Alert October 14, 2008

DOL Issues Final Rule Regarding Statutory Exemption for Cross-Trading

The Department of Labor (the “DOL”) issued a final rule relating to the new statutory prohibited transaction exemption for cross-trading under the Employee Retirement Income Security Act of 1974, as amended (“ERISA”).  The Pension Protection Act of 2006 added a new Section 408(b)(19) to ERISA, which provides relief for certain cross-trades between large plans.  Specifically, the new statutory exemption provides relief for the purchase and sale of a security between a plan and another account managed by the same manager if certain requirements are satisfied.  One requirement is that the manager must establish policies and procedures that are fair and equitable to all accounts, including policies and procedures for allocating cross-trades, and must designate an individual responsible for periodically reviewing cross-trades for compliance with such policies and procedures.  The final rule is substantially similar to the interim final rule (see the February 27, 2007 Alert).  Clarifications and modifications to the interim final rule include (i) a requirement that the policies and procedures include a statement regarding the manager’s conflicting loyalties and how the manager will mitigate such conflicts, (ii) compliance reviews may be performed using a sampling methodology provided such methodology is disclosed in the policies and procedures, (iii) every plan participating in a collective fund or other pooled account covered by the exemption must satisfy the minimum $100 million plan size requirement, (iv) the minimum plan size requirement need only be verified on an annual (rather than quarterly) basis, and (v) individual portfolio managers of the same entity may rely on the exemption.  Although the DOL refused to  state that the exemption may be relied upon for cross-trades by affiliated managers, the DOL indicated that such cross-trades would not constitute a per se violation of Section 406(b)(2) of ERISA. However, a violation of ERISA’s fiduciary rules could result if there was an agreement or understanding between the parties to favor one party or client.  The final rule becomes effective on February 4, 2009.