[Federal Register Volume 67, Number 29 (Tuesday, February 12, 2002)]
[Notices]
[Pages 6613-6638]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-3341]



[[Page 6613]]

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Part III





Department of Labor





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Pension and Welfare Benefits Administration



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Class Exemption for Cross-Trades of Securities by Index and Model-
Driven Funds; Notice

Federal Register / Vol. 67, No. 29 / Tuesday, February 12, 2002 / 
Notices

[[Page 6614]]


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DEPARTMENT OF LABOR

Pension and Welfare Benefits Administration

[Prohibited Transaction Exemption 2002-12; Application No. D-10851]


Class Exemption for Cross-Trades of Securities by Index and 
Model-Driven Funds

AGENCY: Pension and Welfare Benefits Administration, Department of 
Labor.

ACTION: Grant of class exemption.

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SUMMARY: This document contains a final exemption from certain 
prohibited transaction restrictions of the Employee Retirement Income 
Security Act of 1974 (the Act or ERISA), the Federal Employees' 
Retirement System Act (FERSA), and from certain taxes imposed by the 
Internal Revenue Code of 1986 (the Code). The exemption permits cross-
trades of securities among Index and Model-Driven Funds (Funds) managed 
by investment managers, and among such Funds and certain large accounts 
which engage such managers to carry out a specific portfolio 
restructuring program or to otherwise act as a ``trading adviser'' for 
such a program. The exemption affects participants and beneficiaries of 
employee benefit plans whose assets are invested in Index or Model-
Driven Funds, large pension plans and other large accounts involved in 
portfolio restructuring programs, as well as the Funds and their 
investment managers. This exemption does not address cross-trades of 
securities among ``actively-managed'' accounts. The Department is 
considering additional safeguards to protect participants in plans that 
engage in active cross-trading prior to publishing a proposal to permit 
such cross-trades.

EFFECTIVE DATE: The effective date of the exemption is April 15, 2002.

FOR FURTHER INFORMATION CONTACT: Karen E. Lloyd or Christopher J. Motta 
of the Office of Exemption Determinations, Pension and Welfare Benefits 
Administration, U.S. Department of Labor, Washington, DC 20210 at (202) 
693-8540; or Michael Schloss, Plan Benefits Security Division, Office 
of the Solicitor, U.S. Department of Labor, Washington, DC 20210, at 
(202) 693-5600. (These are not toll-free numbers.)

Paperwork Reduction Act Analysis

    In accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 
3501-3520)(PRA 95), the Department submitted the information collection 
request (ICR) included in the Class Exemption for Cross-Trades of 
Securities by Index and Model-Driven Funds to the Office of Management 
and Budget (OMB) for review and clearance at the time the Notice of 
proposed class exemption was published in the Federal Register 
(December 15, 1999, 64 FR 70057). OMB subsequently approved the ICR 
under OMB control number 1210-0115. The approval will expire on April 
30, 2003. The public is not required to respond to an information 
collection request unless it displays a currently valid OMB control 
number.
    As described in detail in the Supplementary Information section 
which follows, the Department of Labor (Department) has made certain 
modifications to the terms of the proposed class exemption in response 
to comments received from the public. Although the recordkeeping and 
information disclosure requirements which constitute the information 
collection provisions of the final class exemption have been clarified 
in certain respects, the information collection provisions have not 
been substantively or materially changed from the proposed exemption. 
The Department has, however, made certain adjustments to its burden 
estimates and underlying assumptions in response to comments on the 
proposal. These adjustments relate to the numbers of entities offering 
Index and Model-Driven Funds and their client plans, and the number of 
Large Accounts that may make use of the exemption, and the estimated 
burden of the record-keeping requirement.
    The Department's original estimates of the number of users of the 
exemption were based on the number of individual exemptions granted and 
applications received, and information received from exemption 
applicants about the number of plans involved, resulting in estimates 
of 10 entities with an average of 20 client plans for each. One 
commenter expressed the view that at least 50 entities with an average 
of 40 client plans would make use of the exemption. Because the 
Department acknowledges that the grant of this final exemption may 
affect the number of entities that would consider implementing a 
program of cross trading involving index and model funds, the assumed 
numbers of entities and plans have been increased for purposes of 
burden estimates to 20 entities and 40 plans, respectively. Similarly, 
the number of Large Accounts assumed for purposes of estimating burden 
has been increased from 10 to 40. While the assumed number of Large 
Accounts is smaller than the 1,000 offered by the commenter, the 
Department believes that a number approximating 18% of all plans with 
$50 million in assets would substantially overstate the number likely 
to make use of the exemption in connection with a portfolio 
restructuring program in a given year.
    The commenter also indicated that the Department's estimates of the 
time required to establish and maintain the record-keeping systems that 
would be needed to comply with the exemption were significantly low. 
The comment states that a significant investment of $4 to $5 million 
would be required for each user to establish the necessary record-
keeping systems, and that substantial amounts of time would be required 
daily for ongoing record-keeping, and annually for ongoing disclosures. 
Upon consideration of the comment, the Department has concluded that 
its original estimates did omit the impact of the initial investment of 
resources that would be required to enhance existing software and 
systems to track cross-trades to triggering events. As a result, the 
Department has revised its estimates to include the hours, or costs as 
applicable, of 1,040 hours of systems analyst time at $51 per hour 
(based on Occupational Employment Survey data and 1999 Employment Cost 
Index, adjusted for non-wage compensation and overhead.) This change 
adds approximately 12,500 hours and $424,000 to the estimated burden of 
the final exemption. These totals are distributed over a three year 
period for purposes of the annual burden shown below.
    Given that record-keeping systems for securities transactions are 
primarily electronic in nature, and that the Department's burden 
estimates now take into account the start-up cost of modifying 
automated record-keeping systems, the Department has decided not to 
revise the estimated time required to maintain the required records of 
trades and to prepare disclosure materials. In the Department's view, 
the original estimates are reasonable in light of the degree to which 
record-keeping is automated, the industry's existing record-keeping 
practices involving cross-trading, and the information provided by 
other commenters.
    In addition, the final exemption clarifies that the annual 
disclosures are required to be made with respect to only those Funds 
that hold plan assets and in which a given plan invests. The commenter 
had indicated that eliminating the annual disclosure requirement with 
respect to Funds in which a plan had no investments would substantially 
reduce the burden. This clarification, therefore, further supports 
retention of the original assumptions.

[[Page 6615]]

    Finally, the commenter expressed the view that certain of the 
information required to be disclosed by the terms of the proposed 
exemption was duplicative and unnecessary. As noted earlier, with the 
exception of certain clarifications, the information collection 
provisions of the final exemption are unchanged from the proposal. The 
Department's basis for its conclusions with respect to the need for the 
disclosure and record-keeping provisions of the final exemption are 
discussed in detail in the Supplementary Information section that 
follows.
    The burden estimates that result from the revised assumptions are 
presented below:
    Title: Prohibited Transaction Class Exemption for Cross-Trades of 
Securities by Index and Model-Driven Funds.
    Agency: Department of Labor, Pension and Welfare Benefits 
Administration.
    Affected Entities: Business or other for-profit.
    Respondents: 60 (20 entities and 40 Large Accounts).
    Responses: 840.
    Annual Hour Burden: $9,100.
    Annualized Capital/Start-up Cost: $141,000.
    Annual Cost (Operating and Maintenance): $280,000.
    Annual Cost Burden: $421,000.

Executive Order 12866 Statement

    Under Executive Order 12866, the Department must determine whether 
a regulatory action is ``significant'' and therefore subject to the 
requirements of the Executive Order and subject to review by the Office 
of Management and Budget (OMB). Under section 3(f), the order defines a 
``significant regulatory action'' as an action that is likely to result 
in a rule (1) having an annual effect on the economy of $100 million or 
more, or adversely and materially affecting a sector of the economy, 
productivity, competition, jobs, the environment, public health or 
safety, or State, local or tribal governments or communities (also 
referred to as ``economically significant''); (2) creating serious 
inconsistency or otherwise interfering with an action taken or planned 
by another agency; (3) materially altering the budgetary impacts of 
entitlement grants, user fees, or loan programs or the rights and 
obligations of recipients thereof; or (4) raising novel legal or policy 
issues arising out of legal mandates, the President's priorities, or 
the principles set forth in the Executive Order.
    Pursuant to the terms of the Executive Order, it was determined 
that this action is ``significant'' under section 3(f)(1) of the 
Executive Order. Accordingly, this action has been reviewed by OMB.

Economic Analysis

    Establishing a class exemption that permits plans to cross-trade 
can be expected to have a variety of positive economic effects that 
will considerably exceed the direct costs incurred by plans to comply 
with the record keeping and reporting requirements enumerated in the 
PRA section of the final class exemption. By removing existing barriers 
to these types of transactions, the exemption will significantly 
increase the utilization of cross-trading among index and model-driven 
portfolios. This will result in substantial savings to plans by 
lowering the transaction costs in a number of ways. Although there is 
currently no source of data that can be used to precisely estimate the 
level of these savings or the distribution of these effects among 
various parties, extrapolating from several sources can provide a 
reasonable estimate of their overall magnitude.
    Limiting the exemption to index and model-driven portfolio 
management techniques should preclude any changes in the incidence of 
trading activity. In contrast to active management techniques, index 
and model funds will continue to execute trades at the same levels that 
they would in the absence of the exemption because their trading is 
motivated by the need to remain within their tracking parameters rather 
than in response to marginal changes in expected transaction costs. It 
is therefore reasonable to assume that the changes in costs will result 
solely from a decrease in the cost of executing many individual trades 
rather than from a change in the levels of trades.
    Changes in the costs of individual trades will result from (1) the 
elimination of commission costs that would otherwise be associated with 
a trade, (2) the avoidance of bid-ask spreads that impose costs for 
transactions executed through dealers, (3) the absence of fees and 
taxes that might otherwise apply, and (4) the avoidance of the market 
impact of large trades which might otherwise require price concessions 
to execute or effect the trade which would directly impact the market 
value of the resulting holdings.
    Only the first three of these effects are considered in the 
analysis. The last, market impact, is not included because it can 
reasonably be expected to have largely offsetting effects. ERISA plans 
are equally likely to be on either side of a cross trade and in most 
cases are likely to represent both parties to a transaction. In some 
instances, they will be advantaged by avoiding the changes in an 
individual securities price that might otherwise have resulted from a 
trade executed through another venue. In other circumstances, they will 
be disadvantaged. An equal probability of either will result in 
essentially offsetting effects in the aggregate.
    A similarly conservative approach is taken in regard to two other 
aspects of the analysis. These are a result of the limitations in the 
available data and the absence of any experience with the full scope of 
relief afforded by the exemption on which to base an estimate. Although 
some data on the amount of ERISA plan assets in index funds is 
available, there is no similar source of reliable information to 
estimate the size of ERISA model driven assets to which the exemption 
would apply. There is also no experience with more extensive 
opportunities for cross-trading that are available under the exemption 
resulting from increased flexibility in allocating cross-trading 
opportunities, the extension of relief to a broader range of entities, 
and the inclusion of debt securities in the allowable transactions. 
Consequently the analysis is limited to index funds and does not 
incorporate increases in savings resulting from the extension of relief 
to circumstances with which there is no prior experience. As such, it 
should be interpreted as an extremely conservative estimate that is 
likely to represent a lower bound of the level of savings that can be 
expected to accrue to plans.
    Two large financial services firms currently operating under 
individual exemptions that permit cross-trading among ERISA plans 
provided estimates of the savings in commissions, spreads, and fees 
that they have experienced managing both ERISA and non-ERISA indexed 
assets. These two estimates represent a significant portion of the 
ERISA plan universe and are therefore likely to be representative of 
the cost savings likely to occur. One of the firms estimated the cost 
savings to be approximately $275 million per year for a total indexed 
portfolio of $400 billion. The other estimated a savings of $207 
million for $441 billion of indexed assets under management. Both of 
these include ERISA and non-ERISA assets, however, the experience 
should be indicative of expected results because the nature of trading 
costs for indexed funds should be virtually identical. Averaging these 
figures yields an estimate that costs savings of .057% or 5.7 basis 
points for each dollar of affected ERISA plan assets can be expected.

[[Page 6616]]

    A recent survey of pension funds indicates that among the largest 
private sector defined benefit pension funds, 14% of the total assets 
were held in index funds. Among defined contribution plans, index funds 
constituted 12% of total assets. Applying these percentages to the most 
recent estimates of the total value of private pension funds yields an 
estimate of approximately $584 billion of ERISA pension funds that are 
currently managed as indexed funds.
    Applying the estimate of $.00057 of savings for each dollar of 
assets under management results in an estimated level of cost 
reductions of approximately $332 million per year that will result from 
the class exemption. This total cost savings estimate overlaps, in 
part, current costs savings experienced by plans whose managers have 
cross-trading programs covered under existing individual exemptions. 
While certain large index fund managers are successfully operating 
cross-trading programs for ERISA plans at this time, the class 
exemption is expected to create additional cost savings for these plans 
by increasing the number and frequency of cross-trading opportunities 
among the managers' client accounts. In addition, new cross-trading 
opportunities will be made available for plans whose assets are managed 
by entities that currently do not have individual exemptions. Finally, 
the conservative nature of the total estimate is highlighted by the 
fact that cost savings associated with cross-trading by model-driven 
funds have not been factored into the estimate of total cost savings 
due to the absence of available data.

SUPPLEMENTARY INFORMATION: On December 15, 1999, the Department of 
Labor (the Department) published a notice in the Federal Register (64 
FR 70057) of the pendency of a proposed class exemption from the 
restrictions of sections 406(a)(1)(A) and 406(b)(2) of the Act, section 
8477(c)(2)(B) of FERSA,\1\ and from the taxes imposed by section 
4975(a) and (b) of the Code by reason of section 4975(c)(1)(A) of the 
Code.
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    \1\ The Department has responsibility for the administration and 
enforcement of section 8477 of FERSA. Section 8477 establishes the 
standards of fiduciary responsibility and requirements relating to 
the activities of fiduciaries with respect to the Federal Thrift 
Savings Fund. All references herein to the fiduciary responsibility 
provisions of Part 4 of Title I of ERISA also apply to the 
corresponding provisions of FERSA. Accordingly, the relief provided 
under this class exemption applies to cross-trades of securities by 
the Federal Thrift Savings Fund.
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    The Department proposed the class exemption on its own motion 
pursuant to section 408(a) of the Act and section 4975(c)(2) of the 
Code, and in accordance with the procedures set forth in 29 CFR part 
2570, subpart B, (55 FR 32836, August 10, 1990).\2\ The Department's 
determination to proceed with the proposed class exemption was based, 
in part, on information received from interested persons in response to 
a notice (the Notice) published in the Federal Register on March 20, 
1998 (63 FR 13696).
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    \2\ Section 102 of Reorganization Plan No. 4 of 1978, 5 U.S.C. 
App. 1 (1996) generally transferred the authority of the Secretary 
of the Treasury to issue exemptions under section 4975(c)(2) of the 
Code to the Secretary of Labor.
    In the discussion of the exemption, references to specific 
provisions of the Act should be read to refer as well to the 
corresponding provisions of section 4975 of the Code.
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    The notice of pendency gave interested persons an opportunity to 
comment or request a public hearing on the proposal. Fourteen (14) 
public comments were received by the Department. Upon consideration of 
all the comments received, the Department has determined to grant the 
proposed class exemption subject to certain modifications. These 
modifications and the major comments are discussed below.

Discussion of Comments Received

    The comments received by the Department were generally supportive 
of the issuance of a separate class exemption for cross-trading of 
securities by Index and Model-Driven Funds. However, many of the 
commenters requested specific modifications to the proposal in the 
following areas:
    1. Accounts Permitted to Cross-Trade. Several comments noted that 
section I(a) and (b) of the proposal does not explicitly permit cross-
trades between two or more Large Accounts. These comments noted that 
when more than one Large Account is buying or selling a particular 
security as part of a manager's cross-trading program, that security 
could be traded between two Large Accounts, two Index or Model-Driven 
Funds, or any combination thereof. In the operation of a cross-trading 
program, the matching of the buyer and seller would be coincidental. 
The commenters believe that a manager should be permitted to submit 
trade lists from each Large Account to its cross-trade allocation 
system and allow trades submitted on behalf of one Large Account to be 
crossed with trades submitted on behalf of another Large Account.
    The Department notes that section I(a) and (b) of the proposal does 
not provide relief for cross-trades exclusively between two or more 
Large Accounts. The Department is of the view that such cross-trading 
would be outside the scope of the exemption because, among other 
things, there would be no ``triggering event'' to limit the amount of 
discretion exercised by the manager where such transactions occurred 
solely between Large Accounts.
    The Department does recognize, however, that a manager's cross-
trading program that complies with the requirements of the proposal may 
produce cross-trade opportunities that result from both triggering 
events of particular Index and Model-Driven Funds as well as from the 
decision of an independent fiduciary to restructure all or a portion of 
a Large Account's portfolio. Under such circumstances, the Department 
anticipates that the allocation of buying and selling opportunities 
across all Funds and Accounts participating in the cross-trading 
program may result in some individual cross-trades between two Large 
Accounts. In such an event, the exemption would permit the 
``coincidental'' matching of a buyer and seller of particular 
securities where both buyer and seller are Large Accounts since such 
cross trades would be part of a unified process-driven cross-trading 
program where the allocations of available securities (from all Funds 
and/or Large Accounts) resulted from an objective process which did not 
permit the exercise of discretion by the manager, as required under 
section II(d) of the exemption. The Department has revised section I of 
the exemption to clarify this point.
    Another commenter noted that no specific relief for cross-trades 
between two Large Accounts may be necessary where the decision to 
liquidate or restructure is made by an independent fiduciary or 
independent Account representative, and, therefore, the manager would 
not be acting as a fiduciary for either side of the transaction. Thus, 
the commenter suggested that the Department may wish to clarify whether 
additional relief for cross-trades exclusively between two or more 
Large Accounts is necessary. Alternatively, the commenter suggested 
that section I(b) of the proposal be modified to explicitly permit 
cross-trades solely between Large Accounts.
    In response to this comment, the Department notes that violations 
of section 406(b)(2) of the Act would occur if the manager used its 
discretionary authority to determine whether to cross-trade securities 
between two Large Accounts at least one of which holds plan assets, 
which securities to cross-trade, the timing of such cross-trades,

