Proposed Class Exemption for the Receipt of Certain Investment Services by Individuals for Whose Benefit Individual Retirement Accounts or Retirement Plans for Self-Employed Individuals Have Been Established or Maintained

DEPARTMENT OF LABOR

[Exemption Application D-09707]

Proposed Class Exemption for the Receipt of Certain Investment

Services by Individuals for Whose Benefit Individual Retirement

Accounts or Retirement Plans for Self-Employed Individuals Have Been

Established or Maintained

AGENCY: Pension and Welfare Benefits Administration, U. S. Department

of Labor

ACTION: Notice of Proposed Class Exemption.

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SUMMARY: This document contains a notice of pendency before the

Department of Labor (the Department) of a proposed class exemption from

the prohibited transaction restrictions of the Employee Retirement

Income Security Act of 1974 (ERISA) and the Internal Revenue Code of

1986 (the Code). The proposed class exemption would permit the receipt

of services at reduced or no cost by an individual for whose benefit an

individual retirement account (IRA) or, if self-employed, a Keogh Plan

is established or maintained, or by members of his or her family, from

a broker-dealer, provided that the conditions of the exemption are met.

If granted, the exemption would affect individuals with beneficial

interests in such plans who receive such services as well as the

broker-dealers who provide such services.

DATES: Written comments and requests for a public hearing must be

received by the Department on or before September 16, 1996.

ADDRESSES: All written comments (at least three copies) and requests

for a public hearing should be sent to: Office of Exemption

Determinations, Pension and Welfare Benefits Administration, Room N-

5649, U. S. Department of Labor, 200 Constitution Avenue, N.W.,

Washington, DC 20210, (Attn: D-09707). The application for exemption

and comments received from interested persons will be available for

public inspection in the Public Documents Room, Pension and Welfare

Benefits Administration, U. S. Department of Labor, room N-5638, 200

Constitution Avenue, N.W., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Allison Padams, Office of Exemption

Determinations, Pension and Welfare Benefits Administration, U. S.

Department of Labor, (202) 219-8971, (This is not a toll-free number);

or Paul D. Mannina, Plan Benefits Security Division , Office of

Solicitor, U. S. Department of Labor (202) 219-9141, (This is not a

toll-free number.)

SUPPLEMENTARY INFORMATION: Notice is hereby given of the pendency

before the Department of a proposed exemption from the restrictions of

sections 406(a)(1)(D) and 406(b) of ERISA and the sanctions resulting

from the application of sections 4975(a) and (b), 4975(c)(3) and

408(e)(2) of the Code by reason of section 4975(c)(1)(D), (E) and (F)

of the Code. This exemption was requested in an exemption application

filed on behalf of the Securities Industry Association (the SIA or the

Applicant). The Applicant is a securities industry trade association

representing the business interests of more than 700 securities firms

in North America which collectively account for ninety percent of the

securities firm revenue in the United States. The members of the SIA

are, among other things, engaged in the business of providing brokerage

and investment advisory services to the public. The Applicant

represents that IRAs and Keogh Plans constitute approximately less than

one-third of assets of the accounts managed by broker-dealers.

The application was filed pursuant to section 408(a) of ERISA 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, August 10,

1990.) 1

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\1\ Section 102 of Reorganization Plan No. 4 of 1978 (43 FR

47713, October 17, 1978) generally transferred the authority of the

Secretary of the Treasury to issue administrative exemptions under

section 4975(c)(2) of the Code to the Secretary of Labor.

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Background

Section 4975(c)(1) (D), (E) and (F) of the Code prohibits the

transfer to, or use by or for the benefit of, a disqualified person of

the income or assets of a plan; an act by a disqualified person who is

a fiduciary whereby he deals with the income or assets of the plan in

his own interest or for his own account; and the receipt of any

consideration for his own personal account by any disqualified person

who is a fiduciary from any party dealing with the plan in

[[Page 39997]]

connection with a transaction involving the income or assets of the

plan.2

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\2\ With respect to those IRAs that are part of a Simplified

Employee Pension described in section 408(k) of the Code, references

to section 4975(c)(1)(D), (E) and (F) should be read to refer as

well to the parallel provisions of ERISA.

