Grant of Individual Exemption to Amend and Replace Prohibited Transaction Exemption (PTE) 96-14 Involving Morgan Stanley & Co. Incorporated (MS&Co) and Morgan Stanley Trust Company (MSTC), Located in New York, NY

DEPARTMENT OF LABOR

Pension and Welfare Benefits Administration

[Prohibited Transaction Exemption 98-40; Exemption Application No. D-

10429]

Grant of Individual Exemption to Amend and Replace Prohibited

Transaction Exemption (PTE) 96-14 Involving Morgan Stanley & Co.

Incorporated (MS&Co) and Morgan Stanley Trust Company (MSTC), Located

in New York, NY

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

Labor.

ACTION: Grant of individual exemption to modify and replace PTE 96-14.

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SUMMARY: This document contains a final exemption which amends and

replaces PTE 96-14 (61 FR 10032, March 12, 1996). PTE 96-14, as

clarified by a Notice of Technical Correction dated June 4, 1996 (61 FR

28243), permits the lending of securities to MS&Co and to any other

U.S. registered broker-dealers affiliated with MSTC (the Affiliated

Broker-Dealers; collectively, the MS Broker-Dealers) by employee

benefit plans with respect to which the MS Broker-Dealer who is

borrowing such securities is a party in interest or for which MSTC acts

as directed trustee or custodian and securities lending agent. In

addition, PTE 96-14 permits MSTC to receive compensation in connection

with securities lending transactions. These transactions are described

in a notice of pendency (the Old Notice) that was published in the

Federal Register on August 11, 1995 at 60 FR 41118.

The current exemption replaces PTE 96-14 but incorporates by

reference the facts, representations and virtually all of the

conditions that are contained in the Old Notice, the final exemption

with respect thereto and the technical correction, except where

modified.

EFFECTIVE DATE: This exemption is effective as of March 12, 1996 for

transactions that are covered by PTE 96-14.

FOR FURTHER INFORMATION CONTACT: Ms. Jan D. Broady, Office of Exemption

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

Department of Labor, telephone (202) 219-8881. (This is not a toll-free

number.)

SUPPLEMENTARY INFORMATION: On January 26, 1998, the Department of Labor

(the Department) published a notice of proposed exemption (the New

Notice) in the Federal Register (63 FR 3767) that would amend and

replace PTE 96-14. PTE 96-14 provides an exemption from certain

prohibited transaction restrictions of section 406 of the Employee

Retirement Income Security Act of 1974 (the Act) and from the sanctions

resulting from the application of section 4975 of the Internal Revenue

Code of 1986 (the Code), as amended, by reason of section 4975(c)(1) of

the Code. The proposed exemption was requested in an application filed

on behalf of MS&Co and MSTC (collectively, the Applicants) pursuant to

section 408(a) of the Act and section 4975(c)(2) of the Code, and in

accordance with the procedures (the Procedures) set forth in 29 CFR

Part 2570, Subpart B (55 FR 32836, 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. Accordingly, this replacement exemption is being issued

solely by the Department.

The New Notice gave interested persons an opportunity to comment on

the proposed exemption and to request a public hearing. The only

written comment submitted to the Department during the comment period

was provided by the Applicants.

[[Page 46242]]

In their comment, the Applicants state that they wish to modify the

operative language of the New Notice by adding MS&Co to the lending

agent entities. The Applicants also wish to clarify that the exemption

would cover situations where MSTC and MS&Co, as securities lending

agents, act in a custodial or non-custodial capacity with respect to

loaned securities. The Applicants believe the modification is necessary

because MSTC and MS&Co may both act, from time to time, as non-

custodial securities lending agents. As securities lending agents, the

Applicants note that both MSTC and MS&Co would be confronted with the

same issues under the prohibited transaction provisions of the Act and

the Code if they were to lend client-plan securities to an MS Broker-

Dealer, even though neither MSTC or MS&Co would have physical custody

of the collateral for the securities loan. Under such circumstances,

the Applicants explain that the collateral pledged by the MS Broker-

Dealer would be held in a short-term investment vehicle selected by the

client-plan's fiduciary which would be independent of MSTC, MS&Co and

the affiliated borrower. The Applicants also point out that in its

expanded scope, the exemption would still be subject to the same terms

and conditions as set forth in the New Notice.

