The Amended QPAM Exemption: Nine Key Practical Impacts for Asset Managers

After a long wait, on April 3, 2024, the U.S. Department of Labor (“DOL”) published in the Federal Register its finalized amendments (“Final Amendments”) to the qualified professional asset manager (“QPAM”) class prohibited transaction exemption 84-14. Many early discussions have focused on favorable changes that lessen the immediate compliance burden-- but a deeper review shows that the Final Amendments raise some key issues for asset managers, regardless of whether they currently serve as QPAMs or not.

As evidenced by the preambles to its July 27, 2022 proposal (“Proposal”) (see our prior alert here) and the Final Amendments, the DOL has used the amendments to clarify and expand the list of actions that would cause a financial institution to lose its ability to qualify as a QPAM. Beyond this primary focus on crimes and misconduct, the DOL has also revised the requirements regarding the QPAM’s role in overseeing transactions, and added new notification, recordkeeping, and size requirements that we expect will have widespread impact on asset managers seeking to utilize the exemption or to reserve the ability to use the exemption, if needed. While the Final Amendments address certain concerns that were raised by stakeholders during the notice-and-comment process, many questions and challenges still remain.

This alert discusses nine of the key practical impacts that the Final Amendments will have on asset managers once the Final Amendments take effect on June 17, 2024.

New Ways to Lose Access to the Exemption

Entities that rely on the QPAM exemption are expected to maintain a high standard of integrity in the interest of protecting the retirement assets they manage. An entity will lose its QPAM status for a period of 10 years if the QPAM, any affiliate or any direct or indirect owner of a 5% or more interest in the QPAM is convicted in a U.S. federal or state court or released from imprisonment (whichever is later) as a result of having committed certain financial crimes such as fraud, embezzlement, tax evasion, misappropriation of funds or securities, among others.

• Foreign Crimes – In light of the number of financial institutions that have requested individual exemptions from the DOL in recent years in connection with criminal convictions stemming from the activities of their foreign affiliates, the Final Amendments resolve any lingering ambiguity by expanding the list of disqualifying actions to include foreign crimes that are substantially equivalent to the existing list of U.S. crimes. According to the DOL, while a foreign convicted entity may seem remote, it can also be a sign of more “pervasive compliance failures at various other entities within the corporate family, including at parent entities” and that “corporate malfeasance at entities that control, are under common control with, or are controlled by the QPAM indicates the possibility of increased risk of harm to client Plans and IRA owners.”

• Note, in response to commenters’ concerns regarding convictions that occur in foreign nations with the intent to harm U.S.-based investment managers, the DOL revised the definition of “Criminal Conviction” in the Proposal by excluding convictions and imprisonments that occur within foreign jurisdictions that are included on the Department of Commerce’s list of foreign adversaries (i.e., China, Cuba, Iran, North Korea, Russia and the regime of Venezuelan politician Nicolás Maduro).

• Prohibited Misconduct – The DOL has also created a new disqualifying trigger— “Participation in Prohibited Misconduct,” which includes (i) entry into a non-prosecution agreement (“NPA”) or deferred prosecution agreement (“DPA”) where the factual allegations that form the basis for the NPA or DPA would have constituted an enumerated crime if it had been successfully prosecuted, and (ii) a final judgment or court-approved settlement by federal or state regulators that the QPAM has participated in certain categories of conduct, including engaging in a systematic pattern of conduct that violates the exemption’s conditions or provides materially misleading information to the DOL, the Department of Treasury, the Internal Revenue Service, the Securities and Exchange Commission or various other state or federal regulatory and law enforcement agencies in connection with the conditions of the exemption. For purposes of this trigger, “Participation in” refers not only to active participation in prohibited misconduct, but also to knowing approval of the conduct, or knowledge of such conduct without taking active steps to prohibit such conduct, including reporting the conduct to appropriate compliance personnel.

