DOL Proposes Stricter Prohibited Transaction Exemption Application Procedures

MIA BUTZBAUGH, July 28, 2022 

The Employee Retirement Income Security Act of 1974, as amended (ERISA) includes rules that limit plan fiduciaries’ conduct. The limits set forth in ERISA Sections 406 and 407(a) are known as the “prohibited transaction rules” and are so broad that, absent exemptions, employee benefit plans would be unable to function. For example, ERISA’s prohibited transaction rules bar fiduciaries from hiring professionals (such as actuaries, auditors, or recordkeepers) for services that are necessary to operate a plan. 

To address that problem, ERISA includes certain statutory exemptions to the prohibited transaction rules, and it authorizes the Department of Labor (DOL) to issue administrative exemptions of two types: the DOL may grant “individual” prohibited transaction exemptions (PTEs) for specific transactions, and it may grant “class” PTEs to provide relief for parties who engage in the categories of transactions described in the exemption.¹ 

Although the DOL may initiate administrative PTEs, exemptions are typically issued in response to applications, such as those from plans, plan sponsors and service providers. In 1975, the DOL first adopted procedures for PTE applications. Those procedures were most recently updated in 2011. In March of this year, the DOL issued proposed rules that would significantly revise the current procedures. 

Grants of Individual PTEs Have Dramatically Declined 

The DOL’s website provides information about the individual PTEs it has granted since 1996. These individual PTEs include authorizations under “EXPRO,” a DOL program that expedites applications for transactions that are “substantially similar” to those described in recently issued PTEs. In all, the DOL granted 1,255 individual PTEs from 1996 through 2021. Of those, almost 70 percent were granted during the first ten years of that period, from 1996 through 2005; only 30 percent were granted in the 16-year period from 2006 through 2021. While the DOL granted an average of 68 PTEs each year for the five-year period of 1996 through 2000, it granted an  average of only seven PTEs each year from 2016 through 2020. 

It’s likely that various factors have contributed to the drop-off in the DOL’s grant of individual PTEs, such as the enactment of new statutory PTEs and the adoption of class PTEs that eliminated the need for certain individual PTEs, as well as constraints on or redirection of the DOL’s resources. Still, the decline in individual PTEs since 2005 is dramatic, as is the fact that the DOL issued only five individual PTEs over the past two years. That suggests the DOL may be reluctant to grant individual PTEs, even when they are needed and appropriate.

Proposed Rules Would Make Significant Changes to PTE Procedures

In light of the decline in individual PTEs, it may be no surprise that, under the DOL’s proposed rules, the PTE application process would become more demanding and expensive, with limited opportunity to communicate informally with the DOL. Below is a description of a few of the notable proposed changes.

Pre-submission Contact with the DOL Would Not Be Anonymous and Would Be Part of the Public Record

Currently, it is not uncommon for plans and other parties to ask the DOL’s exemption staff for informal, non-binding advice about whether a specific fact pattern would result in a prohibited transaction and require an exemption. This is permitted under the DOL’s current PTE procedures, which also provide that any such advice from the DOL is not part of the administrative record.

The proposed rules, however, provide that a party that contacts the DOL to inquire whether a specific fact  pattern would require an exemption is a “pre-submission applicant” and the DOL “will not engage a pre-submission applicant” unless the applicant identifies and fully describes the possible transaction, identifies itself and the relevant plan and parties to the potential transaction, and sets forth the prohibited transactions it believes to be applicable. Further, information provided to the DOL before a PTE application is submitted, including notes the DOL may take during a pre-submission conference, would become part of the administrative record and open for public inspection.

Additional Requirements for Appraisers and Fiduciaries to Be Independent

Exemptions to ERISA’s prohibited transactions rules some­times involve fiduciaries or appraisers who are independent of the parties engaging in the transaction. The PTE procedures say the DOL’s determination of whether a fiduciary or appraiser is “independent” for this purpose is based on the relevant facts and circumstances, but the current procedures say that when considering revenue, the fiduciary or appraiser is deemed independent if its revenue from the parties in interest² or their affiliates makes up no more than two percent of its total revenue; and even if such revenue is above two percent, the fiduciary or appraiser still may be independent if it does not exceed five percent. The proposed rules eliminate the two-percent safe harbor and provide that, unless the DOL in its sole discretion determines otherwise, an appraiser or fiduciary will not be treated as independent if its revenue from the parties involved in the exemption transaction³ is more than two percent of its total revenue. 

