Morningstar - Q3 2020 - 15

we think it is possible that new CITs could be
created for the 403(b) marketplace, and we want
to protect against such possible gaming of
the law. Nonetheless, such a concern is unlikely to
be relevant on day one of the Public Service
Retirement Fairness Act going into law.
Consequently, the proposed legislation would be
beneficial at this time with or without our
improvement. Efforts should be made to include
such a change in the near term.
The Patchwork of Regulations and Oversight

Unlike registered funds, which are regulated
by the SEC, CITs are governed by a patchwork of
regulations and an inconsistent framework.
CITs consist of A1 funds, which are common trust
funds, and A2 funds, which are collective
investment funds. A1 funds are predominantly
governed by the U.S. Treasury's Office of
the Comptroller of the Currency, or OCC, or state
law. No one entity regulates A2 funds; rather,
these funds are subject to various statutes,
related regulations, and rulings under banking,
securities, and tax law.
In terms of federal banking laws, the OCC's
regulations apply to CITs sponsored by national
banks and trust companies. The terms A1
funds and A2 funds refer to the specific sections
of the OCC regulations that established these
two types of vehicles.
Many states apply the OCC's rules either
by statute, rule, guidance, or as best
practices to regulate A1 and A2 funds sponsored
by state-chartered institutions.
In addition, different agencies have oversight
of certain aspects of CITs under certain conditions.
The U.S. Department of Labor regulates CITs
with ERISA plan assets. The trustee and any
subadvisor of a CIT generally must comply with
ERISA fiduciary standards in managing the
CIT. ERISA's prohibited transaction rules also
control all deals, including those between the CIT
and any "parties of interest," as well as the
CIT's fiduciaries.
Most CITs qualify as exempt from U.S.
taxes because they are "group trusts." Certain
requirements apply to qualify for this treatment,

including that each investing plan adopt the terms
of the group trust as part of its own trust.
The SEC may regulate CITs under the Securities
Act of 1933 and the Investment Company Act
of 1940. Under Section 3(a)(2) of the Securities Act,
interests in CITs typically qualify as "exempt
securities" and, therefore, are exempt from
registration under the Securities Act so long
as the CIT is "maintained by a bank." Under the
1940 Act, most CITs avoid registration as
investment companies by relying on an exclusion
from the definition of an investment company
found in Section 3(c)(11) of the 1940 Act, which
is substantially similar to the Securities Act
exemption. Under Section 3(a)(12) of the Securities
Exchange Act of 1934, CIT interests also
typically qualify as "exempted securities" and,
therefore, enjoy broad exemptions from the
requirements of that act.
If a CIT sponsor uses a broker/dealer to sell
its CITs, the broker/dealer's representatives must
comply with Financial Industry Regulatory Authority
rules. If a CIT invests in commodity interests,
the CIT's sponsor and subadvisor (if any) would
have to comply with applicable Commodity Futures
Trading Commission rules and regulations.
A Nexus With ERISA Would Allow for MoreConsistent Data

The lack of consistent data on CITs further supports
our recommendation that CITs made available
in 403(b) plans be limited to those already in 401(k)
plans. This way, the information available to
401(k) plan recipients is also available to 403(b)
plan recipients.

Reduced paperwork and regulatory compliance
work are what allows CITs to be cheaper than
publicly registered products. Participants in ERISA
plans with CITs are nonetheless guaranteed
access to certain information, including
basic fee and performance data, as well as
a benchmark comparison. Furthermore, many CIT
providers voluntarily report their data to
third-party databases such as Morningstar. While
there are several simple improvements to
Form 5500 that could improve CIT data access, the
lack of required public disclosure in place today
should not represent a significant barrier.
A First Step

The Public Service Retirement Fairness Act seeks
to make the benefits of CITs available to retirement
plan investors who have not had access to
low-cost investments. We agree with its objective
and believe that introducing CITs to 403(b)
plans is an improvement for investors. However,
the bill could be improved. Given the regulatory
status of CITs and the limited availability
of their data, we believe that it would be beneficial
to 403(b) investors if their investments were
restricted to CITs already available in 401(k) plans.
Still, the bill as-is would show that the
federal government is serious about modernizing
403(b) plans and would be a useful first step
to addressing the often-subpar definedcontribution retirement options available to our
public servants. K
Aron Szapiro is director of policy research with Morningstar.

The lack of comprehensive reporting on CITs can
sometimes lead to a lack of consistent, reliable,
and comparable public data, a stark contrast to the
wealth of information available for mutual funds.
The primary regulatory filing for CIT data
is Form 5500. This filing is governed by the IRS,
Department of Labor, and Pension Benefit
Guaranty Corp. It is focused on monitoring
ERISA-compliant defined-benefit and -contribution
plans. Because CITs are not the focus of the
filing, Form 5500 is deficient in collecting necessary
data to fully evaluate them.

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