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Fiduciary Focus:
Prohibited Transaction Discussion
ERISA SECTION 406(a)(1)(C) prohibits transactions
that directly or indirectly provide goods, services, or
facilities between 401(k) plans and their parties in
interest unless a statutory exemption exists. This is an
extremely broad prohibition that could seriously hamper
a plan’s ability to perform plan functions if not for an
exemption provided in ERISA Section 408(b)(2), allowing
transactions that are otherwise prohibited by those
transactions are:
-
Necessary for the establishment and/or operation of
the plan,
-
Established by a reasonable agreement between the
plan and the party in interest, and
-
Compensation paid for the goods, services or
facilities is reasonable.
Even
though two of the conditions set forth above utilize the
term "reasonable", ERISA does not define the term
"reasonable." Instead, the reasonableness of a
transaction is determined using facts and circumstances
on a case-by-case basis. The only explicit example of
reasonableness provided in the regulations states that a
contract or arrangement will not be judged reasonable if
the plan cannot terminate the contract or arrangement
without penalty on reasonably short notice. It is the
plan fiduciary’s responsibility to assess whether or not
a plan transaction is reasonable. In making this
assessment, the plan fiduciary must utilize all aspects
of the standard of care demanded by ERISA of plan
fiduciaries.
It is
important to note that the exemption provided by ERISA
Section 408(b)(2) also applies to parties in interest
who are plan fiduciaries as long as the fiduciary
involved in the transaction:
- Is
not a party to the decision to select himself or
herself as a service provider to the plan,
-
Does not participate in the decision determining how
much he or she will be compensated for the services
provided to the plan, and
-
Does not use his or her plan authority to cause the
plan to pay an additional fee for the services
provided.
As a
part of your client’s responsibility for ensuring that
plan functions and plan business are effectively and
efficiently transacted, it is essential that they
understand that having parties in interest, including
plan fiduciaries, provide services to the plan may be
the most reasonable and effective solution to the plan’s
needs. But, as a plan fiduciary your client must ensure
that the party in interest’s services are absolutely
essential to the plan, that someone who is not a party
in interest to the plan could not just as reasonably and
cost effectively provide the services, and that the
prohibited transaction exemption conditions established
in ERISA Section 408(b)(2) and briefly described above
are meticulously followed.
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