Investment Managers Beware: DOL Proposes Major Changes to QPAM Exemption | K&L Gates LLP

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Summary

The Department of Labor’s proposed amendment to the QPAM exemption would impose stricter conditions and make it more difficult for managers to claim one of the most commonly used ERISA exemptions. All investment advisers and other financial institutions that manage the assets of the plan, or may manage the assets of the plan in the future, should understand the proposed changes and consider submitting comments on the proposal.

The Prohibited Transactions Exemption (PTE) 84-14, more commonly referred to as the “QPAM Exemption”, is one of the most commonly invoked exemptions from the Prohibited Transactions Restrictions of the Employee Retirement Income Security Act. 1974, as amended (ERISA), and the Internal Revenue Code (Code).

Without an exemption, most transactions, including purchases, sales, leases, and loans, between a retirement or welfare plan (Plan) subject to ERISA or the Code and an “interested party” of the Map are prohibited.1 The definition of interested party is very broad and includes any entity and most of its affiliates that provide any type of service to a Plan. It can be very difficult to determine and track which entities have interests in a plan, so many plan asset managers routinely rely on an exemption, often the QPAM exemption, for all or nearly all transactions entered into on behalf of a Planner. For decades, investment advisers and other financial institutions that qualify to be a “qualified professional asset manager” or “QPAM” have relied on the relatively simple requirements of the QPAM exemption in order to engage in a wide range of investment transactions on behalf of a Plan, usually without having to undergo the arduous process of determining whether the transaction involves an otherwise prohibited interested party.

On July 27, 2022, on its own initiative, the Department of Labor (DOL) released a Proposed Amendment to the QPAM Exemption (Proposed Amendment). If the proposed amendment is passed as proposed, the ubiquitous QPAM exemption will have stricter terms and require additional affirmative action for those seeking to avail themselves of the exemption. The proposed amendment would revise the QPAM exemption conditions for:

  1. Require a one-time notice to the DOL that a QPAM relies on the exemption. Each manager relying on the QPAM exemption will need to notify the DOL by email, including the legal and operating names of each business entity relying on the exemption. If an entity’s name changes, it should update its notice.
  2. Require the inclusion of specific terms in a written management agreement that apply in the event the manager becomes ineligible to serve as a QPAM due to a criminal conviction or written notice of ineligibility in relation to misconduct prohibited. These provisions include (a) an agreement allowing a Plan to terminate its agreement with MAQP without cost or penalty, except for reasonable charges for limited purposes disclosed in advance, (b) indemnification by MAQP for any loss to the Plan arising out of conduct that results in ineligibility, including the costs of unwinding transactions and transferring Plan assets to another asset manager, and (c) an agreement not to employ a person who has engaged in criminal or other conduct that would result in ineligibility.
  3. Update the list of crimes that result in ineligibility to be a QPAM to explicitly include foreign crimes that are substantially equivalent to previously listed crimes.
  4. Expand on the circumstances that may lead to ineligibility. This extension would include (a) any conduct that forms the basis of a non-prosecution or deferred prosecution agreement (under domestic or foreign jurisdiction) that, if successfully prosecuted, would have constituted a covered crime, and not only condemnation; (b) intentionally violate or engage in a pattern or systematic practice of violating the terms of the QPAM Exemption in connection with prohibited transactions otherwise not exempted; or (c) provide materially misleading information to the DOL in connection with the terms of the QPAM Exemption. Participation in prohibited misconduct would involve not only anyone actively participating, but also knowing the approval of the conduct or knowledge of the conduct without taking active steps to prohibit the conduct, such as reporting to appropriate compliance personnel.
  5. Provide for a one-year liquidation period to help plans avoid or minimize possible negative impacts of terminating or changing QPAMs or adjusting asset management arrangements when a QPAM becomes ineligible. During the one-year period, QPAM could not enter into new transactions relying on the QPAM exemption, but could continue to rely on the QPAM exemption for existing transactions.
  6. Provide guidance on the process a manager who has become ineligible (or plans to become ineligible) to be a QPAM should follow when applying for an individual exemption.2
  7. Provide that for a QPAM to rely on the QPAM Exemption with respect to any transaction, the terms of that transaction and any related negotiations must be the “sole responsibility” of the QPAM.3
  8. Significantly revise upwards the amount of assets under management (AUM) and capital thresholds that a QPAM must meet to qualify as a QPAM, and put in place a process for the DOL to adjust these amounts annually.4
  9. Add a requirement to keep records for six years.