[[Page 6617]]

and the amount of securities to cross-trade notwithstanding that the 
overall determination to restructure the accounts was made by 
independent fiduciaries.
    Accordingly, except as provided above, the Department has 
determined not to expand the relief provided under this exemption to 
include cross-trades solely between two or more Large Accounts. The 
Department notes that the final exemption provides a manager with a 
significant amount of time in which to conduct cross-trades for a Large 
Account in connection with a specific portfolio restructuring program. 
A manager's discretion to time specific cross-trades for two Large 
Accounts, absent the limitations provided by a process-driven cross-
trading program involving ``triggering events'' for Index and Model-
Driven Funds, would entail the type of discretion commonly exercised by 
managers for ``actively-managed'' accounts. In this regard, relief for 
cross-trades by ``actively-managed'' accounts and pooled funds 
containing ``plan assets'' will be considered by the Department in a 
separate proceeding.
    2. Use of closing prices. One commenter suggested that the 
Department modify the requirement that all cross-trades occur at the 
closing prices for the securities on the relevant market in order to 
allow for alternate pricing methodologies (e.g., ``volume weighted 
average price'' or ``VWAP''), after appropriate disclosure to the 
affected plans. Section II(a) of the proposal requires that the cross-
trade be executed at the closing price, as defined in section IV(h). 
Section IV(h) of the proposal defines ``closing price'' as the price 
for a security on the date of the transaction, as determined by 
objective procedures disclosed to Fund investors in advance and 
consistently applied with respect to securities traded in the same 
market, which procedures shall indicate the independent pricing source 
used to establish the closing price and the time frame after the close 
of the market in which the closing price will be determined. The 
commenter does note that ``closing prices'' are the most appropriate 
prices currently in use for cross-trades of securities by Index and 
Model-Driven Funds, whose objective is to track the return of an index, 
since the calculation of an Index Fund's ``tracking error'' is based on 
closing prices for the securities listed in the relevant index. 
However, the commenter states that index providers may utilize 
alternative pricing methodologies in the future and suggests that the 
Department should consider broadening the exemption to include such 
pricing methodologies.
    The Department notes that many commenters have indicated that the 
use of closing prices for cross-trades of securities by Index and 
Model-Driven Funds is common industry practice at the present time. The 
Department does not believe that it has sufficient information at this 
time to determine which types of alternative pricing methodologies may 
be used by managers in the future or how such pricing systems would 
enable Index and Model-Driven Funds to better achieve their investment 
goals and strategies. Therefore, the Department has determined not to 
modify the requirement that cross-trades be executed at the closing 
price. The Department would be prepared to consider additional relief 
at a later date upon proper demonstration that the appropriate findings 
can be made under section 408(a) of the Act with respect to other 
pricing methods for cross-traded securities.
    3. ``Triggering Events'' and Cross-Trade Executions. Several of the 
comments objected to the requirement in section II(b) of the proposal 
that any cross-trade of securities by a Fund be executed no later than 
the close of the second business day following a ``triggering event.'' 
These comments noted that previously issued individual exemptions for 
cross-trades by Index and Model-Driven Funds allowed cross-trades to be 
executed within three (3) business days of a ``triggering event'' and 
that the proposal's reduction of this requirement to two days is 
inconsistent with the stated premise of the proposal that cross-trading 
is beneficial to plans. Other comments noted that, once an investment 
decision is made, a manager should have 5 days to trade after a 
``triggering event''--the same period of time to execute the trade as 
is permitted under the safe harbor provided in the Department's 
regulations for determining whether a broker-dealer is a fiduciary when 
it executes a securities transaction on behalf of a plan (see 29 CFR 
2510.3-21(d)). Another comment requested that section II(b) be revised 
to require that cross-trades be executed either within three (3) days 
of a ``triggering event,'' or within such other period of time as the 
manager may disclose to the independent plan fiduciary pursuant to the 
disclosure requirements under section II(l) of the proposal.
    In response to the comments, the Department has determined that it 
would be appropriate to modify section II(b) of the final exemption to 
require that all cross-trades by a Fund be executed no later than the 
close of the third business day following a Fund's ``triggering 
event.'' The Department notes that a three-day limit for cross-trades 
by a Fund following the relevant ``triggering event(s)'' has worked 
successfully in the past for managers who were granted individual 
exemptions.\3\
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    \3\ See, for example, Prohibited Transaction Exemption (PTE) 95-
56, 60 FR 35933 (July 12, 1999), regarding Mellon Bank, N.A., and 
its Affiliates.
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    4. Blackout Period for Cross-Trades by Model-Driven Funds. Many of 
the comments objected to the requirement in section II(c) of the 
proposal that no cross-trades by a Model-Driven Fund may take place 
within ten (10) business days following any change made by the manager 
to the model underlying the Fund. The preamble to the proposal 
indicated that this restriction is intended to prevent model changes 
which might be made by managers, in part, to deliberately create 
additional cross-trading activity. The comments suggested that such a 
long delay on the ability of a manager to cross-trade after a change in 
the computer model was unnecessarily restrictive. According to the 
commenters, this condition would prevent cross-trading during the 10-
day ``blackout'' period even though other ``triggering events'' were 
occurring in the Fund. Other commenters noted that there are already 
sufficient restrictions on a manager's discretion built into the 
proposal.
    While most comments objected to the 10-day ``blackout'' period, 
several of the comments indicated that a 5-day period would be 
sufficient to safeguard against the Department's concerns regarding 
model changes that may be timed to create additional cross-trading 
opportunities. Other commenters suggested that, rather than imposing a 
``blackout'' period for an arbitrary period of time (e.g., 5 or 10 
days), a more flexible approach could be used where a Model-Driven Fund 
would be able to cross-trade following the period of time necessary to 
complete the first re-balancing of the Fund's portfolio after the 
change is made by the manager to the Fund's model. Thus, under this 
approach, the ``blackout'' period could be less than three (3) days. 
One comment suggested that any cross-trading ``hiatus'' for a Fund 
should not be more than three (3) days. Other comments simply requested 
that the condition for a ``blackout'' period after a model change be 
deleted. Still other comments noted that, in the absence of a 
``blackout'' period, a requirement for 10-day prior notice of a model 
change to each relevant plan's independent fiduciary should suffice. 
Finally, some

[[Page 6618]]

commenters requested clarification that model changes made either (i) 
at the direction of a client plan, or (ii) as a direct result of input 
changes furnished by a third party data vendor (e.g., BARRA or Vestek), 
would not invoke a ``blackout'' period because such model changes would 
not be the result of an exercise of discretion on the part of the 
manager.
    The Department continues to believe that some ``blackout'' period 
is necessary to prevent managers from exercising their discretion over 
the criteria or data used for a model to generate specific cross-trade 
opportunities. However, in recognition that a 10-day restriction may be 
too long a period to prevent a Model-Driven Fund from cross-trading, 
the Department has decided to modify the final exemption to require 
that cross-trades not take place within three (3) business days 
following any change made by the manager to the model underlying the 
Fund.
    In addition, with respect to the one commenter's concerns that 
model changes resulting from independent events should not invoke a 
``blackout'' period for a Model-Driven Fund, the Department 
acknowledges that any change to a model which is not the result of an 
exercise of discretion by the manager (e.g., changes directed by an 
independent plan fiduciary or furnished by a third party data vendor 
whose model is being used by the manager) would not require a 
``blackout'' period for cross-trades by such Fund.
    5. Restrictions on Cross-Trades by a Manager Plan. One comment 
objected to, and requested the deletion of, the requirement in section 
II(e) of the proposal that no more than ten (10) percent of the assets 
of any Fund or Large Account engaging in a cross-trade may be comprised 
of assets of employee benefit plans maintained by the manager for its 
own employees (i.e., a Manager Plan), for which the manager exercises 
investment discretion. The comment stated that this condition would 
create a disincentive to in-house management and may cause investment 
managers to place assets of a Manager Plan with outside managers solely 
on the basis of the potential cost savings that the outside managers 
could derive from cross-trades.
    The comment noted that for large plans, in-house management is 
frequently more cost-effective and keeps the asset management function 
closer to the people who have the most to gain from maximizing 
investment performance and minimizing investment risk. The comment 
further noted that larger in-house fiduciaries also manage assets for 
unaffiliated plans and other institutional investors, often as a result 
of a corporate spin-off with an accompanying plan restructuring. The 
comment stated that it understood the Department's concern regarding a 
manager's potential ability, through cross-trades, to unduly benefit a 
Manager Plan at the expense of its outside clients. However, the 
commenter believes that the other conditions of the proposal, including 
``triggering events'' for cross-trades, detailed disclosures of cross-
trading procedures and reporting of cross-trades resulting from a 
portfolio restructuring, would serve as a check on the manager's 
ability to favor a Manager Plan. Moreover, the commenter notes that to 
the extent that a Manager Plan's assets are commingled with assets of 
outside clients that are held in an Index or Model-Driven Fund managed 
as a collective investment fund, it would not be possible for the 
manager to ``favor'' only the Manager Plan in that Fund, even if the 
Manager Plan's assets represented more than 10 percent of the Fund's 
total assets. In any event, the comment noted that the 10 percent 
limitation should not apply to cross-trades that are made solely 
between Manager Plans.
    With respect to the commenter's request to delete the 10% 
limitation in section II(e) of the proposal, the Department notes that, 
without such a percentage limitation, a substantial majority of the 
investors in a Fund could be comprised of Manager Plans. The Department 
does not believe that deletion of this percentage requirement would 
ensure a sufficient level of independent investor oversight of the 
manager's cross-trading program.
    However, in consideration of the arguments raised by the 
commenters, the Department believes that a 20% limitation would still 
ensure a sufficient level of independent investor oversight in a Fund 
and would not unduly restrict the investment opportunities available 
for a Manager Plan with respect to such Funds. Therefore, the 
Department has modified section II(e) to increase the percentage 
limitation to 20%.
    Accordingly, this exemption does not provide relief for cross-
trades of securities of Index and Model-Driven Funds maintained by a 
manager under circumstances where the assets of the Manager Plans 
comprise all or a high percentage of the assets of the Fund. As noted 
above, the Department believes that the presence of independent 
fiduciaries to approve of plan participation in cross-trading programs 
following receipt of meaningful disclosures and the ability of such 
fiduciaries to periodically monitor the arrangements provide important 
protections under the exemption. However, in response to several 
comments, the Department wishes to take the opportunity to state that 
the granting of this exemption does not foreclose future consideration 
of additional relief for cross-trading transactions that do not fit 
within the framework developed by the Department for this exemption. 
For example, the Department is currently considering additional relief 
for transactions involving assets of plans managed by in-house 
managers, as well as for transactions involving discretionary asset 
managers.
    With respect to the comments requesting that the exemption allow 
cross-trades to occur solely between two or more Manager Plans, the 
Department notes that relief for these transactions could involve the 
exercise of discretion on both sides to a transaction that is 
inconsistent with the underlying concept of the proposal--which is to 
provide relief for cross-trades made pursuant to ``process-driven'' 
investment strategies. For this reason, the Department has determined 
not to revise the exemption in this regard.
    Another comment stated that section II(e) of the proposal does not 
adequately address how the independent authorization conditions in 
section II(i) through (n) of the proposal would apply to a Manager 
Plan, given that the plan fiduciary responsible for the plan's 
investment matters is unlikely to be independent of the manager. This 
comment suggested that the Department not require an independent 
fiduciary authorization for a Manager Plan's participation in the 
manager's cross-trading program. The commenter stated that the 
suggested modification would be consistent with other exemptions that 
do not apply an independent authorization requirement to plans of the 
fiduciary for whom relief is provided.\4\ Accordingly, the commenter 
requests that the Department adopt a similar provision under the final 
exemption.
---------------------------------------------------------------------------

    \4\ In this regard, see section IV(d)(1)(A) of PTE 86-128 (51 FR 
at 41696, November 18, 1986).
---------------------------------------------------------------------------

    The Department concurs with the comments and has determined to 
modify section II(h) of the final exemption (formerly section II(i) of 
the proposal) to clarify that the requirement that the authorizing 
fiduciary be independent of the manager shall not apply in the case of 
a Manager Plan. Nevertheless, the appropriate fiduciary for the Manager 
Plan must still receive the proper disclosures and provide an

[[Page 6619]]

authorization for the Manager Plan to participate in the manager's 
cross-trading program. This clarification modifies the disclosure and 
authorization requirements applicable to a plan's participation in a 
manager's cross-trading program, as described in section II(h) through 
(l) of the final exemption (formerly section II(i) through (m) of the 
proposal).
    In addition, the Department has also determined to modify the 
requirements contained in section II(n) of the proposal, relating to 
disclosures to, and authorization by, a fiduciary of a Large Account 
who is independent of the manager for cross-trades in connection with a 
portfolio restructuring for the Large Account. To clarify this matter, 
the Department has revised section II(m) of the final exemption 
(formerly section II(n) of the proposal) by adding the parenthetical 
phrase ``* * * (other than in the case of any assets of a Manager 
Plan)'' to the requirements for an independent fiduciary discussed in 
section II(m)(1) through (4). In this regard, the Department notes that 
the final exemption still requires that proper disclosures be made to, 
and written authorization be made by, a Manager Plan's fiduciary in 
order for the Manager Plan to participate in a specific portfolio 
restructuring program.
    6. Exclusion of Thinly-Traded Equity Securities. A number of 
commenters objected to the condition contained in section II(f)(1) of 
the proposal that required that cross-trades of equity securities 
involve only securities that are widely-held, actively-traded, and for 
which market quotations are readily available from independent sources. 
In this regard, the terms ``widely-held'' and ``actively-traded'' are 
deemed to include any security listed in an ``Index'' (as that term is 
defined in section IV(c) of the proposal).
    The comments stated that this requirement was not necessary for an 
exemption for cross-trading by Index and Model-Driven Funds. According 
to the comments, security selection for such Funds is driven solely by 
objective factors. The commenters argued that the level of trading and 
diversity of holdings for securities are not relevant to security 
selections made by Funds and that such factors should not serve as a 
constraint on the ability of such Funds to cross-trade. Generally, the 
comments noted that if market prices are readily available, the 
exclusion of ``closely-held'' and ``thinly-traded'' equity securities 
is unduly restrictive. They further argued that such limitations would 
prevent use of the exemption for many ``small-cap'' and foreign equity 
securities. Thus, the commenters urged the Department to delete the 
requirement that cross-traded equity securities be ``widely-held'' and 
``actively-traded.''
    As an alternative approach, one commenter suggested a limitation 
based on a comparison of the size of the cross-trade to the prior 
public trading volume in the security over a reasonable period of time 
prior to the date of the transaction. Such a volume limitation would 
prevent cross-trades of equity securities where the total volume of 
shares being cross-traded would exceed a certain percentage of the 
total number of shares publicly traded on the market during a 
particular period of time.
    The Department is not persuaded by the arguments submitted in favor 
of deletion of the requirements contained in section II(f)(1) that 
equity securities that are cross-traded must be ``widely-held'' and 
``actively-traded.'' The Department continues to believe that cross-
trades of ``thinly-traded'' securities raise issues as to whether both 
sides of the cross-trade have benefitted equally from the avoidance of 
adverse market impact. The avoidance of market impact would be more 
dramatic with ``thinly-traded'' equity securities than with equity 
securities that are ``widely-held'' and ``actively-traded.'' \5\ 
Similarly, the avoidance of liquidity restraints would be more dramatic 
with ``thinly-traded'' equity securities than with equity securities 
that are ``widely-held'' and ``actively-traded.''
---------------------------------------------------------------------------

    \5\ The Department notes that these concerns would also arise 
with ``thinly-traded'' debt securities. However, since ``thinly-
traded'' debt securities of different issuers with the same coupon 
rate, maturity, and credit rating are relatively fungible, the 
Department did not believe that it would be appropriate to apply 
these concepts to such securities for purposes of this exemption.
---------------------------------------------------------------------------

    In order to address its concerns without unnecessarily restricting 
the scope of relief under the proposal, the Department determined to 
deem equity securities that are included in an Index (as defined in 
section IV(c) of the exemption) to be ``widely-held'' and ``actively-
traded'' for purposes of the exemption. However, the Department notes 
that the exemption does not preclude a manager from cross-trading a 
particular equity security not included in an index if the manager 
otherwise determines that such security is ``widely-held'' and 
``actively-traded.''\6\
---------------------------------------------------------------------------

    \6\ With respect to the selection criteria for securities 
included in a Fund's portfolio which are not included in an Index, 
the Department assumes that any screening criteria and/or weighting 
procedures used to create the portfolio will be determined using 
purely mathematical computations based upon objective raw data. In 
addition, the Department assumes that the investment management 
agreement relating to each Fund, as approved by plan investors in 
the Fund, would set forth the specific dates on which the Fund's 
portfolio will be re-balanced. In this regard, the Department notes 
that no relief would be provided under this exemption for violations 
of section 406(b)(1) of the Act which may occur as a result of a 
manager's exercise of fiduciary authority or discretion to affect 
the components of an Index.
---------------------------------------------------------------------------

    With respect to the comment suggesting a trading volume limitation, 
the Department notes that other commenters have discouraged it from 
addressing its concerns about cross-trades of ``thinly-traded'' 
securities through volume limitations, based on arbitrary percentages 
of the average daily trading volume for the securities. These 
commenters noted that the systems used by managers to allocate cross-
trades among various Funds would have difficulty monitoring and re-
allocating cross-traded securities to conform to such volume 
limitations.
    In consideration of the above, the Department has determined not to 
modify section II(f)(1) in the final exemption.
    7. Cross-Trades of Securities Issued By the Manager. Several 
comments objected to the requirement in section II(h) of the proposal 
that cross-trades not involve securities issued by the manager, unless 
the manager has obtained a separate prohibited transaction exemption 
for the acquisition of such security. One commenter noted that, 
although some institutions have obtained individual exemptions to deal 
with issues relating to acquisitions and dispositions of the manager's 
own stock by its Index and Model-Driven Funds,\7\ others have concluded 
that no exemptive relief is necessary based on the facts and 
circumstances surrounding their individual situations. The commenter 
noted that, with regard to certain Index Funds, the manager does not 
exercise discretion in choosing the individual stocks to buy or sell, 
but rather seeks to mechanically purchase stocks selected through 
objective criteria which is outside of the manager's control. For 
example, in an Index Fund that is designed to replicate the exact 
capitalization-weighted composition of the Standard & Poor's 500 
Composite Stock Price Index (the S&P 500 Index), if the manager's stock 
is included in the index, that stock will be purchased in the 
proportion dictated by the index without the manager exercising any 
investment discretion. In such instances, the commenter stated that a 
manager's failure to acquire the stock would cause ``tracking error,'' 
thereby subverting the goal of plan investors in

[[Page 6620]]

the Fund to replicate the performance of the index. Other comments 
stated that it was not clear why a restriction for cross-trades of a 
manager's own stock is necessary and that there appears to be no reason 
to exclude such securities from the exemption. The Department accepts 
these comments and has determined to delete section II(h) of the 
proposal from the final exemption.
---------------------------------------------------------------------------

