Compliance March 5, 2008

SEC Proposes Easing of ETF Regulations

March 5, 2008 (PLANSPONSOR.COM) - The Securities and Exchange Commission (SEC) has proposed two new rules under the Investment Company Act to allow exchange-traded funds (ETFs) to operate without first getting SEC exemptive orders.
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An SEC news release said the commission also proposed amendments to disclosure Form N-1A to include additional information for ETF investors who purchase shares in the secondary markets.

“The proposed rules would increase investor choice by eliminating a barrier to entry for new participants in this fast-growing market, while preserving investor protections,” said Andrew J. Donohue, Director of the SEC’s Division of Investment Management, in the news release. “Permitting most ETFs to come directly to market without the cost and delay of obtaining an exemptive order would also allow staff to focus on more novel and difficult requests.”

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Specifically, the commission released:

  • Proposed Rule 6c-11, which would provide several exemptions from the act to permit ETFs to form and operate without the need to obtain individual exemptive relief from the commission. The rule would codify most of the exemptions previously granted by the commission to index-based ETFs and, pursuant to several recently issued exemptive orders, to fully transparent actively managed ETFs.
  • Proposed Rule 12d1-4, which would allow investment companies to make larger investments in ETFs than currently permitted, which limits one investment company to acquiring no more than 3% of another investment company’s shares. The exemptions in the proposed rule would be subject to several conditions designed to address the historical abuses associated with “pyramiding” schemes that often occurred with fund investment in other funds.
  • Amendments to Form N-1A, which open-end funds use to register and offer their securities under the Securities Act of 1933, would accommodate the use of the form by ETFs. The proposed amendments are designed to provide key information to investors who purchase ETF shares in secondary market transactions, where most ETF investors  purchase their shares.

The comment period for the proposal will end 60 days from the date of publication of the proposed rule in the Federal Register.

Compliance March 4, 2008

(b)lines Series: 403(b) Final Regulations – Transfers and Exchanges

March 4, 2008 ((b)lines) - The new 403(b) regulations concerning plan transfers and contract exchanges both expand permissible transactions for participants and place controls on conditions of the transactions to ensure compliance with limitations and distribution restrictions. Participants are no longer on their own to decide if they can make a transfer or exchange. These provisions of the new regulations were generally effective September 24, 2007.
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The main provisions regarding transfers and exchanges outlined by the Groom Law Group include:

Tax-Free Transfers and Exchanges

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The final regulations provide for three specific kinds of non-taxable exchanges or transfers of amounts in section 403(b) contracts, which are not subject to the distribution restrictions:

  • change of investments within the same plan (contract exchange),
  • plan-to-plan transfer with another employer plan receiving the exchange, or
  • transfer to purchase permissive service credit (or repayment to a governmental DB plan).  

Contract Exchanges

As under the proposed regulations, contract exchanges under the same plan may be made if conditions similar to the conditions for transfers are met. The Preamble of the regulations explains that this is intended for mere change of investment within the same plan.   However, the final regulations expand the requirements to allow exchanges to contracts otherwise not allowed as plan investments if the transferee contract includes distribution restrictions that are no less stringent than those imposed on the contract being exchanged and the employer enters into an agreement with the issuer of the other contract to provide information in the future to comply with the Code, including information regarding employment status, severance from employment, hardship withdrawal, and deemed distribution of a loan. It remains to be seen whether such information sharing agreements will be commonly entered into given the additional administrative complications they introduce.

Plan-to-Plan Transfers

The final regulations permit transfers between 403(b) contracts between separate plans, provided that both plans permit it, and generally reflect the requirements of Revenue Ruling 90-24 that the benefit not be reduced and the transferee contract impose restrictions on distributions no less stringent than those imposed on the transferor.  

If a transfer does not constitute a complete transfer of the participant or beneficiary’s interest in the 403(b) plan, the transfer must be treated as involving a pro-rata portion of the participant’s or beneficiary’s after-tax contributions, if any.

Under prior guidance transfers by employees and beneficiaries may only be made to 403(b) contracts of the individual’s employer. The final regulations expand this provision to include a former employer – that is, if the participant (or decedent, in the case of a beneficiary transfer) is an employee or former employee of the employer for the receiving plan.

Permissible Service Credit Transfers

The final regulations track the proposed rules and include only a “barebones” statement of the EGTRRA rule that permits 403(b) plan transfers to purchase permissive service credit under a governmental defined benefit plan (or to repay a prior cashout under such a plan).   The preamble confirms that such a transfer will not violate the general in-service distribution prohibition for elective deferrals and earnings.

Permissible Service Credit Transfers

The final regulations track the proposed rules and include only a "barebones" statement of the EGTRRA rule that permits 403(b) plan transfers to purchase permissive service credit under a governmental defined benefit plan (or to repay a prior cashout under such a plan).   The preamble confirms that such a transfer will not violate the general in-service distribution prohibition for elective deferrals and earnings.

Mergers and Transfers with Non-403(b) Plans Prohibited

The final regulations reiterate the proposed regulations that 403(b) assets may not be merged with, or transferred to or from, other types of tax-favored retirement arrangements (401(k) plans, 457 plans, defined benefit plans, etc.).

Any other transfer/exchange is considered either a taxable distribution, unless rolled over, if the exchange occurs after a distributable event, or a taxable conversion to a section 403(c) nonqualified annuity contract if a distributable event has not occurred.  

The regulations authorize the IRS to issue future guidance of general applicability allowing contract exchanges in other cases, where the resulting contract has procedures that are reasonably designed to ensure compliance with Code section 403(b). Additionally, any contract exchanges that were permitted under Revenue Ruling 90-24 (and other existing legal requirements) and occurred on or before September 24, 2007, are not subject to these rules.

The IRS has already issued some transition guidance in Revenue Procedure 2007-71 that clarifies or grandfathers certain other exchanges and transfers.

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