Financial Firms as ERISA Plan Sponsors:

The When, What and How of the o t eQ QPAM Audit ud t Requirement

May 1 1, 2013
Mary E. Alcock Cleary Gottlieb Steen & Hamilton LLP Virginia Bartlett Bartlett ONeill Consulting, Inc. Linda Haynes Seyfarth Shaw LLP Susan Mangiero Fiduciary Leadership, LLC Howard Pianko Seyfarth Shaw LLP
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Program Description
Starting in 2012 when a Department of Labor amendment of the Qualified Professional A Asset t Manager M (QPAM) prohibited hibit d t transaction ti class l exemption ti b became effective, ff ti a new requirement was imposed on financial firms when managing assets of ERISA plans they maintain for their own employees. These firms now must undergo an annual compliance audit with respect to their plan related investment activities if they want to b able be bl t to rely l upon th the QPAM exemption ti f from the th prohibited hibit d transaction t ti rules l of f Section 406(a) of ERISA. Given the newness of this requirement, and with a June 30, 2013 deadline for audit completion l ti generally ll pending, di affected ff t d fi financial i l fi firms are wrestling tli with ith many questions about how the QPAM compliance audit process works. In this session, counsel and compliance officers at asset management firms will learn what needs to be done to comply with this important regulation and practical, nuts and bolts considerations id ti th that t may need dt to be b addressed. dd d Topics T i that th t will ill be b covered d by b the th interi t disciplinary team of speakers include: (1) Why and when the QPAM audit is required (2) What are the applicable DOL requirements (3) What a compliance audit means from the accounting perspective (4) Documents and data that must be provided to the audit dit team t (5) Sampling S li and dt testing ti aspects t of f th the audit dit (6) Correcting C ti any identified id tifi d deficiencies and (7) Using the results to enhance fund governance.
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Webinar Faculty
Speakers: Mary E. Alcock ~ Cleary Gottlieb Steen & Hamilton LLP Vi i i B Virginia Bartlett l ~ Bartlett B l O'N O'Neill ill C Consulting, li I Inc. Linda Haynes ~ Seyfarth Shaw LLP Susan Mangiero ~ Fiduciary Leadership, LLC

Moderator: Howard Pianko ~ Seyfarth Shaw LLP

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Webinar Faculty
MARY E. ALCOCK is counsel based in the New York office of Cleary Gottlieb Steen & Hamilton LLP. LLP Ms. Alcock's practice focuses on employee benefits and compensation matters, including executive compensation design and regulation and the fiduciary, securities law and tax aspects of pension fund investment. She regularly advises clients on corporate governance issues as well as on disclosure issues relating to executive compensation and other benefit arrangements. Ms. Alcock also counsels financial institutions with respect to their many and varied interactions with U.S. pension and other plans, including the design and marketing of financial products. Ms. Alcock is recognized as a leading employee benefits lawyer by The Best Lawyers in America and The Legal 500. Ms. Alcock joined the firm in 1993 and became counsel in 2002. She received a J.D. d degree i in 1993 f from Y Yale l L Law S School h l and d an undergraduate d d t d degree, summa cum laude l d , in 1988 from Yale University. Ms. Alcock is a member of the New York State Bar. Mary can be reached at [email protected] or 212-225-2998.

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Webinar Faculty
VIRGINIA BARTLETT has over 30 years of experience working with all types of employee benefit programs. programs Her background includes servings as an employee plans specialist with the Employee Plans/Exempt Organizations Division of the Internal Revenue Service as well as an investigator with the U.S. Department of Labors Pension and Welfare Benefits Administration Office of Enforcement. She has extensive experience in the design and implementation of employee benefit programs programs, consulting on mergers and acquisitions issues that relate to employee benefit plan issues and conducting IRS and ERISA compliance reviews. Prior to establishing Bartlett ONeill Consulting, Inc., Virginia was a senior vice president i Cl in Clark kC Consultings lti H Human C Capital it l P Practice, ti where h she h was a member b of f th the Employee Benefits Consulting group and in charge of the national Retirement Plans group. g y directs tax and ERISA compliance p reviews and p participates p in employee p y She regularly benefit plan audits, vendor search and selection, and vendor transition. She has also served as an independent fiduciary for employee benefit plans of major financial institution and Fortune 500 companies. Virginia can be reached at [email protected] vbartlett@bartlettoneill com or 678-735-3470. 678 735 3470