The Department concurs with the changes requested by the Applicants

and has amended the operative language of the current exemption to read

as follows:

The restrictions of sections 406(a)(1)(A) through (D) 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, effective

March 12, 1996, to (1) the lending of securities to Morgan Stanley &

Co. Incorporated (MS&Co) and to any other U.S. registered broker-

dealers affiliated with Morgan Stanley Trust Company (MSTC) or MS&Co

(the Affiliated Broker-Dealer; collectively, the MS Broker-Dealers)

by employee benefit plans with respect to which the MS Broker-Dealer

who is borrowing such securities is a party in interest or for which

(a) MSTC acts as directed trustee, (b) MSTC or MS&Co acts as

custodian and securities lending agent, or (c) MSTC or MS&Co acts as

noncustodial securities lending agent; and (2) the receipt of

compensation by MSTC or MS&Co in connection with these transactions,

provided that the following conditions are met:

Similarly, the Department has revised the first sentence of

Representation 5 of the Old Notice as follows:

5. MSTC and MS&Co request an exemption for the lending of

securities owned by certain pension plans (client-plans) for which

(a) MSTC will serve as directed trustee, (b) MSTC or MS&Co will

serve as custodian and securities lending agent, or (c) MSTC or

MS&Co will serve as noncustodial securities lending agent to the MS

Broker-Dealers, 1 following disclosure of MSTC's and

MS&Co's affiliation with the MS Broker-Dealers, under either of the

two arrangements described as Plan A and Plan B, and for the receipt

of compensation by MSTC or MS&Co in connection with such

transactions.

\1\ The Old Notice refers to the MS Broker-Dealers as the ``MS

Group'' in Representation 5. Because the Applicants believed that

the use of the term ``MS Group'' would cause confusion since clients

and internal personnel often refer to Morgan Stanley Group, Inc.

(the parent entity of MS&Co and MSTC) as the ``MS Group,'' they

requested that all references to the MS Group be replaced with term

``MS Broker-Dealers.'' The Department did not object to this change

and made the requested modification in the final exemption.

In addition to the foregoing changes and to reflect the expanded

scope of the exemption, the Applicants have requested that the

Department include references to MS&Co in Footnote 2 as well as in

Conditions 3, 7 and 13 of the New Notice.

In response, the Department has decided to adopt the suggested

modifications.

The Applicants also comment that Condition 12(b) of the New Notice

unnecessarily restricts the ability of a client-plan to effect

securities loans under the Applicants' lending program, particularly

where the independent investment manager's in-house plan wishes to

invest in the commingled investment vehicle. After careful

consideration, the Department has decided to revise Condition (12)(b)

of the New Notice. As currently drafted, Condition (12)(b) provides

that--

In the case of two or more plans which are not maintained by the

same employer, controlled group of corporations or employee

organization (the Unrelated Plans), whose assets are commingled for

investment purposes in a group trust or any other form of entity the

assets of which are ``plan assets'' under the Plan Asset Regulation,

which entity is engaged in securities lending arrangements with MS

Broker-Dealers, the foregoing $50 million requirement shall be

deemed satisfied if such trust or other entity has aggregate assets

which are in excess of $50 million; provided that the fiduciary

responsible for making the investment decision on behalf of such

group trust or other entity--

(i) Is neither the sponsoring employer, a member of the

controlled group of corporations, the employee organization, nor an

affiliate;

(ii) Has full investment responsibility with respect to plan

assets invested therein; and

(iii) Has total assets under its management and control,

exclusive of the $50 million threshold amount attributable to plan

investment in the commingled entity, which are in excess of $100

million.

Accordingly, the Department has modified the Condition (12)(b) to read

as follows:

In the case of two or more plans which are not maintained by the

same employer, controlled group of corporations or employee

organization (the Unrelated Plans), whose assets are commingled for

investment purposes in a group trust or any other form of entity the

assets of which are ``plan assets'' under the Plan Asset Regulation,

which entity is engaged in securities lending arrangements with the

MS Broker-Dealers, the foregoing $50 million requirement is

satisfied if such trust or other entity has aggregate assets which

are in excess of $50 million (excluding the assets of any plan with

respect to which the fiduciary responsible for making the investment

decision on behalf of such group trust or other entity or any member

of the controlled group of corporations including such fiduciary is

the employer maintaining such plan or an employee organization whose

members are covered by such plan). However, the fiduciary

responsible for making the investment decision on behalf of such

group trust or other entity--

(i) Has full investment responsibility with respect to plan

assets invested therein; and

(ii) Has total assets under its management and control,

exclusive of the $50 million threshold amount attributable to plan

investment in the commingled entity, which are in excess of $100

million.