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The term ``disqualified person'' as defined in section 4975(e)(2)

of the Code includes a fiduciary and a person providing services to the

plan. Persons who exercise discretionary authority or control over the

assets of the plan are subject to the prohibitions contained in section

4975 of the Code.3 The receipt of reduced or no cost services by

an individual under an arrangement in which plan assets are taken into

account for purposes of pricing the services is a prohibited

transaction.4 Such prohibited transactions are generally subject

to taxation under section 4975 of the Code or the loss of exemption

from tax by reason of section 408(e)(2)(A) of the Code. In the absence

of an exemption, the individual who receives reduced or no cost

services as a result of establishing or maintaining his or her IRA or

Keogh Plan would benefit from the use of his or her plan's assets in

violation of section 4975 of the Code.

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3 See section 4975(e)(3) of the Code.

4 See Advisory Opinion 89-12A (July 14, 1989.)

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In recognition of the business practice of banks offering services

at reduced or no cost to encourage individuals to establish IRAs and

Keogh Plans, the Department granted PTE 93-33 (58 FR 31053, May 28,

1993, as amended, 59 FR 22686, May 2, 1994).5 PTE 93-33 permits

the receipt of reduced or no cost banking services by individuals for

whose benefit individual retirement accounts or Keogh Plans are

established or maintained pursuant to an arrangement in which the

account balance of the IRA or Keogh Plan is taken into account for

purposes of determining eligibility to receive such services provided

the conditions of the exemption are met. The conditions of PTE 93-33

require that: (a) the IRA or Keogh Plan, the account balance of which

is taken into account for purposes of determining eligibility to

receive services at reduced or no cost, is established and maintained

for the exclusive benefit of the participant covered under the IRA or

Keogh Plan, his or her spouse or their beneficiaries; (b) the services

must be of the type that the bank itself could offer consistent with

applicable federal and state banking law; (c) the services are provided

by the bank (or affiliate of the bank) in the ordinary course of the

bank's business to customers who qualify for reduced or no cost banking

services but do not maintain an IRA or Keogh Plan with the bank; (d)

for purposes of determining eligibility to receive services at reduced

or no cost, the account balance required by the bank for the IRA or

Keogh Plan is equal to the lowest balance required for any other type

of account which the bank includes to determine eligibility to receive

reduced or no cost services; and (e) the rate of return on the IRA or

Keogh Plan investment is no less favorable than the rate of return on

an identical investment that could have been made at the same time at

the same branch of the bank by a customer of the bank who is not

eligible for (or who does not receive) reduced or no cost services.

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5 PTE 93-33 amended and redesignated PTE 93-2 (58 FR 3561,

January 11, 1993).

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Summary of the Application

According to the Applicant, broker-dealers have also developed the

capacity to view accounts on an aggregate basis as a result of enhanced

computer capabilities, and in response to customer demands. The

Applicant represents that broker-dealers have offered premium brokerage

service arrangements to customers who maintain total accounts equaling

a minimum value or generating a minimum amount of commissions or fees.

Under a typical ``relationship'' brokerage arrangement, all of an

individual's accounts including those established by members of the

individual's family are viewed on an aggregate basis, rather than

individually.

The Applicant represents that broker-dealers are limited in the

types of services they may offer to customers. Both the New York Stock

Exchange (NYSE) and the National Association of Securities Dealers

(NASD) (and corresponding requirements of other exchanges) require that

broker-dealers ``know their customer'' 6 such that any investments

recommended by a broker- dealer to a customer must be suitable for the

customer in light of, among other things, his investment experience,

financial condition and age. In addition, broker-dealers have an

obligation to act in the customer's best interests with respect to the

customer's investment in securities effected through the broker-dealer.