    \7\ For example, see Prohibited Transaction Exemption (PTE) 
2000-30, 65 FR 37166 (June 13, 2000), regarding Barclays Bank PLC 
and its Affiliates.
---------------------------------------------------------------------------

    However, the Department notes that the exemption does not provide 
relief for any discretionary changes in an Index or Model-Driven Fund 
made by a manager, or any other discretionary decisions by the manager, 
which are designed to result in cross-trades of the manager's own stock 
for the benefit of the manager. Only cross-trades generated by non-
discretionary changes in a Fund (e.g., changes in the capitalization 
weighting of the manager's stock within an index, or the addition or 
removal of the manager's stock from an index) are covered by this 
exemption. Accordingly, no relief is provided for such discretionary 
changes regarding the manager's own stock.
    As noted previously, all conditions in the final exemption have 
been re-designated to reflect the deletion of section II(h) of the 
proposal.
    8. Disclosure and Authorization Requirements. Many comments raised 
concerns about the scope of the disclosure and authorization 
requirements contained in section II(j), (k), (l) and (m) of the 
proposal. In this regard, the comments noted that section II(i) of the 
proposal expressly states that the written authorization requirement 
for a plan's participation in a manager's cross-trading program only 
applies to plans investing in an Index or Model-Driven Fund that holds 
``plan assets'' subject to the Act. The commenters urged the Department 
to clarify that the notice and disclosure requirements contained in 
section II(j), (k), (l) and (m) of the proposal similarly apply only to 
independent fiduciaries of employee benefit plans that invest in Funds 
holding plan assets.
    The Department acknowledges the commenters' concerns regarding the 
intended scope of the disclosure and authorization requirements of the 
proposal and wishes to clarify that such requirements were meant to 
apply only to those Index and Model-Driven Funds which hold ``plan 
assets,'' as defined under the Department's regulations (see 29 CFR 
2510.3-101). Therefore, the Department has revised section II(i) and 
(l) of the final exemption (formerly section II(j) and (m) of the 
proposal) accordingly.
    Other comments objected to the prior written authorization 
requirement contained in section II(i) of the proposal, noting that 
prior individual exemptions granted by the Department for cross-trades 
by Index and Model-Driven Funds did not contain a similar requirement. 
These comments expressed the view that requiring prior written consent 
from an independent plan fiduciary as a condition for the plan to 
invest in a Fund that is part of a manager's cross-trading program 
serves no useful purpose. The comments noted that if a plan fiduciary 
were to develop any objections to cross-trading on philosophical 
grounds, then the plan would be free to withdraw from the Fund without 
penalty. The commenters believed that imposition of such a requirement 
will be perceived negatively by plan sponsors as an unnecessary 
obstacle to their ability to freely invest and reinvest plan assets in 
a manager's Funds.
    The Department disagrees with the commenters' assertion that prior 
written consent from an independent plan fiduciary is unnecessary. The 
Department notes that part of the reason for proposing a class 
exemption for cross-trades of securities by Index and Model-Driven 
Funds was to address issues which had come to the Department's 
attention subsequent to its granting of a number of individual cross-
trading exemptions.
    As stated in the Notice published on March 20, 1998, the Department 
recognizes that it is important to retain the flexibility to 
periodically review its exemption policy in the context of changed 
circumstances or new facts that may be brought to its attention (see 63 
FR at 13698, first paragraph of section entitled ``Issues and 
Developments''). The Department became aware of new issues involving 
cross-trades, including cross-trades by certain ``passive'' investment 
managers, through enforcement proceedings that raised concerns about 
whether plan fiduciaries were being provided with adequate disclosures 
regarding a manager's cross-trading program.
    The Department continues to believe that adequate disclosures are 
necessary in order to enable a plan fiduciary to understand a manager's 
cross-trading program and how that program may affect the investment 
goals and objectives of Funds in which the plan may invest. The 
Department notes that the written authorization required by section 
II(i) of the proposal will apply to all of the Funds which participate 
in a manager's cross-trading program. Thus, once an authorization is 
provided by an independent fiduciary, a plan will be able to invest in 
any of the Funds without any additional authorization. The Department 
further notes that the authorizations required under the exemption for 
existing plan investors in any Funds may be obtained through a separate 
notice which describes the Funds' participation in the manager's cross-
trading program. Under this requirement, failure to return the 
termination form by the date specified in the notice will be deemed to 
be an approval by the independent plan fiduciary of the plan's 
participation in the cross-trading program. Therefore, the Department 
has determined not to revise the authorization requirements in the 
final exemption.
    With respect to the required content for the disclosures that must 
be furnished pursuant to sections II(l) and (m) of the proposal, the 
commenters were concerned that the initial and annual notices must 
identify all Index and Model-Driven Funds participating in the 
manager's cross-trading program, together with detailed information 
regarding the ``triggering events'' and other information relating to 
each Fund. The comments noted that requiring such disclosures would 
cause managers to violate confidentiality restrictions contained in 
many client agreements and would also raise privacy concerns for 
clients who do not wish their identity, or the fact that they maintain 
an investment account with the manager, to be disclosed. In this 
regard, the comments noted that managers are restricted from disclosing 
confidential information about clients, particularly the Funds in which 
clients invest. In addition, the comments stated that such detailed 
disclosure would be of little practical value to plan fiduciaries when 
deciding whether to authorize or maintain plan investments in a 
particular Fund. As an alternative, several comments suggested that the 
initial and annual notices should include only general descriptions of 
the types of Funds that participate in the manager's cross-trading 
program and of the ``triggering events'' that give rise to cross-trade 
opportunities.
    The Department acknowledges the concerns expressed by the 
commenters regarding the confidentiality restrictions contained in 
client agreements and privacy concerns relating to the identity of such 
clients and the Funds in which they may invest. Nevertheless, the 
Department continues to believe that the required disclosures will be 
useful to a plan fiduciary in understanding the scope and operation of 
the manager's cross-trading program and whether participation in the 
program remains in the plan's best interests. However, the Department 
does not intend for the disclosures in section II(k) of the

[[Page 6621]]

exemption (relating to a manager's ongoing disclosures of information 
about the cross-trading program) or section II(l) of the exemption 
(relating to disclosures for an annual re-authorization of the cross-
trading program by an independent plan fiduciary) to require that 
privileged or confidential information be revealed by the manager. For 
example, these provisions, as revised herein, do not require a manager 
to furnish to independent plan fiduciaries the identity of any clients 
of the manager that are invested in other Funds that are added to the 
cross-trading program. In addition, any information disclosed by the 
manager regarding new ``triggering events'' for existing Funds need 
only provide such information with respect to Funds in which the plans 
are invested. With respect to disclosures regarding new ``triggering 
events'' which must be provided to the relevant independent plan 
fiduciaries of the affected Funds (as discussed further below), the 
Department does not believe that the final exemption requires the 
disclosure of privileged or confidential information.
    Other commenters requested that the Department clarify that portion 
of section II(l) of the proposal which requires that the manager notify 
each relevant independent plan fiduciary of the addition of Funds to 
the manager's cross-trading program, or changes to, or additions of, 
``triggering events'' regarding Funds, following a plan's initial 
authorization of participation in the program. Specifically, the 
comments requested clarification as to whether the phrase ``each 
relevant independent plan fiduciary'' was intended by the Department to 
be limited to fiduciaries of plans invested in those specific Funds 
that are added to a manager's cross-trading program or whose 
``triggering events'' have been modified. The comments noted that it 
would be burdensome to require managers to notify all plans regarding 
modifications to ``triggering events'' that may occur in all Funds, 
including Funds in which such plans are not invested, just because such 
Funds participate in the cross-trading program. In addition, it would 
be difficult to provide notice to all plans prior to, or within 10 days 
following, such events affecting any of the Funds.
    In consideration of such comments, the Department has modified 
section II(k) of the final exemption (formerly section II(l) of the 
proposal) to provide that the ongoing notices of information that must 
be furnished to ``each relevant independent plan fiduciary'' are 
required to be made only to those fiduciaries whose plans are invested 
in the affected Funds (i.e., the Funds added to the program or whose 
``triggering events'' have been changed).
    Other commenters stated that certain of the disclosures are 
unnecessary. For example, several comments objected to the statement 
required by section II(k) of the proposal, relating to investment 
decisions for a Fund not being based on the availability of cross-trade 
opportunities. These comments noted that this statement would be 
duplicative of other information required in the proposal and would 
provide no added protection to plans, other than the manager's promise 
to follow the conditions of the exemption. Certain comments objected to 
the disclosures described in section II(l) of the proposal including 
the required statement that ``* * * the Manager will have a potentially 
conflicting division of loyalties and responsibilities to the parties 
to any cross-trade transaction * * *.'' In addition, section II(l) of 
the proposal required that the Manager explain how its cross-trading 
practices and procedures will mitigate such conflicts. According to the 
comments, following the terms of the exemption should be viewed as 
precisely what is necessary to mitigate the conflicts. Thus, the 
commenters believed that it will be misleading to inform client plans 
that the operation of a manager's cross-trading program, even with 
adherence to the terms of the proposed exemption, will still create 
conflicts.
    The Department believes that specific statements relating to the 
fact that investment decisions for a Fund will not be based on cross-
trade opportunities (as described in section II(k) of the proposal), 
and that there are potential conflicts of interest in such cross-trades 
(as described in section II(l) of the proposal), are important to an 
independent plan fiduciary's understanding of the issues involved with 
cross-trades of securities. The Department notes that, in any cross-
trading program, including cross-trading programs maintained by 
``passive'' investment managers, there would be a potential for abuse 
if a manager were able to control cross-trade opportunities to favor 
the interests of particular clients. Therefore, the Department has 
determined not to revise the exemption as requested.
    Section II(l) of the proposal requires that independent plan 
fiduciaries be furnished with detailed disclosure of the procedures to 
be implemented under the manager's cross-trading program (including the 
``triggering events'' that will create cross-trading opportunities, the 
independent pricing services that will be used by the manager to price 
the cross-traded securities, and the methods that will be used for 
determining closing price). The comments noted that the preamble to the 
proposal suggests with respect to foreign securities that the 
applicable independent pricing source should provide the price in local 
currency rates and, if that currency is other than U.S. dollars, also 
provide the U.S. dollar exchange rate (see first paragraph of Section 
IV.B. of the preamble, 64 FR at 70062). In this regard, the comments 
noted that most pricing services that price foreign securities do not 
provide currency conversion rates. These commenters suggested that 
managers be allowed to use another independent service to provide such 
conversion rates, so long as the service is disclosed to plan 
investors.
    The Department acknowledges the commenter's concerns, based on the 
language contained in the preamble to the proposal. However, the 
Department did not intend to prevent a manager from using another 
independent service to provide the appropriate currency exchange rates 
for a foreign security. Thus, the Department notes that no modification 
to section II(k) of the final exemption (formerly section II(l) of the 
proposal) is necessary.
    A number of the comments noted that Section II(m) of the proposal 
(relating to a plan's annual re-authorization of its participation in 
the manager's cross-trading program) appears to require, among other 
things, that each plan fiduciary be notified annually of: (i) Any 
change in the ``triggering events'' in the Funds in which their plans 
are invested; (ii) any change in the ``triggering events'' in the Funds 
in which their plans are not invested; and (iii) any ``triggering 
events'' and other disclosure items for new Funds added to the cross-
trading program since the last annual notice. These comments stated 
that the latter two categories of disclosures noted above are 
irrelevant to a plan fiduciary who has no assets invested in those 
Funds. The commenters believe that such information in the annual 
disclosures will make it more difficult for plans to properly analyze 
data which is relevant to an annual re-authorization of the plan's 
participation in the manager's cross-trading program. The comments 
suggested that annual disclosures to a plan fiduciary should be limited 
to that material which is relevant to its plan's investments in the 
manager's Funds. If a plan fiduciary determines to invest in other 
Funds for which no annual disclosure information has been previously 
provided, the fiduciary would then be provided with

[[Page 6622]]

the material relevant to the new Funds in such annual disclosures.\8\
---------------------------------------------------------------------------

    \8\ With respect to such annual disclosures, it should be noted 
that all relevant independent plan fiduciaries of plans invested in 
a Fund that is added to a manager's cross-trading program, or has 
changed or added any ``triggering events'' for cross-trades by such 
Fund after the Fund is included in the program, will already have 
been provided a separate notice of such event(s) prior to, or within 
ten (10) days following, each event, as required by section II(k) of 
the exemption.
---------------------------------------------------------------------------

    Upon consideration of these comments, the Department believes that 
some plan fiduciaries may still find information about other Funds to 
be useful and should be provided that information by the manager upon 
request. Therefore, in order to limit the scope of the annual 
disclosures required in section II(l) of the exemption (formerly 
section II(m) of the proposal), the Department has modified that 
section to read as follows:

    ``* * * Such annual re-authorization must provide information to 
the relevant independent plan fiduciary regarding each Fund in which 
the plan is invested as well as explicit notification that the plan 
fiduciary may upon request obtain disclosures regarding any new 
Funds in which the plan is not invested that are added to the cross-
trading program, or any new triggering events that may have been 
added to existing Funds in which the plan is not invested, since the 
time of the initial authorization * * * etc.'' [emphasis added]

    A commenter requested that the annual re-authorization requirement 
contained in section II(m) of the proposal be deleted in its entirety. 
The commenter stated that coordinating such a re-authorization would 
entail the same administrative burdens as a requirement for periodic 
notice of new Funds to all plan fiduciaries investing in Funds which 
participate in the manager's cross-trading program. According to the 
commenter, a plan could request that the plan's investment in any Fund 
that participates in the cross-trading program be terminated without 
penalty. Thus, the commenter maintained that a plan's participants and 
beneficiaries should be adequately protected without having to re-
authorize participation in the cross-trading program every year.
    In the event that the Department determined to retain the annual 
re-authorization requirement, the commenter requested two modifications 
to section II(m) of the proposal. First, the commenter believed that 
providing a plan fiduciary with a list of new Funds participating in 
the manager's cross-trading program would not provide the fiduciary 
with any useful information. Therefore, the commenter requested that 
the requirement in section II(m) of the proposal for disclosure 
regarding new Funds added to the manager's cross-trading program or any 
new triggering events be modified to permit the manager to make such 
information available upon request. Second, the commenter noted that 
section II(m) of the proposal requires the use of a ``special 
termination form'' in the annual re-authorization. The commenter noted 
that there are other methods of communication which would be easier and 
more efficient for a plan fiduciary to use in the event that the 
fiduciary decides to terminate its prior authorization.
    The Department has determined that it would not be appropriate to 
delete the requirement for plan fiduciaries of affected Funds to 
provide an annual re-authorization of their plan's participation in the 
manager's cross-trading program. The Department believes that annual 
re-authorization will help ensure effective monitoring of a cross-
trading program by the affected plans. Therefore, the Department has 
retained this requirement in section II(l) of the exemption.
    However, in response to the comments regarding the need for a 
special termination form to be sent to each plan fiduciary, the 
Department has modified section II(l) of the exemption (formerly 
section II(m) of the proposal) to permit other forms of written 
communication to be used to terminate an authorization. Thus, the 
following new sentence has been added to section II(l) of the final 
exemption:

    ``* * * In lieu of providing a special termination form, the 
notice may permit the independent plan fiduciary to utilize another 
written instrument by the specified date to terminate the plan's 
participation in the cross-trading program, provided that in such 
case the notice explicitly discloses that a termination form may be 
obtained from the Manager upon request.''

    In response to the comments regarding the requirement in the 
proposal for the annual disclosures to include a list of any new Funds 
participating in the manager's cross-trading program in which the plan 
is not invested, or any new triggering events for a manager's Funds in 
which the plan is not invested, the Department has previously noted 
above that section II(l) of the exemption has been modified to require 
that such information need only be provided by a manager upon request.
    9. Authorizations for Large Account Restructures. Under section 
II(n)(3) of the proposal, a portfolio restructuring program must be 
completed within the later of: (i) 30 days of the initial authorization 
by an independent fiduciary of the Large Account; or (ii) 30 days of 
the manager's initial receipt of assets associated with the portfolio 
restructuring, unless such fiduciary agrees to extend this period for 
another 30-days. The comments requested a number of revisions and 
clarifications to this provision. First, the commenters noted that most 
portfolio restructuring programs are completed within a thirty (30) day 
period. However, very large portfolio restructurings may take 
considerably longer. In such instances, the commenters believe that it 
would be more efficient to allow the manager to obtain authorization to 
extend the 30-day restructure period at the time of the Large Account 
fiduciary's initial authorization. Second, one commenter questioned 
whether securities that cannot be cross-traded with the manager's Funds 
and, therefore, must be traded on the open market, are affected by the 
30-day deadline. Third, another commenter suggested that the 30-day 
period should begin for each asset on the date on which the asset is 
included as part of the restructuring account. According to the 
comment, this change would be responsive to the fact that the manager 
or trading adviser for a Large Account may not receive all assets to be 
restructured at the same time.
    In response to these comments, the Department has determined to 
modify section II(m)(3) of the exemption (formerly section II(n)(3) of 
the proposal) to allow the initial authorization by an independent 
fiduciary of the Large Account for a specific portfolio restructuring 
to be effective for 60 days. The 60-day restructure period can be 
extended for another 30 days if the independent fiduciary for the Large 
Account agrees to the extension. In addition, the Department wishes to 
clarify that only securities that are cross-traded are affected by the 
requirements of section II(m) of the final exemption.
    Accordingly, the Department has revised section II(m)(3) of the 
exemption (formerly section II(n)(3) of the proposal) to provide that:

    ``* * *All cross-trades made in connection with the portfolio 
restructuring program must be completed by the Manager within sixty 
(60) days of the initial authorization * * *'' [emphasis added]

    In light of the Department's revision to section II(m)(3), the 
Department does not believe that any further relief is warranted.
    10. Record-keeping. Several comments expressed concerns regarding 
the record-keeping requirements contained in section III(a) of the 
proposal. In this regard, section III(a)(2)