The Department wishes to emphasize that although the independent

investment manager's own plan may participate in the commingled

investment vehicle, for purposes of determining whether the $50 million

aggregation requirement is met, the assets of such plan must not be

counted.

Therefore, after giving full consideration to the entire record,

including the written comment provided by the Applicants, the

Department has made the aforementioned changes to the New Notice and

has decided to grant the replacement exemption as modified herein.

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 section 4975(c)(2) of the Code does

not relieve a fiduciary or other party in interest or disqualified

person from certain other provisions of the Act and 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 require, among other things, a fiduciary to

discharge his or her duties respecting the plan solely in the interest

of the participants and beneficiaries of

[[Page 46243]]

the plan and in a prudent fashion in accordance with section

404(a)(1)(B) of the Act; nor does it affect the requirements of section

401(a) of the Code that the plan operate for the exclusive benefit of

the employees of the employer maintaining the plan and their

beneficiaries;

(2) The exemption will not extend to transactions prohibited under

section 406(b)(3) of the Act and section 4975(c)(1)(F) of the Code;

(3) In accordance with section 408(a) of the Act, section

4975(c)(2) of the Code, the Procedures cited above, and based upon the

entire record, the Department finds that the exemption is

administratively feasible, in the interest of the plan and its

participants and beneficiaries and protective of the rights of

participants and beneficiaries of the plan;

(4) This exemption will be supplemental to, and not in derogation

of, any other provisions of the Act and the Code, including statutory

or administrative exemptions. 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

(5) This exemption is subject to the express condition that the New

Notice, the Old Notice and the final exemption underlying PTE 96-14,

and the notice of technical correction to PTE 96-14, accurately

describe, where relevant, the material terms of the transactions to be

consummated pursuant to this exemption.

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 cited

above, the Department hereby replaces PTE 96-14 as follows.

Section I. Covered Transactions

The restrictions of sections 406(a)(1) (A) through (D) 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, effective

March 12, 1996, to (1) the lending of securities to Morgan Stanley &

Co. Incorporated (MS&Co) and to any other U.S. registered broker-

dealers affiliated with Morgan Stanley Trust Company (MSTC) or MS&Co

(the Affiliated Broker-Dealer; collectively, the MS Broker-Dealers) by

employee benefit plans with respect to which the MS Broker-Dealer who

is borrowing such securities is a party in interest or for which (a)

MSTC acts as directed trustee, (b) MSTC or MS&Co acts as custodian and

securities lending agent, or (c) MSTC or MS&Co acts as noncustodial

securities lending agent; and (2) the receipt of compensation by MSTC

or MS&Co in connection with these transactions, provided that the

following conditions are met:

(1) Neither MS&Co nor MSTC will have any discretionary authority or

control over a client-plan's assets involved in the transaction or

renders investment advice (within the meaning of 29 CFR 2510.3-21(c))

with respect to those assets;

(2) The terms of each loan of securities by a client-plan to the MS

Broker-Dealer will be at least as favorable to such plan as those of a

comparable arm's length transaction between unrelated parties;

(3) Any arrangement for MSTC or MS&Co to lend plan securities to

the MS Broker-Dealers will be approved in advance by a plan fiduciary

who is independent of MSTC, MS&Co and the MS Broker-Dealers;

2 (In this regard, the independent fiduciary also will

approve the general terms of the securities loan agreement between the

client-plan and the MS Broker-Dealer, the specific terms of which will

be negotiated and entered into by MSTC or MS&Co which will act as a

liaison between the lender and the borrower to facilitate the lending

transaction.)

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\2\ The Department, herein, is not providing exemptive relief

for securities lending transactions engaged in by primary lending

agents, other than MSTC or MS&Co, beyond that provided pursuant to

Prohibited Transaction Exemption (PTE) 81-6 (46 FR 7527, January 23,

1981, as amended at 52 FR 18754, May 19, 1987) and PTE 82-63 (47 FR

14804, April 6, 1982).

