DOL cracking down on exemptions

Prophecies of a tougher Department of Labor when it comes to exempting asset managers with a parent company in legal trouble started coming true this summer.

Most financial firms rely on a general class exemption from the DOL to serve as a qualified professional asset manager for retirement plan clients. But if the firm's affiliates or parent are convicted on criminal charges, it must seek an individual exemption to continue handling those assets.

And now recent DOL decisions are shaking up what used to be a straightforward process.

“It's fairly clear that this DOL is taking a much harder line so far on what historically has been seen as a rubber stamp,” said Tim Barron, chief investment officer at consultant Segal Rogerscasey in Darien, Conn. “It's a huge potential problem for these gigantic firms.”

The latest signal of a tougher DOL approach to QPAMs came mid-July, when the Department of Labor tentatively denied QPAM exemption requests from three large asset managers — Deutsche Bank AG, UBS Global Asset Management and Royal Bank of Scotland Group — whose parents were convicted earlier this year of manipulating benchmark interest rates and other charges.

In separate letters to the three firms, Lyssa Hall, the director of exemption determinations at the Employee Benefits Security Administration, Washington, said the denial was based on a “failure to demonstrate” that an exemption would be in the interest of the plan clients and protective of plan participants.

Deutsche Bank and UBS executives are in discussions with DOL officials to address concerns raised in the temporary denials. An RBS spokeswoman declined to comment.

As of Dec. 31, Deutsche Asset & Wealth Management ran $11.5 billion in U.S. institutional tax-exempt assets, of which $8.2 billion is covered by a QPAM exemption. UBS Global Asset Management ran $55.3 billion, according to Pensions & Investments' data. RBS figures were not available.

The denials were an unusual step for the DOL. The last denial was made in 2013 against UBS after a Japanese division pleaded guilty to criminal charges. The firm later won a QPAM exemption, after agreeing to conditions to protect affected pension plans, such as additional training and independent plan audits.

On Sept. 4, DOL officials granted a temporary, nine-month exemption for Deutsche Bank as its Deutsche Securities Korea Co. affiliate awaits sentencing in a market manipulation criminal case. Deutsche Bank also entered a deferred prosecution agreement with the Department of Justice.

UBS and RBS, whose sentencings on the criminal convictions have not been scheduled, were not offered a temporary exemption.

Five major banks — Citicorp, J.P. Morgan Chase & Co., Barclays PLC, RBS and UBS — pleaded guilty in May to foreign exchange manipulation and will pay $2.5 billion in criminal fines. Citigroup, J.P. Morgan and Barclays also applied for QPAM exemptions.

Deutsche Bank in April pleaded guilty to wire fraud and paid $775 million in criminal penalties.

For financial watchdog groups frustrated with other regulators' responses to these high-profile criminal convictions, the DOL's action was a welcome change.

Bartlett Naylor, financial policy advocate with Congress Watch in Washington, applauded the DOL “for demonstrating spine regarding these applications. QPAM status allows financial firms to steer clients into hazardous investments riven with conflicts. Only firms with spotless records should be allowed such freedom,” he said.

The point of both denying applications and granting temporary ones is to have more control over how the asset manager divisions work in pension plans' interests, DOL officials say. “Every single exemption contains conditions that protects plans and participants,” DOL spokesman Michael Trupo said in an interview.

Conditions in an exemption granted in April to BNP Paribas Investment Partners, which managed $3.62 billion for U.S. institutional tax-exempt clients as of Dec. 31, “would provide much or all of the deterrent effect that would have been achieved through outright denial,” the exemption notice said.

BNP Paribas sought the exemption following its parent company's June 2014 guilty plea to violating U.S. sanctions in several countries. Along with an $8.97 billion settlement with U.S. and New York state authorities, the firm added compliance measures and agreed to clear dollars through a third-party bank.

Between more stringent conditions and the recent trend of issuing exemptions on a temporary basis, the DOL is “holding the applicant's feet to the fire,” said Stephen Saxon, chairman of the Groom Law Group in Washington, who as a junior associate in the early 1980s worked with the department to develop the QPAM exemption. “QPAMs have become more complicated in the level and complexity of the conditions they set, and they are more difficult to get,” Mr. Saxon said.

Pension plan consultants say that while their clients don't like headline risk, it is pretty rare for asset managers to get dropped unless there is a direct connection to the misdeeds.

“The client perspective seems to be "wait to see if something happens,'” said Mr. Barron of Segal Rogerscasey.

“We always reach out to asset managers and see what's going on here. One of the things you do is make sure that risk controls are in place. The next question should be, how is this going to impact asset management? Are employees going to be affected or are assets going to flow out? You don't want be part of an asset stampede.”

Some institutional investors aware of the DOL's temporary denial said they are just starting to determine how it might affect their portfolios, and declined to comment while the affected companies have a chance to respond. “We will continue to monitor and assess their business practices and engage them on issues of concern,” said David Barrett, spokesman for Connecticut Treasurer Denise L. Nappier, principal fiduciary for the $29.6 billion Connecticut Retirement Plans & Trust Funds, Hartford.

“There's no bright line. It's really a matter of facts and circumstances,” said Andy Irving, Newark, N.J.-based senior vice president and counsel for Arthur J. Gallagher & Co.'s institutional investment and fiduciary services practice. “It depends on the holdings; some are easier to get out of than others. But it's always disruptive. You balance that against whether there are bad actors or distractions.”

DOL denying an exemption because of a criminal action “can have the effect of depriving plans of products and professionals that can add value,” Mr. Irving said. “It still means the plans and consultants have to be vigilant.”

Charles Van Vleet, chief investment officer of Textron Inc., Providence, R.I. , notes that for an institutional separate account, “changing asset managers can be expensive on three levels: trading costs, opportunity costs and time.”

“In all cases however, there is a loss of staff time to research, plan and coordinate the process,” said Mr. Van Vleet, whose $10.4 billion portfolio does not include any of the asset managers seeking QPAM exemptions.

The more vocal opponents to the QPAM exemptions for the six banks include a group of Democratic members of Congress led by Rep. Maxine Waters, D-Calif., ranking member of the House Financial Services Committee. In June, the group wrote to Labor Secretary Thomas Perez after the five banks pled guilty, asking him to reconsider the waiver process.

“We urge you to give due weight to the seriousness of their criminal behavior, their extensive recidivist history, and the need to protect our nation's workers and retirees from these bad actors who have admitted to misappropriating client information and overcharging them for over five years.”

The group dunned the Securities and Exchange Commission for “rubber-stamping” similar waiver requests, and urged the Department of Labor to make such applications for exemption subject to public hearings. n