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Webinar Faculty
LINDA HAYNES is a partner practicing in the Employee Benefits and Executive Compensation Department of Seyfarth Shaw. Shaw She has substantial experience counseling mid-sized to Fortune 500 clients in all elements of employee benefit plans and executive compensation. Ms. Haynes regularly counsels public and private clients in connection with the design, development and on-going compliance of their employee benefit programs, programs including qualified and non-qualified non qualified retirement plans, plans health plans, plans cafeteria plans, and other types of welfare plans. She has substantial experience in advising employee benefit plan fiduciaries regarding their duties and responsibilities. For numerous clients, Ms. Haynes routinely participates i th in their i fid fiduciary i committee itt meetings. ti Sh She f frequently tl conducts d t t training i i f for fid fiduciary i committees, including training regarding general fiduciary duties under ERISA, prohibited transactions and current developments. Ms. Haynes regularly advises clients regarding fiduciary issues and obligations raised by proposed plan investments. In addition, she counsels clients regarding employee benefit plan investment policies policies, negotiates investment management agreements, and reviews alternative investment vehicles. Ms. Haynes works closely with the firms Employee Benefits Litigation group in cases involving complex ERISA issues, including fiduciary issues and hybrid defined benefit plan issues p Linda can be reached at [email protected] or 312-460-5955.
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Webinar Faculty
SUSAN MANGIERO is a managing director with Fiduciary Leadership, LLC. She provides compliance, compliance dispute and litigation support to asset managers managers, institutional investors and their counsel. Dr. Mangiero is a CFA charterholder, a certified Financial Risk Manager and an Accredited Investment Fiduciary Analyst. She has provided testimony before the ERISA Advisory Council, the OECD and the International Organization of Pension Supervisors as well as offering expert testimony and behindthe-scenes forensic analysis, calculation of damages and rebuttal report commentary for various investment governance, investment performance, fiduciary breach, prudence, risk and valuation litigation and arbitration matters. Dr. Mangiero g has p provided insights g about asset allocation, , fiduciary y duties, , risk management, modeling, hedge effectiveness, hedge funds, private equity funds, ERISA, valuation and industry best practices for consulting clients and employers that include the General Electric Company, Prudential Retirement, PricewaterhouseCoopers, Mesirow Financial, Bankers Trust, Bank of America, Chilean pension regulator, World Bank Pension Benefit Guaranty Corporation Bank, Corporation, RiskMetrics, RiskMetrics U.S. U S Department of Labor, Labor Northern Trust Company and the U.S. Securities and Exchange Commission. Dr. Mangiero is the author of Risk Management for Pensions, Endowments and Foundations (John Wiley & Sons, 2005), a primer on risk and valuation issues, with an emphasis on fiduciary responsibility and best practices. She is a member of the 401(k) vendor RFP best practices committee for the Association of Financial Professionals. Susan can be reached at [email protected] or 203-261-5519.
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Webinar Faculty
HOWARD PIANKO is the head of Seyfarth Shaw's New York office benefits practice and the national chair of its Fiduciary Advisory Services practice group. group During his more than 35 years of experience in employee benefits law and executive compensation, he has counseled both domestic and international clients on matters running the full benefits gamut. He originated, and chaired, the PLI pension investment program in the 1980's; then began co-chairing co chairing this program annually in 1991 (21 years ago) ago). This is the second year that he has co-chaired the PLI Basic Fiduciary Investment Program. He also has co-chaired the PLI Basic ERISA Fiduciary Investment Program for three years. He is a Charter Fellow in the American College of Employee Benefits Counsel and a f founding di member b of f th the I International t ti lP Pension i and dE Employee l B Benefits fit L Lawyers Association. He has been recognized for his professional expertise by, among others, Best Lawyers in America, Chambers, Legal 500 and Super Lawyers. His current practice focuses extensively on ERISA fiduciary and plan governance matters, executive compensation including cross-border incentive, incentive equity and compensatory schemes and the benefit and employment law aspect of mergers and acquisitions. Howard can be reached at [email protected] or 212-218-5518.

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Regulatory Considerations
Prohibited Transactions Definition of QPAM QPAM Exemption When a QPAM Manages In-House ERISA Assets Definition of INHAM INHAM Exemption QPAM Audit Requirements

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Why a QPAM
ERISAs ERISA s Prohibited Transactions Rules

ERISA contains prohibited p transaction rules

prohibit specified transactions (e.g., sales, loans, leases) involving an ERISA plan and those with certain specified relationships p ( (including g a service p provider) ) a party p y in interest to the plan

ERISA: (i) contains statutory exemptions to these rules (e g provision of services); and (ii) authorizes the DOL (e.g., to issue individual or class exemptions from these prohibitions One such class exemption applies to a Qualified Professional Asset Manager or QPAM

