DOL finalizes changes to the QPAM prohibited transaction exemption – expanding the situations in which a QPAM may be disqualified because of “misconduct”

On April 3, 2024, the Department of Labor finalized amendments to its “qualified professional asset manager” (QPAM) class prohibited transaction exemption (PTE). In this article, we begin with a discussion of why the changes made by this amendment matter to plan sponsors. We then provide some background on the PTE and then discuss the changes made by the 2024 amendments.

Why this matters to plan sponsors

As discussed further below, QPAMs are an essential tool for plan management, providing a solution to the problem of unintentional, “nickel and dime” prohibited transactions that sponsors/plans (especially large sponsors and large plans with complicated portfolios) might otherwise commit.

The changes made by DOL in the 2024 amendment generally expand (1) the sorts of misconduct that might disqualify a QPAM and (2) the sorts of remedies that a plan might have (very much including remedies against the QPAM) upon such disqualification.

For plans, finding a suitable QPAM can be a complicated process. Subsequent disqualification of that QPAM, and, e.g., the search for a substitute, may involve significant costs.

Thus, while from one point of view the changes made by the DOL to the QPAM PTE enhance plan protections/rights, on the other, in expanding the situations in which disqualification might happen and in increasing the QPAM’s regulatory burden, the changes may in some circumstances and for some sponsors increase the costs of finding and retaining a QPAM and increase the possibility that a current and (from, e.g., the sponsor fiduciary’s point of view) perfectly appropriate QPAM relationship may be disrupted.

Background

ERISA broadly prohibits transactions (including sales, leases, loans, and the provision of services) between a plan and persons connected with the plan (defined as ‘‘parties in interest’’), including sponsors, sponsor employees, and plan service providers. It then provides for Prohibited Transaction Exemptions (PTEs) to permit activity that is net-beneficial to plans. There are statutory exemptions (e.g., for service providers), class administrative exemptions (adopted by DOL through a rulemaking process and applicable to an entire class of activity, e.g., fiduciary advice), and individual exemptions for unique, one-off transactions.

DOL adopted the QPAM PTE to “permit … an investment fund holding assets of Plans and IRAs that is managed by a ‘qualified professional asset manager’ (QPAM) to engage in transactions with a ‘party in interest’” without violating ERISA, subject to certain conditions. The exemption generally covers any prohibited transaction other than fiduciary violations (such as self-dealing or receipt of a kickback). For example, EIRSA prohibits a sponsor from borrowing money from the plan, and thus (ordinarily) the plan could not buy a bond (as part of a fixed income strategy) issued by the sponsor. But under the PTE (and subject to its conditions), a QPAM managing the plan’s fixed income fund could buy that bond.

To be a QPAM, the manager must be a bank, savings and loan association, insurance company, or 1940 Act investment adviser, meeting certain capital/asset requirements, that is “independent of and unrelated to the employer sponsoring [the plan].” And the terms of the transaction must be determined by the QPAM – thus, a transaction pre-arranged by the sponsor/fiduciary with a counter-party could not be “laundered” through a QPAM.

The QPAM PTE also includes an “integrity” requirement, disqualifying certain persons from being QPAMs for certain criminal convictions and misconduct. It is this requirement that is the primary focus of the 2024 amendments.

Misconduct by affiliates

As discussed below, the changes made by the 2024 amendments expand the sorts of misconduct that may trigger QPAM disqualification. Those changes do not (literally) change the QPAM PTE affiliate rules, under which, if an affiliate (however remote from the actual QPAM entity – the person actually managing the plan’s funds) engages in misconduct, then the QPAM is disqualified.

This element, however, was identified as problematic by many commenters on DOL’s original proposal. As a practical matter, a sophisticated investor/plan fiduciary may itself be satisfied with its relationship with its plan’s QPAM and that QPAM’s integrity, notwithstanding, e.g., a foreign conviction of a (relatively remote) affiliate for an “integrity” crime. DOL did not change its proposal to accommodate this concern directly but suggested that (as in the past) this problem could be dealt with via an individual exemption.

2024 changes to the 1984 PTE – Expansion of the “integrity”/misconduct rules

The major change made by the 2024 amendment to the QPAM PTE is an expansion of the misconduct rules, as follows:

Expansion of the “scope of misconduct”: The 2024 amendment significantly expands the sorts of misconduct that may result in disqualification of a QPAM. In this regard, it:

• “Updates” the list of disqualifying crimes to explicitly include foreign crimes.

• Extends disqualification to “Prohibited Misconduct,” defined as:

  • NPAs and DPAs:Entering into “a non-prosecution (NPA) or deferred prosecution agreement (DPA) … where the factual allegations that form the basis for the NPA or DPA would have constituted a [disqualifying] crime.”

  • Intentional abuse: Having been found by a regulating authority to have:

    • Engaged in “a systematic pattern or practice of conduct that violates the conditions of [the PTE],”

    • Intentionally engaged in “conduct that violates the conditions of [the PTE],” or

    • Provided “materially misleading information to [regulatory authorities].”

One-year wind-down period: The 2024 amendment provides for a one-year wind-down/transition, following disqualification, providing plans with a period to arrange for an alternative QPAM and the disqualified QPAM with time to apply for an individual exemption. During this period, the QPAM may continue to operate, subject to certain conditions. Those conditions include that:

Plan may exit with no fees: The disqualified QPAM must allow plans to exit the fund without an fees (except fees “designed to … prevent … generally recognized abusive investment practices, or … ensure equitable treatment of all investors”).

QPAM liability for plan losses: The disqualified QPAM must agree “to indemnify, hold harmless, and promptly restore actual losses to the client [p]lans for any damages that directly result to them from a violation of applicable laws, a breach of contract, or any claim arising out of the conduct that is the subject of [the disqualifying misconduct].”

Other changes

The 2024 amendment also:

• Requires QPAMs to file “a one-time notice to the Department that the QPAM is relying upon the exemption.” This will function, in effect, as a registry of QPAMs.

• Clarifies the rule requiring that the QPAM have independent responsibility for decisions (e.g., in situations in which a sponsor and counterparty have previously engaged in negotiations).

• Increases the capital/asset thresholds for QPAMs.

• Adds a QPAM recordkeeping requirement.

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Sponsors whose plan’s use a QPAM will want to review the new rules with counsel and with their QPAM providers.

We will continue to follow this issue.