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(4) A client-plan may terminate the arrangement at any time without

penalty on five business days notice;

(5) The client-plans will receive collateral consisting of cash,

securities issued or guaranteed by the U.S. Government or its agencies

or instrumentalities, bank letters of credit or other collateral

permitted under PTE 81-6 or any successor, from the MS Broker-Dealers

by physical delivery, book entry in a securities depository, wire

transfer or similar means by the close of business on or before the day

the loaned securities are delivered to the MS Broker-Dealers;

(6) The market value of the collateral will initially equal at

least 102 percent of the market value of the loaned securities and, if

the market value of the collateral falls below 100 percent, the MS

Broker-Dealers will deliver additional collateral on the following day

such that the market value of the collateral will again equal 102

percent;

(7) Prior to entering into a loan agreement, the MS Broker-Dealer

will furnish its most recent publicly-available audited and unaudited

financial statements to MSTC or MS&Co, which, in turn, will provide the

statements to the client-plan before the plan is asked to approve the

terms of the loan agreement. The loan agreement will contain a

requirement that the MS Broker-Dealer must promptly notify lenders at

the time of a loan of any material adverse changes in its financial

condition since the date of the most recently furnished financial

statements. If any such changes have taken place, MSTC or MS&Co will

not make any further loans to the MS Broker-Dealer unless an

independent fiduciary of the client-plan approves the loan in view of

the changed financial condition;

(8) In return for lending securities, the client-plan either will--

(a) Receive a reasonable fee, which is related to the value of the

borrowed securities and the duration of the loan, or

(b) Have the opportunity to derive compensation through the

investment of cash collateral. (Under such circumstances, the client-

plan may pay a loan rebate or similar fee to the borrowing MS Broker-

Dealer, if such fee is not greater than the fee the Client Plan would

pay in a comparable arm's length transaction with an unrelated party.)

(9) All procedures regarding the securities lending activities

will, at a minimum, conform to the applicable provisions of PTE 81-6

and PTE 82-63;

(10) The MS Broker-Dealer will indemnify and hold harmless each

lending client-plan against any and all losses, damages, liabilities,

costs and expenses (including attorney's fees) incurred by such plan in

connection with the lending of securities to the MS Broker-Dealers;

(11) The client-plan will receive the equivalent of all

distributions made to holders of the borrowed securities during the

term of the loan, including, but not limited to, cash dividends,

interest payments, shares of stock as a result of stock splits and

rights to purchase additional securities, or other distributions;

(12) Only plans with total assets having an aggregate market value

of at least $50 million will be permitted to lend securities to the MS

Broker-Dealers; provided, however that--

(a) In the case of two or more plans which are maintained by the

same employer, controlled group of corporations or employee

organization (the Related Plans), whose assets are commingled for

investment purposes in

[[Page 46244]]

a single master trust or any other entity the assets of which are

``plan assets'' under 29 CFR 2510.3-101 (the Plan Asset Regulation),

which entity is engaged in securities lending arrangements with the MS

Broker-Dealers, the foregoing $50 million requirement shall be deemed

satisfied if such trust or other entity has aggregate assets which are

in excess of $50 million; provided that, if the fiduciary responsible

for making the investment decision on behalf of such master trust or

other entity is not the employer or an affiliate of the employer, such

fiduciary has total assets under its management and control, exclusive

of the $50 million threshold amount attributable to plan investment in

the commingled entity, which are in excess of $100 million, or

(b) In the case of two or more plans which are not maintained by

the same employer, controlled group of corporations or employee

organization (the Unrelated Plans), whose assets are commingled for

investment purposes in a group trust or any other form of entity the

assets of which are ``plan assets'' under the Plan Asset Regulation,

which entity is engaged in securities lending arrangements with the MS

Broker-Dealers, the foregoing $50 million requirement is satisfied if

such trust or other entity has aggregate assets which are in excess of

$50 million (excluding the assets of any plan with respect to which the

fiduciary responsible for making the investment decision on behalf of

such group trust or other entity or any member of the controlled group

of corporations including such fiduciary is the employer maintaining

such plan or an employee organization whose members are covered by such

plan). However, the fiduciary responsible for making the investment

decision on behalf of such group trust or other entity--

(i) Has full investment responsibility with respect to plan assets

invested therein; and

(ii) Has total assets under its management and control, exclusive

of the $50 million threshold amount attributable to plan investment in

the commingled entity, which are in excess of $100 million.