In this regard, the Applicant states that by causing a customer to make

a particular securities investment by offering incentives, the broker-

dealer could be deemed to have violated the NYSE or NASD suitability

rules unless the investment was in all respects suitable for the

customer.

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6 See NYSE Rule 406 and NASD Article III, Section 2 of the

Rules of Fair Practice.

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The Applicant further represents that, although each broker-dealer

firm establishes its own programs, services provided under a

relationship brokerage program typically have investment oriented

components. Services often include financial planning services, direct

deposit/debit and automatic fund transfer privileges, enhanced account

statements, toll-free access to a client service center, check writing

privileges, debit/credit cards, special newsletters and reduced

brokerage and asset management fees.

The Applicant believes that including IRAs and Keogh Plans in

relationship brokerage programs would be beneficial to IRAs and Keoghs.

For example, a broker-dealer may choose to offer customers reduced

brokerage fees as part of its relationship brokerage program. Under

such an arrangement, IRAs and Keogh Plans may be able to realize the

benefits derived from economies of scale. Fees such as commissions and

professional asset management fees often decline in relative terms as

the size of the assets under management increases. Thus, including the

assets of an IRA or Keogh Plan would lower the cost to the IRA or Keogh

Plan compared to the cost it would pay for the same service on an

independent basis.

Additionally, IRA and Keogh Plans also may benefit if a broker-

dealer provides a customer with a combined account statement or other

account management tools (automatic transfers and telephone access)

because the individual can easily view the assets of all of his or her

various accounts at the same time. This in turn could enable the

individual to formulate a total investment strategy taking into account

the retirement needs of the individual. Further, because many of the

additional services provided under relationship brokerage arrangements

are investment oriented, an individual may be able to more effectively

and efficiently invest his or her assets. Thus, the Applicant states

that such services provide a benefit which is equally important and

useful to the individual in his or her capacity as the manager of the

investments of the IRA or Keogh Plan.

Discussion of the Proposed Exemption

1. Scope

The exemption proposed herein by the Department would provide

relief from the restrictions of sections 406(a)(1)(D) and 406(b) of

ERISA and the sanctions resulting from the application of sections 4975

(a) and (b)

[[Page 39998]]

of the Code, including the loss of exemption of an individual

retirement account (IRA) pursuant to section 408(e)(2)(A) of the Code,

by reason of section 4975(c)(1) (D), (E) and (F) of the Code for the

receipt of services at reduced or no cost by an individual for whose

benefit an IRA or Keogh Plan is established or maintained, or by

members of his or her family, from a broker-dealer registered under the

Securities Exchange Act of 1934 pursuant to an arrangement in which the

IRA or Keogh Plan account value or the service fees generated by the

IRA or Keogh Plan are taken into account for purposes of determining

eligibility to receive such services.7

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\7\ The exemption if granted, would apply only to IRAs and Keogh

Plans that are not ``employee benefit plans'' covered by title I of

ERISA except for Simplified Employee Pensions (SEPs) described in

section 408(k) of the Code which provide the participants with the

unrestricted authority to transfer their SEP balances to IRAs

sponsored by different financial institutions. See 29 CFR 2510.3-

2(d) and 29 CFR 2510.3-3(b).

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2. Proposed Conditions

The proposed exemption contains conditions (described below) which

are viewed by the Department as necessary to ensure that the retirement

income of IRA and Keogh Plan participants is not jeopardized by

relationship brokerage programs.

Under the proposal, the IRA or Keogh Plan whose account value or

service fees generated by the IRA or Keogh Plan is taken into

consideration for purposes of determining eligibility to receive

services at reduced or no cost, must be established and maintained for

the exclusive benefit of the participant covered under the IRA or Keogh

Plan, his or her spouse or their beneficiaries. The term ``account

value'' is defined in section III(d) as investments in cash or

securities held in the account for which market quotations are readily

available. The term ``account value'' does not include investments

offered by the broker-dealer (or affiliate) exclusively to IRAs and

Keogh Plans.

