manager’s potential clients?
– When can plan prevent disclosure?
• When can ERISA plan release information about investment?
– Any limits on what ERISA plan can disclose?
– What notice is required to manager?
– Disclose to plan’s professionals to operate ERISA plan?
– When can manager prevent disclosure?
– Section 101(k) for multiemployer plans
• Special issue – DOL, IRS audits
44
Issues For Negotiation Under Investment Contract
Reporting
• Sufficient for ongoing monitoring by plan’s investment consultant?
• Sufficient for ERISA plan’s auditor to prepare financial statements?
• ERISA plan auditor needs financial statement of underlying investments
“tiered” investment structure – example, in hedge fund.
45
Issues For Negotiation Under Investment Contract
• Conflicts of Interest
– Avoided, either because manager is ERISA fiduciary or by contract?
• Bonding
– ERISA Section 412 requires any person handling plan assets to be bonded
– ERISA fiduciary manager should have own bond
• Proxies
– Agreement should make clear who votes proxies (if any)
46
Issues For Negotiation Under Investment Contract
• Termination of Agreement
– For separate account investment, usually at any time
– If commingled/collective vehicle – what is frequency/ liquidity?
– Timing of notice
• Redemptions/Liquidation of Investment
– When and with what notice period?
– Does strategy make liquidation impractical or inadvisable even if
unrestricted?
– What is fund getting back—in kind securities or cash?
– If in kind securities, who manages until liquidated and for what fee?
47
What Is A QPAM?
• “Qualified Professional Asset Manager” (“QPAM”) is investment
professional that meets regulatory and asset minimums under Prohibited
Transaction Exemption (PTE) 84-14.
• PTE 84-14 is a class exemption – applies to transactions that meet the rules
in PTE – no separate filing with DOL to meet exemption.
• Under PTE 84-14, as amended, QPAM is entity meeting definition of
investment manager that also has substantial assets
– Bank with equity capital in excess of $1,000,000
– Insurance company with net worth in excess of $1,000,000, or
– Registered investment adviser with total client assets under
management in excess of $85,000,000 and with partners/shareholders
equity in excess of $1,000,000.
48
Rules to Meet QPAM Exemption
QPAM transaction must meet following rules:
• Assets of plan (and related plans) in transaction cannot exceed 20% of all
assets managed by QPAM.
• Terms of transaction must be at least as favorable to plan as terms
available in arm’s length transaction.
• Counterparty (and its affiliates) cannot have power to appoint or terminate
QPAM as manager of plan assets or to negotiate for plan over terms of
QPAM’s engagement.
49
When To Consider Using QPAM?
• PTE 84-14 provides limited exemption to prohibited transaction rules for
specified transactions involving plan assets managed by QPAM and limited
group of parties in interest unrelated to and with no direct or indirect control
over QPAM.
• Result: QPAM Exemption allows Section 3(38) manager to engage in
certain party-in-interest prohibited transactions in investment that otherwise
would violate ERISA fiduciary conflict in interest rules.
• QPAM exemption allows manager to use services of affiliates with violating
the prohibited transaction provisions of ERISA.
• Practical: Manager already a QPAM for investment and structured to use
affiliates as back-office administration for collective trust-so built into
investment
• Possible: Fund would consider using QPAM on evaluating investment in
related industry. Example: manager invests in building supermarkets for
supermarket industry pension fund.
50
Part III
Monitoring ERISA Section 3(38)
Discretionary Managers
David Russell
51
Investment Monitoring
• ERISA Plan Trustees have a duty to monitor the plan investments.
• That monitoring includes ongoing due diligence and compliance
monitoring of the 3(38) Fiduciary as well as the underlying investments.
• Information flows and investment transparency should be sufficient to
monitor performance, fees, transactions and portfolio holdings.
• Multiple parties, in addition to the Trustees, require detailed information:
• Administrators – Contributions, plan benefit payments, 5500 filings
• Auditor - Audits
• Dept. of Labor – Audits
• Actuary – Actuarial valuations
• Consultants – Performance reporting, risk measurement
52
Investment Monitoring
• Should the Trustees hire an Independent Consultant who is an ERISA
Section 3(21) fiduciary for performance reporting and monitoring of
managers?
• Most plan do. Consultants can provide Trustees with:
• Performance reporting
• Risk measurement
• Ongoing manager due diligence
• Compliance monitoring.
• Ongoing manager due diligence and compliance monitoring includes
ongoing monitoring all of the items originally reviewed in the RFP and
evaluating any changes.
53
Part IV
Questions?
54