On July 27, 2022 the U.S. Department of Labor (DOL) proposed significant modifications to Prohibited Transaction Class Exemption 84-14 (the QPAM Exemption). The DOL will accept written comments and requests for public hearings regarding its proposed amendment until September 26, 2022. Any final amendment to the QPAM Exemption will not be effective until 60 days after its publication, and any final amendment will not be published until after the DOL has reviewed and considered all comments and requests received within the applicable notice period. The proposed amendment, if finalized as proposed, would make the following changes:
1. Required Updates to Management Agreements if the QPAM Exemption is Utilized
Every management agreement for which a manager acts as a QPAM must be amended to include a statement that, in the event of a criminal conviction in violation of the QPAM Exemption or receipt of a written notice of ineligibility provided by the DOL (an Ineligibility Notice), the QPAM will:
- agree to not restrict the ability of any plan to terminate the management agreement with, or withdraw from the vehicle managed by, the manager;
- not impose fees, penalties or charges on any such termination or withdrawal by a plan, except for reasonable fees, disclosed in advance, that are specifically designed to (i) prevent abusive investment practices or (ii) ensure equitable treatment of all investors in a pooled fund, provided that such fees are applied consistently and in a like manner to all such investors;
- agree to indemnify and restore actual losses to plans for any damages resulting from a violation of applicable laws, a breach of contract or any claim arising out of the conduct that is subject of a “Criminal Conviction” (as defined in the proposed amendment) or an Ineligibility Notice, specifically including losses and costs arising from unwinding transactions with third parties and from transitioning plan assets to an alternative asset managers as a result of the QPAM’s inability to rely on the QPAM Exemption; and
- not employ any individual who participated in the conduct that is the subject of a Criminal Conviction or an Ineligibility Notice regardless of whether the individual is separately convicted of the criminal conduct.
2. Required Notice to the DOL
Every entity that acts as a QPAM must notify the DOL via email of its reliance on the QPAM Exemption. The QPAM must report the legal name of each entity relying on the exemption and any other name the QPAM may operate under. This notification must be updated if there is a change to the legal or operating name of the QPAM or if it is no longer relying on the exemption. It is unclear under the proposal whether managers of “springing ERISA funds” that are not currently over their 25% threshold should notify the DOL. The DOL intends to make publicly available a list of all entities that notify it of their intent to rely on the QPAM Exemption.
3. Increased AUM and Shareholder/Partner Equity Requirements
The amount of client assets under management required of a QPAM that is a SEC-registered investment adviser (RIA) is increased from $85 million to $135,870,000. The required equity/capital requirements of the QPAM entity is increased as well, with the shareholder or partner equity of an RIA increasing from $1 million to $2,040,000. Furthermore, the AUM and equity/capital requirements will be increased annually to adjust for inflation.
4. Expansion of Restriction on Involvement by Other Parties in Covered Transactions
In its current form, the QPAM Exemption only requires that the terms of the transaction be negotiated by, or under the authority and general direction of, the QPAM, with the QPAM making the decision to enter into the transaction, and the transaction not being part of an agreement, arrangement or understanding designed to benefit a party in interest. The proposed amendment, however, would more significantly restrict the ability of other parties in interest to be involved in any aspect of a transaction and would require that the terms of the transaction and associated negotiations be the sole responsibility of the QPAM. Relief under QPAM Exemption would not cover any transaction that was “planned, negotiated, or initiated by a Party in Interest, in whole or in part, and presented to a QPAM for approval”. Among other things, this proposed modification could have the effect of preventing managers from relying on the QPAM Exemption for transactions sourced by sub-advisors and finders.
5. Expansion of Disqualifying Events
The proposed amendment clarifies that a QPAM convicted of a foreign crime substantially similar to one of the crimes listed in the QPAM exemption (Listed Crimes) (or whose affiliate or 5% owner is so convicted) would be prevented from relying on the QPAM Exemption for 10 years. In a significant expansion, the proposed amendment provides that a QPAM which receives (or whose affiliate or 5% owner receives) an Ineligibility Notice from the DOL for participating in Prohibited Misconduct would be unable to rely on the QPAM Exemption for 10 years. In going beyond a criminal conviction requirement, “Prohibited Misconduct” is defined as: (i) any conduct that forms the basis for a non-prosecution or deferred prosecution agreement (or similar foreign agreement) that, if successfully prosecuted, would have constituted a Listed Crime; (ii) intentionally violating or engaging in a systematic pattern or practice of violating the conditions of the QPAM Exemption in connection with otherwise non-exempt prohibited transactions; or (iii) providing materially misleading information to the DOL in connection with the conditions of the QPAM Exemption.
6. Required Record Retention and Availability
A QPAM must maintain records necessary to determine whether the conditions of the QPAM Exemption have been met with respect to a transaction for six years. The QPAM must make these records available to the U.S. Internal Revenue Service (IRS), the DOL, any fiduciary of any plan managed by a QPAM or invested in an investment fund managed by a QPAM, any contributing employer or employer to such plan, and any participant or beneficiary of such plan. While this would appear to include the financial statement of the QPAM, the QPAM is not required to provide privileged commercial or financial information of the QPAM, nor privileged trade secrets or information regarding any fund in which the plan is not invested.
7. Creation of Written Ineligibility Notice and Process for Individual Exemptions
Any entity which has received an Ineligibility Notice from the DOL will be prevented from utilizing the QPAM Exemption. The amendment also provides the process by which such notice will be issued and the opportunities available for a manager to respond to any such notice. In addition, the amendment provides requirements for how applications for individual exemptions following a Criminal Conviction must be made to the DOL.
8. Creation of a QPAM Winding-Down Period
Any QPAM that becomes ineligible due to a Criminal Conviction or an Ineligibility Notice may continue to rely on the QPAM Exemption with regard to existing accounts for a period of one year so long as certain additional conditions are met.
If you would like our assistance in commenting on the proposed amendment, or if you have any questions on the matter, please contact S. John Ryan at (212) 574-1679, Michael O’Brien at (212) 574-1505, or Bradley Fay at (212) 574-1429.