Investment managers face continued cross-trading limitations.

• Author: Day, Althea R.
• Position: ERISA plan cross-trading

Given the proliferation of employee benefit plan transactions involving securities "cross-trades" (and related prohibited transaction exemption requests), the Department of Labor (DOL) is focusing additional scrutiny on these transactions. Specifically, on March 20, 1998, the DOL issued a notice indicating that it is seeking input in defining or redefining the standards and safeguards that should be required as a condition for exemptive relief.

At issue is the application of the Employee Retirement Income Security Act of 1974's (ERISA's) fiduciary and prohibited transaction rules, which prohibit a plan fiduciary from acting in any transaction involving a plan on behalf of a party whose interests are adverse to the interests of the plan or its participants and beneficiaries (ERISA Section 406(b)(2)). Normal plan operations often involve cross-trading transactions that technically violate these rules, even if no harm actually results to plan participants or beneficiaries.

The type of ERISA violation will depend, in part, on the nature of the cross-trade (i.e., whether it is a direct cross-trade or a brokered cross-trade). A direct cross-trade occurs when an investment manager causes the purchase or sale of a particular security to be made directly between two or more accounts under its management without using a broker as intermediary. A brokered cross-trade occurs when an investment manager places simultaneous purchase and sale orders for the same security with a broker-dealer under an arrangement that rewards the linkage with reduced broker commissions. Under ERISA, these transactions would trigger one or more ERISA violations if, for example, one of the accounts involved in the cross-trade is an employee benefit account and the investment manager has investment discretion with respect to both of the accounts involved; ERISA Section 406(b)(2) precludes an ERISA fiduciary from acting in a transaction involving a plan on behalf of a party with adverse interests; or the investment manager represents both the buyer and the seller in a cross-trade. ERISA Section 406(b)(2) precludes an ERISA fiduciary from acting in a transaction involving a plan on behalf of a party with adverse interests; ERISA Section 404(a) (1) (A) requires a fiduciary to discharge its duties solely in the interests of plan participants and for the exclusive purpose of providing benefits to such participants and beneficiaries; and ERISA Section 403 (c) (1) requires plan...