After rejecting significantly increased costs from a decades' long corporate service provider, “Joan,” CFO of a local manufacturing firm, finds herself negotiating contract terms with a potentially new corporate service provider. In reviewing the contract’s covenants and terms, Joan notices explicit language that the manufacturing firm’s 401(k) plan will move to the new service provider’s investment management group for the duration of the proposed five-year contract. The seasoned account executive has included in the contract’s covenant terms clear wording that the fee income generated from the manufacturer’s 401(k) plan is required to maintain the corporate contract’s “good standing.” Joan is also the chair of the firm’s 401(k) committee which is considering issuance of a benchmarking RFP as part of the committee’s due diligence process. 

In addition to reporting and disclosure, prudence and exclusive purpose provisions, ERISA identifies certain transactions as “prohibited transactions.” ERISA section 406(a) forbids transactions between a plan and a party-in-interest, while ERISA 406(b) prohibits fiduciaries from engaging in self-dealing and acting inappropriately in conflict-of-interest situations. Arguably, today the most common type of 406(a) prohibited transaction is the failure to remit employee deferrals in a timely manner, giving the employer – who is a party in interest – the opportunity to use these plan assets on its own behalf, such as meeting bank account balance minimums or paying outstanding corporate account payables prior to remitting the contribution. Other incidents of 406(a) violations could be the outright lending of plan assets to the plan sponsor, or to the owner in an amount that exceeds the participant loan regulations. 

Some 406(a) prohibited transactions are exempted through statutory exemption contained directly in ERISA, or through a prohibited transaction exemption (also called a “PTE”) that’s promulgated by the Department of Labor, EBSA. An example of an exemption would be the loan taken by an ESOP (employee stock ownership plan) with guaranteed repayment by the plan sponsor.

Often ERISA 406(b) prohibited transactions are not as clear or transparent. In the above example, the account executive for the potentially new corporate service provider, by presenting a proposed corporate contract with the explicit language, may be taking on an accidental fiduciary role (see Retirement Meditation #46) by effectively taking control over retirement plan assets to drive fee income to the corporate service provider. How the CFO responds to the new covenant language could further create additional prohibited transaction violations under both ERISA 406(a) and 406(b).

Has your retirement plan engaged in a prohibited transaction?

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