• In a notable change from the Proposal, the DOL removed agreements with foreign governments that are substantially equivalent to domestic NPAs and DPAs in the Final Amendments; however, a manager is required to provide notice to the DOL in connection with such non-U.S. NPAs and DPAs, and the DOL may choose to treat them as disqualifying. Furthermore, the DOL eliminated the written warning letter and ineligibility notice procedures that were in the Proposal where it would have been responsible for making certain factual determinations with respect to whether an action constituted Prohibited Misconduct. Instead, under the Final Amendments, the DOL will rely on the factual determinations that were made in specified judicial proceedings.

Once an entity becomes ineligible because of a Criminal Conviction or Participation in Prohibited Misconduct, it is entitled to a one-year transition period during which it may continue to rely on the exemption for any pre-existing arrangements with client plans (assuming the entity complies with all of the other conditions of the QPAM exemption, including some additional conditions that apply during the transition period). In order to obtain relief that extends beyond that one-year period, the entity would have to request an individual exemption from the DOL that would require the entity to present evidence (which would be publicly accessible) of, among other things: (i) the scope of its involvement in the conduct at issue, (ii) its independence from any bad actors, (iii) its corporate culture and compliance structures, and (iv) other information relevant to assessing whether the entity should be permitted to continue relying on the QPAM exemption notwithstanding the disqualifying conduct.

In light of these changes, financial institutions should be mindful of the activities of their foreign affiliates and should strive to promote a global culture of compliance across their corporate structure. Moreover, when considering entry into an NPA or DPA, financial institutions should consider what impact that might have on their ability to qualify as a QPAM.

New Questions about the Role of the QPAM in Overseeing the Transaction

In order for a transaction to qualify for relief under the exemption, the QPAM must be the ultimate decisionmaker—negotiating the terms in order to ensure that the QPAM retains fiduciary responsibility. The DOL had proposed to strengthen this requirement by specifying that the terms of the transaction, commitments, investment of fund assets, and any corresponding negotiations must be the “sole responsibility” of the QPAM. In response to commenters’ concerns about the feasibility of this standard in various common scenarios involving collective investment trusts (CITs), co-investments, and sub-advisers, the DOL made some modifications in the Final Amendments; however, the use of “sole responsibility” still appears in the operative text. Furthermore, the DOL’s preamble explanation suggests that where more than one party has discretion to enter into a transaction or where the financial institution counterparty/party-in-interest presents an investment opportunity to a QPAM, that would not satisfy the condition’s requirements. This means that common transactions like co-investments and derivative transactions may require extra analysis and documentation to show that the QPAM acted independently.

While the DOL says the QPAM exemption still permits the use of sub-advisers, managers will need to ensure that there is clarity regarding who has ultimate authority, which can be an issue for CITs and similar arrangements. The DOL recommends that affected parties involved in such transactions should seek an advisory opinion or request other guidance regarding whether the exemption is available, although it is unclear whether such an approach would be practicable, given that the DOL has only issued four advisory opinions since 2019.

Modifications to Existing Agreements on Written Indemnification; Penalty-free Withdrawal Rights

The Proposal sought to change the written management agreement component of the exemption by requiring QPAMs to abide by certain standards of integrity when acting on behalf of client plans. In particular, the Proposal would have required that the written management agreement between a QPAM and its client plans include certain terms up front that would apply in the event of QPAM ineligibility, including that the QPAM would not restrict the plans’ ability to terminate or withdraw or impose fees, penalties, or charges in the event of ineligibility. Additionally, the written management agreement would have required the QPAM to indemnify, and hold harmless, and promptly restore actual losses to each client plan for any damages directly resulting from a violation of applicable laws, a breach of contract, or any claim arising out of the failure of such QPAM to remain eligible for exemptive relief.

The Proposal did not include any grandfathering for existing arrangements, meaning that managers would have needed to amend all existing management agreements with ERISA plans to include this new language where the exemption was or could have been relied upon. This re-papering exercise would have been a massive undertaking for managers with large numbers of ERISA accounts, and in a welcome change, the Final Amendments now provide that entities will only have to agree to these plan protections during the one-year transition period following an entity’s ineligibility date (as opposed to up front, prior to any disqualification trigger).

