Securities Laws and 403(b) Plans:

Prospectus Delivery, Free Transferability, Rule 22c-2, and Other Things That Go Bump In The Night

Written by: Bob Toth

One of the most striking differences between 403(b) plans and 401(k) plans is the way in which the Securities Act of 1933 and the Security Exchange Act of 1934 apply to them.  Though the new 403(b) regulations attempt to make 403(b) plans look and act almost like 401(k) plans, the application of securities laws will make that objective difficult – if not impossible – to achieve without wholesale revision of the securities laws.

For instance, except for anti-fraud provisions, 401(k) plans are generally exempt from securities laws.  There are some exceptions – most notably for plans with company stock – but the broad exemption from securities laws generally means that 401(k) plans are free from registration as a security, and that securities purchased by these plans need not be registered. On the other side, 403(b) plans enjoy no such luxury.

The continued application of the securities laws to 403(b) plans presents numerous challenges to sponsors and vendors alike in the new world charted out by the IRS's final regulations.  The intersection of the securities laws requirements and the new regulations will affect plan relationships with brokers and advisors, and will affect the drafting of plan documents and the setting up of plan procedures.  Some examples: 

·        Likely the most expensive of the differences is the requirement of prospectuses to individual plan participants – something that is done for purposes of ERISA § 404(c) purposes, but otherwise only upon request in the 401(k) world. Even the e-delivery of these documents are subject to certain conditions.

·        Free transferability is a nit-picky rule for 403(b)s. The 403(b) distribution limitations can cause a conflict with the SEC's rules on liquidity and free transferability. The SEC granted relief a few years ago, as long as certain signed disclosures are put into affect-rules which will need to be incorporated into the administration of those new 403(b) plans.

·        Rule 22c-2 (the rule which attempts to restrict the excessive trading of mutual fund shares) applies directly at the participant level.  Though 401(k) vendors are painfully aware of this rule because of the difficulties in dealing with it at the "omnibus" level, the practical effect for 403(b) plans is that Rule 22c-2 applies directly at the individual level without an intermediary.

·        The SEC views the plan participant as the purchaser and owner of the investment of the 403(b) annuity contract or custodial account.  In 401(k) plans, the trustee is the "owner," with the participants having only a beneficial interest in the plan.  The impact of this view can be substantial, as 403(b) plan sponsors (with their new administrative responsibilities under the new regulations) will need to pay close attention to a number of SEC pronouncements and be aware of the impact on their plans. Incidentally, its not just 403(b) plans that will have to pay increased attention to the SEC.  This recent Report of Investigation highlights the SEC interest in the retirement plan world, including the management of state-administered defined benefit pension plans. Thanks to the great bloggers at Pension Risk Matters for this tip.