The proposed exemption limits the services that may be offered by

broker-dealers under a relationship brokerage program to those services

that the broker-dealer itself may offer consistent with all applicable

federal and state laws regulating broker-dealers. This condition would

exclude the provision of services that are not investment oriented. For

example, broker-dealers could not offer restaurant or travel discounts

under this class exemption. However, the term ``service'' is defined in

section III(g) to include incidental products of a de minimis value.

The Department notes that this definition would permit broker-dealers

to provide such products as free debit/credit cards.

The Investment Company Institute (ICI) requested that the

Department clarify that the proposed exemption would provide relief for

a relationship brokerage program whereby a broker-dealer offers reduced

sales charges with respect to the purchase of investment company shares

as the size of the purchase increases. In this regard, a broker-dealer

would aggregate total purchases of all of a customer's accounts,

including IRAs and Keogh Plans. Thus, a broker-dealer would set a

schedule of commission rates that vary according to the size of the

transaction. For example, for transactions totaling an amount of less

than $10,000, the sales charge would be 6.5%; for a transaction of

$10,000 but less than $25,000, the sales charge would be 6.0%, and for

a transaction of $25,000 but less than $50,000, the sales charge would

be 5.00%. The Department notes that such programs would be covered by

the proposed exemption provided that all of the conditions of the

proposal are met.8

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\8\ In this regard, the Department notes that the programs

described by the ICI as ``letter of intent programs,'' in which

broker-dealers reduce sales commissions based on the aggregate of a

customer's actual purchases and anticipated purchases, as agreed to

by the customer, raise additional issues that are outside the scope

of this proposed exemption.

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Under the proposal, the services must be provided by the broker-

dealer (or an affiliate of the broker-dealer) in the ordinary course of

the broker-dealer's business to customers who are eligible for reduced

or no cost services, but do not maintain IRAs or Keogh Plans with the

broker-dealer. Thus, no relief would be provided for a service that was

offered solely to customers who maintain IRAs or Keogh Plans with the

broker-dealer.

Under the proposal, the determination of eligibility to receive

services at reduced or no cost must be based on the value of the

customer's accounts or on the amount of fees generated by the

customer's accounts. For eligibility requirements based on account

values, the eligibility requirement based on the account value of the

IRA or Keogh Plan must be as favorable as any requirement imposed by

the broker-dealer on any account whose value the broker-dealer includes

to determine eligibility. For example, if a broker-dealer establishes a

$10,000 threshold for the receipt of certain reduced or no cost

services, any combination of accounts (such as personal accounts, IRAs

or Keogh Plans) that equal $10,000 would be sufficient to satisfy the

threshold requirement. In this regard, a broker-dealer could not set a

threshold amount of $10,000 for a customer with a personal account and

a $20,000 threshold for customers maintaining IRAs and Keogh Plans with

the broker-dealer.

For eligibility requirements based on the amount of fees generated,

the proposal requires that the minimum amount of fees which must be

generated by an IRA or Keogh plan be equal to the lowest amount of fees

generated by any other type of account which the broker-dealer includes

to determine eligibility for such programs.9

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\9\ The Applicant describes the following fees as applicable to

relationship brokerage programs: administrative fees (charges for

maintaining an account with the broker-dealer), brokerage fees (fees

for execution of an order to buy or sell securities), wrap fees

(bundled fees under which customers receive more than one service),

service fees (fees for research concerning investment opportunities,

postage and handling charges or ancillary charges such as ATM fees),

custodial fees (fees for serving as IRA or Keogh Plan custodian),

and investment management fees (fees for managing assets).

