Mortgage loan participations and indirect plan transactions

P/OPINION 75-103



                                                                   406


                           October 22, 1975


Dear             :

This is in response to your letter of March 18, 1975, to
Mr.                  , Assistant Secretary of Labor for
Labor-Management Relations, asking whether a proposed
transaction between             Savings and Loan Association
(GWS) and the             Pension Trust of Southern California
(the Trust) would violate section 406 of the Employee
Retirement Income Security Act of 1974 (ERISA).

The transaction is described in your letter as follows:

       The transaction would involve the sale to the
       Trust of up to a 90% participation interest in
       a series of loans secured by mortgages on owner-
       occupied, single family dwellings in Southern
       California. All loans subject to the transaction
       would be those which had been originated by
       and held in its portfolio prior to the consummation
       of the transaction with the Trust. The Trust would
       purchase up to $20 million worth of a participation
       interest in these loans and (GWS) would retain
       a 10%, or more, participation interest in these
       loans and would also retain the responsibility for
       servicing the loans. The Trust would then receive
       its pro rata share of monthly principal and interest
       payments made by the borrowers. The interest yield
       to the Trust would be dependent upon a number of factors
       and subject to arms-length negotiation among (GWS),
       the Trust and the Trust s investment advisors. The funds
       provided by the Trust as a result of their purchase would
       then be available to (GWS) for recycling into home
       mortgages in the Southern California area encompassed
       by the             Union, thus providing a spur to
       construction in the area.
2


P/OPINION 75-103


Section 406(a)(1) of ERISA prohibits certain transactions,
whether direct or indirect, between a plan and a party in
interest. If the trust presently has no relationship with
(GWS) that causes the latter to be a party in interest
as that term is defined in ERISA section 3(14), the proposed
sale and purchase of the participation interest would not
constitute a direct transaction prohibited by section
406(a)(1).

An indirect prohibited transaction can occur where a plan
engages in a transaction with a person who is not a party
in interest pursuant to an agreement or understanding
whereby that person is in turn to engage in a transaction
with a party in interest. Thus, for example, if the trust
purchases a participation interest in loans from (GWS)
pursuant to an agreement or understanding that (GWS) will
use the funds received from the trust or other funds of
(GWS) to make loans to parties in interest, the arrangement
would constitute an indirect prohibited transaction.
This reasoning is consistent with ERISA IB 75-2 (copy enclosed),
which addressed the application of section 406 where a plan
invests in securities of a corporation or partnership and
a party in interest subsequently engages in a transaction
with the corporation or partnership.

Applying the above analysis to the proposed transaction,
the possibility of an indirect prohibited transaction
arises by virtue of the statement that the funds provided
by the trust to      "… would then be available to
for recycling into home mortgages in the Southern California
area encompassed by the              Union, thus providing
a spur to construction in the area." While this statement
expresses a general recognition that recycling of the funds
would benefit to some degree persons who are parties in
interest, it alone does not indicate such an arrangement
as would constitute an indirect prohibited transaction.
If the funds received by     merely go into its normal
business operations and if there is not commitment by (GWS)
to the Trust to make loans for the benefit of any party or
parties in interest, the making of any loans by (GWS) which
ultimately benefit any party in interest would not constitute
a prohibited transaction under section 406 of ERISA.
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P/OPINION 75-103


We wish to emphasize that the foregoing analysis is
predicated upon your representation that the proposed
agreement contemplates a one-time sale of the participation
interest to the Trust, following which (GWS) would service
the loans on behalf of the Trust. We specifically do not
decide that a series of sales interspersed with the servicing
of loan-shares previously acquired by the Trust from (GWS)
would not result in a prohibited transaction by (GWS).

The Internal Revenue Service has advised us that it is in
concurrence both with the conclusion and analysis contained
in this letter.

Sincerely,