401(k) and Pension Sponsors — Do You Know Where Your Securities Are?

The Department of Labor (DOL) has recently turned its attention to securities lending. If you are responsible for selecting funds for a retirement plan, you must understand securities lending.


Third parties may want to borrow a security for a short time. The borrower will typically “short sell” the security, i.e., sell the security expecting to buy it back later at a lower price, generating a profit equal to the decline in the price of the security. The borrower pays a fee to borrow the security and provides collateral to secure the loan (usually cash or an equivalent). At the end of the loan period, the borrower returns the security to the plan. The plan benefits by receiving the fee and investing the collateral, while continuing to receive any dividends and growth in the value of the loaned security.

Securities lending is not without risk. If the borrower fails to return the security and the collateral is insufficient, the plan could suffer a loss. In addition, because the plan trustee or investment manager usually acts as the lending agent and shares in the profits, lending is a prohibited transaction (PT) under the Employee Retirement Income Security Act of 1974 (ERISA). The practice is so common, however, that the DOL has granted a prohibited transaction exemption (PTE) that hinges on approval of the arrangement by an independent fiduciary—you, the plan sponsor fiduciary.


1. Determine your responsibility.

When you approve a new investment, review the documents to determine whether you are approving securities lending. This will likely be the case if you are approving a collective investment trust (CIT). Many plans are turning from mutual funds to CITs because of the potential cost savings, but CITs carry additional risks and responsibilities for the fiduciary approving them. With mutual funds, the fund shares, not the underlying investments, are the plan’s asset. With a CIT, the plan is appointing a CIT trustee—an ERISA fiduciary—for a portion of its assets, and the underlying investments are plan assets. So, when a plan CIT loans securities, a plan fiduciary is loaning plan assets. You are the independent fiduciary approving that fiduciary’s profit on the lending.

2. Understand the securities lending program terms.

Before approving a CIT that includes securities lending, you should document your understanding of the following issues:
  • Who is the lending agent? It most likely will be the trustee of the CIT or an affiliate.
  • Is the lending agent’s share of the profits reasonable for the services provided? Investigate what the standard share is for the level of assets invested in the CIT and the level of risk retained by the plan.
  • Do borrowers have to meet minimum requirements? The lending agent should set strict standards borrowers must meet to limit the risk to the plan.
  • What types of collateral are required? The lending agent should limit acceptable collateral to cash or cash equivalents and require that the value of the collateral exceed the value of the loaned security.
  • How is the collateral invested? The lending agent should limit collateral investments to secure, limited duration investments.
  • What is the net profit to the plan? Is it worth the risk?
  • What portion of assets are on loan at any time? The more that is loaned, the higher the risk. Also, consider the effect of the lending on any asset allocation requirements.
  • What does the plan’s investment policy statement say about securities lending? Follow your Investment Policy Statement (IPS).
  • Who bears the risk of the arrangement? Often the plan bears the entire risk of losses. If the arrangement is insured, determine what losses are covered.
  • Are any non-lending versions of the investment or a similar fund available?
  • Is the CIT trustee also a part-owner of Equilend? Equilend is a platform for lending securities that a number of lending agents co-own.

The DOL has issued another PTE for their use of Equilend, which also depends on your consent. If the lending agent is one of Equilend’s owners, you must understand the implications of that PTE as well.

3. Determine whether the lending arrangement is in the best interest of plan participants and document your reasons for your conclusion.

4. Make sure all the other requirements of the relevant PTEs are met.

When you sign CIT documents, you alone are responsible for approving any securities lending arrangement disclosed. The CIT trustee is not responsible and will not highlight the issue apart from what appears to be a routine disclosure. The DOL expects you to determine whether the decision to permit securities lending was made with due care and in the participants’ best interests.