Most trustees of pension plans that make loan or equity investments in real estate directly through a separate account relationship or indirectly through a commingled fund vehicle, understand the importance of hiring a qualified and capable real estate investment manager to implement the pension plans’ real estate investment strategy. Pension plans who develop a real estate strategy as part of their overall asset allocation model typically invest in individual assets which are in the operating stage of the investment cycle to generate cash flow and long-term appreciation, and/or engage in the making of loans secured by real estate. It is the investment manager’s typical responsibility to:

>	Source the investments;
>	Perform the appropriate due diligence to substantiate the long-term value of the investment;
>	Close the acquisition and/or loan transaction;
>	Oversee all portfolio and asset management responsibilities;
>	Develop appropriate ongoing investment management strategies;
>	Oversee the leasing, financing, maintenance, and renovation of all aspects of the property;
>	Develop valuation models;
>	Oversee all disposition efforts; and
>	Maximize the value of the asset.

In short, the investment manager is responsible for all aspects of the investment.

However, for the reasons discussed in this article, trustees of pension plans which are governed by the Employee Retirement Income Security Act of 1974, as amended, ("ERISA") should also make certain that their real estate investment managers qualify as a Qualified Professional Asset Manager ("QPAM") under ERISA. Not all real estate investment managers are necessarily qualified as a QPAM. In addition, trustees must be mindful that many Errors & Omissions insurance policies which protect trustees of pension plans from fiduciary liability require that all real estate transactions be reviewed, overseen, and passed upon by an investment manager who qualifies as a QPAM.

As most trustees know, ERISA has imposed significant fiduciary responsibilities on corporate and Taft-Hartley pension fund trustees with respect to the management of their pension plan assets. In fact, in certain circumstances, trustees can be held personally liable for losses incurred on investments made by their pension plan. This risk of personal liability under ERISA can be eliminated by hiring an "investment manager" (as defined in ERISA §(38)), so long as the trustees act prudently in the appointment and retention of the investment manager. If the investment manager has been prudently engaged and the responsibility for making investments has been properly delegated, trustees will not be responsible for the acts or omissions of the investment manager, or be under any obligation to invest or manage any assets of the pension plan that the investment manager is responsible for investing. Additionally, the following procedural guidelines outlined in ERISA should be followed to further minimize trustees’ personal liability: (1  2  3 )

>develop appropriate investment guidelines for the investment manager;

>effectively delegate investment responsibilities to the investment manager; and

>exercise regular and diligent oversight over the investment manager’s activities once management is delegated.

1	See Article by Stanley L. Iezman, Operating Pension Funds in Compliance With ERISA Procedures – How to avoid a Department of Labor audit: A primer for lawyers, Real Estate Review, Spring 1999, Copyright Real Estate Review
2	See Article by Stanley L. Iezman, A Real Estate Investment Program for Pension Plans: How to Avoid a Department of Labor Audit, Journal of Pension Plan Investing, Fall 1996, Volume 1, Number 2, Copyright Aspen Publishers, Inc.
3	See Article by Stanley L. Iezman, Complying With ERISA: A Primer For Pension Plan Trustees, Real Estate Review, Spring 1997.

Because of the risk of personal liability involved in the investment of plan assets, most pension plan trustees typically delegate their investment responsibilities to investment managers. ERISA expressly authorizes such delegations, as long as the plan documents allow the trustees to delegate fiduciary responsibilities. An investment manager is defined under ERISA as a fiduciary who acknowledges in writing that it is a fiduciary with respect to the plan and is registered as:

>an investment adviser with the Securities and Exchange Commission under the Investment Advisers Act of 1940; or

>a United States commercial bank; or

>an insurance company qualified under the laws of one or more of the United States.

Further, the use of an investment manager who is also a QPAM allows the pension plan to engage in certain transactions that may otherwise be prohibited under ERISA. The prohibited transaction provisions of ERISA are quite broad and preclude numerous types of transactions between "parties in interest" and the pension plan. These prohibitions unfortunately are not always practical in the world of real estate investment. For example, a pension plan that owns an office, industrial, apartment, or retail property, cannot lease to anyone affiliated directly or indirectly to the pension plan. Thus, entering into a lease for building space with a tenant who happens to be a family member of someone providing services to the pension plan, or who falls within the broad party in interest definition in ERISA, may be a prohibited transaction. By hiring an investment manager who also qualifies as a QPAM, trustees can insure that they do not inadvertently violate ERISA’s party in interest prohibited transaction guidelines.