(In addition, none of the entities described above must be formed

for the sole purpose of making loans of securities.)

(13) No loan of securities will be made by MSTC or MS&Co as

securities lending agent to any MS Broker-Dealer on any day on which

the market value of the securities proposed to be loaned, when added to

the market value of all client-plan securities subject to outstanding

loans to MS Broker-Dealers, exceeds 50 percent of the market value of

all client-plan securities subject to securities loans, including the

market value of securities proposed to be loaned to the MS Broker-

Dealer. (For purposes of this paragraph, market value shall be

determined in U.S. dollars, based on the last preceding business day's

closing prices of the securities and the last preceding business day's

closing foreign exchange rates, if applicable.);

(14) With regard to the ``exclusive borrowing'' agreement, the MS

Broker-Dealer will directly negotiate the agreement with a plan

fiduciary who is independent of the MS Broker-Dealers and MSTC, and

such agreement may be terminated by either party to the agreement at

any time;

(15) Prior to any plan's approval of the lending of its securities

to an MS Broker-Dealer, a copy of this exemption (and the notice of

pendency) will be provided to the client-plan;

(16) Each client-plan will receive monthly reports with respect to

securities lending transactions so that an independent fiduciary of a

client-plan may monitor such transactions with the MS Broker-Dealer;

Section II. General Conditions

(1) MS Broker-Dealers will maintain, or cause to be maintained, for

a period of six years from the date of such transactions, in a manner

that is convenient and accessible for audit and examination, such

records as are necessary to enable the persons described in paragraph

(2) to determine whether the conditions of this exemption have been

met, except that--

(a) A prohibited transaction will not be considered to have

occurred if, due to circumstances beyond the control of the MS Broker-

Dealers, the records are lost or destroyed prior to the end of the six

year period, and

(b) No party in interest other than the MS Broker-Dealers shall be

subject to the civil penalty that may be assessed under section 502(i)

of the Act, or to the taxes imposed by section 4975(a) and (b) of the

Code, if the records are not maintained, or are not available for

examination as required below by paragraph (2);

(2) Notwithstanding any provisions of subsections (a)(2) and (b) of

section 504 of the Act, the records referred to in paragraph (1) are

unconditionally available at their customary location during normal

business hours by--

(i) Any duly authorized employee or representative of the

Department, the Internal Revenue Service or the Securities and Exchange

Commission (the SEC),

(ii) Any fiduciary of a participating client-plan or any duly

authorized representative of such fiduciary, and

(iii) Any contributing employer to any participating client-plan or

any duly authorized employee representative of such employer;

(3) None of the persons described above in paragraphs (ii)-(iii) of

paragraph (2) are authorized to examine the trade secrets of MS&Co or

its affiliates or commercial or financial information which is

privileged or confidential.

Section III. Definitions

For purposes of this exemption,

(1) An ``affiliate'' of a person includes--

(a) Any person directly or indirectly through one or more

intermediaries, controlling, controlled by, or under common control

with such other person;

(b) Any officer, director, or partner, employee or relative (as

defined in section 3(15) of the Act) of such other person; and

(c) Any corporation or partnership of which such other person is an

officer, director or partner.

(2) The term ``control'' means the power to exercise a controlling

influence over the management or policies of a person other than an

individual.

EFFECTIVE DATE: This exemption is effective as of March 12, 1996.

The availability of this exemption is subject to the express

condition that the material facts and representations contained in the

application for exemption are true and complete and accurately describe

all material terms of the transactions. In the case of continuing

transactions, if any of the material facts or representations described

in the applications change, the exemption will cease to apply as of the

date of such change. In the event of any such change, an application

for a new exemption must be made to the Department.

For a more complete statement of the facts and representations

supporting the Department's decision to grant this exemption, refer to

the New Notice, the Old Notice and the final exemption underlying PTE

96-14, and the notice of technical correction to PTE 96-14, all of

which are cited above Signed at Washington, D.C., this 24th day of

August, 1998.

Ivan L. Strasfeld,

Director of Exemption Determinations, Pension and Welfare Benefits

Administration, U.S. Department of Labor.

[FR Doc. 98-23284 Filed 8-28-98; 8:45 am]

BILLING CODE 4510-29-P