[[Page 6623]]

requires, among other things, that each manager retain, on a Fund by 
Fund basis, trade lists which specify the amounts of each security to 
be purchased or sold for a Fund. This information should be provided in 
sufficient detail to allow an independent plan fiduciary to verify that 
each of the investment decisions for the Fund were made in response to 
specific triggering events. Section III(a)(3) of the proposal requires 
that, on a Fund by Fund basis, the manager must record the actual 
trades executed on a particular day, noting which of those trades 
(including all cross-trades) resulted from triggering events. The 
comments noted that the preamble to the proposal does not seem to 
require that the notations necessary to meet the requirements of 
section III(a)(3) specify which specific triggering event caused each 
trade (or cross-trade), provided that it is clear that a triggering 
event(s) caused such trades.
    Other commenters stated that the record-keeping requirements of 
section III(a) are unnecessary because, under the proposed exemption, 
an Index or Model-Driven Fund can only cross-trade as a result of a 
triggering event. In addition, these commenters suggested that such a 
record-keeping requirement would be extremely burdensome if it became 
necessary to ``tag'' each purchase or sale of a security to a specific 
triggering event. In such instances, the comments stated that the 
exemption would involve so much additional record-keeping and costs 
(i.e., millions of dollars worth per year per manager) that no manager 
will be able to economically maintain or operate a cross-trading 
program for its client accounts. Conversely, the comments noted that if 
the Department believes that ``tagging'' is not required under the 
proposal, this record-keeping requirement should be deleted since all 
cross-trades by a manager's Funds will result from at least one 
``triggering event'' in order to meet the conditions of the exemption. 
Other comments noted that records regarding specific triggering events 
should be retained only if the triggering event resulted in actual 
cross-trading.
    In response to these comments, the Department notes that other 
commenters have indicated that the record-keeping requirements 
contained in section III of the proposal are consistent with their 
current record-keeping practices. In this regard, the Department 
understands that under the individual exemptions granted for cross-
trades by Index and Model-Driven Funds, managers have established 
record-keeping and monitoring systems designed to ensure compliance 
with the terms and conditions of those exemptions.
    The Department notes that the record-keeping requirements contained 
in the proposal, while more specific than those of the individual 
exemptions, were designed to be consistent with the record-keeping 
systems of managers operating cross-trading programs under the 
individual exemptions. Thus, the Department is not persuaded by the 
arguments submitted in favor of deletion of this record-keeping 
requirement. The Department continues to believe that records must be 
maintained with sufficient specificity to permit an independent plan 
fiduciary to verify compliance with the conditions of the exemption.
    In response to the commenter's request for clarification as to 
whether the record-keeping requirements contained in section III(a) of 
the proposal would mandate that a manager's records demonstrate that 
each cross-trade by a Fund resulted from a specific ``triggering 
event,'' the Department believes that the following discussion will be 
helpful.
    When more than one bona fide ``triggering event'' has occurred, the 
Department expects that a manager's record-keeping system will be able 
to demonstrate that the cross-trades by the Fund resulted from such 
``triggering events.'' For example, if a manager's record-keeping 
system enables the manager to ``link'' purchases and sales of specific 
amounts of securities in each cross-trade by a Fund to ``triggering 
events'' within the 3-day period, then such a system would satisfy the 
record-keeping requirements of the exemption.
    As discussed by the Department in the preamble to the proposal, the 
record-keeping requirements are intended to assure that independent 
plan fiduciaries will be able to determine whether Funds and their 
underlying models or indexes operate consistently in following the 
input of triggering event information. This information should be kept 
in sufficient detail to enable a replication of specific historical 
events in order to satisfy an inquiry by interested persons (as 
described in section III(b)(1) of the exemption). The Department 
further notes that records regarding specific triggering events need 
only be maintained if such events resulted in cross-trades that are 
subject to the conditions of this exemption.
    Another comment noted that section III(a) of the proposal requires 
that the records must be ``* * * readily available to assure 
accessibility and maintained so that an independent fiduciary'' may 
obtain them within a reasonable period of time. The comment noted that 
most of the required records would be maintained electronically and 
archived after a few months. The commenter maintained that, while such 
records are retrievable within a period of days or weeks, the exemption 
should recognize that the volume of trading and records involved would 
make faster retrieval impossible. Another comment requested that the 
Department acknowledge that a ``reasonable period of time'' in this 
context would be thirty (30) days. In this regard, the Department 
acknowledges that thirty (30) days may be a reasonable period of time 
for obtaining and assembling the required information for interested 
persons if the volume and complexity of the cross-trading records that 
must be assembled for such persons is significant.
    Other comments noted that making records available to plan 
participants and beneficiaries would be unduly burdensome and would add 
no significant additional protections.
    The Department has determined that it would be appropriate to 
modify section III(b)(1) to exclude plan participants and beneficiaries 
unless such persons are participants or beneficiaries in a Manager 
Plan.
    11. Definition of ``Index Fund'' and ``Model-Driven Fund.'' Several 
comments noted that, unlike prior individual exemptions for cross-
trading, the definition of the term ``Index Fund'' in the proposal (see 
section IV(a) below) requires not only that a Fund be designed to track 
the rate of return, risk profile and other characteristics of an 
independently maintained securities index, but also that such tracking 
occur either by ``* * * replicating the same combination of securities 
which compose such index'' or by ``* * * sampling the securities which 
compose such index based on objective criteria and data.'' The 
commenters urged the Department to clarify that this definition was not 
intended to preclude an Index Fund from holding cash, cash equivalents 
or other equitizing cash investments.
    The Department concurs with this comment. The definition of the 
term ``Index Fund'' under section IV(a) of the exemption is not 
intended to prevent a Fund from holding cash, cash equivalents or other 
equitizing cash investments. For example, the Department notes that the 
definition of ``triggering event'' contained in section IV(d)(3) of the 
exemption specifically contemplates that a Fund may have an 
accumulation of cash which is attributable to interest or dividends on,

[[Page 6624]]

and/or tender offers for, portfolio securities.
    In this regard, the Department recognizes that significant levels 
of cash or cash equivalents in an Index Fund generally will create 
``tracking error'' vis-a-vis the independently maintained securities 
index which the Fund is designed to track. Therefore, assets other than 
securities which are included in the designated index will only be held 
by a Fund for a limited period of time.
    However, the Department also understands that many managers use 
temporary cash investments to buy index futures contracts (e.g., S&P 
500 futures) in order to more precisely replicate the rate of return 
and other characteristics of the index prior to investing in the actual 
securities. It is the view of the Department that the term ``Index 
Fund'' would allow the use of futures contracts by an Index Fund in 
order to reduce ``tracking error'' and to achieve the designated 
investment objectives of the Fund provided that such use is disclosed 
to plan investors. The disclosures should adequately describe the 
appropriate parameters and limitations on a manager's use of futures 
contracts for a Fund.
    In this regard, the Department's conclusion is based upon its 
understanding that ``passive'' investment strategies employed by 
managers for Index Funds do not primarily rely on futures contracts to 
achieve a Fund's investment objectives, but rather rely on such 
contracts as a means for temporarily investing cash accumulations in 
the Fund prior to actually investing in and holding securities 
contained in the index. Conversely, the Department is unable to 
conclude that an Index Fund which invests primarily in index futures 
contracts as a means of achieving its investment objectives would meet 
the definition of ``Index Fund'' under section IV(a) of this exemption.
    Several comments noted that the definition of the term ``Model-
Driven Fund'' under the proposal (see section IV(b) below) requires 
that the identity and amount of a Fund's securities be ``* * * selected 
by a computer model that is based on prescribed objective criteria 
using independent third party data, not within the control of the 
Manager * * *'' These comments expressed concern that the definition 
does not appear to include separately managed Index Fund portfolios 
that exclude specific securities based on independent plan sponsor 
direction (as opposed to the determination of a computer model). In 
this regard, the comments noted that the Department has recognized in 
the past that the composition of a Model-Driven Fund may be influenced 
by client-initiated instructions to delete certain securities (e.g., 
tobacco stocks) from an index that is otherwise being tracked. The 
comments suggested that the definition should be modified to include 
plan sponsor direction. According to the comments, this modification 
will not affect the intended purpose of the definition, which is to 
limit the amount of discretion a manager may exercise to affect the 
identity or amount of securities to be purchased or sold and to assure 
that such transactions are not part of an arrangement to benefit the 
manager.
    In response to these comments, the Department notes that the 
definition of ``Model-Driven Fund'' in section IV(b)(1) of the 
exemption would include separately managed Fund portfolios which 
exclude specific securities based upon an independent plan fiduciary's 
(e.g., a plan sponsor's) direction. The Department understands that 
managers will often use computer models which are designed to 
``screen'' certain securities that are listed in an index from the 
acquisitions that a Fund would otherwise make, in order to accommodate 
plan sponsor direction. The definition of ``Model-Driven Fund,'' by 
allowing the identity of the securities which compose the Fund to be 
selected by a computer model, can accommodate Fund portfolios which are 
specifically designed to meet the guidelines dictated by plan sponsors. 
Thus, the Department does not believe that any further modification to 
this definition is necessary.
    Another commenter noted that the definition of ``Model-Driven 
Fund'' in section IV(b) of the proposal is limited to Funds which use a 
computer model to ``transform an Index.'' The commenter stated that 
many Model-Driven Funds do not seek merely to ``transform an index'' by 
limiting their investment universe to those securities contained in a 
single Index, but rather seek to apply quantitative techniques using 
various forms of publicly available data across a wide spectrum of 
securities. For example, the Fund may seek to design a portfolio based 
on the largest 2500 stocks in the United States, based on market 
capitalization. These stocks may be contained in various independently 
maintained indexes, but not all 2500 stocks will be contained in a 
single index. The commenter urged the Department to delete the phrase 
``* * * to transform an Index'' from section IV(b)(1) of the proposal 
and to substitute in its place the following ``* * * to achieve an 
investment return that is either based upon or measured by an Index.''
    The Department does not believe that it would be appropriate in the 
context of a passive cross-trading exemption to permit managers to use 
indexes merely as a benchmark for the performance of a portfolio of a 
Model-Driven Fund. Accordingly, the Department has determined not to 
revise this definition.
    Another comment related to both the definitions of ``Index Fund'' 
and ``Model-Driven Fund.'' The commenter noted that sections IV(a)(3) 
and IV(b)(2) of the proposal provide that each definition includes any 
investment fund, account or portfolio which either contains ``plan 
assets,'' is an investment company registered under the Investment 
Company Act of 1940, ``* * * or is an institutional investor.'' The 
comment noted that many index and model-driven funds are structured as 
common trust funds, limited liability companies, New Hampshire trusts 
or other forms of collective investment vehicles. Many of these funds 
do not contain ``plan assets'' subject to the Act, but are managed in 
the exact same manner as Funds that do contain ``plan assets.'' The 
commenter is concerned that the definitions of ``Index Fund'' and 
``Model-Driven Fund'' will not include such funds unless the phrase ``* 
* * or is an institutional investor'' contained in sections IV(a)(3) 
and IV(b)(2) is modified to provide ``* * * or contains assets of one 
or more institutional investors.''
    The Department concurs with the commenter's suggestion and, 
accordingly, has modified sections IV(a)(3) and IV(b)(2) of the final 
exemption.
    12. Definition of ``Triggering Event.'' Section IV(d) of the 
proposal defines the term ``triggering event'' by listing four specific 
``events'' that are included within the definition. In this regard, the 
comments noted that the preamble to the proposal states that if a 
computer model used to create a portfolio for a Model-Driven Fund is 
designed to exclude particular securities for reasons specified by a 
plan client or the plan's investment guidelines, such exclusions would 
not be considered a separate triggering event. However, the comments 
noted that some of the Department's prior individual exemptions for 
cross-trading included, as a separate triggering event, the following:

    ``* * * a change in the composition or weighting of a portfolio 
used for a Model-Driven Fund which results from an independent 
fiduciary's decision to exclude certain stocks or types of stocks 
from the

[[Page 6625]]

Fund even though such stocks are part of the index used by the 
Fund.''\9\
---------------------------------------------------------------------------

    \9\ See, for example, condition (c)(2) of PTE 94-36 (59 FR 
19249, April 22, 1994) regarding The Northern Trust Company.
---------------------------------------------------------------------------

    The commenters requested that the Department modify the 
definition of ``triggering event'' to include a similar provision 
under the final exemption.
    In response to the comments, the Department has added a fifth 
``triggering event'' to section IV(d) of the exemption to 
incorporate the suggestion made by the commenters. Thus, section 
IV(d)(5) of the exemption includes within the definition of the term 
``triggering event'' purchases and sales of securities made by Funds 
after changes to the portfolio of an Index or Model-Driven Fund 
solely as a result of an independent fiduciary's decision to exclude 
certain securities from the Fund.
    In this regard, the Department notes that with respect to a 
Model-Driven Fund, if the exclusion of certain securities is ``built 
into'' the original design of the model, the operation of that model 
by the manager should not create additional cross-trade 
opportunities for the Fund, since the Fund was not designed to buy 
the specific securities which are excluded. Similarly, if an 
``excluded security'' is added to an index which has been used by 
the model to create a portfolio for a Model-Driven Fund, the model 
should have been already programed to ``screen'' such securities 
from the acquisitions made by the Fund. Moreover, the additional 
triggering event would not apply with respect to any Index Fund or 
Model-Driven Fund that is a collective investment fund maintained by 
the manager, if the decision to exclude certain securities from the 
Fund's portfolio was made by the manager.
    Lastly, the Department notes that the ``triggering event'' 
contained in section IV(d) would be effective on the date that the 
independent fiduciary directed the manager to exclude the securities 
from the Index or Model-Driven Fund, and, accordingly, the cross-
trades of such securities would have to occur within three (3) 
business days, pursuant to the requirements of section II(b) of the 
exemption.
    Another comment suggested a further modification to the 
definition of ``triggering event'' in the proposal. The commenter 
objected to the requirement in section IV(d)(2) of the proposal that 
a triggering event include a ``specific amount'' of net change in 
the overall level of assets in a Fund, as a result of investments 
and withdrawals, and the requirement in section IV(d)(3) of a 
``specified amount'' of accumulated cash or stock in a Fund. The 
commenter suggested that the references to ``specific amount'' and 
``specified amount'' be changed to ``material amount'' in both 
section IV(d)(2) and (3). In connection with this modification, the 
commenter also requested that a manager be allowed to either (i) 
identify such material amount in advance as a specified amount of 
net change (or accumulated cash or securities) relating to such 
Fund, or (ii) disclose, in the description of the manager's cross-
trading practices, pursuant to section II(l) of the proposal, the 
parameters for determining a material amount of net change (or 
accumulated cash or stock), including any amount of discretion 
retained by the manager that may affect such net change (or 
accumulated cash or securities), in sufficient detail to allow the 
independent fiduciary to determine whether the authorization to 
engage in cross-trading should be given.
    The Department has considered the commenter's suggestions for 
changes to the definition of ``triggering event,'' as contained in 
section IV(d)(2) and (3) of the proposal, and has determined that it 
would be appropriate to modify the final exemption. Thus, section 
IV(d)(2) and (3) of the exemption now reads as follows:

    ``(d) Triggering Event:
    (2) A material amount of net change in the overall level of 
assets in a Fund, as a result of investments in and withdrawals from 
the Fund, provided that: (A) such material amount has either been 
identified in advance as a specified amount of net change relating 
to such Fund and disclosed in writing as a ``triggering event'' to 
an independent fiduciary of each plan having assets held in the Fund 
prior to, or within ten (10) days following, its inclusion as a 
``triggering event'' for such Fund, or the Manager has otherwise 
disclosed in the description of its cross-trading practices pursuant 
to section II(k) the parameters for determining a material amount of 
net change, including any amount of discretion retained by the 
Manager that may affect such net change, in sufficient detail to 
allow the independent fiduciary to determine whether the 
authorization to engage in cross-trading should be given; and * * 
*.'' [emphasis added]
    (3) An accumulation in the Fund of a material amount of either:
    (A) cash which is attributable to interest or dividends on, and/
or tender offers for, portfolio securities; or
    (B) stock attributable to dividends on portfolio securities; 
provided that such material amount has either been identified in 
advance as a specified amount relating to such Fund and disclosed in 
writing as a ``triggering event'' to an independent fiduciary of 
each plan having assets held in the Fund prior to, or within ten 
(10) days after, its inclusion as a ``triggering event'' for such 
Fund, or the Manager has otherwise disclosed in the description of 
its cross-trading practices pursuant to section II(k) the parameters 
for determining a material amount of accumulated cash or securities, 
including any amount of discretion retained by the Manager that may 
affect such accumulated amount, in sufficient detail to allow the 
independent fiduciary to determine whether the authorization to 
engage in cross-trading should be given * * * '' [emphasis added]

    In connection with the modification noted above, the Department 
cautions managers that any parameters established for determining a 
material amount of net change (or accumulated cash or securities), and 
any discretion retained by the manager which may affect such amounts, 
must be sufficiently limited and described in enough detail to enable 
proper identification and monitoring of such triggering events by plan 
fiduciaries.
    Further, with respect to the ``triggering events'' that must be 
disclosed to client plans, certain comments noted that section 
III(b)(2) of the proposal permits a manager, under certain 
circumstances, to refuse to disclose to clients any trade secrets, or 
commercial or financial information that is privileged or confidential, 
where such information is contained in the manager's record-keeping 
system. However, these comments noted that the proposal does not 
include a similar protection for privileged or confidential information 
included within the mandated client disclosures for triggering events. 
For example, the triggering event contained in section IV(d)(4) of the 
proposal (i.e., a change in the model-prescribed portfolio solely by 
operation of the formulae contained in the computer model underlying 
the Fund) can only be utilized if certain disclosures are made to an 
independent fiduciary of each of the plans participating in the Model-
Driven Fund. The comments stated that certain of these disclosures may 
involve highly proprietary information that the investment manager is 
reluctant to disclose to clients, particularly through a written 
communication that a client could easily transmit to others. Thus, the 
comments requested that the Department allow a manager to refuse to 
disclose trade secrets, or commercial or financial information that is 
privileged or confidential, so long as the manager notes the reason for 
non-disclosure in its general disclosure to clients.
    In this regard, the Department does not believe that the disclosure 
of basic factors for making changes in a portfolio for a Model-Driven 
Fund would require that privileged or confidential information be 
revealed by the manager to independent plan fiduciaries. Therefore, the 
Department has not modified the language of section IV(d)(4) in the 
final exemption.
    13. Definition of ``Large Account.'' One comment noted that section 
IV(e) of the proposal excludes from the definition of ``Large Account'' 
any ``

[[Page 6626]]

