Good News for P.R. Plans
Art by Tim Bower
The Division of Investment Management of the Securities and Exchange Commission (SEC) issued a no-action letter on March 25, clarifying that an employer-sponsored retirement plan that meets requirements for favorable tax treatment under the Puerto Rico (P.R.) tax code may participate in certain pooled investment vehicles without requiring the vehicle or interests in it to be registered under U.S. securities laws. This should be welcome news to named fiduciaries of Puerto Rico retirement plans and the advisers to such fiduciaries.
By way of background, retirement plans formed in Puerto Rico under Puerto Rico law and offered by private-sector employers to employees there are subject to the fiduciary provisions of the Employee Retirement Income Security Act (ERISA), just like U.S. retirement plans, and intended to meet the tax qualification provisions of the Internal Revenue Code (IRC). In some cases, Puerto Rico plans are designed to be tax-exempt under IRC Section 501(a), like U.S. tax-qualified plans, and under Section 1081.01(a) of the Puerto Rico Internal Revenue Code (P.R. Code). Such plans are dual-qualified plans. In other cases, the Puerto Rico plans intend to be tax-exempt only under the P.R. Code and are often called P.R.-only plans. The latter are the subject of the SEC’s no-action letter.
Section 3(c)(11) of the Investment Company Act of 1940 (’40 Act) excludes from the definition of “investment company” a “collective trust fund maintained by a bank [and] consisting solely of assets of one or more” trusts including “[a]ny employee’s stock bonus, pension or profit-sharing trust which meets the requirements for qualification under [IRC] Section 401.” Thus, under Section 3(c)(11), a collective investment trust (CIT) maintained by a bank is not required to register as an investment company in accordance with the ’40 Act like other pooled investment vehicles, such as mutual funds, that do meet the definition. The units of a CIT are also exempt from registration under Section 3(a)(2) of the Securities Act of 1933 and Section 12(g)(2)(H) of the Securities Exchange Act of 1934.
In recent years, fiduciaries to ERISA-governed plans have looked to CITs as investment options for their participant-directed defined contribution (DC) plans because these trusts typically are lower cost. However, the U.S. banks that maintain the CITs often have restricted their investment by Puerto Rico plans.
The U.S. banks that maintain these CITs in the U.S. typically allow dual-qualified plans to participate in them—i.e., purchase interests in the CITs. The banks do so because those plans are qualified under IRC Section 401(a). Thus, the exclusion under Section 3(c)(11) of the ’40 Act and the aforementioned exemptions under the Securities Act and the Exchange Act apply. Some U.S. banks, however, have been unwilling to accept P.R.-only plans as investors,
due to a concern that this would make their CITs subject to the securities laws. P.R.-only plans do not comply with Section 401(a).
In its recent no-action letter issued to a U.S. financial services company that maintained a stable value fund organized as a CIT in the U.S., the Division of Investment Management stated it would not take action against the CIT for failing to register as an investment company, based on the exception under Section 3(c)(11), even if P.R.-only plans owned interests in the CIT under certain conditions.
Those conditions are: 1) any P.R.-only plan that invests in the CIT will meet the requirements for tax exemption under Section 1081.01(a) of the P.R. Code; 2) the CIT, any P.R.-only plan, and other collective trusts in which the CIT intends to invest—referred to here as underlying trusts—will be subject to the provisions of Title I of ERISA; 3) the CIT and the underlying trusts—but for the CIT’s acceptance of assets of P.R.-only plans—would qualify for aforementioned exclusion under ’40 Act Section 3(c)(11) and exemptions under Securities Act Section 3(a)(2) and Exchange Act Section 12(g)(2)(H); and 4) the CIT and the underlying trusts will at all times remain in compliance with the terms of Revenue Ruling 81-100.
The Division of Investment Management’s no-action letter position appears to signal that the SEC will allow CITs to accept P.R.-only plans as investors without the trusts becoming subject to the panoply of registration and compliance requirements found in the ’40 Act, Securities Act and Exchange Act. For that reason, the banks that maintain the CITs may be more willing to admit such investors. The named fiduciaries to P.R.-only plans and their advisers should inquire as to the availability of such investment options. CITs may offer investment strategies at a lower cost to the P.R.-only plans, which may further enable compliance with requirements of ERISA’s fiduciary duty provisions.
David Kaleda is a principal in the fiduciary responsibility practice group at Groom Law Group, Chartered, in Washington, D.C. He has an extensive background in the financial services sector. His range of experience includes handling fiduciary matters affecting investment managers, advisers, broker/dealers, insurers, banks and service providers. He served on the Department of Labor’s ERISA Advisory Council from 2012 through 2014.