United States: DOL Provides Guidance on Fiduciary Duties of Directed Trustees
(Financial Services Alert - Developments of Note)

The Department of Labor (the "DOL") recently issued Field Assistance Bulletin 2004-03 (the "Bulletin") under the Employee Retirement Income Security Act of 1974, as amended ("ERISA"). The Bulletin provides the DOL’s views on the responsibilities of directed trustees under ERISA, particularly with respect to directions involving employer securities. The Bulletin states that a directed trustee, by definition, will always be a "fiduciary" under ERISA, but that the duties of a directed trustee under Section 403(a)(1) of ERISA are "significantly narrower" than the duties generally ascribed to a discretionary trustee. Under ERISA, a directed trustee may follow the "proper" directions of a named fiduciary, and a direction is "proper" only if the direction is "made in accordance with the terms of the plan" and "not contrary to [ERISA]." As to the first component, the Bulletin states that a directed trustee must make a determination whether the direction is inconsistent with the terms of the plan. In this regard, the Bulletin states that a directed trustee has a duty to request and review all the documents and instruments governing the plan that are relevant to its duties as directed trustee, which may include, e.g., the plan’s investment policy statement. The Bulletin indicates that it is the view of the DOL that a direction is consistent with the terms of a plan if the plan documents do not prohibit the direction. According to the Bulletin, if the plan documents are ambiguous, the directed trustee should obtain a clarification of the plan terms from the plan fiduciary that is responsible for interpreting such terms, and that the directed trustee may rely upon such determination.

As to the second component, the Bulletin states that a directed trustee may not follow a direction that the directed trustee "knows or should know" is contrary to ERISA. In this regard, the Bulletin states that a directed trustee must follow processes that are designed to avoid non-exempt prohibited transactions, and that a directed trustee may satisfy this obligation by obtaining appropriate written representations from the directing fiduciary that the plan maintains and follows procedures for identifying prohibited transactions and, if prohibited, identifying the individual or class exemption applicable to the transaction. The Bulletin further states that a directed trustee may rely on the representations of the directing fiduciary unless the directed trustee "knows" that the representations are false.

According to the Bulletin, a directed trustee does not have an independent obligation to determine the prudence of every transaction, and in particular a directed trustee’s obligation to question the prudence of market transactions involving publicly-traded stock is quite limited. Such an obligation could arise, for example, if the directed trustee possesses material non-public information regarding a security, in which case the directed trustee has a duty to inquire about the named fiduciary’s knowledge and consideration of such information. The Bulletin does provide, however, that the possession of non-public information by one part of an organization will not be imputed to the organization as a whole where the organization maintains procedures designed to prevent the illegal disclosure of such information under securities, banking or other laws. The Bulletin expressly leaves open the question as to whether such firewalls will be effective if they are established voluntarily rather than being legally required. In addition, if the directed trustee performs an internal analysis in which it concludes that a company’s current financial statements are materially inaccurate, then unless such analysis is publicly-available the directed trustee has an obligation to disclose this analysis to the named fiduciary before following a direction to purchase the company’s securities.

The Bulletin further provides that, absent material non-public information, a directed trustee "will rarely have an obligation under ERISA to question the prudence of a direction to purchase publicly-traded securities at the market price solely on the basis of publicly-available information." Only in "limited, extraordinary circumstances, where there are clear and compelling public indicators," that call into serious question a company’s viability as a going concern, or where the instruction is from a corporate employee after the company or its officers or directors have been formally charged by regulators with financial irregularities, would a directed trustee have a duty not to follow a named fiduciary’s instruction without further inquiry. The Bulletin clarifies that information provided by a directed trustee to a named fiduciary concerning the prudence of a direction is not investment advice under ERISA. Finally, the Bulletin notes that, if a directed trustee has knowledge of a fiduciary breach, the directed trustee may be liable as a co-fiduciary unless the directed trustee takes reasonable steps to remedy the breach.

The FASB published Statement 123R, Share-Based Payment. Statement 123R generally requires that compensation costs relating to share-based payment transactions be recognized in financial statements. Statement 123R focuses principally on transactions in which an employee or director is providing services in exchange for the share-based compensation, and generally eliminates the ability of an issuer to account for such transactions using FASB Opinion 25. Statement 123R does not change the treatment of share-based payments with non-employees (other than directors), nor does it change accounting for employee share ownership plans currently governed under SOP 93-6. As to employee share-based compensation, Statement 123R generally requires that such transactions be accounted for using a fair-value based method. Statement 123R details generally how share-based compensation is to be valued for those purposes, but does not prescribe a specific valuation technique. Public entities (other than small business issuers) must apply Statement 123R as of the first interim or annual reporting period beginning after June 15, 2005. Public small business issuers must comply by the first interim or annual period after December 15, 2005. Nonpublic entities will not need to comply until the first annual reporting period after December 15, 2005.

Under a provision included in spending legislation recently signed into law by President Bush, the SEC must submit a report to the Senate Appropriations Committee that provides justification for final rules issued by the SEC requiring that the chair of the board of directors of a mutual fund be an independent director. The report must analyze whether mutual funds chaired by independent directors perform better, have lower expenses, or have better compliance records than mutual funds chaired by directors who are not independent. The report is due to the Committee no later than May 1, 2005. The SEC must act upon the recommendations in the report no later than January 1, 2006.

The OCC issued an interpretative letter ("Letter No. 1012") in which it concluded that a national bank’s (the "Bank") bonding company (the "Insurer") does not have the right under 12 C.F.R. § 4.37 to gain access to the Bank’s OCC examination reports, examiner work papers and Suspicious Activity Reports ("SARs"). The Bank that is the subject of Letter No. 1012 sought insurance coverage from the Insurer for its potential liability in a separate matter to the Securities Investor Protection Corporation. The Insurer alleged that the Bank made material misstatements in its application for insurance when it replied "no" to questions as to whether regulators had materially criticized the Bank’s operations and whether the Bank’s directors and officers had been alerted to material violations of law and regulation. The Insurer also asserted that the Bank had not disclosed to the Insurer that the Bank had failed to file a SAR when a customer attempted to give the Bank’s President a paper bag containing $25,000 in cash. The OCC concluded that while the OCC may disclose sections of examination reports if a national bank has made specific misrepresentations about OCC statements in examinations, the OCC will not permit disclosure of such nonpublic information "to confirm or refute a bank’s general statements that do not misrepresent the tenor of nonpublic OCC information…or a bank’s general statements about its condition." The OCC also pointed out that there is no exception for bonding companies under the disclosure restrictions in 12 C.F.R. § 4.37. The OCC, accordingly, denied the Insurer’s request for access to OCC examination reports and work papers. Letter No. 1012 also states that, as required by law, OCC regulation and "abundant case law," including Whitney National Bank v Karam, 306 F. Supp. 2d 678 (S.D. Tex. 2004), the OCC will not disclose any SARs or state whether a SAR was filed.

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