* * * Index Fund or Model-Driven Fund sponsored, maintained, trusteed 
or managed by the Manager * * *'' [emphasis added] The commenter noted 
that some banks act as a directed trustee for group trusts which are 
managed by third party investment managers. In these situations, the 
bank acts as a non-discretionary trustee and its primary role is to 
provide custody and record-keeping services for the group trust. The 
commenter stated that there is no reason that an independent investment 
manager should be precluded from retaining the bank as a trading 
adviser for the liquidation or restructuring of the Large Account 
since, in its capacity as a non-discretionary trustee, the bank will 
not be making the underlying investment decisions for the portfolio 
restructuring of the Large Account. Therefore, the commenter requested 
that the word ``trusteed'' be deleted from the definition of ``Large 
Account'' in section IV(e) of the proposal.
    In this regard, the Department does not believe that it would be 
appropriate to include all investment funds trusteed by the manager in 
the definition of ``Large Account'' contained in the exemption. 
However, the Department has determined it would be appropriate to 
modify the language of section IV(e) of the final exemption to include 
an Index Fund or a Model-Driven Fund for which the manager is a 
nondiscretionary trustee. Consequently, the Department has added a 
definition of the term ``nondiscretionary trustee'' to the exemption 
under section IV(m).
    Other comments suggested that the definition of ``Large Account'' 
in section IV(e) of the proposal should be modified by deleting 
entirely the phrase which provides that a Large Account `` * * * is not 
an Index Fund or a Model-Driven Fund sponsored, maintained, trusteed or 
managed by the Manager.'' These comments stated that, if the decision 
to liquidate a Fund's portfolio is made by an independent plan 
fiduciary, and such decision is entirely out of the manager's control, 
it should not matter whether the portfolio is an Index or Model-Driven 
Fund that is managed by the manager.
    In response to these comments, the Department has determined that 
it would not be appropriate to make the requested modification to the 
definition of the term ``Large Account'' in section IV(e) of the 
exemption. The Department continues to believe that cross-trades by a 
manager's Index and Model-Driven Funds should be subject to the 
requirements and limitations applicable to Funds under the exemption, 
such as specified ``triggering events'' for cross-trade opportunities.
    Another comment noted that section IV(e) of the proposal defines a 
``Large Account'' as any investment fund, account or portfolio that, 
among other things, holds assets of a registered investment company 
other than an investment company advised or sponsored by the manager. 
The commenter believes that the limitation excluding investment 
companies advised or sponsored by the manager should be deleted. The 
commenter argued that the Large Account would not be participating in 
the manager's cross-trading program unless it were advised by the 
manager, and that the definition in the proposal excludes the very 
category of investment companies for which relief was intended.
    The Department notes that the commenter's argument that a Large 
Account could be, and most likely would be, a registered investment 
company advised or sponsored by the manager is not consistent with the 
record upon which the exemption was developed by the Department. In 
this regard, the category of investment companies for which relief was 
intended under this exemption, as well as under prior individual 
exemptions, were those entities that are independent of the manager 
operating the cross-trading program, but who decide to hire the manager 
in order to carry out a specific portfolio restructuring program. In 
such instances, the restructured portfolio will often become an ``Index 
Fund'' or ``Model-Driven Fund'' (as defined herein) that will be 
managed by the manager.
    However, the situation described by the commenter, which would 
permit the inclusion within a manager's cross-trading program for Large 
Accounts of ``actively-managed'' investment company portfolios advised 
by the manager, would expand the scope of the exemption beyond that 
intended by the Department. As discussed further below, the Department 
is not providing relief at this time for cross-trading programs 
involving ``actively-managed'' accounts or funds. Therefore, in 
response to this comment, the Department has determined not to modify 
section IV(e)(3) of the final exemption.
    Other comments noted that the definition of ``Large Account'' in 
section IV(e) of the proposal requires that the plan or institutional 
investor whose assets are held by the Large Account have $50 million or 
more in total assets. The commenter suggested that the definition be 
revised to permit assets of affiliated plans maintained by the same 
employer, or controlled group of employers, to be aggregated for 
purposes of meeting the $50 million threshold.
    In consideration of the commenter's suggestion, the Department has 
modified the definition of ``Large Account'' in section IV(e)(1) of the 
exemption to permit the aggregation of assets of employee benefit plans 
maintained by the same employer, or controlled group of employers, 
provided that such assets are pooled for investment purposes in a 
single master trust.
    14. Definition of ``Portfolio Restructuring Program.'' Several 
comments noted that the term ``portfolio restructuring program'' is 
defined in section IV(f) of the proposal to include the buying and 
selling of securities on behalf of a Large Account in order to produce 
a portfolio of securities which will be an Index Fund or a Model-Driven 
Fund ``managed by the Manager * * *'' In this regard, the comments 
noted that portfolio restructuring assignments occasionally contemplate 
that a manager will construct an Index Fund or Model-Driven Fund 
portfolio or some other type of portfolio which, once formed, will be 
managed on an ongoing basis by either the plan sponsor or an 
independent third party manager. In addition, the comments stated that 
since the terms ``Index Fund'' and ``Model-Driven Fund'' are already 
defined in the proposal, the phrase ``* * * managed by the Manager'' in 
the definition of ``portfolio restructuring program'' is unnecessary. 
Accordingly, the commenters suggested that the phrase ``managed by the 
Manager'' be deleted from the definition in section IV(f) of the final 
exemption.
    In response to the comments, the Department has modified the 
definition of the term ``portfolio restructuring program'' in section 
IV(f) of the exemption to reads as follows:

    ``(f) Portfolio restructuring program--Buying and selling the 
securities on behalf of a Large Account in order to produce a 
portfolio of securities which will be an Index Fund or a Model-
Driven Fund managed by the Manager or by another investment manager, 
or in order to produce a portfolio of securities the composition of 
which is designated by a party independent of the Manager, without 
regard to the requirements of * * * etc.'' [emphasis added]

    15. Volume Restrictions for Cross-Traded Securities. A number of 
commenters responded to the Department's request for information on 
whether Index and Model-Driven Funds may hold a significant amount of 
the outstanding shares of a particular security, whether cross-trades 
of securities by a manager's Funds may represent a high percentage of 
the

[[Page 6627]]

outstanding daily trading volume for such securities, and whether some 
volume limitation for cross-traded securities would be appropriate. The 
commenters expressed the view that, even if a manager's Funds were 
cross-trading securities representing a high percentage of the average 
daily trading volume, there is no reason to impose a volume limitation 
in the exemption so long as the purchase or sale of such securities is 
mandated by a triggering event of an Index or Model-Driven Fund and the 
securities can be crossed at the closing market price, as established 
through an independent pricing source. These comments noted that such 
cross-trades are beneficial to plans regardless of whether the 
securities involved are thinly-traded, whether the Index and Model-
Driven Funds hold significant amounts of the outstanding shares of the 
securities, or whether the manager's trading represents a high 
percentage of the trading volume for the securities. The commenters 
again noted the significant savings which are incurred by avoiding 
brokerage commissions and bid-ask spreads.
    Thus, most commenters expressed the view that if a manager's Index 
and Model-Driven Funds have a bona fide need to buy or sell specific 
amounts of securities on any particular business day, in response to 
various triggering events, there should not be an arbitrary percentage 
limitation that would inhibit the manager from taking advantage of all 
cross-trade opportunities for such securities. However, another 
commenter expressed the view that the Department's exclusion of 
``thinly-traded'' equity securities (by requiring in section II(f)(1) 
of the proposal that all cross-traded equity securities must be 
``widely-held'' and ``actively-traded'') is unduly burdensome and 
unnecessary. As an alternative, this commenter recommended that the 
Department include ``thinly-traded'' equity securities, but impose some 
reasonable limitation on cross-trades of such securities, based on a 
comparison of the size of the cross-trade to the prior trading volume 
in the security over a reasonable period of time prior to the date of 
the transaction.
    After considering the comments regarding the inclusion of ``thinly-
traded'' equity securities in the exemption if an appropriate volume 
limitation is imposed, the Department has determined not to adopt this 
approach. The Department's decision is based, in part, on its 
understanding that, since a process-driven cross-trading program must 
allocate cross-trade opportunities in a mechanical fashion, it would 
not be economically feasible to override such allocations whenever the 
equity securities involved exceeded a specified volume limitation. 
Therefore, the Department continues to believe that it is more 
appropriate to allow cross-trades of all equity securities that are 
listed in an independently maintained third party index (see definition 
of ``Index'' in section IV(c) of the exemption), without any volume 
limitations. Under the exemption, the Department deemed all equity 
securities listed in an index to be ``widely-held'' and ``actively-
traded'' for purposes of this exemption in order to allow the largest 
possible universe of equity securities to be cross-traded within the 
parameters of the conditions of the exemption. In the Department's 
view, the inclusion of ``thinly-traded'' equity securities that are not 
listed in an index would require additional safeguards, such as volume 
information and limitations, which may not be economically feasible in 
connection with the operation of a manager's cross-trading program.
    16. Avoidance of Adverse Market Impact; Savings in Transaction 
Costs; A Computer Model's Consideration of Liquidity. In response to 
specific questions posed by the Department in the preamble to the 
proposal on the avoidance of market impact through cross-trades (see 
Section IV.B. of the preamble, 64 FR at 70063), several commenters 
noted that, by cross-trading at the close of market price, both sides 
of the cross-trade benefit by avoiding the potential for adverse market 
impact. The comments stated that adverse market impact occurs each time 
an investor trades through the market as the market price moves away 
from the offered price, meaning that the price decreases when the 
investor wants to sell and increases when the investor wants to buy.
    One commenter stated that the Department appears to have concerns 
about the fact that a manager's avoidance of market impact may not be 
beneficial to plans at certain times. These concerns originate from the 
assumption that a manager could benefit certain plans by using a 
particular trade's market impact as an opportunity for obtaining a 
better price for a security on the open market. In this regard, the 
commenter noted that market impact is unpredictable and cannot be 
forecast by the manager. The commenter stated that managers believe 
that in most cases market impact is to be avoided, if possible. Thus, 
the commenter expressed the view that cross-trading, by avoiding the 
uncertainty of market impact, enables a manager to avoid the 
possibility of harm to certain clients which would result if trades 
were placed on the open market, and also eliminate transaction costs 
and custody costs.
    Most commenters noted that a ``passive'' manager would have no 
incentive to use the limited amount of discretion allowed by its cross-
trading program to favor one Fund or Account over another. One 
commenter stated that each manager would have the same trading goals 
for all Funds and Large Accounts--i.e., to maximize cross-trading and 
to minimize transaction costs for open market transactions.
    Another commenter noted that Index and Model-Driven Funds are often 
buying and selling the same securities because there are many different 
Funds maintained by a manager that are tracking the same index (e.g., 
the S&P 500 Index). Many managers also design portfolios for Model-
Driven Funds that are based on the same index. Moreover, many large 
capitalization stocks are listed in more than one index. The commenters 
noted that cross-trades of such stocks between Index and Model-Driven 
Funds, pursuant to triggering events that occur without a manager's 
exercise of any investment discretion, at an objectively determined 
``closing price'' as reported from a reputable third party source, are 
an efficient and effective way of meeting the investment objectives of 
plans which invest in such Funds.
    In response, the Department recognizes the merits of cross-trading 
to reduce or eliminate transaction costs in the context of ``passively 
managed'' assets. In such instances, a manager has limited investment 
discretion as a result of independently determined triggering events.
    With respect to the Department's concerns that the avoidance of 
market impact through cross-trades may not equally benefit both sides 
of such transactions, the Department notes that the potential for abuse 
appears to be significantly less with ``passively-managed'' assets than 
with ``actively-managed'' assets. However, the Department does not 
believe that the commenters have demonstrated that cross-trading 
creates market impact savings, if any, for both sides to any given 
cross-trade. The Department has been provided with data by one 
commenter demonstrating some market impact savings for one side in 
cross-trades of significant amounts of securities (i.e. market impact 
savings were measured where the cross-trades involved a large 
capitalization security traded in amounts averaging one and a quarter 
days of the average public trading volume of the security). No data

[[Page 6628]]

was provided to the Department measuring market impact savings for 
smaller cross-trades, nor was data provided measuring the market impact 
savings, if any, for each side in a particular cross-trade. Even so, as 
noted below, certain commenters have concluded that there has been 
significant transaction cost savings with cross-trading ``passively-
managed'' assets and that these savings are attributable solely to the 
reduction or elimination of brokerage commissions and bid-ask spreads.
    Another commenter noted that the preamble to the proposal suggests 
that relief would not be available under the exemption if the computer 
model used for a Fund considered the liquidity or availability of 
securities that are in the cross-trading ``network'' of Funds managed 
by the manager (see the sixth paragraph of Section IV.A. of the 
preamble, 64 FR at 70062). This commenter expressed the view that such 
a restriction is harmful to plans and misapprehends the operation of 
some ``passively-managed'' Funds. The commenter stated that truly 
``passive'' Index Funds track the relevant indices and attempt to 
reduce or eliminate ``tracking error'' between the value of the Fund's 
portfolio vis-a-vis the value of the index's portfolio. The more 
identical an Index Fund's portfolio looks when compared to the 
underlying index's portfolio, and the cheaper the acquisition and 
disposition costs of the securities in the index, the lower the 
``tracking error'' becomes. Thus, a successful ``passive'' manager is 
one who has the least amount of tracking error in its Index Funds. The 
commenter noted that the model used for such an Index Fund will always 
start with the proposition that the portfolio wants each security in 
the index in its precise capitalization-weighting, as determined by the 
index. The more information the model has about the costs of 
acquisition of any security, the less the tracking error will be for 
the Fund's portfolio and the more successful the manager will be in 
meeting the plan's investment objectives.
    The Department's concerns regarding a computer model's 
consideration of liquidity or availability of certain securities that 
are in the manager's cross-trading ``network'' are best illustrated by 
the following example:

    A computer model for a Model-Driven Fund identifies three 
possible securities for acquisition by the Fund in an attempt to 
achieve the optimal portfolio for the Fund within the specified 
guidelines dictated by the Fund's investors. These securities are 
identified, for purposes of this example, as ``A'', ``B'', and 
``C''. Security ``A'' is the most liquid of the three securities, 
based on third party data, and security ``C'' is the least liquid. 
The model considers each security's liquidity factor, among other 
factors, and the estimated transaction costs which would be incurred 
to acquire the security, as part of its determination as to which 
security to buy and how much of the security to buy.
    Assume that the model is programmed to make the selection of 
which security to buy, and the amount to buy, by considering only 
the liquidity information about each security that is available 
based on third party market data. Let's also assume that, based on 
such data, the model chooses security ``A'' and does not choose 
securities ``B'' or ``C''. The exemption would apply for acquisition 
of security ``A'' to be made by the Fund through cross-trades.
    However, let's assume that the model is programmed to make the 
selection of which security to buy, and the amount to buy, by 
considering cross-trade opportunities that are available for each 
security, in addition to other liquidity information that is 
available based on third party data. Let's also assume that security 
``C'' is available through a cross-trade and that the Fund can 
acquire all the securities it needs through cross-trades of that 
security. The model has been programmed to ``view'' security ``C'' 
as having ``infinite liquidity'' because the data within the control 
of the manager suggests that it can be acquired without incurring 
any transaction costs. However, this circumstance results from the 
fact that the necessary number of shares of security ``C'' which the 
model has determined that the Fund needs is available through cross-
trades. Under this example, security ``C'' is considerably less 
liquid than security ``A'' based upon available third party data. 
The exemption would not apply for acquisitions of security ``C'' to 
be made by the Fund through cross-trades because the selection of 
security ``C'' was based upon the manager's own liquidity 
information at that time and not liquidity information based solely 
on third party data.

    The Department believes that adoption of the commenter's liquidity 
approach could result in cross-trading opportunities within the control 
of the manager impacting upon the investment determinations of the 
Fund. In this regard, the Department notes that investment decisions 
made by a Fund may not be based in whole or in part by the manager on 
the availability of cross-trade opportunities and must be made prior to 
the identification and determination of any cross-trade opportunities, 
pursuant to the statement required under section II(j) of the 
exemption. Therefore, any model's consideration of information relating 
to cross-trade opportunities for particular securities, as part of the 
model's determination of which securities to buy or sell, how much of a 
security to buy or sell, or when to execute a sale or purchase of the 
securities for the Fund, would not be permitted under the exemption. 
The Department continues to believe that liquidity considerations and 
other factors considered by a computer model must be based on 
independent third party data, not within the control of the manager, as 
described under section IV(b) of the exemption.
    Other commenters noted that the transaction cost savings 
attributable to cross-trades, pursuant to cross-trading programs 
operating under the Department's existing individual exemptions, are 
significant. In response to the Department's questions about whether 
such cost savings are attributable to the avoidance of market impact or 
only commission savings, one commenter stated that its clients have 
saved over $300 million annually through cross-trading and that this 
calculation is based entirely on the avoidance of brokerage commissions 
and bid-ask spreads. Another commenter stated that its clients saved 
approximately $282 million in the calendar year 1999, based on the 
total number of shares that were cross-traded during the year, broken 
down by the market in which each share would have been traded if it 
went to the open market. This commenter also confirmed that these 
savings are attributable to savings in brokerage commissions, bid-ask 
spreads and taxes, as applicable in each market. Thus, in both 
instances, the commenters noted significant cost savings even without 
taking into consideration whatever measurable ``savings'' may have been 
attributable to the avoidance of market impact.
    17. Effect of Class Exemption on Individual Exemptions; Appropriate 
Scope of Relief for the Exemption. The commenters expressed many 
different points of view in response to the Department's invitation for 
comments on the effect that the continuation of current individual 
exemptions, for cross-trades by Index and Model-Driven Funds, would 
have in offering an advantage to those investment managers granted such 
relief compared to those managers which would utilize this exemption 
(see Section IV.H. of the preamble to the proposal, 64 FR at 70066).
    One comment noted that the proposal would expand the relief for 
cross-trading beyond the relief currently available under the 
individual exemptions, particularly by permitting cross-trades of debt 
securities and by expanding the definitions of Funds and Large Accounts 
that are permitted to cross-trade. However, the comment also noted that 
the proposal imposes a number of additional disclosure, authorization 
and operational requirements on cross-trading programs. Thus, the 
comment stated that it is not

