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DOL Issues Guidance on Mutual Fund Settlement Distributions

The Department of Labor (“DOL”) recently issued guidance regarding the distribution and allocation of mutual fund settlement payments made to employee benefit plans and their participants. This guidance is directly related to SEC enforcement actions alleging late trading and market timing activities. As a result of these actions, numerous mutual funds have established settlement funds.

Each of these settlement funds will be operated by an independent distribution consultant (“IDC”) that is appointed pursuant to SEC procedures. The IDC will establish a plan to distribute the proceeds of the settlement fund to shareholders.

The nature of the plan will vary from fund to fund. Some may distribute settlement proceeds directly to beneficial shareholders, including ERISA plans. Others may distribute settlement proceeds to intermediaries (such as broker-dealers or recordkeepers) that are shareholders of record. These intermediaries will then be responsible for distributing the proceeds to beneficial shareholders.

The DOL does not consider settlement funds to be plan assets, even if some proceeds are to be distributed to ERISA plans. Thus, IDCs are not ERISA fiduciaries. However, once proceeds are distributed to an ERISA plan or an intermediary of such a plan, those proceeds will be considered plan assets held by ERISA fiduciaries. Consequently, these proceeds must – as with any plan asset – be held in trust and managed in accordance with ERISA’s fiduciary provisions.

Plan fiduciaries must also ensure that plan assets are allocated fairly to individual participants. Fortunately, the DOL guidance should make compliance with this requirement relatively painless in many situations.

If, as a condition to the distribution, the IDC requires that fiduciaries utilize a particular methodology for allocating settlement fund proceeds among plan participants and beneficiaries, the DOL will view the prudent application of this methodology as satisfying the fiduciary’s responsibilities. Similarly, if the IDC provides for, but does not require, an allocation methodology, prudent application of this methodology will also satisfy the fiduciary’s responsibilities.

If the IDC does not provide for any allocation methodology, plans must adopt a “prudent” methodology. The DOL guidance requires that the selection of this methodology involve a process of weighing the benefit of more exact allocations to those participants who suffered harm against the costs of greater precision. In particular, the DOL guidance states that if incomplete plan records or other considerations make exact allocations to those affected by market timing or late trading too costly, plans may allocate settlement proceeds to accounts currently holding the relevant mutual funds.

Settlement proceeds generally may not be used to offset employer contributions or pay plan administrative expenses. The DOL guidance does, however, permit plans to use proceeds that would be considered forfeitures, as well as proceeds of extremely small value, to pay plan expenses.

Regardless of the size of the settlement, plan fiduciaries should treat settlement proceeds from mutual funds with the same care they would show to any other plan asset. In the absence of an IDC-created allocation methodology, fiduciaries should also carefully consider and document the allocation plan for distributing settlement proceeds.