Co-authored by Kevin M. Foley.
In Advisory Opinion 2011-09A, the U.S. Department of Labor (DOL) indicated that a personal indemnification of a broker by the holder of an individual retirement account (IRA), for losses in excess of the value of the assets in a futures trading account established for the IRA, raises prohibited transaction issues under section 4975 of the Internal Revenue Code of 1986 (the Code). Further, the DOL said that Prohibited Transaction Class Exemption 80-26 (PTE 80-26) does not provide an exemption for such a prohibited transaction. Previously, the DOL has advised practitioners informally of this position, but the Advisory Opinion formalizes it.
Under both the Employee Retirement Income Security Act of 1974 (ERISA) and Code section 4975, an extension of credit between a plan and a party in interest or a disqualified person is a prohibited transaction. (A "disqualified person" is the section 4975 parallel to a "party in interest" under ERISA, and an IRA holder who self-directs the IRA’s investments is a disqualified person with respect to the IRA.) 80-26 is a DOL Class Exemption applicable to ERISA and section 4975, which permits loans and extensions of credit between a plan and a party in interest or disqualified person for payment of a plan’s "ordinary operating expenses" or purposes "incidental to the ordinary operation of the plan."
Earlier, in Advisory Opinion 2009-03A, the DOL advised that a security interest to a broker in an IRA holder’s non-IRA assets held by the broker, to cover losses in excess of the IRA’s assets, would constitute a prohibited transaction. Advisory Opinion 2011-09A provides further advice affecting a broker’s attempts to protect against trading losses that exceed the value of the account’s assets.
In Advisory Opinion 2011-09A the DOL stated that the IRA holder’s indemnification of the broker for trading losses in excess of the IRA’s assets constituted a prohibited extension of credit between the IRA holder and the IRA. The DOL stated that PTE 80-26 would not cover the indemnification because (i) it was not used to pay expenses of "an ordinary activity attributable to a plan" and (ii) it was not "incidental" to the operation of a plan, as would be the case with an extension of credit to cover, for example, a bank overdraft or liquidity problem.
While the DOL advice addresses a futures account established for an IRA, the same principles would apply to similar arrangements, such as an options trading account, and to plans subject to ERISA if, for example, the plan sponsor was asked to provide indemnification for the plan’s trading losses.
Advisory Opinion 2011-9A may be found here.
Advisory Opinion 2009-3A may be found here.