 

Prohibited Transactions
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§406 of ERISA prohibits fiduciaries, including trustees and investment managers, from entering into certain transactions if they know or should know that any such transactions are with a party in interest, unless a statutory or administrative exemption is available under §408 of ERISA. These prohibited transactions include:

>the sale, exchange or leasing of any property between a pension plan and a party in interest; ( 4 )

4	Section 3(14) of ERISA defines "party in interest" as follows:
	The term party in interest means, as to an employee benefit plan:
	(A) any fiduciary (including, but not limited to, and administrator, officer, trustee, or custodian), counsel, or employee of such employee benefit plan;
	(B) a person providing services to such plan;
	(C) an employer any of whose employees are covered by such plan;
	(D) an employee organization any of whose members are covered by such plan;
	(E) an owner, direct or indirect, of 50% or more of
	(i) the combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock of a corporation,
	(ii) the capital interest or the profits interest of a partnership, or
	(iii) the beneficial interest of a trust or unincorporated enterprise which is an employer or an employee organization described in subparagraph (C) or (D);
	(F) a relative...of any individual described in subparagraph (A), (B), (C) or (E);
	(G) a corporation, partnership, trust or estate of which (or in which) fifty percent (50%) or more of
	(i) the combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock of such corporation,
	(ii) the capital interest or profits interest of such partnership; or
	(iii) the beneficial interest of such trust, or estate,
	is owned directly or indirectly, or held by persons described in subparagraph (A), (B), (C), (D), or (E);
	(H) an employee, officer, director (or an individual having powers or responsibilities similar to those of officers or directors), or a ten percent (10%) or more shareholder directly or indirectly, of a person described in subparagraph (B), (C), (D), (E), or (G), or the employee benefit plan; or
	(I) a ten percent (10%) or more (directly or indirectly in capital or profits) partner or joint venturer of a person described in subparagraph (B), (C), (D), (E), or (G).

 

>the lending of money or other extension of credit between a pension plan and a party in interest;

>the furnishing of goods, services or facilities between a pension plan and a party in interest;

>the transfer to, or use by or for the benefit of, a party in interest, of any assets of a pension plan; and

>the acquisition on behalf of a pension plan of any employer security or employer real property unless the requirements of §407 of ERISA are met.

§408 of ERISA provides for certain statutory and administrative exemptions to the party in interest prohibited transaction provisions. The statutory exemptions are narrowly drafted and provide little protection for the typical party in interest transactions that arise in a real estate investment program.

ERISA also allows the Secretary of Labor to grant administrative exemptions from prohibited transactions, provided that the exemption is:

>	administratively feasible;
>	in the interest of the plan, its participants and beneficiaries; and
>	protective of the rights of the participants and beneficiaries of the plan.

Administrative exemptions can be granted on both an individual basis to a particular applicant requesting exemptive relief, and on a "class" basis applicable to all transactions within a defined class of exempted transactions. Unfortunately, the time and expense required to process an individual exemption application with the Department of Labor makes this process impractical for most party in interest transactions that would arise in a real estate investment program.

Fortunately, on March 13, 1984, the Secretary of Labor approved Prohibited Transaction Class Exemption 84-14, also known as the QPAM Exemption. The QPAM Exemption provides a practical way for pension plans and their trustees to avoid liability for engaging in certain party in interest prohibited transactions in their real estate investment programs.

 

QPAM Requirements
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As stated earlier, all investment managers are not QPAM’s. In order to qualify as a QPAM, a real estate investment manager must:

>be registered as an investment adviser under the Investment Advisers Act of 1940;

>have total client assets under its management and control in excess of $85 million as of the last day of the QPAM's most recent fiscal year; and

>have shareholders' or partners' equity in excess of $1,000,000 (or have an affiliate that satisfies this net worth requirement and unconditionally guarantees payment of all of the adviser's liabilities) as determined by the QPAM's most recent balance sheet provided it is no more than two years old and was prepared in accordance with GAAP.