[[Page 6629]]

clear whether managers who continue to utilize their individual 
exemptions would have an advantage over those utilizing the class 
exemption.
    Another comment stated that some individual exemptions have been 
relied upon by managers for more than a decade and that such exemptions 
should remain in place after the class exemption is granted. This 
commenter noted that managers have invested substantial time and 
resources in the current cross-trading systems, and other programmatic 
features in such systems have been developed in reliance upon the 
conditions of the individual exemptions. Any revocation of the existing 
exemptions would mandate conformance with the new exemption's 
requirements and features, and the manager's cross-trading procedures 
and systems would have to be significantly revised. The commenter 
stated that such revisions would place an undue burden on the managers, 
would add significant costs to the operation of the existing cross-
trading programs, and would not provide any added benefits to the 
managers' client plans.
    However, other commenters stated that, by permitting firms to 
continue to rely on individual exemptions that have, in some respects, 
less stringent conditions than the proposal, the Department would 
create a competitive advantage for advisers who already have 
exemptions. Some commenters further stated that, by granting the class 
exemption, the Department is already creating a competitive advantage 
for firms that ``passively manage'' plan assets over those which 
``actively manage'' such assets. These commenters urged the Department 
to hold all firms to the same standard, at least with respect to the 
class exemption, and eliminate the existing individual exemptions to 
ensure an ``equal playing field'' for all similarly situated managers 
that ``passively-manage'' assets.
    In this regard, the Department has not made a determination at the 
present time whether to revoke any past individual exemptions for 
cross-trading programs involving Index and Model-Driven Funds. It is 
not clear whether managers who continue to utilize their individual 
exemptions will have an advantage over those utilizing the class 
exemption since cross-trades may only be performed if they conform with 
either all of the provisions of an individual exemption or all of the 
provisions of the class exemption (i.e., managers who hold individual 
exemptions may not pick and choose selected provisions from their own 
exemptions and the class exemption). As noted in the preamble to the 
proposal, prior to modifying or revoking any individual exemption, the 
Department must publish a notice of its proposed action in the Federal 
Register and provide interested persons with an opportunity to comment 
on any proposed revocation or modification of such exemptions.
    Other commenters requested that the Department expand the proposal 
to permit cross-trades by ``actively-managed'' plan accounts of a 
manager. These commenters noted that the clear advantages of cross-
trading should be available to both actively and passively managed 
funds, and that the Department's exclusion of ``actively-managed'' 
funds from the current exemption is unfair.
    Other commenters stated that it was appropriate for the Department 
to handle cross-trades by ``passively-managed'' funds separately. Such 
commenters noted that ``passive'' managers have far less discretion 
than ``active'' managers. One comment stated that a class exemption 
attempting to address both ``actively'' and ``passively'' managed funds 
would be confusing and could lead to the application of unnecessarily 
burdensome conditions on ``passively-managed'' funds to address 
concerns applicable only to ``actively-managed'' funds.
    The Department has determined to grant this exemption for cross-
trading programs involving Index and Model-Driven Funds and to 
separately proceed with its consideration of relief for cross-trades by 
``actively-managed'' plan accounts or pooled funds containing ``plan 
assets'' covered by the Act.\10\ The Department acknowledges that 
appropriate cross-trades of securities by ``actively-managed'' accounts 
or funds would be beneficial to employee benefit plans in saving 
transaction costs and avoiding adverse market impact for both sides of 
the transactions. However, the Department believes that adequate 
safeguards must be developed in order to prevent abuses which could 
occur when an investment manager has significant investment discretion 
which could be used to benefit certain clients or the manager itself at 
the expense of its ERISA-covered accounts.
---------------------------------------------------------------------------

    \10\ Interested persons may wish to review the information 
received by the Department in response to the Notice published in 
the Federal Register on March 20, 1998 (63 FR 13696) and in the 
testimony provided at the public hearing on cross-trades of 
securities by ``actively-managed'' plan accounts and pooled funds 
(the Hearing), which was held at the Department on February 10 and 
11, 2000. Copies of the comments received by the Department in 
response to the Notice, and the testimony received at the Hearing, 
are available for public inspection in the Public Documents Room, 
Pension and Welfare Benefits Administration, U.S. Department of 
Labor, Room N-1513, 200 Constitution Avenue NW, Washington, DC 
20210. For copies of the comments relating to the Notice, interested 
persons should request File No. M-9043. For copies of the testimony 
received at the Hearing, interested persons should request File No. 
D-10851 (Cross-Trades of Securities Hearing).
---------------------------------------------------------------------------

    The Department is currently considering what conditions may be 
necessary to address potential abuses in cross-trading programs that 
would involve ``actively-managed'' plan accounts. The Department 
continues to receive and review additional information from various 
interested persons which will assist the Department in developing a 
separate class exemption for cross-trades by ``actively-managed'' plan 
accounts.

Description of the Exemption

A. Scope and General Rule

    The exemption consists of four parts. Section I sets forth the 
general exemption and describes the transactions covered by the 
exemption. Sections II and III contain specific and general conditions 
applicable to transactions described in section I. Section IV contains 
definitions for certain terms used in the exemption.
    The exemption set forth in section I provides relief from the 
restrictions of sections 406(a)(1)(A) and 406(b)(2) of ERISA and 
section 8477(c)(2)(B) of FERSA for: (a) The purchase and sale of 
securities between an Index or Model-Driven Fund and another such Fund, 
at least one of which holds ``plan assets'' subject to the Act; and (b) 
the purchase and sale of securities between such Funds and certain 
large accounts (Large Accounts) pursuant to portfolio restructuring 
programs of the Large Accounts. The exemption also would apply to 
cross-trades between two or more Large Accounts if such cross-trades 
occur as part of a single cross-trading program involving both Funds 
and Large Accounts pursuant to which securities are cross-traded solely 
as a result of the objective operation of the program.
    The exemption under section I(a) applies to cross-trades of 
securities among Index or Model-Driven Funds managed by the same 
investment manager where both Funds contain plan assets. However, as 
stated above, a violation of section 406(b)(2) occurs when an 
investment manager has investment discretion with respect to both sides 
of a cross-trade of securities and at least one side is an entity which 
contains plan assets. As a result, the exemption is also applicable to 
situations where the investment manager has investment discretion for 
both Funds involved in a cross-trade but one Fund does not contain plan 
assets

[[Page 6630]]

because, for example, it is registered as an investment company under 
the Investment Company Act of 1940 (e.g., a mutual fund). Any mutual 
fund or other institutional investor covered by the exemption under 
section I(a) must meet the definition of an Index Fund or a Model-
Driven Fund, contained in section IV(a) and (b). Institutional 
investors which meet the definitions contained in section IV(a) and (b) 
may include, but are not limited to, entities such as insurance company 
separate accounts or general accounts, governmental plans, university 
endowment funds, charitable foundation funds, trusts or other funds 
exempt from taxation under section 501(a) of the Code.
    The exemption under section I(b) applies to the purchase and sale 
of securities between a Fund and a Large Account, at least one of which 
holds ``plan assets'' subject to ERISA or FERSA, pursuant to portfolio 
restructuring programs initiated on behalf of certain Large Accounts. 
The term ``Large Account'' is defined in section IV(e) to include 
certain large employee benefit plans or other large institutional 
investors with at least $50 million in total assets, including certain 
insurance company separate and general accounts and registered 
investment companies. For purposes of the $50 million requirement, the 
assets of one or more employee benefit plans maintained by the same 
employer, or controlled group of employers, may be aggregated, provided 
that such assets are pooled for investment purposes in a single master 
trust. A portfolio restructuring program, as defined in section IV(f), 
involves the buying and selling of securities on behalf of a Large 
Account in order to produce a portfolio of securities which either 
becomes an Index Fund or a Model-Driven Fund or resembles such a Fund, 
or to carry out a liquidation of a specified portfolio of securities 
for a Large Account. The Fund or other portfolio resulting from the 
restructuring program will be either managed by the manager of the Fund 
or by an investment manager that is independent of the Fund manager. 
The definition of a Large Account requires that an independent 
fiduciary authorize a Fund manager (i.e., a Manager, as defined in 
section IV(i)) to restructure all or part of the portfolio or to act as 
a ``trading adviser'' as defined in section IV(g) with respect to the 
restructuring of such portfolio. The trading adviser's role is limited 
under the exemption to the disposition within a stated period of time 
of a securities portfolio of a Large Account and/or the creation of the 
required portfolio.
    Under this definition, the manager may not have any discretionary 
authority for any asset allocation, restructuring or liquidation 
decisions or otherwise provide investment advice with respect to such 
transactions. In this regard, the Department notes that it expects the 
investment manager to comply with the applicable securities laws in 
connection with any portfolio restructuring program.
    Section IV(a) and (b) require that the Index or Model-Driven Fund 
be based upon an index which represents the investment performance of a 
specific segment of the public market for equity or debt securities. 
Section IV(c) requires that the index be established and maintained by 
an independent organization which is: in the business of providing 
financial information or brokerage services to institutional clients; a 
publisher of financial news or information; or a public stock exchange 
or association of securities dealers. The index must be a standardized 
index of securities which is not specifically tailored for the use of 
the Fund manager.
    Section IV(a) and (b) specifically define Index and Model-Driven 
Funds for purposes of the exemption. These definitions are designed to 
limit the amount of discretion the manager can exercise to affect the 
identity or amount of securities to be purchased or sold and to assure 
that the purchase or sale of any security is not part of an 
arrangement, agreement or understanding designed to benefit the 
manager. Under the definition of ``Index Fund'' contained in section 
IV(a), the investment manager must track the rate of return of an 
independently maintained securities index by either replicating the 
same combination of securities which compose such index or by investing 
in a representative sample of such portfolio based on objective 
criteria and data designed to recreate the projected return, risk 
profile and other characteristics of the index. Under the definition of 
``Model-Driven Fund'' contained in section IV(b), trading decisions are 
passive or process-driven since the identity and the amount of the 
securities contained in the Fund must be selected by a computer model. 
Although the manager can use its discretion to design the computer 
model, the model must be based on prescribed objective criteria using 
third party data, not within the control of the manager, to transform 
an independently maintained index. Thus, for example, no exemptive 
relief would be available if the manager designed the computer model to 
consider the liquidity or the availability of a security based on 
information that was solely within the control of the manager. In such 
instances, the computer model would be considering data that was not 
from a third party source, and that was within the control of the 
manager.

B. Price and Securities

    Section II(a) of the exemption requires that each cross-trade be 
executed at the closing price for that security. In addition, section 
II(g) of the exemption requires that the manager may not receive any 
brokerage fees or commissions as a result of the cross-trades.
    Closing price is defined in section IV(h) as the price for the 
security on the date of the transaction, as determined by objective 
procedures disclosed to Fund investors in advance and consistently 
applied with respect to securities traded in the same market. The 
procedures shall indicate the independent pricing source (and 
alternates, if the designated pricing source is unavailable) used to 
establish the closing price and the time frame after the close of the 
market in which the closing price will be determined. The pricing 
source must be independent of the manager and must be engaged in the 
ordinary course of business of providing financial news and pricing 
information to institutional investors and/or the general public, and 
must be widely recognized as an accurate and reliable source for such 
information. In this regard, some managers may use one pricing service 
for pricing domestic securities and another pricing service for pricing 
foreign securities. With respect to foreign securities, the applicable 
independent pricing source should provide the price in local currency 
rates and, if that currency is other than U.S. dollars, may also 
provide the U.S. dollar exchange rate. Thus, securities must be cross-
traded in all cases at the closing prices received by the manager from 
the relevant independent pricing source.
    The Department has adopted this definition of the term ``closing 
price'' in an effort to be consistent with the methods for determining 
the price of cross-traded securities currently utilized by Index and 
Model-Driven Fund investment managers, according to both the comments 
received in response to the proposal published on December 15, 1999 and 
the comments received in response to the Notice published on March 20, 
1998. In addition, the Department believes that this pricing approach 
will ensure that the pricing procedures utilized are objective and not 
subject to the discretion or

[[Page 6631]]

manipulation of any of the involved parties.
    Section II(f) of the exemption requires that cross-trades of either 
equity securities or fixed income securities involve only securities 
for which market quotations are readily available from independent 
sources that are engaged in the ordinary course of business of 
providing financial news and pricing information to institutional 
investors and/or the general public, and are widely recognized as 
accurate and reliable sources for such information. Section II(f)(1) 
further requires that cross-trades of equity securities only involve 
securities which are widely-held and actively-traded. In this regard, 
the Department notes that equity securities will be deemed to be 
``widely-held'' and ``actively-traded'' under this exemption if such 
securities are included in an independently maintained index, as 
defined in section IV(c) herein. The Department expects that managers, 
in making their determinations regarding the types of securities 
included within the scope of this condition, would consider information 
about the average daily trading volume for equities traded on any 
recognized securities exchange or automated broker-dealer quotation 
system which would be readily available from independent pricing 
sources or other independent sources which publish financial news and 
information.

C. Triggering Events

    Section II(b) of the exemption requires that any purchase or sale 
of securities by a Fund in a cross-trade with another Fund or with a 
Large Account occur as a direct result of a ``triggering event,'' as 
defined in section IV(d), and that such cross-trade be executed no 
later than the close of the third business day following such 
``triggering event.'' The Department believes that trading pursuant to 
triggering events limits the discretion of the manager to affect the 
identity or amount of securities to be purchased or sold. Triggering 
events, as defined in section IV(d), are outside the control of the 
manager and will ``automatically'' cause the buy or sell decision to 
occur.
    Triggering events are defined in section IV(d) as:
    (1) A change in the composition or weighting of the index 
underlying the Fund by the independent organization creating and 
maintaining the index;
    (2) A material amount of net change in the overall level of assets 
in a Fund, as a result of investments in and withdrawals from the Fund, 
provided that:
    (A) Such material amount has either been identified in advance as a 
specified amount of net change relating to such Fund and disclosed in 
writing as a ``triggering event'' to an independent fiduciary of each 
plan having assets held in the Fund prior to, or within ten (10) days 
following, its inclusion as a ``triggering event'' for such Fund or the 
Manager has otherwise disclosed in the description of its cross-trading 
practices pursuant to section II(k) the parameters for determining a 
material amount of net change, including any amount of discretion 
retained by the Manager that may affect such net change, in sufficient 
detail to allow the independent fiduciary to determine whether the 
authorization to engage in cross-trading should be given; and
    (B) Investments or withdrawals as a result of the manager's 
discretion to invest or withdraw assets of a Manager Plan, other than a 
Manager Plan which is a defined contribution plan under which 
participants direct the investment of their accounts among various 
investment options, including such Fund, will not be taken into account 
in determining the specified amount of net change;
    (3) An accumulation in the Fund of a material amount of either:
    (A) Cash which is attributable to interest or dividends on, and/or 
tender offers for, portfolio securities; or
    (B) Stock attributable to dividends on portfolio securities;

provided that such material amount has either been identified in 
advance as a specified amount relating to such Fund and disclosed in 
writing as a ``triggering event'' to an independent fiduciary of each 
plan having assets held in the Fund prior to, or within ten (10) days 
after, its inclusion as a ``triggering event'' for such Fund, or the 
Manager has otherwise disclosed in the description of its cross-trading 
practices pursuant to section II(k) the parameters for determining a 
material amount of accumulated cash or securities, including any amount 
of discretion retained by the Manager that may affect such accumulated 
amount, in sufficient detail to allow the independent fiduciary to 
determine whether the authorization to engage in cross-trading should 
be given;
    (4) A change in the composition of the portfolio of a Model-Driven 
Fund mandated solely by operation of the formulae contained in the 
computer model underlying the Fund where the basic factors for making 
such changes (and any fixed frequency for operating the computer model) 
have been disclosed in writing to an independent fiduciary of each plan 
having assets held in the Fund, prior to, or within ten (10) days 
after, its inclusion as a ``triggering event'' for such Fund; or
    (5) A change in the composition or weighting of a portfolio for an 
Index Fund or a Model-Driven Fund which results from an independent 
fiduciary's direction to exclude certain securities or types of 
securities from the Fund, notwithstanding that such securities are part 
of the index used by the Fund.
    The first three triggering events have been adopted based upon 
those triggering events utilized in prior individual exemptions, with 
an additional requirement in the second and third triggering events for 
the amounts involved, or the parameters for determining such amounts, 
to be specified and disclosed to independent fiduciaries of plans 
investing in the Funds. In addition, the fourth triggering event has 
been added in order to clarify that a triggering event also occurs as a 
result of a change in the composition of a Fund's portfolio mandated 
solely by operation of the computer model underlying the Fund. For 
example, if a model contained a formula for a Fund requiring only 
stocks with a certain price/earnings ratio and some of the originally 
prescribed stocks now were above the specified tolerances of the 
formula relating to that model, a triggering event would occur 
requiring that those stocks be sold by the Fund. The Department has 
included this triggering event under this exemption in order to clarify 
that Model-Driven Funds may need to buy or sell securities to conform 
to changes to the portfolio prescribed by the model that differ from 
changes to a portfolio necessitated as a result of changes to the 
underlying index. The exemption does not require that a computer model 
be operated according to any fixed frequency. However, the Department 
is of the view that the exemption would not be available unless the 
formulae contained in the computer model underlying a Fund were 
operated by the manager on an objective basis rather than being used 
for the purpose of creating cross-trade opportunities in response to 
the needs of other Funds or certain Large Accounts.
    The Department further notes that under section II(k), disclosures 
must be made to independent plan fiduciaries of the affected Funds 
regarding the triggering events that would create cross-trading 
opportunities for such Funds under the manager's cross-trading program. 
Under the model-driven triggering event contained in the exemption, the 
basic factors for making changes in the composition of the

[[Page 6632]]

portfolio of a Model-Driven Fund mandated solely by operation of the 
formulae contained in the computer model must be included in these 
disclosures.
    The Department notes that a fifth triggering event has been added 
to the final exemption, based on comments received, which permits plan 
sponsors to direct the manager to delete certain securities from an 
Index or Model-Driven Fund where the Fund otherwise would hold such 
securities based upon the particular index or computer model. The 
Department understands that this triggering event is consistent with 
practices utilized by certain managers in prior individual exemptions 
and will facilitate additional cross-trade opportunities.

D. Modifications to the Computer Model

    Section II(c) requires that, if the model or the computer program 
used to generate the model underlying the Fund is changed by the 
manager, no cross-trades of any securities can be engaged in pursuant 
to the exemption for three (3) business days following the change. This 
restriction recognizes the authority of the manager to change 
assumptions involving computer models after the model's activation.
    The Department notes that the three (3) business day ``blackout'' 
period for cross-trades by a Fund after any change made by the manager 
to the model underlying the Fund is intended to prevent model changes 
which might be made by managers, in part, to deliberately create 
additional cross-trading activity.
    In addition, under section IV(b), a computer model for a Model-
Driven Fund must use independent third party data, not within the 
control of the manager, to transform an index.

E. Allocation of Cross-Trade Opportunities

    The Department notes that frequently the amount of a security which 
all of the Funds need to buy may be less than the amount of such 
security which all of the Funds will need to sell, or vice versa. Thus, 
section II(d) of the exemption requires that all cross-trade 
opportunities be allocated by the manager among potential buyers, or 
sellers, on an objective basis. Under section II(d), this basis for 
allocation must have been previously disclosed to independent 
fiduciaries on behalf of each plan investor, and must not permit the 
exercise of any discretion by the manager. In previous individual 
exemptions, applicants have relied on different systems (e.g. pro rata 
or queue) to objectively allocate cross-trade opportunities. While it 
appears to the Department that a pro rata basis of allocation would be 
the method least subject to scrutiny, the Department recognizes the 
validity of other workable objective systems. However, the Department 
cautions that such systems may not permit the exercise of discretion by 
the manager.

