On July 26, 2022, the U.S. Department of Labor (the “Department”) issued a proposal to amend prohibited transaction class exemption 84-14 (the “QPAM Exemption”) under ERISA. The QPAM Exemption currently allows a plan’s investment fund to engage in transactions with “parties in interest” to the plan if, among other conditions, the assets are managed by a “qualified professional asset manager,” or “QPAM,” that is independent of the parties in interest and that meets certain other requirements.
The Department stated that the purpose of the proposed rule is to address changes in the financial services industry that have occurred since the QPAM Exemption was first adopted in 1984 and last amended in 2010. Specifically, the Department noted that it has consistently reviewed individual exemption applications for continued reliance on the QPAM Exemption after the QPAMs or their affiliates are convicted of crimes, which otherwise precludes such reliance. This experience in evaluating corporate crimes and convictions prompted the Department to codify the conditions it routinely includes when granting those individual exemptions. The proposed rule would change the requirements for all QPAMs, not just those subject to disqualification, however.
If finalized, the proposed rule would:
- Expand the circumstances in Section I(g) that may lead to a 10-year ineligibility, including additional events and forms of misconduct, including foreign convictions that are substantially equivalent to the listed crimes and non-prosecution or deferred prosecution agreements;
- Require a one-time notice to the Department that a QPAM is relying upon the exemption (the Department intends to keep a current list of eligible QPAMs on its website);
- Require up-front terms in a written management agreement that apply in the event of ineligibility, including provisions indemnifying plans for the cost of transitioning away and indemnifying, holding harmless and promptly restoring actual losses to plans for any damages directly resulting from a violation of applicable laws, breach of contract or claim arising from the manager’s ineligibility;
- Provide a one-year wind-down period to help plans avoid or minimize possible negative effects of terminating or switching QPAMs or adjusting investment management arrangements;
- Require entities applying for individual exemptions after a loss of QPAM eligibility to review the Department’s most recent individual exemptions on point, noting that similar conditions will likely apply if the applicant’s exemption is granted;
- Expand the conditions in Section I(c) regarding a QPAM's authority over investment decisions;
- Require QPAMs to maintain and make available to the DOL, the IRS and other regulators, as well as plan fiduciaries, participants and beneficiaries of any relevant plan the records necessary to determine whether the conditions of the QPAM Exemption have been met for six years from the date of a covered transaction; and
- Increase the assets under management (“AUM”) requirement for registered investment advisers (not banks and/or insurance companies) from $85 million to $135.87 million and the shareholders’ or partners’ equity requirement from $1 million to $2.04 million (adjusted annually thereafter for inflation), with the equity capital requirement for banks and insurance companies rising to $2.72 million.
Notably, the proposed rule contains no grandfathering provision for existing QPAMs, which, at a minimum, will not have written agreements in place that incorporate the proposed updates. If finalized as drafted, any manager relying on the QPAM Exemption (and any manager reserving the right to rely on the QPAM Exemption) will need to update their written management agreements by the final rule’s effective date. In addition, existing QPAMs that meet the current capital and/or AUM requirement, but which may not meet the amended requirements may need to consider alternatives to the QPAM Exemption (and amend their documents accordingly). The costs, in time and money, to effect these changes, which could conceivably affect millions of discretionary investment management agreements, will be significant.
While the QPAM Exemption provides an efficient mechanism for managers to engage in numerous otherwise-prohibited transactions and is often seen as an informal, yet desirable “seal of approval,” comparable relief can be found in other exemptions. This flexibility will likely be very useful for managers that cannot meet or choose not to meet the new QPAM requirements (e.g., the burdensome new indemnification requirements). For example, Section 408(b)(17) of ERISA provides an exemption for a broad variety of transactions (e.g., sales, exchanges, leases, loans, uses and transfers) between a plan and a service provider party in interest if, among other conditions, they are directed by a fiduciary in good faith and the plan pays no more, or receives no less, than “adequate consideration”. Other broad trading exemptions with relatively workable conditions are available to certain types of funds, including bank collective investment funds and insurance company pooled separate accounts. While these exemptions have been available and used for many years, the breadth of, familiarity with and relative ease of relying on the QPAM Exemption have limited their use, especially given some uncertainty with certain of their conditions. This may change if the risks and costs of relying on the QPAM Exemption increase significantly.
As noted, the Department did not limit its proposed changes to issues of misconduct. It also expanded the language in Section I(c) to ensure that the QPAM itself has and exercises sole responsibility for all aspects of a transaction, including the legwork (e.g., finding investments, conducting due diligence and negotiating terms) and the final investment decision. This expanded language would seem to limit the ability of a QPAM to outsource some of its investment process to finders, consultants, and sub-advisers, even where the QPAM fully and independently reviews the transaction and all relevant information, supplements it as necessary and decides whether to proceed. This limitation could severely impact the business models of some managers.
The Department also added new language to inhibit transactions entered for the benefit of parties in interests, rather than plans: “No relief is provided under this exemption for any transaction that has been planned, negotiated, or initiated by a Party in Interest, in whole or in part, and presented to a QPAM for approval.” Yet, however well-intentioned, the language is overly broad. By its terms, it would seem to prohibit QPAMs from even considering, for example, investment products and solutions proposed or otherwise marketed by independent broker-dealers, whether on their own or in response to a request for proposal or other inquiry. This result conflicts with common market practices and is unworkable.
The Department similarly added new language to clarify that the exemption is not available for transactions that do not involve plan investments (e.g., it does not cover hiring a service provider for a welfare plan): “The prohibited transaction relief provided under this exemption applies only in connection with an Investment Fund that is established primarily for investment purposes.” The proposed addition of a primary basis test goes too far, however. It would seem to exclude without good reason, for example, investment-related transactions by assets pools with mixed purposes, such as the plan’s main trust (the other purposes of which are to provide for the payment of benefits and plan expenses). Segregating out assets into separate investment pools may provide a work-around for some, but not all transactions (e.g., trust-level overlays).
Written comments, and requests for a public hearing, must be submitted to the Department by September 26, 2022. The Department is currently proposing that, if the amendment is finalized, it will become effective 60 days after being published in the Federal Register.