Trustees of pension plans who elect to hire an investment manager who is a QPAM need to be mindful that they may not be able to hire an investment manager to act as a QPAM on a one time transaction basis to review a single real estate transaction, be it a lease, purchase, sale, or loan. Although definitive guidelines have not been issued, the Department of Labor has indicated that a QPAM must have a longer term investment management relationship with the pension plan. To the extent that a QPAM is hired solely to "pass" on a single transaction, then the QPAM requirements may not be met. This trap for the unwary must be carefully monitored by counsel and the trustees of the plan to ensure they receive the statutory benefits of engaging a QPAM.

The underlying philosophy of the QPAM exemption is to ensure that the investment manager is truly neutral and acting as a third party in an arms length relationship to ensure the economic viability of the investment, and that it is suitable for the pension plans’ risk parameters. In those circumstances where an investment manager is asked to review and pass upon a single transaction, it can be argued that the QPAM is not acting as an independent third party expert who will objectively assess the viability of the transaction, but rather that the QPAM has an incentive to approve the transaction because of the single transaction relationship.

This area must be carefully monitored to ensure that the pension plan and trustees maintain their fiduciary protection through the hiring of a QPAM who is properly qualified and properly engaged.

 

QPAM: Exempt Real Estate Transactions
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The QPAM exemption is very useful in connection with real estate transactions and, if used properly, provides protection to the trustees of a pension plan. If the investment manager qualifies as a QPAM and is acting as a true fiduciary and QPAM, then certain real estate transactions which would otherwise be prohibited transactions can qualify for the exemption.

It is important to note that the conditions for relief under the QPAM rules are stringent. In addition to engaging a qualified QPAM, trustees must be mindful that the following rules must be carefully followed in order to qualify for the QPAM exemption:

>the transaction must be negotiated by the investment manager/QPAM or under its general direction, and the investment manager/QPAM must be responsible for the decision to enter into the transaction; ( 5 )

>the party in interest involved in the transaction cannot be the investment manager/QPAM or any of its affiliates;

>the terms of the transaction must be at least as favorable as the terms of an arm’s-length transaction between unrelated persons;

>neither the investment manager/QPAM, its affiliates nor the owners of more than five percent (5%) of the outstanding ownership interests in the investment manager/QPAM have been convicted of specific types of felonies involving fraud or deception during the ten years preceding the transaction;

>the pension plan creating the party in interest relationship cannot represent greater than 20% of the total client assets managed by the investment manager/QPAM;

>neither the party in interest involved in the transaction nor its affiliates can hold the power to appoint or terminate the investment manager/QPAM or to negotiate, renew or modify the terms of the investment manager/QPAM’s investment management contract with the pension plan at the time of the transaction, and cannot have exercised such powers during the one-year period preceding the transaction; and

>the transaction cannot be of the type described in certain Department of Labor exemptions pertaining to securities lending arrangements, mortgage pool investments, and residential mortgage financing.

5	The question of discretion being granted to the investment manager is an important one for trustees. Trustees must delegate to the investment manager discretion over the investment, otherwise, the investment manager may not be a QPAM with respect to the transaction.
	See Article by Stanley L. Iezman, Discretionary and Non-discretionary Real Estate Investment Accounts: A Primer for Trustees, to be published by International Foundation of Employee Benefit Plans, Employee Benefits Digest, September 1999. Copyright International Foundation of Employee Benefit Plans.

The QPAM exemption also allows pension plans to enter into certain sales and leases, or provide services between a pension plan and the employer sponsoring the plan, or affiliates of the employer. Thus, a QPAM can pass upon the fairness of transactions involving those relationships that can be very helpful to many pension plans. The conditions for relief under this part of the QPAM exemption vary depending on whether the transaction involves the transfer of goods and services or the leasing of office or commercial space. Trustees are encouraged to seek the guidance of qualified legal counsel, as well as a qualified QPAM when considering these types of transactions.