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The proposal also requires that the combined total of all service

fees or commissions received by the broker-dealer from the IRA or Keogh

Plan must be reasonable within the meaning of sections 4975(d)(2) of

the Code.10 The Department wishes to note that the scope of relief

provided by the proposal is limited to the arrangement under which the

account value of the IRA or Keogh Plan, or the fees generated by the

IRA or Keogh Plan, is taken into account for purposes of determining

eligibility to receive services at reduced or no cost. Thus, no relief

would be provided under the proposed exemption for the provision of

services to the IRA or Keogh Plan or for any self-dealing arising in

connection with the provision of such services. In this regard, see

section 4975(d)(2) of the Code and applicable regulations.

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\10\ Also, the Applicant represents that a broker-dealer is

subject to the NASD Rule set forth in Article III, Section 3 which

provides that charges for services performed must be reasonable.

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Under the proposed exemption, the IRA or Keogh Plan customer who

becomes eligible for relationship brokerage services must be eligible

to receive the same services that are provided to non-IRA or non-Keogh

Plan customers with either account values of the same amount or the

same amount of fees generated. The proposal also requires that the

investment performance of the IRA and Keogh Plan be no less favorable

than the investment performance of identical investments which could

have been made at the same time by a customer of the broker-dealer who

is not eligible for (or who does not receive) reduced or no cost

investment services. This condition

[[Page 39999]]

ensures that the investment performance of an IRA or Keogh Plan will

not be affected due to the inclusion of the IRA or Keogh Plan in the

relationship brokerage program. Thus, under the proposal, a broker-

dealer could not offer an investment to an IRA or Keogh Plan of a

customer who receives reduced or no cost services unless the IRA or

Keogh Plan earns no less than that which could be earned on an

identical investment available to customers of such broker-dealer who

are not eligible for receiving such services.

Notice to Interested Persons

Because many participants in IRAs or Keogh Plans and broker-dealers

sponsoring IRAs or Keogh Plans could be considered interested persons,

the only practical form of notice is publication in the Federal

Register.

General Information

The attention of interested person is directed to the following:

(1) Before an exemption may be granted under section 408(a) of

ERISA and section 4975(c)(2) of the Code, the Department must find that

the exemption is administratively feasible, in the interests of the

IRAs and Keogh Plans and their participants and beneficiaries and

protective of the rights of participants and beneficiaries of such

plans.

(2) The proposed exemption, if granted, will be supplemental to,

and not in derogation of, any other provisions of ERISA and the Code

including statutory or administrative exemptions and transitional

rules. Furthermore, the fact that a transaction is subject to an

administrative exemption is not dispositive of whether the transaction

is in fact a prohibited transaction.

(3) If granted, the proposed exemption will be applicable to a

transaction only if the conditions specified in the class exemption are

met.

Written Comments and Hearing Request

All interested persons are invited to submit written comments or

requests for a public hearing on the proposed exemption to the address

and within the time period set forth above. All comments will be made a

part of the record. Comments and requests for a hearing should state

the reasons for the writer's interest in the proposed exemption.

Comments received will be available for public inspection with the

referenced application at the above address.

Proposed Exemption

On the basis of the facts and representations set forth in the

application and this document, the Department is considering granting

the following exemption under the authority of section 408(a) of ERISA

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,

August 10, 1990].

Section I: Covered Transactions

Effective (date of publication of final exemption in the Federal

Register), the restrictions of sections 406(a)(1)(D) and 406(b) of

ERISA and the sanctions resulting from the application of section 4975

of the Code, including the loss of exemption of an IRA pursuant to

section 408(e)(2)(A) of the Code, by reason of section 4975(c)(1) (D),

(E), and (F) of the Code, shall not apply to the receipt of services at

reduced or no cost by an individual for whose benefit an IRA or, if

self-employed, a Keogh Plan, is established or maintained, or by

members of his or her family, from a broker-dealer registered under the

Securities Exchange Act of 1934 pursuant to an arrangement in which the

account value of, or the fees incurred for services provided to, the

IRA or Keogh Plan is taken into account for purposes of determining

eligibility to receive such services, provided that each condition of

Section II of this exemption is satisfied.

