Keywords: Collective Investment Trusts, CIT, investment manager, OCIO
A collective investment trust ("CIT") is a longstanding vehicle used by banks and trust companies to commingle the assets of qualified retirement trusts for investment. In recent years, CITs are enjoying a resurgence for defined contribution plans as an alternative to mutual funds in a 401(k) plan line up. The primary reason for the new popularity of CITs is that they often have a lower expense ratio than mutual funds as a result of being free from the extensive regulatory requirements imposed on mutual funds under the securities laws. But there are many other differences between CITs and mutual funds that plan fiduciaries should understand when adding an investment option structured as a CIT to their 401(k) plan line up. This blog provides a number of examples of issues that plan fiduciaries who are not familiar with CITs could miss.
- Trust terms may vary and must be reviewed. While the extensive regulation of mutual funds under the Investment Company Act of 1940 and other securities laws increases their administrative and compliance expenses, it also ensures a high degree of uniformity across mutual funds with respect to key terms and features such as liquidity, trading frequency, leverage limitations, valuation, expense calculation and reporting and disclosure requirements. CITs, on the other hand, enjoy a significant amount of flexibility with respect to what they invest in and how, leverage, trading frequency and other key terms and features. For example, while some CITs provide daily valuation and liquidity, others may allow redemptions only on a quarterly basis or less frequently, or may impose lock up periods if their assets are less liquid. As a result, unlike mutual funds, plan fiduciaries should never invest plan assets into a CIT before they have carefully reviewed the terms of the CIT set forth in the CIT's declaration of trust and related trust documentation.
- Investment manager appointment procedures must be satisfied. As a commingled trust vehicle, the assets of a CIT are considered plan assets and the CIT trustee and investment manager (if any) are considered fiduciaries under ERISA to each plan investor with respect to the assets of the plan invested in the CIT. This means that by investing plan assets in a CIT, a plan fiduciary is delegating investment authority over the plan's assets to the CIT trustee and its investment manager. The investment must therefore follow the procedures under the plan for appointment and delegation of investment discretion to an investment manager.If the plan's named fiduciaries have delegated authority for selection and monitoring of plan investment options to an investment manager or OCIO, the investment manager or OCIO would need to be authorized to act as a named fiduciary of the plan to appoint investment managers in order to invest the plan in a CIT.In addition to following the applicable procedures for appointment and delegation of investment discretion to an investment manager, public pension plan fiduciaries will need to consider whether a side letter agreement is needed to address state statutory requirements that vary from ERISA.
- Look through reporting on Form 5500. Consistent with the plan asset status of a CIT, a fiduciary of a plan that holds an investment in a CIT is required to report the plan's pro rata share of each asset in the CIT on the plan's Form 5500 annual report. Many banks and trust companies that sponsor CITs ease the burden of look through reporting by directly reporting CIT holdings to the DOL. However, plan fiduciaries need to confirm whether or not the trustee files directly, and consider the plan's indirect interest in the CIT assets in completing other portions of the annual report.
- Confirm the CIT's tax-exempt status. Pursuant to a series of IRS revenue rulings, CITs are afforded treatment as Internal Revenue Code Section 501(a) tax-exempt group trusts, provided that they limit their investors to those permitted under the rulings to invest in a group trust and satisfy certain other conditions. While not required to obtain a determination letter from the IRS, most sponsor's of CITs file their documents with the IRS in order to confirm the CIT's qualification as a group trust. The consequences of failure to qualify are significant, as the CIT would be taxed as a corporation. Therefore, plan fiduciaries should request a copy of the CIT's IRS determination letter or otherwise confirm the CIT's tax-exempt status prior to investing plan assets in a CIT.
So, while CIT's offer many benefits as investment vehicles for 401(k) plans and may reduce plan expenses, plan fiduciaries need to understand the differences between mutual funds and CITs for a smooth and successful implementation of a CIT as a new investment option for the plan.
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