The proposed rules also provide that a fiduciary will not be independent unless it is independent of and unrelated to any party involved in the exemption transaction and any other party “involved in the development of the exemption request” (such as consultants or advisors that assist with structuring the exemption transaction and submitting the exemption application). Further, when evaluating a fiduciary’s independence, the DOL will consider “whether the fiduciary has an interest in the subject transaction or future transactions of the same nature or type.” This is to address the DOL’s concern about whether a fiduciary has a conflict of interest if, for example, it may “use the exemption transaction to promote its fiduciary services to potential clients contemplating similar transactions or if its work with respect to the exemption transaction is connected to a valued relationship with a third party, such as an investment advisor or bank.”

Applications Must Include Additional Information

The proposed rules specify additional information a PTE application must include, beyond what is already required for applications. For example, an application would be required to include:

• A description of any material benefit (including the avoidance of any materially adverse outcome) that a party involved in the exemption transaction may receive if the exemption is granted;
• The costs and benefits (quantified, if possible) of the exemption transaction to the affected plan(s), participants, and beneficiaries; 
• A detailed description of the alternatives to the exemption transaction that would not involve a prohibited transaction and why those alternatives were not pursued;
• A description of each conflict of interest or potential instance of self-dealing that would be permitted if the exemption is granted;
• A statement that the exemption transaction will be in the “best interest” of the plan and its participants and beneficiaries;⁴ 
• Various statements and information from any qualified independent appraiser, auditor, or accountant whose reports or documents are submitted in support of the exemption application, including a detailed description of any relationship that provider has had or may have with any party involved in the development of the exemption request that may influence the appraiser, auditor, or accountant and a copy of its services agreement with the plan, which agreement may not (i) provide for any direct or indirect indemnification or reimbursement of the service provider for a failure to adhere to its contract or applicable law; or (ii) waive any rights, claims, or remedies of the plan or participants or beneficiaries with respect to the exemption transaction; and
• A statement that the independent fiduciary maintains fiduciary liability insurance in an amount sufficient to indemnify the plan for losses resulting from the independent fiduciary’s breach of applicable law or its contract, and with no exclusion for actions by the DOL or any other federal, state, or other regulatory body, the plan, or plan participants or beneficiaries.

Also, applications for individual PTEs would need to state whether the plan or plan sponsor has had any prior transactions with a party involved in the exemption transaction.

Past PTEs Are Not Determinative of Future PTEs

The proposed rules state the existence of a PTE is not determinative of whether a future exemption application with the same or similar facts will be proposed, or if an exemption is proposed, whether it will include the same conditions as the previously issued PTE. It is unknown what impact this language — which the DOL’s preamble says reflects “existing policy that it has the sole discretionary authority to issue exemptions and is not bound by facts or conditions of prior exemptions in making determination with respect to an exemption application” — will have on the EXPRO program.

Other Noteworthy Changes

The proposed rules provide for many more changes to the current PTE application procedures, beyond those briefly summarized above. For example, the proposed rules would: require certain additional reporting to the DOL while a PTE application is pending and after a PTE is granted; permit the DOL to hold a conference with “any party,” including the qualified independent fiduciary or the qualified independent appraiser, regarding any matter related to the exemption request and without the presence of the applicant or other parties to the transaction or their representatives; increase scrutiny of applications for retroactive PTEs; and permit the DOL, under certain circumstances, to issue a final denial letter without first issuing a tentative denial letter or holding a hearing.

Pending Issuance of Final Regulations

It is unknown which of the proposed changes to the PTE application could be adopted as final rules, but anyone considering filing a PTE application before the final regulations are issued should carefully review the proposed rules and the DOL’s explanatory preamble (which, in several cases, says the proposed rules simply formalize the DOL’s current practice). Certainly the proposed rules, along with the very few PTEs granted in recent years, indicate it will continue to be an uphill battle to secure a PTE.

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¹  The Internal Revenue Code of 1986, as amended (Code) also includes prohibited transaction rules and allows for individual and class exemptions thereto. The DOL is authorized to issue those exemptions. See 92 Stat. 3790. Therefore, the procedures discussed in this article also apply to the Code’s prohibited transaction rules, but for ease of reading, we refer only to ERISA.

²  As defined by ERISA Section 3(14).  

³  “Party involved in the exemption transaction” is a new term that includes not only an ERISA party in interest but also any party engaged in the exemption transaction or an affiliate thereof and any party providing services to either a party in interest or a party engaged in the exemption transaction. Prop. DOL Reg. § 2570.31(l). As such, relative to the current procedures, the proposed rules broaden the pool of revenue the DOL will consider.

⁴  Under Prop. DOL Reg. § 2570.34(b)(2)(iii), an exemption is in the “best interest” of the plan if the plan fiduciary causing the plan to enter into the transaction determines, with the care, skill, prudence, and diligence under the circumstances then prevailing, that a prudent person acting in a like capacity and familiar with such matters would, in the conduct of an enterprise of a like character with like aims, enter into the exemption transaction based on the plan’s circumstances and needs.