Section II: Conditions

(a) The IRA or Keogh Plan whose account value or whose fees are

taken into account for purposes of determining eligibility to receive

services under the arrangement is established and maintained for the

exclusive benefit of the participant covered under the IRA or Keogh

Plan, his or her spouse or their beneficiaries.

(b) The services offered under the relationship brokerage

arrangement must be of the type that the broker-dealer itself could

offer consistent with all applicable federal and state laws regulating

broker-dealers.

(c) The services offered under the arrangement are provided by the

broker-dealer (or an affiliate of the broker-dealer) in the ordinary

course of the broker-dealer's business to customers who qualify for

reduced or no cost services, but do not maintain IRAs or Keogh Plans

with the broker-dealer.

(d) For purposes of determining eligibility to receive services,

the arrangement satisfies one of the following:

(i) Eligibility requirements based on the account value of the IRA

or Keogh Plan are as favorable as any such requirements based on the

value of any other type of account which the broker-dealer includes to

determine eligibility; and

(ii) Eligibility requirements based on the amount of fees incurred

by the IRA or Keogh Plan are as favorable as any requirements based on

the amount of fees incurred by any other type of account which the

broker-dealer includes to determine eligibility.

(e) The combined total of all fees for the provision of services to

the IRA or Keogh Plan is not in excess of reasonable compensation

within the meaning of section 4975(d)(2).

(f) The investment performance of the IRA or Keogh Plan investment

is no less favorable than the investment performance on an identical

investment(s) that could have been made at the same time by a customer

of the broker-dealer who is not eligible for (or who does not receive)

reduced or no cost services.

(g) The services offered under the arrangement to the IRA or Keogh

Plan customer must be the same as are offered to non-IRA or non-Keogh

Plan customers with account values of the same amount or the same

amount of fees generated.

Section III: Definitions

The following definitions apply to this exemption:

(a) The term broker-dealer means a broker-dealer registered under

the Securities Exchange Act of 1934.

(b) The term IRA means an individual retirement account described

in Code section 408(a). For purposes of this exemption, the term IRA

shall not include an IRA which is an employee benefit plan covered by

Title I of ERISA, except for a Simplified Employee Pension (SEP)

described in section 408(k) of the Code which provides participants

with the unrestricted authority to transfer their SEP balances to IRAs

sponsored by different financial institutions.

(c) The term Keogh Plan means a pension, profit-sharing, or stock

bonus plan qualified under Code section 401(a) and exempt from taxation

under Code section 501(a) under which some or all of the participants

are employees described in section 401(c) of the Code. For purposes of

this exemption, the term Keogh Plan shall not include a Keogh Plan

which is an employee benefit plan covered by title I of ERISA.

(d) The term account value means investments in cash or securities

held in the account for which market quotations are readily available.

For purposes this exemption, the term account value shall

[[Page 40000]]

not include investments in securities that are offered by the broker-

dealer [or its affiliate] exclusively to IRAs and Keogh Plans.

(e) An affiliate of a broker-dealer includes any person directly or

indirectly controlling, controlled by, or under common control with the

broker-dealer. The term control means the power to exercise a

controlling influence over the management or policies of a person other

than an individual.

(f) The term members of his or her family refers to beneficiaries

of the individual for whose benefit the IRA or Keogh Plan is

established or maintained, who would be members of the family as that

term is defined in Code section 4975(e)(6), or a brother, a sister, or

spouse of a brother or sister.

(g) The term service includes incidental products of a de minimis

value which are directly related to the provision of services covered

by the exemption.

(h) The term fees means commissions and other fees received by the

broker-dealer from the IRA or Keogh Plan for the provision of services,

including, but not limited to, brokerage commissions, investment

management fees, custodial fees, and administrative fees.

Signed at Washington, D.C., this 25th day of July 1996.

Olena Berg,

Assistant Secretary, Pension and Welfare Benefits Administration U.S.

Department of Labor.

[FR Doc. 96-19484 Filed 7-30-96; 8:45 am]

BILLING CODE 4510-29-P