F. Requirements for Cross-Trades by a Manager Plan

    Section II(e) of the exemption requires that no more than twenty 
(20) percent of the assets of the Fund or Large Account at the time of 
the cross-trade may be comprised of assets of employee benefit plans 
maintained by the Manager for its own employees (Manager Plans) for 
which the Manager exercises investment discretion. In this regard, the 
Department wishes to note that this percentage limitation would not 
apply to any Manager Plan(s) for which the Manager does not exercise 
investment discretion. For example, a Manager Plan which is a defined 
contribution plan under which participants direct the investment of 
their accounts among various investment options would not be subject to 
the twenty (20) percent limit.

G. Disclosures and Authorizations

    Section II(h) of the exemption requires that a plan's participation 
in a cross-trade program of a manager involving Index and Model-Driven 
Funds at least one of which holds ``plan assets'' subject to the Act 
will be subject to the prior written authorization of a plan fiduciary 
who is independent of the manager. However, for purposes of this 
exemption, the requirement that the authorizing fiduciary be 
independent of the manager shall not apply in the case of a Manager 
Plan. In this regard, section II(e) of the exemption requires that no 
more than twenty (20) percent of the assets of the Fund or Large 
Account at the time of the cross-trade may be comprised of assets of a 
Manager Plan for which the Manager exercises investment discretion.
    The authorization described in section II(h), once given, would 
apply to all Funds that comprise the manager's cross-trading program at 
the time of the authorization. Thus, a new authorization by an 
independent plan fiduciary for investment in a different Fund, in which 
the plan did not invest at the time of its initial written 
authorization, would not be necessary to the extent that such Fund was 
part of the program at the time of the original authorization. However, 
where a manager makes new Funds available for plan investors or changes 
triggering events relating to Funds subject to the initial 
authorization, and such Funds or triggering events were not previously 
disclosed as being part of the manager's cross-trading program, section 
II(k) of the exemption requires that the manager furnish additional 
disclosures to an independent plan fiduciary. The Manager shall provide 
a notice to each relevant independent plan fiduciary of plans invested 
in the affected Funds prior to, or within ten (10) days following, such 
addition of Funds or change to, or addition of, triggering events, 
which contains a description of such Fund(s) or triggering event(s). 
Such notice will also include a statement that the plan has the right 
to terminate its participation in the cross-trading program and its 
investment in any Index Fund or Model-Driven Fund without penalty at 
any time, as soon as is necessary to effectuate the withdrawal in an 
orderly manner.
    As noted below, section II(l) requires that disclosures be made to 
the relevant independent plan fiduciaries regarding each Fund in which 
the plan is invested as part of the notice required for a plan's annual 
re-authorization of its participation in the manager's cross-trading 
program. In addition, section II(l) requires that disclosures regarding 
any new Funds, or new triggering events in any existing Funds, in which 
a plan is not invested be made available, upon request, as part of the 
notice required for a plan's annual re-authorization of its 
participation in the manager's cross-trading program.
    Section II(i) clarifies the meaning of Section II(h) with respect 
to existing plan investors in any of the Funds, which hold plan assets 
subject to the Act, prior to a manager's implementation of a cross-
trading program. Under section II(i), the authorizing independent 
fiduciary must be furnished notice and an opportunity to object to that 
plan's participation in the program not less than forty-five (45) days 
prior to the implementation of the cross-trade program. Section II(i) 
further states that the failure of the authorizing fiduciary to return 
a special termination form provided in the notice by a specified date 
that is at least thirty (30) days from receipt shall be deemed to be 
approval of the plan's participation in the program. If the authorizing 
plan fiduciary objects to the plan's inclusion in the program, the plan 
will be given the opportunity to withdraw without penalty prior to the 
program's implementation.
    Sections II(j) and II(k) describe the type of information that is 
required to be disclosed to a plan fiduciary prior to the authorization 
defined in sections II(h)

[[Page 6633]]

and II(i). Important among these disclosures is a statement describing 
the conflicts that will exist as a result of the manager's cross-
trading activities. This statement must also detail and explain how the 
manager's practices and procedures will mitigate such conflicts. Such 
writing must include a statement that:
    Investment decisions will not be based in whole or in part by the 
manager on the availability of cross-trade opportunities. These 
investment decisions include:
     Which securities to buy or sell;
     How much of each security to buy or sell; and,
     When to execute a sale or purchase of each security.
    Investment decisions will be made prior to the identification and 
determination of any cross-trade opportunities. In addition, all cross-
trades by a Fund will be based solely upon triggering events set forth 
in the exemption. Records documenting each cross-trade transaction will 
be retained by the manager.
    Section II(l) further requires that notice be provided to the 
authorizing plan fiduciary at least annually of the plan's right to 
terminate its participation in the cross-trading program and its 
investment in any of the Funds without penalty. Such notice must be 
accompanied by a special termination form. Failure to return the form 
by a specified date that is at least thirty (30) days from the receipt 
will be deemed approval of the plan's continued participation in the 
cross-trading program. In lieu of providing a special termination form, 
the notice may permit the independent plan fiduciary to utilize another 
written instrument by the specified date to terminate the plan's 
participation in the cross-trading program, provided that in such case 
the notice explicitly discloses that a termination form may be obtained 
from the Manager upon request. Such annual re-authorization will 
provide information to the relevant independent plan fiduciary 
regarding each Fund in which the plan is invested, as well as explicit 
notification that the plan fiduciary may request and obtain disclosures 
regarding any new Funds in which the plan is not invested that are 
added to the cross-trading program, or any new ``triggering events'' 
(as defined in Section IV(d) below) that may have been added to 
existing Funds in which the plan is not invested, since the time of the 
initial authorization described in Section II(h), or the time of the 
notice described in Section II(i).
    Section II(m) of the exemption details specific requirements for 
cross-trades of securities which will occur in connection with a Large 
Account restructuring. In particular, section II(m)(2) requires that 
the authorization for such cross-trades must be made in writing prior 
to the cross-trade transactions by fiduciaries of the Large Account who 
are independent of the manager (except in the case of a Manager Plan). 
Such authorization must follow full written disclosure of information 
regarding the cross-trading program. Such authorization may be 
terminated at will upon receipt by the manager of written notice of 
termination. A termination form must be supplied to the Large Account 
fiduciary concurrent with the written description of the cross-trading 
program. Under section II(m)(3), the portfolio restructuring program 
must be completed within sixty (60) days of the initial authorization 
made by the Large Account's fiduciary (or initial receipt of assets 
associated with the restructuring, if later), unless the Large 
Account's fiduciary agrees in writing to extend this period for another 
thirty (30) days. Large Account fiduciaries may utilize the termination 
form or any other written instrument at any time within the 60-day 
period, or the additional 30-day period, to terminate their prior 
written authorization for cross-trading related to the portfolio 
restructuring program. Under section II(m)(4), within thirty (30) days 
of the completion of the restructuring program, the Large Account 
fiduciary must be fully apprised in writing of the results of the 
transactions. Such writing may include, upon request by the Large 
Account fiduciary, additional information sufficient to allow the 
independent fiduciary for the Large Account to verify the need for each 
cross-trade and the determination of the above decisions. However, 
pursuant to section III(b)(2) the manager may refuse to disclose to a 
Large Account fiduciary or other person any such information which is 
deemed confidential or privileged if the manager is otherwise permitted 
by law to withhold such information from such person, provided that by 
the close of the thirtieth (30th) day following the request, the 
manager gives a written notice to such person advising that person both 
the reasons for the refusal and that the Department may request such 
information.

H. Recordkeeping

    Section III(a) requires that the manager maintain records necessary 
to allow a determination of whether the conditions of the exemption 
have been met. These records must be maintained for a period of six (6) 
years from the date of the transactions. These records must include 
records which identify the following:
    (1) On a Fund by Fund basis, the specific triggering events which 
result in the creation of the model prescribed output or trade list of 
specific securities to be cross-traded;
    (2) On a Fund by Fund basis, the model prescribed output or trade 
list which describes: (A) which securities to buy or sell; (B) how much 
of each security to buy or sell; in detail sufficient to allow an 
independent plan fiduciary to verify that each of the above decisions 
for the Fund was made in response to specific triggering events; and
    (3) On a Fund by Fund basis, the actual trades executed by the Fund 
on a particular day and which of those trades were associated with 
triggering events.
    As explained to the Department, the triggering event relating to 
net investments in, or withdrawals from, a Fund results in new cash to 
invest in the Fund or the need to liquidate securities from a Fund. The 
model or index underlying the Fund determines which securities to 
purchase or sell based on the amount of net investments or withdrawals. 
This process results in the creation of a trade list or a model 
prescribed output of securities to be purchased or sold. The manager 
then applies its objective allocation system to the trade lists or 
model prescribed outputs used for other Funds participating in the 
cross-trade program to determine which particular cross-trades will 
occur between Funds. For those securities which cannot be cross-traded 
after application of the manager's allocation system, the necessary 
purchases and sales are made through other means.
    In the view of the Department, records must be maintained of this 
cross-trading activity with enough specificity to allow an independent 
plan fiduciary to verify whether the safeguards of this exemption have 
been met. Section II(b) requires that any cross-trade of securities by 
a Fund occur as a direct result of a ``triggering event'' as defined in 
section IV(d) and is executed no later than the close of the third 
business day following such ``triggering event.'' Among the records 
needed to verify that this condition has been satisfied, section 
III(a)(1) requires that, on a Fund by Fund basis, the manager maintain 
a record of the specific triggering events which result in the creation 
of the list of specific securities for the manager's cross-trading 
system. Section III(a)(2) further requires that, on a Fund by Fund 
basis, the manager maintain records of

[[Page 6634]]

the model prescribed output or trade list, as well as the procedures 
utilized by the manager to determine which securities to buy or sell 
and how much of each security to buy or sell, in detail sufficient to 
allow an independent plan fiduciary to verify that each of the above 
decisions for the Fund was made in response to specific triggering 
events. As provided by section III(b)(2), if such material is viewed as 
a trade secret, or privileged or confidential, the manager may refuse 
to disclose such information if reasons for the refusal are given and 
the person is also notified that the Department of Labor may request 
such information.
    This record-keeping requirement is intended to assure that 
independent plan fiduciaries will be able to determine whether Funds 
and their underlying models or indexes operate consistently in 
following the input of triggering event information. The Department 
does not intend to prescribe a detailed list of records that are 
necessary to enable a determination of compliance with the exemption 
because the necessary records will depend on the nature of the Index or 
Model-Driven Funds involved and other factors. This information, 
however, should be kept in sufficient detail to enable a replication of 
specific historical events in order to satisfy an inquiry by persons 
identified in section III(b)(1). Section III(a)(3) requires that, on a 
Fund by Fund basis, records be maintained of the actual trades executed 
by the Fund on a particular day and which of those trades resulted from 
triggering events.
    Further, Section III(a) requires that the records must be readily 
available to assure accessibility and maintained so that an independent 
fiduciary, or other persons identified in section III(b)(1), may obtain 
them within a reasonable time. This requirement should permit the 
records to be retrieved and assembled quickly, regardless of the 
location in which they are maintained. For those records which are not 
maintained electronically, the records should be maintained in a 
central location to facilitate assembly and examination.
    All records must be unconditionally available at their customary 
location for examination during normal business hours by the persons 
described in section III(b)(1). However, as noted with respect to 
information which may be disclosed to a Large Account fiduciary or 
other person, the manager may refuse to disclose to a person, other 
than a duly authorized employee or representative of the Department or 
the Internal Revenue Service, any such information which is deemed 
confidential or privileged if the manager is otherwise permitted by law 
to withhold such information from such person. In such instances, the 
manager shall provide, by the close of the thirtieth (30th) day 
following the request, a written notice to such person advising that 
person of the reasons for the refusal and that the Department may 
request such information.

General Information

    The attention of interested persons is directed to the following:
    (1) The fact that a transaction is the subject of an exemption 
under section 408(a) of the Act and section 4975(c)(2) of the Code does 
not relieve a fiduciary or other party in interest or disqualified 
person from certain other provisions of the Act and the Code, including 
any prohibited transaction provisions to which the exemption does not 
apply and the general fiduciary responsibility provisions of section 
404 of the Act which require, among other things, that a fiduciary 
discharge his duties with respect to the plan solely in the interests 
of the participants and beneficiaries of the plan and in a prudent 
fashion in accordance with section 404(a)(1)(B) of the Act; nor does it 
affect the requirement of section 401(a) of the Code that the plan must 
operate for the exclusive benefit of the employees of the employer 
maintaining the plan and their beneficiaries;
    (2) In accordance with section 408(a) of the Act and section 
4975(c)(2) of the Code, and based upon the entire record, the 
Department finds that the exemption is administratively feasible, in 
the interests of the plans and their participants and beneficiaries and 
protective of the rights of participants and beneficiaries of such 
plans;
    (3) The exemption is applicable to a particular transaction only if 
the conditions specified in the class exemption are met; and
    (4) The exemption is supplemental to, and not in derogation of, any 
other provisions of the Code and the Act, including statutory or 
administrative exemptions and transitional rules. Furthermore, the fact 
that a transaction is subject to an administrative or statutory 
exemption is not dispositive of whether the transaction is in fact a 
prohibited transaction.

Exemption

    Accordingly, the following exemption is granted under the authority 
of section 408(a) of the Act and section 4975(c)(2) of the Code, and in 
accordance with the procedures set forth in 29 CFR part 2570, subpart B 
(55 FR 32836, 32847, August 10, 1990.)

Section I--Exemption for Cross-Trading of Securities by Index and/
or Model-Driven Funds

    Effective April 15, 2002, the restrictions of sections 406(a)(1)(A) 
and 406(b)(2) of the Act, section 8477(c)(2)(B) of FERSA, and the 
sanctions resulting from the application of section 4975 of the Code, 
by reason of section 4975(c)(1)(A) of the Code, shall not apply to the 
transactions described below if the applicable conditions set forth in 
Sections II and III below are satisfied.
    (a) The purchase and sale of securities between an Index Fund or a 
Model-Driven Fund (a ``Fund''), as defined in Sections IV(a) and (b) 
below, and another Fund, at least one of which holds ``plan assets'' 
subject to the Act or FERSA; or
    (b) The purchase and sale of securities between a Fund and a Large 
Account, as defined in Section IV(e) below, at least one of which holds 
``plan assets'' subject to the Act or FERSA, pursuant to a portfolio 
restructuring program, as defined in Section IV(f) below, of the Large 
Account;

Notwithstanding the foregoing, this exemption shall apply to cross-
trades between two or more Large Accounts pursuant to a portfolio 
restructuring program if such cross-trades occur as part of a single 
cross-trading program involving both Funds and Large Accounts for which 
securities are cross-traded solely as a result of the objective 
operation of the program.

Section II. Specific Conditions

    (a) The cross-trade is executed at the closing price, as defined in 
Section IV(h) below.
    (b) Any cross-trade of securities by a Fund occurs as a direct 
result of a ``triggering event,'' as defined in Section IV(d) below, 
and is executed no later than the close of the third business day 
following such ``triggering event.''
    (c) If the cross-trade involves a Model-Driven Fund, the cross-
trade does not take place within three (3) business days following any 
change made by the Manager to the model underlying the Fund.
    (d) The Manager has allocated the opportunity for all Funds or 
Large Accounts to engage in the cross-trade on an objective basis which 
has been previously disclosed to the authorizing fiduciaries of plan 
investors, and which does not permit the exercise of discretion by the 
Manager (e.g., a pro rata allocation system).
    (e) No more than twenty (20) percent of the assets of the Fund or 
Large Account at the time of the cross-trade is

[[Page 6635]]