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Why a QPAM
ERISA Impact - Absent Relief

Absent relief, a manager effecting a transaction involving ERISA plan assets under management and a counterparty who is a party in interest would be engaging in a prohibited transaction
applies to a separate, managed account as well as to a commingled fund
under DOL regulations, if ERISA plan assets constitute 25% or more of the fund, the fund is subject to ERISA

investment manager compliance with Section 406(a) may not be feasible in terms of the possible universe of those considered to be parties in interest with respect to the ERISA plan (e.g., would need a roster as to who is a party in interest)

QPAM relief does not apply to a breach of fiduciary rules under ERISA 406(b)
no self-dealing, lf d li ki kickback kb k or conflict fli t of fi interest t t
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What is a QPAM
Th QPAM Exemption E ti 84 14 The - PTE 84-14

Issued in 1984, the QPAM exemption confers relief from the party in interest prohibited transaction rules under Section 406(a) of ERISA subject to:
A Status Requirements the Manager A.
is a SEC-registered investment adviser or state or federally regulated bank or state-regulated insurance company has at least $85 million in assets under management as of the end of the most recent fiscal year has a minimum of $1 million in owners equity

B. Operational Requirements ensure QPAM independence

no power to appoint - QPAM counterparty is not person (or affiliate) who has power to appoint QPAM as Manager of the plan

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What is a QPAM
The QPAM Exemption PTE 84-14
(continued) no relation to QPAM counterparty is not the QPAM or related to the QPAM no undue leverage plan (and related plans) do not represent more th 20% of than f th the assets t managed db by th the QPAM

C. Other Considerations
exemption not available if transaction is covered by certain other prohibited hibit d t transaction ti exemptions ti (PTE (PTEs) ) no relief under Section 406(b) for a fiduciary breach that is a prohibited transaction

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What is an INHAM
What If Employer Manages Assets Of A Plan It Sponsors

In 1996 the DOL issued the In-House Asset Manager g Exemption (INHAM) applicable to a plan sponsor who manages the investment of assets of a plan maintained for its own employees:
A. Status Requirements the INHAM
is a subsidiary (80% or more) of plan sponsor or parent is a SEC-registered investment adviser has at least $85 million in assets of affiliated plans under management as of the end of the most recent fiscal year assets t of f plans l of f all ll affiliated ffili t d entities titi must t be b at t least l t $250 million illi

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What is an INHAM
What If Employer Manages Assets Of A Plan It Sponsors B. Operational Requirements ensure QPAM independence
INHAM independence with respect to transaction (limited plan sponsor veto permitted) Transaction is not covered by certain other PTEs Counterparty is not employer or certain affiliates Counterparty is not a fiduciary with respect to assets involved in the transaction Counterparty is not the INHAM or related to the INHAM

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What is an INHAM
What If Employer Manages Assets Of A Plan It Sponsors C. Governance and Audit Requirements
INHAM must adopt written policies and procedures that address compliance with objective requirements as to the conditions of the exemption: INHAM status and authority Counterparty requirements Transactional conditions INHAM must have an annual audit of compliance with policies and procedures and objective requirements by an independent and qualified auditor Test T t of f representative t ti sample l of f transactions t ti Written audit report issued

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Exemptive Relief When Financial Firm QPAM is Managing Assets of Plan it Sponsors
Is the financial firm subject j to the INHAM exemption p (audit required) or does the QPAM exemption (no audit required) apply?
Originally Originally, the financial community generally acted as if the QPAM exemption applied Around 2003 DOL began to take the position that the QPAM exemption does not extend to management of QPAM QPAMs s own plans, but extended transitional relief In 2010, the DOL amended the QPAM exemption to apply governance and audit requirements to QPAM QPAM-sponsored sponsored plans where QPAM is managing assets of the plan

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The When and How of the QPAM Audit Requirement q

2010 QPAM Amendment to 84-14

As amended, , the QPAM Q exemption p is available in respect p of a financial firms in-house managed plans if: Policies and procedure are adopted to address compliance li with ith objective bj ti requirements i t of f the th exemption:
QPAM status and authority Counterparty requirements Transactional conditions

Annual exemption audit Independent and qualified auditor Must be completed p ( (together g with the auditors written report) within 6 months after the end of the audited year
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The When and How of the QPAM Audit Requirement q

Audit Requirements For In-House Plan Management

Definition of exemption p audit

Review of written policies and procedures for consistency with objective requirements of the exemption:
QPAM status and authority Counterparty requirements Transaction conditions

Test representative sample of plan transactions Written audit report

Steps taken by auditor List Li of f fi findings di and d opinion i i on compliance li

