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Warner Norcross + Judd LLP is a corporate law firm with over 230 attorneys serving clients in nine offices throughout Michigan. Among the largest law firms in Michigan, Warner works in virtually all areas of business law.

Michigan Law Firm - Warner Norcross + Judd LLP

The Department of Labor (DOL) has recently turned its attention to securities lending. If you are responsible for selecting funds for a retirement plan, you must understand securities lending. 

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WHAT IS SECURITIES LENDING?

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Third parties may want to borrow a security for a short time. The borrower will typically “short sell” the security, i.e., sell the security expecting to buy it back later at a lower price, generating a profit equal to the decline in the price of the security. The borrower pays a fee to borrow the security and provides collateral to secure the loan (usually cash or an equivalent). At the end of the loan period, the borrower returns the security to the plan. The plan benefits by receiving the fee and investing the collateral, while continuing to receive any dividends and growth in the value of the loaned security.

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Securities lending is not without risk. If the borrower fails to return the security and the collateral is insufficient, the plan could suffer a loss. In addition, because the plan trustee or investment manager usually acts as the lending agent and shares in the profits, lending is a prohibited transaction (PT) under the Employee Retirement Income Security Act of 1974 (ERISA). The practice is so common, however, that the DOL has granted a prohibited transaction exemption (PTE) that hinges on approval of the arrangement by an independent fiduciary—you, the plan sponsor fiduciary.

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When you approve a new investment, review the documents to determine whether you are approving securities lending. This will likely be the case if you are approving a collective investment trust (CIT). Many plans are turning from mutual funds to CITs because of the potential cost savings, but CITs carry additional risks and responsibilities for the fiduciary approving them. With mutual funds, the fund shares, not the underlying investments, are the plan’s asset. With a CIT, the plan is appointing a CIT trustee—an ERISA fiduciary—for a portion of its assets, and the underlying investments are plan assets. So, when a plan CIT loans securities, a plan fiduciary is loaning plan assets. You are the independent fiduciary approving that fiduciary’s profit on the lending.

2. Understand the securities lending program terms.

Before approving a CIT that includes securities lending, you should document your understanding of the following issues:

The DOL has issued another PTE for their use of Equilend, which also depends on your consent. If the lending agent is one of Equilend’s owners, you must understand the implications of that PTE as well.

3. Determine whether the lending arrangement is in the best interest of plan participants and document your reasons for your conclusion.

4. Make sure all the other requirement of the relevant PTEs are met.

When you sign CIT documents, you alone are responsible for approving any securities lending arrangement disclosed. The CIT trustee is not responsible and will not highlight the issue apart from what appears to be a routine disclosure. The DOL expects you to determine whether the decision to permit securities lending was made with due care and in the participants’ best interests. 

Of Counsel

Mary Jo Larson

Employee Benefits

401(k) and Pension Sponsors — Do You Know Where Your Securities Are?

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401(k) and Pension Sponsors — Do You Know Where Your Securities Are?

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