comprised of assets of employee benefit plans maintained by the Manager 
for its own employees (Manager Plans) for which the Manager exercises 
investment discretion.
    (f)(1) Cross-trades of equity securities involve only securities 
that are widely-held, actively-traded, and for which market quotations 
are readily available from independent sources that are engaged in the 
ordinary course of business of providing financial news and pricing 
information to institutional investors and/or the general public, and 
are widely recognized as accurate and reliable sources for such 
information. For purposes of this requirement, the terms ``widely-
held'' and ``actively-traded'' shall be deemed to include any security 
listed in an Index, as defined in Section IV(c) below; and
    (2) Cross-trades of fixed-income securities involve only securities 
for which market quotations are readily available from independent 
sources that are engaged in the ordinary course of business of 
providing financial news and pricing information to institutional 
investors and/or the general public, and are widely recognized as 
accurate and reliable sources for such information.
    (g) The Manager receives no brokerage fees or commissions as a 
result of the cross-trade.
    (h) As of the date this exemption is granted, a plan's 
participation in the Manager's cross-trading program as a result of 
investments made in any Index or Model-Driven Fund that holds plan 
assets is subject to a written authorization executed in advance of 
such investment by a fiduciary of the plan which is independent of the 
Manager engaging in the cross-trade transactions. For purposes of this 
exemption, the requirement that the authorizing fiduciary be 
independent of the Manager shall not apply in the case of a Manager 
Plan.
    (i) With respect to existing plan investors in any Index or Model-
Driven Fund that holds plan assets as of the date this exemption is 
granted, the independent fiduciary is furnished with a written notice, 
not less than forty-five (45) days prior to the implementation of the 
cross-trading program, that describes the Fund's participation in the 
Manager's cross-trading program, provided that:
    (1) Such notice allows each plan an opportunity to object to the 
plan's participation in the cross-trading program as a Fund investor by 
providing the plan with a special termination form;
    (2) The notice instructs the independent plan fiduciary that 
failure to return the termination form to the Manager by a specified 
date (which shall be at least 30 days following the plan's receipt of 
the form) shall be deemed to be an approval by the plan of its 
participation in the Manager's cross-trading program as a Fund 
investor; and
    (3) If the independent plan fiduciary objects to the plan's 
participation in the cross-trading program as a Fund investor by 
returning the termination form to the Manager by the specified date, 
the plan is given the opportunity to withdraw from each Index or Model-
Driven Fund without penalty prior to the implementation of the cross-
trading program, within such time as may be reasonably necessary to 
effectuate the withdrawal in an orderly manner.
    (j) Prior to obtaining the authorization described in Section 
II(h), and in the notice described in Section II(i), the following 
statement must be provided by the Manager to the independent plan 
fiduciary:
    Investment decisions for the Fund (including decisions regarding 
which securities to buy or sell, how much of a security to buy or sell, 
and when to execute a sale or purchase of securities for the Fund) will 
not be based in whole or in part by the Manager on the availability of 
cross-trade opportunities and will be made prior to the identification 
and determination of any cross-trade opportunities. In addition, all 
cross-trades by a Fund will be based solely upon a ``triggering event'' 
set forth in this exemption. Records documenting each cross-trade 
transaction will be retained by the Manager.
    (k) Prior to any authorization set forth in Section II(h), and at 
the time of any notice described in Section II(i) above, the 
independent plan fiduciary must be furnished with any reasonably 
available information necessary for the fiduciary to determine whether 
the authorization should be given, including (but not limited to) a 
copy of this exemption, an explanation of how the authorization may be 
terminated, detailed disclosure of the procedures to be implemented 
under the Manager's cross-trading practices (including the ``triggering 
events'' that will create the cross-trading opportunities, the 
independent pricing services that will be used by the manager to price 
the cross-traded securities, and the methods that will be used for 
determining closing price), and any other reasonably available 
information regarding the matter that the authorizing fiduciary 
requests. The independent plan fiduciary must also be provided with a 
statement that the Manager will have a potentially conflicting division 
of loyalties and responsibilities to the parties to any cross-trade 
transaction and must explain how the Manager's cross-trading practices 
and procedures will mitigate such conflicts.
    With respect to Funds that are added to the Manager's cross-trading 
program or changes to, or additions of, triggering events regarding 
Funds, following the authorizations described in section II(h) or 
section II(i), the Manager shall provide a notice to each relevant 
independent plan fiduciary of each plan invested in the affected Funds 
prior to, or within ten (10) days following, such addition of Funds or 
change to, or addition of, triggering events, which contains a 
description of such Fund(s) or triggering event(s). Such notice will 
also include a statement that the plan has the right to terminate its 
participation in the cross-trading program and its investment in any 
Index Fund or Model-Driven Fund without penalty at any time, as soon as 
is necessary to effectuate the withdrawal in an orderly manner.
    (l) At least annually, the Manager notifies the independent 
fiduciary for each plan that has previously authorized participation in 
the Manager's cross-trading program as a Fund investor, that the plan 
has the right to terminate its participation in the cross-trading 
program and its investment in any Index Fund or Model-Driven Fund that 
holds plan assets without penalty at any time, as soon as is necessary 
to effectuate the withdrawal in an orderly manner. This notice shall 
also provide each independent plan fiduciary with a special termination 
form and instruct the fiduciary that failure to return the form to the 
Manager by a specified date (which shall be at least thirty (30) days 
following the plan's receipt of the form) shall be deemed an approval 
of the subject plan's continued participation in the cross-trading 
program as a Fund investor. In lieu of providing a special termination 
form, the notice may permit the independent plan fiduciary to utilize 
another written instrument by the specified date to terminate the 
plan's participation in the cross-trading program, provided that in 
such case the notice explicitly discloses that a termination form may 
be obtained from the Manager upon request. Such annual re-authorization 
must provide information to the relevant independent plan fiduciary 
regarding each Fund in which the plan is invested, as well as explicit 
notification that the plan fiduciary may request and obtain disclosures 
regarding any new Funds in which the plan is not invested that are 
added to the cross-trading program, or

[[Page 6636]]

any new triggering events (as defined in Section IV(d) below) that may 
have been added to any existing Funds in which the plan is not 
invested, since the time of the initial authorization described in 
Section II(h), or the time of the notice described in Section II(i).
    (m) With respect to a cross-trade involving a Large Account:
    (1) The cross-trade is executed in connection with a portfolio 
restructuring program, as defined in Section IV(f) below, with respect 
to all or a portion of the Large Account's investments which an 
independent fiduciary of the Large Account (other than in the case of 
any assets of a Manager Plan) has authorized the Manager to carry out 
or to act as a ``trading adviser,'' as defined in Section IV(g) below, 
in carrying out a Large Account-initiated liquidation or restructuring 
of its portfolio;
    (2) Prior to the cross-trade, a fiduciary of the Large Account who 
is independent of the Manager (other than in the case of any assets of 
a Manager Plan) \11\ has been fully informed of the Manager's cross-
trading program, has been provided with the information required in 
Section II(k), and has provided the Manager with advance written 
authorization to engage in cross-trading in connection with the 
restructuring, provided that--
---------------------------------------------------------------------------

    \11\ However, proper disclosures must be made to, and written 
authorization must be made by, an appropriate fiduciary for the 
Manager Plan in order for the Manager Plan to participate in a 
specific portfolio restructuring program as part of a Large Account.
---------------------------------------------------------------------------

    (A) Such authorization may be terminated at will by the Large 
Account upon receipt by the Manager of written notice of termination.
    (B) A form expressly providing an election to terminate the 
authorization, with instructions on the use of the form, is supplied to 
the authorizing Large Account fiduciary concurrent with the receipt of 
the written information describing the cross-trading program. The 
instructions for such form must specify that the authorization may be 
terminated at will by the Large Account, without penalty to the Large 
Account, upon receipt by the Manager of written notice from the 
authorizing Large Account fiduciary;
    (3) All cross-trades made in connection with the portfolio 
restructuring program must be completed by the Manager within sixty 
(60) days of the initial authorization (or initial receipt of assets 
associated with the restructuring, if later) to engage in such 
restructuring by the Large Account's independent fiduciary, unless such 
fiduciary agrees in writing to extend this period for another thirty 
(30) days; and,
    (4) No later than thirty (30) days following the completion of the 
Large Account's portfolio restructuring program, the Large Account's 
independent fiduciary must be fully apprised in writing of all cross-
trades executed in connection with the restructuring. Such writing 
shall include a notice that the Large Account's independent fiduciary 
may obtain, upon request, the information described in Section III(a), 
subject to the limitations described in Section III(b). However, if the 
program takes longer than sixty (60) days to complete, interim reports 
containing the transaction results must be provided to the Large 
Account fiduciary no later than fifteen (15) days following the end of 
the initial sixty (60) day period and the succeeding thirty (30) day 
period.

Section III--General Conditions

    (a) The Manager maintains or causes to be maintained for a period 
of six (6) years from the date of each cross-trade the records 
necessary to enable the persons described in paragraph (b) of this 
Section to determine whether the conditions of the exemption have been 
met, including records which identify:
    (1) On a Fund by Fund basis, the specific triggering events which 
result in the creation of the model prescribed output or trade list of 
specific securities to be cross-traded;
    (2) On a Fund by Fund basis, the model prescribed output or trade 
list which describes: (A) Which securities to buy or sell; and (B) how 
much of each security to buy or sell; in detail sufficient to allow an 
independent plan fiduciary to verify that each of the above decisions 
for the Fund was made in response to specific triggering events; and
    (3) On a Fund by Fund basis, the actual trades executed by the Fund 
on a particular day and which of those trades resulted from triggering 
events.
    Such records must be readily available to assure accessibility and 
maintained so that an independent fiduciary, or other persons 
identified below in paragraph (b) of this Section, may obtain them 
within a reasonable period of time. However, a prohibited transaction 
will not be considered to have occurred if, due to circumstances beyond 
the control of the Manager, the records are lost or destroyed prior to 
the end of the six-year period, and no party in interest other than the 
Manager shall be subject to the civil penalty that may be assessed 
under section 502(i) of the Act or to the taxes imposed by sections 
4975(a) and (b) of the Code if the records are not maintained or are 
not available for examination as required by paragraph (b) below.
    (b)(1) Except as provided in paragraph (b)(2) and notwithstanding 
any provisions of sections 504(a)(2) and (b) of the Act, the records 
referred to in paragraph (a) of this Section are unconditionally 
available at their customary location for examination during normal 
business hours by--
    (A) Any duly authorized employee or representative of the 
Department of Labor or the Internal Revenue Service,
    (B) Any fiduciary of a Plan participating in a cross-trading 
program who has the authority to acquire or dispose of the assets of 
the Plan, or any duly authorized employee or representative of such 
fiduciary,
    (C) Any contributing employer with respect to any Plan 
participating in a cross-trading program or any duly authorized 
employee or representative of such employer, and
    (D) Any participant or beneficiary of any Manager Plan 
participating in a cross-trading program, or any duly authorized 
employee or representative of such participant or beneficiary.
    (2) If in the course of seeking to inspect records maintained by a 
Manager pursuant to this exemption, any person described in paragraph 
(b)(1)(B) through (D) seeks to examine trade secrets, or commercial or 
financial information of the Manager that is privileged or 
confidential, and the Manager is otherwise permitted by law to withhold 
such information from such person, the Manager may refuse to disclose 
such information provided that, by the close of the thirtieth (30th) 
day following the request, the Manager gives a written notice to such 
person advising the person of the reasons for the refusal and that the 
Department of Labor may request such information.
    (3) The information required to be disclosed to persons described 
in paragraph (b)(1)(B) through (D) shall be limited to information that 
pertains to cross-trades involving a Fund or Large Account in which 
they have an interest.

Section IV--Definitions

    The following definitions apply for purposes of this exemption:
    (a) Index Fund--Any investment fund, account or portfolio 
sponsored, maintained, trusteed, or managed by the Manager or an 
Affiliate, in which one or more investors invest, and--
    (1) Which is designed to track the rate of return, risk profile and 
other characteristics of an Index, as defined in Section IV(c) below, 
by either (i) replicating the same combination of securities which 
compose such Index or

[[Page 6637]]

(ii) sampling the securities which compose such Index based on 
objective criteria and data;
    (2) For which the Manager does not use its discretion, or data 
within its control, to affect the identity or amount of securities to 
be purchased or sold;
    (3) That either contains ``plan assets'' subject to the Act, is an 
investment company registered under the Investment Company Act of 1940, 
or contains assets of one or more institutional investors, which may 
include, but not be limited to, such entities as an insurance company 
separate account or general account, a governmental plan, a university 
endowment fund, a charitable foundation fund, a trust or other fund 
which is exempt from taxation under section 501(a) of the Code; and,
    (4) That involves no agreement, arrangement, or understanding 
regarding the design or operation of the Fund which is intended to 
benefit the Manager, its Affiliates, or any party in which the Manager 
or an Affiliate may have an interest.
    (b) Model-Driven Fund--Any investment fund, account or portfolio 
sponsored, maintained, trusteed, or managed by the Manager or an 
Affiliate, in which one or more investors invest, and--
    (1) Which is composed of securities the identity of which and the 
amount of which are selected by a computer model that is based on 
prescribed objective criteria using independent third party data, not 
within the control of the Manager, to transform an Index, as defined in 
Section IV(c) below;
    (2) Which either contains ``plan assets'' subject to the Act, is an 
investment company registered under the Investment Company Act of 1940, 
or contains assets of one or more institutional investors, which may 
include, but not be limited to, such entities as an insurance company 
separate account or general account, a governmental plan, a university 
endowment fund, a charitable foundation fund, a trust or other fund 
which is exempt from taxation under section 501(a) of the Code; and
    (3) That involves no agreement, arrangement, or understanding 
regarding the design or operation of the Fund or the utilization of any 
specific objective criteria which is intended to benefit the Manager, 
its Affiliates, or any party in which the Manager or an Affiliate may 
have an interest.
    (c) Index--A securities index that represents the investment 
performance of a specific segment of the public market for equity or 
debt securities in the United States and/or foreign countries, but only 
if--
    (1) The organization creating and maintaining the index is--
    (A) Engaged in the business of providing financial information, 
evaluation, advice or securities brokerage services to institutional 
clients,
    (B) A publisher of financial news or information, or
    (C) A public securities exchange or association of securities 
dealers; and,
    (2) The index is created and maintained by an organization 
independent of the Manager, as defined in Section IV(i) below; and,
    (3) The index is a generally accepted standardized index of 
securities which is not specifically tailored for the use of the 
Manager.
    (d) Triggering Event:
    (1) A change in the composition or weighting of the Index 
underlying a Fund by the independent organization creating and 
maintaining the Index;
    (2) A material amount of net change in the overall level of assets 
in a Fund, as a result of investments in and withdrawals from the Fund, 
provided that: (A) Such material amount has either been identified in 
advance as a specified amount of net change relating to such Fund and 
disclosed in writing as a ``triggering event'' to an independent 
fiduciary of each plan having assets held in the Fund prior to, or 
within ten (10) days following, its inclusion as a ``triggering event'' 
for such Fund or the Manager has otherwise disclosed in the description 
of its cross-trading practices pursuant to section II(k) the parameters 
for determining a material amount of net change, including any amount 
of discretion retained by the Manager that may affect such net change, 
in sufficient detail to allow the independent fiduciary to determine 
whether the authorization to engage in cross-trading should be given; 
and
    (B) Investments or withdrawals as a result of the Manager's 
discretion to invest or withdraw assets of a Manager Plan, other than a 
Manager Plan which is a defined contribution plan under which 
participants direct the investment of their accounts among various 
investment options, including such Fund, will not be taken into account 
in determining the specified amount of net change;
    (3) An accumulation in the Fund of a material amount of either:
    (A) Cash which is attributable to interest or dividends on, and/or 
tender offers for, portfolio securities; or
    (B) Stock attributable to dividends on portfolio securities; 
provided that such material amount has either been identified in 
advance as a specified amount relating to such Fund and disclosed in 
writing as a ``triggering event'' to an independent fiduciary of each 
plan having assets held in the Fund prior to, or within ten (10) days 
after, its inclusion as a ``triggering event'' for such Fund, or the 
Manager has otherwise disclosed in the description of its cross-trading 
practices pursuant to section II(k) the parameters for determining a 
material amount of accumulated cash or securities, including any amount 
of discretion retained by the Manager that may affect such accumulated 
amount, in sufficient detail to allow the independent fiduciary to 
determine whether the authorization to engage in cross-trading should 
be given;
    (4) A change in the composition of the portfolio of a Model-Driven 
Fund mandated solely by operation of the formulae contained in the 
computer model underlying the Fund where the basic factors for making 
such changes (and any fixed frequency for operating the computer model) 
have been disclosed in writing to an independent fiduciary of each plan 
having assets held in the Fund, prior to, or within ten (10) days 
after, its inclusion as a ``triggering event'' for such Fund; or
    (5) A change in the composition or weighting of a portfolio for an 
Index Fund or a Model-Driven Fund which results from an independent 
fiduciary's direction to exclude certain securities or types of 
securities from the Fund, notwithstanding that such securities are part 
of the index used by the Fund.
    (e) Large Account--Any investment fund, account or portfolio that 
is not an Index Fund or a Model-Driven Fund sponsored, maintained, 
trusteed (other than a Fund for which the Manager is a nondiscretionary 
trustee) or managed by the Manager, which holds assets of either:
    (1) An employee benefit plan within the meaning of section 3(3) of 
the Act that has $50 million or more in total assets (for purposes of 
this requirement, the assets of one or more employee benefit plans 
maintained by the same employer, or controlled group of employers, may 
be aggregated provided that such assets are pooled for investment 
purposes in a single master trust);
    (2) An institutional investor that has total assets in excess of 
$50 million, such as an insurance company separate account or general 
account, a governmental plan, a university endowment fund, a charitable 
foundation fund, a trust or other fund

[[Page 6638]]

which is exempt from taxation under section 501(a) of the Code; or
    (3) An investment company registered under the Investment Company 
Act of 1940 (e.g., a mutual fund) other than an investment company 
advised or sponsored by the Manager;

provided that the Manager has been authorized to restructure all or a 
portion of the portfolio for such Large Account or to act as a 
``trading adviser'' (as defined in Section IV(g) below) in connection 
with a portfolio restructuring program (as defined in Section IV(f)) 
for the Large Account.
    (f) Portfolio restructuring program--Buying and selling the 
securities on behalf of a Large Account in order to produce a portfolio 
of securities which will be an Index Fund or a Model-Driven Fund 
managed by the Manager or by another investment manager, or in order to 
produce a portfolio of securities the composition of which is 
designated by a party independent of the Manager, without regard to the 
requirements of Section IV(a)(3) or (b)(2), or to carry out a 
liquidation of a specified portfolio of securities for the Large 
Account.
    (g) Trading adviser--A person whose role is limited with respect to 
a Large Account to the disposition of a securities portfolio in 
connection with a portfolio restructuring program that is a Large 
Account-initiated liquidation or restructuring within a stated period 
of time in order to minimize transaction costs. The person does not 
have discretionary authority or control with respect to any underlying 
asset allocation, restructuring or liquidation decisions for the 
account in connection with such transactions and does not render 
investment advice [within the meaning of 29 CFR 2510.3-21(c)] with 
respect to such transactions.
    (h) Closing price--The price for a security on the date of the 
transaction, as determined by objective procedures disclosed to 
investors in advance and consistently applied with respect to 
securities traded in the same market, which procedures shall indicate 
the independent pricing source (and alternates, if the designated 
pricing source is unavailable) used to establish the closing price and 
the time frame after the close of the market in which the closing price 
will be determined.
    (i) Manager--A person who is:
    (1) A bank or trust company, or any Affiliate thereof, as defined 
in Section IV(j) below, which is supervised by a state or federal 
agency; or,
    (2) An investment adviser or any Affiliate thereof, as defined in 
Section IV(j) below, which is registered under the Investment Advisers 
Act of 1940.
    (j) Affiliate--An ``affiliate'' of a Manager includes:
    (1) Any person, directly or indirectly, through one or more 
intermediaries, controlling, controlled by or under common control with 
the person;
    (2) Any officer, director, employee or relative of such person, or 
partner of any such person; and
    (3) Any corporation or partnership of which such person is an 
officer, director, partner or employee.
    (k) Control--The power to exercise a controlling influence over the 
management or policies of a person other than an individual.
    (l) Relative--A ``relative'' is a person that is defined in section 
3(15) of the Act (or a ``member of the family'' as that term is defined 
in section 4975(e)(6) of the Code), or a brother, a sister, or a spouse 
of a brother or a sister.
    (m) Nondiscretionary trustee--A plan trustee whose powers and 
duties with respect to any assets of the plan are limited to (1) the 
provision of nondiscretionary trust services to the plan, and (2) 
duties imposed on the trustee by any provision or provisions of the Act 
or the Code. The term ``nondiscretionary trust services'' means 
custodial services and services ancillary to custodial services, none 
of which services are discretionary. For purposes of this exemption, a 
person who is otherwise a nondiscretionary trustee will not fail to be 
a nondiscretionary trustee solely by reason of having been delegated, 
by the sponsor of a master or prototype plan, the power to amend such 
plan.

    Signed at Washington, DC, this 6th day of February, 2002.
Alan D. Lebowitz,
Deputy Assistant Secretary for Program Operations, Pension and Welfare 
Benefits Administration, Department of Labor.
[FR Doc. 02-3341 Filed 2-11-02; 8:45 am]
BILLING CODE 4510-29-P