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The When and How of the QPAM Audit Requirement q

Audit Requirements For In-House Plan Management

Auditor Qualifications Q
Independence
Financial independence Relational independence

Appropriate technical training or experience and proficiency with ERISAs fiduciary responsibility provisions
Audit Audit-related related training or experience Other training or experience Proficiency with ERISAs fiduciary rules

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Audit Steps
Determine scope p of investment managers g discretion Determine transactions covered by QPAM audit
Collective Investment Trusts (PTE 91-38) S Securities Lending ( (PTE 81-6) ) Interests in Mortgage Pools (PTE 81-7) Certain mortgage financing arrangements (PTE 8287) General background documents Policies and procedures Objective compliance with QPAM Requirements Requests re specific transactions

Document request

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Audit Steps (continued)

Review of documents and identify y sampling p g Review of sample transaction documentation Issue report Miscellaneous Items
Confidentiality
Fiduciary exception to attorney client privilege

Use of report
Not filed with the DOL

Impact of adverse report

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Audit Implementation
Auditor Skill Set Transaction Sampling Compliance Report Investor and Private Funds Using QPAM Compliance Audit Results to Improve Governance

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Skill Set of Audit Team

1. ERISA 2. Valuation 3 Compliance Process Mapping 3. 4. Service Provider Contracts 5 Investment Objectives and Impediments 5. 6. Transaction Sampling (statistical v. judgemental) 7 Data Quality 7. 8. Trading Practices

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Transaction Sampling
1. Goal is to avoid sampling risk or the possibility that the audit sample will not detect a problem or bad item within a reasonable error tolerance level 2. Sample size depends on uniformity or transactions (or lack thereof) 3. Attribute sampling to see whether internal control procedures are working results in yes yes or no no versus maybe maybe answer 4. Not all variables behave in a non-normal way, which in turn impacts testing

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Compliance Audit Report

1. The independent auditors report must identify each examined transaction that did not comply with the QPAMs policies and procedures or the QPAM Exemption as well as the specific policies, procedures, and exemption conditions that were not satisfied. ti fi d 2. Upon discovering noncompliant transactions, an auditor may be required q to conduct additional testing g in order to fully y assess the scope or pattern of non-compliance during the audit period. 3. The DOL expects the auditors written report, to the extent applicable will describe steps taken by the QPAM to remedy any applicable, prohibited transactions.

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Investors and Private Funds

According to a July 2012 survey conducted by Towers Watson, assets under management t in i the th alternative lt ti i investment t t space exceed d $4 $4.87 87 t trillion illi with ith pension i fund allocations to the top 100 alternative investment managers at more than $1.23 trillion. Pension fund monies accounted for one third of the total assets under management. Insurance company allocations represented about 7% of assets under management t with ith sovereign i wealth lth f funds, d endowments d t and df foundations d ti making ki up 5% of assets under management. Of the top 100 managers, ranked by assets under management, pension funds comprised 74% of the total dollars. According to a recent SecondMarket and IMN Alternative Assets Survey Survey, 50% of institutional investor respondents allocated to commodities, 44.3% allocated to private equity funds, 39.7% allocated to hard assets, 17.2% allocated to other, 12.6% allocated to wine, 9.8% allocated to art, 8.6% allocated to timberland and 6.3% allocated to esoteric esoteric ABS ABS. Respondents were allowed to choose more than one answer. According to Institutional Investors Come Calling With New Due Diligence Checklist For Operations Operations (FINAlternatives, December 15 15, 2011) 2011), surveillance procedures procedures, access to capital and counterparty risk management are important.
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Economics of Governance
1. NYSE CEO Duncan Niederauer recently testified before a Congressional panel that market malfunctions have made investors less interested in putting their their money at risk. Fewer dollars invested means lower revenue for private fund owners. 2. Litigation and regulatory enforcement against asset managers is on the rise. 3. QPAM compliance audit deficiencies can lead to recognition and subsequent correction of problems. 4. The cost of the QPAM compliance audit can be considered a down payment to a more thorough assessment of risks.

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Questions?
Mary a y Alcock: coc [email protected] a coc @cgs co
Cleary Gottlieb Steen & Hamilton LLP, New York

Virginia g Bartlett: [email protected] @

Bartlett ONeill Consulting, Atlanta

Linda Haynes: y [email protected] y @ y

Seyfarth Shaw LLP, Chicago

Susan Mangiero: g [email protected] @ y p

Fiduciary Leadership LLC, Trumbull CT

Howard Pianko: [email protected] p @ y

Seyfarth Shaw LLP, New York
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