While the proposed extensions to QPAM ineligibility in the Proposed Amendments are important, particularly for QPAMs with foreign affiliates, the proposed changes to other terms should not be overlooked. Taken as a whole, the proposed amendment has the potential to disrupt the operations of any manager of plan assets and includes a number of pitfalls for the unwary. A single DOL notice may not be a difficult condition, but ignoring this condition, or not updating the notice when an entity changes its name, could result in the QPAM exemption not being available and exposing managers liability for non-exempts. prohibited transactions. The notice requirement also eliminates the possibility of retroactively relying on the QPAM exemption, for example in a circumstance where a manager realizes that it has managed plan assets unintentionally (for example, by due to an error in the calculation of the “25% test”5). The requirement to include specific terms in the written management agreement between a QPAM and a scheme means that if the proposed amendment is finalized, QPAM will need to amend any existing management agreements with the schemes, which may be a daunting task for great managers. with many clients (as most QPAMs are likely to be). The “clarification” in the Proposed Amendments that dealing in transactions should be the “sole responsibility” of a QPAM may cast doubt on whether the QPAM Exemption can apply where there are co-managers or sub-managers. advisors, or for mutual funds where there is a separate trustee and investment manager.

The proposed change would make the QPAM exemption more difficult to invoke, and fewer asset managers may be able to qualify as QPAMs. This may require asset managers to rely on other available PTEs, such as the “service provider” exemption under section 408(b)(17) of ERISA.6 The proposed amendment may also result in increased reluctance on the part of some asset managers to provide investment management services to plans, which will result in less capacity available for plan investments in certain pooled investment vehicles. , or fewer investment opportunities for schemes.

Comments on the proposed amendments are expected by September 26, 2022, and any manager who currently manages plan assets, or who may manage plan assets in the future, should consider submitting a comment.

1 Or “Disqualified Person” as defined in the Code. For purposes of this Client Alert, references to Interested Parties shall be construed to include Disqualified Persons, and references to ERISA Prohibited Transactions shall be construed to include parallel Code Prohibited Transactions.

2 It is common for a Manager who has become ineligible to be a QPAM after an Affiliate has been convicted of a crime to apply to the DOL for an individual exemption to allow the Manager to continue to transact on behalf of Plans. These individual exemptions were routinely granted, but the DOL has increased oversight of these situations in recent years.

3 The current wording of the QPAM exemption provides that the terms of the transaction must be negotiated “under the general authority and direction of” QPAM.

4 The current AUM threshold of $85,000,000 would initially be adjusted to $135,870,000. Currently, any US-based asset manager who meets the AUM threshold required to register as an investment adviser with the Securities and Exchange Commission meets the AUM threshold for the QPAM exemption; this would no longer be the case if the threshold for assets under management were adjusted as proposed. The shareholders’ and partners’ equity and the brokers’ net worth thresholds of US$1,000,000 would be increased to US$2,040,000. Other equity or net worth thresholds for banks, savings in loan associations and insurance companies would be adjusted from $1,000,000 to $2,720,000.

5 A private fund can avoid having its assets considered as plan assets if the equity participation of “benefit plan investors” (i.e. plans subject to ERISA or the Code, or other entities deemed to hold plan assets) is less than 25% of the value of any class of entity interest in the fund.

6 Although the service provider exemption in Section 408(b)(17) is similar in magnitude to the QPAM exemption, some asset managers have refused to rely on it, particularly for more exotic transactions, due to the uncertainty regarding some of its terms and the absence of any clarifying regulations from the DOL. These uncertainties include (1) what is meant when the exemption refers to “securities” and (2) what is meant by “adequate consideration” when there is no generally recognized market.

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