ERISA & Fiduciaries: What are Prohibited Transactions?

ERISA code can be a dry read, but it is essential for plan sponsors to understand what the code says and how to stay compliant with the law. Our ERISA whitepaper breaks down relevant sections of the code for plan sponsors to show how the law applies to their fiduciary duties.

I am sharing some of our analysis of specific parts of the ERISA code in a series of blog posts. In the first post, I discussed the “prudent man” standard as spelled out in Section 404(a) of ERISA.

This post, the next in this series, covers prohibited transactions. A word like “prohibited” is a red flag for anyone reading through a legal document. The definition of what is prohibited and what is not ought to be clear, but there are some gray areas in these provisions where plan sponsors and fiduciaries can easily find themselves in trouble.

I’ll discuss some specific examples of ERISA prohibited transactions later in this post. But first, let’s review the code:

ERISA Section 406, 29 USC 1106 – Prohibited transactions

(a) Transactions between plan and party in interest – Except as provided in section 1108 of this title:

 (1) A fiduciary with respect to a plan shall not cause the plan to engage in a transaction, if he knows or should know that such transaction constitutes a direct or indirect –

 (A) sale or exchange, or leasing, of any property between the plan and a party in interest;

 (B) lending of money or other extension of credit between the plan and a party in interest;

 (C) furnishing of goods, services, or facilities between the plan and a party in interest;

 (D) transfer to, or use by or for the benefit of a party in interest, of any assets of the plan; or

 (E) acquisition, on behalf of the plan, of any employer security or employer real property in violation of section 1107(a) of this title.

 (2) No fiduciary who has authority or discretion to control or manage the assets of a plan shall permit the plan to hold any employer security or employer real property if he knows or should know that holding such security or real property violates section 1107(a) of this title.

I highlighted the first line in this section because it’s important to discuss. What is meant by “party in interest”? This is the kind of vague language often found in legalese that can drive lay people nuts. The vague-ness is on purpose. “Party in interest” can cover a wide swath of players involved in the management of a retirement plan. They’re also often referred to as “disqualified persons” and typically include the following:

• A plan fiduciary
• The employer
• An employee organization whose members are covered by the plan (e.g., the local office of a labor union)
• Service providers
• Any substantial owners in the company
• Company officers and other highly compensated employees
• Family members of any of the above.

That’s a lot of people who may be subject to ERISA violations under the prohibited transactions code. Many of these folks may know nothing about ERISA and as a result, may unwittingly violate the law just by following what they believe are normal business practices. The burden of responsibility is always on the plan fiduciary. They must monitor business dealings among service providers and anyone directly or indirectly connected to the plan as a “party in interest”.

The next line I highlighted covers the “furnishing of goods, services, or facilities” between the plan and parties in interest. This section of the code is meant to prevent self-dealing among plan sponsors and reduce the potential for conflicts of interest for plan fiduciaries. A plan sponsor receiving “kickbacks” from a service provider would obviously not be in the best interests of participants. This part of ERISA explicitly makes this practice illegal.

But other types of transactions might fall under this provision, such as legal, accounting or recordkeeping services provided by an outside firm to the plan. Paying fees for these services from plan assets would seem to be a prohibited transaction.

But ERISA allows for exemptions that permit payments for services, if those services are necessary and the compensation provided is deemed reasonable. This is where things get interesting for plan sponsors and other parties-in-interest. Many of the plan sponsor lawsuits that are making recent headlines concern the reasonableness of fees paid to service providers and the failure of plan fiduciaries to monitor these expenses.

My next blog post in this series will delve deeper into these exemptions and discuss the standards plan sponsors must follow in order to avoid costly litigation.