In order for a lease of any commercial or residential property between a plan and an employer, or its affiliates, to qualify for exemptive relief, a separate set of requirements is applied under the QPAM exemption. These requirements are:

>no commission may be paid to the investment manager/QPAM, the employer or any of their affiliates in connection with the lease;

>the space leased must be suitable (or adaptable without excessive cost) for use by different tenants;

>the amount of space covered by the lease cannot exceed fifteen percent (15%) of the rentable space in the building in which space is leased;

>neither the lease nor other employer real estate can exceed ten percent (10%) in the aggregate of the fair market value of the assets of the plan managed by the investment manager/QPAM.

In addition, the QPAM exemption applies, to a limited degree, to transactions involving the lease of property between a pension plan and a QPAM exercising discretionary control over the assets of the plan.

 

Hiring the Investment Manager/QPAM
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When hiring an investment manager who is also going to act as a QPAM to oversee and implement the real estate investment strategy of the pension plan, the trustees of the pension plan and their counsel need to ensure that the selected QPAM has the necessary real estate investment management experience to undertake the assigned responsibilities. Further, the investment management contract that is to be executed by the investment manager should also contain the following representations in writing (among other matters):

>

that the investment manager is an investment manager as defined in §3(38) of ERISA, which includes the following: > that the client who is retaining the investment manager does not represent more than 20% of the total assets being managed by that investment manager; > that the investment manager is properly licensed as an investment adviser with the Securities and Exchange Commission under the Investment Advisers Act of 1940; > that the investment manager is acting as a fiduciary with respect to the matter being reviewed; > that the investment manager has appropriate Errors & Omissions insurance coverage; and > that the investment manager has the experience, qualifications and background to perform the work in question.

Counsel and the trustees of the pension plan need to be cautious when selecting a QPAM because the qualification criteria are specific, and hiring an investment manager who is not actually a QPAM does not absolve the trustees of their fiduciary obligations under ERISA, and may cause their Errors and Omissions Insurance policy to be voided, thereby losing the protections afforded by that insurance policy for the real estate investments made by the pension plan. Thus, a pension plan should only consider engaging an investment manager who exclusively provides these types of real estate investment management services, and who has the requisite qualifications and experience to do so. When evaluating candidates for this role, trustees must also evaluate whether their candidates have any conflicts of interest that could impact their ability to act as a QPAM and investment manager for the pension plan.

 

Trustees Ongoing Fiduciary Responsibilities
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In selecting an investment manager, pension plan trustees have the responsibility to ensure that the investment manager’s experience, qualifications and investment approach are consistent with the plan’s investment guidelines, and that the investment manager has the capacity to provide the services involved.

Once a pension plan has hired an investment manager/QPAM and delegated its investment management responsibility, the trustees still have the continuing obligation to oversee the investment manager’s performance and ensure that they are performing their duties properly.

 

Conclusion
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In conclusion, it is important for pension plan trustees to understand the following points: (i) they must act prudently in their decision to hire an investment manager and delegate their authority in order to avoid retaining liability for the investment activities of the pension plan; (ii) pension plans should have a well-defined investment strategy and carefully drafted investment guidelines to guide the investment manager in their activities; and, (iii) they must carefully monitor what the investment manager is doing on a regular basis. For Taft-Hartley pension plans, hiring an investment manager who is also a QPAM is critical to the proper delegation of these responsibilities, and ensures that the investment manager can practicably avoid the prohibited transaction restrictions that could otherwise hinder the development and implementation of a sound real estate investment policy.

 

 

Stanley L. Iezman, Esq. is the President and Chief Executive Officer and Scott W. Darling, Esq., is the Director of Portfolio Management of American Realty Advisors, an investment manager and QPAM under ERISA and a registered investment adviser with the Securities and Exchange Commission, that currently manages over $4 billion in real estate investments (gross market value of all assets managed by American as of September 30, 2006 excluding partners' share of equity and partners' share of debt on partnership investments plus $738 million in commitments not yet drawn) for domestic pension plans. Mr. Iezman is also an adjunct professor of real estate asset management at the University of Southern California’s School of Policy, Planning, and Development Lusk Center for Real Estate Development. American Realty Advisors is located in Glendale, California (818/545-1152).