Mr. Michael P. Connors
Smith and Downey
201 Moreland Road, Suite 10
Hauppauge, New York 11788
Re: Mutual Fund Investment for Employee Benefit Plans.
Dear Mr. Connors:
You have asked whether the investments a federal credit union (FCU) intends to make in shares of a mutual fund for a particular employee benefit plan are subject to the restrictions on investments an FCU may make on its own behalf contained in the FCU Act and our regulations. Based on our understanding of the plan, as briefly described below, they are not.
Our understanding of this employee benefit plan, based on your correspondence and our telephone conversations, is as follows. To provide a benefit to its employee, the FCU agrees to make a fixed annual payment to purchase shares in a mutual fund during the employee’s employment. For each annual payment by the FCU, the employee receives an option to purchase shares after satisfying the plan’s service requirement at a price fixed by formula. The employee’s option is to purchase, in addition to the shares purchased with the FCU’s annual payment, an additional number of shares equal to 1/3 the number of shares purchased with the annual payment made by the FCU. To exercise the option, the employee pays the FCU the price fixed by formula. The FCU then uses that payment to purchase the additional shares. The employee receives the shares purchased by the FCU’s annual payment along with the additional shares. Our understanding is that the employee’s payment is intended to ensure that the benefit is characterized for tax purposes as an option plan rather than a Section 457(f) deferred compensation plan under the provisions of the Internal Revenue Code.
We also note here how the fixed price formula would work. The price paid by the employee is set at a fixed percentage, for example, 25% of the fair market value of the mutual fund shares to be received at the time the employee elects to receive the shares. The percentage will be set to ensure that the FCU will receive a sufficient payment from the employee to purchase the additional shares. The presumed result is that the employee is able to purchase the shares at a price less than the fair market value at the time of purchase, with economic and tax consequences favorable to the employee.
We also understand that the employee may request a particular mutual fund from a menu of funds, but the FCU makes the actual selection and purchase of the shares. The FCU is the owner of the shares until the executive satisfies the service requirement and exercises the options. After satisfying the service requirement, the employee does not have to buy all the shares at once. The employee has a continuing option and may make partial purchases over time until the employee dies or has purchased all the shares to which the employee is entitled. If the employee dies without having purchased the shares, the employee’s estate will have the option to make the purchase of shares. If the estate does not exercise the option, the FCU will liquidate its shares in the mutual fund.
Your letter states that the FCU may use a so-called "rabbi trust" to hold the shares it purchases and explains that the difference between a rabbi trust and a real trust is that the assets of a rabbi trust are subject to creditors of the FCU. Rev. Rul. 92-64, 1992-2 CB 422. Your letter explains that a rabbi trust is a permissible, asset-holding vehicle for a nonqualified deferred compensation plan and for the plan you describe. You also have stated that the FCU would not be the trustee. The trustee would be another party, most likely another financial institution, with trust powers.
Based on your discussion of the above-noted formula for determining the exercise price to be paid by the employee at the time of receiving the shares, this plan poses no investment risk or cost to the FCU other than the fixed annual payments and any associated administrative costs. The investments have no direct economic benefit to the FCU; indirectly, of course, the FCU benefits from providing the employee benefit program and, if the FCU were liquidated, shares held in a rabbi trust would be available to satisfy claims made by creditors against the FCU.
An FCU investing on its own behalf is subject to the investment provisions of the FCU Act and our regulations. 12 U.S.C. §§1757(7), (8), (15);12 C.F.R. Part 703. These provisions do not apply when an FCU is acting under its authority to provide retirement or other benefits for employees. 12 U.S.C. §1761b(12); 12 C.F.R. §701.19. We conclude that, under the proposed plan, the FCU’s investments have the purpose of providing an employee benefit, and, therefore, the statutory and regulatory limitations on an FCU’s investments for its own account, do not apply.
We defer to the appropriate regional office for any determination on the safety and soundness of the plan, including, for example, whether the FCU has the ability to fund the annual payments and administrative costs associated with the plan. Also, please note that we express no opinion on the permissibility of your proposed plan under other laws, such as the Employee Retirement Income Security Act or the Internal Revenue Code.
Sheila A. Albin
Associate General Counsel
cc: Office of Examination & Insurance