Registration with the DOL

The Proposal included a requirement for QPAMs to report to the DOL by email (at QPAM@dol.gov) the legal name of each business entity relying on the exemption and any name under which the QPAM may be operating. The Final Amendments retain this registration requirement and specify that the notification must be made within 90 calendar days of either the QPAM’s reliance on the exemption or a change to the QPAM’s legal or operating name. Under the Final Amendments, if a QPAM fails to report its reliance on the exemption within 90 days, there is a 90-day cure period during which the QPAM can provide the notification (along with an explanation for its failure to provide the notification within the initial 90-day window). If a QPAM fails to report following this total 180-day period, the exemption will not be available for transactions that occur until the failure is fully cured. The Final Amendments also clarify that an entity may, but is not required to, notify the DOL that it is no longer relying on the exemption, after which the DOL will remove the entity from its publicly available list of QPAMs relying on the exemption.

New Recordkeeping Requirements

Consistent with the Proposal, the Final Amendments add a new recordkeeping provision that would require QPAMs to maintain records necessary to enable the DOL, fiduciaries, contributing employers, and plan participants to determine that the exemption’s conditions have been satisfied with respect to a transaction. For those individuals and entities seeking to inspect these records (other than the DOL), that right is fund- and transaction-specific—interested persons will not be authorized to examine records regarding an investment fund that they are not invested in, privileged trade secrets or privileged commercial or financial information of the QPAM, or information identifying other individuals. Records must be kept for six years from the date of the transaction. Any failure to maintain the records necessary to determine whether the conditions of the QPAM exemption have been met would result in the loss of exemptive relief only for the transaction(s) for which such records are missing or have not been maintained.

Updated Asset Management and Equity Thresholds

The Proposal increased certain thresholds in the QPAM definition as follows: the asset management threshold would be increased from $85,000,000 to $135,870,000; the equity capital threshold for banks, savings and loan associations and insurance companies would be increased from $1,000,000 to $2,720,000; and the equity capital threshold for registered investment advisers and broker-dealers would be increased from $1,000,000 to $2,040,000. According to the DOL, the purpose of the QPAM exemption’s minimum asset and equity thresholds pertain to a central premise of the exemption, which is that “large financial services institutions would be able to withstand improper influence from Parties in Interest.” According to the agency, the original thresholds needed to be revisited because they “may no longer provide significant protections for plans in the current financial marketplace.” The Final Amendments generally retain these increases but implement them in three-year increments beginning in 2024 and ending in 2030. Consistent with the Proposal, the Final Amendments contemplate that the DOL will make subsequent annual adjustments to these figures to keep up with inflation.

The impact of these changes is that for new asset managers with relatively small assets under management, the higher thresholds that will apply over the next several years may present barriers to reliance on the QPAM exemption going forward.

Conclusion

Often regarded as the gold standard among financial institutions when seeking relief from ERISA’s prohibited transaction rules, the QPAM exemption remains a critical tool that enables ERISA plans to access a diverse array of investment options. However, significant uncertainty remains regarding the application of certain provisions of the Final Amendments, which could make the QPAM exemption less appealing or potentially unavailable under certain circumstances.

Given that the Final Amendments take effect on June 17, 2024, asset managers and other financial institutions should be considering what compliance steps they will need to take in order to ensure continued (or go-forward) reliance on the exemption, and whether they may need to use other exemptions such as the service provider exemption set forth in Section 408(b)(17) of ERISA or class prohibited transaction exemption 91-38 for CITs in certain situations.

It will be especially important to review existing trading agreements, including prime brokerage agreements and ISDAs and existing credit agreements to determine whether an alternative exemption is permitted under the contracts.

If you have any questions, please feel free to reach out to any of the attorneys listed below.

• Joshua A. Lichtenstein
• Sharon Remmer
• Reagan Haas
• Jonathan M. Reinstein
• Alexa Voskerichian